diff --git a/raw/filings/0000889900/2014/0001564590-15-000634/filing.txt b/raw/filings/0000889900/2014/0001564590-15-000634/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..7869838de9b68559378e6344a2e63ea1a2108206 --- /dev/null +++ b/raw/filings/0000889900/2014/0001564590-15-000634/filing.txt @@ -0,0 +1,4830 @@ +10-K +1 +pten-10k_20141231.htm +FORM 10-K +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +Form 10-K +(Mark One) +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2014 +or +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-22664 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +450 Gears Road, Suite 500, Houston, Texas +77067 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +(281) 765-7100 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Exchange on Which Registered +Common Stock, $0.01 Par Value +The Nasdaq Global Select Market +Securities Registered Pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x or No ¨ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ or No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x or No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +x +Accelerated filer +¨ +Non-accelerated filer +¨ +Smaller reporting company +¨ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2014, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $5.0 billion, calculated by reference to the closing price of $34.94 for the common stock on the Nasdaq Global Select Market on that date. +As of February 5, 2015, the registrant had outstanding 146,458,290 shares of common stock, $0.01 par value, its only class of common stock. +Documents incorporated by reference: +Portions of the registrant’s definitive proxy statement for the 2015 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings and press releases by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. These “forward-looking statements” involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue and cost expectations and backlog; financing of operations; oil and natural gas prices; source and sufficiency of funds required for building new equipment and additional acquisitions (if further opportunities arise); impact of inflation; demand for our services; competition; equipment availability; government regulation; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipates,” “believes,” “budgeted,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “project,” “strategy,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Forward-looking statements may be made orally or in writing, including, but not limited to, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act. +Forward-looking statements are not guarantees of future performance and a variety of factors could cause actual results to differ materially from the anticipated or expected results expressed in or suggested by these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates, utilization, margins and planned capital expenditures, global economic conditions, excess availability of land drilling rigs and pressure pumping equipment, including as a result of reactivation or construction, equipment specialization and new technologies, adverse industry conditions, adverse credit and equity market conditions, difficulty in building and deploying new equipment and integrating acquisitions, shortages, delays in delivery and interruptions in supply of equipment, supplies and materials, weather, loss of key customers, liabilities from operations for which we do not have and receive full indemnification or insurance, ability to effectively identify and enter new markets, governmental regulation, ability to realize backlog, ability to retain management and field personnel and other factors. Refer to “Risk Factors” contained in Item 1A of this Report for a more complete discussion of factors that might affect our performance and financial results. You are cautioned not to place undue reliance on any of our forward-looking statements. These forward-looking statements are intended to relay our expectations about the future, and speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, changes in internal estimates or otherwise, except as required by law. +1 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We own and operate in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. The Company was formed in 1978 and reincorporated in 1993 as a Delaware corporation. Patterson Energy, Inc. and UTI Energy Corp. merged in 2001 to form Patterson-UTI Energy, Inc. In 2008, the corporate headquarters was moved from Snyder, Texas to Houston, Texas. +Our contract drilling business operates in the continental United States, and western and northern Canada. As of December 31, 2014, we had a drilling fleet that consisted of 239 marketable land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. A drilling rig is considered marketable at a point in time if it is operating or can be made ready to operate without significant capital expenditures. We also have a substantial inventory of drill pipe and drilling rig components that support our ongoing drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2014, we had approximately 1.0 million hydraulic horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in Texas and New Mexico. +Recent Developments +Oil prices declined significantly during the second half of 2014 and have continued to decline in 2015. The closing price of oil was as high as $105.68 per barrel during the third quarter of 2014, as low as $44.08 per barrel in late January 2015 and around $50 per barrel during the first week in February 2015 (WTI spot price as reported by the United States Energy Information Administration). As a result of the decline in oil prices, our industry is now experiencing a severe downturn. Market conditions remain very dynamic and are changing quickly. Although the magnitude as well as the duration of this downturn are not yet known, we believe that 2015 will be a challenging year for our industry. +We believe the vast majority of exploration and production companies, including our customers, have significantly reduced their 2015 capital spending plans. The initial impact of these spending reductions is evidenced by the published rig counts which have declined more 25% since their recent peak in October 2014. +Our rig count has also declined. During October 2014, the number of our drilling rigs operating in the United States was as high as 214, and as of February 10, 2015 we had 173 drilling rigs operating in the United States. We have received indications of customers’ intent to early terminate a number of term contracts and many of our drilling customers are seeking price reductions. We expect the number of our drilling rigs operating in the United States to decline at least another 20% during the next 90 days. +Our pressure pumping business is also beginning to see the effects of reduced spending by customers. Some previously scheduled pressure pumping jobs have been cancelled or deferred and many customers are also seeking price reductions. +2 +In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014. In 2015, we have continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate slightly higher than the reduction in our rig count. We have also reduced our capital expenditure plans for 2015. Along with other reductions, we now plan to only build new drilling rigs that are currently committed under term contracts. We plan to continue to adjust our cost structure in line with our level of operating activity. +We expect that our term contract coverage and scalability with respect to labor and other operating costs should position us to weather this downturn. In the event oil prices remain depressed for a sustained period, or decline further, however, we may experience further, significant declines on both drilling activity and spot dayrate pricing, and on pressure pumping activity and pricing, which could have a material adverse effect on our business, financial condition and results of operations. +Industry Segments +Our revenues, operating profits and identifiable assets are primarily attributable to three industry segments: +· +contract drilling services, +· +pressure pumping services, and +· +oil and natural gas exploration and production. +All of our industry segments had operating profits in 2012 and 2013. In 2014, our contract drilling services and our pressure pumping services segments had operating profits and our oil and natural gas exploration and production segment had an operating loss. Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major and independent oil and natural gas operators. As of December 31, 2014, we had 239 marketable land-based drilling rigs based in the following regions: +· +55 in west Texas and southeastern New Mexico, +· +23 in north central and east Texas, northern Louisiana and eastern Oklahoma, +· +37 in the Rocky Mountain region (Colorado, Utah, Wyoming, Montana and North Dakota), +· +40 in south Texas, +· +34 in the Texas panhandle and western Oklahoma, +· +40 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +· +10 in western and northern Canada. +Our marketable drilling rigs have rated maximum depth capabilities ranging from 10,000 feet to 25,000 feet. Of these drilling rigs, 195 are electric rigs and 44 are mechanical rigs. An electric rig differs from a mechanical rig in that the electric rig converts the power from its diesel engines (the sole energy source for a mechanical rig) into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as replacement parts for marketable rigs. +Drilling rigs are typically equipped with engines, drawworks, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs to ensure that our drilling equipment is competitive. We have spent over $2.0 billion during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2014, 2013 and 2012, we spent approximately $772 million, $505 million and $745 million, respectively, on these capital expenditures. +Depth and complexity of the well and drill site conditions are the principal factors in determining the specifications of the rig selected for a particular job. +3 +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to three years) and provide for the use of the drilling rig to drill multiple wells. During 2014, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 20 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. We believe that our drilling contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations; however, each drilling contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer supervises the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2014, 2013 and 2012 were under daywork contracts. +From time to time more than five years ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turnkey basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2014 +2013 +2012 +Average rigs operating per day(1) +211 +192 +221 +Number of rigs operated during the year +231 +235 +267 +Number of wells drilled during the year +3,740 +3,378 +3,587 +Number of operating days +77,000 +69,918 +80,833 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain an important source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +4 +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX 1500 ® rigs are 1,500 horsepower electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other highly automated pipe handling equipment. APEX 1000 ® rigs are 1,000 horsepower electric rigs with advanced technology equipment similar to the APEX 1500 ® rigs, but with a more compact design to fit on smaller locations. APEX WALKING ® rigs are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. Many APEX 1500 ® and APEX 1000 ® rigs have also been equipped with walking systems as noted below. As of December 31, 2014, our drilling fleet was comprised of the following: +Number of Rigs +Classification +U.S. +Canada +Total +With Walking Systems +APEX 1500 rigs +81 +— +81 +43 +APEX 1000 rigs +15 +— +15 +9 +APEX WALKING rigs +49 +— +49 +49 +Other electric rigs +44 +6 +50 +4 +Total electric rigs +189 +6 +195 +105 +Mechanical rigs +40 +4 +44 +— +Total +229 +10 +239 +105 +Number of Rigs +Horsepower +U.S. +Canada +Total +950 and less +13 +5 +18 +1,000 to 1,400 +81 +5 +86 +1,500 +122 +— +122 +1,700 and greater +13 +— +13 +Total +229 +10 +239 +Average horsepower +1,327 +1,025 +1,314 +Average depth rating +18,096 +14,005 +17,925 +At December 31, 2014, we owned and operated 286 trucks and 323 trailers used to rig down, transport and rig up our drilling rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (Southwest Region) and the Appalachian region (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. We believe that our pressure pumping contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations; however, each pressure pumping contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +5 +Equipment — We have pressure pumping equipment used in providing hydraulic and nitrogen fracturing services as well as nitrogen, cementing and acid pumping services, with a total of approximately 1.0 million hydraulic horsepower as of December 31, 2014. Pressure pumping equipment at December 31, 2014 included: +Hydraulic +Other +Fracturing +Pumping +Equipment +Equipment +Total +Southwest Region: +Number of units +275 +32 +307 +Approximate hydraulic horsepower +638,800 +32,165 +670,965 +Northeast Region: +Number of units +149 +94 +243 +Approximate hydraulic horsepower +303,800 +54,700 +358,500 +Combined: +Number of units +424 +126 +550 +Approximate hydraulic horsepower +942,600 +86,865 +1,029,465 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and that sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Oil and Natural Gas Interests +We own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in producing regions of Texas and New Mexico. Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014. +Customers +The customers of each of our contract drilling and pressure pumping business segments are oil and natural gas operators. Our customer base includes both major and independent oil and natural gas operators. With respect to our consolidated operating revenues in 2014, we received approximately 41% from our ten largest customers, 28% from our five largest customers and 16% from our two largest customers. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. During 2014, no single customer accounted for more than 10% of our consolidated operating revenues. +Competition +The contract drilling and pressure pumping businesses are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for land drilling and pressure pumping services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +· +drilling of oil and natural gas wells, +6 +· +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +· +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +· +use of underground storage tanks and injection wells, and +· +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operation. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +· +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +· +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. If such changes are made to CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, as amended, and implementing regulations govern: +· +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +· +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial +7 +harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, U.S. Environmental Protection Agency (“EPA”) community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing on groundwater quality, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by United States lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customer to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks +8 +to our customers by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, our drilling rigs and certain other assets, such insurance does not cover the full replacement cost of the rigs or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation and equipment insurance coverage and a $2.0 million per occurrence self-insured retention on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We self-insure a number of other risks, including loss of earnings and business interruption, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. +If a significant accident or other event occurs and is not fully covered by insurance or an enforceable or recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 7,900 full-time employees as of February 10, 2015. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +9 +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America. If these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +· +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +· +the prices, and expectations about future prices, of oil and natural gas, +· +the supply of and demand for drilling and pressure pumping equipment, +· +the cost of exploring for, developing, producing and delivering oil and natural gas, +· +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, and +· +merger and divestiture activity among oil and natural gas producers. +In particular, our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by factors such as: +· +market supply and demand, +· +domestic and international military, political, economic and weather conditions, +· +the desire and ability of the Organization of Petroleum Exporting Countries, commonly known as OPEC, to set and maintain production and price targets, +· +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +· +technical advances affecting energy consumption and production, and +· +the price and availability of alternative fuels. +All of these factors are beyond our control. During the nine months ended September 30, 2014, oil prices averaged $99.96 per barrel, natural gas prices averaged $4.59 per Mcf and demand for drilling activities increased. During the three months ended December 31, 2014, drilling activity slowed as oil prices averaged $73.16 per barrel and natural gas prices averaged $3.80 per Mcf. Drilling activity has significantly decreased since December 31, 2014, as oil prices averaged $47.22 per barrel and natural gas prices averaged $2.99 per Mcf during January 2015. Our average number of rigs operating remains well below the number of our available rigs, and given current oil pricing and existing market trends, we expect our average number of rigs operating to continue to decline through at least the first quarter of 2015. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Continued low market prices for oil and natural gas will likely result in decreased demand for our drilling rigs and pressure pumping services and adversely affect our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our drilling rigs and pressure pumping services. +Global Economic Conditions May Adversely Affect Our Operating Results. +Global economic conditions and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise may result in reduced access to financing by us, our customers and our suppliers and reduced demand for our services. Furthermore, these factors may result in certain of our customers experiencing an inability to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, and there is no assurance that the global economic environment will not quickly deteriorate again due to one or more factors, including a decline in the price for oil or natural gas. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +10 +A General Excess of Operable Land Drilling Rigs, Increasing Rig Specialization and Excess Pressure Pumping Equipment May Adversely Affect Our Utilization and Profit Margins. +The North American oil and natural gas services industry has experienced downturns in demand during the last decade, including a downturn that started late in 2014. During these periods, there have been substantially more drilling rigs and pressure pumping equipment available than necessary to meet demand. As a result, drilling and pressure pumping contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods. +Construction of new technology drilling rigs has increased in recent years. The addition of new technology drilling rigs to the market, combined with a reduction in the drilling of vertical wells, has resulted in excess capacity of conventional drilling rigs. Similarly, the substantial recent increase in unconventional resource plays has led to higher demand for pressure pumping services and there has been a significant increase in the construction of new pressure pumping equipment across the industry. As a result of low oil and natural gas prices and the construction of new equipment, there is currently an excess of drilling rigs and pressure pumping equipment available. In circumstances of excess capacity, providers of contract drilling and pressure pumping services have difficulty sustaining profit margins and may sustain losses during downturn periods. We cannot predict the future level of demand for our contract drilling or pressure pumping services or future conditions in the oil and natural gas contract drilling or pressure pumping businesses. +In addition, unconventional resource plays have substantially increased and some drilling rigs are not capable of drilling these wells efficiently. Accordingly, the utilization of some older technology drilling rigs may be hampered by their lack of capability to successfully compete for this work. Other ongoing factors which could continue to adversely affect utilization rates and pricing, even in an environment of high oil and natural gas prices and increased drilling activity, include: +· +movement of drilling rigs from region to region, +· +reactivation of land-based drilling rigs, and +· +construction of new technology drilling rigs. +Shortages, Delays in Delivery and Interruptions in Supply of Drill Pipe, Replacement Parts, Other Equipment, Supplies and Materials Adversely Affect Our Operating Results. +During periods of increased demand for drilling and pressure pumping services, the industry has experienced shortages of drill pipe, replacement parts, other equipment, supplies and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +· +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +· +transportation and other logistical challenges, and +· +a shortage in the number of vendors able or willing to provide the necessary equipment, supplies and materials, including as a result of commitments of vendors to other customers or third parties. +These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs. Severe shortages, delays in delivery and interruptions in supply could limit our ability to construct and operate our drilling rigs and pressure pumping equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to +11 +negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, our drilling rigs and certain other assets, such insurance does not cover the full replacement cost of the rigs or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation and equipment insurance coverage and a $2.0 million per occurrence self-insured retention on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We self-insure a number of other risks, including loss of earnings and business interruption, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs and is not fully covered by insurance or an enforceable or recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +New Technologies May Cause Our Operating Methods and Equipment to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive in our Industry. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance of rigs and equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs. Accordingly, a higher level of capital expenditures may be required to maintain and improve existing rigs and equipment and purchase and construct newer, higher specification drilling rigs to meet the increasingly sophisticated needs of our customers. In addition, technological changes, process improvements and other factors that increase operational efficiencies could result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping business could have similar effects. +In recent years, we have added drilling rigs to our fleet through new construction, and we have purchased new pressure pumping equipment. Although we take measures to ensure that we use advanced oil and natural gas drilling technology, changes in technology or improvements in competitors’ equipment could make our equipment less competitive. +If we are not successful in building new rigs and pressure pumping equipment or upgrading our existing rigs and pressure pumping equipment in a timely and cost-effective manner, we could lose market share. One or more technologies that we implement in the future may not work as we expect, and we may be adversely affected. Additionally, new technologies, services or standards could render some of our services, drilling rigs or pressure pumping equipment obsolete, which could have a material adverse impact on our business, financial condition, cash flows and results of operation. +Our Current Backlog of Contract Drilling Revenue May Not Ultimately Be Realized as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +As of December 31, 2014, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $1.5 billion. Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of +12 +time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate, renegotiate or fail to honor their contractual obligations. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to cancel or negotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the renegotiation or termination of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Oil Service Business Sectors in Which We Operate Are Highly Competitive with Excess Capacity, which Adversely Affects Our Operating Results. +The land drilling and pressure pumping businesses are highly competitive. At times, particularly in low commodity price environments, available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. This excess capacity has resulted in substantial competition for drilling and pressure pumping contracts. The ability to move drilling rigs and pressure pumping equipment from one market to another in response to market conditions heightens the competition in the industry. +We believe that price competition for drilling and pressure pumping contracts will continue to be intense due to the existence of available rigs and pressure pumping equipment. As a result of competition, our utilization may decrease and/or we may be unable to maintain or increase prices for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Reliance on Management and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel. During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. The loss of key employees, the failure to obtain or attract and retain qualified personnel and increased wage rates could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2014, we received approximately 41% from our ten largest customers, 28% from our five largest customers and 16% from our two largest customers. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Growth Through the Building of New Rigs and Pressure Pumping Equipment and Rig and Other Acquisitions Are Not Assured. +We have increased our drilling rig fleet and pressure pumping horsepower in the past through mergers, acquisitions and new construction. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building new rigs and pressure pumping equipment. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, contract drillers may continue to build new, high technology rigs and providers of pressure pumping services may continue to build new, high horsepower equipment. +There can be no assurance that we will: +· +have sufficient capital resources to complete additional acquisitions or build new rigs or pressure pumping equipment, +· +successfully integrate additional drilling rigs, pressure pumping equipment or other assets or businesses, +· +effectively manage the growth and increased size of our organization, drilling fleet and pressure pumping equipment, +· +successfully deploy idle, stacked or additional rigs and pressure pumping equipment, +· +maintain the crews necessary to operate additional drilling rigs and pressure pumping equipment, or +· +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition or the building of new drilling rigs and pressure pumping equipment. +13 +We may incur substantial indebtedness to finance future acquisitions, build new drilling rigs or build new pressure pumping equipment and also may issue equity, convertible or debt securities in connection with any such acquisitions or building program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +· +substantial civil, criminal and/or administrative penalties, +· +modification, denial or revocation of permits or other authorizations, +· +imposition of limitations on our operations, and +· +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the countries in which we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, we may be deemed to be a responsible party under these laws and regulations. +Changes in environmental laws and regulations occur frequently and such laws and regulations tend to become more stringent over time. Stricter laws, regulations or enforcement policies could significantly increase compliance costs for us and our customers and have a material adverse effect on our operations or financial position. For example, on August 16, 2012, the EPA issued final rules that establish new air emission control requirements for natural gas and NGL production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds and National Emissions Standards for Hazardous Air Pollutants (“NESHAPS”) to address hazardous air pollutants frequently associated with gas production and processing activities. Among other things, these final rules require the reduction of volatile organic compound emissions from natural gas wells through the use of reduced emission completions or “green completions” on all hydraulically fractured wells constructed or refractured after January 1, 2015. In addition, gas wells are now required to use completion combustion device equipment (i.e., flaring) if emissions cannot be directed to a gathering line. Further, the final rules under NESHAPS include Maximum Achievable Control Technology standards for “small” glycol dehydrators that are located at major sources of hazardous air pollutants and modifications to the leak detection standards for valves. These rules may require the implementation of new operating standards which may impact our business. In 2012, seven states sued the EPA to compel the agency to make a determination as to whether setting standards of performance limiting methane emissions from oil and natural gas sources is appropriate and, if so, to promulgate performance standards for methane emissions from existing oil and natural gas sources. In April 2014, the EPA released a set of five white papers analyzing methane emissions from the industry. In January 2015, EPA announced plans to issue a proposed rule in summer 2015 governing methane emissions from the oil and natural gas industry. If these or other initiatives result in an increase in regulation, it could increase costs to us and our customers or reduce demand for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Potential Legislation and Regulation Covering Hydraulic Fracturing Could Increase Our Costs and Limit or Delay Our Operations. +Members of the U.S. Congress and the EPA are reviewing proposals for more stringent regulation of hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. For example, the EPA is conducting a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater. As part of this study, the EPA sent requests to a number of companies, including our company, for information on their hydraulic fracturing practices. We have responded to the inquiry. The EPA released a progress report on December 21, 2012 outlining work currently underway and is expected to release a draft final report in early 2015. This and other ongoing or proposed studies, depending on their course, and any meaningful results obtained, could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) or other regulatory mechanism. In addition, legislation has been proposed in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process +14 +are impairing ground water or causing other damage. These bills, if adopted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SWDA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel. In May 2014, the EPA issued an Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations. For example, Colorado, North Dakota, Montana, Texas, Louisiana, and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in response to such regulation. +Finally, some jurisdictions have taken steps to enact hydraulic fracturing bans or moratoria. New York announced in December 2014 that it will ban high volume fracturing activities combined with horizontal drilling. Certain communities in Colorado have also enacted bans on hydraulic fracturing. Voters in the city of Denton, Texas also recently approved a moratorium on hydraulic fracturing. These actions have been the subject of legal challenges. +The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could make it more difficult to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. +Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business +We are aware of the increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. The EPA has adopted rules requiring the reporting of GHG emissions from specified large GHG emission sources on an annual basis. Further, following a finding by the EPA that certain GHGs represent an endangerment to human health, the EPA finalized a rule to address permitting of GHG emissions from stationary sources under the Clean Air Act’s New Source Review Prevention of Significant Deterioration (“PSD”) and Title V programs. This final rule “tailors” the PSD and Title V programs to apply to certain stationary sources of GHG emissions in a multi-step process, with the largest sources first subject to permitting. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs. Additional legislation or regulation by these states and regions, the EPA, and/or any international agreements to which the United States may become a party, that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our operations. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +Legal Proceedings Could Have a Negative Impact on our Business. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. +15 +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect our Opportunities and Future Business. +We currently conduct operations in Canada, and we have incurred selling, general and administrative expenses related to the evaluation of and preparation for other international opportunities. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements or the interpretation thereof which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. +There can be no assurance that we will: +· +identify attractive opportunities in international markets, +· +have sufficient capital resources to pursue and consummate international opportunities, +· +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, +· +effectively manage the start-up, development and growth of an international organization and assets, +· +hire, attract and retain the personnel necessary to successfully conduct international operations, or +· +successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some of the parts of the world where contract drilling and pressure pumping activities are conducted have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +We may incur substantial indebtedness to finance an international transaction or operations and also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operation. +Our Business Is Subject to Cybersecurity Risks and Threats. +Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow. It is possible that our business, financial and other systems could be compromised, which might not be noticed for some period of time. Risks associated with these threats include, among other things, loss of intellectual property, disruption of our and customers’ business operations and safety procedures, loss or damage to our worksite data delivery systems, unauthorized disclosure of personal information, and increased costs to prevent, respond to or mitigate cybersecurity events. +16 +We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under Our Long Term Debt +We have borrowings outstanding under our senior notes, term loan facility and, from time to time, revolving credit facility. These obligations are guaranteed by each of our existing U.S. subsidiaries other than immaterial subsidiaries. Our ability to meet our interest and principal payment obligations depends in large part on dividends paid to us by our subsidiaries. If our subsidiaries do not generate sufficient cash flows to pay us dividends, we may be unable to meet our interest and principal payment obligations. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. The margin on LIBOR loans ranges from 2.25% to 3.25% and the margin on base rate loans ranges from 1.25% to 2.25%, based on our debt to capitalization ratio. At December 31, 2014, the margin on LIBOR loans was 2.25% and the margin on base rate loans was 1.25%. Based on our debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015. As of December 31, 2014, we had $303 million outstanding under our revolving credit facility at a weighted average interest rate of 2.65% and $82.5 million outstanding under our term credit facility at an interest rate of 2.50%. A one percent increase in the interest rate on the borrowings outstanding under our revolving credit facility and term credit facility as of December 31, 2014 would increase our annual cash interest expense by approximately $3.8 million. Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed. +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 450 Gears Road, Suite 500, Houston, Texas. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling Operations — Our drilling services are supported by several offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania and western Canada. +Pressure Pumping — Our pressure pumping services are supported by several offices and yard facilities located throughout our areas of operations, including Texas, Pennsylvania, Ohio, West Virginia and Kentucky. +Oil and Natural Gas Working Interests — Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +17 +We own our administrative offices in Snyder, Texas, as well as several of our other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +In May 2013, the U.S. Equal Employment Opportunity Commission (“EEOC”) notified us of cause findings related to certain of our employment practices. The cause findings relate to allegations that we tolerated a hostile work environment for employees based on national origin and race. The cause findings also allege, among other things, failure to promote, subjecting employees to adverse employment terms and conditions and retaliation. We and the EEOC engaged in the statutory conciliation process. In March 2014, the EEOC notified us that this matter will be forwarded to its legal unit for litigation review. In November 2014, we and the EEOC participated in a mediation to resolve the matter. Discussions are ongoing. If no resolution is reached, we believe that litigation will ensue, and we intend to defend ourselves vigorously. Based on the information available to us at this time, we do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows; however, there can be no assurance as to the ultimate outcome of this matter. +In October 2014, we were notified by EPA region 6 that it intends to seek civil penalties for alleged RCRA administrative violations at a former facility of one of our subsidiaries in Midland, Texas. The EPA subsequently alleged RCRA administrative violations at other facilities of that subsidiary and are seeking an aggregate monetary penalty of approximately $1.1 million. We are in negotiations with the EPA regarding the scope and amount of any potential settlement. We do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows. +Other than the matters described above, the Company is party to various other legal proceedings arising in the normal course of its business; the Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows. +Item 4. Mine Safety Disclosure. +Not applicable. +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P MidCap 400 Index and several other market indices. The following table provides high and low sales prices of our common stock for the periods indicated: +High +Low +2013: +First quarter +$ +25.48 +$ +18.59 +Second quarter +25.12 +18.96 +Third quarter +22.41 +18.83 +Fourth quarter +26.09 +21.29 +2014: +First quarter +$ +31.95 +$ +24.37 +Second quarter +35.42 +30.24 +Third quarter +38.43 +31.12 +Fourth quarter +33.28 +14.01 +18 +(b) Holders +As of February 5, 2015, there were approximately 1,300 holders of record of our common stock. +(c) Dividends +We paid cash dividends during the years ended December 31, 2013 and 2014 as follows: +Per Share +Total +(in thousands) +2013: +Paid on March 29, 2013 +$ +0.05 +$ +7,312 +Paid on June 28, 2013 +0.05 +7,361 +Paid on September 30, 2013 +0.05 +7,231 +Paid on December 31, 2013 +0.05 +7,208 +Total cash dividends +$ +0.20 +$ +29,112 +2014: +Paid on March 27, 2014 +$ +0.10 +$ +14,456 +Paid on June 26, 2014 +0.10 +14,562 +Paid on September 24, 2014 +0.10 +14,634 +Paid on December 24, 2014 +0.10 +14,636 +Total cash dividends +$ +0.40 +$ +58,288 +On February 4, 2015, our Board of Directors approved a cash dividend on our common stock in the amount of $0.10 per share to be paid on March 25, 2015 to holders of record as of March 11, 2015. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our credit facilities and other factors. +(e) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2014. +Period Covered +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands)(1) +October 2014 +— +$ +— +— +$ +187,016 +November 2014 +— +$ +— +— +$ +187,016 +December 2014 +— +$ +— +— +$ +187,016 +Total +— +$ +— +— +$ +187,016 +(1) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2009 through December 31, 2014, with the cumulative total return of the Standard & Poors 500 Stock Index, the Standard & Poors MidCap Index, the Oilfield Service Index and a peer group determined by us. Our peer group consists of Helmerich & Payne, Inc., Nabors Industries, Ltd., Pioneer Energy Services Corp. and Precision Drilling Corp. All of the companies in our peer group are providers of +19 +land-based drilling services. Nabors Industries, Ltd. also is a provider of pressure pumping services. The graph assumes investment of $100 on December 31, 2009 and reinvestment of all dividends. +Fiscal Year Ended December 31, +2009 +2010 +2011 +2012 +2013 +2014 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +142.07 +132.82 +125.36 +171.93 +114.47 +Peer Group Index +100.00 +116.37 +112.73 +99.43 +132.93 +103.78 +S&P 500 Stock Index +100.00 +115.06 +117.49 +136.30 +180.44 +205.14 +Oilfield Service Index +100.00 +126.92 +113.53 +117.14 +151.78 +116.06 +S&P MidCap Index +100.00 +126.64 +124.45 +146.70 +195.84 +214.97 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +20 +Item 6. Selected Financial Data. +Our selected consolidated financial data as of December 31, 2014, 2013, 2012, 2011 and 2010, and for each of the five years in the period ended December 31, 2014 should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report. Due to the sale of our drilling and completion fluids business in January 2010 and the sale of our electric wireline business in January 2011, the results of operations for those businesses have been reclassified and are presented as discontinued operations for all periods presented. +Years Ended December 31, +2014 +2013 +2012 +2011 +2010 +(In thousands, except per share amounts) +Statement of Operations Data: +Operating revenues: +Contract drilling +$ +1,838,830 +$ +1,679,611 +$ +1,821,713 +$ +1,669,581 +$ +1,081,898 +Pressure pumping +1,293,265 +979,166 +841,771 +845,803 +350,608 +Oil and natural gas +50,196 +57,257 +59,930 +50,559 +30,425 +Total +3,182,291 +2,716,034 +2,723,414 +2,565,943 +1,462,931 +Operating costs and expenses: +Contract drilling +1,066,659 +968,754 +1,075,491 +972,778 +655,678 +Pressure pumping +1,036,310 +744,243 +580,878 +561,398 +235,100 +Oil and natural gas +13,102 +12,909 +11,303 +9,615 +7,020 +Depreciation, depletion, amortization and impairment +718,730 +597,469 +526,614 +437,279 +333,493 +Selling, general and administrative +80,145 +73,852 +64,473 +64,271 +53,042 +Net gain on asset disposals +(15,781 +) +(3,384 +) +(33,806 +) +(4,999 +) +(22,812 +) +Provision for bad debts +— +— +1,100 +— +(2,000 +) +Acquisition-related expenses +— +— +— +— +2,485 +Total +2,899,165 +2,393,843 +2,226,053 +2,040,342 +1,262,006 +Operating income +283,126 +322,191 +497,361 +525,601 +200,925 +Other expense +(28,843 +) +(25,750 +) +(21,688 +) +(14,883 +) +(10,171 +) +Income from continuing operations before income taxes +254,283 +296,441 +475,673 +510,718 +190,754 +Income tax expense +91,619 +108,432 +176,196 +187,938 +72,856 +Income from continuing operations +$ +162,664 +$ +188,009 +$ +299,477 +$ +322,780 +$ +117,898 +Income from continuing operations per common share: +Basic +$ +1.12 +$ +1.29 +$ +1.96 +$ +2.08 +$ +0.77 +Diluted +$ +1.11 +$ +1.28 +$ +1.96 +$ +2.06 +$ +0.76 +Cash dividends per common share +$ +0.40 +$ +0.20 +$ +0.20 +$ +0.20 +$ +0.20 +Weighted average number of common shares +outstanding: +Basic +144,066 +144,356 +151,144 +153,871 +152,772 +Diluted +145,376 +145,303 +151,699 +155,304 +153,276 +Balance Sheet Data: +Total assets +$ +5,394,011 +$ +4,687,127 +$ +4,556,911 +$ +4,221,901 +$ +3,423,031 +Borrowings under line of credit +303,000 +— +— +110,000 +— +Other long term debt +670,000 +682,500 +692,500 +382,500 +392,500 +Stockholders’ equity +2,905,810 +2,755,997 +2,640,657 +2,516,631 +2,187,607 +Working capital +340,688 +454,373 +340,128 +346,238 +241,445 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Recent Developments — Oil prices declined significantly during the second half of 2014 and have continued to decline in 2015. The closing price of oil was as high as $105.68 per barrel during the third quarter of 2014, as low as $44.08 per barrel in late +21 +January 2015 and around $50 per barrel during the first week in February 2015 (WTI spot price as reported by the United States Energy Information Administration). As a result of the decline in oil prices, our industry is now experiencing a severe downturn. Market conditions remain very dynamic and are changing quickly. Although the magnitude as well as the duration of this downturn are not yet known, we believe that 2015 will be a challenging year for our industry. +We believe the vast majority of exploration and production companies, including our customers, have significantly reduced their 2015 capital spending plans. The initial impact of these spending reductions is evidenced by the published rig counts which have declined more 25% since their recent peak in October 2014. +Our rig count has also declined. During October 2014, the number of our drilling rigs operating in the United States was as high as 214, and as of February 10, 2015 we had 173 drilling rigs operating in the United States. We have received indications of customers’ intent to early terminate a number of term contracts and many of our drilling customers are seeking price reductions. We expect the number of our drilling rigs operating in the United States to decline at least another 20% during the next 90 days. +Our pressure pumping business is also beginning to see the effects of reduced spending by customers. Some previously scheduled pressure pumping jobs have been cancelled or deferred and many customers are also seeking price reductions. +In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014. In 2015, we have continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate slightly higher than the reduction in our rig count. We have also reduced our capital expenditure plans for 2015. Along with other reductions, we now plan to only build new drilling rigs that are currently committed under term contracts. We plan to continue to adjust our cost structure in line with our level of operating activity. +We expect that our term contract coverage and scalability with respect to labor and other operating costs should position us to weather this downturn. In the event oil prices remain depressed for a sustained period, or decline further, however, we may experience further, significant declines on both drilling activity and spot dayrate pricing, and on pressure pumping activity and pricing, which could have a material adverse effect on our business, financial condition and results of operations. +Management Overview — We are a leading provider of services to the North American oil and natural gas industry. Our services primarily involve the drilling, on a contract basis, of land-based oil and natural gas wells and pressure pumping services. In addition to these services, we also invest, on a non-operating working interest basis, in oil and natural gas properties. +As of December 31, 2014, we had a drilling fleet that consisted of 239 land-based drilling rigs. There continues to be uncertainty with respect to the global economic environment, and oil and natural gas prices are volatile. Oil prices declined significantly during the second half of 2014 and have continued to decline in 2015. The closing price of oil was as high as $105.68 per barrel during the third quarter of 2014, as low as $44.08 per barrel in late January 2015 and around $50 per barrel during the first week in February 2015 (WTI spot price as reported by the United States Energy Information Administration). In response, many of our customers have announced significant reductions in their 2015 capital spending budgets. During October 2014, the number of our drilling rigs operating in the United States was as high as 214, and as of February 10, 2015 we had 173 drilling rigs operating in the United States. We expect the number of our drilling rigs operating in the United States to continue to decline at least through the first quarter of 2015. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by expanding our areas of operation and improving the capabilities of our drilling fleet during the last several years. As of December 31, 2014, we have completed 145 new APEX ® rigs and made performance and safety improvements to existing high capacity rigs. We have plans to complete 16 additional new APEX ® rigs in 2015. +In connection with horizontal shale and other unconventional resource plays, we have added equipment to perform service intensive fracturing jobs. As of December 31, 2014, we had approximately 1.0 million hydraulic horsepower in our pressure pumping fleet. This is a net increase of approximately 866,000 horsepower since the end of 2009. In recent years, low natural gas prices and the industry-wide addition of new pressure pumping equipment to the marketplace led to an excess supply of pressure pumping equipment in North America. +We maintain a backlog of commitments for contract drilling revenues under term contracts, which we define as contracts with a fixed term of six months or more. Our backlog as of December 31, 2014 was approximately $1.5 billion. We expect approximately $953 million of our backlog to be realized in 2015. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to other fees such as for mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving, on standby or incurring maintenance and repair time in excess of +22 +what is permitted under the drilling contract. In addition, generally our term drilling contracts are subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts for which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Not Ultimately Be Realized as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +For the three years ended December 31, 2014, our operating revenues consisted of the following (dollars in thousands): +2014 +2013 +2012 +Contract drilling +$ +1,838,830 +58 +% +$ +1,679,611 +62 +% +$ +1,821,713 +67 +% +Pressure pumping +1,293,265 +41 +% +979,166 +36 +% +841,771 +31 +% +Oil and natural gas +50,196 +1 +% +57,257 +2 +% +59,930 +2 +% +$ +3,182,291 +100 +% +$ +2,716,034 +100 +% +$ +2,723,414 +100 +% +Generally, the profitability of our business is impacted most by two primary factors in our contract drilling segment: our average number of rigs operating and our average revenue per operating day. During 2014, our average number of rigs operating was 203 in the United States and 8 in Canada compared to 184 in the United States and 8 in Canada in 2013 and 214 in the United States and 7 in Canada in 2012. Our average revenue per operating day was $23,880 in 2014 compared to $24,020 in 2013 and $22,540 in 2012. We had consolidated net income of $163 million for 2014 compared to $188 million for 2013. This decrease in consolidated net income was due to a charge of $77.9 million related to the retirement of 55 mechanical drilling rigs and the write-off of excess spare components for the now reduced size of our mechanical rig fleet. Also, revenues in 2013 included early termination revenues totaling approximately $65.2 million related to early contract terminations. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas. During periods of improved commodity prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when these commodity prices deteriorate, the demand for our services generally weakens and we experience downward pressure on pricing for our services. Oil and natural gas prices and our monthly average number of rigs operating have declined from recent highs. In December 2014, our average number of rigs operating was 208 in the United States and 8 in Canada. In January 2015, our average number of rigs operating decreased to 198. +We are also highly impacted by operational risks, competition, the availability of excess equipment, labor issues and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. Please see “Risk Factors” in Item 1A of this Report. +Critical Accounting Policies +In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition, the use of estimates and oil and natural gas properties. +Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying values of certain assets may not be recovered over their estimated remaining useful lives. In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The cyclical nature of our industry has resulted in fluctuations in rig utilization over periods of time. Management believes that the contract drilling industry will continue to be cyclical and rig utilization will continue to fluctuate. Based on management’s expectations of future trends, we estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as management’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional vertical wells versus drilling longer horizontal wells using high capacity rigs). The components comprising rigs that will +23 +no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. In 2014, we identified 55 mechanical rigs that we determined would no longer be marketed. We recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the now reduced size of our mechanical fleet. In 2013, we identified 48 rigs that would no longer be marketed. Also, we had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. We recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. In 2012, we identified 36 rigs that it determined would no longer be marketed and recorded a charge of $5.2 million related to the retirement of these rigs. +We also evaluate our fleet of marketable pressure pumping equipment and in 2012 identified approximately 37,000 horsepower of pressure pumping equipment that would be retired. The net book value of these assets of $7.3 million was expensed in our consolidated statements of operations. There were no similar charges in 2014 or 2013. +In light of the significant decline in oil and natural gas commodity prices beginning in the fourth quarter of 2014 and continuing into 2015, we deemed it necessary to assess the recoverability of long-lived assets within our contract drilling and pressure pumping segments. With respect to these assets, we estimated future cash flows over the expected life of the assets, and determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets. Based on this assessment, no impairment was indicated. Impairment considerations related to our oil and natural gas segment are discussed below. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. We evaluate goodwill at least annually on December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing have been determined to be the same as our operating segments. We currently have goodwill in our contract drilling and pressure pumping operating segments. We first determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors. If so, then goodwill impairment is determined using a two-step impairment test. From time to time, we may perform the first step of quantitative testing for goodwill impairment in lieu of performing a qualitative assessment. The first step is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of the shortfall. +We performed a quantitative impairment assessment of our goodwill as of December 31, 2013. In completing the first step of the analysis, we used a three-year projection of discounted cash flows, plus a terminal value determined using the constant growth method to estimate the fair value of the reporting units. In developing this fair value estimate, we applied key assumptions including an assumed discount rate of 11.87% for the contract drilling reporting unit and an assumed discount rate of 12.40% for the pressure pumping reporting unit. An assumed long-term growth rate of 3.00% was used for both reporting units. Based on the results of the first step of the impairment test in 2013, we concluded that no impairment was indicated in our contract drilling or pressure pumping reporting units, as the estimated fair value of each reporting unit exceeded its carrying value. +In connection with our annual goodwill impairment assessment as of December 31, 2014, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than their carrying amounts and further testing was not necessary. In making this determination, we considered the continued demand experienced during 2014 for our services in the contract drilling and pressure pumping businesses. We also considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in these operating segments. Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account. Our overall market capitalization and the large amount of calculated excess of the fair values of our reporting units over their carrying values from our 2013 quantitative Step 1 assessment of goodwill were also considered. +We have undertaken extensive efforts in the past several years to upgrade our fleet of equipment and believe that we are well positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells. In the event that market conditions were to remain weak for a protracted period, we may be required to record an impairment of goodwill in our contract drilling or pressure pumping reporting units in the future, and such impairment could be material. +Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed. Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs. All of the wells we drilled in 2014, 2013 and 2012 were drilled under daywork contracts. +24 +Use of estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Key estimates used by management include: +· +allowance for doubtful accounts, +· +depreciation, depletion and amortization, +· +fair values of assets acquired and liabilities assumed in acquisitions, +· +goodwill and long-lived asset impairments, and +· +reserves for self-insured levels of insurance coverage. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense. Geological and geophysical costs, including seismic costs and costs to carry and retain undeveloped properties, are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on our expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (level 3 inputs in the fair value hierarchy of fair value accounting). The expected future net cash flows are discounted using an annual rate of 10% to determine fair value. We review unproved oil and natural gas properties quarterly to assess potential impairment. Our impairment assessment is made on a lease-by-lease basis and considers factors such as our intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to proved and unproved oil and natural gas properties totaled approximately $20.9 million, $4.0 million and $1.9 million for the years ended December 31, 2014, 2013 and 2012, respectively, and is included in depreciation, depletion, amortization and impairment in the consolidated statements of operations. +For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Liquidity and Capital Resources +Our liquidity as of December 31, 2014 included approximately $341 million in working capital and approximately $157 million available under our $500 million revolving credit facility. Subsequent to December 31, 2014, we received an $82 million federal income tax refund related to 2014. The refund, along with other cash generated from our cash management efforts, were used to repay $103 million outstanding under our revolving credit facility during 2015. As of February 10, 2015, availability under the revolving credit facility was $260 million. In an attempt to further increase availability under our revolving credit facility, we are working with a lender to move $39.8 million of letters of credit currently outstanding under our revolving credit facility into a new separate facility to be used only for letters of credit. +We believe our current liquidity together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to build new equipment, make improvements to our existing equipment, service our debt and pay cash dividends. If under current market conditions we desire to pursue opportunities for growth that require capital, we believe we would +25 +likely require additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +As of December 31, 2014, we had working capital of $341 million, including cash and cash equivalents of $43 million, compared to working capital of $454 million and cash and cash equivalents of $250 million at December 31, 2013. +During 2014, our sources of cash flow included: +· +$729 million from operating activities, +· +$303 million in net borrowings under our revolving credit facility, +· +$39.6 million from the exercise of stock options and related tax benefits associated with stock-based compensation, and +· +$33.2 million in proceeds from the disposal of property and equipment. +During 2014, we used $176 million to acquire pressure pumping operations, $58.3 million to pay dividends on our common stock, $13.6 million to repurchase shares of our common stock, $10.0 million to repay long-term debt and $1.1 billion: +· +to build new drilling rigs and pressure pumping equipment, +· +to make capital expenditures for the betterment and refurbishment of our drilling rigs and pressure pumping equipment, +· +to acquire and procure equipment and facilities for our drilling and pressure pumping operations, and +· +to fund investments in oil and natural gas properties on a working interest basis. +We paid cash dividends during the year ended December 31, 2014 as follows: +Per Share +Total +(in thousands) +Paid on March 27, 2014 +$ +0.10 +$ +14,456 +Paid on June 26, 2014 +0.10 +14,562 +Paid on September 24, 2014 +0.10 +14,634 +Paid on December 24, 2014 +0.10 +14,636 +Total cash dividends +$ +0.40 +$ +58,288 +On February 4, 2015, our Board of Directors approved a cash dividend on our common stock in the amount of $0.10 per share to be paid on March 25, 2015 to holders of record as of March 11, 2015. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our credit facilities and other factors. +On August 1, 2007, our Board of Directors approved a stock buyback program authorizing purchases of up to $250 million of our common stock in open market or privately negotiated transactions. On July 25, 2012, our Board of Directors terminated the remaining authority under the 2007 stock buyback program, and approved a new stock buyback program authorizing purchases of up to $150 million of our common stock in open market or privately negotiated transactions. On September 6, 2013, the Company’s Board of Directors terminated any remaining authority under the 2012 stock buyback program, and approved a new stock buyback program that authorizes purchase of up to $200 million of the Company’s common stock in open market or privately negotiated transactions. As of December 31, 2014, we had remaining authorization to purchase approximately $187 million of our outstanding common stock under the new stock buyback program. Shares purchased under a buyback program are accounted for as treasury stock. +We acquired shares of stock from employees during 2014, 2013 and 2012 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options by employees. The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) or the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback program. +26 +Treasury stock acquisitions during the year ended December 31, 2014, 2013 and 2012 were as follows (dollars in thousands): +2014 +2013 +2012 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +42,268,057 +$ +880,888 +38,146,738 +$ +795,051 +27,487,571 +$ +624,759 +Purchases pursuant to stock buyback programs: +2007 program +— +— +— +— +4,708,784 +70,092 +2012 program +— +— +2,567,266 +51,107 +5,863,451 +98,892 +2013 program +13,898 +466 +602,564 +12,517 +— +— +Acquisitions pursuant to long-term incentive plans +536,630 +17,681 +951,489 +22,213 +86,932 +1,308 +Treasury shares at end of period +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +38,146,738 +$ +795,051 +On September 27, 2012, we entered into a credit agreement (the “Credit Agreement”). The Credit Agreement is a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility. The Credit Agreement replaced a previous senior unsecured revolving credit facility. +The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time. The revolving credit facility contains a letter of credit facility that is limited to $150 million and a swing line facility that is limited to $40 million, in each case outstanding at any time. +The term loan facility provides for a loan of $100 million, which was drawn on December 24, 2012. The term loan facility is payable in quarterly principal installments which commenced December 27, 2012. The installment amounts vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments, 5.00% of the original principal amount for the subsequent four quarterly installments and 13.75% of the original principal amount for the final four quarterly installments. +Subject to customary conditions, we may request that the lenders’ aggregate commitments with respect to the revolving credit facility and/or the term loan facility be increased by up to $100 million, not to exceed total commitments of $700 million. The maturity date under the Credit Agreement is September 27, 2017 for both the revolving facility and the term facility. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 2.25% to 3.25% and the applicable margin on base rate loans varies from 1.25% to 2.25%, in each case determined based upon our debt to capitalization ratio. As of December 31, 2014, the applicable margin on LIBOR rate loans was 2.25% and the applicable margin on base rate loans was 1.25%. Based on our debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%. +Each of our U.S. subsidiaries, other than one domestic holding company and certain immaterial subsidiaries, has unconditionally guaranteed all existing and future indebtedness and liabilities of the other guarantors and us arising under the Credit Agreement and other loan documents. Such guarantees also cover obligations of us and any of our subsidiaries arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 45%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2014. The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require us to repay all the outstanding +27 +amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy such acceleration is automatic), and (iii) require us to cash collateralize any outstanding letters of credit. +As of December 31, 2014, we had $82.5 million principal amount outstanding under the term loan facility at an interest rate of 2.50% and $303 million outstanding under the revolving credit facility at a weighted interest rate of 2.65%. We had $39.8 million in letters of credit outstanding at December 31, 2014 and, as a result, had available borrowing capacity of approximately $157 million at that date. +On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. We will pay interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amounts of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. We will pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are our senior unsecured obligations, which rank equally in right of payment with all of our other unsubordinated indebtedness. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of our existing domestic subsidiaries other than immaterial subsidiaries. +The Series A Notes and Series B Notes are prepayable at our option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. We must offer to prepay the notes upon the occurrence of any change of control. In addition, we must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2014. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +Commitments and Contingencies — As of December 31, 2014, we maintained letters of credit in the aggregate amount of $39.8 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2014, no amounts had been drawn under the letters of credit. +As of December 31, 2014, we had commitments to purchase approximately $512 million of major equipment for our drilling and pressure pumping businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. These agreements expire in 2016, 2017 and 2018. As of December 31, 2014, the remaining obligation under these agreements was approximately $71.8 million, of which materials with a total purchase price of approximately $15.4 million were +28 +required to be purchased during 2015. In the event that the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. +In November 2011, our pressure pumping business entered into an agreement with a proppant vendor to advance up to $12.0 million to such vendor to finance its construction of certain processing facilities. This advance is secured by the underlying processing facilities and bears interest at an annual rate of 5.0%. Repayment of the advance is to be made through discounts applied to purchases from the vendor and repayment of all amounts advanced must be made no later than October 1, 2017. As of December 31, 2014, advances of approximately $11.8 million had been made under this agreement and repayments of approximately $8.6 million had been received resulting in a balance outstanding of approximately $3.2 million. +In May 2013, the EEOC notified us of cause findings related to certain of our employment practices. The cause findings relate to allegations that we tolerated a hostile work environment for employees based on national origin and race. The cause findings also allege, among other things, failure to promote, subjecting employees to adverse employment terms and conditions and retaliation. We and the EEOC engaged in the statutory conciliation process. In March 2014, the EEOC notified us that this matter will be forwarded to its legal unit for litigation review. In November 2014, we and the EEOC participated in a mediation to resolve the matter. Discussions are ongoing. If no resolution is reached, we believe that litigation will ensue, and we intend to defend ourselves vigorously. Based on the information available to us at this time, we do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows; however, there can be no assurance as to the ultimate outcome of this matter. +In October 2014, we were notified by EPA Region 6 that it intends to seek civil penalties for alleged RCRA violations at a former facility on one of our subsidiaries in Midland, Texas. The EPA subsequently alleged RCRA violations at other facilities of that subsidiary and are seeking an aggregate monetary penalty of approximately $1.1 million. We are in negotiations with the EPA regarding the scope and amount of any potential settlement. We do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +29 +Contractual Obligations +The following table presents information with respect to our contractual obligations as of December 31, 2014 (dollars in thousands): +Payments due by period +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Term loan (1) +$ +82,500 +$ +12,500 +$ +70,000 +$ +— +$ +— +Interest on term loan (2) +4,082 +1,992 +2,090 +— +— +Revolving credit (3) +303,000 +— +303,000 +— +— +Interest on revolving credit (4) +22,280 +8,132 +14,148 +— +— +Series A Notes (5) +300,000 +— +— +— +300,000 +Interest on Series A Notes (6) +85,940 +14,910 +29,820 +29,820 +11,390 +Series B Notes (7) +300,000 +— +— +— +300,000 +Interest on Series B Notes (8) +95,506 +12,810 +25,620 +25,620 +31,456 +Leases (9) +34,882 +14,554 +12,269 +4,472 +3,587 +Equipment purchases (10) +511,819 +511,819 +— +— +— +Inventory purchases (11) +71,774 +15,441 +39,833 +16,500 +— +$ +1,811,783 +$ +592,158 +$ +496,780 +$ +76,412 +$ +646,433 +(1) +Represents repayments of borrowings under the term loan portion of the Credit Agreement. The term loan matures on September 27, 2017. +(2) +Interest to be paid on term loan using 2.50% rate in effect as of December 31, 2014. +(3) +Represents repayments of borrowings under the revolving credit portion of the Credit Agreement. The revolving credit matures on September 27, 2017. +(4) +Interest to be paid on revolving credit using the weighted interest rate of 2.65% in effect as of December 31, 2014. +(5) +Principal repayment of the Series A Notes is required at maturity on October 5, 2020. +(6) +Interest to be paid on the Series A Notes using 4.97% coupon rate. +(7) +Principal repayment of the Series B Notes is required at maturity on June 14, 2022 +(8) +Interest to be paid on the Series B Notes using 4.27% coupon rate. +(9) +See Note 11 of Notes to Consolidated Financial Statements. +(10) +Represents commitments to purchase major equipment to be delivered in 2015 based on expected delivery dates. +(11) +Represents commitments to purchase proppants and chemicals for our pressure pumping business. +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements at December 31, 2014. +30 +Results of Operations +Comparison of the years ended December 31, 2014 and 2013 +The following tables summarize operations by business segment for the years ended December 31, 2014 and 2013: +Year Ended December 31, +Contract Drilling +2014 +2013 +% Change +(Dollars in thousands) +Revenues +$ +1,838,830 +$ +1,679,611 +9.5 +% +Direct operating costs +1,066,659 +968,754 +10.1 +% +Margin (1) +772,171 +710,857 +8.6 +% +Selling, general and administrative +6,297 +5,867 +7.3 +% +Depreciation, amortization and impairment +524,023 +438,728 +19.4 +% +Operating income +$ +241,851 +$ +266,262 +(9.2 +)% +Operating days +77,000 +69,918 +10.1 +% +Average revenue per operating day +$ +23.88 +$ +24.02 +(0.6 +)% +Average direct operating costs per operating day +$ +13.85 +$ +13.86 +(0.1 +)% +Average margin per operating day (1) +$ +10.03 +$ +10.17 +(1.4 +)% +Average rigs operating +211.0 +191.6 +10.1 +% +Capital expenditures +$ +771,593 +$ +504,508 +52.9 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +The demand for our contract drilling services is impacted by the market price of oil and natural gas. The reactivation and construction of new land drilling rigs in the United States in recent years has contributed to an excess capacity of land drilling rigs compared to demand. Also in recent years, customer demand has shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs. The average market price of oil and natural gas for each of the fiscal quarters and full year in 2014 and 2013 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2013: +Average oil price per Bbl (1) +$ +94.34 +$ +94.10 +$ +105.84 +$ +97.34 +$ +97.91 +Average natural gas price per Mcf (2) +$ +3.49 +$ +4.01 +$ +3.55 +$ +3.85 +$ +3.73 +2014: +Average oil price per Bbl (1) +$ +98.75 +$ +103.35 +$ +97.78 +$ +73.16 +$ +93.26 +Average natural gas price per Mcf (2) +$ +5.21 +$ +4.61 +$ +3.96 +$ +3.80 +$ +4.39 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy Information Administration. +Revenues and direct operating costs increased in 2014 compared to 2013 as a result of an increase in the number of rigs operating. Revenues in 2013 included approximately $65.2 million of early termination revenues. Average revenue per operating day and average margin per operating day were higher in 2013 due to the early termination revenue. Capital expenditures were incurred in 2014 and 2013 to build new drilling rigs, to modify and upgrade existing drilling rigs and to acquire additional equipment including top drives, drill pipe, drill collars, engines, fluid circulating systems, rig hoisting systems and safety enhancement equipment. In 2014, we identified 55 mechanical rigs that we determined would no longer be marketed. We recorded additional depreciation, amortization and impairment expense of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the now reduced size of our mechanical fleet. In 2013, we identified 48 rigs that would no longer be marketed. Also, we had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. We recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. Significant capital expenditures incurred in recent years to add new rig capacity also contributed to the increase in depreciation expense. +31 +Year Ended December 31, +Pressure Pumping +2014 +2013 +% Change +(Dollars in thousands) +Revenues +$ +1,293,265 +$ +979,166 +32.1 +% +Direct operating costs +1,036,310 +744,243 +39.2 +% +Margin (1) +256,955 +234,923 +9.4 +% +Selling, general and administrative +20,279 +17,695 +14.6 +% +Depreciation, amortization and impairment +147,595 +129,984 +13.5 +% +Operating income +$ +89,081 +$ +87,244 +2.1 +% +Fracturing jobs +1,224 +1,261 +(2.9 +)% +Other jobs +4,253 +4,800 +(11.4 +)% +Total jobs +5,477 +6,061 +(9.6 +)% +Average revenue per fracturing job +$ +991.89 +$ +705.57 +40.6 +% +Average revenue per other job +$ +18.62 +$ +18.63 +(0.1 +)% +Average revenue per total job +$ +236.13 +$ +161.55 +46.2 +% +Average direct operating costs per total job +$ +189.21 +$ +122.79 +54.1 +% +Average margin per total job (1) +$ +46.92 +$ +38.76 +21.1 +% +Margin as a percentage of total revenues (1) +19.9 +% +24.0 +% +(17.1 +)% +Capital expenditures +$ +241,359 +$ +122,782 +96.6 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Revenues and direct operating costs increased primarily due to an increase in the size of our jobs and the size of our pressure pumping fleet. Our customers have continued the development of unconventional reservoirs resulting in an increase in larger multi-stage fracturing jobs associated therewith. In connection with the horizontal shale and other unconventional resource plays, we have added equipment to perform service intensive fracturing jobs, including the June 2014 acquisition of an East Texas-based pressure pumping operation and the October 2014 acquisition of a Texas-based pressure pumping operation. As a result, we have continued to experience an increase in the number of these larger multi-stage fracturing jobs as a proportion of the total fracturing jobs we performed. Additionally, the average size of the multi-stage fracturing jobs has increased. Average revenue per fracturing job and average direct operating costs per total job increased as a result of this increase in the proportion of larger multi-stage fracturing jobs and the increased size of the jobs in 2014 as compared to 2013. Depreciation expense increased due to capital expenditures. +Year Ended December 31, +Oil and Natural Gas Production and Exploration +2014 +2013 +% Change +(Dollars in thousands, except commodity prices) +Revenues - Oil +$ +44,436 +$ +51,583 +(13.9 +)% +Revenues – Natural gas and liquids +5,760 +5,674 +1.5 +% +Revenues - Total +50,196 +57,257 +(12.3 +)% +Direct operating costs +13,102 +12,909 +1.5 +% +Margin (1) +37,094 +44,348 +(16.4 +)% +Depletion and impairment +42,576 +24,400 +74.5 +% +Operating income (loss) +$ +(5,482 +) +$ +19,948 +(127.5 +)% +Capital expenditures +$ +36,683 +$ +31,245 +17.4 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depletion and impairment. +Oil revenues decreased as a result of lower average oil prices and lower production. Natural gas and liquids revenue increased due to higher average prices, partially offset by lower production. Direct operating costs and depletion expense increased primarily due to the addition of new wells. Depletion and impairment expense in 2014 includes approximately $20.9 million of oil and natural gas property impairments, compared to approximately $4.0 million of oil and natural gas property impairments in 2013. The impairment in 2014 is primarily the result of lower oil prices. +32 +Year Ended December 31, +Corporate and Other +2014 +2013 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +53,569 +$ +50,290 +6.5 +% +Depreciation +$ +4,536 +$ +4,357 +4.1 +% +Net gain on asset disposals +$ +(15,781 +) +$ +(3,384 +) +366.3 +% +Provision for bad debts +$ +— +$ +— +— +Interest income +$ +979 +$ +918 +6.6 +% +Interest expense +$ +29,825 +$ +28,359 +5.2 +% +Other income +$ +3 +$ +1,691 +(99.8 +)% +Capital expenditures +$ +2,706 +$ +3,926 +(31.1 +)% +Selling, general and administrative expense for 2014 increased primarily due to higher personnel costs. Gains and losses on the disposal of assets are treated as part of our corporate activities because such transactions relate to corporate strategy decisions of our executive management group. The net gain on the disposal of assets in 2014 resulted primarily from miscellaneous sales of drilling equipment and sales of certain oil and natural gas properties. +Comparison of the years ended December 31, 2013 and 2012 +The following tables summarize operations by business segment for the years ended December 31, 2013 and 2012: +Year Ended December 31, +Contract Drilling +2013 +2012 +% Change +(Dollars in thousands) +Revenues +$ +1,679,611 +$ +1,821,713 +(7.8 +)% +Direct operating costs +968,754 +1,075,491 +(9.9 +)% +Margin (1) +710,857 +746,222 +(4.7 +)% +Selling, general and administrative +5,867 +6,513 +(9.9 +)% +Depreciation, amortization and impairment +438,728 +390,316 +12.4 +% +Operating income +$ +266,262 +$ +349,393 +(23.8 +)% +Operating days +69,918 +80,833 +(13.5 +)% +Average revenue per operating day +$ +24.02 +$ +22.54 +6.6 +% +Average direct operating costs per operating day +$ +13.86 +$ +13.31 +4.1 +% +Average margin per operating day (1) +$ +10.17 +$ +9.23 +10.2 +% +Average rigs operating +191.6 +220.9 +(13.3 +)% +Capital expenditures +$ +504,508 +$ +744,949 +(32.3 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +The demand for our contract drilling services is impacted by the market price of oil and natural gas. The reactivation and construction of new land drilling rigs in the United States in recent years contributed to an excess capacity of land drilling rigs compared to demand. Customer demand shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs. The average market price of oil and natural gas for each of the fiscal quarters and full year in 2013 and 2012 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2012: +Average oil price per Bbl (1) +$ +102.88 +$ +93.42 +$ +92.24 +$ +87.96 +$ +94.12 +Average natural gas price per Mcf (2) +$ +2.45 +$ +2.28 +$ +2.88 +$ +3.40 +$ +2.75 +2013: +Average oil price per Bbl (1) +$ +94.34 +$ +94.10 +$ +105.84 +$ +97.34 +$ +97.91 +Average natural gas price per Mcf (2) +$ +3.49 +$ +4.01 +$ +3.55 +$ +3.85 +$ +3.73 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +33 +(2) +The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy Information Administration. +Revenues and direct operating costs decreased in 2013 compared to 2012 as a result of a decrease in the number of rigs operating. A greater proportion of our high specification APEX ® rigs working combined with early contract termination revenues caused an increase in the average revenue per operating day. Capital expenditures were incurred in 2013 and 2012 to build new drilling rigs, to modify and upgrade existing drilling rigs and to acquire additional equipment including top drives, drill pipe, drill collars, engines, fluid circulating systems, rig hoisting systems and safety enhancement equipment. In 2013, we identified 48 rigs that would no longer be marketed. Also, we had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. We recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. In 2012, we identified 36 rigs that we determined would no longer be marketed and recorded additional depreciation, amortization and impairment expense of $5.2 million related to the retirement of these rigs. Significant capital expenditures incurred in recent years to add new rig capacity also contributed to the increase in depreciation expense. +Year Ended December 31, +Pressure Pumping +2013 +2012 +% Change +(Dollars in thousands) +Revenues +$ +979,166 +$ +841,771 +16.3 +% +Direct operating costs +744,243 +580,878 +28.1 +% +Margin (1) +234,923 +260,893 +(10.0 +)% +Selling, general and administrative +17,695 +17,036 +3.9 +% +Depreciation, amortization and impairment +129,984 +111,062 +17.0 +% +Operating income +$ +87,244 +$ +132,795 +(34.3 +)% +Fracturing jobs +1,261 +1,229 +2.6 +% +Other jobs +4,800 +5,659 +(15.2 +)% +Total jobs +6,061 +6,888 +(12.0 +)% +Average revenue per fracturing job +$ +705.57 +$ +590.70 +19.4 +% +Average revenue per other job +$ +18.63 +$ +20.46 +(8.9 +)% +Average revenue per total job +$ +161.55 +$ +122.21 +32.2 +% +Average direct operating costs per total job +$ +122.79 +$ +84.33 +45.6 +% +Average margin per total job (1) +$ +38.76 +$ +37.88 +2.3 +% +Margin as a percentage of revenues (1) +24.0 +% +31.0 +% +(22.6 +)% +Capital expenditures +$ +122,782 +$ +194,117 +(36.7 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +In connection with the development of unconventional reservoirs, customers continued to increase the average size of the fracturing jobs. As a result, we experienced an increase in the size of these multi-stage fracturing jobs resulting in higher revenues and costs. Average revenue per fracturing job increased as a result of this increase in the larger multi-stage fracturing jobs in 2013 as compared to 2012. Average direct operating costs per total job increased primarily as a result of increased amounts of materials and labor used on the larger multi-stage fracturing jobs. Depreciation, amortization and impairment expense increased in 2013 due primarily to significant capital expenditures incurred to add capacity. In 2012, depreciation, amortization and impairment expenses included approximately $7.3 million related to the retirement of certain pressure pumping equipment. There were no comparable charges in 2013. +34 +Year Ended December 31, +Oil and Natural Gas Production and Exploration +2013 +2012 +% Change +(Dollars in thousands, except commodity prices) +Revenues - Oil +$ +51,583 +$ +55,335 +(6.8 +)% +Revenues – Natural gas and liquids +5,674 +4,595 +23.5 +% +Revenues - Total +57,257 +59,930 +(4.5 +)% +Direct operating costs +12,909 +11,303 +14.2 +% +Margin (1) +44,348 +48,627 +(8.8 +)% +Depletion and impairment +24,400 +21,417 +13.9 +% +Operating income +$ +19,948 +$ +27,210 +(26.7 +)% +Capital expenditures +$ +31,245 +$ +29,888 +4.5 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depletion and impairment. +Oil revenues decreased as a result of lower production partially offset by higher average oil prices. Natural gas and liquids revenue increased due to higher average prices and higher production. Direct operating costs and depletion expense also increased primarily due to the addition of new wells. Depletion and impairment expense in 2013 includes approximately $4.0 million of oil and natural gas property impairments compared to approximately $1.9 million of oil and natural gas property impairments in 2012. +Year Ended December 31, +Corporate and Other +2013 +2012 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +50,290 +$ +40,924 +22.9 +% +Depreciation +$ +4,357 +$ +3,819 +14.1 +% +Net gain on asset disposals +$ +(3,384 +) +$ +(33,806 +) +(90.0 +)% +Provision for bad debts +$ +— +$ +1,100 +(100.0 +)% +Interest income +$ +918 +$ +554 +65.7 +% +Interest expense +$ +28,359 +$ +22,750 +24.7 +% +Other income +$ +1,691 +$ +508 +232.9 +% +Capital expenditures +$ +3,926 +$ +5,034 +(22.0 +)% +Selling, general and administrative expense for 2013 increased primarily due to higher costs associated with stock-based compensation and expenses to evaluate and prepare for international growth opportunities. Selling, general and administrative expense in 2012 included a reduction in personnel costs related to the final determination of payouts under the 2009 Performance Unit Awards upon the completion of the performance period. There was no similar reduction in 2013. Gains and losses on the disposal of assets are treated as part of our corporate activities because such transactions relate to corporate strategy decisions of our executive management group. The gain on the disposal of assets in 2012 includes a gain of approximately $22.6 million associated with the sale of our flowback operations and a $4.5 million gain from the auction sale of certain excess drilling assets. An additional provision for bad debts was recorded in 2012 with no similar increase in 2013. Interest expense increased in 2013 primarily due to a full year of interest charges related to the $300 million of Series B Senior Notes issued and sold on June 14, 2012. +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by U.S. GAAP. We define Adjusted EBITDA as net income plus net interest expense, income tax expense and depreciation, depletion, amortization and impairment expense. We present Adjusted EBITDA (a non-U.S. GAAP measure) because we believe it provides to both management and investors additional information with respect to both the performance of our fundamental business activities and our ability to meet our capital expenditures and working capital requirements. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measures of net income or operating cash flow. +Year Ended December 31, +2014 +2013 +2012 +(Dollars in thousands) +Net income +$ +162,664 +$ +188,009 +$ +299,477 +Income tax expense +91,619 +108,432 +176,196 +Net interest expense +28,846 +27,441 +22,196 +Depreciation, depletion, amortization and impairment +718,730 +597,469 +526,614 +Adjusted EBITDA +$ +1,001,859 +$ +921,351 +$ +1,024,483 +35 +Income Taxes +Year Ended December 31, +2014 +2013 +2012 +(Dollars in thousands) +Income before income taxes +$ +254,283 +$ +296,441 +$ +475,673 +Income tax expense +$ +91,619 +$ +108,432 +$ +176,196 +Effective tax rate +36.0 +% +36.6 +% +37.0 +% +The effective tax rate is a result of a federal rate of 35.0% adjusted as follows: +2014 +2013 +2012 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes +2.5 +3.7 +2.5 +Permanent differences +(1.4 +) +(1.5 +) +(0.2 +) +Other, net +(0.1 +) +(0.6 +) +(0.3 +) +Effective tax rate +36.0 +% +36.6 +% +37.0 +% +The Domestic Production Activities Deduction was enacted as part of the American Jobs Creation Act of 2004 (as revised by the Emergency Economic Stabilization Act of 2008) and allows a deduction of 9% in 2010 and thereafter on the lesser of qualified production activities income or taxable income. The permanent difference for 2012 does not include any deduction as it is limited to taxable income and we did not have taxable income in 2012 due to the utilization of net operating loss carryforwards. The permanent difference for 2013 includes a deduction of $10.0 million as we fully utilized our remaining net operating loss carryforwards. The permanent difference for 2014 includes a deduction of $8.8 million. +We record deferred federal income taxes based primarily on the temporary differences between the book and tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be settled. As a result of fully recognizing the benefit of our deferred income taxes, we incur deferred income tax expense as these benefits are utilized. We recognized deferred tax expense of approximately $44 million in 2014, $51 million in 2013 and $160 million in 2012. +On January 1, 2010, we converted our Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes. Because the statutory tax rates in Canada are lower than those in the United States, this transaction triggered a $5.1 million reduction in deferred tax liabilities, which is being amortized as a reduction to deferred income tax expense over the weighted average remaining useful life of the Canadian assets. +As a result of the above conversion, our Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada. Effective January 1, 2010, we have elected to permanently reinvest these unremitted earnings in Canada, and intend to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $47.5 million as of December 31, 2014. The unrecognized deferred tax liability associated with these earnings was approximately $7.2 million, net of available foreign tax credits. This liability would be recognized if we received a dividend of the unremitted earnings. +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. During the nine months ended September 30, 2014, oil prices averaged $99.96 per barrel, natural gas prices averaged $4.59 per Mcf and demand for drilling activities increased. During the three months ended December 31, 2014, drilling activity slowed as oil prices averaged $73.16 per barrel and natural gas prices averaged $3.80 per Mcf. Drilling activity has significantly decreased since December 31, 2014, as oil prices averaged $47.22 per barrel and natural gas prices averaged $2.99 per Mcf during January 2015. Our average number of rigs operating remains well below the number of our available rigs, and given current oil pricing and existing market trends, we expect our average number of rigs operating to continue to decline through at least the first quarter of 2015. +36 +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Continued low market prices for oil and natural gas will likely result in decreased demand for our drilling rigs and pressure pumping services and adversely affect our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our drilling rigs and pressure pumping services. +Impact of Inflation +Inflation has not had a significant impact on our operations during the three years ended December 31, 2014. We believe that inflation will not have a significant near-term impact on our financial position. +Recently Issued Accounting Standards +In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. We are currently evaluating the impact this guidance will have on our consolidated financial statements. +In June 2014, the FASB issued an accounting standards update to provide guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition. The requirements in this update are effective during interim and annual periods beginning after December 15, 2015. The adoption of this update is not expected to have a material impact on our consolidated financial statements. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +We currently have exposure to interest rate market risk associated with any borrowings that we have under our term credit facility or our revolving credit facility. Interest is paid on the outstanding principal amount of borrowings at a floating rate based on, at our election, LIBOR or a base rate. The margin on LIBOR loans ranges from 2.25% to 3.25% and the margin on base rate loans ranges from 1.25% to 2.25%, based on our debt to capitalization ratio. At December 31, 2014, the margin on LIBOR loans was 2.25% and the margin on base rate loans was 1.25%. Based on our debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015. As of December 31, 2014, we had $303 million outstanding under our revolving credit facility at a weighted interest rate of 2.65% and $82.5 million outstanding under our term credit facility at an interest rate of 2.50%. The interest rate on the borrowing outstanding under our term credit facility is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate. A one percent increase in the interest rate on the borrowings outstanding under our revolving credit facility and term credit facility as of December 31, 2014 would increase our annual cash interest expense by approximately $3.8 million. +We conduct a portion of our business in Canadian dollars through our Canadian land-based drilling operations. The exchange rate between Canadian dollars and U.S. dollars has fluctuated during the last several years. If the value of the Canadian dollar against the U.S. dollar weakens, revenues and earnings of our Canadian operations will be reduced and the value of our Canadian net assets will decline when they are translated to U.S. dollars. This currency risk is not material to our results of operations or financial condition. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +37 +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2014, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2014. +The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None. +38 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +39 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.2 +Amendment to Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.4 +Second Amended and Restated Bylaws (filed August 6, 2007 as Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference). +10.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference). +10.2 +Patterson-UTI Energy, Inc. Amended and Restated 1997 Long-Term Incentive Plan (filed July 28, 2003 as Exhibit 4.7 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003 and incorporated herein by reference).* +10.3 +Amendment to the Patterson-UTI Energy, Inc. Amended and Restated 1997 Long-Term Incentive Plan (filed August 9, 2004 as Exhibit 10.7 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference).* +10.4 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.5 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.6 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.7 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.8 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.9 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +40 +10.10 +Form of Cash-Settled Performance Unit Award Agreement pursuant to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended from time to time (filed February 19, 2010 as Exhibit 10.9 to the Company’s Annual Report on +Form 10-K for the year ended December 31, 2009 and incorporated herein by reference).* +10.11 +Form of Amendment to Cash-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed May 4, 2010 as Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010 and incorporated herein by reference).* +10.12 +Form of Share-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010 and incorporated herein by reference).* +10.13 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.14 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed April 21, 2014 as Exhibit 10.2 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.15 +Form of Executive Officer Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.3 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.16 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.17 +Form of Non-Employee Director Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.5 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.18 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.19 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns and John E. Vollmer III (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.20 +Letter Agreement dated February 6, 2006 between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed May 1, 2006 as Exhibit 10.25 to the Company’s Annual Report on Form 10-K, as amended, and incorporated herein by reference).* +10.21 +Employment Agreement, effective as of January 1, 2012, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed February 10, 2012 as Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 and incorporated herein by reference). * +10.22 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Cloyce A. Talbott, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, John E. Vollmer III, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon and Tiffany J. Thom (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.23 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.24 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.25 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed on February 4, 2004 as Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.26 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.27 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and John E. Vollmer, III, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.28 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +41 +10.29 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of November 2, 2009, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed November 2, 2009 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2009 and incorporated herein by reference).* +10.30 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of April 2, 2012, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed July 30, 2012 as Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012 and incorporated herein by reference).* +10.31 +Severance Agreement, effective as of April 2, 2012, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 30, 2012 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012 and incorporated herein by reference).* +10.32 +Credit Agreement dated September 27, 2012, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed September 28, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.33 +Amendment No. 1 to Credit Agreement dated as of January 9, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed January 12, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.34 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.35 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+ +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. +42 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2014 and 2013 +F-3 +Consolidated Statements of Operations for the years ended December 31, 2014, 2013 and 2012 +F-4 +Consolidated Statements of Comprehensive Income for the years ended December 31, 2014, 2013 and 2012 +F-5 +Consolidated Statements of Changes In Stockholder s’ Equity for the years ended December 31, 2014, 2013 and 2012 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and 2012 +F-7 +Notes to Consolidated Financial Statements +F-8 +Schedule II – Valuation and Qualifying Accounts +S-1 +F-1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc.: +In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 12, 2015 +F-2 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2014 +2013 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +43,012 +$ +249,509 +Accounts receivable, net of allowance for doubtful accounts of $3,546 and $3,674 at December 31, 2014 and 2013, respectively +663,404 +451,517 +Federal and state income taxes receivable +81,726 +— +Inventory +32,251 +21,248 +Deferred tax assets, net +37,075 +32,952 +Other +51,624 +53,424 +Total current assets +909,092 +808,650 +Property and equipment, net +4,131,071 +3,635,541 +Goodwill and intangible assets +220,813 +167,470 +Deposits on equipment purchases +112,379 +52,560 +Other +20,656 +22,906 +Total assets +$ +5,394,011 +$ +4,687,127 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +382,438 +$ +173,150 +Federal and state income taxes payable +— +10,670 +Accrued expenses +173,466 +160,457 +Current portion of long-term debt +12,500 +10,000 +Total current liabilities +568,404 +354,277 +Borrowings under revolving credit facility +303,000 +— +Other long-term debt +670,000 +682,500 +Deferred tax liabilities, net +935,660 +887,864 +Other +11,137 +6,489 +Total liabilities +2,488,201 +1,931,130 +Commitments and contingencies (see Note 8) +Stockholders’ equity: +Preferred stock, par value $.01; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $.01; authorized 300,000,000 shares with 189,262,876 and 186,487,246 issued and 146,444,291 and 144,219,189 outstanding at December 31, 2014 and 2013, respectively +1,893 +1,865 +Additional paid-in capital +984,674 +913,505 +Retained earnings +2,811,815 +2,707,439 +Accumulated other comprehensive income +6,463 +14,076 +Treasury stock, at cost, 42,818,585 shares and 42,268,057 shares at December 31, 2014 and 2013, respectively +(899,035 +) +(880,888 +) +Total stockholders’ equity +2,905,810 +2,755,997 +Total liabilities and stockholders’ equity +$ +5,394,011 +$ +4,687,127 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2014 +2013 +2012 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +1,838,830 +$ +1,679,611 +$ +1,821,713 +Pressure pumping +1,293,265 +979,166 +841,771 +Oil and natural gas +50,196 +57,257 +59,930 +Total operating revenues +3,182,291 +2,716,034 +2,723,414 +Operating costs and expenses: +Contract drilling +1,066,659 +968,754 +1,075,491 +Pressure pumping +1,036,310 +744,243 +580,878 +Oil and natural gas +13,102 +12,909 +11,303 +Depreciation, depletion, amortization and impairment +718,730 +597,469 +526,614 +Selling, general and administrative +80,145 +73,852 +64,473 +Net gain on asset disposals +(15,781 +) +(3,384 +) +(33,806 +) +Provision for bad debts +— +— +1,100 +Total operating costs and expenses +2,899,165 +2,393,843 +2,226,053 +Operating income +283,126 +322,191 +497,361 +Other income (expense): +Interest income +979 +918 +554 +Interest expense, net of amount capitalized +(29,825 +) +(28,359 +) +(22,750 +) +Other +3 +1,691 +508 +Total other expense +(28,843 +) +(25,750 +) +(21,688 +) +Income before income taxes +254,283 +296,441 +475,673 +Income tax expense: +Current +47,946 +57,863 +15,760 +Deferred +43,673 +50,569 +160,436 +Total income tax expense +91,619 +108,432 +176,196 +Net income +$ +162,664 +$ +188,009 +$ +299,477 +Net income per common share: +Basic +$ +1.12 +$ +1.29 +$ +1.96 +Diluted +$ +1.11 +$ +1.28 +$ +1.96 +Weighted average number of common shares outstanding: +Basic +144,066 +144,356 +151,144 +Diluted +145,376 +145,303 +151,699 +Cash dividends per common share +$ +0.40 +$ +0.20 +$ +0.20 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +Year Ended December 31, +2014 +2013 +2012 +(In thousands) +Net income +162,664 +$ +188,009 +$ +299,477 +Other comprehensive income, net of taxes of $0 for 2014, $0 for 2013 and $0 for 2012: +Foreign currency translation adjustment +(7,613 +) +(7,691 +) +2,308 +Total comprehensive income +155,051 +$ +180,318 +$ +301,785 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings +Income +Stock +Total +(In thousands) +Balance, December 31, 2011 +183,295 +1,833 +840,731 +2,279,367 +19,459 +(624,759 +) +2,516,631 +Net income +— +— +— +299,477 +— +— +299,477 +Foreign currency translation +adjustment +— +— +— +— +2,308 +— +2,308 +Issuance of restricted stock +792 +8 +(8 +) +— +— +— +— +Vesting of restricted stock units +8 +— +— +— +— +— +— +Forfeitures of restricted stock +(99 +) +(1 +) +1 +— +— +— +— +Exercise of stock options +64 +1 +933 +— +— +— +934 +Stock-based compensation +— +— +23,185 +— +— +— +23,185 +Tax expense related to stock- +based compensation +— +— +(1,284 +) +— +— +— +(1,284 +) +Payment of cash dividends +— +— +— +(30,302 +) +— +— +(30,302 +) +Purchase of treasury stock +— +— +— +— +— +(170,292 +) +(170,292 +) +Balance, December 31, 2012 +184,060 +$ +1,841 +$ +863,558 +$ +2,548,542 +$ +21,767 +$ +(795,051 +) +2,640,657 +Net income +— +— +— +188,009 +— +— +188,009 +Foreign currency translation +adjustment +— +— +— +— +(7,691 +) +— +(7,691 +) +Issuance of restricted stock +1,312 +13 +(13 +) +— +— +— +— +Vesting of restricted stock units +9 +— +— +— +— +— +— +Forfeitures of restricted stock +(84 +) +(1 +) +1 +— +— +— +— +Exercise of stock options +1,190 +12 +19,274 +— +— +— +19,286 +Stock-based compensation +— +— +25,891 +— +— +— +25,891 +Tax benefit related to stock- +based compensation +— +— +4,794 +— +— +— +4,794 +Payment of cash dividends +— +— +— +(29,112 +) +— +— +(29,112 +) +Purchase of treasury stock +— +— +— +— +— +(85,837 +) +(85,837 +) +Balance, December 31, 2013 +186,487 +$ +1,865 +$ +913,505 +$ +2,707,439 +$ +14,076 +$ +(880,888 +) +$ +2,755,997 +Net income +— +— +— +162,664 +— +— +162,664 +Foreign currency translation +adjustment +— +— +— +— +(7,613 +) +— +(7,613 +) +Issuance of restricted stock +1,102 +11 +(11 +) +— +— +— +— +Vesting of restricted stock units +10 +1 +— +— +— +— +1 +Forfeitures of restricted stock +(61 +) +(1 +) +1 +— +— +— +— +Exercise of stock options +1,725 +17 +35,418 +— +— +— +35,435 +Stock-based compensation +— +— +27,032 +— +— +— +27,032 +Tax benefit related to stock- +based compensation +— +— +8,729 +— +— +— +8,729 +Payment of cash dividends +— +— +— +(58,288 +) +— +— +(58,288 +) +Purchase of treasury stock +— +— +— +— +— +(18,147 +) +(18,147 +) +Balance, December 31, 2014 +189,263 +1,893 +984,674 +2,811,815 +6,463 +(899,035 +) +2,905,810 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2014 +2013 +2012 +(In thousands) +Cash flows from operating activities: +Net income +$ +162,664 +$ +188,009 +$ +299,477 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation, depletion, amortization and impairment +718,730 +597,469 +526,614 +Provision for bad debts +— +— +1,100 +Dry holes and abandonments +550 +89 +308 +Deferred income tax expense +43,673 +50,569 +160,436 +Stock-based compensation expense +27,032 +25,891 +23,185 +Net gain on asset disposals +(15,781 +) +(3,384 +) +(33,806 +) +Tax expense related to stock-based compensation +— +— +(1,284 +) +Changes in operating assets and liabilities: +Accounts receivable +(214,059 +) +12,007 +52,612 +Income taxes receivable/payable +(92,352 +) +4,447 +3,506 +Inventory and other assets +(5,737 +) +570 +5,276 +Accounts payable +86,621 +11,331 +(25,199 +) +Accrued expenses +12,838 +1,973 +(6,048 +) +Other liabilities +4,547 +(100 +) +(837 +) +Net cash provided by operating activities +728,726 +888,871 +1,005,340 +Cash flows from investing activities: +Acquisitions +(176,301 +) +— +— +Purchases of property and equipment +(1,052,341 +) +(662,461 +) +(973,988 +) +Proceeds from disposal of assets +33,233 +10,386 +66,027 +Net cash used in investing activities +(1,195,409 +) +(652,075 +) +(907,961 +) +Cash flows from financing activities: +Purchases of treasury stock +(13,554 +) +(73,510 +) +(170,292 +) +Dividends paid +(58,288 +) +(29,112 +) +(30,302 +) +Tax benefit related to stock-based compensation +8,729 +4,794 +— +Proceeds from long-term debt +— +— +400,000 +Repayment of long-term debt +(10,000 +) +(6,250 +) +(93,750 +) +Proceeds from borrowings under revolving credit facility +349,500 +— +123,400 +Repayment of borrowings under revolving credit facility +(46,500 +) +— +(233,400 +) +Debt issuance costs +— +— +(7,581 +) +Proceeds from exercise of stock options +30,842 +6,959 +934 +Net cash provided by (used in) financing activities +260,729 +(97,119 +) +(10,991 +) +Effect of foreign exchange rate changes on cash +(543 +) +(891 +) +389 +Net increase (decrease) in cash and cash equivalents +(206,497 +) +138,786 +86,777 +Cash and cash equivalents at beginning of year +249,509 +110,723 +23,946 +Cash and cash equivalents at end of year +$ +43,012 +$ +249,509 +$ +110,723 +Supplemental disclosure of cash flow information: +Net cash paid during the year for: +Interest, net of capitalized interest of $6,883 in 2014, $7,775 in 2013 and $8,673 in 2012 +$ +(27,813 +) +$ +(26,228 +) +$ +(16,651 +) +Income taxes +(125,953 +) +(42,600 +) +(7,964 +) +Non-cash investing and financing activities: +Net increase (decrease) in payables for purchases of property and equipment +$ +122,148 +$ +(26,899 +) +$ +(27,838 +) +Net (increase) decrease in deposits on equipment purchases +(59,819 +) +(8,784 +) +55,767 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “Patterson-UTI” or the “Company”), provides onshore contract drilling services to major and independent oil and natural gas operators in the continental United States, and western and northern Canada. The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. The Company also invests in oil and natural gas properties on a non-operating working interest basis. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, the Company has no controlling financial interests in any other entity which would require consolidation. +The U.S. dollar is the functional currency for all of the Company’s operations except for its Canadian operations, which use the Canadian dollar as its functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed. Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs. All of the wells the Company drilled in 2014, 2013 and 2012 were drilled under daywork contracts. +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts represents the Company’s estimate of the amount of probable credit losses existing in the Company’s accounts receivable. The Company reviews the adequacy of its allowance for doubtful accounts at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectable, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with the Company’s pressure pumping activities. The inventories are stated at the lower of cost or market, determined under the average cost method. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Drilling rigs and other equipment +1.25-15 +Buildings +15-20 +Other +3-12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. The Company reviews wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If +F-8 +no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, the Company considers the well costs to be impaired and recognizes the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +The Company reviews its proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (level 3 inputs in the fair value hierarchy of fair value accounting). The expected future net cash flows are discounted using an annual rate of 10% to determine fair value. The Company reviews unproved oil and natural gas properties quarterly to assess potential impairment. The Company’s impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. The Company assesses impairment of its goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Net income per common share — The Company provides a dual presentation of its net income per common share in its consolidated statements of operations: Basic net income per common share (“Basic EPS”) and diluted net income per common share (“Diluted EPS”). +Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock. Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock and restricted stock units. The dilutive effect of stock options and restricted stock units is determined using the treasury stock method. The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested shares of restricted stock. +F-9 +The following table presents information necessary to calculate income from continuing operations per share and net income per share for the years ended December 31, 2014, 2013 and 2012, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2014 +2013 +2012 +BASIC EPS: +Net income +$ +162,664 +$ +188,009 +$ +299,477 +Adjust for income attributed to holders of non-vested restricted stock +(1,663 +) +(1,859 +) +(2,532 +) +Income attributed to common stockholders +$ +161,001 +$ +186,150 +$ +296,945 +Weighted average number of common shares outstanding, excluding non-vested shares of restricted stock +144,066 +144,356 +151,144 +Basic net income per common share +$ +1.12 +$ +1.29 +$ +1.96 +DILUTED EPS: +Income attributed to common stockholders +$ +161,001 +$ +186,150 +$ +296,945 +Weighted average number of common shares outstanding, excluding non-vested shares of restricted stock +144,066 +144,356 +151,144 +Add dilutive effect of potential common shares +1,310 +947 +555 +Weighted average number of diluted common shares outstanding +145,376 +145,303 +151,699 +Diluted income per common share +$ +1.11 +$ +1.28 +$ +1.96 +Potentially dilutive securities excluded as anti-dilutive +1,088 +2,447 +5,416 +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. The Company’s policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — The Company recognizes the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards (See Note 10). +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Issued Accounting Standards — In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements. +In June 2014, the FASB issued an accounting standards update to provide guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a +performance condition. The requirements in this update are effective during interim and annual periods beginning after December 15, 2015. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements. +F-10 +2. Acquisitions +During 2014, the Company completed two pressure pumping acquisitions. In June 2014, a subsidiary of the Company acquired the East Texas-based pressure pumping assets of a privately held company. This acquisition included 31,500 horsepower of hydraulic fracturing equipment. In October 2014, a subsidiary of the Company completed the acquisition of the Texas-based pressure pumping assets of a privately held company. This acquisition included 148,250 horsepower of hydraulic fracturing equipment. +In total, the Company paid $176 million in cash for these two acquisitions plus the assumption of property leases and other contractual obligations. The purchase price was allocated to the assets acquired based on fair value. A summary of the purchase price allocation follows (in thousands): +Inventory +$ +1,357 +Equipment +117,958 +Goodwill +56,986 +Total purchase price +$ +176,301 +Results of operations of the acquired businesses are included in the Company’s consolidated results of operations from their respective dates of acquisition. Revenues of $80.8 million and income from operations of $13.7 million from the acquired businesses are included in the consolidated statement of operations for the year ended December 31, 2014. +The following represents pro-forma unaudited financial information for the years ended December 31, 2014 and 2013 as if the acquisitions had been completed on January 1, 2013 (in thousands, except per share amounts): +2014 +2013 +(Unaudited) +Revenue +$ +3,302,492 +$ +2,854,867 +Net income +$ +169,831 +$ +196,600 +Basic net income per common share +$ +1.17 +$ +1.35 +Diluted net income per common share +$ +1.16 +$ +1.34 +3. Property and Equipment +Property and equipment consisted of the following at December 31, 2014 and 2013 (in thousands): +2014 +2013 +Equipment +$ +6,679,894 +$ +5,749,975 +Oil and natural gas properties +196,234 +183,571 +Buildings +83,465 +80,050 +Land +12,038 +12,054 +6,971,631 +6,025,650 +Less accumulated depreciation, depletion and impairment +(2,840,560 +) +(2,390,109 +) +Property and equipment, net +$ +4,131,071 +$ +3,635,541 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets for 2014, 2013 and 2012 (in thousands): +2014 +2013 +2012 +Depreciation and impairment expense +$ +693,390 +$ +573,106 +$ +502,953 +Amortization expense +3,643 +3,993 +4,110 +Depletion expense +21,697 +20,370 +19,551 +Total +$ +718,730 +$ +597,469 +$ +526,614 +The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable (a “triggering event”). In light of the significant decline in oil and natural gas commodity prices beginning in the fourth quarter of 2014 and continuing into 2015, management deemed it necessary to assess the recoverability +F-11 +of long-lived assets within its contract drilling and pressure pumping segments. With respect to the long-lived assets in the Company’s oil and natural gas exploration and production segment, the Company assesses the recoverability of long-lived assets at the end of each quarter due to revisions in its oil and natural gas reserve estimates and expectations about future commodity prices. +Long-lived assets are evaluated for impairment at the lowest level for which identifiable cash flows can be separated from other long-lived assets. The Company performs the first step of its impairment assessments by comparing the undiscounted cash flows for each long-lived asset or asset group to its respective carrying value. In 2014, the Company’s analysis indicated that the carrying amounts of long-lived assets in the contract drilling and pressure pumping segments were recoverable. The Company’s analysis indicated that the carrying amounts of certain oil and natural gas properties were not recoverable at various testing dates in 2014, 2013 and 2012. The Company’s estimates of expected future net cash flows from impaired properties are used in measuring the fair value of such properties. The Company recorded impairment charges of $20.9 million, $4.0 million and $1.9 million in 2014, 2013 and 2012, respectively, related to its oil and natural gas properties. +On a periodic basis, the Company evaluates its fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional vertical wells versus drilling longer horizontal wells using high capacity rigs). The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to its yards to be used as spare equipment. The remaining components of these rigs are retired. In 2014, the Company identified 55 mechanical rigs that it determined would no longer be marketed. The Company recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the now reduced size of the Company’s mechanical fleet. In 2013, the Company identified 48 rigs that would no longer be marketed. Also, the Company had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, the Company had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. The Company recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. In 2012, the Company identified 36 rigs that it determined would no longer be marketed and recorded a charge of $5.2 million related to the retirement of these rigs. +In 2013, due to a shift in customer demand away from mechanically powered drilling rigs to electric powered drilling rigs, the Company recorded in its consolidated statement of operations a charge of $29.9 million related to 55 mechanical rigs that were not under contract. Although these 55 rigs remained marketable at the time, the Company had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. There were no similar charges in 2014 or 2012. +The Company also evaluates its fleet of marketable pressure pumping equipment and in 2012 identified approximately 37,000 horsepower of pressure pumping equipment that would be retired. The net book value of these assets of $7.3 million was expensed in the Company’s consolidated statements of operations. There were no similar charges in 2014 or 2013. +During 2012, the Company sold its flowback operations in a cash transaction. The sale price was $42.5 million and the Company recognized a gain on disposal of $22.6 million. +4. Goodwill and Intangible Assets +Goodwill — Goodwill by operating segment as of December 31, 2014 and 2013 and changes for the years then ended are as follows (in thousands): +Contract +Pressure +Drilling +Pumping +Total +Balance December 31, 2012 +$ +86,234 +$ +67,575 +$ +153,809 +Changes to goodwill +— +— +- +Balance December 31, 2013 +86,234 +67,575 +153,809 +Changes to goodwill +— +56,986 +56,986 +Balance December 31, 2014 +$ +86,234 +$ +124,561 +$ +210,795 +There were no accumulated impairment losses as of December 31, 2014 or 2013. +Goodwill is evaluated at least annually on December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. The Company’s reporting units for impairment testing have been determined to be its operating segments. The Company first +F-12 +determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors. If so, then goodwill impairment is determined using a two-step impairment test. From time to time, the Company may perform the first step of quantitative testing for goodwill impairment in lieu of performing a qualitative assessment. The first step is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of the shortfall. +The Company performed a quantitative impairment assessment of its goodwill as of December 31, 2013. In completing the first step of the analysis, the Company used a three-year projection of discounted cash flows, plus a terminal value determined using the constant growth method to estimate the fair value of the reporting units. In developing this fair value estimate, the Company applied key assumptions including an assumed discount rate of 11.87% for the contract drilling reporting unit and an assumed discount rate of 12.40% for the pressure pumping reporting unit. An assumed long-term growth rate of 3.00% was used for both reporting units. Based on the results of the first step of the impairment test in 2013, the Company concluded that no impairment was indicated in its contract drilling or pressure pumping reporting units as the estimated fair value of each reporting unit exceeded its carrying value. +In connection with its annual goodwill impairment assessment as of December 31, 2014, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of the Company’s reporting units were greater than their carrying amounts and further testing was not necessary. In making this determination, the Company considered the continued demand experienced during 2014 for its services in the contract drilling and pressure pumping businesses. The Company also considered the current and expected levels of commodity prices for oil and natural gas, which influence its overall level of business activity in these operating segments. Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account. The Company’s overall market capitalization and the large amount of calculated excess of the fair values of the Company’s reporting units over their carrying values from its 2013 quantitative impairment assessment were also considered. +The Company has undertaken extensive efforts in the past several years to upgrade its fleet of equipment and believes that it is well positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells that has resulted primarily from currently low oil and natural gas prices. In the event that market conditions were to remain weak for a protracted period, the Company may be required to record an impairment of goodwill in its contract drilling or pressure pumping reporting units in the future, and such impairment could be material. +Intangible Assets — Intangible assets were recorded in the pressure pumping operating segment in connection with the fourth quarter 2010 acquisition of the assets of a pressure pumping business. As a result of the purchase price allocation, the Company recorded intangible assets related to a non-compete agreement and the customer relationships acquired. These intangible assets were recorded at fair value on the date of acquisition. +The non-compete agreement had a term of three years from October 1, 2010. The value of this agreement was estimated using a with and without scenario where cash flows were projected through the term of the agreement assuming the agreement is in place and compared to cash flows assuming the non-compete agreement was not in place. The intangible asset associated with the non-compete agreement was amortized on a straight-line basis over the three-year term of the agreement. Amortization expense of $350,000 and $467,000 was recorded in the years ended December 31, 2013 and 2012, respectively, associated with the non-compete agreement. The non-compete agreement expired in 2013. +The value of the customer relationships was estimated using a multi-period excess earnings model to determine the present value of the projected cash flows associated with the customers in place at the time of the acquisition and taking into account a contributory asset charge. The resulting intangible asset is being amortized on a straight-line basis over seven years. Amortization expense of $3.6 million was recorded in each of the years ended December 31, 2014, 2013 and 2012, associated with customer relationships. +The Company concluded no triggering events necessitating an impairment assessment of the non-compete agreement had occurred in 2013 or 2012. The Company concluded no triggering events necessitating an impairment assessment of the customer relationships had occurred in 2014, 2013 or 2012. +F-13 +The following table presents the gross carrying amount and accumulated amortization of the customer relationships as of December 31, 2014 and 2013 (in thousands): +2014 +2013 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +25,500 +$ +(15,482 +) +$ +10,018 +$ +25,500 +$ +(11,839 +) +$ +13,661 +5. Accrued Expenses +Accrued expenses consisted of the following at December 31, 2014 and 2013 (in thousands): +2014 +2013 +Salaries, wages, payroll taxes and benefits +$ +52,956 +$ +45,836 +Workers’ compensation liability +77,348 +74,975 +Property, sales, use and other taxes +11,644 +12,367 +Insurance, other than workers’ compensation +9,632 +10,129 +Accrued interest payable +7,427 +7,604 +Other +14,459 +9,546 +$ +173,466 +$ +160,457 +6. Asset Retirement Obligation +The Company records a liability for the estimated costs to be incurred in connection with the abandonment of oil and natural gas properties in the future. This liability is included in the caption “other” in the liabilities section of the consolidated balance sheet. The following table describes the changes to the Company’s asset retirement obligations during 2014 and 2013 (in thousands): +2014 +2013 +Balance at beginning of year +$ +4,837 +$ +4,422 +Liabilities incurred +473 +375 +Liabilities settled +(197 +) +(126 +) +Accretion expense +169 +166 +Revision in estimated costs of plugging oil and natural gas wells +19 +— +Asset retirement obligation at end of year +$ +5,301 +$ +4,837 +7. Long Term Debt +Credit Facilities— On August 19, 2010, the Company entered into a committed senior unsecured Credit Agreement (the “2010 Credit Agreement”) which included a revolving credit facility that permitted aggregate borrowings of up to $400 million and a $100 million term loan facility. The term loan facility was fully drawn on August 19, 2010. The term loan facility was payable in quarterly principal installments commencing November 10, 2010. The installment amounts were scheduled to vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments and 5.00% of the original principal amount for the next subsequent three quarterly installments, with the balance due on the maturity date of August 19, 2014. The outstanding balance of the term loan facility was paid in full on June 14, 2012. +On September 27, 2012, the Company entered into a Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender, and each of the other lenders party thereto. The Credit Agreement is a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility. The Credit Agreement replaced the 2010 Credit Agreement. +The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time. The revolving credit facility contains a letter of credit facility that is limited to $150 million and a swing line facility that is limited to $40 million, in each case outstanding at any time. +F-14 +The term loan facility provides for a loan of $100 million, which was drawn on December 24, 2012. The term loan facility is payable in quarterly principal installments, which commenced December 27, 2012. The installment amounts vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments, 5.00% of the original principal amount for the subsequent four quarterly installments and 13.75% of the original principal amount for the final four quarterly installments. +Subject to customary conditions, the Company may request that the lenders’ aggregate commitments with respect to the revolving credit facility and/or the term loan facility be increased by up to $100 million, not to exceed total commitments of $700 million. The maturity date under the Credit Agreement is September 27, 2017 for both the revolving facility and the term facility. +Loans under the Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 2.25% to 3.25% and the applicable margin on base rate loans varies from 1.25% to 2.25%, in each case determined based upon the Company’s debt to capitalization ratio. As of December 31, 2014, the applicable margin on LIBOR rate loans was 2.25% and the applicable margin on base rate loans was 1.25%. Based on the Company’s debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015. A letter of credit fee is payable by the Company equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%. +Each U.S. subsidiary of the Company, other than one domestic holding company and certain immaterial subsidiaries, has unconditionally guaranteed all existing and future indebtedness and liabilities of the other guarantors and the Company arising under the Credit Agreement and other loan documents. Such guarantees also cover obligations of the Company and any subsidiary of the Company arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 45%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2014. The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants. +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require the Company to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic), and (iii) require the Company to cash collateralize any outstanding letters of credit. +As of December 31, 2014, the Company had $82.5 million principal amount outstanding under the term loan facility at an interest rate of 2.50% and $303 million principal amount outstanding under the revolving credit facility at a weighted average interest rate of 2.65%. The Company had $39.8 million in letters of credit outstanding at December 31, 2014 and, as a result, had available borrowing capacity of approximately $157 million at that date. +Senior Notes – On October 5, 2010, the Company completed the issuance and sale of $300 million in aggregate principal amount of its 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. The Company will pay interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, the Company completed the issuance and sale of $300 million in aggregate principal amounts of its 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. The Company will pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +F-15 +The Series A Notes and Series B Notes are senior unsecured obligations of the Company which rank equally in right of payment with all other unsubordinated indebtedness of the Company. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of the existing domestic subsidiaries of the Company other than immaterial subsidiaries. +The Series A Notes and Series B Notes are prepayable at the Company’s option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. The Company must offer to prepay the notes upon the occurrence of any change of control. In addition, the Company must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2014. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +The Company incurred approximately $10.8 million in debt issuance costs during 2010 in connection with the 2010 Credit Agreement and the Series A Notes. The Company incurred approximately $7.6 million in debt issuance costs during 2012 in connection with the Series B Notes and the Credit Agreement. These costs were deferred and are recognized as interest expense over the term of the underlying debt. Interest expense related to the amortization of debt issuance costs for the 2010 Credit Agreement, the Series A Notes, the Series B Notes and the Credit Agreement was approximately $2.2 million, $2.2 million and $3.4 million for the years ended December 31, 2014, 2013 and 2012, respectively. The amount for the year ended December 31, 2012 includes $978,000 of costs related to the early termination of the 2010 Credit Agreement. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2014 (in thousands): +Year ending December 31, +2015 +$ +12,500 +2016 +28,750 +2017 +344,250 +2018 +— +2019 +— +Thereafter +600,000 +Total +$ +985,500 +8. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2014, the Company maintained letters of credit in the aggregate amount of $39.8 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2014, no amounts had been drawn under the letters of credit. +As of December 31, 2014, the Company had commitments to purchase approximately $512 million of major equipment for its drilling and pressure pumping businesses. +F-16 +The Company’s pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. These agreements expire in 2016, 2017 and 2018. As of December 31, 2014, the remaining obligation under these agreements was approximately $71.8 million, of which materials with a total purchase price of approximately $15.4 million are required to be purchased during 2015. In the event that the required minimum quantities are not purchased during any contract year, the Company could be required to make a liquidated damages payment to the respective vendor for any shortfall. +In November 2011, the Company’s pressure pumping business entered into an agreement with a proppant vendor to advance up to $12.0 million to such vendor to finance the construction of certain processing facilities. This advance is secured by the underlying processing facilities and bears interest at an annual rate of 5.0%. Repayment of the advance is to be made through discounts applied to purchases from the vendor and repayment of all amounts advanced must be made no later than October 1, 2017. As of December 31, 2014, advances of approximately $11.8 million had been made under this agreement and repayments of approximately $8.6 million had been received resulting in a balance outstanding of approximately $3.2 million. +Contingencies – In May 2013, the U.S. Equal Employment Opportunity Commission (“EEOC”) notified the Company of cause findings related to certain of its employment practices. The cause findings relate to allegations that the Company tolerated a hostile work environment for employees based on national origin and race. The cause findings also allege, among other things, failure to promote, subjecting employees to adverse employment terms and conditions and retaliation. The Company and the EEOC engaged in the statutory conciliation process. In March 2014, the EEOC notified the Company that this matter will be forwarded to its legal unit for litigation review. In November 2014, the Company and the EEOC participated in a mediation to resolve the matter. Discussions are ongoing. If no resolution is reached, the Company believes that litigation will ensue, and the Company intends to defend itself vigorously. Based on the information available to the Company at this time, the Company does not expect the outcome of this matter to have a material adverse effect on its financial condition, results of operations or cash flows; however, there can be no assurance as to the ultimate outcome of this matter. +In October 2014, the Company was notified by EPA Region 6 that it intends to seek civil penalties for alleged RCRA administrative violations at a former facility of one of the Company’s subsidiaries in Midland, Texas. The EPA subsequently alleged RCRA administrative violations at other facilities of that subsidiary and are seeking an aggregate monetary penalty of approximately $1.1 million. The Company is in negotiations with the EPA regarding the scope and amount of any potential settlement. The Company does not expect the outcome of this matter to have a material adverse effect on its financial condition, results of operations or cash flows. +The Company’s operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose the Company to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +Any contractual right to indemnification that the Company may have for any such risk, may be unenforceable or limited due to negligent or willful acts of commission or omission by the Company, its subcontractors and/or suppliers. The Company’s customers may dispute, or be unable to meet, their contractual indemnification obligations to the Company due to financial, legal or other reasons. Accordingly, the Company may be unable to transfer these risks to its customers by contract or indemnification agreements. Incurring a liability for which the Company is not fully indemnified or insured could have a material adverse effect on its business, financial condition, cash flows and results of operations. +The Company has insurance coverage for comprehensive general liability, automobile liability, workers’ compensation and employer’s liability, and certain other specific risks. The Company has also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, the Company generally maintains a $1.5 million per occurrence deductible on its workers’ compensation and equipment insurance coverages and a $2.0 million per occurrence self-insured retention on its general liability coverage and $2.0 million per occurrence deductible on its automobile liability insurance coverage. The Company self-insures a number of other risks, including loss of earnings and business interruption, and does not carry a significant amount of insurance to cover risks of underground reservoir damage. If a significant accident or other event occurs and is not fully covered by insurance or an enforceable or recoverable indemnity from a customer, it could have a material adverse effect on the Company’s business, financial condition, cash flows and results of operations. Accrued expenses related to insurance claims are set forth in Note 5. +The Company is party to various legal proceedings arising in the normal course of its business. The Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows. +F-17 +Other Matters — The Company has Change in Control Agreements with its Chairman of the Board, Chief Executive Officer, two Senior Vice Presidents and its General Counsel (the “Key Employees”). Each Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless the Company notifies the Key Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control of the Company occurs during the term of the agreement and the Key Employee’s employment is terminated (i) by the Company other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Key Employee for good reason (as those terms are defined in the Change in Control Agreements), then the Key Employee shall generally be entitled to, among other things: +● +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment for each Key Employee prorated for the portion of the fiscal year preceding the termination date); +● +a payment equal to 2.5 times (in the case of the Chairman of the Board and Chief Executive Officer), 2 times (in the case of the Senior Vice Presidents) or 1.5 times (in the case of the General Counsel) of the sum of (i) the highest annual salary in effect for such Key Employee and (ii) the average of the three annual bonuses earned by the Key Employee for the three fiscal years preceding the termination date and +● +continued coverage under the Company’s welfare plans for up to three years (in the case of the Chairman of the Board and Chief Executive Officer) or two years (in the case of the Senior Vice Presidents and General Counsel). +Other than with respect to the Chief Executive Officer, each Change in Control Agreement provides the Key Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +9. Stockholders’ Equity +Cash Dividends – The Company paid cash dividends during the years ended December 31, 2012, 2013 and 2014 as follows: +Per Share +Total +(in thousands) +2012: +Paid on March 30, 2012 +$ +0.05 +$ +7,788 +Paid on June 29, 2012 +0.05 +7,650 +Paid on September 28, 2012 +0.05 +7,518 +Paid on December 28, 2012 +0.05 +7,346 +Total cash dividends +$ +0.20 +$ +30,302 +2013: +Paid on March 29, 2013 +$ +0.05 +$ +7,312 +Paid on June 28, 2013 +0.05 +7,361 +Paid on September 30, 2013 +0.05 +7,231 +Paid on December 31, 2013 +0.05 +7,208 +Total cash dividends +$ +0.20 +$ +29,112 +2014: +Paid on March 27, 2014 +$ +0.10 +$ +14,456 +Paid on June 26, 2014 +0.10 +14,562 +Paid on September 24, 2014 +0.10 +14,634 +Paid on December 24, 2014 +0.10 +14,636 +Total cash dividends +$ +0.40 +$ +58,288 +On February 4, 2015, the Company’s Board of Directors approved a cash dividend on its common stock in the amount of $0.10 per share to be paid on March 25, 2015 to holders of record as of March 11, 2015. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of the Company’s credit facilities and other factors. +On August 1, 2007, the Company’s Board of Directors approved a stock buyback program authorizing purchases of up to $250 million of the Company’s common stock in open market or privately negotiated transactions. On July 25, 2012, the Company’s Board of Directors terminated the remaining authority under the 2007 stock buyback program, and approved a new stock buyback program authorizing purchases of up to $150 million of common stock in open market or privately negotiated transactions. On September 6, +F-18 +2013, the Company’s Board of Directors terminated any remaining authority under the 2012 stock buyback program, and approved a new stock buyback program that authorizes purchase of up to $200 million of the Company’s common stock in open market or privately negotiated transactions. As of December 31, 2014, the Company had remaining authorization to purchase approximately $187 million of the Company’s outstanding common stock under the new stock buyback program. Shares purchased under a buyback program are accounted for as treasury stock. +The Company acquired shares of stock from employees during 2014, 2013 and 2012 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options by employees. The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) or the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback programs. +Treasury stock acquisitions during the years ended December 31, 2014, 2013 and 2012 were as follows (dollars in thousands): +2014 +2013 +2012 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +42,268,057 +$ +880,888 +38,146,738 +$ +795,051 +27,487,571 +$ +624,759 +Purchases pursuant to stock buyback programs: +2007 program +— +— +— +— +4,708,784 +70,092 +2012 program +— +— +2,567,266 +51,107 +5,863,451 +98,892 +2013 program +13,898 +466 +602,564 +12,517 +— +— +Acquisitions pursuant to long-term incentive plans +536,630 +17,681 +951,489 +22,213 +86,932 +1,308 +Treasury shares at end of period +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +38,146,738 +$ +795,051 +10. Stock-based Compensation +The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards consist of equity instruments in the form of stock options, restricted stock or restricted stock units and have included service and, in certain cases, performance conditions. The Company’s share-based awards have also included both cash-settled and share-settled performance unit awards. Cash-settled performance unit awards are accounted for as liability awards. Share-settled performance unit awards are accounted for as equity awards. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +The Company’s shareholders have approved the 2014 Plan, and the Board of Directors adopted a resolution that no future grants would be made under any of the Company’s other previously existing plans. The Company’s share-based compensation plans at December 31, 2014 follow: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan +9,100,000 +1,242,600 +6,478,876 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +6,070,794 +— +Patterson-UTI Energy, Inc. Amended and Restated 1997 Long-Term Incentive Plan, as amended (“1997 Plan”) +— +300,000 +— +A summary of the 2014 Plan follows: +· +The Compensation Committee of the Board of Directors administers the plan other than the awards to directors. +· +All employees, officers and directors are eligible for awards. +· +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +· +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +· +All options granted under the plan are granted with an exercise price equal to or greater than the fair market value of the Company’s common stock at the time the option is granted. +F-19 +· +The plan provides for awards of incentive stock options, non-incentive stock options, tandem and freestanding stock appreciation rights, restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalents. As of December 31, 2014, non-incentive stock options, restricted stock awards, restricted stock units and performance unit awards had been granted under the plan. +Options granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. Restricted stock awards granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. +Options granted under the 1997 Plan typically vested over three or five years as dictated by the Compensation Committee. These options have terms of no more than ten years. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. Restricted stock awards granted under the 1997 Plan typically vested over four years. +Stock Options— The Company estimates the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date the options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. Weighted-average assumptions used to estimate grant date fair values for stock options granted in the years ended December 31, 2014, 2013 and 2012 follow: +2014 +2013 +2012 +Volatility +35.89 +% +41.36 +% +48.79 +% +Expected term (in years) +5.00 +5.00 +5.00 +Dividend yield +1.17 +% +0.89 +% +1.21 +% +Risk-free interest rate +1.76 +% +0.70 +% +0.87 +% +Stock option activity for the year ended December 31, 2014 follows: +Weighted-average +Shares +exercise price +Outstanding at beginning of year +7,319,695 +$ +21.23 +Granted +491,750 +$ +32.32 +Exercised +(1,725,195 +) +$ +20.54 +Cancelled +— +$ +— +Expired +— +— +Outstanding at end of year +6,086,250 +$ +22.32 +Exercisable at end of year +5,224,223 +$ +21.45 +During 2014, the Company acquired 190,919 shares of treasury stock from employees upon the exercise of stock options. Shares having a market value of $4.6 million were withheld from employees and added to treasury stock to satisfy the exercise price in connection with the exercise of the stock options. Shares having a market value of $1.6 million were withheld from employees and added to treasury stock to satisfy payroll tax withholding obligations upon the exercise of the stock options. +Options outstanding at December 31, 2014 have an aggregate intrinsic value of approximately $4.3 million and a weighted-average remaining contractual term of 4.92 years. Options exercisable at December 31, 2014 have an aggregate intrinsic value of approximately $4.2 million and a weighted-average remaining contractual term of 4.28 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2014, 2013 and 2012 follows: +2014 +2013 +2012 +Weighted-average grant date fair value of stock options granted (per share) +$ +9.81 +$ +7.59 +$ +6.37 +Aggregate grant date fair value of stock options vested during the year (in thousands) +$ +5,173 +$ +5,240 +$ +5,512 +Aggregate intrinsic value of stock options exercised (in thousands) +$ +21,862 +$ +8,683 +$ +138 +F-20 +As of December 31, 2014, options to purchase 862,000 shares were outstanding and not vested. All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2014 with respect to these non-vested options follows: +Aggregate intrinsic value (in thousands) +$ +33 +Weighted-average remaining contractual term +8.77 years +Weighted-average remaining expected term +3.77 years +Weighted-average remaining vesting period +1.63 years +Unrecognized compensation cost +$6.0 million +Restricted Stock— For all restricted stock awards to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock activity for the year ended December 31, 2014 follows: +Weighted- +average Grant +Shares +Date Fair Value +Non-vested restricted stock outstanding at beginning of year +1,496,692 +$ +20.84 +Granted +813,150 +$ +33.07 +Vested +(755,564 +) +$ +21.67 +Forfeited +(61,219 +) +$ +24.66 +Non-vested restricted stock outstanding at end of year +1,493,059 +$ +26.93 +As of December 31, 2014, approximately 1.4 million shares of non-vested restricted stock outstanding are expected to vest. Additional information as of December 31, 2014 with respect to these non-vested shares follows: +Aggregate intrinsic value +$23.2 million +Weighted-average remaining vesting period +1.83 years +Unrecognized compensation cost +$29.0 million +Restricted Stock Units— For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions. Non-forfeitable cash dividend equivalents are paid on certain non-vested restricted stock units. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2014 follows: +Weighted-average +Grant Date Fair +Shares +Value +Non-vested restricted stock units outstanding at beginning of year +20,256 +$ +20.67 +Granted +24,250 +$ +34.66 +Vested +(9,754 +) +$ +22.13 +Forfeited +(667 +) +$ +21.09 +Non-vested restricted stock units outstanding at end of year +34,085 +$ +30.20 +Performance Unit Awards. In 2009, the Company granted cash-settled performance unit awards to certain executive officers (the “2009 Performance Units”). The 2009 Performance Units provided for those executive officers to receive a cash payment upon the achievement of certain performance goals established by the Compensation Committee during a specified period. The performance period for the 2009 Performance Units was the period from April 1, 2009 through March 31, 2012. The performance goals for the 2009 Performance Units were tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals were considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the performance units. Generally, the recipients would receive a target payment if the Company’s total shareholder return was positive and, when compared to the peer group, was at or above the 50 th percentile but less than the 75 th percentile and two times the +F-21 +target if at the 75 th percentile or higher. If the Company’s total shareholder return was positive, and, when compared to the peer group, was at or above the 25 th percentile but less than the 50 th percentile, the recipients would only receive one-half of the target payment. The total target amount with respect to the 2009 Performance Units was approximately $3.4 million. Because the 2009 Performance Units were settled in cash at the end of the performance period, they were accounted for as liability awards and the Company’s pro-rated obligation was measured at estimated fair value at the end of each reporting period using a Monte Carlo simulation model. The performance period ended on March 31, 2012 and the Company’s total shareholder return was at the 46 th percentile. The resulting cash payments totaling $1.7 million were paid in April 2012. For the year ended December 31, 2012, a compensation benefit of approximately $1.9 million was recognized. +In 2010, 2011, 2012, 2013 and 2014 the Company granted stock-settled performance unit awards to certain executive officers (the “Stock-Settled Performance Units”). The Stock-Settled Performance Units provide for the recipients to receive a grant of shares of stock upon the achievement of certain performance goals established by the Compensation Committee during a specified period. The performance period for the Stock-Settled Performance Units is the three year period commencing on April 1 of the year of grant. For the 2012 and 2013 Stock-Settled Performance Units, the performance period can extend for an additional two years in certain circumstances. The performance goals for the Stock-Settled Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective performance units. Generally, the recipients will receive a target number of shares if the Company’s total shareholder return is positive and, when compared to the peer group, is at the 50 th percentile and two times the target if at the 75 th percentile or higher. If the Company’s total shareholder return is positive, and, when compared to the peer group, is at the 25 th percentile, the recipients will only receive one-half of the target number of shares. The grant of shares when achievement is between the 25 th and 75 th percentile will be determined on a pro-rata basis. The performance period for the 2010 Stock-Settled Performance Units ended on March 31, 2013, and the Company’s total shareholder return was at the 93 rd percentile. In April 2013, 357,500 shares were issued to settle the 2010 Stock-Settled Performance Units. The performance period for the 2011 Stock-Settled Performance Units ended on March 31, 2014, and the Company’s total shareholder return was at the 94 th percentile. In April 2014, 288,750 shares were issued to settle the 2011 Stock-Settled Performance Units. The total target number of shares with respect to the Stock-Settled Performance Units is set forth below: +2014 +2013 +2012 +2011 +2010 +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +154,000 +236,500 +192,000 +144,375 +178,750 +Because the Stock-Settled Performance Units are stock-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Stock-Settled Performance Units is set forth below (in thousands): +2014 +2013 +2012 +2011 +2010 +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +5,388 +$ +5,564 +$ +3,065 +$ +5,569 +$ +3,117 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Stock-Settled Performance Units is set forth below (in thousands): +2014 +2013 +2012 +2011 +2010 +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2014 +$ +1,347 +$ +1,855 +$ +1,022 +$ +464 +NA +Year ended December 31, 2013 +NA +$ +1,391 +$ +1,022 +$ +1,856 +$ +260 +Year ended December 31, 2012 +NA +NA +$ +766 +$ +1,856 +$ +1,039 +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid on certain restricted stock units. These payments are recognized as follows: +· +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +F-22 +· +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +· +Dividend equivalents are recognized as additional compensation cost for restricted stock units. +11. Leases +The Company incurred rent expense of $51.9 million, $47.4 million and $39.0 million for the years ended December 31, 2014, 2013 and 2012, respectively. Rent expense is primarily related to short-term equipment rentals that are generally passed through to customers. +Future minimum rental payments required under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 2014 are as follows: +Year ending December 31, +2015 +$ +14,554 +2016 +8,838 +2017 +3,431 +2018 +2,638 +2019 +1,834 +Thereafter +3,587 +Total +$ +34,882 +12. Income Taxes +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2014, 2013 and 2012 are as follows (in thousands): +2014 +2013 +2012 +Federal income tax expense (benefit): +Current +$ +39,438 +$ +41,558 +$ +(512 +) +Deferred +39,673 +47,136 +156,003 +79,111 +88,694 +155,491 +State income tax expense: +Current +3,987 +11,733 +12,455 +Deferred +5,292 +4,229 +5,483 +9,279 +15,962 +17,938 +Foreign income tax expense (benefit): +Current +4,521 +4,572 +3,817 +Deferred +(1,292 +) +(796 +) +(1,050 +) +3,229 +3,776 +2,767 +Total income tax expense: +Current +47,946 +57,863 +15,760 +Deferred +43,673 +50,569 +160,436 +Total income tax expense: +$ +91,619 +$ +108,432 +$ +176,196 +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2014, 2013 and 2012 is summarized as follows: +2014 +2013 +2012 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes +2.5 +3.7 +2.5 +Permanent differences +(1.4 +) +(1.5 +) +(0.2 +) +Other, net +(0.1 +) +(0.6 +) +(0.3 +) +Effective tax rate +36.0 +% +36.6 +% +37.0 +% +F-23 +The Domestic Production Activities Deduction was enacted as part of the American Jobs Creation Act of 2004 (as revised by the Emergency Economic Stabilization Act of 2008) and allows a deduction of 9% in 2010 and thereafter on the lesser of qualified production activities income or taxable income. The permanent difference for 2012 does not include any deduction as it is limited to taxable income and the Company did not have taxable income in 2012 due to the utilization of net operating loss carryforwards. The permanent differences for 2013 include a deduction of $10.0 million as the Company fully utilized its remaining net operating loss carryforwards. The permanent difference for 2014 includes a deduction of $8.8 million. +The tax effect of significant temporary differences representing deferred tax assets and liabilities and changes therein were as follows (in thousands): +December 31, +Net +December 31, +Net +December 31, +Net +December 31, +2014 +Change +2013 +Change +2012 +Change +2011 +Deferred tax assets: +Current: +Net operating loss carryforwards +$ +— +$ +(— +) +$ +— +$ +(18,914 +) +$ +18,914 +$ +(95,662 +) +$ +114,576 +Workers’ compensation allowance +28,310 +698 +27,612 +2,534 +25,078 +1,074 +24,004 +Other +22,396 +2,749 +19,647 +(804 +) +20,451 +1,651 +18,800 +50,706 +3,447 +47,259 +(17,184 +) +64,443 +(92,937 +) +157,380 +Non-current: +Net operating loss carryforwards +12,464 +(988 +) +13,452 +1,690 +11,762 +(6,672 +) +18,434 +Expense associated with employee stock options +14,386 +(1,822 +) +16,208 +1,536 +14,672 +1,944 +12,728 +Federal benefit of state deferred tax liabilities +24,019 +1,181 +22,838 +816 +22,022 +1,762 +20,260 +Other +16,047 +1,344 +14,703 +(421 +) +15,124 +4,454 +10,670 +66,916 +(285 +) +67,201 +3,621 +63,580 +1,488 +62,092 +Total deferred tax assets +117,622 +3,162 +114,460 +(13,563 +) +128,023 +(91,449 +) +219,472 +Deferred tax liabilities: +Current: +Other +(13,631 +) +676 +(14,307 +) +(2,823 +) +(11,484 +) +3,171 +(14,655 +) +Non-current: +Property and equipment basis difference +(986,953 +) +(47,359 +) +(939,594 +) +(33,997 +) +(905,597 +) +(69,774 +) +(835,823 +) +Other +(15,623 +) +(152 +) +(15,471 +) +(186 +) +(15,285 +) +(2,384 +) +(12,901 +) +(1,002,576 +) +(47,511 +) +(955,065 +) +(34,183 +) +(920,882 +) +(72,158 +) +(848,724 +) +Total deferred tax liabilities +(1,016,207 +) +(46,835 +) +(969,372 +) +(37,006 +) +(932,366 +) +(68,987 +) +(863,379 +) +Net deferred tax liability +$ +(898,585 +) +$ +(43,673 +) +$ +(854,912 +) +$ +(50,569 +) +$ +(804,343 +) +$ +(160,436 +) +$ +(643,907 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. The Company expects the deferred tax assets at December 31, 2014 and 2013 to be realized as a result of the reversal of existing taxable temporary differences giving rise to deferred tax liabilities and the generation of taxable income; therefore, no valuation allowance is considered necessary. +Other deferred tax assets consist primarily of the tax effect of various allowance accounts and tax-deferred expenses expected to generate future tax benefits of approximately $38.4 million. Other deferred tax liabilities consist primarily of the tax effect of receivables from insurance companies and tax-deferred income not yet recognized for tax purposes. +For income tax purposes, the Company has approximately $164 million of state net operating losses that can be carried forward as of December 31, 2014. The state net operating losses that can be carried forward, if unused, are scheduled to expire as follows: 2016—$6.8 million; 2025—$630,000; 2026—$16.9 million: 2029—$31.9 million; 2030—$25.7 million; 2031—$82.5 million. +As of December 31, 2014, the Company had no unrecognized tax benefits. The Company has established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2014, the tax years ended +F-24 +December 31, 2011 through December 31, 2013 are open for examination by U.S. taxing authorities. As of December 31, 2014, the tax years ended December 31, 2010 through December 31, 2013 are open for examination by Canadian taxing authorities. +On January 1, 2010, the Company converted its Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes. Because the statutory tax rates in Canada are lower than those in the United States, this transaction triggered a $5.1 million reduction in deferred tax liabilities, which is being amortized as a reduction to deferred income tax expense over the weighted average remaining useful life of the Canadian assets. +As a result of the above conversion, the Company’s Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada. Effective January 1, 2010, the Company has elected to permanently reinvest these unremitted earnings in Canada, and intends to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $47.5 million as of December 31, 2014. The unrecognized deferred tax liability associated with these earnings was approximately $7.2 million, net of available foreign tax credits. This liability would be recognized if the Company received a dividend of the unremitted earnings. +13. Employee Benefits +The Company maintains a 401(k) plan for all eligible employees. The Company’s operating results include expenses of approximately $7.2 million in 2014, $6.2 million in 2013 and $5.4 million in 2012 for the Company’s contributions to the plan. +14. Business Segments +The Company’s revenues, operating profits and identifiable assets are primarily attributable to three business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) the investment, on a non-operating working interest basis, in oil and natural gas properties. Each of these segments represents a distinct type of business. These segments have separate management teams which report to the Company’s chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. +Contract Drilling — The Company markets its contract drilling services to major and independent oil and natural gas operators. As of December 31, 2014, the Company had 239 land-based drilling rigs in the continental United States, and western and northern Canada. +For the years ended December 31, 2014, 2013 and, 2012, contract drilling revenue earned in Canada was $87.5 million, $86.6 million and $79.4 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $57.6 million and $69.1 million as of December 31, 2014 and 2013, respectively. +Pressure Pumping — The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services are primarily well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. Cementing is the process of inserting material between the hole and the pipe to center and stabilize the pipe in the hole. +Oil and Natural Gas — The Company owns and invests in oil and natural gas assets as a non-operating working interest owner. The Company’s oil and natural gas interests are located primarily in Texas and New Mexico. +Major Customer — No single customer accounted for 10% or more of consolidated operating revenue in 2014. During 2013, one customer accounted for approximately $286 million or 10.5% of the Company’s consolidated operating revenues. These revenues were earned in both the Company’s contract drilling and pressure pumping businesses. No single customer accounted for 10% or more of consolidated operating revenues in 2012. +F-25 +The following tables summarize selected financial information relating to the Company’s business segments (in thousands): +Years Ended December 31, +2014 +2013 +2012 +Revenues: +Contract drilling +$ +1,843,707 +$ +1,684,878 +$ +1,826,519 +Pressure pumping +1,294,569 +979,166 +841,771 +Oil and natural gas +50,196 +57,257 +59,930 +Total segment revenues +3,188,472 +2,721,301 +2,728,220 +Elimination of intercompany revenues(a) +(6,181 +) +(5,267 +) +(4,806 +) +Total revenues +$ +3,182,291 +$ +2,716,034 +$ +2,723,414 +Income before income taxes: +Contract drilling +$ +241,851 +$ +266,262 +$ +349,393 +Pressure pumping +89,081 +87,244 +132,795 +Oil and natural gas +(5,482 +) +19,948 +27,210 +325,450 +373,454 +509,398 +Corporate and other +(58,105 +) +(54,647 +) +(45,843 +) +Net gain on asset disposals(b) +15,781 +3,384 +33,806 +Interest income +979 +918 +554 +Interest expense +(29,825 +) +(28,359 +) +(22,750 +) +Other +3 +1,691 +508 +Income before income taxes +$ +254,283 +$ +296,441 +$ +475,673 +Identifiable assets: +Contract drilling +$ +4,000,576 +$ +3,569,588 +$ +3,538,289 +Pressure pumping +1,186,010 +761,199 +784,128 +Oil and natural gas +50,945 +58,656 +54,188 +Corporate and other(c) +156,480 +297,684 +180,306 +Total assets +$ +5,394,011 +$ +4,687,127 +$ +4,556,911 +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +524,023 +$ +438,728 +$ +390,316 +Pressure pumping +147,595 +129,984 +111,062 +Oil and natural gas +42,576 +24,400 +21,417 +Corporate and other +4,536 +4,357 +3,819 +Total depreciation, depletion, amortization and impairment +$ +718,730 +$ +597,469 +$ +526,614 +Capital expenditures: +Contract drilling +$ +771,593 +$ +504,508 +$ +744,949 +Pressure pumping +241,359 +122,782 +194,117 +Oil and natural gas +36,683 +31,245 +29,888 +Corporate and other +2,706 +3,926 +5,034 +Total capital expenditures +$ +1,052,341 +$ +662,461 +$ +973,988 +(a) +Consists of contract drilling and, in 2014, pressure pumping intercompany revenues for services provided to the oil and natural gas exploration and production segment. +(b) +Net gains or losses associated with the disposal of assets relate to corporate strategy decisions of the executive management group. Accordingly, the related gains or losses have been separately presented and excluded from the results of specific segments. +(c) +Corporate and other assets primarily include cash on hand, income tax receivables and certain deferred tax assets. +15. Concentrations of Credit Risk +Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +F-26 +The Company believes it has placed its demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2014 and 2013, the Company’s demand deposits and temporary cash investments consisted of the following (in thousands): +2014 +2013 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +636 +$ +369 +Deposits in FDIC and SIPC-insured institutions over insurance limits +1,420 +269,314 +Deposits in foreign banks +43,664 +20,921 +45,720 +290,604 +Less outstanding checks and other reconciling items +(2,708 +) +(41,095 +) +Cash and cash equivalents +$ +43,012 +$ +249,509 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which the Company provides services. As is general industry practice, the Company typically does not require customers to provide collateral. No significant losses from individual customers were experienced during the years ended December 31, 2014, 2013 or 2012. No provision for bad debts was recognized in 2014 or in 2013. The Company recognized $1.1 million provision for bad debts in 2012. +16. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of the Company’s outstanding debt balances (including current portion) as of December 31, 2014 and 2013 is set forth below (in thousands): +December 31, 2014 +December 31, 2013 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +Borrowings under Credit Agreements: +Revolving credit facility +$ +303,000 +$ +303,000 +$ +— +$ +— +Term loan facility +82,500 +82,500 +92,500 +92,500 +4.97% Series A Senior Notes +300,000 +288,346 +300,000 +304,293 +4.27% Series B Senior Notes +300,000 +269,173 +300,000 +286,772 +Total debt +$ +985,500 +$ +943,019 +$ +692,500 +$ +683,565 +The carrying values of the balances outstanding under the revolving credit facility and the term loan facility approximate their fair values as these instruments have floating interest rates. The fair values of the Series A Notes and Series B Notes at December 31, 2014 and 2013 are based on discounted cash flows associated with the respective notes using current market rates of interest at those respective dates. For the Series A Notes, the current market rates used in measuring this fair value were 5.77% at December 31, 2014 and 4.52% at December 31, 2013. For the Series B Notes, the current market rates used in measuring this fair value were 6.00% at December 31, 2014 and 4.89% at December 31, 2013. These fair value estimates are based on observable market inputs and are considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting. +F-27 +17. Quarterly Financial Information (in thousands, except per share amounts) (unaudited) +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2013 +Operating revenues +$ +667,039 +$ +659,316 +$ +730,907 +$ +658,772 +Operating income +94,932 +70,606 +124,551 +32,102 +Net income +56,230 +40,768 +74,420 +16,591 +Net income per common share: +Basic +$ +0.38 +$ +0.28 +$ +0.51 +$ +0.12 +Diluted +$ +0.38 +$ +0.28 +$ +0.51 +$ +0.11 +2014 +Operating revenues +$ +678,168 +$ +757,276 +$ +845,628 +$ +901,219 +Operating income +58,776 +87,226 +30,291 +106,833 +Net income +34,822 +54,283 +15,976 +57,583 +Net income per common share: +Basic +$ +0.24 +$ +0.37 +$ +0.11 +$ +0.39 +Diluted +$ +0.24 +$ +0.37 +$ +0.11 +$ +0.39 +F-28 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions(1) +Balance +(In thousands) +Year Ended December 31, 2014 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,674 +$ +— +$ +(128 +) +$ +3,546 +Year Ended December 31, 2013 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,513 +$ +— +$ +161 +$ +3,674 +Year Ended December 31, 2012 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +4,887 +$ +1,100 +$ +(2,474 +) +$ +3,513 +(1) +Consists of uncollectible accounts (written off) or recovered. +S-1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 12, 2015 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 12, 2015. +Signature +Title +/s/ Mark S. Siegel +Chairman of the Board +Mark S. Siegel +/s/ William Andrew Hendricks, Jr. +President and Chief Executive Officer +William Andrew Hendricks, Jr. +(Principal Executive Officer) +/s/ John E. Vollmer III +Senior Vice President — Corporate Development, +John E. Vollmer III +Chief Financial Officer and Treasurer +(Principal Financial and Accounting Officer) +/s/ Kenneth N. Berns +Senior Vice President and Director +Kenneth N. Berns +/s/ Charles O. Buckner +Director +Charles O. Buckner +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Curtis W. Huff +Director +Curtis W. Huff +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Cloyce A. Talbott +Director +Cloyce A. Talbott +/s/ Tiffany J. Thom +Director +Tiffany J. Thom +EXHIBIT INDEX +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.2 +Amendment to Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.4 +Second Amended and Restated Bylaws (filed August 6, 2007 as Exhibit 3.3 to the Company’s Quarterly Report on Form +10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference). +10.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference). +10.2 +Patterson-UTI Energy, Inc. Amended and Restated 1997 Long-Term Incentive Plan (filed July 28, 2003 as Exhibit 4.7 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003 and incorporated herein by reference).* +10.3 +Amendment to the Patterson-UTI Energy, Inc. Amended and Restated 1997 Long-Term Incentive Plan (filed August 9, 2004 as Exhibit 10.7 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference).* +10.4 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.5 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.6 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.7 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.8 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.9 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.10 +Form of Cash-Settled Performance Unit Award Agreement pursuant to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended from time to time (filed February 19, 2010 as Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and incorporated herein by reference).* +10.11 +Form of Amendment to Cash-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed May 4, 2010 as Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010 and incorporated herein by reference).* +10.12 +Form of Share-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010 and incorporated herein by reference).* +10.13 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.14 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed April 21, 2014 as Exhibit 10.2 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.15 +Form of Executive Officer Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.3 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.16 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.17 +Form of Non-Employee Director Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.5 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.18 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.19 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns and John E. Vollmer III (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.20 +Letter Agreement dated February 6, 2006 between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed May 1, 2006 as Exhibit 10.25 to the Company’s Annual Report on Form 10-K, as amended, and incorporated herein by reference).* +10.21 +Employment Agreement, effective as of January 1, 2012, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed February 10, 2012 as Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 and incorporated herein by reference). * +10.22 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Cloyce A. Talbott, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, John E. Vollmer III, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon and Tiffany J. Thom (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.23 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.24 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form +10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.25 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed on February 4, 2004 as Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.26 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.27 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and John E. Vollmer, III, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.28 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.29 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of November 2, 2009, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed November 2, 2009 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2009 and incorporated herein by reference).* +10.30 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of April 2, 2012, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed July 30, 2012 as Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012 and incorporated herein by reference).* +10.31 +Severance Agreement, effective as of April 2, 2012, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 30, 2012 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012 and incorporated herein by reference).* +10.32 +Credit Agreement dated September 27, 2012, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed September 28, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.33 +Amendment No. 1 to Credit Agreement dated as of January 9, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed January 12, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.34 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.35 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+ +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. \ No newline at end of file diff --git a/raw/filings/0000889900/2014/0001564590-15-000634/filing_metadata.csv b/raw/filings/0000889900/2014/0001564590-15-000634/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..5aa52b777ab7b161a416ae6742ab5bb2b5a760d9 --- /dev/null +++ b/raw/filings/0000889900/2014/0001564590-15-000634/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2015-02-12,2014-12-31,2015-02-12T11:10:55.000Z,0001564590-15-000634,pten-10k_20141231.htm,FORM 10-K,23336415,1,0,https://www.sec.gov/Archives/edgar/data/889900/000156459015000634/pten-10k_20141231.htm,https://www.sec.gov/Archives/edgar/data/889900/000156459015000634/,2014,2014,1 diff --git a/raw/filings/0000889900/2014/0001564590-15-000634/item1.txt b/raw/filings/0000889900/2014/0001564590-15-000634/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..63dcd68ede9b7e07bf524d0297fa2f15143e7518 --- /dev/null +++ b/raw/filings/0000889900/2014/0001564590-15-000634/item1.txt @@ -0,0 +1,251 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We own and operate in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. The Company was formed in 1978 and reincorporated in 1993 as a Delaware corporation. Patterson Energy, Inc. and UTI Energy Corp. merged in 2001 to form Patterson-UTI Energy, Inc. In 2008, the corporate headquarters was moved from Snyder, Texas to Houston, Texas. +Our contract drilling business operates in the continental United States, and western and northern Canada. As of December 31, 2014, we had a drilling fleet that consisted of 239 marketable land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. A drilling rig is considered marketable at a point in time if it is operating or can be made ready to operate without significant capital expenditures. We also have a substantial inventory of drill pipe and drilling rig components that support our ongoing drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2014, we had approximately 1.0 million hydraulic horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in Texas and New Mexico. +Recent Developments +Oil prices declined significantly during the second half of 2014 and have continued to decline in 2015. The closing price of oil was as high as $105.68 per barrel during the third quarter of 2014, as low as $44.08 per barrel in late January 2015 and around $50 per barrel during the first week in February 2015 (WTI spot price as reported by the United States Energy Information Administration). As a result of the decline in oil prices, our industry is now experiencing a severe downturn. Market conditions remain very dynamic and are changing quickly. Although the magnitude as well as the duration of this downturn are not yet known, we believe that 2015 will be a challenging year for our industry. +We believe the vast majority of exploration and production companies, including our customers, have significantly reduced their 2015 capital spending plans. The initial impact of these spending reductions is evidenced by the published rig counts which have declined more 25% since their recent peak in October 2014. +Our rig count has also declined. During October 2014, the number of our drilling rigs operating in the United States was as high as 214, and as of February 10, 2015 we had 173 drilling rigs operating in the United States. We have received indications of customers’ intent to early terminate a number of term contracts and many of our drilling customers are seeking price reductions. We expect the number of our drilling rigs operating in the United States to decline at least another 20% during the next 90 days. +Our pressure pumping business is also beginning to see the effects of reduced spending by customers. Some previously scheduled pressure pumping jobs have been cancelled or deferred and many customers are also seeking price reductions. +2 +In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014. In 2015, we have continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate slightly higher than the reduction in our rig count. We have also reduced our capital expenditure plans for 2015. Along with other reductions, we now plan to only build new drilling rigs that are currently committed under term contracts. We plan to continue to adjust our cost structure in line with our level of operating activity. +We expect that our term contract coverage and scalability with respect to labor and other operating costs should position us to weather this downturn. In the event oil prices remain depressed for a sustained period, or decline further, however, we may experience further, significant declines on both drilling activity and spot dayrate pricing, and on pressure pumping activity and pricing, which could have a material adverse effect on our business, financial condition and results of operations. +Industry Segments +Our revenues, operating profits and identifiable assets are primarily attributable to three industry segments: +· +contract drilling services, +· +pressure pumping services, and +· +oil and natural gas exploration and production. +All of our industry segments had operating profits in 2012 and 2013. In 2014, our contract drilling services and our pressure pumping services segments had operating profits and our oil and natural gas exploration and production segment had an operating loss. Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major and independent oil and natural gas operators. As of December 31, 2014, we had 239 marketable land-based drilling rigs based in the following regions: +· +55 in west Texas and southeastern New Mexico, +· +23 in north central and east Texas, northern Louisiana and eastern Oklahoma, +· +37 in the Rocky Mountain region (Colorado, Utah, Wyoming, Montana and North Dakota), +· +40 in south Texas, +· +34 in the Texas panhandle and western Oklahoma, +· +40 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +· +10 in western and northern Canada. +Our marketable drilling rigs have rated maximum depth capabilities ranging from 10,000 feet to 25,000 feet. Of these drilling rigs, 195 are electric rigs and 44 are mechanical rigs. An electric rig differs from a mechanical rig in that the electric rig converts the power from its diesel engines (the sole energy source for a mechanical rig) into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as replacement parts for marketable rigs. +Drilling rigs are typically equipped with engines, drawworks, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs to ensure that our drilling equipment is competitive. We have spent over $2.0 billion during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2014, 2013 and 2012, we spent approximately $772 million, $505 million and $745 million, respectively, on these capital expenditures. +Depth and complexity of the well and drill site conditions are the principal factors in determining the specifications of the rig selected for a particular job. +3 +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to three years) and provide for the use of the drilling rig to drill multiple wells. During 2014, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 20 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. We believe that our drilling contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations; however, each drilling contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer supervises the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2014, 2013 and 2012 were under daywork contracts. +From time to time more than five years ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turnkey basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2014 +2013 +2012 +Average rigs operating per day(1) +211 +192 +221 +Number of rigs operated during the year +231 +235 +267 +Number of wells drilled during the year +3,740 +3,378 +3,587 +Number of operating days +77,000 +69,918 +80,833 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain an important source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +4 +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX 1500 ® rigs are 1,500 horsepower electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other highly automated pipe handling equipment. APEX 1000 ® rigs are 1,000 horsepower electric rigs with advanced technology equipment similar to the APEX 1500 ® rigs, but with a more compact design to fit on smaller locations. APEX WALKING ® rigs are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. Many APEX 1500 ® and APEX 1000 ® rigs have also been equipped with walking systems as noted below. As of December 31, 2014, our drilling fleet was comprised of the following: +Number of Rigs +Classification +U.S. +Canada +Total +With Walking Systems +APEX 1500 rigs +81 +— +81 +43 +APEX 1000 rigs +15 +— +15 +9 +APEX WALKING rigs +49 +— +49 +49 +Other electric rigs +44 +6 +50 +4 +Total electric rigs +189 +6 +195 +105 +Mechanical rigs +40 +4 +44 +— +Total +229 +10 +239 +105 +Number of Rigs +Horsepower +U.S. +Canada +Total +950 and less +13 +5 +18 +1,000 to 1,400 +81 +5 +86 +1,500 +122 +— +122 +1,700 and greater +13 +— +13 +Total +229 +10 +239 +Average horsepower +1,327 +1,025 +1,314 +Average depth rating +18,096 +14,005 +17,925 +At December 31, 2014, we owned and operated 286 trucks and 323 trailers used to rig down, transport and rig up our drilling rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (Southwest Region) and the Appalachian region (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. We believe that our pressure pumping contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations; however, each pressure pumping contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +5 +Equipment — We have pressure pumping equipment used in providing hydraulic and nitrogen fracturing services as well as nitrogen, cementing and acid pumping services, with a total of approximately 1.0 million hydraulic horsepower as of December 31, 2014. Pressure pumping equipment at December 31, 2014 included: +Hydraulic +Other +Fracturing +Pumping +Equipment +Equipment +Total +Southwest Region: +Number of units +275 +32 +307 +Approximate hydraulic horsepower +638,800 +32,165 +670,965 +Northeast Region: +Number of units +149 +94 +243 +Approximate hydraulic horsepower +303,800 +54,700 +358,500 +Combined: +Number of units +424 +126 +550 +Approximate hydraulic horsepower +942,600 +86,865 +1,029,465 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and that sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Oil and Natural Gas Interests +We own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in producing regions of Texas and New Mexico. Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014. +Customers +The customers of each of our contract drilling and pressure pumping business segments are oil and natural gas operators. Our customer base includes both major and independent oil and natural gas operators. With respect to our consolidated operating revenues in 2014, we received approximately 41% from our ten largest customers, 28% from our five largest customers and 16% from our two largest customers. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. During 2014, no single customer accounted for more than 10% of our consolidated operating revenues. +Competition +The contract drilling and pressure pumping businesses are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for land drilling and pressure pumping services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +· +drilling of oil and natural gas wells, +6 +· +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +· +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +· +use of underground storage tanks and injection wells, and +· +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operation. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +· +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +· +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. If such changes are made to CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, as amended, and implementing regulations govern: +· +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +· +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial +7 +harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, U.S. Environmental Protection Agency (“EPA”) community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing on groundwater quality, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by United States lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customer to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks +8 +to our customers by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, our drilling rigs and certain other assets, such insurance does not cover the full replacement cost of the rigs or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation and equipment insurance coverage and a $2.0 million per occurrence self-insured retention on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We self-insure a number of other risks, including loss of earnings and business interruption, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. +If a significant accident or other event occurs and is not fully covered by insurance or an enforceable or recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 7,900 full-time employees as of February 10, 2015. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. \ No newline at end of file diff --git a/raw/filings/0000889900/2014/0001564590-15-000634/item13.txt b/raw/filings/0000889900/2014/0001564590-15-000634/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2014/0001564590-15-000634/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2014/0001564590-15-000634/item9a.txt b/raw/filings/0000889900/2014/0001564590-15-000634/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..0df531767d4312a6ea1ee37b67d5c08888da71ca --- /dev/null +++ b/raw/filings/0000889900/2014/0001564590-15-000634/item9a.txt @@ -0,0 +1,8 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2014, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2014. +The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2014/0001564590-15-000634/rp_note.txt b/raw/filings/0000889900/2014/0001564590-15-000634/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2014/0001564590-15-000634/rpt_disclosure.txt b/raw/filings/0000889900/2014/0001564590-15-000634/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2015/0001564590-16-012604/filing.txt b/raw/filings/0000889900/2015/0001564590-16-012604/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..7076d6a46a23fd5e90cb76db7216789b39c481fe --- /dev/null +++ b/raw/filings/0000889900/2015/0001564590-16-012604/filing.txt @@ -0,0 +1,4981 @@ +10-K +1 +pten-10k_20151231.htm +10-K +pten-10k_20151231.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +Form 10-K +(Mark One) +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2015 +or +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-22664 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +450 Gears Road, Suite 500, Houston, Texas +77067 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +(281) 765-7100 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Exchange on Which Registered +Common Stock, $0.01 Par Value +The Nasdaq Global Select Market +Securities Registered Pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x or No ¨ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ or No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x or No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +x +Accelerated filer +¨ +Non-accelerated filer +¨ +Smaller reporting company +¨ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2015, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $2.7 billion, calculated by reference to the closing price of $18.82 for the common stock on the Nasdaq Global Select Market on that date. +As of February 4, 2016, the registrant had outstanding 147,179,777 shares of common stock, $0.01 par value, its only class of common stock. +Documents incorporated by reference: +Portions of the registrant’s definitive proxy statement for the 2016 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings and press releases by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. These “forward-looking statements” involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue and cost expectations and backlog; financing of operations; oil and natural gas prices; source and sufficiency of funds required for building new equipment, upgrading existing equipment and additional acquisitions (if opportunities arise); impact of inflation; demand for our services; competition; equipment availability; government regulation; debt service obligations; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipates,” “believes,” “budgeted,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “project,” “should,” “strategy,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Forward-looking statements may be made orally or in writing, including, but not limited to, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act. +Forward-looking statements are not guarantees of future performance and a variety of factors could cause actual results to differ materially from the anticipated or expected results expressed in or suggested by these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates, utilization, margins and planned capital expenditures, global economic conditions, excess availability of land drilling rigs and pressure pumping equipment, including as a result of reactivation or construction, equipment specialization and new technologies, competition, adverse industry conditions, adverse credit and equity market conditions, failure by our customers to pay us or satisfy their contractual obligations (particularly with respect to fixed-term contracts), difficulty in building and deploying new equipment and integrating acquisitions, shortages, delays in delivery and interruptions in supply of equipment, supplies and materials, weather, loss of key customers, liabilities from operations for which we do not have and receive full indemnification or insurance, ability to effectively identify and enter new markets, governmental regulation, ability to realize backlog, ability to retain management and field personnel, legal procedings and other factors. Refer to “Risk Factors” contained in Item 1A of this Report for a more complete discussion of factors that might affect our performance and financial results. You are cautioned not to place undue reliance on any of our forward-looking statements. These forward-looking statements are intended to relay our expectations about the future, and speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, changes in internal estimates or otherwise, except as required by law. +1 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We own and operate in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. Patterson Energy, Inc. and UTI Energy Corp. merged in 2001 to form Patterson-UTI Energy, Inc. Our corporate headquarters are in Houston, Texas. +Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. As of December 31, 2015, we had a drilling fleet that consisted of 221 marketable land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. A drilling rig is considered marketable at a point in time if it is operating or can be made ready to operate without significant capital expenditures. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2015, we had approximately 1.1 million hydraulic horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in Texas and New Mexico. +Recent Developments +Oil prices have significantly declined since the second half of 2014. The closing price of oil, which was as high as $105.68 per barrel during the third quarter of 2014, reached a low price for 2015 of $34.55 in December 2015 and reached a twelve-year low of $26.68 in January 2016. As a result of the prolonged decline in oil prices, our industry continues to experience a severe decline in both contract drilling and pressure pumping activity levels. We do not expect this to change until commodity prices improve. +Low commodity prices are negatively impacting spending by exploration and production companies. The impact of these spending reductions is evidenced by published rig counts, which in the United States decreased more than 60% during 2015 and is now almost 70% lower than the peak in 2014. +Our rig count has also significantly declined. As of December 31, 2015, we had 80 drilling rigs operating in the United States, which was a decrease of 63% from the recent peak of 214 rigs in October 2014. Our operating rig count has continued to decline in 2016. On average, we operated 78 rigs in the United States during January 2016. Term contracts provided some support of our operating rig count during 2015. Based on contracts currently in place, we expect an average of 59 rigs operating under term contracts during the first quarter and an average of 46 rigs operating under term contracts during 2016. +Our pressure pumping business is continuing to experience the effects of reduced spending by customers and downward pressure on pricing. Due to market conditions, as of December 31, 2015, we had stacked approximately 38% of our fracturing horsepower. With the weakness in commodity prices since the beginning of 2016, we have seen a significant decrease in the amount of available work, and the profitability of available work has continued to deteriorate. In response, since the beginning of 2016, we have stacked approximately 140,000 fracturing horsepower. In total, we now have stacked slightly more than half of our fleet of more than 1 million hydraulic fracturing horsepower. +2 +In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014. In 2015, we continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate generally proportionate with the reduction in our rig count. In 2015, we significantly reduced our pressure pumping headcount and obtained lowe r prices on many products and services that we use. We also reduced our capital expenditures in 2015, and we expect our capital expenditures for 2016 to primarily consist of maintenance capital, inspections and potential upgrades, as we do not expect to b uild any new rigs or purchase any new fracturing horsepower in 2016. We plan to continue to adjust our cost structure in line with our level of operating activity. +We expect that our term contract coverage in contract drilling and scalability with respect to labor and other operating costs in contract drilling and pressure pumping should position us to weather this downturn. In the event oil prices remain depressed for a sustained period, or decline further, we may experience further significant declines in both drilling activity and spot dayrate pricing and in pressure pumping activity, which could have a material adverse effect on our business, financial condition and results of operations. +Industry Segments +Our revenues, operating profits and identifiable assets are primarily attributable to three industry segments: +· +contract drilling services, +· +pressure pumping services, and +· +oil and natural gas exploration and production. +All of our industry segments had operating profits in 2013. In 2014, our contract drilling services and our pressure pumping services segments had operating profits and our oil and natural gas exploration and production segment had an operating loss. Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014. All of our industry segments had operating losses in 2015. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2015, we had 221 marketable land-based drilling rigs based in the following regions: +· +46 in west Texas and southeastern New Mexico, +· +17 in north central and east Texas and northern Louisiana +· +36 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +· +37 in south Texas, +· +29 in western Oklahoma, +· +45 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +· +11 in western Canada. +Our marketable drilling rigs have rated maximum depth capabilities ranging from approximately 10,000 feet to 25,000 feet. Of these drilling rigs, 202 are electric rigs and 19 are mechanical rigs. An electric rig differs from a mechanical rig in that the electric rig converts the power from its diesel engines (the sole energy source for a mechanical rig) into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketable rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs to ensure that our drilling equipment is competitive. We have spent over $1.8 billion during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2015, 2014 and 2013, we spent approximately $527 million, $772 million and $505 million, respectively, on these capital expenditures. +3 +Depth and complexity of the well and drill site conditions are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to three years) and provide for the use of the drilling rig to drill multiple wells. During 2015, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 17 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. We believe that our drilling contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each drilling contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2015, 2014 and 2013 were under daywork contracts. +From time to time more than five years ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turnkey basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2015 +2014 +2013 +Average rigs operating per day(1) +124 +211 +192 +Number of rigs operated during the year +223 +231 +235 +Number of wells drilled during the year +2,448 +3,740 +3,378 +Number of operating days +45,142 +77,000 +69,918 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +4 +To address our cust omers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performanc e and safety improvements to existing high capacity rigs. APEX 1500 ® rigs are 1,500 horsepower electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other highly automated pipe handling equip ment. APEX 1000 ® rigs are 1,000 horsepower electric rigs with advanced technology equipment similar to the APEX 1500 ® rigs, but with a more compact design to fit on smaller locations. APEX WALKING ® rigs are designed to efficiently drill multiple wells fr om a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. Many APEX 1500 ® and APEX 1000 ® rigs have also been equipped with walking systems as noted below. As of December 31, 2015, our drilli ng fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent With Walking Systems +APEX 1500 rigs +96 +1 +97 +62 +% +APEX 1000 rigs +15 +— +15 +60 +% +APEX WALKING rigs +49 +— +49 +100 +% +Other electric rigs +35 +6 +41 +12 +% +Total electric rigs +195 +7 +202 +61 +% +Mechanical rigs +15 +4 +19 +Total +210 +11 +221 +Number of Rigs +Horsepower +United States +Canada +Total +2,000 to 2,500 +12 +— +12 +1,500 +133 +1 +134 +1,000 to 1,400 +61 +5 +66 +750 to 950 +4 +5 +9 +Total +210 +11 +221 +Average horsepower +1,386 +1,068 +1,370 +Average depth rating +18,700 +14,550 +18,493 +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (Southwest Region) and the Appalachian region (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. We believe that our pressure pumping contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each pressure pumping contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +5 +Equipment — We have pressure pumping equipment used in providing hydraulic and nitrogen fracturing se rvices as well as nitrogen, cementing and acid pumping services, wi th a total of approximately 1.1 million hydraulic horsepower as of December 31, 2015. Pressure pumping equipment at December 31, 2015 included: +Hydraulic +Other +Fracturing +Pumping +Equipment +Equipment +Total +Southwest Region: +Number of units +285 +32 +317 +Approximate hydraulic horsepower +663,800 +32,165 +695,965 +Northeast Region: +Number of units +169 +94 +263 +Approximate hydraulic horsepower +353,800 +55,400 +409,200 +Combined: +Number of units +454 +126 +580 +Approximate hydraulic horsepower +1,017,600 +87,565 +1,105,165 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and that sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Oil and Natural Gas Interests +We own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in producing regions of Texas and New Mexico. Our oil and natural gas assets constituted less than 1% of our consolidated assets as of December 31, 2015. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2015, we received approximately 49% from our ten largest customers and approximately 33% from our five largest customers. During 2015, one customer accounted for approximately $244 million, or approximately 13%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Competition +The contract drilling and pressure pumping businesses are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn, such as the current market environment. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for land drilling and pressure pumping services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +· +drilling of oil and natural gas wells, +· +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +6 +· +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +· +use of underground storage tanks and injection wells, and +· +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operation. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +· +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +· +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. If such changes are made to CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +· +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +· +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the +7 +liability for owners and operators is the same under the Fe deral Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages . +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, U.S. Environmental Protection Agency (“EPA”) community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are no t fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our drilling rigs , pressu re pumping equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be ade quate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our drilling rigs an d pressure pumping equipment and certain other assets, such insurance does not cover the full replacement cost of such drilling rigs, pressure pumping equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage , a $2.0 million per occurrence self-insured retention on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We self-insure a number of other risks, including loss of earnings and bu siness interruption, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 3,400 full-time employees as of February 4, 2016. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +9 +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +· +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +· +the prices, and expectations about future prices, of oil and natural gas, +· +the supply of and demand for drilling and pressure pumping equipment, +· +the cost of exploring for, developing, producing and delivering oil and natural gas, +· +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, and +· +merger and divestiture activity among oil and natural gas producers. +In particular, our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +· +market supply and demand, +· +the desire and ability of the Organization of Petroleum Exporting Countries, commonly known as OPEC, to set and maintain production and price targets, +· +the level of production by OPEC and non-OPEC countries, +· +domestic and international military, political, economic and weather conditions, +· +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +· +technical advances affecting energy consumption and production, and +· +the price and availability of alternative fuels. +All of these factors are beyond our control. Oil prices have significantly declined since the second half of 2014. The closing price of oil, which was as high as $105.68 per barrel during the third quarter of 2014, reached a low price for 2015 of $34.55 in December 2015 and reached a twelve-year low of $26.68 in January 2016. As a result of the prolonged decline in oil prices, our industry continues to experience a severe decline in both contract drilling and pressure pumping activity levels. We do not expect this to change until commodity prices improve. Currently, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our fracturing horsepower is stacked. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A continued decline in demand for oil and natural gas or prolonged low oil or natural gas prices would likely result in further reduced capital expenditures by our customers and decreased demand for our drilling rigs and pressure pumping services, which could have a material adverse effect on our operating results, financial condition and cash flows. +Global Economic Conditions May Adversely Affect Our Operating Results. +Global economic conditions and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, and there is no assurance that the global economic environment will not quickly deteriorate again due to one or more factors, including a decline in the price for oil or natural gas. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +10 +Excess Equipment and a Highly Competitive Oil Service Industry May Adversely Affect our Utilization and Profit Margins and the Carrying Value of our Assets. +The North American land drilling and pressure pumping businesses are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment, such as the current environment, can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. In addition, in recent years there has been a substantial increase in the construction of new technology drilling rigs and new pressure pumping equipment. Low commodity prices and construction of new equipment can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. Even in an environment of high oil and natural gas prices and increased drilling activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to an excess of equipment. High competition and excess equipment can cause drilling and pressure pumping contractors to have difficulty maintaining utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or excess equipment in the oil and natural gas contract drilling or pressure pumping businesses or the level of demand for our contract drilling or pressure pumping services. +The excess of operable land drilling rigs, increasing rig specialization and excess pressure pumping equipment, which has been exacerbated by the decline in oil and natural gas prices could affect the fair market value or our drilling and pressure pumping equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices could result in future impairment to our long-lived assets and goodwill. +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our drilling rigs, pressure pumping equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our drilling rigs and pressure pumping equipment and certain other assets, such insurance does not cover the full replacement cost of such drilling rigs, pressure pumping equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage and a $2.0 million per occurrence self-insured retention on our general liability coverage, a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We self-insure a number of other risks, including loss of earnings and business interruption, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for +11 +which we are not fully insured or indemnified could materiall y adversely affect our business, financial condition, cash flows and results of operations . +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Current Backlog of Contract Drilling Revenue May Continue to Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2015, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $710 million. Our contract drilling backlog may continue to decline as fixed-term, drilling contract coverage over time may not be offset by new contracts, including as a result of the decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. +New Technologies May Cause Our Operating Methods and Equipment to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive in our Industry. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance of drilling rigs and equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs. Accordingly, a higher level of capital expenditures may be required to maintain and improve existing rigs and equipment and purchase and construct newer, higher specification drilling rigs to meet the increasingly sophisticated needs of our customers. In addition, technological changes, process improvements and other factors that increase operational efficiencies could result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping business could have similar effects. +In recent years, we have added drilling rigs to our fleet through new construction, and we have purchased new pressure pumping equipment. We have also improved existing drilling rigs and pressure pumping equipment by adding equipment designed to enhance functionality and performance. Although we take measures to ensure that we use advanced oil and natural gas drilling and pressure pumping technology, changes in technology, improvements in competitors’ equipment and changes relating to the wells to be drilled and completed could make our equipment less competitive. +If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our services, drilling rigs or pressure pumping equipment obsolete, which could have a material adverse impact on our business, financial condition, cash flows and results of operation. +Shortages, Delays in Delivery and Interruptions in Supply of Drill Pipe, Replacement Parts, Other Equipment, Supplies and Materials Could Adversely Affect Our Operating Results. +During periods of increased demand for drilling and pressure pumping services, the industry has experienced shortages of drill pipe, replacement parts, other equipment, supplies and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +· +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +· +transportation and other logistical challenges, and +· +a shortage in the number of vendors able or willing to provide the necessary equipment, supplies and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +12 +These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs . Severe shortages, delays in delivery and interruptions in supply could limit our ability to construct and operate our drilling rigs and pressure pumping equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations . +Loss of Key Personnel and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel. During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of key personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2015, we received approximately 49% from our ten largest customers, 33% from our five largest customers and 13% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Growth Through the Building of New Rigs and Pressure Pumping Equipment and Rig and Other Acquisitions Are Not Assured. +We have increased our drilling rig fleet and pressure pumping horsepower in the past through mergers, acquisitions and new construction. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building new rigs and pressure pumping equipment. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, when commodity prices improve, contract drillers may continue to build new, high technology rigs and providers of pressure pumping services may continue to build new, high horsepower equipment. +There can be no assurance that we will: +· +have sufficient capital resources to complete additional acquisitions or build new rigs or pressure pumping equipment, +· +successfully integrate additional drilling rigs, pressure pumping equipment or other assets or businesses, +· +effectively manage the growth and increased size of our organization, drilling fleet and pressure pumping equipment, +· +successfully deploy idle, stacked or additional rigs and pressure pumping equipment, +· +maintain the crews necessary to operate additional drilling rigs and pressure pumping equipment, or +· +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition or the building of new drilling rigs and pressure pumping equipment. +We may incur substantial indebtedness to finance future acquisitions, build new drilling rigs or build new pressure pumping equipment, and we also may issue equity, convertible or debt securities in connection with any such acquisitions or building program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +· +substantial civil, criminal and/or administrative penalties, +13 +· +modification, denial or revocation of permits or other authorizations, +· +imposition of limitations on our operations, and +· +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the countries in which we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, we may be deemed to be a responsible party under these laws and regulations. +Changes in environmental laws and regulations occur frequently and such laws and regulations tend to become more stringent over time. Stricter laws, regulations or enforcement policies could significantly increase compliance costs for us and our customers and have a material adverse effect on our operations or financial position. For example, on August 16, 2012, the EPA issued final rules that establish new air emission control requirements for natural gas and NGL production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds and National Emissions Standards for Hazardous Air Pollutants (“NESHAPS”) to address hazardous air pollutants frequently associated with gas production and processing activities. Among other things, these final rules require the reduction of volatile organic compound emissions from natural gas wells through the use of reduced emission completions or “green completions” on all hydraulically fractured wells constructed or refractured after January 1, 2015. In addition, gas wells are now required to use completion combustion device equipment (i.e., flaring) if emissions cannot be directed to a gathering line. Further, the final rules under NESHAPS include Maximum Achievable Control Technology standards for “small” glycol dehydrators that are located at major sources of hazardous air pollutants and modifications to the leak detection standards for valves. In December 2014, the EPA finalized amendments to these rules that distinguished between multiple flowback stages during completion and clarified that storage tanks permanently removed from service are not affected by any requirements. Then in July 2015, the EPA finalized two updates to the rules addressing the definition of low pressure gas wells and references to tanks that are connected to one another (referred to as connected in parallel). These rules may require the implementation of new operating standards which may impact our business. In September 2015, the EPA published a proposed rule that would update and expand the New Source Performance Standards by setting additional emissions limits for volatile organic compounds and regulating methane emissions for new and modified sources in the oil and gas industry. The EPA also published a proposed rule in September 2015 concerning aggregation of sources that would affect source determinations for air permitting in the oil and gas industry. If these or other initiatives result in an increase in regulation, it could increase costs to us and our customers or reduce demand for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations. +Members of the U.S. Congress and the EPA are reviewing proposals for more stringent regulation of hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. For example, the EPA is conducting a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater. As part of this study, the EPA sent requests to a number of companies, including our company, for information on hydraulic fracturing practices. We have responded to the inquiry. The EPA released a progress report in December 2012 outlining work currently underway and released a draft assessment report in June 2015. The draft assessment report concluded that activities have not led to widespread systematic impacts on drinking water resources in the United States, but there are above and below ground mechanisms by which hydraulic fracturing could affect drinking water resources. Further, we conduct drilling and pressure pumping activities in numerous states. Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) and other aspects of the oil and gas industry. In addition, legislation has been proposed in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if adopted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SDWA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel. In May 2014, the EPA issued an +14 +Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing. Further, in March 2015, the Bureau of Land Management (“BLM”) issued a final rule to regulate hydraulic fracturing on Indian land. The rule requires companies to publicly disclose chemicals used in hydraulic fracturing operations to the BLM. However, in September 201 5, the U.S. District Court of Wyoming granted a preliminary injunction temporarily preventing enforcement of the rule. A final decision is pending. In April 2015, the EPA published proposed pretreatment standards for disposal of wastewater produced from s hale gas operations to publicly owned treatment works. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations. For example, Colorado, North Dakota, Montana, Texas, Louisiana, and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performe d and requiring various degrees of chemical disclosure. Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in res ponse to such regulation. +Finally, some jurisdictions have taken steps to enact hydraulic fracturing bans or moratoria. In June 2015, New York banned high volume fracturing activities combined with horizontal drilling. Certain communities in Colorado have also enacted bans on hydraulic fracturing. Voters in the city of Denton, Texas approved a moratorium on hydraulic fracturing in November 2014, though it was later lifted in 2015. These actions have been the subject of legal challenges. +The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could make it more difficult to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. +Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business +We are aware of the increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. The EPA has adopted rules requiring the reporting of GHG emissions from specified large GHG emission sources on an annual basis. Further, following a finding by the EPA that certain GHGs represent an endangerment to human health, the EPA finalized a rule to address permitting of GHG emissions from stationary sources under the Clean Air Act’s New Source Review Prevention of Significant Deterioration (“PSD”) and Title V programs. This final rule “tailors” the PSD and Title V programs to apply to certain stationary sources of GHG emissions in a multi-step process, with the largest sources first subject to permitting. However, in June 2014, the U.S. Supreme Court in UARG v. EPA limited application of this rule to sources that would otherwise need permits based on emission of conventional pollutants. In April 2015, the D.C. Circuit Court of Appeals narrowed the rule in accordance with the Supreme Court’s decision. In addition, the United States was actively involved in the United Nations Conference on Climate Change in Paris, which led to the creation of the Paris Agreement. The Paris Agreement will be open for signing in April 2016 and will require countries to review and “represent a progression” in their intended nationally determined contributions, which set emissions reduction goals, every five years, beginning in 2020. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs. Additional legislation or regulation by these states and regions, the EPA, and/or any international agreements to which the United States may become a party, that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our operations. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +Legal Proceedings Could Have a Negative Impact on our Business. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, such as the one we are currently experiencing, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. +15 +Political, Economic and Social Instability Risk and Laws Associated with Cond ucting International Operations Could Adversely Affect our Opportunities and Future Bus iness. +We currently conduct operations in Canada, and we have incurred selling, general and administrative expenses related to the evaluation of and preparation for other international opportunities. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements or the interpretation thereof which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. +There can be no assurance that we will: +· +identify attractive opportunities in international markets, +· +have sufficient capital resources to pursue and consummate international opportunities, +· +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, +· +effectively manage the start-up, development and growth of an international organization and assets, +· +hire, attract and retain the personnel necessary to successfully conduct international operations, or +· +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some of the parts of the world where contract drilling and pressure pumping activities are conducted have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +Our Business Is Subject to Cybersecurity Risks and Threats. +Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow. It is possible that our business, financial and other systems could be compromised, which might not be noticed for some period of time. Risks associated with these threats include, among other things, loss of intellectual property, disruption of our and customers’ business operations and safety procedures, loss or damage to our worksite data delivery systems, unauthorized disclosure of personal information, and increased costs to prevent, respond to or mitigate cybersecurity events. +16 +We Are Dependent U pon Our Subsidiaries to Meet our Obligations Under Our Long- Term Debt +We have borrowings outstanding under our senior notes, term loan agreement, term loan facility and, from time to time, revolving credit facility. These obligations are guaranteed by each of our existing U.S. subsidiaries other than immaterial subsidiaries. Our ability to meet our interest and principal payment obligations depends in large part on dividends paid to us by our subsidiaries. If our subsidiaries do not generate sufficient cash flows to pay us dividends, we may be unable to meet our interest and principal payment obligations. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. The margin on LIBOR loans ranges from 2.25% to 3.25% and the margin on base rate loans ranges from 1.25% to 2.25%, based on our debt to capitalization ratio. At December 31, 2015, the margin on LIBOR loans was 2.25% and the margin on base rate loans was 1.25%. Based on our debt to capitalization ratio at December 31, 2015, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2016. As of December 31, 2015, we had no amounts outstanding under our revolving credit facility and $70.0 million outstanding under our term credit facility at an interest rate of 2.875%. A one percent increase in the interest rate on the borrowings outstanding under our revolving credit facility and term credit facility as of December 31, 2015 would increase our annual cash interest expense by approximately $632,000. +We have in place a term loan agreement which bears interest, at our election, at the per annum rate of LIBOR plus 3.25% or base rate plus 2.25%. As of December 31, 2015, we had $185 million outstanding under the term loan agreement at an interest rate of 3.875%. A one percent increase in the interest rate on the borrowings outstanding under the term loan agreement as of December 31, 2015 would increase our annual cash interest expense by approximately $1.8 million. +We have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2015, no amounts had been disbursed under any letters of credit. +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed. +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 450 Gears Road, Suite 500, Houston, Texas. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling Operations — Our drilling services are supported by several offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania and western Canada. +17 +Pressure Pumping — Our pre ssure pumping services are supported by several offices and yard facilities located throughout our areas of operations, including Texas, Pennsylvania, Ohio and West Virginia. +Oil and Natural Gas Working Interests — Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas, as well as several of our other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +We are party to various other legal proceedings arising in the normal course of its business; we do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, results of operations or cash flows. +Item 4. Mine Safety Disclosure. +Not applicable. +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P MidCap 400 Index and several other market indices. The following table provides high and low sales prices of our common stock for the periods indicated: +High +Low +2014: +First quarter +$ +31.95 +$ +24.37 +Second quarter +35.42 +30.24 +Third quarter +38.43 +31.12 +Fourth quarter +33.28 +14.01 +2015: +First quarter +$ +19.70 +$ +13.30 +Second quarter +23.11 +18.30 +Third quarter +18.80 +12.97 +Fourth quarter +17.45 +12.82 +(b) Holders +As of February 4, 2016, there were approximately 1,300 holders of record of our common stock. +18 +(c) Dividends +We paid cash dividends during the years ended December 31, 2014 and 2015 as follows: +Per Share +Total +(in thousands) +2014: +Paid on March 27, 2014 +$ +0.10 +$ +14,456 +Paid on June 26, 2014 +0.10 +14,562 +Paid on September 24, 2014 +0.10 +14,634 +Paid on December 24, 2014 +0.10 +14,636 +Total cash dividends +$ +0.40 +$ +58,288 +2015: +Paid on March 25, 2015 +$ +0.10 +$ +14,640 +Paid on June 24, 2015 +0.10 +14,712 +Paid on September 24, 2015 +0.10 +14,712 +Paid on December 24, 2015 +0.10 +14,711 +Total cash dividends +$ +0.40 +$ +58,775 +On February 3, 2016, our Board of Directors approved a cash dividend on our common stock in the amount of $0.10 per share to be paid on March 24, 2016 to holders of record as of March 10, 2016. Our 2015 Term Loan Agreement contains a covenant that could restrict our ability to make dividend payments later in 2016. This covenant applies to only the 2015 Term Loan Agreement indebtedness, and we believe that our strong financial position allows us various alternatives to address this restriction, including repayment of this debt. However, the amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +(e) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2015. +Period Covered +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands)(1) +October 2015 +— +$ +— +— +$ +186,836 +November 2015 +— +$ +— +— +$ +186,836 +December 2015 +— +$ +— +— +$ +186,836 +Total +— +$ +— +— +$ +186,836 +(1) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2010 through December 31, 2015, with the cumulative total return of the Standard & Poors 500 Stock Index, the Standard & Poors MidCap Index, the Oilfield Service Index and a peer group determined by us. Our peer group consists of Helmerich & Payne, Inc., Nabors Industries, Ltd., Pioneer Energy Services Corp. and Precision Drilling Corp. All of the companies in our peer group are providers of +19 +land-based drill ing services. Nab ors Industries, Ltd. also has a majority equity interest in C&J Energy Services Ltd., which has a pressure pumping business . The graph assumes investment of $100 on December 31, 2010 and reinvestment of all dividends. +Fiscal Year Ended December 31, +2010 +2011 +2012 +2013 +2014 +2015 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +93.49 +88.24 +121.02 +80.57 +75.02 +Peer Group Index +100.00 +96.88 +85.44 +114.23 +89.19 +67.10 +S&P 500 Stock Index +100.00 +102.11 +118.45 +156.82 +178.28 +180.75 +Oilfield Service Index +100.00 +89.45 +92.29 +119.59 +91.44 +70.06 +S&P MidCap Index +100.00 +98.27 +115.84 +154.64 +169.75 +166.06 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +20 +Item 6. Selected Financial Data. +Our selected consolidated financial data as of December 31, 2015, 2014, 2013, 2012 and 2011, and for each of the five years in the period ended December 31, 2015 should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report. Due to the sale of our electric wireline business in January 2011, the results of operations for that business have been reclassified and are presented as discontinued operations for all periods presented. +Years Ended December 31, +2015 +2014 +2013 +2012 +2011 +(In thousands, except per share amounts) +Statement of Operations Data: +Operating revenues: +Contract drilling +$ +1,153,892 +$ +1,838,830 +$ +1,679,611 +$ +1,821,713 +$ +1,669,581 +Pressure pumping +712,454 +1,293,265 +979,166 +841,771 +845,803 +Oil and natural gas +24,931 +50,196 +57,257 +59,930 +50,559 +Total +1,891,277 +3,182,291 +2,716,034 +2,723,414 +2,565,943 +Operating costs and expenses: +Contract drilling +608,848 +1,066,659 +968,754 +1,075,491 +972,778 +Pressure pumping +612,021 +1,036,310 +744,243 +580,878 +561,398 +Oil and natural gas +11,500 +13,102 +12,909 +11,303 +9,615 +Depreciation, depletion, amortization and impairment +864,759 +718,730 +597,469 +526,614 +437,279 +Impairment of goodwill +124,561 +- +- +- +- +Selling, general and administrative +87,173 +80,145 +73,852 +64,473 +64,271 +Net gain on asset disposals +(10,613 +) +(15,781 +) +(3,384 +) +(33,806 +) +(4,999 +) +Provision for bad debts +— +— +— +1,100 +— +Total +2,298,249 +2,899,165 +2,393,843 +2,226,053 +2,040,342 +Operating income (loss) +(406,972 +) +283,126 +322,191 +497,361 +525,601 +Other expense +(35,477 +) +(28,843 +) +(25,750 +) +(21,688 +) +(14,883 +) +Income (loss) from continuing operations before income taxes +(442,449 +) +254,283 +296,441 +475,673 +510,718 +Income tax expense (benefit) +(147,963 +) +91,619 +108,432 +176,196 +187,938 +Income (loss) from continuing operations +$ +(294,486 +) +$ +162,664 +$ +188,009 +$ +299,477 +$ +322,780 +Income (loss) from continuing operations per common share: +Basic +$ +(2.00 +) +$ +1.12 +$ +1.29 +$ +1.96 +$ +2.08 +Diluted +$ +(2.00 +) +$ +1.11 +$ +1.28 +$ +1.96 +$ +2.06 +Cash dividends per common share +$ +0.40 +$ +0.40 +$ +0.20 +$ +0.20 +$ +0.20 +Weighted average number of common shares outstanding: +Basic +145,416 +144,066 +144,356 +151,144 +153,871 +Diluted +145,416 +145,376 +145,303 +151,699 +155,304 +Balance Sheet Data: +Total assets +$ +4,533,317 +$ +5,394,011 +$ +4,687,127 +$ +4,556,911 +$ +4,221,901 +Borrowings under line of credit +— +303,000 +— +— +110,000 +Other long-term debt +791,250 +670,000 +682,500 +692,500 +382,500 +Stockholders’ equity +2,561,131 +2,905,810 +2,755,997 +2,640,657 +2,516,631 +Working capital +178,404 +340,688 +454,373 +340,128 +346,238 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Recent Developments — Oil prices have significantly declined since the second half of 2014. The closing price of oil, which was as high as $105.68 per barrel during the third quarter of 2014, reached a low price for 2015 of $34.55 in December 2015 and reached a twelve-year low of $26.68 in January 2016. As a result of the prolonged decline in oil prices, our industry continues to experience a +21 +severe decline in both contract drilling and pressure pumping activity levels. We do not expect this to change until commodity prices improve. +Low commodity prices are negatively impacting spending by exploration and production companies. The impact of these spending reductions is evidenced by published rig counts, which in the United States decreased more than 60% during 2015 and is now almost 70% lower than the peak in 2014. +Our rig count has also significantly declined. As of December 31, 2015, we had 80 drilling rigs operating in the United States, which was a decrease of 63% from the recent peak of 214 rigs in October 2014. Our operating rig count has continued to decline in 2016. On average, we operated 78 rigs in the United States during January 2016. Term contracts provided some support of our operating rig count during 2015. Based on contracts currently in place, we expect an average of 59 rigs operating under term contracts during the first quarter and an average of 46 rigs operating under term contracts during 2016. +Our pressure pumping business is continuing to experience the effects of reduced spending by customers and downward pressure on pricing. Due to market conditions, as of December 31, 2015, we had stacked approximately 38% of our fracturing horsepower. With the weakness in commodity prices since the beginning of 2016, we have seen a significant decrease in the amount of available work, and the profitability of available work has continued to deteriorate. In response, since the beginning of 2016, we have stacked approximately 140,000 fracturing horsepower. In total, we now have stacked slightly more than half of our fleet of more than 1 million hydraulic fracturing horsepower. +In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014. In 2015, we continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate generally proportionate with the reduction in our rig count. In 2015, we significantly reduced our pressure pumping headcount and obtained lower prices on many products and services that we use. We also reduced our capital expenditures in 2015, and we expect our capital expenditures for 2016 to primarily consist of maintenance capital, inspections and potential upgrades, as we do not expect to build any new rigs or purchase any new fracturing horsepower in 2016. We plan to continue to adjust our cost structure in line with our level of operating activity. +We expect that our term contract coverage in contract drilling and scalability with respect to labor and other operating costs in contract drilling and pressure pumping should position us to weather this downturn. In the event oil prices remain depressed for a sustained period, or decline further, we may experience further significant declines in both drilling activity and spot dayrate pricing and in pressure pumping activity, which could have a material adverse effect on our business, financial condition and results of operations. +Management Overview — We are a leading provider of services to the North American oil and natural gas industry. Our services primarily involve the drilling, on a contract basis, of land-based oil and natural gas wells and pressure pumping services. In addition to these services, we also invest, on a non-operating working interest basis, in oil and natural gas properties. +We operate land-based drilling rigs in oil and natural gas producing regions of the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. There continues to be uncertainty with respect to the global economic environment, and oil and natural gas prices are significantly depressed. During the fourth quarter of 2015, our average number of rigs operating in the United States was 88 compared to an average of 210 drilling rigs operating during the same period in 2014. During the fourth quarter of 2015, our average number of rigs operating in Canada was three compared to an average of nine drilling rigs operating during the fourth quarter of 2014. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by expanding our areas of operation and improving the capabilities of our drilling fleet during the last several years. As of December 31, 2015, our rig fleet included 161 APEX ® rigs. We do not expect to add any new rigs to our fleet during 2016. +In connection with the development of horizontal shale and other unconventional resource plays, we have added equipment to perform service intensive fracturing jobs. As of December 31, 2015, we had approximately 1.1 million hydraulic horsepower in our pressure pumping fleet. We have increased the horsepower of our pressure pumping fleet by more than eight-fold since the beginning of 2009, although we have not ordered or committed to purchase any new horsepower since October 2014 and there is currently no new horsepower on order. In recent years, the industry-wide addition of new pressure pumping equipment to the marketplace and lower oil and natural gas prices have led to an excess supply of pressure pumping equipment in North America. +We maintain a backlog of commitments for contract drilling revenues under term contracts, which we define as contracts with a fixed term of six months or more. Our contract drilling backlog as of December 31, 2015 and 2014 was $710 million and $1.5 billion, respectively. The decrease in backlog at December 31, 2015 from December 31, 2014, is primarily due to the revenue earned since December 31, 2014, including from the receipt of early termination payments, and the expiration and termination of term contracts. Approximately 40 percent of the total December 31, 2015 backlog is reasonably expected to remain after 2016. We generally +22 +calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to other fees such as for mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the ri g is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. In addition, generally our term drilling contracts are subject to termination by the customer on short notice and provide for an early termina tion payment to us in the event that the contract is terminated by the customer. For contracts that we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate , for the period we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Continue to Decline and May Not Ultimately Be Realized , as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment .” +For the three years ended December 31, 2015, our operating revenues consisted of the following (dollars in thousands): +2015 +2014 +2013 +Contract drilling +$ +1,153,892 +61 +% +$ +1,838,830 +58 +% +$ +1,679,611 +62 +% +Pressure pumping +712,454 +38 +% +1,293,265 +41 +% +979,166 +36 +% +Oil and natural gas +24,931 +1 +% +50,196 +1 +% +57,257 +2 +% +$ +1,891,277 +100 +% +$ +3,182,291 +100 +% +$ +2,716,034 +100 +% +Generally, the profitability of our business is impacted most by two primary factors in our contract drilling segment: our average number of rigs operating and our average revenue per operating day. During 2015, our average number of rigs operating was 120 in the United States and four in Canada compared to 203 in the United States and eight in Canada in 2014 and 184 in the United States and eight in Canada in 2013. Our average rig revenue per operating day was $25,560 in 2015 compared to $23,880 in 2014 and $24,020 in 2013. We had a consolidated net loss of $294 million for 2015 compared to consolidated net income of $163 million for 2014. The financial results for 2015 include pretax non-cash charges totaling approximately $288 million. These charges include $125 million from the impairment of all goodwill associated with our pressure pumping business, $131 million from the write-down of drilling equipment primarily related to mechanical rigs and spare mechanical rig components, $22.0 from the write-down of pressure pumping equipment and closed facilities and $10.7 million related to the impairment of certain oil and natural gas properties. The financial results for 2014 include a pretax non-cash charge of $77.9 million related to the retirement of mechanical rigs and the write-off of excess spare components. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas. During periods of improved commodity prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when these commodity prices deteriorate, the demand for our services generally weakens and we experience downward pressure on pricing for our services. Oil and natural gas prices and our monthly average number of rigs operating have significantly declined from recent highs. In December 2015, our average number of rigs operating was 82 in the United States. In January 2016, our average number of rigs operating decreased to 78 in the United States. +We are also highly impacted by operational risks, competition, the availability of excess equipment, labor issues, weather and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. Please see “Risk Factors” in Item 1A of this Report. +Critical Accounting Policies +In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition, the use of estimates and oil and natural gas properties. +Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying values of certain assets may not be recovered over their estimated remaining useful lives. In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The cyclical nature of our industry has resulted in fluctuations in rig utilization over periods of time. Management believes that the contract drilling industry will continue to be cyclical and rig utilization will continue to fluctuate. Based on management’s expectations of future trends, we estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as management’s expectations regarding the continuation of these trends in the future. +23 +Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fai r value. +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional, vertical wells versus drilling longer, horizontal wells using higher specification rigs). The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs will be retired. In 2015, we identified 24 mechanical rigs and 9 non-APEX® electric rigs that would no longer be marketed. Also, we had 15 additional mechanical rigs that were not operating. Although these 15 rigs remain marketable, we have lower expectations with respect to utilization of these rigs due to the industry shift to higher specification drilling rigs. In 2015, we recorded a charge of $131 million related to the retirement of the 33 rigs, the 15 mechanical rigs that remain marketable but were not operating, and the write-down of excess spare rig components to their realizable values. In 2014, we identified 55 mechanical rigs that we determined would no longer be marketed, and we recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the reduced size of our mechanical fleet. In 2013, we identified 48 rigs that would no longer be marketed. Also, we had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. In 2013, we recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. +We also periodically evaluate our pressure pumping assets, and in 2015, we recorded a charge of $22.0 million for the write-down of pressure pumping equipment and certain closed facilities. There were no similar charges in 2014 or 2013. +We evaluate the recoverability of our long-lived assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable (a “triggering event”). During the first quarter of 2015, oil prices averaged $48.54 per barrel and reached a low of $43.39 per barrel in March 2015. Oil prices improved during the second quarter of 2015 and averaged $57.85 per barrel. Although the price improvement was earlier than we projected, this improvement was generally consistent with our assumption at December 31, 2014 that oil prices would improve late in 2015 and continue to improve in 2016, resulting in improved activity levels for both the contract drilling and pressure pumping businesses. During the second quarter of 2015 as oil prices increased, we received requests from customers to reactivate drilling rigs to resume operations in the third quarter of 2015. We believed this was an indication that future activity levels would be improving for both the contract drilling and pressure pumping businesses. During the third quarter of 2015, however, oil prices declined and averaged $46.42 per barrel and reached a new low for 2015 of $38.22 per barrel in August 2015. +With lower oil prices in August, we lowered our expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. In light of these revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping services during the third quarter of 2015, we deemed it necessary to assess the recoverability of long-lived asset groups for both contract drilling and pressure pumping. We performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within our contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 60%, respectively. +Due to the continued deterioration of crude oil prices in the fourth quarter of 2015, we deemed it necessary to again assess the recoverability of long-lived assets groups for both contract drilling and pressure pumping. We performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within our contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 100%, respectively. +For both of the assessments performed in 2015, the expected cash flows for the contract drilling segment included the backlog of commitments for contract drilling revenues under term contracts, which was approximately $801 million and $710 million at September 30, 2015 and December 31, 2015, respectively. Rigs not under term contracts will be subject to pricing in the spot market. Utilization and rates for rigs in the spot market and for the pressure pumping segment were estimated based upon our historical experience in prior downturns. Also, the expected cash flows for the contract drilling and pressure pumping segments were based on the assumption that activity levels in both segments would begin to recover in the first quarter of 2017 in response to improved oil prices. While we believe these assumptions with respect to future pricing for oil and natural gas are reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil and natural gas prices will recover is highly uncertain. Potential events that could affect our assumptions regarding future prices and the timeframe for a recovery are affected by factors such as: +· +market supply and demand, +24 +· +the desire and ability of the Organization of Petroleum Exporting Countries, commonly known as OPEC, to set and maintain production and price targets, +· +the level of production by OPEC and non-OPEC countries, +· +domestic and international military, political, economic and weather conditions, +· +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +· +technical advances affecting energy consumption and production, +· +the price and availability of alternative fuels, +· +the cost of exploring for, developing, producing and delivering oil and natural gas, and +· +regulations regarding the exploration, development, production and delivery of oil and natural gas. +All of these factors are beyond our control. If the current lower oil and natural gas commodity price environment were to last into 2017 and beyond, our actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future and such impairment could be material. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing have been determined to be our operating segments. We first determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if it is, then goodwill impairment is determined using a two-step quantitative impairment test. From time to time, we may perform the first step of the quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. The first step of the quantitative testing is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the quantitative testing is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of the shortfall. +During the first quarter of 2015, oil prices averaged $48.54 per barrel and reached a low of $43.39 per barrel in March 2015. Oil prices improved during the second quarter of 2015 and averaged $57.85 per barrel. Although the price improvement was earlier than we projected, this improvement was generally consistent with our assumption at December 31, 2014, that oil prices would improve in late 2015 and continue to improve in 2016, resulting in improved activity levels for both the contract drilling and pressure pumping businesses. During the second quarter of 2015 as oil prices increased, we received requests from customers to reactivate drilling rigs to resume operations in the third quarter of 2015. We believed this was an indication that future activity levels would be improving for both the contract drilling and pressure pumping businesses. During the third quarter of 2015, however, oil prices declined and averaged $46.42 per barrel and reached a new low for 2015 of $38.22 per barrel in August 24, 2015. With lower oil prices in August, we lowered our expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. In light of our revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping services during the third quarter of 2015, we performed a quantitative impairment assessment of our goodwill as of September 30, 2015. In completing the first step of the assessment, the fair value of each reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of our contract drilling and pressure pumping reporting units, such as future oil and natural gas prices and projected demand for our services, and assumptions related to discount rates, long-term growth rates and control premiums. +Based on the results of the first step of the goodwill impairment test as of September 30, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 15%, and we concluded that no impairment was indicated in our contract drilling reporting unit; however, impairment was indicated in our pressure pumping reporting unit. In the three months ended September 30, 2015, we recognized an impairment charge of $125 million associated with the impairment of all of the goodwill of the pressure pumping reporting unit. +We performed a quantitative impairment assessment of the goodwill of our contract drilling reporting unit as of December 31, 2015. In completing the first step of the assessment, the fair value of the contract drilling reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of the reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of our contract drilling reporting unit, such as future oil and natural gas prices and projected demand for our services, and assumptions related to discount rates, long-term growth rates and control premiums. Based on the results of the first step of the quantitative impairment assessment of our goodwill, as of December 31, 2015, the fair value of our contract drilling reporting unit exceeded its carrying value by approximately 16%, and we concluded that no impairment was indicated in our contract drilling reporting unit. +25 +In connection with our annual goodwill impairment assessment as of December 31, 2014, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than their carrying amounts and further testing was not necessary. In making this determination, we considered the continued demand experienced during 2014 for our services in the contract drilling and pressure pumping businesses. We also considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in these operating segments. Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account. Our overall market capitalization and the large amount of calculated excess of the f air values of our reporting units over their carrying values from our 2013 quantitative Step 1 assessment of goodwill were also considered. +We have undertaken extensive efforts in the past several years to upgrade our fleet of equipment and believe that we are well positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells. In the event that market conditions were to remain weak for a protracted period, we may be required to record an impairment of goodwill in our contract drilling reporting unit in the future, and such impairment could be material. +Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed. Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs. All of the wells we drilled in 2015, 2014 and 2013 were drilled under daywork contracts. +Use of estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Key estimates used by management include: +· +allowance for doubtful accounts, +· +depreciation, depletion and amortization, +· +fair values of assets acquired and liabilities assumed in acquisitions, +· +goodwill and long-lived asset impairments, and +· +reserves for self-insured levels of insurance coverage. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense. Geological and geophysical costs, including seismic costs and costs to carry and retain undeveloped properties, are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on our expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). The expected future net cash flows are discounted using an annual rate of 10% to determine fair value. We review unproved oil and natural gas properties quarterly to assess potential impairment. Our impairment assessment is made on a lease-by-lease basis and considers factors such as our intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to proved and unproved oil and natural gas properties totaled +26 +approximately $ 10.7 million, $ 20.9 million and $ 4.0 million for the years ended Dece mber 31, 201 5 , 201 4 and 201 3 , respectively, and is included in depreciation, depletion, amortization and impairment in the consolidated statements of operations. +For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Liquidity and Capital Resources +Our liquidity as of December 31, 2015 included approximately $178 million in working capital and $500 million available under our revolving credit facility. +We believe our current liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt and pay cash dividends. If under current market conditions we desire to pursue opportunities for growth that require capital, we believe we would likely require additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +As of December 31, 2015, we had working capital of $178 million, including cash and cash equivalents of $113 million, compared to working capital of $341 million and cash and cash equivalents of $43 million at December 31, 2014. +During 2015, our sources of cash flow included: +· +$999 million from operating activities, +· +$200 million in borrowings pursuant to a new term loan agreement, and +· +$20.8 million in proceeds from the disposal of property and equipment. +During 2015, we used a net of $303 million to pay off our revolving credit facility, $58.8 million to pay dividends on our common stock, $27.5 million to repay long-term debt, $8.0 million to acquire shares of our common stock, $2.0 million to pay debt issuance costs and $744 million: +· +to build and to acquire components to build new drilling rigs and to purchase new pressure pumping equipment, +· +to make capital expenditures for the betterment and refurbishment of existing drilling rigs and pressure pumping equipment, +· +to acquire and procure equipment and facilities for our drilling and pressure pumping operations, and +· +to fund investments in oil and natural gas properties on a non-operating working interest basis. +We paid cash dividends during the year ended December 31, 2015 as follows: +Per Share +Total +(in thousands) +Paid on March 25, 2015 +$ +0.10 +$ +14,640 +Paid on June 24, 2015 +0.10 +14,712 +Paid on September 24, 2015 +0.10 +14,712 +Paid on December 24, 2015 +0.10 +14,711 +Total cash dividends +$ +0.40 +$ +58,775 +On February 3, 2016, our Board of Directors approved a cash dividend on our common stock in the amount of $0.10 per share to be paid on March 24, 2016 to holders of record as of March 10, 2016. Our 2015 Term Loan Agreement contains a covenant that could restrict our ability to make dividend payments later in 2016. This covenant applies to only the 2015 Term Loan Agreement indebtedness, and we believe that our strong financial position allows us various alternatives to address this restriction, including repayment of this debt. However, the amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +On July 25, 2012, our Board of Directors approved a stock buyback program authorizing purchases of up to $150 million of our common stock in open market or privately negotiated transactions. On September 6, 2013, our Board of Directors terminated any remaining authority under the 2012 stock buyback program, and approved a new stock buyback program that authorizes purchase of up to $200 million of our common stock in open market or privately negotiated transactions. As of December 31, 2015, we had +27 +remaining authorization to purchase approximately $187 million of our outstanding common stock under the 2013 stock buyback program. Shares purchased under a buyback program are accounted for as treasury stock. +We acquired shares of stock from employees during 2015, 2014 and 2013 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options by employees. The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) or the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback programs. +Treasury stock acquisitions during the year ended December 31, 2015, 2014 and 2013 were as follows (dollars in thousands): +2015 +2014 +2013 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +38,146,738 +$ +795,051 +Purchases pursuant to stock buyback programs: +2012 program +— +— +— +— +2,567,266 +51,107 +2013 program +8,618 +180 +13,898 +466 +602,564 +12,517 +Acquisitions pursuant to long-term incentive plans +380,037 +7,830 +536,630 +17,681 +951,489 +22,213 +Treasury shares at end of period +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +2012 Credit Agreement — On September 27, 2012, we entered into a credit agreement (the “Credit Agreement”). The Credit Agreement is a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility. The Credit Agreement replaced a previous senior unsecured revolving credit facility. +The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time. The revolving credit facility contains a letter of credit facility that is limited to $150 million and a swing line facility that is limited to $40 million, in each case outstanding at any time. +The term loan facility provides for a loan of $100 million, which was drawn on December 24, 2012. The term loan facility is payable in quarterly principal installments which commenced December 27, 2012. The installment amounts vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments, 5.00% of the original principal amount for the subsequent four quarterly installments and 13.75% of the original principal amount for the final four quarterly installments. +Subject to customary conditions, we may request that the lenders’ aggregate commitments with respect to the revolving credit facility and/or the term loan facility be increased by up to $100 million, not to exceed total commitments of $700 million. The maturity date under the Credit Agreement is September 27, 2017 for both the revolving facility and the term facility. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 2.25% to 3.25% and the applicable margin on base rate loans varies from 1.25% to 2.25%, in each case determined based upon our debt to capitalization ratio. As of December 31, 2015, the applicable margin on LIBOR rate loans was 2.25% and the applicable margin on base rate loans was 1.25%. Based on our debt to capitalization ratio at September 30, 2015, the applicable margin on LIBOR rate loans is 2.25% and the applicable margin on base rate loans is 1.25% as of January 1, 2016. Based on our debt to capitalization ratio at December 31, 2015, the applicable margin on LIBOR rate loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2016. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%. +Each of our domestic subsidiaries will unconditionally guarantee all existing and future indebtedness and liabilities of the other guarantors and us arising under the Credit Agreement, other than (a) Ambar Lone Star Fluid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million. Such guarantees also cover our obligations and those of any of our subsidiaries arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 45%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last +28 +day of t he most recently ended fiscal quarter. We also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings be fore interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 201 5 . The Credit Agreement also contains customary repres entations, warranties and affirmative and negative covenants. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require us to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy such acceleration is automatic), and (iii) require us to cash collateralize any outstanding letters of credit. +As of December 31, 2015, we had $70.0 million principal amount outstanding under the term loan facility at an interest rate of 2.875% and no amounts outstanding under the revolving credit facility. We currently have available borrowing capacity of $500 million under the revolving credit facility. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2015, we had $41.1 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015 (the “Continuing Guaranty”), our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. +2015 Term Loan Agreement — On March 18, 2015, we entered into a Term Loan Agreement (the “2015 Term Loan Agreement”) with Wells Fargo Bank, N.A., as administrative agent and lender, each of the other lenders party thereto, Wells Fargo Securities, LLC, as Lead Arranger and Sole Book Runner, and Bank of America, N.A. and The Bank Of Tokyo-Mitsubishi UFJ, LTD., as Co-Syndication Agents. +The 2015 Term Loan Agreement is a senior unsecured single-advance term loan facility pursuant to which we made a term loan borrowing of $200 million on March 18, 2015 (the “Term Loan Borrowing”). The Term Loan Borrowing is payable in quarterly principal installments, together with accrued interest, on each June 30, September 30, December 31 and March 31, commencing on June 30, 2015. Each of the first four principal installments is in an amount equal to 2.5% of the Term Loan Borrowing and each successive quarterly installment, until and including June 30, 2017, is in an amount equal to 5.0% of the Term Loan Borrowing, with the outstanding principal balance of the Term Loan Borrowing due on the maturity date under the 2015 Term Loan Agreement. The maturity date under the 2015 Term Loan Agreement is September 27, 2017. Loans under the 2015 Term Loan Agreement bear interest, at our election, at the per annum rate of LIBOR rate plus 3.25% or base rate plus 2.25%. +Each of our domestic subsidiaries will unconditionally guarantee all existing and future indebtedness and liabilities of the other guarantors and us arising under the 2015 Term Loan Agreement and other Loan Documents (as defined in the 2015 Term Loan Agreement), other than (a) Ambar Lone Star Fluid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million. +29 +The 2015 Term Loan Agreement requires quarterly compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 45%. The 2015 Term Loan Agreement generally defines the debt to capitalization rat io as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the most recently ended fiscal quarter. We also must not permit the interest coverage ra tio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The 2015 Term Loan Agreement generally defines the interest coverage ratio as the ratio of EBITDA of the four prior fiscal quarters to interest charges for the same period. We were in compliance with these financial covenants as of December 31 , 2015. +The 2015 Term Loan Agreement further provides that neither we nor our subsidiaries are permitted to make restricted payments unless, after giving effect to such restricted payment, our pro forma ratio of debt to EBITDA for the four prior fiscal quarters, determined as of the preceding ending quarterly period, does not exceed 2.50 to 1.00. Restricted payments are generally defined as (a) dividends and distributions made on account of our equity interests or our subsidiaries and (b) payments made to redeem, repurchase or otherwise retire our equity interests or our subsidiaries. Payments made solely in the form of common equity interests, made to us and our subsidiaries, or made in connection with our long-term incentive plans are not restricted payments under the 2015 Term Loan Agreement. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +The 2015 Term Loan Agreement also contains customary representations, warranties, affirmative and negative covenants, and events of default. Events of default under the 2015 Term Loan Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, Loan Document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to accelerate and require us to repay all the outstanding amounts owed under any Loan Document (provided that in limited circumstances with respect to insolvency and bankruptcy, such acceleration is automatic). +As of December 31, 2015, we had $185 million principal amount outstanding under the 2015 Term Loan Agreement at an interest rate of 3.875%. +Senior Notes — On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. We pay interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amounts of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. We pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations, which rank equally in right of payment with all of our other unsubordinated indebtedness. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of our domestic subsidiaries other than subsidiaries that are not required to be guarantors under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at our option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. We must offer to prepay the notes upon the occurrence of any change of control. In addition, we must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2015. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement +30 +ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amoun t of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if we default in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +Commitments and Contingencies — As of December 31, 2015, we maintained letters of credit in the aggregate amount of $41.1 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2015, no amounts had been drawn under the letters of credit. +As of December 31, 2015, we had commitments to purchase approximately $73.5 million of major equipment for our drilling and pressure pumping businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. These agreements expire in 2016, 2017 and 2018. As of December 31, 2015, the remaining obligation under these agreements was approximately $26.6 million, of which materials with a total purchase price of approximately $9.5 million were required to be purchased during 2016. In the event that the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. +In November 2011, our pressure pumping business entered into an agreement with a proppant vendor to advance up to $12.0 million to such vendor to finance its construction of certain processing facilities. This advance is secured by the underlying processing facilities and bears interest at an annual rate of 5.0%. Repayment of the advance is to be made through discounts applied to purchases from the vendor and repayment of all amounts advanced must be made no later than October 1, 2017. As of December 31, 2015, advances of approximately $11.8 million had been made under this agreement and repayments of approximately $10.6 million had been received resulting in a balance outstanding of approximately $1.2 million. +A $12.3 million charge related to the previously disclosed settlement of a lawsuit filed by the U.S. Equal Employment Opportunity Commission against our U.S. contract drilling subsidiary was recorded in the first quarter of 2015. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Contractual Obligations +The following table presents information with respect to our contractual obligations as of December 31, 2015 (dollars in thousands): +Payments due by period +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Term loan (1) +$ +70,000 +$ +28,750 +$ +41,250 +$ +— +$ +— +Interest on term loan (2) +2,734 +2,046 +688 +— +— +2015 Term Loan (3) +185,000 +35,000 +150,000 +— +— +Interest on 2015 Term Loan (4) +10,913 +6,843 +4,070 +— +— +Series A Notes (5) +300,000 +— +— +300,000 +— +Interest on Series A Notes (6) +71,030 +14,910 +29,820 +26,300 +— +Series B Notes (7) +300,000 +— +— +— +300,000 +Interest on Series B Notes (8) +82,696 +12,810 +25,620 +25,620 +18,646 +Leases (9) +30,162 +10,522 +9,022 +5,963 +4,655 +Equipment purchases (10) +73,464 +73,464 +— +— +— +Inventory purchases (11) +26,550 +9,525 +17,025 +— +— +$ +1,152,549 +$ +193,870 +$ +277,495 +$ +357,883 +$ +323,301 +31 +(1) +Represents repayments of borrowings under the term loan portion of the Credit Agreement. The term loan matures o n September 27, 2017. +(2) +Interest to be paid on term loan using 2.875% rate in effect through March 31, 2016 and using 3.375% thereafter. +(3) +Represents repayments of borrowings under the 2015 Term Loan Agreement. The 2015 Term Loan Agreement matures on September 27, 2017. +(4) +Interest to be paid on 2015 Term Loan using 3.875% rate in effect as of December 31, 2015. +(5) +Principal repayment of the Series A Notes is required at maturity on October 5, 2020. +(6) +Interest to be paid on the Series A Notes using 4.97% coupon rate. +(7) +Principal repayment of the Series B Notes is required at maturity on June 14, 2022. +(8) +Interest to be paid on the Series B Notes using 4.27% coupon rate. +(9) +See Note 11 of Notes to Consolidated Financial Statements. +(10) +Represents commitments to purchase major equipment to be delivered in 2016 based on expected delivery dates. +(11) +Represents commitments to purchase proppants and chemicals for our pressure pumping business. +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements at December 31, 2015. +Results of Operations +Comparison of the years ended December 31, 2015 and 2014 +The following tables summarize operations by business segment for the years ended December 31, 2015 and 2014: +Year Ended December 31, +Contract Drilling +2015 +2014 +% Change +(Dollars in thousands) +Revenues +$ +1,153,892 +$ +1,838,830 +(37.2 +)% +Direct operating costs +608,848 +1,066,659 +(42.9 +)% +Margin (1) +545,044 +772,171 +(29.4 +)% +Selling, general and administrative +17,840 +6,297 +183.3 +% +Depreciation, amortization and impairment +618,434 +524,023 +18.0 +% +Operating income (loss) +$ +(91,230 +) +$ +241,851 +NA +Operating days +45,142 +77,000 +(41.4 +)% +Average revenue per operating day +$ +25.56 +$ +23.88 +7.0 +% +Average direct operating costs per operating day +$ +13.49 +$ +13.85 +(2.6 +)% +Average margin per operating day (1) +$ +12.07 +$ +10.03 +20.3 +% +Average rigs operating +123.7 +211.0 +(41.4 +)% +Capital expenditures +$ +527,054 +$ +771,593 +(31.7 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +The demand for our contract drilling services is impacted by the market price of oil and natural gas. The decline in prices for oil and natural gas, together with the reactivation and construction of new land drilling rigs in the United States in recent years have resulted in an excess capacity of land drilling rigs compared to demand. Also in recent years, customer demand has shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs. The average market price of oil and natural gas for each of the fiscal quarters and full year in 2015 and 2014 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2014: +Average oil price per Bbl (1) +$ +98.75 +$ +103.35 +$ +97.78 +$ +73.16 +$ +93.26 +Average natural gas price per Mcf (2) +$ +5.21 +$ +4.61 +$ +3.96 +$ +3.80 +$ +4.39 +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +$ +48.69 +Average natural gas price per Mcf (2) +$ +2.90 +$ +2.75 +$ +2.76 +$ +2.12 +$ +2.63 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +32 +(2) +The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy Information Administration. +The decreases in revenues and direct operating costs primarily result from the decrease in the number of rigs operating. Average revenue per operating day and average margin per operating day were higher in 2015 primarily due to higher average dayrates and early termination revenues of approximately $69.4 million. Selling, general and administrative expense for 2015 includes a $12.3 million charge related to a previously disclosed legal settlement. Depreciation, amortization and impairment expense for 2015 includes a charge of $131 million related to the write-down of drilling equipment primarily related to mechanical rigs and spare mechanical rig components. Depreciation, amortization and impairment expense for 2014 includes a charge of $77.9 million related to the retirement of mechanical drilling rigs and the write-off of excess spare mechanical rig components. The increase in depreciation expense also reflects significant capital expenditures incurred in recent years to build new drilling rigs, to modify and upgrade existing drilling rigs and to acquire additional related equipment such as top drives, drill pipe, drill collars, engines, fluid circulating systems, rig hoisting systems and safety enhancement equipment. +Year Ended December 31, +Pressure Pumping +2015 +2014 +% Change +(Dollars in thousands) +Revenues +$ +712,454 +$ +1,293,265 +(44.9 +)% +Direct operating costs +612,021 +1,036,310 +(40.9 +)% +Margin (1) +100,433 +256,955 +(60.9 +)% +Selling, general and administrative +16,318 +20,279 +(19.5 +)% +Depreciation, amortization and impairment +214,552 +147,595 +45.4 +% +Impairment of goodwill +124,561 +— +NA +Operating income (loss) +$ +(254,998 +) +$ +89,081 +NA +Fracturing jobs +610 +1,224 +(50.2 +)% +Other jobs +2,080 +4,253 +(51.1 +)% +Total jobs +2,690 +5,477 +(50.9 +)% +Average revenue per fracturing job +$ +1,117.95 +$ +991.89 +12.7 +% +Average revenue per other job +$ +14.66 +$ +18.62 +(21.3 +)% +Average revenue per total job +$ +264.85 +$ +236.13 +12.2 +% +Average direct operating costs per total job +$ +227.52 +$ +189.21 +20.2 +% +Average margin per total job (1) +$ +37.34 +$ +46.92 +(20.4 +)% +Margin as a percentage of revenues (1) +14.1 +% +19.9 +% +(29.1 +)% +Capital expenditures and acquisitions +$ +197,577 +$ +241,359 +(18.1 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Revenues and direct operating costs decreased primarily due to a decrease in the number of jobs, although the average size of the fracturing jobs increased. Average revenue per fracturing job and average direct operating costs per total job increased as a result of the increased size of the jobs in 2015 as compared to 2014. The total number of jobs decreased as a result of the downturn in the oil and natural gas industry. Depreciation, amortization and impairment expense for 2015 includes a charge of $22.0 million related to the write-down of pressure pumping equipment and closed facilities. There were no similar charges in 2014. Depreciation expense also increased due to capital expenditures and acquisitions. All of the goodwill associated with our pressure pumping business was impaired during 2015. +Year Ended December 31, +Oil and Natural Gas Production and Exploration +2015 +2014 +% Change +(Dollars in thousands) +Revenues - Oil +$ +22,318 +$ +44,436 +(49.8 +)% +Revenues – Natural gas and liquids +2,613 +5,760 +(54.6 +)% +Revenues - Total +24,931 +50,196 +(50.3 +)% +Direct operating costs +11,500 +13,102 +(12.2 +)% +Margin (1) +13,431 +37,094 +(63.8 +)% +Depletion and impairment +26,301 +42,576 +(38.2 +)% +Operating loss +$ +(12,870 +) +$ +(5,482 +) +134.8 +% +Capital expenditures +$ +16,625 +$ +36,683 +(54.7 +)% +33 +(1) +Margin is defined as revenues less direct operating costs and excludes depletion and impairment. +Oil and natural gas and liquids revenues decreased as a result of lower commodity prices. Direct operating costs include a reduction in taxes due to lower revenues. Depletion and impairment expense in 2015 includes approximately $10.7 million of oil and natural gas property impairments compared to approximately $20.9 million of oil and natural gas property impairments in 2014. +Year Ended December 31, +Corporate and Other +2015 +2014 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +53,015 +$ +53,569 +(1.0 +)% +Depreciation +$ +5,472 +$ +4,536 +20.6 +% +Net gain on asset disposals +$ +(10,613 +) +$ +(15,781 +) +(32.7 +)% +Interest income +$ +964 +$ +979 +(1.5 +)% +Interest expense +$ +36,475 +$ +29,825 +22.3 +% +Other income +$ +34 +$ +3 +1,033.3 +% +Capital expenditures +$ +2,520 +$ +2,706 +(6.9 +)% +Gains and losses on the disposal of assets are treated as part of our corporate activities because such transactions relate to corporate strategy decisions of our executive management group. Interest expense increased primarily due to borrowings under the 2015 Term Loan Agreement. +Comparison of the years ended December 31, 2014 and 2013 +The following tables summarize operations by business segment for the years ended December 31, 2014 and 2013: +Year Ended December 31, +Contract Drilling +2014 +2013 +% Change +(Dollars in thousands) +Revenues +$ +1,838,830 +$ +1,679,611 +9.5 +% +Direct operating costs +1,066,659 +968,754 +10.1 +% +Margin (1) +772,171 +710,857 +8.6 +% +Selling, general and administrative +6,297 +5,867 +7.3 +% +Depreciation, amortization and impairment +524,023 +438,728 +19.4 +% +Operating income +$ +241,851 +$ +266,262 +(9.2 +)% +Operating days +77,000 +69,918 +10.1 +% +Average revenue per operating day +$ +23.88 +$ +24.02 +(0.6 +)% +Average direct operating costs per operating day +$ +13.85 +$ +13.86 +(0.1 +)% +Average margin per operating day (1) +$ +10.03 +$ +10.17 +(1.4 +)% +Average rigs operating +$ +211.0 +191.6 +10.1 +% +Capital expenditures +$ +771,593 +$ +504,508 +52.9 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +34 +The deman d for our contract drilling services is impacted by the market price of oil and natural gas. The reactivation and construction of new land drilling rigs in the United States in recent years contributed to an excess capacity of land drilling rigs compared to demand. Customer demand shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs. The average market price of oil and natural gas for each of the f iscal quarters and full year in 201 4 and 201 3 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2013: +Average oil price per Bbl (1) +$ +94.37 +$ +94.10 +$ +105.84 +$ +97.34 +$ +97.91 +Average natural gas price per Mcf (2) +$ +3.49 +$ +4.01 +$ +3.55 +$ +3.85 +$ +3.73 +2014: +Average oil price per Bbl (1) +$ +98.75 +$ +103.35 +$ +97.78 +$ +73.16 +$ +93.26 +Average natural gas price per Mcf (2) +$ +5.21 +$ +4.61 +$ +3.96 +$ +3.80 +$ +4.39 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy Information Administration. +Revenues and direct operating costs increased in 2014 compared to 2013 as a result of an increase in the number of rigs operating. Revenues in 2013 included approximately $65.2 million of early termination revenues. Average revenue per operating day and average margin per operating day were higher in 2013 due to the early termination revenue. Capital expenditures were incurred in 2014 and 2013 to build new drilling rigs, to modify and upgrade existing drilling rigs and to acquire additional equipment including top drives, drill pipe, drill collars, engines, fluid circulating systems, rig hoisting systems and safety enhancement equipment. In 2014, we identified 55 mechanical rigs that we determined would no longer be marketed. We recorded additional depreciation, amortization and impairment expense of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the now reduced size of our mechanical fleet. In 2013, we identified 48 rigs that would no longer be marketed. Also, we had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. We recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. Significant capital expenditures incurred in recent years to add new rig capacity also contributed to the increase in depreciation expense. +Year Ended December 31, +Pressure Pumping +2014 +2013 +% Change +(Dollars in thousands) +Revenues +$ +1,293,265 +$ +979,166 +32.1 +% +Direct operating costs +1,036,310 +744,243 +39.2 +% +Margin (1) +256,955 +234,923 +9.4 +% +Selling, general and administrative +20,279 +17,695 +14.6 +% +Depreciation, amortization and impairment +147,595 +129,984 +13.5 +% +Operating income +$ +89,081 +$ +87,244 +2.1 +% +Fracturing jobs +1,224 +1,261 +(2.9 +)% +Other jobs +4,253 +4,800 +(11.4 +)% +Total jobs +5,477 +6,061 +(9.6 +)% +Average revenue per fracturing job +$ +991.89 +$ +705.57 +40.6 +% +Average revenue per other job +$ +18.62 +$ +18.63 +(0.1 +)% +Average revenue per total job +$ +236.13 +$ +161.55 +46.2 +% +Average direct operating costs per total job +$ +189.21 +$ +122.79 +54.1 +% +Average margin per total job (1) +$ +46.92 +$ +38.76 +21.1 +% +Margin as a percentage of revenues (1) +19.9 +% +24.0 +% +(17.1 +)% +Capital expenditures +$ +241,359 +$ +122,782 +96.6 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Revenues and direct operating costs increased primarily due to an increase in the size of our jobs and the size of our pressure pumping fleet. Our customers continued the development of unconventional reservoirs resulting in an increase in larger multi-stage +35 +fracturing jobs associated therewith. In connection with the horizontal shale and other unconventional resource plays, we added equipment to perform service intensive fracturing jobs, includ ing the June 2014 acquisition of an East Texas-based pressure pumping operation and the October 2014 acquisition of a Texas-based pressure pumping operation. As a result, we continued to experience an increase in the number of these larger multi-stage fra cturing jobs as a proportion of the total fracturing jobs we performed. Additionally, the average size of the multi-stage fracturing jobs increased. Average revenue per fracturing job and average direct operating costs per total job increased as a result of this increase in the proportion of larger multi-stage fracturing jobs and the increased size of the jobs in 2014 as compared to 2013. Depreciation expense increased due to capital expenditures. +Year Ended December 31, +Oil and Natural Gas Production and Exploration +2014 +2013 +% Change +(Dollars in thousands) +Revenues - Oil +$ +44,436 +$ +51,583 +(13.9 +)% +Revenues – Natural gas and liquids +5,760 +5,674 +1.5 +% +Revenues - Total +50,196 +57,257 +(12.3 +)% +Direct operating costs +13,102 +12,909 +1.5 +% +Margin (1) +37,094 +44,348 +(16.4 +)% +Depletion and impairment +42,576 +24,400 +74.5 +% +Operating income (loss) +$ +(5,482 +) +$ +19,948 +NA +Capital expenditures +$ +36,683 +$ +31,245 +17.4 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depletion and impairment. +Oil revenues decreased as a result of lower average oil prices and lower production. Natural gas and liquids revenue increased due to higher average prices, partially offset by lower production. Direct operating costs and depletion expense increased primarily due to the addition of new wells. Depletion and impairment expense in 2014 includes approximately $20.9 million of oil and natural gas property impairments, compared to approximately $4.0 million of oil and natural gas property impairments in 2013. The impairment in 2014 is primarily the result of lower oil prices. +Year Ended December 31, +Corporate and Other +2014 +2013 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +53,569 +$ +50,290 +6.5 +% +Depreciation +$ +4,536 +$ +4,357 +4.1 +% +Net gain on asset disposals +$ +(15,781 +) +$ +(3,384 +) +366.3 +% +Interest income +$ +979 +$ +918 +6.6 +% +Interest expense +$ +29,825 +$ +28,359 +5.2 +% +Other income +$ +3 +$ +1,691 +(99.8 +)% +Capital expenditures +$ +2,706 +$ +3,926 +(31.1 +)% +Selling, general and administrative expense for 2014 increased primarily due to higher personnel costs. Gains and losses on the disposal of assets are treated as part of our corporate activities because such transactions relate to corporate strategy decisions of our executive management group. The net gain on the disposal of assets in 2014 resulted primarily from miscellaneous sales of drilling equipment and sales of certain oil and natural gas properties. +36 +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by U.S. GAAP. We define Adjusted EBITDA as net income (loss) plus net interest expense, income tax expense (benefit) and depreciation, depletion, amortization and impairment expense. We present Adjusted EBITDA (a non-U.S. GAAP measure) because we believe it provides to both management and investors additional information with respect to both the performance of our fundamental business activities and our ability to meet our capital expenditures and working capital requirements. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measures of net income (loss) or operating cash flow. +Year Ended December 31, +2015 +2014 +2013 +(Dollars in thousands) +Net income (loss) +$ +(294,486 +) +$ +162,664 +$ +188,009 +Income tax expense (benefit) +(147,963 +) +91,619 +108,432 +Net interest expense +35,511 +28,846 +27,441 +Depreciation, depletion, amortization and impairment +864,759 +718,730 +597,469 +Impairment of goodwill +124,561 +— +— +Adjusted EBITDA +$ +582,382 +$ +1,001,859 +$ +921,351 +Income Taxes +Year Ended December 31, +2015 +2014 +2013 +(Dollars in thousands) +Income (loss) before income taxes +$ +(442,449 +) +$ +254,283 +$ +296,441 +Income tax expense (benefit) +$ +(147,963 +) +$ +91,619 +$ +108,432 +Effective tax rate +33.4 +% +36.0 +% +36.6 +% +The effective tax rate is a result of a federal rate of 35.0% adjusted as follows: +2015 +2014 +2013 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes +2.1 +2.5 +3.7 +Permanent differences +(1.3 +) +(1.4 +) +(1.5 +) +Other differences, net +(2.4 +) +(0.1 +) +(0.6 +) +Effective tax rate +33.4 +% +36.0 +% +36.6 +% +The Domestic Production Activities Deduction (IRC section 199 deduction) was enacted as part of the American Jobs Creation Act of 2004 (as revised by the Emergency Economic Stabilization Act of 2008) and allows a deduction of 9% in 2010 and thereafter on the lesser of qualified production activities income or taxable income. The permanent differences for 2013 include a deduction of $10.0 million as we fully utilized our remaining net operating loss carryforwards. The permanent differences for 2014 include a deduction of $8.8 million. The permanent differences for 2015 do not include any deduction as it is limited to taxable income, and we did not have taxable income in 2015 as a result of our election to utilize bonus depreciation. +The 2015 other differences include a 1.0% reduction related to the reconciliation of the deferred tax liability associated with the conversion of our Canadian operations to a controlled foreign corporation. The impact to the deferred tax liability from the conversion is being amortized over the weighted average remaining useful life of the Canadian assets. The 2015 other differences also include a 0.7% reduction for the lost benefit of the 2014 IRC section 199 deduction of $8.8 million as a result of our adoption of the final tangible property regulations with the filing of the 2014 tax return. +We record deferred federal income taxes based primarily on the temporary differences between the book and tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be settled. As a result of fully recognizing the benefit of our deferred income taxes, we incur deferred income tax expense as these benefits are utilized. We recognized a deferred tax benefit of approximately $100 million in 2015 and deferred tax expense of approximately $44 million in 2014 and $51 million in 2013. +On January 1, 2010, we converted our Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes. This transaction triggered a $1 million increase in deferred tax liabilities, which is being amortized as an +37 +increase to deferred i ncome tax expense over the weighted average remaining useful life of the Canadian assets. This will be fully amortized by December 31, 2016. +As a result of the above conversion, our Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada. Effective January 1, 2010, we have elected to permanently reinvest these unremitted earnings in Canada, and intend to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $28.4 million as of December 31, 2015. The unrecognized deferred tax liability associated with these earnings was approximately $3.8 million, net of available foreign tax credits. This liability would be recognized if we received a dividend of the unremitted earnings. +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. Oil prices have significantly declined since the second half of 2014. The closing price of oil, which was as high as $105.68 per barrel during the third quarter of 2014, reached a low price for 2015 of $34.55 in December 2015 and reached a twelve-year low of $26.68 in January 2016. As a result of the prolonged decline in oil prices, our industry continues to experience a severe decline in both contract drilling and pressure pumping activity levels. We do not expect this to change until commodity prices improve. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A continued decline in demand for oil and natural gas or prolonged low oil or natural gas prices would likely result in further reduced capital expenditures by our customers and decreased demand for our drilling rigs and pressure pumping services, which could have a material adverse effect on our operating results, financial condition and cash flows. +Impact of Inflation +Inflation has not had a significant impact on our operations during the three years ended December 31, 2015. We believe that inflation will not have a significant near-term impact on our financial position. +Recently Issued Accounting Standards +In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. We are currently evaluating the impact this guidance will have on our consolidated financial statements. +In June 2014, the FASB issued an accounting standards update to provide guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition. The requirements in this update are effective during interim and annual periods beginning after December 15, 2015. The adoption of this update is not expected to have a material impact on our consolidated financial statements. +In April 2015, the FASB issued an accounting standards update to provide guidance for the presentation of debt issuance costs. Under this guidance, debt issuance costs shall be presented in the balance sheet as a direct deduction from the carrying amount of the related debt and shall not be classified as a deferred charge. Amortization of debt issuance costs shall continue to be reported as interest expense. The requirements in this update are effective during interim and annual periods beginning after December 15, 2015. The adoption of this update is not expected to have a material impact on our consolidated financial statements. +In November 2015, the FASB issued an accounting standards update to provide guidance for the presentation of deferred tax liabilities and assets. Under this guidance, for a particular tax-paying component of an entity and within a particular tax jurisdiction, all deferred tax liabilities and assets, as well as any related valuation allowance, shall be offset and presented as a single noncurrent amount. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. The adoption of this update is not expected to have a material impact on our consolidated financial statements. +38 +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +We currently have exposure to interest rate market risk associated with any borrowings that we have under the Credit Agreement, the 2015 Term Loan Agreement and the Reimbursement Agreement. +Under the Credit Agreement, interest is paid on the outstanding principal amount of borrowings at a floating rate based on, at our election, LIBOR or a base rate. The margin on LIBOR loans ranges from 2.25% to 3.25% and the margin on base rate loans ranges from 1.25% to 2.25%, based on our debt to capitalization ratio. At December 31, 2015, the margin on LIBOR loans was 2.25% and the margin on base rate loans was 1.25%. Based on our debt to capitalization ratio at September 30, 2015, the applicable margin on LIBOR loans is 2.25% and the applicable margin on base rate loans is 1.25% as of January 1, 2016. Based on our debt to capitalization ratio at December 31, 2015, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2016. As of December 31, 2015, we had no amounts outstanding under our revolving credit facility and $70.0 million outstanding under our term loan facility at an interest rate of 2.875%. The interest rate on the borrowings outstanding under the Credit Agreement is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate. A one percent increase in the interest rate on the borrowings outstanding under our term credit facility as of December 31, 2015 would increase our annual cash interest expense by approximately $632,000. +Loans under the 2015 Term Loan Agreement bear interest, at our election, at the per annum rate of LIBOR plus 3.25% or base rate plus 2.25%. As of December 31, 2015, we had $185 million principal amount outstanding under the 2015 Term Loan Agreement at an interest rate of 3.875%. A one percent increase in the interest rate on the borrowings outstanding under 2015 Term Loan Agreement as of December 31, 2015 would increase our annual cash interest expense by approximately $1.8 million. +Under the Reimbursement Agreement, we will reimburse the issuing bank on demand for any amounts that it has disbursed under any letters of credit. We are obligated to pay to the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2015, no amounts had been disbursed under any letters of credit. +We conduct a portion of our business in Canadian dollars through our Canadian land-based drilling operations. The exchange rate between Canadian dollars and U.S. dollars has fluctuated during the last several years. If the value of the Canadian dollar against the U.S. dollar weakens, revenues and earnings of our Canadian operations will be reduced and the value of our Canadian net assets will decline when they are translated to U.S. dollars. This currency risk is not material to our results of operations or financial condition. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2015, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2015, based on the +39 +Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 201 5 . +The effectiveness of our internal control over financial reporting as of December 31, 2015 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None. +40 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +41 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.4 +Second Amended and Restated Bylaws (filed August 6, 2007 as Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference). +10.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference). +10.2 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.3 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.4 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.7 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.8 +Form of Share-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010 and incorporated herein by reference).* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.10 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed April 21, 2014 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +42 +10.11 +Form of Executive Officer Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.3 to the Company’s Current +Report on Form 8-K, and incorporated herein by reference).* +10.12 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.13 +Form of Non-Employee Director Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.5 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.14 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.15 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns and John E. Vollmer III (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.16 +Employment Agreement, effective as of January 1, 2012, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed February 10, 2012 as Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 and incorporated herein by reference). * +10.17 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, John E. Vollmer III, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon and Tiffany J. Thom (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.18 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.19 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.20 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed on February 4, 2004 as Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.21 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.22 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and John E. Vollmer, III, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.23 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.24 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of November 2, 2009, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed November 2, 2009 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2009 and incorporated herein by reference).* +10.25 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of April 2, 2012, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed July 30, 2012 as Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012 and incorporated herein by reference).* +10.26 +Credit Agreement dated September 27, 2012, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed September 28, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.27 +Amendment No. 1 to Credit Agreement dated as of January 9, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed January 12, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.28 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +43 +10.29 +Amendment No. 1 to Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated October 5, 2010) (filed October 28, 2015 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.30 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.31 +Amendment No. 1 to Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated June 14, 2012) (filed October 28, 2015 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.32 +Reimbursement Agreement, dated as March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.33 +Continuing Guaranty, dated as of March 16, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 16, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.34 +Term Loan Agreement, dated as March 18, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent and lender, each of the other lenders party thereto, Wells Fargo Securities, LLC, as Lead Arranger and Sole Book Runner, and Bank of America, N.A. and The Bank of Tokyo-Mitsubishi UFJ, LTD., as Co-Syndication Agents (filed March 18, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.35 +Continuing Guaranty, dated as of March 18, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 18, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+ +99.1 +Stipulation and Proposed Order of Dismissal, dated December 17, 2015.+ +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2015, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. +44 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 201 5 and 201 4 +F-3 +Consolidated Statements of Operations for the years ended December 31, 201 5 , 201 4 and 201 3 +F-4 +Consolidated Statements of Comprehensive Income for the years ended December 31, 201 5 , 201 4 and 201 3 +F-5 +Consolidated Statements of Changes In Stockhold ers’ Equity for the years ended December 31, 201 5 , 201 4 and 201 3 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 201 5 , 201 4 and 201 3 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +R eport of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc.: +In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 10, 2016 +F-2 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2015 +2014 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +113,346 +$ +43,012 +Accounts receivable, net of allowance for doubtful accounts of $3,545 and $3,546 at +December 31, 2015 and 2014, respectively +219,672 +663,404 +Federal and state income taxes receivable +33,454 +81,726 +Inventory +14,716 +32,251 +Deferred tax assets, net +65,121 +37,075 +Other +40,227 +51,624 +Total current assets +486,536 +909,092 +Property and equipment, net +3,920,708 +4,131,071 +Goodwill and intangible assets +92,609 +220,813 +Deposits on equipment purchases +22,367 +112,379 +Other +11,097 +20,656 +Total assets +$ +4,533,317 +$ +5,394,011 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +82,771 +$ +382,438 +Accrued expenses +161,611 +173,466 +Current portion of long-term debt +63,750 +12,500 +Total current liabilities +308,132 +568,404 +Borrowings under revolving credit facility +— +303,000 +Other long-term debt +791,250 +670,000 +Deferred tax liabilities, net +863,833 +935,660 +Other +8,971 +11,137 +Total liabilities +1,972,186 +2,488,201 +Commitments and contingencies (see Note 8) +Stockholders’ equity: +Preferred stock, par value $.01; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $.01; authorized 300,000,000 shares with 190,374,801 and +189,262,876 issued and 147,167,561 and 146,444,291 outstanding at +December 31, 2015 and 2014, respectively +1,904 +1,893 +Additional paid-in capital +1,011,811 +984,674 +Retained earnings +2,458,554 +2,811,815 +Accumulated other comprehensive income (loss) +(4,093 +) +6,463 +Treasury stock, at cost, 43,207,240 shares and 42,818,585 shares at +December 31, 2015 and 2014, respectively +(907,045 +) +(899,035 +) +Total stockholders’ equity +2,561,131 +2,905,810 +Total liabilities and stockholders’ equity +$ +4,533,317 +$ +5,394,011 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2015 +2014 +2013 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +1,153,892 +$ +1,838,830 +$ +1,679,611 +Pressure pumping +712,454 +1,293,265 +979,166 +Oil and natural gas +24,931 +50,196 +57,257 +Total operating revenues +1,891,277 +3,182,291 +2,716,034 +Operating costs and expenses: +Contract drilling +608,848 +1,066,659 +968,754 +Pressure pumping +612,021 +1,036,310 +744,243 +Oil and natural gas +11,500 +13,102 +12,909 +Depreciation, depletion, amortization and impairment +864,759 +718,730 +597,469 +Impairment of goodwill +124,561 +— +— +Selling, general and administrative +87,173 +80,145 +73,852 +Net gain on asset disposals +(10,613 +) +(15,781 +) +(3,384 +) +Total operating costs and expenses +2,298,249 +2,899,165 +2,393,843 +Operating income (loss) +(406,972 +) +283,126 +322,191 +Other income (expense): +Interest income +964 +979 +918 +Interest expense, net of amount capitalized +(36,475 +) +(29,825 +) +(28,359 +) +Other +34 +3 +1,691 +Total other expense +(35,477 +) +(28,843 +) +(25,750 +) +Income (loss) before income taxes +(442,449 +) +254,283 +296,441 +Income tax expense (benefit): +Current +(48,090 +) +47,946 +57,863 +Deferred +(99,873 +) +43,673 +50,569 +Total income tax expense (benefit) +(147,963 +) +91,619 +108,432 +Net income (loss) +$ +(294,486 +) +$ +162,664 +$ +188,009 +Net income (loss) per common share: +Basic +$ +(2.00 +) +$ +1.12 +$ +1.29 +Diluted +$ +(2.00 +) +$ +1.11 +$ +1.28 +Weighted average number of common shares outstanding: +Basic +145,416 +144,066 +144,356 +Diluted +145,416 +145,376 +145,303 +Cash dividends per common share +$ +0.40 +$ +0.40 +$ +0.20 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +Year Ended December 31, +2015 +2014 +2013 +(In thousands) +Net income (loss) +$ +(294,486 +) +$ +162,664 +$ +188,009 +Other comprehensive loss, net of taxes of $0 for 2015, $0 for 2014 and +$0 for 2013: +Foreign currency translation adjustment +(10,556 +) +(7,613 +) +(7,691 +) +Total comprehensive income (loss) +$ +(305,042 +) +$ +155,051 +$ +180,318 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings +Income +Stock +Total +(In thousands) +Balance, December 31, 2012 +184,060 +$ +1,841 +$ +863,558 +$ +2,548,542 +$ +21,767 +$ +(795,051 +) +$ +2,640,657 +Net income +— +— +— +188,009 +— +— +188,009 +Foreign currency translation +adjustment +— +— +— +— +(7,691 +) +— +(7,691 +) +Issuance of restricted stock +1,312 +13 +(13 +) +— +— +— +— +Vesting of restricted stock units +9 +— +— +— +— +— +— +Forfeitures of restricted stock +(84 +) +(1 +) +1 +— +— +— +— +Exercise of stock options +1,190 +12 +19,274 +— +— +— +19,286 +Stock-based compensation +— +— +25,891 +— +— +— +25,891 +Tax benefit related to stock- +based compensation +— +— +4,794 +— +— +— +4,794 +Payment of cash dividends +— +— +— +(29,112 +) +— +— +(29,112 +) +Purchase of treasury stock +— +— +— +— +— +(85,837 +) +(85,837 +) +Balance, December 31, 2013 +186,487 +1,865 +913,505 +2,707,439 +14,076 +(880,888 +) +2,755,997 +Net income +— +— +— +162,664 +— +— +162,664 +Foreign currency translation +adjustment +— +— +— +— +(7,613 +) +— +(7,613 +) +Issuance of restricted stock +1,102 +11 +(11 +) +— +— +— +— +Vesting of restricted stock units +10 +1 +— +— +— +— +1 +Forfeitures of restricted stock +(61 +) +(1 +) +1 +— +— +— +— +Exercise of stock options +1,725 +17 +35,418 +— +— +— +35,435 +Stock-based compensation +— +— +27,032 +— +— +— +27,032 +Tax benefit related to stock- +based compensation +— +— +8,729 +— +— +— +8,729 +Payment of cash dividends +— +— +— +(58,288 +) +— +— +(58,288 +) +Purchase of treasury stock +— +— +— +— +— +(18,147 +) +(18,147 +) +Balance, December 31, 2014 +189,263 +1,893 +984,674 +2,811,815 +6,463 +(899,035 +) +2,905,810 +Net loss +— +— +— +(294,486 +) +— +— +(294,486 +) +Foreign currency translation +adjustment +— +— +— +— +(10,556 +) +— +(10,556 +) +Issuance of restricted stock +1,180 +12 +(12 +) +— +— +— +— +Vesting of restricted stock units +14 +— +— +— +— +— +— +Forfeitures of restricted stock +(82 +) +(1 +) +1 +— +— +— +— +Stock-based compensation +— +— +28,510 +— +— +— +28,510 +Tax expense related to stock- +based compensation +— +— +(1,362 +) +— +— +— +(1,362 +) +Payment of cash dividends +— +— +— +(58,775 +) +— +— +(58,775 +) +Purchase of treasury stock +— +— +— +— +— +(8,010 +) +(8,010 +) +Balance, December 31, 2015 +190,375 +$ +1,904 +$ +1,011,811 +$ +2,458,554 +$ +(4,093 +) +$ +(907,045 +) +$ +2,561,131 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2015 +2014 +2013 +(In thousands) +Cash flows from operating activities: +Net income (loss) +$ +(294,486 +) +$ +162,664 +$ +188,009 +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depreciation, depletion, amortization and impairment +864,759 +718,730 +597,469 +Impairment of goodwill +124,561 +— +— +Dry holes and abandonments +1,224 +550 +89 +Deferred income tax expense (benefit) +(99,873 +) +43,673 +50,569 +Stock-based compensation expense +28,510 +27,032 +25,891 +Net gain on asset disposals +(10,613 +) +(15,781 +) +(3,384 +) +Tax expense related to stock-based compensation +(1,362 +) +— +— +Changes in operating assets and liabilities: +Accounts receivable +440,884 +(214,059 +) +12,007 +Income taxes receivable/payable +49,895 +(92,352 +) +4,447 +Inventory and other assets +40,238 +(5,737 +) +570 +Accounts payable +(131,649 +) +86,621 +11,331 +Accrued expenses +(10,303 +) +12,838 +1,973 +Other liabilities +(2,348 +) +4,547 +(100 +) +Net cash provided by operating activities +999,437 +728,726 +888,871 +Cash flows from investing activities: +Acquisitions +— +(176,301 +) +— +Purchases of property and equipment +(743,776 +) +(1,052,341 +) +(662,461 +) +Proceeds from disposal of assets +20,814 +33,233 +10,386 +Net cash used in investing activities +(722,962 +) +(1,195,409 +) +(652,075 +) +Cash flows from financing activities: +Purchases of treasury stock +(8,010 +) +(13,554 +) +(73,510 +) +Dividends paid +(58,775 +) +(58,288 +) +(29,112 +) +Tax benefit related to stock-based compensation +— +8,729 +4,794 +Proceeds from long-term debt +200,000 +— +— +Repayment of long-term debt +(27,500 +) +(10,000 +) +(6,250 +) +Proceeds from borrowings under revolving credit facility +54,000 +349,500 +— +Repayment of borrowings under revolving credit facility +(357,000 +) +(46,500 +) +— +Debt issuance costs +(1,979 +) +— +— +Proceeds from exercise of stock options +— +30,842 +6,959 +Net cash provided by (used in) financing activities +(199,264 +) +260,729 +(97,119 +) +Effect of foreign exchange rate changes on cash +(6,877 +) +(543 +) +(891 +) +Net increase (decrease) in cash and cash equivalents +70,334 +(206,497 +) +138,786 +Cash and cash equivalents at beginning of year +43,012 +249,509 +110,723 +Cash and cash equivalents at end of year +$ +113,346 +$ +43,012 +$ +249,509 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $6,332 in 2015, $6,883 in 2014 and $7,775 in 2013 +$ +(33,452 +) +$ +(27,813 +) +$ +(26,228 +) +Income taxes +97,333 +(125,953 +) +(42,600 +) +Non-cash investing and financing activities: +Net (decrease) increase in payables for purchases of property and equipment +$ +(167,308 +) +$ +122,148 +$ +(26,899 +) +Net decrease in deposits on equipment purchases +(90,012 +) +(59,819 +) +(8,784 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “Patterson-UTI” or the “Company”), provides onshore contract drilling services to major, independent and other oil and natural gas operators in the continental United States and western Canada. The Company provides pressure pumping services to major, independent and other oil and natural gas operators primarily in Texas and the Appalachian region. The Company also invests in oil and natural gas properties on a non-operating working interest basis. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, the Company has no controlling financial interests in any other entity which would require consolidation. +The U.S. dollar is the functional currency for all of the Company’s operations except for its Canadian operations, which use the Canadian dollar as its functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed. Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs. All of the wells the Company drilled in 2015, 2014 and 2013 were drilled under daywork contracts. +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts represents the Company’s estimate of the amount of probable credit losses existing in the Company’s accounts receivable. The Company reviews the adequacy of its allowance for doubtful accounts at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectable, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with the Company’s pressure pumping activities. The inventories are stated at the lower of cost or market, determined under the average cost method. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Drilling rigs and other equipment +1.25-15 +Buildings +15-20 +Other +3-12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. The Company reviews wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of +F-8 +drilling, the Company considers the well costs to be impaired and recognizes the costs as expense. Geologi cal and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +The Company reviews its proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). The expected future net cash flows are discounted using an annual rate of 10% to determine fair value. The Company reviews unproved oil and natural gas properties quarterly to assess potential impairment. The Company’s impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. The Company assesses impairment of its goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Net income (loss) per common share — The Company provides a dual presentation of its net income (loss) per common share in its consolidated statements of operations: Basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock. Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock and restricted stock units. The dilutive effect of stock options and restricted stock units is determined using the treasury stock method. The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested shares of restricted stock. +F-9 +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2015, 2014 and 2013, as well as potentially dilutive securities excluded from the weighted average numbe r of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2015 +2014 +2013 +BASIC EPS: +Net income (loss) +$ +(294,486 +) +$ +162,664 +$ +188,009 +Adjust for (income) loss attributed to holders of non-vested restricted stock +3,022 +(1,663 +) +(1,859 +) +Income (loss) attributed to common stockholders +$ +(291,464 +) +$ +161,001 +$ +186,150 +Weighted average number of common shares outstanding, excluding non-vested shares of restricted stock +145,416 +144,066 +144,356 +Basic net income (loss) per common share +$ +(2.00 +) +$ +1.12 +$ +1.29 +DILUTED EPS: +Income (loss) attributed to common stockholders +$ +(291,464 +) +$ +161,001 +$ +186,150 +Weighted average number of common shares outstanding, excluding non-vested shares of restricted stock +145,416 +144,066 +144,356 +Add dilutive effect of potential common shares +— +1,310 +947 +Weighted average number of diluted common shares outstanding +145,416 +145,376 +145,303 +Diluted net income (loss) per common share +$ +(2.00 +) +$ +1.11 +$ +1.28 +Potentially dilutive securities excluded as anti-dilutive +7,781 +1,088 +2,447 +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. The Company’s policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — The Company recognizes the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards (See Note 10). +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Issued Accounting Standards — In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements. +In June 2014, the FASB issued an accounting standards update to provide guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a +performance condition. The requirements in this update are effective during interim and annual periods beginning after December 15, 2015. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements. +F-10 +In April 2015, the FASB issued an accounting standards update to provide guidance for the presentation of debt issuance costs. Under this guidance, debt issua nce costs shall be presented in the balance sheet as a direct deduction from the carrying amount of the related debt and shall not be classified as a deferred charge. Amortization of debt issuance costs shall continue to be reported as interest expense. T he requirements in this update are effective during interim and annual periods beginning after December 15, 2015. The adoption of this update is not expected to have a material impact on the Company’s con solidated financial statements. +In November 2015, the FASB issued an accounting standards update to provide guidance for the presentation of deferred tax liabilities and assets. Under this guidance, for a particular tax-paying component of an entity and within a particular tax jurisdiction, all deferred tax liabilities and assets, as well as any related valuation allowance, shall be offset and presented as a single noncurrent amount. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements. +2. Acquisitions +During 2014, the Company completed two pressure pumping acquisitions. In June 2014, a subsidiary of the Company acquired the East Texas-based pressure pumping assets of a privately held company. This acquisition included 31,500 horsepower of hydraulic fracturing equipment. In October 2014, a subsidiary of the Company completed the acquisition of the Texas-based pressure pumping assets of a privately held company. This acquisition included 148,250 horsepower of hydraulic fracturing equipment. +In total, the Company paid $176 million in cash for these two acquisitions plus the assumption of property leases and other contractual obligations. The purchase price was allocated to the assets acquired based on fair value. A summary of the purchase price allocation follows (in thousands): +Inventory +$ +1,357 +Equipment +117,958 +Goodwill +56,986 +Total purchase price +$ +176,301 +Results of operations of the acquired businesses are included in the Company’s consolidated results of operations from their respective dates of acquisition. Revenues of $80.8 million and income from operations of $13.7 million from the acquired businesses are included in the consolidated statement of operations for the year ended December 31, 2014. +The following represents pro-forma unaudited financial information for the years ended December 31, 2014 and 2013 as if the acquisitions had been completed on January 1, 2013 (in thousands, except per share amounts): +2014 +2013 +(Unaudited) +Revenue +$ +3,302,492 +$ +2,854,867 +Net income +$ +169,831 +$ +196,600 +Basic net income per common share +$ +1.17 +$ +1.35 +Diluted net income per common share +$ +1.16 +$ +1.34 +3. Property and Equipment +Property and equipment consisted of the following at December 31, 2015 and 2014 (in thousands): +2015 +2014 +Equipment +$ +6,963,148 +$ +6,679,894 +Oil and natural gas properties +200,923 +196,234 +Buildings +96,470 +83,465 +Land +22,370 +12,038 +Total property and equipment +7,282,911 +6,971,631 +Less accumulated depreciation, depletion and impairment +(3,362,203 +) +(2,840,560 +) +Property and equipment, net +$ +3,920,708 +$ +4,131,071 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets for 2015, 2014 and 2013 (in thousands): +F-11 +2015 +2014 +2013 +Depreciation and impairment expense +$ +845,543 +$ +693,390 +$ +573,106 +Amortization expense +3,643 +3,643 +3,993 +Depletion expense +15,573 +21,697 +20,370 +Total +$ +864,759 +$ +718,730 +$ +597,469 +On a periodic basis, the Company evaluates its fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional, vertical wells versus drilling longer, horizontal wells using higher specification rigs). The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to the Company’s yards to be used as spare equipment. The remaining components of these rigs will be retired. In 2015, the Company identified 24 mechanical rigs and 9 non-APEX® electric rigs that would no longer be marketed. Also, the Company had 15 additional mechanical rigs that were not operating. Although these 15 rigs remain marketable, the Company has lower expectations with respect to utilization of these rigs due to the industry shift to higher specification drilling rigs. In 2015, the Company recorded a charge of $131 million related to the retirement of the 33 rigs, the 15 mechanical rigs that remain marketable but were not operating, and the write-down of excess spare rig components to their realizable values. In 2014, the Company identified 55 mechanical rigs that it determined would no longer be marketed, and the Company recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the reduced size of the Company’s mechanical fleet. In 2013, the Company identified 48 rigs that would no longer be marketed. Also, the Company had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, the Company had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. In 2013, the Company recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. +The Company also periodically evaluates its pressure pumping assets, and in 2015, the Company recorded a charge of $22.0 million for the write-down of pressure pumping equipment and certain closed facilities. There were no similar charges in 2014 or 2013. +The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable (a “triggering event”). During the first quarter of 2015, oil prices averaged $48.54 per barrel and reached a low of $43.39 per barrel in March 2015. Oil prices improved during the second quarter of 2015 and averaged $57.85 per barrel. Although the price improvement was earlier than the Company projected, this improvement was generally consistent with the Company’s assumption at December 31, 2014 that oil prices would improve late in 2015 and continue to improve in 2016, resulting in improved activity levels for both the contract drilling and pressure pumping businesses. During the second quarter of 2015 as oil prices increased, the Company received requests from customers to reactivate drilling rigs to resume operations in the third quarter of 2015. The Company believed this was an indication that future activity levels would be improving for both the contract drilling and pressure pumping businesses. During the third quarter of 2015, however, oil prices declined and averaged $46.42 per barrel and reached a new low for 2015 of $38.22 per barrel in August 2015. +With lower oil prices in August, the Company lowered its expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. In light of these revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping services during the third quarter of 2015, management deemed it necessary to assess the recoverability of long-lived asset groups for both contract drilling and pressure pumping. The Company performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within its contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 60%, respectively. +Due to the continued deterioration of crude oil prices in the fourth quarter of 2015, management deemed it necessary to again assess the recoverability of long-lived assets groups for both contract drilling and pressure pumping. The Company performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within its contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 100%, respectively. +For both of the assessments performed in 2015, the expected cash flows for the contract drilling segment included the backlog of commitments for contract drilling revenues under term contracts, which was approximately $801 million and $710 million at September 30, 2015 and December 31, 2015, respectively . Rigs not under term contracts will be subject to pricing in the spot market. Utilization and rates for rigs in the spot market and for the pressure pumping segment were estimated based upon the +F-12 +Company’s historical experience in prior downturns. Also, the expected cash flows for the contract drilling and pressure pumping segments were based on the assumption that activity levels in both segments would begin to recover in the first quarter of 2017 in respo nse to improved oil prices. While management believes these assumptions with respect to future pricing for oil and natural gas are reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil and natural gas prices will recover is highly uncertain. Potential events that could affect the Company’s assumptions regarding future prices and the timeframe for a recovery are affected by factors such as: +· +· market supply and demand, +· +· the desire and ability of the Organization of Petroleum Exporting Countries, commonly known as OPEC, to set and maintain production and price targets, +· +· the level of production by OPEC and non-OPEC countries, +· +· domestic and international military, political, economic and weather conditions, +· +· legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +· +· technical advances affecting energy consumption and production, +· +· the price and availability of alternative fuels, +· +· the cost of exploring for, developing, producing and delivering oil and natural gas, and +· +· regulations regarding the exploration, development, production and delivery of oil and natural gas. +All of these factors are beyond the Company’s control. If the current lower oil and natural gas commodity price environment were to last into 2017 and beyond, the Company’s actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future and such impairment could be material. +With respect to the long-lived assets in the Company’s oil and natural gas exploration and production segment, the Company assessed the recoverability of long-lived assets each quarter due to revisions in oil and natural gas reserve estimates and expectations about future commodity prices. The Company’s analysis indicated that the carrying amounts of certain oil and natural gas properties were not recoverable at various testing dates in 2015. The Company’s estimates of expected future net cash flows from impaired properties are used in measuring the fair value of such properties. The Company recorded impairment charges of $10.7 million in 2015 related to our oil and natural gas properties. +4. Goodwill and Intangible Assets +Goodwill — Goodwill by operating segment as of December 31, 2015 and 2014 and changes for the years then ended are as follows (in thousands): +Contract +Pressure +Drilling +Pumping +Total +Balance December 31, 2013 +$ +86,234 +$ +67,575 +$ +153,809 +Changes to goodwill +— +56,986 +56,986 +Balance December 31, 2014 +86,234 +124,561 +210,795 +Changes to goodwill +— +(124,561 +) +(124,561 +) +Balance December 31, 2015 +$ +86,234 +$ +— +$ +86,234 +There were no accumulated impairment losses related to goodwill in the contract drilling operating segment as of December 31, 2015 or 2014. +Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. The Company’s reporting units for impairment testing have been determined to be its operating segments. The Company first determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if it is, then goodwill impairment is determined using a two-step quantitative impairment test. From time to time, the Company may perform the first step of the quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. The first step of the quantitative testing is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the quantitative testing is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of the shortfall. +F-13 +During the first quarter of 2015, oil prices averaged $48.54 per barrel and reached a low of $43.39 per barrel i n March 2015. Oil prices improved during the second quarter of 2015 and averaged $57.85 per barrel. Although the price improvement was earlier than the Company projected, this improvement was generally consistent with the Company’s assumption at December 31, 2014, that oil prices would improve in late 2015 and co ntinue to improve in 2016, resulting in improved activity levels for both the contract drilling and pressure pumping businesses. During the second quarter of 2015 as oil prices increased, the Company received requests from customers to reactivate drilling rigs to resume operations in the third quarter of 2015. The Company believed this was an indication that future activity levels would be improving for both the contract drilling and pressure pumping businesses. During the third quarter of 2015, however, oil prices declined and averaged $46.42 per barrel and reached a new low for 2015 of $38.22 per barrel i n August 2015. With lower oil prices in August, the Company lowered its expectations with respect to future activity levels in both the contract drill ing and pressure pumping businesses. In light of the Company’s revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping servic es during the third quarter of 2015, the Company performed a quantitative impairment assessment of its goodwill as of September 30, 2015. In completing the first step of the assessment , the fair value of each reporting unit was estimated using both the in come and market valuation methods. The estimate of the fair value of each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future perform ance of the Company’s contract drilling and pressure pumping reporting units, such as future oil and natural gas prices and projected demand for the Company’s services, and assumptions related to discount rates, long-term growth rates and control premiums. +Based on the results of the first step of the goodwill impairment test as of September 30, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 15%, and management concluded that no impairment was indicated in its contract drilling reporting unit; however, impairment was indicated in its pressure pumping reporting unit. In the three months ended September 30, 2015, the Company recognized an impairment charge of $125 million associated with the impairment of all of the goodwill of the pressure pumping reporting unit. +The Company performed a quantitative impairment assessment of the goodwill of its contract drilling reporting unit as of December 31, 2015. In completing the first step of the assessment, the fair value of the contract drilling reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of the reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of the Company’s contract drilling reporting unit, such as future oil and natural gas prices and projected demand for the Company’s services, and assumptions related to discount rates, long-term growth rates and control premiums. Based on the results of the first step of the quantitative impairment assessment of its goodwill as of December 31, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 16%, and management concluded that no impairment was indicated in its contract drilling reporting unit. +In connection with its annual goodwill impairment assessment as of December 31, 2014, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of the Company’s reporting units were greater than their carrying amounts and further testing was not necessary. In making this determination, the Company considered the continued demand experienced during 2014 for its services in the contract drilling and pressure pumping businesses. The Company also considered the current and expected levels of commodity prices for oil and natural gas, which influence its overall level of business activity in these operating segments. Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account. The Company’s overall market capitalization and the large amount of calculated excess of the fair values of the Company’s reporting units over their carrying values from its 2013 quantitative impairment assessment were also considered. +The Company has undertaken extensive efforts in the past several years to upgrade its fleet of equipment and believes that it is well positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells that has resulted primarily from currently low oil and natural gas prices. In the event that market conditions were to remain weak for a protracted period, the Company may be required to record an impairment of goodwill in its contract drilling reporting unit in the future, and such impairment could be material. +Intangible Assets — Intangible assets were recorded in the pressure pumping operating segment in connection with the fourth quarter 2010 acquisition of the assets of a pressure pumping business. As a result of the purchase price allocation, the Company recorded intangible assets related to a non-compete agreement and the customer relationships acquired. These intangible assets were recorded at fair value on the date of acquisition. +The non-compete agreement had a term of three years from October 1, 2010. The value of this agreement was estimated using a with and without scenario where cash flows were projected through the term of the agreement assuming the agreement is in place and compared to cash flows assuming the non-compete agreement was not in place. The intangible asset associated with the non-compete agreement was amortized on a straight-line basis over the three-year term of the agreement. Amortization expense of $350,000 was recorded in the year ended December 31, 2013 associated with the non-compete agreement. The non-compete agreement expired in 2013. +F-14 +The value of the customer relationships was estimated using a multi-period excess earnings model to determine the present value of the projected cash flows associated with the customers in place at the time of the acquisition and taking into account a cont ributory asset charge. The resulting intangible asset is being amortized on a straight-line basis over seven years. Amortization expense of $ 3.6 million was recorded in each of the years ended December 31, 201 5 , 201 4 and 201 3 , associated with customer re lationships. +The Company concluded no triggering events necessitating an impairment assessment of the non-compete agreement had occurred in 2013. The Company concluded no triggering events necessitating an impairment assessment of the customer relationships had occurred in 2014 or 2013. The assessment of the recoverability of the pressure pumping asset group included the customer relationship intangible asset, and no impairment was indicated. +The following table presents the gross carrying amount and accumulated amortization of the customer relationships as of December 31, 2015 and 2014 (in thousands): +2015 +2014 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +25,500 +$ +(19,125 +) +$ +6,375 +$ +25,500 +$ +(15,482 +) +$ +10,018 +5. Accrued Expenses +Accrued expenses consisted of the following at December 31, 2015 and 2014 (in thousands): +2015 +2014 +Salaries, wages, payroll taxes and benefits +$ +27,055 +$ +52,956 +Workers’ compensation liability +75,358 +77,348 +Property, sales, use and other taxes +9,061 +11,644 +Insurance, other than workers’ compensation +12,817 +9,632 +Accrued interest payable +7,668 +7,427 +Other +29,652 +14,459 +$ +161,611 +$ +173,466 +6. Asset Retirement Obligation +The Company records a liability for the estimated costs to be incurred in connection with the abandonment of oil and natural gas properties in the future. This liability is included in the caption “other” in the liabilities section of the consolidated balance sheet. +The following table describes the changes to the Company’s asset retirement obligations during 2015 and 2014 (in thousands): +2015 +2014 +Balance at beginning of year +$ +5,301 +$ +4,837 +Liabilities incurred +340 +473 +Liabilities settled +(120 +) +(197 +) +Accretion expense +171 +169 +Revision in estimated costs of plugging oil and natural gas wells +— +19 +Asset retirement obligation at end of year +$ +5,692 +$ +5,301 +7. Long-Term Debt +2012 Credit Agreement — On September 27, 2012, the Company entered into a Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender, and each of the other lenders party thereto. The Credit Agreement is a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility. The Credit Agreement replaced a previous senior unsecured revolving credit facility. +The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time. The revolving credit facility contains a letter of credit facility that is limited to $150 million and a swing line facility that is limited to $40 million, in each case outstanding at any time. +F-15 +The term loan facility provides for a loan of $100 million, which was drawn on December 24, 2012. The term loan facility is payable in quarterly principal installments, which commenced December 27, 2012. The installment amounts vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments, 5.00% of the original principal amount for the subsequent four quarterly installments and 13.75% of the original principal amount for th e final four quarterly installments. +Subject to customary conditions, the Company may request that the lenders’ aggregate commitments with respect to the revolving credit facility and/or the term loan facility be increased by up to $100 million, not to exceed total commitments of $700 million. The maturity date under the Credit Agreement is September 27, 2017 for both the revolving facility and the term facility. +Loans under the Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 2.25% to 3.25% and the applicable margin on base rate loans varies from 1.25% to 2.25%, in each case determined based upon the Company’s debt to capitalization ratio. At December 31, 2015, the applicable margin on LIBOR rate loans was 2.25% and the applicable margin on base rate loans was 1.25%. Based on the Company’s debt to capitalization ratio at September 30, 2015, the applicable margin on LIBOR rate loans is 2.25% and the applicable margin on base rate loans is 1.25% as of January 1, 2016. Based on the Company’s debt to capitalization ratio at December 31, 2015, the applicable margin on LIBOR rate loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2016. A letter of credit fee is payable by the Company equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%. +Each domestic subsidiary of the Company will unconditionally guarantee all existing and future indebtedness and liabilities of the other guarantors and the Company arising under the Credit Agreement, other than (a) Ambar Lone Star Fluid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million. Such guarantees also cover obligations of the Company and any subsidiary of the Company arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 45%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2015. The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants. +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require the Company to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic), and (iii) require the Company to cash collateralize any outstanding letters of credit. +As of December 31, 2015, the Company had $70.0 million principal amount outstanding under the term loan facility at an interest rate of 2.875% and no amounts outstanding under the revolving credit facility. The Company currently has available borrowing capacity of $500 million under the revolving credit facility. +2015 Reimbursement Agreement — On March 16, 2015, the Company entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which the Company may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2015, the Company had $41.1 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, the Company will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by the Company at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. The Company is obligated to pay to Scotiabank interest on all amounts not paid by the Company on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a +F-16 +calendar year for the actual number of da ys elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +The Company has also agreed that if obligations under the Credit Agreement are secured by liens on any of its or any of its subsidiaries’ property, then the Company’s reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, the Company’s payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by subsidiaries of the Company that from time to time guarantee payment under the Credit Agreement. +2015 Term Loan Agreement — On March 18, 2015, the Company entered into a Term Loan Agreement (the “2015 Term Loan Agreement”) with Wells Fargo Bank, N.A., as administrative agent and lender, each of the other lenders party thereto, Wells Fargo Securities, LLC, as Lead Arranger and Sole Book Runner, and Bank of America, N.A. and The Bank Of Tokyo-Mitsubishi UFJ, LTD., as Co-Syndication Agents. +The 2015 Term Loan Agreement is a senior unsecured single-advance term loan facility pursuant to which the Company made a term loan borrowing of $200 million on March 18, 2015 (the “Term Loan Borrowing”). The Term Loan Borrowing is payable in quarterly principal installments, together with accrued interest, on each June 30, September 30, December 31 and March 31, commencing on June 30, 2015. Each of the first four principal installments is in an amount equal to 2.5% of the Term Loan Borrowing and each successive quarterly installment, until and including June 30, 2017, is in an amount equal to 5.0% of the Term Loan Borrowing, with the outstanding principal balance of the Term Loan Borrowing due on the maturity date under the 2015 Term Loan Agreement. The maturity date under the 2015 Term Loan Agreement is September 27, 2017. Loans under the 2015 Term Loan Agreement bear interest, at the Company’s election, at the per annum rate of LIBOR rate plus 3.25% or base rate plus 2.25%. +Each domestic subsidiary of the Company will unconditionally guarantee all existing and future indebtedness and liabilities of the other guarantors and the Company arising under the 2015 Term Loan Agreement and other Loan Documents (as defined in the 2015 Term Loan Agreement), other than (a) Ambar Lone Star Fluid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million. +The 2015 Term Loan Agreement requires quarterly compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 45%. The 2015 Term Loan Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the most recently ended fiscal quarter. The Company also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The 2015 Term Loan Agreement generally defines the interest coverage ratio as the ratio of EBITDA of the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2015. +The 2015 Term Loan Agreement further provides that neither the Company nor its subsidiaries is permitted to make restricted payments unless, after giving effect to such restricted payment, its pro forma ratio of debt to EBITDA for the four prior fiscal quarters, determined as of the preceding ending quarterly period, does not exceed 2.50 to 1.00. Restricted payments are generally defined as (a) dividends and distributions made on account of equity interests of the Company or its subsidiaries and (b) payments made to redeem, repurchase or otherwise retire equity interests of the Company or its subsidiaries. Payments made solely in the form of common equity interests, made to the Company and its subsidiaries, or made in connection with the Company’s long-term incentive plans are not restricted payments under the 2015 Term Loan Agreement. +The 2015 Term Loan Agreement also contains customary representations, warranties, affirmative and negative covenants, and events of default. Events of default under the 2015 Term Loan Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, Loan Document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to accelerate and require the Company to repay all the outstanding amounts owed under any Loan Document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic). +As of December 31, 2015, the Company had $185 million principal amount outstanding under the 2015 Term Loan Agreement at a rate of 3.875%. +F-17 +Senior Notes – On October 5, 2010, the Company completed the issuance and sale of $300 million in aggregate principal amount of its 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear inte rest at a rate of 4.97 % per annum. The Company pay s interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, the Company completed the issuance and sale of $300 million in aggregate principal amounts of its 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. The Company pays interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations of the Company, which rank equally in right of payment with all other unsubordinated indebtedness of the Company. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of the existing domestic subsidiaries of the Company other than subsidiaries that are not required to be guarantors under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at the Company’s option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. The Company must offer to prepay the notes upon the occurrence of any change of control. In addition, the Company must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2015. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +The Company incurred approximately $10.8 million in debt issuance costs during 2010 in connection with the Series A Notes and a previous senior unsecured revolving credit facility. The Company incurred approximately $7.6 million in debt issuance costs during 2012 in connection with the Series B Notes and the Credit Agreement. The Company incurred approximately $2.0 million in debt issuance costs during 2015 in connection with the Reimbursement Agreement and the 2015 Term Loan Agreement. These costs were deferred and are recognized as interest expense over the term of the underlying debt. Interest expense related to the amortization of debt issuance costs was approximately $2.8 million, $2.2 million and $2.2 million for the years ended December 31, 2015, 2014 and 2013, respectively. +F-18 +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 201 5 (in thousands): +Year ending December 31, +2016 +$ +63,750 +2017 +191,250 +2018 +— +2019 +— +2020 +300,000 +Thereafter +300,000 +Total +$ +855,000 +8. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2015, the Company maintained letters of credit in the aggregate amount of $41.1 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2015, no amounts had been drawn under the letters of credit. +As of December 31, 2015, the Company had commitments to purchase approximately $73.5 million of major equipment for its drilling and pressure pumping businesses. +The Company’s pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. These agreements expire in 2016, 2017 and 2018. As of December 31, 2015, the remaining obligation under these agreements was approximately $26.5 million, of which materials with a total purchase price of approximately $9.5 million are required to be purchased during 2016. In the event that the required minimum quantities are not purchased during any contract year, the Company could be required to make a liquidated damages payment to the respective vendor for any shortfall. +In November 2011, the Company’s pressure pumping business entered into an agreement with a proppant vendor to advance up to $12.0 million to such vendor to finance the construction of certain processing facilities. This advance is secured by the underlying processing facilities and bears interest at an annual rate of 5.0%. Repayment of the advance is to be made through discounts applied to purchases from the vendor and repayment of all amounts advanced must be made no later than October 1, 2017. As of December 31, 2015, advances of approximately $11.8 million had been made under this agreement and repayments of approximately $10.6 million had been received resulting in a balance outstanding of approximately $1.2 million. +Contingencies – A $12.3 million charge related to the previously disclosed settlement of a lawsuit filed by the U.S. Equal Employment Opportunity Commission against the Company’s U.S. contract drilling subsidiary was recorded in 2015. +The Company’s operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose the Company to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +Any contractual right to indemnification that the Company may have for any such risk, may be unenforceable or limited due to negligent or willful acts of commission or omission by the Company, its subcontractors and/or suppliers. The Company’s customers and other third parties may dispute, or be unable to meet, their contractual indemnification obligations to the Company due to financial, legal or other reasons. Accordingly, the Company may be unable to transfer these risks to its customers and other third parties by contract or indemnification agreements. Incurring a liability for which the Company is not fully indemnified or insured could have a material adverse effect on its business, financial condition, cash flows and results of operations. +The Company has insurance coverage for fire, windstorm and other risks of physical loss to its rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. The Company has also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, the Company generally maintains a $1.5 million per occurrence deductible on its workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on its equipment insurance coverage, a $2.0 million per occurrence self-insured retention on its general liability coverage and a $2.0 million per occurrence deductible on its automobile liability insurance coverage. The Company self-insures a number of other risks, including loss of earnings and business interruption, and does not carry a significant amount of insurance to cover risks of underground reservoir damage. If a significant accident or other event occurs that +F-19 +is not fully covered by insurance or an enforceable and recoverable indemnity fr om a third party , it could have a material adverse effect on the Company’s business, financial condition, cash flows and results of operations. Accrued expenses related to insurance claims are set forth in Note 5. +The Company is party to various legal proceedings arising in the normal course of its business. The Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows. +Other Matters — The Company has Change in Control Agreements with its Chairman of the Board, Chief Executive Officer, two Senior Vice Presidents and its General Counsel (the “Key Employees”). Each Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless the Company notifies the Key Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control of the Company occurs during the term of the agreement and the Key Employee’s employment is terminated (i) by the Company other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Key Employee for good reason (as those terms are defined in the Change in Control Agreements), then the Key Employee shall generally be entitled to, among other things: +● +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment for each Key Employee prorated for the portion of the fiscal year preceding the termination date); +● +a payment equal to 2.5 times (in the case of the Chairman of the Board and Chief Executive Officer), 2 times (in the case of the Senior Vice Presidents) or 1.5 times (in the case of the General Counsel) of the sum of (i) the highest annual salary in effect for such Key Employee and (ii) the average of the three annual bonuses earned by the Key Employee for the three fiscal years preceding the termination date and +● +continued coverage under the Company’s welfare plans for up to three years (in the case of the Chairman of the Board and Chief Executive Officer) or two years (in the case of the Senior Vice Presidents and General Counsel). +Other than with respect to the Chief Executive Officer, each Change in Control Agreement provides the Key Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +9. Stockholders’ Equity +Cash Dividends – The Company paid cash dividends during the years ended December 31, 2013, 2014 and 2015 as follows: +Per Share +Total +(in thousands) +2013: +Paid on March 29, 2013 +$ +0.05 +$ +7,312 +Paid on June 28, 2013 +0.05 +7,361 +Paid on September 30, 2013 +0.05 +7,231 +Paid on December 31, 2013 +0.05 +7,208 +Total cash dividends +$ +0.20 +$ +29,112 +2014: +Paid on March 27, 2014 +$ +0.10 +$ +14,456 +Paid on June 26, 2014 +0.10 +14,562 +Paid on September 24, 2014 +0.10 +14,634 +Paid on December 24, 2014 +0.10 +14,636 +Total cash dividends +$ +0.40 +$ +58,288 +2015: +Paid on March 25, 2015 +$ +0.10 +$ +14,640 +Paid on June 24, 2015 +0.10 +14,712 +Paid on September 24, 2015 +0.10 +14,712 +Paid on December 24, 2015 +0.10 +14,711 +Total cash dividends +$ +0.40 +$ +58,775 +On February 3, 2016, the Company’s Board of Directors approved a cash dividend on its common stock in the amount of $0.10 per share to be paid on March 24, 2016 to holders of record as of March 10, 2016. The Company’s 2015 Term Loan Agreement contains +F-20 +a covenant that could restrict its ability to make dividend payments later in 2016. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directo rs and will depend upon business conditions, results of operations, financial condition, terms of the Company’s debt agreements and other factors. +On July 25, 2012, the Company’s Board of Directors approved a stock buyback program authorizing purchases of up to $150 million of common stock in open market or privately negotiated transactions. On September 6, 2013, the Company’s Board of Directors terminated any remaining authority under the 2012 stock buyback program, and approved a new stock buyback program that authorizes purchase of up to $200 million of the Company’s common stock in open market or privately negotiated transactions. As of December 31, 2015, the Company had remaining authorization to purchase approximately $187 million of the Company’s outstanding common stock under the 2013 stock buyback program. Shares purchased under a buyback program are accounted for as treasury stock. +The Company acquired shares of stock from employees during 2015, 2014 and 2013 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options by employees. The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) or the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback programs. +Treasury stock acquisitions during the years ended December 31, 2015, 2014 and 2013 were as follows (dollars in thousands): +2015 +2014 +2013 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +38,146,738 +$ +795,051 +Purchases pursuant to stock buyback programs: +2012 program +— +— +— +— +2,567,266 +51,107 +2013 program +8,618 +180 +13,898 +466 +602,564 +12,517 +Acquisitions pursuant to long-term incentive plans +380,037 +7,830 +536,630 +17,681 +951,489 +22,213 +Treasury shares at end of period +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +10. Stock-based Compensation +The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards consist of equity instruments in the form of stock options, restricted stock or restricted stock units and have included service and, in certain cases, performance conditions. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +The Company’s shareholders have approved the 2014 Plan, and the Board of Directors adopted a resolution that no future grants would be made under any of the Company’s other previously existing plans. The Company’s share-based compensation plans at December 31, 2015 follow: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan +9,100,000 +2,509,623 +4,018,824 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +5,271,563 +— +A summary of the 2014 Plan follows: +· +The Compensation Committee of the Board of Directors administers the plan other than the awards to directors. +· +All employees, officers and directors are eligible for awards. +· +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +· +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +· +All options granted under the plan are granted with an exercise price equal to or greater than the fair market value of the Company’s common stock at the time the option is granted. +F-21 +· +The plan provides for awards of incentive stock options, non-incentive stock options, tandem and freestanding stock app reciation rights, restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equiv alents. As of December 31, 2015 , non-incentive stock options, restricted stock awards, restricted stock units and perfo rmance unit awards had been granted under the plan. +Options granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. Restricted stock awards granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. +Stock Options— The Company estimates the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date the options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. Weighted-average assumptions used to estimate grant date fair values for stock options granted in the years ended December 31, 2015, 2014 and 2013 follow: +2015 +2014 +2013 +Volatility +37.95 +% +35.89 +% +41.36 +% +Expected term (in years) +5.00 +5.00 +5.00 +Dividend yield +2.00 +% +1.17 +% +0.89 +% +Risk-free interest rate +1.37 +% +1.76 +% +0.70 +% +Stock option activity for the year ended December 31, 2015 follows: +Weighted-average +Shares +exercise price +Outstanding at beginning of year +6,086,250 +$ +22.32 +Granted +831,000 +$ +20.06 +Exercised +— +— +Cancelled +(10,000 +) +$ +16.59 +Expired +(600,000 +) +$ +26.06 +Outstanding at end of year +6,307,250 +$ +21.68 +Exercisable at end of year +5,224,082 +$ +21.49 +Options outstanding at December 31, 2015 have an aggregate intrinsic value of approximately $1.7 million and a weighted-average remaining contractual term of 4.99 years. Options exercisable at December 31, 2015 have an aggregate intrinsic value of approximately $1.7 million and a weighted-average remaining contractual term of 4.16 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2015, 2014 and 2013 follows: +2015 +2014 +2013 +Weighted-average grant date fair value of stock options granted (per share) +$ +5.79 +$ +9.81 +$ +7.59 +Aggregate grant date fair value of stock options vested during the year (in thousands) +$ +5,077 +$ +5,173 +$ +5,240 +Aggregate intrinsic value of stock options exercised (in thousands) +$ +— +$ +21,862 +$ +8,683 +As of December 31, 2015, options to purchase 1.1 million shares were outstanding and not vested. All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2015 with respect to these non-vested options follows: +Aggregate intrinsic value (in thousands) +$ +— +Weighted-average remaining contractual term +8.99 years +Weighted-average remaining expected term +3.99 years +Weighted-average remaining vesting period +1.89 years +Unrecognized compensation cost +$5.8 million +Restricted Stock— For all restricted stock awards to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non- +F-22 +forfeitable di vidends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock activity for the year ended December 31, 2015 follows: +Weighted- +average Grant +Shares +Date Fair Value +Non-vested restricted stock outstanding at beginning of year +1,493,059 +$ +26.93 +Granted +795,600 +$ +20.58 +Vested +(774,235 +) +$ +24.89 +Forfeited +(82,174 +) +$ +25.89 +Non-vested restricted stock outstanding at end of year +1,432,250 +$ +24.56 +As of December 31, 2015, approximately 1.3 million shares of non-vested restricted stock outstanding are expected to vest. Additional information as of December 31, 2015 with respect to these non-vested shares follows: +Aggregate intrinsic value +$19.9 million +Weighted-average remaining vesting period +1.8 years +Unrecognized compensation cost +$25.1 million +Restricted Stock Units— For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions. Non-forfeitable cash dividend equivalents are paid on certain non-vested restricted stock units. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2015 follows: +Weighted-average +Grant Date Fair +Shares +Value +Non-vested restricted stock units outstanding at beginning of year +34,085 +$ +30.20 +Granted +22,100 +$ +20.85 +Vested +(14,499 +) +$ +27.37 +Forfeited +— +$ +— +Non-vested restricted stock units outstanding at end of year +41,686 +$ +26.22 +Performance Unit Awards. Each year, beginning in 2010, the Company granted stock-settled performance unit awards to certain executive officers (the “Stock-Settled Performance Units”). The Stock-Settled Performance Units provide for the recipients to receive a grant of shares of stock upon the achievement of certain performance goals established by the Compensation Committee during a specified period. The performance period for the Stock-Settled Performance Units is the three year period commencing on April 1 of the year of grant. For the 2012 and 2013 Stock-Settled Performance Units, the performance period can extend for an additional two years in certain circumstances. The performance goals for the Stock-Settled Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective performance units. Generally, the recipients will receive a target number of shares if the Company’s total shareholder return is positive and, when compared to the peer group, is at the 50 th percentile and two times the target if at the 75 th percentile or higher. If the Company’s total shareholder return is positive, and, when compared to the peer group, is at the 25 th percentile, the recipients will only receive one-half of the target number of shares. The grant of shares when achievement is between the 25 th and 75 th percentile will be determined on a pro-rata basis. There is no payout unless the Company’s total shareholder return is positive and, when compared to the peer group, is at or above the 25 th percentile. The total target number of shares with respect to the Stock-Settled Performance Units is set forth below: +2015 +2014 +2013 +2012 +2011 +2010 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +190,600 +154,000 +236,500 +192,000 +144,375 +178,750 +F-23 +For the stock-settled Performance Units that have been settled, following are the total shareholder return percentiles and the number of shares issued: +2012 +2011 +2010 +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Total shareholder return percentile for performance period +87 th +94 th +93 rd +Shares issued +384,000 +288,750 +357,500 +Because the Stock-Settled Performance Units are stock-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Stock-Settled Performance Units is set forth below (in thousands): +2015 +2014 +2013 +2012 +2011 +2010 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +4,052 +$ +5,388 +$ +5,564 +$ +3,065 +$ +5,569 +$ +3,117 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Stock-Settled Performance Units is set forth below (in thousands): +2015 +2014 +2013 +2012 +2011 +2010 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2015 +$ +1,013 +$ +1,796 +$ +1,855 +$ +255 +NA +NA +Year ended December 31, 2014 +NA +$ +1,347 +$ +1,855 +$ +1,022 +$ +464 +NA +Year ended December 31, 2013 +NA +NA +$ +1,391 +$ +1,022 +$ +1,856 +$ +260 +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid on certain restricted stock units. These payments are recognized as follows: +· +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +· +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +· +Dividend equivalents are recognized as additional compensation cost for restricted stock units. +11. Leases +The Company incurred rent expense of $37.6 million, $51.9 million and $47.4 million for the years ended December 31, 2015, 2014 and 2013, respectively. Rent expense is primarily related to short-term equipment rentals that are generally passed through to customers. +Future minimum rental payments required under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 2015 are as follows: +Year ending December 31, +2016 +$ +10,522 +2017 +4,969 +2018 +4,053 +2019 +3,229 +2020 +2,734 +Thereafter +4,655 +Total +$ +30,162 +F-24 +12. Income Taxes +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2015, 2014 and 2013 are as follows (in thousands): +2015 +2014 +2013 +Federal income tax expense (benefit): +Current +$ +(42,020 +) +$ +39,438 +$ +41,558 +Deferred +(83,812 +) +39,673 +47,136 +(125,832 +) +79,111 +88,694 +State income tax expense (benefit): +Current +(3,480 +) +3,987 +11,733 +Deferred +(12,433 +) +5,292 +4,229 +(15,913 +) +9,279 +15,962 +Foreign income tax expense (benefit): +Current +(2,590 +) +4,521 +4,572 +Deferred +(3,628 +) +(1,292 +) +(796 +) +(6,218 +) +3,229 +3,776 +Total income tax expense (benefit): +Current +(48,090 +) +47,946 +57,863 +Deferred +(99,873 +) +43,673 +50,569 +Total income tax expense (benefit): +$ +(147,963 +) +$ +91,619 +$ +108,432 +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2015, 2014 and 2013 is summarized as follows: +2015 +2014 +2013 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes +2.1 +2.5 +3.7 +Permanent differences +(1.3 +) +(1.4 +) +(1.5 +) +Other differences, net +(2.4 +) +(0.1 +) +(0.6 +) +Effective tax rate +33.4 +% +36.0 +% +36.6 +% +The Domestic Production Activities Deduction (IRC section 199 deduction) was enacted as part of the American Jobs Creation Act of 2004 (as revised by the Emergency Economic Stabilization Act of 2008) and allows a deduction of 9% in 2010 and thereafter on the lesser of qualified production activities income or taxable income. The permanent differences for 2013 include a deduction of $10.0 million as the Company fully utilized its remaining net operating loss carryforwards. The permanent differences for 2014 include a deduction of $8.8 million. The permanent differences for 2015 do not include any deduction as it is limited to taxable income, and the Company did not have taxable income in 2015 as a result of the Company’s election to utilize bonus depreciation. +The 2015 other differences include a 1% reduction related to the reconciliation of the deferred tax liability associated with the conversion of the Company’s Canadian operations to a controlled foreign corporation. The impact to the deferred tax liability from the conversion is being amortized over the weighted average remaining useful life of the Canadian assets. The 2015 other differences also include a 0.7% reduction for the lost benefit of the 2014 IRC section 199 deduction of $8.8 million as a result of the Company’s adoption of the final tangible property regulations with the filing of the 2014 tax return. +F-25 +The tax effect of significant temporary differences representing deferred tax assets and liabilities and changes therein were as follows (in thousands): +December 31, +Net +December 31, +Net +December 31, +Net +December 31, +2015 +Change +2014 +Change +2013 +Change +2012 +Deferred tax assets: +Current: +Net operating loss carryforwards +$ +27,887 +$ +27,887 +$ +— +$ +— +$ +— +$ +(18,914 +) +$ +18,914 +Workers’ compensation allowance +28,734 +424 +28,310 +698 +27,612 +2,534 +25,078 +Other +21,305 +(1,091 +) +22,396 +2,749 +19,647 +(804 +) +20,451 +77,926 +27,220 +50,706 +3,447 +47,259 +(17,184 +) +64,443 +Non-current: +Net operating loss carryforwards +77,514 +65,050 +12,464 +(988 +) +13,452 +1,690 +11,762 +Expense associated with employee stock options +14,591 +205 +14,386 +(1,822 +) +16,208 +1,536 +14,672 +Federal benefit of state deferred tax liabilities +24,485 +466 +24,019 +1,181 +22,838 +816 +22,022 +Other +20,441 +4,394 +16,047 +1,344 +14,703 +(421 +) +15,124 +137,031 +70,115 +66,916 +(285 +) +67,201 +3,621 +63,580 +Less: +Allowance to reduce deferred tax asset to expected realizable value +(603 +) +(603 +) +— +— +— +— +— +Total deferred tax assets +214,354 +96,732 +117,622 +3,162 +114,460 +(13,563 +) +128,023 +Deferred tax liabilities: +Current: +Other +(12,805 +) +826 +(13,631 +) +676 +(14,307 +) +(2,823 +) +(11,484 +) +Non-current: +Property and equipment basis difference +(986,922 +) +31 +(986,953 +) +(47,359 +) +(939,594 +) +(33,997 +) +(905,597 +) +Other +(13,339 +) +2,284 +(15,623 +) +(152 +) +(15,471 +) +(186 +) +(15,285 +) +(1,000,261 +) +2,315 +(1,002,576 +) +(47,511 +) +(955,065 +) +(34,183 +) +(920,882 +) +Total deferred tax liabilities +(1,013,066 +) +3,141 +(1,016,207 +) +(46,835 +) +(969,372 +) +(37,006 +) +(932,366 +) +Net deferred tax liability +$ +(798,712 +) +$ +99,873 +$ +(898,585 +) +$ +(43,673 +) +$ +(854,912 +) +$ +(50,569 +) +$ +(804,343 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and necessary allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. The Company expects the carrying value of the deferred tax assets at December 31, 2015 and 2014 to be realized as a result of the reversal of existing taxable temporary differences giving rise to deferred tax liabilities and the generation of taxable income. The valuation allowance of $603,000 is related to state net operating losses being carried forward that will expire in 2016. +Other deferred tax assets consist primarily of the tax effect of various allowance accounts and tax-deferred expenses expected to generate future tax benefits of approximately $41.7 million. Other deferred tax liabilities consist primarily of the tax effect of receivables from insurance companies and tax-deferred income not yet recognized for tax purposes. +For income tax purposes, the Company has approximately $257 million of federal net operating losses and approximately $237 million, net of valuation allowance, of state net operating losses as of December 31, 2015. Of these amounts, approximately $111 million will be carried back to prior years and the remaining balance can be carried forward to future years. Net operating losses that can be carried forward, if unused, are scheduled to expire as follows: 2025—$2.8 million; 2026—$17.1 million; 2027—$75,000; 2029—$33.2 million; 2030—$27.5 million; 2031—$88.0 million; 2034—$2,000; 2035—$213.9 million. +As of December 31, 2015, the Company had no unrecognized tax benefits. The Company has established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2015, the tax years ended December 31, 2012 through December 31, 2014 are open for examination by U.S. taxing authorities. As of December 31, 2015, the tax years ended December 31, 2011 through December 31, 2014 are open for examination by Canadian taxing authorities. +On January 1, 2010, the Company converted its Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes. This transaction triggered a $1.0 million increase in deferred tax liabilities, which is being amortized +F-26 +as a n increase to deferred income tax expense over the weighted average remaining useful life of the Canadian assets. This will be fully amortized by December 31, 2016. +As a result of the above conversion, the Company’s Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada. Effective January 1, 2010, the Company has elected to permanently reinvest these unremitted earnings in Canada, and intends to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $28.4 million as of December 31, 2015. The unrecognized deferred tax liability associated with these earnings was approximately $3.8 million, net of available foreign tax credits. This liability would be recognized if the Company received a dividend of the unremitted earnings. +13. Employee Benefits +The Company maintains a 401(k) plan for all eligible employees. The Company’s operating results include expenses of approximately $7.1 million in 2015, $7.2 million in 2014 and $6.2 million in 2013 for the Company’s contributions to the plan. +14. Business Segments +The Company’s revenues, operating profits and identifiable assets are primarily attributable to three business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) the investment, on a non-operating working interest basis, in oil and natural gas properties. Each of these segments represents a distinct type of business. These segments have separate management teams which report to the Company’s chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. +Contract Drilling — The Company markets its contract drilling services to major and independent oil and natural gas operators. As of December 31, 2015, the Company had 221 land-based drilling rigs in the continental United States and western Canada. +For the years ended December 31, 2015, 2014 and, 2013, contract drilling revenue earned in Canada was $37.5 million, $87.5 million and $86.6 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $53.4 million and $57.6 million as of December 31, 2015 and 2014, respectively. +Pressure Pumping — The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services are primarily well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. Cementing is the process of inserting material between the hole and the pipe to center and stabilize the pipe in the hole. +Oil and Natural Gas — The Company owns and invests in oil and natural gas assets as a non-operating working interest owner. The Company’s oil and natural gas interests are located primarily in Texas and New Mexico. +Major Customer — During 2015, one customer accounted for approximately $244 million or 13% of the Company’s consolidated operating revenues. These revenues were earned in both the Company’s contract drilling and pressure pumping businesses. During 2014, no single customer accounted for more than 10% of consolidated operating revenue. During 2013, one customer accounted for approximately $286 million or 10.5% of the Company’s consolidated operating revenues. These revenues were earned in both the Company’s contract drilling and pressure pumping businesses. +F-27 +The following tables summarize selected financial information relating to the Company’s business segments (in thousands): +Years Ended December 31, +2015 +2014 +2013 +Revenues: +Contract drilling +$ +1,155,565 +$ +1,843,707 +$ +1,684,878 +Pressure pumping +712,454 +1,294,569 +979,166 +Oil and natural gas +24,931 +50,196 +57,257 +Total segment revenues +1,892,950 +3,188,472 +2,721,301 +Elimination of intercompany revenues(a) +(1,673 +) +(6,181 +) +(5,267 +) +Total revenues +$ +1,891,277 +$ +3,182,291 +$ +2,716,034 +Income (loss) before income taxes: +Contract drilling +$ +(91,230 +) +$ +241,851 +$ +266,262 +Pressure pumping +(254,998 +) +89,081 +87,244 +Oil and natural gas +(12,870 +) +(5,482 +) +19,948 +(359,098 +) +325,450 +373,454 +Corporate and other +(58,487 +) +(58,105 +) +(54,647 +) +Net gain on asset disposals(b) +10,613 +15,781 +3,384 +Interest income +964 +979 +918 +Interest expense +(36,475 +) +(29,825 +) +(28,359 +) +Other +34 +3 +1,691 +Income (loss) before income taxes +$ +(442,449 +) +$ +254,283 +$ +296,441 +Identifiable assets: +Contract drilling +$ +3,457,044 +$ +4,000,576 +$ +3,569,588 +Pressure pumping +813,704 +1,186,010 +761,199 +Oil and natural gas +34,073 +50,945 +58,656 +Corporate and other(c) +228,496 +156,480 +297,684 +Total assets +$ +4,533,317 +$ +5,394,011 +$ +4,687,127 +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +618,434 +$ +524,023 +$ +438,728 +Pressure pumping +214,552 +147,595 +129,984 +Oil and natural gas +26,301 +42,576 +24,400 +Corporate and other +5,472 +4,536 +4,357 +Total depreciation, depletion, amortization and impairment +$ +864,759 +$ +718,730 +$ +597,469 +Capital expenditures: +Contract drilling +$ +527,054 +$ +771,593 +$ +504,508 +Pressure pumping +197,577 +241,359 +122,782 +Oil and natural gas +16,625 +36,683 +31,245 +Corporate and other +2,520 +2,706 +3,926 +Total capital expenditures +$ +743,776 +$ +1,052,341 +$ +662,461 +(a) +Consists of contract drilling and, in 2014, pressure pumping intercompany revenues for services provided to the oil and natural gas exploration and production segment. +(b) +Net gains or losses associated with the disposal of assets relate to corporate strategy decisions of the executive management group. Accordingly, the related gains or losses have been separately presented and excluded from the results of specific segments. +(c) +Corporate and other assets primarily include cash on hand, income tax receivables and certain deferred tax assets. +15. Concentrations of Credit Risk +Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +F-28 +The Company believes it has placed its demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 201 5 and 201 4 , the Company’s demand deposits and temporary ca sh investments consisted of the following (in thousands): +2015 +2014 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +617 +$ +636 +Deposits in FDIC and SIPC-insured institutions over insurance limits +130,330 +1,420 +Deposits in foreign banks +15,303 +43,664 +146,250 +45,720 +Less outstanding checks and other reconciling items +(32,904 +) +(2,708 +) +Cash and cash equivalents +$ +113,346 +$ +43,012 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which the Company provides services. As is general industry practice, the Company typically does not require customers to provide collateral. No significant losses from individual customers were experienced during the years ended December 31, 2015, 2014 or 2013. No provision for bad debts was recognized in 2015, 2014 or 2013. +16. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of the Company’s outstanding debt balances (including current portion) as of December 31, 2015 and 2014 is set forth below (in thousands): +December 31, 2015 +December 31, 2014 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +Borrowings under Credit Agreement: +Revolving credit facility +$ +— +$ +— +$ +303,000 +$ +303,000 +Term loan facility +70,000 +70,000 +82,500 +82,500 +2015 Term Loan +185,000 +185,000 +— +— +4.97% Series A Senior Notes +300,000 +279,635 +300,000 +288,346 +4.27% Series B Senior Notes +300,000 +258,806 +300,000 +269,173 +Total debt +$ +855,000 +$ +793,441 +$ +985,500 +$ +943,019 +The carrying values of the balances outstanding under the revolving credit facility, the term loan facility, and the 2015 Term Loan approximate their fair values as these instruments have floating interest rates. The fair values of the Series A Notes and Series B Notes at December 31, 2015 and 2014 are based on discounted cash flows associated with the respective notes using current market rates of interest at those respective dates. For the Series A Notes, the current market rates used in measuring this fair value were 6.66% at December 31, 2015 and 5.77% at December 31, 2014. For the Series B Notes, the current market rates used in measuring this fair value were 6.95% at December 31, 2015 and 6.00% at December 31, 2014. These fair value estimates are based on observable market inputs and are considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting. +F-29 +17. Quarterly Financial Information (in thousands, except per share amounts) (unaudited) +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2014 +Operating revenues +$ +678,168 +$ +757,276 +$ +845,628 +$ +901,219 +Operating income +58,776 +87,226 +30,291 +106,833 +Net income +34,822 +54,283 +15,976 +57,583 +Net income per common share: +Basic +$ +0.24 +$ +0.37 +$ +0.11 +$ +0.39 +Diluted +$ +0.24 +$ +0.37 +$ +0.11 +$ +0.39 +2015 +Operating revenues +$ +657,699 +$ +472,761 +$ +422,251 +$ +338,566 +Operating income (loss) +24,103 +(24,764 +) +(329,515 +) +(76,796 +) +Net income (loss) +9,125 +(18,975 +) +(225,978 +) +(58,658 +) +Net income (loss) per common share: +Basic +$ +0.06 +$ +(0.13 +) +$ +(1.54 +) +$ +(0.40 +) +Diluted +$ +0.06 +$ +(0.13 +) +$ +(1.54 +) +$ +(0.40 +) +F-30 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions(1) +Balance +(In thousands) +Year Ended December 31, 2015 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,546 +$ +— +$ +(1 +) +$ +3,545 +Year Ended December 31, 2014 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,674 +$ +— +$ +(128 +) +$ +3,546 +Year Ended December 31, 2013 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,513 +$ +— +$ +161 +$ +3,674 +(1) +Consists of uncollectible accounts (written off) or recovered. +S-1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 10, 2016 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 10, 2016. +Signature +Title +/s/ Mark S. Siegel +Chairman of the Board +Mark S. Siegel +/s/ William Andrew Hendricks, Jr. +President and Chief Executive Officer +William Andrew Hendricks, Jr. +(Principal Executive Officer) +/s/ John E. Vollmer III +Senior Vice President — Corporate Development, +John E. Vollmer III +Chief Financial Officer and Treasurer +(Principal Financial and Accounting Officer) +/s/ Kenneth N. Berns +Senior Vice President and Director +Kenneth N. Berns +/s/ Charles O. Buckner +Director +Charles O. Buckner +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Curtis W. Huff +Director +Curtis W. Huff +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Tiffany J. Thom +Director +Tiffany J. Thom +EXHIBIT INDEX +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.4 +Second Amended and Restated Bylaws (filed August 6, 2007 as Exhibit 3.3 to the Company’s Quarterly Report on Form +10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference). +10.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference). +10.2 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.3 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.4 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.7 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.8 +Form of Share-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010 and incorporated herein by reference).* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.10 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed April 21, 2014 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.11 +Form of Executive Officer Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.3 to the Company’s Current Report on Form 8-K, and incorporated herein by reference).* +10.12 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.13 +Form of Non-Employee Director Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.5 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.14 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.15 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns and John E. Vollmer III (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.16 +Employment Agreement, effective as of January 1, 2012, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed February 10, 2012 as Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 and incorporated herein by reference). * +10.17 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, John E. Vollmer III, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon and Tiffany J. Thom (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.18 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.19 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form +10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.20 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed on February 4, 2004 as Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.21 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.22 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and John E. Vollmer, III, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.23 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.24 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of November 2, 2009, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed November 2, 2009 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2009 and incorporated herein by reference).* +10.25 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of April 2, 2012, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed July 30, 2012 as Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012 and incorporated herein by reference).* +10.26 +Credit Agreement dated September 27, 2012, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed September 28, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.27 +Amendment No. 1 to Credit Agreement dated as of January 9, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed January 12, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.28 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.29 +Amendment No. 1 to Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated October 5, 2010) (filed October 28, 2015 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.30 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.31 +Amendment No. 1 to Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated June 14, 2012) (filed October 28, 2015 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.32 +Reimbursement Agreement, dated as March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.33 +Continuing Guaranty, dated as of March 16, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 16, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.34 +Term Loan Agreement, dated as March 18, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent and lender, each of the other lenders party thereto, Wells Fargo Securities, LLC, as Lead Arranger and Sole Book Runner, and Bank of America, N.A. and The Bank of Tokyo-Mitsubishi UFJ, LTD., as Co-Syndication Agents (filed March 18, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.35 +Continuing Guaranty, dated as of March 18, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 18, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+ +99.1 +Stipulation and Proposed Order of Dismissal, dated December 17, 2015.+ +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2015, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. \ No newline at end of file diff --git a/raw/filings/0000889900/2015/0001564590-16-012604/filing_metadata.csv b/raw/filings/0000889900/2015/0001564590-16-012604/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..3216a96a1c57d5151580374ec1b94a7fa910a8d7 --- /dev/null +++ b/raw/filings/0000889900/2015/0001564590-16-012604/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2016-02-10,2015-12-31,2016-02-10T21:53:13.000Z,0001564590-16-012604,pten-10k_20151231.htm,10-K,17981945,1,0,https://www.sec.gov/Archives/edgar/data/889900/000156459016012604/pten-10k_20151231.htm,https://www.sec.gov/Archives/edgar/data/889900/000156459016012604/,2015,2015,1 diff --git a/raw/filings/0000889900/2015/0001564590-16-012604/item1.txt b/raw/filings/0000889900/2015/0001564590-16-012604/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..6d43dbcd41d93ba7c74b099e3ee67a2d696937c3 --- /dev/null +++ b/raw/filings/0000889900/2015/0001564590-16-012604/item1.txt @@ -0,0 +1,252 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We own and operate in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. Patterson Energy, Inc. and UTI Energy Corp. merged in 2001 to form Patterson-UTI Energy, Inc. Our corporate headquarters are in Houston, Texas. +Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. As of December 31, 2015, we had a drilling fleet that consisted of 221 marketable land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. A drilling rig is considered marketable at a point in time if it is operating or can be made ready to operate without significant capital expenditures. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2015, we had approximately 1.1 million hydraulic horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in Texas and New Mexico. +Recent Developments +Oil prices have significantly declined since the second half of 2014. The closing price of oil, which was as high as $105.68 per barrel during the third quarter of 2014, reached a low price for 2015 of $34.55 in December 2015 and reached a twelve-year low of $26.68 in January 2016. As a result of the prolonged decline in oil prices, our industry continues to experience a severe decline in both contract drilling and pressure pumping activity levels. We do not expect this to change until commodity prices improve. +Low commodity prices are negatively impacting spending by exploration and production companies. The impact of these spending reductions is evidenced by published rig counts, which in the United States decreased more than 60% during 2015 and is now almost 70% lower than the peak in 2014. +Our rig count has also significantly declined. As of December 31, 2015, we had 80 drilling rigs operating in the United States, which was a decrease of 63% from the recent peak of 214 rigs in October 2014. Our operating rig count has continued to decline in 2016. On average, we operated 78 rigs in the United States during January 2016. Term contracts provided some support of our operating rig count during 2015. Based on contracts currently in place, we expect an average of 59 rigs operating under term contracts during the first quarter and an average of 46 rigs operating under term contracts during 2016. +Our pressure pumping business is continuing to experience the effects of reduced spending by customers and downward pressure on pricing. Due to market conditions, as of December 31, 2015, we had stacked approximately 38% of our fracturing horsepower. With the weakness in commodity prices since the beginning of 2016, we have seen a significant decrease in the amount of available work, and the profitability of available work has continued to deteriorate. In response, since the beginning of 2016, we have stacked approximately 140,000 fracturing horsepower. In total, we now have stacked slightly more than half of our fleet of more than 1 million hydraulic fracturing horsepower. +2 +In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014. In 2015, we continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate generally proportionate with the reduction in our rig count. In 2015, we significantly reduced our pressure pumping headcount and obtained lowe r prices on many products and services that we use. We also reduced our capital expenditures in 2015, and we expect our capital expenditures for 2016 to primarily consist of maintenance capital, inspections and potential upgrades, as we do not expect to b uild any new rigs or purchase any new fracturing horsepower in 2016. We plan to continue to adjust our cost structure in line with our level of operating activity. +We expect that our term contract coverage in contract drilling and scalability with respect to labor and other operating costs in contract drilling and pressure pumping should position us to weather this downturn. In the event oil prices remain depressed for a sustained period, or decline further, we may experience further significant declines in both drilling activity and spot dayrate pricing and in pressure pumping activity, which could have a material adverse effect on our business, financial condition and results of operations. +Industry Segments +Our revenues, operating profits and identifiable assets are primarily attributable to three industry segments: +· +contract drilling services, +· +pressure pumping services, and +· +oil and natural gas exploration and production. +All of our industry segments had operating profits in 2013. In 2014, our contract drilling services and our pressure pumping services segments had operating profits and our oil and natural gas exploration and production segment had an operating loss. Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014. All of our industry segments had operating losses in 2015. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2015, we had 221 marketable land-based drilling rigs based in the following regions: +· +46 in west Texas and southeastern New Mexico, +· +17 in north central and east Texas and northern Louisiana +· +36 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +· +37 in south Texas, +· +29 in western Oklahoma, +· +45 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +· +11 in western Canada. +Our marketable drilling rigs have rated maximum depth capabilities ranging from approximately 10,000 feet to 25,000 feet. Of these drilling rigs, 202 are electric rigs and 19 are mechanical rigs. An electric rig differs from a mechanical rig in that the electric rig converts the power from its diesel engines (the sole energy source for a mechanical rig) into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketable rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs to ensure that our drilling equipment is competitive. We have spent over $1.8 billion during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2015, 2014 and 2013, we spent approximately $527 million, $772 million and $505 million, respectively, on these capital expenditures. +3 +Depth and complexity of the well and drill site conditions are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to three years) and provide for the use of the drilling rig to drill multiple wells. During 2015, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 17 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. We believe that our drilling contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each drilling contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2015, 2014 and 2013 were under daywork contracts. +From time to time more than five years ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turnkey basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2015 +2014 +2013 +Average rigs operating per day(1) +124 +211 +192 +Number of rigs operated during the year +223 +231 +235 +Number of wells drilled during the year +2,448 +3,740 +3,378 +Number of operating days +45,142 +77,000 +69,918 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +4 +To address our cust omers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performanc e and safety improvements to existing high capacity rigs. APEX 1500 ® rigs are 1,500 horsepower electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other highly automated pipe handling equip ment. APEX 1000 ® rigs are 1,000 horsepower electric rigs with advanced technology equipment similar to the APEX 1500 ® rigs, but with a more compact design to fit on smaller locations. APEX WALKING ® rigs are designed to efficiently drill multiple wells fr om a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. Many APEX 1500 ® and APEX 1000 ® rigs have also been equipped with walking systems as noted below. As of December 31, 2015, our drilli ng fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent With Walking Systems +APEX 1500 rigs +96 +1 +97 +62 +% +APEX 1000 rigs +15 +— +15 +60 +% +APEX WALKING rigs +49 +— +49 +100 +% +Other electric rigs +35 +6 +41 +12 +% +Total electric rigs +195 +7 +202 +61 +% +Mechanical rigs +15 +4 +19 +Total +210 +11 +221 +Number of Rigs +Horsepower +United States +Canada +Total +2,000 to 2,500 +12 +— +12 +1,500 +133 +1 +134 +1,000 to 1,400 +61 +5 +66 +750 to 950 +4 +5 +9 +Total +210 +11 +221 +Average horsepower +1,386 +1,068 +1,370 +Average depth rating +18,700 +14,550 +18,493 +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (Southwest Region) and the Appalachian region (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. We believe that our pressure pumping contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each pressure pumping contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors. +5 +Equipment — We have pressure pumping equipment used in providing hydraulic and nitrogen fracturing se rvices as well as nitrogen, cementing and acid pumping services, wi th a total of approximately 1.1 million hydraulic horsepower as of December 31, 2015. Pressure pumping equipment at December 31, 2015 included: +Hydraulic +Other +Fracturing +Pumping +Equipment +Equipment +Total +Southwest Region: +Number of units +285 +32 +317 +Approximate hydraulic horsepower +663,800 +32,165 +695,965 +Northeast Region: +Number of units +169 +94 +263 +Approximate hydraulic horsepower +353,800 +55,400 +409,200 +Combined: +Number of units +454 +126 +580 +Approximate hydraulic horsepower +1,017,600 +87,565 +1,105,165 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and that sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Oil and Natural Gas Interests +We own and invest in oil and natural gas assets as a non-operating working interest owner. Our oil and natural gas working interests are located primarily in producing regions of Texas and New Mexico. Our oil and natural gas assets constituted less than 1% of our consolidated assets as of December 31, 2015. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2015, we received approximately 49% from our ten largest customers and approximately 33% from our five largest customers. During 2015, one customer accounted for approximately $244 million, or approximately 13%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Competition +The contract drilling and pressure pumping businesses are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn, such as the current market environment. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for land drilling and pressure pumping services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +· +drilling of oil and natural gas wells, +· +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +6 +· +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +· +use of underground storage tanks and injection wells, and +· +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operation. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +· +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +· +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. If such changes are made to CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +· +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +· +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the +7 +liability for owners and operators is the same under the Fe deral Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages . +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, U.S. Environmental Protection Agency (“EPA”) community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are no t fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our drilling rigs , pressu re pumping equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be ade quate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our drilling rigs an d pressure pumping equipment and certain other assets, such insurance does not cover the full replacement cost of such drilling rigs, pressure pumping equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage , a $2.0 million per occurrence self-insured retention on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We self-insure a number of other risks, including loss of earnings and bu siness interruption, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 3,400 full-time employees as of February 4, 2016. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. \ No newline at end of file diff --git a/raw/filings/0000889900/2015/0001564590-16-012604/item13.txt b/raw/filings/0000889900/2015/0001564590-16-012604/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2015/0001564590-16-012604/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2015/0001564590-16-012604/item9a.txt b/raw/filings/0000889900/2015/0001564590-16-012604/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..4575c04dc309ae9bdff0b7b6730017ea36a94869 --- /dev/null +++ b/raw/filings/0000889900/2015/0001564590-16-012604/item9a.txt @@ -0,0 +1,10 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2015, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2015, based on the +39 +Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 201 5 . +The effectiveness of our internal control over financial reporting as of December 31, 2015 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2015/0001564590-16-012604/rp_note.txt b/raw/filings/0000889900/2015/0001564590-16-012604/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2015/0001564590-16-012604/rpt_disclosure.txt b/raw/filings/0000889900/2015/0001564590-16-012604/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2016/0001564590-17-001437/filing.txt b/raw/filings/0000889900/2016/0001564590-17-001437/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..02eb576fa6c53233494adc513ede4f4547b2358e --- /dev/null +++ b/raw/filings/0000889900/2016/0001564590-17-001437/filing.txt @@ -0,0 +1,5115 @@ +10-K +1 +pten-10k_20161231.htm +PTEN-10K-20161231 +pten-10k_20161231.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +Form 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2016 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-22664 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N, Suite 800, Houston, Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +(281) 765-7100 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Exchange on Which Registered +Common Stock, $0.01 Par Value +The Nasdaq Global Select Market +Securities Registered Pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ or No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $3.1 billion, calculated by reference to the closing price of $21.32 for the common stock on the Nasdaq Global Select Market on that date. +As of February 6, 2017, the registrant had outstanding 166,334,905 shares of common stock, $0.01 par value, its only class of common stock. +Documents incorporated by reference: +Portions of the registrant’s definitive proxy statement for the 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings and press releases by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue and cost expectations and backlog; financing of operations; oil and natural gas prices; rig counts; source and sufficiency of funds required for building new equipment, upgrading existing equipment and additional acquisitions (if opportunities arise); impact of inflation; demand for our services; competition; equipment availability; government regulation; debt service obligations; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +On December 12, 2016, we entered into an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”), pursuant to which a subsidiary of ours will be merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly owned subsidiaries (the “SSE merger”). These forward-looking statements include, without limitation, our expectations with respect to: +• +synergies, costs and other anticipated financial impacts of the SSE merger; +• +future financial and operating results of the combined company; +• +the combined company’s plans, objectives, expectations and intentions with respect to future operations and services; +• +approval of the SSE merger by stockholders; +• +the satisfaction of the closing conditions to the SSE merger; and +• +the timing of the completion of the SSE merger. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +the receipt of approval of both our and SSE’s stockholders; +• +the time required to complete the SSE merger; +• +uncertainty as to whether the conditions to closing the SSE merger will be satisfied or whether the SSE merger will be completed; +• +the diversion of management time on merger-related issues; +• +the ultimate timing, outcome and results of integrating our operations with those of SSE; +• +the effects of our business combination with SSE, including the combined company’s future financial condition, results of operations, strategy and plans; +• +potential adverse reactions or changes to business relationships resulting from the announcement or completion of the SSE merger; +• +expected benefits from the SSE merger and our ability to realize those benefits; +• +expectations regarding regulatory approval of the SSE merger; +• +whether merger-related litigation will occur and, if so, the results of any litigation, settlements and investigations; +• +potential triggering of change of control provisions in certain agreements to which SSE is a party; +• +availability of capital and the ability to repay indebtedness when due; +1 +• +v olatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +loss of key customers; +• +utilization, margins and planned capital expenditures; +• +interest rate volatility; +• +compliance with covenants under our debt agreements; +• +excess availability of land drilling rigs and pressure pumping equipment, including as a result of reactivation or construction; +• +equipment specialization and new technologies; +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• +difficulty in building and deploying new equipment; +• +expansion and development trends of the oil and natural gas industry; +• +weather; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +the ability to retain management and field personnel; +• +the ability to effectively identify and enter new markets; +• +the ability to realize backlog; +• +strength and financial resources of competitors; +• +environmental risks and ability to satisfy future environmental costs; +• +global economic conditions; +• +adverse oil and natural gas industry conditions; +• +adverse credit and equity market conditions; +• +operating costs; +• +competition and demand for our services; +• +liabilities from operations for which we or SSE, as applicable, do not have and receive full indemnification or insurance; +• +governmental regulation; +• +ability to obtain insurance coverage on commercially reasonable terms; +• +financial flexibility; +• +legal proceedings; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in either Patterson-UTI’s or SSE’s SEC filings. +We caution that the foregoing list of factors is not exclusive. Additional information concerning these and other risk factors is contained in this Report and may be contained in our future filings with the SEC. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us, SSE, the SSE merger or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. As of December 31, 2016, we had a drilling fleet that consisted of 202 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2016, we had approximately 1.1 million hydraulic horsepower (approximately 1.0 million of which was hydraulic fracturing horsepower) to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also manufacture and sell pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2014, 2015 and 2016 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2014: +Average oil price per Bbl (1) +$ +98.75 +$ +103.35 +$ +97.78 +$ +73.16 +Average rigs operating per day - U.S. (2) +193 +201 +209 +210 +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +Average rigs operating per day - U.S. (2) +165 +122 +105 +88 +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +3 +The closing price of oil was as high as $10 7.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have recovered substantially from the lows experienced in the first quarter of 2016. During the fourth quarter of 2016, the Organization of Petroleum Exporting Countries (“ OPEC ”) and certain non-OPEC countries, including Russia, a nnounced an agreement to cut oil production. The announcement resulted in an increase in oil prices, which averaged $51.97 per barrel in December 2016. In response to improved prices, U.S. rig counts have been increasing, and we believe they will conti nue to increase throughout 2017 if prices for these commodities remain at or above current levels. +Our rig count in the United States declined significantly during the industry downturn that began in late 2014, but has steadily improved on a monthly basis since May 2016. For the fourth quarter, our average rig count improved to 66 rigs in the United States, up from the third quarter average of 60 rigs. Our rig count in the United States at December 31, 2016 of 74 rigs was 42% greater than the low of 52 rigs in April 2016; however, it was 65% less than the high of 214 rigs in October 2014. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 44 rigs operating under term contracts during the first quarter of 2017 and an average of 37 rigs operating under term contracts throughout 2017. +Activity levels in our pressure pumping business have also improved. Looking forward, we expect to see further increases in activity across the industry, especially in the Permian Basin. We have reactivated two frac spreads since mid-December 2016 at a cost of approximately $2 million per spread, including both operating and capital expenditures. Approximately 45% of the more than one million hydraulic fracturing horsepower in our fleet remains stacked. We expect the cost to reactivate our remaining idle frac spreads would be approximately $3 million per frac spread, including both operating and capital expenditures. +On December 12, 2016, we entered into an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”), pursuant to which a subsidiary of ours will be merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly owned subsidiaries (the “SSE merger”). Under the merger agreement, we will acquire all of the issued and outstanding shares of common stock of SSE in exchange for approximately 49.6 million shares of our common stock, subject to certain downward adjustments set forth in the merger agreement. SSE provides contract drilling, pressure pumping and oilfield rental services in many of the most active oil and natural gas plays onshore in the United States. SSE owns a fleet of 40 AC drilling rigs, approximately 93% of which are pad capable, including 28 fit-for-purpose PeakeRigs™. The remainder of SSE’s rig fleet includes 51 SCR rigs. Additionally, SSE owns approximately 500,000 horsepower of modern, efficient fracturing equipment located in the Anadarko Basin and Eagle Ford Shale. The SSE oilfield rentals business has a modern, well-maintained fleet of premium rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +The completion of the SSE merger is subject to satisfaction or waiver of certain closing conditions, including, but not limited to, approval by our and SSE’s respective stockholders and other closing conditions set forth in the merger agreement. Subject to closing conditions, the SSE merger is expected to be completed late in the first quarter or early in the second quarter of 2017. +Industry Segments +Our revenues, operating profits and identifiable assets are primarily attributable to two industry segments: +• +contract drilling services, and +• +pressure pumping services. +Both of these industry segments had operating losses in 2016 and 2015. In 2014, both of these industry segments had operating profits. +We changed our reporting segment presentation in 2016, as we no longer consider our oil and natural gas exploration and production activities to be significant to an understanding of our results. We now present the oil and natural gas exploration and production activities, drilling technology and international activities as “Other” and “Corporate” reflects only corporate activities. This change in segment presentation was applied retrospectively to all periods presented herein. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 15 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2016, we had 202 marketed land-based drilling rigs based in the following regions: +• +42 in west Texas and southeastern New Mexico, +4 +• +1 6 in north central and east Texas and northern Louisiana , +• +35 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +35 in south Texas, +• +24 in western Oklahoma, +• +43 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +7 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,000 feet to 25,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $1.4 billion during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2016, 2015 and 2014, we spent approximately $73 million, $527 million and $772 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to three years) and provide for the use of the drilling rig to drill multiple wells. During 2016, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 14 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. We believe that our drilling contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each drilling contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements, applicable law or other factors. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2016, 2015 and 2014 were under daywork contracts. +From time to time more than five years ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turnkey basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +5 +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2016 +2015 +2014 +Average rigs operating per day - U.S.(1) +63 +120 +203 +Average rigs operating per day - Canada(1) +2 +4 +8 +Number of rigs operated during the year +100 +223 +231 +Number of wells drilled during the year +1,470 +2,448 +3,740 +Number of operating days +23,596 +45,142 +77,000 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2016, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad Capable +APEX ® 1500 HP rigs +126 +1 +127 +70 +% +APEX ® 1000 HP rigs +26 +— +26 +88 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 2000 HP rigs +3 +— +3 +100 +% +Other electric rigs +35 +6 +41 +20 +% +Total +195 +7 +202 +63 +% +Average horsepower +1,428 +1,171 +1,419 +The U.S. land rig industry has recently begun referring to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has a 750,000 pound hookload, has a 7,500 psi circulating system and is pad capable. We currently estimate there are approximately 375 super-spec rigs in the United States, which includes 65 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (Southwest Region) and the Appalachian region (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. We believe that our pressure pumping contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each pressure pumping contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements, applicable law or other factors. +6 +Equipment — We have pressure pumping equipment used in providing hydraulic and nitrog en fracturing services as well as nitrogen, cementing and acid pumping services, wi th a total of approximately 1.1 million hydraulic horsepower (approximately 1.0 million of which was hydraulic fracturing horsepower) as of December 31, 2016. Pressure pumping equipment at December 31, 2016 included: +Hydraulic +Other +Fracturing +Pumping +Equipment +Equipment +Total +Southwest Region: +Number of units +284 +30 +314 +Approximate hydraulic horsepower +662,000 +30,890 +692,890 +Northeast Region: +Number of units +169 +94 +263 +Approximate hydraulic horsepower +353,800 +55,400 +409,200 +Combined: +Number of units +453 +124 +577 +Approximate hydraulic horsepower +1,015,800 +86,290 +1,102,090 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material, or should one of our suppliers fail to timely deliver our materials. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2016, we received approximately 51% from our ten largest customers and approximately 33% from our five largest customers. During 2016, one customer accounted for approximately $124 million, or approximately 14%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Competition +The contract drilling and pressure pumping businesses are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn, such as the current market environment. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for land drilling and pressure pumping services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, and +• +our employees. +7 +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business . We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future . However, compliance costs under existing laws or under any new requirements could become material , and we could incur liability in any instance of noncompliance . +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +8 +The Oil Poll ution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial h arm will be done to the environment by discharges on or into navigable waters . Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions . Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages . +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +9 +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to neg ligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our drilling rigs, pressure pumping equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our drilling rigs and pressure pumping equipment and certain other assets, such insurance does not cover the full replacement cost of such drilling rigs, pressure pumping equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cyber risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 3,600 full-time employees as of February 7, 2017. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +10 +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling and pressure pumping equipment, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, and +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, +• +the desire and ability of OPEC to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +• +domestic and international military, political, economic and weather conditions, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +• +the price and availability of alternative fuels. +All of these factors are beyond our control. The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil prices averaged $49.15 during the fourth quarter of 2016. As a result of the lower level of oil prices, our industry has experienced a severe decline in both contract drilling and pressure pumping activity levels. Currently, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our fracturing horsepower is stacked. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A continued decline in demand for oil and natural gas, prolonged low oil or natural gas prices or expectations of further decreases in oil and natural gas prices, would likely result in further reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +11 +Global Economic Conditions May Adversely Affect Our Operating Results . +Global economic conditions and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, and there is no assurance that the global economic environment will not quickly deteriorate again due to one or more factors, including a decline in the price for oil or natural gas. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Excess Equipment and a Highly Competitive Oil Service Industry May Adversely Affect Our Utilization and Profit Margins and the Carrying Value of our Assets. +The North American land drilling and pressure pumping businesses are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. In addition, in recent years there has been a substantial increase in the construction of new technology drilling rigs and new pressure pumping equipment. Low commodity prices and construction of new equipment can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. Even in an environment of high oil and natural gas prices and increased drilling activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to an excess supply of equipment. In addition, we may be unable to replace fixed-term contracts that were terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. Accordingly, high competition and excess equipment can cause drilling and pressure pumping contractors to have difficulty maintaining utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or excess equipment in the oil and natural gas contract drilling or pressure pumping businesses or the level of demand for our contract drilling or pressure pumping services. +The excess supply of operable land drilling rigs, increasing rig specialization and excess pressure pumping equipment, which has been exacerbated by the decline in oil and natural gas prices could affect the fair market value or our drilling and pressure pumping equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices could result in future impairment to our long-lived assets and goodwill. +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our customer contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +12 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not availab le or because of the high premium costs . The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our drilling rigs , pressure pumping equipment and certain other assets, employer’s liability, autom obile liability, commercial general liability, workers’ compensation and insurance for other specific risks . We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will cont inue to be available or available on terms that are acceptable to us . While we carry insurance to cover physical damage to, or loss of, a substantial portion of our drilling rigs and pressure pumping equipment and certain other assets, such insurance does not cover the full replacement cost of such drilling rigs , pressure pumping equipment or other assets . We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies . For example, we gen erally maintain a $1. 5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage , a $2.0 million per occurrence deductible on our general liability covera ge, and a $2.0 million per occurrence deductible on our automobile liability insurance coverage . We also self-insure a number of other risks, including loss of earnings and business interruption and cyber risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage . +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Current Backlog of Contract Drilling Revenue May Continue to Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2016, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $417 million. Our contract drilling backlog may continue to decline as fixed-term drilling contract coverage over time may not be offset by new contracts, including as a result of the decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. +New Technologies May Cause Our Operating Methods and Equipment to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive in Our Industry. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance of drilling rigs and equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs. Accordingly, a higher level of capital expenditures may be required to maintain and improve existing rigs and equipment and purchase and construct newer, higher specification drilling rigs to meet the increasingly sophisticated needs of our customers. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping business could have similar effects. +In recent years, we have added drilling rigs to our fleet through new construction, and we have purchased new pressure pumping equipment. We have also improved existing drilling rigs and pressure pumping equipment by adding equipment designed to enhance functionality and performance. Although we take measures to ensure that we use advanced oil and natural gas drilling and pressure pumping technology, changes in technology, improvements in competitors’ equipment and changes relating to the wells to be drilled and completed could make our equipment less competitive. +13 +If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technolog y that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, w e may be adversely affected . Additionally, n ew technologies, services or standards could render so me of our services, drilling rigs or pressure pumping equipment obsolete, which could have a material adverse impact on our business, financial condition, cash flows and results of operation . +Shortages, Delays in Delivery, and Interruptions in Supply, of Equipment and Materials Could Adversely Affect Our Operating Results. +During periods of increased demand for drilling and pressure pumping services, the industry has experienced shortages of equipment for upgrades, drill pipe, replacement parts and other equipment and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +transportation and other logistical challenges, and +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs. Severe shortages, delays in delivery and interruptions in supply could limit our ability to operate, maintain, upgrade and construct our drilling rigs and pressure pumping equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Loss of Key Personnel and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel, particularly after a prolonged industry downturn. During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of key personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even if it is generally a period of lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2016, we received approximately 51% from our ten largest customers, 33% from our five largest customers and 14% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Growth Through the Building of New Rigs and Pressure Pumping Equipment and Rig and Other Acquisitions Are Not Assured. +We have increased our drilling rig fleet and pressure pumping horsepower in the past through mergers, acquisitions and new construction. While we have entered into the merger agreement with SSE, there is no assurance that the SSE merger will be completed. The SSE merger is subject to a number of conditions, certain of which are beyond our control and may prevent, delay or otherwise materially adversely affect completion of the SSE merger. In addition, there can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building new rigs and pressure pumping equipment. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, improved commodity prices may cause contract drillers to continue to build new, high technology rigs and providers of pressure pumping services to continue to build new, high horsepower equipment. +14 +There can be no assurance that we will: +• +have sufficient capital resources to complete additional acquisitions or build new rigs or pressure pumping equipment, +• +successfully integrate additional drilling rigs, pressure pumping equipment or other assets or businesses, +• +effectively manage the growth and increased size of our organization, drilling fleet and pressure pumping equipment, +• +successfully deploy idle, stacked or additional rigs and pressure pumping equipment, +• +maintain the crews necessary to operate additional drilling rigs and pressure pumping equipment, or +• +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition or the building of new drilling rigs and pressure pumping equipment. +We may incur substantial indebtedness to finance future acquisitions, build new drilling rigs or build new pressure pumping equipment, and we also may issue equity, convertible or debt securities in connection with any such acquisitions or building program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. See “-Risk Factors Relating to the Pending SSE Merger.” +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties, +• +modification, denial or revocation of permits or other authorizations, +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the countries in which we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment and a manufacturer and servicer of oilfield service equipment, we may be deemed to be a responsible party under these laws and regulations. +Changes in environmental laws and regulations occur frequently and such laws and regulations tend to become more stringent over time. Stricter laws, regulations or enforcement policies could significantly increase compliance costs for us and our customers and have a material adverse effect on our operations or financial position. For example, on August 16, 2012, the EPA issued final rules that establish new air emission control requirements for natural gas and NGL production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds and National Emissions Standards for Hazardous Air Pollutants (“NESHAPS”) to address hazardous air pollutants frequently associated with gas production and processing activities. In June 2016, the EPA published a final rule that updates and expands the New Source Performance Standards by setting additional emissions limits for volatile organic compounds and regulating methane emissions for new and modified sources in the oil and gas industry. In addition, the EPA has announced that it intends to impose methane emission standards for existing sources and has issued information collection requests for oil and natural gas facilities. The EPA also published a final rule in June 2016 concerning aggregation of sources that affects source determinations for air permitting in the oil and gas industry. In November 2016, the Department of the Interior issued final rules relating to the venting, flaring and leaking of natural gas by oil and natural gas producers who operate on federal and Indian lands. The rules limit routine flaring of natural gas, require the payment of royalties on avoidable gas losses and require plans or programs relating to gas capture and leak detection and repair. These or other initiatives could increase costs to us and our customers or reduce demand for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations. +15 +Potential Legislation and Regulation Covering Hydraulic Fract uring or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations . +Members of the U.S. Congress and the EPA are reviewing proposals for more stringent regulation of hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. For example, the EPA conducted a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater. As part of this study, the EPA sent requests to a number of companies, including our company, for information on hydraulic fracturing practices. We responded to the inquiry. The EPA released its final report in December 2016. It concluded that hydraulic fracturing activities can impact drinking water resources under some circumstances, including large volume spills and inadequate mechanical integrity of wells. Further, we conduct drilling and pressure pumping activities in numerous states. Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. When caused by human activity, such seismic activity is called induced seismicity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) and other aspects of the oil and gas industry. +In addition, legislation has been proposed, but not enacted, in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if enacted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SDWA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel. In May 2014, the EPA issued an Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing. Further, in March 2015, the Bureau of Land Management (“BLM”) issued a final rule to regulate hydraulic fracturing on Indian land. The rule requires companies to publicly disclose chemicals used in hydraulic fracturing operations to the BLM. However, in June 2016, the U.S. District Court of Wyoming struck down the rule, finding that the BLM lacked authority to promulgate the rule. That decision is currently being appealed by the federal government. In June 2016, the EPA published final pretreatment standards for disposal of wastewater produced from shale gas operations to publicly owned treatment works. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations. For example, Colorado, Louisiana, Montana, North Dakota, Texas and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in response to such regulation. +In addition, in light of concerns about induced seismicity, some state regulatory agencies have modified their regulations or issued orders to address induced seismicity. For example, the Oklahoma Corporation Commission (“OCC”) has implemented volume reduction plans, and at times required shut-ins, for oil and natural gas disposal wells injecting wastewater into the Arbuckle formation. The OCC also recently released well completion seismicity guidelines for operators in the SCOOP and STACK plays that call for hydraulic fracturing operations to be suspended following earthquakes of certain magnitudes in the vicinity. +Finally, some jurisdictions have taken steps to enact hydraulic fracturing bans or moratoria. In June 2015, New York banned high volume fracturing activities combined with horizontal drilling. Certain communities in Colorado have also enacted bans on hydraulic fracturing. Voters in the city of Denton, Texas approved a moratorium on hydraulic fracturing in November 2014, though it was later lifted in 2015. These actions have been the subject of legal challenges. +The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could make it more difficult to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. +16 +The Design, Manufacture, Sal e and Servicing of Products, including Rig Components, May Subject Us to Liability for Personal Injury, Property Damage and Environmental Contamination Should Such Equipment Fail to Perform to Specifications. +We provide products, including rig components such as top drives, to customers involved in oil and gas exploration, development and production. Because of applications which use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. +Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business +We are aware of the increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. The EPA has adopted rules requiring the reporting of GHG emissions from specified large GHG emission sources on an annual basis. Further, following a finding by the EPA that certain GHGs represent an endangerment to human health, the EPA finalized a rule to address permitting of GHG emissions from stationary sources under the Clean Air Act’s New Source Review Prevention of Significant Deterioration (“PSD”) and Title V programs. This final rule “tailors” the PSD and Title V programs to apply to certain stationary sources of GHG emissions in a multi-step process, with the largest sources first subject to permitting. However, in June 2014, the U.S. Supreme Court in UARG v. EPA limited application of this rule to sources that would otherwise need permits based on emission of conventional pollutants. In April 2015, the D.C. Circuit Court of Appeals narrowed the rule in accordance with the Supreme Court’s decision. In October 2015, the EPA finalized rules that added new sources to the scope of the GHG monitoring and reporting requirements. These new sources include gathering and boosting facilities as well as completions and workovers from hydraulically fractured oil wells. The revisions also include the addition of well identification reporting requirements for certain facilities. Also, in November 2016, the EPA published a final rule adding monitoring methods for detecting leaks from oil and gas equipment and emission factors for leaking equipment to be used to calculate and report GHG emissions resulting from equipment leaks. In addition, the United States was actively involved in the United Nations Conference on Climate Change in Paris, which led to the creation of the Paris Agreement. In April 2016, the United States signed the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, every five years. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs. Additional legislation or regulation by these states and regions, the EPA, and/or any international agreements to which the United States may become a party, that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our operations. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +Legal Proceedings Could Have a Negative Impact on Our Business. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, such as the one we are currently experiencing, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect Our Opportunities and Future Business. +We currently conduct operations in Canada, and we have incurred selling, general and administrative expenses related to the evaluation of and preparation for other international opportunities. Also, through our recent Warrior acquisition, we sell products, including rig components, for use in numerous oil and gas producing regions outside of North America. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the +17 +markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated wit h foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where contract drilling and pressure pumping activities are conducted or where our consumers for the Warrior products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +Our Business Is Subject to Cybersecurity Risks and Threats. +Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow. It is possible that our business, financial and other systems could be compromised, which might not be noticed for some period of time. Risks associated with these threats include, among other things, loss of intellectual property, disruption of our and customers’ business operations and safety procedures, loss or damage to our worksite data delivery systems, unauthorized disclosure of personal information, and increased costs to prevent, respond to or mitigate cybersecurity events. +We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under our Long-Term Debt +We have borrowings outstanding under our senior notes and, from time to time, our revolving credit facility. These obligations are guaranteed by each of our existing U.S. subsidiaries other than immaterial subsidiaries. Our ability to meet our interest and principal payment obligations depends in large part on dividends paid to us by our subsidiaries. If our subsidiaries do not generate sufficient cash flows to pay us dividends, we may be unable to meet our interest and principal payment obligations. +18 +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Servic e Obligations to Increase Significantly . +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. Until September 27, 2017, the applicable margin on LIBOR rate loans varies from 2.75% to 3.25% and the applicable margin on base rate loans varies from 1.75% to 2.25%, in each case determined based upon our debt to capitalization ratio. Beginning September 27, 2017, the applicable margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on our excess availability under the credit facility. As of December 31, 2016, the applicable margin on LIBOR rate loans was 2.75% and the applicable margin on base rate loans was 1.75%. Based on our debt to capitalization ratio at September 30, 2016, the applicable margin on LIBOR loans was 2.75% and the applicable margin on base rate loans was 1.75% as of January 1, 2017. Based on our debt to capitalization ratio at December 31, 2016, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2017. As of December 31, 2016, we had no amounts outstanding under our revolving credit facility. +We have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2016, no amounts had been disbursed under any letters of credit. +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed. +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +Risk Factors Related to the Pending SSE Merger +Our expectations regarding our business may be impacted by the following risk factors related to the pending SSE merger: +The SSE Merger is Subject to Conditions, Including Certain Conditions That May Not Be Satisfied, or Completed on a Timely Basis, If At All. +The SSE merger is subject to a number of conditions, certain of which are beyond our control and may prevent, delay or otherwise materially adversely affect completion of the SSE merger. Notably, the completion of the SSE merger is conditioned on receiving the approval of both our and SSE’s respective stockholders. At any time prior to the receipt of such approvals, each of our board of directors and the board of directors of SSE may change its recommendation with respect to the SSE merger, in each case in response to a superior proposal or an intervening event if the applicable board of directors determines in good faith, after consultation with its outside counsel, that, among other things, the failure to do so would be inconsistent with its fiduciary duties under applicable law and complies with certain other specified conditions. Consequently, we cannot predict whether and when these conditions will be satisfied. Any delay in completing the SSE merger could cause the combined company not to realize some or all of the benefits that we expect to achieve if the SSE merger is successfully completed within its expected time frame. +Current Patterson-UTI Stockholders Will Have a Reduced Ownership and Voting Interest in the Combined Company After the SSE Merger. +We will issue up to 49,559,000 shares of common stock to SSE stockholders in the SSE merger. As a result of these issuances, SSE stockholders are expected to hold up to approximately 23% of the combined company’s outstanding common stock immediately following completion of the SSE merger. +19 +Our stockholders currently have the right to vote for our directors and on other matters affecting our company. Each of our stockholders will remain a stockholder of our company w ith a percentage ownership of the combined company that will be smaller than the stockholder’s percentage of our company prior to the SSE merger. As a result of these reduced ownership percentages, our stockholders will have less voting power in the combin ed company than they now have with respect to our company . +Uncertainties Associated With the SSE Merger May Cause a Loss of Key Employees, Which Could Adversely Affect the Future Business and Operations of the Combined Company. +We are dependent on the experience and industry knowledge of our officers and other key employees to execute our business plan. Our success until the SSE merger and the combined company’s success after the SSE merger will depend in part upon our ability to retain key employees. Current and prospective employees may experience uncertainty about their roles within the combined company following the SSE merger, which may have an adverse effect on our ability to attract or retain key personnel. Accordingly, no assurance can be given that the combined company will be able to attract or retain key employees to the same extent that we have previously been able to attract or retain our own employees. +Failure to Complete the SSE Merger Could Negatively Impact Our Future Business and Financial Results. +We cannot make any assurances that we will be able to satisfy all of the conditions to the SSE merger or succeed in any litigation brought in connection with the SSE merger. If the SSE merger is not completed, our financial results may be adversely affected and we will be subject to several risks, including but not limited to: +• +being required to pay SSE a termination fee of either $40,000,000 or $100,000,000, in each case under certain circumstances provided in the merger agreement; +• +payment of costs relating to the SSE merger, such as legal, accounting, financial advisor and printing fees, regardless of whether the SSE merger is completed; +• +the focus of our management team on the SSE merger instead of the pursuit of other opportunities that could have been beneficial to us; and +• +the potential occurrence of litigation related to any failure to complete the SSE merger. +In addition, if the SSE merger is not completed, we may experience negative reactions from the financial markets and from our customers and employees. If the SSE merger is not completed, we cannot assure our stockholders that these risks will not materialize and will not materially and adversely affect our business, financial results and stock price. +The Merger Agreement Contains Provisions That Limit Our Ability to Pursue Alternatives to the SSE Merger, Could Discourage a Potential Competing Acquirer of Us From Making a Favorable Alternative Transaction Proposal and, in Specified Circumstances, Could Require Us to Pay a Termination Fee to SSE. +The merger agreement contains “non-solicitation” provisions that, subject to limited exceptions, restrict our ability to, among other things, directly or indirectly, solicit, initiate, facilitate, knowingly encourage or induce or take any action that could be reasonably expected to lead to the making, submission or announcement of a proposal competing with the transactions contemplated by the merger agreement. In addition, while our board of directors has the ability, in certain circumstances, to change its recommendation of the transaction to our stockholders, we cannot terminate the merger agreement to accept an alternative proposal, and SSE generally has an opportunity to modify the terms of the SSE merger and the merger agreement in response to any alternative proposals that may be made before our board of directors may withdraw or modify its recommendation. Moreover, in certain circumstances, we may be required to pay up to $7,500,000 of SSE’s expenses or we may be required to pay SSE a termination fee of either $40,000,000 or $100,000,000. +These provisions could discourage a potential third party that might have an interest in acquiring all or a significant portion of us from considering or proposing that acquisition, even if it were prepared to pay consideration with a higher per share cash or market value than the market value proposed to be received or realized in the SSE merger. In addition, these provisions might result in a potential third party acquirer proposing to pay a lower price to our stockholders than it might otherwise have proposed to pay because of the added expense of the termination fee that may become payable in certain circumstances. If the merger agreement is terminated and we determine to seek another business combination, we may not be able to negotiate a transaction with another party on terms comparable to, or better than, the terms of the SSE merger. +20 +Completion of the SSE M erg er May Trigger Change in Control or Other Provisions in Certain Agreements to Which SSE is a P arty. +The completion of the SSE merger may trigger change in control or other provisions in certain agreements to which SSE is a party. If we and SSE are unable to negotiate waivers of those provisions, the counterparties may exercise their rights and remedies under the agreements, potentially terminating the agreements or seeking monetary damages. Even if we and SSE are able to negotiate waivers, the counterparties may require a fee for such waivers or seek to renegotiate the agreements on terms less favorable to SSE or the combined company. +We and SSE May be Unable to Obtain the Regulatory Clearances and Approvals Required to Complete the SSE Merger or, in Order to Do So, We May be Required to Comply With Material Restrictions or Conditions. +Under the HSR Act, neither we nor SSE may complete the SSE merger until required information and materials are furnished to the U.S. Department of Justice (“DOJ”) and the U.S. Federal Trade Commission (“FTC”), and the applicable waiting period under the HSR Act terminates or expires. On January 3, 2017, we and SSE filed the requisite notification and report forms under the HSR Act with the DOJ and the FTC. On January 13, 2017, we and SSE were notified by the FTC that the early termination of the waiting period under the HSR Act had been granted. +The SSE merger may also be subject to the regulatory requirements of other municipal, state, federal, or foreign governmental agencies and authorities. Regulatory entities may impose certain requirements or obligations as conditions for their approval or in connection with their review. +The merger agreement may require us to accept conditions from these regulators that could adversely impact the combined company without us having the right to refuse to close the SSE merger on the basis of those regulatory conditions. We cannot provide any assurance that we will obtain the necessary clearances or approvals, or that any required conditions will not have a material adverse effect on the combined company following the SSE merger or result in the abandonment of the SSE merger. +Additionally, even after the above-described statutory waiting periods have expired, and even after completion of the SSE merger, governmental authorities could seek to challenge the SSE merger. We may not prevail and may incur significant costs in defending or settling any action under the antitrust laws. +The Pendency of the SSE Merger Could Adversely Affect Our Business and Operations. +In connection with the pending SSE merger, some of our customers or vendors may delay or defer decisions, which could negatively affect our revenues, earnings, cash flows and expenses, regardless of whether the SSE merger is completed. Similarly, our current and prospective employees may experience uncertainty about their future roles with the combined company following the SSE merger, which may materially adversely affect our ability to attract, retain and motivate key personnel during the pendency of the SSE merger and which may materially adversely divert attention from the daily activities of our existing employees. +In addition, due to operating covenants in the merger agreement, we may be unable, during the pendency of the SSE merger, to pursue strategic transactions, undertake significant capital projects, undertake certain significant financing transactions and otherwise pursue other actions that are not in the ordinary course of business, even if such actions would prove beneficial to us. Further, the process of seeking to accomplish the SSE merger could also divert the focus of management from pursuing other opportunities that could be beneficial to us, without realizing any of the benefits which might have resulted had the SSE merger been completed. +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling Operations — Our drilling services are supported by several offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania and western Canada. +21 +Pressure Pumping — Our pressure pumping services ar e supported by several offices and yard facilities located throughout our areas of operations, including Texas, Pennsylvania, Ohio and West Virginia. +Our manufacture, sale and service of pipe handling components are supported by offices and yard facilities located in western Canada and Texas. Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas, as well as several other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +We are party to various legal proceedings arising in the normal course of its business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, results of operations or cash flows. +Item 4. Mine Safety Disclosure. +Not applicable. +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P MidCap 400 Index and several other market indices. The following table provides high and low sales prices of our common stock for the periods indicated: +High +Low +2016 +First quarter +$ +18.75 +$ +10.94 +Second quarter +22.12 +16.06 +Third quarter +22.66 +17.61 +Fourth quarter +29.56 +20.79 +2015 +First quarter +$ +19.70 +$ +13.30 +Second quarter +23.11 +18.30 +Third quarter +18.80 +12.97 +Fourth quarter +17.45 +12.82 +(b) Holders +As of February 6, 2017, there were approximately 1,126 holders of record of our common stock. +22 +(c) Dividends +We paid cash dividends during the years ended December 31, 2016 and 2015 as follows: +Per Share +Total +(in thousands) +2016 +Paid on March 24, 2016 +$ +0.10 +$ +14,712 +Paid on June 23, 2016 +0.02 +2,953 +Paid on September 22, 2016 +0.02 +2,953 +Paid on December 22, 2016 +0.02 +2,961 +Total cash dividends +$ +0.16 +$ +23,579 +2015 +Paid on March 25, 2015 +$ +0.10 +$ +14,640 +Paid on June 24, 2015 +0.10 +14,712 +Paid on September 24, 2015 +0.10 +14,712 +Paid on December 24, 2015 +0.10 +14,711 +Total cash dividends +$ +0.40 +$ +58,775 +On February 8, 2017, our Board of Directors approved a cash dividend on our common stock in the amount of $0.02 per share to be paid on March 22, 2017 to holders of record as of March 8, 2017. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. The merger agreement prohibits us (unless consented to in advance by SSE, which consent may not be unreasonably withheld, delayed or conditioned) from paying dividends to holders of our common stock in excess of $0.02 per share per quarter until the earlier of the effective time of the SSE merger and the termination of the merger agreement in accordance with its terms. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2016. +Period Covered +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands)(1) +October 2016 +— +$ +— +— +$ +186,653 +November 2016 +— +$ +— +— +$ +186,653 +December 2016 (2) +16,325 +$ +26.89 +— +$ +186,653 +Total +16,325 +— +$ +186,653 +(1) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. +(2) +We withheld 16,325 shares in December 2016 with respect to exercises of stock options by directors. These shares were acquired at fair market value pursuant to the terms of the 2014 Plan and not pursuant to the stock buyback program. +23 +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2011 through December 31, 2016, with the cumulative total return of the Standard & Poors 500 Stock Index, the Standard & Poors MidCap Index, the Oilfield Service Index and a peer group determined by us. We changed our peer group in 2016 to align with the peer group used by the compensation committee of our board of directors. In addition, our former peer group has been impacted by acquisitions over recent years. Our new peer group consists of Atwood Oceanics Inc., Basic Energy Services, Inc., Diamond Offshore Drilling Inc., Ensco plc., Forum Energy Technologies, Inc., FMC Technologies, Inc. (n/k/a TechnipFMC plc), Helmerich & Payne, Inc., Nabors Industries, Ltd., Noble Corp., Oceaneering International, Oil States International Inc., Precision Drilling Corporation, Parker Drilling Company, Rowan Companies Inc., Superior Energy Services, Inc., Transocean Ltd., Unit Corp. and Weatherford International Ltd. +The graph assumes investment of $100 on December 31, 2011 and reinvestment of all dividends. +Fiscal Year Ended December 31, +2011 +2012 +2013 +2014 +2015 +2016 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +94.38 +129.45 +86.18 +80.24 +144.44 +Peer Group Index +100.00 +102.72 +121.96 +81.22 +53.18 +58.98 +S&P 500 Stock Index +100.00 +116.00 +153.57 +174.60 +177.01 +198.18 +Oilfield Service Index +100.00 +103.17 +133.69 +102.23 +78.32 +93.19 +S&P MidCap Index +100.00 +117.88 +157.37 +174.74 +168.98 +204.03 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +24 +Item 6. Selected Financial Data. +Our selected consolidated financial data as of December 31, 2016, 2015, 2014, 2013 and 2012, and for each of the five years in the period ended December 31, 2016, should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report. +Years Ended December 31, +2016 +2015 +2014 +2013 +2012 +(In thousands, except per share amounts) +Statement of Operations Data: +Operating revenues: +Contract drilling +$ +543,663 +$ +1,153,892 +$ +1,838,830 +$ +1,679,611 +$ +1,821,713 +Pressure pumping +354,070 +712,454 +1,293,265 +979,166 +841,771 +Other +18,133 +24,931 +50,196 +57,257 +59,930 +Total +915,866 +1,891,277 +3,182,291 +2,716,034 +2,723,414 +Operating costs and expenses: +Contract drilling +305,804 +608,848 +1,066,659 +968,754 +1,075,491 +Pressure pumping +334,588 +612,021 +1,036,310 +744,243 +580,878 +Other +8,384 +11,500 +13,102 +12,909 +11,303 +Depreciation, depletion, amortization and impairment +668,434 +864,759 +718,730 +597,469 +526,614 +Impairment of goodwill +— +124,561 +— +— +— +Selling, general and administrative +69,205 +74,913 +80,145 +73,852 +64,473 +Other operating (income) expense, net +(14,323 +) +1,647 +(15,781 +) +(3,384 +) +(33,806 +) +Provision for bad debts +— +— +— +— +1,100 +Total +1,372,092 +2,298,249 +2,899,165 +2,393,843 +2,226,053 +Operating income (loss) +(456,226 +) +(406,972 +) +283,126 +322,191 +497,361 +Other expense +(39,970 +) +(35,477 +) +(28,843 +) +(25,750 +) +(21,688 +) +Income (loss) before income taxes +(496,196 +) +(442,449 +) +254,283 +296,441 +475,673 +Income tax expense (benefit) +(177,562 +) +(147,963 +) +91,619 +108,432 +176,196 +Net income (loss) +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +$ +188,009 +$ +299,477 +Net income (loss) per common share: +Basic +$ +(2.18 +) +$ +(2.00 +) +$ +1.12 +$ +1.29 +$ +1.96 +Diluted +$ +(2.18 +) +$ +(2.00 +) +$ +1.11 +$ +1.28 +$ +1.96 +Cash dividends per common share +$ +0.16 +$ +0.40 +$ +0.40 +$ +0.20 +$ +0.20 +Weighted average number of common shares outstanding: +Basic +146,178 +145,416 +144,066 +144,356 +151,144 +Diluted +146,178 +145,416 +145,376 +145,303 +151,699 +Balance Sheet Data: +Total assets +$ +3,804,606 +$ +4,529,484 +$ +5,390,912 +$ +4,683,375 +$ +4,552,507 +Borrowings under line of credit +— +— +303,000 +— +— +Other long-term debt +598,437 +787,900 +667,029 +678,873 +688,188 +Stockholders’ equity +2,248,724 +2,561,131 +2,905,810 +2,755,997 +2,640,657 +Working capital +18,506 +178,887 +340,816 +454,498 +340,220 +25 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Recent Developments — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2014, 2015 and 2016 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2014: +Average oil price per Bbl (1) +$ +98.75 +$ +103.35 +$ +97.78 +$ +73.16 +Average rigs operating per day - U.S. (2) +193 +201 +209 +210 +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +Average rigs operating per day - U.S. (2) +165 +122 +105 +88 +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have recovered substantially from the lows experienced in the first quarter of 2016. During the fourth quarter of 2016, OPEC and certain non-OPEC countries, including Russia, announced an agreement to cut oil production. The announcement resulted in an increase in oil prices, which averaged $51.97 per barrel in December 2016. In response to improved prices, U.S. rig counts have been increasing, and we believe they will continue to increase throughout 2017 if prices for these commodities remain at or above current levels. +Our rig count in the United States declined significantly during the industry downturn that began in late 2014, but has steadily improved on a monthly basis since May 2016. For the fourth quarter, our average rig count improved to 66 rigs in the United States, up from the third quarter average of 60 rigs. Our rig count in the United States at December 31, 2016 of 74 rigs was 42% greater than the low of 52 rigs in April 2016; however, it was 65% less than the high of 214 rigs in October 2014. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 44 rigs operating under term contracts during the first quarter of 2017 and an average of 37 rigs operating under term contracts throughout 2017. +Activity levels in our pressure pumping business have also improved. Looking forward, we expect to see further increases in activity across the industry, especially in the Permian Basin. We have reactivated two frac spreads since mid-December 2016 at a cost of approximately $2 million per spread, including both operating and capital expenditures. Approximately 45% of the more than one million hydraulic fracturing horsepower in our fleet remains stacked. We expect the cost to reactivate our remaining idle frac spreads would be approximately $3 million per frac spread, including both operating and capital expenditures. +On December 12, 2016, we entered into the merger agreement with SSE, pursuant to which a subsidiary of ours will be merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly owned subsidiaries. Under the merger agreement, we will acquire all of the issued and outstanding shares of common stock of SSE in exchange for approximately 49.6 million shares of our common stock, subject to certain downward adjustments set forth in the merger agreement. SSE provides contract drilling, pressure pumping and oilfield rental services in many of the most active oil and natural gas plays onshore in the United States. SSE owns a fleet of 40 AC drilling rigs, approximately 93% of which are pad capable, including 28 fit-for purpose PeakeRigs™. The remainder of SSE’s rig fleet includes 51 SCR rigs. Additionally, SSE owns approximately 500,000 horsepower of modern, efficient fracturing equipment located in the Anadarko Basin and Eagle Ford Shale. The SSE oilfield rentals business has a modern, well-maintained fleet of premium rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +The completion of the SSE merger is subject to satisfaction or waiver of certain closing conditions, including, but not limited to, approval by our and SSE’s respective stockholders and other closing conditions set forth in the merger agreement. Subject to closing conditions, the SSE merger is expected to be completed late in the first quarter or early in the second quarter of 2017. +26 +Management Overview — We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pres sure pumping equipment. Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. Our pressure pumping business operates primarily in Texas a nd the Appalachian region. We also manufacture and sell pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil a nd natural gas assets that are primarily located in Texas and New Mexico . +There continues to be uncertainty with respect to the global economic environment, and oil and natural gas prices have been depressed. During the fourth quarter of 2016, our average number of rigs operating in the United States was 66 compared to an average of 88 drilling rigs operating during the same period in 2015. During the fourth quarter of 2016, our average number of rigs operating in Canada was two compared to an average of three drilling rigs operating during the fourth quarter of 2015. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by expanding our areas of operation and improving the capabilities of our drilling fleet during the last several years. As of December 31, 2016, our rig fleet included 161 APEX ® rigs. We expect to add two new APEX ® rigs to our fleet during 2017. +In connection with the development of horizontal shale and other unconventional resource plays, we have added equipment to perform service intensive fracturing jobs. As of December 31, 2016, we had approximately 1.1 million hydraulic horsepower in our pressure pumping fleet (approximately 1.0 million of which was hydraulic fracturing horsepower). We have increased the horsepower of our pressure pumping fleet by more than eight-fold since the beginning of 2009, although we have not ordered or committed to purchase any new horsepower since October 2014 and there is currently no new horsepower on order. In recent years, the industry-wide addition of new pressure pumping equipment to the marketplace and lower oil and natural gas prices have led to an excess supply of pressure pumping equipment in North America. +We maintain a backlog of commitments for contract drilling revenues under term contracts, which we define as contracts with a fixed term of six months or more. Our contract drilling backlog as of December 31, 2016 and 2015 was $417 million and $710 million, respectively. The decrease in backlog at December 31, 2016 from December 31, 2015, is primarily due to the revenue earned since December 31, 2015, including revenue from the receipt of early termination payments, and the expiration and termination of certain of our term contracts. Approximately 29% of the total December 31, 2016 backlog is reasonably expected to remain after 2017. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to other fees such as for mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts that we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Continue to Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +For the three years ended December 31, 2016, our operating revenues consisted of the following (dollars in thousands): +2016 +2015 +2014 +Contract drilling +$ +543,663 +59 +% +$ +1,153,892 +61 +% +$ +1,838,830 +58 +% +Pressure pumping +354,070 +39 +% +712,454 +38 +% +1,293,265 +41 +% +Other +18,133 +2 +% +24,931 +1 +% +50,196 +1 +% +$ +915,866 +100 +% +$ +1,891,277 +100 +% +$ +3,182,291 +100 +% +Generally, the profitability of our business is most impacted by two primary factors in our contract drilling segment: our average number of rigs operating and our average revenue per operating day. During 2016, our average number of rigs operating was 63 in the United States and two in Canada compared to 120 in the United States and four in Canada in 2015, and 203 in the United States and eight in Canada in 2014. Our average rig revenue per operating day was $23,040 in 2016 compared to $25,560 in 2015 and $23,880 in 2014. We had a consolidated net loss of $319 million for 2016 compared to consolidated net loss of $294 million for 2015 and consolidated net income of $163 million for 2014. The financial results for 2015 include pretax non-cash charges totaling approximately $288 million. These charges include $125 million from the impairment of all goodwill associated with our pressure pumping business, $131 million from the write-down of drilling equipment primarily related to mechanical rigs and spare mechanical rig components, $22.0 from the write-down of pressure pumping equipment and closed facilities and $10.7 million related to the impairment of certain oil and natural gas properties. The financial results for 2014 include a pretax non-cash charge of $77.9 million related to the retirement of mechanical rigs and the write-off of excess spare components. +27 +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas. During periods of improved commodity pric es, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when these commodity prices deteriorate, the demand for our services generally weakens a nd we experience downward pressure on pricing for our services. Oil and natural gas prices and our number of rigs operating have significantly declined from 2014 . In December 201 6 , our average number of rigs operating was 71 in the United States . In January 201 7 , our average number of rigs operating in creased to 7 6 in the United States. +We are also highly impacted by operational risks, competition, the availability of excess equipment, labor issues, weather and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. Please see “Risk Factors” in Item 1A of this Report. +Critical Accounting Policies +In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition, the use of estimates and oil and natural gas properties. +Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional, vertical wells versus drilling longer, horizontal wells using higher specification rigs). The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs will be retired. In 2016, we retired 19 mechanical rigs but recorded no impairment charge as we had written down 15 of those rigs in 2015 that remained marketed. In 2015, we identified 24 mechanical rigs and 9 non-APEX® electric rigs that would no longer be marketed. Also, we had 15 additional mechanical rigs that were not operating. Although these 15 rigs remained marketed at that time, we had lower expectations with respect to utilization of these rigs due to the industry shift to higher specification drilling rigs. In 2015, we recorded a charge of $131 million related to the retirement of the 33 rigs, the 15 mechanical rigs that remained marketed but were not operating, and the write-down of excess spare rig components to their realizable values. In 2014, we identified 55 mechanical rigs that we determined would no longer be marketed, and we recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the reduced size of our mechanical fleet. +We also periodically evaluate our pressure pumping assets, and in 2015, we recorded a charge of $22.0 million for the write-down of pressure pumping equipment and certain closed facilities. There were no similar charges in 2016 or 2014. +We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying values of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The cyclical nature of our industry has resulted in fluctuations in rig utilization over periods of time. Management believes that the contract drilling industry will continue to be cyclical and rig utilization will continue to fluctuate. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as management’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +Based on recent commodity prices, our results of operations for the year ended December 31, 2016 and management’s expectations of operating results in future periods, we concluded that no triggering events occurred during the year ended December 31, 2016 with respect to our contract drilling or pressure pumping segments. Our expectations of future operating results were based on the assumption that activity levels in both segments will begin to recover by early 2017 in response to improved future oil prices. +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new low for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August, we lowered our expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of these revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping services during the third quarter of 2015, we concluded a triggering event had occurred and deemed it necessary to assess the recoverability of long-lived asset groups for both contract drilling and pressure pumping. We performed a Step 1 analysis as required +28 +by ASC 360-10-35 to assess the recoverability of long-li ved assets within our contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exc eeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approxim ate ly 120% and 60%, respectively. +Due to the continued deterioration of crude oil prices in the fourth quarter of 2015, we deemed it necessary to once again assess the recoverability of long-lived assets groups for both contract drilling and pressure pumping. We performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within our contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 100%, respectively. +For both of the assessments performed in 2015, the expected cash flows for the contract drilling segment included the backlog of commitments for contract drilling revenues under term contracts, which was approximately $801 million and $710 million at September 30, 2015 and December 31, 2015, respectively. Rigs not under term contracts would be subject to pricing in the spot market. Utilization and rates for rigs in the spot market and for the pressure pumping segment were estimated based upon our historical experience in prior downturns. Also, the expected cash flows for the contract drilling and pressure pumping segments were based on the assumption that activity levels in both segments would begin to recover in the first quarter of 2017 in response to improved oil prices. While we believe these assumptions with respect to future pricing for oil and natural gas are reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil and natural gas prices will recover is highly uncertain. Potential events that could affect our assumptions regarding future prices and the timeframe for a recovery are affected by factors such as: +• +market supply and demand, +• +the desire and ability of OPEC to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries +• +domestic and international military, political, economic and weather conditions, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, +• +the price and availability of alternative fuels, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, and +• +regulations regarding the exploration, development, production and delivery of oil and natural gas. +All of these factors are beyond our control. If the current oil and natural gas commodity price environment were to last through 2017 and beyond, our actual cash flows would likely be less than the expected cash flows used in the aforementioned 2015 assessments and could result in impairment charges in the future, and any such impairment charges could be material. +We concluded that no triggering events occurred during the year ended December 31, 2014 with respect to our contract drilling or pressure pumping segments based on our results of the operations for the year ended December 31, 2014 and the prevailing commodity prices at that time. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing have been determined to be our operating segments. We first determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if so, the resulting goodwill impairment is determined using a two-step quantitative impairment test. From time to time, we may perform the first step of the quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. The first step of the quantitative testing is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the quantitative testing is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities, with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of such shortfall. +29 +In connection with our annual goodwill impairment assessment as of December 31, 2016, we determined based on an assessment of qualitative f actors that it was more likely than not that the fair values of our contract drilling reporting unit w as greater than its carrying amount and further testing was not necessary. In making this determination, we considered the demand experienced during 2016 for our contract drilling business. We also considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in this reporting unit, as well as its operating results for 2016 a nd forecasted operating results for 2017. Lastly, management considered o ur overall market capitalization at December 31, 2016 and the significant amount of calculated excess of the fair value of our reporting unit over its carrying value from our 2015 qu antitative impairment assessment of goodwill. +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new low for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August, we lowered our expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of our revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for our contract drilling and pressure pumping services, we performed a quantitative Step 1 impairment assessment of our goodwill as of September 30, 2015. In completing the Step 1 assessment, the fair value of each reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of our contract drilling and pressure pumping reporting units, such as future oil and natural gas prices and projected demand for our services, and assumptions related to discount rates, long-term growth rates and control premiums. +Based on the results of the Step 1 goodwill impairment test as of September 30, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 15%, and we concluded that no impairment was indicated in our contract drilling reporting unit; however, impairment was indicated in our pressure pumping reporting unit. In the third quarter of 2015, we recognized an impairment charge of $125 million associated with the impairment of all of the goodwill in our pressure pumping reporting unit. +In connection with our annual goodwill impairment assessment as of December 31, 2015, we performed a quantitative Step 1 impairment assessment of the goodwill in our contract drilling reporting unit. In completing the Step 1 assessment, the fair value of the contract drilling reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of the reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of our contract drilling reporting unit, such as future oil and natural gas prices and projected demand for our services, and assumptions related to discount rates, long-term growth rates and control premiums. Based on the results of the quantitative Step 1 impairment assessment of our goodwill, as of December 31, 2015, the fair value of our contract drilling reporting unit exceeded its carrying value by approximately 16%, and we concluded that no impairment was indicated in our contract drilling reporting unit. +In connection with our annual goodwill impairment assessment as of December 31, 2014, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than their respective carrying amounts and no further testing was deemed necessary. In making this determination, we considered the continued demand experienced during 2014 for our contract drilling and pressure pumping businesses. We also considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in these reporting units. Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account. Lastly, management considered our overall market capitalization at December 31, 2014 and the large amount of calculated excess of the fair values of our reporting units over their respective carrying values from our 2013 quantitative impairment assessment. +We have undertaken extensive efforts in the past several years to upgrade our fleet of equipment and believe that we are well-positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells. In the event that market conditions were to remain weak for a protracted period, we may be required to record an impairment of goodwill in our contract drilling reporting unit in future periods, and any such impairment could be material. +Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed. Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs. All of the wells we drilled in 2016, 2015 and 2014 were drilled under daywork contracts. +Use of estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +30 +Key estim ates used by management include: +• +allowance for doubtful accounts, +• +depreciation, depletion and amortization, +• +fair values of assets acquired and liabilities assumed in acquisitions, +• +goodwill and long-lived asset impairments, and +• +reserves for self-insured levels of insurance coverage. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense. Geological and geophysical costs, including seismic costs and costs to carry and retain undeveloped properties, are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on our expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). The expected future net cash flows are discounted using an annual rate of 10% to determine fair value. We review unproved oil and natural gas properties quarterly to assess potential impairment. Our impairment assessment is made on a lease-by-lease basis and considers factors such as our intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to both proved and unproved oil and natural gas properties totaled approximately $2.8 million, $10.7 million and $20.9 million for the years ended December 31, 2016, 2015 and 2014, respectively, and such amounts are included in depreciation, depletion, amortization and impairment in the consolidated statements of operations. +For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Liquidity and Capital Resources +Our liquidity as of December 31, 2016 included approximately $18.5 million in working capital and $500 million available under our revolving credit facility. +On January 24, 2017, we entered into an agreement with certain lenders under our revolving credit facility pursuant to which we exercised approximately $95.8 million of the $100 million commitment increase feature available thereunder in order to increase the aggregate commitments under our revolving credit facility to approximately $595.8 million. The effectiveness of the aggregate commitment increase is subject to certain conditions, including the consummation of the SSE merger and the repayment and termination of the SSE credit facility, as well as other customary conditions. +On January 27, 2017, we completed an offering of 18.2 million shares of our common stock, and we intend to use the net proceeds from this offering of approximately $470 million to fund the repayment of SSE’s outstanding net indebtedness upon closing of the SSE merger. If the SSE merger is not consummated, we intend to use the net proceeds of the offering for general corporate purposes, which may include repayment of outstanding indebtedness or investments in working capital. +31 +We believe our current liquidity , together with cash expected to be generated from operations in 2017 , should provide us with sufficient ability to fund our current plans to maintain and make improv ements to our existing equipment, service our debt and pay cash dividends for at least the next 12 months . If under current market conditions we desire to pursue opportunities for growth , in addition to the SSE merger, that require capital, we believe we would likely require additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +As of December 31, 2016, we had working capital of $18.5 million, including cash and cash equivalents of $35.2 million, compared to working capital of $179 million, including cash and cash equivalents of $113 million, at December 31, 2015. +During 2016, our sources of cash flow included: +• +$305 million from operating activities, and +• +$21.9 million in proceeds from the disposal of property and equipment. +During 2016, we used $255 million to repay long-term debt, $23.6 million to pay dividends on our common stock, $3.6 million to acquire shares of our common stock, $3.4 million to pay debt issuance costs and $120 million: +• +to build and acquire components to build new drilling rigs, +• +to purchase new pressure pumping equipment, +• +to make capital expenditures for the betterment and refurbishment of existing drilling rigs and pressure pumping equipment, +• +to acquire and procure equipment and facilities for our drilling and pressure pumping operations, and +• +to fund investments in oil and natural gas properties on a non-operating working interest basis. +We paid cash dividends during the year ended December 31, 2016 as follows: +Per Share +Total +(in thousands) +Paid on March 24, 2016 +$ +0.10 +$ +14,712 +Paid on June 23, 2016 +0.02 +2,953 +Paid on September 22, 2016 +0.02 +2,953 +Paid on December 22, 2016 +0.02 +2,961 +Total cash dividends +$ +0.16 +$ +23,579 +On February 8, 2017, our Board of Directors approved a cash dividend on our common stock in the amount of $0.02 per share to be paid on March 22, 2017 to holders of record as of March 8, 2017. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. The merger agreement prohibits us (unless consented to in advance by SSE, which consent may not be unreasonably withheld, delayed or conditioned) from paying dividends to holders of our common stock in excess of $0.02 per share per quarter until the earlier of the effective time of the SSE merger and the termination of the merger agreement in accordance with its terms. +On September 6, 2013, our Board of Directors approved a stock buyback program that authorizes purchase of up to $200 million of our common stock in open market or privately negotiated transactions. As of December 31, 2016, we had remaining authorization to purchase approximately $187 million of our outstanding common stock under the 2013 stock buyback program. Shares purchased under a buyback program are accounted for as treasury stock. +We acquired shares of stock from directors in 2016 and from employees during 2016, 2015 and 2014 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options. The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan or the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan and not pursuant to the stock buyback program. +32 +Treasury stock acquisitions during the year s ended December 31, 201 6 , 201 5 and 201 4 were as follows (dollars in thousands): +2016 +2015 +2014 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +Purchases pursuant to 2013 stock buyback program +8,488 +183 +8,618 +180 +13,898 +466 +Acquisitions pursuant to long-term incentive plans +176,889 +3,866 +380,037 +7,830 +536,630 +17,681 +Treasury shares at end of period +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +2012 Credit Agreement — On September 27, 2012, we entered into a Credit Agreement (“Base Credit Agreement”). The Base Credit Agreement (as amended, the “Credit Agreement”) is a committed senior unsecured credit facility that includes a revolving credit facility. +On July 8, 2016, we entered into Amendment No. 2 to the Credit Agreement (“Amendment No. 2”), which amended the Base Credit Agreement. The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time, subject to a borrowing base calculated by reference to ours and certain of our subsidiaries’ eligible equipment, inventory, accounts receivable and unencumbered cash as described in Amendment No. 2. The revolving credit facility contains a letter of credit facility that is limited to $50 million and a swing line facility that is limited to $20 million, in each case outstanding at any time. Subject to customary conditions, we may request that the lenders’ aggregate commitments with respect to the revolving credit facility be increased by up to $100 million, not to exceed total commitments of $600 million. The maturity date under the Base Credit Agreement was September 27, 2017 for the revolving credit facility; however, Amendment No. 2 extended the maturity date of $357.9 million in revolving credit commitments of certain lenders to March 27, 2019. +The term loan facility included in the Base Credit Agreement, which facility was terminated in connection with Amendment No. 2, provided for a loan of $100 million, which was drawn on December 24, 2012 and was payable in quarterly principal installments. As a condition precedent, Amendment No. 2 required that we repay the entire outstanding principal amount of this term loan. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. Until September 27, 2017, the applicable margin on LIBOR rate loans varies from 2.75% to 3.25% and the applicable margin on base rate loans varies from 1.75% to 2.25%, in each case determined based upon our debt to capitalization ratio. Beginning September 27, 2017, the applicable margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on our availability under the credit facility. As of December 31, 2016, the applicable margin on LIBOR rate loans was 2.75% and the applicable margin on base rate loans was 1.75%. Based on our debt to capitalization ratio at September 30, 2016, the applicable margin on LIBOR loans is 2.75% and the applicable margin on base rate loans is 1.75% as of January 1, 2017. Based on our debt to capitalization ratio at December 31, 2016, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2017. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%. +Each of our domestic subsidiaries unconditionally guarantees all existing and future indebtedness and liabilities of the other guarantors and ours arising under the Credit Agreement, other than (a) Ambar Lone Star Fluid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million. Such guarantees also cover our or any of our subsidiaries arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 40%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit our interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2016. +33 +Amendment No . 2 limits our ability to make investments in foreign subsidiaries or joint ventures such that, if the book value of all such investments since September 27, 2012 is above 20% of the total consolidated book value of our consolidated assets on a pro forma b asis, we will not be able to make such investment. Amendment No. 2 also restricts our ability to pay dividends and make equity repurchases, subject to certain exceptions, including an exception allowing such restricted payments if before and immediately a fter giving effect to such restricted payment, the Pro Forma Debt Service Coverage Ratio (as defined in Amendment No. 2) is at least 1.50 to 1.00. In addition, Amendment No. 2 requires that, if our consolidated cash balance, subject to certain exclusions, is more than $100 million at the end of the day on which a borrowing is made, we can only use the proceeds from such borrowing to fund acquisitions, capital expenditures and the repurchase of indebtedness, and if such proceeds are not used in such manner within three business days, we must repay such unused proceeds on the fourth business day following such borrowings. Amendment No. 2 also decreased the permitted amount of certain secured indebtedness of us and our subsidiaries and decreased the permitted amount of certain unsecured indebtedness of our subsidiaries. +The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require us to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to our insolvency and bankruptcy, such acceleration is automatic), and (iii) require us to cash collateralize any outstanding letters of credit. +As of December 31, 2016, we had no amounts outstanding under our revolving credit facility, with available borrowing capacity of $500 million. +On January 17, 2017, we entered into Amendment No. 3 to Credit Agreement (“Amendment No. 3”), which amended the Credit Agreement by restating the definition of Consolidated EBITDA to provide for the add-back of transaction expenses related to the SSE merger. +On January 24, 2017, we entered into an agreement with certain lenders under our revolving credit facility pursuant to which we exercised approximately $95.8 million of the $100 million commitment increase feature available thereunder in order to increase the aggregate commitments under our revolving credit facility to approximately $595.8 million. The effectiveness of the aggregate commitment increase is subject to certain conditions, including the consummation of the SSE merger and the repayment and termination of the SSE credit facility, as well as other customary conditions. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2016, we had $38.2 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015 (the “Continuing Guaranty”), our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. +34 +2015 Term Loan Agreement — On March 18, 2015, we entered into a Term Loan Agree ment (the “2015 Term Loan Agreement”). The 2015 Term Loan Agreement was a senior unsecured single-advance term loan facility pursuant to which we made a term loan borrowing of $200 million on March 18, 2015 (the “Term Loan Borrowing”). The Term Loan Borrowing was payable in quarterly principal installments, together with accrued interest. Loans under the 2015 Term Loan Agreement bore interest, at our election, at the per annum rate of LIBOR rate plus 3.25% or base rate plus 2.25%. +As a condition precedent to Amendment No 2, we repaid the entire outstanding principal amount under the 2015 Term Loan Agreement and terminated the agreement on July 8, 2016. +Senior Notes — On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. We pay interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amounts of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. We pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations, which rank equally in right of payment with all of our other unsubordinated indebtedness. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of our domestic subsidiaries other than subsidiaries that are not required to be guarantors under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at our option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. We must offer to prepay the notes upon the occurrence of any change of control. In addition, we must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit our interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2016. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if we default in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +Commitment Letter – On December 12, 2016 in connection with the execution of the merger agreement, we entered into a financing commitment letter (the “Commitment Letter”) with Canyon Capital Advisors LLC for a senior unsecured bridge facility in an aggregate principal amount not to exceed $150 million (the “Bridge Facility”), for the purposes of repaying or redeeming certain of SSE and its subsidiaries’ indebtedness and to pay related fees and expenses. Any undrawn commitments under the Bridge Facility will automatically terminate on the closing date of the SSE merger. The Bridge Facility will be subject to representations, warranties and covenants that, subject to certain agreed modifications, will be substantially similar to our revolving credit facility. The funding of the Bridge Facility is subject to our compliance with customary terms and conditions precedent as set forth in the Commitment Letter, including, among others: (i) the execution and delivery by us of definitive documentation consistent with the Commitment Letter and (ii) the SSE merger shall have been, or substantially simultaneously with the funding under the Bridge Facility shall be, consummated in accordance with the terms of the merger agreement. We do not currently expect to enter into the Bridge Facility. +35 +Commitments and Contingencies — The merger agreement provides for an expense reimbursement in an amount not to exceed $7 .5 million in respect of bona fide, out of pocket expenses actually incurred by SSE in connection with the m erger agreement if the merger agreement is terminated if our stockholde rs fail to approve the issuance of our common stock in the SSE merger. The merger agreement also provides that we may be required to pay SSE a termination fee of $100 million in certain circumstances, including if our board of directors changes its recomm endation as a result of a superior parent proposal (as defined in the merger agreement) or if the merger agreement is terminated in certain circumstances and we enter into certain types of alternative acquisition transactions within 12 months of terminatio n. In certain other circumstances, we may be required to pay SSE a termination fee of $40 million. In no event will we be obligated to make more than one expense reimbursement payment or more than one termination fee payment to SSE. +The description of the expense reimbursement, termination payments and other provisions of the merger agreement does not purport to be complete and is qualified in its entirety by the full text of the merger agreement, which we filed with the SEC on December 13, 2016 as Exhibit 2.1 to our Current Report on Form 8-K. +As of December 31, 2016, we maintained letters of credit in the aggregate amount of $38.2 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2016, no amounts had been drawn under the letters of credit. +As of December 31, 2016, we had commitments to purchase approximately $68.4 million of major equipment for our drilling and pressure pumping businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. As of December 31, 2016, the remaining obligation under these agreements was approximately $17.0 million, of which materials with a total purchase price of approximately $9.5 million were required to be purchased during 2017. In the event that the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Contractual Obligations +The following table presents information with respect to our contractual obligations as of December 31, 2016 (dollars in thousands): +Payments due by period +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Series A Notes (1) +$ +300,000 +$ +— +$ +— +$ +300,000 +$ +— +Interest on Series A Notes (2) +59,640 +14,910 +29,820 +14,910 +— +Series B Notes (3) +300,000 +— +— +— +300,000 +Interest on Series B Notes (4) +72,912 +12,810 +25,620 +25,620 +8,862 +Leases (5) +31,053 +5,707 +9,515 +6,686 +9,145 +Equipment purchases (6) +68,423 +68,423 +— +— +— +Inventory purchases (7) +17,025 +9,525 +7,500 +— +— +$ +849,053 +$ +111,375 +$ +72,455 +$ +347,216 +$ +318,007 +(1) +Principal repayment of the Series A Notes is required at maturity on October 5, 2020. +(2) +Interest to be paid on the Series A Notes using 4.97% coupon rate. +(3) +Principal repayment of the Series B Notes is required at maturity on June 14, 2022. +(4) +Interest to be paid on the Series B Notes using 4.27% coupon rate. +(5) +See Note 12 of Notes to Consolidated Financial Statements. +(6) +Represents commitments to purchase major equipment to be delivered in 2017 based on expected delivery dates. +(7) +Represents commitments to purchase proppants and chemicals for our pressure pumping business. +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements at December 31, 2016. +36 +Results of Operations +Comparison of the years ended December 31, 2016 and 2015 +The following tables summarize operations by business segment for the years ended December 31, 2016 and 2015: +Year Ended December 31, +Contract Drilling +2016 +2015 +% Change +(Dollars in thousands) +Revenues +$ +543,663 +$ +1,153,892 +(52.9 +)% +Direct operating costs +305,804 +608,848 +(49.8 +)% +Margin (1) +237,859 +545,044 +(56.4 +)% +Selling, general and administrative +5,743 +5,580 +2.9 +% +Depreciation, amortization and impairment +467,974 +618,434 +(24.3 +)% +Operating loss +$ +(235,858 +) +$ +(78,970 +) +198.7 +% +Operating days +23,596 +45,142 +(47.7 +)% +Average revenue per operating day +$ +23.04 +$ +25.56 +(9.9 +)% +Average direct operating costs per operating day +$ +12.96 +$ +13.49 +(3.9 +)% +Average margin per operating day (1) +$ +10.08 +$ +12.07 +(16.5 +)% +Average rigs operating +64.5 +123.7 +(47.9 +)% +Capital expenditures +$ +72,508 +$ +527,054 +(86.2 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +The demand for our contract drilling services is impacted by the market price of oil and natural gas. The decline in prices for oil and natural gas, together with the reactivation and construction of new land drilling rigs in the United States in recent years, have resulted in an excess capacity of land drilling rigs compared to demand. Also in recent years, customer demand has shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs. The average market price of oil and natural gas for each of the fiscal quarters and full year in 2016 and 2015 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +$ +43.15 +Average natural gas price per Mcf (2) +$ +2.00 +$ +2.14 +$ +2.88 +$ +3.04 +$ +2.51 +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +$ +48.69 +Average natural gas price per Mcf (2) +$ +2.90 +$ +2.75 +$ +2.76 +$ +2.12 +$ +2.63 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information +Administration. +(2) The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy +Information Administration. +The decreases in revenues and direct operating costs primarily result from the decrease in the number of rigs operating. Average revenue per operating day and average margin per operating day were higher in 2015 primarily due to higher average dayrates and early termination revenues of approximately $69.4 million. Early termination revenues were approximately $24.6 million in 2016. Depreciation, amortization and impairment expense for 2015 included a charge of $131 million related to the write-down of drilling equipment primarily related to mechanical rigs and spare mechanical rig components. There were no similar charges in 2016. Capital expenditures were significantly lower as no new rigs were added to the fleet in 2016 and drilling activity was lower, which required less maintenance capital. +37 +Year Ended December 31, +Pressure Pumping +2016 +2015 +% Change +(Dollars in thousands) +Revenues +$ +354,070 +$ +712,454 +(50.3 +)% +Direct operating costs +334,588 +612,021 +(45.3 +)% +Margin (1) +19,482 +100,433 +(80.6 +)% +Selling, general and administrative +11,238 +16,318 +(31.1 +)% +Depreciation, amortization and impairment +184,872 +214,552 +(13.8 +)% +Impairment of goodwill +— +124,561 +NA +Operating loss +$ +(176,628 +) +$ +(254,998 +) +(30.7 +)% +Fracturing jobs +352 +610 +(42.3 +)% +Other jobs +799 +2,080 +(61.6 +)% +Total jobs +1,151 +2,690 +(57.2 +)% +Average revenue per fracturing job +$ +982.56 +$ +1,117.95 +(12.1 +)% +Average revenue per other job +$ +10.28 +$ +14.66 +(29.9 +)% +Average revenue per total job +$ +307.62 +$ +264.85 +16.1 +% +Average direct operating costs per total job +$ +290.69 +$ +227.52 +27.8 +% +Average margin per total job (1) +$ +16.93 +$ +37.34 +(54.7 +)% +Margin as a percentage of revenues (1) +5.5 +% +14.1 +% +(61.0 +)% +Capital expenditures +$ +39,584 +$ +197,577 +(80.0 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Revenues and direct operating costs decreased in 2016 as a result of declines in both activity and pricing. Average revenue per fracturing job and average revenue per other job decreased due to market-related pricing constraints. Average revenue per total job and average direct operating costs per total job increased as a result of a shift in the job mix toward fracturing jobs. The total number of jobs decreased as a result of the downturn in the oil and natural gas industry. Lower selling, general and administrative expense in 2016 reflects lower personnel costs due to headcount reductions. Depreciation, amortization and impairment expense for 2015 includes a charge of $22.0 million related to the write-down of pressure pumping equipment and closed facilities. There were no similar charges in 2016. In addition, all of the goodwill associated with our pressure pumping business was impaired during 2015. +Year Ended December 31, +Other Operations +2016 +2015 +% Change +(Dollars in thousands) +Revenues +$ +18,133 +$ +24,931 +(27.3 +)% +Direct operating costs +8,384 +11,500 +(27.1 +)% +Margin (1) +9,749 +13,431 +(27.4 +)% +Selling, general and administrative +3,026 +1,399 +116.3 +% +Depreciation, depletion and impairment +10,114 +26,301 +(61.5 +)% +Operating loss +$ +(3,391 +) +$ +(14,269 +) +(76.2 +)% +Capital expenditures +$ +6,116 +$ +16,625 +(63.2 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion and impairment and selling, general and administrative expenses. +Revenues from other operations decreased as a result of lower production and lower oil prices which resulted in lower revenues from our oil and natural gas working interests. Direct operating costs include a reduction in production taxes due to lower revenues. Selling, general and administrative expense increased from 2015 as the 2016 results include costs related to our drilling technology service business which was acquired in September 2016. Depreciation, depletion and impairment expense in 2016 includes approximately $2.8 million of oil and natural gas property impairments as compared to approximately $10.7 million of oil and natural gas property impairments in 2015. +38 +Year Ended December 31, +Corporate +2016 +2015 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +49,198 +$ +51,616 +(4.7 +)% +Depreciation +$ +5,474 +$ +5,472 +0.0 +% +Other operating (income) expense, net +Net gain on asset disposals +$ +(14,771 +) +$ +(10,613 +) +39.2 +% +Other, including legal settlements, net of insurance reimbursements +448 +12,260 +(96.3 +)% +Other operating (income) expense, net +$ +(14,323 +) +$ +1,647 +NA +Interest income +$ +327 +$ +964 +(66.1 +)% +Interest expense +$ +40,366 +$ +36,475 +10.7 +% +Other income +$ +69 +$ +34 +102.9 +% +Capital expenditures +$ +1,591 +$ +2,520 +(36.9 +)% +Lower selling, general and administrative expense reflects lower personnel costs due to headcount reductions. Other operating (income) expense, net includes net gains associated with the disposal of assets related to corporate strategy decisions of the executive management group. Accordingly, the related gains or losses have been excluded from the results of specific segments. Interest expense increased primarily due to lower capitalized interest, as we reduced our level of capital expenditures in 2016. In addition, we repaid the entire outstanding principal amount of our bank term loans. As a result, we wrote off $1.4 million of previously unamortized debt issuance costs in 2016 related to these bank term loans. +Comparison of the years ended December 31, 2015 and 2014 +The following tables summarize operations by business segment for the years ended December 31, 2015 and 2014: +Year Ended December 31, +Contract Drilling +2015 +2014 +% Change +(Dollars in thousands) +Revenues +$ +1,153,892 +$ +1,838,830 +(37.2 +)% +Direct operating costs +608,848 +1,066,659 +(42.9 +)% +Margin (1) +545,044 +772,171 +(29.4 +)% +Selling, general and administrative +5,580 +6,297 +(11.4 +)% +Depreciation, amortization and impairment +618,434 +524,023 +18.0 +% +Operating income (loss) +$ +(78,970 +) +$ +241,851 +NA +Operating days +45,142 +77,000 +(41.4 +)% +Average revenue per operating day +$ +25.56 +$ +23.88 +7.0 +% +Average direct operating costs per operating day +$ +13.49 +$ +13.85 +(2.6 +)% +Average margin per operating day (1) +$ +12.07 +$ +10.03 +20.3 +% +Average rigs operating +$ +123.7 +211.0 +(41.4 +)% +Capital expenditures +$ +527,054 +$ +771,593 +(31.7 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +39 +The demand for our contract drilling services is impacted by the market price of oil and natural gas. The reactivation and construction of new land drilling rigs in the United States in recent years contributed to an excess capacity of land drilling rigs compared to demand . Customer demand shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs. The average market price of oil and natural gas for each of the fiscal qua rters and full year in 201 5 and 201 4 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +$ +48.69 +Average natural gas price per Mcf (2) +$ +2.90 +$ +2.75 +$ +2.76 +$ +2.12 +$ +2.63 +2014: +Average oil price per Bbl (1) +$ +98.75 +$ +103.35 +$ +97.78 +$ +73.16 +$ +93.26 +Average natural gas price per Mcf (2) +$ +5.21 +$ +4.61 +$ +3.96 +$ +3.80 +$ +4.39 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information +Administration. +(2) The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy +Information Administration. +The decreases in revenues and direct operating costs primarily result from the decrease in the number of rigs operating. Average revenue per operating day and average margin per operating day were higher in 2015 primarily due to higher average dayrates and early termination revenues of approximately $69.4 million. Depreciation, amortization and impairment expense for 2015 includes a charge of $131 million related to the write-down of drilling equipment primarily related to mechanical rigs and spare mechanical rig components. Depreciation, amortization and impairment expense for 2014 includes a charge of $77.9 million related to the retirement of mechanical drilling rigs and the write-off of excess spare mechanical rig components. The increase in depreciation expense also reflects significant capital expenditures incurred in recent years to build new drilling rigs, to modify and upgrade existing drilling rigs and to acquire additional related equipment such as top drives, drill pipe, drill collars, engines, fluid circulating systems, rig hoisting systems and safety enhancement equipment. +Year Ended December 31, +Pressure Pumping +2015 +2014 +% Change +(Dollars in thousands) +Revenues +$ +712,454 +$ +1,293,265 +(44.9 +)% +Direct operating costs +612,021 +1,036,310 +(40.9 +)% +Margin (1) +100,433 +256,955 +(60.9 +)% +Selling, general and administrative +16,318 +20,279 +(19.5 +)% +Depreciation, amortization and impairment +214,552 +147,595 +45.4 +% +Impairment of goodwill +124,561 +— +NA +Operating income (loss) +$ +(254,998 +) +$ +89,081 +NA +Fracturing jobs +610 +1,224 +(50.2 +)% +Other jobs +2,080 +4,253 +(51.1 +)% +Total jobs +2,690 +5,477 +(50.9 +)% +Average revenue per fracturing job +$ +1,117.95 +$ +991.89 +12.7 +% +Average revenue per other job +$ +14.66 +$ +18.62 +(21.3 +)% +Average revenue per total job +$ +264.85 +$ +236.13 +12.2 +% +Average direct operating costs per total job +$ +227.52 +$ +189.21 +20.2 +% +Average margin per total job (1) +$ +37.34 +$ +46.92 +(20.4 +)% +Margin as a percentage of revenues (1) +14.1 +% +19.9 +% +(29.1 +)% +Capital expenditures and acquisitions +$ +197,577 +$ +241,359 +(18.1 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +40 +Revenues and direct operating costs decreased primarily due to a decrease in the number of jobs, although the average size of the fracturing jobs increased. Average revenue per fracturing job an d average direct operating costs per total job increased as a result of the increased size of the jobs in 2015 as compared to 2014. T he total number of jobs decreased as a result of the downturn in the oil and natural gas industry. Depreciation, amortiza tion and impairment expense for 2015 includes a charge of $22.0 million related to the write-down of pressure pumping equipment and closed facilities. There were no similar charges in 2014. Depreciation expense also increased due to capital expenditures and acquisitions. All of the goodwill associated with our pressure pumping business was impaired during 2015. +Year Ended December 31, +Other +2015 +2014 +% Change +(Dollars in thousands) +Revenues +$ +24,931 +$ +50,196 +(50.3 +)% +Direct operating costs +11,500 +13,102 +(12.2 +)% +Margin (1) +13,431 +37,094 +(63.8 +)% +Selling, general and administrative +1,399 +1,256 +11.4 +% +Depreciation, depletion and impairment +26,301 +42,576 +(38.2 +)% +Operating loss +$ +(14,269 +) +$ +(6,738 +) +111.8 +% +Capital expenditures +$ +16,625 +$ +36,683 +(54.7 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion and impairment and selling, general and administrative expenses. +Revenues from other operations decreased as a result of lower commodity prices which resulted in lower revenues from our oil and natural gas working interests. Direct operating costs include a reduction in production taxes due to lower revenues. Depreciation, depletion and impairment expense in 2015 includes approximately $10.7 million of oil and natural gas property impairments compared to approximately $20.9 million of oil and natural gas property impairments in 2014. +Year Ended December 31, +Corporate +2015 +2014 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +51,616 +$ +52,313 +(1.3 +)% +Depreciation +$ +5,472 +$ +4,536 +20.6 +% +Other operating (income) expense, net +Net gain on asset disposals +$ +(10,613 +) +$ +(15,781 +) +(32.7 +)% +Legal settlements, net of insurance reimbursements +12,260 +— +NA +Other operating (income) expense, net +$ +1,647 +$ +(15,781 +) +NA +Interest income +$ +964 +$ +979 +(1.5 +)% +Interest expense +$ +36,475 +$ +29,825 +22.3 +% +Other income +$ +34 +$ +3 +1,033.3 +% +Capital expenditures +$ +2,520 +$ +2,706 +(6.9 +)% +Gains on the disposal of assets are treated as part of our corporate activities because such transactions relate to corporate strategy decisions of our executive management group. Interest expense increased primarily due to borrowings under the 2015 Term Loan Agreement. +41 +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by U.S. GAAP. We define Adjusted EBITDA as net income (loss) plus net interest expense, income tax expense (benefit) and depreciation, depletion, amortization and impairment expense (including impairment of goodwill). We present Adjusted EBITDA (a non-U.S. GAAP measure) because we believe it provides to both management and investors additional information with respect to both the performance of our fundamental business activities and our ability to meet our capital expenditures and working capital requirements. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measure of net income (loss). Set forth below is a reconciliation of Adjusted EBITDA to our net income (loss), the nearest performance measure under U.S. GAAP. +Year Ended December 31, +2016 +2015 +2014 +(Dollars in thousands) +Net income (loss) +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +Income tax expense (benefit) +(177,562 +) +(147,963 +) +91,619 +Net interest expense +40,039 +35,511 +28,846 +Depreciation, depletion, amortization and impairment +668,434 +864,759 +718,730 +Impairment of goodwill +— +124,561 +— +Adjusted EBITDA +$ +212,277 +$ +582,382 +$ +1,001,859 +Income Taxes +Year Ended December 31, +2016 +2015 +2014 +(Dollars in thousands) +Income (loss) before income taxes +$ +(496,196 +) +$ +(442,449 +) +$ +254,283 +Income tax expense (benefit) +$ +(177,562 +) +$ +(147,963 +) +$ +91,619 +Effective tax rate +35.8 +% +33.4 +% +36.0 +% +The effective tax rate is a result of a federal rate of 35.0% adjusted as follows: +2016 +2015 +2014 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes +2.0 +2.1 +2.5 +Permanent differences +(0.1 +) +(1.3 +) +(1.4 +) +Other differences, net +(1.1 +) +(2.4 +) +(0.1 +) +Effective tax rate +35.8 +% +33.4 +% +36.0 +% +The lower 2015 effective rate is primarily related to the impact of goodwill impairment charges in 2015 along with an adjustment to our deferred tax liability associated with the 2010 conversion of our Canadian operations to a controlled foreign corporation. +We record deferred federal income taxes based primarily on the temporary differences between the book and tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be settled. As a result of fully recognizing the benefit of our deferred income taxes, we incur deferred income tax expense as these benefits are utilized. We recognized a deferred tax benefit of approximately $152 million in 2016 and $100 million in 2015 and deferred tax expense of approximately $43.7 million in 2014. +On January 1, 2010, we converted our Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes. This transaction triggered a $1.0 million increase in deferred tax liabilities, which is being amortized as an increase to deferred income tax expense over the weighted average remaining useful life of the Canadian assets. This amount was fully amortized as of December 31, 2016. +As a result of the above conversion, our Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada. Effective January 1, 2010, we have elected to permanently reinvest these unremitted earnings in Canada, and we intend to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $18.8 million as of December 31, 2016. The unrecognized deferred tax liability associated with these earnings was approximately $2.5 million, net of available foreign tax credits. This liability would be recognized if we received a dividend of the unremitted earnings. +42 +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have recovered substantially from the lows experienced in the first quarter of 2016. During the fourth quarter of 2016, OPEC and certain non-OPEC countries, including Russia, announced an agreement to cut oil production. The announcement resulted in an increase in oil prices, which averaged $51.97 per barrel in December 2016. In response to improved prices, U.S. rig counts have been increasing, and we believe they will continue to increase throughout 2017 if prices for these commodities remain at or above current levels. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A continued decline in demand for oil and natural gas, prolonged low oil or natural gas prices or expectations of further decreases in oil and natural gas prices, would likely result in further reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +Inflation has not had a significant impact on our operations during the three years ended December 31, 2016. We believe that inflation will not have a significant near-term impact on our financial position. +Recently Issued Accounting Standards +In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. We expect to adopt this new revenue guidance utilizing the retrospective method of adoption in the first quarter of 2018, and because we are still evaluating the portion of our contract drilling revenues that will be subject to the new leasing guidance discussed below, we are unable to quantify the impact that the new revenue standard will have on our consolidated financial statements upon adoption. +In February 2016, the FASB issued an accounting standards update to provide guidance for the accounting for leasing transactions. The requirements in this update are effective during interim and annual periods beginning after December 15, 2018. Since a portion of our contract drilling revenue will be subject to this new leasing guidance, we expect to adopt this updated leasing guidance at the same time we adopt the new revenue standard discussed above, utilizing the retrospective method of adoption. Upon adoption of these two new standards, we expect to have a lease component and a service component of revenue related to our drilling contracts. We are still evaluating the impact of this new guidance on our consolidated financial statements. This new leasing guidance will also impact us in situations where we are the lessee, and in certain circumstances we will need to record a right-of-use asset and lease liability on our consolidated financial statements. We have not quantified the impact of this guidance to such situations, although we expect the future minimum rental payments disclosed in Note 12 of our consolidated financial statements will provide some visibility into our estimated adoption impact. +In November 2015, the FASB issued an accounting standards update to provide guidance for the presentation of deferred tax liabilities and assets. Under this guidance, for a particular tax-paying component of an entity and within a particular tax jurisdiction, all deferred tax liabilities and assets, as well as any related valuation allowance, shall be offset and presented as a single noncurrent amount. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. The adoption of this update is not expected to have a material impact on our consolidated financial statements. +43 +In March 2016, the FASB issued an accounting standards update to provide guidan ce for the accounting for share-based payment transactions, including the related income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. We believe this guidance will cause volatility in our effective tax rates and diluted earnings per share due to the tax effects related to share-based payments being recorded i n the income statement. The volatility in future periods will depend on our stock price and the number of shares that vest in the case of restricted stock , or the number of shares that are exercised in the case of stock options. +In August 2016, the FASB issued an accounting standard to clarify the presentation of cash receipts and payments in specific situations on the statement of cash flows. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. The adoption of this update is not expected to have a material impact on our consolidated financial statements. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +We currently have exposure to interest rate market risk associated with any borrowings that we have under the Credit Agreement and the Reimbursement Agreement. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. Until September 27, 2017, the applicable margin on LIBOR rate loans varies from 2.75% to 3.25% and the applicable margin on base rate loans varies from 1.75% to 2.25%, in each case determined based upon our debt to capitalization ratio. Beginning September 27, 2017, the applicable margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on our excess availability under the credit facility. As of December 31, 2016, the applicable margin on LIBOR rate loans was 2.75% and the applicable margin on base rate loans was 1.75%. Based on our debt to capitalization ratio at September 30, 2016, the applicable margin on LIBOR loans was 2.75% and the applicable margin on base rate loans was 1.75% as of January 1, 2017. Based on our debt to capitalization ratio at December 31, 2016, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2017. As of December 31, 2016, we had no amounts outstanding under our revolving credit facility. +Under the Reimbursement Agreement, we will reimburse the issuing bank on demand for any amounts that it has disbursed under any letters of credit. We are obligated to pay to the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2016, no amounts had been disbursed under any letters of credit. +We conduct a portion of our business in Canadian dollars through our Canadian land-based drilling operations and our Warrior Rig Technologies Limited subsidiary. The exchange rate between Canadian dollars and U.S. dollars has fluctuated during the last several years. If the value of the Canadian dollar against the U.S. dollar weakens, revenues and earnings of our Canadian operations will be reduced and the value of our Canadian net assets will decline when they are translated to U.S. dollars. This currency risk is not material to our results of operations or financial condition. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +44 +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2016, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2016, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2016. +The effectiveness of our internal control over financial reporting as of December 31, 2016 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None. +45 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +46 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger by and among Patterson-UTI Energy, Inc., Pyramid Merger Sub, Inc. and Seventy Seven Energy Inc., dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 2.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.4 +Second Amended and Restated Bylaws (filed August 6, 2007 as Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference). +10.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference). +10.2 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.3 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.4 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.7 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.8 +Form of Share-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010 and incorporated herein by reference).* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +47 +10.10 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed April 21, 2014 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.11 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed May 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.12 +Form of Executive Officer Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.3 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.13 +Form of Executive Officer Restricted Stock Award Agreement (filed May 2, 2016 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.14 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.15 +Form of Non-Employee Director Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.5 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.16 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.17 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns and John E. Vollmer III (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.18 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed January 17, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.19 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). * +10.20 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler.*+ +10.21 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, John E. Vollmer III, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon and Tiffany J. Thom (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.22 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.23 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.24 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed on February 4, 2004 as Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.25 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.26 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and John E. Vollmer, III, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.27 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.28 +Credit Agreement dated September 27, 2012, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed September 28, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +48 +10.29 +Amendment No. 1 to Credit Agreement dated as of January 9, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed January 12, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.30 +Amendment No. 2 to Credit Agreement dated as of July 8, 2016, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto (filed July 12, 2016 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.31 +Amendment No. 3 to Credit Agreement dated as of January 17, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto.+ +10.32 +Commitment Increase Agreement, dated as of January 24, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto (filed January 24, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.33 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.34 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated October 5, 2010) (filed October 28, 2015 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.35 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.36 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated June 14, 2012) (filed October 28, 2015 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.37 +Reimbursement Agreement, dated as March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.38 +Continuing Guaranty, dated as of March 16, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 16, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.39 +Term Loan Agreement, dated as March 18, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent and lender, each of the other lenders party thereto, Wells Fargo Securities, LLC, as Lead Arranger and Sole Book Runner, and Bank of America, N.A. and The Bank of Tokyo-Mitsubishi UFJ, LTD., as Co-Syndication Agents (filed March 18, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.40 +Continuing Guaranty, dated as of March 18, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 18, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.41 +Commitment Letter, dated December 12, 2016, between Patterson-UTI Energy, Inc. and Canyon Capital Advisors LLC (filed December 13, 2016 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.42 +Voting and Support Agreement, by and among Patterson-UTI Energy, Inc. and certain affiliates of Axar Capital Management, LLC, dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.43 +Voting and Support Agreement, by and among Patterson-UTI Energy, Inc. and certain affiliates of Blue Mountain Capital Management, LLC, dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 10.3 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.44 +Voting and Support Agreement, by and among Patterson-UTI Energy, Inc. and certain affiliates of Mudrick Capital Management, L.P., dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +49 +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+ +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. +Item 16. Form 10-K Summary +None. +50 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 201 6 and 201 5 +F-3 +Consolidated Statements of Operations for the years ended December 31, 201 6 , 201 5 and 201 4 +F-4 +Consolidated Statements of Comprehensive Income ( Loss) for the years ended December 31, 201 6 , 201 5 and 201 4 +F-5 +Consolidated Statements of Changes In Stockholders’ Equity for the years ended December 31, 201 6 , 201 5 and 201 4 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 201 6 , 201 5 and 201 4 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +R eport of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc.: +In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 13, 2017 +F-2 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2016 +2015 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +35,152 +$ +113,346 +Accounts receivable, net of allowance for doubtful accounts of $3,191 and $3,545 at +December 31, 2016 and 2015, respectively +148,091 +219,672 +Federal and state income taxes receivable +2,126 +33,454 +Inventory +20,191 +14,716 +Deferred tax assets, net +36,439 +65,121 +Other +41,322 +40,227 +Total current assets +283,321 +486,536 +Property and equipment, net +3,408,963 +3,920,708 +Goodwill and intangible assets +88,966 +92,609 +Deposits on equipment purchases +16,050 +22,367 +Other +7,306 +7,264 +Total assets +$ +3,804,606 +$ +4,529,484 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +125,667 +$ +82,771 +Accrued expenses +139,148 +161,611 +Current portion of long-term debt, net of debt issuance cost of $483 at +December 31, 2015 +— +63,267 +Total current liabilities +264,815 +307,649 +Long-term debt, net of debt issuance cost of $1,563 and $3,350 at +December 31, 2016 and 2015, respectively +598,437 +787,900 +Deferred tax liabilities, net +682,976 +863,833 +Other +9,654 +8,971 +Total liabilities +1,555,882 +1,968,353 +Commitments and contingencies (see Note 9) +Stockholders’ equity: +Preferred stock, par value $.01; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $.01; authorized 300,000,000 shares with 191,525,872 and +190,374,801 issued and 148,133,255 and 147,167,561 outstanding at +December 31, 2016 and 2015, respectively +1,915 +1,904 +Additional paid-in capital +1,042,696 +1,011,811 +Retained earnings +2,116,341 +2,458,554 +Accumulated other comprehensive loss +(1,134 +) +(4,093 +) +Treasury stock, at cost, 43,392,617 shares and 43,207,240 shares at +December 31, 2016 and 2015, respectively +(911,094 +) +(907,045 +) +Total stockholders’ equity +2,248,724 +2,561,131 +Total liabilities and stockholders’ equity +$ +3,804,606 +$ +4,529,484 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2016 +2015 +2014 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +543,663 +$ +1,153,892 +$ +1,838,830 +Pressure pumping +354,070 +712,454 +1,293,265 +Other +18,133 +24,931 +50,196 +Total operating revenues +915,866 +1,891,277 +3,182,291 +Operating costs and expenses: +Contract drilling +305,804 +608,848 +1,066,659 +Pressure pumping +334,588 +612,021 +1,036,310 +Other +8,384 +11,500 +13,102 +Depreciation, depletion, amortization and impairment +668,434 +864,759 +718,730 +Impairment of goodwill +— +124,561 +— +Selling, general and administrative +69,205 +74,913 +80,145 +Other operating (income) expense, net +(14,323 +) +1,647 +(15,781 +) +Total operating costs and expenses +1,372,092 +2,298,249 +2,899,165 +Operating income (loss) +(456,226 +) +(406,972 +) +283,126 +Other income (expense): +Interest income +327 +964 +979 +Interest expense, net of amount capitalized +(40,366 +) +(36,475 +) +(29,825 +) +Other +69 +34 +3 +Total other expense +(39,970 +) +(35,477 +) +(28,843 +) +Income (loss) before income taxes +(496,196 +) +(442,449 +) +254,283 +Income tax expense (benefit) +(177,562 +) +(147,963 +) +91,619 +Net income (loss) +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +Net income (loss) per common share: +Basic +$ +(2.18 +) +$ +(2.00 +) +$ +1.12 +Diluted +$ +(2.18 +) +$ +(2.00 +) +$ +1.11 +Weighted average number of common shares outstanding: +Basic +146,178 +145,416 +144,066 +Diluted +146,178 +145,416 +145,376 +Cash dividends per common share +$ +0.16 +$ +0.40 +$ +0.40 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2016 +2015 +2014 +(In thousands) +Net income (loss) +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +Other comprehensive loss, net of taxes of $0 for 2016, $0 for 2015 and +$0 for 2014: +Foreign currency translation adjustment +2,959 +(10,556 +) +(7,613 +) +Total comprehensive income (loss) +$ +(315,675 +) +$ +(305,042 +) +$ +155,051 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings +Income +Stock +Total +(In thousands) +Balance, December 31, 2013 +186,487 +$ +1,865 +$ +913,505 +$ +2,707,439 +$ +14,076 +$ +(880,888 +) +$ +2,755,997 +Net income +— +— +— +162,664 +— +— +162,664 +Foreign currency translation +adjustment +— +— +— +— +(7,613 +) +— +(7,613 +) +Issuance of restricted stock +1,102 +11 +(11 +) +— +— +— +— +Vesting of restricted stock units +10 +1 +— +— +— +— +1 +Forfeitures of restricted stock +(61 +) +(1 +) +1 +— +— +— +— +Exercise of stock options +1,725 +17 +35,418 +— +— +— +35,435 +Stock-based compensation +— +— +27,032 +— +— +— +27,032 +Tax benefit related to stock- +based compensation +— +— +8,729 +— +— +— +8,729 +Payment of cash dividends +— +— +— +(58,288 +) +— +— +(58,288 +) +Purchase of treasury stock +— +— +— +— +— +(18,147 +) +(18,147 +) +Balance, December 31, 2014 +189,263 +1,893 +984,674 +2,811,815 +6,463 +(899,035 +) +2,905,810 +Net loss +— +— +— +(294,486 +) +— +— +(294,486 +) +Foreign currency translation +adjustment +— +— +— +— +(10,556 +) +— +(10,556 +) +Issuance of restricted stock +1,180 +12 +(12 +) +— +— +— +— +Vesting of restricted stock units +14 +— +— +— +— +— +— +Forfeitures of restricted stock +(82 +) +(1 +) +1 +— +— +— +— +Stock-based compensation +— +— +28,510 +— +— +— +28,510 +Tax benefit related to stock- +based compensation +— +— +(1,362 +) +— +— +— +(1,362 +) +Payment of cash dividends +— +— +— +(58,775 +) +— +— +(58,775 +) +Purchase of treasury stock +— +— +— +— +— +(8,010 +) +(8,010 +) +Balance, December 31, 2015 +190,375 +1,904 +1,011,811 +2,458,554 +(4,093 +) +(907,045 +) +2,561,131 +Net loss +— +— +— +(318,634 +) +— +— +(318,634 +) +Foreign currency translation +adjustment +— +— +— +— +2,959 +— +2,959 +Shares issued for acquisition +354 +3 +6,730 +— +— +— +6,733 +Issuance of restricted stock +785 +8 +(8 +) +— +— +— +— +Vesting of restricted stock units +15 +— +— +— +— +— +— +Forfeitures of restricted stock +(43 +) +— +— +— +— +— +— +Exercise of stock options +40 +707 +— +— +— +707 +Stock-based compensation +— +— +28,324 +— +— +— +28,324 +Tax expense related to stock- +based compensation +— +— +(4,868 +) +— +— +— +(4,868 +) +Payment of cash dividends +— +— +— +(23,579 +) +— +— +(23,579 +) +Purchase of treasury stock +— +— +— +— +— +(4,049 +) +(4,049 +) +Balance, December 31, 2016 +191,526 +$ +1,915 +$ +1,042,696 +$ +2,116,341 +$ +(1,134 +) +$ +(911,094 +) +$ +2,248,724 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2016 +2015 +2014 +(In thousands) +Cash flows from operating activities: +Net income (loss) +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +Adjustments to reconcile net income (loss) to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +668,434 +864,759 +718,730 +Impairment of goodwill +— +124,561 +— +Dry holes and abandonments +58 +1,224 +550 +Deferred income tax expense (benefit) +(152,160 +) +(99,873 +) +43,673 +Stock-based compensation expense +28,324 +28,510 +27,032 +Net gain on asset disposals +(14,771 +) +(10,613 +) +(15,781 +) +Tax expense related to stock-based compensation +(4,868 +) +(1,362 +) +— +Amortization of debt issuance costs +2,270 +1,245 +653 +Changes in operating assets and liabilities: +Accounts receivable +72,327 +440,884 +(214,059 +) +Income taxes receivable/payable +30,379 +49,895 +(92,352 +) +Inventory and other assets +5,664 +38,993 +(6,390 +) +Accounts payable +12,024 +(131,649 +) +86,621 +Accrued expenses +(24,573 +) +(10,303 +) +12,838 +Other liabilities +560 +(2,348 +) +4,547 +Net cash provided by operating activities +305,034 +999,437 +728,726 +Cash flows from investing activities: +Acquisitions +155 +— +(176,301 +) +Purchases of property and equipment +(119,799 +) +(743,776 +) +(1,052,341 +) +Proceeds from disposal of assets +21,889 +20,814 +33,233 +Net cash used in investing activities +(97,755 +) +(722,962 +) +(1,195,409 +) +Cash flows from financing activities: +Purchases of treasury stock +(3,610 +) +(8,010 +) +(13,554 +) +Dividends paid +(23,579 +) +(58,775 +) +(58,288 +) +Tax benefit related to stock-based compensation +— +— +8,729 +Proceeds from long-term debt +— +200,000 +— +Repayment of long-term debt +(255,000 +) +(27,500 +) +(10,000 +) +Proceeds from borrowings under revolving credit facility +200,500 +54,000 +349,500 +Repayment of borrowings under revolving credit facility +(200,500 +) +(357,000 +) +(46,500 +) +Debt issuance costs +(3,357 +) +(1,979 +) +— +Proceeds from exercise of stock options +268 +— +30,842 +Net cash provided by (used in) financing activities +(285,278 +) +(199,264 +) +260,729 +Effect of foreign exchange rate changes on cash +(195 +) +(6,877 +) +(543 +) +Net increase (decrease) in cash and cash equivalents +(78,194 +) +70,334 +(206,497 +) +Cash and cash equivalents at beginning of year +113,346 +43,012 +249,509 +Cash and cash equivalents at end of year +$ +35,152 +$ +113,346 +$ +43,012 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $398 in 2016, $6,332 in 2015 +and $6,883 in 2014 +$ +(36,551 +) +$ +(33,452 +) +$ +(27,813 +) +Income taxes +52,716 +97,333 +(125,953 +) +Non-cash investing and financing activities: +Net increase (decrease) in payables for purchases of property and equipment +$ +28,926 +$ +(167,308 +) +$ +122,148 +Issuance of common stock for business acquisition +6,733 +— +— +Net decrease (increase) in deposits on equipment purchases +6,317 +90,012 +(59,819 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “Patterson-UTI” or the “Company”), provides onshore contract drilling services to oil and natural gas operators in the continental United States and western Canada. The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. The Company also manufactures and sells pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, the Company owns and invests, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, the Company has no controlling financial interests in any other entity which would require consolidation. +The U.S. dollar is the functional currency for all of the Company’s operations except for its Canadian subsidiaries, which use the Canadian dollar as their functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +During 2016, the Company determined that certain income and expense items should be classified as “other operating (income) expense, net” in the consolidated statements of operations. This caption now includes gains and losses on asset disposals and expenses related to certain legal settlements. Gains and losses on asset disposals were previously presented as a separate line in the consolidated statements of operations. Expenses related to certain legal settlements were previously included in operating costs of the respective operating segment or within selling, general and administrative expense. For comparative purposes, all such prior period amounts were reclassified to conform to the current presentation, including the Company’s previously disclosed $12.3 million legal settlement that was previously included within selling, general and administrative expense for the year ended December 31, 2015. Also during 2016, the Company adopted new guidance for the presentation of debt issuance costs as a direct deduction from the carrying amount of the related debt liability, and such guidance was applied retrospectively, resulting in the retroactive adjustment of debt issuance costs and the long-term debt as of December 31, 2015 (See Note 8). In addition, the Company changed its reporting segment presentation in 2016, as the Company no longer considers its oil and natural gas exploration and production activities to be significant to an understanding of the Company’s results. The Company now presents the oil and natural gas exploration and production activities, drilling technology and international activities as “Other” and “Corporate” reflects only corporate activities. This change in segment presentation was applied retrospectively to all periods presented herein (See Note 15). +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed. Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs. All of the wells the Company drilled in 2016, 2015 and 2014 were drilled under daywork contracts. +Revenue is presented net of any sales tax charged to customers which the Company is required to remit to local or state governmental taxing authorities. Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of the Company’s customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts represents the Company’s estimate of the amount of probable credit losses existing in the Company’s accounts receivable. The Company reviews the adequacy of its allowance for doubtful accounts at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectable, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with the Company’s pressure pumping activities and materials used in its drilling technology business. Such inventories are stated at the lower of cost or market, with cost determined using the average cost method. +F-8 +Other current assets — Other current assets includes reimbursement from the Company’s workers compensation insurance carrier for claims in excess of the C ompany’s deductible in the amount of $21.1 million and $25.1 million at December 31, 2016 and 2015, respectively. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Drilling rigs and other equipment +1.25-15 +Buildings +15-20 +Other +3-12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. The Company reviews wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, the Company considers the well costs to be impaired and recognizes the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +The Company reviews its proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). The expected future net cash flows are discounted using an annual rate of 10% to determine fair value. The Company reviews unproved oil and natural gas properties quarterly to assess potential impairment. The Company’s impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. The Company assesses impairment of its goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Net income (loss) per common share — The Company provides a dual presentation of its net income (loss) per common share in its consolidated statements of operations: Basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock. Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock. +F-9 +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, in cluding stock options, non-vested shares of restricted stock and restricted stock units. The dilutive effect of stock options and restricted stock units is determined using the treasury stock method. The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested share s of restricted stock. +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2016, 2015 and 2014, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2016 +2015 +2014 +BASIC EPS: +Net income (loss) +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +Adjust for (income) loss attributed to holders of non-vested restricted stock +— +3,022 +(1,663 +) +Income (loss) attributed to common stockholders +$ +(318,634 +) +$ +(291,464 +) +$ +161,001 +Weighted average number of common shares outstanding, excluding non-vested shares of restricted stock +146,178 +145,416 +144,066 +Basic net income (loss) per common share +$ +(2.18 +) +$ +(2.00 +) +$ +1.12 +DILUTED EPS: +Income (loss) attributed to common stockholders +$ +(318,634 +) +$ +(291,464 +) +$ +161,001 +Weighted average number of common shares outstanding, excluding non-vested shares of restricted stock +146,178 +145,416 +144,066 +Add dilutive effect of potential common shares +— +— +1,310 +Weighted average number of diluted common shares outstanding +146,178 +145,416 +145,376 +Diluted net income (loss) per common share +$ +(2.18 +) +$ +(2.00 +) +$ +1.11 +Potentially dilutive securities excluded as anti-dilutive +9,057 +7,781 +1,088 +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. The Company’s policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — The Company recognizes the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards (See Note 11). +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Issued Accounting Standards — In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. The Company expects to adopt this new revenue guidance utilizing the retrospective method of adoption in the first quarter of 2018, and because the Company is still evaluating the portion of its contract drilling revenues that will be subject to the new leasing guidance discussed below, it is unable to quantify the impact that the new revenue standard will have on the Company’s consolidated financial statements upon adoption. +F-10 +In February 2016, the FASB issued an accounting standards update to provide guidance for the accounting for leasing transactions. The req uirements in this update are effective during interim and annual periods beginning after December 15, 2018. Since a portion of the Company’s contract drilling revenue will be subject to th is new leasing guidance, it expects to adopt th is updated leasing g uidance at the same time its adopts the new revenue standard discussed above, utilizing the re trospective method of adoption. Upon adoption of th ese two new standards , the Company expects to have a lease component and a service component of revenue related to its drilling contracts. The Company is still evaluating the impact of th is new guidance on its consolidated financial statements . Th is new leasing guidance will also impact the Company in situations where it is the lessee , and in certain circumstances it will have a right - of - use asset and lease liability on its consolidated financial statements. T he Company has not quantified the impact of th is guidance to such situations , although it expects the future mini mum rental payments disclosed in Note 12 will provide some visibility into the estimated adoption impact on the Company . +In November 2015, the FASB issued an accounting standards update to provide guidance for the presentation of deferred tax liabilities and assets. Under this guidance, for a particular tax-paying component of an entity and within a particular tax jurisdiction, all deferred tax liabilities and assets, as well as any related valuation allowance, shall be offset and presented as a single noncurrent amount. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements. +In March 2016, the FASB issued an accounting standards update to provide guidance for the accounting for share-based payment transactions, including the related income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The requirements in this update are effective during interim and annual periods beginning after December 15, 2016. The Company believes this guidance will cause volatility in its effective tax rates and diluted earnings per share due to the tax effects related to share-based payments being recorded in the income statement. The volatility in future periods will depend on the Company’s stock price and the number of shares that vest in the case of restricted stock, or the number of shares that are exercised in the case of stock options. +In August 2016, the FASB issued an accounting standard to clarify the presentation of cash receipts and payments in specific situations on the statement of cash flows. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements. +2. Acquisitions +On December 12, 2016, the Company entered into an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”) pursuant to which a subsidiary of the Company will be merged with and into SSE, with SSE continuing as the surviving entity and one of the Company’s wholly owned subsidiaries (the “SSE merger”). Under the terms of the merger agreement, the Company will acquire all of the issued and outstanding shares of common stock of SSE, in exchange for approximately 49.6 million shares of common stock of the Company, subject to certain downward adjustments set forth in the merger agreement. +SSE provides contract drilling, pressure pumping and oilfield rental services in many of the most active oil and natural gas plays onshore in the United States. SSE owns a fleet of 40 AC drilling rigs, approximately 93% of which are pad capable, including 28 fit- for-purpose PeakeRigs™. The remainder of SSE’s rig fleet includes 51 SCR rigs. Additionally, SSE owns approximately 500,000 horsepower of modern, efficient fracturing equipment located in the Anadarko Basin and Eagle Ford Shale. The SSE oilfield rentals business has a modern, well-maintained fleet of premium rental tools, and it provides specialized services for land-based oil and natural gas drilling, completion and workover activities. The completion of the merger is subject to satisfaction or waiver of certain closing conditions, including, but not limited to, approval by the Company’s and SSE’s respective stockholders and other closing conditions set forth in the merger agreement. Subject to closing conditions, the merger is expected to be completed late in the first quarter or early in the second quarter of 2017. +Additionally, during September 2016, the Company issued 353,804 shares of its common stock, valued at $6.7 million, in connection with the acquisition of Warrior Rig Ltd. and certain related entities (“Warrior”). Based in Calgary, Warrior manufactures and sells pipe handling components and related technology for drilling contractors in North America and other select markets. This acquisition was not significant to the Company’s consolidated financial statements. +3. Inventory +Inventory consisted of the following at December 31, 2016 and 2015 (in thousands). +2016 +2015 +Work-in-process +$ +1,803 +$ +— +Raw materials and supplies +18,388 +14,716 +Inventory +$ +20,191 +$ +14,716 +F-11 +4 . Property and Equipment +Property and equipment consisted of the following at December 31, 2016 and 2015 (in thousands): +2016 +2015 +Equipment +$ +6,809,129 +$ +6,963,148 +Oil and natural gas properties +201,568 +200,923 +Buildings +97,029 +96,470 +Land +22,270 +22,370 +Total property and equipment +7,129,996 +7,282,911 +Less accumulated depreciation, depletion and impairment +(3,721,033 +) +(3,362,203 +) +Property and equipment, net +$ +3,408,963 +$ +3,920,708 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets for 2016, 2015 and 2014 (in thousands): +2016 +2015 +2014 +Depreciation and impairment expense +$ +657,571 +$ +845,543 +$ +693,390 +Amortization expense +3,643 +3,643 +3,643 +Depletion expense +7,220 +15,573 +21,697 +Total +$ +668,434 +$ +864,759 +$ +718,730 +On a periodic basis, the Company evaluates its fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional, vertical wells versus drilling longer, horizontal wells using higher specification rigs). The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to the Company’s yards to be used as spare equipment. The remaining components of these rigs are retired. In 2016, the Company retired 19 mechanical rigs but recorded no impairment charge as it had written down 15 of those rigs in 2015 that remained marketed. In 2015, the Company identified 24 mechanical rigs and 9 non-APEX® electric rigs that would no longer be marketed. Also, the Company had 15 additional mechanical rigs that were not operating. Although these 15 rigs remained marketed at that time, the Company had lower expectations with respect to utilization of these rigs due to the industry shift to higher specification drilling rigs. In 2015, the Company recorded a charge of $131 million related to the retirement of the 33 rigs, the 15 mechanical rigs that remained marketed but were not operating, and the write-down of excess spare rig components to their realizable values. In 2014, the Company identified 55 mechanical rigs that it determined would no longer be marketed, and the Company recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the reduced size of the Company’s mechanical fleet. +The Company also periodically evaluates its pressure pumping assets, and in 2015, the Company recorded a charge of $22.0 million for the write-down of pressure pumping equipment and certain closed facilities. There were no similar charges in 2016 or 2014. +The Company reviews its long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that their carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The Company estimates future cash flows over the life of the respective assets or asset groupings in its assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as the Company’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +Based on recent commodity prices, the Company’s results of operations for the year ended December 31, 2016 and management’s expectations of operating results in future periods, the Company concluded that no triggering events occurred during the year ended December 31, 2016 with respect to its contract drilling or pressure pumping segments. Management’s expectations of future operating results were based on the assumption that activity levels in both segments will begin to recover by early 2017 in response to improved future oil prices. +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new low for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August 2015, the Company lowered its expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of these revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping services during the third quarter of 2015, management concluded a triggering event had occurred and deemed it necessary to assess the recoverability of long-lived asset groups for both contract drilling and pressure pumping. The Company +F-12 +performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within its contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over t he expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 60%, respectively. +Due to the continued deterioration of crude oil prices in the fourth quarter of 2015, management deemed it necessary to once again assess the recoverability of long-lived assets groups for both contract drilling and pressure pumping. The Company performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within its contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 100%, respectively. +For both of the assessments performed in 2015, the expected cash flows for the contract drilling segment included the backlog of commitments for contract drilling revenues under term contracts, which was approximately $801 million and $710 million at September 30, 2015 and December 31, 2015, respectively . Rigs not under term contracts would be subject to pricing in the spot market. Utilization and rates for rigs in the spot market and for the pressure pumping segment were estimated based upon the Company’s historical experience in prior downturns. Also, the expected cash flows for the contract drilling and pressure pumping segments were based on the assumption that activity levels in both segments would begin to recover in the first quarter of 2017 in response to improved oil prices. While management believed these assumptions with respect to future pricing for oil and natural gas were reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil and natural gas prices will recover is highly uncertain. Potential events that could affect the Company’s assumptions regarding future prices and the timeframe for a recovery are affected by factors such as: +• +market supply and demand, +• +the desire and ability of the Organization of Petroleum Exporting Countries, commonly known as OPEC, to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries +• +domestic and international military, political, economic and weather conditions, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, +• +the price and availability of alternative fuels, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, and +• +regulations regarding the exploration, development, production and delivery of oil and natural gas. +All of these factors are beyond the Company’s control. If the current oil and natural gas commodity price environment were to continue through 2017 and beyond, the Company’s actual cash flows would likely be less than the expected cash flows used in the aforementioned 2015 assessments and could result in impairment charges in the future, and any such impairment charges could be material. +The Company concluded that no triggering events occurred during the year ended December 31, 2014 with respect to its contract drilling or pressure pumping segments based on the Company’s results of operations for the year ended December 31, 2014 and the prevailing commodity prices at that time. +With respect to the long-lived assets in the Company’s oil and natural gas exploration and production segment, the Company assessed the recoverability of long-lived assets each quarter due to revisions in oil and natural gas reserve estimates and expectations about future commodity prices. The Company’s analysis indicated that the carrying amounts of certain oil and natural gas properties were not recoverable at various testing dates in 2016 and 2015. The Company’s estimates of expected future net cash flows from impaired properties are used in measuring the fair value of such properties. The Company recorded impairment charges of $2.8 million in 2016, $10.7 million in 2015 and $20.9 million in 2014 related to its oil and natural gas properties. +F-13 +5 . Goodwill and Intangible Assets +Goodwill — Goodwill by operating segment as of December 31, 2016 and 2015 and changes for the years then ended are as follows (in thousands): +Contract +Pressure +Drilling +Pumping +Total +Balance December 31, 2014 +$ +86,234 +$ +124,561 +$ +210,795 +Changes to goodwill +— +(124,561 +) +(124,561 +) +Balance December 31, 2015 +86,234 +— +86,234 +Changes to goodwill +— +— +— +Balance December 31, 2016 +$ +86,234 +$ +— +$ +86,234 +There were no accumulated impairment losses related to goodwill in the contract drilling operating segment as of December 31, 2016 or 2015. +Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. The Company’s reporting units for impairment testing have been determined to be its operating segments. The Company first determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if so, the resulting goodwill impairment is determined using a two-step quantitative impairment test. From time to time, the Company may perform the first step of the quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. The first step of the quantitative testing is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the quantitative testing is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities, with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of such shortfall. +In connection with its annual goodwill impairment assessment as of December 31, 2016, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of the Company’s contract drilling reporting unit was greater than its carrying amount and further testing was not necessary. In making this determination, the Company considered the demand experienced during 2016 for its contract drilling business. The Company also considered the current and expected levels of commodity prices for oil and natural gas, which influence its overall level of business activity in this reporting unit, as well as its operating results for 2016 and forecasted operating results for 2017. Lastly, management considered the Company’s overall market capitalization at December 31, 2016 and the significant amount of calculated excess of the fair value of the Company’s reporting unit over its carrying value from its 2015 quantitative impairment assessment of goodwill. +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new low for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August, the Company lowered its expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of the Company’s revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for its contract drilling and pressure pumping services, the Company performed a quantitative Step 1 impairment assessment of its goodwill as of September 30, 2015. In completing the Step 1 assessment, the fair value of each reporting unit was estimated using both the income and market valuation methods. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of the Company’s contract drilling and pressure pumping reporting units, such as future oil and natural gas prices and projected demand for the Company’s services, and assumptions related to discount rates, long-term growth rates and control premiums. +Based on the results of the Step 1 goodwill impairment test as of September 30, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 15%, and management concluded that no impairment was indicated in its contract drilling reporting unit; however, impairment was indicated in its pressure pumping reporting unit. In the third quarter of 2015, the Company recognized an impairment charge of $125 million associated with the impairment of all of the goodwill in its pressure pumping reporting unit. +F-14 +In connection with its annual impairment asset at December 31, 2015, t he Company performed a quantitative Step 1 impairment assessment of the goodwill in its contract drilling reporting unit . In completing the Step 1 assessment, the fair value of the contract drilling reporting unit was estimated using both the income and market valuation methods. The estimate of t he fair value of the reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of the Company’s contract drilling reporting uni t, such as future oil and natural gas prices and projected demand for the Company’s services, and assumptions related to discount rates, long-term growth rates and control premiums. Based on the results of the quantitative Step 1 impairment assessment of its goodwill as of December 31, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 16 %, and management concluded that no impairment was indicated in its contract drilling reporting unit. +In connection with its annual goodwill impairment assessment as of December 31, 2014, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of the Company’s reporting units were greater than their respective carrying amounts and no further testing was deemed necessary. In making this determination, the Company considered the continued demand experienced during 2014 for its contract drilling and pressure pumping businesses. The Company also considered the current and expected levels of commodity prices for oil and natural gas, which influence its overall level of business activity in these reporting units. Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account. Lastly, management considered the Company’s overall market capitalization at December 31, 2014 and the large amount of calculated excess of the fair values of the Company’s reporting units over their respective carrying values from its 2013 quantitative impairment assessment. +The Company has undertaken extensive efforts in the past several years to upgrade its fleet of equipment and believes that it is well-positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells. In the event that market conditions were to remain weak for a protracted period, the Company may be required to record an impairment of goodwill in its contract drilling reporting unit in future periods, and any such impairment could be material. +Intangible Assets — Intangible assets were recorded in the pressure pumping operating segment in connection with the fourth quarter 2010 acquisition of the assets of a pressure pumping business. As a result of the purchase price allocation, the Company recorded intangible assets related to a non-compete agreement and the customer relationships acquired. These intangible assets were recorded at fair value on the date of acquisition. +The value of the customer relationships was estimated using a multi-period excess earnings model to determine the present value of the projected cash flows associated with the customers in place at the time of the acquisition and taking into account a contributory asset charge. The resulting intangible asset is being amortized on a straight-line basis over seven years. Amortization expense of $3.6 million was recorded in each of the years ended December 31, 2016, 2015 and 2014, associated with customer relationships. +The Company concluded that no triggering events necessitating an impairment assessment of these customer relationships had occurred in 2016, 2015 or 2014. The assessment of the recoverability of the pressure pumping asset group included the customer relationship intangible asset, and no impairment was indicated. +The gross carrying amount and accumulated amortization of the customer relationships as of December 31, 2016 and 2015 are as follows (in thousands): +2016 +2015 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +25,500 +$ +(22,768 +) +$ +2,732 +$ +25,500 +$ +(19,125 +) +$ +6,375 +F-15 +6 . Accrued Expenses +Accrued expenses consisted of the following at December 31, 2016 and 2015 (in thousands): +2016 +2015 +Salaries, wages, payroll taxes and benefits +$ +21,138 +$ +27,055 +Workers’ compensation liability +67,775 +75,358 +Property, sales, use and other taxes +6,766 +9,061 +Insurance, other than workers’ compensation +9,566 +12,817 +Accrued interest payable +6,740 +7,668 +Other +27,163 +29,652 +$ +139,148 +$ +161,611 +7. Asset Retirement Obligation +The Company records a liability for the estimated costs to be incurred in connection with the abandonment of oil and natural gas properties in the future. This liability is included in the caption “other” in the liabilities section of the consolidated balance sheet. +The changes to the asset retirement obligations during 2016 and 2015 are as follows (in thousands): +2016 +2015 +Balance at beginning of year +$ +5,692 +$ +5,301 +Liabilities incurred +164 +340 +Liabilities settled +(124 +) +(120 +) +Accretion expense +166 +171 +Revision in estimated costs of plugging oil and natural gas wells +42 +— +Asset retirement obligation at end of year +$ +5,940 +$ +5,692 +8. Long-Term Debt +2012 Credit Agreement — On September 27, 2012, the Company entered into a Credit Agreement (“Base Credit Agreement”) with Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender, and each of the other lenders party thereto. The Base Credit Agreement (as amended, the “Credit Agreement”) is a committed senior unsecured credit facility that includes a revolving credit facility. +On July 8, 2016, the Company entered into Amendment No. 2 to the Credit Agreement (Amendment No. 2”), which amended the Base Credit Agreement. The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time, subject to a borrowing base calculated by reference to the Company’s and certain of its subsidiaries’ eligible equipment, inventory, accounts receivable and unencumbered cash as described in Amendment No 2. The revolving credit facility contains a letter of credit facility that is limited to $50 million and a swing line facility that is limited to $20 million, in each case outstanding at any time. Subject to customary conditions, the Company may request that the lenders’ aggregate commitments with respect to the revolving credit facility be increased by up to $100 million, not to exceed total commitments of $600 million. The maturity date under the Base Credit Agreement was September 27, 2017 for the revolving credit facility, however, Amendment No. 2 extended the maturity date of $357.9 million in revolving credit commitments of certain lenders to March 27, 2019. +The term loan facility included in the Base Credit Agreement, which facility was terminated in connection with Amendment No. 2, provided for a loan of $100 million, which was drawn on December 24, 2012 and was payable in quarterly principal installments. As a condition precedent, Amendment No. 2 required that the Company repay the entire outstanding principal amount of this term loan. +Loans under the Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. Until September 27, 2017, the applicable margin on LIBOR rate loans varies from 2.75% to 3.25% and the applicable margin on base rate loans varies from 1.75% to 2.25%, in each case determined based upon the Company’s debt to capitalization ratio. Beginning September 27, 2017, the applicable margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on the Company’s excess availability under the credit facility. At December 31, 2016, the applicable margin on LIBOR rate loans was 2.75% and the applicable margin on base rate loans was 1.75%. Based on the Company’s debt to capitalization ratio at September 30, 2016, the applicable margin on LIBOR rate loans is 2.75% and the applicable margin on base rate loans is 1.75% as of January 1, 2017. Based on the Company’s debt to capitalization ratio at December 31, 2016, the applicable margin on LIBOR rate loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2017. A letter of credit fee is payable by the Company equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%. +F-16 +Each domestic subsidiary of the Company unconditionally guarantees all existing and future indebtedness and liabilities of the other guarantors and the Company arising under the Credit Agreement, other than (a) Ambar Lone Star Fl uid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million . Such guarantees also cover obligations of the Company and any subsidiary of the Company arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 40%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit its interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2016. +Amendment No. 2 limits the Company’s ability to make investments in foreign subsidiaries or joint ventures such that, if the book value of all such investments since September 27, 2012 is above 20% of the total consolidated book value of the assets of the Company and its subsidiaries on a pro forma basis, the Company will not be able to make such investment. Amendment No. 2 also restricts the Company’s ability to pay dividends and make equity repurchases, subject to certain exceptions, including an exception allowing such restricted payments if before and immediately after giving effect to such restricted payment, the Pro Forma Debt Service Coverage Ratio (as defined in Amendment No. 2) is at least 1.50 to 1.00. In addition, Amendment No. 2 requires that, if the consolidated cash balance of the Company and its subsidiaries, subject to certain exclusions, is more than $100 million at the end of the day on which a borrowing is made, the Company can only use the proceeds from such borrowing to fund acquisitions, capital expenditures and the repurchase of indebtedness, and if such proceeds are not used in such manner within three business days, the Company must repay such unused proceeds on the fourth business day following such borrowings. Amendment No. 2 also decreased the permitted amount of certain secured indebtedness of the Company and its subsidiaries and decreased the permitted amount of certain unsecured indebtedness of the Company’s subsidiaries. +The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants. +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require the Company to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic), and (iii) require the Company to cash collateralize any outstanding letters of credit. +As of December 31, 2016, the Company had no amounts outstanding under the revolving credit facility, with available borrowing capacity of $500 million. +On January 17, 2017, the Company entered into Amendment No. 3 to Credit Agreement (“Amendment No. 3”), which amended the Credit Agreement by restating the definition of Consolidated EBITDA to provide for the add-back of transaction expenses related to the SSE merger. +On January 24, 2017, the Company entered into an agreement with certain lenders under its revolving credit facility pursuant to which the Company exercised approximately $95.8 million of the $100 million commitment increase feature available thereunder in order to increase the aggregate commitments under its revolving credit facility to approximately $595.8 million. The effectiveness of the aggregate commitment increase is subject to certain conditions, including the consummation of the SSE merger and the repayment and termination of the SSE credit facility, as well as other customary conditions. +2015 Reimbursement Agreement — On March 16, 2015, the Company entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which the Company may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2016, the Company had $38.2 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, the Company will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by the Company at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. The Company is obligated to pay to Scotiabank interest on all amounts not paid by the Company on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +F-17 +The Company has also agreed that if obligations under the Credit Agreement are secured by liens on any of its or any of its subsidiaries’ property, then the Company’s reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, the Company’s payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by subsidiaries of the Company that from time to time guarantee payment under the Credit Agreement. +2015 Term Loan Agreement — On March 18, 2015, the Company entered into a Term Loan Agreement (the “2015 Term Loan Agreement”) with Wells Fargo Bank, N.A., as administrative agent and lender, each of the other lenders party thereto, Wells Fargo Securities, LLC, as Lead Arranger and Sole Book Runner, and Bank of America, N.A. and The Bank Of Tokyo-Mitsubishi UFJ, LTD., as Co-Syndication Agents. +The 2015 Term Loan Agreement was a senior unsecured single-advance term loan facility pursuant to which the Company made a term loan borrowing of $200 million on March 18, 2015 (the “Term Loan Borrowing”). The Term Loan Borrowing was payable in quarterly principal installments, together with accrued interest. Loans under the 2015 Term Loan Agreement bore interest, at the Company’s election, at the per annum rate of LIBOR rate plus 3.25% or base rate plus 2.25%. +As a condition precedent to Amendment No 2, the Company repaid the entire outstanding principal amount under the 2015 Term Loan Agreement and terminated the agreement on July 8, 2016. +Senior Notes – On October 5, 2010, the Company completed the issuance and sale of $300 million in aggregate principal amount of its 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. The Company pays interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, the Company completed the issuance and sale of $300 million in aggregate principal amounts of its 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. The Company pays interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations of the Company, which rank equally in right of payment with all other unsubordinated indebtedness of the Company. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of the existing domestic subsidiaries of the Company other than subsidiaries that are not required to be guarantors under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at the Company’s option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. The Company must offer to prepay the notes upon the occurrence of any change of control. In addition, the Company must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit its interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2016. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +F-18 +Commitment Letter – On December 12 , 2016, in connection with execution of the merger agreement, the Company entered into a financing commitment letter (t he “Commitment Letter”) with Canyon Capital Advisors LLC for a senior un secured bridge facility in an aggregate principal amount not to exceed $150 million (the “Bridge Facility”), for the purposes of repaying or redeeming certain of SSE and its subsidiari es’ indebtedness and to pay related fees and expenses. Any undrawn commitments under the Bridge Facility will automatically terminate on the closing date of the SSE merger. The Bridge Facility will be subject to representations, warranties and covenants that, subject to certain agreed modifications, will be substantially similar to our revolving credit facility. The funding of the Bridge Facility is subject to our compliance with customary terms and conditions precedent as set forth in the Commitment Let ter, including, among others: (i) the execution and delivery by us of definitive documentation consistent with the Commitment Letter and (ii) the SSE merger shall have been, or substantially simultaneously with the funding under the Bridge Facility shall b e, consummated in accordance with the terms of the merger agreement. The Company does not currently expect to enter into the Bridge Facility. +The Company incurred approximately $10.8 million in debt issuance costs during 2010 in connection with the Series A Notes and a previous senior unsecured revolving credit facility. The Company incurred approximately $7.6 million in debt issuance costs during 2012 in connection with the Series B Notes and the Credit Agreement. The Company incurred approximately $2.0 million in debt issuance costs during 2015 in connection with the Reimbursement Agreement and the 2015 Term Loan Agreement. The Company incurred approximately $3.4 million in debt issuance costs during 2016 in connection with Amendment No. 2. These costs were deferred and are being recognized as interest expense over the term of the underlying debt. +In April and August 2015, the Financial Accounting Standards Board (“FASB”) issued accounting standards updates to provide guidance for the presentation of debt issuance costs. Under this guidance, debt issuance costs, except those related to line-of-credit arrangements, are presented in the balance sheet as a direct deduction from the carrying amount of the related debt. Debt issuance costs related to line-of-credit arrangements can continue to be classified as a deferred charge. Amortization of debt issuance costs continues to be reported as interest expense. This guidance became effective for the Company during the three months ended March 31, 2016. This guidance was applied retrospectively, and debt issuance costs and long-term debt as of December 31, 2015 were retroactively adjusted in the balance sheet. There was no impact on the Company’s results of operations or cash flows as a result of the adoption of this guidance. Interest expense related to the amortization of debt issuance costs was approximately $4.1 million, $2.8 million and $2.2 million for the years ended December 31, 2016, 2015 and 2014, respectively. Amortization of debt issuance costs for the year ended December 31, 2016 includes $1.4 million of costs related to the early termination of the 2012 and 2015 term loan agreements. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2016 (in thousands): +Year ending December 31, +2017 +$ +— +2018 +— +2019 +— +2020 +300,000 +2021 +— +Thereafter +300,000 +Total +$ +600,000 +F-19 +9 . Commitments, Contingencies and Other Matters +Commitments – The merger agreement provides for an expense reimbursement in an amount not to exceed $7.5 million in respect of bona fide, out of pocket expenses actually incurred by SSE in connection with the merger agreement if the agreement is terminated if the Company’s stockholders fail to approve the issuance of the Company’s common stock in the SSE merger. The merger agreement also provides that the Company may be required to pay SSE a termination fee of $100 million in certain circumstances, including if the Company’s board of directors changes its recommendation as a result of a superior parent proposal (as defined in the merger agreement) of if the merger agreement is terminated in certain circumstances and the Company enters into certain types of alternative acquisition transactions within 12 months of termination. In certain other circumstances, the Company may be required to pay SSE a termination fee of $40 million. In no event will the Company be obligated to make more than one expense reimbursement payment or more than one termination fee payment to SSE. +As of December 31, 2016, the Company maintained letters of credit in the aggregate amount of $38.2 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2016, no amounts had been drawn under the letters of credit. +As of December 31, 2016, the Company had commitments to purchase approximately $68.4 million of major equipment for its drilling and pressure pumping businesses. +The Company’s pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. As of December 31, 2016, the remaining obligation under these agreements was approximately $17.0 million, of which materials with a total purchase price of approximately $9.5 million are required to be purchased during 2017. In the event that the required minimum quantities are not purchased during any contract year, the Company could be required to make a liquidated damages payment to the respective vendor for any shortfall. +Contingencies – The Company’s operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose the Company to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +Any contractual right to indemnification that the Company may have for any such risk may be unenforceable or limited due to negligent or willful acts of commission or omission by the Company, its subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield service agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of the Company. The Company’s customers and other third parties may dispute, or be unable to meet, their contractual indemnification obligations to the Company due to financial, legal or other reasons. Accordingly, the Company may be unable to transfer these risks to its customers and other third parties by contract or indemnification agreements. Incurring a liability for which the Company is not fully indemnified or insured could have a material adverse effect on its business, financial condition, cash flows and results of operations. +The Company has insurance coverage for fire, windstorm and other risks of physical loss to its rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. The Company has also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, the Company generally maintains a $1.5 million per occurrence deductible on its workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on its equipment insurance coverage, a $2.0 million per occurrence deductible on its general liability coverage and a $2.0 million per occurrence deductible on its automobile liability insurance coverage. The Company also self-insures a number of other risks, including loss of earnings and business interruption and cyber risks, and does not carry a significant amount of insurance to cover risks of underground reservoir damage. If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on the Company’s business, financial condition, cash flows and results of operations. +The Company is party to various legal proceedings arising in the normal course of its business. The Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows. +F-20 +Other Matters — The Company has Change in Control Agreements with its Chairma n of the Board and two of its Senior Vice Presidents (the “Specified Employees”). Each Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless the Company notifies the Specified Employee at least ninety days b efore the end of such renewal period that the term will not be extended. If a change in control of the Company occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by the Company other than for cause or other t han automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreements), then the Specified Employee shall generally be entitled to, among other th ings: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment for each Specified Employee prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2.5 times (in the case of the Chairman of the Board) or 2 times (in the case of the Senior Vice Presidents) of the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under the Company’s welfare plans for up to three years (in the case of the Chairman of the Board) or two years (in the case of the Senior Vice Presidents). +Each Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +The Company has Employment Agreements with its Chief Executive Officer, General Counsel and the President of the Company’s subsidiary, Patterson-UTI Drilling Company LLC (“Patterson-UTI Drilling”). In the case of the Chief Executive Officer and the General Counsel, the Employment Agreement supersedes the prior Change in Control Agreement with each executive and, in the case of the President of Patterson-UTI Drilling, the Employment Agreement supersedes his prior employment agreement. Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such termination at least 30 days before the effective date of such termination. Under specified circumstances, the Company may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by either (i) providing written notice 10 days before the effective date of such termination and by granting at least 10 days to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of such termination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by the Company to not be capable of being cured, the executive may be terminated for cause on the date the written notice is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following termination by the Company of the executive other than for Cause, or termination by the executive for Good Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by the Company without Cause, or the executive terminates his employment for Good Reason: +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the General Counsel and President of Patterson-UTI Drilling) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees, +• +the Company will accelerate vesting of all options and restricted stock awards on the 60th day following the executive’s termination, and +• +the Company will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +If a termination by the Company other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, which for the President of Patterson-UTI Drilling includes a change in control of the Company or, in certain circumstances, of Patterson-UTI Drilling), the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years, and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the General Counsel and President of Patterson-UTI Drilling) of subsidized benefits continuation coverage. +F-21 +10 . Stockholders’ Equity +Cash Dividends – The Company paid cash dividends during the years ended December 31, 2016, 2015 and 2014 as follows: +Per Share +Total +(in thousands) +2016 +Paid on March 24, 2016 +$ +0.10 +$ +14,712 +Paid on June 23, 2016 +0.02 +2,953 +Paid on September 22, 2016 +0.02 +2,953 +Paid on December 22, 2016 +0.02 +2,961 +Total cash dividends +$ +0.16 +$ +23,579 +2015 +Paid on March 25, 2015 +$ +0.10 +$ +14,640 +Paid on June 24, 2015 +0.10 +14,712 +Paid on September 24, 2015 +0.10 +14,712 +Paid on December 24, 2015 +0.10 +14,711 +Total cash dividends +$ +0.40 +$ +58,775 +2014 +Paid on March 27, 2014 +$ +0.10 +$ +14,456 +Paid on June 26, 2014 +0.10 +14,562 +Paid on September 24, 2014 +0.10 +14,634 +Paid on December 24, 2014 +0.10 +14,636 +Total cash dividends +$ +0.40 +$ +58,288 +On February 8, 2017, the Company’s Board of Directors approved a cash dividend on its common stock in the amount of $0.02 per share to be paid on March 22, 2017 to holders of record as of March 8, 2017. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of the Company’s debt agreements and other factors. The merger agreement prohibits the Company (unless consented to in advance by SSE, which consent may not be unreasonably withheld, delayed or conditioned) from paying dividends to holders of the Company’s common stock in excess of $0.02 per share per quarter until the earlier of the effective time of the SSE merger and the termination of the merger agreement in accordance with its terms. +On January 27, 2017, the Company completed an offering of 18.2 million shares of its common stock and it intends to use the net proceeds from this offering of approximately $470 million to fund the repayment of SSE’s outstanding net indebtedness upon closing of the SSE merger. If the SSE merger is not consummated, the Company intends to use the net proceeds of the offering for general corporate purposes, which may include repayment of outstanding indebtedness or investments in working capital. +On September 6, 2013, the Company’s Board of Directors approved a stock buyback program that authorizes purchase of up to $200 million of the Company’s common stock in open market or privately negotiated transactions. As of December 31, 2016, the Company had remaining authorization to purchase approximately $187 million of the Company’s outstanding common stock under the 2013 stock buyback program. Shares purchased under a buyback program are accounted for as treasury stock. +The Company acquired shares of stock from directors during 2016 and from employees during 2016, 2015 and 2014 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options. The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) or the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback program. +F-22 +Treasury stock acquisitions during the years ended December 31, 201 6 , 201 5 and 2 01 4 were as follows (dollars in thousands): +2016 +2015 +2014 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +42,268,057 +$ +880,888 +Purchases pursuant to 2013 stock buyback program: +8,488 +183 +8,618 +180 +13,898 +466 +Acquisitions pursuant to long-term incentive plans +176,889 +3,866 +380,037 +7,830 +536,630 +17,681 +Treasury shares at end of period +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +11. Stock-based Compensation +The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards consist of equity instruments in the form of stock options, restricted stock or restricted stock units and have included service and, in certain cases, performance conditions. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +The Company’s shareholders approved the 2014 Plan, and the Board of Directors adopted a resolution that no future grants would be made under any of the Company’s other previously existing plans. The Company’s share-based compensation plans at December 31, 2016 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan +9,100,000 +3,851,760 +1,784,452 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +4,454,500 +— +A summary of the 2014 Plan follows: +• +The Compensation Committee of the Board of Directors administers the plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +All options granted under the plan are granted with an exercise price equal to or greater than the fair market value of the Company’s common stock at the time the option is granted. +• +The plan provides for awards of incentive stock options, non-incentive stock options, tandem and freestanding stock appreciation rights, restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalents. As of December 31, 2016, non-incentive stock options, restricted stock awards, restricted stock units and performance unit awards had been granted under the plan. +Options granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. Restricted stock awards granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. +F-23 +Stock Options— The Company estimates the grant date fair val ues of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date the options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. Weighted-average assumptions used to estimate grant date fair values for stock options granted during the years ended December 31, 201 6 , 201 5 and 201 4 are as follow s : +2016 +2015 +2014 +Volatility +35.11 +% +37.95 +% +35.89 +% +Expected term (in years) +5.00 +5.00 +5.00 +Dividend yield +2.05 +% +2.00 +% +1.17 +% +Risk-free interest rate +1.40 +% +1.37 +% +1.76 +% +Stock option activity for the year ended December 31, 2016 follows: +Weighted-average +Shares +exercise price +Outstanding at beginning of year +6,307,250 +$ +21.68 +Granted +969,900 +$ +18.40 +Exercised +(40,000 +) +$ +17.69 +Expired +(550,000 +) +$ +28.26 +Outstanding at end of year +6,687,150 +$ +20.68 +Exercisable at end of year +5,326,606 +$ +21.01 +Options outstanding at December 31, 2016 have an aggregate intrinsic value of approximately $46.8 million and a weighted-average remaining contractual term of 5.13 years. Options exercisable at December 31, 2016 have an aggregate intrinsic value of approximately $36.2 million and a weighted-average remaining contractual term of 4.15 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2016, 2015 and 2014 follows: +2016 +2015 +2014 +Weighted-average grant date fair value of stock options granted (per share) +$ +4.90 +$ +5.79 +$ +9.81 +Aggregate grant date fair value of stock options vested during the year (in thousands) +$ +4,729 +$ +5,077 +$ +5,173 +Aggregate intrinsic value of stock options exercised (in thousands) +$ +366 +$ +— +$ +21,862 +As of December 31, 2016, options to purchase 1.4 million shares were outstanding and not vested. All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2016 with respect to these non-vested options follows: +Aggregate intrinsic value (in thousands) +$10.5 million +Weighted-average remaining contractual term +9.0 years +Weighted-average remaining expected term +4.0 years +Weighted-average remaining vesting period +2.0 years +Unrecognized compensation cost +$6.0 million +Restricted Stock— For all restricted stock awards to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +F-24 +Restricted stock activity for the year ended December 31, 201 6 follows: +Weighted- +average Grant +Shares +Date Fair Value +Non-vested restricted stock outstanding at beginning of year +1,432,250 +$ +24.56 +Granted +785,486 +$ +20.58 +Vested +(747,029 +) +$ +24.77 +Forfeited +(43,252 +) +$ +24.57 +Non-vested restricted stock outstanding at end of year +1,427,455 +$ +22.26 +As of December 31, 2016, approximately 1.3 million shares of non-vested restricted stock outstanding are expected to vest. Additional information as of December 31, 2016 with respect to these non-vested shares follows: +Aggregate intrinsic value +$34.0 million +Weighted-average remaining vesting period +1.8 years +Unrecognized compensation cost +$21.3 million +Restricted Stock Units— For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions. Non-forfeitable cash dividend equivalents are paid on certain non-vested restricted stock units. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2016 follows: +Weighted-average +Grant Date Fair +Shares +Value +Non-vested restricted stock units outstanding at beginning of year +41,686 +$ +26.22 +Granted +178,254 +$ +19.31 +Vested +(15,033 +) +$ +27.30 +Forfeited +(13,252 +) +$ +24.08 +Non-vested restricted stock units outstanding at end of year +191,655 +$ +19.85 +Performance Unit Awards. The Company has granted stock-settled performance unit awards to certain executive officers (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive a grant of shares of stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is the three year period commencing on April 1 of the year of grant, except that for the Performance Units granted in 2013 the performance period was extended pursuant to its terms, as described below. +The performance goals for the Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective performance units. Generally, the recipients will receive a target number of shares if the Company’s total shareholder return is positive and, when compared to the peer group, is at the 50 th percentile. If the Company’s total shareholder return during the performance period is positive and, when compared to the peer group, is at the 75 th percentile or higher, then the recipients will receive two times the target number of shares. If the Company’s total shareholder return is positive and, when compared to the peer group, is at the 25 th percentile, the recipients will only receive one-half of the target number of shares. If the Company’s total shareholder return during the performance period is positive and, when compared to the peer group, is between the 25 th and 75 th percentile, then the shares to be received by the recipients will be determined on a pro-rata basis. For the Performance Units awarded prior to 2016, there is no payout unless the Company’s total shareholder return is positive and, when compared to the peer group, is at or above the 25 th percentile. +For the Performance Units granted in April 2016, if the Company’s total shareholder return is negative and, when compared to the peer group, is at or above the 25 th percentile, then the recipients will receive one-half of the number of shares they would have received had the Company’s total shareholder return been positive. +F-25 +In respect of the 2013 Performance Units, for which the performance period ended March 31, 2016, the Company’s total shareholder return for the performance period was negative, the Company’s total shareholder r eturn for the performance period when compared to the peer group was above the 75 th percentile, and there was no payout; provided, however, that pursuant to the terms of those 2013 awards, if, during the two-year period ending March 31, 2018, the Company’s total shareholder return for any 30 consecutive day period equals or exceeds 18 percent on an annualized basis from April 1, 2013 through the last day of such 30 consecutive day period, and the recipient is actively employed by the Company through the las t day of the extended performance period, then the Company will issue to the recipient the number of shares equal to the amount the recipient would have been entitled to receive had the Company’s total shareholder return been positive during the initial th ree year performance period. +The total target number of shares with respect to the Performance Units for the years 2011-2016 is set forth below: +2016 +2015 +2014 +2013 +2012 +2011 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +185,000 +190,600 +154,000 +236,500 +192,000 +144,375 +For the Performance Units that have been settled, the total shareholder return percentiles and the number of shares issued are as follows: +2012 +2011 +Performance +Performance +Unit Awards +Unit Awards +Total shareholder return percentile for performance period +87 th +94 th +Shares issued +384,000 +288,750 +Because the Performance Units are stock-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2016 +2015 +2014 +2013 +2012 +2011 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +3,854 +$ +4,052 +$ +5,388 +$ +5,564 +$ +3,065 +$ +5,569 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2016 +2015 +2014 +2013 +2012 +2011 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2016 +$ +963 +$ +1,351 +$ +1,796 +$ +464 +NA +NA +Year ended December 31, 2015 +NA +$ +1,013 +$ +1,796 +$ +1,855 +$ +255 +NA +Year ended December 31, 2014 +NA +NA +$ +1,347 +$ +1,855 +$ +1,022 +$ +464 +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid on certain restricted stock units. These payments are recognized as follows: +• +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +• +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +• +Dividend equivalents are recognized as additional compensation cost for restricted stock units. +F-26 +12 . Leases +The Company incurred rent expense of $25.3 million, $37.6 million and $51.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. Rent expense is primarily related to short-term equipment rentals that are generally passed through to customers. +Future minimum rental payments required under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 2016 are as follows: +Year ending December 31, +2017 +$ +5,707 +2018 +4,991 +2019 +4,524 +2020 +3,864 +2021 +2,822 +Thereafter +9,145 +Total +$ +31,053 +13. Income Taxes +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): +2016 +2015 +2014 +Federal income tax expense (benefit): +Current +$ +(24,777 +) +$ +(42,020 +) +$ +39,438 +Deferred +(134,592 +) +(83,812 +) +39,673 +(159,369 +) +(125,832 +) +79,111 +State income tax expense (benefit): +Current +(257 +) +(3,480 +) +3,987 +Deferred +(14,163 +) +(12,433 +) +5,292 +(14,420 +) +(15,913 +) +9,279 +Foreign income tax expense (benefit): +Current +(368 +) +(2,590 +) +4,521 +Deferred +(3,405 +) +(3,628 +) +(1,292 +) +(3,773 +) +(6,218 +) +3,229 +Total income tax expense (benefit): +Current +(25,402 +) +(48,090 +) +47,946 +Deferred +(152,160 +) +(99,873 +) +43,673 +Total income tax expense (benefit): +$ +(177,562 +) +$ +(147,963 +) +$ +91,619 +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2016, 2015 and 2014 is summarized as follows: +2016 +2015 +2014 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes +2.0 +2.1 +2.5 +Permanent differences +(0.1 +) +(1.3 +) +(1.4 +) +Other differences, net +(1.1 +) +(2.4 +) +(0.1 +) +Effective tax rate +35.8 +% +33.4 +% +36.0 +% +The lower 2015 effective tax rate is primarily related to the impact of goodwill impairment charges in 2015, along with an adjustment to the Company’s deferred tax liability associated with the 2010 conversion of its Canadian operations to a controlled foreign corporation. +F-27 +The tax effect of significant temporary differences representing deferred tax assets and liabilities at December 31, 2016 and 2015 are as follows (in thousands): +2016 +2015 +Deferred tax assets: +Current: +Net operating loss carryforwards +$ +4,702 +$ +27,887 +Workers’ compensation allowance +25,736 +28,734 +Other +16,710 +21,305 +47,148 +77,926 +Non-current: +Net operating loss carryforwards +198,783 +77,514 +AMT credit +7,907 +— +Expense associated with employee stock options +14,443 +14,591 +Federal benefit of state deferred tax liabilities +23,026 +24,485 +Other +19,137 +20,441 +263,296 +137,031 +Less: +Allowance to reduce deferred tax asset to expected realizable value +— +(603 +) +Total deferred tax assets +310,444 +214,354 +Deferred tax liabilities: +Current: +Other +(10,709 +) +(12,805 +) +Non-current: +Property and equipment basis difference +(929,483 +) +(986,922 +) +Other +(16,789 +) +(13,339 +) +(946,272 +) +(1,000,261 +) +Total deferred tax liabilities +(956,981 +) +(1,013,066 +) +Net deferred tax liability +$ +(646,537 +) +$ +(798,712 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and necessary allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. The Company expects the carrying value of its deferred tax assets at December 31, 2016 and 2015 to be realized as a result of the reversal of existing taxable temporary differences giving rise to deferred tax liabilities, as well as the generation of taxable income in future periods. As of December 31, 2016 the Company does not consider a valuation allowance necessary. The valuation allowance of $603,000 related to state net operating losses that expired in 2016. +Other deferred tax assets consist primarily of the tax effect of various allowance accounts and tax-deferred expenses expected to generate future tax benefits of approximately $35.8 million. Other deferred tax liabilities consist primarily of the tax effect of receivables from insurance companies and tax-deferred income not yet recognized for tax purposes. +For income tax purposes, the Company has approximately $484 million of federal net operating losses, approximately $16 million of Canadian net operating losses and approximately $389 million, of state net operating losses as of December 31, 2016. Of these amounts, approximately $16 million of Canadian and $5 million of state losses will be carried back to prior years and the remaining balance can be carried forward to future years. Net operating losses that can be carried forward, if unused, are scheduled to expire as follows: 2025—$2.8 million; 2026—$17.1 million; 2027—$102,000; 2029—$33.2 million; 2030—$28.6 million; 2031—$92.0 million; 2034—$30,000; 2035—$302.6 million, 2036 - $391.1 million. +As of December 31, 2016, the Company had no unrecognized tax benefits. The Company has established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2016, the tax years ended December 31, 2013 through December 31, 2015 are open for examination by U.S. taxing authorities. As of December 31, 2016, the tax years ended December 31, 2012 through December 31, 2015 are open for examination by Canadian taxing authorities. +On January 1, 2010, the Company converted its Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes. This transaction triggered a $1.0 million increase in deferred tax liabilities, which is being amortized as an increase to deferred income tax expense over the weighted average remaining useful life of the Canadian assets. This amount was fully amortized as of December 31, 2016. +F-28 +As a result of the above conversion, the Company’s Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada. Effective January 1, 2010, the Company has elected to permanently reinvest these unremitted earnings in Canada, and it intends to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $ 1 8 . 8 million as of December 31, 201 6 . The unrecogniz ed deferred tax liability associated with these earnings was approximately $ 2.5 million, net of available foreign tax credits. This liability would be recognized if the Company received a dividend of the unremitted earnings. +14. Employee Benefits +The Company maintains a 401(k) plan for all eligible employees. The Company’s operating results include expenses of approximately $4.4 million in 2016, $7.1 million in 2015 and $7.2 million in 2014 for the Company’s contributions to the plan. +15. Business Segments +The Company’s revenues, operating profits and identifiable assets are primarily attributable to two business segments: (i) contract drilling of oil and natural gas wells and (ii) pressure pumping services. Each of these segments represents a distinct type of business. These segments have separate management teams which report to the Company’s chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. +Contract Drilling — The Company markets its contract drilling services to major and independent oil and natural gas operators. As of December 31, 2016, the Company had 202 marketed land-based drilling rigs in the continental United States and western Canada. +For the years ended December 31, 2016, 2015 and, 2014, contract drilling revenue earned in Canada was $15.6 million, $37.5 million and $87.5 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $44.0 million and $53.4 million as of December 31, 2016 and 2015, respectively. +Pressure Pumping — The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services are primarily well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. Cementing is the process of inserting material between the hole and the pipe to center and stabilize the pipe in the hole. +Major Customer — During 2016, one customer accounted for approximately $124 million or 14% of the Company’s consolidated operating revenues. During 2015, one customer accounted for approximately $244 million or 13% of the Company’s consolidated operating revenues. These revenues were earned in both the Company’s contract drilling and pressure pumping businesses. During 2014, no single customer accounted for more than 10% of the Company’s consolidated operating revenue. +F-29 +The following tables summarize selected financial information relating to the Company’s business segments (in thousands): +Years Ended December 31, +2016 +2015 +2014 +Revenues: +Contract drilling +$ +544,196 +$ +1,155,565 +$ +1,843,707 +Pressure pumping +354,070 +712,454 +1,294,569 +Other operations(a) +18,299 +24,931 +50,196 +Elimination of intercompany revenues(b) +(699 +) +(1,673 +) +(6,181 +) +Total revenues +$ +915,866 +$ +1,891,277 +$ +3,182,291 +Income (loss) before income taxes: +Contract drilling +$ +(235,858 +) +$ +(78,970 +) +$ +241,851 +Pressure pumping +(176,628 +) +(254,998 +) +89,081 +Other operations +(3,391 +) +(14,269 +) +(6,738 +) +Corporate +(54,672 +) +(57,088 +) +(56,849 +) +Other operating income (expense), net (c) +14,323 +(1,647 +) +15,781 +Interest income +327 +964 +979 +Interest expense +(40,366 +) +(36,475 +) +(29,825 +) +Other +69 +34 +3 +Income (loss) before income taxes +$ +(496,196 +) +$ +(442,449 +) +$ +254,283 +Identifiable assets: +Contract drilling +$ +3,032,819 +$ +3,457,044 +$ +4,000,576 +Pressure pumping +653,630 +813,704 +1,186,010 +Other operations +48,885 +38,726 +51,313 +Corporate(d) +69,272 +220,010 +153,013 +Total assets +$ +3,804,606 +$ +4,529,484 +$ +5,390,912 +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +467,974 +$ +618,434 +$ +524,023 +Pressure pumping +184,872 +214,552 +147,595 +Other operations +10,114 +26,301 +42,576 +Corporate +5,474 +5,472 +4,536 +Total depreciation, depletion, amortization and impairment +$ +668,434 +$ +864,759 +$ +718,730 +Capital expenditures: +Contract drilling +$ +72,508 +$ +527,054 +$ +771,593 +Pressure pumping +39,584 +197,577 +241,359 +Other operations +6,116 +16,625 +36,683 +Corporate +1,591 +2,520 +2,706 +Total capital expenditures +$ +119,799 +$ +743,776 +$ +1,052,341 +(a) +Other operations includes the Company’s pipe handling components and related technology business, the oil and natural gas working interests and the Middle East/North Africa business. +( b ) +Consists of contract drilling and, in 2016, intercompany revenues between the pipe handling component manufacturer and the pipe handling component service provider, and in 2014, pressure pumping intercompany revenues for services provided to the oil and natural gas exploration and production segment. +( c ) +Other operating income (expense), net includes net gains or losses associated with the disposal of assets relate to corporate strategy decisions of the executive management group. Accordingly, the related gains or losses have been separately presented and excluded from the results of specific segments. This caption also includes expenses related to certain legal settlements net of insurance reimbursements. +( d ) +Corporate assets primarily include cash on hand, income tax receivables and certain deferred tax assets. +F-30 +16 . Concentrations of Credit Risk +Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +The Company believes it has placed its demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2016 and 2015, the Company’s demand deposits and temporary cash investments consisted of the following (in thousands): +2016 +2015 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +846 +$ +617 +Deposits in FDIC and SIPC-insured institutions over insurance limits +12,866 +130,330 +Deposits in foreign banks +27,557 +15,303 +41,269 +146,250 +Less outstanding checks and other reconciling items +(6,117 +) +(32,904 +) +Cash and cash equivalents +$ +35,152 +$ +113,346 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which the Company provides services. As is general industry practice, the Company typically does not require customers to provide collateral. No significant losses from individual customers were experienced during the years ended December 31, 2016, 2015 or 2014. No provision for bad debts was recognized in 2016, 2015 or 2014. +17. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of the Company’s outstanding debt balances (including current portion) as of December 31, 2016 and 2015 is set forth below (in thousands): +December 31, 2016 +December 31, 2015 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +Borrowings under Credit Agreement: +Revolving credit facility +$ +— +$ +— +$ +— +$ +— +Term loan facility +— +— +70,000 +70,000 +2015 Term Loan +— +— +185,000 +185,000 +4.97% Series A Senior Notes +300,000 +283,534 +300,000 +279,635 +4.27% Series B Senior Notes +300,000 +263,194 +300,000 +258,806 +Total debt +$ +600,000 +$ +546,728 +$ +855,000 +$ +793,441 +The carrying values of the balances outstanding under the revolving credit facility, the term loan facility, and the 2015 Term Loan approximate their fair values as these instruments have floating interest rates. The fair values of the Series A Notes and Series B Notes at December 31, 2016 and 2015 are based on discounted cash flows associated with the respective notes using current market rates of interest at those respective dates. For the Series A Notes, the current market rates used in measuring this fair value were 6.65% at December 31, 2016 and 6.66% at December 31, 2015. For the Series B Notes, the current market rates used in measuring this fair value were 7.02% at December 31, 2016 and 6.95% at December 31, 2015. These fair value estimates are based on observable market inputs and are considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting. +F-31 +18. Quarterly Financial Information (in thousands, except per share amounts) (unaudited) +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2016 +Operating revenues +$ +268,939 +$ +193,907 +$ +206,133 +$ +246,887 +Operating loss +(95,259 +) +(124,332 +) +(123,409 +) +(113,226 +) +Net loss +(70,503 +) +(85,866 +) +(84,143 +) +(78,122 +) +Net loss per common share: +Basic +$ +(0.48 +) +$ +(0.58 +) +$ +(0.58 +) +$ +(0.53 +) +Diluted +$ +(0.48 +) +$ +(0.58 +) +$ +(0.58 +) +$ +(0.53 +) +2015 +Operating revenues +$ +657,699 +$ +472,761 +$ +422,251 +$ +338,566 +Operating income (loss) +24,103 +(24,764 +) +(329,515 +) +(76,796 +) +Net income (loss) +9,125 +(18,975 +) +(225,978 +) +(58,658 +) +Net income (loss) per common share: +Basic +$ +0.06 +$ +(0.13 +) +$ +(1.54 +) +$ +(0.40 +) +Diluted +$ +0.06 +$ +(0.13 +) +$ +(1.54 +) +$ +(0.40 +) +F-32 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions(1) +Balance +(In thousands) +Year Ended December 31, 2016 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,545 +$ +— +$ +(354 +) +$ +3,191 +Year Ended December 31, 2015 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,546 +$ +— +$ +(1 +) +$ +3,545 +Year Ended December 31, 2014 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,674 +$ +— +$ +(128 +) +$ +3,546 +(1) +Consists of uncollectible accounts written off. +S-1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 13, 2017 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 13, 2017. +Signature +Title +/s/ Mark S. Siegel +Chairman of the Board +Mark S. Siegel +/s/ William Andrew Hendricks, Jr. +President and Chief Executive Officer +William Andrew Hendricks, Jr. +(Principal Executive Officer) +/s/ John E. Vollmer III +Senior Vice President — Corporate Development, +John E. Vollmer III +Chief Financial Officer and Treasurer +(Principal Financial and Accounting Officer) +/s/ Kenneth N. Berns +Senior Vice President and Director +Kenneth N. Berns +/s/ Charles O. Buckner +Director +Charles O. Buckner +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Curtis W. Huff +Director +Curtis W. Huff +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Tiffany J. Thom +Director +Tiffany J. Thom +EXHIBIT INDEX +2.1 +Agreement and Plan of Merger by and among Patterson-UTI Energy, Inc., Pyramid Merger Sub, Inc. and Seventy Seven Energy Inc., dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 2.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.4 +Second Amended and Restated Bylaws (filed August 6, 2007 as Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference). +10.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference). +10.2 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.3 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.4 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.7 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.8 +Form of Share-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010 and incorporated herein by reference).* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.10 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed April 21, 2014 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.11 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed May 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.12 +Form of Executive Officer Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.3 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.13 +Form of Executive Officer Restricted Stock Award Agreement (filed May 2, 2016 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.14 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.15 +Form of Non-Employee Director Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.5 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.16 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current +Report on Form 8-K and incorporated herein by reference).* +10.17 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns and John E. Vollmer III (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.18 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed January 17, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.19 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). * +10.20 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler.*+ +10.21 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, John E. Vollmer III, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon and Tiffany J. Thom (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.22 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.23 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.24 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed on February 4, 2004 as Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.25 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.26 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and John E. Vollmer, III, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.27 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007 and incorporated herein by reference).* +10.28 +Credit Agreement dated September 27, 2012, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed September 28, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.29 +Amendment No. 1 to Credit Agreement dated as of January 9, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed January 12, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.30 +Amendment No. 2 to Credit Agreement dated as of July 8, 2016, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto (filed July 12, 2016 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.31 +Amendment No. 3 to Credit Agreement dated as of January 17, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto.+ +10.32 +Commitment Increase Agreement, dated as of January 24, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto (filed January 24, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and +incorporated herein by reference). +10.33 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.34 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated October 5, 2010) (filed October 28, 2015 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.35 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.36 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated June 14, 2012) (filed October 28, 2015 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 and incorporated herein by reference). +10.37 +Reimbursement Agreement, dated as March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.38 +Continuing Guaranty, dated as of March 16, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 16, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.39 +Term Loan Agreement, dated as March 18, 2015, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent and lender, each of the other lenders party thereto, Wells Fargo Securities, LLC, as Lead Arranger and Sole Book Runner, and Bank of America, N.A. and The Bank of Tokyo-Mitsubishi UFJ, LTD., as Co-Syndication Agents (filed March 18, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.40 +Continuing Guaranty, dated as of March 18, 2015, by Patterson Petroleum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 18, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.41 +Commitment Letter, dated December 12, 2016, between Patterson-UTI Energy, Inc. and Canyon Capital Advisors LLC (filed December 13, 2016 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.42 +Voting and Support Agreement, by and among Patterson-UTI Energy, Inc. and certain affiliates of Axar Capital Management, LLC, dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.43 +Voting and Support Agreement, by and among Patterson-UTI Energy, Inc. and certain affiliates of Blue Mountain Capital Management, LLC, dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 10.3 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.44 +Voting and Support Agreement, by and among Patterson-UTI Energy, Inc. and certain affiliates of Mudrick Capital Management, L.P., dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+ +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. \ No newline at end of file diff --git a/raw/filings/0000889900/2016/0001564590-17-001437/filing_metadata.csv b/raw/filings/0000889900/2016/0001564590-17-001437/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..e963f732747e41038f4ba20b99bbc80857ad7f0a --- /dev/null +++ b/raw/filings/0000889900/2016/0001564590-17-001437/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2017-02-13,2016-12-31,2017-02-13T21:02:23.000Z,0001564590-17-001437,pten-10k_20161231.htm,PTEN-10K-20161231,17061237,1,0,https://www.sec.gov/Archives/edgar/data/889900/000156459017001437/pten-10k_20161231.htm,https://www.sec.gov/Archives/edgar/data/889900/000156459017001437/,2016,2016,1 diff --git a/raw/filings/0000889900/2016/0001564590-17-001437/item1.txt b/raw/filings/0000889900/2016/0001564590-17-001437/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..238c04898ecc42d54638549d1f3586942fec36ee --- /dev/null +++ b/raw/filings/0000889900/2016/0001564590-17-001437/item1.txt @@ -0,0 +1,278 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. As of December 31, 2016, we had a drilling fleet that consisted of 202 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2016, we had approximately 1.1 million hydraulic horsepower (approximately 1.0 million of which was hydraulic fracturing horsepower) to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also manufacture and sell pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2014, 2015 and 2016 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2014: +Average oil price per Bbl (1) +$ +98.75 +$ +103.35 +$ +97.78 +$ +73.16 +Average rigs operating per day - U.S. (2) +193 +201 +209 +210 +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +Average rigs operating per day - U.S. (2) +165 +122 +105 +88 +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +3 +The closing price of oil was as high as $10 7.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have recovered substantially from the lows experienced in the first quarter of 2016. During the fourth quarter of 2016, the Organization of Petroleum Exporting Countries (“ OPEC ”) and certain non-OPEC countries, including Russia, a nnounced an agreement to cut oil production. The announcement resulted in an increase in oil prices, which averaged $51.97 per barrel in December 2016. In response to improved prices, U.S. rig counts have been increasing, and we believe they will conti nue to increase throughout 2017 if prices for these commodities remain at or above current levels. +Our rig count in the United States declined significantly during the industry downturn that began in late 2014, but has steadily improved on a monthly basis since May 2016. For the fourth quarter, our average rig count improved to 66 rigs in the United States, up from the third quarter average of 60 rigs. Our rig count in the United States at December 31, 2016 of 74 rigs was 42% greater than the low of 52 rigs in April 2016; however, it was 65% less than the high of 214 rigs in October 2014. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 44 rigs operating under term contracts during the first quarter of 2017 and an average of 37 rigs operating under term contracts throughout 2017. +Activity levels in our pressure pumping business have also improved. Looking forward, we expect to see further increases in activity across the industry, especially in the Permian Basin. We have reactivated two frac spreads since mid-December 2016 at a cost of approximately $2 million per spread, including both operating and capital expenditures. Approximately 45% of the more than one million hydraulic fracturing horsepower in our fleet remains stacked. We expect the cost to reactivate our remaining idle frac spreads would be approximately $3 million per frac spread, including both operating and capital expenditures. +On December 12, 2016, we entered into an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”), pursuant to which a subsidiary of ours will be merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly owned subsidiaries (the “SSE merger”). Under the merger agreement, we will acquire all of the issued and outstanding shares of common stock of SSE in exchange for approximately 49.6 million shares of our common stock, subject to certain downward adjustments set forth in the merger agreement. SSE provides contract drilling, pressure pumping and oilfield rental services in many of the most active oil and natural gas plays onshore in the United States. SSE owns a fleet of 40 AC drilling rigs, approximately 93% of which are pad capable, including 28 fit-for-purpose PeakeRigs™. The remainder of SSE’s rig fleet includes 51 SCR rigs. Additionally, SSE owns approximately 500,000 horsepower of modern, efficient fracturing equipment located in the Anadarko Basin and Eagle Ford Shale. The SSE oilfield rentals business has a modern, well-maintained fleet of premium rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +The completion of the SSE merger is subject to satisfaction or waiver of certain closing conditions, including, but not limited to, approval by our and SSE’s respective stockholders and other closing conditions set forth in the merger agreement. Subject to closing conditions, the SSE merger is expected to be completed late in the first quarter or early in the second quarter of 2017. +Industry Segments +Our revenues, operating profits and identifiable assets are primarily attributable to two industry segments: +• +contract drilling services, and +• +pressure pumping services. +Both of these industry segments had operating losses in 2016 and 2015. In 2014, both of these industry segments had operating profits. +We changed our reporting segment presentation in 2016, as we no longer consider our oil and natural gas exploration and production activities to be significant to an understanding of our results. We now present the oil and natural gas exploration and production activities, drilling technology and international activities as “Other” and “Corporate” reflects only corporate activities. This change in segment presentation was applied retrospectively to all periods presented herein. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 15 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2016, we had 202 marketed land-based drilling rigs based in the following regions: +• +42 in west Texas and southeastern New Mexico, +4 +• +1 6 in north central and east Texas and northern Louisiana , +• +35 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +35 in south Texas, +• +24 in western Oklahoma, +• +43 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +7 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,000 feet to 25,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $1.4 billion during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2016, 2015 and 2014, we spent approximately $73 million, $527 million and $772 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to three years) and provide for the use of the drilling rig to drill multiple wells. During 2016, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 14 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. We believe that our drilling contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each drilling contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements, applicable law or other factors. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2016, 2015 and 2014 were under daywork contracts. +From time to time more than five years ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turnkey basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +5 +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2016 +2015 +2014 +Average rigs operating per day - U.S.(1) +63 +120 +203 +Average rigs operating per day - Canada(1) +2 +4 +8 +Number of rigs operated during the year +100 +223 +231 +Number of wells drilled during the year +1,470 +2,448 +3,740 +Number of operating days +23,596 +45,142 +77,000 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2016, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad Capable +APEX ® 1500 HP rigs +126 +1 +127 +70 +% +APEX ® 1000 HP rigs +26 +— +26 +88 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 2000 HP rigs +3 +— +3 +100 +% +Other electric rigs +35 +6 +41 +20 +% +Total +195 +7 +202 +63 +% +Average horsepower +1,428 +1,171 +1,419 +The U.S. land rig industry has recently begun referring to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has a 750,000 pound hookload, has a 7,500 psi circulating system and is pad capable. We currently estimate there are approximately 375 super-spec rigs in the United States, which includes 65 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (Southwest Region) and the Appalachian region (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. We believe that our pressure pumping contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each pressure pumping contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements, applicable law or other factors. +6 +Equipment — We have pressure pumping equipment used in providing hydraulic and nitrog en fracturing services as well as nitrogen, cementing and acid pumping services, wi th a total of approximately 1.1 million hydraulic horsepower (approximately 1.0 million of which was hydraulic fracturing horsepower) as of December 31, 2016. Pressure pumping equipment at December 31, 2016 included: +Hydraulic +Other +Fracturing +Pumping +Equipment +Equipment +Total +Southwest Region: +Number of units +284 +30 +314 +Approximate hydraulic horsepower +662,000 +30,890 +692,890 +Northeast Region: +Number of units +169 +94 +263 +Approximate hydraulic horsepower +353,800 +55,400 +409,200 +Combined: +Number of units +453 +124 +577 +Approximate hydraulic horsepower +1,015,800 +86,290 +1,102,090 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material, or should one of our suppliers fail to timely deliver our materials. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2016, we received approximately 51% from our ten largest customers and approximately 33% from our five largest customers. During 2016, one customer accounted for approximately $124 million, or approximately 14%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Competition +The contract drilling and pressure pumping businesses are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn, such as the current market environment. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for land drilling and pressure pumping services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, and +• +our employees. +7 +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business . We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future . However, compliance costs under existing laws or under any new requirements could become material , and we could incur liability in any instance of noncompliance . +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +8 +The Oil Poll ution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial h arm will be done to the environment by discharges on or into navigable waters . Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions . Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages . +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +9 +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our drilling and pressure pumping contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to neg ligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our drilling rigs, pressure pumping equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our drilling rigs and pressure pumping equipment and certain other assets, such insurance does not cover the full replacement cost of such drilling rigs, pressure pumping equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cyber risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 3,600 full-time employees as of February 7, 2017. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +10 \ No newline at end of file diff --git a/raw/filings/0000889900/2016/0001564590-17-001437/item13.txt b/raw/filings/0000889900/2016/0001564590-17-001437/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2016/0001564590-17-001437/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2016/0001564590-17-001437/item9a.txt b/raw/filings/0000889900/2016/0001564590-17-001437/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e9c79c186ef4cf3cb6b0a977d6eb7dbea3d9bb65 --- /dev/null +++ b/raw/filings/0000889900/2016/0001564590-17-001437/item9a.txt @@ -0,0 +1,8 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2016, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2016, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2016. +The effectiveness of our internal control over financial reporting as of December 31, 2016 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2016/0001564590-17-001437/rp_note.txt b/raw/filings/0000889900/2016/0001564590-17-001437/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2016/0001564590-17-001437/rpt_disclosure.txt b/raw/filings/0000889900/2016/0001564590-17-001437/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2017/0001564590-18-002481/filing.txt b/raw/filings/0000889900/2017/0001564590-18-002481/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..8cdbf0a2dccd253a6f9621c374d778d4447ff6e2 --- /dev/null +++ b/raw/filings/0000889900/2017/0001564590-18-002481/filing.txt @@ -0,0 +1,5472 @@ +10-K +1 +pten-10k_20171231.htm +10-K +pten-10k_20171231.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +Form 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2017 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-22664 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N, Suite 800, Houston, Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +(281) 765-7100 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Exchange on Which Registered +Common Stock, $0.01 Par Value +The Nasdaq Global Select Market +Securities Registered Pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ or No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Smaller reporting company +☐ +Non-accelerated filer +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2017, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $4.2 billion, calculated by reference to the closing price of $20.19 for the common stock on the Nasdaq Global Select Market on that date. +As of February 16, 2018, the registrant had outstanding 222,286,372 shares of common stock, $0.01 par value, its only class of common stock. +Documents incorporated by reference: +Portions of the registrant’s definitive proxy statement for the 2018 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings and press releases by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue and cost expectations and backlog; financing of operations; oil and natural gas prices; rig counts; source and sufficiency of funds required for building new equipment, upgrading existing equipment and additional acquisitions (if opportunities arise); impact of inflation; demand for our services; competition; equipment availability; government regulation; debt service obligations; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +On April 20, 2017, we completed our merger with Seventy Seven Energy Inc. (“SSE”), pursuant to which a subsidiary of ours was merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly owned subsidiaries (the “SSE merger”). On October 11, 2017, we completed our acquisition of MS Directional, LLC (f/k/a Multi-Shot, LLC) (“MS Directional”). These forward-looking statements include, without limitation, our expectations with respect to: +• +synergies, costs and other anticipated financial impacts of the SSE merger and the MS Directional acquisition; +• +future financial and operating results of the combined company; and +• +the combined company’s plans, objectives, expectations and intentions with respect to future operations and services. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +the diversion of management time on merger-related issues; +• +the ultimate timing, outcome and results of integrating our operations with those of SSE and MS Directional; +• +the effects of our business combination with SSE and MS Directional, including the combined company’s future financial condition, results of operations, strategy and plans; +• +potential adverse reactions or changes to business relationships resulting from the SSE merger and MS Directional acquisition; +• +expected benefits from the SSE merger and MS Directional acquisition and our ability to realize those benefits; +• +the results of merger-related litigation, settlements and investigations; +• +availability of capital and the ability to repay indebtedness when due; +• +volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +loss of key customers; +• +utilization, margins and planned capital expenditures; +• +synergies, costs and financial and operating impacts of acquisitions; +• +interest rate volatility; +• +compliance with covenants under our debt agreements; +• +excess availability of land drilling rigs, pressure pumping and directional drilling equipment, including as a result of reactivation, improvement or construction; +• +specialization of methods, equipment and services and new technologies; +1 +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• +difficulty in building and deploying new equipment; +• +expansion and development trends of the oil and natural gas industry; +• +weather; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +the ability to retain management and field personnel; +• +the ability to effectively identify and enter new markets; +• +the ability to realize backlog; +• +strength and financial resources of competitors; +• +environmental risks and ability to satisfy future environmental costs; +• +global economic conditions; +• +adverse oil and natural gas industry conditions; +• +adverse credit and equity market conditions; +• +operating costs; +• +competition and demand for our services; +• +liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• +governmental regulation; +• +ability to obtain insurance coverage on commercially reasonable terms; +• +financial flexibility; +• +legal proceedings and actions by governmental or other regulatory agencies; +• +technology-related disputes; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in our SEC filings. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. As of December 31, 2017, we had a drilling fleet that consisted of 295 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2017, we had approximately 1.6 million fracturing horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, directional surveying, measurement-while-drilling, and wireline steering tools. +We have other operations where we provide oilfield rental equipment in many of the major producing onshore oil and gas basins in the United States, and we also manufacture and sell pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”) initially guaranteed on a senior unsecured basis by certain of our subsidiaries. The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. We intend to use the remainder of the net proceeds for general corporate purposes. +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of MS Directional. The aggregate consideration paid by us consisted of $69.8 million in cash and approximately 8.8 million shares of our common stock. Based on the closing price of our common stock on the closing date of the transaction, the total fair value of the consideration transferred to effect the acquisition of MS Directional was approximately $257 million. +3 +On December 12, 2016, we entered into an Agreement and Plan of Merger (the “merger agreement”) with SSE. On April 20, 2017, pursuant to the m erger agreement, a subsidiary of ours was merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly - owned subsidiaries. Pursuant to the terms of the merger agreement, we acquired all of the issued and outstanding shares o f common stock of SSE, in exchange for approximately 46.3 million shares of our common stock. Concurrent with the closing of the merger, we repaid all of the outstanding debt of SSE totaling $472 million. Based on the closing price of our common stock on April 20, 2017, the total fair value of the consideration transferred to effect the acquisition of SSE was approximately $1.5 billion. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary named Seventy Sev en Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of our wholly - owned subsidiaries. +Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of modern, efficient fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a modern, well-maintained fleet of premium oilfield rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +Operational data in the discussion and analysis in this Report includes the results of operations of the MS Directional business since October 11, 2017 and the results of operations of the SSE businesses since April 20, 2017. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2015, 2016 and 2017 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +Average rigs operating per day - U.S. (2) +165 +122 +105 +88 +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have modestly recovered from the lows experienced in the first quarter of 2016. Oil prices averaged $55.37 per barrel in the fourth quarter of 2017. +Our rig count in the United States declined significantly during the industry downturn that began in late 2014, but has improved since the second quarter of 2016. Our average rig count in the United States was 159 rigs for both the third and fourth quarter of 2017, with the third quarter of 2017 being the first quarter with a full quarter contribution from the rigs acquired in the SSE merger. Our rig count in the United States at December 31, 2017 was 163 rigs. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 96 rigs operating under term contracts during the first quarter of 2018 and an average of 67 rigs operating under term contracts throughout 2018. +Activity levels in our pressure pumping business also improved during 2017, especially in the Permian Basin. We reactivated two frac spreads during the third quarter and one additional frac spread during the fourth quarter. With the addition of these three frac spreads, we exited 2017 with 23 active frac spreads or approximately 1.25 million active fracturing horsepower. +Industry Segments +Our revenues, operating income (loss) and identifiable assets are primarily attributable to two industry segments: +• +contract drilling services, and +• +pressure pumping services. +Our contract drilling services industry segment had operating losses in 2017, 2016 and 2015. Our pressure pumping services industry segment had operating income in 2017 and operating losses in 2016 and 2015. Our third industry segment, directional drilling services, is a new segment for us as a result of the MS Directional acquisition and accounted for approximately two percent of our 2017 consolidated revenues. +4 +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14 of Notes to Consolidat ed Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2017, we had 295 marketed land-based drilling rigs based in the following regions: +• +71 in west Texas and southeastern New Mexico, +• +32 in north central and east Texas and northern Louisiana, +• +42 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +40 in south Texas, +• +55 in western Oklahoma, +• +48 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +7 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 25,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $954 million during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2017, 2016 and 2015, we spent approximately $354 million, $73 million and $527 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to two years) and provide for the use of the drilling rig to drill multiple wells. During 2017, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 15 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2017, 2016 and 2015 were under daywork contracts. +5 +From time to time more than five y ears ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turn key basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2017 +2016 +2015 +Average rigs operating per day - U.S.(1) +136 +63 +120 +Average rigs operating per day - Canada(1) +2 +2 +4 +Number of rigs operated during the year +179 +100 +223 +Number of wells drilled during the year +3,160 +1,470 +2,448 +Number of operating days +50,427 +23,596 +45,142 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2017, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad Capable +APEX ® 1500 HP rigs +164 +1 +165 +86 +% +APEX ® 1000 HP rigs +20 +— +20 +100 +% +APEX ® 1200 HP rigs +4 +— +4 +100 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 2000 HP rigs +5 +— +5 +60 +% +Other electric rigs +90 +6 +96 +49 +% +Total +288 +7 +295 +75 +% +Average horsepower +1,394 +1,171 +1,389 +The U.S. land rig industry has recently begun referring to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has a 750,000 pound hookload, has a 7,500 psi circulating system and is pad capable. We currently estimate there are approximately 550 super-spec rigs in the United States, which includes 130 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (West and South Regions) and the Mid-Continent (Mid-Con Region) and Appalachian regions (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +6 +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum rev enue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as nitrogen, cementing and acid pumping services, with a total of approximately 1.6 million horsepower as of December 31, 2017. Pressure pumping equipment at December 31, 2017 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +West Texas Region +Number of units +235 +30 +265 +Approximate horsepower +537,950 +30,890 +568,840 +South Texas Region +Number of units +147 +— +147 +Approximate horsepower +361,250 +— +361,250 +Mid-Con Region +Number of units +134 +— +134 +Approximate horsepower +305,500 +— +305,500 +Northeast Region +Number of units +169 +95 +264 +Approximate horsepower +353,800 +55,400 +409,200 +Combined: +Number of units +685 +125 +810 +Approximate horsepower +1,558,500 +86,290 +1,644,790 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material, or should one of our suppliers fail to timely deliver our materials. +Directional Drilling Operations +General – We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, directional surveying, measurement while drilling (“MWD”), and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, manufacture and maintain our own fleet of downhole drilling motors and MWD equipment. We occasionally rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. As a complement to our core directional drilling services, we provide downhole survey services and rent our proprietary drilling motors to both oil and natural gas operators and other oilfield service companies. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. We utilize our fleet of directional drilling motors, MWD equipment and survey equipment to provide: (1) directional drilling services, (2) third-party motor rentals and (3) downhole survey services. +7 +Directional Drilling Services – We provide our directional drilling services on a day-rate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the numbe r of days of work completed. Our day rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a stand-by rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Third-Party Motor Rental – We rent our drilling motors on an hourly- or day-rate basis to complement our directional drilling services and optimize the utilization of our asset base. Our third-party motor rental revenue is recognized as work progresses based on the number of days or hours our motors are used or are on location. +Downhole Survey Services – We provide our downhole survey services on a day-rate, hourly-rate or completed-job basis. Revenue for our downhole survey services is recognized upon the completion of each day’s work. Our downhole survey services are typically non-contractual. We normally provide a quote to our customers in advance and then issue an invoice for the downhole survey services provided based on a completed field ticket. +Equipment – We generally design, manufacture, maintain and inspect our own equipment. We occasionally rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment and survey tools. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have th e ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2017, we had a comprehensive fleet of over 1,600 motors that serve both internal needs and external motor rental requirements. In addition to our motor fleet, we had 112 MWD systems as well as downhole surveying equipment to provide accurate wellbore surveys. +Oilfield Rentals +Our oilfield rentals business has a modern, well-maintained fleet of premium oilfield rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. We offer an extensive line of rental tools, including a full line of tubular products specifically designed for horizontal drilling and completion, with high-torque, premium-connection drill pipe, drill collars and tubing. Additionally, we offer surface rental equipment including blowout preventers, frac tanks, mud tanks and environmental containment that encompass all phases of the hydrocarbon extraction and production process. Our air drilling equipment and services enable extraction in select basins where certain segments of formations preclude the use of drilling fluid, permitting operators to drill through problematic zones without the risk of fluid absorption and damage to the wellbore. We also provide frac-support services, including delivery of on-site frac water through a water transfer operation using innovative lay-flat pipe, and monitoring and controlling of production returns. We offer oilfield rental services in many of the major producing onshore oil and gas basins in the United States. We price our rentals and services based on the type of equipment being rented and the services being performed. Substantially all rental revenue we earn is based upon a charge for the actual period of time the rental is provided to our customer on a market-based, fixed per-day or per-hour fee. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and oilfield rentals contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2017, we received approximately 43% from our ten largest customers and approximately 29% from our five largest customers. During 2017, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +Backlog +Our contract drilling backlog as of December 31, 2017 and 2016 was $544 million and $417 million, respectively. Approximately 19% of the total contract drilling backlog at December 31, 2017 is reasonably expected to remain after 2018. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn, such as the current market environment. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +• +directional drilling services, third-party motor rentals and downhole survey services, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, and +• +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +9 +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D crite ria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +10 +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupatio nal Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +11 +Employees +We had approximately 8,000 full-time employees as of February 16, 2018. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling, pressure pumping and directional drilling services, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, and +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, +• +the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”) to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +• +domestic and international military, political, economic and weather conditions, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +12 +• +the price and availability of alternative fuels. +All of these factors are beyond our control. The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. As a result of the lower level of oil prices, our industry has experienced a severe decline in both contract drilling and pressure pumping activity levels. While oil and natural gas prices modestly recovered since the first quarter of 2016, and we have experienced an increase in the demand for our services since 2016, our average number of rigs operating remains well below the number of our available rigs, and a portion of our pressure pumping horsepower remains stacked. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices or expectations of decreases in oil and natural gas prices, would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Global Economic Conditions May Adversely Affect Our Operating Results. +Global economic conditions and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, and there is no assurance that the global economic environment will not quickly deteriorate again due to one or more factors, including a decline in the price for oil or natural gas. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Excess Equipment and a Highly Competitive Oil Service Industry May Adversely Affect Our Utilization and Profit Margins and the Carrying Value of our Assets. +The North American land drilling and pressure pumping businesses are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. In addition, in recent years there has been a substantial increase in the construction of new technology drilling rigs and new pressure pumping equipment and the improvement of existing drilling rigs. Low commodity prices and construction of new equipment and the improvement of existing drilling rigs can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. Even in an environment of high oil and natural gas prices and increased drilling activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to an excess supply of equipment. In addition, we may be unable to replace fixed-term contracts that were terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. Accordingly, high competition and excess equipment can cause drilling, pressure pumping and directional drilling contractors to have difficulty maintaining utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or excess equipment in the oil and natural gas contract drilling, pressure pumping or directional drilling businesses or the level of demand for our contract drilling, pressure pumping or directional drilling services. +The excess supply of operable land drilling rigs, increasing rig specialization and excess pressure pumping and directional drilling equipment, which has been exacerbated by a decline in oil and natural gas prices could affect the fair market value of our drilling, pressure pumping and directional drilling equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices could result in future impairment to our long-lived assets and goodwill. +13 +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provis ions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our customer contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage, and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cyber risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +On January 22, 2018, an accident at a drilling site in Pittsburg County, Oklahoma resulted in the losses of life of five people, including three of our employees. Based on the information we have available as of the date of this Report, we believe that we have adequate insurance to cover any losses, excluding the applicable insurance deductibles and investigation-related expenses. However, if this accident is not, or another significant accident or other event occurs that is not, fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +14 +Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Cont racts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2017, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $544 million. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts, including as a result of the decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services. +New Technologies May Cause Our Operating Methods, Equipment and Services to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive in Our Industry. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance of drilling rigs and other equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and other equipment. Accordingly, a higher level of capital expenditures may be required to maintain and improve existing rigs and other equipment and purchase and construct newer, higher specification drilling rigs and other equipment to meet the increasingly sophisticated needs of our customers. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping and directional drilling businesses could have similar effects. +In recent years, we have added drilling rigs to our fleet through new construction, purchased new pressure pumping equipment and acquired a directional drilling services company. We have also improved existing drilling rigs and pressure pumping equipment by adding equipment designed to enhance functionality and performance. Although we take measures to ensure that we use advanced oil and natural gas drilling, pressure pumping and directional drilling technology, changes in technology, improvements in competitors’ equipment and changes relating to the wells to be drilled and completed could make our equipment less competitive. +If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment and services obsolete, which could have a material adverse impact on our business, financial condition, cash flows and results of operation. +Shortages, Delays in Delivery, and Interruptions in Supply, of Equipment and Materials Could Adversely Affect Our Operating Results. +During periods of increased demand for oilfield services, the industry has experienced shortages of equipment for upgrades, drill pipe, replacement parts and other equipment and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +transportation and other logistical challenges, and +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs. Severe shortages, delays in delivery and interruptions in supply could limit our ability to operate, maintain, upgrade and construct our drilling rigs and pressure pumping and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +15 +Loss of Key Personnel and Competition for Experienced Personnel May Neg atively Impact Our Financial Condition and Results of Operations . +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel, particularly after a prolonged industry downturn. During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of key personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even if it is generally a period of lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2017, we received approximately 43% from our ten largest customers, 29% from our five largest customers and 8% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Growth Through Acquisitions or the Building of New Rigs and Pressure Pumping Equipment Is Not Assured. +We have increased our drilling rig fleet and pressure pumping fleet and expanded our business lines in the past through mergers, acquisitions and new construction. For example, we completed the SSE merger and the MS Directional acquisition during 2017. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building new rigs and pressure pumping equipment. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, improved commodity prices may cause contract drillers to continue to build new, high technology rigs and providers of pressure pumping services to continue to build new, high horsepower equipment. +There can be no assurance that we will: +• +have sufficient capital resources to complete additional acquisitions or build new rigs or pressure pumping equipment, +• +successfully integrate additional drilling rigs, pressure pumping equipment or other assets or businesses, including SSE and MS Directional, +• +effectively manage the growth and increased size of our organization, drilling fleet and pressure pumping equipment, +• +successfully deploy idle, stacked, upgraded or additional rigs and pressure pumping equipment, +• +maintain the crews necessary to operate additional drilling rigs and pressure pumping equipment, or +• +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition or the building of new drilling rigs and pressure pumping equipment. +Our failure to achieve consolidation savings, to integrate acquired businesses and assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising from events prior to any acquisitions or prior to our establishment of adequate compliance oversight. While we generally seek to obtain indemnities for liabilities for events occurring before such acquisitions, these are limited in amount and duration, may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build new drilling rigs or build new pressure pumping equipment, and we also may issue equity, convertible or debt securities in connection with any such acquisitions or building program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. +16 +Environmental and Occupational Health and Safety Laws and Regulatio ns, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties, +• +modification, denial or revocation of permits or other authorizations, +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the countries in which we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, a manufacturer and servicer of oilfield service equipment and a provider of directional drilling services, we may be deemed to be a responsible party under these laws and regulations. +Changes in environmental laws and regulations occur frequently and such laws and regulations tend to become more stringent over time. Stricter laws, regulations or enforcement policies could significantly increase compliance costs for us and our customers and have a material adverse effect on our operations or financial position. For example, on August 16, 2012, the EPA issued final rules that establish new air emission control requirements for natural gas and NGL production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds and National Emissions Standards for Hazardous Air Pollutants (“NESHAPS”) to address hazardous air pollutants frequently associated with gas production and processing activities. In June 2016, the EPA published a final rule that updates and expands the New Source Performance Standards by setting additional emissions limits for volatile organic compounds and regulating methane emissions for new and modified sources in the oil and gas industry. In addition, the EPA has announced that it intends to impose methane emission standards for existing sources and has issued information collection requests for oil and natural gas facilities. The EPA also published a final rule in June 2016 concerning aggregation of sources that affects source determinations for air permitting in the oil and gas industry. In November 2016, the Department of the Interior issued final rules relating to the venting, flaring and leaking of natural gas by oil and natural gas producers who operate on federal and Indian lands. The rules limited routine flaring of natural gas, require the payment of royalties on avoidable gas losses and require plans or programs relating to gas capture and leak detection and repair. The EPA issued a two-year stay of these requirements in December 2017 and has indicated that the requirements could be rescinded or significantly revised in the future. These or other initiatives could increase costs to us and our customers or reduce demand for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations. +Members of the U.S. Congress and the EPA are reviewing proposals for more stringent regulation of hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. For example, the EPA conducted a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater. As part of this study, the EPA sent requests to a number of companies, including our company, for information on hydraulic fracturing practices. We responded to the inquiry. The EPA released its final report in December 2016. It concluded that hydraulic fracturing activities can impact drinking water resources under some circumstances, including large volume spills and inadequate mechanical integrity of wells. Further, we conduct drilling, pressure pumping and directional drilling activities in numerous states. Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. When caused by human activity, such seismic activity is called induced seismicity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) and other aspects of the oil and gas industry. +17 +In addition, legi slation has been proposed, but not enacted, in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydrau lic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if enacted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SDWA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel. In May 2014, the EPA issued an Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing. Further, in March 2015, the Bureau of Land Management (“BLM”) issued a final rule to regulate hydraulic fracturing on Indian land. The rule requires companies to publicly disclose chemicals used in hydraulic fracturing operations to the BLM. However, these rules were rescinded by rule in December 2017. In June 2016, the EPA published final pretreatment standards for disposal of wastewater produced from shale gas operations to publicly owned treatment works. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations. For example, Colorado, Louisiana, Montana, North Dakota, Texas and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in response to such regulation. +In addition, in light of concerns about induced seismicity, some state regulatory agencies have modified their regulations or issued orders to address induced seismicity. For example, the Oklahoma Corporation Commission (“OCC”) has implemented volume reduction plans, and at times required shut-ins, for oil and natural gas disposal wells injecting wastewater into the Arbuckle formation. The OCC also recently released well completion seismicity guidelines for operators in the SCOOP and STACK plays that call for hydraulic fracturing operations to be suspended following earthquakes of certain magnitudes in the vicinity. +Finally, some jurisdictions have taken steps to enact hydraulic fracturing bans or moratoria. In June 2015, New York banned high volume fracturing activities combined with horizontal drilling. Certain communities in Colorado have also enacted bans on hydraulic fracturing. Voters in the city of Denton, Texas approved a moratorium on hydraulic fracturing in November 2014, though it was later lifted in 2015. These actions have been the subject of legal challenges. +The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could make it more difficult to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. +The Design, Manufacture, Sale and Servicing of Products, including Rig Components, May Subject Us to Liability for Personal Injury, Property Damage and Environmental Contamination Should Such Equipment Fail to Perform to Specifications. +We provide products, including rig components such as top drives, to customers involved in oil and gas exploration, development and production. Because of applications which use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. +Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business +We are aware of the increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. The EPA has adopted rules requiring the reporting of GHG emissions from specified large GHG emission sources on an annual basis. Further, following a finding by the EPA that certain GHGs represent an endangerment to human health, the EPA finalized a rule to address permitting of GHG emissions from stationary sources under the Clean Air Act’s New Source Review Prevention of Significant Deterioration (“PSD”) and Title V programs. This final rule “tailors” the PSD and Title V programs to apply to certain stationary sources of GHG +18 +emissions in a multi-step process, with the largest sources first subject to permitting. However, in June 2014, the U. S. Supreme Court in UARG v. EPA limited application of this rule to sources that would otherwise need permits based on emission of conventional pollutants. In April 2015, the D.C. Circuit Court of Appeals narrowed the rule in accordance with the Supreme C ourt’s decision. In October 2015, the EPA finalized rules that added new sources to the scope of the GHG monitoring and reporting requirements. These new sources include gathering and boosting facilities as well as completions and workovers from hydrauli cally fractured oil wells. The revisions also include the addition of well identification reporting requirements for certain facilities. Also, in November 2016, the EPA published a final rule adding monitoring methods for detecting leaks from oil and gas equipment and emission factors for leaking equipment to be used to calculate and report GHG emissions resulting from equipment leaks. In addition, the United States was actively involved in the United Nations Conference on Climate Change in Paris, which led to the creation of the Paris Agreement. In April 2016, the United States signed the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, ev ery five years. In June 2017, President Trump announced that the United States will withdraw from the Paris Agreement unless it is renegotiated. The State Department informed the United Nations of the United States’ withdrawal in August 2017. However, s everal states and geographic regions in the United States have adopted legislation and regulations to reduce emissions of GHGs. Additional legislation or regulation by these states and regions, the EPA, and/or any international agreements to which the Uni ted States may become a party, that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our operations. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any d irect and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +Legal Proceedings and Governmental Investigations Could Have a Negative Impact on Our Business, Financial Condition and Results of Operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. For example, the January 22, 2018 accident at a drilling site in Pittsburg County, Oklahoma is currently under governmental investigation by the EPA, OSHA and the U.S. Chemical Safety and Hazard Investigation Board. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. +Technology Disputes Could Negatively Impact Our Operations or Increase Our Costs. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, including patent rights. The majority of the intellectual property rights relating to our drilling rigs, pressure pumping equipment and directional drilling services are owned by us or certain of our supplying vendors. However, in the event that we or one of our supplying vendors becomes involved in a dispute over infringement rights relating to equipment owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or our ability to provide services or products, or we could be required to cease use of some equipment or forced to modify our equipment, services or products. We could also be required to pay license fees or royalties for the use of equipment or provision of services or products. Technology disputes involving us or our supplying vendors could have a material adverse impact on our business, financial condition and results of operations. +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect Our Opportunities and Future Business. +We currently conduct operations in Canada, and we have incurred selling, general and administrative expenses related to the evaluation of and preparation for other international opportunities. Also, we sell products, including rig components, for use in numerous oil and gas producing regions outside of North America. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +19 +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effe ct on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may b e conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. Wh ile we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our op erations to conform to local law (or the administration thereof) on terms we find acceptable. +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where contract drilling and pressure pumping activities are conducted or where our consumers for the Warrior products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +Our Business Is Subject to Cybersecurity Risks and Threats. +Our operations are increasingly dependent on information technologies and services. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, theft, viruses, malware, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• +theft or misappropriation of funds; +• +loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• +disruption or impairment of our and our customers’ business operations and safety procedures; +• +loss or damage to our worksite data delivery systems; and +• +increased costs to prevent, respond to or mitigate cybersecurity events. +20 +Although we utilize various procedures and controls to mitigate our exposure to such risk, cybersecurity attacks and other cyber events are evolving and unpredictable. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber in cident could go unnoticed for a period time. Any such incident could have a material adverse effect on our business, financial condition and results of operations. +We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under Our Long-Term Debt. +We have borrowings outstanding under our senior notes and, from time to time, our revolving credit facility. These obligations are guaranteed by each of our existing U.S. subsidiaries other than immaterial subsidiaries. Our ability to meet our interest and principal payment obligations depends in large part on dividends paid to us by our subsidiaries. If our subsidiaries do not generate sufficient cash flows to pay us dividends, we may be unable to meet our interest and principal payment obligations. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. The applicable margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on our excess availability under the credit facility. As of December 31, 2017, the applicable margin on LIBOR rate loans was 3.50% and the applicable margin on base rate loans was 2.50%. As of December 31, 2017, we had $268 million outstanding under our revolving credit facility at a weighted average interest rate of 5.71%. +We have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2017, no amounts had been disbursed under any letters of credit. +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed. +A Downgrade in Our Credit Rating Could Negatively Impact Our Cost of and Ability to Access Capital. +Our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels and other considerations. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, and potentially require us to post letters of credit for certain obligations. +We May Not Be Able to Generate Sufficient Cash to Service All of Our Debt, Including Our Senior Notes and Debt Under Our Credit Agreement, and We May Be Forced to Take Other Actions to Satisfy Our Obligations Under Our Debt, which May Not Be Successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our Credit Agreement and senior notes contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +21 +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +SSE is Subject to Continuing Contingent T ax Liabilities of Chesapeake Energy Corporation (“CHK”) F ollowing its Spin-Off from CHK. +Under the Internal Revenue Code of 1986, as amended (the “Code”), and the related rules and regulations, each corporation that was a member of CHK’s consolidated tax reporting group during any taxable period or portion of any taxable period ending on or before June 30, 2014, the effective time of SSE’s spin-off, is jointly and severally liable for the federal income tax liability of the entire consolidated tax reporting group for that taxable period. SSE has entered into a tax sharing agreement with CHK that allocates the responsibility for prior year taxes of CHK’s consolidated tax reporting group between SSE and CHK and its subsidiaries. However, if CHK were unable to pay, SSE nevertheless could be required to pay the entire amount of such taxes. +SSE’s Tax Sharing Agreement Limits its Ability to Take Certain Actions and May Require SSE to Indemnify CHK for Significant Tax Liabilities Which Cannot be Precisely Quantified at This Time. +Under the terms of SSE’s tax sharing agreement with CHK, SSE generally is responsible for all taxes attributable to its business, whether accruing before, on or after the date of the spin-off, and CHK generally is responsible for any taxes arising from the spin-off or certain related transactions that are imposed on SSE, CHK or its other subsidiaries. Although CHK generally will be responsible for any taxes arising from the spin-off, SSE would be responsible for any such taxes to the extent such taxes result from certain actions or failures to act by SSE that occur after June 30, 2014, the effective date of the tax sharing agreement. SSE’s liabilities under the tax sharing agreement could have a material adverse effect on us. At this time, we cannot precisely quantify the amount of liabilities SSE may have under the tax sharing agreement and there can be no assurances as to their final amounts. +In addition, in the tax sharing agreement SSE covenanted not to take any action, or fail to take any action, after the effective date of the tax sharing agreement, which action or failure to act is inconsistent with the spin-off qualifying under Sections 355 and 368(a)(1)(D) of the Code. As a result, SSE might determine to continue to operate certain of its business operations for the foreseeable future even if a sale or discontinuance of such business might otherwise have been advantageous. +In Connection with SSE’s Separation from CHK, CHK Indemnified SSE for Certain Liabilities. However, There Can Be No Assurance that the Indemnities Will be Sufficient to Insure SSE Against the Full Amount of Such Liabilities, or That CHK’s Ability to Satisfy its Indemnification Obligation Will Not Be Impaired in the Future. +Pursuant to the tax sharing agreement, CHK agreed to indemnify SSE for certain liabilities. However, third parties could seek to hold SSE responsible for any of the liabilities that CHK has agreed to retain, and there can be no assurance that the indemnity from CHK will be sufficient to protect SSE against the full amount of such liabilities, or that CHK will be able to fully satisfy its indemnification obligations. Moreover, even if SSE ultimately succeeds in recovering from CHK any amounts for which SSE is held liable, SSE may be temporarily required to bear these losses. In addition, in certain circumstances, SSE will be prohibited from making an indemnity claim until it first seeks an insurance recovery. If CHK is unable to satisfy its indemnification obligations, the underlying liabilities could have a material adverse effect on our business, financial condition and results of operations. +22 +We May Not Be Able to Utilize a Portion of SSE’s or Our Net Operating Loss Carryforwards (“NOLs”) to Offset Future Taxable Income for U.S. Federal Tax Purposes, Which Could Adversely Affect Our Net Income and Cash Flows. +As of December 31, 2017, SSE had federal income tax NOLs of approximately $238.0 million, which will expire between 2034 and 2037, and, as of December 31, 2017, we had federal income tax NOLs of approximately $867.1 million, which will expire between 2035 and 2037. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be predicted with any accuracy. In addition, Section 382 of the Code generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred—or were to occur—with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382. However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. Any unused annual limitation with respect to an NOL generally may be carried over to later years, subject to the expiration of the NOL 20 years after it arose. +SSE underwent an ownership change in 2016 as a result of its emergence from Chapter 11 bankruptcy proceedings, and experienced another ownership change in 2017 as a result of its acquisition pursuant to the SSE merger, and the corresponding annual limitation associated with either of those changes in ownership could prevent us from fully utilizing—prior to their expiration—SSE’s NOLs as of the effective time of the SSE merger. While our issuance of stock pursuant to the SSE merger was, standing alone, insufficient to result in an ownership change with respect to us, we cannot assure you that we will not undergo an ownership change as a result of the merger taking into account other changes in ownership of our stock occurring within the relevant three-year period described above. If we were to undergo an ownership change, we may be prevented from fully utilizing our NOLs as of the time of the SSE merger prior to their expiration. Future changes in stock ownership or future regulatory changes could also limit our ability to utilize SSE’s or our NOLs. To the extent we are not able to offset future taxable income with SSE’s or our NOLs, our net income and cash flows may be adversely affected. +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling Operations — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania and western Canada. +Pressure Pumping — Our pressure pumping services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Pennsylvania, Ohio and West Virginia. +Directional Drilling — Our directional drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Pennsylvania, Colorado and Montana. +Our Oilfield Rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our manufacture, sale and service of pipe handling components are supported by offices and yard facilities located in western Canada and Texas. Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas and Oklahoma City, Oklahoma, as well as several other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +23 +Item 3. Legal Proceedings. +On January 22, 2018, an accident at a drilling site in Pittsburg County, Oklahoma resulted in the losses of life of five people, including three of our employees. The EPA, OSHA and the U.S. Chemical Safety and Hazard Investigation Board are currently conducting investigations related to this accident. These investigations are ongoing, and we are cooperating with the agencies regarding these investigations. The results of these investigations are not known at this time, and we are unable to determine what finding they might reach, predict what actions these agencies may require or estimate what penalties, if any, they might assess. +While we are not currently party to any claims or lawsuits relating to this accident, based on the information we have available as of the date of this Report, we believe that we have adequate insurance to cover any losses, excluding the applicable insurance deductibles and investigation-related expenses. However, if this accident is not, or another significant accident or other event occurs that is not, fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Additionally, we are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, results of operations or cash flows. +Item 4. Mine Safety Disclosure. +Not applicable. +24 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P MidCap 400 Index and several other market indices. The following table provides high and low sales prices of our common stock for the periods indicated: +High +Low +2017 +First quarter +$ +29.76 +$ +22.83 +Second quarter +25.75 +19.06 +Third quarter +21.74 +14.83 +Fourth quarter +23.26 +17.24 +2016 +First quarter +$ +18.75 +$ +10.94 +Second quarter +22.12 +16.06 +Third quarter +22.66 +17.61 +Fourth quarter +29.56 +20.79 +(b) Holders +As of February 16, 2018, there were approximately 1,087 holders of record of our common stock. +(c) Dividends +We paid cash dividends during the years ended December 31, 2017 and 2016 as follows: +Per Share +Total +(in thousands) +2017 +Paid on March 22, 2017 +$ +0.02 +$ +3,326 +Paid on June 22, 2017 +0.02 +4,269 +Paid on September 21, 2017 +0.02 +4,271 +Paid on December 21, 2017 +0.02 +4,449 +Total cash dividends +$ +0.08 +$ +16,315 +2016 +Paid on March 24, 2016 +$ +0.10 +$ +14,712 +Paid on June 23, 2016 +0.02 +2,953 +Paid on September 22, 2016 +0.02 +2,953 +Paid on December 22, 2016 +0.02 +2,961 +Total cash dividends +$ +0.16 +$ +23,579 +On February 7, 2018, our Board of Directors approved a cash dividend on our common stock in the amount of $0.02 per share to be paid on March 22, 2018 to holders of record as of March 8, 2018. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +25 +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2017. +Period Covered +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands)(1) +October 2017 +— +$ +— +— +$ +186,544 +November 2017 +— +$ +— +— +$ +186,544 +December 2017 (2) +26,640 +$ +21.98 +— +$ +186,544 +Total +26,640 +— +$ +186,544 +(1) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the plan are held as treasury shares. There is no expiration date associated with the buyback program. +(2) +We withheld 26,640 shares in December 2017 with respect to exercises of stock options by directors. These shares were acquired at fair market value pursuant to the terms of the 2014 Plan and not pursuant to the stock buyback program. +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2012 through December 31, 2017, with the cumulative total return of the Standard & Poors 500 Stock Index, the Standard & Poors MidCap Index, the Oilfield Service Index and a peer group determined by us. We changed our peer group in 2017 to align with the peer group used by the compensation committee of our board of directors. Our new peer group consisted of Basic Energy Services, Inc., Diamond Offshore Drilling Inc., Ensco plc., Forum Energy Technologies, Inc., Halliburton Company, Helmerich & Payne, Inc., Nabors Industries, Ltd., National Oilwell Varco, Inc., Noble Corporation plc., Oceaneering International, Oil States International Inc., Precision Drilling Corporation, Rowan Companies plc., Superior Energy Services, Inc., TechnipFMC plc, Transocean Ltd., Unit Corp. and Weatherford International plc. Our old peer group consisted of Atwood Oceanics Inc., Basic Energy Services, Inc., Diamond Offshore Drilling Inc., Ensco plc., Forum Energy Technologies, Inc., TechnipFMC plc, Helmerich & Payne, Inc., Nabors Industries, Ltd., Noble Corp., Oceaneering International, Oil States International Inc., Precision Drilling Corporation, Parker Drilling Company, Rowan Companies Inc., Superior Energy Services, Inc., Transocean Ltd., Unit Corp. and Weatherford International Ltd. +26 +The graph assumes investment of $100 on December 31, 2012 and reinvestment of all dividends. +Fiscal Year Ended December 31, +2012 +2013 +2014 +2015 +2016 +2017 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +137.15 +91.31 +85.02 +153.04 +131.30 +S&P 500 Stock Index +100.00 +132.39 +150.51 +152.59 +170.84 +208.14 +S&P MidCap Index +100.00 +133.50 +146.54 +143.35 +173.08 +201.20 +Oilfield Service Index +100.00 +129.58 +99.08 +75.91 +90.32 +74.78 +New Peer Group Index +100.00 +124.21 +92.02 +63.43 +80.98 +68.81 +Old Peer Group Index +100.00 +118.73 +79.07 +51.77 +57.42 +43.52 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +27 +Item 6. Selected Financial Data. +Our selected consolidated financial data as of December 31, 2017, 2016, 2015, 2014 and 2013, and for each of the five years in the period ended December 31, 2017, should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report. The table below includes the results of operations of SSE since the merger date of April 20, 2017 and the results of operations of MS Directional since the acquisition date of October 11, 2017. +Year Ended December 31, +2017 +2016 +2015 +2014 +2013 +(In thousands, except per share amounts) +Statement of Operations Data: +Operating revenues: +Contract drilling +$ +1,040,033 +$ +543,663 +$ +1,153,892 +$ +1,838,830 +$ +1,679,611 +Pressure pumping +1,200,311 +354,070 +712,454 +1,293,265 +979,166 +Directional drilling +45,580 +— +— +— +— +Other +70,760 +18,133 +24,931 +50,196 +57,257 +Total +2,356,684 +915,866 +1,891,277 +3,182,291 +2,716,034 +Operating costs and expenses: +Contract drilling +667,105 +305,804 +608,848 +1,066,659 +968,754 +Pressure pumping +966,835 +334,588 +612,021 +1,036,310 +744,243 +Directional drilling +32,172 +— +— +— +— +Other +51,428 +8,384 +11,500 +13,102 +12,909 +Depreciation, depletion, amortization and impairment +783,341 +668,434 +864,759 +718,730 +597,469 +Impairment of goodwill +— +— +124,561 +— +— +Selling, general and administrative +105,847 +69,205 +74,913 +80,145 +73,852 +Merger and integration expenses +74,451 +— +— +— +— +Other operating (income) expense, net +(31,957 +) +(14,323 +) +1,647 +(15,781 +) +(3,384 +) +Total +2,649,222 +1,372,092 +2,298,249 +2,899,165 +2,393,843 +Operating income (loss) +(292,538 +) +(456,226 +) +(406,972 +) +283,126 +322,191 +Other expense +(35,263 +) +(39,970 +) +(35,477 +) +(28,843 +) +(25,750 +) +Income (loss) before income taxes +(327,801 +) +(496,196 +) +(442,449 +) +254,283 +296,441 +Income tax expense (benefit) +(333,711 +) +(177,562 +) +(147,963 +) +91,619 +108,432 +Net income (loss) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +$ +188,009 +Net income (loss) per common share: +Basic +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +$ +1.12 +$ +1.29 +Diluted +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +$ +1.11 +$ +1.28 +Cash dividends per common share +$ +0.08 +$ +0.16 +$ +0.40 +$ +0.40 +$ +0.20 +Weighted average number of common shares outstanding: +Basic +198,447 +146,178 +145,416 +144,066 +144,356 +Diluted +199,882 +146,178 +145,416 +145,376 +145,303 +Balance Sheet Data: +Total assets +$ +5,758,856 +$ +3,772,291 +$ +4,465,048 +$ +5,353,837 +$ +4,650,423 +Borrowings under line of credit +268,000 +— +— +303,000 +— +Other long-term debt +598,783 +598,437 +787,900 +667,029 +678,873 +Stockholders’ equity +3,982,493 +2,248,724 +2,561,131 +2,905,810 +2,755,997 +Working capital +200,605 +(17,933 +) +178,887 +340,816 +454,498 +28 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Recent Developments — On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 3.95% Senior Notes due 2028 initially guaranteed on a senior unsecured basis by certain of our subsidiaries. We used $239 million of the net proceeds from the sale to repay amounts outstanding under our revolving credit facility. We intend to use the remainder of the net proceeds for general corporate purposes. +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of MS Directional. The aggregate consideration paid by us consisted of $69.8 million in cash and approximately 8.8 million shares of our common stock. Based on the closing price of our common stock on the closing date of the transaction, the total fair value of the consideration transferred to effect the acquisition of MS Directional was approximately $257 million. +MS Directional is a leading directional drilling services company in the United States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, directional surveying, measurement while drilling, and wireline steering tools. Operational and financial data in the discussion and analysis below includes the results of operations of the MS Directional business since October 11, 2017. +On December 12, 2016, we entered into the merger agreement with SSE. On April 20, 2017, pursuant to the merger agreement, a subsidiary of ours was merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly-owned subsidiaries. Pursuant to the terms of the merger agreement, we acquired all of the issued and outstanding shares of common stock of SSE, in exchange for approximately 46.3 million shares of our common stock. Concurrent with the closing of the merger, we repaid all of the outstanding debt of SSE totaling $472 million. Based on the closing price of our common stock on April 20, 2017, the total fair value of the consideration transferred to effect the acquisition of SSE was approximately $1.5 billion. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary SSE LLC, with SSE LLC continuing as the surviving entity and one of our wholly-owned subsidiaries. +Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of modern, efficient fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a modern, well-maintained fleet of premium oilfield rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. Operational and financial data in the discussion and analysis below includes the results of operations of the SSE businesses since April 20, 2017. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2015, 2016 and 2017 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +Average rigs operating per day - U.S. (2) +165 +122 +105 +88 +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have modestly recovered from the lows experienced in the first quarter of 2016. Oil prices averaged $55.37 per barrel in the fourth quarter of 2017. +Our rig count in the United States declined significantly during the industry downturn that began in late 2014, but has improved since the second quarter of 2016. Our average rig count in the United States was 159 rigs for both the third and fourth quarter of 2017, with the third quarter of 2017 being the first quarter with a full quarter contribution from the rigs acquired in the SSE merger. Our rig count in the United States at December 31, 2017 was 163 rigs. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 96 rigs operating under term contracts during the first quarter of 2018 and an average of 67 rigs operating under term contracts throughout 2018. +29 +Activity levels in our pressure pumping business also improved during 2017, especially in the Permian Basin. We reactivated two frac spreads during the third quarter, and one additional frac spread during the fourth quarter. With the addition of these three frac spreads, we exited 2017 with 23 active frac spreads or approximately 1.25 million active fracturing horsepower. +Management Overview — We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. Our pressure pumping business operates primarily in Texas and the Mid-Continent and Appalachian regions. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. We have other operations through which we provide oilfield rental tools in select markets in the United States, and we also manufacture and sell pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by expanding our areas of operation and improving the capabilities of our drilling fleet during the last several years. As of December 31, 2017, our rig fleet included 199 APEX ® rigs. +In connection with the development of horizontal shale and other unconventional resource plays, in the last five years we have added equipment to perform service intensive fracturing jobs. As of December 31, 2017, we had approximately 1.6 million horsepower in our pressure pumping fleet. In recent years, the industry-wide addition of new pressure pumping equipment to the marketplace and lower oil and natural gas prices have led to an excess supply of pressure pumping equipment in North America. +We maintain a backlog of commitments for contract drilling revenues under term contracts, which we define as contracts with a fixed term of six months or more. Our contract drilling backlog as of December 31, 2017 and 2016 was $544 million and $417 million, respectively. Approximately 19% of the total contract drilling backlog at December 31, 2017 is reasonably expected to remain after 2018. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to other fees such as for mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts that we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Continue to Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas. During periods of improved commodity prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when these commodity prices deteriorate, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. We are also highly impacted by operational risks, competition, the availability of excess equipment, labor issues, weather and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. Please see “Risk Factors” in Item 1A of this Report. +For the three years ended December 31, 2017, our operating revenues consisted of the following (dollars in thousands): +2017 +2016 +2015 +Contract drilling +$ +1,040,033 +44.1 +% +$ +543,663 +59.4 +% +$ +1,153,892 +61.0 +% +Pressure pumping +1,200,311 +50.9 +% +354,070 +38.7 +% +712,454 +37.7 +% +Directional drilling +45,580 +1.9 +% +— +— +% +— +— +% +Other +70,760 +3.1 +% +18,133 +1.9 +% +24,931 +1.3 +% +$ +2,356,684 +100.0 +% +$ +915,866 +100.0 +% +$ +1,891,277 +100.0 +% +Generally, the revenues in our contract drilling segment are most impacted by two primary factors: our average number of rigs operating and our average revenue per operating day. During 2017, our average number of rigs operating was 136 in the United States and two in Canada, compared to 63 in the United States and two in Canada in 2016, and 120 in the United States and four in Canada in 2015. Our average rig revenue per operating day was $20,620 in 2017, compared to $23,040 in 2016 and $25,560 in 2015. +30 +Generally, the revenues in our pressure pumping segment are most impacted by our number of fracturing jobs and the size (including whether or not we provide proppant and other materials ) of those jobs , which is reflected in our average revenue per fracturing job. We completed 622 fracturing jobs during 2017 compared to 352 fracturing jobs in 2016 and 610 fracturing jobs in 2015. Our average revenue per fracturing job was $1.894 million in 2017 compared to $982,560 in 2016 and $1.118 million in 2015. +For the three years ended December 31, 2017, our operating income (loss) consisted of the following (dollars in thousands): +2017 +2016 +2015 +Contract drilling +$ +(171,897 +) +58.8 +% +$ +(235,858 +) +51.7 +% +$ +(78,970 +) +19.4 +% +Pressure pumping +21,028 +(7.2 +)% +(176,628 +) +38.7 +% +(254,998 +) +62.7 +% +Directional drilling +(21 +) +— +% +— +— +% +— +— +% +Other +(20,813 +) +7.1 +% +(3,391 +) +0.7 +% +(14,269 +) +3.5 +% +Corporate +(120,835 +) +41.3 +% +(40,349 +) +8.9 +% +(58,735 +) +14.4 +% +$ +(292,538 +) +100.0 +% +$ +(456,226 +) +100.0 +% +$ +(406,972 +) +100.0 +% +Discussion of our operating income (loss) follows in the “Results of Operations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations. +On December 22, 2017, significant U.S. tax law changes were enacted (“tax reform”). Tax reform reduces the U.S. federal corporate tax rate from 35% to 21% beginning in 2018, requires companies to pay a one-time transition tax on foreign earnings that were previously tax deferred, creates new taxes on future foreign earnings, places a limitation on the tax deductibility of interest expense, accelerates the expensing of certain business assets, and reduces the amount of executive pay that will be tax deductible, among other changes. At December 31, 2017, we had not completed our accounting for the tax effects of the tax reform, however, in certain cases, we have made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax. For the items for which we were able to determine a reasonable estimate, we recognized a provisional amount in accordance with Staff Accounting Bulletin (SAB) 118 of approximately $219 million of tax benefit as a result of tax reform, which is included as a component of income tax expense from continuing operations. See Note 12 of Notes to Consolidated Financial Statements contained in this Report for additional information related to the impact of tax reform. +The improvement in demand for our services and the income tax rate change resulted in consolidated net income of $5.9 million for 2017 compared to a consolidated net loss of $319 million for 2016 and a consolidated net loss of $294 million for 2015. +Results of Operations +Comparison of the years ended December 31, 2017 and 2016 +The following tables summarize results of operations by business segment for the years ended December 31, 2017 and 2016: +Year Ended December 31, +Contract Drilling +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +1,040,033 +$ +543,663 +91.3 +% +Direct operating costs +667,105 +305,804 +118.1 +% +Margin (1) +372,928 +237,859 +56.8 +% +Selling, general and administrative +5,934 +5,743 +3.3 +% +Depreciation, amortization and impairment +538,891 +467,974 +15.2 +% +Operating loss +$ +(171,897 +) +$ +(235,858 +) +(27.1 +)% +Operating days +50,427 +23,596 +113.7 +% +Average revenue per operating day +$ +20.62 +$ +23.04 +(10.5 +)% +Average direct operating costs per operating day +$ +13.23 +$ +12.96 +2.1 +% +Average margin per operating day (1) +$ +7.40 +$ +10.08 +(26.6 +)% +Average rigs operating +138.2 +64.5 +114.3 +% +Capital expenditures +$ +354,425 +$ +72,508 +388.8 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +31 +The demand for our contract drilling services is impacted by the market price of oil and natural gas. The average market price of oil and natural gas for each of the fiscal quarters and full year in 2017 and 2016 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +$ +50.88 +Average natural gas price per Mcf (2) +$ +3.01 +$ +3.08 +$ +2.95 +$ +2.90 +$ +2.99 +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +$ +43.15 +Average natural gas price per Mcf (2) +$ +2.00 +$ +2.14 +$ +2.88 +$ +3.04 +$ +2.51 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy Information Administration. +Revenues and direct operating costs increased primarily due to an increase in operating days. Operating days and average rigs operating increased due to a recovery in the oil and natural gas industry and the rigs acquired in the SSE merger. Depreciation, amortization and impairment increased due to the additional SSE assets and due to a $29.0 million impairment from the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. There was no similar charge in 2016. Average revenue per operating day decreased during 2017 due to a reduction in early termination revenue and the expiration of higher day rate, legacy long-term rig contracts. Early termination revenue in 2017 was $4.9 million, compared to $24.6 million in 2016. Average direct operating costs per operating day increased as a result of a reduction in the proportion of rigs on standby and an increase in rig reactivation expenses. Capital expenditures increased due to upgrading rigs to super-spec capability, building a new rig, higher maintenance capital expenditures and other general property and equipment upgrades. +Year Ended December 31, +Pressure Pumping +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +1,200,311 +$ +354,070 +239.0 +% +Direct operating costs +966,835 +334,588 +189.0 +% +Margin (1) +233,476 +19,482 +1,098.4 +% +Selling, general and administrative +14,442 +11,238 +28.5 +% +Depreciation, amortization and impairment +198,006 +184,872 +7.1 +% +Operating income (loss) +$ +21,028 +$ +(176,628 +) +NA +Fracturing jobs +622 +352 +76.7 +% +Other jobs +1,262 +799 +57.9 +% +Total jobs +1,884 +1,151 +63.7 +% +Average revenue per fracturing job +$ +1,894.40 +$ +982.56 +92.8 +% +Average revenue per other job +$ +17.43 +$ +10.28 +69.6 +% +Average revenue per total job +$ +637.11 +$ +307.62 +107.1 +% +Average direct operating costs per total job +$ +513.18 +$ +290.69 +76.5 +% +Average margin per total job (1) +$ +123.93 +$ +16.93 +632.0 +% +Margin as a percentage of revenues (1) +19.5 +% +5.5 +% +254.5 +% +Capital expenditures +$ +171,436 +$ +39,584 +333.1 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +32 +Revenues and direct operating costs in creased in 201 7 primarily due to a n in crease in the number and size of fracturing jobs. T he total number of jobs in creased as a result of the SSE merger and a recovery in the oil and natural gas industry. Average revenue per job increased due to improved pricing and an increase in the size of the jobs. Average direct operating costs per total job increased primarily due to the increase in the size of the jo bs. Selling, general and administrative expenses increased due to the increase in organizational size and activity as a result of the SSE merger . The increase in capital expenditures was primarily due to higher maintenance capital expenditures as a result of higher activity and investments to reactivate frac spreads. +Year Ended December 31, +Directional Drilling +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +45,580 +$ +— +NA +Direct operating costs +32,172 +— +NA +Margin (1) +13,408 +— +NA +Selling, general and administrative +4,082 +— +NA +Depreciation and amortization +9,347 +— +NA +Operating loss +$ +(21 +) +$ +— +NA +Capital expenditures +$ +7,795 +$ +— +NA +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation and amortization and selling, general and administrative expenses. +Our directional drilling segment originated with the October 11, 2017 acquisition of MS Directional, and consequently we have no results for the prior year in this segment. +Year Ended December 31, +Other Operations +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +70,760 +$ +18,133 +290.2 +% +Direct operating costs +51,428 +8,384 +513.4 +% +Margin (1) +19,332 +9,749 +98.3 +% +Selling, general and administrative +10,743 +3,026 +255.0 +% +Depreciation, depletion and impairment +29,402 +10,114 +190.7 +% +Operating loss +$ +(20,813 +) +$ +(3,391 +) +513.8 +% +Capital expenditures +$ +31,547 +$ +6,116 +415.8 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion and impairment and selling, general and administrative expenses. +Revenues, direct operating costs, selling, general and administrative expense and depreciation expense from other operations increased primarily as a result of the inclusion of our oilfield rental business acquired in the SSE merger on April 20, 2017 and our pipe handling components and related technology business acquired in September 2016. The increase in capital expenditures was primarily due to investments in the oilfield rental business and in oil and natural gas working interests. +Year Ended December 31, +Corporate +2017 +2016 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +70,646 +$ +49,198 +43.6 +% +Merger and integration expenses +$ +74,451 +$ +— +NA +Depreciation +$ +7,695 +$ +5,474 +40.6 +% +Other operating (income) expense, net +Net gain on asset disposals +$ +(33,510 +) +$ +(14,771 +) +126.9 +% +Other, including legal settlements, net of insurance reimbursements +1,553 +448 +246.7 +% +Other operating income, net +$ +(31,957 +) +$ +(14,323 +) +123.1 +% +Interest income +$ +1,866 +$ +327 +470.6 +% +Interest expense +$ +37,472 +$ +40,366 +(7.2 +)% +Other income +$ +343 +$ +69 +397.1 +% +Capital expenditures +$ +1,884 +$ +1,591 +18.4 +% +33 +Selling, general and administration expense increased in 2017 primarily due to the personnel added as a result of the SSE merger . The merger and integration expenses incurred in 2017 are related to the SSE merger and MS Directional acquisition . Other operating income includes net gains associated with the disposal of assets. Accordingly, the re lated gains or losses have been excluded from th e results of specific segments. The 2017 period includes a gain of $11.2 million related to the sale of real estate and $8.4 million from the sale of certain oil and gas properties . Interest income increased due to our investment of the proceeds from our stock offering in the first quarter of 2017 prior to utilizing those proceeds to repay SSE indebtedness . Interest expense decreased primarily due to lower debt outstanding during 2017 compared to 2016 . +Comparison of the years ended December 31, 2016 and 2015 +The following tables summarize results of operations by business segment for the years ended December 31, 2016 and 2015: +Year Ended December 31, +Contract Drilling +2016 +2015 +% Change +(Dollars in thousands) +Revenues +$ +543,663 +$ +1,153,892 +(52.9 +)% +Direct operating costs +305,804 +608,848 +(49.8 +)% +Margin (1) +237,859 +545,044 +(56.4 +)% +Selling, general and administrative +5,743 +5,580 +2.9 +% +Depreciation, amortization and impairment +467,974 +618,434 +(24.3 +)% +Operating loss +$ +(235,858 +) +$ +(78,970 +) +198.7 +% +Operating days +23,596 +45,142 +(47.7 +)% +Average revenue per operating day +$ +23.04 +$ +25.56 +(9.9 +)% +Average direct operating costs per operating day +$ +12.96 +$ +13.49 +(3.9 +)% +Average margin per operating day (1) +$ +10.08 +$ +12.07 +(16.5 +)% +Average rigs operating +$ +64.5 +$ +123.7 +(47.9 +)% +Capital expenditures +$ +72,508 +$ +527,054 +(86.2 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +The demand for our contract drilling services is impacted by the market price of oil and natural gas. The reactivation and construction of new land drilling rigs in the United States in recent years contributed to an excess capacity of land drilling rigs compared to demand. Customer demand shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs. The average market price of oil and natural gas for each of the fiscal quarters and full year in 2016 and 2015 follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +Year +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +$ +43.15 +Average natural gas price per Mcf (2) +$ +2.00 +$ +2.14 +$ +2.88 +$ +3.04 +$ +2.51 +2015 +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +$ +48.69 +Average natural gas price per Mcf (2) +$ +2.90 +$ +2.75 +$ +2.76 +$ +2.12 +$ +2.63 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +The average natural gas price represents the average monthly Henry Hub Spot price as reported by the United States Energy Information Administration. +The decreases in revenues and direct operating costs primarily result from the decrease in the number of rigs operating. Average revenue per operating day and average margin per operating day were higher in 2015 primarily due to higher average dayrates and early termination revenues of approximately $69.4 million. Early termination revenues were approximately $24.6 million in 2016. Depreciation, amortization and impairment expense for 2015 included a charge of $131 million related to the write-down of drilling equipment primarily related to mechanical rigs and spare mechanical rig components. There were no similar charges in 2016. Capital expenditures were significantly lower as no new rigs were added to the fleet in 2016 and drilling activity was lower, which required less maintenance capital. +34 +Year Ended December 31, +Pressure Pumping +2016 +2015 +% Change +(Dollars in thousands) +Revenues +$ +354,070 +$ +712,454 +(50.3 +)% +Direct operating costs +334,588 +612,021 +(45.3 +)% +Margin (1) +19,482 +100,433 +(80.6 +)% +Selling, general and administrative +11,238 +16,318 +(31.1 +)% +Depreciation, amortization and impairment +184,872 +214,552 +(13.8 +)% +Impairment of goodwill +- +124,561 +NA +Operating loss +$ +(176,628 +) +$ +(254,998 +) +(30.7 +)% +Fracturing jobs +352 +610 +(42.3 +)% +Other jobs +799 +2,080 +(61.6 +)% +Total jobs +1,151 +2,690 +(57.2 +)% +Average revenue per fracturing job +$ +982.56 +$ +1,117.95 +(12.1 +)% +Average revenue per other job +$ +10.28 +$ +14.66 +(29.9 +)% +Average revenue per total job +$ +307.62 +$ +264.85 +16.1 +% +Average direct operating costs per total job +$ +290.69 +$ +227.52 +27.8 +% +Average margin per total job (1) +$ +16.93 +$ +37.34 +(54.7 +)% +Margin as a percentage of revenues (1) +5.5 +% +14.1 +% +(61.0 +)% +Capital expenditures and acquisitions +$ +39,584 +$ +197,577 +(80.0 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Revenues and direct operating costs decreased in 2016 as a result of declines in both activity and pricing. Average revenue per fracturing job and average revenue per other job decreased due to market-related pricing constraints. Average revenue per total job and average direct operating costs per total job increased as a result of a shift in the job mix toward fracturing jobs. The total number of jobs decreased as a result of the downturn in the oil and natural gas industry. Lower selling, general and administrative expense in 2016 reflects lower personnel costs due to headcount reductions. Depreciation, amortization and impairment expense for 2015 includes a charge of $22.0 million related to the write-down of pressure pumping equipment and closed facilities. There were no similar charges in 2016. In addition, all of the goodwill associated with our pressure pumping business was impaired during 2015. +Year Ended December 31, +Other Operations +2016 +2015 +% Change +(Dollars in thousands) +Revenues +$ +18,133 +$ +24,931 +(27.3 +)% +Direct operating costs +8,384 +11,500 +(27.1 +)% +Margin (1) +9,749 +13,431 +(27.4 +)% +Selling, general and administrative +3,026 +1,399 +116.3 +% +Depreciation, depletion and impairment +10,114 +26,301 +(61.5 +)% +Operating loss +$ +(3,391 +) +$ +(14,269 +) +(76.2 +)% +Capital expenditures +$ +6,116 +$ +16,625 +(63.2 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion and impairment and selling, general and administrative expenses. +Revenues from other operations decreased as a result of lower production and lower oil prices which resulted in lower revenues from our oil and natural gas working interests. Direct operating costs include a reduction in production taxes due to lower revenues. Selling, general and administrative expense increased from 2015 as the 2016 results include costs related to our drilling technology service business which was acquired in September 2016. Depreciation, depletion and impairment expense in 2016 includes approximately $2.8 million of oil and natural gas property impairments as compared to approximately $10.7 million of oil and natural gas property impairments in 2015. +35 +Year Ended December 31, +Corporate +2016 +2015 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +49,198 +$ +51,616 +(4.7 +)% +Depreciation +$ +5,474 +$ +5,472 +0.0 +% +Other operating (income) expense, net +Net gain on asset disposals +$ +(14,771 +) +$ +(10,613 +) +39.2 +% +Legal settlements, net of insurance reimbursements +448 +12,260 +(96.3 +)% +Other operating (income) expense, net +$ +(14,323 +) +$ +1,647 +NA +Interest income +$ +327 +$ +964 +(66.1 +)% +Interest expense +$ +40,366 +$ +36,475 +10.7 +% +Other income +$ +69 +$ +34 +102.9 +% +Capital expenditures +$ +1,591 +$ +2,520 +(36.9 +)% +Lower selling, general and administrative expense reflects lower personnel costs due to headcount reductions. Other operating (income) expense, net includes net gains associated with the disposal of assets related to corporate strategy decisions of the executive management group. Accordingly, the related gains or losses have been excluded from the results of specific segments. Interest expense increased primarily due to lower capitalized interest, as we reduced our level of capital expenditures in 2016. In addition, we repaid the entire outstanding principal amount of our bank term loans. As a result, we expensed $1.4 million of previously unamortized debt issuance costs in 2016 related to these bank term loans. +Income Taxes +Year Ended December 31, +2017 +2016 +2015 +(Dollars in thousands) +Loss before income taxes +$ +(327,801 +) +$ +(496,196 +) +$ +(442,449 +) +Income tax benefit +$ +(333,711 +) +$ +(177,562 +) +$ +(147,963 +) +Effective tax rate +101.8 +% +35.8 +% +33.4 +% +The effective tax rate is a result of a federal rate of 35.0% adjusted as follows: +2017 +2016 +2015 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes - net of the federal income tax benefit +1.9 +2.0 +2.1 +Permanent differences +(1.3 +) +(0.1 +) +(1.3 +) +One-time tax effects of tax reform +66.7 +— +— +Share-based payments +3.6 +— +— +Acquisition related differences +(3.3 +) +— +— +Other differences, net +(0.8 +) +(1.1 +) +(2.4 +) +Effective tax rate +101.8 +% +35.8 +% +33.4 +% +The effective tax rate increased by approximately 66.0% to 101.8% for 2017 compared to 2016, primarily due to a 66.7% increase related to the tax reform enacted on December 22, 2017 and a 3.6% increase for excess tax benefits from employee stock compensation deductions. These increases were partially offset by a 3.3% decrease in the effective tax rate for acquisitions that resulted in the revaluation of deferred tax assets and liabilities at the new state tax rates at which they are expected to reverse. The lower 2015 effective rate is primarily related to the impact of goodwill impairment charges in 2015 along with an adjustment to our deferred tax liability associated with the 2010 conversion of our Canadian operations to a controlled foreign corporation. +36 +Tax reform reduces the U . S . federal corporate tax rate from 35% to 21% beginning in 2018, requires companies to pay a one-time transition tax on foreign earnings that were previously tax deferred, creates new taxes on future foreign earnings, places a new limitation on the tax deduc tibility of interest expense, accelerates the expensing of certain business assets, and reduces the amount of executive pay that will be tax deductible, among other changes. Based on a reduced US federal corporate tax rate of 21% from tax reform, we remea sured certain deferred tax assets and liabilities at the tax rates at which they are expected to reverse in the future. Due to the limited time to consider tax reform and its various interpretations, we are still analyzing and refining our calculations, w hich could potentially affect the measurement of these balances or give rise to new deferred tax amounts, however, in certain cases, we have made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax. F or the items for which we were able to determine a reasonable estimate, we recognized a provisional amount , in accordance with Staff Accounting Bulletin (SAB) 118 , of approximately $ 219 million of tax benefit , which is included as a component of income tax expense from continuing operations resulting in the above impact to our 2017 effective tax rate . See Note 1 2 of Notes to Consolidated Financial Statements contained in this Report for additional information related to th e impact of tax reform . +Prior to tax reform, we had elected to permanently reinvest unremitted earnings in Canada effective January 1, 2010, and we intended to do so for the foreseeable future. As a result, no deferred U.S. federal or state income taxes had been provided on such unremitted foreign earnings. With the enactment of tax reform, there is a new territorial tax system that provides for a 100% dividends received deduction on future earnings, if remitted. However, we will need to continue to evaluate our reinvestment intentions on future earnings and any other residual basis differences in order to determine whether we can continue to assert indefinite reinvestment or whether we will be required to provide for additional taxes that would be due on future earnings if remitted, such as foreign withholding taxes or state and local taxes. We will also need to determine whether we will be required to provide for additional taxes on any other outside basis differences in our foreign operations. Due to the limited time to consider these provisions, we are still evaluating how tax reform will affect our existing accounting position to indefinitely reinvest unremitted foreign earnings. We will continue to assert permanent reinvestment with respect to future unremitted earnings and have not recorded any deferred federal or state income taxes that would be provided on future unremitted earnings. We will finalize our intentions on whether we will permanently reinvest our foreign unremitted earnings within the measurement period provided under SAB 118. +We record deferred federal income taxes based primarily on the temporary differences between the book and tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be settled. As a result of fully recognizing the benefit of our deferred income taxes, we incur deferred income tax expense as these benefits are utilized. We recognized a deferred tax benefit of approximately $330 million in 2017, $152 million in 2016 and $100 million in 2015. +In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-09, “Compensation-Stock Compensation” (ASU 2016-09). The new standard was effective for us on January 1, 2017. Among other provisions, the new standard requires that excess tax benefits and tax deficiencies that arise upon vesting or exercise of share-based payments be recognized as income tax benefits and expenses in the income statement. Previously, such amounts were recorded to additional paid-in-capital. This aspect of the new guidance was required to be adopted prospectively. Our effective income tax rate for the year ended December 31, 2017 includes approximately $12 million of excess tax benefits from share-based compensation awards that vested or were exercised during the period. +During 2017, we had significant merger and acquisition activity. Based on this activity, we evaluated our overall state deferred tax rate, resulting in a slightly increased rate. We remeasured certain deferred tax assets and liabilities at the tax rates at which they are expected to reverse in the future and recorded additional taxes of approximately $11 million, resulting in the above impact to the 2017 effective tax rate. +Liquidity and Capital Resources +Our liquidity as of December 31, 2017 included approximately $201 million in working capital, including $42.8 million of cash and cash equivalents, and $227 million available under our revolving credit facility. +We believe our current liquidity, together with cash expected to be generated from operations in 2018, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt and pay cash dividends for at least the next 12 months. If we pursue opportunities for growth that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +As of December 31, 2017, we had working capital of $201 million, including cash and cash equivalents of $42.8 million, compared to negative working capital of $17.9 million, including cash and cash equivalents of $35.2 million, at December 31, 2016. +37 +During 2017, our sources of cash flow included: +• +$301 million from operating activities, +• +$60.9 million in proceeds from the disposal of property and equipment, +• +$268 million in net borrowings under our revolving credit facility, and +• +$472 million from net proceeds from common stock issuance. +During 2017, we used $502 million, net of cash acquired, for the acquisitions of SSE and MS Directional, $16.3 million to pay dividends on our common stock, $6.8 million to acquire shares of our common stock and $567 million: +• +to make capital expenditures for the acquisition, betterment and refurbishment of drilling rigs and pressure pumping equipment, +• +to acquire and procure equipment and facilities to support our drilling, pressure pumping, directional drilling, oilfield rental and manufacturing operations, and +• +to fund investments in oil and natural gas properties on a non-operating working interest basis. +We paid cash dividends during the year ended December 31, 2017 as follows: +Per Share +Total +(in thousands) +Paid on March 22, 2017 +$ +0.02 +$ +3,326 +Paid on June 22, 2017 +0.02 +4,269 +Paid on September 21, 2017 +0.02 +4,271 +Paid on December 21, 2017 +0.02 +4,449 +Total cash dividends +$ +0.08 +$ +16,315 +On February 7, 2018, our Board of Directors approved a cash dividend on our common stock in the amount of $0.02 per share to be paid on March 22, 2018 to holders of record as of March 8, 2018. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +On September 6, 2013, our Board of Directors approved a stock buyback program that authorizes purchase of up to $200 million of our common stock in open market or privately negotiated transactions. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the plan are held as treasury shares. There is no expiration date associated with the buyback program. As of December 31, 2017, we had remaining authorization to purchase approximately $187 million of our outstanding common stock under the 2013 stock buyback program. +We acquired shares of stock from directors in 2017 and 2016 and from employees during 2017, 2016 and 2015 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options. The remainder of these shares was acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2017, 2016 and 2015 were as follows (dollars in thousands): +2017 +2016 +2015 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +Purchases pursuant to 2013 stock buyback program +5,503 +109 +8,488 +183 +8,618 +180 +Acquisitions pursuant to long-term incentive plan +404,491 +7,508 +176,889 +3,866 +380,037 +7,830 +Treasury shares at end of period +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +2012 Credit Agreement — On September 27, 2012, we entered into a Credit Agreement (“Base Credit Agreement”). The Base Credit Agreement (as amended, the “Credit Agreement”) is a committed senior unsecured credit facility that includes a revolving credit facility. +38 +On July 8, 2016, we entered into Amendment No. 2 to Credit Agreement (“Amendment No. 2”), which amended the Base Credit Agreement to, among other things, make borrowings under the revolving credit facility subject to a borrowing base calculated by reference to our and certai n of our subsidiaries’ eligible equipment, inventory, accounts receivable and unencumbered cash as described in Amendment No. 2. The revolving credit facility contains a letter of credit facility that is limited to $50 million and a swing line facility th at is limited to $20 million, in each case outstanding at any time. The maturity date under the Base Credit Agreement was September 27, 2017 for the revolving credit facility; however, Amendment No. 2 extended the maturity date of $357.9 million in revolv ing credit commitments of certain lenders to March 27, 2019. On January 17, 2017, we entered into Amendment No. 3 to Credit Agreement, which amended the Credit Agreement by restating the definition of Consolidated EBITDA to provide for the add-back of tra nsaction expenses related to the SSE merger. On January 24, 2017, we entered into an agreement with certain lenders under our revolving credit facility to increase the aggregate commitments under our revolving credit facility to approximately $595.8 milli on, subject to the satisfaction of certain conditions. The aggregate commitment increase became effective on April 20, 2017 upon the consummation of the SSE merger and the repayment and termination of the SSE credit facility. On April 20, 2017, we entere d into Amendment No. 4 to Credit Agreement which permitted outstanding letters of credit under the SSE credit facility to be deemed to be incurred under our credit facility and increased the amount of the accordion feature of our revolving credit facility to permit aggregate commitments to be increased to an amount not to exceed $700 million (subject to satisfaction of certain conditions and the procurement of additional commitments from new or existing lenders). On April 20, 2017, we also entered into an additional commitment increase agreement with certain of our lenders pursuant to which total commitments available under our revolving credit facility (after giving effect to both commitment increases) increased to $632 million through September 2017 and t o $490 million through March 2019. On October 27, 2017, we entered into an additional commitment increase agreement with certain of our lenders pursuant to which total commitments available under our revolving credit facility increased to $500 million thro ugh March 27, 2019. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. Until September 27, 2017, the applicable margin on LIBOR rate loans varied from 2.75% to 3.25% and the applicable margin on base rate loans varied from 1.75% to 2.25%, in each case determined based upon our debt to capitalization ratio. Beginning September 27, 2017, the applicable margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on our excess availability under the revolving credit facility. As of December 31, 2017, the applicable margin on LIBOR rate loans was 3.50% and the applicable margin on base rate loans was 2.50%. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the revolving credit facility is 0.50%. +Each of our domestic subsidiaries unconditionally guarantees all existing and future indebtedness and liabilities of the other guarantors and ours arising under the Credit Agreement, other than (a) Ambar Lone Star Fluid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million. Such guarantees also cover our or any of our subsidiaries arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 40%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit our interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2017. +The Credit Agreement limits our ability to make investments in foreign subsidiaries or joint ventures such that, if the book value of all such investments since September 27, 2012 is above 20% of our total consolidated book value of the assets on a pro forma basis, we will not be able to make such investment. The Credit Agreement also restricts our ability to pay dividends and make equity repurchases, subject to certain exceptions, including an exception allowing such restricted payments if before and immediately after giving effect to such restricted payment, the Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) is at least 1.50 to 1.00. In addition, the Credit Agreement requires that, if our consolidated cash balance, subject to certain exclusions, is more than $100 million at the end of the day on which a borrowing is made, we can only use the proceeds from such borrowing to fund acquisitions, capital expenditures and the repurchase of indebtedness, and if such proceeds are not used in such manner within three business days, we must repay such unused proceeds on the fourth business day following such borrowings. +The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +39 +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and re quire us to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to our insolvency and bankruptcy, such acceleration is automatic), and (iii) require us to cash collateralize any outstanding le tters of credit. +As of December 31, 2017, we had $268 million outstanding under our revolving credit facility at a weighted average interest rate of 5.71%. We had $4.6 million in letters of credit outstanding under our revolving credit facility at December 31, 2017 and, as a result, had available borrowing capacity of $227 million at that date. As of February 16, 2018, we had repaid all amounts outstanding under our revolving credit facility, had approximately $118,000 of letters of credit outstanding under our revolving credit facility, and had borrowing capacity of $499.9 million. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2017, we had $54.9 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015 (the “Continuing Guaranty”), our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. +Series A & B Senior Notes — On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. We pay interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amounts of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. We pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations, which rank equally in right of payment with all of our other unsubordinated indebtedness. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of our domestic subsidiaries other than subsidiaries that are not required to be guarantors under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at our option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. We must offer to prepay the notes upon the occurrence of any change of control. In addition, we must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +40 +The respective note purchase agreements require compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit our interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2017. We do not expect that the restrictions and covenants will impair, in any material respect, o ur ability to operate or react to opportunities that might arise. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if we default in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +2028 Senior Notes — On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 2028 Notes initially guaranteed on a senior unsecured basis by certain of our subsidiaries. The net proceeds before offering expenses were approximately $521 million of which we used $239 million to repay amounts outstanding under our revolving credit facility. We intend to use the remainder of the net proceeds for general corporate purposes. +We pay interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028. The 2028 Notes bear interest at a rate of 3.95% per annum. +The 2028 Notes are our senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The 2028 Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the 2028 Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the 2028 Notes. The guarantors’ guarantees of the 2028 Notes (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. In the future, the Guarantees may be released and terminated under certain circumstances. +We, at our option, may redeem the Notes in whole or part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date, plus a make-whole premium. Additionally, commencing on November 1, 2027, we, at our option, may redeem the 2028 Notes in whole or part, at a redemption price equal to 100% of the principal amount of the 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date. +The indenture pursuant to which the 2028 Notes were issued includes covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indenture. +Upon the occurrence of a change of control, as defined in the indenture, each holder of the 2028 Notes may require us to purchase all or a portion of such holder’s 2028 Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indenture also provides for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the 2028 Notes to become or to be declared due and payable. +Common Stock Offering — On January 27, 2017, we completed an offering of 18.2 million shares of our common stock and raised net proceeds of $472 million. We used the net proceeds of the offering to repay of SSE’s outstanding indebtedness of approximately $472 million. +41 +Commitments and Cont ingencies — As of December 31, 2017, we maintained letters of credit in the aggregate amount of $59.5 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the t erms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2017, no amounts had been drawn under the letters of credit. +As of December 31, 2017, we had commitments to purchase approximately $172 million of major equipment for our drilling and pressure pumping businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. As of December 31, 2017, the remaining obligation under these agreements was approximately $140 million, of which materials with a total purchase price of approximately $35.9 million were required to be purchased during 2018. In the event that the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Contractual Obligations +The following table presents information with respect to our contractual obligations as of December 31, 2017 (in thousands): +Payments due by period +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Revolving credit facility (1) +$ +268,000 +$ +— +$ +268,000 +$ +— +$ +— +Series A Notes (2) +300,000 +— +300,000 +— +— +Interest on Series A Notes (3) +44,730 +14,910 +29,820 +— +— +Series B Notes (4) +300,000 +— +— +300,000 +— +Interest on Series B Notes (5) +60,102 +12,810 +25,620 +21,672 +— +Leases (6) +48,022 +13,616 +16,480 +9,009 +8,917 +Equipment purchases (7) +172,123 +172,123 +— +— +— +Inventory purchases (8) +140,004 +35,933 +24,418 +6,626 +73,027 +Total (9) +$ +1,332,981 +$ +249,392 +$ +664,338 +$ +337,307 +$ +81,944 +(1) +Revolving credit facility matures on March 27, 2019. +(2) +Principal repayment of the Series A Notes is required at maturity on October 5, 2020. +(3) +Interest to be paid on the Series A Notes using 4.97% coupon rate. +(4) +Principal repayment of the Series B Notes is required at maturity on June 14, 2022. +(5) +Interest to be paid on the Series B Notes using 4.27% coupon rate. +(6) +See Note 11 of Notes to Consolidated Financial Statements. +(7) +Represents commitments to purchase major equipment to be delivered in 2018 based on expected delivery dates. +(8) +Represents commitments to purchase proppants and chemicals for our pressure pumping business. +(9) +Excludes $525 million principal repayment of, and interest to be paid on, the 2028 Notes. +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements at December 31, 2017. +42 +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by accounting principles generally accepted in the United States of America (“U.S. GAAP”). We define Adjusted EBITDA as net income (loss) plus net interest expense, income tax expense (benefit) and depreciation, depletion, amortization and impairment expense (including impairment of goodwill). We present Adjusted EBITDA because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measure of net income (loss). Our computations of Adjusted EBITDA may not be the same as other similarly titled measures of other companies. Set forth below is a reconciliation of the non-U.S. GAAP financial measure of Adjusted EBITDA to the U.S. GAAP financial measure of net income (loss). +Year Ended December 31, +2017 +2016 +2015 +(Dollars in thousands) +Net income (loss) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +Income tax benefit +(333,711 +) +(177,562 +) +(147,963 +) +Net interest expense +35,606 +40,039 +35,511 +Depreciation, depletion, amortization and impairment +783,341 +668,434 +864,759 +Impairment of goodwill +— +— +124,561 +Adjusted EBITDA +$ +491,146 +$ +212,277 +$ +582,382 +Critical Accounting Policies +In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition, the use of estimates and oil and natural gas properties. +Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional, vertical wells versus drilling longer, horizontal wells using higher specification rigs). The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs will be retired. In 2017, we recorded an impairment charge of $29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. In 2016, we retired 19 mechanical rigs but recorded no impairment charge as we had written down mechanical rigs that were still marketed in 2015. In 2015, we identified 24 mechanical rigs and nine non-APEX® electric rigs that would no longer be marketed. Also, we had 15 additional mechanical rigs that continued to be marketed but were not operating and which we had lower expectations with respect to utilization of these rigs due to the industry shift to higher specification drilling rigs. In 2015, we recorded a charge of $131 million related to the retirement of the 33 rigs, the 15 mechanical rigs that remained marketed but were not operating, and the write-down of excess spare rig components to their realizable values. +We also periodically evaluate our pressure pumping assets, and in 2015, we recorded a charge of $22.0 million for the write-down of pressure pumping equipment and certain closed facilities. There were no similar charges in 2017 or 2016. +We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying values of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The cyclical nature of our industry has resulted in fluctuations in rig utilization over periods of time. Management believes that the contract drilling industry will continue to be cyclical and rig utilization will continue to fluctuate. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as management’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +43 +Based on current commodity prices, our results of operations for the year ended December 31, 2017 a nd management’s expectations of operating results in future periods, we concluded that no triggering events occurred during the year ended December 31, 2017 with respect to our reporting segments. Our expectations of future operating results were based on the assumption that activity levels in all segments and our other operations will remain relatively stable or improve in response to relatively stable or increasing oil prices. +We concluded that no triggering events occurred during the year ended December 31, 2016, with respect to our reporting segments, based on our results of operations for the year ended December 31, 2016, our expectations of operating results in future periods and the prevailing commodity prices at the time. +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new low for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August, we lowered our expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of these revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping services during the third quarter of 2015, we concluded a triggering event had occurred and deemed it necessary to assess the recoverability of long-lived asset groups for both contract drilling and pressure pumping. We performed a Step 1 analysis to assess the recoverability of long-lived assets within our contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 60%, respectively. +Due to the continued deterioration of crude oil prices in the fourth quarter of 2015, we deemed it necessary to once again assess the recoverability of long-lived assets groups for both contract drilling and pressure pumping. We performed a Step 1 analysis as required by ASC 360-10-35 to assess the recoverability of long-lived assets within our contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 100%, respectively. +For both of the assessments performed in 2015, the expected cash flows for the contract drilling segment included the backlog of commitments for contract drilling revenues under term contracts, which was approximately $801 million and $710 million at September 30, 2015 and December 31, 2015, respectively. Rigs not under term contracts would be subject to pricing in the spot market. Utilization and rates for rigs in the spot market and for the pressure pumping segment were estimated based upon our historical experience in prior downturns. Also, the expected cash flows for the contract drilling and pressure pumping segments were based on the assumption that activity levels in both segments would begin to recover in the first quarter of 2017 in response to improved oil prices. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing have been determined to be our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, we may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +In January 2017, the FASB issued an accounting standards update to eliminate Step 2 from the goodwill impairment test. An entity will now perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. We adopted this update in 2017. Prior to adoption w e first determined whether it was more likely than not that the fair value of a reporting unit was less than its carrying value after considering qualitative, market and other factors, and if so, the resulting goodwill impairment was determined using a two-step quantitative impairment test. The first step of the quantitative testing was to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeded its fair value, the second step of the quantitative testing was performed whereby the fair value of the reporting unit was allocated to its identifiable tangible and intangible assets and liabilities, with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill was less than the carrying value of goodwill, an impairment loss was recognized in the amount of such shortfall. +44 +In connection with our annual goodwill impairment assessment as of December 31, 2017 and 2016, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than the respective carrying amount. In making this determination, we considered the curr ent and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in our reporting units, as well as our operating results for 2017 and 2016 and forecasted operating results for the respective succe eding year. Management also considered our overall market capitalization at December 31, 2017 and 2016. +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new low for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August, we lowered our expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of our revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for our contract drilling and pressure pumping services, we performed a quantitative Step 1 impairment assessment of our goodwill as of September 30, 2015. In completing the Step 1 assessment, the fair value of each reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of our contract drilling and pressure pumping reporting units, such as future oil and natural gas prices and projected demand for our services, and assumptions related to discount rates, long-term growth rates and control premiums. +Based on the results of the Step 1 goodwill impairment test as of September 30, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 15%, and we concluded that no impairment was indicated in our contract drilling reporting unit; however, impairment was indicated in our pressure pumping reporting unit. In the third quarter of 2015, we recognized an impairment charge of $125 million associated with the impairment of all of the goodwill in our pressure pumping reporting unit. +In connection with our annual goodwill impairment assessment as of December 31, 2015, we performed a quantitative Step 1 impairment assessment of the goodwill in our contract drilling reporting unit. In completing the Step 1 assessment, the fair value of the contract drilling reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of the reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of our contract drilling reporting unit, such as future oil and natural gas prices and projected demand for our services, and assumptions related to discount rates, long-term growth rates and control premiums. Based on the results of the quantitative Step 1 impairment assessment of our goodwill, as of December 31, 2015, the fair value of our contract drilling reporting unit exceeded its carrying value by approximately 16%, and we concluded that no impairment was indicated in our contract drilling reporting unit. +Revenue recognition — Revenues from our contract drilling, pressure pumping, directional drilling, oilfield rental and pipe handling components and related technology activities are recognized as services are performed. All of the wells we drilled in 2017, 2016 and 2015 were drilled under daywork contracts. Revenues from sales of products are recognized upon customer acceptance. Revenues are presented net of any sales tax charged to the customer that we are required to remit to local or state governmental taxing authorities. +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expense when incurred. +Use of estimates — The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Key estimates used by management include: +• +allowance for doubtful accounts, +• +depreciation, depletion and amortization, +• +fair values of assets acquired and liabilities assumed in acquisitions, +• +goodwill and long-lived asset impairments, and +• +reserves for self-insured levels of insurance coverage. +For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +45 +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have modestly recovered from the lows experienced in the first quarter of 2016. Oil prices averaged $55.37 per barrel in the fourth quarter of 2017. In response to improved prices, U.S. rig counts have increased, and we believe they will continue to increase throughout 2018 if prices for these commodities remain at or above current levels. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices or expectations of decreases in oil and natural gas prices, would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +Inflation has not had a significant impact on our operations during the three years ended December 31, 2017. We believe that inflation will not have a significant near-term impact on our financial position. +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +We currently have exposure to interest rate market risk associated with any borrowings that we have under the Credit Agreement and the Reimbursement Agreement. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. Beginning September 27, 2017, the applicable margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on our excess availability under the revolving credit facility. As of December 31, 2017, the applicable margin on LIBOR rate loans was 3.50% and the applicable margin on base rate loans was 2.50%. +As of December 31, 2017, we had $268 million outstanding under our revolving credit facility at a weighted average interest rate of 5.71%. The interest rate on the borrowings outstanding under our revolving credit facility is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate. +Under the Reimbursement Agreement, we will reimburse the issuing bank on demand for any amounts that it has disbursed under any letters of credit. We are obligated to pay to the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2017, no amounts had been disbursed under any letters of credit. +We conduct a portion of our business in Canadian dollars through our Canadian land-based drilling operations and our Canadian manufacturing subsidiary. The exchange rate between Canadian dollars and U.S. dollars has fluctuated during the last several years. If the value of the Canadian dollar against the U.S. dollar weakens, revenues and earnings of our Canadian operations will be reduced and the value of our Canadian net assets will decline when they are translated to U.S. dollars. This currency risk is not material to our results of operations or financial condition. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +46 +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2017, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2017. +Our wholly-owned subsidiary, MS Directional, LLC, was excluded from our evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017. We acquired MS Directional, LLC on October 11, 2017. This subsidiary was excluded from the scope of our review due to the fact that the acquisition closed in the fourth quarter of 2017, at which time we began integrating the acquired business into our existing internal controls over financial reporting. The acquired business represented approximately two percent of our consolidated revenues for the year ended December 31, 2017 and approximately five percent of our consolidated total assets as of December 31, 2017. +The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None. +47 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +48 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger by and among Patterson-UTI Energy, Inc., Pyramid Merger Sub, Inc. and Seventy Seven Energy Inc., dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 2.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Comp any’s Quarterly Report on Form 10-Q and incorporated herein by reference) . +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) . +3.4 +Seco nd Amended and Restated Bylaws (filed August 6, 2007 as Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). +4.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhib it 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +4.2 +Registration Rights Agreement, dated as of October 11, 2017, between Patterson-UTI Energy, Inc. and the sellers party thereto.+ +4.3 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.4 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19 , 2018 as Exhibit 4.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.5 +Form of 3.95% Senior Note due 2028 (inc luded in Exhibit 4.4 above). +4.6 +Registration Rights Agreement, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Goldman, Sachs & Co. LLC, Wells Fargo Securities, LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated (filed January 19, 2018 as Exhibit 4.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.1 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Of ficer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein b y reference) .* +10.2 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +49 +10. 3 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.4 +Third Amend ment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.5 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K an d incorporated herein by reference). * +10.6 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 a s Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.7 +Form of Share-Settled Performance Unit Award Agreement under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010 and incorporated herein by reference) .* +10.8 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and i ncorporated herein by reference) .* +10.9 +Patterson-UTI Energy, Inc. Omnibus Incentive Plan (filed April 21, 2017 as Exhibit 4.4 to the Company’s Registration Statement on Form S-8 and incorporated herein by reference)* +10.10 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (as amended and restated effective June 29, 2017) (filed June 30, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.11 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed April 21, 2014 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.12 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed May 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.13 +Form of Executive Officer Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.3 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.14 +Form of Executive Officer Restricted Stock Award Agreement (filed May 2, 2016 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.15 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 4, 2017 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q and incorp orated herein by reference).* +10.16 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.17 +Form of Non-Employee Director Restricted Stock Award Agreement (filed April 21, 2014 as Exhibit 10.5 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.18 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.19 +Form of Non-Employee Director Restricted Stock Unit Award Agreement .+* +10.20 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel and Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference) .* +10.21 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed January 17, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.22 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). * +10.23 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to the Company’s Annual Report o n Form 10-K for the year ended December 31, 2016 and incorporated herein by reference) .* +10.24 +Employment Agreement, dated as of September 3, 2017, b etween Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +50 +10.25 +Employment Agreement, dated as of December 31, 2017, between Patterson-UTI Energy, Inc. and John E. Vollmer III (filed December 27, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.26 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, John E. Vollmer III, Seth D. Wexler, William Andrew Hendr icks, Jr., Michael W. Conlon, Tiffany J. Thom and C. Andrew Smith (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference) .* +10.27 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference) .* +10.28 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form 10-K fo r the year ended December 31, 2003 and incorporated herein by reference) .* +10.29 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.30 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.31 +Credit Agreement dated September 27, 2012, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed September 28, 2012 as Exhibit 10.1 to the Company’s Cu rrent Report on Form 8-K and incorporated herein by reference). +10.32 +Amendment No. 1 to Credit Agreement , dated as of January 9, 2015, among Patterson- UTI Energy, Inc., as borrower, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuer and lender parties thereto (filed January 12, 2015 as Exhibit 10.1 to the Co mpany’s Current Report on Form 8-K and incorporated herein by reference). +10.33 +Amendment No. 2 to Credit Agreement dated as of July 8, 2016, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto (filed July 12, 2016 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) . +10.34 +Amendment No. 3 to Credit Agreement dated as of January 17, 2017 , by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party thereto (filed February 13, 2017 as Exhibit 10 .31 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference). +10.35 +Commitment Increase Agreement, dated as of January 24, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and certain other lenders party theret o (filed January 24, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.36 +Amendment No. 4 to Credit Agreement, dated as of April 20, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender and the other lenders party thereto (filed April 21, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.37 +Commitment Increase Agreement, dated as of April 20, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit an d swing line lender and the other lenders party thereto (filed April 21, 2017 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.38 +Commitment Increase Agreement, dated as of October 27, 2017, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and Wells Fargo Bank, N.A., as administrative agent, issuer of letters of credit and swing line lender (filed November 2, 2017 as Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). +51 +10.39 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.40 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated October 5, 2010) (filed October 28, 2015 as Exhibit 10.1 to the Company’s Quar terly Report on Form 10-Q and incorporated herein by reference) . +10.41 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.42 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named ther ein (relates to Note Purchase Agreement dated June 14, 2012) (filed October 28, 2015 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). +10.43 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to t he Company’s Current Report on Form 8-K and incorporated herein by reference) . +10.44 +Continuing Guaranty, dated as of March 16, 2015, by Patterson Petro leum LLC, Patterson-UTI Drilling Company LLC, Patterson-UTI Management Services, LLC, Universal Well Services, Inc. and Universal Pressure Pumping, Inc. (filed March 16, 2015 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated here in by reference). +10.45 +Securities Purchase Agreement, dated as of September 4, 2017, between Patterson-UTI Energy, Inc., certain holders of limited liability company interests of Multi-Shot, LLC, and MS Incentive Plan Holdco, LLC (filed September 8, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended. + +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended. + +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. + +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2017, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. +Item 16. Form 10-K Summary +None. +52 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2017 and 2016 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2017, 2016 and 2015 +F-5 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2017, 2016 and 201 5 +F-6 +Consolidated Statements of Changes In Stockholders’ Equity for the years ended December 31, 2017, 2016 and 2015 +F-7 +Consolidated Statemen ts of Cash Flows for the years ended December 31, 2017, 2016 and 2015 +F-8 +Notes to Consolidated Financial Statements +F-9 +F-1 +R eport of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc.: +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes and financial statement schedule listed in the index appearing under Item 15(a)(2) (collectively referred to as the “Consolidated Financial Statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016 , and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Change in Accounting Principle +As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it presents deferred tax assets and liabilities in 2017. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting , included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A . Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits i n accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +As described in Management’s Report on Internal Control over Financial Reporting, management has excluded MS Directional, LLC from its assessment of internal control over financial reporting as of December 31, 2017 because it was acquired by the Company in a purchase business combination during 2017. MS Directional, LLC is a wholly-owned subsidiary whose total assets and total revenues excluded from management’s assessment and our audit of internal control over financial reporting represent 5% and 2%, respectively of the related consolidated financial statement amounts as of and for the year ended December 31, 2017. +F-2 +Definition an d Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 20, 2018 +We have served as the Company’s auditor since 1993. +F-3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2017 +2016 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +42,828 +$ +35,152 +Accounts receivable, net of allowance for doubtful accounts of $2,323 and $3,191 at +December 31, 2017 and 2016, respectively +580,354 +148,091 +Federal and state income taxes receivable +1,152 +2,126 +Inventory +69,167 +20,191 +Other +53,354 +41,322 +Total current assets +746,855 +246,882 +Property and equipment, net +4,254,730 +3,408,963 +Goodwill and intangible assets +687,072 +88,966 +Deposits on equipment purchases +16,351 +16,050 +Deferred tax assets, net +3,875 +4,124 +Other +49,973 +7,306 +Total assets +$ +5,758,856 +$ +3,772,291 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +319,621 +$ +125,667 +Accrued expenses +226,629 +139,148 +Total current liabilities +546,250 +264,815 +Borrowings under revolving credit facility +268,000 +— +Long-term debt, net of debt issuance cost of $1,217 and $1,563 at +December 31, 2017 and 2016, respectively +598,783 +598,437 +Deferred tax liabilities, net +350,836 +650,661 +Other +12,494 +9,654 +Total liabilities +1,776,363 +1,523,567 +Commitments and contingencies (see Note 8) +Stockholders’ equity: +Preferred stock, par value $.01; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $.01; authorized 300,000,000 shares with 266,259,083 and +191,525,872 issued and 222,456,472 and 148,133,255 outstanding at +December 31, 2017 and 2016, respectively +2,662 +1,915 +Additional paid-in capital +2,785,823 +1,042,696 +Retained earnings +2,105,897 +2,116,341 +Accumulated other comprehensive income (loss) +6,822 +(1,134 +) +Treasury stock, at cost, 43,802,611 shares and 43,392,617 shares at +December 31, 2017 and 2016, respectively +(918,711 +) +(911,094 +) +Total stockholders’ equity +3,982,493 +2,248,724 +Total liabilities and stockholders’ equity +$ +5,758,856 +$ +3,772,291 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2017 +2016 +2015 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +1,040,033 +$ +543,663 +$ +1,153,892 +Pressure pumping +1,200,311 +354,070 +712,454 +Directional drilling +45,580 +— +— +Other +70,760 +18,133 +24,931 +Total operating revenues +2,356,684 +915,866 +1,891,277 +Operating costs and expenses: +Contract drilling +667,105 +305,804 +608,848 +Pressure pumping +966,835 +334,588 +612,021 +Directional drilling +32,172 +— +— +Other +51,428 +8,384 +11,500 +Depreciation, depletion, amortization and impairment +783,341 +668,434 +864,759 +Impairment of goodwill +— +— +124,561 +Selling, general and administrative +105,847 +69,205 +74,913 +Merger and integration expenses +74,451 +— +— +Other operating (income) expense, net +(31,957 +) +(14,323 +) +1,647 +Total operating costs and expenses +2,649,222 +1,372,092 +2,298,249 +Operating loss +(292,538 +) +(456,226 +) +(406,972 +) +Other income (expense): +Interest income +1,866 +327 +964 +Interest expense, net of amount capitalized +(37,472 +) +(40,366 +) +(36,475 +) +Other +343 +69 +34 +Total other expense +(35,263 +) +(39,970 +) +(35,477 +) +Loss before income taxes +(327,801 +) +(496,196 +) +(442,449 +) +Income tax benefit +(333,711 +) +(177,562 +) +(147,963 +) +Net income (loss) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +Net income (loss) per common share: +Basic +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +Diluted +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +Weighted average number of common shares outstanding: +Basic +198,447 +146,178 +145,416 +Diluted +199,882 +146,178 +145,416 +Cash dividends per common share +$ +0.08 +$ +0.16 +$ +0.40 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2017 +2016 +2015 +(In thousands) +Net income (loss) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +Other comprehensive income (loss), net of taxes of $0 for 2017, $0 +for 2016 and $0 for 2015: +Foreign currency translation adjustment +7,956 +2,959 +(10,556 +) +Total comprehensive income (loss) +$ +13,866 +$ +(315,675 +) +$ +(305,042 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings +Income (Loss) +Stock +Total +(In thousands) +Balance, December 31, 2014 +189,263 +$ +1,893 +$ +984,674 +$ +2,811,815 +$ +6,463 +$ +(899,035 +) +$ +2,905,810 +Net loss +— +— +— +(294,486 +) +— +— +(294,486 +) +Foreign currency translation adjustment +— +— +— +— +(10,556 +) +— +(10,556 +) +Issuance of restricted stock +1,180 +12 +(12 +) +— +— +— +— +Vesting of restricted stock units +14 +— +— +— +— +— +— +Forfeitures of restricted stock +(82 +) +(1 +) +1 +— +— +— +— +Stock-based compensation +— +— +28,510 +— +— +— +28,510 +Tax expense related to stock- +based compensation +— +— +(1,362 +) +— +— +— +(1,362 +) +Payment of cash dividends +— +— +— +(58,775 +) +— +— +(58,775 +) +Purchase of treasury stock +— +— +— +— +— +(8,010 +) +(8,010 +) +Balance, December 31, 2015 +190,375 +1,904 +1,011,811 +2,458,554 +(4,093 +) +(907,045 +) +2,561,131 +Net loss +— +— +— +(318,634 +) +— +— +(318,634 +) +Foreign currency translation adjustment +— +— +— +— +2,959 +— +2,959 +Shares issued for acquisition +354 +3 +6,730 +— +— +— +6,733 +Issuance of restricted stock +785 +8 +(8 +) +— +— +— +— +Vesting of restricted stock units +15 +— +— +— +— +— +— +Forfeitures of restricted stock +(43 +) +— +— +— +— +— +— +Exercise of stock options +40 +— +707 +— +— +— +707 +Stock-based compensation +— +— +28,324 +— +— +— +28,324 +Tax expense related to stock- +based compensation +— +— +(4,868 +) +— +— +— +(4,868 +) +Payment of cash dividends +— +— +— +(23,579 +) +— +— +(23,579 +) +Purchase of treasury stock +— +— +— +— +— +(4,049 +) +(4,049 +) +Balance, December 31, 2016 +191,526 +1,915 +1,042,696 +2,116,341 +(1,134 +) +(911,094 +) +2,248,724 +Net income +— +— +— +5,910 +— +— +5,910 +Foreign currency translation adjustment +— +— +— +— +7,956 +— +7,956 +Equity offering +18,170 +182 +471,388 +— +— +— +471,570 +Shares issued for acquisitions +55,097 +551 +1,226,339 +— +— +— +1,226,890 +Issuance of restricted stock +891 +9 +(9 +) +— +— +— +— +Vesting of restricted stock units +549 +5 +(5 +) +— +— +— +— +Forfeitures of restricted stock +(24 +) +— +— +— +— +— +— +Exercise of stock options +50 +— +931 +— +— +— +931 +Stock-based compensation +— +— +44,483 +— +— +— +44,483 +Payment of cash dividends +— +— +— +(16,315 +) +— +— +(16,315 +) +Dividend equivalents +— +— +— +(39 +) +— +— +(39 +) +Purchase of treasury stock +— +— +— +— +— +(7,617 +) +(7,617 +) +Balance, December 31, 2017 +266,259 +$ +2,662 +$ +2,785,823 +$ +2,105,897 +$ +6,822 +$ +(918,711 +) +$ +3,982,493 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2017 +2016 +2015 +(In thousands) +Cash flows from operating activities: +Net income (loss) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +Adjustments to reconcile net income (loss) to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +783,341 +668,434 +864,759 +Impairment of goodwill +— +— +124,561 +Dry holes and abandonments +1,929 +58 +1,224 +Deferred income tax benefit +(330,346 +) +(152,160 +) +(99,873 +) +Stock-based compensation expense +44,483 +28,324 +28,510 +Net gain on asset disposals +(33,510 +) +(14,771 +) +(10,613 +) +Tax expense related to stock-based compensation +— +(4,868 +) +(1,362 +) +Amortization of debt issuance costs +346 +2,270 +1,245 +Changes in operating assets and liabilities: +Accounts receivable +(239,482 +) +72,327 +440,884 +Income taxes receivable/payable +990 +30,379 +49,895 +Inventory and other assets +(23,449 +) +5,664 +38,993 +Accounts payable +104,072 +12,024 +(131,649 +) +Accrued expenses +(14,190 +) +(24,573 +) +(10,303 +) +Other liabilities +617 +560 +(2,348 +) +Net cash provided by operating activities +300,711 +305,034 +999,437 +Cash flows from investing activities: +Acquisitions, net of cash acquired +(501,954 +) +155 +— +Purchases of property and equipment +(567,087 +) +(119,799 +) +(743,776 +) +Proceeds from disposal of assets +60,945 +21,889 +20,814 +Other investments +(2,520 +) +— +— +Net cash used in investing activities +(1,010,616 +) +(97,755 +) +(722,962 +) +Cash flows from financing activities: +Proceeds from equity offering +471,570 +— +— +Purchases of treasury stock +(6,809 +) +(3,610 +) +(8,010 +) +Dividends paid +(16,315 +) +(23,579 +) +(58,775 +) +Proceeds from long-term debt +— +— +200,000 +Repayment of long-term debt +— +(255,000 +) +(27,500 +) +Proceeds from borrowings under revolving credit facility +599,000 +200,500 +54,000 +Repayment of borrowings under revolving credit facility +(331,000 +) +(200,500 +) +(357,000 +) +Debt issuance costs +— +(3,357 +) +(1,979 +) +Proceeds from exercise of stock options +123 +268 +— +Net cash provided by (used in) financing activities +716,569 +(285,278 +) +(199,264 +) +Effect of foreign exchange rate changes on cash +1,012 +(195 +) +(6,877 +) +Net increase (decrease) in cash and cash equivalents +7,676 +(78,194 +) +70,334 +Cash and cash equivalents at beginning of year +35,152 +113,346 +43,012 +Cash and cash equivalents at end of year +$ +42,828 +$ +35,152 +$ +113,346 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $1,175 in 2017, $398 in 2016 +and $6,332 in 2015 +$ +(34,953 +) +$ +(36,551 +) +$ +(33,452 +) +Income taxes +3,947 +52,716 +97,333 +Non-cash investing and financing activities: +Net increase (decrease) in payables for purchases of property +and equipment +$ +17,228 +$ +28,926 +$ +(167,308 +) +Issuance of common stock for business acquisition +1,226,890 +6,733 +— +Net decrease (increase) in deposits on equipment purchases +(301 +) +6,317 +90,012 +The accompanying notes are an integral part of these consolidated financial statements. +F-8 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “Patterson-UTI” or the “Company”), provides onshore contract drilling services to oil and natural gas operators in the continental United States and western Canada. The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. The Company provides directional drilling services in most major producing onshore oil and gas basins in the United States. The Company also provides oilfield rental equipment in many of the major producing onshore oil and gas basins in the United States and manufactures and sells pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, the Company owns and invests, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, the Company has no controlling financial interests in any other entity which would require consolidation. +The U.S. dollar is the functional currency for all of the Company’s operations except for its Canadian subsidiaries, which use the Canadian dollar as their functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +In 2017, the Company adopted new guidance for the presentation of deferred tax liabilities and assets and such guidance was applied retrospectively, resulting in the reclassification of $36.4 million from current deferred tax assets as of December 31, 2016. Of this amount, $4.1 million was reclassified to long-term deferred tax assets and $32.3 million was reclassified to long-term deferred tax liabilities. During 2016, the Company determined that certain income and expense items should be classified as “other operating (income) expense, net” in the consolidated statements of operations. This caption now includes gains and losses on asset disposals and expenses related to certain legal settlements. Gains and losses on asset disposals were previously presented as a separate line in the consolidated statements of operations. Expenses related to certain legal settlements were previously included in operating costs of the respective operating segment or within selling, general and administrative expense. For comparative purposes, all such prior period amounts were reclassified to conform to the current presentation, including the Company’s previously disclosed $12.3 million legal settlement that was previously included within selling, general and administrative expense for the year ended December 31, 2015. In addition, the Company changed its reporting segment presentation in 2016, as the Company no longer considers its oil and natural gas exploration and production activities to be significant to an understanding of the Company’s results. The Company now presents the oil and natural gas exploration and production activities, oilfield rental business, pipe handling components and related technology business and Middle East/North Africa activities as “Other” and “Corporate” reflects only corporate activities. This change in segment presentation was applied retrospectively to all periods presented herein (See Note 14). +On December 12, 2016, the Company entered into an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”), and the merger closed on April 20, 2017 (the “merger date”). The Company’s results include the results of operations of SSE since the merger date (See Note 2). On October 11, 2017, the Company acquired all of the issued and outstanding limited liability company interests of MS Directional, LLC (f/k/a Multi-Shot, LLC) (“MS Directional”). The Company’s results include the results of operations of MS Directional since October 11, 2017 (See Note 2). The acquisition of MS Directional created a new directional drilling reporting segment for the Company (See Note 14). +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Revenue recognition — Revenues from our contract drilling, pressure pumping, directional drilling, oilfield rental and pipe handling components and related technology activities are recognized as services are performed. All of the wells the Company drilled in 2017, 2016 and 2015 were drilled under daywork contracts. Revenue from sales of products are recognized upon customer acceptance. Revenue is presented net of any sales tax charged to the customer that the Company is required to remit to local or state governmental taxing authorities. +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of the Company’s customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +F-9 +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts represents the Company’s estimate of the amount of probable credit losses existing in the Company’s accoun ts receivable. The Company reviews the adequacy of its allowance for doubtful accounts at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for col lectability. Account balances, when determined to be uncollectable, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with the Company’s pressure pumping activities and materials used in its directional drilling and drilling technology business. Such inventories are stated at the lower of cost or market, with cost determined using the average cost method. +Other current assets — Other current assets includes reimbursement from the Company’s workers compensation insurance carrier for claims in excess of the Company’s deductible in the amount of $30.0 million and $21.1 million at December 31, 2017 and 2016, respectively. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Equipment +1.25-15 +Buildings +15-20 +Other +3-12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. The Company reviews wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, the Company considers the well costs to be impaired and recognizes the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +The Company reviews its proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). The Company reviews unproved oil and natural gas properties quarterly to assess potential impairment. The Company’s impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. The Company assesses impairment of its goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. +F-10 +Net income (loss) per common share — The Company provides a dual presentation of its net income (loss) per common share in its consolidated statements of operations: Basic net income (loss) per common share (“Basic EPS”) and diluted net inco me (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock. Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock and restricted stock units. The dilutive effect of stock options and restricted stock units is determined using the treasury stock method. The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested shares of restricted stock. +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2017, 2016 and 2015, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2017 +2016 +2015 +BASIC EPS: +Net income (loss) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +Adjust for (income) loss attributed to holders of non-vested restricted stock +(170 +) +— +3,022 +Income (loss) attributed to common stockholders +$ +5,740 +$ +(318,634 +) +$ +(291,464 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +198,447 +146,178 +145,416 +Basic net income (loss) per common share +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +DILUTED EPS: +Income (loss) attributed to common stockholders +$ +5,740 +$ +(318,634 +) +$ +(291,464 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +198,447 +146,178 +145,416 +Add dilutive effect of potential common shares +1,435 +— +— +Weighted average number of diluted common shares outstanding +199,882 +146,178 +145,416 +Diluted net income (loss) per common share +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +Potentially dilutive securities excluded as anti-dilutive +3,289 +9,057 +7,781 +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. The Company’s policy is to account for interest and penalties with respect to income taxes as operating expenses. +F-11 +On December 22, 2017, significant changes were enacted to U.S. tax law (“tax reform”). One of the provisions of tax reform is the introduction of a new U.S. tax on certain off-shore earnings referred to as Global Intangible Low-T axed Income ( “ GILTI ” ) at an effective tax rate of 10.5% (in the case of a corporation) for tax years beginning after December 31, 2017 (increasing to 13.125% for tax years beginning after December 31, 2025) with a partial offset for any related foreign tax credits. The Company is still evaluating the GILTI provisions of tax reform and its impact, if any, on the Company’s consolidated financial statements at December 31, 2017. The Financial Accounting Standards Board ( “ FASB ” ) staff allowed companies to ado pt an accounting policy to either provide deferred taxes for GILTI or treat it as a tax cost in the year incurred. The Company has not yet determined its accounting policy because determining the impact of the GILTI provisions requires analysis of its exi sting legal entity structure, the reversal of its U.S. GAAP and U.S. tax basis differences in the assets and liabilities of its foreign subsidiaries, and its ability to offset any tax with foreign tax credits. As such, the Company did not record a deferre d income tax expense or benefit related to the GILTI provisions in its c onsolidated s tatement of o perations for the year ended December 31, 2017 and will finalize its evaluation of the GILTI provisions during the measurement period provided under Staff Accounting Bulletin ( “ SAB ” ) 118. +Stock-based compensation — The Company recognizes the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards (See Note 10). +As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, based on historical experience. Forfeitures are estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates. +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Issued Accounting Standards — In May 2014, the FASB issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. The Company adopted this new revenue guidance effective January 1, 2018, utilizing the modified retrospective method, and will expand its consolidated financial statement disclosures in order to comply with the update. The adoption of this update did not have a material impact on the Company’s consolidated financial statements. +In February 2016, the FASB issued an accounting standards update to provide guidance for the accounting for leasing transactions. The standard requires the lessee to recognize a lease liability along with a right-of-use asset for all leases with a term longer than one year. A lessee is permitted to make an accounting policy election by class of underlying asset to not recognize the lease liability and related right-of-use asset for leases with a term of one year or less. The provisions of this standard also apply to situations where the Company is the lessor. The requirements in this update are effective during interim and annual periods beginning after December 15, 2018. The Company previously disclosed its intention to adopt this standard at the same time as it adopted the new revenue standard discussed above; however, the Company now expects to adopt this new guidance in the first quarter of 2019. The Company is currently evaluating the impact that this new guidance will have on its consolidated financial statements. +In November 2015, the FASB issued an accounting standards update to provide guidance for the presentation of deferred tax liabilities and assets. Under this guidance, for a particular tax-paying component of an entity and within a particular tax jurisdiction, all deferred tax liabilities and assets, as well as any related valuation allowance, shall be offset and presented as a single noncurrent amount. This guidance became effective for the Company during the three months ended March 31, 2017. The adoption of this update was applied retrospectively, resulting in the reclassification of $36.4 million from current deferred tax assets as of December 31, 2016. Of this amount, $4.1 million was reclassified to long-term deferred tax assets and $32.3 million was reclassified to long-term deferred tax liabilities. +In March 2016, the FASB issued an accounting standards update to provide guidance for the accounting for share-based payment transactions, including the related income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This guidance became effective for the Company during the three months ended March 31, 2017. The Company believes this guidance has caused and will continue to cause volatility in its effective tax rates and diluted earnings per share due to the tax effects related to share-based payments being recorded in the statement of operations. The volatility in future periods will depend on the Company’s stock price and the number of shares that vest in the case of restricted stock, restricted stock units and performance stock units, or the number of shares that are exercised in the case of stock options. +In August 2016, the FASB issued an accounting standard to clarify the presentation of cash receipts and payments in specific situations on the statement of cash flows. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on the Company’s consolidated financial statements. +F-12 +In January 2017, the FASB issued an accounting standards update to eliminate Step 2 from the goodwill impairment test. An entity will now perform its annual or interim goodwill impa irment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not e xceed the total amount of goodwill allocated to that reporting unit. The requirements in this update are effective during interim and annual periods in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual good will impairment tests performed on testing dates on or after January 1, 2017. The Company adopted this update in 2017, which did not have a material impact on the Company’s consolidated financial statements. +In May 2017, the FASB issued an accounting standards update that provided clarity on which changes to the terms or conditions of share-based payment awards require an entity to apply modification accounting provisions. The requirements in this update are effective during interim and annual periods in fiscal years beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on the Company’s consolidated financial statements. +2. Acquisitions +SSE +On April 20, 2017, pursuant to the merger agreement, a subsidiary of the Company was merged with and into SSE, with SSE continuing as the surviving entity and one of the Company’s wholly owned subsidiaries (the “SSE merger”). Pursuant to the terms of the merger agreement, the Company acquired all of the issued and outstanding shares of common stock of SSE, in exchange for approximately 46.3 million shares of common stock of the Company. Concurrent with the closing of the merger, the Company repaid all of the outstanding debt of SSE totaling $472 million. Based on the closing price of the Company’s common stock on April 20, 2017, the total fair value of the consideration transferred to effect the acquisition of SSE was approximately $1.5 billion. On April 20, 2017, following the SSE merger, SSE was merged with and into a newly-formed subsidiary of the Company named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of the Company’s wholly owned subsidiaries. +Through the SSE merger, the Company acquired a fleet of 91 drilling rigs, 36 of which the Company considers to be APEX® rigs. Additionally, through the SSE merger, the Company acquired approximately 500,000 horsepower of modern, efficient fracturing equipment. The oilfield rentals business acquired through the SSE merger has a modern, well-maintained fleet of premium rental tools, and it provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +The merger has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date, with the remaining unallocated amount recorded as goodwill. Merger and integration expenses incurred by the Company related to the SSE merger were $69.5 million. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of Company common stock issued to SSE shareholders +46,298 +Company common stock price on April 20, 2017 +$ +22.45 +Fair value of common stock issued +$ +1,039,396 +Plus SSE long-term debt repaid by Company +$ +472,000 +Total fair value of consideration transferred +$ +1,511,396 +F-13 +The final determination of the fair value of assets acquired and liabilities assumed at the merger date will be completed as soon as possible, but no later than one year from the merger date (the “measurement period”). The Company’s preliminary purchase price allocation is subject to revision as additional information about the fair value of assets and liabilities becomes available. Additional information that existed as of the merger date, but at the time was unknown to the Company, may become known to the Company during the remainder of the measurement period. The final determination of fair value may differ materially from these preliminary estimates. The following table represents the preliminary allocation of the total purchase price of SSE to the assets acquired and the liabilities assumed based on the fair value at the merger date, with the excess of the purchase price over the estimated fair value of the identifiable net assets acquired recorded as goodwill (in thousands): +Identifiable assets acquired +Cash and cash equivalents +$ +37,806 +Accounts receivable +149,659 +Inventory +8,518 +Other current assets +19,038 +Property and equipment +984,433 +Other long-term assets +20,918 +Intangible assets +22,500 +Total identifiable assets acquired +1,242,872 +Liabilities assumed +Accounts payable and accrued liabilities +133,415 +Deferred income taxes +32,881 +Other long-term liabilities +1,734 +Total liabilities assumed +168,030 +Net identifiable assets acquired +1,074,842 +Goodwill +436,554 +Total net assets acquired +$ +1,511,396 +The goodwill reflected above has decreased $1.9 million from the original preliminary purchase price allocation as a result of measurement period adjustments, primarily related to a valuation adjustment to a long-term asset offset by valuation adjustments to accounts payable and accrued liabilities and deferred income taxes. +The acquired goodwill is not deductible for tax purposes. Among the factors that contributed to a purchase price resulting in the recognition of goodwill was SSE’s reputation as an experienced provider of high-quality contract drilling and pressure pumping services in a safe and efficient manner. See Note 5 for a breakdown of goodwill acquired by operating segment. +A portion of the fair value consideration transferred has been provisionally assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Assets +Favorable drilling contracts +$ +22,500 +0.83 +MS Directional +On October 11, 2017, the Company acquired all of the issued and outstanding limited liability company interests of MS Directional. The aggregate consideration paid by the Company consisted of $69.8 million in cash and approximately 8.8 million shares of the Company’s common stock. The purchase price is subject to customary post-closing adjustments relating to cash, net working capital and indebtedness of MS Directional as of the closing. Based on the closing price of the Company’s common stock on the closing date of the transaction, the total fair value of the consideration transferred to effect the acquisition of MS Directional was approximately $257 million. +MS Directional is a leading directional drilling services company in the United States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, directional surveying, measurement while drilling, and wireline steering tools. +The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date, with the remaining unallocated amount recorded as goodwill. Merger and integration expenses incurred by the Company related to this acquisition amounted to $5.0 million. +F-14 +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of Company common stock issued to MS Directional shareholders +8,798 +Company common stock price on October 11, 2017 +$ +21.31 +Fair value of common stock issued +$ +187,494 +Plus MS Directional long-term debt repaid by Company +$ +63,000 +Plus cash to sellers +$ +6,781 +Total fair value of consideration transferred +$ +257,275 +The final determination of the fair value of assets acquired and liabilities assumed at the acquisition date will be completed as soon as possible, but no later than one year from the acquisition date (the “measurement period”). The Company’s preliminary purchase price allocation is subject to revision as additional information about the fair value of assets and liabilities becomes available. Additional information that existed as of the acquisition date, but at the time was unknown to the Company, may become known to the Company during the remainder of the measurement period. The final determination of fair value may differ materially from these preliminary estimates. The following table represents the preliminary allocation of the total purchase price of MS Directional to the assets acquired and the liabilities assumed based on the fair value at the merger date, with the excess of the purchase price over the estimated fair value of the identifiable net assets acquired recorded as goodwill (in thousands): +Identifiable assets acquired +Cash and cash equivalents +$ +2,021 +Accounts receivable +42,782 +Inventory +28,060 +Other current assets +155 +Property and equipment +63,998 +Other long-term assets +318 +Intangible assets +74,682 +Total identifiable assets acquired +212,016 +Liabilities assumed +Accounts payable and accrued liabilities +43,099 +Other long-term liabilities +327 +Total liabilities assumed +43,426 +Net identifiable assets acquired +168,590 +Goodwill +88,685 +Total net assets acquired +$ +257,275 +The acquired goodwill is deductible for tax purposes. Among the factors that contributed to a purchase price resulting in the recognition of goodwill was MS Directional’s reputation as an experienced provider of high-quality directional drilling services in a safe and efficient manner. All of the goodwill acquired is attributable to the direction drilling operating segment (See Note 5). +A portion of the fair value consideration transferred has been provisionally assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Assets +Developed technology +$ +48,000 +10.00 +Customer relationships +26,200 +3.00 +Internal use software +482 +5.00 +$ +74,682 +7.51 +F-15 +Pro Forma +The results of SSE’s operations since the SSE merger date of April 20, 2017 and the results of MS Directional since the acquisition date of October 11, 2017 are included in our consolidated statement of operations. It is impractical to quantify the contribution of the SSE operations since the merger, as the contract drilling and pressure pumping businesses were fully integrated into the Company’s existing operations in 2017. The contribution of MS Directional since the date of the acquisition is reflected as the Company’s directional drilling segment, as disclosed in Note 14. The following pro forma condensed combined financial information was derived from the historical financial statements of the Company, SSE and MS Directional and gives effect to the acquisitions as if they had occurred on January 1, 2016. The below information reflects pro forma adjustments based on available information and certain assumptions the Company believes are reasonable, including (i) adjustments related to the depreciation and amortization of the fair value of acquired intangibles and fixed assets, (ii) removal of the historical interest expense of the acquired entities, (iii) the tax benefit of the aforementioned pro forma adjustments, and (iv) adjustments related to the common shares outstanding to reflect the impact of the consideration exchanged in the acquisitions. Additionally, the pro forma loss for the year ended December 31, 2017 was adjusted to exclude the Company’s merger and integration-related costs of $74.5 million and SSE’s merger related costs of $36.7 million with a corresponding inclusion in the net loss for the year ended December 31, 2016 to give effect as if the acquisitions had occurred on January 1, 2016. The pro forma results of operations do not include any cost savings or other synergies that may result from the SSE merger or MS Directional acquisition. The pro forma results of operations also do not include any estimated costs that have been or will be incurred by the Company to integrate the SSE and MS Directional operations. The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the SSE merger and MS Directional acquisition taken place on January 1, 2016; furthermore, the financial information is not intended to be a projection of future results. The following table summarizes selected financial information of the Company on a pro forma basis (in thousands, except per share data): +2017 +2016 +(Unaudited) +Revenues +$ +2,738,579 +$ +1,567,141 +Net income (loss) +$ +29,584 +$ +(505,413 +) +Net income (loss) per share +Basic +$ +0.13 +$ +(2.30 +) +Diluted +$ +0.13 +$ +(2.30 +) +Warrior Rig Ltd +During September 2016, the Company issued 353,804 shares of its common stock, valued at $6.7 million, in connection with the acquisition of Warrior Rig Ltd. and certain related entities (“Warrior”). Based in Calgary, Warrior manufactures and sells pipe handling components and related technology for drilling contractors in North America and other select markets. This acquisition was not material to the Company’s consolidated financial statements. +3. Inventory +Inventory consisted of the following at December 31, 2017 and 2016 (in thousands). +2017 +2016 +Finished goods +$ +2,270 +$ +— +Work-in-process +529 +1,803 +Raw materials and supplies +66,368 +18,388 +Inventory +$ +69,167 +$ +20,191 +4. Property and Equipment +Property and equipment consisted of the following at December 31, 2017 and 2016 (in thousands): +2017 +2016 +Equipment +$ +8,066,404 +$ +6,809,129 +Oil and natural gas properties +211,566 +201,568 +Buildings +185,475 +97,029 +Land +26,593 +22,270 +Total property and equipment +8,490,038 +7,129,996 +Less accumulated depreciation, depletion and impairment +(4,235,308 +) +(3,721,033 +) +Property and equipment, net +$ +4,254,730 +$ +3,408,963 +F-16 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets and liabilities for 2017, 2016 and 2015 (in thousands): +2017 +2016 +2015 +Depreciation and impairment expense +$ +753,510 +$ +657,571 +$ +845,543 +Amortization expense +21,764 +3,643 +3,643 +Depletion expense +8,067 +7,220 +15,573 +Total +$ +783,341 +$ +668,434 +$ +864,759 +On a periodic basis, the Company evaluates its fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional, vertical wells versus drilling longer, horizontal wells using higher specification rigs). The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to the Company’s yards to be used as spare equipment. The remaining components of these rigs are retired. In 2017, the Company r ecorded an impairment charge of $29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. In 2016, the Company retired 19 mechanical rigs but recorded no impairment charge as it had written down mechanical rigs that were still marketed in 2015. In 2015, the Company identified 24 mechanical rigs and nine non-APEX® electric rigs that would no longer be marketed. Also, the Company had 15 additional mechanical rigs that continued to be marketed but were not operating and which the Company had lower expectations with respect to utilization of these rigs due to the industry shift to higher specification drilling rigs. In 2015, the Company recorded a charge of $131 million related to the retirement of the 33 rigs, the 15 mechanical rigs that remained marketed but were not operating, and the write-down of excess spare rig components to their realizable values. +The Company also periodically evaluates its pressure pumping assets, and in 2015, the Company recorded a charge of $22.0 million for the write-down of pressure pumping equipment and certain closed facilities. There were no similar charges in 2017 or 2016. +The Company reviews its long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that their carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The Company estimates future cash flows over the life of the respective assets or asset groupings in its assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as the Company’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +Based on current commodity prices, the Company’s results of operations for the year ended December 31, 2017 and management’s expectations of operating results in future periods, the Company concluded that no triggering events occurred during the year ended December 31, 2017 with respect to its reporting segments. The Company’s expectations of future operating results were based on the assumption that activity levels in all segments and in the Company’s other operations will remain relatively stable or improve in response to relatively stable or increasing oil prices. +The Company concluded that no triggering events occurred during the year ended December 31, 2016 with respect to its reporting segments based on the Company’s results of operations for the year ended December 31, 2016, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new low for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August 2015, the Company lowered its expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of these revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for contract drilling and pressure pumping services during the third quarter of 2015, management concluded a triggering event had occurred and deemed it necessary to assess the recoverability of long-lived asset groups for both contract drilling and pressure pumping. The Company performed a Step 1 analysis to assess the recoverability of long-lived assets within its contract drilling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 60%, respectively. +F-17 +Due to the continued deterioration of crude oil prices in the fourth quarter of 2015, manage ment deemed it necessary to once again assess the recoverability of long-lived assets groups for both contract drilling and pressure pumping. The Company performed a Step 1 analysis to assess the recoverability of long-lived assets within its contract dri lling and pressure pumping segments. With respect to these assets, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the long-lived assets within the contract drilling and pressure pumping segments by approximately 120% and 100%, resp ectively. +For both of the assessments performed in 2015, the expected cash flows for the contract drilling segment included the backlog of commitments for contract drilling revenues under term contracts, which was approximately $801 million and $710 million at September 30, 2015 and December 31, 2015, respectively . Rigs not under term contracts would be subject to pricing in the spot market. Utilization and rates for rigs in the spot market and for the pressure pumping segment were estimated based upon the Company’s historical experience in prior downturns. Also, the expected cash flows for the contract drilling and pressure pumping segments were based on the assumption that activity levels in both segments would begin to recover in the first quarter of 2017 in response to improved oil prices. +5. Goodwill and Intangible Assets +Goodwill — Goodwill by operating segment as of December 31, 2017 and 2016 and changes for the years then ended are as follows (in thousands): +Contract +Pressure +Directional +Oilfield +Drilling +Pumping +Drilling +Rental +Total +Balance December 31, 2015 and 2016 +$ +86,234 +$ +— +$ +— +$ +— +$ +86,234 +Goodwill acquired +308,826 +121,444 +88,685 +6,284 +525,239 +Balance December 31, 2017 +$ +395,060 +$ +121,444 +$ +88,685 +$ +6,284 +$ +611,473 +There were no accumulated impairment losses related to goodwill as of December 31, 2017 or 2016. +Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. The Company’s reporting units for impairment testing have been determined to be its operating segments. The Company determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, the Company may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of such shortfall. +In January 2017, the FASB issued an accounting standards update to eliminate Step 2 from the goodwill impairment test. An entity will now perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The Company adopted this update in 2017. Prior to adoption the Company first determined whether it was more likely than not that the fair value of a reporting unit was less than its carrying value after considering qualitative, market and other factors, and if so, the resulting goodwill impairment was determined using a two-step quantitative impairment test. The first step of the quantitative testing was to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeded its fair value, the second step of the quantitative testing was performed whereby the fair value of the reporting unit was allocated to its identifiable tangible and intangible assets and liabilities, with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill was less than the carrying value of goodwill, an impairment loss was recognized in the amount of such shortfall. +In connection with its annual goodwill impairment assessment as of December 31, 2017 and 2016, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of its reporting units were greater than the respective carrying amount. In making this determination, the Company considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in its reporting units, as well as the Company’s operating results for 2017 and 2016 and forecasted operating results for the respective succeeding year. Management also considered the Company’s overall market capitalization at December 31, 2017 and 2016. +F-18 +During the third quarter of 2015, oil prices declined and averaged $46.42 per barrel, reaching a new lo w for 2015 of $38.22 per barrel in August 2015. In light of these lower oil prices in August, the Company lowered its expectations with respect to future activity levels in both the contract drilling and pressure pumping businesses. As a result of the Co mpany’s revised expectations of the duration of the lower oil and natural gas commodity price environment and the related deterioration of the markets for its contract drilling and pressure pumping services, the Company performed a quantitative Step 1 impa irment assessment of its goodwill as of September 30, 2015. In completing the Step 1 assessment, the fair value of each reporting unit was estimated using both the income and market valuation methods. The estimate of fair value for each reporting unit re quired the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of the Company’s contract drilling and pressure pumping reporting units, such as futur e oil and natural gas prices and projected demand for the Company’s services, and assumptions related to discount rates, long-term growth rates and control premiums. +Based on the results of the Step 1 goodwill impairment test as of September 30, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 15%, and management concluded that no impairment was indicated in its contract drilling reporting unit; however, impairment was indicated in its pressure pumping reporting unit. In the third quarter of 2015, the Company recognized an impairment charge of $125 million associated with the impairment of all of the goodwill in its pressure pumping reporting unit. +In connection with its annual impairment asset at December 31, 2015, the Company performed a quantitative Step 1 impairment assessment of the goodwill in its contract drilling reporting unit. In completing the Step 1 assessment, the fair value of the contract drilling reporting unit was estimated using both the income and market valuation methods. The estimate of the fair value of the reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of the Company’s contract drilling reporting unit, such as future oil and natural gas prices and projected demand for the Company’s services, and assumptions related to discount rates, long-term growth rates and control premiums. Based on the results of the quantitative Step 1 impairment assessment of its goodwill as of December 31, 2015, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 16%, and management concluded that no impairment was indicated in its contract drilling reporting unit. +Intangible Assets — In 2017, intangible assets were recorded in the Company’s directional drilling operating segment with the acquisition of MS Directional and in the contract drilling operating segment with the SSE merger (See Note 2). In addition, intangible assets were recorded in the pressure pumping operating segment in connection with the 2010 acquisition of the assets of a pressure pumping business. The Company’s intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight line basis. The following table identifies the segment and weighted average useful life of each of the Company’s intangible assets: +Weighted Average +Segment +Useful Life +(in years) +Customer relationships +Pressure pumping +7.00 +Customer relationships +Directional drilling +3.00 +Developed technology +Directional drilling +10.00 +Favorable drilling contracts +Contract drilling +0.83 +Internal use software +Directional drilling +5.00 +The Company concluded that no triggering events necessitating an impairment assessment of the intangible assets had occurred in 2017, 2016 or 2015. The assessment of the recoverability of the respective operating segments asset group included the respective intangible assets, and no impairment was indicated. +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2017 and 2016 are as follows (in thousands): +2017 +2016 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +26,200 +$ +(1,943 +) +$ +24,257 +$ +25,500 +$ +(22,768 +) +$ +2,732 +Developed technology +48,000 +(1,137 +) +46,863 +— +— +— +Favorable drilling contracts +22,500 +(18,482 +) +4,018 +— +— +— +Internal use software +482 +(21 +) +461 +— +— +— +$ +97,182 +$ +(21,583 +) +$ +75,599 +$ +25,500 +$ +(22,768 +) +$ +2,732 +Amortization expense on intangible assets of approximately $24.3 million, $3.6 million and $3.6 million for the years ended December 31, 2017, 2016 and 2015, respectively. The remaining amortization expense associated with finite-lived intangible assets is expected to be as follows (in thousands): +F-19 +Year ending December 31, +2018 +$ +17,580 +2019 +13,630 +2020 +11,686 +2021 +4,896 +2022 +4,875 +Thereafter +22,932 +Total +$ +75,599 +6. Accrued Expenses +Accrued expenses consisted of the following at December 31, 2017 and 2016 (in thousands): +2017 +2016 +Salaries, wages, payroll taxes and benefits +$ +50,443 +$ +21,138 +Workers’ compensation liability +80,751 +67,775 +Property, sales, use and other taxes +29,332 +6,766 +Insurance, other than workers’ compensation +10,816 +9,566 +Accrued interest payable +7,558 +6,740 +Accrued merger and integration +16,101 +— +Other +31,628 +27,163 +$ +226,629 +$ +139,148 +7. Long-Term Debt +2012 Credit Agreement — On September 27, 2012, the Company entered into a Credit Agreement (“Base Credit Agreement”) with Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender, and each of the other lenders party thereto. The Base Credit Agreement (as amended, the “Credit Agreement”) is a committed senior unsecured credit facility that includes a revolving credit facility. +On July 8, 2016, the Company entered into Amendment No. 2 to the Credit Agreement (Amendment No. 2”), which amended the Base Credit Agreement to, among other things, make borrowings under the revolving credit facility subject to a borrowing base calculated by reference to the Company’s and certain of its subsidiaries’ eligible equipment, inventory, accounts receivable and unencumbered cash as described in Amendment No. 2. The revolving credit facility contains a letter of credit facility that is limited to $50 million and a swing line facility that is limited to $20 million, in each case outstanding at any time. The maturity date under the Base Credit Agreement was September 27, 2017 for the revolving credit facility; however, Amendment No. 2 extended the maturity date of $357.9 million in revolving credit commitments of certain lenders to March 27, 2019. On January 17, 2017, the Company entered into Amendment No. 3 to Credit Agreement, which amended the Credit Agreement by restating the definition of Consolidated EBITDA to provide for the add-back of transaction expenses related to the SSE merger. On January 24, 2017, the Company entered into an agreement with certain lenders under its revolving credit facility to increase the aggregate commitments under its revolving credit facility to approximately $595.8 million, subject to the satisfaction of certain conditions. The aggregate commitment increase became effective on April 20, 2017 upon the consummation of the SSE merger and the repayment and termination of the SSE credit facility. On April 20, 2017, the Company entered into Amendment No. 4 to Credit Agreement which permitted outstanding letters of credit under the SSE credit facility to be deemed to be incurred under the Company’s credit facility and increased the amount of the accordion feature of the Company’s revolving credit facility to permit aggregate commitments to be increased to an amount not to exceed $700 million (subject to satisfaction of certain conditions and the procurement of additional commitments from new or existing lenders). On April 20, 2017, the Company also entered into an additional commitment increase agreement with certain of its lenders pursuant to which total commitments available under the Company’s revolving credit facility (after giving effect to both commitment increases) increased to $632 million through September 2017 and to $490 million through March 2019. On October 27, 2017, the Company entered into an additional commitment increase agreement with certain of its lenders pursuant to which total commitments available under the Company’s revolving credit facility increased to $500 million through March 27, 2019. +F-20 +Loans under the Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. Until September 27, 2017, the ap plicable margin on LIBOR rate loans varie d from 2.75% to 3.25% and the applicable margin on base rate loans varied from 1.75% to 2.25%, in each case determined based upon the Company’s debt to capitalization ratio. Beginning September 27, 2017, the applic able margin on LIBOR rate loans varies from 3.25% to 3.75% and the applicable margin on base rate loans varies from 2.25% to 2.75%, in each case determined based on the Company’s excess availability under the credit facility. At December 31, 2017, the app licable margin on LIBOR rate loans was 3 . 50 % and the applicable margin on base rate loans was 2 . 50 %. A letter of credit fee is payable by the Company equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstand ing letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%. +Each domestic subsidiary of the Company unconditionally guarantees all existing and future indebtedness and liabilities of the other guarantors and the Company arising under the Credit Agreement, other than (a) Ambar Lone Star Fluid Services LLC, (b) domestic subsidiaries that directly or indirectly have no material assets other than equity interests in, or capitalization indebtedness owed by, foreign subsidiaries, and (c) any subsidiary having total assets of less than $1 million. Such guarantees also cover obligations of the Company and any subsidiary of the Company arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement. +The Credit Agreement requires compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 40%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit its interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2017. +The Credit Agreement limits the Company’s ability to make investments in foreign subsidiaries or joint ventures such that, if the book value of all such investments since September 27, 2012 is above 20% of the total consolidated book value of the assets of the Company and its subsidiaries on a pro forma basis, the Company will not be able to make such investment. The Credit Agreement also restricts the Company’s ability to pay dividends and make equity repurchases, subject to certain exceptions, including an exception allowing such restricted payments if before and immediately after giving effect to such restricted payment, the Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) is at least 1.50 to 1.00. In addition, the Credit Agreement requires that, if the consolidated cash balance of the Company and its subsidiaries, subject to certain exclusions, is more than $100 million at the end of the day on which a borrowing is made, the Company can only use the proceeds from such borrowing to fund acquisitions, capital expenditures and the repurchase of indebtedness, and if such proceeds are not used in such manner within three business days, the Company must repay such unused proceeds on the fourth business day following such borrowings. +The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants. +Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require the Company to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic), and (iii) require the Company to cash collateralize any outstanding letters of credit. +As of December 31, 2017, the Company had $268 million outstanding under the revolving credit facility at a weighted average interest rate of 5.71%. The Company had $4.6 million in letters of credit outstanding under its revolving credit facility at December 31, 2017 and, as a result, had available borrowing capacity of $227 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, the Company entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which the Company may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2017, the Company had $54.9 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, the Company will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by the Company at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. The Company is obligated to pay to Scotiabank interest on all amounts not paid by the Company on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +F-21 +The Company has also agreed that if obligations under the Credit Agreement are secured by liens on any of its or any of its subsidiaries’ property, then the Company’s reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, the Company’s payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by subsidiaries of the Company that from time to time guarantee payment under the Credit Agreement. +Series A & B Senior Notes – On October 5, 2010, the Company completed the issuance and sale of $300 million in aggregate principal amount of its 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. The Company pays interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, the Company completed the issuance and sale of $300 million in aggregate principal amounts of its 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. The Company pays interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations of the Company, which rank equally in right of payment with all other unsubordinated indebtedness of the Company. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of the existing domestic subsidiaries of the Company other than subsidiaries that are not required to be guarantors under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at the Company’s option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. The Company must offer to prepay the notes upon the occurrence of any change of control. In addition, the Company must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit its interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2017. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +2028 Senior Notes – On January 19, 2018, the Company completed its offering of $525 million aggregate principal amount of the Company’s 2028 Notes initially guaranteed on a senior unsecured basis by certain of its subsidiaries. The net proceeds before offering expenses were approximately $521 million of which the Company used $239 million to repay amounts outstanding under its revolving credit facility. The Company intends to use the remainder of the net proceeds for general corporate purposes. +The Company pays interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028. The 2028 Notes bear interest at a rate of 3.95% per annum. +F-22 +The 2028 Notes are senior unsecured obligations of the Company, which rank equally with all of the Company’s other existing and future senior unsecured debt and will rank senior in right of payment to all of the Compan y’s other future subordinated debt. The 2028 Notes will be effectively subordinated to any of the Company’s future secured debt to the extent of the value of the assets securing such debt. In addition, the 2028 Notes will be structurally subordinated to the liabilities (including trade payables) of the Company’s subsidiaries that do not guarantee the 2028 Notes. The guarantors’ guarantees of the 2028 Notes (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecur ed senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. I n the future, the Guarantees may be released and terminated under certain circumstances. +The Company, at its option, may redeem the Notes in whole or part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date, plus a make-whole premium. Additionally, commencing on November 1, 2027, the Company, at its option, may redeem the 2028 Notes in whole or part, at a redemption price equal to 100% of the principal amount of the 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date. +The indenture pursuant to which the 2028 Notes were issued includes covenants that, among other things, limit the Company and its subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indenture. +Upon the occurrence of a change of control, as defined in the indenture, each holder of the 2028 Notes may require the Company to purchase all or a portion of such holder’s 2028 Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indenture also provides for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the 2028 Notes to become or to be declared due and payable. +The Company incurred approximately $6.0 million in debt issuance costs in connection with the Credit Agreement. The Company incurred approximately $1.9 million in debt issuance costs in connection with the Series A Notes and approximately $1.6 million in debt issuance costs in connection with the Series B Notes . These costs were deferred and are being recognized as interest expense over the term of the underlying debt. Debt issuance costs, except those related to line-of-credit arrangements, are presented in the balance sheet as a direct deduction from the carrying amount of the related debt. Debt issuance costs related to line-of-credit arrangements are classified as a deferred charge. Amortization of debt issuance costs is reported as interest expense. Interest expense related to the amortization of debt issuance costs was approximately $2.6 million, $4.1 million and $2.8 million for the years ended December 31, 2017, 2016 and 2015, respectively. Amortization of debt issuance costs for the year ended December 31, 2016 includes $1.4 million of costs related to the early termination of the previous term loan agreements. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2017 (in thousands): +Year ending December 31, +2018 +$ +— +2019 +268,000 +2020 +300,000 +2021 +— +2022 +300,000 +Thereafter +— +Total +$ +868,000 +8. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2017, the Company maintained letters of credit in the aggregate amount of $59.5 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2017, no amounts had been drawn under the letters of credit. +As of December 31, 2017, the Company had commitments to purchase approximately $172 million of major equipment for its drilling and pressure pumping businesses. +The Company’s pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. As of December 31, 2017, the remaining obligation under these agreements was approximately $140 million, of which materials with a total purchase price of approximately $35.9 million are required to be purchased during 2018. In the event that the required minimum quantities are not purchased during any contract year, the Company could be required to make a liquidated damages payment to the respective vendor for any shortfall. +F-23 +Contingencies – The Company’s operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose the Company to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +Any contractual right to indemnification that the Company may have for any such risk may be unenforceable or limited due to negligent or willful acts of commission or omission by the Company, its subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield service agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of the Company. The Company’s customers and other third parties may dispute, or be unable to meet, their contractual indemnification obligations to the Company due to financial, legal or other reasons. Accordingly, the Company may be unable to transfer these risks to its customers and other third parties by contract or indemnification agreements. Incurring a liability for which the Company is not fully indemnified or insured could have a material adverse effect on its business, financial condition, cash flows and results of operations. +The Company has insurance coverage for fire, windstorm and other risks of physical loss to its rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. The Company has also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, the Company generally maintains a $1.5 million per occurrence deductible on its workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on its equipment insurance coverage, a $2.0 million per occurrence deductible on its general liability coverage and a $2.0 million per occurrence deductible on its automobile liability insurance coverage. The Company also self-insures a number of other risks, including loss of earnings and business interruption and cyber risks, and does not carry a significant amount of insurance to cover risks of underground reservoir damage. +On January 22, 2018, an accident at a drilling site in Pittsburg County, Oklahoma resulted in the losses of life of five people, including three of the Company’s employees. Based on the information the Company has available as of the date of this Report, the Company believes that it has adequate insurance to cover any losses, excluding the applicable insurance deductibles and investigation-related expenses. However, if this accident is not, or another significant accident or other event occurs that is not, fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on the Company’s business, financial condition, cash flows and results of operations. +The Company is party to various legal proceedings arising in the normal course of its business. The Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows. +Other Matters — The Company has Change in Control Agreements with its Chairman of the Board and one of its Executive Vice Presidents (the “Specified Employees”). Each Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless the Company notifies the Specified Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control of the Company occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by the Company other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreements), then the Specified Employee shall generally be entitled to, among other things: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment for each Specified Employee prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2.5 times (in the case of the Chairman of the Board) or 2 times (in the case of the Executive Vice President) of the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under the Company’s welfare plans for up to three years (in the case of the Chairman of the Board) or two years (in the case of the Executive Vice President). +Each Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +F-24 +The Company has Employment Agreements with its Chief Executive Officer, Chief Financial Officer, General Counsel and the President of the Company’s subsidiary, Patterson-UTI Drilling Company LLC (“Patterson-UTI Drilling”) . In the case of the Chief Executive Officer and the General Counsel, the Employment Agreement supersedes the prior Change in Control Agreement with each executive and, in the case of the President of Patterson-UTI Drilling, the Employment Agreement super sedes his prior employment agreement. Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such t ermination at least 30 days before the effective date of such termination. Under specified circumstances, the Company may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by either (i) providing written notice 10 days before the effective date of such termination and by granting at least 10 days to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of suc h termination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by the Company to not be capable of being cured, the executive may be terminated for cause on the date the written n otice is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following termination by the Company of the executive other than for Cause, or termination by the executive for Good Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by the Company without Cause, or the executive terminates his employment for Good Reason : +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees, +• +the Company will accelerate vesting of all options and restricted stock awards on the 60th day following the executive’s termination, and +• +the Company will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +If a termination by the Company other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, which for the President of Patterson-UTI Drilling includes a change in control of the Company or, in certain circumstances, of Patterson-UTI Drilling), the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years, and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) of subsidized benefits continuation coverage. +9. Stockholders’ Equity +Stock Offering – On January 27, 2017, the Company completed an offering of 18.2 million shares of its common stock and raised net proceeds of $472 million. The Company used the net proceeds of the offering to repay SSE’s outstanding indebtedness of approximately $472 million. +F-25 +Cash Dividends – The Company paid cash dividends during the years ended December 31, 2017, 2016 and 2015 as follows: +Per Share +Total +(in thousands) +2017 +Paid on March 22, 2017 +$ +0.02 +$ +3,326 +Paid on June 22, 2017 +0.02 +4,269 +Paid on September 21, 2017 +0.02 +4,271 +Paid on December 21, 2017 +0.02 +4,449 +Total cash dividends +$ +0.08 +$ +16,315 +2016 +Paid on March 24, 2016 +$ +0.10 +$ +14,712 +Paid on June 23, 2016 +0.02 +2,953 +Paid on September 22, 2016 +0.02 +2,953 +Paid on December 22, 2016 +0.02 +2,961 +Total cash dividends +$ +0.16 +$ +23,579 +2015 +Paid on March 25, 2015 +$ +0.10 +$ +14,640 +Paid on June 24, 2015 +0.10 +14,712 +Paid on September 24, 2015 +0.10 +14,712 +Paid on December 24, 2015 +0.10 +14,711 +Total cash dividends +$ +0.40 +$ +58,775 +On February 7, 2018, the Company’s Board of Directors approved a cash dividend on its common stock in the amount of $0.02 per share to be paid on March 22, 2018 to holders of record as of March 8, 2018. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of the Company’s debt agreements and other factors. +On September 6, 2013, the Company’s Board of Directors approved a stock buyback program that authorizes purchase of up to $200 million of the Company’s common stock in open market or privately negotiated transactions. All purchases to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the plan are held as treasury shares. There is no expiration date associated with the buyback program. As of December 31, 2017, the Company had remaining authorization to purchase approximately $187 million of the Company’s outstanding common stock under the 2013 stock buyback program. +The Company acquired shares of stock from directors during 2017 and 2016 and from employees during 2017, 2016 and 2015 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options. The remainder of these shares was acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2017, 2016 and 2015 were as follows (dollars in thousands): +2017 +2016 +2015 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +42,818,585 +$ +899,035 +Purchases pursuant to 2013 stock buyback program +5,503 +109 +8,488 +183 +8,618 +180 +Acquisitions pursuant to long-term incentive plan +404,491 +7,508 +176,889 +3,866 +380,037 +7,830 +Treasury shares at end of period +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +10. Stock-based Compensation +The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards consist of equity instruments in the form of stock options, restricted stock or restricted stock units and have included service and, in certain cases, performance conditions. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +F-26 +The 2014 Plan was originally approved by the Company’s stockholders effective as of April 17, 2014 , and the Board of Directors adopted a resolution that no future grants would be made und er any of the Company’s other previously existing plans. On June 29, 2017, the Company’s stockholders approved the amendment and restatement of the 2014 Plan (the “Amended and Restated Plan”) to increase the number of shares available under the plan to 10 ,049,156 shares. The aggregate number of shares of the Company’s c ommon s tock authorized for grant under the Amended and Restated Plan is 18.9 million, which includes 9.1 million shares previously authorized under the 2014 Plan . The Company’s share-based compensation plans at December 31, 2017 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +Amended and Restated Plan +18,900,000 +5,286,459 +7,647,874 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +3,804,500 +— +A summary of the Amended and Restated Plan follows: +• +The Compensation Committee of the Board of Directors administers the plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +All options granted under the plan are granted with an exercise price equal to or greater than the fair market value of the Company’s common stock at the time the option is granted. +• +The plan provides for awards of incentive stock options, non-incentive stock options, tandem and freestanding stock appreciation rights, restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalents. As of December 31, 2017, non-incentive stock options, restricted stock awards, restricted stock units and performance unit awards had been granted under the plan. +Options granted under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. Restricted stock awards granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. +Stock Options— The Company estimates the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date the options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the year ended December 31, 2017. Weighted-average assumptions used to estimate grant date fair values for stock options granted during the years ended December 31, 2016 and 2015 are as follows: +2016 +2015 +Volatility +35.11 +% +37.95 +% +Expected term (in years) +5.00 +5.00 +Dividend yield +2.05 +% +2.00 +% +Risk-free interest rate +1.40 +% +1.37 +% +Stock option activity for the year ended December 31, 2017 follows: +Weighted-average +Shares +exercise price +Outstanding at beginning of year +6,687,150 +$ +20.68 +Exercised +(50,000 +) +$ +18.63 +Expired +(600,000 +) +$ +24.17 +Outstanding at end of year +6,037,150 +$ +20.35 +Exercisable at end of year +5,515,968 +$ +20.49 +F-27 +Options outstanding at December 31, 2017 have an aggregate intrinsic value of approximately $ 25.9 million and a weighted-average remaining contractual term of 4.65 years. Options exercisable at December 31, 2017 have an aggregate intrinsic value of approximately $ 23.7 million and a weighted-average remaining contractual term of 4. 3 1 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2017, 2016 and 2015 follows: +2017 +2016 +2015 +Weighted-average grant date fair value of stock options granted (per share) +NA +$ +4.90 +$ +5.79 +Aggregate grant date fair value of stock options vested during the year +(in thousands) +$ +4,565 +$ +4,729 +$ +5,077 +Aggregate intrinsic value of stock options exercised (in thousands) +$ +209 +$ +366 +$ +— +As of December 31, 2017, options to purchase 521,182 shares were outstanding and not vested. All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2017 with respect to these non-vested options follows: +Aggregate intrinsic value +$2.1 million +Weighted-average remaining contractual term +8.2 years +Weighted-average remaining expected term +3.2 years +Weighted-average remaining vesting period +1.4 years +Unrecognized compensation cost +$2.6 million +Restricted Stock— For all restricted stock awards to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock activity for the year ended December 31, 2017 follows: +Weighted- +average Grant +Shares +Date Fair Value +Non-vested restricted stock outstanding at beginning of year +1,427,455 +$ +22.26 +Granted +890,904 +$ +21.78 +Vested +(764,213 +) +$ +23.40 +Forfeited +(23,808 +) +$ +22.34 +Non-vested restricted stock outstanding at end of year +1,530,338 +$ +21.41 +As of December 31, 2017, approximately 1.5 million shares of non-vested restricted stock outstanding are expected to vest. Additional information as of December 31, 2017 with respect to these non-vested shares follows: +Aggregate intrinsic value +$34.0 million +Weighted-average remaining vesting period +1.3 years +Unrecognized compensation cost +$19.6 million +Restricted Stock Units— For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable cash dividend equivalents are paid on certain non-vested restricted stock units, and forfeitable dividend equivalents are accrued on certain other restricted stock units that will be paid upon vesting. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2017 follows: +Weighted-average +Grant Date Fair +Shares +Value +Non-vested restricted stock units outstanding at beginning of year +191,655 +$ +19.85 +Granted +1,238,692 +$ +19.85 +Assumed (1) +505,551 +$ +22.45 +Vested +(549,451 +) +$ +22.24 +Forfeited +(49,174 +) +$ +21.26 +Non-vested restricted stock units outstanding at end of year +1,337,273 +$ +19.80 +(1) +Restricted stock unit awards under the Seventy Seven Energy Inc. 2016 Omnibus Incentive Plan, which was adopted, assumed, amended and renamed by the Company in connection with the SSE merger. No additional awards will be made under this plan. +F-28 +Performance Unit Awards. The Company has granted share-settled performance unit awards to certain executive officers (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive a grant of shares of common stock upon the a chievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is the three year period commencing on April 1 of the year of grant, except that for the Performa nce Units granted in 2013 the performance period was extended pursuant to its terms, as described below, and for the Performance Units granted in 2017 the three-year performance period commenced on May 1. +The performance goals for the Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. Generally, the recipients will receive a target number of shares if the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 50 th percentile. If the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 75 th percentile or higher, then the recipients will receive two times the target number of shares. If the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 25 th percentile, the recipients will only receive one-half of the target number of shares. If the Company’s total shareholder return during the performance period, when compared to the peer group, is between the 25 th and 75 th percentile, then the shares to be received by the recipients will be determined on a pro-rata basis. +For the Performance Units awarded prior to 2016, there is no payout unless the Company’s total shareholder return is positive and, when compared to the peer group, is at or above the 25 th percentile. In respect of the 2013 Performance Units, for which the performance period ended March 31, 2016, the Company’s total shareholder return for the performance period was negative, the Company’s total shareholder return for the performance period when compared to the peer group was above the 75 th percentile, and there was no payout; provided, however, that pursuant to the terms of those 2013 awards, if, during the two-year period ending March 31, 2018, the Company’s total shareholder return for any 30 consecutive day period equals or exceeds 18 percent on an annualized basis from April 1, 2013 through the last day of such 30 consecutive day period, and the recipient is actively employed by the Company through the last day of the extended performance period, then the Company will issue to the recipient the number of shares equal to the amount the recipient would have been entitled to receive had the Company’s total shareholder return been positive during the initial three-year performance period. +For the Performance Units granted in April 2016, if the Company’s total shareholder return is negative, and, when compared to the peer group is at or above the 25th percentile, then the recipients will receive one-half of the number of shares they would have received had the Company’s total shareholder return been positive. For the Performance Units granted in May 2017, the payout is based on relative performance and does not have an absolute performance requirement. +The total target number of shares with respect to the Performance Units for the years 2012-2017 is set forth below: +2017 +2016 +2015 +2014 +2013 +2012 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +186,198 +185,000 +190,600 +154,000 +236,500 +192,000 +The 2012 Performance Units settled with an 87th total shareholder return percentile and 384,000 shares were issued. The 2014 Performance Units settled with an 89 th total shareholder return percentile and a negative total shareholder return, so there was no payout under such Performance Units. +Because the Performance Units are stock-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2017 +2016 +2015 +2014 +2013 +2012 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +5,780 +$ +3,854 +$ +4,052 +$ +5,388 +$ +5,564 +$ +3,065 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2017 +2016 +2015 +2014 +2013 +2012 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2017 +$ +1,284 +$ +1,285 +$ +1,351 +$ +449 +NA +NA +Year ended December 31, 2016 +NA +$ +963 +$ +1,351 +$ +1,796 +$ +464 +NA +Year ended December 31, 2015 +NA +NA +1,013 +$ +1,796 +$ +1,855 +$ +255 +F-29 +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as follows: +• +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +• +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +• +Dividend equivalents are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +• +Dividend equivalents are recognized as additional compensation cost for the portion of restricted stock units that are not expected to vest or that ultimately do not vest. +11. Leases +The Company incurred rent expense of $48.9 million, $25.3 million and $37.6 million for the years ended December 31, 2017, 2016 and 2015, respectively. Rent expense is primarily related to short-term equipment rentals that are generally passed through to customers. +Future minimum rental payments required under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 2017 are as follows (in thousands): +Year ending December 31, +2018 +$ +13,616 +2019 +9,368 +2020 +7,112 +2021 +5,165 +2022 +3,844 +Thereafter +8,917 +Total +$ +48,022 +12. Income Taxes +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2017, 2016 and 2015 are as follows (in thousands): +2017 +2016 +2015 +Federal income tax benefit: +Current +$ +(42 +) +$ +(24,777 +) +$ +(42,020 +) +Deferred +(335,106 +) +(134,592 +) +(83,812 +) +(335,148 +) +(159,369 +) +(125,832 +) +State income tax expense (benefit): +Current +(215 +) +(257 +) +(3,480 +) +Deferred +4,511 +(14,163 +) +(12,433 +) +4,296 +(14,420 +) +(15,913 +) +Foreign income tax expense (benefit): +Current +(3,108 +) +(368 +) +(2,590 +) +Deferred +249 +(3,405 +) +(3,628 +) +(2,859 +) +(3,773 +) +(6,218 +) +Total income tax benefit: +Current +(3,365 +) +(25,402 +) +(48,090 +) +Deferred +(330,346 +) +(152,160 +) +(99,873 +) +Total income tax benefit: +$ +(333,711 +) +$ +(177,562 +) +$ +(147,963 +) +F-30 +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2017, 2016 and 2015 is summarized as follows: +2017 +2016 +2015 +Statutory tax rate +35.0 +% +35.0 +% +35.0 +% +State income taxes - net of the federal income tax benefit +1.9 +2.0 +2.1 +Permanent differences +(1.3 +) +(0.1 +) +(1.3 +) +One-time tax effects of tax reform +66.7 +— +— +Share-based payments +3.6 +— +— +Acquisition related differences +(3.3 +) +— +— +Other differences, net +(0.8 +) +(1.1 +) +(2.4 +) +Effective tax rate +101.8 +% +35.8 +% +33.4 +% +The effective tax rate increased by approximately 66.0% to 101.8% for 2017 compared to 2016, primarily due to a 66.7% increase related to tax reform enacted on December 22, 2017 and a 3.6% increase for excess tax benefits from employee stock compensation deductions. These increases were partially offset by a 3.3% decrease in the effective tax rate for acquisitions that resulted in the revaluation of deferred tax assets and liabilities at the new state tax rates at which they are expected to reverse. The lower 2015 effective tax rate is primarily related to the impact of goodwill impairment charges in 2015, along with an adjustment to the Company’s deferred tax liability associated with the 2010 conversion of its Canadian operations to a controlled foreign corporation. +Tax reform reduces the U.S. federal corporate tax rate from 35% to 21% beginning in 2018, requires companies to pay a one-time transition tax on foreign earnings that were previously tax deferred, creates new taxes on future foreign earnings, places a new limitation on the tax deductibility of interest expense, accelerates the expensing of certain business assets, and reduces the amount of executive pay that will be tax deductible, among other changes. Based on a reduced U.S. federal corporate tax rate of 21% from tax reform, the Company remeasured certain deferred tax assets and liabilities at the tax rates at which they are expected to reverse in the future. Due to the limited time to consider tax reform and its various interpretations, the Company is still analyzing and refining its calculations, which could potentially affect the measurement of these balances or give rise to new deferred tax amounts, however, in certain cases, the Company has made a reasonable estimate of the effects on its existing deferred tax balances and the one-time transition tax. For the items for which the Company was able to determine a reasonable estimate, it recognized a provisional amount, in accordance with SAB 118, of approximately $219 million of tax benefit, which is included as a component of income tax expense from continuing operations resulting in the above impact to the Company’s 2017 effective income tax rate. +The one-time transition tax is based on the total post-1986 earnings and profits (E&P) of the Company’s foreign operation which it has previously deferred from U.S. income taxes. Based on its current analysis, the Company has estimated an E&P deficit and therefore has not recorded any additional taxes for the one-time transition tax. The Company notes that its analysis of the transition tax is provisional and represents a reasonable estimate resulting from the mandatory deemed repatriation of its post-1986 untaxed foreign E&P. Determining the provisional transition tax required a significant number of steps, including determining the composition of the Company’s post-1986 untaxed foreign E&P that is held in cash or liquid assets and other assets at several measurement dates, as a different rate is applied to each when determining the transition tax liability, and analyzing the Company’s accumulated foreign post-1986 E&P, including historical practices and assertions. As a result of these factors, as well as the proximity of the enactment of tax reform to its year-end, the Company had limited time to consider tax reform and its various interpretations and has not completed its calculation of the total post-1986 E&P amounts of its foreign operations. Adjustments to the Company’s estimates may occur once it finalizes these calculations. +Prior to tax reform, the Company had elected to permanently reinvest unremitted earnings in Canada effective January 1, 2010, and it intended to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes had been provided on such unremitted foreign earnings. With the enactment of tax reform, there is a new territorial tax system that provides for a 100% dividends received deduction on future earnings, if remitted. However, the Company will need to continue to evaluate its reinvestment intentions on future earnings and any other residual basis differences in order to determine whether it can continue to assert indefinite reinvestment or whether it will be required to provide for additional taxes that would be due on future earnings if remitted, such as foreign withholding taxes or state and local taxes. The Company will also need to determine whether it will be required to provide for additional taxes on any other outside basis differences in its foreign operations. Due to the limited time to consider these provisions, the Company is still evaluating how tax reform will affect its existing accounting position to indefinitely reinvest unremitted foreign earnings. The Company will continue to assert permanent reinvestment with respect to future unremitted earnings and has not recorded any deferred federal or state income taxes that would be provided on future unremitted earnings. The Company will finalize its intentions on whether it will permanently reinvest its foreign unremitted earnings within the measurement period provided under SAB 118. +F-31 +Tax reform also introduced a new GILTI U.S. tax on certain off-shore earnings at an effective tax rate of 10.5 % for tax years beginning after December 31, 2017 (increasing to 13.125% for tax years beginning after December 31, 2025) with a partial offset for any related foreign tax credits. The Company is still evaluating the GILTI provisions of t ax reform and its impact, if any, on the Company’s consolidated financial statements at December 31, 2017. The FASB staff allowed companies to adopt an accounting policy to either provide deferred taxes for GILTI or treat it as a tax cost in the year incurred. Th e Company has not yet determined its accounting policy because determining the impact of the GILTI provisions requires analysis of its existing legal entity structure, the reversal of differences in the assets and liabilities of its foreign subsidiaries, a nd its ability to offset any tax with foreign tax credits. As such, the Company did not record a deferred income tax expense or benefit related to the GILTI provisions in its c onsolidated s tatement of o perations for the year ended December 31, 2017 and wi ll finalize its evaluation of the GILTI provisions during the measurement period provided under SAB 118. +In addition to the provisions above, the tax reform also changed the individuals whose compensation is subject to a $1 million cap on deductibility under Section 162(m) and includes performance-based compensation such as stock options and stock appreciation rights in the calculation. For taxable years beginning before December 31, 2017, a public company had been able to deduct up to $1 million of compensation paid to covered employees consisting of the chief executive officer and the next three highest compensated officers, but not the chief financial officer (CFO). However, the limit did not apply to performance-based compensation. The new law expands the definition of covered employees to include the CFO and any individual who has been considered a covered employee, even if that individual is no longer a covered employee. Thus, once an individual is a covered employee, the deduction limitation applies to compensation paid to that individual at any point in the future, including after a separation from service. Any individual who is a covered employee for a tax year after December 31, 2016 will remain a covered employee for all future years. The law also eliminates the exception for performance-based compensation. The provision generally applies to taxable years beginning after December 31, 2017 and provides a transition for compensation paid pursuant to a written binding contract that is in effect on November 2, 2017. The Company will need to carefully review the terms of its compensation plans and agreements to assess whether such plans and agreements are considered to be written binding contracts in effect on November 2, 2017. Due to the complexity of applying this new provision and the limited time to consider tax reform, the Company has not yet completed its analysis of these new provisions and will finalize its analysis during the measurement period provided under SAB 118. +In March 2016, the FASB issued Accounting Standards Update No. 2016-09, "Compensation-Stock Compensation". The new standard was effective for the Company on January 1, 2017. Among other provisions, the new standard requires that excess tax benefits and tax deficiencies that arise upon vesting or exercise of share-based payments be recognized as income tax benefits and expenses in the income statement. Previously, such amounts were recorded to additional paid-in-capital. This aspect of the new guidance was required to be adopted prospectively. The effective income tax rate for the year ended December 31, 2017 includes approximately $12 million of excess tax benefits from share-based compensation awards that vested or were exercised during the period. +During 2017, there was significant merger and acquisition activity by the Company. Based on this activity, an evaluation was made of the Company’s overall state deferred tax rate, resulting in a slightly increased rate. The Company remeasured certain deferred tax assets and liabilities at the tax rates at which they are expected to reverse in the future and recorded additional taxes of approximately $11 million, impacting the 2017 effective income tax rate. +The tax effect of significant temporary differences representing deferred tax assets and liabilities at December 31, 2017 and 2016 are as follows (in thousands): +2017 +2016 +Deferred tax assets: +Net operating loss carryforwards +$ +285,542 +$ +203,485 +Alternative minimum tax credit +7,907 +7,907 +Scientific research and experimental development tax credit +898 +— +Expense associated with stock options and restricted stock +12,338 +17,116 +Workers' compensation allowance +19,662 +26,157 +Federal benefit of state deferred tax liabilities +5,660 +5,310 +Other +27,066 +14,998 +Total deferred tax assets +359,073 +274,973 +Deferred tax liabilities: +Property and equipment basis difference +(695,111 +) +(911,972 +) +Other +(10,923 +) +(9,538 +) +Total deferred tax liabilities +(706,034 +) +(921,510 +) +Net deferred tax liability +$ +(346,961 +) +$ +(646,537 +) +F-32 +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and necessary allowances are provided. The ultimate realization of deferr ed tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the Company’s carryback availability, the scheduled reversal of deferred tax liabilitie s, projected future taxable income and tax planning strategies in making this assessment. The Company expects the full carrying value of its deferred tax assets at December 31, 2017 and 2016 to be realized as a result of the timing of the reversal s of its existing taxable temporary differences , which will give rise to taxable income and offset deductible temporary differences in the permitted carryforward periods. As of December 31, 2017 , the Company does not consider a valuation allowance necessary. +Other deferred tax assets consist primarily of the tax effect of various allowance accounts and tax-deferred expenses expected to generate future tax benefits of approximately $27.1 million. Other deferred tax liabilities of approximately $10.9 million consists primarily of the tax effect of receivables from insurance companies and tax-deferred income not yet recognized for tax purposes. +For income tax purposes, the Company has approximately $1.1 billion of gross federal net operating losses, approximately $19.2 million of Canadian net operating losses and approximately $678 million of post-apportionment state net operating losses as of December 31, 2017. Of these amounts, approximately $11 million of Canadian and $1 million of state losses will be carried back to prior years and the remaining balance can be carried forward to future years. Net operating losses that can be carried forward, if unused, are scheduled to expire as follows: 2023—$137,000; 2024—$2.4 million; 2025—$2.8 million; 2026—$17.4 million; 2027—$102,000; 2029—$33.2 million; 2030—$28.6 million; 2031—$101.9 million; 2032—$9.7 million; 2034—$30,000; 2035—$302.7 million, 2036 - $644.6 million; and 2037—$647.1 million. +As of December 31, 2017, the Company had no unrecognized tax benefits. The Company has established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2017, the tax years ended December 31, 2013 through December 31, 2016 are open for examination by U.S. taxing authorities. As of December 31, 2017, the tax years ended December 31, 2013 through December 31, 2016 are open for examination by Canadian taxing authorities. +13. Employee Benefits +The Company maintains a 401(k) plan for all eligible employees. The Company’s operating results include expenses of approximately $8.7 million in 2017, $4.4 million in 2016 and $7.1 million in 2015 for the Company’s contributions to the plan. +14. Business Segments +At December 31, 2017, the Company had three business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) directional drilling services. Each of these segments represents a distinct type of business. These segments have separate management teams which report to the Company’s chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. +Contract Drilling — The Company markets its contract drilling services to major and independent oil and natural gas operators. As of December 31, 2017, the Company had 295 marketed land-based drilling rigs in the continental United States and western Canada. +For the years ended December 31, 2017, 2016 and, 2015, contract drilling revenue earned in Canada was $13.7 million, $15.6 million and $37.5 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $52.0 million and $44.0 million as of December 31, 2017 and 2016, respectively. +Pressure Pumping — The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Pressure pumping services are primarily well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. +Directional Drilling — The Company provides a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. +Major Customer — During 2017, no single customer accounted for more than 10% of the Company’s consolidated operating revenues. During 2016, one customer accounted for approximately $124 million or 14% of the Company’s consolidated operating revenues. During 2015, one customer accounted for approximately $244 million or 13% of the Company’s consolidated operating revenues. These revenues in 2015 and 2016 were earned in both the Company’s contract drilling and pressure pumping businesses. +F-33 +The following tables summari ze selected financial information relating to the Company’s business segments (in thousands): +Year Ended December 31, +2017 +2016 +2015 +Revenues: +Contract drilling +$ +1,041,492 +$ +544,196 +$ +1,155,565 +Pressure pumping +1,200,311 +354,070 +712,454 +Directional drilling +45,580 +— +— +Other operations(a) +76,781 +18,299 +24,931 +Elimination of intercompany revenues(b) +(7,480 +) +(699 +) +(1,673 +) +Total revenues +$ +2,356,684 +$ +915,866 +$ +1,891,277 +Income (loss) before income taxes: +Contract drilling +$ +(171,897 +) +$ +(235,858 +) +$ +(78,970 +) +Pressure pumping +21,028 +(176,628 +) +(254,998 +) +Directional drilling +(21 +) +— +— +Other operations +(20,813 +) +(3,391 +) +(14,269 +) +Corporate +(152,792 +) +(54,672 +) +(57,088 +) +Other operating income (expense), net (c) +31,957 +14,323 +(1,647 +) +Interest income +1,866 +327 +964 +Interest expense +(37,472 +) +(40,366 +) +(36,475 +) +Other +343 +69 +34 +Loss before income taxes +$ +(327,801 +) +$ +(496,196 +) +$ +(442,449 +) +Identifiable assets: +Contract drilling +$ +3,931,994 +$ +3,032,819 +$ +3,457,044 +Pressure pumping +1,209,424 +653,630 +813,704 +Directional drilling +301,275 +— +— +Other operations +172,094 +48,885 +38,726 +Corporate(d) +144,069 +36,957 +155,574 +Total assets +$ +5,758,856 +$ +3,772,291 +$ +4,465,048 +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +538,891 +$ +467,974 +$ +618,434 +Pressure pumping +198,006 +184,872 +214,552 +Directional drilling +9,347 +— +— +Other operations +29,402 +10,114 +26,301 +Corporate +7,695 +5,474 +5,472 +Total depreciation, depletion, amortization and impairment +$ +783,341 +$ +668,434 +$ +864,759 +Capital expenditures: +Contract drilling +$ +354,425 +$ +72,508 +$ +527,054 +Pressure pumping +171,436 +39,584 +197,577 +Directional drilling +7,795 +— +— +Other operations +31,547 +6,116 +16,625 +Corporate +1,884 +1,591 +2,520 +Total capital expenditures +$ +567,087 +$ +119,799 +$ +743,776 +( a) +Other operations includes the Company’s oilfield rental tools business, pipe handling components and related technology business, the oil and natural gas working interests and the Middle East/North Africa activities. +(b) +In 2017, intercompany revenues consists of contract drilling and revenues from other operations for services provided to contract drilling, pressure pumping and within other operations. In 2016, intercompany revenues consists of contract drilling and revenues within other operations. In 2015, intercompany revenues only consisted of contract drilling. +(c) +Other operating income (expense), net includes net gains or losses associated with the disposal of assets relate to corporate strategy decisions of the executive management group. Accordingly, the related gains or losses have been separately presented and excluded from the results of specific segments. This caption also includes expenses related to certain legal settlements net of insurance reimbursements. +(d) +Corporate assets primarily include cash on hand, income tax receivables, certain property and equipment, and certain deferred tax assets. +F-34 +15. Concentrations of Credit Risk +Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +The Company believes it has placed its demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2017 and 2016, the Company’s demand deposits and temporary cash investments consisted of the following (in thousands): +2017 +2016 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +13,860 +$ +846 +Deposits in FDIC and SIPC-insured institutions over insurance limits +106,849 +12,866 +Deposits in foreign banks +21,479 +27,557 +142,188 +41,269 +Less outstanding checks and other reconciling items +(99,360 +) +(6,117 +) +Cash and cash equivalents +$ +42,828 +$ +35,152 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which the Company provides services. As is general industry practice, the Company typically does not require customers to provide collateral. No significant losses from individual customers were experienced during the years ended December 31, 2017, 2016 or 2015. No expense for bad debts was recognized in 2017, 2016 or 2015. +16. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of the Company’s outstanding debt balances as of December 31, 2017 and 2016 is set forth below (in thousands): +December 31, 2017 +December 31, 2016 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +Borrowings under Credit Agreement: +Revolving credit facility +$ +268,000 +$ +268,000 +$ +— +$ +— +4.97% Series A Senior Notes +300,000 +303,966 +300,000 +283,534 +4.27% Series B Senior Notes +300,000 +295,616 +300,000 +263,194 +Total debt +$ +868,000 +$ +867,582 +$ +600,000 +$ +546,728 +The carrying value of the balances outstanding under the revolving credit facility approximates its fair values as this instrument has floating interest rates. The fair values of the Series A Notes and Series B Notes at December 31, 2017 and 2016 are based on discounted cash flows associated with the respective notes using current market rates of interest at those respective dates. For the Series A Notes, the current market rates used in measuring this fair value were 4.46% at December 31, 2017 and 6.65% at December 31, 2016. For the Series B Notes, the current market rates used in measuring this fair value were 4.64% at December 31, 2017 and 7.02% at December 31, 2016. These fair value estimates are based on observable market inputs and are considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting. +F-35 +17. Quarterly Financial Information (in thousands, except per share amounts) (unaudited) +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2017 +Operating revenues +$ +305,175 +$ +579,186 +$ +684,989 +$ +787,334 +Operating loss +(92,639 +) +(140,236 +) +(38,016 +) +(21,647 +) +Net income (loss) +(63,539 +) +(92,184 +) +(33,769 +) +195,402 +Net income (loss) per common share: +Basic +$ +(0.40 +) +$ +(0.46 +) +$ +(0.16 +) +$ +0.88 +Diluted +$ +(0.40 +) +$ +(0.46 +) +$ +(0.16 +) +$ +0.88 +2016 +Operating revenues +$ +268,939 +$ +193,907 +$ +206,133 +$ +246,887 +Operating loss +(95,259 +) +(124,332 +) +(123,409 +) +(113,226 +) +Net loss +(70,503 +) +(85,866 +) +(84,143 +) +(78,122 +) +Net loss per common share: +Basic +$ +(0.48 +) +$ +(0.58 +) +$ +(0.58 +) +$ +(0.53 +) +Diluted +$ +(0.48 +) +$ +(0.58 +) +$ +(0.58 +) +$ +(0.53 +) +F-36 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions(1) +Balance +(In thousands) +Year Ended December 31, 2017 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,191 +$ +— +$ +(868 +) +$ +2,323 +Year Ended December 31, 2016 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,545 +$ +— +$ +(354 +) +$ +3,191 +Year Ended December 31, 2015 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,546 +$ +— +$ +(1 +) +$ +3,545 +(1) +Consists of uncollectible accounts written off. +S-1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 20, 2018 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 20, 2018. +Signature +Title +/s/ Mark S. Siegel +Chairman of the Board +Mark S. Siegel +/s/ William Andrew Hendricks, Jr. +President, Chief Executive Officer +William Andrew Hendricks, Jr. +and Director +(Principal Executive Officer) +/s/ C. Andrew Smith +Executive Vice President and +C. Andrew Smith +Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Charles O. Buckner +Director +Charles O. Buckner +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Curtis W. Huff +Director +Curtis W. Huff +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Tiffany J. Thom +Director +Tiffany J. Thom +S-2 \ No newline at end of file diff --git a/raw/filings/0000889900/2017/0001564590-18-002481/filing_metadata.csv b/raw/filings/0000889900/2017/0001564590-18-002481/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..afda9bb9ca96661b6fabed3a9aec3369f24200bb --- /dev/null +++ b/raw/filings/0000889900/2017/0001564590-18-002481/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2018-02-20,2017-12-31,2018-02-20T21:42:20.000Z,0001564590-18-002481,pten-10k_20171231.htm,10-K,18283330,1,0,https://www.sec.gov/Archives/edgar/data/889900/000156459018002481/pten-10k_20171231.htm,https://www.sec.gov/Archives/edgar/data/889900/000156459018002481/,2017,2017,1 diff --git a/raw/filings/0000889900/2017/0001564590-18-002481/item1.txt b/raw/filings/0000889900/2017/0001564590-18-002481/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..98dc5e309bcc30b131ef4095e19d7f653878a301 --- /dev/null +++ b/raw/filings/0000889900/2017/0001564590-18-002481/item1.txt @@ -0,0 +1,319 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada, and we are pursuing contract drilling opportunities outside of North America. As of December 31, 2017, we had a drilling fleet that consisted of 295 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells. As of December 31, 2017, we had approximately 1.6 million fracturing horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, directional surveying, measurement-while-drilling, and wireline steering tools. +We have other operations where we provide oilfield rental equipment in many of the major producing onshore oil and gas basins in the United States, and we also manufacture and sell pipe handling components and related technology to drilling contractors in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”) initially guaranteed on a senior unsecured basis by certain of our subsidiaries. The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. We intend to use the remainder of the net proceeds for general corporate purposes. +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of MS Directional. The aggregate consideration paid by us consisted of $69.8 million in cash and approximately 8.8 million shares of our common stock. Based on the closing price of our common stock on the closing date of the transaction, the total fair value of the consideration transferred to effect the acquisition of MS Directional was approximately $257 million. +3 +On December 12, 2016, we entered into an Agreement and Plan of Merger (the “merger agreement”) with SSE. On April 20, 2017, pursuant to the m erger agreement, a subsidiary of ours was merged with and into SSE, with SSE continuing as the surviving entity and one of our wholly - owned subsidiaries. Pursuant to the terms of the merger agreement, we acquired all of the issued and outstanding shares o f common stock of SSE, in exchange for approximately 46.3 million shares of our common stock. Concurrent with the closing of the merger, we repaid all of the outstanding debt of SSE totaling $472 million. Based on the closing price of our common stock on April 20, 2017, the total fair value of the consideration transferred to effect the acquisition of SSE was approximately $1.5 billion. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary named Seventy Sev en Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of our wholly - owned subsidiaries. +Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of modern, efficient fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a modern, well-maintained fleet of premium oilfield rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +Operational data in the discussion and analysis in this Report includes the results of operations of the MS Directional business since October 11, 2017 and the results of operations of the SSE businesses since April 20, 2017. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2015, 2016 and 2017 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2015: +Average oil price per Bbl (1) +$ +48.54 +$ +57.85 +$ +46.42 +$ +41.96 +Average rigs operating per day - U.S. (2) +165 +122 +105 +88 +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil and natural gas prices have modestly recovered from the lows experienced in the first quarter of 2016. Oil prices averaged $55.37 per barrel in the fourth quarter of 2017. +Our rig count in the United States declined significantly during the industry downturn that began in late 2014, but has improved since the second quarter of 2016. Our average rig count in the United States was 159 rigs for both the third and fourth quarter of 2017, with the third quarter of 2017 being the first quarter with a full quarter contribution from the rigs acquired in the SSE merger. Our rig count in the United States at December 31, 2017 was 163 rigs. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 96 rigs operating under term contracts during the first quarter of 2018 and an average of 67 rigs operating under term contracts throughout 2018. +Activity levels in our pressure pumping business also improved during 2017, especially in the Permian Basin. We reactivated two frac spreads during the third quarter and one additional frac spread during the fourth quarter. With the addition of these three frac spreads, we exited 2017 with 23 active frac spreads or approximately 1.25 million active fracturing horsepower. +Industry Segments +Our revenues, operating income (loss) and identifiable assets are primarily attributable to two industry segments: +• +contract drilling services, and +• +pressure pumping services. +Our contract drilling services industry segment had operating losses in 2017, 2016 and 2015. Our pressure pumping services industry segment had operating income in 2017 and operating losses in 2016 and 2015. Our third industry segment, directional drilling services, is a new segment for us as a result of the MS Directional acquisition and accounted for approximately two percent of our 2017 consolidated revenues. +4 +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14 of Notes to Consolidat ed Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2017, we had 295 marketed land-based drilling rigs based in the following regions: +• +71 in west Texas and southeastern New Mexico, +• +32 in north central and east Texas and northern Louisiana, +• +42 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +40 in south Texas, +• +55 in western Oklahoma, +• +48 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +7 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 25,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $954 million during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2017, 2016 and 2015, we spent approximately $354 million, $73 million and $527 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to two years) and provide for the use of the drilling rig to drill multiple wells. During 2017, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 15 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis. Under daywork contracts, we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. All of the wells we drilled in 2017, 2016 and 2015 were under daywork contracts. +5 +From time to time more than five y ears ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis). We generally assume greater operational and economic risk drilling on a turn key basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2017 +2016 +2015 +Average rigs operating per day - U.S.(1) +136 +63 +120 +Average rigs operating per day - Canada(1) +2 +2 +4 +Number of rigs operated during the year +179 +100 +223 +Number of wells drilled during the year +3,160 +1,470 +2,448 +Number of operating days +50,427 +23,596 +45,142 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2017, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad Capable +APEX ® 1500 HP rigs +164 +1 +165 +86 +% +APEX ® 1000 HP rigs +20 +— +20 +100 +% +APEX ® 1200 HP rigs +4 +— +4 +100 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 2000 HP rigs +5 +— +5 +60 +% +Other electric rigs +90 +6 +96 +49 +% +Total +288 +7 +295 +75 +% +Average horsepower +1,394 +1,171 +1,389 +The U.S. land rig industry has recently begun referring to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has a 750,000 pound hookload, has a 7,500 psi circulating system and is pad capable. We currently estimate there are approximately 550 super-spec rigs in the United States, which includes 130 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (West and South Regions) and the Mid-Continent (Mid-Con Region) and Appalachian regions (Northeast Region). Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +6 +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum rev enue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as nitrogen, cementing and acid pumping services, with a total of approximately 1.6 million horsepower as of December 31, 2017. Pressure pumping equipment at December 31, 2017 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +West Texas Region +Number of units +235 +30 +265 +Approximate horsepower +537,950 +30,890 +568,840 +South Texas Region +Number of units +147 +— +147 +Approximate horsepower +361,250 +— +361,250 +Mid-Con Region +Number of units +134 +— +134 +Approximate horsepower +305,500 +— +305,500 +Northeast Region +Number of units +169 +95 +264 +Approximate horsepower +353,800 +55,400 +409,200 +Combined: +Number of units +685 +125 +810 +Approximate horsepower +1,558,500 +86,290 +1,644,790 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material, or should one of our suppliers fail to timely deliver our materials. +Directional Drilling Operations +General – We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, directional surveying, measurement while drilling (“MWD”), and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, manufacture and maintain our own fleet of downhole drilling motors and MWD equipment. We occasionally rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. As a complement to our core directional drilling services, we provide downhole survey services and rent our proprietary drilling motors to both oil and natural gas operators and other oilfield service companies. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. We utilize our fleet of directional drilling motors, MWD equipment and survey equipment to provide: (1) directional drilling services, (2) third-party motor rentals and (3) downhole survey services. +7 +Directional Drilling Services – We provide our directional drilling services on a day-rate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the numbe r of days of work completed. Our day rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a stand-by rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Third-Party Motor Rental – We rent our drilling motors on an hourly- or day-rate basis to complement our directional drilling services and optimize the utilization of our asset base. Our third-party motor rental revenue is recognized as work progresses based on the number of days or hours our motors are used or are on location. +Downhole Survey Services – We provide our downhole survey services on a day-rate, hourly-rate or completed-job basis. Revenue for our downhole survey services is recognized upon the completion of each day’s work. Our downhole survey services are typically non-contractual. We normally provide a quote to our customers in advance and then issue an invoice for the downhole survey services provided based on a completed field ticket. +Equipment – We generally design, manufacture, maintain and inspect our own equipment. We occasionally rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment and survey tools. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have th e ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2017, we had a comprehensive fleet of over 1,600 motors that serve both internal needs and external motor rental requirements. In addition to our motor fleet, we had 112 MWD systems as well as downhole surveying equipment to provide accurate wellbore surveys. +Oilfield Rentals +Our oilfield rentals business has a modern, well-maintained fleet of premium oilfield rental tools, and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. We offer an extensive line of rental tools, including a full line of tubular products specifically designed for horizontal drilling and completion, with high-torque, premium-connection drill pipe, drill collars and tubing. Additionally, we offer surface rental equipment including blowout preventers, frac tanks, mud tanks and environmental containment that encompass all phases of the hydrocarbon extraction and production process. Our air drilling equipment and services enable extraction in select basins where certain segments of formations preclude the use of drilling fluid, permitting operators to drill through problematic zones without the risk of fluid absorption and damage to the wellbore. We also provide frac-support services, including delivery of on-site frac water through a water transfer operation using innovative lay-flat pipe, and monitoring and controlling of production returns. We offer oilfield rental services in many of the major producing onshore oil and gas basins in the United States. We price our rentals and services based on the type of equipment being rented and the services being performed. Substantially all rental revenue we earn is based upon a charge for the actual period of time the rental is provided to our customer on a market-based, fixed per-day or per-hour fee. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and oilfield rentals contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2017, we received approximately 43% from our ten largest customers and approximately 29% from our five largest customers. During 2017, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +Backlog +Our contract drilling backlog as of December 31, 2017 and 2016 was $544 million and $417 million, respectively. Approximately 19% of the total contract drilling backlog at December 31, 2017 is reasonably expected to remain after 2018. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn, such as the current market environment. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing, nitrogen and acidizing and related well servicing activities, +• +directional drilling services, third-party motor rentals and downhole survey services, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, and +• +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +9 +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D crite ria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +10 +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupatio nal Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +11 +Employees +We had approximately 8,000 full-time employees as of February 16, 2018. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. \ No newline at end of file diff --git a/raw/filings/0000889900/2017/0001564590-18-002481/item13.txt b/raw/filings/0000889900/2017/0001564590-18-002481/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2017/0001564590-18-002481/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2017/0001564590-18-002481/item9a.txt b/raw/filings/0000889900/2017/0001564590-18-002481/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..9a66831b13ee99a3b3a573c7bbe7a42b3078fc0d --- /dev/null +++ b/raw/filings/0000889900/2017/0001564590-18-002481/item9a.txt @@ -0,0 +1,9 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2017, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2017. +Our wholly-owned subsidiary, MS Directional, LLC, was excluded from our evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017. We acquired MS Directional, LLC on October 11, 2017. This subsidiary was excluded from the scope of our review due to the fact that the acquisition closed in the fourth quarter of 2017, at which time we began integrating the acquired business into our existing internal controls over financial reporting. The acquired business represented approximately two percent of our consolidated revenues for the year ended December 31, 2017 and approximately five percent of our consolidated total assets as of December 31, 2017. +The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2017/0001564590-18-002481/rp_note.txt b/raw/filings/0000889900/2017/0001564590-18-002481/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2017/0001564590-18-002481/rpt_disclosure.txt b/raw/filings/0000889900/2017/0001564590-18-002481/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2018/0001564590-19-002863/filing.txt b/raw/filings/0000889900/2018/0001564590-19-002863/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..76e0474d4a472d8f4927b79cf5bf6fe820878a34 --- /dev/null +++ b/raw/filings/0000889900/2018/0001564590-19-002863/filing.txt @@ -0,0 +1,5481 @@ +10-K +1 +pten-10k_20181231.htm +10-K +pten-10k_20181231.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +Form 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2018 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-22664 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N, Suite 800, Houston, Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +(281) 765-7100 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Exchange on Which Registered +Common Stock, $0.01 Par Value +The Nasdaq Global Select Market +Securities Registered Pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ or No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Smaller reporting company +☐ +Non-accelerated filer +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 29, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $3.9 billion, calculated by reference to the closing price of $18.00 for the common stock on the Nasdaq Global Select Market on that date. +As of February 8, 2019, the registrant had outstanding 213,652,772 shares of common stock, $0.01 par value, its only class of common stock. +Documents incorporated by reference: +Portions of the registrant’s definitive proxy statement for the 2019 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings, press releases and presentations by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. As used in this Report, “the Company,” “us,” “we,” our” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its operations through its wholly-owned subsidiaries and has no employees or independent business operations. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue and cost expectations and backlog; financing of operations; oil and natural gas prices; rig counts; source and sufficiency of funds required for building new equipment, upgrading existing equipment and additional acquisitions (if opportunities arise); impact of inflation; demand for our services; competition; equipment availability; government regulation; debt service obligations; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +adverse oil and natural gas industry conditions; +• +global economic conditions; +• +volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +excess availability of land drilling rigs, pressure pumping and directional drilling equipment, including as a result of reactivation, improvement or construction; +• +competition and demand for our services; +• +strength and financial resources of competitors; +• +utilization, margins and planned capital expenditures; +• +liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• +the ability to realize backlog; +• +specialization of methods, equipment and services and new technologies; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +cybersecurity events; +• +the ability to retain management and field personnel; +• +loss of key customers; +• +synergies, costs and financial and operating impacts of acquisitions; +• +difficulty in building and deploying new equipment; +• +governmental regulation; +• +environmental risks and ability to satisfy future environmental costs; +• +legal proceedings and actions by governmental or other regulatory agencies; +1 +• +technology-related disputes; +• +the ability to effectively identify and enter new markets; +• +weather; +• +operating costs; +• +expansion and development trends of the oil and natural gas industry; +• +ability to obtain insurance coverage on commercially reasonable terms; +• +financial flexibility; +• +interest rate volatility; +• +adverse credit and equity market conditions; +• +availability of capital and the ability to repay indebtedness when due; +• +compliance with covenants under our debt agreements; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in our filings with the SEC. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada , and we are pursuing contract drilling opportunities outside of North America . As of December 31, 2018, we had a drilling fleet that consisted of 252 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. As of December 31, 2018, we had approximately 1.6 million fracturing horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, motor rentals, directional surveying, measurement-while-drilling, wireline steering tools and services that improve the accuracy of horizontal wellbore placement. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also manufacture and sell pipe handling components and related technology to drilling contractors, and provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +On October 25, 2018, we acquired all of the issued and outstanding shares of Current Power Solutions, Inc. (“Current Power”). Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. +On March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. +On February 20, 2018, we acquired the business of Superior QC, LLC (“Superior QC”), including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. +On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”) . The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. +3 +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of M S Directional , LLC (f/k/a Multi-Shot, LLC) (“MS Directional”) . MS Directional is a leading directional drilling services company in the Unit ed States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, motor rentals, directional surveyin g, measurement - while - drilling, and wireline steering tools. +On April 20, 2017, pursuant to an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”), a subsidiary of ours was merged with and into SSE (the “SSE merger”), with SSE continuing as the surviving entity and one of our wholly-owned subsidiaries. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of our wholly-owned subsidiaries. Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +Operational data in the discussion and analysis in this Report includes the results of operations of Current Power since October 25, 2018, the results of operations of Superior QC since February 20, 2018, the results of operations of the MS Directional business since October 11, 2017 and the results of operations of the SSE businesses since April 20, 2017. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2016, 2017 and 2018 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil prices have recovered from the lows experienced in the first quarter of 2016. Oil prices reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil reached a fourth quarter 2018 high of $76.40 per barrel on October 3, 2018, before declining by 42% over the course of three months to reach a low of $44.48 per barrel in late December 2018. Oil prices averaged $59.08 per barrel in the fourth quarter of 2018. +Our rig count declined significantly during the industry downturn that began in late 2014 but has improved since the second quarter of 2016. Our average rig count for the fourth quarter of 2018 was 183 rigs, which included 182 rigs in the United States and one rig in Canada. This was an increase from our average rig count for the third quarter of 2018 of 178 rigs, which included 177 rigs in the United States and one rig in Canada. Our rig count in the United States at December 31, 2018 of 183 rigs was greater than the rig count of 163 rigs at December 31, 2017. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 122 rigs operating under term contracts during the first quarter of 2019 and an average of 78 rigs operating under term contracts throughout 2019. +With the weakness in crude oil prices late in the fourth quarter, operators have been delaying starting new completion projects in the first quarter, and pricing remains extremely competitive. As such, we have made the decision to idle spreads rather than work at unreasonably low prices. We ended the fourth quarter with 20 active spreads and idled three spreads early in the first quarter of 2019 . +Industry Segments +Our revenues, operating income (loss) and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +4 +• +directional drilling services . +Our contract drilling services industry segment had operating losses in 2018, 2017 and 2016. Our pressure pumping services industry segment had operating losses in 2018 and 2016 and operating income in 2017. Our third industry segment, directional drilling services, was a new segment for us as a result of the MS Directional acquisition in 2017 and accounted for approximately six percent and two percent of our 2018 and 2017 consolidated revenues, respectively. Our directional drilling segment had operating losses in 2018 and 2017. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 16 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2018, we had 252 marketed land-based drilling rigs based in the following regions: +• +74 in west Texas and southeastern New Mexico, +• +24 in north central and east Texas and northern Louisiana, +• +37 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +31 in south Texas, +• +38 in western Oklahoma, +• +42 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +6 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 25,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs, or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $822 million during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2018, 2017 and 2016, we spent approximately $395 million, $354 million and $72.5 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to four years) or for a specified number of wells. During 2018, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 21 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +5 +Our drilling contracts provide for payment on a daywork basis , pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate wh en the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2018 +2017 +2016 +Average rigs operating per day - U.S. (1) +175 +136 +63 +Average rigs operating per day - Canada (1) +1 +2 +2 +Number of rigs operated during the year +193 +179 +100 +Number of wells drilled during the year +3,088 +2,553 +1,164 +Number of operating days +64,479 +50,427 +23,596 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500-ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad-capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2018, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad-Capable +APEX ® 1500 HP rigs +169 +— +169 +94 +% +APEX ® 1000 HP rigs +14 +— +14 +100 +% +APEX ® 1200 HP rigs +4 +— +4 +100 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 2000 HP rigs +6 +— +6 +67 +% +Other electric rigs +48 +6 +54 +59 +% +Total +246 +6 +252 +87 +% +Average horsepower +1,465 +1,117 +1,457 +The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be at least a 1,500 horsepower, AC powered rig that has a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We currently estimate there are approximately 650 super-spec rigs in the United States, which includes 149 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania, Ohio and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas (West and South Regions), the Mid-Continent region (Mid-Con Region) and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +6 +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term cont racts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.6 million horsepower as of December 31, 2018. Pressure pumping equipment at December 31, 2018 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +West Texas Region +Number of units +229 +31 +260 +Approximate horsepower +524,450 +32,340 +556,790 +South Texas Region +Number of units +138 +1 +139 +Approximate horsepower +334,750 +950 +335,700 +Mid-Con Region +Number of units +118 +— +118 +Approximate horsepower +269,250 +— +269,250 +Northeast Region +Number of units +200 +78 +278 +Approximate horsepower +430,050 +44,700 +474,750 +Combined: +Number of units +685 +110 +795 +Approximate horsepower +1,558,500 +77,990 +1,636,490 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Directional Drilling Operations +General – We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, motor rentals, directional surveying, measurement-while-drilling (MWD), and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. We sometimes rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. As a complement to our core directional drilling services, we provide downhole survey services and rent our proprietary drilling motors to both oil and natural gas operators and other oilfield service companies. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. We utilize our fleet of directional drilling motors, MWD equipment and survey equipment to provide: (1) directional drilling services, (2) third-party motor rentals and (3) downhole survey services. +7 +Directional Drilling Services – We provide our directional drilling services on a day-rate basis, typically under master service agree ments. Revenue from directional drilling services is recognized as work progresses based on the number of days of work completed. Our day rates and other charges generally vary by location and depend on the equipment and personnel required for the job an d market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a stand-by rate is typically agreed upon in advance and charged on a daily basis during periods whe n drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Third-Party Motor Rental – We rent our drilling motors on an hourly- or day-rate basis to complement our direction al drilling services and optimize the utilization of our asset base. Our third-party motor rental revenue is recognized as work progresses based on the number of days or hours our motors are used or are on location. +Downhole Survey Services – We provide our downhole survey services on a day-rate, hourly-rate or completed-job basis. Revenue for our downhole survey services is recognized upon the completion of each day’s work. Our downhole survey services are typically non-contractual. We normally provide a quote to our customers in advance and then issue an invoice for the downhole survey services provided based on a completed field ticket. +Equipment – We generally design, assemble, maintain and inspect our own equipment. We sometimes rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment and survey tools. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2018, we had a comprehensive fleet of over 1,600 motors that serve both internal needs and external motor rental requirements. In addition to our motor fleet, we had 127 MWD systems as well as downhole surveying equipment to provide accurate wellbore surveys. +Horizontal Wellbore Placement – We provide software and services used to improve the statistical accuracy of horizontal wellbore placement. Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. We provide these services to customers with onshore and offshore operations. +Oilfield Rentals +Our oilfield rentals business has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. We offer an extensive line of rental tools, including a full line of tubular products specifically designed for horizontal drilling and completion, with high-torque, premium-connection drill pipe, drill collars and tubing. Additionally, we offer surface rental equipment including blowout preventers, frac tanks, mud tanks and environmental containment that encompass all phases of the hydrocarbon extraction and production process. Our air drilling equipment and services enable extraction in select basins where certain segments of formations preclude the use of drilling fluid, permitting operators to drill through problematic zones without the risk of fluid absorption and damage to the wellbore. We offer oilfield rental services in many of the major producing onshore oil and gas basins in the United States. We price our rentals and services based on the type of equipment being rented and the services being performed. Substantially all rental revenue we earn is based upon a charge for the actual period of time the rental is provided to our customer on a market-based, fixed per-day or per-hour fee. +Other Operations +We manufacture and sell pipe handling components and related technology for drilling contractors in North America and other select markets, and provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling, oilfield rentals and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +8 +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2018, we received approximately 41% from our ten largest customers and approximately 26% from our five largest customers. During 2018, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +Our contract drilling backlog as of December 31, 2018 and 2017 was $770 million and $544 million, respectively. Approximately 23% of the total contract drilling backlog at December 31, 2018 is reasonably expected to remain after 2019. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, third-party motor rentals, and downhole survey services, +• +services that improve the statistical accuracy of horizontal wellbore placement, including for customers with offshore operations, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +manufacture and sale of pipe handling components and related technology, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their +9 +treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by pri or owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA has not yet proposed such a rule. If changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +10 +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handli ng, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar en vironmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the sa tisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequ ent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +11 +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the fut ure, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage . Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 8,000 full-time employees as of February 8, 2019. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of calendar years, we sometimes experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling, pressure pumping and directional drilling services, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the availability of and constraints in pipeline, storage and other transportation capacity in the basins in which we operate, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production, use and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, and +12 +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Oil and natural gas prices and markets can be extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, +• +the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil-producing nations, such as Russia, to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +• +domestic and international military, political, economic and weather conditions, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +• +the price and availability of alternative fuels. +All of these factors are beyond our control. The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. As a result of the lower level of oil prices, our industry experienced a severe decline in activity levels. While oil and natural gas prices modestly recovered since the first quarter of 2016, and we have experienced an increase in the demand for our services since 2016, our average number of rigs operating remains well below the number of our available rigs, and a portion of our pressure pumping horsepower remains stacked. Oil prices remain volatile, as the closing price of oil reached a fourth quarter 2018 high of $76.40 per barrel on October 3, 2018, before declining by 42% over the course of three months to reach a low of $44.48 per barrel in late December 2018. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices or expectations of decreases in oil and natural gas prices would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Global Economic Conditions May Adversely Affect Our Operating Results. +Global economic conditions and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise, may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. An economic slowdown or recession in the United States or in any other country that significantly affects the supply of or demand for oil or natural gas could negatively impact our operations and therefore adversely affect our results. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, and there is no assurance that the global economic environment will not quickly deteriorate again due to one or more factors, including a decline in the price for oil or natural gas. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +13 +Ex cess Equipment and a Highly Competitive Oil Service Industry May Adversely Affect Our Utilization and Profit Margins and the Carrying Value of our Assets. +The North American land drilling and pressure pumping businesses are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. In addition, in recent years there has been a substantial increase in the construction of new technology drilling rigs and new pressure pumping equipment and the improvement of existing drilling rigs. Low commodity prices and construction of new equipment and the improvement of existing drilling rigs can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. Even in an environment of high oil and natural gas prices and increased drilling activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to an excess supply of equipment. +We periodically seek to increase the prices on our services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry, and we are not always successful in raising or maintaining our existing prices. With the active rig count below the peak seen in 2014 and many rigs, including highly capable AC rigs, and pressure pumping equipment still idle, there is considerable pricing pressure in the industry. Even if we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial condition, cash flows and results of operations. In addition, we may be unable to replace fixed-term contracts that were terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. +Accordingly, high competition and excess equipment can cause oil and natural gas service contractors to have difficulty maintaining pricing, utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or excess equipment in the oil and natural gas service businesses or the level of demand for our contract drilling, pressure pumping or directional drilling services. +The excess supply of operable land drilling rigs, increasing rig specialization and excess pressure pumping and directional drilling equipment, which has been exacerbated by a decline in oil and natural gas prices, could affect the fair market value of our drilling, pressure pumping and directional drilling equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices could result in future impairment to our long-lived assets and goodwill. For example, we recognized impairment charges of $277 million and $29 million in 2018 and 2017, respectively. +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance . +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +14 +We maintain insurance coverage of types and amounts that we believe to be customary in the indu stry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our eq uipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cove r any losses or liabilities, or that this insurance will continue to be available , or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generall y maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage, a nd a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cyber security risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +On January 22, 2018, an accident at a drilling site in Pittsburg County, Oklahoma resulted in the losses of life of five people, including three of our employees. Lawsuits have been filed in the District Court for Pittsburg County, Oklahoma in connection with the five individuals who lost their lives and one of our employees who was injured in the accident. The lawsuits have been consolidated for discovery purposes under Cause No. CJ-2018-60 (the “Litigation”). These lawsuits allege various causes of action against us including negligence, gross negligence, knowledge that injury or death was substantially certain, acting with purpose, recklessness, wrongful death and survival, and the plaintiffs seek an unspecified amount of damages, including punitive or exemplary damages, costs, interest, and other relief. We dispute the plaintiffs’ allegations and intend to continue to defend ourselves vigorously. Based on the information we have available as of the date of this Report, we believe that we have adequate insurance to cover the Litigation. However, if this accident is not, or another significant accident or other event occurs that is not, fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2018, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $770 million. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a description of our calculation of backlog. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts or may be reduced by price adjustments to existing contracts, including as a result of the decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services. +New Technologies May Cause Our Operating Methods, Equipment and Services to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive in Our Industry. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance of drilling rigs and pressure pumping and other equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and pressure pumping and other equipment. Accordingly, a higher level of capital expenditures may be required to maintain and improve existing +15 +rigs and pressure pumping and other equipment and purchase and construct newer, higher specification drilling rigs and pressure pumping and other equipment to meet the increasingly sophisticated needs of our customers. In addition, technologic al changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping and directional drilling business es could have similar effects. +In recent years, we have added drilling rigs to our fleet through new construction, purchased new pressure pumping equipment and acquired a directional drilling services company. We have also improved existing drilling rigs and pressure pumping equipment by adding equipment and technology designed to enhance functionality and performance. Although we take measures to ensure that we use advanced oil and natural gas drilling, pressure pumping and directional drilling technology, changes in technology, improvements in competitors’ equipment and changes relating to the wells to be drilled and completed could make our equipment less competitive. +If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment and services obsolete, which could reduce our competitiveness and have a material adverse impact on our business, financial condition, cash flows and results of operation. +Shortages, Delays in Delivery, and Interruptions in Supply, of Equipment and Materials Could Adversely Affect Our Operating Results. +During periods of increased demand for oilfield services, the industry has experienced shortages of equipment for upgrades, drill pipe, replacement parts and other equipment and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +transportation and other logistical challenges, and +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs. Severe shortages, delays in delivery and interruptions in supply could limit our ability to operate, maintain, upgrade and construct our drilling rigs and pressure pumping and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Loss of Key Personnel and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations. +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel, particularly after a prolonged industry downturn. During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of key personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even if it is generally a period of lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2018, we received approximately 41% from our ten largest customers, 26% from our five largest customers and 8% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +16 +Our Business Is Subject to Cybersecurity Risks and Threats. +Our operations are increasingly dependent on information technologies and services. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, attempts to gain unauthorized access to our data and systems, theft, viruses, malware, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• +theft or misappropriation of funds, including via “phishing” or similar attacks directed at us or our customers; +• +loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• +disruption or impairment of our and our customers’ business operations and safety procedures; +• +destruction or damage to our and our customers’ equipment; +• +downtime and loss of revenue; +• +injury to our reputation; +• +negative impacts on our ability to compete; +• +loss or damage to our worksite data delivery systems; and +• +increased costs to prevent, respond to or mitigate cybersecurity events. +Although we utilize various procedures and controls to mitigate our exposure to such risks, cybersecurity attacks and other cyber events are evolving and unpredictable. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber incident could go unnoticed for a period of time. Any such incident could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Growth Through Acquisitions, the Building of New Rigs and Pressure Pumping Equipment and the Development of Technology Is Not Assured. +We have grown our drilling rig fleet and pressure pumping fleet and expanded our business lines and use of technology in the past through mergers, acquisitions, new construction and technology development. For example, we completed the SSE merger and the MS Directional acquisition during 2017. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building new rigs and pressure pumping equipment or developing new technology. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, our competitors may continue to build new, high technology rigs and new, high horsepower equipment and develop new technology. +There can be no assurance that we will: +• +have sufficient capital resources to complete additional acquisitions, build new rigs or pressure pumping equipment or develop new technology, +• +successfully integrate additional drilling rigs, pressure pumping equipment, acquired or developed technology or other assets or businesses, +• +effectively manage the growth and increased size of our organization, drilling fleet and pressure pumping equipment, +• +successfully deploy idle, stacked, upgraded or additional rigs, pressure pumping equipment and acquired or developed technology, +• +maintain the crews necessary to operate additional drilling rigs and pressure pumping equipment or the personnel necessary to evaluate, develop and deploy new technology, or +• +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition, the building of new drilling rigs and pressure pumping equipment or the development of new technology. +17 +Our failure to achieve consolidation savings, to inte grate acquired businesses and technology and other assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising f rom events prior to any acquisitions , prior to our establishment of adequate compliance oversight or in connection with disputes over acquired or developed technology . While we generally seek to obtain indemnities for liabilities arising from events occurr ing before such acquisitions, these are limited in amount and duration, may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build new drilling rigs or new pressure pumping equipment or develop new technology, and we also may issue equity, convertible or debt securities in connection with any such acquisitions or building program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties or judgments, +• +modification, denial or revocation of permits or other authorizations, +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the places that we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, a manufacturer and servicer of equipment and automation to the energy, marine and mining industries and a provider of directional drilling services, we may be deemed to be a responsible party under these laws and regulations. +Changes in environmental laws and regulations occur frequently and such laws and regulations tend to become more stringent over time. Stricter laws, regulations or enforcement policies could significantly increase compliance costs for us and our customers and have a material adverse effect on our operations or financial position. For example, on August 16, 2012, the EPA issued final rules that establish new air emission control requirements for natural gas and NGL production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds and National Emissions Standards for Hazardous Air Pollutants (“NESHAPS”) to address hazardous air pollutants frequently associated with gas production and processing activities. In June 2016, the EPA published a final rule that updates and expands the New Source Performance Standards by setting additional emissions limits for volatile organic compounds and regulating methane emissions for new and modified sources in the oil and gas industry. The EPA finalized amendments to some requirements in these standards in February 2018 and September 2018, including rescission of certain requirements and revisions to other requirements such as fugitive emissions monitoring frequency. In November 2016, the EPA announced that it intends to impose methane emission standards for existing sources and issued information collection requests for oil and natural gas facilities. That information request was withdrawn in March 2017. The EPA also published a final rule in June 2016 concerning aggregation of sources that affects source determinations for air permitting in the oil and gas industry. In November 2016, the Department of the Interior’s Bureau of Land Management (“BLM”) issued final rules relating to the venting, flaring and leaking of natural gas by oil and natural gas producers who operate on federal and Indian lands. The rules limited routine flaring of natural gas, require the payment of royalties on avoidable gas losses and require plans or programs relating to gas capture and leak detection and repair. The BLM issued a two-year stay of these requirements in December 2017. In February 2018, the BLM proposed to repeal certain of the requirements of the 2016 methane rules. Several states filed judicial challenges to the BLM’s proposed repeal. In April 2018, a federal court stayed the litigation pending finalization or withdrawal of the BLM’s February 2018 proposal. In September 2018, the BLM published a final rule that largely adopted the February 2018 proposal and rescinded several requirements. The September 2018 rule was challenged in the U.S. District Court for the Northern District of California almost immediately after issuance. The challenge is still pending. These or other initiatives could increase costs to us and our customers or reduce demand for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations. +18 +Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations. +Members of the U.S. Congress and the EPA are reviewing proposals for more stringent regulation of hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. For example, the EPA conducted a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater. As part of this study, the EPA sent requests to a number of companies, including our company, for information on hydraulic fracturing practices. We responded to the inquiry. The EPA released its final report in December 2016. It concluded that hydraulic fracturing activities can impact drinking water resources under some circumstances, including large volume spills and inadequate mechanical integrity of wells. Further, we conduct drilling, pressure pumping and directional drilling activities in numerous states. Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. When caused by human activity, such seismic activity is called induced seismicity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) and other aspects of the oil and gas industry. +In addition, legislation has been proposed, but not enacted, in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if enacted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SDWA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel. In May 2014, the EPA issued an Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing. The EPA has not yet finalized this rule. Further, in March 2015, the BLM issued a final rule to regulate hydraulic fracturing on Indian land. The rule required companies to publicly disclose chemicals used in hydraulic fracturing operations to the BLM. However, this rule was rescinded by rule in December 2017. In June 2016, the EPA published final pretreatment standards for disposal of wastewater produced from shale gas operations to publicly owned treatment works. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations. For example, Colorado, Louisiana, Montana, North Dakota, Texas and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in response to such regulation. +In addition, in light of concerns about induced seismicity, some state regulatory agencies have modified their regulations or issued orders to address induced seismicity. For example, the Oklahoma Corporation Commission (“OCC”) has implemented volume reduction plans, and at times required shut-ins, for oil and natural gas disposal wells injecting wastewater into the Arbuckle formation. The OCC also recently released well completion seismicity guidelines for operators in the SCOOP and STACK plays that call for hydraulic fracturing operations to be suspended following earthquakes of certain magnitudes in the vicinity. +Finally, some jurisdictions have taken steps to enact hydraulic fracturing bans or moratoria. In June 2015, New York banned high volume fracturing activities combined with horizontal drilling. Certain communities in Colorado have also enacted bans on hydraulic fracturing. Voters in the city of Denton, Texas approved a moratorium on hydraulic fracturing in November 2014, though it was later lifted in 2015. These actions have been the subject of legal challenges. In November 2018, voters rejected an initiative that would have materially restricted hydraulic fracturing activity in Colorado. +The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could make it more difficult to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. +19 +Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business +We are aware of the increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. The EPA has adopted rules requiring the reporting of GHG emissions from specified large GHG emission sources on an annual basis. In October 2015, the EPA finalized rules that added new sources to the scope of the GHG monitoring and reporting requirements. These new sources include gathering and boosting facilities as well as completions and workovers from hydraulically fractured oil wells. The revisions also include the addition of well identification reporting requirements for certain facilities. Also, in November 2016, the EPA published a final rule adding monitoring methods for detecting leaks from oil and gas equipment and emission factors for leaking equipment to be used to calculate and report GHG emissions resulting from equipment leaks. In addition, the United States was actively involved in the United Nations Conference on Climate Change in Paris, which led to the creation of the Paris Agreement. In April 2016, the United States signed the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, every five years. In June 2017, President Trump announced that the United States will withdraw from the Paris Agreement unless it is renegotiated. The State Department informed the United Nations of the United States’ withdrawal in August 2017. Due to the Paris Agreement’s protocol, the earliest the United States will be able to withdraw is 2020. However, several states and geographic regions in the United States have adopted legislation and regulations to reduce emissions of GHGs. Additional legislation or regulation by these states and regions, the EPA, and/or any international agreements to which the United States may become a party, that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our operations. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +The Design, Manufacture, Sale and Servicing of Products, including Electrical Controls and Rig Components, May Subject Us to Liability for Personal Injury, Property Damage and Environmental Contamination Should Such Equipment Fail to Perform to Specifications. +We provide products, including electrical controls and rig components such as top drives, to customers involved in oil and gas exploration, development and production and in the marine and mining industries. Because of applications which use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause harm to our reputation, contractual and warranty-related liability, damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. +Legal Proceedings and Governmental Investigations Could Have a Negative Impact on Our Business, Financial Condition and Results of Operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. For example, the EPA, OSHA and the U.S. Chemical Safety and Hazard Investigation Board (“CSB”) initiated investigations relating to the January 22, 2018 accident at a drilling site in Pittsburg County, Oklahoma. The EPA and CSB investigations are ongoing. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Please see “Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Technology Disputes Could Negatively Impact Our Operations or Increase Our Costs. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, or a third party’s infringement of our rights, including patent rights. The majority of the intellectual property rights relating to our drilling rigs, pressure pumping equipment and directional drilling services are owned by us or certain of our supplying vendors. However, in the event that we or one of our customers or supplying vendors becomes involved in a dispute over infringement of intellectual property rights relating to equipment or technology owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or technology or our ability to provide services or products, or we could be required +20 +to cease use of some equipment or technology or forced to modify our equipment, technology, services or products. We could also be required to pay licens e fees or royalties for the use of equipment or technology or provision of services or products. In addition, we may lose a competitive advantage in the event we are unsuccessful in enforcing our rights against third parties. Technology disputes involvin g us or our customers or supplying vendors could have a material adverse impact on our business, financial condition , cash flows and results of operation s . +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect Our Opportunities and Future Business. +We currently conduct operations in Canada, and we have incurred selling, general and administrative expenses related to the evaluation of and preparation for other international opportunities. Also, we sell products, including rig components and electrical controls, for use in numerous oil and gas producing regions outside of North America. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where contract drilling and pressure pumping activities are conducted or where our consumers for products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +21 +We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under O ur Long-Term Debt . +We have borrowings outstanding under our senior notes and, from time to time, our revolving credit facility. Our ability to meet our interest and principal payment obligations depends in large part on dividends paid to us by our subsidiaries. If our subsidiaries do not generate sufficient cash flows to pay us dividends, we may be unable to meet our interest and principal payment obligations. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. As of December 31, 2018, the applicable margin on LIBOR rate loans was 1.50% and the applicable margin on base rate loans was 0.50%. As of December 31, 2018, we had no amounts outstanding under our revolving credit facility. +We have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2018, no amounts had been disbursed under any letters of credit. +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed. +A Downgrade in Our Credit Rating Could Negatively Impact Our Cost of and Ability to Access Capital. +Our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels, industry conditions and other considerations. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, and potentially require us to post letters of credit for certain obligations. +We May Not Be Able to Generate Sufficient Cash to Service All of Our Debt, Including Our Senior Notes and Debt Under Our Credit Agreement, and We May Be Forced to Take Other Actions to Satisfy Our Obligations Under Our Debt, which May Not Be Successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our Credit Agreement and senior notes contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +22 +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +As a Result of the SSE Merger, We Are Subject to Continuing Contingent T ax Liabilities of Chesapeake Energy Corporation (“CHK”) F ollowing SSE’s Spin-Off from CHK. +Under the Internal Revenue Code of 1986, as amended (the “Code”), and the related rules and regulations, each corporation (or its successor) that was a member of CHK’s consolidated tax reporting group during any taxable period or portion of any taxable period ending on or before June 30, 2014, the effective time of SSE’s spin-off, is jointly and severally liable for the federal income tax liability of the entire consolidated tax reporting group for that taxable period. SSE entered into a tax sharing agreement with CHK that generally provides that SSE is responsible for all taxes attributable to its business, whether accruing before, on or after the date of the spin-off, and CHK is responsible for any taxes arising from the spin-off or certain related transactions that are imposed on SSE, CHK or its other subsidiaries. Notwithstanding such agreement, if CHK were unable to pay the taxes it is responsible for, we (as the successor to SSE) could be required to pay the entire amount of such taxes under U.S. tax law, which could have a material adverse effect on us. +We May Not Be Able to Utilize a Portion of SSE’s or Our Net Operating Loss Carryforwards (“NOLs”) to Offset Future Taxable Income for U.S. Federal Tax Purposes, Which Could Adversely Affect Our Net Income and Cash Flows. +As of December 31, 2018, we had gross federal income tax NOLs of approximately $1.3 billion, approximately $247 million of which were assumed in connection with the SSE merger. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be predicted with any accuracy. In addition, Section 382 of the Code generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred—or were to occur—with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382. However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. Any unused annual limitation with respect to an NOL generally may be carried over to later years. Any NOL arising prior to January 1, 2018 is subject to expiration 20 years after it arose. NOLs arising on or after January 1, 2018 are not subject to expiration . +SSE underwent an ownership change in 2016 as a result of its emergence from Chapter 11 bankruptcy proceedings, and experienced another ownership change in 2017 as a result of its acquisition pursuant to the SSE merger, and the corresponding annual limitation associated with either of those changes in ownership could prevent us from fully utilizing—prior to their expiration—our NOLs relating to SSE as of the effective time of the SSE merger. While our issuance of stock pursuant to the SSE merger was, standing alone, insufficient to result in an ownership change with respect to us, we cannot assure you that we will not undergo an ownership change as a result of the merger taking into account other changes in ownership of our stock occurring within the relevant three-year period described above. If we were to undergo an ownership change, we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected . +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +23 +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Hou ston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling Operations — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania and western Canada. +Pressure Pumping — Our pressure pumping services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Pennsylvania, Ohio and West Virginia. +Directional Drilling — Our directional drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Pennsylvania, Colorado and Montana. +Our oilfield rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our manufacture, sale and service of pipe handling components are supported by offices and yard facilities located in western Canada and Texas. Our electrical controls and automation operation is supported by an office and yard facility in Texas. Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas and Oklahoma City, Oklahoma, as well as several other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 5 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +On January 22, 2018, an accident at a drilling site in Pittsburg County, Oklahoma resulted in the losses of life of five people, including three of our employees. The EPA, OSHA and the CSB initiated investigations related to this accident. The EPA and the CSB investigations are ongoing, and we are cooperating with the agencies regarding these investigations. +On July 18, 2018, OSHA issued a citation containing alleged violations, proposed abatement dates and an aggregate proposed penalty of approximately $74,000. We have filed a notice of contest with OSHA that contests all citation items, abatement dates and proposed penalties. The Department of Labor filed a complaint on OSHA’s behalf seeking enforcement of the citation as issued. We have filed an answer to the complaint and are litigating our contest of the citation items. The ultimate resolution of the OSHA citation items is not known at this time, and we are unable to determine what alleged violations and proposed penalties will be modified or eliminated, if any. +Lawsuits have been filed in the District Court for Pittsburg County, Oklahoma in connection with the five individuals who lost their lives and one of our employees who was injured in the accident. The lawsuits have been consolidated for discovery purposes under Cause No. CJ-2018-60 (the “Litigation”). These lawsuits allege various causes of action against us including negligence, gross negligence, knowledge that injury or death was substantially certain, acting with purpose, recklessness, wrongful death and survival, and the plaintiffs seek an unspecified amount of damages, including punitive or exemplary damages, costs, interest, and other relief. We dispute the plaintiffs’ allegations and intend to continue to defend ourselves vigorously. Based on the information we have available as of the date of this Report, we believe that we have adequate insurance to cover the Litigation. However, if this accident is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Additionally, we are party to various legal proceedings arising in the normal course of our business. +We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +Item 4. Mine Safety Disclosure. +Not applicable. +24 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P MidCap 400 Index and several other market indices. +(b) Holders +As of February 8, 2019, there were approximately 1,100 holders of record of our common stock. +(c) Dividends +On February 6, 2019, our Board of Directors approved a cash dividend on our common stock in the amount of $0.04 per share to be paid on March 21, 2019 to holders of record as of March 7, 2019. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2018. +Period Covered +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands) (2) +October 2018 +4,630 +$ +16.23 +— +$ +200,260 +November 2018 +1,527,000 +$ +15.47 +1,527,000 +$ +176,641 +December 2018 +2,289,195 +$ +11.53 +2,288,278 +$ +150,263 +Total +3,820,825 +3,815,278 +$ +150,263 +(1) +We withheld 4,630 shares in October 2018 and 917 shares in December 2018 with respect to employees’ tax withholding upon vesting of restricted stock units. These shares were acquired at fair market value pursuant to the terms of the Patterson-UTI Energy, Inc. Long-Term Incentive Plan and not pursuant to the stock buyback program. +(2) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. On July 26, 2018, we announced that our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. Shares of stock purchased under the plan are held as treasury shares. On February 7, 2019, we announced that our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2013 through December 31, 2018, with the cumulative total return of the S & P 500 Index, the S & P MidCap 400 Index, the Oilfield Service Index and a peer group determined by us. Our peer group consists of Basic Energy Services, Inc., Diamond Offshore Drilling Inc., Ensco plc., Forum Energy Technologies, Inc., Halliburton Company, Helmerich & Payne, Inc., Nabors Industries, Ltd., National Oilwell Varco, Inc., Noble Corporation plc., Oceaneering International, Oil States International Inc., Precision Drilling Corporation, Rowan Companies plc., Superior Energy Services, Inc., TechnipFMC plc, Transocean Ltd., Unit Corp. and Weatherford International plc. +25 +The graph assumes investment of $100 on December 31, 201 3 and reinvestment of all dividends. +Fiscal Year Ended December 31, +2013 +2014 +2015 +2016 +2017 +2018 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +66.58 +61.99 +111.59 +95.74 +43.44 +S&P 500 Stock Index +100.00 +113.69 +115.26 +129.05 +157.22 +150.33 +S&P MidCap Index +100.00 +109.77 +107.38 +129.65 +150.70 +134.00 +Oilfield Service Index +100.00 +76.46 +58.59 +69.71 +57.71 +31.62 +Peer Group Index +100.00 +74.09 +51.06 +65.20 +55.40 +31.77 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +26 +Item 6. Selected Financial Data. +Our selected consolidated financial data as of December 31, 2018, 2017, 2016, 2015, and 2014, and for each of the five years in the period ended December 31, 2018, should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report. The table below includes the results of operations of Current Power since October 25, 2018, the results of operations of Superior QC since February 20, 2018, the results of operations of MS Directional since October 11, 2017 and the results of operations of SSE since April 20, 2017. +2018 +2017 +2016 +2015 +2014 +(In thousands, except per share amounts) +Statement of Operations Data: +Operating revenues: +Contract drilling +$ +1,430,492 +$ +1,040,033 +$ +543,663 +$ +1,153,892 +$ +1,838,830 +Pressure pumping +1,573,396 +1,200,311 +354,070 +712,454 +1,293,265 +Directional drilling +209,275 +45,580 +— +— +— +Other +113,834 +70,760 +18,133 +24,931 +50,196 +Total +3,326,997 +2,356,684 +915,866 +1,891,277 +3,182,291 +Operating costs and expenses: +Contract drilling +885,704 +667,105 +305,804 +608,848 +1,066,659 +Pressure pumping +1,263,850 +966,835 +334,588 +612,021 +1,036,310 +Directional drilling +175,829 +32,172 +— +— +— +Other +77,104 +51,428 +8,384 +11,500 +13,102 +Depreciation, depletion, amortization and impairment +916,318 +783,341 +668,434 +864,759 +718,730 +Impairment of goodwill +211,129 +— +— +124,561 +— +Selling, general and administrative +134,071 +105,847 +69,205 +74,913 +80,145 +Merger and integration expenses +2,738 +74,451 +— +— +— +Other operating (income) expense, net +(17,569 +) +(31,957 +) +(14,323 +) +1,647 +(15,781 +) +Total +3,649,174 +2,649,222 +1,372,092 +2,298,249 +2,899,165 +Operating income (loss) +(322,177 +) +(292,538 +) +(456,226 +) +(406,972 +) +283,126 +Other expense +(45,231 +) +(35,263 +) +(39,970 +) +(35,477 +) +(28,843 +) +Income (loss) before income taxes +(367,408 +) +(327,801 +) +(496,196 +) +(442,449 +) +254,283 +Income tax expense (benefit) +(45,987 +) +(333,711 +) +(177,562 +) +(147,963 +) +91,619 +Net income (loss) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +$ +162,664 +Net income (loss) per common share: +Basic +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +$ +1.12 +Diluted +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +$ +1.11 +Cash dividends per common share +$ +0.14 +$ +0.08 +$ +0.16 +$ +0.40 +$ +0.40 +Weighted average number of common shares outstanding: +Basic +218,643 +198,447 +146,178 +145,416 +144,066 +Diluted +218,643 +199,882 +146,178 +145,416 +145,376 +Balance Sheet Data: +Total assets +$ +5,469,866 +$ +5,758,856 +$ +3,772,291 +$ +4,465,048 +$ +5,353,837 +Borrowings under line of credit +— +268,000 +— +— +303,000 +Other long-term debt +1,119,205 +598,783 +598,437 +787,900 +667,029 +Stockholders’ equity +3,505,423 +3,982,493 +2,248,724 +2,561,131 +2,905,810 +Working capital +423,881 +200,605 +(17,933 +) +178,887 +340,816 +27 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Recent Developments — On October 25, 2018, we acquired all of the issued and outstanding shares of Current Power Solutions, Inc. (“Current Power”). Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. Operational and financial data in the discussion and analysis below includes the results of operations of the Current Power business in our other operations since October 25, 2018. +On March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. See “ Liquidity and Capital Resources.” +On February 20, 2018, we acquired the business of Superior QC, LLC (“Superior QC”), including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Operational and financial data in the discussion and analysis below includes the results of operations of the Superior QC business in our directional drilling segment since February 20, 2018. +On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”) . We used $239 million of the net proceeds from the sale to repay amounts outstanding under our revolving credit facility. +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of MS Directional, LLC (f/k/a Multi-Shot, LLC) (“MS Directional”). MS Directional is a leading directional drilling services company in the United States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, motor rentals, directional surveying, measurement-while-drilling, and wireline steering tools. Operational and financial data in the discussion and analysis below includes the results of operations of the MS Directional business in our directional drilling segment since October 11, 2017. +On April 20, 2017, pursuant to an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”), a subsidiary of ours was merged with and into SSE (the “SSE merger”), with SSE continuing as the surviving entity and one of our wholly-owned subsidiaries. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of our wholly-owned subsidiaries. Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. Operational and financial data in the discussion and analysis below includes the results of operations of the SSE business since April 20, 2017. +Management Overview — We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. Our contract drilling business operates in the continental United States and western Canada , and we are pursuing contract drilling opportunities outside of North America . Our pressure pumping business operates primarily in Texas and the Mid-Continent and Appalachian regions. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of horizontal wellbore placement. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also manufacture and sell pipe handling components and related technology to drilling contractors, and provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil prices have recovered from the lows experienced in the first quarter of 2016. Oil prices reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil reached a fourth quarter 2018 high of $76.40 per barrel on October 3, 2018, before declining by 42% over the course of three months to reach a low of $44.48 per barrel in late December 2018. Oil prices averaged $59.08 per barrel in the fourth quarter of 2018. +28 +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2016, 2017, and 2018 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our rig count declined significantly during the industry downturn that began in late 2014 but has improved since the second quarter of 2016. Our average rig count for the fourth quarter of 2018 was 183 rigs, which included 182 rigs in the United States and one rig in Canada. This was an increase from our average rig count for the third quarter of 2018 of 178 rigs, which included 177 rigs in the United States and one rig in Canada. Our rig count in the United States at December 31, 2018 of 183 rigs was greater than the rig count of 163 rigs at December 31, 2017. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 122 rigs operating under term contracts during the first quarter of 2019 and an average of 78 rigs operating under term contracts throughout 2019. +With the weakness in crude oil prices late in the fourth quarter, operators have been delaying starting new completion projects in the first quarter, and pricing remains extremely competitive. As such, we have made the decision to idle spreads rather than work at unreasonably low prices. We ended the fourth quarter with 20 active spreads and idled three spreads early in the first quarter of 2019 . +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas. During periods of improved commodity prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when these commodity prices deteriorate, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. +The North American oil and natural gas services industry is cyclical and at times experiences downturns in demand. During these periods, there has been substantially more oil and natural gas service equipment available than necessary to meet demand. As a result, oil and natural gas service contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods. Currently, there is an excess of drilling rigs that are not super-spec, pressure pumping equipment and directional drilling equipment available. In circumstances of excess capacity, providers of oil and natural gas services have difficulty sustaining profit margins and may sustain losses during downturn periods. We cannot predict either the future level of demand for our oil and natural gas services or future conditions in the oil and natural gas service businesses. +We are also highly impacted by operational risks, competition, the availability of excess equipment, labor issues, weather, the availability of products in our pressure pumping business, supplier delays and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. Please see “Risk Factors” in Item 1A of this Report. +For the three years ended December 31, 2018, our operating revenues consisted of the following (dollars in thousands): +2018 +2017 +2016 +Contract drilling +$ +1,430,492 +43.0 +% +$ +1,040,033 +44.1 +% +$ +543,663 +59.4 +% +Pressure pumping +1,573,396 +47.3 +% +1,200,311 +50.9 +% +354,070 +38.7 +% +Directional drilling +209,275 +6.3 +% +45,580 +1.9 +% +— +— +% +Other +113,834 +3.4 +% +70,760 +3.1 +% +18,133 +1.9 +% +$ +3,326,997 +100.0 +% +$ +2,356,684 +100.0 +% +$ +915,866 +100.0 +% +Contract Drilling +Contract drilling operations accounted for 43.0% of our consolidated 2018 revenues, and contract drilling revenues increased 37.5% over 2017. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by expanding our areas of operation and improving the capabilities of our drilling fleet during the last several years. The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be at least a 1,500 horsepower, AC powered rig +29 +that has a 750,000 - pound hookload, a 7,500 - psi circulating system , and is pad - capable. As of December 31, 2018 , our rig fleet included 198 APEX ® rigs , of which 149 were super-spec rigs. W e delivered 14 rigs with major upg rades in 2018 and one additional major rig upgrade in January 2019 . We currently have one additional major rig upgrade contracted for delivery in 2019. +We maintain a backlog of commitments for contract drilling revenues under term contracts, which we define as contracts with a fixed term of six months or more. Our contract drilling backlog as of December 31, 2018 and 2017 was $770 million and $544 million, respectively. Approximately 23% of the total contract drilling backlog at December 31, 2018 is reasonably expected to remain after 2019. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to other fees such as for mobilization, other than initial mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. For contracts that contain variable dayrate pricing, our backlog calculation uses the dayrate in effect for periods where the dayrate is fixed, and, for periods that remain subject to variable pricing, uses the commodity price in effect at December 31, 2018. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts on which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period over which we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Continue to Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +Ongoing factors which could continue to adversely affect utilization rates and pricing, even in an environment of high oil and natural gas prices and increased drilling activity, include: +• +movement of drilling rigs from region to region, +• +reactivation of drilling rigs, +• +refurbishment and upgrades of existing drilling rigs, +• +development of new technologies that enhance drilling efficiency, +• +construction of new technology drilling rigs. +Pressure Pumping +Pressure pumping operations accounted for 47.3% of our consolidated 2018 revenues, and pressure pumping revenues increased 31.1% over 2017. As of December 31, 2018, we had approximately 1.6 million horsepower in our pressure pumping fleet. In response to unreasonably low prices in the completions market, we reduced the number of active frac spreads to 20 as of the end of the fourth quarter and idled three spreads early in the first quarter of 2019. +Directional Drilling +Directional drilling operations accounted for 6.3% of our consolidated 2018 revenues. Activity for directional drilling commenced with the acquisition of MS Directional in October 2017, which provides a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, motor rentals, directional surveying, measurement-while-drilling, and wireline steering tools, and we provide services that improve the statistical accuracy of horizontal wellbore placement. +Other Operations +Other operations revenues accounted for 3.4% of our consolidated 2018 revenues, and our other operations revenues increased 60.9% over 2017. Our oilfield rentals business, which was acquired with the SSE merger, provides the largest revenue contribution to our other operations. Our oilfield rentals business has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. Other operations also includes the results of our electrical controls and automation business, the results of our pipe handling components and related technology business, and the results of our ownership, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Capital Expenditures +Cash capital expenditures for 2018 totaled $641 million. For 2019, based on near-term activity levels, we expect cash used for capital expenditures to be approximately $465 million. +30 +For the three years ended December 31, 2018 , our operating income (loss) consisted of the following (dollars in thousand s): +2018 +2017 +2016 +Contract drilling +$ +(33,115 +) +10.3 +% +$ +(171,897 +) +58.8 +% +$ +(235,858 +) +51.7 +% +Pressure pumping +(77,328 +) +24.0 +% +21,028 +(7.2 +)% +(176,628 +) +38.7 +% +Directional drilling +(117,497 +) +36.5 +% +(21 +) +— +% +— +— +% +Other +(18,221 +) +5.7 +% +(20,813 +) +7.1 +% +(3,391 +) +0.7 +% +Corporate +(76,016 +) +23.5 +% +(120,835 +) +41.3 +% +(40,349 +) +8.9 +% +$ +(322,177 +) +100.0 +% +$ +(292,538 +) +100.0 +% +$ +(456,226 +) +100.0 +% +Discussion of our operating income (loss) follows in the “Results of Operations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations. +While demand for our contract drilling and pressure pumping services improved in 2018 and merger and integration expenses were lower, an impairment of goodwill and write-downs to drilling and pressure pumping equipment contributed to a consolidated net loss of $321 million for 2018, compared to consolidated net income of $5.9 million for 2017 and a consolidated net loss of $319 million for 2016. Our net income for 2017 was positive due to the 2017 tax law change. +Results of Operations +Comparison of the years ended December 31, 2018 and 2017 +The following tables summarize results of operations by business segment for the years ended December 31, 2018 and 2017: +Year Ended December 31, +Contract Drilling +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +1,430,492 +$ +1,040,033 +37.5 +% +Direct operating costs +885,704 +667,105 +32.8 +% +Margin (1) +544,788 +372,928 +46.1 +% +Selling, general and administrative +6,296 +5,934 +6.1 +% +Depreciation, amortization and impairment +571,607 +538,891 +6.1 +% +Operating loss +$ +(33,115 +) +$ +(171,897 +) +(80.7 +)% +Operating days +64,479 +50,427 +27.9 +% +Average revenue per operating day +$ +22.19 +$ +20.62 +7.6 +% +Average direct operating costs per operating day +$ +13.74 +$ +13.23 +3.9 +% +Average margin per operating day (1) +$ +8.45 +$ +7.40 +14.2 +% +Average rigs operating +176.7 +138.2 +27.9 +% +Capital expenditures +$ +394,595 +$ +354,425 +11.3 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +Generally, the revenues in our contract drilling segment are most impacted by two primary factors: our average number of rigs operating and our average revenue per operating day. During 2018, our average number of rigs operating was 175 in the United States and one in Canada, compared to 136 in the United States and two in Canada in 2017. Our average rig revenue per operating day was $22,190 in 2018, compared to $20,620 in 2017. Our average revenue per operating day is largely dependent on the pricing terms of our rig contracts. +Revenues and direct operating costs increased primarily due to an increase in operating days. Operating days and average rigs operating increased in 2018 primarily due to the recovery in the oil and natural gas industry, the contribution of rigs acquired in the SSE merger and the contribution from rigs that have been upgraded to super-spec capability. Capital expenditures increased in 2018 due to the upgrade of rigs to super-spec capability, higher maintenance capital expenditures and other equipment upgrades. Depreciation, amortization, and impairment for 2018 included a charge of $48.4 million related to the retirement of 42 legacy non-APEX® rigs and related equipment. Based on the strong customer preference across the industry for super-spec drilling rigs, we believe the 42 rigs that were retired had limited commercial opportunity. Depreciation, amortization, and impairment for 2017 included a charge of $29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. +31 +Year Ended December 31, +Pressure Pumping +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +1,573,396 +$ +1,200,311 +31.1 +% +Direct operating costs +1,263,850 +966,835 +30.7 +% +Margin (1) +309,546 +233,476 +32.6 +% +Selling, general and administrative +15,420 +14,442 +6.8 +% +Depreciation, amortization and impairment +250,010 +198,006 +26.3 +% +Impairment of goodwill +121,444 +— +NA +Operating income (loss) +$ +(77,328 +) +$ +21,028 +NA +Fracturing jobs +812 +622 +30.5 +% +Other jobs +1,081 +1,262 +(14.3 +)% +Total jobs +1,893 +1,884 +0.5 +% +Average revenue per fracturing job +$ +1,909.42 +$ +1,894.40 +0.8 +% +Average revenue per other job +$ +21.23 +$ +17.43 +21.8 +% +Average revenue per total job +$ +831.17 +$ +637.11 +30.5 +% +Average direct operating costs per total job +$ +667.64 +$ +513.18 +30.1 +% +Average margin per total job (1) +$ +163.52 +$ +123.93 +31.9 +% +Margin as a percentage of revenues (1) +19.7 +% +19.5 +% +1.0 +% +Capital expenditures +$ +173,848 +$ +171,436 +1.4 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Generally, the revenues in our pressure pumping segment are most impacted by our number of fracturing jobs and the size (including whether or not we provide proppant and other materials) of those jobs, which is reflected in our average revenue per fracturing job. We completed 812 fracturing jobs during 2018 compared to 622 fracturing jobs in 2017. Our average revenue per fracturing job was $1.909 million in 2018 compared to $1.894 million in 2017. +Revenues and direct operating costs in 2018 increased primarily due to an increase in the number of fracturing jobs. Depreciation, amortization and impairment expense increased due to the assets acquired in the SSE merger. Also included in depreciation, amortization and impairment expense for 2018 is a charge of $17.4 million related to the write-down of obsolete sand-handling equipment. There was no similar charge in the comparable period of 2017. All of the goodwill associated with our pressure pumping business was impaired during 2018. See Note 6 of Notes to Consolidated Financial Statements for additional information. +Year Ended December 31, +Directional Drilling +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +209,275 +$ +45,580 +359.1 +% +Direct operating costs +175,829 +32,172 +446.5 +% +Margin (1) +33,446 +13,408 +149.4 +% +Selling, general and administrative +15,941 +4,082 +290.5 +% +Depreciation and amortization +45,317 +9,347 +384.8 +% +Impairment of goodwill +89,685 +— +NA +Operating loss +$ +(117,497 +) +$ +(21 +) +NA +Capital expenditures +$ +35,929 +$ +7,795 +360.9 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation and amortization and selling, general and administrative expenses. +Our directional drilling segment originated with the October 11, 2017 acquisition of MS Directional, and consequently the results for 2017 include less than three months of operations. Margins in 2018 were negatively impacted by higher third-party rental expenses due to delays in the delivery of equipment and by higher repairs and maintenance costs. All of the goodwill associated with our directional drilling business was impaired during 2018. See Note 6 of Notes to Consolidated Financial Statements for additional information. +32 +Year Ended December 31, +Other Operations +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +113,834 +$ +70,760 +60.9 +% +Direct operating costs +77,104 +51,428 +49.9 +% +Margin (1) +36,730 +19,332 +90.0 +% +Selling, general and administrative +13,439 +10,743 +25.1 +% +Depreciation, depletion, amortization and impairment +41,512 +29,402 +41.2 +% +Operating loss +$ +(18,221 +) +$ +(20,813 +) +(12.5 +)% +Capital expenditures +$ +34,660 +$ +31,547 +9.9 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion, amortization and impairment and selling, general and administrative expenses. +Revenues, direct operating costs, and depreciation, depletion, amortization and impairment expense from other operations increased primarily as a result of the inclusion of our oilfield rentals business acquired in the SSE merger on April 20, 2017. The increase in capital expenditures was due to investments in the oilfield rentals business. +Year Ended December 31, +Corporate +2018 +2017 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +82,975 +$ +70,646 +17.5 +% +Merger and integration expenses +$ +2,738 +$ +74,451 +(96.3 +)% +Depreciation +$ +7,872 +$ +7,695 +2.3 +% +Other operating (income) expense, net +Net gain on asset disposals +(28,958 +) +(33,510 +) +(13.6 +)% +Legal-related expenses and settlements, net of insurance reimbursements +12,684 +561 +NA +Research and development +3,444 +1,002 +243.7 +% +Other +(4,739 +) +(10 +) +NA +Other operating income, net +$ +(17,569 +) +$ +(31,957 +) +(45.0 +)% +Interest income +$ +5,597 +$ +1,866 +199.9 +% +Interest expense +$ +51,578 +$ +37,472 +37.6 +% +Other income +$ +750 +$ +343 +118.7 +% +Capital expenditures +$ +2,426 +$ +1,884 +28.8 +% +Selling, general and administrative expense increased in 2018, but as a percentage of consolidated revenues decreased to 2.5%, compared to 3.0% in 2017. Selling, general and administrative expense increased in 2018 primarily due to the personnel added as a result of the SSE merger. Merger and integration expenses incurred in 2018 are related to the SSE merger, the MS Directional acquisition and the Superior QC acquisition. Merger and integration expenses incurred in 2017 are related to the SSE merger and the MS Directional acquisition. Other operating income includes net gains associated with the disposal of assets. Accordingly, the related gains or losses have been excluded from the results of specific segments. The majority of the net gain on asset disposals during the 2018 period reflects gains on disposal of drilling equipment. The 2017 period included a gain of $11.2 million related to the sale of real estate. Legal-related expenses and settlements in 2018 includes insurance deductibles and investigation costs related to an accident at a drilling site in January 2018. Research and development expense during 2018 and 2017 relate primarily to the funding of research into pressure pumping technology. Other operating income during 2018 also includes the gain on the collection of a note receivable that had previously been discounted. Interest income increased in 2018 due to interest earned on the portion of the proceeds of the January 2018 debt offering that were held as cash during 2018. The debt offering also resulted in an increase in interest expense for 2018. +33 +Comparison of the years ended De cember 31, 2017 and 2016 +The following tables summarize results of operations by business segment for the years ended December 31, 2017 and 2016: +Year Ended December 31, +Contract Drilling +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +1,040,033 +$ +543,663 +91.3 +% +Direct operating costs +667,105 +305,804 +118.1 +% +Margin (1) +372,928 +237,859 +56.8 +% +Selling, general and administrative +5,934 +5,743 +3.3 +% +Depreciation, amortization and impairment +538,891 +467,974 +15.2 +% +Operating loss +$ +(171,897 +) +$ +(235,858 +) +(27.1 +)% +Operating days +50,427 +23,596 +113.7 +% +Average revenue per operating day +$ +20.62 +$ +23.04 +(10.5 +)% +Average direct operating costs per operating day +$ +13.23 +$ +12.96 +2.1 +% +Average margin per operating day (1) +$ +7.40 +$ +10.08 +(26.6 +)% +Average rigs operating +$ +138.2 +$ +64.5 +114.3 +% +Capital expenditures +$ +354,425 +$ +72,508 +388.8 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +Revenues and direct operating costs increased primarily due to an increase in operating days. Operating days and average rigs operating increased due to a recovery in the oil and natural gas industry and the rigs acquired in the SSE merger. Depreciation, amortization and impairment increased due to the additional SSE assets and due to a $29.0 million impairment from the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. There was no similar charge in 2016. Average revenue per operating day decreased during 2017 due to a reduction in early termination revenue and the expiration of higher day rate, legacy long-term rig contracts. Many of our higher day rate, legacy long-term rig contracts were entered into during periods of higher demand, and as a result, these legacy contracts had a higher day rate on average relative to the more recent contracts pursuant to which work was performed during 2017. The majority of these legacy contracts expired during the recent downturn prior to and during 2017, and as a result we experienced a lower average revenue per operating day during 2017 relative to 2016. Early termination revenue in 2017 was $4.9 million, compared to $24.6 million in 2016. Average direct operating costs per operating day increased as a result of a reduction in the proportion of rigs on standby and an increase in rig reactivation expenses. Capital expenditures increased due to the upgrade of rigs to super-spec capability, building a new rig, higher maintenance capital expenditures and other general property and equipment upgrades. +Year Ended December 31, +Pressure Pumping +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +1,200,311 +$ +354,070 +239.0 +% +Direct operating costs +966,835 +334,588 +189.0 +% +Margin (1) +233,476 +19,482 +1,098.4 +% +Selling, general and administrative +14,442 +11,238 +28.5 +% +Depreciation, amortization and impairment +198,006 +184,872 +7.1 +% +Operating income (loss) +$ +21,028 +$ +(176,628 +) +NA +Fracturing jobs +622 +352 +76.7 +% +Other jobs +1,262 +799 +57.9 +% +Total jobs +1,884 +1,151 +63.7 +% +Average revenue per fracturing job +$ +1,894.40 +$ +982.56 +92.8 +% +Average revenue per other job +$ +17.43 +$ +10.28 +69.6 +% +Average revenue per total job +$ +637.11 +$ +307.62 +107.1 +% +Average direct operating costs per total job +$ +513.18 +$ +290.69 +76.5 +% +Average margin per total job (1) +$ +123.93 +$ +16.93 +632.0 +% +Margin as a percentage of revenues (1) +19.5 +% +5.5 +% +254.5 +% +Capital expenditures +$ +171,436 +$ +39,584 +333.1 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +34 +Revenues and direct operating costs increased in 2017 primarily due to an increase in the number and size of fracturing jobs. The total number of jobs increased as a result of the SSE merger and a recovery in the oil and natural gas industry. Average revenue per job increased due to improved pricing and an increase in the size of the jobs. Average direct operating costs per total job increased primarily due to the increase in the size of the job s. Selling, general and administrative expenses increased due to the increase in organizational size and activity as a result of the SSE merger. The increase in capital expenditures was primarily due to higher maintenance capital expenditures as a result of higher activity and investments to reactivate frac spreads. +Year Ended December 31, +Directional Drilling +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +45,580 +$ +— +NA +Direct operating costs +32,172 +— +NA +Margin (1) +13,408 +— +NA +Selling, general and administrative +4,082 +— +NA +Depreciation and amortization +9,347 +— +NA +Operating loss +$ +(21 +) +$ +— +NA +Capital expenditures +$ +7,795 +$ +— +NA +(1)Margin is defined as revenues less direct operating costs and excludes depreciation and amortization and selling, general and administrative expenses. +Our directional drilling segment originated with the October 11, 2017 acquisition of MS Directional, and consequently we had no results for the prior year in this segment. +Year Ended December 31, +Other Operations +2017 +2016 +% Change +(Dollars in thousands) +Revenues +$ +70,760 +$ +18,133 +290.2 +% +Direct operating costs +51,428 +8,384 +513.4 +% +Margin (1) +19,332 +9,749 +98.3 +% +Selling, general and administrative +10,743 +3,026 +255.0 +% +Depreciation, depletion and impairment +29,402 +10,114 +190.7 +% +Operating loss +$ +(20,813 +) +$ +(3,391 +) +513.8 +% +Capital expenditures +$ +31,547 +$ +6,116 +415.8 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion and impairment and selling, general and administrative expenses. +Revenues, direct operating costs, selling, general and administrative expense and depreciation expense from other operations increased primarily as a result of the inclusion of our oilfield rentals business acquired in the SSE merger on April 20, 2017 and our pipe handling components and related technology business acquired in September 2016. The increase in capital expenditures was primarily due to investments in the oilfield rentals business and in oil and natural gas working interests. +Year Ended December 31, +Corporate +2017 +2016 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +70,646 +$ +49,198 +43.6 +% +Merger and integration expenses +$ +74,451 +$ +— +NA +Depreciation +$ +7,695 +$ +5,474 +40.6 +% +Other operating (income) expense, net +Net gain on asset disposals +$ +(33,510 +) +$ +(14,771 +) +126.9 +% +Other, including legal settlements, net of insurance reimbursements +1,553 +448 +246.7 +% +Other operating income, net +$ +(31,957 +) +$ +(14,323 +) +123.1 +% +Interest income +$ +1,866 +$ +327 +470.6 +% +Interest expense +$ +37,472 +$ +40,366 +(7.2 +)% +Other income +$ +343 +$ +69 +397.1 +% +Capital expenditures +$ +1,884 +$ +1,591 +18.4 +% +Selling, general and administration expense increased in 2017 primarily due to the personnel added as a result of the SSE merger. The merger and integration expenses incurred in 2017 are related to the SSE merger and MS Directional acquisition. Other operating income includes net gains associated with the disposal of assets. Accordingly, the related gains or losses have been excluded from the results +35 +of specific segments. The 2017 period includes a gain of $11.2 million related to the sale of real e state and $8.4 million from the sale of certain oil and gas properties. Interest income increased due to our investment of the proceeds from our stock offering in the first quarter of 2017 prior to utilizing those proceeds to repay SSE indebtedness. Inte rest expense decreased primarily due to lower debt outstanding during 2017 compared to 2016. +Income Taxes +Year Ended December 31, +2018 +2017 +2016 +(Dollars in thousands) +Loss before income taxes +$ +(367,408 +) +$ +(327,801 +) +$ +(496,196 +) +Income tax benefit +$ +(45,987 +) +$ +(333,711 +) +$ +(177,562 +) +Effective tax rate +12.5 +% +101.8 +% +35.8 +% +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2018, 2017 and 2016 is summarized as follows: +2018 +2017 +2016 +Statutory tax rate +21.0 +% +35.0 +% +35.0 +% +State income taxes - net of the federal income tax benefit +1.2 +1.9 +2.0 +Goodwill impairment +(6.9 +) +— +— +Permanent differences +(0.6 +) +(1.3 +) +(0.1 +) +Tax effects of tax reform +(1.3 +) +66.7 +— +Share-based payments +(0.1 +) +3.6 +— +Acquisition related differences +— +(3.3 +) +— +Valuation allowance +(3.7 +) +— +— +State deferred tax remeasurement +2.3 +— +— +Other differences, net +0.6 +(0.8 +) +(1.1 +) +Effective tax rate +12.5 +% +101.8 +% +35.8 +% +The effective tax rate decreased by approximately 89.3% to 12.5% for 2018 compared to 2017. This was primarily due to U.S. tax reform legislation known as the Tax Cuts and Jobs Act, enacted on December 22, 2017 (“Tax Reform”), which resulted in a 66.7% increase in the 2017 effective tax rate due to the remeasurement of U.S. deferred taxes and a 14% decrease in the 2018 effective tax rate due to the change in U.S. federal corporate tax rate. Also impacting the 2018 effective tax rate are certain goodwill impairment charges, which are not deductible for tax purposes, and valuation allowances being established against deferred tax assets in certain state and non-U.S. jurisdictions. The goodwill impairment and valuation allowances resulted in a 6.9% and 3.7% decrease in the effective tax rate, respectively. These decreases were partially offset by a 2.3% increase in the effective tax rate following the remeasurement of deferred tax assets and liabilities for state tax purposes. +Tax Reform includes, among other things, a reduction of the U.S. federal corporate tax rate from 35% to 21% for tax years beginning 2018, a mandatory deemed repatriation tax on foreign earnings, repeal of the corporate alternative minimum tax, expensing of certain capital investments, and reducing the amount of executive pay that will be tax deductible. Tax Reform also makes fundamental changes to the taxation of multinational entities, including a shift from worldwide taxation with deferral to a hybrid territorial system, a minimum tax on certain low-taxed foreign earnings, and new measures to deter base erosion and promote export sales from the United States. For December 31, 2017, we recorded provisional amounts for certain enactment-date effects of Tax Reform by applying the guidance in Staff Accounting Bulletin 118 (“SAB 118”) because we had not yet completed our enactment-date accounting for these effects. In 2017, we recorded approximately $219 million of tax benefit related to the enactment-date effects of Tax Reform that related solely to adjusting deferred tax assets and liabilities to the new U.S. federal corporate tax rate at which they are expected to reverse. After filing our 2017 income tax returns in the fourth quarter of 2018, we completed our accounting for all of the enactment-date income tax effects of Tax Reform. As a result, we recognized $4.6 million of tax expense as an adjustment to the provisional amounts recorded at December 31, 2017 and included these adjustments as a component of income tax expense. The changes to 2017 enactment-date provisional amounts decreased the effective tax rate in 2018 by 1.3%. +Prior to Tax Reform, we had elected to permanently reinvest unremitted earnings in Canada effective January 1, 2010, and we intend to do so for the foreseeable future. If we were to repatriate earnings, in the form of dividends or otherwise, we may be subject to certain income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable. +We record deferred income taxes based primarily on the temporary differences between the book and tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be settled. As a result of recognizing the benefit of deferred income taxes, we incur +36 +deferred income tax expense as these benefits are utilize d. We recognized a deferred tax benefit of approximately $41.2 million in 2018, $330 million in 2017 and $152 million in 2016. +Liquidity and Capital Resources +Our liquidity as of December 31, 2018 included approximately $424 million in working capital, including $245 million of cash and cash equivalents, and $600 million available under our revolving credit facility. +On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 2028 Notes. We used $239 million of the net proceeds from the sale to repay amounts outstanding under our revolving credit facility. As described below, on March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. +We believe our current liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt and pay cash dividends for at least the next 12 months. If we pursue opportunities for growth that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +As of December 31, 2018, we had working capital of $424 million, including cash and cash equivalents of $245 million, compared to working capital of $201 million, including cash and cash equivalents of $42.8 million, at December 31, 2017. +During 2018, our sources of cash flow included: +• +$731 million from operating activities, +• +$47.4 million in proceeds from the disposal of property and equipment, +• +$23.8 million from collection of a note receivable, and +• +$521 million from proceeds from the issuance of long-term debt. +During 2018, we used $268 million to repay net borrowings under our revolving credit facility, $14.2 million for acquisitions, $30.6 million to pay dividends on our common stock, $4.5 million for debt issuance costs, $162 million for the repurchases of our common stock and $641 million: +• +to make capital expenditures for the acquisition, betterment and refurbishment of drilling rigs and pressure pumping equipment, +• +to acquire and procure equipment and facilities to support our drilling, pressure pumping, directional drilling, oilfield rentals and manufacturing operations, and +• +to fund investments in oil and natural gas properties on a non-operating working interest basis. +We paid cash dividends during the year ended December 31, 2018 as follows: +Per Share +Total +(in thousands) +Paid on March 22, 2018 +$ +0.02 +$ +4,443 +Paid on June 21, 2018 +0.04 +8,832 +Paid on September 20, 2018 +0.04 +8,685 +Paid on December 20, 2018 +0.04 +8,629 +Total cash dividends +$ +0.14 +$ +30,589 +On February 6, 2019, our Board of Directors approved a cash dividend on our common stock in the amount of $0.04 per share to be paid on March 21, 2019 to holders of record as of March 7, 2019. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +37 +On September 6, 2013, our Board of Directors approved a stock buyback program that authorize d purchase s of up to $200 million of our common stock in open market or privately negotiated transactions. On July 25, 2018, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s disc retion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the plan are held as treasury shares. There is no expiration date associated with the b uyback program. As of December 31, 2018 , we had remaining authorization to purchase approximately $150 million of our outstanding common stock under the stock buyback program. On February 6, 2019, our Board of Directors approved another increase of the a uthorization under the stock buyback program to allow for $250 million of future share repurchases. +We acquired shares of stock from directors in 2017 and 2016 and from employees during 2018, 2017 and 2016 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options. The remainder of these shares was acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock and restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2018, 2017 and 2016 were as follows (dollars in thousands): +2018 +2017 +2016 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +Purchases pursuant to stock buyback program +9,331,131 +150,497 +5,503 +109 +8,488 +183 +Acquisitions pursuant to long-term incentive plan +567,354 +11,240 +404,491 +7,508 +176,889 +3,866 +Treasury shares at end of period +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +2018 Credit Agreement — On March 27, 2018, we entered into an amended and restated credit agreement (the “Credit Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Lead Arrangers and Joint Book Runners. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $300 million, not to exceed total commitments of $900 million. The maturity date under the Credit Agreement is March 27, 2023. We have the option, subject to certain conditions, to exercise two one-year extensions of the maturity date. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10% to 0.30% based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. +As of December 31, 2018, we had no amounts outstanding under our revolving credit facility. We had $81,000 in letters of credit outstanding under our revolving credit facility at December 31, 2018 and, as a result, had available borrowing capacity of approximately $600 million at that date. +38 +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Sc otiabank”), pursuant to which we may fro m time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2018 , we had $58.4 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015 (the “Continuing Guaranty”), our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +Series A & B Senior Notes — On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. We pay interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. We pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations which rank equally in right of payment with all of our other unsubordinated indebtedness. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of our domestic subsidiaries other than subsidiaries that are not required to be guarantors under the Credit Agreement. None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at our option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. We must offer to prepay the notes upon the occurrence of any change of control. In addition, we must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. We must not permit our debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. We also must not permit our interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. We were in compliance with these covenants at December 31, 2018. We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if we default in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +39 +2028 Senior Notes — On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 2028 Notes . T he net proceeds before offering expenses were approximately $521 million , of which we used $239 million to r epay amounts outstanding under our revolving credit facility. +We pay interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028. The 2028 Notes bear interest at a rate of 3.95% per annum. +The 2028 Notes are senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The 2028 Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the 2028 Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the 2028 Notes. None of our subsidiaries are currently required to be a guarantor under the 2028 Notes. If our subsidiaries guarantee the 2028 Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +We, at our option, may redeem the Notes in whole or in part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date, plus a make-whole premium. Additionally, commencing on November 1, 2027, we, at our option, may redeem the 2028 Notes in whole or in part, at a redemption price equal to 100% of the principal amount of the 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date. +The indenture pursuant to which the 2028 Notes were issued includes covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indenture. +Upon the occurrence of a change of control, as defined in the indenture, each holder of the 2028 Notes may require us to purchase all or a portion of such holder’s 2028 Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indenture also provides for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the 2028 Notes to become or to be declared due and payable. +Commitments — As of December 31, 2018, we maintained letters of credit in the aggregate amount of $58.5 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2018, no amounts had been drawn under the letters of credit. +As of December 31, 2018, we had commitments to purchase major equipment and make investments totaling approximately $107 million for our drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The agreements expire in years 2019 through 2022 and in 2043. As of December 31, 2018, the remaining obligation under these agreements was approximately $114 million, of which approximately $24.7 million relates to purchases required during 2019. In the event the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. +40 +Trading and Investing — We have not engaged in trading activities that incl ude high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Contractual Obligations +The following table presents information with respect to our contractual obligations as of December 31, 2018 (in thousands): +Payments due by period +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Series A Notes (1) +$ +300,000 +— +300,000 +— +$ +— +Interest on Series A Notes (2) +29,820 +14,910 +14,910 +— +— +Series B Notes (3) +300,000 +— +— +300,000 +— +Interest on Series B Notes (4) +47,292 +12,810 +25,620 +8,862 +— +2028 Notes (5) +525,000 +— +— +— +525,000 +Interest on 2028 Notes (6) +197,006 +20,737 +41,475 +41,475 +93,319 +Leases (7) +40,860 +11,408 +15,612 +7,288 +6,552 +Equipment purchases (8) +107,088 +107,088 +— +— +— +Inventory purchases (9) +114,174 +24,725 +20,583 +5,533 +63,333 +Total +$ +1,661,240 +$ +191,678 +$ +418,200 +$ +363,158 +$ +688,204 +(1) +Principal repayment of the Series A Notes is required at maturity on October 5, 2020. +(2) +Interest to be paid on the Series A Notes using 4.97% coupon rate. +(3) +Principal repayment of the Series B Notes is required at maturity on June 14, 2022. +(4) +Interest to be paid on the Series B Notes using 4.27% coupon rate. +(5) +Principal repayment of the 2028 Notes is required at maturity on February 1, 2028. +(6) +Interest to be paid on the 2028 Notes using 3.95% coupon rate. +(7) +See Note 12 of Notes to Consolidated Financial Statements. +(8) +Represents commitments to purchase major equipment to be delivered in 2019 based on expected delivery dates. +(9) +Represents commitments to purchase proppants and chemicals for our pressure pumping business. +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements at December 31, 2018. +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by accounting principles generally accepted in the United States of America (“U.S. GAAP”). We define Adjusted EBITDA as net income (loss) plus net interest expense, income tax expense (benefit) and depreciation, depletion, amortization and impairment expense (including impairment of goodwill). We present Adjusted EBITDA because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measure of net income (loss). Our computations of Adjusted EBITDA may not be the same as other similarly titled measures of other companies. Set forth below is a reconciliation of the non-U.S. GAAP financial measure of Adjusted EBITDA to the U.S. GAAP financial measure of net income (loss). +Year Ended December 31, +2018 +2017 +2016 +(Dollars in thousands) +Net income (loss) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +Income tax benefit +(45,987 +) +(333,711 +) +(177,562 +) +Net interest expense +45,981 +35,606 +40,039 +Depreciation, depletion, amortization and impairment +916,318 +783,341 +668,434 +Impairment of goodwill +211,129 +— +— +Adjusted EBITDA +$ +806,020 +$ +491,146 +$ +212,277 +41 +Critical Accounting Policies +In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition, the use of estimates and oil and natural gas properties. +Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. During 2018, we identified 42 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, we believe the 42 rigs that were retired had limited commercial opportunity. In 2018, we recorded a charge of $48.4 million related to this retirement. In 2017, we recorded a charge of $29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. In 2016, we retired 19 mechanical rigs but recorded no charge as we had written down mechanical rigs that were still marketed in 2015. +We also periodically evaluate our pressure pumping assets, and in 2018, we recorded a charge of $17.4 million for the write-down of pressure pumping equipment. The pressure pumping equipment was primarily obsolete sand handling equipment, which has been replaced with more efficient sand solutions. There were no similar charges in 2017 or 2016. +In addition, we review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. Management deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 38%, 58%, 9% and 23%, respectively. +For the assessment performed in 2018, the expected cash flows for our asset groups included utilization , revenue and costs for our equipment and services that were estimated based upon our existing contract backlog, as well as recent contract tenders and customer inquiries. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the fourth quarter of 2018, and would begin to recover in late 2019 and continue into 2020 in response to improved oil prices. While we believe these assumptions with respect to future oil pricing are reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil prices will recover is highly uncertain. Potential events that could affect our assumptions regarding future prices and the timeframe for a recovery are affected by factors such as those described in “Risk Factors–We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results.” +All of these factors are beyond our control. If the lower oil price environment experienced at the end of 2018 were to last into 2020 and beyond, our actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future and such impairment could be material. +We concluded that no triggering events occurred during the years ended December 31, 2017 or 2016 with respect to our asset groups based on our results of operations for the years ended December 31, 2017 and 2016, our expectations of operating results in future periods and the prevailing commodity prices at the time. +42 +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing are our operating segments. We determine whether it is more likely than not that the fair value o f a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, we may perform qu antitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of December 31, 2018. In completing the assessment, the fair value of each reporting unit was estimated using the income valuation method. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of our contract drilling, pressure pumping, directional drilling and oilfield rentals reporting units, such as future oil and natural gas prices and projected demand for our services, and assumptions related to discount rates and long-term growth rates. +Based on the results of the goodwill impairment test as of December 31, 2018, the fair value of the contract drilling and oilfield rentals reporting units exceeded their carrying values by approximately 16% and 14%, respectively, and we concluded that no impairment was indicated in our contract drilling and oilfield rentals reporting units; however, impairment was indicated in our pressure pumping and directional drilling reporting units. We recognized an impairment charge of $211 million associated with the impairment of all of the goodwill in our pressure pumping and directional drilling reporting units. +While management believes the assumptions used with respect to future oil pricing are reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil prices will recover is highly uncertain. If the lower oil price environment experienced at the end of 2018 were to last into 2020 and beyond, our actual cash flows would likely be less than the expected cash flows used in these assessments and could result in additional impairment charges in the future and such impairment could be material. +In connection with our annual goodwill impairment assessment as of December 31, 2017 and 2016, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than the respective carrying amount. In making this determination, we considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in our reporting units, as well as our operating results for 2017 and 2016 and forecasted operating results for the respective succeeding year. Management also considered our overall market capitalization at December 31, 2017 and 2016. +Revenue recognition — On January 1, 2018, we adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on our consolidated financial statements, and a cumulative adjustment was not recognized. Revenues for reporting periods beginning after January 1, 2018 are presented under Topic 606, while revenues prior to January 1, 2018 continue to be reported under previous revenue recognition requirements of Topic 605. +Use of estimates — The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Key estimates used by management include: +• +allowance for doubtful accounts, +• +depreciation, depletion and amortization, +• +fair values of assets acquired and liabilities assumed in acquisitions, +• +goodwill and long-lived asset impairments, and +• +reserves for self-insured levels of insurance coverage. +For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +43 +Volatility of Oil and Natural Gas Prices and its Impac t on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil prices have recovered from the lows experienced in the first quarter of 2016. Oil prices reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil reached a fourth quarter 2018 high of $76.40 per barrel on October 3, 2018, before declining by 42% over the course of three months to reach a low of $44.48 per barrel in late December 2018. Oil prices averaged $59.08 per barrel in the fourth quarter of 2018. U.S. rig counts increased in response to improved oil prices in early 2018. However, rig counts have fallen in response to lower oil prices, and we believe the rig count will not increase until oil prices increase. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices or expectations of decreases in oil and natural gas prices, would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +Inflation has not had a significant impact on our operations during the three years ended December 31, 2018. We believe that inflation will not have a significant near-term impact on our financial position. +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As of December 31, 2018, we would have had exposure to interest rate market risk associated with any borrowings that we had under the Credit Agreement and the Reimbursement Agreement. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based on our credit rating. As of December 31, 2018, the applicable margin on LIBOR rate loans was 1.50% and the applicable margin on base rate loans was 0.50%. As of December 31, 2018, we had no amounts outstanding under our revolving credit facility. The interest rate on borrowings outstanding under our revolving credit facility is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate. +Under the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. We are obligated to pay Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2018, no amounts had been disbursed under any letters of credit. +We conduct a portion of our business in Canadian dollars. The exchange rate between Canadian dollars and U.S. dollars has fluctuated during the last several years. If the value of the Canadian dollar against the U.S. dollar weakens, revenues and earnings of our Canadian operations will be reduced and the value of our Canadian net assets will decline when they are translated to U.S. dollars. This currency risk is not material to our financial condition or results of operations. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +44 +Item 8. Financial Statements a nd Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2018, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2018, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2018. +The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None . +45 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +46 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger by and among Patterson-UTI Energy, Inc., Pyramid Merger Sub, Inc. and Seventy Seven Energy Inc., dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 2.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) . +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8 -K and incorporated herein by reference) . +3.4 +Certificate of Amendment to Restated Certificate of Incorporation, as amended (filed July 30, 2018 as Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018 and incorporated herein by reference). +3.5 +Fourth Amended and Restated Bylaws (filed February 12, 2019 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) . +4.1 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhib it 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +4.2 +Registration Rights Agreement, dated as of October 11, 2017, between Patterson-UTI Energy, Inc. and the sellers party thereto. (filed February 20, 2018 as Exhibit 4.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 a nd incorporated herein by reference). +4.3 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to the Company’s Current Report on Form 8-K and incorporated herei n by reference). +4.4 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein an d Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.5 +Form of 3.95% Senior Note due 2028 (included in Exhibit 4.4 above). +4.6 +Registration Rights Agreement, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Goldman, Sachs & Co. LLC, Wells Fargo Securities, LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated (filed January 19, 2018 as Exhibit 4.4 to the C ompany’s Current Report on Form 8-K and incorporated herein by reference). +10.1 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +47 +10.2 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.3 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.4 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhib it 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.5 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.6 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.7 +Patterson-UTI Energy, Inc. Omnibus Incentive Plan (filed April 21, 2017 as Exhibit 4.4 to the Company’s Registration Statement on Form S-8 and incorporated herein by reference) . * +10.8 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan ( filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (as amended and restated effective June 29, 2017) (filed June 30, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.10 +Form of Executive Officer Restricted Stock Award Agreement (filed May 2, 2016 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q and incorporated h erein by reference) .* +10.11 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 4, 2017 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). * +10.12 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.13 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.14 +Form of Non-Employee Director Restricted Stock Unit Award Agreement (filed February 20, 2018 as Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 and incorporated herein by reference) . * +10.15 +Form of Executive Officer Share-Settled Performance Share Award Agreement.*+ +10.16 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel and Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference) .* +10.17 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed January 17, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.18 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein b y reference). * +10.19 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference) .* +10.20 +Employment Agreement, dated as of September 3, 2017, between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.21 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon, Tiffany J. Thom, C. Andrew Smith and Janeen S. Judah (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year en ded December 31, 2003 and incorporated herein by reference) .* +48 +10.2 2 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 2 9, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference) .* +10.23 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference) .* +10.24 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q and incorporated here in by reference) .* +10.25 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into Nove mber 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.26 +Amended and Restated Credit Agreement dated March 27, 2018 among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2018 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.27 +Note Purchase Agreement dated October 5, 2010 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed October 6, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.28 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named therein (relates to Note Purchase Agreement dated October 5, 2010) (filed October 28, 2015 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) . +10.29 +Note Purchase Agreement dated June 14, 2012 by and among Patterson-UTI Energy, Inc. and the purchasers named therein (filed June 18, 2012 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.30 +Amendment No. 1 to Note Purchase Agreement, dated as of October 22, 2015, by and among Patterson-UTI Energy, Inc., certain subsidiaries of Patterson-UTI Energy, Inc. party thereto, and the purchasers named ther ein (relates to Note Purchase Agreement dated June 14, 2012) (filed October 28, 2015 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). +10.31 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to t he Company’s Current Report on Form 8-K and incorporated herein by reference) . +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended. + +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended. + +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. + +101 +The following materials from Patterson-UTI Energy, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.+ +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. +Item 16. Form 10-K Summary +None. +49 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2018 and 2017 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2018 , 2017 and 2016 +F-5 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2018 , 2017 and 2016 +F-6 +Consolidated Statements of Changes In Stockholders’ Equity for the years ended December 31, 2018 , 2017 and 2016 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2018 , 2017 and 2016 +F-8 +Notes to Consolidated Financial Statements +F-9 +F-1 +R eport of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc.: +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes and financial statement schedule listed in the index appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits i n accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial stat ements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated f inancial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +F-2 +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 13, 2019 +We have served as the Company’s auditor since 1993. +F-3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2018 +2017 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +245,029 +$ +42,828 +Accounts receivable, net of allowance for doubtful accounts of $2,312 and $2,323 at +December 31, 2018 and 2017, respectively +558,817 +580,354 +Federal and state income taxes receivable +4,110 +1,152 +Inventory +65,579 +69,167 +Other +76,662 +53,354 +Total current assets +950,197 +746,855 +Property and equipment, net +4,002,549 +4,254,730 +Goodwill and intangible assets +477,640 +687,072 +Deposits on equipment purchases +12,040 +16,351 +Deferred tax assets, net +— +3,875 +Other +27,440 +49,973 +Total assets +$ +5,469,866 +$ +5,758,856 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +288,962 +$ +319,621 +Federal and state income taxes payable +1,408 +5 +Accrued expenses +235,946 +226,624 +Total current liabilities +526,316 +546,250 +Borrowings under revolving credit facility +— +268,000 +Long-term debt, net of debt discount and issuance costs of $5,795 and $1,217 at +December 31, 2018 and 2017, respectively +1,119,205 +598,783 +Deferred tax liabilities, net +306,161 +350,836 +Other +12,761 +12,494 +Total liabilities +1,964,443 +1,776,363 +Commitments and contingencies (see Note 9) +Stockholders’ equity: +Preferred stock, par value $.01; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $.01; authorized 400,000,000 shares at December 31, 2018 and 300,000,000 shares at December 31, 2017 with 267,315,526 and 266,259,083 issued and 213,614,430 and 222,456,472 outstanding at +December 31, 2018 and 2017, respectively +2,673 +2,662 +Additional paid-in capital +2,827,154 +2,785,823 +Retained earnings +1,753,557 +2,105,897 +Accumulated other comprehensive income +2,487 +6,822 +Treasury stock, at cost, 53,701,096 shares and 43,802,611 shares at +December 31, 2018 and 2017, respectively +(1,080,448 +) +(918,711 +) +Total stockholders’ equity +3,505,423 +3,982,493 +Total liabilities and stockholders’ equity +$ +5,469,866 +$ +5,758,856 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2018 +2017 +2016 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +1,430,492 +$ +1,040,033 +$ +543,663 +Pressure pumping +1,573,396 +1,200,311 +354,070 +Directional drilling +209,275 +45,580 +— +Other +113,834 +70,760 +18,133 +Total operating revenues +3,326,997 +2,356,684 +915,866 +Operating costs and expenses: +Contract drilling +885,704 +667,105 +305,804 +Pressure pumping +1,263,850 +966,835 +334,588 +Directional drilling +175,829 +32,172 +— +Other +77,104 +51,428 +8,384 +Depreciation, depletion, amortization and impairment +916,318 +783,341 +668,434 +Impairment of goodwill +211,129 +— +— +Selling, general and administrative +134,071 +105,847 +69,205 +Merger and integration expenses +2,738 +74,451 +— +Other operating income, net +(17,569 +) +(31,957 +) +(14,323 +) +Total operating costs and expenses +3,649,174 +2,649,222 +1,372,092 +Operating loss +(322,177 +) +(292,538 +) +(456,226 +) +Other income (expense): +Interest income +5,597 +1,866 +327 +Interest expense, net of amount capitalized +(51,578 +) +(37,472 +) +(40,366 +) +Other +750 +343 +69 +Total other expense +(45,231 +) +(35,263 +) +(39,970 +) +Loss before income taxes +(367,408 +) +(327,801 +) +(496,196 +) +Income tax benefit +(45,987 +) +(333,711 +) +(177,562 +) +Net income (loss) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +Net income (loss) per common share: +Basic +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +Diluted +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +Weighted average number of common shares outstanding: +Basic +218,643 +198,447 +146,178 +Diluted +218,643 +199,882 +146,178 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2018 +2017 +2016 +(In thousands) +Net income (loss) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +Other comprehensive income (loss), net of taxes of $0 for 2018, $0 +for 2017 and $0 for 2016: +Foreign currency translation adjustment +(4,335 +) +7,956 +2,959 +Total comprehensive income (loss) +$ +(325,756 +) +$ +13,866 +$ +(315,675 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings +Income (Loss) +Stock +Total +(In thousands) +Balance, December 31, 2015 +190,375 +$ +1,904 +$ +1,011,811 +$ +2,458,554 +$ +(4,093 +) +$ +(907,045 +) +$ +2,561,131 +Net loss +— +— +— +(318,634 +) +— +— +(318,634 +) +Foreign currency translation adjustment +— +— +— +— +2,959 +— +2,959 +Shares issued for acquisition +354 +3 +6,730 +— +— +— +6,733 +Issuance of restricted stock +785 +8 +(8 +) +— +— +— +— +Vesting of restricted stock units +15 +— +— +— +— +— +— +Forfeitures of restricted stock +(43 +) +— +— +— +— +— +— +Exercise of stock options +40 +— +707 +— +— +— +707 +Stock-based compensation +— +— +28,324 +— +— +— +28,324 +Tax expense related to stock- +based compensation +— +— +(4,868 +) +— +— +— +(4,868 +) +Payment of cash dividends +— +— +— +(23,579 +) +— +— +(23,579 +) +Purchase of treasury stock +— +— +— +— +— +(4,049 +) +(4,049 +) +Balance, December 31, 2016 +191,526 +1,915 +1,042,696 +2,116,341 +(1,134 +) +(911,094 +) +2,248,724 +Net income +— +— +— +5,910 +— +— +5,910 +Foreign currency translation adjustment +— +— +— +— +7,956 +— +7,956 +Equity offering +18,170 +182 +471,388 +— +— +— +471,570 +Shares issued for acquisitions +55,097 +551 +1,226,339 +— +— +— +1,226,890 +Issuance of restricted stock +891 +9 +(9 +) +— +— +— +— +Vesting of restricted stock units +549 +5 +(5 +) +— +— +— +— +Forfeitures of restricted stock +(24 +) +— +— +— +— +— +— +Exercise of stock options +50 +— +931 +— +— +— +931 +Stock-based compensation +— +— +44,483 +— +— +— +44,483 +Payment of cash dividends +— +— +— +(16,315 +) +— +— +(16,315 +) +Dividend equivalents +— +— +— +(39 +) +— +— +(39 +) +Purchase of treasury stock +— +— +— +— +— +(7,617 +) +(7,617 +) +Balance, December 31, 2017 +266,259 +2,662 +2,785,823 +2,105,897 +6,822 +(918,711 +) +3,982,493 +Net loss +— +— +— +(321,421 +) +— +— +(321,421 +) +Foreign currency translation adjustment +— +— +— +— +(4,335 +) +— +(4,335 +) +Restricted stock issued for acquisition +192 +2 +2,930 +— +— +— +2,932 +Issuance of restricted stock +381 +4 +(4 +) +— +— +— +— +Issuance of common stock +— +— +— +— +— +— +— +Vesting of restricted stock units +452 +5 +(5 +) +— +— +— +— +Forfeitures of restricted stock +(8 +) +— +— +— +— +— +— +Exercise of stock options +40 +— +485 +— +— +— +485 +Stock-based compensation +— +— +37,925 +— +— +— +37,925 +Payment of cash dividends +— +— +— +(30,589 +) +— +— +(30,589 +) +Dividend equivalents +— +— +— +(330 +) +— +— +(330 +) +Purchase of treasury stock +— +— +— +— +— +(161,737 +) +(161,737 +) +Balance, December 31, 2018 +267,316 +$ +2,673 +$ +2,827,154 +$ +1,753,557 +$ +2,487 +$ +(1,080,448 +) +$ +3,505,423 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2018 +2017 +2016 +(In thousands) +Cash flows from operating activities: +Net income (loss) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +Adjustments to reconcile net income (loss) to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +916,318 +783,341 +668,434 +Impairment of goodwill +211,129 +— +— +Dry holes and abandonments +915 +1,929 +58 +Deferred income tax benefit +(41,185 +) +(330,346 +) +(152,160 +) +Stock-based compensation expense +37,925 +44,483 +28,324 +Net gain on asset disposals +(28,958 +) +(33,510 +) +(14,771 +) +Tax expense related to stock-based compensation +— +— +(4,868 +) +Amortization of debt discount and issuance costs +830 +346 +2,270 +Changes in operating assets and liabilities: +Accounts receivable +23,515 +(239,482 +) +72,327 +Income taxes receivable/payable +(1,555 +) +990 +30,379 +Inventory and other assets +(1,470 +) +(23,449 +) +5,664 +Accounts payable +(69,453 +) +104,072 +12,024 +Accrued expenses +4,136 +(14,190 +) +(24,573 +) +Other liabilities +(56 +) +617 +560 +Net cash provided by operating activities +730,670 +300,711 +305,034 +Cash flows from investing activities: +Acquisitions, net of cash acquired +(14,211 +) +(501,954 +) +155 +Purchases of property and equipment +(641,458 +) +(567,087 +) +(119,799 +) +Proceeds from disposal of assets +47,357 +60,945 +21,889 +Collection of note receivable +23,760 +— +— +Other investments +— +(2,520 +) +— +Net cash used in investing activities +(584,552 +) +(1,010,616 +) +(97,755 +) +Cash flows from financing activities: +Proceeds from equity offering +— +471,570 +— +Purchases of treasury stock +(161,737 +) +(6,809 +) +(3,610 +) +Dividends paid +(30,589 +) +(16,315 +) +(23,579 +) +Proceeds from long-term debt +521,194 +— +— +Repayment of long-term debt +— +— +(255,000 +) +Proceeds from borrowings under revolving credit facility +79,000 +599,000 +200,500 +Repayment of borrowings under revolving credit facility +(347,000 +) +(331,000 +) +(200,500 +) +Debt issuance costs +(4,489 +) +— +(3,357 +) +Proceeds from exercise of stock options +485 +123 +268 +Net cash provided by (used in) financing activities +56,864 +716,569 +(285,278 +) +Effect of foreign exchange rate changes on cash +(781 +) +1,012 +(195 +) +Net increase (decrease) in cash and cash equivalents +202,201 +7,676 +(78,194 +) +Cash and cash equivalents at beginning of year +42,828 +35,152 +113,346 +Cash and cash equivalents at end of year +$ +245,029 +$ +42,828 +$ +35,152 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $1,435 in 2018, $1,175 in 2017 +and $398 in 2016 +$ +(41,184 +) +$ +(34,953 +) +$ +(36,551 +) +Income taxes +3,172 +3,947 +52,716 +Non-cash investing and financing activities: +Receivable from property and equipment insurance +$ +15,000 +$ +— +$ +— +Net increase in payables for purchases of property +and equipment +36,241 +17,228 +28,926 +Issuance of common stock for business acquisitions +2,932 +1,226,890 +6,733 +Net decrease (increase) in deposits on equipment purchases +4,311 +(301 +) +6,317 +The accompanying notes are an integral part of these consolidated financial statements. +F-8 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “Patterson-UTI” or the “Company”), is a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. The Company’s contract drilling business operates in the continental United States and western Canada, and the Company is pursuing contract drilling opportunities outside of North America. The Company’s pressure pumping business operates primarily in Texas and the Mid-Continent and Appalachian regions. The Company also provides a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and the Company provides services that improve the statistical accuracy of horizontal wellbore placement. The Company has other operations through which the Company provides oilfield rental tools in select markets in the United States. The Company also manufactures and sells pipe handling components and related technology to drilling contractors, and provides electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, the Company owns and invests, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, the Company has no controlling financial interests in any other entity which would require consolidation. As used in these notes, “the Company” refers collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its business operations through its wholly-owned subsidiaries and has no employees or independent operations. +The U.S. dollar is the functional currency for all of the Company’s operations except for its Canadian subsidiaries, which use the Canadian dollar as their functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Revenue recognition — Revenues from the Company’s contract drilling, pressure pumping, directional drilling, oilfield rentals and pipe handling components and related technology activities are recognized as services are performed. All of the wells the Company drilled in 2018, 2017 and 2016 were drilled under daywork contracts. Revenue from sales of products are recognized upon customer acceptance. Revenue is presented net of any sales tax charged to the customer that the Company is required to remit to local or state governmental taxing authorities. +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of the Company’s customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +On January 1, 2018, the Company adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on the Company’s consolidated financial statements, and a cumulative adjustment was not recognized. See Note 3 for additional information. +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts represents the Company’s estimate of the amount of probable credit losses existing in the Company’s accounts receivable. The Company reviews the adequacy of its allowance for doubtful accounts at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectable, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with the Company’s pressure pumping activities and materials used in its directional drilling and drilling technology business. Such inventories are stated at the lower of cost or market, with cost determined using the average cost method. +F-9 +Other current assets — O ther current assets includes reimbursement from the Company’s workers compensation insurance carrier for claims in excess of the Company’s deductible in the amount of $36 million and $30 million at December 31, 2018 and 2017 , respectively. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Equipment +1.25-15 +Buildings +15-20 +Other +3-12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. The Company reviews wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, the Company considers the well costs to be impaired and recognizes the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +The Company reviews its proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). The Company reviews unproved oil and natural gas properties quarterly to assess potential impairment. The Company’s impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. The Company assesses impairment of its goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. The Company’s policy is to account for interest and penalties with respect to income taxes as operating expenses. +F-10 +Stock-based compensation — The Company recognizes the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards (See Note 1 1 ). +As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, based on historical experience. Forfeitures are estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates. +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Issued Accounting Standards — In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. The Company adopted this new revenue guidance effective January 1, 2018, utilizing the modified retrospective method, and expanded its consolidated financial statement disclosures in order to comply with the update. The adoption of this update did not have a material impact on the Company’s consolidated financial statements (See Note 3). +In February 2016, the FASB issued an accounting standards update to provide guidance for the accounting for leasing transactions. The standard requires the lessee to recognize a lease liability along with a right-of-use asset for all leases with a term longer than one year. A lessee is permitted to make an accounting policy election by class of underlying asset to not recognize the lease liability and related right-of-use asset for leases with a term of one year or less. The provisions of this standard also apply to situations where the Company is the lessor. The requirements in this update are effective during interim and annual periods beginning after December 15, 2018. The Company adopted this new guidance effective January 1, 2019. ASC 842 requires a modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. The Company has elected to report all leases at the beginning of the period of adoption and not restate its comparative periods. Based on the Company’s lease portfolio, the Company anticipates recognizing a right-of-use asset and a related lease liability of approximately $35 million on its balance sheet, with an immaterial impact on the Company’s consolidated statement of operations compared to the previous lease accounting guidance. +Practical Expedients Adopted with Topic 842 +The Company has elected to adopt the following practical expedients upon the transition date to Topic 842 on January 1, 2019: +• +Transitional practical expedients package: An entity may elect to apply the listed practical expedients as a package to all the leases that commenced before the effective date. The practical expedients are: +a) +The entity need not reassess whether any expired or existing contracts are or contains leases; +b) +The entity need not reassess the lease classification for expired or existing contracts; +c) +The entity need not reassess initial direct costs for any existing leases. +• +Use of portfolio approach: An entity can apply this guidance to a portfolio of leases with similar characteristics if the entity reasonably expects that the application of the leases model to the portfolio would not differ materially from the application of the leases model to the individual leases in that portfolio. This approach can also be applied to other aspects of the leases guidance for which lessees/lessors need to make judgments and estimates, such as determining the discount rate and determining and reassessing the lease term. +• +Lease and non-lease components: As a practical expedient, a lessor may combine lease and non-lease components where the revenue recognition pattern is the same and where the lease component, when accounted for separately, would be considered an operating lease. +In March 2016, the FASB issued an accounting standards update to provide guidance for the accounting for share-based payment transactions, including the related income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This guidance became effective for the Company during the three months ended March 31, 2017. The Company believes this guidance has caused and will continue to cause volatility in its effective tax rates and diluted earnings per share due to the tax effects related to share-based payments being recorded in the statement of operations. The volatility in future periods will +F-11 +depend on the Company’s stock price and the number of shares that vest in the case of restricted stock, restric ted stock units and performance stock units, or the number of shares that are exercised in the case of stock options. +In August 2016, the FASB issued an accounting standards update to clarify the presentation of cash receipts and payments in specific situations on the statement of cash flows. The requirements in this update are effective during interim and annual periods beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on the Company’s consolidated financial statements. +In May 2017, the FASB issued an accounting standards update that provided clarity on which changes to the terms or conditions of share-based payment awards require an entity to apply modification accounting provisions. The requirements in this update are effective during interim and annual periods in fiscal years beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on the Company’s consolidated financial statements. +In March 2018, the FASB issued an accounting standards update to update the income tax accounting in U.S. GAAP to reflect the SEC interpretive guidance released on December 22, 2017, when significant U.S. tax law changes were enacted with the enactment of the Tax Cuts and Jobs Act (“Tax Reform”). The adoption of this update in March 2018 did not have a material impact on the Company’s consolidated financial statements, as the Company was already following the SEC guidance. See Note 13 for additional information. +In August 2018, the FASB issued an accounting standards update to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the impact this new guidance will have on its consolidated financial statements. +2. Acquisitions +SSE +On April 20, 2017, pursuant to the merger agreement, a subsidiary of the Company was merged with and into SSE, with SSE continuing as the surviving entity and one of the Company’s wholly owned subsidiaries (the “SSE merger”). Pursuant to the terms of the merger agreement, the Company acquired all of the issued and outstanding shares of common stock of SSE, in exchange for approximately 46.3 million shares of common stock of the Company. Concurrent with the closing of the merger, the Company repaid all of the outstanding debt of SSE totaling $472 million. Based on the closing price of the Company’s common stock on April 20, 2017, the total fair value of the consideration transferred to effect the acquisition of SSE was approximately $1.5 billion. On April 20, 2017, following the SSE merger, SSE was merged with and into a newly-formed subsidiary of the Company named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of the Company’s wholly owned subsidiaries. +Through the SSE merger, the Company acquired a fleet of 91 drilling rigs, 36 of which the Company considers to be APEX® rigs. Additionally, through the SSE merger, the Company acquired approximately 500,000 horsepower of fracturing equipment. The oilfield rentals business acquired through the SSE merger has a fleet of premium rental tools, and it provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +The merger has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date, with the remaining unallocated amount recorded as goodwill. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of Company common stock issued to SSE shareholders +46,298 +Company common stock price on April 20, 2017 +$ +22.45 +Fair value of common stock issued +$ +1,039,396 +Plus SSE long-term debt repaid by Company +$ +472,000 +Total fair value of consideration transferred +$ +1,511,396 +F-12 +The following table represents the final allocation of the total purchase price of SSE to the assets acquired and the liabilities assumed based on the fair value at the merger date, with the excess of the purchase price over the estimated fair value of the identifiable net assets acquired record ed as goodwill (in thousands): +Identifiable assets acquired +Cash and cash equivalents +$ +37,806 +Accounts receivable +149,659 +Inventory +8,518 +Other current assets +19,038 +Property and equipment +984,433 +Other long-term assets +20,918 +Intangible assets +22,500 +Total identifiable assets acquired +1,242,872 +Liabilities assumed +Accounts payable and accrued liabilities +133,415 +Deferred income taxes +32,881 +Other long-term liabilities +1,734 +Total liabilities assumed +168,030 +Net identifiable assets acquired +1,074,842 +Goodwill +436,554 +Total net assets acquired +$ +1,511,396 +The acquired goodwill is not deductible for tax purposes. Among the factors that contributed to a purchase price resulting in the recognition of goodwill was SSE’s reputation as an experienced provider of high-quality contract drilling and pressure pumping services in a safe and efficient manner, access to new geographies, access to new product lines, increased scale of operations, supply chain and corporate efficiencies as well as infrastructure optimization. The acquired goodwill was attributable to three operating segments, with $309 million to contract drilling, $121 million to pressure pumping and $6.3 million to oilfield rentals. See Note 6 for additional information regarding goodwill. +A portion of the fair value consideration transferred has been assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Assets +Favorable drilling contracts +$ +22,500 +0.83 +MS Directional +On October 11, 2017, the Company acquired all of the issued and outstanding limited liability company interests of MS Directional. The aggregate consideration paid by the Company consisted of $69.8 million in cash and approximately 8.8 million shares of the Company’s common stock. The purchase price was subject to customary post-closing adjustments relating to cash, net working capital and indebtedness of MS Directional as of the closing. Based on the closing price of the Company’s common stock on the closing date of the transaction, the total fair value of the consideration transferred to effect the acquisition of MS Directional was approximately $257 million. +MS Directional is a leading directional drilling services company in the United States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, motor rentals, directional surveying, measurement-while-drilling, and wireline steering tools. +The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date, with the remaining unallocated amount recorded as goodwill. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of Company common stock issued to MS Directional shareholders +8,798 +Company common stock price on October 11, 2017 +$ +21.31 +Fair value of common stock issued +$ +187,494 +Plus MS Directional long-term debt repaid by Company +$ +63,000 +Plus cash to sellers +$ +6,781 +Total fair value of consideration transferred +$ +257,275 +F-13 +The following table represents the final allocation of the total purchase price of MS Directional to the assets acquired and the liabilities assumed based on the fair value at the merger date, with the excess of the purchase price over the estimated fair value of the identifi able net assets acquired recorded as goodwill (in thousands): +Identifiable assets acquired +Cash and cash equivalents +$ +2,021 +Accounts receivable +42,782 +Inventory +28,060 +Other current assets +155 +Property and equipment +63,998 +Other long-term assets +318 +Intangible assets +74,682 +Total identifiable assets acquired +212,016 +Liabilities assumed +Accounts payable and accrued liabilities +44,099 +Other long-term liabilities +327 +Total liabilities assumed +44,426 +Net identifiable assets acquired +167,590 +Goodwill +89,685 +Total net assets acquired +$ +257,275 +The goodwill reflected above increased $1.0 million from the original preliminary purchase price allocation as a result of a measurement period adjustment that related to a valuation adjustment to accounts payable and accrued liabilities. +The acquired goodwill is deductible for tax purposes. Among the factors that contributed to a purchase price resulting in the recognition of goodwill was MS Directional’s reputation as an experienced provider of high-quality directional drilling services in a safe and efficient manner, access to new product lines, favorable market trends underlying these new business lines, earnings and growth opportunities and future technology development possibilities. All of the goodwill acquired is attributable to the directional drilling operating segment. See Note 6 for additional information regarding goodwill. +A portion of the fair value consideration transferred has been assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Assets +Developed technology +$ +48,000 +10.00 +Customer relationships +26,200 +3.00 +Internal use software +482 +5.00 +$ +74,682 +7.51 +F-14 +Pro Forma +The results of SSE’s operations since the SSE merger date of April 20, 2017 and the results of MS Directional since the acquisition date of October 11, 2017 are included in the Company’s consolidated statement of operations. It is impractical to quantify the contribution of the SSE operations since the merger, as the contract drilling and pressure pumping businesses were fully integrated into the Company’s existing operations in 2017. The contribution of MS Directional since the date of the acquisition accounts for substantially all of the Company’s directional drilling segment, as disclosed in Note 14. The following pro forma condensed combined financial information was derived from the historical financial statements of the Company, SSE and MS Directional and gives effect to the acquisitions as if they had occurred on January 1, 2016. The below information reflects pro forma adjustments based on available information and certain assumptions the Company believes are reasonable, including (i) adjustments related to the depreciation and amortization of the fair value of acquired intangibles and fixed assets, (ii) removal of the historical interest expense of the acquired entities, (iii) the tax benefit of the aforementioned pro forma adjustments, and (iv) adjustments related to the common shares outstanding to reflect the impact of the consideration exchanged in the acquisitions. Additionally, the pro forma loss for the year ended December 31, 2017 was adjusted to exclude the Company’s merger and integration-related costs of $74.5 million and SSE’s merger related costs of $36.7 million with a corresponding inclusion in the net loss for the year ended December 31, 2016 to give effect as if the acquisitions had occurred on January 1, 2016. The pro forma results of operations do not include any cost savings or other synergies that may result from the SSE merger or MS Directional acquisition. The pro forma results of operations also do not include any estimated costs that have been incurred by the Company to integrate the SSE and MS Directional operations. The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the SSE merger and MS Directional acquisition taken place on January 1, 2016; furthermore, the financial information is not intended to be a projection of future results. The following table summarizes selected financial information of the Company on a pro forma basis (in thousands, except per share data): +2017 +2016 +(Unaudited) +Revenues +$ +2,738,579 +$ +1,567,141 +Net income (loss) +$ +29,584 +$ +(505,413 +) +Net income (loss) per share +Basic +$ +0.13 +$ +(2.30 +) +Diluted +$ +0.13 +$ +(2.30 +) +Current Power Solutions, Inc. (“Current Power”) +During October 2018, the Company acquired Current Power. Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. This acquisition was not material to the Company’s consolidated financial statements. +Superior QC, LLC (“Superior QC”) +During February 2018, the Company acquired the business of Superior QC, including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) survey fault detection, isolation and recovery (FDIR) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. This acquisition was not material to the Company’s consolidated financial statements. +Warrior Rig Ltd +During September 2016, the Company acquired Warrior Rig Ltd. and certain related entities (“Warrior”). Based in Calgary, Warrior manufactures and sells pipe handling components and related technology for drilling contractors in North America and other select markets. This acquisition was not material to the Company’s consolidated financial statements . +3. Revenues +ASC Topic 606 Revenue from Contracts with Customers +On January 1, 2018, the Company adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on the Company’s consolidated financial statements, and a cumulative adjustment was not recognized. Revenues for reporting periods beginning after January 1, 2018 are presented under Topic 606, while revenues prior to January 1, 2018 continue to be reported under previous revenue recognition requirements of Topic 605. +The Company’s contracts with customers include both long-term and short-term contracts. Services that primarily generate revenue earned for the Company include the operating business segments of contract drilling, pressure pumping and directional drilling +F-15 +that comprise the Company’ s reportable segments. The Company also derives revenues from its other operations which include the Company’s operating business segments of oilfield rentals, oilfield technology, electrical controls and automation, and oil and natural gas working intere sts. For more information on the Company’s business segmen ts, see Note 16 . +Charges for services are considered a series of distinct services. Since each distinct service in a series would be satisfied over time if it were accounted for separately, and the entity would measure its progress towards satisfaction using the same measure of progress for each distinct service in the series, the Company is able to account for these integrated services as a single performance obligation that is satisfied over time. +The transaction price is the amount of consideration to which the Company expects to be entitled in exchange for transferring promised goods or services to a customer, based on terms of the Company’s contracts with its customers. The consideration promised in a contract with a customer may include fixed amounts and/or variable amounts. Payments received for services are considered variable consideration as the time in service will fluctuate as the services are provided. Topic 606 provides an allocation exception, which allows the Company to allocate variable consideration to one or more distinct services promised in a series of distinct services that form part of a single performance obligation as long as certain criteria are met. These criteria state that the variable payment must relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service, and allocation of the variable consideration is consistent with the standards’ allocation objective. Since payments received for services meet both of these criteria requirements, the Company recognizes revenue when the service is performed. +An estimate of variable consideration should be constrained to the extent that it is not probable that a significant revenue reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Payments received for other types of consideration are fully constrained as they are highly susceptible to factors outside the entity’s influence and therefore could be subject to a significant revenue reversal once resolved. As such, revenue received for these types of consideration is recognized when the service is performed. +Estimates of variable consideration are subject to change as facts and circumstances evolve. As such, the Company will evaluate its estimates of variable consideration that are subject to constraints throughout the contract period and revise estimates, if necessary, at the end of each reporting period. +The Company is a working interest owner of oil and natural gas properties located in Texas and New Mexico. The ownership terms are outlined in joint operating agreements for each well between the operator of the wells and the various interest owners, including the Company, who are considered non-operators of the well. The Company receives revenue each period for its working interest in the well during the period. The revenue received for the working interests from these oil and gas properties does not fall under the scope of the new revenue standard, and therefore, will continue to be reported under current guidance ASC 932-323 Extractive Activities – Oil and Gas, Investments – Equity Method and Joint Ventures. +Reimbursement Revenue – Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of the Company’s customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +The Company’s disaggregated revenue recognized from contracts with customers is included in Note 16. +Accounts Receivable and Contract Liabilities +Accounts receivable is the Company’s right to consideration once it becomes unconditional. Payment terms range from 30 to 60 days. +Accounts receivable balances were $554 million and $577 million as of December 31, 2018 and 2017, respectively. These balances do not include amounts related to the Company’s oil and gas working interests as those contracts are excluded from Topic 606. Accounts receivable balances are included in “Accounts Receivable” in the Consolidated Balance Sheets. +The Company does not have any contract asset balances, and as such, contract balances are not presented at the net amount at a contract level. Contract liabilities include prepayments received from customers prior to the requested services being completed. Once the services are complete and have been invoiced, the prepayment is applied against the customer’s account to offset the accounts receivable balance. Also included in contract liabilities are payments received from customers for the initial mobilization of newly constructed or upgraded rigs that were moved on location to the initial well site. These mobilization payments are allocated to the overall performance obligation and amortized over the initial term of the contract. During the year ended December 31, 2018, contract liabilities increased approximately $1.5 million due to customer payments relating to the initial mobilization of upgraded rigs and decreased approximately $1.6 million due to amounts amortized and recorded in drilling revenue. +F-16 +Contract liability balances for customer prepayments were $ 3.0 million and $9.1 million as of December 31 , 2018 and 2017, respectively. Contract liability balances for deferred mobilization payments relating to newly constructed or upgraded rigs were $ 4.6 million and $4.7 million as of December 31 , 2018 and 2017, respectively. Contract liability balances for customer prepayments are included in “Accounts Payable” and contract liability balances for deferred mobilization payments are included in “Accrued Liabilities” in the Consolidated Balance Sheets. +Contract Costs +Costs incurred for newly constructed or rig upgrades based on a contract with a customer are considered capital improvements and are capitalized to drilling equipment and depreciated over the estimated useful life of the asset. +Practical Expedients Adopted with Topic 606 +The Company has elected to adopt the following practical expedients upon the transition date to Topic 606 on January 1, 2018: +• +Use of portfolio approach: An entity can apply this guidance to a portfolio of contracts (or performance obligations) with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying this guidance to the portfolio would not differ materially from applying this guidance to the individual contracts (or performance obligations) within that portfolio. +• +Excluding disclosure about transaction price: As a practical expedient, an entity need not disclose the information for a performance obligation if either of the following conditions is met: +a) +The performance obligation is part of a contract that has an original expected duration of one year or less. +b) +The entity recognizes revenue from the satisfaction of the performance obligation. +• +Excluding sales taxes from the transaction price: The scope of this policy election is the same as the scope of the policy election under previous guidance. This election provides exclusion from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction and collected by the entity from a customer. +• +Costs of obtaining a contract: An entity can immediately expense costs of obtaining a contract if they would be amortized within a year. +4. Inventory +Inventory consisted of the following at December 31, 2018 and 2017 (in thousands). +2018 +2017 +Finished goods +$ +347 +$ +2,270 +Work-in-process +6,375 +529 +Raw materials and supplies +58,857 +66,368 +Inventory +$ +65,579 +$ +69,167 +5. Property and Equipment +Property and equipment consisted of the following at December 31, 2018 and 2017 (in thousands): +2018 +2017 +Equipment +$ +8,370,933 +$ +8,066,404 +Oil and natural gas properties +219,855 +211,566 +Buildings +186,736 +185,475 +Land +26,144 +26,593 +Total property and equipment +8,803,668 +8,490,038 +Less accumulated depreciation, depletion and impairment +(4,801,119 +) +(4,235,308 +) +Property and equipment, net +$ +4,002,549 +$ +4,254,730 +F-17 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets and liabilities for 2018 , 2017 and 2016 (in thousands): +2018 +2017 +2016 +Depreciation and impairment expense +$ +887,155 +$ +753,510 +$ +657,571 +Amortization expense +18,197 +21,764 +3,643 +Depletion expense +10,966 +8,067 +7,220 +Total +$ +916,318 +$ +783,341 +$ +668,434 +On a periodic basis, the Company evaluates its fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to the Company’s yards to be used as spare equipment. The remaining components of these rigs are retired . In 2018, the Company identified 42 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, the Company believes the 42 rigs that were retired had limited commercial opportunity. The Company recorded a $48.4 million charge related to this retirement. In 2017, the Company r ecorded a charge of $29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. In 2016, the Company retired 19 mechanical rigs but recorded no charge as it had written down mechanical rigs that were still marketed in 2015. +The Company also periodically evaluates its pressure pumping assets, and in 2018, the Company recorded a charge of $17.4 million for the write-down of pressure pumping equipment. The pressure pumping equipment was primarily obsolete sand handling equipment, which has been replaced with more efficient sand solutions. There were no similar charges in 2017 or 2016. +The Company reviews its long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that their carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The Company estimates future cash flows over the life of the respective assets or asset groupings in its assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as the Company’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +Due to the decline in the market price of the Company’s common stock and the deterioration of crude oil prices in the fourth quarter of 2018, the Company lowered its expectations with respect to future activity levels in certain of its operating segments. The Company deemed it necessary to assess the recoverability of its contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups. The Company performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within its contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 38%, 58%, 9% and 23%, respectively. +For the assessment performed in 2018, the expected cash flows for the Company’s asset groups included utilization , revenue and costs for the Company’s equipment and services that were estimated based upon the Company’s existing contract backlog, as well as recent contract tenders and customer inquiries . Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the fourth quarter of 2018, and would begin to recover in late 2019 and continue into 2020 in response to improved oil prices. While the Company believes these assumptions with respect to future oil pricing are reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil prices will recover is highly uncertain. Potential events that could affect the Company’s assumptions regarding future prices and the timeframe for a recovery are affected by factors such as those described in “Risk Factors–We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results.” +All of these factors are beyond the Company’s control. If the lower oil price environment experienced at the end of 2018 were to last into 2020 and beyond, the Company’s actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future, and such impairment could be material. +The Company concluded that no triggering events occurred during the years ended December 31, 2017 or 2016 with respect to its asset groups based on the Company’s results of operations for the years ended December 31, 2017 and 2016, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +F-18 +6 . Goodwill and Intangible Assets +Goodwill — Goodwill by operating segment as of December 31, 2018 and 2017 and changes for the years then ended are as follows (in thousands): +Contract +Pressure +Directional +Other +Drilling +Pumping +Drilling +Operations +Total +Balance December 31, 2016 +$ +86,234 +$ +— +$ +— +$ +— +$ +86,234 +Goodwill acquired +308,826 +121,444 +88,685 +6,284 +525,239 +Balance December 31, 2017 +395,060 +121,444 +88,685 +6,284 +611,473 +Goodwill acquired +— +— +— +9,412 +9,412 +Measurement period adjustment +— +— +1,000 +— +1,000 +Impairment +— +(121,444 +) +(89,685 +) +— +(211,129 +) +Balance December 31, 2018 +$ +395,060 +$ +— +$ +— +$ +15,696 +$ +410,756 +There were no accumulated impairment losses related to goodwill in the contract drilling segment or other operations as of December 31, 2018 or 2017. +Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. The Company’s reporting units for impairment testing are its operating segments. The Company determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, the Company may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +Due to the decline in the market price of the Company’s common stock and the deterioration of crude oil prices in the fourth quarter of 2018, the Company lowered its expectations with respect to future activity levels in certain of its operating segments. The Company performed a quantitative impairment assessment of its goodwill as of December 31, 2018. In completing the assessment, the fair value of each reporting unit was estimated using the income valuation method. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The inputs included assumptions related to the future performance of the Company’s contract drilling, pressure pumping, directional drilling and oilfield rentals reporting units, such as future oil and natural gas prices and projected demand for the Company’s services, and assumptions related to discount rates and long-term growth rates. +Based on the results of the goodwill impairment test as of December 31, 2018, the fair value of the contract drilling and oilfield rentals reporting units exceeded their carrying values by approximately 16% and 14%, respectively, and management concluded that no impairment was indicated in its contract drilling and oilfield rentals reporting units; however, impairment was indicated in its pressure pumping and directional drilling reporting units. The Company recognized an impairment charge of $211 million associated with the impairment of all of the goodwill in its pressure pumping and directional drilling reporting units. +While management believes the assumptions used with respect to future oil pricing are reasonable, actual future prices may vary significantly from the ones that were assumed. The timeframe over which oil prices will recover is highly uncertain. If the lower oil price environment experienced at the end of 2018 were to last into 2020 and beyond, the Company’s actual cash flows would likely be less than the expected cash flows used in these assessments and could result in additional impairment charges in the future and such impairment could be material. +In connection with its annual goodwill impairment assessment as of December 31, 2017 and 2016, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of its reporting units were greater than the respective carrying amount. In making this determination, the Company considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in its reporting units, as well as the Company’s operating results for 2017 and 2016 and forecasted operating results for the respective succeeding year. Management also considered the Company’s overall market capitalization at December 31, 2017 and 2016. +Intangible Assets — In 2018, intangible assets were recorded in the Company’s directional drilling operating segment with the acquisition of Superior QC and in other operations with the acquisition of Current Power. In 2017, intangible assets were recorded in the Company’s directional drilling operating segment with the acquisition of MS Directional and in the contract drilling operating segment with the SSE merger (See Note 2). The Company’s intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight line basis. The following table identifies the segment and weighted average useful life of each of the Company’s intangible assets: +F-19 +Weighted Average +Segment +Useful Life +(in years) +Customer relationships +Directional drilling +3.00 +Customer relationships +Other operations +7.00 +Developed technology +Directional drilling +10.00 +Favorable drilling contracts +Contract drilling +0.83 +Internal use software +Directional drilling +5.00 +Due to the decline in the market price of the Company’s common stock and the deterioration of crude oil prices in the fourth quarter of 2018, the Company lowered its expectations with respect to activity levels in certain of its operating segments. The Company deemed it necessary to assess the recoverability of its contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 5 for additional information. +The Company concluded that no triggering events necessitating an impairment assessment of the intangible assets had occurred in 2017 or 2016. +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2018 and 2017 are as follows (in thousands): +2018 +2017 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +28,000 +$ +(10,719 +) +$ +17,281 +$ +26,200 +$ +(1,943 +) +$ +24,257 +Developed technology +55,772 +(6,533 +) +49,239 +48,000 +(1,137 +) +46,863 +Favorable drilling contracts +22,500 +(22,500 +) +— +22,500 +(18,482 +) +4,018 +Internal use software +482 +(118 +) +364 +482 +(21 +) +461 +$ +106,754 +$ +(39,870 +) +$ +66,884 +$ +97,182 +$ +(21,583 +) +$ +75,599 +Amortization expense on intangible assets of approximately $18.3 million, $24.3 million and $3.6 million for the years ended December 31, 2018, 2017 and 2016, respectively. The remaining amortization expense associated with finite-lived intangible assets is expected to be as follows (in thousands): +Year ending December 31, +2019 +$ +14,664 +2020 +12,721 +2021 +5,931 +2022 +5,909 +2023 +5,834 +Thereafter +21,825 +Total +$ +66,884 +7. Accrued Expenses +Accrued expenses consisted of the following at December 31, 2018 and 2017 (in thousands): +2018 +2017 +Salaries, wages, payroll taxes and benefits +$ +58,160 +$ +50,438 +Workers’ compensation liability +83,772 +80,751 +Property, sales, use and other taxes +25,318 +29,332 +Insurance, other than workers’ compensation +9,531 +10,816 +Accrued interest payable +15,774 +7,558 +Accrued merger and integration +2,403 +16,101 +Other +40,988 +31,628 +$ +235,946 +$ +226,624 +F-20 +8 . Long-Term Debt +2018 Credit Agreement — On March 27, 2018, the Company entered into an amended and restated credit agreement (the “Credit Agreement”) among the Company, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Lead Arrangers and Joint Book Runners. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. Subject to customary conditions, the Company may request that the lenders’ aggregate commitments be increased by up to $300 million, not to exceed total commitments of $900 million. The maturity date under the Credit Agreement is March 27, 2023. The Company has the option, subject to certain conditions, to exercise two one-year extensions of the maturity date. +Loans under the Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon the Company’s credit rating. A letter of credit fee is payable by the Company equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10% to 0.30% based on the Company’s credit rating. +No subsidiaries of the Company are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that the Company believes are customary for agreements of this nature, including certain restrictions on the ability of the Company and each subsidiary of the Company to incur debt and grant liens. If the Company’s credit rating is below investment grade, the Company will become subject to a restricted payment covenant, which would require the Company to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. The Credit Agreement also requires that the Company’s total debt to capitalization ratio, expressed as a percentage, not exceed 50%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. +As of December 31, 2018, the Company had no amounts outstanding under the revolving credit facility. The Company had $81,000 in letters of credit outstanding under the revolving credit facility at December 31, 2018 and, as a result, had available borrowing capacity of approximately $600 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, the Company entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which the Company may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2018, the Company had $58.4 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, the Company will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by the Company at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. The Company is obligated to pay to Scotiabank interest on all amounts not paid by the Company on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +The Company has also agreed that if obligations under the Credit Agreement are secured by liens on any of its or any of its subsidiaries’ property, then the Company’s reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, the Company’s payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by subsidiaries of the Company that from time to time guarantee payment under the Credit Agreement. No subsidiaries of the Company currently guarantee payment under the Credit Agreement. +F-21 +S eries A & B S enior Notes – On October 5, 2010, the Company completed the issuance and sale of $300 million in aggregate principal amount of its 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a pr ivate placement. The Series A Notes bear interest at a rate of 4.97% per annum. The Company pays interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020. +On June 14, 2012, the Company completed the issuance and sale of $300 million in aggregate principal amount of its 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. The Company pays interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022. +The Series A Notes and Series B Notes are senior unsecured obligations of the Company, which rank equally in right of payment with all other unsubordinated indebtedness of the Company. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of the existing domestic subsidiaries of the Company other than subsidiaries that are not required to be guarantors under the Credit Agreement. No subsidiaries of the Company are currently required to be a guarantor under the Credit Agreement. +The Series A Notes and Series B Notes are prepayable at the Company’s option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. The Company must offer to prepay the notes upon the occurrence of any change of control. In addition, the Company must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date. +The respective note purchase agreements require compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit its interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2018. +Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable. +2028 Senior Notes – On January 19, 2018, the Company completed its offering of $525 million aggregate principal amount of the Company’s 3.95% Senior Notes due 2028 (the “2028 Notes”). The net proceeds before offering expenses were approximately $521 million of which the Company used $239 million to repay amounts outstanding under its revolving credit facility. +The Company pays interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028. The 2028 Notes bear interest at a rate of 3.95% per annum. +The 2028 Notes are senior unsecured obligations of the Company, which rank equally with all of the Company’s other existing and future senior unsecured debt and will rank senior in right of payment to all of the Company’s other future subordinated debt. The 2028 Notes will be effectively subordinated to any of the Company’s future secured debt to the extent of the value of the assets securing such debt. In addition, the 2028 Notes will be structurally subordinated to the liabilities (including trade payables) of the Company’s subsidiaries that do not guarantee the 2028 Notes. No subsidiaries of the Company are currently required to be a guarantor under the 2028 Notes. If subsidiaries of the Company guarantee the 2028 Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +The Company, at its option, may redeem the Notes in whole or in part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date, plus a make-whole premium. Additionally, commencing on November 1, 2027, the Company, at its option, may redeem the 2028 Notes in whole or in part, at a redemption price equal to 100% of the principal amount of the 2028 Notes to be redeemed, plus accrued and unpaid interest, if any, on those 2028 Notes to the redemption date. +The indenture pursuant to which the 2028 Notes were issued includes covenants that, among other things, limit the Company and its subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indenture. +F-22 +Upon the occurrence of a change of control, as defi ned in the indenture, each holder of the 2028 Notes may require the Company to purchase all or a portion of such holder’s 2028 Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurc hase date. +The indenture also provides for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the 2028 Notes to become or to be declared due and payable. +The Company incurred approximately $4.6 million in debt issuance costs in connection with the 2018 Credit Agreement. The Company incurred approximately $1.9 million in debt issuance costs in connection with the Series A Notes and approximately $1.6 million in debt issuance costs in connection with the Series B Notes . The Company incurred approximately $1.6 million in debt issuance costs in connection with the 2028 Notes. These costs were deferred and are being recognized as interest expense over the term of the underlying debt. Debt issuance costs, except those related to line-of-credit arrangements, are presented in the balance sheet as a direct deduction from the carrying amount of the related debt. Debt issuance costs related to line-of-credit arrangements are classified as a deferred charge. Amortization of debt issuance costs is reported as interest expense. Interest expense related to the amortization of debt issuance costs was approximately $2.0 million, $2.6 million and $4.1 million for the years ended December 31, 2018, 2017 and 2016, respectively. Amortization of debt issuance costs for the year ended December 31, 2018 includes $317,000 of debt issuance costs related to commitments by lenders under the Company’s previous credit agreement who did not participate in the 2018 Credit Agreement. Amortization of debt issuance costs for the year ended December 31, 2016 includes $1.4 million of costs related to the early termination of the previous term loan agreements. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2018 (in thousands): +Year ending December 31, +2019 +$ +— +2020 +300,000 +2021 +— +2022 +300,000 +2023 +— +Thereafter +525,000 +Total +$ +1,125,000 +9. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2018, the Company maintained letters of credit in the aggregate amount of $58.5 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2018, no amounts had been drawn under the letters of credit. +As of December 31, 2018, the Company had commitments to purchase major equipment and make investments totaling approximately $107 million for its drilling, pressure pumping, directional drilling and oilfield rentals businesses. +The Company’s pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The agreements expire in years 2019 through 2022 and in 2043. As of December 31, 2018, the remaining obligation under these agreements was approximately $114 million, of which approximately $24.7 million relates to purchases required during 2019. In the event the required minimum quantities are not purchased during any contract year, the Company could be required to make a liquidated damages payment to the respective vendor for any shortfall. +Contingencies – The Company’s operations are subject to many hazards inherent in the businesses in which it operates, including inclement weather, blowouts, explosions, fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose the Company to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving the Company’s employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause the Company to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to the Company’s reputation, loss of customers and an inability to obtain insurance. +F-23 +Any contractual right to indemnification that the Company may have for any such risk may be unenforceable or limited due to negligent or will ful acts of commission or omission by the Company, its subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressl y prohibiting certain indemnity agreements contained in or related to oilfield service agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of the Company. The Company’s customers and other third parties may disput e, or be unable to meet, their contractual indemnification obligations to the Company due to financial, legal or other reasons. Accordingly, the Company may be unable to transfer these risks to its customers and other third parties by contract or indemnif ication agreements. Incurring a liability for which the Company is not fully indemnified or insured could have a material adverse effect on its business, financial condition, cash flows and results of operations. +The Company has insurance coverage for fire, windstorm and other risks of physical loss to its equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. The Company has also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, the Company generally maintains a $1.5 million per occurrence deductible on its workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on its equipment insurance coverage, a $2.0 million per occurrence deductible on its general liability coverage and a $2.0 million per occurrence deductible on its automobile liability insurance coverage. The Company also self-insures a number of other risks, including loss of earnings and business interruption and cybersecurity risks, and does not carry a significant amount of insurance to cover risks of underground reservoir damage. +On January 22, 2018, an accident at a drilling site in Pittsburg County, Oklahoma resulted in the losses of life of five people, including three of the Company’s employees. Lawsuits have been filed in the District Court for Pittsburg County, Oklahoma in connection with the five individuals who lost their lives and one of the Company’s employees who was injured in the accident. The lawsuits have been consolidated for discovery purposes under Cause No. CJ-2018-60 (the “Litigation”). These lawsuits allege various causes of action against the Company including negligence, gross negligence, knowledge that injury or death was substantially certain, acting with purpose, recklessness, wrongful death and survival, and the plaintiffs seek an unspecified amount of damages, including punitive or exemplary damages, costs, interest, and other relief. The Company disputes the plaintiffs’ allegations and intends to continue to defend itself vigorously. Based on the information the Company has available as of the date of this Report, the Company believes that it has adequate insurance to cover the Litigation. However, if this accident is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on the Company’s business, financial condition, cash flows and results of operations. +The Company is party to various other legal proceedings arising in the normal course of its business. The Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, cash flows or results of operations. +Other Matters — The Company has Change in Control Agreements with its Chairman of the Board and one of its Executive Vice Presidents (the “Specified Employees”). Each Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless the Company notifies the Specified Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control of the Company occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by the Company other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreements), then the Specified Employee shall generally be entitled to, among other things: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment for each Specified Employee prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2.5 times (in the case of the Chairman of the Board) or 2 times (in the case of the Executive Vice President) of the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under the Company’s welfare plans for up to three years (in the case of the Chairman of the Board) or two years (in the case of the Executive Vice President). +Each Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +F-24 +The Company has Employment Agreements with its Chief Executive Officer, Chief Financial Officer, General Counsel and the President of the Company’s subsidiary, Patterson-UTI Drilling Company LLC (“Patterson-UTI Drilling”). In the case of the Chief Executive Officer and the General Counsel, the Employment Agreement supersedes the prior Change in Control Agreement with each executive and, in the case of the President of Patterson-UTI Drilling, the Employment Agreement supersed es his prior employment agreement. Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such term ination at least 30 days before the effective date of such termination. Under specified circumstances, the Company may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by either (i) pro viding written notice 10 days before the effective date of such termination and by granting at least 10 days to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of such t ermination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by the Company to not be capable of being cured, the executive may be terminated for cause on the date the written noti ce is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following termination by the Company of the executive other than for Cause, or termination by the executive for Go od Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by the Company without Cause, or the executive terminates his employment for Good Reason : +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees, +• +the Company will accelerate vesting of all options and restricted stock awards on the 60th day following the executive’s termination, and +• +the Company will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +If a termination by the Company other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, which for the President of Patterson-UTI Drilling includes a change in control of the Company or, in certain circumstances, of Patterson-UTI Drilling), the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years, and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) of subsidized benefits continuation coverage. +10. Stockholders’ Equity +Stock Offering – On January 27, 2017, the Company completed an offering of 18.2 million shares of its common stock and raised net proceeds of $472 million. The Company used the net proceeds of the offering to repay SSE’s outstanding indebtedness of approximately $472 million. +F-25 +Cash Dividends – The Company paid cash dividends during the years ended December 31, 2018 , 2017 and 2016 as follows: +Per Share +Total +(in thousands) +2018 +Paid on March 22, 2018 +$ +0.02 +$ +4,443 +Paid on June 21, 2018 +0.04 +8,832 +Paid on September 20, 2018 +0.04 +8,685 +Paid on December 20, 2018 +0.04 +8,629 +Total cash dividends +$ +0.14 +$ +30,589 +2017 +Paid on March 22, 2017 +$ +0.02 +$ +3,326 +Paid on June 22, 2017 +0.02 +4,269 +Paid on September 21, 2017 +0.02 +4,271 +Paid on December 21, 2017 +0.02 +4,449 +Total cash dividends +$ +0.08 +$ +16,315 +2016 +Paid on March 24, 2016 +$ +0.10 +$ +14,712 +Paid on June 23, 2016 +0.02 +2,953 +Paid on September 22, 2016 +0.02 +2,953 +Paid on December 22, 2016 +0.02 +2,961 +Total cash dividends +$ +0.16 +$ +23,579 +On February 6, 2019, the Company’s Board of Directors approved a cash dividend on its common stock in the amount of $0.04 per share to be paid on March 21, 2019 to holders of record as of March 7, 2019. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of the Company’s debt agreements and other factors. +On September 6, 2013, the Company’s Board of Directors approved a stock buyback program that authorized purchases of up to $200 million of the Company’s common stock in open market or privately negotiated transactions. On July 25, 2018, the Company’s Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2018, the Company had remaining authorization to purchase approximately $150 million of the Company’s outstanding common stock under the stock buyback program. Shares of stock purchased under the plan are held as treasury shares. On February 6, 2019, the Company’s Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of share repurchases. +The Company acquired shares of stock from directors during 2017 and 2016 and from employees during 2018, 2017, and 2016 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options. The remainder of these shares was acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock and restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2018, 2017 and 2016 were as follows (dollars in thousands): +2018 +2017 +2016 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +43,207,240 +$ +907,045 +Purchases pursuant to stock buyback program +9,331,131 +150,497 +5,503 +109 +8,488 +183 +Acquisitions pursuant to long-term incentive plan +567,354 +11,240 +404,491 +7,508 +176,889 +3,866 +Treasury shares at end of period +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +F-26 +11 . Stock-based Compensation +The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards include equity instruments in the form of stock options, restricted stock or restricted stock units that have included service conditions and, in certain cases, performance conditions. The Company’s share-based awards also include share-settled performance unit awards. Share-settled performance unit awards are accounted for as equity awards. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +The 2014 Plan was originally approved by the Company’s stockholders effective as of April 17, 2014, and the Board of Directors adopted a resolution that no future grants would be made under any of the Company’s other previously existing plans. On June 29, 2017, the Company’s stockholders approved the amendment and restatement of the 2014 Plan (the “Amended and Restated Plan”) to increase the number of shares available under the plan to 10,049,156 shares. The aggregate number of shares of the Company’s common stock authorized for grant under the Amended and Restated Plan is 18.9 million, which includes 9.1 million shares previously authorized under the 2014 Plan. The Company’s share-based compensation plans at December 31, 2018 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +Amended and Restated Plan +18,900,000 +6,203,695 +2,471,800 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +3,268,500 +— +A summary of the Amended and Restated Plan follows: +• +The Compensation Committee of the Board of Directors administers the plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +All options granted under the plan are granted with an exercise price equal to or greater than the fair market value of the Company’s common stock at the time the option is granted. +• +The plan provides for awards of incentive stock options, non-incentive stock options, tandem and freestanding stock appreciation rights, restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalents. As of December 31, 2018, non-incentive stock options, restricted stock awards, restricted stock units and performance unit awards had been granted under the plan. +Options granted under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. +Stock Options— The Company estimates the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date the options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the years ended December 31, 2018 or 2017. Weighted-average assumptions used to estimate grant date fair values for stock options granted during the year ended December 31, 2016 is as follows: +2016 +Volatility +35.11 +% +Expected term (in years) +5.00 +Dividend yield +2.05 +% +Risk-free interest rate +1.40 +% +F-27 +Stock option activity for the year ended December 31, 2018 follows: +Weighted-average +Shares +exercise price +Outstanding at beginning of year +6,037,150 +$ +20.35 +Exercised +(40,000 +) +$ +12.12 +Expired +(496,000 +) +$ +29.01 +Outstanding at end of year +5,501,150 +$ +19.63 +Exercisable at end of year +5,362,269 +$ +19.66 +Options outstanding at December 31, 2018 have no intrinsic value and a weighted-average remaining contractual term of 4.05 years. Options exercisable at December 31, 2018 have no intrinsic value and a weighted-average remaining contractual term of 3.96 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2018, 2017 and 2016 follows: +2018 +2017 +2016 +Weighted-average grant date fair value of stock options granted (per share) +NA +NA +$ +4.90 +Aggregate grant date fair value of stock options vested during the year +(in thousands) +$ +1,954 +$ +4,565 +$ +4,729 +Aggregate intrinsic value of stock options exercised (in thousands) +$ +— +$ +209 +$ +366 +As of December 31, 2018, options to purchase 138,881 shares were outstanding and not vested. All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2018 with respect to these non-vested options follows: +Aggregate intrinsic value +$ +— +Weighted-average remaining contractual term +7.45 years +Weighted-average remaining expected term +2.45 years +Weighted-average remaining vesting period +1.09 years +Unrecognized compensation cost (in thousands) +$ +673 +Restricted Stock— For all restricted stock awards made to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock activity for the year ended December 31, 2018 follows: +Weighted- +average Grant +Shares +Date Fair Value +Non-vested restricted stock outstanding at beginning of year +1,530,338 +$ +21.41 +Vested +(1,085,743 +) +$ +21.41 +Forfeited +(8,371 +) +$ +21.60 +Non-vested restricted stock outstanding at end of year +436,224 +$ +21.41 +As of December 31, 2018, approximately 423,000 million shares of non-vested restricted stock outstanding are expected to vest. Additional information as of December 31, 2018 with respect to these non-vested shares follows: +Aggregate intrinsic value +$4.4 million +Weighted-average remaining vesting period +1 year +Unrecognized compensation cost +$6.9 million +Restricted Stock Units— For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Forfeitable dividend equivalents are accrued on certain restricted stock units that will be paid upon vesting. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +F-28 +Restricted stock unit activity for the year ended December 31, 2018 follows: +Weighted-average +Time +Performance +Grant Date Fair +Based +Based +Value +Non-vested restricted stock units outstanding at beginning of year +1,223,273 +114,000 +$ +19.80 +Granted +1,726,865 +— +$ +19.15 +Granted in connection with acquisitions +204,222 +359,315 +$ +16.99 +Vested (1) +(413,858 +) +(38,000 +) +$ +19.65 +Forfeited +(137,894 +) +— +$ +19.43 +Non-vested restricted stock units outstanding at end of year +2,602,608 +435,315 +$ +18.95 +(1) +All of the performance-based restricted stock units that vested during 2018 were granted in 2017. +As of December 31, 2018, approximately 2.9 million non-vested restricted stock units outstanding are expected to vest. Additional information as of December 31, 2018 with respect to these non-vested restricted stock units follows: +Aggregate intrinsic value +$29.7 million +Weighted-average remaining vesting period +2.3 year +Unrecognized compensation cost +$44.2 million +Performance Unit Awards. The Company has granted share-settled performance unit awards to certain employees (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive a grant of shares of common stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is the three year period commencing on April 1 of the year of grant, except that for the Performance Units granted in 2017 the three-year performance period commenced on May 1. +The performance goals for the Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. Generally, the recipients will receive a target number of shares if the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 50 th percentile. If the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 75 th percentile or higher, then the recipients will receive two times the target number of shares. If the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 25 th percentile, then the recipients will only receive one-half of the target number of shares. If the Company’s total shareholder return during the performance period, when compared to the peer group, is between the 25 th and 75 th percentile, then the shares to be received by the recipients will be determined using linear interpolation for levels of achievement between these points. +For the Performance Units awarded prior to 2016, there is no payout unless the Company’s total shareholder return is positive and, when compared to the peer group, is at or above the 25 th percentile. In respect of the 2013 Performance Units, for which the performance period ended March 31, 2016, the Company’s total shareholder return for the performance period was negative, the Company’s total shareholder return for the performance period when compared to the peer group was above the 75 th percentile, and there was no payout; provided, however, that pursuant to the terms of those 2013 awards, if, during the two-year period ending March 31, 2018, the Company’s total shareholder return for any 30 consecutive day period equals or exceeds 18 percent on an annualized basis from April 1, 2013 through the last day of such 30 consecutive day period, and the recipient is actively employed by the Company through the last day of the extended performance period, then the Company will issue to the recipient the number of shares equal to the amount the recipient would have been entitled to receive had the Company’s total shareholder return been positive during the initial three-year performance period. The performance criteria for this extended period was not met and therefore there was no payout under the 2013 awards. +For the Performance Units granted in April 2016, if the Company’s total shareholder return is negative, and, when compared to the peer group is at or above the 25th percentile, then the recipients will receive one-half of the number of shares they would have received had the Company’s total shareholder return been positive. For the Performance Units granted in May 2017 and April 2018, the payout is based on relative performance and does not have an absolute performance requirement. +The total target number of shares with respect to the Performance Units for the years 2013-2018 is set forth below: +2018 +2017 +2016 +2015 +2014 +2013 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +310,700 +186,198 +185,000 +190,600 +154,000 +236,500 +F-29 +As noted above, there was no payout under the 2013 Performance Units. The 2014 Performance Units settled with a negative total shareholder return, so there was no payout under such Performance Units. In April 2018, 381,200 shares were issued to settle the 2015 Performance Units. The Performance Units granted in 2016, 2017, and 2018 have not reached the end of their respective performance periods. +Because the Performance Units are share-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2018 +2017 +2016 +2015 +2014 +2013 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +8,004 +$ +5,780 +$ +3,854 +$ +4,052 +$ +5,388 +$ +5,564 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2018 +2017 +2016 +2015 +2014 +2013 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2018 +$ +2,001 +$ +1,927 +$ +1,285 +$ +338 +NA +NA +Year ended December 31, 2017 +NA +$ +1,284 +$ +1,285 +$ +1,351 +$ +449 +NA +Year ended December 31, 2016 +NA +NA +$ +963 +$ +1,351 +$ +1,796 +$ +464 +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as follows: +• +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +• +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +• +Dividend equivalents are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +• +Dividend equivalents are recognized as additional compensation cost for the portion of restricted stock units that are not expected to vest or that ultimately do not vest. +12. Leases +The Company incurred rent expense of $105.2 million, $48.9 million and $25.3 million for the years ended December 31, 2018, 2017 and 2016, respectively. Rent expense is primarily related to short-term equipment rentals that are generally passed through to customers. +Future minimum rental payments required under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 2018 are as follows (in thousands): +Year ending December 31, +2019 +$ +11,408 +2020 +9,069 +2021 +6,543 +2022 +4,625 +2023 +2,663 +Thereafter +6,552 +Total +$ +40,860 +F-30 +1 3 . Income Taxes +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2018, 2017 and 2016 are as follows (in thousands): +2018 +2017 +2016 +Federal income tax benefit: +Current +$ +(3,954 +) +$ +(42 +) +$ +(24,777 +) +Deferred +(35,081 +) +(335,106 +) +(134,592 +) +(39,035 +) +(335,148 +) +(159,369 +) +State income tax expense (benefit): +Current +1,704 +(215 +) +(257 +) +Deferred +(11,147 +) +4,511 +(14,163 +) +(9,443 +) +4,296 +(14,420 +) +Foreign income tax expense (benefit): +Current +(2,552 +) +(3,108 +) +(368 +) +Deferred +5,043 +249 +(3,405 +) +2,491 +(2,859 +) +(3,773 +) +Total income tax benefit: +Current +(4,802 +) +(3,365 +) +(25,402 +) +Deferred +(41,185 +) +(330,346 +) +(152,160 +) +Total income tax benefit: +$ +(45,987 +) +$ +(333,711 +) +$ +(177,562 +) +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2018, 2017 and 2016 is summarized as follows: +2018 +2017 +2016 +Statutory tax rate +21.0 +% +35.0 +% +35.0 +% +State income taxes - net of the federal income tax benefit +1.2 +1.9 +2.0 +Goodwill impairment +(6.9 +) +— +— +Permanent differences +(0.6 +) +(1.3 +) +(0.1 +) +Tax effects of tax reform +(1.3 +) +66.7 +— +Share-based payments +(0.1 +) +3.6 +— +Acquisition related differences +— +(3.3 +) +— +Valuation allowance +(3.7 +) +— +— +State deferred tax remeasurement +2.3 +— +— +Other differences, net +0.6 +(0.8 +) +(1.1 +) +Effective tax rate +12.5 +% +101.8 +% +35.8 +% +The effective tax rate decreased by approximately 89.3% to 12.5% for 2018 compared to 2017. This was primarily due to Tax Reform, which resulted in a 66.7% increase in the 2017 effective tax rate due to the remeasurement of the U.S. deferred taxes and a 14% decrease in the 2018 effective tax rate due to the change in U.S. federal corporate tax rate. Also impacting the 2018 effective tax rate are certain goodwill impairment charges, which are not deductible for tax purposes, and valuation allowances being established against deferred tax assets in certain state and non-U.S. jurisdictions. The goodwill impairment and valuation allowances resulted in a 6.9% and 3.7% decrease in the effective tax rate, respectively. These decreases were partially offset by a 2.3% increase in the effective tax rate following the remeasurement of deferred tax assets and liabilities for state tax purposes. +Tax Reform includes, among other things, a reduction of the U.S. federal corporate tax rate from 35% to 21% for tax years beginning 2018, a mandatory deemed repatriation tax on foreign earnings, repeal of the corporate alternative minimum tax, expensing of certain capital investments, and reducing the amount of executive pay that will be tax deductible. Tax Reform also makes fundamental changes to the taxation of multinational entities, including a shift from worldwide taxation with deferral to a hybrid territorial system, a minimum tax on certain low-taxed foreign earnings, and new measures to deter base erosion and promote export sales from the United States. For December 31, 2017, the Company recorded provisional amounts for certain enactment-date effects of Tax Reform by applying the guidance in Staff Accounting Bulletin 118 (“SAB 118”) because the Company had not yet completed its enactment-date accounting for these effects. In 2017, the Company recorded approximately $219 million of tax benefit related to the enactment-date effects of Tax Reform that related solely to adjusting deferred tax assets and liabilities to the new U.S. federal corporate tax rate at which they are expected to reverse. After the filing of the Company’s 2017 income tax returns in the fourth quarter of 2018, the Company completed its accounting for all of the enactment-date income tax effects of Tax Reform. As a result, the Company recognized $4.6 million of tax expense as an adjustment to the provisional amounts recorded at December 31, 2017 and included these adjustments as a component of income tax expense. The changes to 2017 enactment-date provisional amounts decreased the effective tax rate in 2018 by 1.3%. +F-31 +For Tax Reform, the one-time transition tax is based on the Company’s total post-1986 earnings and profits ( “ E&P ” ), the tax on which it previously deferred from U.S. income taxes under U.S. law. At December 31, 2017, the Company estimated an E&P deficit for each of its foreign subsidiaries and therefore did not rec ord any additional taxes for the one-time transition tax. Upon further analysis of Tax Reform, along with notices and regulations issued and proposed by the U.S. Department of the Treasury and the Internal Revenue Service, the Company finalized its calcula tions of the transition tax liability for its 2017 income tax filings during the fourth quarter of 2018. The final transition tax computation resulted in approximately $13.7 million of Section 965 income inclusion which was completely offset by 2017 net o perating losses . +At December 31, 2017, the Company remeasured its U.S. deferred tax assets and liabilities based on the tax rates at which they were expected to reverse in the future and recorded a provisional tax benefit of approximately $219 million. Upon further analysis of certain aspects of Tax Reform along with the filing of the Company’s 2017 income tax returns, the Company adjusted its December 31, 2017 provisional estimate on the remeasurement of U.S. deferred tax assets and liabilities by recording additional tax expense of $1.7 million, which is included as a component of income tax expense. +Effective 2018, Tax Reform also subjects a U.S. shareholder to tax on global intangible low-taxed income (“GILTI”) earned by certain foreign subsidiaries. Guidance from the FASB allows an entity to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or to provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. The Company has elected to account for GILTI in the year the tax is incurred. In 2018, the Company was not subject to the tax imposed by the GILTI provisions. +In addition to the introduction of GILTI, Tax Reform introduced a new provision called the base erosion and anti-abuse tax (“BEAT”), which is aimed at preventing or reducing U.S. tax base erosion. The BEAT provisions eliminate the deductions for certain base-erosion payments made to related foreign corporations and imposes a new minimum tax if greater than regular tax. In 2018, the Company was not subject to the minimum tax imposed by the BEAT provisions. +Prior to Tax Reform, the Company had elected to permanently reinvest unremitted earnings in Canada effective January 1, 2010, and it intends to do so for the foreseeable future. If the Company were to repatriate earnings, in the form of dividends or otherwise, it might be subject to certain income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable. +The tax effect of significant temporary differences representing deferred tax assets and liabilities at December 31, 2018 and 2017 are as follows (in thousands): +2018 +2017 +Deferred tax assets: +Net operating loss carryforwards +$ +324,389 +$ +275,402 +Tax credits +6,404 +9,053 +Expense associated with stock options and restricted stock +13,375 +12,126 +Workers' compensation allowance +19,900 +19,323 +Other +22,423 +25,891 +386,491 +341,795 +Allowance to reduce deferred tax asset to expected realizable value +(13,232 +) +— +Total deferred tax assets +373,259 +341,795 +Deferred tax liabilities: +Property and equipment basis difference +(669,196 +) +(678,093 +) +Other +(10,224 +) +(10,663 +) +Total deferred tax liabilities +(679,420 +) +(688,756 +) +Net deferred tax liability +$ +(306,161 +) +$ +(346,961 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and necessary allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company considers carryback availability, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. In 2018, the Company recorded $13.2 million of valuation allowances against its net deferred tax assets, with $4.9 million relating to certain state jurisdictions, $8.1 million relating to a Canadian subsidiary and $0.2 million relating to operations outside of North America. These valuation allowances were recorded due to a change in judgment as to the realizability of these assets in future tax years. +For income tax purposes, the Company has approximately $1.3 billion of gross federal net operating losses, approximately $24.7 million of gross Canadian net operating losses and approximately $735 million of post-apportionment state net operating losses +F-32 +as of December 31, 2018, before valuatio n allowances. The majority of Federal net operating losses will expire in varying amounts, if unused, between 2034 and 2037. Federal net operating losses generated in 2018 can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2038. State net operating losses will expire in varying amounts, if unused, between 2023 and 2038 . +As of December 31, 2018, the Company had no unrecognized tax benefits. The Company has established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2018, the tax years ended December 31, 2013 through December 31, 2017 are open for examination by U.S. taxing authorities. As of December 31, 2018, the tax years ended December 31, 2012 through December 31, 2017 are open for examination by Canadian taxing authorities. +14. Earnings Per Share +The Company provides a dual presentation of its net income (loss) per common share in its consolidated statements of operations: basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock. Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock, performance units and restricted stock units. The dilutive effect of stock options, performance units and restricted stock units is determined using the treasury stock method. The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested shares of restricted stock. +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2018, 2017 and 2016, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2018 +2017 +2016 +BASIC EPS: +Net income (loss) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +Adjust for (income) loss attributed to holders of non-vested restricted stock +— +(170 +) +— +Income (loss) attributed to common stockholders +$ +(321,421 +) +$ +5,740 +$ +(318,634 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +218,643 +198,447 +146,178 +Basic net income (loss) per common share +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +DILUTED EPS: +Income (loss) attributed to common stockholders +$ +(321,421 +) +$ +5,740 +$ +(318,634 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +218,643 +198,447 +146,178 +Add dilutive effect of potential common shares +— +1,435 +— +Weighted average number of diluted common shares outstanding +218,643 +199,882 +146,178 +Diluted net income (loss) per common share +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +Potentially dilutive securities excluded as anti-dilutive +9,762 +3,289 +9,057 +15. Employee Benefits +The Company maintains a 401(k) plan for all eligible employees. The Company’s operating results include expenses of approximately $14.3 million in 2018, $8.7 million in 2017 and $4.4 million in 2016 for the Company’s contributions to the plan. +F-33 +16 . Business Segments +At December 31, 2018, the Company had three reportable business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) directional drilling services. Each of these segments represents a distinct type of business and has a separate management team that reports to the Company’s chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. +Contract Drilling — The Company markets its contract drilling services to major and independent oil and natural gas operators. As of December 31, 2018, the Company had 252 marketed land-based drilling rigs in the continental United States and western Canada. +For the years ended December 31, 2018, 2017 and, 2016, contract drilling revenue earned in Canada was $9.3 million, $13.7 million and $15.6 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $26.2 million and $52.0 million as of December 31, 2018 and 2017, respectively. +Pressure Pumping — The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. The Company also provides cementing services through its pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. +Directional Drilling — The Company provides a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Substantially all of the revenue in the directional drilling segment is from directional drilling, downhole performance motors and measurement-while-drilling services, which are sold as a bundle. +Major Customer — During 2018 and 2017, no single customer accounted for more than 10% of the Company’s consolidated operating revenues. During 2016, one customer accounted for approximately $124 million or 14% of the Company’s consolidated operating revenues. These revenues in 2016 were earned in both the Company’s contract drilling and pressure pumping businesses. +F-34 +The following tables summarize selected financial information relating to the Company’s business segments (in thousands): +Year Ended December 31, +2018 +2017 +2016 +Revenues: +Contract drilling +$ +1,432,012 +$ +1,041,492 +$ +544,196 +Pressure pumping +1,573,396 +1,200,311 +354,070 +Directional drilling +209,275 +45,580 +— +Other operations (1) +131,028 +76,781 +18,299 +Elimination of intercompany revenues (2) +(18,714 +) +(7,480 +) +(699 +) +Total revenues +$ +3,326,997 +$ +2,356,684 +$ +915,866 +Income (loss) before income taxes: +Contract drilling +$ +(33,115 +) +$ +(171,897 +) +$ +(235,858 +) +Pressure pumping +(77,328 +) +21,028 +(176,628 +) +Directional drilling +(117,497 +) +(21 +) +— +Other operations +(18,221 +) +(20,813 +) +(3,391 +) +Corporate +(93,585 +) +(152,792 +) +(54,672 +) +Other operating income, net (3) +17,569 +31,957 +14,323 +Interest income +5,597 +1,866 +327 +Interest expense +(51,578 +) +(37,472 +) +(40,366 +) +Other +750 +343 +69 +Loss before income taxes +$ +(367,408 +) +$ +(327,801 +) +$ +(496,196 +) +Identifiable assets: +Contract drilling +$ +3,817,638 +$ +3,931,994 +$ +3,032,819 +Pressure pumping +921,237 +1,209,424 +653,630 +Directional drilling +239,341 +301,275 +— +Other operations +177,374 +172,094 +48,885 +Corporate (4) +314,276 +144,069 +36,957 +Total assets +$ +5,469,866 +$ +5,758,856 +$ +3,772,291 +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +571,607 +$ +538,891 +$ +467,974 +Pressure pumping +250,010 +198,006 +184,872 +Directional drilling +45,317 +9,347 +— +Other operations +41,512 +29,402 +10,114 +Corporate +7,872 +7,695 +5,474 +Total depreciation, depletion, amortization and impairment +$ +916,318 +$ +783,341 +$ +668,434 +Capital expenditures: +Contract drilling +$ +394,595 +$ +354,425 +$ +72,508 +Pressure pumping +173,848 +171,436 +39,584 +Directional drilling +35,929 +7,795 +— +Other operations +34,660 +31,547 +6,116 +Corporate +2,426 +1,884 +1,591 +Total capital expenditures +$ +641,458 +$ +567,087 +$ +119,799 +( 1 ) +Other operations includes the Company’s oilfield rentals business, pipe handling components and related technology business, the electrical controls and automation business, the oil and natural gas working interests and the Middle East/North Africa activities. +( 2 ) +In 2018 and 2017, intercompany revenues consists of contract drilling and revenues from other operations for services provided to contract drilling, pressure pumping and within other operations. In 2016, intercompany revenues consists of contract drilling and revenues within other operations. +( 3 ) +Other operating income (expense), net includes net gains or losses associated with the disposal of assets relate to corporate strategy decisions of the executive management group. Accordingly, the related gains or losses have been separately presented and excluded from the results of specific segments. This caption also includes expenses related to certain legal-related expenses and settlements, net of insurance reimbursements and certain research and development expenses. +( 4 ) +Corporate assets primarily include cash on hand and certain property and equipment. +F-35 +17 . Concentrations of Credit Risk +Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +The Company believes it has placed its demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2018 and 2017, the Company’s demand deposits and temporary cash investments consisted of the following (in thousands): +2018 +2017 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +191,457 +$ +13,860 +Deposits in FDIC and SIPC-insured institutions over insurance limits +38,425 +106,849 +Deposits in foreign banks +22,698 +21,479 +252,580 +142,188 +Less outstanding checks and other reconciling items +(7,551 +) +(99,360 +) +Cash and cash equivalents +$ +245,029 +$ +42,828 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which the Company provides services. As is general industry practice, the Company typically does not require customers to provide collateral. No significant losses from individual customers were experienced during the years ended December 31, 2018, 2017 or 2016. No expense for bad debts was recognized in 2018, 2017 or 2016. +18. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of the Company’s outstanding debt balances as of December 31, 2018 and 2017 is set forth below (in thousands): +December 31, 2018 +December 31, 2017 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +Borrowings under Credit Agreement: +Revolving credit facility +$ +— +$ +— +$ +268,000 +$ +268,000 +3.95% Senior Notes +525,000 +482,488 +— +— +4.97% Series A Senior Notes +300,000 +300,043 +300,000 +303,966 +4.27% Series B Senior Notes +300,000 +293,900 +300,000 +295,616 +Total debt +$ +1,125,000 +$ +1,076,431 +$ +868,000 +$ +867,582 +The carrying value of the balances outstanding under the revolving credit facility approximates its fair values as this instrument has floating interest rates. The fair value of the 3.95% Senior Notes at December 31, 2018 is based on discounted cash flows associated with the notes using the market rate of interest at December 31, 2018 of 5.07%. The fair value estimate of the 3.95% Senior Notes is considered a Level 1 fair value estimate in the fair value hierarchy of fair value accounting. The fair values of the Series A Notes and Series B Notes at December 31, 2018 and 2017 are based on discounted cash flows associated with the respective notes using current market rates of interest at those respective dates. For the Series A Notes, the current market rates used in measuring this fair value were 4.97% at December 31, 2018 and 4.46% at December 31, 2017. For the Series B Notes, the current market rates used in measuring this fair value were 4.92% at December 31, 2018 and 4.64% at December 31, 2017. These fair value estimates are based on observable market inputs and are considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting. +F-36 +1 9 . Quarterly Financial Information (in thousands, except per share amounts) (unaudited) +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2018 +Operating revenues +$ +809,164 +$ +854,418 +$ +867,478 +$ +795,937 +Operating loss +(22,102 +) +(9,004 +) +(80,281 +) +(210,790 +) +Net loss +(34,417 +) +(10,713 +) +(75,042 +) +(201,249 +) +Net loss per common share: +Basic +$ +(0.16 +) +$ +(0.05 +) +$ +(0.34 +) +$ +(0.93 +) +Diluted +$ +(0.16 +) +$ +(0.05 +) +$ +(0.34 +) +$ +(0.93 +) +2017 +Operating revenues +$ +305,175 +$ +579,186 +$ +684,989 +$ +787,334 +Operating loss +(92,639 +) +(140,236 +) +(38,016 +) +(21,647 +) +Net income (loss) +(63,539 +) +(92,184 +) +(33,769 +) +195,402 +Net income (loss) per common share: +Basic +$ +(0.40 +) +$ +(0.46 +) +$ +(0.16 +) +$ +0.88 +Diluted +$ +(0.40 +) +$ +(0.46 +) +$ +(0.16 +) +$ +0.88 +F-37 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions (1) +Balance +(In thousands) +Year Ended December 31, 2018 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +2,323 +$ +— +$ +(11 +) +$ +2,312 +Year Ended December 31, 2017 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,191 +$ +— +$ +(868 +) +$ +2,323 +Year Ended December 31, 2016 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,545 +$ +— +$ +(354 +) +$ +3,191 +(1) +Consists of uncollectible accounts written off. +S-1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 13, 2019 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 13, 2019. +Signature +Title +/s/ Mark S. Siegel +Chairman of the Board +Mark S. Siegel +/s/ William Andrew Hendricks, Jr. +President, Chief Executive Officer +William Andrew Hendricks, Jr. +and Director +(Principal Executive Officer) +/s/ C. Andrew Smith +Executive Vice President and +C. Andrew Smith +Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Charles O. Buckner +Director +Charles O. Buckner +/s/ Tiffany Thom Cepak +Director +Tiffany Thom Cepak +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Curtis W. Huff +Director +Curtis W. Huff +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Janeen S. Judah +Director +Janeen S. Judah +S-2 \ No newline at end of file diff --git a/raw/filings/0000889900/2018/0001564590-19-002863/filing_metadata.csv b/raw/filings/0000889900/2018/0001564590-19-002863/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..460cd88a671ef52285c6ad74bbb279bc36d5559a --- /dev/null +++ b/raw/filings/0000889900/2018/0001564590-19-002863/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2019-02-13,2018-12-31,2019-02-13T22:12:39.000Z,0001564590-19-002863,pten-10k_20181231.htm,10-K,18216189,1,0,https://www.sec.gov/Archives/edgar/data/889900/000156459019002863/pten-10k_20181231.htm,https://www.sec.gov/Archives/edgar/data/889900/000156459019002863/,2018,2018,1 diff --git a/raw/filings/0000889900/2018/0001564590-19-002863/item1.txt b/raw/filings/0000889900/2018/0001564590-19-002863/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..06ac7704de7da0f10f8bff27998fe8d37e83f266 --- /dev/null +++ b/raw/filings/0000889900/2018/0001564590-19-002863/item1.txt @@ -0,0 +1,334 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada , and we are pursuing contract drilling opportunities outside of North America . As of December 31, 2018, we had a drilling fleet that consisted of 252 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. As of December 31, 2018, we had approximately 1.6 million fracturing horsepower to provide these services. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, motor rentals, directional surveying, measurement-while-drilling, wireline steering tools and services that improve the accuracy of horizontal wellbore placement. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also manufacture and sell pipe handling components and related technology to drilling contractors, and provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +On October 25, 2018, we acquired all of the issued and outstanding shares of Current Power Solutions, Inc. (“Current Power”). Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. +On March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. +On February 20, 2018, we acquired the business of Superior QC, LLC (“Superior QC”), including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. +On January 19, 2018, we completed an offering of $525 million aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”) . The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. +3 +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of M S Directional , LLC (f/k/a Multi-Shot, LLC) (“MS Directional”) . MS Directional is a leading directional drilling services company in the Unit ed States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, motor rentals, directional surveyin g, measurement - while - drilling, and wireline steering tools. +On April 20, 2017, pursuant to an Agreement and Plan of Merger (the “merger agreement”) with Seventy Seven Energy Inc. (“SSE”), a subsidiary of ours was merged with and into SSE (the “SSE merger”), with SSE continuing as the surviving entity and one of our wholly-owned subsidiaries. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of our wholly-owned subsidiaries. Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +Operational data in the discussion and analysis in this Report includes the results of operations of Current Power since October 25, 2018, the results of operations of Superior QC since February 20, 2018, the results of operations of the MS Directional business since October 11, 2017 and the results of operations of the SSE businesses since April 20, 2017. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2016, 2017 and 2018 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2016: +Average oil price per Bbl (1) +$ +33.18 +$ +45.41 +$ +44.85 +$ +49.15 +Average rigs operating per day - U.S. (2) +71 +55 +60 +66 +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +The closing price of oil was as high as $107.95 per barrel in June 2014. Prices began to fall in the third quarter of 2014 and reached a twelve-year low of $26.19 in February 2016. Oil prices have recovered from the lows experienced in the first quarter of 2016. Oil prices reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil reached a fourth quarter 2018 high of $76.40 per barrel on October 3, 2018, before declining by 42% over the course of three months to reach a low of $44.48 per barrel in late December 2018. Oil prices averaged $59.08 per barrel in the fourth quarter of 2018. +Our rig count declined significantly during the industry downturn that began in late 2014 but has improved since the second quarter of 2016. Our average rig count for the fourth quarter of 2018 was 183 rigs, which included 182 rigs in the United States and one rig in Canada. This was an increase from our average rig count for the third quarter of 2018 of 178 rigs, which included 177 rigs in the United States and one rig in Canada. Our rig count in the United States at December 31, 2018 of 183 rigs was greater than the rig count of 163 rigs at December 31, 2017. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 122 rigs operating under term contracts during the first quarter of 2019 and an average of 78 rigs operating under term contracts throughout 2019. +With the weakness in crude oil prices late in the fourth quarter, operators have been delaying starting new completion projects in the first quarter, and pricing remains extremely competitive. As such, we have made the decision to idle spreads rather than work at unreasonably low prices. We ended the fourth quarter with 20 active spreads and idled three spreads early in the first quarter of 2019 . +Industry Segments +Our revenues, operating income (loss) and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +4 +• +directional drilling services . +Our contract drilling services industry segment had operating losses in 2018, 2017 and 2016. Our pressure pumping services industry segment had operating losses in 2018 and 2016 and operating income in 2017. Our third industry segment, directional drilling services, was a new segment for us as a result of the MS Directional acquisition in 2017 and accounted for approximately six percent and two percent of our 2018 and 2017 consolidated revenues, respectively. Our directional drilling segment had operating losses in 2018 and 2017. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 16 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2018, we had 252 marketed land-based drilling rigs based in the following regions: +• +74 in west Texas and southeastern New Mexico, +• +24 in north central and east Texas and northern Louisiana, +• +37 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +31 in south Texas, +• +38 in western Oklahoma, +• +42 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +6 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 25,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs, or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $822 million during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2018, 2017 and 2016, we spent approximately $395 million, $354 million and $72.5 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (frequently six months to four years) or for a specified number of wells. During 2018, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 21 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +5 +Our drilling contracts provide for payment on a daywork basis , pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate wh en the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2018 +2017 +2016 +Average rigs operating per day - U.S. (1) +175 +136 +63 +Average rigs operating per day - Canada (1) +1 +2 +2 +Number of rigs operated during the year +193 +179 +100 +Number of wells drilled during the year +3,088 +2,553 +1,164 +Number of operating days +64,479 +50,427 +23,596 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500-ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad-capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2018, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad-Capable +APEX ® 1500 HP rigs +169 +— +169 +94 +% +APEX ® 1000 HP rigs +14 +— +14 +100 +% +APEX ® 1200 HP rigs +4 +— +4 +100 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 2000 HP rigs +6 +— +6 +67 +% +Other electric rigs +48 +6 +54 +59 +% +Total +246 +6 +252 +87 +% +Average horsepower +1,465 +1,117 +1,457 +The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be at least a 1,500 horsepower, AC powered rig that has a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We currently estimate there are approximately 650 super-spec rigs in the United States, which includes 149 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania, Ohio and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas (West and South Regions), the Mid-Continent region (Mid-Con Region) and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +6 +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term cont racts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.6 million horsepower as of December 31, 2018. Pressure pumping equipment at December 31, 2018 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +West Texas Region +Number of units +229 +31 +260 +Approximate horsepower +524,450 +32,340 +556,790 +South Texas Region +Number of units +138 +1 +139 +Approximate horsepower +334,750 +950 +335,700 +Mid-Con Region +Number of units +118 +— +118 +Approximate horsepower +269,250 +— +269,250 +Northeast Region +Number of units +200 +78 +278 +Approximate horsepower +430,050 +44,700 +474,750 +Combined: +Number of units +685 +110 +795 +Approximate horsepower +1,558,500 +77,990 +1,636,490 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Directional Drilling Operations +General – We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, motor rentals, directional surveying, measurement-while-drilling (MWD), and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. We sometimes rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. As a complement to our core directional drilling services, we provide downhole survey services and rent our proprietary drilling motors to both oil and natural gas operators and other oilfield service companies. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. We utilize our fleet of directional drilling motors, MWD equipment and survey equipment to provide: (1) directional drilling services, (2) third-party motor rentals and (3) downhole survey services. +7 +Directional Drilling Services – We provide our directional drilling services on a day-rate basis, typically under master service agree ments. Revenue from directional drilling services is recognized as work progresses based on the number of days of work completed. Our day rates and other charges generally vary by location and depend on the equipment and personnel required for the job an d market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a stand-by rate is typically agreed upon in advance and charged on a daily basis during periods whe n drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Third-Party Motor Rental – We rent our drilling motors on an hourly- or day-rate basis to complement our direction al drilling services and optimize the utilization of our asset base. Our third-party motor rental revenue is recognized as work progresses based on the number of days or hours our motors are used or are on location. +Downhole Survey Services – We provide our downhole survey services on a day-rate, hourly-rate or completed-job basis. Revenue for our downhole survey services is recognized upon the completion of each day’s work. Our downhole survey services are typically non-contractual. We normally provide a quote to our customers in advance and then issue an invoice for the downhole survey services provided based on a completed field ticket. +Equipment – We generally design, assemble, maintain and inspect our own equipment. We sometimes rent motors and equipment from third parties during periods in which we experience shortages from our vendors, which can occur during periods of increased industry activity. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment and survey tools. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2018, we had a comprehensive fleet of over 1,600 motors that serve both internal needs and external motor rental requirements. In addition to our motor fleet, we had 127 MWD systems as well as downhole surveying equipment to provide accurate wellbore surveys. +Horizontal Wellbore Placement – We provide software and services used to improve the statistical accuracy of horizontal wellbore placement. Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. We provide these services to customers with onshore and offshore operations. +Oilfield Rentals +Our oilfield rentals business has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. We offer an extensive line of rental tools, including a full line of tubular products specifically designed for horizontal drilling and completion, with high-torque, premium-connection drill pipe, drill collars and tubing. Additionally, we offer surface rental equipment including blowout preventers, frac tanks, mud tanks and environmental containment that encompass all phases of the hydrocarbon extraction and production process. Our air drilling equipment and services enable extraction in select basins where certain segments of formations preclude the use of drilling fluid, permitting operators to drill through problematic zones without the risk of fluid absorption and damage to the wellbore. We offer oilfield rental services in many of the major producing onshore oil and gas basins in the United States. We price our rentals and services based on the type of equipment being rented and the services being performed. Substantially all rental revenue we earn is based upon a charge for the actual period of time the rental is provided to our customer on a market-based, fixed per-day or per-hour fee. +Other Operations +We manufacture and sell pipe handling components and related technology for drilling contractors in North America and other select markets, and provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling, oilfield rentals and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +8 +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2018, we received approximately 41% from our ten largest customers and approximately 26% from our five largest customers. During 2018, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +Our contract drilling backlog as of December 31, 2018 and 2017 was $770 million and $544 million, respectively. Approximately 23% of the total contract drilling backlog at December 31, 2018 is reasonably expected to remain after 2019. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in these businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, third-party motor rentals, and downhole survey services, +• +services that improve the statistical accuracy of horizontal wellbore placement, including for customers with offshore operations, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +manufacture and sale of pipe handling components and related technology, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their +9 +treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by pri or owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA has not yet proposed such a rule. If changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +10 +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handli ng, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar en vironmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the sa tisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequ ent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $2.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +11 +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the fut ure, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage . Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 8,000 full-time employees as of February 8, 2019. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of calendar years, we sometimes experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. \ No newline at end of file diff --git a/raw/filings/0000889900/2018/0001564590-19-002863/item13.txt b/raw/filings/0000889900/2018/0001564590-19-002863/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2018/0001564590-19-002863/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2018/0001564590-19-002863/item9a.txt b/raw/filings/0000889900/2018/0001564590-19-002863/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..6540893fcaf871ae053949987c123a213b1250bb --- /dev/null +++ b/raw/filings/0000889900/2018/0001564590-19-002863/item9a.txt @@ -0,0 +1,8 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2018, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2018, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2018. +The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2018/0001564590-19-002863/rp_note.txt b/raw/filings/0000889900/2018/0001564590-19-002863/rp_note.txt new file mode 100644 index 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+75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N , Suite 800 , Houston , Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +(281) 765-7100 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Trading Symbol +Name of Exchange on Which Registered +Common Stock, $0.01 Par Value +PTEN +The Nasdaq Global Select Market +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ or No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Smaller reporting company +☐ +Non-accelerated filer +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 28, 2019, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $ 2.3 billion, calculated by reference to the closing price of $11.51 for the common stock on the Nasdaq Global Select Market on that date. +As of February 7, 2020, the registrant had outstanding 192,151,761 shares of common stock, $0.01 par value, its only class of common stock. +Documents incorporated by reference: +Portions of the registrant’s definitive proxy statement for the 2020 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings, press releases and presentations by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. As used in this Report, “the Company,” “us,” “we,” our” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its operations through its wholly-owned subsidiaries and has no employees or independent business operations. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue and cost expectations and backlog; financing of operations; oil and natural gas prices; rig counts; source and sufficiency of funds required for building new equipment, upgrading existing equipment and additional acquisitions (if opportunities arise); impact of inflation; demand for our services; competition; equipment availability; government regulation; debt service obligations; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +adverse oil and natural gas industry conditions; +• +global economic conditions; +• +volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +excess availability of land drilling rigs, pressure pumping and directional drilling equipment, including as a result of reactivation, improvement or construction; +• +competition and demand for our services; +• +strength and financial resources of competitors; +• +utilization, margins and planned capital expenditures; +• +liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• +the ability to realize backlog; +• +specialization of methods, equipment and services and new technologies, including the ability to develop and obtain satisfactory returns from new technology; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +cybersecurity events; +• +the ability to retain management and field personnel; +• +loss of key customers; +• +synergies, costs and financial and operating impacts of acquisitions; +• +difficulty in building and deploying new equipment; +• +governmental regulation; +• +environmental, social and governance practices, including the perception thereof; +1 +• +environmental risks and ability to satisfy future environmental costs; +• +legal proceedings and actions by governmental or other regulatory agencies; +• +technology-related disputes; +• +the ability to effectively identify and enter new markets; +• +weather; +• +operating costs; +• +expansion and development trends of the oil and natural gas industry; +• +ability to obtain insurance coverage on commercially reasonable terms; +• +financial flexibility; +• +interest rate volatility; +• +adverse credit and equity market conditions; +• +availability of capital and the ability to repay indebtedness when due; +• +stock price volatility; +• +compliance with covenants under our debt agreements; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in our filings with the SEC. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada , and, from time to time, we pursue contract drilling opportunities outside of North America . As of December 31, 2019, we had a drilling fleet that consisted of 216 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2019, we had approximately 1.3 million fracturing horsepower to provide these services. We also provide wireline and cementing services through the pressure pumping segment. Our wireline services offering primarily consists of “plug-and-perf,” which involves the setting of plugs between hydraulic fracturing stages and the creation of perforations for each cluster within the fracturing stage itself. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, measurement-while-drilling, wireline steering tools and services that improve the statistical accuracy of horizontal wellbore placement. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Recent Developments in Financing and Merger and Acquisition Activity — On November 15, 2019, we completed an offering of $350 million in aggregate principal amount of our 5.15% Senior Notes due November 15, 2029 (the “2029 Notes”). The net proceeds before offering expenses were approximately $347 million. On December 16, 2019, we used a portion of the net proceeds from the offering to prepay our 4.27% Series B Senior Notes due June 14, 2022. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $315 million, plus accrued interest to the prepayment date. The remaining net proceeds and available cash on hand was used to repay $50 million of the borrowings under the Term Loan Agreement (as defined below). +On August 22, 2019, we entered into a term loan agreement (the “Term Loan Agreement”) that permits a single borrowing of up to $150 million, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $75 million, not to exceed total commitments of $225 million. On September 25, 2019, we used $150 million of borrowings from the Term Loan Agreement and approximately $158 million of cash on hand to prepay our 4.97% Series A Senior Notes due October 5, 2020 . The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $308 million, plus accrued interest to the prepayment date. We repaid $50 million of the borrowings +3 +under the Term Loan Agreement on December 16, 2019, and we had $100 million in outstanding borrowings under the Term Loan Agreement as of December 31, 2019. +On October 25, 2018, we acquired all of the issued and outstanding shares of Current Power Solutions, Inc. (“Current Power”). Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. +On March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. +On February 20, 2018, we acquired the business of Superior QC, LLC (“Superior QC”), including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. +On January 19, 2018, we completed an offering of $525 million in aggregate principal amount of our 3.95% Senior Notes due 2028 . The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of MS Directional, LLC (f/k/a Multi-Shot, LLC) (“MS Directional”). MS Directional is a leading directional drilling services company in the United States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, measurement-while-drilling, and wireline steering tools. +On April 20, 2017, pursuant to an Agreement and Plan of Merger with Seventy Seven Energy Inc. (“SSE”), a subsidiary of ours was merged with and into SSE (the “SSE merger”), with SSE continuing as the surviving entity and one of our wholly-owned subsidiaries. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of our wholly-owned subsidiaries. Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +Operational data in the discussion and analysis in this Report includes the results of operations of Current Power since October 25, 2018, the results of operations of Superior QC since February 20, 2018, the results of operations of the MS Directional business since October 11, 2017 and the results of operations of the SSE businesses since April 20, 2017. +4 +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 201 7 , 201 8 and 201 9 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Oil prices have recovered from a 12-year low of $26.19 in February 2016 and reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil began the year at a low of $46.31 per barrel on January 2, 2019, before increasing by 43% over the course of four months to reach a high of $66.24 per barrel in late April 2019. Since May 2019, oil prices have generally ranged between $50 and $60 per barrel . Oil prices averaged $56.94 per barrel in the fourth quarter of 2019 and closed at $50.06 per barrel on February 3, 2020 . +Our rig count declined significantly during the industry downturn that began in late 2014, improved following the second quarter of 2016, and has declined since the fourth quarter of 2018. Our average active rig count for the fourth quarter of 2019 was 123 rigs, which included 122 rigs in the United States and less than one rig operating in Canada. This was a decrease from our average active rig count for the third quarter of 2019 of 142 rigs, which included 142 rigs in the United States and less than one rig in Canada. Our rig count in the United States at December 31, 2019 of 121 rigs was less than the rig count of 183 rigs at December 31, 2018. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 77 rigs operating under term contracts during the first quarter of 2020 and an average of 58 rigs operating under term contracts throughout 2020. +The pressure pumping market showed signs of oversupply in the second half of 2018 and was oversupplied in 2019. In response to oversupplied market conditions, we reduced the number of active pressure pumping spreads to 11 as of the end of 2019. We expect to average ten active pressure pumping spreads during the first quarter of 2020. +Industry Segments +Our revenues, operating income (loss) and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Our contract drilling services industry segment had operating losses in 2019, 2018 and 2017. Our pressure pumping services industry segment had operating losses in 2019 and 2018 and operating income in 2017. Our directional drilling services industry segment was a new segment for us as a result of the MS Directional acquisition in 2017 and accounted for approximately 7.6% and 6.3% percent of our 2019 and 2018 consolidated revenues, respectively. Our directional drilling segment had operating losses in 2019, 2018 and 2017. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 16 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +5 +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2019, we had 216 marketed land-based drilling rigs based in the following regions: +• +64 in west Texas and southeastern New Mexico, +• +18 in north central and east Texas and northern Louisiana, +• +35 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +25 in south Texas, +• +31 in western Oklahoma, +• +37 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +6 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 24,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $943 million during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2019, 2018 and 2017, we spent approximately $194 million, $395 million and $354 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. During 2019, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 20 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +6 +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2019 +2018 +2017 +Average rigs operating per day - U.S. (1) +149 +175 +136 +Average rigs operating per day - Canada (1) +1 +1 +2 +Number of rigs operated during the year +189 +193 +179 +Number of wells drilled during the year +2,703 +3,088 +2,553 +Number of operating days +54,544 +64,479 +50,427 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet during the last several years. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500-ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad-capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2019, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad-Capable +APEX ® 1500 HP rigs +172 +— +172 +94 +% +APEX ® 1000 HP rigs +12 +— +12 +100 +% +APEX ® 2000 HP rigs +6 +— +6 +67 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 1200 HP rigs +3 +— +3 +100 +% +Other electric rigs +12 +6 +18 +72 +% +Total +210 +6 +216 +Average horsepower +1,458 +1,117 +1,448 +The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We currently estimate there are approximately 690 super-spec rigs in the United States, which includes 150 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, West Virginia and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas (West and South Regions), the Mid-Continent region (Mid-Con Region) and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +7 +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.4 million horsepower as of December 31, 2019 . Pressure pumping equipment at December 31, 2019 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +West Texas Region +Number of units +207 +17 +224 +Approximate horsepower +492,000 +18,555 +510,555 +South Texas Region +Number of units +112 +— +112 +Approximate horsepower +270,750 +— +270,750 +Mid-Con Region +Number of units +68 +— +68 +Approximate horsepower +157,000 +— +157,000 +Northeast Region +Number of units +186 +12 +198 +Approximate horsepower +416,900 +8,000 +424,900 +Combined: +Number of units +573 +29 +602 +Approximate horsepower +1,336,650 +26,555 +1,363,205 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Wireline – Our wireline services offering primarily consists of “plug-and-perf,” which involves the setting of plugs between hydraulic fracturing stages and the creation of perforations for each cluster within the fracturing stage itself. These wireline services are complementary to our pressure pumping services. As of December 31, 2019, we had not yet performed any wireline operations. +Directional Drilling Operations +General – We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, measurement-while-drilling (MWD), and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +Directional Drilling Services – We provide our directional drilling services on a day-rate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days of work completed. Our day rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a stand-by rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +8 +Equipment – We generally design, assemble , maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2019 , we had a comprehensive fleet of over 1,000 motors. In addition to our motor fleet, we had over 100 MWD systems. +Horizontal Wellbore Placement – We provide software and services used to improve the statistical accuracy of horizontal wellbore placement. Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. We provide these services to customers with onshore and offshore operations. +Oilfield Rentals +Our oilfield rentals business has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. We offer an extensive line of rental tools, including a full line of tubular products specifically designed for horizontal drilling and completion, with high-torque, premium-connection drill pipe, drill collars and tubing. Additionally, we offer surface rental equipment including blowout preventers, frac tanks, mud tanks and environmental containment that encompass all phases of the hydrocarbon extraction and production process. Our air drilling equipment and services enable extraction in select basins where certain segments of formations preclude the use of drilling fluid, permitting operators to drill through problematic zones without the risk of fluid absorption and damage to the wellbore. We offer oilfield rental services in many of the major producing onshore oil and gas basins in the United States. We price our rentals and services based on the type of equipment being rented and the services being performed. Substantially all rental revenue we earn is based upon a charge for the actual period of time the rental is provided to our customer on a market-based, fixed per-day or per-hour fee. +Other Operations +We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling, oilfield rentals and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2019, we received approximately 41% from our ten largest customers and approximately 26% from our five largest customers. During 2019, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +Our contract drilling backlog as of December 31, 2019 and 2018 was approximately $605 million and $770 million, respectively. Approximately 28% of the total contract drilling backlog at December 31, 2019 is reasonably expected to remain after 2020. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +9 +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +We continue to pursue initiatives to make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example: +• +we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions; and +• +we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +Our goal is to provide an incident-free work environment. The safety of our employees and others is our highest priority, and we have robust safety training programs in place that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All field-based employees are required to attend an Employee Safety Orientation, which includes classes on behavior-based safety, hazard awareness, safe systems of work, permission to work, time out for safety, energy isolation, hazard communication (HAZCOM), material handling and other topics. +We are committed to fostering a work environment where all people feel valued and respected. We offer our workforce the opportunity to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. +In 2019, we trained over 4,000 employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, including wireline services, +• +directional drilling services, +• +services that improve the statistical accuracy of horizontal wellbore placement, including for customers with offshore operations, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +10 +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +11 +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases and Related Divestment and Other Efforts Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +12 +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 5,800 full-time employees as of February 7, 2020. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of calendar years, we have recently experienced slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +13 +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling, pressure pumping and directional drilling services, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the availability of capital for oil and natural gas industry participants, including our customers, +• +the availability of and constraints in pipeline, storage and other transportation capacity in the basins in which we operate, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production, use and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, and +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Oil and natural gas prices and markets can be extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, +• +the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil-producing nations, such as Russia, to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +• +domestic and international military, political, economic and weather conditions, +• +changes to tax, tariff and import/export regulations by the United States or other countries, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +• +the price and availability of alternative fuels. +All of these factors are beyond our control. Oil prices reached a twelve-year low of $26.19 per barrel in February 2016. As a result of the lower level of oil prices, our industry experienced a severe decline in activity levels. While oil and natural gas prices modestly recovered since the first quarter of 2016, our average number of rigs operating remains well below the number of our available rigs, and a portion of our pressure pumping horsepower remains stacked. Oil prices remain volatile, as the closing price of oil started the year at a low of $46.31 per barrel on January 2, 2019, before increasing by 43% over the course of four months to reach a high of $66.24 per barrel in late April 2019. Since May 2019, oil prices have generally ranged between $50 and $60 per barrel. +14 +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Global Economic Conditions May Adversely Affect Our Operating Results. +Demand for energy and for oil and natural gas end products is highly sensitive to economic conditions; as a result, global economic conditions, indications that economic growth is slowing and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise, may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. An economic slowdown or recession in the United States or in any other country that significantly affects the supply of or demand for oil or natural gas could negatively impact our operations and therefore adversely affect our results. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, and there is no assurance that the global economic environment, or expectations for the global economic environment, will not quickly deteriorate again due to one or more factors. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +A Surplus of Equipment and a Highly Competitive Oil Service Industry May Adversely Affect Our Utilization and Profit Margins and the Carrying Value of our Assets. +The North American land drilling and pressure pumping businesses are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment or capital spending reductions by our customers due to investor requirements or other reasons can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. In addition, in recent years there has been a substantial increase in new and upgraded drilling rigs and pressure pumping equipment. Low commodity prices and new and upgraded equipment can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. Even in an environment of high oil and natural gas prices and increased drilling activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to a surplus of equipment. +We periodically seek to increase the prices on our services to offset rising costs, earn returns on our capital investment, and otherwise generate higher returns for our stockholders. However, we operate in a very competitive industry, and we are not always successful in raising or maintaining our existing prices. With the active rig count below the peak seen in 2014 and many rigs, including highly capable AC rigs, and pressure pumping equipment still idle, there is considerable pricing pressure in the industry. Even if we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial condition, cash flows and results of operations. In addition, we may be unable to replace fixed-term contracts that were terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. +Accordingly, high competition and a surplus of equipment can cause oil and natural gas service contractors to have difficulty maintaining pricing, utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or surplus equipment in the oil and natural gas service businesses or the level of demand for our contract drilling, pressure pumping or directional drilling services. +The surplus of operable land drilling rigs, increasing rig specialization and surplus of pressure pumping and directional drilling equipment, which has been exacerbated by a decline in oil and natural gas prices, could affect the fair market value of our drilling, pressure pumping and directional drilling equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices could result in future impairment to our long-lived assets and goodwill. For example, we recognized impairment charges of $221 million and $277 million in 2019 and 2018, respectively. +15 +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, W hich Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance . +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +16 +Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2019, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $605 million. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a description of our calculation of backlog. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts or may be reduced by price adjustments to existing contracts, including as a result of the decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services. +New Technologies May Cause Our Operating Methods, Equipment and Services to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance of drilling rigs and pressure pumping and other equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and pressure pumping and other equipment, as well as new and improved technology and data analytics. Accordingly, we may have to allocate a higher proportion of our capital expenditures to maintain and improve existing rigs and pressure pumping and other equipment, purchase and construct newer, higher specification drilling rigs and pressure pumping and other equipment to meet the increasingly sophisticated needs of our customers, and develop new and improved technology and data analytics. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping and directional drilling businesses could have similar effects. +In recent years, we have added drilling rigs to our fleet through new construction, purchased new pressure pumping equipment and acquired a directional drilling services company. We have also improved existing drilling rigs and pressure pumping equipment by adding equipment and technology designed to enhance functionality and performance. Although we take measures to ensure that we use advanced oil and natural gas drilling, pressure pumping and directional drilling technology, changes in technology, improvements in competitors’ equipment and changes relating to the wells to be drilled and completed could make our equipment less competitive. +We continually attempt to develop new technologies for use in our business. In the event that we are successful in developing new technologies for use in our business, there is no guarantee of future demand for those technologies. Customers may be reluctant or unwilling to adopt our new technologies. We may also have difficulty negotiating satisfactory terms for our new technologies, including terms that would enable us to obtain acceptable returns on our investment in the research and development of new technologies. +Development of new technology is critical to maintaining our competitiveness. There can be no assurance that we will be able to successfully develop technology that our customers demand. If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment and services obsolete, which could reduce our competitiveness and have a material adverse impact on our business, financial condition, cash flows and results of operation. +17 +Shortages, Delays in Delivery, and Interruptions in Supply, of Equipment and Materials Could Adversely Affect Our Operating Results. +Periodically, the oilfield services industry has experienced shortages of equipment for upgrades, drill pipe, replacement parts and other equipment and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +transportation and other logistical challenges, and +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs. Severe shortages, delays in delivery and interruptions in supply could limit our ability to operate, maintain, upgrade and construct our drilling rigs and pressure pumping and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Loss of Key Personnel and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations. +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses and in developing new technologies. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel, particularly after a prolonged industry downturn. During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of key personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even if it is generally a period of lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2019, we received approximately 41% from our ten largest customers, 26% from our five largest customers and 7% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Business Is Subject to Cybersecurity Risks and Threats. +Our operations are increasingly dependent on effective and secure information technologies and services. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, attempts to gain unauthorized access to our data and systems, theft, viruses, malware, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• +theft or misappropriation of funds, including via “phishing” or similar attacks directed at us or our customers; +• +loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• +disruption or impairment of our and our customers’ business operations and safety procedures; +• +destruction or damage to our and our customers’ equipment; +• +downtime and loss of revenue; +• +injury to our reputation; +• +negative impacts on our ability to compete; +• +loss or damage to our information technology systems, including worksite data delivery systems; +18 +• +exposure to litigation ; and +• +increased costs to prevent, respond to or mitigate cybersecurity events. +Although we utilize various procedures and controls to mitigate our exposure to such risks, cybersecurity attacks and other cyber events are evolving and unpredictable. There can be no assurance that the procedures and controls that we implement, or that we cause third party service providers to implement, will be sufficient to protect our systems, information or other property. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber incident could go unnoticed for a period of time. We self-insure most of our cybersecurity risks, and any such incident could have a material adverse effect on our business, financial condition, cash flows and results of operations. As cyber incidents continue to evolve, we may be required to incur additional costs to continue to modify or enhance our protective measures or to investigate or remediate the effects of cyber incidents. +Growth Through Acquisitions, the Building or Upgrading of Equipment and the Development of Technology Is Not Assured. +We have grown our drilling rig fleet and pressure pumping fleet and expanded our business lines and use of technology in the past through mergers, acquisitions, new construction and technology development. For example, we completed the SSE merger and the MS Directional acquisition during 2017. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building or upgrading equipment or developing new technology. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, our competitors may continue to build new equipment and develop new technology. +There can be no assurance that we will: +• +have sufficient capital resources to complete additional acquisitions, build or upgrade equipment or develop new technology, +• +successfully integrate additional equipment, acquired or developed technology or other assets or businesses, +• +effectively manage the growth and increased size of our organization and, equipment, +• +successfully deploy idle, stacked, upgraded or additional equipment and acquired or developed technology, +• +maintain the crews necessary to operate additional equipment or the personnel necessary to evaluate, develop and deploy new technology, or +• +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition, the building or upgrading equipment or the development of new technology. +Our failure to achieve consolidation savings, to integrate acquired businesses and technology and other assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising from events prior to any acquisitions, prior to our establishment of adequate compliance oversight or in connection with disputes over acquired or developed technology. While we generally seek to obtain indemnities for liabilities arising from events occurring before such acquisitions, these are limited in amount and duration, may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build or upgrade equipment or develop new technology, and we also may issue equity, convertible or debt securities in connection with any such acquisitions or building or upgrade program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties or judgments, +• +modification, denial or revocation of permits or other authorizations, +19 +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the places that we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, a manufacturer and servicer of equipment and automation to the energy, marine and mining industries and a provider of directional drilling and other services, we may be deemed to be a responsible party under these laws and regulations. +Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations. +Numerous political and regulatory authorities, governmental bodies and officials, and environmental groups devote resources to campaigns aimed at eradicating hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. A number of presidential candidates have also stated that they would support either increased regulation or a ban on hydraulic fracturing; however, we cannot predict whether hydraulic fracturing regulations will be enacted or how stringent they may be. In addition, members of the U.S. Congress and the EPA have reviewed proposals for more stringent regulation of hydraulic fracturing, and various state and local initiatives have been or may be proposed or implemented to further regulate hydraulic fracturing. For example, the EPA conducted a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater and released its final report in December 2016. It concluded that hydraulic fracturing activities can impact drinking water resources under some circumstances, including large volume spills and inadequate mechanical integrity of wells. Further, we conduct drilling, pressure pumping and directional drilling activities in numerous states. Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. When caused by human activity, such seismic activity is called induced seismicity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) and other aspects of the oil and gas industry. +In addition, legislation has been proposed, but not enacted, in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if enacted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SDWA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel. In May 2014, the EPA issued an Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing. The EPA has not yet finalized this rule. In June 2016, the EPA published final pretreatment standards for disposal of wastewater produced from shale gas operations to publicly owned treatment works. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations. For example, Colorado, Louisiana, Montana, North Dakota, Texas and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in response to such regulation. +In addition, in light of concerns about induced seismicity, some state regulatory agencies have modified their regulations or issued orders to address induced seismicity. For example, the Oklahoma Corporation Commission (“OCC”) has implemented volume reduction plans, and at times required shut-ins, for oil and natural gas disposal wells injecting wastewater into the Arbuckle formation. The OCC also recently released well completion seismicity guidelines for operators in the SCOOP and STACK plays that call for hydraulic fracturing operations to be suspended following earthquakes of certain magnitudes in the vicinity. +Finally, several jurisdictions have taken steps to enact hydraulic fracturing bans, moratoria or increased regulations on hydraulic fracturing practices. In June 2015, New York banned high volume fracturing activities combined with horizontal drilling. Certain communities in Colorado have also enacted bans on hydraulic fracturing. Voters in the city of Denton, Texas approved a moratorium +20 +on hydraulic fracturing in November 2014, though it was later lifted in 2015. These actions have been the subject of legal challenges. In November 2018, voters rejected an initiative that would have materially restricted hydraulic fracturing activity in Colorado ; h owever, the Colorado state legislature subsequently passed a package of hydraulic fracturing regulations in April 2019. In November 2019, the California governor’s office imposed new regulations on hydraulic fracturing, including a moratorium on all new hydraulic fracturing permits pending review by a panel of scientists. +The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could make it more difficult to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. Additionally, the adoption of significant restrictions or a prohibition on hydraulic fracturing by a state, region or locality could result in a surplus of oilfield equipment in other states, regions or localities where hydraulic fracturing remains allowed. +Legislation and Regulation of Greenhouse Gases and Related Divestment and Other Efforts Could Adversely Affect Our Business. +We are aware of the increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. The EPA has adopted rules requiring the reporting of GHG emissions from specified large GHG emission sources on an annual basis. In addition, the United States was actively involved in the United Nations Conference on Climate Change in Paris, which led to the creation of the Paris Agreement. In April 2016, the United States signed the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, every five years. In November 2019, the State Department formally informed the United Nations of the United States’ withdrawal from the Paris Agreement. Due to the Paris Agreement’s protocol, the withdrawal will be effective in November 2020. However, several states and geographic regions in the United States have adopted legislation and regulations to reduce emissions of GHGs. Additional legislation or regulation by these states and regions, the EPA, and/or any international agreements to which the United States may become a party, that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our operations. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +In addition to the regulatory efforts described above, there have also been efforts in recent years aimed at the investment community, including investment advisors, sovereign wealth funds, public pension funds, universities and other groups, promoting the divestment of fossil fuel equities as well as to pressure lenders and other financial services companies to limit or curtail activities with companies engaged in the extraction of fossil fuel reserves. If these efforts are successful, our ability to access capital markets may be limited and our stock price may be negatively impacted. +Members of the investment community have recently increased their focus on sustainability practices with regard to the oil and gas industry, including practices related to GHGs and climate change. An increasing percentage of the investment community considers sustainability factors in making investment decisions, and an increasing number of our customers consider sustainability factors in awarding work. If we are unable to successfully continue our sustainability enhancement efforts, we may lose customers, our stock price may be negatively impacted, our reputation may be negatively affected, and it may be more difficult for us to effectively compete. +21 +The Design, Manufacture, Sale and Servicing of Products, including Electrical Controls, May Subject Us to Liability for Personal Injury, Property Damage and Environmental Contamination Should Such Equipment Fail to Perform to Specifications. +We provide products, including electrical controls, to customers involved in oil and gas exploration, development and production and in the marine and mining industries. Because of applications that use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause harm to our reputation, contractual and warranty-related liability, damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. +Legal Proceedings and Governmental Investigations Could Have a Negative Impact on Our Business, Financial Condition and Results of Operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Please see “Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Technology Disputes Could Negatively Impact Our Operations or Increase Our Costs. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, or a third party’s infringement of our rights, including patent rights. The majority of the intellectual property rights relating to our drilling rigs, pressure pumping equipment and directional drilling services are owned by us or certain of our supplying vendors. However, in the event that we or one of our customers or supplying vendors becomes involved in a dispute over infringement of intellectual property rights relating to equipment or technology owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or technology or our ability to provide services or products, or we could be required to cease use of some equipment or technology or forced to modify our equipment, technology, services or products. We could also be required to pay license fees or royalties for the use of equipment or technology or provision of services or products. In addition, we may lose a competitive advantage in the event we are unsuccessful in enforcing our rights against third parties. Technology disputes involving us or our customers or supplying vendors could have a material adverse impact on our business, financial condition, cash flows and results of operations. +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect Our Opportunities and Future Business. +We currently conduct operations in Canada, and we have incurred selling, general and administrative expenses related to the evaluation of and preparation for other international opportunities. We also sell products, including electrical controls, for use in numerous oil and gas producing regions outside of North America, and through our Superior QC business, we occasionally provide remote data analytics and other services to customers to support their operations outside of the United States. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. +22 +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where our services could be provided or where our consumers for products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under Our Long-Term Debt. +We have borrowings outstanding under our senior notes and our term loan agreement and, from time to time, our revolving credit facility. Our ability to meet our interest and principal payment obligations depends in large part on cash flows from our subsidiaries. If our subsidiaries do not generate sufficient cash flows, we may be unable to meet our interest and principal payment obligations. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured term loan facility under our Term Loan Agreement. Interest is paid on the outstanding principal amount of borrowings under the Term Loan Agreement at a floating rate based on, at our election, LIBOR or a base rate . The applicable margin on LIBOR rate loans varies from 1.00% to 1.375%, and the applicable margin on base rate loans varies from 0.00% to 0.375%, in each case determined based upon our credit rating. As of December 31, 2019, the applicable margin on LIBOR rate loans and base rate loans was 1.125% and 0.125%, respectively. As of December 31, 2019, we had $100 million in borrowings outstanding under the Term Loan Agreement. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. As of December 31, 2019, the applicable margin on LIBOR rate loans was 1.50% and the applicable margin on base rate loans was 0.50%. As of December 31, 2019, we had no borrowings outstanding under our revolving credit facility. +Finally, we have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2019, no amounts had been disbursed under any letters of credit. +23 +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed at floating rates under these agreements or under future agreements . +A Downgrade in Our Credit Rating Could Negatively Impact Our Cost of and Ability to Access Capital. +Our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels, industry conditions and other considerations. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, and potentially require us to post letters of credit for certain obligations. +We May Not Be Able to Generate Sufficient Cash to Service All of Our Debt and We May Be Forced to Take Other Actions to Satisfy Our Obligations Under Our Debt, which May Not Be Successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our debt agreements contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +The Market Price of Our Common Stock May Be Highly Volatile, and Investors May Not Be Able to Resell Shares at or Above the Price Paid. +The trading price of our common stock may be volatile. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as other general economic, market or political conditions, could reduce the market price of our common stock in spite of our operating and/or financial performance. The following factors, in addition to other factors described in this “Risk Factors” section and elsewhere in this Report, may have a significant impact on the market price of our common stock: +• +investor perception of us and the industry and markets in which we operate; +• +general financial, domestic, international, economic, and market conditions, including overall fluctuations in the U.S. equity markets; +• +increased focus by the investment community on sustainability practices at our company and in the oil and natural gas industry generally; +• +changes in customer needs, expectations or trends and our ability to maintain relationships with key customers; +• +our ability to implement our business strategy; +• +changes in our capital structure, including the issuance of additional debt; +• +public announcements (including the timing of these announcements) regarding our business, financial performance and prospects or new services or products, service or product enhancements, technological advances or strategic actions, such as acquisitions or divestitures, restructurings or significant contracts, by our competitors or us; +• +trading activity in our stock, including portfolio transactions in our stock by us, our executive officers and directors, and significant stockholders or trading activity that results from the ordinary course rebalancing of stock indices in which we may be included; +• +short-interest in our common stock, which could be significant from time to time; +• +our inclusion in, or removal from, any stock indices; +• +changes in earnings estimates or buy/sell recommendations by securities analysts; +• +whether or not we meet earnings estimates of securities analysts who follow us; and +24 +• +regulatory or legal developments in the United States and foreign countries where we operate. +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +As a Result of the SSE Merger, We Could Be Subject to Certain Contingent T ax Liabilities of Chesapeake Energy Corporation (“CHK”) for Periods Prior to S SE’s Spin-Off from CHK. +Under the Internal Revenue Code of 1986, as amended (the “Code”), and the related rules and regulations, each corporation (or its successor) that was a member of CHK’s consolidated tax reporting group during any taxable period or portion of any taxable period ending on or before the SSE spin-off on June 30, 2014, is jointly and severally liable for the federal income tax liability of the entire consolidated tax reporting group for any such pre-spin-off taxable period during which it was a member of the group. According to CHK’s public filings, CHK’s federal examination cycles 2010 through 2015 were settled with the Internal Revenue Service during 2018, however, certain of these CHK taxable periods remain open for purposes of adjusting federal net operating loss carryforwards upon utilization. In connection with the SSE spin-off, SSE entered into a tax sharing agreement with CHK that generally provides that SSE is responsible for all taxes attributable to its business, whether accruing before, on or after the date of the spin-off, and CHK is responsible for any taxes attributable to the non-SSE businesses and for any taxes arising from the spin-off or certain related transactions that are imposed on SSE, CHK or its other subsidiaries. Notwithstanding such agreement, if CHK were unable to pay the taxes it is responsible for under such agreement, we (as the successor to SSE) could be required to pay the entire amount of such taxes under U.S. tax law, which could have a material adverse effect on us. +We May Not Be Able to Utilize a Portion of SSE’s or Our Net Operating Loss Carryforwards (“NOLs”) to Offset Future Taxable Income for U.S. Federal Tax Purposes, Which Could Adversely Affect Our Net Income and Cash Flows. +As of December 31, 2019, we had gross federal income tax NOLs of approximately $1.4 billion, approximately $247 million of which were assumed in connection with the SSE merger. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be predicted with any accuracy. In addition, Section 382 of the Code generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred—or were to occur—with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382. However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. Any unused annual limitation with respect to an NOL generally may be carried over to later years. Any NOL arising prior to January 1, 2018 is subject to expiration 20 years after it arose. NOLs arising on or after January 1, 2018 are not subject to expiration . +SSE underwent an ownership change in 2016 as a result of its emergence from Chapter 11 bankruptcy proceedings, and experienced another ownership change in 2017 as a result of its acquisition pursuant to the SSE merger, and the corresponding annual limitation associated with either of those changes in ownership could prevent us from fully utilizing—prior to their expiration—our NOLs relating to SSE as of the effective time of the SSE merger. While our issuance of stock pursuant to the SSE merger was, standing alone, insufficient to result in an ownership change with respect to us, we cannot assure you that we will not undergo an ownership change as a result of the merger taking into account other changes in ownership of our stock occurring within the relevant three-year period described above. If we were to undergo an ownership change, we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected . +25 +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania, Ohio, West Virginia and western Canada. +Pressure Pumping — Our pressure pumping services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Pennsylvania, Ohio and West Virginia. +Directional Drilling — Our directional drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Pennsylvania, and Montana. +Our oilfield rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our servicing of equipment for drilling contractors is supported by offices and yard facilities located in Texas. Our electrical controls and automation operation is supported by an office and yard facility in Texas. Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas, as well as several other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 5 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +On July 18, 2018, OSHA issued a citation containing alleged violations, proposed abatement dates and an aggregate proposed penalty of approximately $74,000 in connection with an accident at a drilling site in Pittsburg County, Oklahoma that resulted in the losses of life of five people, including three of our employees. We filed a notice of contest with OSHA that contested all citation items, abatement dates and proposed penalties. The Department of Labor (the “DOL”) filed a complaint on OSHA’s behalf seeking enforcement of the citation as issued, and we filed an answer to the complaint. In October 2019, we and the DOL agreed to a settlement of all but one of the citation items, and a hearing on the remaining citation item was held before an administrative law judge. We and the DOL will file post-hearing briefs and await the judge’s determination. +Additionally, we are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +Item 4. Mine Safety Disclosure. +Not applicable. +26 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P MidCap 400 Index and several other market indices. +(b) Holders +As of February 7, 2020, there were approximately 1,000 holders of record of our common stock. +(c) Dividends +On February 5, 2020, our Board of Directors approved a cash dividend on our common stock in the amount of $0.04 per share to be paid on March 19, 2020 to holders of record as of March 5, 2020. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2019. +Period Covered +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands) (2) +October 2019 +19,700 +$ +8.49 +— +$ +175,000 +November 2019 +840,922 +$ +8.84 +840,000 +$ +167,576 +December 2019 +1,766,695 +$ +9.96 +1,764,987 +$ +150,000 +Total +2,627,317 +2,604,987 +$ +150,000 +(1) +We withheld 22,330 shares in the fourth quarter with respect to employees’ tax withholding obligations upon the vesting of restricted stock and restricted stock units. These shares were acquired at fair market value pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan and not pursuant to the stock buyback program. +(2) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. On July 26, 2018, we announced that our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On February 7, 2019, we announced that our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On July 25, 2019, we announced that our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the buyback program are held as treasury shares. There is no expiration date associated with the buyback program. +27 +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2014 through December 31, 2019, with the cumulative total return of the S & P 500 Index, the S & P MidCap 400 Index, the Oilfield Service Index and a peer group determined by us. Our peer group consists of Basic Energy Services, Inc., Diamond Offshore Drilling Inc., Forum Energy Technologies, Inc., Halliburton Company, Helmerich & Payne, Inc., Nabors Industries, Ltd., National Oilwell Varco, Inc., Noble Corporation plc., Oceaneering International, Oil States International Inc., Precision Drilling Corporation, Superior Energy Services, Inc., TechnipFMC plc, Transocean Ltd., Unit Corp., Valaris plc and Weatherford International plc. +The graph assumes investment of $100 on December 31, 2014 and reinvestment of all dividends. +Fiscal Year Ended December 31, +2014 +2015 +2016 +2017 +2018 +2019 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +93.11 +167.61 +143.80 +65.25 +67.25 +S&P 500 Stock Index +100.00 +101.38 +113.51 +138.29 +132.23 +173.86 +S&P MidCap Index +100.00 +97.82 +118.11 +137.29 +122.07 +154.05 +Oilfield Service Index +100.00 +76.62 +91.16 +75.48 +41.35 +41.12 +Peer Group Index +100.00 +68.92 +88.00 +74.78 +42.88 +41.32 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +28 +Item 6. Selected Financial Data. +Our selected consolidated financial data as of December 31, 2019, 2018, 2017, 2016, and 2015, and for each of the five years in the period ended December 31, 2019, should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report. The table below includes the results of operations of Current Power since October 25, 2018, the results of operations of Superior QC since February 20, 2018, the results of operations of MS Directional since October 11, 2017 and the results of operations of SSE since April 20, 2017. +2019 +2018 +2017 +2016 +2015 +(In thousands, except per share amounts) +Statement of Operations Data: +Operating revenues: +Contract drilling +$ +1,308,350 +$ +1,430,492 +$ +1,040,033 +$ +543,663 +$ +1,153,892 +Pressure pumping +868,694 +1,573,396 +1,200,311 +354,070 +712,454 +Directional drilling +188,786 +209,275 +45,580 +— +— +Other +104,855 +113,834 +70,760 +18,133 +24,931 +Total +2,470,685 +3,326,997 +2,356,684 +915,866 +1,891,277 +Operating costs and expenses: +Contract drilling +785,355 +885,704 +667,105 +305,804 +608,848 +Pressure pumping +724,788 +1,263,850 +966,835 +334,588 +612,021 +Directional drilling +178,645 +175,829 +32,172 +— +— +Other +84,909 +77,104 +51,428 +8,384 +11,500 +Depreciation, depletion, amortization and impairment +1,003,873 +916,318 +783,341 +668,434 +864,759 +Impairment of goodwill +17,800 +211,129 +— +— +124,561 +Selling, general and administrative +133,513 +134,071 +105,847 +69,205 +74,913 +Provision for bad debt +5,683 +— +— +— +— +Merger and integration expenses +— +2,738 +74,451 +— +— +Other operating (income) expense, net +(2,305 +) +(17,569 +) +(31,957 +) +(14,323 +) +1,647 +Total +2,932,261 +3,649,174 +2,649,222 +1,372,092 +2,298,249 +Operating loss +(461,576 +) +(322,177 +) +(292,538 +) +(456,226 +) +(406,972 +) +Other expense +(68,802 +) +(45,231 +) +(35,263 +) +(39,970 +) +(35,477 +) +Loss before income taxes +(530,378 +) +(367,408 +) +(327,801 +) +(496,196 +) +(442,449 +) +Income tax benefit +(104,675 +) +(45,987 +) +(333,711 +) +(177,562 +) +(147,963 +) +Net income (loss) +$ +(425,703 +) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +$ +(294,486 +) +Net income (loss) per common share: +Basic +$ +(2.10 +) +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +Diluted +$ +(2.10 +) +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +$ +(2.00 +) +Cash dividends per common share +$ +0.16 +$ +0.14 +$ +0.08 +$ +0.16 +$ +0.40 +Weighted average number of common shares outstanding: +Basic +203,039 +218,643 +198,447 +146,178 +145,416 +Diluted +203,039 +218,643 +199,882 +146,178 +145,416 +Balance Sheet Data: +Total assets +$ +4,439,615 +$ +5,469,866 +$ +5,758,856 +$ +3,772,291 +$ +4,465,048 +Borrowings under line of credit +— +— +268,000 +— +— +Other long-term debt +966,540 +1,119,205 +598,783 +598,437 +787,900 +Stockholders’ equity +2,833,620 +3,505,423 +3,982,493 +2,248,724 +2,561,131 +Working capital +231,213 +423,881 +200,605 +(17,933 +) +178,887 +29 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Recent Developments — On November 15, 2019, we completed an offering of $350 million in aggregate principal amount of our 5.15% Senior Notes due November 15, 2029 (the “2029 Notes”). The net proceeds before offering expenses were approximately $347 million. On December 16, 2019, we used a portion of the net proceeds from the offering to prepay our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”). The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $315 million, plus accrued interest to the prepayment date. The remaining net proceeds and available cash on hand was used to repay $50 million of the borrowings under the Term Loan Agreement (as defined below). +On August 22, 2019, we entered into a term loan agreement (the “Term Loan Agreement”) that permits a single borrowing of up to $150 million, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $75 million, not to exceed total commitments of $225 million. On September 25, 2019, we used $150 million of borrowings from the Term Loan Agreement and approximately $158 million of cash on hand to prepay our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”). The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $308 million, plus accrued interest to the prepayment date. We repaid $50 million of the borrowings under the Term Loan Agreement on December 16, 2019, and we had $100 million in outstanding borrowings under the Term Loan Agreement as of December 31, 2019. +On October 25, 2018, we acquired all of the issued and outstanding shares of Current Power Solutions, Inc. (“Current Power”). Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. Operational and financial data in the discussion and analysis below includes the results of operations of the Current Power business in our other operations since October 25, 2018. +On March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. See “ Liquidity and Capital Resources.” +On February 20, 2018, we acquired the business of Superior QC, LLC (“Superior QC”), including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Operational and financial data in the discussion and analysis below includes the results of operations of the Superior QC business in our directional drilling segment since February 20, 2018. +On January 19, 2018, we completed an offering of $525 million in aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”) . We used $239 million of the net proceeds from the offering to repay amounts outstanding under our revolving credit facility. +Management Overview — We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. Our contract drilling business operates in the continental United States and western Canada, and, from time to time, we pursue contract drilling opportunities outside of North America. Our pressure pumping business operates primarily in Texas and the Mid-Continent and Appalachian regions. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of horizontal wellbore placement. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +30 +Oil prices have recovered from a 12-year low of $26.19 in February 2016 and reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil began the year at a low of $46.31 per barrel on January 2 , 2019, before increasing by 43% over the course of four months to reach a high of $66.24 per barrel in late April 2019. Since May 2019, oil prices have generally ranged between $50 and $60 per barrel . Oil prices averaged $ 56.94 per barrel in the fourth quarter of 2019 and closed at $ 50.06 per barrel on February 3 , 2020. Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 201 7 , 201 8 , and 201 9 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our rig count declined significantly during the industry downturn that began in late 2014, improved following the second quarter of 2016, and has declined since the fourth quarter of 2018. Our average active rig count for the fourth quarter of 2019 was 123 rigs, which included 122 rigs in the United States and less than one rig operating in Canada . This was a decrease from our average active rig count for the third quarter of 2019 of 142 rigs, which included 142 rigs in the United States and less than one rig in Canada. Our rig count in the United States at December 31, 2019 of 121 rigs was less than the rig count of 183 rigs at December 31, 2018. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 77 rigs operating under term contracts during the first quarter of 2020 and an average of 58 rigs operating under term contracts throughout 2020. +The pressure pumping market showed signs of oversupply in the second half of 2018 and was oversupplied in 2019. In response to oversupplied market conditions, we reduced the number of active pressure pumping spreads to 11 as of the end of 2019. We expect to average ten active pressure pumping spreads during the first quarter of 2020. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and upon our customers’ ability to access capital to fund their operating and capital expenditures. During periods of improved oil and natural gas prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when oil and natural gas prices deteriorate or when our customers have a reduced ability to access capital, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. +The North American oil and natural gas services industry is cyclical and at times experiences downturns in demand. During these periods, there has been substantially more oil and natural gas service equipment available than necessary to meet demand. As a result, oil and natural gas service contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods. Currently, there is an excess supply of drilling rigs, pressure pumping equipment and directional drilling equipment. We cannot predict either the future level of demand for our oil and natural gas services or future conditions in the oil and natural gas service businesses. +We are highly impacted by operational risks, competition, labor issues, weather, the availability of products used in our pressure pumping business, supplier delays and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. See “Risk Factors” in Item 1A of this Report. +For the three years ended December 31, 2019, our operating revenues consisted of the following (dollars in thousands): +2019 +2018 +2017 +Contract drilling +$ +1,308,350 +53.0 +% +$ +1,430,492 +43.0 +% +$ +1,040,033 +44.1 +% +Pressure pumping +868,694 +35.2 +% +1,573,396 +47.3 +% +1,200,311 +50.9 +% +Directional drilling +188,786 +7.6 +% +209,275 +6.3 +% +45,580 +1.9 +% +Other +104,855 +4.2 +% +113,834 +3.4 +% +70,760 +3.1 +% +$ +2,470,685 +100.0 +% +$ +3,326,997 +100.0 +% +$ +2,356,684 +100.0 +% +31 +Contract Drilling +Contract drilling revenues accounted for 53.0% of our consolidated 2019 revenues and decreased 8.5% from 2018. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet during the last several years. The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. As of December 31, 2019, our rig fleet included 198 APEX ® rigs, of which 150 were super-spec rigs. +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog as of December 31, 2019 and 2018 was approximately $605 million and $770 million, respectively. Approximately 28% of the total contract drilling backlog at December 31, 2019 is reasonably expected to remain after 2020. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to fees for other services such as for mobilization, other than initial mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. For contracts that contain variable dayrate pricing, our backlog calculation uses the dayrate in effect for periods where the dayrate is fixed, and, for periods that remain subject to variable pricing, uses the commodity price in effect at December 31, 2019. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts on which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period over which we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +Ongoing factors which could continue to adversely affect utilization rates and pricing, even in an environment of high oil and natural gas prices and increased drilling activity, include: +• +movement of drilling rigs from region to region, +• +reactivation of drilling rigs, +• +refurbishment and upgrades of existing drilling rigs, +• +development of new technologies that enhance drilling efficiency, and +• +construction of new technology drilling rigs. +Pressure Pumping +Pressure pumping revenues accounted for 35.2% of our consolidated 2019 revenues and decreased 44.8% from 2018. As of December 31, 2019, we had approximately 1.4 million horsepower in our pressure pumping fleet. The pressure pumping market showed signs of oversupply in the second half of 2018 and was oversupplied in 2019. In response to oversupplied market conditions, we reduced the number of active pressure pumping spreads to 11 as of the end of the fourth quarter of 2019. We expect to average ten active pressure pumping spreads during the first quarter of 2020. +Directional Drilling +Directional drilling revenues accounted for 7.6% of our consolidated 2019 revenues and decreased 9.8% from 2018. Activity for directional drilling commenced with the acquisition of MS Directional, LLC (f/k/a Multi-Shot, LLC) (“MS Directional”) in October 2017, which provides a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, measurement-while-drilling, and wireline steering tools, and we provide services that improve the statistical accuracy of horizontal wellbore placement. +Other Operations +Other operations revenues accounted for 4.2% of our consolidated 2019 revenues and decreased 7.9% from 2018. Our oilfield rentals business, with a fleet of premium oilfield rental tools, provides the largest revenue contribution to our other operations and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. Other operations also includes the results of our electrical controls and automation business, the results of our drilling equipment service business, and the results of our ownership, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +32 +Capital Expenditures +Cash capital expenditures for 2019 totaled $348 million. For 2020, based on near-term activity levels, we expect cash used for capital expenditures to be approximately $250 million. +For the three years ended December 31, 2019, our operating income (loss) consisted of the following (dollars in thousands): +2019 +2018 +2017 +Contract drilling +$ +(151,329 +) +32.8 +% +$ +(33,115 +) +10.3 +% +$ +(171,897 +) +58.8 +% +Pressure pumping +(102,701 +) +22.3 +% +(77,328 +) +24.0 +% +21,028 +(7.2 +)% +Directional drilling +(52,724 +) +11.4 +% +(117,497 +) +36.5 +% +(21 +) +— +% +Other +(54,725 +) +11.9 +% +(18,221 +) +5.7 +% +(20,813 +) +7.1 +% +Corporate +(100,097 +) +21.6 +% +(76,016 +) +23.5 +% +(120,835 +) +41.3 +% +$ +(461,576 +) +100.0 +% +$ +(322,177 +) +100.0 +% +$ +(292,538 +) +100.0 +% +Discussion of our operating income (loss) follows in the “Results of Operations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Lower demand for our contract drilling and pressure pumping services in 2019, an impairment of goodwill and write-downs to drilling and pressure pumping equipment and an increase in interest expense due to the 2019 prepayment of the Series A Notes and Series B Notes contributed to a consolidated net loss of $426 million for 2019, compared to a consolidated net loss of $321 million for 2018 and consolidated net income of $5.9 million for 2017. Our net income for 2017 was positive due to the 2017 tax law change. +Results of Operations +Comparison of the years ended December 31, 2019 and 2018 +The following tables summarize results of operations by business segment for the years ended December 31, 2019 and 2018: +Year Ended December 31, +Contract Drilling +2019 +2018 +% Change +(Dollars in thousands) +Revenues +$ +1,308,350 +$ +1,430,492 +(8.5 +)% +Direct operating costs +785,355 +885,704 +(11.3 +)% +Margin (1) +522,995 +544,788 +(4.0 +)% +Selling, general and administrative +6,317 +6,296 +0.3 +% +Depreciation, amortization and impairment +668,007 +571,607 +16.9 +% +Operating loss +$ +(151,329 +) +$ +(33,115 +) +357.0 +% +Operating days +54,544 +64,479 +(15.4 +)% +Average revenue per operating day +$ +23.99 +$ +22.19 +8.1 +% +Average direct operating costs per operating day +$ +14.40 +$ +13.74 +4.8 +% +Average margin per operating day (1) +$ +9.59 +$ +8.45 +13.5 +% +Average rigs operating +149.4 +176.7 +(15.4 +)% +Capital expenditures +$ +194,416 +$ +394,595 +(50.7 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +Generally, the revenues in our contract drilling segment are most impacted by two primary factors: our average number of rigs operating and our average revenue per operating day. During 2019, our average number of rigs operating was 149, compared to 177 in 2018. Our average rig revenue per operating day was $23,990 in 2019, compared to $22,190 in 2018. Our average revenue per operating day is largely dependent on the pricing terms of our rig contracts. +Revenues and direct operating costs decreased in 2019 primarily due to a decrease in operating days. Average revenue per operating day increased in 2019. This increase was supported by our upgrades of additional rigs to super-spec capability. +Depreciation, amortization and impairment for 2019 included a charge of $173 million related to the retirement of 36 legacy non-APEX® drilling rigs and related equipment. Depreciation, amortization and impairment for 2018 included a charge of $48.4 million related to the retirement of 42 legacy non- APEX® drilling rigs and related equipment. +Capital expenditures decreased in 2019 primarily due to upgrading more rigs to super-spec capability in 2018 relative to 2019. +33 +Year Ended December 31, +Pressure Pumping +2019 +2018 +% Change +(Dollars in thousands) +Revenues +$ +868,694 +$ +1,573,396 +(44.8 +)% +Direct operating costs +724,788 +1,263,850 +(42.7 +)% +Margin (1) +143,906 +309,546 +(53.5 +)% +Selling, general and administrative +12,655 +15,420 +(17.9 +)% +Depreciation, amortization and impairment +233,952 +250,010 +(6.4 +)% +Impairment of goodwill +— +121,444 +NA +Operating loss +$ +(102,701 +) +$ +(77,328 +) +32.8 +% +Fracturing jobs +505 +812 +(37.8 +)% +Other jobs +844 +1,081 +(21.9 +)% +Total jobs +1,349 +1,893 +(28.7 +)% +Average revenue per fracturing job +$ +1,673.81 +$ +1,909.42 +(12.3 +)% +Average revenue per other job +$ +27.75 +$ +21.23 +30.7 +% +Average revenue per total job +$ +643.95 +$ +831.17 +(22.5 +)% +Average direct operating costs per total job +$ +537.28 +$ +667.64 +(19.5 +)% +Average margin per total job (1) +$ +106.68 +$ +163.52 +(34.8 +)% +Margin as a percentage of revenues (1) +16.6 +% +19.7 +% +(15.7 +)% +Capital expenditures +$ +105,803 +$ +173,848 +(39.1 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Generally, the revenues in our pressure pumping segment are most impacted by our number of fracturing jobs and the size (including whether or not we provide proppant and other materials) of those jobs, which is reflected in our average revenue per fracturing job. Direct operating costs are also most impacted by these same factors. Our average revenue per fracturing job is largely dependent on the pricing terms of our pressure pumping contracts. We completed 505 fracturing jobs during 2019 compared to 812 fracturing jobs in 2018. Our average revenue per fracturing job was $1.674 million in 2019 compared to $1.909 million in 2018. +Revenues and direct operating costs decreased in 2019 primarily due to a decline in the number of fracturing jobs. Average revenue and direct operating costs per job were impacted by lower demand, more customers self-sourcing products and decreases in product prices. +Selling, general and administrative expenses decreased primarily as a result of cost reduction efforts. +Depreciation, amortization and impairment expense included charges of $20.5 million and $17.4 million related to the write-down of pressure pumping equipment in 2019 and 2018, respectively. All of the goodwill associated with our pressure pumping business was impaired during 2018. See Note 6 of Notes to Consolidated Financial Statements for additional information. +The decrease in capital expenditures was primarily due to higher maintenance capital expenditures in 2018 when activity levels were higher. +Year Ended December 31, +Directional Drilling +2019 +2018 +% Change +(Dollars in thousands) +Revenues +$ +188,786 +$ +209,275 +(9.8 +)% +Direct operating costs +178,645 +175,829 +1.6 +% +Margin (1) +10,141 +33,446 +(69.7 +)% +Selling, general and administrative +10,642 +15,941 +(33.2 +)% +Depreciation and amortization +52,223 +45,317 +15.2 +% +Impairment of goodwill +— +89,685 +NA +Operating loss +$ +(52,724 +) +$ +(117,497 +) +(55.1 +)% +Capital expenditures +$ +15,549 +$ +35,929 +(56.7 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation and amortization and selling, general and administrative expenses. +Directional drilling revenue decreased by $20.5 million from 2018 primarily due to decreased job activity, partially offset by increased revenue from Superior QC, which was acquired in the first quarter of 2018. +34 +Direct operating costs for 2019 included a charge of $17.0 million primarily due to the write-down of inventory , partially offset by lower operating costs due to decreased job activity . +Selling, general and administrative expense decreased from 2018 primarily as a result of cost reduction efforts. +Depreciation, amortization and impairment for 2019 included a charge of $8.4 million related to the write-down of directional drilling equipment. There were no similar charges in 2018. +The decrease in capital expenditures was primarily due to higher capital expenditures in 2018 in response to market demand for equipment upgrades. +Year Ended December 31, +Other Operations +2019 +2018 +% Change +(Dollars in thousands) +Revenues +$ +104,855 +$ +113,834 +(7.9 +)% +Direct operating costs +84,909 +77,104 +10.1 +% +Margin (1) +19,946 +36,730 +(45.7 +)% +Selling, general and administrative +14,068 +13,439 +4.7 +% +Depreciation, depletion, amortization and impairment +42,803 +41,512 +3.1 +% +Impairment of goodwill +17,800 +— +NA +Operating loss +$ +(54,725 +) +$ +(18,221 +) +200.3 +% +Capital expenditures +$ +27,132 +$ +34,660 +(21.7 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion, amortization and impairment and selling, general and administrative expenses. +Other operations revenue decreased primarily due to a decline in revenue in our oilfield rentals business. +During the third quarter of 2019, we made the decision to transition away from our engineering and manufacturing efforts in Calgary. Direct operating costs and selling, general and administrative costs for 2019 include $12.4 million and $2.2 million, respectively, of charges associated with this decision. The $12.4 million of charges to direct operating costs is primarily comprised of inventory write-offs. +All of the goodwill associated with our oilfield rentals and electrical controls and automation reporting units was impaired during 2019. +The decrease in capital expenditures was primarily due to 2018 investments in the oilfield rentals business. +Year Ended December 31, +Corporate +2019 +2018 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +89,831 +$ +82,975 +8.3 +% +Merger and integration expenses +$ +— +$ +2,738 +NA +Depreciation +$ +6,888 +$ +7,872 +(12.5 +)% +Other operating (income) expense, net +Net gain on asset disposals +$ +(13,904 +) +$ +(28,958 +) +(52.0 +)% +Legal-related expenses and settlements, net of insurance reimbursements +(3,471 +) +12,684 +NA +Research and development +3,840 +3,444 +11.5 +% +Other +11,230 +(4,739 +) +NA +Other operating income, net +$ +(2,305 +) +$ +(17,569 +) +(86.9 +)% +Provision for bad debts +$ +5,683 +$ +— +NA +Interest income +$ +6,013 +$ +5,597 +7.4 +% +Interest expense +$ +75,204 +$ +51,578 +45.8 +% +Other income +$ +389 +$ +750 +(48.1 +)% +Capital expenditures +$ +4,612 +$ +2,426 +90.1 +% +Selling, general and administrative expense increased in 2019 due to an increase in compensation related expenses. Merger and integration expenses incurred in 2018 are related to the Seventy Seven Energy Inc. merger (the “SSE merger”), MS Directional acquisition and Superior QC acquisition. +35 +Other operating expenses (income), net includes net gains associated with the disposal of assets. Accordingly, the related gains or losses have been excluded from the results of specific segments. The majority of the net gain on asset disposals during 2019 reflect s gains on disposal of drilling equipment. Legal-related expenses and settlements in 2018 includes insurance deductibles and investigation costs related to an accident at a drilling site in January 2018. Legal-related expenses and settlements in 2019 includes proceeds from insurance claims. Other operating expenses (income), net includes a $12.7 million charge recorded in 2019 related to a 2017 capacity reservation agreement that required a cash deposit to increase our access to finer grades of sand for our pressure pumping business . As market prices for sand substantially decreased since 2017, we purchased lower cost sand outside of this capacity reservation contract and revalued the deposit at its expected realizable value. Other operating expenses (income), net includes a gain recorded in 2018 related to the collection of a note receivable that had been recorded at a discount. +A provision for bad debts was recognized in 2019 with respect to accounts receivable balances that were estimated to be uncollectible. Interest expense includes a loss on early debt extinguishment of $24.0 million in 2019 as a result of prepayment of the Series A Notes and Series B Notes. +Results of Operations +Comparison of the years ended December 31, 2018 and 2017 +The following tables summarize results of operations by business segment for the years ended December 31, 2018 and 2017: +Year Ended December 31, +Contract Drilling +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +1,430,492 +$ +1,040,033 +37.5 +% +Direct operating costs +885,704 +667,105 +32.8 +% +Margin (1) +544,788 +372,928 +46.1 +% +Selling, general and administrative +6,296 +5,934 +6.1 +% +Depreciation, amortization and impairment +571,607 +538,891 +6.1 +% +Operating loss +$ +(33,115 +) +$ +(171,897 +) +(80.7 +)% +Operating days +64,479 +50,427 +27.9 +% +Average revenue per operating day +$ +22.19 +$ +20.62 +7.6 +% +Average direct operating costs per operating day +$ +13.74 +$ +13.23 +3.9 +% +Average margin per operating day (1) +$ +8.45 +$ +7.40 +14.2 +% +Average rigs operating +$ +176.7 +$ +138.2 +27.9 +% +Capital expenditures +$ +394,595 +$ +354,425 +11.3 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +Generally, the revenues in our contract drilling segment are most impacted by two primary factors: our average number of rigs operating and our average revenue per operating day. During 2018, our average number of rigs operating was 175 in the United States and one in Canada, compared to 136 in the United States and two in Canada in 2017. Our average rig revenue per operating day was $22,190 in 2018, compared to $20,620 in 2017. Our average revenue per operating day is largely dependent on the pricing terms of our rig contracts. +Revenues and direct operating costs increased primarily due to an increase in operating days. Operating days and average rigs operating increased in 2018 primarily due to the recovery in the oil and natural gas industry, the contribution of rigs acquired in the SSE merger and the contribution from rigs that have been upgraded to super-spec capability. Capital expenditures increased in 2018 due to the upgrade of rigs to super-spec capability, higher maintenance capital expenditures and other equipment upgrades. Depreciation, amortization and impairment for 2018 included a charge of $48.4 million related to the retirement of 42 legacy non-APEX® rigs and related equipment. Based on the strong customer preference across the industry for super-spec drilling rigs, we believe the 42 rigs that were retired had limited commercial opportunity. Depreciation, amortization and impairment for 2017 included a charge of $29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. +36 +Year Ended December 31, +Pressure Pumping +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +1,573,396 +$ +1,200,311 +31.1 +% +Direct operating costs +1,263,850 +966,835 +30.7 +% +Margin (1) +309,546 +233,476 +32.6 +% +Selling, general and administrative +15,420 +14,442 +6.8 +% +Depreciation, amortization and impairment +250,010 +198,006 +26.3 +% +Impairment of goodwill +121,444 +— +NA +Operating income (loss) +$ +(77,328 +) +$ +21,028 +NA +Fracturing jobs +812 +622 +30.5 +% +Other jobs +1,081 +1,262 +(14.3 +)% +Total jobs +1,893 +1,884 +0.5 +% +Average revenue per fracturing job +$ +1,909.42 +$ +1,894.40 +0.8 +% +Average revenue per other job +$ +21.23 +$ +17.43 +21.8 +% +Average revenue per total job +$ +831.17 +$ +637.11 +30.5 +% +Average direct operating costs per total job +$ +667.64 +$ +513.18 +30.1 +% +Average margin per total job (1) +$ +163.52 +$ +123.93 +31.9 +% +Margin as a percentage of revenues (1) +19.7 +% +19.5 +% +1.0 +% +Capital expenditures +$ +173,848 +$ +171,436 +1.4 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Generally, the revenues in our pressure pumping segment are most impacted by our number of fracturing jobs and the size (including whether or not we provide proppant and other materials) of those jobs, which is reflected in our average revenue per fracturing job. We completed 812 fracturing jobs during 2018 compared to 622 fracturing jobs in 2017. Our average revenue per fracturing job was $1.909 million in 2018 compared to $1.894 million in 2017. +Revenues and direct operating costs in 2018 increased primarily due to an increase in the number of fracturing jobs. Depreciation, amortization and impairment expense increased due to the assets acquired in the SSE merger. Also included in depreciation, amortization and impairment expense for 2018 is a charge of $17.4 million related to the write-down of obsolete sand-handling equipment. There was no similar charge in the comparable period of 2017. All of the goodwill associated with our pressure pumping business was impaired during 2018. See Note 6 of Notes to Consolidated Financial Statements for additional information. +Year Ended December 31, +Directional Drilling +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +209,275 +$ +45,580 +359.1 +% +Direct operating costs +175,829 +32,172 +446.5 +% +Margin (1) +33,446 +13,408 +149.4 +% +Selling, general and administrative +15,941 +4,082 +290.5 +% +Depreciation and amortization +45,317 +9,347 +384.8 +% +Impairment of goodwill +89,685 +— +NA +Operating loss +$ +(117,497 +) +$ +(21 +) +NA +Capital expenditures +$ +35,929 +$ +7,795 +360.9 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization, impairment, and selling, general and administrative expenses. +Our directional drilling segment originated with the October 11, 2017 acquisition of MS Directional, and consequently the results for 2017 include less than three months of operations. Margins in 2018 were negatively impacted by higher third-party rental expenses due to delays in the delivery of equipment and by higher repairs and maintenance costs. All of the goodwill associated with our directional drilling business was impaired during 2018. See Note 6 of Notes to Consolidated Financial Statements for additional information. +37 +Year Ended December 31, +Other Operations +2018 +2017 +% Change +(Dollars in thousands) +Revenues +$ +113,834 +$ +70,760 +60.9 +% +Direct operating costs +77,104 +51,428 +49.9 +% +Margin (1) +36,730 +19,332 +90.0 +% +Selling, general and administrative +13,439 +10,743 +25.1 +% +Depreciation, depletion, amortization and impairment +41,512 +29,402 +41.2 +% +Operating loss +$ +(18,221 +) +$ +(20,813 +) +(12.5 +)% +Capital expenditures +$ +34,660 +$ +31,547 +9.9 +% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion, amortization and impairment and selling, general and administrative expenses. +Revenues, direct operating costs, and depreciation, depletion, amortization and impairment expense from other operations increased primarily as a result of the inclusion of our oilfield rentals business acquired in the SSE merger on April 20, 2017. The increase in capital expenditures was due to investments in the oilfield rentals business. +Year Ended December 31, +Corporate +2018 +2017 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +82,975 +$ +70,646 +17.5 +% +Merger and integration expenses +$ +2,738 +$ +74,451 +(96.3 +)% +Depreciation +$ +7,872 +$ +7,695 +2.3 +% +Other operating (income) expense, net +Net gain on asset disposals +$ +(28,958 +) +$ +(33,510 +) +(13.6 +)% +Legal-related expenses and settlements, net of insurance reimbursements +12,684 +561 +NA +Research and development +3,444 +1,002 +243.7 +% +Other +(4,739 +) +(10 +) +NA +Other operating income, net +$ +(17,569 +) +$ +(31,957 +) +(45.0 +)% +Interest income +$ +5,597 +$ +1,866 +199.9 +% +Interest expense +$ +51,578 +$ +37,472 +37.6 +% +Other income +$ +750 +$ +343 +118.7 +% +Capital expenditures +$ +2,426 +$ +1,884 +28.8 +% +Selling, general and administrative expense increased in 2018, but as a percentage of consolidated revenues decreased to 2.5%, compared to 3.0% in 2017. Selling, general and administrative expense increased in 2018 primarily due to the personnel added as a result of the SSE merger. Merger and integration expenses incurred in 2018 are related to the SSE merger, the MS Directional acquisition and the Superior QC acquisition. Merger and integration expenses incurred in 2017 are related to the SSE merger and the MS Directional acquisition. Other operating income includes net gains associated with the disposal of assets. Accordingly, the related gains or losses have been excluded from the results of specific segments. The majority of the net gain on asset disposals during the 2018 period reflects gains on disposal of drilling equipment. The 2017 period included a gain of $11.2 million related to the sale of real estate. Legal-related expenses and settlements in 2018 includes insurance deductibles and investigation costs related to an accident at a drilling site in January 2018. Research and development expense during 2018 and 2017 relate primarily to the funding of research into pressure pumping technology. Other operating income during 2018 also includes the gain on the collection of a note receivable that had previously been discounted. Interest income increased in 2018 due to interest earned on the portion of the proceeds of the January 2018 debt offering that were held as cash during 2018. The debt offering also resulted in an increase in interest expense for 2018. +Income Taxes +Year Ended December 31, +2019 +2018 +2017 +(Dollars in thousands) +Loss before income taxes +$ +(530,378 +) +$ +(367,408 +) +$ +(327,801 +) +Income tax benefit +$ +(104,675 +) +$ +(45,987 +) +$ +(333,711 +) +Effective tax rate +19.7 +% +12.5 +% +101.8 +% +38 +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 201 9 , 201 8 and 201 7 is summarized as follows: +2019 +2018 +2017 +Statutory tax rate +21.0 +% +21.0 +% +35.0 +% +State income taxes - net of the federal income tax benefit +1.7 +1.2 +1.9 +Goodwill impairment +(0.7 +) +(6.9 +) +— +Permanent differences +(0.5 +) +(0.6 +) +(1.3 +) +Tax effects of tax reform +— +(1.3 +) +66.7 +Share-based payments +(0.7 +) +(0.1 +) +3.6 +Acquisition related differences +— +— +(3.3 +) +Valuation allowance +(0.8 +) +(3.7 +) +— +State deferred tax remeasurement +(1.1 +) +2.3 +— +Other differences, net +0.8 +0.6 +(0.8 +) +Effective tax rate +19.7 +% +12.5 +% +101.8 +% +The effective tax rate increased by approximately 7.2% to 19.7% for 2019 compared to 12.5% for 2018. This difference was primarily due to higher goodwill impairment charges in 2018 relative to 2019, which are not deductible for tax purposes. These charges resulted in a 6.9% decrease to the effective tax rate in 2018, as compared to a 0.7% decrease to the effective tax rate in 2019. Another factor was valuation allowances being established against deferred tax assets in certain state and non-U.S. jurisdictions, which were higher in 2018 as compared to 2019. These resulted in a 3.7% decrease to the effective tax rate in 2018, as compared to a 0.8% decrease to the rate in 2019. +We continue to monitor income tax developments in the United States and other countries affecting the Company. In December 2017, the United States enacted U.S. Tax Reform, which materially impacted the consolidated financial statements by decreasing the U.S. corporate statutory tax rate and significantly affecting future periods. We expect several proposed U.S. Treasury regulations under U.S. Tax Reform that were issued during 2018 and 2019 to be finalized during 2020. We will incorporate into our future financial statements the impacts, if any, of these regulations and additional authoritative guidance when finalized. +We continue to elect permanent reinvestment of unremitted earnings in Canada effective January 1, 2010, and we intend to do so for the foreseeable future. If we were to repatriate earnings, in the form of dividends or otherwise, it might be subject to certain income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable. +Liquidity and Capital Resources +Our liquidity as of December 31, 2019 included approximately $231 million in working capital, including $174 million of cash and cash equivalents, and approximately $600 million available under our revolving credit facility. +On January 19, 2018, we completed an offering of $525 million in aggregate principal amount of our 2028 Notes. We used $239 million of the net proceeds from the offering to repay amounts outstanding under our revolving credit facility. As described below, on March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. +On August 22, 2019, we entered into the Term Loan Agreement, which permits a single borrowing of up to $150 million, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $75 million, not to exceed total commitments of $225 million. On September 25, 2019, we used $150 million of borrowings from the Term Loan Agreement and approximately $158 million of cash on hand to prepay the Series A Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $308 million, plus accrued interest to the prepayment date. We repaid $50 million of the borrowings under the Term Loan Agreement on December 16, 2019, and we had $100 million in outstanding borrowings under the Term Loan Agreement as of December 31, 2019. +39 +On November 15, 2019, we completed an offering of $350 million in aggregate principal amount of the 2029 Notes. The net proceeds before offering expenses were approximately $347 million . On December 16, 2019, we used a portion of the net proceeds from the offering to prepay the Series B Notes . The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $315 million , plus accrued interest to the prepayment date . The remaining net proceeds and available cash on hand was used to repay $ 50 million of the borrowings under the Term Loan Agreement. +We believe our current liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt and pay cash dividends for at least the next 12 months. +If we pursue opportunities for growth that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +As of December 31, 2019, we had working capital of $231 million, including cash and cash equivalents of $174 million, compared to working capital of $424 million, including cash and cash equivalents of $245 million, at December 31, 2018. +During 2019, our sources of cash flow included: +• +$696 million from operating activities, +• +$45.8 million in proceeds from the disposal of property and equipment and insurance proceeds, and +• +$497 million in proceeds from the issuance of long-term debt. +During 2019, we used $32.4 million to pay dividends on our common stock, $255 million for repurchases of our common stock, $308 million for the prepayment of the Series A Notes, $315 million for the prepayment of the Series B Notes, $50 million for the repayment of borrowings under the Term Loan Agreement and $348 million: +• +to make capital expenditures for the acquisition, betterment and refurbishment of drilling rigs and pressure pumping equipment and, to a much lesser extent, equipment for our other businesses, +• +to acquire and procure equipment and facilities to support our drilling, pressure pumping, directional drilling, oilfield rentals and manufacturing operations, and +• +to fund investments in oil and natural gas properties on a non-operating working interest basis. +We paid cash dividends during the year ended December 31, 2019 as follows: +Per Share +Total +(in thousands) +Paid on March 21, 2019 +$ +0.04 +$ +8,499 +Paid on June 20, 2019 +0.04 +8,344 +Paid on September 19, 2019 +0.04 +7,847 +Paid on December 19, 2019 +0.04 +7,738 +Total cash dividends +$ +0.16 +$ +32,428 +On February 5, 2020, our Board of Directors approved a cash dividend on our common stock in the amount of $0.04 per share to be paid on March 19, 2020 to holders of record as of March 5, 2020. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +40 +On September 6, 2013, our Board of Directors approved a stock buyback program that authorized purchases of up to $200 million of our common stock in open market or privately negotiated transactions. On July 25, 2018, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On February 6, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On July 24, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the buyback program are held as treasury shares. There is no expiration date associated with the buyback program. As of December 31, 2019, we had remaining authorization to purchase approximately $1 50 million of our outstanding common stock under the stock buyback program. +We acquired shares of stock from directors in 2017 and employees during 2019, 2018, and 2017 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares was acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock and restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2019, 2018 and 2017 were as follows (dollars in thousands): +2019 +2018 +2017 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +Purchases pursuant to stock buyback program +22,566,331 +250,109 +9,331,131 +150,497 +5,503 +109 +Acquisitions pursuant to long-term incentive plan +1,037,947 +14,205 +567,354 +11,240 +404,491 +7,508 +Other +31,013 +372 +— +— +— +— +Treasury shares at end of period +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +2019 Term Loan Agreement — On August 22, 2019, we entered into the Term Loan Agreement among us, as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lender party thereto. +The Term Loan Agreement is a committed senior unsecured term loan facility that permits a single borrowing of up to $150 million, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $75 million, not to exceed total commitments of $225 million. The maturity date under the Term Loan Agreement is June 10, 2022. We repaid $50 million of the borrowings under the Term Loan Agreement on December 16, 2019. +Loans under the Term Loan Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 1.375%, and the applicable margin on base rate loans varies from 0.00% to 0.375%, in each case determined based upon our credit rating. As of December 31, 2019, the applicable margin on LIBOR rate loans and base rate loans was 1.125% and 0.125%, respectively. +The Term Loan Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Term Loan Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. +The Term Loan Agreement requires mandatory prepayment in an amount equal to 100% of the net cash proceeds from the issuance of new senior indebtedness (other than certain permitted indebtedness) if our credit rating is below investment grade. The Term Loan Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50%. The Term Loan Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. +As of December 31, 2019, we had $100 million in borrowings outstanding under the Term Loan Agreement at a LIBOR interest rate of 2.917%. +Credit Agreement — On March 27, 2018, we entered into an amended and restated credit agreement (the “Credit Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National +41 +Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association , as Co-Lead Arrangers and Joint Book Runners. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $300 million, not to exceed total commitments of $900 million. The original maturity date under the Credit Agreement was March 27, 2023. On March 26, 2019, we entered into Amendment No. 1 to Amended and Restated Credit Agreement, which amended the Credit Agreement to, among other things, extend the maturity date under the Credit Agreement from March 27, 2023 to March 27, 2024. We have the option, subject to certain conditions, to exercise two one-year extensions of the maturity date. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10% to 0.30% based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50%. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. +As of December 31, 2019, we had no borrowings outstanding under our revolving credit facility. We had $81,000 in letters of credit outstanding under our revolving credit facility at December 31, 2019 and, as a result, had available borrowing capacity of approximately $600 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2019, we had $63.3 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +42 +Series A Senior Notes and Series B Senior Notes — On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our Series A Notes in a private placement. The Series A Notes bore interest at a rate of 4.97% per annum. On September 25, 2019, we fully prepaid the Series A Notes. The total amount of the prepayment, including the applicable “make-whole” premium , was approximately $308 million, which represents 100% of the principal and the “make-whole” premium to the prepayment date. +On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amount of our Series B Notes in a private placement. The Series B Notes bore interest at a rate of 4.27% per annum. On December 16, 2019, we fully prepaid the Series B Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $315 million, which represents 100% of the principal and the “make-whole” premium to the prepayment date. +As a result of the prepayments, we also recorded a $24.0 million loss on early debt extinguishment in 2019, which was included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +2028 Senior Notes and 2029 Senior Notes — On January 19, 2018, we completed an offering of $525 million in aggregate principal amount of our 2028 Notes. The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. On November 15, 2019, we completed an offering of $350 million in aggregate principal amount of our 2029 Notes. The net proceeds before offering expenses were approximately $347 million, of which we used $315 million to repay in full our Series B Notes, and the remainder to repay a portion of the borrowings under the Term Loan Agreement. +We pay interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028. The 2028 Notes bear interest at a rate of 3.95% per annum. +We pay interest on the 2029 Notes on May 15 and November 15 of each year. The 2029 Notes will mature on November 15, 2029. The 2029 Notes bear interest at a rate of 5.15% per annum. +The 2028 Notes and 2029 Notes (together, the “Senior Notes”) are senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The Senior Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the Senior Notes. None of our subsidiaries are currently required to be a guarantor under the Senior Notes. If our subsidiaries guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +We, at our option, may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, and on August 15, 2029, in the case of the 2029 Notes, we, at our option, may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100% of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date. +The indentures pursuant to which the Senior Notes were issued include covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indentures. +Upon the occurrence of a change of control, as defined in the indentures, each holder of the Senior Notes may require us to purchase all or a portion of such holder’s Senior Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +43 +Commitments — As of December 31, 2019 , we maintained letters of credit in the aggregate amount of $63.4 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2019 , no amounts had been drawn under the letters of credit. +As of December 31, 2019, we had commitments to purchase major equipment and make investments totaling approximately $51 million for our drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The agreements expire in years 2020 through 2023. As of December 31, 2019, the remaining obligation under these agreements was approximately $37.8 million, of which approximately $15.8 million relates to purchases required during 2020. In the event the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Contractual Obligations +The following table presents information with respect to our contractual obligations as of December 31, 2019 (in thousands): +Payments due by period +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +2029 Notes (1) +$ +350,000 +$ +— +$ +— +$ +— +$ +350,000 +Interest on 2029 Notes (2) +180,250 +18,025 +36,050 +36,050 +90,125 +2019 Term Loan (3) +100,000 +— +100,000 +— +— +Interest on 2019 Term Loan (4) +7,193 +2,917 +4,276 +— +— +2028 Notes (5) +525,000 +— +— +— +525,000 +Interest on 2028 Notes (6) +176,269 +20,738 +41,475 +41,475 +72,581 +Leases (7) +40,809 +11,212 +14,704 +7,010 +7,883 +Equipment purchases (8) +50,768 +50,768 +— +— +— +Inventory purchases (9) +37,773 +15,805 +19,693 +2,275 +— +Total +$ +1,468,062 +$ +119,465 +$ +216,198 +$ +86,810 +$ +1,045,589 +(1) +Principal repayment of the 2029 Notes is required at maturity on November 15, 2029. +(2) +Interest to be paid on the 2029 Notes using 5.15% coupon rate. +(3) +Principal repayment of the 2019 Term Loan is required at maturity on June 10, 2022. +(4) +Interest to be paid on 2019 Term Loan using 2.917% rate in effect as of December 31, 2019. +(5) +Principal repayment of the 2028 Notes is required at maturity on February 1, 2028. +(6) +Interest to be paid on the 2028 Notes using 3.95% coupon rate. +(7) +See Note 12 of Notes to Consolidated Financial Statements. +(8) +Represents commitments to purchase major equipment to be delivered in 2020 based on expected delivery dates. +(9) +Represents commitments to purchase proppants and chemicals for our pressure pumping business. +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements at December 31, 2019. +44 +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by accounting principles generally accepted in the United States of America (“U.S. GAAP”). We define Adjusted EBITDA as net income (loss) plus net interest expense, income tax expense (benefit) and depreciation, depletion, amortization and impairment expense (including impairment of goodwill). We present Adjusted EBITDA because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measure of net income (loss). Our computations of Adjusted EBITDA may not be the same as other similarly titled measures of other companies. Set forth below is a reconciliation of the non-U.S. GAAP financial measure of Adjusted EBITDA to the U.S. GAAP financial measure of net income (loss). +Year Ended December 31, +2019 +2018 +2017 +(Dollars in thousands) +Net income (loss) +$ +(425,703 +) +$ +(321,421 +) +$ +5,910 +Income tax benefit +(104,675 +) +(45,987 +) +(333,711 +) +Net interest expense +69,191 +45,981 +35,606 +Depreciation, depletion, amortization and impairment +1,003,873 +916,318 +783,341 +Impairment of goodwill +17,800 +211,129 +— +Adjusted EBITDA +$ +560,486 +$ +806,020 +$ +491,146 +Critical Accounting Policies +In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition and the use of estimates. +Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. In 2019, we identified 36 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, we believe the 36 rigs that were retired have limited commercial opportunity. We recorded a $173 million charge related to this retirement. In 2018, we identified 42 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, we believe the 42 rigs that were retired had limited commercial opportunity. We recorded a $48.4 million charge related to this retirement. In 2017, we recorded a charge of $29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. +We also periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. In 2019, we recorded a charge of $20.5 million for the write-down of pressure pumping equipment compared to a $17.4 million write-down of pressure pumping equipment in 2018. There was no similar charge in 2017. +We also periodically evaluate our directional drilling assets. During 2019, we recorded a charge of $8.4 million for the write-down of directional drilling equipment. There were no similar charges in 2018 or 2017. +We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering +45 +events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and recent commodity prices, our results of operations for the quarter ended September 30, 2019 and our expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of September 30, 2019. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 35%, 54%, 23% and 7%, respectively. +For the assessment performed in 2019, the expected cash flows for our asset groups included revenue growth rates, operating expense growth rates, and terminal growth rates . Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in 2019 and would begin to recover in late 2020 or 2021 in response to improved oil prices. While we believe these assumptions with respect to future oil pricing are reasonable, actual future prices and activity levels may vary significantly from the ones that were assumed. The timeframe over which oil prices and activity levels may recover is highly uncertain. Potential events that could affect our assumptions regarding future prices and the timeframe for a recovery are affected by factors such as those described in “Risk Factors–We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results.” +All of these factors are beyond our control. If the lower oil price environment experienced in 2019 were to last into late 2021 and beyond, our actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future, and such impairment could be material. +We concluded that no triggering events occurred during the quarter ended December 31, 2019 with respect to our asset groups based on our recent results of operations, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +Prior Year Triggering Event Assessment +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of December 31, 2018. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 38%, 58%, 9% and 23%, respectively. +For the assessment performed in 2018, the expected cash flows for our asset groups included revenue growth rates, operating expense growth rates, and terminal growth rates . Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the fourth quarter of 2018, and would begin to recover in late 2019 and continue into 2020 in response to improved oil prices and activity levels. +We concluded that no triggering events occurred during the year ended December 31, 2017 with respect to our asset groups based on our results of operations for the year ended December 31, 2017, our expectations of operating results in future periods and the prevailing commodity prices at the time. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below +46 +its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing are our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, we may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +Due to the decline in the market price of our common stock and recent commodity prices, our results of operations for the quarter ended September 30, 2019 and our expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of September 30, 2019. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of September 30, 2019, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 13% and we concluded that no impairment was indicated in our contract drilling reporting unit; however, impairment was indicated in our oilfield rentals and electrical controls and automation reporting units included in the other operations segment. We recognized an impairment charge of $17.8 million in 2019 associated with the impairment of all of the goodwill in our oilfield rentals and electrical controls and automation reporting units. +The timeframe over which oil prices and activity levels may recover is highly uncertain. If the lower oil price environment experienced in 2019 were to last into late 2021 and beyond, our actual cash flows would likely be less than the expected cash flows used in these assessments and could result in additional goodwill impairment charges in the future and such impairment could be material. +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of December 31, 2018. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment assessment as of December 31, 2018, the fair value of the contract drilling and oilfield rentals reporting units exceeded their carrying values by approximately 16% and 14%, respectively, and we concluded that no impairment was indicated in our contract drilling and oilfield rentals reporting units; however, impairment was indicated in our pressure pumping and directional drilling reporting units. We recognized an impairment charge of $211 million associated with the impairment of all of the goodwill in our pressure pumping and directional drilling reporting units. +In connection with our annual goodwill impairment assessment as of December 31, 2019 and 2017, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than the respective carrying amount. In making this determination, we considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in our reporting units, as well as our 2019 and 2017 operating results and forecasted operating results for the respective succeeding year. We also considered our overall market capitalization at December 31, 2019 and 2017. +Revenue recognition — On January 1, 2018, we adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on our consolidated financial statements, and a cumulative adjustment was not recognized. Revenues for reporting periods beginning after January 1, 2018 are presented under Topic 606, while revenues prior to January 1, 2018 continue to be reported under previous revenue recognition requirements of Topic 605. +Leases — On January 1, 2019, we adopted the new lease guidance under Topic 842, Leases , using the modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. We have elected to report all leases at the beginning of the period of adoption and not restate our comparative periods. This standard does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. See Note 12 for Notes to consolidated financial statements for additional information. +Use of estimates — The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities +47 +at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Key estimates used by management include: +• +allowance for doubtful accounts, +• +depreciation, depletion and amortization, +• +fair values of assets acquired and liabilities assumed in acquisitions, +• +goodwill and long-lived asset impairments, and +• +reserves for self-insured levels of insurance coverage. +For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. Oil prices reached a twelve-year low of $26.19 per barrel in February 2016. Oil prices have recovered from the lows experienced in the first quarter of 2016, and reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil began the year at a low of $46.31 per barrel on January 2, 2019, before increasing by 43% over the course of four months to reach a high of $66.24 per barrel in late April 2019. Since May 2019, oil prices have generally ranged between $50 and $60 per barrel. Oil prices averaged $56.94 per barrel in the fourth quarter of 2019 and closed at $50.06 per barrel on February 3, 2020. U.S. rig counts increased in response to improved oil prices in early 2018. Despite oil prices in the $50s, drilling and pressure pumping activity declined in 2019, particularly toward the end of the year, largely as a result of reduced customer spending. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital, would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +Inflation has not had a significant impact on our operations during the three years ended December 31, 2019. We believe that inflation will not have a significant near-term impact on our financial position. +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As of December 31, 2019, we had exposure to interest rate market risk associated with our borrowings under the Term Loan Agreement, and we would have had exposure to interest rate market risk associated with any borrowings that we had under the Credit Agreement and amounts owed under the Reimbursement Agreement. +Loans under the Term Loan Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 1.375%, and the applicable margin on base rate loans varies from 0.00% to 0.375%, in each case determined based upon our credit rating. As of December 31, 2019, the applicable margin on LIBOR rate loans and base rate loans was 1.125% and 0.125%, respectively. As of December 31, 2019, we had $100 million in borrowings outstanding under the +48 +Term Loan Agreement at a weighted average interest rate of 2.917 % . A one percent increase in the interest rate on the borrowings outstanding under the Term Loan Agreement as of December 3 1 , 2019 would increase our annual cash interest expense by $1. 0 million . +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based on our credit rating. As of December 31, 2019, the applicable margin on LIBOR rate loans was 1.50% and the applicable margin on base rate loans was 0.50%. As of December 31, 2019, we had no borrowings outstanding under our revolving credit facility. The interest rate on borrowings outstanding under our revolving credit facility is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate. +Under the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. We are obligated to pay Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2019, no amounts had been disbursed under any letters of credit. +We conduct a portion of our business in Canadian dollars. The exchange rate between Canadian dollars and U.S. dollars has fluctuated during the last several years. If the value of the Canadian dollar against the U.S. dollar weakens, revenues and earnings of our Canadian operations will be reduced and the value of our Canadian net assets will decline when they are translated to U.S. dollars. This currency risk is not material to our financial condition or results of operations. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2019, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2019. +The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +49 +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None . +50 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +51 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger by and among Patterson-UTI Energy, Inc., Pyramid Merger Sub, Inc. and Seventy Seven Energy Inc., dated as of December 12, 2016 (filed December 13, 2016 as Exhibit 2.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) . +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) . +3.4 +Certificate of Amendment to Restated Certificate of Incorporation, as amended (filed July 30, 2018 as Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018 and incorporated herein by reference). +3.5 +Fourth Amended and Restated Bylaws (filed February 12, 2019 as Exhibit 3.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.1 +Description of Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934. + +4.2 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +4.3 +Registration Rights Agreement, dated as of October 11, 2017, between Patterson-UTI Energy, Inc. and the sellers party thereto. (filed February 20, 2018 as Exhibit 4.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 and incorporated herein by reference). +4.4 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.5 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.6 +Form of 3.95% Senior Note due 2028 (included in Exhibit 4.5 above). +52 +4.7 +Base Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as +trustee (filed November 15, 2019 as Exhibit 4.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.8 +First Supplemental Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +4.9 +Form of 5.15% Senior Note due 2029 (included in Exhibit 4.8 above). +10.1 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.2 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.3 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.4 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.5 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.6 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.7 +Patterson-UTI Energy, Inc. Omnibus Incentive Plan (filed April 21, 2017 as Exhibit 4.4 to the Company’s Registration Statement on Form S-8 and incorporated herein by reference).* +10.8 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (as amended and restated effective June 29, 2017) (filed June 30, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference).* +10.10 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan, as amended and restated and further amended effective June 6, 2019 (filed June 6, 2019 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.11 +Form of Executive Officer Restricted Stock Award Agreement (filed May 2, 2016 as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.12 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 4, 2017 as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.13 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.14 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to the Company’s Current Report on Form 8-K and incorporated herein by reference) .* +10.15 +Form of Non-Employee Director Restricted Stock Unit Award Agreement (filed February 20, 2018 as Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 and incorporated herein by reference).* +53 +10.16 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed February 13, 2019 as Exhibit 10.15 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018 and incorporated herein by +reference).* +10.17 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel and Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference) .* +10.18 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed January 17, 2017 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.19 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference). * +10.20 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference) .* +10.21 +Employment Agreement, dated as of September 3, 2017, between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference). * +10.22 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon, Tiffany J. Thom, C. Andrew Smith and Janeen S. Judah (filed April 28, 2004 as Exhibit 10.11 to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference) .* +10.23 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Mark S. Siegel (filed on February 4, 2004 as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference) .* +10.24 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference) .* +10.25 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Mark S. Siegel, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.26 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q and incorporated herein by reference) .* +10.27 +Amended and Restated Credit Agreement dated March 27, 2018 among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2018 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.28 +Amendment No. 1 to Amended and Restated Credit Agreement, dated March 26, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 26, 2019 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +10.29 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference) . +10.30 +Term Loan Agreement, dated August 22, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lender party thereto (filed August 23, 2019 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +54 +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+ +101.INS +Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document .+ +101.SCH +Inline XBRL Taxonomy Extension Schema Document + +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document + +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document + +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document + +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document + +104 +Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101) . +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. +Item 16. Form 10-K Summary +None. +55 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2019 and 2018 +F-5 +Consolidated Statements of Operations for the years ended December 31, 2019, 2018 and 2017 +F-6 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2019, 2018 and 2017 +F-7 +Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2019, 2018 and 2017 +F-8 +Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018 and 2017 +F-9 +Notes to Consolidated Financial Statements +F-10 +F-1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations, of comprehensive income (loss), of changes in stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2019, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2019 listed in the index appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Change in Accounting Principle +As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2019. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +F-2 +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +Goodwill Impairment Test – Contract Drilling Reporting Unit as of September 30, 2019 +As described in Note 6 to the consolidated financial statements, the Company’s consolidated goodwill balance was $395 million, all of which relates to the contract drilling reporting unit as of December 31, 2019. Management evaluates goodwill at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. The Company’s reporting units for impairment testing are its operating segments. Management determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. As a result of triggering events for the quarter ended September 30, 2019, management performed a quantitative impairment assessment of its goodwill as of September 30, 2019. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The assumptions used in the income approach included discount rate, revenue growth rates, operating expense growth rates, and terminal growth rate. +The principal considerations for our determination that performing procedures relating to the Goodwill Impairment Test – Contract Drilling Reporting Unit as of September 30, 2019 is a critical audit matter are there was significant judgment by management when estimating the fair value of the reporting unit. This in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence obtained related to the significant assumptions in management’s cash flow projections, including discount rate, revenue growth rates, operating expense growth rates, and terminal growth rate. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment test, including controls over the estimation of the fair value of the Company’s reporting unit. These procedures also included, among others, evaluating the appropriateness of the method; testing the completeness, accuracy, and relevance of the underlying data used in the estimate; and evaluating the reasonableness of significant assumptions used by management in developing the fair value estimates including discount rate, revenue growth rates, operating expense growth rates, and terminal growth rate. Evaluating management’s significant assumptions related to the revenue growth rates and operating expense growth rates, involved evaluating whether the significant assumptions used by management were reasonable considering the current and past performance of the reporting unit and considered whether they were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company’s method and certain assumptions, including the discount rate and terminal growth rate. +Long-lived Assets and Intangible Assets Recoverability Test—Asset Groupings in the Contract Drilling and Pressure Pumping Operating Segments as of September 30, 2019 +As described in Notes 5 and 6 to the consolidated financial statements, the Company’s consolidated net property and equipment and consolidated intangible assets balance were $3,307 million and $49 million, respectively, most of which relates to the Contract Drilling and Pressure Pumping asset groupings as of December 31, 2019. Management reviews its long-lived assets, including property and equipment and intangibles, for impairment whenever events or changes in circumstances indicate that their carrying amounts of certain asset groupings may not be recovered over their estimated remaining useful lives . As a result of triggering events for the quarter ended September 30, 2019, management deemed it necessary to assess the recoverability of its contract drilling and pressure pumping asset groups as of September 30, 2019. Management performed an analysis to assess the recoverability of the asset groups within its contract drilling and pressure pumping operating segments as of September 30, 2019. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and management determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. For the +F-3 +assessment performed in 2019, the expected cash flows for the Company’s asset groups included revenue growth rates, operating expenses growth rates, and terminal growth rate. +The principal considerations for our determination that performing procedures relating to the Long-lived Assets and Intangible Assets Recoverability Test – Asset Groupings in the Contract Drilling and Pressure Pumping Operating Segments as of September 30, 2019 is a critical audit matter are there was significant judgment by management when estimating the future undiscounted cash flows of the asset groupings. This in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence obtained related to the significant assumptions in management’s cash flow projections, including revenue growth rates, operating expense growth rates, and terminal growth rate. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s long-lived assets and intangible assets recoverability test, including controls over the estimation of the undiscounted future cash flows of the Company’s asset groupings. These procedures also included, among others, evaluating the appropriateness of the method; testing the completeness, accuracy, and relevance of the underlying data used in the cash flows; and evaluating the reasonableness of significant assumptions used by management in developing their estimate of undiscounted future cash flows including revenue growth rates, operating expense growth rates and terminal growth rate. Evaluating management’s significant assumptions related to the revenue growth rates, operating expense growth rates and terminal growth rate, involved evaluating whether the significant assumptions used by management were reasonable considering the current and past performance of the asset groupings and considered whether they were consistent with evidence obtained in other areas of the audit. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 13, 2020 +We have served as the Company’s auditor since 1993. +F-4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2019 +2018 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +174,185 +$ +245,029 +Accounts receivable, net of allowance for doubtful accounts of $ 6,516 and $ 2,312 at +December 31, 2019 and 2018, respectively +339,699 +558,817 +Federal and state income taxes receivable +6,397 +4,110 +Inventory +36,357 +65,579 +Other +75,177 +76,662 +Total current assets +631,815 +950,197 +Property and equipment, net +3,306,677 +4,002,549 +Right of use asset +31,275 +— +Goodwill and intangible assets +444,004 +477,640 +Deposits on equipment purchases +8,066 +12,040 +Other +17,778 +27,440 +Total assets +$ +4,439,615 +$ +5,469,866 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +170,475 +$ +288,962 +Federal and state income taxes payable +342 +1,408 +Accrued liabilities +219,850 +235,946 +Lease liability +9,935 +— +Total current liabilities +400,602 +526,316 +Long-term lease liability +26,644 +— +Long-term debt, net of debt discount and issuance costs of $ 8,460 and $ 5,795 at +December 31, 2019 and 2018, respectively +966,540 +1,119,205 +Deferred tax liabilities, net +202,959 +306,161 +Other +9,250 +12,761 +Total liabilities +1,605,995 +1,964,443 +Commitments and contingencies (see Note 9) +Stockholders’ equity: +Preferred stock, par value $ .01 ; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $ .01 ; authorized 400,000,000 shares with 269,372,257 and 267,315,526 issued and 192,035,870 and 213,614,430 outstanding at December 31, 2019 and 2018, respectively +2,694 +2,673 +Additional paid-in capital +2,875,680 +2,827,154 +Retained earnings +1,294,902 +1,753,557 +Accumulated other comprehensive income +5,478 +2,487 +Treasury stock, at cost, 77,336,387 shares and 53,701,096 shares at +December 31, 2019 and 2018, respectively +( 1,345,134 +) +( 1,080,448 +) +Total stockholders’ equity +2,833,620 +3,505,423 +Total liabilities and stockholders’ equity +$ +4,439,615 +$ +5,469,866 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2019 +2018 +2017 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +1,308,350 +$ +1,430,492 +$ +1,040,033 +Pressure pumping +868,694 +1,573,396 +1,200,311 +Directional drilling +188,786 +209,275 +45,580 +Other +104,855 +113,834 +70,760 +Total operating revenues +2,470,685 +3,326,997 +2,356,684 +Operating costs and expenses: +Contract drilling +785,355 +885,704 +667,105 +Pressure pumping +724,788 +1,263,850 +966,835 +Directional drilling +178,645 +175,829 +32,172 +Other +84,909 +77,104 +51,428 +Depreciation, depletion, amortization and impairment +1,003,873 +916,318 +783,341 +Impairment of goodwill +17,800 +211,129 +— +Selling, general and administrative +133,513 +134,071 +105,847 +Provision for bad debts +5,683 +— +— +Merger and integration expenses +— +2,738 +74,451 +Other operating income, net +( 2,305 +) +( 17,569 +) +( 31,957 +) +Total operating costs and expenses +2,932,261 +3,649,174 +2,649,222 +Operating loss +( 461,576 +) +( 322,177 +) +( 292,538 +) +Other income (expense): +Interest income +6,013 +5,597 +1,866 +Interest expense, net of amount capitalized +( 75,204 +) +( 51,578 +) +( 37,472 +) +Other +389 +750 +343 +Total other expense +( 68,802 +) +( 45,231 +) +( 35,263 +) +Loss before income taxes +( 530,378 +) +( 367,408 +) +( 327,801 +) +Income tax benefit +( 104,675 +) +( 45,987 +) +( 333,711 +) +Net income (loss) +$ +( 425,703 +) +$ +( 321,421 +) +$ +5,910 +Net income (loss) per common share: +Basic +$ +( 2.10 +) +$ +( 1.47 +) +$ +0.03 +Diluted +$ +( 2.10 +) +$ +( 1.47 +) +$ +0.03 +Weighted average number of common shares outstanding: +Basic +203,039 +218,643 +198,447 +Diluted +203,039 +218,643 +199,882 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2019 +2018 +2017 +(In thousands) +Net income (loss) +$ +( 425,703 +) +$ +( 321,421 +) +$ +5,910 +Other comprehensive income (loss), net of taxes of $ 0 for 2019, $ 0 +for 2018 and $ 0 for 2017: +Foreign currency translation adjustment +2,991 +( 4,335 +) +7,956 +Total comprehensive income (loss) +$ +( 422,712 +) +$ +( 325,756 +) +$ +13,866 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings +Income (Loss) +Stock +Total +(In thousands) +Balance, December 31, 2016 +191,526 +$ +1,915 +$ +1,042,696 +$ +2,116,341 +$ +( 1,134 +) +$ +( 911,094 +) +$ +2,248,724 +Net income +— +— +— +5,910 +— +— +5,910 +Foreign currency translation adjustment +— +— +— +— +7,956 +— +7,956 +Equity offering +18,170 +182 +471,388 +— +— +— +471,570 +Shares issued for acquisitions +55,097 +551 +1,226,339 +— +— +— +1,226,890 +Issuance of restricted stock +891 +9 +( 9 +) +— +— +— +— +Vesting of restricted stock units +549 +5 +( 5 +) +— +— +— +— +Forfeitures of restricted stock +( 24 +) +— +— +— +— +— +— +Exercise of stock options +50 +— +931 +— +— +— +931 +Stock-based compensation +— +— +44,483 +— +— +— +44,483 +Payment of cash dividends +— +— +— +( 16,315 +) +— +— +( 16,315 +) +Dividend equivalents +— +— +— +( 39 +) +— +— +( 39 +) +Purchase of treasury stock +— +— +— +— +— +( 7,617 +) +( 7,617 +) +Balance, December 31, 2017 +266,259 +$ +2,662 +$ +2,785,823 +$ +2,105,897 +$ +6,822 +$ +( 918,711 +) +$ +3,982,493 +Net loss +— +— +— +( 321,421 +) +— +— +( 321,421 +) +Foreign currency translation adjustment +— +— +— +— +( 4,335 +) +— +( 4,335 +) +Restricted stock issued for acquisition +192 +2 +2,930 +— +— +— +2,932 +Issuance of restricted stock +381 +4 +( 4 +) +— +— +— +— +Vesting of restricted stock units +452 +5 +( 5 +) +— +— +— +— +Forfeitures of restricted stock +( 8 +) +— +— +— +— +— +— +Exercise of stock options +40 +— +485 +— +— +— +485 +Stock-based compensation +— +— +37,925 +— +— +— +37,925 +Payment of cash dividends +— +— +— +( 30,589 +) +— +— +( 30,589 +) +Dividend equivalents +— +— +— +( 330 +) +— +— +( 330 +) +Purchase of treasury stock +— +— +— +— +— +( 161,737 +) +( 161,737 +) +Balance, December 31, 2018 +267,316 +$ +2,673 +$ +2,827,154 +$ +1,753,557 +$ +2,487 +$ +( 1,080,448 +) +$ +3,505,423 +Net loss +— +— +— +( 425,703 +) +— +— +( 425,703 +) +Foreign currency translation adjustment +— +— +— +— +2,991 +— +2,991 +Issuance of restricted stock +185 +2 +( 2 +) +— +— +— +— +Vesting of restricted stock units +1,173 +12 +( 12 +) +— +— +— +— +Forfeitures of restricted stock +( 2 +) +— +— +— +— +— +— +Exercise of stock options +700 +7 +9,212 +— +— +— +9,219 +Stock-based compensation +— +— +39,328 +— +— +— +39,328 +Payment of cash dividends +— +— +— +( 32,428 +) +— +— +( 32,428 +) +Dividend equivalents +— +— +— +( 524 +) +— +— +( 524 +) +Purchase of treasury stock +— +— +— +— +— +( 264,686 +) +( 264,686 +) +Balance, December 31, 2019 +269,372 +$ +2,694 +$ +2,875,680 +$ +1,294,902 +$ +5,478 +$ +( 1,345,134 +) +$ +2,833,620 +The accompanying notes are an integral part of these consolidated financial statements. +F-8 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2019 +2018 +2017 +(In thousands) +Cash flows from operating activities: +Net income (loss) +$ +( 425,703 +) +$ +( 321,421 +) +$ +5,910 +Adjustments to reconcile net income (loss) to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +1,003,873 +916,318 +783,341 +Impairment of goodwill +17,800 +211,129 +— +Dry holes and abandonments +109 +915 +1,929 +Deferred income tax benefit +( 103,202 +) +( 41,185 +) +( 330,346 +) +Stock-based compensation expense +39,328 +37,925 +44,483 +Net gain on asset disposals +( 13,904 +) +( 28,958 +) +( 33,510 +) +Write-down of capacity reservation contract +12,673 +— +— +Provision for bad debts +5,683 +— +— +Loss on early debt extinguishment +24,023 +— +— +Amortization of debt discount and issuance costs +937 +830 +346 +Changes in operating assets and liabilities: +Accounts receivable +213,588 +23,515 +( 239,482 +) +Income taxes receivable/payable +( 3,353 +) +( 1,555 +) +990 +Inventory and other assets +29,394 +( 1,470 +) +( 23,449 +) +Accounts payable +( 77,686 +) +( 69,453 +) +104,072 +Accrued expenses +( 18,218 +) +4,136 +( 14,190 +) +Other liabilities +( 9,139 +) +( 56 +) +617 +Net cash provided by operating activities +696,203 +730,670 +300,711 +Cash flows from investing activities: +Acquisitions, net of cash acquired +( 13 +) +( 14,211 +) +( 501,954 +) +Purchases of property and equipment +( 347,512 +) +( 641,458 +) +( 567,087 +) +Proceeds from disposal of assets and insurance claims +45,761 +47,357 +60,945 +Collection of note receivable +— +23,760 +— +Other investments +— +— +( 2,520 +) +Net cash used in investing activities +( 301,764 +) +( 584,552 +) +( 1,010,616 +) +Cash flows from financing activities: +Proceeds from equity offering +— +— +471,570 +Purchases of treasury stock +( 255,467 +) +( 161,737 +) +( 6,809 +) +Dividends paid +( 32,428 +) +( 30,589 +) +( 16,315 +) +Proceeds from long-term debt +496,969 +521,194 +— +Repayment of long-term debt +( 673,443 +) +— +— +Proceeds from borrowings under revolving credit facility +— +79,000 +599,000 +Repayment of borrowings under revolving credit facility +— +( 347,000 +) +( 331,000 +) +Debt issuance costs +( 852 +) +( 4,489 +) +— +Proceeds from exercise of stock options +— +485 +123 +Net cash provided by (used in) financing activities +( 465,221 +) +56,864 +716,569 +Effect of foreign exchange rate changes on cash +( 62 +) +( 781 +) +1,012 +Net increase (decrease) in cash and cash equivalents +( 70,844 +) +202,201 +7,676 +Cash and cash equivalents at beginning of year +245,029 +42,828 +35,152 +Cash and cash equivalents at end of year +$ +174,185 +$ +245,029 +$ +42,828 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $ 732 in 2019, $ 1,435 in 2018 +and $ 1,175 in 2017 +$ +( 76,870 +) +$ +( 41,184 +) +$ +( 34,953 +) +Income taxes +( 1,452 +) +3,172 +3,947 +Non-cash investing and financing activities: +Receivable from property and equipment insurance +$ +— +$ +15,000 +$ +— +Net increase (decrease) in payables for purchases of property and equipment +( 40,857 +) +36,241 +17,228 +Issuance of common stock for business acquisitions +— +2,932 +1,226,890 +Net decrease (increase) in deposits on equipment purchases +3,974 +4,311 +( 301 +) +Cashless exercise of stock options +9,219 +— +— +The accompanying notes are an integral part of these consolidated financial statements. +F-9 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “Patterson-UTI” or the “Company”), is a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. The Company’s contract drilling business operates in the continental United States and western Canada, and the Company is pursuing contract drilling opportunities outside of North America. The Company’s pressure pumping business operates primarily in Texas and the Mid-Continent and Appalachian regions. The Company also provides a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and the Company provides services that improve the statistical accuracy of horizontal wellbore placement. The Company has other operations through which the Company provides oilfield rental tools in select markets in the United States. The Company also services equipment for drilling contractors, and provides electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, the Company owns and invests, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, the Company has no controlling financial interests in any other entity which would require consolidation. As used in these notes, “the Company” refers collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its business operations through its wholly-owned subsidiaries and has no employees or independent operations. +The U.S. dollar is the functional currency for all of the Company’s operations except for its Canadian operations, which use the Canadian dollar as their functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Revenue recognition — Revenues from the Company’s contract drilling, pressure pumping, directional drilling, oilfield rentals, equipment servicing and electrical control and automation activities are recognized as services are performed. All of the wells the Company drilled in 2019, 2018 and 2017 were drilled under daywork contracts. Revenue from sales of products are recognized upon customer acceptance. Revenue is presented net of any sales tax charged to the customer that the Company is required to remit to local or state governmental taxing authorities. +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of the Company’s customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +On January 1, 2018, the Company adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on the Company’s consolidated financial statements, and a cumulative adjustment was not recognized. See Note 3 for additional information. +Leases — T he Company enters operating leases for operating locations, corporate offices and certain operating equipment. As of December 31, 2019, the Company does not have any finance leases. +On January 1, 2019, the Company adopted the new lease guidance under Topic 842, Leases , using the modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. The Company has elected to report all leases at the beginning of the period of adoption and not restate its comparative periods. This standard does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. See Note 12 for additional information. +F-10 +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts represents the Company’s estimate of the amount of probable credit losses existing in the Company’s accounts receivable. The Company reviews the adequacy of its allowance for doubtful accounts at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectible, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with the Company’s pressure pumping activities and materials used in its directional drilling and equipment servicing business. Such inventories are stated at the lower of cost or market, with cost determined using the average cost method. +Other current assets — Other current assets includes reimbursement from the Company’s workers compensation insurance carrier for claims in excess of the Company’s deductible in the amount of $ 39.0 million and $ 35.6 million at December 31, 2019 and 2018, respectively. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Equipment +1.25-15 +Buildings +15-20 +Other +3-12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. The Company reviews wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, the Company considers the well costs to be impaired and recognizes the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +The Company reviews its proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). The Company reviews unproved oil and natural gas properties quarterly to assess potential impairment. The Company’s impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to oil and natural gas properties of approximately $ 2.2 million, $ 1.0 million and $ 4.3 million was recorded for the years ended December 31, 2019, 2018 and 2017, respectively. +F-11 +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. The Company assesses impairment of its goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. The Company’s policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — The Company recognizes the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards (See Note 11). +As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, based on historical experience. Forfeitures are estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates. +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Adopted Accounting Standards — In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. The Company adopted this new revenue guidance effective January 1, 2018, utilizing the modified retrospective method, and expanded its consolidated financial statement disclosures in order to comply with the update (See Note 3). The adoption of this update did not have a material impact on the Company’s consolidated financial statements. +In February 2016, the FASB issued an accounting standards update to provide guidance for the accounting for leasing transactions. The standard requires the lessee to recognize a lease liability along with a right-of-use asset for all leases with a term longer than one year. A lessee is permitted to make an accounting policy election to not recognize the lease liability and related right-of-use asset for leases with a term of one year or less. The provisions of this standard also apply to situations where the Company is the lessor. The Company adopted this new leasing guidance effective January 1, 2019 and expanded its consolidated financial statement disclosures in order to comply with the update (See Note 12). The adoption of this standard resulted in the recording of operating lease right of use assets of approximately $ 31.0 million and operating lease liabilities of approximately $ 35.8 million as of January 1, 2019. +In March 2016, the FASB issued an accounting standards update to provide guidance for the accounting for share-based payment transactions, including the related income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The Company adopted this guidance effective January 1, 2017. The Company believes this guidance has caused and will continue to cause volatility in its effective tax rates and diluted earnings per share due to the tax effects related to share-based payments being recorded in the statement of operations. The volatility in future periods will depend on the Company’s stock price and the number of shares that vest in the case of restricted stock, restricted stock units and performance stock units, or the number of shares that are issued in the case of stock option exercises. +In August 2016, the FASB issued an accounting standards update to clarify the presentation of cash receipts and payments in specific situations on the statement of cash flows. The requirements in this update are effective during interim and annual periods in fiscal years beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on the Company’s consolidated financial statements. +In May 2017, the FASB issued an accounting standards update that provided clarity on which changes to the terms or conditions of share-based payment awards require an entity to apply modification accounting provisions. The requirements in this update are effective during interim and annual periods in fiscal years beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on the Company’s consolidated financial statements. +In March 2018, the FASB issued an accounting standards update to update the income tax accounting in U.S. GAAP to reflect the SEC interpretive guidance released on December 22, 2017, when significant U.S. tax law changes were enacted with the enactment +F-12 +of “H.R.1,” also known as the “Tax Cuts and Jobs Act” (“U.S. Tax Reform”). The adoption of this update in March 2018 did not have a material impact on the Company’s consolidated financial statements, as the Company was already following the SEC guidance (See Note 13). +Recently Issued Accounting Standards — In June 2016, the FASB issued an accounting standards update on measurement of credit losses on financial instruments. This update improves financial reporting by requiring earlier recognition of credit losses on financing receivables and other financial assets in scope by using the Current Expected Credit Losses model (CECL). The CECL model utilizes a lifetime expected credit loss measurement objective for the recognition of credit losses on financial instruments at the time the asset is originated or acquired. This update will apply to receivables arising from revenue transactions such as contract assets and accounts receivables. This update is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. The Company will adopt this new guidance on January 1, 2020 and does not expect this new guidance will have a material impact on its consolidated financial statements. +In August 2018, the FASB issued an accounting standards update to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The capitalized implementation costs of a hosting arrangement that is a service contract will be expensed over the term of the hosting arrangement. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2019, with early adoption permitted. The guidance allows adoption using a retrospective or prospective method. The Company will adopt this new guidance on January 1, 2020 prospectively with respect to all implementation costs incurred after the date of adoption. +In August 2018, the FASB issued an accounting standards update to eliminate certain disclosure requirements for fair value measurements for all entities, require public entities to disclose certain new information and modify certain disclosure requirements. The FASB developed the amendments to Topic 820 as part of its broader disclosure framework project, which aims to improve the effectiveness of disclosures in the notes to financial statements by focusing on requirements that clearly communicate the most important information to users of the financial statements. This update is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. The Company will adopt this new guidance on January 1, 2020 and does not expect this new guidance will have a material impact on its consolidated financial statements. +In December 2019, the FASB issued an accounting standards update to simplify the accounting for income taxes. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company plans to adopt this guidance on January 1, 2021 and is currently evaluating the impact of adoption on its consolidated financial statements. +During the third quarter of 2019, the Company identified and recorded out-of-period adjustments primarily related to the accounting for inventory in its directional drilling segment. The Company concluded that these adjustments were not material to the consolidated financial statements for any of the current or prior periods presented. The net adjustment is reflected as a $ 6.6 million increase to “Loss before income taxes” in the consolidated statements of operations for the year ended December 31, 2019. +2. Acquisitions +SSE +On April 20, 2017 , pursuant to a merger agreement, a subsidiary of the Company was merged with and into Seventy Seven Energy, Inc (“SSE"), with SSE continuing as the surviving entity and one of the Company’s wholly owned subsidiaries (the “SSE merger”). Pursuant to the terms of the merger agreement, the Company acquired all of the issued and outstanding shares of common stock of SSE, in exchange for approximately 46.3 million shares of common stock of the Company. Concurrent with the closing of the merger, the Company repaid all of the outstanding debt of SSE totaling $ 472 million. Based on the closing price of the Company’s common stock on April 20, 2017, the total fair value of the consideration transferred to effect the acquisition of SSE was approximately $ 1.5 billion. On April 20, 2017, following the SSE merger, SSE was merged with and into a newly-formed subsidiary of the Company named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of the Company’s wholly owned subsidiaries. +Through the SSE merger, the Company acquired a fleet of 91 drilling rigs, 36 of which the Company considers to be APEX® rigs. Additionally, through the SSE merger, the Company acquired approximately 500,000 horsepower of fracturing equipment. The oilfield rentals business acquired through the SSE merger has a fleet of premium rental tools, and it provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +The merger has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date, with the remaining unallocated amount recorded as goodwill. +F-13 +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of Company common stock issued to SSE shareholders +46,298 +Company common stock price on April 20, 2017 +$ +22.45 +Fair value of common stock issued +$ +1,039,396 +Plus SSE long-term debt repaid by Company +$ +472,000 +Total fair value of consideration transferred +$ +1,511,396 +The following table represents the final allocation of the total purchase price of SSE to the assets acquired and the liabilities assumed based on the fair value at the merger date, with the excess of the purchase price over the estimated fair value of the identifiable net assets acquired recorded as goodwill (in thousands): +Identifiable assets acquired +Cash and cash equivalents +$ +37,806 +Accounts receivable +149,659 +Inventory +8,518 +Other current assets +19,038 +Property and equipment +984,433 +Other long-term assets +20,918 +Intangible assets +22,500 +Total identifiable assets acquired +1,242,872 +Liabilities assumed +Accounts payable and accrued liabilities +133,415 +Deferred income taxes +32,881 +Other long-term liabilities +1,734 +Total liabilities assumed +168,030 +Net identifiable assets acquired +1,074,842 +Goodwill +436,554 +Total net assets acquired +$ +1,511,396 +The acquired goodwill is not deductible for tax purposes. Among the factors that contributed to a purchase price resulting in the recognition of goodwill was SSE’s reputation as an experienced provider of high-quality contract drilling and pressure pumping services in a safe and efficient manner, access to new geographies, access to new product lines, increased scale of operations, supply chain and corporate efficiencies as well as infrastructure optimization. The acquired goodwill was attributable to three operating segments, with $ 309 million to contract drilling, $ 121 million to pressure pumping and $ 6.3 million to oilfield rentals. See Note 6 for additional information regarding goodwill. +A portion of the fair value consideration transferred has been assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Assets +Favorable drilling contracts +$ +22,500 +0.83 +MS Directional +On October 11, 2017 , the Company acquired all of the issued and outstanding limited liability company interests of MS Directional, LLC (f/k/a Multi-Shot, LLC) (“MS Directional”). The aggregate consideration paid by the Company consisted of $ 69.8 million in cash and approximately 8.8 million shares of the Company’s common stock. The purchase price was subject to customary post-closing adjustments relating to cash, net working capital and indebtedness of MS Directional as of the closing. Based on the closing price of the Company’s common stock on the closing date of the transaction, the total fair value of the consideration transferred to effect the acquisition of MS Directional was approximately $ 257 million. +MS Directional is a leading directional drilling services company in the United States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, measurement-while-drilling, and wireline steering tools. +The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date, with the remaining unallocated amount recorded as goodwill. +F-14 +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of Company common stock issued to MS Directional shareholders +8,798 +Company common stock price on October 11, 2017 +$ +21.31 +Fair value of common stock issued +$ +187,494 +Plus MS Directional long-term debt repaid by Company +$ +63,000 +Plus cash to sellers +$ +6,781 +Total fair value of consideration transferred +$ +257,275 +The following table represents the final allocation of the total purchase price of MS Directional to the assets acquired and the liabilities assumed based on the fair value at the merger date, with the excess of the purchase price over the estimated fair value of the identifiable net assets acquired recorded as goodwill (in thousands): +Identifiable assets acquired +Cash and cash equivalents +$ +2,021 +Accounts receivable +42,782 +Inventory +28,060 +Other current assets +155 +Property and equipment +63,998 +Other long-term assets +318 +Intangible assets +74,682 +Total identifiable assets acquired +212,016 +Liabilities assumed +Accounts payable and accrued liabilities +44,099 +Other long-term liabilities +327 +Total liabilities assumed +44,426 +Net identifiable assets acquired +167,590 +Goodwill +89,685 +Total net assets acquired +$ +257,275 +The goodwill reflected above increased $ 1.0 million from the original preliminary purchase price allocation as a result of a measurement period adjustment that related to a valuation adjustment to accounts payable and accrued liabilities. +The acquired goodwill was deductible for tax purposes. Among the factors that contributed to a purchase price resulting in the recognition of goodwill was MS Directional’s reputation as an experienced provider of high-quality directional drilling services in a safe and efficient manner, access to new product lines, favorable market trends underlying these new business lines, earnings and growth opportunities and future technology development possibilities. All of the goodwill acquired was attributable to the directional drilling operating segment. See Note 6 for additional information regarding goodwill. +A portion of the fair value consideration transferred has been assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Assets +Developed technology +$ +48,000 +10.00 +Customer relationships +26,200 +3.00 +Internal use software +482 +5.00 +$ +74,682 +7.51 +F-15 +Pro Forma +The results of SSE’s operations since the SSE merger date of April 20, 2017 and the results of MS Directional since the acquisition date of October 11, 2017 are included in the Company’s consolidated statement of operations. It is impractical to quantify the contribution of the SSE operations since the merger, as the contract drilling and pressure pumping businesses were fully integrated into the Company’s existing operations in 2017. The contribution of MS Directional since the date of the acquisition accounts for substantially all of the Company’s directional drilling segment, as disclosed in Note 16. The following pro forma condensed combined financial information was derived from the historical financial statements of the Company, SSE and MS Directional and gives effect to the acquisitions as if they had occurred on January 1, 2016. The below information reflects pro forma adjustments based on available information and certain assumptions the Company believes are reasonable, including (i) adjustments related to the depreciation and amortization of the fair value of acquired intangibles and fixed assets, (ii) removal of the historical interest expense of the acquired entities, (iii) the tax benefit of the aforementioned pro forma adjustments, and (iv) adjustments related to the common shares outstanding to reflect the impact of the consideration exchanged in the acquisitions. Additionally, the pro forma loss for the year ended December 31, 2017 was adjusted to exclude the Company’s merger and integration-related costs of $ 74.5 million and SSE’s merger related costs of $ 36.7 million with a corresponding inclusion in the net loss for the year ended December 31, 2016 to give effect as if the acquisitions had occurred on January 1, 2016. The pro forma results of operations do not include any cost savings or other synergies that may result from the SSE merger or MS Directional acquisition. The pro forma results of operations also do not include any estimated costs that have been incurred by the Company to integrate the SSE and MS Directional operations. The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the SSE merger and MS Directional acquisition taken place on January 1, 2016; furthermore, the financial information is not intended to be a projection of future results. The following table summarizes selected financial information of the Company on a pro forma basis (in thousands, except per share data): +2017 +2016 +(Unaudited) +Revenues +$ +2,738,579 +$ +1,567,141 +Net income (loss) +$ +29,584 +$ +( 505,413 +) +Net income (loss) per share +Basic +$ +0.13 +$ +( 2.30 +) +Diluted +$ +0.13 +$ +( 2.30 +) +Current Power Solutions, Inc. (“Current Power”) +During October 2018, the Company acquired Current Power. Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. This acquisition was not material to the Company’s consolidated financial statements. +Superior QC, LLC (“Superior QC”) +During February 2018, the Company acquired the business of Superior QC, including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. This acquisition was not material to the Company’s consolidated financial statements. +3. Revenues +ASC Topic 606 Revenue from Contracts with Customers +On January 1, 2018, the Company adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on the Company’s consolidated financial statements, and a cumulative adjustment was not recognized. Revenues for reporting periods beginning after January 1, 2018 are presented under Topic 606, while revenues prior to January 1, 2018 continue to be reported under previous revenue recognition requirements of Topic 605. +The Company’s contracts with customers include both long-term and short-term contracts. Services that primarily generate revenue earned for the Company include the operating business segments of contract drilling, pressure pumping and directional drilling which comprise the Company’s reportable segments. The Company also derives revenues from its other operations, which include the Company’s operating business segments of oilfield rentals, equipment servicing, electrical controls and automation, and oil and natural gas working interests. For more information on the Company’s business segments, see Note 16. +Charges for services are considered a series of distinct services. Since each distinct service in a series would be satisfied over time if it were accounted for separately, and the entity would measure its progress towards satisfaction using the same measure of progress +F-16 +for each distinct service in the series, the Company is able to account for these integrated services as a single performance obligation that is satisfied over time. +The transaction price is the amount of consideration to which the Company expects to be entitled in exchange for transferring promised goods or services to a customer, based on terms of the Company’s contracts with its customers. The consideration promised in a contract with a customer may include fixed amounts and/or variable amounts. Payments received for services are considered variable consideration as the time in service will fluctuate as the services are provided. Topic 606 provides an allocation exception, which allows the Company to allocate variable consideration to one or more distinct services promised in a series of distinct services that form part of a single performance obligation as long as certain criteria are met. These criteria state that the variable payment must relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service, and allocation of the variable consideration is consistent with the standards’ allocation objective. Since payments received for services meet both of these criteria requirements, the Company recognizes revenue when the service is performed. +An estimate of variable consideration should be constrained to the extent that it is not probable that a significant revenue reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Payments received for other types of consideration are fully constrained as they are highly susceptible to factors outside the entity’s influence and therefore could be subject to a significant revenue reversal once resolved. As such, revenue received for these types of consideration is recognized when the service is performed. +Estimates of variable consideration are subject to change as facts and circumstances evolve. As such, the Company will evaluate its estimates of variable consideration that are subject to constraints throughout the contract period and revise estimates, if necessary, at the end of each reporting period. +The Company is a working interest owner of oil and natural gas properties located in Texas and New Mexico. The ownership terms are outlined in joint operating agreements for each well between the operator of the wells and the various interest owners, including the Company, who are considered non-operators of the well. The Company receives revenue each period for its working interest in the well during the period. The revenue received for the working interests from these oil and gas properties does not fall under the scope of the new revenue standard, and therefore, will continue to be reported under current guidance ASC 932-323 Extractive Activities – Oil and Gas, Investments – Equity Method and Joint Ventures. +Reimbursement Revenue – Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of the Company’s customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +The Company’s disaggregated revenue recognized from contracts with customers is included in Note 16. +Accounts Receivable and Contract Liabilities +Accounts receivable is the Company’s right to consideration once it becomes unconditional. Payment terms typically range from 30 to 60 days . +Accounts receivable balances were $ 336 million and $ 554 million as of December 31, 2019 and 2018, respectively. These balances do not include amounts related to the Company’s oil and gas working interests as those contracts are excluded from Topic 606. Accounts receivable balances are included in “Accounts Receivable” in the consolidated balance sheets. +The Company does not have any significant contract asset balances, and as such, contract balances are not presented at the net amount at a contract level. Contract liabilities include prepayments received from customers prior to the requested services being completed. Once the services are complete and have been invoiced, the prepayment is applied against the customer’s account to offset the accounts receivable balance. Also included in contract liabilities are payments received from customers for the initial mobilization of newly constructed or upgraded rigs that were moved on location to the initial well site. These mobilization payments are allocated to the overall performance obligation and amortized over the initial term of the contract. During the year ended December 31, 2019 and 2018, approximately $ 1.0 million and $ 1.6 million , respectively, was amortized and recorded in drilling revenue. +Total contract liability balances were $ 2.7 million and $ 7.6 million as of December 31, 2019 and December 31, 2018, respectively. Contract liability balances are included in “Accounts payable” and “Accrued liabilities” in the consolidated balance sheets. +Contract Costs +Costs incurred for newly constructed or rig upgrades based on a contract with a customer are considered capital improvements and are capitalized to drilling equipment and depreciated over the estimated useful life of the asset. +F-17 +Practical Expedients Adopted with Topic 606 +The Company has elected to adopt the following practical expedients upon the transition date to Topic 606 on January 1, 2018: +• +Use of portfolio approach: An entity can apply this guidance to a portfolio of contracts (or performance obligations) with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying this guidance to the portfolio would not differ materially from applying this guidance to the individual contracts (or performance obligations) within that portfolio. +• +Excluding disclosure about transaction price: As a practical expedient, an entity need not disclose the information for a performance obligation if either of the following conditions is met: +a) +The performance obligation is part of a contract that has an original expected duration of one year or less. +b) +The entity recognizes revenue from the satisfaction of the performance obligation. +• +Excluding sales taxes from the transaction price: The scope of this policy election is the same as the scope of the policy election under previous guidance. This election provides exclusion from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction and collected by the entity from a customer. +• +Costs of obtaining a contract: An entity can immediately expense costs of obtaining a contract if they would be amortized within a year. +4. Inventory +Inventory consisted of the following at December 31, 2019 and 2018 (in thousands): +2019 +2018 +Finished goods +$ +105 +$ +347 +Work-in-process +1,229 +6,375 +Raw materials and supplies +35,023 +58,857 +Inventory +$ +36,357 +$ +65,579 +5. Property and Equipment +Property and equipment consisted of the following at December 31, 2019 and 2018 (in thousands): +2019 +2018 +Equipment +$ +8,114,326 +$ +8,370,933 +Oil and natural gas properties +226,646 +219,855 +Buildings +184,700 +186,736 +Land +25,747 +26,144 +Total property and equipment +8,551,419 +8,803,668 +Less accumulated depreciation, depletion and impairment +( 5,244,742 +) +( 4,801,119 +) +Property and equipment, net +$ +3,306,677 +$ +4,002,549 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment, intangible assets and liabilities for 2019, 2018 and 2017 (in thousands): +2019 +2018 +2017 +Depreciation and impairment expense +$ +974,206 +$ +887,155 +$ +753,510 +Amortization expense +17,722 +18,197 +21,764 +Depletion expense +11,945 +10,966 +8,067 +Total +$ +1,003,873 +$ +916,318 +$ +783,341 +F-18 +On a periodic basis, the Company evaluates its fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to the Company’s yards to be used as spare equipment. The remaining components of these rigs are retired. In 2019, the Company identified 36 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, the Company believes the 36 rigs that were retired have limited commercial opportunity. The Company recorded a $ 173 million charge related to this retirement. In 2018, the Company identified 42 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, the Company believes the 42 rigs that were retired had limited commercial opportunity. The Company recorded a $ 48.4 million charge related to this retirement. In 2017, the Company r ecorded a charge of $ 29.0 million for the write-down of drilling equipment with no continuing utility as a result of the upgrade of certain rigs to super-spec capability. +The Company also periodically evaluates its pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. In 2019, the Company recorded a charge of $ 20.5 million for the write-down of pressure pumping equipment compared to a $ 17.4 million write-down of pressure pumping equipment in 2018. There was no similar charge in 2017. +The Company also periodically evaluates its directional drilling assets. During 2019, the Company recorded a charge of $ 8.4 million for the write-down of directional drilling equipment. There were no similar charges in 2018 or 2017. +The Company reviews its long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The Company estimates future cash flows over the life of the respective assets or asset groupings in its assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as the Company’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +2019 Triggering Event Assessment +Due to the decline in the market price of the Company’s common stock and recent commodity prices, the Company’s results of operations for the quarter ended September 30, 2019 and management’s expectations of operating results in future periods, the Company lowered its expectations with respect to future activity levels in certain of its operating segments. The Company deemed it necessary to assess the recoverability of its contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. The Company performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within its contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of September 30, 2019. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 35 %, 54 %, 23 % and 7 %, respectively. +For the assessment performed in 2019, the expected cash flows for the Company’s asset groups included revenue growth rates, operating expense growth rates, and terminal growth rates. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in 2019 and would begin to recover in late 2020 or 2021 in response to improved oil prices. While the Company believes these assumptions with respect to future oil pricing are reasonable, actual future prices and activity levels may vary significantly from the ones that were assumed. The timeframe over which oil prices and activity levels may recover is highly uncertain. +All of these factors are beyond the Company’s control. If the lower oil price environment experienced in 2019 were to last into late 2021 and beyond, the Company’s actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future, and such impairment could be material. +The Company concluded that no triggering events occurred during the quarter ended December 31, 2019 with respect to its asset groups based on the Company’s results of operations for the current year, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +F-19 +Prior Year Triggering Event Assessment +Due to the decline in the market price of the Company’s common stock and the deterioration of crude oil prices in the fourth quarter of 2018, the Company lowered its expectations with respect to future activity levels in certain of its operating segments. The Company deemed it necessary to assess the recoverability of its contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups. The Company performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within its contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of December 31, 2018. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and the Company determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 38 %, 58 %, 9 % and 23 %, respectively. +For the assessment performed in 2018, the expected cash flows for the Company’s asset groups included revenue growth rates, operating expense growth rates, and terminal growth rates. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the fourth quarter of 2018, and would begin to recover in late 2019 and continue into 2020 in response to improved oil prices and activity levels. +The Company concluded that no triggering events occurred during the year ended December 31, 2017 with respect to its asset groups based on the Company’s results of operations for the year ended December 31, 2017 management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +6. Goodwill and Intangible Assets +Goodwill — Goodwill by operating segment as of December 31, 2019 and 2018 and changes for the years then ended are as follows (in thousands): +Contract +Pressure +Directional +Other +Drilling +Pumping +Drilling +Operations +Total +Balance, December 31, 2017 +$ +395,060 +$ +121,444 +$ +88,685 +$ +6,284 +$ +611,473 +Goodwill acquired +— +— +— +9,412 +9,412 +Measurement period adjustment +— +— +1,000 +— +1,000 +Impairment +— +( 121,444 +) +( 89,685 +) +— +( 211,129 +) +Balance, December 31, 2018 +$ +395,060 +$ +— +$ +— +$ +15,696 +$ +410,756 +Measurement period adjustment +— +— +— +$ +2,104 +2,104 +Impairment +— +— +— +( 17,800 +) +( 17,800 +) +Balance, December 31, 2019 +$ +395,060 +$ +— +$ +— +$ +— +$ +395,060 +There were no accumulated impairment losses related to goodwill in the contract drilling segment as of December 31, 2019 or 2018. +The change to goodwill in Other Operations in 2019 was primarily a result of a measurement period adjustment related to accrued liabilities, which resulted in a $ 2.1 million increase from the original purchase price allocation assessed with the Current Power acquisition. +Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. The Company’s reporting units for impairment testing are its operating segments. The Company determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, the Company may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +F-20 +Due to the decline in the market price of the Company’s common stock and recent commodity prices, the Company’s results of operations for the quarter ended September 3 0 , 2019 and management’s expectations of operating results in future periods, the Company lowered its expectations with respect to future activity levels in certain of its operating segments. The Company performed a quantitative impairment assessment of its goodwill as of Sept ember 3 0 , 2019. In completing the assessment, the fair value of each reporting unit was estimated using the income approach . The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates , revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of September 30, 2019, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 13 % and management concluded that no impairment was indicated in its contract drilling reporting unit; however, impairment was indicated in its oilfield rentals and electrical controls and automation reporting units included in the other operations segment. The Company recognized an impairment charge of $ 17.8 million in 2019 associated with the impairment of all of the goodwill in its oilfield rentals and electrical controls and automation reporting units. +The timeframe over which oil prices and activity levels may recover is highly uncertain. If the lower oil price environment experienced in 2019 were to last into late 2021 and beyond, the Company’s actual cash flows would likely be less than the expected cash flows used in these assessments and could result in additional goodwill impairment charges in the future and such impairment could be material. +Due to the decline in the market price of the Company’s common stock and the deterioration of crude oil prices in the fourth quarter of 2018, the Company lowered its expectations with respect to future activity levels in certain of its operating segments. The Company performed a quantitative impairment assessment of its goodwill as of December 31, 2018. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of December 31, 2018, the fair value of the contract drilling and oilfield rentals reporting units exceeded their carrying values by approximately 16 % and 14 %, respectively, and the Company concluded that no impairment was indicated in its contract drilling and oilfield rentals reporting units; however, impairment was indicated in its pressure pumping and directional drilling reporting units. The Company recognized an impairment charge of $ 211 million associated with the impairment of all of the goodwill in its pressure pumping and directional drilling reporting units. +In connection with the Company’s annual goodwill impairment assessment as of December 31, 2019 and 2017, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of its reporting units were greater than the respective carrying amount. In making this determination, the Company considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in its reporting units, as well as its 2019 and 2017 operating results and forecasted operating results for the respective succeeding year. The Company also considered its overall market capitalization at December 31, 2019 and 2017. +Intangible Assets — In 2018, intangible assets were recorded in the Company’s directional drilling operating segment with the acquisition of Superior QC and in other operations with the acquisition of Current Power. In 2017, intangible assets were recorded in the Company’s directional drilling operating segment with the acquisition of MS Directional and in the contract drilling operating segment with the SSE merger. See Note 2 for additional information. The Company’s intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight line basis. The Company did no t incur any costs to renew or extend the term of acquired intangible assets in 2019 or 2018. The following table identifies the segment and weighted average useful life of each of the Company’s intangible assets: +Weighted Average +Segment +Useful Life +(in years) +Customer relationships +Directional drilling +3.00 +Customer relationships +Other operations +7.00 +Developed technology +Directional drilling +5.22 +Favorable drilling contracts +Contract drilling +0.83 +Internal use software +Directional drilling +5.00 +Due to the decline in the market price of the Company’s common stock and recent commodity prices, the Company’s results of operations for the quarter ended September 30, 2019 and management’s expectations of operating results in future periods, the Company lowered its expectations with respect to future activity levels in certain of its operating segments. The Company deemed it necessary to assess the recoverability of its contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 5 for additional information. +F-21 +Due to the decline in the market price of the Company’s common stock and the deterioration of crude oil prices in the fourth quarter of 2018, the Company lowered its expectations with respect to activity levels in certain of its operating segments. The Company deemed it necessary to assess the recoverability of its contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of December 31, 2018. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 5 for additional information. +The Company concluded that no triggering events necessitating an impairment assessment of the intangible assets had occurred during the quarter ended December 31, 2019 or in 2017. +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2019 and 2018 are as follows (in thousands): +2019 +2018 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +28,000 +$ +( 19,710 +) +$ +8,290 +$ +28,000 +$ +( 10,719 +) +$ +17,281 +Developed technology +55,772 +( 15,386 +) +40,386 +55,772 +( 6,533 +) +49,239 +Favorable drilling contracts +— +— +— +22,500 +( 22,500 +) +— +Internal use software +482 +( 214 +) +268 +482 +( 118 +) +364 +$ +84,254 +$ +( 35,310 +) +$ +48,944 +$ +106,754 +$ +( 39,870 +) +$ +66,884 +Amortization expense on intangible assets of approximately $ 17.9 million, $ 18.3 million and $ 24.3 million was recorded for the years ended December 31, 2019, 2018 and 2017, respectively. The remaining amortization expense associated with finite-lived intangible assets is expected to be as follows (in thousands): +Year ending December 31, +2020 +$ +19,273 +2021 +12,483 +2022 +12,461 +2023 +1,034 +2024 +1,034 +Thereafter +2,659 +Total +$ +48,944 +7. Accrued Liabilities +Accrued expenses consisted of the following at December 31, 2019 and 2018 (in thousands): +2019 +2018 +Salaries, wages, payroll taxes and benefits +$ +57,615 +$ +66,285 +Workers’ compensation liability +81,112 +83,772 +Property, sales, use and other taxes +22,404 +25,318 +Insurance, other than workers’ compensation +9,218 +9,531 +Accrued interest payable +12,021 +15,774 +Other +37,480 +35,266 +Accrued liabilities +$ +219,850 +$ +235,946 +8. Long-Term Debt +2019 Term Loan Agreement — On August 22, 2019 , the Company entered into a term loan agreement (“Term Loan Agreement”) among the Company, as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lender party thereto. +The Term Loan Agreement is a committed senior unsecured term loan facility that permits a single borrowing of up to $ 150 million, which was drawn in full by the Company on September 23, 2019. Subject to customary conditions, the Company may request that the lenders’ aggregate commitments be increased by up to $ 75 million, not to exceed total commitments of $ 225 million. The maturity date under the Term Loan Agreement is June 10, 2022 . The Company repaid $ 50 million of the borrowings under the Term Loan Agreement on December 16, 2019. +F-22 +Loans under the Term Loan Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00 % to 1.375 %, and the applicable margin on base rate loans varies from 0.00 % to 0.375 %, in each case determined based upon the Company’s credit rating. As of December 31, 2019, the applicable margin on LIBOR rate loans and base rate loans was 1.125 % and 0.125 %, respectively. +The Term Loan Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that the Company believes are customary for agreements of this nature, including certain restrictions on the ability of the Company and each subsidiary of the Company to incur debt and grant liens. If the Company’s credit rating is below investment grade, the Company will become subject to a restricted payment covenant, which would require the Company to have a Pro Forma Debt Service Coverage Ratio (as defined in the Term Loan Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. +The Term Loan Agreement requires mandatory prepayment in an amount equal to 100 % of the net cash proceeds from the issuance of new senior indebtedness (other than certain permitted indebtedness) if the Company’s credit rating is below investment grade. The Term Loan Agreement also requires that the Company’s total debt to capitalization ratio, expressed as a percentage, not exceed 50 %. The Term Loan Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. +As of December 31, 2019, the Company had $ 100 million in borrowings outstanding under the Term Loan Agreement at a LIBOR interest rate of 2.917 %. +2018 Credit Agreement — On March 27, 2018 , the Company entered into an amended and restated credit agreement (the “Credit Agreement”) among the Company, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Lead Arrangers and Joint Book Runners. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $ 600 million, including a letter of credit facility that, at any time outstanding, is limited to $ 150 million and a swing line facility that, at any time outstanding, is limited to $ 20 million. Subject to customary conditions, the Company may request that the lenders’ aggregate commitments be increased by up to $ 300 million, not to exceed total commitments of $ 900 million. The original maturity date under the Credit Agreement was March 27, 2023 . On March 26, 2019, the Company entered into Amendment No. 1 to Amended and Restated Credit Agreement, which amended the Credit Agreement to, among other things, extend the maturity date under the Credit Agreement from March 27, 2023 to March 27, 2024. The Company has the option, subject to certain conditions, to exercise two one-year extensions of the maturity date. +Loans under the Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00 % to 2.00 % and the applicable margin on base rate loans varies from 0.00 % to 1.00 %, in each case determined based upon the Company’s credit rating. A letter of credit fee is payable by the Company equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10 % to 0.30 % based on the Company’s credit rating. +No subsidiaries of the Company are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that the Company believes are customary for agreements of this nature, including certain restrictions on the ability of the Company and each subsidiary of the Company to incur debt and grant liens. If the Company’s credit rating is below investment grade, the Company will become subject to a restricted payment covenant, which would require the Company to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. The Credit Agreement also requires that the Company’s total debt to capitalization ratio, expressed as a percentage, not exceed 50 %. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. +As of December 31, 2019, the Company had no borrowings outstanding under the revolving credit facility. The Company had $ 81,000 in letters of credit outstanding under the revolving credit facility at December 31, 2019 and, as a result, had available borrowing capacity of approximately $ 600 million at that date. +F-23 +2015 Reimbursement Agreement — On March 16, 2015, the Company entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which the Company may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2019, the Company had $ 63.3 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, the Company will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by the Company at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. The Company is obligated to pay to Scotiabank interest on all amounts not paid by the Company on the date of demand or when otherwise due at the LIBOR rate plus 2.25 % per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +The Company has also agreed that if obligations under the Credit Agreement are secured by liens on any of its or any of its subsidiaries’ property, then the Company’s reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, the Company’s payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by subsidiaries of the Company that from time to time guarantee payment under the Credit Agreement. No subsidiaries of the Company currently guarantee payment under the Credit Agreement. +Series A Senior Notes and Series B Senior Notes — On October 5, 2010 , the Company completed the issuance and sale of $ 300 million in aggregate principal amount of its 4.97 % Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bore interest at a rate of 4.97% per annum. On September 25, 2019, the Company fully prepaid the Series A Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $ 308 million, which represents 100 % of the principal and the “make-whole” premium to the prepayment date. +On June 14, 2012 , the Company completed the issuance and sale of $ 300 million in aggregate principal amount of its 4.27 % Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bore interest at a rate of 4.27% per annum. On December 16, 2019, the Company fully prepaid the Series B Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $ 315 million, which represents 100 % of the principal and the “make-whole” premium to the prepayment date . +Primarily as a result of the “make-whole” premiums, the Company incurred a $ 8.2 million loss on early extinguishment of the Series A Notes in the three months ended September 30, 2019, and a $ 15.8 million loss on early extinguishment of the Series B Notes in the three months ended December 31, 2019, which were included in “Interest expense , net of amount capitalized” in the consolidated statements of operations . +2028 Senior Notes and 2029 Senior Notes — On January 19, 2018, the Company completed its offering of $ 525 million in aggregate principal amount of the Company’s 3.95% Senior Notes due 2028 (the “2028 Notes”). The net proceeds before offering expenses were approximately $ 521 million of which the Company used $ 239 million to repay amounts outstanding under its revolving credit facility. On November 15, 2019, the Company completed an offering of $ 350 million in aggregate principal amount of the Company’s 5.15% Senior Notes due 2029 (the “2029 Notes”). The net proceeds before offering expenses were approximately $ 347 million. The Company used a portion of the net proceeds from the offering to prepay its Series B Notes. The remaining net proceeds and available cash on hand was used to repay $ 50 million of the borrowings under the Term Loan Agreement. +The Company pays interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028 . The 2028 Notes bear interest at a rate of 3.95 % per annum. +The Company pays interest on the 2029 Notes on May 15 and November 15 of each year. The 2029 Notes will mature on November 15, 2029 . The 2029 Notes bear interest at a rate of 5.15 % per annum. +F-24 +The 2028 Notes and 2029 Notes (together, the “Senior Notes”) are senior unsecured obligations of the Company, which rank equally with all of the Company’s other existing and future senior unsecured debt and will rank senior in right of payment to all of the Company’s other future subordinated debt. The Senior Notes will be effectively subordinated to any of the Company’s future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of the Company’s subsidiaries that d o not guarantee the Senior Notes. No subsidiaries of the Company are currently required to be a guarantor under the Senior Notes . If subsidiaries of the Company guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +The Company, at its option, may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, and on August 15, 2029, in the case of the 2029 Notes, the Company, at its option, may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100 % of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date. +The indentures pursuant to which the Senior Notes were issued include covenants that, among other things, limit the Company and its subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indenture. +Upon the occurrence of a change of control, as defined in the indentures, each holder of the Senior Notes may require the Company to purchase all or a portion of such holder’s Senior Notes at a price equal to 101 % of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +Debt issuance costs — The Company incurred approximately $151,000 debt issuance costs in connection with the Term Loan Agreement. The Company incurred approximately $ 4.6 million in debt issuance costs in connection with the Credit Agreement. The Company incurred approximately $ 1.9 million in debt issuance costs in connection with the Series A Notes and approximately $ 1.6 million in debt issuance costs in connection with the Series B Notes . The Company incurred approximately $ 1.6 million in debt issuance costs in connection with the 2028 Notes and approximately $ 1.0 million in debt issuance costs in connection with the 2029 Notes. These costs were deferred and are being recognized as interest expense over the term of the underlying debt. Debt issuance costs, except those related to line-of-credit arrangements, are presented in the balance sheet as a direct deduction from the carrying amount of the related debt. Debt issuance costs related to line-of-credit arrangements are classified as a deferred charge. Amortization of debt issuance costs is reported as interest expense. Interest expense related to the amortization of debt issuance costs was approximately $ 2.0 million, $ 2.0 million and $ 2.6 million for the years ended December 31, 2019, 2018 and 2017, respectively. Amortization of debt issuance costs for the year ended December 31, 2019 includes $ 185,000 of debt issuance costs that were expensed as a result of the Series A Notes prepayment, $ 394,000 of debt issuance costs that were expensed as a result of the Series B Notes prepayment and approximately $ 50,000 of debt issuance costs that were expensed as a result of the Term Loan Agreement partial repayment. Amortization of debt issuance costs for the year ended December 31, 2018 includes $ 317,000 of debt issuance costs related to commitments by lenders under the Company’s previous credit agreement who did not participate in the Credit Agreement. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2019 (in thousands): +Year ending December 31, +2020 +$ +— +2021 +— +2022 +100,000 +2023 +— +2024 +— +Thereafter +875,000 +Total +$ +975,000 +F-25 +9. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2019, the Company maintained letters of credit in the aggregate amount of $ 63.4 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2019, no amounts had been drawn under the letters of credit. +As of December 31, 2019, the Company had commitments to purchase major equipment and make investments totaling approximately $ 51 million for its drilling, pressure pumping, directional drilling and oilfield rentals businesses. +The Company’s pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The agreements expire in years 2020 through 2023. As of December 31, 2019, the remaining obligation under these agreements was approximately $ 37.8 million, of which approximately $ 15.8 million relates to purchases required during 2020. In the event the required minimum quantities are not purchased during any contract year, the Company could be required to make a liquidated damages payment to the respective vendor for any shortfall. In 2017, the Company entered into a capacity reservation agreement that required a cash deposit to increase the Company’s access to finer grades of sand for its pressure pumping business. As market prices for sand substantially decreased since 2017, the Company purchased lower cost sand outside of this capacity reservation contract and recorded a charge of $ 12.7 million in the second quarter of 2019 to revalue the deposit to its expected realizable value. +Contingencies – The Company’s operations are subject to many hazards inherent in the businesses in which it operates, including inclement weather, blowouts, explosions, fires, loss of well control, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose the Company to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving the Company’s employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause the Company to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to the Company’s reputation, loss of customers and an inability to obtain insurance. +The Company has indemnification agreements with many of its customers, and also maintains liability and other forms of insurance. In general, the Company’s contracts typically contain provisions requiring its customers to indemnify the Company for, among other things, reservoir and certain pollution damage. The Company’s right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by the Company, its subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of the Company. +The Company’s customers and other third parties may dispute, or be unable to meet, their indemnification obligations to the Company due to financial, legal or other reasons. Accordingly, the Company may be unable to transfer these risks to its customers and other third parties by contract or indemnification agreements. Incurring a liability for which the Company is not fully indemnified or insured could have a material adverse effect on its business, financial condition, cash flows and results of operations. +The Company maintains insurance coverage of types and amounts that the Company believes to be customary in the industry, but is not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that the Company maintains includes insurance for fire, windstorm and other risks of physical loss to its equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. The Company cannot assure, however, that any insurance obtained will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to the Company. While the Company carries insurance to cover physical damage to, or loss of, a substantial portion of its equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. The Company has also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, the Company generally maintains a $ 1.5 million per occurrence deductible on its workers’ compensation insurance coverage, a $ 1.0 million per occurrence deductible on its equipment insurance coverage, a $ 10.0 million per occurrence deductible on its general liability coverage and a $ 2.0 million per occurrence deductible on its automobile liability insurance coverage. The Company also self-insures a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and does not carry a significant amount of insurance to cover risks of underground reservoir damage. +F-26 +On July 18, 2018, the U.S. Occupational Safety and Health Administration (“OSHA”) issued a citation containing alleged violations, proposed abatement dates and an aggregate proposed penalty of approximately $ 74,000 in connection with an accident at a drilling site in Pittsburg County, Oklahoma that resulted in the losses of life of five people, including three of the Company’s employees. The Company filed a notice of contest with OSHA that contested all citation items, abatement dates and proposed penalties. The Department of Labor (the “DOL”) filed a complaint on OSHA’s behalf seeking enforcement of the citation as issued, and the Company filed an answer to the complaint. In October 2019, the Company and the DOL agreed to a settlement of all but one of the citation items, and a hearing on the remaining citation item was held before an administrative law judge. The Company and the DOL will file post-hearing briefs and await the judge’s determination. +The Company is party to various other legal proceedings arising in the normal course of its business. The Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, cash flows or results of operations . +Other Matters — The Company has Change in Control Agreements with its Chairman of the Board and one of its Executive Vice Presidents (the “Specified Employees”). Each Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless the Company notifies the Specified Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control of the Company occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by the Company other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreements), then the Specified Employee shall generally be entitled to, among other things: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment for each Specified Employee prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2.5 times (in the case of the Chairman of the Board) or 2 times (in the case of the Executive Vice President) of the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under the Company’s welfare plans for up to three years (in the case of the Chairman of the Board) or two years (in the case of the Executive Vice President). +Each Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +The Company has Employment Agreements with its Chief Executive Officer, Chief Financial Officer, General Counsel and the President of the Company’s subsidiary, Patterson-UTI Drilling Company LLC (“Patterson-UTI Drilling”). In the case of the Chief Executive Officer and the General Counsel, the Employment Agreement supersedes the prior Change in Control Agreement with each executive and, in the case of the President of Patterson-UTI Drilling, the Employment Agreement supersedes his prior employment agreement. Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such termination at least 30 days before the effective date of such termination. Under specified circumstances, the Company may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by either (i) providing written notice 10 days before the effective date of such termination and by granting at least 10 days to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of such termination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by the Company to not be capable of being cured, the executive may be terminated for cause on the date the written notice is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following termination by the Company of the executive other than for Cause, or termination by the executive for Good Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by the Company without Cause, or the executive terminates his employment for Good Reason: +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees, +• +the Company will accelerate vesting of all options and restricted stock awards on the 60th day following the executive’s termination , and +• +the Company will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +F-27 +If a termination by the Company other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, which for the President of Patterson-UTI Drilling includes a change in control of the Company or, in certain circumstances, of Patterson-UTI Drilling), the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years , and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) of subsidized benefits continuation coverage. +10. Stockholders’ Equity +Stock Offering – On January 27, 2017, the Company completed an offering of 18.2 million shares of its common stock and raised net proceeds of $ 472 million. The Company used the net proceeds of the offering to repay SSE’s outstanding indebtedness of approximately $ 472 million . +Cash Dividends – The Company paid cash dividends during the years ended December 31, 2019, 2018 and 2017 as follows: +Per Share +Total +(in thousands) +2019 +Paid on March 21, 2019 +$ +0.04 +$ +8,499 +Paid on June 20, 2019 +0.04 +8,344 +Paid on September 19, 2019 +0.04 +7,847 +Paid on December 19, 2019 +0.04 +7,738 +Total cash dividends +$ +0.16 +$ +32,428 +2018 +Paid on March 22, 2018 +$ +0.02 +$ +4,443 +Paid on June 21, 2018 +0.04 +8,832 +Paid on September 20, 2018 +0.04 +8,685 +Paid on December 20, 2018 +0.04 +8,629 +Total cash dividends +$ +0.14 +$ +30,589 +2017 +Paid on March 22, 2017 +$ +0.02 +$ +3,326 +Paid on June 22, 2017 +0.02 +4,269 +Paid on September 21, 2017 +0.02 +4,271 +Paid on December 21, 2017 +0.02 +4,449 +Total cash dividends +$ +0.08 +$ +16,315 +On February 5, 2020 , the Company’s Board of Directors approved a cash dividend on its common stock in the amount of $ 0.04 per share to be paid on March 19, 2020 to holders of record as of March 5, 2020 . The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of the Company’s debt agreements and other factors. +On September 6, 2013, the Company’s Board of Directors approved a stock buyback program that authorized purchases of up to $ 200 million of the Company’s common stock in open market or privately negotiated transactions. On July 25, 2018, the Company’s Board of Directors approved an increase of the authorization under the stock buyback program to allow for $ 250 million of future share repurchases. On February 6, 2019, the Company’s Board of Directors approved another increase of the authorization under the stock buyback program to allow for $ 250 million of future share repurchases. On July 24, 2019, the Company’s Board of Directors approved another increase of the authorization under the stock buyback program to allow for $ 250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2019, the Company had remaining authorization to purchase approximately $ 150 million of the Company’s outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +F-28 +The Company acquired shares of stock from directors in 2017 and employees during 2019, 2018, and 2017 that are ac counted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligation s upon the exercise of stock options. The remainder of these shares was acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock and restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Plan (as defined below ) and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2019, 2018 and 2017 were as follows (dollars in thousands): +2019 +2018 +2017 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +43,392,617 +$ +911,094 +Purchases pursuant to stock buyback program +22,566,331 +250,109 +9,331,131 +150,497 +5,503 +109 +Acquisitions pursuant to long-term incentive plan +1,037,947 +14,205 +567,354 +11,240 +404,491 +7,508 +Other +31,013 +372 +— +— +— +— +Treasury shares at end of period +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +11. Stock-based Compensation +The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards include equity instruments in the form of stock options, restricted stock or restricted stock units that have included service conditions and, in certain cases, performance conditions. The Company’s share-based awards also include share-settled performance unit awards. Share-settled performance unit awards are accounted for as equity awards. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +The Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) was originally approved by the Company’s stockholders effective as of April 17, 2014 and authorized 9.1 million shares for issuance. The Board of Directors adopted a resolution that no future grants would be made under any of the Company’s other previously existing plans. On June 29, 2017, the Company’s stockholders approved the amendment and restatement of the 2014 Plan (the “Amended and Restated Plan”) to increase the number of shares available under the plan by 9.8 million shares. On June 6, 2019, the Company’s stockholders approved an amendment to the Amended and Restated Plan to increase the number of shares available for issuance under the plan by 9.5 million shares and to extend the latest date on which awards may be granted under the Amended and Restated Plan to June 6, 2029 (the “Amendment” and the Amended and Restated Plan, as amended by the Amendment, the “Plan”). The aggregate number of shares of the Company’s common stock authorized for grant under the Plan is 28.4 million. The Company’s share-based compensation plans at December 31, 2019 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +Amended and Restated Plan +28,400,000 +6,320,440 +8,331,502 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +2,533,500 +— +A summary of the Plan follows: +• +The Compensation Committee of the Board of Directors administers the Plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +All options granted under the Plan are granted with an exercise price equal to or greater than the fair market value of the Company’s common stock at the time the option is granted. +• +The Plan provides for awards of incentive stock options, non-incentive stock options, tandem and freestanding stock appreciation rights, restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalents. As of December 31, 2019, non-incentive stock options, restricted stock awards, restricted stock units and performance unit awards had been granted under the Plan. +F-29 +Options granted under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. +Stock Options— The Company estimates the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date such options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the years ended December 31, 2019, 2018 and 2017. +Stock option activity for the year ended December 31, 2019 follows: +Weighted Average +Shares +Exercise Price Per Share +Outstanding at beginning of year +5,501,150 +$ +19.63 +Exercised +( 700,000 +) +$ +13.17 +Expired +( 35,000 +) +$ +14.95 +Outstanding at end of year +4,766,150 +$ +20.62 +Exercisable at end of year +4,736,150 +$ +20.63 +Options outstanding at December 31, 2019 have no intrinsic value and a weighted-average remaining contractual term of 3.62 years. Options exercisable at December 31, 2019 have no intrinsic value and a weighted-average remaining contractual term of 3.60 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2019, 2018 and 2017 follows (in thousands, except per share data): +2019 +2018 +2017 +Weighted-average grant date fair value of stock options granted (per share) +NA +NA +NA +Aggregate grant date fair value of stock options vested during the year +$ +543 +$ +1,954 +$ +4,565 +Aggregate intrinsic value of stock options exercised +$ +— +$ +— +$ +209 +As of December 31, 2019, options to purchase 30,000 shares were outstanding and not vested. All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2019 with respect to these non-vested options follows (dollars in thousands): +Aggregate intrinsic value +$ +— +Weighted-average remaining contractual term +6.71 years +Weighted-average remaining expected term +1.71 years +Weighted-average remaining vesting period +1.71 years +Unrecognized compensation cost +$ +151 +Restricted Stock— For all restricted stock awards made to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock activity for the year ended December 31, 2019 follows: +Weighted Average +Grant Date Fair +Shares +Value Per Share +Non-vested restricted stock outstanding at beginning of year +436,224 +$ +21.41 +Vested +( 362,673 +) +$ +21.38 +Forfeited +( 1,500 +) +$ +21.71 +Non-vested restricted stock outstanding at end of year +72,051 +$ +21.59 +As of December 31, 2019, approximately 72,000 shares of non-vested restricted stock outstanding are expected to vest. Additional information as of December 31, 2019 with respect to these non-vested shares follows (dollars in thousands): +Aggregate intrinsic value +$ +757 +Weighted-average remaining vesting period +. 3 year +Unrecognized compensation cost +$ +1,247 +F-30 +Restricted Stock Units— For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Forfeitable dividend equivalents are accrued on certain restricted stock units that will be paid upon vesting. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2019 follows: +Weighted Average +Time +Performance +Grant Date Fair +Based +Based +Value Per Share +Non-vested restricted stock units outstanding at beginning of year +2,602,608 +435,315 +$ +18.95 +Granted +1,505,048 +— +$ +12.40 +Vested (1) +( 1,135,231 +) +( 38,000 +) +$ +19.19 +Forfeited +( 340,699 +) +— +$ +17.08 +Non-vested restricted stock units outstanding at end of year +2,631,726 +397,315 +$ +15.81 +(1) +All of the performance-based restricted stock units that vested during 2019 were granted in 2017. +As of December 31, 2019, approximately 2.9 million non-vested restricted stock units outstanding are expected to vest. Additional information as of December 31, 2019 with respect to these non-vested restricted stock units follows (dollars in thousands): +Aggregate intrinsic value +$ +30,938 +Weighted-average remaining vesting period +1.9 years +Unrecognized compensation cost +$ +36,933 +Performance Unit Awards. The Company has granted share-settled performance unit awards to certain employees (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive a grant of shares of common stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is the three year period commencing on April 1 of the year of grant, except that for the Performance Units granted in 2017 the three-year performance period commenced on May 1. +The performance goals for the Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. For the Performance Units granted in May 2017 and April 2018, the recipients will receive a target number of shares if the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 50th percentile. For the Performance Units granted in April 2019, the recipients will receive the target number of shares if the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 55th percentile. If the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 75th percentile or higher, then the recipients will receive two times the target number of shares. If the Company’s total shareholder return during the performance period, when compared to the peer group, is at the 25th percentile, then the recipients will only receive one-half of the target number of shares. If the Company’s total shareholder return during the performance period, when compared to the peer group, is between the 25th and target percentile, or the target and 75th percentile, then the shares to be received by the recipients will be determined using linear interpolation for levels of achievement between these points. +For the Performance Units awarded prior to 2016, there was no payout unless the Company’s total shareholder return was positive and, when compared to the peer group was at or above the 25 th percentile. For the Performance Units granted in April 2016, if the Company’s total shareholder return was negative, and, when compared to the peer group was at or above the 25 th percentile, then the recipients would receive one-half of the number of shares they would have received had the Company’s total shareholder return been positive. For the Performance Units granted in May 2017 and April 2018, the payout is based on relative performance and does not have an absolute performance requirement. For the Performance Units granted in April 2019, the payout shall not exceed the target number of shares if the Company’s total shareholder return is negative or zero. +The total target number of shares with respect to the Performance Units for the years 2014-2019 is set forth below: +2019 +2018 +2017 +2016 +2015 +2014 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +489,800 +310,700 +186,198 +185,000 +190,600 +154,000 +F-31 +The 2014 Performance Units settled with a negative total shareholder return, so there was no payout under such Performance Units. In April 2018, 381,200 shares were issued to settle the 2015 Performance Units. In April 2019, 185,000 shares were issued to settle the 2016 Performance Units. The Performance Units granted in 2017, 2018, and 2019 have not reached the end of their respective performance periods. +Because the Performance Units are share-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2019 +2018 +2017 +2016 +2015 +2014 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +9,958 +$ +8,004 +$ +5,780 +$ +3,854 +$ +4,052 +$ +5,388 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2019 +2018 +2017 +2016 +2015 +2014 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2019 +$ +2,489 +$ +2,668 +$ +1,927 +$ +321 +NA +NA +Year ended December 31, 2018 +NA +$ +2,001 +$ +1,927 +$ +1,285 +$ +338 +NA +Year ended December 31, 2017 +NA +NA +$ +1,284 +$ +1,285 +$ +1,351 +$ +449 +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as follows: +• +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +• +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +• +Dividend equivalents are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +• +Dividend equivalents are recognized as additional compensation cost for the portion of restricted stock units that are not expected to vest or that ultimately do not vest. +12. Leases +ASC Topic 842 Leases +On January 1, 2019, the Company adopted the new lease guidance under Topic 842, Leases , using the modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. The Company has elected to report all leases at the beginning of the period of adoption and not restate its comparative periods. This standard does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. +The Company has entered into operating leases for operating locations, corporate offices and certain operating equipment. These leases have remaining lease terms of one month to nine years as of December 31, 2019. Currently, the Company does not have any finance leases. Renewal options are included in the right of use asset and lease liability if it is reasonably certain that the Company will exercise the option. The Company has elected the short-term lease recognition practical expedient whereby right of use assets and lease liabilities are not recognized for leasing arrangements with an initial term of one year or less. +Topic 842 requires that lessees and lessors discount lease payments at the lease commencement date using the rate implicit in the lease, if available, or the lessee’s incremental borrowing rate. The Company uses the implicit rate when readily determinable. If the implicit rate is not readily determinable, the Company uses its incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. +In the fourth quarter of 2019 the Company entered into a sale-leaseback transaction that qualified as a sale. The Company sold a facility for proceeds of $ 10.2 million and concurrently entered into an operating lease agreement with the unrelated third-party for certain floors of the building for a 58 -month term. The associated gain on sale of approximately $ 800,000 is included in “Other operating expenses (income), net” in the consolidated statements of operations. +F-32 +For the year ended December 31, 2019 the Company has entered into 3 new facility leases and recorded an increase to the operating lease right-of-use assets and corresponding operating lease liabilities of approximately $ 3.8 million. The Company also extended 9 facilities leases and recorded an increase to the operating lease right-of-use assets and corresponding operating lease liabilities of approximately $ 7.1 million. +Practical Expedients Adopted with Topic 842 +The Company has elected to adopt the following practical expedients upon the transition date to Topic 842 on January 1, 2019: +• +Transitional practical expedients package: An entity may elect to apply the listed practical expedients as a package to all the leases that commenced before the effective date. The practical expedients are: +a) +The entity need not reassess whether any expired or existing contracts are or contain leases; +b) +The entity need not reassess the lease classification for expired or existing contracts; +c) +The entity need not reassess initial direct costs for any existing leases. +• +Use of portfolio approach: An entity can apply this guidance to a portfolio of leases with similar characteristics if the entity reasonably expects that the application of the leases model to the portfolio would not differ materially from the application of the leases model to the individual leases in that portfolio. This approach can also be applied to other aspects of the leases guidance for which lessees/lessors need to make judgments and estimates, such as determining the discount rate and determining and reassessing the lease term. +• +Lease and non-lease components: As a practical expedient, lease and non-lease components may be combined where the revenue recognition pattern is the same and where the lease component, when accounted for separately, would be considered an operating lease. The Company’s contract drilling, pressure pumping and directional drilling contracts contain a lease component related to the underlying equipment utilized, in addition to the service component provided by the Company’s crews and expertise to operate the related equipment. The Company has concluded that the non-lease service of operating its equipment and providing expertise in the services provided to customers is predominant in the Company’s drilling, pressure pumping and directional drilling contracts. With the election of this practical expedient, the Company will continue to present a single performance obligation for these contracts under the revenue guidance in ASC 606. +Lease expense consisted of the following for the year ended December 31, 2019 (in thousands): +Year Ended +December 31, 2019 +Operating lease cost +$ +10,944 +Short-term lease expense (1) +440 +Total lease expense +$ +11,384 +(1) +Short-term lease expense represents expense related to leases with a contract term of one year or less. +Supplemental cash flow information related to leases for the year ended December 31, 2019 is as follows (in thousands): +Year Ended +December 31, 2019 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ +10,033 +Right of use assets obtained in exchange for lease obligations: +Operating leases +$ +10,870 +Supplemental balance sheet information related to leases as of December 31, 2019 is as follows: +December 31, 2019 +Weighted Average Remaining Lease Term: +Operating leases +5.3 years +Weighted Average Discount Rate: +Operating leases +4.2 +% +F-33 +Maturities of operating lease liabilities as of December 31, 2019 are as follows (in thousands): +Year ending December 31, +2020 +$ +11,212 +2021 +8,484 +2022 +6,220 +2023 +3,955 +2024 +3,055 +Thereafter +7,883 +Total lease payments +40,809 +Less imputed interest +( 4,230 +) +Total +$ +36,579 +13. Income Taxes +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2019, 2018 and 2017 are as follows (in thousands): +2019 +2018 +2017 +Federal income tax benefit: +Current +$ +( 1,976 +) +$ +( 3,954 +) +$ +( 42 +) +Deferred +( 90,441 +) +( 35,081 +) +( 335,106 +) +( 92,417 +) +( 39,035 +) +( 335,148 +) +State income tax expense (benefit): +Current +851 +1,704 +( 215 +) +Deferred +( 11,593 +) +( 11,147 +) +4,511 +( 10,742 +) +( 9,443 +) +4,296 +Foreign income tax expense (benefit): +Current +( 348 +) +( 2,552 +) +( 3,108 +) +Deferred +( 1,168 +) +5,043 +249 +( 1,516 +) +2,491 +( 2,859 +) +Total income tax benefit: +Current +( 1,473 +) +( 4,802 +) +( 3,365 +) +Deferred +( 103,202 +) +( 41,185 +) +( 330,346 +) +Total income tax benefit: +$ +( 104,675 +) +$ +( 45,987 +) +$ +( 333,711 +) +Loss before income taxes for the U.S. for years ended December 31, 2019, 2018, and 2017 are $ 499.9 million, $ 343.1 million, and $ 312.9 million, respectively. Loss before income taxes for non-U.S. jurisdictions for years ended December 31, 2019, 2018, and 2017 are $ 30.5 million, $ 24.3 million, and $ 14.9 million, respectively. The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2019, 2018 and 2017 is summarized as follows: +2019 +2018 +2017 +Statutory tax rate +21.0 +% +21.0 +% +35.0 +% +State income taxes - net of the federal income tax benefit +1.7 +1.2 +1.9 +Goodwill impairment +( 0.7 +) +( 6.9 +) +— +Permanent differences +( 0.5 +) +( 0.6 +) +( 1.3 +) +Tax effects of tax reform +— +( 1.3 +) +66.7 +Share-based payments +( 0.7 +) +( 0.1 +) +3.6 +Acquisition related differences +— +— +( 3.3 +) +Valuation allowance +( 0.8 +) +( 3.7 +) +— +State deferred tax remeasurement +( 1.1 +) +2.3 +— +Other differences, net +0.8 +0.6 +( 0.8 +) +Effective tax rate +19.7 +% +12.5 +% +101.8 +% +The effective tax rate increased by approximately 7.2 % to 19.7 % for 2019 compared to 12.5 % for 2018. This difference was primarily due to higher goodwill impairment charges in 2018 relative to 2019, which are not deductible for tax purposes. These charges resulted in a 6.9 % decrease to the effective tax rate in 2018, as compared to a 0.7 % decrease to the effective tax rate in 2019. Another factor was valuation allowances being established against deferred tax assets in certain state and non-U.S. jurisdictions, which +F-34 +were higher in 2018 as compared to 2019. These resulted in a 3.7 % decrease to the effective tax rate in 2018, as compared to a 0.8 % decrease to the rate in 2019. +The Company continues to monitor income tax developments in the United States and other countries affecting the Company. In December 2017, the United States enacted U.S. Tax Reform, which materially impacted the consolidated financial statements by decreasing the U.S. corporate statutory tax rate and significantly affecting future periods. The Company expects several proposed U.S. Treasury regulations under U.S. Tax Reform that were issued during 2018 and 2019 to be finalized during 2020. The Company will incorporate into its future financial statements the impacts, if any, of these regulations and additional authoritative guidance when finalized. +The Company continues to elect permanent reinvestment of unremitted earnings in Canada effective January 1, 2010, and it intends to do so for the foreseeable future. If the Company were to repatriate earnings, in the form of dividends or otherwise, it might be subject to certain income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable. +The tax effect of significant temporary differences representing deferred tax assets and liabilities at December 31, 2019 and 2018 are as follows (in thousands): +2019 +2018 +Deferred tax assets: +Net operating loss carryforwards +$ +375,308 +$ +324,389 +Tax credits +4,138 +6,404 +Expense associated with stock options and restricted stock +10,561 +13,375 +Workers' compensation allowance +19,536 +19,900 +Other deferred tax asset +21,698 +22,423 +431,241 +386,491 +Less: +Valuation allowance +( 17,231 +) +( 13,232 +) +Total deferred tax assets +414,010 +373,259 +Deferred tax liabilities: +Property and equipment basis difference +( 607,785 +) +( 669,196 +) +Other +( 9,184 +) +( 10,224 +) +Total deferred tax liabilities +( 616,969 +) +( 679,420 +) +Net deferred tax liability +$ +( 202,959 +) +$ +( 306,161 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and necessary allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company considers carryback availability, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. In 2019, the Company recorded an additional $ 4 million of valuation allowances against its net deferred tax assets, primarily relating to certain Canadian subsidiaries. These valuation allowances were recorded due to a change in judgment as to the realizability of these assets in future tax years. +For income tax purposes, the Company has approximately $ 1.4 billion of gross federal net operating losses, approximately $ 47.4 million of gross Canadian net operating losses and approximately $ 847 million of post-apportionment state net operating losses as of December 31, 2019, before valuation allowances. The majority of federal net operating losses will expire in varying amounts, if unused, between 2034 and 2037 . Federal net operating losses generated in 2018 and 2019 can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2039 . State net operating losses will expire in varying amounts, if unused, between 2023 and 2039 . +As of December 31, 2019, the Company had no unrecognized tax benefits. The Company has established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2019, the tax years ended December 31, 2014 through December 31, 2018 are open for examination by U.S. taxing authorities. As of December 31, 2019, the tax years ended December 31, 2012 through December 31, 2018 are open for examination by Canadian taxing authorities. +F-35 +14. Earnings Per Share +The Company provides a dual presentation of its net income (loss) per common share in its consolidated statements of operations: basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock. Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock, performance units and restricted stock units. The dilutive effect of stock options, performance units and restricted stock units is determined using the treasury stock method. The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested shares of restricted stock. +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2019, 2018 and 2017, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2019 +2018 +2017 +BASIC EPS: +Net income (loss) +$ +( 425,703 +) +$ +( 321,421 +) +$ +5,910 +Adjust for (income) loss attributed to holders of non-vested restricted stock +— +— +( 170 +) +Income (loss) attributed to common stockholders +$ +( 425,703 +) +$ +( 321,421 +) +$ +5,740 +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +203,039 +218,643 +198,447 +Basic net income (loss) per common share +$ +( 2.10 +) +$ +( 1.47 +) +$ +0.03 +DILUTED EPS: +Income (loss) attributed to common stockholders +$ +( 425,703 +) +$ +( 321,421 +) +$ +5,740 +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +203,039 +218,643 +198,447 +Add dilutive effect of potential common shares +— +— +1,435 +Weighted average number of diluted common shares outstanding +203,039 +218,643 +199,882 +Diluted net income (loss) per common share +$ +( 2.10 +) +$ +( 1.47 +) +$ +0.03 +Potentially dilutive securities excluded as anti-dilutive +9,195 +9,762 +3,289 +15. Employee Benefits +The Company maintains a 401(k) plan for all eligible employees. The Company’s operating results include expenses of approximately $ 13.2 million in 2019, $ 14.3 million in 2018 and $ 8.7 million in 2017 for the Company’s contributions to the plan. +16. Business Segments +At December 31, 2019, the Company had three reportable business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) directional drilling services. Each of these segments represents a distinct type of business and has a separate management team that reports to the Company’s chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. +F-36 +Contract Drilling — The Company markets its contract drilling services to major and independent oil and natural gas operators. As of December 31, 2019, the Company had 216 marketed land-based drilling rigs in the continental United States and western Canada. +For the years ended December 31, 2019, 2018 and, 2017, contract drilling revenue earned in Canada was $ 4.7 million, $ 9.3 million and $ 13.7 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $ 20.1 million and $ 26.2 million as of December 31, 2019 and 2018, respectively. +Pressure Pumping — The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. The Company also provides wireline and cementing services through its pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. +Directional Drilling — The Company provides a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Substantially all of the revenue in the directional drilling segment is from directional drilling, downhole performance motors and measurement-while-drilling services, which are sold as a bundle. +Major Customer — During 2019, 2018 and 2017, no single customer accounted for more than 10% of the Company’s consolidated operating revenues. +F-37 +The following tables summarize selected financial information relating to the Company’s business segments (in thousands): +Year Ended December 31, +2019 +2018 +2017 +Revenues: +Contract drilling +$ +1,309,988 +$ +1,432,012 +$ +1,041,492 +Pressure pumping +868,694 +1,573,396 +1,200,311 +Directional drilling +188,786 +209,275 +45,580 +Other operations (1) +122,885 +131,028 +76,781 +Elimination of intercompany revenues (2) +( 19,668 +) +( 18,714 +) +( 7,480 +) +Total revenues +$ +2,470,685 +$ +3,326,997 +$ +2,356,684 +Income (loss) before income taxes: +Contract drilling +$ +( 151,329 +) +$ +( 33,115 +) +$ +( 171,897 +) +Pressure pumping +( 102,701 +) +( 77,328 +) +21,028 +Directional drilling +( 52,724 +) +( 117,497 +) +( 21 +) +Other operations +( 54,725 +) +( 18,221 +) +( 20,813 +) +Corporate +( 96,719 +) +( 93,585 +) +( 152,792 +) +Other operating income, net (3) +2,305 +17,569 +31,957 +Provision for bad debts +( 5,683 +) +— +— +Interest income +6,013 +5,597 +1,866 +Interest expense +( 75,204 +) +( 51,578 +) +( 37,472 +) +Other +389 +750 +343 +Loss before income taxes +$ +( 530,378 +) +$ +( 367,408 +) +$ +( 327,801 +) +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +668,007 +$ +571,607 +$ +538,891 +Pressure pumping +233,952 +250,010 +198,006 +Directional drilling +52,223 +45,317 +9,347 +Other operations +42,803 +41,512 +29,402 +Corporate +6,888 +7,872 +7,695 +Total depreciation, depletion, amortization and impairment +$ +1,003,873 +$ +916,318 +$ +783,341 +Capital expenditures: +Contract drilling +$ +194,416 +$ +394,595 +$ +354,425 +Pressure pumping +105,803 +173,848 +171,436 +Directional drilling +15,549 +35,929 +7,795 +Other operations +27,132 +34,660 +31,547 +Corporate +4,612 +2,426 +1,884 +Total capital expenditures +$ +347,512 +$ +641,458 +$ +567,087 +Identifiable assets: +Contract drilling +$ +3,190,463 +$ +3,817,638 +$ +3,931,994 +Pressure pumping +695,570 +921,237 +1,209,424 +Directional drilling +164,273 +239,341 +301,275 +Other operations +128,290 +177,374 +172,094 +Corporate (4) +261,019 +314,276 +144,069 +Total assets +$ +4,439,615 +$ +5,469,866 +$ +5,758,856 +( 1 ) +Other operations includes the Company’s oilfield rentals business, drilling equipment service business, the electrical controls and automation business, the oil and natural gas working interests and Middle East organizational activities. +( 2 ) +Intercompany revenues consists of contract drilling and revenues from other operations for services provided to contract drilling, pressure pumping and within other operations . +( 3 ) +Other operating income, net includes net gains associated with the disposal of assets related to corporate strategy decisions of the executive management group. Accordingly, the related gains have been excluded from the operating results of specific segments. This caption also includes certain legal-related expenses and settlements, net of insurance reimbursements and certain research and development expenses . +( 4 ) +Corporate assets primarily include cash on hand and certain property and equipment. +F-38 +17. Concentrations of Credit Risk +Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +The Company believes it has placed its demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2019 and 2018, the Company’s demand deposits and temporary cash investments consisted of the following (in thousands): +2019 +2018 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +1,250 +$ +750 +Deposits in FDIC and SIPC-insured institutions over insurance limits +179,375 +229,132 +Deposits in foreign banks +2,309 +22,698 +182,934 +252,580 +Less outstanding checks and other reconciling items +( 8,749 +) +( 7,551 +) +Cash and cash equivalents +$ +174,185 +$ +245,029 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which the Company provides services. As is general industry practice, the Company typically does not require customers to provide collateral. A $ 5.7 million provision for bad debts was recognized in 2019 with respect to accounts receivable balances that were estimated to be uncollectible . No expense for bad debts was recognized in 2018 and 2017. +18. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of the Company’s outstanding debt balances as of December 31, 2019 and 2018 is set forth below (in thousands): +December 31, 2019 +December 31, 2018 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +3.95% Senior Notes +$ +525,000 +$ +511,485 +$ +525,000 +$ +482,488 +5.15% Senior Notes +350,000 +358,864 +— +— +4.97% Series A Senior Notes +— +— +300,000 +300,043 +4.27% Series B Senior Notes +— +— +300,000 +293,900 +2019 Term Loan +100,000 +100,000 +— +— +Total debt +$ +975,000 +$ +970,349 +$ +1,125,000 +$ +1,076,431 +The fair value of the 3.95 % Senior Notes at December 31, 2019 and December 31, 2018 are based on discounted cash flows associated with the notes using the 4.33 % market rate of interest at December 31, 2019 and the 5.07 % market rate of interest at December 31, 2018. The fair value of the 5.15 % Senior Notes at December 31, 2019 is based on discounted cash flows associated with the notes using the 4.81 % market rate of interest at December 31, 2019. The fair value estimates of the 3.95 % Senior Notes and the 5.15 % Senior Notes are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. The fair values of the Series A Notes and Series B Notes at December 31, 2018 are based on discounted cash flows associated with the respective notes using current market rates of interest at those respective dates. For the Series A Notes, the current market rate used in measuring this fair value was 4.97 % at December 31, 2018. For the Series B Notes, the current market rate used in measuring this fair value was 4.92 % at December 31, 2018. These fair value estimates are based on observable market inputs and are considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting. The carrying values of the balance outstanding at December 31, 2019 under the Term Loan Agreement approximated its fair value as the instrument has a floating interest rate. +F-39 +19. Quarterly Financial Information (in thousands, except per share amounts) (unaudited) +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2019 +Operating revenues +$ +704,171 +$ +675,765 +$ +598,452 +$ +492,297 +Operating loss +( 23,383 +) +( 48,125 +) +( 307,305 +) +( 82,763 +) +Net loss +( 28,614 +) +( 49,447 +) +( 261,719 +) +( 85,923 +) +Net loss per common share: +Basic +$ +( 0.14 +) +$ +( 0.24 +) +$ +( 1.31 +) +$ +( 0.44 +) +Diluted +$ +( 0.14 +) +$ +( 0.24 +) +$ +( 1.31 +) +$ +( 0.44 +) +2018 +Operating revenues +$ +809,164 +$ +854,418 +$ +867,478 +$ +795,937 +Operating loss +( 22,102 +) +( 9,004 +) +( 80,281 +) +( 210,790 +) +Net loss +( 34,417 +) +( 10,713 +) +( 75,042 +) +( 201,249 +) +Net loss per common share: +Basic +$ +( 0.16 +) +$ +( 0.05 +) +$ +( 0.34 +) +$ +( 0.93 +) +Diluted +$ +( 0.16 +) +$ +( 0.05 +) +$ +( 0.34 +) +$ +( 0.93 +) +F-40 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions (1) +Balance +(In thousands) +Year Ended December 31, 2019 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +2,312 +$ +5,683 +$ +( 1,479 +) +$ +6,516 +Year Ended December 31, 2018 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +2,323 +$ +— +$ +( 11 +) +$ +2,312 +Year Ended December 31, 2017 +Deducted from asset accounts: +Allowance for doubtful accounts +$ +3,191 +$ +— +$ +( 868 +) +$ +2,323 +(1) +Consists of uncollectible accounts written off . +S-1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 13, 2020 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 13, 2020. +Signature +Title +/s/ Mark S. Siegel +Chairman of the Board +Mark S. Siegel +/s/ William Andrew Hendricks, Jr. +President, Chief Executive Officer +William Andrew Hendricks, Jr. +and Director +(Principal Executive Officer) +/s/ C. Andrew Smith +Executive Vice President and +C. Andrew Smith +Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Charles O. Buckner +Director +Charles O. Buckner +/s/ Tiffany Thom Cepak +Director +Tiffany Thom Cepak +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Curtis W. Huff +Director +Curtis W. Huff +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Janeen S. Judah +Director +Janeen S. Judah +S-2 \ No newline at end of file diff --git a/raw/filings/0000889900/2019/0001564590-20-004584/filing_metadata.csv b/raw/filings/0000889900/2019/0001564590-20-004584/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..27c76adcc11f165f00432f9da411cb0aeb223b95 --- /dev/null +++ b/raw/filings/0000889900/2019/0001564590-20-004584/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2020-02-13,2019-12-31,2020-02-13T21:03:59.000Z,0001564590-20-004584,pten-10k_20191231.htm,10-K,20884298,1,1,https://www.sec.gov/Archives/edgar/data/889900/000156459020004584/pten-10k_20191231.htm,https://www.sec.gov/Archives/edgar/data/889900/000156459020004584/,2019,2019,1 diff --git a/raw/filings/0000889900/2019/0001564590-20-004584/item1.txt b/raw/filings/0000889900/2019/0001564590-20-004584/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..581bba9a029ed98184f3f9ed91bbd0046ab05896 --- /dev/null +++ b/raw/filings/0000889900/2019/0001564590-20-004584/item1.txt @@ -0,0 +1,345 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. We were formed in 1978 and reincorporated in 1993 as a Delaware corporation. +Our contract drilling business operates in the continental United States and western Canada , and, from time to time, we pursue contract drilling opportunities outside of North America . As of December 31, 2019, we had a drilling fleet that consisted of 216 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Mid-Continent and Appalachian regions. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2019, we had approximately 1.3 million fracturing horsepower to provide these services. We also provide wireline and cementing services through the pressure pumping segment. Our wireline services offering primarily consists of “plug-and-perf,” which involves the setting of plugs between hydraulic fracturing stages and the creation of perforations for each cluster within the fracturing stage itself. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, downhole performance motors, measurement-while-drilling, wireline steering tools and services that improve the statistical accuracy of horizontal wellbore placement. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Recent Developments in Financing and Merger and Acquisition Activity — On November 15, 2019, we completed an offering of $350 million in aggregate principal amount of our 5.15% Senior Notes due November 15, 2029 (the “2029 Notes”). The net proceeds before offering expenses were approximately $347 million. On December 16, 2019, we used a portion of the net proceeds from the offering to prepay our 4.27% Series B Senior Notes due June 14, 2022. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $315 million, plus accrued interest to the prepayment date. The remaining net proceeds and available cash on hand was used to repay $50 million of the borrowings under the Term Loan Agreement (as defined below). +On August 22, 2019, we entered into a term loan agreement (the “Term Loan Agreement”) that permits a single borrowing of up to $150 million, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $75 million, not to exceed total commitments of $225 million. On September 25, 2019, we used $150 million of borrowings from the Term Loan Agreement and approximately $158 million of cash on hand to prepay our 4.97% Series A Senior Notes due October 5, 2020 . The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $308 million, plus accrued interest to the prepayment date. We repaid $50 million of the borrowings +3 +under the Term Loan Agreement on December 16, 2019, and we had $100 million in outstanding borrowings under the Term Loan Agreement as of December 31, 2019. +On October 25, 2018, we acquired all of the issued and outstanding shares of Current Power Solutions, Inc. (“Current Power”). Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. +On March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. +On February 20, 2018, we acquired the business of Superior QC, LLC (“Superior QC”), including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. +On January 19, 2018, we completed an offering of $525 million in aggregate principal amount of our 3.95% Senior Notes due 2028 . The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. +On October 11, 2017, we acquired all of the issued and outstanding limited liability company interests of MS Directional, LLC (f/k/a Multi-Shot, LLC) (“MS Directional”). MS Directional is a leading directional drilling services company in the United States, with operations in most major producing onshore oil and gas basins. MS Directional provides a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, measurement-while-drilling, and wireline steering tools. +On April 20, 2017, pursuant to an Agreement and Plan of Merger with Seventy Seven Energy Inc. (“SSE”), a subsidiary of ours was merged with and into SSE (the “SSE merger”), with SSE continuing as the surviving entity and one of our wholly-owned subsidiaries. On April 20, 2017, following the SSE merger, SSE was merged with and into our newly-formed subsidiary named Seventy Seven Energy LLC (“SSE LLC”), with SSE LLC continuing as the surviving entity and one of our wholly-owned subsidiaries. Through the SSE merger, we acquired a fleet of 91 drilling rigs, 36 of which we consider to be APEX® rigs. Additionally, through the SSE merger, we acquired approximately 500,000 horsepower of fracturing equipment located in Oklahoma and Texas. The oilfield rentals business acquired through the SSE merger has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. +Operational data in the discussion and analysis in this Report includes the results of operations of Current Power since October 25, 2018, the results of operations of Superior QC since February 20, 2018, the results of operations of the MS Directional business since October 11, 2017 and the results of operations of the SSE businesses since April 20, 2017. +4 +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 201 7 , 201 8 and 201 9 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2017: +Average oil price per Bbl (1) +$ +51.77 +$ +48.24 +$ +48.16 +$ +55.37 +Average rigs operating per day - U.S. (2) +81 +145 +159 +159 +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Oil prices have recovered from a 12-year low of $26.19 in February 2016 and reached a high of $77.41 in June 2018. Oil prices remain volatile, as the closing price of oil began the year at a low of $46.31 per barrel on January 2, 2019, before increasing by 43% over the course of four months to reach a high of $66.24 per barrel in late April 2019. Since May 2019, oil prices have generally ranged between $50 and $60 per barrel . Oil prices averaged $56.94 per barrel in the fourth quarter of 2019 and closed at $50.06 per barrel on February 3, 2020 . +Our rig count declined significantly during the industry downturn that began in late 2014, improved following the second quarter of 2016, and has declined since the fourth quarter of 2018. Our average active rig count for the fourth quarter of 2019 was 123 rigs, which included 122 rigs in the United States and less than one rig operating in Canada. This was a decrease from our average active rig count for the third quarter of 2019 of 142 rigs, which included 142 rigs in the United States and less than one rig in Canada. Our rig count in the United States at December 31, 2019 of 121 rigs was less than the rig count of 183 rigs at December 31, 2018. Term contracts have supported our operating rig count during the last three years. Based on contracts currently in place, we expect an average of 77 rigs operating under term contracts during the first quarter of 2020 and an average of 58 rigs operating under term contracts throughout 2020. +The pressure pumping market showed signs of oversupply in the second half of 2018 and was oversupplied in 2019. In response to oversupplied market conditions, we reduced the number of active pressure pumping spreads to 11 as of the end of 2019. We expect to average ten active pressure pumping spreads during the first quarter of 2020. +Industry Segments +Our revenues, operating income (loss) and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Our contract drilling services industry segment had operating losses in 2019, 2018 and 2017. Our pressure pumping services industry segment had operating losses in 2019 and 2018 and operating income in 2017. Our directional drilling services industry segment was a new segment for us as a result of the MS Directional acquisition in 2017 and accounted for approximately 7.6% and 6.3% percent of our 2019 and 2018 consolidated revenues, respectively. Our directional drilling segment had operating losses in 2019, 2018 and 2017. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 16 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +5 +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2019, we had 216 marketed land-based drilling rigs based in the following regions: +• +64 in west Texas and southeastern New Mexico, +• +18 in north central and east Texas and northern Louisiana, +• +35 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +25 in south Texas, +• +31 in western Oklahoma, +• +37 in the Appalachian region (Pennsylvania, Ohio and West Virginia), and +• +6 in western Canada. +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 24,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $943 million during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2019, 2018 and 2017, we spent approximately $194 million, $395 million and $354 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. During 2019, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 20 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +6 +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2019 +2018 +2017 +Average rigs operating per day - U.S. (1) +149 +175 +136 +Average rigs operating per day - Canada (1) +1 +1 +2 +Number of rigs operated during the year +189 +193 +179 +Number of wells drilled during the year +2,703 +3,088 +2,553 +Number of operating days +54,544 +64,479 +50,427 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet during the last several years. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500-ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad-capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2019, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +United States +Canada +Total +Percent Pad-Capable +APEX ® 1500 HP rigs +172 +— +172 +94 +% +APEX ® 1000 HP rigs +12 +— +12 +100 +% +APEX ® 2000 HP rigs +6 +— +6 +67 +% +APEX ® 1400 HP rigs +5 +— +5 +100 +% +APEX ® 1200 HP rigs +3 +— +3 +100 +% +Other electric rigs +12 +6 +18 +72 +% +Total +210 +6 +216 +Average horsepower +1,458 +1,117 +1,448 +The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We currently estimate there are approximately 690 super-spec rigs in the United States, which includes 150 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, West Virginia and western Canada. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas (West and South Regions), the Mid-Continent region (Mid-Con Region) and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. +Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +7 +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.4 million horsepower as of December 31, 2019 . Pressure pumping equipment at December 31, 2019 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +West Texas Region +Number of units +207 +17 +224 +Approximate horsepower +492,000 +18,555 +510,555 +South Texas Region +Number of units +112 +— +112 +Approximate horsepower +270,750 +— +270,750 +Mid-Con Region +Number of units +68 +— +68 +Approximate horsepower +157,000 +— +157,000 +Northeast Region +Number of units +186 +12 +198 +Approximate horsepower +416,900 +8,000 +424,900 +Combined: +Number of units +573 +29 +602 +Approximate horsepower +1,336,650 +26,555 +1,363,205 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +Wireline – Our wireline services offering primarily consists of “plug-and-perf,” which involves the setting of plugs between hydraulic fracturing stages and the creation of perforations for each cluster within the fracturing stage itself. These wireline services are complementary to our pressure pumping services. As of December 31, 2019, we had not yet performed any wireline operations. +Directional Drilling Operations +General – We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, downhole performance motors, measurement-while-drilling (MWD), and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +Directional Drilling Services – We provide our directional drilling services on a day-rate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days of work completed. Our day rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a stand-by rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +8 +Equipment – We generally design, assemble , maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2019 , we had a comprehensive fleet of over 1,000 motors. In addition to our motor fleet, we had over 100 MWD systems. +Horizontal Wellbore Placement – We provide software and services used to improve the statistical accuracy of horizontal wellbore placement. Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. We provide these services to customers with onshore and offshore operations. +Oilfield Rentals +Our oilfield rentals business has a fleet of premium oilfield rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. We offer an extensive line of rental tools, including a full line of tubular products specifically designed for horizontal drilling and completion, with high-torque, premium-connection drill pipe, drill collars and tubing. Additionally, we offer surface rental equipment including blowout preventers, frac tanks, mud tanks and environmental containment that encompass all phases of the hydrocarbon extraction and production process. Our air drilling equipment and services enable extraction in select basins where certain segments of formations preclude the use of drilling fluid, permitting operators to drill through problematic zones without the risk of fluid absorption and damage to the wellbore. We offer oilfield rental services in many of the major producing onshore oil and gas basins in the United States. We price our rentals and services based on the type of equipment being rented and the services being performed. Substantially all rental revenue we earn is based upon a charge for the actual period of time the rental is provided to our customer on a market-based, fixed per-day or per-hour fee. +Other Operations +We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling, oilfield rentals and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2019, we received approximately 41% from our ten largest customers and approximately 26% from our five largest customers. During 2019, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +Our contract drilling backlog as of December 31, 2019 and 2018 was approximately $605 million and $770 million, respectively. Approximately 28% of the total contract drilling backlog at December 31, 2019 is reasonably expected to remain after 2020. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +9 +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +We continue to pursue initiatives to make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example: +• +we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions; and +• +we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +Our goal is to provide an incident-free work environment. The safety of our employees and others is our highest priority, and we have robust safety training programs in place that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All field-based employees are required to attend an Employee Safety Orientation, which includes classes on behavior-based safety, hazard awareness, safe systems of work, permission to work, time out for safety, energy isolation, hazard communication (HAZCOM), material handling and other topics. +We are committed to fostering a work environment where all people feel valued and respected. We offer our workforce the opportunity to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. +In 2019, we trained over 4,000 employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, including wireline services, +• +directional drilling services, +• +services that improve the statistical accuracy of horizontal wellbore placement, including for customers with offshore operations, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +10 +To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations. Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, each as amended, and implementing regulations govern: +• +the prevention of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +11 +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment. Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. We are also aware of legislation proposed by U.S. lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases and Related Divestment and Other Efforts Could Adversely Affect Our Business.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +12 +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Employees +We had approximately 5,800 full-time employees as of February 7, 2020. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Seasonality +Seasonality has not significantly affected our overall operations. However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw. Additionally, toward the end of calendar years, we have recently experienced slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +13 \ No newline at end of file diff --git a/raw/filings/0000889900/2019/0001564590-20-004584/item13.txt b/raw/filings/0000889900/2019/0001564590-20-004584/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2019/0001564590-20-004584/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2019/0001564590-20-004584/item9a.txt b/raw/filings/0000889900/2019/0001564590-20-004584/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..542ca6ba8cbf06747b9fe4c94fe6f27fb9888f3b --- /dev/null +++ b/raw/filings/0000889900/2019/0001564590-20-004584/item9a.txt @@ -0,0 +1,9 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2019, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2019. +The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +49 +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2019/0001564590-20-004584/rp_note.txt b/raw/filings/0000889900/2019/0001564590-20-004584/rp_note.txt new file mode 100644 index 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period from to +Commission File Number 1-39270 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N , Suite 800 , Houston , Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +(281) 765-7100 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Trading Symbol +Name of Exchange on Which Registered +Common Stock, $0.01 Par Value +PTEN +The Nasdaq Global Select Market +Preferred Stock Purchase Rights +The Nasdaq Global Select Market +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ or No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Smaller reporting company +☐ +Non-accelerated filer +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2020, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $ 639 million, calculated by reference to the closing price of $3.47 for the common stock on the Nasdaq Global Select Market on that date. +As of February 4, 2021, the registrant had outstanding 187,736,421 shares of common stock, $0.01 par value, its only class of common stock. +Documents incorporated by reference: +Portions of the registrant’s definitive proxy statement for the 2021 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings, press releases and presentations by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. As used in this Report, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its operations through its wholly-owned subsidiaries and has no employees or independent business operations. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue, cost and margin expectations and backlog; financing of operations; oil and natural gas prices; rig counts and frac spreads; source and sufficiency of funds required for building new equipment, upgrading existing equipment and acquisitions (if opportunities arise); demand and pricing for our services; competition; equipment availability; government regulation; legal proceedings; debt service obligations; impact of inflation; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +adverse oil and natural gas industry conditions; including the rapid decline in crude oil prices as a result of economic repercussions from the COVID-19 pandemic; +• +global economic conditions; +• +volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +excess availability of land drilling rigs, pressure pumping and directional drilling equipment, including as a result of reactivation, improvement or construction; +• +competition and demand for our services; +• +strength and financial resources of competitors; +• +utilization, margins and planned capital expenditures; +• +liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• +the ability to realize backlog; +• +specialization of methods, equipment and services and new technologies, including the ability to develop and obtain satisfactory returns from new technology; +• +the ability to retain management and field personnel; +• +loss of key customers; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +cybersecurity events; +• +synergies, costs and financial and operating impacts of acquisitions; +• +difficulty in building and deploying new equipment; +• +governmental regulation; +1 +• +climate legislation, regulation and other related risks; +• +environmental, social and governance practices, including the perception thereof; +• +environmental risks and ability to satisfy future environmental costs; +• +technology-related disputes; +• +legal proceedings and actions by governmental or other regulatory agencies; +• +the ability to effectively identify and enter new markets; +• +weather; +• +operating costs; +• +expansion and development trends of the oil and natural gas industry; +• +ability to obtain insurance coverage on commercially reasonable terms; +• +financial flexibility; +• +interest rate volatility; +• +adverse credit and equity market conditions; +• +availability of capital and the ability to repay indebtedness when due; +• +stock price volatility; +• +compliance with covenants under our debt agreements; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in our filings with the SEC. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and, from time to time, we pursue contract drilling opportunities in other select markets . As of December 31, 2020, we had a drilling fleet that consisted of 210 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2020, we had approximately 1.3 million fracturing horsepower to provide these services. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors and wireline steering tools. We also provide services that improve the statistical accuracy of horizontal wellbore placement. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +3 +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2018, 2019 and 2020 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in the United States. +Oil prices remain extremely volatile, as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and closed at $53.55 per barrel on February 1, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered from the lows experienced in the first half of 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $42.45 per barrel in the fourth quarter of 2020 . +Our active rig count has declined since the fourth quarter of 2018. Our average active rig count for the fourth quarter of 2020 was 62 rigs. This was an increase from our average active rig count for the third quarter of 2020 of 60 rigs. Our U.S. active rig count at December 31, 2020 of 65 rigs was less than the rig count of 121 rigs at December 31, 2019, due to the significantly reduced demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place, we expect an average of 42 rigs operating under term contracts during the first quarter of 2021 and an average of 34 rigs operating under term contracts throughout 2021. +The pressure pumping market remains oversupplied. In response to oversupplied market conditions, we implemented changes during the second quarter of 2020 to further streamline our operations, improve our efficiencies, and reduce our overall cost structure, while maintaining our customer service levels. +Recent Developments in Financial Matters — During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes (as defined below) in the open market. The principal amounts retired through these transactions totaled $15.5 million related to our 2028 Notes and $0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $3.4 million and $0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +On December 24, 2020, we elected to repay $50 million of the borrowings under our Term Loan Agreement (as defined below). As of December 31, 2020, we had $50 million in borrowings remaining under the Term Loan Agreement at a LIBOR-based interest rate of 1.52%. The maturity date of the Term Loan Agreement is June 10, 2022. +On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement to, among other things, extend the maturity date for $550 million of revolving credit commitments of certain lenders under the Credit Agreement (as defined below) from March 27, 2024 to March 27, 2025. We have the option, subject to certain conditions, to exercise an additional one-year extension of the maturity date. +Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” for additional detail regarding our 2028 Notes, 2029 Notes, Term Loan Agreement and Credit Agreement. +4 +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $38.3 million of charges associated with this plan in the second quarter of 2020. In conjunction with our restructuring, we closed our Canadian drilling operations. We recorded an impairment of $8.3 million associated with that closure. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan. +The following table presents restructuring expenses by reportable segment f or the year ended December 31 , 2020 (in thousands) : +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +Corporate +Total +Severance costs +$ +1,821 +$ +3,460 +$ +503 +$ +501 +$ +215 +$ +6,500 +Contract termination costs +— +20,373 +— +— +— +20,373 +Other exit costs +523 +194 +827 +— +— +1,544 +Right-of-use asset abandonments +86 +7,304 +1,845 +— +686 +9,921 +Total +$ +2,430 +$ +31,331 +$ +3,175 +$ +501 +$ +901 +$ +38,338 +Industry Segments +Our revenues, operating loss and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Our contract drilling services, pressure pumping services, and directional drilling services industry segments had operating losses in 2020, 2019 and 2018. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 17 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2020, we had 210 marketed land-based drilling rigs based in the following regions: +• +68 in west Texas and southeastern New Mexico, +• +19 in north central and east Texas and northern Louisiana, +• +35 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +23 in south Texas, +• +29 in western Oklahoma, and +• +36 in the Appalachian region (Pennsylvania, Ohio and West Virginia). +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 24,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $694 million during the last three years on capital expenditures to modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2020, 2019 and 2018, we spent approximately $105 million, $194 million and $395 million, respectively, on these capital expenditures. +5 +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. During 2020, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 19 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2020 +2019 +2018 +Average rigs operating per day (1) +82 +149 +177 +Number of rigs operated during the year +132 +189 +193 +Number of wells drilled during the year +1,327 +2,703 +3,088 +Number of operating days +29,904 +54,544 +64,479 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in the United States. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet during the last several years. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500-ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad-capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2020, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +Total +Percent Pad-Capable +APEX ® 1500 HP rigs +172 +94 +% +APEX ® 1000 HP rigs +12 +100 +% +APEX ® 2000 HP rigs +6 +67 +% +APEX ® 1400 HP rigs +5 +100 +% +APEX ® 1200 HP rigs +3 +100 +% +Other electric rigs +12 +83 +% +Total +210 +Average horsepower +1,458 +6 +The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We currently estimate there are approximately 690 super-spec rigs in the United States, which includes 150 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio and West Virginia. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. The scope and impact of our cementing services were insignificant during the fiscal years 2020, 2019 and 2018. +Pressure Pumping Contracts — Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.4 million horsepower as of December 31, 2020. Pressure pumping equipment at December 31, 2020 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +Texas Region +Number of units +401 +17 +418 +Approximate horsepower +953,250 +18,555 +971,805 +Northeast Region +Number of units +167 +11 +178 +Approximate horsepower +371,150 +7,500 +378,650 +Other Regions +Number of units +5 +— +5 +Approximate horsepower +12,250 +— +12,250 +Combined: +Number of units +573 +28 +601 +Approximate horsepower +1,336,650 +26,055 +1,362,705 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +Materials — Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +7 +Directional Drilling Operations +General — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (MWD) and supply and rental of downhole performance motors and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +Directional Drilling Services — We provide our directional drilling services on a dayrate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days of work completed. Our dayrates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a standby rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Equipment — We generally design, assemble, maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2020, we had a comprehensive fleet of over 1,000 motors. In addition to our motor fleet, we had over 100 MWD systems. +Wellbore Placement Data Analytics — We provide software and services used to improve the statistical accuracy of horizontal wellbore placement. Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. We provide these services to customers with onshore and offshore operations. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing onshore oil and gas basins in the United States. We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2020, we received approximately 54% from our ten largest customers and approximately 35% from our five largest customers. During 2020, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +Backlog +Our contract drilling backlog as of December 31, 2020 and 2019 was approximately $301 million and $605 million, respectively. Approximately 21% of the total contract drilling backlog at December 31, 2020 is reasonably expected to remain after 2021. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +We encourage you to review our latest Sustainability Report, located on our website, for more detailed information regarding our Sustainability and Human Capital programs and initiatives. Nothing on our website, including our Sustainability Report or sections thereof, shall be deemed incorporated by reference into this Report or other filings that we make with the SEC. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell™ lithium battery hybrid energy management system. EcoCell™ is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 3,000 full-time employees as of January 31, 2021. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs in place that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All field-based employees are required to attend an Employee Safety Orientation, which includes classes on behavior-based safety, hazard awareness, safe systems of work, permission to work, time out for safety, energy isolation, hazard communication (HAZCOM) and material handling. In response to the COVID-19 pandemic, we implemented, and continue to implement, safety protocols at our offices, facilities and worksites. These protocols include allowing many of our office-based employees to work from home, while implementing additional safety measures for employees continuing critical on-site work. +9 +Diversity and Inclusion – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require our employees to complete training on an annual basis regarding our commitment to a respectful workplace for all. Supervisors and managers are required to complete respectful workplace training to ensure they understand our expectations for them regarding their obligations to promote a work environment where all employees feel valued and respected. +Maintaining our Core Values – In 2020, we trained over 4,000 employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, +• +services that improve the statistical accuracy of horizontal wellbore placement, including for customers with offshore operations, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. Federal, state, foreign, regional and local environmental laws, rules and regulations, including laws, rules, regulations and executive actions related to the mitigation of climate change or greenhouse gas emissions, currently apply to our operations and are likely to become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We +10 +could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that may govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act (the “Clean Water Act”) and the Oil Pollution Act of 1990 (the “Oil Pollution Act”), each as amended, and implementing regulations govern: +• +the prevention and permitting of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Clean Water Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +11 +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Certain politicians have also vocalized support for a nationwide ban on hydraulic fracturing. Additional legislation or regulation could lead to operational delays or increased operating costs in the production of oil and natural gas or could make it more difficult to perform hydraulic fracturing. These developments could also lead to litigation challenging proposed or existing wells. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we provide for our exploration and production customers , and such efforts could adversely affect our business, financial condition, cash flows and results of operations . See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. There has also been legislation proposed by U.S. lawmakers to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA, and future federal action to address climate change is likely. +President Biden and the Democratic Party, which now controls Congress, have identified climate change as a priority, and it is likely that new executive orders, regulatory action, and/or legislation targeting greenhouse gas emissions, or prohibiting, delaying or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. For example, the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee, and President Biden recently announced a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of Federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. President Biden also announced that the United States is taking steps to reenter the Paris Agreement. +Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and +12 +reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we have recently experienced slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +13 +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +Business and Operating Risks +The Effects of the COVID-19 Pandemic, Have Had, and Are Expected to Continue to Have, a Significant Adverse Impact on Our Business, Liquidity, Results of Operations and Financial Condition. +The effects of the COVID-19 pandemic, including related governmental actions and restrictions, have had, and are expected to continue to have, a significant adverse impact on the global economy, including the worldwide demand for oil and natural gas, and the level of demand for our services, which has impacted and is expected to continue to impact our business, liquidity, results of operations and our financial condition. +In response to the COVID-19 pandemic, governmental authorities have imposed mandatory closures, sought voluntary closures and imposed restrictions on, or advisories with respect to, travel, business operations and public gatherings or interactions. While some governmental authorities have re-opened various sectors of the economy, the ongoing COVID-19 outbreak may significantly worsen, and new strains of COVID-19 may emerge, which may cause governmental authorities to reconsider restrictions on travel, business and social activities. In the event governmental authorities retain, increase or reimpose restrictions, the re-opening of the economy may be further curtailed. +In early March 2020, OPEC+ was initially unable to reach an agreement to continue to impose limits on the production of crude oil, and shortly thereafter the World Health Organization determined the COVID-19 outbreak to be a pandemic. The convergence of these events created the unprecedented dual impact of a global oil demand decline coupled with the risk of a substantial increase in supply. In response to the rapid decline in commodity prices, exploration and production companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered from the lows experienced in the first half of 2020, customer spending has not returned to pre-pandemic levels. +Given the nature and significance of the events described above, we are not able to enumerate all potential risks to our business from the recent volatility in crude oil prices and the COVID-19 pandemic; however, we believe that in addition to the impacts described above, other current and potential impacts of these recent events include, but are not limited to: +• +liquidity challenges, including impacts related to delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies; +• +customers, suppliers and other third parties seeking to terminate, reject, renegotiate or otherwise avoid, and otherwise failing to perform, their contractual obligations to us; +• +additional credit rating downgrades of our corporate debt and potentially higher borrowing costs in the future; +• +a need to preserve liquidity, which could result in a further reduction or suspension of our quarterly dividend or a delay or change in our capital investment plan; +• +cybersecurity issues, as digital technologies may become more vulnerable and experience a higher rate of cyberattacks in the current environment of remote connectivity; +• +litigation risk and possible loss contingencies related to COVID-19 and its impact, including with respect to commercial contracts, employee matters and insurance arrangements; +• +disruption to our supply chain for raw materials essential to our business; +• +a further reduction of our workforce to adjust to market conditions, including severance payments, retention issues, and an inability to hire employees when market conditions improve; +• +additional costs associated with rationalization of our portfolio of real estate facilities, including exit of leases and facility closures to align with expected activity and workforce capacity; +• +additional asset impairments, along with other accounting charges; +• +additional infections and quarantining of our employees and the personnel of our customers, suppliers and other third parties in areas in which we operate and delays or suspensions of operations resulting therefrom; +14 +• +additional actions undertaken by international, national, regional and local governments and health officials to contain the virus or treat its effects; and +• +a structural shift in the global economy and its demand for oil and natural gas as a result of changes in the way people work, travel and interact, or in connection with a global recession or depression. +The full extent of the impact of COVID-19 on our business, liquidity, results of operations and financial condition will depend largely on future developments, including the duration and further spread of the virus, including any new strains of COVID-19, and the related impact on the oil and gas industry, the impact of governmental actions designed to prevent the spread of COVID-19 and the further development and availability of effective treatments and vaccines, all of which are highly uncertain. +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in the United States. When these expenditures decline, our business may suffer. The rapid decline in oil prices resulting from the COVID-19 pandemic and the activities of OPEC+ has caused a significant decline in both customer activity and prices for our services, which has had, and is expected to continue to have, a significant impact on our business. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling, pressure pumping and directional drilling services, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the availability of capital for oil and natural gas industry participants, including our customers, +• +the availability of and constraints in pipeline, storage and other transportation capacity in the basins in which we operate, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production, use and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, +• +increased focus by the investment community on sustainability practices in the oil and natural gas industry, and +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Oil and natural gas prices and markets can be extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, including impacts on supply and demand due to economic repercussions from the COVID-19 pandemic, +• +the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil-producing nations, such as Russia, to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +• +domestic and international military, political, economic, health and weather conditions, including the impacts of war or terrorist activity, pandemics and other unexpected disasters or events such as the COVID-19 pandemic, +• +changes to tax, tariff and import/export regulations by the United States or other countries, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +• +the price and availability of alternative fuels and energy sources. +15 +All of these factors are beyond our control. Oil prices remain extremely volatile , as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and closed at $53.55 per barrel on February 1, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered from the lows experienced in the first half of 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $42.45 per barrel in the fourth quarter of 2020. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Global Economic Conditions May Adversely Affect Our Operating Results. +Demand for energy and for oil and natural gas end products is highly sensitive to economic conditions; as a result, global economic conditions, indications that economic growth is slowing and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, including economic repercussions from the COVID-19 pandemic, low commodity prices or otherwise, may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. An economic slowdown or recession in the United States or in any other country that significantly affects the supply of or demand for oil or natural gas could negatively impact our operations and therefore adversely affect our results. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, including as a result of the COVID-19 pandemic, and there is no assurance that the global economic environment, or expectations for the global economic environment, will recover in the near term or not quickly deteriorate again due to one or more factors, including due to uncertainties relating to the COVID-19 pandemic. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +A Surplus of Equipment and a Highly Competitive Oil Service Industry May Adversely Affect Our Utilization and Profit Margins and the Carrying Value of our Assets. +The land drilling and pressure pumping industries in the United States are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment or capital spending reductions by our customers due to customer consolidation, to investor requirements or other reasons can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. In addition, in recent years there has been a substantial increase in new and upgraded drilling rigs and pressure pumping equipment. Low commodity prices and new and upgraded equipment can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. Even in an environment of high oil and natural gas prices and increased drilling activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to a surplus of equipment. +Due to the recently significantly reduced demand for our services, certain of our industry competitors may initiate bankruptcy proceedings or engage in debt refinancing transactions, management changes, or other strategic initiatives in an attempt to reduce operating costs to maintain a position in the market. This could result in such competitors emerging with stronger or healthier balance sheets and, in turn, an improved ability to compete with us in the future. We may also see corporate consolidations among both our customers and competitors, which could significantly alter industry conditions and competition within the industry, and have a material adverse effect on our business, financial condition, cash flows and results of operations. +16 +We periodically seek to increase the prices on our services to offset rising costs , earn returns on our capital investment, and otherwise generate higher returns for our stockholders. However, we operate in a very competitive industry , and we are not always successful in raising or maintaining our existing prices. With the active rig count well below the peak seen in 2014 and many rigs, including highly capable AC rigs, and pressure pumping equipment still idle, there is considerable pricing pressure in the industry. Even if we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial condition , cash flows and results of operations. In addition, we may be unable to replace fixed-term contracts that were terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. +Accordingly, high competition and a surplus of equipment can cause oil and natural gas service contractors to have difficulty maintaining pricing, utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or surplus equipment in the oil and natural gas service businesses or the level of demand for our contract drilling, pressure pumping or directional drilling services. +The surplus of operable land drilling rigs, increasing rig specialization and surplus of pressure pumping and directional drilling equipment, which has been exacerbated by a decline in oil and natural gas prices, could affect the fair market value of our drilling, pressure pumping and directional drilling equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices could result in future impairment to our long-lived assets and goodwill. For example, we recognized impairment charges of $395 million, $221 million and $277 million in 2020, 2019 and 2018, respectively. +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance . +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +17 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available , or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $ 10 .0 million per occurrence deductible on our general liability coverage , a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage , and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most of our cyber security risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations, including as a result of their bankruptcy. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2020, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $301 million. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a description of our calculation of backlog. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts or may be reduced by price adjustments to existing contracts, including as a result of the decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services. +New Technologies May Cause Our Operating Methods, Equipment and Services to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance, including environmental performance, of drilling rigs and pressure pumping and other equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and pressure pumping and other equipment, as well as new and improved technology, such as drilling automation technology and lower-emissions operations and services, and data analytics. Accordingly, we may have to allocate a higher proportion of our capital expenditures to maintain and improve existing rigs and pressure pumping and other equipment, purchase and construct newer, higher specification drilling rigs and pressure pumping and other equipment to meet the increasingly sophisticated needs of our customers, and develop new and improved technology and data analytics. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping and directional drilling businesses could have similar effects. +18 +In recent years, we have added drilling rigs to our fleet through new construction, purchased new pressure pumping equipment and acquired a directional drilling services company. We have also improved existing drilling rigs and pressure pumping equipment by adding equipment and technology designed to enhance functionality and performance. Although we take measures to ensure that we use advanced oil and natural gas drilling, pressure pumping and directional drilling technology, changes in technology, improvements in competitors’ equipment , increasing customer demands for new and improved technology, such as drilling automation technology and lower-emissions operations and services, and changes relating to the wells to be drilled and completed could make our equipment less competitive. +We continually attempt to develop new technologies for use in our business. In the event that we are successful in developing new technologies for use in our business, there is no guarantee of future demand for those technologies. Customers may be reluctant or unwilling to adopt our new technologies. We may also have difficulty negotiating satisfactory terms for our new technologies, including terms that would enable us to obtain acceptable returns on our investment in the research and development of new technologies. +Development of new technology is critical to maintaining our competitiveness. There can be no assurance that we will be able to successfully develop technology that our customers demand. Some of our competitors have greater financial, technical and personnel resources that may allow them to enjoy technological advantages and develop and implement new technology on a more timely basis or in a more cost-effective manner. If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment and services obsolete, which could reduce our competitiveness and have a material adverse impact on our business, financial condition, cash flows and results of operation. +Loss of Key Personnel and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations. +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses and in developing new technologies. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel, particularly after a prolonged industry downturn. During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of key personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even in a period of generally lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2020, we received approximately 54% from our ten largest customers and approximately 35% from our five largest customers and 8% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Shortages, Delays in Delivery, and Interruptions in Supply, of Equipment and Materials Could Adversely Affect Our Operating Results. +Periodically, the oilfield services industry has experienced shortages of equipment for upgrades, drill pipe, replacement parts and other equipment and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +transportation and other logistical challenges, and +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +19 +These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs. Severe shortages, delays in delivery and interruptions in supply could limit our ability to operate, maintain, upgrade and construct our drilling rigs and pressure pumping and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Business Is Subject to Cybersecurity Risks and Threats. +Our operations are increasingly dependent on effective and secure information technologies and services. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, attempts to gain unauthorized access to our data and systems, theft, viruses, malware, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• +theft or misappropriation of funds, including via “phishing” or similar attacks directed at us or our customers; +• +loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• +disruption or impairment of our and our customers’ business operations and safety procedures; +• +destruction or damage to our and our customers’ equipment; +• +downtime and loss of revenue; +• +injury to our reputation; +• +negative impacts on our ability to compete; +• +loss or damage to our information technology systems, including worksite data delivery systems; +• +exposure to litigation; and +• +increased costs to prevent, respond to or mitigate cybersecurity events. +In response to the COVID-19 pandemic, many of our office personnel moved to a “remote work” model in March 2020. This model has significantly increased the use of remote networking and online conferencing services that enable employees to work outside of our corporate infrastructure and, in some cases, use their own personal devices. This may expose us to additional cybersecurity risks or related incidents. +Although we utilize various procedures and controls to mitigate our exposure to the risks described above, cybersecurity attacks and other cyber events are evolving and unpredictable. There can be no assurance that the procedures and controls that we implement, or that we cause third party service providers to implement, will be sufficient to protect our systems, information or other property. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber incident could go unnoticed for a period of time. We self-insure most of our cybersecurity risks, and any such incident could have a material adverse effect on our business, financial condition, cash flows and results of operations. As cyber incidents continue to evolve, we may be required to incur additional costs to continue to modify or enhance our protective measures or to investigate or remediate the effects of cyber incidents. +Our Commitments Under Supply Agreements Could Exceed Our Requirements, Exposing Us to Risks Including Price, Timing of Delivery and Quality of Equipment and Materials Upon Which Our Business Relies. +We have purchase commitments with certain vendors to supply equipment and materials, including, in the case of our pressure pumping business, proppants . Some of these agreements are take-or-pay agreements with minimum purchase obligations. If demand for our services decreases from current levels, demand for the equipment that we use and the materials that we supply as part of these services will also decrease. In addition, some of our customers may self-source certain materials. If demand for our services and/or materials decreases enough, we could have contractual minimum commitments that exceed the required amount of materials we need to supply to our customers. In this instance, we could be required to purchase materials that we do not have a present need for, pay for materials that we do not take delivery of or pay prices in excess of market prices at the time of purchase. +20 +Growth Through Acquisitions , the Building or Upgrading of Equipment and the Development of Technology Is Not Assured. +We have grown our drilling rig fleet and pressure pumping fleet and expanded our business lines and use of technology in the past through mergers, acquisitions, new construction and technology development. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building or upgrading equipment or developing new technology. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, our competitors may continue to build new equipment and develop new technology, including drilling automation technology and lower-emissions operations and services. +There can be no assurance that we will: +• +have sufficient capital resources to complete additional acquisitions, build or upgrade equipment or develop new technology, +• +successfully integrate additional equipment, acquired or developed technology or other assets or businesses, +• +effectively manage the growth and increased size of our organization, +• +successfully deploy idle, stacked, upgraded or additional equipment and acquired or developed technology, +• +maintain the crews necessary to operate additional equipment or the personnel necessary to evaluate, develop and deploy new technology, or +• +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition, the building or upgrading equipment or the development of new technology. +Our failure to achieve consolidation savings, to integrate acquired businesses and technology and other assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising from events prior to any acquisitions, prior to our establishment of adequate compliance oversight or in connection with disputes over acquired or developed technology. While we generally seek to obtain indemnities for liabilities arising from events occurring before such acquisitions, these are limited in amount and duration, may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build or upgrade equipment or develop new technology, and we also may issue equity, convertible or debt securities in connection with any such acquisitions or building or upgrade program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. +Fuel Conservation Measures Could Reduce Demand for Oil and Natural Gas, Which Would, In Turn, Reduce the Demand for Our Services. +Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas may have a material adverse effect on our business, financial condition, cash flows and results of operations. Additionally, the increased competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, and biofuels) could reduce demand for oil and natural gas and therefore for our services, which would lead to a reduction in our revenues. +21 +Legal and Regulatory Risks +Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations. +Numerous political and regulatory authorities, governmental bodies and officials, and environmental groups devote resources to campaigns aimed at eradicating hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. President Biden and other presidential candidates stated that they would support either increased regulation or a ban on hydraulic fracturing; however, we cannot predict whether hydraulic fracturing regulations will be enacted during the Biden Administration or how stringent they may be. In addition, members of the U.S. Congress and the EPA have reviewed proposals for more stringent regulation of hydraulic fracturing, and various state and local initiatives have been or may be proposed or implemented to further regulate hydraulic fracturing. For example, the EPA conducted a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater and released its final report in December 2016. It concluded that hydraulic fracturing activities can impact drinking water resources under some circumstances, including large volume spills and inadequate mechanical integrity of wells. Further, we conduct drilling, pressure pumping and directional drilling activities in numerous states. Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. When caused by human activity, such seismic activity is called induced seismicity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) and other aspects of the oil and gas industry. +In addition, legislation has been proposed, but not enacted, in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if enacted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SDWA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel. In May 2014, the EPA issued an Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing. The EPA has not yet finalized this rule. In June 2016, the EPA published final pretreatment standards for disposal of wastewater produced from shale gas operations to publicly owned treatment works. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations. For example, Colorado, Louisiana, Montana, North Dakota, Texas and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in response to such regulation. +In addition, in light of concerns about induced seismicity, some state regulatory agencies have modified their regulations or issued orders to address induced seismicity. For example, the Oklahoma Corporation Commission (“OCC”) has implemented volume reduction plans, and at times required shut-ins, for oil and natural gas disposal wells injecting wastewater into the Arbuckle formation. The OCC also recently released well completion seismicity guidelines for operators in the SCOOP and STACK plays that call for hydraulic fracturing operations to be suspended following earthquakes of certain magnitudes in the vicinity. +Finally, several jurisdictions have taken steps to enact hydraulic fracturing bans, moratoria or increased regulations on hydraulic fracturing practices. In June 2015, New York banned high volume fracturing activities combined with horizontal drilling. Certain communities in Colorado have also enacted bans on hydraulic fracturing. Voters in the city of Denton, Texas approved a moratorium on hydraulic fracturing in November 2014, though it was later lifted in 2015. These actions have been the subject of legal challenges. In November 2018, voters rejected an initiative that would have materially restricted hydraulic fracturing activity in Colorado; however, the Colorado state legislature subsequently passed a package of oil and gas development regulations in April 2019. In November 2019, the California governor’s office imposed new regulations on hydraulic fracturing, including a moratorium on all new hydraulic fracturing permits pending review by a panel of scientists. Recently, bills have been introduced in the New Mexico Senate to place a moratorium on hydraulic fracturing. Further, at various times during his campaign, President Biden proposed a ban of new leases for production of minerals on federal lands, and the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee. Subsequently, +22 +President Biden issued an executive order imposing a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive revi ew and reconsideration of f ederal oil and gas permitting and leasing practices . +The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could restrict our ability, or make it more difficult, to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. Additionally, the adoption of significant restrictions or a prohibition on hydraulic fracturing by a state, region or locality could result in a surplus of oilfield equipment in other states, regions or localities where hydraulic fracturing remains allowed. +Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services. +The physical and regulatory effects of climate change could have a negative impact on our operations, our customers’ operations and the overall demand for our customers’ products and, accordingly, our services. There is an increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. These efforts have included consideration of cap-and-trade programs, carbon taxes, GHG reporting and tracking programs and regulations that directly limit GHG emissions from certain sources. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. In the absence of federal GHG-limiting legislation, the EPA has determined that GHG emissions present a danger to public health and the environment and has adopted regulations that, among other things, establish construction and operating permit reviews for GHG emissions from certain large stationary sources, require the monitoring and annual reporting of GHG emissions from certain oil and natural gas system sources, implement CAA emission standards directing the reduction of methane emissions from certain new, modified, or reconstructed facilities in the oil and natural gas sector, and together with the DOT, implement GHG emissions limits on vehicles manufactured for operation in the United States. +In April 2016, the United States signed the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, every five years. In November 2020, the United States’ previously-announced withdrawal from the Paris Agreement became effective. On January 20, 2021 President Biden announced that the United States would be reentering the Paris Agreement. This reentry will become effective on February 19, 2021. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +Governmental, scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks in the United States. Critical declarations made by one or more presidential candidates included proposals to ban hydraulic fracturing of oil and natural gas wells and bans on new leases for production of minerals on federal lands. President Biden and the Democratic Party, which now controls Congress, have identified climate change as a priority, and it is likely that new executive orders, regulatory action, and/or legislation targeting greenhouse gas emissions, or prohibiting or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. For example, the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee, and President Biden issued an executive order imposing a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Other actions impacting oil and natural gas production activities that could be pursued by the Biden administration may include more restrictive requirements for the establishment of pipeline infrastructure or the permitting of liquified natural gas export facilities. +It is not possible at this time to predict the timing and effects of climate change or to predict the timing or effect of rejoining the Paris Agreement or whether additional climate-related legislation, regulations or other measures will be adopted at the local, state, regional, national and international levels. However, continued efforts by governments and non-governmental organizations to reduce GHG emissions appear likely, and additional legislation, regulation or other measures that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our business. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, +23 +existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations increase compliance costs, add operating restrictions, or reduce demand for our customers’ products and, accordingly, our services. +There are also increasing financial risks for oil and natural gas producers, as stockholders and bondholders currently invested in oil and natural gas companies concerned about the potential effects of climate change and other sustainability-related issues may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors. Additionally, the lending and investment practices of institutional lenders and investors have been the subject of intensive lobbying efforts in recent years, oftentimes public in nature, not to provide funding for oil and natural gas producers. Limitation of investments in and financings for oil and natural gas could result in the restriction, delay, or cancellation of drilling and completion programs or development of production activities. An increasing number of our customers consider sustainability factors in awarding work. If we are unable to successfully continue our sustainability enhancement efforts, we may lose customers, our stock price may be negatively impacted, our reputation may be negatively affected, and it may be more difficult for us to effectively compete. +Increasing attention to the risks of climate change has resulted in an increased possibility of lawsuits or investigations brought by public and private entities against oil and natural gas companies in connection with their GHG emissions. Should we be targeted by any such litigation or investigations, we may incur liability, which, to the extent that societal pressures or political or other factors are involved, could be imposed without regard to the causation of or contribution to the asserted damage, or to other mitigating factors. +These political, litigation, and financial risks may result in our customers restricting or cancelling production activities, incurring liability for infrastructure damage as a result of climatic changes, or impairing their ability to continue to operate in an economic manner, which also could reduce demand for our products and services. One or more of these developments could have a material adverse effect on our business, financial condition, cash flows and results of operations. Finally, increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, floods and other climatic events. If any such effects were to occur, they could have an adverse effect on our operations. +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties or judgments, +• +modification, denial or revocation of permits or other authorizations, +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the places that we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, a manufacturer and servicer of equipment and automation to the energy, marine and mining industries and a provider of directional drilling and other services, we may be deemed to be a responsible party under these laws and regulations. +Technology Disputes Could Negatively Impact Our Operations or Increase Our Costs. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, or a third party’s infringement of our rights, including patent rights. The majority of the intellectual property rights relating to our drilling rigs, pressure pumping equipment and directional drilling services are owned by us or certain of our supplying vendors. However, in the event that we or one of our customers or supplying vendors becomes involved in a dispute over infringement of intellectual property rights relating to equipment or technology owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or technology or our ability to provide services or products, or we could be required to cease use of some equipment or technology or forced to modify our equipment, technology, services or products. We could also be required to pay license fees or royalties for the use of equipment or technology or provision of services or products. In addition, we may lose a competitive advantage in the event we are unsuccessful in enforcing our rights against third parties. Technology disputes involving us or our customers or supplying vendors could have a material adverse impact on our business, financial condition, cash flows and results of operations. +24 +The Design, Manufacture, Sale and Servicing of Products, including Electrical Controls, May Subject Us to Liability for Personal Injury, Property Damage and Environmental Contamination Should Such Equipment Fail to Perform to Specifications. +We provide products, including electrical controls, to customers involved in oil and gas exploration, development and production and in the marine and mining industries. Because of applications that use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause harm to our reputation, contractual and warranty-related liability, damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. +Legal Proceedings and Governmental Investigations Could Have a Negative Impact on Our Business, Financial Condition and Results of Operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Additionally, actions or decisions we have taken or may take as a consequence of the COVID-19 pandemic may result in investigations, litigation or legal claims against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Please see “Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect Our Opportunities and Future Business. +We sell products, including electrical controls, for use in numerous oil and gas producing regions outside of North America, and through our Superior QC business, we occasionally provide remote data analytics and other services to customers to support their operations outside of the United States. We also continue to evaluate opportunities from time to time to provide our other services outside of the United States. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +25 +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where our services could be provided or where our consumers for products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. In addition, investors could negatively view potential violations, inquiries or allegations of misconduct under the FCPA or similar laws, which could adversely affect our reputation and the market for our shares. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +Many countries, including the United States, control the import and export of certain goods, services and technology and impose related import and export recordkeeping and reporting obligations. Governments also may impose economic sanctions against certain countries, persons and other entities that may restrict or prohibit transactions involving such countries, persons and entities. In particular, U.S. sanctions are targeted against certain countries that are heavily involved in the oil and gas industry. The laws and regulations concerning import and export activity, recordkeeping and reporting, including customs, export controls and economic sanctions, are complex and constantly changing. Any failure to comply with applicable legal or regulatory requirements governing international trade could also result in criminal and civil penalties and sanctions, such as fines, imprisonment, debarment from government contracts, seizure of shipments and loss of import and export privileges. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +Financial Risks +We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under Our Long-Term Debt. +We have borrowings outstanding under our senior notes and our term loan agreement and, from time to time, our revolving credit facility. Our ability to meet our interest and principal payment obligations depends in large part on cash flows from our subsidiaries. If our subsidiaries do not generate sufficient cash flows, we may be unable to meet our interest and principal payment obligations. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured term loan facility under our Term Loan Agreement. Interest is paid on the outstanding principal amount of borrowings under the Term Loan Agreement at a floating rate based on, at our election, LIBOR or a base rate . The applicable margin on LIBOR rate loans varies from 1.00% to 1.375%, and the applicable margin on base rate loans varies from 0.00% to 0.375%, in each case determined based upon our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans and base rate loans was 1.375% and 0.375%, respectively. As of December 31, 2020, we had $50 million in borrowings outstanding under the Term Loan Agreement. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. As of December 31, 2020, we had no borrowings outstanding under our revolving credit facility. +Finally, we have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2020, no amounts had been disbursed under any letters of credit. +26 +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed at floating rates under these agreements or under future agreements . +A Downgrade in Our Credit Rating Could Negatively Impact Our Cost of and Ability to Access Capital. +Our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels, industry conditions and other considerations, including the impact of the COVID-19 pandemic. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, and potentially require us to post letters of credit for certain obligations. +We May Not Be Able to Generate Sufficient Cash to Service All of Our Debt and We May Be Forced to Take Other Actions to Satisfy Our Obligations Under Our Debt, which May Not Be Successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our debt agreements contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +Risks Related to Our Common Stock and Corporate Structure +The Market Price of Our Common Stock May Be Highly Volatile, and Investors May Not Be Able to Resell Shares at or Above the Price Paid. +The trading price of our common stock may be volatile. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as other general economic, market or political conditions, could reduce the market price of our common stock in spite of our operating and/or financial performance. The following factors, in addition to other factors described in this “Risk Factors” section and elsewhere in this Report, may have a significant impact on the market price of our common stock: +• +investor perception of us and the industry and markets in which we operate; +• +general financial, domestic, international, economic, and market conditions, including overall fluctuations in the U.S. equity markets; +• +increased focus by the investment community on sustainability practices at our company and in the oil and natural gas industry generally; +• +changes in customer needs, expectations or trends and our ability to maintain relationships with key customers; +• +our ability to implement our business strategy; +• +changes in our capital structure, including the issuance of additional debt; +• +public announcements (including the timing of these announcements) regarding our business, financial performance and prospects or new services or products, service or product enhancements, technological advances or strategic actions, such as acquisitions or divestitures, restructurings or significant contracts, by our competitors or us; +• +trading activity in our stock, including portfolio transactions in our stock by us, our executive officers and directors, and significant stockholders or trading activity that results from the ordinary course rebalancing of stock indices in which we may be included; +• +short-interest in our common stock, which could be significant from time to time; +• +our inclusion in, or removal from, any stock indices; +27 +• +changes in earnings estimates or buy/sell recommendations by securities analysts; +• +whether or not we meet earnings estimates of securities analysts who follow us; and +• +regulatory or legal developments in the United States and foreign countries where we operate. +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. In addition, we have adopted a stockholder rights agreement that could make it more difficult for a third-party to acquire our common stock without the approval of our Board of Directors. +28 +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania, and Ohio. +Pressure Pumping — Our pressure pumping services are supported by multiple offices and yard facilities located in Texas and Pennsylvania. +Directional Drilling — Our directional drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, North Dakota, and Ohio. +Our oilfield rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our servicing of equipment for drilling contractors is supported by offices and yard facilities located in Texas. Our electrical controls and automation operation is supported by an office and yard facility in Texas. Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas, as well as several other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +Item 4. Mine Safety Disclosure. +Not applicable. +29 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P SmallCap 600 Index and several other market indices. +(b) Holders +As of February 4, 2021, there were approximately 900 holders of record of our common stock. +(c) Dividends +On February 3, 2021, our Board of Directors approved a cash dividend on our common stock in the amount of $0.02 per share to be paid on March 18, 2021 to holders of record as of March 4, 2021. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2020. +Period Covered +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands) (2) +October 2020 +16,582 +$ +2.84 +— +$ +130,000 +November 2020 +— +$ +— +— +$ +130,000 +December 2020 +537 +$ +5.43 +— +$ +130,000 +Total +17,119 +— +(1) +We withheld 17,119 shares in the fourth quarter with respect to employees’ tax withholding obligations upon the vesting of restricted stock units. These shares were acquired at fair market value pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended, and not pursuant to the stock buyback program. +(2) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. On July 26, 2018, we announced that our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On February 7, 2019, we announced that our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On July 25, 2019, we announced that our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the buyback program are held as treasury shares. There is no expiration date associated with the buyback program. +30 +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2015 through December 31, 2020, with the cumulative total return of the S & P 500 Index, the S & P SmallCap 600 Index, the Oilfield Service Index and a peer group determined by us. We changed our peer group in 2020 to align with the peer group used by the compensation committee of our Board of Directors. Our new peer group consists of ChampionX Corporation, Archrock, Inc., Cimarex Energy Co., Diamond Offshore Drilling Inc., EQT Corporation, Helmerich & Payne, Inc., Liberty Oilfield Services Inc., Nabors Industries, Ltd., National Oilwell Varco, Inc., NexTier Oilfield Solutions Inc., Noble Corporation plc., Oceaneering International, Oil States International Inc., PDC Energy, Inc., Precision Drilling Corporation, Range Resources, TechnipFMC plc, Transocean Ltd., Valaris plc, and WPX Energy, Inc. Our old peer group consisted of Basic Energy Services, Inc., Diamond Offshore Drilling, Inc., Forum Energy Technologies, Inc., Halliburton Company, Helmerich & Payne, Inc., Nabors Industries, Ltd., National Oilwell Varco, Inc., Noble Corporation plc., Oceaneering International, Oil States International, Inc., Precision Drilling Corporation, Superior Energy Services, Inc., TechnipFMC plc., Transocean Ltd., Unit Corp., Valaris plc and Weatherford International plc. +The graph assumes investment of $100 on December 31, 2015 and reinvestment of all dividends. +Fiscal Year Ended December 31, +2015 +2016 +2017 +2018 +2019 +2020 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +180.01 +154.44 +70.07 +72.23 +36.98 +S&P 500 Stock Index +100.00 +111.96 +136.40 +130.42 +171.49 +203.04 +S&P SmallCap 600 Index +100.00 +126.56 +143.30 +131.15 +161.03 +179.20 +Oilfield Service Index +100.00 +118.98 +98.51 +53.97 +53.67 +31.09 +Old Peer Group Index +100.00 +127.68 +108.49 +62.22 +59.96 +35.06 +New Peer Group Index +100.00 +126.23 +102.15 +63.67 +60.68 +34.89 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +31 +Item 6. Selected Financial Data. +Our selected consolidated financial data as of December 31, 2020, 2019, 2018, 2017 and 2016, and for each of the five years in the period ended December 31, 2020, should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report. We completed several mergers and acquisitions during the five-year period ended December 31, 2020. As such, the table below includes the results of operations of Current Power since October 25, 2018, the results of operations of Superior QC since February 20, 2018, the results of operations of MS Directional since October 11, 2017 and the results of operations of Seventy Seven Energy since April 20, 2017. See Note 2 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report for financial information pertaining to these transactions. +On January 1, 2018, we adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers, using the modified retrospective method. Additionally, on January 1, 2019, we adopted the new lease guidance under Topic 842, Leases, using the modified retrospective approach. See Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report for information pertaining to the adoption of these standards and comparability between periods. +2020 +2019 +2018 +2017 +2016 +(In thousands, except per share amounts) +Statement of Operations Data: +Operating revenues: +Contract drilling +$ +669,126 +$ +1,308,350 +$ +1,430,492 +$ +1,040,033 +$ +543,663 +Pressure pumping +336,111 +868,694 +1,573,396 +1,200,311 +354,070 +Directional drilling +73,356 +188,786 +209,275 +45,580 +— +Other +45,656 +104,855 +113,834 +70,760 +18,133 +Total +1,124,249 +2,470,685 +3,326,997 +2,356,684 +915,866 +Operating costs and expenses: +Contract drilling +380,822 +785,355 +885,704 +667,105 +305,804 +Pressure pumping +310,261 +724,788 +1,263,850 +966,835 +334,588 +Directional drilling +69,050 +178,645 +175,829 +32,172 +— +Other +41,790 +84,909 +77,104 +51,428 +8,384 +Depreciation, depletion, amortization and impairment +670,910 +1,003,873 +916,318 +783,341 +668,434 +Impairment of goodwill +395,060 +17,800 +211,129 +— +— +Selling, general and administrative +97,611 +133,513 +134,071 +105,847 +69,205 +Credit loss expense +5,606 +5,683 +— +— +— +Merger and integration expenses +— +— +2,738 +74,451 +— +Restructuring expenses +38,338 +— +— +— +— +Other operating expenses (income), net +7,059 +(2,305 +) +(17,569 +) +(31,957 +) +(14,323 +) +Total +2,016,507 +2,932,261 +3,649,174 +2,649,222 +1,372,092 +Operating loss +(892,258 +) +(461,576 +) +(322,177 +) +(292,538 +) +(456,226 +) +Other expense +(38,760 +) +(68,802 +) +(45,231 +) +(35,263 +) +(39,970 +) +Loss before income taxes +(931,018 +) +(530,378 +) +(367,408 +) +(327,801 +) +(496,196 +) +Income tax benefit +(127,326 +) +(104,675 +) +(45,987 +) +(333,711 +) +(177,562 +) +Net income (loss) +$ +(803,692 +) +$ +(425,703 +) +$ +(321,421 +) +$ +5,910 +$ +(318,634 +) +Net income (loss) per common share: +Basic +$ +(4.27 +) +$ +(2.10 +) +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +Diluted +$ +(4.27 +) +$ +(2.10 +) +$ +(1.47 +) +$ +0.03 +$ +(2.18 +) +Cash dividends per common share +$ +0.10 +$ +0.16 +$ +0.14 +$ +0.08 +$ +0.16 +Weighted average number of common shares outstanding: +Basic +188,013 +203,039 +218,643 +198,447 +146,178 +Diluted +188,013 +203,039 +218,643 +199,882 +146,178 +Balance Sheet Data: +Total assets +$ +3,299,069 +$ +4,439,615 +$ +5,469,866 +$ +5,758,856 +$ +3,772,291 +Long-term lease liability +19,118 +26,644 +— +— +— +Borrowings under line of credit +— +— +— +268,000 +— +Other long-term debt +901,484 +966,540 +1,119,205 +598,783 +598,437 +Stockholders’ equity +2,016,059 +2,833,620 +3,505,423 +3,982,493 +2,248,724 +Working capital +204,234 +231,213 +423,881 +200,605 +(17,933 +) +32 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Management Overview and Recent Developments in Market Conditions — We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and, from time to time, we pursue contract drilling opportunities in other select markets. Our pressure pumping business operates primarily in Texas and the Appalachian region. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of horizontal wellbore placement. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for drilling and completion services in the United States. +Oil prices remain extremely volatile , as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and closed at $53.55 per barrel on February 1, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices recovered from the lows experienced in the first half of 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $42.45 per barrel in the fourth quarter of 2020. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2018, 2019 and 2020 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our active rig count has declined since the fourth quarter of 2018. Our average active rig count for the fourth quarter of 2020 was 62 rigs. This was an increase from our average active rig count for the third quarter of 2020 of 60 rigs. Our U.S. active rig count at December 31, 2020 of 65 rigs was less than the rig count of 121 rigs at December 31, 2019, due to the significantly reduced demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place, we expect an average of 42 rigs operating under term contracts during the first quarter of 2021 and an average of 34 rigs operating under term contracts throughout 2021. +Due to the downturn in completions activity since March, we averaged seven active pressure pumping spreads during the fourth quarter, up from an average of five active spreads during the third quarter, but down from an average of 12 active spreads during the fourth quarter of 2019. We expect to average seven active pressure pumping spreads during the first quarter of 2021. The pressure pumping market remains oversupplied. +Recent Developments in Financial Matters — During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes (as defined below) in the open market. The principal amounts retired through these transactions totaled $15.5 million related to our 2028 Notes and $0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $3.4 million and $0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +33 +On December 24, 2020, we elected to repay $50 million of the borrowings under our Term Loan Agreement (as defined below). As of December 31, 2020, we had $50 million in borrowings remaining under the Term Loan Agreement at a LIBOR-based interest rate of 1.52%. The maturity date of the Term Loan Agreement is June 10, 2022. +On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement (“Amendment No. 2”) to, among other things, extend the maturity date for $550 million of revolving credit commitments of certain lenders under the Credit Agreement (as defined below) from March 27, 2024 to March 27, 2025. We have the option, subject to certain conditions, to exercise an additional one-year extension of the maturity date. +Please see “– Liquidity and Capital Resources” for additional detail regarding our 2028 Notes, 2029 Notes, Term Loan Agreement and Credit Agreement. +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $38.3 million of charges associated with this plan in the second quarter of 2020. In conjunction with our restructuring, we closed our Canadian drilling operations. We recorded an impairment of $8.3 million associated with that closure. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan. +The following table presents restructuring expenses by reportable segment f or the year ended December 31 , 2020 (in thousands) : +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +Corporate +Total +Severance costs +$ +1,821 +$ +3,460 +$ +503 +$ +501 +$ +215 +$ +6,500 +Contract termination costs +— +20,373 +— +— +— +20,373 +Other exit costs +523 +194 +827 +— +— +1,544 +Right-of-use asset abandonments +86 +7,304 +1,845 +— +686 +9,921 +Total +$ +2,430 +$ +31,331 +$ +3,175 +$ +501 +$ +901 +$ +38,338 +We estimate that the restructuring plan implemented in 2020 will result in annual cost savings of approximately $94 million. Of these estimated annual cost savings, approximately $14 million, $43 million, $7 million and $8 million are attributable to operating expense savings for contract drilling, pressure pumping, directional drilling and other operations, respectively. Annual selling, general and administrative cost savings are estimated to be approximately $22 million. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and upon our customers’ ability to access capital to fund their operating and capital expenditures. During periods of improved oil and natural gas prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when oil and natural gas prices are relatively low or when our customers have a reduced ability to access capital, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. We may also be impacted by delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies. +The North American oil and natural gas services industry is cyclical and at times experiences downturns in demand. During these periods, there has been substantially more oil and natural gas service equipment available than necessary to meet demand. As a result, oil and natural gas service contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods. Currently, there is an excess supply of drilling rigs, pressure pumping equipment and directional drilling equipment. We cannot predict either the future level of demand for our oil and natural gas services or future conditions in the oil and natural gas service businesses. +In addition to the dependence on oil and natural gas prices and demand for our services, w e are highly impacted by operational risks, competition, labor issues, weather, the availability, from time to time, of products used in our pressure pumping business, supplier delays and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations, including as a result of the COVID-19 pandemic. See “Risk Factors” in Item 1A of this Report. +For the three years ended December 31, 2020, our operating revenues consisted of the following (dollars in thousands): +2020 +2019 +2018 +Contract drilling +$ +669,126 +59.5 +% +$ +1,308,350 +53.0 +% +$ +1,430,492 +43.0 +% +Pressure pumping +336,111 +29.9 +% +868,694 +35.2 +% +1,573,396 +47.3 +% +Directional drilling +73,356 +6.5 +% +188,786 +7.6 +% +209,275 +6.3 +% +Other +45,656 +4.1 +% +104,855 +4.2 +% +113,834 +3.4 +% +$ +1,124,249 +100.0 +% +$ +2,470,685 +100.0 +% +$ +3,326,997 +100.0 +% +34 +Contract Drilling +Contract drilling revenues accounted for 59.5% of our consolidated 2020 revenues and decreased 48.9% from 2019. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet during the last several years. The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. As of December 31, 2020, our rig fleet included 198 APEX ® rigs, of which 150 were super-spec rigs. +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog as of December 31, 2020 and 2019 was approximately $301 million and $605 million, respectively. Approximately 21% of the total contract drilling backlog at December 31, 2020 is reasonably expected to remain after 2021. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to fees for other services such as for mobilization, other than initial mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. For contracts that contain variable dayrate pricing, our backlog calculation uses the dayrate in effect for periods where the dayrate is fixed, and, for periods that remain subject to variable pricing, uses the commodity price in effect at December 31, 2020. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts on which we have received notice for the rig to be placed on standby, our backlog calculation uses the standby rate for the period over which we expect to receive the standby rate. For contracts on which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period over which we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +Pressure Pumping +Pressure pumping revenues accounted for 29.9% of our consolidated 2020 revenues and decreased 61.3% from 2019. As of December 31, 2020, we had approximately 1.4 million horsepower in our pressure pumping fleet. The pressure pumping market remains oversupplied. In response to oversupplied market conditions, we implemented changes during the second quarter of 2020 that are intended to further streamline our operations, improve our efficiencies, and reduce our overall cost structure, while maintaining our customer service levels. +Directional Drilling +Directional drilling revenues accounted for 6.5% of our consolidated 2020 revenues and decreased 61.1% from 2019. We provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors and wireline steering tools. We also provide services that improve the statistical accuracy of horizontal wellbore placement. +Other Operations +Other operations revenues accounted for 4.1% of our consolidated 2020 revenues and decreased 56.5% from 2019. Our oilfield rentals business, with a fleet of premium oilfield rental tools, provides the largest revenue contribution to our other operations and provides specialized services for land-based oil and natural gas drilling, completion and workover activities. Other operations also includes the results of our electrical controls and automation business, the results of our drilling equipment service business, and the results of our ownership, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Capital Expenditures +Cash capital expenditures for 2020 totaled $145 million. This was a reduction from the $348 million of cash capital expenditures for 2019, due largely to lower activity levels . Based on our current outlook for activity, we expect our capital expenditures for 2021 to be approximately $135 million. +35 +For the three years ended December 31, 2020 , our operating loss es consisted of the following (dollars in thousands): +2020 +2019 +2018 +Contract drilling +$ +(543,438 +) +60.9 +% +$ +(151,329 +) +32.8 +% +$ +(33,115 +) +10.3 +% +Pressure pumping +(166,666 +) +18.7 +% +(102,701 +) +22.3 +% +(77,328 +) +24.0 +% +Directional drilling +(40,612 +) +4.6 +% +(52,724 +) +11.4 +% +(117,497 +) +36.5 +% +Other +(41,685 +) +4.7 +% +(54,725 +) +11.9 +% +(18,221 +) +5.7 +% +Corporate +(99,857 +) +11.1 +% +(100,097 +) +21.6 +% +(76,016 +) +23.5 +% +$ +(892,258 +) +100.0 +% +$ +(461,576 +) +100.0 +% +$ +(322,177 +) +100.0 +% +Lower demand for our contract drilling and pressure pumping services, an impairment of goodwill and an implementation of a restructuring plan in 2020 contributed to a consolidated net loss of $804 million for 2020, compared to a consolidated net loss of $426 million for 2019 and consolidated net loss of $321 million for 2018. +Results of Operations +Comparison of the years ended December 31, 2020 and 2019 +The following tables summarize results of operations by business segment for the years ended December 31, 2020 and 2019: +Year Ended December 31, +Contract Drilling +2020 +2019 +% Change +(Dollars in thousands) +Revenues +$ +669,126 +$ +1,308,350 +(48.9 +)% +Direct operating costs +380,822 +785,355 +(51.5 +)% +Margin (1) +288,304 +522,995 +(44.9 +)% +Restructuring expenses +2,430 +— +NA +Other operating expenses (income), net +(4,185 +) +— +NA +Selling, general and administrative +4,666 +6,317 +(26.1 +)% +Depreciation, amortization and impairment +433,771 +668,007 +(35.1 +)% +Impairment of goodwill +395,060 +— +NA +Operating loss +$ +(543,438 +) +$ +(151,329 +) +259.1 +% +Operating days (2) +29,904 +54,544 +(45.2 +)% +Average revenue per operating day +$ +22.38 +$ +23.99 +(6.7 +)% +Average direct operating costs per operating day +$ +12.73 +$ +14.40 +(11.6 +)% +Average margin per operating day (1) +$ +9.64 +$ +9.59 +0.5 +% +Average rigs operating +81.7 +$ +149.4 +(45.3 +)% +Capital expenditures +$ +105,037 +$ +194,416 +(46.0 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per operating day is defined as margin divided by operating days. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for contract drilling services. +Generally, the revenues in our contract drilling segment are most impacted by two primary factors: our average number of rigs operating and our average revenue per operating day. During 2020, our average number of rigs operating was 82, compared to 149 in 2019. Our average rig revenue per operating day was $22,380 in 2020, compared to $23,990 in 2019. Our average revenue per operating day is largely dependent on the pricing terms of our rig contracts. +Revenues and direct operating costs decreased primarily due to a decrease in operating days. Average direct operating costs per operating day decreased due to cost reduction efforts and a higher percentage of rigs on standby during 2020. Rigs on standby have very little associated cost. Average margin per operating day in 2020 included benefits from lump sum early termination revenue and a credit to operating costs for sales and use taxes. +Restructuring expenses were recognized in the second quarter of 2020 and primarily related to severance costs. See Note 20 of Notes to Consolidated Financial Statements for additional information. +36 +The increase in other operating expenses (income), net is primarily due to an insurance reimbursement for damaged drilling equipment. +Depreciation, amortization and impairment expense decreased primarily due to a $173 million write-down in 2019 related to the retirement of 36 legacy non-APEX® drilling rigs. In addition to the charge in 2019, no depreciation expense was recorded for this equipment in 2020. Additionally, in the second quarter of 2020 we recorded a $8.3 million write-down related to the closing of our Canadian drilling operations. +All of the goodwill associated with our contract drilling reporting unit was impaired in 2020. See Note 7 of Notes to Consolidated Financial Statements for additional information. +The decrease in capital expenditures was primarily due to higher maintenance capital expenditures in 2019 when activity levels were higher and reduced capital expenditures in 2020 due to lower activity. +Year Ended December 31, +Pressure Pumping +2020 +2019 +% Change +(Dollars in thousands) +Revenues +$ +336,111 +$ +868,694 +(61.3 +)% +Direct operating costs +310,261 +724,788 +(57.2 +)% +Margin (1) +25,850 +143,906 +(82.0 +)% +Restructuring expenses +31,331 +— +NA +Selling, general and administrative +8,555 +12,655 +(32.4 +)% +Depreciation, amortization and impairment +152,630 +233,952 +(34.8 +)% +Operating loss +$ +(166,666 +) +$ +(102,701 +) +62.3 +% +Fracturing jobs +265 +505 +(47.5 +)% +Other jobs +736 +844 +(12.8 +)% +Total jobs +1,001 +1,349 +(25.8 +)% +Average revenue per fracturing job +$ +1,188.46 +$ +1,673.81 +(29.0 +)% +Average revenue per other job +$ +28.76 +$ +27.75 +3.7 +% +Average revenue per total job +$ +335.78 +$ +643.95 +(47.9 +)% +Average direct operating costs per total job +$ +309.95 +$ +537.28 +(42.3 +)% +Average margin per total job (1) +$ +25.82 +$ +106.68 +(75.8 +)% +Margin as a percentage of revenues (1) +7.7 +% +16.6 +% +(53.6 +)% +Capital expenditures +$ +21,678 +$ +105,803 +(79.5 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, amortization and impairment and selling, general and administrative expenses. Average margin per total job is defined as margin divided by total jobs. Margin as a percentage of revenues is defined as margin divided by revenues. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for pressure pumping services. +Generally, the revenues in our pressure pumping segment are most impacted by our number of fracturing jobs and the size (including whether or not we provide proppant and other materials) of those jobs, which is reflected in our average revenue per fracturing job. Direct operating costs are also most impacted by these same factors. Our average revenue per fracturing job is largely dependent on the pricing terms of our pressure pumping contracts. We completed 265 fracturing jobs during 2020 compared to 505 fracturing jobs in 2019. Our average revenue per fracturing job was $1.188 million in 2020 compared to $1.674 million in 2019. +Revenues and direct operating costs decreased in 2020 primarily due to a decline in the number of fracturing jobs. Average revenue and direct operating costs per job were impacted by lower demand and a change in the composition of our jobs. +Restructuring expenses were recognized in the second quarter of 2020. These restructuring expenses included $7.3 million related to right-of-use asset abandonments, $3.5 million of severance costs and $20.4 million of contract termination costs. See Note 20 of Notes to Consolidated Financial Statements for additional information. +Selling, general and administrative expenses decreased primarily as a result of cost reduction efforts. +Depreciation, amortization and impairment expense decreased due to the significant decline in capital expenditures and a $20.5 million write-down of pressure pumping equipment in 2019, which resulted in no depreciation expense being recorded for this equipment in 2020. +37 +The decrease in capital expenditures was primarily due to higher maintenance capital expenditures in 2019 when activity levels were higher and reduced capital expenditures in 2020 due to lower activity . +Year Ended December 31, +Directional Drilling +2020 +2019 +% Change +(Dollars in thousands) +Revenues +$ +73,356 +$ +188,786 +(61.1 +)% +Direct operating costs +69,050 +178,645 +(61.3 +)% +Margin (1) +4,306 +10,141 +(57.5 +)% +Restructuring expenses +3,175 +— +NA +Selling, general and administrative +5,239 +10,642 +(50.8 +)% +Depreciation and amortization +36,504 +52,223 +(30.1 +)% +Operating loss +$ +(40,612 +) +$ +(52,724 +) +(23.0 +)% +Capital expenditures +$ +4,681 +$ +15,549 +(69.9 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation and amortization and selling, general and administrative expenses. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for directional drilling services. +Directional drilling revenue decreased by $115 million from 2019 primarily due to decreased job activity. +Directional drilling direct operating costs decreased by $110 million primarily due to lower direct costs from decreased job activity and cost reduction efforts. +Restructuring expenses were recognized in the second quarter of 2020 and were primarily attributable to severance and right-of-use asset abandonments. See Note 20 of Notes to Consolidated Financial Statements for additional information. +Selling, general and administrative expenses decreased primarily as a result of cost reduction efforts. +The decrease in capital expenditures was primarily due to higher maintenance capital expenditures in 2019 when activity levels were higher and reduced capital expenditures in 2020 due to lower activity. +Year Ended December 31, +Other Operations +2020 +2019 +% Change +(Dollars in thousands) +Revenues +$ +45,656 +$ +104,855 +(56.5 +)% +Direct operating costs +41,790 +84,909 +(50.8 +)% +Margin (1) +3,866 +19,946 +(80.6 +)% +Restructuring expenses +501 +— +NA +Selling, general and administrative +3,539 +14,068 +(74.8 +)% +Depreciation, depletion, amortization and impairment +41,511 +42,803 +(3.0 +)% +Impairment of goodwill +— +17,800 +NA +Operating loss +$ +(41,685 +) +$ +(54,725 +) +(23.8 +)% +Capital expenditures +$ +12,378 +$ +27,132 +(54.4 +)% +(1) +Margin is defined as revenues less direct operating costs and excludes depreciation, depletion, amortization and impairment and selling, general and administrative expenses. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for oilfield rental and other services. +Other operations revenue decreased by $59.2 million from 2019 primarily due to a decrease in the volume of services provided by our oilfield rentals business and a decline in the average price per barrel of crude oil received by our oil and natural gas assets. +Other operations direct operating costs decreased by $43.1 million from 2019 primarily due to a decrease in the volume of services provided by our oilfield rentals business. Additionally, a portion of the decrease is attributed to the decision to transition away from our engineering and manufacturing efforts in Calgary during 2019. Charges associated with this decision totaled $12.4 million for direct operating costs in 2019, which were primarily comprised of inventory write-offs. +38 +Restructuring expenses were recognized in 2020 and related to severance costs. See Note 20 of Notes to Consolidated Financial Statements for additional information. +Selling, general and administrative expense decreased primarily as a result of cost reduction efforts in addition to the transition away from our engineering and manufacturing efforts in Calgary during 2019. Charges associated with that decision totaled $2.2 million in 2019. +Depreciation, depletion, amortization and impairment remained relatively consistent with the comparable prior year period. We recognized a $11.2 million impairment related to certain of our oil and natural gas assets recorded in 2020, whereas $2.2 million of oil and natural gas property impairments were recorded in 2019. However, the increased oil and natural gas property impairments were partially offset by decreased 2020 depletion of our oil and natural gas assets primarily due to a decrease in production as well as certain equipment reaching the end of its depreciable life in our oilfield rentals business. +There were no impairments of goodwill in 2020 as all of the goodwill associated with our oilfield rentals and electrical controls and automation businesses was impaired in 2019. +The decrease in capital expenditures was primarily due to higher maintenance capital expenditures in 2019 when activity levels were higher and reduced capital expenditures in 2020 due to lower activity and commodity prices. +Year Ended December 31, +Corporate +2020 +2019 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +75,612 +$ +89,831 +(15.8 +)% +Restructuring expenses +$ +901 +$ +— +NA +Depreciation +$ +6,494 +$ +6,888 +(5.7 +)% +Other operating expenses (income), net +Net gain on asset disposals +$ +(3,079 +) +$ +(13,904 +) +(77.9 +)% +Legal-related expenses and settlements, net of insurance reimbursements +1,680 +(3,471 +) +NA +Research and development +3,411 +3,840 +(11.2 +)% +Other +9,232 +11,230 +(17.8 +)% +Other operating expense (income), net +$ +11,244 +$ +(2,305 +) +NA +Credit loss expense +$ +5,606 +$ +5,683 +(1.4 +)% +Interest income +$ +1,254 +$ +6,013 +(79.1 +)% +Interest expense +$ +40,770 +$ +75,204 +(45.8 +)% +Other income +$ +756 +$ +389 +94.3 +% +Capital expenditures +$ +1,707 +$ +4,612 +(63.0 +)% +Selling, general and administrative expense decreased primarily as a result of cost reduction efforts. +Restructuring expenses were recognized in 2020 and were primarily attributable to severance and right-of-use asset abandonments. See Note 20 of Notes to Consolidated Financial Statements for additional information. +Other operating expenses (income), net includes net gains or losses associated with the disposal of assets. Accordingly, the related gains or losses have been excluded from the results of specific segments. The majority of the net gain on asset disposals during 2019 reflect gains on disposal of drilling equipment. Legal-related expenses and settlements in 2019 includes proceeds from insurance claims. +Other expenses, net include charges of $9.2 million and $12.7 million in 2020 and 2019, respectively related to a 2017 capacity reservation agreement that required a cash deposit to increase our access to finer grades of sand for our pressure pumping business. As market prices for sand substantially decreased since 2017, we purchased lower cost sand outside of this capacity reservation contract and revalued the deposit at its expected realizable value. There is no value assigned to the capacity reservation contract subsequent to the charge recorded in the second quarter of 2020. +A provision for credit losses was recognized in the twelve months ended December 31 , 2020 with respect to accounts receivable balances that are estimated to be uncollectible. +39 +Interest expense was lower in the twelve months ended December 31 , 2020. Interest expense for the twelve months ended December 31, 2019 included a loss on debt extinguishment of $24.0 million as a result of full prepayment of the Series A Notes and Series B Notes (as defined below). Additionally, interest expense for the twelve months ended December 31, 2020 included a gain on debt extinguishment of $3.6 million associated with the repurchase of portions of our 2028 Notes and 2029 Notes. +Comparison of the years ended December 31, 2019 and 2018 +A discussion of our results of operations for the fiscal year ended December 31, 2019 compared to the fiscal year ended December 31, 2018 is included in Part II, Item 7— "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 13, 2020. +Income Taxes +The effective tax rate decreased by approximately 6% to 13.7% for 2020 compared to 19.7% for 2019. This difference was primarily due to higher goodwill impairment charges in 2020 relative to 2019, which are not deductible for tax purposes. These charges resulted in an 8.2% decrease to the effective tax rate in 2020, as compared to a 0.7% decrease to the effective tax rate in 2019. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. During 2020, the United States enacted various legislation related to COVID-19 relief, which includes multiple tax provisions. We have considered these tax provisions and do not currently expect any material impact to our financial statements. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +Liquidity and Capital Resources +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $38.3 million of charges associated with this plan in second quarter of 2020. There were no restructuring charges in the comparable periods of 2019. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan. +While oilfield services activity and revenues declined significantly throughout 2020, we aligned our cost structure with the changing activity levels and enhanced our liquidity position. Our liquidity as of December 31, 2020 included approximately $204 million in working capital, $225 million of cash and cash equivalents, and approximately $600 million available under our revolving credit facility. +On January 19, 2018, we completed an offering of $525 million in aggregate principal amount of our 2028 Notes. We used $239 million of the net proceeds from the offering to repay amounts outstanding under our revolving credit facility. As described below, on March 27, 2018, we entered into an amended and restated credit agreement, which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. +On August 22, 2019, we entered into the Term Loan Agreement, which permitted a single borrowing of up to $150 million initially, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $75 million, not to exceed total commitments of $225 million. On September 25, 2019, we used $150 million of borrowings from the Term Loan Agreement and approximately $158 million of cash on hand to prepay the Series A Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $308 million, plus accrued interest to the prepayment date. We repaid $50 million of the borrowings under the Term Loan Agreement on December 16, 2019, and an additional $50 million on December 24, 2020. As of December 31, 2020, we had $50 million in borrowings remaining under the Term Loan Agreement at a LIBOR-based interest rate of 1.52%. The maturity date of the Term Loan Agreement is June 10, 2022. +On November 15, 2019, we completed an offering of $350 million in aggregate principal amount of the 2029 Notes. The net proceeds before offering expenses were approximately $347 million. On December 16, 2019, we used a portion of the net proceeds from the offering to prepay the Series B Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $315 million, plus accrued interest to the prepayment date. The remaining net proceeds and available cash on hand was used to repay $50 million of the borrowings under the Term Loan Agreement. +On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement to, among other things, extend the maturity date for $550 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, +40 +2024 to March 27, 2025. We have the option, subject to certain conditions , to exercise an additional one-year extension of the maturity date. +During the fourth quarter of 2020, we elected to repurchase portions of our Senior Notes due 2028 and 2029 in the open market. The principal amounts retired through these transactions totaled $15.5 million related to our 2028 Notes and $0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $3.4 million and $0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +We believe our current liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt and pay cash dividends for at least the next 12 months. +If we pursue opportunities for growth that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +As of December 31, 2020, we had working capital of $204 million, including cash and cash equivalents of $225 million, compared to working capital of $231 million, including cash and cash equivalents of $174 million, at December 31, 2019. +During 2020, our sources of cash flow included: +• +$279 million from operating activities, +• +$20.9 million in proceeds from the disposal of property and equipment and insurance claims. +During 2020, we used $18.9 million to pay dividends on our common stock, $21.2 million for repurchases of our common stock, $12.0 million for repurchases of our 2028 Notes, $0.6 million for repurchases of our 2029 Notes, $50.0 million to repay a portion of the outstanding borrowings under our Term Loan Agreement due June 2022, and $145 million: +• +to make capital expenditures for the betterment and refurbishment of drilling and pressure pumping equipment and, to a much lesser extent, equipment for our other businesses, +• +to acquire and procure equipment to support our drilling, pressure pumping, directional drilling, oilfield rentals and manufacturing operations, and +• +to fund investments in oil and natural gas properties on a non-operating working interest basis. +We paid cash dividends during the year ended December 31, 2020 as follows: +Per Share +Total +(in thousands) +Paid on March 19, 2020 +$ +0.04 +$ +7,629 +Paid on June 18, 2020 +0.02 +3,735 +Paid on September 17, 2020 +0.02 +3,746 +Paid on December 17, 2020 +0.02 +3,752 +Total cash dividends +$ +0.10 +$ +18,862 +On February 3, 2021, our Board of Directors approved a cash dividend on our common stock in the amount of $0.02 per share to be paid on March 18, 2021 to holders of record as of March 4, 2021. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +We may, at any time and from time to time, seek to retire or purchase our outstanding debt for cash through open-market purchases, privately negotiated transactions, redemptions or otherwise. Such repurchases, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. +41 +On September 6, 2013, our Board of Directors approved a stock buyback program that authorized purchases of up to $200 million of our common stock in open market or privately negotiated transactions. On July 25, 2018, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On February 6, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On July 24, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the buyback program are held as treasury shares. There is no expiration date associated with the buyback program. As of December 31, 20 20 , we had remaining authorization to purchase approximately $1 3 0 million of our outstanding common stock under the stock buyback program. +We acquired shares of stock from employees during 2020, 2019 and 2018 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock and restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended, and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2020, 2019 and 2018 were as follows (dollars in thousands): +2020 +2019 +2018 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +Purchases pursuant to stock buyback program +5,826,266 +20,000 +22,566,331 +250,109 +9,331,131 +150,497 +Acquisitions pursuant to long-term incentive plan +239,669 +1,179 +1,037,947 +14,205 +567,354 +11,240 +Other +— +— +31,013 +372 +— +— +Treasury shares at end of period +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +2019 Term Loan Agreement — On August 22, 2019, we entered into a term loan agreement (“Term Loan Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lender party thereto. +The Term Loan Agreement is a committed senior unsecured term loan facility that permitted a single borrowing of up to $150 million initially, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $75 million, not to exceed total commitments of $225 million. We repaid $50 million of the borrowings under the Term Loan Agreement on December 16, 2019, and an additional $50 million on December 24, 2020. As of December 31, 2020, we had $50 million in borrowings remaining under the Term Loan Agreement at a LIBOR-based interest rate of 1.52%. The maturity date under the Term Loan Agreement is June 10, 2022. +Loans under the Term Loan Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 1.375%, and the applicable margin on base rate loans varies from 0.00% to 0.375%, in each case determined based upon our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans and base rate loans was 1.375% and 0.375% , respectively. +The Term Loan Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Term Loan Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at one of the two ratings agencies. +The Term Loan Agreement requires mandatory prepayment in an amount equal to 100% of the net cash proceeds from the issuance of new senior indebtedness (other than certain permitted indebtedness) if our credit rating is below investment grade at both Moody’s and S&P. Our credit rating is currently investment grade at one of the two ratings agencies. The Term Loan Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50%. The Term Loan Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2020. +42 +Credit Agreement — On March 27, 2018, we entered into an amended and restated credit agreement (the “Credit Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association , as Co-Lead Arrangers and Joint Book Runners. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $300 million, not to exceed total commitments of $900 million. The original maturity date under the Credit Agreement was March 27, 2023. On March 26, 2019, we entered into Amendment No. 1 to Amended and Restated Credit Agreement, which amended the Credit Agreement to, among other things, extend the maturity date under the Credit Agreement from March 27, 2023 to March 27, 2024. On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement to, among other things, extend the maturity date for $550 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2024 to March 27, 2025. We have the option, subject to certain conditions, to exercise an additional one-year extension of the maturity date. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10% to 0.30% based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at one of the two ratings agencies. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50%. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2020. +As of December 31, 2020, we had no borrowings outstanding under our revolving credit facility. We had $0.1 million in letters of credit outstanding under the Credit Agreement at December 31, 2020 and, as a result, had available borrowing capacity of approximately $600 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2020, we had $60.7 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +43 +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +Series A Senior Notes and Series B Senior Notes — On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bore interest at a rate of 4.97% per annum. On September 25, 2019, we fully prepaid the Series A Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $308 million, which represents 100% of the principal and the “make-whole” premium to the prepayment date. +On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bore interest at a rate of 4.27% per annum. On December 16, 2019, we fully prepaid the Series B Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $315 million, which represents 100% of the principal and the “make-whole” premium to the prepayment date. +Primarily as a result of the “make-whole” premiums, we incurred an $8.2 million loss on early extinguishment of the Series A Notes in the three months ended September 30, 2019, and a $15.8 million loss on early extinguishment of the Series B Notes in the three months ended December 31, 2019, which were included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +2028 Senior Notes and 2029 Senior Notes — On January 19, 2018, we completed an offering of $525 million in aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”). The net proceeds before offering expenses were approximately $521 million, of which we used $239 million to repay amounts outstanding under our revolving credit facility. On November 15, 2019, we completed an offering of $350 million in aggregate principal amount of our 5.15% Senior Notes due 2029 (the “2029 Notes”). The net proceeds before offering expenses were approximately $347 million. We used a portion of the net proceeds from the offering to prepay our Series B Notes. The remaining net proceeds and available cash on hand was used to repay $50 million of the borrowings under the Term Loan Agreement in 2019. +During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes in the open market. The principal amounts retired through these transactions totaled $15.5 million related to our 2028 Notes and $0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $3.4 million and $0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +We pay interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028. The 2028 Notes bear interest at a rate of 3.95% per annum. +We pay interest on the 2029 Notes on May 15 and November 15 of each year. The 2029 Notes will mature on November 15, 2029. The 2029 Notes bear interest at a rate of 5.15% per annum. +The 2028 Notes and 2029 Notes (together, the “Senior Notes”) are our senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The Senior Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the Senior Notes. None of our subsidiaries are currently required to be a guarantor under the Senior Notes. If our subsidiaries guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +At our option, we may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, and on August 15, 2029, in the case of the 2029 Notes, at our option, we may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100% of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date. +44 +The indenture s pursuant to which the Senior Notes were issued include covenants that, among ot her things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indenture s . +Upon the occurrence of a change of control triggering event, as defined in the indentures, each holder of the Senior Notes may require us to purchase all or a portion of such holder’s Senior Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +Commitments — As of December 31, 2020, we maintained letters of credit in the aggregate amount of $60.8 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2020, no amounts had been drawn under the letters of credit. +As of December 31, 2020, we had commitments to purchase major equipment totaling approximately $14.7 million for our drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The agreements expire in years 2021 and 2022. As of December 31, 2020, the remaining obligation under these agreements was approximately $13.4 million, of which approximately $10.0 million and $3.4 million relate to 2021 and 2022, respectively. In the event the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. In 2017, we entered into a capacity reservation agreement that required a cash deposit to increase our access to finer grades of sand for our pressure pumping business. As market prices for sand substantially decreased since 2017, we purchased lower cost sand outside of this capacity reservation contract and recorded a charge of $9.2 million and $12.7 million in the second quarters of 2020 and 2019, respectively, to revalue the deposit to its expected realizable value. There is no value assigned to the capacity reservation contract subsequent to the charge recorded in the second quarter of 2020. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Contractual Obligations +The following table presents information with respect to our contractual obligations as of December 31, 2020 (in thousands): +Payments due by period +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +2029 Notes (1) +$ +349,250 +$ +— +$ +— +$ +— +$ +349,250 +Interest on 2029 Notes (2) +161,878 +17,986 +35,973 +35,973 +71,946 +Term Loan Agreement (3) +50,000 +— +50,000 +— +— +Interest on Term Loan Agreement (4) +1,116 +761 +355 +— +— +2028 Notes (5) +509,505 +— +— +— +509,505 +Interest on 2028 Notes (6) +150,941 +20,125 +40,251 +40,251 +50,314 +Leases (7) +29,125 +8,011 +10,236 +5,237 +5,641 +Equipment purchases (8) +14,738 +14,738 +— +— +— +Inventory purchases (9) +13,380 +10,030 +3,350 +— +— +Total +$ +1,279,933 +$ +71,651 +$ +140,165 +$ +81,461 +$ +986,656 +(1) +Principal repayment of the 2029 Notes is required at maturity on November 15, 2029. +(2) +Interest to be paid on the 2029 Notes using 5.15% coupon rate. +(3) +Principal repayment of the Term Loan Agreement is required at maturity on June 10, 2022. +(4) +Interest to be paid on Term Loan Agreement using a LIBOR-based interest rate of 1.52% rate in effect as of December 31, 2020. +(5) +Principal repayment of the 2028 Notes is required at maturity on February 1, 2028. +(6) +Interest to be paid on the 2028 Notes using 3.95% coupon rate. +(7) +See Note 13 of Notes to Consolidated Financial Statements. +(8) +Represents commitments to purchase major equipment to be delivered in 2021 based on expected delivery dates. +(9) +Represents commitments to purchase proppants and chemicals for our pressure pumping business. +45 +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements at December 31, 2020. +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by accounting principles generally accepted in the United States of America (“U.S. GAAP”). We define Adjusted EBITDA as net income (loss) plus net interest expense, income tax expense (benefit) and depreciation, depletion, amortization and impairment expense (including impairment of goodwill). We present Adjusted EBITDA because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measure of net income (loss). Our computations of Adjusted EBITDA may not be the same as other similarly titled measures of other companies. Set forth below is a reconciliation of the non-U.S. GAAP financial measure of Adjusted EBITDA to the U.S. GAAP financial measure of net income (loss). +Year Ended December 31, +2020 +2019 +2018 +(Dollars in thousands) +Net loss +$ +(803,692 +) +$ +(425,703 +) +$ +(321,421 +) +Income tax benefit +(127,326 +) +(104,675 +) +(45,987 +) +Net interest expense +39,516 +69,191 +45,981 +Depreciation, depletion, amortization and impairment +670,910 +1,003,873 +916,318 +Impairment of goodwill +395,060 +17,800 +211,129 +Adjusted EBITDA +$ +174,468 +$ +560,486 +$ +806,020 +Critical Accounting Policies +In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition, leases and the use of estimates. +Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. In the second quarter of 2020, we recorded an impairment of $8.3 million related to the closing of our Canadian drilling operations. In 2019, we identified 36 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 36 rigs that were retired had limited commercial opportunity. We recorded a $173 million charge related to this retirement. In 2018, we identified 42 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 42 rigs that were retired had limited commercial opportunity. We recorded a $48.4 million charge related to this retirement. +We also periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. In 2019, we recorded a charge of $20.5 million for the write-down of pressure pumping equipment compared to a $17.4 million write-down of pressure pumping equipment in 2018. There was no similar charge in 2020. +46 +We also periodically evaluate our directional drilling assets. During 2019, we recorded a charge of $8.4 million for the write-down of directional drilling equipment. There w as no similar charge in 2020 or 2018. +We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of March 31, 2020. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of March 31, 2020. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 15%, 22%, 3% and 9%, respectively. +For the assessment performed in the first quarter of 2020, the expected cash flows for our asset groups included revenue and operating expense growth rates. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the second half of 2019 and the first quarter of 2020 and would begin to recover in 2022 in response to improved oil prices. While we believed these assumptions with respect to future oil pricing were reasonable, actual future prices and activity levels may vary significantly from the ones that were assumed. The timeframe over which oil prices and activity levels may recover is highly uncertain. Potential events that could affect our assumptions regarding future prices and the timeframe for a recovery are affected by factors such as those described in “Risk Factors–We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results.” +All of these factors are beyond our control. If the lower oil price environment experienced in 2020 were to last into late 2022 and beyond, our actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future, and such impairment charges could be material. +After the assessment we performed in the first quarter of 2020, we concluded that no triggering events occurred during the periods thereafter through December 31, 2020 with respect to our asset groups based on our recent results of operations, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices, our results of operations for the quarter ended September 30, 2019 and management’s expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of September 30, 2019. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 35%, 54%, 23% and 7%, respectively. +For the assessment performed in 2019, the expected cash flows for our asset groups included revenue and operating expense growth rates. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in 2019 and would begin to recover in late 2020 or 2021 in response to improved oil prices. +47 +We concluded that no triggering events occurred during the quarter ended December 31, 2019 with respect to our asset groups based on our recent results of operations, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +2018 Triggering Event Assessment +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of December 31, 2018. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 38%, 58%, 9% and 23%, respectively. +For the assessment performed in 2018, the expected cash flows for our asset groups included revenue and operating expense growth rates. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the fourth quarter of 2018, and would begin to recover in late 2019 and continue into 2020 in response to improved oil prices and activity levels. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing are our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, we may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in our contract drilling reporting unit. We performed a quantitative impairment assessment of our goodwill as of March 31, 2020. In completing the assessment, the fair value of our contract drilling operating segment was estimated using the income approach. The estimate of fair value required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates . +Based on the results of the goodwill impairment test as of March 31, 2020, impairment was indicated in our contract drilling reporting unit. We recognized an impairment charge of $395 million in the quarter ended March 31, 2020 associated with the impairment of all of the goodwill in our contract drilling reporting unit. We had no remaining goodwill balance as of December 31, 2020. +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and recent commodity prices, our results of operations for the quarter ended September 30, 2019 and our expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of September 30, 2019. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of September 30, 2019, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 13% and we concluded that no impairment was indicated in our contract drilling reporting unit; however, impairment was indicated in our oilfield rentals and electrical controls and automation reporting units included in the other operations segment. We recognized an impairment charge of $17.8 million in 2019 associated with the impairment of all of the goodwill in our oilfield rentals and electrical controls and automation reporting units. +48 +In connection with our annual goodwill impairment assessment as of December 31, 2019, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than the respective carrying amount. In making this determination, we considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in our reporting units, as well as our 2019 operating results and forecasted operating results for the succeeding year. We also considered our overall market capitalization at December 31, 2019. +2018 Triggering Event Assessment +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of December 31, 2018. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of December 31, 2018, the fair value of the contract drilling and oilfield rentals reporting units exceeded their carrying values by approximately 16% and 14%, respectively, and we concluded that no impairment was indicated in our contract drilling and oilfield rentals reporting units; however, impairment was indicated in our pressure pumping and directional drilling reporting units. We recognized an impairment charge of $211 million associated with the impairment of all of the goodwill in our pressure pumping and directional drilling reporting units. +Revenue recognition — On January 1, 2018, we adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on our consolidated financial statements, and a cumulative adjustment was not recognized. Revenues for reporting periods beginning after January 1, 2018 are presented under Topic 606, while revenues prior to January 1, 2018 continue to be reported under previous revenue recognition requirements of Topic 605. +Leases — On January 1, 2019, we adopted the new lease guidance under Topic 842, Leases , using the modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. We have elected to report all leases at the beginning of the period of adoption and not restate our comparative periods. This standard does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. See Note 13 for Notes to consolidated financial statements for additional information. +Use of estimates — The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Key estimates used by management include: +• +allowance for credit losses, +• +depreciation, depletion and amortization, +• +fair values of assets acquired and liabilities assumed in acquisitions, +• +goodwill and long-lived asset impairments, and +• +reserves for self-insured levels of insurance coverage. +For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +49 +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. Oil prices remain extremely volatile , as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and closed at $53.55 per barrel on February 1, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered from the lows experienced in the first half of 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $42.45 per barrel in the fourth quarter of 2020. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital, would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +Inflation has not had a significant impact on our operations during the three years ended December 31, 2020. We believe that inflation will not have a significant near-term impact on our financial position. +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As of December 31, 2020, we had exposure to interest rate market risk associated with our borrowings under the Term Loan Agreement, and we would have had exposure to interest rate market risk associated with any borrowings that we had under the Credit Agreement and amounts owed under the Reimbursement Agreement. +Loans under the Term Loan Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 1.375%, and the applicable margin on base rate loans varies from 0.00% to 0.375%, in each case determined based upon our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans and base rate loans was 1.375% and 0.375%, respectively. As of December 31, 2020, we had $50 million in borrowings outstanding under the Term Loan Agreement at a LIBOR-based interest rate of 1.52%. A one percent increase in the interest rate on the borrowings outstanding under the Term Loan Agreement as of December 31, 2020 would increase our annual cash interest expense by $0.5 million. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based on our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. As of December 31, 2020, we had no borrowings outstanding under our revolving credit facility. The interest rate on borrowings outstanding under our revolving credit facility is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. We are obligated to pay Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2020, no amounts had been disbursed under any letters of credit. +50 +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2020, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2020, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2020. +The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None . +51 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website within four business days following the date of the amendment or waiver. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +52 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.4 +Certificate of Amendment to Restated Certificate of Incorporation, as amended (filed July 30, 2018 as Exhibit 3.4 to our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018 and incorporated herein by reference). +3.5 +Fourth Amended and Restated Bylaws (filed February 12, 2019 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.6 +Certificate of Designation of the Series A Junior Participating Preferred Stock of Patterson-UTI Energy, Inc., dated April 22, 2020 (filed April 23, 2020 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.1 +Description of Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934. + +4.2 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +4.3 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.4 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.5 +Form of 3.95% Senior Note due 2028 (included in Exhibit 4.4 above). +4.6 +Base Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.7 +First Supplemental Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +53 +4. 8 +Form of 5.15% Senior Note due 2029 (included in Exhibit 4.7 above). +4.9 +Stockholder Rights Agreement, dated as of April 22, 2020, by and between Patterson-UTI Energy, Inc. and Continental Stock Transfer & Trust Company, as rights agent (which includes the Form of Rights Certificate as Exhibit B thereto) (filed April 23, 2020 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.10 +First Amendment to Stockholder Rights Agreement, dated as of July 22, 2020, by and between Patterson-UTI Energy, Inc. and Continental Stock Transfer & Trust Company, as rights agent (filed July 23, 2020 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.1 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.2 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). * +10.3 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.4 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.7 +Patterson-UTI Energy, Inc. Omnibus Incentive Plan (filed April 21, 2017 as Exhibit 4.4 to our Registration Statement on Form S-8 and incorporated herein by reference).* +10.8 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (as amended and restated effective June 29, 2017) (filed June 30, 2017 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.10 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan, as amended and restated and further amended effective June 6, 2019 (filed June 6, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.11 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 4, 2017 as Exhibit 10.5 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.12 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to our Current Report on Form 8-K and incorporated herein by reference).* +10.13 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to our Current Report on Form 8-K and incorporated herein by reference).* +10.14 +Form of Non-Employee Director Restricted Stock Unit Award Agreement (filed April 28, 2020 as Exhibit 10.11 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.15 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed July 28, 2020 as Exhibit 10.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.16 +2020 Phantom Unit Award Agreement, dated May 11, 2020, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 28, 2020 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +54 +10.17 +Amendment No. 1 to Performance Share Award Agreement, dated May 11, 2020, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 28, 2020 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.18 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to our Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.19 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed January 17, 2017 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.20 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.21 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference).* +10.22 +Employment Agreement, dated as of September 3, 2017, between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.23 +Employment Agreement, dated as of April 8, 2020, between Patterson-UTI Management Services, LLC and Mark S. Siegel (filed April 9, 2020 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). * +10.24 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Mark S. Siegel, Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Charles O. Buckner, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon, Tiffany J. Thom, C. Andrew Smith and Janeen S. Judah (filed April 28, 2004 as Exhibit 10.11 to our Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.25 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to our Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.26 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.27 +Amended and Restated Credit Agreement dated March 27, 2018 among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2018 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.28 +Amendment No. 1 to Amended and Restated Credit Agreement, dated March 26, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 26, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.29 +Amendment No. 2 to Amended and Restated Credit Agreement, dated March 27, 2020, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2020 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.30 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.31 +Term Loan Agreement, dated August 22, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lender party thereto (filed August 23, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +55 +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.++ +101.INS +Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document .+ +101.SCH +Inline XBRL Taxonomy Extension Schema Document + +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document + +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document + +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document + +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document + +104 +Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101) . +* +Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ +Filed herewith. +++ +Furnished herewith. +Item 16. Form 10-K Summary +None. +56 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2020 and 2019 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2020, 2019 and 2018 +F-5 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2020, 2019 and 2018 +F-6 +Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2020, 2019 and 2018 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and 2018 +F-8 +Notes to Consolidated Financial Statements +F-9 +F-1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of operations, of comprehensive income (loss), of changes in stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2020, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2020 appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Change in Accounting Principle +As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2019. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +F-2 +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Critical Audit Matters +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Long-lived Assets and Intangible Assets Recoverability Test —Asset Groupings in the Contract Drilling, Pressure Pumping, and Directional Drilling Operating Segments as of March 31, 2020 +As described in Notes 6 and 7 to the consolidated financial statements, the Company’s consolidated net property and equipment and consolidated intangible assets balance were $2,761 million and $30 million, respectively, most of which relates to the Contract Drilling and Pressure Pumping asset groupings as of December 31, 2020. Management reviews its long-lived assets, including property and equipment and intangibles, for impairment whenever events or changes in circumstances indicate that their carrying amounts of certain asset groupings may not be recovered over their estimated remaining useful lives. As a result of triggering events for the quarter ended March 31, 2020, management deemed it necessary to assess the recoverability of its contract drilling, pressure pumping, and directional drilling asset groups as of March 31, 2020. Management performed an analysis to assess the recoverability of the asset groups within its contract drilling, pressure pumping and directional drilling operating segments as of March 31, 2020. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and management determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. For the assessment performed in 2020, the expected cash flows for the Company’s asset groups included revenue growth rates and operating expense growth rates. +The principal considerations for our determination that performing procedures relating to the Long-lived Assets and Intangible Assets Recoverability Test – Asset Groupings in the Contract Drilling, Pressure Pumping, and Directional Drilling Operating Segments as of March 31, 2020 is a critical audit matter are the significant judgment by management in estimating the future undiscounted cash flows of the asset groupings which, in turn, led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence obtained related to the significant assumptions in management’s cash flow projections related to revenue growth rates for all three asset groupings and operating expense growth rates for the directional drilling asset grouping. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s long-lived assets and intangible assets recoverability test, including controls over the estimation of the undiscounted future cash flows of the Company’s asset groupings. These procedures also included, among others, evaluating the appropriateness of the method, testing the completeness, accuracy, and relevance of the underlying data used in the cash flows, and evaluating the reasonableness of significant assumptions used by management in developing their estimate of undiscounted future cash flows including revenue growth rates and operating expense growth rates. Evaluating management’s significant assumptions related to the revenue growth rates for all three asset groupings and operating expense growth rates for the directional drilling asset grouping, involved evaluating whether the significant assumptions used by management were reasonable considering the current and past performance of the asset groupings and considered whether they were consistent with evidence obtained in other areas of the audit. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 9, 2021 +We have served as the Company’s auditor since 1993. +F-3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2020 +2019 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +224,915 +$ +174,185 +Accounts receivable, net of allowance for credit losses of $ 10,842 and $ 6,516 at +December 31, 2020 and 2019, respectively +160,214 +339,699 +Federal and state income taxes receivable +4,428 +6,397 +Inventory +33,085 +36,357 +Other +55,314 +75,177 +Total current assets +477,956 +631,815 +Property and equipment, net +2,761,041 +3,306,677 +Right of use asset +16,850 +31,275 +Goodwill and intangible assets +30,087 +444,004 +Deposits on equipment purchases +1,716 +8,066 +Other +11,419 +17,778 +Total assets +$ +3,299,069 +$ +4,439,615 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +91,622 +$ +170,475 +Federal and state income taxes payable +— +342 +Accrued liabilities +175,004 +219,850 +Lease liability +7,096 +9,935 +Total current liabilities +273,722 +400,602 +Long-term lease liability +19,118 +26,644 +Long-term debt, net of debt discount and issuance costs of $ 7,271 and $ 8,460 at +December 31, 2020 and 2019, respectively +901,484 +966,540 +Deferred tax liabilities, net +77,676 +202,959 +Other +11,010 +9,250 +Total liabilities +1,283,010 +1,605,995 +Commitments and contingencies (see Note 10) +Stockholders’ equity: +Preferred stock, par value $ 0.01 ; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $ 0.01 ; authorized 400,000,000 shares with 271,028,688 +and 269,372,257 issued and 187,626,366 and 192,035,870 outstanding at +December 31, 2020 and 2019, respectively +2,710 +2,694 +Additional paid-in capital +2,902,236 +2,875,680 +Retained earnings +472,014 +1,294,902 +Accumulated other comprehensive income +5,412 +5,478 +Treasury stock, at cost, 83,402,322 shares and 77,336,387 shares at +December 31, 2020 and 2019, respectively +( 1,366,313 +) +( 1,345,134 +) +Total stockholders’ equity +2,016,059 +2,833,620 +Total liabilities and stockholders’ equity +$ +3,299,069 +$ +4,439,615 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2020 +2019 +2018 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +669,126 +$ +1,308,350 +$ +1,430,492 +Pressure pumping +336,111 +868,694 +1,573,396 +Directional drilling +73,356 +188,786 +209,275 +Other +45,656 +104,855 +113,834 +Total operating revenues +1,124,249 +2,470,685 +3,326,997 +Operating costs and expenses: +Contract drilling +380,822 +785,355 +885,704 +Pressure pumping +310,261 +724,788 +1,263,850 +Directional drilling +69,050 +178,645 +175,829 +Other +41,790 +84,909 +77,104 +Depreciation, depletion, amortization and impairment +670,910 +1,003,873 +916,318 +Impairment of goodwill +395,060 +17,800 +211,129 +Selling, general and administrative +97,611 +133,513 +134,071 +Credit loss expense +5,606 +5,683 +— +Merger and integration expenses +— +— +2,738 +Restructuring expenses +38,338 +— +— +Other operating expenses (income), net +7,059 +( 2,305 +) +( 17,569 +) +Total operating costs and expenses +2,016,507 +2,932,261 +3,649,174 +Operating loss +( 892,258 +) +( 461,576 +) +( 322,177 +) +Other income (expense): +Interest income +1,254 +6,013 +5,597 +Interest expense, net of amount capitalized +( 40,770 +) +( 75,204 +) +( 51,578 +) +Other +756 +389 +750 +Total other expense +( 38,760 +) +( 68,802 +) +( 45,231 +) +Loss before income taxes +( 931,018 +) +( 530,378 +) +( 367,408 +) +Income tax benefit +( 127,326 +) +( 104,675 +) +( 45,987 +) +Net loss +$ +( 803,692 +) +$ +( 425,703 +) +$ +( 321,421 +) +Net loss per common share: +Basic +$ +( 4.27 +) +$ +( 2.10 +) +$ +( 1.47 +) +Diluted +$ +( 4.27 +) +$ +( 2.10 +) +$ +( 1.47 +) +Weighted average number of common shares outstanding: +Basic +188,013 +203,039 +218,643 +Diluted +188,013 +203,039 +218,643 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2020 +2019 +2018 +(In thousands) +Net loss +$ +( 803,692 +) +$ +( 425,703 +) +$ +( 321,421 +) +Other comprehensive income (loss), net of taxes of $ 0 for 2020, $ 0 +for 2019 and $ 0 for 2018: +Foreign currency translation adjustment +( 66 +) +2,991 +( 4,335 +) +Total comprehensive income (loss) +$ +( 803,758 +) +$ +( 422,712 +) +$ +( 325,756 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings +Income (Loss) +Stock +Total +(In thousands) +Balance, December 31, 2017 +266,259 +$ +2,662 +$ +2,785,823 +$ +2,105,897 +$ +6,822 +$ +( 918,711 +) +$ +3,982,493 +Net loss +— +— +— +( 321,421 +) +— +— +( 321,421 +) +Foreign currency translation adjustment +— +— +— +— +( 4,335 +) +— +( 4,335 +) +Restricted stock issued for acquisition +192 +2 +2,930 +— +— +— +2,932 +Issuance of restricted stock +381 +4 +( 4 +) +— +— +— +— +Vesting of restricted stock units +452 +5 +( 5 +) +— +— +— +— +Forfeitures of restricted stock +( 8 +) +— +— +— +— +— +— +Exercise of stock options +40 +— +485 +— +— +— +485 +Stock-based compensation +— +— +37,925 +— +— +— +37,925 +Payment of cash dividends +— +— +— +( 30,589 +) +— +— +( 30,589 +) +Dividend equivalents +— +— +— +( 330 +) +— +— +( 330 +) +Purchase of treasury stock +— +— +— +— +— +( 161,737 +) +( 161,737 +) +Balance, December 31, 2018 +267,316 +$ +2,673 +$ +2,827,154 +$ +1,753,557 +$ +2,487 +$ +( 1,080,448 +) +$ +3,505,423 +Net loss +— +— +— +( 425,703 +) +— +— +( 425,703 +) +Foreign currency translation adjustment +— +— +— +— +2,991 +— +2,991 +Issuance of restricted stock +185 +2 +( 2 +) +— +— +— +— +Vesting of restricted stock units +1,173 +12 +( 12 +) +— +— +— +— +Forfeitures of restricted stock +( 2 +) +— +— +— +— +— +— +Exercise of stock options +700 +7 +9,212 +— +— +— +9,219 +Stock-based compensation +— +— +39,328 +— +— +— +39,328 +Payment of cash dividends +— +— +— +( 32,428 +) +— +— +( 32,428 +) +Dividend equivalents +— +— +— +( 524 +) +— +— +( 524 +) +Purchase of treasury stock +— +— +— +— +— +( 264,686 +) +( 264,686 +) +Balance, December 31, 2019 +269,372 +$ +2,694 +$ +2,875,680 +$ +1,294,902 +$ +5,478 +$ +( 1,345,134 +) +$ +2,833,620 +Net loss +— +— +— +( 803,692 +) +— +— +( 803,692 +) +Foreign currency translation adjustment +— +— +— +— +( 66 +) +— +( 66 +) +Issuance of restricted stock +333 +3 +( 3 +) +— +— +— +— +Vesting of restricted stock units +1,324 +13 +( 13 +) +— +— +— +— +Stock-based compensation +— +— +26,572 +— +— +— +26,572 +Payment of cash dividends +— +— +— +( 18,862 +) +— +— +( 18,862 +) +Dividend equivalents +— +— +— +( 334 +) +— +— +( 334 +) +Purchase of treasury stock +— +— +— +— +— +( 21,179 +) +( 21,179 +) +Balance, December 31, 2020 +271,029 +$ +2,710 +$ +2,902,236 +$ +472,014 +$ +5,412 +$ +( 1,366,313 +) +$ +2,016,059 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2020 +2019 +2018 +(In thousands) +Cash flows from operating activities: +Net loss +$ +( 803,692 +) +$ +( 425,703 +) +$ +( 321,421 +) +Adjustments to reconcile net loss to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +670,910 +1,003,873 +916,318 +Impairment of goodwill +395,060 +17,800 +211,129 +Dry holes and abandonments +1,285 +109 +915 +Deferred income tax benefit +( 125,283 +) +( 103,202 +) +( 41,185 +) +Stock-based compensation expense +26,572 +39,328 +37,925 +Net gain on asset disposals +( 3,079 +) +( 13,904 +) +( 28,958 +) +Net gain on insurance reimbursement +( 4,172 +) +— +— +Write-down of capacity reservation contract +9,207 +12,673 +— +Credit loss expense +5,606 +5,683 +— +Restructuring expenses, non-cash +25,067 +— +— +(Gain) loss on early debt extinguishment +( 3,596 +) +24,023 +— +Amortization of debt discount and issuance costs +912 +937 +830 +Changes in operating assets and liabilities: +Accounts receivable +173,862 +213,588 +23,515 +Income taxes receivable/payable +1,635 +( 3,353 +) +( 1,555 +) +Inventory and other assets +27,192 +29,394 +( 1,470 +) +Accounts payable +( 48,602 +) +( 77,686 +) +( 69,453 +) +Accrued liabilities +( 59,240 +) +( 18,218 +) +4,136 +Other liabilities +( 10,786 +) +( 9,139 +) +( 56 +) +Net cash provided by operating activities +278,858 +696,203 +730,670 +Cash flows from investing activities: +Acquisitions, net of cash acquired +— +( 13 +) +( 14,211 +) +Purchases of property and equipment +( 145,481 +) +( 347,512 +) +( 641,458 +) +Proceeds from disposal of assets and insurance claims +20,929 +45,761 +47,357 +Collection of note receivable +— +— +23,760 +Other +( 424 +) +— +— +Net cash used in investing activities +( 124,976 +) +( 301,764 +) +( 584,552 +) +Cash flows from financing activities: +Purchases of treasury stock +( 21,179 +) +( 255,467 +) +( 161,737 +) +Dividends paid +( 18,862 +) +( 32,428 +) +( 30,589 +) +Proceeds from long-term debt +— +496,969 +521,194 +Repayment of long-term debt +( 62,525 +) +( 673,443 +) +— +Proceeds from borrowings under revolving credit facility +— +— +79,000 +Repayment of borrowings under revolving credit facility +— +— +( 347,000 +) +Debt issuance costs +( 584 +) +( 852 +) +( 4,489 +) +Proceeds from exercise of stock options +— +— +485 +Net cash provided by (used in) financing activities +( 103,150 +) +( 465,221 +) +56,864 +Effect of foreign exchange rate changes on cash +( 2 +) +( 62 +) +( 781 +) +Net increase (decrease) in cash and cash equivalents +50,730 +( 70,844 +) +202,201 +Cash and cash equivalents at beginning of year +174,185 +245,029 +42,828 +Cash and cash equivalents at end of year +$ +224,915 +$ +174,185 +$ +245,029 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $ 431 in 2020, $ 732 in 2019 +and $ 1,435 in 2018 +$ +( 43,368 +) +$ +( 76,870 +) +$ +( 41,184 +) +Income taxes +3,709 +( 1,452 +) +3,172 +Non-cash investing and financing activities: +Receivable from property and equipment insurance +$ +— +$ +— +$ +15,000 +Net increase (decrease) in payables for purchases of property and equipment +( 30,241 +) +( 40,857 +) +36,241 +Issuance of common stock for business acquisitions +— +— +2,932 +Net decrease in deposits on equipment purchases +6,350 +3,974 +4,311 +Cashless exercise of stock options +— +9,219 +— +The accompanying notes are an integral part of these consolidated financial statements. +F-8 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “we,” “us,” “our,” “ours” and like terms) , is a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. Our contract drilling business operates in the continental United States. Our pressure pumping business operates primarily in Texas and the Appalachian region. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of horizontal wellbore placement. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating, working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +In the second quarter of 2020, we closed our Canadian drilling operations in response to our longer-term outlook for the western Canadian market. As a result of the closure, we recorded an impairment of $ 8.3 million. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, we have no controlling financial interests in any other entity which would require consolidation. As used in these notes, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its business operations through its wholly-owned subsidiaries and has no employees or independent operations. +The U.S. dollar is the functional currency for all of our operations except for our Canadian operations, which use the Canadian dollar as their functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Revenue recognition — Revenues from our contract drilling, pressure pumping, directional drilling, oilfield rentals, equipment servicing and electrical control and automation activities are recognized as services are performed. All of the wells we drilled in 2020, 2019 and 2018 were drilled under daywork contracts. Revenue from sales of products are recognized upon customer acceptance. Revenue is presented net of any sales tax charged to the customer that we are required to remit to local or state governmental taxing authorities. +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +On January 1, 2018, we adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on our consolidated financial statements, and a cumulative adjustment was not recognized. See Note 3 for additional information. +Leases — We enter operating leases for operating locations, corporate offices and certain operating equipment. As of December 31, 2020, we did not have any finance leases. +On January 1, 2019, we adopted the new lease guidance under Topic 842, Leases , using the modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. We have elected to report all leases at the beginning of the period of adoption and not restate our comparative periods. This standard does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. See Note 13 for additional information. +F-9 +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for credit losses represents our estimate of the amount of probable credit losses existing in our accounts receivable. We review the adequacy of our allowance for credit losses at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectible, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with our pressure pumping activities and materials used in our directional drilling and equipment servicing business. Such inventories are stated at the lower of cost or market, with cost determined using the average cost method. +Other current assets — Other current assets includes reimbursement from our workers compensation insurance carrier for claims in excess of our deductible in the amount of $ 36.1 million and $ 39.0 million at December 31, 2020 and 2019, respectively. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Equipment +1.25-15 +Buildings +15-20 +Other +3-12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +F-10 +We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds our undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. T he fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). We review unproved oil and natural gas properties quarterly to assess potential impairment. Our impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to oil and natural gas properties of approximately $ 11.2 million, $ 2.2 million and $ 1.0 million was recorded for the years ended December 31, 2020 , 201 9 and 201 8 , respectively. +Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. We assess impairment of goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. Our policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — We recognize the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards (See Note 12). +As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, based on historical experience. Forfeitures are estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates. +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Adopted Accounting Standards — In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers. Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers. We adopted this new revenue guidance effective January 1, 2018, utilizing the modified retrospective method, and expanded our consolidated financial statement disclosures in order to comply with the update (See Note 3). The adoption of this update did not have a material impact on our consolidated financial statements. +In February 2016, the FASB issued an accounting standards update to provide guidance for the accounting for leasing transactions. The standard requires the lessee to recognize a lease liability along with a right-of-use asset for all leases with a term longer than one year. A lessee is permitted to make an accounting policy election to not recognize the lease liability and related right-of-use asset for leases with a term of one year or less. The provisions of this standard also apply to situations where we are the lessor. We adopted this new leasing guidance effective January 1, 2019 and expanded our consolidated financial statement disclosures in order to comply with the update (See Note 13). The adoption of this standard resulted in the recording of operating lease right-of-use assets of approximately $ 31.0 million and operating lease liabilities of approximately $ 35.8 million as of January 1, 2019. +In August 2016, the FASB issued an accounting standards update to clarify the presentation of cash receipts and payments in specific situations on the statement of cash flows. The requirements in this update are effective during interim and annual periods in fiscal years beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on our consolidated financial statements. +In May 2017, the FASB issued an accounting standards update that provided clarity on which changes to the terms or conditions of share-based payment awards require an entity to apply modification accounting provisions. The requirements in this update are effective during interim and annual periods in fiscal years beginning after December 15, 2017. The adoption of this update on January 1, 2018 did not have a material impact on our consolidated financial statements. +In March 2018, the FASB issued an accounting standards update to update the income tax accounting in U.S. GAAP to reflect the SEC interpretive guidance released on December 22, 2017, when significant U.S. tax law changes were enacted with the enactment of “H.R.1,” also known as the “Tax Cuts and Jobs Act” (“U.S. Tax Reform”). The adoption of this update in March 2018 did not have a material impact on our consolidated financial statements, as we were already following the SEC guidance (See Note 14). +In June 2016, the FASB issued an accounting standards update on measurement of credit losses on financial instruments. The new guidance requires us to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The new standard is effective for fiscal years beginning after December 15, 2019, including all interim periods within those years. We adopted ASU 2016-13 as of January 1, 2020. The adoption +F-11 +of this guidance and recognition of a loss allowance at an amount equal to expected credit losses for accounts receivable was not material and did not result in a transition adjustment to retained earnings. For more information regarding credit losses, see Note 4 . +In August 2018, the FASB issued an accounting standards update to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The capitalized implementation costs of a hosting arrangement that is a service contract will be expensed over the term of the hosting arrangement. We adopted this new guidance on January 1, 2020 prospectively with respect to all implementation costs incurred after the date of adoption. There was no material impact on our consolidated financial statements. +In August 2018, the FASB issued an accounting standards update to eliminate certain disclosure requirements for fair value measurements for all entities, require public entities to disclose certain new information and modify certain disclosure requirements. The FASB developed the amendments to Topic 820 as part of its broader disclosure framework project, which aims to improve the effectiveness of disclosures in the notes to financial statements by focusing on requirements that clearly communicate the most important information to users of the financial statements. We adopted this new guidance on January 1, 2020 and there was no material impact on our consolidated financial statements. +Recently Issued Accounting Standards — In December 2019, the FASB issued an accounting standards update to simplify the accounting for income taxes. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2020, with early adoption permitted. We adopted this new guidance on January 1, 2021, and we do not expect this new guidance will have a material impact on our consolidated financial statements. +In March 2020, the FASB issued an accounting standards update to provide temporary optional expedients that simplify the accounting for contract modifications to existing debt agreements expected to arise from the market transition from LIBOR to alternative reference rates. The amendments in the update are effective as of March 12, 2020 through December 31, 2022 and may be applied to contract modifications from the beginning of an interim period that includes or is subsequent to March 12, 2020. We plan to adopt this standard when LIBOR is discontinued and are currently evaluating the impact of adoption on our consolidated financial statements. +During the third quarter of 2019, we identified and recorded out-of-period adjustments primarily related to the accounting for inventory in our directional drilling segment. We concluded that these adjustments were not material to the consolidated financial statements for any of the current or prior periods presented. The net adjustment is reflected as a $ 6.6 million increase to “Loss before income taxes” in the consolidated statements of operations for the year ended December 31, 2019. +2. Acquisitions +Current Power Solutions, Inc. (“Current Power”) +During October 2018, we acquired Current Power. Current Power is a provider of electrical controls and automation to the energy, marine and mining industries. This acquisition was not material to our consolidated financial statements. +Superior QC, LLC (“Superior QC”) +During February 2018, we acquired the business of Superior QC, including its assets and intellectual property. Superior QC is a provider of software and services used to improve the statistical accuracy of horizontal wellbore placement. Superior QC’s measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. This acquisition was not material to our consolidated financial statements. +3. Revenues +ASC Topic 606 Revenue from Contracts with Customers +On January 1, 2018, we adopted the new revenue guidance under Topic 606, Revenue from Contracts with Customers , using the modified retrospective method for contracts that were not complete at December 31, 2017. The adoption of the new accounting standard did not have a material impact on our consolidated financial statements, and a cumulative adjustment was not recognized. Revenues for reporting periods beginning on or after January 1, 2018 are presented under Topic 606. +Our contracts with customers include both long-term and short-term contracts. Services that primarily generate revenue earned for us include the operating business segments of contract drilling, pressure pumping and directional drilling which comprise our reportable segments. We also derive revenues from our other operations, which include our operating business segments of oilfield rentals, equipment servicing, electrical controls and automation, and oil and natural gas working interests. For more information on our business segments, see Note 17. +F-12 +Charges for services are considered a series of distinct services. Since each distinct service in a series would be satisfied over time if it were accounted for separately, and the entity would measure its progress towards satisfaction using the same measure of progress for each distinct service in the series, we are able to account for these integrated services as a single performance obligation that is satisfied over time. +The transaction price is the amount of consideration to which we expect to be entitled in exchange for transferring promised goods or services to a customer, based on terms of our contracts with our customers. The consideration promised in a contract with a customer may include fixed amounts and/or variable amounts. Payments received for services are considered variable consideration as the time in service will fluctuate as the services are provided. Topic 606 provides an allocation exception, which allows us to allocate variable consideration to one or more distinct services promised in a series of distinct services that form part of a single performance obligation as long as certain criteria are met. These criteria state that the variable payment must relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service, and allocation of the variable consideration is consistent with the standards’ allocation objective. Since payments received for services meet both of these criteria requirements, we recognize revenue when the service is performed. +An estimate of variable consideration should be constrained to the extent that it is not probable that a significant revenue reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Payments received for other types of consideration are fully constrained as they are highly susceptible to factors outside the entity’s influence and therefore could be subject to a significant revenue reversal once resolved. As such, revenue received for these types of consideration is recognized when the service is performed. +Estimates of variable consideration are subject to change as facts and circumstances evolve. As such, we will evaluate our estimates of variable consideration that are subject to constraints throughout the contract period and revise estimates, if necessary, at the end of each reporting period. +We are a non-operating, working interest owner of oil and natural gas properties primarily located in Texas and New Mexico. The ownership terms are outlined in joint operating agreements for each well between the operator of the well and the various interest owners, including us, who are considered non-operators of the well. We receive revenue each period for our working interest in the well during the period. The revenue received for the working interests from these oil and gas properties does not fall under the scope of the new revenue standard, and therefore, will continue to be reported under current guidance ASC 932-323 Extractive Activities – Oil and Gas, Investments – Equity Method and Joint Ventures. +Reimbursement Revenue – Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +Operating Lease Revenue – Lease income from equipment that we lease to others is recognized on a straight-line basis over the lease term. +Our disaggregated revenue recognized from contracts with customers is included in Note 17. +Accounts Receivable and Contract Liabilities +Accounts receivable is our right to consideration once it becomes unconditional. Payment terms typically range from 30 to 60 days . +Accounts receivable balances were $ 158 million and $ 336 million as of December 31, 2020 and 2019, respectively. These balances do not include amounts related to our oil and gas working interests as those contracts are excluded from Topic 606. Accounts receivable balances are included in “Accounts receivable” in the consolidated balance sheets. +We do not have any significant contract asset balances. Contract liabilities include prepayments received from customers prior to the requested services being completed. Once the services are complete and have been invoiced, the prepayment is applied against the customer’s account to offset the accounts receivable balance. Also included in contract liabilities are payments received from customers for the initial mobilization of newly constructed or upgraded rigs that were moved on location to the initial well site. These mobilization payments are allocated to the overall performance obligation and amortized over the initial term of the contract. During the year ended December 31, 2020 and 2019, approximately $ 0.1 million and $ 1.0 million , respectively, was amortized and recorded in drilling revenue. +Total contract liability balances were $ 0.6 million and $ 2.7 million as of December 31, 2020 and December 31, 2019, respectively. Contract liability balances are included in “Accounts payable” and “Accrued liabilities” in the consolidated balance sheets. +F-13 +Contract Costs +Costs incurred for newly constructed rigs or rig upgrades based on a contract with a customer are considered capital improvements and are capitalized to drilling equipment and depreciated over the estimated useful life of the asset. +Practical Expedients Adopted with Topic 606 +We have elected to adopt the following practical expedients upon the transition date to Topic 606 on January 1, 2018: +• +Use of portfolio approach: An entity can apply this guidance to a portfolio of contracts (or performance obligations) with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying this guidance to the portfolio would not differ materially from applying this guidance to the individual contracts (or performance obligations) within that portfolio +• +Excluding disclosure about transaction price: As a practical expedient, an entity need not disclose the information for a performance obligation if either of the following conditions is met: +a) +The performance obligation is part of a contract that has an original expected duration of one year or less. +b) +The entity recognizes revenue from the satisfaction of the performance obligation. +• +Excluding sales taxes from the transaction price: The scope of this policy election is the same as the scope of the policy election under previous guidance. This election provides exclusion from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction and collected by the entity from a customer. +• +We do not disclose information about the transaction price allocated to remaining performance obligations and when revenue will be recognized because we recognize revenue equal to what we have the right to invoice when that amount corresponds directly with the value to the customer of the entity’s performance to date. +• +Costs of obtaining a contract: An entity can immediately expense costs of obtaining a contract if they would be amortized within a year. +4. Credit Losses +ASC Topic 326 Current Expected Credit Losses (CECL) +On January 1, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments , which introduces a new model to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Our customers are primarily oil and natural gas exploration and production companies, which are collectively exposed to oil and natural gas commodity price risk. Our customers require services from us at various stages of the exploration and production process. Accordingly, we have aggregated our trade receivables by segment. Any customers that have experienced a deterioration in credit quality are removed from the pool and evaluated individually. We utilized an accounts receivable aging schedule and historical credit loss information to estimate expected credit losses. Due to the significant decline in crude oil prices during the quarter ended March 31, 2020 and its related impact to our customers, we increased our historical credit loss rates used to determine our March 31, 2020 allowance for credit losses in the first quarter of 2020. We continued to monitor and evaluate our expected credit losses using these increased credit loss rates throughout the remainder of 2020. +The adoption of the new accounting standard did not have a material impact on our consolidated financial statements and did not result in a transition adjustment to retained earnings. +The allowance for credit losses related to accounts receivable as of December 31, 2020, and changes for the quarters ended March 31, June 30, September 30 and December 31, 2020 are as follows (in thousands): +Balance at December 31, 2019 +$ +6,516 +Provision for expected credit losses +1,055 +Balance at March 31, 2020 +7,571 +Provision for expected credit losses +4,551 +Balance at June 30, 2020 +12,122 +Write-offs +( 1,126 +) +Balance at September 30, 2020 +10,996 +Write-offs +( 154 +) +Balance at December 31, 2020 +$ +10,842 +F-14 +5. Inventory +Inventory consisted of the following at December 31, 2020 and 2019 (in thousands): +2020 +2019 +Finished goods +$ +600 +$ +105 +Work-in-process +802 +1,229 +Raw materials and supplies +31,683 +35,023 +Inventory +$ +33,085 +$ +36,357 +6. Property and Equipment +Property and equipment consisted of the following at December 31, 2020 and 2019 (in thousands): +2020 +2019 +Equipment +$ +7,647,451 +$ +8,114,326 +Oil and natural gas properties +222,738 +226,646 +Buildings +193,503 +184,700 +Land +25,781 +25,747 +Total property and equipment +8,089,473 +8,551,419 +Less accumulated depreciation, depletion, amortization and impairment +( 5,328,432 +) +( 5,244,742 +) +Property and equipment, net +$ +2,761,041 +$ +3,306,677 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment, intangible assets and liabilities for 2020, 2019 and 2018 (in thousands): +2020 +2019 +2018 +Depreciation and impairment expense +$ +644,943 +$ +974,206 +$ +887,155 +Amortization expense +19,281 +17,722 +18,197 +Depletion expense +6,686 +11,945 +10,966 +Total +$ +670,910 +$ +1,003,873 +$ +916,318 +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. In the second quarter of 2020, we recorded an impairment of $ 8.3 million related to the closing of our Canadian drilling operations. In 2019, we identified 36 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 36 rigs that were retired had limited commercial opportunity. We recorded a $ 173 million charge related to this retirement. In 2018, we identified 42 legacy non-APEX® rigs and related equipment that would be retired. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 42 rigs that were retired had limited commercial opportunity. We recorded a $ 48.4 million charge related to this retirement. +We also periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. In 2019, we recorded a charge of $ 20.5 million for the write-down of pressure pumping equipment compared to a $ 17.4 million write-down of pressure pumping equipment in 2018. There was no similar charge in 2020. +We also periodically evaluate our directional drilling assets. During 2019, we recorded a charge of $ 8.4 million for the write-down of directional drilling equipment. There was no similar charge in 2020 or 2018. +We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +F-15 +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of March 31, 2020. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of March 31, 2020. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 15 %, 22 %, 3 % and 9 %, respectively. +For the assessment performed in the first quarter of 2020, the expected cash flows for our asset groups i ncluded revenue and operating expense growth rates. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the second half of 2019 and the first quarter of 2020 and would begin to recover in 2022 in response to improved oil prices. While we believed these assumptions with respect to future oil pricing were reasonable, actual future prices and activity levels may vary significantly from the ones that were assumed. The timeframe over which oil prices and activity levels may recover is highly uncertain. +All of these factors are beyond our control. If the lower oil price environment experienced in 2020 were to last into late 2022 and beyond, our actual cash flows would likely be less than the expected cash flows used in these assessments and could result in impairment charges in the future, and such impairment charges could be material. +After the assessment we performed in the first quarter of 2020, we concluded that no triggering events occurred during the periods thereafter through December 31, 2020 with respect to our asset groups based on our recent results of operations, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices, our results of operations for the quarter ended September 30, 2019 and management’s expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of September 30, 2019. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 35 %, 54 %, 23 % and 7 %, respectively. +For the assessment performed in 2019, the expected cash flows for our asset groups i ncluded revenue and operating expense growth rates . Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in 2019 and would begin to recover in late 2020 or 2021 in response to improved oil prices. +We concluded that no triggering events occurred during the quarter ended December 31, 2019 with respect to our asset groups based on our recent results of operations, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +2018 Triggering Event Assessment +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of December 31, 2018. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 38 %, 58 %, 9 % and 23 %, respectively. +F-16 +For the assessment performed in 2018, the expected cash flows for our asset groups i ncluded revenue and operating expense growth rates . Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the fourth quarter of 2018, and would begin to recover in late 2019 and continue into 2020 in response to improved oil prices and activity levels. +7. Goodwill and Intangible Assets +Goodwill — Goodwill by operating segment as of December 31, 2020 and 2019 and changes for the years then ended are as follows (in thousands): +Contract +Other +Drilling +Operations +Total +Balance, December 31, 2018 +$ +395,060 +$ +15,696 +$ +410,756 +Measurement period adjustment +— +$ +2,104 +2,104 +Impairment +— +( 17,800 +) +( 17,800 +) +Balance, December 31, 2019 +$ +395,060 +$ +— +$ +395,060 +Impairment +( 395,060 +) +— +( 395,060 +) +Balance, December 31, 2020 +$ +— +$ +— +$ +— +The change to goodwill in Other Operations in 2019 was primarily a result of a measurement period adjustment related to accrued liabilities, which resulted in a $ 2.1 million increase from the original purchase price allocation assessed with the Current Power acquisition. +Goodwill is evaluated at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing are our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, we may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in our contract drilling reporting unit. We performed a quantitative impairment assessment of our goodwill as of March 31, 2020. In completing the assessment, the fair value of our contract drilling operating segment was estimated using the income approach. The estimate of fair value required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of March 31, 2020, impairment was indicated in our contract drilling reporting unit. We recognized an impairment charge of $395 million in the quarter ended March 31, 2020 associated with the impairment of all of the goodwill in our contract drilling reporting unit. We had no remaining goodwill balance as of December 31, 2020. +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and recent commodity prices, our results of operations for the quarter ended September 30, 2019 and our expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of September 30, 2019. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +F-17 +Based on the results of the goodwill impairment test as of September 30, 2019, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 13 % and we concluded that no impairment was indicated in our contract drilling reporting unit; however, impairment was indicated in our oilfield rentals and electrical controls and automation reporting units included in the other operations segment. We recognized an impairment charge of $ 17.8 million in 2019 associated with the impairment of all of the goodwill in our oilfield rentals and electrical controls and automation reporting units. +In connection with our annual goodwill impairment assessment as of December 31, 2019, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than the respective carrying amount. In making this determination, we considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in our reporting units, as well as our 2019 operating results and forecasted operating results for the succeeding year. We also considered our overall market capitalization at December 31, 2019. +2018 Triggering Event Assessment +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of December 31, 2018. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of December 31, 2018, the fair value of the contract drilling and oilfield rentals reporting units exceeded their carrying values by approximately 16 % and 14 %, respectively, and we concluded that no impairment was indicated in our contract drilling and oilfield rentals reporting units; however, impairment was indicated in our pressure pumping and directional drilling reporting units. We recognized an impairment charge of $ 211 million associated with the impairment of all of the goodwill in our pressure pumping and directional drilling reporting units. +Intangible Assets — In 2018, intangible assets were recorded in our directional drilling operating segment with the acquisition of Superior QC and in other operations with the acquisition of Current Power. See Note 2 for additional information. Additionally, intangible assets were recorded in our directional drilling operating segment with the acquisition of MS Directional in 2017. Our intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight-line basis. We have no t incurred any costs to renew or extend the term of acquired intangible assets since the acquisition in 2018. The following table identifies the segment and weighted average useful life of each of our intangible assets: +Weighted Average +Segment +Useful Life +(in years) +Customer relationships +Directional drilling +3.00 +Customer relationships +Other operations +7.00 +Developed technology +Directional drilling +5.89 +Internal use software +Directional drilling +5.00 +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of March 31, 2020. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 6 for additional information . +After the assessment we performed in the first quarter of 2020, we concluded that no triggering events necessitating an impairment assessment of the intangible assets occurred throughout the remainder of 2020 . +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in 2019, our results of operations for the quarter ended September 30, 2019 and our expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 6 for additional information. +F-18 +We concluded that no triggering events necessitating an impairment assessment of the intangible assets had occurred during the quarter ended December 31, 2019. +2018 Triggering Event Assessment +Due to the decline in the market price of our common stock and the deterioration of crude oil prices in the fourth quarter of 2018, we lowered our expectations with respect to activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of December 31, 2018. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 6 for additional information. +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2020 and 2019 are as follows (in thousands): +2020 +2019 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +28,000 +$ +( 26,757 +) +$ +1,243 +$ +28,000 +$ +( 19,710 +) +$ +8,290 +Developed technology +55,772 +( 27,515 +) +28,257 +55,772 +( 15,386 +) +40,386 +Internal use software +906 +( 319 +) +587 +482 +( 214 +) +268 +$ +84,678 +$ +( 54,591 +) +$ +30,087 +$ +84,254 +$ +( 35,310 +) +$ +48,944 +Amortization expense on intangible assets of approximately $ 19.3 million, $ 17.9 million and $ 18.3 million was recorded for the years ended December 31, 2020, 2019 and 2018, respectively. The remaining amortization expense associated with finite-lived intangible assets is expected to be as follows (in thousands): +Year ending December 31, +2021 +$ +12,568 +2022 +12,546 +2023 +1,119 +2024 +1,119 +2025 +1,068 +Thereafter +1,667 +Total +$ +30,087 +8. Accrued Liabilities +Accrued expenses consisted of the following at December 31, 2020 and 2019 (in thousands): +2020 +2019 +Salaries, wages, payroll taxes and benefits +$ +37,627 +$ +57,615 +Workers’ compensation liability +70,847 +81,112 +Property, sales, use and other taxes +10,666 +22,404 +Insurance, other than workers’ compensation +8,462 +9,218 +Accrued interest payable +11,325 +12,021 +Accrued restructuring expenses +14,310 +— +Other +21,767 +37,480 +Accrued liabilities +$ +175,004 +$ +219,850 +9. Long-Term Debt +2019 Term Loan Agreement — On August 22, 2019 , we entered into a term loan agreement (“Term Loan Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lender party thereto. +F-19 +The Term Loan Agreement is a committed senior unsecured term loan facility that permitted a single borrowing of up to $ 150 million initially, which we drew in full on September 23, 2019. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $ 75 million, not to exceed total commitments of $ 225 million. We repaid $ 50 million of the borrowings under the Term Loan Agreement on December 16, 2019, and an additional $ 50 million on December 24, 2020. As of December 31, 2020, we had $ 50 million in borrowings remaining under the Term Loan Agreement at a LIBOR-based interest rate of 1.52 %. The maturity date under the Term Loan Agreement is June 10, 2022 . +Loans under the Term Loan Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00 % to 1.375 %, and the applicable margin on base rate loans varies from 0.00 % to 0.375 %, in each case determined based upon our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans and base rate loans was 1.375 % and 0.375 %, respectively. +The Term Loan Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Term Loan Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at one of the two ratings agencies. +The Term Loan Agreement requires mandatory prepayment in an amount equal to 100 % of the net cash proceeds from the issuance of new senior indebtedness (other than certain permitted indebtedness) if our credit rating is below investment grade at both Moody’s and S&P. Our credit rating is currently investment grade at one of the two ratings agencies. The Term Loan Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50 %. The Term Loan Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2020. +Credit Agreement — On March 27, 2018 , w e entered into an amended and restated credit agreement (the “Credit Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Lead Arrangers and Joint Book Runners . +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $ 600 million, including a letter of credit facility that, at any time outstanding, is limited to $ 150 million and a swing line facility that, at any time outstanding, is limited to $ 20 million. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $ 300 million, not to exceed total commitments of $ 900 million. The original maturity date under the Credit Agreement was March 27, 2023 . On March 26, 2019, we entered into Amendment No. 1 to Amended and Restated Credit Agreement, which amended the Credit Agreement to, among other things, extend the maturity date under the Credit Agreement from March 27, 2023 to March 27, 2024 . On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement (“Amendment No. 2”) to, among other things, extend the maturity date for $ 550 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2024 to March 27, 2025. We have the option, subject to certain conditions, to exercise a n additional one-year extension of the maturity date. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00 % to 2.00 % and the applicable margin on base rate loans varies from 0.00 % to 1.00 %, in each case determined based upon our credit rating. As of December 31, 2020, the applicable margin on LIBOR rate loans was 1.75 % and the applicable margin on base rate loans was 0.75 %. A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10 % to 0.30 % based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +F-20 +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at one of the two ratings agencies. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50 %. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2020. +As of December 31, 2020, we had no borrowings outstanding under our revolving credit facility. We had $ 0.1 million in letters of credit outstanding under the Credit Agreement at December 31, 2020 and, as a result, had available borrowing capacity of approximately $ 600 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2020, we had $ 60.7 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25 % per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +Series A Senior Notes and Series B Senior Notes — On October 5, 2010 , we completed the issuance and sale of $ 300 million in aggregate principal amount of our 4.97 % Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bore interest at a rate of 4.97% per annum. On September 25, 2019, we fully prepaid the Series A Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $ 308 million, which represents 100 % of the principal and the “make-whole” premium to the prepayment date. +On June 14, 2012 , we completed the issuance and sale of $ 300 million in aggregate principal amount of our 4.27 % Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bore interest at a rate of 4.27% per annum. On December 16, 2019, we fully prepaid the Series B Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $ 315 million, which represents 100 % of the principal and the “make-whole” premium to the prepayment date . +Primarily as a result of the “make-whole” premiums, we incurred an $ 8.2 million loss on early extinguishment of the Series A Notes in the three months ended September 30, 2019, and a $ 15.8 million loss on early extinguishment of the Series B Notes in the three months ended December 31, 2019, which were included in “Interest expense , net of amount capitalized” in the consolidated statements of operations . +F-21 +2028 S enior Notes and 2029 Senior Notes — On January 19, 2018, we completed an offering of $ 525 million in aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”). T he net proceeds before offering expenses were approximately $ 521 million , of which we used $ 239 million to repay amounts outstanding under our revolving credit facility. On November 15, 2019, we completed an offering of $ 350 million in aggregate principal amount of our 5.15% Senior Notes due 2029 (the “2029 Notes”). The net proceeds before offering expenses were approximately $ 347 million . We used a portion of the net proceeds from the offering to prepay our Series B Notes . The remaining net proceeds and available cash on hand was used to repay $ 50 million of the borrowings under the Term Loan Agreement in 2019. +During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes in the open market. The principal amounts retired through these transactions totaled $ 15.5 million related to our 2028 Notes and $ 0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $ 3.4 million and $ 0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +We pay interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028 . The 2028 Notes bear interest at a rate of 3.95 % per annum. +We pay interest on the 2029 Notes on May 15 and November 15 of each year. The 2029 Notes will mature on November 15, 2029 . The 2029 Notes bear interest at a rate of 5.15 % per annum. +The 2028 Notes and 2029 Notes (together, the “Senior Notes”) are our senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The Senior Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the Senior Notes. None of our subsidiaries are currently required to be a guarantor under the Senior Notes. If our subsidiaries guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +At our option, we may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, and on August 15, 2029, in the case of the 2029 Notes, at our option, we may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100 % of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date. +The indentures pursuant to which the Senior Notes were issued include covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indentures. +Upon the occurrence of a change of control triggering event, as defined in the indentures, each holder of the Senior Notes may require us to purchase all or a portion of such holder’s Senior Notes at a price equal to 101 % of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +Debt issuance costs — We incurred approximately $ 0.2 million in debt issuance costs in connection with the Term Loan Agreement. We incurred approximately $ 4.6 million in debt issuance costs in connection with the Credit Agreement. We also incurred an additional $ 0.4 million in debt issuance costs in connection with our entry into Amendment No. 2. We incurred approximately $ 1.9 million in debt issuance costs in connection with the Series A Notes and approximately $ 1.6 million in debt issuance costs in connection with the Series B Notes . We incurred approximately $ 1.6 million in debt issuance costs in connection with the 2028 Notes and approximately $ 1.0 million in debt issuance costs in connection with the 2029 Notes. These costs were deferred and are being recognized as interest expense over the term of the underlying debt. Debt issuance costs, except those related to line-of-credit arrangements, are presented in the balance sheet as a direct deduction from the carrying amount of the related debt. Debt issuance costs related to line-of-credit arrangements are classified as a deferred charge. Amortization of debt issuance costs is reported as interest expense. +F-22 +Interest expense related to the amortization of debt issuance costs was approximately $ 1.1 million, $ 2.0 million and $ 2.0 million for the years ended December 31, 2020 , 2019 and 2018 , respectively. Amortization of debt issuance costs for the year ended December 31, 2020 includes $ 0.1 million of debt issuance costs that were expensed as a result of the early redemption of a portion of our 2028 Notes and our 2029 Notes as well as the partial repayment of our borrowings under our Term Loan Agreement. Amortization of debt issuance costs for the year ended December 3 1 , 2019 includes $ 0.2 million of debt issuance costs that were expensed as a result of the Series A Notes prepayment , $ 0.4 million of debt issuance costs that were expensed as a result of the Series B Notes prepayment and approximately $ 0.1 million of debt issuance costs that were expensed as a result of the Term Loan Agreement partial repayment . Amortization of debt issuance costs for the yea r ended December 31, 2018 includes $ 0.3 million of debt issuance costs related to commitments by lenders under our previous credit agreement who did not participate in the Credit Agreement. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2020 (in thousands): +Year ending December 31, +2021 +$ +— +2022 +50,000 +2023 +2024 +— +2025 +— +Thereafter +858,755 +Total +$ +908,755 +10. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2020, we maintained letters of credit in the aggregate amount of $ 60.8 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2020, no amounts had been drawn under the letters of credit. +As of December 31, 2020, we had commitments to purchase major equipment totaling approximately $ 14.7 million for our drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The agreements expire in years 2021 and 2022. As of December 31, 2020, the remaining obligation under these agreements was approximately $ 13.4 million, of which approximately $ 10.0 million and $ 3.4 million relate to 2021 and 2022, respectively. In the event the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. In 2017, we entered into a capacity reservation agreement that required a cash deposit to increase our access to finer grades of sand for our pressure pumping business. As market prices for sand substantially decreased since 2017, we purchased lower cost sand outside of this capacity reservation contract and recorded a charge of $ 9.2 million and $ 12.7 million in the second quarters of 2020 and 2019, respectively, to revalue the deposit to its expected realizable value. There is no value assigned to the capacity reservation contract subsequent to the charge recorded in the second quarter of 2020. +Contingencies – Our operations are subject to many hazards inherent in the businesses in which it operates, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +F-23 +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $ 1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $ 1.0 million per occurrence deductible on our equipment insurance coverage, a $ 10.0 million per occurrence deductible on our general liability coverage, a $ 2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $ 5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows or results of operations. +Other Matters — We have a Change in Control Agreement with one of our Executive Vice Presidents (the “Specified Employee”). The Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless we notify the Specified Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by us other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreement), then the Specified Employee shall generally be entitled to, among other things: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2 times the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under our welfare plans for up to two years . +The Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +We have Employment Agreements with our Chief Executive Officer, Chief Financial Officer, General Counsel and the President of our subsidiary, Patterson-UTI Drilling Company LLC (“Patterson-UTI Drilling”). In the case of the Chief Executive Officer and the General Counsel, the Employment Agreement supersedes the prior Change in Control Agreement with each executive and, in the case of the President of Patterson-UTI Drilling, the Employment Agreement supersedes his prior employment agreement. Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such termination at least 30 days before the effective date of such termination. Under specified circumstances, we may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by either (i) providing written notice 10 days before the effective date of such termination and by granting at least 10 days to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of such termination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by us to not be capable of being cured, the executive may be terminated for cause on the date the written notice is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following our decision to terminate the executive other than for Cause, or termination by the executive for Good Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by us without Cause, or the executive terminates his employment for Good Reason: +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +F-24 +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees, +• +we will accelerate vesting of all options and restricted stock awards on the 60th day following the executive’s termination , and +• +we will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +If our decision to terminate other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, which for the President of Patterson-UTI Drilling includes a change in control of us or, in certain circumstances, of Patterson-UTI Drilling), the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years , and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) of subsidized benefits continuation coverage. +11. Stockholders’ Equity +Stockholder Rights Agreement — On April 22, 2020, our Board of Directors adopted a stockholder rights agreement and declared a dividend of one right (a “Right”) for each outstanding share of our common stock to stockholders of record at the close of business on May 8, 2020. Each Right entitles its holder, subject to the terms of the Rights Agreement (as defined below), to purchase from us one one-thousandth of a share of our Series A Junior Participating Preferred Stock, par value $ 0.01 per share, at an exercise price of $ 17.00 per Right, subject to adjustment. The description and terms of the Rights are set forth in a stockholder rights agreement, dated as of April 22, 2020 (the “Rights Agreement”), between us and Continental Stock Transfer & Trust Company, as rights agent (the “Rights Agent”). +Initially, these Rights are not exercisable and trade with our shares of common stock. Under the Rights Agreement, the Rights generally become exercisable only if a person or group of persons acting together (each, an “acquiring person”) acquires beneficial ownership of 10% (12% for passive investors, subject to the Excluded Persons exception below) or more of the outstanding shares of our common stock. +In that situation, each holder of a Right (other than the acquiring person, whose Rights will become void) will become entitled to purchase additional shares of our common stock at a 50 % discount. In addition, if we are acquired in a merger or other business combination after an unapproved party acquires more than 10% (12% for passive investors, subject to the Excluded Persons exception below) of our outstanding shares of common stock, each holder of a Right would then be entitled to purchase shares of the acquiring company’s stock at a 50 % discount. Our Board of Directors, at its option, may exchange each Right (other than Rights owned by the acquiring person that have become void) in whole or in part, at an exchange ratio of one share of our common stock per outstanding Right, subject to adjustment. Except as provided in the Rights Agreement, our Board of Directors is entitled to redeem the Rights at $ 0.001 per Right. +Persons or groups that beneficially own 10% (12% for passive investors, subject to the Excluded Persons exception below) or more of our outstanding common stock prior to our announcement of our adoption of the Rights Agreement will generally not cause the Rights to be exercisable until such time as those persons or groups become the beneficial owner of any additional shares of our common stock, subject to certain exceptions. +On July 22, 2020, we and the Rights Agent entered into an amendment to the Rights Agreement. The amendment revises the definition of “acquiring person” in the Rights Agreement to exclude Excluded Persons. The amendment defines “Excluded Persons” as BlackRock, Inc. (collectively with the investment funds and accounts for which it acts or may act as manager and/or investment advisor, “BlackRock”) and The Vanguard Group, Inc. (together with the investment funds and accounts for which it acts or may act as manager and/or investment advisor, “Vanguard”). Our Board of Directors may determine, in its sole discretion, that BlackRock or Vanguard is no longer an “Excluded Person” if any of the representations, warranties, conditions or provisions in letter agreements between us and BlackRock or Vanguard, respectively, are breached or cease to be true, correct and complete in all material respects. Under each letter agreement, BlackRock and Vanguard represent, respectively, among other things, that: +• +Such investor will not acquire 20% or more of our then-outstanding common stock; +• +No single fund of such investor holds or will hold an economic interest (taking into account the ownership rules of Section 382 of the Internal Revenue Code) of 4.9% or more of our common stock, other than as disclosed to us; and +• +Such investor will only acquire beneficial ownership of our common stock in the ordinary course of business and not with the purpose or effect of changing or influencing control of us. +F-25 +The Rights Agreement will expire on April 21, 2021 , but our Board of Directors may consider earlier termination of the Rights Agreement if warranted. +Cash Dividends – We paid cash dividends during the years ended December 31, 2020, 2019 and 2018 as follows: +Per Share +Total +(in thousands) +2020 +Paid on March 19, 2020 +$ +0.04 +$ +7,629 +Paid on June 18, 2020 +0.02 +3,735 +Paid on September 17, 2020 +0.02 +3,746 +Paid on December 17, 2020 +0.02 +3,752 +Total cash dividends +$ +0.10 +$ +18,862 +2019 +Paid on March 21, 2019 +$ +0.04 +$ +8,499 +Paid on June 20, 2019 +0.04 +8,344 +Paid on September 19, 2019 +0.04 +7,847 +Paid on December 19, 2019 +0.04 +7,738 +Total cash dividends +$ +0.16 +$ +32,428 +2018 +Paid on March 22, 2018 +$ +0.02 +$ +4,443 +Paid on June 21, 2018 +0.04 +8,832 +Paid on September 20, 2018 +0.04 +8,685 +Paid on December 20, 2018 +0.04 +8,629 +Total cash dividends +$ +0.14 +$ +30,589 +On February 3, 2021 , our Board of Directors approved a cash dividend on our common stock in the amount of $ 0.02 per share to be paid on March 18, 2021 to holders of record as of March 4, 2021 . The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. +Share Repurchases and Acquisitions – On September 6, 2013, our Board of Directors approved a stock buyback program that authorized purchases of up to $ 200 million of our common stock in open market or privately negotiated transactions. On July 25, 2018, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $ 250 million of future share repurchases. On February 6, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $ 250 million of future share repurchases. On July 24, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $ 250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2020, we had remaining authorization to purchase approximately $ 130 million of our outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2020, 2019, and 2018 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock and restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Plan (as defined below) and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2020, 2019 and 2018 were as follows (dollars in thousands): +2020 +2019 +2018 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +43,802,611 +$ +918,711 +Purchases pursuant to stock buyback program +5,826,266 +20,000 +22,566,331 +250,109 +9,331,131 +150,497 +Acquisitions pursuant to long-term incentive plan +239,669 +1,179 +1,037,947 +14,205 +567,354 +11,240 +Other +— +— +31,013 +372 +— +— +Treasury shares at end of period +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +F-26 +12. Stock-based Compensation +We use share-based payments to compensate employees and non-employee directors. We recognize the cost of share-based payments under the fair-value-based method. Share-based awards include equity instruments in the form of stock options, restricted stock or restricted stock units that have included service conditions and, in certain cases, performance conditions. Our share-based awards also include share-settled performance unit awards. Share-settled performance unit awards are accounted for as equity awards. In 2020, we granted performance-based cash-settled phantom units, which are accounted for as a liability classified award. We issue shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +The Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) was originally approved by our stockholders effective as of April 17, 2014 and authorized 9.1 million shares for issuance. The Board of Directors adopted a resolution that no future grants would be made under any of our other previously existing plans. On June 29, 2017, our stockholders approved the amendment and restatement of the 2014 Plan (the “Amended and Restated Plan”) to increase the number of shares available under the plan by 9.8 million shares. On June 6, 2019, our stockholders approved an amendment to the Amended and Restated Plan to increase the number of shares available for issuance under the plan by 9.5 million shares and to extend the latest date on which awards may be granted under the Amended and Restated Plan to June 6, 2029 (the “Amendment” and the Amended and Restated Plan, as amended by the Amendment, the “Plan”). The aggregate number of shares of our common stock authorized for grant under the Plan is 28.4 million. +Our share-based compensation plans at December 31, 2020 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +Amended and Restated Plan +28,400,000 +6,634,513 +4,986,392 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +1,793,500 +— +A summary of the Plan follows: +• +The Compensation Committee of the Board of Directors administers the Plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +All options granted under the Plan are granted with an exercise price equal to or greater than the fair market value of our common stock at the time the option is granted. +• +The Plan provides for awards of incentive stock options, non-incentive stock options, tandem and freestanding stock appreciation rights, restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalents. As of December 31, 2020, non-incentive stock options, restricted stock awards, restricted stock units and performance unit awards had been granted under the Plan. +Options granted under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. +F-27 +Stock Options — We estimate the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of our common stock over the most recent period equal to the expected term of the options as of the date such options are granted. The expected term assumptions are based on our experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the year s ended December 31, 2020 , 201 9 and 201 8 . +Stock option activity for the year ended December 31, 2020 follows: +Weighted Average +Shares +Exercise Price Per Share +Outstanding at beginning of year +4,766,150 +$ +20.62 +Exercised +— +$ +— +Expired +( 740,000 +) +$ +15.10 +Outstanding at end of year +4,026,150 +$ +21.63 +Exercisable at end of year +4,011,150 +$ +21.64 +Options outstanding at December 31, 2020 have no intrinsic value and a weighted-average remaining contractual term of 3.22 years. Options exercisable at December 31, 2020 have no intrinsic value and a weighted-average remaining contractual term of 3.21 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2020, 2019 and 2018 follows (in thousands, except per share data): +2020 +2019 +2018 +Weighted-average grant date fair value of stock options granted (per share) +NA +NA +NA +Aggregate grant date fair value of stock options vested during the year +$ +89 +$ +543 +$ +1,954 +Aggregate intrinsic value of stock options exercised +$ +— +$ +— +$ +— +As of December 31, 2020, options to purchase 15,000 shares were outstanding and not vested. All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2020 with respect to these non-vested options follows (dollars in thousands): +Aggregate intrinsic value +$ +— +Weighted-average remaining contractual term +5.71 years +Weighted-average remaining expected term +0.71 years +Weighted-average remaining vesting period +0.71 years +Unrecognized compensation cost +$ +63 +Restricted Stock— For all restricted stock awards made to date, shares of common stock were issued when the awards were granted. Non-vested shares are subject to forfeiture for failure to fulfill service conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. We use the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock activity for the year ended December 31, 2020 follows: +Weighted Average +Grant Date Fair +Shares +Value Per Share +Non-vested restricted stock outstanding at beginning of year +72,051 +$ +21.59 +Vested +( 72,051 +) +$ +21.59 +Forfeited +— +$ +— +Non-vested restricted stock outstanding at end of year +— +$ +— +Restricted Stock Units — For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Forfeitable dividend equivalents are accrued on certain restricted stock units that will be paid upon vesting. We use the straight-line method to recognize periodic compensation cost over the vesting period. +F-28 +Restricted stock unit activity for the year ended December 31, 2020 follows: +Weighted Average +Time +Performance +Grant Date Fair +Based +Based +Value Per Share +Non-vested restricted stock units outstanding at beginning of year +2,631,726 +397,315 +$ +15.81 +Granted +1,691,246 +— +$ +4.25 +Vested (1) +( 1,285,658 +) +( 38,000 +) +$ +16.32 +Forfeited +( 295,766 +) +— +$ +13.39 +Non-vested restricted stock units outstanding at end of year +2,741,548 +359,315 +$ +9.52 +(1) +All of the performance-based restricted stock units that vested during 2020 were granted in 2017. +As of December 31, 2020, approximately 3.0 million non-vested restricted stock units outstanding are expected to vest. Additional information as of December 31, 2020 with respect to these non-vested restricted stock units follows (dollars in thousands): +Aggregate intrinsic value +$ +15,977 +Weighted-average remaining vesting period +1.76 years +Unrecognized compensation cost +$ +20,623 +Performance Unit Awards — We have granted share-settled performance unit awards to certain employees (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive a grant of shares of common stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is the three-year period commencing on April 1 of the year of grant, except that for the Performance Units granted in 2017 the three-year performance period commenced on May 1. +The performance goals for the Performance Units are tied to our total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. For the Performance Units granted in April 2018, the recipients will receive a target number of shares if our total shareholder return during the performance period, when compared to the peer group, is at the 50th percentile. For the Performance Units granted in April 2019 and April 2020, the recipients will receive the target number of shares if our total shareholder return during the performance period, when compared to the peer group, is at the 55th percentile. If our total shareholder return during the performance period, when compared to the peer group, is at the 75th percentile or higher, then the recipients will receive two times the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is at the 25th percentile, then the recipients will only receive one-half of the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is between the 25th and target percentile, or the target and 75th percentile, then the shares to be received by the recipients will be determined using linear interpolation for levels of achievement between these points. +For the Performance Units granted in April 2018, the payout is based on relative performance and does not have an absolute performance requirement. For the Performance Units granted in April 2019 and April 2020, the payout shall not exceed the target number of shares if our total shareholder return is negative or zero. Additionally, the Performance Units granted in April 2020 will not pay out if our total shareholder return is not equal to or greater than the total stockholder return of the S&P 500 Index for the Performance Period. +The total target number of shares with respect to the Performance Units for the years 2015-2020 is set forth below: +2020 +2019 +2018 +2017 +2016 +2015 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +500,500 +489,800 +310,700 +186,198 +185,000 +190,600 +In April 2018, 381,200 shares were issued to settle the 2015 Performance Units. In April 2019, 185,000 shares were issued to settle the 2016 Performance Units. In May 2020, 332,773 shares were issued to settle the 2017 Performance Units. The Performance Units granted in 2018, 2019, and 2020 have not reached the end of their respective performance periods. +F-29 +Because the Performance Units are share -settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2020 +2019 +2018 +2017 +2016 +2015 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +826 +$ +9,958 +$ +8,004 +$ +5,780 +$ +3,854 +$ +4,052 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2020 +2019 +2018 +2017 +2016 +2015 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2020 +$ +206 +$ +3,319 +$ +2,668 +$ +642 +NA +NA +Year ended December 31, 2019 +NA +$ +2,489 +$ +2,668 +$ +1,927 +$ +321 +NA +Year ended December 31, 2018 +NA +NA +$ +2,001 +$ +1,927 +$ +1,285 +$ +338 +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as follows: +• +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +• +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +• +Dividend equivalents are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +• +Dividend equivalents are recognized as additional compensation cost for the portion of restricted stock units that are not expected to vest or that ultimately do not vest. +Phantom Units — In May 2020, the Compensation Committee approved a grant of long-term performance-based phantom units to our Chief Executive Officer and President, William A. Hendricks, Jr (the “Phantom Units”). The Phantom Units were granted outside of the 2014 Plan. Pursuant to this phantom unit grant, Mr. Hendricks may earn from 0 % to 200 % of a target award of 298,500 phantom units based on our achievement of the same performance conditions over the same Performance Period that applies to the Performance Units granted in April 2020, as described above. Earned Phantom Units, if any, will be settled in 2023 , following completion of the three-year Performance Period, in a cash payment equal to the number of earned phantom units multiplied by our average trading price per share over the twenty consecutive trading days ending March 31, 2023. Because the Phantom Units are cash-settled awards, they are accounted for as a liability classified award. The grant date fair value of the Phantom Units was $ 1.2 million. Compensation expense is recognized on a straight-line basis over the performance period, with the amount recognized fluctuating as a result of the Phantom Units being remeasured to fair value at the end of each reporting period due to their liability-award classification. We recognized $ 0.6 million compensation expense associated with the Phantom Units in 2020 . +13. Leases +ASC Topic 842 Leases +On January 1, 2019, we adopted the new lease guidance under Topic 842, Leases , using the modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. We have elected to report all leases at the beginning of the period of adoption and not restate our comparative periods. This standard does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. +We have entered into operating leases for operating locations, corporate offices and certain operating equipment. These leases have remaining lease terms of six months to eight years as of December 31, 2020. Currently, we do not have any finance leases. Renewal options are included in the right-of-use asset and lease liability if it is reasonably certain that we will exercise the option, and termination options are included in the right-of-use asset and lease liability if it is not reasonably certain we will exercise the option. We have elected the short-term lease recognition practical expedient whereby right of use assets and lease liabilities are not recognized for leasing arrangements with an initial term of one year or less. +F-30 +Topic 842 requires that lessees and lessors discount lease payments at the lease commencement date using the rate implicit in the lease, if available, or the lessee’s incremental borrowing rate. We use the implicit rate when readily determinable. If the implicit rate is not readily determinable, we use our incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. +In the fourth quarter of 2019, we had entered into a sale-leaseback transaction that qualified as a sale. We sold a facility for proceeds of $ 10.2 million and concurrently entered into an operating lease agreement with the unrelated third-party for certain floors of the building for a 58 -month term. The associated gain on sale of approximately $ 0.8 million was included in “Other operating expenses (income), net” in the consolidated statements of operations. +For the year ended December 31, 2020, we entered into two new facility leases and recorded an increase to the operating lease right-of-use assets and corresponding operating lease liabilities of approximately $ 1.5 million. We also extended two facilities leases and recorded an increase to the operating lease right-of-use assets and corresponding operating lease liabilities of approximately $ 0.2 million. We terminated four facility leases and three operating equipment leases and recorded a decrease to the operating lease right-of-use assets of approximately $ 0.4 million and corresponding lease liabilities of approximately $ 2.2 million. The right-of-use assets that were formally terminated were partially impaired in the second quarter of 2020 in conjunction with our restructuring plan. See Note 20 for additional information on our restructuring expenses. +Practical Expedients Adopted with Topic 842 +We have elected to adopt the following practical expedients upon the transition date to Topic 842 on January 1, 2019: +• +Transitional practical expedients package: An entity may elect to apply the listed practical expedients as a package to all the leases that commenced before the effective date. The practical expedients are: +a) +The entity need not reassess whether any expired or existing contracts are or contain leases; +b) +The entity need not reassess the lease classification for expired or existing contracts; +c) +The entity need not reassess initial direct costs for any existing leases. +• +Use of portfolio approach: An entity can apply this guidance to a portfolio of leases with similar characteristics if the entity reasonably expects that the application of the leases model to the portfolio would not differ materially from the application of the lease model to the individual leases in that portfolio. This approach can also be applied to other aspects of the leases guidance for which lessees/lessors need to make judgments and estimates, such as determining the discount rate and determining and reassessing the lease term. +• +Lease and non-lease components: As a practical expedient, lease and non-lease components may be combined where the revenue recognition pattern is the same and where the lease component, when accounted for separately, would be considered an operating lease. Our contract drilling, pressure pumping and directional drilling contracts contain a lease component related to the underlying equipment utilized, in addition to the service component provided by our crews and expertise to operate the related equipment. We have concluded that the non-lease service of operating our equipment and providing expertise in the services provided to customers is predominant in our drilling, pressure pumping and directional drilling contracts. With the election of this practical expedient, we will continue to present a single performance obligation for these contracts under the revenue guidance in ASC 606. +Lease expense consisted of the following for the years ended December 31, 2020 and 2019 (in thousands): +Year Ended +Year Ended +December 31, 2020 +December 31, 2019 +Operating lease cost +$ +6,911 +$ +10,944 +Short-term lease expense (1) +2 +440 +Total lease expense +$ +6,913 +$ +11,384 +(1) +Short-term lease expense represents expense related to leases with a contract term of one year or less. +Supplemental cash flow information related to leases for the years ended December 31, 2020 and 2019 is as follows (in thousands): +Year Ended +Year Ended +December 31, 2020 +December 31, 2019 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ +11,576 +$ +10,033 +Right of use assets obtained in exchange for lease obligations: +Operating leases +$ +1,763 +$ +10,870 +F-31 +Supplemental balance sheet information related to leases as of December 31, 2020 and 2019 is as follows: +December 31, 2020 +December 31, 2019 +Weighted Average Remaining Lease Term: +Operating leases +5.2 years +5.3 years +Weighted Average Discount Rate: +Operating leases +4.1 +% +4.2 +% +Maturities of operating lease liabilities as of December 31, 2020 are as follows (in thousands): +Year ending December 31, +2021 +$ +8,011 +2022 +6,206 +2023 +4,030 +2024 +3,128 +2025 +2,109 +Thereafter +5,641 +Total lease payments +29,125 +Less imputed interest +( 2,911 +) +Total +$ +26,214 +14. Income Taxes +Loss before income taxes for the U.S. for years ended December 31, 2020, 2019 and 2018 are $ 917 million, $ 500 million, and $ 343 million, respectively. Loss before income taxes for non-U.S. jurisdictions for years ended December 31, 2020, 2019 and 2018 are $ 14.2 million, $ 30.5 million, and $ 24.3 million, respectively. +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2020, 2019 and 2018 are as follows (in thousands): +2020 +2019 +2018 +Federal income tax benefit: +Current +$ +( 1,977 +) +$ +( 1,976 +) +$ +( 3,954 +) +Deferred +( 107,334 +) +( 90,441 +) +( 35,081 +) +( 109,311 +) +( 92,417 +) +( 39,035 +) +State income tax expense (benefit): +Current +225 +851 +1,704 +Deferred +( 17,949 +) +( 11,593 +) +( 11,147 +) +( 17,724 +) +( 10,742 +) +( 9,443 +) +Foreign income tax expense (benefit): +Current +( 291 +) +( 348 +) +( 2,552 +) +Deferred +— +( 1,168 +) +5,043 +( 291 +) +( 1,516 +) +2,491 +Total income tax benefit: +Current +( 2,043 +) +( 1,473 +) +( 4,802 +) +Deferred +( 125,283 +) +( 103,202 +) +( 41,185 +) +Total income tax benefit: +$ +( 127,326 +) +$ +( 104,675 +) +$ +( 45,987 +) +F-32 +The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2020, 2019 and 2018 is summarized as follows: +2020 +2019 +2018 +Statutory tax rate +21.0 +% +21.0 +% +21.0 +% +State income taxes - net of the federal income tax benefit +1.7 +1.4 +1.1 +Goodwill impairment +( 8.2 +) +( 0.7 +) +( 6.9 +) +Permanent differences +( 0.6 +) +( 1.2 +) +( 0.7 +) +Tax effects of tax reform +— +— +( 1.3 +) +Valuation allowance +( 0.2 +) +( 0.8 +) +( 3.7 +) +State deferred tax remeasurement +— +( 1.1 +) +2.3 +Other differences, net +— +1.1 +0.7 +Effective tax rate +13.7 +% +19.7 +% +12.5 +% +The effective tax rate decreased by approximately 6.0 % to 13.7 % for 2020 compared to 19.7 % for 2019. This difference was primarily due to higher goodwill impairment charges in 2020 relative to 2019, which are not deductible for tax purposes. These charges resulted in a 8.2 % decrease to the effective tax rate in 2020, as compared to a 0.7 % decrease to the effective tax rate in 2019. +The tax effect of temporary differences and tax attributes representing deferred tax assets and liabilities at December 31, 2020 and 2019 are as follows (in thousands): +2020 +2019 +Deferred tax assets: +Net operating loss carryforwards +$ +370,875 +$ +375,308 +Tax credits +4,918 +4,138 +Expense associated with stock-based compensation +11,252 +10,561 +Workers' compensation allowance +17,177 +19,536 +Other deferred tax asset +24,735 +21,698 +428,957 +431,241 +Less: +Valuation allowance +( 19,133 +) +( 17,231 +) +Total deferred tax assets +409,824 +414,010 +Deferred tax liabilities: +Property and equipment basis difference +( 475,025 +) +( 607,785 +) +Other +( 12,475 +) +( 9,184 +) +Total deferred tax liabilities +( 487,500 +) +( 616,969 +) +Net deferred tax liability +$ +( 77,676 +) +$ +( 202,959 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and when necessary valuation allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We assess the realizability of our deferred tax assets quarterly and consider carryback availability, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. In 2020, we recorded an additional $ 1.9 million of valuation allowances against our net deferred tax assets, primarily relating to certain Canadian subsidiaries. +For income tax purposes, we have approximately $ 1.4 billion of gross federal net operating losses, approximately $ 49.4 million of gross Canadian net operating losses and approximately $ 931 million of post-apportionment state net operating losses as of December 31, 2020, before valuation allowances. The majority of federal net operating losses will expire in varying amounts, if unused, between 2034 and 2037 . Federal net operating losses generated in 2018, 2019 and 2020 can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2040 . State net operating losses will expire in varying amounts, if unused, between 2023 and 2040 . +As of December 31, 2020, we had no unrecognized tax benefits. We have established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2020, the tax years ended December 31, 2014 through December 31, 2019 are open for examination by U.S. taxing authorities. As of December 31, 2020, the tax years ended December 31, 2013 through December 31, 2019 are open for examination by Canadian taxing authorities. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. During 2020, the United States enacted various legislation related to COVID-19 relief, which includes multiple tax provisions. We have considered these tax provisions and do not currently expect any material impact to our financial statements. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +F-33 +We continue to elect permanent reinvestment of unremitted earnings in Canada effective January 1, 2010, and we intend to do so for the foreseeable future. If we were to repatriate earnings, in the form of dividends or otherwise, we may be subject to certain income and/or withholding taxes (subject to an adjustment for foreign tax credits). +15. Earnings Per Share +We provide a dual presentation of our net loss per common share in our consolidated statements of operations: basic net loss per common share (“Basic EPS”) and diluted net loss per common share (“Diluted EPS”). +Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock. Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock, performance units and restricted stock units. The dilutive effect of stock options, performance units and restricted stock units is determined using the treasury stock method. The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested shares of restricted stock. +The following table presents information necessary to calculate net loss per share for the years ended December 31, 2020, 2019 and 2018, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2020 +2019 +2018 +BASIC EPS: +Net loss attributed to common stockholders +$ +( 803,692 +) +$ +( 425,703 +) +$ +( 321,421 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +188,013 +203,039 +218,643 +Basic net loss per common share +$ +( 4.27 +) +$ +( 2.10 +) +$ +( 1.47 +) +DILUTED EPS: +Net loss attributed to common stockholders +$ +( 803,692 +) +$ +( 425,703 +) +$ +( 321,421 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +188,013 +203,039 +218,643 +Add dilutive effect of potential common shares +— +— +— +Weighted average number of diluted common shares outstanding +188,013 +203,039 +218,643 +Diluted net loss per common share +$ +( 4.27 +) +$ +( 2.10 +) +$ +( 1.47 +) +Potentially dilutive securities excluded as anti-dilutive +8,747 +9,195 +9,762 +16. Employee Benefits +We maintain a 401(k) plan for all eligible employees. Our operating results include expenses of approximately $ 7.7 million in 2020, $ 13.2 million in 2019 and $ 14.3 million in 2018 for our contributions to the plan. +17. Business Segments +At December 31, 2020, we had three reportable business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) directional drilling services. Each of these segments represents a distinct type of business and has a separate management team that reports to our chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. +Contract Drilling — We market our contract drilling services to major and independent oil and natural gas operators. As of December 31, 2020, we had 210 marketed land-based drilling rigs in the continental United States. +F-34 +Given our longer-term outlook for the western Canadian market, we elected to close our Canadian drilling operations during the second quarter of 2020. As a result, we recognized an impairment charge of $ 8.3 million related to the closure. For the years ended December 31, 2020 , 2019 and, 2018 , contract drilling revenue earned in Canada was $ 1.0 million, $ 4.7 million and $ 9.3 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $ 8.2 million and $ 20.1 million as of December 31, 2020 and 2019 , respectively. +Pressure Pumping — We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. We also provide cementing services through our pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. +Directional Drilling — We provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Substantially all of the revenue in the directional drilling segment is from directional drilling, downhole performance motors and measurement-while-drilling services, which are sold as a bundle. +Major Customer — During 2020, 2019 and 2018, no single customer accounted for more than 10% of our consolidated operating revenues. +F-35 +The following tables summarize selected financial information relating to our business segments (in thousands): +Year Ended December 31, +2020 +2019 +2018 +Revenues: +Contract drilling +$ +670,357 +$ +1,309,988 +$ +1,432,012 +Pressure pumping +336,111 +868,694 +1,573,396 +Directional drilling +73,356 +188,786 +209,275 +Other operations (1) +57,962 +122,885 +131,028 +Elimination of intercompany revenues - Contract drilling (2) +( 1,231 +) +( 1,638 +) +( 1,520 +) +Elimination of intercompany revenues - Other operations (2) +( 12,306 +) +( 18,030 +) +( 17,194 +) +Total revenues +$ +1,124,249 +$ +2,470,685 +$ +3,326,997 +Income (loss) before income taxes: +Contract drilling +$ +( 543,438 +) +$ +( 151,329 +) +$ +( 33,115 +) +Pressure pumping +( 166,666 +) +( 102,701 +) +( 77,328 +) +Directional drilling +( 40,612 +) +( 52,724 +) +( 117,497 +) +Other operations +( 41,685 +) +( 54,725 +) +( 18,221 +) +Corporate +( 94,251 +) +( 94,414 +) +( 76,016 +) +Credit loss expense +( 5,606 +) +( 5,683 +) +— +Interest income +1,254 +6,013 +5,597 +Interest expense +( 40,770 +) +( 75,204 +) +( 51,578 +) +Other +756 +389 +750 +Loss before income taxes +$ +( 931,018 +) +$ +( 530,378 +) +$ +( 367,408 +) +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +433,771 +$ +668,007 +$ +571,607 +Pressure pumping +152,630 +233,952 +250,010 +Directional drilling +36,504 +52,223 +45,317 +Other operations +41,511 +42,803 +41,512 +Corporate +6,494 +6,888 +7,872 +Total depreciation, depletion, amortization and impairment +$ +670,910 +$ +1,003,873 +$ +916,318 +Capital expenditures: +Contract drilling +$ +105,037 +$ +194,416 +$ +394,595 +Pressure pumping +21,678 +105,803 +173,848 +Directional drilling +4,681 +15,549 +35,929 +Other operations +12,378 +27,132 +34,660 +Corporate +1,707 +4,612 +2,426 +Total capital expenditures +$ +145,481 +$ +347,512 +$ +641,458 +Identifiable assets: +Contract drilling +$ +2,315,318 +$ +3,190,463 +$ +3,817,638 +Pressure pumping +486,702 +695,570 +921,237 +Directional drilling +107,807 +164,273 +239,341 +Other operations +88,676 +128,290 +177,374 +Corporate (3) +300,566 +261,019 +314,276 +Total assets +$ +3,299,069 +$ +4,439,615 +$ +5,469,866 +( 1 ) +Other operations includes our oilfield rentals business, drilling equipment service business, the electrical controls and automation business and the oil and natural gas working interests . +( 2 ) +Intercompany revenues consist of revenues from contract drilling for services provided to our other operations, and revenues from other operations for services provided to contract drilling, pressure pumping and within other operations . These revenues are generally based on estimated external selling prices and are eliminated during consolidation. +( 3 ) +Corporate assets primarily include cash on hand and certain property and equipment. +F-36 +18. Concentrations of Credit Risk +Financial instruments which potentially subject us to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +We believe we have placed our demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2020 and 2019, our demand deposits and temporary cash investments consisted of the following (in thousands): +2020 +2019 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +1,000 +$ +1,250 +Deposits in FDIC and SIPC-insured institutions over insurance limits +227,961 +179,375 +Deposits in foreign banks +1,966 +2,309 +230,927 +182,934 +Less outstanding checks and other reconciling items +( 6,012 +) +( 8,749 +) +Cash and cash equivalents +$ +224,915 +$ +174,185 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which we provide services. As is general industry practice, we typically do not require customers to provide collateral. A $ 5.6 million and $ 5.7 million provision for credit loss was recognized in 2020 and 2019, respectively, in relation to accounts receivable balances that were estimated to be uncollectible . No credit loss expense was recognized in 2018. +19. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of our outstanding debt balances as of December 31, 2020 and 2019 is set forth below (in thousands): +December 31, 2020 +December 31, 2019 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +3.95% Senior Notes +$ +509,505 +$ +471,019 +$ +525,000 +$ +511,485 +5.15% Senior Notes +349,250 +319,560 +350,000 +358,864 +Term Loan Agreement +50,000 +50,000 +100,000 +100,000 +Total debt +$ +908,755 +$ +840,579 +$ +975,000 +$ +970,349 +The fair values of the 3.95 % Senior Notes at December 31, 2020 and December 31, 2019 are based on discounted cash flows associated with the notes using the 5.24 % market rate of interest at December 31, 2020 and the 4.33 % market rate of interest at December 31, 2019. The fair values of the 5.15 % Senior Notes at December 31, 2020 and December 31, 2019 are based on discounted cash flows associated with t he notes using the 6.42 % market rate of interest at December 31, 2020 and the 4.81 % market rate of interest at December 31, 2019. The fair value estimates of the 3.95 % Senior Notes and the 5.15 % Senior Notes are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. T he carrying value of the balance outstanding at December 31, 2020 under the Term Loan Agreement approximated its fair value as the instrument has a floating interest rate. +20. Restructuring Expenses +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $ 38.3 million of charges associated with this plan in the second quarter of 2020. T here were no restructuring charges in the comparable periods of 2019 and 2018. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan . +Contract termination costs relate primarily to agreements to purchase minimum quantities of proppants (sand) from certain vendors. These costs are primarily comprised of a $ 5.3 million negotiated settlement and termination of an existing contract to purchase minimum quantities of sand and $ 14.0 million of contractual future payments under two existing contracts to purchase minimum quantities of sand without future economic benefit to us. We will not receive any sand under these contracts. Other exit costs relate primarily to facility closure costs and moving expenses. +F-37 +The right of use (“ROU”) asset abandonments relate to facility and equipment ROU assets abandoned as a result of restructuring. +The following table presents restructuring expenses by reportable segment f or the year ended December 31 , 2020 (in thousands) : +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +Corporate +Total +Severance costs +$ +1,821 +$ +3,460 +$ +503 +$ +501 +$ +215 +$ +6,500 +Contract termination costs +— +20,373 +— +— +— +20,373 +Other exit costs +523 +194 +827 +— +— +1,544 +Right-of-use asset abandonments +86 +7,304 +1,845 +— +686 +9,921 +Total +$ +2,430 +$ +31,331 +$ +3,175 +$ +501 +$ +901 +$ +38,338 +The following table presents the consolidated balance sheet captions that restructuring accruals are included in as of December 31 , 2020 (in thousands) : +December 31, 2020 +Accrued liabilities +$ +14,310 +Other long-term liabilities +200 +Total +$ +14,510 +21. Quarterly Financial Information (in thousands, except per share amounts) (unaudited) +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2020 +Operating revenues +$ +445,927 +$ +250,380 +$ +207,141 +$ +220,801 +Operating loss +( 494,410 +) +( 159,084 +) +( 114,566 +) +( 124,198 +) +Net loss +( 434,722 +) +( 150,332 +) +( 112,111 +) +( 106,527 +) +Net loss per common share: +Basic +$ +( 2.28 +) +$ +( 0.81 +) +$ +( 0.60 +) +$ +( 0.57 +) +Diluted +$ +( 2.28 +) +$ +( 0.81 +) +$ +( 0.60 +) +$ +( 0.57 +) +Included within net loss: +Goodwill impairment, after tax +$ +340,147 +$ +— +$ +— +$ +— +Restructuring, after tax +— +33,967 +— +— +Oil and natural gas assets impairment, after tax +9,084 +604 +— +— +Impairment of property and equipment related to Canadian drilling operations, after tax (1) +— +7,314 +— +— +Net gain from the realization of insurance proceeds, after tax (2) +— +( 3,696 +) +— +— +Impairment of capacity reservation contract, after tax (3) +— +8,157 +— +— +Gain on early debt extinguishment, after tax (4) +— +— +— +( 2,916 +) +(1) +Impairment of property and equipment related to Canadian drilling operations was included in “Depreciation, depletion, amortization and impairment” in the consolidated statements of operations. +(2) +Net gain from the realization of insurance proceeds was included in “Other operating expenses (income), net” in the consolidated statements of operations. +(3) +Impairment of capacity reservation contract was included in “Other operating expenses (income), net” in the consolidated statements of operations. +(4) +Gain on early debt extinguishment was included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +F-38 +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2019 +Operating revenues +$ +704,171 +$ +675,765 +$ +598,452 +$ +492,297 +Operating loss +( 23,383 +) +( 48,125 +) +( 307,305 +) +( 82,763 +) +Net loss +( 28,614 +) +( 49,447 +) +( 261,719 +) +( 85,923 +) +Net loss per common share: +Basic +$ +( 0.14 +) +$ +( 0.24 +) +$ +( 1.31 +) +$ +( 0.44 +) +Diluted +$ +( 0.14 +) +$ +( 0.24 +) +$ +( 1.31 +) +$ +( 0.44 +) +Included within net loss: +Goodwill impairment, after tax +$ +— +$ +— +$ +14,276 +$ +— +Impairment of capacity reservation contract, after tax (1) +— +10,519 +— +— +Impairment of property and equipment, after tax (2) +— +— +162,581 +— +Directional drilling charges (3) +— +— +13,616 +— +Oilfield technology and manufacturing charges, after tax (4) +— +— +11,694 +— +Early repayment of debt charge, after tax (5) +— +— +6,614 +12,401 +(1) +Impairment of capacity reservation contract was included in “Other operating expenses (income), net” in the consolidated statements of operations. +(2) +Impairment of property and equipment was included in “Depreciation, depletion, amortization and impairment” in the consolidated statements of operations. +(3) +Directional drilling charges were included in “Direct operating costs” in the consolidated statements of operations. +(4) +Inventory write-offs and severance expense as a result of transitioning away from our engineering and manufacturing efforts in Calgary were included in “Direct operating costs” and “Selling, general and administrative” in the consolidated statements of operations, respectively. +(5) +Early repayment of debt charge was included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +F-39 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions (1) +Balance +(In thousands) +Year Ended December 31, 2020 +Deducted from asset accounts: +Allowance for credit losses +$ +6,516 +$ +5,606 +$ +( 1,280 +) +$ +10,842 +Year Ended December 31, 2019 +Deducted from asset accounts: +Allowance for credit losses +$ +2,312 +$ +5,683 +$ +( 1,479 +) +$ +6,516 +Year Ended December 31, 2018 +Deducted from asset accounts: +Allowance for credit losses +$ +2,323 +$ +— +$ +( 11 +) +$ +2,312 +(1) +Consists of uncollectible accounts written-off . +S-1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 9, 2021 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 9, 2021. +Signature +Title +/s/ Curtis W. Huff +Chairman of the Board +Curtis W. Huff +/s/ William Andrew Hendricks, Jr. +President, Chief Executive Officer +William Andrew Hendricks, Jr. +and Director +(Principal Executive Officer) +/s/ C. Andrew Smith +Executive Vice President and +C. Andrew Smith +Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Tiffany Thom Cepak +Director +Tiffany Thom Cepak +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Janeen S. Judah +Director +Janeen S. Judah +S-2 \ No newline at end of file diff --git a/raw/filings/0000889900/2020/0001564590-21-005045/filing_metadata.csv b/raw/filings/0000889900/2020/0001564590-21-005045/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..db38fbecaa27044f9e4b2ab759787687eb7a223f --- /dev/null +++ b/raw/filings/0000889900/2020/0001564590-21-005045/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2021-02-09,2020-12-31,2021-02-09T22:08:06.000Z,0001564590-21-005045,pten-10k_20201231.htm,10-K,21151332,1,1,https://www.sec.gov/Archives/edgar/data/889900/000156459021005045/pten-10k_20201231.htm,https://www.sec.gov/Archives/edgar/data/889900/000156459021005045/,2020,2020,1 diff --git a/raw/filings/0000889900/2020/0001564590-21-005045/item1.txt b/raw/filings/0000889900/2020/0001564590-21-005045/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..ccd48c765a9bf67b4c8faf2cfb11a6bbe3cf1edb --- /dev/null +++ b/raw/filings/0000889900/2020/0001564590-21-005045/item1.txt @@ -0,0 +1,367 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and, from time to time, we pursue contract drilling opportunities in other select markets . As of December 31, 2020, we had a drilling fleet that consisted of 210 marketed land-based drilling rigs. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2020, we had approximately 1.3 million fracturing horsepower to provide these services. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors and wireline steering tools. We also provide services that improve the statistical accuracy of horizontal wellbore placement. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +3 +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2018, 2019 and 2020 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2018: +Average oil price per Bbl (1) +$ +62.88 +$ +68.04 +$ +69.76 +$ +59.08 +Average rigs operating per day - U.S. (2) +166 +175 +177 +182 +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in the United States. +Oil prices remain extremely volatile, as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and closed at $53.55 per barrel on February 1, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered from the lows experienced in the first half of 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $42.45 per barrel in the fourth quarter of 2020 . +Our active rig count has declined since the fourth quarter of 2018. Our average active rig count for the fourth quarter of 2020 was 62 rigs. This was an increase from our average active rig count for the third quarter of 2020 of 60 rigs. Our U.S. active rig count at December 31, 2020 of 65 rigs was less than the rig count of 121 rigs at December 31, 2019, due to the significantly reduced demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place, we expect an average of 42 rigs operating under term contracts during the first quarter of 2021 and an average of 34 rigs operating under term contracts throughout 2021. +The pressure pumping market remains oversupplied. In response to oversupplied market conditions, we implemented changes during the second quarter of 2020 to further streamline our operations, improve our efficiencies, and reduce our overall cost structure, while maintaining our customer service levels. +Recent Developments in Financial Matters — During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes (as defined below) in the open market. The principal amounts retired through these transactions totaled $15.5 million related to our 2028 Notes and $0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $3.4 million and $0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +On December 24, 2020, we elected to repay $50 million of the borrowings under our Term Loan Agreement (as defined below). As of December 31, 2020, we had $50 million in borrowings remaining under the Term Loan Agreement at a LIBOR-based interest rate of 1.52%. The maturity date of the Term Loan Agreement is June 10, 2022. +On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement to, among other things, extend the maturity date for $550 million of revolving credit commitments of certain lenders under the Credit Agreement (as defined below) from March 27, 2024 to March 27, 2025. We have the option, subject to certain conditions, to exercise an additional one-year extension of the maturity date. +Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” for additional detail regarding our 2028 Notes, 2029 Notes, Term Loan Agreement and Credit Agreement. +4 +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $38.3 million of charges associated with this plan in the second quarter of 2020. In conjunction with our restructuring, we closed our Canadian drilling operations. We recorded an impairment of $8.3 million associated with that closure. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan. +The following table presents restructuring expenses by reportable segment f or the year ended December 31 , 2020 (in thousands) : +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +Corporate +Total +Severance costs +$ +1,821 +$ +3,460 +$ +503 +$ +501 +$ +215 +$ +6,500 +Contract termination costs +— +20,373 +— +— +— +20,373 +Other exit costs +523 +194 +827 +— +— +1,544 +Right-of-use asset abandonments +86 +7,304 +1,845 +— +686 +9,921 +Total +$ +2,430 +$ +31,331 +$ +3,175 +$ +501 +$ +901 +$ +38,338 +Industry Segments +Our revenues, operating loss and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Our contract drilling services, pressure pumping services, and directional drilling services industry segments had operating losses in 2020, 2019 and 2018. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 17 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to major, independent and other oil and natural gas operators. As of December 31, 2020, we had 210 marketed land-based drilling rigs based in the following regions: +• +68 in west Texas and southeastern New Mexico, +• +19 in north central and east Texas and northern Louisiana, +• +35 in the Rocky Mountain region (Colorado, Wyoming and North Dakota), +• +23 in south Texas, +• +29 in western Oklahoma, and +• +36 in the Appalachian region (Pennsylvania, Ohio and West Virginia). +Our marketed drilling rigs have rated maximum depth capabilities ranging from approximately 13,200 feet to 24,000 feet. All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have spent approximately $694 million during the last three years on capital expenditures to modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2020, 2019 and 2018, we spent approximately $105 million, $194 million and $395 million, respectively, on these capital expenditures. +5 +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. During 2020, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 19 days. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2020 +2019 +2018 +Average rigs operating per day (1) +82 +149 +177 +Number of rigs operated during the year +132 +189 +193 +Number of wells drilled during the year +1,327 +2,703 +3,088 +Number of operating days +29,904 +54,544 +64,479 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers. While conventional wells remain a source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in the United States. +To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet during the last several years. We have delivered new APEX ® rigs to the market and have made performance and safety improvements to existing high capacity rigs. APEX ® rigs are electric rigs with advanced electronic drilling systems, 500-ton top drives, iron roughnecks, hydraulic catwalks, and other automated pipe handling equipment. APEX ® rigs that are pad-capable are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe. As of December 31, 2020, our marketed land-based drilling fleet was comprised of the following: +Number of Rigs +Classification +Total +Percent Pad-Capable +APEX ® 1500 HP rigs +172 +94 +% +APEX ® 1000 HP rigs +12 +100 +% +APEX ® 2000 HP rigs +6 +67 +% +APEX ® 1400 HP rigs +5 +100 +% +APEX ® 1200 HP rigs +3 +100 +% +Other electric rigs +12 +83 +% +Total +210 +Average horsepower +1,458 +6 +The U.S. land rig industry refers to certain high specification rigs as “super-spec” rigs. We consider a super-spec rig to be a 1,500 horsepower, AC powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We currently estimate there are approximately 690 super-spec rigs in the United States, which includes 150 of our APEX® rigs. +We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio and West Virginia. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. The scope and impact of our cementing services were insignificant during the fiscal years 2020, 2019 and 2018. +Pressure Pumping Contracts — Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.4 million horsepower as of December 31, 2020. Pressure pumping equipment at December 31, 2020 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +Texas Region +Number of units +401 +17 +418 +Approximate horsepower +953,250 +18,555 +971,805 +Northeast Region +Number of units +167 +11 +178 +Approximate horsepower +371,150 +7,500 +378,650 +Other Regions +Number of units +5 +— +5 +Approximate horsepower +12,250 +— +12,250 +Combined: +Number of units +573 +28 +601 +Approximate horsepower +1,336,650 +26,055 +1,362,705 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +Materials — Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials. +7 +Directional Drilling Operations +General — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (MWD) and supply and rental of downhole performance motors and wireline steering tools, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of major integrated energy companies and large North American independent oil and natural gas operators. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +Directional Drilling Services — We provide our directional drilling services on a dayrate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days of work completed. Our dayrates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a standby rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Equipment — We generally design, assemble, maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. As of December 31, 2020, we had a comprehensive fleet of over 1,000 motors. In addition to our motor fleet, we had over 100 MWD systems. +Wellbore Placement Data Analytics — We provide software and services used to improve the statistical accuracy of horizontal wellbore placement. Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. We provide these services to customers with onshore and offshore operations. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing onshore oil and gas basins in the United States. We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2020, we received approximately 54% from our ten largest customers and approximately 35% from our five largest customers. During 2020, no customer accounted for more than 10% of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +Backlog +Our contract drilling backlog as of December 31, 2020 and 2019 was approximately $301 million and $605 million, respectively. Approximately 21% of the total contract drilling backlog at December 31, 2020 is reasonably expected to remain after 2021. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +We encourage you to review our latest Sustainability Report, located on our website, for more detailed information regarding our Sustainability and Human Capital programs and initiatives. Nothing on our website, including our Sustainability Report or sections thereof, shall be deemed incorporated by reference into this Report or other filings that we make with the SEC. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell™ lithium battery hybrid energy management system. EcoCell™ is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 3,000 full-time employees as of January 31, 2021. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our employees are represented by a union. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs in place that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All field-based employees are required to attend an Employee Safety Orientation, which includes classes on behavior-based safety, hazard awareness, safe systems of work, permission to work, time out for safety, energy isolation, hazard communication (HAZCOM) and material handling. In response to the COVID-19 pandemic, we implemented, and continue to implement, safety protocols at our offices, facilities and worksites. These protocols include allowing many of our office-based employees to work from home, while implementing additional safety measures for employees continuing critical on-site work. +9 +Diversity and Inclusion – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require our employees to complete training on an annual basis regarding our commitment to a respectful workplace for all. Supervisors and managers are required to complete respectful workplace training to ensure they understand our expectations for them regarding their obligations to promote a work environment where all employees feel valued and respected. +Maintaining our Core Values – In 2020, we trained over 4,000 employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, +• +services that improve the statistical accuracy of horizontal wellbore placement, including for customers with offshore operations, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. Federal, state, foreign, regional and local environmental laws, rules and regulations, including laws, rules, regulations and executive actions related to the mitigation of climate change or greenhouse gas emissions, currently apply to our operations and are likely to become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We +10 +could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that may govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act (the “Clean Water Act”) and the Oil Pollution Act of 1990 (the “Oil Pollution Act”), each as amended, and implementing regulations govern: +• +the prevention and permitting of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Clean Water Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +11 +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Certain politicians have also vocalized support for a nationwide ban on hydraulic fracturing. Additional legislation or regulation could lead to operational delays or increased operating costs in the production of oil and natural gas or could make it more difficult to perform hydraulic fracturing. These developments could also lead to litigation challenging proposed or existing wells. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we provide for our exploration and production customers , and such efforts could adversely affect our business, financial condition, cash flows and results of operations . See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. There has also been legislation proposed by U.S. lawmakers to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA, and future federal action to address climate change is likely. +President Biden and the Democratic Party, which now controls Congress, have identified climate change as a priority, and it is likely that new executive orders, regulatory action, and/or legislation targeting greenhouse gas emissions, or prohibiting, delaying or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. For example, the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee, and President Biden recently announced a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of Federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. President Biden also announced that the United States is taking steps to reenter the Paris Agreement. +Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and +12 +reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we have recently experienced slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +13 \ No newline at end of file diff --git a/raw/filings/0000889900/2020/0001564590-21-005045/item13.txt b/raw/filings/0000889900/2020/0001564590-21-005045/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2020/0001564590-21-005045/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2020/0001564590-21-005045/item9a.txt b/raw/filings/0000889900/2020/0001564590-21-005045/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..9df91a6efcef5c3dd98e715b5a56e7d01b3f3b16 --- /dev/null +++ b/raw/filings/0000889900/2020/0001564590-21-005045/item9a.txt @@ -0,0 +1,8 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2020, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2020, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2020. +The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2020/0001564590-21-005045/rp_note.txt b/raw/filings/0000889900/2020/0001564590-21-005045/rp_note.txt new file mode 100644 index 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1934 +For the fiscal year ended December 31, 2021 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 1-39270 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N , Suite 800 , Houston , Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +( 281 ) 765-7100 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common Stock, $0.01 Par Value +PTEN +The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ or No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Smaller reporting company +☐ +Non-accelerated filer +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2021 , the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $ 1.8 billion, calculated by reference to the closing price of $9.94 for the common stock on the Nasdaq Global Select Market on that date. +As of February 10, 2022, the registrant had outstanding 215,265,785 shares of common stock, $0.01 par value, its only class of common stock. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s definitive proxy statement for the 2022 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings, press releases and presentations by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. As used in this Report, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its operations through its wholly-owned subsidiaries and has no employees or independent business operations. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue, cost and margin expectations and backlog; financing of operations; oil and natural gas prices; rig counts and frac spreads; source and sufficiency of funds required for building new equipment, upgrading existing equipment and acquisitions (if opportunities arise); demand and pricing for our services; competition; equipment availability; government regulation; legal proceedings; debt service obligations; impact of inflation; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +adverse oil and natural gas industry conditions, including as a result of economic repercussions from the COVID-19 pandemic; +• +global economic conditions; +• +volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +excess availability of land drilling rigs, pressure pumping and directional drilling equipment, including as a result of reactivation, improvement or construction; +• +competition and demand for our services; +• +strength and financial resources of competitors; +• +utilization, margins and planned capital expenditures; +• +liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• +the ability to realize backlog; +• +specialization of methods, equipment and services and new technologies, including the ability to develop and obtain satisfactory returns from new technology; +• +the ability to retain management and field personnel; +• +loss of key customers; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +cybersecurity events; +• +synergies, costs and financial and operating impacts of acquisitions; +• +the effects of the acquisition of Pioneer Energy Services Corp. (“Pioneer”) on us, including our future financial condition, results of operations, strategy and plans; +1 +• +potential adverse reactions or changes to business or employee relationships resulting from the acquisition; +• +the failure to realize expected synergies and other benefits from the acquisition in the timeframe expected or at all; +• +difficulty in building and deploying new equipment; +• +governmental regulation; +• +climate legislation, regulation and other related risks; +• +environmental, social and governance practices, including the perception thereof; +• +environmental risks and ability to satisfy future environmental costs; +• +technology-related disputes; +• +legal proceedings and actions by governmental or other regulatory agencies; +• +the ability to effectively identify and enter new markets; +• +weather; +• +operating costs; +• +expansion and development trends of the oil and natural gas industry; +• +ability to obtain insurance coverage on commercially reasonable terms; +• +financial flexibility; +• +adverse credit and equity market conditions; +• +availability of capital and the ability to repay indebtedness when due; +• +stock price volatility; +• +compliance with covenants under our debt agreements; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in our filings with the SEC. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +W e are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets . As of December 31, 2021, we had a drilling fleet that consisted of 184 marketed land-based drilling rigs in the United States and eight in Colombia. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our contract drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2021, we had approximately 1.1 million fracturing horsepower to provide these services. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors. We also provide services that improve the statistical accuracy of directional and horizontal wellbores. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2019, 2020 and 2021 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day - U.S. (2) +69 +73 +80 +106 +3 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +In 2020, reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in the United States. +Oil prices remain extremely volatile, as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and recovered to reach a 2021 high of $85.64 per barrel on October 26, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered in 2021, and demand for our services has improved since the commodity price decline in 2020, our average number of rigs operating remains well below the number of our available rigs, and a portion of our pressure pumping horsepower remains stacked. Oil prices averaged $77.45 per barrel in the fourth quarter of 2021. +Although our active rig count has not fully recovered to its 2019 levels, it increased in 2021 after significant declines in 2020. Our average active U.S. rig count for the fourth quarter of 2021 was 106 rigs. This was an increase from our average active rig count for the third quarter of 2021 of 80 rigs. The increase was partially due to our acquisition of active U.S. rigs from Pioneer Energy Services Corp. (“Pioneer”), which averaged 13 active rigs during the fourth quarter of 2021. Our active U.S. rig count at December 31, 2021 of 111 rigs was more than the rig count of 65 rigs at December 31, 2020, partially due to the increase in rigs from the Pioneer acquisition and, more significantly, due to the recovery of oil prices and improved demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place in the United States, we expect an average of 51 rigs operating under term contracts during the first quarter, and an average of 39 rigs operating under term contracts during 2022. +We ended the fourth quarter of 2021 with 11 active pressure pumping spreads compared to ten at the end of the third quarter. Our average active spread count was approximately ten spreads and effective utilization was close to 11 spreads for the fourth quarter of 2021. We calculated average active spreads as the average number of spreads that were crewed and actively marketed during the period, and we calculated effective utilization as total pumping days during the quarter divided by 75 days, which we consider full effective utilization for a spread for the period. We expect to average approximately 11 active spreads in the first quarter of 2022. The pressure pumping market has improved but remains oversupplied. +Due to improving activity levels and increasing tightness in the overall labor market, we saw general oilfield cost inflation across our segments during 2021, including increases in the cost of labor, services and supplies. This inflation, combined with the increasing challenge of attracting employees to the industry, is increasing the complexity of reactivating equipment. We believe this challenge, combined with the increasing market tightness for premium drilling and completion services, will support higher pricing for our services in 2022. During 2021, we increased our capital expenditure forecast to approximately $170 million, in part, based on conversations with customers about increasing activity levels into 2022. Actual 2021 capital expenditures excluding discontinued operations totaled $166 million. +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. +Recent Developments in Financial Matters and Merger and Acquisition Activity — On October 1, 2021, we completed the acquisition of Pioneer Energy Services Corp. (“Pioneer”) by acquiring 100% of its equity interests . Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $30 million cash, which based on the closing price of our common stock of $9.44 on October 1, 2021, valued the transaction at approximately $278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. Through the Pioneer acquisition, we acquired Pioneer’s 100% pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. We believe the acquisition of Pioneer enhances our position as a leading provider of contract drilling services in the United States and expands our geographic footprint into Latin America. +4 +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business (collectively, “Pioneer Production Services”), to Clearwell Dynamics, LLC (“Clearwell”). The sale price was $43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses have been presented as a discontinued operation in these consolidated financial statements. In connection with the sale of our Pioneer Production Services business, we entered into a transition services agreement with Clearwell, pursuant to which we agreed to provide each other certain administrative and operational services on an interim, transitional basis through June 30, 2022. +On December 30, 2021, we repaid the final $50 million of borrowings under the 2019 Term Loan Agreement (“Term Loan Agreement”), and as a result had no remaining borrowings under the Term Loan Agreement as of December 31, 2021. +Industry Segments +Our revenues, operating loss and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Our contract drilling services, pressure pumping services, and directional drilling services industry segments had operating losses in 2021, 2020 and 2019. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 17 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to oil and natural gas operators in the United States and Colombia. As of December 31, 2021, we had 192 marketed land-based drilling rigs based in the following regions: +Region +Number of Rigs +West Texas +73 +Appalachia +33 +Rockies +24 +Oklahoma +20 +South Texas +19 +East Texas +15 +Colombia +8 +Total +192 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We have 171 super-spec rigs in total. +Due to evolving customer preferences, we have begun to refer to certain premium rigs as “Tier-1, super-spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allow for more clearance underneath the rig floor. We currently estimate there are fewer than 400 Tier-1, super-spec rigs in the United States, which includes our 107 Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +5 +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet during the last several years. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with many having high pressure mud systems, walking systems and increased hookload capacity. We have spent approximately $409 million during the last three years on capital expenditures to modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2021, 2020 and 2019, we spent approximately $110 million, $105 million and $194 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2021 +2020 +2019 +Average rigs operating per day - U.S. (1) +82 +82 +149 +Number of rigs operated during the year - U.S. +118 +131 +186 +Number of wells drilled during the year - U.S. +1,662 +1,324 +2,690 +Number of operating days - U.S. +29,960 +29,857 +54,282 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. In the fourth quarter of 2021, we identified 43 legacy, non-super-spec rigs and equipment to be abandoned. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 43 rigs that were abandoned had limited commercial opportunity. We recorded a $220 million charge related to this abandonment in the fourth quarter of 2021. +6 +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist™ application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell™ lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. The scope and impact of our cementing services were insignificant during the fiscal years 2021, 2020 and 2019. +Pressure Pumping Contracts — Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.1 million horsepower as of December 31, 2021. Pressure pumping equipment at December 31, 2021 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +Texas Region +Number of units +355 +12 +367 +Approximate horsepower +847,500 +14,280 +861,780 +Northeast Region +Number of units +121 +9 +130 +Approximate horsepower +281,900 +5,800 +287,700 +Combined: +Number of units +476 +21 +497 +Approximate horsepower +1,129,400 +20,080 +1,149,480 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +We periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. In the fourth quarter of 2021, we recorded a charge of $32.2 million related to the abandonment of approximately 0.2 million horsepower within our pressure pumping fleet. The majority of these units were frac pumps but also included pump down units. These units were abandoned due to changes in customer preferences for dual fuel, advancements in technology, and prohibitive reactivation costs. +Materials — Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +7 +Directional Drilling Operations +General — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (MWD) and supply and rental of downhole performance motors, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of oil and natural gas operators in the United States. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +Directional Drilling Services — We provide our directional drilling services primarily on a dayrate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days or footage completed. Our rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a standby rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Equipment — We generally design, assemble, maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. +We periodically evaluate our directional drilling assets. In the fourth quarter of 2021, we abandoned certain directional drilling equipment totaling $2.5 million and recorded a charge on our developed technology intangible asset of $11.4 million due to advances in technology that rendered those assets, and their related spare parts inventory, obsolete. The inventory write-down in 2021 totaled $4.0 million. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization to determine optimal steering recommendation placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing onshore oil and gas basins in the United States. We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2021, we received approximately 57% from our ten largest customers and approximately 39% from our five largest customers. During 2021, one customer accounted for approximately $216 million, or approximately 16%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +Backlog +Our contract drilling backlog in the United States as of December 31, 2021 and 2020 was approximately $325 million and $301 million, respectively. Approximately 22% of our contract drilling backlog in the United States at December 31, 2021 is reasonably expected to remain after 2022. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +We encourage you to review our latest Sustainability Report, located on our website, for more detailed information regarding our Sustainability and Human Capital programs and initiatives. Nothing on our website, including our Sustainability Report or sections thereof, shall be deemed incorporated by reference into this Report or other filings that we make with the SEC. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell™ lithium battery hybrid energy management system. EcoCell™ is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 5,000 full-time employees as of January 31, 2022. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs in place that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have safety education on an annual basis which incorporates learning associated with hazard awareness, safe systems of work, permission to work, time out for safety, energy isolation, material handling and management of change. +9 +In response to the COVID-19 pandemic, we implemented, and continue to maintain, safety protocols at our offices, facilities and worksites. These protocols include allowing many of our office-based employees to work from home. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require new supervisors and managers in the United States to attend an instructor-led course relative to diversity, inclusion and respect to ensure they understand our expectations regarding their obligations to promote a work environment where all employees are valued and respected. Supplemental diversity, inclusion and respect training for supervisors and managers is required on a biannual basis. All other employees are educated on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +Maintaining our Core Values – In 2021, we trained over 3,500 employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, +• +services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. Federal, state, foreign, regional and local environmental laws, rules and regulations, including laws, rules, regulations and executive actions related to the mitigation of climate change or greenhouse gas emissions, currently apply to our operations and are likely to become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +10 +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that may govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act (the “Clean Water Act”) and the Oil Pollution Act of 1990 (the “Oil Pollution Act”), each as amended, and implementing regulations govern: +• +the prevention and permitting of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Clean Water Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +11 +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Certain politicians have also vocalized support for a nationwide ban on hydraulic fracturing. Additional legislation or regulation could lead to operational delays or increased operating costs in the production of oil and natural gas or could make it more difficult to perform hydraulic fracturing. These developments could also lead to litigation challenging proposed or existing wells. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we provide for our exploration and production customers, and such efforts could adversely affect our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. There has also been legislation proposed by U.S. lawmakers to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA, and future federal action to address climate change is likely. +President Biden and the Democratic Party, which controls Congress, have identified climate change as a priority, and it is likely that additional executive orders, regulatory action, and/or legislation targeting greenhouse gas emissions, or prohibiting, delaying or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. For example, the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee, and President Biden recently announced a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of Federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Although a federal judge for the U.S. District Court of the Western District of Louisiana issued a nationwide preliminary injunction against the pause of oil and natural gas leasing on public lands or in offshore waters while litigation challenging that aspect of the executive order is ongoing, the Biden Administration may take other regulatory steps in the future that could impact our operations. +In February 2021, the United States rejoined the Paris Agreement, and in the future, the United States may also choose to adhere to other international agreements targeting GHG reductions. In April 2021, President Biden set a new goal for the United States to achieve a 50-52 percent reduction from 2005 levels in economy-wide net greenhouse gas pollution in 2030. Further, in November 2021, the Unites States and other countries entered into the Glasgow Climate Pact, which includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions by 30% by 2030, and cooperating toward the advancement of the development of clean energy. +Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +12 +We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +13 +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +Business and Operating Risks +The Effects of the COVID-19 Pandemic, Have Had, and Are Expected to Continue to Have, a Significant Adverse Impact on Our Business, Liquidity, Results of Operations and Financial Condition. +The effects of the COVID-19 pandemic, including related governmental actions and restrictions, have had, and are expected to continue to have, a significant adverse impact on the global economy, including the worldwide demand for oil and natural gas, and the level of demand for our services, which has impacted and is expected to continue to impact our business, liquidity, results of operations and our financial condition. +In response to the COVID-19 pandemic, governmental authorities have imposed mandatory closures, sought voluntary closures and imposed restrictions on, or advisories with respect to, travel, business operations and public gatherings or interactions. While many governmental authorities have loosened these restrictions, the ongoing COVID-19 outbreak may significantly worsen, and new strains of COVID-19 may emerge, which may cause governmental authorities to reconsider restrictions on travel, business and social activities. In the event governmental authorities retain, increase or reimpose restrictions, the loosening of restrictions may be further curtailed. +In early March 2020, OPEC+ was initially unable to reach an agreement to continue to impose limits on the production of crude oil, and shortly thereafter the World Health Organization determined the COVID-19 outbreak to be a pandemic. The convergence of these events created the unprecedented dual impact of a global oil demand decline coupled with the risk of a substantial increase in supply. In response to the rapid decline in commodity prices, exploration and production companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices and demand for our services have recovered in 2021, customer spending has not returned to pre-pandemic levels. +Given the nature and significance of the events described above, we are not able to enumerate all potential risks to our business from the recent volatility in crude oil prices and the COVID-19 pandemic; however, we believe that in addition to the impacts described above, other current and potential impacts of these recent events include, but are not limited to: +• +liquidity challenges, including impacts related to delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies; +• +customers, suppliers and other third parties seeking to terminate, reject, renegotiate or otherwise avoid, and otherwise failing to perform, their contractual obligations to us; +• +additional credit rating downgrades of our corporate debt and potentially higher borrowing costs in the future; +• +a need to preserve liquidity, which could result in a further reduction or suspension of our quarterly dividend or a delay or change in our capital investment plan; +• +cybersecurity issues, as digital technologies may become more vulnerable and experience a higher rate of cyberattacks in the current environment of remote connectivity; +• +litigation risk and possible loss contingencies related to COVID-19 and its impact, including with respect to commercial contracts, employee matters and insurance arrangements; +• +disruption to our supply chain for raw materials essential to our business; +• +loss of workers and labor shortages; +• +general oilfield cost inflation, including increases in the cost of labor, services and supplies; +14 +• +a further reduction of our workforce to adjust to market conditions, including severance payments, retention issues, and an inability to hire employees when market conditions improve; +• +additional costs associated with rationalization of our portfolio of real estate facilities, including exit of leases and facility closures to align with expected activity and workforce capacity; +• +additional asset impairments, along with other accounting charges; +• +additional infections and quarantining of our employees and the personnel of our customers, suppliers and other third parties in areas in which we operate and delays or suspensions of operations resulting therefrom; +• +additional actions undertaken by international, national, regional and local governments and health officials, including mandates and testing, to contain the virus or treat its effects; and +• +a structural shift in the global economy and its demand for oil and natural gas as a result of changes in the way people work, travel and interact, or in connection with a global recession or depression. +The full extent of the impact of COVID-19 on our business, liquidity, results of operations and financial condition will depend largely on future developments, including the duration and further spread of the virus, including any new strains of COVID-19, and the related impact on the oil and gas industry, the impact of governmental actions designed to prevent the spread of COVID-19 and the further development, availability, timely distribution and acceptance of effective treatments and vaccines, all of which are highly uncertain. +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in the United States. When these expenditures decline, our business may suffer. The rapid decline in oil prices resulting from the COVID-19 pandemic and the activities of OPEC+ caused a significant decline in both customer activity and prices for our services in 2020. While oil prices and demand for our services have recovered in 2021, activity has not fully recovered to its 2019 levels, and these events therefore continue to have, and are expected to continue to have, a significant impact on our business. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling, pressure pumping and directional drilling services, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the availability of capital for oil and natural gas industry participants, including our customers, and the extent to which they are willing or able to deploy capital, +• +the availability of and constraints in pipeline, storage and other transportation capacity in the basins in which we operate, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production, use and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, +• +increased focus by the investment and financing community on sustainability practices in the oil and natural gas industry, and +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Oil and natural gas prices and markets can be extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, including impacts on supply and demand due to economic repercussions from the COVID-19 pandemic, +• +the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil-producing nations, such as Russia, to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +15 +• +domestic and international military, political, economic, health and weather conditions, including the impacts of war or terrorist activity, pandemics and other unexpected disasters or events such as the COVID-19 pandemic, +• +changes to tax, tariff and import/export regulations by the United States or other countries, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +• +the development, price, availability and market acceptance of alternative fuels and energy sources. +All of these factors are beyond our control. Oil prices remain extremely volatile, as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and recovered to reach a 2021 high of $85.64 per barrel on October 26, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered in 2021, and demand for our services has improved since the commodity price decline in 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $77.45 per barrel in the fourth quarter of 2021. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Global Economic Conditions May Adversely Affect Our Operating Results. +Concerns regarding global economic conditions, energy costs, geopolitical issues, supply chain disruptions, inflation, the availability and cost of credit and the COVID-19 pandemic have contributed to increased economic uncertainty. Demand for energy and for oil and natural gas end products is highly sensitive to economic conditions; as a result, global economic conditions, indications that economic growth is slowing and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, including economic repercussions from the COVID-19 pandemic, low commodity prices or otherwise, may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. An economic slowdown or recession in the United States or in any other country that significantly affects the supply of or demand for oil or natural gas could negatively impact our operations and therefore adversely affect our results. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, including as a result of the COVID-19 pandemic, and there is no assurance that the global economic environment, or expectations for the global economic environment, will not quickly deteriorate again due to one or more factors, including due to uncertainties relating to the COVID-19 pandemic. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +A Surplus of Equipment and a Highly Competitive Oil Service Industry May Adversely Affect Our Utilization and Profit Margins and the Carrying Value of our Assets. +The land drilling and pressure pumping industries in the United States are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment or capital spending reductions by our customers due to customer consolidation, investor requirements or other reasons can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. In addition, in recent years there has been a substantial increase in new and upgraded drilling rigs and pressure pumping equipment. Low commodity prices and new and upgraded equipment can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. Even in an environment of high oil and natural gas prices and/or increased drilling and completion activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to a surplus of equipment. +16 +In times of reduced demand for our industry’s services, certain of our industry competitors may initiate bankruptcy proceedings or engage in debt refinancing transactions, management changes, or other strategic initiatives in an attempt to reduce operating costs to maintain a position in the market. This could result in such competitors emerging with stronger or healthier balance sheets and, in turn, an improved ability to compete with us in the future. We may also see corporate consolidations among both our customers and competitors, which could significantly alter industry conditions and competition within the industry, and have a material adverse effect on our business, financial condition, cash flows and results of operations. +We periodically seek to increase the prices on our services to offset rising costs, earn returns on our capital investment, and otherwise generate higher returns for our stockholders. However, we operate in a very competitive industry, and we are not always successful in raising or maintaining our existing prices. With drilling and completion activity well below the peak seen in 2014 and many rigs, including highly capable AC-powered rigs, and pressure pumping equipment still idle, there are limitations on the ability to raise or maintain prices across our fleet. Even if we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial condition, cash flows and results of operations. In addition, we may be unable to replace fixed-term contracts that expire or are terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. +Accordingly, high competition and a surplus of equipment can cause oil and natural gas service contractors to have difficulty maintaining pricing, utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or surplus equipment in the oil and natural gas service businesses or the level of demand for our contract drilling, pressure pumping or directional drilling services. +The surplus of operable land drilling rigs, increasing rig specialization and surplus of pressure pumping and directional drilling equipment, which can be exacerbated by capital spending reductions by our customers, could affect the fair market value of our contract drilling, pressure pumping and directional drilling equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices or changes in customer preferences and requirements could result in future impairment to our long-lived assets. For example, we recognized impairment charges of $267 million, $423 million and $221 million in 2021, 2020 and 2019, respectively. +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance . +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +17 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations, including as a result of their bankruptcy. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2021, our contract drilling backlog in the United States for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $325 million. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a description of our calculation of backlog. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts or may be reduced by price adjustments to existing contracts, including as a result of the decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services. +New Technologies May Cause Our Operating Methods, Equipment and Services to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance, including environmental performance, of drilling rigs and pressure pumping and other equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and pressure pumping and other equipment, as well as new and improved technology, such as drilling automation technology and lower-emissions operations and services, and data analytics. Accordingly, we may have to allocate a higher proportion of our capital expenditures to maintain and improve existing rigs and pressure pumping and other equipment, purchase and construct newer, higher specification drilling rigs and pressure pumping and other equipment to meet the increasingly sophisticated needs of our customers, and develop new and improved technology and data analytics. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping and directional drilling businesses could have similar effects. +18 +In recent years, we have added drilling rigs to our fleet through new construction and acquisitions, purchased new pressure pumping equipment and acquired a directional drilling services company. We have also improved existing drilling rigs and pressure pumping equipment by adding equipment and technology designed to enhance functionality and performance and reduce emissions. Although we take measures to ensure that we use advanced oil and natural gas drilling, pressure pumping and directional drilling technology, changes in technology, improvements in competitors’ equipment, increasing customer demands for new and improved technology, such as drilling automation technology and lower-emissions operations and services, and changes relating to the wells to be drilled and completed could make our equipment less competitive. +We continually attempt to develop new technologies for use in our business. In the event that we are successful in developing or acquiring new technologies for use in our business, there is no guarantee of future demand for those technologies. Customers may be reluctant or unwilling to adopt our new technologies. We may also have difficulty negotiating satisfactory terms for our new technologies, including terms that would enable us to obtain acceptable returns on our investment in the development or acquisition of new technologies. +Development and acquisition of new technology is critical to maintaining our competitiveness. There can be no assurance that we will be able to successfully develop or acquire technology that our customers demand. Some of our competitors have greater financial, technical and personnel resources that may allow them to enjoy technological advantages and develop, acquire and implement new technology on a more timely basis or in a more cost-effective manner. If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment and services obsolete, which could reduce our competitiveness and have a material adverse impact on our business, financial condition, cash flows and results of operation. +Loss of Key Personnel and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations. +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled personnel in operating and supporting our businesses and in developing new technologies. In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel, particularly after a prolonged industry downturn. During periods of high demand for our services or inflation, wage rates for operations personnel are also likely to increase, resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of key personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even in a period of generally lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. We may also face a loss of workers and labor shortages as a result of quarantines, vaccine mandates or requirements and enforcement of other COVID-19 regulations in jurisdictions where we operate. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2021, we received approximately 57% from our ten largest customers and approximately 39% from our five largest customers and 16% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Shortages, Delays in Delivery, and Interruptions in Supply, of Equipment and Materials Could Adversely Affect Our Operating Results. +Periodically, the oilfield services industry has experienced shortages of equipment for upgrades, drill pipe, replacement parts and other equipment and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +effects of the COVID-19 pandemic, +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +transportation and other logistical challenges, and +19 +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +These price increases, delays in delivery and interruptions in supply may require us to delay operations, increase capital and repair expenditures or otherwise incur higher operating costs. During the COVID-19 pandemic, there have been significant disruptions and delays across the global supply chain, which have created a tightening of supplies and shortages in a number of areas, including basic raw materials. Severe shortages, delays in delivery and interruptions in supply could increase our costs and limit our ability to operate, maintain, upgrade and construct our drilling rigs and pressure pumping and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Business Is Subject to Cybersecurity Risks and Threats. +Our operations are increasingly dependent on effective and secure information technologies and services. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, attempts to gain unauthorized access to our data and systems, theft, viruses, malware, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• +theft or misappropriation of funds, including via “phishing” or similar attacks directed at us or our customers; +• +loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• +disruption or impairment of our and our customers’ business operations and safety procedures; +• +personal injuries and destruction or damage to our and our customers’ property; +• +downtime and loss of revenue; +• +injury to our reputation, including the perception of our products or services as having security vulnerabilities; +• +negative impacts on our ability to compete; +• +loss or damage to our information technology systems, including operational technologies and worksite data delivery systems; +• +exposure to litigation and legal and regulatory costs; and +• +increased costs to prevent, respond to or mitigate cybersecurity events. +In response to the COVID-19 pandemic, many of our office personnel have moved to a “remote work” model. This model has significantly increased the use of remote networking and online conferencing services that enable employees to work outside of our corporate infrastructure and, in some cases, use their own personal devices. This may expose us to additional cybersecurity risks or related incidents. +Although we utilize various procedures and controls to mitigate our exposure to the risks described above, cybersecurity attacks and other cyber events are evolving and unpredictable. There can be no assurance that the procedures and controls that we implement, or that we cause third party service providers to implement, will be sufficient to protect our people, systems, information or other property. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber incident could go unnoticed for a period of time. We self-insure most of our cybersecurity risks, and any such incident could have a material adverse effect on our business, financial condition, cash flows and results of operations. As cyber incidents continue to evolve, we may be required to incur additional costs to continue to modify or enhance our protective measures or to investigate or remediate the effects of cyber incidents. +Our Commitments Under Supply Agreements Could Exceed Our Requirements, Exposing Us to Risks Including Price, Timing of Delivery and Quality of Equipment and Materials Upon Which Our Business Relies. +We have purchase commitments with certain vendors to supply equipment and materials, including, in the case of our pressure pumping business, proppants. Some of these agreements are take-or-pay agreements with minimum purchase obligations. If demand for our services decreases from current levels, demand for the equipment that we use and the materials that we supply as part of these services will also decrease. In addition, our customers may self-source certain materials. If demand for our services and/or materials decreases enough, we could have contractual minimum commitments that exceed the required amount of materials we need to supply to our customers. In this instance, we could be required to purchase materials that we do not have a present need for, pay for materials that we do not take delivery of or pay prices in excess of market prices at the time of purchase. +20 +Growth Through Acquisitions, the Building or Upgrading of Equipment and the Development of Technology Is Not Assured. +We have grown our drilling rig fleet and pressure pumping fleet and expanded our business lines and use of technology in the past through mergers, acquisitions, upgrades, new construction and technology development. For example, we completed the Pioneer acquisition during 2021. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building or upgrading equipment or developing new technology. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, our competitors may continue to upgrade and build new equipment and develop new technology, including drilling automation technology and lower-emissions operations and services. +There can be no assurance that we will: +• +have sufficient capital resources to complete additional acquisitions, build or upgrade equipment or develop new technology, +• +successfully integrate additional equipment, acquired or developed technology or other assets or businesses, including Pioneer, +• +effectively manage the growth and increased size, complexity and geography of our organization, including as a result of the Pioneer acquisition, +• +successfully deploy idle, stacked, upgraded or additional equipment and acquired or developed technology, +• +maintain the crews necessary to operate additional equipment or the personnel necessary to evaluate, acquire, develop and deploy new technology, or +• +successfully improve our financial condition, results of operations, business or prospects as a result of any completed acquisition, the building or upgrading equipment or the development of new technology. +Our failure to achieve consolidation savings, to integrate acquired businesses and technology and other assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising from events prior to any acquisitions, prior to our establishment of adequate compliance oversight or in connection with disputes over acquired or developed technology. While we generally seek to obtain indemnities for liabilities arising from events occurring before such acquisitions, these are limited in amount and duration, may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build or upgrade equipment or acquire or develop new technology, and we also may issue equity, convertible or debt securities in connection with any such acquisitions or building or upgrade program. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth could strain our management, operations, employees and other resources. +Fuel Conservation Measures Could Reduce Demand for Oil and Natural Gas, Which Would, In Turn, Reduce the Demand for Our Services. +Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas may have a material adverse effect on our business, financial condition, cash flows and results of operations. Additionally, the increased competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, and biofuels) or increased focus on reducing the use of oil and natural gas (such as governmental mandates that ban the sale of new gasoline-powered automobiles) could reduce demand for oil and natural gas and therefore for our services, which would lead to a reduction in our revenues. +Legal and Regulatory Risks +Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations. +Numerous political and regulatory authorities, governmental bodies and officials, and environmental groups devote resources to campaigns aimed at eradicating hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. +21 +President Biden and other political candidates and officeholders stated that they would support either increased regulation or a ban on hydraulic fracturing; however, we cannot predict whether hydraulic fracturing regulations will be enacted during the Biden Administration or how stringent they may be. In addition, members of the U.S. Congress and the EPA have reviewed proposals for more stringent regulation of hydraulic fracturing, and various state and local initiatives have been or may be proposed or implemented to further regulate hydraulic fracturing. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing and other aspects of the oil and gas industry. +In addition, legislation has been proposed, but not enacted, and may be proposed in the future, in the U.S. Congress to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if enacted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations, including a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. +Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. When caused by human activity, such seismic activity is called induced seismicity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In light of concerns about induced seismicity, some state regulatory agencies have modified their regulations or issued orders to address induced seismicity. +Finally, several jurisdictions have taken steps to enact hydraulic fracturing bans, moratoria or increased regulations on hydraulic fracturing practices. These actions have been the subject of legal challenges. +The full impact of the foregoing actions remains unclear, but the adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could restrict our ability, or make it more difficult, to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. Additionally, the adoption of significant restrictions or a prohibition on hydraulic fracturing by a state, region or locality could result in a surplus of oilfield equipment in other states, regions or localities where hydraulic fracturing remains allowed. +Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services. +The physical and regulatory effects of climate change could have a negative impact on our operations, our customers’ operations and the overall demand for our customers’ products and, accordingly, our services. There is an increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. These efforts have included consideration of cap-and-trade programs, carbon taxes, GHG reporting and tracking programs and regulations that directly limit GHG emissions from certain sources. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. In the absence of federal GHG-limiting legislation, the EPA has determined that GHG emissions present a danger to public health and the environment and has adopted regulations that, among other things, establish construction and operating permit reviews for GHG emissions from certain large stationary sources, require the monitoring and annual reporting of GHG emissions from certain oil and natural gas system sources, implement CAA emission standards directing the reduction of methane emissions from certain new, modified, or reconstructed facilities in the oil and natural gas sector, and together with the DOT, implement GHG emissions limits on vehicles manufactured for operation in the United States. +22 +In April 2016, the United States signed the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, every five years. Under the Paris Agreement, the Biden Administration has committed the United States to reducing its greenhouse gas emissions by 50-52% from 2005 levels by 2030. In November 2021, the Unites States and other countries entered into the Glasgow Climate Pact, which includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions 30% by 2030, and cooperating toward the advancement of the development of clean energy. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +Governmental, scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks in the United States. President Biden and the Democratic Party, which currently controls Congress, have identified climate change as a priority, and it is likely that additional executive orders, regulatory action, and/or legislation targeting greenhouse gas emissions, or prohibiting or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. President Biden issued an executive order imposing a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Other actions impacting oil and natural gas production activities that could be pursued by the Biden administration may include more restrictive requirements for the establishment of pipeline infrastructure or the permitting of liquified natural gas export facilities. +It is not possible at this time to predict the timing and effects of climate change or whether additional climate-related legislation, regulations or other measures will be adopted at the local, state, regional, national and international levels. However, continued efforts by governments and non-governmental organizations to reduce GHG emissions appear likely, and additional legislation, regulation or other measures that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our business. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations increase compliance costs, add operating restrictions, or reduce demand for our customers’ products and, accordingly, our services. +There are also increasing financial risks for oil and natural gas producers, as stockholders and bondholders currently invested in oil and natural gas companies concerned about the potential effects of climate change, ESG and other sustainability-related issues may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors, or into competitors who are perceived to have stronger ESG practices and disclosures. Our ESG practices and disclosures may not satisfy investor requirements or their requirements may not be made known to us. We may continue to face increasing pressure regarding our ESG practices and disclosures, which pressures have intensified recently in connection with the COVID-19 pandemic, significant societal events and worldwide efforts to mitigate climate change. Additionally, the lending and investment practices of institutional lenders and investors have been the subject of intensive lobbying efforts in recent years, oftentimes public in nature, not to provide funding for oil and natural gas producers. Limitation of investments in and financings for oil and natural gas could result in the restriction, delay, or cancellation of drilling and completion programs or development of production activities. An increasing number of our customers consider sustainability factors in awarding work. If we are unable to meet the ESG standards or investment criteria set by our customers, investors and other parties, or if we are unable to successfully continue our sustainability enhancement efforts, we may lose customers, we may lose investors, our cost of capital may increase, our stock price may be negatively impacted, our reputation may be negatively affected, and it may be more difficult for us to effectively compete. +Increasing attention to the risks of climate change has resulted in an increased possibility of lawsuits or investigations brought by public and private entities against oil and natural gas companies in connection with their GHG emissions. Should we be targeted by any such litigation or investigations, we may incur liability, which, to the extent that societal pressures or political or other factors are involved, could be imposed without regard to the causation of or contribution to the asserted damage, or to other mitigating factors. +These political, litigation, and financial risks may result in our customers restricting or cancelling production activities, incurring liability for infrastructure damage as a result of climatic changes, or impairing their ability to continue to operate in an economic manner, which also could reduce demand for our products and services. One or more of these developments could have a material adverse effect on our business, financial condition, cash flows and results of operations. Finally, increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, floods and other climatic events. If any such effects were to occur, they could have an adverse effect on our operations. +23 +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties or judgments, +• +modification, denial or revocation of permits or other authorizations, +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the places that we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, a manufacturer and servicer of equipment and automation to the energy, marine and mining industries and a provider of directional drilling and other services, we may be deemed to be a responsible party under these laws and regulations. +Technology Disputes Could Negatively Impact Our Operations or Increase Our Costs. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, or a third party’s infringement of our rights, including patent rights. The majority of the intellectual property rights relating to our drilling rigs, pressure pumping equipment and directional drilling services are owned by us or certain of our supplying vendors. However, in the event that we or one of our customers or supplying vendors becomes involved in a dispute over infringement of intellectual property rights relating to equipment or technology owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or technology or our ability to provide services or products, or we could be required to cease use of some equipment or technology or forced to modify our equipment, technology, services or products. We could also be required to pay license fees or royalties for the use of equipment or technology or provision of services or products. In addition, we may lose a competitive advantage in the event we are unsuccessful in enforcing our rights against third parties. Regardless of the merits, any such claims may result in significant legal and other costs, including reputational harm, and may distract management from running our business. Technology disputes involving us or our customers or supplying vendors could have a material adverse impact on our business, financial condition, cash flows and results of operations. +The Design, Manufacture, Sale and Servicing of Products, including Electrical Controls, May Subject Us to Liability for Personal Injury, Property Damage and Environmental Contamination Should Such Equipment Fail to Perform to Specifications. +We provide products, including electrical controls, to customers involved in oil and gas exploration, development and production and in the marine and mining industries. Because of applications that use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause harm to our reputation, contractual and warranty-related liability, damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. +Legal Proceedings and Governmental Investigations Could Have a Negative Impact on Our Business, Financial Condition and Results of Operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Additionally, actions or decisions we have taken or may take as a consequence of the COVID-19 pandemic may result in investigations, litigation or legal claims against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Please see “Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +24 +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect Our Opportunities and Future Business. +We provide contract drilling services in Colombia, we sell products, including electrical controls, for use in numerous oil and gas producing regions outside of North America, and through our Superior QC business, we occasionally provide remote data analytics and other services to customers to support their operations outside of the United States. We also continue to evaluate opportunities from time to time to provide our other services outside of the United States. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, changing political conditions and changing laws and policies affecting trade and investment, strikes, work stoppages, labor disputes and other slowdowns, terrorism, war, kidnapping of employees, regional economic downturns, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, difficulty in collecting international accounts receivable, potentially longer payment cycles, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, foreign taxation and customs regulations, the overlap of different tax structures, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. Additionally, we may be subject to foreign governmental regulations favoring or requiring the awarding of contracts to local contractors or requiring foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. These regulations could adversely affect our ability to compete. +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling rigs, pressure pumping equipment or other assets or businesses, such as the Colombia contract drilling business acquired through the Pioneer acquisition, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where our services could be provided or where our consumers for products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. In addition, investors could negatively view potential violations, inquiries or allegations of misconduct under the FCPA or similar laws, which could adversely affect our reputation and the market for our shares. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +25 +Many countries, including the United States, control the import and export of certain goods, services and technology and impose related import and export recordkeeping and reporting obligations. Governments also may impose economic sanctions against certain countries, persons and other entities that may restrict or prohibit transactions involving such countries, persons and entities. In particular, U.S. sanctions are targeted against certain countries that are heavily involved in the oil and gas industry. The laws and regulations concerning import and export activity, recordkeeping and reporting, including customs, export controls and economic sanctions, are complex and constantly changing. Any failure to comply with applicable legal or regulatory requirements governing international trade could also result in criminal and civil penalties and sanctions, such as fines, imprisonment, debarment from government contracts, seizure of shipments and loss of import and export privileges. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +Financial Risks +We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under Our Long-Term Debt. +We have borrowings outstanding under our senior notes and, from time to time, our revolving credit facility. Our ability to meet our interest and principal payment obligations depends in large part on cash flows from our subsidiaries. If our subsidiaries do not generate sufficient cash flows, we may be unable to meet our interest and principal payment obligations. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. As of December 31, 2021, the applicable margin on LIBOR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. As of December 31, 2021, we had no borrowings outstanding under our revolving credit facility. +We also have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2021, no amounts had been disbursed under any letters of credit. +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed at floating rates under these agreements or under future agreements. +A Downgrade in Our Credit Rating Could Negatively Impact Our Cost of and Ability to Access Capital. +Our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels, industry conditions and other considerations, including the impact of the COVID-19 pandemic. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, and potentially require us to post letters of credit for certain obligations. +We May Not Be Able to Generate Sufficient Cash to Service All of Our Debt and We May Be Forced to Take Other Actions to Satisfy Our Obligations Under Our Debt, which May Not Be Successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +26 +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our debt agreements contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +Risks Related to Our Common Stock and Corporate Structure +The Market Price of Our Common Stock May Be Highly Volatile, and Investors May Not Be Able to Resell Shares at or Above the Price Paid. +The trading price of our common stock may be volatile. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as other general economic, market or political conditions, could reduce the market price of our common stock in spite of our operating and/or financial performance. The following factors, in addition to other factors described in this “Risk Factors” section and elsewhere in this Report, may have a significant impact on the market price of our common stock: +• +investor perception of us and the industry and markets in which we operate; +• +general financial, domestic, international, economic, and market conditions, including overall fluctuations in the U.S. equity markets; +• +increased focus by the investment community on sustainability practices at our company and in the oil and natural gas industry generally; +• +changes in customer needs, expectations or trends and our ability to maintain relationships with key customers; +• +our ability to implement our business strategy; +• +changes in our capital structure, including the issuance of additional debt; +• +public announcements (including the timing of these announcements) regarding our business, financial performance and prospects or new services or products, service or product enhancements, technological advances or strategic actions, such as acquisitions or divestitures, restructurings or significant contracts, by our competitors or us; +• +trading activity in our stock, including portfolio transactions in our stock by us, our executive officers and directors, and significant stockholders or trading activity that results from the ordinary course rebalancing of stock indices in which we may be included; +• +short-interest in our common stock, which could be significant from time to time; +• +our inclusion in, or removal from, any stock indices; +• +changes in earnings estimates or buy/sell recommendations by securities analysts; +• +whether or not we meet earnings estimates of securities analysts who follow us; and +• +regulatory or legal developments in the United States and foreign countries where we operate. +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +27 +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania, Ohio, and internationally in Colombia. +Pressure Pumping — Our pressure pumping services are supported by multiple offices and yard facilities located in Texas and Pennsylvania. +Directional Drilling — Our directional drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, North Dakota, and Ohio. +Our oilfield rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our servicing of equipment for drilling contractors is supported by offices and yard facilities located in Texas. Our electrical controls and automation operation is supported by an office and yard facility in Texas. Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas, as well as several other facilities. We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +Item 4. Mine Safety Disclosure. +Not applicable. +28 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P SmallCap 600 Index and several other market indices. +(b) Holders +As of February 10, 2022, there were approximately 1,000 holders of record of our common stock. +(c) Dividends +On February 9, 2022, our Board of Directors approved a cash dividend on our common stock in the amount of $0.04 per share to be paid on March 17, 2022 to holders of record as of March 3, 2022. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend in order to improve our financial flexibility and best position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2021. +Period Covered +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands) (2) +October 2021 +291,926 +$ +9.42 +— +$ +130,000 +November 2021 +— +$ +— +— +$ +130,000 +December 2021 +523 +$ +8.01 +— +$ +130,000 +Total +292,449 +— +(1) +Upon the issuance of shares for the Pioneer acquisition in October 2021, we withheld 275,477 shares with respect to Pioneer employees’ tax withholding obligations. In addition, we withheld 16,972 shares in the fo urth quarter with respect to employees’ tax withholding obligations upon the vesting of restricted stock units. These shares were acquired at fair market value. Acquisitions of 16,972 shares were made pursuant to the terms of the Amended and Restated 2014 Long-Term Incentive Plan, as amended and the 2021 Long-Term Incentive Plan, and not pursuant to the stock buyback program. +(2) +On September 9, 2013, we announced that our Board of Directors approved a stock buyback program authorizing purchases of up to $200 million of our common stock in open market or privately negotiated transactions. On July 26, 2018, we announced that our Board of Directors approved an increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On February 7, 2019, we announced that our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. On July 25, 2019, we announced that our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the buyback program are held as treasury shares. There is no expiration date associated with the buyback program. +29 +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2016 through December 31, 2021, with the cumulative total return of the S&P 500 Index, the S&P SmallCap 600 Index, the Oilfield Service Index and a peer group determined by us. We changed our peer group in 2021 to align with the peer group used by the compensation committee of our Board of Directors. Our new peer group consists of Archrock, Inc., Bristow Group Inc., Cactus, Inc., ChampionX Corp., EQT Corporation, Helix Energy Solutions Group, Inc., Helmerich & Payne, Inc., Liberty Oilfield Services, Inc., Nabors Industries Ltd., NexTier Oilfield Solutions, Inc., NOV Inc., Oceaneering International, Inc., Oil States International, Inc., PDC Energy, Inc., Precision Drilling Corporation, Range Resources Corporation, TechnipFMC Plc. and Transocean Ltd. Our old peer group consisted of ChampionX Corporation, Archrock, Inc., Cimarex Energy Co., Diamond Offshore Drilling, Inc., EQT Corporation, Helmerich & Payne, Inc., Liberty Oilfield Services, Inc., Nabors Industries Ltd., NexTier Oilfield Solutions, Inc., NOV Inc., Noble Corporation plc., Oceaneering International, Inc., Oil States International, Inc., PDC Energy, Inc., Precision Drilling Corporation, Range Resources Corporation, TechnipFMC Plc, Transocean Ltd., Valaris plc and WPX Energy, Inc. +The graph assumes investment of $100 on December 31, 2016 and reinvestment of all dividends. +Index Data: Copyright Standard and Poor’s, Inc. Used with permission. All rights reserved. +Fiscal Year Ended December 31, +2016 +2017 +2018 +2019 +2020 +2021 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +85.80 +38.93 +40.13 +20.54 +33.34 +S&P 500 Stock Index +100.00 +121.83 +116.49 +153.17 +181.35 +233.41 +S&P SmallCap 600 Index +100.00 +113.23 +103.63 +127.24 +141.60 +179.58 +Oilfield Service Index +100.00 +82.80 +45.36 +45.11 +26.13 +31.55 +Old Peer Group Index +100.00 +80.92 +50.44 +48.07 +27.64 +38.21 +New Peer Group Index +100.00 +78.34 +49.73 +49.38 +29.21 +37.66 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +30 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Management Overview and Recent Developments in Market Conditions — We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. Our pressure pumping business operates primarily in Texas and the Appalachian region. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of directional and horizontal wellbores. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +During 2020, reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+ early in the year, led to a significant reduction in crude oil prices and demand for drilling and completion services in the United States. Although OPEC+ agreed in April 2020 to cut oil production, OPEC+ has been gradually reducing such cuts, and in July 2021 agreed to further reduce such cuts on a monthly basis with a goal of phasing out all production cuts towards the end of 2022. There is no assurance that the most recent OPEC+ agreement will be observed by its parties, and OPEC+ may change its agreement based on market conditions or other reasons. +Oil prices remain extremely volatile, as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and recovered to reach a 2021 high of $85.64 per barrel on October 26, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered in 2021, and demand for our services has improved since the commodity price decline in 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $77.45 per barrel in the fourth quarter of 2021. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2019, 2020 and 2021 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day - U.S. (2) +69 +73 +80 +106 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Although our active rig count has not fully recovered to its 2019 levels, it increased in 2021 after a significant decline in 2020. Our average active rig count in the U.S. for the fourth quarter of 2021 was 106 rigs. This was an increase from our average active rig count for the third quarter of 2021 of 80 rigs. The increase was partially due to our acquisition of active U.S. rigs from Pioneer, which averaged 13 active rigs during the fourth quarter of 2021. Our active U.S. rig count at December 31, 2021 of 111 rigs was more than the rig count of 65 rigs at December 31, 2020, partially due to the increase in rigs from the Pioneer acquisition and, more significantly, due to the recovery of oil prices and improved demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place in the United States, we expect an average of 51 rigs operating under term contracts during the first quarter, and an average of 39 rigs operating under term contracts during 2022. +31 +We ended the fourth quarter of 2021 with 11 active pressure pumping spreads compared to ten at the end of the third quarter. Our average active spread count was approximately ten spreads and effective utilization was close to 11 spreads for the fourth quarter of 2021. We calculated average active spreads as the average number of spreads that were crewed and actively marketed during the period, and we calculated effective utilization as total pumping days during the quarter divided by 75 days, which we consider full effective utilization for a spread for the period. We expect to average approximately 11 active spreads in the first quarter of 2022. The pressure pumping market has improved but remains oversupplied. +Due to improving activity levels and increasing tightness in the overall labor market, we saw general oilfield cost inflation across our segments during 2021, including increases in the cost of labor, services and supplies. This inflation, combined with the increasing challenge of attracting employees to the industry, is increasing the complexity of reactivating equipment. We believe this challenge, combined with the increasing market tightness for premium drilling and completion services, will support higher pricing for our services in 2022. During 2021, we increased our capital expenditure forecast to approximately $170 million, in part, based on conversations with customers about increasing activity levels into 2022. Actual 2021 capital expenditures excluding discontinued operations totaled $166 million. +Recent Developments in Financial Matters and Merger and Acquisition Activity — On October 1, 2021, we completed the acquisition of Pioneer by acquiring 100% of its equity interests . Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $30 million cash, which based on the closing price of our common stock of $9.44 on October 1, 2021, valued the transaction at approximately $278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. Through the Pioneer acquisition, we acquired Pioneer’s 100% pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. We believe the acquisition of Pioneer enhances our position as a leading provider of contract drilling services in the United States and expands our geographic footprint into Latin America. +On December 31, 2021, we completed the sale of Pioneer Production Services to Clearwell. The sale price was $43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses have been presented as a discontinued operation in these consolidated financial statements. In connection with the sale of our Pioneer Production Services business, we entered into a transition services agreement with Clearwell, pursuant to which we agreed to provide each other certain administrative and operational services on an interim, transitional basis through June 30, 2022. +On December 30, 2021, we repaid the final $50 million of borrowings under the Term Loan Agreement, and as a result had no remaining borrowings under the Term Loan Agreement as of December 31, 2021. +During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes (as defined below) in the open market. The principal amounts retired through these transactions totaled $15.5 million related to our 2028 Notes and $0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $3.4 million and $0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement (“Amendment No. 2”) to, among other things, extend the maturity date for $550 million of revolving credit commitments of certain lenders under the Credit Agreement (as defined below) from March 27, 2024 to March 27, 2025. We have the option, subject to certain conditions, to exercise an additional one-year extension of the maturity date. +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $38.3 million of charges associated with this plan in the second quarter of 2020. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan. There have been no restructuring charges in 2021. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and upon our customers’ ability to access capital to fund their operating and capital expenditures. During periods of improved oil and natural gas prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when oil and natural gas prices are relatively low or when our customers have a reduced ability to access capital, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. We may also be impacted by delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies. +32 +The North American oil and natural gas services industry is cyclical and at times experiences downturns in demand. During these periods, there has been substantially more oil and natural gas service equipment available than necessary to meet demand. As a result, oil and natural gas service contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods. While the market for premium equipment has tightened, there remains an excess supply of drilling rigs, pressure pumping equipment and directional drilling equipment. We cannot predict either the future level of demand for our oil and natural gas services or future conditions in the oil and natural gas service businesses. +In addition to the dependence on oil and natural gas prices and demand for our services, we are highly impacted by operational risks, competition, labor issues, weather, the availability, from time to time, of products used in our pressure pumping business, supplier delays and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations, including as a result of the COVID-19 pandemic. See “Risk Factors” in Item 1A of this Report. +For the three years ended December 31, 2021, our operating revenues consisted of the following (dollars in thousands): +2021 +2020 +2019 +Contract drilling +$ +664,030 +48.9 +% +$ +669,126 +59.5 +% +$ +1,308,350 +53.0 +% +Pressure pumping +523,756 +38.6 +% +336,111 +29.9 +% +868,694 +35.2 +% +Directional drilling +111,481 +8.2 +% +73,356 +6.5 +% +188,786 +7.6 +% +Other +57,814 +4.3 +% +45,656 +4.1 +% +104,855 +4.2 +% +$ +1,357,081 +100.0 +% +$ +1,124,249 +100.0 +% +$ +2,470,685 +100.0 +% +Contract Drilling +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet during the last several years. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we have begun to refer to certain premium rigs as “Tier-1, super spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allow for more clearance underneath the rig floor. As of December 31, 2021, our rig fleet included 171 super-spec rigs, of which 107 were Tier-1, super-spec rigs. +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2021 and 2020 was approximately $325 million and $301 million, respectively. Approximately 22% of the total contract drilling backlog in the United States at December 31, 2021 is reasonably expected to remain after 2022. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to fees for other services such as for mobilization, other than initial mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. For contracts that contain variable dayrate pricing, our backlog calculation uses the dayrate in effect for periods where the dayrate is fixed, and, for periods that remain subject to variable pricing, uses the commodity price in effect at December 31, 2021. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts on which we have received notice for the rig to be placed on standby, our backlog calculation uses the standby rate for the period over which we expect to receive the standby rate. For contracts on which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period over which we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +Pressure Pumping +As of December 31, 2021, we had approximately 1.1 million horsepower in our pressure pumping fleet. The pressure pumping market has improved but remains oversupplied. In response to oversupplied market conditions, we implemented changes during the second quarter of 2020 that were intended to further streamline our operations, improve our efficiencies, and reduce our overall cost structure, while maintaining our customer service levels. +Directional Drilling +We provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors. We also provide services that improve the statistical accuracy of directional and horizontal wellbores. +33 +Other Operations +Our oilfield rentals business, with a fleet of premium oilfield rental tools, along with the results of our ownership, as a non-operating working interest owner, in oil and gas assets located in Texas and New Mexico, provide the largest revenue contributions to our other operations. Other operations also includes the results of our electrical controls and automation business and the results of our drilling equipment service business. +Capital Expenditures +Cash capital expenditures for 2021, excluding discontinued operations, totaled $166 million. This was an increase from the $145 million of cash capital expenditures for 2020, due largely to higher activity levels in 2021 . Based on our current outlook for activity, we expect our capital expenditures for 2022 to be approximately $350 million. +For the three years ended December 31, 2021, our operating losses consisted of the following (dollars in thousands): +2021 +2020 +2019 +Contract drilling +$ +(423,029 +) +62.4 +% +$ +(543,438 +) +60.9 +% +$ +(151,329 +) +32.8 +% +Pressure pumping +(118,863 +) +17.5 +% +(166,666 +) +18.7 +% +(102,701 +) +22.3 +% +Directional drilling +(35,301 +) +5.2 +% +(40,612 +) +4.6 +% +(52,724 +) +11.4 +% +Other +(9,905 +) +1.5 +% +(41,685 +) +4.7 +% +(54,725 +) +11.9 +% +Corporate +(90,652 +) +13.4 +% +(99,857 +) +11.1 +% +(100,097 +) +21.6 +% +$ +(677,750 +) +100.0 +% +$ +(892,258 +) +100.0 +% +$ +(461,576 +) +100.0 +% +While demand for our services improved in 2021, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. This reduced demand, combined with impairments to our contract drilling, pressure pumping and directional drilling equipment contributed to a consolidated net loss of $655 million for 2021, compared to a consolidated net loss of $804 million for 2020 and consolidated net loss of $426 million for 2019. +Results of Operations +Comparison of the years ended December 31, 2021 and 2020 +The following tables summarize results of operations by business segment for the years ended December 31, 2021 and 2020: +Year Ended December 31, +Contract Drilling +2021 +2020 +% Change +(Dollars in thousands) +Revenues +$ +664,030 +$ +669,126 +(0.8 +)% +Direct operating costs +463,456 +380,822 +21.7 +% +Adjusted gross margin (1) +200,574 +288,304 +(30.4 +)% +Restructuring expenses +— +2,430 +NA +Other operating expenses (income), net +25 +(4,185 +) +NA +Selling, general and administrative +4,699 +4,666 +0.7 +% +Depreciation, amortization and impairment +618,879 +433,771 +42.7 +% +Impairment of goodwill +— +395,060 +NA +Operating loss +$ +(423,029 +) +$ +(543,438 +) +(22.2 +)% +Operating days - U.S. (2) +29,960 +29,857 +0.3 +% +Average revenue per operating day - U.S. +$ +21.64 +$ +22.38 +(3.3 +)% +Average direct operating costs per operating day - U.S. +$ +15.11 +$ +12.68 +19.2 +% +Average adjusted gross margin per operating day - U.S. (1) +$ +6.53 +$ +9.70 +(32.7 +)% +Average rigs operating - U.S. +82 +82 +0.6 +% +Capital expenditures +$ +109,894 +$ +105,037 +4.6 +% +(1) +Adjusted gross margin is defined as revenues less direct operating costs and excludes restructuring expenses, other operating expenses (income), net, selling, general and administrative expenses, depreciation, amortization and impairment and impairment of goodwill. Average adjusted gross margin per operating day is defined as adjusted gross margin divided by operating days +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for contract drilling services in 2020 and early 2021. +34 +Generally, the revenues in our contract drilling segment are most impacted by two primary factors: our average number of rigs operating and our average revenue per operating day. Our average revenue per operating day is largely dependent on the pricing terms of our rig contracts. Lump sum early termination revenues were $4.1 million in 2021, which was less than the $13.3 million recorded during the comparable period of 2020. +Revenues remained relatively flat in 2021 as compared to 2020 despite this reduction in lump sum early termination revenues. However, $41.5 million of our revenues in 2021 related to additional drilling rigs from the Pioneer acquisition. Without the impact of the Pioneer acquisition, 2021 revenues would have been approximately $623 million, a 7% decrease, and operating days from our U.S. operations would have been 28,722, a 3.8% decrease from 2020. The reduction in lump sum early termination revenues from 2020 resulted in an incremental 1.4% decrease. Average revenue per operating day excluding the effects of the Pioneer acquisition did not change significantly. +The Pioneer acquisition added $30.5 million of direct operating costs in 2021, which contributed to an 8.0% increase as compared to 2020. Apart from the increase attributed to the Pioneer acquisition, direct operating costs increased $52.2 million, or 13.7%, as compared to 2020. Apart from the Pioneer acquisition, average direct operating costs per operating day in the U.S. were $15,069, an 18.8% increase. The increases in direct operating costs and average direct operating costs per day were primarily due to a reduction in the proportion of rigs on standby and rig reactivation costs. Rigs on standby have very little associated cost. +Restructuring expenses were recognized in 2020 and primarily related to severance costs. See Note 20 of Notes to Consolidated Financial Statements included in Item 8 of this Report. +The change in other operating expenses (income), net is primarily due to an insurance reimbursement for damaged drilling equipment in 2020. +Depreciation, amortization and impairment expense increased primarily due to a $220 million impairment charge related to abandonment of 43 legacy non-super-spec rigs and equipment. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 43 rigs that were abandoned had limited commercial opportunity. In the second quarter of 2020 we recorded an impairment of $8.3 million related to the closing of our Canadian drilling operations. Without the impairment charge in 2021, depreciation and amortization expense would have decreased to approximately $399 million, an 8.1% decrease as compared to 2020. The decrease excluding impairment was due to lower cumulative capital expenditures in recent years, which reduced our depreciable asset base as depreciation, amortization and impairment outpaced capital expenditures between the periods. This decline was partially offset by incremental depreciation and amortization associated with the additional rigs from the Pioneer acquisition, which contributed three months of expense after the October 1, 2021 closing date. +All of the goodwill associated with our contract drilling reporting unit was impaired in 2020. See Note 7 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Year Ended December 31, +Pressure Pumping +2021 +2020 +% Change +(Dollars in thousands) +Revenues +$ +523,756 +$ +336,111 +55.8 +% +Direct operating costs +475,953 +310,261 +53.4 +% +Adjusted gross margin (1) +47,803 +25,850 +84.9 +% +Restructuring expenses +— +31,331 +NA +Selling, general and administrative +7,361 +8,555 +(14.0 +)% +Depreciation, amortization and impairment +159,305 +152,630 +4.4 +% +Operating loss +$ +(118,863 +) +$ +(166,666 +) +(28.7 +)% +Average active spreads (2) +8 +6 +38.3 +% +Effective utilization (3) +8.7 +5.6 +55.4 +% +Fracturing jobs +422 +265 +59.2 +% +Other jobs +754 +736 +2.4 +% +Total jobs +1,176 +1,001 +17.5 +% +Average revenue per fracturing job +$ +1,187.29 +$ +1,188.46 +(0.1 +)% +Average revenue per other job +$ +30.13 +$ +28.76 +4.8 +% +Average revenue per total job +$ +445.37 +$ +335.78 +32.6 +% +Average direct operating costs per total job +$ +404.72 +$ +309.95 +30.6 +% +Average adjusted gross margin per total job (1) +$ +40.65 +$ +25.82 +57.4 +% +Adjusted gross margin as a percentage of revenues (1) +9.1 +% +7.7 +% +18.2 +% +Capital expenditures +$ +34,676 +$ +21,678 +60.0 +% +35 +(1) +Adjusted gross margin is defined as revenues less direct operating costs and excludes restructuring expenses, selling, general and administrative expenses and depreciation, amortization and impairment. Average adjusted gross margin per total job is defined as adjusted gross margin divided by total jobs. Adjusted gross margin as a percentage of revenues is defined as adjusted gross margin divided by revenues. +(2) +Average active spreads is the average number of spreads that were crewed and actively marketed during the period. +(3) +Effective utilization is calculated as total pumping days during the year divided by 300 days, which we consider full effective utilization for a year. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for pressure pumping services in 2020 and early 2021. +Generally, the revenues in our pressure pumping segment are most impacted by our number of fracturing jobs and the size (including whether or not we provide proppant and other materials) of those jobs, which is reflected in our average revenue per fracturing job. Direct operating costs are also most impacted by these same factors. Our average revenue per fracturing job is largely dependent on the pricing terms of our pressure pumping contracts and the size of the jobs. +Revenues and direct operating costs increased primarily due to an increase in fracturing jobs as activity levels continue to recover from the industry downturn in 2020. Average revenue per total job increased primarily due to a mix of activity weighted toward higher revenue fracturing jobs. Average direct operating costs per total job increased also as a result of the significant increase in fracturing jobs, which generally have higher direct operating costs. We exited 2021 with 11 active spreads as compared to five active spreads on December 31, 2020. +Restructuring expenses were recognized in the second quarter of 2020. These restructuring expenses included $7.3 million related to right-of-use asset abandonments, $3.5 million of severance costs and $20.4 million of contract termination costs. See Note 20 of Notes to Consolidated Financial Statements in Item 8 of this Report . +Selling, general and administrative expenses decreased primarily as a result of cost reduction efforts. +Depreciation, amortization and impairment expense increased as a result of a $32.2 million impairment charge related to the abandonment of approximately 0.2 million horsepower within our pressure pumping fleet. The majority of these units were frac pumps but also included pump down units. These units were abandoned due to a combination of customer preference for dual fuel units, advancements in technology, and prohibitive reactivation costs. Excluding the impairment charge in 2021, depreciation and amortization would have been $127 million, a 16.7% decline. The decrease excluding impairment is due to lower cumulative capital expenditures in recent years, which reduced our depreciable asset base as depreciation, amortization and impairment outpaced capital expenditures between periods. +Capital expenditures increased due to increased maintenance capital, mostly related to engines and transmissions as well as higher inflationary pressure on replacement items. +Year Ended December 31, +Directional Drilling +2021 +2020 +% Change +(Dollars in thousands) +Revenues +$ +111,481 +$ +73,356 +52.0 +% +Direct operating costs +101,628 +69,050 +47.2 +% +Adjusted gross margin (1) +9,853 +4,306 +128.8 +% +Restructuring expenses +— +3,175 +NA +Selling, general and administrative +4,884 +5,239 +(6.8 +)% +Depreciation, amortization and impairment +40,270 +36,504 +10.3 +% +Operating loss +$ +(35,301 +) +$ +(40,612 +) +(13.1 +)% +Capital expenditures +$ +8,591 +$ +4,681 +83.5 +% +(1) +Adjusted gross margin is defined as revenues less direct operating costs and excludes restructuring expenses, selling, general and administrative expenses and depreciation, amortization and impairment. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for directional drilling services in 2020 and early 2021. +Directional drilling revenue and direct operating costs increased from 2020 primarily due to increased job activity. We averaged 30.1 jobs per day in 2021 as compared to 18.9 jobs per day for the comparable period in 2020. Additionally, a portion of the increase in direct operating costs relates to an inventory write-down of $4.0 million in 2021. Excluding the effects of this write-down, direct operating costs would have been approximately $97.6 million, an increase of 41.3% as compared to 2020. See Note 5 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information regarding the inventory write-down . +36 +Restructuring expenses were recognized in the second quarter of 2020 and were primarily attributable to severance and right-of-use asset abandonments. See Note 20 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information . +Depreciation, amortization and impairment increased as a result of the abandonment of an $11.4 million developed technology intangible asset and $2.5 million of directional drilling equipment in 2021. Excluding these charges, depreciation and amortization expense would have been $26.4 million, a 27.8% decline as compared to 2020. The decrease excluding impairments is due to lower cumulative capital expenditures in recent years, which reduced our depreciable asset base as depreciation, amortization and impairment outpaced capital expenditures between the periods. +Capital expenditures increased due to higher levels of activity requiring premium equipment to meet market demands. +Year Ended December 31, +Other Operations +2021 +2020 +% Change +(Dollars in thousands) +Revenues +$ +57,814 +$ +45,656 +26.6 +% +Direct operating costs +40,911 +41,790 +(2.1 +)% +Adjusted gross margin (1) +16,903 +3,866 +337.2 +% +Restructuring expenses +— +501 +NA +Selling, general and administrative +1,943 +3,539 +(45.1 +)% +Depreciation, depletion, amortization and impairment +24,865 +41,511 +(40.1 +)% +Operating loss +$ +(9,905 +) +$ +(41,685 +) +(76.2 +)% +Capital expenditures +$ +11,638 +$ +12,378 +(6.0 +)% +(1) +Adjusted gross margin is defined as revenues less direct operating costs and excludes restructuring expenses, selling, general and administrative expenses and depreciation, depletion, amortization and impairment. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic, combined with production increases from OPEC+, led to a significant reduction in crude oil prices and demand for oilfield rental and other services in 2020 and early 2021. +Other operations revenue increased from 2020 primarily due to an $8.6 million increase in our oil and natural gas revenues as a result of favorable crude oil and natural gas market prices. Average WTI-Cushing prices in 2021 were $68.14 per barrel as compared to $39.16 per barrel in 2020. Because the increase in oil and natural gas revenues was driven by market pricing, we did not have a commensurate increase in direct operating costs for our oil and natural gas business. We also recognized a $4.7 million increase in revenue from our oilfield rentals business primarily due to an increase in our volume of services. +Other operations direct operating costs remained relatively flat despite the increase in revenues primarily due to the majority of the revenue increase being driven by market prices rather than incremental activity. +Restructuring expenses were recognized in 2020 and related to severance costs. +Selling, general and administrative expense decreased primarily as a result of cost reduction efforts. +Depreciation, depletion, amortization and impairment decreased primarily due to an $11.2 million impairment related to certain of our oil and natural gas assets in 2020 as compared to a $1.3 million impairment of oil and natural gas assets in 2021. Excluding the impairment to our oil and natural gas properties in both years, the decrease in depreciation, depletion and amortization would have been $6.7 million, a 22.2% decrease. The impairment in 2020 reduced our depreciable base, which lowered depreciation in subsequent periods. Additionally, the decrease in depreciation, depletion, amortization and impairment was partially due to lower cumulative capital expenditures in recent years, which also reduced our depreciable asset base as depreciation, depletion, amortization and impairment outpaced capital expenditures between the periods. +37 +Year Ended December 31, +Corporate +2021 +2020 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +73,495 +$ +75,612 +(2.8 +)% +Merger and integration expenses +$ +12,060 +$ +— +NA +Restructuring expenses +$ +— +$ +901 +NA +Depreciation +$ +5,859 +$ +6,494 +(9.8 +)% +Other operating expenses (income), net +Net gain on asset disposals +$ +(1,426 +) +$ +(3,079 +) +(53.7 +)% +Legal-related expenses and settlements, net of insurance reimbursements +762 +1,680 +(54.6 +)% +Research and development +1,371 +3,411 +(59.8 +)% +Other +31 +9,232 +(99.7 +)% +Other operating expense (income), net +$ +738 +$ +11,244 +(93.4 +)% +Credit loss expense +$ +(1,500 +) +$ +5,606 +NA +Interest income +$ +222 +$ +1,254 +(82.3 +)% +Interest expense +$ +41,978 +$ +40,770 +3.0 +% +Other income (expense) +$ +(275 +) +$ +756 +NA +Capital expenditures +$ +1,521 +$ +1,707 +(10.9 +)% +Selling, general and administrative expense decreased primarily as a result of cost reduction efforts. +Merger and integration expenses were recognized in 2021 related to the Pioneer acquisition, which closed on October 1, 2021, and the subsequent divestiture of Pioneer’s well servicing rig business and wireline business, which closed on December 31, 2021. See Note 2 of Notes to Consolidated Financial Statements in Item 8 of this Report. +Restructuring expenses were recognized in 2020 and were primarily attributable to severance and right-of-use asset abandonments. See Note 20 of Notes to Consolidated Financial Statements in Item 8 of this Report . +Other operating expenses (income), net includes net gains associated with the disposal of assets. Accordingly, the related gains have been excluded from the results of specific segments. The majority of the net gain on asset disposals in 2021 reflect gains on disposals of buildings, land and drilling equipment, while the gain on asset disposals in 2020 related to disposals of drilling and pressure pumping equipment. Additionally, other operating expenses (income), net includes charges of $9.2 million in the second quarter of 2020 related to a 2017 capacity reservation agreement that required a cash deposit to increase our access to finer grades of sand for our pressure pumping business. As market prices for sand substantially decreased since 2017, we purchased lower cost sand outside of this capacity reservation contract and revalued the deposit at its expected realizable value. The deposit related to the capacity reservation agreement had no balance remaining subsequent to the charge recorded in the second quarter of 2020. +A provision for credit losses of $5.6 million was recognized in 2020 with respect to accounts receivable balances that were estimated to be uncollectible. During 2021, we reversed $1.5 million of our credit loss provision related to certain customers who had previously experienced a deterioration in credit quality. Since initially recording loss provisions for these receivables, we have collected portions of the accounts that were deemed uncollectible. +Interest expense increased slightly as compared to 2020. However, 2020 interest expense was favorably impacted by a gain on debt extinguishment of $3.6 million associated with the repurchase of portions of our 2028 Notes and 2029 Notes. Excluding the effects of the gain, interest expense would have decreased by $2.4 million, a 5.5% decrease. Additionally, on December 30, 2021, we repaid the final $50 million of borrowings under the 2019 Term Loan Agreement , and as a result had no remaining borrowings under the Term Loan Agreement as of December 31, 2021. Accordingly, we will not incur interest expense related to the Term Loan Agreement in subsequent periods. +Comparison of the years ended December 31, 2020 and 2019 +A discussion of our results of operations for the fiscal year ended December 31, 2020 compared to the fiscal year ended December 31, 2019 is included in Part II, Item 7— "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC on February 9, 2021. +38 +Income Taxes +The effective tax rate decreased by approximately 5% to 8.7% for 2021 compared to 13.7% for 2020. The difference was primarily due to nondeductible goodwill impairment charges in 2020 impacting the effective tax rate and changes in valuation allowance positions between 2020 and 2021. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +Liquidity and Capital Resources +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $38.3 million of charges associated with this plan in second quarter of 2020. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan. There were no restructuring charges in 2021. +Our primary sources of liquidity are cash and cash equivalents, availability under our revolving credit facility and cash provided by operating activities. As of December 31, 2021 , we had approximately $148 million in working capital, including $118 million of cash and cash equivalents, and approximately $600 million available under our revolving credit facility. +We have an amended and restated credit agreement (the “Credit Agreement”), which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $150 million and a swing line facility that, at any time outstanding, is limited to $20 million. As of December 31, 2021, we had no borrowings outstanding under our revolving credit facility, and $0.1 million in letters of credit outstanding under the Credit Agreement and, as a result, had available borrowing capacity of approximately $600 million at that date. Of the revolving credit commitments, $50 million expires on March 27, 2024, and the remaining $550 million expires on March 27, 2025. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $300 million, not to exceed total commitments of $900 million. Additionally, we have the option, subject to certain conditions, to exercise one one-year extension of the maturity date. +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, as described in “Item 7A” below. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant. The Credit Agreement also contains a financial covenant that requires our total debt to capitalization ratio, expressed as a percentage, not exceed 50%. +We also have a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. +Our outstanding debt at December 31, 2021 was $859 million and consisted of $510 million of 3.95% Senior Notes due 2028 (the “2028 Notes”), $349 million of 5.15% Senior Notes due 2029 (the “2029 Notes”). We were in compliance with all covenants at December 31, 2021. +For a full description of the Credit Agreement, the Reimbursement Agreement, the 2028 Notes and the 2029 Notes, see Note 9 of Notes to consolidated financial statements in Item 8 of this Report. +We had $71.5 million of outstanding letters of credit at December 31, 2021, which were comprised of $71.4 million outstanding under the Reimbursement Agreement and $0.1 million outstanding under the Credit Agreement. We maintain these letters of credit primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2021, no amounts had been drawn under the letters of credit. +39 +Cash Requirements +We believe our curr ent liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt and pay cash dividends for at least the next 12 months. +If we pursue opportunities for growth that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +A portion of our capital expenditures can be adjusted and managed by us to match market demand and activity levels. Based on our current outlook for activity, we expect our capital expenditures for 2022 to be approximately $350 million. The majority of these expenditures are expected to be used for normal, recurring items necessary to support our business. +We anticipate $9.7 million of expenditures in 2022 related to various contractual obligations such as certain purchase commitments and operating lease liabilities. +As of December 31, 2021, we had working capital of $148 million, including cash and cash equivalents of $118 million, compared to working capital of $204 million, including cash and cash equivalents of $225 million, at December 31, 2020. +During 2021, our sources of cash flow included: +• +$95.5 million from operating activities, +• +$42.0 million in proceeds, net of disposed cash, from the disposal of the Pioneer Production Services business, +• +$23.3 million in proceeds from the disposal of property and equipment. +During 2021, we used $29.4 million, net of acquired cash, for the acquisition of Pioneer, $15.6 million to pay dividends on our common stock, $50 million to repay borrowings under our Term Loan Agreement and $166 million: +• +to make capital expenditures for the betterment and refurbishment of drilling and pressure pumping equipment and, to a much lesser extent, equipment for our other businesses, +• +to acquire and procure equipment to support our contract drilling, pressure pumping, directional drilling, oilfield rentals and manufacturing operations, and +• +to fund investments in oil and natural gas properties on a non-operating working interest basis. +We paid cash dividends during the year ended December 31, 2021 as follows: +Per Share +Total +(in thousands) +Paid on March 18, 2021 +$ +0.02 +$ +3,754 +Paid on June 17, 2021 +0.02 +3,769 +Paid on September 16, 2021 +0.02 +3,780 +Paid on December 16, 2021 +0.02 +4,302 +Total cash dividends +$ +0.08 +$ +15,605 +On February 9, 2022, our Board of Directors approved a cash dividend on our common stock in the amount of $0.04 per share to be paid on March 17, 2022 to holders of record as of March 3, 2022. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend in order to improve our financial flexibility and best position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +We may, at any time and from time to time, seek to retire or purchase our outstanding debt for cash through open-market purchases, privately negotiated transactions, redemptions or otherwise. Such repurchases, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. +40 +On September 6, 2013, our Board of Directors approved a stock buyback program that authorized purchases of up to $200 million of our common stock in open market or privately negotiated transactions. The authorized repurchases under this program were subsequently increased in July 2018 and February 2019, and on July 24, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2021, we had remaining authorization to purchase approximately $130 million of our outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2021, 2020 and 2019 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”) and the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), and not pursuant to the stock buyback program. Upon the issuance of shares for the Pioneer acquisition in October 2021, we withheld shares with respect to Pioneer employees’ tax withholding obligations. +Treasury stock acquisitions during the years ended December 31, 2021, 2020 and 2019 were as follows (dollars in thousands): +2021 +2020 +2019 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +Purchases pursuant to stock buyback program +— +— +5,826,266 +20,000 +22,566,331 +250,109 +Acquisitions pursuant to long-term incentive plan +451,196 +3,727 +239,669 +1,179 +1,037,947 +14,205 +Purchases in connection with Pioneer acquisition +275,477 +2,601 +— +— +— +— +Other +— +— +— +— +31,013 +372 +Treasury shares at end of period +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +As of December 31, 2021, we had unrecognized compensation costs of $17.3 million and $6.6 million related to our unvested restricted stock units and our unvested Performance Units, respectively. The weighted-average remaining vesting periods for these awards were 1.66 years and 1.44 years, respectively as of December 31, 2021. See Note 12 of Notes to consolidated financial statements in Item 8 of this Report for additional discussion regarding our stock-based compensation. +Commitments — As of December 31, 2021, we had commitments to purchase major equipment totaling approximately $99.0 million for our drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The remaining terms of the agreements are less than one year . In the event the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. In 2017, we entered into a capacity reservation agreement that required a cash deposit to increase our access to finer grades of sand for our pressure pumping business. As market prices for sand substantially decreased since 2017, we purchased lower cost sand outside of this capacity reservation contract and recorded a charge of $9.2 million and $12.7 million in the second quarters of 2020 and 2019, respectively, to revalue the deposit to its expected realizable value. There is no value assigned to the capacity reservation contract subsequent to the charge recorded in the second quarter of 2020. +See Note 10 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our current commitments and contingencies as of December 31, 2021. +Operating lease liabilities totaled $25.0 million at December 31, 2021. See Note 13 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our operating leases as of December 31, 2021. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +41 +Critical Accounting Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. Accounting estimates and assumptions discussed in this section are those considered to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. We believe the following critical accounting estimates used in preparing our consolidated financial statements address all important areas where the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Allowance for credit losses — We utilize an accounts receivable aging schedule and historical credit loss information to estimate expected credit losses. We evaluate our accounts receivable periodically through review of historical collection experience, current aging status of the customer accounts, financial condition of our customers, and the overall economic environment of the oil and gas industry. Any customers that have experienced a deterioration in credit quality are removed from the pool and evaluated individually. This process involves judgment and estimation. Accordingly, our results of operations can be affected by adjustments to the allowance due to actual write-offs that differ from estimated amounts. During 2021, we updated our expected credit loss rates for historical credit loss information associated with customers with accounts receivable acquired in the Pioneer acquisition. In applying our methodology of estimating credit losses, we determined no material changes to our credit loss rates. See Note 4 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Depreciation and amortization — Property and equipment is carried at cost less accumulated depreciation and amortization. No provision for salvage value is considered in determining depreciation of our property and equipment. We calculate depreciation and amortization on our assets based on the estimated useful lives that we believe are reasonable. The estimated useful lives are subject to key assumptions such as maintenance, utilization and job variation. These estimates may change due to a number of factors such as changes in operating conditions or advances in technology. The method of depreciation does not change whenever equipment becomes idle. Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. See Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Fair values of assets acquired and liabilities assumed in acquisitions — Assets acquired and liabilities assumed in a business combination are recorded at their estimated fair values on the date of acquisition. The difference between the purchase price amount and the net fair value of assets acquired and liabilities assumed is recognized as goodwill on the balance sheet if the purchase price exceeds the estimated net fair value or as a bargain purchase gain on the income statement if the purchase price is less than the estimated net fair value. We apply significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involves the use of significant estimates and assumptions with respect to market day rates, direct operating costs, rig utilization percentages, expectations regarding the amount of future capital and operating costs, and discount rates. Changes in these judgments or estimates can have a material impact on the valuation of the respective assets and liabilities acquired and our results of operations in periods after acquisition, such as through depreciation and amortization expense. The allocation of the purchase price may be modified up to one year after the acquisition date as more information is obtained about the fair value of assets acquired and liabilities assumed. See Note 2 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +Impairment of long-lived assets — We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. If the carrying amount of the asset is not recoverable based on its estimated undiscounted cash flows expected to result from the use and eventual disposition, an impairment loss is recognized in an amount by which its carrying amount exceeds its estimated fair value. The inputs used to determine such fair value are primarily based upon internally developed cash flow models. Our cash flow models are based on a number of estimates regarding future operations that may be subject to significant variability, are sensitive to changes in market conditions, and are reasonably likely to change in the future. We determined no triggering events occurred in 2021. See Note 6 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +42 +Accruals for self-insured levels of insurance coverage — We maintain insurance coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employers’ liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. Our insurance accruals are based on claims filed and estimates of claims incurred but not reported and are developed by our management with assistance from our third-party actuary and third-party claims administrator. The insurance accruals are influenced by our past claims experience factors, which have a limited history, and by published industry development factors. If we experience insurance claims or costs above or below our historically evaluated levels, our estimates could be materially affected. The frequency and number of claims or incidents could vary significantly over time, which could materially affect our self-insurance liabilities. Additionally, the actual costs to settle the self-insurance liabilities could materially differ from the original estimates and cause us to incur additional costs in future periods associated with prior year claims. +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. For many years, oil and natural gas prices and markets have been extremely volatile. Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report. Oil prices remain extremely volatile, as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and recovered to reach a 2021 high of $85.64 per barrel on October 26, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered in 2021, and demand for our services has improved since the commodity price decline in 2020, our average number of rigs operating remains well below the number of our available rigs, and a significant portion of our pressure pumping horsepower remains stacked. Oil prices averaged $77.45 per barrel in the fourth quarter of 2021. +We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital, would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +A s previously disclosed within our Quarterly Reports on Form 10-Q for the periods ended June 30, 2021 and September 30, 2021, due to improving activity levels and increasing tightness in the overall labor market, we have seen general oilfield cost inflation across our segments during 2021, including increases in the cost of labor, services and supplies. This inflation, combined with the increasing challenge of attracting employees to the industry, is increasing the complexity of reactivating equipment. We believe this challenge, combined with the increasing market tightness for premium drilling and completion services, will support higher pricing for our services in 2022 . However, to date, this general inflationary trend has not had a material effect on our operating margins as both revenues and costs are impacted in tandem. +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report. +43 +Non-GAAP Measurements +Adjusted EBITDA +A djusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by U.S. GAAP. We define Adjusted EBITDA as loss from continuing operations plus income tax benefit, net interest expense, and depreciation, depletion, amortization and impairment expense (including impairment of goodwill). We present Adjusted EBITDA because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from loss from continuing operations in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measure of loss from continuing operations. Our computations of Adjusted EBITDA may not be the same as other similarly titled measures of other companies. Set forth below is a reconciliation of the non-U.S. GAAP financial measure of Adjusted EBITDA to the U.S. GAAP financial measure of loss from continuing operations. +Year Ended December 31, +2021 +2020 +2019 +(in thousands) +Loss from continuing operations +$ +(657,079 +) +$ +(803,692 +) +$ +(425,703 +) +Income tax benefit +(62,702 +) +(127,326 +) +(104,675 +) +Net interest expense +41,756 +39,516 +69,191 +Depreciation, depletion, amortization and impairment +849,178 +670,910 +1,003,873 +Impairment of goodwill +— +395,060 +17,800 +Adjusted EBITDA +$ +171,153 +$ +174,468 +$ +560,486 +Adjusted Gross Margin +We define “Adjusted gross margin” as total revenue less costs of revenues (excluding depreciation, depletion, amortization and impairment expense). Adjusted gross margin is included as a supplemental disclosure because it is a useful indicator of our operating performance. +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +(in thousands) +For the year ended December 31, 2021 +Operating revenues +$ +664,030 +$ +523,756 +$ +111,481 +$ +57,814 +Less cost of sales +(463,456 +) +(475,953 +) +(101,628 +) +(40,911 +) +Less depreciation, depletion, amortization and impairment +(618,879 +) +(159,305 +) +(40,270 +) +(24,865 +) +GAAP gross margin +(418,305 +) +(111,502 +) +(30,417 +) +(7,962 +) +Depreciation, depletion, amortization and impairment +618,879 +159,305 +40,270 +24,865 +Adjusted gross margin +$ +200,574 +$ +47,803 +$ +9,853 +$ +16,903 +For the year ended December 31, 2020 +Operating revenues +$ +669,126 +$ +336,111 +$ +73,356 +$ +45,656 +Less cost of sales +(380,822 +) +(310,261 +) +(69,050 +) +(41,790 +) +Less depreciation, depletion, amortization and impairment +(433,771 +) +(152,630 +) +(36,504 +) +(41,511 +) +GAAP gross margin +(145,467 +) +(126,780 +) +(32,198 +) +(37,645 +) +Depreciation, depletion, amortization and impairment +433,771 +152,630 +36,504 +41,511 +Adjusted gross margin +$ +288,304 +$ +25,850 +$ +4,306 +$ +3,866 +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As of December 31, 2021, we would have had exposure to interest rate market risk associated with any borrowings that we had under the Credit Agreement and amounts owed under the Reimbursement Agreement. +44 +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based on our credit rating. As of December 31, 2021, the applicable margin on LIBOR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. As of December 31, 2021, we had no borrowings outstanding under our revolving credit facility. The interest rate on borrowings outstanding under our revolving credit facility is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. We are obligated to pay Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2021, no amounts had been disbursed under any letters of credit. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2021, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2021, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2021. +The acquired businesses associated with Pioneer Energy Services Corp. (“Pioneer”), were excluded from our evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2021. These subsidiaries were excluded from the scope of our review due to the fact that the acquisition closed in the fourth quarter of 2021, at which time we began integrating the acquired business into our existing internal controls over financial reporting. Under guidelines established by the SEC, companies are permitted to exclude acquisitions from their assessment of internal control over financial reporting during the first year of an acquisition while integrating the acquired company. As a result of these integration activities, certain controls will be evaluated and may be changed. The acquired businesses represented approximately three percent of our consolidated revenues for the year ended December 31, 2021 and approximately 10% of our consolidated total assets as of December 31, 2021. +The effectiveness of our internal control over financial reporting as of December 31, 2021 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +45 +Changes in Internal Control over Financial Reporting: +Except as noted above, there were no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None . +46 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference . +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Corporate Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website within four business days following the date of the amendment or waiver. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +47 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Report of Independent Registered Public Accounting Firm +The report of our independent registered public accounting firm (PCAOB ID: 238 ) with respect to the above-referenced financial statements and their report on internal control over financial reporting are included on page F-2 of this Report. +(a)(3) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger, dated July 5, 2021, among Patterson-UTI Energy, Inc., Crescent Merger Sub Inc., Crescent Ranch Second Merger Sub LLC, and Pioneer Energy Services Corp. (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed on July 6, 2021). +2.2 +Amendment No. 1 to Agreement and Plan of Merger, dated September 13, 2021, among Patterson-UTI Energy, Inc., Crescent Merger Sub Inc., Crescent Ranch Second Merger Sub LLC, and Pioneer Energy Services Corp. (incorporated by reference to Exhibit 2.2 to our Current Report on Form 8-K filed on October 4, 2021). +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.4 +Certificate of Amendment to Restated Certificate of Incorporation, as amended (filed July 30, 2018 as Exhibit 3.4 to our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018 and incorporated herein by reference). +3.5 +Fourth Amended and Restated Bylaws (filed February 12, 2019 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.6 +Certificate of Designation of the Series A Junior Participating Preferred Stock of Patterson-UTI Energy, Inc., dated April 22, 2020 (filed April 23, 2020 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.1 +Description of Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934. + +4.2 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +4.3 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +48 +4.4 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.5 +Form of 3.95% Senior Note due 2028 (included in Exhibit 4.4 above). +4.6 +Base Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.7 +First Supplemental Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.8 +Form of 5.15% Senior Note due 2029 (included in Exhibit 4.7 above). +4.9 +Stockholder Rights Agreement, dated as of April 22, 2020, by and between Patterson-UTI Energy, Inc. and Continental Stock Transfer & Trust Company, as rights agent (which includes the Form of Rights Certificate as Exhibit B thereto) (filed April 23, 2020 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.10 +First Amendment to Stockholder Rights Agreement, dated as of July 22, 2020, by and between Patterson-UTI Energy, Inc. and Continental Stock Transfer & Trust Company, as rights agent (filed July 23, 2020 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.1 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.2 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). * +10.3 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.4 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.7 +Patterson-UTI Energy, Inc. Omnibus Incentive Plan (filed April 21, 2017 as Exhibit 4.4 to our Registration Statement on Form S-8 and incorporated herein by reference).* +10.8 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (filed April 21, 2014 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.9 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (as amended and restated effective June 29, 2017) (filed June 30, 2017 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.10 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan, as amended and restated and further amended effective June 6, 2019 (filed June 6, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.11 +Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (incorporated by reference to Annex A of our Definitive Proxy Statement on Schedule 14A, filed on April 12, 2021).* +10.12 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 3, 2021 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +49 +10.13 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to our Current Report on Form 8-K and incorporated herein by reference).* +10.14 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to our Current Report on Form 8-K and incorporated herein by reference).* +10.15 +Form of Non-Employee Director Restricted Stock Unit Award Agreement (filed April 28, 2020 as Exhibit 10.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.16 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed August 3, 2021 as Exhibit 10.3 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.17 +2020 Phantom Unit Award Agreement, dated May 11, 2020, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 28, 2020 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.18 +Amendment No. 1 to Performance Share Award Agreement, dated May 11, 2020, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 28, 2020 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.19 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to our Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.20 +Employment Agreement, effective as of January 1, 2017, by and between Patterson-UTI Drilling Company LLC and James M. Holcomb (filed January 17, 2017 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.21 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and James M. Holcomb (filed August 3, 2021 as Exhibit 10.7 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.22 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.23 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 3, 2021 as Exhibit 10.4 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.24 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference).* +10.25 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed August 3, 2021 as Exhibit 10.6 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.26 +Employment Agreement, dated as of September 3, 2017, between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.27 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed August 3, 2021 as Exhibit 10.5 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.28 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon, Tiffany J. Thom, James M. Holcomb, C. Andrew Smith and Janeen S. Judah (filed April 28, 2004 as Exhibit 10.11 to our Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +50 +10.29 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to our Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.30 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.31 +Amended and Restated Credit Agreement dated March 27, 2018 among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2018 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.32 +Amendment No. 1 to Amended and Restated Credit Agreement, dated March 26, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 26, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.33 +Amendment No. 2 to Amended and Restated Credit Agreement, dated March 27, 2020, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2020 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.34 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.++ +101.INS +Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document .+ +101.SCH +Inline XBRL Taxonomy Extension Schema Document + +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document + +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document + +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document + +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document + +104 +Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101) . +* Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ Filed herewith. +++ Furnished herewith. +51 +Item 16. Form 10-K Summary +None. +52 +INDEX TO CONS OLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2021 and 2020 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2021, 2020 and 2019 +F-5 +Consolidated Statements of Comprehensive Loss for the years ended December 31, 2021, 2020 and 2019 +F-6 +Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2021, 2020 and 2019 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2021, 2020 and 2019 +F-8 +Notes to Consolidated Financial Statements +F-9 +F- 1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) as of December 31, 2021 and 2020, and the related consolidated statements of operations, of comprehensive loss, of changes in stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2021, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2021 appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +As described in Management’s Report on Internal Control over Financial Reporting, management has excluded Pioneer Energy Services Corp. (“Pioneer”) from its assessment of internal control over financial reporting as of December 31, 2021, because it was acquired by the Company in a purchase business combination during 2021. We have also excluded Pioneer from our audit of internal control over financial reporting. Pioneer is a wholly owned subsidiary whose total assets and total revenues excluded from management’s assessment and our audit of internal control over financial reporting represent 10% and approximately 3%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2021. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +F- 2 +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Critical Audit Matters +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Acquisition of Pioneer – Valuation of the United States Drilling Rigs +As described in Notes 1 and 2 to the consolidated financial statements, on October 1, 2021, the Company completed the acquisition of Pioneer by acquiring 100% of its equity interests for total consideration transferred of approximately $278 million. The Pioneer acquisition resulted in $215 million of property and equipment being recorded, of which a significant portion relates to 17 AC drilling rigs in the United States. The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. A discounted cash flow model was used by a third-party specialist in determining the fair value of the property and equipment and intangible assets. Management applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to market day rates, direct operating costs, rig utilization percentages, expectations regarding the amount of future capital and operating costs, and discount rates. +The principal considerations for our determination that performing procedures relating to the valuation of the United States drilling rigs acquired in the Pioneer acquisition is a critical audit matter are (i) the significant judgment by management when determining the fair value of the United States drilling rigs, which in turn led to (ii) a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating management’s significant assumptions used in the valuation related to the market day rates and discount rate; and (iii) the audit effort involved the use of professionals with specialized skill and knowledge. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the acquisition accounting, including controls over management’s valuation of the United States drilling rigs and controls over the determination of significant assumptions related to the market day rates and discount rate. These procedures also included, among others (i) reading the purchase agreement and (ii) testing management’s process for determining the fair value of the United States drilling rigs. Testing management’s process included evaluating the appropriateness of the discounted cash flow model, testing the completeness and accuracy of data provided by management, and evaluating the reasonableness of significant assumptions related to the market day rates and discount rate. Evaluating the reasonableness of the market day rates involved considering the consistency with external market and industry data and the past performance of the acquired business. Professionals with specialized skill and knowledge were used to assist in evaluating the appropriateness of the discounted cash flow model and in evaluating the reasonableness of the discount rate significant assumption. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 16, 2022 +We have served as the Company’s auditor since 1993. +F- 3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED BALANCE SHEETS +December 31, +2021 +2020 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +117,524 +$ +224,915 +Accounts receivable, net of allowance for credit losses of $ 8,493 and $ 10,842 at +December 31, 2021 and 2020, respectively +356,083 +160,214 +Federal and state income taxes receivable +67 +4,428 +Inventory +42,359 +33,085 +Other +67,620 +55,314 +Total current assets +583,653 +477,956 +Property and equipment, net +2,331,755 +2,761,041 +Right of use asset +19,024 +16,850 +Intangible assets +7,537 +30,087 +Deposits on equipment purchases +849 +1,716 +Other +11,055 +11,419 +Deferred tax assets, net +3,975 +— +Total assets +$ +2,957,848 +$ +3,299,069 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +190,219 +$ +91,023 +Federal and state income taxes payable +232 +— +Accrued liabilities +238,511 +175,603 +Lease liability +6,891 +7,096 +Total current liabilities +435,853 +273,722 +Long-term lease liability +18,108 +19,118 +Long-term debt, net of debt discount and issuance costs of $ 6,432 and $ 7,271 at +December 31, 2021 and 2020, respectively +852,323 +901,484 +Deferred tax liabilities, net +29,234 +77,676 +Other +12,843 +11,010 +Total liabilities +1,348,361 +1,283,010 +Commitments and contingencies (see Note 10) +Stockholders’ equity: +Preferred stock, par value $ 0.01 ; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $ 0.01 ; authorized 400,000,000 shares with 299,268,967 +and 271,028,688 issued and 215,139,972 and 187,626,366 outstanding at +December 31, 2021 and 2020, respectively +2,993 +2,710 +Additional paid-in capital +3,171,536 +2,902,236 +Retained earnings (deficit) +( 198,316 +) +472,014 +Accumulated other comprehensive income +5,915 +5,412 +Treasury stock, at cost, 84,128,995 shares and 83,402,322 shares at +December 31, 2021 and 2020, respectively +( 1,372,641 +) +( 1,366,313 +) +Total stockholders’ equity +1,609,487 +2,016,059 +Total liabilities and stockholders’ equity +$ +2,957,848 +$ +3,299,069 +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEME NTS OF OPERATIONS +Year Ended December 31, +2021 +2020 +2019 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +664,030 +$ +669,126 +$ +1,308,350 +Pressure pumping +523,756 +336,111 +868,694 +Directional drilling +111,481 +73,356 +188,786 +Other +57,814 +45,656 +104,855 +Total operating revenues +1,357,081 +1,124,249 +2,470,685 +Operating costs and expenses: +Contract drilling +463,456 +380,822 +785,355 +Pressure pumping +475,953 +310,261 +724,788 +Directional drilling +101,628 +69,050 +178,645 +Other +40,911 +41,790 +84,909 +Depreciation, depletion, amortization and impairment +849,178 +670,910 +1,003,873 +Impairment of goodwill +— +395,060 +17,800 +Selling, general and administrative +92,382 +97,611 +133,513 +Credit loss expense +( 1,500 +) +5,606 +5,683 +Merger and integration expenses +12,060 +— +— +Restructuring expenses +— +38,338 +— +Other operating expenses (income), net +763 +7,059 +( 2,305 +) +Total operating costs and expenses +2,034,831 +2,016,507 +2,932,261 +Operating loss +( 677,750 +) +( 892,258 +) +( 461,576 +) +Other income (expense): +Interest income +222 +1,254 +6,013 +Interest expense, net of amount capitalized +( 41,978 +) +( 40,770 +) +( 75,204 +) +Other +( 275 +) +756 +389 +Total other expense +( 42,031 +) +( 38,760 +) +( 68,802 +) +Loss from continuing operations before income taxes +( 719,781 +) +( 931,018 +) +( 530,378 +) +Income tax benefit +( 62,702 +) +( 127,326 +) +( 104,675 +) +Loss from continuing operations +( 657,079 +) +( 803,692 +) +( 425,703 +) +Income from discontinued operations, net of tax +2,534 +— +— +Net loss +$ +( 654,545 +) +$ +( 803,692 +) +$ +( 425,703 +) +Net loss per common share - basic: +Continuing operations +$ +( 3.37 +) +$ +( 4.27 +) +$ +( 2.10 +) +Discontinued operations +$ +0.01 +$ +— +$ +— +Net loss - basic +$ +( 3.36 +) +$ +( 4.27 +) +$ +( 2.10 +) +Net loss per common share - diluted: +Continuing operations +$ +( 3.37 +) +$ +( 4.27 +) +$ +( 2.10 +) +Discontinued operations +$ +0.01 +$ +— +$ +— +Net loss - diluted +$ +( 3.36 +) +$ +( 4.27 +) +$ +( 2.10 +) +Weighted average number of common shares outstanding: +Basic +195,021 +188,013 +203,039 +Diluted +195,021 +188,013 +203,039 +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2021 +2020 +2019 +(In thousands) +Net loss +$ +( 654,545 +) +$ +( 803,692 +) +$ +( 425,703 +) +Other comprehensive loss, net of taxes of $ 0 for 2021, $ 0 +for 2020 and $ 0 for 2019: +Foreign currency translation adjustment +503 +( 66 +) +2,991 +Total comprehensive loss +$ +( 654,042 +) +$ +( 803,758 +) +$ +( 422,712 +) +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings (Deficit) +Income (Loss) +Stock +Total +(In thousands) +Balance, December 31, 2018 +267,316 +$ +2,673 +$ +2,827,154 +$ +1,753,557 +$ +2,487 +$ +( 1,080,448 +) +$ +3,505,423 +Net loss +— +— +— +( 425,703 +) +— +— +( 425,703 +) +Foreign currency translation adjustment +— +— +— +— +2,991 +— +2,991 +Issuance of restricted stock +185 +2 +( 2 +) +— +— +— +— +Vesting of restricted stock units +1,173 +12 +( 12 +) +— +— +— +— +Forfeitures of restricted stock +( 2 +) +— +— +— +— +— +— +Exercise of stock options +700 +7 +9,212 +— +— +— +9,219 +Stock-based compensation +— +— +39,328 +— +— +— +39,328 +Payment of cash dividends +— +— +— +( 32,428 +) +— +— +( 32,428 +) +Dividend equivalents +— +— +— +( 524 +) +— +— +( 524 +) +Purchase of treasury stock +— +— +— +— +— +( 264,686 +) +( 264,686 +) +Balance, December 31, 2019 +269,372 +$ +2,694 +$ +2,875,680 +$ +1,294,902 +$ +5,478 +$ +( 1,345,134 +) +$ +2,833,620 +Net loss +— +— +— +( 803,692 +) +— +— +( 803,692 +) +Foreign currency translation adjustment +— +— +— +— +( 66 +) +— +( 66 +) +Issuance of restricted stock +333 +3 +( 3 +) +— +— +— +— +Vesting of restricted stock units +1,324 +13 +( 13 +) +— +— +— +— +Stock-based compensation +— +— +26,572 +— +— +— +26,572 +Payment of cash dividends +— +— +— +( 18,862 +) +— +— +( 18,862 +) +Dividend equivalents +— +— +— +( 334 +) +— +— +( 334 +) +Purchase of treasury stock +— +— +— +— +— +( 21,179 +) +( 21,179 +) +Balance, December 31, 2020 +271,029 +$ +2,710 +$ +2,902,236 +$ +472,014 +$ +5,412 +$ +( 1,366,313 +) +$ +2,016,059 +Net loss +— +— +— +( 654,545 +) +— +— +( 654,545 +) +Foreign currency translation adjustment +— +— +— +— +503 +— +503 +Shares issued for acquisition +26,274 +263 +247,762 +— +— +— +248,025 +Issuance of restricted stock +621 +6 +( 6 +) +— +— +— +— +Vesting of restricted stock units +1,345 +14 +( 14 +) +— +— +— +— +Stock-based compensation +— +— +21,558 +— +— +— +21,558 +Payment of cash dividends +— +— +— +( 15,605 +) +— +— +( 15,605 +) +Dividend equivalents +— +— +— +( 180 +) +— +— +( 180 +) +Purchase of treasury stock +— +— +— +— +— +( 6,328 +) +( 6,328 +) +Balance, December 31, 2021 +299,269 +$ +2,993 +$ +3,171,536 +$ +( 198,316 +) +$ +5,915 +$ +( 1,372,641 +) +$ +1,609,487 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2021 +2020 +2019 +(In thousands) +Cash flows from operating activities: +Net loss +$ +( 654,545 +) +$ +( 803,692 +) +$ +( 425,703 +) +Adjustments to reconcile net loss to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +849,178 +670,910 +1,003,873 +Impairment of goodwill +— +395,060 +17,800 +Dry holes and abandonments +178 +1,285 +109 +Deferred income tax benefit +( 62,980 +) +( 125,283 +) +( 103,202 +) +Stock-based compensation expense +21,558 +26,572 +39,328 +Net gain on asset disposals +( 1,426 +) +( 3,079 +) +( 13,904 +) +Net gain on insurance reimbursement +— +( 4,172 +) +— +Write-down of capacity reservation contract +— +9,207 +12,673 +Credit loss expense +( 1,500 +) +5,606 +5,683 +Restructuring expenses, non-cash +— +25,067 +— +(Gain) loss on early debt extinguishment +— +( 3,596 +) +24,023 +Amortization of debt discount and issuance costs +839 +912 +937 +Changes in operating assets and liabilities: +Accounts receivable +( 147,356 +) +173,862 +213,588 +Income taxes receivable/payable +4,516 +1,635 +( 3,353 +) +Inventory and other assets +( 5,850 +) +27,192 +29,394 +Accounts payable +50,941 +( 46,576 +) +( 77,281 +) +Accrued liabilities +50,271 +( 61,266 +) +( 18,623 +) +Other liabilities +( 7,812 +) +( 10,786 +) +( 9,139 +) +Net cash used in operating activities of discontinued operations +( 516 +) +— +— +Net cash provided by operating activities +95,496 +278,858 +696,203 +Cash flows from investing activities: +Acquisitions, net of cash acquired +( 29,358 +) +— +( 13 +) +Purchases of property and equipment +( 166,320 +) +( 145,481 +) +( 347,512 +) +Proceeds from disposal of assets and insurance claims +23,339 +20,929 +45,761 +Other +( 522 +) +( 424 +) +— +Net cash provided by investing activities of discontinued operations +41,267 +— +— +Net cash used in investing activities +( 131,594 +) +( 124,976 +) +( 301,764 +) +Cash flows from financing activities: +Purchases of treasury stock +( 6,328 +) +( 21,179 +) +( 255,467 +) +Dividends paid +( 15,605 +) +( 18,862 +) +( 32,428 +) +Proceeds from long-term debt +— +— +496,969 +Repayment of long-term debt +( 50,000 +) +( 62,525 +) +( 673,443 +) +Debt issuance costs +— +( 584 +) +( 852 +) +Net cash used in financing activities +( 71,933 +) +( 103,150 +) +( 465,221 +) +Effect of foreign exchange rate changes on cash +640 +( 2 +) +( 62 +) +Net increase (decrease) in cash and cash equivalents +( 107,391 +) +50,730 +( 70,844 +) +Cash and cash equivalents at beginning of year +224,915 +174,185 +245,029 +Cash and cash equivalents at end of year +$ +117,524 +$ +224,915 +$ +174,185 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $ 260 in 2021, $ 431 in 2020 +and $ 732 in 2019 +$ +( 40,464 +) +$ +( 43,368 +) +$ +( 76,870 +) +Income taxes +4,196 +3,709 +( 1,452 +) +Non-cash investing and financing activities: +Net increase (decrease) in payables for purchases of property and equipment +$ +31,393 +$ +( 30,241 +) +$ +( 40,857 +) +Issuance of common stock for business acquisitions +248,025 +— +— +Net decrease in deposits on equipment purchases +867 +6,350 +3,974 +Cashless exercise of stock options +— +— +9,219 +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +N OTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “we,” “us,” “our,” “ours” and like terms), is a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. Our pressure pumping business operates primarily in Texas and the Appalachian region. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of directional and horizontal wellbores. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating, working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +In the fourth quarter of 2021, we completed the acquisition of Pioneer Energy Services Corp. (“Pioneer” ). Through the Pioneer acquisition, we acquired Pioneer’s 100 % pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. The well servicing rigs and wireline services units, as discussed below, were subsequently divested. We believe the acquisition of Pioneer enhances our position as a leading provider of contract drilling services in the United States and expands our geographic footprint into Latin America, see Note 2. +On December 31, 2021, we completed the sale of the previously acquired well servicing rig business and wireline business (collectively, “ Pioneer Production Services”), to Clearwell Dynamics, LLC (“Clearwell”). The sale price was $ 43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses have been presented as a discontinued operation in these consolidated financial statements, s ee Note 2. +In the second quarter of 2020, we closed our Canadian drilling operations in response to our longer-term outlook for the western Canadian market. As a result of the closure, we recorded an impairment of $ 8.3 million. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, we have no controlling financial interests in any other entity which would require consolidation. As used in these notes, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its business operations through its wholly-owned subsidiaries and has no employees or independent operations. Certain prior year amounts have been reclassified to conform to current year presentation. +The U.S. dollar is the functional currency for all of our operations except for our Canadian operations, which used the Canadian dollar as their functional currency. The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates . +Revenue recognition — Revenues from our contract drilling, pressure pumping, directional drilling, oilfield rentals, equipment servicing and electrical control and automation activities are recognized as services are performed. All of the wells we drilled in 2021, 2020 and 2019 were drilled under daywork contracts. Revenue from sales of products are recognized upon customer acceptance. Revenue is presented net of any sales tax charged to the customer that we are required to remit to local or state governmental taxing authorities. +F- 9 +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +Leases — We have operating leases for operating locations, corporate offices and certain operating equipment. As of December 31, 2021, we did not have any finance leases. +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for credit losses represents our estimate of the amount of probable credit losses existing in our accounts receivable. We review the adequacy of our allowance for credit losses at least quarterly. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectible, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with our pressure pumping activities, materials used in our directional drilling and equipment servicing business and spare parts for our Colombia contract drilling business. Such inventories are stated at the lower of cost or net realizable value, with cost determined using the average cost method. +Other current assets — Other current assets includes reimbursement from our workers compensation insurance carrier for claims in excess of our deductible in the amount of $ 29.9 million and $ 36.1 million at December 31, 2021 and 2020 , respectively. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Equipment +1.25 - 15 +Buildings +15 - 20 +Other +3 - 12 +Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +F- 10 +We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds our undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). We review unproved oil and natural gas properties quarterly to assess potential impairment. Our impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to oil and natural gas properties of approximately $ 1.3 million, $ 11.2 million and $ 2.2 million was recorded for the years ended December 31, 2021, 2020 and 2019, respectively. +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. Our policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — We recognize the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards, see Note 12. +As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, based on historical experience. Forfeitures are estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates. +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds. +Recently Adopted Accounting Standards — In June 2016, the FASB issued an accounting standards update on measurement of credit losses on financial instruments. The new guidance requires us to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The new standard was effective for fiscal years beginning after December 15, 2019, including all interim periods within those years. We adopted ASU 2016-13 as of January 1, 2020. The adoption of this guidance and recognition of a loss allowance at an amount equal to expected credit losses for accounts receivable was not material and did not result in a transition adjustment to retained earnings. For more information regarding credit losses, see Note 4. +In August 2018, the FASB issued an accounting standards update to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The capitalized implementation costs of a hosting arrangement that is a service contract will be expensed over the term of the hosting arrangement. The new standard was effective for fiscal years beginning after December 15, 2019, including all interim periods within those years. We adopted this new guidance on January 1, 2020 prospectively with respect to all implementation costs incurred after the date of adoption. There was no material impact on our consolidated financial statements. +In August 2018, the FASB issued an accounting standards update to eliminate certain disclosure requirements for fair value measurements for all entities, require public entities to disclose certain new information and modify certain disclosure requirements. The FASB developed the amendments to Topic 820 as part of its broader disclosure framework project, which aims to improve the effectiveness of disclosures in the notes to financial statements by focusing on requirements that clearly communicate the most important information to users of the financial statements. The new standard was effective for fiscal years beginning after December 15, 2019, including all interim periods within those years. We adopted this new guidance on January 1, 2020 and there was no material impact on our consolidated financial statements. +In December 2019, the FASB issued an accounting standards update to simplify the accounting for income taxes. The amendments in the update were effective for public business entities for fiscal years beginning after December 15, 2020, with early adoption permitted. We adopted this new guidance on January 1, 2021, and there was no material impact on our consolidated financial statements. +F- 11 +Recently Issued Accounting Standards — In March 2020, the FASB issued an accounting standards update to provide temporary optional expedients that simplify the accounting for contract modifications to existing debt agreements expected to arise from the market transition from LIBOR to alternative reference rates. The amendments in the update are effective as of March 12, 2020 through December 31, 2022 and may be applied to contract modifications from the beginning of an interim period that includes or is subsequent to March 12, 2020. We plan to adopt this standard when LIBOR is discontinued, and we do not expect this new guidance will have a material impact on our consolidated financial statements. +In October 2 021, the FASB issued an accounting standards update , which requires contract assets and contract liabilities (i.e., deferred revenue) acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers. Generally, this new guidance will result in the acquirer recognizing contract assets and contract liabilities at the same amounts recorded by the acquiree. Historically, such amounts were recognized by the acquirer at fair value in acquisition accounting. The amendments should be applied prospectively to acquisitions occurring on or after the effective date. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2022, with early adoption permitted. We plan to adopt this new guidance on January 1, 2023, and we do not expect this new guidance will have a material impact on our consolidated financial statements. +During the third quarter of 2019, we identified and recorded out-of-period adjustments primarily related to the accounting for inventory in our directional drilling segment. We concluded that these adjustments were not material to the consolidated financial statements for any of the current or prior periods presented. The net adjustment is reflected as a $ 6.6 million increase to “Loss before income taxes” in the consolidated statements of operations for the year ended December 31, 2019. +2. Acquisitions and Discontinued Operations +Pioneer Energy Services Corp. +On October 1, 2021, we completed the acquisition of Pioneer by acquiring 100 % of its equity interests . Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $ 30 million cash, which based on the closing price of our common stock of $ 9.44 on October 1, 2021, valued the transaction at approximately $ 278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. +The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of our common stock issued to Pioneer shareholders +26,274 +Our common stock price on October 1, 2021 +$ +9.44 +Fair value of common stock issued +$ +248,025 +Plus cash consideration +$ +30,007 +Total fair value of consideration transferred +$ +278,032 +A discounted cash flow model was used by a third-party specialist in determining the fair value of the property and equipment and intangible assets. We applied significant judgement in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to market day rates, direct operating costs, rig utilization percentages, expectations regarding the amount of future capital and operating costs, and discount rates. Certain data necessary to complete the purchase price allocation is not yet available, including final tax returns that provide the underlying tax basis of Pioneer's assets and liabilities. We expect to complete the purchase price allocation during the 12-month period following the acquisition date. +F- 12 +Identifiable assets acquired +Cash and cash equivalents +$ +649 +Accounts receivable +44,832 +Inventory +8,513 +Held for sale assets +73,649 +Other current assets +5,272 +Property and equipment +217,536 +Other long-term assets +9,698 +Intangible assets +907 +Total identifiable assets acquired +361,056 +Liabilities assumed +Accounts payable and accrued liabilities +30,391 +Held for sale liabilities +32,160 +Deferred income taxes +15,543 +Other long-term liabilities +4,930 +Total liabilities assumed +83,024 +Total net assets acquired +$ +278,032 +Approximately $ 41.5 million of revenues and $ 30.5 million of direct operating expenses attributed to the Pioneer acquisition are included in the consolidated statements of operations for the period from the closing date on October 1, 2021 through December 31, 2021, excluding the acquired well servicing rig business and the wireline businesses that have been presented as a discontinued operation in the consolidated statements of operations. Revenues and direct operating expenses for our discontinued operations are presented below. +A portion of the fair value consideration transferred has been provisionally assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Assets +Trade name +$ +907 +5.00 +Pro Forma +The results of Pioneer’s operations since the Pioneer merger date of October 1, 2021 are included in our consolidated statements of operations. The following pro forma condensed combined financial information was derived from our and Pioneer's historical financial statements, excluding the well servicing rig business and wireline business that were disposed on December 31, 2021, and gives effect to the acquisition as if it had occurred on January 1, 2020. The below information reflects pro forma adjustments based on available information and certain assumptions we believe are reasonable, including (i) adjustments related to the depreciation and amortization of the fair value of acquired intangibles and fixed assets, (ii) removal of the historical interest expense, loss on debt extinguishment and reorganization expenses of the acquired entities and (iv) the tax benefit of the aforementioned pro forma adjustments. +The pro forma results of operations do not include any cost savings or other synergies that may result from the Pioneer acquisition. The pro forma results of operations also do not include any estimated costs that have been or will be incurred to integrate Pioneer operations. The pro forma results of operations include our merger and integration-related costs of $ 12.1 million and Pioneer's merger related costs of $ 4.6 million for the year ended December 31, 2021. +The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the Pioneer acquisition taken place on January 1, 2020; furthermore, the financial information is not intended to be a projection of future results. The following table summarizes our selected financial information on a pro forma basis (in thousands, except per share data): +2021 +2020 +(Unaudited) +Revenues +$ +1,464,351 +$ +1,255,554 +Net loss +$ +( 666,032 +) +$ +( 809,996 +) +During 2021, we incurred costs related to the Pioneer acquisition totaling $ 12.1 million, which are included in our consolidated statements of operations as “Merger and integration expenses.” +F- 13 +Discontinued Operations +On December 31, 2021, we completed the sale of the previously acquired well servicing rig business and wireline business (collectively, “ Pioneer Production Services ” ), to Clearwell. The sale price was $ 43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses have been presented as a discontinued operation in these consolidated financial statements. +Summarized operating results from discontinued operations that are included in our consolidated statements of operations for the year ended December 31, 2021 are shown below (in thousands): +2021 +Operating revenues: +Wireline revenue +$ +9,868 +Well servicing revenue +19,652 +Total operating revenues +29,520 +Operating costs and expenses: +Wireline +10,465 +Well servicing +16,585 +Total operating costs and expenses +27,050 +Operating income +2,470 +Total other income (expense) +64 +Income from discontinued operations before income taxes +2,534 +Income tax benefit +— +Income from discontinued operations, net of tax +$ +2,534 +In connection with the sale of our Pioneer Production Services business, we entered into a transition services agreement with Clearwell, pursuant to which we agreed to provide each other certain administrative and operational services on an interim, transitional basis through June 30, 2022. +3. Revenues +ASC Topic 606 Revenue from Contracts with Customers +Our contracts with customers include both long-term and short-term contracts. Services that primarily generate our earned revenue include the operating business segments of contract drilling, pressure pumping and directional drilling which comprise our reportable segments. We also derive revenues from our other operations, which include our operating business segments of oilfield rentals, equipment servicing, electrical controls and automation, and oil and natural gas working interests. For more information on our business segments, see Note 17. +Charges for services are considered a series of distinct services. Since each distinct service in a series would be satisfied over time if it were accounted for separately, and the entity would measure its progress towards satisfaction using the same measure of progress for each distinct service in the series, we are able to account for these integrated services as a single performance obligation that is satisfied over time. +The transaction price is the amount of consideration to which we expect to be entitled in exchange for transferring promised goods or services to a customer, based on terms of our contracts with our customers. The consideration promised in a contract with a customer may include fixed amounts and/or variable amounts. Payments received for services are considered variable consideration as the time in service will fluctuate as the services are provided. Topic 606 provides an allocation exception, which allows us to allocate variable consideration to one or more distinct services promised in a series of distinct services that form part of a single performance obligation as long as certain criteria are met. These criteria state that the variable payment must relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service, and allocation of the variable consideration is consistent with the standards’ allocation objective. Since payments received for services meet both of these criteria requirements, we recognize revenue when the service is performed. +F- 14 +An estimate of variable consideration should be constrained to the extent that it is not probable that a significant revenue reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Payments received for other types of consideration are fully constrained as they are highly susceptible to factors outside our influence and therefore could be subject to a significant revenue reversal once resolved. As such, revenue received for these types of consideration is recognized when the service is performed. +Estimates of variable consideration are subject to change as facts and circumstances evolve. As such, we will evaluate our estimates of variable consideration that are subject to constraints throughout the contract period and revise estimates, if necessary, at the end of each reporting period. +We are a non-operating working interest owner of oil and natural gas properties primarily located in Texas and New Mexico. The ownership terms are outlined in joint operating agreements for each well between the operator of the well and the various interest owners, including us, who are considered non-operators of the well. We receive revenue each period for our working interest in the well during the period. The revenue received for the working interests from these oil and gas properties does not fall under the scope of ASC Topic 606, and therefore, is reported under ASC 932-323 Extractive Activities – Oil and Gas, Investments – Equity Method and Joint Ventures. +Reimbursement Revenue – Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +Operating Lease Revenue – Lease income from equipment that we lease to others is recognized on a straight-line basis over the lease term. Lease income recognized during the years ended December 31, 2021, 2020 and 2019 was not material. +Our disaggregated revenue recognized from contracts with customers is included in Note 17. +Accounts Receivable and Contract Liabilities +Accounts receivable is our right to consideration once it becomes unconditional. Payment terms typically range from 30 to 60 days. +Accounts receivable balances were $ 352 million and $ 158 million as of December 31, 2021 and 2020, respectively. These balances do not include amounts related to our oil and gas working interests as those contracts are excluded from Topic 606. Accounts receivable balances are included in “Accounts receivable” in the consolidated balance sheets. +We do not have any significant contract asset balances. Contract liabilities include prepayments received from customers prior to the requested services being completed. Once the services are complete and have been invoiced, the prepayment is applied against the customer’s account to offset the accounts receivable balance. Also included in contract liabilities are payments received from customers for the initial mobilization of newly constructed or upgraded rigs that were moved on location to the initial well site. These mobilization payments are allocated to the overall performance obligation and amortized over the initial term of the contract. During the year ended December 31, 2021 , no such payments were amortized and recorded in drilling revenue. During the year ended December 31, 2020, approximately $ 0.1 million was amortized and recorded in drilling revenue. +Total contract liability balances were $ 60.3 million and $ 0.6 million as of December 31, 2021 and December 31, 2020, respectively. During the year ended December 31, 2021, contract liabilities in creased by $ 59.7 million primarily due to customer payments. The majority of the contract liabilities balance is expected to be recognized in 2022. The increase in contract liability balances are included in “Accrued liabilities” in the consolidated balance sheets. +Contract Costs +Costs incurred for newly constructed rigs or rig upgrades based on a contract with a customer are considered capital improvements and are capitalized to drilling equipment and depreciated over the estimated useful life of the asset. +F- 15 +4. Credit Losses +ASC Topic 326 Current Expected Credit Losses (CECL) +On January 1, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments , which introduced a new model to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Our customers are primarily oil and natural gas exploration and production companies, which are collectively exposed to oil and natural gas commodity price risk. Our customers require services from us at various stages of the exploration and production process. Accordingly, we have aggregated our trade receivables by segment. Any customers that have experienced a deterioration in credit quality are removed from the pool and evaluated individually. We utilize an accounts receivable aging schedule and historical credit loss information to estimate expected credit losses. Due to the significant decline in crude oil prices during the quarter ended March 31, 2020 and its related impact to our customers, we increased our historical credit loss rates used to determine our March 31, 2020 allowance for credit losses in the first quarter of 2020. We continued to monitor and evaluate our expected credit losses using these increased credit loss rates throughout the remainder of 2020 and in 2021. +During 2021, we reversed $ 1.5 million of our credit loss provision related to certain customers who had previously experienced a deterioration in credit quality. Since initially recording loss provisions for these receivables, we have collected portions of the accounts that were deemed uncollectible. +The adoption of the new accounting standard did not have a material impact on our consolidated financial statements and did not result in a transition adjustment to retained earnings. +The allowance for credit losses related to accounts receivable as of December 31, 2020 and 2021, and changes for the periods ended December 31, 2020 and 2021 are as follows (in thousands): +Balance at January 1, 2020 +$ +6,516 +Provision for expected credit losses +5,606 +Write-offs +( 1,280 +) +Balance at December 31, 2020 +10,842 +Provision for expected credit losses +( 1,500 +) +Write-offs +( 849 +) +Balance at December 31, 2021 +$ +8,493 +5. Inventory +Inventory consisted of the following at December 31, 2021 and 2020 (in thousands): +2021 +2020 +Finished goods +$ +515 +$ +600 +Work-in-process +882 +802 +Raw materials and supplies +40,962 +31,683 +Inventory +$ +42,359 +$ +33,085 +We maintain certain surplus quantities of spare parts that serve as backup components and maintenance materials for our directional drilling and Colombia contract drilling operations. In 2021, advances in technologies rendered certain directional drilling equipment, and spare parts used to service that equipment, obsolete. Based on our assessment of limited alternative uses or active markets to recapture costs, we recorded a write-down of $ 4.0 million. The write-down is recorded in "Operating costs and expenses - Directional drilling" in the consolidated statements of operations. +F- 16 +6. Property and Equipment +Property and equipment consisted of the following at December 31, 2021 and 2020 (in thousands): +2021 +2020 +Equipment +$ +7,742,101 +$ +7,647,451 +Oil and natural gas properties +229,403 +222,738 +Buildings +182,280 +193,503 +Land +24,562 +25,781 +Total property and equipment +8,178,346 +8,089,473 +Less accumulated depreciation, depletion, amortization and impairment +( 5,846,591 +) +( 5,328,432 +) +Property and equipment, net +$ +2,331,755 +$ +2,761,041 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment, intangible assets and liabilities for 2021, 2020 and 2019 (in thousands): +2021 +2020 +2019 +Depreciation and impairment expense +$ +818,999 +$ +644,943 +$ +974,206 +Amortization expense +24,606 +19,281 +17,722 +Depletion expense +5,573 +6,686 +11,945 +Total +$ +849,178 +$ +670,910 +$ +1,003,873 +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are abandoned. In the fourth quarter of 2021, we identified 43 legacy non-super-spec rigs and equipment to be abandoned. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 43 rigs that were abandoned had limited commercial opportunity. We recorded a $ 220 million charge related to this abandonment in the fourth quarter of 2021 . In the second quarter of 2020, we recorded an impairment of $ 8.3 million related to the closing of our Canadian drilling operations. In 2019, we identified 36 legacy non-APEX ® rigs and related equipment that were abandoned. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 36 rigs that were abandoned had limited commercial opportunity. We recorded a $ 173 million charge related to this abandonment. +We also periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are abandoned. In the fourth quarter of 2021, we recorded a charge of $ 32.2 million related to the abandonment of approximately 0.2 million horsepower within our pressure pumping fleet. The majority of these units were frac pumps but also included pump down units. These units were abandoned due to changes in customer preferences for dual fuel, advancements in technology, and prohibitive reactivation costs . In 2019, we recorded a charge of $ 20.5 million for the write-down of pressure pumping equipment. There was no similar charge in 2020. +We also periodically evaluate our directional drilling assets. In the fourth quarter of 2021, we abandoned certain directional drilling equipment totaling $ 2.5 million and recorded a charge on our developed technology intangible asset of $ 11.4 million due to advances in technology that rendered those assets, and their related spare parts inventory, obsolete. During 2019, we recorded a charge of $ 8.4 million for the write-down of directional drilling equipment. There was no similar charge in 2020. +We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +F- 17 +2021 Triggering Event Assessment +Based on current commodity prices, our results of operations for the year ended December 31, 2021 and management’s expectations of operating results in future periods, we concluded that no triggering events occurred during the year ended December 31, 2021 with respect to our asset groups within our operating segments. Our expectations of future operating results were based on the assumption that activity levels in all of our reporting segments and our other operations will remain relatively stable or improve in response to relatively stable or increasing oil prices. +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of March 31, 2020. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of March 31, 2020. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 15 %, 22 %, 3 % and 9 %, respectively. +For the assessment performed in the first quarter of 2020, the expected cash flows for our asset groups i ncluded revenue and operating expense growth rates. Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in the second half of 2019 and the first quarter of 2020 and would begin to recover in 2022 in response to improved oil prices. +After the assessment we performed in the first quarter of 2020, we concluded that no triggering events occurred during the periods thereafter through December 31, 2020 with respect to our asset groups based on the recent results of operations leading up to that date, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices, our results of operations for the quarter ended September 30, 2019 and management’s expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. We performed an analysis as required by ASC 360-10-35 to assess the recoverability of the asset groups within our contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments as of September 30, 2019. With respect to these asset groups, future cash flows were estimated over the expected remaining life of the assets, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups, and no impairment was indicated. Expected cash flows, on an undiscounted basis, exceeded the carrying values of the asset groups within the contract drilling, pressure pumping, directional drilling and oilfield rentals operating segments by approximately 35 %, 54 %, 23 % and 7 %, respectively. +For the assessment performed in 2019, the expected cash flows for our asset groups i ncluded revenue and operating expense growth rates . Also, the expected cash flows for the contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups were based on the assumption that activity levels in all four segments would generally be lower than levels experienced in 2019 and would begin to recover in late 2020 or 2021 in response to improved oil prices. +We concluded that no triggering events occurred during the quarter ended December 31, 2019 with respect to our asset groups based on the recent results of operations leading up to that date, management’s expectations of operating results in future periods and the prevailing commodity prices at the time. +F- 18 +7. Goodwill and Intangible Assets +Goodwill — As a result of a triggering event in the first quarter of 2020, we fully impaired our remaining goodwill balance, and as a result, we had no goodwill balance as of December 31, 2021. At times when we have a goodwill balance, we are required to evaluate goodwill at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing are our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, we may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in our contract drilling reporting unit. We performed a quantitative impairment assessment of our goodwill as of March 31, 2020. In completing the assessment, the fair value of our contract drilling operating segment was estimated using the income approach. The estimate of fair value required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of March 31, 2020, impairment was indicated in our contract drilling reporting unit. We recognized an impairment charge of $ 395 million in the quarter ended March 31, 2020 associated with the impairment of all of the goodwill in our contract drilling reporting unit. We had no remaining goodwill balance as of December 31, 2020. +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices leading up to September 30, 2021, our results of operations for the quarter ended September 30, 2019 and our expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We performed a quantitative impairment assessment of our goodwill as of September 30, 2019. In completing the assessment, the fair value of each reporting unit was estimated using the income approach. The estimate of fair value for each reporting unit required the use of significant unobservable inputs, representative of a Level 3 fair value measurement. The assumptions included discount rates, revenue growth rates, operating expense growth rates, and terminal growth rates. +Based on the results of the goodwill impairment test as of September 30, 2019, the fair value of the contract drilling reporting unit exceeded its carrying value by approximately 13 % and we concluded that no impairment was indicated in our contract drilling reporting unit; however, impairment was indicated in our oilfield rentals and electrical controls and automation reporting units included in the other operations segment. We recognized an impairment charge of $ 17.8 million in 2019 associated with the impairment of all of the goodwill in our oilfield rentals and electrical controls and automation reporting units. +In connection with our annual goodwill impairment assessment as of December 31, 2019, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than the respective carrying amount. In making this determination, we considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in our reporting units, as well as our 2019 operating results and forecasted operating results for the succeeding year. We also considered our overall market capitalization at December 31, 2019. +Intangible Assets — In 2021, an intangible asset was recorded in our contract drilling operating segment with the acquisition of Pioneer. See Note 2 for additional information. Our intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight-line basis. The following table identifies the segment and weighted average useful life of each of our intangible assets: +Weighted Average +Segment +Useful Life +(in years) +Customer relationships +Other operations +7.00 +Developed technology +Directional drilling +10.00 +Internal use software +Directional drilling +5.00 +Trade name +Contract drilling +5.00 +F- 19 +During 2021, we achieved certain internal advancements in our directional drilling technology that have rendered obsolete certain technology acquired as part of the MS Directional acquisition. Accordingly, we recorded a charge of $ 11.4 million to abandon these developed technology intangibles and certain related internal use software. +2021 Triggering Event Assessment +Based on current commodity prices, our results of operations for the year ended December 31, 2021 and management’s expectations of operating results in future periods, we concluded that no triggering events occurred during the year ended December 31, 2021. Our expectations of future operating results were based on the assumption that activity levels in all segments and our other operations will remain relatively stable or improve in response to relatively stable or increasing oil prices. +2020 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in the first quarter of 2020, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of March 31, 2020. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 6 for additional information. +After the assessment we performed in the first quarter of 2020, we concluded that no triggering events necessitating an impairment assessment of the intangible assets occurred throughout the remainder of 2020 . +2019 Triggering Event Assessment +Due to the decline in the market price of our common stock and commodity prices in 2019, our results of operations for the quarter ended September 30, 2019 and our expectations of operating results in future periods, we lowered our expectations with respect to future activity levels in certain of our operating segments. We deemed it necessary to assess the recoverability of our contract drilling, pressure pumping, directional drilling and oilfield rentals asset groups as of September 30, 2019. The assessments of recoverability of the asset groups included the respective intangible assets, and no impairment was indicated. See Note 6 for additional information. +We concluded that no triggering events necessitating an impairment assessment of the intangible assets had occurred during the quarter ended December 31, 2019. +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2021 and 2020 are as follows (in thousands): +2021 +2020 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +1,800 +$ +( 814 +) +$ +986 +$ +28,000 +$ +( 26,757 +) +$ +1,243 +Developed technology +55,772 +( 50,996 +) +4,776 +55,772 +( 27,515 +) +28,257 +Internal use software +1,428 +( 515 +) +913 +906 +( 319 +) +587 +Trade name +907 +( 45 +) +862 +— +— +— +$ +59,907 +$ +( 52,370 +) +$ +7,537 +$ +84,678 +$ +( 54,591 +) +$ +30,087 +Amortization and impairment expense on intangible assets of approximately $ 24.0 million, $ 19.3 million and $ 17.9 million was recorded for the years ended December 31, 2021, 2020 and 2019 , respectively, which included an $ 11.4 million impairment in 2021. The remaining amortization expense associated with finite-lived intangible assets is expected to be as follows (in thousands): +Year ending December 31, +2022 +$ +1,405 +2023 +1,405 +2024 +1,405 +2025 +1,354 +2026 +1,078 +Thereafter +890 +Total +$ +7,537 +F- 20 +8. Accrued Liabilities +Accrued expenses consisted of the following at December 31, 2021 and 2020 (in thousands): +2021 +2020 +Salaries, wages, payroll taxes and benefits +$ +52,252 +$ +37,627 +Workers’ compensation liability +67,921 +70,847 +Property, sales, use and other taxes +9,673 +10,666 +Insurance, other than workers’ compensation +6,494 +8,462 +Accrued interest payable +11,226 +11,325 +Accrued restructuring expenses +7,884 +14,310 +Customer prepayment +60,282 +599 +Other +22,779 +21,767 +Accrued liabilities +$ +238,511 +$ +175,603 +9. Long-Term Debt +Long-term debt consisted of the following at December 31, 2021 and 2020 (in thousands): +Effective Interest Rate +December 31, 2021 +December 31, 2020 +Term Loan Agreement (1) +$ +— +$ +50,000 +3.95 % Senior Notes +4.03 % +509,505 +509,505 +5.15 % Senior Notes +5.26 % +349,250 +349,250 +858,755 +908,755 +Less deferred financing costs and discounts +( 6,432 +) +( 7,271 +) +Total +$ +852,323 +$ +901,484 +(1) +The borrowings outstanding under the Term Loan Agreement maturing in June 2022 were previously classified as long-term because we had the ability and intent to repay these obligations utilizing our revolving credit facility. +2019 Term Loan Agreement — On August 22, 2019 , we entered into a term loan agreement (“Term Loan Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lender party thereto. +The Term Loan Agreement was a committed senior unsecured term loan facility that permitted a single borrowing of up to $ 150 million initially, which we drew in full on September 23, 2019. We repaid $ 50 million of these borrowings in each of 2019 and 2020, and o n December 30, 2021, we repaid the final $ 50 million of borrowings under the Term Loan Agreement, and as a result had no remaining borrowings under the Term Loan Agreement as of December 31, 2021. +Credit Agreement — On March 27, 2018 , we entered into an amended and restated credit agreement (the “Cred it Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Lead Arrangers and Joint Book Runners. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $ 600 million, including a letter of credit facility that, at any time outstanding, is limited to $ 150 million and a swing line facility that, at any time outstanding, is limited to $ 20 million. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $ 300 million, not to exceed total commitments of $ 900 million. The original maturity date under the Credit Agreement was March 27, 2023 . On March 26, 2019, we entered into Amendment No. 1 to Amended and Restated Credit Agreement, which amended the Credit Agreement to, among other things, extend the maturity date under the Credit Agreement from March 27, 2023 to March 27, 2024 . On March 27, 2020, we entered into Amendment No. 2 to Amended and Restated Credit Agreement (“Amendment No. 2”) to, among other things, extend the maturity date for $ 550 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2024 to March 27, 2025 . We have the option, subject to certain conditions, to exercise an additional one-year extension of the maturity date. +F- 21 +Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate. The applicable margin on LIBOR rate loans varies from 1.00 % to 2.00 % and the applicable margin on base rate loans varies from 0.00 % to 1.00 %, in each case determined based upon our credit rating. As of December 31, 2021, the applicable margin on LIBOR rate loans was 1.75 % and the applicable margin on base rate loans was 0.75 % . A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10 % to 0.30 % based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at one of the two ratings agencies. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50 %. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2021. +As of December 31, 2021, we had no borrowings outstanding under our revolving credit facility. We had $ 0.1 million in letters of credit outstanding under the Credit Agreement at December 31, 2021 and, as a result, had available borrowing capacity of approximately $ 600 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. On October 7, 2021, an additional $ 7.3 million of letters of credit were issued by Scotiabank in connection with the closing of the Pioneer acquisition. As of December 31, 2021 , we had $ 71.4 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25 % per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +Series A Senior Notes and Series B Senior Notes — On October 5, 2010 , we completed the issuance and sale of $ 300 million in aggregate principal amount of our 4.97 % Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bore interest at a rate of 4.97% per annum. On September 25, 2019, we fully prepaid the Series A Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $ 308 million, which represents 100 % of the principal and the “make-whole” premium to the prepayment date. +F- 22 +On June 14, 2012 , we completed the issuance and sale of $ 300 million in aggregate principal amount of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bore interest at a rate of 4.27 % per annum. On December 16, 2019, we fully prepaid the Series B Notes. The total amount of the prepayment, including the applicable “make-whole” premium, was approximately $ 315 million, which represents 100 % of the principal and the “make-whole” premium to the prepayment date. +Primarily as a result of the “make-whole” premiums, we incurred an $ 8.2 million loss on early extinguishment of the Series A Notes in the three months ended September 30, 2019, and a $ 15.8 million loss on early extinguishment of the Series B Notes in the three months ended December 31, 2019, which were included in “Interest expense , net of amount capitalized” in the consolidated statements of operations. +2028 Senior Notes and 2029 Senior Notes — On January 19, 2018, we completed an offering of $ 525 million in aggregate principal amount of our 3.95% Senior Notes due 2028 (the “2028 Notes”). The net proceeds before offering expenses were approximately $ 521 million, of which we used $ 239 million to repay amounts outstanding under our revolving credit facility. On November 15, 2019, we completed an offering of $ 350 million in aggregate principal amount of our 5.15% Senior Notes due 2029 (the “2029 Notes”). The net proceeds before offering expenses were approximately $ 347 million. We used a portion of the net proceeds from the offering to prepay our Series B Notes. The remaining net proceeds and available cash on hand was used to repay $ 50 million of the borrowings under the Term Loan Agreement in 2019. +During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes in the open market. The principal amounts retired through these transactions totaled $ 15.5 million related to our 2028 Notes and $ 0.8 million related to our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $ 3.4 million and $ 0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in the consolidated statements of operations. +We pay interest on the 2028 Notes on February 1 and August 1 of each year . The 2028 Notes will mature on February 1, 2028 . The 2028 Notes bear interest at a rate of 3.95 % per annum. +We pay interest on the 2029 Notes on May 15 and November 15 of each year. The 2029 Notes will mature on November 15, 2029 . The 2029 Notes bear interest at a rate of 5.15 % per annum. +The 2028 Notes and 2029 Notes (together, the “Senior Notes”) are our senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The Senior Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the Senior Notes. None of our subsidiaries are currently required to be a guarantor under the Senior Notes. If our subsidiaries guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +At our option, we may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100 % of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, and on August 15, 2029, in the case of the 2029 Notes, at our option, we may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100 % of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date. +The indentures pursuant to which the Senior Notes were issued include covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indentures. +Upon the occurrence of a change of control triggering event, as defined in the indentures, each holder of the Senior Notes may require us to purchase all or a portion of such holder’s Senior Notes at a price equal to 101 % of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +F- 23 +Debt issuance costs — We incurred approximately $ 0.2 million in debt issuance costs in connection with the Term Loan Agreement. We incurred approximately $ 4.6 million in debt issuance costs in connection with the Credit Agreement. We also incurred an additional $ 0.4 million in debt issuance costs in connection with our entry into Amendment No. 2. We incurred approximately $ 1.9 million in debt issuance costs in connection with the Series A Notes and approximately $ 1.6 million in debt issuance costs in connection with the Series B Notes. We incurred approximately $ 1.6 million in debt issuance costs in connection with the 2028 Notes and approximately $ 1.0 million in debt issuance costs in connection with the 2029 Notes. These costs were deferred and are being recognized as interest expense over the term of the underlying debt. Debt issuance costs, except those related to line-of-credit arrangements, are presented in the balance sheet as a direct reduction of the carrying amount of the related debt. Debt issuance costs related to line-of-credit arrangements are included in “Other non-current assets” in the consolidated balance sheets. Amortization of debt issuance costs is reported as interest expense. +Interest expense related to the amortization of debt issuance costs was approximately $ 1.0 million, $ 1.1 million and $ 2.0 million for the years ended December 31, 2021, 2020 and 2019 , respectively. Amortization of debt issuance costs for the year ended December 31, 2021 includes minimal debt issuance costs that were expensed as a result of the complete prepayment of our borrowings under our Term Loan Agreement. Amortization of debt issuance costs for the year ended December 31, 2020 includes $ 0.1 million of debt issuance costs that were expensed as a result of the early redemption of a portion of our 2028 Notes and our 2029 Notes as well as the partial repayment of our borrowings under our Term Loan Agreement. Amortization of debt issuance costs for the year ended December 31, 2019 includes $ 0.2 million of debt issuance costs that were expensed as a result of the Series A Notes prepayment, $ 0.4 million of debt issuance costs that were expensed as a result of the Series B Notes prepayment and approximately $ 0.1 million of debt issuance costs that were expensed as a result of the Term Loan Agreement partial repayment. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2021 (in thousands): +Year ending December 31, +2022 +$ +— +2023 +— +2024 +— +2025 +— +2026 +— +Thereafter +858,755 +Total +$ +858,755 +10. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2021 , we maintained letters of credit in the aggregate amount of $ 71.5 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2021 , no amounts had been drawn under the letters of credit. +As of December 31, 2021 , we had commitments to purchase major equipment totaling approximately $ 99.0 million for our contract drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. The remaining terms of the agreements are less than one year . I n the event the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall. In 2017, we entered into a capacity reservation agreement that required a cash deposit to increase our access to finer grades of sand for our pressure pumping business. As market prices for sand substantially decreased since 2017, we purchased lower cost sand outside of this capacity reservation contract and recorded a charge of $ 9.2 million and $ 12.7 million in the second quarters of 2020 and 2019, respectively, to revalue the deposit to its expected realizable value. There is no value assigned to the capacity reservation contract subsequent to the charge recorded in the second quarter of 2020. +F- 24 +Contingencies – Our operations are subject to many hazards inherent in the businesses in which it operates, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $ 1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $ 1.0 million per occurrence deductible on our equipment insurance coverage, a $ 10.0 million per occurrence deductible on our general liability coverage, a $ 2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $ 5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows or results of operations. +Other Matters — We have a Change in Control Agreement with one of our Executive Vice Presidents (the “Specified Employee”). The Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless we notify the Specified Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by us other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreement), then the Specified Employee shall generally be entitled to, among other things: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2 times the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under our welfare plans for up to two years . +The Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +F- 25 +We have Employment Agreements with our Chief Executive Officer, Chief Financial Officer, General Counsel and the President of our subsidiary, Patterson-UTI Drilling Company LLC (“Patterson-UTI Drilling”). Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such termination at least 30 days before the effective date of such termination. Under specified circumstances, we may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by either (i) providing written notice 10 days before the effective date of such termination and by granting at least 10 days to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of such termination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by us to not be capable of being cured, the executive may be terminated for cause on the date the written notice is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following our decision to terminate the executive other than for Cause, or termination by the executive for Good Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by us without Cause, or the executive terminates his employment for Good Reason: +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees, +• +we will accelerate vesting of all options and restricted stock awards on the 60th day following the executive’s termination , and +• +we will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +If our decision to terminate other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, which for the President of Patterson-UTI Drilling includes a change in control of us or, in certain circumstances, of Patterson-UTI Drilling), the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years , and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the Chief Financial Officer, General Counsel and President of Patterson-UTI Drilling) of subsidized benefits continuation coverage. +11. Stockholders’ Equity +Cash Dividend — On February 9, 2022 , our Board of Directors approved a cash dividend on our common stock in the amount of $ 0.04 per share to be paid on March 17, 2022 to holders of record as of March 3, 2022 . The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend in order to improve our financial flexibility and best position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +Share Repurchases and Acquisitions — On September 6, 2013, our Board of Directors approved a stock buyback program that authorized purchases of up to $ 200 million of our common stock in open market or privately negotiated transactions. The authorized repurchases under this program were subsequently increased in July 2018 and February 2019, and on July 24, 2019, our Board of Directors approved another increase of the authorization under the stock buyback program to allow for $ 250 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2021, we had remaining authorization to purchase approximately $ 130 million of our outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2021, 2020 and 2019 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”) and the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), and not pursuant to the stock buyback program. Upon the issuance of shares for the Pioneer acquisition in October 2021, we withheld shares with respect to Pioneer employees’ tax withholding obligations. +F- 26 +Treasury stock acquisitions during the years ended December 31, 2021, 2020 and 2019 were as follows (dollars in thousands): +2021 +2020 +2019 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +53,701,096 +$ +1,080,448 +Purchases pursuant to stock buyback program +— +— +5,826,266 +20,000 +22,566,331 +250,109 +Acquisitions pursuant to long-term incentive plan +451,196 +3,727 +239,669 +1,179 +1,037,947 +14,205 +Purchases in connection with Pioneer acquisition +275,477 +2,601 +— +— +— +— +Other +— +— +— +— +31,013 +372 +Treasury shares at end of period +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +Stockholder Rights Agreement — On April 22, 2020, our Board of Directors adopted a stockholder rights agreement and declared a dividend of one right (a “Right”) for each outstanding share of our common stock to stockholders of record at the close of business on May 8, 2020. Each Right entitled its holder, subject to the terms of the Rights Agreement (as defined below), to purchase from us one one-thousandth of a share of our Series A Junior Participating Preferred Stock, par value $ 0.01 per share, at an exercise price of $ 17.00 per Right, subject to adjustment. The description and terms of the Rights were set forth in a stockholder rights agreement, dated as of April 22, 2020 (the “Rights Agreement”), between us and Continental Stock Transfer & Trust Company, as rights agent (the “Rights Agent”). The Rights Agreement expired on April 21, 2021 . +12. Stock-based Compensation +We use share-based payments to compensate employees and non-employee directors. We recognize the cost of share-based payments under the fair-value-based method. Share-based awards include equity instruments in the form of stock options, restricted stock or restricted stock units that have included service conditions and, in certain cases, performance conditions. Our share-based awards also include share-settled performance unit awards. Share-settled performance unit awards are accounted for as equity awards. In 2020, we granted performance-based cash-settled phantom units, which are accounted for as a liability classified award. We issue shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest. +On June 3, 2021, our stockholders approved the 2021 Plan. No additional awards will be granted under any of our previously existing plans. The aggregate number of shares of Common Stock authorized for grant under the 2021 Plan is approximately 13.5 million, which includes approximately 4.9 million shares previously authorized under our 2014 Plan. +Our share-based compensation plans at December 31, 2021 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +2021 Plan +13,467,480 +2,483,250 +8,288,582 +2014 Plan +— +4,986,734 +— +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +1,487,500 +— +A summary of the 2021 Plan follows: +• +The Compensation Committee of the Board of Directors administers the Plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +The Plan provides that the total compensation paid to each non-employee director for their service as such, whether in cash or in equity awards under the 2021 Plan (based on the grant date fair value of any such awards) during a single fiscal year may not exceed $ 750,000 ; however, the foregoing limit will instead be $ 1,000,000 for any fiscal year in which the non-employee director is first appointed to the Board of Directors or any fiscal year in which the non-employee director serves as chairman or lead director. +• +All options granted under the 2021 Plan are granted with an exercise price equal to or greater than fair market value of our common stock at the time the option is granted. +F- 27 +• +The Plan provides for awards of incentive and non-incentive stock options, stock appreciation rights (“SARs”), restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalent rights. +Options granted under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan and 2014 Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. +Stock Options — We estimate the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of our common stock over the most recent period equal to the expected term of the options as of the date such options are granted. The expected term assumptions are based on our experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the years ended December 31, 2021, 2020 and 2019. +Stock option activity for the year ended December 31, 2021 follows: +Weighted Average +Shares +Exercise Price Per Share +Outstanding at beginning of year +4,026,150 +$ +21.63 +Exercised +— +$ +— +Expired +( 306,000 +) +$ +30.10 +Outstanding at end of year +3,720,150 +$ +20.93 +Exercisable at end of year +3,720,150 +$ +20.93 +Options outstanding and exercisable at December 31, 2021 have no intrinsic value and a weighted-average remaining contractual term of 2.45 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2021, 2020 and 2019 follows (in thousands, except per share data): +2021 +2020 +2019 +Weighted-average grant date fair value of stock options granted (per share) +NA +NA +NA +Aggregate grant date fair value of stock options vested during the year +$ +89 +$ +89 +$ +543 +Aggregate intrinsic value of stock options exercised +$ +— +$ +— +$ +— +As of December 31, 2021 , no options to purchase shares were outstanding and not vested. +Restricted Stock Units — For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Forfeitable dividend equivalents are accrued on certain restricted stock units that will be paid upon vesting. We use the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2021 follows: +Weighted Average +Time +Performance +Grant Date Fair +Based +Based +Value Per Share +Non-vested restricted stock units outstanding at beginning of year +2,741,548 +359,315 +$ +9.52 +Granted +1,797,875 +— +$ +8.32 +Vested +( 1,345,034 +) +— +$ +10.89 +Forfeited +( 149,670 +) +— +$ +10.33 +Non-vested restricted stock units outstanding at end of year +3,044,719 +359,315 +$ +8.31 +As of December 31, 2021 , approximately 3.3 million non-vested restricted stock units outstanding are expected to vest. Additional information as of December 31, 2021 with respect to these non-vested restricted stock units follows (dollars in thousands): +Aggregate intrinsic value +$ +27,977 +Weighted-average remaining vesting period +1.66 years +Unrecognized compensation cost +$ +17,290 +F- 28 +Performance Unit Awards — We have granted share-settled performance unit awards to certain employees (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive a grant of shares of common stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is generally the three-year period commencing on April 1 of the year of grant. +The performance goals for the Performance Units are tied to our total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. For the performance units granted in April 2021, the peer group also includes three market indices. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. Under the Performance Units granted beginning in April 2019, the recipients will receive the target number of shares if our total shareholder return during the performance period, when compared to the peer group, is at the 55 th percentile. If our total shareholder return during the performance period, when compared to the peer group, is at the 75 th percentile or higher, then the recipients will receive two times the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is at the 25 th percentile, then the recipients will only receive one-half of the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is between the 25 th and 55 th percentile, or the 55 th and 75 th percentile, then the shares to be received by the recipients will be determined using linear interpolation for levels of achievement between these points. +Under the Performance Units granted beginning in April 2019, the payout shall not exceed the target number of shares if our total shareholder return is negative or zero. Additionally, the Performance Units granted in April 2020 will not pay out if our total shareholder return is not equal to or greater than the total stockholder return of the S&P 500 Index for the performance period. +The total target number of shares with respect to the Performance Units for the years 2016-2021 is set forth below: +2021 +2020 +2019 +2018 +2017 +2016 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +843,000 +500,500 +489,800 +310,700 +186,198 +185,000 +In April 2019, 185,000 shares were issued to settle the 2016 Performance Units. In May 2020, 332,773 shares were issued to settle the 2017 Performance Units. In April 2021, 621,400 shares were issued to settle the 2018 Performance Units. The Performance Units granted in 2019, 2020 and 2021 have not reached the end of their respective performance periods. +Because the Performance Units are share-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2021 +2020 +2019 +2018 +2017 +2016 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +7,225 +$ +826 +$ +9,958 +$ +8,004 +$ +5,780 +$ +3,854 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2021 +2020 +2019 +2018 +2017 +2016 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2021 +$ +1,806 +$ +275 +$ +3,319 +$ +667 +NA +NA +Year ended December 31, 2020 +NA +$ +206 +$ +3,319 +$ +2,668 +$ +642 +NA +Year ended December 31, 2019 +NA +NA +$ +2,489 +$ +2,668 +$ +1,927 +$ +321 +As of December 31, 2021, we had unrecognized compensation cost of $ 6.6 million related to our unvested Performance Units. The weighted-average remaining vesting period for these unvested Performance Units was 1.44 years as of December 31, 2021. +Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as follows: +• +Dividends are recognized as reductions of retained earnings for the portion of restricted stock awards expected to vest. +• +Dividends are recognized as additional compensation cost for the portion of restricted stock awards that are not expected to vest or that ultimately do not vest. +• +Dividend equivalents are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +F- 29 +• +Dividend equivalents are recognized as additional compensation cost for the portion of restricted stock units that are not expected to vest or that ultimately do not vest. +Phantom Units — In May 2020, the Compensation Committee approved a grant of long-term performance-based phantom units to our Chief Executive Officer and President, William A. Hendricks, Jr (the “Phantom Units”). The Phantom Units were granted outside of the 2014 Plan. Pursuant to this phantom unit grant, Mr. Hendricks may earn from 0 % to 200 % of a target award of 298,500 phantom units based on our achievement of the same performance conditions over the same p erformance p eriod that applies to the Performance Units granted in April 2020, as described above. Earned Phantom Units, if any, will be settled in 2023 , following completion of the three-year p erformance p eriod, in a cash payment equal to the number of earned phantom units multiplied by our average trading price per share over the twenty consecutive trading days ending March 31, 2023. Because the Phantom Units are cash-settled awards, they are accounted for as a liability classified award. The grant date fair value of the Phantom Units was $ 1.2 million. Compensation expense is recognized on a straight-line basis over the performance period, with the amount recognized fluctuating as a result of the Phantom Units being remeasured to fair value at the end of each reporting period due to their liability-award classification. We recognized $ 1.8 million and $ 0.6 million compensation expense associated with the Phantom Units in 2021 and 2020, respectively. +13. Leases +ASC Topic 842 Leases +On January 1, 2019, we adopted the new lease guidance under Topic 842, Leases , using the modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. We have elected to report all leases at the beginning of the period of adoption and not restate our comparative periods. This standard does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. +We have entered into operating leases for operating locations, corporate offices and certain operating equipment. These leases have remaining lease terms of five months to seven years as of December 31, 2021 . Currently, we do not have any finance leases. Renewal options are included in the right-of-use asset and lease liability if it is reasonably certain that we will exercise the option, and termination options are included in the right-of-use asset and lease liability if it is not reasonably certain we will exercise the option. We have elected the short-term lease recognition practical expedient whereby right-of-use assets and lease liabilities are not recognized for leasing arrangements with an initial term of one year or less. +Topic 842 requires that lessees and lessors discount lease payments at the lease commencement date using the rate implicit in the lease, if available, or the lessee’s incremental borrowing rate. We use the implicit rate when readily determinable. If the implicit rate is not readily determinable, we use our incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. +In the fourth quarter of 2019, we had entered into a sale-leaseback transaction that qualified as a sale. We sold a facility for proceeds of $ 10.2 million and concurrently entered into an operating lease agreement with the unrelated third-party for certain floors of the building for a 58 -month term. The associated gain on sale of approximately $ 0.8 million was included in “Other operating expenses (income), net” in the consolidated statements of operations. +For the year ended December 31, 2020, we entered into two new facility leases and recorded an increase to the operating lease right-of-use assets and corresponding operating lease liabilities of approximately $ 1.5 million. We also extended two facilities leases and recorded an increase to the operating lease right-of-use assets and corresponding operating lease liabilities of approximately $ 0.2 million. We terminated four facility leases and three operating equipment leases and recorded a decrease to the operating lease right-of-use assets of approximately $ 0.4 million and corresponding lease liabilities of approximately $ 2.2 million. The right-of-use assets that were formally terminated were partially impaired in the second quarter of 2020 in conjunction with our restructuring plan. See Note 20 for additional information on our restructuring expenses. +For the year ended December 31, 2021, we entered into one new facility lease and recorded an increase to the operating lease right-of-use asset and corresponding operating lease liability of approximately $ 0.7 million. We also acquired five facility leases as part of the Pioneer acquisition in the fourth quarter of 2021, and recorded an increase to the operating lease right-of-use assets of approximately $ 4.1 million and corresponding operating lease liabilities of approximately $ 4.3 million. We transferred one of these facility leases as part of the Clearwell sale in the fourth quarter of 2021, and recorded a decrease to the operating lease right-of-use asset and corresponding lease liability of approximately $ 0.2 million. We extended three facilities leases and recorded an increase to the operating lease right-of-use assets and corresponding lease liabilities of approximately $ 1.6 million. We terminated two facility leases and recorded a decrease to the operating lease liabilities of approximately $ 0.5 million. The right-of-use assets that were formally terminated were previously impaired in 2020 and 2019. +F- 30 +Practical Expedients Adopted with Topic 842 +We have elected to adopt the following practical expedients upon the transition date to Topic 842 on January 1, 2019: +• +Transitional practical expedients package: An entity may elect to apply the listed practical expedients as a package to all the leases that commenced before the effective date. The practical expedients are: +a. +The entity need not reassess whether any expired or existing contracts are or contain leases; +b. +The entity need not reassess the lease classification for expired or existing contracts; +c. +The entity need not reassess initial direct costs for any existing leases. +• +Use of portfolio approach: An entity can apply this guidance to a portfolio of leases with similar characteristics if the entity reasonably expects that the application of the leases model to the portfolio would not differ materially from the application of the lease model to the individual leases in that portfolio. This approach can also be applied to other aspects of the leases guidance for which lessees/lessors need to make judgments and estimates, such as determining the discount rate and determining and reassessing the lease term. +• +Lease and non-lease components: As a practical expedient, lease and non-lease components may be combined where the revenue recognition pattern is the same and where the lease component, when accounted for separately, would be considered an operating lease. Our contract drilling, pressure pumping and directional drilling contracts contain a lease component related to the underlying equipment utilized, in addition to the service component provided by our crews and expertise to operate the related equipment. We have concluded that the non-lease service of operating our equipment and providing expertise in the services provided to customers is predominant in our drilling, pressure pumping and directional drilling contracts. With the election of this practical expedient, we will continue to present a single performance obligation for these contracts under the revenue guidance in ASC 606. +Lease expense consisted of the following for the years ended December 31, 2021, 2020, and 2019 (in thousands): +Year Ended +Year Ended +Year Ended +December 31, 2021 +December 31, 2020 +December 31, 2019 +Operating lease cost +$ +4,984 +$ +6,911 +$ +10,944 +Short-term lease expense (1) +41 +2 +440 +Total lease expense +$ +5,025 +$ +6,913 +$ +11,384 +(1) +Short-term lease expense represents expense related to leases with a contract term of one year or less. +Supplemental cash flow information related to leases for the years ended December 31, 2021, 2020 and 2019 is as follows (in thousands): +Year Ended +Year Ended +Year Ended +December 31, 2021 +December 31, 2020 +December 31, 2019 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ +7,323 +$ +11,576 +$ +10,033 +Right of use assets obtained in exchange for lease obligations: +Operating leases +$ +6,413 +$ +1,763 +$ +10,870 +Supplemental balance sheet information related to leases as of December 31, 2021 and 2020 is as follows: +December 31, 2021 +December 31, 2020 +Weighted Average Remaining Lease Term: +Operating leases +4.8 years +5.2 years +Weighted Average Discount Rate: +Operating leases +3.8 +% +4.1 +% +F- 31 +Maturities of operating lease liabilities as of December 31, 2021 are as follows (in thousands): +Year ending December 31, +2022 +$ +7,662 +2023 +5,670 +2024 +4,390 +2025 +3,354 +2026 +2,691 +Thereafter +3,508 +Total lease payments +27,275 +Less imputed interest +( 2,276 +) +Total +$ +24,999 +14. Income Taxes +Loss before income taxes for the U.S. for years ended December 31, 2021, 2020 and 2019 are $ 721 million, $ 917 million, and $ 500 million, respectively. Income before income taxes for non-U.S. jurisdictions for the year ended December 31, 2021 is $ 0.9 million. Loss before income taxes for non-U.S. jurisdictions for years ended December 31, 2020 and 2019 are $ 14.2 million and $ 30.5 million, respectively. +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2021, 2020 and 2019 are as follows (in thousands): +2021 +2020 +2019 +Federal income tax benefit: +Current +$ +— +$ +( 1,977 +) +$ +( 1,976 +) +Deferred +( 86,878 +) +( 107,334 +) +( 90,441 +) +( 86,878 +) +( 109,311 +) +( 92,417 +) +State income tax expense (benefit): +Current +144 +225 +851 +Deferred +23,028 +( 17,949 +) +( 11,593 +) +23,172 +( 17,724 +) +( 10,742 +) +Foreign income tax expense (benefit): +Current +134 +( 291 +) +( 348 +) +Deferred +870 +— +( 1,168 +) +1,004 +( 291 +) +( 1,516 +) +Total income tax benefit: +Current +278 +( 2,043 +) +( 1,473 +) +Deferred +( 62,980 +) +( 125,283 +) +( 103,202 +) +Total income tax benefit: +$ +( 62,702 +) +$ +( 127,326 +) +$ +( 104,675 +) +The difference between the statutory U.S. federal income tax rate and the effective income tax rate for the years ended December 31, 2021, 2020 and 2019 is summarized as follows: +2021 +2020 +2019 +Statutory tax rate +21.0 +% +21.0 +% +21.0 +% +State income taxes - net of the federal income tax benefit +3.0 +1.7 +1.4 +Goodwill impairment +— +( 8.2 +) +( 0.7 +) +Permanent differences +( 0.8 +) +( 0.6 +) +( 1.2 +) +Valuation allowance +( 13.3 +) +( 0.2 +) +( 0.8 +) +State deferred tax remeasurement +( 0.8 +) +— +( 1.1 +) +Other differences, net +( 0.4 +) +— +1.1 +Effective tax rate +8.7 +% +13.7 +% +19.7 +% +The effective tax rate decreased by approximately 5.0 % to 8.7 % for 2021 compared to 13.7 % for 2020. The difference was primarily due to nondeductible goodwill impairment charges in 2020 impacting the effective tax rate and changes in valuation allowance positions between 2020 and 2021. +F- 32 +The tax effect of temporary differences and tax attributes representing deferred tax assets and liabilities at December 31, 2021 and 2020 are as follows (in thousands): +2021 +2020 +Deferred tax assets: +Net operating loss carryforwards +$ +457,362 +$ +370,875 +Tax credits +4,453 +4,918 +Expense associated with stock-based compensation +9,364 +11,252 +Workers' compensation allowance +14,833 +17,177 +Other deferred tax asset +26,483 +24,735 +512,495 +428,957 +Less: +Valuation allowance +( 189,737 +) +( 19,133 +) +Total deferred tax assets +322,758 +409,824 +Deferred tax liabilities: +Property and equipment basis difference +( 335,980 +) +( 475,025 +) +Other +( 12,037 +) +( 12,475 +) +Total deferred tax liabilities +( 348,017 +) +( 487,500 +) +Net deferred tax liability +$ +( 25,259 +) +$ +( 77,676 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and when necessary, valuation allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We assess the realizability of our deferred tax assets quarterly and consider carryback availability, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. In 2021, we recorded an additional $ 170.6 million of valuation allowances against our net deferred tax assets. This primarily related to U.S. federal and state deferred tax assets, as well as valuation allowances that were recorded through the acquisition of Pioneer. +For income tax purposes, we have approximately $ 1.7 billion of gross federal net operating losses, approximately $ 52.4 million of gross Canadian net operating losses, approximately $ 25.2 million of gross Colombian net operating losses and approximately $ 1.1 billion of post-apportionment state net operating losses as of December 31, 2021, before valuation allowances. The majority of federal net operating losses will expire in varying amounts, if unused, between 2031 and 2037 . Federal net operating losses generated after 2017 can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2041 . Colombian net operating losses will expire in varying amounts, if unused, between 2028 and 2033 . State net operating losses will expire in varying amounts, if unused, between 2022 and 2041 . +As of December 31, 2021, we had no unrecognized tax benefits. We have established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2021, the tax years ended December 31, 2014 through December 31, 2020 are open for examination by U.S. taxing authorities. As of December 31, 2021, the tax years ended December 31, 2014 through December 31, 2020 are open for examination by Canadian taxing authorities. As of December 31, 2021, the tax years ended December 31, 2015 through December 31, 2020 are open for examination by Colombian taxing authorities. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +We continue to elect permanent reinvestment of unremitted earnings in foreign jurisdictions and we intend to do so for the foreseeable future. If we were to repatriate earnings, in the form of dividends or otherwise, we may be subject to certain income and/or withholding taxes (subject to an adjustment for foreign tax credits). +F- 33 +15. Earnings Per Share +We provide a dual presentation of our net loss per common share in our consolidated statements of operations: basic net loss per common share (“Basic EPS”) and diluted net loss per common share (“Diluted EPS”). +Basic EPS excludes dilution and is determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock, performance units and restricted stock units. The dilutive effect of stock options, performance units and restricted stock units is determined using the treasury stock method. +The following table presents information necessary to calculate net loss per share for the years ended December 31, 2021, 2020 and 2019, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2021 +2020 +2019 +BASIC EPS: +Net loss from continuing operations attributed to common stockholders +$ +( 657,079 +) +$ +( 803,692 +) +$ +( 425,703 +) +Net income from discontinued operations attributed to common stockholders +$ +2,534 +$ +— +$ +— +Net loss attributed to common stockholders +$ +( 654,545 +) +$ +( 803,692 +) +$ +( 425,703 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +195,021 +188,013 +203,039 +Basic loss from continuing operations per common share +$ +( 3.37 +) +$ +( 4.27 +) +$ +( 2.10 +) +Basic income from discontinued operations per common share +$ +0.01 +$ +— +$ +— +Basic net loss per common share +$ +( 3.36 +) +$ +( 4.27 +) +$ +( 2.10 +) +DILUTED EPS: +Net loss from continuing operations attributed to common stockholders +$ +( 657,079 +) +$ +( 803,692 +) +$ +( 425,703 +) +Net income from discontinued operations attributed to common stockholders +$ +2,534 +$ +— +$ +— +Net loss attributed to common stockholders +$ +( 654,545 +) +$ +( 803,692 +) +$ +( 425,703 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +195,021 +188,013 +203,039 +Diluted loss from continuing operations per common share +$ +( 3.37 +) +$ +( 4.27 +) +$ +( 2.10 +) +Diluted income from discontinued operations per common share +$ +0.01 +$ +— +$ +— +Diluted net loss per common share +$ +( 3.36 +) +$ +( 4.27 +) +$ +( 2.10 +) +Potentially dilutive securities excluded as anti-dilutive +9,551 +8,747 +9,195 +16. Employee Benefits +We maintain a 401(k) plan for all eligible employees. Our operating results include expenses of approximately $ 7.6 million in 2021 , $ 7.7 million in 2020 and $ 13.2 million in 2019 for our contributions to the plan. +17. Business Segments +At December 31, 2021, we had three reportable business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) directional drilling services. Each of these segments represents a distinct type of business and has a separate management team that reports to our chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. We also disclose our identifiable assets for these segments, which are primarily comprised of long-lived assets. +Contract Drilling — We market our contract drilling services to major and independent oil and natural gas operators. As of December 31, 2021 , we had 184 marketed land-based drilling rigs in the continental United States and eight in Colombia. +Our acquisition of Pioneer in 2021 expanded our geographic footprint into Latin America with the addition of eight SCR drilling rigs in Colombia. Our revenues and direct operating costs for our Colombian operations are included as part of our contract drilling segment. +F- 34 +For the year ended December 31, 2021, contract drilling revenue earned in Colombia was $ 15.8 million. Additionally, long-lived assets for the contract drilling segment recorded as part of our Colombian operations totaled $ 39.3 million as of December 31, 2021. +Pressure Pumping — We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. We also provide cementing services through our pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. +Directional Drilling — We provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Substantially all of the revenue in the directional drilling segment is from directional drilling, downhole performance motors and measurement-while-drilling services, which are sold as a bundle. +Major Customer — During 2021 , one customer accounted for approximately $ 216 million or 16 % of our consolidated operating revenues. These revenues in 2021 were earned in both our contract drilling and pressure pumping businesses. During 2020 and 2019 no single customer accounted for more than 10% of our consolidated operating revenues. +F- 35 +The following tables summarize selected financial information relating to our business segments (in thousands): +Year Ended December 31, +2021 +2020 +2019 +Revenues: +Contract drilling +$ +667,918 +$ +670,357 +$ +1,309,988 +Pressure pumping +523,756 +336,111 +868,694 +Directional drilling +111,481 +73,356 +188,786 +Other operations (1) +75,505 +57,962 +122,885 +Elimination of intercompany revenues - Contract drilling (2) +( 3,888 +) +( 1,231 +) +( 1,638 +) +Elimination of intercompany revenues - Other operations (2) +( 17,691 +) +( 12,306 +) +( 18,030 +) +Total revenues +$ +1,357,081 +$ +1,124,249 +$ +2,470,685 +Income (loss) before income taxes: +Contract drilling +$ +( 423,029 +) +$ +( 543,438 +) +$ +( 151,329 +) +Pressure pumping +( 118,863 +) +( 166,666 +) +( 102,701 +) +Directional drilling +( 35,301 +) +( 40,612 +) +( 52,724 +) +Other operations +( 9,905 +) +( 41,685 +) +( 54,725 +) +Corporate +( 92,152 +) +( 94,251 +) +( 94,414 +) +Credit loss expense +1,500 +( 5,606 +) +( 5,683 +) +Interest income +222 +1,254 +6,013 +Interest expense +( 41,978 +) +( 40,770 +) +( 75,204 +) +Other +( 275 +) +756 +389 +Loss before income taxes +$ +( 719,781 +) +$ +( 931,018 +) +$ +( 530,378 +) +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +618,879 +$ +433,771 +$ +668,007 +Pressure pumping +159,305 +152,630 +233,952 +Directional drilling +40,270 +36,504 +52,223 +Other operations +24,865 +41,511 +42,803 +Corporate +5,859 +6,494 +6,888 +Total depreciation, depletion, amortization and impairment +$ +849,178 +$ +670,910 +$ +1,003,873 +Capital expenditures: +Contract drilling +$ +109,894 +$ +105,037 +$ +194,416 +Pressure pumping +34,676 +21,678 +105,803 +Directional drilling +8,591 +4,681 +15,549 +Other operations +11,638 +12,378 +27,132 +Corporate +1,521 +1,707 +4,612 +Total capital expenditures +$ +166,320 +$ +145,481 +$ +347,512 +Identifiable assets: +Contract drilling +$ +2,169,501 +$ +2,315,318 +$ +3,190,463 +Pressure pumping +458,202 +486,702 +695,570 +Directional drilling +87,285 +107,807 +164,273 +Other operations +85,932 +88,676 +128,290 +Corporate (3) +156,928 +300,566 +261,019 +Total assets +$ +2,957,848 +$ +3,299,069 +$ +4,439,615 +(1) +Other operations includes our oilfield rentals business, drilling equipment service business, the electrical controls and automation business and the oil and natural gas working interests . +(2) +Intercompany revenues consist of revenues from contract drilling for services provided to our other operations, and revenues from other operations for services provided to contract drilling, pressure pumping and within other operations . These revenues are generally based on estimated external selling prices and are eliminated during consolidation . +(3) +Corporate assets primarily include cash on hand and certain property and equipment . +F- 36 +18. Concentrations of Credit Risk +Financial instruments which potentially subject us to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +We believe we have placed our demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2021 and 2020, our demand deposits and temporary cash investments consisted of the following (in thousands): +2021 +2020 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +2,043 +$ +1,000 +Deposits in FDIC and SIPC-insured institutions over insurance limits +125,405 +227,961 +Deposits in foreign banks +9,342 +1,966 +136,790 +230,927 +Less outstanding checks and other reconciling items +( 19,266 +) +( 6,012 +) +Cash and cash equivalents +$ +117,524 +$ +224,915 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which we provide services. As is general industry practice, we typically do not require customers to provide collateral. A $ 5.6 million provision for credit loss was recognized in 2020 in relation to accounts receivable balances that were estimated to be uncollectible . During 2021, we reversed $ 1.5 million of our credit loss provision related to certain customers who had previously experienced a deterioration in credit quality. Since initially recording loss provisions for these receivables, we have collected portions of the accounts that were deemed uncollectible. +19. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of our outstanding debt balances as of December 31, 2021 and 2020 is set forth below (in thousands): +December 31, 2021 +December 31, 2020 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +3.95% Senior Notes +$ +509,505 +$ +511,652 +$ +509,505 +$ +471,019 +5.15% Senior Notes +349,250 +359,142 +349,250 +319,560 +Term Loan Agreement +— +— +50,000 +50,000 +Total debt +$ +858,755 +$ +870,794 +$ +908,755 +$ +840,579 +The fair values of the 3.95 % Senior Notes and the 5.15 % Senior Notes at December 31, 2021 and December 31, 2020 are based on quoted market prices, which are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. The fair values of the 3.95% Senior Notes implied a 3.87 % market rate of interest at December 31, 2021 and the 5.24 % market rate of interest at December 31, 2020, based on their quoted market prices. The fair values of the 5.15 % Senior Notes implied a 4.72 % market rate of interest at December 31, 2021 and the 6.42 % market rate of interest at December 31, 2020, based on their quoted market prices. T he carrying value of the balance outstanding at December 31, 2020 under the Term Loan Agreement approximated its fair value as the instrument had a floating interest rate. +20. Restructuring Expenses +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $ 38.3 million of charges associated with this plan in the second quarter of 2020. T here were no restructuring charges in the comparable periods of 2021 or 2019. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan . +Contract termination costs related primarily to agreements to purchase minimum quantities of proppants (sand) from certain vendors. These costs were primarily comprised of a $ 5.3 million negotiated settlement and termination of a contract to purchase minimum quantities of sand and $ 14.0 million of contractual future payments under two contracts to purchase minimum quantities of sand without future economic benefit to us. We will not receive any sand under these contracts. Other exit costs related primarily to facility closure costs and moving expenses. +F- 37 +The right-of-use asset abandonments related to facility and equipment right-of-use assets abandoned as a result of restructuring. +The following table presents restructuring expenses by reportable segment f or the year ended December 31 , 2020 (in thousands) : +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +Corporate +Total +Severance costs +$ +1,821 +$ +3,460 +$ +503 +$ +501 +$ +215 +$ +6,500 +Contract termination costs +— +20,373 +— +— +— +20,373 +Other exit costs +523 +194 +827 +— +— +1,544 +Right-of-use asset abandonments +86 +7,304 +1,845 +— +686 +9,921 +Total +$ +2,430 +$ +31,331 +$ +3,175 +$ +501 +$ +901 +$ +38,338 +F- 38 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +S CHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions (1) +Balance +(In thousands) +Year Ended December 31, 2021 +Deducted from asset accounts: +Allowance for credit losses +$ +10,842 +$ +( 1,500 +) +$ +( 849 +) +$ +8,493 +Year Ended December 31, 2020 +Deducted from asset accounts: +Allowance for credit losses +$ +6,516 +$ +5,606 +$ +( 1,280 +) +$ +10,842 +Year Ended December 31, 2019 +Deducted from asset accounts: +Allowance for credit losses +$ +2,312 +$ +5,683 +$ +( 1,479 +) +$ +6,516 +(1) +Consists of uncollectible accounts written-off. +S- 1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 16, 2022 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 16, 2022. +Signature +Title +/s/ Curtis W. Huff +Chairman of the Board +Curtis W. Huff +/s/ William Andrew Hendricks, Jr. +President, Chief Executive Officer +William Andrew Hendricks, Jr. +and Director +(Principal Executive Officer) +/s/ C. Andrew Smith +Executive Vice President and +C. Andrew Smith +Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Tiffany Thom Cepak +Director +Tiffany Thom Cepak +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Janeen S. Judah +Director +Janeen S. Judah +S- 2 \ No newline at end of file diff --git a/raw/filings/0000889900/2021/0000950170-22-001347/filing_metadata.csv b/raw/filings/0000889900/2021/0000950170-22-001347/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..156d753484714c4de365c7ff42b932d3728a7c5d --- /dev/null +++ b/raw/filings/0000889900/2021/0000950170-22-001347/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2022-02-16,2021-12-31,2022-02-16T21:04:06.000Z,0000950170-22-001347,pten-20211231.htm,10-K,21353612,1,1,https://www.sec.gov/Archives/edgar/data/889900/000095017022001347/pten-20211231.htm,https://www.sec.gov/Archives/edgar/data/889900/000095017022001347/,2021,2021,1 diff --git a/raw/filings/0000889900/2021/0000950170-22-001347/item1.txt b/raw/filings/0000889900/2021/0000950170-22-001347/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..f36bf7598856e39ad69308f39f6132d2565ab435 --- /dev/null +++ b/raw/filings/0000889900/2021/0000950170-22-001347/item1.txt @@ -0,0 +1,282 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +W e are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets . As of December 31, 2021, we had a drilling fleet that consisted of 184 marketed land-based drilling rigs in the United States and eight in Colombia. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our contract drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2021, we had approximately 1.1 million fracturing horsepower to provide these services. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors. We also provide services that improve the statistical accuracy of directional and horizontal wellbores. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2019, 2020 and 2021 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2019: +Average oil price per Bbl (1) +$ +54.83 +$ +59.78 +$ +56.37 +$ +56.94 +Average rigs operating per day - U.S. (2) +174 +157 +142 +122 +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day - U.S. (2) +69 +73 +80 +106 +3 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +In 2020, reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in the United States. +Oil prices remain extremely volatile, as the closing price of oil (WTI-Cushing) reached a first quarter 2020 high of $63.27 per barrel on January 6, 2020, declined to negative $36.98 per barrel on April 20, 2020, and recovered to reach a 2021 high of $85.64 per barrel on October 26, 2021. In response to the rapid decline in commodity prices, E&P companies acted swiftly to reduce drilling and completion activity starting late in the first quarter of 2020. While oil prices have recovered in 2021, and demand for our services has improved since the commodity price decline in 2020, our average number of rigs operating remains well below the number of our available rigs, and a portion of our pressure pumping horsepower remains stacked. Oil prices averaged $77.45 per barrel in the fourth quarter of 2021. +Although our active rig count has not fully recovered to its 2019 levels, it increased in 2021 after significant declines in 2020. Our average active U.S. rig count for the fourth quarter of 2021 was 106 rigs. This was an increase from our average active rig count for the third quarter of 2021 of 80 rigs. The increase was partially due to our acquisition of active U.S. rigs from Pioneer Energy Services Corp. (“Pioneer”), which averaged 13 active rigs during the fourth quarter of 2021. Our active U.S. rig count at December 31, 2021 of 111 rigs was more than the rig count of 65 rigs at December 31, 2020, partially due to the increase in rigs from the Pioneer acquisition and, more significantly, due to the recovery of oil prices and improved demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place in the United States, we expect an average of 51 rigs operating under term contracts during the first quarter, and an average of 39 rigs operating under term contracts during 2022. +We ended the fourth quarter of 2021 with 11 active pressure pumping spreads compared to ten at the end of the third quarter. Our average active spread count was approximately ten spreads and effective utilization was close to 11 spreads for the fourth quarter of 2021. We calculated average active spreads as the average number of spreads that were crewed and actively marketed during the period, and we calculated effective utilization as total pumping days during the quarter divided by 75 days, which we consider full effective utilization for a spread for the period. We expect to average approximately 11 active spreads in the first quarter of 2022. The pressure pumping market has improved but remains oversupplied. +Due to improving activity levels and increasing tightness in the overall labor market, we saw general oilfield cost inflation across our segments during 2021, including increases in the cost of labor, services and supplies. This inflation, combined with the increasing challenge of attracting employees to the industry, is increasing the complexity of reactivating equipment. We believe this challenge, combined with the increasing market tightness for premium drilling and completion services, will support higher pricing for our services in 2022. During 2021, we increased our capital expenditure forecast to approximately $170 million, in part, based on conversations with customers about increasing activity levels into 2022. Actual 2021 capital expenditures excluding discontinued operations totaled $166 million. +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. +Recent Developments in Financial Matters and Merger and Acquisition Activity — On October 1, 2021, we completed the acquisition of Pioneer Energy Services Corp. (“Pioneer”) by acquiring 100% of its equity interests . Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $30 million cash, which based on the closing price of our common stock of $9.44 on October 1, 2021, valued the transaction at approximately $278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. Through the Pioneer acquisition, we acquired Pioneer’s 100% pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. We believe the acquisition of Pioneer enhances our position as a leading provider of contract drilling services in the United States and expands our geographic footprint into Latin America. +4 +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business (collectively, “Pioneer Production Services”), to Clearwell Dynamics, LLC (“Clearwell”). The sale price was $43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses have been presented as a discontinued operation in these consolidated financial statements. In connection with the sale of our Pioneer Production Services business, we entered into a transition services agreement with Clearwell, pursuant to which we agreed to provide each other certain administrative and operational services on an interim, transitional basis through June 30, 2022. +On December 30, 2021, we repaid the final $50 million of borrowings under the 2019 Term Loan Agreement (“Term Loan Agreement”), and as a result had no remaining borrowings under the Term Loan Agreement as of December 31, 2021. +Industry Segments +Our revenues, operating loss and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Our contract drilling services, pressure pumping services, and directional drilling services industry segments had operating losses in 2021, 2020 and 2019. +See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 17 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments. +Contract Drilling Operations +General — We market our contract drilling services to oil and natural gas operators in the United States and Colombia. As of December 31, 2021, we had 192 marketed land-based drilling rigs based in the following regions: +Region +Number of Rigs +West Texas +73 +Appalachia +33 +Rockies +24 +Oklahoma +20 +South Texas +19 +East Texas +15 +Colombia +8 +Total +192 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. We have 171 super-spec rigs in total. +Due to evolving customer preferences, we have begun to refer to certain premium rigs as “Tier-1, super-spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allow for more clearance underneath the rig floor. We currently estimate there are fewer than 400 Tier-1, super-spec rigs in the United States, which includes our 107 Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +5 +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet during the last several years. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with many having high pressure mud systems, walking systems and increased hookload capacity. We have spent approximately $409 million during the last three years on capital expenditures to modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2021, 2020 and 2019, we spent approximately $110 million, $105 million and $194 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2021 +2020 +2019 +Average rigs operating per day - U.S. (1) +82 +82 +149 +Number of rigs operated during the year - U.S. +118 +131 +186 +Number of wells drilled during the year - U.S. +1,662 +1,324 +2,690 +Number of operating days - U.S. +29,960 +29,857 +54,282 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. In the fourth quarter of 2021, we identified 43 legacy, non-super-spec rigs and equipment to be abandoned. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 43 rigs that were abandoned had limited commercial opportunity. We recorded a $220 million charge related to this abandonment in the fourth quarter of 2021. +6 +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist™ application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell™ lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. The scope and impact of our cementing services were insignificant during the fiscal years 2021, 2020 and 2019. +Pressure Pumping Contracts — Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.1 million horsepower as of December 31, 2021. Pressure pumping equipment at December 31, 2021 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +Texas Region +Number of units +355 +12 +367 +Approximate horsepower +847,500 +14,280 +861,780 +Northeast Region +Number of units +121 +9 +130 +Approximate horsepower +281,900 +5,800 +287,700 +Combined: +Number of units +476 +21 +497 +Approximate horsepower +1,129,400 +20,080 +1,149,480 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +We periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. In the fourth quarter of 2021, we recorded a charge of $32.2 million related to the abandonment of approximately 0.2 million horsepower within our pressure pumping fleet. The majority of these units were frac pumps but also included pump down units. These units were abandoned due to changes in customer preferences for dual fuel, advancements in technology, and prohibitive reactivation costs. +Materials — Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +7 +Directional Drilling Operations +General — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (MWD) and supply and rental of downhole performance motors, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of oil and natural gas operators in the United States. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +Directional Drilling Services — We provide our directional drilling services primarily on a dayrate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days or footage completed. Our rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a standby rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Equipment — We generally design, assemble, maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. +We periodically evaluate our directional drilling assets. In the fourth quarter of 2021, we abandoned certain directional drilling equipment totaling $2.5 million and recorded a charge on our developed technology intangible asset of $11.4 million due to advances in technology that rendered those assets, and their related spare parts inventory, obsolete. The inventory write-down in 2021 totaled $4.0 million. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization to determine optimal steering recommendation placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing onshore oil and gas basins in the United States. We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2021, we received approximately 57% from our ten largest customers and approximately 39% from our five largest customers. During 2021, one customer accounted for approximately $216 million, or approximately 16%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +8 +Backlog +Our contract drilling backlog in the United States as of December 31, 2021 and 2020 was approximately $325 million and $301 million, respectively. Approximately 22% of our contract drilling backlog in the United States at December 31, 2021 is reasonably expected to remain after 2022. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as a part of Item 7 of this Report for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +We encourage you to review our latest Sustainability Report, located on our website, for more detailed information regarding our Sustainability and Human Capital programs and initiatives. Nothing on our website, including our Sustainability Report or sections thereof, shall be deemed incorporated by reference into this Report or other filings that we make with the SEC. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell™ lithium battery hybrid energy management system. EcoCell™ is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 5,000 full-time employees as of January 31, 2022. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs in place that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have safety education on an annual basis which incorporates learning associated with hazard awareness, safe systems of work, permission to work, time out for safety, energy isolation, material handling and management of change. +9 +In response to the COVID-19 pandemic, we implemented, and continue to maintain, safety protocols at our offices, facilities and worksites. These protocols include allowing many of our office-based employees to work from home. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require new supervisors and managers in the United States to attend an instructor-led course relative to diversity, inclusion and respect to ensure they understand our expectations regarding their obligations to promote a work environment where all employees are valued and respected. Supplemental diversity, inclusion and respect training for supervisors and managers is required on a biannual basis. All other employees are educated on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +Maintaining our Core Values – In 2021, we trained over 3,500 employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, +• +services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. Federal, state, foreign, regional and local environmental laws, rules and regulations, including laws, rules, regulations and executive actions related to the mitigation of climate change or greenhouse gas emissions, currently apply to our operations and are likely to become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +10 +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that may govern our operations. +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act (the “Clean Water Act”) and the Oil Pollution Act of 1990 (the “Oil Pollution Act”), each as amended, and implementing regulations govern: +• +the prevention and permitting of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Clean Water Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +11 +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Certain politicians have also vocalized support for a nationwide ban on hydraulic fracturing. Additional legislation or regulation could lead to operational delays or increased operating costs in the production of oil and natural gas or could make it more difficult to perform hydraulic fracturing. These developments could also lead to litigation challenging proposed or existing wells. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we provide for our exploration and production customers, and such efforts could adversely affect our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. There has also been legislation proposed by U.S. lawmakers to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA, and future federal action to address climate change is likely. +President Biden and the Democratic Party, which controls Congress, have identified climate change as a priority, and it is likely that additional executive orders, regulatory action, and/or legislation targeting greenhouse gas emissions, or prohibiting, delaying or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. For example, the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee, and President Biden recently announced a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of Federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Although a federal judge for the U.S. District Court of the Western District of Louisiana issued a nationwide preliminary injunction against the pause of oil and natural gas leasing on public lands or in offshore waters while litigation challenging that aspect of the executive order is ongoing, the Biden Administration may take other regulatory steps in the future that could impact our operations. +In February 2021, the United States rejoined the Paris Agreement, and in the future, the United States may also choose to adhere to other international agreements targeting GHG reductions. In April 2021, President Biden set a new goal for the United States to achieve a 50-52 percent reduction from 2005 levels in economy-wide net greenhouse gas pollution in 2030. Further, in November 2021, the Unites States and other countries entered into the Glasgow Climate Pact, which includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions by 30% by 2030, and cooperating toward the advancement of the development of clean energy. +Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +12 +We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services.” +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +13 +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. \ No newline at end of file diff --git a/raw/filings/0000889900/2021/0000950170-22-001347/item13.txt b/raw/filings/0000889900/2021/0000950170-22-001347/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2021/0000950170-22-001347/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2021/0000950170-22-001347/item9a.txt b/raw/filings/0000889900/2021/0000950170-22-001347/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..90a70336f5a3c6d53d029a5c01ef2cd34696f336 --- /dev/null +++ b/raw/filings/0000889900/2021/0000950170-22-001347/item9a.txt @@ -0,0 +1,10 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2021, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2021, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2021. +The acquired businesses associated with Pioneer Energy Services Corp. (“Pioneer”), were excluded from our evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2021. These subsidiaries were excluded from the scope of our review due to the fact that the acquisition closed in the fourth quarter of 2021, at which time we began integrating the acquired business into our existing internal controls over financial reporting. Under guidelines established by the SEC, companies are permitted to exclude acquisitions from their assessment of internal control over financial reporting during the first year of an acquisition while integrating the acquired company. As a result of these integration activities, certain controls will be evaluated and may be changed. The acquired businesses represented approximately three percent of our consolidated revenues for the year ended December 31, 2021 and approximately 10% of our consolidated total assets as of December 31, 2021. +The effectiveness of our internal control over financial reporting as of December 31, 2021 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +45 +Changes in Internal Control over Financial Reporting: +Except as noted above, there were no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2021/0000950170-22-001347/rp_note.txt 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COMMISSION +Washington, D.C. 20549 +Form 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2022 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 1-39270 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N , Suite 800 , Houston , Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +( 281 ) 765-7100 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common Stock, $0.01 Par Value +PTEN +The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ or No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Smaller reporting company +☐ +Non-accelerated filer +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2022 , the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $ 3.4 billion, calculated by reference to the closing price of $15.76 for the common stock on the Nasdaq Global Select Market on that date. +As of February 9, 2023, the registrant had outstanding 213,655,888 sh ar es of common stock, $0.01 par value, its only class of common stock. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s definitive proxy statement for the 2023 Annual Meeting of Stockholders are incorporated by reference into Part III of this report . +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings, press releases and presentations by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. As used in this Report, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its operations through its wholly-owned subsidiaries and has no employees or independent business operations. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue, cost and margin expectations and backlog; financing of operations; oil and natural gas prices; rig counts and frac spreads; source and sufficiency of funds required for building new equipment, upgrading existing equipment and acquisitions (if opportunities arise); demand and pricing for our services; competition; equipment availability; government regulation; legal proceedings; debt service obligations; impact of inflation and economic downturns; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +adverse oil and natural gas industry conditions; +• +global economic conditions, including inflationary pressures and risks of economic downturns or recessions in the United States and elsewhere; +• +volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +excess availability of land drilling rigs, pressure pumping and directional drilling equipment, including as a result of reactivation, improvement or construction; +• +competition and demand for our services; +• +the impact of the ongoing conflict in Ukraine; +• +strength and financial resources of competitors; +• +utilization, margins and planned capital expenditures; +• +liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• +the ability to realize backlog; +• +specialization of methods, equipment and services and new technologies, including the ability to develop and obtain satisfactory returns from new technology; +• +the ability to retain management and field personnel; +• +loss of key customers; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +cybersecurity events; +• +synergies, costs and financial and operating impacts of acquisitions; +• +difficulty in building and deploying new equipment; +1 +• +governmental regulation; +• +climate legislation, regulation and other related risks; +• +environmental, social and governance practices, including the perception thereof; +• +environmental risks and ability to satisfy future environmental costs; +• +technology-related disputes; +• +legal proceedings and actions by governmental or other regulatory agencies; +• +the ability to effectively identify and enter new markets; +• +public health crises, pandemics and epidemics; +• +weather; +• +operating costs; +• +expansion and development trends of the oil and natural gas industry; +• +ability to obtain insurance coverage on commercially reasonable terms; +• +financial flexibility; +• +adverse credit and equity market conditions; +• +availability of capital and the ability to repay indebtedness when due; +• +our return of capital to stockholders; +• +stock price volatility; +• +compliance with covenants under our debt agreements; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in our filings with the SEC. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. As of December 31, 2022, we had a drilling fleet that consisted of 184 marketed land-based drilling rigs in the United States and eight in Colombia. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our contract drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2022, we had approximately 1.2 million fracturing horsepower to provide these services. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors. We also provide services that improve the statistical accuracy of directional and horizontal wellbores. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2020, 2021 and 2022 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day - U.S. (2) +69 +73 +80 +106 +2022: +Average oil price per Bbl (1) +$ +94.45 +$ +108.72 +$ +93.18 +$ +82.79 +Average rigs operating per day - U.S. (2) +115 +121 +128 +131 +3 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in 2020 and early 2021. However, market fundamentals are now strong, as demand increased for drilling and completions equipment and services in 2022, and industry supply of Tier-1, super-spec rigs and premium pressure pumping equipment remains constrained. We expect our rig count in the United States will average 130 rigs in the first quarter and then grow modestly throughout the remainder of 2023. The current demand for equipment and services and strong pricing environment remain dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, response to the COVID-19 pandemic (including any resurgences and/or lockdowns in the United States and abroad) and continued focus by exploration and production companies and service companies on capital discipline. Oil prices averaged $82.79 per barrel in the fourth quarter of 2022 and closed at $77.97 per barrel on January 30, 2023. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $5.55 per MMBtu in the fourth quarter of 2022 and closed at $2.82 per MMBtu on January 30, 2023. +Our average active U.S. rig count for the fourth quarter of 2022 was 131 rigs. This was an increase from our average active rig count for the third quarter of 2022 of 128 rigs. Our active U.S. rig count at December 31, 2022 of 132 rigs was more than the rig count of 111 rigs at December 31, 2021, due in large part to the recovery of oil prices and improved demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place in the United States, we expect an average of 87 rigs operating under term contracts during the first quarter of 2023 and an average of 56 rigs operating under term contracts during 2023. +Our average active spread count was 12 in the fourth quarter of 2022, consistent with the third quarter of 2022. We calculated average active spreads as the average number of spreads that were crewed and actively marketed during the period. We expect to average approximately 12 active spreads in the first quarter of 2023. Based on our outlook for 2023 activity, we currently expect to activate a 13th spread towards the end of 2023. +Due to improving activity levels, supply chain disruptions and increasing tightness in the overall labor market, we continue to see general oilfield cost inflation across our segments, including increases in the cost of labor, services and supplies. Supply chain disruptions and the increasing challenge of attracting and retaining employees are increasing the complexity of reactivating equipment. +Pricing for our drilling and completion services increased in 2022 due in part to the limited supply of readily available, high-quality drilling and completion equipment. +Our 2023 capital expenditure forecast is approximately $550 million. +Recent Developments in Financial Matters and Merger and Acquisition Activity — On October 1, 2021, we completed the acquisition of Pioneer Energy Services Corp. (“Pioneer”) by acquiring 100% of its equity interests. Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $30 million cash, which based on the closing price of our common stock of $9.44 on October 1, 2021, valued the transaction at approximately $278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. Through the Pioneer acquisition, we acquired Pioneer’s 100% pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. The purchase price allocation was finalized in 2022. The measurement period adjustments did not have a material impact on our consolidated financial statements. +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business to Clearwell Dynamics, LLC. The sale price was $43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses were presented as a discontinued operation during the fourth quarter of 2021. +On November 9, 2022, we entered into Amendment No. 3 to Amended and Restated Credit Agreement (“Amendment No.3”), which amended our amended and restated credit agreement, dated as of March 27, 2018 (as amended, the “Credit Agreement”), among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +4 +Amendment No. 3, among other things, (i) revised the capacity under the letter of credit facility to $100 million; (ii) revised the capacity under the swing line facility to the lesser of $50 million and the amount of the swing line provider’s unused commitment; (iii) changed the LIBOR reference rate to a SOFR reference rate; and (iv) extended the maturity date for $416.7 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026. As a result, of the $600 million of revolving credit commitments under the Credit Agreement, the maturity date for $416.7 million of such commitments is March 27, 2026; the maturity date for $133.3 million of such commitments is March 27, 2025; and the maturity date for the remaining $50 million of such commitments is March 27, 2024. +As of December 31, 2022, we had no borrowings outstanding under our revolving credit facility. We had no letters of credit outstanding under the Credit Agreement at December 31, 2022 and, as a result, had available borrowing capacity of $600 million at that date. +During the fourth quarter of 2022, we elected to repurchase portions of our 3.95% Senior Notes due 2028 (the “2028 Notes”) and our 5.15% Senior Notes due 2029 (the “2029 Notes”) in the open market. The principal amounts retired through these transactions totaled $21.0 million of our 2028 Notes and $1.4 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $2.3 million and $0.1 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations. +Industry Segments +Our revenues, operating loss and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Contract Drilling Operations +General — We market our contract drilling services to oil and natural gas operators in the United States and Colombia. As of December 31, 2022, we had 192 marketed land-based drilling rigs based in the following regions: +Region +Number of Rigs +West Texas +80 +Appalachia +27 +Rockies +23 +Oklahoma +20 +South Texas +17 +East Texas +17 +Colombia +8 +Total +192 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super-spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allow for more clearance underneath the rig floor. We have 172 super-spec rigs, of which 118 were Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +5 +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with many having high pressure mud systems, walking systems and increased hookload capacity. We have spent approximately $471 million during the last three years on capital expenditures to modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2022, 2021 and 2020, we spent approximately $256 million, $110 million, and $105 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2022 +2021 +2020 +Average rigs operating per day - U.S. (1) +124 +82 +82 +Number of rigs operated during the year - U.S. +132 +118 +131 +Number of wells drilled during the year - U.S. +2,489 +1,662 +1,324 +Number of operating days - U.S. +45,216 +29,960 +29,857 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. We had no impairment related to the marketability or condition of our drilling rigs during 2022. +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist® application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell™ lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +6 +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. The scope and impact of our cementing services were insignificant during the fiscal years 2022, 2021 and 2020. +Pressure Pumping Contracts — Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.2 million horsepower as of December 31, 2022. Pressure pumping equipment at December 31, 2022 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +Texas Region +Number of units +369 +12 +381 +Approximate horsepower +887,750 +14,280 +902,030 +Northeast Region +Number of units +123 +9 +132 +Approximate horsepower +282,150 +5,800 +287,950 +Combined: +Number of units +492 +21 +513 +Approximate horsepower +1,169,900 +20,080 +1,189,980 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +We periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability or condition of our equipment during 2022. +Materials — Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +Directional Drilling Operations +General — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (MWD) and supply and rental of downhole performance motors, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of oil and natural gas operators in the United States. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +7 +Directional Drilling Services — We provide our directional drilling services primarily on a dayrate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days or footage completed. Our rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a standby rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Equipment — We generally design, assemble, maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization algorithms to determine optimal steering recommendations that enhance well placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing onshore oil and gas basins in the United States. We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2022, we received approximately 49% from our ten largest customers and approximately 34% from our five largest customers. During 2022, one customer accounted for approximately $476 million, or approximately 18%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +Our contract drilling backlog in the United States as of December 31, 2022 and 2021 was approximately $830 million and $325 million, respectively. Approximately 32% of our contract drilling backlog in the United States at December 31, 2022 is reasonably expected to remain after 2023. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment” for information pertaining to backlog. +8 +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, our communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions as compared to our traditional diesel-only equipment, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell™ lithium battery hybrid energy management system. EcoCell™ is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 6,500 full-time employees as of January 31, 2023. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies, as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have annual safety education that incorporates learning associated with hazard awareness, safe systems of work, permission to work, stop work authority, energy isolation, material handling and management of change. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require new supervisors and managers in the United States to attend an instructor-led course relative to diversity, inclusion and respect to ensure they understand our expectations regarding their obligations to promote a work environment where all employees are valued and respected. Supplemental diversity, inclusion and respect training for supervisors and managers is required on a biannual basis. All other employees are educated annually on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +9 +Maintaining our Core Values – We provide annual training for our employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. We have implemented policies allowing many of our office-based employees the flexibility to work from home. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, +• +services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. Federal, state, foreign, regional and local environmental laws, rules and regulations, including laws, rules, regulations and executive actions related to the mitigation of climate change or greenhouse gas emissions, currently apply to our operations and are likely to become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that may govern our operations. +10 +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act (the “Clean Water Act”) and the Oil Pollution Act of 1990 (the “Oil Pollution Act”), each as amended, and implementing regulations govern: +• +the prevention and permitting of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Clean Water Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Certain politicians have also vocalized support for a nationwide ban on hydraulic fracturing. Additional legislation or regulation could lead to operational delays or increased operating costs in the production of oil and natural gas or could make it more difficult to perform hydraulic fracturing. These developments could also lead to litigation challenging proposed or existing wells. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we provide for our exploration and production customers, and such efforts could adversely affect our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +11 +Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. There has also been legislation proposed by U.S. lawmakers to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA, and future federal action to address climate change is likely. +President Biden and the Democratic Party have identified climate change as a priority, and it is likely that additional executive orders and/or regulatory action targeting greenhouse gas emissions, or prohibiting, delaying or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. For example, the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee. In 2021, President Biden issued an executive order imposing a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of Federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Although a federal judge for the U.S. District Court of the Western District of Louisiana issued a permanent injunction in 13 states that filed a lawsuit against the pause of oil and natural gas leasing on public lands or in offshore waters, the Biden Administration may take other regulatory steps in the future that could impact our operations. +In February 2021, the United States rejoined the Paris Agreement, and in the future, the United States may also choose to adhere to other international agreements targeting GHG reductions. In April 2021, President Biden set a new goal for the United States to achieve a 50-52 percent reduction from 2005 levels in economy-wide net greenhouse gas pollution in 2030. Further, in November 2021, the United States and other countries entered into the Glasgow Climate Pact, which includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions by 30% by 2030, and cooperating toward the advancement of the development of clean energy. +Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services.” +12 +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $5.0 million per occurrence deductible on our pressure pumping equipment without fire suppression systems, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +13 +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +Business and Operating Risks +We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in the United States. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling, pressure pumping and directional drilling services, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the availability of capital for oil and natural gas industry participants, including our customers, and the extent to which they are willing or able to deploy capital, +• +the availability of and constraints in pipeline, storage and other transportation capacity in the basins in which we operate, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production, use and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling and pressure pumping activities, including hydraulic fracturing, +• +increased focus by the investment and financing community on sustainability practices in the oil and natural gas industry, and +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Oil and natural gas prices and markets can be extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, +• +the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil-producing nations, such as Russia, to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +• +domestic and international military, political, economic, health and weather conditions, including the impacts of war, including the impact of the ongoing conflict in Ukraine, or terrorist activity, pandemics and other unexpected disasters or events, +• +changes to tax, tariff and import/export regulations and sanctions by the United States or other countries, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +• +the development, price, availability and market acceptance of alternative fuels and energy sources. +14 +All of these factors are beyond our control. Reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in 2020 and early 2021. However, market fundamentals have improved. The current demand for equipment and services and improved market fundamentals remain dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, response to the COVID-19 pandemic (including any resurgences and/or lockdowns in the United States and abroad) and continued focus by exploration and production companies and service companies on capital discipline. Oil prices averaged $82.79 per barrel in the fourth quarter of 2022 and closed at $77.97 per barrel on January 30, 2023. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $5.55 per MMBtu in the fourth quarter of 2022 and closed at $2.82 per MMBtu on January 30, 2023. +In light of these and other factors, we expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Global Economic Conditions May Adversely Affect Our Operating Results. +Concerns regarding global economic conditions, energy costs, geopolitical issues, supply chain disruptions, inflation and the availability and cost of credit have contributed to increased economic uncertainty. Demand for energy and for oil and natural gas end products is highly sensitive to economic conditions; as a result, global economic conditions, indications that economic growth is slowing and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise, may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. An economic slowdown or recession in the United States or in any other country that significantly affects the supply of or demand for oil or natural gas could negatively impact our operations and therefore adversely affect our results. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, such as a result of the COVID-19 pandemic or the conflict in Ukraine, and there is no assurance that the global economic environment, or expectations for the global economic environment, will not quickly deteriorate again due to one or more factors, including as a result of actual or perceived threats to geopolitical stability and changes in production from OPEC, its members and other oil-producing nations. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +A Surplus of Equipment and a Highly Competitive Oil Service Industry May Adversely Affect Our Utilization and Profit Margins and the Carrying Value of our Assets. +The land drilling and pressure pumping industries in the United States are highly competitive, and at times available land drilling rigs and pressure pumping equipment exceed the demand for such equipment. A low commodity price environment or capital spending reductions by our customers due to customer consolidation, investor requirements or other reasons can result in substantially more drilling rigs and pressure pumping equipment being available than are needed to meet demand. Low commodity prices and a rise in new and upgraded equipment can result in excess capacity and substantial competition for a declining number of drilling and pressure pumping contracts. +Operating costs for our core businesses include all direct and indirect costs associated with the operation, maintenance and support of our equipment, which is often not affected by changes in our rates and utilization. During periods of reduced revenue and/or activity, certain of our fixed costs, such as depreciation, may not decline and often we may incur additional costs. During times of reduced utilization, reductions in costs may not be immediate as we may incur additional costs associated with maintaining and stacking equipment, or we may not be able to fully reduce the cost of our support operations in a particular geographic region due to the need to support the remaining operations in that region. Accordingly, a decline in revenue due to lower rates and/or utilization may not be offset by a corresponding decrease in operating costs, which could have a material adverse impact on our business, financial condition and results of operations. +15 +Even in an environment of high oil and natural gas prices and/or increased drilling and completion activity, reactivation and improvement of existing drilling rigs and pressure pumping equipment, construction of new technology drilling rigs and new pressure pumping equipment, and movement of drilling rigs and pressure pumping equipment from region to region in response to market conditions or otherwise can lead to a surplus of equipment. +In times of reduced demand for our industry’s services, certain of our industry competitors may initiate bankruptcy proceedings or engage in debt refinancing transactions, management changes, or other strategic initiatives in an attempt to reduce operating costs to maintain a position in the market. This could result in such competitors emerging with stronger or healthier balance sheets and, in turn, an improved ability to compete with us in the future. We may also see corporate consolidations among both our customers and competitors, which could significantly alter industry conditions and competition within the industry, and have a material adverse effect on our business, financial condition, cash flows and results of operations. +We periodically seek to increase the prices on our services to offset rising costs, earn returns on our capital investment, and otherwise generate higher returns for our stockholders. However, we operate in a very competitive industry, and we are not always successful in raising or maintaining our existing prices. Even if we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs, including capital expenditures, without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs, including capital expenditures, increase could have a material adverse effect on our business, financial condition, cash flows and results of operations. In addition, we may be unable to replace fixed-term contracts that expire or are terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. +Accordingly, high competition and a surplus of equipment can cause oil and natural gas service contractors to have difficulty maintaining pricing, utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or surplus equipment in the oil and natural gas service businesses or the level of demand for our contract drilling, pressure pumping or directional drilling services. +A surplus of operable land drilling rigs, increasing rig specialization and surplus of pressure pumping and directional drilling equipment, which can be exacerbated by capital spending reductions by our customers, could affect the fair market value of our contract drilling, pressure pumping and directional drilling equipment, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices or changes in customer preferences and requirements could result in future impairment to our long-lived assets. For example, we recognized impairment charges of $4.5 million, $267 million and $423 million in 2022, 2021 and 2020, respectively. +Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +16 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $5.0 million per occurrence deductible on our pressure pumping equipment without fire suppression systems, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate or renegotiate or otherwise fail to honor their contractual obligations, including as a result of their bankruptcy. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. As of December 31, 2022, our contract drilling backlog in the United States for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $830 million. Please see Note 3 of Notes to consolidated financial statements in Item 8 of this Report for a description of our calculation of backlog. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts or may be reduced by price adjustments to existing contracts, including as a result of a decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services or otherwise. +New Technologies May Cause Our Operating Methods, Equipment and Services to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive. +The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance, including environmental performance, of drilling rigs and pressure pumping and other equipment. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and pressure pumping and other equipment, as well as new and improved technology, such as drilling automation technology and lower-emissions operations and services, and data analytics. Accordingly, we may have to allocate a higher proportion of our capital expenditures to maintain and improve existing rigs and pressure pumping and other equipment, purchase and construct newer, higher specification drilling rigs and pressure pumping and other equipment to meet the increasingly sophisticated needs of our customers, and develop new and improved technology and data analytics. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled +17 +and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the pressure pumping and directional drilling businesses could have similar effects. +We continually attempt to develop or acquire new technologies for use in our business. In the event that we are successful in developing or acquiring new technologies for use in our business, there is no guarantee of future demand for those technologies. Customers may be reluctant or unwilling to adopt our new technologies. We may also have difficulty negotiating satisfactory terms for our new technologies, including terms that would enable us to obtain acceptable returns on our investment in the development or acquisition of new technologies. +Development and acquisition of new technology is critical to maintaining our competitiveness. There can be no assurance that we will be able to successfully develop or acquire technology that our customers demand. Some of our competitors have greater financial, technical and personnel resources that may allow them to enjoy technological advantages and develop, acquire and implement new technology on a more timely basis or in a more cost-effective manner. If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment and services obsolete, which could reduce our competitiveness and have a material adverse impact on our business, financial condition, cash flows and results of operation. +Loss of Key Personnel and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations. +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled field-based and non-field based personnel in operating and supporting our businesses and in developing new technologies. In times of increasing demand for our services, it may be difficult to attract and retain qualified field-based and non-field based personnel, particularly after a prolonged industry downturn. During periods of high demand for our services or inflation, wage rates for personnel are also likely to increase (and, during recent periods of high demand and inflation, have increased), resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even in a period of generally lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations. +With respect to our consolidated operating revenues in 2022, we received approximately 49% from our ten largest customers, approximately 34% from our five largest customers and 18% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Shortages, Delays in Delivery, and Interruptions in Supply, of Equipment and Materials Could Adversely Affect Our Operating Results. +Periodically, the oilfield services industry has experienced shortages of equipment for upgrades, drill pipe, replacement parts and other equipment and materials, including, in the case of our pressure pumping operations, proppants, cement, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +lingering effects of the COVID-19 pandemic, +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +labor shortages or other labor issues, +• +transportation, fuel shortages and other logistical challenges, and +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +18 +These price increases, delays in delivery and interruptions in supply may require us to delay operations, increase capital and repair expenditures or otherwise incur higher operating costs. During recent years, there have been significant disruptions and delays across the global supply chain, which have created a tightening of supplies and shortages in a number of areas, including basic raw materials. Severe shortages, delays in delivery and interruptions in supply could increase our costs and limit our ability to operate, maintain, upgrade and construct our drilling rigs and pressure pumping and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our Business Is Subject to Cybersecurity Risks and Threats. +Our operations are increasingly dependent on effective and secure information technologies and services. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, attempts to gain unauthorized access to data and systems, theft, viruses, malware, ransomware, denial-of-service attacks, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• +theft or misappropriation of funds, including via “phishing” or similar attacks directed at us or third parties, including our customers and vendors; +• +loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• +disruption or impairment of our and our customers’ and vendors’ business operations and safety procedures; +• +personal injuries and destruction or damage to property; +• +downtime and loss of revenue; +• +injury to our reputation, including the perception of our products or services as having security vulnerabilities; +• +negative impacts on our ability to compete; +• +loss or damage to our and our customers’ and vendors’ information technology systems, including operational technologies and worksite data delivery systems; +• +exposure to litigation and legal and regulatory liability and costs; and +• +increased costs to prevent, respond to or mitigate cybersecurity events. +Many of our office personnel have moved to a “remote work” model. This model has significantly increased the use of remote networking and online conferencing services that enable employees to work outside of our corporate infrastructure and, in some cases, use their own personal devices. This may expose us to additional cybersecurity risks or related incidents. Additionally, geopolitical tensions or conflicts, such as the ongoing conflict in Ukraine, may heighten the risk of cybersecurity attacks and other cyber events. +Although we utilize various procedures and controls to mitigate our exposure to the risks described above, cybersecurity attacks and other cyber events are evolving and unpredictable. There can be no assurance that the procedures and controls that we implement, or that our third party service providers implement, will be sufficient to protect our people, systems, information or other property. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber incident could go unnoticed for a period of time. We self-insure most of our cybersecurity risks, and any such incident could have a material adverse effect on our business, financial condition, cash flows and results of operations. As cyber incidents continue to evolve, we may be required to incur additional costs to continue to modify or enhance our protective measures or to investigate or remediate the effects of cyber incidents. +Our Commitments Under Supply Agreements Could Exceed Our Requirements, Exposing Us to Risks Including Price, Timing of Delivery and Quality of Equipment and Materials Upon Which Our Business Relies. +We have purchase commitments with certain vendors to supply equipment and materials, including, in the case of our pressure pumping business, proppants. Some of these agreements are take-or-pay agreements with minimum purchase obligations. If demand for our services decreases from current levels, demand for the equipment that we use and the materials that we supply as part of these services will also decrease. In addition, our customers may self-source certain materials. If demand for our services and/or materials decreases enough, we could have contractual minimum commitments that exceed the required amount of materials we need to supply to our customers. In this instance, we could be required to purchase materials that we do not have a present need for, pay for materials that we do not take delivery of or pay prices in excess of market prices at the time of purchase. +19 +Growth Through Acquisitions, the Building or Upgrading of Equipment and the Development of Technology Is Not Assured. +We have grown our drilling rig fleet and pressure pumping fleet and expanded our business lines and use of technology in the past through mergers, acquisitions, upgrades, new construction and technology development. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building or upgrading equipment or developing new technology. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, our competitors may continue to upgrade and build new equipment and develop new technology, including drilling automation technology and lower-emissions operations and services. +There can be no assurance that we will: +• +successfully complete any acquisitions we attempt on the terms announced, or at all, +• +have sufficient capital resources to complete additional acquisitions, build or upgrade equipment or develop new technology, +• +through due diligence conducted prior to an acquisition, successfully uncover situations that could result in financial or legal exposure, or appropriately quantify the exposure from known risks, +• +successfully integrate additional equipment, acquired or developed technology or other assets or businesses into our operations and internal controls, including financial reporting disclosure and cybersecurity and information technology systems, +• +effectively manage the growth and increased size, complexity and geography of our organization, including as a result of any completed merger or acquisition, +• +successfully deploy idle, stacked, upgraded or additional equipment and acquired or developed technology, +• +maintain the crews necessary to operate additional equipment or the personnel necessary to evaluate, acquire, develop and deploy new technology, or +• +successfully improve our financial condition, results of operations, business or prospects, or provide an adequate return of capital, as a result of any completed acquisition, the building or upgrading equipment or the development of new technology. +Our failure to achieve consolidation savings, to integrate acquired businesses and technology and other assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising from events occurring prior to any completed acquisitions, prior to our establishment of adequate compliance oversight or in connection with disputes over acquired or developed technology. While we generally seek to obtain indemnities for liabilities arising from events occurring before such acquisitions, we may be unable to do so, and any indemnities we do obtain will be limited in amount and duration, may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build or upgrade equipment or acquire or develop new technology, and we also may issue equity, convertible or debt securities in connection with any such acquisitions, building or upgrade program or technology development. Use of cash for these purposes may adversely affect our cash available for capital expenditures and other uses, debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth and resulting integration efforts could strain our management, operations, employees and other resources. +Public Health Crises, Pandemics and Epidemics, such as the COVID-19 Pandemic, Have Had, and May Continue to Have, a Significant Adverse Impact on Our Business, Liquidity, Results of Operations and Financial Condition. +The effects of public health crises, pandemics and epidemics, such as the COVID-19 pandemic, including related governmental actions and restrictions related thereto, have had, and may continue to have, a significant adverse impact on the global economy, including the worldwide demand for oil and natural gas, and the level of demand for our services, which has impacted and may continue to impact our business, liquidity, results of operations and our financial condition. +Such public health crises, pandemics and epidemics are continuously evolving, and we are not able to enumerate all potential risks to our business from such events, including the COVID-19 pandemic and related volatility in crude oil prices; however, we believe that in addition to the impacts described above, other current and potential impacts include, but are not limited to: liquidity challenges; customers, suppliers and other third parties seeking to terminate, reject, renegotiate or otherwise avoid, and otherwise failing to perform, their contractual obligations to us; credit rating downgrades of our corporate debt and potentially higher borrowing costs in the future; a need to preserve liquidity; cybersecurity issues; litigation risk and possible loss contingencies; disruption to our supply chain; loss of workers and labor shortages; general oilfield cost inflation; a reduction of our workforce; costs associated with rationalization of our portfolio of real estate facilities; asset impairments and other accounting charges; infections and quarantining of our employees and the personnel of our customers, suppliers and other third parties; actions undertaken by international, national, regional and local governments and health officials; and a structural shift in the global economy and its demand for oil and natural gas. +20 +The full extent of the impact of public health crises, pandemics and epidemics on our business, liquidity, results of operations and financial condition will depend largely on future developments, including the duration and further spread of a subject pathogen, including any new strains thereof, and the related impact on the oil and gas industry, the impact of governmental actions designed to prevent the spread thereof and the further development, availability, timely distribution and acceptance of effective treatments and vaccines, all of which are highly uncertain. +Fuel Conservation Measures Could Reduce Demand for Oil and Natural Gas, Which Would, In Turn, Reduce the Demand for Our Services. +Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas may have a material adverse effect on our business, financial condition, cash flows and results of operations. Additionally, the increased competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, and biofuels) or increased focus on reducing the use of oil and natural gas (such as governmental mandates that ban the sale of new gasoline-powered automobiles, and new legislation such as the Inflation Reduction Act of 2022, which contains tax inducements and other provisions that incentivize investment, development, and deployment of alternative energy sources and technologies) could reduce demand for oil and natural gas and therefore for our services, which would lead to a reduction in our revenues. +Legal and Regulatory Risks +Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations. +Numerous political and regulatory authorities, governmental bodies and officials, and environmental groups devote resources to campaigns aimed at eradicating hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production. +President Biden and other political candidates and officeholders stated that they would support either increased regulation or a ban on hydraulic fracturing; however, we cannot predict whether hydraulic fracturing regulations will be enacted during the Biden Administration or how stringent they may be. In addition, members of the U.S. Congress and the EPA have reviewed proposals for more stringent regulation of hydraulic fracturing, and various state and local initiatives have been or may be proposed or implemented to further regulate hydraulic fracturing. In addition, a number of lawsuits have been filed against other industry participants alleging damages and regulatory violations in connection with such activity. These and other ongoing or proposed studies could spur initiatives to further regulate hydraulic fracturing and other aspects of the oil and gas industry. +In addition, legislation has been proposed, but not enacted, and may be proposed in the future, in the U.S. Congress to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process are impairing ground water or causing other damage. These bills, if enacted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business. +Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities. Certain states where we operate have adopted or are considering disclosure legislation and/or regulations, including a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure. +Some parties believe that there is a correlation between hydraulic fracturing and other oilfield related activities and the increased occurrence of seismic activity. When caused by human activity, such seismic activity is called induced seismicity. The extent of this correlation, if any, is the subject of studies of both state and federal agencies. In light of concerns about induced seismicity, some state regulatory agencies have modified their regulations or issued orders to address induced seismicity. +Finally, several jurisdictions have taken steps to enact hydraulic fracturing bans, moratoria or increased regulations on hydraulic fracturing practices. These actions have been the subject of legal challenges. +The full impact of the foregoing actions remains unclear, but the adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could restrict our ability, or make it more difficult, to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services. Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations. Additionally, the adoption of significant +21 +restrictions or a prohibition on hydraulic fracturing by a state, region or locality could result in a surplus of oilfield equipment in other states, regions or localities where hydraulic fracturing remains allowed. +Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services. +The physical and regulatory effects of climate change could have a negative impact on our operations, our customers’ operations and the overall demand for our customers’ products and, accordingly, our services. There is an increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. These efforts have included consideration of cap-and-trade programs, carbon taxes, GHG reporting, tracking programs, attestation requirements and regulations that directly limit GHG emissions from certain sources. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. In the absence of federal GHG-limiting legislation, the EPA has determined that GHG emissions present a danger to public health and the environment and has adopted regulations that, among other things, establish construction and operating permit reviews for GHG emissions from certain large stationary sources, require the monitoring and annual reporting of GHG emissions from certain oil and natural gas system sources, implement CAA emission standards directing the reduction of methane emissions from certain new, modified, or reconstructed facilities in the oil and natural gas sector, and together with the DOT, implement GHG emissions limits on vehicles manufactured for operation in the United States. +The United States is currently a member of the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, every five years. Under the Paris Agreement, the Biden Administration has committed the United States to reducing its greenhouse gas emissions by 50-52% from 2005 levels by 2030. In November 2021, the United States and other countries entered into the Glasgow Climate Pact, which includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions 30% by 2030, and cooperating toward the advancement of the development of clean energy. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +Governmental, scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks in the United States. President Biden and the Democratic Party have identified climate change as a priority, and it is likely that additional executive orders and/or regulatory action targeting greenhouse gas emissions, or prohibiting or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. In 2021, President Biden issued an executive order imposing a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Although a federal judge for the U.S. District Court of the Western District of Louisiana issued a permanent injunction in 13 states that filed a lawsuit against the pause of oil and natural gas leasing on public lands or in offshore waters, the Biden Administration may take other regulatory steps in the future that could impact our operations. Other actions impacting oil and natural gas production activities that could be pursued by the Biden administration may include more restrictive requirements for the establishment of pipeline infrastructure or the permitting of liquified natural gas export facilities. +It is not possible at this time to predict the timing and effects of climate change or whether additional climate-related legislation, regulations or other measures will be adopted at the local, state, regional, national and international levels. However, continued efforts by governments and non-governmental organizations to reduce GHG emissions appear likely, and additional legislation, regulation or other measures that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our business. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations increase compliance costs, add operating restrictions, or reduce demand for our customers’ products and, accordingly, our services. +Increasing attention to the risks of climate change has resulted in an increased possibility of lawsuits or investigations brought by public and private entities against oil and natural gas companies in connection with their GHG emissions. Should we be targeted by any +22 +such litigation or investigations, we may incur liability, which, to the extent that societal pressures or political or other factors are involved, could be imposed without regard to the causation of or contribution to the asserted damage, or to other mitigating factors. +These political, litigation, and financial risks may result in our customers restricting or cancelling production activities, incurring liability for infrastructure damage as a result of climatic changes, or impairing their ability to continue to operate in an economic manner, which also could reduce demand for our products and services. One or more of these developments could have a material adverse effect on our business, financial condition, cash flows and results of operations. Finally, increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, floods and other climatic events. If any such effects were to occur, they could have an adverse effect on our and our customers’ facilities and operations. +Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties or judgments, +• +modification, denial or revocation of permits or other authorizations, +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the places that we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and pressure pumping equipment, a manufacturer and servicer of equipment and automation to the energy, marine and mining industries and a provider of directional drilling and other services, we may be deemed to be a responsible party under these laws and regulations. +Technology Disputes Could Negatively Impact Our Operations or Increase Our Costs. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, or a third party’s infringement of our rights, including patent rights. The majority of the intellectual property rights relating to our drilling rigs, pressure pumping equipment and directional drilling services are owned by us or certain of our supplying vendors. However, in the event that we or one of our customers or supplying vendors becomes involved in a dispute over infringement of intellectual property rights relating to equipment or technology owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or technology or our ability to provide services or products, or we could be required to cease use of some equipment or technology or forced to modify our equipment, technology, services or products. We could also be required to pay license fees or royalties for the use of equipment or technology or provision of services or products. In addition, we may lose a competitive advantage in the event we are unsuccessful in enforcing our rights against third parties. Regardless of the merits, any such claims may result in significant legal and other costs, including reputational harm, and may distract management from running our business. Some of our competitors and current and potential vendors have a substantial amount of intellectual property related to new equipment and technologies. We cannot guarantee that our equipment, technology, services or products will not be determined to infringe currently issued or future issued patents or other intellectual property rights belonging to others, including, without limitation, situations in which our equipment, technology, services or products may be covered by patent applications filed by other parties. Technology disputes involving us or our customers or supplying vendors could have a material adverse impact on our business, financial condition, cash flows and results of operations. +The Design, Manufacture, Sale and Servicing of Products, including Electrical Controls, May Subject Us to Liability for Personal Injury, Property Damage and Environmental Contamination Should Such Equipment Fail to Perform to Specifications. +We provide products, including electrical controls, to customers involved in oil and gas exploration, development and production and in the marine and mining industries. Because of applications that use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause harm to our reputation, contractual and warranty-related liability, damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. +23 +Legal Proceedings and Governmental Investigations Could Have a Negative Impact on Our Business, Financial Condition and Results of Operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Please see “Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect Our Opportunities and Future Business. +We provide contract drilling services in Colombia, we sell products, including electrical controls, for use in numerous oil and gas producing regions outside of North America, and through our Superior QC business, we occasionally provide remote data analytics and other services to customers to support their operations outside of the United States. We also continue to evaluate opportunities from time to time to provide our services outside of the United States. International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, changing political conditions and changing laws and policies affecting trade and investment, strikes, work stoppages, labor disputes and other slowdowns, terrorism, war, kidnapping of employees, blockades, regional economic downturns, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, difficulty in collecting international accounts receivable, potentially longer payment cycles, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, foreign taxation and customs regulations, the overlap of different tax structures, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. Additionally, we may be subject to foreign governmental regulations favoring or requiring the awarding of contracts to local contractors or requiring foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. These regulations could adversely affect our ability to compete. +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling and completion operations or other assets or businesses, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +24 +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where our services could be provided or where our consumers for products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. In addition, investors could negatively view potential violations, inquiries or allegations of misconduct under the FCPA or similar laws, which could adversely affect our reputation and the market for our shares. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets. +Many countries, including the United States, control the import and export of certain goods, services and technology and impose related import and export recordkeeping and reporting obligations. Governments also may impose economic sanctions against certain countries, persons and other entities that may restrict or prohibit transactions involving such countries, persons and entities. In particular, U.S. sanctions are targeted against certain countries that are heavily involved in the oil and gas industry. The laws and regulations concerning import and export activity, recordkeeping and reporting, including customs, export controls and economic sanctions, are complex and constantly changing. Any failure to comply with applicable legal or regulatory requirements governing international trade could also result in criminal and civil penalties and sanctions, such as fines, imprisonment, debarment from government contracts, seizure of shipments and loss of import and export privileges. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +Financial Risks +Investor Sentiment and Public Perception Related to the Oil and Natural Gas Industry and to ESG Initiatives could Increase our Costs of Capital and our Reporting Requirements and Impact Our Operations. +There are increasing financial risks for oil and natural gas producers, as stockholders and bondholders currently invested in oil and natural gas companies and concerned about the potential effects of climate change, ESG and other sustainability-related issues may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors, or into competitors who are perceived to have stronger ESG practices and disclosures. Our ESG practices and disclosures may not satisfy investor requirements or their requirements may not be made known to us. We may continue to face increasing pressure regarding our ESG practices and disclosures, which pressures have intensified recently in connection with significant societal events and worldwide efforts to mitigate climate change. +We have developed, and will continue to develop, goals and other objectives related to ESG and sustainability matters. Statements related to these goals and objectives reflect our current plans and do not constitute a guarantee that they will be achieved. Our ability to achieve any stated goal or objective is subject to numerous factors and conditions, some of which are outside of our control. Our efforts to accurately report on ESG and sustainability matters, including our efforts to research, establish, accomplish and accurately report on goals and objectives, expose us to numerous operational, reputational, financial, legal, and other risks. Standards for tracking and reporting on ESG and sustainability matters, including climate-related matters, have not been harmonized and continue to evolve. Our processes and controls for reporting on ESG and sustainability matters, including our goals and objectives, may not always comply with evolving and disparate standards for identifying, measuring, and reporting such metrics, including any climate change and sustainability-related public company disclosure requirements adopted by the SEC, and such standards may change over time, which could result in significant revisions to our current ESG practices and disclosures. +The lending and investment practices of institutional lenders and investors have been the subject of intensive lobbying efforts in recent years, oftentimes public in nature, not to provide funding for oil and natural gas producers, and some lenders and insurers have announced that they will not lend to or provide insurance for oil and natural gas companies. Limitation of investments in and financings for oil and natural gas could result in the restriction, delay, or cancellation of drilling and completion programs or development of production activities. An increasing number of our customers consider sustainability factors in awarding work. If we are unable to meet the ESG standards or investment criteria set by our customers, investors and other parties, which continue to evolve, if we are unable to successfully continue our sustainability enhancement efforts, or if, notwithstanding our own efforts, our industry becomes the focus of increasing ESG and sustainability related pressures, we may lose customers, we may lose investors, our cost of capital may increase, +25 +our stock price may be negatively impacted, our reputation may be negatively affected, and it may be more difficult for us to effectively compete. +Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, the SOFR rate or base rate. The applicable margin on SOFR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. As of December 31, 2022, the applicable margin on SOFR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. As of December 31, 2022, we had no borrowings outstanding under our revolving credit facility. +We also have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2022, no amounts had been disbursed under any letters of credit, and we had $65.0 million in letters of credit outstanding under the reimbursement agreement. +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed at floating rates under these agreements or under future agreements. +A Downgrade in Our Credit Rating Could Negatively Impact Our Cost of and Ability to Access Capital. +Our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels, industry conditions and other considerations. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, and potentially require us to post letters of credit for certain obligations. +Our Ability to Access Capital Markets Could be Limited. +From time to time, we may need to access capital markets to obtain financing. Our ability to access capital markets for financing could be limited by oil and gas prices, our existing capital structure, our credit ratings, the state of the economy, the health or market perceptions of the drilling and overall oil and gas industry, the liquidity of the capital markets and ESG considerations and other factors. Many of the factors that affect our ability to access capital markets are outside of our control. No assurance can be given that we will be able to access capital markets on terms acceptable to us when required to do so, which could have a material adverse impact on our business, financial condition and results of operations. +We May Not Be Able to Generate Sufficient Cash to Service All of Our Debt and We May Be Forced to Take Other Actions to Satisfy Our Obligations Under Our Debt, which May Not Be Successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, including the ability of our subsidiaries to generate sufficient cash flows, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our debt agreements contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +26 +Our Return of Capital to Stockholders, Including Through the Payment of Dividends and Repurchases of our Common Stock, is within the Discretion of our Board of Directors, and There is No Guarantee That We Will Return Capital to Shareholders, Including Through the Payment of Dividends and Repurchases of our Common Stock, in the Future or at Levels Anticipated by our Stockholders. +Although we currently plan to return capital to stockholders, the amount and timing of returns of capital to stockholders may vary from time to time. The amount and timing of all returns of capital, including future dividend payments and purchases pursuant to our stock buyback program, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend or limit, suspend or terminate our stock repurchase program. There can be no assurance that we will pay a dividend or make repurchases of our common stock in the future. The payment of dividends and stock repurchases could diminish our cash reserves, which may impact our ability to meet our working capital needs, satisfy our debt obligations, make capital expenditures, grow and pursue strategic opportunities and acquisitions. In addition, any elimination of, or downward revision in, our stock buyback program or dividend payments could have an adverse effect on the market price of our common stock. +Risks Related to Our Common Stock and Corporate Structure +The Market Price of Our Common Stock May Be Highly Volatile, and Investors May Not Be Able to Resell Shares at or Above the Price Paid. +The trading price of our common stock may be volatile. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as other general economic, market or political conditions, could reduce the market price of our common stock in spite of our operating and/or financial performance. The following factors, in addition to other factors described in this “Risk Factors” section and elsewhere in this Report, may have a significant impact on the market price of our common stock: +• +investor perception of us and the industry and markets in which we operate; +• +general financial, domestic, international, economic, and market conditions, including overall fluctuations in the U.S. equity markets; +• +increased focus by the investment community on sustainability practices at our company and in the oil and natural gas industry generally; +• +changes in customer needs, expectations or trends and our ability to maintain relationships with key customers; +• +our ability to implement our business strategy; +• +changes in our capital structure, including the issuance of additional debt; +• +public announcements (including the timing of these announcements) regarding our business, financial performance and prospects or new services or products, service or product enhancements, technological advances or strategic actions, such as acquisitions or divestitures, restructurings or significant contracts, by our competitors or us; +• +trading activity in our stock, including portfolio transactions in our stock by us, our executive officers and directors, and significant stockholders or trading activity that results from the ordinary course rebalancing of stock indices in which we may be included; +• +any elimination of, or downward revision in, our stock buyback program or dividend payments; +• +short-interest in our common stock, which could be significant from time to time; +• +our inclusion in, or removal from, any stock indices; +• +changes in earnings estimates or buy/sell recommendations by securities analysts; +• +whether or not we meet earnings estimates of securities analysts who follow us; and +• +regulatory or legal developments in the United States and foreign countries where we operate. +27 +Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +Item 1B. Unresolved Staff Comments. +None. +Item 2. Properties +Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space. +Contract Drilling — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania, Ohio, and internationally in Colombia. +Pressure Pumping — Our pressure pumping services are supported by multiple offices and yard facilities located in Texas and Pennsylvania. +Directional Drilling — Our directional drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, North Dakota, and Ohio. +Our oilfield rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our servicing of equipment for drilling contractors is supported by offices and yard facilities located in Texas. Our electrical controls and automation operation is supported by an office and yard facility in Texas. Our interests in oil and natural gas properties are primarily located in Texas and New Mexico. +We own our administrative offices in Snyder, Texas, as well as several other facilities. We also lease a number of facilities, and we do not believe that any one of the owned or leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +Item 4. Mine Safety Disclosure. +Not applicable. +28 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P SmallCap 600 Index and several other market indices. +(b) Holders +As of February 9, 2023, there were approximately 800 holders of record of our common stock. +(c) Dividends +On February 8, 2023, our Board of Directors approved a cash dividend on our common stock in the amount of $0.08 per share to be paid on March 16, 2023 to holders of record as of March 2, 2023. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend in order to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2022. +Period Covered +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands) (2) +October 2022 +— +$ +— +— +$ +300,000 +November 2022 +2,247,013 +$ +18.08 +2,247,013 +$ +259,380 +December 2022 +1,007,586 +$ +16.43 +1,007,586 +$ +242,827 +Total +3,254,599 +3,254,599 +(1) +No shares were withheld in the fourth quarter with respect to employees’ tax withholding obligations upon the vesting of restricted stock units. +(2) +We have a stock buyback program, which was originally approved by our Board of Directors on September 9, 2013. Our Board of Directors most recently approved an increase of the authorization under the stock buyback program on October 26, 2022. Under the program, we are authorized to repurchase up to $300 million of our common stock in open market or privately negotiated transactions after October 26, 2022. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. Shares of stock purchased under the buyback program are held as treasury shares. There is no expiration date associated with the buyback program. +29 +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2017 through December 31, 2022, with the cumulative total return of the S&P 500 Index, the S&P SmallCap 600 Index and the Oilfield Service Index. The graph also shows our previous company-determined 2021 peer group, which consisted of Archrock, Inc., Bristow Group Inc., Cactus, Inc., ChampionX Corp., EQT Corporation, Helix Energy Solutions Group, Inc., Helmerich & Payne, Inc., Liberty Oilfield Services, Inc., Nabors Industries Ltd., NexTier Oilfield Solutions, Inc., NOV Inc., Oceaneering International, Inc., Oil States International, Inc., PDC Energy, Inc., Precision Drilling Corporation, Range Resources Corporation, TechnipFMC Plc. and Transocean Ltd. We elected to replace our previous peer group with the Oilfield Service Index to improve consistency of disclosures between reporting periods. +The graph assumes investment of $100 on December 31, 2017 and reinvestment of all dividends. +Index Data: Copyright Standard and Poor’s, Inc. Used with permission. All rights reserved. +Fiscal Year Ended December 31, +2017 +2018 +2019 +2020 +2021 +2022 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +45.37 +46.77 +23.94 +38.85 +78.35 +S&P 500 Index +100.00 +95.62 +125.72 +148.85 +191.58 +156.88 +S&P SmallCap 600 Index +100.00 +91.52 +112.37 +125.05 +158.59 +133.06 +Oilfield Service Index +100.00 +54.78 +54.48 +31.56 +38.10 +61.53 +Old Peer Group Index +100.00 +63.49 +63.03 +37.28 +48.05 +76.33 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +30 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Management Overview and Recent Developments in Market Conditions — We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. Our pressure pumping business operates primarily in Texas and the Appalachian region. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of directional and horizontal wellbores. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in 2020 and early 2021. However, market fundamentals are now strong, as demand increased for drilling and completions equipment and services in 2022, and industry supply of Tier-1, super-spec rigs and premium pressure pumping equipment remains constrained. We expect our rig count in the United States will average 130 rigs in the first quarter and then grow modestly throughout the remainder of 2023. The current demand for equipment and services and strong pricing environment remain dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, response to the COVID-19 pandemic (including any resurgences and/or lockdowns in the United States and abroad) and continued focus by exploration and production companies and service companies on capital discipline. Oil prices averaged $82.79 per barrel in the fourth quarter of 2022 and closed at $77.97 per barrel on January 30, 2023. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $5.55 per MMBtu in the fourth quarter of 2022 and closed at $2.82 per MMBtu on January 30, 2023. +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2020, 2021 and 2022 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day - U.S. (2) +69 +73 +80 +106 +2022: +Average oil price per Bbl (1) +$ +94.45 +$ +108.72 +$ +93.18 +$ +82.79 +Average rigs operating per day - U.S. (2) +115 +121 +128 +131 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our average active U.S. rig count for the fourth quarter of 2022 was 131 rigs. This was an increase from our average active rig count for the third quarter of 2022 of 128 rigs. Our active U.S. rig count at December 31, 2022 of 132 rigs was more than the rig count of 111 rigs at December 31, 2021, due in large part to the recovery of oil prices and improved demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place in the United States, we expect an average of 87 rigs operating under term contracts during the first quarter of 2023 and an average of 56 rigs operating under term contracts during 2023. +Our average active spread count was 12 in the fourth quarter of 2022, consistent with the third quarter of 2022. We calculated average active spreads as the average number of spreads that were crewed and actively marketed during the period. We expect to average approximately 12 active spreads in the first quarter of 2023. Based on our outlook for 2023 activity, we currently expect to activate a 13th spread towards the end of 2023. +31 +Due to improving activity levels, supply chain disruptions and increasing tightness in the overall labor market, we continue to see general oilfield cost inflation across our segments, including increases in the cost of labor, services and supplies. Supply chain disruptions and the increasing challenge of attracting and retaining employees are increasing the complexity of reactivating equipment. Pricing for our drilling and completion services increased in 2022 due in part to the limited supply of readily available, high-quality drilling and completion equipment. +Our 2023 capital expenditure forecast is approximately $550 million. +Recent Developments in Financial Matters and Merger and Acquisition Activity — On October 1, 2021, we completed the acquisition of Pioneer by acquiring 100% of its equity interests. Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $30 million cash, which based on the closing price of our common stock of $9.44 on October 1, 2021, valued the transaction at approximately $278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. Through the Pioneer acquisition, we acquired Pioneer’s 100% pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. The purchase price allocation was finalized in 2022. The measurement period adjustments did not have a material impact on our consolidated financial statements. +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business to Clearwell Dynamics, LLC. The sale price was $43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses were presented as a discontinued operation during the fourth quarter of 2021. +On November 9, 2022, we entered into Amendment No. 3 to Amended and Restated Credit Agreement (“Amendment No. 3”), which amended our Credit Agreement (as defined below), among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +Amendment No. 3, among other things, (i) revised the capacity under the letter of credit facility to $100 million; (ii) revised the capacity under the swing line facility to the lesser of $50 million and the amount of the swing line provider’s unused commitment; (iii) changed the LIBOR reference rate to a SOFR reference rate; and (iv) extended the maturity date for $416.7 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026. As a result, of the $600 million of revolving credit commitments under the Credit Agreement, the maturity date for $416.7 million of such commitments is March 27, 2026; the maturity date for $133.3 million of such commitments is March 27, 2025; and the maturity date for the remaining $50 million of such commitments is March 27, 2024. +As of December 31, 2022, we had no borrowings outstanding under our revolving credit facility. We had no letters of credit outstanding under the Credit Agreement at December 31, 2022 and, as a result, had available borrowing capacity of $600 million at that date. +During the fourth quarter of 2022, we elected to repurchase portions of our 2028 Notes and 2029 Notes (as defined below) in the open market. The principal amounts retired through these transactions totaled $21.0 million of our 2028 Notes and $1.4 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $2.3 million and $0.1 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and upon our customers’ ability to access capital to fund their operating and capital expenditures. During periods of improved oil and natural gas prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when oil and natural gas prices are relatively low or when our customers have a reduced ability to access capital, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. We may also be impacted by delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies. +The North American oil and natural gas services industry is cyclical and at times experiences downturns in demand. During these periods, there has been substantially more oil and natural gas service equipment available than necessary to meet demand. As a result, oil and natural gas service contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the +32 +downturn periods. We cannot predict either the future level of demand for our oil and natural gas services or future conditions in the oil and natural gas service businesses. +In addition to the dependence on oil and natural gas prices and demand for our services, we are highly impacted by operational risks, competition, labor issues, weather, the availability, from time to time, of products used in our pressure pumping business, supplier delays and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations, including as a result of the COVID-19 pandemic. See “Risk Factors” in Item 1A of this Report. +For the three years ended December 31, 2022, our operating revenues and net income consisted of the following (dollars in thousands): +2022 +2021 +2020 +Contract drilling +$ +1,316,672 +49.7 +% +$ +664,030 +48.9 +% +$ +669,126 +59.5 +% +Pressure pumping +1,022,413 +38.6 +% +523,756 +38.6 +% +336,111 +29.9 +% +Directional drilling +216,498 +8.2 +% +111,481 +8.2 +% +73,356 +6.5 +% +Other +92,009 +3.5 +% +57,814 +4.3 +% +45,656 +4.1 +% +$ +2,647,592 +100.0 +% +$ +1,357,081 +100.0 +% +$ +1,124,249 +100.0 +% +Net income (loss) +$ +154,658 +$ +(654,545 +) +$ +(803,692 +) +Contract Drilling +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allow for more clearance underneath the rig floor. As of December 31, 2022, our rig fleet included 172 super-spec rigs, of which 118 were Tier-1, super-spec rigs. +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2022 and 2021 was approximately $830 million and $325 million, respectively. Approximately 32% of the total contract drilling backlog in the United States at December 31, 2022 is reasonably expected to remain after 2023. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.” +Pressure Pumping +As of December 31, 2022, we had approximately 1.2 million horsepower in our pressure pumping fleet. We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services, such as hydraulic fracturing, for completion of new wells and remedial work on existing wells. We also provide cementing services through the pressure pumping segment. +Directional Drilling +We provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors. We also provide services that improve the statistical accuracy of directional and horizontal wellbores. +Other Operations +Our oilfield rentals business, with a fleet of premium oilfield rental tools, along with the results of our ownership, as a non-operating working interest owner, in oil and gas assets located in Texas and New Mexico, provide the largest revenue contributions to our other operations. Other operations also includes the results of our electrical controls and automation business and the results of our drilling equipment service business. +33 +Capital Expenditures +Cash capital expenditures for 2022 totaled $437 million. This was an increase from the $166 million of cash capital expenditures excluding discontinued operations for 2021, due largely to higher activity levels in 2022. Based on our current outlook for activity, we expect our capital expenditures for 2023 to be approximately $550 million. +Comparison of the years ended December 31, 2021 and 2020 +A discussion of our financial condition and results of operations for the fiscal year ended December 31, 2021 compared to the fiscal year ended December 31, 2020 is included in Part II, Item 7— “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 16, 2022. +Results of Operations +Comparison of the years ended December 31, 2022 and 2021 +The following tables summarize results of operations by business segment for the years ended December 31, 2022 and 2021: +Year Ended December 31, +Contract Drilling +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +1,316,672 +$ +664,030 +98.3 +% +Direct operating costs +832,180 +463,456 +79.6 +% +Adjusted gross margin (1) +484,492 +200,574 +141.6 +% +Other operating (income) expenses, net +(34 +) +25 +NA +Selling, general and administrative +6,774 +4,699 +44.2 +% +Depreciation, amortization and impairment +337,513 +618,879 +(45.5 +)% +Operating income (loss) +$ +140,239 +$ +(423,029 +) +NA +Operating days - U.S. (2) +45,216 +29,960 +50.9 +% +Average revenue per operating day - U.S. +$ +27.57 +$ +21.64 +27.4 +% +Average direct operating costs per operating day - U.S. +$ +17.32 +$ +15.11 +14.6 +% +Average adjusted gross margin per operating day - U.S. (3) +$ +10.25 +$ +6.53 +56.9 +% +Average rigs operating - U.S. (2) +124 +82 +50.9 +% +Capital expenditures +$ +255,634 +$ +109,894 +132.6 +% +(1) +Adjusted gross margin is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross margin to adjusted gross margin by segment. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. Average rigs operating is defined as operating days divided by the number of days in the period. +(3) +Average adjusted gross margin per operating day is defined as adjusted gross margin divided by operating days. +Generally, the revenues in our contract drilling segment are most impacted by two primary factors: our average number of rigs operating and our average revenue per operating day. Our average revenue per operating day is largely dependent on the pricing terms of our rig contracts. Revenues increased primarily due to an increase in operating days and improved pricing. Average revenue per operating day increased primarily due to improved pricing. +Direct operating costs increased due to an increase in operating days, increased reactivation costs and inflationary cost pressure on labor and supplies. Average direct operating costs per operating day increased primarily due to a lower portion of our rigs being on standby, increased reactivation costs and inflationary cost pressure beginning in the second half of 2021. Rigs on standby have very little associated cost. +Depreciation, amortization and impairment expense decreased primarily due to a $220 million impairment charge related to the abandonment of 43 legacy non-super-spec rigs and equipment in 2021. Additionally, depreciation, amortization and impairment expense decreased partially due to a lower depreciable asset base during 2022 as a result of the impairment charge taken in 2021. +The increase in capital expenditures was primarily due to rig reactivations, higher maintenance capital expenditures and upgrading certain rig components. +34 +Year Ended December 31, +Pressure Pumping +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +1,022,413 +$ +523,756 +95.2 +% +Direct operating costs +781,385 +475,953 +64.2 +% +Adjusted gross margin (1) +241,028 +47,803 +404.2 +% +Selling, general and administrative +8,763 +7,361 +19.0 +% +Depreciation, amortization and impairment +98,162 +159,305 +(38.4 +)% +Operating income (loss) +$ +134,103 +$ +(118,863 +) +NA +Average active spreads (2) +12 +8 +44.6 +% +Fracturing jobs +558 +422 +32.2 +% +Other jobs +669 +754 +(11.3 +)% +Total jobs +1,227 +1,176 +4.3 +% +Average revenue per fracturing job +$ +1,799.97 +$ +1,187.29 +51.6 +% +Average revenue per other job +$ +26.95 +$ +30.13 +(10.6 +)% +Average revenue per total job +$ +833.26 +$ +445.37 +87.1 +% +Average direct operating costs per total job +$ +636.83 +$ +404.72 +57.4 +% +Average adjusted gross margin per total job (3) +$ +196.44 +$ +40.65 +383.2 +% +Adjusted gross margin as a percentage of revenues (3) +23.6 +% +9.1 +% +159.3 +% +Capital expenditures +$ +137,935 +$ +34,676 +297.8 +% +(1) +Adjusted gross margin is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross margin to adjusted gross margin by segment. +(2) +Average active spreads is the average number of spreads that were crewed and actively marketed during the period. +(3) +Average adjusted gross margin per total job is defined as adjusted gross margin divided by total jobs. Adjusted gross margin as a percentage of revenues is defined as adjusted gross margin divided by revenues. +Generally, the revenues in our pressure pumping segment are most impacted by the number and design of fracturing jobs (including whether or not we provide proppant and other materials). Direct operating costs are also most impacted by these same factors. Our average revenue per fracturing job is largely dependent on the pricing terms of our pressure pumping contracts and the design of the jobs. +Revenues increased primarily due to an increase in the number of higher revenue fracturing jobs, improved pricing and continued improvement in asset utilization and efficiency. Direct operating costs increased primarily due to an increase in the number of higher cost fracturing jobs as well as inflationary cost pressure on labor and supplies. +Our average revenue per total job increased primarily as a result of a shift in the mix of total jobs toward higher revenue fracturing jobs. Average revenue per fracturing job increased primarily due to improved pricing. Average direct operating costs per total job increased primarily as a result of a shift toward higher cost fracturing jobs as well as inflationary cost pressure on labor and supplies. +Depreciation, amortization and impairment expense decreased due to a lower depreciable asset base in 2022 partially as a result of a $32.2 million impairment charge taken in 2021. This impairment charge was related to the abandonment of approximately 0.2 million horsepower within our pressure pumping fleet. Additionally, a portion of the decrease related to certain equipment that reached the end of its useful life during 2022. This decrease in 2022 outpaced incremental depreciation resulting from equipment additions in 2020 and 2021, when our capital expenditures were significantly lower. +The increase in capital expenditures was primarily due to costs associated with reactivating stacked equipment as well as upgrades and the increase in maintenance capital expenditures associated with a higher average number of active spreads. +Year Ended December 31, +Directional Drilling +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +216,498 +$ +111,481 +94.2 +% +Direct operating costs +179,135 +101,628 +76.3 +% +Adjusted gross margin (1) +37,363 +9,853 +279.2 +% +Selling, general and administrative +6,401 +4,884 +31.1 +% +Depreciation, amortization and impairment +15,428 +40,270 +(61.7 +)% +Operating income (loss) +$ +15,534 +$ +(35,301 +) +NA +Capital expenditures +$ +16,598 +$ +8,591 +93.2 +% +35 +(1) +Adjusted gross margin is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross margin to adjusted gross margin by segment. +Revenue increased primarily due to increased job activity and improved pricing. We averaged 44.6 jobs per day in 2022 as compared to 30.1 jobs per day in 2021. +Direct operating costs were higher by $77.5 million, or 76.3%, primarily due to increased job activity and cost inflation. +Depreciation, amortization and impairment expense decreased due to a lower depreciable asset base in 2022 as a result of the abandonment of an $11.4 million developed technology intangible asset and $2.5 million of directional drilling equipment in 2021. +Capital expenditures increased due to higher levels of activity requiring premium equipment to meet market demands. +Year Ended December 31, +Other Operations +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +92,009 +$ +57,814 +59.1 +% +Direct operating costs +53,850 +40,911 +31.6 +% +Adjusted gross margin (1) +38,159 +16,903 +125.8 +% +Selling, general and administrative +2,678 +1,943 +37.8 +% +Depreciation, depletion, amortization and impairment +27,671 +24,865 +11.3 +% +Operating income (loss) +$ +7,810 +$ +(9,905 +) +NA +Capital expenditures +$ +25,504 +$ +11,638 +119.1 +% +(1) +Adjusted gross margin is defined as revenues less direct operating costs (excluding depreciation, depletion, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross margin to adjusted gross margin by segment. +Revenue increased from 2021 primarily due to a $17.7 million increase in our oilfield rentals business revenues due to higher service volumes and improved pricing as well as a $13.5 million increase in our oil and natural gas revenues resulting from favorable crude oil market prices and increased production. Average WTI-Cushing prices in 2022 were $94.90 per barrel as compared to $68.14 per barrel in 2021. +Direct operating costs increased due to incremental production costs from our oil and natural gas assets as well as a higher service volume provided by our oilfield rentals business and cost inflation. +Depreciation, depletion, amortization and impairment increased primarily due to a $4.5 million impairment in our oil and natural gas business in 2022. +The increase in capital expenditures was primarily related to incremental spending in our oilfield rentals and oil and natural gas businesses. +Year Ended December 31, +Corporate +2022 +2021 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +91,973 +$ +73,495 +25.1 +% +Merger and integration expenses +$ +2,069 +$ +12,060 +(82.8 +)% +Depreciation +$ +5,171 +$ +5,859 +(11.7 +)% +Other operating (income) expenses, net +Net gain on asset disposals +$ +(12,075 +) +$ +(1,426 +) +746.8 +% +Legal-related expenses and settlements, net of insurance reimbursements +(349 +) +762 +NA +Research and development +992 +1,371 +(27.6 +)% +Other +(1,126 +) +31 +NA +Other operating expense (income), net +$ +(12,558 +) +$ +738 +NA +Credit loss expense +$ +— +$ +(1,500 +) +NA +Interest income +$ +360 +$ +222 +62.2 +% +Interest expense +$ +40,256 +$ +41,978 +(4.1 +)% +Other expense +$ +(3,273 +) +$ +(275 +) +1,090.2 +% +Capital expenditures +$ +1,126 +$ +1,521 +(26.0 +)% +36 +Selling, general and administrative expense increased primarily due to increased personnel costs as a result of higher headcount, wage growth and changes in stock-based compensation. +Merger and integration expenses were recognized in 2021 related to the Pioneer acquisition, which closed on October 1, 2021, and the subsequent divestiture of Pioneer’s well servicing rig business and wireline business, which closed on December 31, 2021. +Other operating (income) expenses, net includes net gains associated with the disposal of assets. Accordingly, the related gains or losses have been excluded from the results of specific segments. The $12.1 million gain on asset disposals in 2022 was primarily due to the release of an $11.5 million cumulative translation adjustment from accumulated other comprehensive income into net income (loss) in our consolidated statements of operations upon substantially completing our exit from our Canadian operations. The majority of the net gain on asset disposals in 2021 reflect gains on disposals of buildings, land and drilling equipment. +The $3.0 million change in other expense was primarily due to foreign currency adjustments related to our Colombian operations. +Interest expense was favorably impacted by a gain on debt extinguishment of $2.5 million associated with the repurchase of portions of our 2028 Notes and 2029 Notes in 2022. Excluding the effects of the gain, interest expense would have increased by $0.7 million, a 1.8% increase. Additionally, on December 30, 2021, we repaid the final $50 million of borrowings under the 2019 Term Loan Agreement , and as a result had no remaining borrowings under the Term Loan Agreement as of December 31, 2021. Accordingly, we did not incur interest expense related to the Term Loan Agreement in 2022. +Income Taxes +The effective tax rate decreased by approximately 0.8% to 7.9% for 2022 compared to 8.7% for 2021. Our effective income tax rate fluctuates based on, among other factors, changes in pre-tax income in countries with varying statutory tax rates, changes in valuation allowances, and the impacts of various other permanent adjustments. +The ability to recognize a portion of our U.S. federal and state net operating losses resulted in a significant impact, through changes in valuation allowances, in our effective tax rate for the year ended December 31, 2022. This benefit was partly offset by state and local income taxes and various other permanent adjustments. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +Liquidity and Capital Resources +Our primary sources of liquidity are cash and cash equivalents, availability under our revolving credit facility and cash provided by operating activities. As of December 31, 2022, we had approximately $278 million in working capital, including $138 million of cash and cash equivalents, and approximately $600 million available under our revolving credit facility. +We have an amended and restated credit agreement (as amended, the “Credit Agreement”), which is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $100 million and a swing line facility that, at any time outstanding, is limited to, the lesser of $50 million and the amount of the swing line provider’s unused commitment. As of December 31, 2022, we had no borrowings outstanding under our revolving credit facility, and no letters of credit outstanding under the Credit Agreement and, as a result, had available borrowing capacity of approximately $600 million at that date. Of the revolving credit commitments, $50 million expires on March 27, 2024, $133.3 million expires on March 27, 2025, and the remaining $416.7 million expires on March 27, 2026. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $300 million, not to exceed total commitments of $900 million. Additionally, we have the option, subject to certain conditions, to exercise one one-year extension of the maturity date. +Loans under the Credit Agreement bear interest by reference, at our election, to the SOFR rate or base rate, as described in “Item 7A” below. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant. The Credit Agreement also contains a financial covenant that requires our total debt to capitalization ratio, expressed as a percentage, not exceed 50%. +We also have a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any +37 +letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. A letter of credit fee is payable by us equal to 1.50% times the amount of outstanding letters of credit. +We had $65.0 million letters of credit outstanding at December 31, 2022 under the Reimbursement Agreement. We maintain letters of credit primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2022, no amounts had been drawn under the letters of credit. +Our outstanding debt at December 31, 2022 consisted of $489 million of 3.95% Senior Notes due 2028 (the “2028 Notes”) and $348 million of 5.15% Senior Notes due 2029 (the “2029 Notes”). We were in compliance with all covenants at December 31, 2022. +For a full description of the Credit Agreement, the Reimbursement Agreement, the 2028 Notes and the 2029 Notes, see Note 9 of Notes to consolidated financial statements in Item 8 of this Report. +Cash Requirements +We believe our current liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt and pay cash dividends for at least the next 12 months. +If we pursue opportunities for growth that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +A portion of our capital expenditures can be adjusted and managed by us to match market demand and activity levels. Based on our current outlook for activity, we expect our capital expenditures for 2023 to be approximately $550 million. The majority of these expenditures are expected to be used for normal, recurring items necessary to support our business. +We anticipate $28.5 million of expenditures in 2023 related to various contractual obligations such as certain purchase commitments and operating lease liabilities. +As of December 31, 2022, we had working capital of $278 million, including cash and cash equivalents of $138 million, compared to working capital of $148 million, including cash and cash equivalents of $118 million, at December 31, 2021. +During 2022, our sources of cash flow included: +• +$566 million from operating activities, and +• +$26.1 million in proceeds from the disposal of property and equipment. +During 2022, our uses of cash flow included: +• +$439 million to make capital expenditures for the betterment and refurbishment of drilling and pressure pumping equipment and, to a much lesser extent, equipment for our other businesses, to acquire and procure equipment to support our contract drilling, pressure pumping, directional drilling, oilfield rentals and manufacturing operations, and to fund investments in oil and natural gas properties on a non-operating working interest basis, +• +$70.1 million for repurchases of our common stock, +• +$43.1 million to pay dividends on our common stock, +• +$18.6 million for repurchases of our 2028 Notes, and +• +$1.2 million for repurchases of our 2029 Notes. +38 +We paid cash dividends during the year ended December 31, 2022 as follows: +Per Share +Total +(in thousands) +Paid on March 17, 2022 +$ +0.04 +$ +8,611 +Paid on June 16, 2022 +0.04 +8,652 +Paid on September 15, 2022 +0.04 +8,673 +Paid on December 15, 2022 +0.08 +17,160 +Total cash dividends +$ +0.20 +$ +43,096 +On February 8, 2023, our Board of Directors approved a cash dividend on our common stock in the amount of $0.08 per share to be paid on March 16, 2023 to holders of record as of March 2, 2023. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend in order to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +We may, at any time and from time to time, seek to retire or purchase our outstanding debt for cash through open-market purchases, privately negotiated transactions, redemptions or otherwise. Such repurchases, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. +In September 2013, our Board of Directors approved a stock buyback program. In October 2022, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $300 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2022, we had remaining authorization to purchase approximately $243 million of our outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2022, 2021 and 2020 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”) and the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), and not pursuant to the stock buyback program. Upon the issuance of shares for the Pioneer acquisition in October 2021, we withheld shares with respect to Pioneer employees’ tax withholding obligations. +Treasury stock acquisitions during the years ended December 31, 2022, 2021 and 2020 were as follows (dollars in thousands): +2022 +2021 +2020 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +Purchases pursuant to stock buyback program +3,254,599 +57,173 +— +— +5,826,266 +20,000 +Acquisitions pursuant to long-term incentive plan +1,372,101 +23,237 +451,196 +3,727 +239,669 +1,179 +Purchases in connection with Pioneer acquisition +— +— +275,477 +2,601 +— +— +Other +3,027 +28 +— +— +— +— +Treasury shares at end of period +88,758,722 +$ +1,453,079 +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +As of December 31, 2022, we had unrecognized compensation costs of $26.0 million and $11.1 million related to our unvested restricted stock units and our unvested Performance Units, respectively. The weighted-average remaining vesting periods for these awards were 1.40 years and 1.20 years, respectively as of December 31, 2022. See Note 12 of Notes to consolidated financial statements in Item 8 of this Report for additional discussion regarding our stock-based compensation. +Commitments — As of December 31, 2022, we had commitments to purchase major equipment totaling approximately $130 million for our drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. As of December 31, 2022, the remaining minimum obligation under these agreements was approximately $25.6 million, of which approximately $22.6 million and $3.0 million relate to the remainder of 2023 and 2024, respectively. +39 +See Note 10 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our current commitments and contingencies as of December 31, 2022. +Operating lease liabilities totaled $24.7 million at December 31, 2022. See Note 13 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our operating leases as of December 31, 2022. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Critical Accounting Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. Accounting estimates and assumptions discussed in this section are those considered to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. We believe the following critical accounting estimates used in preparing our consolidated financial statements address all important areas where the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. For additional information on our accounting policies, see Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Allowance for credit losses — We utilize an accounts receivable aging schedule and historical credit loss information to estimate expected credit losses. We evaluate our accounts receivable periodically through review of historical collection experience, current aging status of the customer accounts, financial condition of our customers, and the overall economic environment of the oil and gas industry. Any customers that have experienced a deterioration in credit quality are removed from the pool and evaluated individually. This process involves judgment and estimation. Accordingly, our results of operations can be affected by adjustments to the allowance due to actual write-offs that differ from estimated amounts. In applying our methodology of estimating credit losses, we determined that there were no material changes to our credit loss rates. See Note 4 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Depreciation and amortization — Property and equipment is carried at cost less accumulated depreciation and amortization. No provision for salvage value is considered in determining depreciation of our property and equipment. We calculate depreciation and amortization on our assets based on the estimated useful lives that we believe are reasonable. The estimated useful lives are subject to key assumptions such as maintenance, utilization and job variation. These estimates may change due to a number of factors such as changes in operating conditions or advances in technology. The method of depreciation does not change whenever equipment becomes idle. Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. See Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Fair values of assets acquired and liabilities assumed in acquisitions — Assets acquired and liabilities assumed in a business combination are recorded at their estimated fair values on the date of acquisition. The difference between the purchase price amount and the net fair value of assets acquired and liabilities assumed is recognized as goodwill on the balance sheet if the purchase price exceeds the estimated net fair value or as a bargain purchase gain on the income statement if the purchase price is less than the estimated net fair value. We apply significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involves the use of significant estimates and assumptions with respect to market day rates, direct operating costs, rig utilization percentages, expectations regarding the amount of future capital and operating costs, and discount rates. Changes in these judgments or estimates can have a material impact on the valuation of the respective assets and liabilities acquired and our results of operations in periods after acquisition, such as through depreciation and amortization expense. The allocation of the purchase price may be modified up to one year after the acquisition date as more information is obtained about the fair value of assets acquired and liabilities assumed. See Note 2 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Impairment of long-lived assets — We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. If the carrying amount of the asset is not recoverable based on its estimated undiscounted cash flows expected to result from the use and eventual disposition, an impairment loss is recognized in +40 +an amount by which its carrying amount exceeds its estimated fair value. The inputs used to determine such fair value are primarily based upon internally developed cash flow models. Our cash flow models are based on a number of estimates regarding future operations that may be subject to significant variability, are sensitive to changes in market conditions, and are reasonably likely to change in the future. We determined no triggering events occurred in 2022. See Note 6 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Accruals for self-insured levels of insurance coverage — We maintain insurance coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employers’ liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. Our insurance accruals are based on claims filed and estimates of claims incurred but not reported and are developed by our management with assistance from our third-party actuary and third-party claims administrator. The insurance accruals are influenced by our past claims experience factors, which have a limited history, and by published industry development factors. If we experience insurance claims or costs above or below our historically evaluated levels, our estimates could be materially affected. The frequency and number of claims or incidents could vary significantly over time, which could materially affect our self-insurance liabilities. Additionally, the actual costs to settle the self-insurance liabilities could materially differ from the original estimates and cause us to incur additional costs in future periods associated with prior year claims. +Income taxes — We are subject to income taxes in the United States and other foreign jurisdictions. We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. In assessing the realizability of our deferred tax assets, if it is more likely than not that a portion of the deferred tax assets will not be realized in a future period, the deferred tax assets will be reduced by a valuation allowance. We believe the valuation allowance is a critical accounting estimate because it is susceptible to change from period to period, requires assumptions about our future income over the lives of the deferred tax assets, and because the impact of increasing or decreasing the valuation allowance is potentially material to our results of operations. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We recognize tax benefits related to uncertain tax positions when, in our judgment, it is more likely than not that such positions will be sustained on examination, including resolutions of any related appeals or litigation, based on the technical merits. We adjust our liabilities for uncertain tax positions when our judgment changes as a result of new information previously unavailable. We routinely monitor the potential impact of these situations. As of December 31, 2022, we have no unrecognized tax benefits. +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in 2020 and early 2021. However, market fundamentals are now strong, as demand increased for drilling and completions equipment and services in 2022, and industry supply of Tier-1, super-spec rigs and premium pressure pumping equipment remains constrained. We expect our rig count in the United States will average 130 rigs in the first quarter and then grow modestly throughout the remainder of 2023. The current demand for equipment and services and strong pricing environment remain dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, response to the COVID-19 pandemic (including any resurgences and/or lockdowns in the United States and abroad) and continued focus by exploration and production companies and service companies on capital discipline. Oil prices averaged $82.79 per barrel in the fourth quarter of 2022. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $5.55 per MMBtu in the fourth quarter of 2022. +In light of these and other factors, we expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access sources of capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs +41 +or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +Due to improving activity levels and increasing tightness in the overall labor market, we have seen general oilfield cost inflation across our segments during 2022, including increases in the cost of labor, services and supplies. This inflation, combined with the increasing challenge of attracting and retaining employees, is increasing the complexity of reactivating equipment. In response to this challenge, combined with the increasing market tightness for our drilling and completion services, we increased the pricing for our drilling and completion services in 2022 . +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Non-GAAP Financial Measures +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by accounting principles generally accepted in the United States of America (“GAAP”). We define Adjusted EBITDA as net income (loss) from continuing operations plus income tax expense (benefit), net interest expense, and depreciation, depletion, amortization and impairment expense (including impairment of goodwill). We present Adjusted EBITDA as a supplemental disclosure because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) from continuing operations in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the GAAP measure of net income (loss) from continuing operations. Our computations of Adjusted EBITDA may not be the same as similarly titled measures of other companies. Set forth below is a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income (loss) from continuing operations. +Year Ended December 31, +2022 +2021 +2020 +(in thousands) +Net income (loss) from continuing operations +$ +154,658 +$ +(657,079 +) +$ +(803,692 +) +Income tax expense (benefit) +13,204 +(62,702 +) +(127,326 +) +Net interest expense +39,896 +41,756 +39,516 +Depreciation, depletion, amortization and impairment +483,945 +849,178 +670,910 +Impairment of goodwill +— +— +395,060 +Adjusted EBITDA +$ +691,703 +$ +171,153 +$ +174,468 +42 +Adjusted Gross Margin +We define “Adjusted gross margin” as revenues less direct operating costs (excluding depreciation, depletion, amortization and impairment expense). Adjusted gross margin is included as a supplemental disclosure because it is a useful indicator of our operating performance. +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +(in thousands) +For the year ended December 31, 2022 +Revenues +$ +1,316,672 +$ +1,022,413 +$ +216,498 +$ +92,009 +Less direct operating costs +(832,180 +) +(781,385 +) +(179,135 +) +(53,850 +) +Less depreciation, depletion, amortization and impairment +(337,513 +) +(98,162 +) +(15,428 +) +(27,671 +) +GAAP gross margin +146,979 +142,866 +21,935 +10,488 +Depreciation, depletion, amortization and impairment +337,513 +98,162 +15,428 +27,671 +Adjusted gross margin +$ +484,492 +$ +241,028 +$ +37,363 +$ +38,159 +For the year ended December 31, 2021 +Revenues +$ +664,030 +$ +523,756 +$ +111,481 +$ +57,814 +Less direct operating costs +(463,456 +) +(475,953 +) +(101,628 +) +(40,911 +) +Less depreciation, depletion, amortization and impairment +(618,879 +) +(159,305 +) +(40,270 +) +(24,865 +) +GAAP gross margin +(418,305 +) +(111,502 +) +(30,417 +) +(7,962 +) +Depreciation, depletion, amortization and impairment +618,879 +159,305 +40,270 +24,865 +Adjusted gross margin +$ +200,574 +$ +47,803 +$ +9,853 +$ +16,903 +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As of December 31, 2022, we would have had exposure to interest rate market risk associated with any outstanding borrowings and letters of credit that we had under the Credit Agreement and amounts owed under the Reimbursement Agreement. +Loans under the Credit Agreement bear interest by reference, at our election, to the SOFR rate or base rate. The applicable margin on SOFR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based upon our credit rating. As of December 31, 2022, the applicable margin on SOFR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. A letter of credit fee is payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10% to 0.30% based upon our credit rating. As of December 31, 2022, we had no borrowings or letters of credit outstanding under the Credit Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. We are obligated to pay Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2022, no amounts had been disbursed under any letters of credit. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +43 +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2022, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2022, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2022. +The effectiveness of our internal control over financial reporting as of December 31, 2022 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None . +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections. +None . +44 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference . +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Corporate Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website within four business days following the date of the amendment or waiver. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +45 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Report of Independent Registered Public Accounting Firm +The report of our independent registered public accounting firm (PCAOB ID: 238 ) with respect to the above-referenced financial statements and their report on internal control over financial reporting are included on page F-2 of this Report. +(a)(3) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger, dated July 5, 2021, among Patterson-UTI Energy, Inc., Crescent Merger Sub Inc., Crescent Ranch Second Merger Sub LLC, and Pioneer Energy Services Corp. (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed on July 6, 2021). +2.2 +Amendment No. 1 to Agreement and Plan of Merger, dated September 13, 2021, among Patterson-UTI Energy, Inc., Crescent Merger Sub Inc., Crescent Ranch Second Merger Sub LLC, and Pioneer Energy Services Corp. (incorporated by reference to Exhibit 2.2 to our Current Report on Form 8-K filed on October 4, 2021). +3.1 +Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation, as amended (filed August 9, 2004 as Exhibit 3.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference). +3.3 +Certificate of Elimination with respect to Series A Participating Preferred Stock (filed October 27, 2011 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.4 +Certificate of Amendment to Restated Certificate of Incorporation, as amended (filed July 30, 2018 as Exhibit 3.4 to our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018 and incorporated herein by reference). +3.5 +Fourth Amended and Restated Bylaws (filed February 12, 2019 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.6 +Certificate of Designation of the Series A Junior Participating Preferred Stock of Patterson-UTI Energy, Inc., dated April 22, 2020 (filed April 23, 2020 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.1 +Description of Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934 (filed February 16, 2022 as Exhibit 4.1 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 and incorporated herein by reference). +4.2 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +46 +4.3 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.4 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.5 +Form of 3.95% Senior Note due 2028 (included in Exhibit 4.4 above). +4.6 +Base Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.7 +First Supplemental Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.8 +Form of 5.15% Senior Note due 2029 (included in Exhibit 4.7 above). +10.1 +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, including Form of Executive Officer Restricted Stock Award Agreement, Form of Executive Officer Stock Option Agreement, Form of Non-Employee Director Restricted Stock Award Agreement and Form of Non-Employee Director Stock Option Agreement (filed June 21, 2005 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.2 +First Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.3 +Second Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed June 6, 2008 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.4 +Third Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Fourth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed April 27, 2010 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Fifth Amendment to the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (filed August 2, 2010 as Exhibit 10.4 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.7 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan, as amended and restated and further amended effective June 6, 2019 (filed June 6, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.8 +Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (incorporated by reference to Annex A of our Definitive Proxy Statement on Schedule 14A, filed on April 12, 2021).* +10.9 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 3, 2021 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.10 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to our Current Report on Form 8-K and incorporated herein by reference).* +10.11 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to our Current Report on Form 8-K and incorporated herein by reference).* +10.12 +Form of Non-Employee Director Restricted Stock Unit Award Agreement (filed May 3, 2022 as Exhibit 10.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.13 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed August 3, 2021 as Exhibit 10.3 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +47 +10.14 +2020 Phantom Unit Award Agreement, dated May 11, 2020, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 28, 2020 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.15 +Amendment No. 1 to Performance Share Award Agreement, dated May 11, 2020, by and between Patterson-UTI Energy, Inc. and William A. Hendricks, Jr. (filed July 28, 2020 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.16 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to our Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.17 +Employment Agreement, dated as of January 1, 2023, by and between Patterson-UTI Energy, Inc. and James M. Holcomb (filed on January 3, 2023 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.18 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.19 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 3, 2021 as Exhibit 10.4 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.20 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference).* +10.21 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed August 3, 2021 as Exhibit 10.6 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.22 +Employment Agreement, dated as of September 3, 2017, between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.23 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed August 3, 2021 as Exhibit 10.5 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.24 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of Kenneth N. Berns, Curtis W. Huff, Terry H. Hunt, Seth D. Wexler, William Andrew Hendricks, Jr., Michael W. Conlon, Tiffany J. Thom, James M. Holcomb, C. Andrew Smith, Janeen S. Judah, Cesar Jaime and Julie J. Robertson (filed April 28, 2004 as Exhibit 10.11 to our Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.25 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to our Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.26 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.27 +Amended and Restated Credit Agreement dated March 27, 2018 among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2018 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +48 +10.28 +Amendment No. 1 to Amended and Restated Credit Agreement, dated March 26, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 26, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.29 +Amendment No. 2 to Amended and Restated Credit Agreement, dated March 27, 2020, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2020 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.30 +Amendment No. 3 to Amended and Restated Credit Agreement, dated November 9, 2022, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +10.31 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.++ +101.INS +Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.+ +101.SCH +Inline XBRL Taxonomy Extension Schema Document+ +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document+ +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document+ +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document+ +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document+ +104 +Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101) . +* Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ Filed herewith. +++ Furnished herewith. +Item 16. Form 10-K Summary +None. +49 +INDEX TO CONS OLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2022 and 2021 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2022, 2021 and 2020 +F-5 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2022, 2021 and 2020 +F-6 +Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2022, 2021 and 2020 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2022, 2021 and 2020 +F-8 +Notes to Consolidated Financial Statements +F-9 +F- 1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of operations, of comprehensive income (loss), of changes in stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2022, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +F- 2 +Critical Audit Matters +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Revenue Recognition – Operating Revenues +As described in Notes 1 and 3 to the consolidated financial statements, operating revenues relate to contract drilling, pressure pumping, directional drilling, oilfield rentals, equipment servicing and electrical control and automation activity. The Company recognizes revenue based on the customers’ ability to benefit from the services provided in an amount that reflects the consideration the Company expects to receive in exchange for those services. This typically happens when the service is performed. The Company recognized total operating revenues of $2,648 million for the year ended December 31, 2022. +The principal consideration for our determination that performing procedures relating to revenue recognition for operating revenues is a critical audit matter is a high degree of auditor effort in performing procedures related to the Company’s revenue recognition. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the recording of revenue upon completion of the service. These procedures also included, among others, (i) evaluating revenue transactions by testing the issuance and settlement of invoices and credit memos; (ii) tracing transactions not settled to a detailed listing of accounts receivable; (iii) confirming a sample of outstanding customer invoice balances at year end and obtaining and inspecting source documents, including invoices, contracts, proof of service, and subsequent cash receipts, where applicable, for confirmations not returned; and (iv) testing the completeness and accuracy of data provided by management. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 13, 2023 +We have served as the Company’s auditor since 1993. +F- 3 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED BALANCE SHEETS +December 31, +2022 +2021 +(In thousands, except share data) +ASSETS +Current assets: +Cash and cash equivalents +$ +137,553 +$ +117,524 +Accounts receivable, net of allowance for credit losses of $ 2,875 and $ 8,493 at +December 31, 2022 and 2021, respectively +565,520 +356,083 +Federal and state income taxes receivable +399 +67 +Inventory +58,038 +42,359 +Other +67,909 +67,620 +Total current assets +829,419 +583,653 +Property and equipment, net +2,260,576 +2,331,755 +Right of use asset +20,841 +19,024 +Intangible assets, net +5,845 +7,537 +Deposits on equipment purchases +13,051 +849 +Other +10,881 +11,055 +Deferred tax assets, net +3,210 +3,975 +Total assets +$ +3,143,823 +$ +2,957,848 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +237,056 +$ +190,219 +Federal and state income taxes payable +4,644 +232 +Accrued liabilities +304,143 +238,511 +Lease liability +5,123 +6,891 +Total current liabilities +550,966 +435,853 +Long-term lease liability +19,594 +18,108 +Long-term debt, net of debt discount and issuance costs of $ 5,468 and $ 6,432 at +December 31, 2022 and 2021, respectively +830,937 +852,323 +Deferred tax liabilities, net +28,738 +29,234 +Other +48,065 +12,843 +Total liabilities +1,478,300 +1,348,361 +Commitments and contingencies (see Note 10) +Stockholders’ equity: +Preferred stock, par value $ 0.01 ; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $ 0.01 ; authorized 400,000,000 shares with 302,325,853 +and 299,268,967 issued and 213,567,131 and 215,139,972 outstanding at +December 31, 2022 and 2021, respectively +3,023 +2,993 +Additional paid-in capital +3,202,973 +3,171,536 +Retained deficit +( 87,394 +) +( 198,316 +) +Accumulated other comprehensive income +— +5,915 +Treasury stock, at cost, 88,758,722 shares and 84,128,995 shares at +December 31, 2022 and 2021, respectively +( 1,453,079 +) +( 1,372,641 +) +Total stockholders’ equity +1,665,523 +1,609,487 +Total liabilities and stockholders’ equity +$ +3,143,823 +$ +2,957,848 +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEME NTS OF OPERATIONS +Year Ended December 31, +2022 +2021 +2020 +(In thousands, except per share data) +Operating revenues: +Contract drilling +$ +1,316,672 +$ +664,030 +$ +669,126 +Pressure pumping +1,022,413 +523,756 +336,111 +Directional drilling +216,498 +111,481 +73,356 +Other +92,009 +57,814 +45,656 +Total operating revenues +2,647,592 +1,357,081 +1,124,249 +Operating costs and expenses: +Contract drilling +832,180 +463,456 +380,822 +Pressure pumping +781,385 +475,953 +310,261 +Directional drilling +179,135 +101,628 +69,050 +Other +53,850 +40,911 +41,790 +Depreciation, depletion, amortization and impairment +483,945 +849,178 +670,910 +Impairment of goodwill +— +— +395,060 +Selling, general and administrative +116,589 +92,382 +97,611 +Credit loss expense +— +( 1,500 +) +5,606 +Merger and integration expenses +2,069 +12,060 +— +Restructuring expenses +— +— +38,338 +Other operating (income) expenses, net +( 12,592 +) +763 +7,059 +Total operating costs and expenses +2,436,561 +2,034,831 +2,016,507 +Operating income (loss) +211,031 +( 677,750 +) +( 892,258 +) +Other income (expense): +Interest income +360 +222 +1,254 +Interest expense, net of amount capitalized +( 40,256 +) +( 41,978 +) +( 40,770 +) +Other +( 3,273 +) +( 275 +) +756 +Total other expense +( 43,169 +) +( 42,031 +) +( 38,760 +) +Income (loss) from continuing operations before income taxes +167,862 +( 719,781 +) +( 931,018 +) +Income tax expense (benefit) +13,204 +( 62,702 +) +( 127,326 +) +Income (loss) from continuing operations +154,658 +( 657,079 +) +( 803,692 +) +Income from discontinued operations, net of tax +— +2,534 +— +Net income (loss) +$ +154,658 +$ +( 654,545 +) +$ +( 803,692 +) +Net income (loss) per common share - basic: +Continuing operations +$ +0.72 +$ +( 3.37 +) +$ +( 4.27 +) +Discontinued operations +$ +— +$ +0.01 +$ +— +Net income (loss) - basic +$ +0.72 +$ +( 3.36 +) +$ +( 4.27 +) +Net income (loss) per common share - diluted: +Continuing operations +$ +0.70 +$ +( 3.37 +) +$ +( 4.27 +) +Discontinued operations +$ +— +$ +0.01 +$ +— +Net income (loss) - diluted +$ +0.70 +$ +( 3.36 +) +$ +( 4.27 +) +Weighted average number of common shares outstanding: +Basic +215,935 +195,021 +188,013 +Diluted +219,496 +195,021 +188,013 +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2022 +2021 +2020 +(In thousands) +Net income (loss) +$ +154,658 +$ +( 654,545 +) +$ +( 803,692 +) +Other comprehensive income (loss): +Foreign currency translation adjustment, net of taxes of $ 0 for all periods +1,793 +503 +( 66 +) +Release of cumulative translation adjustment, net of taxes of $ 3,770 for 2022 and $ 0 for 2021 and 2020, respectively +( 7,708 +) +— +— +Total comprehensive income (loss) +$ +148,743 +$ +( 654,042 +) +$ +( 803,758 +) +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Other +Number of +Paid-in +Retained +Comprehensive +Treasury +Shares +Amount +Capital +Earnings (Deficit) +Income +Stock +Total +(In thousands) +Balance, December 31, 2019 +269,372 +$ +2,694 +$ +2,875,680 +$ +1,294,902 +$ +5,478 +$ +( 1,345,134 +) +$ +2,833,620 +Net loss +— +— +— +( 803,692 +) +— +— +( 803,692 +) +Foreign currency translation adjustment +— +— +— +— +( 66 +) +— +( 66 +) +Issuance of restricted stock +333 +3 +( 3 +) +— +— +— +— +Vesting of restricted stock units +1,324 +13 +( 13 +) +— +— +— +— +Stock-based compensation +— +— +26,572 +— +— +— +26,572 +Payment of cash dividends ($ 0.10 per share) +— +— +— +( 18,862 +) +— +— +( 18,862 +) +Dividend equivalents +— +— +— +( 334 +) +— +— +( 334 +) +Purchase of treasury stock +— +— +— +— +— +( 21,179 +) +( 21,179 +) +Balance, December 31, 2020 +271,029 +$ +2,710 +$ +2,902,236 +$ +472,014 +$ +5,412 +$ +( 1,366,313 +) +$ +2,016,059 +Net loss +— +— +— +( 654,545 +) +— +— +( 654,545 +) +Foreign currency translation adjustment +— +— +— +— +503 +— +503 +Shares issued for acquisition +26,274 +263 +247,762 +— +— +— +248,025 +Issuance of restricted stock +621 +6 +( 6 +) +— +— +— +— +Vesting of restricted stock units +1,345 +14 +( 14 +) +— +— +— +— +Stock-based compensation +— +— +21,558 +— +— +— +21,558 +Payment of cash dividends ($ 0.08 per share) +— +— +— +( 15,605 +) +— +— +( 15,605 +) +Dividend equivalents +— +— +— +( 180 +) +— +— +( 180 +) +Purchase of treasury stock +— +— +— +— +— +( 6,328 +) +( 6,328 +) +Balance, December 31, 2021 +299,269 +$ +2,993 +$ +3,171,536 +$ +( 198,316 +) +$ +5,915 +$ +( 1,372,641 +) +$ +1,609,487 +Net income +— +— +— +154,658 +— +— +154,658 +Foreign currency translation adjustment +— +— +— +— +1,793 +— +1,793 +Release of cumulative translation adjustment +— +— +— +— +( 7,708 +) +— +( 7,708 +) +Issuance of restricted stock +980 +10 +( 10 +) +— +— +— +— +Vesting of restricted stock units +1,437 +14 +( 14 +) +— +— +— +— +Exercise of stock options +640 +6 +10,362 +— +— +— +10,368 +Stock-based compensation +— +— +21,099 +— +— +— +21,099 +Payment of cash dividends ($ 0.20 per share) +— +— +— +( 43,096 +) +— +— +( 43,096 +) +Dividend equivalents +— +— +— +( 640 +) +— +— +( 640 +) +Purchase of treasury stock +— +— +— +— +— +( 80,438 +) +( 80,438 +) +Balance, December 31, 2022 +302,326 +$ +3,023 +$ +3,202,973 +$ +( 87,394 +) +$ +— +$ +( 1,453,079 +) +$ +1,665,523 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2022 +2021 +2020 +(In thousands) +Cash flows from operating activities: +Net income (loss) +$ +154,658 +$ +( 654,545 +) +$ +( 803,692 +) +Adjustments to reconcile net income (loss) to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +483,945 +849,178 +670,910 +Impairment of goodwill +— +— +395,060 +Dry holes and abandonments +119 +178 +1,285 +Deferred income tax expense (benefit) +6,998 +( 62,980 +) +( 125,283 +) +Stock-based compensation expense +21,099 +21,558 +26,572 +Net gain on asset disposals +( 12,075 +) +( 1,426 +) +( 3,079 +) +Net gain on insurance reimbursement +— +— +( 4,172 +) +Write-down of capacity reservation contract +— +— +9,207 +Credit loss expense +— +( 1,500 +) +5,606 +Restructuring expenses, non-cash +— +— +25,067 +Gain on early debt extinguishment +( 2,461 +) +— +( 3,596 +) +Amortization of debt discount and issuance costs +835 +839 +912 +Changes in operating assets and liabilities: +Accounts receivable +( 209,226 +) +( 147,356 +) +173,862 +Income taxes receivable/payable +4,171 +4,516 +1,635 +Inventory and other assets +( 14,154 +) +( 5,850 +) +27,192 +Accounts payable +38,986 +50,941 +( 46,576 +) +Accrued liabilities +65,091 +50,271 +( 61,266 +) +Other liabilities +28,202 +( 7,812 +) +( 10,786 +) +Net cash used in operating activities of discontinued operations +— +( 516 +) +— +Net cash provided by operating activities +566,188 +95,496 +278,858 +Cash flows from investing activities: +Acquisitions, net of cash acquired +— +( 29,358 +) +— +Purchases of property and equipment +( 436,797 +) +( 166,320 +) +( 145,481 +) +Proceeds from disposal of assets and insurance claims +26,074 +23,339 +20,929 +Other +( 2,504 +) +( 522 +) +( 424 +) +Net cash provided by investing activities of discontinued operations +— +41,267 +— +Net cash used in investing activities +( 413,227 +) +( 131,594 +) +( 124,976 +) +Cash flows from financing activities: +Purchases of treasury stock +( 70,070 +) +( 6,328 +) +( 21,179 +) +Dividends paid +( 43,096 +) +( 15,605 +) +( 18,862 +) +Proceeds from borrowings under revolving credit facility +150,000 +— +— +Repayment of borrowings under revolving credit facility +( 150,000 +) +— +— +Repayment of senior notes +( 19,760 +) +— +( 12,525 +) +Repayment of term loan +— +( 50,000 +) +( 50,000 +) +Debt issuance costs +( 455 +) +— +( 584 +) +Net cash used in financing activities +( 133,381 +) +( 71,933 +) +( 103,150 +) +Effect of foreign exchange rate changes on cash +449 +640 +( 2 +) +Net increase (decrease) in cash and cash equivalents +20,029 +( 107,391 +) +50,730 +Cash and cash equivalents at beginning of year +117,524 +224,915 +174,185 +Cash and cash equivalents at end of year +$ +137,553 +$ +117,524 +$ +224,915 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $ 976 in 2022, $ 260 in 2021 +and $ 431 in 2020 +$ +( 39,855 +) +$ +( 40,464 +) +$ +( 43,368 +) +Income taxes +( 1,526 +) +4,196 +3,709 +Non-cash investing and financing activities: +Net increase (decrease) in payables for purchases of property and equipment +$ +7,953 +$ +31,393 +$ +( 30,241 +) +Issuance of common stock for business acquisitions +— +248,025 +— +Net (increase) decrease in deposits on equipment purchases +( 12,202 +) +867 +6,350 +Cashless exercise of stock options +10,368 +— +— +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +N OTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “we,” “us,” “our,” “ours” and like terms), is a Houston, Texas-based oilfield services company that primarily owns and operates in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment. Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. Our pressure pumping business operates primarily in Texas and the Appalachian region. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States, and we provide services that improve the statistical accuracy of directional and horizontal wellbores. We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. In addition, we own and invest, as a non-operating, working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +In the fourth quarter of 2021, we completed the acquisition of Pioneer Energy Services Corp. (“Pioneer”). Through the Pioneer acquisition, we acquired Pioneer’s 100 % pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. The purchase price allocation was finalized in 2022. The measurement period adjustments did not have a material impact on our consolidated financial statements. +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business to Clearwell Dynamics, LLC. The sale price was $ 43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses were presented as a discontinued operation during the fourth quarter of 2021. +In the second quarter of 2020, we closed our Canadian drilling operations in response to our longer-term outlook for the western Canadian market. As a result of the closure, we recorded an impairment of $ 8.3 million. In April 2022, we sold certain assets to substantially complete our exit from our Canadian operations. The Canadian dollar was our functional currency for our Canadian operations. Prior to the substantial completion of our exit, the effects of exchange rate changes were reflected in accumulated other comprehensive income, which is a separate component of stockholders ’ equity. Upon substantial completion of our exit, we released the $ 7.7 million cumulative translation adjustment, net of tax of $ 3.8 million, from accumulated other comprehensive income into net income (loss). The release resulted in an $ 11.5 million pre-tax gain, which was recorded in other operating (income) expenses, net. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries, we have no controlling financial interests in any other entity which would require consolidation. As used in these notes, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its business operations through its wholly-owned subsidiaries and has no employees or independent operations. Certain prior year amounts have been reclassified to conform to current year presentation. The U.S. dollar is the functional currency for all of our operations. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates . +Revenue recognition — Revenues from our contract drilling, pressure pumping, directional drilling, oilfield rentals, equipment servicing and electrical control and automation activities are recognized as services are performed. All of the wells we drilled in 2022, 2021 and 2020 were drilled under daywork contracts. Revenue is presented net of any sales tax charged to the customer that we are required to remit to local or state governmental taxing authorities. +F- 9 +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +Leases — We have operating leases for operating locations, corporate offices and certain operating equipment. We determine if a contract contains a lease at inception or as a result of an acquisition. A right-of-use asset and corresponding lease liability are recognized on our consolidated balance sheet at commencement at an amount based on the present value of the remaining lease payments over the lease term. Renewal options are included in the right-of-use asset and lease liability if it is reasonably certain that we will exercise the option, and termination options are included in the right-of-use asset and lease liability if it is not reasonably certain we will exercise the option. By our policy election, right-of-use assets and lease liabilities with an initial term of one year or less are not recognized for leasing arrangements, and non-lease and lease components are treated as a single lease component instead of bifurcating lease. Lease expense is recognized on a straight-line basis. If available, we use the rate implicit in the lease at commencement date to discount the lease payments. If the implicit rate is not readily determinable, we use our incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. As of December 31, 2022, we did not have any finance leases. +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for credit losses represents our estimate of the amount of probable credit losses existing in our accounts receivable. See Note 4 for our methodology on allowance of credit losses. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectible, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with our pressure pumping activities, materials used in our directional drilling and equipment servicing business and spare parts for our Colombia contract drilling business. Such inventories are stated at the lower of cost or net realizable value, with cost determined using the average cost method. +Other current assets — Other current assets includes reimbursement from our workers compensation insurance carrier for claims in excess of our deductible in the amount of $ 34.6 million and $ 29.9 million at December 31, 2022 and 2021 , respectively. +Property and equipment — Property and equipment is carried at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever equipment becomes idle. The estimated useful lives, in years, are shown below: +Useful Lives +Equipment +1.25 - 15 +Buildings +15 - 20 +Other +3 - 12 +Long-lived assets, including property and equipment, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives. In the event a triggering event is identified, we estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. Assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings for impairment assessment. Cash flow estimates are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. Asset impairments are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any impairment is measured at fair value. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in our consolidated statements of operations. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized +F- 10 +using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds our undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). We review unproved oil and natural gas properties quarterly to assess potential impairment. Our impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to oil and natural gas properties of approximately $ 4.5 million, $ 1.3 million and $ 11.2 million was recorded for the years ended December 31, 2022, 2021 and 2020, respectively. +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. Our policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — We recognize the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards, see Note 12. +As share-based compensation expense recognized in our consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, based on historical experience. Forfeitures are estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates. +Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds with original maturities of three months or less. +Recently Adopted Accounting Standards — In December 2019, the FASB issued an accounting standards update to simplify the accounting for income taxes. The amendments in the update were effective for public business entities for fiscal years beginning after December 15, 2020, with early adoption permitted. We adopted this new guidance on January 1, 2021, and there was no material impact on our consolidated financial statements. +Recently Issued Accounting Standards — In March 2020, the FASB issued an accounting standards update to provide temporary optional expedients that simplify the accounting for contract modifications to existing debt agreements expected to arise from the market transition from LIBOR to alternative reference rates. The amendments in the update are effective as of March 12, 2020 through December 31, 2022 and may be applied to contract modifications from the beginning of an interim period that includes or is subsequent to March 12, 2020. We plan to adopt this standard when LIBOR is discontinued, and we do not expect this new guidance will have a material impact on our consolidated financial statements. +In October 2021, the FASB issued an accounting standards update, which requires contract assets and contract liabilities (i.e., deferred revenue) acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers. Generally, this new guidance will result in the acquirer recognizing contract assets and contract liabilities at the same amounts recorded by the acquiree. Historically, such amounts were recognized by the acquirer at fair value in acquisition accounting. The amendments should be applied prospectively to acquisitions occurring on or after the effective date. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2022, with early adoption permitted. We plan to adopt this new guidanc e on January 1, 2023, and we do not expect this new guidance will have a material impact on our consolidated financial statements. +F- 11 +2. Acquisitions and Discontinued Operations +Pioneer Energy Services Corp. +On October 1, 2021, we completed the acquisition of Pioneer by acquiring 100 % of its equity interests . Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $ 30 million cash, which based on the closing price of our common stock of $ 9.44 on October 1, 2021, valued the transaction at approximately $ 278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. +The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of our common stock issued to Pioneer shareholders +26,274 +Our common stock price on October 1, 2021 +$ +9.44 +Fair value of common stock issued +$ +248,025 +Plus cash consideration +$ +30,007 +Total fair value of consideration transferred +$ +278,032 +A discounted cash flow model was used by a third-party specialist in determining the fair value of the property and equipment and intangible assets. We applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to market day rates, direct operating costs, rig utilization percentages, expectations regarding the amount of future capital and operating costs, and discount rates. The purchase price allocation was finalized in the third quarter of 2022. The measurement period adjustments did not have a material impact on our consolidated financial statements. +Identifiable assets acquired +Cash and cash equivalents +$ +649 +Accounts receivable +44,832 +Inventory +8,513 +Held for sale assets +73,649 +Other current assets +4,479 +Property and equipment +215,356 +Other long-term assets +9,698 +Total identifiable assets acquired +357,176 +Liabilities assumed +Accounts payable and accrued liabilities +30,222 +Held for sale liabilities +32,160 +Deferred income taxes +11,832 +Other long-term liabilities +4,930 +Total liabilities assumed +79,144 +Total net assets acquired +$ +278,032 +Approximately $ 41.5 million of revenues and $ 30.5 million of direct operating expenses attributed to the Pioneer acquisition are included in our consolidated statements of operations for the period from the closing date on October 1, 2021 through December 31, 2021, excluding the acquired well servicing rig business and the wireline businesses that have been presented as a discontinued operation in our consolidated statements of operations. Revenues and direct operating expenses for our discontinued operations are presented below. +Pro Forma +The results of Pioneer’s operations since the Pioneer merger date of October 1, 2021, are included in our consolidated statements of operations. The following pro forma condensed combined financial information was derived from our and Pioneer’s historical financial statements, excluding the well servicing rig business and wireline business that were disposed on December 31, 2021, and gives effect to the acquisition as if it had occurred on January 1, 2020. The below information reflects pro forma adjustments based on available information and certain assumptions we believe are reasonable, including (i) adjustments related to the depreciation and amortization of the fair value of acquired fixed assets, (ii) removal of the historical interest expense, loss on debt extinguishment and reorganization expenses of the acquired entities and (iv) the tax benefit of the aforementioned pro forma adjustments. +F- 12 +The pro forma results of operations do not include any cost savings or other synergies that may result from the Pioneer acquisition. The pro forma results of operations also do not include any estimated costs that have been or will be incurred to integrate Pioneer operations. The pro forma results of operations include our merger and integration-related costs of $ 12.1 million and Pioneer ’ s merger related costs of $ 4.6 million for the year ended December 31, 2021. +The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the Pioneer acquisition taken place on January 1, 2020; furthermore, the financial information is not intended to be a projection of future results. The following table summarizes our selected financial information on a pro forma basis (in thousands, except per share data): +2021 +2020 +(Unaudited) +Revenues +$ +1,464,351 +$ +1,255,554 +Net loss +$ +( 666,032 +) +$ +( 809,996 +) +During 2021, we incurred costs related to the Pioneer acquisition totaling $ 12.1 million, which are included in our consolidated statements of operations as “Merger and integration expenses.” +Discontinued Operations +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business to Clearwell Dynamics, LLC. The sale price was $ 43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses were presented as a discontinued operation in the consolidated financial statements during the fourth quarter of 2021. +Summarized operating results from discontinued operations that are included in our consolidated statements of operations for the year ended December 31, 2021 are shown below (in thousands): +2021 +Operating revenues: +Wireline revenue +$ +9,868 +Well servicing revenue +19,652 +Total operating revenues +29,520 +Operating costs and expenses: +Wireline +10,465 +Well servicing +16,585 +Total operating costs and expenses +27,050 +Operating income +2,470 +Total other income (expense) +64 +Income from discontinued operations before income taxes +2,534 +Income tax benefit +— +Income from discontinued operations, net of tax +$ +2,534 +3. Revenues +ASC Topic 606 Revenue from Contracts with Customers +Revenue is recognized based on our customers’ ability to benefit from our services in an amount that reflects the consideration we expect to receive in exchange for those services. This typically happens when the service is performed. Services that primarily generate our earned revenue include the operating business segments of contract drilling, pressure pumping and directional drilling, which comprise our reportable segments. We also derive revenues from our other operations, which include our operating business segments of oilfield rentals, equipment servicing, electrical controls and automation, and oil and natural gas working interests. For more information on our business segments, including disaggregated revenue recognized from contracts with customers, see Note 17. +Within each of our operating segments, the services we provide represent a series of distinct services, generally provided daily, that are substantially the same, with the same pattern of transfer to the customer. Because our customers benefit equally throughout the +F- 13 +service period and our efforts in providing services are incurred relatively evenly over the period of performance, revenue is recognized over time as we provide services to the customer. +We are a non-operating working interest owner of oil and natural gas properties primarily located in Texas and New Mexico. The ownership terms are outlined in joint operating agreements for each well between the operator of the well and the various interest owners, including us, who are considered non-operators of the well. We receive revenue each period for our working interest in the well during the period. The revenue received for the working interests from these oil and gas properties does not fall under the scope of the new revenue standard, and therefore, will continue to be reported under current guidance ASC 932-323 Extractive Activities – Oil and Gas, Investments – Equity Method and Joint Ventures . +Reimbursement Revenue — Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +Operating Lease Revenue — Lease income from equipment that we lease to others is recognized on a straight-line basis over the lease term. Lease income recognized during the years ended December 31, 2022, 2021 and 2020 was not material. +Accounts Receivable and Contract Liabilities +Accounts receivable is our right to consideration once it becomes unconditional. Payment terms typically range from 30 to 60 days. +Accounts receivable balances were $ 561 million and $ 352 million as of December 31, 2022 and 2021, respectively. These balances do not include amounts related to our oil and gas working interests as those contracts are excluded from Topic 606. Accounts receivable balances are included in “Accounts receivable” in our consolidated balance sheets. +We do not have any significant contract asset balances. Contract liabilities include prepayments received from customers prior to the requested services being completed. Once the services are complete and have been invoiced, the prepayment is applied against the customer’s account to offset the accounts receivable balance. Also included in contract liabilities are payments received from customers for the initial mobilization of newly constructed or upgraded rigs that were moved on location to the initial well site. These mobilization payments are allocated to the overall performance obligation and amortized over the initial term of the contract. During the year ended December 31, 2022 , $ 1.4 million of such payments were amortized and recorded in drilling revenue. During the year ended December 31, 2021, no such payments were amortized and recorded in drilling revenue. +Total contract liability balances were $ 147.8 million and $ 60.3 million as of December 31, 2022 and December 31, 2021, respectively. The $ 87.5 million increase was primarily due to customer prepayments. In 2022, w e recognized $ 59.7 million of revenue that was included in the contract liability balance at the beginning of the period. Revenue related to our contract liabilities balance is expected to be recognized through 2026. The $ 110.2 million current portion of our contract liability balance is included in “Accrued liabilities” and $ 37.6 million noncurrent portion of our contract liability balance is included in “Other” in our consolidated balance sheets. +Contract Costs +Costs incurred for newly constructed rigs or rig upgrades based on a contract with a customer are considered capital improvements and are capitalized to drilling equipment and depreciated over the estimated useful life of the asset. +Remaining Performance Obligations +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2022 was approximately $ 830 million. Approximately 32 % of the total contract drilling backlog in the United States at December 31, 2022 is reasonably expected to remain at December 31, 2023 . We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to fees for other services such as for mobilization, other than initial mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. For contracts that contain variable dayrate pricing, our backlog calculation uses the dayrate in effect for periods where the dayrate is fixed, and, for periods that remain subject to variable pricing, uses commodity pricing or other related indices in effect at December 31, 2022. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts on which we have received notice for the rig to be placed on standby, our backlog calculation uses the standby rate for the period over which we expect to receive the standby rate. For contracts on which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period over which we expect to receive the lower rate. +F- 14 +4. Credit Losses +ASC Topic 326 Current Expected Credit Losses (CECL) +Our customers are primarily oil and natural gas exploration and production companies, which are collectively exposed to oil and natural gas commodity price risk. Our customers require services from us at various stages of the exploration and production process. Accordingly, we have aggregated our trade receivables by segment. We utilize an accounts receivable aging schedule and historical credit loss information to estimate expected credit losses. We evaluate our accounts receivable periodically through review of historical collection experience, current aging status of the customer accounts, financial condition of our customers, and the overall economic environment of the oil and gas industry. Any customers that have experienced a deterioration in credit quality are removed from the pool and evaluated individually. +During 2021, we reversed $ 1.5 million of our credit loss provision related to certain customers who had previously experienced a deterioration in credit quality. Since initially recording loss provisions for these receivables, we have collected portions of the accounts that were deemed uncollectible. During 2022, we wrote-off $ 5.6 million of our credit loss provision related to certain customers, as we reached final settlements. +The allowance for credit losses related to accounts receivable as of December 31, 2021 and 2022, and changes for the periods ended December 31, 2021 and 2022 are as follows (in thousands): +Balance at December 31, 2020 +$ +10,842 +Provision for expected credit losses +( 1,500 +) +Write-offs +( 849 +) +Balance at December 31, 2021 +8,493 +Write-offs +( 5,618 +) +Balance at December 31, 2022 +$ +2,875 +5. Inventory +Inventory consisted of the following at December 31, 2022 and 2021 (in thousands): +2022 +2021 +Finished goods +$ +28 +$ +515 +Work-in-process +2,341 +882 +Raw materials and supplies +55,669 +40,962 +Inventory +$ +58,038 +$ +42,359 +We maintain certain surplus quantities of spare parts that serve as backup components and maintenance materials for our directional drilling and Colombia contract drilling operations. In 2021, advances in technologies rendered certain directional drilling equipment, and spare parts used to service that equipment, obsolete. Based on our assessment of limited alternative uses or active markets to recapture costs, we recorded a write-down of $ 4.0 million. The write-down is recorded in “Operating costs and expenses - Directional drilling” in our consolidated statements of operations. There was no similar write-down in 2022. +6. Property and Equipment +Property and equipment consisted of the following at December 31, 2022 and 2021 (in thousands): +2022 +2021 +Equipment +$ +7,551,099 +$ +7,742,101 +Oil and natural gas properties +236,156 +229,403 +Buildings +175,212 +182,280 +Land +23,610 +24,562 +Total property and equipment +7,986,077 +8,178,346 +Less accumulated depreciation, depletion, amortization and impairment +( 5,725,501 +) +( 5,846,591 +) +Property and equipment, net +$ +2,260,576 +$ +2,331,755 +F- 15 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment, intangible assets and liabilities for 2022, 2021 and 2020 (in thousands): +2022 +2021 +2020 +Depreciation and impairment expense +$ +472,969 +$ +818,999 +$ +644,943 +Amortization expense +2,891 +24,606 +19,281 +Depletion expense +8,085 +5,573 +6,686 +Total +$ +483,945 +$ +849,178 +$ +670,910 +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are abandoned. There were no impairments in 2022. In the fourth quarter of 2021, we identified 43 legacy non-super-spec rigs and equipment to be abandoned. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 43 rigs that were abandoned had limited commercial opportunity. We recorded a $ 220 million charge related to this abandonment in the fourth quarter of 2021 . In the second quarter of 2020, we recorded an impairment of $ 8.3 million related to the closing of our Canadian drilling operations. +We also periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are abandoned. In the fourth quarter of 2021, we recorded a charge of $ 32.2 million related to the abandonment of approximately 0.2 million horsepower within our pressure pumping fleet. The majority of these units were frac pumps but also included pump down units. These units were abandoned due to changes in customer preferences for dual fuel, advancements in technology, and prohibitive reactivation costs. There were no similar charges in 2020 or 2022. +We also periodically evaluate our directional drilling assets. In the fourth quarter of 2021, we abandoned certain directional drilling equipment totaling $ 2.5 million and recorded a charge on our developed technology intangible asset of $ 11.4 million due to advances in technology that rendered those assets, and their related spare parts inventory, obsolete. There were no similar charges in 2020 or 2022. +7. Goodwill and Intangible Assets +Goodwill — As a result of a triggering event in the first quarter of 2020, we fully impaired our remaining goodwill balance, and as a result, we had no goodwill balance as of December 31, 2021 or December 31, 2022. At times when we have a goodwill balance, we are required to evaluate goodwill at least annually as of December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For impairment testing purposes, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing are our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if this is the case, any necessary goodwill impairment is determined using a quantitative impairment test. From time to time, we may perform quantitative testing for goodwill impairment in lieu of performing the qualitative assessment. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +Intangible Assets — Our intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight-line basis. The following table identifies the segment and weighted average useful life of each of our intangible assets: +Weighted Average +Segment +Useful Life +(in years) +Developed technology +Directional drilling +10.0 +Other +Directional drilling and Other operations +5.5 +During 2021, we achieved certain internal advancements in our directional drilling technology that have rendered obsolete certain technology acquired as part of the MS Directional acquisition. Accordingly, we recorded a charge of $ 11.4 million to abandon these developed technology intangibles and certain related internal use software. +F- 16 +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2022 and 2021 are as follows (in thousands): +2022 +2021 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Developed technology +$ +7,772 +$ +( 3,773 +) +$ +3,999 +$ +55,772 +$ +( 50,996 +) +$ +4,776 +Other +3,250 +( 1,404 +) +1,846 +4,135 +( 1,374 +) +2,761 +Intangible assets, net +$ +11,022 +$ +( 5,177 +) +$ +5,845 +$ +59,907 +$ +( 52,370 +) +$ +7,537 +Amortization and impairment expense on intangible assets of approximately $ 1.3 million, $ 24.0 million, and $ 19.3 million was recorded for the years ended December 31, 2022, 2021 and 2020 , respectively, which included an $ 11.4 million impairment in 2021. The remaining amortization expense associated with finite-lived intangible assets is expected to be as follows (in thousands): +Year ending December 31, +2023 +$ +1,454 +2024 +1,454 +2025 +1,269 +2026 +777 +2027 +777 +Thereafter +114 +Total +$ +5,845 +8. Accrued Liabilities +Accrued expenses consisted of the following at December 31, 2022 and 2021 (in thousands): +2022 +2021 +Salaries, wages, payroll taxes and benefits +$ +73,308 +$ +52,252 +Workers’ compensation liability +67,853 +67,921 +Property, sales, use and other taxes +10,119 +9,673 +Insurance, other than workers’ compensation +3,644 +6,494 +Accrued interest payable +10,522 +11,226 +Accrued restructuring expenses +— +7,884 +Deferred revenue +110,215 +60,282 +Other +28,482 +22,779 +Accrued liabilities +$ +304,143 +$ +238,511 +9. Long-Term Debt +Long-term debt consisted of the following at December 31, 2022 and 2021 (in thousands): +Effective Interest Rate +December 31, 2022 +December 31, 2021 +3.95 % Senior Notes +4.03 % +$ +488,505 +$ +509,505 +5.15 % Senior Notes +5.26 % +347,900 +349,250 +836,405 +858,755 +Less deferred financing costs and discounts +( 5,468 +) +( 6,432 +) +Total +$ +830,937 +$ +852,323 +Credit Agreement — On March 27, 2018 , we entered into an amended and restated credit agreement ( as amended, the “Credit Agreement”) among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender, each of the other lenders and letter of credit issuers party thereto, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Syndication Agents, Royal Bank of Canada, as Documentation Agent and Wells Fargo Securities, LLC, The Bank of Nova Scotia and U.S. Bank National Association, as Co-Lead Arrangers and Joint Book Runners. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $ 600 million, including a letter of credit facility that, at any time outstanding, is limited to $ 100 million and a swing line facility that, at any time outstanding, is limited to the lesser of $ 50 million and the unused portion of the commitment of the swing line provider at such time. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $ 300 million, not to exceed total commitments of $ 900 million. +F- 17 +On November 9, 2022, we entered into Amendment No. 3 to Amended and Restated Credit Agreement (“Amendment No. 3”) which, among other things, (i) revised the capacity under the letter of credit facility to $ 100 million; (ii) revised the capacity under the swing line facility to the lesser of $ 50 million and the amount of the swing line provider ’ s unused commitment; (iii) changed the LIBOR reference rate to a SOFR reference rate; and (iv) extended the maturity date for $ 416.7 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026 . As a result, of the $ 600 million of revolving credit commitments under the Credit Agreement, the maturity date for $ 416.7 million of such commitments is March 27, 2026 ; the maturity date for $ 133.3 million of such commitments is March 27, 2025 ; and the maturity date for the remaining $ 50 million of such commitments is March 27, 2024 . +Loans under the Credit Agreement bear interest by reference, at our election, to the SOFR rate or base rate. The applicable margin on SOFR rate loans varies from 1.00 % to 2.00 % and the applicable margin on base rate loans varies from 0.00 % to 1.00 %, in each case determined based upon our credit rating. As of December 31, 2022, the applicable margin on SOFR rate loans was 1.75 % and the applicable margin on base rate loans was 0.75 % . A letter of credit fee is payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10 % to 0.30 % based upon our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt in excess of the Priority Debt Basket (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to incur debt and grant liens. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at one of the two ratings agencies. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50 %. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2022. +As of December 31, 2022 , we had no borrowings outstanding under our revolving credit facility. We had no letters of credit outstanding under the Credit Agreement at December 31, 2022 and, as a result, had available borrowing capacity of $ 600 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2022 , we had $ 65.0 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any letters of credit. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25 % per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amou nts. A letter of credit fee is payable by us equal to 1.50% times the amount of outstanding letters of credit. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +F- 18 +2028 Senior Notes and 2029 Senior Notes — On January 19, 2018, we completed an offering of $ 525 million in aggregate principal amount of our 3.95 % Senior Notes due 2028 (the “2028 Notes”). On November 15, 2019, we completed an offering of $ 350 million in aggregate principal amount of our 5.15% Senior Notes due 2029 (the “2029 Notes”). +During the fourth quarter of 2020, we elected to repurchase portions of our 2028 Notes and 2029 Notes in the open market. The principal amounts retired through these transactions totaled $ 15.5 million of our 2028 Notes and $ 0.8 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $ 3.4 million and $ 0.2 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations. +During the fourth quarter of 2022, we elected to repurchase portions of our 2028 Notes and 2029 Notes in the open market. The principal amounts retired through these transactions totaled $ 21.0 million of our 2028 Notes and $ 1.4 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $ 2.3 million and $ 0.1 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations. +We pay interest on the 2028 Notes on February 1 and August 1 of each year . The 2028 Notes will mature on February 1, 2028 . The 2028 Notes bear interest at a rate of 3.95 % per annum. +We pay interest on the 2029 Notes on May 15 and November 15 of each year. The 2029 Notes will mature on November 15, 2029 . The 2029 Notes bear interest at a rate of 5.15 % per annum. +The 2028 Notes and 2029 Notes (together, the “Senior Notes”) are our senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The Senior Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the Senior Notes. None of our subsidiaries are currently required to be a guarantor under the Senior Notes. If our subsidiaries guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +At our option, we may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100 % of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, and on August 15, 2029, in the case of the 2029 Notes, at our option, we may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100 % of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date. +The indentures pursuant to which the Senior Notes were issued include covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indentures. +Upon the occurrence of a change of control triggering event, as defined in the indentures, each holder of the Senior Notes may require us to purchase all or a portion of such holder’s Senior Notes at a price equal to 101 % of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +Debt issuance costs — We incurred approximately $ 4.6 million in debt issuance costs in connection with the Credit Agreement. We also incurred an additional $ 0.4 million in debt issuance costs in connection with our entry into Amendment No. 2 and $ 0.5 million in debt issuance costs in connection with our entry into Amendment No.3. We incurred approximately $ 1.6 million in debt issuance costs in connection with the 2028 Notes and approximately $ 1.0 million in debt issuance costs in connection with the 2029 Notes. These costs were deferred and are being recognized as interest expense over the term of the underlying debt. Debt issuance costs, except those related to line-of-credit arrangements, are presented in the balance sheet as a direct reduction of the carrying amount of the related debt. Debt issuance costs related to line-of-credit arrangements are included in “Other non-current assets” in our consolidated balance sheets. Amortization of debt issuance costs is reported as interest expense. +F- 19 +Interest expense related to the amortization of debt issuance costs was approximately $ 1.0 million, $ 1.0 million, and $ 1.1 million for the years ended December 31, 2022, 2021 and 2020 , respectively. Amortization of debt issuance costs for the year ended December 31, 2022 includes $ 0.1 million of debt issuance costs that were expensed as a result of the early redemption of a portion of our 2028 Notes and 2029 Notes and $ 0.5 million of debt issuance costs that was incurred as a result of the entry into Amendment No. 3. Amortization of debt issuance costs for the year ended December 31, 2021 includes minimal debt issuance costs that were expensed as a result of the complete prepayment of our borrowings under our Term Loan Agreement. Amortization of debt issuance costs for the year ended December 31, 2020 includes $ 0.1 million of debt issuance costs that were expensed as a result of the early redemption of a portion of our 2028 Notes and 2029 Notes as well as the partial repayment of our borrowings under our Term Loan Agreement. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2022 (in thousands): +Year ending December 31, +2023 +$ +— +2024 +— +2025 +— +2026 +— +2027 +— +Thereafter +836,405 +Total +$ +836,405 +10. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2022 , we maintained letters of credit in the aggregate amount of $ 65.0 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2022 , no amounts had been drawn under the letters of credit. +As of December 31, 2022 , we had commitments to purchase major equipment totaling approximately $ 130 million for our contract drilling, pressure pumping, directional drilling and oilfield rentals businesses. +Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. As of December 31, 2022, the remaining minimum obligation under these agreements was approximately $ 25.6 million, of which approximately $ 22.6 million and $ 3.0 million relate to the remainder of 2023 and 2024, respectively. +Contingencies – Our operations are subject to many hazards inherent in the businesses in which it operates, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, +F- 20 +automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $ 1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $ 1.0 million per occurrence deductible on our equipment insurance coverage, a $ 5.0 million per occurrence deductible on our pressure pumping equipment without fire suppression systems, a $ 10.0 million per occurrence deductible on our general liability coverage, a $ 2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $ 5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows or results of operations. +Other Matters — We have a Change in Control Agreement with one of our Executive Vice Presidents (the “Specified Employee”). The Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless we notify the Specified Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by us other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreement), then the Specified Employee shall generally be entitled to, among other things: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2 times the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under our welfare plans for up to two years . +The Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +We have Employment Agreements with our Chief Executive Officer, Chief Financial Officer, Chief Operating Officer and General Counsel. Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such termination at least 30 days before the effective date of such termination. Under specified circumstances, we may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by providing written notice 10 -30 days, depending on the nature of the cause trigger, before the effective date of such termination and granting at least 10 – 20 days, depending on the nature of the cause trigger, to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of such termination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by us to not be capable of being cured, the executive may be terminated for cause on the date the written notice is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following our decision to terminate the executive other than for Cause, or termination by the executive for Good Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by us without Cause, or the executive terminates his employment for Good Reason: +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the Chief Financial Officer, Chief Operating Officer and General Counsel) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees; +• +we will accelerate vesting of all time-based equity, phantom equity and long-term cash incentive awards on the 60th day following the executive’s termination +F- 21 +and will cause all performance-based equity, phantom equity and long-term cash incentive awards to continue in effect through the end of the applicable performance period and vest based on actual results as if the executive had remained employed through the end of the applicable performance period; and +• +we will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +If our decision to terminate other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years , and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the Chief Financial Officer, Chief Operating Officer and General Counsel) of subsidized benefits continuation coverage. +11. Stockholders’ Equity +Cash Dividend — On February 8, 2023 , our Board of Directors approved a cash dividend on our common stock in the amount of $ 0.08 per share to be paid on March 16, 2023 to holders of record as of March 2, 2023 . The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +Share Repurchases and Acquisitions — In September 2013, our Board of Directors approved a stock buyback program. In October 2022, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $ 300 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2022, we had remaining authorization to purchase approximately $ 243 million of our outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2022, 2021 and 2020 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”) and the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), and not pursuant to the stock buyback program. Upon the issuance of shares for the Pioneer acquisition in October 2021, we withheld shares with respect to Pioneer employees’ tax withholding obligations. +Treasury stock acquisitions during the years ended December 31, 2022, 2021 and 2020 were as follows (dollars in thousands): +2022 +2021 +2020 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +77,336,387 +$ +1,345,134 +Purchases pursuant to stock buyback program +3,254,599 +57,173 +— +— +5,826,266 +20,000 +Acquisitions pursuant to long-term incentive plan +1,372,101 +23,237 +451,196 +3,727 +239,669 +1,179 +Purchases in connection with Pioneer acquisition +— +— +275,477 +2,601 +— +— +Other +3,027 +28 +— +— +— +— +Treasury shares at end of period +88,758,722 +$ +1,453,079 +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +Release of Cumulative Translation Adjustment — In April 2022, we sold certain assets to substantially complete our exit from our Canadian operations. We used the Canadian dollar as our functional currency for our Canadian operations. Prior to the substantial completion of our exit, the effects of exchange rate changes were reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. Upon substantial completion of our exit, we released the $ 7.7 million cumulative translation adjustment, net of tax of $ 3.8 million, from accumulated other comprehensive income into net income (loss) in the second quarter of 2022. The release resulted in an $ 11.5 million pre-tax gain, which was recorded in other operating income, net. +F- 22 +12. Stock-based Compensation +We use share-based payments to compensate employees and non-employee directors. We recognize the cost of share-based payments under the fair-value-based method. Share-based awards include equity instruments in the form of stock options, restricted stock, or restricted stock units that have included service conditions and, in certain cases, performance conditions. Our share-based awards also include share-settled performance unit awards. Share-settled performance unit awards are accounted for as equity awards. In 2020, we granted performance-based cash-settled phantom units, which are accounted for as a liability classified award. We issue shares of common stock when vested stock options are exercised, when restricted stock is granted and after restricted stock units and share-settled performance unit awards vest. +On June 3, 2021, our stockholders approved the 2021 Plan. No additional awards will be granted under any of our previously existing plans after such date. The aggregate number of shares of Common Stock authorized for grant under the 2021 Plan is approximately 13.5 million, which includes approximately 4.9 million shares previously authorized for issuance under our 2014 Plan. +Our share-based compensation plans at December 31, 2022 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +2021 Plan +13,467,480 +3,851,825 +3,689,156 +2014 Plan +— +3,588,486 +— +Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended +— +672,500 +— +A summary of the 2021 Plan follows: +• +The Compensation Committee of the Board of Directors administers the Plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +The Plan provides that the total compensation paid to each non-employee director for their service as such, whether in cash or in equity awards under the 2021 Plan (based on the grant date fair value of any such awards) during a single fiscal year may not exceed $ 750,000 ; however, the foregoing limit will instead be $ 1,000,000 for any fiscal year in which the non-employee director is first appointed to the Board of Directors or any fiscal year in which the non-employee director serves as chairman or lead director. +• +All options granted under the 2021 Plan are granted with an exercise price equal to or greater than fair market value of our common stock at the time the option is granted. +• +The Plan provides for awards of incentive and non-incentive stock options, stock appreciation rights (“SARs”), restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalent rights. +Options granted under the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan, as amended, and 2014 Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. +Stock Options — We estimate the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of our common stock over the most recent period equal to the expected term of the options as of the date such options are granted. The expected term assumptions are based on our experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the years ended December 31, 2022, 2021 and 2020. +F- 23 +Stock option activity for the year ended December 31, 2022 follows: +Weighted Average +Shares +Exercise Price Per Share +Outstanding at beginning of year +3,720,150 +$ +20.93 +Exercised +( 640,000 +) +$ +16.20 +Expired +( 175,000 +) +$ +17.37 +Outstanding at end of year +2,905,150 +$ +22.19 +Exercisable at end of year +2,905,150 +$ +22.19 +Options outstanding and exercisable at December 31, 2022 have an intrinsic value of approximately $ 0.1 million and a weighted-average remaining contractual term of 2.04 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2022, 2021 and 2020 follows (in thousands, except per share data): +2022 +2021 +2020 +Weighted-average grant date fair value of stock options granted (per share) +NA +NA +NA +Aggregate grant date fair value of stock options vested during the year +$ +— +$ +89 +$ +89 +Aggregate intrinsic value of stock options exercised +$ +410 +$ +— +$ +— +As of December 31, 2022 , no options to purchase shares were outstanding and unvested. +Restricted Stock Units — For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Forfeitable dividend equivalents are accrued on certain restricted stock units that will be paid upon vesting. We use the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2022 follows: +Weighted Average +Time +Performance +Grant Date Fair +Based +Based +Value Per Share +Non-vested restricted stock units outstanding at beginning of year +3,044,719 +359,315 +$ +8.31 +Granted +1,554,849 +— +$ +17.37 +Vested +( 1,437,286 +) +— +$ +7.32 +Forfeited +( 71,436 +) +— +$ +13.15 +Non-vested restricted stock units outstanding at end of year +3,090,846 +359,315 +$ +12.71 +As of December 31, 2022 , approximately 3.2 million non-vested restricted stock units outstanding are expected to vest. Additional information as of December 31, 2022 with respect to these non-vested restricted stock units follows (dollars in thousands): +Aggregate intrinsic value +$ +54,672 +Weighted-average remaining vesting period +1.40 years +Unrecognized compensation cost +$ +25,998 +Performance Unit Awards — We have granted share-settled performance unit awards to certain employees (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive a grant of shares of common stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is generally the three-year period commencing on April 1 of the year of grant. +The performance goals for the Performance Units are tied to our total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. For the performance units granted in April 2021 and April 2022, the peer group also includes three market indices and one market index, respectively. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. Under the Performance Units granted beginning in April 2019, the recipients will receive the target number of shares if our total shareholder return during the performance period, when compared to the peer group, is at the 55th percentile. If our total shareholder return during the performance period, when compared to the peer group, is at the 75th percentile or higher, then the recipients will receive two times the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is at the 25th percentile, then the recipients will only receive one-half of the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is between the 25th and 55th percentile, or the 55th and 75th percentile, then the shares to be received by the recipients will be determined using linear interpolation for levels of achievement between these points. +F- 24 +Under the Performance Units granted beginning in April 2019, the payout shall not exceed the target number of shares if our absolute total shareholder return is negative or zero. Additionally, the Performance Units granted in April 2020 will not pay out if our total shareholder return is not equal to or greater than the total stockholder return of the S&P 500 Index for the performance period. +The total target number of shares with respect to the Performance Units for the years 2017-2022 is set forth below: +2022 +2021 +2020 +2019 +2018 +2017 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +414,000 +843,000 +500,500 +489,800 +310,700 +186,198 +In May 2020, 332,773 shares were issued to settle the 2017 Performance Units. In April 2021, 621,400 shares were issued to settle the 2018 Performance Units. In April 2022, 979,600 shares were issued to settle the 2019 Performance Units. The Performance Units granted in 2020, 2021 and 2022 have not reached the end of their respective performance periods. +Because the Performance Units are share-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2022 +2021 +2020 +2019 +2018 +2017 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +10,743 +$ +7,225 +$ +826 +$ +9,958 +$ +8,004 +$ +5,780 +The weighted-average fair value calculations for performance units granted during the years ended December 31, 2022, 2021 and 2020 were based on the following weighted-average assumptions set forth below: +2022 +2021 +2020 +Risk-free interest rate (1) +2.9 +% +0.4 +% +0.4 +% +Expected stock volatility (2) +86.5 +% +83.2 +% +66.2 +% +Expected dividend yield (3) +1.0 +% +1.3 +% +7.7 +% +Expected term (in years) +3 +3 +3 +(1) +The risk-free interest rate is based on U.S. Treasury securities for the expected term of the performance units. +(2) +Expected volatilities are based on the daily closing price of our stock based upon historical experience over a three-year period . +(3) +Expected dividend yield is based on the annualized dividend in effect on the measurement date and the stock price on the grant date. +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2022 +2021 +2020 +2019 +2018 +2017 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2022 +$ +2,686 +$ +2,408 +$ +275 +$ +830 +NA +NA +Year ended December 31, 2021 +NA +$ +1,806 +$ +275 +$ +3,319 +$ +667 +NA +Year ended December 31, 2020 +NA +NA +$ +206 +$ +3,319 +$ +2,668 +$ +642 +As of December 31, 2022, we had unrecognized compensation cost of $ 11.1 million related to our unvested Performance Units. The weighted-average remaining vesting period for these unvested Performance Units was 1.20 years as of December 31, 2022. +Dividends on Equity Awards – Dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +Phantom Units — In May 2020, the Compensation Committee approved a grant of long-term performance-based phantom units to our Chief Executive Officer and President, William A. Hendricks, Jr (the “Phantom Units”). The Phantom Units were granted outside of the 2014 Plan. Pursuant to this phantom unit grant, Mr. Hendricks may earn from 0 % to 200 % of a target award of 298,500 phantom units based on our achievement of the same performance conditions over the same performance period that applies to the Performance Units granted in April 2020, as described above. Earned Phantom Units, if any, will be settled in 2023 , following completion of the three-year performance p eriod, in a cash payment equal to the number of earned phantom units multiplied by our average trading price per share over the twenty consecutive trading days ending March 31, 2023. +F- 25 +Because the Phantom Units are cash-settled awards, they are accounted for as a liability classified award. The grant date fair value of the Phantom Units was $ 1.2 million. Compensation expense is recognized on a straight-line basis over the performance period, with the amount recognized fluctuating as a result of the Phantom Units being remeasured to fair value at the end of each reporting period due to their liability-award classification. We recognized $ 6.0 million, $ 1.8 million, and $ 0.6 million in compensation expense associated with the Phantom Units in 2022, 2021, and 2020, respectively. +13. Leases +ASC Topic 842 Leases +We have entered into operating leases for operating locations, corporate offices and certain operating equipment. These leases have remaining lease terms of approximately two months to eleven years as of December 31, 2022. Currently, we do not have any finance leases. +Lease expense consisted of the following for the years ended December 31, 2022, 2021, and 2020 (in thousands): +Year Ended December 31, +2022 +2021 +2020 +Operating lease cost +$ +5,664 +$ +4,984 +$ +6,911 +Short-term lease expense (1) +— +41 +2 +Total lease expense (2) +$ +5,664 +$ +5,025 +$ +6,913 +(1) +Short-term lease expense represents expense related to leases with a contract term of one year or less. +(2) +Total lease expense is recorded in operating costs for the respective segments and within "selling, general and administrative" in our consolidated statements of operations. +Supplemental cash flow information related to leases for the years ended December 31, 2022, 2021 and 2020 is as follows (in thousands): +Year Ended December 31, +2022 +2021 +2020 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ +6,858 +$ +7,323 +$ +11,576 +Right of use assets obtained in exchange for lease obligations: +Operating leases +$ +6,530 +$ +6,413 +$ +1,763 +Supplemental balance sheet information related to leases as of December 31, 2022 and 2021 is as follows: +December 31, 2022 +December 31, 2021 +Weighted Average Remaining Lease Term: +Operating leases +6.1 years +4.8 years +Weighted Average Discount Rate: +Operating leases +4.1 +% +3.8 +% +Maturities of operating lease liabilities as of December 31, 2022 are as follows (in thousands): +Year ending December 31, +2023 +$ +5,928 +2024 +5,114 +2025 +4,432 +2026 +3,785 +2027 +3,144 +Thereafter +5,848 +Total lease payments +28,251 +Less imputed interest +( 3,534 +) +Total +$ +24,717 +F- 26 +14. Income Taxes +Income before income taxes for the United States for the year ended December 31, 2022 was $ 166 million. Loss before income taxes for the United States for the years ended December 31, 2021 and 2020 was $ 721 million and $ 917 million, respectively. Income before income taxes for non-U.S. jurisdictions for the years ended December 31, 2022 and 2021 was $ 2 million and $ 0.9 million, respectively. Loss before income taxes for non-U.S. jurisdictions for years ended December 31, 2020 was $ 14.2 million. +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2022, 2021 and 2020 are as follows (in thousands): +2022 +2021 +2020 +Federal income tax expense (benefit): +Current +$ +480 +$ +— +$ +( 1,977 +) +Deferred +11,820 +( 86,878 +) +( 107,334 +) +12,300 +( 86,878 +) +( 109,311 +) +State income tax expense (benefit): +Current +2,647 +144 +225 +Deferred +( 4,896 +) +23,028 +( 17,949 +) +( 2,249 +) +23,172 +( 17,724 +) +Foreign income tax expense (benefit): +Current +2,750 +134 +( 291 +) +Deferred +403 +870 +— +3,153 +1,004 +( 291 +) +Total income tax expense (benefit): +Current +5,877 +278 +( 2,043 +) +Deferred +7,327 +( 62,980 +) +( 125,283 +) +Total income tax expense (benefit) +$ +13,204 +$ +( 62,702 +) +$ +( 127,326 +) +The difference between the statutory U.S. federal income tax rate and the effective income tax rate for the years ended December 31, 2022, 2021 and 2020 is summarized as follows: +2022 +2021 +2020 +Statutory tax rate +21.0 +% +21.0 +% +21.0 +% +State income taxes - net of the federal income tax benefit +3.0 +3.0 +1.7 +State deferred tax remeasurement +9.4 +( 0.8 +) +— +Goodwill impairment +— +— +( 8.2 +) +Valuation allowance +( 33.4 +) +( 13.3 +) +( 0.2 +) +U.S. impact of foreign operations +1.3 +— +— +Effect of foreign taxes +1.6 +( 0.1 +) +( 0.1 +) +Non-deductible compensation +4.3 +( 0.3 +) +— +Share-based compensation +( 1.9 +) +( 0.3 +) +( 0.5 +) +Non-deductible expenses +1.2 +( 0.2 +) +( 0.1 +) +Other differences, net +1.4 +( 0.3 +) +0.1 +Effective tax rate +7.9 +% +8.7 +% +13.7 +% +Our effective income tax rate fluctuates based on, among other factors, changes in pre-tax income in countries with varying statutory tax rates, changes in valuation allowances, and the impacts of various other permanent adjustments. +The ability to recognize a portion of our U.S. federal and state net operating losses resulted in a significant impact, through changes in valuation allowances, in our effective tax rate for the year ended December 31, 2022. This benefit was partly offset by state and local income taxes and various other permanent adjustments. +The tax effect of temporary differences and tax attributes representing deferred tax assets and liabilities at December 31, 2022 and 2021 are as follows (in thousands): +F- 27 +2022 +2021 +Deferred tax assets: +Net operating loss carryforwards +$ +382,936 +$ +457,362 +Tax credits +4,222 +4,453 +Expense associated with stock options and restricted stock +8,178 +9,364 +Workers’ compensation allowance +15,770 +14,833 +Other deferred tax asset +25,020 +26,483 +436,126 +512,495 +Less: +Allowance to reduce deferred tax asset to expected realizable value +( 91,685 +) +( 189,737 +) +Total deferred tax assets +344,441 +322,758 +Deferred tax liabilities: +Property and equipment basis difference +( 355,129 +) +( 335,980 +) +Other +( 14,840 +) +( 12,037 +) +Total deferred tax liabilities +( 369,969 +) +( 348,017 +) +Net deferred tax liability +$ +( 25,528 +) +$ +( 25,259 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and when necessary, valuation allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We assess the realizability of our deferred tax assets quarterly and consider carryback availability, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. During 2022, we reduced the valuation allowance against our net deferred tax assets by $ 98.1 million, which primarily related to U.S. federal and state activity. +For income tax purposes, we have approximately $ 1.4 billion of gross U.S. federal net operating losses, approximately $ 48.3 million of gross Canadian net operating losses, approximately $ 18.8 million of gross Colombian net operating losses and approximately $ 1.0 billion of post-apportionment U.S. state net operating losses as of December 31, 2022, before valuation allowances. The majority of U.S. federal net operating losses will expire in varying amounts, if unused, between 2030 and 2037 . U.S. federal net operating losses generated after 2017 can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2037 and 2042 . Colombian net operating losses will expire in varying amounts, if unused, between 2028 and 2032 . U.S. state net operating losses will expire in varying amounts, if unused, between 2023 and 2042 . +As of December 31, 2022, we had no unrecognized tax benefits. We have established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2022, the tax years ended December 31, 2014 through December 31, 2021 are open for examination by U.S. taxing authorities. As of December 31, 2022, the tax years ended December 31, 2015 through December 31, 2021 are open for examination by Canadian taxing authorities. As of December 31, 2022, the tax years ended December 31, 2017 through December 31, 2021 are open for examination by Colombian taxing authorities. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +We continue to elect permanent reinvestment of unremitted earnings in foreign jurisdictions and we intend to do so for the foreseeable future. If we were to repatriate earnings, in the form of dividends or otherwise, we may be subject to certain income and/or withholding taxes (subject to an adjustment for foreign tax credits). +15. Earnings Per Share +We provide a dual presentation of our net income (loss) per common share in our consolidated statements of operations: basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock, performance units and restricted stock units. The dilutive effect of stock options, performance units and restricted stock units is determined using the treasury stock method. +F- 28 +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2022, 2021 and 2020, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2022 +2021 +2020 +BASIC EPS: +Net income (loss) from continuing operations attributed to common stockholders +$ +154,658 +$ +( 657,079 +) +$ +( 803,692 +) +Net income from discontinued operations attributed to common stockholders +$ +— +$ +2,534 +$ +— +Net income (loss) attributed to common stockholders +$ +154,658 +$ +( 654,545 +) +$ +( 803,692 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +215,935 +195,021 +188,013 +Basic income (loss) from continuing operations per common share +$ +0.72 +$ +( 3.37 +) +$ +( 4.27 +) +Basic income from discontinued operations per common share +$ +— +$ +0.01 +$ +— +Basic net income (loss) per common share +$ +0.72 +$ +( 3.36 +) +$ +( 4.27 +) +DILUTED EPS: +Net income (loss) from continuing operations attributed to common stockholders +$ +154,658 +$ +( 657,079 +) +$ +( 803,692 +) +Net income from discontinued operations attributed to common stockholders +$ +— +$ +2,534 +$ +— +Net income (loss) attributed to common stockholders +$ +154,658 +$ +( 654,545 +) +$ +( 803,692 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +219,496 +195,021 +188,013 +Diluted income (loss) from continuing operations per common share +$ +0.70 +$ +( 3.37 +) +$ +( 4.27 +) +Diluted income from discontinued operations per common share +$ +— +$ +0.01 +$ +— +Diluted net income (loss) per common share +$ +0.70 +$ +( 3.36 +) +$ +( 4.27 +) +Potentially dilutive securities excluded as anti-dilutive +3,541 +9,551 +8,747 +16. Employee Benefits +We maintain a 401(k) plan for all eligible employees. Our operating results include expenses of approximately $ 11.0 million in 2022 , $ 7.6 million in 2021 and $ 7.7 million in 2020 for our contributions to the plan. +17. Business Segments +At December 31, 2022, we had three reportable business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) directional drilling services. Each of these segments represents a distinct type of business and has a separate management team that reports to our chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. We also disclose our identifiable assets for these segments, which are primarily comprised of long-lived assets. +Our acquisition of Pioneer in 2021 expanded our geographic footprint into Latin America with the addition of eight SCR drilling rigs in Colombia. Property and equipment, net and revenue for our domestic and international operations for the years ended December 31, 2022, 2021 and 2020 are as follows (in thousands): +Year Ended December 31, +2022 +2021 +2020 +Property and equipment, net: +United States (1) +$ +2,213,242 +$ +2,292,448 +$ +2,761,041 +Colombia (2) +47,334 +39,307 +— +Property and equipment, net +$ +2,260,576 +$ +2,331,755 +$ +2,761,041 +Revenue: +United States (1) +$ +2,577,471 +$ +1,341,330 +$ +1,124,249 +Colombia (2) +70,121 +15,751 +— +Total revenues +$ +2,647,592 +$ +1,357,081 +$ +1,124,249 +F- 29 +(1) +Our Canadian operations in 2021 and 2020 were included in the United States amounts as they were not material individually. In April 2022, we substantially completed our exit from our Canadian operations. +(2) +Our Colombian operations are included as part of our contract drilling segment. +Contract Drilling — We market our contract drilling services to major and independent oil and natural gas operators. As of December 31, 2022 , we had 184 marketed land-based drilling rigs in the continental United States and eight in Colombia. +Pressure Pumping — We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. We also provide cementing services through our pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. +Directional Drilling — We provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Substantially all of the revenue in the directional drilling segment is from directional drilling, downhole performance motors and measurement-while-drilling services, which are sold as a bundle. +Major Customer — During 2022 , one customer accounted for approximately $ 476 million or 18 % of our consolidated operating revenues. These revenues in 2022 were earned in our contract drilling, pressure pumping, and directional drilling businesses. During 2021, one customer accounted for approximately $ 216 million or 16 % of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. No single customer accounted for more than 10% of our consolidated revenues in 2020. +F- 30 +The following tables summarize selected financial information relating to our business segments (in thousands): +Year Ended December 31, +2022 +2021 +2020 +Revenues: +Contract drilling +$ +1,329,092 +$ +667,918 +$ +670,357 +Pressure pumping +1,022,413 +523,756 +336,111 +Directional drilling +216,498 +111,481 +73,356 +Other operations (1) +117,607 +75,505 +57,962 +Elimination of intercompany revenues - Contract drilling (2) +( 12,420 +) +( 3,888 +) +( 1,231 +) +Elimination of intercompany revenues - Other operations (2) +( 25,598 +) +( 17,691 +) +( 12,306 +) +Total revenues +$ +2,647,592 +$ +1,357,081 +$ +1,124,249 +Income (loss) before income taxes: +Contract drilling +$ +140,239 +$ +( 423,029 +) +$ +( 543,438 +) +Pressure pumping +134,103 +( 118,863 +) +( 166,666 +) +Directional drilling +15,534 +( 35,301 +) +( 40,612 +) +Other operations +7,810 +( 9,905 +) +( 41,685 +) +Corporate +( 86,655 +) +( 92,152 +) +( 94,251 +) +Credit loss expense +— +1,500 +( 5,606 +) +Interest income +360 +222 +1,254 +Interest expense +( 40,256 +) +( 41,978 +) +( 40,770 +) +Other +( 3,273 +) +( 275 +) +756 +Income (loss) before income taxes +$ +167,862 +$ +( 719,781 +) +$ +( 931,018 +) +Depreciation, depletion, amortization and impairment: +Contract drilling +$ +337,513 +$ +618,879 +$ +433,771 +Pressure pumping +98,162 +159,305 +152,630 +Directional drilling +15,428 +40,270 +36,504 +Other operations +27,671 +24,865 +41,511 +Corporate +5,171 +5,859 +6,494 +Total depreciation, depletion, amortization and impairment +$ +483,945 +$ +849,178 +$ +670,910 +Capital expenditures: +Contract drilling +$ +255,634 +$ +109,894 +$ +105,037 +Pressure pumping +137,935 +34,676 +21,678 +Directional drilling +16,598 +8,591 +4,681 +Other operations +25,504 +11,638 +12,378 +Corporate +1,126 +1,521 +1,707 +Total capital expenditures +$ +436,797 +$ +166,320 +$ +145,481 +Identifiable assets: +Contract drilling +$ +2,197,137 +$ +2,169,501 +$ +2,315,318 +Pressure pumping +541,975 +458,202 +486,702 +Directional drilling +121,111 +87,285 +107,807 +Other operations +93,947 +85,932 +88,676 +Corporate (3) +189,653 +156,928 +300,566 +Total assets +$ +3,143,823 +$ +2,957,848 +$ +3,299,069 +(1) +Other operations includes our oilfield rentals business, drilling equipment service business, the electrical controls and automation business and our oil and natural gas working interests . +(2) +Intercompany revenues consist of revenues from contract drilling for services provided to our other operations, and revenues from other operations for services provided to contract drilling, pressure pumping and within other operations . These revenues are generally based on estimated external selling prices and are eliminated during consolidation . +(3) +Corporate assets primarily include cash on hand and certain property and equipment . +F- 31 +18. Concentrations of Credit Risk +Financial instruments which potentially subject us to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables. +We believe we have placed our demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2022 and 2021, our demand deposits and temporary cash investments consisted of the following (in thousands): +2022 +2021 +Deposits in FDIC and SIPC-insured institutions under insurance limits +$ +601 +$ +2,043 +Deposits in FDIC and SIPC-insured institutions over insurance limits +149,769 +125,405 +Deposits in foreign banks +6,406 +9,342 +156,776 +136,790 +Less outstanding checks and other reconciling items +( 19,223 +) +( 19,266 +) +Cash and cash equivalents +$ +137,553 +$ +117,524 +Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which we provide services. As is general industry practice, we typically do not require customers to provide collateral. +19. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of our outstanding debt balances as of December 31, 2022 and 2021 is set forth below (in thousands): +December 31, 2022 +December 31, 2021 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +3.95% Senior Notes +$ +488,505 +$ +431,556 +$ +509,505 +$ +511,652 +5.15% Senior Notes +347,900 +313,164 +349,250 +359,142 +Total debt +$ +836,405 +$ +744,720 +$ +858,755 +$ +870,794 +The fair values of the 3.95 % Senior Notes and the 5.15 % Senior Notes at December 31, 2022 and December 31, 2021 are based on quoted market prices, which are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. The fair values of the 3.95 % Senior Notes implied a 6.69 % market rate of interest at December 31, 2022 and the 3.87 % market rate of interest at December 31, 2021, based on their quoted market prices. The fair values of the 5.15 % Senior Notes implied a 7.01 % market rate of interest at December 31, 2022 and the 4.72 % market rate of interest at December 31, 2021, based on their quoted market prices. +20. Restructuring Expenses +During the second quarter of 2020, we implemented a restructuring plan to improve operating margins, achieve operational efficiencies and reduce indirect support costs. The restructuring included workforce reductions, changes to management structure and facility consolidations and closures. We recorded $ 38.3 million of charges associated with this plan in the second quarter of 2020. T here were no restructuring charges in the comparable periods of 2022 and 2021. We completed the restructuring plan during the third quarter of 2020 and did not incur additional expenses related to the plan . +Contract termination costs related primarily to agreements to purchase minimum quantities of proppants (sand) from certain vendors. These costs were primarily comprised of a $ 5.3 million negotiated settlement and termination of a contract to purchase minimum quantities of sand and $ 14.0 million of contractual future payments under two contracts to purchase minimum quantities of sand without future economic benefit to us. We will not receive any sand under these contracts. Other exit costs related primarily to facility closure costs and moving expenses. +The right-of-use asset abandonments related to facility and equipment right-of-use assets abandoned as a result of restructuring. +F- 32 +The following table presents restructuring expenses by reportable segment f or the year ended December 31 , 2020 (in thousands): +Contract Drilling +Pressure Pumping +Directional Drilling +Other Operations +Corporate +Total +Severance costs +$ +1,821 +$ +3,460 +$ +503 +$ +501 +$ +215 +$ +6,500 +Contract termination costs +— +20,373 +— +— +— +20,373 +Other exit costs +523 +194 +827 +— +— +1,544 +Right-of-use asset abandonments +86 +7,304 +1,845 +— +686 +9,921 +Total +$ +2,430 +$ +31,331 +$ +3,175 +$ +501 +$ +901 +$ +38,338 +F- 33 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +S CHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Charged to +Beginning +Costs and +Ending +Description +Balance +Expenses +Deductions (1) +Balance +(In thousands) +Year Ended December 31, 2022 +Deducted from asset accounts: +Allowance for credit losses +$ +8,493 +$ +— +$ +( 5,618 +) +$ +2,875 +Year Ended December 31, 2021 +Deducted from asset accounts: +Allowance for credit losses +$ +10,842 +$ +( 1,500 +) +$ +( 849 +) +$ +8,493 +Year Ended December 31, 2020 +Deducted from asset accounts: +Allowance for credit losses +$ +6,516 +$ +5,606 +$ +( 1,280 +) +$ +10,842 +(1) +Consists of uncollectible accounts written-off. +S- 1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 13, 2023 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 13, 2023. +Signature +Title +/s/ Curtis W. Huff +Chairman of the Board +Curtis W. Huff +/s/ William Andrew Hendricks, Jr. +President, Chief Executive Officer +William Andrew Hendricks, Jr. +and Director +(Principal Executive Officer) +/s/ C. Andrew Smith +Executive Vice President and +C. Andrew Smith +Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Tiffany Thom Cepak +Director +Tiffany Thom Cepak +/s/ Michael W. Conlon +Director +Michael W. Conlon +/s/ Terry H. Hunt +Director +Terry H. Hunt +/s/ Cesar Jaime +Director +Cesar Jaime +/s/ Janeen S. Judah +Director +Janeen S. Judah +/s/ Julie J. Robertson +Director +Julie J. Robertson +S- 2 \ No newline at end of file diff --git a/raw/filings/0000889900/2022/0000950170-23-002618/filing_metadata.csv b/raw/filings/0000889900/2022/0000950170-23-002618/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..cb3e08cb96bed2979c138c5c1eb0e8b4541c574d --- /dev/null +++ b/raw/filings/0000889900/2022/0000950170-23-002618/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2023-02-13,2022-12-31,2023-02-13T21:26:15.000Z,0000950170-23-002618,pten-20221231.htm,10-K,22324650,1,1,https://www.sec.gov/Archives/edgar/data/889900/000095017023002618/pten-20221231.htm,https://www.sec.gov/Archives/edgar/data/889900/000095017023002618/,2022,2022,1 diff --git a/raw/filings/0000889900/2022/0000950170-23-002618/item1.txt b/raw/filings/0000889900/2022/0000950170-23-002618/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..010ec5ab4d691ce458dd4c132729f0ac0e4ab3e2 --- /dev/null +++ b/raw/filings/0000889900/2022/0000950170-23-002618/item1.txt @@ -0,0 +1,279 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based oilfield services company that primarily owns and operates one of the largest fleets of land-based drilling rigs in the United States and a large fleet of pressure pumping equipment. +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. As of December 31, 2022, we had a drilling fleet that consisted of 184 marketed land-based drilling rigs in the United States and eight in Colombia. A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer. We also have a substantial inventory of drill pipe and drilling rig components that support our contract drilling operations. +We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Substantially all of the revenue in the pressure pumping segment is from well stimulation services (such as hydraulic fracturing) for completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. As of December 31, 2022, we had approximately 1.2 million fracturing horsepower to provide these services. We also provide cementing services through the pressure pumping segment. Cementing is the process of inserting material between the wall of the well bore and the casing to support and stabilize the casing. Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite. +We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and gas basins in the United States. Our directional drilling services include directional drilling, measurement-while-drilling and supply and rental of downhole performance motors. We also provide services that improve the statistical accuracy of directional and horizontal wellbores. +We have other operations through which we provide oilfield rental tools in select markets in the United States. We also service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2020, 2021 and 2022 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2020: +Average oil price per Bbl (1) +$ +45.76 +$ +27.81 +$ +40.89 +$ +42.45 +Average rigs operating per day - U.S. (2) +123 +82 +60 +62 +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day - U.S. (2) +69 +73 +80 +106 +2022: +Average oil price per Bbl (1) +$ +94.45 +$ +108.72 +$ +93.18 +$ +82.79 +Average rigs operating per day - U.S. (2) +115 +121 +128 +131 +3 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Reduced demand for crude oil and refined products related to the COVID-19 pandemic led to a significant reduction in crude oil prices and demand for drilling and completion services in 2020 and early 2021. However, market fundamentals are now strong, as demand increased for drilling and completions equipment and services in 2022, and industry supply of Tier-1, super-spec rigs and premium pressure pumping equipment remains constrained. We expect our rig count in the United States will average 130 rigs in the first quarter and then grow modestly throughout the remainder of 2023. The current demand for equipment and services and strong pricing environment remain dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, response to the COVID-19 pandemic (including any resurgences and/or lockdowns in the United States and abroad) and continued focus by exploration and production companies and service companies on capital discipline. Oil prices averaged $82.79 per barrel in the fourth quarter of 2022 and closed at $77.97 per barrel on January 30, 2023. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $5.55 per MMBtu in the fourth quarter of 2022 and closed at $2.82 per MMBtu on January 30, 2023. +Our average active U.S. rig count for the fourth quarter of 2022 was 131 rigs. This was an increase from our average active rig count for the third quarter of 2022 of 128 rigs. Our active U.S. rig count at December 31, 2022 of 132 rigs was more than the rig count of 111 rigs at December 31, 2021, due in large part to the recovery of oil prices and improved demand for drilling services in the United States. Term contracts help support our operating rig count. Based on contracts currently in place in the United States, we expect an average of 87 rigs operating under term contracts during the first quarter of 2023 and an average of 56 rigs operating under term contracts during 2023. +Our average active spread count was 12 in the fourth quarter of 2022, consistent with the third quarter of 2022. We calculated average active spreads as the average number of spreads that were crewed and actively marketed during the period. We expect to average approximately 12 active spreads in the first quarter of 2023. Based on our outlook for 2023 activity, we currently expect to activate a 13th spread towards the end of 2023. +Due to improving activity levels, supply chain disruptions and increasing tightness in the overall labor market, we continue to see general oilfield cost inflation across our segments, including increases in the cost of labor, services and supplies. Supply chain disruptions and the increasing challenge of attracting and retaining employees are increasing the complexity of reactivating equipment. +Pricing for our drilling and completion services increased in 2022 due in part to the limited supply of readily available, high-quality drilling and completion equipment. +Our 2023 capital expenditure forecast is approximately $550 million. +Recent Developments in Financial Matters and Merger and Acquisition Activity — On October 1, 2021, we completed the acquisition of Pioneer Energy Services Corp. (“Pioneer”) by acquiring 100% of its equity interests. Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $30 million cash, which based on the closing price of our common stock of $9.44 on October 1, 2021, valued the transaction at approximately $278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and gas exploration and production companies in the United States and internationally in Colombia. Through the Pioneer acquisition, we acquired Pioneer’s 100% pad-capable drilling rig fleet consisting of 17 AC-powered rigs in the United States and eight SCR rigs in Colombia and production services assets consisting of 123 well servicing rigs and 72 wireline services units. The purchase price allocation was finalized in 2022. The measurement period adjustments did not have a material impact on our consolidated financial statements. +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business to Clearwell Dynamics, LLC. The sale price was $43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses were presented as a discontinued operation during the fourth quarter of 2021. +On November 9, 2022, we entered into Amendment No. 3 to Amended and Restated Credit Agreement (“Amendment No.3”), which amended our amended and restated credit agreement, dated as of March 27, 2018 (as amended, the “Credit Agreement”), among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +4 +Amendment No. 3, among other things, (i) revised the capacity under the letter of credit facility to $100 million; (ii) revised the capacity under the swing line facility to the lesser of $50 million and the amount of the swing line provider’s unused commitment; (iii) changed the LIBOR reference rate to a SOFR reference rate; and (iv) extended the maturity date for $416.7 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026. As a result, of the $600 million of revolving credit commitments under the Credit Agreement, the maturity date for $416.7 million of such commitments is March 27, 2026; the maturity date for $133.3 million of such commitments is March 27, 2025; and the maturity date for the remaining $50 million of such commitments is March 27, 2024. +As of December 31, 2022, we had no borrowings outstanding under our revolving credit facility. We had no letters of credit outstanding under the Credit Agreement at December 31, 2022 and, as a result, had available borrowing capacity of $600 million at that date. +During the fourth quarter of 2022, we elected to repurchase portions of our 3.95% Senior Notes due 2028 (the “2028 Notes”) and our 5.15% Senior Notes due 2029 (the “2029 Notes”) in the open market. The principal amounts retired through these transactions totaled $21.0 million of our 2028 Notes and $1.4 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $2.3 million and $0.1 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations. +Industry Segments +Our revenues, operating loss and identifiable assets are primarily attributable to three industry segments: +• +contract drilling services, +• +pressure pumping services, and +• +directional drilling services. +Contract Drilling Operations +General — We market our contract drilling services to oil and natural gas operators in the United States and Colombia. As of December 31, 2022, we had 192 marketed land-based drilling rigs based in the following regions: +Region +Number of Rigs +West Texas +80 +Appalachia +27 +Rockies +23 +Oklahoma +20 +South Texas +17 +East Texas +17 +Colombia +8 +Total +192 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super-spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allow for more clearance underneath the rig floor. We have 172 super-spec rigs, of which 118 were Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +5 +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have improved the capability of our drilling fleet. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with many having high pressure mud systems, walking systems and increased hookload capacity. We have spent approximately $471 million during the last three years on capital expenditures to modify, upgrade and extend the lives of components of our drilling fleet. During fiscal years 2022, 2021 and 2020, we spent approximately $256 million, $110 million, and $105 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2022 +2021 +2020 +Average rigs operating per day - U.S. (1) +124 +82 +82 +Number of rigs operated during the year - U.S. +132 +118 +131 +Number of wells drilled during the year - U.S. +2,489 +1,662 +1,324 +Number of operating days - U.S. +45,216 +29,960 +29,857 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. We had no impairment related to the marketability or condition of our drilling rigs during 2022. +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist® application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell™ lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +6 +Pressure Pumping Operations +General — We provide pressure pumping services to oil and natural gas operators, primarily in Texas and the Appalachian region (Northeast Region). Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) for the completion of new wells and remedial work on existing wells. Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas. This is accomplished by pumping fluids and proppant under pressure into the well bore to fracture the formation. Many wells in conventional plays also receive well stimulation services. We also provide cementing services through the pressure pumping segment. The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing. The scope and impact of our cementing services were insignificant during the fiscal years 2022, 2021 and 2020. +Pressure Pumping Contracts — Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract. The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have pressure pumping equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services, with a total of approximately 1.2 million horsepower as of December 31, 2022. Pressure pumping equipment at December 31, 2022 included: +Other +Fracturing +Pumping +Equipment +Equipment +Total +Texas Region +Number of units +369 +12 +381 +Approximate horsepower +887,750 +14,280 +902,030 +Northeast Region +Number of units +123 +9 +132 +Approximate horsepower +282,150 +5,800 +287,950 +Combined: +Number of units +492 +21 +513 +Approximate horsepower +1,169,900 +20,080 +1,189,980 +Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite, as well as bins for storage of materials at the worksite. +We periodically evaluate our pressure pumping assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability or condition of our equipment during 2022. +Materials — Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +Directional Drilling Operations +General — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (MWD) and supply and rental of downhole performance motors, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of oil and natural gas operators in the United States. We believe our customers use our services because of the quality of our specialized, technology-driven equipment and our well-trained and experienced workforce, which enable us to provide our customers with high-quality, reliable and safe directional drilling services. +7 +Directional Drilling Services — We provide our directional drilling services primarily on a dayrate basis, typically under master service agreements. Revenue from directional drilling services is recognized as work progresses based on the number of days or footage completed. Our rates and other charges generally vary by location and depend on the equipment and personnel required for the job and market conditions in the region in which the services are performed. In addition to rates that are charged during periods of active directional drilling, a standby rate is typically agreed upon in advance and charged on a daily basis during periods when drilling is temporarily suspended while other on-site activity is conducted at the direction of the operator or another service provider. +Equipment — We generally design, assemble, maintain and inspect our own equipment. We have developed proprietary equipment for our drilling motors, mud pulse and electromagnetic data transfer MWD equipment. We believe that our vertical integration strategy allows us to deliver better operational performance and higher equipment reliability to our customers. Vertical integration also allows us to build our tools more efficiently and at a lower cost than if purchased from third parties. In addition, we have the ability to upgrade our tools in response to market conditions or our customers’ job requirements, which allows us to minimize the costs and delays associated with sending equipment to original manufacturers. Our internal maintenance capability also affords us enhanced control over our supply chain and increases the effective utilization of our assets. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our measurement-while-drilling (MWD) Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization algorithms to determine optimal steering recommendations that enhance well placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing onshore oil and gas basins in the United States. We service equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Contracts +We believe that our contract drilling, pressure pumping, directional drilling and other contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2022, we received approximately 49% from our ten largest customers and approximately 34% from our five largest customers. During 2022, one customer accounted for approximately $476 million, or approximately 18%, of our consolidated operating revenues. These revenues were earned in both our contract drilling and pressure pumping businesses. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +Our contract drilling backlog in the United States as of December 31, 2022 and 2021 was approximately $830 million and $325 million, respectively. Approximately 32% of our contract drilling backlog in the United States at December 31, 2022 is reasonably expected to remain after 2023. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Decline and May Not Ultimately Be Realized, as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment” for information pertaining to backlog. +8 +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our contract drilling, pressure pumping and directional drilling businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, our communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who are our most important asset and our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, a practice on which all of our success depends. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions as compared to our traditional diesel-only equipment, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell™ lithium battery hybrid energy management system. EcoCell™ is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 6,500 full-time employees as of January 31, 2023. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies, as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have annual safety education that incorporates learning associated with hazard awareness, safe systems of work, permission to work, stop work authority, energy isolation, material handling and management of change. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require new supervisors and managers in the United States to attend an instructor-led course relative to diversity, inclusion and respect to ensure they understand our expectations regarding their obligations to promote a work environment where all employees are valued and respected. Supplemental diversity, inclusion and respect training for supervisors and managers is required on a biannual basis. All other employees are educated annually on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +9 +Maintaining our Core Values – We provide annual training for our employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. We have implemented policies allowing many of our office-based employees the flexibility to work from home. +Government and Environmental Regulation +All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, cementing and acidizing and related well servicing activities, +• +directional drilling services, +• +services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, and +• +our employees. +To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry. The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. Federal, state, foreign, regional and local environmental laws, rules and regulations, including laws, rules, regulations and executive actions related to the mitigation of climate change or greenhouse gas emissions, currently apply to our operations and are likely to become more stringent in the future. Any limitation, suspension or moratorium of the services and products we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operations. +We believe we use operating and disposal practices that are standard in the industry. However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations. Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that may govern our operations. +10 +In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on: +• +owners and operators of sites, including prior owners and operators who are no longer active at a site; and +• +persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. For example, in December 2016, the U.S. Environmental Protection Agency (“EPA”) and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain exploration and production related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking by March 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA issued a report on April 23, 2019, determining that no revisions were necessary. However, if changes are made to the classification of exploration and production wastes under CERCLA and/or RCRA in the future, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination. +The Federal Water Pollution Control Act (the “Clean Water Act”) and the Oil Pollution Act of 1990 (the “Oil Pollution Act”), each as amended, and implementing regulations govern: +• +the prevention and permitting of discharges, including oil and produced water spills, into jurisdictional waters; and +• +liability for drainage into such waters. +The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities. Liability may be imposed for oil removal costs and a variety of public and private damages. Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up. +The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial harm will be done to the environment by discharges on or into navigable waters. Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions. Although the liability for owners and operators is the same under the Clean Water Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages. +The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. Due to concerns raised relating to potential impacts of hydraulic fracturing, including on groundwater quality and seismic activity, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether. Certain politicians have also vocalized support for a nationwide ban on hydraulic fracturing. Additional legislation or regulation could lead to operational delays or increased operating costs in the production of oil and natural gas or could make it more difficult to perform hydraulic fracturing. These developments could also lead to litigation challenging proposed or existing wells. Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we provide for our exploration and production customers, and such efforts could adversely affect our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing or Other Aspects of the Oil and Gas Industry Could Increase Our Costs and Limit or Delay Our Operations.” +11 +Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. There has also been legislation proposed by U.S. lawmakers to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA, and future federal action to address climate change is likely. +President Biden and the Democratic Party have identified climate change as a priority, and it is likely that additional executive orders and/or regulatory action targeting greenhouse gas emissions, or prohibiting, delaying or restricting oil and gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. For example, the acting Secretary of the Department of the Interior recently issued an order preventing staff from producing any new fossil fuel leases or permits without sign-off from a top political appointee. In 2021, President Biden issued an executive order imposing a moratorium on new oil and gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of Federal oil and gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Although a federal judge for the U.S. District Court of the Western District of Louisiana issued a permanent injunction in 13 states that filed a lawsuit against the pause of oil and natural gas leasing on public lands or in offshore waters, the Biden Administration may take other regulatory steps in the future that could impact our operations. +In February 2021, the United States rejoined the Paris Agreement, and in the future, the United States may also choose to adhere to other international agreements targeting GHG reductions. In April 2021, President Biden set a new goal for the United States to achieve a 50-52 percent reduction from 2005 levels in economy-wide net greenhouse gas pollution in 2030. Further, in November 2021, the United States and other countries entered into the Glasgow Climate Pact, which includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions by 30% by 2030, and cooperating toward the advancement of the development of clean energy. +Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. See “Item 1A. Risk Factors – Our and Our Customers’ Operations are Subject to a Number of Risks Arising Out of the Threat of Climate Change That Could Result in Increased Operating and Capital Costs, Limit the Areas in Which Oil and Natural Gas Production May Occur and Reduce Demand for Our Services.” +12 +Risks and Insurance +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs. The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available, or available on terms that are acceptable to us. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $5.0 million per occurrence deductible on our pressure pumping equipment without fire suppression systems, a $10.0 million per occurrence deductible on our general liability coverage, a $2.0 million per occurrence deductible on our primary automobile liability insurance coverage, and a $5.0 million per occurrence deductible on our excess automobile liability insurance coverage. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims. We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +13 \ No newline at end of file diff --git a/raw/filings/0000889900/2022/0000950170-23-002618/item13.txt b/raw/filings/0000889900/2022/0000950170-23-002618/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2022/0000950170-23-002618/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2022/0000950170-23-002618/item9a.txt b/raw/filings/0000889900/2022/0000950170-23-002618/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..0f6297ba902e1d828ce88586241ba4552b13f234 --- /dev/null +++ b/raw/filings/0000889900/2022/0000950170-23-002618/item9a.txt @@ -0,0 +1,8 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2022, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2022, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2022. +The effectiveness of our internal control over financial reporting as of December 31, 2022 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2022/0000950170-23-002618/rp_note.txt b/raw/filings/0000889900/2022/0000950170-23-002618/rp_note.txt new file mode 100644 index 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+ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2023 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 1-39270 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +10713 W. Sam Houston Pkwy N , Suite 800 , Houston , Texas +77064 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code: +( 281 ) 765-7100 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common Stock, $0.01 Par Value +PTEN +The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ or No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ or No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ or No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Smaller reporting company +☐ +Non-accelerated filer +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2023 , the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $ 2.4 billion, calculated by reference to the closing price of $11.97 for the common stock on the Nasdaq Global Select Market on that date. +As of February 20, 2024, the registrant had outstanding 408,192,236 shares of common stock, $0.01 par value, its only class of common stock. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s definitive proxy statement for the 2024 Annual Meeting of Stockholders are incorporated by reference into Part III of this report . +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings, press releases and presentations by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. As used in this Report, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its operations through its wholly-owned subsidiaries and has no employees or independent business operations. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue, cost and margin expectations and backlog; financing of operations; oil and natural gas prices; rig counts and frac spreads; source and sufficiency of funds required for building new equipment, upgrading existing equipment and acquisitions (if opportunities arise); demand and pricing for our services; competition; equipment availability; government regulation; legal proceedings; debt service obligations; impact of inflation and economic downturns; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• +the successful integration and expected benefits of the merger (the “NexTier merger”) with NexTier Oilfield Solutions Inc. (“NexTier”) and the acquisition (the “Ulterra acquisition”) of Ulterra Drilling Technologies, L.P. (“Ulterra”) on our financial condition, results of operations, strategy and plans and our ability to realize those benefits; +• +synergies, costs and financial and operating impacts of acquisitions, including the NexTier merger and the Ulterra acquisition; +• +the successful integration of NexTier and Ulterra operations and the future financial and operating results of the combined company; +• +the combined company’s plans, objectives, expectations and intentions with respect to future operations and services; +• +adverse oil and natural gas industry conditions; +• +global economic conditions, including inflationary pressures and risks of economic downturns or recessions in the United States and elsewhere; +• +volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• +excess supply of drilling and completions equipment, including as a result of reactivation, improvement or construction; +• +competition and demand for our services; +• +the impact of the ongoing Ukraine/Russia and Israel/Hamas conflicts and instability in other international regions; +• +strength and financial resources of competitors; +• +utilization, margins and planned capital expenditures; +• +ability to obtain insurance coverage on commercially reasonable terms and liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• +operating hazards attendant to the oil and natural gas business; +• +failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +1 +• +the ability to realize backlog; +• +specialization of methods, equipment and services and new technologies, including the ability to develop and obtain satisfactory returns from new technology; +• +the ability to retain management and field personnel; +• +loss of key customers; +• +shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• +cybersecurity events; +• +difficulty in building and deploying new equipment; +• +governmental regulation, including climate legislation, regulation and other related risks; +• +environmental, social and governance practices, including the perception thereof; +• +environmental risks and ability to satisfy future environmental costs; +• +technology-related disputes; +• +legal proceedings and actions by governmental or other regulatory agencies; +• +the ability to effectively identify and enter new markets; +• +public health crises, pandemics and epidemics; +• +weather; +• +operating costs; +• +expansion and development trends of the oil and natural gas industry; +• +financial flexibility, including availability of capital and the ability to repay indebtedness when due; +• +adverse credit and equity market conditions; +• +our return of capital to stockholders, including timing and amounts (including any plans or commitments in respect thereof) of any dividends and share repurchases; +• +stock price volatility; +• +compliance with covenants under our debt agreements; and +• +other financial, operational and legal risks and uncertainties detailed from time to time in our filings with the SEC. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained elsewhere in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. +Drilling Services +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and natural gas basins in the United States, and we provide services that improve the statistical accuracy of wellbore placement for directional and horizontal wells. We also service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. +Completion Services +Our well completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States, including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. +Drilling Products +We serve the energy and mining markets by manufacturing and distributing drill bits through North America and internationally in over 30 countries. Our drilling equipment is used in oil and natural gas exploration and production and in mining operations. We have manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman . +Other +Other consists of our oilfield rentals business, with a fleet of premium oilfield rental tools, along with the results of our ownership, as a non-operating working interest owner, in oil and natural gas assets located in Texas and New Mexico . +3 +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2021, 2022 and 2023 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day – U.S. (2) +69 +73 +80 +106 +2022: +Average oil price per Bbl (1) +$ +94.45 +$ +108.72 +$ +93.18 +$ +82.79 +Average rigs operating per day – U.S. (2) +115 +121 +128 +131 +2023: +Average oil price per Bbl (1) +$ +75.93 +$ +73.54 +$ +82.25 +$ +78.53 +Average rigs operating per day – U.S. (2) +131 +128 +120 +118 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Crude oil prices and demand for drilling and completion equipment and services increased from 2021 to 2022, and industry supply of Tier-1, super-spec rigs became constrained. Commodity price volatility in the second quarter of 2023 resulted in a decline in industry activity; commodity prices subsequently increased during the third quarter before declining in the fourth quarter of 2023. We expect our rig count in the United States will average 120 rigs in the first quarter. The current demand for equipment and services remains dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $78.53 per barrel in the fourth quarter of 2023 and closed at $78.72 per barrel on February 20, 2024. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.74 per MMBtu in the fourth quarter of 2023 and closed at $1.50 per MMBtu on February 20, 2024. +Our average active U.S. rig count for the fourth quarter of 2023 was 118 rigs. This was a decrease from our average active rig count for the third quarter of 2023 of 120 rigs. Our active U.S. rig count at December 31, 2023 of 121 rigs was less than the rig count of 132 rigs at December 31, 2022, due in large part to the decline in commodity prices and reduced demand for drilling services in the United States. We expect our rig count in the United States will average 120 rigs in the first quarter of 2024. Term contracts help support our operating rig count. Based on contracts in place in the United States as of February 14, 2024, we expect an average of 79 rigs operating under term contracts during the first quarter of 2024 and an average of 52 rigs operating under term contracts during 2024. +Our completion services business was impacted by calendar inefficiencies during the second half of 2023 resulting from a decline in customer activity during the third quarter. Completion services activity stabilized in the fourth quarter of 2023. We believe activity will modestly decline in the first quarter of 2024. +Drilling products demand increased from the third quarter of 2023 despite a decline in the global rig count. Drilling Products demand is expected to remain steady through the first quarter, given the expectation for a steady market in the U.S. and moderate growth in international markets relative to what we saw in the fourth quarter. +Our 2024 capital expenditure forecast is approximately $740 million. +Recent Developments in Business Combinations and Financial Matters — On September 1, 2023, we completed the NexTier merger. Each share of common stock of NexTier issued and outstanding immediately prior to the effective time (including outstanding restricted shares) was converted into the right to receive 0.752 shares of our common stock, which based on the closing price of our common stock of $14.91 on September 1, 2023, valued the transaction at approximately $2.8 billion, including the assumption of debt. NexTier is a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins. +On August 14, 2023, we completed the Ulterra acquisition. Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $376 million cash, which based on the closing price of +4 +our common stock of $14.94 on August 14, 2023, valued the transaction at closing at approximately $897 million. Ulterra is a global provider of specialized drill bit solutions. +On September 13, 2023, we completed the offering of $400 million in aggregate principal amount of our 7.15% Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses were approximately $396 million, which we used to repay amounts outstanding under our revolving credit facility. +On August 29, 2023, we entered into Amendment No. 4 to Amended and Restated Credit Agreement (the “Credit Agreement Amendment”), which amended our Amended and Restated Credit Agreement, dated as of March 27, 2018 (as amended, the “Credit Agreement”), by and among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +The Credit Agreement Amendment, among other things, (i) deemed certain outstanding letters of credit issued for the account of BEP Diamond Holdings Corp. (the entity we acquired in the Ulterra acquisition) with a face amount of $2.5 million to have been issued under the Credit Agreement, and (ii) extended the maturity date for $85 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026. As a result, of the $600 million of revolving credit commitments under the Credit Agreement, the maturity date for $501.7 million of such commitments is March 27, 2026; the maturity date for $48.3 million of such commitments is March 27, 2025; and the maturity date for the remaining $50 million of such commitments is March 27, 2024. +During the first quarter of 2023, we elected to repurchase portions of our 3.95% Senior Notes due 2028 (the “2028 Notes”) and our 5.15% Senior Notes due 2029 (the “2029 Notes”) in the open market. The principal amounts retired through these transactions totaled $6.0 million of our 2028 Notes and $3.0 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $0.8 million and $0.3 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations included as a part of Item 8 of this Report. +As of December 31, 2023, we had no borrowings outstanding under our revolving credit facility. We had $2.6 million in letters of credit outstanding under the Credit Agreement at December 31, 2023 and, as a result, had available borrowing capacity of approximately $597 million at that date. +Industry Segments +Our revenues, operating income and loss and identifiable assets are primarily attributable to three industry segments: +• +drilling services, +• +completion services, and +• +drilling products. +Drilling Services Operations +General — We provide our contract drilling services to oil and natural gas operators in the United States and Colombia. As of December 31, 2023, we had 192 marketed land-based drilling rigs based in the following regions: +Region +Number of Rigs +West Texas +82 +Appalachia +27 +Rockies +23 +Oklahoma +19 +South Texas +18 +East Texas +15 +Colombia +8 +Total +192 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super-spec” rigs, +5 +which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allows for more clearance underneath the rig floor. As of December 31, 2023, we had 173 super-spec rigs, of which 131 were Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with many having high pressure mud systems, walking systems and increased hookload capacity. During fiscal years 2023, 2022 and 2021, we spent approximately $335 million, $256 million, and $110 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2023 +2022 +2021 +Average rigs operating per day – U.S. (1) +124 +124 +82 +Number of wells drilled during the year – U.S. +2,530 +2,489 +1,662 +Number of operating days – U.S. +45,270 +45,216 +29,960 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. We had no impairment related to the marketability or condition of our drilling rigs during 2023. +6 +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist® application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell® lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +Directional Drilling — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (“MWD”) and supply and rental of downhole performance motors, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of oil and natural gas operators in the United States. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our MWD Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization to determine optimal steering recommendations and placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Drilling Services — We service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. +Completion Services Operations +Our completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. Our completion services are designed in partnership with our customers to enhance both initial production rates and estimated ultimate recovery from new and existing wells. +We utilize our in-house capabilities, including our data control instruments business, to offer a technologically advanced and efficiency focused range of completion techniques. The majority of revenue for this segment is generated by our hydraulic fracturing business. +Hydraulic Fracturing — Hydraulic fracturing services are performed to enhance production of oil and natural gas from formations with low permeability and restricted flow of hydrocarbons. The process of hydraulic fracturing involves pumping a highly viscous, pressurized fracturing fluid, typically a mixture of water, chemicals and proppant, into a well casing or tubing in order to fracture underground mineral formations. These fractures release trapped hydrocarbon particles and free a channel for the oil or natural gas to flow freely to the wellbore for collection. Fracturing fluid mixtures include proppant that becomes lodged in the cracks created by the hydraulic fracturing process, “propping” them open to facilitate the flow of hydrocarbons upward through the well. +Completion Support Services — In late 2020, NexTier began evolving its completion service offerings to develop an integrated natural gas treatment and delivery solution. In 2021, NexTier launched its Power Solutions business, which focuses on gas sourcing, compression, transport, decompression, treatment and related services for fracturing operations. We believe this integration solution assists our customers by reducing emissions at the wellsite and throughout their operations. As part of NexTier’s wellsite integration strategy to provide and integrate a variety of services for its customers at the wellsite to maximize efficiencies and profitability, in 2022, NexTier acquired sand hauling, wellsite storage, and last mile logistics assets and rebranded its entire last mile logistics operation as NexMile Logistics. The assets acquired were combined with NexTier’s existing last mile logistics assets to create a leading player in the delivery and storage of proppant at the wellsite. +Wireline and Pumping Services — Our wireline services involve the use of a truck equipped with a spool of wireline that is unwound and lowered into oil and natural gas wells to convey specialized tools or equipment for well completion, well intervention, pipe recovery and reservoir evaluation purposes. We offer our wireline services in conjunction with our hydraulic +7 +fracturing services in “plug-and-perf” well completion to maximize efficiency for our customers. “Plug-and-perf” is a multi-stage well completion technique for cased-hole wells that consists of pumping a plug and perforating guns to a specified depth. Once the plug is set, the zone is perforated and the tools are removed from the well, a ball is pumped down to isolate the zones below the plug and the hydraulic fracturing treatment is applied. In addition, we offer wireline and pumping services that are not integrated with our fracturing services. We are one of the leading providers of perforating, pumpdown, pipe recovery, pressure pumping, and wellsite make-up and pressure testing services. We are highly experienced in safely servicing deep, high-pressure, high-temperature wells in some of the most active onshore basins in the United States. Our in-house manufacturing capabilities allow us to manage costs and lead times with regard to hardware and perforating guns, switches and accessories, providing us with a competitive advantage and enabling higher returns. +Cementing — Our cementing services incorporate custom engineered mixing and blending equipment that is designed to deliver precision and accuracy in providing annulus isolation and hydraulic seal, while protecting freshwater zones from our customers’ zone of interest. Our cement division has the expertise to cement shallow to complex high temperature, high pressure wells. We also offer engineering software and technical guidance for remedial cementing applications and acidizing to optimize the performance of our customers’ wells. We are one of the largest providers of specialty cementing services in the United States. Our operations are supported by multiple full-service laboratory facilities with advanced capabilities. +Completion Service Contracts — Our completion services operations are conducted pursuant to a work order for a specific job or pursuant to a contract generally for a specified period of time, which may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have well completion equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services. We periodically evaluate our completion services assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability or condition of our equipment during 2023. +Materials — Our completion services operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time, and can be subject to significant price volatility. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +Drilling Products Operations +Our Ulterra business has manufacturing and distribution sites of drilling equipment in North America and internationally, which are geographically positioned to serve the energy and mining markets in over 30 countries. Ulterra’s drilling equipment is used in oil and natural gas exploration and production and in mining operations. Ulterra has manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Ulterra’s primary business is the design, manufacture, sale and rental of matrix and steel-bodied polycrystalline diamond compact (“PDC”) drill bits. PDC drill bits are typically rented, except in select international markets where they are sold. Used bits may be repaired and refurbished for the subsequent customer. Ulterra has an industry-leading position in the North American PDC drill bit market. +We periodically evaluate our drill bits for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability or condition of our equipment during 2023. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing oil and natural gas basins in the United States. +8 +In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Research, Engineering and Technology +We employ research, engineering and technology teams across our businesses, who work on initiatives to enhance our existing product and service offerings and develop new products and services to meet customer demands. +Contracts +We believe that our contracts for drilling services, completion services, drilling products and other services and products generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2023, we received approximately 49% from our ten largest customers and approximately 35% from our five largest customers. During 2023, one customer accounted for approximately $588 million, or approximately 14%, of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2023 and 2022 was approximately $700 million and $830 million, respectively. Approximately 16% of our contract drilling backlog in the United States at December 31, 2023 is reasonably expected to remain after 2024. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment” for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our drilling services and completion services businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, our communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who, through the diversity of their backgrounds, experiences and talents, are our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, values which are embedded in our culture and a practice on which all of our success depends. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions as compared to our traditional diesel-only equipment, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +9 +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell® lithium battery hybrid energy management system. The EcoCell® system is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 10,600 full-time employees as of January 31, 2024. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies, as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have annual safety education that incorporates learning associated with hazard awareness, safe systems of work, permission to work, stop work authority, energy isolation, material handling and management of change. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require new supervisors and managers in the United States to attend an instructor-led course relative to diversity, inclusion and respect to ensure they understand our expectations regarding their obligations to promote a work environment where all employees are valued and respected. Supplemental diversity, inclusion and respect training for supervisors and managers is required on a biannual basis. All other employees are educated annually on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +Maintaining our Core Values – We provide annual training for our employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. We have implemented policies allowing many of our office-based employees the flexibility to work from home. +Government and Environmental Regulation +Our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business and the oil and natural gas industry including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, wireline and pumping, completion support and cementing, +• +provision of specialized drill bit solutions, +• +directional drilling services, +10 +• +services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, +• +conducting international operations, and +• +our employees. +Our business operations are subject to various environmental, as well as employee health and safety, laws and regulations, including those addressing the management, disposal and releases of regulated substances. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. See “Item 1A. Risk Factors – The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. Several states and geographic regions in the United States, as well as foreign jurisdictions, have adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of international treaties related to GHG emissions. See “Item 1A. Risk Factors – Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services.” +We operate throughout North America and internationally in over 30 countries and, accordingly, are subject to the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery and anti-corruption laws in other jurisdictions. Our operations also are subject to other laws and regulations in relation to our international operations, including with respect to the import and export of certain goods and economic sanctions. See “Item 1A. Risk Factors – Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business.” +The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and natural gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Risks and Insurance +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. The insurances that we maintain include coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation as well as insurance for other specific risks. We cannot assure that any insurance obtained by us will be adequate to cover any losses or liabilities nor can we assure that any insurance obtained by us will continue to be made available for purchase or made available on acceptable terms. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some +11 +cases to retain a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, and, for our automobile insurance coverage, a per occurrence deductible ranging from $2.0 million to $10.0 million. We also self-insure a number of risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +Risk Factors Summary +The following is a summary of the principal risks included in this Report that we believe could adversely affect our business, financial condition, cash flows and results of operations: +Business and Operating Risks +• +We are dependent on the oil and natural gas industry and market prices for oil and natural gas. Declines in customers’ operating and capital expenditures and in oil and natural gas prices may adversely affect our operating results. +• +Global economic conditions may adversely affect our operating results. +• +A surplus of equipment and a highly competitive oil service industry may adversely affect our utilization and profit margins and the carrying value of our assets. +• +Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us. +• +Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment. +• +New technologies may cause our operating methods, equipment, products and services to become less competitive, and higher levels of capital expenditures may be necessary to remain competitive. +• +Loss of key personnel and competition for experienced personnel may negatively impact our financial condition and results of operations. +• +The loss of large customers could have a material adverse effect on our financial condition and results of operations. +12 +• +Shortages, delays in delivery, and interruptions in supply, of equipment and materials could adversely affect our operating results. +• +Our business is subject to cybersecurity risks and threats. +• +Our commitments under supply agreements could exceed our requirements, exposing us to risks including price, timing of delivery and quality of equipment and materials upon which our business relies. +• +Growth through acquisitions, the building or upgrading of equipment and the development of technology is not assured. +• +Our business relationships may be subject to disruption due to uncertainty associated with any pending or recently completed acquisitions, including the NexTier merger or the Ulterra acquisition, which could have a material adverse effect on our results of operations, cash flows and financial position. +• +Public health crises, pandemics and epidemics may have a significant adverse impact on our business, liquidity, results of operations and financial condition. +• +Fuel conservation measures could reduce demand for oil and natural gas, which would, in turn, reduce the demand for our services. +Risks Relating to the NexTier Merger and Ulterra Acquisition +• +Our ability to utilize our historic U.S. net operating loss carryforwards is expected to be limited as a result of the completion of the NexTier merger. +• +Uncertainties associated with the NexTier merger and the Ulterra acquisition may cause a loss of management personnel and other key employees, which could adversely affect our future business and operations. +• +We have incurred and are expected to continue incurring transaction costs in connection with the NexTier merger and the Ulterra acquisition, which may be in excess of those we anticipated. +• +The benefits and synergies attributable to the NexTier merger and the Ulterra acquisition may vary from expectations. +Legal and Regulatory Risks +• +The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition. +• +Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services. +• +Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results. +• +Technology disputes could negatively impact our operations, costs, revenues and competitiveness. +• +The design, manufacture, sale or rental, and servicing of products, including drill bits and electrical controls, may subject us to liability for personal injury, property damage and environmental contamination should such equipment fail to perform to specifications. +• +Legal proceedings and governmental investigations could have a negative impact on our business, financial condition and results of operations. +• +Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business. +• +We are subject to complex and evolving laws and regulations regarding data privacy and security. +Financial Risks +• +Investor sentiment and public perception related to the oil and natural gas industry and to ESG initiatives could increase our costs of capital and our reporting requirements and impact our operations. +• +Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly. +13 +• +Our ability to access capital markets could be limited, and a downgrade in our credit rating could negatively impact our cost of and ability to access capital. +• +We may not be able to generate sufficient cash to service all of our debt and we may be forced to take other actions to satisfy our obligations under our debt, which may not be successful. +• +Our return of capital to stockholders, including through the payment of dividends and repurchases of our common stock, is within the discretion of our Board of Directors, and there is no guarantee that we will return capital to shareholders, including through the payment of dividends and repurchases of our common stock, in the future or at levels anticipated by our stockholders. +Risks Related to Our Common Stock and Corporate Structure +• +The market price of our common stock may be highly volatile, and investors may not be able to resell shares at or above the price paid. +• +Anti-takeover measures in our charter documents and under state law could discourage an acquisition and thereby affect the related purchase price. +• +Our bylaws provide that the Court of Chancery of the State of Delaware and the federal district courts of the United States are the exclusive forums for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees. +Business and Operating Risks +We are dependent on the oil and natural gas industry and market prices for oil and natural gas. Declines in customers’ operating and capital expenditures and in oil and natural gas prices may adversely affect our operating results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• +the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• +the prices, and expectations about future prices, of oil and natural gas, +• +the supply of and demand for drilling services, completion services and drilling products, +• +the cost of exploring for, developing, producing and delivering oil and natural gas, +• +the availability of capital for oil and natural gas industry participants, including our customers, and the extent to which they are willing or able to deploy capital, +• +the availability of and constraints in pipeline, storage and other transportation capacity in the basins in which we operate, +• +the environmental, tax and other laws and governmental regulations regarding the exploration, development, production, use and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling services and completion services activities, including hydraulic fracturing, +• +increased focus by the investment and financing community and the general public on sustainability practices in the oil and natural gas industry, and +• +merger and divestiture activity among oil and natural gas producers. +In particular, our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Oil and natural gas prices and markets can be extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• +market supply and demand, +• +the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil-producing nations, such as Russia, to set and maintain production and price targets, +• +the level of production by OPEC and non-OPEC countries, +14 +• +domestic and international military, political, economic, health and weather conditions, including the impacts of war, including the impact of the ongoing armed conflicts between Russia and Ukraine and Israel and Hamas and the continuation of, or any escalation in the severity of, these conflicts, or terrorist activity, pandemics and other unexpected disasters or events, +• +changes to tax, tariff and import/export regulations and sanctions by the United States or other countries, +• +legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• +technical advances affecting energy consumption and production, and +• +the development, price, availability and market acceptance of alternative fuels and energy sources. +All of these factors are beyond our control. Crude oil prices and demand for drilling and completion equipment and services increased in 2022, and industry supply of Tier-1, super-spec rigs became constrained. Commodity price volatility in the second quarter of 2023 resulted in a decline in industry activity; commodity prices subsequently increased during the third quarter before declining in the fourth quarter of 2023. The current demand for equipment and services remains dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $78.53 per barrel in the fourth quarter of 2023 and closed at $78.72 per barrel on February 20, 2024. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.74 per MMBtu in the fourth quarter of 2023 and closed at $1.50 per MMBtu on February 20, 2024. +In light of these and other factors, we expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Global economic conditions may adversely affect our operating results. +Concerns regarding global economic conditions, energy costs, geopolitical issues, supply chain disruptions, inflation and the availability and cost of credit have contributed to increased economic uncertainty. Demand for energy and for oil and natural gas end products is highly sensitive to economic conditions; as a result, global economic conditions, indications that economic growth is slowing and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise, may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. An economic slowdown or recession in the United States or in any other country that significantly affects the supply of or demand for oil or natural gas could negatively impact our operations and therefore adversely affect our results. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, such as a result of the COVID-19 pandemic or the ongoing armed conflicts between Russia and Ukraine and Israel and Hamas, and there is no assurance that the global economic environment, or expectations for the global economic environment, will not quickly deteriorate again due to one or more factors, including as a result of actual or perceived threats to geopolitical stability and changes in production from OPEC, its members and other oil-producing nations. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +A surplus of equipment and a highly competitive oil service industry may adversely affect our utilization and profit margins and the carrying value of our assets. +Our industry is highly competitive, and at times available drilling services equipment, completion services equipment, and drilling products exceed the demand for such equipment and products. A low commodity price environment or capital spending reductions by our customers due to customer consolidation (which is currently occurring in the industry), investor requirements or other reasons can result in substantially more equipment and products being available than are needed to meet demand. Low commodity prices and a rise in new and upgraded equipment or products can result in excess capacity and substantial competition for a declining number of drilling services and completion services contracts and drilling products rentals and sales. +15 +Operating costs for our drilling services and completion services businesses include all direct and indirect costs associated with the operation, maintenance and support of our equipment, which is often not affected by changes in our rates and utilization. During periods of reduced revenue and/or activity, certain of our fixed costs, such as depreciation, may not decline and often we may incur additional costs. During times of reduced utilization, reductions in costs may not be immediate as we may incur additional costs associated with maintaining and stacking equipment, or we may not be able to fully reduce the cost of our support operations in a particular geographic region due to the need to support the remaining operations in that region. Accordingly, a decline in revenue due to lower rates and/or utilization may not be offset by a corresponding decrease in operating costs, which could have a material adverse impact on our business, financial condition and results of operations. +Even in an environment of high oil and natural gas prices and/or increased drilling and completion activity, reactivation and improvement of existing drilling services and completion services equipment, construction of new technology drilling services and completion services equipment, movement of drilling services and completion services equipment from region to region in response to market conditions or otherwise can lead to a surplus of equipment. +In times of reduced demand for our industry’s services, certain of our industry competitors may initiate bankruptcy proceedings or engage in debt refinancing transactions, management changes, or other strategic initiatives in an attempt to reduce operating costs to maintain a position in the market. This could result in such competitors emerging with stronger or healthier balance sheets and, in turn, an improved ability to compete with us in the future. We may also see corporate consolidations among both our customers and competitors, which could significantly alter industry conditions and competition within the industry, and have a material adverse effect on our business, financial condition, cash flows and results of operations. +We periodically seek to increase the prices on our services to offset rising costs, earn returns on our capital investment, and otherwise generate higher returns for our stockholders. However, we operate in a very competitive industry, and we are not always successful in raising or maintaining our existing prices. Even if we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs, including capital expenditures, without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs, including capital expenditures, increase could have a material adverse effect on our business, financial condition, cash flows and results of operations. In addition, we may be unable to replace fixed-term contracts that expire or are terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. +Accordingly, high competition and a surplus of equipment and products can cause oil and natural gas service contractors to have difficulty maintaining pricing, utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or surplus equipment and products in the oil and natural gas service businesses or the level of demand for our drilling services, completion services or drilling products. +A surplus of operable land drilling rigs, other drilling services equipment and drilling products, increasing rig specialization and surplus of completion services equipment, which can be exacerbated by capital spending reductions by our customers, could affect the fair market value of our drilling services equipment, completion services equipment, and drilling products, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices or changes in customer preferences and requirements could result in future impairment to our long-lived assets. For example, we recognized impairment charges of $7.0 million, $4.5 million and $267 million in 2023, 2022 and 2021, respectively. +Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, unplanned power outages and surges, computer system disruptions or cybersecurity incidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +16 +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. See “Item 1. Business – Risks and Insurance” for a description of our insurance coverage. We also self-insure a number of risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate, suspend or renegotiate or otherwise fail to honor their contractual obligations, including as a result of their bankruptcy. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination, suspension or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. +As of December 31, 2023, our contract drilling backlog in the United States for future revenues under term contracts, which we define as contracts with a duration of six months or more, was approximately $700 million. Please see Note 3 of Notes to consolidated financial statements in Item 8 of this Report for a description of our calculation of backlog. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts or may be reduced by price adjustments to existing contracts, including as a result of a decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services or otherwise. +New technologies may cause our operating methods, equipment, products and services to become less competitive, and higher levels of capital expenditures may be necessary to remain competitive. +The market for our services and products is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance, including environmental performance, of drilling services equipment, completion services equipment, and drilling products. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and completion services and other equipment, as well as new and improved technology, such as drilling automation technology and lower-emissions operations and services, +17 +specialized drill bit solutions and data analytics. Accordingly, we may have to allocate a higher proportion of our capital expenditures to maintain and improve existing rigs and completion services and other equipment, purchase and construct newer, higher specification drilling rigs and completion services and other equipment to meet the increasingly sophisticated needs of our customers, and develop new and improved technology, specialized drill bit solutions and data analytics. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the completion services and other drilling services businesses could have similar effects. +We continually attempt to develop or acquire new technologies for use in our business. For example, we have invested in natural gas-powered equipment, including electric pumps, to replace legacy diesel completion services equipment. In the event that we are successful in developing or acquiring new technologies for use in our business, there is no guarantee of future demand for those technologies. Customers may be reluctant or unwilling to adopt our new technologies. We may also have difficulty negotiating satisfactory terms for our new technologies, including terms that would enable us to obtain acceptable returns on our investment in the development or acquisition of new technologies. +Development and acquisition of new technology is critical to maintaining our competitiveness. There can be no assurance that we will be able to successfully develop or acquire technology that our customers demand. Some of our competitors have greater financial, technical and personnel resources that may allow them to enjoy technological advantages and develop, acquire and implement new technology on a more timely basis or in a more cost-effective manner. If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment, services and products obsolete, which could reduce our competitiveness and have a material adverse impact on our business, financial condition, cash flows and results of operation. +Loss of key personnel and competition for experienced personnel may negatively impact our financial condition and results of operations. +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled field-based and non-field-based personnel in operating and supporting our businesses and in developing new technologies. In times of increasing demand for our services, it may be difficult to attract and retain qualified field-based and non-field-based personnel, particularly after a prolonged industry downturn. During periods of high demand for our services or inflation, wage rates for personnel are also likely to increase (and, during recent periods of high demand and inflation, have increased), resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even in a period of generally lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The loss of large customers could have a material adverse effect on our financial condition and results of operations. +With respect to our consolidated operating revenues in 2023, we received approximately 49% from our ten largest customers, approximately 35% from our five largest customers and 14% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Shortages, delays in delivery, and interruptions in supply, of equipment and materials could adversely affect our operating results. +Periodically, the oilfield services industry has experienced shortages of equipment for upgrades, drill pipe, raw materials, replacement parts and other equipment and materials, including, in the case of our completion services operations, proppants, cement, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• +weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• +labor shortages or other labor issues, +• +transportation, fuel shortages and other logistical challenges, and +18 +• +a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +These price increases, delays in delivery and interruptions in supply may require us to delay operations, increase capital and repair expenditures or otherwise incur higher operating costs. During recent years, there have been significant disruptions and delays across the global supply chain, which have created a tightening of supplies and shortages in a number of areas, including basic raw materials. Severe shortages, delays in delivery and interruptions in supply could increase our costs and limit our ability to construct, operate, maintain and upgrade drilling services equipment, completion services equipment, drilling products and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our business is subject to cybersecurity risks and threats. +Our operations are increasingly dependent on effective and secure information technologies and services, including our own systems and the systems of third party vendors and service providers upon which we rely, such as those providing cloud services to us. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, attempts to gain unauthorized access to data and systems, theft, viruses, malware, ransomware, denial-of-service attacks, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• +theft or misappropriation of funds, including via “phishing” or similar attacks directed at us or third parties, including our customers and vendors; +• +loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• +disruption or impairment of our and our customers’ and vendors’ business operations and safety procedures; +• +personal injuries and destruction or damage to property; +• +downtime and loss of revenue; +• +injury to our reputation, including the perception of our products or services as having security vulnerabilities; +• +negative impacts on our ability to compete; +• +loss or damage to our and our customers’ and vendors’ information technology systems, including operational technologies and worksite data delivery systems; +• +exposure to litigation and legal and regulatory liability and costs; and +• +increased costs to prevent, respond to or mitigate cybersecurity events. +Some of our office personnel remain on a “remote work” model. This model has significantly increased the use of remote networking and online conferencing services that enable employees to work outside of our corporate infrastructure and, in some cases, use their own personal devices. This may expose us to additional cybersecurity risks or related incidents. Additionally, geopolitical tensions or conflicts, such as the ongoing armed conflicts between Russia and Ukraine and Israel and Hamas and the continuation of, or any escalation in the severity of, these conflicts, may heighten the risk of cybersecurity attacks and other cyber events. +Although we utilize various procedures and controls to mitigate our exposure to the risks described above, cybersecurity attacks and other cyber events are evolving and unpredictable. There can be no assurance that the procedures and controls that we implement, or that our third party service providers implement, will be sufficient to protect our people, systems, information or other property. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber incident could go unnoticed for a period of time. We self-insure most of our cybersecurity risks, and any such incident could have a material adverse effect on our business, financial condition, cash flows and results of operations. As cyber incidents continue to evolve, we may be required to incur additional costs to continue to modify or enhance our protective measures or to investigate or remediate the effects of cyber incidents. +19 +Our commitments under supply agreements could exceed our requirements, exposing us to risks including price, timing of delivery and quality of equipment and materials upon which our business relies. +We have purchase commitments with certain vendors to supply equipment and materials, including, in the case of our completion services business, proppants. Some of these agreements are take-or-pay or similar agreements with minimum purchase obligations. If demand for our services decreases from current levels, demand for the equipment that we use and the materials that we supply as part of these services will also decrease. In addition, our customers may self-source certain materials. If demand for our services and/or materials decreases enough, we could have contractual minimum commitments that exceed the required amount of materials we need to supply to our customers. In this instance, we could be required to purchase materials that we do not have a present need for, pay for materials that we do not take delivery of or pay prices in excess of market prices at the time of purchase. +Growth through acquisitions, the building or upgrading of equipment and the development of technology is not assured. +We have grown our drilling rig fleet and completion services fleet and expanded our business lines and use of technology in the past through mergers, acquisitions, upgrades, new construction and technology development. For example, in 2023, we significantly expanded our completions business through the NexTier merger, and we added a specialized drill bit solutions business through the Ulterra acquisition. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building or upgrading equipment or developing or acquiring new technology. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, our competitors may continue to upgrade and build new equipment and develop new technology, including drilling automation technology and lower-emissions operations and services. +There can be no assurance that we will: +• +successfully complete any acquisitions we attempt on the terms announced, or at all, +• +have sufficient capital resources to complete additional acquisitions, build or upgrade equipment or develop or acquire new technology, +• +through due diligence conducted prior to an acquisition, successfully uncover situations that could result in financial or legal exposure, or appropriately quantify the exposure from known risks, +• +successfully integrate additional equipment, acquired or developed technology or other assets or businesses, including the combination of our business with the businesses of NexTier and Ulterra, into our operations and internal controls, including financial reporting disclosure and cybersecurity and information technology systems, +• +effectively manage the growth and increased size, complexity and geography of our organization, and increased scrutiny from governmental authorities, including as a result of the NexTier merger, Ulterra acquisition or any other completed merger or acquisition, +• +maintain existing business relationships and contract terms with our customers, distributors, suppliers, vendors, landlords, joint venture partners and other business partners, as well as with those of any acquired business, such as NexTier or Ulterra, +• +successfully deploy idle, stacked, upgraded or additional equipment and acquired or developed technology, +• +maintain key employees, the crews necessary to operate additional equipment, and the personnel necessary to evaluate, acquire, develop and deploy new technology, or be successful in hiring replacements for departing personnel, +• +avoid unknown liabilities and unforeseen increased expenses or delays associated with the NexTier merger, Ulterra acquisition or any other merger or acquisition, or +• +successfully improve our financial condition, results of operations, business or prospects, or provide an adequate return of capital, as a result of the NexTier merger, Ulterra acquisition or any other completed acquisition, the building or upgrading equipment or the development of new technology. +In addition, because we, NexTier and Ulterra previously operated independently, it is possible that the integration process could result in: +• +diversion of the attention of our management; and +• +the disruption of, or the loss of momentum in, our ongoing businesses or inconsistencies in standards, controls, procedures and policies. +20 +Our failure to achieve consolidation savings, to integrate acquired businesses and technology and other assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising from events occurring prior to any completed acquisitions, prior to our establishment of adequate compliance oversight or in connection with disputes over acquired or developed technology. While we generally seek to obtain indemnities for liabilities arising from events occurring before such acquisitions, we may be unable to do so, and any indemnities we do obtain will be limited in amount and duration, may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build or upgrade equipment or acquire or develop new technology, and we also may issue equity, convertible or debt securities in connection with any such acquisitions, building or upgrade program or technology development. Use of cash for these purposes may adversely affect our cash available for capital expenditures and other uses, debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth and resulting integration efforts could strain our management, operations, employees and other resources. +Our business relationships may be subject to disruption due to uncertainty associated with any pending or recently completed acquisitions, including the NexTier merger or the Ulterra acquisition, which could have a material adverse effect on our results of operations, cash flows and financial position. +Parties with which we do business may experience uncertainty associated with any pending or recently completed acquisitions, such as the NexTier merger and the Ulterra acquisition, including with respect to current or future business relationships with us. Our business relationships may be subject to disruption as customers, distributors, suppliers, vendors, landlords, joint venture partners and other business partners may attempt to delay or defer entering into new business relationships, negotiate changes in existing business relationships or consider entering into business relationships with parties other than us. These disruptions could have a material adverse effect on our results of operations, cash flows and financial position, as well as a material adverse effect on our ability to realize the expected cost savings and other benefits of the applicable transaction. +Public health crises, pandemics and epidemics may have a significant adverse impact on our business, liquidity, results of operations and financial condition. +The effects of public health crises, pandemics and epidemics, including related governmental actions and restrictions related thereto, have had, and may in the future have, a significant adverse impact on the global economy, including the worldwide demand for oil and natural gas, and the level of demand for our services. +We are not able to enumerate all potential risks to our business from the emergence of a public health crisis, pandemic or epidemic; however, we believe that in addition to the impacts described above, other current and potential impacts include, but are not limited to: volatility in oil and natural gas prices; liquidity challenges; customers, suppliers and other third parties seeking to terminate, reject, renegotiate or otherwise avoid, and otherwise failing to perform, their contractual obligations to us; credit rating downgrades of our corporate debt and potentially higher borrowing costs in the future; a need to preserve liquidity; cybersecurity issues; litigation risk and possible loss contingencies; disruption to our supply chain; loss of workers and labor shortages; general oilfield cost inflation; a reduction of our workforce; costs associated with rationalization of our portfolio of real estate facilities; asset impairments and other accounting charges; infections and quarantining of our employees and the personnel of our customers, suppliers and other third parties; actions undertaken by international, national, regional and local governments and health officials; and a structural shift in the global economy and its demand for oil and natural gas. +The full extent of the impact of public health crises, pandemics and epidemics on the oil and natural gas industry and our business, liquidity, results of operations and financial condition will depend largely on the scale of such event, including the duration and spread of a subject pathogen, the impact of governmental actions designed to prevent the spread thereof and the further development, availability, timely distribution and acceptance of effective treatments and vaccines. +Fuel conservation measures could reduce demand for oil and natural gas, which would, in turn, reduce the demand for our services. +Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas may have a material adverse effect on our business, financial condition, cash flows and results of operations. Additionally, the increased competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, and biofuels) or increased focus on reducing the use of oil and natural gas (such as governmental mandates that ban the sale of new gasoline-powered automobiles, and new legislation such as the Inflation Reduction Act of 2022, which contains tax inducements and other provisions that incentivize investment, development, and deployment of alternative energy sources and technologies) could reduce demand for oil and natural gas and therefore for our services, which would lead to a reduction in our revenues. +21 +Risks Relating to the NexTier Merger and Ulterra Acquisition +Our ability to utilize our historic U.S. net operating loss carryforwards is expected to be limited as a result of the completion of the NexTier merger. +As of December 31, 2023, we had approximately $1.9 billion of gross U.S. federal net operating losses, approximately $62.3 million of gross Canadian net operating losses, approximately $22.6 million of gross Colombian net operating losses and approximately $1.1 billion of post-apportionment U.S. state net operating losses as of December 31, 2023, before valuation allowances. The majority of U.S. federal net operating losses will expire in varying amounts, if unused, between 2030 and 2037. U.S. federal net operating losses generated after 2017 can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2043. Colombian net operating losses will expire in varying amounts, if unused, between 2028 and 2032. U.S. state net operating losses will expire in varying amounts, if unused, between 2024 and 2043. +Section 382 of the Code (“Section 382”) generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). An ownership change generally occurs if one or more stockholders (or groups of stockholders) who are each deemed to own at least 5% of such corporation’s stock has increased their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change occurs, utilization of the relevant corporation’s NOLs would be subject to an annual limitation under Section 382, generally determined, subject to certain adjustments, by multiplying (i) the fair market value of such corporation’s stock at the time of the ownership change by (ii) a percentage approximately equivalent to the yield on long-term tax-exempt bonds during the month in which the ownership change occurs. Any unused annual limitation may be carried over to later years. +We experienced an ownership change (under Section 382) as a result of the closing of the NexTier merger. Our ability to utilize our available NOLs and other tax attributes to reduce future taxable income following this “ownership change” depends on many factors, including our future income, which cannot be assured. Based on information currently available, we expect this ownership change could cause some of our NOLs incurred prior to January 1, 2018 to expire before we would be able to utilize them to reduce taxable income in future periods, and may also require NOLs to be utilized later than they otherwise would be able to be utilized, increasing cash taxes payable in earlier years. +Uncertainties associated with the NexTier merger and the Ulterra acquisition may cause a loss of management personnel and other key employees, which could adversely affect our future business and operations. +We are dependent on the experience and industry knowledge of our officers and other key employees to execute our business plans. Our success will depend in part upon our ability to retain key management personnel and other key employees. Current and prospective employees may experience uncertainty about their roles within the combined company or other concerns regarding the operations of the combined company following the transactions, any of which may have an adverse effect on our ability to retain or attract key management and other key personnel. In addition, the loss of key personnel could diminish the anticipated benefits of the transactions and the integration of the companies may be more difficult. Furthermore, we may have to incur significant costs in identifying, hiring and retaining replacements for departing employees and may lose significant expertise and talent relating to the business of each of the companies. No assurance can be given that we will be able to retain or attract key management personnel and other key employees to the same extent that we have previously been able to retain or attract our own employees. +We have incurred and are expected to continue incurring transaction costs in connection with the NexTier merger and the Ulterra acquisition, which may be in excess of those we anticipated. +We have incurred and are expected to continue to incur non-recurring costs associated with completing the NexTier merger and the Ulterra acquisition, combining the operations of the three companies and achieving desired synergies. These costs have been, and may continue to be, substantial. We have incurred and will continue to incur costs related to formulating and implementing integration plans, including facilities and systems consolidation costs and other employment-related costs. We will continue to assess the magnitude of these costs, and additional unanticipated costs may be incurred in connection with the integration of the companies’ businesses. While we have assumed that a certain level of expenses would be incurred, there are many factors beyond our control that could affect the total amount or the timing of the expenses. The elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, may not offset integration-related costs to the extent anticipated. The costs described above and any unanticipated costs and expenses could have an adverse effect on our financial condition and operating results. +22 +The benefits and synergies attributable to the NexTier merger and the Ulterra acquisition may vary from expectations. +We may fail to realize the anticipated benefits and synergies expected from the NexTier merger and the Ulterra acquisition, which could adversely affect our business, financial condition and operating results. The success of the transactions will depend, in significant part, on our ability to successfully integrate the acquired businesses and realize the anticipated strategic benefits and synergies from the transactions. The anticipated benefits of the transactions may not be realized fully or at all, or may take longer to realize than expected. Actual operating, technological, strategic and revenue opportunities, if achieved at all, may be less significant than expected or may take longer to achieve than anticipated. If we are not able to achieve these objectives and realize the anticipated benefits and synergies expected from the NexTier merger and the Ulterra acquisition within the anticipated timing or at all, our business, financial condition and operating results may be adversely affected. +Legal and Regulatory Risks +The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition. +Various federal and state legislative and regulatory initiatives have been or could be undertaken that could result in additional requirements or restrictions being imposed on hydraulic fracturing operations or result in the failure to obtain or difficulty or delay in obtaining required permits, renewals or authorizations. For example, the federal Bureau of Land Management (“BLM”) published a final rule in 2015 establishing new or more stringent standards for performing hydraulic fracturing on federal and Indian lands. The BLM rescinded the 2015 rule in late 2017; however, new or more stringent regulations may be promulgated by the Biden administration. The United States may seek to adopt federal regulations or enact federal laws that would impose additional regulatory requirements on or even prohibit hydraulic fracturing in some areas. Legislation and/or regulations have been adopted in many U.S. states that require additional disclosure regarding chemicals used in the hydraulic fracturing process. Legislation, regulations, and/or policies have also been adopted at the state level that impose other types of requirements on hydraulic fracturing operations (such as limits on operations in the event of certain levels of seismic activity). Additional legislation and/or regulations have been adopted or are being considered at the state and local level that could impose further chemical disclosure or other regulatory requirements (such as prohibitions on hydraulic fracturing operations in certain areas) that could affect our operations. Four states (New York, Maryland, Vermont, and Washington) have banned the use of high volume hydraulic fracturing, Oregon has adopted a five-year moratorium, and Colorado has enacted legislation providing local governments with regulatory authority over hydraulic fracturing operations. Local jurisdictions in some states have adopted ordinances that restrict or in certain cases prohibit the use of hydraulic fracturing, although many of these ordinances have been challenged and some have been overturned. The adoption of any future federal, state or local laws or regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition. +Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services. +The physical and regulatory effects of climate change could have a negative impact on our operations, our customers’ operations and the overall demand for our customers’ products and, accordingly, our services. There is an increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. These efforts have included consideration of cap-and-trade programs, carbon taxes, GHG reporting, tracking programs, attestation requirements and regulations that directly limit GHG emissions from certain sources. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. In the absence of federal GHG-limiting legislation, the EPA has determined that GHG emissions present a danger to public health and the environment and has adopted regulations that, among other things, establish construction and operating permit reviews for GHG emissions from certain large stationary sources, require the monitoring and annual reporting of GHG emissions from certain oil and natural gas system sources, implement CAA emission standards directing the reduction of methane emissions from certain new, modified, or reconstructed facilities in the oil and natural gas sector, and together with the U.S. Department of Transportation, implement GHG emissions limits on vehicles manufactured for operation in the United States. +The United States is currently a member of the Paris Agreement, which requires countries to review and “represent a progression” in their nationally determined contributions, which set emissions reduction goals, every five years. Under the Paris Agreement, the Biden Administration has committed the United States to reducing its greenhouse gas emissions by 50-52% from 2005 levels by 2030. In November 2021, the United States and other countries entered into the Glasgow Climate Pact, which +23 +includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions 30% by 2030, and cooperating toward the advancement of the development of clean energy. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of the Paris Agreement. +Governmental, scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks in the United States. President Biden and the Democratic Party have identified climate change as a priority, and it is possible that additional executive orders and/or regulatory action targeting greenhouse gas emissions, or prohibiting or restricting oil and natural gas development activities in certain areas, will be proposed and/or promulgated during the Biden Administration. In 2021, President Biden issued an executive order imposing a moratorium on new oil and natural gas leasing on federal lands and offshore waters pending completion of a comprehensive review and reconsideration of federal oil and natural gas permitting and leasing practices. President Biden’s order also established climate change as a primary foreign policy and national security consideration, affirms that achieving net-zero greenhouse gas emissions by or before midcentury is a critical priority, affirms the Biden Administration’s desire to establish the United States as a leader in addressing climate change, generally further integrates climate change and environmental justice considerations into government agencies’ decision-making, and eliminates fossil fuel subsidies, among other measures. Although a federal judge for the U.S. District Court of the Western District of Louisiana issued a permanent injunction in 13 states that filed a lawsuit against the pause of oil and natural gas leasing on public lands or in offshore waters, the Biden Administration may take other regulatory steps in the future that could impact our operations. Other actions impacting oil and natural gas production activities that could be pursued by the Biden administration may include more restrictive requirements for the establishment of pipeline infrastructure or the permitting of liquified natural gas export facilities, such as the January 2024 pause on permitting of certain new liquified natural gas export facilities. Moreover, in August 2022, President Biden signed into law the Inflation Reduction Act, which contains tax inducements and other provisions that incentivize investment, development, and deployment of alternative energy sources and technologies, which could increase operating costs within the oil and natural gas industry and accelerate the transition away from fossil fuels. +It is not possible at this time to predict the timing and effects of climate change or whether additional climate-related legislation, regulations or other measures will be adopted at the local, state, regional, national and international levels. However, continued efforts by governments and non-governmental organizations to reduce GHG emissions appear likely, and additional legislation, regulation or other measures that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our business. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations increase compliance costs, add operating restrictions, or reduce demand for our customers’ products and, accordingly, our services. +Increasing attention to the risks of climate change has resulted in an increased possibility of lawsuits or investigations brought by public and private entities against oil and natural gas companies in connection with their GHG emissions. Should we be targeted by any such litigation or investigations, we may incur liability, which, to the extent that societal pressures or political or other factors are involved, could be imposed without regard to the causation of or contribution to the asserted damage, or to other mitigating factors. +These political, litigation, and financial risks may result in our customers restricting or cancelling production activities, incurring liability for infrastructure damage as a result of climatic changes, or impairing their ability to continue to operate in an economic manner, which also could reduce demand for our products and services. One or more of these developments could have a material adverse effect on our business, financial condition, cash flows and results of operations. Finally, increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, floods and other climatic events. If any such effects were to occur, they could have an adverse effect on our and our customers’ facilities and operations. +24 +Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. +For example, in the United States, the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (“CERCLA”), and comparable state statutes impose strict liability on owners and operators of sites, including prior owners and operators who are no longer active at a site, as well as persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. The Clean Water Act (“CWA”) and analogous state laws provide for administrative, civil and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1999, as amended, impose liability for the remedial costs and associated damages arising out of any unauthorized discharges, including oil and produced water spills, into jurisdictional waters. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Clean Air Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +Furthermore, the U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Other jurisdictions where we may conduct operations have similar environmental, employee health and safety and other regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +A failure to comply with these requirements could expose us to: +• +substantial civil, criminal and/or administrative penalties or judgments, +• +modification, denial or revocation of permits or other authorizations, +• +imposition of limitations on our operations, and +• +performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the places that we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and completion services equipment, a manufacturer and servicer of equipment and automation to the energy, marine and mining industries and a provider of directional drilling and other services, we may be deemed to be a responsible party under these laws and regulations. In the event hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations, any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +25 +Technology disputes could negatively impact our operations, costs, revenues and competitiveness. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, or a third party’s infringement of our rights, including patent rights. The majority of the intellectual property rights relating to our drilling services equipment, completion services equipment, and drilling products are owned by us or certain of our supplying vendors. However, in the event that we or one of our customers or supplying vendors becomes involved in a dispute over infringement of intellectual property rights relating to equipment or technology owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or technology or our ability to provide services or products, or we could be required to cease use of some equipment or technology or forced to modify our equipment, technology, services or products. We could also be required to pay license fees or royalties for the use of equipment or technology or provision of services or products. In addition, we may lose a competitive advantage in the event we are unsuccessful in enforcing our rights against third parties, third parties are successful in enforcing their rights against us, or our competitors are able to develop technology independently that is similar to ours without infringing on our patents or gaining access to our trade secrets. +Regardless of the merits, any such claims may result in significant legal and other costs, including reputational harm, and may distract management from running our business. Some of our competitors and current and potential vendors have a substantial amount of intellectual property related to new equipment and technologies. We cannot guarantee that our equipment, technology, services or products will not be determined to infringe currently issued or future issued patents or other intellectual property rights belonging to others, including, without limitation, situations in which our equipment, technology, services or products may be covered by patent applications filed by other parties. Technology disputes involving us or our customers or supplying vendors could have a material adverse impact on our business, financial condition, cash flows and results of operations. +Certain subsidiaries we acquired in the Ulterra acquisition are defendants in a claim brought by a subsidiary of NOV Inc. alleging breach of a license agreement related to certain patents. Such subsidiaries have asserted defenses to the claim and are defending vigorously against this claim. An unfavorable judgment or resolution of this claim not covered by indemnity could have a material adverse effect on our business, financial condition and results of operations. +The design, manufacture, sale or rental and servicing of products, including drill bits and electrical controls, may subject us to liability for personal injury, property damage and environmental contamination should such equipment fail to perform to specifications. +We provide products, including specialized drill bit solutions and electrical controls, to customers involved in oil and natural gas exploration, development and production and in the marine and mining industries. Because of applications that use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause harm to our reputation, contractual and warranty-related liability, damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. Any lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. +Legal proceedings and governmental investigations could have a negative impact on our business, financial condition and results of operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Please see “Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +26 +Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business. +We provide specialized drill bit solutions throughout North America and internationally in over 30 countries, as well as contract drilling services in Colombia. We also sell products, including electrical controls, for use in numerous oil and natural gas producing regions outside of North America. In addition, through our Superior QC business, we occasionally provide remote data analytics and other services to customers to support their operations outside of the United States. We also continue to evaluate opportunities from time to time to provide our services and products outside of the United States. International operations and sales or rentals of products are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, changing political conditions and changing laws and policies affecting trade and investment, strikes, work stoppages, labor disputes and other slowdowns, terrorism, war, kidnapping of employees, blockades, regional economic downturns, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, difficulty in collecting international accounts receivable, potentially longer payment cycles, expropriation of equipment as well as expropriation of oil and natural gas exploration and drilling rights, foreign taxation and customs regulations, the overlap of different tax structures, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any current and future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we do not control the actions of our joint venture partners, their actions could have an effect on our investment in the joint ventures and more generally our overall reputation. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. Additionally, we may be subject to foreign governmental regulations favoring or requiring the awarding of contracts to local contractors or requiring foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. These regulations could adversely affect our ability to compete. +There can be no assurance that we will: +• +identify attractive opportunities in international markets, +• +have sufficient capital resources to pursue and consummate international opportunities, +• +successfully integrate international drilling and completion operations or other assets or businesses, +• +effectively manage the start-up, development and growth of an international organization and assets, +• +hire, attract and retain the personnel necessary to successfully conduct international operations, or +• +receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where our services are or could be provided or where our consumers for products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. In addition, investors could negatively view potential violations, inquiries or allegations of misconduct under the FCPA or similar laws, which could adversely affect our reputation and the market for our shares. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, completion services equipment, manufacturing facilities, drilling products or other assets. +27 +Many countries, including the United States, control the import and export of certain goods, services and technology and impose related import and export recordkeeping and reporting obligations. Governments also may impose economic sanctions against certain countries, persons and other entities that may restrict or prohibit transactions involving such countries, persons and entities. In particular, U.S. sanctions are targeted against certain countries that are heavily involved in the oil and natural gas industry. The laws and regulations concerning import and export activity, recordkeeping and reporting, including customs, export controls and economic sanctions, are complex and constantly changing. Any failure to comply with applicable legal or regulatory requirements governing international trade could also result in criminal and civil penalties and sanctions, such as fines, imprisonment, debarment from government contracts, seizure of shipments and loss of import and export privileges. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +We are subject to complex and evolving laws and regulations regarding data privacy and security. +Governments around the world have implemented, and continue to implement, laws and regulations regarding data privacy and security, including with respect to the protection and processing of personal employee and customer data. These laws and regulations vary from jurisdiction to jurisdiction, and we are obligated to comply in all jurisdictions in which we conduct business. In the normal course of business, we and our third-party vendors or service providers may collect, process, and store data that is subject to those specific laws and regulations governing personal data. Failure to comply with these laws and regulations could subject us to significant liability, including fines, penalties, and potential criminal sanctions. +Financial Risks +Investor sentiment and public perception related to the oil and natural gas industry and to ESG initiatives could increase our costs of capital and our reporting requirements and impact our operations. +There are financial risks for oil and natural gas producers, as stockholders and bondholders currently invested in oil and natural gas companies and concerned about the potential effects of climate change, ESG and other sustainability-related issues may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors, or into competitors who are perceived to have stronger ESG practices and disclosures. Our ESG practices and disclosures may not satisfy investor requirements or their requirements may not be made known to us. We may continue to face pressure regarding our ESG practices and disclosures. +We have developed, and will continue to develop, goals and other objectives related to ESG and sustainability matters. Statements related to these goals and objectives made in our published Sustainability Report and other public disclosure reflect our current plans and do not constitute a guarantee that they will be achieved. Our ability to achieve any stated goal or objective is subject to numerous factors and conditions, some of which are outside of our control. Our efforts to accurately report on ESG and sustainability matters, including our efforts to research, establish, accomplish and accurately report on our goals and objectives, expose us to numerous operational, reputational, financial, legal, and other risks. Standards for tracking and reporting on ESG and sustainability matters, including climate-related matters, have not been harmonized and continue to evolve. Our processes and controls for reporting on ESG and sustainability matters, including our goals and objectives, may not always comply with evolving and disparate standards for identifying, measuring, and reporting such metrics, including any climate change and sustainability-related public company disclosure requirements adopted by the SEC, and such standards may change over time, which could result in significant revisions to our current ESG practices and disclosures. +The lending and investment practices of institutional lenders and investors have been the subject of intensive lobbying efforts in recent years, oftentimes public in nature, not to provide funding for oil and natural gas producers, and some lenders and insurers have announced that they will not lend to or provide insurance for oil and natural gas companies. Limitation of investments in and financings for oil and natural gas could result in the restriction, delay, or cancellation of drilling and completion programs or development of production activities. An increasing number of our customers consider sustainability factors in awarding work. If we are unable to meet the ESG standards or investment criteria set by our customers, investors and other parties, which continue to evolve, if we are unable to successfully continue our sustainability enhancement efforts, or if, notwithstanding our own efforts, our industry becomes the focus of increasing ESG and sustainability related pressures, we may lose customers, we may lose investors, our cost of capital may increase, our stock price may be negatively impacted, our reputation may be negatively affected, and it may be more difficult for us to effectively compete or assess acquisitions. At the same time, some stakeholders and +28 +regulators have increasingly expressed or pursued opposing views, legislation, and investment expectations with respect to ESG, including the enactment or proposal of “anti-ESG” legislation or policies. By publishing our Sustainability Report from time to time, our business may also face increased scrutiny related to ESG activities and be unable to satisfy all stakeholders. +Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly. +We have in place a committed senior unsecured credit facility that includes a revolving credit facility. Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, the SOFR rate (subject to a 0.10% per annum adjustment) or base rate, in each case subject to a 0% floor. The applicable margin on SOFR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based on our credit rating. As of December 31, 2023, the applicable margin on SOFR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. As of December 31, 2023, we had no borrowings outstanding under our revolving credit facility. +We also have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. As of December 31, 2023, no amounts had been disbursed under any letters of credit, and we had $87.7 million in letters of credit outstanding under the reimbursement agreement. +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed at floating rates under these agreements or under future agreements, as well as the terms of any future amendments to our existing agreements or future agreements. +Our ability to access capital markets could be limited, and a downgrade in our credit rating could negatively impact our cost of and ability to access capital. +From time to time, we may need to access capital markets to obtain financing. Our ability to access capital markets for financing could be limited by oil and natural gas prices, our existing capital structure, the state of the economy, the health or market perceptions of the drilling and overall oil and natural gas industry, the liquidity of the capital markets and ESG-related regulatory and investor requirements and other factors. Many of the factors that affect our ability to access capital markets are outside of our control. No assurance can be given that we will be able to access capital markets on terms acceptable to us when required to do so, which could have a material adverse impact on our business, financial condition and results of operations. +Additionally, our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels, industry conditions and other considerations. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, impact the terms of future amendments to our senior unsecured credit facility and potentially require us to post letters of credit for certain obligations. +We may not be able to generate sufficient cash to service all of our debt and we may be forced to take other actions to satisfy our obligations under our debt, which may not be successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, including the ability of our subsidiaries to generate sufficient cash flows, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our debt agreements contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +29 +Our return of capital to stockholders, including through the payment of dividends and repurchases of our common stock, is within the discretion of our Board of Directors, and there is no guarantee that we will return capital to shareholders, including through the payment of dividends and repurchases of our common stock, in the future or at levels anticipated by our stockholders. +Although we currently plan to return capital to stockholders, the amount and timing of returns of capital to stockholders may vary from time to time. The amount and timing of all returns of capital, including future dividend payments and purchases pursuant to our stock buyback program, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend or limit, suspend or terminate our stock repurchase program. There can be no assurance that we will pay a dividend or make repurchases of our common stock in the future. The payment of dividends and stock repurchases could diminish our cash reserves, which may impact our ability to meet our working capital needs, satisfy our debt obligations, make capital expenditures, grow and pursue strategic opportunities and acquisitions. In addition, any elimination of, or downward revision in, our stock buyback program or dividend payments could have an adverse effect on the market price of our common stock. +Risks Related to Our Common Stock and Corporate Structure +The market price of our common stock may be highly volatile, and investors may not be able to resell shares at or above the price paid. +The trading price of our common stock may be volatile. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as other general economic, market or political conditions, could reduce the market price of our common stock in spite of our operating and/or financial performance. The following factors, in addition to other factors described in this “Risk Factors” section and elsewhere in this Report, may have a significant impact on the market price of our common stock: +• +investor perception of us and the industry and markets in which we operate; +• +general financial, domestic, international, economic, and market conditions, including overall fluctuations in the U.S. equity markets; +• +increased focus by the investment community on sustainability practices at our company and in the oil and natural gas industry generally; +• +changes in customer needs, expectations or trends and our ability to maintain relationships with key customers; +• +our ability to implement our business strategy; +• +changes in our capital structure, including the issuance of additional debt; +• +public announcements (including the timing of these announcements) regarding our business, financial performance and prospects or new services or products, service or product enhancements, technological advances or strategic actions, such as acquisitions or divestitures, restructurings or significant contracts, by our competitors or us; +• +trading activity in our stock, including portfolio transactions in our stock by us, our executive officers and directors, and significant stockholders or trading activity that results from the ordinary course rebalancing of stock indices in which we may be included; +• +any elimination of, or downward revision in, our stock buyback program or dividend payments; +• +short-interest in our common stock, which could be significant from time to time; +• +our inclusion in, or removal from, any stock indices; +• +changes in earnings estimates or buy/sell recommendations by securities analysts; +• +whether or not we meet earnings estimates of securities analysts who follow us; and +• +regulatory or legal developments in the United States and the foreign countries where we operate. +30 +Anti-takeover measures in our charter documents and under state law could discourage an acquisition and thereby affect the related purchase price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +Our bylaws provide that the Court of Chancery of the State of Delaware and the federal district courts of the United States are the exclusive forums for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees. +Our bylaws provide that, to the fullest extent permitted by law, the Court of Chancery of the State of Delaware (or, if the Court of Chancery does not have, or declines to accept, jurisdiction, another state court or a federal court located within the State of Delaware) is the exclusive forum for any claims, including claims in the right of Patterson-UTI: (a) that are based upon a violation of a duty by a current or former director, officer, employee or stockholder in such capacity, or (b) as to which the General Corporation Law of the State of Delaware confers jurisdiction upon the Court of Chancery. This provision would not apply to suits brought to enforce a duty or liability created by the Exchange Act or any other claim for which the U.S. federal courts have exclusive jurisdiction. Our bylaws further provide that the sole and exclusive forum for any complaint asserting a cause of action arising under the Securities Act, to the fullest extent permitted by law, shall be the federal district courts of the United States. The enforceability of similar exclusive federal forum provisions in other companies’ organizational documents has been challenged in legal proceedings, and while the Delaware Supreme Court has ruled that this type of exclusive federal forum provision is facially valid under Delaware law, there is uncertainty as to whether other courts would enforce such provisions and that investors cannot waive compliance with the federal securities laws and the rules and regulations thereunder. These exclusive forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find either exclusive forum provision in our bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could have a material adverse effect on our business, financial condition, and results of operations. +Item 1B. Unresolved Staff Comments. +None. +Item 1C. Cybersecurity +We have implemented and maintain a cybersecurity program that is aligned with the NIST Framework and reasonably designed to protect our information and to assess, identify, and manage risks from cybersecurity threats that may result in material adverse effects on the confidentiality, integrity, and availability of our information systems. +Governance +Our Board has delegated the primary responsibility to oversee cybersecurity matters to the Audit Committee. The Audit Committee regularly reviews the measures implemented by the Company to identify and mitigate data protection and cybersecurity risks. As part of such reviews, the Audit Committee receives reports and presentations from members of our senior leadership for overseeing the company’s cybersecurity risk management, including the Vice President of Information Technology, which address a wide range of topics including recent developments, evolving standards, vulnerability assessments, third-party and independent reviews, the threat environment, technological trends and information security considerations arising with respect to the Company’s peers and third parties. Such members of our senior leadership also report to the Board at least annually on cybersecurity matters, including information security and cybersecurity risk. We have protocols by which certain cybersecurity incidents that meet established reporting thresholds are escalated within the Company and, where appropriate, reported promptly to the Board and Audit Committee. +31 +Our Audit Committee is responsible for overseeing information security and cybersecurity risk. Senior leadership communicates with the Audit Committee at least quarterly regarding information security and cybersecurity risk and formally reports to the entire Board on information security and cybersecurity risk at least annually. +At the management level, our Vice President of Information Technology, who has extensive cybersecurity knowledge and skills gained from over 18 years of work experience at our company and elsewhere, heads the team responsible for implementing, monitoring, and maintaining information security and cybersecurity practices across our businesses and reports directly to the Chief Financial Officer. +The Vice President of Information Technology receives reports on information security and cybersecurity threats from our Director of Infrastructure and Cybersecurity and in conjunction with management, regularly reviews risk management measures implemented by our company to identify and mitigate information security and cybersecurity risks. A number of experienced information security team members responsible for various parts of the business also report to the Vice President of Information Technology on an ongoing basis. In addition to our internal cybersecurity capabilities, we also regularly engage assessors, consultants, auditors, and other third parties to assist with assessing, identifying, and managing cybersecurity risks. +We have adopted a cybersecurity incident reporting process (“IRP”) that applies in the event of a cybersecurity threat or incident to provide a standardized framework for responding to security incidents. The IRP sets out a coordinated approach to investigating, containing, documenting, and mitigating incidents, including reporting findings and keeping senior management, the Board and other key stakeholders informed and involved as appropriate. +Risk Management and Strategy +Our senior management and representatives from our business units regularly communicate with the Board of Directors on risk management matters, including cybersecurity risks. Senior management conducts regular risk assessments to identify risks that have the potential to significantly affect our business over the short-, medium- and longer term and reviews with the Board of Directors risk mitigation and oversight measures, including prioritization of risk management and allocation of responsibility within our company for the management of a particular risk. +We continue to improve our cybersecurity risk assessment program and activities for assessing, identifying and managing cybersecurity risks through industry standard security frameworks and leading practices, including risk assessments and remediations, software and services, continuous systems monitoring, vendor risk management processes, incident response plans, phishing simulations, employee training, tabletop exercises and communication programs, among other measures. We also employ processes designed to assess, identify, and manage the potential impact of a security incident at critical third-party vendors, service providers or customers or otherwise implicating the third-party technology and systems we use. +All employees with a company-provided email receive annual cyber awareness training. In addition, we perform monthly phishing simulations, with remediation training required as necessary. +While we have not experienced material cybersecurity threats or incidents, or threats or incidents that are reasonably likely to materially affect us, there can be no guarantee that we will not be the subject of future successful attacks, threats or incidents. Information on cybersecurity risks and threats we face can be found in Part I, Item 1A “Risk Factors” of this Report under the heading “Our business is subject to cybersecurity risks and threats.” +Item 2. Properties +Our property consists primarily of drilling rigs and related equipment, completion services equipment and rental bits. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. +Drilling Services — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania, Ohio, and internationally in Colombia. Our servicing of equipment for drilling contractors is supported by offices and yard facilities located in Texas. Our electrical controls and automation operation is supported by an office and yard facility in Texas. +32 +Completion Services — Our completion services are supported by multiple offices and yard facilities located in the Permian, Marcellus Shale/Utica Basins, Haynesville and Eagle Ford, among others. +Drilling Products — Our drilling products segment is supported by multiple offices and manufacturing and distributing facilities located through North America and internationally in over 30 countries. +Other — Our oilfield rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our interests in oil and natural gas assets are primarily located in Texas and New Mexico. +We own or lease administrative offices, manufacturing facilities, research centers, and other facilities throughout the world, none of which is individually material. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +Item 4. Mine Safety Disclosure. +Not applicable. +33 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P SmallCap 600 Index and several other market indices. +(b) Holders +As of February 9, 2024, there were approximately 800 holders of record of our common stock. +(c) Dividends +On February 14, 2024, our Board of Directors approved a cash dividend on our common stock in the amount of $0.08 per share to be paid on March 15, 2024 to holders of record as of March 1, 2024. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend in order to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2023. +Period Covered +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands) (2) +October 2023 +58,178 +$ +12.87 +— +$ +281,031 +November 2023 +1,858,670 +$ +11.91 +1,834,546 +$ +259,183 +December 2023 +5,121,552 +$ +11.07 +4,825,639 +$ +205,676 +Total +7,038,400 +6,660,185 +(1) +378,215 shares were withheld in the fourth quarter with respect to employees’ tax withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended, the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan, as amended, the NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan and the NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan, and not pursuant to the stock buyback program. +(2) +In September 2013, our Board of Directors approved a stock buyback program. In April 2023, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $300 million of future share repurchases. In February 2024, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $1 billion of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the buyback program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. +34 +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2018 through December 31, 2023, with the cumulative total return of the S&P 500 Index, the S&P SmallCap 600 Index and the Oilfield Service Index. +The graph assumes investment of $100 on December 31, 2018 and reinvestment of all dividends. +Index Data: Copyright Standard and Poor’s, Inc. Used with permission. All rights reserved. +Fiscal Year Ended December 31, +2018 +2019 +2020 +2021 +2022 +2023 +Company/Index +($) +($) +($) +($) +($) +($) +Patterson-UTI Energy, Inc. +100.00 +103.08 +52.77 +85.63 +172.71 +113.70 +S&P 500 Index +100.00 +131.47 +155.65 +200.29 +163.98 +207.04 +S&P SmallCap 600 Index +100.00 +122.74 +136.53 +173.04 +145.10 +168.23 +Oilfield Service Index +100.00 +99.45 +57.60 +69.55 +112.31 +114.47 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +35 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Management Overview — We are a Houston, Texas -based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. +Drilling Services +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and natural gas basins in the United States, and we provide services that improve the statistical accuracy of wellbore placement for directional and horizontal wells. We also service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allows for more clearance underneath the rig floor. As of December 31, 2023, our rig fleet included 173 super-spec rigs, of which 131 were Tier-1, super-spec rigs. +Completion Services +Our well completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. +To address evolving customer preferences for emissions-reducing equipment, we have invested in natural gas-powered equipment, including electric pumps, to replace legacy diesel completion services equipment. +Drilling Products +We serve the energy and mining markets by manufacturing and distributing drill bits through North America and internationally in over 30 countries. Our drilling equipment is used in oil and natural gas exploration and production and in mining operations. We have manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Recent Developments in Market Conditions and Outlook — Crude oil prices and demand for drilling and completion equipment and services increased from 2021 to 2022, and industry supply of Tier-1, super-spec rigs became constrained. Commodity price volatility in the second quarter of 2023 resulted in a decline in industry activity; commodity prices subsequently increased during the third quarter before declining in the fourth quarter of 2023. The current demand for equipment and services remains dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. +Oil prices averaged $78.53 per barrel in the fourth quarter of 2023 and closed at 78.72 per barrel on February 20, 2024. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.74 per MMBtu in the fourth quarter of 2023 and closed at $1.50 per MMBtu on February 20, 2024. +36 +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2021, 2022 and 2023 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day – U.S. (2) +69 +73 +80 +106 +2022: +Average oil price per Bbl (1) +$ +94.45 +$ +108.72 +$ +93.18 +$ +82.79 +Average rigs operating per day – U.S. (2) +115 +121 +128 +131 +2023: +Average oil price per Bbl (1) +$ +75.93 +$ +73.54 +$ +82.25 +$ +78.53 +Average rigs operating per day – U.S. (2) +131 +128 +120 +118 +(1) +The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our average active U.S. rig count for the fourth quarter of 2023 was 118 rigs. This was a decrease from our average active rig count for the third quarter of 2023 of 120 rigs. Our active U.S. rig count at December 31, 2023 of 121 rigs was less than the rig count of 132 rigs at December 31, 2022, due in large part to the decline in commodity prices and reduced demand for drilling services in the United States. We expect our rig count in the United States will average 120 rigs in the first quarter of 2024. Term contracts help support our operating rig count. Based on contracts in place in the United States as of February 14, 2024, we expect an average of 79 rigs operating under term contracts during the first quarter of 2024 and an average of 52 rigs operating under term contracts during 2024. +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2023 and 2022 was approximately $700 million and $830 million, respectively. Approximately 16% of our total contract drilling backlog in the United States at December 31, 2023 is reasonably expected to remain after 2024. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment.” +Our completion services business was impacted by calendar inefficiencies during the second half of 2023 resulting from a decline in customer activity during the third quarter. Completion services activity stabilized in the fourth quarter of 2023. We believe activity will modestly decline in the first quarter of 2024. +Drilling products demand increased from the third quarter of 2023 despite a decline in the global rig count. Drilling Products demand is expected to remain steady through the first quarter, given the expectation for a steady market in the U.S. and moderate growth in international markets relative to what we saw in the fourth quarter. +Cash capital expenditures for 2023 totaled $616 million. This was an increase from the $437 million of cash capital expenditures in 2022 due largely to the Ulterra acquisition and NexTier merger in 2023. Based on our current outlook for activity, we expect our capital expenditures for 2024 to be approximately $740 million. +Recent Developments in Business Combinations — On September 1, 2023, we completed our merger (the “NexTier merger”) with NexTier Oilfield Solutions Inc. (“NexTier”). Each share of common stock of NexTier issued and outstanding immediately prior to the effective time (including outstanding restricted shares) was converted into the right to receive 0.752 shares of our common stock, which based on the closing price of our common stock of $14.91 on September 1, 2023, valued the transaction at approximately $2.8 billion, including the assumption of debt. NexTier is a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins. +On August 14, 2023, we completed our acquisition (the “Ulterra acquisition”) of Ulterra Drilling Technologies, L.P. (“Ulterra”). Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $376 million cash, which based on the closing price of our common stock of $14.94 on August 14, 2023, valued the transaction at closing at approximately $897 million. Ulterra is a global provider of specialized drill bit solutions. +Recent Developments in Debt Financing — On September 13, 2023, we completed the offering of $400 million in aggregate principal amount of our 7.15% Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses were approximately $396 million, which we used to repay amounts outstanding under our revolving credit facility. +37 +On August 29, 2023, we entered into Amendment No. 4 to Amended and Restated Credit Agreement (the “Credit Agreement Amendment”), which amended our Amended and Restated Credit Agreement, dated as of March 27, 2018 (as amended, the “Credit Agreement”), by and among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +The Credit Agreement Amendment, among other things, (i) deemed certain outstanding letters of credit issued for the account of BEP Diamond Holdings Corp. (the entity we acquired in the Ulterra acquisition) with a face amount of $2.5 million to have been issued under the Credit Agreement, and (ii) extended the maturity date for $85 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026. As a result, of the $600 million of revolving credit commitments under the Credit Agreement, the maturity date for $501.7 million of such commitments is March 27, 2026; the maturity date for $48.3 million of such commitments is March 27, 2025; and the maturity date for the remaining $50 million of such commitments is March 27, 2024. +As of December 31, 2023, we had no borrowings outstanding under our revolving credit facility. We had $2.6 million in letters of credit outstanding under the Credit Agreement at December 31, 2023 and, as a result, had available borrowing capacity of approximately $597 million at that date. +During the first quarter of 2023, we elected to repurchase portions of our 3.95% Senior Notes due 2028 (the “2028 Notes”) and our 5.15% Senior Notes due 2029 (the “2029 Notes”) in the open market. The principal amounts retired through these transactions totaled $6.0 million of our 2028 Notes and $3.0 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $0.8 million and $0.3 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations included as a part of Item 8 of this Report. +During the fourth quarter of 2022, we elected to repurchase portions of our 2028 Notes and 2029 Notes (as defined above) in the open market. The principal amounts retired through these transactions totaled $21.0 million of our 2028 Notes and $1.4 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $2.3 million and $0.1 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations included as a part of Item 8 of this Report. +Impact on our Business from Oil and Natural Gas Prices and Other Factors — Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas, expectations about future prices, and upon our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. During periods of improved oil and natural gas prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when oil and natural gas prices are relatively low or when our customers have a reduced ability to access, or willingness to deploy capital, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. We may also be impacted by delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies. +The North American oil and natural gas services industry is cyclical and at times experiences downturns in demand. During these periods, there has been substantially more oil and natural gas service equipment available than necessary to meet demand. As a result, oil and natural gas service contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods. We cannot predict either the future level of demand for our oil and natural gas services or future conditions in the oil and natural gas service businesses. +In addition to the dependence on oil and natural gas prices and demand for our services, we are highly impacted by operational risks, competition, labor issues, weather, the availability, from time to time, of products used in our businesses, supplier delays and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. See “Risk Factors” in Item 1A of this Report. +38 +For the three years ended December 31, 2023, our operating revenues and net income consisted of the following (dollars in thousands): +2023 +2022 +2021 +Drilling services +$ +1,919,759 +46.3 +% +$ +1,544,820 +58.3 +% +$ +784,218 +57.8 +% +Completion services +2,017,440 +48.7 +% +1,022,413 +38.6 +% +523,756 +38.6 +% +Drilling products +134,679 +3.2 +% +— +0.0 +% +— +0.0 +% +Other +74,578 +1.8 +% +80,359 +3.1 +% +49,107 +3.6 +% +$ +4,146,456 +100.0 +% +$ +2,647,592 +100.0 +% +$ +1,357,081 +100.0 +% +Net income (loss) +$ +245,952 +$ +154,658 +$ +(654,545 +) +Results of Operations +Effective as of the third quarter of 2023, we revised our reportable segments to align with certain changes in how our Chief Operating Decision Maker (“CODM”) manages and allocates resources to our business as a result of the Ulterra acquisition and NexTier merger. We now have the following reportable business segments: (i) drilling services, (ii) completion services and (iii) drilling products. Accordingly, we recast our results of operations for the first half of 2023 and the year ended December 31, 2022 to align with our revised reportable segments. +Comparison of the years ended December 31, 2023 and 2022 +The following tables summarize results of operations by business segment for the years ended December 31, 2023 and 2022: +Year Ended December 31, +Drilling Services (1) +2023 +2022 +% Change +(Dollars in thousands) +Revenues +$ +1,919,759 +$ +1,544,820 +24.3 +% +Direct operating costs +1,119,200 +1,025,904 +9.1 +% +Adjusted gross profit (2) +800,559 +518,916 +54.3 +% +Selling, general and administrative +15,014 +15,027 +(0.1 +)% +Depreciation, amortization and impairment +364,312 +354,116 +2.9 +% +Other operating income, net +(769 +) +(34 +) +2,161.8 +% +Operating income +$ +422,002 +$ +149,807 +181.7 +% +Capital expenditures +$ +334,780 +$ +272,521 +22.8 +% +Operating days – U.S. (3) +45,270 +45,216 +0.1 +% +Average revenue per operating day – U.S. +$ +36.24 +$ +27.57 +31.5 +% +Average direct operating costs per operating day – U.S. +$ +19.42 +$ +17.32 +12.1 +% +Average adjusted gross profit per operating day – U.S. (3) +$ +16.83 +$ +10.25 +64.2 +% +(1) +Drilling services segment represents our contract drilling, directional drilling, oilfield technology and electrical controls and automation businesses. +(2) +Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +(3) +Operational data relates to our contract drilling business. A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Revenues increased primarily due to improved pricing from our contract drilling business within the United States. +Direct operating costs increased primarily due to inflationary pressure on labor and supplies. +The increase in capital expenditures was primarily due to higher maintenance capital expenditures related to upgrading of certain rig components. +39 +Year Ended December 31, +Completion Services (1) +2023 +2022 +% Change +(Dollars in thousands) +Revenues +$ +2,017,440 +$ +1,022,413 +97.3 +% +Direct operating costs +1,567,940 +781,385 +100.7 +% +Adjusted gross profit (2) +449,500 +241,028 +86.5 +% +Selling, general and administrative +26,050 +8,763 +197.3 +% +Depreciation, amortization and impairment +283,230 +98,162 +188.5 +% +Operating income +$ +140,220 +$ +134,103 +4.6 +% +Capital expenditures +$ +214,746 +$ +137,935 +55.7 +% +(1) +Completion services represents the combination of well completion business from the NexTier merger and our legacy pressure pumping business. +(2) +Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +The changes for the year ended December 31, 2023 as compared to December 31, 2022 can be primarily attributed to the NexTier merger, which closed on September 1, 2023. The NexTier merger had a material impact on our reported results of operations. In order to provide a more meaningful basis for comparison, the discussion on changes below is focused on changes between comparable periods, excluding the effects of the NexTier merger. However, these comparisons do not necessarily reflect what the results of our legacy pressure pumping business would have been had the NexTier merger not occurred and our legacy pressure pumping business continued to operate as a standalone business. +Completion services revenues and direct operating costs, excluding the effects of the NexTier merger, decreased $80.5 million and $49.3 million, or 7.9% and 6.3%, respectively due to calendar inefficiencies and lower customer pricing in 2023. +Selling, general and administrative expense, excluding the effects of the NexTier merger, was relatively flat, totaling $9.5 million in 2023 compared to $8.8 million in 2022. +Depreciation, amortization and impairment, excluding the effects of the NexTier merger, increased $44.2 million, or 45%. The increase was primarily attributable to the change in the estimated useful lives of certain components to reflect recent trends in increased intensity and pumping hours per day in servicing larger jobs. See Note 1 of Notes to consolidated financial statements for additional information on this change in accounting estimate. +Capital expenditures, excluding the effects of the NexTier merger, decreased $32.8 million or 23.8%. The decrease was primarily due to the activation of our twelfth spread in 2022. +Year Ended December 31, +Drilling Products +2023 +2022 +% Change +(Dollars in thousands) +Revenues +$ +134,679 +$ +— +N/A +Direct operating costs +81,555 +— +N/A +Adjusted gross profit (1) +53,124 +— +N/A +Selling, general and administrative +11,158 +— +N/A +Depreciation, amortization and impairment +48,467 +— +N/A +Operating loss +$ +(6,501 +) +$ +— +N/A +Capital expenditures +$ +24,572 +$ +— +N/A +(1) +Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +The results of our drilling products segment reflect the operations of our Ulterra acquisition, from the closing date of August 14, 2023 until December 31, 2023. As such, there were no comparable results for the year ended December 31, 2022. +Direct operating costs and depreciation, amortization and impairment were approximately $11.0 million and $18.0 million higher than they would have otherwise been, respectively, as a result of the step up to fair value of our drill bits in accordance with purchase accounting for a business combination. +40 +Year Ended December 31, +Other +2023 +2022 +% Change +(Dollars in thousands) +Revenues +$ +74,578 +$ +80,359 +(7.2 +)% +Direct operating costs +42,624 +39,261 +8.6 +% +Adjusted gross profit (1) +31,954 +41,098 +(22.2 +)% +Selling, general and administrative +888 +826 +7.5 +% +Depreciation, depletion, amortization and impairment +28,237 +26,496 +6.6 +% +Operating income +$ +2,829 +$ +13,776 +(79.5 +)% +Capital expenditures +$ +24,645 +$ +25,215 +(2.3 +)% +(1) +Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, depletion, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +Revenue decreased from 2022 primarily due to a $10.5 million decrease in our oil and natural gas revenues resulting from unfavorable crude oil market prices and decreased production. Average WTI-Cushing prices in 2023 were $77.58 per barrel as compared to $94.90 per barrel in 2022. This decrease was partially offset by a $4.7 million increase in revenues from our oilfield rentals business. +Year Ended December 31, +Corporate +2023 +2022 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +116,852 +$ +91,973 +27.1 +% +Merger and integration expenses +$ +98,077 +$ +2,069 +4,640.3 +% +Depreciation +$ +7,170 +$ +5,171 +38.7 +% +Other operating income, net +$ +(16,345 +) +$ +(12,558 +) +30.2 +% +Credit loss expense +$ +842 +$ +— +NA +Interest income +$ +6,122 +$ +360 +1,600.6 +% +Interest expense +$ +52,870 +$ +40,256 +31.3 +% +Other income (expense) +$ +1,898 +$ +(3,273 +) +NA +Capital expenditures +$ +16,947 +$ +1,126 +1,405.1 +% +Selling, general and administrative expense increased primarily due to increased personnel costs as a result of higher headcount, wage growth and changes in stock-based compensation. A portion of the increased personnel costs resulted from incremental headcount for corporate functions as part of the NexTier merger. +Merger and integration expense increased due to closing the Ulterra acquisition and NexTier merger in 2023. The increase was primarily attributable to $84.8 million of accelerated stock-based compensation expense and additional cash compensation associated with severance payments as well as certain legal, financial advisory, and other professional fees in order to consummate the transactions. +Other operating income, net increased primarily due to a $5.2 million favorable legal settlement and a $6.5 million reversal of cumulative compensation costs associated with certain performance-based restricted stock units in 2023. +Interest income increased due to interest received from a higher average cash balance in 2023. +Interest expense increased due to the issuance of 2033 Notes in the third quarter of 2023 and finance leases acquired as part of the Ulterra acquisition and NexTier merger. +The increase in capital expenditures was primarily due to the purchase of an aircraft in 2023. +Comparison of the years ended December 31, 2022 and 2021 +Effective as of the third quarter of 2023, we revised our reportable segments to align with certain changes in how our CODM manages and allocates resources to our business as a result of the Ulterra acquisition and NexTier merger. We now have the following reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. Accordingly, we recast our results of operations for the years ended December 31, 2022 and 2021 to align with our revised reportable segments. +The following tables summarize our recast results of operations by business segment for the years ended December 31, 2022 and 2021: +41 +Year Ended December 31, +Drilling Services (1) +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +1,544,820 +$ +784,218 +97.0 +% +Direct operating costs +1,025,904 +577,983 +77.5 +% +Adjusted gross profit (2) +518,916 +206,235 +151.6 +% +Selling, general and administrative +15,027 +10,861 +38.4 +% +Depreciation, amortization and impairment +354,116 +660,402 +(46.4 +)% +Other operating (income) expenses, net +(34 +) +25 +NA +Operating income (loss) +$ +149,807 +$ +(465,053 +) +NA +Capital expenditures +$ +272,521 +$ +118,496 +130.0 +% +Operating days – U.S. (3) +45,216 +29,960 +50.9 +% +Average revenue per operating day – U.S. +$ +27.57 +$ +21.64 +27.4 +% +Average direct operating costs per operating day – U.S. +$ +17.32 +$ +15.11 +14.6 +% +Average adjusted gross profit per operating day – U.S. (3) +$ +10.25 +$ +6.53 +56.9 +% +(1) +Drilling services segment represents our contract drilling, directional drilling, oilfield technology and electrical controls and automation businesses. +(2) +Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +(3) +Operational data relates to our contract drilling business. A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Revenues increased primarily due to an increase in operating days and improved pricing within our contact drilling business as well as increased job activity and improved pricing within our directional drilling business. Average revenue per operating day increased primarily due to improved pricing. +Direct operating costs increased due to an increase in operating days, increased reactivation costs and inflationary cost pressure on labor and supplies within our contract drilling business. A portion of the increase in direct operating costs related to increased job activity and cost inflation within our directional drilling business. +Depreciation, amortization and impairment expense decreased primarily due to a $220 million impairment charge related to the abandonment of 43 legacy non-super-spec rigs and contract drilling equipment and the abandonment of an $11.4 million developed technology intangible asset and $2.5 million of directional drilling equipment in 2021. Additionally, depreciation, amortization and impairment expense decreased partially due to a lower depreciable asset base during 2022 as a result of the impairment charge taken in 2021. +The increase in capital expenditures was primarily due to rig reactivations, higher maintenance capital expenditures and upgrading certain rig components. +Year Ended December 31, +Completion Services (1) +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +1,022,413 +$ +523,756 +95.2 +% +Direct operating costs +781,385 +475,953 +64.2 +% +Adjusted gross profit (2) +241,028 +47,803 +404.2 +% +Selling, general and administrative +8,763 +7,361 +19.0 +% +Depreciation, amortization and impairment +98,162 +159,305 +(38.4 +)% +Operating income (loss) +$ +134,103 +$ +(118,863 +) +N/A +Capital expenditures +$ +137,935 +$ +34,676 +297.8 +% +(1) +Completion services in 2022 and 2021 represents only our legacy pressure pumping business as the NexTier merger was completed in 2023 . +(2) +Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +Revenues increased primarily due to an increase in the number of higher revenue fracturing jobs, improved pricing and continued improvement in asset utilization and efficiency. +42 +Direct operating costs increased primarily due to an increase in the number of higher cost fracturing jobs as well as inflationary cost pressure on labor and supplies. +Depreciation, amortization and impairment expense decreased due to a lower depreciable asset base in 2022 partially as a result of a $32.2 million impairment charge taken in 2021. This impairment charge was related to the abandonment of approximately 0.2 million horsepower within our fleet. Additionally, a portion of the decrease related to certain equipment that reached the end of its useful life during 2022. This decrease in 2022 outpaced incremental depreciation resulting from equipment additions in 2020 and 2021, when our capital expenditures were significantly lower. +The increase in capital expenditures was primarily due to costs associated with reactivating stacked equipment as well as upgrades and the increase in maintenance capital expenditures associated with a higher average number of active spreads. +Year Ended December 31, +Drilling products +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +— +$ +— +N/A +Direct operating costs +— +— +N/A +Adjusted gross profit +— +— +N/A +Selling, general and administrative +— +— +N/A +Depreciation, amortization and impairment +— +— +N/A +Operating loss +$ +— +$ +— +N/A +Capital expenditures +$ +— +$ +— +N/A +Our drilling products segment was added through our acquisition of Ulterra in 2023. As such, there were no results for the years ended December 31, 2022 and 2021. +Year Ended December 31, +Other +2022 +2021 +% Change +(Dollars in thousands) +Revenues +$ +80,359 +$ +49,107 +63.6 +% +Direct operating costs +39,261 +28,012 +40.2 +% +Adjusted gross profit (1) +41,098 +21,095 +94.8 +% +Selling, general and administrative +826 +665 +24.2 +% +Depreciation, depletion, amortization and impairment +26,496 +23,612 +12.2 +% +Operating income (loss) +$ +13,776 +$ +(3,182 +) +N/A +Capital expenditures +$ +25,215 +$ +11,627 +116.9 +% +(1) +Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, depletion, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +Revenue increased from 2021 primarily due to a $17.7 million increase in our oilfield rentals business revenues due to higher service volumes and improved pricing as well as a $13.5 million increase in our oil and natural gas revenues resulting from favorable crude oil market prices and increased production. Average WTI-Cushing prices in 2022 were $94.90 per barrel as compared to $68.14 per barrel in 2021. +Direct operating costs increased due to incremental production costs from our oil and natural gas assets as well as a higher service volume provided by our oilfield rentals business and cost inflation. +Depreciation, depletion, amortization and impairment increased primarily due to a $4.5 million impairment in our oil and natural gas assets in 2022. +The increase in capital expenditures was primarily related to incremental spending in our oilfield rentals and oil and natural gas businesses. +43 +Year Ended December 31, +Corporate +2022 +2021 +% Change +(Dollars in thousands) +Selling, general and administrative +$ +91,973 +$ +73,495 +25.1 +% +Merger and integration expenses +$ +2,069 +$ +12,060 +(82.8 +)% +Depreciation +$ +5,171 +$ +5,859 +(11.7 +)% +Other operating (income) expenses, net +$ +(12,558 +) +$ +738 +N/A +Credit loss expense +$ +— +$ +(1,500 +) +N/A +Interest income +$ +360 +$ +222 +62.2 +% +Interest expense +$ +40,256 +$ +41,978 +(4.1 +)% +Other expense +$ +(3,273 +) +$ +(275 +) +1,090.2 +% +Capital expenditures +$ +1,126 +$ +1,521 +(26.0 +)% +Selling, general and administrative expense increased primarily due to increased personnel costs as a result of higher headcount, wage growth and changes in stock-based compensation. +Merger and integration expenses were recognized in 2021 related to the Pioneer acquisition, which closed on October 1, 2021, and the subsequent divestiture of Pioneer’s well servicing rig business and wireline business, which closed on December 31, 2021. +Other operating (income) expenses, net includes net gains associated with the disposal of assets. Accordingly, the related gains or losses have been excluded from the results of specific segments. The $12.5 million other operating income in 2022 was primarily due to the release of an $11.5 million cumulative translation adjustment from accumulated other comprehensive income into net income (loss) in our consolidated statements of operations upon substantially completing our exit from our Canadian operations. +Interest expense was favorably impacted by a gain on debt extinguishment of $2.5 million associated with the repurchase of portions of our 2028 Notes and 2029 Notes in 2022. Excluding the effects of the gain, interest expense would have increased by $0.7 million, a 1.8% increase. Additionally, on December 30, 2021, we repaid the final $50 million of borrowings under the 2019 Term Loan Agreement, and as a result had no remaining borrowings under the Term Loan Agreement as of December 31, 2021. Accordingly, we did not incur interest expense related to the Term Loan Agreement in 2022. +The $3.0 million change in other expense was primarily due to foreign currency adjustments related to our Colombian operations. +Income Taxes +The effective tax rate increased by approximately 12.0% to 19.9% for 2023 compared to 7.9% for 2022. Our effective income tax rate fluctuates based on, among other factors, changes in pre-tax income in countries with varying statutory tax rates, changes in valuation allowances, and the impacts of various other permanent adjustments. +The ability to recognize a portion of our U.S. federal and state net operating losses resulted in a significant impact, through changes in valuation allowances, in our effective tax rate for the year ended December 31, 2023. This benefit was partly offset by state and local income taxes and various other permanent adjustments. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +Liquidity and Capital Resources +Our primary sources of liquidity are cash and cash equivalents, availability under our revolving credit facility and cash provided by operating activities. As of December 31, 2023, we had approximately $435 million in working capital, including $193 million of cash and cash equivalents, and approximately $597 million available under our revolving credit facility. +As part of the NexTier merger, we assumed the obligations of NexTier Completions Solutions Inc. (“NCS”) under a Master Loan and Security Agreement (as amended, the “Master Agreement”) with Caterpillar Financial Services Corporation. The Master Agreement allows NCS to enter into secured equipment financing term loans from time to time (the “Equipment Loans”). The Equipment Loans may be drawn in multiple tranches, with each loan evidenced by a separate promissory note. The Master Agreement and the Equipment Loans contain customary affirmative and negative covenants, including limitations on further encumbrance of the collateral other than the applicable loans under the Master Agreement. We were in compliance with these covenants at December 31, 2023. The Equipment +44 +Loans bear interest at a rate of 5.25% per annum, and we pay interest on the 1st of each month. The Equipment Loans will mature on June 1, 2025. +On August 29, 2023, we entered into the Credit Agreement Amendment, which amended our Credit Agreement. The Credit Agreement Amendment, among other things, (i) deemed certain outstanding letters of credit issued for the account of BEP Diamond Holdings Corp. (the entity we acquired in the Ulterra acquisition) with a face amount of $2.5 million to have been issued under the Credit Agreement and (ii) extended the maturity date for $85 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026. As a result, of the $600 million of revolving credit commitments under the Credit Agreement, the maturity date for $501.7 million of such commitments is March 27, 2026; the maturity date for $48.3 million of such commitments is March 27, 2025; and the maturity date for the remaining $50 million of such commitments is March 27, 2024. +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $600 million, including a letter of credit facility that, at any time outstanding, is limited to $100 million and a swing line facility that, at any time outstanding, is limited to the lesser of $50 million and the amount of the swing line provider’s unused commitment. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $300 million, not to exceed total commitments of $900 million. +Loans under the Credit Agreement bear interest by reference, at our election, to the SOFR rate (subject to a 0.10% per annum adjustment) or base rate, in each case subject to a 0% floor. The applicable margin on SOFR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based on our credit rating. As of December 31, 2023, the applicable margin on SOFR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. A letter of credit fee is payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10% to 0.30% based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt, which does not qualify for certain limited exceptions and is otherwise, in the aggregate with all other similar debt, in excess of Priority Debt (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to grant liens and on the ability of each of our non-guarantor subsidiaries to incur debt. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would generally require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at both credit rating agencies. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50% as of the last day of each fiscal quarter. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2023. +On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2023, we had $87.7 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any of our letters of credit issued thereunder. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. A letter of credit fee is payable by us equal to 1.50% times the amount of outstanding letters of credit. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +45 +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +We had $92.4 million of outstanding letters of credit at December 31, 2023, which was comprised of $87.7 million outstanding under the Reimbursement Agreement, $2.5 million outstanding under the Credit Agreement, and $2.2 million outstanding with financial institutions providing for short-term borrowing capacity, overdraft protection and bonding requirements. We maintain these letters of credit primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under terms of the underlying insurance contracts and compliance with contractual obligations. These letters of credit expire annually at various times during the year and are typically renewed. +Our outstanding long-term debt at December 31, 2023 was $1.2 billion and consisted of $483 million of our 2028 Notes, $345 million of our 2029 Notes, $400 million of our 2033 Notes and $18.7 million of our Equipment Loans. We were in compliance with all covenants under the associated agreements and indentures at December 31, 2023. +For a full description of the Credit Agreement, the Reimbursement Agreement, the 2028 Notes, the 2029 Notes, the 2033 Notes and the Equipment Loans, see Note 9 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +On August 29, 2023, we entered into a Term Loan Agreement with Wells Fargo Bank, National Association, as administrative agent and a lender, and the other lenders party thereto (the “Term Loan Agreement”). The Term Loan Agreement was a committed senior unsecured term loan facility (the “Term Loan Facility”) that permitted a single borrowing of up to $300 million, which could be drawn by us on or before November 27, 2023. We terminated the Term Loan Facility on September 13, 2023 and, as a result, the commitments under the Term Loan Agreement also terminated in full. We did not borrow under the Term Loan Facility. +Cash Requirements +We believe our current liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt, pay cash dividends and repurchase our common stock and senior notes for at least the next 12 months. +If we pursue other opportunities that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +A portion of our capital expenditures can be adjusted and managed by us to match market demand and activity levels. Based on our current outlook for activity, we expect our capital expenditures for 2024 to be approximately $740 million. The majority of these expenditures are expected to be used for normal, recurring items necessary to support our business. +We anticipate $96.4 million of expenditures in 2024 related to various contractual obligations such as certain commitments to purchase proppants and lease liabilities. +As of December 31, 2023, we had working capital of $435 million, including cash and cash equivalents of $193 million, compared to working capital of $278 million, including cash and cash equivalents of $138 million, at December 31, 2022. +During 2023, our sources of cash flow included: +• +$1.0 billion from operating activities, +• +$26 million in proceeds from the disposal of property and equipment; and +• +$396 million in net proceeds before offering expenses from the issuance of our 2033 Notes. +During 2023, our uses of cash flow and borrowings under our revolving credit facility included: +• +$616 million to make capital expenditures for the betterment and refurbishment of drilling services and completion services equipment and, to a much lesser extent, equipment for our other businesses, to acquire and procure equipment to support our drilling services, completion services, drilling products, oilfield rentals and manufacturing operations, to acquire an aircraft and to fund investments in oil and natural gas properties on a non-operating working interest basis, +• +$357 million, net of acquired cash, for the Ulterra acquisition, +• +$65 million, net of acquired cash, for the NexTier merger, +46 +• +$201 million for repurchases of our common stock, +• +$100 million to pay dividends on our common stock, +• +$16 million for payments related to finance leases, +• +$8 million for repurchases of our 2028 Notes and 2029 Notes, and +• +$12 million for other investing and financing activities +We paid cash dividends during the year ended December 31, 2023 as follows: +Per Share +Total +(in thousands) +Paid on March 16, 2023 +$ +0.08 +$ +16,916 +Paid on June 15, 2023 +0.08 +16,591 +Paid on September 21, 2023 +0.08 +33,217 +Paid on December 15, 2023 +0.08 +33,310 +Total cash dividends +$ +0.32 +$ +100,034 +On February 14, 2024, our Board of Directors approved a cash dividend on our common stock in the amount of $0.08 per share to be paid on March 15, 2024 to holders of record as of March 1, 2024. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend in order to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +We may, at any time and from time to time, seek to retire or purchase our outstanding debt for cash through open-market purchases, privately negotiated transactions, redemptions or otherwise. Such repurchases, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. +In September 2013, our Board of Directors approved a stock buyback program. In April 2023, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $300 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the buyback program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2023, we had remaining authorization to purchase approximately $206 million of our outstanding common stock under the stock buyback program. In February 2024, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $1 billion of future share repurchases. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2023, 2022 and 2021 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”) and the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), the NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan and the NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan, and not pursuant to the stock buyback program. Upon the issuance of shares for the Pioneer acquisition in October 2021, we withheld shares with respect to Pioneer employees’ tax withholding obligations. +47 +Treasury stock acquisitions during the years ended December 31, 2023, 2022 and 2021 were as follows (dollars in thousands): +2023 +2022 +2021 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +88,758,722 +$ +1,453,079 +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +Purchases pursuant to stock buyback program +14,086,229 +168,631 +3,254,599 +57,173 +— +— +Acquisitions pursuant to long-term incentive plan +2,735,060 +35,965 +1,372,101 +23,237 +451,196 +3,727 +Purchases in connection with Pioneer acquisition +— +— +— +— +275,477 +2,601 +Other +— +— +3,027 +28 +— +— +Treasury shares at end of period +105,580,011 +$ +1,657,675 +88,758,722 +$ +1,453,079 +84,128,995 +$ +1,372,641 +As of December 31, 2023, we had unrecognized compensation costs of $51.4 million and $11.1 million related to our unvested restricted stock units and our unvested Performance Units, respectively. The weighted-average remaining vesting periods for these awards were 1.63 years and 1.13 years, respectively as of December 31, 2023. See Note 12 of Notes to consolidated financial statements in Item 8 of this Report for additional discussion regarding our stock-based compensation. +Commitments — As of December 31, 2023, we had commitments to purchase major equipment totaling approximately $153 million. +Our completion services segment has entered into agreements to purchase minimum quantities of proppants from certain vendors. As of December 31, 2023, the remaining minimum obligation under these agreements was approximately $39.7 million, of which approximately $33.7 million, $4.0 million and $2.0 million relate to the remainder of 2024, 2025 and 2026, respectively. +See Note 10 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our current commitments and contingencies as of December 31, 2023. +As part of the Ulterra acquisition and NexTier merger, we acquired additional operating and finance leases. Operating lease liabilities totaled $51.4 million and finance lease liabilities totaled $56.9 million at December 31, 2023. See Note 13 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our operating leases as of December 31, 2023. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +Critical Accounting Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. Accounting estimates and assumptions discussed in this section are those considered to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. We believe the following critical accounting estimates used in preparing our consolidated financial statements address all important areas where the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. For additional information on our accounting policies, see Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Depreciation and amortization — Our industry is very capital intensive, as property and equipment represented 45% of our total assets as of December 31, 2023 and depreciation, depletion, amortization and impairment represented 19% of our total operating costs and expenses in 2023. Our property and equipment is carried at cost less accumulated depreciation and amortization. No provision for salvage value is considered in determining depreciation of our property and equipment. We calculate depreciation and amortization on our assets based on the estimated useful lives that we believe are reasonable. The estimated useful lives are subject to key assumptions such as maintenance, utilization and job variation. These estimates may change due to a number of factors such as changes in operating conditions or advances in technology. The method of depreciation does not change whenever equipment becomes idle. Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. In the third quarter of 2023, we changed the estimated useful lives of certain property and equipment within our completion services segment. See Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +48 +The following table outlines a 10% change in the useful lives on our major categories of property and equipment and the impact on operating income for the year ended December 31, 2023: +Useful Lives +Change +Impact +(in thousands) +Drilling services equipment +1-15 years +10% +$ +47,423 +Completion services equipment +1-25 years +10% +13,567 +$ +60,990 +Impairment of long-lived assets — We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). Assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings for impairment assessment. If there is a triggering event, we estimate future cash flows over the life of the respective assets or asset groupings in our assessment of its recoverability. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. If estimated undiscounted cash flows expected to result from the use and eventual disposition of an asset or asset group is less than its respective carrying amount, an impairment loss is recognized in the amount by which the carrying amount exceeds its estimated fair value. This analysis is based on estimates such as management’s short-term and long-term forecast of operating performance, including revenue growth rates and expected profitability margins, customer attrition rates, contributory asset charges, estimates of the remaining useful life and service potential of the assets within the asset group, and a discount rate based on our weighted average cost of capital. We determined no triggering events occurred in 2023 related to our long-lived assets. See Note 6 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Fair values of assets acquired and liabilities assumed in acquisitions — Assets acquired and liabilities assumed in a business combination are recorded at their estimated fair values on the date of acquisition. The difference between the purchase price amount and the net fair value of assets acquired and liabilities assumed is recognized as goodwill on the balance sheet if the purchase price exceeds the estimated net fair value or as a bargain purchase gain on the income statement if the purchase price is less than the estimated net fair value. We apply significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involves the use of significant estimates and assumptions with respect to rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rates. Changes in these judgments or estimates can have a material impact on the valuation of the respective assets and liabilities acquired and our results of operations in periods after acquisition, such as through depreciation and amortization expense. The allocation of the purchase price may be modified up to one year after the acquisition date as more information is obtained about the fair value of assets acquired and liabilities assumed. See Note 2 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Goodwill — We assess goodwill at least annually on July 31, or more frequently when events and circumstances occur indicating recorded goodwill may be impaired. Goodwill is tested at the reporting unit level, which is at or one level below our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if that is the case, any necessary goodwill impairment is determined using a quantitative impairment test. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +We determined our drilling products operating segment consists of a single reporting unit and, accordingly, goodwill acquired from the Ulterra acquisition was allocated to that reporting unit. We determined our completion services operating segment consists of two reporting units; completion services, which is primarily comprised of our hydraulic fracturing operations and other integrated service offerings, and cementing services. +During the fourth quarter of 2023, our share price experienced a sustained decline which resulted in a decrease to our market capitalization. This decline in share price was deemed a triggering event that warranted a quantitative assessment for goodwill impairment for all three of our reporting units. +We estimated the fair value of the drilling products and the completion services reporting units using the income approach. Under this approach, we used a discounted cash flow model, which utilizes present values of cash flows to estimate fair value. Forecasted cash flows considered known market conditions as of December 31, 2023, and management's anticipated business outlook for each reporting unit. Future cash flows were projected based on estimates of revenue, gross profit, selling, general and administrative expense, changes in working capital, and capital expenditures. The terminal period used within the discounted cash flow model for each reporting unit consisted of a 1% growth estimate. The future cash flows were discounted using a market-participant, risk-adjusted weighted average cost of capital of 10% for the drilling products reporting unit and 12% for the completion services reporting unit. We estimated the fair value of the cementing services reporting unit using a market approach. The market approach was based on trading multiples of companies comparable to the cementing services reporting unit. +49 +The forecast for the drilling products reporting unit assumes continued growth in international markets. Geopolitical instability in regions in which we expect to maintain and grow market share, a global decrease in the demand of drilling products, or other unforeseen macroeconomic considerations could negatively impact the key assumptions used in our goodwill assessment for our drilling products reporting unit. +The forecast for the completion services reporting unit assumes activity in 2024 consistent with 2023 exit levels and moderate increases in activity of 3% to 5% beginning in 2025 and holding flat until the terminal period, which was consistent with rig count forecasts as of December 31, 2023. A sustained decrease in oil prices and rig count could negatively affect the key assumptions used in our goodwill assessment for completion services. +Based on the results of the goodwill impairment tests, the fair values of the drilling products, completion services, and cementing services reporting units exceeded their carrying values by approximately 4%, 11%, and 80%, respectively. Accordingly, no impairment was recorded for any of the reporting units. +Assuming all changes are isolated, a decrease of 100 bps in our long-term revenue growth rate for our drilling products reporting unit would reduce our estimated fair value by approximately 6%, while a 100 bps increase to our discount rate would reduce our estimated fair value by approximately 10%. +Assuming all changes are isolated, a decrease of 100 bps in our long-term revenue growth rate for our completion services reporting unit would reduce our estimated fair value by approximately 6%, while a 100 bps increase to our discount rate would reduce our estimated fair value by approximately 8%. +A decrease in fair value resulting from unfavorable changes to these assumptions, or others, could result in goodwill impairment in future periods that could be material to our results of operations and financial statements as a whole. +Accruals for self-insured levels of insurance coverage — We maintain insurance coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employers’ liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We also self-insure a number of other risks, including loss of earnings and business interruption and most cybersecurity risks, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. Our insurance accruals are based on claims filed and estimates of claims incurred but not reported and are developed by our management with assistance from our third-party actuary and third-party claims administrator. The insurance accruals are influenced by our past claims experience factors and by published industry development factors. If we experience insurance claims or costs above or below our historically evaluated levels, our estimates could be materially affected. The frequency and number of claims or incidents could vary significantly over time, which could materially affect our self-insurance liabilities. Additionally, the actual costs to settle the self-insurance liabilities could materially differ from the original estimates and cause us to incur additional costs in future periods associated with prior year claims. A sensitivity analysis of the impact on earnings for these periods if other assumptions had been used in recording these liabilities is not practicable given the number of underlying assumptions and the wide range of reasonably possible outcomes. See “Item 1A. Risk Factors – Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +Income taxes — We are subject to income taxes in the United States and other foreign jurisdictions. We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. In assessing the realizability of our deferred tax assets, if it is more likely than not that a portion of the deferred tax assets will not be realized in a future period, the deferred tax assets will be reduced by a valuation allowance. We believe the valuation allowance is a critical accounting estimate because it is susceptible to change from period to period, requires assumptions about our future income over the lives of the deferred tax assets, and because the impact of increasing or decreasing the valuation allowance is potentially material to our results of operations. +Our methodology for recording income taxes requires a significant amount of judgment in the use of assumptions and estimates. Additionally, we forecast certain tax elements, such as future taxable income, as well as evaluate the feasibility of implementing tax planning strategies. Given the inherent uncertainty involved with the use of such variables, there can be significant variation between anticipated and actual results. Unforeseen events may significantly impact these variables, and changes to these variables could have a material impact on our income tax accounts. The final determination of our income tax liabilities involves the interpretation of local tax laws and related authorities in each jurisdiction. Changes in the operating environments, including changes in tax law, could impact the determination of our income tax liabilities for a tax year. +50 +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We recognize tax benefits related to uncertain tax positions when, in our judgment, it is more likely than not that such positions will be sustained on examination, including resolutions of any related appeals or litigation, based on the technical merits. We adjust our liabilities for uncertain tax positions when our judgment changes as a result of new information previously unavailable. We routinely monitor the potential impact of these situations. As of December 31, 2023, we have no unrecognized tax benefits. +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Crude oil prices and demand for drilling and completion equipment and services increased from 2021 to 2022, and industry supply of Tier-1, super-spec rigs became constrained. Commodity price volatility in the second quarter of 2023 resulted in a decline in industry activity, commodity prices subsequently increased during the third quarter before declining in the fourth quarter of 2023. The current demand for equipment and services remains dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $78.53 per barrel in the fourth quarter of 2023. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.74 per MMBtu in the fourth quarter of 2023. +In light of these and other factors, we expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our services. +Impact of Inflation +Inflation rates have begun to moderate. However, we continue to actively monitor market trends primarily related to sourcing labor, supplies and equipment. +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +51 +Non-GAAP Financial Measures +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by accounting principles generally accepted in the United States of America (“GAAP”). We define Adjusted EBITDA as net income (loss) from continuing operations plus income tax expense (benefit), net interest expense, depreciation, depletion, amortization and impairment expense and merger and integration expense. We present Adjusted EBITDA as a supplemental disclosure because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) from continuing operations in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the GAAP measure of net income (loss) from continuing operations. Our computations of Adjusted EBITDA may not be the same as similarly titled measures of other companies. Set forth below is a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income (loss) from continuing operations. +Year Ended December 31, +2023 +2022 +2021 +(in thousands) +Net income (loss) from continuing operations +$ +245,952 +$ +154,658 +$ +(657,079 +) +Income tax expense (benefit) +61,152 +13,204 +(62,702 +) +Net interest expense +46,748 +39,896 +41,756 +Depreciation, depletion, amortization and impairment +731,416 +483,945 +849,178 +Merger and integration expense +98,077 +2,069 +12,060 +Adjusted EBITDA +$ +1,183,345 +$ +693,772 +$ +183,213 +Adjusted Gross Profit +We define “Adjusted gross profit” as revenues less direct operating costs (excluding depreciation, depletion, amortization and impairment expense). Adjusted gross profit is included as a supplemental disclosure because it is a useful indicator of our operating performance. +Drilling +Services +Completion +Services +Drilling +Products +Other +(in thousands) +For the year ended December 31, 2023 +Revenues +$ +1,919,759 +$ +2,017,440 +$ +134,679 +$ +74,578 +Less direct operating costs +(1,119,200 +) +(1,567,940 +) +(81,555 +) +(42,624 +) +Less depreciation, depletion, amortization and impairment +(364,312 +) +(283,230 +) +(48,467 +) +(28,237 +) +GAAP gross profit +436,247 +166,270 +4,657 +3,717 +Depreciation, depletion, amortization and impairment +364,312 +283,230 +48,467 +28,237 +Adjusted gross profit +$ +800,559 +$ +449,500 +$ +53,124 +$ +31,954 +For the year ended December 31, 2022 +Revenues +$ +1,544,820 +$ +1,022,413 +$ +— +$ +80,359 +Less direct operating costs +(1,025,904 +) +(781,385 +) +— +(39,261 +) +Less depreciation, depletion, amortization and impairment +(354,116 +) +(98,162 +) +— +(26,496 +) +GAAP gross profit +164,800 +142,866 +— +14,602 +Depreciation, depletion, amortization and impairment +354,116 +98,162 +— +26,496 +Adjusted gross profit +$ +518,916 +$ +241,028 +$ +— +$ +41,098 +For the year ended December 31, 2021 +Revenues +$ +784,218 +$ +523,756 +$ +— +$ +49,107 +Less direct operating costs +(577,983 +) +(475,953 +) +— +(28,012 +) +Less depreciation, depletion, amortization and impairment +(660,402 +) +(159,305 +) +— +(23,612 +) +GAAP gross profit +(454,167 +) +(111,502 +) +— +(2,517 +) +Depreciation, depletion, amortization and impairment +660,402 +159,305 +— +23,612 +Adjusted gross profit +$ +206,235 +$ +47,803 +$ +— +$ +21,095 +52 +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As of December 31, 2023, we would have had exposure to interest rate market risk associated with any outstanding borrowings and letters of credit that we had under the Credit Agreement and amounts owed under the Reimbursement Agreement. +Loans under the Credit Agreement bear interest by reference, at our election, to the SOFR rate (subject to a 0.10% per annum adjustment) or base rate, in each case subject to a 0% floor. The applicable margin on SOFR rate loans varies from 1.00% to 2.00% and the applicable margin on base rate loans varies from 0.00% to 1.00%, in each case determined based on our credit rating. As of December 31, 2023, the applicable margin on SOFR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. A letter of credit fee is payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10% to 0.30% based on our credit rating. As of December 31, 2023, we had $2.6 million in letters of credit outstanding and, as a result, had available borrowing capacity of approximately $597 million at that date. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any of our letters of credit issued thereunder. We are obligated to pay Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25% per annum. +Some of our revenues in foreign countries are denominated in U.S. dollars, and therefore, changes in foreign currency exchange rates impact our earnings to the extent that costs associated with those U.S. dollar revenues are denominated in the local currency. Similarly, some of our revenues are denominated in foreign currencies, but have associated U.S. dollar costs, which also give rise to foreign currency exchange rate exposure. +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2023, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2023, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2023. +53 +We completed the Ulterra acquisition on August 14, 2023 and the NexTier merger on September 1, 2023. We excluded Ulterra’s and NexTier’s disclosure controls and procedures that are subsumed by their internal control over financial reporting from the scope of management’s assessment of the effectiveness of our disclosure controls and procedures. This exclusion is in accordance with the guidance issued by the Staff of the Securities and Exchange Commission that an assessment of recent business combinations may be omitted from management's assessment of internal control over financial reporting for one year following the acquisition. As a result of our integration of the Ulterra and NexTier disclosure controls and procedures, certain controls will be evaluated and may be changed. Ulterra and NexTier’s total revenues constituted approximately 3% and 26% of our consolidated revenues, respectively, for the year ended December 31, 2023. Ulterra’s and NexTier’s total assets constituted approximately 3% and 23% of our consolidated total assets, respectively, as of December 31, 2023. +The effectiveness of our internal control over financial reporting as of December 31, 2023 has been audited by PricewaterhouseCoopers LLP , an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +None . +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections. +None . +54 +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference . +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Corporate Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website within four business days following the date of the amendment or waiver. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +55 +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Report of Independent Registered Public Accounting Firm +The report of our independent registered public accounting firm (PCAOB ID: 238 ) with respect to the above-referenced financial statements and their report on internal control over financial reporting are included on page F-2 of this Report. +(a)(3) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger, dated July 5, 2021, among Patterson-UTI Energy, Inc., Crescent Merger Sub Inc., Crescent Ranch Second Merger Sub LLC, and Pioneer Energy Services Corp. (filed July 6, 2021 as Exhibit 2.1 to our Current Report on Form 8-K and incorporated herein by reference). +2.2 +Amendment No. 1 to Agreement and Plan of Merger, dated September 13, 2021, among Patterson-UTI Energy, Inc., Crescent Merger Sub Inc., Crescent Ranch Second Merger Sub LLC, and Pioneer Energy Services Corp. (filed October 4, 2021 as Exhibit 2.2 to our Current Report on Form 8-K and incorporated herein by reference). +2.3 +Agreement and Plan of Merger, dated as of June 14, 2023, by and among Patterson-UTI Energy, Inc., Pecos Merger Sub Inc., Pecos Second Merger Sub LLC and NexTier Oilfield Solutions Inc. (filed June 15, 2023 as Exhibit 2.1 to our Current Report on Form 8-K and incorporated herein by reference). +2.4 +First Amendment to Agreement and Plan of Merger, dated July 27, 2023, by and between Patterson-UTI and NexTier Oilfield Solutions Inc. (filed July 28, 2023 as Exhibit 2.1 to our Current Report on Form 8-K and incorporated herein by reference). +2.5 +Agreement and Plan of Merger, dated as of July 3, 2023, by and among Patterson-UTI Energy, Inc., PJ Merger Sub Inc., PJ Second Merger Sub LLC, BEP Diamond Holdings Corp. and BEP Diamond Topco L.P. (filed July 5, 2023 as Exhibit 2.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.1 +Restated Certificate of Incorporation (filed September 1, 2023 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.2 +Amended and Restated Bylaws (filed June 15, 2023 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.1 +Description of Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934 . + +4.2 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +4.3 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +56 +4.4 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.5 +Form of 3.95% Senior Note due 2028 (included in Exhibit 4.4 above). +4.6 +Base Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.7 +First Supplemental Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.8 +Form of 5.15% Senior Note due 2029 (included in Exhibit 4.7 above). +4.9 +Second Supplemental Indenture, dated September 13, 2023, between Patterson-UTI Energy, Inc. and U.S. Bank Trust Company, National Association, as trustee (filed September 13, 2023 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.10 +Form of 7.15% Senior Notes due 2033 (included in Exhibit 4.9 above). +10.1 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan, as amended and restated and further amended effective June 6, 2019 (filed June 6, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.2 +Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan, as amended June 8, 2023 (filed June 8, 2023 as Exhibit 99.1 to our Registration Statement on Form S-8 and incorporated herein by reference).* +10.3 +Amendment to the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan, as amended (filed September 1, 2023 as Exhibit 10.5 to our Current Report on Form 8-K and incorporated herein by reference).* +10.4 +NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan, as amended September 1, 2023 (filed September 1, 2023 as Exhibit 10.4 to our Current Report on Form 8-K and incorporated herein by reference).* +10.5 +NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan, as amended September 1, 2023 (filed September 1, 2023 as Exhibit 10.3 to our Current Report on Form 8-K and incorporated herein by reference).* +10.6 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 3, 2021 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.7 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to our Current Report on Form 8-K and incorporated herein by reference).* +10.8 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to our Current Report on Form 8-K and incorporated herein by reference).* +10.9 +Form of Non-Employee Director Restricted Stock Unit Award Agreement (filed May 3, 2022 as Exhibit 10.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.10 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed August 3, 2021 as Exhibit 10.3 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.11 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to our Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +10.12 +Employment Agreement, dated as of January 1, 2023, by and between Patterson-UTI Energy, Inc. and James M. Holcomb (filed on January 3, 2023 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.13 +Letter Agreement, dated August 30, 2023, by and between Patterson-UTI Energy, Inc. and James M. Holcomb (filed September 1, 2023 as Exhibit 10.7 to our Current Report on Form 8-K and incorporated herein by reference).* +57 +10.14 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.15 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 3, 2021 as Exhibit 10.4 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.16 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference).* +10.17 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed August 3, 2021 as Exhibit 10.6 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.18 +Employment Agreement, dated as of September 3, 2017, between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.19 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed August 3, 2021 as Exhibit 10.5 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.20 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to our Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.21 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.22 +Separation Agreement and General Release of Claims, dated September 1, 2023, by and between NexTier Oilfield Solutions Inc. and Robert W. Drummond (filed September 1, 2023 as Exhibit 10.6 to our Current Report on Form 8-K and incorporated herein by reference).* +10.23 +Notice of Adjustment of NexTier Equity Awards in Connection with Merger, dated as of September 1, 2023.+* +10.24 +Form of NexTier Oilfield Solutions Inc. RSU Award Agreement 2021 (filed February 24, 2021 as Exhibit 10.37 to NexTier Oilfield Solutions Inc.’s Annual Report on Form 10-K and incorporated herein by reference).* +10.25 +Form of NexTier Oilfield Solutions Inc. RSU Award Agreement 2022 (filed February 23, 2022 as Exhibit 10.42 to NexTier Oilfield Solutions Inc.’s Annual Report on Form 10-K and incorporated herein by reference).* +10.26 +Form of NexTier Oilfield Solutions Inc. RSU Award Agreement 2023 (filed February 16, 2023 as Exhibit 10.34 to NexTier Oilfield Solutions Inc.’s Annual Report on Form 10-K and incorporated herein by reference).* +10.27 +Form of NexTier Oilfield Solutions Inc. PSU Award Agreement 2023 (filed February 16, 2023 as Exhibit 10.35 to NexTier Oilfield Solutions Inc.’s Annual Report on Form 10-K and incorporated herein by reference).* +10.28 +Form of NexTier Oilfield Solutions Inc. Performance Award Agreement 2022 (filed February 23, 2022 as Exhibit 10.43 to NexTier Oilfield Solutions Inc.’s Annual Report on Form 10-K and incorporated herein by reference).* +10.29 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of its directors and executive officers (filed April 28, 2004 as Exhibit 10.11 to our Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +58 +10.30 +Amended and Restated Credit Agreement dated March 27, 2018 among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2018 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.31 +Amendment No. 1 to Amended and Restated Credit Agreement, dated March 26, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 26, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.32 +Amendment No. 2 to Amended and Restated Credit Agreement, dated March 27, 2020, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2020 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.33 +Amendment No. 3 to Amended and Restated Credit Agreement, dated November 9, 2022, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed November 9, 2022 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.34 +Amendment No. 4 to Amended and Restated Credit Agreement, dated August 29, 2023, by and among Patterson-UTI Energy, Inc., Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and a lender and each of the other letter of credit issuers and lenders party thereto.(filed September 1, 2023 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference). +10.35 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.36 +Term Loan Agreement, dated August 29, 2023, by and among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent and lender and the other lenders party thereto (filed September 1, 2023 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.++ +97 +Patterson-UTI Energy, Inc. Clawback Policy.+ +101.INS +Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.+ +101.SCH +Inline XBRL Taxonomy Extension Schema Document+ +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document+ +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document+ +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document+ +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document+ +104 +Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101) . +59 +* Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ Filed herewith. +++ Furnished herewith. +Item 16. Form 10-K Summary +None. +60 +INDEX TO CONS OLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2023 and 2022 +F-5 +Consolidated Statements of Operations for the years ended December 31, 2023, 2022 and 2021 +F-6 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2023, 2022 and 2021 +F-7 +Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2023, 2022 and 2021 +F-8 +Consolidated Statements of Cash Flows for the years ended December 31, 2023, 2022 and 2021 +F-9 +Notes to Consolidated Financial Statements +F-10 +F- 1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) as of December 31, 2023 and 2022, and the related consolidated statements of operations, of comprehensive income (loss), of changes in stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2023, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2023 appearing on page S-1 (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +As described in Management’s Report on Internal Control over Financial Reporting, management has excluded Ulterra Drilling Technologies, L.P. (Ulterra) and NexTier Oilfield Solutions Inc. (NexTier) from its assessment of internal control over financial reporting as of December 31, 2023, because they were business combinations during 2023. We have also excluded Ulterra and NexTier from our audit of internal control over financial reporting. Ulterra and NexTier are wholly-owned subsidiaries whose total assets and total revenues excluded from management’s assessment and our audit of internal control over financial reporting represent approximately 3% and 23% of total assets, respectively, and approximately 3% and 26% of total revenues, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2023. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in +F- 2 +accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +Acquisition of Ulterra – Valuation of Customer Relationships +As described in Note 2 to the consolidated financial statements, on August 14, 2023, the Company completed the acquisition of Ulterra for total consideration transferred of $897 million. Of the acquired intangible assets, $245 million of customer relationships were recorded. Fair value was estimated by management using a multi-period excess earnings method for customer relationships. Management applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to future rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rate. +The principal considerations for our determination that performing procedures relating to the valuation of customer relationships acquired in the acquisition of Ulterra is a critical audit matter are (i) the significant judgment by management when developing the fair value estimate of the customer relationships acquired; (ii) a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating management’s significant assumptions related to cash flow projections, customer attrition rates, contributory asset charges, and the discount rate; and (iii) the audit effort involved the use of professionals with specialized skill and knowledge. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the acquisition accounting, including controls over management’s valuation of the customer relationships acquired. These procedures also included, among others (i) reading the purchase agreement; (ii) testing management’s process for developing the fair value estimate of the customer relationships acquired; (iii) evaluating the appropriateness of the multi-period excess earnings method used by management; (iv) testing the completeness and accuracy of the underlying data used in the multi-period excess earnings method; and (v) evaluating the reasonableness of the significant assumptions used by management related to cash flow projections, customer attrition rates, contributory asset charges, and the discount rate. Evaluating management’s assumption related to cash flow projections involved considering (i) the current and past performance of the Ulterra business; (ii) the consistency with external market and industry data; and (iii) whether the assumption was consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in evaluating (i) the appropriateness of the multi-period excess earnings method and (ii) the reasonableness of the customer attrition rates, contributory asset charges, and the discount rate assumptions. +Merger with NexTier – Valuation of Customer Relationships, Trade Name and Developed Technology +As described in Note 2 to the consolidated financial statements, on September 1, 2023, the Company completed the merger with NexTier for total consideration transferred of $2,799 million. Of the acquired intangible assets, $540 million of customer relationships, $85 million of a trade name, and $143 million of developed technology were recorded. Fair value was estimated by management using a multi-period excess earnings method for the customer relationships and a relief from royalty method for the trade name and developed technology. Management applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to future rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rate. +The principal considerations for our determination that performing procedures relating to the valuation of the customer relationships, trade name and developed technology acquired in the merger with NexTier is a critical audit matter are (i) the significant judgment by management when developing the fair value estimate of the customer relationships, trade name and developed technology acquired; (ii) a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating management’s significant +F- 3 +assumptions related to cash flow projections, customer attrition rates, contributory asset charges, royalty rates, and the discount rate for the customer relationships, cash flow projections and the royalty rate for the trade name, and cash flow projections and the royalty rate for the developed technology; and (iii) the audit effort involved the use of professionals with specialized skill and knowledge. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the acquisition accounting, including controls over management’s valuation of the customer relationships, trade name and developed technology acquired. These procedures also included, among others (i) reading the merger agreement; (ii) testing management’s process for developing the fair value estimate of the customer relationships, trade name and developed technology acquired; (iii) evaluating the appropriateness of the multi-period excess earnings and relief from royalty methods used by management; (iv) testing the completeness and accuracy of the underlying data used in the multi-period excess earnings and relief from royalty methods; and (v) evaluating the reasonableness of the significant assumptions used by management related to cash flow projections, customer attrition rates, contributory asset charges, royalty rates, and the discount rate for the customer relationships, cash flow projections and the royalty rate for the trade name, and cash flow projections and the royalty rate for the developed technology. Evaluating management’s assumption related to cash flow projections for the customer relationships, trade name and developed technology involved considering (i) the current and past performance of the NexTier business; (ii) the consistency with external market and industry data; and (iii) whether the assumption was consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in evaluating (i) the appropriateness of the multi-period excess earnings and relief from royalty methods and (ii) the reasonableness of the customer attrition rates, contributory asset charges, royalty rates, and the discount rate assumptions for the customer relationships and the royalty rate assumption for the trade name and developed technology. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 27, 2024 +We have served as the Company’s auditor since 1993. +F- 4 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED BALANCE SHEETS +December 31, +2023 +2022 +(In thousands, except share data) +ASSETS +Current assets: +Cash, cash equivalents and restricted cash +$ +192,680 +$ +137,553 +Accounts receivable, net of allowance for credit losses of $ 3,490 and $ 2,875 at +December 31, 2023 and 2022, respectively +971,091 +565,520 +Inventory +180,805 +65,377 +Other current assets +141,122 +60,969 +Total current assets +1,485,698 +829,419 +Property and equipment, net +3,340,412 +2,260,576 +Operating lease right of use asset +47,599 +20,841 +Finance lease right of use asset +63,228 +— +Goodwill +1,379,741 +— +Intangible assets, net +1,051,697 +5,845 +Deposits on equipment purchases +28,305 +13,051 +Other assets +19,424 +10,881 +Deferred tax assets, net +3,927 +3,210 +Total assets +$ +7,420,031 +$ +3,143,823 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +534,420 +$ +237,056 +Accrued liabilities +446,268 +308,787 +Operating lease liability +13,541 +5,123 +Finance lease liability +43,980 +— +Current maturities of long-term debt +12,226 +— +Total current liabilities +1,050,435 +550,966 +Long-term operating lease liability +37,848 +19,594 +Long-term finance lease liability +12,953 +— +Long-term debt, net of debt discount and issuance costs of $ 8,919 and $ 5,468 at +December 31, 2023 and 2022, respectively +1,224,941 +830,937 +Deferred tax liabilities, net +248,107 +28,738 +Other liabilities +25,066 +48,065 +Total liabilities +2,599,350 +1,478,300 +Commitments and contingencies (see Note 10) +Stockholders’ equity: +Preferred stock, par value $ 0.01 ; authorized 1,000,000 shares, no shares issued +— +— +Common stock, par value $ 0.01 ; authorized 800,000,000 and 400,000,000 shares +with 516,775,313 and 302,325,853 issued and 411,195,302 and 213,567,131 +outstanding at December 31, 2023 and 2022, respectively +5,166 +3,023 +Additional paid-in capital +6,407,294 +3,202,973 +Retained earnings (deficit) +57,035 +( 87,394 +) +Accumulated other comprehensive income +472 +— +Treasury stock, at cost, 105,580,011 shares and 88,758,722 shares at +December 31, 2023 and 2022, respectively +( 1,657,675 +) +( 1,453,079 +) +Total stockholders’ equity attributable to controlling interests +4,812,292 +1,665,523 +Noncontrolling interest +8,389 +— +Total equity +4,820,681 +1,665,523 +Total liabilities and stockholders’ equity +$ +7,420,031 +$ +3,143,823 +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEME NTS OF OPERATIONS +Year Ended December 31, +2023 +2022 +2021 +(In thousands, except per share data) +Operating revenues: +Drilling Services +$ +1,919,759 +$ +1,544,820 +$ +784,218 +Completion Services +2,017,440 +1,022,413 +523,756 +Drilling Products +134,679 +— +— +Other +74,578 +80,359 +49,107 +Total operating revenues +4,146,456 +2,647,592 +1,357,081 +Operating costs and expenses: +Drilling Services +1,119,200 +1,025,904 +577,983 +Completion Services +1,567,940 +781,385 +475,953 +Drilling Products +81,555 +— +— +Other +42,624 +39,261 +28,012 +Depreciation, depletion, amortization and impairment +731,416 +483,945 +849,178 +Selling, general and administrative +169,962 +116,589 +92,382 +Credit loss expense +842 +— +( 1,500 +) +Merger and integration expenses +98,077 +2,069 +12,060 +Other operating (income) expenses, net +( 17,114 +) +( 12,592 +) +763 +Total operating costs and expenses +3,794,502 +2,436,561 +2,034,831 +Operating income (loss) +351,954 +211,031 +( 677,750 +) +Other income (expense): +Interest income +6,122 +360 +222 +Interest expense, net of amount capitalized +( 52,870 +) +( 40,256 +) +( 41,978 +) +Other +1,898 +( 3,273 +) +( 275 +) +Total other expense +( 44,850 +) +( 43,169 +) +( 42,031 +) +Income (loss) from continuing operations before income taxes +307,104 +167,862 +( 719,781 +) +Income tax expense (benefit) +61,152 +13,204 +( 62,702 +) +Income (loss) from continuing operations +245,952 +154,658 +( 657,079 +) +Income from discontinued operations, net of tax +— +— +2,534 +Net income (loss) +245,952 +154,658 +( 654,545 +) +Net loss attributable to noncontrolling interest +( 340 +) +— +— +Net income (loss) attributable to common stockholders +$ +246,292 +$ +154,658 +$ +( 654,545 +) +Net income (loss) attributable to common stockholder per common share - basic: +Continuing operations +$ +0.88 +$ +0.72 +$ +( 3.37 +) +Discontinued operations +$ +— +$ +— +$ +0.01 +Net income (loss) - basic +$ +0.88 +$ +0.72 +$ +( 3.36 +) +Net income (loss) attributable to common stockholder per common share - diluted: +Continuing operations +$ +0.88 +$ +0.70 +$ +( 3.37 +) +Discontinued operations +$ +— +$ +— +$ +0.01 +Net income (loss) - diluted +$ +0.88 +$ +0.70 +$ +( 3.36 +) +Weighted average number of common shares outstanding: +Basic +279,501 +215,935 +195,021 +Diluted +280,061 +219,496 +195,021 +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2023 +2022 +2021 +(In thousands) +Net income (loss) +$ +245,952 +$ +154,658 +$ +( 654,545 +) +Other comprehensive income (loss): +Foreign currency translation adjustment, net of taxes of $ 0 for all periods +472 +1,793 +503 +Release of cumulative translation adjustment, net of taxes of $ 0 for 2023, +$ 3,770 for 2022 and $ 0 for 2021 +— +( 7,708 +) +— +Comprehensive income (loss) +246,424 +148,743 +( 654,042 +) +Less: comprehensive loss attributable to noncontrolling interest +( 340 +) +— +— +Comprehensive income (loss) attributable to common stockholders +$ +246,764 +$ +148,743 +$ +( 654,042 +) +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Accumulated +Common Stock +Additional +Retained +Other +Number of +Paid-in +Earnings +Comprehensive +Treasury +Noncontrolling +Shares +Amount +Capital +(Deficit) +Income +Stock +Interest +Total +(In thousands) +Balance, December 31, 2020 +271,029 +$ +2,710 +$ +2,902,236 +$ +472,014 +$ +5,412 +$ +( 1,366,313 +) +— +$ +2,016,059 +Net loss +— +— +— +( 654,545 +) +— +— +— +( 654,545 +) +Foreign currency translation adjustment +— +— +— +— +503 +— +— +503 +Shares issued for acquisition +26,274 +263 +247,762 +— +— +— +— +248,025 +Issuance of restricted stock +621 +6 +( 6 +) +— +— +— +— +— +Vesting of restricted stock units +1,345 +14 +( 14 +) +— +— +— +— +— +Stock-based compensation +— +— +21,558 +— +— +— +— +21,558 +Payment of cash dividends ($ 0.08 per share) +— +— +— +( 15,605 +) +— +— +— +( 15,605 +) +Dividend equivalents +— +— +— +( 180 +) +— +— +— +( 180 +) +Purchase of treasury stock +— +— +— +— +— +( 6,328 +) +— +( 6,328 +) +Balance, December 31, 2021 +299,269 +$ +2,993 +$ +3,171,536 +$ +( 198,316 +) +$ +5,915 +$ +( 1,372,641 +) +$ +— +$ +1,609,487 +Net income +— +— +— +154,658 +— +— +— +154,658 +Foreign currency translation adjustment +— +— +— +— +1,793 +— +— +1,793 +Release of cumulative translation adjustment +— +— +— +— +( 7,708 +) +— +— +( 7,708 +) +Issuance of restricted stock +980 +10 +( 10 +) +— +— +— +— +— +Vesting of restricted stock units +1,437 +14 +( 14 +) +— +— +— +— +— +Exercise of stock options +640 +6 +10,362 +— +— +— +— +10,368 +Stock-based compensation +— +— +21,099 +— +— +— +— +21,099 +Payment of cash dividends ($ 0.20 per share) +— +— +— +( 43,096 +) +— +— +— +( 43,096 +) +Dividend equivalents +— +— +— +( 640 +) +— +— +— +( 640 +) +Purchase of treasury stock +— +— +— +— +— +( 80,438 +) +— +( 80,438 +) +Balance, December 31, 2022 +302,326 +$ +3,023 +$ +3,202,973 +$ +( 87,394 +) +$ +— +$ +( 1,453,079 +) +$ +— +$ +1,665,523 +Net income (loss) +— +— +— +246,292 +— +— +( 340 +) +245,952 +Noncontrolling interest +— +— +— +— +— +— +8,729 +8,729 +Foreign currency translation adjustment +— +— +— +— +472 +— +— +472 +Issuance of common stock - Ulterra acquisition +34,900 +349 +521,057 +— +— +— +— +521,406 +Issuance of common stock - NexTier merger +172,092 +1,720 +2,564,175 +— +— +— +— +2,565,895 +Issuance of replacement awards related to NexTier merger +— +— +72,413 +— +— +— +— +72,413 +Issuance of restricted stock +1,077 +10 +( 10 +) +— +— +— +— +— +Vesting of restricted stock units +6,380 +64 +( 64 +) +— +— +— +— +— +Stock-based compensation +— +— +46,750 +— +— +— +— +46,750 +Payment of cash dividends ($ 0.32 per share) +— +— +— +( 100,034 +) +— +— +— +( 100,034 +) +Dividend equivalents +— +— +— +( 1,829 +) +— +— +— +( 1,829 +) +Purchase of treasury stock +— +— +— +— +— +( 204,596 +) +— +( 204,596 +) +Balance, December 31, 2023 +516,775 +$ +5,166 +$ +6,407,294 +$ +57,035 +$ +472 +$ +( 1,657,675 +) +$ +8,389 +$ +4,820,681 +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +C ONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2023 +2022 +2021 +(In thousands) +Cash flows from operating activities: +Net income (loss) +$ +245,952 +$ +154,658 +$ +( 654,545 +) +Adjustments to reconcile net income (loss) to net cash provided by +operating activities: +Depreciation, depletion, amortization and impairment +731,416 +483,945 +849,178 +Deferred income tax expense (benefit) +51,866 +6,998 +( 62,980 +) +Stock-based compensation +46,750 +21,099 +21,558 +Net gain on asset disposals +( 1,798 +) +( 12,075 +) +( 1,426 +) +Gain on early debt extinguishment +( 1,112 +) +( 2,461 +) +— +Other +59 +954 +( 483 +) +Changes in operating assets and liabilities: +Accounts receivable +84,544 +( 209,226 +) +( 147,356 +) +Inventory +( 30,793 +) +( 23,154 +) +( 2,609 +) +Other current assets +( 10,360 +) +( 1,975 +) +( 4,126 +) +Other assets +24,686 +10,643 +5,260 +Accounts payable +( 69,729 +) +38,986 +50,941 +Accrued liabilities +( 23,484 +) +67,380 +48,540 +Other liabilities +( 42,083 +) +30,416 +( 5,940 +) +Net cash used in operating activities of discontinued operations +— +— +( 516 +) +Net cash provided by operating activities +1,005,914 +566,188 +95,496 +Cash flows from investing activities: +Acquisitions, net of cash acquired - Pioneer +— +— +( 29,358 +) +Acquisitions, net of cash acquired - NexTier +( 65,185 +) +— +— +Acquisitions, net of cash acquired - Ulterra +( 357,314 +) +— +— +Purchases of property and equipment +( 615,690 +) +( 436,797 +) +( 166,320 +) +Proceeds from disposal of assets and insurance claims +26,494 +26,074 +23,339 +Other +( 5,895 +) +( 2,504 +) +( 522 +) +Net cash provided by investing activities of discontinued operations +— +— +41,267 +Net cash used in investing activities +( 1,017,590 +) +( 413,227 +) +( 131,594 +) +Cash flows from financing activities: +Purchases of treasury stock +( 200,710 +) +( 70,070 +) +( 6,328 +) +Dividends paid +( 100,034 +) +( 43,096 +) +( 15,605 +) +Proceeds from borrowings under revolving credit facility +420,000 +150,000 +— +Repayment of borrowings under revolving credit facility +( 420,000 +) +( 150,000 +) +— +Proceeds from issuance of senior notes +396,412 +— +— +Repayment of senior notes +( 7,837 +) +( 19,760 +) +— +Repayment of term loan +— +— +( 50,000 +) +Payments on finance leases +( 15,915 +) +— +— +Debt issuance costs +( 2,395 +) +( 455 +) +— +Other +( 3,954 +) +— +— +Net cash provided by (used in) financing activities +65,567 +( 133,381 +) +( 71,933 +) +Effect of foreign exchange rate changes on cash, cash equivalents and restricted cash +1,236 +449 +640 +Net increase (decrease) in cash, cash equivalents and restricted cash +55,127 +20,029 +( 107,391 +) +Cash, cash equivalents and restricted cash at beginning of year +137,553 +117,524 +224,915 +Cash, cash equivalents and restricted cash at end of year +$ +192,680 +$ +137,553 +$ +117,524 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $ 1,692 in 2023, $ 976 in 2022, and $ 260 in 2021 +$ +( 39,607 +) +$ +( 39,855 +) +$ +( 40,464 +) +Income taxes +( 27,169 +) +( 1,526 +) +4,196 +Non-cash investing and financing activities: +Net increase (decrease) in payables for purchases of property and equipment +$ +( 15,111 +) +$ +7,953 +$ +31,393 +Net (increase) decrease in deposits on equipment purchases +7,876 +( 12,202 +) +867 +Issuance of common stock for business acquisitions +3,159,714 +— +248,025 +Cashless exercise of stock options +— +10,368 +— +Purchases of property and equipment through exchange of lease right of use asset +3,241 +— +— +Derecognition of right of use asset +( 3,241 +) +— +— +The accompanying notes are an integral part of these consolidated financial statements. +F- 9 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +N OTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries and consolidating interest of a joint venture (collectively referred to herein as “we,” “us,” “our,” “ours” and like terms), is a Houston, Texas-based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. We have other operations through which we provide oilfield rental tools in select markets in the United States. In addition, we own and invest, as a non-operating, working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +On August 14, 2023, we completed our acquisition (the “Ulterra acquisition”) of Ulterra Drilling Technologies, L.P. (“Ulterra”). Ulterra is a global provider of specialized drill bit solutions. On September 1, 2023, we completed our merger (the “NexTier merger”) with NexTier Oilfield Solutions Inc. (“NexTier”). NexTier is a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins. See Note 2 for additional details on the acquisition and merger. +In the fourth quarter of 2021, we completed the acquisition of Pioneer Energy Services Corp. (“Pioneer”). Pioneer provided land-based contract drilling services and production services to a diverse group of oil and natural gas exploration and production companies in the United States and internationally in Colombia. The purchase price allocation was finalized in 2022. The measurement period adjustments did not have a material impact on our consolidated financial statements. +On December 31, 2021, we completed the sale of the acquired Pioneer well servicing rig business and wireline business to Clearwell Dynamics, LLC. The sale price was $ 43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses were presented as a discontinued operation during the fourth quarter of 2021. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI, its wholly-owned subsidiaries and the consolidating interest of a joint venture. All significant intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries and our interest in a joint venture, we have no controlling financial interests in any other entity which would require consolidation. As used in these notes, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc, and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its business operations through its wholly-owned subsidiaries and has no employees or independent operations. +Certain prior year amounts have been reclassified to conform to current year presentation. These reclassifications include the change in our reportable segments in 2023. Effective as of the third quarter of 2023, we revised our reportable segments to align with certain changes in how our Chief Operating Decision Maker (“CODM”) manages and allocates resources to our business as a result of the Ulterra acquisition and NexTier merger. We now have the following reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. Accordingly, we recast our results of operations for all years presented to align with our revised reportable segments. These reclassifications had no effect on our previously reported operating and net income (loss) within our consolidated statements of operations or cash flows from operating, investing and financing activities within our consolidated statements of cash flows. +The U.S. dollar is the reporting currency and functional currency for most of our operations except certain of our foreign subsidiaries, which use their local currencies as their functional currency. Assets and liabilities of these foreign subsidiaries are translated into U.S. dollars using the exchange rates in effect as of the balance sheet date. The effects of these translation adjustments are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +The consolidated financial statements include the results of Ulterra from August 14, 2023 to December 31, 2023, and the results of NexTier from September 1, 2023 to December 31, 2023. +F- 10 +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates . +Cash and cash equivalents — Cash equivalents are highly liquid, short-term investments with original maturities of three months or less from their date of purchase. +Restricted cash — Restricted cash includes amounts restricted as cash collateral for the issuance of standby letters of credit. +The following table provides a reconciliation of cash and restricted cash reported within the consolidated balance sheet that sum to the total of such amounts shown in the statement of cash flows for the years ended December 31, 2023 and 2022: +Year Ended December 31, +2023 +2022 +Cash and cash equivalents +$ +190,108 +$ +137,553 +Restricted cash +2,572 +— +Total cash, cash equivalents and restricted cash +$ +192,680 +$ +137,553 +Revenue recognition — Revenues from our drilling services, completion services, drilling products, and other activities are recognized as services are performed. All of the wells we drilled in 2023, 2022 and 2021 were drilled under daywork contracts. Revenue is presented net of any sales tax charged to the customer that we are required to remit to local or state governmental taxing authorities. +Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +As a result of the Ulterra acquisition, our revenues now include a significant amount of rental revenue included within the new “Drilling products” segment. See Note 3 for details . +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for credit losses represents our estimate of the amount of probable credit losses existing in our accounts receivable. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectible, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with our completion services activities, materials used in our equipment servicing business, spare parts for drilling services and raw materials for drilling products. Such inventories are stated at the lower of cost or net realizable value. As inventory is consumed, expense is recorded in direct operating cost in the consolidated statements of operations using the weighted average cost method for non-manufacturing inventory and standard cost method for manufacturing inventory. +We periodically review the nature and quantities of inventory on hand and evaluate the net realizable value of items based on historical usage patterns, known changes to equipment or processes and customer demand for specific products. Provision for excess or obsolete inventories is determined based on historical usage of inventory on-hand, volume on-hand versus anticipated usage, technological advances and consideration of current market conditions. Inventories that have not turned over for more than a year are subject to slow-moving reserve provisions. In addition, inventories that have become obsolete due to technological advances, excess volume on-hand or are no longer configured to operate with our equipment are written off. +Other current assets — Other current assets include reimbursement from our workers compensation insurance carrier for claims in excess of our deductible in the amount of $ 31.0 million and $ 34.6 million at December 31, 2023 and 2022, respectively. We also maintain prepayments for items such as insurance, rent and inventory. +Long-lived assets with definite lives — Property and equipment and definite-lived intangible assets are carried at cost less accumulated depreciation, amortization, depletion and impairment. Depreciation and amortization is recorded on the straight-line method over the estimated useful lives. The method of depreciation does not change whenever property and equipment become idle. +F- 11 +The estimated useful lives are shown below: +Useful Lives +Equipment +1 - 25 years +Rental equipment +4 - 8 runs +Buildings and leasehold improvements +1 - 30 years +Other +3 - 20 years +Amortization of definite-lived intangible assets is calculated on the straight-lined method over the estimated useful lives of the assets, which range from 3 to 15 years. +Long-lived assets with definite lives, including property and equipment and certain intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). Assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings for impairment assessment. If there is a triggering event, we estimate future cash flows over the life of the respective assets or asset groupings in our assessment of its recoverability. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. If estimated undiscounted cash flows expected to result from the use and eventual disposition of an asset or asset group is less than its respective carrying amount, an impairment loss is recognized in the amount by which the carrying amount exceeds its estimated fair value. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in our consolidated statements of operations. +Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting. Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well. Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made. Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known. We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects. If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense. Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred. The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field. Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field. +We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices. Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields. These cash flow estimates are reviewed by an independent petroleum engineer. If the net book value of a field exceeds our undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value. The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (Level 3 inputs in the fair value hierarchy of fair value accounting). We review unproved oil and natural gas properties quarterly to assess potential impairment. Our impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area. If an unproved property is determined to be impaired, the related property costs are expensed. Impairment expense related to oil and natural gas properties of approximately $ 7.0 million, $ 4.5 million and $ 1.3 million was recorded for the years ended December 31, 2023, 2022 and 2021 , respectively. +Goodwill — As a result of both the Ulterra acquisition and the NexTier merger, we have recognized goodwill. Goodwill from acquisitions is recorded as the excess of the consideration transferred plus the fair value of any non-controlling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired. Goodwill is considered to have an indefinite useful economic life and is not amortized. We assess impairment of goodwill at least annually, as of July 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. If the carrying value of a reporting unit exceeds its fair value, we would recognize an impairment in an amount equal to the excess, limited to the total amount of goodwill allocated to the reporting unit. See Note 7 for details. +F- 12 +Leases — We have operating leases for operating locations, corporate offices and certain operating equipment. We determine if a contract contains a lease at inception or as a result of an acquisition. A right-of-use asset and corresponding lease liability are recognized on our consolidated balance sheet at commencement at an amount based on the present value of the remaining lease payments over the lease term. Renewal options are included in the right-of-use asset and lease liability if it is reasonably certain that we will exercise the option, and termination options are included in the right-of-use asset and lease liability if it is not reasonably certain we will exercise the option. By our policy election, right-of-use assets and lease liabilities with an initial term of one year or less are not recognized for leasing arrangements, and non-lease and lease components are treated as a single lease component instead of bifurcating those components. Lease expense is recognized on a straight-line basis. If available, we use the rate implicit in the lease at commencement date to discount the lease payments. If the implicit rate is not readily determinable, we use our incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. +In the third quarter of 2023, as part of the Ulterra acquisition and the NexTier merger, we acquired operating and finance leases. We inherited NexTier’s and Ulterra’s lease classifications as of the time of each respective acquisition. We have elected as an accounting policy election by class of underlying assets to not recognize assets or liabilities at the acquisition date for leases that had a remaining lease term of twelve months or less. See Notes 2 and 13 for details. +For finance leases, we amortize the right-of-use asset on a straight-line basis over the earlier of the useful life of the right-of-use asset or the end of the lease term and record this amortization in depreciation and amortization expense in the consolidated statements of operations. If available, we use the rate implicit in the lease at commencement date to discount the lease payments. If the implicit rate is not available, we use our incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. We include the term of any renewal option for the right-of-use asset and lease liability if it is reasonably certain that we will exercise the option. We also include the term of any termination option for the right-of-use asset and lease liability if it is not reasonably certain we will exercise the option. By our policy election, right-of-use assets and lease liabilities with an initial term of one year or less are not recognized for leasing arrangements, and non-lease and lease components are treated as a single lease component instead of bifurcating those components. For finance leases where we have determined we are reasonably certain to exercise a purchase option to acquire the underlying asset, we amortize the right-of-use asset over the lease term and record this amortization in “Depreciation, depletion, amortization and impairment” in the consolidated statements of operations. We adjust the lease liability to reflect lease payments made during the period and interest incurred on the lease liability using the effective interest method. The incurred interest expense is recorded in “Interest expense” in the consolidated statements of operations. +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. Our policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — We recognize the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards, as described in Note 12. +Concentration of Credit Risk — Our assets that are potentially subject to concentrations of credit risk are cash, cash equivalents and restricted cash and trade accounts receivable. Cash balances are maintained in financial institutions, which at times exceed federally insured limits. We monitor the financial condition of the financial institutions in which accounts are maintained and has not experienced any losses in such accounts. We maintain an allowance for credit losses based upon several factors, including historical collection experience, current aging status of the customer accounts and financial condition of our customers. There were no material changes in the allowance for credit losses in 2023 and 2022. +Change in Accounting Estimate — In the third quarter of 2023, we changed the estimated useful lives of certain property and equipment within our completion services segment. The change in the estimated useful lives was necessitated by recent trends in increased intensity and pumping hours per day of certain components used in servicing larger jobs. We determined the estimated useful life of fluid ends is now less than one year, which results in these components no longer being capitalized to property and equipment but instead recorded to inventory and expensed as direct operating costs as they are consumed. Additionally, we shortened the estimated useful lives of certain other completion components that remain in property and equipment, which resulted in a decrease in the weighted average estimated useful lives of these assets from nine years to seven years. The effect of our change in estimated useful lives of these assets was a decrease in operating income of $ 30.7 million and a decrease in net income of $ 24.3 million for the year ended December 31, 2023, which resulted in a decrease in basic and diluted earnings per share of $ 0.09 and $ 0.09 per share, respectively. +F- 13 +Recently Adopted Accounting Standards — In October 2021, the FASB issued an accounting standards update, which requires contract assets and contract liabilities (i.e., deferred revenue) acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers. Generally, this new guidance will result in the acquirer recognizing contract assets and contract liabilities at the same amounts recorded by the acquiree. Historically, such amounts were recognized by the acquirer at fair value in acquisition accounting. The amendments should be applied prospectively to acquisitions occurring on or after the effective date. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2022, with early adoption permitted. We adopted this new guidance on January 1, 2023, and there was no material impact on our consolidated financial statements. +Recently Issued Accounting Standards — In March 2020, the FASB issued an accounting standards update to provide temporary optional expedients that simplify the accounting for contract modifications to existing debt agreements expected to arise from the market transition from LIBOR to alternative reference rates. The amendments in the update are effective as of March 12, 2020 through December 31, 2022 and may be applied to contract modifications from the beginning of an interim period that includes or is subsequent to March 12, 2020. In December 2022, the FASB issued an update, which deferred the sunset date to December 31, 2024. We do not expect this new guidance will have a material impact on our consolidated financial statements. +In November 2023, the FASB issued an accounting standards update to improve reportable segment disclosure requirements and enhance disclosures about significant segment expenses. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024 on a retrospective basis. We are currently evaluating the effect of this pronouncement on our disclosures. +In December 2023, the FASB issued an accounting standards update to improve income tax disclosure requirements. The amendments in the update are effective for public business entities for fiscal years beginning after December 15, 2024 and should be applied prospectively. We are currently evaluating the effect of this pronouncement on our disclosures. +2. Acquisitions and Discontinued Operations +Pioneer Energy Services Corp. +On October 1, 2021, we completed the acquisition of Pioneer by acquiring 100 % of its equity interests . Total consideration for the acquisition included the issuance of approximately 26.3 million shares of our common stock and payment of $ 30 million cash, which based on the closing price of our common stock of $ 9.44 on October 1, 2021, valued the transaction at approximately $ 278 million. +Pioneer provided land-based contract drilling services and production services to a diverse group of oil and natural gas exploration and production companies in the United States and internationally in Colombia. +The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of our common stock issued to Pioneer shareholders +26,274 +Our common stock price on October 1, 2021 +$ +9.44 +Fair value of common stock issued +$ +248,025 +Plus cash consideration +$ +30,007 +Total fair value of consideration transferred +$ +278,032 +Approximately $ 41.5 million of revenues and $ 30.5 million of direct operating expenses attributed to the Pioneer acquisition are included in our consolidated statements of operations for the period from the closing date on October 1, 2021 through December 31, 2021, excluding the acquired well servicing rig business and the wireline businesses that have been presented as a discontinued operation in our consolidated statements of operations. Revenues and direct operating expenses for our discontinued operations are presented below. During 2021, we incurred costs related to the Pioneer acquisition totaling $ 12.1 million, which are included in our consolidated statements of operations as “Merger and integration expenses.” +Pro Forma +The results of Pioneer’s operations since the Pioneer merger date of October 1, 2021, are included in our consolidated statements of operations. The following pro forma condensed combined financial information was derived from our and Pioneer’s historical financial +F- 14 +statements, excluding the well servicing rig business and wireline business that were disposed on December 31, 2021, and gives effect to the acquisition as if it had occurred on January 1, 2020. The below information reflects pro forma adjustments based on available information and certain assumptions we believe are reasonable, including (i) adjustments related to the depreciation and amortization of the fair value of acquired fixed assets, (ii) removal of the historical interest expense, loss on debt extinguishment and reorganization expenses of the acquired entities and (iv) the tax benefit of the aforementioned pro forma adjustments. +The pro forma results of operations do not include any cost savings or other synergies that may result from the Pioneer acquisition. The pro forma results of operations also do not include any estimated costs that have been or will be incurred to integrate Pioneer operations. The pro forma results of operations include our merger and integration-related costs of $ 12.1 million and Pioneer ’ s merger related costs of $ 4.6 million for the year ended December 31, 2021. +The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the Pioneer acquisition taken place on January 1, 2020; furthermore, the financial information is not intended to be a projection of future results. The following table summarizes our selected financial information on a pro forma basis (in thousands, except per share data): +2021 +(Unaudited) +Revenues +$ +1,464,351 +Net loss +$ +( 666,032 +) +Discontinued Operations +On December 31, 2021, we completed the sale of the acquired well servicing rig business and wireline business to Clearwell Dynamics, LLC. The sale price was $ 43.0 million in cash consideration, subject to customary purchase price adjustments at closing for cash and working capital. The results of operations of these businesses were presented as a discontinued operation in the consolidated financial statements during the fourth quarter of 2021. +Summarized operating results from discontinued operations that are included in our consolidated statements of operations for the year ended December 31, 2021 are shown below (in thousands): +2021 +Operating revenues: +Wireline revenue +$ +9,868 +Well servicing revenue +19,652 +Total operating revenues +29,520 +Operating costs and expenses: +Wireline +10,465 +Well servicing +16,585 +Total operating costs and expenses +27,050 +Operating income +2,470 +Total other income (expense) +64 +Income from discontinued operations before income taxes +2,534 +Income tax benefit +— +Income from discontinued operations, net of tax +$ +2,534 +Ulterra Drilling Technologies, L.P. +On August 14, 2023, we completed the Ulterra acquisition. Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $ 376 million of cash, which based on the closing price of our common stock of $ 14.94 on August 14, 2023, valued the transaction at closing at approximately $ 897 million. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +F- 15 +Shares of our common stock issued to Ulterra +34,900 +Our common stock price on August 14, 2023 +$ +14.94 +Common stock equity consideration +$ +521,406 +Plus net cash consideration (1) +375,740 +Total consideration transferred +$ +897,146 +(1) +Net cash consideration inclu ded $ 370 million cas h consideration as adjusted for customary purchase price adjustments set forth in the Ulterra merger agreement relating to cash, net working capital, indebtedness and transaction expenses of Ulterra as of the closing. The adjustment is subject to a post-closing target net working capital adjustment in accordance with the Ulterra merger agreement. +The acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. +The aggregate purchase price noted above was allocated to the major categories of assets acquired and liabilities assumed based on preliminary estimated fair values as of the date of the business combination. We applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to future rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rate ( 10.5 %). The carrying amounts of cash and cash equivalents, accounts receivable, other assets, accounts payable and accrued liabilities approximate their fair values due to their nature or the short-term maturity of instruments. The remaining assets acquired and liabilities assumed are based on inputs that are not observable in the market and thus represent Level 3 inputs. The fair value of inventory and rental equipment was determined using a replacement cost approach. Intangible assets primarily consist of customer relationships and developed technology, the fair values of which were determined using an income approach. Property and equipment was valued using a combination of indirect cost and a market approach. The fair value was estimated by using a multi-period excess earnings method for customer relationships and a relief from royalty method for trade name and developed technology. Certain data necessary to complete the purchase price allocation is not yet available, including final tax returns that provide the underlying tax basis of Ulterra’s assets and liabilities. The measurement period adjustments in the fourth quarter of 2023 did not have a material impact on our consolidated financial statements. We will complete the purchase price allocation during the 12-month period following the acquisition date. +The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition: +Assets acquired: +Cash and cash equivalents +$ +18,426 +Accounts receivable +68,467 +Inventory (1) +36,313 +Rental equipment (2) +109,055 +Property and equipment +27,583 +Intangible assets +313,000 +Operating lease right of use asset +7,513 +Finance lease right of use asset +5,228 +Other assets +14,274 +Total assets acquired +599,859 +Liabilities assumed: +Accounts payable +23,258 +Accrued liabilities +31,608 +Operating lease liability +7,513 +Finance lease liability +5,228 +Deferred tax liabilities +83,993 +Total liabilities assumed +151,600 +Less: noncontrolling interest +( 8,729 +) +Net assets acquired +439,530 +Goodwill +457,616 +Total consideration transferred +$ +897,146 +(1) +We recorded an adjustmen t of $ 5.5 million to write-up acquired drill bits classified as inventory to estimated fair value. This adjustment will be recorded as direct operating expense as acquired drill bits are sold. +F- 16 +(2) +We recorded an adjustment of $ 74.4 millio n to write-up acquired drill bits classified as long-lived assets to estimated fair value. This adjustment will be depreciated as acquired drill bits are rented over a weighted-average estimated useful lif e of 7.5 run s. +The goodwill recognized in the acquisition represents the excess of the gross consideration transferred over the fair value of the underlying net tangible and identifiable intangible assets acquired and liabilities assumed. Goodwill represents the potential for new growth opportunities internationally with the acquisition of Ulterra as well as the recognition of deferred taxes for the difference between the fair value of the assets acquired and liabilities assumed and the respective carry-over tax basis. Goodwill is not deductible for tax purposes. All of the goodwill was assigned to our Drilling Products segment. See Note 7. +Approximately $ 135 million of revenues and $ 3.4 million of net loss attributed to the Ulterra acquisition are included in the consolidated statements of operations for the period from the closing date on August 14, 2023 through December 31, 2023 . During the twelve months ended December 31, 2023 , we incurred costs related to the Ulterra acquisition totaling $ 5.6 million, which are included in our consolidated statements of operations as “Merger and integration expense.” +A portion of the fair value consideration transferred has been provisionally assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Customer relationships +$ +245,000 +15 +Trade name +16,000 +11 +Developed technology +52,000 +5 +Intangible assets +$ +313,000 +Pro Forma +The following pro forma condensed combined financial information was derived from our and Ulterra’s historical financial statements and gives effect to the acquisition as if it had occurred on January 1, 2022. The below information reflects pro forma adjustments based on available information and certain assumptions we believe are reasonable, including (i) adjustments related to the depreciation and amortization of the step up to fair value of $ 77.6 million for acquired intangibles, $ 74.4 million for acquired drill bits classified as long-lived assets, and $ 5.5 million for acquired drill bits classified as inventory, (ii) removal of $ 12.8 million in 2023 and $ 28.1 million in 2022 of historical interest expense of the acquired entity and (iii) $ 17.4 million in 2023 and $ 11.3 million in 2022 of tax benefit relating to the aforementioned pro forma adjustments. +The pro forma results of operations do not include any anticipated cost savings or other synergies that may result from the Ulterra acquisition nor do they include any estimated costs that will be incurred to integrate Ulterra operations. The pro forma results of operations include our merger and integration expense of $ 5.6 million as if they had been incurred in the first quarter of 2022. +The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the Ulterra acquisition taken place on January 1, 2022. Furthermore, the financial information is not intended to be a projection of future results. The following table summarizes our selected financial information on a pro forma basis (in thousands, except per share data): +2023 +2022 +(Unaudited) +Revenues +$ +4,369,596 +$ +3,017,778 +Net income +$ +190,136 +$ +141,458 +NexTier Oilfield Solutions Inc. +On September 1, 2023, we completed the NexTier merger. Under the terms of the merger agreement, NexTier became our wholly-owned subsidiary. Each share of NexTier common stock issued and outstanding immediately prior to the effective time of the merger was converted into the right to receive 0.752 shares of our common stock. Additionally, certain equity awards that were granted and outstanding under NexTier long-term incentive plans were assumed by us, and such equity awards were converted into equity awards in respect of our common stock in accordance with the merger agreement. +NexTier is a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins. +F- 17 +The total fair value of the consideration transferred was determined as follows (in thousands, except exchange ratio and stock price): +Number of shares of NexTier common stock outstanding as of September 1, 2023 +228,846 +Multiplied by the exchange ratio +0.752 +Number of shares of Patterson-UTI Energy, Inc. common stock issued in connection with the merger +172,092 +Patterson-UTI Energy, Inc. common stock price on September 1, 2023 +$ +14.91 +Common stock equity consideration +2,565,895 +Acceleration of RSU awards +1,997 +Fair value of replacement equity awards (1) +70,416 +NexTier long-term debt repaid by Patterson-UTI Energy, Inc. +161,000 +Consideration transferred +$ +2,799,308 +(1) +In connection with the merger, each of the share-based awards held by legacy NexTier employees were replaced with our share-based awards on the merger date. The fair value of the replacement awards has been allocated between each employee’s pre-combination and post-combination services. Amounts allocated to pre-combination services have been included as consideration transferred as part of the merger. See Note 12 for replacement awards details. +The transaction has been accounted for as a business combination using the acquisition method with Patterson-UTI Energy, Inc. determined to be the acquirer. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. +The aggregate purchase price noted above was allocated to the major categories of assets acquired and liabilities assumed based on preliminary estimated fair values as of the date of the business combination. We applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to future rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rate ( 14.0 %). The carrying amounts of cash and cash equivalents, accounts receivable, inventory, other assets, accounts payable, accrued liabilities, and other liabilities approximate their fair values due to their nature or the short-term maturity of instruments. The remaining assets acquired and liabilities assumed are based on inputs that are not observable in the market and thus represent Level 3 inputs. The fair value of property and equipment was determined using a combination of replacement cost and indirect cost. Intangible assets were valued using an income approach. The fair value was estimated by using multi-period excess earnings method for customer relationships and a relief from royalty method for trade name and developed technology. Certain data necessary to complete the purchase price allocation is not yet available, including final tax returns that provide the underlying tax basis of NexTier’s assets and liabilities. The measurement period adjustments in the fourth quarter of 2023 did not have a material impact on our consolidated financial statements. We will complete the purchase price allocation during the 12-month period following the acquisition date. +The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of the merger: +F- 18 +Assets acquired: +Cash and cash equivalents +$ +95,815 +Accounts receivable +420,200 +Inventory +71,930 +Property and equipment (1) +1,045,610 +Intangible assets +768,000 +Operating lease right of use asset +19,091 +Finance lease right of use asset +50,733 +Other assets +84,677 +Total assets acquired +2,556,056 +Liabilities assumed: +Accounts payable +358,873 +Accrued liabilities +129,535 +Operating lease liability +19,091 +Finance lease liability +50,733 +Deferred tax liabilities +86,293 +Long-term debt +22,533 +Other liabilities +11,815 +Total liabilities assumed +678,873 +Net assets acquired +1,877,183 +Goodwill +922,125 +Total consideration transferred +$ +2,799,308 +(1) +We recorded an adjustment of $ 262.7 million to write-up acquired property and equipment to estimated fair value. This adjustment will be depreciated on a straight-line basis over a weighted average period of six years. +The goodwill recognized in the merger represents the excess of the gross consideration transferred over the fair value of the underlying net tangible and identifiable intangible assets acquired and liabilities assumed. Goodwill largely consisted of the expected synergies and economies of scale from the combined operations of Patterson-UTI Energy, Inc. and NexTier as well as the recognition of deferred taxes for the difference between the fair value of the assets acquired and liabilities assumed and the respective carry-over tax basis. The goodwill is not deductible for tax purposes. All of the goodwill was assigned to our completion services segment. See Note 7. +Approximately $ 1.1 billion of revenues and $ 12.5 million of net income attributed to the NexTier merger are included in the consolidated statements of operations for the period from the closing date on September 1, 2023 through December 31, 2023 . During the twelve months ended December 31, 2023 , we incurred costs related to the NexTier merger totaling $ 92.5 million, which are included in our consolidated statements of operations as “Merger and integration expense.” +A portion of the fair value consideration transferred has been provisionally assigned to identifiable intangible assets as follows: +Fair Value +Weighted Average Useful Life +(in thousands) +(in years) +Customer relationships +$ +540,000 +10 +Trade name +85,000 +10 +Developed technology +143,000 +5 +Intangible assets +$ +768,000 +Pro Forma +The following pro forma condensed combined financial information was derived from our and NexTier's historical financial statements and gives effect to the acquisition as if it had occurred on January 1, 2022. The below information reflects pro forma adjustments based on available information and certain assumptions we believe are reasonable, including (i) adjustments related to the depreciation and amortization of the step up to fair value o f $ 720.7 million for acquired intangibles and $ 262.7 million for acquired property and equipment, (ii) removal of $ 17.7 million in 2023 and $ 30.0 million in 2022 of historical interest expense of the acquired entity and (iii) $ 15.1 million in 2023 and $ 72.7 million of tax benefit in 2022 relating to the aforementioned pro forma adjustments. +F- 19 +The pro forma results of operations do not include any anticipated cost savings or other synergies that may result from the NexTier merger nor do they include any estimated costs that will be incurred to integrate NexTier operations. The pro forma results of operations include our merger and integration expense of $ 92.5 million as if they had been incurred in the first quarter of 2022. +The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the NexTier merger taken place on January 1, 2022. Furthermore, the financial information is not intended to be a projection of future results. The following table summarizes our selected financial information on a pro forma basis (in thousands, except per share data): +2023 +2022 +(Unaudited) +Revenues +$ +6,604,824 +$ +5,892,414 +Net income +$ +598,709 +$ +196,220 +3. Revenues +ASC Topic 606 Revenue from Contracts with Customers +Drilling Services and Completion Services — revenue is recognized based on our customers’ ability to benefit from our services in an amount that reflects the consideration we expect to receive in exchange for those services. This typically happens when the service is performed. The services we provide represent a series of distinct services, generally provided daily, that are substantially the same, with the same pattern of transfer to the customer. Because our customers benefit equally throughout the service period, generally measured in days, and our efforts in providing services are incurred relatively evenly over the period of performance, revenue is recognized as we provide services to the customer. +ASC Topic 842 Revenue from Equipment Rentals +Drilling Products Revenue — revenues are primarily generated from the rental of drilling equipment, comprised of drill bits and downhole tools. These arrangements provide the customer with the right to control the use of identified asset. Generally, the lease terms in such arrangements are for periods of two to three days and do not provide customers with options to purchase the underlying asset. +Other — we are a non-operating working interest owner of oil and natural gas assets primarily located in Texas and New Mexico. The ownership terms are outlined in joint operating agreements for each well between the operator of the well and the various interest owners, including us, who are considered non-operators of the well. We receive revenue each period for our working interest in the well during the period. +Accounts Receivable and Contract Liabilities +Accounts receivable is our right to consideration once it becomes unconditional. Payment terms typically range from 30 to 60 days. +Accounts receivable balances were $ 900 million and $ 561 million as of December 31, 2023 and 2022, respectively. These balances do not include amounts related to our oil and natural gas working interests nor do they include amounts related to our lease revenues under Topic 842 as those contracts are excluded from Topic 606. Accounts receivable balances are included in “Accounts receivable” in our consolidated balance sheets. +We do not have any significant contract asset balances. Contract liabilities include prepayments received from customers prior to the requested services being completed. Once the services are complete and have been invoiced, the prepayment is applied against the customer’s account to offset the accounts receivable balance. Also included in contract liabilities are payments received from customers for reactivation or initial mobilization of newly constructed or upgraded rigs that were moved on location to the initial well site. These payments are allocated to the overall performance obligation and amortized over the initial term of the contract. Total contract liability balances were $ 103 million and $ 148 million as of December 31, 2023 and December 31, 2022, respectively. In 2023, we recognized $ 136 million of revenue that was included in the contract liability balance at the beginning of the period, of which the recognition of $ 28.9 million was due to deferred revenue from a customer prepayment, which became recognizable after the customer changed its drilling schedule. In 2022, we recognized $ 59.7 million of revenue that was included in the contract liability balance at the beginning of the period. Revenue related to our contract liabilities balance is expected to be recognized through 2026. The $ 98.9 million current portion of our contract liability balance is included in “Accrued liabilities” and $ 4.1 million noncurrent portion of our contract liability balance is included in “Other liabilities” in our consolidated balance sheets. +F- 20 +Contract Costs +Costs incurred for newly constructed rigs or rig upgrades based on a contract with a customer are considered capital improvements and are capitalized to drilling equipment and depreciated over the estimated useful life of the asset. +Remaining Performance Obligations +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2023 was approximately $ 700 million. Approximately 16 % of our total contract drilling backlog in the United States at December 31, 2023 is reasonably expected to remain at December 31, 2024 . We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to fees for other services such as for mobilization, other than initial mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. For contracts that contain variable dayrate pricing, our backlog calculation uses the dayrate in effect for periods where the dayrate is fixed, and, for periods that remain subject to variable pricing, uses commodity pricing or other related indices in effect at December 31, 2023 . In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts on which we have received notice for the rig to be placed on standby, our backlog calculation uses the standby rate for the period over which we expect to receive the standby rate. For contracts on which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period over which we expect to receive the lower rate. Please see “Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment” included in Item 1A of this Report. +4 . Inventory +Inventory consisted of the following at December 31, 2023 and 2022 (in thousands): +2023 +2022 +Raw materials and supplies +$ +141,311 +$ +63,008 +Work-in-process +7,437 +2,341 +Finished goods +32,057 +28 +Inventory +$ +180,805 +$ +65,377 +5. Other Current Assets +Other current assets consisted of the following at December 31, 2023 and 2022 (in thousands): +2023 +2022 +Federal and state income taxes receivable +$ +26,949 +$ +11,313 +Workers’ compensation receivable +31,006 +34,632 +Prepaid expenses +46,394 +11,960 +Other +36,773 +3,064 +Other current assets +$ +141,122 +$ +60,969 +6. Property and Equipment +Property and equipment consisted of the following at December 31, 2023 and 2022 (in thousands): +2023 +2022 +Equipment +$ +8,506,727 +$ +7,551,099 +Oil and natural gas properties +238,337 +236,156 +Buildings +248,693 +175,212 +Rental equipment +119,653 +— +Land +38,811 +23,610 +Total property and equipment +9,152,221 +7,986,077 +Less accumulated depreciation, depletion, amortization and impairment +( 5,811,809 +) +( 5,725,501 +) +Property and equipment, net +$ +3,340,412 +$ +2,260,576 +F- 21 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets for 2023, 2022 and 2021 (in thousands): +2023 +2022 +2021 +Depreciation and impairment expense +$ +682,672 +$ +472,969 +$ +818,999 +Amortization expense +41,521 +2,891 +24,606 +Depletion expense +7,223 +8,085 +5,573 +Total +$ +731,416 +$ +483,945 +$ +849,178 +On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are abandoned. There were no impairments in 2022 or 2023 . In the fourth quarter of 2021, we identified 43 legacy non-super-spec rigs and equipment to be abandoned. Based on the strong customer preference across the industry for super-spec drilling rigs, we believed the 43 rigs that were abandoned had limited commercial opportunity. We recorded a $ 220 million charge related to this abandonment in the fourth quarter of 2021. +We also periodically evaluate our other drilling service assets. In the fourth quarter of 2021, we abandoned certain directional drilling equipment totaling $ 2.5 million and recorded a charge on our developed technology intangible asset of $ 11.4 million due to advances in technology that rendered those assets, and their related spare parts inventory, obsolete. There were no similar charges in 2022 or 2023. +We also periodically evaluate our completion services assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are abandoned. In the fourth quarter of 2021, we recorded a charge of $ 32.2 million related to the abandonment of approximately 0.2 million horsepower within our completion services fleet. The majority of these units were frac pumps but also included pump down units. These units were abandoned due to changes in customer preferences for dual fuel, advancements in technology, and prohibitive reactivation costs. There were no similar charges in 2022 or 2023. +We also periodically evaluate our drilling products assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. There have been no impairment charges recorded since the acquisition of these assets as part of the Ulterra acquisition in the third quarter of 2023. +7. Goodwill and Intangible Assets +Goodwill — We had no goodwill balance as of December 31, 2022. As a result of both the Ulterra acquisition and the NexTier merger in 2023, we recognized goodwill. Goodwill is evaluated at least annually on July 31, or more frequently when events and circumstances occur indicating recorded goodwill may be impaired. Goodwill is tested at the reporting unit level, which is at or one level below our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors, and if that is the case, any necessary goodwill impairment is determined using a quantitative impairment test. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. +We determined our drilling products operating segment consists of a single reporting unit and, accordingly, goodwill acquired from the Ulterra acquisition was allocated to that reporting unit. We determined our completion services operating segment consists of two reporting units; completion services, which is primarily comprised of our hydraulic fracturing operations and other integrated service offerings, and cementing services. +Goodwill Impairment Assessment +During the fourth quarter of 2023, our share price experienced a sustained decline which resulted in a decrease to our market capitalization. This decline in share price was deemed a triggering event that warranted a quantitative assessment for goodwill impairment for all three of our reporting units. +We estimated the fair value of the drilling products and the completion services reporting units using the income approach. Under this approach, we used a discounted cash flow model, which utilizes present values of cash flows to estimate fair value. Forecasted cash flows considered known market conditions as of December 31, 2023, and management's anticipated business outlook for each reporting +F- 22 +unit. Future cash flows were projected based on estimates of revenue, gross profit, selling, general and administrative expense, changes in working capital, and capital expenditures. The terminal period used within the discounted cash flow model for each reporting unit consisted of a 1 % growth estimate. The future cash flows were discounted using a market-participant, risk-adjusted weighted average cost of capital of 10 % for the drilling products reporting unit and 12 % for the completion services reporting unit. We estimated the fair value of the cementing services reporting unit using a market approach. The market approach was based on trading multiples of companies comparable to the cementing services reporting unit. +The forecast for the drilling products reporting unit assumes continued growth in international markets. Geopolitical instability in regions in which we expect to maintain and grow market share, a global decrease in the demand of drilling products, or other unforeseen macroeconomic considerations could negatively impact the key assumptions used in our goodwill assessment for our drilling products reporting unit. +The forecast for the completion services reporting unit assumes activity in 2024 consistent with 2023 exit levels and moderate increases in activity of 3 % to 5 % beginning in 2025 and holding flat until the terminal period, which was consistent with rig count forecasts as of December 31, 2023. A sustained decrease in oil prices and rig count could negatively affect the key assumptions used in our goodwill assessment for completion services. +Based on the results of the goodwill impairment tests, the fair values of the drilling products, completion services, and cementing services reporting units exceeded their carrying values by approximately 4 %, 11 %, and 80 %, respectively. Accordingly, no impairment was recorded for any of the reporting units. +Goodwill by operating segment as of December 31, 2022 and 2023 and changes for the years then ended are as follows (in thousands): +Completion +Drilling +Services +Products +Total +Balance, December 31, 2022 +$ +— +$ +— +$ +— +Goodwill acquired +921,656 +451,341 +1,372,997 +Measurement period adjustment +469 +6,275 +6,744 +Balance, December 31, 2023 +$ +922,125 +$ +457,616 +$ +1,379,741 +Intangible Assets — Our intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight-line basis. The following table identifies the segment and weighted average useful life of each of our intangible assets: +Weighted Average +Segment +Useful Life +(in years) +Customer relationships +Drilling Services, Completion Services and Drilling Products +11.1 +Developed technology +Drilling Services, Completion Services and Drilling Products +4.6 +Trade name +Completion Services and Drilling Products +9.7 +Other +Drilling Services and Completion Services +1.8 +During 2021, we achieved certain internal advancements in our directional drilling technology that have rendered obsolete certain technology acquired as part of the MS Directional acquisition. Accordingly, we recorded a charge of $ 11.4 million to abandon these developed technology intangibles and certain related internal use software. +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2023 and 2022 are as follows (in thousands): +2023 +2022 +Gross Carrying +Accumulated +Net Carrying +Gross Carrying +Accumulated +Net Carrying +Amount +Amortization +Amount +Amount +Amortization +Amount +Customer relationships +$ +786,715 +$ +( 25,563 +) +$ +761,152 +$ +1,800 +$ +( 1,071 +) +$ +729 +Developed technology +202,772 +( 16,435 +) +186,337 +7,772 +( 3,773 +) +3,999 +Trade name +101,000 +( 3,406 +) +97,594 +— +— +— +Other +7,345 +( 731 +) +6,614 +1,450 +( 333 +) +1,117 +Intangible assets, net +$ +1,097,832 +$ +( 46,135 +) +$ +1,051,697 +$ +11,022 +$ +( 5,177 +) +$ +5,845 +Amortization and impairment expense on intangible assets of approximately $ 41.5 million, $ 1.3 million, and $ 24.0 million was recorded for the years ended December 31, 2023, 2022 and 2021 , respectively, which included an $ 11.4 million impairment in 2021. +F- 23 +The remaining amortization expense associated with finite-lived intangible assets, excluding in-process software, is ex pected to be as follows (in thousands): +Year ending December 31, +2024 +$ +121,307 +2025 +121,039 +2026 +120,702 +2027 +120,674 +2028 +105,481 +Thereafter +456,608 +Total +$ +1,045,811 +8. Accrued Liabilities +Accrued liabilities consisted of the following at December 31, 2023 and 2022 (in thousands): +2023 +2022 +Salaries, wages, payroll taxes and benefits +$ +129,982 +$ +73,308 +Workers’ compensation liability +67,396 +67,853 +Property, sales, use and other taxes +62,194 +10,119 +Insurance, other than workers’ compensation +11,524 +3,644 +Accrued interest payable +19,172 +10,522 +Deferred revenue +98,914 +110,215 +Federal and state income taxes payable +3,437 +4,644 +Accrued merger and integration expense +15,113 +— +Other +38,536 +28,482 +Accrued liabilities +$ +446,268 +$ +308,787 +9. Long-Term Debt +Long-term debt consisted of the following at December 31, 2023 and 2022 (in thousands): +Effective Interest Rate +December 31, 2023 +December 31, 2022 +3.95 % Senior Notes Due 2028 +4.03 % +482,505 +$ +488,505 +5.15 % Senior Notes Due 2029 +5.26 % +344,895 +347,900 +7.15 % Senior Notes Due 2033 +7.28 % +400,000 +— +Equipment Loans Due 2025 +5.25 % +18,686 +— +1,246,086 +836,405 +Less deferred financing costs and discounts +( 8,919 +) +( 5,468 +) +Less current portion +( 12,226 +) +— +Total +1,224,941 +$ +830,937 +Credit Agreement — On August 29, 2023, we entered into Amendment No. 4 to Amended and Restated Credit Agreement (the “Credit Agreement Amendment”), which amended our Amended and Restated Credit Agreement, dated as of March 27, 2018 (as amended, the “Credit Agreement”), by and among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +The Credit Agreement Amendment, among other things, (i) deemed certain outstanding letters of credit issued for the account of BEP Diamond Holdings Corp. (the entity we acquired in the Ulterra acquisition) with a face amount of $ 2.5 million to have been issued under the Credit Agreement and (ii) extended the maturity date for $ 85 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026 . As a result, of the $ 600 million of revolving credit commitments under the Credit Agreement, the maturity date for $ 501.7 million of such commitments is March 27, 2026 ; the maturity date for $ 48.3 million of such commitments is March 27, 2025 ; and the maturity date for the remaining $ 50 million of such commitments is March 27, 2024 . +The Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $ 600 million, including a letter of credit facility that, at any time outstanding, is limited to $ 100 million and a swing line facility that, at any time outstanding, is limited to the lesser of $ 50 million and the amount of the swing line provider’s unused commitment. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $ 300 million, not to exceed total commitments of $ 900 million. +F- 24 +Loans under the Credit Agreement bear interest by reference, at our election, to the SOFR rate (subject to a 0.10 % per annum adjustment) or base rate, in each case subject to a 0 % floor. The applicable margin on SOFR rate loans varies from 1.00 % to 2.00 % and the applicable margin on base rate loans varies from 0.00 % to 1.00 %, in each case determined based on our credit rating. As of December 31, 2023, the applicable margin on SOFR rate loans was 1.75 % and the applicable margin on base rate loans was 0.75 %. A letter of credit fee is payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10 % to 0.30 % based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt, which does not qualify for certain limited exceptions and is otherwise, in the aggregate with all other similar debt, in excess of Priority Debt (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to grant liens and on the ability of each of our non-guarantor subsidiaries to incur debt. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would generally require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at both credit rating agencies. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50 % as of the last day of each fiscal quarter. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2023. +As of December 31, 2023, we had no borrowings outstanding under our revolving credit facility. We had $ 2.6 million in letters of credit outstanding under the Credit Agreement at December 31, 2023 and, as a result, had available borrowing capacity of approximately $ 597 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2023 , we had $ 87.7 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any of our letters of credit issued thereunder. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the LIBOR rate plus 2.25 % per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amou nts. A letter of credit fee is payable by us equal to 1.50 % times the amount of outstanding letters of credit. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +2028 Senior Notes, 2029 Senior Notes and 2033 Senior Notes —On January 19, 2018, we completed an offering of $ 525 million in aggregate principal amount of our 3.95 % Senior Notes due 2028 (the “2028 Notes”). On November 15, 2019, we completed an offering of $ 350 million in aggregate principal amount of our 5.15 % Senior Notes due 2029 (the “2029 Notes”). On September 13, 2023, we completed an offering of $ 400 million in aggregate principal amount of our 7.15 % Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses from the offering of the 2033 Notes were approximately $ 396 million, which we used to repay amounts outstanding under our revolving credit facility. +F- 25 +We pay interest on the 2028 Notes on February 1 and August 1 of each yea r. The 2028 Notes will mature on February 1, 2028 . The 2028 Notes bear interest at a rate of 3.95 % per annum. +We pay interest on the 2029 Notes on May 15 and November 15 of each year . The 2029 Notes will mature on November 15, 2029 . The 2029 Notes bear interest at a rate of 5.15 % per annum. +We pay interest on the 2033 Notes on April 1 and October 1 of each year . The 2033 Notes will mature on October 1, 2033 . The 2033 Notes bear interest at a rate of 7.15 % per annum. +The 2028 Notes, 2029 Notes and 2033 Notes (together, the “Senior Notes”) are our senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The Senior Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the Senior Notes. None of our subsidiaries are currently required to be a guarantor under the Senior Notes. If our subsidiaries guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +At our option, we may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100% of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, on August 15, 2029, in the case of the 2029 Notes, and on July 1, 2033, in the case of the 2033 Notes, at our option, we may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100 % of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the applicable redemption date. +The indentures pursuant to which the Senior Notes were issued include covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indentures. +Upon the occurrence of a change of control triggering event, as defined in the indentures, each holder of the Senior Notes may require us to purchase all or a portion of such holder’s Senior Notes at a price equal to 101 % of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the applicable repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +Equipment Loans — As part of the NexTier merger, we assumed the obligations of NexTier Completions Solutions Inc. (“NCS”) under a Master Loan and Security Agreement (as amended, the “Master Agreement”) with Caterpillar Financial Services Corporation. The Master Agreement allows NCS to enter into secured equipment financing term loans from time to time (the “Equipment Loans”). The Equipment Loans may be drawn in multiple tranches, with each loan evidenced by a separate promissory note. The Master Agreement and the Equipment Loans contain customary affirmative and negative covenants, including limitations on further encumbrance of the collateral other than the applicable loans under the Master Agreement. We were in compliance with these covenants at December 31, 2023 . The Equipment Loans bear interest at a rate of 5.25 % per annum, and we pay interest on the 1 st of each month. The Equipment Loans will mature on June 1, 2025 . +Drilling Products Letters of Credit — As part of the Ulterra merger, we assumed letters of credit of $ 2.5 million outstanding with financial institutions providing for short-term borrowing capacity, overdraft protection and bonding requirements. We maintain these letters of credit primarily for compliance with contractual obligations. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2023, no amounts had been drawn under the letters of credit. +F- 26 +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2023 (in thousands): +Year ending December 31, +2024 +$ +12,290 +2025 +6,396 +2026 +— +2027 +— +2028 +482,505 +2029 +344,895 +Thereafter +400,000 +Total +$ +1,246,086 +10. Commitments, Contingencies and Other Matters +Commitments – As of December 31, 2023 , we maintained letters of credit in the aggregate amount of $ 92.4 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses that could become payable under the terms of the underlying insurance contracts and compliance with contractual obligations. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2023, no amounts had been drawn under the letters of credit. +As of December 31, 2023 , we had commitments to purchase major equipment totaling approximately $ 153 million. +Our completion services segment has entered into agreements to purchase minimum quantities of proppants from certain vendors. We purchased $ 135 million, $ 93.0 million and $ 66.9 million of proppants under take-or-pay or similar agreements during the years ended December 31, 2023, 2022 and 2021, respectively. As of December 31, 2023 , the remaining minimum obligation under these agreements was approximately $ 39.7 million, of which approximately $ 33.7 million, $ 4.0 million and $ 2.0 million relate to the remainder of 2024, 2025 and 2026, respectively. +Contingencies – Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, unplanned power outages and surges, computer system disruptions or cybersecurity incidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. The insurances that we maintain include coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation as well as insurance for other specific risks. We cannot assure that any insurance obtained by us will be adequate to cover any losses or liabilities nor can we assure that any insurance obtained by us will continue to be made available for purchase or made available on acceptable terms. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some cases to retain a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $ 1.5 +F- 27 +million per occurrence deductible on our workers’ compensation insurance coverage, a $ 1.0 million per occurrence deductible on our equipment insurance coverage, a $ 10.0 million per occurrence deductible on our general liability coverage, and, for our automobile insurance coverage, a per occurrence deductible ranging from $ 2.0 million to $ 10.0 million. We also self-insure a number of risks, including loss of earnings and business interruption and most cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +We are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows or results of operations. +Other Matters — We have a Change in Control Agreement with one of our Executive Vice Presidents (the “Specified Employee”). The Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless we notify the Specified Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control occurs during the term of the agreement and the Specified Employee’s employment is terminated (i) by us other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Specified Employee for good reason (as those terms are defined in the Change in Control Agreement), then the Specified Employee shall generally be entitled to, among other things: +• +a bonus payment equal to the highest bonus paid after the Change in Control Agreement was entered into (such bonus payment prorated for the portion of the fiscal year preceding the termination date); +• +a payment equal to 2 times the sum of (i) the highest annual salary in effect for such Specified Employee and (ii) the average of the three annual bonuses earned by the Specified Employee for the three fiscal years preceding the termination date and +• +continued coverage under our welfare plans for up to two years . +The Change in Control Agreement provides the Specified Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment. +We have Employment Agreements with our Chief Executive Officer, Chief Financial Officer, Chief Business Officer and General Counsel. Each Employment Agreement generally has an initial three-year term, subject to automatic annual renewal. The executive may terminate his employment under his Employment Agreement by providing written notice of such termination at least 30 days before the effective date of such termination. Under specified circumstances, we may terminate the executive’s employment under his Employment Agreement for Cause (as defined in the Employment Agreement) by providing written notice 10 - 30 days, depending on the nature of the cause trigger, before the effective date of such termination and granting at least 10 - 20 days, depending on the nature of the cause trigger, to cure the cause for such termination or (ii) by providing written notice of such termination at least 30 days before the effective date of such termination and by granting at least 20 days to cure the cause for such termination, provided that if the matter is reasonably determined by us to not be capable of being cured, the executive may be terminated for cause on the date the written notice is delivered. The Employment Agreement also provides for, among other things, severance payments and the continuation of certain benefits following our decision to terminate the executive other than for Cause, or termination by the executive for Good Reason (as defined in each Employment Agreement). Under these provisions, if the executive’s employment is terminated by us without Cause, or the executive terminates his employment for Good Reason: +• +the executive will have the right to receive a lump-sum payment consisting of 3 times (in the case of the Chief Executive Officer) or 2.5 times (in the case of the Chief Financial Officer, Chief Business Officer and General Counsel) the sum of (i) his base salary and (ii) the average annual cash bonus received by him for the three years prior to the date of termination; +• +the executive will have the right to receive a pro-rated lump-sum payment equal to his annual cash bonus based on actual results for the year, payable at the same time as annual cash bonuses are paid to active employees; +• +we will accelerate vesting of all time-based equity, phantom equity and long-term cash incentive awards on the 60th day following the executive’s termination and will cause all performance-based equity, phantom equity and long-term cash incentive awards to continue in effect through the end of the applicable performance period and vest based on actual results as if the executive had remained employed through the end of the applicable performance period; and +• +we will pay the executive certain accrued obligations and certain obligations pursuant to the terms of employee benefit plans. +If our decision to terminate other than for Cause or by the executive for Good Reason occurs following a Change in Control (as defined in his Employment Agreement, the executive will generally be entitled to the same severance payments and benefits described above except that the pro-rated lump-sum payment for annual cash bonuses will be based on his highest annual cash bonus for the last three years , and the executive will be entitled to 36 months (in the case of the Chief Executive Officer) or 30 months (in the case of the Chief Financial Officer, Chief Business Officer and General Counsel) of subsidized benefits continuation coverage. +F- 28 +Additionally, our Chief Business Officer is party to a letter agreement with us, which was entered into in connection with the closing of the NexTier merger. The letter agreement provides that, following the one-year anniversary of the closing of the NexTier merger, our Chief Business Officer will not have Good Reason (as defined in his Employment Agreement) to terminate his employment with us due to the transition of his role in connection with the NexTier merger and any resulting changes in his authority, duties or responsibilities. The letter agreement also provides a $ 2 million cash retention bonus, payable in eight quarterly installments following the closing of the NexTier merger, subject to our Chief Business Officer’s continued employment in good standing with us on each applicable payment date. Any unpaid portions of the retention bonus will become payable if our Chief Business Officer’s employment is terminated by us without cause or by our Chief Business Officer for Good Reason (unless, within six months of the closing of the NexTier merger, our Chief Business Officer resigns for Good Reason as a result of the transition of his role, in which case the full amount of the retention bonus will be forfeited with any previously paid portions offset against any severance amounts payable to our Chief Business Officer). +11. Stockholders’ Equity +Cash Dividend — On February 14, 2024 , our Board of Directors approved a cash dividend on our common stock in the amount of $ 0.08 per share to be paid on March 15, 2024 to holders of record as of March 1, 2024 . The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +Share Repurchases and Acquisitions — In September 2013, our Board of Directors approved a stock buyback program. In April 2023, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $ 300 million of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the buyback program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2023 , we had remaining authorization to purchase approximately $ 206 million of our outstanding common stock under the stock buyback program. In February 2024, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $ 1 billion of future share repurchases. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2023, 2022 and 2021 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”) and the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), the NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan and the NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan, and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2023, 2022 and 2021 were as follows (dollars in thousands): +2023 +2022 +2021 +Shares +Cost +Shares +Cost +Shares +Cost +Treasury shares at beginning of period +88,758,722 +$ +1,453,079 +84,128,995 +$ +1,372,641 +83,402,322 +$ +1,366,313 +Purchases pursuant to stock buyback program +14,086,229 +168,631 +3,254,599 +57,173 +— +— +Acquisitions pursuant to long-term incentive plan +2,735,060 +35,965 +1,372,101 +23,237 +451,196 +3,727 +Purchases in connection with Pioneer acquisition +— +— +— +— +275,477 +2,601 +Other +— +— +3,027 +28 +— +— +Treasury shares at end of period +105,580,011 +$ +1,657,675 +88,758,722 +$ +1,453,079 +84,128,995 +$ +1,372,641 +Release of Cumulative Translation Adjustment — In April 2022, we sold certain assets to substantially complete our exit from our Canadian operations. We used the Canadian dollar as our functional currency for our Canadian operations. Prior to the substantial completion of our exit, the effects of exchange rate changes were reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. Upon substantial completion of our exit, we released the $ 7.7 million cumulative translation adjustment, net of tax of $ 3.8 million, from accumulated other comprehensive income into net income (loss) in the second quarter of 2022. The release resulted in an $ 11.5 million pre-tax gain, which was recorded in other operating income, net. +F- 29 +12. Stock-based Compensation +We use share-based payments to compensate employees and non-employee directors. We recognize the cost of share-based payments under the fair-value-based method. Share-based awards include equity instruments in the form of stock options or restricted stock units that have included service conditions and, in certain cases, performance conditions. Our share-based awards also include share-settled performance unit awards. Share-settled performance unit awards are accounted for as equity awards. We issue shares of common stock when vested stock options are exercised and after restricted stock units and share-settled performance unit awards vest. +The 2021 Plan was originally approved by our stockholders on June 3, 2021. Subject to stockholder approval, our Board of Directors approved an amendment to the 2021 Plan to increase the number of shares available for issuance under the 2021 Plan by 5.445 million shares (the “First Amendment”). On June 8, 2023, our stockholders approved the First Amendment. On September 1, 2023, in connection with the NexTier merger, our Board of Directors approved a second amendment to the 2021 Plan (the “Second Amendment,” and together with the First Amendment, the “2021 Plan Amendments”) to assume approximately 10 million shares previously reserved for issuance under the NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan (the “NexTier Plan”). Following the 2021 Plan Amendments, the aggregate number of shares of Common Stock authorized for grant under the 2021 Plan is approximately 29.0 million. +On September 1, 2023, the Board of Directors also approved amendments to the NexTier Plan and the NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan (the “Former C&J Energy Plan” and, together with the NexTier Plan, the “Assumed Plans”) to assume awards that were previously granted under the Assumed Plans (consisting of stock options, time- and performance-based restricted stock units and cash-settled performance unit awards), which, in connection with the NexTier merger, were converted into equity awards in respect of shares of Patterson-UTI Energy, Inc. common stock. +The aggregate number of shares of Common Stock authorized for grant under the 2021 Plan is approximately 29.0 million, which includes approximately 4.9 million shares previously authorized for issuance under our 2014 Plan and approximately 10 million shares assumed from the NexTier merger. +Our share-based compensation plans at December 31, 2023 are as follows: +Shares +Shares Underlying +Shares +Authorized +Awards +Available +Plan Name +for Grant +Outstanding +for Grant +2021 Plan +28,963,412 +5,004,289 +13,910,294 +NexTier Plan +— +2,660,633 +— +Former C&J Energy Plan +— +789,337 +— +2014 Plan +— +2,571,965 +— +A summary of the 2021 Plan follows: +• +The Compensation Committee of the Board of Directors administers the 2021 Plan other than the awards to directors. +• +All employees, officers and directors are eligible for awards. +• +The Compensation Committee determines the vesting schedule for awards. Awards typically vest over one year for non-employee directors and three years for employees. +• +The Compensation Committee sets the term of awards and no option term can exceed 10 years. +• +The 2021 Plan provides that the total compensation paid to each non-employee director for their service as such, whether in cash or in equity awards under the 2021 Plan (based on the grant date fair value of any such awards) during a single fiscal year may not exceed $ 750,000 ; however, the foregoing limit will instead be $ 1,000,000 for any fiscal year in which the non-employee director is first appointed to the Board of Directors or any fiscal year in which the non-employee director serves as chairman or lead director. +• +All options granted under the 2021 Plan are granted with an exercise price equal to or greater than fair market value of our common stock at the time the option is granted. +• +The 2021 Plan provides for awards of incentive and non-incentive stock options, stock appreciation rights (“SARs”), restricted stock awards, other stock unit awards, performance share awards, performance unit awards and dividend equivalent rights. +Options granted under the 2014 Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. +F- 30 +Stock Options — We estimate the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of our common stock over the most recent period equal to the expected term of the options as of the date such options are granted. The expected term assumptions are based on our experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the years ended December 31, 2023, 2022 and 2021. +Stock option activity for the year ended December 31, 2023 follows: +Weighted Average +Shares +Exercise Price Per Share +Outstanding at beginning of year +2,905,150 +$ +22.19 +Assumed (1) +652,573 +$ +27.97 +Exercised +— +$ +— +Expired +( 692,500 +) +$ +22.82 +Outstanding at end of year +2,865,223 +$ +23.36 +Exercisable at end of year +2,865,223 +$ +23.36 +(1) +Awards assumed in connection with the NexTier merger. All of these assumed awards had been previously granted by NexTier under the NexTier Plan or the Former C&J Energy Plan, in periods prior to the NexTier merger. +Options outstanding and exercisable at December 31, 2023 have no intrinsic value and a weighted-average remaining contractual term of 1.69 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2023, 2022 and 2021 follows (in thousands, except per share data): +2023 +2022 +2021 +Weighted-average grant date fair value of stock options granted (per share) +NA +NA +NA +Aggregate grant date fair value of stock options vested during the year +$ +— +$ +— +$ +89 +Aggregate intrinsic value of stock options exercised +$ +— +$ +410 +$ +— +As of December 31, 2023 , no options to purchase shares were outstanding and unvested. +Restricted Stock Units (Equity Based) — For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Forfeitable dividend equivalents are accrued on certain restricted stock units that will be paid upon vesting. We use the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2023 follows: +Weighted Average +Time +Performance +Grant Date Fair +Based +Based +Value Per Share +Non-vested restricted stock units outstanding at beginning of year +3,090,846 +359,315 +$ +12.71 +Granted +1,840,861 +165,276 +$ +11.60 +Assumed (1) +7,438,031 +— +$ +5.62 +Vested +( 6,379,970 +) +— +$ +5.95 +Forfeited +( 162,100 +) +( 3,058 +) +$ +13.78 +Non-vested restricted stock units outstanding at end of year +5,827,668 +521,533 +$ +10.60 +(1) +Awards assumed in connection with the NexTier merger. All of these assumed awards had been previously granted by NexTier under the NexTier Plan or the Former C&J Energy Plan, in periods prior to the NexTier merger. +As of December 31, 2023 , approximately 6.1 million non-vested restricted stock units outstanding are expected to vest. Additional information as of December 31, 2023 with respect to these non-vested restricted stock units follows (dollars in thousands): +Aggregate intrinsic value +$ +65,937 +Weighted-average remaining vesting period +1.63 years +Unrecognized compensation cost +$ +51,434 +F- 31 +Restricted Stock Units (Liability Based) — We converted NexTier’s cash-settled performance based units into our cash-settled restricted stock units in connection with the NexTier merger. These awards are accounted for as liability classified awards and remeasured at fair value at each reporting period. Compensation expense is recorded over the vesting period and is initially based on the fair value at the award conversion date. Compensation expense is subsequently remeasured at each reporting date during the vesting period based on the change in our stock price. Dividend cash equivalents are not paid on cash-settled units. As of December 31, 2023, $ 2.4 and $ 6.2 million are included in “Accrued Liabilities” and “Other Liabilities” in our consolidated balance sheets, respectively. We recognized $ 5.0 million of compensation expense for these awards during the year ended December 31, 2023. +Performance Unit Awards — We have granted share-settled performance unit awards to certain employees (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive shares of common stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is generally the three-year period commencing on April 1 of the year of grant. +The performance goals for the Performance Units are tied to our total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. For the performance units granted in April 2021 and April 2022, the peer group includes three market indices and one market index, respectively. The performance goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. The recipients will receive the target number of shares if our total shareholder return during the performance period, when compared to the peer group, is at the 55th percentile. If our total shareholder return during the performance period, when compared to the peer group, is at the 75th percentile or higher, then the recipients will receive two times the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is at the 25th percentile, then the recipients will only receive one-half of the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is between the 25th and 55th percentile, or the 55th and 75th percentile, then the shares to be received by the recipients will be determined using linear interpolation for levels of achievement between these points. The payout under the Performance Units may not exceed the target number of shares if our absolute total shareholder return is negative or zero. +The total target number of shares granted with respect to the Performance Units for the years 2018-2023 is set forth below: +2023 +2022 +2021 +2020 +2019 +2018 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Target number of shares +631,700 +414,000 +843,000 +500,500 +489,800 +310,700 +In April 2021, 621,400 shares were issued to settle the 2018 Performance Units. In April 2022, 979,600 shares were issued to settle the 2019 Performance Units. In May 2023, 1,001,000 shares were issued to settle the 2020 Performance Units. The Performance Units granted in 2021, 2022 and 2023 have not reached the end of their respective performance periods. +Because the Performance Units are share-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +2023 +2022 +2021 +2020 +2019 +2018 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Aggregate fair value at date of grant +$ +8,440 +$ +10,743 +$ +7,225 +$ +826 +$ +9,958 +$ +8,004 +The weighted-average fair value calculations for performance units granted during the years ended December 31, 2023, 2022 and 2021 were based on the following weighted-average assumptions set forth below: +2023 +2022 +2021 +Risk-free interest rate (1) +3.6 +% +2.9 +% +0.4 +% +Expected stock volatility (2) +72.1 +% +86.5 +% +83.2 +% +Expected dividend yield (3) +3.0 +% +1.0 +% +1.3 +% +Expected term (in years) +3 +3 +3 +(1) +The risk-free interest rate is based on U.S. Treasury securities for the expected term of the performance units. +(2) +Expected volatilities are based on the daily closing price of our stock based upon historical experience over a three-year period . +(3) +Expected dividend yield is based on the annualized dividend in effect on the measurement date and the stock price on the grant date. +F- 32 +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2023 +2022 +2021 +2020 +2019 +2018 +Performance +Performance +Performance +Performance +Performance +Performance +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Unit Awards +Year ended December 31, 2023 +$ +2,248 +$ +3,749 +$ +2,426 +$ +69 +NA +NA +Year ended December 31, 2022 +NA +$ +2,686 +$ +2,408 +$ +275 +$ +830 +NA +Year ended December 31, 2021 +NA +NA +$ +1,806 +$ +275 +$ +3,319 +$ +667 +As of December 31, 2023 , we had unrecognized compensation cost of $ 11.1 million related to our unvested Performance Units. The weighted-average remaining vesting period for these unvested Performance Units was 1.13 years as of December 31, 2023. +Dividends on Equity Awards – Dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +Phantom Units — In May 2020, the Compensation Committee approved a grant of long-term performance-based phantom units to our Chief Executive Officer and President, William A. Hendricks, Jr. (the “Phantom Units”). The Phantom Units were granted outside of the 2014 Plan. Pursuant to this phantom unit grant, Mr. Hendricks could earn from 0 % to 200 % of a target award of 298,500 phantom units based on our achievement of the same performance conditions over the same performance period that applied to the Performance Units granted in April 2020. The Phantom Units settled in May 2023, with a cash payment of $ 7.4 million. +13. Leases +ASC Topic 842 Leases +We acquired $ 7.5 million and $ 19.1 million of operating leases for operating locations, corporate offices, certain operating equipment and light duty vehicles primarily related to the Ulterra acquisition and NexTier merger, respectively. +We acquired $ 5.2 million and $ 50.7 million of finance leases for light duty vehicles and certain operating equipment related to the Ulterra acquisition and NexTier merger, respectively. +Operating leases have remaining lease terms of approximately one month to ten years as of December 31, 2023, and finance leases have remaining lease terms of approximately one month to six years as of December 31, 2023. +Lease expense consisted of the following for the years ended December 31, 2023, 2022 and 2021 (in thousands): +Year Ended December 31, +2023 +2022 +2021 +Operating lease cost +$ +10,073 +$ +5,664 +$ +4,984 +Finance lease cost: +Amortization of right-of-use assets +6,360 +— +— +Interest on lease liabilities +1,395 +— +— +Total finance lease cost +7,755 +— +— +Short-term lease expense (1) +2,278 +— +41 +Total lease expense (2) +$ +20,106 +$ +5,664 +$ +5,025 +(1) +Short-term lease expense represents expense related to leases with a contract term of one year or less. +(2) +Total lease expense is recorded in operating costs for the respective segments and within “ selling, general and administrative ” in our consolidated statements of operations. +F- 33 +Supplemental cash flow information related to leases for the years ended December 31, 2023, 2022 and 2021 is as follows (in thousands): +Year Ended December 31, +2023 +2022 +2021 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ +8,935 +$ +6,858 +$ +7,323 +Operating cash flows from finance leases +1,380 +— +— +Financing cash flows from finance leases +15,915 +— +— +Right of use assets obtained in exchange for lease obligations: +Operating leases (1) +$ +34,802 +$ +6,530 +$ +6,413 +Finance leases (1) +73,245 +— +— +(1) +Includes right of use assets acquired in business combinations. +Supplemental balance sheet information related to leases as of December 31, 2023 and 2022 is as follows: +December 31, 2023 +December 31, 2022 +Weighted Average Remaining Lease Term: +Operating leases +5.0 years +6.1 years +Finance leases +1.5 years +N/A +Weighted Average Discount Rate: +Operating leases +6.1 +% +4.1 +% +Finance leases +7.3 +% +N/A +Maturities of operating and finance lease liabilities as of December 31, 2023 are as follows (in thousands): +Year ending December 31, +Operating +Finance +2024 +$ +16,435 +$ +46,297 +2025 +12,975 +4,842 +2026 +9,387 +4,850 +2027 +7,130 +1,485 +2028 +4,975 +1,485 +Thereafter +9,354 +2,080 +Total lease payments +60,256 +61,039 +Less imputed interest +( 8,867 +) +( 4,106 +) +Total +$ +51,389 +$ +56,933 +14. Income Taxes +Income before income taxes for the United States for the year ended December 31, 2023 was $ 315 million. Income before income taxes for the United States for the year ended December 31, 2022 was $ 166 million. Loss before income taxes for the United States for the year ended December 31, 2021 was $ 721 million. Loss before income taxes for non-U.S. jurisdictions for the year ended December 31, 2023 was $ 8.8 million. Income before income taxes for non-U.S. jurisdictions for the years ended December 31, 2022 and 2021 was $ 2 million and $ 0.9 million, respectively. +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2023, 2022 and 2021 are as follows (in thousands): +2023 +2022 +2021 +Federal income tax expense (benefit): +Current +$ +— +$ +480 +$ +— +Deferred +44,369 +11,820 +( 86,878 +) +44,369 +12,300 +( 86,878 +) +State income tax expense (benefit): +Current +7,002 +2,647 +144 +Deferred +11,279 +( 4,896 +) +23,028 +18,281 +( 2,249 +) +23,172 +F- 34 +Foreign income tax expense (benefit): +Current +1,578 +2,750 +134 +Deferred +( 3,076 +) +403 +870 +( 1,498 +) +3,153 +1,004 +Total income tax expense (benefit): +Current +8,580 +5,877 +278 +Deferred +52,572 +7,327 +( 62,980 +) +Total income tax expense (benefit) +$ +61,152 +$ +13,204 +$ +( 62,702 +) +The difference between the statutory U.S. federal income tax rate and the effective income tax rate for the years ended December 31, 2023, 2022 and 2021 is summarized as follows: +2023 +2022 +2021 +Statutory tax rate +21.0 +% +21.0 +% +21.0 +% +State income taxes - net of the federal income tax benefit +3.2 +3.0 +3.0 +State deferred tax remeasurement +( 0.3 +) +9.4 +( 0.8 +) +Valuation allowance +( 9.2 +) +( 33.4 +) +( 13.3 +) +U.S. impact of foreign operations +— +1.3 +— +Acquisition related costs +1.1 +— +— +Effect of foreign taxes +0.1 +1.6 +( 0.1 +) +Non-deductible compensation +1.8 +4.3 +( 0.3 +) +Share-based compensation +1.6 +( 1.9 +) +( 0.3 +) +Non-deductible expenses +0.7 +1.2 +( 0.2 +) +Other differences, net +( 0.1 +) +1.4 +( 0.3 +) +Effective tax rate +19.9 +% +7.9 +% +8.7 +% +Our effective income tax rate fluctuates based on, among other factors, changes in pre-tax income in countries with varying statutory tax rates, changes in valuation allowances, and the impacts of various other permanent adjustments. +The ability to recognize a portion of our U.S. federal and state net operating losses resulted in a significant impact, through changes in valuation allowances, in our effective tax rate for the year ended December 31, 2023. This benefit was partly offset by state and local income taxes and various other permanent adjustments. +The tax effect of temporary differences and tax attributes representing deferred tax assets and liabilities at December 31, 2023 and 2022 are as follows (in thousands): +2023 +2022 +Deferred tax assets: +Net operating loss carryforwards +$ +498,948 +$ +382,936 +Tax credits +13,488 +4,222 +Expense associated with stock options and restricted stock +10,892 +8,178 +Workers’ compensation allowance +7,024 +15,770 +Other deferred tax asset +69,480 +25,020 +599,832 +436,126 +Less: +Allowance to reduce deferred tax asset to expected realizable value +( 75,250 +) +( 91,685 +) +Total deferred tax assets +524,582 +344,441 +Deferred tax liabilities: +Property and equipment basis difference +( 729,376 +) +( 355,129 +) +Other +( 39,386 +) +( 14,840 +) +Total deferred tax liabilities +( 768,762 +) +( 369,969 +) +Net deferred tax liability +$ +( 244,180 +) +$ +( 25,528 +) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and when necessary, valuation allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We assess the realizability of our deferred tax assets quarterly and consider carryback availability, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. During 2023, we reduced the valuation allowance against our net deferred tax assets by $ 16.4 million, which primarily related to U.S. federal and state activity. +F- 35 +For income tax purposes, we had approximately $ 1.9 billion of gross U.S. federal net operating losses, approximately $ 62.3 million of gross Canadian net operating losses, approximately $ 22.6 million of gross Colombian net operating losses and approximately $ 1.1 billion of post-apportionment U.S. state net operating losses as of December 31, 2023, before valuation allowances. The majority of U.S. federal net operating losses will expire in varying amounts, if unused, between 2030 and 2037 . U.S. federal net operating losses generated after 2017 can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2043 . Colombian net operating losses will expire in varying amounts, if unused, between 2028 and 2032 . U.S. state net operating losses will expire in varying amounts, if unused, between 2024 and 2043 . +As of December 31, 2023, we have not recognized any liabilities associated with unrecognized tax benefits. We have established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2023, the tax years ended December 31, 2010 through December 31, 2022 are open for examination by U.S. taxing authorities. As of December 31, 2023, the tax years ended December 31, 2015 through December 31, 2022 are open for examination by Canadian taxing authorities. As of December 31, 2023, the tax years ended December 31, 2017 through December 31, 2022 are open for examination by Colombian taxing authorities. +We continue to monitor income tax developments, including OECD Pillar 2 legislation, in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +15. Earnings Per Share +We provide a dual presentation of our net income (loss) per common share in our consolidated statements of operations: basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options and non-vested performance units and restricted stock units. The dilutive effect of stock options, non-vested performance units and non-vested restricted stock units is determined using the treasury stock method. +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2023, 2022 and 2021, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2023 +2022 +2021 +BASIC EPS: +Net income (loss) from continuing operations attributed to common stockholders +$ +246,292 +$ +154,658 +$ +( 657,079 +) +Net income from discontinued operations attributed to common stockholders +$ +— +$ +— +$ +2,534 +Net income (loss) attributed to common stockholders +$ +246,292 +$ +154,658 +$ +( 654,545 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +279,501 +215,935 +195,021 +Basic income (loss) from continuing operations per common share +$ +0.88 +$ +0.72 +$ +( 3.37 +) +Basic income from discontinued operations per common share +$ +— +$ +— +$ +0.01 +Basic net income (loss) per common share +$ +0.88 +$ +0.72 +$ +( 3.36 +) +DILUTED EPS: +Net income (loss) from continuing operations attributed to common stockholders +$ +246,292 +$ +154,658 +$ +( 657,079 +) +Net income from discontinued operations attributed to common stockholders +$ +— +$ +— +$ +2,534 +Net income (loss) attributed to common stockholders +$ +246,292 +$ +154,658 +$ +( 654,545 +) +Weighted average number of common shares outstanding, excluding +non-vested shares of restricted stock +280,061 +219,496 +195,021 +Diluted income (loss) from continuing operations per common share +$ +0.88 +$ +0.70 +$ +( 3.37 +) +Diluted income from discontinued operations per common share +$ +— +$ +— +$ +0.01 +Diluted net income (loss) per common share +$ +0.88 +$ +0.70 +$ +( 3.36 +) +Potentially dilutive securities excluded as anti-dilutive +9,214 +3,541 +9,551 +F- 36 +16. Employee Benefits +We maintain a 401(k) plan for all eligible employees. Our operating results include expenses of approximately $ 18.7 million in 2023 , $ 11.0 million in 2022 and $ 7.6 million in 2021 for our contributions to the plan. +17. Business Segments +Effective as of the third quarter of 2023, we revised our reportable segments to align with certain changes in how our CODM manages and allocates resources to our business as a result of the Ulterra acquisition and NexTier merger. Accordingly, we now have the following reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. As a result of the revised reportable segment structure, we have restated the corresponding items of segment information for all periods presented. +Drilling Services — represents our contract drilling, directional drilling, oilfield technology and electrical controls and automation businesses. +Completion Services — represents the combination of our well completion business, which includes hydraulic fracturing, wireline and pumping, completion support, cementing and our legacy pressure pumping business. +Drilling Products — represents our manufacturing and distribution of drill bits business, which was acquired with our acquisition of Ulterra on August 14, 2023. +Property and equipment, net and revenue for our domestic and international operations for the years ended December 31, 2023, 2022 and 2021 are as follows (in thousands): +Year Ended December 31, +2023 +2022 +2021 +Property and equipment, net: +United States +$ +3,257,937 +$ +2,213,242 +$ +2,292,448 +Colombia +48,434 +47,334 +39,307 +International (Excluding Colombia) +34,041 +— +— +Property and equipment, net +$ +3,340,412 +$ +2,260,576 +$ +2,331,755 +Revenue: +United States +$ +4,057,212 +$ +2,577,471 +$ +1,341,330 +Colombia +50,692 +70,121 +15,751 +International (Excluding Colombia) +38,552 +— +— +Total revenues +$ +4,146,456 +$ +2,647,592 +$ +1,357,081 +Major Customer — During 2023 , one customer accounted for approximately $ 588 million or 14 % of our consolidated operating revenues. These revenues were earned in the drilling services, completion services, and drilling products businesses. During 2022, one customer accounted for approximately $ 476 million or 18 % of our consolidated operating revenues. These revenues were earned in both drilling services and completion services businesses. During 2021, one customer accounted for approximately $ 216 million or 16 % of our consolidated operating revenues. These revenues were earned in both drilling services and completion services businesses. +The following tables summarize selected financial information relating to our business segments (in thousands): +F- 37 +Year Ended December 31, +2023 +2022 +2021 +Revenues: +Drilling Services +$ +1,976,401 +$ +1,581,380 +$ +805,295 +Completion Services +2,017,440 +1,022,413 +523,756 +Drilling Products +134,679 +— +— +Other (1) +79,058 +81,966 +49,703 +Elimination of intercompany revenues - Drilling Services (2) +( 56,642 +) +( 36,560 +) +( 21,077 +) +Elimination of intercompany revenues - Other (2) +( 4,480 +) +( 1,607 +) +( 596 +) +Total revenues +$ +4,146,456 +$ +2,647,592 +$ +1,357,081 +Segment operating income (loss) (3) and reconciliation to income (loss) before income taxes: +Drilling Services +$ +422,002 +$ +149,807 +$ +( 465,053 +) +Completion Services +140,220 +134,103 +( 118,863 +) +Drilling Products +( 6,501 +) +— +— +Total segment operating income (loss) (3) +555,721 +283,910 +( 583,916 +) +Other +2,829 +13,776 +( 3,182 +) +Corporate +( 205,754 +) +( 86,655 +) +( 92,152 +) +Credit loss expense +( 842 +) +— +1,500 +Interest income +6,122 +360 +222 +Interest expense +( 52,870 +) +( 40,256 +) +( 41,978 +) +Other +1,898 +( 3,273 +) +( 275 +) +Income (loss) before income taxes +$ +307,104 +$ +167,862 +$ +( 719,781 +) +Depreciation, depletion, amortization and impairment: +Drilling Services +$ +364,312 +$ +354,116 +$ +660,402 +Completion Services +283,230 +98,162 +159,305 +Drilling Products +48,467 +— +— +Other +28,237 +26,496 +23,612 +Corporate +7,170 +5,171 +5,859 +Total depreciation, depletion, amortization and impairment +$ +731,416 +$ +483,945 +$ +849,178 +Capital expenditures: +Drilling Services +$ +334,780 +$ +272,521 +$ +118,496 +Completion Services +214,746 +137,935 +34,676 +Drilling Products +24,572 +— +— +Other +24,645 +25,215 +11,627 +Corporate +16,947 +1,126 +1,521 +Total capital expenditures +$ +615,690 +$ +436,797 +$ +166,320 +Identifiable assets: +Drilling Services +$ +2,368,604 +$ +2,348,177 +$ +2,279,952 +Completion Services +3,835,699 +541,975 +458,202 +Drilling Products +1,011,870 +— +— +Other +59,221 +64,018 +62,766 +Corporate (4) +144,637 +189,653 +156,928 +Total assets +$ +7,420,031 +$ +3,143,823 +$ +2,957,848 +(1) +Other includes our oilfield rentals business and oil and natural gas working interests . +(2) +Intercompany revenues consist of revenues from drilling services provided to our other operations, and revenues from other operations for services provided to drilling services, completion services and within other operations. These revenues are generally based on estimated external selling prices and are eliminated during consolidation . +(3) +Segment operating income (loss) is our measure of segment profitability. It is defined as revenue less operating expenses, selling, general and administrative e xpenses, depreciation, amortization and impairment expenses and other operating income (loss). +(4) +Corporate assets primarily include cash on hand and certain property and equipment . +F- 38 +18. Fair Values of Financial Instruments +The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of our outstanding debt balances as of December 31, 2023 and 2022 is set forth below (in thousands): +December 31, 2023 +December 31, 2022 +Carrying +Fair +Carrying +Fair +Value +Value +Value +Value +3.95% Senior Notes Due 2028 +$ +482,505 +$ +450,540 +$ +488,505 +$ +431,556 +5.15% Senior Notes Due 2029 +344,895 +329,032 +347,900 +313,164 +7.15% Senior Notes Due 2033 +400,000 +424,946 +— +— +Equipment Loans Due 2025 +18,686 +18,766 +— +— +Total debt +$ +1,246,086 +$ +1,223,284 +$ +836,405 +$ +744,720 +The fair values of the 2028 Notes, the 2029 Notes and the 2033 Notes at December 31, 2023 and December 31, 2022 are based on quoted market prices, which are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. The fair value of the Equipment Loans is based on 5.25 %, which is considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting. The fair values of the 2028 Notes implied a 5.79 % market rate of interest at December 31, 2023 and a 6.69 % market rate of interest at December 31, 2022, based on their quoted market prices. The fair values of the 2029 Notes implied a 6.10 % market rate of interest at December 31, 2023 and a 7.01 % market rate of interest at December 31, 2022, based on their quoted market prices. The fair values of the 2033 Notes implied a 6.28 % market rate of interest at December 31, 2023, based on their quoted market price. The fair value of the Equipment Loans implied a 5.36 % market rate of interest at December 31, 2023, based on their benchmark yield. +F- 39 +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +S CHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Additions and adjustments +Beginning +Charged to Costs +Charged to +Ending +Description +Balance +and Expenses +Other Accounts +Deductions +Balance +(In thousands) +Year Ended December 31, 2023 +Allowance for credit losses +$ +2,875 +$ +842 +$ +43 +$ +( 270 +) +(1) +$ +3,490 +Deferred tax valuation allowance +91,685 +— +13,677 +( 30,112 +) +75,250 +Year Ended December 31, 2022 +Allowance for credit losses +$ +8,493 +$ +— +$ +— +$ +( 5,618 +) +(1) +$ +2,875 +Deferred tax valuation allowance +189,737 +— +— +( 98,052 +) +91,685 +Year Ended December 31, 2021 +Allowance for credit losses +$ +10,842 +$ +( 1,500 +) +$ +— +$ +( 849 +) +(1) +$ +8,493 +Deferred tax valuation allowance +19,133 +95,732 +95,393 +( 20,521 +) +189,737 +(1) +Consists of uncollectible accounts written-off. +S- 1 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: +/s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 27, 2024 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 27, 2024. +Signature +Title +/s/ Curtis W. Huff +Chairman of the Board +Curtis W. Huff +/s/ Robert W. Drummond +Vice Chairman of the Board +Robert W. Drummond +/s/ William Andrew Hendricks, Jr. +President, Chief Executive Officer +William Andrew Hendricks, Jr. +and Director +(Principal Executive Officer) +/s/ C. Andrew Smith +Executive Vice President and +C. Andrew Smith +Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Leslie A. Beyer +Director +Leslie A. Beyer +/s/ Tiffany Thom Cepak +Director +Tiffany Thom Cepak +/s/ Gary M. Halverson +Director +Gary M. Halverson +/s/ Cesar Jaime +Director +Cesar Jaime +/s/ Janeen S. Judah +Director +Janeen S. Judah +/s/ Amy H. Nelson +Director +Amy H. Nelson +/s/ Julie J. Robertson +Director +Julie J. Robertson +/s/ James C. Stewart +Director +James C. Stewart +S- 2 \ No newline at end of file diff --git a/raw/filings/0000889900/2023/0000950170-24-020661/filing_metadata.csv b/raw/filings/0000889900/2023/0000950170-24-020661/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..5933b45af29c8c74fcd2be00dc22d03fe20cfefb --- /dev/null +++ b/raw/filings/0000889900/2023/0000950170-24-020661/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2024-02-27,2023-12-31,2024-02-27T13:58:59.000Z,0000950170-24-020661,pten-20231231.htm,10-K,19480089,1,1,https://www.sec.gov/Archives/edgar/data/889900/000095017024020661/pten-20231231.htm,https://www.sec.gov/Archives/edgar/data/889900/000095017024020661/,2023,2023,1 diff --git a/raw/filings/0000889900/2023/0000950170-24-020661/item1.txt b/raw/filings/0000889900/2023/0000950170-24-020661/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..5374c07b494d7c6a3f80912bcff006599660b6aa --- /dev/null +++ b/raw/filings/0000889900/2023/0000950170-24-020661/item1.txt @@ -0,0 +1,235 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. +Drilling Services +Our contract drilling business operates in the continental United States and internationally in Colombia and, from time to time, we pursue contract drilling opportunities in other select markets. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and natural gas basins in the United States, and we provide services that improve the statistical accuracy of wellbore placement for directional and horizontal wells. We also service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. +Completion Services +Our well completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States, including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. +Drilling Products +We serve the energy and mining markets by manufacturing and distributing drill bits through North America and internationally in over 30 countries. Our drilling equipment is used in oil and natural gas exploration and production and in mining operations. We have manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman . +Other +Other consists of our oilfield rentals business, with a fleet of premium oilfield rental tools, along with the results of our ownership, as a non-operating working interest owner, in oil and natural gas assets located in Texas and New Mexico . +3 +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2021, 2022 and 2023 are as follows: +1 st +2 nd +3 rd +4 th +Quarter +Quarter +Quarter +Quarter +2021: +Average oil price per Bbl (1) +$ +57.79 +$ +66.09 +$ +70.62 +$ +77.45 +Average rigs operating per day – U.S. (2) +69 +73 +80 +106 +2022: +Average oil price per Bbl (1) +$ +94.45 +$ +108.72 +$ +93.18 +$ +82.79 +Average rigs operating per day – U.S. (2) +115 +121 +128 +131 +2023: +Average oil price per Bbl (1) +$ +75.93 +$ +73.54 +$ +82.25 +$ +78.53 +Average rigs operating per day – U.S. (2) +131 +128 +120 +118 +(1) +The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Crude oil prices and demand for drilling and completion equipment and services increased from 2021 to 2022, and industry supply of Tier-1, super-spec rigs became constrained. Commodity price volatility in the second quarter of 2023 resulted in a decline in industry activity; commodity prices subsequently increased during the third quarter before declining in the fourth quarter of 2023. We expect our rig count in the United States will average 120 rigs in the first quarter. The current demand for equipment and services remains dependent on macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $78.53 per barrel in the fourth quarter of 2023 and closed at $78.72 per barrel on February 20, 2024. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.74 per MMBtu in the fourth quarter of 2023 and closed at $1.50 per MMBtu on February 20, 2024. +Our average active U.S. rig count for the fourth quarter of 2023 was 118 rigs. This was a decrease from our average active rig count for the third quarter of 2023 of 120 rigs. Our active U.S. rig count at December 31, 2023 of 121 rigs was less than the rig count of 132 rigs at December 31, 2022, due in large part to the decline in commodity prices and reduced demand for drilling services in the United States. We expect our rig count in the United States will average 120 rigs in the first quarter of 2024. Term contracts help support our operating rig count. Based on contracts in place in the United States as of February 14, 2024, we expect an average of 79 rigs operating under term contracts during the first quarter of 2024 and an average of 52 rigs operating under term contracts during 2024. +Our completion services business was impacted by calendar inefficiencies during the second half of 2023 resulting from a decline in customer activity during the third quarter. Completion services activity stabilized in the fourth quarter of 2023. We believe activity will modestly decline in the first quarter of 2024. +Drilling products demand increased from the third quarter of 2023 despite a decline in the global rig count. Drilling Products demand is expected to remain steady through the first quarter, given the expectation for a steady market in the U.S. and moderate growth in international markets relative to what we saw in the fourth quarter. +Our 2024 capital expenditure forecast is approximately $740 million. +Recent Developments in Business Combinations and Financial Matters — On September 1, 2023, we completed the NexTier merger. Each share of common stock of NexTier issued and outstanding immediately prior to the effective time (including outstanding restricted shares) was converted into the right to receive 0.752 shares of our common stock, which based on the closing price of our common stock of $14.91 on September 1, 2023, valued the transaction at approximately $2.8 billion, including the assumption of debt. NexTier is a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins. +On August 14, 2023, we completed the Ulterra acquisition. Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $376 million cash, which based on the closing price of +4 +our common stock of $14.94 on August 14, 2023, valued the transaction at closing at approximately $897 million. Ulterra is a global provider of specialized drill bit solutions. +On September 13, 2023, we completed the offering of $400 million in aggregate principal amount of our 7.15% Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses were approximately $396 million, which we used to repay amounts outstanding under our revolving credit facility. +On August 29, 2023, we entered into Amendment No. 4 to Amended and Restated Credit Agreement (the “Credit Agreement Amendment”), which amended our Amended and Restated Credit Agreement, dated as of March 27, 2018 (as amended, the “Credit Agreement”), by and among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +The Credit Agreement Amendment, among other things, (i) deemed certain outstanding letters of credit issued for the account of BEP Diamond Holdings Corp. (the entity we acquired in the Ulterra acquisition) with a face amount of $2.5 million to have been issued under the Credit Agreement, and (ii) extended the maturity date for $85 million of revolving credit commitments of certain lenders under the Credit Agreement from March 27, 2025 to March 27, 2026. As a result, of the $600 million of revolving credit commitments under the Credit Agreement, the maturity date for $501.7 million of such commitments is March 27, 2026; the maturity date for $48.3 million of such commitments is March 27, 2025; and the maturity date for the remaining $50 million of such commitments is March 27, 2024. +During the first quarter of 2023, we elected to repurchase portions of our 3.95% Senior Notes due 2028 (the “2028 Notes”) and our 5.15% Senior Notes due 2029 (the “2029 Notes”) in the open market. The principal amounts retired through these transactions totaled $6.0 million of our 2028 Notes and $3.0 million of our 2029 Notes, plus accrued interest. We recorded corresponding gains on the extinguishment of these amounts totaling $0.8 million and $0.3 million, respectively, net of the proportional write-off of associated deferred financing costs and original issuance discounts. These gains are included in “Interest expense, net of amount capitalized” in our consolidated statements of operations included as a part of Item 8 of this Report. +As of December 31, 2023, we had no borrowings outstanding under our revolving credit facility. We had $2.6 million in letters of credit outstanding under the Credit Agreement at December 31, 2023 and, as a result, had available borrowing capacity of approximately $597 million at that date. +Industry Segments +Our revenues, operating income and loss and identifiable assets are primarily attributable to three industry segments: +• +drilling services, +• +completion services, and +• +drilling products. +Drilling Services Operations +General — We provide our contract drilling services to oil and natural gas operators in the United States and Colombia. As of December 31, 2023, we had 192 marketed land-based drilling rigs based in the following regions: +Region +Number of Rigs +West Texas +82 +Appalachia +27 +Rockies +23 +Oklahoma +19 +South Texas +18 +East Texas +15 +Colombia +8 +Total +192 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super-spec” rigs, +5 +which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allows for more clearance underneath the rig floor. As of December 31, 2023, we had 173 super-spec rigs, of which 131 were Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with many having high pressure mud systems, walking systems and increased hookload capacity. During fiscal years 2023, 2022 and 2021, we spent approximately $335 million, $256 million, and $110 million, respectively, on these capital expenditures. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2023 +2022 +2021 +Average rigs operating per day – U.S. (1) +124 +124 +82 +Number of wells drilled during the year – U.S. +2,530 +2,489 +1,662 +Number of operating days – U.S. +45,270 +45,216 +29,960 +(1) +A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. We had no impairment related to the marketability or condition of our drilling rigs during 2023. +6 +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist® application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell® lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +Directional Drilling — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (“MWD”) and supply and rental of downhole performance motors, in most major onshore oil and natural gas basins in the United States. We generally design, assemble and maintain our own fleet of downhole drilling motors and MWD equipment. Our customers primarily consist of oil and natural gas operators in the United States. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our MWD Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization to determine optimal steering recommendations and placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Drilling Services — We service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. +Completion Services Operations +Our completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. Our completion services are designed in partnership with our customers to enhance both initial production rates and estimated ultimate recovery from new and existing wells. +We utilize our in-house capabilities, including our data control instruments business, to offer a technologically advanced and efficiency focused range of completion techniques. The majority of revenue for this segment is generated by our hydraulic fracturing business. +Hydraulic Fracturing — Hydraulic fracturing services are performed to enhance production of oil and natural gas from formations with low permeability and restricted flow of hydrocarbons. The process of hydraulic fracturing involves pumping a highly viscous, pressurized fracturing fluid, typically a mixture of water, chemicals and proppant, into a well casing or tubing in order to fracture underground mineral formations. These fractures release trapped hydrocarbon particles and free a channel for the oil or natural gas to flow freely to the wellbore for collection. Fracturing fluid mixtures include proppant that becomes lodged in the cracks created by the hydraulic fracturing process, “propping” them open to facilitate the flow of hydrocarbons upward through the well. +Completion Support Services — In late 2020, NexTier began evolving its completion service offerings to develop an integrated natural gas treatment and delivery solution. In 2021, NexTier launched its Power Solutions business, which focuses on gas sourcing, compression, transport, decompression, treatment and related services for fracturing operations. We believe this integration solution assists our customers by reducing emissions at the wellsite and throughout their operations. As part of NexTier’s wellsite integration strategy to provide and integrate a variety of services for its customers at the wellsite to maximize efficiencies and profitability, in 2022, NexTier acquired sand hauling, wellsite storage, and last mile logistics assets and rebranded its entire last mile logistics operation as NexMile Logistics. The assets acquired were combined with NexTier’s existing last mile logistics assets to create a leading player in the delivery and storage of proppant at the wellsite. +Wireline and Pumping Services — Our wireline services involve the use of a truck equipped with a spool of wireline that is unwound and lowered into oil and natural gas wells to convey specialized tools or equipment for well completion, well intervention, pipe recovery and reservoir evaluation purposes. We offer our wireline services in conjunction with our hydraulic +7 +fracturing services in “plug-and-perf” well completion to maximize efficiency for our customers. “Plug-and-perf” is a multi-stage well completion technique for cased-hole wells that consists of pumping a plug and perforating guns to a specified depth. Once the plug is set, the zone is perforated and the tools are removed from the well, a ball is pumped down to isolate the zones below the plug and the hydraulic fracturing treatment is applied. In addition, we offer wireline and pumping services that are not integrated with our fracturing services. We are one of the leading providers of perforating, pumpdown, pipe recovery, pressure pumping, and wellsite make-up and pressure testing services. We are highly experienced in safely servicing deep, high-pressure, high-temperature wells in some of the most active onshore basins in the United States. Our in-house manufacturing capabilities allow us to manage costs and lead times with regard to hardware and perforating guns, switches and accessories, providing us with a competitive advantage and enabling higher returns. +Cementing — Our cementing services incorporate custom engineered mixing and blending equipment that is designed to deliver precision and accuracy in providing annulus isolation and hydraulic seal, while protecting freshwater zones from our customers’ zone of interest. Our cement division has the expertise to cement shallow to complex high temperature, high pressure wells. We also offer engineering software and technical guidance for remedial cementing applications and acidizing to optimize the performance of our customers’ wells. We are one of the largest providers of specialty cementing services in the United States. Our operations are supported by multiple full-service laboratory facilities with advanced capabilities. +Completion Service Contracts — Our completion services operations are conducted pursuant to a work order for a specific job or pursuant to a contract generally for a specified period of time, which may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have well completion equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services. We periodically evaluate our completion services assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability or condition of our equipment during 2023. +Materials — Our completion services operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time, and can be subject to significant price volatility. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +Drilling Products Operations +Our Ulterra business has manufacturing and distribution sites of drilling equipment in North America and internationally, which are geographically positioned to serve the energy and mining markets in over 30 countries. Ulterra’s drilling equipment is used in oil and natural gas exploration and production and in mining operations. Ulterra has manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Ulterra’s primary business is the design, manufacture, sale and rental of matrix and steel-bodied polycrystalline diamond compact (“PDC”) drill bits. PDC drill bits are typically rented, except in select international markets where they are sold. Used bits may be repaired and refurbished for the subsequent customer. Ulterra has an industry-leading position in the North American PDC drill bit market. +We periodically evaluate our drill bits for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability or condition of our equipment during 2023. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing oil and natural gas basins in the United States. +8 +In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +Research, Engineering and Technology +We employ research, engineering and technology teams across our businesses, who work on initiatives to enhance our existing product and service offerings and develop new products and services to meet customer demands. +Contracts +We believe that our contracts for drilling services, completion services, drilling products and other services and products generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2023, we received approximately 49% from our ten largest customers and approximately 35% from our five largest customers. During 2023, one customer accounted for approximately $588 million, or approximately 14%, of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2023 and 2022 was approximately $700 million and $830 million, respectively. Approximately 16% of our contract drilling backlog in the United States at December 31, 2023 is reasonably expected to remain after 2024. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment” for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our drilling services and completion services businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, our communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who, through the diversity of their backgrounds, experiences and talents, are our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, values which are embedded in our culture and a practice on which all of our success depends. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions as compared to our traditional diesel-only equipment, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +9 +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell® lithium battery hybrid energy management system. The EcoCell® system is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 10,600 full-time employees as of January 31, 2024. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies, as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have annual safety education that incorporates learning associated with hazard awareness, safe systems of work, permission to work, stop work authority, energy isolation, material handling and management of change. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +We require new supervisors and managers in the United States to attend an instructor-led course relative to diversity, inclusion and respect to ensure they understand our expectations regarding their obligations to promote a work environment where all employees are valued and respected. Supplemental diversity, inclusion and respect training for supervisors and managers is required on a biannual basis. All other employees are educated annually on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +Maintaining our Core Values – We provide annual training for our employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. We have implemented policies allowing many of our office-based employees the flexibility to work from home. +Government and Environmental Regulation +Our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business and the oil and natural gas industry including: +• +drilling of oil and natural gas wells, +• +hydraulic fracturing, wireline and pumping, completion support and cementing, +• +provision of specialized drill bit solutions, +• +directional drilling services, +10 +• +services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• +containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• +use of underground storage tanks and injection wells, +• +servicing of equipment for drilling contractors, +• +provision of electrical controls and automation, +• +conducting international operations, and +• +our employees. +Our business operations are subject to various environmental, as well as employee health and safety, laws and regulations, including those addressing the management, disposal and releases of regulated substances. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results. +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. See “Item 1A. Risk Factors – The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. Several states and geographic regions in the United States, as well as foreign jurisdictions, have adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of international treaties related to GHG emissions. See “Item 1A. Risk Factors – Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services.” +We operate throughout North America and internationally in over 30 countries and, accordingly, are subject to the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery and anti-corruption laws in other jurisdictions. Our operations also are subject to other laws and regulations in relation to our international operations, including with respect to the import and export of certain goods and economic sanctions. See “Item 1A. Risk Factors – Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business.” +The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and natural gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Risks and Insurance +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. The insurances that we maintain include coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation as well as insurance for other specific risks. We cannot assure that any insurance obtained by us will be adequate to cover any losses or liabilities nor can we assure that any insurance obtained by us will continue to be made available for purchase or made available on acceptable terms. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets. We have also elected in some +11 +cases to retain a greater amount of risk through increased deductibles on certain insurance policies. For example, in the United States we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation insurance coverage, a $1.0 million per occurrence deductible on our equipment insurance coverage, a $10.0 million per occurrence deductible on our general liability coverage, and, for our automobile insurance coverage, a per occurrence deductible ranging from $2.0 million to $10.0 million. We also self-insure a number of risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted. Occasionally, our operations have been negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. \ No newline at end of file diff --git a/raw/filings/0000889900/2023/0000950170-24-020661/item13.txt b/raw/filings/0000889900/2023/0000950170-24-020661/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2023/0000950170-24-020661/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2023/0000950170-24-020661/item9a.txt b/raw/filings/0000889900/2023/0000950170-24-020661/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..517924148f17289b8b6ad293c0a7e2e42abfb065 --- /dev/null +++ b/raw/filings/0000889900/2023/0000950170-24-020661/item9a.txt @@ -0,0 +1,10 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2023, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2023, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2023. +53 +We completed the Ulterra acquisition on August 14, 2023 and the NexTier merger on September 1, 2023. We excluded Ulterra’s and NexTier’s disclosure controls and procedures that are subsumed by their internal control over financial reporting from the scope of management’s assessment of the effectiveness of our disclosure controls and procedures. This exclusion is in accordance with the guidance issued by the Staff of the Securities and Exchange Commission that an assessment of recent business combinations may be omitted from management's assessment of internal control over financial reporting for one year following the acquisition. As a result of our integration of the Ulterra and NexTier disclosure controls and procedures, certain controls will be evaluated and may be changed. Ulterra and NexTier’s total revenues constituted approximately 3% and 26% of our consolidated revenues, respectively, for the year ended December 31, 2023. Ulterra’s and NexTier’s total assets constituted approximately 3% and 23% of our consolidated total assets, respectively, as of December 31, 2023. +The effectiveness of our internal control over financial reporting as of December 31, 2023 has been audited by PricewaterhouseCoopers LLP , an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2023/0000950170-24-020661/rp_note.txt b/raw/filings/0000889900/2023/0000950170-24-020661/rp_note.txt new file mode 100644 index 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2023-01-01 2023-12-31 0000889900 us-gaap:ValuationAllowanceOfDeferredTaxAssetsMember 2022-12-31 0000889900 us-gaap:ValuationAllowanceOfDeferredTaxAssetsMember 2023-01-01 2023-12-31 0000889900 us-gaap:AllowanceForCreditLossMember 2021-12-31 0000889900 us-gaap:AllowanceForCreditLossMember 2022-01-01 2022-12-31 0000889900 us-gaap:ValuationAllowanceOfDeferredTaxAssetsMember 2021-12-31 0000889900 us-gaap:ValuationAllowanceOfDeferredTaxAssetsMember 2022-01-01 2022-12-31 +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +Form 10-K +(Mark One) +x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31 , 2024 +or +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from _________ to +Commission File Number 1-39270 +Patterson-UTI Energy, Inc. +(Exact name of registrant as specified in its charter) +Delaware +75-2504748 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +10713 W. Sam Houston Pkwy N , Suite 800 +Houston , Texas +77064 +(Address of principal executive offices) (Zip Code) +Registrant’s telephone number, including area code: +( 281 ) 765-7100 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common Stock, $0.01 Par Value PTEN The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x or No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o or No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x or No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +x Accelerated filer o +Smaller reporting company o +Non-accelerated filer o Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. x +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. o +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2024, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $ 4.0 billion, calculated by reference to the closing price of $10.36 for the common stock on the Nasdaq Global Select Market on that date. +As of February 5, 2025, the registrant had outstanding 386,390,297 shares of common stock, $0.01 par value, its only class of common stock. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s definitive proxy statement for the 2025 Annual Meeting of Stockholders are incorporated by reference into Part III of this report. +Table of Contents +TABLE OF CONTENTS +Page No. +PART I +ITEM 1. +Business +3 +ITEM 1A. +Risk Factors +12 +ITEM 1B. +Unresolved Staff Comments +29 +ITEM 1C. +Cybersecurity +29 +ITEM 2. +Properties +30 +ITEM 3. +Legal Proceedings +31 +ITEM 4. +Mine Safety Disclosures +31 +PART II +ITEM 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +32 +ITEM 6. +RESERVED +33 +ITEM 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +34 +ITEM 7A. +Quantitative and Qualitative Disclosures About Market Risk +50 +ITEM 8. +Financial Statements and Supplementary Data +50 +ITEM 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +50 +ITEM 9A. +Controls and Procedures +50 +ITEM 9B. +Other Information +51 +ITEM 9C. +Disclosure Regarding Foreign Jurisdictions That Prevent Inspections +51 +PART III +ITEM 10. +Directors, Executive Officers and Corporate Governance +52 +ITEM 11. +Executive Compensation +52 +ITEM 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +52 +ITEM 13. +Certain Relationships and Related Transactions, and Director Independence +52 +ITEM 14. +Principal Accounting Fees and Services +52 +PART IV +ITEM 15. +Exhibits and Financial Statement Schedule +53 +ITEM 16. +Form 10-K Summary +57 +SIGNATURES +S- 2 +Table of Contents +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Report”) and other public filings, press releases and presentations by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. As used in this Report, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc. and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its operations through its wholly-owned subsidiaries and has no employees or independent business operations. These forward-looking statements involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue, cost and margin expectations and backlog; financing of operations; oil and natural gas prices; rig counts and frac spreads; source and sufficiency of funds required for building new equipment, upgrading existing equipment and acquisitions (if opportunities arise); demand and pricing for our services; competition; equipment availability; government regulation; legal proceedings; debt service obligations; impact of inflation and economic downturns; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipate,” “believe,” “budgeted,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “pursue,” “should,” “strategy,” “target,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. +Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from actual future results expressed or implied by the forward-looking statements. These risks and uncertainties also include those set forth under “Risk Factors” contained in Item 1A of this Report and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act, as well as, among others, risks and uncertainties relating to: +• adverse oil and natural gas industry conditions, including the impact of commodity price volatility on industry outlook; +• global economic conditions, including inflationary pressures and risks of economic downturns or recessions in the United States and elsewhere; +• volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates; +• excess supply of drilling and completions equipment, including as a result of reactivation, improvement or construction; +• competition and demand for our services; +• the impact of the ongoing Ukraine/Russia and Middle East conflicts and instability in other international regions; +• strength and financial resources of competitors; +• utilization, margins and planned capital expenditures; +• ability to obtain insurance coverage on commercially reasonable terms and liabilities from operational risks for which we do not have and receive full indemnification or insurance; +• operating hazards attendant to the oil and natural gas business; +• failure by customers to pay or satisfy their contractual obligations (particularly with respect to fixed-term contracts); +• the ability to realize backlog; +• specialization of methods, equipment and services and new technologies, including the ability to develop and obtain satisfactory returns from new technology and the risk of obsolescence of existing technologies; +• the ability to attract and retain management and field personnel; +• loss of key customers; +• shortages, delays in delivery, and interruptions in supply, of equipment and materials; +• cybersecurity events; +• difficulty in building and deploying new equipment; +• complications with the design or implementation of our new enterprise resource planning system; +1 +Table of Contents +• governmental regulation, including climate legislation, regulation and other related risks; +• environmental, social and governance practices, including the perception thereof; +• environmental risks and ability to satisfy future environmental costs; +• technology-related disputes; +• legal proceedings and actions by governmental or other regulatory agencies; +• changes to tax, tariff and import/export regulations and sanctions by the United States or other countries; +• the ability to effectively identify and enter new markets or pursue strategic acquisitions; +• public health crises, pandemics and epidemics; +• weather; +• operating costs; +• expansion and development trends of the oil and natural gas industry; +• financial flexibility, including availability of capital and the ability to repay indebtedness when due; +• adverse credit and equity market conditions; +• our return of capital to stockholders, including timing and amounts (including any plans or commitments in respect thereof) of any dividends and share repurchases; +• stock price volatility; +• compliance with covenants under our debt agreements; and +• other financial, operational and legal risks and uncertainties detailed from time to time in our filings with the SEC. +We caution that the foregoing list of factors is not exhaustive. Additional information concerning these and other risk factors is contained elsewhere in this Report and may be contained in our future filings with the SEC. You are cautioned not to place undue reliance on any of our forward-looking statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to update publicly or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise. In the event that we update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters or any other forward-looking statements. All subsequent written and oral forward-looking statements concerning us or other matters and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. +2 +Table of Contents +PART I +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. +Drilling Services +Our contract drilling business operates in the continental United States and internationally in Colombia and Ecuador and, from time to time, we pursue contract drilling opportunities in other select markets. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and natural gas basins in the United States, and we provide services that improve the statistical accuracy of wellbore placement for directional and horizontal wells. We also service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. +Completion Services +Our well completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States, including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. +Drilling Products +We serve the energy and mining markets by manufacturing and distributing drill bits throughout North America and internationally in over 30 countries. Our drilling equipment is used in oil and natural gas exploration and production and in mining operations. We have manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Other +Other consists of our oilfield rentals business, with a fleet of premium oilfield rental tools, along with the results of our ownership, as a non-operating working interest owner, in oil and natural gas assets located in Texas and New Mexico. +3 +Table of Contents +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2022, 2023 and 2024 are as follows: +1 st +Quarter +2 nd +Quarter +3 rd +Quarter +4 th +Quarter +2022 +Average oil price per Bbl (1) +$ 94.45 $ 108.72 $ 93.18 $ 82.79 +Average rigs operating per day – U.S. (2) +115 121 128 131 +2023 +Average oil price per Bbl (1) +$ 75.93 $ 73.54 $ 82.25 $ 78.53 +Average rigs operating per day – U.S. (2) +131 128 120 118 +2024 +Average oil price per Bbl (1) +$ 77.50 $ 81.81 $ 76.43 $ 70.73 +Average rigs operating per day – U.S. (2) +121 114 107 105 +(1) The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices, and upon our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. Commodity prices have historically been volatile, but have been relatively range-bound since the end of 2022. The current demand for equipment and services remains impacted by macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $70.73 per barrel in the fourth quarter of 2024 and closed at $73.52 per barrel on February 3, 2025. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.45 per MMBtu in the fourth quarter of 2024 and closed at $3.30 per MMBtu on February 3, 2025. +In our drilling services segment, our average active rig count in the United States for the fourth quarter of 2024 was 105 rigs. This was a decrease from our average active rig count for the third quarter of 2024 of 107 rigs. Our active rig count in the United States at December 31, 2024 of 103 rigs was less than the rig count of 121 rigs at December 31, 2023, reflecting the industry-wide activity declines due to increased drilling efficiencies and market consolidation. We expect our rig count in the United States will average 106 rigs in the first quarter of 2025. Term contracts help support our operating rig count. Based on contracts in place in the United States as of February 5, 2025, we expect an average of 64 rigs operating under term contracts during the first quarter of 2025 and an average of 40 rigs operating under term contracts during 2025. +During the fourth quarter of 2024, our completion services segment was impacted by several long-term dedicated customers reducing sequential completion activity after meeting their annual production targets. We expect a seasonal uptick in activity during the first quarter as customer budgets reset with the start of the new year. +Activity in our drilling products segment was relatively steady in 2024 compared to the prior year. Drilling products demand is expected to remain steady through the first quarter, given the expectation for a steady U.S. market and continued growth in international markets. +Our 2025 capital expenditure forecast is approximately $600 million. +Recent Developments in Joint Ventures, Business Combinations and Financial Matters — In December 2024, one of our subsidiaries closed a previously announced joint venture with subsidiaries of ADNOC Drilling and SLB. Our subsidiary holds a 15 percent interest in a newly created company named Turnwell Industries, which has been awarded a contract to drill and complete 144 unconventional wells for ADNOC. In exchange for the minority equity interest, we are providing unconventional drilling and completion expertise to Turnwell, as well as a limited cash contribution to fund our portion of initial working capital. +On September 1, 2023, we completed our merger (the “NexTier merger”) with NexTier Oilfield Solutions Inc. (“NexTier”), a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins Each share of common stock of NexTier issued and outstanding immediately prior to the effective time (including outstanding restricted shares) was converted into the right to receive 0.752 shares of our common stock, which based on the +4 +Table of Contents +closing price of our common stock of $14.91 on September 1, 2023, valued the transaction at approximately $2.8 billion, including the assumption of debt. +On August 14, 2023, we completed our acquisition (the “Ulterra acquisition”) of Ulterra Drilling Technologies, L.P. (“Ulterra”), a global provider of specialized drill bit solutions. Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $373 million of cash (after purchase price adjustments), which based on the closing price of our common stock of $14.94 on August 14, 2023, valued the transaction at closing at approximately $894 million. +On September 13, 2023, we completed the offering of $400 million in aggregate principal amount of 7.15% Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses were approximately $396 million, which we used to repay amounts outstanding under our Prior Credit Agreement (as defined below). +On January 31, 2025, we entered into the Second Amended and Restated Credit Agreement with the lenders party thereto and Wells Fargo Bank, National Association, as administrative agent, and the other parties thereto (the “Credit Agreement”). The Credit Agreement amended and restated our Amended and Restated Credit Agreement dated as of March 27, 2018 (as amended, restated, supplemented or otherwise modified at December 31, 2024, the “Prior Credit Agreement”). The commitments under the Credit Agreement are $500 million, and the loans and commitments under the Credit Agreement mature on January 31, 2030. +The Credit Agreement provides for a committed senior unsecured credit facility that permits aggregate revolving credit borrowings of up to $500 million, with a letter of credit sub-facility of $100 million and a swing line sub-facility that, at any time outstanding, is limited to the lesser of $50 million and the amount of the swing line provider’s unused commitment. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $200 million, not to exceed total commitments of $700 million. For a description of the Credit Agreement, see “Liquidity and Capital Resources” included in Part II, Item 7— “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report. +As of December 31, 2024, we had no borrowings outstanding under our Prior Credit Agreement. We had $2.1 million in letters of credit outstanding under the Prior Credit Agreement at December 31, 2024 and, as a result, had available borrowing capacity of approximately $613 million under the Prior Credit Agreement at that date. +Industry Segments +Our revenues, operating income and loss and identifiable assets are primarily attributable to three industry segments: +• drilling services, +• completion services, and +• drilling products. +Drilling Services Operations +General — We provide our contract drilling services to oil and natural gas operators in the United States, Colombia and Ecuador. As of December 31, 2024, we had 152 marketed land-based drilling rigs based in the following regions: +Region Number of Rigs +West Texas 70 +Appalachia 21 +Oklahoma 16 +Rockies 15 +South Texas 11 +East Texas 11 +Colombia 7 +Ecuador 1 +Total 152 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel or natural gas engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super-spec” rigs, which we +5 +Table of Contents +consider as being a super-spec rig that also has a third mud pump and raised drawworks that allows for more clearance underneath the rig floor. As of December 31, 2024, we had 135 Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We invest significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with high pressure mud systems, walking systems and increased hookload capacity. During fiscal years 2024, 2023 and 2022, we spent approximately $265 million, $335 million, and $272 million, respectively, on capital expenditures in our Drilling Services operations. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2024 2023 2022 +Average rigs operating per day – U.S. (1) +112 124 124 +Number of wells drilled during the year – U.S. 2,376 2,530 2,489 +Number of operating days – U.S. 40,899 45,270 45,216 +(1) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. During the third quarter of 2024, we identified 42 legacy, non-Tier-1 super-spec drilling rigs and related equipment to be abandoned. Based on the strong customer preference across the industry for Tier-1 super-spec drilling rigs, in addition to efficiency gains and technology advancements that have reduced the total number of rigs needed for the U.S. drilling +6 +Table of Contents +market, we believe the 42 rigs that were abandoned had limited commercial opportunity. Accordingly, we recorded a charge of $114 million related to this abandonment during the third quarter of 2024. No similar charges were incurred in 2022 or 2023. +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist® application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell® lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +Directional Drilling — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (“MWD”) and supply and rental of downhole performance motors, such as our Mpact® drilling motors, and MWD equipment, such as our Mpower™ MWD systems. Our customers primarily consist of oil and natural gas operators in the United States. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our MWD Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization to determine optimal steering recommendations and placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Drilling Services — We service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. +Completion Services Operations +Our completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. Our completion services are designed in partnership with our customers to enhance both initial production rates and estimated ultimate recovery from new and existing wells. +We utilize our in-house capabilities, including our data control instruments business, to offer a technologically advanced and efficiency focused range of completion techniques. The majority of revenue for this segment is generated by our hydraulic fracturing business. +Hydraulic Fracturing — Hydraulic fracturing services are performed to enhance production of oil and natural gas from formations with low permeability and restricted flow of hydrocarbons. The process of hydraulic fracturing involves pumping a highly viscous, pressurized fracturing fluid, typically a mixture of water, chemicals and proppant, into a well casing or tubing in order to fracture underground mineral formations. These fractures release trapped hydrocarbon particles and free a channel for the oil or natural gas to flow freely to the wellbore for collection. Fracturing fluid mixtures include proppant that becomes lodged in the cracks created by the hydraulic fracturing process, “propping” them open to facilitate the flow of hydrocarbons upward through the well. To address evolving customer preferences for emissions-reducing equipment, we have invested in natural gas-powered equipment, including our 100% natural gas-powered Emerald™ line of hydraulic fracturing equipment. +Completion Support Services — Our Power Solutions business is an integrated natural gas treatment and delivery solution, which focuses on gas sourcing, compression, transport, decompression, treatment and related services for oilfield service operations. We believe this integration solution assists our customers by reducing emissions at the wellsite and throughout their operations. As part of our wellsite integration strategy to provide and integrate a variety of services for our customers at the wellsite to maximize efficiencies and profitability, in 2022, we acquired sand hauling, wellsite storage, and last mile logistics assets. The assets acquired were combined with our existing last mile logistics assets to create a leading player in the delivery and storage of proppant at the wellsite. +Wireline and Pumping Services — Our wireline services involve the use of a truck equipped with a spool of wireline that is unwound and lowered into oil and natural gas wells to convey specialized tools or equipment for well completion, well intervention, pipe recovery and reservoir evaluation purposes. We offer our wireline services in conjunction with our hydraulic fracturing services +7 +Table of Contents +in “plug-and-perf” well completion to maximize efficiency for our customers. “Plug-and-perf” is a multi-stage well completion technique for cased-hole wells that consists of pumping a plug and perforating guns to a specified depth. Once the plug is set, the zone is perforated and the tools are removed from the well, a ball is pumped down to isolate the zones below the plug and the hydraulic fracturing treatment is applied. In addition, we offer wireline and pumping services that are not integrated with our fracturing services. We are one of the leading providers of perforating, pumpdown, pipe recovery, pressure pumping, and wellsite make-up and pressure testing services. We are highly experienced in safely servicing deep, high-pressure, high-temperature wells in some of the most active onshore basins in the United States. Our in-house manufacturing capabilities allow us to manage costs and lead times with regard to hardware and perforating guns, switches and accessories, providing us with a competitive advantage and enabling higher returns. +Cementing — Our cementing services incorporate custom engineered mixing and blending equipment that is designed to deliver precision and accuracy in providing annulus isolation and hydraulic seal, while protecting freshwater zones from our customers’ zone of interest. Our cement division has the expertise to cement shallow to complex high temperature, high pressure wells. We also offer engineering software and technical guidance for remedial cementing applications and acidizing to optimize the performance of our customers’ wells. We are one of the largest providers of specialty cementing services in the United States. Our operations are supported by multiple full-service laboratory facilities with advanced capabilities. +Completion Service Contracts — Our completion services operations are conducted pursuant to a work order for a specific job or pursuant to a contract generally for a specified period of time, which may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have well completion equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services. We periodically evaluate our completion services assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. +Materials — Our completion services operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time, and can be subject to significant price volatility. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may or may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +Drilling Products Operations +Our Ulterra business has manufacturing and distribution sites of drilling equipment in North America and internationally, which are geographically positioned to serve the energy and mining markets in over 30 countries. Ulterra’s drilling equipment is used in oil and natural gas exploration and production and in mining operations. Ulterra has manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Ulterra’s primary business is the design, manufacture, sale and rental of matrix and steel-bodied polycrystalline diamond compact (“PDC”) drill bits. PDC drill bits are typically rented, except in select international markets where they are sold. Used bits may be repaired and refurbished for the subsequent customer. Ulterra has an industry-leading position in the North American PDC drill bit market. +We periodically evaluate our drill bits for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability of our equipment during 2024. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and equipment and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing oil and natural gas basins in the United States. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +8 +Table of Contents +Research, Engineering and Technology +We employ research, engineering and technology teams across our businesses, who work on initiatives to enhance our existing product and service offerings and develop new products and services to meet customer demands. +Contracts +We believe that our contracts for drilling services, completion services, drilling products and other services and products generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2024, we received approximately 53% from our ten largest customers and approximately 38% from our five largest customers. During 2024, one customer accounted for approximately $605 million, or approximately 11%, of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2024 and 2023 was approximately $426 million and $700 million, respectively. Approximately 7.1% of our contract drilling backlog in the United States at December 31, 2024 is reasonably expected to remain after 2025. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment” for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our drilling services and completion services businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, our communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who, through the diversity of their backgrounds, experiences and talents, are our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, values which are embedded in our culture and a practice on which all of our success depends. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions as compared to our traditional diesel-only equipment, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell® lithium battery hybrid energy management system. The EcoCell® system is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +9 +Table of Contents +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 9,200 full-time employees as of January 31, 2025. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies, as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have annual safety education that incorporates learning associated with hazard awareness, safe systems of work, permission to work, stop work authority, energy isolation, material handling and management of change. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +All employees are educated annually on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +Maintaining our Core Values – We provide annual training for our employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. We have implemented policies allowing many of our office-based employees the flexibility to work from home. +Government and Environmental Regulation +Our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business and the oil and natural gas industry including: +• drilling of oil and natural gas wells, +• hydraulic fracturing, wireline and pumping, completion support and cementing, +• provision of specialized drill bit solutions, +• directional drilling services, +• services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• use of underground storage tanks and injection wells, +• servicing of equipment for drilling contractors, +• provision of electrical controls and automation, +• conducting international operations, and +10 +Table of Contents +• our employees. +Our business operations are subject to various environmental, as well as employee health and safety, laws and regulations, including those addressing the management, disposal and releases of regulated substances. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results.” +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. See “Item 1A. Risk Factors – The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. Several states and geographic regions in the United States, as well as foreign jurisdictions, have adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of international treaties related to GHG emissions. See “Item 1A. Risk Factors – Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services.” +We operate throughout North America and internationally in over 30 countries and, accordingly, are subject to the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery and anti-corruption laws in other jurisdictions. Our operations also are subject to other laws and regulations in relation to our international operations, including with respect to the import and export of certain goods and economic sanctions. See “Item 1A. Risk Factors – Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business.” +The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and natural gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Risks and Insurance +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. The insurances that we maintain include coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employers’ liability, automobile liability, commercial general liability, workers’ compensation as well as insurance for other specific risks, together with excess loss liability insurance coverage. We have also elected to retain a greater amount of risk through increased deductibles as compared to prior years, or self-insurance on certain insurance policies. We cannot assure that any insurance obtained by us will be adequate to cover any losses or liabilities nor can we assure that any insurance obtained by us will continue to be made available for purchase or made available on acceptable terms. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets, and in certain cases, such as losses arising from or attributable to fire and/or explosion resulting from our hydraulic fracturing operations at the wellsite, is subject to significantly higher deductibles than are applicable to our other coverages. We also self-insure a number of risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our operations are subject to a number of operational risks, including environmental and weather risks, +11 +Table of Contents +which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted and/or their annual drilling and completion targets have been met. Occasionally, our operations are negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. +Item 1A. Risk Factors. +You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes. +Risk Factors Summary +The following is a summary of the principal risks included in this Report that we believe could adversely affect our business, financial condition, cash flows and results of operations: +Business and Operating Risks +• We are dependent on the oil and natural gas industry and market prices for oil and natural gas. Declines in customers’ operating and capital expenditures and in oil and natural gas prices may adversely affect our operating results. +• Global economic conditions may adversely affect our operating results. +• A surplus of equipment and a highly competitive oil service industry may adversely affect our utilization and profit margins and the carrying value of our assets. +• Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us. +• Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment. +• New technologies may cause our operating methods, equipment, products and services to become less competitive, and higher levels of capital expenditures may be necessary to remain competitive. +• Loss of key personnel and competition for experienced personnel may negatively impact our financial condition and results of operations. +• The loss or consolidation of key customers could have a material adverse effect on our financial condition and results of operations. +• Shortages, delays in delivery, and interruptions in supply, of equipment and materials could adversely affect our operating results. +• Our business is subject to cybersecurity risks and threats. +• Our commitments under supply agreements could exceed our requirements, exposing us to risks including price, timing of delivery and quality of equipment and materials upon which our business relies. +• Growth through acquisitions, the building or upgrading of equipment and the development of technology is not assured. +• Complications with the design or implementation of our new enterprise resource planning system could adversely impact our business and operations. +12 +Table of Contents +• Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas, which would, in turn, reduce the demand for our services. +Legal and Regulatory Risks +• The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition. +• Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services. +• Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results. +• Intellectual property disputes could negatively impact our operations, costs, revenues and competitiveness. +• The design, manufacture, sale or rental, and servicing of products, including drill bits and electrical controls, may subject us to liability for personal injury, property damage and environmental contamination. +• Legal proceedings and governmental investigations could have a negative impact on our business, financial condition and results of operations. +• Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business. +• We are subject to complex and evolving laws and regulations regarding data privacy and security. +Financial Risks +• Investor sentiment and public perception related to the oil and natural gas industry and to ESG initiatives could increase our costs of capital and our reporting requirements and impact our operations. +• Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly. +• Our ability to access capital markets could be limited, and a downgrade in our credit rating could negatively impact our cost of and ability to access capital. +• We may not be able to generate sufficient cash to service all of our debt and we may be forced to take other actions to satisfy our obligations under our debt, which may not be successful. +• Our return of capital to stockholders, including through the payment of dividends and repurchases of our common stock, is within the discretion of our Board of Directors, and there is no guarantee that we will return capital to shareholders, including through the payment of dividends and repurchases of our common stock, in the future or at levels anticipated by our stockholders. +• Our ability to utilize our historic U.S. net operating loss carryforwards is expected to be limited as a result of the completion of the NexTier merger. +Risks Related to Our Common Stock and Corporate Structure +• The market price of our common stock may be highly volatile, and investors may not be able to resell shares at or above the price paid. +• Anti-takeover measures in our charter documents and under state law could discourage an acquisition and thereby affect the related purchase price. +• Our bylaws provide that the Court of Chancery of the State of Delaware and the federal district courts of the United States are the exclusive forums for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees. +13 +Table of Contents +Business and Operating Risks +We are dependent on the oil and natural gas industry and market prices for oil and natural gas. Declines in customers’ operating and capital expenditures and in oil and natural gas prices may adversely affect our operating results. +We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas. When these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as: +• the supply of and demand for oil and natural gas, including current natural gas storage capacity and usage, +• the prices, and expectations about future prices, of oil and natural gas, +• the supply of and demand for drilling services, completion services and drilling products, +• the cost of exploring for, developing, producing and delivering oil and natural gas, +• the availability of capital for oil and natural gas industry participants, including our customers, and the extent to which they are willing or able to deploy capital, +• the availability of and constraints in pipeline, storage and other transportation capacity in the basins in which we operate, +• the environmental, tax and other laws and governmental regulations regarding the exploration, development, production, use and delivery of oil and natural gas, and in particular, public pressure on, and legislative and regulatory interest within, federal, state, foreign, regional and local governments to stop, significantly limit or regulate drilling services and completion services activities, including hydraulic fracturing, +• increased focus by the investment and financing community and the general public on sustainability practices in the oil and natural gas industry, and +• merger and divestiture activity among oil and natural gas producers. +In particular, our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices. Oil and natural gas prices and markets can be extremely volatile. Prices, and expectations about future prices, are affected by factors such as: +• market supply and demand, +• the desire and ability of the Organization of Petroleum Exporting Countries (“OPEC”), its members and other oil-producing nations, such as Russia, to set and maintain production and price targets, +• the level of production by OPEC and non-OPEC countries, +• domestic and international military, political, economic, health and weather conditions, including the impacts of war, including the impact of the ongoing armed conflicts between Russia and Ukraine and in the Middle East and the continuation of, or any escalation in the severity of, these conflicts, or terrorist activity, pandemics and other unexpected disasters or events, +• changes to tax, tariff and import/export regulations and sanctions by the United States or other countries, +• legal and other limitations or restrictions on exportation and/or importation of oil and natural gas, +• technical advances affecting energy consumption and production, and +• the development, price, availability and market acceptance of alternative fuels and energy sources. +All of these factors are beyond our control. Commodity prices have historically been volatile, but have been relatively range-bound since the end of 2022. The current demand for equipment and services remains impacted by macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $70.73 per barrel in the fourth quarter of 2024 and closed at $73.52 per barrel on February 3, 2025. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.45 per MMBtu in the fourth quarter of 2024 and closed at $3.30 per MMBtu on February 3, 2025. +In light of these and other factors, we expect oil and natural gas prices to continue to be unpredictable and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a +14 +Table of Contents +reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, including the depletion of capital expenditure budgets and/or meeting annual drilling and completion targets, which could reduce demand for our services. +Global economic conditions may adversely affect our operating results. +Concerns regarding global economic conditions, energy costs, geopolitical issues, supply chain disruptions, public health crises or global pandemics, inflation and the availability and cost of credit have contributed, and may in the future contribute, to increased economic uncertainty. Demand for energy and for oil and natural gas end products is highly sensitive to economic conditions; as a result, global economic conditions, indications that economic growth is slowing and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services. In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise, may result in reduced access to, or an inability to obtain, financing by us, our customers and our suppliers and result in reduced demand for our services. An economic slowdown or recession in the United States or in any other country that significantly affects the supply of or demand for oil or natural gas could negatively impact our operations and therefore adversely affect our results. Furthermore, these factors may result in certain of our customers experiencing an inability or unwillingness to pay suppliers, including us. The global economic environment in the past has experienced significant deterioration in a relatively short period, such as a result of the COVID-19 pandemic or the ongoing armed conflicts between Russia and Ukraine and in the Middle East, and there is no assurance that the global economic environment, or expectations for the global economic environment, will not quickly deteriorate again due to one or more factors, including as a result of actual or perceived threats to geopolitical stability, changes in production from OPEC, its members and other oil-producing nations, or governmental actions or restrictions in response to events such as a global pandemic. A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations. +A surplus of equipment and a highly competitive oil service industry may adversely affect our utilization and profit margins and the carrying value of our assets. +Our industry is highly competitive, and available drilling services equipment, completion services equipment, and drilling products often exceeds the demand for such equipment and products. A low commodity price environment or capital spending reductions by our customers due to additional customer consolidation, investor requirements or other reasons can result in substantially more equipment and products being available than are needed to meet demand. Low commodity prices and a rise in new and upgraded equipment or products can result in excess capacity and substantial competition for a declining number of drilling services and completion services contracts and drilling products rentals and sales. +Operating costs for our drilling services and completion services businesses include all direct and indirect costs associated with the operation, maintenance and support of our equipment, which is often not affected by changes in our rates and utilization. During periods of reduced revenue and/or activity, certain of our fixed costs, such as depreciation, may not decline and often we may incur additional costs. During times of reduced utilization, reductions in costs may not be immediate as we may incur additional costs associated with maintaining and stacking equipment, or we may not be able to fully reduce the cost of our support operations in a particular geographic region due to the need to support the remaining operations in that region. Accordingly, a decline in revenue due to lower rates and/or utilization may not be offset by a corresponding decrease in operating costs, which could have a material adverse impact on our business, financial condition and results of operations. +Even in an environment of high oil and natural gas prices and/or increased drilling and completion activity, reactivation and improvement of existing drilling services and completion services equipment, construction of new technology drilling services and completion services equipment, movement of drilling services and completion services equipment from region to region in response to market conditions or otherwise can lead to a surplus of equipment. +In times of reduced demand for our industry’s services, certain of our industry competitors may initiate bankruptcy proceedings or engage in debt refinancing transactions, management changes, or other strategic initiatives in an attempt to reduce operating costs to maintain a position in the market. This could result in such competitors emerging with stronger or healthier balance sheets and, in turn, an improved ability to compete with us in the future. We may also see corporate consolidations among our customers, competitors and/or vendors, which could significantly alter industry conditions and competition within the industry, and have a material adverse effect on our business, financial condition, cash flows and results of operations. +We periodically seek to increase the prices on our services to offset rising costs, earn returns on our capital investment, and otherwise generate higher returns for our stockholders. However, we operate in a very competitive industry, and we are not always +15 +Table of Contents +successful in raising or maintaining our existing prices. Even if we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs, including capital expenditures, without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs, including capital expenditures, increase could have a material adverse effect on our business, financial condition, cash flows and results of operations. In addition, we may be unable to replace fixed-term contracts that expire or are terminated early, extend expiring contracts or obtain new contracts in the spot market, and the rates and other material terms under any new or extended contracts may be on substantially less favorable rates and terms. +Accordingly, high competition and a surplus of equipment and products can cause oil and natural gas service contractors to have difficulty maintaining pricing, utilization and profit margins and, at times, result in operating losses. We cannot predict the future level of competition or surplus equipment and products in the oil and natural gas service businesses or the level of demand for our drilling services, completion services or drilling products. +A surplus of operable land drilling rigs, other drilling services equipment and drilling products, increasing rig specialization and surplus of completion services equipment, which can be exacerbated by capital spending reductions by our customers, could affect the fair market value of our drilling services equipment, completion services equipment, and drilling products, which in turn could result in additional impairments of our assets. A prolonged period of lower oil and natural gas prices or changes in customer preferences and requirements could result in future impairment to our long-lived assets. For example, we recognized impairment charges of $3.8 million, $7.0 million and $4.5 million in 2024, 2023 and 2022, respectively. +Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us. +Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, unplanned power outages and surges, computer system disruptions or cybersecurity incidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages, and consequential damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. See “Item 1. Business – Risks and Insurance” for a description of our insurance coverage. We also self-insure a number of risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Our insurance may not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations. Our coverage includes aggregate policy limits and exclusions. As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage. There can be no assurance that insurance will be available to cover any or all of our operational or other risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive, or that our coverage will cover a specific loss. Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage. Incurring a liability for +16 +Table of Contents +which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment. +Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term. However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us. Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate, suspend or renegotiate or otherwise fail to honor their contractual obligations, including as a result of their bankruptcy. In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to terminate or renegotiate our contracts for various reasons, including those described above. As a result, we may be unable to realize all of our current contract drilling backlog. In addition, the termination, suspension or renegotiation of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations. +As of December 31, 2024, our contract drilling backlog in the United States for future revenues under term contracts, which we define as contracts with a duration of six months or more, was approximately $426 million. Please see Note 3 of Notes to consolidated financial statements in Item 8 of this Report for a description of our calculation of backlog. Our contract drilling backlog may decline, as fixed-term drilling contract coverage over time may not be offset by new contracts or may be reduced by price adjustments to existing contracts, including as a result of a decline in the price of oil and natural gas, capital spending reductions by our customers or other factors. For these and other reasons, our contract drilling backlog may not generate sufficient liquidity for us during periods of reduced demand for our services or otherwise. +New technologies may cause our operating methods, equipment, products and services to become less competitive, and higher levels of capital expenditures may be necessary to remain competitive. +The market for our services and products is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance, including environmental performance, of drilling services equipment, completion services equipment, and drilling products. Our customers are increasingly demanding the services of newer, higher specification drilling rigs and completion services and other equipment, as well as new and improved technology, such as drilling automation technology and lower-emissions operations and services, specialized drill bit solutions and data analytics. Accordingly, we may have to allocate a higher proportion of our capital expenditures to maintain and improve existing rigs and completion services and other equipment, purchase and construct newer, higher specification drilling rigs and completion services and other equipment to meet the increasingly sophisticated needs of our customers, and develop new and improved technology, specialized drill bit solutions and data analytics. In addition, technological changes, process improvements and other factors that increase operational efficiencies could continue to result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days. Technological and process developments in the completion services and other drilling services businesses could have similar effects. +We continually attempt to develop or acquire new technologies for use in our business. For example, we have invested in natural gas-powered equipment, including electric, direct drive, and dual fuel pumps, to replace legacy diesel completion services equipment. In the event that we are successful in developing or acquiring new technologies for use in our business, there is no guarantee of future demand for those technologies. Customers may be reluctant or unwilling to adopt our new technologies. We may also have difficulty negotiating satisfactory terms for our new technologies, including terms that would enable us to obtain acceptable returns on our investment in the development or acquisition of new technologies. +Development and acquisition of new technology is critical to maintaining our competitiveness. There can be no assurance that we will be able to successfully develop or acquire technology that our customers demand. Some of our competitors have greater financial, technical and personnel resources that may allow them to enjoy technological advantages and develop, acquire and implement new technology on a more timely basis or in a more cost-effective manner. If we are not successful keeping pace with technological advances in a timely and cost-effective manner, demand for our services may decline. If any technology that we need to successfully compete is not available to us or that we implement in the future does not work as we expect, we may be adversely affected. Additionally, new technologies, services or standards could render some of our equipment, services and products obsolete, which could reduce our competitiveness and have a material adverse impact on our business, financial condition, cash flows and results of operation. +17 +Table of Contents +Loss of key personnel and competition for experienced personnel may negatively impact our financial condition and results of operations. +We greatly depend on the efforts of our key employees to manage our operations. The loss of members of management could have a material adverse effect on our business. In addition, we utilize highly skilled field-based and non-field-based personnel in operating and supporting our businesses and in developing new technologies. In times of increasing demand for our services, it may be difficult to attract and retain qualified field-based and non-field-based personnel, particularly after a prolonged industry downturn. During periods of high demand for our services or inflation, wage rates for personnel are also likely to increase (and, during recent periods of high demand and inflation, have increased), resulting in higher operating costs. During periods of lower demand for our services, we may experience reductions in force and voluntary departures of personnel, which could adversely affect our business and make it more it difficult to meet customer demands when demand for our services improves. In addition, even in a period of generally lower demand for our services, if there is a high demand for our services in certain areas, it may be difficult to attract and retain qualified personnel to perform services in such areas. The loss of key employees, the failure to attract and retain qualified personnel and the increase in labor costs could have a material adverse effect on our business, financial condition, cash flows and results of operations. +The loss or consolidation of key customers could have a material adverse effect on our financial condition and results of operations. +Business consolidations within the oil and natural gas industry in recent years have resulted in some of our largest customers combining and using their size and purchasing power to seek economies of scale and pricing concessions. Continuing consolidation within the industry may result in reduced capital spending within the industry generally and by our customers specifically, all of which may lead to decreased demand for our products and services. There is no assurance that we will be able to maintain our level of business and profitability with a customer after its consolidation or replace that business and profit with other customers. Additionally, consolidation among our competitors could significantly alter industry conditions and competition within the industry. As a result, the acquisition of one or more of our key customers or consolidation among our competitors may have a significant adverse impact on our business, results of operations, financial condition and cash flows. We are unable to predict what effect further consolidation in the industry may have on capital spending by our customers, prices that we can charge, our selling strategies, our competitive position, our ability to retain customers or our ability to negotiate favorable agreements with our customers, and our revenue and profitability. +With respect to our consolidated operating revenues in 2024, we received approximately 53% from our ten largest customers, approximately 38% from our five largest customers and 11% from our largest customer. The loss of, or reduction in business from, one or more of our larger customers, due to consolidation or otherwise, could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Shortages, delays in delivery, and interruptions in supply, of equipment and materials could adversely affect our operating results. +Periodically, the oilfield services industry has experienced shortages of equipment for upgrades, drill pipe, raw materials, replacement parts and other equipment and materials, including, in the case of our completion services operations, proppants, cement, acid, gel and water. These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use. In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations. Interruptions may be caused by, among other reasons: +• weather issues, whether short-term such as a hurricane, or long-term such as a drought, +• labor shortages or other labor issues, +• transportation, fuel shortages and other logistical challenges, and +• a shortage in the number of vendors able or willing to provide the necessary equipment and materials, including as a result of commitments of vendors to other customers or third parties or bankruptcies or consolidation. +These price increases, delays in delivery and interruptions in supply may require us to delay operations, increase capital and repair expenditures or otherwise incur higher operating costs. During recent years, there have been significant disruptions and delays across the global supply chain, which have created a tightening of supplies and shortages in a number of areas, including basic raw materials. Severe shortages, delays in delivery and interruptions in supply could increase our costs and limit our ability to construct, operate, maintain and upgrade drilling services equipment, completion services equipment, drilling products and other equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations. +18 +Table of Contents +Our business is subject to cybersecurity risks and threats. +Our operations are increasingly dependent on effective and secure information technologies and services, including our own systems and the systems of third party vendors and service providers upon which we rely, such as those providing cloud services to us. Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow, and include, among other things, storms and natural disasters, terrorist attacks, utility outages, attempts to gain unauthorized access to data and systems, theft, viruses, malware, ransomware, denial-of-service attacks, design defects, human error, or complications encountered as existing systems are maintained, repaired, replaced, or upgraded. Risks associated with these threats include, among other things: +• theft or misappropriation of funds, including via “phishing” or similar attacks directed at us or third parties, including our customers and vendors; +• loss, corruption, or misappropriation of intellectual property, or other proprietary or confidential information (including customer, supplier, or employee data); +• disruption or impairment of our and our customers’ and vendors’ business operations and safety procedures; +• personal injuries and destruction or damage to property; +• downtime and loss of revenue; +• injury to our reputation, including the perception of our products or services as having security vulnerabilities; +• negative impacts on our ability to compete; +• loss or damage to our and our customers’ and vendors’ information technology systems, including operational technologies and worksite data delivery systems; +• exposure to litigation and legal and regulatory liability and costs; and +• increased costs to prevent, respond to or mitigate cybersecurity events. +Some of our office personnel are on a “remote work” model. This model has significantly increased the use of remote networking and online conferencing services that enable employees to work outside of our corporate infrastructure and, in some cases, use their own personal devices. This may expose us to additional cybersecurity risks or related incidents. Additionally, geopolitical tensions or conflicts may further heighten the risk of cybersecurity attacks and other cyber events. In particular, sophisticated nation state actors have targeted critical infrastructure and may continue to do so in the future. +Although we utilize various procedures and controls to mitigate our exposure to or limit the effects of the risks described above, cybersecurity attacks and other cyber events are evolving and unpredictable. In addition, there has been an increase in state-sponsored cyberattacks, which are often conducted by capable, well-funded groups. The rapid evolution and increased adoption of artificial intelligence technologies amplifies these concerns. There can be no assurance that the procedures and controls that we implement, or that our third party service providers implement, will be sufficient to protect our people, systems, information or other property. Moreover, we have no control over the information technology systems of our customers, suppliers, and others with which our systems may connect and communicate. As a result, the occurrence of a cyber incident could go unnoticed for a period of time. Even when an attack has been detected, it is not always immediately apparent what the full nature and scope of any potential harm may be, or how best to remediate it. We self-insure most of our cybersecurity risks, and any such incident could have a material adverse effect on our business, financial condition, cash flows and results of operations. As cyber incidents continue to evolve, we may be required to incur additional costs to continue to modify or enhance our protective measures or to investigate or remediate the effects of cyber incidents. +Our commitments under supply agreements could exceed our requirements, exposing us to risks including price, timing of delivery and quality of equipment and materials upon which our business relies. +We have purchase commitments with certain vendors to supply equipment and materials, including, in the case of our completion services business, proppants. Some of these agreements are take-or-pay or similar agreements with minimum purchase obligations. If demand for our services decreases from current levels, demand for the equipment that we use and the materials that we supply as part of these services will also decrease. In addition, our customers may self-source certain materials. If demand for our services and/or materials decreases enough, we could have contractual minimum commitments that exceed the required amount of materials we need to supply to our customers. In this instance, we could be required to purchase materials that we do not have a present need for, pay for materials that we do not take delivery of or pay prices in excess of market prices at the time of purchase. +19 +Table of Contents +Growth through acquisitions, the building or upgrading of equipment and the development of technology is not assured. +We have grown our drilling rig fleet and completion services fleet and expanded our business lines and use of technology in the past through mergers, acquisitions, upgrades, new construction and technology development. For example, in 2023, we significantly expanded our completions business through the NexTier merger, and we added a specialized drill bit solutions business through the Ulterra acquisition. There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building or upgrading equipment or developing or acquiring new technology. We are also likely to continue to face intense competition from other companies for available acquisition opportunities. In addition, because improved technology has enhanced the ability to recover oil and natural gas, our competitors may continue to upgrade and build new equipment and develop new technology, including drilling automation technology and lower-emissions operations and services. +There can be no assurance that we will: +• successfully complete any acquisitions we attempt on the terms announced, or at all, +• have sufficient capital resources to complete additional acquisitions, build or upgrade equipment or develop or acquire new technology, +• through due diligence conducted prior to an acquisition, successfully uncover situations that could result in financial or legal exposure, or appropriately quantify the exposure from known risks, +• successfully integrate additional equipment, acquired or developed technology or other assets or businesses, including the combination of our business with the businesses of NexTier and Ulterra, into our operations and internal controls, including financial reporting disclosure and enterprise resource planning, cybersecurity and information technology systems, +• effectively manage the growth and increased size, complexity and geography of our organization, and increased scrutiny from governmental authorities, +• maintain existing business relationships and contract terms with our customers, distributors, suppliers, vendors, landlords, joint venture partners and other business partners, as well as with those of any acquired business, +• successfully deploy idle, stacked, upgraded or additional equipment and acquired or developed technology, +• maintain key employees, the crews necessary to operate additional equipment, and the personnel necessary to evaluate, acquire, develop and deploy new technology, or be successful in hiring replacements for departing personnel, +• avoid unknown liabilities and unforeseen increased expenses or delays associated with any merger or acquisition, or +• successfully improve our financial condition, results of operations, business or prospects, or provide an adequate return of capital, as a result of any completed acquisition, the building or upgrading equipment or the development of new technology. +Our failure to achieve consolidation savings, to integrate acquired businesses and technology and other assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our business. In addition, we may incur liabilities arising from events occurring prior to any completed acquisitions, prior to our establishment of adequate compliance oversight or in connection with disputes over acquired or developed technology. While we generally seek to obtain indemnities or insurance for liabilities arising from events occurring before such acquisitions, we may be unable to do so, and any indemnities or insurance we do obtain will be limited in amount and duration, and indemnities may be held to be unenforceable or the seller may not be able to indemnify us. +We may incur substantial indebtedness to finance future acquisitions, build or upgrade equipment or acquire or develop new technology, and we also may issue equity, convertible or debt securities in connection with any such acquisitions, building or upgrade program or technology development. Use of cash for these purposes may adversely affect our cash available for capital expenditures and other uses, debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders. Also, continued growth and resulting integration efforts could strain our management, operations, employees and other resources. +Complications with the design or implementation of our new enterprise resource planning system could adversely impact our business and operations. +We rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of implementing a new enterprise resource planning (“ERP”) system that expands and enhances one of our existing ERP systems to address the operations of our combined company. This ERP system will replace our existing operating and financial systems. The ERP system is designed to accurately maintain our financial records, enhance operational functionality and provide +20 +Table of Contents +timely information to our management team related to the operation of our integrated business. The ERP system implementation process will require the investment of significant personnel and financial resources. We may be unable to successfully implement the ERP system without experiencing delays, increased costs and other difficulties. If we are unable to successfully design and implement the new ERP system as planned, our financial position, results of operations and cash flows could be negatively impacted. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting and disclosure controls and procedures could be adversely affected or our ability to assess those controls adequately could be delayed. +Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas, which would, in turn, reduce the demand for our services. +Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas may have a material adverse effect on our business, financial condition, cash flows and results of operations. Additionally, the increased competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, and biofuels) or increased focus on reducing the use of oil and natural gas (such as governmental mandates that ban the sale of new gasoline-powered automobiles, and new legislation such as the Inflation Reduction Act of 2022, which contains tax inducements and other provisions that incentivize investment, development, and deployment of alternative energy sources and technologies) could reduce demand for oil and natural gas and therefore for our services, which would lead to a reduction in our revenues. +Legal and Regulatory Risks +The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition. +Various federal and state legislative and regulatory initiatives have been or could be undertaken that could result in additional requirements or restrictions being imposed on hydraulic fracturing operations or result in the failure to obtain or difficulty or delay in obtaining required permits, renewals or authorizations. For example, legislation and/or regulations have been adopted in many U.S. states that require additional disclosure regarding chemicals used in the hydraulic fracturing process. Legislation, regulations, and/or policies have also been adopted at the state level that impose other types of requirements on hydraulic fracturing operations (such as limits on operations in the event of certain levels of seismic activity). Additional legislation and/or regulations have been adopted or are being considered at the state and local level that could impose further chemical disclosure or other regulatory requirements (such as prohibitions on hydraulic fracturing operations in certain areas) and/or other limitations on hydraulic fracturing operations via time, place, and manner restrictions) that could affect our operations, and it is possible that these state and local efforts may increase in the absence of federal actions and/or in light of federal regulatory uncertainty. Four states (New York, Maryland, Vermont, and Washington) have banned the use of high volume hydraulic fracturing, Oregon has adopted a five-year moratorium, California has taken regulatory action to phase out hydraulic fracturing permitting and activities in the state, and Colorado has enacted legislation providing local governments with regulatory authority over hydraulic fracturing operations. Local jurisdictions in some states have adopted ordinances that restrict or in certain cases prohibit the use of hydraulic fracturing, although many of these ordinances have been challenged and some have been overturned. The adoption of any future federal, state or local laws or regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition. +Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services. +The physical and regulatory effects of climate change could have a negative impact on our operations, our customers’ operations and the overall demand for our customers’ products and, accordingly, our services. There is an increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues. Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation. These efforts have included consideration of cap-and-trade programs, carbon taxes, GHG reporting, tracking programs, attestation requirements and regulations that directly limit GHG emissions from certain sources. Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions. Those reductions could be costly and difficult to implement. In addition to such legislative efforts, the EPA has determined that GHG emissions present a danger to public health and the environment and has adopted regulations that, among other things, establish construction and operating permit reviews for GHG emissions from certain large stationary sources, require the monitoring and annual reporting of GHG emissions from certain oil and natural gas system sources, implement CAA emission standards directing the reduction of methane emissions from certain new, +21 +Table of Contents +modified, or reconstructed facilities in the oil and natural gas sector, and together with the U.S. Department of Transportation, implement GHG emissions limits on vehicles manufactured for operation in the United States. For example, generators are subject to limits on their emissions of other hazardous air pollutants including mercury under an expanded Mercury and Air Toxics Standards rule adopted by the Biden Administration in 2024. In December 2023, the EPA issued a final rule updating New Source Performance Standards (NSPS) and providing emission guidelines to reduce methane and other pollutants from the oil and gas industry. Additionally, the location and operation of oil and natural gas production is impacted by laws concerning impacts to protected species and their habitats. The federal Endangered Species Act, as amended (“ESA”), restricts activities in the United States that may affect endangered or threatened species and/or their habitats. If endangered species and/or their habitats are located in areas of the United States with oil and natural gas exploration and production operations, such operations can be prohibited or delayed or require potentially costly mitigation efforts. Additionally, in the absence of federal action and listing of endangered species and habitats, states and local governments may increasingly attempt to step in to subject such species and habitats to state protections under analogous state statutes. Changes to the designation of previously unprotected species as threatened or endangered or designation of previously unprotected habitat as critical habitat in areas of the United States can result in limitations on exploration and production activities, impacting our and our customers’ operating costs and demand for services. +In November 2021, the United States and other countries entered into the Glasgow Climate Pact, which includes a range of measures designed to address climate change, including but not limited to the phase-out of fossil fuel subsidies, reducing methane emissions 30% by 2030, and cooperating toward the advancement of the development of clean energy. Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting certain emissions reduction goals. +Governmental, scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks in the United States. A number of new GHG-related initiatives went into effect under the prior Biden Administration, which initiatives may be modified or reversed under the Trump Administration. The Trump Administration may diverge from the Biden Administration’s positions and could withdraw from or otherwise roll back existing GHG commitments. For example, in January 2025, President Trump signed an executive order to withdraw the United States from the Paris Agreement. While it is not possible at this time to predict exactly which and to what extent such commitments will be modified, and how any such actions may impact our business, such actions could prompt more activity from state and local legislative bodies and administrative agencies to pass stricter GHG laws, regulations, and other binding commitments. +It is not possible at this time to predict the timing and effects of climate change or whether additional climate-related legislation, regulations or other measures will be adopted at the local, state, regional, national and international levels. However, continued efforts by governments and non-governmental organizations to reduce GHG emissions appear likely, and additional legislation, regulation or other measures that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our business. The cost of complying with any new law, regulation or treaty will depend on the details of the particular program. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations increase compliance costs, add operating restrictions, or reduce demand for our customers’ products and, accordingly, our services. +Increasing attention to the risks of climate change has resulted in an increased possibility of lawsuits or investigations brought by public and private entities against oil and natural gas companies in connection with their GHG emissions. Should we be targeted by any such litigation or investigations, we may incur liability, which, to the extent that societal pressures or political or other factors are involved, could be imposed without regard to the causation of or contribution to the asserted damage, or to other mitigating factors. +These political, litigation, and financial risks may result in our customers restricting or cancelling production activities, incurring liability for infrastructure damage as a result of climatic changes, or impairing their ability to continue to operate in an economic manner, which also could reduce demand for our products and services. One or more of these developments could have a material adverse effect on our business, financial condition, cash flows and results of operations. Finally, increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, floods and other climatic events. If any such effects were to occur, they could have an adverse effect on our and our customers’ facilities and operations. +22 +Table of Contents +Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results. +Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells. The cost of compliance with these laws and regulations could be substantial. +For example, in the United States, the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (“CERCLA”), and comparable state statutes impose strict liability on owners and operators of sites, including prior owners and operators who are no longer active at a site, as well as persons who disposed of or arranged for the disposal of “hazardous substances” found at sites. +The Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions may be deleted, limited, or modified in the future. The Clean Water Act (“CWA”) and analogous state laws provide for administrative, civil and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1999, as amended, impose liability for the remedial costs and associated damages arising out of any unauthorized discharges, including oil and produced water spills, into jurisdictional waters. +Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Clean Air Act. We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions. We are also subject to regulation by numerous other regulatory agencies, including, but not limited to, the U.S. Department of Labor, which oversees employment practice standards. +Furthermore, the U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees. The OSHA hazard communication standard, EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens. Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety. +Other jurisdictions where we may conduct operations have similar environmental, employee health and safety and other regulatory regimes with which we would be required to comply. These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications. These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment. +A failure to comply with these requirements could expose us to: +• substantial civil, criminal and/or administrative penalties or judgments, +• modification, denial or revocation of permits or other authorizations, +• imposition of limitations on our operations, and +• performance of site investigatory, remedial or other corrective actions. +In addition, environmental laws and regulations in the places that we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills. As an owner and operator of land-based drilling rigs and completion services equipment, a manufacturer and servicer of equipment and automation to the energy, marine and mining industries and a provider of directional drilling and other services, we may be deemed to be a responsible party under these laws and regulations. In the event hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations, any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations. In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials. We could be required to remove or remediate wastes disposed of or released by prior +23 +Table of Contents +owners or operators. In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator. +Intellectual property disputes could negatively impact our operations, costs, revenues and competitiveness. +Our services and products use proprietary technology and equipment, which can involve potential infringement of a third party’s rights, or a third party’s infringement of our rights, including patent rights. The majority of the intellectual property rights relating to our drilling services equipment, completion services equipment, and drilling products are owned by us or certain of our supplying vendors. However, in the event that we or one of our customers or supplying vendors becomes involved in a dispute over infringement of intellectual property rights relating to equipment or technology owned or used by us, services performed by us or products provided by us, we may lose access to important equipment or technology or our ability to provide services or products, or we could be required to cease use of some equipment or technology or forced to modify our equipment, technology, services or products. We could also be required to pay license fees or royalties for the use of equipment or technology or provision of services or products. In addition, we may lose a competitive advantage in the event we are unsuccessful in enforcing our rights against third parties, third parties are successful in enforcing their rights against us, or our competitors are able to develop technology independently that is similar to ours without infringing on our patents or gaining access to our trade secrets. +Regardless of the merits, any such claims may result in significant legal and other costs, including reputational harm, and may distract management from running our business. Some of our competitors and current and potential vendors have a substantial amount of intellectual property related to new equipment and technologies. We cannot guarantee that our equipment, technology, services or products will not be determined to infringe currently issued or future issued patents or other intellectual property rights belonging to others, including, without limitation, situations in which our equipment, technology, services or products may be covered by patent applications filed by other parties. Technology disputes involving us or our customers or supplying vendors could have a material adverse impact on our business, financial condition, cash flows and results of operations. +Certain subsidiaries we acquired in the Ulterra acquisition are defendants in a claim brought by a subsidiary of NOV Inc. alleging breach of a license agreement related to certain patents. Such subsidiaries have asserted defenses to the claim and are defending vigorously against this claim. An unfavorable judgment or resolution of this claim not covered by indemnity could have a material impact on our financial results. +The design, manufacture, sale or rental and servicing of products, including drill bits and electrical controls, may subject us to liability for personal injury, property damage and environmental contamination. +We provide products, including specialized drill bit solutions and electrical controls, to customers involved in oil and natural gas exploration, development and production and in the marine and mining industries. Because of applications that use our products and services, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause harm to our reputation, contractual and warranty-related liability, damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, leading to claims against us. Any lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. +Legal proceedings and governmental investigations could have a negative impact on our business, financial condition and results of operations. +The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time. In addition, during periods of depressed market conditions, we may be subject to an increased risk of our customers, vendors, current and former employees and others initiating legal proceedings against us. Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Please see “Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business. +We provide specialized drill bit solutions throughout North America and internationally in over 30 countries, as well as contract drilling services in Colombia and Ecuador. We also sell products, including electrical controls, for use in numerous oil and natural gas producing regions outside of North America. In addition, through our Superior QC business, we occasionally provide remote data analytics and other services to customers to support their operations outside of the United States. One of our subsidiaries recently closed a joint venture in Abu Dhabi. We also continue to evaluate opportunities from time to time to provide our services and products +24 +Table of Contents +outside of the United States. International operations and sales or rentals of products are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, changing political conditions and changing laws and policies affecting trade and investment, strikes, work stoppages, labor disputes and other slowdowns, terrorism, war, kidnapping of employees, blockades, regional economic downturns, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, difficulty in collecting international accounts receivable, potentially longer payment cycles, expropriation of equipment as well as expropriation of oil and natural gas exploration and drilling rights, foreign taxation and customs regulations, the overlap of different tax structures, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted. +There can be no assurance that there will not be changes in local laws, regulations and administrative requirements, or the interpretation thereof, which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas. Because of the impact of local laws, any current and future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures, such as our Abu Dhabi joint venture) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities. While we do not control the actions of our joint venture partners, their actions could have an effect on our investment in the joint ventures and more generally our overall reputation. While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable. Additionally, we may be subject to foreign governmental regulations favoring or requiring the awarding of contracts to local contractors or requiring foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. These regulations could adversely affect our ability to compete. +There can be no assurance that we will: +• identify attractive opportunities in international markets, +• have sufficient capital resources to pursue and consummate international opportunities, +• successfully integrate international drilling and completion operations or other assets or businesses, +• effectively manage the start-up, development and growth of an international organization and assets, +• hire, attract and retain the personnel necessary to successfully conduct international operations, or +• receive awards for work and successfully improve our financial condition, results of operations, business or prospects as a result of the entry into one or more international markets. +In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business. Some parts of the world where our services are or could be provided or where our consumers for products are located have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business. Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation. In addition, investors could negatively view potential violations, inquiries or allegations of misconduct under the FCPA or similar laws, which could adversely affect our reputation and the market for our shares. We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, completion services equipment, manufacturing facilities, drilling products or other assets. +Many countries, including the United States, control the import and export of certain goods, services and technology and impose related import and export recordkeeping and reporting obligations. Governments also may impose economic sanctions against certain countries, persons and other entities that may restrict or prohibit transactions involving such countries, persons and entities. In particular, U.S. sanctions are targeted against certain countries that are heavily involved in the oil and natural gas industry. The laws and regulations concerning import and export activity, recordkeeping and reporting, including customs, export controls and economic sanctions, are complex and constantly changing. Any failure to comply with applicable legal or regulatory requirements governing international trade could also result in criminal and civil penalties and sanctions, such as fines, imprisonment, debarment from government contracts, seizure of shipments and loss of import and export privileges. +We may incur substantial indebtedness to finance an international transaction or operations, and we also may issue equity, convertible or debt securities in connection with any such transactions or operations. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities +25 +Table of Contents +could be dilutive to existing stockholders. Also, international expansion could strain our management, operations, employees and other resources. +The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operations. +We are subject to complex and evolving laws and regulations regarding data privacy and security. +Governments around the world have implemented, and continue to implement, laws and regulations regarding data privacy and security, including with respect to the protection and processing of personal employee and customer data. These laws and regulations vary from jurisdiction to jurisdiction, and we are obligated to comply in all jurisdictions in which we conduct business. In the normal course of business, we and our third-party vendors or service providers may collect, process, and store data that is subject to those specific laws and regulations governing personal data. Failure to comply with these laws and regulations could subject us to significant liability, including fines, penalties, and potential criminal sanctions. +Financial Risks +Investor sentiment and public perception related to the oil and natural gas industry and to ESG initiatives could increase our costs of capital and our reporting requirements and impact our operations. +There are financial risks for oil and natural gas producers, as stockholders and bondholders currently invested in oil and natural gas companies and concerned about the potential effects of climate change, ESG and other sustainability-related issues may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors, or into competitors who are perceived to have stronger ESG practices and disclosures. At the same time, some stakeholders and regulators have increasingly expressed or pursued opposing views, legislation, and investment expectations with respect to ESG, including the enactment or proposal of “anti-ESG” legislation or policies. In addition, other parties such institutional lenders may consider sustainability factors in lending to us or our customers. Limitations of investments in and financing for oil and natural gas could result in the restriction, delay, or cancellation of drilling and completion programs or development of production activities. Our ESG practices and, through the publishing of our Sustainability Report from time to time, disclosures may be subject to increased scrutiny and may not satisfy the requirements of all stakeholders or their requirements may not be made known to us. We may continue to face pressure regarding our ESG practices and disclosures. +We have developed, and will continue to develop, goals and other objectives related to ESG and sustainability matters. Statements related to these goals and objectives made in our published Sustainability Report and other public disclosure reflect our current plans and do not constitute a guarantee that they will be achieved. Our ability to achieve any stated goal or objective is subject to numerous factors and conditions, some of which are outside of our control. Our efforts to accurately report on ESG and sustainability matters, including our efforts to research, establish, accomplish and accurately report on our goals and objectives, expose us to numerous operational, reputational, financial, legal, and other risks. Standards for tracking and reporting on ESG and sustainability matters, including climate-related matters, have not been harmonized and continue to evolve. Our processes and controls for reporting on ESG and sustainability matters, including our goals and objectives, may not always comply with evolving and disparate standards for identifying, measuring, disclosing and reporting such metrics, and such standards may change over time, which could result in significant revisions to our current ESG practices and disclosures. +Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly. +In January 2025, we put in place a committed senior unsecured revolving credit facility that amended the Prior Credit Agreement. Under the Credit Agreement, interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, the SOFR rate (plus a 0.10% per annum adjustment) or base rate, in each case subject to a 0.00% floor. Under the Credit Agreement, the applicable margin on SOFR rate loans varies from 1.25% to 2.25% and the applicable margin on base rate loans varies from 0.25% to 1.25%, in each case determined based on our credit rating. As of December 31, 2024, under the Prior Credit Agreement, the applicable margin on SOFR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. As of December 31, 2024, we had no borrowings outstanding under the Prior Credit Agreement. +We also have in place a reimbursement agreement pursuant to which we are required to reimburse the issuing bank on demand for any amounts that it has disbursed under any of our letters of credit issued thereunder. We are obligated to pay the issuing bank interest on all amounts not paid by us on the date of demand or when otherwise due at the Prime rate plus 2.00% per annum. As of December 31, 2024, no amounts had been disbursed under any letters of credit, and we had $38.8 million in letters of credit outstanding under the reimbursement agreement. +26 +Table of Contents +Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed at floating rates under these agreements or under future agreements, as well as the terms of any future amendments to our existing agreements or future agreements. +Our ability to access capital markets could be limited, and a downgrade in our credit rating could negatively impact our cost of and ability to access capital. +From time to time, we may need to access capital markets to obtain financing. Our ability to access capital markets for financing could be limited by oil and natural gas prices, our existing capital structure, the state of the economy, the health or market perceptions of the drilling and overall oil and natural gas industry, the liquidity of the capital markets and ESG-related regulatory and investor requirements and other factors. Many of the factors that affect our ability to access capital markets are outside of our control. No assurance can be given that we will be able to access capital markets on terms acceptable to us when required to do so, which could have a material adverse impact on our business, financial condition and results of operations. +Additionally, our ability to access capital markets or to otherwise obtain sufficient financing is enhanced by our senior unsecured debt ratings as provided by major U.S. credit rating agencies. Factors that may impact our credit ratings include debt levels, liquidity, asset quality, cost structure, commodity pricing levels, industry conditions and other considerations. A ratings downgrade could adversely impact our ability in the future to access debt markets, increase the cost of future debt, impact the terms of future amendments to our senior unsecured credit facility and potentially require us to post letters of credit for certain obligations. +We may not be able to generate sufficient cash to service all of our debt and we may be forced to take other actions to satisfy our obligations under our debt, which may not be successful. +Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial and operating performance, including the ability of our subsidiaries to generate sufficient cash flows, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. +In addition, if our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our debt. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and would permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our debt agreements contain restrictions on our ability to dispose of assets. We may not be able to consummate those dispositions, and any proceeds may not be adequate to meet any debt service obligations then due. +Our return of capital to stockholders, including through the payment of dividends and repurchases of our common stock, is within the discretion of our Board of Directors, and there is no guarantee that we will return capital to shareholders, including through the payment of dividends and repurchases of our common stock, in the future or at levels anticipated by our stockholders. +Although we currently plan to return capital to stockholders, the amount and timing of returns of capital to stockholders may vary from time to time. The amount and timing of all returns of capital, including future dividend payments and purchases pursuant to our stock buyback program, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend or limit, suspend or terminate our stock repurchase program. There can be no assurance that we will pay a dividend or make repurchases of our common stock in the future. The payment of dividends and stock repurchases could diminish our cash reserves, which may impact our ability to meet our working capital needs, satisfy our debt obligations, make capital expenditures, grow and pursue strategic opportunities and acquisitions. In addition, any elimination of, or downward revision in, our stock buyback program or dividend payments could have an adverse effect on the market price of our common stock. +Our ability to utilize our historic U.S. net operating loss carryforwards is expected to be limited as a result of the completion of the NexTier merger. +As of December 31, 2024, we had approximately $1.5 billion of gross U.S. federal net operating losses, approximately $58.7 million of gross Canadian net operating losses and approximately $910 million of post-apportionment U.S. state net operating losses as of December 31, 2024, before valuation allowances. The majority of the U.S. federal net operating losses are generated after 2017 +27 +Table of Contents +and can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2044. U.S. state net operating losses will expire in varying amounts, if unused, between 2025 and 2044. +Section 382 of the Internal Revenue Code (“Section 382”) generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). An ownership change generally occurs if one or more stockholders (or groups of stockholders) who are each deemed to own at least 5% of such corporation’s stock has increased their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change occurs, utilization of the relevant corporation’s NOLs would be subject to an annual limitation under Section 382, generally determined, subject to certain adjustments, by multiplying (i) the fair market value of such corporation’s stock at the time of the ownership change by (ii) a percentage approximately equivalent to the yield on long-term tax-exempt bonds during the month in which the ownership change occurs. Any unused annual limitation may be carried over to later years. +We experienced an ownership change (under Section 382) as a result of the closing of the NexTier merger. Our ability to utilize our available NOLs and other tax attributes to reduce future taxable income following this “ownership change” depends on many factors, including our future income, which cannot be assured. Based on information currently available, we expect this ownership change could cause some of our NOLs incurred prior to January 1, 2018 to expire before we would be able to utilize them to reduce taxable income in future periods, and may also require NOLs to be utilized later than they otherwise would be able to be utilized, increasing cash taxes payable in earlier years. +Risks Related to Our Common Stock and Corporate Structure +The market price of our common stock may be highly volatile, and investors may not be able to resell shares at or above the price paid. +The trading price of our common stock may be volatile. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as other general economic, market or political conditions, could reduce the market price of our common stock in spite of our operating and/or financial performance. The following factors, in addition to other factors described in this “Risk Factors” section and elsewhere in this Report, may have a significant impact on the market price of our common stock: +• investor perception of us and the industry and markets in which we operate; +• general financial, domestic, international, economic, and market conditions, including overall fluctuations in the U.S. equity markets; +• increased focus by the investment community on sustainability practices at our company and in the oil and natural gas industry generally; +• changes in customer needs, expectations or trends and our ability to maintain relationships with key customers; +• our ability to implement our business strategy; +• changes in our capital structure, including the issuance of additional debt; +• public announcements (including the timing of these announcements) regarding our business, financial performance and prospects or new services or products, service or product enhancements, technological advances or strategic actions, such as acquisitions or divestitures, restructurings or significant contracts, by our competitors or us; +• trading activity in our stock, including portfolio transactions in our stock by us, our executive officers and directors, and significant stockholders or trading activity that results from the ordinary course rebalancing of stock indices in which we may be included; +• any elimination of, or downward revision in, our stock buyback program or dividend payments; +• short-interest in our common stock, which could be significant from time to time; +• our inclusion in, or removal from, any stock indices; +• changes in earnings estimates or buy/sell recommendations by securities analysts; +• whether or not we meet earnings estimates of securities analysts who follow us; and +• regulatory or legal developments in the United States and the foreign countries where we operate. +28 +Table of Contents +Anti-takeover measures in our charter documents and under state law could discourage an acquisition and thereby affect the related purchase price. +We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law. Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock. It also prohibits stockholders from acting by written consent without the holding of a meeting. In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder. As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us. This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions. +Our bylaws provide that the Court of Chancery of the State of Delaware and the federal district courts of the United States are the exclusive forums for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees. +Our bylaws provide that, to the fullest extent permitted by law, the Court of Chancery of the State of Delaware (or, if the Court of Chancery does not have, or declines to accept, jurisdiction, another state court or a federal court located within the State of Delaware) is the exclusive forum for any claims, including claims in the right of Patterson-UTI: (a) that are based upon a violation of a duty by a current or former director, officer, employee or stockholder in such capacity, or (b) as to which the General Corporation Law of the State of Delaware confers jurisdiction upon the Court of Chancery. This provision would not apply to suits brought to enforce a duty or liability created by the Exchange Act or any other claim for which the U.S. federal courts have exclusive jurisdiction. Our bylaws further provide that the sole and exclusive forum for any complaint asserting a cause of action arising under the Securities Act, to the fullest extent permitted by law, shall be the federal district courts of the United States. The enforceability of similar exclusive federal forum provisions in other companies’ organizational documents has been challenged in legal proceedings, and while the Delaware Supreme Court has ruled that this type of exclusive federal forum provision is facially valid under Delaware law, there is uncertainty as to whether other courts would enforce such provisions and that investors cannot waive compliance with the federal securities laws and the rules and regulations thereunder. These exclusive forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find either exclusive forum provision in our bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could have a material adverse effect on our business, financial condition, and results of operations. +Item 1B. Unresolved Staff Comments. +None. +Item 1C. Cybersecurity +We have implemented and maintain a cybersecurity program that is aligned with the NIST Framework and designed to protect our information and to assess, identify, and manage risks from cybersecurity threats that may result in material adverse effects on the confidentiality, integrity, and availability of our information systems. +Governance +Our Board of Directors has delegated the primary responsibility to oversee cybersecurity matters to the Audit Committee. The Audit Committee periodically reviews the measures implemented by the Company to identify and mitigate data protection and cybersecurity risks. As part of such reviews, the Audit Committee receives reports and presentations from members of our senior leadership for overseeing the company’s cybersecurity risk management, including the Senior Vice President of Information Technology, which address a wide range of topics including recent developments, evolving standards, vulnerability assessments, third-party and independent reviews, the threat environment, technological trends and information security considerations arising with respect to the Company’s peers and third parties. We have protocols by which certain cybersecurity incidents are escalated within the Company and, where appropriate, reported promptly to the Board of Directors and Audit Committee. +Our Audit Committee is responsible for overseeing information security and cybersecurity risk. Senior leadership communicates with the Audit Committee at least quarterly regarding information security and cybersecurity risk and formally reports to the entire Board of Directors on information security and cybersecurity risk at least annually . +29 +Table of Contents +At the management level, our Senior Vice President of Information Technology, who has extensive cybersecurity knowledge and skills gained from over 19 years of work experience at our company and elsewhere, heads the team responsible for implementing, monitoring, and maintaining information security and cybersecurity practices across our businesses and reports directly to our Chief Financial Officer. +The Senior Vice President of Information Technology receives reports on information security and cybersecurity threats from our Director of Infrastructure and Cybersecurity and in conjunction with management, regularly reviews risk management measures implemented by our company to identify and mitigate information security and cybersecurity risks. A number of experienced information security team members responsible for various parts of the business also report to the Senior Vice President of Information Technology on an ongoing basis. In addition to our internal cybersecurity capabilities, we also regularly engage assessors, consultants, auditors, and other third parties to assist with assessing, identifying, and managing cybersecurity risks. +We have adopted a cybersecurity incident reporting process (“IRP”) that applies in the event of a cybersecurity threat or incident to provide a standardized framework for response. The IRP sets out a coordinated approach to investigating, containing, documenting, and mitigating incidents, including reporting findings and keeping senior management, the Board of Directors and other key stakeholders informed and involved as appropriate. +Risk Management and Strategy +Our senior management and representatives from our business units regularly communicate with the Board of Directors on risk management matters, including cybersecurity risks. Senior management conducts regular risk assessments to identify risks that have the potential to significantly affect our business over the short-, medium- and longer term and reviews with the Board of Directors risk mitigation and oversight measures, including prioritization of risk management and allocation of responsibility within our company for the management of a particular risk. +We continue to improve our cybersecurity risk assessment program and activities for assessing, identifying and managing cybersecurity risks through industry standard security frameworks and leading practices, including risk assessments and remediations, software and services, continuous systems monitoring, vendor risk management processes, incident response plans, phishing simulations, employee training, tabletop exercises and communication programs, among other measures. We also employ processes designed to assess, identify, and manage the potential impact of a security incident at critical third-party vendors, service providers or customers or otherwise implicating the third-party technology and systems we use. +All employees with a company-provided email are assigned annual cyber awareness training. In addition, we perform monthly phishing simulations, with remediation training required as necessary. +While we have not experienced material cybersecurity threats or incidents, or threats or incidents that are reasonably likely to materially affect us, there can be no guarantee that we will not be the subject of future successful attacks, threats or incidents. Information on cybersecurity risks and threats we face can be found in Part I, Item 1A “Risk Factors” of this Report under the heading “Our business is subject to cybersecurity risks and threats.” +Item 2. Properties +Our property consists primarily of drilling rigs and related equipment, completion services equipment and rental bits. We own substantially all of the equipment used in our businesses. +Our corporate headquarters is in leased office space and is located at 10713 W. Sam Houston Parkway N., Suite 800, Houston, Texas, 77064. Our telephone number at that address is (281) 765-7100. +Drilling Services — Our drilling services are supported by multiple offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania, Ohio, and internationally in Colombia and Ecuador. Our servicing of equipment for drilling contractors is supported by offices and yard facilities located in Texas. Our electrical controls and automation operation is supported by an office and yard facility in Texas. +Completion Services — Our completion services are supported by multiple offices and yard facilities located in the Permian, Marcellus Shale/Utica Basins, Haynesville and Eagle Ford, among others. +Drilling Products — Our drilling products segment is supported by multiple offices and manufacturing and distributing facilities located throughout North America and internationally in over 30 countries. +30 +Table of Contents +Other — Our oilfield rental operations are supported by offices and yard facilities located in Texas, Oklahoma and Ohio. Our interests in oil and natural gas assets are primarily located in Texas and New Mexico. +We own or lease administrative offices, manufacturing facilities, research centers, and other facilities throughout the world, none of which is individually material. We believe that our existing facilities are suitable and adequate to meet our needs. +We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Report. +Item 3. Legal Proceedings. +Certain subsidiaries we acquired in the Ulterra acquisition are defendants in a claim brought by a subsidiary of NOV Inc. alleging breach of a license agreement related to certain patents. Such subsidiaries have asserted defenses to the claim and are defending vigorously against this claim. +The case is Grant Prideco, Inc., et al. v. Schlumberger Technology Corp., et al., in Texas State Court, District of Harris County, 11th Judicial District. On February 6, 2023, Grant Prideco, Inc., ReedHycalog UK, Ltd. ReedHycalog, LP, National Oilwell Varco, LP (“NOV”) sued Ulterra Drilling Technologies, LP (“Ulterra”) and several other companies. NOV seeks a declaration that United States Patent No. 8,721,752 (the “’752 Patent”) is a “Licensed RH Patent” per the terms of a license agreement between Ulterra and NOV. NOV also alleges a breach of contract based on the license agreement between NOV and Ulterra and seeks allegedly owed royalties since October 22, 2021. NOV also seeks attorney’s fees. +On February 27, 2023, Ulterra filed a plea to the jurisdiction, and subject thereto, an answer, affirmative defenses and counterclaims. Ulterra’s counterclaims include: (i) declaratory judgments of non-infringement of U.S. Pat. No. 7,568,534 and the ’752 patent; (ii) a declaratory judgment of no royalties after Oct. 22, 2021; (iii) a declaratory judgment that certain other identified patents are expired and therefore not infringed after Oct. 22, 2021; and (iv) a declaratory judgment of no breach of contract. On the same day, Ulterra filed a notice of removal in federal court for the Southern District of Texas, Houston Division (SDTX 4:23-cv-00730), as well as a corresponding notice in Texas state court. NOV moved to dismiss and remand the case back to state court. On February 17, 2024, the Court denied NOV’s motion. +Discovery is closed and dispositive motions are scheduled to be fully briefed by the end of March 2025. Trial is currently scheduled for March 31, 2025. An unfavorable judgment or resolution of this claim not covered by indemnity could have a material impact on our financial results. +Additionally, we are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +Item 4. Mine Safety Disclosure. +Not applicable. +31 +Table of Contents +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +(a) Market Information +Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P SmallCap 600 Index and several other market indices. +(b) Holders +As of February 6, 2025, there were approximately 800 holders of record of our common stock. +(c) Dividends +On February 5, 2025, our Board of Directors approved a cash dividend on our common stock in the amount of $0.08 per share to be paid on March 17, 2025 to holders of record as of March 3, 2025. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend for any reason, including to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +(d) Issuer Purchases of Equity Securities +The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2024. +Period Covered +Total Number of Shares Purchased (1) +Average Price Paid per Share Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (in thousands) (2) +October 2024 10,599 $ 8.32 — $ 779,655 +November 2024 — $ — — $ 779,655 +December 2024 2,625,921 $ 7.89 2,625,921 $ 758,934 +Total 2,636,520 2,625,921 +(1) 10,599 shares were withheld in the fourth quarter with respect to employees’ tax withholding obligations upon the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan, as amended and the NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan and not pursuant to the stock buyback program. +(2) In September 2013, our Board of Directors approved a stock buyback program. In February 2024, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $1.0 billion of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the buyback program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. +(e) Performance Graph +The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2019 through December 31, 2024, with the cumulative total return of the S&P 500 Index, the S&P SmallCap 600 Index and the Oilfield Service Index. +32 +Table of Contents +The graph assumes investment of $100 on December 31, 2019 and reinvestment of all dividends. +Index Data: Copyright Standard and Poor’s, Inc. Used with permission. All rights reserved. +Fiscal Year Ended December 31, +Company/Index 2019 ($) 2020 ($) 2021 ($) 2022 ($) 2023 ($) 2024 ($) +Patterson-UTI Energy, Inc. 100.00 51.19 83.08 167.56 110.30 87.21 +S&P 500 Index 100.00 118.39 152.34 124.73 157.48 196.85 +S&P SmallCap 600 Index 100.00 111.24 140.98 118.22 137.07 148.91 +Oilfield Service Index 100.00 57.92 69.94 112.94 115.10 101.68 +The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act. +Item 6. RESERVED +33 +Table of Contents +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Management Overview — We are a Houston, Texas-based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. +Drilling Services +Our contract drilling business operates in the continental United States and internationally in Colombia and Ecuador and, from time to time, we pursue contract drilling opportunities in other select markets. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and natural gas basins in the United States, and we provide services that improve the statistical accuracy of wellbore placement for directional and horizontal wells. We also service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. +We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super spec” rigs, which we consider as being a super-spec rig that also has a third mud pump and raised drawworks that allows for more clearance underneath the rig floor. As of December 31, 2024, our rig fleet included 135 Tier-1, super-spec rigs. +Completion Services +Our well completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. +To address evolving customer preferences for emissions-reducing equipment, we have invested in natural gas-powered equipment, including electric, direct drive, and dual fuel pumps, to replace legacy diesel completion services equipment. +Drilling Products +We serve the energy and mining markets by manufacturing and distributing drill bits throughout North America and internationally in over 30 countries. Our drilling equipment is used in oil and natural gas exploration and production and in mining operations. We have manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Recent Developments in Market Conditions and Outlook — Commodity prices have historically been volatile but have been relatively range-bound since the end of 2022. The current demand for equipment and services remains impacted by macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. +Oil prices averaged $70.73 per barrel in the fourth quarter of 2024 and closed at $73.52 per barrel on February 3, 2025. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.45 per MMBtu in the fourth quarter of 2024 and closed at $3.30 per MMBtu on February 3, 2025. +34 +Table of Contents +Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2022, 2023 and 2024 are as follows: +1 st +Quarter +2 nd +Quarter +3 rd +Quarter +4 th +Quarter +2022 +Average oil price per Bbl (1) +$ 94.45 $ 108.72 $ 93.18 $ 82.79 +Average rigs operating per day – U.S. (2) +115 121 128 131 +2023 +Average oil price per Bbl (1) +$ 75.93 $ 73.54 $ 82.25 $ 78.53 +Average rigs operating per day – U.S. (2) +131 128 120 118 +2024 +Average oil price per Bbl (1) +$ 77.50 $ 81.81 $ 76.43 $ 70.73 +Average rigs operating per day – U.S. (2) +121 114 107 105 +(1) The average oil price represents the average monthly WTI spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +In our drilling services segment, our average active rig count in the United States for the fourth quarter of 2024 was 105 rigs. This was a decrease from our average active rig count for the third quarter of 2024 of 107 rigs. Our active rig count in the United States at December 31, 2024 of 103 rigs was less than the rig count of 121 rigs at December 31, 2023, reflecting the industry-wide activity declines due to increased drilling efficiencies and market consolidation. We expect our rig count in the United States will average 106 rigs in the first quarter of 2025. Term contracts help support our operating rig count. Based on contracts in place in the United States as of February 5, 2025, we expect an average of 64 rigs operating under term contracts during the first quarter of 2025 and an average of 40 rigs operating under term contracts during 2025. +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2024 and 2023 was approximately $426 million and $700 million, respectively. Approximately 7.1% of our total contract drilling backlog in the United States at December 31, 2024 is reasonably expected to remain after 2025. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment.” +During the fourth quarter of 2024, our completion services segment was impacted by several long-term dedicated customers reducing sequential completion activity after meeting their annual production targets. We expect a seasonal uptick in activity during the first quarter of 2025 as customer budgets reset with the start of the new year. +Activity in our drilling products segment was relatively steady in 2024 compared to the prior year. Drilling products demand is expected to remain steady through the first quarter, given the expectation for a steady U.S. market and continued growth in international markets. +During the fourth quarter, we performed work pursuant to an integrated drilling and completion arrangement that included performance incentives, and we are working to expand customer adoption of these types of arrangements. +Cash capital expenditures for 2024 totaled $678 million. This was an increase from the $616 million of cash capital expenditures in 2023 due to a full year of investing in and maintaining assets related to the NexTier merger and the Ulterra acquisition. The incremental capital spending related to these assets was partially offset by a decrease in business activity in 2024. Additionally, we received proceeds from sale of assets or idle equipment of $25.8 million and $26.5 million in 2024 and 2023, respectively. Based on our current outlook for activity, we expect our capital expenditures for 2025 to be approximately $600 million. +Recent Developments in Joint Ventures and Business Combinations — In December 2024, one of our subsidiaries closed a previously announced joint venture with subsidiaries of ADNOC Drilling and SLB. Our subsidiary holds a 15 percent interest in a newly created company named Turnwell Industries, which has been awarded a contract to drill and complete 144 unconventional wells for ADNOC. In exchange for the minority equity interest, we are providing unconventional drilling and completion expertise to Turnwell, as well as a limited cash contribution to fund our portion of initial working capital. +On September 1, 2023, we completed our merger (the “NexTier merger”) with NexTier Oilfield Solutions Inc. ("NexTier"). Each share of common stock of NexTier issued and outstanding immediately prior to the effective time (including outstanding restricted +35 +Table of Contents +shares) was converted into the right to receive 0.752 shares of our common stock, which based on the closing price of our common stock of $14.91 on September 1, 2023, valued the transaction at approximately $2.8 billion, including the assumption of debt. +On August 14, 2023, we completed our acquisition (the “Ulterra acquisition”) of Ulterra Drilling Technologies, L.P. ("Ulterra"). Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $373 million of cash (after purchase price adjustment), which based on the closing price of our common stock of $14.94 on August 14, 2023, valued the transaction at closing at approximately $894 million. +Recent Developments in Debt Financing — On January 31, 2025, we entered into the Second Amended and Restated Credit Agreement with the lenders party thereto and Wells Fargo Bank, National Association, as administrative agent, and the other parties thereto (the “Credit Agreement”). The Credit Agreement amended and restated our Amended and Restated Credit Agreement dated as of March 27, 2018 (as amended, restated, supplemented or otherwise modified at December 31, 2024, the “Prior Credit Agreement”). The commitments under the Credit Agreement are $500 million, and the loans and commitments under the Credit Agreement mature on January 31, 2030. +The Credit Agreement provides for a committed senior unsecured credit facility that permits aggregate revolving credit borrowings of up to $500 million, with a letter of credit sub-facility of $100 million and a swing line sub-facility that, at any time outstanding, is limited to the lesser of $50 million and the amount of the swing line provider’s unused commitment. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $200 million, not to exceed total commitments of $700 million. For a description of the Credit Agreement, see “Liquidity and Capital Resources” included in Part II, Item 7— “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report. +As of December 31, 2024, we had no borrowings outstanding under our Prior Credit Agreement. We had $2.1 million in letters of credit outstanding under the Prior Credit Agreement at December 31, 2024 and, as a result, had available borrowing capacity of approximately $613 million under the Prior Credit Agreement at that date. +On September 13, 2023, we completed the offering of $400 million in aggregate principal amount of 7.15% Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses were approximately $396 million, which we used to repay amounts outstanding under our Prior Credit Agreement (as defined below). +Impact on our Business from Oil and Natural Gas Prices and Other Factors — Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas, expectations about future prices, and upon our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. During periods of improved oil and natural gas prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when oil and natural gas prices are relatively low or when our customers have a reduced ability to access, or willingness to deploy capital, the demand for our services generally weakens, and we experience downward pressure on pricing for our services. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, including the depletion of capital expenditure budgets and/or meeting annual drilling and completion targets, which could reduce demand for our services. We may also be impacted by delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies. +The North American oil and natural gas services industry is cyclical and, at times, experiences downturns in demand. During these periods, there has been substantially more oil and natural gas service equipment available than necessary to meet demand. As a result, oil and natural gas service contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods. We cannot predict either the future level of demand for our oil and natural gas services or future conditions in the oil and natural gas service businesses. +In addition to the dependence on oil and natural gas prices and demand for our services, we are highly impacted by operational risks, competition, labor issues, weather, the availability, from time to time, of products used in our businesses, supplier delays and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. See “Risk Factors” in Item 1A of this Report. +36 +Table of Contents +For the three years ended December 31, 2024, our operating revenues consisted of the following (dollars in thousands): +2024 2023 2022 +Drilling Services $ 1,727,810 32.1 % $ 1,919,759 46.3 % $ 1,544,820 58.3 % +Completion Services 3,232,785 60.1 % 2,017,440 48.7 % 1,022,413 38.6 % +Drilling Products 351,651 6.5 % 134,679 3.2 % — 0.0 % +Other 65,665 1.3 % 74,578 1.8 % 80,359 3.1 % +$ 5,377,911 100.0 % $ 4,146,456 100.0 % $ 2,647,592 100.0 % +Results of Operations +Effective as of the third quarter of 2023, we revised our reportable segments to align with certain changes in how our Chief Operating Decision Maker (“CODM”) manages and allocates resources to our business as a result of the Ulterra acquisition and NexTier merger. We now have the following reportable business segments: (i) drilling services, (ii) completion services and (iii) drilling products. +Comparison of the years ended December 31, 2023 and 2022 +A discussion of our financial condition and results of operations for the fiscal year ended December 31, 2023 compared to the fiscal year ended December 31, 2022 is included in Part II, Item 7— “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, filed with the SEC on February 27, 2024. +Comparison of the years ended December 31, 2024 and 2023 +The following tables summarize results of operations by business segment for the years ended December 31, 2024 and 2023: +Year Ended December 31, +Drilling Services (1) +2024 2023 +% Change +(Dollars in thousands) +Revenues $ 1,727,810 $ 1,919,759 (10.0 %) +Direct operating costs 1,029,591 1,119,200 (8.0 %) +Adjusted gross profit (2) +698,219 800,559 (12.8 %) +Selling, general and administrative 16,502 15,014 9.9 % +Depreciation, amortization and impairment 477,398 364,312 31.0 % +Other operating income, net — (769) (100.0 %) +Operating income $ 204,319 $ 422,002 (51.6 %) +Capital expenditures $ 264,667 $ 334,780 (20.9 %) +Operating days – U.S. (3) +40,899 45,270 (9.7 %) +Average revenue per operating day – U.S. (3) +$ 35.86 $ 36.24 (1.0 %) +Average direct operating costs per operating day – U.S. (3) +$ 19.80 $ 19.42 2.0 % +Average adjusted gross profit per operating day – U.S. (3) +$ 16.06 $ 16.83 (4.6 %) +(1) Drilling services segment represents our contract drilling, directional drilling, oilfield technology and electrical controls and automation businesses. +(2) Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +(3) Operational data relates to our contract drilling business. A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +37 +Table of Contents +Total revenues and direct operating costs decreased primarily due to a decrease in operating days in our contract drilling business within the United States. Average revenue per operating day remained relatively flat while average direct operating costs per operating day increased slightly. The decline in operating days impacted the fixed cost leverage for U.S. drilling rigs. +The decrease in operating days for our U.S. contract drilling business reflects the industry-wide activity declines due to increased drilling efficiencies and market consolidation. +Depreciation, amortization and impairment expense increased primarily due to a charge of $114 million related to the abandonment of 42 legacy, non-Tier-1 super-spec drilling rigs and related equipment. See Note 6 of Notes to consolidated financial statements for additional information. +Capital expenditures decreased primarily due to reduced investment in our ancillary drilling services not included within our contract drilling business and timing of order placement. +Year Ended December 31, +Completion Services (1) +2024 2023 +% Change +(Dollars in thousands) +Revenues $ 3,232,785 $ 2,017,440 60.2 % +Direct operating costs 2,658,170 1,567,940 69.5 % +Adjusted gross profit (2) +574,615 449,500 27.8 % +Selling, general and administrative 41,557 26,050 59.5 % +Depreciation, amortization and impairment 564,155 283,230 99.2 % +Impairment of goodwill 885,240 — NA +Other operating income, net (17,792) — NA +Operating income (loss) $ (898,545) $ 140,220 (740.8 %) +Capital expenditures $ 320,329 $ 214,746 49.2 % +(1) Completion services represents the combination of well completion business from the NexTier merger and our legacy pressure pumping business. +(2) Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +The changes in the results of our completion services segment for the year ended December 31, 2024 as compared to December 31, 2023 can be primarily attributed to the NexTier merger, which closed on September 1, 2023. The NexTier merger had a material impact on our reported results of operations. The results for the year ended December 31, 2024 represent the combination of the well completion business from the NexTier merger and our legacy pressure pumping business. Due to the full integration of our legacy pressure pumping business into the NexTier legal entity in the first quarter of 2024, we are unable to provide a meaningful year-over-year comparison excluding the impact of the NexTier merger. +During the year ended December 31, 2024, we recorded an $885 million impairment charge to goodwill associated with our completion services reporting unit. See Note 7 of Notes to consolidated financial statements for additional information. +Other operating income, net in 2024 was due to gain on legal settlements. +38 +Table of Contents +Year Ended December 31, +Drilling Products 2024 2023 % Change +(Dollars in thousands) +Revenues $ 351,651 $ 134,679 161.1 % +Direct operating costs 191,107 81,555 134.3 % +Adjusted gross profit (1) +160,544 53,124 202.2 % +Selling, general and administrative 35,860 11,158 221.4 % +Depreciation, amortization and impairment 100,610 48,467 107.6 % +Operating income (loss) $ 24,074 $ (6,501) (470.3) % +Capital expenditures $ 61,687 $ 24,572 151.0 % +(1) Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +The changes in the results of our drilling products segment for the year ended December 31, 2024 as compared to December 31, 2023 are attributable to the Ulterra acquisition, which closed on August 14, 2023. As such, there was no meaningful year-over-year comparison. +Direct operating costs and depreciation, amortization and impairment expense were approximately $7.9 million and $17.7 million higher than they would have otherwise been for the year ended December 31, 2024, respectively, as a result of the step up to fair value of our drill bits in accordance with purchase accounting. Direct operating costs and depreciation, amortization and impairment expense were approximately $11.0 million and $18.0 million higher than they would have otherwise been for the year ended December 31, 2023, respectively, as a result of the step up to fair value of our drill bits in accordance with purchase accounting. +Year Ended December 31, +Other 2024 2023 +% Change +(Dollars in thousands) +Revenues $ 65,665 $ 74,578 (12.0) % +Direct operating costs 41,001 42,624 (3.8 %) +Adjusted gross profit (1) +24,664 31,954 (22.8) % +Selling, general and administrative 708 888 (20.3 %) +Depreciation, depletion, amortization and impairment 24,043 28,237 (14.9 %) +Operating income (loss) $ (87) $ 2,829 (103.1 %) +Capital expenditures $ 21,813 $ 24,645 (11.5) % +(1) Adjusted gross profit is defined as revenues less direct operating costs (excluding depreciation, depletion, amortization and impairment expense). See Non-GAAP Financial Measures below for a reconciliation of GAAP gross profit to adjusted gross profit by segment. +Revenue decreased due to a lower volume of services provided by our oilfield rentals business. +Depreciation, depletion, amortization and impairment expense decreased primarily due to a $7.0 million impairment recorded in our oil and natural gas business in 2023 compared to a $3.8 million impairment in 2024. +39 +Table of Contents +Year Ended December 31, +Corporate 2024 2023 +% Change +(Dollars in thousands) +Selling, general and administrative $ 173,710 $ 116,852 48.7 % +Merger and integration expense $ 33,037 $ 98,077 (66.3 %) +Depreciation $ 5,667 $ 7,170 (21.0 %) +Other operating (income) expense, net $ 7,084 $ (15,503) (145.7 %) +Interest income $ (5,729) $ (6,122) (6.4 %) +Interest expense, net of amount capitalized $ 71,963 $ 52,870 36.1 % +Other (income) expense $ 975 $ (1,898) (151.4 %) +Capital expenditures $ 9,890 $ 16,947 (41.6 %) +Selling, general and administrative expense increased primarily due to the reorganization of acquired Ulterra and NexTier support personnel to corporate following the NexTier merger and the Ulterra acquisition. +Merger and integration expense decreased due to the timing of the NexTier merger and the Ulterra acquisition, which both closed in the third quarter of 2023. +The $22.6 million change in other operating income, net was primarily due to a $5.2 million favorable legal settlement and a $6.5 million reversal of cumulative compensation costs associated with certain performance-based restricted stock units in 2023. Additionally, there was a $5.8 million credit loss expense in 2024 due to a deterioration in the financial condition of a customer. +Interest expense increased primarily due to the offering of 2033 Notes in the third quarter of 2023. See Note 9 of Notes to consolidated financial statements for additional information on our long-term debt. +The decrease in capital expenditures was primarily due to the purchase of an aircraft in 2023. +Income Taxes +The effective tax rate decreased to (1.0)% for 2024 compared to 19.9% for 2023. Our effective income tax rate fluctuates based on, among other factors, changes in pre-tax income in countries with varying statutory tax rates, changes in valuation allowances, and the impacts of various other permanent adjustments. The impact of goodwill impairments that are not deductible for income tax had a significant impact on our effective tax rate for the year ended December 31, 2024. +We continue to monitor income tax developments in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +Liquidity and Capital Resources +Our primary sources of liquidity are cash and cash equivalents, availability under our revolving credit facility and cash provided by operating activities. As of December 31, 2024, we had approximately $453 million in working capital, including $239 million of cash and cash equivalents, and approximately $613 million available under the Prior Credit Agreement. +On January 31, 2025, we entered into the Credit Agreement, which amended and restated the Prior Credit Agreement. The commitments under the Credit Agreement are $500 million, and the loans and commitments under the Credit Agreement mature on January 31, 2030. +The Credit Agreement provides for a committed senior unsecured credit facility that permits aggregate revolving credit borrowings of up to $500 million, with a letter of credit sub-facility of $100 million and a swing line sub-facility that, at any time outstanding, is limited to the lesser of $50 million and the amount of the swing line provider’s unused commitment. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $200 million, not to exceed total commitments of $700 million. +40 +Table of Contents +Loans under the Credit Agreement bear interest by reference, at our election, to the SOFR rate (in addition to a 0.10% per annum adjustment) or base rate, in each case subject to a 0% floor. The applicable margin on SOFR rate loans varies from 1.25% to 2.25% and the applicable margin on base rate loans varies from 0.25% to 1.25%, in each case determined based on our credit rating. A letter of credit fee is payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.150% to 0.350% based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Credit Agreement. However, if any subsidiary guarantees or incurs debt, which does not qualify for certain limited exceptions and is otherwise, in the aggregate with all other similar debt, in excess of Priority Debt (as defined in the Credit Agreement), such subsidiary is required to become a guarantor under the Credit Agreement. +The Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to grant liens and on the ability of each of our non-guarantor subsidiaries to incur debt. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would generally require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at both credit rating agencies. The Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50% as of the last day of each fiscal quarter. The Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with the covenants under the Prior Credit Agreement at December 31, 2024. +On March 16, 2015, we entered into a Reimbursement Agreement (as amended from time to time, the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2024, we had $38.8 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any of our letters of credit issued thereunder. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the Prime rate plus 2.00% per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. A letter of credit fee is payable by us equal to 1.50% times the amount of outstanding letters of credit. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +We had $42.9 million of outstanding letters of credit at December 31, 2024, which was comprised of $38.8 million outstanding under the Reimbursement Agreement, $2.1 million outstanding under the Prior Credit Agreement, and $2.0 million outstanding with financial institutions providing for short-term borrowing capacity, overdraft protection and bonding requirements. We maintain these letters of credit primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under terms of the underlying insurance contracts and compliance with contractual obligations. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2024, no amounts had been drawn under the letters of credit. +Our outstanding long-term debt at December 31, 2024 was $1.2 billion and consisted of $483 million of our 2028 Notes, $345 million of our 2029 Notes, $400 million of our 2033 Notes and $6.4 million of Equipment Loans. We were in compliance with all covenants under the associated agreements and indentures at December 31, 2024. +41 +Table of Contents +For a full description of the Prior Credit Agreement, the Reimbursement Agreement, the 2028 Notes, the 2029 Notes, and the 2033 Notes, see Note 9 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Cash Requirements +We believe our current liquidity, together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to maintain and make improvements to our existing equipment, service our debt, pay cash dividends and repurchase our common stock and senior notes for at least the next 12 months. +If we pursue other opportunities that require capital, we believe we would be able to satisfy these needs through a combination of working capital, cash flows from operating activities, borrowing capacity under our revolving credit facility or additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all. +A portion of our capital expenditures can be adjusted and managed by us to match market demand and activity levels. Based on our current outlook for activity, we expect our capital expenditures for 2025 to be approximately $600 million. The majority of these expenditures are expected to be used for normal, recurring items necessary to support our business. +We anticipate $52.2 million of expenditures in 2025 related to various contractual obligations such as certain commitments to purchase proppants and lease liabilities. +As of December 31, 2024, we had working capital of $453 million, including cash, cash equivalents and restricted cash of $241 million, compared to working capital of $435 million, including cash, cash equivalents and restricted cash of $193 million, at December 31, 2023. +During 2024, our sources of cash flow included: +• $1.2 billion from operating activities, and +• $25.8 million in proceeds from the disposal of property and equipment. +During 2024, our uses of cash flow included: +• $678 million to make capital expenditures for the betterment and refurbishment of drilling services and completion services equipment and, to a much lesser extent, equipment for our other businesses, to acquire and procure equipment to support our drilling services, completion services, drilling products, oilfield rentals and manufacturing operations and to fund investments in oil and natural gas properties on a non-operating working interest basis, +• $290 million for repurchases of our common stock, +• $127 million to pay dividends on our common stock, +• $45.5 million for payments related to finance leases, and +• $17.5 million for other investing and financing activities. +We paid cash dividends during the year ended December 31, 2024 as follows: +Per Share Total +(in thousands) +Paid on March 15, 2024 $ 0.08 $ 32,553 +Paid on June 17, 2024 0.08 31,815 +Paid on September 16, 2024 0.08 31,225 +Paid on December 16, 2024 0.08 31,198 +Total cash dividends $ 0.32 $ 126,791 +On February 5, 2025, our Board of Directors approved a cash dividend on our common stock in the amount of $0.08 per share to be paid on March 17, 2025 to holders of record as of March 3, 2025. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend for any reason, including to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +42 +Table of Contents +We may, at any time and from time to time, seek to retire or purchase our outstanding debt for cash through open-market purchases, privately negotiated transactions, redemptions or otherwise. Such repurchases, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. +In September 2013, our Board of Directors approved a stock buyback program. In February 2024, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $1.0 billion of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the buyback program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2024, we had remaining authorization to purchase approximately $759 million of our outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2024, 2023 and 2022 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”), the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), the NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan and the NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan, and not pursuant to the stock buyback program. +Treasury stock acquisitions during the years ended December 31, 2024, 2023 and 2022 were as follows (dollars in thousands): +2024 2023 2022 +Shares Cost Shares Cost Shares Cost +Treasury shares at beginning of period 105,580,011 $ 1,657,675 88,758,722 $ 1,453,079 84,128,995 $ 1,372,641 +Purchases pursuant to stock buyback program 26,646,698 280,327 14,086,229 168,631 3,254,599 57,173 +Acquisitions pursuant to long-term incentive plan 1,213,319 13,065 2,735,060 35,965 1,372,101 23,237 +Other — — — — 3,027 28 +Treasury shares at end of period 133,440,028 $ 1,951,067 105,580,011 $ 1,657,675 88,758,722 $ 1,453,079 +As of December 31, 2024, we had unrecognized compensation costs of $42.8 million and $12.8 million related to our unvested restricted stock units and our unvested Performance Units, respectively. The weighted-average remaining vesting periods for these awards were 1.71 years and 1.04 years, respectively as of December 31, 2024. See Note 12 of Notes to consolidated financial statements in Item 8 of this Report for additional discussion regarding our stock-based compensation. +Commitments — As of December 31, 2024, we had commitments to purchase major equipment totaling approximately $65.9 million. +Our completion services segment has entered into agreements to purchase minimum quantities of proppants from certain vendors. As of December 31, 2024, the remaining minimum obligation under these agreements was approximately $19.8 million, of which approximately, $17.4 million and $2.4 million relate to 2025 and 2026, respectively. +See Note 10 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our current commitments and contingencies as of December 31, 2024. +Operating lease liabilities totaled $47.6 million and finance lease liabilities totaled $25.4 million at December 31, 2024. See Note 13 of Notes to consolidated financial statements in Item 8 of this Report for additional information on our operating and finance leases as of December 31, 2024. +Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts. We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts. +43 +Table of Contents +Critical Accounting Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. Accounting estimates and assumptions discussed in this section are those considered to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. We believe the following critical accounting estimates used in preparing our consolidated financial statements address all important areas where the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. For additional information on our accounting policies, see Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +Depreciation and amortization — Our industry is very capital intensive, as property and equipment represented 51.6% of our total assets as of December 31, 2024 and depreciation, depletion, amortization and impairment represented 18.7% of our total operating costs and expenses in 2024. Our property and equipment is carried at cost less accumulated depreciation and amortization. No provision for salvage value is considered in determining depreciation of our property and equipment. We calculate depreciation and amortization on our assets based on the estimated useful lives that we believe are reasonable. The estimated useful lives are subject to key assumptions such as maintenance, utilization and job variation. These estimates may change due to a number of factors such as changes in operating conditions or advances in technology. The method of depreciation does not change whenever equipment becomes idle. Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +The following table outlines a 10% change in the useful lives on our major categories of property and equipment and the impact on operating income for the year ended December 31, 2024: +Useful Lives Change +Impact +(in thousands) +Drilling services equipment 1-15 years 10% $ 54,444 +Completion services equipment 1-25 years 10% 46,973 +$ 101,417 +Impairment of long-lived assets — We review our long-lived assets, including property and equipment and definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate the undiscounted future cash flows over the life of the respective asset or the primary asset in an asset group. These estimates of cash flows are based on historical trends in the industry as well as our expectations regarding the continuation of these trends in the future. As of December 31, 2024, no impairment was indicated for our long-lived tangible or definite-lived intangible assets. See Note 6 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +While we believe our judgments and assumptions are reasonable, geopolitical instability, global or regional decreases in the demand of our services and products, or other unforeseen macroeconomic considerations could negatively impact the expected cash flows used in our recoverability tests on our asset groups. Such changes could result in impairment charges in the future, which could be material to our results of operations and financial statements as a whole. +Fair values of assets acquired and liabilities assumed in acquisitions — Assets acquired and liabilities assumed in a business combination are recorded at their estimated fair values on the date of acquisition. The difference between the purchase price amount and the net fair value of assets acquired and liabilities assumed is recognized as goodwill on the balance sheet if the purchase price exceeds the estimated net fair value or as a bargain purchase gain on the income statement if the purchase price is less than the estimated net fair value. We apply significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involves the use of significant estimates and assumptions with respect to rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rates. Changes in these judgments or estimates can have a material impact on the valuation of the respective assets and liabilities acquired and our results of operations in periods after acquisition, such as through depreciation and amortization expense. The allocation of the purchase price may be modified up to one year after the acquisition date as more information is obtained about the fair value of assets acquired and liabilities assumed. See Note 2 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +44 +Table of Contents +Goodwill — We assess goodwill at least annually on July 31, or more frequently when events and circumstances occur indicating recorded goodwill may be impaired. Goodwill is tested at the reporting unit level, which is at or one level below our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors. Any necessary goodwill impairment is determined using a quantitative impairment test. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. The fair value of a reporting unit is determined using significant unobservable inputs, or level 3 in the fair value hierarchy. These inputs are based on internal management estimates, forecasts, and significant judgment. +We determined our drilling products operating segment consists of a single reporting unit and, accordingly, goodwill acquired from the Ulterra acquisition was allocated to that reporting unit. We determined our completion services operating segment consists of two reporting units; completion services, which is primarily comprised of our hydraulic fracturing operations and other integrated service offerings, and cementing services. +Negative market indicators such as lower industry-wide drilling rig and pressure pumping fleet count forecasts, increased volatility and pricing declines in the pressure pumping market, and continued efficiency gains and technology advancements reducing operating days have led to our reduced outlook for activity. During the third quarter of 2024, we viewed the reduction in activity forecasts combined with the recent decline in the market price of our common stock as a triggering event that warranted a quantitative assessment for goodwill impairment. +We estimated the fair value of the drilling products and the completion services reporting units using the income approach. Under this approach, we used a discounted cash flow model, which utilized present values of cash flows to estimate fair value. Forecasted cash flows reflected known market conditions in the third quarter of 2024 and management’s anticipated business outlook for each reporting unit. Future cash flows were projected based on estimates of revenue growth rates, gross profit, selling, general and administrative expense, changes in working capital, and capital expenditures. The terminal period used within the discounted cash flow model for each reporting unit consisted of a 1% growth estimate. Future cash flows were then discounted using a market-participant, risk-adjusted weighted average cost of capital of 10.25% for the drilling products reporting unit and 10.75% for the completion services reporting unit. Financial and credit market volatility directly impacts our fair value measurement through the weighted average cost of capital used to determine a discount rate. During times of volatility, significant judgment must be applied to determine whether credit market changes are a short-term or long-term trend. +We estimated the fair value of the cementing services reporting unit in our completion services operating segment using a market approach. The market approach was based on trading multiples of earnings before interest, taxes, depreciation and amortization for companies comparable to the cementing services reporting unit. +The forecast for the completion services reporting unit assumed lower activity in 2025 compared to average activity levels for full year 2024 and increases in estimated activity of 2% to 8% beginning in 2026 through 2029. Those estimates were based on future drilling rig and pressure pumping fleet count forecasts during the third quarter of 2024 and estimated market share. Additionally, the forecast reflected the expectation that industry-wide pricing pressure will persist within the completions market and continue to compress adjusted gross profit. These factors negatively impacted the estimated value of the reporting unit. +Based on the results of the quantitative assessment, the fair value of the completion services reporting unit was less than its carrying value. Accordingly, we recorded an $885 million impairment charge to goodwill for the completion services reporting unit during the third quarter of 2024. +The forecast for the drilling products reporting unit assumed continued growth domestically as well as in international markets. Geopolitical instability in regions in which we expect to maintain and grow market share, a global decrease in the demand of drilling products, or other unforeseen macroeconomic considerations could negatively impact the key assumptions used in our goodwill assessment for our drilling products reporting unit. +Based on the results of the goodwill impairment tests performed during the third quarter of 2024, the fair values of the drilling products and cementing services reporting units exceeded their carrying values by approximately 13% and 73%, respectively. Accordingly, no impairment was recorded for the drilling products and cementing services reporting units. +Assuming all changes are isolated, a decrease of 100 bps in our long-term revenue growth rate for our drilling products reporting unit would reduce our estimated fair value by approximately 5%, while a 100 bps increase to our discount rate would reduce our estimated fair value by approximately 10%. +A decrease in fair value resulting from unfavorable changes to these assumptions, or others, could result in goodwill impairment in future periods that could be material to our results of operations and financial statements as a whole. +45 +Table of Contents +Accruals for self-insured levels of insurance coverage — We maintain insurance coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employers’ liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks. We also self-insure a number of other risks, including loss of earnings and business interruption and most of our cybersecurity risks, and do not carry a significant amount of insurance to cover risks of underground reservoir damage. Our insurance accruals are based on claims filed and estimates of claims incurred but not reported and are developed by our management with assistance from our third-party actuary and third-party claims administrator. The insurance accruals are influenced by our past claims experience factors and by published industry development factors. If we experience insurance claims or costs above or below our historically evaluated levels, our estimates could be materially affected. The frequency and number of claims or incidents could vary significantly over time, which could materially affect our self-insurance liabilities. Additionally, the actual costs to settle the self-insurance liabilities could materially differ from the original estimates and cause us to incur additional costs in future periods associated with prior year claims. A sensitivity analysis of the impact on earnings for these periods if other assumptions had been used in recording these liabilities is not practicable given the number of underlying assumptions and the wide range of reasonably possible outcomes. See “Item 1A. Risk Factors – Our operations are subject to a number of operational risks, including environmental and weather risks, which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +Income taxes — We are subject to income taxes in the United States and other foreign jurisdictions. We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. In assessing the realizability of our deferred tax assets, if it is more likely than not that a portion of the deferred tax assets will not be realized in a future period, the deferred tax assets will be reduced by a valuation allowance. We believe the valuation allowance is a critical accounting estimate because it is susceptible to change from period to period, requires assumptions about our future income over the lives of the deferred tax assets, and because the impact of increasing or decreasing the valuation allowance is potentially material to our results of operations. +Our methodology for recording income taxes requires a significant amount of judgment in the use of assumptions and estimates. Additionally, we forecast certain tax elements, such as future taxable income, as well as evaluate the feasibility of implementing tax planning strategies. Given the inherent uncertainty involved with the use of such variables, there can be significant variation between anticipated and actual results. Unforeseen events may significantly impact these variables, and changes to these variables could have a material impact on our income tax accounts. The final determination of our income tax liabilities involves the interpretation of local tax laws and related authorities in each jurisdiction. Changes in the operating environments, including changes in tax law, could impact the determination of our income tax liabilities for a tax year. +We continue to monitor income tax developments, including OECD Pillar 2 legislation, in the United States and other countries where we have legal entities. We recognize tax benefits related to uncertain tax positions when, in our judgment, it is more likely than not that such positions will be sustained on examination, including resolutions of any related appeals or litigation, based on the technical merits. We adjust our liabilities for uncertain tax positions when our judgment changes as a result of new information previously unavailable. We routinely monitor the potential impact of these situations. As of December 31, 2024, we have no unrecognized tax benefits. +Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices, and upon our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. Commodity prices have historically been volatile, but have been relatively range-bound since the end of 2022. The current demand for equipment and services remains impacted by macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $70.73 per barrel in the fourth quarter of 2024. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.45 per MMBtu in the fourth quarter of 2024. +In light of these and other factors, we expect oil and natural gas prices to continue to be unpredictable and to affect our financial condition, operations and ability to access sources of capital. Higher oil and natural gas prices do not necessarily result in increased activity because demand for our services is generally driven by our customers’ expectations of future oil and natural gas prices, as well as our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. A decline in demand for oil and natural gas, prolonged low oil or natural gas prices, expectations of decreases in oil and natural gas prices or a reduction in the ability of our customers to access capital would likely result in reduced capital expenditures by our customers and +46 +Table of Contents +decreased demand for our services, which could have a material adverse effect on our operating results, financial condition and cash flows. Even during periods of historically moderate or high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs or reduce their levels of capital expenditures for exploration and production for a variety of reasons, including the depletion of capital expenditure budgets and/or meeting annual drilling and completion targets, which could reduce demand for our services. +Impact of Inflation +Inflation rates have begun to moderate. However, we continue to actively monitor market trends primarily related to sourcing labor, supplies and equipment. +Recently Issued Accounting Standards +For a discussion of recently issued accounting standards, see Note 1 of Notes to consolidated financial statements included as a part of Item 8 of this Report. +47 +Table of Contents +Non-GAAP Financial Measures +Adjusted EBITDA +Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by accounting principles generally accepted in the United States of America (“GAAP”). We define Adjusted EBITDA as net income (loss) plus income tax expense (benefit), net interest expense, depreciation, depletion, amortization and impairment expense (including impairment of goodwill) and merger and integration expense. We present Adjusted EBITDA as a supplemental disclosure because we believe it provides to both management and investors additional information with respect to the performance of our fundamental business activities and a comparison of the results of our operations from period to period and against our peers without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be construed as an alternative to the GAAP measure of net income (loss). Our computations of Adjusted EBITDA may not be the same as similarly titled measures of other companies. Set forth below is a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income (loss). +Year Ended December 31, +2024 2023 2022 +(in thousands) +Net income (loss) $ (966,399) $ 245,952 $ 154,658 +Income tax expense (benefit) 9,453 61,152 13,204 +Net interest expense 66,234 46,748 39,896 +Depreciation, depletion, amortization and impairment 1,171,873 731,416 483,945 +Impairment of goodwill 885,240 — — +Merger and integration expense 33,037 98,077 2,069 +Adjusted EBITDA $ 1,199,438 $ 1,183,345 $ 693,772 +48 +Table of Contents +Adjusted Gross Profit +We define “Adjusted gross profit” as revenues less direct operating costs (excluding depreciation, depletion, amortization and impairment expense, which does not include impairment of goodwill). Adjusted gross profit is included as a supplemental disclosure because it is a useful indicator of our operating performance. +Drilling +Services +Completion +Services +Drilling +Products +Other +(in thousands) +For the year ended December 31, 2024 +Revenues $ 1,727,810 $ 3,232,785 $ 351,651 $ 65,665 +Less direct operating costs (1,029,591) (2,658,170) (191,107) (41,001) +Less depreciation, depletion, amortization and impairment (477,398) (564,155) (100,610) (24,043) +GAAP gross profit 220,821 10,460 59,934 621 +Depreciation, depletion, amortization and impairment 477,398 564,155 100,610 24,043 +Adjusted gross profit $ 698,219 $ 574,615 $ 160,544 $ 24,664 +For the year ended December 31, 2023 +Revenues $ 1,919,759 $ 2,017,440 $ 134,679 $ 74,578 +Less direct operating costs (1,119,200) (1,567,940) (81,555) (42,624) +Less depreciation, depletion, amortization and impairment (364,312) (283,230) (48,467) (28,237) +GAAP gross profit 436,247 166,270 4,657 3,717 +Depreciation, depletion, amortization and impairment 364,312 283,230 48,467 28,237 +Adjusted gross profit $ 800,559 $ 449,500 $ 53,124 $ 31,954 +For the year ended December 31, 2022 +Revenues $ 1,544,820 $ 1,022,413 $ — $ 80,359 +Less direct operating costs (1,025,904) (781,385) — (39,261) +Less depreciation, depletion, amortization and impairment (354,116) (98,162) — (26,496) +GAAP gross profit 164,800 142,866 — 14,602 +Depreciation, depletion, amortization and impairment 354,116 98,162 — 26,496 +Adjusted gross profit $ 518,916 $ 241,028 $ — $ 41,098 +49 +Table of Contents +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As of December 31, 2024, we would have had exposure to interest rate market risk associated with any outstanding borrowings and letters of credit that we had under the Prior Credit Agreement and amounts owed under the Reimbursement Agreement. +Loans under the Prior Credit Agreement bore interest by reference, at our election, to the SOFR rate (subject to a 0.10% per annum adjustment) or base rate, in each case subject to a 0% floor. The applicable margin on SOFR rate loans varied from 1.00% to 2.00% and the applicable margin on base rate loans varied from 0% to 1.00%, in each case determined based on our credit rating. As of December 31, 2024, the applicable margin on SOFR rate loans was 1.75% and the applicable margin on base rate loans was 0.75%. A letter of credit fee was payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varied from 0.10% to 0.30% based on our credit rating. As of December 31, 2024, we had $2.1 million in letters of credit outstanding and, as a result, had available borrowing capacity of approximately $613 million at that date. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any of our letters of credit issued thereunder. We are obligated to pay Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the Prime rate plus 2.00% per annum. +Some of our revenues in foreign countries are denominated in U.S. dollars, and therefore, changes in foreign currency exchange rates impact our earnings to the extent that costs associated with those U.S. dollar revenues are denominated in the local currency. Similarly, some of our revenues are denominated in foreign currencies, but have associated U.S. dollar costs, which also give rise to foreign currency exchange rate exposure. +The carrying values of cash, cash equivalents and restricted cash, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. +Item 8. Financial Statements and Supplementary Data. +Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2024, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2024, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2024. +50 +Table of Contents +The effectiveness of our internal control over financial reporting as of December 31, 2024 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +(c) During the three months ended December 31, 2024, certain of our officers and directors listed below adopted or terminated trading arrangements for the sale of shares of our common stock in amounts and prices determined in accordance with a formula set forth in each such plan: +Plans Number of +Shares to +be Sold +Name and Title Action Date Rule +10b5-1 Non-Rule +10b5-1 Expiration +Robert Drummond Jr., Director Termination November 8, 2024 X 1,250,000 Plan terminated November 8, 2024 +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections. +None. +51 +Table of Contents +PART III +Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference. +Item 10. Directors, Executive Officers and Corporate Governance. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer. The text of this code is located on our website under “Corporate Governance.” Our Internet address is www.patenergy.com . We intend to disclose any amendments to or waivers from this code on our website within four business days following the date of the amendment or waiver. +Item 11. Executive Compensation. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +Item 14. Principal Accounting Fees and Services. +The information required by this Item is incorporated herein by reference to the Proxy Statement. +52 +Table of Contents +PART IV +Item 15. Exhibits and Financial Statement Schedule. +(a)(1) Financial Statements +See Index to Consolidated Financial Statements on page F-1 of this Report. +(a)(2) Report of Independent Registered Public Accounting Firm +The report of our independent registered public accounting firm (PCAOB ID: 238 ) with respect to the above-referenced financial statements and their report on internal control over financial reporting are included on page F-2 of this Report. +(a)(3) Financial Statement Schedule +Schedule II — Valuation and qualifying accounts is filed herewith on page S-1. +All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto. +(a)(3) Exhibits +The following exhibits are filed herewith or incorporated by reference herein. Our Commission file number is 0-22664. +2.1 +Agreement and Plan of Merger, dated as of June 14, 2023, by and among Patterson-UTI Energy, Inc., Pecos Merger Sub Inc., Pecos Second Merger Sub LLC and NexTier Oilfield Solutions Inc. (filed June 15, 2023 as Exhibit 2.1 to our Current Report on Form 8-K and incorporated herein by reference). +2.2 +First Amendment to Agreement and Plan of Merger, dated July 27, 2023, by and between Patterson-UTI and NexTier Oilfield Solutions Inc. (filed July 28, 2023 as Exhibit 2.1 to our Current Report on Form 8-K and incorporated herein by reference). +2.3 +Agreement and Plan of Merger, dated as of July 3, 2023, by and among Patterson-UTI Energy, Inc., PJ Merger Sub Inc., PJ Second Merger Sub LLC, BEP Diamond Holdings Corp. and BEP Diamond Topco L.P. (filed July 5, 2023 as Exhibit 2.1 to our Current Report on Form 8-K and incorporated herein by reference). +3.1 +Restated Certificate of Incorporation (filed June 6, 2024 as Exhibit 4.1 to our Registration Statement on Form S-8 and incorporated herein by reference) . +3.2 +Amended and Restated Bylaws (filed June 15, 2023 as Exhibit 3.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.1 +Description of Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934 (filed February 27, 2024 as Exhibit 4.1 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2023 and incorporated herein by reference). +4.2 +Registration Rights Agreement with Bear, Stearns and Co. Inc., dated March 25, 1994, as assigned to REMY Capital Partners III, L.P. (filed March 19, 2002 as Exhibit 4.3 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference) . +4.3 +Base Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.4 +First Supplemental Indenture, dated January 19, 2018, among Patterson-UTI Energy, Inc., the several guarantors named therein and Wells Fargo Bank, National Association, as trustee (filed January 19, 2018 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +53 +Table of Contents +4.5 +Form of 3.95% Senior Note due 2028 (included in Exhibit 4.4 above). +4.6 +Base Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.7 +First Supplemental Indenture, dated November 15, 2019, between Patterson-UTI Energy, Inc. and U.S. Bank National Association, as trustee (filed November 15, 2019 as Exhibit 4.2 to our Current Report on Form 8-K and incorporated herein by reference). +4.8 +Form of 5.15% Senior Note due 2029 (included in Exhibit 4.7 above). +4.9 +Second Supplemental Indenture, dated September 13, 2023, between Patterson-UTI Energy, Inc. and U.S. Bank Trust Company, National Association, as trustee (filed September 13, 2023 as Exhibit 4.1 to our Current Report on Form 8-K and incorporated herein by reference). +4.10 +Form of 7.15% Senior Notes due 2033 (included in Exhibit 4.9 above). +10.1 +Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan, as amended and restated and further amended effective June 6, 2019 (filed June 6, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.2 +Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan, as amended through June 6, 2024 (filed June 6, 2024 as Exhibit 99.1 to our Registration Statement on Form S-8 and incorporated herein by reference).* +10.3 +NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan, as amended September 1, 2023 (filed September 1, 2023 as Exhibit 10.4 to our Current Report on Form 8-K and incorporated herein by reference).* +10.4 +NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan, as amended September 1, 2023 (filed September 1, 2023 as Exhibit 10.3 to our Current Report on Form 8-K and incorporated herein by reference).* +10.5 +Form of Executive Officer Restricted Stock Unit Award Agreement (filed August 3, 2021 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.6 +Form of Executive Officer Stock Option Agreement (filed April 21, 2014 as Exhibit 10.4 to our Current Report on Form 8-K and incorporated herein by reference).* +10.7 +Form of Non-Employee Director Stock Option Agreement (filed April 21, 2014 as Exhibit 10.6 to our Current Report on Form 8-K and incorporated herein by reference).* +10.8 +Form of Non-Employee Director Restricted Stock Unit Award Agreement. * + +10.9 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed August 3, 2021 as Exhibit 10.3 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.10 +Form of Executive Officer Share-Settled Performance Share Award Agreement (filed July 29, 2024 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.11 +Patterson-UTI Energy, Inc. Qualified Retiree Program (filed July 29, 2024 as Exhibit 10.3 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.12 +Form of Letter Agreement regarding termination, effective as of January 29, 2004, entered into by Patterson-UTI Energy, Inc. with Kenneth N. Berns (filed on February 25, 2005 as Exhibit 10.23 to our Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference).* +54 +Table of Contents +10.13 +Employment Agreement, dated as of January 1, 2023, by and between Patterson-UTI Energy, Inc. and James M. Holcomb (filed on January 3, 2023 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.14 +Letter Agreement, dated August 30, 2023, by and between Patterson-UTI Energy, Inc. and James M. Holcomb (filed September 1, 2023 as Exhibit 10.7 to our Current Report on Form 8-K and incorporated herein by reference).* +10.15 +Letter Agreement, dated August 27, 2024, by and between Patterson-UTI Energy, Inc. and James M. Holcomb (filed September 3, 2024 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference).* +10.16 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 2, 2016 as Exhibit 10.2 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.17 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and William Andrew Hendricks, Jr. (filed August 3, 2021 as Exhibit 10.4 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.18 +Employment Agreement, effective as of August 1, 2016, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed February 13, 2017 as Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference).* +10.19 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and Seth D. Wexler (filed August 3, 2021 as Exhibit 10.6 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.20 +Employment Agreement, dated as of September 3, 2017, between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed September 8, 2017 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference).* +10.21 +First Amendment to Employment Agreement, effective as April 9, 2021, by and between Patterson-UTI Energy, Inc. and C. Andrew Smith (filed August 3, 2021 as Exhibit 10.5 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.22 +Patterson-UTI Energy, Inc. Change in Control Agreement, effective as of January 29, 2004, by and between Patterson-UTI Energy, Inc. and Kenneth N. Berns (filed on February 4, 2004 as Exhibit 10.5 to our Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).* +10.23 +First Amendment to Change in Control Agreement Between Patterson-UTI Energy, Inc. and Kenneth N. Berns, entered into November 1, 2007 (filed November 5, 2007 as Exhibit 10.11 to our Quarterly Report on Form 10-Q and incorporated herein by reference).* +10.24 +Separation Agreement and General Release of Claims, dated September 1, 2023, by and between NexTier Oilfield Solutions Inc. and Robert W. Drummond (filed September 1, 2023 as Exhibit 10.6 to our Current Report on Form 8-K and incorporated herein by reference).* +10.25 +Form of Indemnification Agreement entered into by Patterson-UTI Energy, Inc. with each of its directors and executive officers (filed April 28, 2004 as Exhibit 10.11 to our Annual Report on Form 10-K, as amended, for the year ended December 31, 2003 and incorporated herein by reference).* +10.26 +Amended and Restated Credit Agreement dated March 27, 2018 among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2018 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +55 +Table of Contents +10.27 +Amendment No. 1 to Amended and Restated Credit Agreement, dated March 26, 2019, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 26, 2019 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.28 +Amendment No. 2 to Amended and Restated Credit Agreement, dated March 27, 2020, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed March 27, 2020 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.29 +Amendment No. 3 to Amended and Restated Credit Agreement, dated November 9, 2022, among Patterson-UTI Energy, Inc., as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto (filed November 9, 2022 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.30 +Amendment No. 4 to Amended and Restated Credit Agreement, dated August 29, 2023, by and among Patterson-UTI Energy, Inc., Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and a lender and each of the other letter of credit issuers and lenders party thereto.(filed September 1, 2023 as Exhibit 10.2 to our Current Report on Form 8-K and incorporated herein by reference). +10.31 +Commitment Increase Agreement, dated April 5, 2024, by and among Patterson-UTI Energy, Inc., Citibank, N.A., HSBC Bank USA, National Association, Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer and swing line lender and the other letter of credit issuers party thereto (filed May 6, 2024 as Exhibit 10.1 to our Quarterly Report on Form 10-Q and incorporated herein by reference). +10.32 +Second Amended and Restated Credit Agreement, dated January 31, 2025, by and among Patterson-UTI Energy, Inc., Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and a lender and each of the other letter of credit issuers and lenders party thereto with the lenders party thereto (filed February 3, 2025 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.33 +Reimbursement Agreement, dated as of March 16, 2015, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia (filed March 16, 2015 as Exhibit 10.1 to our Current Report on Form 8-K and incorporated herein by reference). +10.34 +Amendment No. 1 to Reimbursement Agreement, dated as of October 16, 2024, by and between Patterson-UTI Energy, Inc. and The Bank of Nova Scotia.+ +19.1 +Insider Trading Compliance Policy.+ +19.2 +Insider Trading Compliance Memorandum.+ +21.1 +Subsidiaries of the Registrant.+ +23.1 +Consent of Independent Registered Public Accounting Firm.+ +31.1 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +31.2 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.+ +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.++ +97 +Patterson-UTI Energy, Inc. Clawback Policy (filed February 27, 2024 as Exhibit 97 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2023 and incorporated herein by reference). +56 +Table of Contents +101.INS Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.+ +101.SCH Inline XBRL Taxonomy Extension Schema Document+ +101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document+ +101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document+ +101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document+ +101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document+ +104 +Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101) . +________________________________ +* Management Contract or Compensatory Plan identified as required by Item 15(a)(3) of Form 10-K. ++ Filed herewith. +++ Furnished herewith. +Item 16. Form 10-K Summary +None. +57 +Table of Contents +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Page +Report of Independent Registered Public Accounting Firm +F- 2 +Consolidated Financial Statements: +Consolidated Balance Sheets as of December 31, 2024 and 2023 +F- 4 +Consolidated Statements of Operations for the years ended December 31, 2024, 2023 and 2022 +F- 5 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2024, 2023 and 2022 +F- 6 +Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2024, 2023 and 2022 +F- 7 +Consolidated Statements of Cash Flows for the years ended December 31, 2024, 2023 and 2022 +F- 8 +Notes to Consolidated Financial Statements +F- 9 +F-1 +Table of Contents +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Patterson-UTI Energy, Inc. and its subsidiaries (the "Company") as of December 31, 2024 and 2023, and the related consolidated statements of operations, of comprehensive income (loss), of changes in stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2024, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2024 appearing on page S-1 (collectively referred to as the "consolidated financial statements"). We also have audited the Company's internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2024 and 2023, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2024 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Critical Audit Matters +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are +F-2 +Table of Contents +material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Goodwill Impairment Assessment – Drilling Products Reporting Unit +As described in Note 7 to the consolidated financial statements, the Company’s goodwill balance for the drilling products reporting unit was $450.5 million as of December 31, 2024. Management evaluates goodwill for impairment at least annually on July 31, or more frequently when events and circumstances occur indicating recorded goodwill may be impaired. Management estimated the fair value of the drilling products reporting unit using the income approach. Under this approach, management used a discounted cash flow model, which utilizes present values of cash flows to estimate fair value. Future cash flows were projected based on estimates of revenue growth rates, gross profit, selling, general and administrative expense, changes in working capital, and capital expenditures. The terminal period used within the discounted cash flow model for the reporting unit consisted of a growth estimate. Future cash flows were then discounted using a market-participant, risk-adjusted weighted average cost of capital. +The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment of the drilling products reporting unit is a critical audit matter are (i) the significant judgment by management when developing the fair value estimate of the drilling products reporting unit; (ii) a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating management’s significant assumptions related to estimates of certain revenue growth rates and the discount rate; and (iii) the audit effort involved the use of professionals with specialized skill and knowledge. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessment, including controls over the valuation of the drilling products reporting unit. These procedures also included, among others (i) testing management’s process for developing the fair value estimate of the drilling products reporting unit; (ii) evaluating the appropriateness of the income approach used by management; (iii) testing the completeness and accuracy of the underlying data used in the income approach; and (iv) evaluating the reasonableness of the significant assumptions used by management related to estimates of certain revenue growth rates and the discount rate. Evaluating management’s assumption related to estimates of certain revenue growth rates involved evaluating whether the assumption used by management was reasonable considering (i) the current and past performance of the drilling products reporting unit; (ii) the consistency with external market and industry data; and (iii) whether the assumption was consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in evaluating (i) the appropriateness of the income approach and (ii) the reasonableness of the discount rate assumption. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +February 11, 2025 +We have served as the Company’s auditor since 1993. +F-3 +Table of Contents +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2024 2023 +(In thousands, except share data) +ASSETS +Current assets: +Cash, cash equivalents and restricted cash $ 241,293 $ 192,680 +Accounts receivable, net of allowance for credit losses of $ 15,047 and $ 3,490 at December 31, 2024 and 2023, respectively +763,806 971,091 +Inventory 167,023 180,805 +Other current assets 123,193 141,122 +Total current assets 1,295,315 1,485,698 +Property and equipment, net 3,010,342 3,340,412 +Operating lease right of use asset 44,385 47,599 +Finance lease right of use asset 27,018 63,228 +Goodwill 487,388 1,379,741 +Intangible assets, net 929,610 1,051,697 +Deposits on equipment purchases 15,699 28,305 +Other assets 23,709 19,424 +Deferred tax assets, net — 3,927 +Total assets $ 5,833,466 $ 7,420,031 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable $ 421,318 $ 534,420 +Accrued liabilities 385,751 446,268 +Operating lease liability 13,322 13,541 +Finance lease liability 15,214 43,980 +Current maturities of long-term debt 6,388 12,226 +Total current liabilities 841,993 1,050,435 +Long-term operating lease liability 34,305 37,848 +Long-term finance lease liability 10,216 12,953 +Long-term debt, net of debt discount and issuance costs of $ 7,637 and $ 8,919 at December 31, 2024 and 2023, respectively +1,219,770 1,224,941 +Deferred tax liabilities, net 238,097 248,107 +Other liabilities 13,241 25,066 +Total liabilities 2,357,622 2,599,350 +Commitments and contingencies (see Note 10) +Stockholders’ equity: +Preferred stock, par value $ 0.01 ; authorized 1,000,000 shares, no shares issued +— — +Common stock, par value $ 0.01 ; authorized 800,000,000 and 800,000,000 shares with 520,784,783 and 516,775,313 issued and 387,344,755 and 411,195,302 outstanding at December 31, 2024 and 2023, respectively +5,206 5,166 +Additional paid-in capital 6,453,606 6,407,294 +Retained earnings (deficit) ( 1,039,338 ) 57,035 +Accumulated other comprehensive income (loss) ( 2,584 ) 472 +Treasury stock, at cost, 133,440,028 shares and 105,580,011 shares at December 31, 2024 and 2023, respectively +( 1,951,067 ) ( 1,657,675 ) +Total stockholders’ equity attributable to controlling interests 3,465,823 4,812,292 +Noncontrolling interest 10,021 8,389 +Total equity 3,475,844 4,820,681 +Total liabilities and stockholders’ equity $ 5,833,466 $ 7,420,031 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +Table of Contents +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +2024 2023 2022 +(In thousands, except per share data) +Operating revenues: +Drilling Services $ 1,727,810 $ 1,919,759 $ 1,544,820 +Completion Services 3,232,785 2,017,440 1,022,413 +Drilling Products 351,651 134,679 — +Other 65,665 74,578 80,359 +Total operating revenues 5,377,911 4,146,456 2,647,592 +Operating costs and expenses: +Drilling Services 1,029,591 1,119,200 1,025,904 +Completion Services 2,658,170 1,567,940 781,385 +Drilling Products 191,107 81,555 — +Other 41,001 42,624 39,261 +Depreciation, depletion, amortization and impairment 1,171,873 731,416 483,945 +Impairment of goodwill 885,240 — — +Selling, general and administrative 268,337 169,962 116,589 +Merger and integration expense 33,037 98,077 2,069 +Other operating income, net ( 10,708 ) ( 16,272 ) ( 12,592 ) +Total operating costs and expenses 6,267,648 3,794,502 2,436,561 +Operating income (loss) ( 889,737 ) 351,954 211,031 +Other income (expense): +Interest income 5,729 6,122 360 +Interest expense, net of amount capitalized ( 71,963 ) ( 52,870 ) ( 40,256 ) +Other income (expense) ( 975 ) 1,898 ( 3,273 ) +Total other income (expense) ( 67,209 ) ( 44,850 ) ( 43,169 ) +Income (loss) before income taxes ( 956,946 ) 307,104 167,862 +Income tax expense 9,453 61,152 13,204 +Net income (loss) ( 966,399 ) 245,952 154,658 +Net income (loss) attributable to noncontrolling interest 1,632 ( 340 ) — +Net income (loss) attributable to common stockholders $ ( 968,031 ) $ 246,292 $ 154,658 +Net income (loss) attributable to common stockholder per common share: +Basic $ ( 2.44 ) $ 0.88 $ 0.72 +Diluted $ ( 2.44 ) $ 0.88 $ 0.70 +Weighted average number of common shares outstanding: +Basic 397,196 279,501 215,935 +Diluted 397,196 280,061 219,496 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +2024 2023 2022 +(In thousands) +Net income (loss) $ ( 966,399 ) $ 245,952 $ 154,658 +Other comprehensive income (loss): +Foreign currency translation adjustment, net of taxes of $ 0 for all periods +( 3,056 ) 472 1,793 +Release of cumulative translation adjustment, net of taxes of $ 0 for 2024 and 2023 and $ 3,770 for 2022 +— — ( 7,708 ) +Comprehensive income (loss) ( 969,455 ) 246,424 148,743 +Less: comprehensive income (loss) attributable to noncontrolling interest 1,632 ( 340 ) — +Comprehensive income (loss) attributable to common stockholders $ ( 971,087 ) $ 246,764 $ 148,743 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +Table of Contents +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +Common Stock Additional +Paid-in +Capital Retained +Earnings +(Deficit) Accumulated +Other +Comprehensive +Income (Loss) Treasury +Stock Noncontrolling +Interest Total +Number of +Shares Amount +(In thousands) +Balance, December 31, 2021 299,269 $ 2,993 $ 3,171,536 $ ( 198,316 ) $ 5,915 $ ( 1,372,641 ) — $ 1,609,487 +Net income — — — 154,658 — — — 154,658 +Foreign currency translation adjustment — — — — 1,793 — — 1,793 +Release of cumulative translation adjustment — — — — ( 7,708 ) — — ( 7,708 ) +Issuance of restricted stock 980 10 ( 10 ) — — — — — +Vesting of restricted stock units 1,437 14 ( 14 ) — — — — — +Exercise of stock options 640 6 10,362 — — — — 10,368 +Stock-based compensation — — 21,099 — — — — 21,099 +Payment of cash dividends ($ 0.20 per share) +— — — ( 43,096 ) — — — ( 43,096 ) +Dividend equivalents — — — ( 640 ) — — — ( 640 ) +Purchase of treasury stock — — — — — ( 80,438 ) — ( 80,438 ) +Balance, December 31, 2022 302,326 $ 3,023 $ 3,202,973 $ ( 87,394 ) $ — $ ( 1,453,079 ) $ — $ 1,665,523 +Net income — — — 246,292 — — ( 340 ) 245,952 +Noncontrolling interest — — — — — — 8,729 8,729 +Foreign currency translation adjustment — — — — 472 — — 472 +Issuance of common stock - Ulterra acquisition 34,900 349 521,057 — — — — 521,406 +Issuance of common stock - NexTier merger 172,092 1,720 2,564,175 — — — — 2,565,895 +Issuance of replacement awards related to NexTier merger — — 72,413 — — — — 72,413 +Issuance of restricted stock 1,077 10 ( 10 ) — — — — — +Vesting of restricted stock units 6,380 64 ( 64 ) — — — — — +Stock-based compensation — — 46,750 — — — — 46,750 +Payment of cash dividends ($ 0.32 per share) +— — — ( 100,034 ) — — — ( 100,034 ) +Dividend equivalents — — — ( 1,829 ) — — — ( 1,829 ) +Purchase of treasury stock — — — — — ( 204,596 ) — ( 204,596 ) +Balance, December 31, 2023 516,775 $ 5,166 $ 6,407,294 $ 57,035 $ 472 $ ( 1,657,675 ) $ 8,389 $ 4,820,681 +Net income (loss) — — — ( 968,031 ) — — 1,632 ( 966,399 ) +Foreign currency translation adjustment — — — — ( 3,056 ) — — ( 3,056 ) +Issuance of restricted stock 719 7 ( 7 ) — — — — — +Vesting of restricted stock units 3,291 33 ( 33 ) — — — — — +Stock-based compensation — — 46,352 — — — — 46,352 +Payment of cash dividends ($ 0.32 per share) +— — — ( 126,791 ) — — — ( 126,791 ) +Dividend equivalents — — — ( 1,551 ) — — — ( 1,551 ) +Purchase of treasury stock — — — — — ( 293,392 ) — ( 293,392 ) +Balance, December 31, 2024 520,785 $ 5,206 $ 6,453,606 $ ( 1,039,338 ) $ ( 2,584 ) $ ( 1,951,067 ) $ 10,021 $ 3,475,844 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +Table of Contents +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +2024 2023 2022 +(In thousands) +Cash flows from operating activities: +Net income (loss) $ ( 966,399 ) $ 245,952 $ 154,658 +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depreciation, depletion, amortization and impairment 1,171,873 731,416 483,945 +Impairment of goodwill 885,240 — — +Deferred income tax expense (benefit) ( 1,765 ) 51,866 6,998 +Stock-based compensation 46,352 46,750 21,099 +Net gain on asset disposals ( 3,688 ) ( 1,798 ) ( 12,075 ) +Other 7,936 ( 1,053 ) ( 1,507 ) +Changes in operating assets and liabilities: +Accounts receivable 203,652 84,544 ( 209,226 ) +Inventory ( 11,463 ) ( 30,793 ) ( 23,154 ) +Other current assets 19,599 ( 10,360 ) ( 1,975 ) +Other assets 33,760 24,686 10,643 +Accounts payable ( 112,858 ) ( 69,729 ) 38,986 +Accrued liabilities ( 66,582 ) ( 23,484 ) 67,380 +Other liabilities ( 30,121 ) ( 42,083 ) 30,416 +Net cash provided by operating activities 1,175,536 1,005,914 566,188 +Cash flows from investing activities: +Acquisitions, net of cash acquired - NexTier — ( 65,185 ) — +Acquisitions, net of cash acquired - Ulterra 2,983 ( 357,314 ) — +Purchases of property and equipment ( 678,386 ) ( 615,690 ) ( 436,797 ) +Proceeds from disposal of assets 25,832 26,473 26,074 +Other ( 5,173 ) ( 5,874 ) ( 2,504 ) +Net cash used in investing activities ( 654,744 ) ( 1,017,590 ) ( 413,227 ) +Cash flows from financing activities: +Purchases of treasury stock ( 290,427 ) ( 200,710 ) ( 70,070 ) +Dividends paid ( 126,791 ) ( 100,034 ) ( 43,096 ) +Proceeds from borrowings under revolving credit facility 50,000 420,000 150,000 +Repayment of borrowings under revolving credit facility ( 50,000 ) ( 420,000 ) ( 150,000 ) +Proceeds from issuance of senior notes — 396,412 — +Repayment of senior notes — ( 7,837 ) ( 19,760 ) +Payments on finance leases ( 45,484 ) ( 15,915 ) — +Other ( 12,290 ) ( 6,349 ) ( 455 ) +Net cash provided by (used in) financing activities ( 474,992 ) 65,567 ( 133,381 ) +Effect of foreign exchange rate changes on cash, cash equivalents and restricted cash 2,813 1,236 449 +Net increase in cash, cash equivalents and restricted cash 48,613 55,127 20,029 +Cash, cash equivalents and restricted cash at beginning of year 192,680 137,553 117,524 +Cash, cash equivalents and restricted cash at end of year $ 241,293 $ 192,680 $ 137,553 +Supplemental disclosure of cash flow information: +Net cash (paid) received during the year for: +Interest, net of capitalized interest of $ 1,334 in 2024, $ 1,692 in 2023, +and $ 976 in 2022 +$ ( 68,563 ) $ ( 39,607 ) $ ( 39,855 ) +Income taxes ( 14,767 ) ( 27,169 ) ( 1,526 ) +Non-cash investing and financing activities: +Net increase (decrease) in payables for purchases of property and equipment $ ( 133 ) $ ( 15,111 ) $ 7,953 +Net (increase) decrease in deposits on equipment purchases 12,607 7,876 ( 12,202 ) +Issuance of common stock for business acquisitions — 3,159,714 — +Cashless exercise of stock options — — 10,368 +Purchases of property and equipment through exchange of lease right of use asset 30,961 3,241 — +Derecognition of right of use asset ( 36,117 ) ( 3,241 ) — +The accompanying notes are an integral part of these consolidated financial statements. +F-8 +Table of Contents +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of Business and Summary of Significant Accounting Policies +A description of the business and basis of presentation follows: +Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries and consolidating interest of a joint venture (collectively referred to herein as “we,” “us,” “our,” “ours” and like terms), is a Houston, Texas-based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. We have other operations through which we provide oilfield rental tools in select markets in the United States. In addition, we own and invest, as a non-operating, working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +On August 14, 2023, we completed our acquisition (the “Ulterra acquisition”) of Ulterra Drilling Technologies, L.P. (“Ulterra”), a global provider of specialized drill bit solutions. On September 1, 2023, we completed our merger (the “NexTier merger”) with NexTier Oilfield Solutions Inc. (“NexTier”), a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins. See Note 2 for additional details on the acquisition and merger. +Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI, its wholly-owned subsidiaries and the consolidating interest of a joint venture. All intercompany accounts and transactions have been eliminated. Except for wholly-owned subsidiaries and our interest in a joint venture, we have no controlling financial interests in any other entity which would require consolidation. As used in these notes, “we,” “us,” “our,” “ours” and like terms refer collectively to Patterson-UTI Energy, Inc, and its consolidated subsidiaries. Patterson-UTI Energy, Inc. conducts its business operations through its wholly-owned subsidiaries and has no employees or independent operations. Certain prior year amounts have been reclassified to conform to current year presentation. +The U.S. dollar is the reporting currency and functional currency for most of our operations except certain of our foreign subsidiaries, which use their local currencies as their functional currency. Assets and liabilities of these foreign subsidiaries are translated into U.S. dollars using the exchange rates in effect as of the balance sheet date. The effects of these translation adjustments are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity. +The consolidated financial statements for the year ended December 31, 2023 include the results of Ulterra from August 14, 2023, and the results of NexTier from September 1, 2023. +A summary of the significant accounting policies follows: +Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates. +Cash and cash equivalents — Cash equivalents are highly liquid, short-term investments with original maturities of three months or less from their date of purchase. +Restricted cash — Restricted cash includes amounts restricted as cash collateral for the issuance of standby letters of credit. +The following table provides a reconciliation of cash and restricted cash reported within the consolidated balance sheets that sum to the total of such amounts shown in the statements of cash flows for the years ended December 31, 2024 and 2023: +Year Ended December 31, +2024 2023 +Cash and cash equivalents $ 239,182 $ 190,108 +Restricted cash 2,111 2,572 +Total cash, cash equivalents and restricted cash $ 241,293 $ 192,680 +F-9 +Table of Contents +Accounts receivable — Trade accounts receivable are recorded at the invoiced amount. The allowance for credit losses represents our estimate of the amount of probable credit losses existing in our accounts receivable. Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability. Account balances, when determined to be uncollectible, are charged against the allowance. +Inventories — Inventories consist primarily of sand and other products to be used in conjunction with our completion services activities, materials used in our equipment servicing business, spare parts for drilling services and raw materials for drilling products. Such inventories are stated at the lower of cost or net realizable value. The majority of our inventory is recorded using weighted average cost. +We periodically review the nature and quantities of inventory on hand and evaluate the net realizable value of items based on historical usage patterns, known changes to equipment or processes and customer demand for specific products. Provision for excess or obsolete inventories is determined based on historical usage of inventory on-hand, volume on-hand versus anticipated usage, technological advances and consideration of current market conditions. Inventories that have not turned over for more than a year are subject to slow-moving reserve provisions. In addition, inventories that have become obsolete due to technological advances or are no longer configured to operate with our equipment are written off. +Other current assets — Other current assets include reimbursement from our workers compensation insurance carrier for claims in excess of our deductible in the amount of $ 33.2 million and $ 31.0 million at December 31, 2024 and 2023, respectively. We also maintain prepayments for items such as insurance, rent and inventory. +Long-lived assets with definite lives — Property and equipment and definite-lived intangible assets are carried at cost less accumulated depreciation, amortization, depletion and impairment. Depreciation and amortization is recorded on the straight-line method over the estimated useful lives. +The estimated useful lives are shown below: +Useful Lives +Equipment +1 - 25 years +Rental equipment +4 - 8 runs +Buildings and leasehold improvements +1 - 30 years +Other +3 - 20 years +Amortization of definite-lived intangible assets is calculated on the straight-lined method over the estimated useful lives of the assets, which range from 3 to 15 years. +Long-lived assets with definite lives, including property and equipment and certain intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). Assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings for impairment assessment. If there is a triggering event, we estimate future cash flows over the life of the respective assets or asset groupings in our assessment of its recoverability. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. If estimated undiscounted cash flows expected to result from the use and eventual disposition of an asset or asset group is less than its respective carrying amount, an impairment loss is recognized in the amount by which the carrying amount exceeds its estimated fair value. +Maintenance and repairs — Maintenance and repairs are charged to expense when incurred. Renewals and betterments which extend the life or improve existing property and equipment are capitalized. +Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in our consolidated statements of operations. +Goodwill — As a result of both the Ulterra acquisition and the NexTier merger, we have recognized goodwill. Goodwill from acquisitions is recorded as the excess of the consideration transferred plus the fair value of any non-controlling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired. Goodwill is considered to have an indefinite useful economic life and is not amortized. We assess impairment of goodwill at least annually, as of July 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value. If the carrying value of a reporting unit exceeds its fair value, we recognize an impairment in an amount equal to the excess, limited to the total amount of +F-10 +Table of Contents +goodwill allocated to the reporting unit. During the third quarter of 2024, we recorded an $ 885 million impairment charge to goodwill related to our completion services reporting unit. See Note 7 for details. +Leases — We have operating leases for operating locations, corporate offices and certain operating equipment. We determine if a contract contains a lease at inception or as a result of an acquisition. A right-of-use asset and corresponding lease liability are recognized on our consolidated balance sheet at commencement at an amount based on the present value of the remaining lease payments over the lease term. The lease term may include the option to extend or terminate the lease when it is reasonably certain that we will exercise the option. By our policy election, right-of-use assets and lease liabilities with an initial term of one year or less are not recognized for leasing arrangements, and non-lease and lease components are treated as a single lease component instead of bifurcating those components. Lease expense is recognized on a straight-line basis. If available, we use the rate implicit in the lease at commencement date to discount the lease payments. If the implicit rate is not readily determinable, we use our incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. +For finance leases, we amortize the right-of-use asset on a straight-line basis over the earlier of the useful life of the right-of-use asset or the end of the lease term and record this amortization in depreciation and amortization expense in the consolidated statements of operations. If available, we use the rate implicit in the lease at commencement date to discount the lease payments. If the implicit rate is not available, we use our incremental borrowing rate based on the information available at the commencement date in the determination of the present value of future lease payments. The lease term may include the option to extend or terminate the lease when it is reasonably certain that we will exercise the option. By our policy election, right-of-use assets and lease liabilities with an initial term of one year or less are not recognized for leasing arrangements, and non-lease and lease components are treated as a single lease component instead of bifurcating those components. For finance leases where we have determined we are reasonably certain to exercise a purchase option to acquire the underlying asset, we amortize the right-of-use asset over the lease term and record this amortization in “Depreciation, depletion, amortization and impairment” in the consolidated statements of operations. We adjust the lease liability to reflect lease payments made during the period and interest incurred on the lease liability using the effective interest method. The incurred interest expense is recorded in “Interest expense” in the consolidated statements of operations. +In the third quarter of 2023, as part of the Ulterra acquisition and the NexTier merger, we acquired certain operating and finance leases. We inherited NexTier’s and Ulterra’s lease classifications as of the time of each respective acquisition. We elected as an accounting policy election by class of underlying assets to not recognize assets or liabilities at the acquisition date for leases that had a remaining lease term of twelve months or less. See Notes 2 and 13 for details. +Revenue recognition — Revenues from our drilling services, completion services, drilling products, and other activities are recognized upon the transfer of control of the related services and products to the customer. See Note 3 for details. +Income taxes — The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. Our policy is to account for interest and penalties with respect to income taxes as operating expenses. +Stock-based compensation — We recognize the cost of share-based payments under the fair-value-based method. Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures. This expense is recognized over the expected life of the awards, as described in Note 12. +Concentration of Credit Risk — Our assets that are potentially subject to concentrations of credit risk are cash, cash equivalents and restricted cash and trade accounts receivable. Cash balances are maintained in financial institutions, which at times exceed federally insured limits. We monitor the financial condition of the financial institutions in which accounts are maintained and we have not experienced any losses in such accounts. We maintain an allowance for credit losses based upon several factors, including historical collection experience, current aging status of the customer accounts and financial condition of our customers. There were no material changes in the allowance for credit losses in 2024 and 2023. +Recently Adopted Accounting Standards — In March 2020, the FASB issued an accounting standards update to provide temporary optional expedients that simplify the accounting for contract modifications to existing debt agreements expected to arise from the market transition from LIBOR to alternative reference rates. The guidance was effective upon issuance and generally can be applied to applicable contract modifications through December 31, 2024. We adopted the optional relief guidance provided under Topic 848 after modifying our debt agreements to update the reference rate from LIBOR to SOFR or Prime Rate. The adoption of the new guidance did not have a material impact on our financial statements. +F-11 +Table of Contents +In November 2023, the FASB issued an accounting standards update to improve reportable segment disclosure requirements and enhance disclosures about significant segment expenses. We adopted this new accounting pronouncement effective January 1, 2024 and expanded our consolidated financial statement disclosures in order to comply with the update. See Note 17 for details. +Recently Issued Accounting Standards —In December 2023, the FASB issued an accounting standards update to improve income tax disclosure requirements. We plan to adopt this accounting pronouncement during fiscal year 2025, with the first disclosure enhancements reflected in our 2025 fiscal year Form 10-K. We are currently evaluating the impact this pronouncement will have on our disclosures. +In November 2024, the FASB issued guidance expanding disclosure requirements related to certain income statement expenses, which requires public entities to disclose additional information about specific expense categories in the notes to the financial statements on an interim and annual basis. This guidance is effective for annual reporting periods beginning after December 15, 2026, and interim periods beginning after December 15, 2027, with early adoption permitted. We are currently evaluating the effect of this pronouncement on our disclosures. +2. Business Combinations +Ulterra Drilling Technologies, L.P. +On August 14, 2023, we completed the Ulterra acquisition. Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $ 373 million of cash (after purchase price adjustments), which based on the closing price of our common stock of $ 14.94 on August 14, 2023, valued the transaction at closing at approximately $ 894 million. +The total fair value of the consideration transferred was determined as follows (in thousands, except stock price): +Shares of our common stock issued to Ulterra 34,900 +Our common stock price on August 14, 2023 $ 14.94 +Common stock equity consideration $ 521,406 +Plus net cash consideration 372,757 +Total consideration transferred $ 894,163 +The acquisition was accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. +The aggregate purchase price noted above was allocated to the major categories of assets acquired and liabilities assumed based on preliminary estimated fair values as of the date of the business combination. We applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to future rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rate ( 10.5 %). The carrying amounts of cash and cash equivalents, accounts receivable, other assets, accounts payable and accrued liabilities approximate their fair values due to their nature or the short-term maturity of instruments. The remaining assets acquired and liabilities assumed are based on inputs that are not observable in the market and thus represent Level 3 inputs. The fair value of inventory and rental equipment was determined using a replacement cost approach. Intangible assets primarily consist of customer relationships and developed technology, the fair values of which were determined using an income approach. Property and equipment was valued using a combination of indirect cost and a market approach. The fair value was estimated by using a multi-period excess earnings method for customer relationships and a relief from royalty method for trade name and developed technology. The purchase price allocation was finalized in the third quarter of 2024. The valuation period adjustments did not have a material impact on our consolidated financial statements. +F-12 +Table of Contents +The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition: +Assets acquired: +Cash and cash equivalents $ 18,426 +Accounts receivable 68,467 +Inventory (1) +36,313 +Rental equipment (2) +109,055 +Property and equipment 27,583 +Intangible assets 313,000 +Operating lease right of use asset 7,513 +Finance lease right of use asset 5,228 +Other assets 15,989 +Total assets acquired 601,574 +Liabilities assumed: +Accounts payable 23,258 +Accrued liabilities 33,323 +Operating lease liability 7,513 +Finance lease liability 5,228 +Deferred tax liabilities 79,863 +Total liabilities assumed 149,185 +Less: noncontrolling interest ( 8,729 ) +Net assets acquired 443,660 +Goodwill 450,503 +Total consideration transferred $ 894,163 +(1) We recorded a n adjustment of $ 5.5 million to write-up acquired drill bits classified as inventory to estimated fair value. This adjustment will be recorded as direct operating expense as acquired drill bits are sold. +(2) We recorded an adjustment of $ 74.4 million to write-up acquired drill bits classified as long-lived assets to estimated fair value. This adjustment will be depreciated as acquired drill bits are rented over a weighted-average estimated useful life of 7.5 runs. +The goodwill recognized in the acquisition represents the excess of the gross consideration transferred over the fair value of the underlying net tangible and identifiable intangible assets acquired and liabilities assumed. Goodwill represents the potential for new growth opportunities internationally with the acquisition of Ulterra as well as the recognition of deferred taxes for the difference between the fair value of the assets acquired and liabilities assumed and the respective carry-over tax basis. Goodwill is not deductible for tax purposes. All of the goodwill was assigned to our Drilling Products segment. See Note 7. +Approximately $ 135 million of revenues and $ 3.4 million of net loss attributed to the Ulterra acquisition are included in the consolidated statements of operations for the period from the closing date on August 14, 2023 through December 31, 2023. We incurred $ 5.6 million of merger and integration expense related to the Ulterra acquisition in 2023. We did not incur any material merger and integration expense related to the Ulterra acquisition in 2024. +A portion of the fair value consideration transferred has been provisionally assigned to identifiable intangible assets as follows: +Fair Value +(in thousands) Weighted Average Useful Life +(in years) +Customer relationships $ 245,000 15 +Trade name 16,000 11 +Developed technology 52,000 5 +Intangible assets $ 313,000 +F-13 +Table of Contents +Pro Forma +The following pro forma condensed combined financial information was derived from our and Ulterra’s historical financial statements and gives effect to the acquisition as if it had occurred on January 1, 2022. The below information reflects pro forma adjustments based on available information and certain assumptions we believe are reasonable, including (i) adjustments related to the depreciation and amortization of the step up to fair value of $ 77.6 million for acquired intangibles, $ 74.4 million for acquired drill bits classified as long-lived assets, and $ 5.5 million for acquired drill bits classified as inventory, (ii) removal of $ 12.8 million in 2023 and $ 28.1 million in 2022 of historical interest expense of the acquired entity and (iii) $ 17.4 million in 2023 and $ 11.3 million in 2022 of tax benefit relating to the aforementioned pro forma adjustments. +The pro forma results of operations do not include any anticipated cost savings or other synergies that may result from the Ulterra acquisition nor do they include any estimated costs that will be incurred to integrate Ulterra operations. The pro forma results of operations include our merger and integration expense of $ 5.6 million as if they had been incurred in the first quarter of 2022. +The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the Ulterra acquisition taken place on January 1, 2022. Furthermore, the financial information is not intended to be a projection of future results. The following table summarizes our selected financial information on a pro forma basis (in thousands, except per share data): +2023 2022 +(Unaudited) +Revenues $ 4,369,596 $ 3,017,778 +Net income $ 190,136 $ 141,458 +NexTier Oilfield Solutions Inc. +On September 1, 2023, we completed the NexTier merger. Under the terms of the merger agreement, NexTier became our wholly-owned subsidiary. Each share of NexTier common stock issued and outstanding immediately prior to the effective time of the merger was converted into the right to receive 0.752 shares of our common stock. Additionally, certain equity awards that were granted and outstanding under NexTier long-term incentive plans were assumed by us, and such equity awards were converted into equity awards in respect of our common stock in accordance with the merger agreement. +NexTier is a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins. +The total fair value of the consideration transferred was determined as follows (in thousands, except exchange ratio and stock price): +Number of shares of NexTier common stock outstanding as of September 1, 2023 228,846 +Multiplied by the exchange ratio 0.752 +Number of shares of Patterson-UTI Energy, Inc. common stock issued in connection with the merger 172,092 +Patterson-UTI Energy, Inc. common stock price on September 1, 2023 $ 14.91 +Common stock equity consideration 2,565,895 +Acceleration of RSU awards 1,997 +Fair value of replacement equity awards (1) +70,416 +NexTier long-term debt repaid by Patterson-UTI Energy, Inc. 161,000 +Consideration transferred $ 2,799,308 +(1) In connection with the merger, each of the share-based awards held by legacy NexTier employees were replaced with our share-based awards on the merger date. The fair value of the replacement awards has been allocated between each employee’s pre-combination and post-combination services. Amounts allocated to pre-combination services have been included as consideration transferred as part of the merger. See Note 12 for replacement awards details. +The transaction was accounted for as a business combination using the acquisition method with Patterson-UTI Energy, Inc. determined to be the acquirer. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date. +F-14 +Table of Contents +The aggregate purchase price noted above was allocated to the major categories of assets acquired and liabilities assumed based on preliminary estimated fair values as of the date of the business combination. We applied significant judgment in estimating the fair value of assets acquired and liabilities assumed, which involved the use of significant estimates and assumptions with respect to future rig counts, cash flow projections, estimated economic useful lives, operating and capital cost estimates, customer attrition rates, contributory asset charges, royalty rates and discount rate ( 14.0 %). The carrying amounts of cash and cash equivalents, accounts receivable, inventory, other assets, accounts payable, accrued liabilities, and other liabilities approximate their fair values due to their nature or the short-term maturity of instruments. The remaining assets acquired and liabilities assumed are based on inputs that are not observable in the market and thus represent Level 3 inputs. The fair value of property and equipment was determined using a combination of replacement cost and indirect cost. Intangible assets were valued using an income approach. The fair value was estimated by using multi-period excess earnings method for customer relationships and a relief from royalty method for trade name and developed technology. The purchase price allocation was finalized in the third quarter of 2024. The valuation period adjustments did not have a material impact on our consolidated financial statements. +The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of the merger: +Assets acquired: +Cash and cash equivalents $ 95,815 +Accounts receivable 420,200 +Inventory 71,930 +Property and equipment (1) +1,045,610 +Intangible assets 768,000 +Operating lease right of use asset 19,091 +Finance lease right of use asset 50,733 +Other assets 84,677 +Total assets acquired 2,556,056 +Liabilities assumed: +Accounts payable 358,873 +Accrued liabilities 129,535 +Operating lease liability 19,091 +Finance lease liability 50,733 +Deferred tax liabilities 86,293 +Long-term debt 22,533 +Other liabilities 11,815 +Total liabilities assumed 678,873 +Net assets acquired 1,877,183 +Goodwill 922,125 +Total consideration transferred $ 2,799,308 +(1) We recorded an adjustment of $ 263 million to write-up acquired property and equipment to estimated fair value. This adjustment will be depreciated on a straight-line basis over a weighted average period of six years . +The goodwill recognized in the merger represents the excess of the gross consideration transferred over the fair value of the underlying net tangible and identifiable intangible assets acquired and liabilities assumed. Goodwill largely consisted of the expected synergies and economies of scale from the combined operations of Patterson-UTI and NexTier as well as the recognition of deferred taxes for the difference between the fair value of the assets acquired and liabilities assumed and the respective carry-over tax basis. All of the goodwill was assigned to our completion services segment. See Note 7. +Approximately $ 1.1 billion of revenues and $ 12.5 million of net income attributed to the NexTier merger are included in the consolidated statements of operations for the period from the closing date on September 1, 2023 through December 31, 2023. During the twelve months ended December 31, 2024 and 2023, we incurred costs related to the NexTier merger totaling $ 28.7 million and $ 92.5 million, respectively, which are included in our consolidated statements of operations as “Merger and integration expense.” +A portion of the fair value consideration transferred has been provisionally assigned to identifiable intangible assets as follows: +F-15 +Table of Contents +Fair Value +(in thousands) Weighted Average Useful Life +(in years) +Customer relationships $ 540,000 10 +Trade name 85,000 10 +Developed technology 143,000 5 +Intangible assets $ 768,000 +Pro Forma +The following pro forma condensed combined financial information was derived from our and NexTier's historical financial statements and gives effect to the acquisition as if it had occurred on January 1, 2022. The below information reflects pro forma adjustments based on available information and certain assumptions we believe are reasonable, including (i) adjustments related to the depreciation and amortization of the step up to fair value of $ 720.7 million for acquired intangibles and $ 262.7 million for acquired property and equipment, (ii) removal of $ 17.7 million in 2023 and $ 30.0 million in 2022 of historical interest expense of the acquired entity and (iii) $ 15.1 million in 2023 and $ 72.7 million of tax benefit in 2022 relating to the aforementioned pro forma adjustments. +The pro forma results of operations do not include any anticipated cost savings or other synergies that may result from the NexTier merger nor do they include any estimated costs that will be incurred to integrate NexTier operations. The pro forma results of operations include our merger and integration expense of $ 92.5 million as if they had been incurred in the first quarter of 2022. +The pro forma condensed combined financial information has been included for comparative purposes and is not necessarily indicative of the results that might have actually occurred had the NexTier merger taken place on January 1, 2022. Furthermore, the financial information is not intended to be a projection of future results. The following table summarizes our selected financial information on a pro forma basis (in thousands, except per share data): +2023 2022 +(Unaudited) +Revenues $ 6,604,824 $ 5,892,414 +Net income $ 598,709 $ 196,220 +3. Revenues +ASC Topic 606 Revenue from Contracts with Customers +Drilling Services and Completion Services — r evenue is recognized based on our customers’ ability to benefit from our services in an amount that reflects the consideration we expect to receive in exchange for those services. This typically happens when the service is performed. The services we provide represent a series of distinct services, generally provided daily, that are substantially the same, with the same pattern of transfer to the customer. Because our customers benefit equally throughout the service period, generally measured in days, and our efforts in providing services are incurred relatively evenly over the period of performance, revenue is recognized as we provide services to the customer. +Drilling Services revenue primarily consists of daywork drilling contracts for which related revenues and expenses are recognized as services are performed. For certain contracts, we receive payments for the mobilization of rigs and other drilling equipment. We defer revenue and related direct operating expense related to mobilizations and recognize those revenues and expenses on a straight-line basis as drilling services are provided. Costs incurred to relocate rigs and other drilling equipment to areas in which a contract has not been secured are expensed as incurred and are recorded in Drilling Services operating expense in the Consolidated Statements of Operations and Comprehensive Income (Loss). For certain contracts, we are also entitled to early termination payments if our customers choose to terminate a contract prior to the expiration of the contractual term. We recognize revenue associated with early termination payments when all contractual requirements have been met. +Completion Services revenue consists of services and products related to our suite of completion businesses including hydraulic fracturing, completion support services, wireline and pumpdown services, and cementing. These services are pursuant to contractual arrangements, such as term contracts and pricing agreements. Revenue from these services is earned as services are rendered, which is generally on a per stage or fixed monthly rate except for our cementing services. All revenue is recognized when a contract with a customer exists, the performance obligations under the contract have been satisfied over time, the amount to which we have the right to invoice has been determined and collectability of amounts subject to invoice is probable. Contract fulfillment costs, such as mobilization costs and shipping and handling costs, are expensed as incurred and are recorded in Completion Services operating +F-16 +Table of Contents +expense in the Consolidated Statements of Operations and Comprehensive Income (Loss). To the extent fulfillment costs are considered separate performance obligations that are billable to the customer, the amounts billed are recorded as revenue in the Consolidated Statements of Operations and Comprehensive Income (Loss). +Once a stage has been completed or products and services have been provided, a field ticket is created that includes charges for the service performed and the chemicals, proppant, and compressed natural gas consumed during the course of the service. The field ticket may also include charges for the mobilization of the equipment and inventory to the location, any additional equipment used on the job, and other miscellaneous items. The field ticket represents the amounts to which we have the right to invoice and to recognize as revenue. +A portion of our contracts contain variable consideration; however, this variable consideration is typically unknown at the time of contract inception, and is not known until the job is complete, at which time the variability is resolved. Examples of variable consideration include the number of hours that will be incurred and the amount of consumables (such as chemicals and proppants) that will be used to complete a job. +Revenue is presented net of any sales tax charged to the customer that we are required to remit to local or state governmental taxing authorities. Reimbursements for the purchase of supplies, equipment, personnel services, shipping and other services that are provided at the request of our customers are recorded as revenue when incurred. The related costs are recorded as operating expenses when incurred. +ASC Topic 842 Revenue from Equipment Rentals +Drilling Products Revenue — revenues are primarily generated from the rental of drilling equipment, comprised of drill bits and downhole tools. These arrangements provide the customer with the right to control the use of the identified asset. Generally, the lease terms in such arrangements are for periods of two to three days and do not provide customers with options to purchase the underlying asset. +Other — we are a non-operating working interest owner of oil and natural gas assets primarily located in Texas and New Mexico. The ownership terms are outlined in joint operating agreements for each well between the operator of the well and the various interest owners, including us, who are considered non-operators of the well. We receive revenue each period for our working interest in the well during the period. +Accounts Receivable and Contract Liabilities +Accounts receivable is our right to consideration once it becomes unconditional. Payment terms typically range from 30 to 60 days. +Accounts receivable balances were $ 697 million and $ 900 million as of December 31, 2024 and 2023, respectively. These balances do not include amounts related to our oil and natural gas working interests nor do they include amounts related to our lease revenues under Topic 842 as those contracts are excluded from Topic 606. Accounts receivable balances are included in “Accounts receivable” in our consolidated balance sheets. +We do not have any significant contract asset balances. Contract liabilities include prepayments received from customers prior to the requested services being completed. Once the services are complete and have been invoiced, the prepayment is applied against the customer’s account to offset the accounts receivable balance. Also included in contract liabilities are payments received from customers for reactivation or initial mobilization of newly constructed or upgraded rigs that were moved on location to the initial well site. These payments are allocated to the overall performance obligation and amortized over the initial term of the contract. Total contract liability balances were $ 75.6 million and $ 103 million as of December 31, 2024 and December 31, 2023, respectively. In 2024, we recognized $ 102 million of revenue that was included in the contract liability balance at the beginning of the period. Revenue related to our contract liabilities balance is expected to be recognized through 2028. In 2023 , we recognized $ 136 million of revenue that was included in the contract liability balance at the beginning of the period, of which the recognition of $ 28.9 million was due to deferred revenue from a customer prepayment, which became recognizable after the customer changed its drilling schedule . The $ 75.2 million current portion of our contract liability balance is included in “Accrued liabilities” and $ 0.4 million noncurrent portion of our contract liability balance is included in “Other liabilities” in our consolidated balance sheets. +Contract Costs +Costs incurred for newly constructed rigs or rig upgrades based on a contract with a customer are considered capital improvements and are capitalized to drilling equipment and depreciated over the estimated useful life of the asset. +F-17 +Table of Contents +Remaining Performance Obligations +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2024 was approximately $ 426 million. Approximately 7.1 % of our total contract drilling backlog in the United States at December 31, 2024 is reasonably expected to remain at December 31, 2025. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to fees for other services such as for mobilization, other than initial mobilization, demobilization and customer reimbursables, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving or incurring maintenance and repair time in excess of what is permitted under the drilling contract. For contracts that contain variable dayrate pricing, our backlog calculation uses the dayrate in effect for periods where the dayrate is fixed, and, for periods that remain subject to variable pricing, uses commodity pricing or other related indices in effect at December 31, 2024. In addition, our term drilling contracts are generally subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. For contracts on which we have received notice for the rig to be placed on standby, our backlog calculation uses the standby rate for the period over which we expect to receive the standby rate. For contracts on which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period over which we expect to receive the lower rate. Please see “Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment” included in Item 1A of this Report. +4. Inventory +Inventory consisted of the following at December 31, 2024 and 2023 (in thousands): +2024 2023 +Raw materials and supplies $ 121,694 $ 141,311 +Work-in-process 6,681 7,437 +Finished goods 38,648 32,057 +Inventory $ 167,023 $ 180,805 +5. Other Current Assets +Other current assets consisted of the following at December 31, 2024 and 2023 (in thousands): +2024 2023 +Federal and state income taxes receivable $ 24,777 $ 26,949 +Workers’ compensation receivable 33,240 31,006 +Prepaid expenses 34,004 46,394 +Other 31,172 36,773 +Other current assets $ 123,193 $ 141,122 +F-18 +Table of Contents +6. Property and Equipment +Property and equipment consisted of the following at December 31, 2024 and 2023 (in thousands): +2024 2023 +Equipment $ 8,416,063 $ 8,506,727 +Oil and natural gas properties 243,663 238,337 +Buildings 248,739 248,693 +Rental equipment 136,256 119,653 +Land 37,847 38,811 +Total property and equipment 9,082,568 9,152,221 +Less accumulated depreciation, depletion, amortization and impairment ( 6,072,226 ) ( 5,811,809 ) +Property and equipment, net $ 3,010,342 $ 3,340,412 +Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets for 2024, 2023 and 2022 (in thousands): +2024 2023 2022 +Depreciation and impairment expense $ 1,039,536 $ 682,672 $ 472,969 +Amortization expense 124,716 41,521 2,891 +Depletion expense 7,621 7,223 8,085 +Total $ 1,171,873 $ 731,416 $ 483,945 +We review our long-lived assets, including property and equipment and definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amounts of certain assets may not be recovered over their estimated remaining useful lives (“triggering events”). In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. We estimate the undiscounted future cash flows over the life of the respective asset or the primary asset in an asset group. These estimates of cash flows are based on historical cyclical trends in the industry as well as our expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value. +Negative market indicators such as lower industry-wide drilling rig count forecasts, increased volatility and pricing declines in the pressure pumping market, and continued efficiency gains and technology advancements reducing operating days have led to our reduced outlook for activity. The reduction in activity forecasts, the recent decline in the market price of our common stock, and the results of the fair value determination of certain of our reporting units, were triggering events indicating that certain of our long-lived tangible and intangible assets may be impaired. We deemed it necessary to perform recoverability tests on our asset groups within our completion services reporting unit and our Latin American contract drilling asset group as of September 30, 2024. Future cash flows were estimated over the expected remaining life of the primary asset for each asset group, and we determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the asset groups. As such, no impairment was indicated for our long-lived tangible or definite-lived intangible assets. +We also evaluated our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed were evaluated, and those components with continuing utility to other marketed rigs were identified for transfer to other rigs or to yards to be used as spare equipment. The remaining components of these rigs were abandoned. During the third quarter of 2024, we identified 42 legacy, non-Tier-1 super-spec drilling rigs and related equipment to be abandoned. Based on the strong customer preference across the industry for Tier-1 super-spec drilling rigs, in addition to efficiency gains and technology advancements that have reduced the total number of rigs needed for the U.S. drilling market, we believe the 42 rigs that were abandoned had limited commercial opportunity. Accordingly, we recorded a charge of $ 114 million related to this abandonment in 2024. No similar charges were incurred in 2022 or 2023. +We also periodically evaluate our other tangible long-lived assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as +F-19 +Table of Contents +parts to support active equipment. The remaining components of this equipment are abandoned. There were no material abandonments in 2022, 2023 or 2024 except for the aforementioned 42 legacy, non-Tier-1 super spec drilling rigs and related equipment. +Geopolitical instability, global or regional decreases in the demand of our services and products, or other unforeseen macroeconomic considerations could negatively impact the expected cash flows used in our recoverability tests on our asset groups. Such changes could result in impairment charges in the future, which could be material to our results of operations and financial statements as a whole. +7. Goodwill and Intangible Assets +Goodwill — Goodwill is evaluated at least annually on July 31, or more frequently when events and circumstances occur indicating recorded goodwill may be impaired. Goodwill is tested at the reporting unit level, which is at or one level below our operating segments. We determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors. Any necessary goodwill impairment is determined using a quantitative impairment test. If the resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the amount of the shortfall. The fair value of a reporting unit is determined using significant unobservable inputs, or level 3 in the fair value hierarchy. These inputs are based on internal management estimates, forecasts, and significant judgment. +We determined our drilling products operating segment consists of a single reporting unit and, accordingly, goodwill acquired from the Ulterra acquisition was allocated to that reporting unit. We determined our completion services operating segment consists of two reporting units; completion services, which is primarily comprised of our hydraulic fracturing operations and other integrated service offerings, and cementing services. +Goodwill Impairment Assessment +Negative market indicators such as lower industry-wide drilling rig and pressure pumping fleet count forecasts, increased volatility and pricing declines in the pressure pumping market, and continued efficiency gains and technology advancements reducing operating days have led to our reduced outlook for activity. During the third quarter of 2024, we viewed the reduction in activity forecasts combined with the decline in the market price of our common stock as a triggering event that warranted a quantitative assessment for goodwill impairment. +We estimated the fair value of the drilling products and the completion services reporting units using the income approach. Under this approach, we used a discounted cash flow model, which utilized present values of cash flows to estimate fair value. Forecasted cash flows reflected known market conditions in the third quarter of 2024 and management's anticipated business outlook for each reporting unit. Future cash flows were projected based on estimates of revenue growth rates, gross profit, selling, general and administrative expense, changes in working capital, and capital expenditures. The terminal period used within the discounted cash flow model for each reporting unit consisted of a 1 % growth estimate. Future cash flows were then discounted using a market-participant, risk-adjusted weighted average cost of capital of 10.25 % for the drilling products reporting unit and 10.75 % for the completion services reporting unit. Financial and credit market volatility directly impacts our fair value measurement through the weighted average cost of capital used to determine a discount rate. During times of volatility, significant judgment must be applied to determine whether credit market changes are a short-term or long-term trend. +We estimated the fair value of the cementing services reporting unit in our completion services operating segment using a market approach. The market approach was based on trading multiples of earnings before interest, taxes, depreciation and amortization for companies comparable to the cementing services reporting unit. +The forecast for the completion services reporting unit assumed lower activity in 2025 compared to average activity levels for full year 2024 and increases in estimated activity of 2 % to 8 % beginning in 2026 through 2029. Those estimates were based on future drilling rig and pressure pumping fleet count forecasts during the third quarter of 2024 and estimated market share. Additionally, the forecast reflected the expectation that industry-wide pricing pressure will persist within the completions market and continue to compress adjusted gross profit. These factors negatively impacted the estimated value of the reporting unit. +Based on the results of the quantitative assessment, the fair value of the completion services reporting unit was less than its carrying value. Accordingly, we recorded an $ 885 million impairment charge to goodwill for the completion services reporting unit during the third quarter of 2024. +The forecast for the drilling products reporting unit assumed continued growth domestically as well as in international markets. Geopolitical instability in regions in which we expect to maintain and grow market share, a global decrease in the demand of drilling products, or other unforeseen macroeconomic considerations could negatively impact the key assumptions used in our goodwill assessment for our drilling products reporting unit. +F-20 +Table of Contents +Based on the results of the goodwill impairment tests performed during the third quarter of 2024, the fair values of the drilling products and cementing services reporting units exceeded their carrying values by approximately 13 % and 73 %, respectively. Accordingly, no impairment was recorded for the drilling products and cementing services reporting units. +Goodwill by operating segment as of December 31, 2023 and 2024 and changes for the years then ended are as follows (in thousands): +Completion +Services Drilling +Products Total +Balance, December 31, 2023 $ 922,125 $ 457,616 $ 1,379,741 +Measurement period adjustment — ( 7,113 ) ( 7,113 ) +Impairment ( 885,240 ) — ( 885,240 ) +Balance, December 31, 2024 $ 36,885 $ 450,503 $ 487,388 +Intangible Assets — Our intangible assets were recorded at fair value on the date of acquisition and are amortized on a straight-line basis. The following table identifies the segment and weighted average useful life of each of our intangible assets: +Segment Weighted Average +Useful Life +(in years) +Customer relationships Drilling Services, Completion Services and Drilling Products 11.5 +Developed technology Drilling Services, Completion Services and Drilling Products 5.2 +Trade name Completion Services and Drilling Products 10.2 +Other Drilling Services and Completion Services 3.1 +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2024 and 2023 are as follows (in thousands): +2024 2023 +Gross Carrying +Amount Accumulated +Amortization Net Carrying +Amount Gross Carrying +Amount Accumulated +Amortization Net Carrying +Amount +Customer relationships $ 782,789 $ ( 95,785 ) $ 687,004 $ 786,715 $ ( 25,563 ) $ 761,152 +Developed technology 202,772 ( 56,562 ) 146,210 202,772 ( 16,435 ) 186,337 +Trade name 101,000 ( 14,097 ) 86,903 101,000 ( 3,406 ) 97,594 +Other 12,986 ( 3,493 ) 9,493 7,345 ( 731 ) 6,614 +Intangible assets, net $ 1,099,547 $ ( 169,937 ) $ 929,610 $ 1,097,832 $ ( 46,135 ) $ 1,051,697 +Amortization expense on intangible assets of approximately $ 124 million, $ 41.5 million, and $ 1.3 million was recorded for the years ended December 31, 2024, 2023 and 2022, respectively. +The remaining amortization expense associated with finite-lived intangible assets, excluding in-process software, is expected to be as follows (in thousands): +Year ending December 31, +2025 $ 123,645 +2026 123,277 +2027 121,250 +2028 105,236 +2029 80,068 +Thereafter 373,535 +Total $ 927,011 +F-21 +Table of Contents +8. Accrued Liabilities +Accrued liabilities consisted of the following at December 31, 2024 and 2023 (in thousands): +2024 2023 +Salaries, wages, payroll taxes and benefits $ 110,212 $ 129,982 +Workers’ compensation liability 73,730 67,396 +Property, sales, use and other taxes 54,445 62,194 +Insurance, other than workers’ compensation 10,703 11,524 +Accrued interest payable 17,484 19,172 +Deferred revenue 75,195 98,914 +Federal and state income taxes payable — 3,437 +Accrued merger and integration expense 4,723 15,113 +Other 39,259 38,536 +Accrued liabilities $ 385,751 $ 446,268 +9. Long-Term Debt +Long-term debt consisted of the following at December 31, 2024 and 2023 (in thousands): +Effective Interest Rate December 31, 2024 December 31, 2023 +3.95 % Senior Notes Due 2028 +4.03 % $ 482,505 $ 482,505 +5.15 % Senior Notes Due 2029 +5.26 % 344,895 344,895 +7.15 % Senior Notes Due 2033 +7.28 % 400,000 400,000 +Equipment Loans Due 2025 5.25 % 6,395 18,686 +1,233,795 1,246,086 +Less deferred financing costs and discounts ( 7,637 ) ( 8,919 ) +Less current portion ( 6,388 ) ( 12,226 ) +Total $ 1,219,770 $ 1,224,941 +Credit Agreement — On January 31, 2025, we entered into the Second Amended and Restated Credit Agreement with the lenders party thereto and Wells Fargo Bank, National Association, as administrative agent, and the other parties thereto (the “Credit Agreement”). The Credit Agreement amended and restated our Amended and Restated Credit Agreement dated as of March 27, 2018 (as amended, restated, supplemented or otherwise modified at December 31, 2024, the “Prior Credit Agreement”). The commitments under the Credit Agreement are $ 500 million, and the loans and commitments under the Credit Agreement mature on January 31, 2030. +The Credit Agreement provides for a committed senior unsecured credit facility that permits aggregate revolving credit borrowings of up to $ 500 million, with a letter of credit sub-facility of $ 100 million and a swing line sub-facility that, at any time outstanding, is limited to the lesser of $ 50 million and the amount of the swing line provider’s unused commitment. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $ 200 million, not to exceed total commitments of $ 700 million. For a description of the Credit Agreement, see “Liquidity and Capital Resources” included in Part II, Item 7— “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report. +On April 5, 2024, we entered into a Commitment Increase Agreement (the “Commitment Increase Agreement”), which increased the commitments under our Amended and Restated Credit Agreement, dated as of March 27, 2018 (as modified by the Commitment Increase Agreement and amended to date, the “Prior Credit Agreement”), by and among us, as borrower, Wells Fargo Bank, National Association, as administrative agent, letter of credit issuer, swing line lender and lender and each of the other letter of credit issuers and lenders party thereto. +The Commitment Increase Agreement increased the commitments under our Prior Credit Agreement to $ 615 million. The maturity date for $ 567 million of such commitments was March 27, 2026; and the maturity date for $ 48.3 million of such commitments was March 27, 2025. +F-22 +Table of Contents +On August 29, 2023, we entered into Amendment No. 4 to Amended and Restated Credit Agreement (the “Credit Agreement Amendment”), which, among other things, extended the maturity date for $ 85.0 million of revolving credit commitments of certain lenders under the Prior Credit Agreement from March 27, 2025 to March 27, 2026. +The Prior Credit Agreement is a committed senior unsecured revolving credit facility that permits aggregate borrowings of up to $ 615 million, including a letter of credit facility that, at any time outstanding, is limited to $ 100 million and a swing line facility that, at any time outstanding, is limited to the lesser of $ 50.0 million and the amount of the swing line provider’s unused commitment. +Loans under the Prior Credit Agreement bear interest by reference, at our election, to the SOFR rate (subject to a 0.10 % per annum adjustment) or base rate, in each case subject to a 0 % floor. The applicable margin on SOFR rate loans varies from 1.00 % to 2.00 % and the applicable margin on base rate loans varies from 0.00 % to 1.00 %, in each case determined based on our credit rating. As of December 31, 2024, the applicable margin on SOFR rate loans was 1.75 % and the applicable margin on base rate loans was 0.75 %. A letter of credit fee is payable by us equal to the applicable margin for SOFR rate loans times the daily amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders varies from 0.10 % to 0.30 % based on our credit rating. +None of our subsidiaries are currently required to be a guarantor under the Prior Credit Agreement. However, if any subsidiary guarantees or incurs debt, which does not qualify for certain limited exceptions and is otherwise, in the aggregate with all other similar debt, in excess of Priority Debt (as defined in the Prior Credit Agreement), such subsidiary is required to become a guarantor under the Prior Credit Agreement. +The Prior Credit Agreement contains representations, warranties, affirmative and negative covenants and events of default and associated remedies that we believe are customary for agreements of this nature, including certain restrictions on our ability and the ability of each of our subsidiaries to grant liens and on the ability of each of our non-guarantor subsidiaries to incur debt. If our credit rating is below investment grade at both Moody’s and S&P, we will become subject to a restricted payment covenant, which would generally require us to have a Pro Forma Debt Service Coverage Ratio (as defined in the Prior Credit Agreement) greater than or equal to 1.50 to 1.00 immediately before and immediately after making any restricted payment. Restricted payments include, among other things, dividend payments, repurchases of our common stock, distributions to holders of our common stock or any other payment or other distribution to third parties on account of our or our subsidiaries’ equity interests. Our credit rating is currently investment grade at both credit rating agencies. The Prior Credit Agreement also requires that our total debt to capitalization ratio, expressed as a percentage, not exceed 50 % as of the last day of each fiscal quarter. The Prior Credit Agreement generally defines the total debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the end of the most recently ended fiscal quarter. We were in compliance with these covenants at December 31, 2024. +As of December 31, 2024, we had no borrowings outstanding under our revolving credit facility. We had $ 2.1 million in letters of credit outstanding under the Prior Credit Agreement at December 31, 2024 and, as a result, had available borrowing capacity of approximately $ 613 million at that date. +2015 Reimbursement Agreement — On March 16, 2015, we entered into a Reimbursement Agreement (as amended from time to time, the “Reimbursement Agreement”) with The Bank of Nova Scotia (“Scotiabank”), pursuant to which we may from time to time request that Scotiabank issue an unspecified amount of letters of credit. As of December 31, 2024, we had $ 38.8 million in letters of credit outstanding under the Reimbursement Agreement. +Under the terms of the Reimbursement Agreement, we will reimburse Scotiabank on demand for any amounts that Scotiabank has disbursed under any of our letters of credit issued thereunder. Fees, charges and other reasonable expenses for the issuance of letters of credit are payable by us at the time of issuance at such rates and amounts as are in accordance with Scotiabank’s prevailing practice. We are obligated to pay to Scotiabank interest on all amounts not paid by us on the date of demand or when otherwise due at the Prime rate plus 2.00 % per annum, calculated daily and payable monthly, in arrears, on the basis of a calendar year for the actual number of days elapsed, with interest on overdue interest at the same rate as on the reimbursement amounts. A letter of credit fee is payable by us equal to 1.50 % times the amount of outstanding letters of credit. +We have also agreed that if obligations under the Credit Agreement are secured by liens on any of our or our subsidiaries’ property, then our reimbursement obligations and (to the extent similar obligations would be secured under the Credit Agreement) other obligations under the Reimbursement Agreement and any letters of credit will be equally and ratably secured by all property subject to such liens securing the Credit Agreement. +Pursuant to a Continuing Guaranty dated as of March 16, 2015, our payment obligations under the Reimbursement Agreement are jointly and severally guaranteed as to payment and not as to collection by our subsidiaries that from time to time guarantee payment under the Credit Agreement. None of our subsidiaries are currently required to guarantee payment under the Credit Agreement. +F-23 +Table of Contents +2028 Senior Notes, 2029 Senior Notes and 2033 Senior Notes —On January 19, 2018, we completed an offering of $ 525 million in aggregate principal amount of 3.95 % Senior Notes due 2028 (the “2028 Notes”). On November 15, 2019, we completed an offering of $ 350 million in aggregate principal amount of 5.15 % Senior Notes due 2029 (the “2029 Notes”). On September 13, 2023, we completed an offering of $ 400 million in aggregate principal amount of 7.15 % Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses from the offering of the 2033 Notes were approximately $ 396 million, which we used to repay amounts outstanding under our Prior Credit Agreement. +We pay interest on the 2028 Notes on February 1 and August 1 of each year. The 2028 Notes will mature on February 1, 2028 . The 2028 Notes bear interest at a rate of 3.95 % per annum. +We pay interest on the 2029 Notes on May 15 and November 15 of each year. The 2029 Notes will mature on November 15, 2029 . The 2029 Notes bear interest at a rate of 5.15 % per annum. +We pay interest on the 2033 Notes on April 1 and October 1 of each year. The 2033 Notes will mature on October 1, 2033 . The 2033 Notes bear interest at a rate of 7.15 % per annum. +The 2028 Notes, 2029 Notes and 2033 Notes (together, the “Senior Notes”) are our senior unsecured obligations, which rank equally with all of our other existing and future senior unsecured debt and will rank senior in right of payment to all of our other future subordinated debt. The Senior Notes will be effectively subordinated to any of our future secured debt to the extent of the value of the assets securing such debt. In addition, the Senior Notes will be structurally subordinated to the liabilities (including trade payables) of our subsidiaries that do not guarantee the Senior Notes. None of our subsidiaries are currently required to be a guarantor under the Senior Notes. If our subsidiaries guarantee the Senior Notes in the future, such guarantees (the “Guarantees”) will rank equally in right of payment with all of the guarantors’ future unsecured senior debt and senior in right of payment to all of the guarantors’ future subordinated debt. The Guarantees will be effectively subordinated to any of the guarantors’ future secured debt to the extent of the value of the assets securing such debt. +At our option, we may redeem the Senior Notes in whole or in part, at any time or from time to time at a redemption price equal to 100 % of the principal amount of such Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the redemption date, plus a “make-whole” premium. Additionally, commencing on November 1, 2027, in the case of the 2028 Notes, on August 15, 2029, in the case of the 2029 Notes, and on July 1, 2033, in the case of the 2033 Notes, at our option, we may redeem the respective Senior Notes in whole or in part, at a redemption price equal to 100 % of the principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest, if any, on those Senior Notes to the applicable redemption date. +The indentures pursuant to which the Senior Notes were issued include covenants that, among other things, limit our and our subsidiaries’ ability to incur certain liens, engage in sale and lease-back transactions or consolidate, merge, or transfer all or substantially all of their assets. These covenants are subject to important qualifications and limitations set forth in the indentures. +Upon the occurrence of a change of control triggering event, as defined in the indentures, each holder of the Senior Notes may require us to purchase all or a portion of such holder’s Senior Notes at a price equal to 101 % of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the applicable repurchase date. +The indentures also provide for events of default which, if any of them occurs, would permit or require the principal of, premium, if any, and accrued interest, if any, on the Senior Notes to become or to be declared due and payable. +Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2024 (in thousands): +Year ending December 31, +2025 $ 6,395 +2026 — +2027 — +2028 482,505 +2029 344,895 +Thereafter 400,000 +Total $ 1,233,795 +F-24 +Table of Contents +10. Commitments and Contingencies +Commitments – As of December 31, 2024, we maintained letters of credit in the aggregate amount of $ 42.9 million primarily for the benefit of various insurance companies as collateral for retrospective premiums and retained losses that could become payable under the terms of the underlying insurance contracts and compliance with contractual obligations. These letters of credit expire annually at various times during the year and are typically renewed. As of December 31, 2024, no amounts had been drawn under the letters of credit. As of December 31, 2024, we had $ 35.0 million in surety bond exposure issued as financial assurance on an insurance agreement. +As of December 31, 2024, we had commitments to purchase major equipment totaling approximately $ 65.9 million. +Our completion services segment has entered into agreements to purchase minimum quantities of proppants from certain vendors. We purchased $ 103 million, $ 135 million and $ 93.0 million of proppants under take-or-pay or similar agreements during the years ended December 31, 2024, 2023 and 2022, respectively. As of December 31, 2024, the remaining minimum obligation under these agreements was approximately $ 19.8 million, of which approximately, $ 17.4 million and $ 2.4 million relate to 2025 and 2026, respectively. +Contingencies – Our operations are subject to many hazards inherent in the businesses in which we operate, including inclement weather, blowouts, explosions, fires, loss of well control, motor vehicle accidents, equipment failure, unplanned power outages and surges, computer system disruptions or cybersecurity incidents, pollution, exposure and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. An accident or other event resulting in significant environmental or property damage, or injuries or fatalities involving our employees or other persons could also trigger investigations by federal, state or local authorities. Such an accident or other event could cause us to incur substantial expenses in connection with the investigation, remediation and resolution, as well as cause lasting damage to our reputation, loss of customers and an inability to obtain insurance. +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers. In addition, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us. +Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons. Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements. Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. The insurances that we maintain include coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employers’ liability, automobile liability, commercial general liability, workers’ compensation as well as insurance for other specific risks, together with excess loss liability insurance coverage. We have also elected to retain a greater amount of risk through increased deductibles as compared to prior years, or self-insurance on certain insurance policies. We cannot assure that any insurance obtained by us will be adequate to cover any losses or liabilities nor can we assure that any insurance obtained by us will continue to be made available for purchase or made available on acceptable terms. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets, and in certain cases, such as losses arising from or attributable to fire and/or explosion resulting from our hydraulic fracturing operations at the wellsite, is subject to significantly higher deductibles than are applicable to our other coverages. We also self-insure a number of risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +Certain subsidiaries we acquired in the Ulterra acquisition are defendants in a claim brought by a subsidiary of NOV Inc. alleging breach of a license agreement related to certain patents. Such subsidiaries have asserted defenses to the claim and are defending vigorously against this claim. +F-25 +Table of Contents +The case is Grant Prideco, Inc., et al. v. Schlumberger Technology Corp., et al., in Texas State Court, District of Harris County, 11th Judicial District. On February 6, 2023, Grant Prideco, Inc., ReedHycalog UK, Ltd. ReedHycalog, LP, National Oilwell Varco, LP (“NOV”) sued Ulterra Drilling Technologies, LP (“Ulterra”) and several other companies. NOV seeks a declaration that United States Patent No. 8,721,752 (the “’752 Patent”) is a “Licensed RH Patent” per the terms of a license agreement between Ulterra and NOV. NOV also alleges a breach of contract based on the license agreement between NOV and Ulterra and seeks allegedly owed royalties since October 22, 2021. NOV also seeks attorney’s fees. +On February 27, 2023, Ulterra filed a plea to the jurisdiction, and subject thereto, an answer, affirmative defenses and counterclaims. Ulterra’s counterclaims include: (i) declaratory judgments of non-infringement of U.S. Pat. No. 7,568,534 and the ’752 patent; (ii) a declaratory judgment of no royalties after Oct. 22, 2021; (iii) a declaratory judgment that certain other identified patents are expired and therefore not infringed after Oct. 22, 2021; and (iv) a declaratory judgment of no breach of contract. On the same day, Ulterra filed a notice of removal in federal court for the Southern District of Texas, Houston Division (SDTX 4:23-cv-00730), as well as a corresponding notice in Texas state court. NOV moved to dismiss and remand the case back to state court. On February 17, 2024, the Court denied NOV’s motion. +Discovery is closed and dispositive motions are scheduled to be fully briefed by the end of March 2025. Trial is currently scheduled for March 31, 2025. An unfavorable judgment or resolution of this claim not covered by indemnity could have a material impact on our financial results. +Additionally, we are party to various legal proceedings arising in the normal course of our business. We do not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on our financial condition, cash flows and results of operations. +11. Stockholders’ Equity +Cash Dividend — On February 5, 2025, our Board of Directors approved a cash dividend on our common stock in the amount of $ 0.08 per share to be paid on March 17, 2025 to holders of record as of March 3, 2025. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our debt agreements and other factors. Our Board of Directors may, without advance notice, reduce or suspend our dividend for any reason, including to improve our financial flexibility and position our company for long-term success. There can be no assurance that we will pay a dividend in the future. +Share Repurchases and Acquisitions — In September 2013, our Board of Directors approved a stock buyback program. In February 2024, our Board of Directors approved an increase of the authorization under the stock buyback program to allow for an aggregate of $ 1.0 billion of future share repurchases. All purchases executed to date have been through open market transactions. Purchases under the buyback program are made at management’s discretion, at prevailing prices, subject to market conditions and other factors. Purchases may be made at any time without prior notice. There is no expiration date associated with the buyback program. As of December 31, 2024, we had remaining authorization to purchase approximately $ 759 million of our outstanding common stock under the stock buyback program. Shares of stock purchased under the buyback program are held as treasury shares. +We acquired shares of stock from employees during 2024, 2023 and 2022 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price and employees’ tax withholding obligations upon the exercise of stock options. The remainder of these shares were acquired to satisfy payroll withholding obligations upon the settlement of performance unit awards and the vesting of restricted stock units. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”), the Patterson-UTI Energy, Inc. 2021 Long-Term Incentive Plan (the “2021 Plan”), the NexTier Oilfield Solutions Inc. Equity and Incentive Award Plan and the NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan, and not pursuant to the stock buyback program. +F-26 +Table of Contents +Treasury stock acquisitions during the years ended December 31, 2024, 2023 and 2022 were as follows (dollars in thousands): +2024 2023 2022 +Shares Cost Shares Cost Shares Cost +Treasury shares at beginning of period 105,580,011 $ 1,657,675 88,758,722 $ 1,453,079 84,128,995 $ 1,372,641 +Purchases pursuant to stock buyback program 26,646,698 280,327 14,086,229 168,631 3,254,599 57,173 +Acquisitions pursuant to long-term incentive plan 1,213,319 13,065 2,735,060 35,965 1,372,101 23,237 +Other — — — — 3,027 28 +Treasury shares at end of period 133,440,028 $ 1,951,067 105,580,011 $ 1,657,675 88,758,722 $ 1,453,079 +12. Stock-based Compensation +We use share-based payments to compensate employees and non-employee directors. We recognize the cost of share-based payments under the fair-value-based method. Share-based awards include equity instruments in the form of stock options or restricted stock units that have included service conditions and, in certain cases, performance conditions. Our share-based awards also include share-settled performance unit awards. Share-settled performance unit awards are accounted for as equity awards. We issue shares of common stock when vested stock options are exercised and after restricted stock units and share-settled performance unit awards vest. +The 2021 Plan was originally approved by our stockholders on June 3, 2021. Our Board of Directors and our stockholders have approved a series of amendments to the 2021 Plan (the “2021 Plan Amendments”) to increase the number of shares available for issuance under the 2021 Plan. Following the 2021 Plan Amendments, the aggregate number of shares of Common Stock authorized for grant under the 2021 Plan is approximately 39.1 million. +On September 1, 2023, the Board of Directors also approved amendments to the NexTier Plan and the NexTier Oilfield Solutions Inc. (Former C&J Energy) Management Incentive Plan (the “Former C&J Energy Plan” and, together with the NexTier Plan, the “Assumed Plans”) to assume awards that were previously granted under the Assumed Plans (consisting of stock options, time- and performance-based restricted stock units and cash-settled performance unit awards), which, in connection with the NexTier merger, were converted into share-based awards in respect of shares of Patterson-UTI Energy, Inc. common stock. +Our share-based compensation plans at December 31, 2024 are as follows: +Plan Name Shares +Authorized +for Grant Shares Underlying +Awards +Outstanding Shares +Available +for Grant +2021 Plan 39,074,510 6,440,885 17,520,596 +NexTier Plan — 977,011 — +Former C&J Energy Plan — 406,405 — +2014 Plan — 1,719,275 — +Stock Options — We estimate the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of our common stock over the most recent period equal to the expected term of the options as of the date such options are granted. The expected term assumptions are based on our experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. +F-27 +Table of Contents +The risk-free interest rate assumptions are determined by reference to United States Treasury yields. No options were granted during the years ended December 31, 2024, 2023 and 2022. +Stock option activity for the year ended December 31, 2024 follows: +Shares Weighted Average +Exercise Price Per Share +Outstanding at beginning of year 2,865,223 $ 23.36 +Exercised — $ — +Expired ( 1,071,218 ) $ 25.19 +Outstanding at end of year 1,794,005 $ 22.26 +Exercisable at end of year 1,794,005 $ 22.26 +Options outstanding and exercisable at December 31, 2024 have no intrinsic value and a weighted-average remaining contractual term of 1.20 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2024, 2023 and 2022 follows (in thousands, except per share data): +2024 2023 2022 +Weighted-average grant date fair value of stock options granted (per share) NA NA NA +Aggregate grant date fair value of stock options vested during the year $ — $ — $ — +Aggregate intrinsic value of stock options exercised $ — $ — $ 410 +As of December 31, 2024, no options to purchase shares were outstanding and unvested. +Restricted Stock Units (Equity Based) — For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Forfeitable dividend equivalents are accrued on certain restricted stock units that will be paid upon vesting. We use the straight-line method to recognize periodic compensation cost over the vesting period. +Restricted stock unit activity for the year ended December 31, 2024 follows: +Time +Based Performance +Based Weighted Average +Grant Date Fair +Value Per Share +Non-vested restricted stock units outstanding at beginning of year 5,827,668 521,533 $ 10.60 +Granted 3,113,411 — $ 10.49 +Vested ( 3,245,228 ) ( 45,661 ) $ 9.11 +Forfeited ( 268,194 ) ( 23,358 ) $ 11.33 +Non-vested restricted stock units outstanding at end of year 5,427,657 452,514 $ 11.34 +As of December 31, 2024, approximately 5.5 million non-vested restricted stock units outstanding are expected to vest. Additional information as of December 31, 2024 with respect to these non-vested restricted stock units follows (dollars in thousands): +Aggregate intrinsic value $ 45,167 +Weighted-average remaining vesting period 1.71 years +Unrecognized compensation cost $ 42,828 +Restricted Stock Units (Liability Based) — We converted NexTier’s cash-settled performance based units into our cash-settled restricted stock units in connection with the NexTier merger. These awards are accounted for as liability classified awards and remeasured at fair value at each reporting period. Compensation expense is recorded over the vesting period and is initially based on the fair value at the award conversion date. Compensation expense is subsequently remeasured at each reporting date during the vesting period based on the change in our stock price. Dividend cash equivalents are not paid on cash-settled units. As of December 31, 2024, $ 3.3 million is included in “Accrued liabilities” in our consolidated balance sheets for these awards. We recognized $ 0.6 million of compensation expense for these awards during the year ended December 31, 2024. +F-28 +Table of Contents +Performance Unit Awards — We have granted share-settled performance unit awards to certain employees (the “Performance Units”) on an annual basis since 2010. The Performance Units provide for the recipients to receive shares of common stock upon the achievement of certain performance goals during a specified period established by the Compensation Committee. The performance period for the Performance Units is generally the three-year period commencing on April 1 of the year of grant, except as described below for the Performance Units granted in May 2024. +The performance goals for the Performance Units are tied to our total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. For the performance units granted in April 2022, the peer group includes one market index. The performance goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective Performance Units. For the Performance Units granted in April 2022 and May 2023, the recipients will receive the target number of shares if our total shareholder return during the performance period, when compared to the peer group, is at the 55 th percentile. If our total shareholder return during the performance period, when compared to the peer group, is at the 75 th percentile or higher, then the recipients will receive two times the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is at the 25 th percentile, then the recipients will only receive one-half of the target number of shares. If our total shareholder return during the performance period, when compared to the peer group, is between the 25 th and 55 th percentile, or the 55 th and 75 th percentile, then the shares to be received by the recipients will be determined using linear interpolation for levels of achievement between these points. +The Performance Units granted in May 2024 (the "2024 Performance Units") are subject to three separate performance periods—a one-year performance period (the “First Performance Period”), a two-year performance period (the “Second Performance Period”) and a three-year performance period (the “Third Performance Period”), each commencing on April 1, 2024. One-third of the total target number of shares subject to the 2024 Performance Units may become earned in respect of each performance period based on our total shareholder return during such performance period (the target number of shares eligible to vest in the applicable performance period, the “Performance Period Target Amount”). The recipients will earn the Performance Period Target Amount if our total shareholder return during the applicable performance period, when compared to the peer group, is at the 55th percentile. If our total shareholder return during the applicable performance period, when compared to the peer group, is at the 75th percentile or higher, then the recipients will earn two times the Performance Period Target Amount. If our total shareholder return during the applicable performance period, when compared to the peer group, is at the 25th percentile, then the recipients will only earn one-half of the Performance Period Target Amount. If our total shareholder return during the applicable performance period, when compared to the peer group, is between the 25th and 55th percentile, or the 55th and 75th percentile, then the shares to be earned by the recipients will be determined using linear interpolation for levels of achievement between these points. Notwithstanding the foregoing, a number of shares no greater than the Performance Period Target Amount may be earned for each of the First Performance Period and the Second Performance Period, unless our total shareholder return during the Third Performance Period is greater than our total shareholder return for, as applicable, the First Performance Period and/or the Second Performance Period, in which case, the number of shares earned in respect of the First Performance and/or the Second Performance Period, as applicable, will be determined as if our total shareholder return during the Third Performance Period was our total shareholder return during the First Performance Period and/or the Second Performance Period, as applicable. If our total shareholder return during the Third Performance Period is zero or negative, no more than the aggregate target number of shares subject to the 2024 Performance Units may be earned, regardless of results during the First Performance Period and the Second Performance Period. A full three-year service vesting period applies to the Performance Units and no shares will vest and be delivered in respect of the 2024 Performance Units until after the completion of the Third Performance Period. +The payout under the 2024 Performance Units may not exceed the target number of shares if our absolute total shareholder return is negative or zero . +The total target number of shares granted with respect to the Performance Units for the years 2019-2024 is set forth below: +2024 +Performance +Unit Awards 2023 +Performance +Unit Awards 2022 +Performance +Unit Awards 2021 +Performance +Unit Awards 2020 +Performance +Unit Awards 2019 +Performance +Unit Awards +Target number of shares 875,100 631,700 414,000 843,000 500,500 489,800 +In April 2022, 979,600 shares were issued to settle the 2019 Performance Units. In May 2023, 1,001,000 shares were issued to settle the 2020 Performance Units. In May 2024, 718,581 shares were issued to settle the 2021 Performance Units. The Performance Units granted in 2022, 2023 and 2024 have not reached the end of their respective performance periods. +Because the Performance Units are share-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Performance Units is set forth below (in thousands): +F-29 +Table of Contents +2024 +Performance +Unit Awards 2023 +Performance +Unit Awards 2022 +Performance +Unit Awards 2021 +Performance +Unit Awards 2020 +Performance +Unit Awards 2019 +Performance +Unit Awards +Aggregate fair value at date of grant $ 10,904 $ 8,440 $ 10,743 $ 7,225 $ 826 $ 9,958 +The weighted-average fair value calculations for performance units granted during the years ended December 31, 2024, 2023 and 2022 were based on the following weighted-average assumptions set forth below: +2024 2023 2022 +Risk-free interest rate (1) +4.6 % 3.6 % 2.9 % +Expected stock volatility (2) +56.9 % 72.1 % 86.5 % +Expected dividend yield (3) +2.9 % 3.0 % 1.0 % +Expected term (in years) 3 3 3 +(1) The risk-free interest rate is based on U.S. Treasury securities for the expected term of the Performance Units. +(2) Expected volatilities are based on the daily closing price of our stock based upon historical experience over a three-year period. +(3) Expected dividend yield is based on the annualized dividend in effect on the measurement date and the stock price on the grant date. +These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Performance Units is set forth below (in thousands): +2024 +Performance +Unit Awards 2023 +Performance +Unit Awards 2022 +Performance +Unit Awards 2021 +Performance +Unit Awards 2020 +Performance +Unit Awards 2019 +Performance +Unit Awards +Year ended December 31, 2024 $ 2,436 $ 2,665 $ 3,459 $ 584 NA NA +Year ended December 31, 2023 NA $ 2,248 $ 3,749 $ 2,426 $ 69 NA +Year ended December 31, 2022 NA NA $ 2,686 $ 2,408 $ 275 $ 830 +As of December 31, 2024, we had unrecognized compensation cost of $ 12.8 million related to our unvested Performance Units. The weighted-average remaining vesting period for these unvested Performance Units was 1.04 years as of December 31, 2024. +Dividends on Equity Awards — Dividend equivalents are paid or accrued on certain restricted stock units. These dividends are recognized as reductions of retained earnings for the portion of restricted stock units expected to vest. +Phantom Units — In May 2020, the Compensation Committee approved a grant of long-term performance-based phantom units to our Chief Executive Officer and President, William A. Hendricks, Jr. (the “Phantom Units”). The Phantom Units were granted outside of the 2014 Plan. Pursuant to this phantom unit grant, Mr. Hendricks could earn from 0 % to 200 % of a target award of 298,500 phantom units based on our achievement of the same performance conditions over the same performance period that applied to the Performance Units granted in April 2020. The Phantom Units settled in May 2023, with a cash payment of $ 7.4 million. +13. Leases +ASC Topic 842 Leases +We have operating and finance leases primarily for office locations, including for both field locations and corporate offices, certain operating equipment, and light duty vehicles. The terms and conditions for these leases vary by the type of underlying asset. +During the third quarter of 2023, we acquired $ 7.5 million and $ 19.1 million of operating leases for operating locations, corporate offices, certain operating equipment and light duty vehicles primarily related to the Ulterra acquisition and NexTier merger, respectively. +We also acquired $ 5.2 million and $ 50.7 million of finance leases for light duty vehicles and certain operating equipment related to the Ulterra acquisition and NexTier merger, respectively. +Operating leases have remaining lease terms of approximately one month to ten years as of December 31, 2024, and finance leases have remaining lease terms of approximately one month to six years as of December 31, 2024. +F-30 +Table of Contents +Lease expense consisted of the following for the years ended December 31, 2024, 2023 and 2022 (in thousands): +Year Ended December 31, +2024 2023 2022 +Operating lease cost $ 18,147 $ 10,073 $ 5,664 +Finance lease cost: +Amortization of right-of-use assets 21,394 6,360 — +Interest on lease liabilities 2,255 1,395 — +Total finance lease cost 23,649 7,755 — +Short-term lease expense (1) +360 2,278 — +Total lease expense (2) +$ 42,156 $ 20,106 $ 5,664 +(1) Short-term lease expense represents expense related to leases with a contract term of one year or less. +(2) Operating lease expense is recorded in operating costs for the respective segments and within “selling, general and administrative”, amortization of right-of-use assets is recorded within “depreciation, depletion, amortization and impairment”, and interest on lease liabilities is recorded within “interest expense” in our consolidated statements of operations. +Supplemental cash flow information related to leases for the years ended December 31, 2024, 2023 and 2022 is as follows (in thousands): +Year Ended December 31, +2024 2023 2022 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases $ 14,838 $ 8,935 $ 6,858 +Operating cash flows from finance leases 2,220 1,380 — +Financing cash flows from finance leases 45,484 15,915 — +Right of use assets obtained in exchange for lease obligations: +Operating leases (1) +$ 12,541 $ 34,802 $ 6,530 +Finance leases (1) +21,234 73,245 — +(1) Includes right of use assets acquired in business combinations in 2023. +Lease terms and discount rates related to leases as of December 31, 2024 and 2023 is as follows: +2024 2023 +Weighted Average Remaining Lease Term: +Operating leases 4.8 years 5.0 years +Finance leases 2.3 years 1.5 years +Weighted Average Discount Rate: +Operating leases 6.5 % 6.1 % +Finance leases 7.4 % 7.3 % +F-31 +Table of Contents +Maturities of operating and finance lease liabilities as of December 31, 2024 are as follows (in thousands): +Year ending December 31, Operating Finance +2025 $ 15,791 $ 16,664 +2026 11,692 6,264 +2027 8,238 1,490 +2028 6,700 1,485 +2029 5,904 1,485 +Thereafter 6,944 595 +Total lease payments 55,269 27,983 +Less imputed interest ( 7,642 ) ( 2,553 ) +Total $ 47,627 $ 25,430 +14. Income Taxes +Income (loss) before income taxes for the United States and non-U.S. jurisdictions for the years ended December 31, 2024, 2023, and 2022 are as follows (in thousands): +2024 2023 2022 +Income (loss) before income taxes: +United States $ ( 946,388 ) $ 315,897 $ 165,878 +Non-U.S. ( 10,558 ) ( 8,793 ) 1,984 +$ ( 956,946 ) $ 307,104 $ 167,862 +Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2024, 2023 and 2022 are as follows (in thousands): +2024 2023 2022 +Federal income tax expense (benefit): +Current $ 417 $ — $ 480 +Deferred ( 1,390 ) 44,369 11,820 +( 973 ) 44,369 12,300 +State income tax expense (benefit): +Current 4,882 7,002 2,647 +Deferred ( 1,412 ) 11,279 ( 4,896 ) +3,470 18,281 ( 2,249 ) +Foreign income tax expense (benefit): +Current 5,269 1,578 2,750 +Deferred 1,687 ( 3,076 ) 403 +6,956 ( 1,498 ) 3,153 +Total income tax expense (benefit): +Current 10,568 8,580 5,877 +Deferred ( 1,115 ) 52,572 7,327 +Total income tax expense $ 9,453 $ 61,152 $ 13,204 +F-32 +Table of Contents +The differences between the statutory U.S. federal income tax rate and the effective income tax rate for the years ended December 31, 2024, 2023 and 2022 are summarized as follows: +2024 2023 2022 +Statutory tax rate 21.0 % 21.0 % 21.0 % +State income taxes - net of the federal income tax benefit 0.5 3.2 3.0 +State deferred tax remeasurement ( 0.7 ) ( 0.3 ) 9.4 +Goodwill impairment ( 19.4 ) — — +Valuation allowance ( 1.3 ) ( 9.2 ) ( 33.4 ) +U.S. impact of foreign operations ( 0.2 ) — 1.3 +Acquisition related costs — 1.1 — +Effect of foreign taxes 0.3 0.1 1.6 +Non-deductible compensation ( 0.7 ) 1.8 4.3 +Share-based compensation ( 0.3 ) 1.6 ( 1.9 ) +Non-deductible expenses ( 0.7 ) 0.7 1.2 +Other differences, net 0.5 ( 0.1 ) 1.4 +Effective tax rate ( 1.0 %) 19.9 % 7.9 % +Our effective income tax rate fluctuates based on, among other factors, changes in pre-tax income in countries with varying statutory tax rates, changes in valuation allowances, and the impacts of various other permanent adjustments. +The impact of goodwill impairment that is not deductible for income tax had a significant impact on our effective tax rate for the year ended December 31, 2024. +The tax effect of temporary differences and tax attributes representing deferred tax assets and liabilities at December 31, 2024 and 2023 are as follows (in thousands): +2024 2023 +Deferred tax assets: +Net operating loss carryforwards $ 406,876 $ 498,948 +Tax credits 17,254 13,488 +Expense associated with stock options and restricted stock units 8,344 10,892 +Workers’ compensation allowance 9,437 7,024 +Other deferred tax asset 79,132 69,480 +521,043 599,832 +Less: +Allowance to reduce deferred tax asset to expected realizable value ( 86,693 ) ( 75,250 ) +Total deferred tax assets 434,350 524,582 +Deferred tax liabilities: +Property and equipment basis difference ( 654,541 ) ( 729,376 ) +Other ( 17,906 ) ( 39,386 ) +Total deferred tax liabilities ( 672,447 ) ( 768,762 ) +Net deferred tax liability $ ( 238,097 ) $ ( 244,180 ) +In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized, and when necessary, valuation allowances are provided. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We assess the realizability of our deferred tax assets quarterly and consider carryback availability, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. During 2024, we increased the valuation allowance against our net deferred tax assets by $ 11.4 million, which primarily related to U.S. state and foreign activity. +F-33 +Table of Contents +For income tax purposes, we had approximately $ 1.5 billion of gross U.S. federal net operating losses, approximately $ 58.7 million of gross Canadian net operating losses and approximately $ 910 million of post-apportionment U.S. state net operating losses as of December 31, 2024, before valuation allowances. The majority of the U.S. federal net operating losses are generated after 2017 and can be carried forward indefinitely. Canadian net operating losses will expire in varying amounts, if unused, between 2036 and 2044 . U.S. state net operating losses will expire in varying amounts, if unused, between 2025 and 2044 . +As of December 31, 2024, we have not recognized any liabilities associated with unrecognized tax benefits. We have established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2024, the tax years ended December 31, 2010 through December 31, 2023 are open for examination by U.S. taxing authorities. As of December 31, 2024, the tax years ended December 31, 2017 through December 31, 2023 are open for examination by Canadian taxing authorities. As of December 31, 2024, the tax years ended December 31, 2018 through December 31, 2023 are open for examination by Colombian taxing authorities. +We continue to monitor income tax developments, including OECD Pillar 2 legislation, in the United States and other countries where we have legal entities. We will incorporate into our future financial statements the impacts, if any, of future regulations and additional authoritative guidance when finalized. +15. Earnings Per Share +We provide a dual presentation of our net income (loss) per common share in our consolidated statements of operations: basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”). +Basic EPS excludes dilution and is determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period. +Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options and non-vested performance units and non-vested restricted stock units. The dilutive effect of stock options, non-vested performance units and non-vested restricted stock units is determined using the treasury stock method. +The following table presents information necessary to calculate net income (loss) per share for the years ended December 31, 2024, 2023 and 2022, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts): +2024 2023 2022 +BASIC EPS: +Net income (loss) attributable to common stockholders $ ( 968,031 ) $ 246,292 $ 154,658 +Weighted average number of common shares outstanding, excluding non-vested restricted stock units 397,196 279,501 215,935 +Basic net income (loss) per common share $ ( 2.44 ) $ 0.88 $ 0.72 +DILUTED EPS: +Net income (loss) attributable to common stockholders $ ( 968,031 ) $ 246,292 $ 154,658 +Weighted average number of common shares outstanding, excluding non-vested restricted stock units 397,196 280,061 219,496 +Diluted net income (loss) per common share $ ( 2.44 ) $ 0.88 $ 0.70 +Potentially dilutive securities excluded as anti-dilutive 7,674 9,214 3,541 +16. Employee Benefits +We maintain a 401(k) plan for all eligible employees. Our operating results include expenses of approximately $ 34.6 million in 2024, $ 18.7 million in 2023 and $ 11.0 million in 2022 for our contributions to the plan. +17. Business Segments +Our Chief Operating Decision Maker (“CODM”) is our Chief Executive Officer, who has ultimate responsibility for enterprise decisions. Effective as of the third quarter of 2023, we revised our reportable segments to align with certain changes in how our +F-34 +Table of Contents +CODM manages and allocates resources to our business as a result of the Ulterra acquisition and NexTier merger. Our business is organized based on the services and products we provided in three segments: (i) drilling services, (ii) completion services, and (iii) drilling products. The CODM evaluates segment performance based primarily on segment operating income (loss). +Drilling Services — represents our contract drilling, directional drilling, oilfield technology and electrical controls and automation businesses. +Completion Services — represents the combination of our well completion business, which includes hydraulic fracturing, wireline and pumping, completion support, cementing and our legacy pressure pumping business. +Drilling Products — represents our manufacturing and distribution of drill bits business, which was acquired with our acquisition of Ulterra on August 14, 2023. +Our results for the year ended December 31, 2024 are not comparable for our Completion Services and Drilling Products reportable segments since results for 2023 include a partial period beginning on the closing date for each acquisition. +Geographic Information +Consolidated revenues by country based on sales destination of the products or services for the years ended December 31, 2024, 2023 and 2022 are as follows (in thousands): +Year Ended December 31, +2024 2023 2022 +Revenue: +United States $ 5,249,154 $ 4,057,212 $ 2,577,471 +Canada 33,518 12,501 — +Colombia 12,223 48,592 70,121 +Other Countries 83,016 28,151 — +Total revenues $ 5,377,911 $ 4,146,456 $ 2,647,592 +Property and equipment, net by country based on the location for the years ended December 31, 2024, 2023 and 2022 are as follows (in thousands): +Year Ended December 31, +2024 2023 +Property and equipment, net: +United States $ 2,950,342 $ 3,257,937 +Canada 12,695 16,018 +Colombia 35,154 48,302 +Other Countries 12,151 18,155 +Property and equipment, net $ 3,010,342 $ 3,340,412 +Major Customer — During 2024, one customer accounted for approximately $ 605 million or 11 % of our consolidated operating revenues. These revenues were earned in the drilling services, completion services, and drilling products businesses. During 2023, one customer accounted for approximately $ 588 million or 14 % of our consolidated operating revenues. These revenues were earned in both drilling services and completion services businesses. During 2022, one customer accounted for approximately $ 476 million or 18 % of our consolidated operating revenues. These revenues were earned in both drilling services and completion services businesses. +The following tables summarize selected financial information relating to our business segments (in thousands): +F-35 +Table of Contents +Drilling Services Completion Services Drilling Products Total +Year Ended December 31, 2024 +Revenues from external customers $ 1,727,810 $ 3,232,785 $ 351,651 $ 5,312,246 +Direct operating costs (1) +1,029,591 2,658,170 191,107 3,878,868 +Selling, general and administrative 16,502 41,557 35,860 93,919 +Depreciation, amortization and impairment (1) +477,398 564,155 100,610 1,142,163 +Impairment of goodwill — 885,240 — 885,240 +Other segment items (2) +— ( 17,792 ) — ( 17,792 ) +Segment operating income (loss) (3) +$ 204,319 $ ( 898,545 ) $ 24,074 $ ( 670,152 ) +Reconciliation of revenue: +Total segment revenues from external customers $ 5,312,246 +Other revenues (4) +65,665 +Total consolidated revenues $ 5,377,911 +Reconciliation to consolidated income (loss) before income taxes: +Segment operating income (loss) (3) +$ ( 670,152 ) +Other (4) +( 87 ) +Corporate ( 219,498 ) +Interest income 5,729 +Interest expense ( 71,963 ) +Other income (expense) ( 975 ) +Income before income taxes $ ( 956,946 ) +Drilling Services Completion Services Drilling Products Total +Year Ended December 31, 2023 +Revenues from external customers $ 1,919,759 $ 2,017,440 $ 134,679 $ 4,071,878 +Direct operating costs (1) +1,119,200 1,567,940 81,555 2,768,695 +Selling, general and administrative 15,014 26,050 11,158 52,222 +Depreciation, amortization and impairment (1) +364,312 283,230 48,467 696,009 +Other segment items (2) +( 769 ) — — ( 769 ) +Segment operating income (loss) (3) +$ 422,002 $ 140,220 $ ( 6,501 ) $ 555,721 +Reconciliation of revenue: +Total segment revenues from external customers $ 4,071,878 +Other revenues (4) +74,578 +Total consolidated revenues $ 4,146,456 +Reconciliation to consolidated income (loss) before income taxes: +Segment operating income (3) +$ 555,721 +Other (4) +2,829 +Corporate ( 206,596 ) +Interest income 6,122 +Interest expense ( 52,870 ) +Other income (expense) 1,898 +Income before income taxes $ 307,104 +F-36 +Table of Contents +Drilling Services Completion Services Drilling Products Total +Year Ended December 31, 2022 +Revenues from external customers $ 1,544,820 $ 1,022,413 $ — $ 2,567,233 +Direct operating costs (1) +1,025,904 781,385 — 1,807,289 +Selling, general and administrative 15,027 8,763 — 23,790 +Depreciation, amortization and impairment (1) +354,116 98,162 — 452,278 +Other segment items (2) +( 34 ) — — ( 34 ) +Segment operating income (3) +$ 149,807 $ 134,103 $ — $ 283,910 +Reconciliation of revenue: +Total segment revenues from external customers $ 2,567,233 +Other revenues (4) +80,359 +Total consolidated revenues $ 2,647,592 +Reconciliation to consolidated income (loss) before income taxes: +Segment operating income (3) +$ 283,910 +Other (4) +13,776 +Corporate ( 86,655 ) +Interest income 360 +Interest expense ( 40,256 ) +Other income (expense) ( 3,273 ) +Income before income taxes $ 167,862 +(1) The significant expense categories and amounts align with the segment-level information that is regularly provided to the chief operating decision maker. +(2) Other segment items for each reportable segment includes other operating expenses (income). +(3) Segment operating income (loss) is our measure of segment profitability. It is defined as revenue less operating expenses, selling, general and administrative expenses, depreciation, amortization and impairment expense and other operating expenses (income). +(4) Other includes our oilfield rentals business and oil and natural gas working interests. +Other business segment information +Year Ended December 31, +2024 2023 2022 +Capital expenditures: +Drilling Services $ 264,667 $ 334,780 $ 272,521 +Completion Services 320,329 214,746 137,935 +Drilling Products 61,687 24,572 — +Segment capital expenditures $ 646,683 $ 574,098 $ 410,456 +Other 21,813 24,645 25,215 +Corporate 9,890 16,947 1,126 +Total capital expenditures $ 678,386 $ 615,690 $ 436,797 +Identifiable assets: +Drilling Services $ 2,047,986 $ 2,368,604 $ 2,348,177 +Completion Services 2,468,707 3,835,699 541,975 +Drilling Products 966,200 1,011,870 — +Segment assets $ 5,482,893 $ 7,216,173 $ 2,890,152 +Other 55,580 59,221 64,018 +Corporate (1) +294,993 144,637 189,653 +Total assets $ 5,833,466 $ 7,420,031 $ 3,143,823 +(1) Corporate assets primarily include cash on hand and certain property and equipment. +F-37 +Table of Contents +18. Fair Values of Financial Instruments +The carrying values of cash, cash equivalents and restricted cash, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. +The estimated fair value of our outstanding debt balances as of December 31, 2024 and 2023 is set forth below (in thousands): +2024 2023 +Carrying +Value Fair +Value Carrying +Value Fair +Value +3.95 % Senior Notes Due 2028 +$ 482,505 $ 461,720 $ 482,505 $ 450,540 +5.15 % Senior Notes Due 2029 +344,895 336,490 344,895 329,032 +7.15 % Senior Notes Due 2033 +400,000 419,265 400,000 424,946 +Equipment Loans Due 2025 6,395 6,424 18,686 18,766 +Total debt $ 1,233,795 $ 1,223,899 $ 1,246,086 $ 1,223,284 +The fair values of the 2028 Notes, the 2029 Notes and the 2033 Notes at December 31, 2024 and 2023 are based on quoted market prices, which are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting. The fair value of the Equipment Loans is based on a 5.25 % stated rate of interest, which is considered a Level 2 fair value estimate in the fair value hierarchy of fair value accounting. +The implied market rates of interest used to determine the fair value of our outstanding debt balances as of December 31, 2024 and 2023 are set forth below: +2024 2023 +3.95 % Senior Notes Due 2028 +5.49 % 5.79 % +5.15 % Senior Notes Due 2029 +5.73 % 6.10 % +7.15 % Senior Notes Due 2033 +6.42 % 6.28 % +Equipment Loans Due 2025 5.28 % 5.36 % +F-38 +Table of Contents +PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +Additions and adjustments +Description Beginning +Balance Charged to Costs +and Expenses Charged to +Other Accounts Deductions Ending +Balance +(In thousands) +Year Ended December 31, 2024 +Allowance for credit losses $ 3,490 $ 5,755 $ 6,050 $ ( 248 ) (1) $ 15,047 +Deferred tax valuation allowance 75,250 11,443 — — 86,693 +Year Ended December 31, 2023 +Allowance for credit losses $ 2,875 $ 842 $ 43 $ ( 270 ) (1) $ 3,490 +Deferred tax valuation allowance 91,685 — 13,677 ( 30,112 ) 75,250 +Year Ended December 31, 2022 +Allowance for credit losses $ 8,493 $ — $ — $ ( 5,618 ) (1) $ 2,875 +Deferred tax valuation allowance 189,737 — — ( 98,052 ) 91,685 +_____________________________________ +(1) Consists of uncollectible accounts written-off. +S-1 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. +PATTERSON-UTI ENERGY, INC. +By: /s/ William Andrew Hendricks, Jr. +William Andrew Hendricks, Jr. +President and Chief Executive Officer +Date: February 11, 2025 +Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 11, 2025. +Signature Title +/s/ Curtis W. Huff Chairman of the Board +Curtis W. Huff +/s/ Robert W. Drummond Vice Chairman of the Board +Robert W. Drummond +/s/ William Andrew Hendricks, Jr. President, Chief Executive Officer +William Andrew Hendricks, Jr. and Director +(Principal Executive Officer) +/s/ C. Andrew Smith Executive Vice President and +C. Andrew Smith Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ Leslie A. Beyer Director +Leslie A. Beyer +/s/ Tiffany Thom Cepak Director +Tiffany Thom Cepak +/s/ Gary M. Halverson Director +Gary M. Halverson +/s/ Cesar Jaime Director +Cesar Jaime +/s/ Janeen S. Judah Director +Janeen S. Judah +/s/ Amy H. Nelson Director +Amy H. Nelson +/s/ Julie J. Robertson Director +Julie J. Robertson +/s/ James C. Stewart Director +James C. Stewart +S-2 \ No newline at end of file diff --git a/raw/filings/0000889900/2024/0000889900-25-000034/filing_metadata.csv b/raw/filings/0000889900/2024/0000889900-25-000034/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..fe2946e666e682aae08e07198eb06be8a0aa461b --- /dev/null +++ b/raw/filings/0000889900/2024/0000889900-25-000034/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000889900,PTEN,PATTERSON UTI ENERGY INC,10-K,2025-02-11,2024-12-31,2025-02-11T21:15:58.000Z,0000889900-25-000034,pten-20241231.htm,10-K,13999299,1,1,https://www.sec.gov/Archives/edgar/data/889900/000088990025000034/pten-20241231.htm,https://www.sec.gov/Archives/edgar/data/889900/000088990025000034/,2024,2024,1 diff --git a/raw/filings/0000889900/2024/0000889900-25-000034/item1.txt b/raw/filings/0000889900/2024/0000889900-25-000034/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..933e321bea0b108f942942f27b5a27706db1693e --- /dev/null +++ b/raw/filings/0000889900/2024/0000889900-25-000034/item1.txt @@ -0,0 +1,179 @@ +Item 1. Business +Available Information +This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website ( www.patenergy.com ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report or other filings that we make with the SEC. The SEC maintains an internet site ( www.sec.gov ) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. +Overview +We are a Houston, Texas-based leading provider of drilling and completion services to oil and natural gas exploration and production companies in the United States and other select countries, including contract drilling services, integrated well completion services and directional drilling services in the United States, and specialized drill bit solutions in the United States, Middle East and many other regions around the world. We operate under three reportable business segments: (i) drilling services, (ii) completion services, and (iii) drilling products. +Drilling Services +Our contract drilling business operates in the continental United States and internationally in Colombia and Ecuador and, from time to time, we pursue contract drilling opportunities in other select markets. We also provide a comprehensive suite of directional drilling services in most major producing onshore oil and natural gas basins in the United States, and we provide services that improve the statistical accuracy of wellbore placement for directional and horizontal wells. We also service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries, in North America and other select markets. +Completion Services +Our well completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States, including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. +Drilling Products +We serve the energy and mining markets by manufacturing and distributing drill bits throughout North America and internationally in over 30 countries. Our drilling equipment is used in oil and natural gas exploration and production and in mining operations. We have manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Other +Other consists of our oilfield rentals business, with a fleet of premium oilfield rental tools, along with the results of our ownership, as a non-operating working interest owner, in oil and natural gas assets located in Texas and New Mexico. +3 +Table of Contents +Recent Developments +Recent Developments in Market Conditions — Quarterly average oil prices and our quarterly average number of rigs operating in the United States for 2022, 2023 and 2024 are as follows: +1 st +Quarter +2 nd +Quarter +3 rd +Quarter +4 th +Quarter +2022 +Average oil price per Bbl (1) +$ 94.45 $ 108.72 $ 93.18 $ 82.79 +Average rigs operating per day – U.S. (2) +115 121 128 131 +2023 +Average oil price per Bbl (1) +$ 75.93 $ 73.54 $ 82.25 $ 78.53 +Average rigs operating per day – U.S. (2) +131 128 120 118 +2024 +Average oil price per Bbl (1) +$ 77.50 $ 81.81 $ 76.43 $ 70.73 +Average rigs operating per day – U.S. (2) +121 114 107 105 +(1) The average oil price represents the average monthly West Texas Intermediate (WTI) spot price as reported by the United States Energy Information Administration. +(2) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices, and upon our customers’ ability to access, and willingness to deploy, capital to fund their operating and capital expenditures. Commodity prices have historically been volatile, but have been relatively range-bound since the end of 2022. The current demand for equipment and services remains impacted by macro conditions, including commodity prices, geopolitical environment, inflationary pressures, economic conditions in the United States and elsewhere, as well as customer consolidation and focus by exploration and production companies and service companies on capital returns. Oil prices averaged $70.73 per barrel in the fourth quarter of 2024 and closed at $73.52 per barrel on February 3, 2025. Natural gas prices (based on the Henry Hub Spot Market Price) averaged $2.45 per MMBtu in the fourth quarter of 2024 and closed at $3.30 per MMBtu on February 3, 2025. +In our drilling services segment, our average active rig count in the United States for the fourth quarter of 2024 was 105 rigs. This was a decrease from our average active rig count for the third quarter of 2024 of 107 rigs. Our active rig count in the United States at December 31, 2024 of 103 rigs was less than the rig count of 121 rigs at December 31, 2023, reflecting the industry-wide activity declines due to increased drilling efficiencies and market consolidation. We expect our rig count in the United States will average 106 rigs in the first quarter of 2025. Term contracts help support our operating rig count. Based on contracts in place in the United States as of February 5, 2025, we expect an average of 64 rigs operating under term contracts during the first quarter of 2025 and an average of 40 rigs operating under term contracts during 2025. +During the fourth quarter of 2024, our completion services segment was impacted by several long-term dedicated customers reducing sequential completion activity after meeting their annual production targets. We expect a seasonal uptick in activity during the first quarter as customer budgets reset with the start of the new year. +Activity in our drilling products segment was relatively steady in 2024 compared to the prior year. Drilling products demand is expected to remain steady through the first quarter, given the expectation for a steady U.S. market and continued growth in international markets. +Our 2025 capital expenditure forecast is approximately $600 million. +Recent Developments in Joint Ventures, Business Combinations and Financial Matters — In December 2024, one of our subsidiaries closed a previously announced joint venture with subsidiaries of ADNOC Drilling and SLB. Our subsidiary holds a 15 percent interest in a newly created company named Turnwell Industries, which has been awarded a contract to drill and complete 144 unconventional wells for ADNOC. In exchange for the minority equity interest, we are providing unconventional drilling and completion expertise to Turnwell, as well as a limited cash contribution to fund our portion of initial working capital. +On September 1, 2023, we completed our merger (the “NexTier merger”) with NexTier Oilfield Solutions Inc. (“NexTier”), a predominately U.S. land-focused oilfield service provider, with a diverse set of well completion and production services across a variety of active basins Each share of common stock of NexTier issued and outstanding immediately prior to the effective time (including outstanding restricted shares) was converted into the right to receive 0.752 shares of our common stock, which based on the +4 +Table of Contents +closing price of our common stock of $14.91 on September 1, 2023, valued the transaction at approximately $2.8 billion, including the assumption of debt. +On August 14, 2023, we completed our acquisition (the “Ulterra acquisition”) of Ulterra Drilling Technologies, L.P. (“Ulterra”), a global provider of specialized drill bit solutions. Total consideration for the acquisition included the issuance of 34.9 million shares of our common stock and payment of approximately $373 million of cash (after purchase price adjustments), which based on the closing price of our common stock of $14.94 on August 14, 2023, valued the transaction at closing at approximately $894 million. +On September 13, 2023, we completed the offering of $400 million in aggregate principal amount of 7.15% Senior Notes due 2033 (the “2033 Notes”). The net proceeds before offering expenses were approximately $396 million, which we used to repay amounts outstanding under our Prior Credit Agreement (as defined below). +On January 31, 2025, we entered into the Second Amended and Restated Credit Agreement with the lenders party thereto and Wells Fargo Bank, National Association, as administrative agent, and the other parties thereto (the “Credit Agreement”). The Credit Agreement amended and restated our Amended and Restated Credit Agreement dated as of March 27, 2018 (as amended, restated, supplemented or otherwise modified at December 31, 2024, the “Prior Credit Agreement”). The commitments under the Credit Agreement are $500 million, and the loans and commitments under the Credit Agreement mature on January 31, 2030. +The Credit Agreement provides for a committed senior unsecured credit facility that permits aggregate revolving credit borrowings of up to $500 million, with a letter of credit sub-facility of $100 million and a swing line sub-facility that, at any time outstanding, is limited to the lesser of $50 million and the amount of the swing line provider’s unused commitment. Subject to customary conditions, we may request that the lenders’ aggregate commitments be increased by up to $200 million, not to exceed total commitments of $700 million. For a description of the Credit Agreement, see “Liquidity and Capital Resources” included in Part II, Item 7— “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report. +As of December 31, 2024, we had no borrowings outstanding under our Prior Credit Agreement. We had $2.1 million in letters of credit outstanding under the Prior Credit Agreement at December 31, 2024 and, as a result, had available borrowing capacity of approximately $613 million under the Prior Credit Agreement at that date. +Industry Segments +Our revenues, operating income and loss and identifiable assets are primarily attributable to three industry segments: +• drilling services, +• completion services, and +• drilling products. +Drilling Services Operations +General — We provide our contract drilling services to oil and natural gas operators in the United States, Colombia and Ecuador. As of December 31, 2024, we had 152 marketed land-based drilling rigs based in the following regions: +Region Number of Rigs +West Texas 70 +Appalachia 21 +Oklahoma 16 +Rockies 15 +South Texas 11 +East Texas 11 +Colombia 7 +Ecuador 1 +Total 152 +All of these drilling rigs are electric rigs. An electric rig converts the power from its diesel or natural gas engines into electricity to power the rig. The U.S. land rig industry has in recent years referred to certain high specification rigs as “super-spec” rigs, which we consider to be at least a 1,500 horsepower, AC-powered rig that has at least a 750,000-pound hookload, a 7,500-psi circulating system, and is pad-capable. Due to evolving customer preferences, we refer to certain premium rigs as “Tier-1, super-spec” rigs, which we +5 +Table of Contents +consider as being a super-spec rig that also has a third mud pump and raised drawworks that allows for more clearance underneath the rig floor. As of December 31, 2024, we had 135 Tier-1, super-spec rigs. +We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as upgrades or replacement parts for marketed rigs. +Drilling rigs are typically equipped with engines, drawworks, top drives, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment. Over time, components on a drilling rig are replaced or rebuilt. We invest significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs. We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by improving the capabilities of our drilling fleet. Over the years, we have made performance and safety improvements to our rig fleet. Our APEX ® rigs are AC-powered electric rigs with high pressure mud systems, walking systems and increased hookload capacity. During fiscal years 2024, 2023 and 2022, we spent approximately $265 million, $335 million, and $272 million, respectively, on capital expenditures in our Drilling Services operations. +Depth and complexity of the well, drill site conditions and the number of wells to be drilled on a pad are the principal factors in determining the specifications of the rig selected for a particular job. +Our contract drilling operations depend on the availability of drill pipe, replacement parts and other related rig equipment, fuel and other materials and qualified personnel. Some of these have been in short supply from time to time. +We perform repair and/or upgrade work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Ohio, Pennsylvania, and internationally in Colombia. +Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis. Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract. Our drilling contracts are generally either on a well-to-well basis or a term basis. Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells. Term contracts are entered into for a specified period of time (we define term contracts as contracts with a duration of six months or more) or for a specified number of wells. +Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses. Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer. +Our drilling contracts provide for payment on a daywork basis, pursuant to which we provide the drilling rig and crew to the customer. The customer provides the program for the drilling of the well. Our compensation is based on a contracted rate per day during the period the drilling rig is utilized. We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control. Daywork contracts typically provide separately for mobilization of the drilling rig. +Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows: +Year Ended December 31, +2024 2023 2022 +Average rigs operating per day – U.S. (1) +112 124 124 +Number of wells drilled during the year – U.S. 2,376 2,530 2,489 +Number of operating days – U.S. 40,899 45,270 45,216 +(1) A rig is considered to be operating if it is earning revenue pursuant to a contract on a given day. +Rig Fleet Evaluation — On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring inactive rigs to working condition and the expected demand for drilling services by rig type. The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. During the third quarter of 2024, we identified 42 legacy, non-Tier-1 super-spec drilling rigs and related equipment to be abandoned. Based on the strong customer preference across the industry for Tier-1 super-spec drilling rigs, in addition to efficiency gains and technology advancements that have reduced the total number of rigs needed for the U.S. drilling +6 +Table of Contents +market, we believe the 42 rigs that were abandoned had limited commercial opportunity. Accordingly, we recorded a charge of $114 million related to this abandonment during the third quarter of 2024. No similar charges were incurred in 2022 or 2023. +Drilling Technology — We continue to enhance the technology offerings that can be used with our drilling operations. Our proprietary operating system for APEX® drilling rigs, Cortex®, can allow for the deployment of custom applications for rig performance, control and optimization. For instance, our GenAssist® application can employ smart engine logic turning engines on and off to reduce fuel consumption and emissions. Our Cortex® Key edge server can connect to various systems at the well site, streaming large data sets and providing a single, high-speed data aggregation source. Our EcoCell® lithium battery hybrid energy management system is capable of utilizing stored energy to help reduce fuel consumption and emissions. +Directional Drilling — We generally utilize our own proprietary downhole motors and equipment to provide a comprehensive suite of directional drilling services, including directional drilling, measurement-while-drilling (“MWD”) and supply and rental of downhole performance motors, such as our Mpact® drilling motors, and MWD equipment, such as our Mpower™ MWD systems. Our customers primarily consist of oil and natural gas operators in the United States. +Wellbore Placement Optimization Services — We provide software and services used to improve the accuracy of directional and horizontal wellbores, wellbore quality, and on-bottom ROP (rate of penetration). Our MWD Survey FDIR (fault detection, isolation and recovery) service is a data analytics technology to analyze MWD survey data in real-time and more accurately identify the position of a well. Our HiFi Nav™ offering enhances FDIR by targeting improved vertical placement of the directional well within the reservoir. Our HiFi Guidance™ service utilizes trajectory optimization to determine optimal steering recommendations and placement within the reservoir, targeting minimal sliding, faster ROP, and a higher percentage of the wellbore placed in the desired drilling window. We provide these services to customers with onshore and offshore operations. +Other Drilling Services — We service and re-certify equipment for drilling contractors, and we provide electrical controls and automation to the energy, marine and mining industries in North America and other select markets. +Completion Services Operations +Our completion services business consists of services for hydraulic fracturing, wireline and pumping, completion support, and cementing. It also includes our power solutions natural gas fueling business and our proppant last mile logistics and storage business. Our completion services business operates in several of the most active basins in the continental United States including the Permian, the Marcellus Shale/Utica, the Eagle Ford, Mid-Continental, Haynesville, and the Bakken/Rockies. The high density of our operations in the basins in which we are most active provides us the opportunity to leverage our fixed costs and to quickly respond with what we believe are highly efficient, integrated solutions that are best suited to address customer requirements. Our completion services are designed in partnership with our customers to enhance both initial production rates and estimated ultimate recovery from new and existing wells. +We utilize our in-house capabilities, including our data control instruments business, to offer a technologically advanced and efficiency focused range of completion techniques. The majority of revenue for this segment is generated by our hydraulic fracturing business. +Hydraulic Fracturing — Hydraulic fracturing services are performed to enhance production of oil and natural gas from formations with low permeability and restricted flow of hydrocarbons. The process of hydraulic fracturing involves pumping a highly viscous, pressurized fracturing fluid, typically a mixture of water, chemicals and proppant, into a well casing or tubing in order to fracture underground mineral formations. These fractures release trapped hydrocarbon particles and free a channel for the oil or natural gas to flow freely to the wellbore for collection. Fracturing fluid mixtures include proppant that becomes lodged in the cracks created by the hydraulic fracturing process, “propping” them open to facilitate the flow of hydrocarbons upward through the well. To address evolving customer preferences for emissions-reducing equipment, we have invested in natural gas-powered equipment, including our 100% natural gas-powered Emerald™ line of hydraulic fracturing equipment. +Completion Support Services — Our Power Solutions business is an integrated natural gas treatment and delivery solution, which focuses on gas sourcing, compression, transport, decompression, treatment and related services for oilfield service operations. We believe this integration solution assists our customers by reducing emissions at the wellsite and throughout their operations. As part of our wellsite integration strategy to provide and integrate a variety of services for our customers at the wellsite to maximize efficiencies and profitability, in 2022, we acquired sand hauling, wellsite storage, and last mile logistics assets. The assets acquired were combined with our existing last mile logistics assets to create a leading player in the delivery and storage of proppant at the wellsite. +Wireline and Pumping Services — Our wireline services involve the use of a truck equipped with a spool of wireline that is unwound and lowered into oil and natural gas wells to convey specialized tools or equipment for well completion, well intervention, pipe recovery and reservoir evaluation purposes. We offer our wireline services in conjunction with our hydraulic fracturing services +7 +Table of Contents +in “plug-and-perf” well completion to maximize efficiency for our customers. “Plug-and-perf” is a multi-stage well completion technique for cased-hole wells that consists of pumping a plug and perforating guns to a specified depth. Once the plug is set, the zone is perforated and the tools are removed from the well, a ball is pumped down to isolate the zones below the plug and the hydraulic fracturing treatment is applied. In addition, we offer wireline and pumping services that are not integrated with our fracturing services. We are one of the leading providers of perforating, pumpdown, pipe recovery, pressure pumping, and wellsite make-up and pressure testing services. We are highly experienced in safely servicing deep, high-pressure, high-temperature wells in some of the most active onshore basins in the United States. Our in-house manufacturing capabilities allow us to manage costs and lead times with regard to hardware and perforating guns, switches and accessories, providing us with a competitive advantage and enabling higher returns. +Cementing — Our cementing services incorporate custom engineered mixing and blending equipment that is designed to deliver precision and accuracy in providing annulus isolation and hydraulic seal, while protecting freshwater zones from our customers’ zone of interest. Our cement division has the expertise to cement shallow to complex high temperature, high pressure wells. We also offer engineering software and technical guidance for remedial cementing applications and acidizing to optimize the performance of our customers’ wells. We are one of the largest providers of specialty cementing services in the United States. Our operations are supported by multiple full-service laboratory facilities with advanced capabilities. +Completion Service Contracts — Our completion services operations are conducted pursuant to a work order for a specific job or pursuant to a contract generally for a specified period of time, which may include minimum revenue, usage or stage requirements. We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items. +Equipment — We have well completion equipment used in providing hydraulic fracturing services as well as cementing and acid pumping services. We periodically evaluate our completion services assets for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. +Materials — Our completion services operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time, and can be subject to significant price volatility. We purchase these materials from various suppliers. These purchases are made in the spot market or pursuant to other arrangements that may or may not cover all of our required supply. These supply arrangements sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material. Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers, including trucking companies, fail to timely deliver our materials. +Drilling Products Operations +Our Ulterra business has manufacturing and distribution sites of drilling equipment in North America and internationally, which are geographically positioned to serve the energy and mining markets in over 30 countries. Ulterra’s drilling equipment is used in oil and natural gas exploration and production and in mining operations. Ulterra has manufacturing and repair facilities located in Fort Worth, Texas, Leduc, Alberta and Saudi Arabia and repair facilities located in Argentina, Colombia and Oman. +Ulterra’s primary business is the design, manufacture, sale and rental of matrix and steel-bodied polycrystalline diamond compact (“PDC”) drill bits. PDC drill bits are typically rented, except in select international markets where they are sold. Used bits may be repaired and refurbished for the subsequent customer. Ulterra has an industry-leading position in the North American PDC drill bit market. +We periodically evaluate our drill bits for marketability based on the condition of inactive equipment, expenditures that would be necessary to bring the equipment to working condition and the expected demand for such equipment. The components of equipment that will no longer be marketed are evaluated, and those components with continuing utility will be used as parts to support active equipment. The remaining components of this equipment are retired. We had no impairment related to the marketability of our equipment during 2024. +Other Operations +Our oilfield rentals business has a fleet of premium rental tools and equipment and provides specialized services for land-based oil and natural gas drilling, completion and workover activities in many of the major producing oil and natural gas basins in the United States. In addition, we own and invest, as a non-operating working interest owner, in oil and natural gas assets that are primarily located in Texas and New Mexico. +8 +Table of Contents +Research, Engineering and Technology +We employ research, engineering and technology teams across our businesses, who work on initiatives to enhance our existing product and service offerings and develop new products and services to meet customer demands. +Contracts +We believe that our contracts for drilling services, completion services, drilling products and other services and products generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations. However, each contract contains the actual terms setting forth our rights and obligations and those of the customer or supplier, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer or supplier requirements, applicable law or other factors. +Customers +Our customer base includes major, independent and other oil and natural gas operators. With respect to our consolidated operating revenues in 2024, we received approximately 53% from our ten largest customers and approximately 38% from our five largest customers. During 2024, one customer accounted for approximately $605 million, or approximately 11%, of our consolidated operating revenues. The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations. +Backlog +We maintain a backlog of commitments for contract drilling services under term contracts, which we define as contracts with a duration of six months or more. Our contract drilling backlog in the United States as of December 31, 2024 and 2023 was approximately $426 million and $700 million, respectively. Approximately 7.1% of our contract drilling backlog in the United States at December 31, 2024 is reasonably expected to remain after 2025. See Note 3 of Notes to consolidated financial statements in Item 8 of this Report and “Item 1A. Risk Factors – Our current backlog of contract drilling revenue may decline and may not ultimately be realized, as fixed-term contracts may in certain instances be terminated without an early termination payment” for information pertaining to backlog. +Competition +The businesses in which we operate are highly competitive. Historically, available equipment used in our drilling services and completion services businesses has frequently exceeded demand, particularly in an industry downturn. The price for our services is a key competitive factor, in part because equipment used in these businesses can be moved from one area to another in response to market conditions. In addition to price, we believe availability, condition and technical specifications of equipment (including emission reduction capabilities), quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job. We expect that the market for our services will continue to be highly competitive. +Human Capital and Sustainability +We strive to be a leader in our industry in the area of environmental, social, governance and other sustainability-related issues, and we remain committed to managing these issues for the long-term benefit of our employees, our communities and our business. We aim to minimize our environmental impact in the communities in which we work and live, while providing services for our customers in a safe and responsible manner. We invest extensively in the safety, health and well-being of our people, who, through the diversity of their backgrounds, experiences and talents, are our greatest strength. Importantly, we maintain a rigorous focus on ethics and integrity at every level of our operations, values which are embedded in our culture and a practice on which all of our success depends. +Environment – We continue to pursue initiatives to mitigate climate change risk and make improvements in air quality, water quality, land usage, use of energy and reducing waste materials. For example, we utilize natural gas engines, dual-fuel equipment and other technologies that reduce our carbon and other greenhouse gas emissions as compared to our traditional diesel-only equipment, and we employ spill prevention plans and use additional protective measures in environmentally sensitive areas. +We have strengthened our position as a leader in alternative fuel technology with the commercialization of our EcoCell® lithium battery hybrid energy management system. The EcoCell® system is capable of efficiently displacing one of the gensets on a drilling rig to reduce both fuel consumption and emissions. The value of this technology is enhanced when used in combination with our Cortex® power management system and our dual-fuel engines, as the natural gas substitution rate can be optimized. +9 +Table of Contents +Through our Current Power business, we provide in-house electrical engineering, control system automation and installation services to connect drilling rigs to utility electrical lines. This capability enables our customers to use utility power, instead of natural gas or diesel fuel, to power drilling operations. Using utility power is an optimal power solution for our drilling rigs as it minimizes emission impacts at the wellsite. +Some of our key human capital areas of focus include: +Employees – We had approximately 9,200 full-time employees as of January 31, 2025. The number of employees fluctuates depending on the current and expected demand for our services. We consider our employee relations to be satisfactory. None of our U.S. employees are represented by a union. Although some of our Colombian employees may be union members, we have not entered into any collective bargaining arrangements with the unions with which those employees are affiliated. +Training and Safety – Our training programs include opportunities for employees to advance in their professional careers through intensive, multi-day classroom training programs in numerous skills and competencies, as well as management training programs. These programs are geared to providing our employees with opportunities to advance throughout our company. +The safety of our employees and others is our highest priority, as our goal is to provide an incident-free work environment. We have robust safety training programs that are designed to comply with applicable laws and industry standards and to benefit our employees, communities and our business. All U.S. field-based employees are required to have annual safety education that incorporates learning associated with hazard awareness, safe systems of work, permission to work, stop work authority, energy isolation, material handling and management of change. +Diversity, Inclusion and Respect – We are committed to fostering a work environment where all people feel valued and respected. We embrace our diversity of people, thoughts and talents, and combine these strengths to pursue extraordinary results for our company, our employees and our stockholders. We are committed to recruiting, hiring and retaining the highest caliber talent for our business by utilizing outreach initiatives and partnerships with a diverse group of organizations, industry associations and networks. +All employees are educated annually on our commitment to a respectful workplace for all to ensure they understand their role as they engage with co-workers. +Maintaining our Core Values – We provide annual training for our employees on our Code of Business Conduct and Ethics, which addresses conflicts of interest, confidentiality, fair dealing with others, proper use of company assets, compliance with laws, insider trading, keeping of books and records, zero tolerance for discrimination and harassment in the work environment, as well as reporting of violations. +Health and Benefits – Our health and benefits program provides for extensive preventative care and is designed to improve our employees’ fitness for work, personal safety on the job and overall well-being. We have implemented policies allowing many of our office-based employees the flexibility to work from home. +Government and Environmental Regulation +Our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business and the oil and natural gas industry including: +• drilling of oil and natural gas wells, +• hydraulic fracturing, wireline and pumping, completion support and cementing, +• provision of specialized drill bit solutions, +• directional drilling services, +• services that improve the accuracy of directional and horizontal wellbores, including for customers with offshore operations, wellbore quality, and on-bottom ROP, +• containment and disposal of hazardous materials, oilfield waste, other waste materials and acids, +• use of underground storage tanks and injection wells, +• servicing of equipment for drilling contractors, +• provision of electrical controls and automation, +• conducting international operations, and +10 +Table of Contents +• our employees. +Our business operations are subject to various environmental, as well as employee health and safety, laws and regulations, including those addressing the management, disposal and releases of regulated substances. For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and occupational health and safety laws and regulations, including violations thereof, could materially adversely affect our operating results.” +Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations. See “Item 1A. Risk Factors – The adoption of any future federal, state, or local laws or implementing regulations imposing reporting obligations on, or limiting or banning, the hydraulic fracturing process could make it more difficult to complete natural gas and oil wells and could have a material adverse effect on our business, results of operations, and financial condition.” +There has been an increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues. Several states and geographic regions in the United States, as well as foreign jurisdictions, have adopted legislation and regulations to reduce emissions of GHGs, including cap and trade regimes and commitments to contribute to meeting the goals of international treaties related to GHG emissions. See “Item 1A. Risk Factors – Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating and capital costs, limit the areas in which oil and natural gas production may occur and reduce demand for our services.” +We operate throughout North America and internationally in over 30 countries and, accordingly, are subject to the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery and anti-corruption laws in other jurisdictions. Our operations also are subject to other laws and regulations in relation to our international operations, including with respect to the import and export of certain goods and economic sanctions. See “Item 1A. Risk Factors – Political, economic and social instability risk and laws associated with conducting international operations could adversely affect our opportunities and future business.” +The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, delay the permitting of, or related to, such operations, restrict or prohibit oil and natural gas development in certain areas, reduce the demand for oil and natural gas and otherwise have an adverse effect on our operations or business, and could have a material adverse effect on our business, financial condition, cash flows and results of operations. To date, applicable environmental and other laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business. We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future. However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance. +Risks and Insurance +We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance. In general, our contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage. +In addition, we maintain insurance coverage of the types and in the amounts we believe to be customary in the industry, but we do not insure against all risks, either because insurance is not available or because it is not commercially justifiable. The insurances that we maintain include coverage for fire, windstorm and other risks of physical loss to our equipment and certain other assets, employers’ liability, automobile liability, commercial general liability, workers’ compensation as well as insurance for other specific risks, together with excess loss liability insurance coverage. We have also elected to retain a greater amount of risk through increased deductibles as compared to prior years, or self-insurance on certain insurance policies. We cannot assure that any insurance obtained by us will be adequate to cover any losses or liabilities nor can we assure that any insurance obtained by us will continue to be made available for purchase or made available on acceptable terms. While we carry insurance to cover physical damage to, or loss of, a substantial portion of our equipment and certain other assets, such insurance does not cover the full replacement cost of such equipment or other assets, and in certain cases, such as losses arising from or attributable to fire and/or explosion resulting from our hydraulic fracturing operations at the wellsite, is subject to significantly higher deductibles than are applicable to our other coverages. We also self-insure a number of risks, including loss of earnings and business interruption and most of our cybersecurity risks, and we do not carry a significant amount of insurance to cover risks of underground reservoir damage. +If a significant accident or other event occurs that is not fully covered by insurance or an enforceable and recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations. See “Item 1A. Risk Factors – Our operations are subject to a number of operational risks, including environmental and weather risks, +11 +Table of Contents +which could expose us to significant losses and damage claims. We are not fully insured against all of these risks and our contractual indemnity provisions may not fully protect us.” +Seasonality +Seasonality has not significantly affected our overall operations. Toward the end of calendar years, we experience slower activity in connection with the holidays and as customers’ capital expenditure budgets are depleted and/or their annual drilling and completion targets have been met. Occasionally, our operations are negatively impacted by severe weather conditions. +Raw Materials and Subcontractors +We use many suppliers of raw materials and services. Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all. We also utilize numerous independent subcontractors from various trades. \ No newline at end of file diff --git a/raw/filings/0000889900/2024/0000889900-25-000034/item13.txt b/raw/filings/0000889900/2024/0000889900-25-000034/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..df4d629883fd1666cbfb1d39d09d531143e906ea --- /dev/null +++ b/raw/filings/0000889900/2024/0000889900-25-000034/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information required by this Item is incorporated herein by reference to the Proxy Statement. \ No newline at end of file diff --git a/raw/filings/0000889900/2024/0000889900-25-000034/item9a.txt b/raw/filings/0000889900/2024/0000889900-25-000034/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..97c43e7d6cd4c7afce9edf4d1e8142f18c8b3f5d --- /dev/null +++ b/raw/filings/0000889900/2024/0000889900-25-000034/item9a.txt @@ -0,0 +1,10 @@ +Item 9A. Controls and Procedures. +Disclosure Controls and Procedures: +Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2024, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. +Management’s Report on Internal Control over Financial Reporting: +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2024, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2024. +50 +Table of Contents +The effectiveness of our internal control over financial reporting as of December 31, 2024 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report. +Changes in Internal Control over Financial Reporting: +There have been no changes to our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000889900/2024/0000889900-25-000034/rp_note.txt b/raw/filings/0000889900/2024/0000889900-25-000034/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000889900/2024/0000889900-25-000034/rpt_disclosure.txt b/raw/filings/0000889900/2024/0000889900-25-000034/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000896493/2014/0001437749-15-006253/filing.txt b/raw/filings/0000896493/2014/0001437749-15-006253/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..4da73179d9e31ce45390b4d2844dd721dbe5ad13 --- /dev/null +++ b/raw/filings/0000896493/2014/0001437749-15-006253/filing.txt @@ -0,0 +1,2575 @@ +10-K +1 +dpw20141231_10k.htm +FORM 10-K +dpw20141231_10k.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2014 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ___________ to __________ +Commission File Number 1-12711 +DIGITAL POWER CORPORATION +(Exact name of registrant as specified in its charter) +California +94-1721931 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +48430 Lakeview Blvd, Fremont, California 94538-3158 +(Address of principal executive offices, including zip code) +510-657-2635 +(Registrant's telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of each exchange on which registered +Common Stock, no par value +NYSE MKT +Securities registered pursuant to Section 12(g) of the Act: +Title of Each Class +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☐ No ☑ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. +Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes ☑ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☐ (do not check if a smaller reporting company) +Smaller reporting company ☑ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). +Yes ☐ No ☑ +As of June 30, 2014, the aggregate market value of the voting common stock held by non-affiliates was approximately $4,450,009 based upon the closing price of the common stock on the NYSE MKT on that date. Shares of common stock held by each officer and director and by each person who owns 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of March 22, 2014, the number of shares of common stock outstanding was 6,775,971. +DOCUMENTS INCORPORATED BY REFERENCE +None. +INDEX +Page No. +Forward-Looking Statements +1 +PART I +Item 1. +Description of Business. +1 +Item 1A. +Risk Factors. +9 +Item 1B. +Unresolved Staff Comments. +15 +Item 2. +Description of Property. +15 +Item 3. +Legal Proceedings. +15 +Item 4. +Mine Safety Disclosures +15 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +16 +Item 6. +Selected Financial Data. +16 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations. +16 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk. +21 +Item 8. +Financial Statements and Supplementary Data. +21 +Item 9. +Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. +22 +Item 9A. +Controls and Procedures. +22 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance. +23 +Item 11. +Executive Compensation. +27 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +31 +Item 13. +Certain Relationships and Related Transactions, and Director Independence. +33 +Item 14. +Principal Accountant Fees and Services. +34 +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +35 +Signatures +As used in this annual report, the terms “we,” “us,” “our,” “Company,” “Digital,” or “Digital Power,” mean Digital Power Corporation, a California corporation, and its subsidiaries unless otherwise indicated. +The following information should be read in conjunction with the Consolidated Financial Statements and the notes thereto located elsewhere in this Annual Report on Form 10-K. This Report, and in particular “Management's Discussion and Analysis of Financial Condition and Results of Operations,” contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In this report, the words "believes," "anticipates," "intends," "expects," "plans," "should," "will," "seeks" and words of similar import identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: our history of net losses; our dependence on Telkoor Telecom Ltd. to design certain of our standard products; the possible limits of our strategic focus on our power supply component competencies; our dependence on a few major customers; uncertainty of market acceptance of our product; the effects of the ongoing slowdown affecting world financial markets; and other factors referenced in "Risk Factors" and other sections of this Annual Report. Given these uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. +PART I. +ITEM 1. DESCRIPTION OF BUSINESS. +General +We are a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the most demanding applications in the medical, military, telecom and industrial markets. We are highly focused on high-grade and custom product designs for both the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. We are a California corporation originally formed in 1969, and our common stock trades on the NYSE MKT under the symbol “DPW”. Our corporate headquarters are located in the heart of the Silicon Valley. +We also have a wholly-owned subsidiary, Digital Power Limited ("DPL"), which operates under the brand name of “Gresham Power Electronics” (“Gresham”). DPL is located in Salisbury, England, and designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. DPL’s defense business has specialists in the field of naval applications of power distribution conversion. +We believe that we are one of the first companies in the power solutions industry to introduce a product strategy based on the premise that products developed with an extremely flexible architecture enable rapid modifications to meet unique customer requirements for non-standard output voltages. The development and implementation of this strategy has resulted in broad acceptance in the telecom/industrial, and increasingly in the medical market, segments for our new line of high density and high efficiency power products. These products set an industry standard for providing high-power output in package sizes that are among the smallest available for such commercial products. +We market and sell our products to many diverse market segments, including the telecom, industrial, medical and military/defense industries. Our products serve a global market, with an emphasis on North America and Europe. We offer a broad product variety, including a full custom product design, standard and modified-standard products. Our unique high-speed switching power rectifiers includes but are not limited to custom power products, front-end, open-frame, enclosed, Compact PCI, MicroTCA, PoE (Power over Ethernet) and other product solutions, providing power output from 50 to 24,000 watts. +1 +In an effort to provide short lead-times, high quality products and competitive pricing to support our markets, we have entered into production agreements with several contract manufacturers located in Asia, primarily China. These agreements allow us to better control production costs and ensure high quality products deliverable in a timely manner to meet market demand. +We intend to remain an innovative leader in the development of cutting-edge custom power solutions and feature rich products to meet any customer needs and requirements, rugged power systems to meet harsh and extreme operation environmental requirements, and high performance, high efficiency, high-density and modular power systems. We are currently focused on developing even more high-grade custom power system solutions for numerous customers in a broadly diversified range of markets and challenging environments. Each product development is based on best of class performance criteria, including unique, advanced feature sets and a special layout to meet our customers’ unique operating conditions where efficiency, size and time to market are key to their success. +Power System Solutions +We provide custom power system solutions, high-grade flexibility series power supply products, off-the-shelf products and value-added services to diverse industries and markets including military/defense, telecom, medical and industrial. We believe that our solutions leverage a combination of low leakage power emissions, high power density, superior power efficiency, design flexibility and short time to market. +Custom Power System Solution. We provide high-grade custom power system solutions to numerous customers in multiple industry segments. Each custom solution that we develop is based on high power density, digital power processing and a special layout to meet each of our customer’s unique operation environments where efficiency, size and performance are key. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“IP”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including Digital Signal Processing (“DSP”) control for Power Factor Correction (“PFC”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages and unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to original equipment manufacturers (“OEMs”). We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating a complex, time-consuming and costly integration. We believe that this value-added service is well suited to those OEMs who wish to reduce their vendor base and minimize their investment in manufacturing that leads to increased fixed costs. Based on these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power subassemblies and thus are not required to purchase individual parts from many vendors. +2 +Our products have a warranty period from date of shipment to the customer. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic corporation, Digital Power Corporation; the European marketplace is served through DPL, our wholly-owned subsidiary. +Our products are sold directly by our sales force and through a network of manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2015. +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are deployed in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. Examples of the commercial markets we serve and products for these markets include: +■ +Medical (Patient Contact and Non-patient Contact) +■ +Colonoscopy imaging system +■ +Imaging, dispensing equipment +■ +Ventilators +■ +Dialysis, endoscopy, surgical equipment +■ +Ultrasound, MRI +■ +Oxygen concentration +■ +Telecom +■ +Switches/Routers +■ +Storage/Data servers +■ +Servers +■ +Broadband networks and video broadcast systems +■ +Fiber optic networks +■ +Wireless systems +■ +Industrial Process Equipment and Embedded Controls +■ +Packaging equipment, pumps, CNC machines, laser +■ +Intelligent / LED lighting +■ +Industrial printers +■ +Laboratory and diagnostic equipment +■ +ATE (Automatic Test Equipment), scientific +■ +Advanced projectors +These product solutions, which include standard, modified-standard or full custom designs, are designed to meet our customers’ requirements. +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both specific modifications of existing products or full custom designs, are designed for combat environments and meet the requirements of our defense customers. We are compliant with the regulations of International Traffic in Arms Regulations (“ITAR”) and are an approved vendor for the U.S. Air Force, Navy and Army. +3 +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments: +■ +Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air +■ +Naval – Shipboard radar, EW and communication +■ +Mobile and Ground Communications – Active Protection, Communications and Navigation +■ +Surveillance, test equipment +■ +UAV (Unmanned Aerial Vehicle) – Very lightweight power systems +Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +We leverage our strategic alliance and collaboration with Telkoor Telecom Ltd. (“Telkoor”), our largest shareholder, and DPL, our wholly-owned subsidiary, to develop some of the MIL-SPEC products. +Full custom military project services: +● +Program management for each project +● +Quality assurance and control: +o +ISO 9001: 2008 and ISO 17025: 2005 certified +o +Compliance with AS9100 through our manufacturing +o +Compliance with MIL-Q 9858A +o +Compliance with environmental testing in accordance with MIL-STD 810, MIL-STD 202 +o +FRACAS (Failure Reporting, Analysis, and Corrective Action System) +o +100% screening, including ESS (Environmental Stress Screening) and ATP (Acceptance Test Procedure) with random vibration and temperature cycling tests +● +Product Tests: +o +Vertical Random Vibration +o +Sine Sweep Vibrations +o +Shock +o +Salt +o +Fog +o +Polar Temperatures +Typical Product Features: +● +Wide input voltage range +● +Multi-output voltages (DC and AC) +● +Fully approved according to MIL-STD 704, MIL-STD 1275 and MIL-STD 1399 +● +Environmental conditions per MIL-STD 810 +● +EMI/RFI per MIL-STD 461 +● +Wide operating temperature range of -56°C up to +85°C +● +Power output up to 72,000 Watts (3 x 24,000 Watts system) +● +High switching frequency up to 500KHz +● +High efficiency, over 92% +● +High power density up to 28 watts/inch 3 +● +Power factor correction +● +Redundancy and hot swap N+1 +● +Switching Frequency sync to external clock +● +Free convection, forced air cooling and base plate cooling +4 +Strategy +Our strategy is to be the supplier of choice to those companies and OEMs requiring high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that support all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. +Our target market segments include the industrial, telecommunication, medical, and military/defense industries. We do not participate in the personal computer power supply market because of the low margins arising out of the high volume and extremely competitive nature of that market. +Our strategy will continue to focus on expanding our market share by adding new customers from all of our target market segments. We are developing long term relationships, and we intend to expand our customer base in our commercial market segments, including medical, telecom and industrial, while continuing to maintain our existing customers. In the military and defense market segment, we will continue to provide advanced rugged products to customers, and we are striving to expand our business to support the military and defense industries. We believe that our custom power supply solutions, flexibility series, high-grade and high-efficiency power product solutions provide customers with a more effective choice as compared to products offered by other power solution competitors, due in part to a customer’s requirement for output voltages and other features such as redundancy and sense control tailored to its exact requirements within specific parameters. +Furthermore, we believe that we have the talent and engineering experience to satisfy any of our customers’ product or platform requirements. If an OEM customer specifies a different set of power system parameters, we will custom design or modify a product to meet the OEM’s requirements With a wide range of solutions from our custom designs to our high-grade flexibility series products, our professional design team can provide economical and timely product solutions to our OEM customers. In addition, as our power systems meet all appropriate environmental requirements and safety standards, our smaller OEM customers can expedite the process of independent safety agency testing by companies such as Underwriters Laboratories, and save considerable expense. By offering OEM customers choices with Digital Power’s custom, flexibility series, high-grade and high-efficiency power system solutions, we believe we provide certain strategic advantages over our competitors. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom , designs, manufactures, and distributes switching power supplies, uninterruptible power supplies, and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“Gresham”). Frequency converters manufactured by Gresham are used by navel warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low cost manufacturing goals with labor-intensive products, we have entered into production agreements with certain contract manufacturers in Asia. At present, our principal contract manufacturers in Asia are Teamwise, Winco-Power Technology, Shenzhen Watt Electronics, and Energy Recovery Products. +5 +We sell certain products that are developed, manufactured and sold to us by Telkoor, an Israeli company that currently holds 41.3% of our outstanding common stock. In coordination with Telkoor, and in order to accelerate delivery and reduce the cost of some of the products we purchase from Telkoor, we have obtained the right to order products directly from Telkoor’s contract manufacturers, as well as from our own contract manufacturers in China, in exchange for the payment of royalties to Telkoor. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our custom power assemblies per clearly defined test procedures developed by us and our customers. This approach ensures that our customers can use our systems right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products are subject to ITAR, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Any future restrictions or charges imposed by the United States or any other country on our international sales or sales by DPL, our foreign subsidiary, could have a materially adverse effect on our business, financial condition, and operating results. In addition, from time to time, we entered into contracts with defense contract manufacturers for the government of Israel’s defense programs, which were funded by, and governed by the regulations of, the U.S. Foreign Military Financing program. +Sales and Marketing +We market our products directly through our internal sales force as well as through a partner network of independent manufacturer representatives and distributors. Each representative organization is responsible for managing sales in a particular geographic territory. Generally, the representative has the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving its marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of net sales of new “design-in” and 1.75% of net sales for retention, payable after the product is shipped, for any direct sale contribution. Typically, either we or the representative organization may terminate the agreement upon 30 days’ written notice. +6 +Historically, we have also sold products through multiple distributor arrangements which do not specify a particular territory. Each of these arrangements can be terminated by either party upon 30 days’ written notice. +Our promotional efforts, to date, have included product data sheets, participation in trade shows, and our website, www.digipwr.com. We use the corporate website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our website and accessible to the marketplace. We will continue to enhance our website by adding more features and functionalities, such as ecommerce, that will allow our customers to buy directly through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product design solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also partner with various design and contract engineering firms for development of some of our new products supported by our internal engineering services staff. Furthermore, we continue to leverage the close relationship we have with one of our major shareholders, Telkoor, to introduce new products that Telkoor develops for its market and makes available for us. Finally, from time to time, we modify standard products to meet specific customer requirements, including, but not limited to, converting commercial products into full military MIL-SPEC products and other unique modification and adjustments, when applicable. We are experiencing an increasing demand for ruggedization of commercial products for military applications. To meet that requirement, our engineering team continues to ruggedize commercial products, which we sell as commercial off the shelf products to some of our military customers. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC and improved EMI (electromagnetic interference) filtering. We continue to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering lab in California. In August 2010, we purchased the IP and production packages of the compact peripheral component interface (Compact PCI, or CPCI) AC/DC and DC/DC power supply series from Telkoor Power Systems Ltd. (“TPS”), a wholly owned subsidiary of Telkoor. The IP purchase was to support our strategy being a leader supplier of CPCI products for commercial and defense markets. We received from this purchase a portfolio of industry-leading CPCI AC/DC power supplies delivering 600 Watts and 650 Watt of continuous power. These hot-swappable power supplies feature N+1 redundant connection and active load current share. This IP strategic acquisition expands our presence for industrial, telecom, and military/defense applications that require increasing amounts of power. As a result of this purchase, we have decreased our manufacturing costs. +7 +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products comparable in quality to ours. Many of our competitors, including Bel Fuse (Power-One), Emerson (Astec) Technologies, Artesyn, Lambda Electronics, and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition with our customers. We also face competition from current and prospective customers who may decide to design and manufacture internally power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current economic situation, additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to whom we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced product design have significant advantages in the power supply solutions market because they have higher efficiency and high-power density, or power-to-volume ratio, which make them smaller than the solutions offered by our competitors and can thus fit well in numerous custom environments in compliance with our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of outputs product design platform. We believe we have a competitive position with our targeted customers who need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers in only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“NRE”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +8 +Employees +As of December 31, 2014, we had 26 employees located in the United States and the United Kingdom, of whom seven were engaged in engineering and product development, five in sales and marketing, seven in general operations and seven in general administration and finance. All but two of these employees are employed on a full-time basis. None of our employees are currently represented by a trade union. We consider our relations with our employees to be good. +ITEM 1A. RISK FACTORS. +The risk factors listed in this section provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Readers should be aware that the occurrence of any of the events described in these risk factors could have a material adverse effect on our business, results of operations and financial condition. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. +We generated an operating and net loss during the years ended December 31, 2014 and December 31, 2013, we have historically experienced operating and net losses, and we may experience such losses in the future. +For the year ended December 31, 2014, we had an operating loss of $542,000 and a net loss of $658,000 compared to an operating loss of $317,000 and a net loss of $632,000 for the year ended December 31, 2013. Although we have actively taken steps to increase our revenue and reduce manufacturing and operating costs, we may incur operating and net losses in the future unless we continue to increase revenues by selling current and custom design products and continue seeking manufacturing cost reductions through contract manufacturers. +We depend on Telkoor to design and manufacture some of our products and depend on a manufacturing rights agreement with Telkoor under which we have the right to directly place purchase orders with third party manufacturers. +We depend on Telkoor Telecom Ltd. (“Telkoor), our largest shareholder and one of our third party subcontractors, for design and manufacturing capabilities for some of the products that we sell. If Telkoor is unable or unwilling to continue designing or manufacturing our products in required volumes and with a certain level of quality on a timely basis, that could lead to loss of sales and adversely affect our operating results and cash position. We also depend on Telkoor's intellectual property and ability to transfer production to third party manufacturers. Failure to obtain new products in a timely manner or delay in delivery of products to customers will have an adverse effect on our ability to meet our customers’ expectations. In addition, we operate in highly competitive markets where our ability to sell Telkoor’s products could be adversely affected by Telkoor’s agreements with other companies, long lead-times and the high cost of Telkoor’s products. Also, in 2012, Telkoor’s manufacturing lead-times increased, which has hindered our ability to respond to our customers’ needs. Telkoor’s principal offices, research and development and manufacturing facilities are located in Israel. Political, economic, and military conditions in Israel directly affect Telkoor’s operations. We are also dependent upon Telkoor’s terms and conditions with its contract manufacturers for some of our products, which terms and conditions may not always be in our best interest. In 2010, the Company purchased certain IP from Telkoor in order to reduce its dependency on Telkoor with respect to a certain line of products. We also entered into a Manufacturing Rights Agreement with Telkoor, in 2012, pursuant to which we were granted the non-exclusive right to directly place purchase orders for certain products from third party manufacturers in consideration for payment of royalties to Telkoor. This agreement currently accounts for a significant portion of our sales. In the event this agreement is terminated for any reason, it would materially affect our profitability and cash position. +If Telkoor is unable to continue operating as a going concern, our operational and financial results may be significantly adversely affected. Due to extensive losses incurred by Telkoor during 2014 and resultant limited liquidity, Telkoor’s auditors expressed doubt regarding the continued existence of Telkoor as a going concern in its audit opinion regarding Telkoor’s financial statements for the quarter ended September 30, 2014. If Telkoor is unable to rectify its current liquidity problem, there is the possibility that Telkoor will not be able to continue operating in the coming year. We may lose our ability to continue manufacturing product under our Manufacturing Rights Agreement with Telkoor, we may lose our ability to collect on accounts receivable due from Telkoor and may be forced to fully impair our investment in Telkoor which may significantly adversely affect our operational and financial results. +9 +We are dependent upon our ability, and our contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, there is a global shortage of certain electronic components, which has extended our production lead-time and our production costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. Such redesign efforts may require certain regulatory and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in place, and issues may recur in the future. +In addition, some of our products are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While we have had relationships with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our ability to manufacture our products. +Our strategic focus on our custom power supply solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, including those involving Company personnel, which may negatively impact quarterly earnings and profitability as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +We are dependent upon our ability to attract, retain and motivate our key personnel. +Our success depends on our ability to attract, retain and motivate our key management personnel, including, but not limited to, our President and CEO, our V.P. of Finance, marketing and sales personnel, and key engineers necessary to implement our business plan and to grow our business. Competition for certain specific technical and management skill sets is intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or more of our present key employees were to cease to be associated with us, our future results could be adversely affected. Mr. Kohn continues to serve in his role as our President and CEO. However, Mr. Kohn’s employment agreement expired on December 31, 2010, and as of March 27, 2015, Mr. Kohn and the Company had not signed a new employment agreement. +10 +We depend upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon a few major OEMs and other customers for a significant portion of our revenues. We have experienced a reduction of orders by OEMs and a reduction or cancellation of orders, scaling back of certain activities and workforce layoffs by other customers. The loss of any of these customers, or a substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. Furthermore, diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, a substantial decrease in our revenues would likely result. +We are dependent on the electronic equipment industry, and accordingly will be affected by the impact on that industry of current economic conditions. +Substantially all of our existing customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations or rescheduling of, orders or shipments, any of which would materially harm our business. +We outsource, and are dependent upon developer partners for, the development of some of our custom design products. +We made an operational decision to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +We face intense industry competition, price erosion and product obsolescence, which, in turn, could reduce our profitability . +We operate in an industry that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price erosion in the future. +11 +Our future results are dependent on our ability to establish, maintain and expand our manufacturer’ representative OEM relationships and our other relationships. +We market and sell our products through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as with manufacturer’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which would have an adverse effect on our revenues. +We may not be able to procure necessary key components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, our suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that we require to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect on our gross margins and on our results of operations. +We depend on sales of our legacy products for a meaningful portion of our revenues, but these products are mature and their sales will continue to decline. +A relatively large portion of our sales have historically been attributable to our legacy products. We expect that these products may continue to account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining. Although we are unable to predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and sell new products such as custom design and value added products. We cannot assure you that we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell new products. +Our operating results may vary from quarter to quarter. +Our operating results have in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our operating results. It is possible that, in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly. +12 +Failure of our information technology infrastructure to operate effectively could adversely affect our business. +We depend heavily on information technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory restrictions relating to our international sales. +Some of our products are subject to ITAR rules, which are interpreted, enforced and administered by the U.S. Department of State. ITAR controls not only the export, import and trade of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services as well as foreign production. Any delays in obtaining the required export, import or trade licenses for products subject to ITAR rules could have a material adverse effect on our business, financial condition, and/or operating results. In addition, changes in United States export and import laws that require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions or charges imposed by the United States or any other country on our international sales or foreign subsidiary could have a materially adverse effect on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program (FMF). Any such future sales would be subject to these regulations. Failure to comply with ITAR or FMF rules could have a material adverse affect on our financial condition, and/or operating results. +We depend on international operations for a substantial majority of our components and products. +We purchase a substantial majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect on our business, financial condition, and/or operating results. +We depend on international sales for a portion of our revenues. +Sales to customers outside of North America accounted for 50.4% of net revenues in the year ended December 31, 2014 and for 51.2% of net revenues in the year ended December 31, 2013 and we expect that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts receivable, and currency restrictions. In addition, DPL, our wholly-owned subsidiary in the United Kingdom, supports our European and other international customers, distributors, and sales representatives, and therefore is also subject to local regulation. International sales are also subject to the export laws and regulations of the United States and other countries. +If our accounting controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating our internal control over financial reporting in order to comply with Securities and Exchange Commission rules relating to internal control over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such internal control, we may be subject to regulatory sanctions, and our reputation may decline. +13 +The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products and adversely affect the revenues from such products. +Our limited ability to protect our proprietary information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, we may be required to institute legal proceedings, which would be costly and would divert our resources from the development of our business. If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results could be adversely affected. +Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the United States or abroad. +If we are unable to satisfy our customers’ specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be harmed. +Our customers demand that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, any of which would harm our business. +14 +If we ship products that contain defects, the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate. +Our common stock price is volatile . +Our common stock is listed on the NYSE MKT. In the past, our trading price has fluctuated widely, depending on many factors that may have little to do with our operations or business prospects. The exercise of outstanding options and warrants may adversely affect our stock price and a shareholder’s percentage of ownership. As of December 31, 2014, we had outstanding options to purchase an aggregate of 1,262,763 shares of common stock, with a weighted average exercise price of $1.57 per share, exercisable at prices ranging from $0.68 to $1.79 per share. +ITEM 1B. UNRESOLVED STAFF COMMENTS. +Not applicable. +ITEM 2. DESCRIPTION OF PROPERTY. +Our headquarters utilizes 12,396 square foot of leased office, engineering, laboratory, and warehouse space in Fremont, California. (the “Original Premises”). Our total space lease (the “Lease”) commenced on November 1, 2012 and expires on June 30, 2019. The annual base rent under the Lease, payable on a monthly basis, increases during the term of the Lease from approximately $138,000 during the first year to approximately $160,000 during the final year; our current rent under the Lease is $12,119 per month. The Lease also provides for one option to renew for a term of five years. +In September, 2010, our wholly-owned subsidiary, DPL, entered into a new fifteen-year lease for its 25,000 square-foot facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military power products for the European market. Sales and service support staff for its European network of distributors are located within the building together with other functions, such as engineering and administration. DPL’s rent expense is approximately $13,000 per month, and DPL has the option to cancel the lease after ten years. +We currently anticipate that the current leased space will be sufficient to support our current and foreseen future needs. +ITEM 3. LEGAL PROCEEDINGS. +None. +ITEM 4. MINE SAFETY DISCLOSURES +Not Applicable +15 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. +(a) Market Information. +Our common stock is listed and traded on the NYSE MKT under the symbol DPW. The following tables set forth the high and low closing sale prices, as reported by NYSE MKT, for our common stock for the prior two years. +Quarter Ended +High +Low +12/31/2014 +$ +2.25 +$ +1.24 +09/30/2014 +1.63 +1.09 +06/30/2014 +1.67 +0.83 +03/31/2014 +2.24 +0.60 +12/31/2013 +$ +0.73 +$ +0.56 +09/30/2013 +0.75 +0.60 +06/30/2013 +0.78 +0.53 +03/31/2013 +0.82 +0.62 +The last reported sale price of our common stock on the NYSE MKT on March 22, 2015 was $0.93 per share. +(b) Holders +As of March 22, 2015, there was an aggregate of 6,775,971 shares of our common stock outstanding, held by approximately 65 holders of record. +(c) Dividends +We have not declared or paid any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends in the future, if any, will be at the discretion of our Board of Directors (the “Board”) and will depend upon our earnings, capital requirements, and financial position. +ITEM 6. SELECTED FINANCIAL DATA. +Not applicable. +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. +General +We are a solution-driven organization that designs, develops, manufactures and markets high-grade, customized and flexible power solutions for demanding applications in the medical, military, telecom, and industrial markets. Our products serve global markets worldwide. Revenues are generated from selling products to our customers directly by our sales force and through manufacturing representatives and distributors. +Our net loss was $658,000 for the year ended December 31, 2014 compared to $632,000 for the year ended December 31, 2013. A majority of the loss in 2014 (81%) resulted from the further impairment of our 2011 investment in Telkoor (27% of the loss), stock option expenses (38% of the loss), and amortization of our intellectual property purchased in 2010 (16% of the loss) all of which did not have a cash effect in 2014. A majority of the loss in 2013 (81%) resulted from further impairment of our 2011 investment in Telkoor (49% of the loss), stock option expenses (17% of the loss), and amortization of the intellectual property purchased in 2011 (15% of the loss) all of which did not have a cash effect in 2013. +We believe that our cash will be sufficient to fund our operation in the next 12 months. +16 +Foreign Currency Fluctuations +Our wholly-owned subsidiary, DPL, operates using the United Kingdom pound sterling. Therefore, we are subject to monetary fluctuations between the U.S. dollar and the United Kingdom pound sterling. The financial statement of the subsidiary is included in the Company’s consolidated financial statements based on translation into U.S. dollars. For the year ended December 31, 2014 and 2013, we recorded a foreign currency translation income (loss) of $(105,000) and $ 46,000 in Other Comprehensive Income (Loss) in shareholders’ equity, respectively . +Results of Operations +The table below sets forth certain statements of operations data as a percentage of revenues for the years ended December 31, 2014 and 2013: +Years Ended December 31, +2014 +2013 +Revenues +100.00 +% +100.00 +% +Cost of revenues +63.57 +63.87 +Gross profit +36.43 +36.13 +Engineering and product development +9.04 +8.76 +Sales and marketing +13.94 +12.11 +General and administrative +19.45 +18.88 +Total operating expenses +42.43 +39.75 +Operating loss +(6.00 +) +(3.62 +) +Impairment of investment +(1.94 +) +(3.56 +) +Other income, net +.67 +- +Income before tax +(7.27 +) +(7.18 +) +Tax expenses +(0.01 +) +(0.03 +) +Net loss +(7.28 +)% +(7.21 +)% +The following discussion and analysis should be read in connection with the consolidated financial statements and the notes thereto and other financial information included elsewhere in this Annual Report. We prepared the financial statements in accordance with U.S. generally accepted accounting principles, which require management to make estimates, and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. +Year Ended December 31, 2014 Compared to Year Ended December 31, 2013 +Revenues +For the year ended December 31, 2014, revenues increased by 2.9% to $9,022,000 from $8,770,000 for the year ended December 31, 2013. The slight increase in revenues was mainly due to higher sales of our commercial products by our European subsidiary (DPL) offset by lower sales of standard commercial products by our domestic facility. During the years ended December 31, 2014 and December 31, 2013, we generated revenues from the sale of a fully customized product solution for the medical market, as part of our earlier strategy to transition away from a dependence on standard, commodity products. +Revenues derived from our defense products for the year ended December 31, 2014 were $2,584,000, a decrease of 2.9% from revenues of $2,662,000 from defense products for the year ended December 31, 2013. The slight year to year decrease was primarily attributable to the delay in the completion of an incremental major naval military contract in the fourth quarter of the 2014 fiscal year which will be recognized in the first quarter of fiscal 2015. Revenues derived from our commercial products for the year ended December 31, 2014 increased by 6.2% to $6,482,000 from $6,108,000 for the year ended December 31, 2013. The increase in commercial product revenue in 2014 resulted primarily from an increase in sales of our standard commercial products by DPL. +Revenues from our domestic operations decreased by 5.8% to $4,953,000 for the year ended December 31, 2014, from $5,258,000 for the year ended December 31, 2013. The decrease in product revenues was mainly attributed to a decrease in sales of our standard commercial products. +17 +Revenues from our European operations (Gresham/DPL) increased 15.9% to $4,069,000 for the year ended December 31, 2014 compared to $3,512,000 for the year ended December 31, 2013. The increase was primarily attributable to an increase of commercial product sales of standard products. +Gross Margins +Gross margins were 36.4% for the year ended December 31, 2014, compared to 36.1% for the year ended December 31, 2013. The slight year to year increase was primarily the result of the effect of higher revenues of DPL on fixed manufacturing costs and lower inventory write offs and incremental warranty expenses in 2014 versus 2013 for DPL. The increase in margins of DPL were offset by lower margin for our domestic operations primarily the result of fixed manufacturing costs on a lower revenue base in 2014 versus 2013 +Engineering and Product Development +Engineering and product development expenses were $816,000, or 9% of revenues, for the year ended December 31, 2014, compared to $768,000, or 8.8% of revenues, for the year ended December 31, 2013. The slight increase was attributable to engineering related manpower costs of new military projects of DPL and to a lesser extent, incremental stock option expense. +Selling and Marketing +Selling and marketing expenses were $1,258,000, or 13.9% of revenues, for the year ended December 31, 2014, compared to $1,062,000, or 12.1% of revenues, for the year ended December 31, 2013. The increase in selling and marketing expenses for the year ended December 31, 2014 compared to the year ended December 31, 2013 was primarily due to an increase in internal sales personnel costs associated with manpower increases. +General and Administrative +General and administrative expenses were $1,755,000, or 19.4% of revenues, for the year ended December 31, 2014, compared to $1,656,000, or 18.9% of revenues, for the year ended December 31, 2013. The increase in general and administrative expenses during the year ended December 31, 2014 compared to the year ended December 31, 2013 was the result of higher stock option expenses in 2014 ($219,000) compared to 2013 ($98,000) offset by lower legal expenses. +Impairment of investment +The Company recorded an impairment of its investment in Telkoor of $175,000 for the year ended December 31, 2014 compared to $312,000 for the year ended December 31, 2013. In the year ended December 31, 2014, an independent appraiser valuated the holding value of this investment based upon guidelines outlined in ASC 320 and concluded the fair value of the asset had declined by $175,000 from its value reported in the financial statements for the year ended December 31, 2013. For the year ended December 31, 2013, the Company used the value of shares sold by Telkoor late in the year in a private equity transaction as the basis for the value of the investment. The Company concluded that the price paid for those shares was the fair value of its own Telkoor shares under ASC 325 and subsequently recorded an impairment of $312,000 for year ended December 31, 2013. +Financial Income, Net +Financial income was $60,000 for the year ended December 31, 2014 and consisted of foreign currency fluctuations and proceeds from the sale of an equity investment realized from a previously demutualized executive insurance policy. Financial expense/income was neglible in the year ended December 31, 2013. +Net Loss +For the year ended December 31, 2014, we had a net loss of $658,000 compared to a net loss of $632,000 for the year ended December 31, 2013 as detailed in the above narrative. +18 +Critical Accounting Policies +The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported assets, liabilities, sales, and expenses in the accompanying consolidated financial statements. Critical accounting policies are those that require the most subjective and complex judgments, often employing the use of estimates about the effect of matters that are inherently uncertain. The following are considered our most critical accounting policies that, under different conditions or using different assumption or estimates, could show materially different results on our financial condition and results of operations +Revenue Recognition +Revenue from product sales is recognized in accordance with the provisions of ASC 605-15, "Revenue Recognition in Financial Statements", when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred (when risk of loss and title have transferred to the customer), the sale price is fixed or determinable and collection is reasonably assured. +We generally use customer purchase orders and contracts to determine the existence of an arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. We assess whether the sales price is fixed or determinable based on the payment terms associated with the transaction and whether the price is subject to refund or adjustment. We assess collectability based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. +Revenue on shipments to distributors and resellers is recognized on delivery. Generally, we do not grant a right of return. However, certain distributors are allowed, in the sixth month after the initial stock purchase, to rotate stock that has not been sold for other products. This stock rotation may be repeated every six months thereafter for fifteen to eighteen months, based on a fixed percentage at no more than the distributor's purchases during the previous six months. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. +Inventory Obsolescence Accruals +We periodically assess our inventory valuation by reviewing revenue forecasts and technological obsolescence. We write down the value of obsolete or unmarketable inventory to the estimated net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. +During 2014 and 2013, we recorded inventory write-offs of $13,000 and $46,000, respectively. +Allowance for Doubtful Accounts +Our accounts receivable are derived from sales to customers located primarily in the U.S. and Europe. We perform ongoing credit evaluations of our customers’ financial condition and currently require no collateral from our customers. An allowance for doubtful accounts for estimated losses is maintained in anticipation of the inability of customers to make required payments. The allowance for doubtful accounts as of December 31, 2014 and 2013 was $0 and $146,000, respectively. When we become aware that a specific customer is unable to meet its financial obligations as a result of bankruptcy or the deterioration of the customer’s operating results or financial position, for example, we record a specific allowance to reflect the level of credit risk in the customer’s outstanding receivable balance. We are not able to predict changes in the financial condition of customers, and if the condition or circumstances of our customers deteriorates, estimates of the recoverability of trade receivables could be materially affected and we may be required to record additional allowances. Alternatively, if our estimates are determined to be greater than the actual amounts necessary, we may decrease a portion of such allowance in future periods based on actual collection experience. +19 +Marketable Securities +The Company has classified its investment in Telkoor's shares as available-for-sale securities in accordance with ASC 320, "Investment in Debt and Equity Securities". Marketable securities classified as "available for sale securities" are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of shareholders' equity in "accumulated other comprehensive loss". When evaluating the investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company's intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment's amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e. non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost(i.e., cost method investments), as described in ASC 325-20. +The Company recorded an impairment of its investment in Telkoor of $175,000 for the year ended December 31, 2014 compared to $312,000 for the year ended December 31, 2013. In the year ended December 31, 2014, an independent appraiser evaluated the holding value of this investment based upon guidelines outlined in ASC 320 and concluded the fair value of the asset had declined by $175,000 from its value reported in the financial statements for the year ended December 31, 2013. For the year ended December 31, 2013, the Company used the value of shares sold by Telkoor late in the year in a private equity transaction as the basis for the value of the investment. The Company concluded that the price paid for those shares was the fair value of its own Telkoor shares under ASC 325 and subsequently recorded an impairment of $312,000 for year ended December 31, 2013. In accordance with ASC 325, Telkoor’s equity shares held by the Company are presented at cost and will be reviewed for impairment in accordance with ASC 320. +Equity-based Compensation Expense +We account for equity-based compensation in accordance with ASC 718, “Compensation – Stock compensation” ("ASC 718"). Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense over the requisite service periods. Determining the fair value of share-based awards at the grant date requires the exercise of judgment, including the amount of share-based awards that are expected to be forfeited. Estimated forfeitures are based on historical pre-vesting forfeitures. If actual results differ from these estimates, equity-based compensation expense, and therefore our results of operations, could be impacted. +The Company estimates the fair value of stock options granted under ASC 718, using the Black-Scholes option-pricing model, which uses the following assumption: +Expected volatility is based on historical volatility, which is representative of future volatility over the expected term of the options. The expected term of options granted was determined based on the simplified method, which is calculated as the midpoint between the vesting date and the end of the contractual term of the option. The risk free interest rate is based on the yield of U.S Treasury bonds with equivalent terms. The dividend yield is based on the Company's historical and future expectation of dividends payouts. The Company has not paid cash dividends historically and has no plans to pay cash dividends in the foreseeable future. +20 +Liquidity and Capital Resources +On December 31, 2014, we had cash and cash equivalents of $2,110,000 and working capital of $3,588,000. This compares with cash and cash equivalents of $1,696,000 and working capital of $3,841,000 at December 31, 2013. The increase in cash and cash equivalents was due mainly to the incremental collection of accounts receivable offset by a reduction of accounts payable balances. The net loss effect was reduced by non cash related expenses such as stock option compensation, depreciation, and amortization. The decrease in working capital was primarily the result of the reduction of accounts receivable balance. +Net cash provided by operating activities totaled $669,000 and $71,000 for the year ended December 31, 2014 and December 31, 2013, respectively. The net cash provided by operating activities for the year ended December 31, 2014 was mainly due to the aforementioned decrease in accounts receivable balances. +Net cash used in investing activities was $119,000 for the year ended December 31, 2014, compared to net cash used in investing activities of $216,000 for the year ended December 31, 2013. The net usage of cash from investing activities was primarily related to purchase of capital equipment during both years. +Net cash used by financing activities was $90,000 for the year ended December 31, 2014 and related to the purchase of treasury stock related to the closing of the Company’s ESOP plan. +In November 2012, we entered into a new approximately six and half year lease for our headquarters which utilizes 12,396 square foot of leased office, engineering, laboratory, and warehouse space in Fremont, California. The annual base rent under the lease, payable on a monthly basis, increases during the term of the lease from approximately $138,000 during the first year to approximately $160,000 during the final year. The lease also provides for one option to renew for a term of five years. +In September, 2010, our wholly-owned subsidiary, DPL, entered into a new fifteen year lease for its 25,000 square-foot facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military power products for the European market. Sales and service support staff for its European network of distributors are located within the building together with other functions, such as engineering and administration. DPL’s rent expense is approximately $13,000 per month, and DPL has the option to cancel the lease after ten years. +We believe we have adequate resources at this time to continue our operational and promotional efforts to increase sales and support our current operation. However, if we do not increase our sales, we may have to obtain financing through the issuance of debt and/or equity, which may dilute shareholders’ equity. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. +Not applicable. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. +The financial statements required by this Item 8 are included in this Annual Report following Item 15 hereof. As a smaller reporting company, we are not required to provide supplementary financial information. +21 +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +None. +ITEM 9A. CONTROLS AND PROCEDURES. +Evaluation of Disclosure Controls and Procedures +As of December 31, 2014, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our Chief Executive Officer and principal financial officer, of the effectiveness of the design and operation of our controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) were effective as of the end of the period covered by the report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls. Our management has concluded that, as of December 31, 2014, our internal control over financial reporting was effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Evaluation of Changes in Internal Control over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +22 +ITEM 9B. OTHER INFORMATION +None +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. +The following table sets forth the positions and offices presently held by each of our current directors and executive officers and their ages: +Name +Age +Positions Held +Amos Kohn +55 +President, Chief Executive Officer, and Director +William J. Hultzman +62 +Vice President of Finance, Chief Accounting Officer +Ben-Zion Diamant +65 +Chairman of the Board and Director +Robert Smith +69 +Director (2) +Haim Yatim (1) +51 +Director (2) +Aaron Ben-Ze’ev +65 +Director (2) +(1) On November 13,, 2014, Haim Yatim, who had served as a director since 2011, resigned from the Board of Directors and he was reappointed on March 3, 2015 +(2) Member of the Audit, Compensation and Nominating and Governance Committees. +Each of the directors named above will serve until the next annual meeting of our shareholders or until his respective successor is elected and qualified. Subject to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Amos Kohn +Amos Kohn has served as a member of our board of directors since 2003, as our President and Chief Executive Officer since 2008. From March 2011 until August 2013 Mr. Kohn also served as interim Chief Financial Officer. Mr. Kohn has more than 20 years of successful global executive management experience, including multiple C-level roles across private and established, publicly-traded companies. Mr. Kohn has successfully managed cross-functional teams, dri ven corporations to high profitability, built customer loyalty and led businesses through expansion and sustained growth. His areas of expertise include operations, technology innovation, manufacturing, strategic analysis and planning and M&A. Mr. Kohn was Vice President of Business Development at Scopus Video Networks, Inc., a Princeton, New Jersey company that develops and markets digital video networking products (2006-2007); Vice President of Solutions Engineering at ICTV Inc., a leading provider of network-based streaming media technology solutions for digital video and web-driven programming, located in Los Gatos, California (2003-2006); Chief Architect at Liberate Technologies, a leading company in the development of a full range of digital media processing for telecom and cable TV industries, located in San Carlos, California (2000-2003); and Executive Vice President of Engineering and Technology at Golden Channel & Co., the largest cable television multiple-systems operator (MSO) in Israel, where he had executive responsibility for developing and implementing the entire nationwide cable TV system (1989-2000). Mr. Kohn holds a degree in electrical and electronics engineering and is named as an inventor on several United States and international patents. We believe that Mr. Kohn’s extensive executive-level management experience in diversified industries, including, but not limited to, power electronics, telecommunications, cable television, broadcast and wireless, as well as his service as a director on our board since 2003, give him the qualifications and skills to serve as one of our directors. +23 +William J. Hultzman +William J. Hultzman has been serving as Vice President of Finance since August, 2013. Before assuming this role, Mr. Hultzman was the Finance & Business Development Advisor for STEC USA, LLC, a startup company in the industrial automation space. From 2007 to 2009, Mr. Hultzman served as the Vice President of Finance and Corporate Secretary for R.T. Peak Travel Group, a private travel management company. From 1999 to 2007, Mr. Hultzman held the positions of Vice President of Finance & Controlling and then Business Unit General Manager & CFO with Voith Paper Automation, Inc., a subsidiary of one of the largest privately held companies in Europe, Voith AG. Mr. Hultzman held various other executive finance and accounting roles prior to joining Voith including Corporate Controller of Impact Systems, Inc., a publicly held industrial automation company based in Los Gatos, California. Mr. Hultzman has a Bachelor of Science in Business Administration from The Ohio State University, where he graduated cum laude and was a member of Beta Alph Psi, an honorary accounting fraternity +Ben-Zion Diamant +Ben-Zion Diamant has served as a member of our Board of Directors, and has been Chairman of our Board, since 2001. From March 2008 through July 2008, he also served as our Interim President and Chief Executive Officer. He has served as Chief Executive Officer of Telkoor Telecom Ltd. since August 2008; from 1994 through July 2008, he served as Chairman of the Board of Directors of Telkoor and has served as a director of Telkoor since then. From 1992 through 1994, he was a partner and business development manager at Phascom, and from 1989 to 1992, he was a partner and manager at Rotel Communication. Mr. Diamant holds a B.A. degree in political science from Bar-Ilan University. We believe that Mr. Diamant’s business development and executive-level experience, as well as his service as Chairman of our Board since 2001, give him the qualifications and skills to serve as one of our directors. +Robert O. Smith +Robert Smith has served as a member of our Board of Directors since November 2010 and has served as a member of our Advisory Board since 2002. He is currently a C-level executive consultant working with Bay Area high-tech firms on various strategic initiatives in all aspects of their business. From 2004 to 2007, he served on the Board of Directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman of the Board. From 1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of their Compower / Boschert Division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with the JM Smucker Company. Mr. Smith received his BBA degree in Accounting from Ohio University. We believe that Mr. Smith’s executive-level experience, including his previous service as our President, Chief Executive Officer and Chairman of the Board, his extensive experience in the accounting industry, and his service on our Board since November 2010, give him the qualifications and skills to serve as one of our directors. +Aaron Ben-Ze’ev +Aaron Ben-Ze'ev has served as a member of our Board of Directors since September 2012. From 2004 to 2012, Mr. Ben-Ze’ev served as President of the University of Haifa (the "University"), one of seven research universities in Israel, which has a budget more than $217 million and an enrollment of approximately 18,000 students. As President, Professor Ben-Ze'ev was responsible for the overall administrative and financial direction of the University and served as a member of the Financial Committee and the Investment Committee (which oversees an investment portfolio of about $200 million). Professor Ben-Ze'ev is a professor of Philosophy at the University, holds a B.A. degree in Philosophy and Economics and an M.A. in Philosophy from the University of Haifa, and a Ph.D. in Philosophy from the University of Chicago. +24 +Haim Yatim +Haim Yatim has served as a member of our Board of Directors from September 2011 until his resignation in November, 2014. Mr. Yatim rejoined the Company as a director in March, 2015. Mr. Yatim currently serves as Chief Financial Officer of Fularo Ltd., a privately held company in the internet industry where he is responsible for the finance team, business operations, financial planning and financial reports. From 2006 until 2010 he served as Chief Financial Officer and Board Member of SimiGon Ltd., a publicly traded company (AIM:SIM) that develops software for the training and simulation industry. Previously, Mr. Yatim served as CFO of the Company. As the company CFO, Mr. Yatim was responsible for financial reporting to the SEC, corporate accounting and tax preparation, budgeting, forecasting, and risk management. Prior his role at Digital Power, Mr. Yatim was a partner of Kost Forer Gabbay & Kasierer, a Member of Ernst & Young Global where he advised on successful NASDAQ listings of technology companies. Mr. Yatim holds a B.Sc. in Accounting and Economics from University of Tel-Aviv, Israel +Family Relationships +Guy Diamant serves as the General Manager of Telkoor Power Supplies (TPS) and is the son of Ben-Zion Diamant, our Chairman of the Board of Directors. TPS is a key supplier to Digital Power and a wholly-owned subsidiary of our largest shareholder, Telkoor. There are no other family relationships among any of our directors or executive officers. +Board and Committee Membership +Our Board is currently composed of five members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at www.digipwr.com . +25 +Audit Committee +Messrs. Smith, Yatim, and Ben-Ze’ev currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE MKT. Our Board has also determined that Mr. Yatim qualifies as an “audit committee financial expert” as defined in SEC regulations and satisfies the financial sophistication requirements set forth in the NYSE MKT Rules. +The Audit Committee is responsible for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Yatim, and Ben-Ze’ev currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation Committee meets the requirements for independence under the standards of the SEC and the NYSE MKT. +The Compensation Committee is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving salaries, bonuses and other benefits paid to our officers, including our Chief Executive Officer and Chief Financial Officer; and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith, Yatim, and Ben-Ze’ev currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members of the Nominating and Governance Committee meets the requirements for independence under the standards of the SEC and the NYSE MKT. +The Nominating and Governance Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees for each annual meeting of shareholders to the Board; developing and recommending governance principles applicable to our Board; overseeing the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +The Nominating and Governance Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based business and professional skills, experiences and global business and social perspective. +In addition, the Committee seeks directors who exhibit personal integrity and a concern for the long-term interests of shareholders, as well as those who have time available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +26 +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, directors and 10% shareholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based solely upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting persons, we believe that during the year ended December 31, 2014, all such filing requirements applicable to our officers, directors and ten percent shareholders were fulfilled with the following exceptions. +Name +Number of Late Insider Reports +Number of +Transactions Not +Reported on a +Timely Basis +Failure to File Required Forms +William J. Hultzman +1 +- +- +Amos Kohn +2 +- +- +Ben Zion Diamant +1 +- +- +Robert Smith +1 +- +- +Haim Yatim +1 +- +- +Aaron Ben-Ze’ev +1 +- +- +Code of Ethics +We have adopted the Code of Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller or person performing similar functions (collectively, the “Financial Managers”). The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website at www.digipwr.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit or implicit, from a provision of the Code on our website or in a current report on Form 8-K. +ITEM 11. EXECUTIVE COMPENSATION . +Summary Compensation Table +The following Summary Compensation Table sets forth all compensation earned in all capacities during the years ended December 31, 2014 and 2013, by our (i) Chief Executive Officer and (ii) executive officers, other than the Chief Executive Officer, whose salaries for the 2014 year, as determined by Regulation S-K, Item 402, exceeded $100,000 (the individuals falling within categories (i) and (ii) are collectively referred to as the “Named Executive Officers”). +27 +SUMMARY COMPENSATION TABLE +Name and Principal Position +Year +Salary ($) +Bonus ($) +Stock Awards ($) +Option Awards ($)(4) +Nonequity Incentive Plan Compensation ($) +Nonqualified Deferred Compensation Earnings ($) +All Other Compensation ($)(1) +Total ($) +Amos Kohn +2014 +$ +202,458 +$ +- +$ +- +$ +75,031 +$ +- +$ +- +$ +44,603 +$ +322,092 +Chief Executive Officer (2) +2013 +$ +210,000 +$ +29,146 +$ +66,406 +$ +305,552 +William Hultzman +2014 +$ +120,125 +$ +- +$ +- +$ +16,894 +$ +- +$ +- +$ +22,928 +$ +159,947 +Vice President of Finance (3) +2013 +$ +40,051 +$ +- +$ +- +$ +- +$ +- +$ +- +$ +5,163 +$ +45,214 +(1) The amounts in “All Other Compensation” consist of health insurance benefits, long-term and short-term disability insurance benefits, and 401K match amounts. For Mr. Kohn, all other compensation also includes fees of approximately $11,000 and $44,000 in 2014 and 2013, respectively, paid to TechLead, a company for which Mr. Kohn serves as director, to reimburse TechLead for expenses incurred in connection with manpower services provided by TechLead until April, 2014. +(2) Mr. Kohn became our President and Chief Executive Officer in 2008. Prior to that date, he had served as a non-employee member of our Board since 2003. +(3) Mr. Hultzman became our Vice President of Finance and Principal Accounting Officer in late August, 2013. +(4) Represents the equity-based compensation expenses recorded in the Company’s consolidated financial statements for the year ended December 31, 2014, based upon the option’s fair value on the grant date, calculated in accordance with accounting guidance for equity-based compensation. For a discussion of the assumptions used in reaching this valuation, see Note 8 to our consolidated financial statements for the year ended December 31, 2014. +28 +Director Compensation +Independent directors receive $10,000 annually for serving on our Board. The director designated by the Board as the Audit Committee financial expert generally receives an additional annual fee of $5,000 for serving as the financial expert. Directors are paid quarterly in arrears for their services. +Subject to Board approval, upon joining our Board, independent directors may also receive a grant of an option under our 2012 Stock Option Plan to purchase 10,000 shares of our common stock. In addition, subject to Board approval, each independent director may be granted, from time to time, an option to purchase an additional 10,000 shares of our common stock. Options vest over a four-year period, 25% per year. Each option has an exercise price equal to the fair market value of our common stock on the grant date and a maximum term of ten years, subject to earlier termination upon the cessation of service as a director. +Chairman of the Board of Directors, Ben-Zion Diamant, receives monthly consulting fees of $6,000 and no equity compensation. +The table below sets forth, for each non-employee director, the total amount of compensation related to his service during the year ended December 31, 2014: +Director Compensation +Name +Fees +Earned +or Paid +in Cash +($) +Stock +Awards +($) +Option +Awards +($) +Non-Equity Incentive +Plan +Compensation +($) +Nonqualified Deferred Compensation Earnings +($) +All Other Compensation +($) +Total +($) +Ben-Zion Diamant (1) +$ +- +- +$ +25,342 +- +- +$ +72,000 +$ +97,342 +Robert Smith +$ +10,000 +- +$ +1,690 +- +- +- +$ +11,690 +Aaron Ben-Ze’ev +$ +10,000 +- +$ +1,690 +- +- +- +$ +11,690 +Benjamin Kiryati (2) +$ +1,667 +- +$ +433 +- +- +- +$ +2,100 +Haim Yatim (3) +$ +8,750 +- +$ +- +- +- +- +$ +8,750 +(1) +On September 12, 2011, the Company’s Board of Directors approved the payment of monthly consulting fees of $6,000 to Ben-Zion Diamant, our Chairman of the Board of Directors. These fees were first paid on October 5, 2011 and have continued to be paid on a monthly basis since such date. The Board’s decision to approve these fees was based on a recommendation by the Compensation Committee, in consideration for Mr. Diamant’s services to the Company, including manufacturing advisory and corporate advisory services. The Company’s obligation to pay the fees may be terminated at any time by further decision of the Board of Directors and will terminate upon a strategic transaction of the Company. +(2) +Mr. Kiryati joined the Board on October 30, 2014 and resigned on February 26, 2015 +(3) +Mr. Yatim resigned as director on November 13, 2014 and was reappointed on March 3, 2015 +Employment Agreement with Amos Kohn +An employment agreement with Mr. Kohn expired on December 31, 2010. As of March 20, 2015, Mr. Kohn has not reached or signed a new employment agreement. Mr. Kohn continues to serve as the Company’s President and Chief Executive Officer. +In March 2014, the Compensation Committee resolved to grant Mr. Kohn 300,000 stock options under the 2012 Stock Option Plan. The options, which will have an exercise price equal to the closing price of the Company’s shares as of the close of business on April 1, 2014, vest over four years at 25% per year and expire 10 years from the date of grant. +Mr. Kohn continues to serve as the Company’s President and Chief Executive Officer. +Letter Agreement with William J. Hultzman +On August 15, 2013, the Company entered into a letter agreement with William J. Hultzman (the “Letter Agreement”), pursuant to which he became the Company’s Vice President of Finance (principal financial officer and principal accounting officer) on August 21, 2013. Mr. Hultzman replaced Amos Kohn, the Company’s President and Chief Executive Officer, who served as interim Chief Financial Officer since March, 2011. +The following is a brief description of the Letter Agreement with Mr. Hultzman: +Annual Compensation. Mr. Hultzman’s base salary will be $110,000, subject to a performance review after six months and an annual performance review thereafter. He will be eligible for potential salary increases and a bonus grant subject to the Company’s yearly practice and his performance. +Equity Award. Subject to Compensation Committee and Board of Director approval, Mr. Hultzman will be granted an option to purchase 25,000 shares of the Company’s common stock at the closing price at the date of the grant. +Benefits. Mr. Hultzman is eligible to participate in the Company’s 401(k) pension plan and will receive other customary employee benefits. +In March, 2014, the Compensation Committee resolved to grant Mr. Hultzman 100,000 stock options under the 2012 Stock Option Plan. The options, which will have an exercise price equal to the closing price of the Company’s shares as of the close of business on April 1, 2014, vest over four years at 25% per year and expire 10 years from the date of grant. +29 +Advisory Vote on Executive Compensation +At the annual meeting of shareholders on August 12, 2013, shareholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. In addition, shareholders voted, on an advisory basis, that an advisory vote on executive compensation should be held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding equity awards as of December 31, 2014 to the Named Executive Officers: +Option Awards +Stock Awards +Name +Number of Securities Underlying Unexercised Options +(#) +Exercisable +Number of Securities Underlying Unexercised Options (#) Unexercisable +Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) +Option +Exercise +Price ($) +Option Expiration Date +Number +of +Shares +or +Units +of +Stock +That +Have +Not +Vested (#) +Market +Value +of +Shares +or +Units +of +Stock +That +Have +Not +Vested +(#) +Equity +Incentive +Plan +Awards: +Number +of +Unearned +Shares, +Units or +Other +Rights +That Have +Not +Vested +(#) +Equity +Incentive +Plan +Awards: +Market or +Payout +Value of +Unearned +Shares, +Units or +Other +Rights +That Have +Not +Vested ($) +Amos Kohn +10,000 +- +- +$ +1.66 +5/9/2017 +- +- +- +- +50,000 +- +- +$ +1.79 +8/11/2019 +- +- +- +- +75,000 +- +- +$ +1.51 +12/1/2020 +- +- +- +- +75,000 +25,000 +- +$ +1.60 +9/12/2021 +- +- +- +- +- +300,000 +- +$ +1.67 +4/2/2024 +- +- +- +- +William Hultzman +- +100,000 +- +$ +1.67 +4/2/2024 +- +- +- +- +Employee Stock Ownership Plan +The Company had an Employee Stock Ownership Plan ("ESOP") until July 31, 2014 at which time it was entirely liquidated after a decision to terminate the plan as of July 31, 2013 was previously made. The ESOP provided for the Employee Stock Ownership Trust ("ESOT") to distribute the Company's common shares or cash equivalent as retirement benefits to the participants. As of July 31, 2014, the ESOT had distributed or paid the cash equivalent of all of the 167,504 shares previously held prior to plan termination. +Stock Option Plans +Our stock option plans currently consist of the Digital Power 2012 (as amended), 2002, 1998, and 1996 incentive share option plans (the “Incentive Share Option Plans”). All of the Incentive Share Option Plans have expired, except for the 2012 Stock Option Plan (as amended) which was approved by shareholders at the annual general meeting held on August 12, 2013. At such annual general meeting, shareholders approved the 2012 Stock Option Plan (as amended) which increased the number of shares authorized for issuance to 1,372,630 shares from the 410,145 shares originally authorized in December, 2012 under the preceding 2012 Stock Option Plan. Currently authorized for issuance under the Company’s Incentive Stock Option Plans are 655,130 shares of our common stock. +The purpose of the 2012 Stock Option Plan (as amended) is to encourage stock ownership by employees, officers, and directors by giving them a greater personal interest in the success of the business and by providing them an added incentive to advance in their employment or service to Digital Power. The 2012 Stock Option Plan (as amended) provides for the grant of either incentive or non-statutory stock options. The exercise price of any stock option granted under the 2012 Plan (as amended) may not be less than 100% of the fair market value of our common stock on the date of grant. +30 +To the extent that an incentive stock option may be exercised in any given year for more than $100,000, the option will be deemed to be a non-statutory stock option. Generally, our stock option agreements permit cashless exercises where options are exercised and the underlying common stock is sold on the same day. Unless otherwise provided by the Board, an option granted under the 2012 Stock Option Plan (as amended) is exercisable for 10 years. The 2012 Stock Option Plan (as amended) is administered by the Compensation Committee, which has discretion to determine optionees, the number of shares to be covered by each option, the exercise schedule and other terms of the options. The 2012 Stock Option Plan (as amended) may be amended, suspended, or terminated by the Board, but no such action may impair rights under a previously granted option. Each incentive stock option is exercisable, during the lifetime of the optionee, only so long as the optionee remains employed with us. In general, no option is transferable by the optionee other than by will or by the laws of descent and distribution. +As of December 31, 2014, options to purchase 1,262,763 shares of common stock were issued and outstanding under the Incentive Share Option Plans. +401(k) Plan +We have adopted a tax-qualified employee savings and retirement plan, or 401(k) plan, which generally covers all of our full-time employees. Pursuant to the 401(k) plan, eligible employees may make voluntary contributions to the plan up to a maximum of 5% of eligible compensation. The 401(k) plan permits, but does not require, matching contributions by Digital Power on behalf of plan participants. We match contributions at the rate of (1) $1.00 for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary. We are also permitted under the plan to make discretionary contributions. The 401(k) plan is intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. Contributions to such a qualified plan are deductible by Digital Power when made, and neither the contributions nor the income earned on those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained in trust. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. +Security Ownership +Except as otherwise indicated below, the following table sets forth certain information regarding beneficial ownership of our common stock as of March 20, 2015 by: (1) each of our current directors; (2) each of the named executive officers listed in the Summary Compensation Table; (3) each person known to us to be the beneficial owner of more than 5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and executive officers as a group. As of December 31, 2014, there were 6,775,971 shares of our common stock outstanding. +Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of March 20, 2015 are deemed to be outstanding and to be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or group. Unless otherwise indicated by footnote, to our knowledge the persons named in the table have sole voting and sole investment power with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. The table below is based upon information supplied by officers, directors and principal shareholders and Schedules 13D and 13G and Forms 3 and 4 filed with the SEC as of March 20, 2015. Unless otherwise indicated below, the address of each beneficial owner listed below is c/o Digital Power Corporation, 48430 Lakeview Blvd, Fremont, California 94538. +31 +Name and Address +Of Beneficial Owner +Number of Shares +Beneficially Owned +Approximate Percent +of Class +Telkoor Telecom Ltd. +5 Giborei Israel +Netanya 42293 +Israel +2,874,610 +38.99 +% +Amos Kohn +324.749 +(1) +4.40 +% +William J. Hultzman +25,000 +(2) +* +Ben-Zion Diamant +3,149,059 +(3) +42.71 +% +Robert Smith +136,849 +(4) +1.86 +% +Aaron Ben-Ze’ev +7,500 +(5) +* +% +Haim Yatim +1,202 +(6) +* +Barry W. Blank +P.O. Box 32056 +Phoenix, AZ 85064 +419,900 +5.69 +% +All directors and executive officers as a group +3,644,359 +(7) +49.43 +% +* Less than one percent. +(1) Represents (a) options to purchase 285,000 shares of common stock that are currently exercisable or exercisable within 60 days of March 20, 2015 and (b) 39,749 shares of common stock held on behalf of Mr. Kohn by a brokerage firm. +(2) Represents options to purchase 25,000 shares of common stock that are exercisable with 60 days of March 20, 2015 +(3) Mr. Diamant serves as Chief Executive Officer and a director of Telkoor and is its controlling shareholder. Represents (a) options to purchase 162,500 shares, owned by Mr. Diamant, that are currently exercisable or exercisable within 60 days of March 20, 2015; (b) 2,874,610 shares beneficially owned by Telkoor, and (c) 111,949 shares held by a brokerage firm on behalf of Telkoor. Mr. Diamant disclaims beneficial ownership of the shares held by Telkoor, except to the extent of his proportionate pecuniary interest therein. +(4) Represents (a) options to purchase 117,500 shares of common stock that are currently exercisable or exercisable within 60 days of March 20, 2015 and (b) 19,349 shares of common stock held by a brokerage firm. +(5) Represents options to purchase 7,500 shares of common stock that are currently exercisable or exercisable within 60 days of March 20, 2015 +(6) Represents 1,202 shares held on behalf of Mr. Yatim by a brokerage firm +(7) See Notes (1) – (6) above +Securities Authorized for Issuance Under Equity Compensation Plans +The following table sets forth information as of December 31, 2014 with respect to compensation plans under which our common shares are authorized for issuance, aggregated as follows: +● +All compensation plans previously approved by security holders; and +● +All compensation plans not previously approved by security holders. +32 +EQUITY COMPENSATION PLAN INFORMATION +Name +Number of securities to be issued +upon exercise of outstanding +options, warrants and rights +(a) +Weighted-average exercise +price of outstanding options, +warrants and rights +(b) +Number of securities +remaining +available for future +issuance +under equity +compensation plans +(excluding securities in +column (a)) +(c) +Equity compensation plans approved by security holders +1,262,763 +$ +1.57 +655,130 +Equity compensation plans not approved by security holders +141,500 +- +- +Total +1,404,263 +$ +1.53 +655,130 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +Relationship with Telkoor Power Supplies Ltd. +In the years ended December 31, 2014 and 2013, we purchased approximately $868,000 and $1,381,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest shareholder, Telkoor, of which Ben-Zion Diamant is the Chief Executive Officer and controlling shareholder. We have no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. +Purchase of IP from Telkoor by DPL +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest shareholder, Telkoor Telecom Ltd., of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL has paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period the Company sells more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, the Company amended its agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. We will not be required to make any royalty payments to Telkoor under the Manufacturing Agreement with Telkoor (described below) until the shortfall of CPCI 600W product sales will be offset. +Acquisition of Shares of Telkoor +On June 16, 2011 the Company acquired 1,136,666 shares of Telkoor, a major shareholder of the Company and an Israeli company listed in the Tel Aviv stock exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations +33 +Manufacturing Agreement with Telkoor +On December 31, 2012, the Company entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted to the Company the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by the Company to Telkoor. The royalty fees paid by the Company to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Company incurred $44,000 in Telkoor royalty expense in 2013. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, the customers of the Company in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. +Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global (“Kost Forer”), has served as our independent registered public accounting firm since 2002 and has been appointed by the Audit Committee to continue as our independent registered public accounting firm for the year ending December 31, 2014. +Kost Forer also serves as the independent auditors of Telkoor. The auditing of our financial statements and Telkoor’s financial statements are handled by separate teams within Kost Forer. +Fees and Services +The following table shows the aggregate fees billed to us for professional services by Kost Forer for the years ended December 31, 2014 and 2013: +2014 +2013 +Audit Fees +$ +112,000 +$ +115,000 +Audit-Related Fees +$ +- +$ +- +Tax Fees +$ +- +$ +- +All Other Fees +$ +- +$ +- +Total +$ +112,000 +$ +115,000 +Audit Fees - This category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years ended December 31, 2014 and 2013, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2014 and 2013, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements for the relevant years. +Audit-Related Fees - This category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under "Audit Fees," and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, internal control-related matters, and audits of employee benefit plans. +Tax Fees - This category includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax compliance, tax planning and tax advice. +All Other Fees - This category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors that are not reported above under "Audit Fees," "Audit-Related Fees," or "Tax Fees." +The Audit Committee’s policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such pre-approval. +34 +PART IV +ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. +(a) +Exhibits +3.1 +Amended and Restated Articles of Incorporation of Digital Power Corporation (1) +3.2 +Amendment to the Articles of Incorporation (1) +3.3 +Amendment to the Articles of Incorporation (2) +3.4 +Bylaws of Digital Power Corporation (1) +10.1 +1996 Digital Power Incentive Share Option (1) +10.2 +1998 Digital Power Incentive Share Option Plan (3) +10.3 +2002 Digital Power Incentive Share Option Plan (4) +10.4 +Lease, dated as of August 21, 2007, between the Company and SDC Fremont Business Center, Inc. (5) +10.5* +Employment Agreement with Amos Kohn (6) +10.6* +2012 Stock Option Plan, as amended (7) +10.8† +Manufacturing Rights Agreement, dated December 30, 2012, by and between the Company and Telkoor Telecom Ltd. (8) +10.9* +Letter Agreement with William J. Hultzman (9) +10.10 * +Form of Stock Option Agreement for awards made under the 2012 Stock Option Plan (as amended). (10) +99.1 +Press Release, dated March 27, 2015 +23.1 +Consent of Kost Forer Gabbay & Kasierer +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act +(1) +Previously filed with the Commission on October 16, 1996 as an exhibit to the Company’s Registration Statement on Form SB-2. +(2) +Previously filed with the Commission as Exhibit 3.1 to the Company’s Form 8-K filed December 9, 2013 +(3) +Previously filed with the Commission as Exhibit 10.7 to the Company’s Form 10-KSB for the year ended December 31, 1998. +(4) +Previously filed with the Commission as Exhibit A to the Company’s Proxy Statement filed on September 5, 2002. +(5) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on October 22, 2007. +(6) +(7) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on July 10, 2008. +Previously filed with the Commission as Exhibit A to the Company’s DEF-14A filed on June 26, 2013. +(8) +Previously filed with the Commission as Exhibit 10.8 to the Company’s Form 10-K for the year ended December 31, 2012 +(9) +Previously filed with the Commission as Exhibit 10.9 to the Company’s Form 10-Q/A for the quarterly period ended June 30, 2012. +(10) +Previously filed with the Commission as Exhibit 10.10 to the Company’s Form 10-K for the year ended December 31, 2013. +101+ +The following materials from Digital Power Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) Notes to Consolidated Financial Statements. +†Portions of this exhibit have been omitted and filed separately with the Securities and Exchange Commission pursuant to a confidential treatment request. +*Management contract or compensatory plan or arrangement. +35 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED FINANCIAL STATEMENTS +AS OF DECEMBER 31, 2013 +IN U.S. DOLLARS +INDEX +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Balance Sheets +F-3 - F-4 +Consolidated Statements of Operations +F-5 +Consolidated Statements of Comprehensive Loss +F-6 +Statements of Changes in Shareholders' Equity +F-7 +Consolidated Statements of Cash Flows +F-8 +Notes to Consolidated Financial Statements +F-9 - F-30 +F-1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +The Board of Directors and Shareholders of +DIGITAL POWER CORPORATION +We have audited the accompanying consolidated balance sheets of Digital Power Corporation (the "Company") and subsidiary as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and subsidiary as of December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2014 in conformity with U.S. generally accepted accounting principles. +/s/ KOST FORER GABBAY & KASIERER +Tel-Aviv, Israel +KOST FORER GABBAY & KASIERER +March 27, 2015 +A Member of Ernst & Young Global +F-2 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +U.S. dollars in thousands +December 31, +2014 +2013 +ASSETS +CURRENT ASSETS: +Cash and cash equivalents +$ +2,110 +$ +1,696 +Trade receivables (net of allowance for doubtful accounts of $ 0 and $ 146 as of December 31, 2014 and 2013, respectively) +1,548 +2,157 +Prepaid expenses and other receivables +178 +167 +Inventories (Note 3) +1,653 +1,751 +Total current assets +5,489 +5,771 +NON CURRENT ASSETS: +Property and equipment, net (Note 4) +567 +616 +Intangible asset, net (Note 5) +66 +171 +Investment in Telkoor (Note 11) +207 +406 +Long term deposits +13 +13 +Total Non-Current Assets +853 +1,206 +Total Assets +$ +6,342 +$ +6,977 +The accompanying notes are an integral part of the consolidated financial statements. +F-3 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +U.S. dollars in thousands (except per share data) +December 31, +2014 +2013 +LIABILITIES AND SHAREHOLDERS' EQUITY +CURRENT LIABILITIES: +Accounts payable +$ +1,061 +$ +1,109 +Trade payables - related parties (Note 12) +60 +248 +Advances from customers and deferred revenue +435 +128 +Other current liabilities (Note 6) +345 +445 +Total Current Liabilities +1,901 +1,930 +COMMITMENTS AND CONTINGENT LIABILITIES (Note 7) +SHAREHOLDERS' EQUITY (Note 8): +Share capital - +Series A Redeemable Convertible Preferred shares, no par value - 500,000 shares authorized; 0 shares issued and outstanding at December 31, 2014 and 2013 +- +- +Preferred shares, no par value - 1,500,000 shares authorized; 0 shares issued and outstanding at December 31, 2014 and 2013 +- +- +Common Shares, no par value - 30,000,000 shares authorized; 6,775,971 and 6,853,161 shares issued and outstanding at December 31, 2014 and 2013, respectively +- +- +Additional paid-in capital +14,739 +14,582 +Accumulated deficit +(9,940 +) +(9,282 +) +Accumulated other comprehensive loss +(358 +) +(253 +) +Total Shareholders' Equity +4,441 +5,047 +Total Liabilities and Shareholders' Equity +$ +6,342 +$ +6,977 +The accompanying notes are an integral part of the consolidated financial statements. +F-4 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF OPERATIONS +U.S. dollars in thousands (except per share data) +Year ended +December 31, +2014 +2013 +Revenues (Note 13) +$ +9,022 +$ +8,770 +Cost of revenues +5,735 +5,601 +Gross profit +3,287 +3,169 +Operating expenses: +Engineering and product development +816 +768 +Selling and marketing +1,258 +1,062 +General and administrative +1,755 +1,656 +Total operating expenses +3,829 +3,486 +Operating loss +(542 +) +(317 +) +Impairment of investment (Note 11) +(175 +) +(312 +) +Other income, net +60 +- +Loss before income taxes (Note 9c) +(657 +) +(629 +) +Income taxes (Note 9d) +1 +3 +Net Loss +$ +(658 +) +$ +(632 +) +Basic and diluted net loss per share (Note 10) +$ +(0.097 +) +$ +(0.092 +) +Weighted average number of shares used in per share calculations (in thousands) +6,803 +6,853 +The accompanying notes are an integral part of the consolidated financial statements. +F-5 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS +U.S. dollars in thousands +Year ended +December 31, +2014 +2013 +Net Loss +$ +(658 +) +$ +(632 +) +Other comprehensive income (loss): +Change in net foreign currency translation adjustment +(105 +) +46 +Other comprehensive income (loss) +(105 +) +46 +Total comprehensive income loss +$ +(763 +) +$ +(586 +) +The accompanying notes are an integral part of the consolidated financial statements. +F-6 +DIGITAL POWER CORPORATION AND SUBSIDIARY +STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY +U.S. dollars in thousands (except share data) +Common Shares Number +Additional paid-in capital +Accumulated deficit +Other accumulated comprehensive income (loss) +Total shareholders equity +Balance as of January 1, 2013 +6,853,161 +$ +14,476 +$ +(8,650 +) +$ +(299 +) +$ +5,527 +Stock compensation related to options granted to non- employees +- +2 +- +- +2 +Stock compensation related to options granted to employees +- +104 +- +- +104 +Comprehensive loss: +Net loss +- +- +(632 +) +- +(632 +) +Foreign currency translation Adjustments +- +- +- +46 +46 +Balance as of December 31, 2013 +6,853,161 +$ +14,582 +$ +(9,282 +) +$ +(253 +) +$ +5,047 +- +Stock compensation related to options granted to non- employees +- +1 +- +- +1 +Stock compensation related to options granted to employees +- +246 +- +- +246 +Exercise of options granted to employees +40,951 +- +- +- +- +Purchase of treasury stock +(118,141 +) +( 90 +) +- +- +(90 +) +Comprehensive loss: +Net loss +- +- +(658 +) +- +(658 +) +Foreign currency translation adjustments +- +- +- +(105 +) +(105 +) +Balance as of December 31, 2014 +6,775,971 +$ +14,739 +$ +(9,940 +) +$ +(358 +) +$ +4,441 +The accompanying notes are an integral part of the consolidated financial statements +F-7 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +U.S. dollars in thousands +Year ended +December 31, +2014 +2013 +Cash flows from operating activities : +Net loss +$ +(658 +) +$ +(632 +) +Adjustments required to reconcile net loss to net cash provided by operating activities: +Depreciation +139 +110 +Amortization of intangible asset +106 +96 +Inventory write-down +13 +46 +Impairment of investment in Telkoor +175 +376 +Stock compensation related to options granted to employees +246 +104 +Stock compensation related to options granted to non-employees +1 +2 +Decrease (increase) in trade receivables, net +581 +(750 +) +Increase in prepaid expenses and other receivables +(15 +) +(28 +) +Decrease in inventories +49 +238 +Increase (decrease) in accounts payable and trade payables - related parties +(221 +) +365 +Increase in advances from customers, deferred revenues and other current liabilities +253 +144 +Net cash provided by operating activities +669 +71 +Cash flows from investing activities : +Purchase of property and equipment +(119 +) +(216 +) +Net cash used in investing activities +(119 +) +(216 +) +Cash flows from financing activities : +Purchase of treasury stock +( 90 +) +- +Net cash used in financing activities +( 90 +) +- +Effect of exchange rate changes on cash and cash equivalents +(46 +) +20 +Increase (decrease) in cash and cash equivalents +414 +(125 +) +Cash and cash equivalents at the beginning of the year +1,696 +1,821 +Cash and cash equivalents at the end of the year +$ +2,110 +$ +1,696 +Non-cash activities : +Reclassification of property and equipment to inventory +$ +16 +The accompanying notes are an integral part of the consolidated financial statements. +F-8 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 1:- GENERAL +a. +Digital Power Corporation ("the Company" or "DPC") was incorporated in 1969, under the General Corporation Law of the State of California. The Company and Digital Power Limited ("DPL"), a wholly owned subsidiary located in the United Kingdom, are currently engaged in the design, manufacture and sale of switching power supplies and converters. The Company has two reportable geographic segments - North America (sales through DPC) and Europe (sales through DPL). +b. +The Company depends on Telkoor Telecom Ltd. ("Telkoor"), a major shareholder of the Company and one of DPC's third party subcontractors, for manufacturing capabilities in production of the products which DPC sells. If these manufacturers are unable or unwilling to continue manufacturing the Company's products in required volumes on a timely basis, that could lead to loss of sales, and adversely affect the Company's operating results and cash position. The Company also depends on Telkoor's intellectual property and ability to transfer production to third party manufacturers. Failure to obtain new products in a timely manner or delay in delivery of products to customers will have an adverse effect on the Company's ability to meet its customers' expectations. In 2010, the Company purchased a specific IP from Telkoor in order to reduce its dependency on Telkoor with respect to a certain line of products. See also Notes 5 and 12. +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES +The consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”). +a. +Use of estimates: +The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions. The Company's management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +b. +Financial statements in U.S. dollars: +A substantial portion of the revenues of the Company is generated in U.S. dollars ("dollar"). In addition, a substantial portion of the costs of the Company is incurred in dollars. The Company's management believes that the dollar is the currency of the primary economic environment in which the Company operates. +Accordingly, monetary accounts maintained in currencies other than the dollar are remeasured into U.S. dollars in accordance with Accounting Standards Codification No. 830, "Foreign Currency Matters" ("ASC No. 830"). All transactions gains and losses from the remeasurement of monetary balance sheet items are reflected in the statements of operations as financial income or expenses as appropriate. +F-9 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +The financial statements of the foreign subsidiary, whose functional currency has been determined to be its local currency, have been translated into U.S. dollars in accordance with Accounting Codification Statement ("ASC") 830, "Foreign Currency Translation". All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate for the period. The resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss) in shareholders' equity. +c. +Principles of consolidation: +The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. Intercompany transactions and balances have been eliminated upon consolidation. +d. +Cash equivalents: +Cash equivalents are short-term highly liquid investments that are readily convertible to cash with original maturities of three months or less at acquisition. +e. +Inventories: +Inventories are stated at the lower of cost or market value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological obsolescence. +Cost is determined as follows: +Raw materials, parts and supplies - using the "first-in, first-out" method. +Work-in-progress and finished products - on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically assesses its inventories valuation in respect of obsolete and slow moving items by reviewing revenue forecasts and technological obsolescence. When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at the time of the review was not expected to be sold, is written off. +F-10 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +During 2014 and 2013, the Company recorded inventory write-offs of $13 and $46, respectively, within the cost of revenue. +f. +Property and equipment and intangible asset, net: +Property and equipment as well as an intangible asset are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets, at the following annual rates: +% +Intangible asset +20 +Computers, software and related equipment +20 +– +33 +Office furniture and equipment +10 +– +20 +Leasehold improvements +Over the term of the lease or the life +of the asset, whichever is shorter +The long-lived assets of the Company and its subsidiary are reviewed for impairment in accordance with ASC 360, "Property, Plant, and Equipment", whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. As of December 31, 2014 and 2013, no impairment losses have been identified. +g. +Revenue recognition: +The Company and its subsidiary generate their revenues from the sale of their products through a direct and indirect sales force. +Revenues from products are recognized in accordance with ASC 605-15, "Revenue Recognition in Financial Statements", when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the seller's price to the buyer is fixed or determinable, no further obligation exists and collectability is reasonably assured. +F-11 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +Generally, the Company does not grant a right of return. However, certain distributors are allowed, in the sixth month after the initial stock purchase, to rotate stock that has not been sold for other products. This stock rotation may be repeated every six months thereafter for 15-18 months, based on a fixed percentage at no more than the distributor's purchases during the previous six months. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. +Service revenues are deferred and recognized on a straight-line basis over the term of the service agreement. Service revenues are immaterial in proportion to the Company's revenues. +h. +Engineering and product development costs: +Engineering and product development costs are charged to the statement of operations as incurred. +i. +Income taxes: +The Company and its subsidiary account for income taxes in accordance with ASC 740, "Income Taxes" (“ASC 740”). This statement prescribes the use of the liability method whereby deferred tax assets and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company and its subsidiary provide a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. +ASC 740 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with ASC 740. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. No liability for unrecognized tax benefits was recorded as a result of the implementation of ASC 740 as of December 31, 2014 and 2013. +F-12 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +j. +Warranty costs: +The Company offers a warranty period for all of its products. Warranty periods range from one to two years depending on the product. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company's warranty liability include the number of units sold, historical rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. +Warranty liability accruals were $97 and $104 for the years ended December 31, 2014 and December 31, 2013 respectively. +k. +Accounting for stock-based compensation: +The Company accounts for stock-based compensation in accordance with ASC 718 "Compensation – Stock Compensation" ("ASC 718"). +ASC 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in the Company's consolidated statements of operations. +The Company estimates the fair value of stock options granted under ASC 718 using the Black-Scholes option-pricing model that uses the following assumptions. +Expected volatility is based on historical volatility that is representative of future volatility over the expected term of the options. The expected term of options granted was determined based on the simplified method, which is calculated as the midpoint between the vesting date and the end of the contractual term of the option. The Company uses the simplified method as it has determined that sufficient data is not available to develop an estimate of the expected option term based upon historical participant behavior. The risk free interest rate is based on the yield of U.S. Treasury bonds with equivalent terms. The dividend yield is based on the Company's historical and future expectation of dividends payouts. The Company has not paid cash dividends historically and has no plans to pay cash dividends in the foreseeable future. +The Company recognizes compensation expense based on awards ultimately expected to vest, net of estimated forfeitures at the time of grant. Estimated forfeitures are based on historical pre-vesting forfeitures. ASC 718 requires forfeitures to be estimated and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. +F-13 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +There were 795,000 options granted in 2014 and none in 2013. The fair value for options granted in 2014 is amortized over their vesting period using a straight-line recognition method and estimated at the date of grant with the following weighted average assumptions: +Weighted Average fair value +$ +1.66 +Dividend yield +0 +% +Expected volatility +77.5 +% +Risk-free interest +2.16 +% +Expected life (years) +6.25 +The Company applies ASC 718 and ASC 505-50, “Equity Based Payments to Non-Employees”, with respect to options and warrants issued to non-employees. +F-14 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +l. +Fair value of financial instruments and securities: +The Company measures its financial instruments at fair value. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value: +Level 1 - +inputs are based upon unadjusted quoted prices for identical instruments traded in active markets. +Level 2 - +inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3 - +inputs are generally unobservable and typically reflect management's estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. +The carrying amounts of financial instruments carried at cost, including cash and cash equivalents, trade receivables, trade payables and trade payables – related party approximate their fair value due to the short-term maturities of such instruments. +m. +Basic and diluted net loss per share: +Basic net earnings loss per share is computed based on the weighted average number of Common shares outstanding during each year. Diluted net loss per share are computed based on the weighted average number of Common shares outstanding during each year, plus dilutive potential Common shares considered outstanding during the year, if any, in accordance with ASC 260, "Earnings per Share". +n. +Concentrations of credit risks: +Financial instruments that potentially subject the Company and its subsidiary to concentrations of credit risk consist principally of cash and cash equivalents, long term deposits and trade receivables. +F-15 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +Cash and cash equivalents are invested in banks in the U.S. and in the UK. Such deposits in the United States may be in excess of insured limits and are not insured in other jurisdictions. +Trade receivables of the Company and its subsidiary are mainly derived from sales to customers located primarily in the U.S. and in Europe. The Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is determined with respect to those amounts that the Company and its subsidiary have determined to be doubtful of collection. +o. +Comprehensive income: +The Company accounts for comprehensive income in accordance with ASC No. 220, "Comprehensive Income". Comprehensive income generally represents all changes in shareholders' equity during the period except those resulting from investments by, or distributions to, shareholders. The Company determined that its items of other comprehensive income relate to changes in foreign currency translation adjustments. +p. +Operating lease: +The Company and its subsidiary have operating lease agreements for the lease of their building facilities in the U.S. and UK. The rent in connection with the leases is charged to expense over the lease term. If rental payments are not made on a straight-line basis, rental expenses are nevertheless recognized on a straight-line basis. +q. +Marketable securities: +The Company classifies its investment in Telkoor's shares in accordance with ASC 320, "Investment in Debt and Equity Securities" and ASC 325, “Investment – Other”. Marketable securities classified as “available for sale securities” are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of shareholder’s equity in "accumulated other comprehensive loss" in equity. When evaluating the investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company's intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment's amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC 325-20. +r. +New a ccounting pronouncements and o ther s tandards: +In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers," (ASU 2014-09), which creates a new Topic, Accounting Standards Codification Topic 606. The standard is principle-based and provides a five-step model to determine when and how revenue is recognized. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The accounting standard is effective for annual and interim periods beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the impact of adopting this guidance. +F-16 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 3:- INVENTORIES +December 31, +2014 +2013 +Raw materials, parts and supplies +$ +287 +$ +186 +Work in progress +357 +428 +Finished products +1,009 +1,137 +$ +1,653 +$ +1,751 +NOTE 4:- PROPERTY AND EQUIPMENT, NET +December 31, +2014 +2013 +Cost: +Computers, software and related equipment +$ +1,640 +$ +1,624 +Office furniture and equipment +259 +265 +Leasehold improvements +617 +619 +2,516 +2,508 +Accumulated depreciation +Computers, software and related equipment +1,252 +1,209 +Office furniture and equipment +231 +223 +Leasehold improvements +466 +460 +1,949 +1,892 +Depreciated cost +$ +567 +$ +616 +Depreciation expense was $139 and $ 110 for the years ended December 31, 2014 and 2013, respectively. The Company reclassified computers, software, and related equipment with depreciated cost of $16 to inventory in the year ended December 31, 2014. The Company retired fully depreciated leasehold improvements of $125 in the year ended December 31, 2013 related to its former domestic facility +NOTE 5:- INTANGIBLE ASSET, NET +On August 25, 2010, the Company and its wholly-owned subsidiary, DPL, entered into an agreement with Telkoor Power Supplies Ltd. ("TPS"), a subsidiary of Telkoor Telecom Ltd., pursuant to which, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets” or “IP”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. The IP was purchased in order to decrease lead time and costs of the production process. In consideration for the purchase of the IP, DPL paid TPS an amount of $480. The consideration for the right to sell the Assets in Israel will be paid to the Company as a yearly royalty fee of 15% of TPS's direct production costs of sales. +F-17 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +TPS will provide the Company training and technical support, if necessary, for a period of 60 months in order to enable the Company to properly and effectively use the IP to manufacture the Assets. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event that annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based on an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period the Company sells more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600 W AC/DC power supply series (CPCI 600W) through 2013, the Company amended its agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. The Company will not be required to make any royalty payments to Telkoor under the manufacturing agreement with Telkoor until the shortfall of CPCI 600W product sales will be offset. In light of this change, the Company believes the additional offset available under the expansion of covered products adequate to cover the remaining asset value at December 31, 2014 of $66. +F-18 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 5:- INTANGIBLE ASSET, NET (Cont.) +To date, DPL has designated a manufacturing facility to manufacture the units of the IP purchased and accordingly decreased its manufacturing costs of the CPCI 600W product. The Company expects cost reductions in royalty expense offsets available through the expanded agreement to adequately cover the remaining unamortized balance of the asset. +The useful life method of the IP has been determined to be five years and the amortization method is the straight-line method, as management considers this method as the most appropriate. +December 31, +2014 +2013 +Cost: +480 +480 +Accumulated depreciation +414 +309 +Depreciated cost +$ +66 +$ +171 +Amortization expense was $106 and $96 for the years ended December 31, 2014 and December 31, 2013, respectively. +The annual amortization expense relating to intangible assets as of December 31, 2014 is estimated to be $66 in the year ended December 31, 2015. +NOTE 6:- OTHER CURRENT LIABILITIES +December 31, +2014 +2013 +Accrued payroll and payroll taxes +$ +65 +$ +112 +Warranty accrual +97 +104 +Accrued expenses and other +183 +229 +$ +345 +$ +445 +F-19 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES +Lease commitments: +The Company has an operating lease agreement in the U.S. which expires on various dates, the latest of which is in 2019. In September 2010, the Company's subsidiary signed a new agreement for a lease in respect of the UK facility for a period of fifteen years with an option to cancel the lease after ten years. In November 2012, the Company signed a new agreement for a lease for the US headquarters for a period of 7 years with an option to extend for additional five years. +Future non-cancellable rental commitments under operating leases are as follows: +Year ended December 31, +2015 +$ +325 +2016 +318 +2017 +322 +2018 +325 +2019 +246 +2020 through 2021 +123 +$ +1,659 +Total rent expense for the years ended December 31, 2014 and 2013 was approximately $309 and $ 298, respectively. +NOTE 8:- SHAREHOLDERS' EQUITY +a. +Preferred shares: +There are authorized Preferred shares in the amount of 500,000 shares of Series A cumulative Redeemable Convertible Preferred shares ("Series A"), and an additional 1,500,000 Preferred shares that have been authorized, but the rights, preferences, privileges and restrictions on these shares have not been determined. DPC's Board of Directors is authorized to create a new series of Preferred shares and determine the number of shares, as well as the rights, preferences, privileges and restrictions granted to or imposed upon any series of Preferred shares. As of December 31, 2014, there were no Preferred shares issued or outstanding. +b. +Common shares: +Common shares confer upon the holders the rights to receive notice to participate and vote in the general meeting of shareholders of the Company, to receive dividends, if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. +F-20 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 8:- SHAREHOLDERS' EQUITY (Cont.) +c. +Share Option Plans: +1. +Under the Company's Digital Power 2012 (As Amended) ("Incentive Share Option Plan"), options may be granted to employees, officers, consultants, service providers and directors of the Company or its subsidiary. +2. +As of December 31, 2014, the Company has authorized according to the Incentive Share Option Plan the grant of options to officers, management, other key employees and others of up to 1,372,630 options for the Company's Common shares. The maximum term of the options is ten years from the date of grant. As of December 31, 2014, an aggregate of 655,130 of the Company's options are still available for future grant. +3. +The options granted generally become fully vested after four years. Any options that are forfeited or cancelled before expiration become available for future grants. +The options outstanding as of December 31, 2014 have been classified by exercise price, as follows: +Exercise +Price +Options +outstanding +as of +December 31, +2014 +Weighted +average +remaining +contractual +term +Weighted +average +exercise +price +Options +exercisable +as of +December 31, +2014 +Weighted +average +exercise +price +of options +exercisable +Years +$ +0.68 +- +0.84 +55,763 +4.70 +$ +0.73 +45,763 +$ +0.74 +$ +1.05 +- +1.32 +80,000 +4.92 +$ +1.21 +50,000 +$ +1.15 +$ +1.51 +- +1.69 +1,077,000 +8.29 +$ +1.65 +339,500 +$ +1.54 +$ +1.79 +50,000 +5.61 +$ +1.79 +50,000 +$ +1.79 +1,262,763 +7.65 +$ +1.57 +485,263 +$ +1.45 +4. The total equity-based compensation expense related to all of the Company’s equity based awards, including non-employee options recognized for the years ended December 31, 2014 and 2013 is comprised as follows: +Year ended +December 31, +2014 +2013 +Cost of revenues +$ +4 +$ +1 +Engineering and product development expenses +17 +4 +Selling and marketing expenses +7 +3 +General and administration expenses +219 +98 +Total equity-based compensation expense +$ +247 +$ +106 +F-21 +A summary of option activity under the Company's stock option plans as of December 31, 2014 and changes during the year then ended are as follows: +Year ended December 31, 2014 +Amount of options +Weighted average exercise price +Weighted average remaining contractual term (years) +Aggregate intrinsic value +Outstanding beginning of year +712,763 +$ +1.33 +5.38 +$ +- +Granted +795,000 +$ +1.59 +Exercised +( 92,500 +) +$ +.93 +Forfeited +( 72,500 +) +$ +1.66 +Expired +( 80,000 +) +$ +1.38 +Outstanding end of year +1,262,763 +$ +1.57 +7.65 +$ +41.57 +Exercisable end of year +485,263 +$ +1.45 +5.26 +$ +34.27 +The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December 31, 2014 and the exercise price, multiplied by the number of in-the-money-options) that would have been received by the option holders had all option holders exercised their options on December 31, 2014. This amount changes based upon the fair market value of the Company’s shares. +As of December 31, 2014, there was $ 744 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company's stock option plans. That cost is expected to be recognized over a weighted average period of 3.35 years. +d. +Options issued to non-emloyees: +The Company's outstanding options to non-employees as of December 31, 2014 are as follows: +Issuance date +Options +for +Common +shares +Exercise +price per +share +Options +exercisable +February 2005 +20,000 +$ +1.19 +20,000 +March 2006 +100,000 +$ +1.16 +100,000 +December 2010 +21,500 +$ +1.51 +21,500 +141,500 +141,500 +All options are exercisable for ten years from the date of grant. +In 2010, the Company granted 41,500 options to Telkoor's employees of which 21,500 are outstanding at December 31, 2014. These options vest over four years. The fair value of these options was estimated using the Black-Scholes option-pricing model with the following assumptions for 2014: risk-free interest rates of 2.14%, dividend yield of 0%, volatility of 79.9%, and the remaining contractual term of the options of 5.92 years. +F-22 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +e. +Employee stock ownership plan: +The Company had an Employee Stock Ownership Plan ("ESOP") until July 31, 2014 at which time it was entirely liquidated after a decision to terminate the plan as of July 31, 2013 was previously made. The ESOP provided for the Employee Stock Ownership Trust ("ESOT") to distribute the Company's common shares or cash equivalent as retirement benefits to the participants. As of July 31, 2014, the ESOT had distributed or paid the cash equivalent of all of the 167,504 shares previously held prior to plan termination. +f. +Dividends: +In the event that cash dividends are declared in the future, such dividends will be paid in U.S. dollars. The Company does not intend to pay cash dividends in the foreseeable future. +F-23 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 9:- TAXES ON INCOME +a. +Deferred income taxes: +Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax asset and liabilities are as follows: +December 31, +2014 +2013 +Net operating loss carryforward +$ +1,958 +$ +1,775 +Reserves and allowances +202 +258 +Credit carryforward +173 +153 +Depreciation and amortization +127 +101 +Net deferred tax asset before valuation allowance +2,460 +2,287 +Valuation allowance +(2,460 +) +(2,287 +) +Net deferred tax asset +$ +- +$ +- +As of December 31, 2014 and 2013, the Company and its subsidiary provided a valuation allowance of $2,460 and $2,287 respectively, in respect of deferred tax assets resulting from short-term temporary differences and depreciation charged in advance of a capital allowance taken, as well as from carryforward losses. +Management currently believes that since the Company and its subsidiary have a history of losses, it is more likely than not that the deferred tax assets regarding the remainder of the tax loss carryforward and other temporary differences will not be realized in the foreseeable future. +b. +Net operating tax losses carryforward: +As of December 31, 2014, the Company had approximately $4,135 in federal net operating loss carryforward for income tax purposes, which can be carried forward and offset against taxable income for 20 years and expire between 2021 and 2035. +F-24 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 9:- TAXES ON INCOME (Cont.) +Utilization of U.S. net operating losses may be subject to substantial annual limitation, due to the "change in ownership" provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses before utilization. The Company believes that, as a result of having undergone an "Ownership Change" in 2002 within the meaning of section 382 of the Internal Revenue Code, its ability to use its net operating loss carryforward and other tax attributes to offset future U.S. taxable income, and thereby reduce its tax liability, is limited. +As of December 31, 2014, the Company subsidiary had accumulated losses for income tax purposes in the amount of approximately $1,718. These net operating losses may be carried forward and offset against taxable income in the future for an indefinite period. +c. +Loss before income taxes consists of the following: +Year ended +December 31, +2014 +2013 +Domestic (U.S.) +$ +(600 +) +$ +(137 +) +Foreign (UK) +(57 +) +(492 +) +$ +(657 +) +$ +(629 +) +The Company is required to calculate and account for income taxes in each jurisdiction in which the Company or its subsidiary operate. Significant judgment is required in determining its worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of the Company's business, there are many transactions and calculations where the ultimate tax determination is uncertain. +Our provision for income taxes consists of the following: +Year ended +December 31, +2014 +2013 +Current: +Federal +$ +- +$ +- +State +- +- +Foreign +1 +3 +1 +3 +Deferred: +Federal +- +- +State +- +- +Foreign +- +- +- +- +Tax expenses +$ +1 +$ +3 +There is no provision in respect of unrecognized tax benefits for the years ended December 31, 2014 and 2013. +F-25 +d. +A reconciliation between the theoretical tax expense, assuming all income is taxed at the statutory tax rate applicable to income of the Company and the actual tax expense as reported in the statements of operations is as follows: +Year ended +December 31, +2014 +2013 +Income (loss) before income taxes +$ +(657 +) +$ +(676 +) +Theoretical tax at U.S. statutory tax rate (34%) +$ +(223 +) +$ +(230 +) +Taxes in respect of prior years +37 +(153 +) +Tax adjustment in respect of foreign subsidiary +(41 +) +35 +Nondeductible expenses +87 +39 +Operating carryforward losses, credits and temporary differences for which valuation allowance was (utilized) provided +141 +312 +Tax expenses +$ +1 +$ +3 +F-26 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 10:- NET LOSS PER SHARE +The following table sets forth the computation of the basic and diluted net loss per share: +Year ended +December 31, +Numerator: +2014 +2013 +Net loss available to Common shareholders +$ +(658 +) +$ +(632 +) +Denominator: +Total weighted average numbers of shares outstanding used in computing: +Basic and diluted loss per share +6,803,269 +6,853,161 +Basic and diluted net loss per share +$ +(0.097 +) +$ +(0.092 +) +NOTE 11:- INVESTMENT IN TELKOOR +On June 16, 2011 the Company has acquired 1,136,666 shares of Telkoor, a major shareholder of the Company and an Israeli company listed in the Tel Aviv stock exchange, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. +The Company has classified its investment in Telkoor's shares as available-for-sale securities in accordance with ASC 320, "Investment in Debt and Equity Securities". Marketable securities classified as "available for sale securities" are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of shareholders' equity in "accumulated other comprehensive loss". When evaluating the investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company's intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment's amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e. non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost(i.e., cost method investments), as described in ASC 325-20. +The Company recorded an impairment of its investment in Telkoor of $175 for the year ended December 31, 2014 compared to $312 for the year ended December 31, 2013. In the year ended December 31, 2014, an independent appraiser evaluated the holding value of this investment based upon guidelines outlined in ASC 320 and concluded the fair value of the asset had declined by $175 from its value reported in the financial statements for the year ended December 31, 2013. For the year ended December 31, 2013, the Company used the value of shares sold by Telkoor late in the year in a private equity transaction as the basis for the value of the investment. The Company concluded that the price paid for those shares was the fair value of its own Telkoor shares under ASC 325 and subsequently recorded an impairment of $312 for year ended December 31, 2013. In accordance with ASC 325, Telkoor’s equity shares held by the Company are presented at cost and will be reviewed for impairment in accordance with ASC 320. +F-27 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 12:- RELATED PARTY TRANSACTIONS +The results of operations from transactions with Telkoor, a major shareholder, were as follows: +Year ended +December 31, +2014 +2013 +Purchases of products from Telkoor +$ +868 +$ +1,381 +Transactions with Telkoor are derived mainly from purchase of power supplies from Telkoor. In addition, in 2010, the Company purchased IP from one of Telkoor's subsidiaries in the amount of $ 480. See Note 5 for further discussion. +The Company believes that the transactions described above are on a basis no less favorable than could be obtained from an independent third party. Although it is not practical to determine the amounts that the Company would have incurred had it purchased from an unaffiliated entity, management believes that the amounts chargeable for the above transactions provided by these agreements are reasonable. All future transactions between the Company and Telkoor will be on terms no less favorable than could be obtained from an independent third party. +F-28 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 13:- SEGMENT CUSTOMERS AND GEOGRAPHICAL INFORMATION +a. +The Company has two reportable geographic segments; see Note 1a for a brief description of the Company's business. The data is presented in accordance with ASC 280 (formerly: Statement of Financial Accounting Standards No.131, "Disclosure about Segments of an Enterprise and Related Information") ("ASC 280"). +The following data presents the revenues, expenditures and other operating data of the Company's geographic operating segments: +Year ended December 31, 2014 +DPC +DPL +Eliminations +Total +Revenues +$ +4,953 +$ +4,069 +$ +- +$ +9,022 +Intersegment revenues +211 +39 +(250 +) +- +Total revenues +$ +5,164 +$ +4,108 +$ +(250 +) +$ +9,022 +Depreciation & amortization expense +$ +68 +$ +177 +$ +- +$ +245 +Operating income (loss) +$ +(623 +) +$ +81 +$ +- +$ +(542 +) +Impairment of investment +$ +(175 +) +Otherincome, net +60 +Income taxes +1 +Net loss +$ +(658 +) +Expenditures for segment assets as of December 31, 2014 +$ +76 +$ +43 +$ +- +$ +119 +Identifiable assets as of December 31, 2014 +$ +2,919 +$ +3,423 +$ +- +$ +6,342 +F-29 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 13:- SEGMENTS CUSTOMERS AND GEOGRAPHICAL INFORMATION (Cont.) +Year ended December 31, 2013 +DPC +DPL +Eliminations +Total +Revenues +$ +5,258 +$ +3,512 +$ +- +$ +8,770 +Intersegment revenues +307 +- +(307 +) +- +Total revenues +$ +5,565 +$ +3,512 +$ +(307 +) +$ +8,770 +Depreciation and amortization expense +$ +45 +$ +161 +$ +- +$ +206 +Operating income (loss) +$ +(183 +) +$ +(134 +) +$ +(317 +) +Impairment of Investment +(312 +) +Income taxes +3 +Net loss +$ +(632 +) +Expenditures for segment assets as of December 31, 2013 +$ +163 +$ +53 +$ +- +$ +216 +Identifiable assets as of December 31, 2013 +$ +4,046 +$ +2,931 +$ +- +$ +6,977 +b. +Major customers' data as a percentage of total revenues: There was no customer who accounted for more than 10% of the net revenues of the Company in 2014 and 2013. +c. +Total revenues from external customers divided on the basis of the Company's product lines are as follows: +Year ended +December 31, +2014 +2013 +Revenues: +Commercial products +$ +6,438 +$ +6,108 +Defense products +2,584 +2,662 +$ +9,022 +$ +8,770 +F-30 +SIGNATURES +In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: March 27, 2015 +DIGITAL POWER CORPORATION +By: +/s/ Amos Kohn +Amos Kohn +President and Chief Executive Officer +/s/ William J. Hultzman +V.P of Finance +Principal Accounting Officer +In accordance with the Exchange Act, this report has been signed below by the following person on behalf of the registrant and in the capacities indicated. +/s/ Ben-Zion Diamant +Ben-Zion Diamant, Chairman of the Board +/s/ Amos Kohn +Amos Kohn, +President, Chief Executive Officer, Chief Financial +Officer and Director +/s/ Haim Yatim +Haim Yatim, Director +/s/ Robert O. Smith +Robert O. Smith, Director +/s/Aaron Ben-Ze'ev +Aaron Ben-Ze'ev, Director \ No newline at end of file diff --git a/raw/filings/0000896493/2014/0001437749-15-006253/filing_metadata.csv b/raw/filings/0000896493/2014/0001437749-15-006253/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..4ce913d90d8fb44f0e0b3de7e71e259dd8a525bd --- /dev/null +++ b/raw/filings/0000896493/2014/0001437749-15-006253/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2015-03-27,2014-12-31,2015-03-27T21:24:59.000Z,0001437749-15-006253,dpw20141231_10k.htm,FORM 10-K,9309441,1,0,https://www.sec.gov/Archives/edgar/data/896493/000143774915006253/dpw20141231_10k.htm,https://www.sec.gov/Archives/edgar/data/896493/000143774915006253/,2014,2014,1 diff --git a/raw/filings/0000896493/2014/0001437749-15-006253/item1.txt b/raw/filings/0000896493/2014/0001437749-15-006253/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..1c6e81e91635be8e08388954159c740e2cedbc2f --- /dev/null +++ b/raw/filings/0000896493/2014/0001437749-15-006253/item1.txt @@ -0,0 +1,179 @@ +ITEM 1. DESCRIPTION OF BUSINESS. +General +We are a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the most demanding applications in the medical, military, telecom and industrial markets. We are highly focused on high-grade and custom product designs for both the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. We are a California corporation originally formed in 1969, and our common stock trades on the NYSE MKT under the symbol “DPW”. Our corporate headquarters are located in the heart of the Silicon Valley. +We also have a wholly-owned subsidiary, Digital Power Limited ("DPL"), which operates under the brand name of “Gresham Power Electronics” (“Gresham”). DPL is located in Salisbury, England, and designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. DPL’s defense business has specialists in the field of naval applications of power distribution conversion. +We believe that we are one of the first companies in the power solutions industry to introduce a product strategy based on the premise that products developed with an extremely flexible architecture enable rapid modifications to meet unique customer requirements for non-standard output voltages. The development and implementation of this strategy has resulted in broad acceptance in the telecom/industrial, and increasingly in the medical market, segments for our new line of high density and high efficiency power products. These products set an industry standard for providing high-power output in package sizes that are among the smallest available for such commercial products. +We market and sell our products to many diverse market segments, including the telecom, industrial, medical and military/defense industries. Our products serve a global market, with an emphasis on North America and Europe. We offer a broad product variety, including a full custom product design, standard and modified-standard products. Our unique high-speed switching power rectifiers includes but are not limited to custom power products, front-end, open-frame, enclosed, Compact PCI, MicroTCA, PoE (Power over Ethernet) and other product solutions, providing power output from 50 to 24,000 watts. +1 +In an effort to provide short lead-times, high quality products and competitive pricing to support our markets, we have entered into production agreements with several contract manufacturers located in Asia, primarily China. These agreements allow us to better control production costs and ensure high quality products deliverable in a timely manner to meet market demand. +We intend to remain an innovative leader in the development of cutting-edge custom power solutions and feature rich products to meet any customer needs and requirements, rugged power systems to meet harsh and extreme operation environmental requirements, and high performance, high efficiency, high-density and modular power systems. We are currently focused on developing even more high-grade custom power system solutions for numerous customers in a broadly diversified range of markets and challenging environments. Each product development is based on best of class performance criteria, including unique, advanced feature sets and a special layout to meet our customers’ unique operating conditions where efficiency, size and time to market are key to their success. +Power System Solutions +We provide custom power system solutions, high-grade flexibility series power supply products, off-the-shelf products and value-added services to diverse industries and markets including military/defense, telecom, medical and industrial. We believe that our solutions leverage a combination of low leakage power emissions, high power density, superior power efficiency, design flexibility and short time to market. +Custom Power System Solution. We provide high-grade custom power system solutions to numerous customers in multiple industry segments. Each custom solution that we develop is based on high power density, digital power processing and a special layout to meet each of our customer’s unique operation environments where efficiency, size and performance are key. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“IP”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including Digital Signal Processing (“DSP”) control for Power Factor Correction (“PFC”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages and unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to original equipment manufacturers (“OEMs”). We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating a complex, time-consuming and costly integration. We believe that this value-added service is well suited to those OEMs who wish to reduce their vendor base and minimize their investment in manufacturing that leads to increased fixed costs. Based on these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power subassemblies and thus are not required to purchase individual parts from many vendors. +2 +Our products have a warranty period from date of shipment to the customer. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic corporation, Digital Power Corporation; the European marketplace is served through DPL, our wholly-owned subsidiary. +Our products are sold directly by our sales force and through a network of manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2015. +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are deployed in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. Examples of the commercial markets we serve and products for these markets include: +■ +Medical (Patient Contact and Non-patient Contact) +■ +Colonoscopy imaging system +■ +Imaging, dispensing equipment +■ +Ventilators +■ +Dialysis, endoscopy, surgical equipment +■ +Ultrasound, MRI +■ +Oxygen concentration +■ +Telecom +■ +Switches/Routers +■ +Storage/Data servers +■ +Servers +■ +Broadband networks and video broadcast systems +■ +Fiber optic networks +■ +Wireless systems +■ +Industrial Process Equipment and Embedded Controls +■ +Packaging equipment, pumps, CNC machines, laser +■ +Intelligent / LED lighting +■ +Industrial printers +■ +Laboratory and diagnostic equipment +■ +ATE (Automatic Test Equipment), scientific +■ +Advanced projectors +These product solutions, which include standard, modified-standard or full custom designs, are designed to meet our customers’ requirements. +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both specific modifications of existing products or full custom designs, are designed for combat environments and meet the requirements of our defense customers. We are compliant with the regulations of International Traffic in Arms Regulations (“ITAR”) and are an approved vendor for the U.S. Air Force, Navy and Army. +3 +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments: +■ +Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air +■ +Naval – Shipboard radar, EW and communication +■ +Mobile and Ground Communications – Active Protection, Communications and Navigation +■ +Surveillance, test equipment +■ +UAV (Unmanned Aerial Vehicle) – Very lightweight power systems +Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +We leverage our strategic alliance and collaboration with Telkoor Telecom Ltd. (“Telkoor”), our largest shareholder, and DPL, our wholly-owned subsidiary, to develop some of the MIL-SPEC products. +Full custom military project services: +● +Program management for each project +● +Quality assurance and control: +o +ISO 9001: 2008 and ISO 17025: 2005 certified +o +Compliance with AS9100 through our manufacturing +o +Compliance with MIL-Q 9858A +o +Compliance with environmental testing in accordance with MIL-STD 810, MIL-STD 202 +o +FRACAS (Failure Reporting, Analysis, and Corrective Action System) +o +100% screening, including ESS (Environmental Stress Screening) and ATP (Acceptance Test Procedure) with random vibration and temperature cycling tests +● +Product Tests: +o +Vertical Random Vibration +o +Sine Sweep Vibrations +o +Shock +o +Salt +o +Fog +o +Polar Temperatures +Typical Product Features: +● +Wide input voltage range +● +Multi-output voltages (DC and AC) +● +Fully approved according to MIL-STD 704, MIL-STD 1275 and MIL-STD 1399 +● +Environmental conditions per MIL-STD 810 +● +EMI/RFI per MIL-STD 461 +● +Wide operating temperature range of -56°C up to +85°C +● +Power output up to 72,000 Watts (3 x 24,000 Watts system) +● +High switching frequency up to 500KHz +● +High efficiency, over 92% +● +High power density up to 28 watts/inch 3 +● +Power factor correction +● +Redundancy and hot swap N+1 +● +Switching Frequency sync to external clock +● +Free convection, forced air cooling and base plate cooling +4 +Strategy +Our strategy is to be the supplier of choice to those companies and OEMs requiring high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that support all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. +Our target market segments include the industrial, telecommunication, medical, and military/defense industries. We do not participate in the personal computer power supply market because of the low margins arising out of the high volume and extremely competitive nature of that market. +Our strategy will continue to focus on expanding our market share by adding new customers from all of our target market segments. We are developing long term relationships, and we intend to expand our customer base in our commercial market segments, including medical, telecom and industrial, while continuing to maintain our existing customers. In the military and defense market segment, we will continue to provide advanced rugged products to customers, and we are striving to expand our business to support the military and defense industries. We believe that our custom power supply solutions, flexibility series, high-grade and high-efficiency power product solutions provide customers with a more effective choice as compared to products offered by other power solution competitors, due in part to a customer’s requirement for output voltages and other features such as redundancy and sense control tailored to its exact requirements within specific parameters. +Furthermore, we believe that we have the talent and engineering experience to satisfy any of our customers’ product or platform requirements. If an OEM customer specifies a different set of power system parameters, we will custom design or modify a product to meet the OEM’s requirements With a wide range of solutions from our custom designs to our high-grade flexibility series products, our professional design team can provide economical and timely product solutions to our OEM customers. In addition, as our power systems meet all appropriate environmental requirements and safety standards, our smaller OEM customers can expedite the process of independent safety agency testing by companies such as Underwriters Laboratories, and save considerable expense. By offering OEM customers choices with Digital Power’s custom, flexibility series, high-grade and high-efficiency power system solutions, we believe we provide certain strategic advantages over our competitors. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom , designs, manufactures, and distributes switching power supplies, uninterruptible power supplies, and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“Gresham”). Frequency converters manufactured by Gresham are used by navel warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low cost manufacturing goals with labor-intensive products, we have entered into production agreements with certain contract manufacturers in Asia. At present, our principal contract manufacturers in Asia are Teamwise, Winco-Power Technology, Shenzhen Watt Electronics, and Energy Recovery Products. +5 +We sell certain products that are developed, manufactured and sold to us by Telkoor, an Israeli company that currently holds 41.3% of our outstanding common stock. In coordination with Telkoor, and in order to accelerate delivery and reduce the cost of some of the products we purchase from Telkoor, we have obtained the right to order products directly from Telkoor’s contract manufacturers, as well as from our own contract manufacturers in China, in exchange for the payment of royalties to Telkoor. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our custom power assemblies per clearly defined test procedures developed by us and our customers. This approach ensures that our customers can use our systems right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products are subject to ITAR, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Any future restrictions or charges imposed by the United States or any other country on our international sales or sales by DPL, our foreign subsidiary, could have a materially adverse effect on our business, financial condition, and operating results. In addition, from time to time, we entered into contracts with defense contract manufacturers for the government of Israel’s defense programs, which were funded by, and governed by the regulations of, the U.S. Foreign Military Financing program. +Sales and Marketing +We market our products directly through our internal sales force as well as through a partner network of independent manufacturer representatives and distributors. Each representative organization is responsible for managing sales in a particular geographic territory. Generally, the representative has the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving its marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of net sales of new “design-in” and 1.75% of net sales for retention, payable after the product is shipped, for any direct sale contribution. Typically, either we or the representative organization may terminate the agreement upon 30 days’ written notice. +6 +Historically, we have also sold products through multiple distributor arrangements which do not specify a particular territory. Each of these arrangements can be terminated by either party upon 30 days’ written notice. +Our promotional efforts, to date, have included product data sheets, participation in trade shows, and our website, www.digipwr.com. We use the corporate website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our website and accessible to the marketplace. We will continue to enhance our website by adding more features and functionalities, such as ecommerce, that will allow our customers to buy directly through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product design solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also partner with various design and contract engineering firms for development of some of our new products supported by our internal engineering services staff. Furthermore, we continue to leverage the close relationship we have with one of our major shareholders, Telkoor, to introduce new products that Telkoor develops for its market and makes available for us. Finally, from time to time, we modify standard products to meet specific customer requirements, including, but not limited to, converting commercial products into full military MIL-SPEC products and other unique modification and adjustments, when applicable. We are experiencing an increasing demand for ruggedization of commercial products for military applications. To meet that requirement, our engineering team continues to ruggedize commercial products, which we sell as commercial off the shelf products to some of our military customers. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC and improved EMI (electromagnetic interference) filtering. We continue to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering lab in California. In August 2010, we purchased the IP and production packages of the compact peripheral component interface (Compact PCI, or CPCI) AC/DC and DC/DC power supply series from Telkoor Power Systems Ltd. (“TPS”), a wholly owned subsidiary of Telkoor. The IP purchase was to support our strategy being a leader supplier of CPCI products for commercial and defense markets. We received from this purchase a portfolio of industry-leading CPCI AC/DC power supplies delivering 600 Watts and 650 Watt of continuous power. These hot-swappable power supplies feature N+1 redundant connection and active load current share. This IP strategic acquisition expands our presence for industrial, telecom, and military/defense applications that require increasing amounts of power. As a result of this purchase, we have decreased our manufacturing costs. +7 +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products comparable in quality to ours. Many of our competitors, including Bel Fuse (Power-One), Emerson (Astec) Technologies, Artesyn, Lambda Electronics, and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition with our customers. We also face competition from current and prospective customers who may decide to design and manufacture internally power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current economic situation, additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to whom we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced product design have significant advantages in the power supply solutions market because they have higher efficiency and high-power density, or power-to-volume ratio, which make them smaller than the solutions offered by our competitors and can thus fit well in numerous custom environments in compliance with our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of outputs product design platform. We believe we have a competitive position with our targeted customers who need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers in only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“NRE”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +8 +Employees +As of December 31, 2014, we had 26 employees located in the United States and the United Kingdom, of whom seven were engaged in engineering and product development, five in sales and marketing, seven in general operations and seven in general administration and finance. All but two of these employees are employed on a full-time basis. None of our employees are currently represented by a trade union. We consider our relations with our employees to be good. \ No newline at end of file diff --git a/raw/filings/0000896493/2014/0001437749-15-006253/item13.txt b/raw/filings/0000896493/2014/0001437749-15-006253/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..56739917ebaea6087f060eb3b2c7fdf8ab8b7af0 --- /dev/null +++ b/raw/filings/0000896493/2014/0001437749-15-006253/item13.txt @@ -0,0 +1,10 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +Relationship with Telkoor Power Supplies Ltd. +In the years ended December 31, 2014 and 2013, we purchased approximately $868,000 and $1,381,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest shareholder, Telkoor, of which Ben-Zion Diamant is the Chief Executive Officer and controlling shareholder. We have no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. +Purchase of IP from Telkoor by DPL +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest shareholder, Telkoor Telecom Ltd., of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL has paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period the Company sells more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, the Company amended its agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. We will not be required to make any royalty payments to Telkoor under the Manufacturing Agreement with Telkoor (described below) until the shortfall of CPCI 600W product sales will be offset. +Acquisition of Shares of Telkoor +On June 16, 2011 the Company acquired 1,136,666 shares of Telkoor, a major shareholder of the Company and an Israeli company listed in the Tel Aviv stock exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations +33 +Manufacturing Agreement with Telkoor +On December 31, 2012, the Company entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted to the Company the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by the Company to Telkoor. The royalty fees paid by the Company to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Company incurred $44,000 in Telkoor royalty expense in 2013. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, the customers of the Company in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. \ No newline at end of file diff --git a/raw/filings/0000896493/2014/0001437749-15-006253/item9a.txt b/raw/filings/0000896493/2014/0001437749-15-006253/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..92aff3386e46f4aaeb14c2395632af7381eb375c --- /dev/null +++ b/raw/filings/0000896493/2014/0001437749-15-006253/item9a.txt @@ -0,0 +1,11 @@ +ITEM 9A. CONTROLS AND PROCEDURES. +Evaluation of Disclosure Controls and Procedures +As of December 31, 2014, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our Chief Executive Officer and principal financial officer, of the effectiveness of the design and operation of our controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) were effective as of the end of the period covered by the report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls. Our management has concluded that, as of December 31, 2014, our internal control over financial reporting was effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Evaluation of Changes in Internal Control over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +22 \ No newline at end of file diff --git a/raw/filings/0000896493/2014/0001437749-15-006253/rp_note.txt b/raw/filings/0000896493/2014/0001437749-15-006253/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000896493/2014/0001437749-15-006253/rpt_disclosure.txt b/raw/filings/0000896493/2014/0001437749-15-006253/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..56739917ebaea6087f060eb3b2c7fdf8ab8b7af0 --- /dev/null +++ b/raw/filings/0000896493/2014/0001437749-15-006253/rpt_disclosure.txt @@ -0,0 +1,10 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +Relationship with Telkoor Power Supplies Ltd. +In the years ended December 31, 2014 and 2013, we purchased approximately $868,000 and $1,381,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest shareholder, Telkoor, of which Ben-Zion Diamant is the Chief Executive Officer and controlling shareholder. We have no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. +Purchase of IP from Telkoor by DPL +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest shareholder, Telkoor Telecom Ltd., of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL has paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period the Company sells more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, the Company amended its agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. We will not be required to make any royalty payments to Telkoor under the Manufacturing Agreement with Telkoor (described below) until the shortfall of CPCI 600W product sales will be offset. +Acquisition of Shares of Telkoor +On June 16, 2011 the Company acquired 1,136,666 shares of Telkoor, a major shareholder of the Company and an Israeli company listed in the Tel Aviv stock exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations +33 +Manufacturing Agreement with Telkoor +On December 31, 2012, the Company entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted to the Company the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by the Company to Telkoor. The royalty fees paid by the Company to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Company incurred $44,000 in Telkoor royalty expense in 2013. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, the customers of the Company in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. \ No newline at end of file diff --git a/raw/filings/0000896493/2015/0001437749-16-028665/filing.txt b/raw/filings/0000896493/2015/0001437749-16-028665/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..c0cd9df13973a607c04fc29401b436fdbd44a9e4 --- /dev/null +++ b/raw/filings/0000896493/2015/0001437749-16-028665/filing.txt @@ -0,0 +1,2716 @@ +10-K +1 +dpw20151119_10k.htm +FORM 10-K +dpw20151119_10k.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2015 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ___________ to __________ +Commission File Number 1-12711 +DIGITAL POWER CORPORATION +(Exact name of registrant as specified in its charter) +California +94-1721931 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +48430 Lakeview Blvd, Fremont, California 94538-3158 +(Address of principal executive offices, including zip code) +510-657-2635 +(Registrant's telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of each exchange on which registered +Common Stock, no par value +NYSE MKT +Securities registered pursuant to Section 12(g) of the Act: +Title of Each Class +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☐ No ☑ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. +Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes ☑ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☐ (do not check if a smaller reporting company) +Smaller reporting company ☑ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). +Yes ☐ No ☑ +As of June 30, 2015, the aggregate market value of the voting common stock held by non-affiliates was approximately $3,063,382 based upon the closing price of the common stock on the NYSE MKT on that date. Shares of common stock held by each officer and director and by each person who owns 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of March 22, 2016, the number of shares of common stock outstanding was 6,775,971. +DOCUMENTS INCORPORATED BY REFERENCE +None. +INDEX +Page No. +Forward-Looking Statements +1 +PART I +Item 1. +Description of Business. +1 +Item 1A. +Risk Factors. +9 +Item 1B. +Unresolved Staff Comments. +15 +Item 2. +Description of Property. +15 +Item 3. +Legal Proceedings. +15 +Item 4. +Mine Safety Disclosures. +15 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +16 +Item 6. +Selected Financial Data. +16 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations. +16 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk. +21 +Item 8. +Financial Statements and Supplementary Data. +21 +Item 9. +Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. +22 +Item 9A. +Controls and Procedures. +22 +Item 9B. +Other Information +23 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance. +23 +Item 11. +Executive Compensation. +28 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +32 +Item 13. +Certain Relationships and Related Transactions, and Director Independence. +34 +Item 14. +Principal Accountant Fees and Services. +35 +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +36 +Signatures +As used in this annual report, the terms “we,” “us,” “our,” “Company,” “Digital,” or “Digital Power,” mean Digital Power Corporation, a California corporation, and its subsidiaries unless otherwise indicated. +The following information should be read in conjunction with the Consolidated Financial Statements and the notes thereto located elsewhere in this Annual Report on Form 10-K. This Report, and in particular “Management's Discussion and Analysis of Financial Condition and Results of Operations,” contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In this report, the words "believes," "anticipates," "intends," "expects," "plans," "should," "will," "seeks" and words of similar import identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: our history of net losses; our dependence on third parties, including Advice Electronics Ltd., to design certain of our standard products; the possible limits of our strategic focus on our power supply component competencies; our dependence on a few major customers; uncertainty of market acceptance of our products; the effects of the ongoing slowdown affecting world financial markets; and other factors referenced in "Risk Factors" and other sections of this Annual Report. Given these uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. +PART I +ITEM 1. DESCRIPTION OF BUSINESS. +General +We are a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the most demanding applications in the medical, military, telecom and industrial markets. We are highly focused on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. We are a California corporation originally formed in 1969, and our common stock trades on the NYSE MKT under the symbol “DPW”. Our corporate headquarters are located in the heart of the Silicon Valley. +Our wholly-owned UK -based subsidiary, Digital Power Limited ("DPL"), located in Salisbury, England, operates under the brand name of “Gresham Power Electronics” (“Gresham”). DPL designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products . +We believe that we are one of the first companies in the power solutions industry to introduce a product strategy based on the premise that products developed with an extremely flexible architecture enable rapid modifications to meet unique customer requirements for non-standard input and output voltages. We continue to sell products with flexible configurations to customers serving diversified applications in telecom, industrial and medical market segments. We believe our high density and high efficiency power products have set an industry standard for providing high-power output in a small packaging sizes. +We market and sell our products to many diverse market segments, including the telecom, industrial, medical and military/defense industries. Our products serve a global market, with an emphasis on North America and Europe. We offer a broad product variety, including a full custom product design, standard and modified-standard products. Our unique high-speed switching power rectifiers include but are not limited to defense and commercial custom power products, server power supplies, front-end, open-frame, enclosed, CompactPCI, MicroTCA, Desktop/Wall-mount Adaptors, Power over Ethernet POE) and other product solutions. Our product power range is from 10 watts to 75,000 watts. +1 +In an effort to provide high quality products, better control our manufacturing costs and sell our products in a competitive pricing to support our markets, we have entered into several contract manufacturing agreements with several manufacturers both domestically and in Asia, primarily China. To comply with the US International Traffic in Arms Regulations (“ITAR”) regulations, we manufacture our military products by a domestic manufacturer that complies with US ITAR regulations and is certified to perform such manufacturing services. +We intend to remain an innovative leader in the development of cutting-edge custom power solutions and feature rich products to meet any customer needs and requirements, rugged power systems to meet harsh and extreme operation environment conditions, and high efficiency, high-density and scalable power systems. +Power System Solutions +We provide custom power system solutions, high-grade flexibility series power supply products, off-the-shelf products and value-added services to diverse industries and markets including military/defense, telecom, medical and industrial. We believe that our solutions leverage a combination of low leakage power emissions, high power density, superior power efficiency, design flexibility and short time to market. +Custom Power System Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution technology includes full Digital Signal Processing (“DSP”) control, digital load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customer’s unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“IP”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“PFC”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages and unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to original equipment manufacturers (“OEMs”). We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating a complex, time-consuming and costly integration. We believe that this value-added service is well suited to those OEMs who wish to reduce their vendor base and minimize their investment in manufacturing that leads to increased fixed costs. Based on these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +2 +Our products have a warranty period from date of shipment to the customer. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic corporation, Digital Power Corporation; the European marketplace is served through DPL, our wholly-owned subsidiary. +We sell products to our OEM customers through direct sales or through our sales channels , including our manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2016 . +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. +Medical (Patient Contact and Non-patient Contact): +● +Colonoscopy imaging system +● +Imaging, dispensing equipment +● +Ventilators +● +Dialysis, endoscopy, surgical equipment +● +Ultrasound, MRI +● +Oxygen concentrations +Telecom : +● +Switches/Routers +● +Storage/Data servers +● +Servers +● +Broadband networks and video broadcast systems +● +Fiber optic networks +● +Wireless systems +Industrial Process Equipment and Embedded Controls: +● +Packaging equipment, pumps, CNC machines, laser +● +Intelligent / LED lighting +● +Industrial printers +● +Laboratory and diagnostic instrument +● +Scientific equipment +● +Advanced projectors +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We are compliant with the regulations of ITAR and are an approved vendor for the U.S. Air Force, Navy and Army. +3 +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments: +● +Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air +● +Naval – Naval power conversion and distribution +● +Mobile and Ground Communications – Active Protection, Communications and Navigation +● +Artillery – Gyro modular azimuth position and navigation system +● +Surveillance, test equipment +● +UAV (Unmanned Aerial Vehicle) – Very lightweight power systems +Our military products meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary DPL develops and manufactures some military and defense products manly being deployed in international naval fleets. +Full custom military project services: +● +Program management for each project +● +Quality assurance and control: +o +ISO 9001: 2008 and ISO 17025: 2005 certified +o +Compliance with AS9100 through our manufacturing +o +Compliance with MIL-Q 9858A +o +Compliance with environmental testing in accordance with MIL-STD 810, MIL-STD 202 +o +FRACAS (Failure Reporting, Analysis, and Corrective Action System) +o +100% screening, including ESS (Environmental Stress Screening) and ATP (Acceptance Test Procedure) with random vibration and temperature cycling tests +● +Product Tests: +o +Vertical Random Vibration +o +Sine Sweep Vibrations +o +Shock +o +Salt +o +Fog +o +Polar Temperatures +● +Typical Product Features: +o +Wide input voltage range +o +Multi-output voltages (DC and AC) +o +Fully approved according to MIL-STD 704, MIL-STD 1275 and MIL-STD 1399 +o +Environmental conditions per MIL-STD 810 +o +EMI/RFI per MIL-STD 461 +o +Wide operating temperature range of -56°C up to +105°C +o +Power output up to 72,000 Watts (3 x 24,000 Watts system) +o +High switching frequency up to 500KHz +o +High efficiency, over 92% +o +High power density up to 28 watts/inch 3 +o +Power factor correction +o +Redundancy and hot swap N+1 +o +Switching Frequency sync to external clock +o +Free convection, forced air cooling and base plate cooling +4 +Strategy +Our strategy is to be the supplier of choice to those companies and OEMs requiring high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that support all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. Our target market segments include the industrial, telecommunication, medical, and military/defense industries. +Our strategy will continue to focus on expanding our market share by adding new customers from all of our target market segments. We are developing long term relationships, and we intend to expand our customer base in our commercial market segments, including medical, telecom and industrial, while continuing to maintain our existing customers. In the military and defense market segment, we will continue to provide advanced rugged products to customers, and we are striving to expand our business to support the military and defense industries. We believe that our custom power supply solutions, flexibility series, high-grade and high-efficiency power product solutions provide customers with a more effective choice as compared to products offered by other power solution competitors, due in part to a customer’s requirement for output voltages and other features such as redundancy and sense control tailored to its exact requirements within specific parameters. +Furthermore, we believe that we have the talent and engineering experience to satisfy any of our customers’ product or platform requirements. If an OEM customer specifies a different set of power system parameters, we will custom design or modify a product to meet the OEM’s requirements. With a wide range of solutions from our custom designs to our high-grade flexibility series products, our professional design team can provide economical and timely product solutions to our OEM customers. In addition, as our power systems meet all appropriate environmental requirements and safety standards, our smaller OEM customers can expedite the process of independent safety agency testing by companies such as Underwriters Laboratories, and save considerable expense. By offering OEM customers choices with our custom, flexibility series, high-grade and high-efficiency power system solutions, we believe we provide certain strategic advantages over our competitors. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom , designs, manufactures, and distributes switching power supplies, uninterruptible power supplies, and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“Gresham”). Frequency converters manufactured by Gresham are used by naval warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low cost manufacturing goals with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and in Asia. +5 +We sell certain products that are developed, manufactured and sold to us by Advice Electronics Ltd. (“Advice”), an Israeli company that acquired the assets and commercial operations of our major shareholder Telkoor Telecom Ltd. in January 2016. We entered into a manufacturing and royalty rights agreement with Advice in January 2016. This agreement formalized the business relationship between Advice and us in order to allow us to continue manufacturing certain of Telkoor’s products (currently owned by Advice) and the respective royalty charge. +In June 2015, OHM Power Solutions Ltd. (“Ohm”) acquired from Telkoor its entire military assets and military operation. The asset sale between Telkoor and Ohm does not affect our ability to manufacturing and sell certain of Telkoor’s military products. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Any future restrictions or charges may be imposed by the United States or any other foreign country . In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs that are funded and governed by the e U.S. Foreign Military Financing program. +Sales and Marketing +We market our products directly through our internal sales force as well as through our channel partners including independent manufacturer representatives (Reps) and distributors. Each manufacturing Rep promotes our products in a particular assigned geographic territory. Generally, the Rep has the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving its marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% of gross sales for retention, payable after products were shipped to the customer in the assigned territory. Typically, either we or the Reps are entitled to terminate the Rep agreement upon 30 days’ written notice. +6 +Historically, we have also sold products through multiple power focused distributors. Distributors are not assigned to a particular geographical territory. Each of these arrangements can be terminated by either party upon 30 days’ written notice. +We provide comprehensive collateral including product data sheets, participation in trade shows, and our website, www.digipwr.com. We use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our website and accessible to the marketplace. We will continue to enhance our website by adding more features and functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of our product development projects to engineering partners in order to achieve the best technological and product design results for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the shelf (“COTS”) products and for other customized product requirements, when applicable. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering integrating laboratory located in California. +7 +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products comparable in quality to ours. Many of our competitors, including Bel Fuse), Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to whom we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of output product design platforms. We believe we have a competitive position with our targeted customers who need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“NRE”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +8 +Employees +As of December 31, 2015, we had 26 employees located in the United States and the United Kingdom, of whom six were engaged in engineering and product development, seven in sales and marketing, seven in general operations and six in general administration and finance. All but two of these employees are employed on a full-time basis. None of our employees are currently represented by a trade union. We consider our relations with our employees to be good . +ITEM 1A. RISK FACTORS. +The risk factors listed in this section provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Readers should be aware that the occurrence of any of the events described in these risk factors could have a material adverse effect on our business, results of operations and financial condition. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. +We generated an operating and net loss during the years ended December 31, 2015 and December 31, 2014, we have historically experienced operating and net losses, and we may experience such losses in the future. +For the year ended December 31, 2015, the Company had an operating loss of $1,003,000 and a net loss of $1,096,000 compared to an operating loss of $542,000 and a net loss of $658,000 for the year ended December 31, 2014 . Although we have actively taken steps to increase our revenue and reduce manufacturing and operating costs, we may incur operating and net losses in the future unless we continue to increase revenues by selling current and custom design products and continue seeking manufacturing cost reductions through contract manufacturers. +We depend on Advice Electronics Ltd. ("Advice") to maintain the technology and to manufacture some of our products . We also depend on the right to manufactur e certain products subject to royalty payments with Advice . +In January 2016, Telkoor Telecom Ltd. (“Telkoor”) sold its entire commercial assets to Advice Ltd. which included without limitation product IP, manufacturing rights, customer base, inventory, staff and technological capabilities. Following such transaction, we entered into a manufacturing and distribution agreement with Advice. This agreement will allow us to manufacture certain Advice products (formerly owned by Telkoor) through August 2017 against royalty payments. From August 2017 through December 2020, subject to Advice's consent, we will be allowed to continue distributing and selling certain Advice products while keeping product branding under our brand, after which we will be entitled to distribute the products under DPC branding until December 2020. +We depend on Advice to design and retain product technology up to date and for manufacturing capabilities for some certain of the products that we sell. If Advice is unable or unwilling to continue designing or manufacturing our products in required volumes and with a certain level of quality on a timely basis, that could lead to loss of sales and adversely affect our operating results and cash position. We also depend on Advice's intellectual property and ability to transfer production to third party manufacturers. Failure to obtain new products in a timely manner or delay in delivery of products to customers will have an adverse effect on our ability to meet our customers’ expectations. In addition, we operate in highly competitive markets where our ability to sell Advice’s products could be adversely affected by Advice's agreements with third parties, long lead-times and the high cost of Advice’s products. Also, in 2012, Telkoor’s products manufacturing lead-times increased, which has hindered our ability to respond to our customers’ needs. Advice's principal offices, research and development and manufacturing facilities are located in Israel. Political, economic, and military conditions in Israel directly affect Advice operations. We are also dependent upon Advice’s terms and conditions with its contract manufacturers for some of our products, which terms and conditions may not always be in our best interest. In 2010, we purchased certain IP from Telkoor in order to reduce its dependency on Telkoor with respect to a certain line of products. We also entered into a Manufacturing Rights Agreement with Advice , in 2016, pursuant to which we were granted the non-exclusive right to directly place purchase orders for certain products from a third party manufacturer in consideration for payment of royalties to Advice. This agreement currently accounts for a significant portion of our sales. In the event this agreement is terminated for any reason, it would materially affect our profitability and cash position. +9 +We are dependent upon our ability, and our contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, there is a global shortage of certain electronic components, which has extended our production lead-time and our production costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. Such redesign efforts may require certain regulatory and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in place, and issues may recur in the future. +In addition, some of our products are manufactured, assembled and tested by third party subcontractors and contract manufacturers located domestically and in Asia. While we have had relationships with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our ability to manufacture our products. +If we do not satisfy the NYSE requirements for continued listing or are unable to comply with our business plan , our common stock could be delisted from NYSE. +The listing of our common stock on the NYSE MKT is contingent on our compliance with the NYSE MKT's conditions for continued listing. On December 18, 2015, we were notified by the NYSE MKT that we were no longer in compliance with the NYSE MKT continued listing standards because our last reported stockholders' equity was below continued listing standards. The NYSE MKT requires that a listed company's stockholders' equity be $4.0 million or more if it has reported losses from continuing operations and/or net losses in three of its four most recent fiscal years. +Following submission of our plan demonstrating how we intend to regain compliance with the continued listing standards, we were notified on March 9, 2016 that the NYSE MKT granted us a listing extension on the basis of our plan until June 19, 2017. We are subject to periodic review by NYSE MKT staff during the extension period. Failure to make progress consistent with the plan or to regain compliance with the continued listing standards by the end of the extension period could result in our common stock being delisted from the NYSE MKT. +There is no assurance that we will be able to regain compliance with the abovementioned standard or any other applicable NYSE MKT listing standard. Upon such an occurrence trading of our common stock will be suspended by the NYSE MKT and we may be delisting by the NYSE MKT. In the event our common stock is no longer listed for trading on the NYSE MKT our tranding volume and share price may decrease and we may experience further difficulties in raising capital which could materially affect our operations and financial results. +Our strategic focus on our custom power supply solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, including those involving our personnel, which may negatively impact quarterly earnings and profitability as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +We are dependent upon our ability to attract, retain and motivate our key personnel. +Our success depends on our ability to attract, retain and motivate our key management personnel, including, but not limited to, our President and CEO, our V.P. of Finance, marketing and sales personnel, and key engineers necessary to implement our business plan and to grow our business. Competition for certain specific technical and management skill sets is intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or more of our present key employees were to cease to be associated with us, our future results could be adversely affected. Mr. Kohn continues to serve in his role as our President and CEO. However, Mr. Kohn’s employment agreement expired on December 31, 2010, and as of March 27, 2016, the Company had not signed a new employment agreement with Mr. Kohn. +10 +We depend upon a few major customers for a majority of our revenues, and th e loss of any of these customers, or the substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon a few major OEMs and other customers for a significant portion of our revenues. We have experienced a reduction of orders by OEMs and a reduction or cancellation of orders, scaling back of certain activities and workforce layoffs by other customers. The loss of any of these customers, or a substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. Furthermore, diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, a substantial decrease in our revenues would likely result. +We are dependent on the electronic equipment industry, and accordingly will be affected by the impact on that industry of current economic conditions. +Substantially all of our existing customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant manufacturing facilities, we must rely on, and will continue to rely on, a limited number of contract manufacturers to manufacture our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations or rescheduling of, orders or shipments, any of which would materially harm our business. +We outsource, and are dependent upon developer partners for, the development of some of our custom design products. +We made an operational decision to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +We face intense industry competition, price erosion and product obsolescence, which, in turn, could reduce our profitability . +We operate in an industry that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price erosion in the future. +11 +Our future results are dependent on our ability to establish, maintain and expand our manufacturer’ representative OEM relationships and our other relationships. +We market and sell our products through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as with manufacturer’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which would have an adverse effect on our revenues. +We may not be able to procure necessary key components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, our suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that we require to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect on our gross margins and on our results of operations. +We depend on sales of our legacy products for a meaningful portion of our revenues, but these products are mature and their sales will continue to decline. +A relatively large portion of our sales have historically been attributable to our legacy products. We expect that these products may continue to account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining. Although we are unable to predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and sell new products such as custom design and value added products. We cannot assure you that we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell new products. +Our operating results may vary from quarter to quarter. +Our operating results have in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our operating results. It is possible that, in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly. +12 +Failure of our information technology infrastructure to operate effectively could adversely affect our business. +We depend heavily on information technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory restrictions relating to our international sales. +Some of our products are subject to International Traffic In Arms Regulation (“ITAR”) , which are interpreted, enforced and administered by the U.S. Department of State. ITAR regulation controls not only the export, import and trade of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services as well as foreign production. Any delays in obtaining the required export, import or trade licenses for products subject to ITAR regulation and rules could have a material adverse effect on our business, financial condition, and/or operating results. In addition, changes in United States export and import laws that require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions or charges imposed by the United States or any other country on our international sales or foreign subsidiary could have a materially adverse effect on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program (“FMF”). Any such future sales would be subject to these regulations. Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial condition, and/or operating results. +We depend on international operations for a substantial majority of our components and products. +We purchase a substantial majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect on our business, financial condition, and/or operating results. +We depend on international sales for a portion of our revenues. +Sales to customers outside of North America accounted for 55 .7% of net revenues in the year ended December 31, 2015 and for 5 0.4% of net revenues in the year ended December 31, 2014 and we expect that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts receivable, and currency restrictions. In addition, DPL, our wholly-owned subsidiary in the United Kingdom, supports our European and other international customers, distributors, and sales representatives, and therefore is also subject to local regulation. International sales are also subject to the export laws and regulations of the United States and other countries. +If our accounting controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating our internal control over financial reporting in order to comply with Securities and Exchange Commission rules relating to internal control over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such internal control, we may be subject to regulatory sanctions, and our reputation may decline. +13 +The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products and adversely affect the revenues from such products. +Our limited ability to protect our proprietary information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, we may be required to institute legal proceedings, which would be costly and would divert our resources from the development of our business. If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results could be adversely affected. +Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the United States or abroad. +If we are unable to satisfy our customers’ specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be harmed. +Our customers demand that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, any of which would harm our business. +14 +If we ship products that contain defects, the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate. +Our common stock price is volatile . +Our common stock is listed on the NYSE MKT LLC . In the past, our trading price has fluctuated widely, depending on many factors that may have little to do with our operations or business prospects. The exercise of outstanding options and warrants may adversely affect our stock price and a shareholder’s percentage of ownership. As of December 31, 2015, we had outstanding options to purchase an aggregate of 1,288 ,500 shares of common stock, with a weighted average exercise price of $1.47 per share, exercisable at prices ranging from $0.65 to $1.79 per share. +ITEM 1B. UNRESOLVED STAFF COMMENTS. +Not applicable. +ITEM 2. DESCRIPTION OF PROPERTY. +Our headquarters utilize 12,396 square foot of leased office, engineering, laboratory, and warehouse space in Fremont, California. (the “Original Premises”). Our total space lease (the “Lease”) commenced on November 1, 2012 and expires on June 30, 2019. The annual base rent under the Lease, payable on a monthly basis, increases during the term of the Lease from approximately $138,000 during the first year to approximately $160,000 during the final year; our current rent under the Lease is $12,610 per month. The Lease also provides for one option to renew for a term of five years. +In September, 2010, our wholly-owned subsidiary, DPL, entered into a new fifteen-year lease for its 25,000 square-foot facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military power products for the European market. Sales and service support staff for its European network of distributors are located within the building together with other functions, such as engineering and administration. DPL’s rent expense is approximately $12 ,000 per month, and DPL has the option to cancel the lease after ten years. +We currently anticipate that the current leased space will be sufficient to support our current and foreseen future needs. +ITEM 3. LEGAL PROCEEDINGS. +None. +ITEM 4. MINE SAFETY DISCLOSURES +Not Applicable +15 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. +(a) Market Information. +Our common stock is listed and traded on the NYSE MKT under the symbol DPW. The following tables set forth the high and low closing sale prices, as reported by NYSE MKT, for our common stock for the prior two years. +Quarter Ended +High +Low +12/31/2015 +$ +0.82 +$ +0.54 +09/30/2015 +0.95 +0.61 +06/30/2015 +1.25 +0.79 +03/31/2015 +1.3 +0.87 +12/31/2014 +$ +2.25 +$ +1.24 +09/30/2014 +1.63 +1.09 +06/30/2014 +1.67 +0.83 +03/31/2014 +2.24 +0.60 +The last reported sale price of our common stock on the NYSE MKT on March 22, 2016 was $0.4 0 per share. +(b) Holders +As of March 22, 2016, there was an aggregate of 6,775,971 shares of our common stock outstanding, held by approximately 64 holders of record. +(c) Dividends +We have not declared or paid any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends in the future, if any, will be at the discretion of our Board of Directors (the “Board”) and will depend upon our earnings, capital requirements, and financial position. +ITEM 6. SELECTED FINANCIAL DATA. +Not applicable. +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. +General +We are a solution-driven organization that designs, develops, manufactures and markets high-grade, customized and flexible power solutions for demanding applications in the medical, military, telecom, and industrial markets. Our products serve global markets worldwide. Revenues are generated from selling products to our customers directly by our sales force and through manufacturing representatives and distributors. +Our net loss was $1,096,000 for the year ended December 31, 2015 compared to $658,000 for the year ended December 31, 2014. Part of the loss in 2015 (approximately 36% of the loss) resulted from a decrease in sales , further impairment of our 2011 investment in Telkoor (10% of the loss), stock option expenses (20% of the loss), and amortization of our intellectual property purchased in 2010 (6% of the loss). In 2015, our cash decreased by $869 . A majority of the loss in 2014 (approximately 81% of the loss) resulted from the further impairment of our 2011 investment in Telkoor (27% of the loss), stock option expenses (38% of the loss), and amortization of our intellectual property purchased in 2010 (16% of the loss) all of which did not have a cash effect in 2014. +We believe that our cash will be sufficient to fund our operation in the next 12 months. +16 +Foreign Currency Fluctuations +Our wholly-owned subsidiary, DPL, operates using the United Kingdom pound sterling. Therefore, we are subject to monetary fluctuations between the U.S. dollar and the United Kingdom pound sterling. The financial statement of the subsidiary is included in our consolidated financial statements based on translation into U.S. dollars. For the year ended December 31, 2015 and 2014, we recorded a foreign currency translation loss of $100,000 and $ 105,000 in Other Comprehensive Income (Loss) in shareholders’ equity, respectively . +Results of Operations +The table below sets forth certain statements of operations data as a percentage of revenues for the years ended December 31, 2015 and 2014: +Years Ended December 31, +2015 +2014 +Revenues +100.00 +% +100.00 +% +Cost of revenues +65.07 +63.57 +Gross profit +34.93 +36.43 +Engineering and product development +11.51 +9.04 +Sales and marketing +15.39 +13.94 +General and administrative +20.97 +19.45 +Total operating expenses +47.87 +42.43 +Operating loss +(12.94 +) +(6.00 +) +Impairment of investment +(1.56 +) +(1.94 +) +Other income , net +0.21 +0.67 +Income before tax +(14.29 +) +(7.27 +) +Tax Income (expenses) +0.01 +(0.01 +) +Net loss +(14.28 +)% +(7.28 +)% +The following discussion and analysis should be read in connection with the consolidated financial statements and the notes thereto and other financial information included elsewhere in this Annual Report. We prepared the financial statements in accordance with U.S. generally accepted accounting principles, which require management to make estimates, and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. +Year Ended December 31, 201 5 Compared to Year Ended December 31, 201 4 +Revenues +For the year ended December 31, 2015, revenues decreased by 13.9 % to $7 ,766,000 from $9 ,022,000 for the year ended December 31, 2014 . The decrease in revenues was mainly due to a decrease in orders and shipments of commercial products and the timing of shipments of military products of our domestic operation. Gross revenues of DPL declined by approximately 3.3 % primarily due to decrease of commercial sales. +Revenues derived from our defense products for the year ended December 31, 2015 were $2,964,000, an increase of 14 .7% from revenues of $2,584,000 from defense products for the year ended December 31, 2014. The increase was primarily attributable to partial deliveries of an incremental major naval military contract in 2015. Revenues derived from our commercial products for the year ended December 31, 2015 decreased by 25 .4% to $4 ,802,000 from $6,438,000 for the year ended December 31, 2014 . The decrease in commercial product revenue in 2015 resulted primarily from a commercial products by DPL. +Revenues from our domestic operations decreased by 22 .6% to $3 ,833,000 for the year ended December 31, 2015, from $4 ,953,000 for the year ended December 31, 2014. The decrease in product revenues was mainly attributed to a decrease in sales of our standard commercial products. +17 +Revenues from our European operations (Gresham/DPL) decreased 3.4% to $3 ,933,000 for the year ended December 31, 2015 compared to $4 ,069,000 for the year ended December 31, 2014. The decrease was primarily attributable to a decrease of commercial product sales of standard products. +Gross Margins +Gross margins were 34 .9% for the year ended December 31, 2015, compared to 36.4% for the year ended December 31, 2014 . The decrease in gross margins for the year ended December 31, 2015 compared to the comparable period of 2014 was mainly due to the effect of lower revenues on fixed manufacturing overhead costs and changes in the product mix. +Engineering and Product Development +Engineering and product development expenses were $894,000, or 11.5% of revenues, for the year ended December 31, 2015, compared to $816,000, or 9% of revenues, for the year ended December 31, 2014 The overall increase in our engineering and product development expenses for the comparative periods was mainly due to multiple projects of full custom product development for new applications and new markets. These products developments required contracted engineering services and safety license fees associated with their developments. +Selling and Marketing +Selling and marketing expenses were $1,195,000, or 15 .4% of revenues, for the year ended December 31, 2015, compared to $1,258,000, or 13 .9% of revenues, for the year ended December 31, 2014. The decrease in selling and marketing expenses for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily the result of a temporary decrease in direct manpower cost due to a reduced headcount. In July 2015 the company hired two senior sales that it dismissed in December 2015. +General and Administrative +General and administrative expenses were $1,627,000, or 20 .9% of revenues, for the year ended December 31, 2015, compared to $1,755 ,000, or 19 .4% of revenues, for the year ended December 31, 2014. The decrease in our general and administrative expenses for the comparative period was mainly due to lower stock based compensation expenses which accounted for a $2 0,000 decrease from 2014 to 2015, one -time costs of our U.K subsidiary at 2014, lower legal costs and design of our former CFO . +Impairment of investment +We recorded an impairment of our investment in Telkoor of $110 ,000 for the year ended December 31, 2015 compared to $175,000 for the year ended December 31, 2014 . In the year ended December 31, 2014 , an independent appraiser valuated the holding value of this investment based upon guidelines outlined in ASC 320 and concluded the fair value of the asset . +Financial Income, Net +Financial income was $16,000 for the year ended December 31, 2015 and consisted of foreign currency fluctuations compared to $60,000 for the year ended December 31, 2014 that consisted also from foreign currency fluctuations and proceeds from the sale of an equity investment realized from a previously demutualized executive insurance policy. +Net Loss +For the year ended December 31, 2015, we had a net loss of $1,096,000 compared to a net loss of $658,000 for the year ended December 31, 2014 as detailed in the above narrative. +18 +Critical Accounting Policies +The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported assets, liabilities, sales, and expenses in the accompanying consolidated financial statements. Critical accounting policies are those that require the most subjective and complex judgments, often employing the use of estimates about the effect of matters that are inherently uncertain. The following are considered our most critical accounting policies that, under different conditions or using different assumption or estimates, could show materially different results on our financial condition and results of operations . +Revenue Recognition +Revenue from product sales is recognized in accordance with the provisions of ASC 605-15, "Revenue Recognition in Financial Statements", when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred (when risk of loss and title have transferred to the customer), the sale price is fixed or determinable and collection is reasonably assured. +We generally use customer purchase orders and contracts to determine the existence of an arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. We assess whether the sales price is fixed or determinable based on the payment terms associated with the transaction and whether the price is subject to refund or adjustment. We assess collectability based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. +Revenue on shipments to distributors and resellers is recognized on delivery. Generally, we do not grant a right of return. However, certain distributors are allowed, in the sixth month after the initial stock purchase, to rotate stock that has not been sold for other products. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. +Inventory Obsolescence Accruals +We periodically assess our inventory valuation by reviewing revenue forecasts and technological obsolescence. We write down the value of obsolete or unmarketable inventory to the estimated net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. +During 2015 and 2014, we recorded inventory write-offs of $9 ,000 and $13 ,000, respectively. +Allowance for Doubtful Accounts +Our accounts receivable are derived from sales to customers located primarily in the U.S. and Europe. We perform ongoing credit evaluations of our customers’ financial condition and currently require no collateral from our customers. An allowance for doubtful accounts for estimated losses is maintained in anticipation of the inability of customers to make required payments. The allowance for doubtful accounts as of December 31, 2015 and 2014 was $0, respectively. When we become aware that a specific customer is unable to meet its financial obligations as a result of bankruptcy or the deterioration of the customer’s operating results or financial position, for example, we record a specific allowance to reflect the level of credit risk in the customer’s outstanding receivable balance. We are not able to predict changes in the financial condition of customers, and if the condition or circumstances of our customers deteriorates, estimates of the recoverability of trade receivables could be materially affected and we may be required to record additional allowances. Alternatively, if our estimates are determined to be greater than the actual amounts necessary, we may decrease a portion of such allowance in future periods based on actual collection experience. +19 +Marketable Securities +We have classified our investment in Telkoor's shares in accordance with ASC 320, "Investment in Debt and Equity Securities" and ASC 325, “Investment – Other”. Marketable securities classified as “available for sale securities” are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of shareholder’s equity in "accumulated other comprehensive loss" in equity. When evaluating the investment for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not that we will be required to sell the investment before recovery of the investment's amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC 325-20. +We recorded an impairment of its investment in Telkoor of $110,000 for the year ended December 31, 2015 compared to $175,000 for the year ended December 31, 2014. In the year ended December 31, 2014, an independent appraiser evaluated the holding value of this investment based upon guidelines outlined in ASC 320 and concluded the fair value of the asset had declined by $175,000 from its value reported in the financial statements for the year ended December 31, 2013. +Equity-based Compensation Expense +We account for equity-based compensation in accordance with ASC 718, “Compensation – Stock compensation” ("ASC 718"). Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense over the requisite service periods. Determining the fair value of share-based awards at the grant date requires the exercise of judgment, including the amount of share-based awards that are expected to be forfeited. Estimated forfeitures are based on historical pre-vesting forfeitures. If actual results differ from these estimates, equity-based compensation expense, and therefore our results of operations, could be impacted. +We estimate the fair value of stock options granted under ASC 718, using the Black-Scholes option-pricing model, which uses the following assumption: +Expected volatility is based on historical volatility, which is representative of future volatility over the expected term of the options. The expected term of options granted was determined based on the simplified method, which is calculated as the midpoint between the vesting date and the end of the contractual term of the option. The risk free interest rate is based on the yield of U.S Treasury bonds with equivalent terms. The dividend yield is based on our historical and future expectation of dividends payouts. We have not paid cash dividends historically and has no plans to pay cash dividends in the foreseeable future. +20 +Liquidity and Capital Resources +On December 31, 2015, we had cash and cash equivalents of $1,241,000 and working capital of $2,659,000. This compares with cash and cash equivalents of $2,110,000 and working capital of $3,588,000 at December 31, 2014. The decrease in cash and cash equivalents was due mainly to operational losses. +Net cash used provided by operating activities totaled $529,000 and $669,000 for the years ended December 31, 2015 and December 31, 2014, respectively. The decrease in net cash used by operating activities for the year ended December 31, 2015 was mainly due to the operating loss. +Net cash used in investing activities was $306,000 for the year ended December 31, 2015, compared to net cash used in investing activities of $119,000 for the year ended December 31, 2014. The increase of the net usage of cash from investing activities was primarily related to leasehold improvements at DPL. +Net cash used by financing activities was $0 and $90,000 for the year ended December 31, 2015 and December 31, 2014, respectively, The decrease related to the purchase of treasury stock related to the closing of our ESOP plan . +In November 2012, we entered into a new approximately six and half year lease for our headquarters which utilizes 12,396 square foot of leased office, engineering, laboratory, and warehouse space in Fremont, California. The annual base rent under the lease, payable on a monthly basis, increases during the term of the lease from approximately $138,000 during the first year to approximately $160,000 during the final year. The lease also provides for one option to renew for a term of five years. +In September, 2010, our wholly-owned subsidiary, DPL, entered into a new fifteen year lease for its 25,000 square-foot facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military power products for the European market. Sales and service support staff for its European network of distributors are located within the building together with other functions, such as engineering and administration. DPL’s rent expense is approximately $12,000 per month, and DPL has the option to cancel the lease after ten years. +We believe we have adequate resources at this time to continue our operational and promotional efforts to increase sales and support our current operation. However, if we do not increase our sales, we may have to obtain financing through the issuance of debt and/or equity, which may dilute shareholders’ equity. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. +Not applicable. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. +The financial statements required by this Item 8 are included in this Annual Report following Item 15 hereof. As a smaller reporting company, we are not required to provide supplementary financial information. +21 +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +None. +ITEM 9A. CONTROLS AND PROCEDURES. +Evaluation of Disclosure Controls and Procedures +As of December 31, 2015, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our Chief Executive Officer and principal financial officer, of the effectiveness of the design and operation of our controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) were effective as of the end of the period covered by the report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2015. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls. Our management has concluded that, as of December 31, 2015, our internal control over financial reporting was effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Evaluation of Changes in Internal Control over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +22 +ITEM 9B. OTHER INFORMATION . +None +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. +The following table sets forth the positions and offices presently held by each of our current directors and executive officers and their ages: +Name +Age +Positions Held +Amos Kohn +56 +President, Chief Executive Officer, and Director +Uri Friedlander +53 +Vice President of Finance, Chief Accounting Officer +Ben-Zion Diamant +66 +Chairman of the Board and Director +Israel Levi +75 +Director (2) +Haim Yatim (1) +52 +Director (2) +Moti Rosenberg +67 +Director (2) +(1) On November 13, 2014, Haim Yatim, who had served as a director since 2011, resigned from the Board of Directors and was reappointed on March 3, 2015. +(2) Member of the Audit, Compensation and Nominating and Governance Committees. +Each of the directors named above will serve until the next annual meeting of our shareholders or until his respective successor is elected and qualified. Subject to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Amos Kohn +Amos Kohn, 56 , has served as a member of our board of directors since 2003, as our President and Chief Executive Officer since 2008. From March 2011 until August 2013 Mr. Kohn also served as interim Chief Financial Officer. Mr. Kohn has more than 20 years of successful global executive management experience, including multiple C-level roles across private and established, publicly-traded companies. Mr. Kohn has successfully managed cross-functional teams, driven corporations to high profitability, built customer loyalty and led businesses through expansion and sustained growth. His areas of expertise include operations, technology innovation, manufacturing, strategic analysis and planning and M&A. Mr. Kohn was Vice President of Business Development at Scopus Video Networks, Inc., a Princeton, New Jersey company that develops and markets digital video networking products (2006-2007); Vice President of Solutions Engineering at ICTV Inc., a leading provider of network-based streaming media technology solutions for digital video and web-driven programming, located in Los Gatos, California (2003-2006); Chief Architect at Liberate Technologies, a leading company in the development of a full range of digital media processing for telecom and cable TV industries, located in San Carlos, California (2000-2003); and Executive Vice President of Engineering and Technology at Golden Channel & Co., the largest cable television multiple-systems operator (MSO) in Israel, where he had executive responsibility for developing and implementing the entire nationwide cable TV system (1989-2000). Mr. Kohn holds a degree in electrical and electronics engineering and is named as an inventor on several United States and international patents. We believe that Mr. Kohn’s extensive executive-level management experience in diversified industries, including, but not limited to, power electronics, telecommunications, cable television, broadcast and wireless, as well as his service as a director on our board since 2003, give him the qualifications and skills to serve as one of our directors. +23 +Uri Friedlander +Since 1997, Mr. Friedlander, age 53, has served as the Chief Financial Officer of Telkoor Telecom Ltd., the Company's largest shareholder. From 1991 to 1997, Mr. Fridlander was the controller of I.T.L Ltd., a developer of electro optic military systems, and Q.P.S Ltd., a developer of power supplies, units of the Clal Electronics Ltd. Group. From 1986 until 1991 he served as an auditor for Lyboshitz & Kasirer (Arthur Andersen) public accountants. Mr. Friedlander earned a B.A. in accounting and economics from Tel-Aviv University. +Ben-Zion Diamant +Ben-Zion Diamant, 66, has served as a member of our Board of Directors, and has been Chairman of our Board, since 2001. From March 2008 through July 2008, he also served as our Interim President and Chief Executive Officer. He has served as Chief Executive Officer of Telkoor Telecom Ltd. since August 2008; from 1994 through July 2008, he served as Chairman of the Board of Directors of Telkoor and has served as a director of Telkoor since then. From 1992 through 1994, he was a partner and business development manager at Phascom, and from 1989 to 1992, he was a partner and manager at Rotel Communication. Mr. Diamant holds a B.A. degree in political science from Bar-Ilan University. We believe that Mr. Diamant’s business development and executive-level experience, as well as his service as Chairman of our Board since 2001, give him the qualifications and skills to serve as one of our directors. +Israel Levi +Israel Levi, 75, is a seasoned telecommunications, technology, and business operations executive with multi-disciplinary expertise in operations management, quality control, information technology, systems, and R&D organizations. Mr. Levi served as an officer and held senior management positions including Senior Vice President of Worldwide Operations and Quality, Senior Vice President of Systems and Technology and Senior Vice President of Research & Development with Harmonic, Inc. from 1989 to 2007. Previous to that, he directed product development at Digital Switch Corporation (currently Nortel), Catel Telecommunications and Bell Northern Research (currently Nortel). Mr. Levi received his M.S. degree in Electrical Engineering from Carleton University, Ottawa, Canada and a B.Sc. degree from Technion Institute of Technology, Haifa, Israel. He is named as an inventor on 5 patents and previously served on the Board from 2008 until 2010. +24 +Haim Yatim +Haim Yatim, 52, has served as a member of our Board of Directors from September 2011 until his resignation in November, 2014. Mr. Yatim rejoined the Company as a director in March, 2015. Mr. Yatim currently serves as Chief Financial Officer of Fularo Ltd., a privately held company in the internet industry where he is responsible for the finance team, business operations, financial planning and financial reports. From 2006 until 2010 he served as Chief Financial Officer and Board Member of SimiGon Ltd., a publicly traded company (AIM:SIM) that develops software for the training and simulation industry. Previously, Mr. Yatim served as CFO of the Company. As the company CFO, Mr. Yatim was responsible for financial reporting to the SEC, corporate accounting and tax preparation, budgeting, forecasting, and risk management. Prior his role at Digital Power, Mr. Yatim was a partner of Kost Forer Gabbay & Kasierer, a Member of Ernst & Young Global where he advised on successful NASDAQ listings of technology companies. Mr. Yatim holds a B.Sc. in Accounting and Economics from University of Tel-Aviv, Israel. +Moti Rosenberg +Moti Rosenberg, 67, has served as an independent consultant to various companies in the design and implementation of homeland security systems in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate Ltd., a manufacturer of armor protection systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg was the general manager of ZIV U.P.V.C Products Ltd.'s doors and window factory. Mr. Rosenberg is an active reserve officer and a retired colonel from the Israeli Defense Force (IDF), where he served for 26 years and was involved in the development of weapon systems. In the IDF, Mr. Rosenberg served in various capacities, including platoon, company, battalion, and brigade commander, head of the training center for all IDF infantry, and head of the Air Force's Special Forces. Mr. Rosenberg received a B.A in History from the University of Tel Aviv and a Master of Arts in Political Science from the University of Haifa in Israel. +Family Relationships +Guy Diamant serves as the Operation Manager of Telkoor Power Supplies (TPS) and is the son of Ben-Zion Diamant, our Chairman of the Board of Directors. and a wholly-owned subsidiary of our largest shareholder, Telkoor. There are no other family relationships among any of our directors or executive officers. +Board and Committee Membership +Our Board is currently composed of five members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at www.digipwr.com . +25 +Audit Committee +Messrs. Levi, Yatim, and Rosenberg currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE MKT. Our Board has also determined that Mr. Yatim qualifies as an “audit committee financial expert” as defined in SEC regulations and satisfies the financial sophistication requirements set forth in the NYSE MKT Rules. +The Audit Committee is responsible for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Levi, Yatim, and Rosenberg currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation Committee meets the requirements for independence under the standards of the SEC and the NYSE MKT. +The Compensation Committee is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving salaries, bonuses and other benefits paid to our officers, including our Chief Executive Officer and Chief Financial Officer; and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Levi, Yatim, and Rosenberg currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members of the Nominating and Governance Committee meets the requirements for independence under the standards of the SEC and the NYSE MKT. +The Nominating and Governance Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees for each annual meeting of shareholders to the Board; developing and recommending governance principles applicable to our Board; overseeing the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +The Nominating and Governance Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based business and professional skills, experiences and global business and social perspective. +In addition, the Committee seeks directors who exhibit personal integrity and a concern for the long-term interests of shareholders, as well as those who have time available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +26 +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, directors and 10% shareholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based solely upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting persons, we believe that during the year ended December 31, 2015, all such filing requirements applicable to our officers, directors and ten percent shareholders were fulfilled with the following exceptions. +Name +Number of Late Insider Reports +Number of Transactions Not +Reported on a Timely Basis +Failure to File Required Forms +William J. Hultzman +- +- +- +Amos Kohn +- +- +- +Ben Zion Diamant +- +- +- +Robert Smith +- +- +- +Haim Yatim +- +- +- +Aaron Ben-Ze’ev +- +- +- +Uri Friedlander +1 +- +- +Moti Rosenberg +- +- +- +Israel Levy +- - +- +Code of Ethics +We have adopted the Code of Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller or person performing similar functions (collectively, the “Financial Managers”). The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website at www.digipwr.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit or implicit, from a provision of the Code on our website or in a current report on Form 8-K. +27 +ITEM 11. EXECUTIVE COMPENSATION . +Summary Compensation Table +The following Summary Compensation Table sets forth all compensation earned in all capacities during the years ended December 31, 2015 and 2014, by our (i) Chief Executive Officer and (ii) executive officers, other than the Chief Executive Officer, whose salaries for the 2015 year, as determined by Regulation S-K, Item 402, exceeded $100,000 (the individuals falling within categories (i) and (ii) are collectively referred to as the “Named Executive Officers”). +SUMMARY COMPENSATION TABLE +Name and Principal Position +Year +Salary ($) +Bonus ($) +Stock Awards ($) +Option Awards ($)(4) +Nonequity Incentive Plan Compensation ($) +Nonqualified Deferred Compensation Earnings ($) +Other Compensation ($)(1) +Total ($) +Amos Kohn +2015 +$ +215,118 +$ +- +$ +- +$ +120,184 +$ +- +$ +- +$ +43,677 +$ +378,979 +Chief Executive Officer (2) +2014 +$ +202,458 +$ +- +$ +- +$ +75,031 +$ +- +$ +- +$ +44,603 +$ +322,092 +William Hultzman +2015 +$ +112,375 +$ +- +$ +- +$ +11,855 +$ +- +$ +- +$ +13,575 +$ +137,805 +Former Vice President of Finance (3) +2014 +$ +120,125 +$ +- +$ +16,894 +$ +- +$ +- +$ +22,928 +$ +159,947 +_________________________________________________________________________ +(1) The amounts in “All Other Compensation” consist of health insurance benefits, long-term and short-term disability insurance benefits, and 401K match amounts. For Mr. Kohn, all other compensation also includes fees of approximately $ 11,000 in 2014, respectively, paid to Techlead, a company for which Mr. Kohn serves as director, to reimburse Techlead for expenses incurred in connection with manpower services provided by Techlead until April, 2014. +(2) Mr. Kohn became our President and Chief Executive Officer in 2008. Prior to that date, he had served as a non-employee member of our Board since 2003. +(3) Mr. Hultzman became our Vice President of Finance and Principal Accounting Officer in late August, 2013 and resigned on August 21, 2015. +(4) Mr. Friedlander became our Vice President of Finance and Principal Accounting Officer on October 7, 2015. +(5) Represents the equity-based compensation expenses recorded in our consolidated financial statements for the year ended December 31, 2015, based upon the option’s fair value on the grant date, calculated in accordance with accounting guidance for equity-based compensation. For a discussion of the assumptions used in reaching this valuation, see Note 8 to our consolidated financial statements for the year ended December 31, 2015. +28 +Director Compensation +Independent directors receive $10,000 annually for serving on our Board. The director designated by the Board as the Audit Committee financial expert generally receives an additional annual fee of $5,000 for serving as the financial expert. Directors are paid quarterly in arrears for their services. +Subject to Board approval, upon joining our Board, independent directors may also receive a grant of an option under our 2012 Stock Option Plan to purchase 10,000 shares of our common stock. In addition, subject to Board approval, each independent director may be granted, from time to time, an option to purchase an additional 10,000 shares of our common stock. Options vest over a four-year period, 25% per year. Each option has an exercise price equal to the fair market value of our common stock on the grant date and a maximum term of ten years, subject to earlier termination upon the cessation of service as a director. +Chairman of the Board of Directors, Ben-Zion Diamant, receives monthly consulting fees of $6,000 and no equity compensation. Effective March 21, 2016, Mr. Diamant's monthly consulting fee increased to $7,500. +The table below sets forth, for each non-employee director, the total amount of compensation related to his service during the year ended December 31, 2015: +Director Compensation +Name +Fees +Earned +or Paid +in Cash +($) +Stock +Awards +($) +Option +Awards +($) +Non-Equity Incentive +Plan +Compensation +($) +Nonqualified Deferred Compensation Earnings +($) +All Other Compensation +($) +Total +($) +Ben-Zion Diamant (1) +$ +- +- +$ +50,037 +- +- +$ +72,000 +$ +122,037 +Robert Smith (2) +$ +5,000 +- +$ +1,100 +- +- +- +$ +6,100 +Aaron Ben-Ze’ev (3) +$ +5,000 +- +$ +1,185 +- +- +- +$ +6,185 +Benjamin Kiryati (4) +$ +3,334 +- +$ +- +- +- +- +$ +3,334 +Haim Yatim (5) +$ +8,333 +- +$ +833 +- +- +- +$ +9,166 +Israel Levi (6) +$ +5,000 +- +$ +1,208 +- +- +- +$ +6,208 +Moti Rosenberg (7) +$ +5,000 +- +$ +416 +- +- +- +$ +5,416 +(1) +On September 12, 2011, our Board of Directors approved the payment of monthly consulting fees of $6,000 to Ben-Zion Diamant, our Chairman of the Board of Directors. These fees were first paid on October 5, 2011 and have continued to be paid on a monthly basis since such date. The Board’s decision to approve these fees was based on a recommendation by the Compensation Committee, in consideration for Mr. Diamant’s services to us, including manufacturing advisory and corporate advisory services. Our obligation to pay the fees may be terminated at any time by further decision of the Board of Directors and will terminate upon a strategic transaction. On March 21, 2016, the Compensation Committee and Board of Directors approved an increase to the monthly consulting fee to Mr. Diamant to $7,500 effective as of March 21, 2016. The increase was approved in light of Mr. Diamant's increased capital raising and business development efforts on behalf of the Company. +(2) +Mr. Smith joined the Board on November 16 , 201 0 and resigned on June 30, 2015 . +(3) +Mr. Ben Zeev joined the Board on July 24 , 2014 and resigned on June 30, 2015 . +(4) +Mr. Kiryati joined the Board on October 30, 2014 and resigned on February 26, 2015. +(5) +Mr. Yatim resigned as director on November 13, 2014 and was reappointed on March 3, 2015. +(6) +Mr. Levi joined the Board on June 30, 2015. +(7) +Mr. Rosenberg joined the Board on June 30, 2015. +Employment Agreement with Amos Kohn +An employment agreement with Mr. Kohn expired on December 31, 2010. As of March 20, 2015, Mr. Kohn has not reached or signed a new employment agreement. Mr. Kohn continues to serve as our President and Chief Executive Officer. +In March 2014, the Compensation Committee resolved to grant Mr. Kohn 300,000 stock options under the 2012 Stock Option Plan. The options, which will have an exercise price equal to the closing price of our shares as of the close of business on April 1, 2014, vest over four years at 25% per year and expire 10 years from the date of grant. +Mr. Kohn continues to serve as our President and Chief Executive Officer. +29 +Letter Agreement with William J. Hultzman +On August 15, 2013, we entered into a letter agreement with William J. Hultzman (the “Letter Agreement”), pursuant to which he became our Vice President of Finance (principal financial officer and principal accounting officer) on August 21, 2013. Mr. Hultzman replaced Amos Kohn, our President and Chief Executive Officer, who served as interim Chief Financial Officer since March, 2011. +The following is a brief description of the Letter Agreement with Mr. Hultzman: +Annual Compensation. Mr. Hultzman’s base salary will be $110,000, subject to a performance review after six months and an annual performance review thereafter. He will be eligible for potential salary increases and a bonus grant subject to our yearly practice and his performance. +Equity Award. Subject to Compensation Committee and Board of Director approval, Mr. Hultzman will be granted an option to purchase 25,000 shares of our common stock at the closing price at the date of the grant. +Benefits. Mr. Hultzman is eligible to participate in the Company’s 401(k) pension plan and will receive other customary employee benefits. +In March, 2014, the Compensation Committee resolved to grant Mr. Hultzman 100,000 stock options under the 2012 Stock Option Plan. The options, which will have an exercise price equal to the closing price of our shares as of the close of business on April 1, 2014, vest over four years at 25% per year and expire 10 years from the date of grant. +In August 2015 Mr. Hultzman resigned from the Company . +Mr. Friedlander Compensation +On October 7, 2015 the Compensation Committee agree to pay Mr. Friedlander an annual payment of $58,000 (which includes compensation and business expenses and travel) and granted him 20,000 stock options under the 2012 Stock Option Plan. The options, which will have an exercise price equal to the closing price of the Company’s shares on the close of business on October 7, 2015, vest over a four year period at 25% per year and expire 10 years from the date of grant. +Advisory Vote on Executive Compensation +At the annual meeting of shareholders on August 12, 2013, shareholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. In addition, shareholders voted, on an advisory basis, that an advisory vote on executive compensation should be held every three years. +30 +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding equity awards as of December 31, 2015 to the Named Executive Officers: +Option Awards +Stock Awards +Name +Number of +Securities +Underlying +Unexercised +Options +(#) +Exercisable +Number of +Securities +Underlying +Unexercised +Options (#) +Unexercisable +Equity +Incentive +Plan +Awards: +Number of +Securities +Underlying +Unexercised +Unearned +Options (#) +Option +Exercise +Price ($) +Option Expiration +Date +Number +of +Shares +or +Units +of +Stock +That +Have +Not +Vested (#) +Market +Value +of +Shares +or +Units +of +Stock +That +Have +Not +Vested +(#) +Equity +Incentive +Plan +Awards: +Number +of +Unearned +Shares, +Units or +Other +Rights +That Have +Not +Vested +(#) +Equity +Incentive +Plan +Awards: +Market or +Payout +Value of +Unearned +Shares, +Units or +Other +Rights +That Have +Not +Vested ($) +Amos Kohn +10,000 +- +- +$ +1.66 +5/9/2017 +- +- +- +- +50,000 +- +- +$ +1.79 +8/11/2019 +- +- +- +- +75,000 +- +- +$ +1.51 +12/1/2020 +- +- +- +- +100,000 +- +- +$ +1.60 +9/12/2021 +- +- +- +- +75,000 +225,000 +- +$ +1.67 +4/2/2024 +- +- +- +- +Uri Friedlander +- +20,000 +- +$ +0.65 +7/10/2025 +- +- +- +- +Employee Stock Ownership Plan +We had an Employee Stock Ownership Plan ("ESOP") until July 31, 2014 at which time it was entirely liquidated after a decision to terminate the plan as of July 31, 2013 was previously made. The ESOP provided for the Employee Stock Ownership Trust ("ESOT") to distribute our common shares or cash equivalent as retirement benefits to the participants. As of July 31, 2014, the ESOP had distributed or paid the cash equivalent of all of the 167,504 shares previously held prior to plan termination. +Stock Option Plans +Our stock option plans currently consist of the Digital Power 2012 (as amended), 2002, 1998, and 1996 incentive share option plans (the “Incentive Share Option Plans”). All of the Incentive Share Option Plans have expired, except for the 2012 Stock Option Plan (as amended) which was approved by shareholders at the annual general meeting held on August 12, 2013. At such annual general meeting, shareholders approved the 2012 Stock Option Plan (as amended) which increased the number of shares authorized for issuance to 1,372,630 shares from the 410,145 shares originally authorized in December, 2012 under the preceding 2012 Stock Option Plan. Currently authorized for issuance under our Incentive Stock Option Plans are 761,130 shares of our common stock. +The purpose of the 2012 Stock Option Plan (as amended) is to encourage stock ownership by employees, officers, and directors by giving them a greater personal interest in the success of the business and by providing them an added incentive to advance in their employment or service to Digital Power. The 2012 Stock Option Plan (as amended) provides for the grant of either incentive or non-statutory stock options. The exercise price of any stock option granted under the 2012 Plan (as amended) may not be less than 100% of the fair market value of our common stock on the date of grant. +31 +To the extent that an incentive stock option may be exercised in any given year for more than $100,000, the option will be deemed to be a non-statutory stock option. Generally, our stock option agreements permit cashless exercises where options are exercised and the underlying common stock is sold on the same day. Unless otherwise provided by the Board, an option granted under the 2012 Stock Option Plan (as amended) is exercisable for 10 years. The 2012 Stock Option Plan (as amended) is administered by the Compensation Committee, which has discretion to determine optionees, the number of shares to be covered by each option, the exercise schedule and other terms of the options. The 2012 Stock Option Plan (as amended) may be amended, suspended, or terminated by the Board, but no such action may impair rights under a previously granted option. Each incentive stock option is exercisable, during the lifetime of the optionee, only so long as the optionee remains employed with us. In general, no option is transferable by the optionee other than by will or by the laws of descent and distribution. +As of December 31, 2015, options to purchase 1,146,000 shares of common stock were issued and outstanding under the Incentive Share Option Plans. +401(k) Plan +We have adopted a tax-qualified employee savings and retirement plan, or 401(k) plan, which generally covers all of our full-time employees. Pursuant to the 401(k) plan, eligible employees may make voluntary contributions to the plan up to a maximum of 5% of eligible compensation. The 401(k) plan permits, but does not require, matching contributions by Digital Power on behalf of plan participants. We match contributions at the rate of (1) $1.00 for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary. We are also permitted under the plan to make discretionary contributions. The 401(k) plan is intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. Contributions to such a qualified plan are deductible by Digital Power when made, and neither the contributions nor the income earned on those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained in trust. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. +Security Ownership +Except as otherwise indicated below, the following table sets forth certain information regarding beneficial ownership of our common stock as of March 20, 2016 by: (1) each of our current directors; (2) each of the named executive officers listed in the Summary Compensation Table; (3) each person known to us to be the beneficial owner of more than 5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and executive officers as a group. As of December 31, 2015, there were 6,775,971 shares of our common stock outstanding. +Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of March 20, 2016 are deemed to be outstanding and to be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or group. Unless otherwise indicated by footnote, to our knowledge the persons named in the table have sole voting and sole investment power with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. The table below is based upon information supplied by officers, directors and principal shareholders and Schedules 13D and 13G and Forms 3 and 4 filed with the SEC as of March 20, 2016. Unless otherwise indicated below, the address of each beneficial owner listed below is c/o Digital Power Corporation, 48430 Lakeview Blvd, Fremont, California 94538. +32 +Name and Address +Of Beneficial Owner +Number of Shares +Beneficially Owned +Approximate Percent +of Class +Telkoor Telecom Ltd. +5 Giborei Israel +Netanya 42293 +Israel +2,714,610 +40.06 +% +Amos Kohn +424,749 +(1) +5.93 +% +Ben-Zion Diamant +3,026,559 +(2) +43.39 +% +Israel Levi +15,000 +(3) +* +Haim Yatim +1,202 +* +Barry W. Blank +P.O. Box 32056 +Phoenix, AZ 85064 +419,900 +5.60 +% +All directors and executive officers as a group +3,467,510 +(4) +47.01 +% +* Less than one percent. +(1) Represents (a) options to purchase 385,000 shares of common stock that are currently exercisable or exercisable within 60 days of March 20, 2016 and (b) 39,749 shares of common stock held on behalf of Mr. Kohn by a brokerage firm. +(2) Mr. Diamant serves as Chief Executive Officer and a director of Telkoor and is its controlling shareholder. Represents (a) options to purchase 200,000 shares, owned by Mr. Diamant, that are currently exercisable or exercisable within 60 days of March 20, 2015 (b) 2,714,610 shares beneficially owned by Telkoor, and (c) 111,949 shares held by a brokerage firm on behalf of Telkoor. Mr. Diamant disclaims beneficial ownership of the shares held by Telkoor, except to the extent of his proportionate pecuniary interest therein. +(3) Represents (a) options to purchase 15,000 shares of common stock that are currently exercisable or exercisable within 60 days of March 20, 2016. +(4) See Notes (1) – (4) above. +Securities Authorized for Issuance Under Equity Compensation Plans +The following table sets forth information as of December 31, 2015 with respect to compensation plans under which our common shares are authorized for issuance, aggregated as follows: +● +All compensation plans previously approved by security holders; and +● +All compensation plans not previously approved by security holders. +33 +EQUITY COMPENSATION PLAN INFORMATION +Name +Number of securities +to be issued +upon exercise of +outstanding +options, warrants +and rights +(a) +Weighted-average +exercise +price of outstanding +options, +warrants and rights +(b) +Number of securities +remaining +available for future +issuance +under equity +compensation plans +(excluding securities in +column (a)) +(c) +Equity compensation plans approved by security holders +1,288,500 +$ +1.53 +761,130 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +Relationship with Telkoor Power Supplies Ltd. +In the years ended December 31, 2015 and 2014, we purchased approximately $594,000 and $868,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest shareholder, Telkoor, of which Ben-Zion Diamant is the Chief Executive Officer and its controlling shareholder. We had no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. In Januar 2016, Telkoor sold its commercial intellectual property to Advice Electronics Ltd. As a result, of that date no further orders have been placed with Telkoor. +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest shareholder, Telkoor Telecom Ltd., of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL has paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor Telecom Ltd. sold its assets, including it subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Acquisition of Shares of Telkoor +On June 16, 2011 we acquired 1,136,666 shares of Telkoor, a major shareholder of the Company which was listed on the Tel Aviv Stock Exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations. As of December 31, 2105 the shares represented 8.4% of the outstanding shares of Telkoor which have since de-listed from the Tel Aviv Stock Exchange. +34 +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. We incurred $44,000 in Telkoor royalty expense in 2013. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016 , Telkoor sold all its commercial IP to Advice Electronics Ltd. ("Advice”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under DPC branding until December 2020. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. +Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global (“Kost Forer”), has served as our independent registered public accounting firm since 2002 and has been appointed by the Audit Committee to continue as our independent registered public accounting firm for the year ending December 31, 2015. +Kost Forer also serves as the independent auditors of Telkoor. The auditing of our financial statements and Telkoor’s financial statements are handled by separate teams within Kost Forer. +Fees and Services +The following table shows the aggregate fees billed to us for professional services by Kost Forer for the years ended December 31, 2015 and 2014: +2015 +2014 +Audit Fees +$ +100,00 +$ +89,152 +Audit-Related Fees +$ +- +$ +- +Tax Fees +$ +- +$ +- +All Other Fees +$ +- +$ +- +Total +$ +100,000 +$ +89,152 +Audit Fee - This category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years ended December 31, 2015 and 2014, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2015 and 2014, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements for the relevant years. +Audit-Related Fees - This category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under "Audit Fees," and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, internal control-related matters, and audits of employee benefit plans. +Tax Fees . This category includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax compliance, tax planning and tax advice. +All Other Fees - This category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors that are not reported above under "Audit Fees," "Audit-Related Fees," or "Tax Fees." +The Audit Committee’s policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such pre-approval. +35 +PART IV +ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. +(a) Exhibits +3.1 +Amended and Restated Articles of Incorporation of Digital Power Corporation (1) +3.2 +Amendment to the Articles of Incorporation (1) +3.3 +Amendment to the Articles of Incorporation (2) +3.4 +Bylaws of Digital Power Corporation (1) +10.1 +1996 Digital Power Incentive Stock Option Plan (1) +10.2 +1998 Digital Power Incentive Stock Option Plan (3) +10.3 +2002 Digital Power Stock Option Plan (4) +10.4 +Lease, dated as of August 21, 2007, between the Company and SDC Fremont Business Center, Inc. (5) +10.5* +Employment Agreement with Amos Kohn (6) +10.6* +2012 Stock Option Plan, as amended (7) +10.7 +Manufacturing and Distribution Rights Agreement, dated January 7, 2016, by and between the Company and Advice Electronics Ltd. +10.8* +Letter Agreement with William J. Hultzman (8) +10.9 * +Form of Stock Option Agreement for awards made under the 2012 Stock Option Plan (as amended). (9) +23.1 +Consent of Kost Forer Gabbay & Kasierer +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act +99.1 +Press Release, dated March 30, 2016 +(1) +Previously filed with the Commission on October 16, 1996 as an exhibit to the Company’s Registration Statement on Form SB-2. +(2) +Previously filed with the Commission as Exhibit 3.1 to the Company’s Form 8-K filed December 9, 2013 +(3) +Previously filed with the Commission as Exhibit 10.7 to the Company’s Form 10-KSB for the year ended December 31, 1998. +(4) +Previously filed with the Commission as Exhibit A to the Company’s Proxy Statement filed on September 5, 2002. +(5) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on October 22, 2007. +(6) +(7) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on July 10, 2008. +Previously filed with the Commission as Exhibit A to the Company’s DEF-14A filed on June 26, 2013. +(8) +Previously filed with the Commission as Exhibit 10.9 to the Company’s Form 10-Q/A for the quarterly period ended June 30, 2012. +(9) +Previously filed with the Commission as Exhibit 10.9 to the Company’s Form 10-K for the year ended December 31, 2013. +†Portions of this exhibit have been omitted and filed separately with the Securities and Exchange Commission pursuant to a confidential treatment request. +*Management contract or compensatory plan or arrangement. +36 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED FINANCIAL STATEMENTS +AS OF DECEMBER 31, 2015 +IN U.S. DOLLARS +INDEX +Page +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Balance Sheets +F-3 - F-4 +Consolidated Statements of Operations +F-5 +Consolidated Statements of Comprehensive Loss +F-6 +Statements of Changes in Shareholders' Equity +F-7 +Consolidated Statements of Cash Flows +F-8 +Notes to Consolidated Financial Statements +F-9 - F-32 +F-1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +The Board of Directors and Shareholders of +DIGITAL POWER CORPORATION +We have audited the accompanying consolidated balance sheets of Digital Power Corporation (the "Company") and subsidiary as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive loss, shareholders' equity and cash flows for each of the two years in the period ended December 31, 2015. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and subsidiary at December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2015 in conformity with U.S. generally accepted accounting principles. +/s/ KOST FORER GABBAY & KASIERER +Tel-Aviv, Israel +KOST FORER GABBAY & KASIERER +March 30, 2016 +A Member of Ernst & Young Global +F-2 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +U.S. dollars in thousands +December 31, +201 5 +201 4 +ASSETS +CURRENT ASSETS: +Cash and cash equivalents +$ +1,241 +$ +2,110 +Trade receivables (net of allowance for doubtful accounts of $ 0 and $ 0 as of December 31, 2015 and 2014, respectively) +1,240 +1,548 +Trade receivables - related parties (Note 12) +77 +- +Prepaid expenses and other receivables +187 +178 +Inventories (Note 3) +1,542 +1,653 +Total current assets +4,287 +5,489 +NON CURRENT ASSETS: +Property and equipment, net (Note 4) +709 +567 +Intangible asset, net (Note 5) +- +66 +Investment in Telkoor (Note 11) +90 +207 +Long term deposits +13 +13 +Total Non-Current Assets +812 +853 +Total Assets +$ +5,099 +$ +6,342 +The accompanying notes are an integral part of the consolidated financial statements. +F-3 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +U.S. dollars in thousands (except per share data) +December 31, +201 5 +201 4 +LIABILITIES AND SHAREHOLDERS' EQUITY +CURRENT LIABILITIES: +Accounts payable +$ +937 +1,061 +Trade payables - related parties (Note 12) +- +60 +Advances from customers and deferred revenue +211 +435 +Other current liabilities (Note 6) +480 +345 +Total Current Liabilities +1,628 +1,901 +COMMITMENTS AND CONTINGENT LIABILITIES (Note 7) +SHAREHOLDERS' EQUITY (Note 8): +Share capital - +Series A Redeemable Convertible Preferred shares, no par value - 500,000 shares authorized; 0 shares issued and outstanding at December 31, 2015 and 2014 +- +- +Preferred shares, no par value - 1,500,000 shares authorized; 0 shares issued and outstanding at December 31, 2015 and 2014 +- +- +Common Shares, no par value - 30,000,000 shares authorized; 6,775,971 and 6,853,161 shares issued and outstanding at December 31, 2015 and 2014, respectively. +- +- +Additional paid-in capital +14,965 +14,739 +Accumulated deficit +(11,036 +) +(9,940 +) +Accumulated other comprehensive loss +(458 +) +(358 +) +Total Shareholders' Equity +3,471 +4,441 +Total Liabilities and Shareholders' Equity +$ +5,099 +$ +6,342 +The accompanying notes are an integral part of the consolidated financial statements. +F-4 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF OPERATIONS +U.S. dollars in thousands (except per share data) +Year ended +December 31, +201 5 +201 4 +Revenues (Note 13) +$ +7,766 +$ +9,022 +Cost of revenues +5,053 +5,735 +Gross profit +2,713 +3,287 +Operating expenses: +Engineering and product development +894 +816 +Selling and marketing +1,195 +1,258 +General and administrative +1,627 +1,755 +Total operating expenses +3,716 +3,829 +Operating loss +(1,003 +) +(542 +) +Impairment of investment (Note 11) +(110 +) +(175 +) +Other income , net +16 +60 +Loss before income taxes (Note 9c) +(1,097 +) +(657 +) +Income taxes (Note 9d) +(1 +) +1 +Net Loss +$ +(1,096 +) +$ +(658 +) +Basic and diluted net loss per share (Note 10) +$ +(0.16 +) +$ +(0.10 +) +Weighted average number of shares used in per share calculations (in thousands) +6,776 +6,803 +The accompanying notes are an integral part of the consolidated financial statements. +F-5 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS +U.S. dollars in thousands +Year ended +December 31, +201 5 +201 4 +Net Loss +$ +(1,096 +) +$ +(658 +) +Other comprehensive loss: +Change in net foreign currency translation adjustment +(100 +) +(105 +) +Other comprehensive loss +(100 +) +(105 +) +Total comprehensive income loss +$ +(1,196 +) +$ +(763 +) +The accompanying notes are an integral part of the consolidated financial statements. +F-6 +DIGITAL POWER CORPORATION AND SUBSIDIARY +STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY +U.S. dollars in thousands (except share data) +Other +Common +Additional +accumulated +Total +Shares +paid-in +Accumulated +comprehensive +shareholders +Number +capital +deficit +income (loss) +equity +Balance as of January 1, 2014 +6,853,161 +$ +14,582 +$ +(9,282 +) +$ +(253 +) +$ +5,047 +Stock compensation related to options granted to non- employees +- +1 +- +- +1 +Stock compensation related to options granted to employees +- +246 +- +- +246 +Exercise of options granted to employees +40,951 +- - - - +Purchase of treasury stock +(118,141 +) +(90 +) +- +- +(90 +) +Comprehensive loss: +Net loss +- +- +(658 +) +- +(658 +) +Foreign currency translation Adjustments +- +- +- +(105 +) +(105 +) +Balance as of December 31, 2014 +6,775,971 +$ +14,739 +$ +(9,940 +) +$ +(358 +) +$ +4,441 +Stock compensation related to options granted to employees +- +226 +- +- +226 +Comprehensive loss: +Net loss +- +- +(1,096 +) +- +(1,096 +) +Foreign currency translation adjustments +- +- +- +(100 +) +(100 +) +Balance as of December 31, 2015 +6,775,971 +$ +14,965 +$ +(11,036 +) +$ +(458 +) +$ +3,471 +The accompanying notes are an integral part of the consolidated financial statements. +F-7 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +U.S. dollars in thousands +Year ended +December 31, +201 5 +201 4 +Cash flows from operating activities : +Net loss +$ +(1,096 +) +$ +(658 +) +Adjustments required to reconcile net loss to net cash provided by operating activities: +Depreciation +148 +139 +Amortization of intangible asset +66 +106 +Inventory write-down +9 +13 +Impairment of investment in Telkoor +110 +175 +Stock compensation related to options granted to employees +226 +246 +Stock compensation related to options granted to non-employees +- +1 +Decrease in trade receivables +288 +581 +Increase in prepaid expenses and other receivables +(14 +) +(15 +) +Decrease in inventories +57 +49 +Decrease in accounts payable and trade payables - related parties +(258 +) +(221 +) +Increase (decrease) in advances from customers, deferred revenues and other current liabilities +(65 +) +253 +Net cash provided (used) by operating activities +(529 +) +669 +Cash flows from investing activities : +Purchase of property and equipment +(306 +) +(119 +) +Net cash used in investing activities +(306 +) +(119 +) +Cash flows from financing activities : +Purchase of treasury stock +- +( 90 +) +Net cash used in financing activities +- +( 90 +) +Effect of exchange rate changes on cash and cash equivalents +(34 +) +(46 +) +Increase (decrease) in cash and cash equivalents +(869 +) +414 +Cash and cash equivalents at the beginning of the year +2,110 +1,696 +Cash and cash equivalents at the end of the year +$ +1,241 +$ +2,110 +Non-cash activities : +Reclassification of property and equipment to inventory +$ +- +16 +The accompanying notes are an integral part of the consolidated financial statements. +F-8 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 1:- GENERAL +a. +Digital Power Corporation ("the Company" or "DPC") was incorporated in 1969, under the General Corporation Law of the State of California. The Company and Digital Power Limited ("DPL"), a wholly owned subsidiary located in the United Kingdom, are currently engaged in the design, manufacture and sale of switching power supplies and converters. The Company has two reportable geographic segments - North America (sales through DPC) and Europe (sales through DPL). +b. +In 2015 20% of Company sales were of Telkoor products. 10% were purchased directly from Telkoor Power supplies Ltd ( "TPS" a subsudary of Telkoor Telecom Ltd. ("Telkoor"), a major shareholder of the Company) .And 10% were purchased mainly from one of DPC's third party subcontractors . +c . +In January 2016, Telkoor Telecom Ltd. (“Telkoor”) sold its entire commercial assets to Advice Ltd. (Refer also to Note 14). Consequently, the company depend on Advice, for design, retain product technology up-to-date and manufacturing capabilities for some certain of the products that company sell. If Advice is unable or unwilling to continue designing or manufacturing our products in required volumes and with a certain level of quality on a timely basis, that could lead to loss of sales and adversely affect the company operating results and cash position. The company also depend on Advice's intellectual property and ability to transfer production to third party manufacturers. Failure to obtain new products in a timely manner or delay in delivery of products to customers will have an adverse effect on the company ability to meet our customers’ expectations. In addition, the company operate in highly competitive markets where the ability to sell Advice’s products could be adversely affected by Advice agreements with other companies, long lead-times and the high cost of Advice’s products. In 2010, the Company purchased a specific IP from Telkoor in order to reduce its dependency on Telkoor with respect to a certain line of products. See also Notes 5 and 12. +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES +The consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”). +a. +Use of estimates: +The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions. The Company's management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +b. +Financial statements in U.S. dollars: +A substantial portion of the revenues of the Company is generated in U.S. dollars ("dollar"). In addition, a substantial portion of the costs of the Company is incurred in dollars. The Company's management believes that the dollar is the currency of the primary economic environment in which the Company operates. +Accordingly, monetary accounts maintained in currencies other than the dollar are remeasured into U.S. dollars in accordance with Accounting Standards Codification No. 830, "Foreign Currency Matters" ("ASC No. 830"). All transactions gains and losses from the remeasurement of monetary balance sheet items are reflected in the statements of operations as financial income or expenses as appropriate. +F-9 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +The financial statements of the foreign subsidiary, whose functional currency has been determined to be its local currency, have been translated into U.S. dollars in accordance with Accounting Codification Statement ("ASC") 830, "Foreign Currency Translation". All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate for the period. The resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss) in shareholders' equity. +c. +Principles of consolidation: +The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. Intercompany transactions and balances have been eliminated upon consolidation. +d. +Cash equivalents: +Cash equivalents are short-term highly liquid investments that are readily convertible to cash with original maturities of three months or less at acquisition. +e. +Inventories: +Inventories are stated at the lower of cost or market value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological obsolescence. +Cost is determined as follows: +Raw materials, parts and supplies - using the "first-in, first-out" method. +Work-in-progress and finished products - on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically assesses its inventories valuation in respect of obsolete and slow moving items by reviewing revenue forecasts and technological obsolescence. When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at the time of the review was not expected to be sold, is written off. +F-10 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +During 2015 and 2014, the Company recorded inventory write-offs of $9 and $13, respectively, within the cost of revenue. +f. +Property and equipment and intangible asset, net: +Property and equipment as well as an intangible asset are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets, at the following annual rates: +% +Intangible asset +20 +Computers, software and related equipment +20 +– +33 +Office furniture and equipment +10 +– +20 +Leasehold improvements +Over the term of the lease or the life +of the asset, whichever is shorter +The long-lived assets of the Company and its subsidiary are reviewed for impairment in accordance with ASC 360, "Property, Plant, and Equipment", whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. As of December 31, 2015 and 2014, no impairment losses have been identified. +g. +Revenue recognition: +The Company and its subsidiary generate their revenues from the sale of their products through a direct and indirect sales force. +Revenues from products are recognized in accordance with ASC 605-15, "Revenue Recognition in Financial Statements", when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the seller's price to the buyer is fixed or determinable, no further obligation exists and collectability is reasonably assured. +F-11 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +Generally, the Company does not grant a right of return. However, certain distributors are allowed, in the sixth month after the initial stock purchase, to rotate stock that has not been sold for other products. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. +Service revenues are deferred and recognized on a straight-line basis over the term of the service agreement. Service revenues are immaterial in proportion to the Company's revenues. +h. +Engineering and product development costs: +Engineering and product development costs are charged to the statement of operations as incurred. +i. +Income taxes: +The Company and its subsidiary account for income taxes in accordance with ASC 740, "Income Taxes" (“ASC 740”). This statement prescribes the use of the liability method whereby deferred tax assets and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company and its subsidiary provide a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. +ASC 740-10 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with ASC 740. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. No liability for unrecognized tax benefits was recorded as a result of the implementation of ASC 740 as of December 31, 2015 and 2014. +F-12 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +j. +Warranty costs: +The Company offers a warranty period for all of its products. Warranty periods range from one to two years depending on the product. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company's warranty liability include the number of units sold, historical rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. +Warranty liability accruals were $94 and $97 for the years ended December 31, 2015 and December 31, 2014 respectively. +k. +Accounting for stock-based compensation: +The Company accounts for stock-based compensation in accordance with ASC 718 "Compensation – Stock Compensation" ("ASC 718"). +ASC 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in the Company's consolidated statements of operations. +The Company estimates the fair value of stock options granted under ASC 718 using the Black-Scholes option-pricing model that uses the following assumptions. +Expected volatility is based on historical volatility that is representative of future volatility over the expected term of the options. The expected term of options granted was determined based on the simplified method, which is calculated as the midpoint between the vesting date and the end of the contractual term of the option. The Company uses the simplified method as it has determined that sufficient data is not available to develop an estimate of the expected option term based upon historical participant behavior. The risk free interest rate is based on the yield of U.S. Treasury bonds with equivalent terms. The dividend yield is based on the Company's historical and future expectation of dividends payouts. The Company has not paid cash dividends historically and has no plans to pay cash dividends in the foreseeable future. +The Company recognizes share-based compensation expenses for the value of its awards based on the straight line method over the requisite service period of each of the awards . +F-13 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) +In 2015, the Company estimated the fair value of stock options granted using the Black-Scholes option pricing model with the following weighted average assumptions: +2015 +2014 +Weighted Average fair value +$0.44 +$0.45 +Dividend yield +0% +0% +Expected volatility +87.6 +- +88.3% +74.4% +Risk-free interest +1.60 +- +1.91% +1.04% +Expected life (years) +5.5 +- +7 +6.25 +The Company applies ASC 718 and ASC 505-50, “Equity Based Payments to Non-Employees”, with respect to options and warrants issued to non-employees. +F-14 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +l. +Fair value of financial instruments and securities: +Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the "exit price") in an orderly transaction between market participants at the measurement date. +In determining fair value, the Company uses various valuation approaches. ASC 820 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company's assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. +Level 1 - +Quoted prices in active markets for identical assets or liabilities . +Level 2 - +Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. +Level 3 - +Valuations based on inputs that are unobservable and significant to the overall fair value measurement. +The carrying amounts of financial instruments carried at cost, including cash and cash equivalents, trade receivables, trade payables and trade payables – related party approximate their fair value due to the short-term maturities of such instruments. +m. +Basic and diluted net loss per share: +Basic net earnings loss per share is computed based on the weighted average number of Common shares outstanding during each year. Diluted net loss per share are computed based on the weighted average number of Common shares outstanding during each year, plus dilutive potential Common shares considered outstanding during the year, if any, in accordance with ASC 260, "Earnings per Share". +n. +Concentrations of credit risks: +Financial instruments that potentially subject the Company and its subsidiary to concentrations of credit risk consist principally of cash and cash equivalents, long term deposits and trade receivables. +F-15 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +Cash and cash equivalents are invested in banks in the U.S. and in the UK. Such deposits in the United States may be in excess of insured limits and are not insured in other jurisdictions. +Trade receivables of the Company and its subsidiary are mainly derived from sales to customers located primarily in the U.S. and in Europe. The Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is determined with respect to those amounts that the Company and its subsidiary have determined to be doubtful of collection. +o. +Comprehensive loss: +The Company reports comprehensive loss in accordance with ASC 220, "Comprehensive Income". This Statement establishes standards for the reporting and presentation of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined that its items of other comprehensive loss relates to changes in foreign currency translation adjustments. +p. +Operating lease: +The Company and its subsidiary have operating lease agreements for the lease of their building facilities in the U.S. and UK. The rent in connection with the leases is charged to expense over the lease term. If rental payments are not made on a straight-line basis, rental expenses are nevertheless recognized on a straight-line basis. +q. +Marketable securities: +The Company classifies its investment in Telkoor's shares in accordance with ASC 320, "Investment in Debt and Equity Securities" and ASC 325, “Investment – Other”. Marketable securities classified as “available for sale securities” are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of shareholder’s equity in "accumulated other comprehensive loss" in equity. When evaluating the investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company's intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment's amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC 325-20. +r. +New a ccounting pronouncements and o ther s tandards: +1. +In May 2014, the FASB issued ASU No. 2014-09 related to revenue recognition. This new standard will replace all current GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition guidance provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This guidance can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. In 2015, the FASB issued guidance to defer the effective date to fiscal years beginning after December 15, 2017 with early adoption for fiscal years beginning December 15, 2016. The Company is evaluating the impact of adopting this new accounting guidance on its consolidated financial statements. +2. +In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330), Simplifying the Measurement of Inventory.”Under this ASU, the measurement principle for inventory will change from lower of cost or market value to lower of cost and net realizable value. The ASU defines net realizable value as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The ASU is applicable to inventory that is accounted for under the first-in, first-out method and is effective for reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is evaluating the impact of adopting this new accounting guidance on its consolidated financial statements. +3. +In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern , or ASU 2014-15. ASU 2014-15 amends FASB Accounting Standards Codification 205-40 Presentation of Financial Statements – Going Concern , by providing guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements, including requiring management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements and providing certain disclosures if there is substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 will be effective for our fiscal 2016 and annual financial statements and for interim periods beginning in the first quarter of fiscal 2017. The adoption of this accounting standard may affect our financial statement disclosures in future periods. +4. +In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), aimed at making leasing activities more transparent and comparable. The new standard requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including today’s operating leases. For public business entities, the standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. For all other entities, the standard is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted for all entities. We are currently evaluating the impact of ASU 2016-02 on our consolidated financial statements and related disclosures. +F-16 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 3:- INVENTORIES +December 31, +201 5 +201 4 +Raw materials, parts and supplies +$ +336 +$ +287 +Work in progress +191 +357 +Finished products +1,015 +1,009 +$ +1,542 +$ +1,653 +NOTE 4:- PROPERTY AND EQUIPMENT, NET +December 31, +201 5 +201 4 +Cost: +Computers, software and related equipment +$ +1,726 +$ +1,640 +Office furniture and equipment +257 +259 +Leasehold improvements +771 +617 +2,754 +2,516 +Accumulated depreciation +Computers, software and related equipment +1,336 +1,252 +Office furniture and equipment +237 +231 +Leasehold improvements +472 +466 +2,045 +1,949 +Depreciated cost +$ +709 +$ +567 +Depreciation expense was $148 and $ 139 for the years ended December 31, 2015 and 2014, respectively. +NOTE 5:- INTANGIBLE ASSET, NET +On August 25, 2010, the Company and its wholly-owned subsidiary, DPL, entered into an agreement with Telkoor Power Supplies Ltd. ("TPS"), a subsidiary of Telkoor Telecom Ltd., pursuant to which, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets” or “IP”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. The IP was purchased in order to decrease lead time and costs of the production process. In consideration for the purchase of the IP, DPL paid TPS an amount of $480. The consideration for the right to sell the Assets in Israel will be paid to the Company as a yearly royalty fee of 15% of TPS's direct production costs of sales. +F-17 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +TPS will provide the Company training and technical support, if necessary, for a period of 60 months in order to enable the Company to properly and effectively use the IP to manufacture the Assets. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event that annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based on an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period the Company sells more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600 W AC/DC power supply series (CPCI 600W) through 2013, the Company amended its agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. The Company will not be required to make any royalty payments to Telkoor under the manufacturing agreement with Telkoor until the shortfall of CPCI 600W product sales will be offset. As of December 31 2015 the remaining shortfall balance is $86 . since from 2016 the company will pay royalties to Advice, Telkoor will return this amount by services to the company or by cash . +F-18 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 5:- INTANGIBLE ASSET, NET (Cont.) +To date, DPL has designated a manufacturing facility to manufacture the units of the IP purchased and accordingly decreased its manufacturing costs of the CPCI 600W product. +The useful life method of the IP has been determined to be five years and the amortization method is the straight-line method, as management considers this method as the most appropriate. +December 31, +201 5 +201 4 +Cost: +480 +480 +Accumulated depreciation +480 +414 +Depreciated cost +$ +- +$ +66 +Amortization expense was $66 and $106 for the years ended December 31, 2015 and December 31, 2014, respectively. +. +NOTE 6:- OTHER CURRENT LIABILITIES +December 31, +201 5 +201 4 +Accrued payroll and payroll taxes +$ +36 +$ +65 +Warranty accrual +95 +97 +Accrued expenses and other +350 +183 +$ +480 +$ +345 +F-19 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES +Lease commitments: +In November 2012, the Company signed an operating lease agreement for the US headquarters for a period of 7 years with an option to extend for additional five years.. In September 2010, the Company's subsidiary signed a new agreement for a lease in respect of the UK facility for a period of fifteen years with an option to cancel the lease after ten years. +Future non-cancellable rental commitments under operating leases are as follows: +Year ended December 31, +2016 +$ +315 +2017 +319 +2018 +322 +2019 +205 +$ +1,161 +Total rent expense for the years ended December 31, 2015 and 2014 was approximately $299 and $ 309, respectively. +NOTE 8:- SHAREHOLDERS' EQUITY +a. +Preferred shares: +There are authorized Preferred shares in the amount of 500,000 shares of Series A cumulative Redeemable Convertible Preferred shares ("Series A"), and an additional 1,500,000 Preferred shares that have been authorized, but the rights, preferences, privileges and restrictions on these shares have not been determined. DPC's Board of Directors is authorized to create a new series of Preferred shares and determine the number of shares, as well as the rights, preferences, privileges and restrictions granted to or imposed upon any series of Preferred shares. As of December 31, 2015, there were no Preferred shares issued or outstanding. +b. +Common shares: +Common shares confer upon the holders the rights to receive notice to participate and vote in the general meeting of shareholders of the Company, to receive dividends, if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. +F-20 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 8:- SHAREHOLDERS' EQUITY (Cont.) +c. +Share Option Plans: +1. +Under the Company's Digital Power 2012 (As Amended) ("Incentive Share Option Plan"), options may be granted to employees, officers, consultants, service providers and directors of the Company or its subsidiary. +2. +As of December 31, 2015, the Company has authorized according to the Incentive Share Option Plan the grant of options to officers, management, other key employees and others of up to 1,372,630 options for the Company's Common shares. The maximum term of the options is ten years from the date of grant. As of December 31, 2015, an aggregate of 761,130 of the Company's options are still available for future grant. +3. +The options granted generally become fully vested after four years. Any options that are forfeited or cancelled before expiration become available for future grants. +The options outstanding as of December 31, 2015 have been classified by exercise price, as follows: +Exercise +Price +Options +outstanding +as of +December 31, +2015 +Weighted +average +remaining +contractual +term +Weighted +average +exercise +price +Options +exercisable +as of +December 31, +2015 +Weighted +average +exercise +price +of options +exercisable +Years +$0.65 +- +0.79 +105,000 +8.45 +$ +0.67 +25,000 +$ +0.74 +$1.1 +- +1.32 +65,000 +3.13 +$ +1.20 +50,000 +$ +1.17 +$1.51 +- +1.69 +926,000 +6.96 +$ +1.62 +513,500 +$ +1.58 +$1.79 +50,000 +3.61 +$ +1.79 +50,000 +$ +1.79 +1,146,000 +6.74 +$ +1.52 +638,500 +$ +1.53 +4. +The total equity-based compensation expense related to all of the Company’s equity based awards, including non-employee options recognized for the years ended December 31, 2015 and 2014 is comprised as follows: +Year ended +December 31, +201 5 +2014 +Cost of revenues +$ +7 +$ +4 +Engineering and product development expenses +20 +17 +Selling and marketing expenses +6 +7 +General and administration expenses +193 +219 +Total equity-based compensation expense +$ +226 +$ +247 +F-21 +5. +A summary of option activity under the Company's stock option plans as of December 31, 2015 and changes during the year then ended are as follows: +Year ended December 31, 2015 +Weighted +Weighted +average +A verage +remaining +Aggregate +Amount of +exercise +contractual +intrinsic +options +price +term (years) +value +Outstanding beginning of year +1,262,763 +$ +1.57 +7.65 +$ +41.57 +Granted +155,000 +$ +0.67 +Forfeited +(261,000 +) +$ +1.29 +Expired +(10,763 +) +$ +0.7 +Outstanding end of year +1,146,000 +$ +1.52 +6.74 +$ +- +Exercisable end of year +638,500 +$ +1.53 +5.34 +$ +- +The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December 31, 2015 and the exercise price, multiplied by the number of in-the-money-options) that would have been received by the option holders had all option holders exercised their options on December 31, 2015. This amount changes based upon the fair market value of the Company’s shares. +As of December 31, 2015, there was $ 415 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company's stock option plans. That cost is expected to be recognized over a weighted average period of 2.43 years. +d. +Options issued to non-employees: +The Company's outstanding options to non-employees as of December 31, 2015 are as follows: +Issuance date +Options +for +Common +shares +Exercise +price per +share +Options +exercisable +March 2006 +100,000 +$ +1.16 +100,000 +December 2010 +17,500 +$ +1.51 +17,500 +October 2015 +$ +25,000 +0.65 +- +142,500 +117,500 +All options are exercisable for ten years from the date of grant. +In 2015 , the Company granted 25,000 options to Telkoor's employee . These options vest over four years. The fair value of these options was estimated using the Black-Scholes option-pricing model with the following assumptions for 2015: risk-free interest rates of 1.61%, dividend yield of 0%, volatility of 88.3%, and the remaining contractual term of the options of 6.25 years. The total fair value is less than $1 thousend. +F-22 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +e. +Employee stock ownership plan: +The Company had an Employee Stock Ownership Plan ("ESOP") until July 31, 2014 at which time it was entirely liquidated after a decision to terminate the plan as of July 31, 2013 was previously made. The ESOP provided for the Employee Stock Ownership Trust ("ESOT") to distribute the Company's common shares or cash equivalent as retirement benefits to the participants. As of July 31, 2014, the ESOT had distributed or paid the cash equivalent of all of the 167,504 shares previously held prior to plan termination. +f. +Dividends: +In the event that cash dividends are declared in the future, such dividends will be paid in U.S. dollars. The Company does not intend to pay cash dividends in the foreseeable future. +F-23 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 9:- TAXES ON INCOME +a. +Deferred income taxes: +Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax asset and liabilities are as follows: +December 31, +201 5 +201 4 +Net operating loss carryforward +$ +2,233 +$ +1,958 +Reserves and allowances +225 +202 +Credit carryforward +153 +173 +Depreciation and amortization +142 +127 +Net deferred tax asset before valuation allowance +2,753 +2,460 +Valuation allowance +(2,753 +) +(2,460 +) +Net deferred tax asset +$ +- +$ +- +As of December 31, 2015 and 2014, the Company and its subsidiary provided a valuation allowance of $2,753 and $2,460 respectively, in respect of deferred tax assets resulting from short-term temporary differences and depreciation charged in advance of a capital allowance taken, as well as from carryforward losses. +Management currently believes that since the Company and its subsidiary have a history of losses, it is more likely than not that the deferred tax assets regarding the remainder of the tax loss carryforward and other temporary differences will not be realized in the foreseeable future. +b. +Net operating tax losses carryforward: +As of December 31, 2015, the Company had approximately $3,769 in federal net operating loss carryforward for income tax purposes, which can be carried forward and offset against taxable income for 20 years and expire between 2021 and 2034. +F-24 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 9:- TAXES ON INCOME (Cont.) +Utilization of U.S. net operating losses may be subject to substantial annual limitation, due to the "change in ownership" provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses before utilization. The Company believes that, as a result of having undergone an "Ownership Change" in 2002 within the meaning of section 382 of the Internal Revenue Code, its ability to use its net operating loss carryforward and other tax attributes to offset future U.S. taxable income, and thereby reduce its tax liability, is limited. +As of December 31, 2015, the Company subsidiary had accumulated losses for income tax purposes in the amount of approximately $1,69. These net operating losses may be carried forward and offset against taxable income in the future for an indefinite period. +c. +Loss before income taxes consists of the following: +Year ended +December 31, +201 5 +201 4 +Domestic (U.S.) +$ +(1,090 +) +$ +(600 +) +Foreign (UK) +(7 +) +(57 +) ) +$ +(1,097 +) +$ +(657 +) +The Company is required to calculate and account for income taxes in each jurisdiction in which the Company or its subsidiary operate. Significant judgment is required in determining its worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of the Company's business, there are many transactions and calculations where the ultimate tax determination is uncertain. +Our provision for income taxes consists of the following: +Year ended +December 31, +201 5 +201 4 +Current: +Federal +$ +- +$ +- +State +- +- +Foreign +(1 +) +1 +(1 +) +1 +Deferred: +Federal +- +- +State +- +- +Foreign +- +- +- +- +Tax expenses +$ +(1 +) +$ +1 +There is no provision in respect of unrecognized tax benefits for the years ended December 31, 2015 and 2014. +F-25 +d. +A reconciliation between the theoretical tax expense, assuming all income is taxed at the statutory tax rate applicable to income of the Company and the actual tax expense as reported in the statements of operations is as follows: +Year ended +December 31, +201 5 +201 4 +Income (loss) before income taxes +$ +(1,097 +) +$ +(657 +) +Theoretical tax at U.S. statutory tax rate (34%) +$ +(373 +) +$ +(223 +) +Taxes in respect of prior years +2 +37 +) +Tax adjustment in respect of foreign subsidiary +(16 +) +(41 +) +Nondeductible expenses +79 +87 +Operating carryforward losses, credits and temporary differences for which valuation allowance was (utilized) provided +307 +141 +Tax expenses +$ +(1 +) +$ +1 +F-26 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 10:- NET LOSS PER SHARE +The following table sets forth the computation of the basic and diluted net loss per share: +Year ended +December 31, +Numerator: +201 5 +201 4 +Net loss available to Common shareholders +$ +(1,096 +) +$ +(658 +) +Denominator: +Total weighted average numbers of shares outstanding used in computing: +Basic and diluted loss per share +6,775,971 +6,803,269 +Basic and diluted net loss per share +$ +(0.16 +) +$ +(0.10 +) +NOTE 11:- INVESTMENT IN TELKOOR +On June 16, 2011 the Company has acquired 1,136,666 shares of Telkoor, a major shareholder of the Company and an Israeli company listed in the Tel Aviv stock exchange, which represented 8.8% ( 8.4% as of December 31, 2015 ) of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. +The Company has classified its investment in Telkoor's shares as available-for-sale securities in accordance with ASC 320, "Investment in Debt and Equity Securities". Marketable securities classified as "available for sale securities" are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of shareholders' equity in "accumulated other comprehensive loss". When evaluating the investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company's intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment's amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e. non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost(i.e., cost method investments), as described in ASC 325-20. +The Company recorded an impairment of its investment in Telkoor of $110 for the year ended December 31, 2015 compared to $175 for the year ended December 31, 2014. In the year ended December 31, 2014, an independent appraiser evaluated the holding value of this investment based upon guidelines outlined in ASC 320 and concluded the fair value of the asset. +F-27 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 12:- RELATED PARTY TRANSACTIONS +The results of operations from transactions with Telkoor, a major shareholder, were as follows: +Year ended +December 31, +201 5 +201 4 +Purchases of products from Telkoor +$ +594 +$ +868 +Transactions with Telkoor are derived mainly from purchase of power supplies from Telkoor. In addition, in 2010, the Company purchased IP from one of Telkoor's subsidiaries in the amount of $ 480. See Note 5 for further discussion. +The Company believes that the transactions described above are on a basis no less favorable than could be obtained from an independent third party. Although it is not practical to determine the amounts that the Company would have incurred had it purchased from an unaffiliated entity, management believes that the amounts chargeable for the above transactions provided by these agreements are reasonable. All future transactions between the Company and Telkoor will be on terms no less favorable than could be obtained from an independent third party. +F-28 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 13:- SEGMENT CUSTOMERS AND GEOGRAPHICAL INFORMATION +a. +The Company has two reportable geographic segments; see Note 1a for a brief description of the Company's business. The data is presented in accordance with ASC 280. +The following data presents the revenues, expenditures and other operating data of the Company's geographic operating segments: +Year ended December 31, 201 5 +DPC +DPL +Eliminations +Total +Revenues +$ +3,833 +$ +3,933 +$ +- +$ +7,766 +Intersegment revenues +371 +- +(371 +) +- +Total revenues +$ +4,204 +$ +3,933 +$ +(371 +) +$ +7,766 +Depreciation & amortization expense +$ +74 +$ +139 +$ +- +$ +213 +Operating income (loss) +$ +(1,086 +) +$ +83 +$ +- +$ +(1,003 +) +Impairment of investment +$ +(111 +) +Other income, net +16 +Income taxes +(1 +) +Net loss +$ +(1,096 +) +Expenditures for segment assets as of December 31, 2015 +$ +58 +$ +248 +$ +- +$ +306 +Identifiable assets as of December 31, 2015 +$ +2,384 +$ +2,715 +$ +- +$ +5,099 +F-29 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +U.S. dollars in thousands (except share and per share data) +NOTE 13:- SEGMENTS CUSTOMERS AND GEOGRAPHICAL INFORMATION (Cont.) +Year ended December 31, 2014 +DPC +DPL +Eliminations +Total +Revenues +$ +4,953 +$ +4,069 +$ +- +$ +9,022 +Intersegment revenues +211 +39 +(250 +) +- +Total revenues +$ +5,164 +$ +4,108 +$ +(250 +) +$ +9,022 +Depreciation and amortization +expense +$ +68 +$ +177 +$ +- +$ +245 +Operating income (loss) +$ +(623 +) +$ +81 +$ +- +$ +(542 +) +Impairment of investment +(175 +) +Other income, net +60 +Income taxes +(1 +) +Net loss +$ +(658 +) +Expenditures for segment assets as of December 31, 2014 +$ +76 +$ +43 +$ +- +$ +119 +Identifiable assets as of December 31, 2014 +$ +2,919 +$ +3,423 +$ +- +$ +6,342 +b. +The following table provides the percentage of total revenues attributable to a single customer from which 10% or more of total revenues are derived: +Total Revenues by Major +Customer +(in thousands) +Percentage of Total +Company Revenues +Coustomer A +$853 +11% +Coustomer B +$1,809 +23% +Revenue from customer A was attributable to DPC and revenue from Coustomer B attributable to DPL. +F-30 +c. +Total revenues from external customers divided on the basis of the Company's product lines are as follows: +Year ended +December 31, +201 5 +201 4 +Revenues: +Commercial products +$ +4,802 +$ +6,438 +Defense products +2,964 +2,584 +$ +7,766 +$ +9,022 +d. +Financial data relating to geographic areas: +The Company's total revenues are attributed to geographic areas based on the location. +The following table presents total revenues for the years ended December 31, 2015, 2014. Other than as shown, no foreign country contributed materially to revenues or long-lived assets for these periods. +2015 +Total revenue +2014 +Total revenue +North America +$ +3,435 +$ +4,527 +Europe (including UK) +1,704 +2,941 +Asia +768 +1,430 +Australia +42 +8 +South America +3 +3 +South Korea +1,814 +113 +$ +7,766 +$ +9,022 +F-31 +NOTE 14:- SUBSEQUENT EVENTS +In January 2016, Telkoor Telecom Ltd. (“Telkoor”) sold its entire commercial assets to Advice Ltd. which included without limitation product IP, manufacturing rights, customer base, inventory, staff and technological capabilities. Following such transaction, we entered into a manufacturing rights and royalty agreement with Advice. This agreement will allow the company to manufacture certain Advice products (formerly owned by Telkoor) through August 2017 against royalty payments. From August 2017 through December 2020, we will be allowed to continue distributing and selling certain Advice products while keeping product branding under Advice's brand, after which we will be entitled to distribute the products under DPC branding until December 2020. +F-32 +SIGNATURES +In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: March 30, 2016 +DIGITAL POWER CORPORATION +By: +/s/ Amos Kohn +Amos Kohn +President and Chief Executive Officer +/s/ Uri Friedlander +V.P of Finance +Principal Accounting Officer +In accordance with the Exchange Act, this report has been signed below by the following person on behalf of the registrant and in the capacities indicated. +/s/ Ben-Zion Diamant +Ben-Zion Diamant, Chairman of the Board +/s/ Amos Kohn +Amos Kohn, +President, Chief Executive Officer, +Chief Financial Officer and Director +/s/ Haim Yatim +Haim Yatim, Director +/s/ Israel Levy +Israel Levy, Director +/s/ Moti Rosenberg +Moti Rosenberg, Director \ No newline at end of file diff --git a/raw/filings/0000896493/2015/0001437749-16-028665/filing_metadata.csv b/raw/filings/0000896493/2015/0001437749-16-028665/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..f9bbc4d5b465ebbd4847ac5e02d124c6481b0fc3 --- /dev/null +++ b/raw/filings/0000896493/2015/0001437749-16-028665/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2016-03-30,2015-12-31,2016-03-30T19:59:05.000Z,0001437749-16-028665,dpw20151119_10k.htm,FORM 10-K,1887808,1,0,https://www.sec.gov/Archives/edgar/data/896493/000143774916028665/dpw20151119_10k.htm,https://www.sec.gov/Archives/edgar/data/896493/000143774916028665/,2015,2015,1 diff --git a/raw/filings/0000896493/2015/0001437749-16-028665/item1.txt b/raw/filings/0000896493/2015/0001437749-16-028665/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..7cb135b8432c10b7039e259ad98cc30d2ab9e5dc --- /dev/null +++ b/raw/filings/0000896493/2015/0001437749-16-028665/item1.txt @@ -0,0 +1,178 @@ +ITEM 1. DESCRIPTION OF BUSINESS. +General +We are a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the most demanding applications in the medical, military, telecom and industrial markets. We are highly focused on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. We are a California corporation originally formed in 1969, and our common stock trades on the NYSE MKT under the symbol “DPW”. Our corporate headquarters are located in the heart of the Silicon Valley. +Our wholly-owned UK -based subsidiary, Digital Power Limited ("DPL"), located in Salisbury, England, operates under the brand name of “Gresham Power Electronics” (“Gresham”). DPL designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products . +We believe that we are one of the first companies in the power solutions industry to introduce a product strategy based on the premise that products developed with an extremely flexible architecture enable rapid modifications to meet unique customer requirements for non-standard input and output voltages. We continue to sell products with flexible configurations to customers serving diversified applications in telecom, industrial and medical market segments. We believe our high density and high efficiency power products have set an industry standard for providing high-power output in a small packaging sizes. +We market and sell our products to many diverse market segments, including the telecom, industrial, medical and military/defense industries. Our products serve a global market, with an emphasis on North America and Europe. We offer a broad product variety, including a full custom product design, standard and modified-standard products. Our unique high-speed switching power rectifiers include but are not limited to defense and commercial custom power products, server power supplies, front-end, open-frame, enclosed, CompactPCI, MicroTCA, Desktop/Wall-mount Adaptors, Power over Ethernet POE) and other product solutions. Our product power range is from 10 watts to 75,000 watts. +1 +In an effort to provide high quality products, better control our manufacturing costs and sell our products in a competitive pricing to support our markets, we have entered into several contract manufacturing agreements with several manufacturers both domestically and in Asia, primarily China. To comply with the US International Traffic in Arms Regulations (“ITAR”) regulations, we manufacture our military products by a domestic manufacturer that complies with US ITAR regulations and is certified to perform such manufacturing services. +We intend to remain an innovative leader in the development of cutting-edge custom power solutions and feature rich products to meet any customer needs and requirements, rugged power systems to meet harsh and extreme operation environment conditions, and high efficiency, high-density and scalable power systems. +Power System Solutions +We provide custom power system solutions, high-grade flexibility series power supply products, off-the-shelf products and value-added services to diverse industries and markets including military/defense, telecom, medical and industrial. We believe that our solutions leverage a combination of low leakage power emissions, high power density, superior power efficiency, design flexibility and short time to market. +Custom Power System Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution technology includes full Digital Signal Processing (“DSP”) control, digital load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customer’s unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“IP”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“PFC”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages and unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to original equipment manufacturers (“OEMs”). We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating a complex, time-consuming and costly integration. We believe that this value-added service is well suited to those OEMs who wish to reduce their vendor base and minimize their investment in manufacturing that leads to increased fixed costs. Based on these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +2 +Our products have a warranty period from date of shipment to the customer. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic corporation, Digital Power Corporation; the European marketplace is served through DPL, our wholly-owned subsidiary. +We sell products to our OEM customers through direct sales or through our sales channels , including our manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2016 . +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. +Medical (Patient Contact and Non-patient Contact): +● +Colonoscopy imaging system +● +Imaging, dispensing equipment +● +Ventilators +● +Dialysis, endoscopy, surgical equipment +● +Ultrasound, MRI +● +Oxygen concentrations +Telecom : +● +Switches/Routers +● +Storage/Data servers +● +Servers +● +Broadband networks and video broadcast systems +● +Fiber optic networks +● +Wireless systems +Industrial Process Equipment and Embedded Controls: +● +Packaging equipment, pumps, CNC machines, laser +● +Intelligent / LED lighting +● +Industrial printers +● +Laboratory and diagnostic instrument +● +Scientific equipment +● +Advanced projectors +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We are compliant with the regulations of ITAR and are an approved vendor for the U.S. Air Force, Navy and Army. +3 +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments: +● +Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air +● +Naval – Naval power conversion and distribution +● +Mobile and Ground Communications – Active Protection, Communications and Navigation +● +Artillery – Gyro modular azimuth position and navigation system +● +Surveillance, test equipment +● +UAV (Unmanned Aerial Vehicle) – Very lightweight power systems +Our military products meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary DPL develops and manufactures some military and defense products manly being deployed in international naval fleets. +Full custom military project services: +● +Program management for each project +● +Quality assurance and control: +o +ISO 9001: 2008 and ISO 17025: 2005 certified +o +Compliance with AS9100 through our manufacturing +o +Compliance with MIL-Q 9858A +o +Compliance with environmental testing in accordance with MIL-STD 810, MIL-STD 202 +o +FRACAS (Failure Reporting, Analysis, and Corrective Action System) +o +100% screening, including ESS (Environmental Stress Screening) and ATP (Acceptance Test Procedure) with random vibration and temperature cycling tests +● +Product Tests: +o +Vertical Random Vibration +o +Sine Sweep Vibrations +o +Shock +o +Salt +o +Fog +o +Polar Temperatures +● +Typical Product Features: +o +Wide input voltage range +o +Multi-output voltages (DC and AC) +o +Fully approved according to MIL-STD 704, MIL-STD 1275 and MIL-STD 1399 +o +Environmental conditions per MIL-STD 810 +o +EMI/RFI per MIL-STD 461 +o +Wide operating temperature range of -56°C up to +105°C +o +Power output up to 72,000 Watts (3 x 24,000 Watts system) +o +High switching frequency up to 500KHz +o +High efficiency, over 92% +o +High power density up to 28 watts/inch 3 +o +Power factor correction +o +Redundancy and hot swap N+1 +o +Switching Frequency sync to external clock +o +Free convection, forced air cooling and base plate cooling +4 +Strategy +Our strategy is to be the supplier of choice to those companies and OEMs requiring high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that support all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. Our target market segments include the industrial, telecommunication, medical, and military/defense industries. +Our strategy will continue to focus on expanding our market share by adding new customers from all of our target market segments. We are developing long term relationships, and we intend to expand our customer base in our commercial market segments, including medical, telecom and industrial, while continuing to maintain our existing customers. In the military and defense market segment, we will continue to provide advanced rugged products to customers, and we are striving to expand our business to support the military and defense industries. We believe that our custom power supply solutions, flexibility series, high-grade and high-efficiency power product solutions provide customers with a more effective choice as compared to products offered by other power solution competitors, due in part to a customer’s requirement for output voltages and other features such as redundancy and sense control tailored to its exact requirements within specific parameters. +Furthermore, we believe that we have the talent and engineering experience to satisfy any of our customers’ product or platform requirements. If an OEM customer specifies a different set of power system parameters, we will custom design or modify a product to meet the OEM’s requirements. With a wide range of solutions from our custom designs to our high-grade flexibility series products, our professional design team can provide economical and timely product solutions to our OEM customers. In addition, as our power systems meet all appropriate environmental requirements and safety standards, our smaller OEM customers can expedite the process of independent safety agency testing by companies such as Underwriters Laboratories, and save considerable expense. By offering OEM customers choices with our custom, flexibility series, high-grade and high-efficiency power system solutions, we believe we provide certain strategic advantages over our competitors. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom , designs, manufactures, and distributes switching power supplies, uninterruptible power supplies, and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“Gresham”). Frequency converters manufactured by Gresham are used by naval warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low cost manufacturing goals with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and in Asia. +5 +We sell certain products that are developed, manufactured and sold to us by Advice Electronics Ltd. (“Advice”), an Israeli company that acquired the assets and commercial operations of our major shareholder Telkoor Telecom Ltd. in January 2016. We entered into a manufacturing and royalty rights agreement with Advice in January 2016. This agreement formalized the business relationship between Advice and us in order to allow us to continue manufacturing certain of Telkoor’s products (currently owned by Advice) and the respective royalty charge. +In June 2015, OHM Power Solutions Ltd. (“Ohm”) acquired from Telkoor its entire military assets and military operation. The asset sale between Telkoor and Ohm does not affect our ability to manufacturing and sell certain of Telkoor’s military products. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Any future restrictions or charges may be imposed by the United States or any other foreign country . In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs that are funded and governed by the e U.S. Foreign Military Financing program. +Sales and Marketing +We market our products directly through our internal sales force as well as through our channel partners including independent manufacturer representatives (Reps) and distributors. Each manufacturing Rep promotes our products in a particular assigned geographic territory. Generally, the Rep has the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving its marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% of gross sales for retention, payable after products were shipped to the customer in the assigned territory. Typically, either we or the Reps are entitled to terminate the Rep agreement upon 30 days’ written notice. +6 +Historically, we have also sold products through multiple power focused distributors. Distributors are not assigned to a particular geographical territory. Each of these arrangements can be terminated by either party upon 30 days’ written notice. +We provide comprehensive collateral including product data sheets, participation in trade shows, and our website, www.digipwr.com. We use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our website and accessible to the marketplace. We will continue to enhance our website by adding more features and functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of our product development projects to engineering partners in order to achieve the best technological and product design results for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the shelf (“COTS”) products and for other customized product requirements, when applicable. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering integrating laboratory located in California. +7 +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products comparable in quality to ours. Many of our competitors, including Bel Fuse), Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to whom we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of output product design platforms. We believe we have a competitive position with our targeted customers who need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“NRE”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +8 +Employees +As of December 31, 2015, we had 26 employees located in the United States and the United Kingdom, of whom six were engaged in engineering and product development, seven in sales and marketing, seven in general operations and six in general administration and finance. All but two of these employees are employed on a full-time basis. None of our employees are currently represented by a trade union. We consider our relations with our employees to be good . \ No newline at end of file diff --git a/raw/filings/0000896493/2015/0001437749-16-028665/item13.txt b/raw/filings/0000896493/2015/0001437749-16-028665/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..80eeaef16e4015ed21032154325886b7f15f62fd --- /dev/null +++ b/raw/filings/0000896493/2015/0001437749-16-028665/item13.txt @@ -0,0 +1,11 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +Relationship with Telkoor Power Supplies Ltd. +In the years ended December 31, 2015 and 2014, we purchased approximately $594,000 and $868,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest shareholder, Telkoor, of which Ben-Zion Diamant is the Chief Executive Officer and its controlling shareholder. We had no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. In Januar 2016, Telkoor sold its commercial intellectual property to Advice Electronics Ltd. As a result, of that date no further orders have been placed with Telkoor. +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest shareholder, Telkoor Telecom Ltd., of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL has paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor Telecom Ltd. sold its assets, including it subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Acquisition of Shares of Telkoor +On June 16, 2011 we acquired 1,136,666 shares of Telkoor, a major shareholder of the Company which was listed on the Tel Aviv Stock Exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations. As of December 31, 2105 the shares represented 8.4% of the outstanding shares of Telkoor which have since de-listed from the Tel Aviv Stock Exchange. +34 +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. We incurred $44,000 in Telkoor royalty expense in 2013. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016 , Telkoor sold all its commercial IP to Advice Electronics Ltd. ("Advice”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under DPC branding until December 2020. \ No newline at end of file diff --git a/raw/filings/0000896493/2015/0001437749-16-028665/item9a.txt b/raw/filings/0000896493/2015/0001437749-16-028665/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..b035c1318b442113b44d30c03d7b1491ad3f8c28 --- /dev/null +++ b/raw/filings/0000896493/2015/0001437749-16-028665/item9a.txt @@ -0,0 +1,11 @@ +ITEM 9A. CONTROLS AND PROCEDURES. +Evaluation of Disclosure Controls and Procedures +As of December 31, 2015, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our Chief Executive Officer and principal financial officer, of the effectiveness of the design and operation of our controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) were effective as of the end of the period covered by the report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2015. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls. Our management has concluded that, as of December 31, 2015, our internal control over financial reporting was effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Evaluation of Changes in Internal Control over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +22 \ No newline at end of file diff --git a/raw/filings/0000896493/2015/0001437749-16-028665/rp_note.txt b/raw/filings/0000896493/2015/0001437749-16-028665/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000896493/2015/0001437749-16-028665/rpt_disclosure.txt b/raw/filings/0000896493/2015/0001437749-16-028665/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..80eeaef16e4015ed21032154325886b7f15f62fd --- /dev/null +++ b/raw/filings/0000896493/2015/0001437749-16-028665/rpt_disclosure.txt @@ -0,0 +1,11 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +Relationship with Telkoor Power Supplies Ltd. +In the years ended December 31, 2015 and 2014, we purchased approximately $594,000 and $868,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest shareholder, Telkoor, of which Ben-Zion Diamant is the Chief Executive Officer and its controlling shareholder. We had no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. In Januar 2016, Telkoor sold its commercial intellectual property to Advice Electronics Ltd. As a result, of that date no further orders have been placed with Telkoor. +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest shareholder, Telkoor Telecom Ltd., of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL has paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor Telecom Ltd. sold its assets, including it subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Acquisition of Shares of Telkoor +On June 16, 2011 we acquired 1,136,666 shares of Telkoor, a major shareholder of the Company which was listed on the Tel Aviv Stock Exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations. As of December 31, 2105 the shares represented 8.4% of the outstanding shares of Telkoor which have since de-listed from the Tel Aviv Stock Exchange. +34 +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. We incurred $44,000 in Telkoor royalty expense in 2013. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016 , Telkoor sold all its commercial IP to Advice Electronics Ltd. ("Advice”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under DPC branding until December 2020. \ No newline at end of file diff --git a/raw/filings/0000896493/2016/0001437749-17-006372/filing.txt b/raw/filings/0000896493/2016/0001437749-17-006372/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..0014a3cdeee6f2b93d7d15013c7bb396e0c1ff5b --- /dev/null +++ b/raw/filings/0000896493/2016/0001437749-17-006372/filing.txt @@ -0,0 +1,2668 @@ +10-K +1 +dpw20161231_10k.htm +FORM 10-K +dpw20161231_10k.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2016 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ___________ to __________ +Commission File Number 1-12711 +DIGITAL POWER CORPORATION +(Exact name of registrant as specified in its charter) +California +94-1721931 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +48430 Lakeview Blvd, Fremont, California 94538-3158 +(Address of principal executive offices, including zip code) +510-657-2635 +(Registrant's telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of each exchange on which registered +Common Stock, no par value +NYSE MKT +Securities registered pursuant to Section 12(g) of the Act: +Title of Each Class +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☐ No ☑ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. +Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes ☑ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☐ (do not check if a smaller reporting company) +Smaller reporting company ☑ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). +Yes ☐ No ☑ +As of June 30, 2016, the aggregate market value of the voting common stock held by non-affiliates was approximately $1,601,000 based upon the closing price of the common stock on the NYSE MKT on that date. Shares of common stock held by each officer and director and by each person who owns 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of April 5, 2017, the number of shares of common stock outstanding was 9,216,853 . +DOCUMENTS INCORPORATED BY REFERENCE +None. +INDEX +Page No. +Forward-Looking Statements +1 +PART I +Item 1. +Description of Business. +1 +Item 1A. +Risk Factors. +8 +Item 1B. +Unresolved Staff Comments. +16 +Item 2. +Description of Property. +16 +Item 3. +Legal Proceedings. +17 +Item 4. +Mine Safety Disclosures. +17 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +17 +Item 6. +Selected Financial Data. +18 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations. +18 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk. +24 +Item 8. +Financial Statements and Supplementary Data. +24 +Item 9. +Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. +24 +Item 9B. +Other Information +26 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance. +26 +Item 11. +Executive Compensation. +31 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +35 +Item 13. +Certain Relationships and Related Transactions, and Director Independence. +36 +Item 14. +Principal Accountant Fees and Services. +39 +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +40 +i +Forward Looking Statement +As used in this annual report, the terms “we,” “us,” “our,” “Company,” “Digital,” or “Digital Power,” mean Digital Power Corporation, a California corporation, and its subsidiaries unless otherwise indicated. +The following information should be read in conjunction with the Consolidated Financial Statements and the notes thereto located elsewhere in this Annual Report on Form 10-K. This Report, and in particular “Management's Discussion and Analysis of Financial Condition and Results of Operations,” contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In this report, the words "believes," "anticipates," "intends," "expects," "plans," "should," "will," "seeks" and words of similar import identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: our history of net losses; our intent to develop business in new areas and markets, our dependence on third parties, including Advice Electronics Ltd., to design certain of our standard products; the possible limits of our strategic focus on our power supply component competencies; our dependence on a few major customers; uncertainty of market acceptance of our products; the effects of the ongoing slowdown affecting world financial markets; and other factors referenced in "Risk Factors" and other sections of this Annual Report. Given these uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. +PART I +ITEM 1. +Business. +General +We are a growth company seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy that occurred as a result of a change in control completed in September 2016. Our acquisition and development target strategy includes companies that have developed a “new way of doing business” in mature, well-developed industries experiencing changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; companies that are related to our core business in the commercial and defense industries; and companies that will enhance our overall revenues. It is our goal to substantially increase our gross revenues in the near future. +We were originally a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the medical, military, telecom and industrial markets. Although we intend to seek growth through acquisitions, we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. +We also have operations located in Europe through our wholly-owned subsidiary, Digital Power Limited ("DPL"), Salisbury, England, which operates under the brand name of “Gresham Power Electronics” (“Gresham”). DPL designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products . +We are a California corporation formed in 1969 and located in the heart of the Silicon Valley at 48430 Lakeview Blvd, Fremont, California 94538-3158. Our phone number is 510-657-2635 and our website address is www.digipwr.com. +1 +Recent Events – Change of Control +On September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, LLC (“Philou Ventures”), a Wyoming limited liability company, and Telkoor Telecom Ltd., an Israeli company (“Telkoor”) pursuant to which the Philou Ventures agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock. In consideration for such shares, Philou Ventures agreed to pay Telkoor $1.5 million. On September 22, 2016, the sale between Telkoor and Philou Ventures closed and Philou Ventures became the Company’s largest shareholder with Telkoor no longer being associated with the Company. Further, in conjunction therewith, Messrs. Israel Levi, Haim Yatim, and Ben-Zion Diamant resigned from the board of directors of the Company and the remaining members of the board of directors of the Company consisting of Mr. Amos Kohn and Mr. Moti Rosenberg filled one of the vacancies caused by the resignations by appointing Mr. Robert O. Smith to the board. Shortly thereafter, on October 13, 2016, Kristine Ault and William Horne were appointed to the board of directors. +Strategy +Our strategy to increase revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business of power system solutions for the military-aerospace, medical and industrial-telecommunication industries, we have determined that significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient sales and marketing force as a result of deferring research and development of new products because of limited working capital, and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution companies. +Therefore, we believe that the best strategy for us and our shareholders is to invest our core business to support releases of advanced new power technologies and to expand our customer base and market share in our major serving markets. To support the organic growth, we have hired number of additional personal and investing to enhance our product offerings with state of the art technology. While we implementing new organic growth strategy, we are focusing on finding and acquiring companies which have developed new technology and but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies that enhance our overall revenues. Further, as discussed below, we have made a recent investment in Avalanche International, Corp. which has acquired rights to a company that has developed a cost effective and environment friendly material synthesis technology for textile applications. +As a result of this strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase in infrastructure expenses to seek new opportunities and investing in companies that demonstrate revenue potential, but our initially incurring losses, we anticipate to continue to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Core Business – Power Systems Solutions +We provide the highest density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and modify-standard product solutions and value-added services to diverse industries and markets including military-aerospace, medical and industrial- telecommunication. We believe that our solutions leverage a combination of low leakage power emissions, very high power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +2 +Our strategy is to be the supplier of choice to those companies and OEMs requiring high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that support all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. Our target market segments include the industrial - telecommunication, medical, and military-aerospace industries. +Custom Power System Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution technology includes full Digital Signal Processing (“DSP”) control, digital load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customer’s unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“IP”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“PFC”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages and unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to original equipment manufacturers (“OEMs”). We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating a complex, time-consuming and costly integration. We believe that this value-added service is well suited to those OEMs who wish to reduce their vendor base and minimize their investment in manufacturing that leads to increased fixed costs. Based on these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Our products have a warranty period from date of shipment to the customer. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic corporation, Digital Power Corporation; the European marketplace is served through DPL, our wholly-owned subsidiary. +3 +We sell products to our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2017 . +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture our military products by a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ITAR”) and is certified to perform such manufacturing services. We are compliant with the US ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned Aerial Vehicle) – Very lightweight power systems . +Our military products meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary DPL develops and manufactures some military and defense products mainly being deployed in international naval fleets. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom , designs, manufactures, and distributes switching power supplies, uninterruptible power supplies, and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“Gresham”). Frequency converters manufactured by Gresham are used by naval warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +4 +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low cost manufacturing goals with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and in Asia. +We sell certain products that are developed, manufactured and sold to us by Advice Electronics Ltd. (“Advice”), an Israeli company that acquired the assets and commercial operations of our major shareholder Telkoor in January 2016. We entered into a manufacturing and royalty rights agreement with Advice in January 2016. This agreement formalized the business relationship between Advice and us in order to allow us to continue manufacturing certain of Telkoor’s products (currently owned by Advice) and the respective royalty charge. +In June 2015, OHM Power Solutions Ltd. (“Ohm”) acquired from Telkoor its entire military assets and military operation. The asset sale between Telkoor and Ohm does not affect our ability to manufacturing and sell certain of Telkoor’s military products. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Any future restrictions or charges may be imposed by the United States or any other foreign country. In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs that are funded and governed by the e U.S. Foreign Military Financing program. +5 +Sales and Marketing +We market our products directly through our internal sales force as well as through our channel partners including independent manufacturer representatives (Reps) and distributors. Each manufacturing Rep promotes our products in a particular assigned geographic territory. Generally, the Reps have the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving its marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales for retention, payable after products were shipped to the customer in the assigned territory. Typically, either we or the Reps are entitled to terminate the Rep agreement upon 30 days’ written notice. +Historically, we have also sold products through multiple power focused distributors. Distributors are not assigned to a particular geographical territory. Each of these arrangements can be terminated by either party upon 30 days’ written notice. +We provide comprehensive collateral including product data sheets, participation in trade shows, and our website, www.digipwr.com. We use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our website and accessible to the marketplace. We will continue to enhance our website by adding more features and functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of our product development projects to engineering partners in order to achieve the best technological and product design results for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the shelf (“COTS”) products and for other customized product requirements, when applicable. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering integrating laboratory located in California. +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products comparable in quality to ours. Many of our competitors, including Bel Fuse), Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +6 +We anticipate in the current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to whom we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of output product design platforms. We believe we have a competitive position with our targeted customers who need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“NRE”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +7 +Research and Development +During the years ended December 31, 2016 and 2015, we spent approximately $709,000 and $894,000, respectively, on research and development. +Employees +As of December 31, 2016 we had 26 employees located in the United States and the United Kingdom, of whom six were engaged in engineering and product development, seven in sales and marketing, seven in general operations and six in general administration and finance. All but two of these employees are employed on a full-time basis. None of our employees are currently represented by a trade union. We consider our relations with our employees to be good. +Recent Investments - Avalanche International, Corp. +We have made an investment in Avalanche International Corp. (“Avalanche”) through a series of convertible loans in the aggregate amount of approximately $1,530,000 as of March 31, 2017. Avalanche is a development stage company whose primary business includes manufacturing and distributing of premium vape liquid and distributor of vape accessories and the development and operating of restaurants. More recently, in March 2017, Avalanche contractually acquired the rights to MTIX Limited, an English company located in Huddersfield, West Yorkshire, U.K. that owns the proprietary rights for the development of a cost effective and environmentally friendly material synthesis technology for textile applications. MTIX’s Multiplexed Laser Surface Enhancement “MLSE TM ” technology utilizes combined high powered pulsed UV laser and atmospheric plasma to create high energy reaction zone at substrate interface promoting rapid synthesis to achieve the required functional treatments. On March 15, 2017, we announced that we had entered into a $50 million purchase order with MTIX to manufacture, install and service fabric treatment machines that utilize MTIX’s proprietary MLSE™ system. The purchase order is subject to standard terms and conditions including that MTIX can cancel its order at any time subject to payment for expenses incurred and other contractually agreed expenses owed due to the cancellation of the purchase order. No assurance can be given that MTIX will order $50 million in fabric machines which are the subject of the purchase order. +ITEM 1A. Risk Factors +An investment in our securities is speculative and involves a high degree of risk. Our business, financial condition or results of operations could be adversely affected by any of these risks. You should carefully consider the following factors as well as the other information contained in other reports that we file with the SEC before deciding to invest in our securities. The risks and uncertainties we have described are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our operations. Past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. If any of these risks actually occurs, our business, business prospects, financial condition or results of operations could be seriously harmed. This could cause the trading price of our shares of common stock to decline, resulting in a loss of all or part of your investment. Please also read carefully the section “Forward-Looking Statements” at the beginning of this Annual Report. +We generated operating and net losses for the years ended December 31, 2016 and 2015. +We have historically experienced operating and net losses, and anticipate continuing to experience such losses in the future. For the years ended December 31, 2016 and 2015, we had an operating loss of approximately $1,219,000 and $1,003,000 and net losses of approximately $1,122,000 and $1,096,000, respectively. Although we have actively taken steps to increase our revenue and reduce manufacturing and operating costs, we anticipate incurring operating and net losses in the future until we increase revenues. +8 +Our Growth Strategy Is Risky . +Our growth strategy through acquisitions is risky. Some of the companies that we have identified to acquire or make a significant investment in may not have a developed business or are experiencing inefficiencies and incurring losses. Therefore, we may lose our investment in the event that these companies’ businesses do not develop as planned or that we are unable to achieve the cost efficiencies or reduction of losses as anticipated. +Further, in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement our plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that provide revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development and investments will produce sufficient revenues to offset these increases in expenditures. +If we do not satisfy the NYSE requirements for continued listing or are unable to fulfill our compliance plan, our common stock could be delisted from NYSE. +The listing of our common stock on the NYSE MKT is contingent on our compliance with the NYSE MKT's conditions for continued listing. On December 18, 2015, we were notified by the NYSE MKT that we were no longer in compliance with the NYSE MKT continued listing standards because our last reported stockholders' equity was below continued listing standards. The NYSE MKT requires that a listed company's stockholders' equity be $4.0 million or more if it has reported losses from continuing operations and/or net losses in three of its four most recent fiscal years. The NYSE MKT has indicated that we may be required to attain stockholders’ equity of $6.0 million or more if we experience a loss for the year ended December 31, 2016, which we did experience . +Following submission of our compliance plan demonstrating how we intend to regain compliance with the continued listing standards, we were notified on March 9, 2016 that the NYSE MKT granted us a listing extension on the basis of our plan until June 19, 2017. We are subject to periodic review by NYSE MKT staff during the extension period. Failure to make progress consistent with the plan or to regain compliance with the continued listing standards by the end of the extension period could result in our common stock being delisted from the NYSE MKT. +There is no assurance that we will be able to regain compliance with the abovementioned standard or any other applicable NYSE MKT continued listing standard. Upon such an occurrence, trading of our common stock will be suspended by the NYSE MKT and we may be delisted by the NYSE MKT. In the event our common stock is no longer listed for trading on the NYSE MKT, our trading volume and share price may decrease and we may experience further difficulties in raising capital which could materially affect our operations and financial results. +We Will Need to Raise Additional Capital to Increase our Stockholders’ Equity and to Fund our Operations in Furtherance of Our Business Plan. +We will need to quickly raise additional capital in order to increase our stockholders’ equity in order to meet the NYSE MKT continued listing standards and to fund our operations in furtherance of our business plan. The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, debt securities, units consisting of the forgoing securities, equity investments from strategic development partners or some combination of each. Any additional equity financings may be financially dilutive to, and will be dilutive from an ownership perspective to our stockholders, and such dilution may be significant based upon the size of such financing. Additionally, we cannot assure that such funding will be available on a timely basis, in needed quantities, or on terms favorable to us, if at all. +9 +A Principal Stockholder Has Significant Influence Over Us. +Per its filings with the SEC, Philou Ventures own approximately 30.8% of our current outstanding common stock. As a result, they will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of the combined company’s assets, and any other significant corporate transaction. Their interests may not always coincide with those of our other stockholders. +A Principal Stockholder Has Certain Rights to Maintain Its Ownership Interest in Us +In connection with entering into a Series B Preferred Stock purchase agreement with Philou Ventures, we granted the right to Philou Ventures to participate in future offering under substantially the same term of such offerings in order to allow Philou Ventures to maintain its ownership interest. If exercised by Philou Ventures, this contractual right granted to it has the effect of allowing Philou Ventures to maintain its interest in us and dilute existing shareholders’ ownership interests. +Our Success Is Dependent On Key Management +Our success depends substantially on the performance of certain key officers and personnel, in particular their ability to identify, acquire and operate new businesses and opportunities. The loss of services of Messrs. Ault or Kohn could have a material adverse effect on our business, results of operations, financial condition and prospects. We have not obtained key person insurance for these individuals. +We Have Pledged All Of Our Assets. +We have entered into a 12% Secured Convertible Note with a face value of $530,000 due October 20, 2019, that is secured by all of our assets. The 12% Secured Convertible Note includes standard events of default. If we default under the 12% Secured Convertible Note, the holder may accelerate the due date of our repayment obligation. At such time, we may not have enough available cash to repay the 12% Secured Convertible Note and the holder could take control of and sell our pledged assets. An event of default could significantly harm our financial condition, operating results, business, and prospects and cause the price of our common stock to decline. +We depend on Advice Electronics Ltd. (“Advice”) to maintain the technology used to manufacture our products and to manufacture some of our products. We also depend on the right to manufacture certain products subject to royalty payments with Advice. +In January 2016, Telkoor, a prior affiliate, sold its entire commercial assets to Advice which included without limitation product IP, manufacturing rights, customer base, inventory, staff and technological capabilities. Following such transaction, we entered into a manufacturing and distribution agreement with Advice. This agreement allows us to manufacture certain Advice products (formerly owned by Telkoor) through August 2017 against royalty payments. From August 2017 through December 2020, subject to Advice's consent, we will be allowed to continue distributing and selling certain Advice products while keeping product branding under our brand, after which we will be entitled to distribute the products under Digital Power Corporation brand until December 2020. +10 +We depend on Advice to design and retain product technology up to date and for manufacturing capabilities for certain of the products that we sell. If Advice is unable or unwilling to continue designing or manufacturing our products in required volumes and with a certain level of quality on a timely basis, that could lead to loss of sales and adversely affect our operating results and cash position. We also depend on Advice's intellectual property and ability to transfer production to third party manufacturers. Failure to obtain new products in a timely manner or delay in delivery of products to customers will have an adverse effect on our ability to meet our customers’ expectations. In addition, we operate in highly competitive markets where our ability to sell Advice’s products could be adversely affected by Advice's agreements with third parties, long lead-times and the high cost of Advice’s products. Also, in 2012, Telkoor’s products manufacturing lead-times increased, which hindered our ability to respond to our customers’ needs in timely manner. Advice's principal offices, research and development and manufacturing facilities are located in Israel. Political, economic, and military conditions in Israel directly affect Advice operations. We are also dependent upon Advice’s terms and conditions with its contract manufacturers for some of our products, which terms and conditions may not always be in our best interest. In 2010, we purchased certain IP from Telkoor in order to reduce our dependency on Telkoor with respect to a certain line of products. We also entered into a Manufacturing Rights Agreement with Advice in 2016, pursuant to which we were granted the non-exclusive right to directly place purchase orders for certain products from a third party manufacturer in consideration for payment of royalties to Advice. This agreement currently accounts for a significant portion of our sales. In the event this agreement is terminated for any reason, it would materially affect our financial position. +We are dependent upon our ability, and our contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, there is a global shortage of certain electronic components, which has extended our production lead-time and our production costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. Such redesign efforts may require certain regulatory and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in place, and issues may recur in the future. +In addition, some of our products are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While we have had relationships with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our ability to manufacture our products. +Our strategic focus on our custom power supply solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, including those involving our personnel, which may negatively impact quarterly earnings and profitability as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +11 +We are dependent upon our ability to attract, retain and motivate our key personnel. +Our success depends on our ability to attract, retain and motivate our key management personnel, including, but not limited to, our President and Chief Executive Officer, our Vice Preseident of Finance, marketing and sales personnel, and key engineers necessary to implement our business plan and to grow our business. Competition for certain specific technical and management skill sets is intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or more of our present key employees were to cease to be associated with us, our future results could be adversely affected. +We depend upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon a few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or cancel their orders scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, a substantial decrease in our revenues would likely result. We are dependent on the electronic equipment industry, and accordingly will be affected by the impact on that industry of current economic conditions. +Substantially all of our existing customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations or rescheduling of, orders or shipments, any of which would materially harm our business. +We outsource, and are dependent upon developer partners for, the development of some of our custom design products. +We made an operational decision to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +12 +We face intense industry competition, price erosion and product obsolescence, which, in turn, could reduce our profitability. +We operate in an industry that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price erosion in the future. +Our future results are dependent on our ability to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell our products through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as with manufacturers’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which would have an adverse effect on our revenues. +We may not be able to procure necessary key components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, our suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that we require to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect on our gross margins and on our results of operations. +Although we depend on sales of our legacy products for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large portion of our sales have historically been attributable to our legacy products. We expect that these products may continue to account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining. Although we are unable to predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and sell new products such as custom design and value added products. We cannot assure you that we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell new products. +13 +Our operating results may vary from quarter to quarter. +Our operating results have in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our operating results for such quarter. It is possible that, in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly. +Failure of our information technology infrastructure to operate effectively could adversely affect our business. +We depend heavily on information technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory restrictions relating to our international sales. +Some of our products are subject to International Traffic In Arms Regulation (“ITAR”), which are interpreted, enforced and administered by the U.S. Department of State. ITAR regulation controls not only the export, import and trade of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services as well as foreign production. Any delays in obtaining the required export, import or trade licenses for products subject to ITAR regulation and rules could have a material adverse effect on our business, financial condition, and/or operating results. In addition, changes in United States export and import laws that require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions or charges imposed by the United States or any other country on our international sales or foreign subsidiary could have a materially adverse effect on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program (“FMF”). Any such future sales would be subject to these regulations. Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial condition, and/or operating results. +We depend on international operations for a substantial majority of our components and products. +We purchase a substantial majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect on our business, financial condition, and/or operating results. +14 +We depend on international sales for a portion of our revenues. +Sales to customers outside of North America accounted for 40.2% and 55.8% of net revenues for the years ended December 31, 2016 and 2015, and we expect that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts receivable, and currency restrictions. In addition, DPL, our wholly-owned subsidiary in the United Kingdom, supports our European and other international customers, distributors, and sales representatives, and therefore is also subject to local regulation. International sales are also subject to the export laws and regulations of the United States and other countries. +If our accounting controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating our internal control over financial reporting in order to comply with Securities and Exchange Commission (“SEC”) rules relating to internal control over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such internal control, we may be subject to regulatory sanctions, and our reputation may decline. +The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products and adversely affect the revenues from such products. +Our limited ability to protect our proprietary information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, we may be required to institute legal proceedings, which would be costly and would divert our resources from the development of our business. If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results could be adversely affected. +Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the United States or abroad. +15 +If we are unable to satisfy our customers’ specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be harmed. +Our customers demand that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, any of which would harm our business. +If we ship products that contain defects, the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate. +Our common stock price is volatile. +Our common stock is listed on the NYSE MKT. In the past, our trading price has fluctuated widely, depending on many factors that may have little to do with our operations or business prospects. The exercise of outstanding options and warrants may adversely affect our stock price and a shareholder’s percentage of ownership. As of December 31, 2016, we had outstanding options to purchase an aggregate of 2,256,000 shares of common stock, with a weighted average exercise price of $0.83 per share, exercisable at prices ranging from $0.65 to $1.69 per share and warrants to purchase up 1,749,126 shares of common stock at exercise prices ranging from $0.01 to $0.90 per share. +In addition, we have contractually agreed to register shares of common stock, and common stock underlying outstanding warrants and convertible debt in connection with private placement of our securities. Our shares of common stock are thinly traded. Therefore, the resale of a large number of shares of common stock and common stock underlying warrants and convertible debt by the selling stockholders may adversely affect the market price of our common stock. +Item 1B. +Unresolved Staff Comments. +Not applicable. +Item 2. +Properties. +Our headquarters utilize 12,396 square foot of leased office, engineering, laboratory, and warehouse space in Fremont, California. Our headquarter lease commenced on November 1, 2012 and expires on June 30, 2019. The annual base rent under the lease, payable on a monthly basis, increases during the term of the lease from approximately $138,000 during the first year to approximately $160,000 during the final year. The lease also provides for one option to renew for a term of five years. +16 +In September, 2010, our wholly-owned subsidiary, DPL, entered into a fifteen-year lease for its 25,000 square-foot facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military power products for the European market. Sales and service support staff for its European network of distributors are located within the building together with other functions, such as engineering and administration. DPL’s rent expense is approximately $12,000 per month, and DPL has the option to cancel the lease after ten years. +We currently anticipate that the current leased space will be sufficient to support our current and foreseen future needs. +Item 3. Legal Proceedings. +None. +Item 4. Mine Safety Disclosures. +Not Applicable +PART II +Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases Of Equity Securities. +(a) +Market Information. +Our common stock is listed on the NYSE MKT under the symbol DPW. The following table sets forth our high and low sale prices on the NYSE MKT through March 31, 2017 and for each quarter for the past two fiscal years. +NYSE-MKT +2017 +High +Low +January 1, 2017 through March 31, 2017 +$ +1.75 +$ +0.59 +For 2016 +December 31, 2016 +$ +0.85 +$ +0.52 +September 30, 2016 +$ +1.40 +$ +0.39 +June 30, 2016 +$ +0.62 +$ +0.35 +March 31, 2016 +$ +0.60 +$ +0.39 +For 2015 +December 31, 2015 +$ +0.82 +$ +0.54 +September 30, 2015 +$ +0.95 +$ +0.61 +June 30, 2015 +$ +1.25 +$ +0.79 +March 31, 2015 +$ +1.30 +$ +0.87 +(b) +Holders +As of March 31, 2017, there was an aggregate of 8,856,851 shares of our common stock outstanding, held by approximately 68 holders of record. +17 +(c) +Dividends +We have not declared or paid any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends in the future, if any, will be at the discretion of our Board of Directors and will depend upon our earnings, capital requirements, and financial position. +(d) +Securities Authorized for Issuance Under Equity Compensation Plans +The following table sets forth information as of December 31, 2016, with respect to compensation plans under which our shares of common stock are authorized for issuance, aggregated as follows: +• All compensation plans previously approved by security holders; and +• All compensation plans not previously approved by security holders. +Equity Compensation Plan Information +Name +Number of securities to +be issued upon exercise +of outstanding options, +warrants and rights +Weighted-average +exercise price of +outstanding options, +warrants and rights +Number of securities +remaining available for +future issuance under +equity compensation +plans(excluding +securities in column (a) +(a) +(b) +(c) +Equity compensation plans approved by security holders +2,256,000 +$ +0.83 +3,322,630 +Equity compensation plans not approved by security holders +317,460 +0.01 +- +Total +2,573,460 +3,322,630 +Item 6. Selected Financial Data. +Because we are a smaller reporting company, this section is not applicable. +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +General +Our business strategy is to grow the Company by making strategic acquisitions. We are a solution-driven organization that designs, develops, manufactures and markets high-grade, customized and flexible power solutions for demanding applications in the medical, military, telecom, and industrial markets. Our products serve global markets worldwide. Revenues are generated from selling products to our customers directly by our sales force and through manufacturing representatives and distributors. The forgoing discussions may not be indicative of our future. +Our net loss was $1,122 ,000 for the year ended December 31, 2016 compared to a net loss of $1,096,000 for the year ended December 31, 2015. Our net loss for the year ended December 31, 2016 includes expenses that related to our growth plan and approximately $543,000 of stock compensation expense. During 2016 our cash decreased by $245 ,000. +To fulfill our business plan and strategy, we will actively seek additional capital to finance our operations for the next 12 months. +18 +Foreign Currency Fluctuations +Our wholly-owned subsidiary, DPL, operates using the United Kingdom pound sterling. Therefore, we are subject to monetary fluctuations between the U.S. dollar and the United Kingdom pound sterling. The financial statements of the subsidiary which are included in our consolidated financial statements have been translated into U.S. dollars. For the year ended December 31, 2016 and 2015, we recorded a foreign currency translation loss of $362,000 and $100,000 as reported in our consolidated statements of comprehensive income (loss). +Results of Operations +The table below sets forth certain statements of operations data as a percentage of revenues for the years ended December 31, 2016 and 2015: +Years Ended December 31 +2016 +2015 +Revenues +100.00 +% +100.00 +% +Cost of revenues +64.38 +65.07 +% +Gross profit +35.62 +34.93 +Engineering and product development +9.33 +11.51 +Sales and marketing +12.06 +15.39 +General and administrative +30.29 +20.97 +Total Operating expenses +51.67 +47.87 +Operating loss +(16.06 +) +(12.94 +) +Impairment of investment +- +(1.56 +) +Other income, net +1.01 +0.21 +Loss before tax +(15.05 +) +(14.29 +)% +Tax Income (benefit) +0.26 +0.01 +Net loss +(14.79 +)% +(14.28 +)% +The following discussion and analysis should be read in connection with the consolidated financial statements and the notes thereto and other financial information included elsewhere in this Annual Report. We prepared the financial statements in accordance with U.S. generally accepted accounting principles, which requires management to make estimates, and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. +Year Ended December 31, 201 6 Compared to Year Ended December 31, 201 5 +Revenues +For the year ended December 31, 2016, revenues decreased by 2.2 % to $7,596,000 from $7,766,000 for the year ended December 31, 2015. The decrease is attributed to a decline in value of military product orders shipped by DPL . +Revenues derived from our defense products for the year ended December 31, 2016 were $2,289,000, a decrease of 22.8% from revenues of $2,964,000 from defense products for the year ended December 31, 2015. The decrease was primarily attributable to a decrease of sales of major international naval military contracts in 2016. Revenues derived from our commercial products for the year ended December 31, 2016 increased by 10.5% to $5,307,000 from $4,802,000 for the year ended December 31, 2015 . The increase in commercial product revenue in 2016 resulted primarily from sales of commercial products by our domestic operation . +19 +Revenues from our domestic operations increased by 18 .8% to $4,552,000 for the year ended December 31, 2016, from $3 ,833,000 for the year ended December 31, 2015. The increase in revenue is mostly attributable from a rising sales volume of commercial and military products in North America. +Revenues from our European operations (Gresham/DPL) decreased 22.6% to $3,044,000 for the year ended December 31, 2016 compared to $3 ,933,000 for the year ended December 31, 2015. The decrease was primarily attributable to a decrease of military product sales and the impact of a weakening of the British Pound and Euro against the USD. +Gross Profit Margins +Gross margins were 35.62% for the year ended December 31, 2016, compared to 34 .9% for the year ended December 31, 2015 . The slight increase in gross margins for the year ended December 31, 2016 compared to the prior year 2015 was mainly attributable to the increase in profitability of our commercial products sold by our U.S . operations. +Engineering and Product Development +Engineering and product development expenses were $709,000, or 9.3% of revenues, for the year ended December 31, 2016, compared to $894,000, or 11.5% of revenues , for the year ended December 31, 2015. The overall decrease in our engineering and product development expenses for the comparative year was primarily related to the completion of custom product development efforts for medical and broadband applications, which lowered the amount of outside contracted engineering services incurred by our U.S . operations . +Selling and Marketing +Selling and marketing expenses were $916,000, or 12.1% of revenues, for the year ended December 31, 2016, compared to $1,195,000, or 15.4% of revenues, for the year ended December 31, 2015. The decrease in sales and marketing expenses for the comparative period was primarily the result of reduction in sales staff. The decrease in selling and marketing expenses for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily the result of a temporary decrease in direct manpower cost due to a reduced headcount. In July 2015 the Company hired two senior sales who were dismissed in December 2015. +General and Administrative +General and administrative expenses were $2,300,000, or 30.29% of revenues, for the year ended December 31, 2016, compared to $1,627,000, or 20.9% of revenues, for the year ended December 31, 2015. The increase in our general and administrative expenses for the comparative period was mainly due to higher stock based compensation expenses which accounted for a $322,000 increase from 2015 to 2016, an increase in legal costs related to the Telkoor and Philou Ventures transaction and an increase in investor relationship costs . +Impairment of investment +No impairment related to our investment in Telkoor was recognized for the year ended December 31, 2016. For the year ended December 31, 2015, we recognized an $110 ,000 impairment expense related to our Telkoor investment. On September 22, 2016, we sold our investment in Telkoor back to Telkoor for $90,000 which was equal to the carrying amount of the investment. +Other Income, Net +Other income, net was $77,000 for the year ended December 31, 2016 and consisted of foreign currency transaction gains of $110,000 offset by non-cash interest expense resulting from the accretion of discount on our 12% Secured Convertible Note plus contractual interest compared to $16,000 for the year ended December 31, 2015 which consisted only of foreign currency transaction gains. +20 +Net Loss +For the year ended December 31, 2016, we had a net loss of $1,122,000 compared to a net loss of $1,096,000 for the year ended December 31, 2015. +Other comprehensive income (loss) +Other comprehensive loss was $362,000 and $100,000, respectively, for the years ended December 31, 2016 and 2015. The significant other comprehensive loss for the year ended December 31, 2016, which decreased our equity reflects the impact of the weakening of the British Pound on the equity of our UK-based subsidiary DPL following the referendum in the UK on membership in the European Union. +Critical Accounting Policies +The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported assets, liabilities, revenues, and expenses in the accompanying consolidated financial statements. Critical accounting policies are those that require the most subjective and complex judgments, often employing the use of estimates about the effect of matters that are inherently uncertain. The following are considered our most critical accounting policies that, under different conditions or using different assumption or estimates, could show materially different results on our financial condition and results of operations . +Revenue Recognition +Revenue from product sales is recognized in accordance with the provisions of ASC 605-15, "Revenue Recognition in Financial Statements", when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred (when risk of loss and title have transferred to the customer), the sale price is fixed or determinable and collection is reasonably assured. +We generally use customer purchase orders and contracts to determine the existence of an arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. We assess whether the sales price is fixed or determinable based on the payment terms associated with the transaction and whether the price is subject to refund or adjustment. We assess collectability based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. +Revenue on shipments to distributors and resellers is recognized on delivery. Generally, we do not grant a right of return. However, certain distributors are allowed, in the sixth month after the initial stock purchase, to rotate stock that has not been sold for other products. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. +Inventory Obsolescence Accruals +We periodically assess our inventory valuation by reviewing revenue forecasts and technological obsolescence. We write down the value of obsolete or unmarketable inventory to the estimated net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs would be necessary. +During 2016 and 2015, we recorded inventory write-down of $84,000 and $9 ,000, respectively. +21 +Allowance for Doubtful Accounts +Our accounts receivable are derived from sales to customers located primarily in the U.S. and Europe. We perform ongoing credit evaluations of our customers’ financial condition and currently require no collateral from our customers. An allowance for doubtful accounts for estimated losses is maintained in anticipation of the inability of customers to make required payments. The allowance for doubtful accounts as of December 31, 2016 and 2015 was $32,000 and $0, respectively . When we become aware that a specific customer is unable to meet its financial obligations as a result of bankruptcy or the deterioration of the customer’s operating results or financial position, for example, we record a specific allowance to reflect the level of credit risk in the customer’s outstanding receivable balance. We are not able to predict changes in the financial condition of customers, and if the condition or circumstances of our customers deteriorates, estimates of the recoverability of trade receivables could be materially affected and we may be required to record additional allowances. Alternatively, if our estimates are determined to be greater than the actual amounts necessary, we may decrease a portion of such allowance in future periods based on actual collection experience. +Marketable Securities +We classify our investment in shares of common stock of Telkoor and Avalanche International Corp. (“Avalanche”) in accordance with Accounting Standards Codification (ASC) 320, "Investment in Debt and Equity Securities" (ASC No. 320”) and ASC 325, “Investment – Other” (“ASC No. 325’). Marketable securities classified as “available for sale securities” are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of shareholder’s equity in "accumulated other comprehensive loss" in equity. When evaluating the investment for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not that we will be required to sell the investment before recovery of the investment's amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC 325-20. +We did not record any impairment of our investments in Telkoor or Avalanche during the year ended December 31, 2016. For the year ended December 31, 2015, we recognized an impairment of our investment in Telkoor in the amount of $110,000. On September 22, 1016, we sold our shares in Telkoor back to Telkoor for $90,000 which represented our book value. +Equity-based Compensation Expense +We account for equity-based compensation in accordance with ASC 718, “Compensation – Stock compensation” ("ASC 718"). Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense over the requisite service periods. Determining the fair value of share-based awards at the grant date requires the exercise of judgment, including the amount of share-based awards that are expected to be forfeited. Estimated forfeitures are based on historical pre-vesting forfeitures. If actual results differ from these estimates, equity-based compensation expense, and therefore our results of operations, could be impacted. +We estimate the fair value of stock options granted under ASC 718, using the Black-Scholes option-pricing model, which uses the following assumption: +Expected volatility is based on historical volatility, which is representative of future volatility over the expected term of the options. The expected term of options granted was determined based on the simplified method, which is calculated as the midpoint between the vesting date and the end of the contractual term of the option. The risk free interest rate is based on the yield of U.S . Treasury bonds with equivalent terms. The dividend yield is based on our historical and future expectation of dividends payouts. We have not paid cash dividends historically and have no plans to pay cash dividends in the foreseeable future. +Convertible Instruments +The Company accounts for hybrid contracts that feature conversion options in accordance with applicable GAAP. ASC 815 “Derivatives and Hedging Activities,” (“ASC 815”) requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under other applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument. +22 +Conversion options that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, in accordance with ASC 470-20 “Debt with Conversion and Other Options” (“ASC 470-20”). Under ASC 470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded conversion options should be bifurcated from their host instruments) in accordance with ASC 815. Under ASC 815, a portion of the proceeds received upon the issuance of the hybrid contract are allocated to the fair value of the derivative. The derivative is subsequently marked to market at each reporting date based on current fair value, with the changes in fair value reported in results of operations. +Common Stock Warrants +The Company classifies as equity any warrants that (i) require physical settlement or net-share settlement or (ii) provide the Company with a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any warrants that (i) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the Company’s control), (ii) gives the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement) or (iii) that contain reset provisions that do not qualify for the scope exception. The Company assesses classification of its common stock warrants and other freestanding derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. The Company’s freestanding derivatives consist of warrants to purchase common stock that were issued in connection with its (i) convertible notes, (ii) equity funding, and (iii) officer of the Company for the services. The Company evaluated these warrants to assess their proper classification and determined that the common stock warrants meet the criteria for equity or liability classification in the balance sheet. The warrants classified as liability are initially recorded at fair value, with gains and losses arising from changes in fair value recognized in other income (expense) in the statements of operations at each period end while such instruments remain outstanding +Liquidity and Capital Resources +On December 31, 2016, we had cash and cash equivalents of $996,000 and working capital of $1,963,000. This compares with cash and cash equivalents of $1,241,000 and working capital of $2,659,000 at December 31, 2015. The decrease in cash and cash equivalents was due mainly to operational losses and our investment in Avalanche International in the form convertible notes in the aggregate amount of $1,036,000. +Net cash used in operating activities totaled $358,000 and $529,000 for the years ended December 31, 2016 and December 31, 2015, respectively. The decrease in net cash used in operating activities for the year ended December 31, 2016, was principally due to a decrease in our operating loss. +Net cash used in investing activities was $1,029,000 for the year ended December 31, 2016, compared to net cash used in investing activities of $306,000 for the year ended December 31, 2015. The increase of the net usage of cash from investing activities was primarily related to the investment in Avalanche. +23 +Net cash provided by financing activities was $1,279,000 and $0 for the year ended December 31, 2016 and December 31, 2015, respectively. The increase in financing activities related to the sale of a $530,000 convertible note for net proceeds of $488,000, a term loan of $250,000 and the sale of $541,000 in units consisting of shares of Common stock and warrants to purchase Common Stock. +Subsequent to year end through April 5, 2017, we sold 1,526,667 shares of common stock at $0.60 to $0.75 per share raising, in the aggregate, $970,000 before expenses. In addition, we sold 25,000 shares of Series B Preferred Stock at $10.00 per share in exchange for the cancellation of debt of $250,000. +We expect to continue to incur losses for the foreseeable future and will be required to raise additional capital to continue to support our working capital requirements. We believe that the MLSE purchase order contract of $50 million by MTIX will contribute to generate meaningful revenue and corresponding cash in 2017. In addition, we have been successful over the last 12 months in raising capital to support our working capital requirements. We will anticipate that we will continue to raise capital through public and private equity offerings, debt financings, or other means. If we are unable to secure additional capital, we may be required to curtail our current operations and take additional measures to reduce costs expenses, including reducing our workforce, eliminating outside consultants, ceasing or reducing review of potential acquisitions and reducing legal fees in order to conserve cash in order to sustain operations and meet our obligations. +Based on the above, we believe that we will have sufficient capital resources to sustain operations through at least the next twelve months from the date of this filing. +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk. +Because we are a smaller reporting company, this section is not applicable +Item 8. +Financial Statements and Supplementary Data. +The financial statements required by this Item 8 are included in this Annual Report following Item 15 hereof. As a smaller reporting company, we are not required to provide supplementary financial information. +Item 9. +Changes In and Disagreements with Accountants on Accounting and Financial Disclosure. +On December 29, 2016, we dismissed Kost Forer Gabbay and Kasierer, a member of Ernst & Young Global (“Kost Forer”) as our independent registered public accounting firm. Our Audit Committee approved the dismissal of Kost Forer. Kost Forer’s report on our consolidated financial statements as of and for the fiscal years ended December 31, 2014 and 2015 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principle. +During the fiscal years ended December 31, 2014 and 2015 and through December 29, 2016, there were (i) no disagreements with Kost Forer on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to Kost Forer’s satisfaction, would have caused Kost Forer to make reference thereon in their report on the financial statements for the fiscal years ended December 31, 2014 and 2015, and (ii) no “reportable events” as that term is defined in Item 304(a)(1)(v) of Regulation S-K. +On January 13, 2017, we, as approved by the Audit Committee, appointed Marcum LLP (“Marcum”) as our independent registered public accounting firm for the fiscal year ended December 31, 2016. During our two most recent fiscal years (fiscal years ended December 31, 2014 and 2015) and during the subsequent interim period through January 13, 2017, neither we nor anyone acting on our behalf consulted with Marcum regarding (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on our financial statements, and neither a written report nor oral advice was provided to us that Marcum concluded was an important factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a disagreement (as defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions) or a reportable event (as described in Item 304(a)(1)(v) of Regulation S-K). +24 +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +As of December 31, 2016, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) were effective as of the end of the period covered by the report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls . Our management has concluded that, as of December 31, 2016, our internal control over financial reporting was effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +25 +Evaluation of Changes in Internal Control over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information . +None +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +The following table sets forth the positions and offices presently held by each of our current directors and executive officers and their ages: +Name +Age +Position Held +Milton C. Ault, III (1) +47 +Executive Chairman of the Board +Amos Kohn +57 +President, Chief Executive Officer, Director +Kristine Ault ( 2 ) +47 +Director +William B. Horne ( 2 ) ( 4 ) +49 +Director +Robert O. Smith ( 3 ) ( 4 ) +73 +Director +Moti Rosenberg ( 4 ) +68 +Director +Uri Friedlander +54 +Vice President of Finance, Chief Accounting Officer +(1) +Effective March 16, 2017, Mr. Ault was appointed to the Board. +(2) +On October 13, 2016, Kristine Ault and William B. Horne were appointed to the Board. Pursuant to a securities purchase agreement dated September 5, 2016 by and among the Company, Philou Ventures, and Telkoor, Philou Ventures has the right to appoint two members to the Board of Directors. +(3) +On September 22, 2016 , Mr. Robert O. Smith was appointed to the board +(4) +Independent Director and Member of the Audit, Compensation and Nominating and Governance Committees. +Each of the directors named above will serve until the next annual meeting of our shareholders or until his respective successor is elected and qualified. Subject to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Mr. Milton “Todd” Ault, III +On March 16, 2017, Mr. Ault, age 47, was appointed Executive Chairman of the Board. Mr. Ault is a seasoned business professional and entrepreneur that has spent more than twenty-seven years identifying value in various financial markets including equities, fixed income, commodities, and real estate. Mr. Ault founded on February 25, 2016 Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s Disease and has served as its Chairman since. Mr. Ault has served as Chairman of Ault & Company, a holding company since December 2015, and as Chairman of Avalanche International Corp since September 2014, a company whose shares are registered under the Exchange Act. Since January, 2011, Mr. Ault has been the Vice President of Business Development for MCKEA Holdings, LLC, a family office. Through this position, Mr. Ault has consulted for a few publicly traded and privately held companies, providing each of them the benefit of his diversified experience, that range from development stage to seasoned businesses. He was the President, Chief Executive Officer, Director and Chairman of the Board of Zealous, Inc. from August 2007 until June 4, 2010 and again from February 2011 through May 1, 2011. Mr. Ault was a registered representative at Strome Securities, LP, from July 1998 until December 2005, where he was involved in portfolio management and worked on several activism campaigns including Taco Cabana, Jack In The Box (formerly Foodmaker), and 21st Century Holdings Co. Mr. Ault became majority shareholder of Franklin Capital Corp and was elected to its board of directors in July 2004 and became its Chairman and Chief Executive Officer in October 2004 serving until January 2006, and again from July 2006 to January 2007. In April 2005, the company changed its name to Patient Safety Technologies, Inc. (OTCBB:PSTX, OTCQB:PSTX) (“PST”) and purchased SurgiCount Medical, Inc. Stryker Corporation (NYSE:SYK) acquired PST at the beginning of 2014 in a deal valued at approximately one hundred twenty million dollars ($120,000,000). PST’s wholly owned operating subsidiary, SurgiCount Medical, Inc., is the company that developed the SafetySponge® System; a bar coding technology for inventory control that aims to detect and prevent the incidence of foreign objects left in the body after surgery. We believe that Mr. Ault’s business background demonstrates he has the qualifications to serve as one of our directors and as Chairman . +26 +Amos Kohn +Amos Kohn, 57, has served as a member of our board of directors since 2003, as our President and Chief Executive Officer since 2008. From March 2011 until August 2013 Mr. Kohn also served as interim Chief Financial Officer. Mr. Kohn has more than 20 years of successful global executive management experience, including multiple C-level roles across private and established, publicly-traded companies. Mr. Kohn has successfully managed cross-functional teams, driven corporations to high profitability, built customer loyalty and led businesses through expansion and sustained growth. His areas of expertise include operations, technology innovation, manufacturing, strategic analysis and planning and M&A. Mr. Kohn was Vice President of Business Development at Scopus Video Networks, Inc., a Princeton, New Jersey company that develops and markets digital video networking products (2006-2007); Vice President of Solutions Engineering at ICTV Inc., a leading provider of network-based streaming media technology solutions for digital video and web-driven programming, located in Los Gatos, California (2003-2006); Chief Architect at Liberate Technologies, a leading company in the development of a full range of digital media processing for telecom and cable TV industries, located in San Carlos, California (2000-2003); and Executive Vice President of Engineering and Technology at Golden Channel & Co., the largest cable television multiple-systems operator (MSO) in Israel, where he had executive responsibility for developing and implementing the entire nationwide cable TV system (1989-2000). Mr. Kohn holds a degree in electrical and electronics engineering and is named as an inventor on several United States and international patents. We believe that Mr. Kohn’s extensive executive-level management experience in diversified industries, including, but not limited to, power electronics, telecommunications, cable television, broadcast and wireless, as well as his service as a director on our board since 2003, give him the qualifications and skills to serve as one of our directors. +Kristine Ault +Kristine Ault, age 47, serves as one of our directors. She is a seasoned business woman who has served as the managing member of a private holding company that make equity investments in other operating businesses since 2011 and has served as a member of our board of directors since October 2016. Prior to that, she worked in the finance department of Strome Securities, L.P. in Santa Monica, California. Ms. Ault was appointed as Trustee for a private trust in 1997 and currently administers four private trusts. Her work experience ranges from ABC Cable Networks to the vineyards of Sonoma and Napa Valley. Ms. Ault holds a B.A . degree in Radio-Television-Film and minor in Business Administration from California State University Northridge. She also received an A.A in Natural Sciences and Mathematics from Napa Valley College. We believe that Ms. Ault's experiences, attributes and abilities in business administration and accounting with equity investments give her the qualifications and skill set to serve as one of our directors. +27 +William B. Horne +William B. Horne, age 49, serves as one of our independent directors. He has served as the Chief Financial Officer of Targeted Medical Pharma, Inc. (OTCBB: TRGM) since August 2013 and has served as a member of our board of directors since October 2016. Mr. Horne is a director of and chief financial officer to Avalanche International, Co., a company whose shares of common stock are registered under the Exchange Act. Mr. Horne previously held the position of Chief Financial Officer in various companies in the healthcare and high-tech field, including OptimisCorp, from January 2008 to May 2013, a privately held, diversified healthcare technology company located in Los Angeles, California. Mr. Horne served as the Chief Financial Officer of Patient Safety Technologies, Inc. (OTCBB: PSTX), a medical device company located in Irvine, California, from June 2005 to October 2008 and as the interim Chief Executive Officer from January 2007 to April 2008. In his dual role at Patient Safety Technologies, Mr. Horne was directly responsible for structuring the divestiture of non-core assets, capital financings and debt restructuring. Mr. Horne held the position of Managing Member & Chief Financial Officer of Alaska Wireless Communications, LLC, a privately held, advanced cellular communications company, from its inception in May 2002 until November 2007. Mr. Horne was responsible for negotiating the sale of Alaska Wireless to General Communication Inc. (NASDAQ: GNCMA). From November 1996 to December 2001, Mr. Horne held the position of Chief Financial Officer of The Phoenix Partners, a venture capital limited partnership located in Seattle, Washington. Mr. Horne has also held supervisory positions at Price Waterhouse, LLP and has a Bachelor of Arts Magna Cum Laude in Accounting from Seattle University. We believe that Mr. Horne's extensive financial and accounting experience in diversified industries and with companies involving complex transactions give him the qualifications and skills to serve as one of our directors. +Robert O. Smith +Robert Smith, age 73, serves as one of our independent directors. Previously, he served as a member of our Board of Directors from November 2010 until May 2015, and served as a member of our Advisory Board from 2002 until 2015. He is currently a C-level executive consultant working with Bay Area high-tech firms on various strategic initiatives in all aspects of their business. From 2004 to 2007, he served on the Board of Directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman of the Board. From 1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of their Compower/Boschert Division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with the JM Smucker Company. Mr. Smith received his BBA degree in Accounting from Ohio University. We believe that Mr. Smith’s executive-level experience, including his previous service as our President, Chief Executive Officer and Chairman of the Board, his extensive experience in the accounting industry, and his service on our Board from November 2010 until May 2015, give him the qualifications and skills to serve as one of our directors. +Moti Rosenberg +Moti Rosenberg, age 70, serves as one of our independent directors. He has served as an independent consultant to various companies in the design and implementation of homeland security systems in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate Ltd., a manufacturer of armor protection systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg was the general manager of ZIV U.P.V.C Products Ltd.'s doors and window factory. Mr. Rosenberg is an active reserve officer and a retired colonel from the Israeli Defense Force (IDF), where he served for 26 years and was involved in the development of weapon systems. In the IDF, Mr. Rosenberg served in various capacities, including platoon, company, battalion, and brigade commander, head of the training center for all IDF infantry, and head of the Air Force's Special Forces. Mr. Rosenberg received a B.A in History from the University of Tel Aviv and a Master of Arts in Political Science from the University of Haifa in Israel. We believe that Mr. Rosenberg’s business background give him the qualifications to serve as one of our directors. +Uri Friedlander +Mr. Friedlander, age 54, has served as Vice President, Chief Accounting officer since October, 2015. Since 1997, Mr. Fridlander has served as the Chief Financial Officer of Telkoor. From 1991 to 1997, Mr. Fridlander was the controller of I.T.L Ltd., a developer of electro optic military systems, and Q.P.S Ltd., a developer of power supplies, units of the Clal Electronics Ltd. Group. From 1986 until 1991 he served as an auditor for Lyboshitz & Kasirer (Arthur Andersen) public accountants. Mr. Friedlander earned a B.A. in accounting and economics from Tel-Aviv University. +28 +Involvement in Certain Legal Proceedings +Except as disclosed below, to our knowledge, none of our current directors or executive officers has, during the past ten years: +● +been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +● +had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time; +● +been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; +● +been found by a court of competent jurisdiction in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated; +● +been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or +● +been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member. +1. Mr. Ault held series 7, 24, and 63 licenses and managed four domestic hedge funds and one bond fund from 1998 through 2008. On April 26, 2012, as a result from an investigation by FINRA involving activities during 2008, Mr. Ault agreed to a settlement with FINRA in which he did not admit to any liability or violation of any laws or regulatory rules and that included restitution and a suspension from association with a FINRA member firm for a period of two years. As part of that settlement, Mr. Ault agreed that he would make restitution to certain investors. Mr. Ault did not within the prescribed time period make a restitution payment to certain of the investors as he was unable to locate all of them, nor did he forward the undistributed restitution in the state where the investor was known to have resided, as directed by FINRA. +2. Mr. Ault was CEO, President and Chairman of Zealous Holdings, Inc. that filed for bankruptcy protection under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) on February 20, 2009, in the U.S. Bankruptcy Court, Central District of California. This Chapter 11 filing was subsequently converted to a Chapter 7 filing by order of the Bankruptcy Court. Zealous Holdings, Inc. was not an entity that was entitled to a discharge under the bankruptcy code. As such Zealous Holdings, Inc. did not receive a discharge. Ultimately, Zealous Holdings, Inc. ceased doing business and was permanently closed. +3. Mr. Ault filed for bankruptcy protection under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) on December 8, 2009, in the U.S. Bankruptcy Court, Central District of California. This Chapter 13 filing was subsequently converted to a Chapter 7 filing by order of the Bankruptcy Court and months later, the petition being withdrawn and dismissed without prejudice. +29 +Except as set forth in our discussion below in “Certain Relationships and Related Transactions,” none of our directors or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC. +Family Relationships. Milton C. Ault, III and Kristine Ault are spouses. +Board and Committee Membership +Our Board is currently composed of five members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at www.digipwr.com . +Audit Committee +Messrs. Horne, Smith, and Rosenberg currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE MKT. Our Board has also determined that Mr. Horne qualifies as an “audit committee financial expert” as defined in SEC regulations and satisfies the financial sophistication requirements set forth in the NYSE MKT Rules. +The Audit Committee is responsible for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Horne, Smith, and Rosenberg currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation Committee meets the requirements for independence under the standards of the NYSE MKT. Mr. Smith serves as Chairman of the Compensation Committee. +The Compensation Committee is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving salaries, bonuses and other benefits paid to our officers, including our Chief Executive Officer and Chief Financial Officer; and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith, Horne, and Rosenberg currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members of the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE MKT. Mr. Rosenberg serves as Chairman of the Nominating and Governance Committee. +The Nominating and Governance Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees for each annual meeting of shareholders to the Board; developing and recommending governance principles applicable to our Board; overseeing the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +30 +The Nominating and Governance Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based business and professional skills, experiences and global business and social perspective. +In addition, the Committee seeks directors who exhibit personal integrity and a concern for the long-term interests of shareholders, as well as those who have time available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, directors and ten percent shareholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based solely upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting persons, we believe that during the during current fiscal year and the year ended December 31, 2016, all such filing requirements applicable to our officers, directors and ten percent shareholders were fulfilled with the following exceptions. +During the fiscal year 2016, Messrs. Horne, Smith and Rosenberg, and Ms. Ault each inadvertently filed late one Form 4 reporting one transaction and Mr. Kohn inadvertently file three Forms 4s late reporting eight transactions . +Code of Ethics +We have adopted the Code of Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller or person performing similar functions (collectively, the “Financial Managers”). The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website at www.digipwr.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request to our President and CEO, Amos Kohn, we will provide without charge, a copy of our Code of Ethical Conduct. +ITEM 11. EXECUTIVE COMPENSATION . +Summary Compensation Table +The following Summary Compensation Table sets forth all compensation earned in all capacities during the years ended December 31, 2016 and 2015, by our Chief Executive Officer (“Named Executive Officer”). Because we are a Smaller Reporting Company, we only have to report information of our Chief Executive Officer as no other officer met the definition of Named Executive Officer within the meaning of SEC rules. +Summary Compensation Table +Name and +Principal +Position +Year +Salary ($) +Bonus +($) +Stock +Awards +($) +Option +Awards +($)( 1 ) +Non-equity +Incentive Plan +Compensation ($) +Nonqualified +Deferred +Compensation +Earnings ($) +Other +Compensation +($)(2 ) +Total ($) +Amos Kohn +2016 +$ +234,866 +- +- +$ +366,409 +- +- +$ +36,269 +$ +637,564 +Chief Executive Officer +2015 +$ +215,118 +- +- +$ +120,184 +- +- +$ +43,677 +$ +378,979 +(1) +Represents the equity-based compensation expenses recorded in our consolidated financial statements for the year ended December 31, 2016, based upon the option’s fair value on the grant date, calculated in accordance with accounting guidance for equity-based compensation. For a discussion of the assumptions used in reaching this valuation, see Note 8 to our consolidated financial statements for the year ended December 31, 2016. +(2) +The amounts in "All Other Compensation" consist of health insurance benefits, long-term and short-term disability insurance benefits, and 401K matching amounts. +31 +Employment Agreement with Amos Kohn +On November 30, 2016, as amended on February 22, 2017, the Company entered into an employment agreement with Amos Kohn to serve as President and Chief Executive Officer with an effective date of September 22, 2016. +For his services, Mr. Kohn will be paid a salary of $300,000 per annum increasing to $350,000 per annum provided that the Company achieves revenues in the aggregate amount of at least $10,000,000 as determined in accordance with U.S. GAAP for the trailing four calendar quarters. +In addition, Mr. Kohn shall be eligible for an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s compensation committee after conferring with Mr. Kohn. The target amount of Mr. Kohn’s annual performance bonus shall be 25% to 50% of his then annual base salary but may be greater upon mutual agreement between Mr. Kohn and the compensation committee. +Further, Mr. Kohn is entitled to receive equity participation as follows: (i) ten-year warrants to purchase 317,460 shares of the Company's Common Stock (the "Warrant Grant") at an exercise price of $0.01 per share subject to vesting quarterly over two years effective January 1, 2017; and (ii) ten-year options to purchase 1,000,000 shares of the Company’s Common Stock at an exercise price of $0.65 per share. The option to purchase 1,000,000 shares of Common Stock is subject to the following vesting schedule: (1) options to purchase 500,000 shares of Common Stock shall vest upon the effective date; (2) options to purchase 250,000 shares of Common Stock shall vest ratably over six months beginning with the first month after the effective date; and (3) options to purchase 250,000 shares of common stock shall vest ratably over twelve months beginning with the first month after the effective date. As part of the grant of the options to purchase 1,000,000 shares, Mr. Kohn forfeited options to purchase 535,000 shares of common stock previously granted to him under the Company’s Incentive Share Option Plans. +In the event that Mr. Kohn is terminated by the Company without cause, or if Mr. Kohn resigns for good reason, Mr. Kohn shall be entitled to (i) all annual salary earned prior to the termination date, any earned but unpaid portion of Mr. Kohn’s annual performance bonus for the year preceding in which such termination occurred and any earned but unpaid paid time off; (ii) an amount equal to 100% of Mr. Kohn’s then in effect annual base salary plus an additional 1/12th of Mr. Kohn’s annual base salary for each year of employment with the Company prior to such termination; (iii) an amount equal to the average of Mr. Kohn’s two prior years’ annual bonuses (with such average not to exceed 50% of the Mr. Kohn’s annual base salary in effect at the time of termination) prorated for the portion of the year that executive was employed; (iv) accelerated vesting of all outstanding unvested stock options and other equity arrangements subject to vesting and held by Mr. Kohn through the termination date and the Company’s right to repurchase Mr. Kohn’s restricted stock shall cease; and (v) to the extent required by COBRA, continuation of group health benefits pursuant to the Company's standard programs or in effect at the termination date at Company expense for a period of not less than 18 months. +If Mr. Kohn is terminated without cause, or resigns for good reason within 12 months of a change of control, Mr. Kohn shall be entitled to receive: (i) payment in a lump sum of Mr. Kohn annual base salary for 24 months and any accrued, unused paid time-off; (ii) accelerated vesting of all outstanding unvested stock options and other equity arrangements subject to vesting and the Company’s right to repurchase Mr. Kohn restricted stock shall cease; and (iii) to the extent required by COBRA, continuation of group health benefits pursuant to the Company's standard programs or in effect at the termination date at the Company’s expense for a period of not less than 18 months. +32 +Mr. Friedlander +On October 7, 2015 the Compensation Committee agree to pay Mr. Friedlander an annual payment of $58,000 (which includes compensation and business expenses and travel) and granted him 20,000 stock options under the 2012 Stock Option Plan. The options, which will have an exercise price equal to the closing price of the Company’s shares on the close of business on October 7, 2015, vest over a four year period at 25% per year and expire 10 years from the date of grant. Mr. Friedlander does not have an employment contract. +Advisory Vote on Executive Compensation +At the annual meeting of shareholders on December 28, 2016, the shareholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. In addition, shareholders voted, on an advisory basis, that an advisory vote on executive compensation should be held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding equity awards as of December 31, 2016 to the Named Executive Officer. +Option Award +Stock Award +Name +Number of +securities +underlying un +exercised +options (#) +exercisable +Number of +securities +underlying +unexercised +options (#) +exercisable +Equity incentive +plan awards: +Number of +securities +underlying +unexercised +unearned +options (#) +Option +exercise +price ($) +Option +expiration date +Number of +shares or +units of +stock that +have not +vested (#) +Market +value of +units of +stock that +have not +vested (#) +Equity +income plan +award: +Number of +unearned +shares, units +or other rights +that have not +vested (#) +Equity +income plan +awards: +Market or +payout value +of unearned +shares, units +or other rights +that have not +vested ($) +Amos Kohn +687,500 +(1) +312,500 +(1) +$ +0.65 +9/22/27 +317,460 +(2) +$ +0.01 +9/22/27 +(1) Effective September 22, 2016, Mr. Kohn was granted options to 1,000,000 shares of Common Stock at $0.65 per share. The options to purchase 1,000,000 shares of Common Stock are subject to the following vesting schedule: (1) options to purchase 500,000 shares of Common Stock shall vest upon the effective date; (2) options to purchase 250,000 shares of Common Stock shall vest ratably over six months beginning with the first month after the effective date; and (3) options to purchase 250,000 shares of common stock shall vest ratably over twelve months beginning with the first month after the effective date. In connection with the grant of options to purchase 1,000,000 shares of Common Stock, Mr. Kohn forfeited options to purchase 535,000 shares of common stock previously granted to him under the Company’s 2012 Plan. +(2) Represents warrants to purchase 317,460 shares of the Company's Common Stock at an exercise price of $0.01 per share subject to vesting quarterly over two years beginning January 1, 2017 granted to Mr. Kohn in connection with his employment agreement. +Director Compensation +During 2015, independent directors received $10,000 annually for serving on our Board. Directors are paid quarterly in arrears for their services. For 2016, and thereafter, the Company pays each independent director $20,000 annually, other than Mr. Smith, who will receive $30,000 annually due to anticipated additional services to be provided by Mr. Smith as a lead independent director. +33 +On November 22, 2016, each non-employee director received options to purchase 200,000 shares of Common Stock at an exercise price of $0.70 per share. The options are subject to vesting of which one-third vested immediately and the remaining unvested options will vest equally on the subsequent anniversary dates. +The table below sets forth, for each non-employee director, the total amount of compensation related to his or her service during the year ended December 31, 2016: +Name +Fees +Earned or +Paid in +Cash +Warrant +Awards +Option +Awards +Non-Equity +Incentive Plan +Compensation +Nonqualified +Deferred +Compensation +Earnings +All Other +Compensation +Total ($) +Robert Smith (1) +$ +5,000 +- +$ +32,145 +(5) +- +- +- +$ +37,145 +Kristine Ault (2) +- +$ +32,145 +(5) +$ +32,145 +William B Horne (2) +$ +3,333 +$ +32,145 +(5) +$ +35,478 +Moti Rosenberg +$ +11,666 +$ +33,355 +(5) +$ +45,021 +Ben-Zion Diamant (3) +$ +24,693 +$ +85,983 +$ +110,676 +Haim Yatim (4) +$ +13,498 +$ +1,758 +$ +15,256 +Israel Levi (4) +$ +7,500 +$ +1,758 +$ +9,258 +(1) +Mr. Smith was appointed to the Board on September 22, 2016. +(2) +Ms. Ault and Mr. Horne were each appointed to the Board on October 13, 2016. +(3) +On September 12, 2011, our Board of Directors approved the payment of monthly consulting fees of $6,000 to Ben-Zion Diamant, our former Chairman of the Board of Directors. On March 21, 2016, the Compensation Committee and Board of Directors approved an increase to the monthly consulting fee to Mr. Diamant to $7,500 effective as of March 21, 2016. Mr. Diamant resigned as a director on September 22, 2016, but as part of a Securities Purchase Agreement by and among the Company, Philou Ventures and Telkoor, Mr. Diamant will continue to receive $7,500 for a period of 18 months from September 5, 2016. +(4) +Messrs. Yatim and Levi each resigned from the board on September 22, 2016. +(5) +Effective November 2016, the non-employee director received options to purchase 200,000 shares at $.70 per share with one-third of the grant to vest immediately and the remaining two-thirds to vest over the remaining two anniversary dates. +Stock Option Plans +On December 28, 2016, the shareholder approve the 2016 Stock Incentive Plan (the “2016 Stock Incentive Plan”), under which options to acquire up to 4,000,000 shares of common stock may be granted to the Company's directors, officers, employees and consultants. The 2016 Stock Incentive Plan is in addition to the Company’s current 2012 Stock Option Plan, as amended (the “2012 Plan”), which provides for the issuance of a maximum of 1,372,630 shares of the Company’s common stock to be offered to the Company’s directors, officers, employees, and consultants. +The purpose of both the 2016 Stock Incentive Plan and 2012 Plan is to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial responsibility for the direction and management of the Company, as well as certain directors and consultants of the Company, additional incentives to exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, to reward outstanding performance and to provide a means to attract and retain persons of outstanding ability to the service of the Company. +As of December 31, 2016, options to purchase 2,266,000 shares of common stock were issued and outstanding, and 3,312,630 shares are available for future issuance , under collectively the 2012 Plan and the 2016 Stock Incentive Plan. +34 +401(k) Plan +We have adopted a tax-qualified employee savings and retirement plan, or 401(k) plan, which generally covers all of our full-time employees. Pursuant to the 401(k) plan, eligible employees may make voluntary contributions to the plan up to a maximum of 5% of eligible compensation. The 401(k) plan permits, but does not require, matching contributions by Digital Power on behalf of plan participants. We match contributions at the rate of (1) $1.00 for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary. We are also permitted under the plan to make discretionary contributions. The 401(k) plan is intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. Contributions to such a qualified plan are deductible by the Company when made, and neither the contributions nor the income earned on those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained in trust. +Item 12. Security Ownership Of Certain Beneficial Owners And Management And Related Stockholder Matters. +Except as otherwise indicated below, the following table sets forth certain information regarding beneficial ownership of our common stock as of March 20, 2017 by (1) each of our current directors; (2) each of the named executive officers listed in the Summary Compensation Table located above in the section entitled “Executive Compensation”; (3) each person known to us to be the beneficial owner of more than 5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and executive officers as a group. As of March 20, 2017, there were 8,856,851 shares of our common stock outstanding. +Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of the Record Date are deemed to be outstanding and to be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table have sole voting and sole investment power with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. Unless otherwise indicated below, the address of each beneficial owner listed below is c/o Digital Power Corporation, 48430 Lakeview Blvd, Fremont, California 94538. +Name and address of beneficial owner +Number of +shares +beneficially +owned +Approximate +percent of class +Philou Ventures, LLC +P.O. Box 3587 Tustin, CA 92705 +2,725,860 +30.8 +% +Amos Kohn +951,865 +(1) +9.8 +% +Uri Friedlander +5,000 +(2) +* +Robert Smith +66,667 +(3) +* +Moti Rosenberg +66,667 +(4) +* +Kristine Ault +2,794,327 +(5) +31.3 +% +Milton Ault, III +2,794,327 +(6) +31.3 +% +William Horne +66,667 +(7) +* +All directors and executive officers as a group (seven persons) +3,955,043 +(8) +39.5 +% +Barry W. Blank, +P.O. Box 32056, Phoenix, AZ 85064 +419,900 +4.7 +% +35 +* Less than one percent. +(1) +Includes options to purchase 812,500 shares and warrants to purchase 79,365 exercisable within 60 days of March 20, 2017. +(2) +Represents options to purchase 5,000 shares of common stock that are exercisable within 60 days of March 20, 2017 . +(3) +Represents options to purchase 66,667 shares of common stock that are exercisable within 60 days of March 20, 2017 . +(4) +Represents options to purchase 66,667 shares of common stock that are exercisable within 60 days of March 20, 2017 . +(5) +Includes shares owned by Philou Ventures of which Ms. Ault is the Manager. Also includes options to purchase 66,667 shares of common stock that are exercisable within 60 days of March 20, 2017 . +(6) +Mr. Ault is the spouse of Kristine Ault. Includes 2,715,610 shares owned by Philou Ventures which may be deemed beneficially owned by Mr. Ault. +(7) +Represents options to purchase 66,667 shares of common stock that are exercisable within 60 days of March 20, 2017 . +(8) +Include options and warrants to purchase 1,163,533 shares of common stock that are exercisable within 60 days of March 20, 2017. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information sets forth certain related transactions between us and certain of our shareholder of directors. Prior to September 22, 2016, Telkoor was our largest shareholder and Telkoor’s Chief Exectuive Officer, Benzi Diamant, was our Chairman of the Board. Effective September 22, 2016, Telkoor sold all of its shares of common stock of the Company to Philou Ventures, and as a result, Philou Ventures is our largest shareholder. Philou Ventures’ Manager is Kristine L. Ault, one of our directors. Ms. Ault is the spouse of Milton C. Ault, III, who is our Executive Chairman of the Board. +Telkoor Telecom, Ltd. +As previously disclosed, on September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, and Telkoor pursuant to which Telkoor agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the then Company’s outstanding shares of common stock. In consideration for such shares, Philou agreed to pay Telkoor $1.5 million. +In conjunction with the securities purchase agreement, we entered into a rescission agreement with Telkoor in order to resolve all financial issues between the parties, including the repurchase by Telkoor of 1,136,666 shares of common stock of Telkoor beneficially owned by us for book value . +Finally, as part of the securities purchase agreement, we have agreed to pay Mr. Diamant $7,500 for a period of eighteen months from September 5, 2016 for consulting services . +Relationship with Telkoor Power Supplies Ltd. +During the years ended December 31, 2016 and 2015, we purchased approximately $0 and $594,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest then shareholder, Telkoor, of which Ben-Zion Diamant was the Chief Executive Officer and its controlling shareholder. We had no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. In January 2016, Telkoor sold its commercial intellectual property to Advice Electronics Ltd. As a result, of that date no further orders have been placed with Telkoor. +36 +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest then shareholder, Telkoor , of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor sold its assets, including its subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Acquisition of Shares of Telkoor +On June 16, 2011 we acquired 1,136,666 shares of Telkoor, a then major shareholder of the Company which was listed on the Tel Aviv Stock Exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations. As of December 31, 2105 the shares represented 8.4% of the outstanding shares of Telkoor which have since de-listed from the Tel Aviv Stock Exchange. +On September 22, 2016, the Company sold such shares back to Telkoor for $90,000. +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016 , Telkoor sold all its commercial IP to Advice Electronics Ltd. ("Advice”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under our branding until December 2020. +37 +Philou Ventures, LLC +On March 9, 2017, we entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Philou Ventures. Philou Ventures is the Company’s largest stockholder and Kristine L. Ault, one of our directors, controls and is a Manager of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures will invest up to $5,000,000 in us through the purchase of Series B Preferred Stock (“Preferred Stock”) over the Term, as specified herein. Each share of Preferred Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guarantees to purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE MKT. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares of Preferred Stock in a sufficient amount in order us to meet the NYSE MKT’s minimum stockholders’ equity continued listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “Guaranteed Purchases”). In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of Preferred Stock, up to the 500,000 share maximum (“Voluntary Purchases”). All consideration for Voluntary Purchases shall be delivered through a series of varying payments (“Payments”) by Philou Ventures, at its sole and absolute discretion, during the period commencing on the closing date and ending 36 months therefrom (the “Term”). We have the right to request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining the minimum stockholders’ equity required by the NYSE MKT. The Preferred Stock shall not be callable by us for 25 years from the closing date. +In addition, for each share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price equal to $0.70 per share of common stock +Further, Philou Ventures shall have the right to participate our future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest us Philou Ventures’ right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +Finally, in order to meet the requirement of the NYSE Mkt Rule 713, Philou Ventures will not (i) vote the shares of Preferred Stock; (ii) convert such shares of Preferred Stock into shares of Common Stock or (iii) exercise its rights under the Warrant until the requirement of NYSE Mkt Rule 713 has been met at a meeting, or by the requisite written consent, of the holders of the outstanding shares of Common Stock. +On December 29, 2016, MCKEA Holdings lent us $250,000 in the form of a demand note bearing simple interest at 6.0%. Kristine L. Ault is the managing member of MCKEA Holdings, which in turn, is the member of Philou Ventures. On March 24, 2017, MCKEA Holdings cancelled the $250,000 demand note to purchase 25,000 shares of Preferred Stock and received warrants to purchase 357,143 shares of common stock at $0.70 per share. +Avalanche International , Corp. +During the quarter ended December 31, 2016, Avalanche International, Corp. (“Avalanche”) issued to the Company two $525,000 12% Convertible Promissory Notes, with identical terms, dated October 5, 2016 and November 30, 2016. In consideration for the issuance of the Notes, the Company loaned $1,000,000 to Avalanche of which $950,000 was funded as of December 31, 2016, and the remaining $50,000 was funded on February 17, 2016. The Notes, in the aggregate principal amount of $1,050,000, include an original issue discount of $50,000. The Notes accrue simple interest at 12% per annum and are convertible into shares of Avalanche common stock at $0.74536 per share. +38 +At any time after six months from the date of the Notes, the Company may convert the principal and interest into shares of Avalanche common stock. The conversion price of the Notes is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The Notes contain standard and customary events of default including, but not limited to failure to make payments when due under the Notes and bankruptcy or insolvency of Avalanche . +On February 22, 2017, subsequent to year-end, Avalanche issued the Company a third $525,000 12% Convertible Promissory Note (the “Third Note”). During the period from February 22, 2017 to March 3, 2017, the Company funded $172,371 pursuant to this Third Note. +Avalanche is a holding company which on March 3, 2017, entered into a share exchange agreement with MTIX and the three shareholders of MTIX. Upon the terms and subject to the conditions set forth in the share exchange agreement, Avalanche will acquire MTIX from the sellers through the transfer of all issued and outstanding ordinary shares of MTIX by the sellers to Avalanche. MTIX has developed a cost effective and environment friendly material synthesis technology for textile applications utilizing the proprietary MLSE™ system which uses a combination of high voltage plasma and laser energy to imbue fabrics with desirable technical characteristics. On March 15, 2017, the Company announced that it had entered into a $50 million purchase order with MTIX to manufacture, install and service fabric treatment machines that utilize MTIX’s proprietary MLSE™ system. +Milton C. Ault, III and William Horne, two of our directors, are directors of Avalanche. In addition, based on Avalanche’s Form 10-K for the year ended December 31, 2015, Philou Ventures is the largest shareholder of Avalanche. Philou Ventures is our largest shareholder, and Kristine L. Ault, Milton C. Ault, III’s spouse, is the manager for Philou Ventures. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. +Marcum LLP serves as our independent registered public accounting firm for the year ended December 31, 2016. Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global (“Kost Forer”) was our prior independent registered public accounting firm. +Fees and Services +The following table shows the aggregate fees billed to us for professional services by Marcum LLP and Kost Forer, respectively, for the years ended December 31, 2016 and 2015: +2016 +2015 +Audit Fees +$ +129,545 +$ +100,000 +Audit Related Fees +Tax Fees +All Other Fees +Total +$ +129,545 +$ +100,000 +Audit Fee. This category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years ended December 31, 2016 and 2015, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2016 and 2015, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements for the relevant years. +Audit-Related Fees. This category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under "Audit Fees," and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, internal control-related matters, and audits of employee benefit plans. +39 +Tax Fees . This category includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax compliance, tax planning and tax advice. +All Other Fees. This category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors that are not reported above under "Audit Fees," "Audit-Related Fees," or "Tax Fees." +The Audit Committee’s policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such pre-approval. +PART IV +ITEM 15. +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. +(a) +Exhibits +3.1 +Amended and Restated Articles of Incorporation of Digital Power Corporation (1) +3.2 +Amendment to the Articles of Incorporation (1) +3.3 +Amendment to the Articles of Incorporation (2) +3.4 +Certificate of Determination; Series B Preferred Stock (3) +3.4 +Bylaws of Digital Power Corporation (1) +10.1 +Avalanche International $500,000 12% Senior Secured Note +10.2 +Employment Agreement, as amended, with Amos Kohn * (5) +10.3 +2012 Stock Option Plan, as amended (6) +10.4 +Manufacturing and Distribution Rights Agreement, dated January 7, 2016, by and between the Company and Advice Electronics Ltd. (7) +10.6 +Securities Purchase Agreement among the Company, Philou Ventures, LLC and Telkoor Telecom. (8) +10.7 +Rescission Agreement with Telkoor Telecom (9) +10.8 +Form of 12% Secured Convertible Note (10) +10.9 +Digital Power Corporation 2016 Stock Incentive Plan (11) +10.10 +Preferred Stock Securities Agreement (12) +10.11 +2016 Stock Incentive Plan (13) +21.1 +Digital Power Limited +23.1 +Consent of Kost Forer Gabbay & Kasierer +23.2 +Consent of Marcum, LLP +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act +(1) +Previously filed with the Commission on October 16, 1996 as an exhibit to the Company’s Registration Statement on Form SB-2. +(2) +Previously filed with the Commission as Exhibit 3.1 to the Company’s Form 8-K filed December 9, 2013 . +(3) +Previously filed with the Commission as Exhibit 3.1 to the Company’s Form 8-K filed March 9, 2017. +(4) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on October 22, 2007. +(5) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on December 5, 2016, as amended with such amendment filed on Form 8-K on March 27, 2017. +(6 ) +Previously filed with the Commission as Exhibit A to the Company’s DEF-14A filed on June 26, 2013. +(7) +Previously filed with the Commission on Form 10-K for the year ended December 31, 2015 on March 30, 2016. +40 +(8) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed September 9, 2016 . +(9) +Previously filed with the Commission as Exhibit 10.2 to the Company’s Form 8-K filed September 9, 2016. +(10) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed October 27, 2016 +(11) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed December 30, 2016 +(12) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on March 9, 2017. +(13) +Previously filed with the Commission as Exhibit 10.1 to the Company’s Form 8-K filed on December 30, 2016. +101.INS +XBRL Instance Document‡ +101.SCH +XBRL Taxonomy Extension Schema Document‡ +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document‡ +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document‡ +101.LAB +XBRL Taxonomy Extension Label Linkbase Document‡ +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document‡ +Footnotes to Exhibit Index +‡ XBRL information is furnished and not filed for purpose of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, and is not subject to liability under those sections, is not part of any registration statement or prospectus to which it relates and is not incorporated or deemed to be incorporated by reference into any registration statement, prospectus or other document. +*Management contract or compensatory plan or arrangement. +41 +SIGNATURES +In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: April 10, 2017 +DIGITAL POWER CORPORATION +By: /s/ Amos Kohn +Amos Kohn +President and Chief Executive Officer +(Principal Executive Officer) +By: /s/ Uri Friedlander +V.P of Finance +(Principal Accounting Officer) +In accordance with the Exchange Act, this report has been signed below by the following person on behalf of the registrant and in the capacities indicated. +/s/ Milton C. Ault, III +Milton “Todd” Ault, III, Executive Chairman of the Board +/s/ Amos Kohn +Amos Kohn, President, Chief Executive Officer, and Director +/s/ Kristine Ault +Kristine Ault, Director +/s/ William Horne +William Horne, Director +/s/ Moti Rosenberg +Moti Rosenberg, Director +/s/ Robert O. Smith +Robert O. Smith, Director +42 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED FINANCIAL STATEMENTS +AS OF DECEMBER 31, 2016 AND 2015 +INDEX +Page +Reports of Independent Registered Public Accounting Firms +F-2 and F-3 +Consolidated Balance Sheets +F-4 - F-5 +Consolidated Statements of Operations +F-6 +Consolidated Statements of Comprehensive Loss +F-7 +Consolidated Statements of Changes in Stockholders' Equity +F-8 +Consolidated Statements of Cash Flows +F-9 +Notes to Consolidated Financial Statements +F-10 - F-33 +F - 1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +The Board of Directors and Shareholders of +DIGITAL POWER CORPORATION +We have audited the accompanying consolidated balance sheet of Digital Power Corporation (the "Company") and subsidiary as of December 31, 2015, and the related consolidated statements of operations, comprehensive loss, shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and subsidiary at December 31, 2015, and the consolidated results of its operations and its cash flows for year then ended in conformity with U.S. generally accepted accounting principles. +/s/ KOST FORER GABBAY & KASIERER +Tel-Aviv, Israel +KOST FORER GABBAY & KASIERER +March 30, 2016 +A Member of Ernst & Young Global +F - 2 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Audit Committee of the +Board of Directors and Shareholders +Of Digital Power Corporation and Subsidiary . +We have audited the accompanying consolidated balance sheet of Digital Power Corporation and Subsidiary (the “Company”) as of December 31, 2016, and the related consolidated statements of operations, comprehensive loss, changes in stockholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Digital Power Corporation and Subsidiary, as of December 31, 2016, and the consolidated results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. +Marcum llp +New York, NY +April 10, 2017 +F - 3 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +U.S. dollars in thousands +As of December 31, +2016 +2015 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ +996 +$ +1,241 +Accounts receivable, net +1,439 +1,240 +Accounts receivable – related party +- +77 +Inventories, net +1,122 +1,542 +Prepaid expenses and other current assets +285 +187 +Total current assets +3,842 +4,287 +Property and equipment, net +570 +709 +Investments, - related parties, net of original issue discount of $45 and $0, respectively. +1,036 +90 +Deposits +24 +13 +TOTAL ASSETS +$ +5,472 +$ +5,099 +The accompanying notes are an integral part of these consolidated financial statements. +F - 4 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS (continued) +U.S. dollars in thousands +As of December 31, +2016 +2015 +LIABILITIES AND STOCKHOLDERS’ EQUITY +CURRENT LIABILITIES +Accounts payable +$ +1,231 +$ +937 +Note payable – related party +250 +- +Advances from customers and deferred revenues +- +211 +Other current liabilities +398 +480 +Total current liabilities +1,879 +1,628 +Convertible notes – related party, net of unamortized issuance discount of $497 +34 +- +Total liabilities +1,913 +1,628 +COMMITMENTS +STOCKHOLDERS’ EQUITY +Series A Redeemable Convertible Preferred Stock, no par value, - 500,000 shares authorized; 0 shares issued and outstanding at December 31, 2016 and 2015. +- +- +Preferred Stock, no par value – 1,500,000 shares authorized; 0 shares issued and outstanding at December 31, 2016 and 2015. +- +- +Common Stock, no par value – 30,000,000 shares authorized; 7,677,637 and 6,775,971 shares issued and outstanding at December 31, 2016 and 2015, respectively. +- +- +Additional paid-in-capital +16,537 +14,965 +Accumulated deficit +(12,158 +) +(11,036 +) +Accumulated other comprehensive loss +(820 +) +(458 +) +Total stockholder’s equity +3,559 +3,471 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ +5,472 +$ +5,099 +The accompanying notes are an integral part of these consolidated financial statements. +F - 5 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF OPERATIONS +U.S. dollars in thousands (except per share data) +For the Years Ended December 31, +2016 +2015 +Revenues +$ +7,596 +$ +7,766 +Cost of revenues +4,890 +5,053 +Gross profit +2,706 +2,713 +Operating expenses: +Engineering and product development +709 +894 +Selling and marketing +916 +1,195 +General and administrative +2,300 +1,627 +Total operating expenses +3,925 +3,716 +Operating loss +(1,219 +) +(1,003 +) +Other income and expenses: +Impairment of investment – related party +- +(110 +) +Other income, net +77 +16 +Total other income and (expenses) +77 +(94 +) +Loss before income tax benefits +(1,142 +) +(1,097 +) +Benefit for income taxes +20 +1 +Net loss +$ +(1,122 +) +$ +(1,096 +) +Net loss per common share – Basic and diluted +$ +(0.16 +) +$ +(0.16 +) +Weighted average shares of common stock – Basic and diluted +6,917 +6,776 +The accompanying notes are an integral part of these consolidated financial statements. +F - 6 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS +U.S. dollars in thousands +For the Years Ended December 31, +2016 +2015 +Net Loss +$ +(1,122 +) +$ +(1,096 +) +Other comprehensive loss: +Change in foreign currency translation adjustment +(362 +) +(100 +) +Comprehensive loss +$ +(1,484 +) +$ +(1,196 +) +The accompanying notes are an integral part of these consolidated financial statements. +F - 7 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY +For the Years Ended December 31, 2016 and 2015 +U.S. dollars in thousands (except share data) +Common +stock +Additional +paid-in- +capital +Accumulated +Deficit +Other +Accumulated +comprehensive +loss +Total +stockholders’ +equity +Balance at January 1, 2015 +6,775,971 +$ +14,739 +$ +(9,940 +) +$ +(358 +) +$ +4,441 +Stock-based compensation – options +- +226 +- +- +226 +Comprehensive loss: +Net loss +- +- +(1,096 +) +- +(1,096 +) +Foreign currency translation loss +- +- +- +(100 +) +(100 +) +Balance at December 31, 2015 +6,775,971 +14,965 +(11,036 +) +(458 +) +3,471 +Stock-based compensation – options +- +520 +- +- +520 +Stock-based compensation - warrants +- +23 +- +- +23 +Issuance of common stock and warrants for cash +901,666 +541 +- +- +541 +Beneficial conversion feature in connection with convertible notes +- +329 +- +- +329 +Fair value warrants issued in connection with convertible notes +- +159 +- +- +159 +Comprehensive loss: +Net loss +- +- +(1,122 +) +- +(1,122 +) +Foreign currency translation loss +- +- +- +(362 +) +(362 +) +Balance at December 31, 2016 +7,677,637 +$ +16,537 +$ +(12,158 +) +$ +(820 +) +$ +3,559 +The accompanying notes are an integral part of these consolidated financial statements. +F - 8 +DIGITAL POWER CORPORATION AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +U.S. dollars in thousands +For the Years Ended December 31, +2016 +2015 +Cash flows from operating activities: +Net loss +$ +(1,122 +) +$ +(1,096 +) +Adjustments to reconcile net loss to net cash used in operating activities: +Depreciation and amortization +161 +214 +Amortization of debt discount +34 +- +Accretion of discount on note receivable +(2 +) +- +Provision for bad debts +32 +- +Reserve for inventory +68 +9 +Impairment of investment – related party +- +110 +Stock-based compensation +543 +226 +Changes in operating assets and liabilities: +Accounts receivable +(311 +) +288 +Accounts receivable – related party +77 +- +Inventories +209 +57 +Prepaid expenses and other current assets +(119 +) +(14 +) +Other assets +(11 +) +- +Accounts payable +322 +(258 +) +Advances from customers and deferred revenues +(181 +) +- +Other current liabilities +(58 +) +(65 +) +Net cash used in operating activities +(358 +) +(529 +) +Cash flows from investing activities: +Purchase of property and equipment +(85 +) +(306 +) +Proceeds from sale of investment – related party +90 +- +Investments – related party +(1,034 +) +- +Net cash used in investing activities +(1,029 +) +(306 +) +Cash flows from financing activities: +Proceeds from sales of common stock and warrants +541 +- +Net proceeds from issuances of convertible notes – related party +488 +- +Proceeds from short term loan – related party +250 +- +Net cash provided by financing activities +1,279 +- +Effect of exchange rate on cash and cash equivalents +(137 +) +(34 +) +Decrease in cash and cash equivalents +(245 +) +(869 +) +Cash and cash equivalents - Beginning of the year +1,241 +2,110 +Cash and cash equivalents - End of the year +$ +996 +$ +1,241 +The accompanying notes are an integral part of these consolidated financial statements. +F - 9 +DIGITAL POWER CORPORATION AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +December 31, 2016 and 2015 +U.S. dollars in thousands (except share and per share data) +NOTE 1: GENERAL +Digital Power Corporation ( " DPC" ) was incorporated in 1969, under the General Corporation Law of the State of California. DPC and Digital Power Limited ( "DPL" ), a wholly owned subsidiary, located in the United Kingdom (DPC and DPL collectively the “Company”), are currently engaged in the design, manufacture and sale of switching power supplies and converters. The Company has two reportable geographic segments - North America (sales through DPC) and Europe (sales through DPL). +NOTE 2: LIQUIDITY, FINANCIAL CONDITION AND MANAGEMENT’S PLANS +The Company incurred a net loss of $1,122 for the year ended December 31, 2016 and had an accumulated deficit of $12,158 at December 31, 2016 from having incurred losses since its inception. The Company had $1,963 of working capital at December 31, 2016 and used approximately $358 of cash in its operating activities during the year ended December 31, 2016. The Company has financed its operations principally through issuances of convertible debt, a promissory note and equity securities. +On September 5, 2016, the Company entered into a rescission agreement with Telkoor Telecom Ltd., a related party entity, pursuant to which the Company sold back its investment of 1,136,666 shares of common stock of Telkoor at its carrying value of $90. (See Note 7). +On October 21, 2016, the Company issued a 12% convertible secured note in the principal amount of $530 to an existing stockholder of the Company for a net proceeds of $488 (See Note 10). +On November 15, 2016, the Company sold 901,666 units for aggregate proceeds of $541, each unit consisted of a share of common stock and a warrant to purchase one share of common stock (See Note 10). +On December 29, 2016, the Company entered into an agreement with MCKEA Holdings, LLC (“MCKEA”), a related party, for a demand promissory note in the amount of $250 bearing interest at the rate of 6% per annum (See Note 9). +During the fourth quarter of 2016, the Company invested $950 in Avalanche International Corporation (“AVLP”), a related party entity, through convertible notes with an aggregate face value of $997, additionally, the Company acquired shares of common stock of AVLP for approximately $84 (see Note 7). +In February 2017, the Company issued demand promissory notes and warrants to purchase 333,333 shares of common stock at $ 0.70 per share for aggregate proceeds of $400. Further in February 2017, the holders of $400 in demand promissory notes agreed to extinguish their $400 of debt by purchasing 666,667 shares of common stock of the Company at $0.60 per share (See Note 16). +On March 9, 2017, the Company entered into a preferred stock purchase agreement with Philou Ventures LLC (“Philou”), a related party entity, pursuant to which Philou agreed to invest up to $5,000,000 in the Company through the purchase of Series B Preferred Stock over a term of 36 months (See Note 13). On March 24, 2017, Philou purchased 25,000 shares of Series B Preferred Stock pursuant to the preferred stock purchase agreement in consideration of cancellation of Company debt of $250 due to MCKEA. +On March 15, 2017, Company entered into a subscription agreement with one investor for the sale of 500,000 shares of common stock at $0.60 per share for the aggregate purchase price of $300. +F - 10 +In March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX Ltd. (“MTIX") to manufacture, install and service the Multiplex Laser Surface Enhancement (‘MLSE) plasma-laser system (See Note 14). +On March 28, 2017, the Company issued $270 in demand promissory notes to several investors, then on April 5, 2017, the Company canceled these promissory notes by issuing 360,000 shares of common stock at $0.75 per share, in addition, the Company also issued warrants to purchase 180,000 shares of common stock at $0.90 per share to these investors (See Note 16). +The Company expects to continue to incur losses for the foreseeable future and needs raise additional capital to continue its business development initiatives and to support its working capital requirements. Management believes that the MLSE purchase order of $50 million will be a source of revenue and generating cash flows. Management believes that the Company has access to capital resources through potential public or private issuance of debt or equity securities. If the Company is unable to raise additional capital, it may be required to curtail operations and take additional measures to reduce costs , including reducing its workforce, eliminating outside consultants and reducing legal fees in order to conserve its cash in amounts sufficient to sustain operations and meet its obligations. +Based on the above, management believes that the Company has sufficient capital resources to sustain operations through at least April 10, 2018 . +NOTE 3: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles ( “U.S. GAAP” ). +Principles of Consolidation +The consolidated financial statements include the accounts of DPC and its wholly-owned subsidiary, DPL. All significant intercompany accounts and transactions have been eliminated in consolidation. In addition, DPC and DPL share certain employees and various costs. Such expenses are principally paid by DPC. Due to the nature of the parent and subsidiary relationship, the individual financial position and operating results of DPC and DPL may be different from those that would have been obtained had they been autonomous . +Use of Estimates +The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions. The Company's management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. Key estimates include fair value of certain financial instruments, reserve for trade receivables and inventories, carrying amounts of investments, accruals of certain liabilities, and deferred income taxes and related valuation allowance. +Foreign Currency Translation +A substantial portion of the Company’s revenues are generated in U.S. dollars ( " U.S. dollar" ). In addition, a substantial portion of the Company’s costs are incurred in U.S. dollars. Company management has determined that the U.S. dollar is the currency of the primary economic environment in which it operates. +Accordingly, monetary accounts maintained in currencies other than the U.S. dollar are re -measured into U.S. dollars in accordance with Financial Accounting Standards Board ( “FASB” ) issued Accounting Standards Codification ( “ASC” ) No. 830, Foreign Currency Matters ( "ASC No. 830" ). All transaction gains and losses from the re -measurement of monetary balance sheet items are reflected in the statements of operations as financial income or expenses as appropriate. +F - 11 +The financial statements of the DPL, whose functional currency has been determined to be its local currency, British Pound ( “GBP” ), have been translated into U.S. dollars in accordance with ASC No. 830. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate in effect for the reporting period. The resulting translation adjustments are reported as other comprehensive income (loss) in the consolidated statement of comprehensive income (loss) and accumulated comprehensive income (loss) in statement of changes in stockholders' equity. +Cash and Cash Equivalents +The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. These balances may, at times, exceed the U.S. Federal Deposit Insurance Corporation insurance limits. The Company has cash and cash equivalents of $736 and $868 at December 31, 2016 and 2015, respectively, in the United Kingdom ( “ U.K ” ). The Company has not experienced any losses on deposits of cash and cash equivalents. +Marketable Securities +The Company classifies its investments in shares of common stock of Telkoor and AVLP in accordance with ASC No. 320, Investment in Debt and Equity Securities ( “ASC No. 320 ” ) and ASC No. 325, Investment – Other ( “ASC No. 325 ” ). Marketable securities classified as “available-for-sale securities” and carried at fair value, based on quoted market prices. Unrealized gains and losses are reported in a separate component of stockholder’s equity in “accumulated other comprehensive loss” in equity. When evaluating the investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment’s amortized cost basis. +Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC No. 325-20. +The Company classifies its investment in debt securities of AVLP in accordance with ASC No. 320 and ASC No. 825. Investment in convertible promissory notes in AVLP is classified as available-for-sale securities and is carried at fair value based on quoted market prices. Unrealized gains and losses are reported in a separate component of stockholder’s equity in “accumulated other comprehensive loss” in equity. When evaluating the investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment’s amortized cost basis. Additionally, the investment in debt securities of AVLP qualifies for application of fair value option in accordance with ASC No. 825. +Accounts Receivable and Allowance for Doubtful Accounts +The Company’s receivables are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount of the Company’s receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. The Company individually reviews all accounts receivable balances and based upon an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected . The Company estimates the allowance for doubtful accounts based on historical collection trends, age of outstanding receivables and existing economic conditions. If events or changes in circumstances indicate that a specific receivable balance may be impaired, further consideration is given to the collectability of those balances and the allowance is adjusted accordingly. A customer’s receivable balance is considered past-due based on its contractual terms. Past-due receivable balances are written-off when the Company’s internal collection efforts have been unsuccessful in collecting the amount due. Based on an assessment as of December 31, 2016 and 2015, of the collectability of invoices, accounts receivable are presented net of an allowance for doubtful accounts of $32 and nil, respectively +F - 12 +Inventories +Inventories are stated at the lower of cost or market value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological obsolescence. +Cost of inventories is determined as follows: +Raw materials, parts and supplies - using the "first-in, first-out" method. +Work-in-progress and finished products - on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically assesses its inventories valuation in respect of obsolete and slow moving items by reviewing revenue forecasts and technological obsolescence. When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at the time of the review was not expected to be sold, is written off. +During the years ended December 31, 2016 and 2015, the Company recorded inventory write-offs of $84 and $9, respectively, within the cost of revenue. +Property and Equipment, Net +Property and equipment as well as an intangible asset are stated at cost, net of accumulated depreciation and amortization. Repairs and maintenance costs are expensed as incurred. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets, at the following annual rates: +Useful lives (in years) +Computer, software and related equipment +3 +- +5 +Office furniture and equipment +5 +- +10 +Leasehold improvements +Over the term of the lease of the life of the asset, whichever is shorter +Long-Lived Assets +The long-lived assets of the Company are reviewed for impairment in accordance with ASC No. 360, Property, Plant, and Equipment , whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. As of December 31, 2016 and 2015, no impairment charges were necessary. +Revenue Recognition +The Company generates revenues from the sale of its products through a direct and indirect sales force. +Revenues from products are recognized in accordance with ASC No. 605, Revenue Recognition , when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the seller's price to the buyer is fixed or determinable, no further obligation exists and collectability is reasonably assured. +Generally, the Company does not grant a right of return. However, certain distributors are allowed, in the six months after the initial stock purchase, to rotate stock that has not been sold for other products. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. +F - 13 +Service revenues are deferred and recognized on a straight-line basis over the term of the service agreement. Service revenues are immaterial in proportion to the Company's revenues. +Warranty +The Company offers a warranty period for all of its products. Warranty periods range from one to two years depending on the product. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company's warranty liability include the number of units sold, historical rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. +As of December 31, 2016 and 2015, the Company has accrued warranty liability of $86 and $94, respectively. +Income Taxes +The Company determines its income taxes under the asset and liability method in accordance with FASB ASC No. 740, Income Taxes , which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the fiscal years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Statements of Income and Comprehensive Income in the period that includes the enactment date. +The Company accounts for uncertain tax positions in accordance with ASC No. 740-10-25 . ASC No. 740-10-25 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2016 and 2015, there are no uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in the financial statements . +Common Stock Purchase Warrants and Other Derivative Financial Instruments +The Company classifies Common Stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, which principally consist of issuance of warrants to purchase shares of common in connection with convertible notes, units and to employers of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features or variable settlement provision that cause them to not be indexed to the Company’s own stock. +F - 14 +Stock-Based Compensation +The Company accounts for stock-based compensation in accordance with ASC 718 "Compensation – Stock Compensation" ("ASC 718"). +ASC 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in the Company's consolidated statements of operations. +The Company estimates the fair value of stock options granted under ASC 718 using the Black-Scholes option-pricing model that uses the following assumptions. +Expected volatility is based on historical volatility that is representative of future volatility over the expected term of the options. The expected term of options granted was determined based on the simplified method, which is calculated as the midpoint between the vesting date and the end of the contractual term of the option. The Company uses the simplified method as it has determined that sufficient data is not available to develop an estimate of the expected option term based upon historical participant behavior. The risk free interest rate is based on the yield of U.S. Treasury bonds with equivalent terms. The dividend yield is based on the Company's historical and future expectation of dividends payouts. The Company has not paid cash dividends historically and has no plans to pay cash dividends in the foreseeable future. +The Company recognizes share-based compensation expenses for the value of its awards based on the straight line method over the requisite service period of each of the awards . +During the years 2016 and 2015, the Company estimated the fair value of stock options granted using the Black-Scholes option pricing model with the following weighted average assumptions +2016 +2015 +Weighted average fair value +$0.46 +$0.44 +Dividend yield +0% +0% +Expected volatility +97.7% +- +98.2% +87.6% +- +88.3% +Risk-free interest rate +1.26% +- +1.77% +1.60% +- +1.91% +Expected life (years) +5 +5.5 +- +7 +Convertible Instruments +The Company accounts for hybrid contracts that feature conversion options in accordance with applicable GAAP. ASC No. 815 Derivatives and Hedging Activities , (“ASC 815”) requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument. +F - 15 +Conversion options that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, in accordance with ASC 470-20 “Debt with Conversion and Other Options” (“ASC 470-20”). Under ASC 470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded conversion options should be bifurcated from their host instruments) in accordance with ASC 815. +Concentration of Credit Risk +Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, long term deposits and trade receivables. +Cash and cash equivalents are invested in banks in the U.S. and in the UK. Such deposits in the United States may be in excess of insured limits and are not insured in other jurisdictions. +Trade receivables of the Company and its subsidiary are mainly derived from sales to customers located primarily in the U.S. and in Europe. The Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is determined with respect to those amounts that the Company and its subsidiary have determined to be doubtful of collection +Comprehensive Loss +The Company reports comprehensive loss in accordance with ASC 220, "Comprehensive Income". This Statement establishes standards for the reporting and presentation of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined that its items of other comprehensive loss relates to changes in foreign currency translation adjustments. +Fair value of Financial Instruments +In accordance with ASC 820, “Fair Value Measurements and Disclosures”, fair value is defined as the exit price, or the amount that would be received for the sale of an as set or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +The guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +Level 1: +Quoted market prices in active markets for identical assets or liabilities. +Level 2: +Other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. +Level 3: +Unobservable inputs reflecting the reporting entity’s own assumptions. +The carrying amounts of financial instruments carried at cost, including cash and cash equivalents, trade receivables and trade receivable – related party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the short-term maturities of such instruments. +F - 16 +As of December 31, 2016, the fair value of the Company's investments was $1,036 ($90 as of December 31, 2015). I nvestments as of December 31, 2016 were concentrated in AVLP. The Company's investment in AVLP is comprised of convertible promissory notes of $952, net of unamortized discount and marketable equity securities of $84 which are classified as available-for-sale investments. For investments in marketable equity securities, the Company took into consideration general market conditions, the duration and extent to which the fair value is below cost, and the Company’s ability and intent to hold the investment for a sufficient period of time to allow for recovery of value in the foreseeable future. As a result of this analysis, the Company has determined that its cost basis in Avalanche equitable securities approximates the current fair value +Consistent with the guidance at ASC 835, the Company’s presumption is that the fair value of its convertible promissory notes in Avalanche have a present value equivalent to the cash proceeds exchanged. Further, the discount shall be reported in the balance sheet as a direct deduction from the face amount of the convertible promissory notes. Thus, the Company has determined that the amortized cost of its convertible promissory notes approximates fair value and are subject to a periodic impairment review. The interest income, including amortization of the discount arising at acquisition, for the convertible promissory notes are included in earnings. In the future, if the Company does not expect to recover the entire amortized cost basis, the Company shall recognize other-than-temporary impairments in other comprehensive income (loss). +The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. +The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy: +Fair V alue Measurement at December 31, 2016 +Total +Level 1 +Level 2 +Level 3 +Investments – AVLP – a related party controlled by Philou, a majority shareholder of the Company +$ +1,036 +$ +84 +$ +952 +$ +- +Fair V alue Measurement at December 31, 201 5 +Total +Level 1 +Level 2 +Level 3 +Investment – Telkoor – a related party, the Company's majority shareholder until September 22, 2016 +$ +90 +$ +- +$ +- +$ +90 +As of December 31, 2015, the Company valued the investment in Telkoor for $90. +The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial instruments for the years ended December 31, 2016 and 2015, which are treated as investments, as follows: +2016 +2015 +Balance at the beginning of year +$ +90 +$ +207 +Impairment +- +(110 +) +Effect of exchange rate +- +(7 +) +Disposition of investments +(90 +) +- +Balance at the end of year +$ +- +$ +90 +F - 17 +Debt Discounts +The Company accounts for debt discount according to ASC No. 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through periodic charges to interest expense over the term of the related financial instrument using the effective interest method. During the years ended December 31, 2016 and 2015, the Company recorded amortization of debt discounts of $2 and nil, respectively +Net Loss per Share +Net loss per share is computed by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation of the basic and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock equivalents is anti-dilutive due to the Company’s net loss position for all periods presented. The Company has included 317,460 warrants, with an exercise price of $.01, in its earnings per share calculation for the year ended December 31, 2016. Anti-dilutive securities consisted of the following at December 31: +2016 +2015 +Stock options +2,256,000 +1,146,000 +Warrants +1,431,666 +- +Convertible notes +963,636 +- +Total +4,651,302 +1,146,000 +Recently Issued and Adopted Accounting Standards +From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board, (FASB), or other standard setting bodies and adopted by the Company as of the specified effective date. Unless otherwise discussed, the impact of recently issued standards that are not yet effective will not have a material impact on the Company’s consolidated financial position or results of operations upon adoption. +In October 2016, the FASB issued updated guidance related to the recognition of income tax consequences of an intra-entity transfer of an asset other than inventory. This guidance will be effective for the first quarter of tax year 2018; however, early adoption is permitted. The Company is evaluating the impact that this guidance will have its consolidated financial statements. +In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230)” (“ASU 2016-15”), which seeks to reduce the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. For public entities, Update 2016-15 becomes effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the provisions of Update 2016-15 and assessing the impact, if any, it may have on its consolidated financial position, results of operations, cash flows or financial statement disclosures. +In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718)” (“ASU 2016-09”), which seeks to simplify accounting for share-based payment transactions including income tax consequences, classification of awards as either equity or liabilities, and the classification on the statement of cash flows. For public entities, Update 2016-09 becomes effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, with early adoption permitted. The Company has not yet determined the effect that ASU 2016-09 will have on its consolidated financial position, results of operations or financial statement disclosures. +In March 2016, the FASB issued guidance that involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This guidance will be effective for the first quarter of tax year 2017; however, early adoption is permitted. The Company is evaluating the impact that this guidance will have on its consolidated financial statements. +F - 18 +In February 2016, the FASB issued ASU No. 2016-02, “ Leases ” . The new standard provides guidance intended to improve financial reporting about leasing transaction. The ASU affects all companies that lease assets such as real estate, airplanes and manufacturing equipment. The ASU will require companies that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The new standard will take effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company has not determined the potential effects of this ASU on its consolidated financial statements. +In January 2016, the FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Liabilities" (“ASU 2016-01”). ASU 2016-01 requires equity investments (excluding equity method investments and investments that are consolidated) to be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have a readily determinable fair value may be measured at cost, adjusted for impairment and observable price changes. The ASU also simplifies the impairment assessment of equity investments, eliminates the disclosure of the assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at cost on the balance sheet and requires the exit price to be used when measuring fair value of financial instruments for disclosure purposes. Under ASU 2016-01, changes in fair value (resulting from instrument-specific credit risk) will be presented separately in other comprehensive income for liabilities measured using the fair value option and financial assets and liabilities will be presented separately by measurement category and type either on the balance sheet or in the financial statement disclosures. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company has not yet determined the effect that ASU 2016-01 will have on its consolidated financial position, results of operations, or financial statement disclosures. +In August 2014, the FASB issued ASU 2014-15, "Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern." The amendments is this ASU are intended to provide guidance on the responsibility of reporting entity management. Specifically, this ASU provides guidance to management related to evaluating whether there is substantial doubt about the reporting entity’s ability to continue as a going concern and about related financial statement note disclosures. Although the presumption that a reporting entity will continue to operate as a going concern is fundamental to the preparation of financial statements, prior to the issuance of this ASU, there was no guidance in U.S. generally accepted accounting principles (U.S. GAAP) related to the concept. Due to the lack of guidance in U.S. GAAP, practitioners and their clients often faced challenges in determining whether, when, and how a reporting entity should disclose the relevant information in its financial statements. As a result, the FASB issued this guidance to require management evaluation and potential financial statement disclosures. This ASU will be effective for financial statements with periods ending after December 15, 2016. The Company adopted the ASU during the fiscal year and corrected in this report. +In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC Topic 605, “Revenue Recognition” and some cost guidance included in ASC Subtopic 605-35, "Revenue Recognition - Construction-Type and Production-Type Contracts.” The core principle of ASU 2014-09 is that revenue is recognized when the transfer of goods or services to customers occurs in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. ASU 2014-09 requires the disclosure of sufficient information to enable readers of the Company’s financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. ASU 2014-09 also requires disclosure of information regarding significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 provides two methods of retrospective application. The first method would require the Company to apply ASU 2014-09 to each prior reporting period presented. The second method would require the Company to retrospectively apply ASU 2014-09 with the cumulative effect recognized at the date of initial application. ASU 2014-09 will be effective for the Company beginning in fiscal 2019 as a result of ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date," which was issued by the FASB in August 2015 and extended the original effective date by one year. The Company is currently evaluating the impact of adopting the available methodologies of ASU 2014-09 and 2015-14 upon its financial statements in future reporting periods. The Company has not yet selected a transition method. The Company is in the process of evaluating the new standard against its existing accounting policies, including the timing of revenue recognition, and its contracts with customers to determine the effect the guidance will have on its financial statements and what changes to systems and controls may be warranted. +F - 19 +There have been four new ASUs issued amending certain aspects of ASU 2014-09, ASU 2016-08, "Principal versus Agent Considerations (Reporting Revenue Gross Versus Net)," was issued in March, 2016 to clarify certain aspects of the principal versus agent guidance in ASU 2014-09. In addition, ASU 2016-10, "Identifying Performance Obligations and Licensing," issued in April 2016, amends other sections of ASU 2014-09 including clarifying guidance related to identifying performance obligations and licensing implementation. ASU 2016-12, "Revenue from Contracts with Customers - Narrow Scope Improvements and Practical Expedients" provides amendments and practical expedients to the guidance in ASU 2014-09 in the areas of assessing collectability, presentation of sales taxes received from customers, noncash consideration, contract modification and clarification of using the full retrospective approach to adopt ASU 2014-09. Finally, ASU 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” was issued in December 2016, and provides elections regarding the disclosures required for remaining performance obligations in certain cases and also makes other technical corrections and improvements to the standard. With its evaluation of the impact of ASU 2014-09, the Company will also consider the impact on its financial statements related to the updated guidance provided by these four new ASUs. +The Company has considered all other recently issued accounting standards and does not believe the adoption of such standards will have a material impact on its consolidated financial statements. +N OTE 4: INVENTORIES +At December 31, 2016 and 2015, inventories consist of: +2016 +2015 +Raw materials, parts and supplies +$ +271 +$ +336 +Work-in-progress +238 +191 +Finished products +613 +1,015 +Total inventories +$ +1,122 +$ +1,542 +N OTE 5 : PROPERTY AND EQUIPMENT, NET +At December 31, 2016 and 2015, property and equipment consist of: +2016 +2015 +Computer, software and related equipment +$ +1,652 +$ +1,726 +Office furniture and equipment +240 +257 +Leasehold improvements +699 +771 +2,591 +2,754 +Accumulated depreciation and amortization +(2,021 +) +(2,045 +) +Property and equipment, net +$ +570 +$ +709 +For the years ended December 31, 2016 and 2015, depreciation and amortization expense amounted to $161 and $214, respectively. +NOTE 6: INTANGIBLE ASSET, NET +On August 25, 2010, the Company entered into an agreement with Telkoor Power Supplies Ltd. ("TPS"), a subsidiary of Telkoor, pursuant to which, (i) TPS sold, assigned and conveyed to the Company all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets” or “IP”) and (ii) the Company granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. The IP was purchased in order to decrease lead time and costs of the production process. In consideration for the purchase of the IP, the Company paid TPS an amount of $480. The consideration for the right to sell the Assets in Israel will be paid to the Company as a yearly royalty fee of 15% of TPS's direct production costs of sales. +F - 20 +TPS will provide the Company training and technical support, if necessary, for a period of 60 months in order to enable the Company to properly and effectively use the IP to manufacture the Assets. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event that annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based on an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period the Company sells more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by the Company of the Compact Peripheral Component Interface 600 W AC/DC power supply series (CPCI 600W) through 2013, the Company amended its agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. The Company will not be required to make any royalty payments to Telkoor under the manufacturing agreement with Telkoor until the shortfall of CPCI 600W product sales will be offset. As of December 31 2015 the remaining shortfall balance was $86 . During the year 2016 , the Company paid royalties to Advice, Telkoor refunded $40 from this amount by services to the Company and the balance cancelled with the recession agreement. (See Note 7) +The useful life of the IP has been determined to be five years and the amortization method is the straight-line method, as management considers this method as the most appropriate. +December 31, +201 6 +201 5 +Beginning balance of IP +$ +480 +$ +480 +Accumulated amortization +(480 +) +(480 +) +Ending balance of IP +$ +- +$ +- +Amortization expense was $0 and $66 for the years ended December 31, 2016 and December 31, 2015, respectively. +N OTE 7 : INVESTMENTS – RELATED PARTIES +Avalanche International Corporation (AVLP) +Investments in AVLP at December 31, 2016 consist of: +Balance at January 1, 2016 +$ +- +Investment in convertible promissory notes of AVLP - Gross +997 +Original issue discount +(47 +) +Accretion of discount +2 +Investment in convertible promissory note of AVLP - Net +952 +Investment in common stock of AVLP +84 +Balance at December 31, 2016 +$ +1,036 +During the last quarter of 2016 , the Company made certain strategic investments in AVLP, a related party controlled by Philou, an existing majority stockholder. The Company’s investments in AVLP consist of convertible promissory notes bearing interest of 12% per annum purchased at a 5% discount and shares of common stock of AVLP . +F - 21 +On October 5, 2016 and November 30, 2016, the Company entered into two 12% Convertible Promissory Note agreements ("Notes Receivable") in the principal amount of $525 each, net of a 5% original issue discount ($25 each) with interest payable at 12% per annum. All principal and accrued interest shall be due for payment on or before two years from the origination dates of each note. At any time after six months, the Company has the right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of AVLP at $0.74536 per share, subject to adjustment. The principal amount of each note is convertible into 704,357 shares common stock of AVLP. +During the last quarter of 2016, the Company invested $950 pursuant to Notes Receivable and remaining balance of $50 was invested on February 17, 2017 . +. +The original issue discount of $50 on the Notes Receivable is being amortized as interest income through the maturity date using the interest rate method. The original issue discount on the Note Receivable is amortized as interest income through the maturity date using the interest method, the Company recorded $2 interest income for the discount accretion. +As of December 31, 2016 the Company recorded contractual interest receivables of $13. +On February 22, 2017, subsequent to year-end, AVLP issued the Company a third $525 12% Convertible Promissory Note (the “Third Note”) with original issue discount of 5%. During the period from February 22, 2017 to April 5, 2017, the Company funded $457 pursuant to this Third Note. +The Company has classified the all the above noted Notes , it holds in AVLP , as Available-for-Sale securities, subject to the guidance in ASC 320. The Convertible Promissory Notes qualify for application of the Fair Value Option Subsections of Subtopic 320-10 and 825-10. +At December 31, 2016, the closing market price of AVLP’s common Stock was $0.45. Subsequent to year-end, the closing market price of AVLP’s common stock was in the range of $0.25 and $0.45 and due to the illiquidity and significant volatility of AVLP’s common stock, the Company has determined that its cost basis in AVLP common stock approximates the current fair value. +The Company has concluded that indicators of impairment, including those described in ASC 320-10-35-27, do not currently exist for the Company’s investment in AVLP’s Notes. +In addition the Company purchased at the market 250 ,900 shares of Avalanche at total cost of $84 . The investment is accounted under the fair value -method in accordance with ASC 32 0-1 0. +Based upon the closing market price at December 31, 2016, and most recently at March 30, 2017 ($0.30), the Company has concluded that its investment in shares of AVLP common stock is not impaired. +Telkoor Telecom Ltd. (Telkoor) +Investment in Telkoor at December 31, 2016 and 2015 consists of: +2016 +2015 +Balance at January 1, 2016 +$ +90 +$ +207 +Impaired +- +(110 +) +Exchange rate +- +(7 +) +Disposed/(sold) +(90 +) +- +Balance at December 31, 2016 +$ +- +$ +90 +On June 16, 2011, the Company acquired 1,136,666 shares of Telkoor, the Company's major shareholder at the time, and an Israeli company listed in the Tel Aviv stock exchange (at such time) for $1,000, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between the Company and Telkoor was updated and extended. +F - 22 +The Company recorded an impairment of its investment in Telkoor of $0 and $110 for the years ended December 31 2016 and 2015, respectively. On September 5, 2016, the Company entered into a Securities Purchase Agreement (the “Agreement”) with Philou , and Telkoor pursuant to which the Philou purchased all of the Telkoor 2,714,610 shares of the common stock invested in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock for a consideration of $1.5 million to Telkoor . +Pursuant to the Agreement, the Company entered into a Rescission Agreement with the Telkoor in order to resolve all financial issues between the parties, including the repurchase by the Seller of 1,136,666 shares of common stock in Seller beneficially owned by the Company for their book value. +The closing of the transactions under the Agreement and the Rescission Agreement occurred on September 22, 2016. +Equity securities that do not have readily determinable fair values (i.e. non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC 325-20. The Company carried its investment in Telkoor's shares at historical cost, net of impairment charges in accordance with ASC 325-20 "Investments in Other". +N OTE 8 : OTHER CURRENT LIABILITIES +Other current liabilities at December 31, 2016 and 2015 consist of: +2016 +2015 +Accrued payroll and payroll taxes +$ +128 +$ +105 +Warranty liability +86 +95 +Other accrued expenses +184 +280 +Total +$ +398 +$ +480 +N OTE 9 : DEMAND NOTE PAYABLE – RELATED PARTY +On December 29, 2016 , the Company entered into an agreement with MCKEA, an entity of which a Board member is the managing member and of which it is the member of the Company's largest shareholder, for a demand promissory note (“Note”) in the amount of $250 bearing interest at the rate of 6% per annum on unpaid principal and shall be due and payable upon demand of payment by MCKEA . Note may be prepaid, in whole or in part, without penalty, at the option of the Company and without the consent of MCKEA . As of December 31, 2016, no interest was accrued on the Note. Subsequent to December 31, 2016, Note was converted in the Company’s preferred stock (See Note 16). +N OTE 10 : CONVERTIBLE NOTE – RELATED PARTY +Balance at January 1, 2016 +$ +- +Proceeds from convertible note +530 +Unamortized debt discounts +(484 +) +Unamortized financing cost +(12 +) +Balance at December 31, 2016 +$ +34 +On October 21, 2016, the Company, entered into a 12% Convertible Secured Note (“Convertible Note) in the principal amount of $530 and was sold to an existing stockholder of the Company for $500, bearing interest at 12% simple interest on the principal amount, is secured by all the assets of the Company, and is due on October 20, 2019. Interest only payments are due on a quarterly basis and the principal may be converted into shares of the Company’s common stock at $0.55 per share. Subject to certain beneficial ownership limitations, the noteholder may convert the principal amount of the Convertible Note at any time into common stock. The conversion price of the Convertible Note is subject to adjustment for customary stock splits, stock dividends, combinations or other standard anti-dilution events. +F - 23 +The Convertible Note contains standard and customary events of default including, but not limited to failure to make payments when due under the Convertible Note agreement and bankruptcy or insolvency of the Company. +Upon 30 days’ notice, the Company has the right to prepay the Convertible Note. In addition, provided that the closing price for a share of the Company’s common stock exceeds $3.00 per share for 30 consecutive trading days, the Company has the right to compel the noteholder to convert the principal amount into shares of common stock at the contractual conversion price. +As additional consideration, the investor received a three-year warrant to purchase 265,000 shares of common stock each at an exercise price of $0.80 and a three-year warrant to purchase 265,000 shares of common stock each at an exercise price of $0.90 (collectively “Warrants”). Warrants are exercisable commencing six months after the issuance date and are subject to certain beneficial ownership limitations. The exercise price of the Warrants is subject to adjustment for customary stock splits, stock dividends, combinations and other standard anti-dilution events. The Warrants may be exercised for cash or on a cashless basis. The Warrants has a call feature that permits the Company to force redemption at $0.001 per share in the event the closing price for a share of the Company’s common stock exceeds $3.00 for 30 consecutive trading days. +The Company computed the fair value of these warrants using the Black-Scholes option pricing model and allocated $159 of the proceeds to additional paid-in capital. +The beneficiary conversion feature (BCF) embedded in the Debenture is accounted for under ASC Topic 470 – De bt. At issuance, the estimated fair value of the BCF totaled $332. The BCF was allocated from the net proceeds of the Debenture after allocating relative fair value of warrants and limited to remaining net proceeds available for BCF. The BCF is recorded as additional debt discount is being amortized to interest expense over the term of the Debenture using the effective interest method. The valuation of the BCF was calculated based on effective conversion price compared with the market price of common stock on the date of issuance of Convertible Note. +The Company recorded total debt discount in the amount of $518 based on the relative fair values of the Warrants of $159, BCF of $329 and original issue discount (OID) of $30. The debt discount is being amortized as non-cash interest expense over the term of the debt. In addition, the Company incurred $13 of debt issuance costs which is also being amortized as non-cash interest expense over the term of the debt. During the year ended December 31, 2016, non-cash interest expense of $34 was recorded as amortization of debt discount and debt financing cost. +As of December 31, 2016, the Company has recorded accrued interest of $12 on Convertible Note obligation. +N OTE 11 : COMMITMENTS +Lease commitments +In November 2012, the Company signed an operating lease agreement for the US headquarters for a period of 7 years with an option to extend for additional 5 years. In September 2009, the Company's subsidiary signed a new agreement for a lease in respect of the UK facility for a period of 15 years with an option to cancel the lease after 10 years on September 2019. +Future non-cancellable rental commitments under operating leases are as follows: +Year Ended December 31, +2017 +$ +291 +2018 +295 +2019 +219 +2020 +139 +2021 +139 +2022 to 2024 +383 +Total +$ +1,466 +Total rent expense for the years ended December 31, 2016 and 2015 was approximately $294 and $299, respectively. +F - 24 +N OTE 12 : STOCKHOLDERS’ EQUITY +Preferred Stock +There are authorized Preferred stock in the amount of 500,000 shares of Series A cumulative Redeemable Convertible Preferred shares ("Series A"), and an additional 1,500,000 Preferred shares that have been authorized, but the rights, preferences, privileges and restrictions on these shares have not been determined. The Company’s Board of Directors is authorized to create a new series of preferred shares and determine the number of shares, as well as the rights, preferences, privileges and restrictions granted to or imposed upon any series of preferred shares. As of December 31, 2016, there were no preferred shares issued or outstanding. +Common Stock +Common stock confer upon the holders the rights to receive notice to participate and vote in the general meeting of shareholders of the Company, to receive dividends, if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. +On November 15, 2016, the Company entered into subscription agreements (the “Subscription Agreements”) with nine accredited investors. Pursuant to the terms of the Subscription Agreements, the Company sold 901,666 units (“Units”) at $0.60 for an aggregate purchase price of approximately $541,000. Each unit consists of one share of common stock and one warrant to purchase one share of common stock (the “Warrant Shares”) at an exercise price of $0.80. +According to the agreement, the Company registered all of the shares of common stock then issued as part of the Units and Warrant Shares then issued and issuable upon exercise of the Warrant Shares. The Subscription Agreement provides that, until November 15, 2017, Investors who purchased at least $100,000 have the right to participate in the purchase of up to 50% of the securities offered by the Company in any future financing transactions, with limited exceptions. +The Warrants entitle the holders to purchase, in the aggregate, up to 901,666 shares of Common Stock at an exercise price of $0.80 per share for a period of three years. The Warrant Shares are exercisable upon the six month anniversary of the issuance date. The exercise price of the Warrant Shares is subject to adjustment for stock splits, stock dividends, combinations and other standard anti-dilution events. The Warrant Shares may be exercised for cash or, upon the failure to maintain an effective registration statement, on a cashless basis. +The Warrant Shares do not require a net cash-settlement or provide the holder with a choice of net-cash settlement. The Warrant Shares also do not contain a variable settlement provision. Accordingly, the Company classified the Warrant Shares as equity instruments. +Stock Option Plans +Under the Company's Digital Power 2016 and 2012 (As Amended) ("Incentive Share Option Plan"), options may be granted to employees, officers, consultants, service providers and directors of the Company. +As of December 31, 2016, the Company authorized according to the Incentive Share Option Plan the grant of options to officers, management, other key employees and others of up to 5,372,630 options for the Company's common stock. The maximum term of the options is ten years from the date of grant. As of December 31, 2016, an aggregate of 3,322,630 of the Company's options are still available for future grant. +F - 25 +The options granted generally become fully vested after four years. Any options that are forfeited or cancelled before expiration become available for future grants. +The options outstanding as of December 31, 2016 have been classified by exercise price, as follows: +Exercise +Price +Options +Outstanding as +of December 31, +2016 +Weighted +Average +Remaining +Contractual +Term (Years) +Weighted +Average +Exercise +Price +Option +Exercisable as +of December +31, 2016 +Weighted +Average +Exercise Price +of Options +Exercisable +$0.65 +- +$0.70 +1,865,000 +9.76 +$ +0.67 +996,667 +$ +0.66 +$1.10 +- +$1.32 +25,000 +6.84 +$ +1.28 +15,000 +$ +1.25 +$1.51 +- +$1.69 +366,000 +5.57 +$ +1.60 +316,000 +$ +1.59 +2,256,000 +9.05 +$ +0.83 +1,327,667 +$ +0.89 +The total stock-based compensation expense related to all of the Company’s equity based awards, including non-employee options recognized for the years ended December 31, 2016 and 2015 is comprised as follows: +2016 +2015 +Cost of revenues +$ +6 +$ +7 +Engineering and product development +17 +20 +Selling and marketing +5 +6 +General and administrative +492 +193 +Total stock-based compensation +$ +520 +$ +226 +A summary of option activity under the Company's stock option plans as of December 31, 2016 and 2015 and changes during the years then ended are as follows: +Amount of +Options +Weighted +Average +Exercise +Price +Weighted +Average +remaining +Contractual +Term +(Years) +Aggregate +Intrinsic +Value +Balance at January 1, 2015 +1,262,763 +$ +1.57 +7.65 +Granted +155,000 +0.67 +Forfeited +(261,000 +) +1.29 +Expired +(10,763 +) +0.70 +Balance at December 31, 2015 +1,146,000 +1.52 +6.74 +Granted +1,800,000 +0.67 +Forfeited +(650,000 +) +1.59 +Expired +(40,000 +) +1.16 +Balance outstanding at December 31, 2016 +2,256,000 +$ +0.83 +9.08 +$ +- +Exercisable at December 31, 2016 +1,327,667 +$ +0.89 +8.64 +$ +- +The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December 31, 2016, $0.65 and the exercise price, multiplied by the number of in-the-money-options). +F - 26 +As of December 31, 2016, there was $492 of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Company's stock option plans. That cost is expected to be recognized over a weighted average period of 1.81 years. +Options Issued to Non-Employees +As of December 31, 2015, the Company's had options outstanding to purchase 142,500 shares of common stock to non-employees. During the year ended December 31, 2016, options to purchase 102,500 shares of common stock were forfeited and 40,000 options were expired. +Warrants +Warrants Issued to Executive Officer +In connection with executive employment agreement, on November 3, 2016, the Company issued to its Chief Executive Officer a ten-year warrant to purchase 317,460 shares of the Company's common stock (the "Warrant "), at an exercise price of $0.01 per share subject to vesting. The Warrant shall be subject to vesting of which warrants to purchase 39,682 shares shall vest beginning on January 1, 2017, and on the first date of each quarter thereafter through July 1, 2018, with warrants to purchase 39,686 shares to vest on October 1, 2018. The fair value of the Warrant using the Black-Scholes option pricing model was $188, which was amortized ratably over a period of two years out of which $23 was recorded as stock-based compensation in general and administrative expenses during the year ended December 31, 2016 . +Amount of +Warrants +Weighted +Average +Exercise +Price +Weighted +Average +remaining +Contractual +Term +(Years) +Aggregate +Intrinsic +Value +Balance at January 1, 2016 +- +- +- +- +Granted +317,460 +$ +0.01 +Forfeited +- +Expired +Balance outstanding at December 31, 2016 +317,460 +$ +0.01 +9.8 +$ +203 +Exercisable at December 31, 2016 +- +- +- +The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December 31, 2016, $0.65 and the exercise price, multiplied by the number of in-the-money warrants). +NOTE 1 3 : INCOME TAXES +Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and income tax purposes. Significant components of the Company's deferred tax assets are as follows: +December 31, +2016 +2015 +Deferred tax asset: +Net operating loss +$ +2,206 +$ +2,233 +Reserves and allowances +295 +225 +Tax Credit carryforward +153 +153 +Property and equipment +194 +142 +Total deferred tax asset +2,848 +2,753 +Valuation allowance +(2,848 +) +(2,753 +) +Deferred tax asset, net +$ +— +$ +— +F - 27 +The Company had Federal and state net operating loss carryforwards of approximately $5,334 and $3,622, respectively, available to offset future taxable income, expiring at various times from December 31through December 31, 2036. In accordance with Section 382 of the Internal Revenue Code, the future utilization of the Company’s net operating loss to offset future taxable income may be subject to an annual limitation as a result of ownership changes that may have occurred previously or that could occur in the future. The Company has not yet determined whether such an ownership change has occurred; however , the Company will be completing a Section 382 analysis regarding the limitation of the net operating loss. +In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences representing net future deductible amounts become deductible. Management considers the scheduled reversal of deferred tax assets, projected future taxable income and tax planning strategies in making this assessment. After consideration of all of the information available and due to the last five years significant losses there is substantial doubt related to the Company’s ability to utilize its deferred tax assets, the Company recorded a full valuation allowance of the deferred tax asset. For the year ended December 31, 2016, the valuation allowance has increased by $95 . +The 2013 through 2016 tax years remain open to examination by the Internal Revenue Service ( “IRS” ) and the 2012 through 2016 tax years remain open to examination by the California Franchise Tax Board ( “FTB” ). The IRS and FTB have the authority to examine those tax years until the applicable statute of limitations expires . +As of December 31, 2016, the Company’s foreign subsidiary had accumulated losses for income tax purposes in the amount of approximately $906. All of the Company’s international accumulated losses were generated in the United Kingdom, which has a statutory tax rate of 20%. These net operating losses may be carried forward and offset against taxable income in the future for an indefinite period. The Company has not recognized a U.S. deferred income tax asset on non-U.S. losses because the Company plans to indefinitely reinvest such earnings outside the U.S. Remittances of non-U.S. earnings, if any, are based on estimates and judgments of projected cash flow needs, as well as the working capital and investment requirements of the Company’s non-U.S. and U.S. operations. Material changes in the Company’s estimates of cash, working capital, and investment needs could require repatriation of indefinitely reinvested non-U.S. earnings, which would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. +The net income tax benefit consists of the following: +December 31, +2016 +2015 +Current +Foreign +$ +(20 +) +$ +(1 +) +Federal +— +— +State +— +— +Income tax (benefit) +$ +(20 +) +$ +(1 +) +F - 28 +The Company’s effective tax rates were (1.7%) and (0.1%) for the years ended December 31, 2016 and 2015, respectively. During the year ended December 31, 2016, the effective tax rate differed from the U.S. federal statutory rate primarily due to the change in the valuation allowance and the issuance of incentive stock options to the Company’s employees. The reconciliation of income tax attributable to operations computed at the U.S. Federal statutory income tax rate of 34% to income tax expense is as follows: +Year Ended December 31, +2016 +2015 +Tax benefit at U.S. Federal statutory tax rate +(34.0% +) +(34.0% +) +Increase (decrease) in tax rate resulting from: +Stock compensation expense +12.1 +% +— +Taxes in respect of prior years +9.1 +% +0.2 +% +Increase in valuation allowance +8.3 +% +28.0 +% +Nondeductible meals & entertainment expense and other +4.4 +% +7.2 +% +State taxes, net of federal benefit +0.3 +% +— +Foreign rate differential +(0.2% +) +(1.5% +) +Foreign R&D credit +(1.7% +) +— +Effective tax rate +(1.7% +) +(0.1% +) +The Company accounts for uncertain tax positions in accordance with ASC No. 740-10-25. ASC No. 740-10-25 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2016 and 2015, there are no uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +NOTE 14: RELATED PARTY TRANSACTIONS +a. +On September 5, 2016, the Company entered into a Securities Purchase Agreement with Philou, and Telkoor pursuant to which the Philou purchased all of the Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock. In consideration for such shares, the Philou paid Telkoor $1.5 million. +Pursuant to the Securities Purchase Agreement, the Company entered into a Rescission Agreement with the Telkoor in order to resolve all financial issues between the parties, including the repurchase by the Telkoor of 1,136,666 shares of common stock in Telkoor owned by the Company for $90, which was equal to the carrying amount of the investment. +The closing of the transactions under the Securities Purchase Agreement and the Rescission Agreement occurred on September 22, 2016. +Philou is the Company’s largest stockholder. Kristine Ault, a director of the Company, is managing member of MCKEA, which in turn, is the member of Philou. Kristine Ault’s spouse is Milton Ault who is Executive Chairman of the Board of the Directors of the Company. +In addition, on March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000 in the Company through the purchase of Series B Preferred Stock over a specified term . +F - 29 +b. +In anticipation of the acquisition of MTIX by AVLP and the expectation of future business generated by the Company from a strategic investment into AVLP, the Company entered into three 12% Convertible Promissory Note agreements with AVLP in the principal amount of $525 each, including a 5% original issue discount. After six months, the Company has a right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of AVLP at $0.74536 per share +During the last quarter of 2016, the Company invested $950 pursuant to 12% Convertible Promissory Notes and another $507 was invested on the first quarter of 2017. (The remaining balance to invest is $43). +Further, the Company has acquired 250,900 shares of AVLP Common Stock in the open market for $85 . +AVLP, a Nevada corporation, is a holding company currently engaged in acquiring and/or developing businesses in which AVLP maintains a controlling interest. AVLP anticipates that its subsidiaries will be engaged in a number of diverse business activities. AVLP currently has two subsidiaries, Smith and Ramsay Brands, LLC (“SRB”) and Restaurant Capital Group, LLC (“RCG”). SRB was formed on May 19, 2014, and RCG was formed on October 22, 2015. AVLP is quoted under the symbol “AVLP” on the OTC Pink sheets operated by OTC Markets Group, Inc. +Philou is AVLP’s controlling shareholder. Mr. Ault is Chairman of AVLP’s Board of Directors and Mr. William B. Horne is the Chief Financial Officer of AVLP. Mr. Horne is also the audit committee chairman of the Company. +On October 24, 2016, AVLP entered into a letter of intent to acquire MTIX, an advanced materials and processing Technology Company located in Huddersfield, West Yorkshire, UK. On October 26, 2016, pursuant to the term of the letter of intent, AVLP made an initial payment of $50 towards the purchase of MTIX. +On March 3, 2017, AVLP entered into a Share Exchange Agreement with MTIX and the three current shareholders of MTIX . Upon the terms and subject to the conditions set forth in the Share Exchange Agreement, AVLP will acquire MTIX from the MTIX shareholders through the transfer of all issued and outstanding ordinary shares of MTIX (the “MTIX Shares”) by the MTIX shareholders to AVLP in exchange for the issuance by AVLP of: (a) 7% secured convertible promissory notes in the aggregate principal face amount of $9,500 to the MTIX shareholders in pro rata amounts commensurate with their current respective ownership percentages of MTIX’s ordinary shares, (b) (i) $500 in cash, $50 of which was paid on October 26, 2016, and (ii) 100,000 shares of AVLP’s newly designated shares of Class B Convertible Preferred Stock to the principal shareholder of MTIX. +On the closing date, the fully-diluted AVLP shares shall be 52,128,325 shares of common stock, assuming that (i) the MTIX promissory notes are convertible into shares of AVLP Common Stock at a conversion price of $0.50 per share, (ii) the shares of AVLP Class B Convertible Preferred Stock are convertible into shares of AVLP Common Stock at a conversion rate of $0.50 per share and (iii) the issuance of stock options to purchase an aggregate of 531,919 shares of AVLP Common Stock to the members of the MTIX management group . +During March 2017 , the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the MLSE plasma-laser system . +c. +On December 29, 2016, the Company received a $250 short term loan from MCKEA, the member of Philou. Ms. Ault, a director of the Company, is the managing member of MCKEA . On March 24, 2017, the $250 loan was cancelled in consideration for the issuance of 25,000 shares of Series B preferred stock of the Company to Philou. +d. +On September 22, 2016, the Company entered into consulting agreement with Mr. Ault to assist the Company in developing a business strategy, identifying new business opportunities, developing a capital raising program and implementing of a capital deployment program. For his services Mr. Ault will be paid a monthly fee of $15 from November 1, 2016 through June 30, 2017 and may be renewed . +F - 30 +e. +On October 21, 2016, the Company entered into a 12% convertible secured note in the principal amount of $530 with Mr. Barry Blank, an existing stockholder of the Company, for $500 due on October 20, 2019. The principal amount of 12% convertible secured note may be convertible into shares of the Company’s common stock at $0.55 per share, subject to certain beneficial ownership limitations Mr. Blank may convert the principal amount of the convertible note at any time into common stock . +Mr. Blank owns 419,900 shares of the common stock of the Company, constituting approximately 5.02% of the Company’s outstanding shares of common stock. The 12% convertible secured note will convert into 963,636 shares of common stock which represent 20.5% of the Company’s outstanding shares of common stock without regard to an beneficial ownership limitation. +As additional consideration, Mr. Blank received a three-year warrant to purchase 265,000 shares of common stock each at an exercise price of $0.80 and a three-year warrant to purchase 265,000 shares of common stock each at an exercise price of $0.90. +f. +On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000,000 in the Company through the purchase of Series B Preferred Stock over the 36 months . +g. +On March 24, 2017, Philou purchased 25,000 shares of Series B Preferred Stock (Note 16). +NOTE 15: SEGMENT CUSTOMERS AND GEOGRAPHICAL INFORMATION +The Company has two reportable geographic segments; see Note 1 for a brief description of the Company’s business. +The following data presents the revenues, expenditures and other operating data of the Company’s geographic operating segments and presented in accordance with ASC 280. +Year Ended December 31, 2016 +DPC +DPL +Eliminations +Total +Revenues +$ +4,552 +$ +3,044 +$ +- +$ +7,596 +Inter-segment revenues +145 +- +(145 +) +- +Total revenues +$ +4,697 +$ +3,044 +$ +(145 +) +$ +7,596 +Depreciation and amortization expenses +$ +75 +$ +86 +$ +- +$ +161 +Operating income (loss) +$ +(1,110 +) +$ +(109 +) +$ +- +$ +(1,219 +) +Other income, net +77 +Income taxes +20 +Net loss +$ +(1,122 +) +Capital expenditures for segment assets for the year ended December 31, 2016 +$ +32 +$ +53 +$ +- +$ +85 +Identifiable assets as of December 31, 2016 +$ +3,152 +$ +2,320 +$ +- +$ +5,472 +F - 31 +Year Ended December 31, 201 5 +DPC +DPL +Eliminations +Total +Revenues +$ +3,833 +$ +3,933 +$ +- +$ +7,766 +Inter-segment revenues +371 +- +(371 +) +- +Total revenues +$ +4,204 +$ +3,933 +$ +(371 +) +$ +7,766 +Depreciation and amortization expenses +$ +74 +$ +139 +$ +- +$ +213 +Operating income (loss) +$ +(1,086 +) +$ +83 +$ +- +$ +(1,003 +) +Impairment of investment +(110 +) +Other income, net +16 +Income taxes +1 +Net loss +$ +(1,096 +) +Capital expenditures for segment assets for the year ended December 31, 2015 +$ +58 +$ +248 +$ +- +$ +306 +Identifiable assets as of December 31, 2015 +$ +2,384 +$ +2,715 +$ +- +$ +5,099 +The following table provides the percentage of total revenues attributable to a single customer from which 10% or more of total revenues are derived: +For the year ended December 31,2016 +Total Revenues +by Major +Customers +(in thousands) +Percentage of +Total +Company +Revenues +Customer A +$ +1,328 +17 +% +Customer B +$ +750 +10 +% +For the year ended December 31,2015 +Total Revenues +by Major +Customers +(in thousands) +Percentage of +Total +Company +Revenues +Customer A +$ +853 +11 +% +Customer B +$ +1,809 +23 +% +Revenue from customer A was attributable to DPC and revenue from Customer B attributable to DPL. +For the years ended December 31, 2016 and 2015, total revenues from external customers divided on the basis of the Company’s product lines are as follows: +2016 +2015 +Revenues: +Commercial products +$ +5,307 +$ +4,802 +Defense products +2,289 +2,964 +Total revenues +$ +7,596 +$ +7,766 +F - 32 +Financial data relating to geographic areas: +The Company’s total revenues are attributed to geographic areas based on the location. +The following table presents total revenues for the years ended December 31, 2016 and 2015. Other than as shown, no foreign country contributed materially to revenues or long-lived assets for these periods: +2016 +2015 +North America +$ +4,541 +$ +3,435 +Europe (including UK) +1,845 +1,704 +Asia +255 +768 +Australia +123 +42 +South America +81 +3 +South Korea +751 +1,814 +Total revenues +$ +7,596 +$ +7,766 +NOTE 16: SUBSEQUENT EVENTS +In February 2017, the Company issued $400 in demand promissory notes and five year warrants to purchase 333,333 shares of common stock at $ 0.70, per share. +In February 16, 2017 , the holder of the $100 in demand promissory notes agreed to cancel its demand promissory note for the purchase of 166,667 shares of Common Stock at $0.60 per share . +In February 23, 2017, the holders of the $300 in demand promissory notes agreed to cancel their demand promissory notes to purchase of 500,000 shares of Common Stock at $0.60 per share . +On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou, the majority stockholder of the Company and of which Kristine Ault, a director of the Company, is the managing member of MCKEA which, in turn, is the Manager of Philou. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000,000 in the Company through the purchase of Series B Preferred Stock over the term of 36 months. +In addition, for each share of Series B Preferred Stock purchased, Philou will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Series B Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price equal to $0.70 per share of common stock +Further, Philou shall have the right to participate in the Company’s future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest in the Company. Philou’s right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Series B Preferred Stock. +On March 15, 2017, Company entered into a subscription agreement with an investor for the sale of 500,000 shares of common stock at $0.60 per share for the aggregate purchase price of $300. +On March 24, 2017, Philou purchased 25,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the cancellation of the Company debt due to an affiliate of Philou in the amount of $250 . +On March 28, 2017, the Company issued $270 in demand promissory notes to several investors. These demand promissory notes bear interest at the rate of 6% per annum. On April 5, 2017, the Company canceled these promissory notes by issuing 360,000 shares of common stock at $0.75 per share. In addition, the Company also issued warrants to purchase 180,000 shares of common stock at $0.90 per share to these investors. +F-33 +. \ No newline at end of file diff --git a/raw/filings/0000896493/2016/0001437749-17-006372/filing_metadata.csv b/raw/filings/0000896493/2016/0001437749-17-006372/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..bfa770c664c6eedfc3ae4e3b71b780e495a58a76 --- /dev/null +++ b/raw/filings/0000896493/2016/0001437749-17-006372/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2017-04-10,2016-12-31,2017-04-10T21:10:57.000Z,0001437749-17-006372,dpw20161231_10k.htm,FORM 10-K,8899949,1,0,https://www.sec.gov/Archives/edgar/data/896493/000143774917006372/dpw20161231_10k.htm,https://www.sec.gov/Archives/edgar/data/896493/000143774917006372/,2016,2016,1 diff --git a/raw/filings/0000896493/2016/0001437749-17-006372/item1.txt b/raw/filings/0000896493/2016/0001437749-17-006372/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..80df95531532baedd076dfc851a61ed34526dbe4 --- /dev/null +++ b/raw/filings/0000896493/2016/0001437749-17-006372/item1.txt @@ -0,0 +1,71 @@ +ITEM 1. +Business. +General +We are a growth company seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy that occurred as a result of a change in control completed in September 2016. Our acquisition and development target strategy includes companies that have developed a “new way of doing business” in mature, well-developed industries experiencing changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; companies that are related to our core business in the commercial and defense industries; and companies that will enhance our overall revenues. It is our goal to substantially increase our gross revenues in the near future. +We were originally a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the medical, military, telecom and industrial markets. Although we intend to seek growth through acquisitions, we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. +We also have operations located in Europe through our wholly-owned subsidiary, Digital Power Limited ("DPL"), Salisbury, England, which operates under the brand name of “Gresham Power Electronics” (“Gresham”). DPL designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products . +We are a California corporation formed in 1969 and located in the heart of the Silicon Valley at 48430 Lakeview Blvd, Fremont, California 94538-3158. Our phone number is 510-657-2635 and our website address is www.digipwr.com. +1 +Recent Events – Change of Control +On September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, LLC (“Philou Ventures”), a Wyoming limited liability company, and Telkoor Telecom Ltd., an Israeli company (“Telkoor”) pursuant to which the Philou Ventures agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock. In consideration for such shares, Philou Ventures agreed to pay Telkoor $1.5 million. On September 22, 2016, the sale between Telkoor and Philou Ventures closed and Philou Ventures became the Company’s largest shareholder with Telkoor no longer being associated with the Company. Further, in conjunction therewith, Messrs. Israel Levi, Haim Yatim, and Ben-Zion Diamant resigned from the board of directors of the Company and the remaining members of the board of directors of the Company consisting of Mr. Amos Kohn and Mr. Moti Rosenberg filled one of the vacancies caused by the resignations by appointing Mr. Robert O. Smith to the board. Shortly thereafter, on October 13, 2016, Kristine Ault and William Horne were appointed to the board of directors. +Strategy +Our strategy to increase revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business of power system solutions for the military-aerospace, medical and industrial-telecommunication industries, we have determined that significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient sales and marketing force as a result of deferring research and development of new products because of limited working capital, and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution companies. +Therefore, we believe that the best strategy for us and our shareholders is to invest our core business to support releases of advanced new power technologies and to expand our customer base and market share in our major serving markets. To support the organic growth, we have hired number of additional personal and investing to enhance our product offerings with state of the art technology. While we implementing new organic growth strategy, we are focusing on finding and acquiring companies which have developed new technology and but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies that enhance our overall revenues. Further, as discussed below, we have made a recent investment in Avalanche International, Corp. which has acquired rights to a company that has developed a cost effective and environment friendly material synthesis technology for textile applications. +As a result of this strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase in infrastructure expenses to seek new opportunities and investing in companies that demonstrate revenue potential, but our initially incurring losses, we anticipate to continue to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Core Business – Power Systems Solutions +We provide the highest density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and modify-standard product solutions and value-added services to diverse industries and markets including military-aerospace, medical and industrial- telecommunication. We believe that our solutions leverage a combination of low leakage power emissions, very high power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +2 +Our strategy is to be the supplier of choice to those companies and OEMs requiring high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that support all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. Our target market segments include the industrial - telecommunication, medical, and military-aerospace industries. +Custom Power System Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution technology includes full Digital Signal Processing (“DSP”) control, digital load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customer’s unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“IP”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“PFC”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages and unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to original equipment manufacturers (“OEMs”). We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating a complex, time-consuming and costly integration. We believe that this value-added service is well suited to those OEMs who wish to reduce their vendor base and minimize their investment in manufacturing that leads to increased fixed costs. Based on these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Our products have a warranty period from date of shipment to the customer. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic corporation, Digital Power Corporation; the European marketplace is served through DPL, our wholly-owned subsidiary. +3 +We sell products to our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2017 . +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture our military products by a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ITAR”) and is certified to perform such manufacturing services. We are compliant with the US ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned Aerial Vehicle) – Very lightweight power systems . +Our military products meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary DPL develops and manufactures some military and defense products mainly being deployed in international naval fleets. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom , designs, manufactures, and distributes switching power supplies, uninterruptible power supplies, and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“Gresham”). Frequency converters manufactured by Gresham are used by naval warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +4 +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low cost manufacturing goals with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and in Asia. +We sell certain products that are developed, manufactured and sold to us by Advice Electronics Ltd. (“Advice”), an Israeli company that acquired the assets and commercial operations of our major shareholder Telkoor in January 2016. We entered into a manufacturing and royalty rights agreement with Advice in January 2016. This agreement formalized the business relationship between Advice and us in order to allow us to continue manufacturing certain of Telkoor’s products (currently owned by Advice) and the respective royalty charge. +In June 2015, OHM Power Solutions Ltd. (“Ohm”) acquired from Telkoor its entire military assets and military operation. The asset sale between Telkoor and Ohm does not affect our ability to manufacturing and sell certain of Telkoor’s military products. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Any future restrictions or charges may be imposed by the United States or any other foreign country. In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs that are funded and governed by the e U.S. Foreign Military Financing program. +5 +Sales and Marketing +We market our products directly through our internal sales force as well as through our channel partners including independent manufacturer representatives (Reps) and distributors. Each manufacturing Rep promotes our products in a particular assigned geographic territory. Generally, the Reps have the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving its marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales for retention, payable after products were shipped to the customer in the assigned territory. Typically, either we or the Reps are entitled to terminate the Rep agreement upon 30 days’ written notice. +Historically, we have also sold products through multiple power focused distributors. Distributors are not assigned to a particular geographical territory. Each of these arrangements can be terminated by either party upon 30 days’ written notice. +We provide comprehensive collateral including product data sheets, participation in trade shows, and our website, www.digipwr.com. We use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our website and accessible to the marketplace. We will continue to enhance our website by adding more features and functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of our product development projects to engineering partners in order to achieve the best technological and product design results for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the shelf (“COTS”) products and for other customized product requirements, when applicable. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering integrating laboratory located in California. +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products comparable in quality to ours. Many of our competitors, including Bel Fuse), Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +6 +We anticipate in the current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to whom we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of output product design platforms. We believe we have a competitive position with our targeted customers who need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“NRE”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +7 +Research and Development +During the years ended December 31, 2016 and 2015, we spent approximately $709,000 and $894,000, respectively, on research and development. +Employees +As of December 31, 2016 we had 26 employees located in the United States and the United Kingdom, of whom six were engaged in engineering and product development, seven in sales and marketing, seven in general operations and six in general administration and finance. All but two of these employees are employed on a full-time basis. None of our employees are currently represented by a trade union. We consider our relations with our employees to be good. +Recent Investments - Avalanche International, Corp. +We have made an investment in Avalanche International Corp. (“Avalanche”) through a series of convertible loans in the aggregate amount of approximately $1,530,000 as of March 31, 2017. Avalanche is a development stage company whose primary business includes manufacturing and distributing of premium vape liquid and distributor of vape accessories and the development and operating of restaurants. More recently, in March 2017, Avalanche contractually acquired the rights to MTIX Limited, an English company located in Huddersfield, West Yorkshire, U.K. that owns the proprietary rights for the development of a cost effective and environmentally friendly material synthesis technology for textile applications. MTIX’s Multiplexed Laser Surface Enhancement “MLSE TM ” technology utilizes combined high powered pulsed UV laser and atmospheric plasma to create high energy reaction zone at substrate interface promoting rapid synthesis to achieve the required functional treatments. On March 15, 2017, we announced that we had entered into a $50 million purchase order with MTIX to manufacture, install and service fabric treatment machines that utilize MTIX’s proprietary MLSE™ system. The purchase order is subject to standard terms and conditions including that MTIX can cancel its order at any time subject to payment for expenses incurred and other contractually agreed expenses owed due to the cancellation of the purchase order. No assurance can be given that MTIX will order $50 million in fabric machines which are the subject of the purchase order. \ No newline at end of file diff --git a/raw/filings/0000896493/2016/0001437749-17-006372/item13.txt b/raw/filings/0000896493/2016/0001437749-17-006372/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..10ec4bda92da4e42b9ce78ef931de7451cfd8f09 --- /dev/null +++ b/raw/filings/0000896493/2016/0001437749-17-006372/item13.txt @@ -0,0 +1,31 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information sets forth certain related transactions between us and certain of our shareholder of directors. Prior to September 22, 2016, Telkoor was our largest shareholder and Telkoor’s Chief Exectuive Officer, Benzi Diamant, was our Chairman of the Board. Effective September 22, 2016, Telkoor sold all of its shares of common stock of the Company to Philou Ventures, and as a result, Philou Ventures is our largest shareholder. Philou Ventures’ Manager is Kristine L. Ault, one of our directors. Ms. Ault is the spouse of Milton C. Ault, III, who is our Executive Chairman of the Board. +Telkoor Telecom, Ltd. +As previously disclosed, on September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, and Telkoor pursuant to which Telkoor agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the then Company’s outstanding shares of common stock. In consideration for such shares, Philou agreed to pay Telkoor $1.5 million. +In conjunction with the securities purchase agreement, we entered into a rescission agreement with Telkoor in order to resolve all financial issues between the parties, including the repurchase by Telkoor of 1,136,666 shares of common stock of Telkoor beneficially owned by us for book value . +Finally, as part of the securities purchase agreement, we have agreed to pay Mr. Diamant $7,500 for a period of eighteen months from September 5, 2016 for consulting services . +Relationship with Telkoor Power Supplies Ltd. +During the years ended December 31, 2016 and 2015, we purchased approximately $0 and $594,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest then shareholder, Telkoor, of which Ben-Zion Diamant was the Chief Executive Officer and its controlling shareholder. We had no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. In January 2016, Telkoor sold its commercial intellectual property to Advice Electronics Ltd. As a result, of that date no further orders have been placed with Telkoor. +36 +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest then shareholder, Telkoor , of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor sold its assets, including its subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Acquisition of Shares of Telkoor +On June 16, 2011 we acquired 1,136,666 shares of Telkoor, a then major shareholder of the Company which was listed on the Tel Aviv Stock Exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations. As of December 31, 2105 the shares represented 8.4% of the outstanding shares of Telkoor which have since de-listed from the Tel Aviv Stock Exchange. +On September 22, 2016, the Company sold such shares back to Telkoor for $90,000. +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016 , Telkoor sold all its commercial IP to Advice Electronics Ltd. ("Advice”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under our branding until December 2020. +37 +Philou Ventures, LLC +On March 9, 2017, we entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Philou Ventures. Philou Ventures is the Company’s largest stockholder and Kristine L. Ault, one of our directors, controls and is a Manager of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures will invest up to $5,000,000 in us through the purchase of Series B Preferred Stock (“Preferred Stock”) over the Term, as specified herein. Each share of Preferred Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guarantees to purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE MKT. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares of Preferred Stock in a sufficient amount in order us to meet the NYSE MKT’s minimum stockholders’ equity continued listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “Guaranteed Purchases”). In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of Preferred Stock, up to the 500,000 share maximum (“Voluntary Purchases”). All consideration for Voluntary Purchases shall be delivered through a series of varying payments (“Payments”) by Philou Ventures, at its sole and absolute discretion, during the period commencing on the closing date and ending 36 months therefrom (the “Term”). We have the right to request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining the minimum stockholders’ equity required by the NYSE MKT. The Preferred Stock shall not be callable by us for 25 years from the closing date. +In addition, for each share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price equal to $0.70 per share of common stock +Further, Philou Ventures shall have the right to participate our future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest us Philou Ventures’ right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +Finally, in order to meet the requirement of the NYSE Mkt Rule 713, Philou Ventures will not (i) vote the shares of Preferred Stock; (ii) convert such shares of Preferred Stock into shares of Common Stock or (iii) exercise its rights under the Warrant until the requirement of NYSE Mkt Rule 713 has been met at a meeting, or by the requisite written consent, of the holders of the outstanding shares of Common Stock. +On December 29, 2016, MCKEA Holdings lent us $250,000 in the form of a demand note bearing simple interest at 6.0%. Kristine L. Ault is the managing member of MCKEA Holdings, which in turn, is the member of Philou Ventures. On March 24, 2017, MCKEA Holdings cancelled the $250,000 demand note to purchase 25,000 shares of Preferred Stock and received warrants to purchase 357,143 shares of common stock at $0.70 per share. +Avalanche International , Corp. +During the quarter ended December 31, 2016, Avalanche International, Corp. (“Avalanche”) issued to the Company two $525,000 12% Convertible Promissory Notes, with identical terms, dated October 5, 2016 and November 30, 2016. In consideration for the issuance of the Notes, the Company loaned $1,000,000 to Avalanche of which $950,000 was funded as of December 31, 2016, and the remaining $50,000 was funded on February 17, 2016. The Notes, in the aggregate principal amount of $1,050,000, include an original issue discount of $50,000. The Notes accrue simple interest at 12% per annum and are convertible into shares of Avalanche common stock at $0.74536 per share. +38 +At any time after six months from the date of the Notes, the Company may convert the principal and interest into shares of Avalanche common stock. The conversion price of the Notes is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The Notes contain standard and customary events of default including, but not limited to failure to make payments when due under the Notes and bankruptcy or insolvency of Avalanche . +On February 22, 2017, subsequent to year-end, Avalanche issued the Company a third $525,000 12% Convertible Promissory Note (the “Third Note”). During the period from February 22, 2017 to March 3, 2017, the Company funded $172,371 pursuant to this Third Note. +Avalanche is a holding company which on March 3, 2017, entered into a share exchange agreement with MTIX and the three shareholders of MTIX. Upon the terms and subject to the conditions set forth in the share exchange agreement, Avalanche will acquire MTIX from the sellers through the transfer of all issued and outstanding ordinary shares of MTIX by the sellers to Avalanche. MTIX has developed a cost effective and environment friendly material synthesis technology for textile applications utilizing the proprietary MLSE™ system which uses a combination of high voltage plasma and laser energy to imbue fabrics with desirable technical characteristics. On March 15, 2017, the Company announced that it had entered into a $50 million purchase order with MTIX to manufacture, install and service fabric treatment machines that utilize MTIX’s proprietary MLSE™ system. +Milton C. Ault, III and William Horne, two of our directors, are directors of Avalanche. In addition, based on Avalanche’s Form 10-K for the year ended December 31, 2015, Philou Ventures is the largest shareholder of Avalanche. Philou Ventures is our largest shareholder, and Kristine L. Ault, Milton C. Ault, III’s spouse, is the manager for Philou Ventures. \ No newline at end of file diff --git a/raw/filings/0000896493/2016/0001437749-17-006372/item9a.txt b/raw/filings/0000896493/2016/0001437749-17-006372/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..329968403c81caa983e6d12c08477e5c3a8426de --- /dev/null +++ b/raw/filings/0000896493/2016/0001437749-17-006372/item9a.txt @@ -0,0 +1,11 @@ +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +As of December 31, 2016, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) were effective as of the end of the period covered by the report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls . Our management has concluded that, as of December 31, 2016, our internal control over financial reporting was effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +25 +Evaluation of Changes in Internal Control over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2016/0001437749-17-006372/rp_note.txt b/raw/filings/0000896493/2016/0001437749-17-006372/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..4ab5297ee0b9e303a2e602763e009a3aa1ea663a --- /dev/null +++ b/raw/filings/0000896493/2016/0001437749-17-006372/rp_note.txt @@ -0,0 +1,31 @@ +NOTE 14: RELATED PARTY TRANSACTIONS +a. +On September 5, 2016, the Company entered into a Securities Purchase Agreement with Philou, and Telkoor pursuant to which the Philou purchased all of the Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock. In consideration for such shares, the Philou paid Telkoor $1.5 million. +Pursuant to the Securities Purchase Agreement, the Company entered into a Rescission Agreement with the Telkoor in order to resolve all financial issues between the parties, including the repurchase by the Telkoor of 1,136,666 shares of common stock in Telkoor owned by the Company for $90, which was equal to the carrying amount of the investment. +The closing of the transactions under the Securities Purchase Agreement and the Rescission Agreement occurred on September 22, 2016. +Philou is the Company’s largest stockholder. Kristine Ault, a director of the Company, is managing member of MCKEA, which in turn, is the member of Philou. Kristine Ault’s spouse is Milton Ault who is Executive Chairman of the Board of the Directors of the Company. +In addition, on March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000 in the Company through the purchase of Series B Preferred Stock over a specified term . +F - 29 +b. +In anticipation of the acquisition of MTIX by AVLP and the expectation of future business generated by the Company from a strategic investment into AVLP, the Company entered into three 12% Convertible Promissory Note agreements with AVLP in the principal amount of $525 each, including a 5% original issue discount. After six months, the Company has a right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of AVLP at $0.74536 per share +During the last quarter of 2016, the Company invested $950 pursuant to 12% Convertible Promissory Notes and another $507 was invested on the first quarter of 2017. (The remaining balance to invest is $43). +Further, the Company has acquired 250,900 shares of AVLP Common Stock in the open market for $85 . +AVLP, a Nevada corporation, is a holding company currently engaged in acquiring and/or developing businesses in which AVLP maintains a controlling interest. AVLP anticipates that its subsidiaries will be engaged in a number of diverse business activities. AVLP currently has two subsidiaries, Smith and Ramsay Brands, LLC (“SRB”) and Restaurant Capital Group, LLC (“RCG”). SRB was formed on May 19, 2014, and RCG was formed on October 22, 2015. AVLP is quoted under the symbol “AVLP” on the OTC Pink sheets operated by OTC Markets Group, Inc. +Philou is AVLP’s controlling shareholder. Mr. Ault is Chairman of AVLP’s Board of Directors and Mr. William B. Horne is the Chief Financial Officer of AVLP. Mr. Horne is also the audit committee chairman of the Company. +On October 24, 2016, AVLP entered into a letter of intent to acquire MTIX, an advanced materials and processing Technology Company located in Huddersfield, West Yorkshire, UK. On October 26, 2016, pursuant to the term of the letter of intent, AVLP made an initial payment of $50 towards the purchase of MTIX. +On March 3, 2017, AVLP entered into a Share Exchange Agreement with MTIX and the three current shareholders of MTIX . Upon the terms and subject to the conditions set forth in the Share Exchange Agreement, AVLP will acquire MTIX from the MTIX shareholders through the transfer of all issued and outstanding ordinary shares of MTIX (the “MTIX Shares”) by the MTIX shareholders to AVLP in exchange for the issuance by AVLP of: (a) 7% secured convertible promissory notes in the aggregate principal face amount of $9,500 to the MTIX shareholders in pro rata amounts commensurate with their current respective ownership percentages of MTIX’s ordinary shares, (b) (i) $500 in cash, $50 of which was paid on October 26, 2016, and (ii) 100,000 shares of AVLP’s newly designated shares of Class B Convertible Preferred Stock to the principal shareholder of MTIX. +On the closing date, the fully-diluted AVLP shares shall be 52,128,325 shares of common stock, assuming that (i) the MTIX promissory notes are convertible into shares of AVLP Common Stock at a conversion price of $0.50 per share, (ii) the shares of AVLP Class B Convertible Preferred Stock are convertible into shares of AVLP Common Stock at a conversion rate of $0.50 per share and (iii) the issuance of stock options to purchase an aggregate of 531,919 shares of AVLP Common Stock to the members of the MTIX management group . +During March 2017 , the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the MLSE plasma-laser system . +c. +On December 29, 2016, the Company received a $250 short term loan from MCKEA, the member of Philou. Ms. Ault, a director of the Company, is the managing member of MCKEA . On March 24, 2017, the $250 loan was cancelled in consideration for the issuance of 25,000 shares of Series B preferred stock of the Company to Philou. +d. +On September 22, 2016, the Company entered into consulting agreement with Mr. Ault to assist the Company in developing a business strategy, identifying new business opportunities, developing a capital raising program and implementing of a capital deployment program. For his services Mr. Ault will be paid a monthly fee of $15 from November 1, 2016 through June 30, 2017 and may be renewed . +F - 30 +e. +On October 21, 2016, the Company entered into a 12% convertible secured note in the principal amount of $530 with Mr. Barry Blank, an existing stockholder of the Company, for $500 due on October 20, 2019. The principal amount of 12% convertible secured note may be convertible into shares of the Company’s common stock at $0.55 per share, subject to certain beneficial ownership limitations Mr. Blank may convert the principal amount of the convertible note at any time into common stock . +Mr. Blank owns 419,900 shares of the common stock of the Company, constituting approximately 5.02% of the Company’s outstanding shares of common stock. The 12% convertible secured note will convert into 963,636 shares of common stock which represent 20.5% of the Company’s outstanding shares of common stock without regard to an beneficial ownership limitation. +As additional consideration, Mr. Blank received a three-year warrant to purchase 265,000 shares of common stock each at an exercise price of $0.80 and a three-year warrant to purchase 265,000 shares of common stock each at an exercise price of $0.90. +f. +On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000,000 in the Company through the purchase of Series B Preferred Stock over the 36 months . +g. +On March 24, 2017, Philou purchased 25,000 shares of Series B Preferred Stock (Note 16). \ No newline at end of file diff --git a/raw/filings/0000896493/2016/0001437749-17-006372/rpt_disclosure.txt b/raw/filings/0000896493/2016/0001437749-17-006372/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..10ec4bda92da4e42b9ce78ef931de7451cfd8f09 --- /dev/null +++ b/raw/filings/0000896493/2016/0001437749-17-006372/rpt_disclosure.txt @@ -0,0 +1,31 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information sets forth certain related transactions between us and certain of our shareholder of directors. Prior to September 22, 2016, Telkoor was our largest shareholder and Telkoor’s Chief Exectuive Officer, Benzi Diamant, was our Chairman of the Board. Effective September 22, 2016, Telkoor sold all of its shares of common stock of the Company to Philou Ventures, and as a result, Philou Ventures is our largest shareholder. Philou Ventures’ Manager is Kristine L. Ault, one of our directors. Ms. Ault is the spouse of Milton C. Ault, III, who is our Executive Chairman of the Board. +Telkoor Telecom, Ltd. +As previously disclosed, on September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, and Telkoor pursuant to which Telkoor agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the then Company’s outstanding shares of common stock. In consideration for such shares, Philou agreed to pay Telkoor $1.5 million. +In conjunction with the securities purchase agreement, we entered into a rescission agreement with Telkoor in order to resolve all financial issues between the parties, including the repurchase by Telkoor of 1,136,666 shares of common stock of Telkoor beneficially owned by us for book value . +Finally, as part of the securities purchase agreement, we have agreed to pay Mr. Diamant $7,500 for a period of eighteen months from September 5, 2016 for consulting services . +Relationship with Telkoor Power Supplies Ltd. +During the years ended December 31, 2016 and 2015, we purchased approximately $0 and $594,000, respectively, of products from Telkoor Power Supplies, Ltd., a wholly-owned subsidiary of our largest then shareholder, Telkoor, of which Ben-Zion Diamant was the Chief Executive Officer and its controlling shareholder. We had no written agreement for the purchase of these products, other than purchase orders that are placed in the ordinary course of business when the products are needed. In January 2016, Telkoor sold its commercial intellectual property to Advice Electronics Ltd. As a result, of that date no further orders have been placed with Telkoor. +36 +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest then shareholder, Telkoor , of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor sold its assets, including its subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Acquisition of Shares of Telkoor +On June 16, 2011 we acquired 1,136,666 shares of Telkoor, a then major shareholder of the Company which was listed on the Tel Aviv Stock Exchange, for $0.88 (NIS 3) per share, which represented 8.8% of the outstanding shares of Telkoor. As a result of this transaction, an existing manufacturing agreement between Digital Power and Telkoor was updated and extended. Until September 30, 2012 the investment was accounted for as an available-for-sale investment and then reclassified the accounting of the investment at cost less accumulated impairments derived from independent appraisals or available market valuations. As of December 31, 2105 the shares represented 8.4% of the outstanding shares of Telkoor which have since de-listed from the Tel Aviv Stock Exchange. +On September 22, 2016, the Company sold such shares back to Telkoor for $90,000. +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the "Manufacturing Agreement") with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage, or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016 , Telkoor sold all its commercial IP to Advice Electronics Ltd. ("Advice”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under our branding until December 2020. +37 +Philou Ventures, LLC +On March 9, 2017, we entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Philou Ventures. Philou Ventures is the Company’s largest stockholder and Kristine L. Ault, one of our directors, controls and is a Manager of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures will invest up to $5,000,000 in us through the purchase of Series B Preferred Stock (“Preferred Stock”) over the Term, as specified herein. Each share of Preferred Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guarantees to purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE MKT. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares of Preferred Stock in a sufficient amount in order us to meet the NYSE MKT’s minimum stockholders’ equity continued listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “Guaranteed Purchases”). In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of Preferred Stock, up to the 500,000 share maximum (“Voluntary Purchases”). All consideration for Voluntary Purchases shall be delivered through a series of varying payments (“Payments”) by Philou Ventures, at its sole and absolute discretion, during the period commencing on the closing date and ending 36 months therefrom (the “Term”). We have the right to request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining the minimum stockholders’ equity required by the NYSE MKT. The Preferred Stock shall not be callable by us for 25 years from the closing date. +In addition, for each share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price equal to $0.70 per share of common stock +Further, Philou Ventures shall have the right to participate our future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest us Philou Ventures’ right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +Finally, in order to meet the requirement of the NYSE Mkt Rule 713, Philou Ventures will not (i) vote the shares of Preferred Stock; (ii) convert such shares of Preferred Stock into shares of Common Stock or (iii) exercise its rights under the Warrant until the requirement of NYSE Mkt Rule 713 has been met at a meeting, or by the requisite written consent, of the holders of the outstanding shares of Common Stock. +On December 29, 2016, MCKEA Holdings lent us $250,000 in the form of a demand note bearing simple interest at 6.0%. Kristine L. Ault is the managing member of MCKEA Holdings, which in turn, is the member of Philou Ventures. On March 24, 2017, MCKEA Holdings cancelled the $250,000 demand note to purchase 25,000 shares of Preferred Stock and received warrants to purchase 357,143 shares of common stock at $0.70 per share. +Avalanche International , Corp. +During the quarter ended December 31, 2016, Avalanche International, Corp. (“Avalanche”) issued to the Company two $525,000 12% Convertible Promissory Notes, with identical terms, dated October 5, 2016 and November 30, 2016. In consideration for the issuance of the Notes, the Company loaned $1,000,000 to Avalanche of which $950,000 was funded as of December 31, 2016, and the remaining $50,000 was funded on February 17, 2016. The Notes, in the aggregate principal amount of $1,050,000, include an original issue discount of $50,000. The Notes accrue simple interest at 12% per annum and are convertible into shares of Avalanche common stock at $0.74536 per share. +38 +At any time after six months from the date of the Notes, the Company may convert the principal and interest into shares of Avalanche common stock. The conversion price of the Notes is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The Notes contain standard and customary events of default including, but not limited to failure to make payments when due under the Notes and bankruptcy or insolvency of Avalanche . +On February 22, 2017, subsequent to year-end, Avalanche issued the Company a third $525,000 12% Convertible Promissory Note (the “Third Note”). During the period from February 22, 2017 to March 3, 2017, the Company funded $172,371 pursuant to this Third Note. +Avalanche is a holding company which on March 3, 2017, entered into a share exchange agreement with MTIX and the three shareholders of MTIX. Upon the terms and subject to the conditions set forth in the share exchange agreement, Avalanche will acquire MTIX from the sellers through the transfer of all issued and outstanding ordinary shares of MTIX by the sellers to Avalanche. MTIX has developed a cost effective and environment friendly material synthesis technology for textile applications utilizing the proprietary MLSE™ system which uses a combination of high voltage plasma and laser energy to imbue fabrics with desirable technical characteristics. On March 15, 2017, the Company announced that it had entered into a $50 million purchase order with MTIX to manufacture, install and service fabric treatment machines that utilize MTIX’s proprietary MLSE™ system. +Milton C. Ault, III and William Horne, two of our directors, are directors of Avalanche. In addition, based on Avalanche’s Form 10-K for the year ended December 31, 2015, Philou Ventures is the largest shareholder of Avalanche. Philou Ventures is our largest shareholder, and Kristine L. Ault, Milton C. Ault, III’s spouse, is the manager for Philou Ventures. \ No newline at end of file diff --git a/raw/filings/0000896493/2017/0001214659-18-002858/filing.txt b/raw/filings/0000896493/2017/0001214659-18-002858/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..d59357d28128e0bccd20d48f6086b0d58df6a0fd --- /dev/null +++ b/raw/filings/0000896493/2017/0001214659-18-002858/filing.txt @@ -0,0 +1,4932 @@ +10-K +1 +dpw33018010k.htm +UNITED STATES SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the Fiscal Year Ended December 31, 2017 +Commission file number 1-12711 +DPW HOLDINGS, INC. +(Exact name of registrant as specified in its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +48430 Lakeview Blvd Fremont, CA +94538-3158 +(510) 657-2635 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered under Section 12(b) of the Act: +Title of Each Class +Name of each exchange on which registered +Common Stock, $0.001 par value per share +NYSE American +Securities registered under Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☑ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding year (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☐ +Smaller reporting company ☑ +(Do not check if a smaller reporting company) +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑ +As of June 30, 2017, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $6,831,098 based on the closing sale price as reported on the NYSE Market. Such determination should not be deemed an admission that such directors, officers, or 5 percent beneficial owners are, in fact, affiliates of the registrant. +There were 43,562,860 shares of common stock outstanding as of April 13, 2018. +Documents incorporated by reference: None +DPW HOLDINGS, INC. AND SUBSIDIARIES +FORM 10-K +For the Fiscal Year Ended DECEMBER 31, 2017 +INDEX +Page +PART I +Item 1. +Description of Business +2 +Item 1A. +Risk Factors +11 +Item 1B. +Unresolved Staff Comments +41 +Item 2. +Description of Properties +42 +Item 3. +Legal Proceedings +42 +Item 4. +Mine Safety Disclosures +42 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity +Securities +42 +Item 6. +Selected Financial Data +46 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +46 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk. +59 +Item 8. +Financial Statements and Supplementary Data. +F-1 – F-64 +Item 9. +Changes in and Disagreements With Accountants on Accounting and Financial Disclosure +59 +Item 9A. +Controls and Procedures +60 +Item 9B. +Other Information +61 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +61 +Item 11. +Executive Compensation +66 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +70 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +71 +Item 14. +Principal Accountant Fees and Services +75 +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +76 +Signatures +83 +i +NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “ Annual Report ”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. We have attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predict,” “should” or “will” or the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties and other factors may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels or activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Our expectations are as of the date this Annual Report is filed, and we do not intend to update any of the forward-looking statements after the date this Annual Report is filed to confirm these statements to actual results, unless required by law. +This Annual Report also contains estimates and other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified the statistical and other industry data generated by independent parties and contained in this Annual Report and, accordingly, we cannot guarantee their accuracy or completeness, though we do generally believe the data to be reliable. In addition, projections, assumptions and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere in this Annual Report. These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us . +PART I +ITEM 1. +BUSINESS +General +We are a growth company seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy which we began implementing upon the change in control that was completed in September 2016. Our acquisition and development target strategy include companies that have developed a “new way of doing business” in mature, well-developed industries experiencing changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; companies whose business is related to our core business in the commercial and defense industries; and companies that will enhance our overall revenues. It is our goal to substantially increase our gross revenues in the near future. +We operate as a holding company with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed an investment company under the Investment Company Act of 1940, as amended (the "Investment Company Act" ). Generally, this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets will be invested in investment securities as such term is defined in the Investment Company Act. We are a diversified holding company owning subsidiaries engaged in the following operating businesses: commercial and defense solutions, commercial lending, cryptocurrency blockchain mining and advanced textile technology. We also maintain a large investment in Avalanche International, Corp., which is doing business as MTIX International. +Originally, we were primarily a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system solutions for the medical, military, telecom and industrial markets. Although we are actively seeking growth through acquisitions, we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. +We have operations located in Europe through our wholly-owned subsidiary, Digital Power Limited (“ DP Limited ”), Salisbury, England, which operates under the brand name of “Gresham Power Electronics” (“ Gresham ”). DP Limited designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products. +ii +On November 30, 2016, DPW Holdings formed Digital Power Lending, LLC (“ DP Lending ”), a wholly-owned subsidiary. DP Lending is engaged in providing commercial loans to companies throughout the United States to provide them with operating capital to finance the growth of their businesses. The loans will range in duration from six months to three years, DP Lending operates under California Finance Lending License #60DBO-77905. +On June 2, 2017, DPW Holdings purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is a design-to-manufacture original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. Microphase is headquartered in Shelton, Connecticut. +On April 25, 2017, DPW Holdings formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. The Company intends to operate its existing businesses in the customized and flexible power system solutions for the medical, military, telecom, commercial and industrial markets, other than the European markets which are primarily served by DP Limited, in Coolisys. The Company intends to transfer Digital Power North American operations, Digital Power Ltd. (“Gresham Power”), and Microphase Corporation as subsidiaries of Coolisys. +Further, on September 1, 2017, Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an extended sales organization for the Company’s overall flexible power system solutions. +We are a Delaware corporation, initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located in Silicon Valley at 48430 Lakeview Blvd, Fremont, California 94538-3158. Our phone number is 510-657-2635 and our website address is www.dpwholdings.com . +Recent Events +On September 18, 2017, the Board of Directors of Digital Power Corporation voted unanimously to recommend a number of proposals to be voted upon at its annual meeting (the “ Meeting ”), including a proposal to approve a change in domicile from California to Delaware (the “ Reincorporation ”). On December 27, 2017, Digital Power Corporation approved the Agreement and Plan of Merger (the “ Merger Agreement ”) providing for the merger (the “ Merger ”) of Digital Power Corporation with and into its wholly owned subsidiary DPW Holdings, Inc. (the “ Company ” or “ DPW ”). The Reincorporation, was approved at the Meeting, which was held on December 28, 2017. +The Reincorporation was consummated on December 29, 2017 pursuant to the Merger Agreement, whereby Digital Power Corporation merged with and into the Company with the Company as the surviving corporation operating as DPW Holdings, Inc. Following the Merger, the Company’s corporate existence is governed by the laws of the State of Delaware. +Upon consummation of the transactions contemplated by the Merger Agreement and resulting Reincorporation, the daily business operations of the Company continued as they were conducted by Digital Power Corporation immediately prior to the Reincorporation and the officers and directors of Digital Power Corporation became the officers and directors of the Company, except that Milton C. Ault III become the Company’s Chief Executive Officer and Amos Kohn remained as its President. +In January 2018, we formed Super Crypto Mining, Inc. ( “SCM ”), a wholly-owned subsidiary. SCM was established to operate our newly formed cryptocurrency business, which is pursuing a variety of digital currency. We are mining the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin and Ethereum. +3 +On January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2.5 million for an aggregate debt of $5 million to two institutional investors. The proceeds from these two promissory notes were used to purchase 1,000 Antminer S9s (“ Miners ”) manufactured by Bitmain Technologies, Inc. in connection with our crypto mining operations. We received delivery of the Miners on February 1, 2018. +On February 27, 2018, we entered into a sales agreement with H.C. Wainwright & Co., LLC (“ HCW ”) to sell shares of our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the “ ATM Offering ”) under which HCW will act as sales agent. As of April 13, 2018, we had received net proceeds of approximately $7.1 million through the sale of 6,648,538 shares of our common stock through the ATM Offering. The offer and sale of the shares through the ATM Offering are made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated February 27, 2018. We believe that the ATM Offering will be a significant source of capital to fund our business strategy during 2018. +Strategy +Our strategy to increase revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business of power system solutions for the military / aerospace, medical and industrial-telecommunication industries, we have determined that significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient sales and marketing force as a result of deferring research and development of new products because of limited working capital, and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution companies. +Therefore, we believe that the best strategy for us and our shareholders is to invest in our core business to support releases of advanced new power technologies and to expand our customer base and market share in our major markets. To support the organic growth, we have hired a number of additional personnel and are investing to enhance our product offerings with state of the art technology. While we implement our new organic growth strategy, we are focusing on finding and acquiring companies that have developed new technology but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies that enhance our overall revenues. Further, as discussed below, we have made a recent investment in Avalanche International, Corp. which acquired the rights to a cost effective and environmentally friendly material synthesis technology for textile applications. +As a result of this strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase in infrastructure expenses and investing in companies that demonstrate revenue potential but are initially incurring losses, we anticipate continuing to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Led by our Chairman and CEO, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global impact. We also use a traditional methodology for valuing stocks that primarily looks for deeply depressed prices. Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve shareholder value, to acquiring a controlling interest or outright ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s CFO, to provide analysis and guidance on all acquisition targets and throughout the acquisition process. +4 +Core Business – Power Systems Solutions +We provide the highest density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and modify-standard product solutions and value-added services to diverse industries and markets including military/aerospace, medical and industrial- telecommunications. We believe that our solutions leverage a combination of low leakage power emissions, very high-power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy is to be the supplier of choice to companies, including OEMs, that require high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that supports all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. Our target market segments include the industrial telecommunication, medical, and military/aerospace industries. +Custom Power System Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution technology includes full Digital Signal Processing (“ DSP ”) control, digital load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customers’ unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any plausible need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“ IP ”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating the need for complex, time-consuming and costly system integration. We believe that this value-added service is well suited to those OEMs that wish to reduce their vendor base and minimize their investment in manufacturing, which would lead to increased fixed costs. Given access to these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas the European marketplace is served through DPL, another wholly-owned subsidiary. +5 +We sell products to our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2018. +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture our military products through a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ ITAR ”) and is certified to perform such manufacturing services. We are compliant with the ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned Aerial Vehicle) – Very lightweight power systems. +Our military products meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary DPL develops and manufactures some military and defense products mainly being deployed in international naval fleets. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom, designs, manufactures, and distributes switching power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“ Gresham ”). Frequency converters manufactured by Gresham are used by naval warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +6 +Microphase Corporation +Microphase designs, manufactures and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication systems. Such components include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s customers are comprised of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors and sub-contractors. Microphase’s recent technology innovations are used in many significant U.S. Government defense programs, including the Polaris submarine, the F-16, the F-35 and the Predator drone. Other notable programs in which Microphase’s products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile System, THAAD (or Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint strike fighter plane, and more recently drone programs including the Predator, the Reaper and the Shadow. +Microphase’s advanced technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in order to accurately recover the signals and facilitate use of the information received. These products include: +· +filters that sort and clarify microwave signals, including multiplexers that are a series of filters combined in a single package; +· +solid state amplifiers that amplify microwave signals; +· +detectors and limiters that are semiconductor devices for detection of radar signals and protection of receivers from damage from high power signals and jamming; +· +detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal detection systems; +· +integrated assemblies that combine multiple functions from a range of components and devices, including transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction assemblies; +· +electronic test and measurement probes; +· +universal test and measurement test platforms and fixtures; and +· +utility probes and antenna probes. +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low-cost manufacturing goals with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and in Asia. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“ RoHS ”), which restricts the use of six hazardous materials in the manufacturing of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +7 +Some of our products are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Further, additional restrictions or charges may in the future be imposed by the United States or any other foreign country. In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs that are funded and governed by the e U.S. Foreign Military Financing program. +Sales and Marketing +We market our products directly through our internal sales force as well as through our channel partners including independent manufacturer representatives and distributors. Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, the manufacturing representatives have the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving their marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales for retention, payable after products are shipped to the customer in the assigned territory. Typically, either we or the manufacturing representatives are entitled to terminate the manufacturing representative agreement upon 30 days’ written notice. +We provide comprehensive collateral including product data sheets, participation in trade shows, and our websites, www.digipwr.com and www.microphase.com . We use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our websites and accessible to the marketplace. We will continue to enhance our websites by adding more features and functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of our product development projects to engineering partners in order to achieve the best technological and product design results for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the shelf (“ COTS ”) products and for other customized product requirements, when applicable. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering integrating laboratory located in California. +8 +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products superior or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of output product design platforms. We believe we have a competitive position with our targeted customers that need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“ NRE ”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +The markets in which Microphase operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors are larger than it is and maintain higher levels of expenditures for research and development. Principal competitive factors in Microphase’s markets are product quality and reliability; technological capabilities; service; past performance; ability to develop and implement complex, integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales channels in international markets; and cost-effectiveness. +In the RF Communications market, principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, MD; RS Microwave, a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith Group, a global technology company listed on the London Stock Exchange; and Delta Diversified Products, a private company based in Arizona. +In the Video amplifier segment, principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately held company headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, a privately held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company based in New York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +9 +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +In conjunction with our majority acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade name, which has been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +Research and Development +During the years ended December 31, 2017 and 2016, we spent approximately $1,120,000 and $709,000, respectively, on research and development. +Employees +As of December 31, 2017, we had 77 employees located in the United States and the United Kingdom, of whom 29 were engaged in engineering and product development, 13 in sales and marketing, 19 in general operations and 16 in general administration and finance. All but three of these employees are employed on a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be good. +10 +ITEM 1A. +RISK FACTORS +An investment in our common stock involves significant risks. You should carefully consider the following risks and all other information set forth in this Annual Report before deciding to invest in our common stock. If any of the events or developments described below occurs, our business, financial condition and results of operations may suffer. In that case, the value of our common stock may decline and you could lose all or part of your investment. +You should consider each of the following risk factors and any other information set forth in this Annual Report and the other reports filed by the Company with the Securities and Exchange Commission (the “ SEC ”), including the Company’s financial statements and related notes, in evaluating the Company’s business and prospects. The risks and uncertainties described below are not the only ones that impact on the Company’s operations and business. Additional risks and uncertainties not presently known to the Company, or that the Company currently considers immaterial, may also impair its business or operations. If any of the following risks actually occurs, the Company’s business and financial condition, results or prospects could be harmed. Please also read carefully the section “Forward-Looking Statements” at the beginning of this Annual Report. +Risks Related to Our Company +We have historically incurred significant losses and our financial situation creates doubt whether we will continue as a going concern . +We have historically experienced operating and net losses and anticipate continuing to experience such losses in the future. For the years ended December 31, 2017 and 2016, we had an operating loss of approximately $5,983,000 and $1,219,000 and net losses of approximately $10,895,000 and $1,122,000, respectively. As of December 31, 2017, the Company had a working capital deficiency of approximately $2,498,000. There are no assurances that we will be able to achieve a level of revenues adequate to generate sufficient cash flow from operations or obtain additional financing through private placements, public offerings and/or bank financing necessary to support our working capital requirements. To the extent that funds generated from any private placements, public offerings and/or bank financing are insufficient, we will have to raise additional working capital. No assurance can be given that additional financing will be available, or if available, will be on acceptable terms. These conditions raise substantial doubt about our ability to continue as a going concern. If adequate working capital is not available we may be forced to discontinue operations, which would cause investors to lose their entire investment. +We expect to continue to incur losses for the foreseeable future and need to raise additional capital to continue business development initiatives and to support our working capital requirements. For example, in March 2017, we were awarded a 3-year, $50 million purchase order by MTIX Ltd. (“ MTIX ”) to manufacture, install and service the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system. We believe that the MLSE purchase order will be a source of revenue and generate significant cash flows for us. However, if we are unable to raise additional capital, we may be required to curtail operations and take additional measures to reduce costs, including reducing our workforce, eliminating outside consultants and reducing legal fees in order to conserve cash in amounts sufficient to sustain operations and meet our obligations. As a result of these financing uncertainties, during the third quarter ended September 30, 2017, we recognized that our dependence on ongoing capital requirements to fund our operations raise substantial doubt about our ability to continue as a going concern. Our ongoing capital requirements have only increased since then, meaning that substantial doubt about our ability to continue as a going concern remains and will likely do so for the foreseeable future. +We will need to raise additional capital to fund our operations in furtherance of our business plan. +Until we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business plan. The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development partners or some combination of each. Any additional equity financings may be financially dilutive to, and will be dilutive from an ownership perspective to our stockholders, and such dilution may be significant based upon the size of such financing. Additionally, we cannot assure that such funding will be available on a timely basis, in needed quantities, or on terms favorable to us, if at all. +11 +Our limited operating history makes it difficult to evaluate our future business prospects and to make decisions based on of our historical performance . +Although our executive officers have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our current business until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate our business on the basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future results based upon our historical data. Reliance on our historical results may not be representative of the results we will achieve, and for certain areas in which we operate, principally those unrelated to defense contracting, will not be indicative at all. Because of the uncertainties related to our lack of historical operations, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in sales, product costs or expenses. If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, which may result in a decline in our stock price. +We have an evolving business model, which increases the complexity of our business. +Our business model has evolved in the past and continues to do so. In prior years we have added additional types of services and product offerings and in some cases we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products or services, and we do not know whether any of them will be successful. From time to time we have also modified aspects of our business model relating to our product mix. We do not know whether these or any other modifications will be successful. The additions and modifications to our business have increased the complexity of our business and placed significant strain on our management, personnel, operations, systems, technical performance, financial resources, and internal financial control and reporting functions. Future additions to or modifications of our business are likely to have similar effects. Further, any new business or website we launch that is not favorably received by the market could damage our reputation or our brand. The occurrence of any of the foregoing could have a material adverse effect on our business. +We are a holding company whose subsidiaries are given certain degree of independence and our failure to integrate our subsidiaries may adversely affect our financial condition . +We have given our subsidiary companies and their executives a certain degree of independence in decision-making. On the one hand, this independence may increase the sense of ownership at all levels, on the other hand it has also increased the difficulty of the integration of operation and management, which has resulted in increased difficulty of management integration. In the event we are not able to successfully manage our subsidiaries this will result in operating difficulties and have a negative impact on our business. +Our independent auditors have expressed doubt about our ability to continue as a going concern. If we do not continue as a going concern, investors will lose their entire investment . +In its report on our financial statements included in this Annual Report, our independent auditors have expressed doubt about our ability to continue as a going concern. Our ability to continue as a going concern is an issue raised as a result of ongoing operating losses and a lack of financing commitments then in place to meet expected cash requirements. Our ability to continue as a going concern is subject to our ability to generate a profit and/or obtain necessary funding from outside sources, including obtaining additional funding from the sale of our securities, increasing sales or obtaining loans and grants from various financial institutions where possible. If we do not continue as a going concern, investors will lose their entire investment. +Our inability to successfully integrate new acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our growth strategy through acquisitions is fraught with risk. On June 2, 2017, we acquired a majority interest in Microphase Corp. Our strategy and business plan is dependent on our ability to successfully integrate Microphase’s and our other acquisition’s operations. In addition, while we are based in Fremont, CA, Microphase’s operations are located in Shelton, Connecticut and Digital Power Limited’s (doing business as Gresham Power) operations are located in Salisbury, England. These distant locations and others that we may become involved with in the future will stretch our resources and management time. Further, failure to quickly and adequately integrate all of these operations and personnel could adversely affect our combined business and our ability to achieve our objectives and strategy. No assurance can be given that we will realize synergies in the areas we currently operate. +12 +If we make any additional acquisitions, they may disrupt or have a negative impact on our business. +We have plans to make additional acquisitions beyond Microphase. For instance, we announced the pending acquisition of Enertec Systems 2001 Ltd. on January 2, 2018. Whenever we make acquisitions, we could have difficulty integrating the acquired companies’ personnel and operations with our own. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot predict the effect expansion may have on our core business. Regardless of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to the risks described above, acquisitions are accompanied by a number of inherent risks, including, without limitation, the following: +· +difficulty of integrating acquired products, services or operations; +· +potential disruption of the ongoing businesses and distraction of our management and the management of acquired companies; +· +difficulty of incorporating acquired rights or products into our existing business; +· +difficulties in disposing of the excess or idle facilities of an acquired company or business and expenses in maintaining such facilities; +· +difficulties in maintaining uniform standards, controls, procedures and policies; +· +potential impairment of relationships with employees and customers as a result of any integration of new management personnel; +· +potential inability or failure to achieve additional sales and enhance our customer base through cross-marketing of the products to new and existing customers; +· +effect of any government regulations which relate to the business acquired; +· +potential unknown liabilities associated with acquired businesses or product lines, or the need to spend significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense of any litigation, whether or not successful, resulting from actions of the acquired company prior to our acquisition. +Our business could be severely impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. +No assurance of successful expansion of operations. +Our significant increase in the scope and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher operating expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make significant demands on our management, finances and other resources. Our ability to manage the anticipated future growth, should it occur, will depend upon a significant expansion of our accounting and other internal management systems and the implementation and subsequent improvement of a variety of systems, procedures and controls. We cannot assure that significant problems in these areas will not occur. Failure to expand these areas and implement and improve such systems, procedures and controls in an efficient manner at a pace consistent with our business could have a material adverse effect on our business, financial condition and results of operations. We cannot assure that attempts to expand our marketing, sales, manufacturing and customer support efforts will succeed or generate additional sales or profits in any future period. As a result of the expansion of our operations and the anticipated increase in our operating expenses, along with the difficulty in forecasting revenue levels, we expect to continue to experience significant fluctuations in its results of operations. +We may be unable to successfully expand our production capacity, which could result in material delays, quality issues, increased costs and loss of business opportunities, which may negatively impact our product margins and profitability . +Part of our future growth strategy is to increase our production capacity to meet increasing demand for our goods. Assuming we obtain sufficient funding to increase our production capacity, any projects to increase such capacity may not be constructed on the anticipated timetable or within budget. We may also experience quality control issues as we implement any production upgrades. Any material delay in completing these projects, or any substantial cost increases or quality issues in connection with these projects could materially delay our ability to bring our products to market and adversely affect our business, reduce our revenue, income and available cash, all of which could harm our financial condition. +13 +If we fail to establish and maintain an effective system of internal control over financial reporting, we may not be able to report our financial results accurately or prevent fraud. Any inability to report and file our financial results accurately and timely could harm our reputation and adversely impact the trading price of our common stock. +Effective internal control over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, and our business and reputation with investors may be harmed. As a result, our small size and any current internal control deficiencies may adversely affect our financial condition, results of operations and access to capital. We have also experienced complications reporting as a result of material weaknesses which resulted in the restatement of our Form 10-Q for the quarterly period ended June 30, 2017, which was filed with the Securities and Exchange Commission (“ Commission ”) on August 21, 2017, and amended on November 14, 2017. We have carried out an evaluation under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent period covered by this report. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses described below. +A material weakness is a deficiency, or a combination of deficiencies, within the meaning of Public Company Accounting Oversight Board (“ PCAOB” ) Audit Standard No. 5, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Management has identified the following material weaknesses which have caused management to conclude that as of June 30, 2017 our internal controls over financial reporting (“ ICFR ”) were not effective at the reasonable assurance level: +1. +We do not have sufficient resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a material weakness. +2. +We have inadequate controls to ensure that information necessary to properly record transactions is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +We have taken steps to remediate some of the weaknesses described above, including a greater level of involvement by our Audit Committee. We intend to continue to address these weaknesses as resources permit. +If our accounting controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating our internal control over financial reporting in order to comply with the Commission’s rules relating to internal control over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such internal control, we may be subject to regulatory sanctions, and our reputation may decline. +14 +We face significant competition, including changes in pricing. +The markets for our products are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing resources, plus experience in research and development, and compete with us by offering lower prices. Competitors could develop new technologies that compete with our products to achieve a lower unit price. If a competitor develops lower cost superior technology or cost-effective alternatives to our products and services, our business could be seriously harmed. +The markets for some of our products are also subject to specific competitive risks because these markets are highly price competitive. Our competitors have competed in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering our prices. This would reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also impact sales and aggravate losses. +Many of our competitors are larger and have greater financial and other resources than we do. +Our products compete and will compete with similar if not identical products produced by our competitors. These competitive products could be marketed by well-established, successful companies that possess greater financial, marketing, distribution personnel, and other resources than we do. Using said resources, these companies can implement extensive advertising and promotional campaigns, both generally and in response to specific marketing efforts by competitors. They can introduce new products to new markets more rapidly. In certain instances, competitors with greater financial resources may be able to enter a market in direct competition with us, offering attractive marketing tools to encourage the sale of products that compete with our products or present cost features that consumers may find attractive. +Our growth strategy is subject to a significant degree of risk. +Our growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition targets or make a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. Therefore, we may lose our investment in the event that these companies’ businesses do not develop as planned or that we are unable to achieve the cost efficiencies or reduction of losses as anticipated. +Further, in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement our plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that provide revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development and investments will produce sufficient revenues to offset these increases in expenditures. +Our business and operations are growing rapidly. If we fail to effectively manage our growth, our business and operating results could be harmed . +We have experienced, and may continue to experience, rapid growth in our operations. This has placed, and may continue to place, significant demands on our management, operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products and services could suffer, which could negatively affect our operating results. To effectively manage our growth, we must continue to improve our operational, financial and management controls and reporting systems and procedures. These systems improvements may require significant capital expenditures and management resources. Failure to implement these improvements could hurt our ability to manage our growth and our financial position. +A principal stockholder has significant influence over us. +Philou Ventures, LLC (“ Philou Ventures ”) beneficially owns approximately 12.0% of our currently outstanding Common Stock on a fully diluted basis, as of April 13, 2018. As a result, it will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of the Company’s assets, and any other significant corporate transaction. Its interests may not always coincide with those of our other stockholders. +15 +Philou Ventures has certain rights to maintain its ownership interest in us +In connection with entering into a Series B Preferred Stock purchase agreement with Philou Ventures, we granted the right to Philou Ventures to participate in future offering under substantially the same term of such offerings in order to allow Philou Ventures to maintain its ownership interest. If exercised by Philou Ventures, this contractual right granted to it has the effect of allowing Philou Ventures to maintain its interest in us and dilute existing shareholders’ ownership interests. +We are heavily dependent on our senior management, and a loss of a member of our senior management team could cause our stock price to suffer . +If we lose the services of Milton C. Ault III, our Chief Executive Officer, William B. Horne, our Chief Financial Officer, Amos Kohn, our President and Chief Executive Officer of Coolisys, one of our principal subsidiaries and/or certain key employees, we may not be able to find appropriate replacements on a timely basis, and our business could be adversely affected. Our existing operations and continued future development depend to a significant extent upon the performance and active participation of these individuals and certain key employees. Although we have entered into employment agreements with Messrs. Horne and Kohn, we have only entered into an independent contractor agreement with Mr. Ault. Although we may enter into employment agreements with Mr. Ault and additional key employees in the future, we cannot guarantee that we will be successful in retaining the services of these individuals. If we were to lose any of these individuals, we may not be able to find appropriate replacements on a timely basis and our financial condition and results of operations could be materially adversely affected. +We rely on highly skilled personnel and the continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our business may be severely disrupted. +Our performance largely depends on the talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise held by our Chief Executive Officer, Milton C. Ault III. His absence, were it to occur, would materially and adversely impact development and implementation of our projects and businesses. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract, among others, new technology developers and to retain and motivate our existing contractors. If one or more of our executive officers are unable or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives joins a competitor or forms a competing company, we may lose some customers. +Our operating results may vary from quarter to quarter. +Our operating results have in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our operating results for such quarter. It is possible that, in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly. +We may be classified as an inadvertent investment company. +We are not engaged in the business of investing, reinvesting, or trading in securities, and we do not hold ourselves out as being engaged in those activities. Under the Investment Company Act of 1940, as amended (the “ 1940 Act ”), however, a company may be deemed an investment company under section 3(a)(1)(C) of the 1940 Act if the value of its investment securities is more than 40% of its total assets (exclusive of government securities and cash items) on a consolidated basis. +16 +We have commenced digital asset mining, the output of which is cryptocurrencies, which the Commission has indicated it deems a security. In the event that the digital assets held by us exceed 40% of our total assets, exclusive of cash, we inadvertently become an investment company. An inadvertent investment company can avoid being classified as an investment company if it can rely on one of the exclusions under the 1940 Act. One such exclusion, Rule 3a-2 under the 1940 Act, allows an inadvertent investment company a grace period of one year from the earlier of (a) the date on which an issuer owns securities and/or cash having a value exceeding 50% of the issuer’s total assets on either a consolidated or unconsolidated basis and (b) the date on which an issuer owns or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive of government securities and cash items) on an unconsolidated basis. We are putting in place policies that we expect will work to keep the investment securities held by us at less than 40% of our total assets, which may include acquiring assets with our cash, liquidating our investment securities or seeking a no-action letter from the Commission if we are unable to acquire sufficient assets or liquidate sufficient investment securities in a timely manner. +As Rule 3a-2 is available to a company no more than once every three years, and assuming no other exclusion were available to us, we would have to keep within the 40% limit for at least three years after we cease being an inadvertent investment company. This may limit our ability to make certain investments or enter into joint ventures that could otherwise have a positive impact on our earnings. In any event, we do not intend to become an investment company engaged in the business of investing and trading securities. +Classification as an investment company under the 1940 Act requires registration with the Commission. If an investment company fails to register, it would have to stop doing almost all business, and its contracts would become voidable. Registration is time consuming and restrictive and would require a restructuring of our operations, and we would be very constrained in the kind of business we could do as a registered investment company. Further, we would become subject to substantial regulation concerning management, operations, transactions with affiliated persons and portfolio composition, and would need to file reports under the 1940 Act regime. The cost of such compliance would result in the Company incurring substantial additional expenses, and the failure to register if required would have a materially adverse impact to conduct our operations. +We will not be able to successfully execute our business strategy if we are deemed to be an investment company under the 1940 Act. +U.S. companies that have more than 100 shareholders or are publicly traded in the U.S. and are, or hold themselves out as being, engaged primarily in the business of investing, reinvesting or trading in securities are subject to regulation under the 1940 Act. Unless a substantial part of our assets consists of, and a substantial part of our income is derived from, interests in majority-owned subsidiaries and companies that we primarily control, we may be required to register and become subject to regulation under the 1940 Act. If bitcoin and other virtual currencies were to be deemed securities for purposes of the 1940 Act, or if we were deemed to own but not operate one or more of our other subsidiaries, we would have difficulty avoiding classification and regulation as an investment company. +If we were deemed to be, and were required to register as, an investment company, we would be forced to comply with substantive requirements under the 1940 Act, including limitations on our ability to borrow, limitations on our capital structure; restrictions on acquisitions of interests in associated companies, prohibitions on transactions with affiliates, restrictions on specific investments, and compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations. If we were forced to comply with the rules and regulations of the 1940 Act, our operations would significantly change, and we would be prevented from successfully executing our business strategy. To avoid regulation under the 1940 Act and related rules promulgated by the Commission, we could need to sell bitcoin and other assets which we would otherwise want to retain and could be unable to sell assets which we would otherwise want to sell. In addition, we could be forced to acquire additional, or retain existing, income-generating or loss-generating assets which we would not otherwise have acquired or retained and could need to forgo opportunities to acquire bitcoin and other assets that would benefit our business. If we were forced to sell, buy or retain assets in this manner, we could be prevented from successfully executing our business strategy. +17 +Securitization of our assets subjects us to various risks . +We may securitize assets to generate cash for funding new investments. We refer to the term securitize to describe a form of leverage under which a company (sometimes referred to as an “originator” or “sponsor”) transfers income producing assets to a single-purpose, bankruptcy-remote subsidiary (also referred to as a “special purpose entity” or SPE), which is established solely for the purpose of holding such assets and entering into a structured finance transaction. The SPE would then issue notes secured by such assets. The special purpose entity may issue the notes in the capital markets either publicly or privately to a variety of investors, including banks, non-bank financial institutions and other investors. There may be a single class of notes or multiple classes of notes, the most senior of which carries less credit risk and the most junior of which may carry substantially the same credit risk as the equity of the SPE. +An important aspect of most debt securitization transactions is that the sale and/or contribution of assets into the SPE be considered a true sale and/or contribution for accounting purposes and that a reviewing court would not consolidate the SPE with the operations of the originator in the event of the originator's bankruptcy based on equitable principles. Viewed as a whole, a debt securitization seeks to lower risk to the note purchasers by isolating the assets collateralizing the securitization in an SPE that is not subject to the credit and bankruptcy risks of the originator. As a result of this perceived reduction of risk, debt securitization transactions frequently achieve lower overall leverage costs for originators as compared to traditional secured lending transactions. +In accordance with the above description, to securitize loans, we may create a wholly owned subsidiary and contribute a pool of our assets to such subsidiary. The SPE may be funded with, among other things, whole loans or interests from other pools and such loans may or may not be rated. The SPE would then sell its notes to purchasers whom we would expect to be willing to accept a lower interest rate and the absence of any recourse against us to invest in a pool of income producing assets to which none of our creditors would have access. We would retain all or a portion of the equity in the SPE. An inability to successfully securitize portions of our portfolio or otherwise leverage our portfolio through secured and unsecured borrowings could limit our ability to grow our business and fully execute our business strategy, and could decrease our earnings, if any. However, the successful securitization of portions of our portfolio exposes us to a risk of loss for the equity we retain in the SPE and might expose us to greater risk on our remaining portfolio because the assets we retain may tend to be those that are riskier and more likely to generate losses. A successful securitization may also impose financial and operating covenants that restrict our business activities and may include limitations that could hinder our ability to finance additional loans and investments. The 1940 Act may also impose restrictions on the structure of any securitizations. +Interests we hold in the SPE, if any, will be subordinated to the other interests issued by the SPE. As such, we will only receive cash distributions on such interests if the SPE has made all cash interest and other required payments on all other interests it has issued. In addition, our subordinated interests will likely be unsecured and rank behind all of the secured creditors, known or unknown, of the SPE, including the holders of the senior interests it has issued. Consequently, to the extent that the value of the SPE's portfolio of assets has been reduced as a result of conditions in the credit markets, or as a result of defaults, the value of the subordinated interests we retain would be reduced. Securitization imposes on us the same risks as borrowing except that our risk in a securitization is limited to the amount of subordinated interests we retain, whereas in a borrowing or debt issuance by us directly we would be at risk for the entire amount of the borrowing or debt issuance. +We may also engage in transactions utilizing SPEs and securitization techniques where the assets sold or contributed to the SPE remain on our balance sheet for accounting purposes. If, for example, we sell the assets to the SPE with recourse or provide a guarantee or other credit support to the SPE, its assets will remain on our balance sheet. Consolidation would also generally result if we, in consultation with the SEC, determine that consolidation would result in a more accurate reflection of our assets, liabilities and results of operations. In these structures, the risks will be essentially the same as in other securitization transactions but the assets will remain our assets for purposes of the limitations described above on investing in assets that are not qualifying assets and the leverage incurred by the SPE will be treated as borrowings incurred by us for purposes of our limitation on the issuance of senior securities. +We may not be able to utilize our net operating loss carry forwards. +At December 31, 2017, we had net operating loss carry forwards (“NOLs”) for income tax purposes of approximately $12.0 million, expiring through 2037, However, we do not know if or when we will have any earnings and capital gains against which we could apply these carry forwards. Furthermore, as a result of changes in the ownership of our common stock, our ability to use our federal NOLs will be limited under Internal Revenue Code Section 382. State NOLs are subject to similar limitations in many cases. As a result, our substantial NOLs may not have any value to us. +18 +Changes in the U.S. tax and other laws and regulations may adversely affect our business. +The U.S. government may revise tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, including modifications that could reduce the profits that we can effectively realize from our international operations, or that could require costly changes to those operations, or the way in which they are structured. For example, the effective tax rates for most U.S. companies reflect the fact that income earned and reinvested outside the U.S. is generally taxed at local rates, which may be much lower than U.S. tax rates. If we expand abroad and there are changes in tax laws, regulations or interpretations that significantly increase the tax rates on non-U.S. income, our effective tax rate could increase and our profits could be reduced. If such increases resulted from our status as a U.S. company, those changes could place us at a disadvantage to our non-U.S. competitors if those competitors remain subject to lower local tax rates. +Recently enacted U.S. tax reform legislation known colloquially as the “Tax Cuts and Jobs Act,” among other things, makes significant changes to the rules applicable to the taxation of corporations, such as changing the corporate tax rate to a flat 21% rate, modifying the rules regarding limitations on certain deductions for executive compensation, introducing a capital investment deduction in certain circumstances, placing certain limitations on the interest deduction, modifying the rules regarding the usability of certain net operating losses, implementing a minimum tax on the “global intangible low-taxed income” of a “United States shareholder” of a “controlled foreign corporation,” modifying certain rules applicable to United States shareholders of controlled foreign corporations, imposing a deemed repatriation tax on certain earnings and adding certain anti-base erosion rules. We are currently in the process of analyzing the effects of this new legislation on us and at this time the ultimate outcome of the new legislation on our business and financial condition is uncertain. It is possible that the application of these new rules may have a material and adverse impact on our operating results, cash flows and financial condition. +Risks Related to Our Business and Industry - Overview +Technology changes rapidly in our business, and if we fail to anticipate new technologies, the quality, timeliness and competitiveness of our products will suffer. +Rapid technology changes in our industry require us to anticipate, sometimes years in advance, which technologies and/or distribution platforms our products must take advantage of in order to make them competitive in the market at the time they are released. Therefore, we usually start our product development with a range of technical development goals that we hope to be able to achieve. We may not be able to achieve these goals, or our competition may be able to achieve them more quickly than we can. In either case, our products may be technologically inferior to competitive products, or less appealing to consumers, or both. If we cannot achieve our technology goals within the original development schedule of our products, then we may delay products until these technology goals can be achieved, which may delay or reduce revenue and increase our development expenses. Alternatively, we may increase the resources employed in research and development in an attempt to accelerate our development of new technologies, either to preserve our product launch schedule or to keep up with our competition, which would increase our development expenses and adversely affect our operations and financial condition. +We are dependent upon our ability, and our contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As a result, there is a global shortage of certain electronic or mineral components, which may extend our production lead-time and our production costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, even worse, redesign some of our products to support currently-available materials. Such redesign efforts may require certain regulatory and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in place, and issues may recur in the future. +19 +In addition, some of our products are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While we have had relationships with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our ability to manufacture our products. +Our strategic focus on our custom power supply solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, including those involving our personnel, which may negatively impact quarterly earnings and profitability as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +We depend upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon a few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or cancel their orders scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, a substantial decrease in our revenues would likely result. We are dependent on the electronic equipment industry, and accordingly will be affected by the impact on that industry of current economic conditions. +Substantially all of our existing customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations or rescheduling of, orders or shipments, any of which would materially harm our business. +20 +We outsource, and are dependent upon developer partners for, the development of some of our custom design products. +We made an operational decision to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +We face intense industry competition, price erosion and product obsolescence, which, in turn, could reduce our profitability. +We operate in an industry that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price erosion in the future. +Our future results are dependent on our ability to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell our products through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as with manufacturers’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which would have an adverse effect on our revenues. +We may not be able to procure necessary key components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, our suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that we require to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect on our gross margins and on our results of operations. +21 +Although we depend on sales of our legacy products for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large portion of our sales have historically been attributable to our legacy products. We expect that these products may continue to account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining. Although we are unable to predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and sell new products such as custom design and value added products. We cannot assure you that we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell new products. +Failure of our information technology infrastructure to operate effectively could adversely affect our business. +We depend heavily on information technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory restrictions relating to our international sales. +Some of our products are subject to International Traffic In Arms Regulation (“ ITAR ”), which are interpreted, enforced and administered by the U.S. Department of State. ITAR regulation controls not only the export, import and trade of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services as well as foreign production. Any delays in obtaining the required export, import or trade licenses for products subject to ITAR regulation and rules could have a material adverse effect on our business, financial condition, and/or operating results. In addition, changes in United States export and import laws that require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions or charges imposed by the United States or any other country on our international sales or foreign subsidiary could have a materially adverse effect on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program (“ FMF ”). Any such future sales would be subject to these regulations. Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial condition, and/or operating results. +We depend on international operations for a substantial majority of our components and products. +We purchase a substantial majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect on our business, financial condition, and/or operating results. +We depend on international sales for a portion of our revenues. +Sales to customers outside of North America accounted for 34.8 % and 40.2% of net revenues for the years ended December 31, 2017 and 2016, and we expect that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts receivable, and currency restrictions. In addition, DPL, our wholly-owned subsidiary in the United Kingdom, supports our European and other international customers, distributors, and sales representatives, and therefore is also subject to local regulation. International sales are also subject to the export laws and regulations of the United States and other countries. +22 +Our sales and profitability may be affected by changes in economic, business and industry conditions . +If the economic climate in the United States or abroad deteriorates, customers or potential customers could reduce or delay their technology and entertainment investments. Reduced or delayed technology and entertainment investments could decrease our sales and profitability. In this environment, our customers may experience financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and professional services. This may lead to longer sales cycles, delays in purchase decisions, payment and collection, and can also result in downward price pressures, causing our sales and profitability to decline. In addition, general economic uncertainty and general declines in capital spending in the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and the markets we serve. There are many other factors which could affect our business, including: +• +The introduction and market acceptance of new technologies, products and services; +• +New competitors and new forms of competition; +• +The size and timing of customer orders (for retail distributed physical product); +• +The size and timing of capital expenditures by our customers; +• +Adverse changes in the credit quality of our customers and suppliers; +• +Changes in the pricing policies of, or the introduction of, new products and services by us or our competitors; +• +Changes in the terms of our contracts with our customers or suppliers; +• +The availability of products from our suppliers; and +• +Variations in product costs and the mix of products sold. +These trends and factors could adversely affect our business, profitability and financial condition and diminish our ability to achieve our strategic objectives. +The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products and adversely affect the revenues from such products. +Our limited ability to protect our proprietary information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, we may be required to institute legal proceedings, which would be costly and would divert our resources from the development of our business. If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results could be adversely affected. +Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the United States or abroad. +23 +If we are unable to satisfy our customers’ specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be harmed. +Our customers demand that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, any of which would harm our business. +If we ship products that contain defects, the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate. +Some of our business is subject to U.S. government procurement laws and regulations . +We must comply with certain laws and regulations relating to the formation, administration and performance of federal government contracts. These laws and regulations affect how we conduct business with our federal government contracts, including the business that we do as a subcontractor. In complying with these laws and regulations, we may incur additional costs, and non-compliance may lead to the assessment of fines and penalties, including contractual damages, or the loss of business. +Risks Related to Our Business and Industry – Super Crypto Mining +We intend to develop an online cloud mining platform which may subject us to additional liabilities from our customers. +The Company intends to develop and offer a cloud mining platform to customers who prefer not to directly acquire and maintain crypto mining hardware. To date, the Company has offered the cloud mining platform to selected customers prior to offering the platform to the general public. The success of this business will be largely dependent on achieving sustainable revenues that are dependent on prices of the various currencies and controlling costs, which are primarily power and computer hardware. In addition, through our management and administration of crypto mining equipment on behalf of our customers, we may become subject to actions from our customers seeking to recover for liabilities arising from, among other matters: +· +erroneously accounting for proceeds from crypto mining activities; +· +power, network or technology failures which prevent our miners from operating efficiently; +· +delays in processing payments at times when there are significant fluctuations in the price of the cryptocurrencies; and +· +hackers or other malicious groups or organizations targeting and attempting to interfere with our miners which could negatively affect the operations of such miners. +24 +The Company may lose access to digital tokens and any cryptocurrency due to loss of private key(s), custodial error, or purchaser error. +A private key, or a combination of private keys, is necessary to control and dispose of cryptocurrency stored in a digital wallet or vault. Accordingly, loss of requisite private key(s) associated with a digital wallet or vault storing cryptocurrency will result in loss of such cryptocurrency. Moreover, any third party that gains access to such private key(s), including by gaining access to login credentials of a digital wallet or secure service used by the Company, may be able to misappropriate any digital token or cryptocurrency held by the Company. Any errors or malfunctions caused by or otherwise related to the digital wallet that the Company chooses to receive and store cryptocurrency, including the Company’s failure to properly maintain or use such digital wallet or secure service, may also result in the loss of any cryptocurrency held by the Company. Additionally, the Company’s failure to follow precisely the procedures for buying and receiving cryptocurrency, including, for instance, if it provides the wrong address for receiving cryptocurrency, may result in the loss of any cryptocurrency held or purchased by the Company. +Hackers or other malicious groups or organizations may attempt to interfere with end users of digital tokens, or cryptocurrency, in a variety of ways. +Hackers or other malicious groups or organizations may target and attempt to interfere with end users of digital tokens, or cryptocurrency, in a variety of ways, including, but not limited to, end user attacks such as malware attacks, denial of service attacks, consensus-based attacks, Sybil attacks, smurfing and spoofing. Furthermore, although the Company utilizes a closed system to mine cryptocurrency, there is a risk that a third party or a member of the Company may intentionally or unintentionally introduce weaknesses into the core infrastructure, which could negatively affect the Company and any cryptocurrency with which the Company is involved. +The Company has discretion over the maintenance, storage and transmission of its cryptocurrency holdings. Currently investments and holdings in cryptocurrencies by the Company are uninsured and, as a result, the Company may lose all of its money invested in cryptocurrencies without any recourse. +Unlike bank accounts or accounts at some other financial institutions, cryptocurrencies are generally uninsured unless an investor purchases private insurance to insure them or holds them with a vendor which provides insurance. Thus, in the event of loss or loss of utility value, there is no public insurer, such as the Securities Investor Protection Corporation (“ SIPC ”) or the Federal Deposit Insurance Corporation (“ FDIC ”), to offer recourse to any investor, including the Company, unless covered independently by private insurance arranged by us. Further, the Company has wide discretion over the storage of its cryptocurrency holdings. The Company intends to use various third party wallet providers, trust companies or others to hold its cryptocurrency holdings. The Company may have a high concentration of its cryptocurrency holdings in one location or with one third party wallet provider, which may be prone to losses arising out of hacking, loss of passwords, compromised access credentials, malware, cyber-attacks or other factors. The Company may not do detailed diligence on third party wallet providers and, as a result, may not be aware of all security vulnerabilities and risks. Certain third party wallet providers may not indemnify the Company against any losses thereby hurting the Company’s ability to recover losses from third party wallet providers. The systems in place to ensure the security of the Company’s cryptocurrency holdings may not prevent the improper access to, damage or theft of the Company’s holdings in cryptocurrencies. Further, a loss due to the storage of the Company’s cryptocurrencies could harm the Company's reputation or result in the loss of some or all of the Company’s cryptocurrencies, including those assets held on behalf of customers for the Company’s online cloud mining platform. +The regulatory status of cryptocurrency and distributed ledger technology is unclear or unsettled in many jurisdictions and it is difficult to predict the impact future regulation may have on either. +The regulatory status of cryptocurrency and distributed ledger technology is unclear or unsettled in many jurisdictions. It is difficult to predict how or whether regulatory agencies may apply existing regulation with respect to such technology and its applications. It is likewise difficult to predict how or whether legislatures or regulatory agencies may implement changes to law and regulation affecting distributed ledger technology and its applications, including applicable cryptocurrency protocols. Regulatory actions could negatively impact any cryptocurrency in various ways, including, for purposes of illustration only, through a determination that cryptocurrency are a regulated financial instrument that requires registration or licensing. +25 +The tax characterization of cryptocurrency is uncertain. +Cryptocurrency holders may be required to pay taxes associated with the transactions contemplated herein, whether in the United States or in their home countries. It is the sole responsibility of cryptocurrency holders to comply with the tax laws of the United States and other jurisdictions applicable to them and pay all relevant taxes. The sale or other exchange of cryptocurrency, or the use of cryptocurrency to pay for goods or services, or holding cryptocurrency as an investment, generally has tax consequences that could result in tax liability. In 2014, the Internal Revenue Service issued guidance on the tax treatment of transactions using cryptocurrency, such as Bitcoins or other similar currencies. +The transfer of any cryptocurrency may be restricted, which may adversely affect its liquidity and the price at which it may be sold. +Cryptocurrency has not been, and will not be, registered under the Securities Act or the securities laws of any other jurisdiction and, unless so registered, may not be offered or sold except pursuant to an exemption from, or a transaction not subject to, the registration requirements of the Securities Act and any other applicable laws and regulations. These restrictions may limit the ability of investors to resell cryptocurrency. It is the responsibility of any holder of a digital token or a cryptocurrency to ensure that all offers and sales of cryptocurrency within the United States and other jurisdictions comply with all applicable laws and regulations. +Cryptocurrency confers no governance rights in any entity. +Because cryptocurrencies confer no governance rights of any kind with respect to any entity with which such digital token or cryptocurrency may be associated, all decisions involving a related company will be made by the management and/or stockholders of such company at their sole discretion. These decisions could adversely affect the utility or value of any applicable digital token or cryptocurrency. +There are unanticipated and unknown risks in buying and holding cryptocurrency and/or cryptographic tokens. +Digital tokens and various cryptocurrencies are a relatively new and untested technology. In addition to the risks specified in these risk factors, there are other risks associated with either the Company’s or a holder’s purchase, holding and use of digital tokens and cryptocurrency cannot be anticipated. Such risks may further materialize as unanticipated variations or combinations of the risks discussed in this prospectus supplement. +Our decision to deal in cryptocurrencies, such as bitcoins, may subject us to exchange risk and additional tax and regulatory requirements. +Bitcoin is not considered legal tender or backed by any government, and it has experienced price volatility, technological glitches and various law enforcement and regulatory interventions. The use of cryptocurrencies such as bitcoin has been prohibited or effectively prohibited in some countries. If we fail to comply with regulations or prohibitions applicable to us, we could face regulatory or other enforcement actions and potential fines and other consequences. From time to time, we may hold bitcoin and other cryptocurrencies directly, and we have exchange rate risk on the amounts we hold as well as the risks that regulatory or other developments may adversely affect the value of the cryptocurrencies we hold. The uncertainties regarding legal and regulatory requirements relating to cryptocurrencies or transactions utilizing cryptocurrencies, as well as potential accounting and tax issues, or other requirements relating to cryptocurrencies could have a material adverse effect on our business. +Various cryptocurrencies facilitate the use of anonymous transactions which could adversely affect the Company. +Although bitcoin and other cryptocurrency transaction details are logged on the blockchain, a buyer or seller of bitcoin may never know to whom the public key belongs or the true identity of the party with whom it is transacting. Some public key addresses are randomized sequences of alphanumeric characters that, standing alone, do not provide sufficient information to identify users. Transacting with a counterparty that is unknown to the Company, such as a party making illicit use of cryptocurrencies, could have an adverse effect on the Company or its reputation. +26 +Our investment in Super Crypto Mining, Inc. may expose us to risks under laws and regulations with which we do not have significant experience. +In 2017, we established our cryptocurrency business, which is pursuing a variety of digital currency. We anticipate mining the top ten cryptocurrencies for our own account. These include Bitcoin, Bitcoin Cash, Litecoin and Ethereum, along with other currencies that we consider to be in the top ten by market capitalization. Virtually every state in the U.S. regulates money transmitters and money services businesses. In some states the licensing requirements and regulations expressly cover companies engaged in digital currency activities; in other states it is not clear whether or how the existing laws and regulations apply to digital currency activities. Further, U.S. federal law requires registration of most such businesses with the Financial Crimes Enforcement Network (“ FinCEN ”). These licenses and registrations subject companies to various anti-money laundering, know-your-customer, record-keeping, reporting and capital and bonding requirements, limitations on the investment of customer funds, and inspection by state and federal regulatory agencies. Under U.S. federal law, it is a crime for a person, entity or business that is required to be registered with FinCEN or licensed in any state to fail to do so, even if the person, entity or business was unaware of the licensing requirement. Further, under U.S. federal law, anyone who owns all or part of an unlicensed money transmitting business is subject to civil and criminal penalties. The business in which we have invested has represented to us that it has not taken any action that could subject it to registration with FinCEN or to the licensing requirements in any state and has agreed that it will not do so until it has become properly licensed in all required states and registered with FinCEN. However, if the business makes an error, even inadvertently, we could be subject to potential civil and criminal penalties as a result. Any such penalties, or even the allegation of criminal activities, could have a material adverse effect on us and our business. Further, all of our foreign business activities expose us to a variety of risks, including risks under the Foreign Corrupt Practices Act. +U.S. and international regulatory changes or actions may restrict the use of or impose heightened regulatory burdens on cryptocurrency or the operation of cryptocurrency network based on currency, securities, or commodities regulations in a manner that adversely affects an investment in us. +Until recently, little or no regulatory attention has been directed toward cryptocurrency and the cryptocurrency networks by U.S. federal and state governments, foreign governments, and self-regulatory agencies. As cryptocurrency has grown in popularity and in market size, the Federal Reserve Board, U.S. Congress, and certain U.S. agencies (e.g., FinCEN and the Federal Bureau of Investigation) have begun to examine the operations of cryptocurrency networks, cryptocurrency users, and cryptocurrency exchange markets. Local state regulators such as the California Department of Financial Institutions and the New York State Department of Financial Services have also initiated examinations of Bitcoins, the Bitcoin Network, and the regulation thereof. Additionally, a U.S. federal magistrate judge in the U.S. District Court for the Eastern District of Texas has ruled that “Bitcoin is a currency or form of money,” two CFTC commissioners publicly expressed a belief that derivatives based on Bitcoins are subject to the same regulation as those based on commodities, and the IRS released guidance treating cryptocurrency as property that is not currency for U.S. federal income tax purposes, although there is no indication yet whether other courts or federal or state regulators will follow these asset classifications. There is a possibility of future regulatory change altering, perhaps to a material extent, the nature of an investment in us or our ability to continue to operate. +Currently, neither the SEC nor the CFTC has formally asserted regulatory authority over cryptocurrency, cryptocurrency networks , or cryptocurrency trading and ownership, though in testimony before the U.S. Senate Committee on Agriculture, Nutrition and Forestry on December 10, 2014, CFTC Chairman Timothy Massad stated that the CFTC believed it had jurisdiction over derivative instruments such as futures and swaps based on digital currencies. On July 25, 2017, the SEC issued an investigative report, stating that offers and sales of digital assets by “virtual” organizations using distributed ledger or cryptocurrency technology (i.e., Initial Coin Offerings or Token Sales) are subject to the requirements of the federal securities laws. Furthermore, the SEC has raised concerns with instances of public companies changing their business models to reflect a focus on cryptocurrency or blockchain technology and is looking closely at the disclosures of public companies that shift their business models to capitalize on the perceived promise of distributed ledger technology and whether the disclosures comply with the federal securities laws, particularly in the context of a securities offering, and in a few instances halted the trading of companies. To the extent that Bitcoins, Ethereum, or Litecoins, themselves are determined to be a security, commodity future or other regulated asset, or to the extent that a US or foreign government or quasi-governmental agency exerts regulatory authority over the Bitcoin, Ethereum, or Litecoin Networks, or cryptocurrency trading and ownership, trading or ownership in cryptocurrency may be adversely affected, which could adversely affect an investment in our company. +To the extent that future regulatory actions or policies limit the ability to exchange cryptocurrency or utilize them for payments, the demand for cryptocurrency will be reduced. Furthermore, regulatory actions may limit the ability of end-users to convert cryptocurrency into fiat currency (e.g., U.S. Dollars) or use cryptocurrency to pay for goods and services. Such regulatory actions or policies could adversely affect an investment in us. +27 +Cryptocurrency currently faces an uncertain regulatory landscape in not only the United States but also in many foreign jurisdictions such as the European Union, China and Russia. While certain governments such as Germany—where the Ministry of Finance has declared Bitcoins to be “Rechnungseinheiten” (a form of private money that is recognized as a unit of account, but not recognized in the same manner as fiat currency) — have issued guidance as to how to treat bitcoins and/or other cryptocurrencies, most regulatory bodies have not yet issued official statements regarding intention to regulate or determinations on regulation of cryptocurrency, the cryptocurrency networks, and cryptocurrency users. Among those for which preliminary guidance has been issued in some form, Canada and Taiwan have labeled cryptocurrency as a digital or virtual currency, distinct from fiat currency, while Sweden and Norway are among those to categorize cryptocurrency as a form of virtual asset or commodity. In China, authorities have recently banned use of bitcoins and/or other cryptocurrencies and ordered Beijing-based cryptocurrency exchanges to cease trading and immediately notify users of their closures. Similarly, Russia has indicated an intention to ban use of bitcoins and/or other cryptocurrencies and Russia’s Central Bank stated that at this stage they will not approve any cryptocurrency trading on any official exchange, nor will it approve the use of the technology for infrastructure purposes. In May 2014, the Central Bank of Bolivia banned the use of Bitcoins as a means of payment. In the summer and fall of 2014, Ecuador announced plans for its own state-backed electronic money, while passing legislation that reportedly prohibits the use of decentralized digital currencies. Conversely, regulatory bodies in some countries such as India and Switzerland have declined to exercise regulatory authority when afforded the opportunity. Various foreign jurisdictions may, in the near future, adopt laws, regulations, or directives that affect cryptocurrency networks and its users, particularly cryptocurrency exchanges and service providers that fall within such jurisdictions’ regulatory scope. Other countries such as Malaysia and Australia have been considering regulation, classification, and potential bans. Such laws, regulations, or directives may conflict with those of the United States and may negatively impact the acceptance of cryptocurrency by users, merchants, and service providers outside of the United States and may, therefore, impede the growth of the cryptocurrency economy. +The effect of any future regulatory change on our company or cryptocurrency is impossible to predict, but such change could be substantial and adverse to us and could adversely affect an investment in us. +It may be illegal now, or in the future, to acquire, own, hold, sell or use cryptocurrency in one or more countries, and ownership of, holding or trading in or company’s securities may also be considered illegal and subject to sanction. +Although currently cryptocurrency is not regulated or are lightly regulated in most countries, including the United States, one or more countries may take regulatory actions in the future that severely restricts the right to acquire, own, hold, sell or use cryptocurrency or to exchange cryptocurrency for fiat currency. Such restrictions may adversely affect an investment in our company. +Cryptocurrency transactions are irrevocable and stolen or incorrectly transferred cryptocurrency may be irretrievable. As a result, any incorrectly executed cryptocurrency transactions could render company liable to lawsuits or criminal charges to the extent company facilitates bad transactions, and thus, adversely affect an investment in us. +Cryptocurrency transactions are not, from an administrative perspective, reversible without the consent and active participation of the recipient of the transaction or, in theory, control or consent of a majority of the processing power on the cryptocurrency network. Once a transaction has been verified and recorded in a block that is added to the blockchain, an incorrect transfer of cryptocurrency or a theft of cryptocurrency generally will not be reversible and we may not be capable of seeking compensation for any such transfer or theft. Although our transfers of cryptocurrency will regularly be made to or from vendors, consultants, services providers, etc. it is possible that, through computer or human error, or through theft or criminal action, our cryptocurrency could be transferred from us in incorrect amounts or to unauthorized third parties. To the extent that we are unable to seek a corrective transaction with such third-party or are incapable of identifying the third-party that has received our cryptocurrency through error or theft, we will be unable to revert or otherwise recover incorrectly transferred company cryptocurrency. To the extent that we are unable to seek redress for such error or theft, such loss could adversely affect an investment in us. In addition, incorrectly executed cryptocurrency transactions could render company liable to lawsuits or criminal charges to the extent company facilitates bad transactions, and thus, adversely affect an investment in us. +28 +The cryptocurrency exchanges on which cryptocurrencies trade are relatively new and, in most cases, largely unregulated and may therefore be more exposed to fraud and failure than established, regulated exchanges for other products. To the extent that the cryptocurrency exchanges representing a substantial portion of the volume in cryptocurrency trading are involved in fraud or experience security failures or other operational issues, such cryptocurrency exchanges’ failures may result in a reduction in the price of cryptocurrency and can adversely affect an investment in us. +The cryptocurrency exchanges on which cryptocurrency trade are new and, in most cases, largely unregulated. Furthermore, many cryptocurrency exchanges do not provide the public with significant information regarding their ownership structure, management teams, corporate practices, or regulatory compliance. As a result, the marketplace may lose confidence in, or may experience problems relating to, cryptocurrency exchanges, including prominent exchanges handling a significant portion of the volume of cryptocurrency trading. These potential consequences of a cryptocurrency exchange’s failure could reduce the demand and use of cryptocurrency, reduce the value of cryptocurrency, and/or adversely affect an investment in us. +In the past, many cryptocurrency exchanges have been closed due to fraud, failure, or security breaches. In many of these instances, the customers of such cryptocurrency exchanges were not compensated or made whole for the partial or complete losses of their account balances in such cryptocurrency exchanges. While smaller cryptocurrency exchanges are less likely to have the infrastructure and capitalization that make larger cryptocurrency exchanges more stable, larger cryptocurrency exchanges are more likely to be appealing targets for hackers and “malware” (i.e., software used or programmed by attackers to disrupt computer operation, gather sensitive information, or gain access to private computer systems). +If the awards of cryptocurrency for solving blocks and transaction fees for recording transactions are not sufficiently high to incentivize miners, miners may respond in a way that reduces confidence in the cryptocurrency networks, which could adversely affect an investment in our company. +If the award of new cryptocurrency for solving blocks declines and transaction fees are not sufficiently high, miners may not have an adequate incentive to continue mining cryptocurrency and may cease their crypto mining operations. Miners ceasing operations would reduce the collective processing power on the cryptocurrency networks, which would adversely affect the confirmation process for transactions (i.e., temporarily decreasing the speed at which blocks are added to the blockchain until the next scheduled adjustment in difficulty for block solutions) and make the cryptocurrency networks more vulnerable to a malicious actor or botnet obtaining control in excess of 50 percent of the processing power on the cryptocurrency networks. Any reduction in confidence in the confirmation process or processing power of cryptocurrency networks may adversely impact Super Crypto Mining, Inc., as well as an investment in us. +In addition, to the extent to which the value of cryptocurrency mined by a professionalized crypto mining operation exceeds the allocable capital and operating costs determines the profit margin of such operation. A professionalized crypto mining operation may be more likely to sell a higher percentage of its newly mined cryptocurrency rapidly if it is operating at a low profit margin—and it may partially or completely cease operations if its profit margin is negative. In a low profit margin environment, a higher percentage of the new cryptocurrency mined each day will be sold into the cryptocurrency exchange markets more rapidly, thereby reducing cryptocurrency prices. Lower cryptocurrency prices will result in further tightening of profit margins, particularly for professionalized crypto mining operations with higher costs and more limited capital reserves, creating a network effect that may further reduce the price of cryptocurrency until crypto mining operations with higher operating costs become unprofitable and remove mining power from the cryptocurrency networks. The network effect of reduced profit margins resulting in greater sales of newly mined cryptocurrency could result in a reduction in the price of cryptocurrency that could adversely impact Super Crypto Mining, Inc., as well as an investment in our company. +To the extent that any miners cease to record transactions in solved blocks, transactions that do not include the payment of a transaction fee will not be recorded on the blockchain until a block is solved by a miner who does not require the payment of transaction fees. Any widespread delays in the recording of transactions could result in a loss of confidence in the cryptocurrency networks, which could adversely impact an investment in us. +To the extent that any miners cease to record transactions in solved blocks, such transactions will not be recorded on the blockchain. Currently, there are no known incentives for miners to elect to exclude the recording of transactions in solved blocks; however, to the extent that any such incentives arise (e.g., a collective movement among miners or one or more mining pools forcing cryptocurrency users to pay transaction fees as a substitute for or in addition to the award of new cryptocurrency upon the solving of a block), actions of miners solving a significant number of blocks could delay the recording and confirmation of transactions on the blockchain. Any systemic delays in the recording and confirmation of transactions on the blockchain could result in greater exposure to double-spending transactions and a loss of confidence in cryptocurrency networks, which could adversely impact an investment in our company. +29 +Intellectual property rights claims may adversely affect the operation of cryptocurrency networks. +Third parties may assert intellectual property claims relating to the holding and transfer of digital currencies and their source code. Regardless of the merit of any intellectual property or other legal action, any threatened action that reduces confidence in cryptocurrency networks’ long-term viability or the ability of end-users to hold and transfer cryptocurrency may adversely affect an investment in us. Additionally, a meritorious intellectual property claim could prevent us and other end-users from accessing cryptocurrency networks or holding or transferring their cryptocurrency. As a result, an intellectual property claim against us or other large cryptocurrency network participants could adversely affect an investment in us. +Currently, there is relatively small use of cryptocurrency in the marketplace in comparison to relatively large use by speculators, thus contributing to price volatility that could adversely affect an investment in us. +As relatively new products and technologies, cryptocurrency has only recently become widely accepted as a means of payment for goods and services, and use of cryptocurrency by remains limited. Conversely, a significant portion of cryptocurrency demand is generated by speculators and investors seeking to profit from the short- or long-term holding of cryptocurrency. A lack of expansion by cryptocurrency into our markets, or a contraction of such use, may result in increased volatility or a reduction in the price of cryptocurrencies, either of which could adversely impact an investment in us. +The acceptance of Bitcoin Network, Ethereum Network, or Litecoin Network software patches or upgrades by a significant, but not overwhelming, percentage of the users and miners in the respective networks could result in a “fork” in the blockchain, resulting in the operation of two separate networks until such time as the forked blockchains are merged. The temporary or permanent existence of forked blockchains could adversely impact Super Crypto Mining, Inc. as well as an investment in us. +Bitcoin, Ethereum, and Litecoin are open source projects and, although there is an influential group of leaders in the cryptocurrency community, there is no official developer or group of developers that formally controls the Bitcoin, Ethereum, or Litecoin Networks. Any individual can download the particular cryptocurrency network software and make any desired modifications, which are proposed to users and miners on the respective network through software downloads and upgrades. A substantial majority of miners and the particular cryptocurrency users must consent to those software modifications by downloading the altered software or upgrade that implements the changes; otherwise, the changes do not become a part of the cryptocurrency network. Generally, changes to various cryptocurrency networks have been accepted by the vast majority of users and miners, ensuring that the cryptocurrency networks remain coherent economic systems; however, a developer or group of developers could potentially propose a modification to a cryptocurrency network that is not accepted by a vast majority of miners and users, but that is nonetheless accepted by a substantial population of participants in the respective cryptocurrency network. In such a case, and if the modification is material and/or not backwards compatible with the prior version of the respective cryptocurrency network software, a “fork” in the blockchain could develop and two separate networks of the same cryptocurrency could result, one running the pre-modification software program and the other running the modified version (e.g., a second bitcoin network). Such a fork in the blockchain typically would be addressed by community-led efforts to merge the forked blockchains, and several prior forks have been so merged without any material impact on the price of Bitcoin, although there can be no assurance that this will always be the case upon a fork. This kind of split in a Bitcoin, Ethereum, or Litecoin Network could materially and adversely impact an investment in us and, in the worst case scenario, harm the sustainability of the respective network’s economy. +The open-source structure of cryptocurrency network protocol means that the developers and other contributors to the protocol are generally not directly compensated for their contributions in maintaining and developing the protocol. A failure to properly monitor and upgrade the protocol could damage the cryptocurrency network and an investment in us. +The Bitcoin, Ethereum, and Litecoin Networks operate based on an open-source protocol maintained by certain core developers and other contributors. The core developers are those developers employed by MIT Media Lab’s Digital Currency Initiative who oversee the Bitcoin Network. As these network protocols are not sold and the networks’ use does not generate revenues for its development team, the core developers and contributors are generally not compensated for maintaining and updating the respective cryptocurrency network protocol. To the extent that material issues arise with the Bitcoin, Ethereum, or Litecoin Network protocols, and the core developers and open-source contributor community are unable to address the issues adequately or in a timely manner, the respective cryptocurrency network, Super Crypto Mining, Inc. and an investment in us may be adversely affected. +30 +The further development and acceptance of cryptocurrency networks, which represents a new and rapidly changing industry, are subject to a variety of factors that are difficult to evaluate. The slowing or stopping of the development or acceptance of digital currency systems may adversely affect our business. +Digital currencies may be used, among other things, to buy and sell goods and services are a new and rapidly evolving industry. The growth of the digital currency industry in general, and in particular the Bitcoin industry, Ethereum industry, and Litecoin industry, are subject to a high degree of uncertainty. The factors affecting the further development of the digital currencies industry, as well as the Bitcoin, Ethereum and Litecoin industries, include: +· +Continued worldwide growth in the adoption and use of Bitcoins, Ethereum, and Litecoins, and other cryptocurrency; +· +Government and quasi-government regulation of Bitcoin, Ethereum, and Litecoin, and other cryptocurrency and their use, or restrictions on or regulation of access to and operation of cryptocurrency networks and system; +· +The maintenance and development of the open-source software protocol of various cryptocurrency networks; +· +The availability and popularity of other forms or methods of buying and selling goods and services, including new means of using fiat currencies; and +· +General economic conditions and the regulatory environment relating to digital currencies. +· +A decline in the popularity or acceptance of the top cryptocurrencies or their networks could adversely affect an investment in us. +The value of cryptocurrency and fluctuations in the price of cryptocurrency could materially and adversely affect the business of Super Crypto Mining, Inc. and investment in the company. +Several factors may affect the value of cryptocurrency, including, but not limited to: +· +Total cryptocurrency in existence; +· +Global cryptocurrency demand, which is influenced by the growth of retail merchants’ and commercial businesses’ acceptance of cryptocurrency as payment for goods and services, the security of online cryptocurrency exchanges and digital wallets that hold cryptocurrency, the perception that the use and holding of cryptocurrency is safe and secure, the lack of regulatory restrictions on their use and the reputation of cryptocurrency for illicit use; +· +Global cryptocurrency supply, which is influenced by similar factors as global cryptocurrency demand, in addition to fiat currency needs by miners (for example, to invest in equipment or pay electricity bills) and taxpayers who may liquidate cryptocurrency holdings around tax deadlines to meet tax obligations; +· +Investors’ expectations with respect to the rate of inflation or deflation of fiat currencies or cryptocurrency; +· +Interest rates; +· +Currency exchange rates, including the rates at which cryptocurrency may be exchanged for fiat currencies; +· +Fiat currency withdrawal and deposit policies of cryptocurrency exchanges and liquidity of such cryptocurrency exchanges; +· +Interruptions in service from or failures of major cryptocurrency exchanges; +· +Cyber theft of cryptocurrency from online cryptocurrency wallet providers, or news of such theft from such providers, or from individuals’ cryptocurrency wallets; +· +Investment and trading activities of large investors, including private and registered funds, that may directly or indirectly invest in cryptocurrency; +· +Monetary policies of governments, trade restrictions, currency devaluations and revaluations; +· +Regulatory measures, if any, that restrict the use of cryptocurrency as a form of payment or the purchase of cryptocurrency on the cryptocurrency market; +· +The availability and popularity of businesses that provide cryptocurrency -related services; +· +The maintenance and development of the open source software protocol of certain cryptocurrency networks; +· +Increased competition from other forms of cryptocurrency or payments services; +· +Global or regional political, economic, or financial events and situations; +31 +· +Expectations among cryptocurrency economy participants that the value of cryptocurrency will soon change; and +· +Fees associated with processing a cryptocurrency transaction. +Banks and financial institutions may not provide banking services, or may cut off services, to businesses that provide cryptocurrency-related services or that accept cryptocurrencies as payment, including financial institutions of investors in the Company’s securities. +A number of companies that provide bitcoin and/or other cryptocurrency-related services have been unable to find banks or financial institutions that are willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial institutions. We also may be unable to obtain or maintain these services for our business. The difficulty that many businesses that provide bitcoin and/or other cryptocurrency-related services have and may continue to have in finding banks and financial institutions willing to provide them services may be decreasing the usefulness of cryptocurrencies as a payment system and harming public perception of cryptocurrencies and could decrease its usefulness and harm its public perception in the future. Similarly, the usefulness of cryptocurrencies as a payment system and the public perception of cryptocurrencies could be damaged if banks or financial institutions were to close the accounts of businesses providing bitcoin and/or other cryptocurrency-related services. This could occur as a result of compliance risk, cost, government regulation or public pressure. The risk applies to securities firms, clearance and settlement firms, national securities and commodities exchanges, the over the counter market and the Depository Trust Company, which, if any of such entities adopts or implements similar policies, rules or regulations, could result in the inability of our investors to open or maintain stock or commodities accounts, including the ability to deposit, maintain or trade the Company’s securities. Such factors would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue its cryptocurrency business segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and harm investors. +Possibility of cryptocurrency algorithms or protocols changing, such as a transition by some networks to proof of stake validation, and other crypto mining related risks could have an adverse impact on the Company’s business prospects. +The underlying cryptocurrency algorithms, protocols and other important factors are constantly changing. It is possible that these changes could negatively impact the Company’s business and business plans. Should the top cryptocurrencies that the Company intends to focus on shift their underlying protocols, algorithms, validation methods or other material factors (for instance from a proof of work validation method to a proof of stake method, which is an alternative method to proof of work for validating cryptocurrency transactions), it could adversely impact the Company’s business prospects. A shift from proof of work validation method to a proof of stake method could render any Company that maintains advantages in the current climate (for example from lower priced electric, processing, real estate, or hosting) less competitive Any major changes related to the top cryptocurrencies could have an adverse impact on the ability of Super Crypto Mining, Inc. and Super Crypto Power to continue as going concerns or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account. +The profitability and success of crypto mining is constantly changing due to various factors. These changes and the Company’s choices related to which cryptocurrencies to focus on for their own account or for customers could adversely affect the Company’s business results. +The miners that the Company has purchased allow the Company to decide which cryptocurrency to mine. The factors that affect the success of mining an individual cryptocurrency change rapidly. Should the Company choose the wrong cryptocurrency to focus its crypto mining operations on, it could adversely impact the Company’s business prospects. +32 +To the extent that the profit margins of cryptocurrency mining operations are not high, operators of cryptocurrency mining operations are more likely to immediately sell cryptocurrency earned by mining in the market, resulting in a reduction in the price of cryptocurrencies that could adversely impact the Company and similar actions could affect other cryptocurrencies. +Over the years, crypto mining operations have evolved from individual users mining with computer processors, graphics processing units and first generation application-specific integrated circuit (“ ASIC ”) servers. Currently, new processing power is predominantly added by incorporated and unincorporated “professionalized” crypto mining operations. Professionalized crypto mining operations may use proprietary hardware or sophisticated ASIC machines acquired from ASIC manufacturers. They require the investment of significant capital for the acquisition of this hardware, the leasing of operating space (often in data centers or warehousing facilities), incurring of electricity costs and the employment of technicians to operate the cryptocurrency mining farms. +As a result, professionalized crypto mining operations are of a greater scale than prior miners and have more defined, regular expenses and liabilities. These regular expenses and liabilities require professionalized crypto mining operations to more immediately sell cryptocurrencies earned from crypto mining operations, whereas it is believed that individual miners in past years were more likely to hold newly mined bitcoins and/or other cryptocurrencies for more extended periods. The immediate selling of newly mined bitcoins and/or other cryptocurrencies greatly increases the supply of bitcoins and/or other cryptocurrencies for sale, creating downward pressure on the price of bitcoins and/or other cryptocurrencies. +The extent to which the value of bitcoins and/or other cryptocurrencies mined by a professionalized crypto mining operation exceeds the allocable capital and operating costs determines the profit margin of such operation. A professionalized crypto mining operation may be more likely to sell a higher percentage of its newly mined bitcoins and/or other cryptocurrencies rapidly if it is operating at a low profit margin—and it may partially or completely cease operations if its profit margin is negative. In a low profit margin environment, a higher percentage could be sold more rapidly, thereby potentially reducing bitcoin and/or other cryptocurrencies prices. Lower bitcoin and/or other cryptocurrencies prices could result in further tightening of profit margins, particularly for professionalized crypto mining operations with higher costs and more limited capital reserves, creating a network effect that may further reduce the price of bitcoin until crypto mining operations with higher operating costs become unprofitable and remove mining power. The network effect of reduced profit margins resulting in greater sales of newly mined bitcoins and/or other cryptocurrencies could result in a reduction in the price of bitcoins and/or other cryptocurrencies that could adversely impact business of Super Crypto Mining, Inc. and the Company. +The foregoing risks associated with bitcoin could be equally applicable to other cryptocurrencies, existing now or introduced in the future. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company may hold or expect to acquire for its own account and harm investors. +Should new services/software embodying new technologies emerge, the Company’s or its investments’ ability to recognize the value of the use of existing hardware and equipment and its underlying technology, may become obsolete and require substantial capital to replace such equipment. +The increase in interest and demand for cryptocurrencies has led to a shortage of crypto mining hardware as individuals purchase equipment for mining at home and large scale mining evolved. Equipment in Super Crypto Mining, Inc.’s crypto mining facilities will require replacement from time to time and new technological innovations could render the Company’s current equipment obsolete at any time. Shortages of graphics processing units may lead to unnecessary downtime for miners and limit the availability or accessibility of cryptocurrency mining processing capabilities in the industry. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company may hold or expect to acquire for its own account. +We have an evolving business model. +As Digital Assets and blockchain technologies become more widely available, we expect the services and products associated with them to evolve. Very recently, the Commission issued a report that promoters that use initial coin offerings or token sales to raise capital may be engaged in the offer and sale of securities in violation of the Securities Act and the Securities Exchange Act of 1934 (the “ Exchange Act ”). This may cause us to potentially change our future business in order to comply fully with the federal securities laws as well as applicable state securities laws. As a result, to stay current with the industry, our business model may need to evolve as well. From time to time we may modify aspects of our business model relating to our product mix and service offerings. We cannot offer any assurance that these or any other modifications will be successful or will not result in harm to the business. We may not be able to manage growth effectively, which could damage our reputation, limit our growth and negatively affect our operating results. +33 +“Digital Asset” — Collectively, all digital assets based upon a computer-generated math-based and/or cryptographic protocol that may, among other things, be used to buy and sell goods or pay for services. Bitcoins represent one type of Digital Asset. +“Digital Security” — A type of Digital Asset that is offered by a promoter as an investment contract, which is a type of security defined by Section 2(a)(1) of the Securities Act. +Since there has been limited precedence set for financial accounting of bitcoin, Ethereum, and other digital assets, it is unclear how the Company will be required to account for digital assets transactions in the future. +Since there has been limited precedence set for the financial accounting of digital assets, it is unclear how the Company will be required to account for digital asset transactions or assets. Furthermore, a change in regulatory or financial accounting standards could result in the necessity to restate the Company’s financial statements. Such a restatement could negatively impact the Company’s business, prospects, financial condition and results of operation. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors. +Demand for bitcoins is driven, in part, by its status as the most prominent and secure digital asset. It is possible that a digital asset other than bitcoins could have features that make it more desirable to a material portion of the digital asset user base, resulting in a reduction in demand for bitcoins, which could have a negative impact on the price of bitcoins and adversely affect an investment in our securities. +The Bitcoin Network and bitcoins, as an asset, hold a “first-to-market” advantage over other digital assets. This first-to-market advantage is driven in large part by having the largest user base and, more importantly, the largest combined mining power in use to secure the blockchain and transaction verification system. Having a large crypto mining network results in greater user confidence regarding the security and long-term stability of a digital asset’s network and its blockchain; as a result, the advantage of more users and miners makes a digital asset more secure, which makes it more attractive to new users and miners, resulting in a network effect that strengthens the first-to-market advantage. +There are thousands of alternate digital assets (or altcoins). Bitcoin enjoys significantly greater acceptance and usage than other altcoin networks in the retail and commercial marketplace, due in large part to the relatively well-funded efforts of payment processing companies including BitPay and Coinbase. +Despite the marked first-mover advantage of the Bitcoin Network over other digital assets, it is possible that an altcoin could become materially popular due to either a perceived or exposed shortcoming of the Bitcoin Network protocol that is not immediately addressed by the core developers of Bitcoin or a perceived advantage of an altcoin that includes features not incorporated into Bitcoin. If an altcoin obtains significant market share (either in market capitalization, mining power or use as a payment technology), this could reduce Bitcoin’s market share and have a negative impact on the demand for, and price of, bitcoins, which in turn, may materially and adversely affect the business, prospects or operations of the Super Crypto Mining, Inc. and the Company. +Risks Related to Our Business and Industry - Microphase +Microphase has a history of losses and our future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on our business and the value of our company. +During the past three fiscal years Microphase has incurred losses from operations. These losses are attributable to lower volumes of its products sold to major defense contractors partially as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. As of June 30, 2017, Microphase had an accumulated deficit of approximately $18 million. Since the financial crisis of 2008, Microphase has been significantly short of capital needed to acquire parts for production of its products to complete orders for such products. At times, Microphase has not had the cash available to make advance payments for the purchase of parts, and then, as a consequence, Microphase would not receive the parts from its vendors required to finish a customer order. This would then delay the delivery of products to customers, and would also delay recognition of the resulting revenues and the receipt of cash from the customer. Sometimes after experiencing a delay in delivery of an order from Microphase, the customer would not place its next order with Microphase, resulting in a loss of business. +34 +Microphase’s future profitability depends upon many factors, including several that are beyond its control. These factors include, without limitation: +· +changes in the demand for ITS products and services; +· +loss of key customers or contracts; +· +the introduction of competitive products; +· +the failure to gain market acceptance of ITS new and existing products; and +· +the failure to successfully and cost effectively develop, introduce and market new products, services and product enhancements in a timely manner. +In addition, Microphase is incurring significant legal, accounting, and other expenses related to being a reporting company without there being a trading market for any of its securities. As a result of these expenditures, Microphase will have to generate and sustain increased revenue to achieve and maintain future profitability. +A large percentage of Microphase’s current revenue is derived from prime defense contractors to the U.S. government and its allies, and the loss of these relationships, a reduction in U.S. government funding or a change in U.S. government spending priorities or bidding processes could have an adverse impact on its business, financial condition, results of operations and cash flows. +Microphase is highly dependent on sales to major defense contractors of the U.S. military and its allies, including Lockheed Martin, Raytheon, BAE Systems and SAAB. The percentages of its revenue that were derived from sales to these named major defense contractors and directly to the U.S. Government were 61.9% in fiscal 2017, 66.8% in fiscal 2016, 65.8% in fiscal 2015, 56.1% in fiscal 2014 and 48.4% in fiscal 2013. Therefore, any significant disruption or deterioration of Microphase’s relationship with any such major defense contractors or the U.S. Government could materially reduce its revenue. In the twelve months ended June 30, 2017 there were three customers that accounted for more than 10% of sales: BAE Systems, Saab and Aselsan. In the twelve months ended June 30, 2016 there were two customers that accounted for more than 10% of sales: Lockheed Martin and BAE Systems. Microphase’s competitors continuously engage in efforts to expand their business relationships with the same major defense contractors and the U.S. Government and will continue these efforts in the future, and the U.S. Government may choose to use other contractors. Microphase expects that a majority of the business that it seeks will be awarded through competitive bidding. Microphase operates in highly competitive markets and its competitors have more extensive or more specialized engineering, manufacturing and marketing capabilities than Microphase does in many areas, and Microphase may not be able to continue to win competitively awarded contracts or to obtain task orders under multi-award contracts. Further, the competitive bidding process involves significant cost and managerial time to prepare bids and proposals for contracts that may not be awarded to Microphase, as well as the risk that Microphase may fail to accurately estimate the resources and costs required to fulfill any contract awarded to us. Following any contract award, Microphase may experience significant expense or delay, contract modification or contract rescission as a result of its competitors protesting or challenging contracts awarded to it in competitive bidding. Major defense contractors to whom Microphase supplies components for systems must compete with other major defense contractors (to which Microphase may not supply components) for military orders from the U.S. Government. In addition, Microphase competes with other policy needs, which may be viewed as more necessary, for limited resources and an ever-changing amount of available funding in the budget and appropriation process. Budget and appropriations decisions made by the U.S. Government are outside of Microphase control and have long-term consequences for its business. U.S. Government spending priorities and levels remain uncertain and difficult to predict and are affected by numerous factors, including until recently sequestration (automatic, across-the-board U.S. Government budgetary spending cuts), and the purchase of our products could be superseded by alternate arrangements. While the US defense budget was recently increased, there can be no assurance that this increase will be maintained for the foreseeable future. A change in U.S. Government spending priorities or an increase in non-procurement spending at the expense of our programs, or a reduction in total U.S. Government spending, could have material adverse consequences on Microphase’s future business. +35 +Microphase’s U.S. government contracts may be terminated by the federal government at any time prior to their completion, which could lead to unexpected loss of sales and reduction in Microphase’s backlog. +Under the terms of Microphase’s U.S. government contracts, the U.S. government may unilaterally: +· +terminate or modify existing contracts; +· +reduce the value of existing contracts through partial termination; and +· +delay the payment of Microphase’s invoices by government payment offices. +The federal government can terminate or modify any of its contracts with Microphase or its prime contractors either for the federal government’s convenience, or if Microphase or its prime contractors default, by failing to perform under the terms of the applicable contract. A termination arising out of Microphase’s default could expose it to liability and have a material adverse effect on its ability to compete for future federal government contracts and subcontracts. If the federal government or its prime contractors terminate and/or materially modify any of Microphase’s contracts or if any applicable options are not exercised, Microphase’s failure to replace sales generated from such contracts would result in lower sales and would adversely affect its earnings, which could have a material adverse effect on Microphase’s business, results of operations and financial condition. Microphase’s backlog as of June 30, 2017 was approximately $4.0 million. Microphase’s backlog could be adversely affected if contracts are modified or terminated. +Microphase’s products with military applications are subject to export regulations, and compliance with these regulations may be costly. +Microphase is required to obtain export licenses before filling foreign orders for many of its products that have military or other governmental applications. United States Export Administration regulations control technology exports like its products for reasons of national security and compliance with foreign policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of a destination country. Thus, any foreign sales of its products requiring export licenses must comply with these general policies. Compliance with these regulations is costly, and these regulations are subject to change, and any such change may require Microphase to improve its technologies, incur expenses or both in order to comply with such regulations. +Microphase depends on U.S. government contracts issued to major defense contractors, which often are only partially funded, subject to immediate termination, and heavily regulated and audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could have an adverse impact on Microphase’s business. +Over its lifetime, a U.S. Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts and subcontracts. The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts may be authorized and appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year basis. Procurement funds are typically made available for obligations over the course of one to three years. Consequently, programs often receive only partial funding initially, and additional funds are designated only as Congress authorizes further appropriations. The termination of funding for a U.S. Government program with respect to major defense contractors for which Microphase is a subcontractor would result in a loss of anticipated future revenue attributable to that program, which could have an adverse impact on its operations. In addition, the termination of, or failure to commit additional funds to, a program for which Microphase is a subcontractor could result in lost revenue and increase its overall costs of doing business. +Generally, U.S. Government contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to Microphase’s contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed must be refunded. Microphase has recorded contract revenues based on costs Microphase expect to realize upon final audit. However, Microphase does not know the outcome of any future audits and adjustments, and Microphase may be required to materially reduce its revenues or profits upon completion and final negotiation of audits. Negative audit findings could also result in termination of a contract, forfeiture of profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting or subcontracting for a period of time. +36 +In addition, U.S. Government contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s convenience upon the payment only for work done and commitments made at the time of termination. Microphase can give no assurance that one or more of the U.S. Government contracts with a major defense contractor under which Microphase provides component products will not be terminated under these circumstances. Also, Microphase can give no assurance that it will be able to procure new contracts to offset the revenue or backlog lost as a result of any termination of its U.S. Government contracts. Because a significant portion of Microphase’s revenue is dependent on its performance and payment under its U.S. Government contracts, the loss of one or more large contracts could have a material adverse impact on its business, financial condition, results of operations and cash flows. +Microphase’s government business also is subject to specific procurement regulations and other requirements. These requirements, though customary in U.S. Government contracts, increase its performance and compliance costs. In addition, these costs might increase in the future, thereby reducing Microphase’s margins, which could have an adverse effect on its business, financial condition, results of operations and cash flows. Failure to comply with these regulations and requirements could lead to fines, penalties, repayments, or compensatory or treble damages, or suspension or debarment from U.S. Government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various laws, including those related to procurement integrity, export control, U.S. Government security regulations, employment practices, protection of the environment, accuracy of records, proper recording of costs and foreign corruption. The termination of a U.S. Government contract or relationship as a result of any of these acts would have an adverse impact on Microphase’s operations and could have an adverse effect on its standing and eligibility for future U.S. Government contracts. +Microphase’s business could be negatively impacted by cybersecurity threats and other security threats and disruptions. +As a U.S. Government defense contractor, Microphase face certain security threats, including threats to its information technology infrastructure, attempts to gain access to its proprietary or classified information, threats to physical security, and domestic terrorism events. Microphase’s information technology networks and related systems are critical to the operation of its business and essential to its ability to successfully perform day-to-day operations. Microphase is also involved with information technology systems for certain customers and other third parties, which generally face similar security threats. Cybersecurity threats in particular, are persistent, evolve quickly and include, but are not limited to, computer viruses, attempts to access information, denial of service and other electronic security breaches. Microphase believes that it has implemented appropriate measures and controls and has invested in skilled information technology resources to appropriately identify threats and mitigate potential risks, but there can be no assurance that such actions will be sufficient to prevent disruptions to mission critical systems, the unauthorized release of confidential information or corruption of data. A security breach or other significant disruption involving these types of information and information technology networks and related systems could: +· +disrupt the proper functioning of these networks and systems and therefore its operations and/or those of certain of its customers; +· +result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of, proprietary, confidential, sensitive or otherwise valuable information of Microphase or its customers, including trade secrets, which others could use to compete against Microphase or for disruptive, destructive or otherwise harmful purposes and outcomes; +· +compromise national security and other sensitive government functions; +· +require significant management attention and resources to remedy the damages that result; +· +subject Microphase to claims for breach of contract, damages, credits, penalties or termination; and +· +damage Microphase’s reputation with its customers (particularly agencies of the U.S. Government) and the public generally. +Any or all of the foregoing could have a negative impact on its business, financial condition, results of operations and cash flows. +37 +Microphase enters into fixed-price contracts that could subject it to losses in the event of cost overruns or a significant increase in inflation. +Microphase has a number of fixed-price contracts which allow it to benefit from cost savings but subject it to the risk of potential cost overruns, particularly for firm fixed-price contracts, because Microphase assumes the entire cost burden. If its initial estimates are incorrect, Microphase can lose money on these contracts. U.S. Government contracts can expose Microphase to potentially large losses because the U.S. Government can hold Microphase responsible for completing a project or, in certain circumstances, paying the entire cost of its replacement by another provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. Because many of these contracts involve new technologies and applications, unforeseen events such as technological difficulties, fluctuations in the price of raw materials, problems with its suppliers and cost overruns, can result in the contractual price becoming less favorable or even unprofitable to Microphase. The U.S. and other countries also may experience a significant increase in inflation. A significant increase in inflation rates could have a significant adverse impact on the profitability of these contracts. Furthermore, if Microphase does not meet contract deadlines or specifications, Microphase may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated damages or suffer major losses if the customer exercises its right to terminate. In addition, some of its contracts have provisions relating to cost controls and audit rights, and if Microphase fails to meet the terms specified in those contracts Microphase may not realize their full benefits. Microphase’s results of operations are dependent on its ability to maximize its earnings from its contracts. Cost overruns could have an adverse impact on its financial results. +Risks Related to Ownership of our Common Stock +If we do not continue to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +The listing of our common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for continued listing. On December 18, 2015, we were notified by the NYSE American that we were no longer in compliance with the NYSE American continued listing standards because our reported stockholders' equity was below continued listing standards. The NYSE American requires that a listed company's stockholders' equity be $4.0 million or more if it has reported losses from continuing operations and/or net losses in three of its four most recent fiscal years. Subsequently, the NYSE American informed us that we are required to attain stockholders’ equity of $6.0 million or more because we experienced a loss for the year ended December 31, 2016. +Following submission of our compliance plan demonstrating how we intend to regain compliance with the continued listing standards, we were notified on March 9, 2016, that the NYSE American granted us a listing extension on the basis of our plan until June 19, 2017. We are subject to periodic review by NYSE American staff during the extension period. Failure to make progress consistent with the plan or to regain compliance with the continued listing standards by the end of the extension period could result in our common stock being delisted from the NYSE American. +On June 19, 2017, we filed a Form 8-K report with the Commission announcing that our Stockholders' Equity was approximately $6,409,000 on a pro-forma basis. In a letter dated June 20, 2017, the NYSE American notified us that we had successfully regained compliance with the NYSE American continued listing standards. Notwithstanding the foregoing, in light of our continue losses, there is no assurance that we will be able to continue to meet the NYSE American continued listing standard. Failure to meet the NYSE American listing requirement, we may be subject to delisting by the NYSE American. In the event our common stock is no longer listed for trading on the NYSE American, our trading volume and share price may decrease and we may experience further difficulties in raising capital which could materially affect our operations and financial results. +On November 20, 2017, we received a letter from NYSE Regulation indicating that the NYSE American had concluded that we failed to comply with Section 401(a) of the NYSE American’s Company Guide, which section requires that a listed company “make immediate public disclosure of all material information concerning its affairs ...” The letter, which relates to our disclosure of certain personnel changes to our board of directors and officers, provided that such letter constituted a warning letter issued to the Company pursuant to Section 1009(a)(i) of the NYSE American Company Guide. On October 12, 2017, we filed a Form 8-K that disclosed that certain personnel changes to our board of directors and executive officers were effective October 6, 2017. On November 6, 2017, we filed an amendment to the above referenced Form 8-K that disclosed that the personnel changes had not in fact occurred. After discussion with the NYSE American, on November 8, 2017, we filed a subsequent Form 8-K that further clarified that we had determined to rescind the personnel changes as of October 23, 2017. In that Form 8-K, we provided additional disclosure explaining why the personnel changes were not undertaken. +38 +On November 29, 2017, we notified the NYSE American, LLC that we were no longer in compliance with Rule 801(h) of the NYSE American Company Guide because, as a smaller reporting company, our Board of Directors was not comprised of at least 50% independent directors. On November 28, 2017, our Board of Directors approved the issuance of cash compensation, and 200,000 shares of common stock and warrants to purchase 1,000,000 shares of common stock subject to vesting and shareholder approval, to Mr. William Horne, a director of the Company, for services. As a result of this compensation, Mr. Horne may not be deemed independent within the meaning of Section 803A(2) of the NYSE American Company Guide. Mr. Horne has resigned from the audit committee of the Board of Directors. Robert Smith has been appointed as chair of the audit committee. On December 8, 2017, our board of directors rescinded the equity compensation granted to Mr. Horne. We believe that we are therefore presently in compliance with Rule 801(h) of the NYSE American Company Guide. +Our common stock price is volatile. +Our common stock is listed on the NYSE American. In the past, our trading price has fluctuated widely, depending on many factors that may have little to do with our operations or business prospects. The exercise of outstanding options and warrants may adversely affect our stock price and a shareholder’s percentage of ownership. As of December 31, 2017, we had outstanding options to purchase an aggregate of 3,842,500 shares of common stock, with a weighted average exercise price of $0.95 per share, exercisable at prices ranging from $0.57 to $1.69 per share and warrants to purchase up 4,388,868 shares of common stock, with a weighted average exercise price of $0.74 per share, at exercise prices ranging from $0.01 to $1.10 per share. +In addition, we have contractually agreed to register shares of common stock, and common stock underlying outstanding warrants and convertible debt in connection with private placement of our securities. Our shares of common stock are thinly traded. Therefore, the resale of a large number of shares of common stock and common stock underlying warrants and convertible debt by the selling stockholders may adversely affect the market price of our common stock. +Volatility in our common stock price may subject us to securities litigation. +Stock markets, in general, have experienced in recent months, and continue to experience, significant price and volume volatility, and the market price of our common stock may continue to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, coupled with depressed economic conditions, could continue to have a depressing effect on the market price of our common stock. The following factors, many of which are beyond our control, may influence our stock price: +· +the status of our growth strategy including the development of new products with any proceeds we may be able to raise in the future; +· +announcements of technological or competitive developments; +· +regulatory developments affecting us, our customers or our competitors; +· +announcements regarding patent or other intellectual property litigation or the issuance of patents to us or our competitors or updates with respect to the enforceability of patents or other intellectual property rights generally in the US or internationally; +· +actual or anticipated fluctuations in our quarterly operating results; +· +changes in financial estimates by securities research analysts; +· +changes in the economic performance or market valuations of our competitors; +· +additions or departures of our executive officers; and +· +sales or perceived sales of additional shares of our common stock. +In addition, the securities markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted securities class action litigation against that company. If we were involved in a class action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense and, whether or not adversely determined, have a material adverse effect on our business, financial condition, results of operations and prospects. +39 +We have a substantial number of convertible notes, warrants , options and preferred stock outstanding that could affect our price. +Due to a number of financings, we have a substantial number of shares that are subject to issuance pursuant to outstanding convertible debt, warrants and options. These conversion prices and exercise prices range from $0.01 to $1.69 per share of common stock. As of December 31, 2017 , the number of shares of common stock subject to convertible notes, warrants , options and preferred stock were 1,283,940, 4,388,868 , 3,842,500 and 2,186,123 , respectively. The issuance of common stock pursuant to convertible notes, warrants , options and preferred stock at conversion or exercise prices less than market prices may have the effect of limiting an increase in market price of our common stock until all of these underling shares have been issued. +We have a number of shares of common stock subject to registration rights. +Due to a number of financings, we have contractually agreed to register with the Commission shares of common stock, and common stock underlying outstanding warrants and convertible debt in connection with private placements of our securities. The potential resale at the same time of a large number of shares of common stock and common stock underlying warrants and convertible debt by the selling stockholders may adversely affect the market price of our common stock. +Sales of additional shares of our common stock could cause the price of our common stock to decline. +Sales of substantial amounts of our common stock in the public market, or the availability of such shares for sale, by us or others, including the issuance of common stock upon exercise of outstanding options and warrants, could adversely affect the price of our common stock. We and our directors and officers may sell shares into the market, which could adversely affect the market price of shares of our common stock. +The rights of the holders of common stock may be impaired by the potential issuance of preferred stock. +Our certificate of incorporation gives our board of directors the right to create new series of preferred stock. As a result, the board of directors may, without stockholder approval, issue preferred stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting power and equity interest of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote per share, could be utilized as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect the price of our common stock. Although we have no present intention to issue any shares of preferred stock or to create a series of preferred stock, we may issue such shares in the future. +The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company and subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial reporting. For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of our internal controls structure and procedures for financial reporting. Section 404 compliance may divert internal resources and will take a significant amount of time and effort to complete. If we fail to maintain compliance under Section 404, or if in the future management determines that our internal control over financial reporting are not effective as defined under Section 404, we could be subject to sanctions or investigations by the NYSE American should we in the future be listed on this market, the Commission, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our common stock. Any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent auditors. We may need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company, particularly if we become fully subject to Section 404 and its auditor attestation requirements, which will increase costs. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives and to meeting the obligations that are associated with being a public company, which may divert attention from other business concerns, which could have a material adverse effect on our business, financial condition and results of operations. +40 +If we fail to comply with the rules under the Sarbanes-Oxley Act of 2002 related to accounting controls and procedures, or if we discover material weaknesses and deficiencies in our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more difficult. +If we fail to comply with the rules under the Sarbanes-Oxley Act of 2002 related to disclosure controls and procedures, or, if we discover material weaknesses and other deficiencies in our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal control over financial reporting. If material weaknesses or significant deficiencies are discovered or if we otherwise fail to achieve and maintain the adequacy of our internal control, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our common stock could drop significantly. +If securities or industry analysts do not publish research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline. +The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. Our research coverage by industry and financial analysts is currently limited. Even if our analyst coverage increases, if one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. +The elimination of monetary liability against our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, officers and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees. +Our certificate of incorporation contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders for damages for the breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have contractual indemnification obligations under any future employment agreements with our officers. The foregoing indemnification obligations could result in us incurring substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. These provisions and the resulting costs may also discourage us from bringing a lawsuit against directors and officers for breaches of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit us and our stockholders. +We do not anticipate paying dividends on our common stock and, accordingly, shareholders must rely on stock appreciation for any return on their investment. +We have never declared or paid cash dividends on our common stock and do not expect to do so in the foreseeable future. The declaration of dividends is subject to the discretion of our board of directors and will depend on various factors, including our operating results, financial condition, future prospects and any other factors deemed relevant by our board of directors. You should not rely on an investment in our company if you require dividend income from your investment in our company. The success of your investment will likely depend entirely upon any future appreciation of the market price of our common stock, which is uncertain and unpredictable. There is no guarantee that our common stock will appreciate in value. +ITEM 1B. +UNRESOLVED STAFF COMMENTS. +Not applicable. +41 +ITEM 2. +PROPERTIES +Our corporate headquarters utilize 12,396 square foot of leased office, engineering, laboratory, and warehouse space in Fremont, California. Our headquarter lease commenced on November 1, 2012 and expires on June 30, 2019. The annual base rent under the lease, payable on a monthly basis, increases during the term of the lease from approximately $138,000 during the first year to approximately $157,000 during the final year. The lease also provides for one option to renew for a term of five years. +In addition, we lease 33,361 square-feet of other space domestically that includes office, engineering, laboratory and warehouse space in both California and Connecticut. The annual base rent under these leases, payable on a monthly basis, is approximately $447,000 during 2018. These leases expire between May 2018 and May 2026. +We also lease facilities internationally. In September, 2010, our wholly-owned subsidiary, DPL, entered into a fifteen-year lease for its 25,000 square-foot facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military power products for the European market. Sales and service support staff for its European network of distributors are located within the building together with other functions, such as engineering and administration. DPL’s rent expense is approximately $13,000 per month, and DPL has the option to cancel the lease after ten years. +We currently anticipate that the current leased space will be sufficient to support our current and foreseen future needs. +ITEM 3. +LEGAL PROCEEDINGS +None. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is listed on the NYSE American under the symbol DPW. The following table sets forth our high and low sale prices per share of our common stock as reported by www.nasdaq.com on the NYSE American through April 13, 2018 and for each quarter for the past two fiscal years. +Fiscal Year Ended December 31, 2016 +High +Low +First Quarter +$ +0.60 +$ +0.39 +Second Quarter +$ +0.62 +$ +0.35 +Third Quarter +$ +1.40 +$ +0.39 +Fourth Quarter +$ +0.85 +$ +0.52 +42 +Fiscal Year Ended December 31, 2017 +High +Low +First Quarter +$ +1.75 +$ +0.50 +Second Quarter +$ +1.05 +$ +0.40 +Third Quarter +$ +0.96 +$ +0.50 +Fourth Quarter +$ +5.95 +$ +0.51 +First Quarter of 2018 +$ +3.50 +$ +0.80 +Second Quarter of 2018 through April 13, 2018 +$ +1.50 +$ +0.74 +On April 13, 2018, the last sales price per share of our common stock was $1.21. +Record Holders +As of April 13, 2018, 43,562,860 shares of our common stock were issued and outstanding and were owned by approximately 84 holders of record. A number of holders of our common stock are “street name” or beneficial holders whose shares of record are held by banks, brokers, and other financial institutions. +Dividend Policy +We have not declared or paid any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends in the future, if any, will be at the discretion of our Board of Directors and will depend upon our earnings, capital requirements, and financial position. +Equity Compensation Information +The following table summarizes information about our equity compensation plans as of December 31, 2017. +Number of Shares +Number of Options +of Common Stock +Weighted- +Remaining Available for +to be Issued +Average +Future Issuance Under +upon Exercise +Exercise Price +Equity Compensation Plans +of Outstanding +of Outstanding +(excluding securities +Options +Options +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation plans approved +by stockholders (1) +3,059,960 +$ +0.69 +$ +2,538,832 +Equity compensation plans not +approved by stockholders +1,100,000 +$ +1.38 +$ +— +Total +4,159,960 +$ +2,538,832 +(1) +Includes warrants to purchase 317,460 of common stock at an exercise price of $0.01 per share of common stock that were issued to Mr. Kohn and approved the Company’s stockholders in December 2017. +Recent Sales of Unregistered Securities +During the Year Ended December 31, 2016 +On November 15, 2016, the Company entered into subscription agreements (the “ 2016 Subscription Agreements ”) with nine accredited investors. Pursuant to the terms of the 2016 Subscription Agreements, the Company sold 901,666 units at $0.60 for an aggregate purchase price of approximately $541, which was used for general operating expenses. Each unit consists of one share of common stock and one warrant to purchase one share of common stock at an exercise price of $0.80. These securities were sold in reliance upon the exemption provided by Section 4(a)(2) of the Securities Act and the safe harbor of Rule 506 under Regulation D promulgated under the Securities Act. +43 +During the Year Ended December 31, 2017 +Between February 16, 2017 and February 23, 2017, the Company issued 666,667 shares of its common stock, an extinguishment price of $0.60 per share, for the cancellation of $400 in demand promissory notes. +On March 8, 2017, the Company issued an aggregate of 12,549 shares of its common stock as payment for services to a consultant. The shares were valued at $10, an average of $0.80 per share . +On March 15, 2017, Company entered into a subscription agreement with a related party for the sale of 500,000 shares of common stock at $0.60 per share for the aggregate purchase price of $300. +On April 5, 2017, the Company issued 360,002 shares of its common stock, at a price of $0.75 per share, for the cancellation of $270 in demand promissory notes. +Between May 9, 2017 and June 18, 2017, the Company issued an aggregate of 956,153 shares of its common stock as payment for services to its consultant. The shares were valued at $498, an average of $0.52 per share. +On July 7, 2017, the Company entered into an asset purchase agreement to acquire the intellectual property of Coolisys.com, in consideration for, in part, 50,000 shares of common stock. The seller of the intellectual property and purchaser of the common stock was an accredited investor. +On June 28, 2017, the Company issued 189,091 shares of its common stock, at a price of $0.55 per share, for the cancellation of a 7% convertible promissory note in the principal amount of $104. +On June 28, 2017, the holders of $55 of in short-term loans agreed to cancel their notes for the purchase of 100,001 shares of the Digital Power’s common stock at a price of $0.55 per share. +On July 24, 2017, we entered into subscription agreements with six investors, and on July 25, 2017 we entered into a securities purchase agreement with an institutional investor, under which we agreed to issue and sell in the aggregate 851,363 shares of common stock to the investors at $0.55 per share for an aggregate purchase price of $468. Of the aggregate purchase price of $468, $445 was paid in cash and $23 was in consideration for the cancellation of debt of the Company. The company granted warrants to purchase 109,090 shares of common stock to two of the investors that entered into the subscription agreements at $0.75 per share. In a concurrent private placement, we sold to the institutional investor warrants to purchase an aggregate of 163,636 shares of the Company’s common stock at an exercise price equal to $0.55 per share. +On July 28, 2017, we entered into an exchange agreement with an institutional investor who was the owner of (i) a 7% Convertible Note in the principal amount of $125 and a warrant dated April 17, 2017 to purchase 83,334 shares of our common stock at $0.90. Under the terms of the exchange agreement, we agreed to exchange the 7% Convertible Note for three new promissory notes in the principal amounts of $110 due August 1, 2017; $35 due August 1, 2017; and $34 due August 8, 2017 (individually, an “Exchange Note” and collectively, the “Exchange Notes”) and to exchange the prior warrant for a new warrant to purchase 83,334 shares of common stock at $0.55 per share. +Concurrent with entering into this exchange agreement, the institutional investor entered into a subscription agreement under which we issued and sold in a registered direct offering 200,000 shares of common stock at $0.55 per share for an aggregate purchase price of $110. The 200,000 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $110. In addition, in a concurrent private placement, the institutional investor entered into a separate securities purchase agreement under which we issued and sold 63,600 shares of common stock at $0.55 per share for an aggregate of purchase price of $35. The 63,600 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $35. Further, we issued a warrant to purchase 120,000 shares of common stock at $0.55 per share. +Between August 21, 2017 and September 5, 2017, the Company issued an aggregate of 680,645 shares of its common stock as payment for services to its consultants. The shares were valued at $424, an average of $0.62 per share. +44 +On September 9, 2017, the Company approved the issuance of 100,000 shares of our common stock to Spartan Capital for capital advisory services. Spartan Capital is an accredited investor. The shares of common stock have yet to be issued by the Company. +On October 5, 2017, Ault & Company purchased 75,000 shares of our common stock at $0.60 per share and a warrant to purchase up to 75,000 shares of our common stock at $0.60 per share for an aggregate purchase price of $45. These shares and warrants have yet to be issued by the Company. Ault & Company is controlled by Mr. Milton Ault, our Executive Chairman. +Between October 3, 2017 and December 28, 2017, the Company issued an aggregate of 612,000 shares of its common stock as payment for services to its consultants. The shares were valued at $791, an average of $1.29 per share. +On October 18, 2017, the Company entered into subscription agreements with five investors, under which we agreed to issue and sell in the aggregate 452,239 shares of common stock to the investors at $0.67 per share for an aggregate purchase price of $303. $210 of the purchase price was paid in cash and $93 was paid through the cancellation of debt incurred by the Company. +On November 2, 2017, in conjunction with the securities purchase agreement to sell the November 5% Convertible Note in the principal amount of $1,111, the Company issued 300,000 shares of restricted common stock to the institutional investor. +On November 7, 2017, the Company entered into subscription agreements with investors under which the Company agreed to issue and sell in the aggregate 725,000 shares of common stock to the investors at $0.60 per share for an aggregate purchase price of $435. $280 of the aggregate purchase price was paid in cash and $155 was paid through the cancellation of debt incurred by the Company. +Between November 27, 2017 and December 28, 2017, the Company issued a total of 1,871,864 shares of its common stock upon the cash and cashless exercise of warrants to purchase an aggregate of 2,113,465 shares of its common stock. These warrants were issued between November 2016 and August 2017 in conjunction with various common stock and debt financings. The Company received cash of $642 as a result of these warrant exercises. +During the period from November 27, 2017 to December 6, 2017, the entire $530 of principal on the Convertible Note was satisfied through the issuance of 963,636 shares of the Company’s common. +On December 4, 2017, in conjunction with the securities purchase agreement to sell the 5% Convertible Note in the principal amount of $550, the Company issued 150,000 shares of restricted common stock to the institutional investor. +Between December 4, 2017 and December 22, 2017, the Company issued a total of 361,458 shares of its common stock upon the cash and cashless exercise of options to purchase an aggregate of 363,500 shares of its common stock. These options were issued pursuant to the Company’s Plans, as described in greater detail under Item 11 below. The Company received cash of $557 as a result of these option exercises. +On December 5, 2017, the Company entered into subscription agreements with investors for the sale of 640,000 shares of common stock at $1.25 per share for the aggregate purchase price of $800,000. The direct offering closed December 13, 2017. +On December 5, 2017, the Company entered into an exchange agreement with several accredited investors for the cancellation of $690 in outstanding principal on the 10% Short-Term Notes. In December 2016, Microphase issued $705 in 10% Short-Term Notes. The 10% Short-Term Notes were due one year from the date of issuance. The amount due pursuant to the 10% Short-Term Notes is equal to the entire original principal amount multiplied by 125% (the “Loan Premium” ) plus accrued interest. In exchange for the cancellation of $690 of outstanding principal and $250 of accrued loan premiums and interest owed to the investors by Microphase Corporation, the Company entered into the exchange agreement pursuant to which the Company issued an aggregate of 1,523,852 shares of common stock and warrants to purchase 380,466 shares of common stock with an exercise price of $1.10 per share of common stock. +45 +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson, pursuant to which the Company issued to WT Johnson convertible promissory notes in the principal amount of $2,268. During December 2017, the Company issued 600,000 shares of its common stock upon the conversion of the promissory notes . +On December 13, 2017 and December 14, 2017, the entire $1,111 of principal on the November 5% Convertible Note was satisfied through the issuance of 1,851,667 shares of the Company’s common stock. +On December 28, 2017, principal and accrued interest of $198 and $5, respectively, on the 12% Convertible Note was satisfied through the issuance of 368,760 shares of the Company’s common stock. +During December 2017, the entire principal and accrued interest of $880 and $54, respectively, on the 10% Convertible Notes was satisfied through the issuance of 1,557,417 shares of the Company’s common stock. +These securities were sold in reliance upon the exemption provided by Section 4(a)(2) of the Securities Act and the safe harbor of Rule 506 under Regulation D promulgated under the Securities Act. +Issuer Repurchases of Equity Securities +Not applicable. +ITEM 6. +SELECTED FINANCIAL DATA. +As a Smaller Reporting Company, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item. +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements. Such forward-looking statements include statements regarding, among others, (a) our expectations about possible business combinations, (b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs for working capital. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “approximate,” “estimate,” “believe,” “intend,” “plan,” “budget,” “could,” “forecast,” “might,” “predict,” “shall” or “project,” or the negative of these words or other variations on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements expressed or implied by any forward-looking statements. These statements may be found in this Annual Report on Form 10-K. +Forward-looking statements are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in this 10-K, changes in local, regional, national or global political, economic, business, competitive, market (supply and demand) and regulatory conditions and the following: +· +Adverse economic conditions; +· +Our ability to effectively execute our business plan; +· +Inability to raise sufficient additional capital to operate our business; +· +Our ability to manage our expansion, growth and operating expenses; +· +Our ability to evaluate and measure our business, prospects and performance metrics; +· +Our ability to compete and succeed in highly competitive and evolving industries; +46 +· +Our ability to respond and adapt to changes in technology and customer behavior; +· +Our ability to protect our intellectual property and to develop , maintain and enhance a strong brand; and +· +Other specific risks referred to in the section entitled “ Risk Factors ”. +We caution you therefore that you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances of future performance. All forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements or other information contained herein unless required by law. +Information regarding market and industry statistics contained in this Annual Report is included based on information available to us that we believe is accurate. It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services. Except as required by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those statements. See the section entitled “ Risk Factors ” for a more detailed discussion of risks and uncertainties that may have an impact on our future results. +The amounts reported within our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are in U.S. dollars in thousands, except shares and per share data. +Recent Developments +On September 18, 2017, the Board of Directors of Digital Power Corporation voted unanimously to recommend a number of proposals to be voted upon at its annual meeting (the “ Meeting ”), including a proposal to approve a change in domicile from California to Delaware (the “ Reincorporation ”). On December 27, 2017, Digital Power Corporation approved the Agreement and Plan of Merger (the “ Merger Agreement ”) providing for the merger (the “ Merger ”) of Digital Power Corporation with and into its wholly owned subsidiary DPW Holdings, Inc. (the “ Company ” or “ DPW ”). Digital Power Corporation filed the Proxy Statement on Schedule 14A related to the Meeting on November 17, 2017, in which each proposal was described in detail. Each proposal, including the one approving the Reincorporation, was approved at the Meeting, which was held on December 28, 2017. +The Reincorporation was consummated on December 29, 2017 pursuant to the Merger Agreement, whereby Digital Power Corporation merged with and into the Company with the Company as the surviving corporation operating as DPW Holdings, Inc. In connection with the Reincorporation the Company and Digital Power Corporation filed: (i) a certificate of merger (the “ Certificate of Merger ”) with the Secretary of State of the State of Delaware, and (ii) the Certificate of Merger with the Secretary of State of the State of California. Following the Merger, the Company’s corporate existence is governed by the laws of the State of Delaware and the Certificate of Incorporation and Bylaws of DPW Holdings, Inc. (the “ Delaware Certificate ” and the “ Delaware Bylaws ,” respectively). +Upon consummation of the transactions contemplated by the Merger Agreement and resulting Reincorporation, the daily business operations of the Company continued as they were conducted by Digital Power Corporation immediately prior to the Reincorporation and the officers and directors of Digital Power Corporation became the officers and directors of the Company, except that Milton C. Ault III become the Company’s Chief Executive Officer and Amos Kohn remained as its President. +On January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2,500 for an aggregate debt of $5,000 to two institutional investors. The proceeds from the two promissory notes were used to purchase 1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with our mining operations. We received delivery of the Miners on February 1, 2018. On March 27, 2018, we paid the principal and accrued interest on each of the 5% promissory notes. +On February 27, 2018, we entered into a sales agreement with H.C. Wainwright & Co., LLC (“ HCW ”) to sell shares of our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the “ ATM Offering ”) under which HCW will act as sales agent. As of April 13, 2018, we had received net proceeds of $7,121 through the sale of 6,648,538 shares of our common stock through the ATM Offering. The offer and sale of the shares through the ATM Offering are made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated February 27, 2018. +47 +GENERAL +We are a growth company seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy which we began implementing upon the change in control that was completed in September 2016. Our acquisition and development target strategy include companies that have developed a “new way of doing business” in mature, well-developed industries experiencing changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; companies that are related to our core business in the commercial and defense industries; and companies that will enhance our overall revenues. It is our goal to substantially increase our gross revenues in the near future. +We were originally a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the medical, military, telecom and industrial markets. Although we intend to seek growth through acquisitions, we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. +We have operations located in Europe through our wholly-owned subsidiary, Digital Power Limited (“ DP Limited ”), Salisbury, England, which operates under the brand name of “Gresham Power Electronics” (“ Gresham ”). DP Limited designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products. +On November 30, 2016, DPW Holdings formed Digital Power Lending, LLC (“ DP Lending ”), a wholly-owned subsidiary. DP Lending is engaged in providing commercial loans to companies throughout the United States to provide them with operating capital to finance the growth of their businesses. The loans will primarily be short-term, ranging from six to twelve months, but may be of longer duration. +On June 2, 2017, DPW Holdings purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is a design-to-manufacture original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. Microphase is headquartered in Shelton, Connecticut. +On April 25, 2017, DPW Holdings formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. The Company intends to operate its existing businesses in the customized and flexible power system solutions for the medical, military, telecom and industrial markets, other than the European markets which are primarily served by DP Limited, in Coolisys. +Further, on September 1, 2017, Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an extended sales organization for the Company’s overall flexible power system solutions. +Foreign Currency Fluctuations +Our wholly-owned subsidiary, DPL, operates using the United Kingdom pound sterling. Therefore, we are subject to monetary fluctuations between the U.S. dollar and the United Kingdom pound sterling. The financial statements of the subsidiary which are included in our consolidated financial statements have been translated into U.S. dollars. For the year ended December 31, 2017 and 2016, we recorded a foreign currency translation gain (loss) of $152 and ($362), respectively, as reported in our consolidated statements of comprehensive income (loss). +48 +Results of Operations +RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016 +The following table summarizes the results of our operations for the years ended December 31, 2017 and 2016. +2017 +2016 +Revenue +$ +10,001 +$ +7,596 +Revenue, related party +174 +— +Cost of revenue +6,325 +4,890 +Gross profit +3,850 +2,706 +Total operating expenses +9,833 +3,925 +Loss from operations +(5,983 +) +(1,219 +) +Interest (expense) income, net +(4,990 +) +77 +Loss before income taxes +(10,973 +) +(1,142 +) +Income tax benefit +78 +20 +Net loss +$ +(10,895 +) +$ +(1,122 +) +Less: Net loss attributable to non-controlling interest +279 +— +Net loss attributable to Digital Power Corp +(10,616 +) +(1,122 +) +Preferred deemed dividends +(584 +) +— +Preferred dividends +(54 +) +— +Loss available to common shareholders +$ +(11,254 +) +$ +(1,122 +) +Basic and diluted net loss per common share +$ +(0.88 +) +$ +(0.16 +) +Basic and diluted weighted average common shares outstanding +12,789,130 +6,916,568 +Comprehensive Loss +Loss available to common shareholders +$ +(11,254 +) +$ +(1,122 +) +Other comprehensive income (loss) +Change in net foreign currency translation adjustments +152 +(362 +) +Net unrealized loss on securities available-for-sale, net of income taxes +5,171 +— +Other comprehensive income (loss) +5,323 +(362 +) +Total Comprehensive loss +$ +(5,931 +) +$ +(1,484 +) +Revenues +Our revenues increased by $2,405 or 31.7% to $10,001 for the year ended December 31, 2017, from $7,596 for the year ended December 31, 2016. The increase in revenue was primarily due to our acquisition of 56.4% of the outstanding equity interests of Microphase on June 2, 2017, combined with our acquisition of all of the outstanding equity interests of Power-Plus on September 1, 2017. Revenues generated by Microphase and Power-Plus during the year ended December 31, 2017, were $2,796 and $798, respectively. Excluding revenues that were generated by our recent acquisitions of Microphase and Power-Plus, the Company generated revenues of $6,407, which represented a decrease of $1,189. As discussed below, the decrease of $1,189 from the year ended December 31, 2016, was primarily due to a decrease in revenues from our European operations. +Revenues from our U.S. operations increased by $3,338, or 73.3%, to $7,890 for the year ended December 31, 2017, from $4,552 for the year ended December 31, 2016. As previously noted, our consolidated revenues include $3,594 in revenues generated from our recent acquisitions of Microphase and Power-Plus. If we had not closed on these acquisitions, then revenues from our U.S. operations would have been $4,296, a decrease of 5.6%. The decrease in revenues from our U.S. operations is attributed to a slight decrease in sales of our legacy products. +Revenues from DP Limited decreased by $933 to $2,111 for the year ended December 31, 2017, from $3,044 for the year ended December 31, 2016, a decrease of 30.7%. The decrease was primarily attributable to a decrease of military and commercial products sales and the impact of a weakening of the British Pound and Euro against the USD. The decline in commercial product sales was mainly attributed to standard commodity products. The decline in military product sales was attributed to technical changes in the design of one of our development contracts. +49 +Revenues, related party +During the year ended December 31, 2017, we recognized $174 in revenues resulting from our relationship with MTIX Limited, a company formed under the laws of England and Wales (“ MTIX ”). MTIX was acquired by Avalanche on August 22, 2017 and is therefore deemed to be a related party. In March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system. Management believes that the MLSE purchase order will be a source of revenue and generate significant cash flows for the Company . However, at December 31, 2017, the $174 in revenues had not yet been received and was reflected on the financial statements as accounts receivable, related party. +Gross Margins +Gross margins increased to 37.8% for the year ended December 31, 2017 compared to 35.6% for the year ended December 31, 2016. The increase in gross margins was mainly attributable to the $174 increase in revenue from MTIX, a related party. If we had not recognized $174 in revenue from MTIX, then our gross margins for the year ended December 31, 2017 would have been 36.8%. The increase in gross margins from 35.6% to 36.8% is mainly attributable to the increase in sales of our commercial products sold in our U.S. operations, which have greater gross margins, combined with the decrease in sales from our European operations. +Engineering and Product Development +Engineering and product development expenses increased by $411 to $1,120 for the year ended December 31, 2017 from $709 for the year ended December 31, 2016. The increase is partly attributed to our acquisition of Microphase, which reported $294 in engineering and product development expenses. The remaining increase is primarily attributed to a $72 increase in personnel costs directly attributed to engineering and product development at the Company’s U.S. based operations and a $52 increase in safety license fees paid to third parties for products developed during the current year. During the fourth quarter of 2016, as part of our growth plan, we hired a new Head of Engineering and Technology, a highly-compensated position. +Selling and Marketing +Selling and marketing expenses were $1,721 for the year ended December 31, 2017 compared to $916 for the year ended December 31, 2016, an increase of $805. Our acquisition of Microphase and Power-Plus accounted for $97 and $300, respectively, of the increase in selling and marketing expenses. The remaining increase of $408 is attributed to an increase in personnel costs directly attributed to sales and marketing personnel at our U.S. based operations. Beginning in December 2016 and throughout the quarter ended March 31, 2017, we augmented our sales and marketing team with the addition of a Vice President of Business Development and two regional sales managers. During the year ended December 31, 2016, the services of our President were reported within selling and marketing expenses due to the significant amount of time in which he devoted to the sales process. The increase in the headcount of our sales and marketing team allowed our President to spend the majority of his time on general corporate matters related to our restructuring and expansion. As such, during the year ended December 31, 2017, the salary of our President, which is $300 per year, was reported within general and administrative expenses. The increase in selling and marketing expenses is attributed to the increase in salaries and benefits and travel related costs for the three new sales and marketing positions and partially offset by the allocation of our President’s salary to general and administrative expense. +General and Administrative +General and administrative expenses were $6,992 for the year ended December 31, 2017 compared to $2,300 for the year ended December 31, 2016, an increase of $4,692. Our acquisition of Microphase accounted for $964 of the increase in general and administrative expenses. The adjusted increase of $3,728 from the comparative prior period was mainly due to higher stock-based compensation expenses, an increase in legal and audit costs, an increase in investor relationship costs and hiring of additional consultants to build an infrastructure in anticipation of our future growth and the allocation of our Chief Executive Officer’s salary to general and administrative expense. The remaining increase in general and administrative expenses is due to various costs, none of which are significant individually. +50 +· +In aggregate, we incurred $1,831 of stock-based compensation during the year ended December 31, 2017. Of this amount, $1,598 was from issuances of equity-based awards pursuant to our Plans and $233 was from stock, options and warrants which were issued outside the Plans. It has been our policy to allocate the majority of stock-based compensation to general and administrative expense. During the year ended December 31, 2017 and 2016, and inclusive of equity-based awards issued outside the Plans, we recorded $1,682 and $516, respectively, of stock-based compensation in general and administrative expense. +· +We experienced an aggregate increase of $1,088 in audit and legal fees due to an overall increase in the operations conducted and the level of complexity and significant number of the transactions entered into during the year ended December 31, 2017. +· +Beginning during the quarter ended December 31, 2016, we spent significant effort on expanding our investor base and on hiring additional consultants to assist building an infrastructure to support our anticipated growth. As a result, we experienced an increase of $882 in costs attributed to investor relations and other consulting fees. +· +Finally, during the year ended December 31, 2016, our Chief Executive Officer’s salary was reflected in selling and marketing expenses. As discussed above, during the year ended December 31, 2017, we recorded the salary and benefits of our Chief Executive Officer to general and administrative expense. +Interest (expense) income, net +Interest expense, net was $4,990 for the year ended December 31, 2017 compared to income of $77 for the year ended December 31, 2016. The increase in interest expense for the year ended December 31, 2017 is primarily related to the amortization of debt discount, in the aggregate amount of $4,688, resulting from the issuance of warrants in conjunction with the sale of debt and equity instruments of $10,589. During the year ended December 31, 2017, as a result of these issuances, non-cash interest expense of $4,688 was recorded from the amortization of debt discount and debt financing costs. The remaining increase in interest expense, net, was due to an increase in the amount of the Company’s total borrowings. Interest expense was partially offset by interest income and the accretion of original issue discount pursuant to the Loan and Security Agreement entered into on September 6, 2017, between the Company and AVLP (“ AVLP Loan Agreement ”) of $704. +Current and Deferred Income Taxes +The Company has made the decision to fully reserve its net deferred tax assets until such time as profitable operations are achieved. As a result of this decision, we recorded an income tax benefit during the years ended December 31, 2017 and 2016, of $78 and $20, respectively. During the year ended December 31, 2017, the income tax benefit was the result of the recognition of net deferred tax liabilities from our acquisition of Microphase. +The ultimate realization of deferred tax assets is dependent upon the existence, or generation, of taxable income in the periods when those temporary differences and net operating loss carryovers are deductible. We considered the scheduled reversal of deferred tax liabilities, taxes paid in carryover years, projected future taxable income, available tax planning strategies, and other factors in making this assessment. Based on available evidence, we believe it is less likely than not that all of the deferred tax assets will be realized. Accordingly, we have established a 100% valuation allowance of $4,009. +Operating Loss +The Company recorded an operating loss of $5,983 for the year ended December 31, 2017 compared to an operating loss of $1,219 for the year ended December 31, 2016. The increase in operating loss is mostly attributable from the increase of general and administrative expenses. +Net Loss +For the foregoing reasons, our net loss for the year ended December 31, 2017, was $10,895 compared to a net loss of $1,122 for the year ended December 31, 2016. After taking into consideration the loss attributable to the non-controlling interest of the minority shareholders of Microphase of $279 and preferred dividends of $638, net loss available to common shareholders during the years ended December 31, 2017 and 2016, was $11,254 and $1,122, respectively. +51 +As reflected in our consolidated statement of cash flows for the years ended December 31, 2017 and 2016, our reported net loss is comprised of non-cash charges of $6,333 and 736, respectively. A summary of these non-cash charges is as follows: +For the Year Ended +December 31, +2017 +2016 +Interest expense – debt discount +$ +4,688 +$ +34 +Stock-based compensation +1,831 +543 +Depreciation and amortization +255 +161 +Interest income on conversion of promissory notes to common stock +13 +— +Accretion of original issue discount on notes receivable – related party +(454 +) +(2 +) +Non-cash items included in net loss +$ +6,333 +$ +736 +Other comprehensive income (loss) +Other comprehensive income (loss) was $5,323 and ($362), respectively, for the years ended December 31, 2017 and 2016. Other comprehensive income for the year ended December 31, 2017, which increased our equity, reflects the impact of the weakening of the British Pound on the equity of DP Limited combined with unrealized gains in our investments in marketable securities, primarily in the warrants that we received as a result of our investment in Avalanche International, Corp, a related party. During the year ended December 31, 2016, the effect of the foreign currency adjustment from the strengthening of the British Pound was the only component of our other comprehensive loss of $362 +LIQUIDITY AND CAPITAL RESOURCES +On December 31, 2017, we had cash and cash equivalents of $1,478. This compares with cash and cash equivalents of $996 at December 31, 2016. The increase in cash and cash equivalents was primarily due to cash used in operating and investing activities in an amount that was slightly less than funds provided by financing activities. +Net cash used in operating activities totaled $4,117 for the year ended December 31, 2017, compared to net cash used by operating activities of $358 for the year ended December 31, 2016. During the year ended December 31, 2017, the increase in net cash used in operating activities compared to the year ended December 31, 2016 was mainly due to the December 31, 2017 year loss of $10,895. The net loss was partially offset by a number of non-cash charges, the amortization of debt discount of $4,688 and stock-based compensation of $1,831, an increase in accounts receivable, related party of $174 and accounts payable and accrued expenses of $1,517 and decreases in our accounts receivable of $285. +Net cash used in investing activities was $8,674 for the year ended December 31, 2017 compared to $1,029 of net cash used in investing activities for the year ended December 31, 2016. The increase of the net usage of cash from investing activities was attributed to the investment in AVLP, investments in marketable securities, debt and equity investments to third parties and the purchase of Power-Plus. +Net cash provided by financing activities was $13,224 and $1,279 for the year ended December 31, 2017 and 2016, respectively. The financing activities related to the sale of 1,309,545 shares of common stock and warrants for net proceeds of $1,962, the sale of Series B and Series C Preferred Stock of $1,540, gross proceeds from the Company’s debt financings of $4,125, gross proceeds from advances of future receipts of $2,889 and payments on debt facilities of $1,873. +Historically, the Company has financed its operations principally through issuances of convertible debt, promissory notes and equity securities. During 2017, as reflected below, the Company continued to successfully obtain additional equity and debt financing and in restructuring existing debt. The following financings transactions were consummated during 2017: +· +In February 2017, the Company issued demand promissory notes and warrants to purchase 333,333 shares of common stock at $ 0.70 per share for aggregate proceeds of $400. Further in February 2017, the holders of $400 in demand promissory notes agreed to extinguish their $400 of debt by cancelling their notes to purchase 666,667 shares of common stock of the Company at $0.60 per share. +52 +· +On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou Ventures LLC (“ Philou ”), a related party, pursuant to which Philou was granted the right to invest up to $5,000 in the Company through the purchase of Series B Preferred Stock over a term of 36 months. On March 24, 2017, Philou purchased 25,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of cancellation of Company debt of $250 due to MCKEA, an affiliate of Philou. On May 5, 2017, Philou purchased an additional 50,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement for $500. +· +On March 15, 2017, the Company entered into a subscription agreement with one investor for the sale of 500,000 shares of common stock at $0.60 per share for the aggregate purchase price of $300. +· +On March 20, 2017, the Company issued $250 in demand promissory note to one of the Company's shareholders. +· +On March 28, 2017, the Company issued $270 in demand promissory notes to several investors. The Company received gross proceeds of $220 on March 31, 2017 and the remaining balance of $50 was received on April 3, 2017. On April 5, 2017, the Company canceled these promissory notes by issuing to the holders 360,000 shares of common stock at $0.75 per share and warrants to purchase 180,002 shares of common stock at $0.90 per share. +· +On April 17, 2017, the Company entered into two 7% convertible notes (the “ 7% Convertible Notes ”) in the aggregate principal amount of $250. The 7% Convertible Notes accrue interest at 7% simple interest on the principal amount and were due on June 2, 2017. The 7% Convertible Notes were not repaid on the maturity date and as such were in default at June 30, 2017. During July 2017, these two 7% Convertible Notes were repaid. +· +On April 26, 2017, the Company entered into a 7% convertible note in the aggregate principal amount of $104. On June 28, 2017, the noteholder converted the outstanding balance into 189,091 shares of Digital Power’s common stock. +· +Between May 5, 2017 and June 30, 2017, the Company received additional short-term loans of $140 from four accredited investors of which $75 was from the Company’s corporate counsel, a related party. As additional consideration, the investors received five-year warrants to purchase 224,371 shares of common stock at a weighted average exercise price of $0.77 per share.During June 2017, the holders of $55 of these short-term loans agreed to cancel their notes for the purchase of 100,001 shares of the Digital Power’s common stock at a price of $0.55 per share. An additional $52 in short-term loans from the related party was converted into one of the Series C Units . +· +Between May 24, 2017 and June 19, 2017, Digital Power entered into subscription agreements (the “ Series C Subscription Agreement ”) with approximately twenty accredited investors (the “ Series C Investors ”) in connection with the sale of twenty-one Units at a purchase price of $52 per Unit raising in the aggregate $1,092 with each Unit consisting of Series C Preferred Stock and Warrants. +· +Between July 6, 2017 and September 13, 2017, the Company received funding as a result of entering into multiple Agreements for the Purchase and Sale of Future Receipts with TVT Capital LLC pursuant to which the Company sold in the aggregate $2,585 in Future Receipts of the Company for $1,772. Under the terms of the agreements, the Company will be obligated to pay the initial daily amount of $13 until the $2,585 has been paid in full. The term Future Receipts means cash, check, ACH, credit card, debit card, bank card, charged card or other form of monetary payment. +· +On July 24, 2017, we entered into subscription agreements with six investors, and on July 25, 2017 we entered into securities purchase agreements (the “ Securities Purchase Agreement ”) with an institutional investor, under which we agreed to issue and sell in the aggregate 851,363 shares of common stock to the investors at $0.55 per share for an aggregate purchase price of $468. Of the aggregate purchase price of $468, $445 was paid in cash and $23 was in consideration for the cancellation of debt from a related party of the Company. +53 +· +On July 28, 2017, we entered into an exchange agreement with an institutional investor who was the owner of (i) a 7% Convertible Note in the principal amount of $125 and a warrant dated April 17, 2017 to purchase 83,334 shares of our common stock at $0.90. Under the terms of the exchange agreement, we agreed to exchange the 7% Convertible Note for three new promissory notes in the principal amounts of $110 due August 1, 2017; $35 due August 1, 2017; and $34 due August 8, 2017 (individually an Exchange Note and collectively the Exchange Notes) and to exchange the prior warrant for a new warrant to purchase 83,334 shares of common stock at $0.55 per share. Concurrent with entering into this exchange agreement, the institutional investor entered into a subscription agreement under which we issued and sold in a registered direct offering 200,000 shares of common stock at $0.55 per share for an aggregate purchase price of $110. The 200,000 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $110. In addition, in a concurrent private placement, the institutional investor entered into a separate securities purchase agreement under which we issued and sold 63,600 shares of common stock at $0.55 per share for an aggregate of purchase price of $35. The 63,600 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $35. Further, we issued a warrant to purchase 120,000 shares of common stock at $0.55 per share. +· +On August 3, 2017, the Company entered into a Securities Purchase Agreement to sell a 12% Convertible (“ 12% Convertible Note ”) and a warrant to purchase 666,666 shares of common stock to an accredited investor (the “ Investor ”). The principal of the Convertible Note may be converted into shares of common stock at $0.55 per share and under the terms of the Warrant, up to 666,666 shares of common stock may be purchased at an exercise price of $0.70 per share. The Convertible Note is in the principal amount of $400 and was sold for $360, bears interest at 12% simple interest on the principal amount, and is due on August 13, 2018. Interest only payments are due on a quarterly basis and the principal is due on August 3, 2018. The principal may be converted into shares of the Company’s common stock at $0.55 per share. During January 2018, the outstanding balance on this 12% Convertible Note was converted into 666,666 shares of our common stock. +· +On August 10, 2017, the Company, entered into Securities Purchase Agreements (“ Agreements ”) with five institutional investors (the “ Investors ”) to sell for an aggregate purchase price of $800, 10% Senior Convertible Promissory Notes (“ Convertible Notes ”) with an aggregate principal face amount of $880 and warrants to purchase an aggregate of 1,475,000 shares of common stock. The principal of the Convertible Notes and interest earned thereon may be converted into shares of common stock at $0.60 per share and under the terms of the Warrant, up to 1,475,000 shares of common stock may be purchased at an exercise price of $0.66 per share. The Convertible Notes are in the aggregate principal amount of $880 and were sold for $800 and bear simple interest at 10% on the principal amount, and principal and interest are due on February 10, 2018. Subject to certain beneficial ownership limitations, each Investor may convert the principal amount of the Convertible Note and accrued interest earned thereon at any time into shares of common stock at $0.60 per share. The conversion price of the Convertible Notes is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. +· +On October 18, 2017, the Company entered into subscription agreements with five investors, under which we agreed to issue and sell in the aggregate 452,239 shares of common stock to the investors at $0.67 per share for an aggregate purchase price of $303. $210 of the purchase price was paid in cash and $93 was paid through the cancellation of debt incurred by the Company. +· +On November 2, 2017, in conjunction with the securities purchase agreement to sell the November 5% Convertible Note in the principal amount of $1,111, the Company issued 300,000 shares of restricted common stock to the institutional investor. +· +On November 7, 2017, the Company entered into subscription agreements with investors under which the Company agreed to issue and sell in the aggregate 725,000 shares of common stock to the investors at $0.60 per share for an aggregate purchase price of $435. $280 of the aggregate purchase price was paid in cash and $155 was paid through the cancellation of debt incurred by the Company. +· +Between November 27, 2017 and December 28, 2017, the Company issued a total of 1,871,864 shares of its common stock upon the cash and cashless exercise of warrants to purchase an aggregate of 2,113,465 shares of its common stock. These warrants were issued between November 2016 and August 2017 in conjunction with various common stock and debt financings. The Company received cash of $642 as a result of these warrant exercises. +54 +· +During the period from November 27, 2017 to December 6, 2017, the entire $530 of principal on the Convertible Note was satisfied through the issuance of 963,636 shares of the Company’s common stock. +· +On December 4, 2017, in conjunction with the securities purchase agreement to sell the 5% Convertible Note in the principal amount of $550, the Company issued 150,000 shares of restricted common stock to the institutional investor. +· +Between December 4, 2017 and December 22, 2017, the Company issued a total of 361,458 shares of its common stock upon the cash and cashless exercise of options to purchase an aggregate of 363,500 shares of its common stock. These options were issued pursuant to the Company’s Plans. The Company received cash of $557 as a result of these option exercises. +· +On December 5, 2017, the Company entered into subscription agreements with investors for the sale of 640,000 shares of common stock at $1.25 per share for the aggregate purchase price of $800,000. The direct offering closed December 13, 2017. +· +On December 5, 2017, the Company entered into an exchange agreement with several accredited investors for the cancellation of $690 in outstanding principal on the 10% Short-Term Notes. In December 2016, Microphase issued $705 in 10% Short-Term Notes. The 10% Short-Term Notes were due one year from the date of issuance. The amount due pursuant to the 10% Short-Term Notes is equal to the entire original principal amount multiplied by 125% (the “Loan Premium” ) plus accrued interest. In exchange for the cancellation of $690 of outstanding principal and $250 of accrued loan premiums and interest owed to the investors by Microphase Corporation, the Company entered into the exchange agreement pursuant to which the Company issued an aggregate of 1,523,852 shares of common stock and warrants to purchase 380,466 shares of common stock with an exercise price of $1.10 per share of common stock. +· +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson, pursuant to which the Company issued to WT Johnson convertible promissory notes in the principal amount of $2,668. During December 2017, the Company issued 600,000 shares of its common stock upon the conversion of the promissory notes . +· +On December 13, 2017 and December 14, 2017, the entire $1,111 of principal on the November 5% Convertible Note was satisfied through the issuance of 1,851,667 shares of the Company’s common stock. +· +On December 28, 2017, principal and accrued interest of $198 and $5, respectively, on the 12% Convertible Note was satisfied through the issuance of 368,760 shares of the Company’s common stock. +· +During December 2017, the entire principal and accrued interest of $880 and $54, respectively, on the 10% Convertible Notes was satisfied through the issuance of 1,557,417 shares of the Company’s common stock. +· +On January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2,500,000 for an aggregate debt of $5,000,000 to two institutional investors. The proceeds from the two promissory notes was used to purchase 1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with our mining operations. We received delivery of the Miners on February 1, 2018. On March 27, 2018, we paid the principal and accrued interest on each of the 5% promissory notes. +· +On February 27, 2018, we entered into a sales agreement with H.C. Wainwright & Co., LLC ( “ HCW ” ) to sell shares of our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the “ ATM Offering ” ) under which HCW acts as sales agent. As of April 13, 2018, we had received net proceeds of $7,121 through the sale of 6,648,538 shares of our common stock through the ATM Offering. The offer and sale of the shares through the ATM Offering will be made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated February 27, 2018. +55 +We expect to continue to incur losses for the foreseeable future and will be required to raise additional capital to continue to support our working capital requirements. We believe that the MLSE purchase order contract of $50 million will contribute to generate meaningful revenue and corresponding cash in 2018. In addition, we have been successful over the last 12 months in raising capital to support our working capital requirements. We anticipate that we will continue to raise capital through public and private equity offerings, debt financings, or other means. If we are unable to secure additional capital, we may be required to curtail our current operations and take additional measures to reduce costs expenses, including reducing our workforce, eliminating outside consultants, ceasing or reducing our due diligence of potential future acquisitions, including the associated legal fees, in order to conserve cash in order to sustain operations and meet our obligations. +Based on the above, these matters raise substantial doubt about the Company’s ability to continue as a going concern. +Critical Accounting Policies +The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported assets, liabilities, revenues, and expenses in the accompanying consolidated financial statements. Critical accounting policies are those that require the most subjective and complex judgments, often employing the use of estimates about the effect of matters that are inherently uncertain. The following are considered our most critical accounting policies that, under different conditions or using different assumption or estimates, could show materially different results on our financial condition and results of operations . +Revenue Recognition +The Company generates revenues from the sale of its products through a direct and indirect sales force. Revenues from products are recognized in accordance with ASC No. 605, Revenue Recognition , when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the seller's price to the buyer is fixed or determinable, no further obligation exists and collectability is reasonably assured. Generally, the Company does not grant a right of return. However, certain distributors are allowed, in the six months after the initial stock purchase, to rotate stock that has not been sold for other products. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. Service revenues are deferred and recognized on a straight-line basis over the term of the service agreement. Service revenues are immaterial in proportion to the Company's revenues. +Accounts Receivable and Allowance for Doubtful Accounts +The Company’s receivables are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount of the Company’s receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. The Company individually reviews all accounts receivable balances and based upon an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. The Company estimates the allowance for doubtful accounts based on historical collection trends, age of outstanding receivables and existing economic conditions. If events or changes in circumstances indicate that a specific receivable balance may be impaired, further consideration is given to the collectability of those balances and the allowance is adjusted accordingly. A customer’s receivable balance is considered past-due based on its contractual terms. Past-due receivable balances are written-off when the Company’s internal collection efforts have been unsuccessful in collecting the amount due. Based on an assessment as of December 31, 2017 and 2016, of the collectability of invoices, accounts receivable are presented net of an allowance for doubtful accounts of $5 and $32, respectively. +Marketable Securities +The Company classifies its investments in equity securities, in accordance with ASC No. 320, Investment in Debt and Equity Securities ( “ASC No. 320” ) and ASC No. 325, Investment – Other ( “ASC No. 325” ). Marketable securities are designated either as trading or available-for-sale securities and are accounted for at fair value. Marketable securities are classified as short-term or long-term based on the nature of the securities and their availability to meet current operating requirements. Marketable securities that are readily available for use in current operations and are classified as short-term available-for-sale securities are reported as a component of current assets in the accompanying consolidated balance sheets. Marketable securities that are not trading securities and are not considered available for use in current operations are classified as long-term available-for-sale securities and are reported as a component of long-term assets in the accompanying consolidated balance sheets. +56 +Securities that are classified as trading are carried at fair value, with changes to fair value reported as a component of income. Securities that are classified as available-for-sale are carried at fair value, with temporary unrealized gains and losses reported as a component of stockholders' equity until their disposition. The cost of securities sold is based on the specific identification method. +All of the Company’s marketable securities are subject to a periodic impairment review. The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. When evaluating the Company’s debt and equity investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment’s amortized cost basis. Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC No. 325-20. For the year ended December 31, 2017, no other-than-temporary impairment charges were recorded. +Common Stock Purchase Warrants and Other Derivative Financial Instruments +The Company classifies common stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, which principally consist of issuance of warrants to purchase shares of common in connection with convertible notes, units and to employees of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features or variable settlement provision that cause them to not be indexed to the Company’s own stock. +Stock-Based Compensation +The Company accounts for stock-based compensation in accordance with ASC No. 718, Compensation – Stock Compensation (“ ASC No. 718 ”). Under ASC No. 718, compensation expense related to stock-based payments is recorded over the requisite service period based on the grant date fair value of the awards. Compensation previously recorded for unvested stock options that are forfeited is reversed upon forfeiture. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock. +The Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of ASC No. 505-50, Equity Based Payments to Non-Employees . Accordingly, the measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement. +57 +Convertible Instruments +The Company accounts for hybrid contracts that feature conversion options in accordance with ASC No. 815, Derivatives and Hedging Activities (“ ASC No. 815 ”). ASC No. 815 requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument. +Conversion options that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, in accordance with ASC No. 470-20, Debt with Conversion and Other Options (“ ASC No. 470-20 ”). Under ASC No. 470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded conversion options should be bifurcated from their host instruments) in accordance with ASC No. 815. +Fair value of Financial Instruments +In accordance with ASC No. 820, Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +The guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +Level 1: Quoted market prices in active markets for identical assets or liabilities. +Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-derived valuations. All significant inputs used in our valuations are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities . Level 2 inputs also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed models such as a discounted cash flow models. +Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts of financial instruments carried at cost, including cash and cash equivalents, trade receivables and trade receivable – related party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the short-term maturities of such instruments. +As of December 31, 2017 and 2016, the fair value of the Company’s investments were $9,300 and $84, respectively, and were concentrated in equity securities of AVLP, a related party (See Note 9), which are classified as available-for-sale investments. At December 31, 2017, the Company's investment in AVLP included marketable equity securities of $826 and warrants to purchase 8,248,440 shares of AVLP common stock at an exercise price of $0.50 per share of common stock. At December 31, 2016, the Company's investment in AVLP included marketable equity securities of $84. For investments in marketable equity securities, the Company took into consideration general market conditions, the duration and extent to which the fair value is above cost, and the Company’s ability and intent to hold the investment for a sufficient period of time to allow for recovery of value in the foreseeable future. As a result of this analysis, the Company has determined that its investment in AVLP marketable equity securities are accounted for pursuant to the fair value method based upon the closing market price of common stock at December 31, 2017, which resulted in an unrealized gain of $550. +58 +At December 31, 2017, the Company held shares of common stock in five companies that it purchased at the market for a total cost of $1,439. In accordance with ASC No. 320-10, these investments are accounted for pursuant to the fair value method based upon the closing market prices of common stock for these five companies at December 31, 2017 resulting in an unrealized gain of $133. +The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy: +Fair Value Measurement at December 31, 2017 +Total +Level 1 +Level 2 +Level 3 +Investments in common stock and warrants of +AVLP – a related party +$ +7,728 +$ +826 +$ +— +$ +6,902 +Investments in marketable securities +$ +1,835 +$ +1,835 +$ +— +$ +— +Total Investments +$ +9,563 +$ +2,661 +$ +— +$ +6,902 +Fair Value Measurement at December 31, 2016 +Total +Level 1 +Level 2 +Level 3 +Investments in common stock and warrants of AVLP – a related party +$ +84 +$ +84 +$ +— +$ +— +We assess the inputs used to measure fair value using a three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market: +· +Level 1 – inputs include quoted prices for identical instruments and are the most observable. +· +Level 2 – inputs include quoted prices for similar assets and observable inputs such as interest rates, currency exchange rates and yield curves. +· +Level 3 – inputs are not observable in the market and include management’s judgments about the assumptions market participants would use in pricing the asset or liability. +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller reporting company, this section is not applicable +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements required by this Item 8 are included in this Annual Report following Item 15 hereof. As a smaller reporting company, we are not required to provide supplementary financial information. +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable +59 +ITEM 9A. +CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2017, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”). We have established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure. +Based upon that evaluation, our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our disclosure controls and procedures were not effective due to certain material weaknesses as described herein. +A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has identified the following two material weaknesses: +1. +We do not have sufficient resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a material weakness +2. +We have inadequate controls to ensure that information necessary to properly record transactions is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +Planned Remediation +Management, in coordination with the input, oversight and support of our Board of Directors, has identified the measures below to strengthen our control environment and internal control over financial reporting. +Until such time as we hire a new Chief Financial Officer, the Chairman of the Audit Committee shall perform the following: +· +assists with documentation and implementation of policies and procedures and monitoring of controls, +· +reviews all anticipated transactions that are not considered in the ordinary course of business to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s financial statements. +We are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. +60 +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls. Our management has concluded that, as of December 31, 2017, our internal control over financial reporting was not effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Changes in Internal Control over Financial Reporting +During the most recent fiscal quarter 2017 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting. +ITEM 9B. +OTHER INFORMATION. +None +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +The following table sets forth the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. Ault, III (1) +48 +Chief Executive Officer, Chairman of the Board and Director +2017 +William B. Horne (2) +49 +Chief Financial Officer and Director +2016 +Amos Kohn +58 +President and Director +2003 +Robert O. Smith (3) (5) +74 +Director +2016 +Moti Rosenberg (5) +69 +Director +2015 +Jeffrey A. Bentz (4) (5) +58 +Director +2018 +61 +(1) +Effective March 16, 2017, Mr. Ault was appointed to the Board. +(2) +On October 13, 2016, William B. Horne was appointed to the Board. Pursuant to a securities purchase agreement dated September 5, 2016 by and among the Company, Philou Ventures, and Telkoor. Philou Ventures has the right to appoint four members to the Board of Directors. +(3) +On September 22, 2016, Mr. Robert O. Smith was appointed to the board. +(4) +On January 24, 2018, Mr. Jeffrey A. Bentz was appointed to the board. +(5) +Independent Director and Member of the Audit, Compensation and Nominating and Governance Committees. +Each of the directors named above will serve until the next annual meeting of our shareholders or until his respective successor is elected and qualified. Subject to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Mr. Milton C. Ault, III +On March 16, 2017, Mr. Ault was appointed Executive Chairman of the Board and on December 28, 2017, Mr. Ault was appointed Chief Executive Officer. Mr. Ault is a seasoned business professional and entrepreneur that has spent more than twenty-seven years identifying value in various financial markets including equities, fixed income, commodities, and real estate. Mr. Ault founded on February 25, 2016 Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s Disease and has served as its Chairman since. Mr. Ault has served as Chairman of Ault & Company, a holding company since December 2015, and as Chairman of Avalanche International Corp since September 2014, a company whose shares are registered under the Exchange Act. Since January, 2011, Mr. Ault has been the Vice President of Business Development for MCKEA Holdings, LLC, a family office. Through this position, Mr. Ault has consulted for a few publicly traded and privately held companies, providing each of them the benefit of his diversified experience, that range from development stage to seasoned businesses. He was the President, Chief Executive Officer, Director and Chairman of the Board of Zealous, Inc. from August 2007 until June 4, 2010 and again from February 2011 through May 1, 2011. Mr. Ault was a registered representative at Strome Securities, LP, from July 1998 until December 2005, where he was involved in portfolio management and worked on several activism campaigns including Taco Cabana, Jack In The Box (formerly Foodmaker), and 21st Century Holdings Co. Mr. Ault became majority shareholder of Franklin Capital Corp and was elected to its board of directors in July 2004 and became its Chairman and Chief Executive Officer in October 2004 serving until January 2006, and again from July 2006 to January 2007. In April 2005, the company changed its name to Patient Safety Technologies, Inc. (OTCBB:PSTX, OTCQB:PSTX) (“PST”) and purchased SurgiCount Medical, Inc. Stryker Corporation (NYSE:SYK) acquired PST at the beginning of 2014 in a deal valued at approximately one hundred twenty million dollars ($120,000,000). PST’s wholly owned operating subsidiary, SurgiCount Medical, Inc., is the company that developed the SafetySponge® System; a bar coding technology for inventory control that aims to detect and prevent the incidence of foreign objects left in the body after surgery. We believe that Mr. Ault’s business background demonstrates he has the qualifications to serve as one of our directors and as Chairman. +Amos Kohn +Mr. Kohn has served as a member of our board of directors since 2003, as our President since 2008. Mr. Kohn also served at our Chief Executive Officer from 2008 to December 2017. From March 2011 until August 2013 and again from July 2017 until January 2018, Mr. Kohn also served as interim Chief Financial Officer. Mr. Kohn has more than 20 years of successful global executive management experience, including multiple C-level roles across private and established publicly-traded companies. Mr. Kohn has successfully managed cross-functional teams, driven corporations to high profitability, built customer loyalty and led businesses through expansion and sustained growth. His areas of expertise include operations, technology innovation, manufacturing, strategic analysis and planning and M&A. Mr. Kohn was Vice President of Business Development at Scopus Video Networks, Inc., a Princeton, New Jersey company that develops and markets digital video networking products (2006-2007); Vice President of Solutions Engineering at ICTV Inc., a leading provider of network-based streaming media technology solutions for digital video and web-driven programming, located in Los Gatos, California (2003-2006); Chief Architect at Liberate Technologies, a leading company in the development of a full range of digital media processing for telecom and cable TV industries, located in San Carlos, California (2000-2003); and Executive Vice President of Engineering and Technology at Golden Channel & Co., the largest cable television multiple-systems operator (MSO) in Israel, where he had executive responsibility for developing and implementing the entire nationwide cable TV system (1989-2000). Mr. Kohn holds a degree in electrical and electronics engineering and is named as an inventor on several United States and international patents. We believe that Mr. Kohn’s extensive executive-level management experience in diversified industries, including, but not limited to, power electronics, telecommunications, cable television, broadcast and wireless, as well as his service as a director on our board since 2003, give him the qualifications and skills to serve as one of our directors. +62 +William B. Horne +Mr. Horne has served as a member of our board of directors since October 2016. On January 25, 2018, Mr. Horne was appointed as our Chief Financial Officer. Prior to his appointment as our Chief Financial Officer, Mr. Horne served as one our independent directors. He has served as the Chief Financial Officer of Targeted Medical Pharma, Inc. (OTCBB: TRGM) since August 2013. Mr. Horne is a director of and Chief Financial Officer to Avalanche International, Corp., a company whose shares of common stock are registered under the Exchange Act. Mr. Horne previously held the position of Chief Financial Officer in various companies in the healthcare and high-tech field, including OptimisCorp, from January 2008 to May 2013, a privately held, diversified healthcare technology company located in Los Angeles, California. Mr. Horne served as the Chief Financial Officer of Patient Safety Technologies, Inc. (OTCBB: PSTX), a medical device company located in Irvine, California, from June 2005 to October 2008 and as the interim Chief Executive Officer from January 2007 to April 2008. In his dual role at Patient Safety Technologies, Mr. Horne was directly responsible for structuring the divestiture of non-core assets, capital financings and debt restructuring. Mr. Horne held the position of Managing Member & Chief Financial Officer of Alaska Wireless Communications, LLC, a privately held, advanced cellular communications company, from its inception in May 2002 until November 2007. Mr. Horne was responsible for negotiating the sale of Alaska Wireless to General Communication Inc. (NASDAQ: GNCMA). From November 1996 to December 2001, Mr. Horne held the position of Chief Financial Officer of The Phoenix Partners, a venture capital limited partnership located in Seattle, Washington. Mr. Horne has also held supervisory positions at Price Waterhouse, LLP and has a Bachelor of Arts Magna Cum Laude in Accounting from Seattle University. We believe that Mr. Horne's extensive financial and accounting experience in diversified industries and with companies involving complex transactions give him the qualifications and skills to serve as one of our directors. +Robert O. Smith +Mr. Smith serves as one of our independent directors. Previously, he served as a member of our Board of Directors from November 2010 until May 2015, and served as a member of our Advisory Board from 2002 until 2015. He is currently a C-level executive consultant working with Bay Area high-tech firms on various strategic initiatives in all aspects of their business. From 2004 to 2007, he served on the Board of Directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman of the Board. From 1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of their Compower/Boschert Division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with the JM Smucker Company. Mr. Smith received his BBA degree in Accounting from Ohio University. We believe that Mr. Smith’s executive-level experience, including his previous service as our President, Chief Executive Officer and Chairman of the Board, his extensive experience in the accounting industry, and his service on our Board from November 2010 until May 2015, give him the qualifications and skills to serve as one of our directors. +Mordechai Rosenberg +Mr. Rosenberg serves as one of our independent directors. He has served as an independent consultant to various companies in the design and implementation of homeland security systems in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate Ltd., a manufacturer of armor protection systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg was the general manager of ZIV U.P.V.C Products Ltd.'s doors and window factory. Mr. Rosenberg is an active reserve officer and a retired colonel from the Israeli Defense Force (IDF), where he served for 26 years and was involved in the development of weapon systems. In the IDF, Mr. Rosenberg served in various capacities, including platoon, company, battalion and brigade commander, head of the training center for all IDF infantry, and head of the Air Force's Special Forces. Mr. Rosenberg received a B.A in History from the University of Tel Aviv and a Master of Arts in Political Science from the University of Haifa in Israel. We believe that Mr. Rosenberg’s business background give him the qualifications to serve as one of our directors. +Mr. Jeffrey Bentz +Mr. Bentz is an experienced businessman who has served since 1994 as President of North Star Terminal & Stevedore Company, a full-service stevedoring company located in Alaska and whose major areas of business include terminal operations and management, stevedore services, and heavy equipment operations. He also has served as a director and advisor to several private companies and agencies. Mr. Bentz obtained a B.A. in Business and Finance from Western Washington University in 1981. We believe that Mr. Bentz’s executive-level experience, including his operational and financial oversight of companies with multiple profit centers and his extensive experience in the real estate and commercial services industries give him the qualifications and skills to serve as one of our directors. +63 +Corporate Governance +Our Board is currently composed of six members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at https://dpwholdings.com . +Audit Committee +Messrs. Smith, Bentz and Rosenberg currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE American. Our Board has also determined that Mr. Smith qualifies as an “audit committee financial expert” as defined in SEC regulations and satisfies the financial sophistication requirements set forth in the NYSE American Rules. +The Audit Committee is responsible for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Bentz and Rosenberg currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation Committee meets the requirements for independence under the standards of the NYSE American. Mr. Smith serves as Chairman of the Compensation Committee. +The Compensation Committee is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving salaries, bonuses and other benefits paid to our officers, including our Chief Executive Officer and Chief Financial Officer; and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith, Bentz, and Rosenberg currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members of the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE American. Mr. Rosenberg serves as Chairman of the Nominating and Governance Committee. +The Nominating and Governance Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees for each annual meeting of shareholders to the Board; developing and recommending governance principles applicable to our Board; overseeing the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +The Nominating and Governance Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based business and professional skills, experiences and global business and social perspective. +In addition, the Committee seeks directors who exhibit personal integrity and a concern for the long-term interests of shareholders, as well as those who have time available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +64 +Involvement in Certain Legal Proceedings +Except as set forth below, to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former director, executive officer, or employee: +· +been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +· +had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time; +· +been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; +· +been found by a court of competent jurisdiction in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated; +· +been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; +· +or been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member. +1. +Mr. Ault held series 7, 24, and 63 licenses and managed four domestic hedge funds and one bond fund from 1998 through 2008. On April 26, 2012, as a result from an investigation by FINRA involving activities during 2008, Mr. Ault agreed to a settlement with FINRA in which he did not admit to any liability or violation of any laws or regulatory rules and that included restitution and a suspension from association with a FINRA member firm for a period of 2 years. As part of that settlement, Mr. Ault agreed that before he would reapply for association with FINRA, if at all, he would make restitution to certain investors. Mr. Ault was able to speak with and pay restitution to one of the investors, but no others. As a result, Mr. Ault is neither eligible, nor does he intend, to apply for association with FINRA. +2. +Mr. Ault was CEO, President and Chairman of Zealous Holdings, Inc. that filed for bankruptcy protection under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) on February 20, 2009, in the U.S. Bankruptcy Court, Central District of California. This Chapter 11 filing was subsequently converted to a Chapter 7 filing by order of the Bankruptcy Court. Zealous Holdings, Inc. was not an entity that was entitled to a discharge under the bankruptcy code. As such Zealous Holdings, Inc. did not receive a discharge. Ultimately, Zealous Holdings, Inc. ceased doing business and was permanently closed. +3. +Mr. Ault filed for bankruptcy protection under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) on December 8, 2009, in the U.S. Bankruptcy Court, Central District of California. This Chapter 13 filing was subsequently converted to a Chapter 7 filing by order of the Bankruptcy Court and months later, the petition being withdrawn and dismissed without prejudice. +65 +Except as set forth in our discussion below in “Certain Relationships and Related Transactions,” none of our directors or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC. +Family Relationships +Milton C. Ault, III and Kristine Ault are spouses. +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, directors and ten percent shareholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based solely upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting persons, we believe that during the during current fiscal year and the year ended December 31, 2017, all such filing requirements applicable to our officers, directors and ten percent shareholders were fulfilled with the following exceptions: During the fiscal year 2017, Messrs. Horne, Smith and Rosenberg, and Ms. Ault each inadvertently filed late one Form 4 reporting one transaction and Mr. Kohn inadvertently filed three Forms 4s late reporting eight transactions. +Code of Ethics +We have adopted the Code of Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller or person performing similar functions (collectively, the “Financial Managers”). The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website at https://dpwholdings.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request to our President, Amos Kohn, we will provide without charge, a copy of our Code of Ethical Conduct. +ITEM 11. +EXECUTIVE COMPENSATION . +Summary Compensation Table +The following Summary Compensation Table sets forth all compensation earned in all capacities during the years ended December 31, 2017 and 2016, by our Chief Executive Officer (the “ Named Executive Officer ”). Because we are a Smaller Reporting Company, we only have to report information of our Chief Executive Officer as no other officer met the definition of Named Executive Officer within the meaning of the SEC rules. +SUMMARY COMPENSATION TABLE +Name and principal position +Year +Salary ($) +Bonus ($) +Stock Awards ($) (1) +Option +Awards ($) (1) +All Other +Compensation ($) +Total ($) +Amos Kohn +2017 +300,000 +0 +0 +92,250 +33,000 (2) +425,250 +President (3) +2016 +234,866 +0 +0 +366,409 +36,269 (2) +637,544 +Milton C. Ault, III +2017 +0 +0 +0 +461,250 +207,500 +668,750 +Chief Executive Officer (4) +2016 +0 +0 +0 +0 +30,000 +30,000 +(1) +The values reported in the “Stock Awards” and “Option Awards” columns represent the aggregate grant date fair value, computed in accordance with Accounting Standards Codification (“ ASC ”) 718 Share Based Payments , of grants of stock options and stock awards to our named executive officer in the years shown. +(2) +The amounts in “All Other Compensation” consist of health insurance benefits, long-term and short-term disability insurance benefits, and 401K matching amounts. +(3) +Mr. Kohn also served as our Chief Executive Officer until December 28, 2017. +(4) +Mr. Ault was appointed as our Chief Executive Officer on December 28, 2017. Amounts included in “All Other Compensation” consist of cash fees earned as an independent contractor. +66 +Employment Agreement with Amos Kohn +On November 30, 2016, as amended on February 22, 2017, the Company entered into an employment agreement with Amos Kohn to serve as President and Chief Executive Officer with an effective date of September 22, 2016. +For his services, Mr. Kohn will be paid a salary of $300,000 per annum increasing to $350,000 per annum provided that the Company achieves revenues in the aggregate amount of at least $10,000,000 as determined in accordance with U.S. GAAP for the trailing four calendar quarters. +In addition, Mr. Kohn shall be eligible for an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s compensation committee after conferring with Mr. Kohn. The target amount of Mr. Kohn’s annual performance bonus shall be 25% to 50% of his then annual base salary but may be greater upon mutual agreement between Mr. Kohn and the compensation committee. +Further, Mr. Kohn is entitled to receive equity participation as follows: (i) ten-year warrants to purchase 317,460 shares of the Company's Common Stock (the “ Warrant Grant ”) at an exercise price of $0.01 per share subject to vesting quarterly over two years effective January 1, 2017; and (ii) ten-year options to purchase 1,000,000 shares of the Company’s Common Stock at an exercise price of $0.65 per share. The option to purchase 1,000,000 shares of Common Stock is subject to the following vesting schedule: (1) options to purchase 500,000 shares of Common Stock shall vest upon the effective date; (2) options to purchase 250,000 shares of Common Stock shall vest ratably over six months beginning with the first month after the effective date; and (3) options to purchase 250,000 shares of common stock shall vest ratably over twelve months beginning with the first month after the effective date. As part of the grant of the options to purchase 1,000,000 shares, Mr. Kohn forfeited options to purchase 535,000 shares of common stock previously granted to him under the Company’s Incentive Share Option Plans. +In the event that Mr. Kohn is terminated by the Company without cause, or if Mr. Kohn resigns for good reason, Mr. Kohn shall be entitled to (i) all annual salary earned prior to the termination date, any earned but unpaid portion of Mr. Kohn’s annual performance bonus for the year preceding in which such termination occurred and any earned but unpaid paid time off; (ii) an amount equal to 100% of Mr. Kohn’s then in effect annual base salary plus an additional 1/12th of Mr. Kohn’s annual base salary for each year of employment with the Company prior to such termination; (iii) an amount equal to the average of Mr. Kohn’s two prior years’ annual bonuses (with such average not to exceed 50% of the Mr. Kohn’s annual base salary in effect at the time of termination) prorated for the portion of the year that executive was employed; (iv) accelerated vesting of all outstanding unvested stock options and other equity arrangements subject to vesting and held by Mr. Kohn through the termination date and the Company’s right to repurchase Mr. Kohn’s restricted stock shall cease; and (v) to the extent required by COBRA, continuation of group health benefits pursuant to the Company's standard programs or in effect at the termination date at Company expense for a period of not less than 18 months. +If Mr. Kohn is terminated without cause, or resigns for good reason within 12 months of a change of control, Mr. Kohn shall be entitled to receive: (i) payment in a lump sum of Mr. Kohn annual base salary for 24 months and any accrued, unused paid time-off; (ii) accelerated vesting of all outstanding unvested stock options and other equity arrangements subject to vesting and the Company’s right to repurchase Mr. Kohn restricted stock shall cease; and (iii) to the extent required by COBRA, continuation of group health benefits pursuant to the Company's standard programs or in effect at the termination date at the Company’s expense for a period of not less than 18 months. +Employment agreement with William B. Horne +On January 25, 2018, we entered into a five-year employment agreement with William Horne to serve as Chief Financial Officer and Executive Vice President of the Company and its subsidiaries. For his services, Mr. Horne will be paid a base salary of $250,000 per annum. Upon signing of the employment agreement, Mr. Horne is entitled to a signing bonus in the amount of $25,000. In addition, Mr. Horne shall be eligible to receive an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s compensation committee. +67 +Further, Mr. Horne is entitled to receive equity participation as follows: (i) a grant of restricted stock in the aggregate amount of 1,000,000 shares of common stock, which shares shall vest in installments of two hundred thousand (200,000) shares annually over five (5) years beginning on January 1, 2019, provided, however, that such shares may, in whole or in part, in the discretion of the Compensation Committee, vest immediately upon the filing of an Annual Report on Form 10-K with the SEC that shows that the Company’s revenues for the applicable fiscal year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates any such vesting, the Company’s Compensation Committee must prior thereto have obtained the consent of Mr. Horne, which consent may be withheld in his discretion, and (ii) an option to purchase 500,000 shares of common stock of the Company at a per share price equal to $2.32, the closing market price of the shares of common stock on January 24, 2018, which option will vest over 60 months. +Mr. Horne’s bonuses, if any, and all stock based compensation shall be subject to “ Company Clawback Rights ” if during the period that Mr. Horne is employed by the Company and upon the termination of Mr. Horne’s employment and for a period of two years thereafter, if there is a restatement of any of the Company’s financial results from which any bonuses and stock based compensation to Mr. Horne shall have been determined. +Upon termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to receive: (i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and (iii) any accrued but unused vacation time. +Further, unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne a “ Separation Payment ” as follows: (A) an amount equal to four weeks of base salary for each full year of service, (B) should Mr. Horne provide the Company with a separation, waiver and release agreement within 60 days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “ Separation Period ”) of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or (2) the 12-month period commencing on the date Mr. Horne is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Horne would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will be paid an amount equal to four times his Separation Payment. +Advisory Vote on Executive Compensation +At the annual meeting of shareholders on December 28, 2016, the shareholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. In addition, shareholders voted, on an advisory basis, that an advisory vote on executive compensation should be held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding equity awards as of December 31, 2017 to the Named Executive Officer. +68 +OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2017 +OPTION AWARDS +Name +Number of +Securities +Underlying +Unexercised +Options (#) +Exercisable +Number of +Securities +Underlying +Unexercised +Options (#) +Unexercisable +Equity Incentive Plan +Awards: Number of +Securities Underlying +Unexercised Unearned +Options (#) +Option +Exercise +Price ($) +Option +Expiration +Date +Amos Kohn +1,000,000 (1) +— +— +$0.65 +11/3/2026 +238,092 (2) +79,368 +— +$0.01 +11/3/2026 +12,500 (3) +87,500 +— +$1.38 +11/28/2027 +Milton C. Ault III +62,500 (4) +437,500 +— +$1.38 +11/28/2027 +(1) +On November 3, 2016, Mr. Kohn was granted options to 1,000,000 shares of Common Stock at $0.65 per share. The options to purchase 1,000,000 shares of Common Stock are subject to the following vesting schedule: (1) options to purchase 500,000 shares of Common Stock shall vest upon the effective date; (2) options to purchase 250,000 shares of Common Stock shall vest ratably over six months beginning with the first month after the effective date; and (3) options to purchase 250,000 shares of common stock shall vest ratably over twelve months beginning with the first month after the effective date. In connection with the grant of options to purchase 1,000,000 shares of Common Stock, Mr. Kohn forfeited options to purchase 535,000 shares of common stock previously granted to him under the Company’s 2012 Plan. +(2) +Represents warrants to purchase 317,460 shares of the Company's Common Stock at an exercise price of $0.01 per share subject to vesting quarterly over two years beginning January 1, 2017 granted to Mr. Kohn in connection with his employment agreement. +(3) +Represents options to purchase 100,000 shares of the Company's Common Stock at an exercise price of $1.38 per share subject to vesting monthly over four years beginning November 28, 2017 granted to Mr. Kohn. +(4) +Represents options to purchase 500,000 shares of the Company's Common Stock at an exercise price of $1.38 per share subject to vesting monthly over four years beginning November 28, 2017 granted to Mr. Ault. +Director Compensation +The Company pays each independent director an annual base amount of $20,000 annually, other than Mr. Smith, who will receive a base amount of $30,000 annually due to anticipated additional services to be provided by Mr. Smith as a lead independent director. Additionally, our Board makes recommendations for adjustments to an independent director’s compensation when the level of services provided are significantly above what was anticipated. +The table below sets forth, for each non-employee director, the total amount of compensation related to his or her service during the year ended December 31, 2017: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($) +Total ($) +Robert O. Smith +30,000 +— +184,500 +(2) +— +214,500 +Kristine Ault (1) +20,000 +— +92,250 +(3) +— +112,250 +William B Horne +80,000 +— +92,250 +(3) +— +172,250 +Mordechai Rosenberg +20,000 +— +92,250 +(3) +— +112,250 +(1) +Ms. Ault resigned from the Board on January 25, 2018. +69 +(2) +On November 28, 2017, Mr. Smith was granted options to purchase 200,000 shares of Common Stock at $1.38 per share. The options shall vest ratably over forty-eight (48) months beginning with the first month after the effective date. +(3) +On November 28, 2017, Ms. Ault and Messrs. Horne and Rosenberg were granted options to purchase 100,000 shares of Common Stock at $1.38 per share. The options shall vest ratably over forty-eight (48) months beginning with the first month after the effective date. +Stock Option Plans +On December 28, 2017, the shareholder’s approved the 2017 Stock Incentive Plan (the “ 2017 Stock Incentive Plan ”), under which options to acquire up to 2,000,000 shares of common stock may be granted to the Company's directors, officers, employees and consultants. The 2017 Stock Incentive Plan is in addition to the Company’s (i) 2016 Stock Incentive Plan (the “ 2016 Stock Incentive Plan ”), under which options to acquire up to 4,000,000 shares of common stock may be granted to the Company's directors, officers, employees and consultants, and (ii) 2012 Stock Option Plan, as amended (the “ 2012 Plan ”), which provides for the issuance of a maximum of 1,372,630 shares of the Company’s common stock to be offered to the Company’s directors, officers, employees, and consultants (collectively the “ Plans ”). +The purpose of the Plans is to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial responsibility for the direction and management of the Company, as well as certain directors and consultants of the Company, additional incentives to exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, to reward outstanding performance and to provide a means to attract and retain persons of outstanding ability to the service of the Company. +As of December 31, 2017, options to purchase 2,742,500 shares of common stock were issued and outstanding, and 2,538,832 shares are available for future issuance under the Plans. +401(k) Plan +We have adopted a tax-qualified employee savings and retirement plan, or 401(k) plan, which generally covers all of our full-time employees. Pursuant to the 401(k) plan, eligible employees may make voluntary contributions to the plan up to a maximum of 5% of eligible compensation. The 401(k) plan permits, but does not require, matching contributions by the Company on behalf of plan participants. We match contributions at the rate of (1) $1.00 for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary. We are also permitted under the plan to make discretionary contributions. The 401(k) plan is intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. Contributions to such a qualified plan are deductible by the Company when made, and neither the contributions nor the income earned on those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained in trust. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. +Except as otherwise indicated below, the following table sets forth certain information regarding beneficial ownership of our common stock as of April 13, 2018 by (1) each of our current directors; (2) each of the named executive officers listed in the Summary Compensation Table located above in the section entitled “Executive Compensation”; (3) each person known to us to be the beneficial owner of more than 5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and executive officers as a group. As of April 13, 2018, there were 43,562,860 shares of our common stock outstanding. +Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of the Record Date are deemed to be outstanding and to be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table have sole voting and sole investment power with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. Unless otherwise indicated below, the address of each beneficial owner listed below is c/o DPW Holdings, Inc., 48430 Lakeview Blvd, Fremont, California 94538. +70 +Name and address of beneficial owner +Number of +shares +Approximate +beneficially +percent +owned +of class +Greater than 5% Beneficial Owners: +Philou Ventures, LLC +5,583,003 +(2) +12.03% +P.O. Box 3587 Tustin, CA 92705 +Kristine Ault +5,885,153 +(3) +12.60% +Directors and Officers: (1) +Milton Ault, III +5,666,503 +(4) +12.19% +Amos Kohn +1,405,156 +(5) +3.14% +Robert Smith +244,997 +(6) +* +William Horne +179,166 +(7) +* +Moti Rosenberg +145,833 +(7) +* +Jeffrey A. Bentz +30,556 +(7) +* +All directors and executive officers as a group (six persons) +7,672,211 +15.90% +* Less than one percent. +(1) +Unless otherwise indicated, the business address of each of the individuals is c/o DPW Holdings, Inc., 48430 Lakeview Blvd, Fremont, California 94538. +(2) +Includes 100,000 shares of Series B Preferred Stock that are convertible in 1,428,571 shares of common stock and warrants to purchase 1,428,572 shares of common stock that are exercisable within 60 days of April 13, 2018. +(3) +Includes shares owned by Philou Ventures of which Ms. Ault is the Manager. Also includes options to purchase 300,000 shares of common stock that are exercisable within 60 days of April 13, 2018. +(4) +Mr. Ault is the spouse of Kristine Ault. Includes 5,583,003 shares owned by Philou Ventures which may be deemed beneficially owned by Mr. Ault. Also includes options to purchase 62,500 shares of common stock that are exercisable within 60 days of April 13, 2018. +(5) +Includes options to purchase 1,012,500 shares and warrants to purchase 238,092 exercisable within 60 days of April 13, 2018. +(6) +Includes options to purchase 158,333 shares of common stock that are exercisable within 60 days of April 13, 2018. +(7) +Represents options to purchase shares of common stock that are exercisable within 60 days of April 13, 2018. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information sets forth certain related transactions between us and certain of our shareholders or directors. Prior to September 22, 2016, Telkoor was our largest shareholder and Telkoor’s Chief Executive Officer, Benzi Diamant, was our Chairman of the Board. Effective September 22, 2016, Telkoor sold all of its shares of common stock of the Company to Philou Ventures, and as a result, Philou Ventures is our largest shareholder. Philou Ventures’ Manager is Kristine L. Ault, a former director. Ms. Ault is the spouse of Milton C. Ault, III, who is our Chief Executive Officer and Chairman of the Board. +Telkoor Telecom, Ltd. +As previously disclosed, on September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, and Telkoor pursuant to which Philou agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock. In consideration for such shares, Philou agreed to pay Telkoor $1.5 million. +71 +In conjunction with the securities purchase agreement, we entered into a rescission agreement with Telkoor in order to resolve all financial issues between the parties, including the repurchase by Telkoor of 1,136,666 shares of common stock of Telkoor beneficially owned by us for book value of $90,000. +Finally, as part of the securities purchase agreement, we have agreed to pay Mr. Diamant $7,500 for a period of eighteen months from September 5, 2016 for consulting services. +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest then shareholder, Telkoor, of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor sold its assets, including its subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the “ Manufacturing Agreement ”) with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016, Telkoor sold all its commercial IP to Advice Electronics Ltd. (“ Advice ”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under our branding until December 2020. +Philou Ventures, LLC +On March 9, 2017, we entered into a Preferred Stock Purchase Agreement (the “ Purchase Agreement ”) with Philou Ventures. Philou Ventures is the Company’s largest stockholder and Kristine L. Ault, a former director, controls and is a Manager of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures may invest up to $5,000,000 in us through the purchase of Series B Preferred Stock (“ Preferred Stock ”) over the Term, as specified herein. Each share of Preferred Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guarantees to purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE American. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares of Preferred Stock in a sufficient amount in order us to meet the NYSE American’s minimum stockholders’ equity continued listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “ Guaranteed Purchases ”). In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of Preferred Stock, up to the 500,000 share maximum (“ Voluntary Purchases ”). All consideration for Voluntary Purchases shall be delivered through a series of varying payments (“ Payments ”) by Philou Ventures, at its sole and absolute discretion, during the period commencing on the closing date and ending 36 months therefrom (the “ Term ”). We have the right to request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining the minimum stockholders’ equity required by the NYSE American. The Preferred Stock shall not be callable by us for 25 years from the closing date. +72 +In addition, for each share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price equal to $0.70 per share of common stock +Further, Philou Ventures shall have the right to participate in our future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest. Philou Ventures’ right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +On December 29, 2016, MCKEA Holdings, LLC ( “ MCKEA ”) lent us $250,000 in the form of a demand note bearing simple interest at 6.0%. MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling shareholder. Kristine L. Ault , a former director and the wife of Milton C. Ault III, Chief Executive Officer and Chairman of the Company’s Board of Directors , is the manager and owner of MCKEA. On March 24, 2017, MCKEA cancelled the $250,000 demand note to purchase 25,000 shares of Preferred Stock and received warrants to purchase 357,143 shares of common stock at $0.70 per share. +On March 20, 2017, Philou arranged for the Company to receive a $250 short-term loan. Between May 5, 2017 and June 2, 2017, Philou purchased an additional 75,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the cancellation of the Company debt due to Philou from the $250 short term loan and cash of $500. In addition, Philou received warrants to purchase 1,071,429 shares of common stock at an exercise price of $0.70 per share of common stock. +Avalanche International, Corp. +On October 5, 2016, November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with Avalanche (the “ AVLP Notes ”) in the principal amount of $525,000 each. The AVLP Notes included a 5% original issue discount, resulting in net loans to Avalanche of $1,500,000 and an original issue discount of $75,000. The AVLP notes accrued interest at 12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of Avalanche at approximately $0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 shares of the Company’s common stock . During the period from March 29, 2017 to August 16, 2017, the Company funded $1,808,952 in excess of the $1,500,000 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, the Company and Avalanche entered into a Loan and Security Agreement (“ AVLP Loan Agreement ”) with an effective date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to $5,000,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019. +In consideration of entering into the AVLP Loan Agreement, the Company and Avalanche cancelled the AVLP Notes and consolidated the AVLP Notes and prior advances totaling $3,308,952 plus original issue discount of $165,448 and issued a new Convertible Promissory Note in the aggregate principal amount of $3,474,400 (the “ New Note ”) that is convertible into shares of Avalanche at a conversion price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior interest accrued under the AVLP Notes and advances will continue to be an obligation of Avalanche. The New Note contains standard events of defaults. In addition, concurrent to issuing the New Note, Avalanche issued to the Company a five-year warrant to purchase 6,948,800 shares of Avalanche Common Stock at $0.50 per share. Future advances under the AVLP Loan Agreement, which totaled $649,820 at December 31, 2017, are evidenced by a convertible promissory note containing a conversion price feature of $0.50 per share and warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by Avalanche are secured by the assets of AVLP. +73 +At December 31, 2017, the Company had provided Avalanche with $4,124,220 pursuant to the non-revolving credit facility. The warrants issued in conjunction with the non-revolving credit facility entitles the Company to purchase up to 8,248,440 shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Avalanche is a holding company which on August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended on July 13, 2017 and August 21, 2017 (the “ Exchange Agreement ”) with MTIX Ltd., a company formed under the laws of England and Wales (“ MTIX ”) and the three (3) shareholders of MTIX (the “ Sellers ”), Avalanche completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, Avalanche acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “ MTIX Shares ”) by the Sellers to Avalanche in exchange (the “ Exchange ”) for the issuance by Avalanche of: (a) 7% secured convertible promissory notes (individually, a “ Note” and collectively, the “Notes ”) in the aggregate principal face amount of $9,500,000 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages of MTIX’s ordinary shares, (b) (i) $500,000 in cash, $50,000 of which was paid on October 26, 2016, and (ii) 100,000 shares of Avalanche’s newly designated shares of Class B Convertible Preferred Stock (the “ Class B Shares ”) to the principal shareholder of MTIX (the “ Majority Shareholder ”). +Milton C. Ault, III and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors, are directors of Avalanche. In addition, Philou Ventures is the controlling shareholder of Avalanche as well as our largest shareholder. +MTIX Limited +MTIX has developed a novel cost effective and environmentally friendly material synthesis technology for textile applications. Designed for global textile manufacturers, the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system uses a combination of plasma and photonic energy to effect material synthesis of a substrate surface. The laser and gasses from the system deliver a dry process to enhance the surface of fabric. During March 2017 the Company was awarded a 3-year, $50 million contract by MTIX to manufacture, install and service the MLSE plasma-laser system. The Company has recognized $923,751 in revenue from MTIX, all of which was reflected as accounts receivable, related party at December 31, 2017. +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson & Sons (Huddersfield) Limited (the “ Holder ”), pursuant to which the Company issued to the Holder, (a) a convertible promissory note in the principal amount of $600,000 (“ Note A ”), and (b) a convertible promissory note in the principal amount of $1,667,766 (“ Note B ”), in exchange for cancellation of (i) an outstanding loan made by the Holder to MTIX in the amount of $265,666; and (ii) cancellation of an aggregate of $2,002,500 owed by MTIX to the Holder pursuant to an Agreement for the Sale and Purchase of a Textile Multi-Laser Enhancement Technology Machine dated as of July 21, 2017 by and between MTIX and the Holder. +Note A is convertible into the Company’s common stock at a conversion price of $1.00 per share, does not bear interest, and matures two years from issuance. Note B is convertible into the Company’s common stock at a conversion price of $0.85 per share, does not bear interest, and matures two years from issuance. However, the Holder shall not have the right to convert any portion of Note B, following receipt by the Holder of an aggregate of $2,267,766 of gross proceeds from the sale of shares of Common Stock issued upon conversion of Note A or Note B. +During December 2017, the Company issued 600,000 shares of its common stock upon the conversion of Note A and the Holder notified the Company that gross proceeds during the month of December 2017 from sales of the 600,000 shares of common stock were sufficient to satisfy the entire $2,267,766 obligation. As a result of entering into the exchange agreement with the Holder, MTIX is obligated to pay the Company $2,668,266, consisting of the amount of the exchange agreement of $2,267,766 and a value added tax of $400,500 from the sale of the Textile Multi-Laser Enhancement Technology Machine . +74 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES. +Marcum LLP serves as our independent registered public accounting firm for the year ended December 31, 2017 and 2016. Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global (“ Kost Forer ”) was our prior independent registered public accounting firm. +Fees and Services +The following table shows the aggregate fees billed to us for professional services by Marcum LLP, respectively, for the years ended December 31, 2017 and 2016: +2017 +2016 +Audit Services +$ +313,986 +$ +81,545 +Audit Related Services +$ +— +$ +— +Tax Services +$ +— +$ +— +All Other Services +$ +— +$ +— +Total +$ +313,986 +$ +81,545 +Audit Fee. This category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years ended December 31, 2017 and 2016, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2017 and 2016, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements for the relevant years. +Audit-Related Fees. This category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under “Audit Fees,” and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, internal control-related matters, and audits of employee benefit plans. +Tax Fees . This category includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax compliance, tax planning and tax advice. +All Other Fees. This category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such pre-approval. +75 +PART IV +ITEM 15. +EXHIBITS +Exhibit +Number +Description +2.1 +Share Exchange Agreement between the Company, Microphase Corporation, Microphase Holding Company, RCKJ Trust, Ergul Family Limited Partnership, and To Hong Yam and Eagle Advisers, LLC, dated April 28, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 2.1 thereto. +2.2 +Agreement and Plan of Merger between the Company and Digital Power Corporation, dated December 27, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 2.1 thereto. +2.3 +State of Delaware, Certificate of Merger of the Company and Digital Power Corporation, dated December 28, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 2.2 thereto. +2.4 +Share Purchase Agreement between Coolisys Technologies, Inc., Enertec Management Ltd., Micronet Enertec Technologies, Inc., and Enertec Systems 2001 Ltd., dated December 31, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on January 2, 2018 as Exhibit 2.1 thereto. +3.1 +Amended and Restated Articles of Incorporation of the Company, dated September 29, 1992. Incorporated by reference to Exhibit 3.1 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on October 16, 1996. +3.2 +Certificate of Amendment to Articles of Incorporation of the Company, dated September 9, 1996. Incorporated by reference to Exhibit 3.2 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on October 16, 1996. +3.3 +Bylaws. Incorporated by reference to Exhibit 3.3 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on October 16, 1996. +3.4 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series B Convertible Preferred Stock, dated March 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 3.1 thereto. +3.5 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series D Convertible Preferred Stock. Incorporated by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 3.1 thereto. +3.6 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series E Convertible Preferred Stock. Incorporated by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 3.2 thereto. +3.7 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series C Convertible Preferred Stock, dated May 15, 2017. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 3.1 thereto. +3.8 +Certification of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.1 thereto. +3.9 +Bylaws, dated September 25, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.2 thereto. +76 +Exhibit +Number +Description +4.1 +Form of Secured Convertible Note, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.1 thereto. +4.2 +Form of Common Stock Purchase Warrant, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.2 thereto. +4.3 +Form of Common Stock Purchase Warrant, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.3 thereto. +4.4 +Form of Common Stock Purchase Warrant, dated November 15, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on November 16, 2016 as Exhibit 4.1 thereto. +4.5 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 4.1 thereto. +4.6 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as Exhibit 4.1 thereto. +4.7 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 4.1 thereto. +4.8 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on June 8, 2017 as Exhibit 4.1 thereto. +4.9 +Form of Common Stock Purchase Warrant, dated July 27, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 26, 2017 as Exhibit 4.1 thereto. +4.1 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.1 thereto. +4.11 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.2 thereto. +4.12 +Form of Convertible Note, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.2 thereto. +4.13 +Form of Common Stock Purchase Warrant, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.3 thereto. +4.14 +Form of Common Stock Purchase Warrant, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 4.1 thereto. +4.15 +Form of Senior Convertible Promissory Note, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 10.2 thereto. +4.16 +Common Stock Purchase Warrant issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 4.1 thereto. +4.17 +Convertible Promissory Note issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.2 thereto. +4.18 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 4.1 thereto. +77 +Exhibit +Number +Description +4.19 +Form of 10% Original Issue Discount Convertible Debenture. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 10.2 thereto. +4.2 +Form of 10% Original Issue Discount Debenture, dated December 4, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.21 +Convertible Promissory Note issued by WT Johnson & Sons (Huddersfield) Ltd. to the Company, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.22 +Convertible Promissory Note issued by WT Johnson & Sons (Huddersfield) Ltd. to the Company, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.2 thereto. +4.23 +Form of Common Stock Purchase Warrant, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.24 +Form of Senior Convertible Promissory Note, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 4.1 thereto. +4.25 +Form of Common Stock Purchase Warrant, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 4.2 thereto. +4.26 +Form of Common Stock Purchase Warrant, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 4.1 thereto. +10.1 +Securities Purchase Agreement between the Company, Philou Ventures, LLC and Telkoor Telecom Ltd., dated September 4, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on September 7, 2016 as Exhibit 10.1 thereto. +10.2 +Rescission Agreement between the Company, Telkoor Telecom Ltd. and Telkoor Power Supplies Ltd., dated September 4, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on September 7, 2016 as Exhibit 10.2 thereto. +10.3 +Waiver Letter to Securities Purchase Agreement between the Company, Philou Ventures, LLC and Telkoor Telecom Ltd., dated September 20, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on September 22, 2016 as Exhibit 10.1 thereto. +10.4 +Registration Rights Agreement, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.4 thereto. +10.5 +Form of Subscription Agreement. Incorporated herein by reference to the Current Report on Form 8-K filed on November 16, 2016 as Exhibit 10.1 thereto. +10.6 +Form of Registration Rights Agreement, dated November 15, 2016. Incorporated by reference to the Current Report on Form 8-K filed on November 16, 2016 as Exhibit 10.2 thereto. +10.7* +Employment Agreement for Amos Kohn, dated November 30, 2016. Incorporated by reference to the Current Report on Form 8-K filed on December 5, 2016 as Exhibit 10.1 thereto. +78 +Exhibit +Number +Description +10.8 +2016 Stock Incentive Plan. Incorporated by reference to the Current Report on Form 8-K filed on December 30, 2016 as Exhibit 10.1 thereto. +10.9 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on February 17, 2017 as Exhibit 10.1 thereto. +10.10* +Amendment No. 1 to Executive Employment Agreement. Amos Kohn, dated February 22, 2017. Incorporated by reference to the Current Report on Form 8-K filed on February 27, 2017 as Exhibit 10.1 thereto. +10.11 +Preferred Stock Purchase Agreement between the Company and Philou Ventures, LLC, dated March 9, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 10.1 thereto. +10.12 +Registration Rights Agreement between the Company and Philou Ventures, LLC. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 10.2 thereto. +10.13 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as Exhibit 10.1 thereto. +10.14 +Form of Subscription Agreement, dated May 1, 2017. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 10.1 thereto. +10.15 +Form of Registration Rights Agreement. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 10.2 thereto. +10.16 +Promissory Note issued by Microphase Corporation to the Company, dated June 2, 2017. Incorporated by reference to the Current Report on Form 8-K filed on June 8, 2017 as Exhibit 10.1 thereto. +10.17 +Promissory Note issued by Microphase Corporation to the Company, dated June 2, 2017. Incorporated by reference to the Current Report on Form 8-K filed on June 8, 2017 as Exhibit 10.2 thereto. +10.18 +Form of Securities Purchase Agreement, dated July 25, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 26, 2017 as Exhibit 10.1 thereto. +10.19 +Form of Exchange Agreement, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 10.1 thereto. +10.2 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 10.2 thereto. +10.21 +Form of Securities Purchase Agreement, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 10.3 thereto. +10.22 +Securities Purchase Agreement between William H. Gordon, Power-Plus Technical Distributors, LLC, and CooliSys Technologies Inc., dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.1 thereto. +10.23 +Form of Securities Purchase Agreement, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.1 thereto. +10.24 +Form of Securities Purchase Agreement, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 10.1 thereto. +10.25 +Form of Registration Rights Agreement, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 10.3 thereto. +79 +Exhibit +Number +Description +10.26 +Loan and Security Agreement between the Company and Avalanche International Corp., dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.1 thereto. +10.27* +Executive Employment Agreement for William Horne, dated October 6, 2017. Incorporated by reference to the Current Report on Form 8-K filed on October 12, 2017 as Exhibit 10.1 thereto. +10.28 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on October 19, 2017 as Exhibit 10.1 thereto. +10.29 +Agreement for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated October 23, 2017. Incorporated by reference to the Current Report on Form 8-K filed on October 23, 2017 as Exhibit 10.1 thereto. +10.3 +Form of Securities Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 10.1 thereto. +10.31 +Form of Registration Rights Agreement. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 10.3 thereto. +10.32 +Form of Loan and Security Agreement between the Company and LAM, Inc., dated November 2, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 7, 2017 as Exhibit 10.1 thereto. +10.33 +Form of Subscription Agreement, dated November 6, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2017 as Exhibit 10.1 thereto. +10.34 +Trust Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.1 thereto. +10.35 +Tenancy-In-Common Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.2 thereto. +10.36 +Form of Securities Purchase Agreement, dated December 4, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.37 +Form of Registration Rights Agreement, dated December 4, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.2 thereto. +10.38 +Exchange Agreement between the Company and WT Johnson & Sons (Huddersfield) Limited, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.39 +Form of Exchange Agreement, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.4 +Form of Subscription Agreement, dated December 1, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.41 +Form of Consulting Agreement. Incorporated by reference to the Current Report on Form 8-K filed on January 2, 2018 as Exhibit 10.1 thereto. +10.42 +Agreement for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated January 10, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 16, 2018 as Exhibit 10.1 thereto. +80 +Exhibit +Number +Description +10.43 +Agreement for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated January 10, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 16, 2018 as Exhibit 10.2 thereto. +10.44 +Form of Securities Purchase Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 10.1 thereto. +10.45 +Form of Registration Rights Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 10.2 thereto. +10.46* +Executive Employment Agreement for William Horne, dated January 25, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 25, 2018 as Exhibit 10.1 thereto. +10.47 +Form of Securities Purchase Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on February 12, 2018 as Exhibit 10.1 thereto. +10.48 +Amendment to Securities Purchase Agreement, dated January 23, 2018, between the Company and Twitchell Fund, LLC. Incorporated by reference to the Current Report on Form 8-K filed on February 12, 2018 as Exhibit 10.2 thereto. +10.49 +Sales Agreement between the Company and H.C. Wainwright & Co., LLC, dated February 27, 2018. Incorporated by reference to the Current Report on Form 8-K filed on February 27, 2018 as Exhibit 10.1 thereto. +10.5 +Asset Purchase Agreement between Super Crypto Mining, Inc. and Blockchain Supply & Services Ltd., dated March 8, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2018 as Exhibit 10.1 thereto. +10.51** +Amended and Restated Master Services Agreement dated March 21, 2018 but effective March 1, 2018. Filed herewith. Confidential Portions have been redacted and a Request for Confidential Treatment has been filed separately with the Commission. +10.52 +Form of Securities Purchase Agreement, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 10.1 thereto. +10.53 +Form of Note, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 10.2 thereto. +10.54 +Form of Amended and Restated Independent Contractor Agreement, dated April 13, 2018. Incorporated by reference to the Current Report on Form 8-K filed on April 13, 2018 as Exhibit 10.1 thereto. +14*** +Code of Ethics. +21*** +List of subsidiaries. +23*** +Consent of Marcum LLP. +31.1*** +Certification of Chief Executive and Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) +32.1**** +Certification of Chief Executive and Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code +81 +Exhibit +Number +Description +101.INS*** +XBRL Instance Document +101.SCH*** +XBRL Taxonomy Extension Schema Document +101.CAL*** +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF*** +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB*** +XBRL Taxonomy Extension Label Linkbase Document +101.PRE*** +XBRL Taxonomy Extension Presentation Linkbase Document +_______________________ +* +Indicates management contract or compensatory plan or arrangement. +** +Confidential treatment is being sought for this agreement, which has been filed separately with the SEC. The confidential portions of this Exhibit have been omitted and are marked by asterisks. +*** +Filed herewith. +**** +Furnished herewith. +82 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. +Dated: April 17, 2018 +DPW HOLDINGS, INC. +By: +/s/ Milton C. Ault, III +Milton C. Ault, III +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ William B. Horne +William B. Horne +Chief Financial Officer +(Principal Accounting Officer) +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +April 17, 2018 +/s/ Milton C. Ault, III +Milton C. Ault, III, Chief +Executive Officer and +Executive Chairman of the +Board +April 17, 2018 +/s/ William B. Horne +William B. Horne, Chief +Financial Officer and +Director +April 17, 2018 +/s/ Amos Kohn +Amos Kohn, President and +Director +April 17, 2018 +/s/ Robert O. Smith +Robert O. Smith, Director +April 17, 2018 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, +Director +April 17, 2018 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +83 +ITEM 8. +FINANCIAL STATEMENTS +DPW HOLDINGS, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Reports of Independent Registered Public Accounting Firm – Marcum LLP +F-2 +Consolidated Balance Sheets as of December 31, 2017 and 2016 +F-3 - F-4 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended +December 31, 2017 and 2016 +F-5 +Consolidated Statements of Changes in Stockholders' Equity for the Years Ended +December 31, 2017 and 2016 +F-6 - F-8 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2017 and +2016 +F-9 - F-10 +Notes to Consolidated Financial Statements +F-11 - F-64 +F-1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Shareholders and Board of Directors of +DPW Holdings, Inc. and Subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of DPW Holdings, Inc. and Subsidiaries (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive loss , changes in stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. +Explanatory Paragraph – Going Concern +The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the Company has a significant working capital deficiency, has incurred significant losses and needs to raise additional funds to meet its obligations and sustain its operations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ Marcum llp +Marcum llp +We have served as the Company’s auditor since 2016. +New York, NY +April 17, 2018 +F-2 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +U.S. dollars in thousands, except share data +December 31, +2017 +2016 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ +1,478 +$ +996 +Marketable securities +1,835 +— +Accounts receivable +1,898 +1,439 +Accounts and other receivable, related party +174 +— +Inventories, net +1,993 +1,122 +Prepaid expenses and other current assets +1,407 +285 +TOTAL CURRENT ASSETS +8,785 +3,842 +Intangible assets +2,898 +— +Goodwill +3,652 +— +Property and equipment, net +1,217 +570 +Investments - related party, net of original issue discount of $2,115 +and $45, respectively +2,333 +965 +Investments in warrants and common stock - related party +7,728 +84 +Investment in preferred stock of private company +1,000 +— +Other investments +1,637 +— +Other investments, related parties +917 +— +Other assets +343 +11 +TOTAL ASSETS +$ +30,510 +$ +5,472 +LIABILITIES AND STOCKHOLDERS' EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ +4,273 +$ +1,231 +Accounts payable and accrued expenses, related party +70 +— +Advances on future receipts +1,963 +— +Short term advances +2,439 +— +Short term advances, related party +245 +— +Revolving credit facility +388 +— +Notes payable +402 +— +Notes payable, related party +134 +250 +Convertible notes payable +398 +— +Other current liabilities +708 +398 +TOTAL CURRENT LIABILITIES +11,020 +1,879 +LONG TERM LIABILITIES +Notes payable +525 +— +Notes payable, related parties +175 +— +Convertible notes payable, related party, net of discount of $496 +— +34 +TOTAL LIABILITIES +$ +11,720 +$ +1,913 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +U.S. dollars in thousands, except share data +December 31, +2017 +2016 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS' EQUITY +Preferred Stock, $0.01 par value, designated in the following classes +$ +— +$ +— +25,000,000 shares authorized; 478,776 and nil shares issued and outstanding +at December 31, 2017 and December 31, 2016, respectively +Series A Convertible Preferred Stock, $0.001 par value – +— +— +500,000 shares authorized; nil shares issued and outstanding at +December 31, 2017 and December 31, 2016 +Series B Convertible Preferred Stock, $10 stated value per +— +— +share, $0.001 par value – 500,000 shares authorized; 100,000 and nil +shares issued and outstanding at December 31, 2017 and December 31, +2016, respectively (liquidation preference of $1,000 and nil at +December 31, 2017 and December 31, 2016, respectively) +Series C Convertible Preferred Stock, $2.40 stated value +— +— +per share, $0.001 par value – 460,000 shares authorized; nil shares +issued and outstanding at December 31, 2017 and December 31, 2016 +Series D Convertible Preferred Stock, $0.01 stated value +— +— +per share, $0.001 par value – 378,776 shares authorized; 378,776 and +nil shares issued and outstanding at December 31, 2017 and December +31, 2016, respectively (liquidation preference of $4) +Series E Convertible Preferred Stock, $45 stated value per +— +— +share, $0.001 par value – 10,000 shares authorized; nil shares issued and +outstanding at December 31, 2017 and December 31, 2016 +Preferred Stock, $0.001 par value – 23,151,224 shares authorized; nil shares +— +— +issued and outstanding at December 31, 2017 and December 31, 2016 +Class A Common Stock, $0.001 par value – 200,000,000 shares authorized; +30,222,299 and 7,677,637 shares issued and outstanding at December 31, 2017 +30 +8 +and 2016, respectively +Class B Common Stock, $0.001 par value – 25,000,000 shares authorized; nil +— +— +shares issued and outstanding at December 31, 2017 and December 31, 2016 +Additional paid-in capital +36,888 +16,529 +Accumulated deficit +(23,412 +) +(12,158 +) +Accumulated other comprehensive loss +4,503 +(820 +) +TOTAL DIGITAL POWER STOCKHOLDERS' EQUITY +18,009 +3,559 +Non-controlling interest +781 +— +TOTAL STOCKHOLDERS' EQUITY +18,790 +3,559 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ +30,510 +$ +5,472 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHNSIVE LOSS +U.S. dollars in thousands, except shares and per share data +For the Year Ended +December 31, +2017 +2016 +Revenue +$ +10,001 +$ +7,596 +Revenue, related party +174 +— +Cost of revenue +6,325 +4,890 +Gross profit +3,850 +2,706 +Operating expenses +Engineering and product development +1,120 +709 +Selling and marketing +1,721 +916 +General and administrative +6,992 +2,300 +Total operating expenses +9,833 +3,925 +Loss from operations +(5,983 +) +(1,219 +) +Interest (expense) income, net +(4,990 +) +77 +Loss before income taxes +(10,973 +) +(1,142 +) +Income tax benefit +78 +20 +Net loss +$ +(10,895 +) +$ +(1,122 +) +Less: Net loss attributable to non-controlling interest +279 +— +Net loss attributable to Digital Power Corp +(10,616 +) +(1,122 +) +Preferred deemed dividends on Series B and Series C Preferred Stock +(584 +) +— +Preferred dividends on Series C Preferred Stock +(54 +) +— +Net loss available to common stockholders +$ +(11,254 +) +$ +(1,122 +) +Basic and diluted net loss per common share +$ +(0.88 +) +$ +(0.16 +) +Basic and diluted weighted average common shares outstanding +12,789,130 +6,916,568 +Comprehensive Loss +Loss available to common stockholders +$ +(11,254 +) +$ +(1,122 +) +Other comprehensive income (loss) +Foreign currency translation adjustment +152 +(362 +) +Net unrealized gain on securities available-for-sale (Disclose warrant in footnote) +5,171 +— +Other comprehensive income (loss) +5,323 +(362 +) +Total Comprehensive loss +$ +(5,931 +) +$ +(1,484 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +U.S. dollars in thousands, except share data +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders’ +Shares +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Total +BALANCES, January 1, 2016 +— +6,775,971 +$ +7 +$ +14,958 +$ +(11,036 +) +$ +(458 +) +$ +— +$ +3,471 +Compensation expense due to stock option issuances +— +— +— +520 +— +— +— +520 +Compensation expense due to warrant issuances +— +— +— +23 +— +— +— +23 +Issuance of common stock and warrants for cash +— +901,666 +1 +540 +— +— +— +541 +Beneficial conversion feature in connection with +convertible notes +— +— +— +329 +— +— +— +329 +Fair value of warrants issued in connection with +convertible notes +— +— +— +159 +— +— +— +159 +Comprehensive loss: +Net loss +— +— +— +— +(1,122 +) +— +— +(1,122 +) +Foreign currency translation adjustments +— +— +— +— +— +(362 +) +— +(362 +) +BALANCES, December 31, 2016 +— +7,677,637 +$ +8 +$ +16,529 +$ +(12,158 +) +$ +(820 +) +$ +— +$ +3,559 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (continued) +U.S. dollars in thousands, except share data +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Equity +BALANCES, December 31, 2016 +— +7,677,637 +$ +8 +$ +16,529 +$ +(12,158 +) +$ +(820 +) +$ +— +$ +3,559 +Compensation expense due to stock option issuances +— +— +— +485 +— +— +— +485 +Compensation expense due to warrant issuances +— +— +— +93 +— +— +— +93 +Issuance of common stock and warrants for cash +— +2,729,645 +3 +1,959 +— +— +— +1,962 +Issuance of common stock for services +— +2,161,345 +2 +1,661 +— +— +— +1,663 +Issuance of common stock for conversion of debt +— +6,759,798 +7 +4,029 +— +— +— +4,036 +Issuance of common stock upon exercise of stock +options +— +361,458 +— +557 +— +— +— +557 +Issuance of common stock upon exercise of warrants +— +3,546,108 +3 +2,242 +— +— +— +2,245 +Issuance of Series B preferred stock for cash and +warrants +50,000 +— +— +500 +— +— +— +500 +Issuance of Series B preferred stock for conversion of +debt +50,000 +— +— +500 +— +— +— +500 +Issuance of Series C preferred stock for cash and +warrants +433,335 +— +— +898 +— +— +— +898 +Issuance of Series C preferred stock for conversion of +debt +21,667 +— +— +52 +— +— +— +52 +Issuance of common stock for conversion of Series C +preferred stock +(455,002 +) +1,820,008 +2 +(2 +) +— +— +— +— +Issuance of Series D preferred stock and common stock +in acquisition of Microphase +378,776 +1,842,448 +2 +1,449 +— +— +945 +2,396 +Issuance of Series E preferred stock and common stock +in acquisition of Microphase +10,000 +— +— +— +— +— +— +— +Issuance of common stock for conversion of Series E +preferred stock +(10,000 +) +600,000 +1 +470 +— +— +— +471 +Issuance of common stock in connection with +convertible notes +— +450,000 +— +399 +— +— +— +399 +Issuance of common stock for domain name +— +50,000 +— +31 +— +— +— +31 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (continued) +U.S. dollars in thousands, except share data +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Equity +Issuance of common stock and warrants in +satisfaction of subsidiary debt +— +1,523,852 +1 +939 +— +— +— +940 +Issuance of common stock for acquisition of debt due +from related party +— +600,000 +1 +599 +— +— +— +600 +Beneficial conversion feature in connection with +convertible notes +— +— +— +787 +— +— +— +787 +Fair value of warrants issued in connection with +convertible notes +— +— +— +2,134 +— +— +— +2,134 +Fair value of personal guarantees in connection with +debt financings +— +— +— +75 +— +— +— +75 +Issuance of common stock for conversion of debt +owed by subsidiary to former stakeholder +— +— +— +— +— +— +115 +115 +Issuance of common stock and cash for exchange fees +and other financing costs +— +100,000 +— +(82 +) +— +— +— +(82 +) +Comprehensive loss: +Net loss +— +— +— +— +(10,616 +) +— +— +(10,616 +) +Preferred dividends +— +— +— +— +(54 +) +— +— +(54 +) +Preferred deemed dividends +— +— +— +584 +(584 +) +— +— +— +Net unrealized gain on securities available-for-sale, +net of income taxes +— +— +— +— +— +5,171 +— +5,171 +Foreign currency translation adjustments +— +— +— +— +— +152 +— +152 +Net loss attributable to non-controlling interest +— +— +— +— +— +— +(279 +) +(279 +) +BALANCES, December 31, 2017 +478,776 +30,222,299 +$ +30 +$ +36,888 +$ +(23,412 +) +$ +4,503 +$ +781 +$ +18,790 +The accompanying notes are an integral part of these consolidated financial statements. +F-8 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +U.S. dollars in thousands +For the Year Ended December 31, +2017 +2016 +Cash flows from operating activities: +Net loss +$ +(10,895 +) +$ +(1,122 +) +Adjustments to reconcile net loss to net cash used in operating activities: +Depreciation +194 +161 +Amortization +61 +— +Interest expense – debt discount +4,688 +34 +Accretion of original issue discount on notes receivable – related party +(454 +) +(2 +) +Interest income on conversion of promissory notes to common stock +13 +— +Deferred taxes +(226 +) +— +Provision for bad debts +(32 +) +32 +Reserve for inventory +— +68 +Stock-based compensation +1,831 +543 +Changes in operating assets and liabilities: +Accounts receivable +285 +(311 +) +Accounts receivable, related party +(174 +) +77 +Inventories +100 +209 +Prepaid expenses and other current assets +(764 +) +(119 +) +Other investments, related party +(335 +) +— +Other assets +(70 +) +(11 +) +Accounts payable and accrued expenses +1,517 +322 +Accounts payable, related parties +70 +— +Other current liabilities +74 +(239 +) +Net cash used in operating activities +(4,117 +) +(358 +) +Cash flows from investing activities: +Purchase of property and equipment +(403 +) +(85 +) +Proceeds from sale of property and equipment +17 +— +Purchase of intangible asset +(50 +) +— +Purchase of Power-Plus +(378 +) +— +Cash received on acquisiton of Microphase +111 +— +Sale of investment – related party +— +90 +Investments – related party +(3,201 +) +(1,034 +) +Investment in real property – related party +(300 +) +— +Investments in marketable securities +(1,486 +) +— +Sales of marketable securities +64 +— +Loans to related parties +(44 +) +— +Proceeds from loans to related parties +35 +— +Investments in debt and equity securities +(3,039 +) +— +Net cash used in investing activities +(8,674 +) +(1,029 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-9 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) +U.S. dollars in thousands, except shares and per share data +For the Year Ended December 31, +2017 +2016 +Cash flows from financing activities: +Gross proceeds from sales of common stock and warrants +$ +2,035 +$ +541 +Proceeds from issuance of preferred stock +1,540 +— +Financing cost in connection with sales of equity securities +(297 +) +— +Proceeds from stock option exercises +557 +— +Proceeds from warrant exercises +2,245 +— +Proceeds from convertible notes payable +2,918 +— +Payments on convertible notes payable +(157 +) +— +Proceeds from convertible notes payable, net – related party +— +488 +Proceeds from notes payable – related party +350 +250 +Proceeds from notes payable +857 +— +Proceeds from short-term advances – related party +245 +— +Proceeds from short-term advances +2,439 +— +Payments on notes payable +(190 +) +— +Proceeds from advances on future receipts +2,889 +— +Payments on advances on future receipts +(1,526 +) +— +Payments of preferred dividends +(35 +) +— +Financing cost in connection with sales of debt securities +(122 +) +— +Payments on revolving credit facilities, net +(524 +) +— +Net cash provided by financing activities +13,224 +1,279 +Effect of exchange rate changes on cash and cash equivalents +49 +(137 +) +Net increase (decrease) in cash and cash equivalents +482 +(245 +) +Cash and cash equivalents at beginning of period +996 +1,241 +Cash and cash equivalents at end of period +$ +1,478 +$ +996 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ +271 +$ +— +Non-cash investing and financing activities: +Cancellation of notes payable – related party into shares of common stock +$ +370 +$ +— +Cancellation of notes payable into shares of common stock +$ +2,204 +$ +— +Cancellation of note payable – related party into series B convertible preferred stock +$ +500 +$ +— +Cancellation of convertible note payable into shares of common stock +$ +2,497 +$ +— +Cancellation of convertible note payable – related party into shares of common stock +$ +530 +$ +— +Issuance of common stock for domain name +$ +31 +$ +— +Issuance of common stock for prepaid services +$ +410 +$ +— +In connection with the Company's acquisition of Microphase Corporation, equity instruments were issued and liabilities assumed during 2017 as follows: +Fair value of assets acquired +$ +8,275 +Equity instruments issued +(1,451 +) +Non-controlling interest +(945 +) +Liabilities assumed +$ +5,879 +The accompanying notes are an integral part of these consolidated financial statements. +F-10 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +1. DESCRIPTION OF BUSINESS +DPW Holdings, Inc. ( “DPW” or the “Company” ), formerly known as Digital Power Corporation, was incorporated in September 2017 under the General Corporation Law of the State of Delaware. Upon the change in domicile from California to Delaware (the “Reincorporation”), which was consummated on December 29, 2017, DPW began to operate as a holding company with operations at the subsidiary level. On April 25, 2017, DPW formed Coolisys Technologies, Inc. ( “Coolisys ”) to operate its existing businesses in the customized and flexible power system solutions for the medical, military, telecom and industrial markets, other than the European markets which are primarily served by DP Limited. Digital Power Limited ( “DP Limited” ), a wholly owned subsidiary, located in the United Kingdom, is currently engaged in the design, manufacture and sale of switching power supplies and converters. On November 30, 2016, DPW formed Digital Power Lending, LLC ( “DP Lending” ). Both DP Lending and Coolisys are wholly-owned subsidiaries. DP Lending is engaged in providing commercial loans to companies throughout the United States to provide them with operating capital to finance the growth of their businesses. The loans will range in duration from six months to 3 years. On June 2, 2017, Digital Power purchased 56.4% of the outstanding equity interests of Microphase Corporation, a Delaware corporation (the “Microphase” ). Microphase is a design-to-manufacture original equipment manufacturer ( “OEM” ) delivering radio frequency ( “RF” ) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers ( “DLVA” ) to the military, aerospace and telecommunications industries. Microphase is headquartered in Shelton, Connecticut. Further, on September 1, 2017, Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability company ( “Power-Plus” ). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related components. The Company’s results of operations include the results of Microphase and Power-Plus from their respective acquisition dates forward. Digital Power, DP Limited, Microphase, Coolisys, Power-Plus and DP Lending (collectively, the “Company” ) has two reportable geographic segments - North America (sales through Microphase, Coolisys, Power-Plus and DP Lending) and Europe (sales through DP Limited). +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +The accompanying consolidated financial statements have been prepared on the basis that the Company will continue as a going concern. As of December 31, 2017, the Company had cash and cash equivalents of $1,478, an accumulated deficit of $23,412 and a negative working capital of $2,235. The Company has incurred recurring losses and reported losses for the years ended December 31, 2017 and 2016, totaled $10,616 and $1,122, respectively. In the past, the Company has financed its operations principally through issuances of convertible debt, promissory notes and equity securities. During 2017, the Company continued to successfully obtain additional equity and debt financing and in restructuring existing debt. +The Company expects to continue to incur losses for the foreseeable future and needs to raise additional capital to continue its business development initiatives and to support its working capital requirements. In March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX Ltd. ( “MTIX” ) to manufacture, install and service the Multiplex Laser Surface Enhancement ( “MLSE” ) plasma-laser system. Management believes that the MLSE purchase order will be a source of revenue and generate significant cash flows for the Company. Management believes that the Company has access to capital resources through potential public or private issuance of debt or equity securities. However, if the Company is unable to raise additional capital, it may be required to curtail operations and take additional measures to reduce costs, including reducing its workforce, eliminating outside consultants and reducing legal fees to conserve its cash in amounts sufficient to sustain operations and meet its obligations. These matters raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might become necessary should the Company be unable to continue as a going concern. +F-11 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America ( “U.S. GAAP” ). +Principles of Consolidation +The consolidated financial statements include the accounts of DPW, its wholly-owned subsidiaries, DP Limited, Coolisys, Power-Plus and DP Lending and its majority-owned subsidiary, Microphase. All significant intercompany accounts and transactions have been eliminated in consolidation. +Accounting Estimates +The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates, judgments and assumptions. The Company's management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. Key estimates include acquisition accounting, fair value of certain financial instruments, reserve for trade receivables and inventories, carrying amounts of investments, accruals of certain liabilities including product warranties, and deferred income taxes and related valuation allowance. +Foreign Currency Translation +A substantial portion of the Company’s revenues are generated in U.S. dollars ( “U.S. dollar” ). In addition, a substantial portion of the Company’s costs are incurred in U.S. dollars. Company management has determined that the U.S. dollar is the functional currency of the primary economic environment in which it operates. +Accordingly, monetary accounts maintained in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with Financial Accounting Standards Board ( “FASB” ) issued Accounting Standards Codification ( “ASC” ) No. 830, Foreign Currency Matters ( “ASC No. 830” ). All transaction gains and losses from the re-measurement of monetary balance sheet items are reflected in the statements of operations as financial income or expenses as appropriate. +The financial statements of DPL, whose functional currency has been determined to be its local currency, British Pound ( “GBP” ), have been translated into U.S. dollars in accordance with ASC No. 830. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate in effect for the reporting period. The resulting translation adjustments are reported as other comprehensive income (loss) in the consolidated statement of comprehensive income (loss) and accumulated comprehensive income (loss) in statement of changes in stockholders' equity (deficit). +Cash and Cash Equivalents +The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. These balances may, at times, exceed the U.S. Federal Deposit Insurance Corporation insurance limits. The Company has cash and cash equivalents of $292 and $736 at December 31, 2017 and 2016, respectively, in the United Kingdom ( “U.K” ). The Company has not experienced any losses on deposits of cash and cash equivalents. +F-12 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Marketable Securities +The Company classifies its investments in equity securities, in accordance with ASC No. 320, Investment in Debt and Equity Securities ( “ASC No. 320” ) and ASC No. 325, Investment – Other ( “ASC No. 325” ). Marketable securities are designated either as trading or available-for-sale securities and are accounted for at fair value. Marketable securities are classified as short-term or long-term based on the nature of the securities and their availability to meet current operating requirements. Marketable securities that are readily available for use in current operations and are classified as short-term available-for-sale securities are reported as a component of current assets in the accompanying consolidated balance sheets. Marketable securities that are not trading securities and are not considered available for use in current operations are classified as long-term available-for-sale securities and are reported as a component of long-term assets in the accompanying consolidated balance sheets. +Securities that are classified as trading are carried at fair value, with changes in fair value reported as a component of income. Securities that are classified as available-for-sale are carried at fair value, with temporary unrealized gains and losses reported as a component of stockholders' equity until their disposition. The cost of securities sold is based on the specific identification method. +All of the Company’s marketable securities are subject to a periodic impairment review. The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. When evaluating the Company’s debt and equity investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of the investment’s amortized cost basis. Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC No. 325-20. For the year ended December 31, 2017, no other-than-temporary impairment charges were recorded. +Accounts Receivable and Allowance for Doubtful Accounts +The Company’s receivables are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount of the Company’s receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. The Company individually reviews all accounts receivable balances and based upon an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. The Company estimates the allowance for doubtful accounts based on historical collection trends, age of outstanding receivables and existing economic conditions. If events or changes in circumstances indicate that a specific receivable balance may be impaired, further consideration is given to the collectability of those balances and the allowance is adjusted accordingly. A customer’s receivable balance is considered past-due based on its contractual terms. Past-due receivable balances are written-off when the Company’s internal collection efforts have been unsuccessful in collecting the amount due. Based on an assessment as of December 31, 2017 and 2016, of the collectability of invoices, accounts receivable are presented net of an allowance for doubtful accounts of $5 and $32, respectively. +Inventories +Inventories are stated at the lower of cost or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological obsolescence. +F-13 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Cost of inventories is determined as follows: +Raw materials, parts and supplies - using the “first-in, first-out” method. +Work-in-progress and finished products - on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically assesses its inventories valuation in respect of obsolete and slow-moving items by reviewing revenue forecasts and technological obsolescence. When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at the time of the review was not expected to be sold, is written off. +During the years ended December 31, 2017 and 2016, the Company recorded inventory write-offs of nil and $84, respectively, within the cost of revenue. +Property and Equipment, Net +Property and equipment as well as an intangible asset are stated at cost, net of accumulated depreciation and amortization. Repairs and maintenance costs are expensed as incurred. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets, at the following annual rates: +Useful lives (in years) +Computer, software and related equipment +3 - 5 +Office furniture and equipment +5 - 10 +Leasehold improvements +Over the term of the lease or the life +of the asset, whichever is shorter. +Goodwill +The Company evaluates its goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other . Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. +The Company tests the recorded amount of goodwill for impairment on an annual basis on December 31 of each fiscal year or more frequently if there are indicators that the carrying amount of the goodwill exceeds its carried value. At December 31, 2017, the Company had two reporting units. The Company performed a qualitative assessment and concluded that no impairment existed as of December 31, 2017. +Intangible Assets +The Company acquired amortizable intangibles assets as part of two asset purchase agreements consisting of trademarks and non-compete agreements. The Company also has the trade name and trademark associated with the acquisition of Microphase that was determined to have an indefinite life. The Company’s intangible assets, net also include definite lived intangible assets, which are being amortized on a straight-line basis over their estimated useful lives as follows: +Useful lives (in years) +Customer list +5 - 14 +Non-competition agreements +3 +Domain name +3 +F-14 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The Company reviews intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets might not be recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant underperformance of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset are less than its carrying amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its fair value, determined based on discounted cash flows. No impairments were recorded on intangible assets as no impairment indicators were noted for the periods presented in these consolidated financial statements. +Long-Lived Assets +The long-lived assets of the Company are reviewed for impairment in accordance with ASC No. 360, Property, Plant, and Equipment , whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. As of December 31, 2017 and 2016, no impairment charges were necessary. +Revenue Recognition +The Company generates revenues from the sale of its products through a direct and indirect sales force. Revenues from products are recognized in accordance with ASC No. 605, Revenue Recognition , when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the seller's price to the buyer is fixed or determinable, no further obligation exists and collectability is reasonably assured. Generally, the Company does not grant a right of return. However, a limited number of distributors are allowed, in the six months after the initial stock purchase, to rotate stock that has not been sold for other products. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire. Service revenues are deferred and recognized on a straight-line basis over the term of the service agreement. Both revenues related to stock rotation rights and service revenues are immaterial in proportion to the Company's revenues. +Warranty +The Company offers a warranty period for all its manufactured products. Warranty periods range from one to two years depending on the product. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company's warranty liability include the number of units sold, historical rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. As of December 31, 2017 and 2016, the Company’s accrued warranty liability was $86. +Income Taxes +The Company determines its income taxes under the asset and liability method in accordance with FASB ASC No. 740, Income Taxes , which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the fiscal years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Statements of Income and Comprehensive Income in the period that includes the enactment date. +F-15 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The Company accounts for uncertain tax positions in accordance with ASC No. 740-10-25 . ASC No. 740-10-25 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2017 and 2016, there are no uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in the financial statements. The Company has not yet filed its 2016 tax returns. +Common Stock Purchase Warrants and Other Derivative Financial Instruments +The Company classifies common stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, which principally consist of issuance of warrants to purchase shares of common in connection with convertible notes, units and to employees of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features or variable settlement provision that cause them to not be indexed to the Company’s own stock. +Stock-Based Compensation +The Company accounts for stock-based compensation in accordance with ASC No. 718, Compensation – Stock Compensation ( “ASC No. 718” ). Under ASC No. 718, compensation expense related to stock-based payments is recorded over the requisite service period based on the grant date fair value of the awards. Compensation previously recorded for unvested stock options that are forfeited is reversed upon forfeiture. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock. +The Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of ASC No. 505-50, Equity Based Payments to Non-Employees . Accordingly, the measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement. +F-16 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Convertible Instruments +The Company accounts for hybrid contracts that feature conversion options in accordance with ASC No. 815, Derivatives and Hedging Activities ( “ASC No. 815” ). ASC No. 815 requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument. +Conversion options that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, in accordance with ASC No. 470-20, Debt with Conversion and Other Options ( “ASC No. 470-20” ). Under ASC No. 470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded conversion options should be bifurcated from their host instruments) in accordance with ASC No. 815. +Concentration of Credit Risk +Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. +Cash and cash equivalents are invested in banks in the U.S. and in the UK. Such deposits in the United States may be in excess of insured limits and are not insured in other jurisdictions. +Trade receivables of the Company and its subsidiaries are mainly derived from sales to customers located primarily in the U.S. and in Europe. The Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is determined with respect to those amounts that the Company and its subsidiaries have determined to be doubtful of collection. +Comprehensive Income (Loss) +The Company reports comprehensive loss in accordance with ASC No. 220, Comprehensive Income . This statement establishes standards for the reporting and presentation of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined that its items of other comprehensive loss relate to changes in foreign currency translation adjustments, unrealized gains on its marketable securities and unrealized gains in its warrants and common stock in AVLP, a related party. +F-17 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Fair value of Financial Instruments +In accordance with ASC No. 820, Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +The guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +Level 1: Quoted market prices in active markets for identical assets or liabilities. +Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-derived valuations. All significant inputs used in our valuations are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities . Level 2 inputs also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed models such as a discounted cash flow models. +Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts of financial instruments carried at cost, including cash and cash equivalents, accounts receivables and accounts receivable – related party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the short-term maturities of such instruments. +As of December 31, 2017 and 2016, the fair value of the Company’s investments were $9,563 and $84, respectively, and were concentrated in equity securities of AVLP, a related party (See Note 9), which are classified as available-for-sale investments. At December 31, 2017, the Company's investment in AVLP included marketable equity securities of $826 and warrants to purchase 8,248,440 shares of AVLP common stock at an exercise price of $0.50 per share of common stock. At December 31, 2016, the Company's investment in AVLP included marketable equity securities of $84. For investments in marketable equity securities, the Company took into consideration general market conditions, the duration and extent to which the fair value is above cost, and the Company’s ability and intent to hold the investment for a sufficient period of time to allow for recovery of value in the foreseeable future. As a result of this analysis, the Company has determined that its investment in AVLP marketable equity securities are valued based upon the closing market price of common stock at December 31, 2017, which resulted in an unrealized gain of $550. +At December 31, 2017, the Company held shares of common stock in six companies that it purchased at the market for a total cost of $1,702. In accordance with ASC No. 320-10, these investments are accounted for based upon the closing market prices of common stock for these five companies at December 31, 2017 resulting in an unrealized gain of $133. +F-18 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy: +Fair Value Measurement at December 31, 2017 +Total +Level 1 +Level 2 +Level 3 +Investments in common stock and warrants of +AVLP – a related party +$ +7,728 +$ +826 +$ +— +$ +6,902 +Investments in marketable securities +$ +1,835 +$ +1,835 +$ +— +$ +— +Total Investments +$ +9,563 +$ +2,661 +$ +— +$ +6,902 +Fair Value Measurement at December 31, 2016 +Total +Level 1 +Level 2 +Level 3 +Investments in common stock and warrants of +AVLP – a related party +$ +84 +$ +84 +$ +— +$ +— +We assess the inputs used to measure fair value using a three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market: +· +Level 1 – inputs include quoted prices for identical instruments and are the most observable. +· +Level 2 – inputs include quoted prices for similar assets and observable inputs such as interest rates, currency exchange rates and yield curves. +· +Level 3 – inputs are not observable in the market and include management’s judgments about the assumptions market participants would use in pricing the asset or liability. +Debt Discounts +The Company accounts for debt discount according to ASC No. 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through periodic charges to interest expense over the term of the related financial instrument using the effective interest method. During the years ended December 31, 2017 and 2016, the Company recorded amortization of debt discounts of $4,688 and $34, respectively. +Net Loss per Share +Net loss per share is computed by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation of the basic and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock equivalents is anti-dilutive due to the Company’s net loss position for all periods presented. The Company has included 317,460 warrants, with an exercise price of $.01, in its earnings per share calculation for the year ended December 31, 2017 and 2016. Anti-dilutive securities, which are convertible into the Company’s Class A common stock, consisted of the following at December 31, +2017 +2016 +Stock options +3,842,500 +2,256,000 +Warrants (1) +4,071,408 +1,431,666 +Convertible notes +1,283,940 +963,636 +Conversion of preferred stock +2,186,123 +— +Total +11,383,971 +4,651,302 +(1) +The Company has excluded the 317,460 warrants with an exercise price of $0.01 per share in its anti-dilutive securities. +F-19 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Reclassifications +Certain prior year amounts have been reclassified for comparative purposes to conform to the current-year financial statement presentation. These reclassifications had no effect on previously reported results of operations. In addition, certain prior year amounts from the restated amounts have been reclassified for consistency with the current period presentation. +Recently Issued Accounting Standards +In May 2014, the Financial Accounting Standards Board ( “FASB” ) issued accounting guidance on the recognition of revenue from contracts with customers, which will supersede nearly all existing revenue recognition guidance under generally accepted accounting principles ( “GAAP” ). Under the new revenue standards, entities will recognize revenue to depict the transfer of goods and services to customers in amounts that reflect the payment to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows from an entity’s contracts with customers. The Company has completed its analysis of the new revenue standards and has concluded that the measurement of revenue and the timing of recognizing revenue is not expected to change. The Company has adopted the new revenue standards on January 1, 2018 using the modified retrospective approach. Based on our analysis, we did not identify a cumulative-effect adjustment to retained earnings at January 1, 2018. Our future financial statements, beginning with the three months ended March 31, 2018, will include additional disclosures as required by the new revenue standards. +In January 2016, the FASB issued ASU No. 2016-01, "Recognition and Measurement of Financial Assets and Liabilities" ( “ASU 2016-01” ). ASU 2016-01 requires equity investments (excluding equity method investments and investments that are consolidated) to be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have a readily determinable fair value may be measured at cost, adjusted for impairment and observable price changes. ASU 2016-01 also simplifies the impairment assessment of equity investments, eliminates the disclosure of the assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at cost on the balance sheet and requires the exit price to be used when measuring fair value of financial instruments for disclosure purposes. Under ASU 2016-01, changes in fair value (resulting from instrument-specific credit risk) will be presented separately in other comprehensive income for liabilities measured using the fair value option and financial assets and liabilities will be presented separately by measurement category and type either on the balance sheet or in the financial statement disclosures. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company has not yet determined the effect that ASU 2016-01 will have on its consolidated financial position, results of operations, or financial statement disclosures. +In February 2016, the FASB issued ASU No. 2016-02, Leases ( “ASU 2016-02” ), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 will be effective beginning in the first quarter of 2019. Early adoption of ASU 2016-02 is permitted. The new standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. The Company is currently evaluating the impact of adopting ASU 2016-02 on its consolidated financial statements. +In March 2016, the FASB issued ASU No. 2016-09, which revises the guidance in ASC 718, Compensation - Stock Compensation , and will change how companies account for certain aspects of share-based payments to employees, including the income tax impact, classification on the statement of cash flows and forfeitures. The guidance is effective for reporting periods (interim and annual) beginning after December 15, 2017, for public companies. The Company adopted this guidance as of and for the three months ended March 31, 2017 and its adoption did not have any significant impact on the Company’s consolidated financial statements and related disclosures. +F-20 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments ( “ASU No. 2016-13” ). ASU 2016-13 requires that expected credit losses relating to financial assets measured on an amortized cost basis and available-for-sale debt securities be recorded through an allowance for credit losses. ASU No. 2016-13 limits the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and also requires the reversal of previously recognized credit losses if fair value increases. The new standard will be effective for the Company on January 1, 2020. Early adoption will be available on January 1, 2019. The Company is currently evaluating the effect that the updated standard will have on its Consolidated Financial Statements and related disclosures. +In August 2016, the FASB issued ASU No. 2016-15, which revises the guidance in ASC 230, Statement of Cash Flows . The new guidance is intended to reduce the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows and is effective for reporting periods (interim and annual) beginning after December 15, 2017, for public companies. The Company adopted this guidance and its adoption did not have any significant impact on the Company’s consolidated financial statements and related disclosures. +In December 2016, the FASB issued ASU No. 2016-19, Technical Corrections and Improvements , which includes numerous technical corrections and clarifications to GAAP that are designed to remove inconsistencies in the board’s accounting guidance. Several provisions in this accounting guidance are effective immediately which did not have an impact on the Company’s consolidated financial statements. Additional provisions in this accounting guidance are effective for the Company in annual financial reporting periods beginning after December 15, 2016. The Company adopted this guidance and its adoption did not have any significant impact on the Company’s consolidated financial statements and related disclosures. +In January 2017, the FASB issued an ASU No. 2017-01, Business Combinations (Topic 805) Clarifying the Definition of a Business . The amendments in this update is to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company adopted this guidance and its adoption did not have any significant impact on the Company’s consolidated financial statements and related disclosures. +In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350) : Simplifying the Accounting for Goodwill Impairment ( “ASU 2017-04” ). ASU 2017-04 removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This standard, which will be effective for the Company beginning in the first quarter of fiscal year 2020, is required to be applied prospectively. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact this standard will have on its financial statements. +In July 2017, the FASB issued ASU No. 2017-11, Earnings per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815) ( “ASU 2017-11” ). ASU 2017-11 consists of two parts. The amendments in Part I of this update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share (“EPS”) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), including related EPS guidance (in Topic 260). The amendments in Part II of this update re-characterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. For public business entities, the amendments in Part I of this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments in Part I of this update are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments in Part II of this update do not require any transition guidance because those amendments do not have an accounting effect. The Company elected early adoption of this guidance and its adoption did not have any significant impact on the Company’s consolidated financial statements and related disclosures. +F-21 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +4. Marketable Securities +Marketable securities in equity securities with readily determinable market prices consisted of the following as of December 31, 2017: +Available-for-sale securities +Gross unrealized +Gross realized +Cost +gains (losses) +gains (losses) +Fair value +Common shares +$ +1,702 +$ +133 +$ +— +$ +1,835 +Available-for-sale Securities +During 2017, the Company invested in the marketable securities of five publicly traded companies. At December 31, 2017, the Company recorded an unrealized gain of $133, representing the difference between the $1,439 cost basis and the estimated fair value, as accumulated other comprehensive income in the stockholder's equity section of the Company’s consolidated balance sheet and as a change in unrealized gains and losses on marketable securities in the Company’s consolidated statements of comprehensive income (loss). The Company’s investment in marketable securities shall be revalued on each balance sheet date. The fair value of the Company’s holdings in marketable securities at December 31, 2017 is a Level 1 measurement. +5. INVENTORIES +At December 31, 2017 and 2016, inventories consist of: +2017 +2016 +Raw materials, parts and supplies +542 +271 +Work-in-progress +685 +238 +Finished products +766 +613 +Total inventories +1,993 +1,122 +F-22 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +6. PROPERTY AND EQUIPMENT, NET +At December 31, 2017 and 2016, property and equipment consist of: +2017 +2016 +Computer, software and related equipment +2,432 +1,652 +Office furniture and equipment +289 +240 +Leasehold improvements +788 +699 +3,509 +2,591 +Accumulated depreciation and amortization +(2,292 +) +(2,021 +) +Property and equipment, net +1,217 +570 +For the years ended December 31, 2017 and 2016, depreciation expense amounted to $194 and $161, respectively. +7. INTANGIBLE ASSETS, NET +At December 31, 2017 intangible assets consist of: +Intangible Assets +Balance as of December 31, 2016 +$ +— +Trade name and trademark +1,740 +Customer list +988 +Non-competition agreements +150 +Domain name +81 +Accumulated amortization +(61 +) +Balance as of December 31 2017 +$ +2,898 +Amortization expense was $61 and nil for the years ended December 31, 2017 and 2016, respectively. +The customer list and non-competition agreements are subject to amortization over their estimated useful lives, which range between 3 and 14 years. The following table presents estimated amortization expense for each of the succeeding five calendar years and thereafter. +2018 +$ +133 +2019 +133 +2020 +117 +2021 +83 +2022 +77 +Thereafter +534 +$ +1,077 +8. GOODWILL +The Company’s goodwill relates to the acquisition of a majority interest in Microphase and the acquisition of all of the outstanding membership interests in Power Plus (See Note 12). +F-23 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +9. INVESTMENTS – RELATED PARTIES +Investments in AVLP at December 31, 2017 and 2016, are comprised of the following: +2017 +2016 +Investment in convertible promissory note of AVLP +$ +4,124 +$ +997 +Investment in warrants of AVLP +6,902 +— +Investment in common stock of AVLP +826 +84 +Accrued interest in convertible promissory note of AVLP +324 +9 +Total investment in AVLP – Gross +12,176 +1,090 +Less: original issue discount +(2,115 +) +(45 +) +Total investment in AVLP – Net +$ +10,061 +$ +1,045 +Investment in warrants and common stock of AVLP +$ +7,728 +$ +84 +Investment in convertible promissory note of AVLP +2,333 +961 +Total investment in AVLP – Net +$ +10,061 +$ +1,045 +During the year ended December 31, 2016, the Company made a strategic decision to invest in AVLP, a related party controlled by Philou, an existing majority stockholder. The Company’s investments in AVLP primarily consist of convertible promissory notes and shares of common stock of AVLP. +On October 5, 2016, November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with AVLP (the “AVLP Notes” ) in the principal amount of $525 each. The AVLP Notes included a 5% original issue discount, resulting in net loans to AVLP of $1,500 and an original issue discount of $75. The AVLP notes accrued interest at 12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of AVLP at approximately $0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 shares of the Company’s common stock . During the period from March 29, 2017 to August 16, 2017, the Company funded $1,809 in excess of the $1,500 net loan amount required pursuant to the terms of the AVLP Notes. +On September 6, 2017, the Company and AVLP entered into a Loan and Security Agreement ( “AVLP Loan Agreement” ) with an effective date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to $5,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019, subject to the terms and conditions stated in the Loan Agreement, including that the Company having available funds to grant such credit. +In consideration of entering into the AVLP Loan Agreement, the Company and AVLP cancelled the AVLP Notes and consolidated the AVLP Notes and prior advances totaling $3,309 plus original issue discount of $165 and issued a new Convertible Promissory Note in the aggregate principal amount of $3,474 (the “New Note” ) that is convertible into shares of AVLP at a conversion price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior interest accrued under the AVLP Notes and advances will continue to be an obligation of AVLP. The New Note contains standard events of defaults. In addition, concurrent to issuing the New Note, AVLP issued to the Company a five-year warrant to purchase 6,948,800 shares of AVLP Common Stock at $0.50 per share. Further, the Company made additional advances under the AVLP Loan Agreement in the aggregate amount of $650. As a result, at December 31, 2017, the Company has provided loans to AVLP in the principal amount $4,124 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants to purchase 8,248,440 shares of AVLP common stock. Future advances under the AVLP Loan Agreement, if any, will be evidenced by a convertible promissory containing a conversion price feature at $0.50 per share and warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. +F-24 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The warrants entitle the Company to purchase up to 8,248,440 shares of AVLP common stock at an exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrant may be exercised for cash or on a cashless basis. The Company recorded an unrealized gain on its investment in warrants of AVLP of $4,513, representing the difference between the cost basis of $2,389 and the estimated fair value of the warrants net of tax as of December 31, 2017, in the Company’s accumulated other comprehensive income in the stockholder's equity section of the Company’s consolidated balance sheet and as a change in net unrealized gains on securities available-for-sale in the Company’s consolidated statements of comprehensive loss. The Company’s investment in Avalanche will be revalued on each balance sheet date. The fair value of the Company’s holdings in the Avalanche warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.89% was derived from the U.S. Treasury yield curve, matching the term of our investment, in effect at the measurement date. The volatility factor of 82.4% was determined based on historical stock prices for similar technology companies with market capitalizations under $100 million. The warrant valuation is a Level 3 measurement. +In accordance with ASC No. 310, Receivables ( “ASC 310” ). The Company accounts for its convertible promissory notes in AVLP at amortized cost, which represents the amount at which the convertible promissory notes were acquired, adjusted for accrued interest and accretion of original issue discount and discount attributed to the fair value of the 8,248,440 warrants that the Company received in conjunction with its investment. Interest is accreted using the effective interest method. The Company records interest on an accrual basis and recognizes it as earned in accordance with the contractual terms of the convertible promissory notes, to the extent that such amounts are expected to be collected. The original issue discount of $165 on the New Note and the discount attributed to the fair value of the warrants of $2,389 is being amortized as interest income through the maturity date. During the years ended December 31, 2017 and 2016, the Company recorded $454 and $2, respectively, of interest income for the discount accretion. As of December 31, 2017 and 2016, the Company recorded contractual interest receivable attributed to the AVLP Notes and AVLP Loan Agreement of $324 and $11, respectively. +The Company evaluated the collectability of both interest and principal for the convertible promissory notes in AVLP to determine whether there was an impairment. Based on current information and events, the Company determined that it is probable that it will be able to collect amounts due according to the existing contractual terms. Impairment assessments require significant judgments and are based on significant assumptions related to the borrower’s credit risk, financial performance, expected sales, and estimated fair value of the collateral. +During the years ended December 31, 2017 and 2016, the Company also acquired in the open market 221,333 shares of AVLP common stock for $192 and 250,900 shares of AVLP common stock for $85, respectively. At December 31, 2017, the closing market price of AVLP’s common stock was $1.75. The Company has determined that its investment in AVLP marketable equity securities are accounted for pursuant to the fair value method and based upon the closing market price of common stock at December 31, 2017, the Company has recognized an unrealized gain of $550. +10. INVESTMENTS IN PREFERRED STOCK OF PRIVATE COMPANY AND OTHER INVESTMENTS +We hold a portfolio of investments in equity and debt securities in other entities that are accounted for under the cost method. +F-25 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Investment in Preferred Stock of Private Company +On December 15, 2017, the Company and Sandstone Diagnostics, Inc. ( “Sandstone ”) entered into a Series A1 Preferred Stock Purchase Agreement ( “Loan Agreement” ) pursuant to which the Company purchased 976,286 shares of Sandstone’s Series A1 Preferred Shares for $1,000. Sandstone is a medical device company focused on a data-driven approach to men’s reproductive health. Founded in 2012 in part by government scientists from Sandia National Laboratories, Sandstone’s mission is to provide innovative, data-driven tools to help men assess, manage, and improve their reproductive health. The funding from the Series A1 Preferred Stock financing will support sales growth and continued product development leveraging the company’s unique technology platform, Sandstone’s Trak™ Male Fertility Testing System. +The Company elected to follow the guidance of ASC No. 321, Equity Securities ( “ASC 321” ) , which provides a measurement alternative to the requirement to carry equity interests at fair value in accordance with ASC 820, Fair value measurement, for certain equity interests without readily determinable fair values. Equity interests measured in accordance with the measurement alternative in ASC 321 are not required to be included within the fair value hierarchy. The Company’s equity investment in Sandstone is recorded at cost. However, any change to the carrying amount will be subsequently adjusted up or down for observable price changes (i.e., prices in orderly transactions for the identical investment or similar investment of the same issuer) and any adjustments to the carrying amount shall be recorded in net income. +Other Investments +On November 1, 2017, the Company and I. AM, Inc. ( “I. AM ”) entered into a Loan and Security Agreement pursuant to which the Company provided I.AM a non-revolving credit facility of up to $1,300 for a period ending on September 25, 2022. As of December 31, 2017, the Company had provided loans of $1,234 to I. AM which accrue interest at a rate of 6.0% on the outstanding daily balance. The Loan Agreement is secured by the assets of I.AM’s membership interests in three restaurant LLCs. During 2017, the Company provided additional loans of $403. These additional loans and the Company’s investment in I. AM are carried at amortized cost. +11. OTHER INVESTMENTS, RELATED PARTIES +The Company’s other related party investments primarily consist of two investments. +MTIX, Ltd. +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson two convertible promissory notes in the principal amount of $600 ( “Note A” ) and $1,668 ( “Note B” ), in exchange for cancellation of amounts due to WT Johnson by MTIX Ltd., a related party of the Company. +During December 2017, the Company issued 600,000 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently sold the 600,000 shares. The proceeds from the sale of Note A were sufficient to satisfy the entire $2,268 obligation as well as an additional $400 of value added tax due to WT Johnson. Concurrent with entering into the exchange agreement, the Company received a promissory note in the amount of $2,668 from MTIX and cancelled Note B. At December 31, 2017, the Company has valued the note receivable at $600, the carrying amount of Note A. The Company will recognize the remainder of the amount due from MTIX upon payment of the promissory note by MTIX . +Israeli Property +During the year ended December 31, 2017, our President, Amos Kohn, purchased certain real property that will serve as a facility for the Company’s business operations in Israel. The Company made $300 of payments to the seller of the property and received a 28% undivided interest in the real property (“Property’). The Company’s subsidiary, Coolisys, entered into a Trust Agreement and Tenancy In Common Agreement with Roni Kohn, who owns a 72% interest in the Property, is the daughter of Mr. Kohn and is an Israeli citizen. The Property was purchased to serve as a residence/office facility for the Company in order to oversee its European operations and to expand its business in the hi-tech industry located in Israel. Pursuant to the Trust Agreement, the Ms. Kohn will hold and manage Coolisys’ undivided 28% interest in the Property. The trust will be in effect until it is terminated by mutual agreement of the parties. During the term of the trust, the Ms. Kohn will not sell, lease, sublease, transfer, grant, encumber, change or effect any other disposition with respect to the Property or the Coolisys’ interest without the Company’s approval. +F-26 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Under the Tenancy In Common Agreement, Coolisys and its executive officers shall have the exclusive rights to use the Property for the Company and its affiliates’ business operations. The Property shall be managed by the Ms. Kohn. Further, pursuant to the Tenancy In Common Agreement, for each completed calendar month of employment of Mr. Kohn by the Company, Ms. Kohn shall have the right to purchase a portion of the Company’s interest in the Property. Such right shall fully vest at the end of five years of continuous employment and the Trustee shall have the right to purchase the Company’s 28% interest in the Property for a nominal value. The Company will amortize its $300,000 investment over ten years, subject to a cliff vesting after five years. During the year ended December 31, 2017, the Company recognized $8 in amortization expense. In the event that Mr. Kohn is not employed by the Company, the Company shall have the right to demand that Ms. Kohn purchase the Company’s remaining interest in the Property that was not subject to vesting for the fair value market value of such unvested Property interest. +Other investments and interest receivable +During the year ended December 31, 2017, DP Lending made loans to Alzamend Neuro, Inc. ( “Alzamend” ), in the amount of $44. AVLP is a party to a management services agreement pursuant to which Avalanche provides management, consulting and financial services to Alzamend. At December 31, 2017, the outstanding principal under these loans was $13. As additional consideration, the Company received a warrant to purchase 22,000 shares of Alzamend’s common stock at an exercise price of $0.30 per share of common stock. Finally, the Company has accrued interest of $11 from its lending activities. +12. ACQUISITIONS +Microphase Corporation +On April 28, 2017, the Company entered into a share exchange agreement with Microphase; Microphase Holding Company LLC, a limited liability company organized under the laws of Connecticut ( “MHC” ), Ergul Family Limited Partnership, a partnership organized under the laws of Connecticut (“ EFLP ”) RCKJ Trust, a trust organized under the laws of New Jersey ( “RCKJ” and with MHC and EFLP, the “Significant Stockholders” ) and those additional persons who have executed the share exchange agreement (collectively, the “Minority Stockholders” and with the Significant Stockholders, the “Stockholders” ). Upon the terms and subject to the conditions set forth in the share exchange greement, the Company acquired 1,603,434 shares (the “Subject Shares” ) of the issued and outstanding common stock of Microphase (the “MPC Common Stock” ), from the Stockholders in exchange for the issuance by the Company of 1,842,448 shares of DPW common stock ( “Common Stock” ) and 378,776 shares of DPW Series D Preferred Stock (collectively, the “Exchange Shares” ), which shares of DPW Series D Preferred Stock are convertible into an aggregate of 757,552 shares of Common Stock and warrants to purchase an aggregate of 1,000,000 shares of Common Stock. At the time of the closing of the acquisition the Exchange Shares constituted 56.4% of the outstanding equity interests of Microphase Corporation . The operating results of Microphase from the closing date of the acquisition, June 2, 2017, through December 31, 2017, are included in the consolidated financial statements. +At closing, the purchase price of Digital Power’s 56.4% interest in Microphase was determined to be $1,451, comprised of the Exchange Shares, valued at $1,222 based on the closing price of the Company’s common stock on June 2, 2017 of $0.47 per share, and the warrants, valued at $229. The Company computed the fair value of these warrants using the Black-Scholes option pricing model. The risk-free rate of 1.4% was derived from the U.S. Treasury yield curve, matching the warrant’s term, in effect at the measurement date. The volatility factor of 105.9% was determined based on the Company’s historical stock prices. +F-27 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Power-Plus Technical Distributors +On August 3, 2017, Coolisys entered into a Securities Purchase Agreement (the “Purchase Agreement” ) to acquire all the outstanding membership Interests of Power-Plus. Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related components. On September 1, 2017, Coolisys completed the acquisition. +Under the terms of the Agreement, Coolisys Technologies acquired all the membership Interests of Power-Plus for a price of $850, which was reduced by certain debts of Power-Plus in the amount of $186. The purchase price of $664 was paid by (i) a two-year promissory note in the amount of $255 payable in 24 monthly installments; and (ii) cash at closing of $409 resulting in a net purchase price of $664. +The acquisition of Microphase and Power-Plus is being accounted for under the purchase method of accounting in accordance with ASC No. 805, Business Combinations . Under the purchase method, assets acquired and liabilities assumed are recorded at their estimated fair values. Goodwill is recorded to the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired less liabilities assumed at the date of acquisition. +The components of the purchase price are as follows: +Microphase +Power-Plus +Cash and cash equivalents +$ +11 +$ +31 +Accounts receivable +439 +235 +Inventories +667 +241 +Prepaid expenses and other current assets +139 +2 +Restricted cash +100 +— +Intangible assets +2,628 +250 +Property and equipment +406 +23 +Other investments +303 +— +Deposits and loans +44 +— +Accounts payable and accrued expenses +(1,576 +) +(389 +) +Deferred tax liability +(226 +) +— +Revolving credit facility +(880 +) +(210 +) +Notes payable +(2,204 +) +— +Notes payable, related parties +(406 +) +— +Convertible notes payable +— +— +Other current liabilities +(220 +) +— +Net liabilities, assets assumed +(775 +) +183 +Goodwill +3,171 +481 +Non-controlling interest +(945 +) +— +Purchase price +$ +1,451 +$ +664 +The following pro forma data summarizes the results of operations for the periods indicated as if the Microphase and Power-Plus acquisitions had been completed as of the beginning of each period presented. The pro forma data gives effect to actual operating results prior to the acquisition. These pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition occurred as of the beginning of each period presented or that may be obtained in future periods: +F-28 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +2017 +2016 +Total Revenue +$ +13,878 +$ +16,409 +Net loss +$ +(12,347 +) +$ +(4,183 +) +Less: Net loss attributable to non-controlling interest +773 +1,365 +Net loss attributable to Digital Power Corp +$ +(11,574 +) +$ +(2,818 +) +Preferred deemed dividends +(584 +) +— +Preferred dividends +(54 +) +— +Loss available to common shareholders +$ +(12,212 +) +$ +(2,818 +) +Basic and diluted net loss per common share +$ +(0.83 +) +$ +(0.32 +) +Basic and diluted weighted average common shares outstanding +14,631,578 +8,759,016 +Comprehensive Loss +Loss available to common shareholders +$ +(12,212 +) +$ +(2,818 +) +Other comprehensive income (loss) +Change in net foreign currency translation adjustments +152 +(362 +) +Net unrealized gain on securities available-for-sale, net of income taxes +5,171 +364 +Other comprehensive income +5,323 +2 +Total Comprehensive loss +$ +(6,889 +) +$ +(2,816 +) +13. STOCK-BASED COMPENSATION +Under the Company's 2017 Stock Incentive Plan (the “2017” Plan), 2016 Stock Incentive Plan (the “2016 Plan” ) and the 2012 Stock Option Plan, as amended (the “2012 Plan” ) (collectively, the “Plans” ), options may be granted to employees, officers, consultants, service providers and directors of the Company. The Plans, as amended, provide for the issuance of a maximum of 7,372,630 shares of the Company’s common stock. The Company also has 206,000 outstanding options that were granted between 2009 and 2011 pursuant to the terms of the Company's 2002 Stock Option Plan (the “2002 Plan” ). Options granted pursuant to the 2002 Plan expire between September 2008 and February 2021. +Options granted under the Plans have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and become exercisable based on a vesting schedule determined at the date of grant. Typically, options granted generally become fully vested after four years. Any options that are forfeited or cancelled before expiration become available for future grants. The options expire between 5 and 10 years from the date of grant. Restricted stock awards granted under the Plans are subject to a vesting period determined at the date of grant. As of December 31, 2017, an aggregate of 2,538,832 of the Company's options are still available for future grant. +During the years ended December 31, 2017 and 2016, the Company granted 810,000 and 1,800,000 options, respectively, from the Plans to its employees at an average exercise price of $0.84 and $0.67, respectively, per share. These options become fully vested after four years. The Company estimated that the grant date fair value of options granted utilizing the Black-Scholes option pricing model during the years ended December 31, 2017 and 2016 was $482 and $820, respectively, which is being recognized as stock-based compensation expense over the requisite four-year service period. During the years ended December 31, 2017 and 2016, the Company also issued 1,948,798 and nil, respectively, shares of common stock to its consultants and service providers pursuant to the 2016 Plan. The Company estimated that the grant date fair value of these shares of common stock was $1,532, which was determined from the closing price of the Company’s common stock on the date of issuance. +The Company has valued the options at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables such as the options’ term, exercise price, current stock price, risk-free interest rate estimated over the expected term and estimated volatility of our stock over the expected term of the options. The risk-free interest rate used in the calculations is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the options as calculated using the simplified method. The estimated volatility was determined based on the historical volatility of our common stock. +F-29 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +During the years ended December 31, 2017 and 2016, the Company estimated the fair value of stock options granted using the Black-Scholes option pricing model with the following weighted average assumptions: +2017 +2016 +Weighted average risk free interest rate +1.73% — 2.14 +% +1.26% — 1.77 +% +Weighted average life (in years) +5.0 +5.0 +Volatility +98.4% — 115.8 +% +97.7% — 98.2 +% +Expected dividend yield +0 +% +0 +% +Weighted average grant-date fair value per share of +options granted +$ +0.60 +$ +0.46 +The options outstanding as of December 31, 2017, have been classified by exercise price, as follows: +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$0.57 - $0.79 +2,350,000 +8.89 +$0.66 +1,568,332 +$0.67 +$1.10 - $1.38 +270,000 +9.67 +$1.38 +35,833 +$1.35 +$1.51 - $1.69 +122,500 +5.06 +$1.63 +92,500 +$1.62 +$0.57 - 1.69 +2,742,500 +8.80 +$0.77 +1,696,665 +$0.73 +The total stock-based compensation expense related to stock options and stock awards issued pursuant to the Plans to the Company’s employees, consultants and directors, included in reported net loss for the years ended December 31, 2017 and 2016, is comprised as follows: +2017 +2016 +Cost of revenues +$ +8 +$ +6 +Engineering and product development +21 +17 +Selling and marketing +46 +5 +General and administrative +1,503 +492 +Stock-based compensation from Plans +$ +1,578 +$ +520 +Stock-based compensation from issuances outside of Plans +253 +— +Total Stock-based compensation +$ +1,831 +$ +520 +The combination of stock-based compensation of $1,578 from the issuances of equity-based awards pursuant to the Plans and stock-based compensation attributed to stock awards of $130 and warrants and options of $123, which were issued outside of the Plans, resulted in aggregate stock-based compensation of $1,831 during the year ended December 31, 2017. During the year ended December 31, 2017, the Company issued 1,100,000 options to purchase shares of common stock at $1.38 per share to its directors and officers. These shares were issued outside of the Plans and are subject to shareholder approval. During the year ended December 31, 2016, the only stock-based compensation expense was from issuances pursuant to the Plans. +F-30 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +A summary of option activity under the Company's stock option plans as of December 31, 2017 and 2016, and changes during the years ended are as follows: +Outstanding Options +Weighted +Weighted +Average +Shares +Average +Remaining +Aggregate +Available +Number +Exercise +Contractual +Intrinsic +for Grant +of Shares +Price +Life (years) +Value +January 1, 2016 +337,630 +1,256,000 +$1.52 +6.74 +$0 +Adoption of 2016 SIP +4,000,000 +— +Granted +(1,800,000) +1,800,000 +0.67 +Forfeited +650,000 +(650,000) +1.59 +Expired +40,000 +(40,000) +1.16 +December 31, 2016 +3,227,630 +2,366,000 +$0.83 +9.08 +$0 +Adoption of 2017 SIP +2,000,000 +— +Stock awards +(1,948,798) +— +Granted +(810,000) +810,000 +$0.84 +Forfeited +70,000 +(70,000) +$0.63 +Exercised +— +(363,500) +$1.56 +December 31, 2017 +2,538,832 +2,742,500 +$0.77 +8.80 +$6,688 +The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December 31, 2017, $3.21 and the exercise price, multiplied by the number of in-the-money-options). +As of December 31, 2017, there was $606 of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Company's stock option plans. That cost is expected to be recognized over a weighted average period of 2.8 years. +14. WARRANTS +During the years ended December 31, 2017 and 2016, the Company issued a total of 10,379,981 warrants at an average exercise price of $0.81 per share. +Warrant issuances during 2016 +During the year ended December 31, 2016, the Company issued a total of 1,749,126 warrants at an average exercise price of $0.67 per share. +(i) +On October 31, 2016, the Company issued a three-year warrant to purchase 265,000 shares of common stock at a per share exercise price of $0.80 and a three-year warrant to purchase 265,000 shares of common stock at a per share exercise price of $0.90 in connection with a 12% Convertible Secured Note in the principal amount of $530 that was sold to an existing stockholder of the Company for $500 . (See Note 21). +(ii) +In connection with an executive employment agreement, on November 3, 2016, the Company issued to its Chief Executive Officer a ten-year warrant to purchase 317,460 shares of the Company's common stock, at an exercise price of $0.01 per share. The Warrant is subject to vesting of which warrants to purchase 39,682 shares shall vest beginning on January 1, 2017, and on the first date of each quarter thereafter through July 1, 2018, with warrants to purchase 39,686 shares to vest on October 1, 2018. +F-31 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +(iii) +On November 15, 2016 , the Company issued three-year warrants to purchase 901,666 shares of common stock each at a per share exercise price of $0.80 in connection with subscription agreements entered into with nine accredited investors. Pursuant to the terms of the subscription agreements, the Company sold 901,666 units at $0.60 for an aggregate purchase price of approximately $541. Each unit consists of one share of common stock and one warrant to purchase one share of common stock (See Note 23). +Warrant issuances during 2017 +During the year ended December 31, 2017, the Company issued a total of 8,630,855 warrants at an average exercise price of $0.83 per share. +(i) +In February 2017, the Company issued five-year warrants to purchase 333,333 shares of common stock at a per share exercise price of $0.70 in connection with $400 of 6% demand promissory notes entered into by the Company (See Note 18i). +(ii) +Between March 24, 2017 and June 2, 2017, the Company issued warrants to purchase 1,428,572 shares of common stock, at an exercise price of $0.70 per share of common stock, in connection with preferred stock purchase agreements to purchase 100,000 shares of Series B Preferred Stock by Philou (See Note 23). +(iii) +On April 5, 2017, the Company issued warrants to purchase 180,002 shares of common stock, at an exercise price of $0.90 per share of common stock, in connection with the cancellation of $270 in demand promissory notes (See Note 18j). +(iv) +On April 17, 2017, the Company issued warrants to purchase 166,668 shares of common stock , at an exercise price of $0.90 per share of common stock, in connection with the issuance of two 7% convertible notes in the aggregate principal amount of $250. On July 25, 2017, the Company agreed to reduce the exercise price of warrants to purchase 83,334 shares of common stock from $0.90 per share to $0.55 per share and on July 28, 2017, the Company issued a new warrant to purchase 83,334 shares of common stock at $0.55 per share and cancelled the prior warrant to purchase 83,334 shares of common stock at $0.90 per share (See Note 20e). +(v) +On April 26, 2017, the Company issued warrants to purchase 160,000 shares of common stock , at an exercise price of $0.80 per share of common stock, in connection with the issuance of a 7% convertible note in the aggregate principal amount of $104 (See Note 20f). +(vi) +Between May 5, 2017 and June 30, 2017, the Company issued warrants to purchase 224,371 shares of common stock in connection with the issuance of short-term loans of $140 that the Company entered into with four accredited investors (See Note 18h) of which $75 was from the Company’s corporate counsel, a related party. The exercise price was $0.75 per share of common stock for 135,909 warrants and $0.80 per share of common stock for the remaining 88,462 warrants. +(vii) +Between May 24, 2017 and June 19, 2017, the Company issued warrants to purchase 1,820,002 shares of common stock issued in connection with the sale of twenty-one units (the “Units” ) at a purchase price of $52 per Unit raising in the aggregate $1,092. Each Unit consisted of 21,667 shares of Series C Preferred Stock and Warrants to purchase 86,667 shares of common stock, at an exercise price of $1.00 per share of common stock (See Note 23). +(viii) +The Company engaged Divine Capital Markets, LLC ( “Divine” ) to act as Placement Agent (the “Placement Agent” ) for the private placement of the Series C Preferred Stock and Warrants. For its services, the Placement Agent received, in addition to a 10.0% commission on the sale of each Unit and a 3.0% non-refundable expense allowance, warrants to purchase 10% of the Units sold at 120% of the Unit purchase price. The warrants to purchase 2.1 Units equates to a warrant to purchase 182,003 shares of the Company’s common stock at $0.72 per share and a second warrant to purchase 182,003 shares of the Company’s common stock at $1.00 per share (See Note 23). +F-32 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +(ix) +On June 2, 2017, the Company issued warrants to purchase 1,000,000 shares of common stock, at an exercise price of $1.10 per share of common stock, pursuant to the terms of a share exchange agreement (See Note 12). +(x) +On July 25, 2017, the Company issued warrants to purchase an aggregate of 163,636 shares of common stock at an exercise price equal to $0.55 per share of common stock in connection with a private placement agreement under which we issued and sold 272,727 shares of common stock to the investor at $0.55 per share for an aggregate purchase price of $150. (See Note 23). +(xi) +On July 28, 2017, the Company entered into an exchange agreement related to a 7% Convertible Note in the principal amount of $125 in which the Company exchanged the 7% Convertible Note for three new promissory notes in the principal amounts of $110 due August 1, 2017; $35 due August 1, 2017; and $34 due August 8, 2017 (individually an Exchange Note and collectively the Exchange Notes). Concurrent with entering into the exchange agreement, the investor entered into a subscription agreement under which we issued and sold in a registered direct offering 200,000 shares of common stock at $0.55 per share for an aggregate purchase price of $110. The 200,000 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $110. Further, the Company issued a warrant to purchase 120,000 shares of common stock at $0.55 per share (See Note 20e) . +(xii) +On August 3, 2017, the Company issued warrants to purchase an aggregate of 666,666 shares of common stock at an exercise price equal to $0.70 per share of common stock in connection with the issuance of a 12% Convertible Promissory Note in the aggregate principal amount of $400 (See Note 20b). +(xiii) +On August 10, 2017, the Company issued warrants to purchase an aggregate of 1,475,000 shares of the common stock at an exercise price equal to $0.66 per share of common stock in connection with the issuance of 10% Convertible Promissory Notes in the aggregate principal amount of $880 (See Note 20d). +(xiv) +On November 2, 2017, the Company paid to Aegis Capital Corp. ( “Aegis” ), its financial advisor, a cash fee of $81 and issued to Aegis a warrant to purchase 148,133 shares of common stock with an exercise price of $0.66 per share of common stock in connection with the issuance of 10% Convertible Promissory Notes in the aggregate principal amount of $1,111 (See Note 20c). +(xv) +On December 5, 2017, the Company entered into an exchange agreement (the “Exchange Agreement” ) with several accredited investors, pursuant to which the Company issued an aggregate of 1,523,852 shares of common stock and warrants to purchase 380,466 shares of common stock with an exercise price of $1.10 per share of common stock, in exchange for cancellation of $690 of outstanding debt owed to the investors by Microphase Corporation (See Note 18f). +F-33 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The following table summarizes information about common stock warrants outstanding at December 31, 2017: +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$0.01 +317,460 +8.84 +$0.01 +158,728 +$0.01 +$0.55 +283,636 +0.48 +$0.55 +— +— +$0.66 +148,133 +4.84 +$0.66 +— +— +$0.70 +1,768,572 +4.78 +$0.70 +1,768,572 +$0.70 +$0.72 +182,003 +4.47 +$0.72 +182,003 +$0.72 +$0.75 +135,909 +4.37 +$0.75 +135,909 +$0.75 +$0.80 +481,666 +2.69 +$0.80 +481,666 +$0.80 +$1.00 +312,003 +4.46 +$1.00 +312,003 +$1.00 +$1.10 +759,486 +3.68 +$1.10 +379,020 +$1.10 +$0.01 - 1.10 +4,388,868 +4.61 +$0.74 +3,417,901 +$0.76 +The Company has valued the warrants at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables such as the warrants’ term, exercise price, current stock price, risk-free interest rate and estimated volatility of our stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +The Company utilized the Black-Scholes option pricing model and the assumptions used during the years ended December 31, 2017 and 2016 : +2017 +2016 +Weighted average risk-free interest rate +1.42% — 2.01% +0.98% — 1.28% +Weighted average life (in years) +4.8 +4.3 +Volatility +98.5% — 128.7% +97.7% — 110.0% +Expected dividend yield +0% +0% +Weighted average grant-date fair value per +share of warrants granted +$ 0.54 +$ 0.49 +15. OTHER CURRENT LIABILITIES +Other current liabilities at December 31, 2017 and 2016 consist of: +2017 +2016 +Accrued payroll and payroll taxes +$ +359 +$ +128 +Warranty liability +86 +86 +Other accrued expenses +263 +184 +$ +708 +$ +398 +16. ADVANCES ON FUTURE RECEIPTS +Between July 6, 2017 and November 1, 2017, the Company received funding as a result of entering into multiple Agreements for the Purchase and Sale of Future Receipts with TVT Capital, LLC pursuant to which the Company sold in the aggregate $4,068 in future receipts of the Company for $2,889. Under the terms of the agreements, the Company will be obligated to pay the initial daily amount of $19 until the $4,068 has been paid in full. As of December 31, 2017, the Company had repaid $1,526. The term future receipts means cash, check, ACH, credit card, debit card, bank card, charged card or other form of monetary payment. The Company recorded a discount in the amount of $1,179 which is reflected as a reduction on the outstanding liability. The discount is being amortized as non-cash interest expense over the term of the agreement. During the years ended December 31, 2017, non-cash interest expense of $600 was recorded from the amortization of debt discounts. +F-34 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +17. REVOLVING CREDIT FACILITY +Microphase entered into a revolving loan agreement with Gerber Finance, Inc. ( “Gerber” ) in February of 2012, as amended in September 2015 and July 2017 (the “Revolving Credit Facility” ). Under the Revolving Credit Facility, Microphase received funds based on a borrowing base, which consisted of a percentage of eligible accounts receivable, up to a maximum revolving amount of $1,400 (the “Maximum Revolving Amount” ). Pursuant to the terms of the Revolving Credit Facility, Microphase was subject to an annual facility fee in an amount equal to 1.75% of the Maximum Revolving Amount due on each anniversary, a monthly collateral monitoring fees of $1 and other fees. Interest accrued at the prime rate plus three and three-quarters percent (3.75%) on the unpaid principal . Effective June 15, 2017, the prime rate was increased from 4.00% to 4.25% resulting in a base rate of 8.00%. In December 2017, the Company paid off the Revolving Credit Facility in cash. The interest expense for the period from June 3, 2017 (date loan was assumed) to December 31, 2017 was $84. +On November 6, 2017, Microphase entered into a factoring agreement with CSNK Working Capital Finance Corp. (the “Factoring Agreement” ). Under the Factoring Agreement, Microphase received funds based on a borrowing base, which consisted solely of eligible accounts receivable. +18. NOTES PAYABLE +Notes Payable at December 31, 2017, are comprised of the following. At December 31, 2016 the Company did not have any Notes Payable. +2017 +Notes payable to Wells Fargo (a) +$ +300 +Note payable to Department of Economic and Community Development (b) +292 +Power-Plus Credit Facilities (c) +171 +Note payable to Power-Plus Member (d) +130 +Note payable to People's United Bank (e) +19 +10% short-term promissory notes (f) +15 +Total notes payable +927 +Less: current portion +(402 +) +Notes payable – long-term portion +$ +525 +(a) +At December 31, 2017, Microphase had guaranteed the repayment of two equity lines of credit in the aggregate amount of $300 with Wells Fargo Bank, NA ( “Wells Fargo” ) (collectively, the “Wells Fargo Notes” ). These loans originated prior to the Company’s acquisition of Microphase and Microphase was the recipient of the actual proceeds from the loans. Microphase had previously guaranteed the payment under the first Wells Fargo equity line during 2008, the proceeds of which Microphase had received from a concurrent loan from Edson Realty Inc., a related party owned real estate holding company. As of December 31, 2017, the first line of credit, which is secured by residential real estate owned by a former officer, had an outstanding balance of $212, with an annual interest rate of 4.00%. Microphase had guaranteed the payment under the second Wells Fargo equity line in 2014. Microphase had received working capital loans from the former CEO from funds that were drawn against the second Wells Fargo equity line. As of December 31, 2017, the second line of credit, secured by the former CEO’s principal residence, had an outstanding balance of $88, with an annual interest rate of 3.00%. During the period June 3, 2017 to December 31, 2017, Microphase incurred $8 of interest on the Wells Fargo Notes. +F-35 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +(b) +In August 2016, Microphase received a $300 loan, of which $8 has been repaid, pursuant to the State of Connecticut Small Business Express Job Creation Incentive Program which is administered through the Department of Economic and Community Development ( “DECD” ) (the “DECD Note” ). The DECD Note bears interest at a rate of 3% per annum and is due in August 2026. Payment of principal and interest was deferred during the initial year and commencing in September 2017, payable in equal monthly installments over the remaining term. During the period June 3, 2017 to December 31, 2017, Microphase incurred $5 of interest on the DECD Note. In conjunction with the DECD Note, Microphase was awarded and received a Small Business Express Matching Grant of $100 by the State of Connecticut. State grant funding requires Microphase to spend an equal amount of cash on eligible expense. The Company has utilized $18 of the grant and the balance of $82 is reported within deferred revenue and classified in accounts payable and accrued in the accompanying consolidated balance sheet at December 31, 2017. +(c) +At December 31, 2017, Power-Plus had guaranteed the repayment of two lines of credit in the aggregate amount of $169 with Bank of America NA ( “B of A” ) and Wells Fargo (collectively, the “Power-Plus Lines” ). As of December 31, 2017, the B of A line of credit had an outstanding balance of $97, with an annual interest rate of 6.25%. As of December 31, 2017, the Wells Fargo line of credit had an outstanding balance of $74, with an annual interest rate of 10.00%. During the period September 2 to December 31, 2017, Power-Plus incurred $4 of interest on the Power-Plus Lines. +(d) +Pursuant to the terms of the Purchase Agreement with Power-Plus, the Company entered into a two-year promissory note in the amount of $255 payable to the former owner as part of the purchase consideration. The $255 note is payable in 24 equal monthly installments. On October 18, 2017, for cancellation of debt, the Company entered into a subscription agreement with the former owner under which the Company sold 138,806 shares of common stock at $0.67 per share for an aggregate purchase price of $93 (See Note 23). +(e) +In December 2016, Microphase utilized a $20 overdraft credit line at People’s United Bank with an annual interest rate of 15%. As of December 31, 2017, the balance of that overdraft credit line was $19. +(f) +In December 2016, Microphase issued $705 in 10% short-term promissory notes to nineteen accredited investors which, after deducting $71 of placement fees to its selling agent, Spartan Capital Securities, LLC ( “Spartan” ), resulted in $634 in net proceeds to Microphase (the “10% Short-Term Notes” ). The 10% Short-Term Notes were due one year from the date of issuance. The amount due pursuant to the 10% Short-Term Notes is equal to the entire original principal amount multiplied by 125% (the “Loan Premium” ) plus accrued interest. During the period June 3, 2017 to December 31, 2017, Microphase incurred $44 of interest on these 10% short-term promissory notes. On December 5, 2017, in exchange for the cancellation of $690 of outstanding principal and $250 of accrued interest owed to the investors by Microphase Corporation, the Company entered into an Exchange Agreement pursuant to which the Company issued an aggregate of 1,523,852 shares of common stock and warrants to purchase 380,466 shares of common stock with an exercise price of $1.10 per share of common stock, (See Note 23). +(g) +On June 2, 2017, pursuant to the terms of the Share Exchange Agreement and in consideration of legal services, Microphase issued a $450 8% promissory note with a maturity date of November 25, 2017 to Lucosky Brookman, LLP (the “Lucosky Note” ). In conjunction with the issuance of the Lucosky Note, the Company issued Lucosky Brookman 10,000 shares of redeemable convertible Series E preferred stock (the “Series E Preferred Stock” ) with a stated value of $45 per share as an alternative to providing a guarantee for the amount of the Lucosky Note. The Company, at its option, had the right to redeem for cash the outstanding shares of Series E Preferred Stock, upon written notice to the holder of the shares, at a cash redemption price equal to $45 multiplied by the number of shares being redeemed. Any such optional redemption by the Company would have resulted in a credit against the Lucosky Note. During the period June 3, 2017 to December 29, 2017, Microphase incurred $21 of interest on the Lucosky Note. On December 29, 2017, the Lucosky Note was satisfied through the conversion of the 10,000 shares of Series E Preferred Stock into 600,000 shares of the Company’s common stock (See Note 23). +F-36 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Other Notes Payable +(h) +Between May 5, 2017 and December 31, 2017, the Company received additional short-term loans of $297 from five accredited investors, of which $75 was from the Company’s corporate counsel, a related party. As additional consideration, the investors received five-year warrants to purchase 224,371 shares of common stock at a weighted average exercise price of $0.77 per share. The warrants are exercisable commencing six months after the issuance date and are subject to certain beneficial ownership limitations. The exercise price of these warrants is subject to adjustment for customary stock splits, stock dividends, combinations and other standard anti-dilution events. The warrants may be exercised for cash or on a cashless basis. During the quarter ended June 30, 2017, the Company recorded debt discount in the amount of $95 based on the estimated fair value of these warrants. The Company computed the fair value of these warrants using the Black-Scholes option pricing model. As a result of the short-term feature of these loans and advances, the debt discount was amortized as non-cash interest expense upon issuance of the warrants using the effective interest method. +During June 2017, the holders of $55 of these short-term loans agreed to cancel their notes for the purchase of 100,001 shares of the Company’s common stock at a price of $0.55 per share. An additional $75 in short-term loans from the Company’s corporate counsel was converted into the Company’s equity securities; $52 was converted into one of the Series C Units and $23 was converted into the Company’s common stock. The Company did not record any additional interest expense as a result of the extinguishment of $130 in short-term loans since the carrying amount of the short-term loans was equivalent to the fair value of the consideration transferred, which was determined from the closing price of the Company’s equity securities on the date of extinguishment . During the year ended December 31, 2017, the Company also repaid $157 in short-term loans. +(i) +In February 2017, the Company issued to eight accredited investors $400 in demand promissory notes bearing interest at a rate of 6% per annum. Of the eight accredited investors, one investor was deemed a related party. As additional consideration, the investors received five-year warrants to purchase 333,333 shares of common stock at an exercise price of $0.70 per share (the “Feb. 2017 Warrants” ). The Feb. 2017 Warrants are exercisable commencing six months after the issuance date and are subject to certain beneficial ownership limitations. The exercise price of the Feb. 2017 Warrants is subject to adjustment for customary stock splits, stock dividends, combinations and other standard anti-dilution events. The Feb. 2017 Warrants may be exercised for cash or on a cashless basis. During the quarter ended March 31, 2017, the Company recorded debt discount in the amount of $151 based on the estimated fair value of the Feb. 2017 Warrants. The Company computed the fair value of these warrants using the Black-Scholes option pricing model. As a result of the due on demand feature of the promissory notes, the debt discount was amortized as non-cash interest expense upon issuance of the Feb. 2017 Warrants using the effective interest method. +Between February 16, 2017 and February 23, 2017, the holders of the $400 in demand promissory notes agreed to cancel their demand promissory notes for the purchase of 666,667 shares of the Company’s common stock, an extinguishment price of $0.60 per share. During the quarter ended March 31, 2017, the Company recorded additional interest expense of $13 as a result of the extinguishment of the $400 in demand promissory notes based on the difference of the carrying amount of the demand promissory notes and the fair value of the consideration transferred, which was determined from the closing price of the Company’s common stock on the date of extinguishment . +(j) +On March 28, 2017, the Company issued $270 in demand promissory notes to several investors. These demand promissory notes accrued interest at the rate of 6% per annum. The Company received gross proceeds of $220 on March 31, 2017. The remaining balance of $50 was received on April 3, 2017. On April 5, 2017, the Company canceled these promissory notes by issuing to the investors 360,000 shares of common stock, at $0.75 per share, and warrants to purchase 180,002 shares of common stock at $0.90 per share. During the quarter ended June 30, 2017, the Company recorded additional interest expense of $109 as a result of the extinguishment of the $270 in demand promissory notes based on the difference of the carrying amount of the demand promissory notes and the fair value of the consideration transferred, which was determined from the closing price of the Company’s common stock on the date of extinguishment . +F-37 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +19. NOTES PAYABLE – RELATED PARTIES +Notes Payable – Related parties at December 31, 2017 and 2016, are comprised of the following: +2017 +2016 +Notes payable to MCKEA Holdings, LLC (a) +$ +— +$ +250 +Notes payable to former officer and employee (b) +309 +— +Total notes payable +309 +250 +Less: current portion +(134 +) +— +Notes payable – long-term portion +$ +175 +$ +250 +(a) +On December 29, 2016, the Company entered into an agreement with MCKEA Holdings, LLC (“MCKEA” ). MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling shareholder. Kristine L. Ault , a director and the wife of Milton C. Ault III, Executive Chairman of the Company’s Board of Directors , is the manager and owner of MCKEA, for a demand promissory note (The “MCKEA Note” ) in the amount of $250 bearing interest at the rate of 6% per annum on unpaid principal. The MCKEA Note may be prepaid, in whole or in part, without penalty, at the option of the Company and without the consent of MCKEA. As of December 31, 2016, no interest was accrued on the MCKEA Note. On March 24, 2017 , the MCKEA Note was cancelled to purchase the Company’s Series B Preferred Stock pursuant to the terms of the Preferred Stock Purchase Agreement entered into on March 9, 2017 (See Note 23). Since there was no difference between the reacquisition price and the net carrying value of the cancelled debt, no gain or loss was recognized as a result of this transaction. +(b) +Microphase is a party to several notes payable agreements with seven of its past officers, employees and their family members. As of December 31, 2017, the aggregate outstanding balance pursuant to these notes payable agreements, inclusive of $47 of accrued interest, was $356, with annual interest rates ranging between 3.00% and 6.00%. During the period June 3, 2017 to September 30, 2017, Microphase incurred $10 of interest on these notes payable agreements. In July 2016, one of these noteholders initiated litigation to collect the balance owed under the terms of his respective agreement and in October 2017, Microphase and the noteholder entered into a settlement agreement whereby Microphase agreed to pay the outstanding principal and interest of $122 and $43, respectively, by issuing to the noteholder 95,834 shares of Microphase common stock valued at $115 and paying $25 in cash. The value of the Microphase common stock was derived from the Company’s recent acquisition of a majority interest in Microphase. Further, the parties agreed the final $25 would be paid within 18 months of the settlement agreement or Microphase would be required to pay the noteholder an additional $25. +20. CONVERTIBLE NOTES +At December 31, 2016 the Company did not have any Convertible Notes whereas at December 31, 2017, Convertible notes are comprised of the following: +2017 +5% Convertible Note (a) +$ +550 +12% Convertible Note (b) +202 +Total convertible notes payable +752 +Less: +Unamortized debt discounts +(351 +) +Unamortized financing cost +(3 +) +Total convertible notes payable, net of financing cost +$ +398 +F-38 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +(a) +On December 4, 2017, the Company entered into a securities purchase agreement to sell a 5% Convertible Note (the “5% Convertible Note” ) and 150,000 shares of restricted common stock to an institutional investor. The principal of the 5% Convertible Note and interest thereon may be converted into shares of common stock at $0.60 per share of common stock, subject to adjustments for lower priced issuances, stock splits, stock dividends, combinations or similar events. The 5% Convertible Note is in the principal amount of $550, included an original issue discount ( “OID” ) of $50 resulting in net proceeds to the Company of $500, bears interest at 5% simple interest on the principal amount, and is due on August 13, 2018. Interest only payments are due on a quarterly basis and the principal is due on June 3, 2018. +At the time of issuance of the 5% Convertible Note, the closing price of the Company’s common stock was in excess of the conversion price, resulting in a BCF. The BCF embedded in the 5% Convertible Note is accounted for under ASC No. 470, De bt. At issuance, the intrinsic value of the BCF totaled $244 based on the difference between the effective conversion price and the fair value of the Company’s common stock at the commitment date of the transaction. The intrinsic value of the BCF exceeded the proceeds allocated to the relative fair value of the 5% Convertible Note. The BCF is being amortized to interest expense over the term of the 5% Convertible Note using the effective interest method. The valuation of the BCF was calculated based on the effective conversion price compared with the market price of the Company’s common stock on the date of issuance of the Convertible Note. +In aggregate, the Company recorded debt discount in the amount of $550 based on the relative fair values of the 150,000 shares of common stock of $256, BCF of $244 and OID of $50. The debt discount is being amortized as non-cash interest expense over the term of the debt. During the year ended December 31, 2017, non-cash interest expense of $381 was recorded from the amortization of debt discounts. In January 2018, the 5% Convertible Note was converted into 921,645 shares of the Company’s common stock based upon the contractual rights included in the 5% Convertible Note. +(b) +On August 3, 2017, the Company entered into a securities purchase agreement to sell a 12% Convertible Note (the “12% Convertible Note” ) and a warrant to purchase 666,666 shares of common stock to an accredited investor. The principal of the 12% Convertible Note may be converted into shares of common stock at $0.55 per share and under the terms of the Warrant, up to 666,666 shares of common stock may be purchased at an exercise price of $0.70 per share. +The 12% Convertible Note is in the principal amount of $400, included an OID of $40 resulting in net proceeds to the Company of $360, bears interest at 12% simple interest on the principal amount, and is due on August 13, 2018. Interest only payments are due on a quarterly basis and the principal is due on August 3, 2018. The principal may be converted into shares of the Company’s common stock at $0.55 per share. +The Company computed the fair value of the 666,666 warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the amount of $167 based on the estimated fair value of the 666,666 warrants. +The beneficial conversion feature ( “BCF” ) embedded in the 12% Convertible Note is accounted for under ASC No. 470, De bt. At issuance, the intrinsic value of the BCF totaled $187. The Company, however, was prohibited from issuing shares of common stock pursuant to the 12% Convertible Note until stockholder approval of such issuance of securities was obtained as required by applicable NYSE American listing rules. The Company received stockholder approval for the share issuances on December 28, 2017. The intrinsic value of the BCF is being amortized to interest expense over the term of the 12% Convertible Note using the effective interest method. The valuation of the BCF was calculated based on the effective conversion price compared with the market price of the Company’s common stock on the date of issuance of the 12% Convertible Note . In aggregate, the Company recorded debt discount in the amount of $394 based on the relative fair values of the 666,666 warrants, BCF and OID of $40. During the year ended December 31, 2017, non-cash interest expense of $212 was recorded from the amortization of debt discounts. +F-39 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +On December 28, 2017, principal and accrued interest of $198 and $5, respectively, on the 12% Convertible Note was satisfied through the issuance of 368,760 shares of the Company’s common stock (See Note 23) and the remaining balance was converted into shares of the Company’s common stock on January 10, 2018 (See Note 27). The fair value of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.79% was derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The volatility factor of 107.3% was determined based on the Company’s historical stock prices. +Convertible Notes Converted into Common Stock during 2017 +(c) +On November 2, 2017, the Company entered into a securities purchase agreement to sell a 5% Convertible Note (the “November 5% Convertible Note” ) and 300,000 shares of restricted common stock to an institutional investor. The principal of the November 5% Convertible Note and interest thereon was convertible into shares of common stock at $0.60 per share of common stock, subject to adjustments for lower priced issuances, stock splits, stock dividends, combinations or similar events. The November 5% Convertible Note was in the principal amount of $1,111 and included an original issue discount ( “OID” ) of $101 and debt issuance costs of $106, resulting in net proceeds to the Company of $904. The November 5% Convertible Note provided for 5% simple interest on the principal amount. +In connection with the November 5% Convertible Note, the Company paid to Aegis Capital Corp. ( “Aegis” ), its financial advisor, a cash fee of $81 and issued to Aegis a warrant to purchase up to 148,133 shares of common stock with an exercise price of $0.66 per share, subject to adjustment for stock splits, stock dividends, combinations or similar events. The warrant is exercisable at any time commencing six months from the date of issuance through five years from the date of issuance and may be exercised for cash or on a “cashless” basis if there is no effective registration statement registering, or no current prospectus available for the resale of, all of the shares of common stock underlying the warrant. +The debt conversion features embedded in the November 5% Convertible Note is accounted for under ASC No. 470, De bt. At the time of issuance, the intrinsic value of the debt conversion features utilizing the Black Scholes option pricing model totaled $424. The intrinsic value of the debt conversion feature combined with the amount of the original issue discount and the relative value of the 300,000 shares of common stock and warrants to purchase 148,133 shares of common stock exceeded the proceeds allocated to the relative fair value of the November 5% Convertible Note and resulted in aggregate debt discount of $723. The respective debt discount of $723 was amortized to interest expense over the term of the November 5% Convertible Note using the effective interest method. In addition, the Company incurred $106 of debt issuance costs which are also being amortized as non-cash interest expense over the term of the debt. +On December 13, 2017 and December 14, 2017, the entire $1,111 of principal on the November 5% Convertible Note was satisfied through the issuance of 1,851,667 shares of the Company’s common stock based upon the contractual rights provided for in the November 5% Convertible Note (See Note 14). +During the year ended December 31, 2017, non-cash interest expense of $829 was recorded from the amortization of debt discounts and debt financing cost. +F-40 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +(d) +On August 10, 2017, the Company, entered into securities purchase agreements with five institutional investors to sell for an aggregate purchase price of $800, 10% Senior Convertible Promissory Notes (the “10% Convertible Notes” ) with an aggregate principal face amount of $880 and warrants to purchase an aggregate of 1,475,000 shares of common stock. The principal of the 10% Convertible Notes and interest earned thereon may be converted into shares of common stock at $0.60 per share and under the terms of the Warrant, up to 1,475,000 shares of common stock may be purchased at an exercise price of $0.66 per share. +The 10% Convertible Notes are in the aggregate principal amount of $880, included an OID of $80 resulting in net proceeds to the Company of $800, bear simple interest at 10% on the principal amount, and principal and interest are due on February 10, 2018. Subject to certain beneficial ownership limitations, each investor may convert the principal amount of the 10% Convertible Notes and accrued interest earned thereon at any time into shares of common stock at $0.60 per share. The conversion price of the 10% Convertible Notes is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. +The Company computed the fair value of the 1,475,000 warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the amount of $357 based on the estimated intrinsic value of the 1,475,000 warrants. The intrinsic value of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.78% was derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The volatility factor of 107.3% was determined based on the Company’s historical stock prices. +The BCF embedded in the 10% Convertible Notes is accounted for under ASC No. 470, De bt. At issuance, the estimated fair value of the BCF totaled $327. The fair value of the BCF was allocated from the net proceeds of the 10% Convertible Notes and was amortized to interest expense over the term of the 10% Convertible Notes using the effective interest method. The valuation of the BCF was calculated based on the effective conversion price compared with the market price of the Company’s common stock on the date of issuance of the 10% Convertible Notes . In aggregate, the Company recorded debt discount in the amount of $764 based on the relative fair values of the 1,475,000 warrants of $357, BCF of $327 and OID of $80. During the years ended December 31, 2017, non-cash interest expense of $764 was recorded from the amortization of debt discounts. +During December 2017, the entire principal and accrued interest of $880 and $54, respectively, on the 10% Convertible Notes was satisfied through the issuance of 1,557,417 shares of the Company’s common stock based upon the contractual rights provided for in the 10% Convertible Note (See Note 14). +Other Convertible Notes Payable +(e) +On April 17, 2017, the Company entered into two 7% convertible notes (the “7% Convertible Notes” ) each in the aggregate principal amount of $125 for a total of $250. The 7% Convertible Notes accrued interest at 7% simple interest on the principal amount and were due on June 2, 2017. The principal was convertible into shares of the Company’s common stock at $0.75 per share. The noteholder could convert the principal amount of the 7% Convertible Notes at any time into common stock. The 7% Convertible Notes contained standard and customary events of default including, but not limited to, failure to make payments when due under the 7% Convertible Note agreements and bankruptcy or insolvency of the Company. The Company had the right to prepay the 7% Convertible Notes. The 7% Convertible Notes were repaid during July 2017. +As additional consideration, the investors received five and a half year warrants to purchase 166,668 shares of common stock at an exercise price of $0.90 per share (collectively the “7% Convertible Note Warrants” ). The 7% Convertible Note Warrants are exercisable commencing six months after the issuance date. The exercise price of the 7% Convertible Note Warrants is subject to adjustment for customary stock splits, stock dividends, combinations and other standard anti-dilution events. The 7% Convertible Note Warrants may be exercised for cash or on a cashless basis. The Company computed the fair value of the 7% Convertible Note Warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the amount of $61 based on the estimated fair value of the 7% Convertible Note Warrants. +F-41 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The BCF embedded in the 7% Convertible Notes is accounted for under ASC No. 470, De bt. At issuance, the estimated fair value of the BCF totaled $31. The fair value of the BCF was allocated from the net proceeds of the 7% Convertible Note and was amortized to interest expense over the term of the 7% Convertible Notes using the effective interest method. The valuation of the BCF was calculated based on the effective conversion price compared with the market price of the Company’s common stock on the date of issuance of the Convertible Note. In aggregate, the Company recorded debt discount in the amount of $93 based on the relative fair values of the 7% Convertible Note Warrants of $61 and BCF of $32. During the three months ended June 30, 2017, the entire non-cash interest expense of $93 was recorded from the amortization of debt discounts. +On July 25, 2017, the Company repaid one of the 7% Convertible Notes. Due to the event of default, the Company agreed to reduce the exercise price of warrants to purchase 83,334 shares of common stock from $0.90 per share to $0.55 per share and made a payment of $144. As a result of this transaction, the Company recorded additional interest expense of $17 and recorded an additional $3 in non-cash interest expense based upon the change in the fair value of the warrants due to the adjustment to the exercise price. +On July 28, 2017, the Company entered into an exchange agreement related to the second 7% Convertible Note. Under the terms of the exchange agreement, the Company exchanged the 7% Convertible Note for three new promissory notes in the principal amounts of $110 due August 1, 2017; $35 due August 1, 2017; and $34 due August 8, 2017 (individually an Exchange Note and collectively the Exchange Notes) and issued a new warrant to purchase 83,334 shares of common stock at $0.55 per share and cancelled the prior warrant to purchase 83,334 shares of common stock at $0.90 per share. The Company recorded a $55 extinguishment charge as a result of this transaction. +Concurrent with entering into the exchange agreement, the investor entered into a subscription agreement under which the Company issued and sold in a registered direct offering 200,000 shares of common stock at $0.55 per share for an aggregate purchase price of $110. The 200,000 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $110. In addition, in a concurrent private placement, the investor entered into a separate securities purchase agreement under which the Company issued and sold 63,600 shares of common stock at $0.55 per share for an aggregate of purchase price of $35. The 63,600 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $35. Further, the Company issued a warrant to purchase 120,000 shares of common stock at $0.55 per share. The final Exchange Note in the principal amount of $34 was repaid. In aggregate, and including the $55 extinguishment charge above, the Company recorded an additional non-cash interest expense of $110 as a result of the extinguishment of the $125 7% Convertible Note based on the difference of the carrying amount of the 7% Convertible Note and the fair value of the consideration transferred, which was determined from the closing price of the Company’s common stock on the date of extinguishment and based upon (i) the change in the fair value of the warrants due to the exchange of the warrant with an exercise price of $0.90 per share with a new warrant with an exercise price of $0.55 per share, (ii) the fair value of the warrant to purchase 120,000 shares of common stock and (iii) the value of the shares of cash and common stock in excess of the amount owed pursuant to the 7% Convertible Note . +(f) +On April 26, 2017, the Company entered into a 7% convertible note in the aggregate principal amount of $104. On June 28, 2017, the noteholder converted the outstanding balance into 189,091 shares of the Company’s common stock . The Company did not record any additional interest expense as a result of the extinguishment since the carrying amount of the convertible notes was equivalent to the fair value of the consideration transferred, which was determined from the closing price of the Company’s equity securities on the date of extinguishment . +As additional consideration, the investor received a five-year warrant to purchase 160,000 shares of common stock at an exercise price of $0.80 per share. The warrants are exercisable commencing six months after the issuance date. The exercise price of the warrants is subject to adjustment for customary stock splits, stock dividends, combinations and other standard anti-dilution events. The warrants may be exercised for cash or on a cashless basis. The Company computed the fair value of these warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the amount of $25 based on the estimated fair value of the warrants. +F-42 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The BCF embedded in this convertible note is accounted for under ASC No. 470, De bt. At issuance, the estimated fair value of the BCF totaled $26. The fair value of the BCF was allocated from the net proceeds of the convertible note and was amortized to interest expense over the term of the c onvertible note using the effective interest method. The valuation of the BCF was calculated based on the effective conversion price compared with the market price of the Company’s common stock on the date of issuance of the convertible note. In aggregate, the Company recorded debt discount in the amount of $51 based on the relative fair values of the warrants of $25 and BCF of $26. During 2017, non-cash interest expense of $51 was recorded from the amortization of debt discounts. The intrinsic value of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.84% was derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The volatility factor of 104.7% was determined based on the Company’s historical stock prices. +21. CONVERTIBLE NOTE – RELATED PARTY +At December 31, 2017 the Company did not have any related party convertible notes. Convertible notes – related party at December 31, 2016 are comprised of the following: +2016 +12% Convertible secured note +$ +530 +Less: +Unamortized debt discounts +(484 +) +Unamortized financing cost +(12 +) +Convertible note – related party +$ +34 +2016 Convertible Note +On October 21, 2016, the Company entered into a 12% convertible secured note (the “Convertible Note” ) in the principal amount of $530. The Convertible Note included an OID of $30 resulting in net proceeds to the Company of $500. Additionally, the Convertible Note accrued interest at 12% simple interest on the principal amount, was secured by all the assets of the Company, and was due on October 20, 2019. Interest only payments were due on a quarterly basis and the principal was convertible into shares of the Company’s common stock at $0.55 per share. The conversion price of the Convertible Note was subject to adjustment for customary stock splits, stock dividends, combinations or other standard anti-dilution events. +As additional consideration, the investor received a three-year warrant to purchase 265,000 shares of common stock, at an exercise price of $0.80 per share, and a three-year warrant to purchase 265,000 shares of common stock, at an exercise price of $0.90 per share (collectively the “Convertible Note Warrants” ). The Convertible Note Warrants are exercisable commencing six months after the issuance date and are subject to certain beneficial ownership limitations. The exercise price of the Convertible Note Warrants is subject to adjustment for customary stock splits, stock dividends, combinations and other standard anti-dilution events. The Convertible Note Warrants may be exercised for cash or on a cashless basis. The Company computed the fair value of the Convertible Note Warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the amount of $159 based on the estimated fair value of the Convertible Note Warrants. +F-43 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The BCF embedded in the Convertible Note is accounted for under ASC No. 470, De bt. At issuance, the estimated fair value of the BCF totaled $329. The intrinsic value of the BCF was allocated from the net proceeds of the Convertible Note and the respective discount and is being amortized to interest expense over the term of the Convertible Note using the effective interest method. The valuation of the BCF was calculated based on the effective conversion price compared with the market price of the Company’s common stock on the date of issuance of the Convertible Note. +In aggregate, the Company recorded debt discount in the amount of $518 based on the relative fair values of the Convertible Note Warrants of $159, BCF of $329 and OID of $30. The debt discount is being amortized as non-cash interest expense over the term of the debt. In addition, the Company incurred $13 of debt issuance costs which are also being amortized as non-cash interest expense over the term of the debt. During the years ended December 31, 2017 and 2016, non-cash interest expense of $496 and $34, respectively, was recorded from the amortization of debt discounts and debt financing cost. +During the period from November 27, 2017 to December 6, 2017, the entire $530 of principal on the Convertible Note was satisfied through the issuance of 963,636 shares of the Company’s common stock based upon the contractual rights provided for in the Convertible Note (See Note 14). As of December 31, 2016, accrued interest on the Convertible Note was $12. +2017 Convertible Note +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson & Sons (Huddersfield) Limited (the “Holder” ), pursuant to which the Company issued to the Holder, (a) a convertible promissory note in the principal amount of $600 ( “Note A” ), and (b) a convertible promissory note in the principal amount of $1,668 ( “Note B” ), in exchange for cancellation of (i) an outstanding loan made by the Holder to MTIX Ltd., a related party of the Company ( “MTIX” ), in the amount of $266; and (ii) cancellation of an aggregate of $2,002 owed by the Company to the Holder pursuant to an Agreement for the Sale and Purchase of a Textile Multi-Laser Enhancement Technology Machine dated as of July 21, 2017 by and between MTIX and the Holder. +Note A is convertible into the Company’s common stock at a conversion price of $1.00 per share, does not bear interest, and matures two years from issuance. Note B is convertible into the Company’s common stock at a conversion price of $0.85 per share, does not bear interest, and matures two years from issuance. However, the Holder shall not have the right to convert any portion of Note B, following receipt by the Holder of an aggregate of $2,268 of gross proceeds from the sale of shares of Common Stock issued upon conversion of Note A or Note B. +During December 2017, the Company issued 600,000 shares of its common stock upon the conversion of Note A and the Holder notified the Company that gross proceeds during the month of December 2017 from sales of the 600,000 shares of common stock were sufficient to satisfy the entire $2,268 obligation. As a result of entering into the exchange agreement with the Holder, MTIX is obligated to pay the Company $2,668, consisting of amount of the exchange agreement of $2,268 and a value added tax of $400 from the sale of the Textile Multi-Laser Enhancement Technology Machine. At December 31, 2017, the Company has valued the note receivable due from MTIX at $600, the carrying amount of Note A. The Company will recognize the remainder of the amount due from MTIX upon payment of the promissory note by MTIX . +22. COMMITMENTS +In November 2012, the Company signed an operating lease agreement for the US headquarters for a period of 7 years with an option to extend for additional 5 years. In September 2009, the Company's United Kingdom subsidiary signed a new agreement for a lease in respect of the UK facility for a period of 15 years with an option to cancel the lease after 10 years on September 2019. In addition, we lease 33,361 square-feet of other space domestically that includes office, engineering, laboratory and warehouse space in both California and Connecticut. The annual base rent under these leases, payable on a monthly basis, is approximately $447,000 during 2018. These leases expire between May 2018 and May 2026. +F-44 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Future non-cancellable rental commitments under operating leases are as follows: +2018 +$ +762 +2019 +682 +2020 +576 +2021 +359 +2022 +348 +Thereafter +1,268 +$ +3,995 +Total rent expense for the years ended December 31, 2017 and 2016 was approximately $291 and $294, respectively. +Employment Agreements +Amos Kohn +On November 30, 2016, the Company entered into an employment agreement with Amos Kohn to serve as President and Chief Executive Officer with an effective date of September 22, 2016. For his services, Mr. Kohn will be paid a salary of $300 per annum increasing to $350 per annum provided that the Company achieves revenues in the aggregate amount of at least $10,000 as determined in accordance with U.S. GAAP for the trailing four calendar quarters. +In addition, Mr. Kohn shall be eligible for an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s compensation committee after conferring with Mr. Kohn. The target amount of Mr. Kohn’s annual performance bonus shall be 25 to 50% of his then annual base salary but may be greater upon mutual agreement between Mr. Kohn and the compensation committee. +Further, Mr. Kohn is entitled to receive equity participation as follows: (A) a warrant to purchase 317,460 shares of the Company’s common stock at $0.01 per share; and (B) a ten-year option to purchase 1,000,000 shares of the Company’s Common Stock at an exercise price of $0.65 per share, which represented the high price for a share of common stock on November 3, 2016, the day the Board approved the grant. The option to purchase 1,000,000 shares of common stock is subject to the following vesting schedule: (1) options to purchase 500,000 shares of Common Stock shall vest upon the effective date; (2) options to purchase 250,000 shares of Common Stock shall vest ratably over six months beginning with the first month after the effective date; and (3) options to purchase 250,000 shares of common stock shall vest ratably over twelve months beginning with the first month after the effective date. As part of the grant of the options to purchase 1,000,000 shares, Mr. Kohn forfeited options to purchase 535,000 shares of common stock previously granted to him under the Company’s Incentive Share Option Plans. +In the event that Mr. Kohn is terminated by the Company without cause, or if Mr. Kohn resigns for good reason, Mr. Kohn shall be entitled to (A) all annual salary earned prior to the termination date, any earned but unpaid portion of Mr. Kohn’s annual performance bonus for the year preceding in which such termination occurred and any earned but unpaid paid time off; (B) an amount equal to 100% of Mr. Kohn’s then in effect annual base salary plus an additional 1/12th of Mr. Kohn’s annual base salary for each year of employment with the Company prior to such termination; (C) an amount equal to the average of Mr. Kohn’s two prior years’ annual bonuses (with such average not to exceed 50% of the Mr. Kohn’s annual base salary in effect at the time of termination) prorated for the portion of the year that executive was employed; (D) accelerated vesting of all outstanding unvested stock options and other equity arrangements subject to vesting and held by Mr. Kohn through the termination date and the Company’s right to repurchase Mr. Kohn’s restricted stock shall cease; and (E) to the extent required by COBRA, continuation of group health benefits pursuant to the Company's standard programs or in effect at the termination date at Company expense for a period of not less than 18 months. +F-45 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +If Mr. Kohn is terminated without cause, or resigns for good reason within 12 months of a change of control, Mr. Kohn shall be entitled to receive: (A) payment in a lump sum of Mr. Kohn annual base salary for 24 months and any accrued, unused paid time-off; (B) accelerated vesting of all outstanding unvested stock options and other equity arrangements subject to vesting and the Company’s right to repurchase Mr. Kohn restricted stock shall cease; and (C) to the extent required by COBRA, continuation of group health benefits pursuant to the Company's standard programs or in effect at the termination date at the Company’s expense for a period of not less than 18 months. +William Horne +On January 25, 2018, the Company entered into a five-year employment agreement with William Horne to serve as Chief Financial Officer and Executive Vice President of the Company and its subsidiaries. For his services, Mr. Horne will be paid a base salary of $250 per annum. +Upon signing of the employment agreement, Mr. Horne is entitled to a signing bonus in the amount of $25. In addition, Mr. Horne shall be eligible to receive an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s compensation committee. +Further, Mr. Horne is entitled to receive equity participation as follows: (A) a grant of restricted stock in the aggregate amount of 1,000,000 shares of common stock, which shares shall vest in installments of two hundred thousand (200,000) shares annually over five (5) years beginning on January 1, 2019, provided, however, that such shares may, in whole or in part, in the discretion of the Compensation Committee, vest immediately upon the filing of an Annual Report on Form 10-K with the SEC that shows that the Company’s revenues for the applicable fiscal year reached or exceeded $100,000; notwithstanding the foregoing, before the Company accelerates any such vesting, the Company’s Compensation Committee must prior thereto have obtained the consent of Mr. Horne, which consent may be withheld in his discretion, and (B) an option to purchase 500,000 shares of common stock of the Company at a per share price equal to the closing price of $2.32, the closing market price of the shares of common stock on January 24, 2018, which option will vest over 60 months. +Mr. Horne’s bonuses, if any, and all stock based compensation shall be subject to “Company Clawback Rights” if during the period that Mr. Horne is employed by the Company and upon the termination of Mr. Horne’s employment and for a period of two years thereafter, if there is a restatement of any of the Company’s financial results from which any bonuses and stock based compensation to Mr. Horne shall have been determined. +Upon termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to receive: (A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued but unused vacation time. +Further, unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne a “ Separation Payment ” as follows: (A) an amount equal to four weeks of base salary for each full year of service, (B) should Mr. Horne provide the Company with a separation, waiver and release agreement within 60 days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “ Separation Period ”) of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or (2) the 12-month period commencing on the date Mr. Horne is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Horne would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will be paid an amount equal to four times his Separation Payment. +F-46 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Acquisition +On December 31, 2017, CooliSys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. ( “MICT” ), a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT ( “EML” and, together with MICT, the “Seller Parties” ), and Enertec Systems 2001 Ltd. ( “Enertec” ), an Israeli corporation and wholly owned subsidiary of EML, pursuant to which Coolisys shall acquire Enertec, subject to the terms and conditions set forth in the Agreement (the “Acquisition” ). Enertec is Israel’s largest private manufacturer of specialized electronic systems for the military market. +The purchase price shall be $5,250, as adjusted for any closing debt surplus or deficit (the “Purchase Price” ). If Enertec’s outstanding debt owed to certain creditors (the “Bank Debt” ) at the closing shall be less than $4,000, then the Purchase Price shall be increased by the difference between $4,000 and such lower Bank Debt. If Enertec’s outstanding Bank Debt at the closing shall be greater than $4,000, then the Purchase Price shall be reduced by the difference between $4,000 and the higher Bank Debt. Consummation of the Acquisition is subject to customary closing conditions. +Either party may terminate the Agreement if the Acquisition has not been consummated within the later of 60 days following signing or 15 days following the Seller Parties’ delivery to Coolisys of Enertec’s audited financial statements for the year ending December 31, 2017 (the “End Date” ), provided however, that the End Date shall be extended by an additional 30 days if Enertec’s Bank Debt is accelerated as a result of the Agreement and such accelerated Bank Debt is greater than $2,000. Coolisys shall be required to pay the Seller Parties a termination fee of $300 in the event that Coolisys fails to consummate the Acquisition by the End Date following satisfaction of all of its closing conditions, or upon termination by the Seller Parties due to Coolisys’s breach of its representations and warranties that have not been cured for 15 days. +23. STOCKHOLDERS’ EQUITY +Preferred Stock +The Company is authorized to issue 25,000,000 shares of Preferred Stock $0.01 par value. The Board of Directors has designated 500,000 shares of its Preferred Stock as Series A cumulative Redeemable Convertible Preferred shares (the “Series A Preferred Stock” ), 500,000 shares as Series B Convertible Preferred Stock (the “Series B Preferred Stock” ), 460,000 shares as Series C Convertible Preferred Stock (the “Series C Preferred Stock” ), 378,776 shares as Series D Convertible Preferred Stock (the “Series D Preferred Stock” ), and 10,000 shares as Series E Convertible Preferred Stock (the “Series E Preferred Stock” ). The rights, preferences, privileges and restrictions on the remaining authorized 23,151,224 shares of Preferred Stock have not been determined. The Company’s Board of Directors is authorized to create a new series of preferred shares and determine the number of shares, as well as the rights, preferences, privileges and restrictions granted to or imposed upon any series of preferred shares. As of December 31, 2017, there were 100,000 shares of Series B Preferred Stock, 378,776 shares of Series D Preferred Stock and no other shares of Preferred Stock were issued or outstanding. +Series B Preferred Stock +On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou, a related party. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000 in the Company through the purchase of Series B Preferred Stock over the term of 36 months. +F-47 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Each share of Series B Preferred Stock has a stated value of $10.00 per share. Each share of Series B Preferred Stock may be convertible at the holder’s option into shares of common stock of the Company at a conversion rate of $0.70 per share, upon the earlier to occur of: (i) 60 months from the closing date, or (ii) upon the filing by the Company of one or more periodic reports that, singly or collectively, evidence that the Company’s gross revenues have reached no less than $10,000 in the aggregate, on a consolidated reporting basis, over four consecutive quarters in accordance with U.S. GAAP. The conversion price will be subject to standard anti-dilution provisions in connection with any stock split, stock dividend, subdivision or similar reclassification of the common stock. +Each share of Series B Preferred Stock shall have the right to receive dividends equal to one ten millionth (0.0000001) of earnings before interest, taxes, depreciation, amortization and stock-based compensation ( “EBITDAS” ) calculated for a particular calendar year. Assuming the purchase of the entire $5,000 of shares of Preferred Stock, the holders thereof will be entitled to receive dividends equal to five percent (5%) in the aggregate of EBITDAS. Payment of dividends shall be calculated for a calendar year, payable on a quarterly basis, with payments to occur no later than 90 days in arrears from each reporting period subject to a year-end reconciliation. EBITDAS shall mean earnings before interest, taxes, depreciation, amortization, and stock-based compensation . +At such time as (i) all shares of common stock issuable upon conversion of all outstanding shares of Series B Preferred Stock (the “Conversion Shares” ) shall have been registered for resale pursuant to an effective Registration Statement covering such Conversion Shares, (ii) but no earlier than the twenty-fifth (25th) anniversary of the effective date, the shares of Series B Preferred Stock shall be subject to redemption in cash at the option of the Company in an amount per share equal to 120% of the greater of (a) the stated value plus all accrued and unpaid dividends, if any and (b) the fair market value of such shares of Series B Preferred Stock. +In addition, for each share of Series B Preferred Stock purchased, Philou will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Series B Preferred Stock purchased divided by $0.70, at an exercise price equal to $0.70 per share of common stock. The warrants do not require a net cash-settlement or provide the holder with a choice of net-cash settlement. The warrants also do not contain a variable settlement provision. Accordingly, any warrants issued to Philou pursuant to the terms of the Preferred Stock Purchase Agreement shall be classified as equity instruments. +Further, Philou shall have the right to participate in the Company’s future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest in the Company. Philou’s right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Series B Preferred Stock. +Between March 24, 2017 and June 2, 2017, Philou purchased 100,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the cancellation of the Company debt due to Philou in the aggregate amount of $500 and cash of $500. In addition, Philou received warrants to purchase 1,428,572 shares of common stock at an exercise price of $0.70 per share of common stock, which have been classified as equity instruments. The Company determined that the estimated relative fair value of these warrants, which are classified as equity, was $401 using the Black-Scholes option pricing model. Since the warrants were classified as equity securities, the Company allocated the $1,000 purchase price based on the relative fair values of the Series B Preferred Stock and the warrants following the guidance in ASC No. 470, Debt . +The Series B Convertible Preferred Stock is convertible at any time, in whole or in part, at the option of Philou, into shares of common stock at a fixed conversion price, which is subject to adjustment for stock splits, stock dividends, combinations or similar events, of $0.70 per share. As the effective conversion price of the Series B Convertible Preferred Stock on a converted basis was below the market price of the Company’s common stock on the date of issuance, it was determined that these discounts represent contingent beneficial conversion features, which was valued at $265 based on the difference between the effective conversion price and the market price of the Company’s common stock on the date of issuance. +F-48 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The Company, however, was prohibited from issuing shares of common stock pursuant to the Series B Convertible Preferred Stock until stockholder approval of such issuance of securities was obtained, as required by applicable NYSE American listing rules. The Company received stockholder approval of such share issuances on December 28, 2017. This provision resulted in a contingent beneficial conversion feature that was recognized on December 28, 2017, the date the contingency was resolved. These features are analogous to preference dividends and are recorded as a non-cash return to preferred shareholders through accumulated deficit. +Series C Preferred Stock +Between May 24, 2017 and June 19, 2017, the Company entered into subscription agreements (the “Series C Subscription Agreement” ) with approximately twenty accredited investors (the “Series C Investors” ) in connection with the sale of twenty-one Units at a purchase price of $52 per Unit raising in the aggregate $1,092 with each Unit consisting of 21,667 shares of Series C Preferred Stock and Warrants to purchase 86,667 shares of common stock. Divine acted as the Company’s placement agent. +Each share of Series C Preferred Stock has a stated value of $2.40 per share. Each share of Series C Preferred Stock may be convertible at the holder’s option into shares of Common Stock of the Company at a conversion price of $0.60 per share, which, currently, represents four shares of Common Stock. The conversion price is subject to standard anti-dilution provisions in connection with any stock split, stock dividend, subdivision or similar reclassification of the Common Stock. Each share of Series C Preferred stock is mandatorily converted into shares of Common Stock based on the then conversion price in effect in the event that the Company’s Common Stock closing price exceeds $1.20 per share for 20 consecutive trading days. As the effective conversion price of the Series C Convertible Preferred Stock on a converted basis was below the market price of the Company’s common stock on the date of issuance, it was determined that these discounts represent beneficial conversion features, which were valued at $319 and recognized as a deemed dividend, based on the difference between the effective conversion price and the market price of the Company’s common stock on the date of issuance. +Each share of Series C Preferred Stock has the right to receive dividends equal $0.24 per share per annum as declared by the Company’s Board of Directors. The dividends will be paid on a quarterly basis on the 20th day following each calendar quarter. +Each share of Series C Preferred Stock shall have dividend and liquidation rights in priority to any shares of Common Stock, the Company’s Series A Preferred Stock (of which none are outstanding) and any other subordinated securities; but shall be subordinated to any senior securities including the Company’s Series B Preferred Stock. +Each share of Series C Preferred Stock is subject to redemption by the Company for the stated value plus accrued but unpaid dividends five years after issuance, provided the holders of Series C Preferred Stock had not elected previously to convert the Series C Preferred Stock into shares of Common Stock. +During December 2017, pursuant to the conversion terms of the Series C Preferred Stock, all of the Series C Investors elected to convert their 455,002 shares of Series C Preferred Stock into 1,820,008 shares of the Company’s common stock. Additionally, of the 1,820,002 warrants that were issued in conjunction with the Series C Subscription Agreements, the Company issued 1,603,335 shares of its common stock upon cash-based exercises that resulted in gross proceeds to the Company of $1,603 and issued 70,909 shares of its common stock upon the cashless exercise of a warrant to purchase 86,667 shares of common stock. +Series D Preferred Stock +On June 2, 2017, pursuant to the terms of the Share Exchange Agreement, the Company acquired 1,603,434 shares of the issued and outstanding common stock of Microphase Common Stock in exchange for the issuance by the Company of 1,842,448 shares of the Company’s Common Stock, 378,776 shares of the Company’s Series D Preferred Stock and warrants to purchase an aggregate of 1,000,000 shares of the Company’s Common Stock. +F-49 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +In the event the Company shall liquidate, dissolve or wind up, the holders of Series D Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of the Company to the holders of the Common Stock, the Company’s Series A Preferred Stock, or to the holders of any other junior series of preferred stock, by reason of their ownership thereof and subject to the rights of the Company’s Series B Preferred Stock, Series C Preferred Stock and any other class or series of Company stock subsequently issued that ranks senior to the Series D Preferred Stock, an amount per share in cash or equivalent value in securities or other consideration equal to its Stated Value of $0.01 per share. +The holders of Series D Preferred Stock shall not be entitled to receive dividends and shall have no voting rights except as otherwise required by law. Upon the shareholders of DPW Common Stock approving the conversion of the Series D Preferred Stock into shares of DPW Common Stock in connection with the acquisition of MPC Common Stock and for purposes of compliance with Rule 713 of the NYSE American, then each share of Series D Preferred Stock shall automatically be converted into two shares of DPW Common Stock, for an aggregate of 757,552 shares of DPW Common Stock. +Series E Preferred Stock +On June 2, 2017, pursuant to the terms of the Share Exchange Agreement and in consideration of legal services, Microphase issued a $450 8% promissory note with a maturity date of November 25, 2017 to an unsecured creditor, Lucosky Brookman, LLP (the “Lucosky Note” ). In conjunction with the issuance of the Lucosky Note, the Company issued Lucosky Brookman 10,000 shares of Series E Preferred Stock with a stated value equal to forty-five dollars ($45.00) per share . The Company, at its option, may redeem for cash, in whole or in part, at any time and from time to time, the shares of Series E Preferred Stock at the time outstanding, upon written notice to the holder of the shares, at a cash redemption price equal to $45 multiplied by the number of shares being redeemed. Any such optional redemption by the Company shall be credited against the Lucosky Note. +In the event the Company shall liquidate, dissolve or wind up, the holders of Series E Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of the Company to the holders of the DPW Common Stock, the Company’s Series A Preferred Stock, or to the holders of any other junior series of preferred stock, by reason of their ownership thereof and subject to the rights of the Company’s Series B Preferred Stock, Series C Preferred Stock and any other class or series of Company stock subsequently issued that ranks senior to the Series E Preferred Stock an amount per share in cash or equivalent value in securities or other consideration equal to $0.01 per share. The holders of Series E Preferred Stock shall not be entitled to receive dividends and shall have no voting rights except as otherwise required by law. Subject to the shareholders of DPW Common Stock of the Company approving the conversion of the Series E Preferred Stock into shares of Common Stock in connection with the acquisition of MPC Common Stock and for purposes of compliance with Rule 713 of the NYSE American, then each share of Series E Preferred Stock may be converted into sixty (60) shares of DPW Common Stock, for an aggregate of 600,000 shares of DPW Common Stock. On December 29, 2017, the Lucosky Note was satisfied through the conversion of the 10,000 shares of Series E Preferred Stock into 600,000 shares of the Company’s common stock. +Common Stock +2016 Issuance +Common stock confers upon the holders the rights to receive notice to participate and vote in the general meeting of shareholders of the Company, to receive dividends, if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. +F-50 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +On November 15, 2016, the Company entered into subscription agreements (the “2016 Subscription Agreements” ) with nine accredited investors. Pursuant to the terms of the 2016 Subscription Agreements, the Company sold 901,666 units at $0.60 for an aggregate purchase price of approximately $541. Each unit consists of one share of common stock and one warrant to purchase one share of common stock (the “Nov. 2016 Warrants”) at an exercise price of $0.80. +The 2016 Subscription Agreement provides that, until November 15, 2017, investors who purchased at least $100 had the right to participate in the purchase of up to 50% of the securities offered by the Company in any future financing transactions, with limited exceptions. +The Nov. 2016 Warrants entitle the holders to purchase, in the aggregate, up to 901,666 shares of Common Stock at an exercise price of $0.80 per share for a period of three years. The Nov. 2016 Warrants are exercisable upon the six-month anniversary of the issuance date. The exercise price of the Nov. 2016 Warrants is subject to adjustment for stock splits, stock dividends, combinations and other standard anti-dilution events. The Nov. 2016 Warrants may be exercised for cash or, upon the failure to maintain an effective registration statement, on a cashless basis. +2017 Issuances +Issuances of Common Stock for Cash or a Combination of Cash and Cancellation of Debt +On March 15, 2017, Company entered into a subscription agreement with a related party for the sale of 500,000 shares of common stock at $0.60 per share for the aggregate purchase price of $300. +On July 24, 2017, we entered into subscription agreements with six investors, and on July 25, 2017 we entered into a securities purchase agreement with an institutional investor, under which we agreed to issue and sell in the aggregate 851,363 shares of common stock to the investors at $0.55 per share for an aggregate purchase price of $468. Of the aggregate purchase price of $468, $445 was paid in cash and $23, which represented 41,818 of the total shares of common stock sold, was in consideration for the cancellation of debt of the Company. The company granted warrants to purchase 109,090 shares of common stock to two of the investors that entered into the subscription agreements at $0.75 per share. In a concurrent private placement, we sold to the institutional investor warrants to purchase an aggregate of 163,636 shares of the Company’s common stock at an exercise price equal to $0.55 per share. +On October 18, 2017, the Company entered into subscription agreements with five investors, under which we agreed to issue and sell in the aggregate 452,239 shares of common stock to the investors at $0.67 per share for an aggregate purchase price of $303. $210 of the purchase price was paid in cash and $93, which represented 138,806 of the total shares of common stock sold, was paid through the cancellation of debt incurred by the Company. +On November 7, 2017, the Company entered into subscription agreements with investors under which the Company agreed to issue and sell in the aggregate 725,000 shares of common stock to the investors at $0.60 per share for an aggregate purchase price of $435. $280 of the aggregate purchase price was paid in cash and $155, which represented 258,333 of the total shares of common stock sold, was paid through the cancellation of debt incurred by the Company. +On December 5, 2017, the Company entered into subscription agreements with investors for the sale of 640,000 shares of common stock at $1.25 per share for the aggregate purchase price of $800. The direct offering closed December 13, 2017. +In aggregate, the above transactions resulted in the issuance of 2,729,645 shares of common stock for cash proceeds, net of $73 in financing costs, of $1,962 and the issuance of 438,957 shares of common stock for the cancellation of $271 in debt incurred by the Company. +F-51 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Issuances of Common Stock for Services +On March 8, 2017, the Company issued an aggregate of 12,547 shares of its common stock as payment for services to a consultant. The shares were valued at $10, an average of $0.80 per share . +Between May 9, 2017 and June 18, 2017, the Company issued an aggregate of 956,153 shares of its common stock as payment for services to its consultant. The shares were valued at $498, an average of $0.52 per share. +Between August 21, 2017 and September 5, 2017, the Company issued an aggregate of 580,645 shares of its common stock as payment for services to its consultants. The shares were valued at $364, an average of $0.62 per share. +Between October 3, 2017 and December 28, 2017, the Company issued an aggregate of 612,000 shares of its common stock as payment for services to its consultants. The shares were valued at $791, an average of $1.29 per share. +In aggregate, during the year ended December 31, 2017, the Company issued a total of 2,161,345 shares of its common stock, with a value of $1,663, to its consultants for services. +Issuance of common stock for conversion of debt +Between February 16, 2017 and February 23, 2017, the Company issued 666,667 shares of its common stock, an extinguishment price of $0.60 per share, for the cancellation of $400 in demand promissory notes. +On April 5, 2017, the Company issued 360,002 shares of its common stock, at a price of $0.75 per share, for the cancellation of $270 in demand promissory notes. +On June 28, 2017, the Company issued 189,091 shares of its common stock, at a price of $0.55 per share, for the cancellation of a 7% convertible promissory note in the principal amount of $104. +On June 28, 2017, the holders of $55 of in short-term loans agreed to cancel their notes for the purchase of 100,001 shares of the Company’s common stock at a price of $0.55 per share. +On July 28, 2017, an institutional investor agreed to cancel two promissory notes in the aggregate amount of $145 for the issuance of 263,600 shares of the Company’s common stock at a price of $0.55 per share. +During the period from November 27, 2017 to December 6, 2017, the entire $530 of principal on the Convertible Note was satisfied through the issuance of 963,636 shares of the Company’s common stock (See Note 18). +On December 13, 2017 and December 14, 2017, the entire $1,111 of principal on the November 5% Convertible Note was satisfied through the issuance of 1,851,667 shares of the Company’s common stock (See Note 20c). +On December 28, 2017, principal and accrued interest of $198 and $5, respectively, on the 12% Convertible Note was satisfied through the issuance of 368,760 shares of the Company’s common stock (See Note 17). +During December 2017, the entire principal and accrued interest of $880 and $54, respectively, on the 10% Convertible Notes was satisfied through the issuance of 1,557,417 shares of the Company’s common stock (See Note 20d). +F-52 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Issuances of Common Stock upon Exercise of Stock Options +Between December 4, 2017 and December 22, 2017, the Company issued a total of 361,458 shares of its common stock upon the cash and cashless exercise of options to purchase an aggregate of 363,500 shares of its common stock. These options were issued pursuant to the Company’s Plans. The Company received cash of $557 as a result of these option exercises. +Issuances of Common Stock upon Exercise of Warrants +Between November 27, 2017 and December 28, 2017, the Company issued a total of 1,871,864 shares of its common stock upon the cash and cashless exercise of warrants to purchase an aggregate of 2,113,465 shares of its common stock. These warrants were issued between November 2016 and August 2017 in conjunction with various common stock and debt financings. The Company received cash of $642 as a result of these warrant exercises. +During December 2017, in conjunction with the Series C Subscription Agreements, the Company issued 1,603,335 shares of its common stock upon cash-based exercises that resulted in gross proceeds to the Company of $1,603 and issued 70,909 shares of its common stock upon the cashless exercise of a warrant to purchase 86,667 shares of common stock. +In aggregate, the Company received gross proceeds of $2,245 from the issuance of 3,546,108 shares of common stock in connection with warrant exercises. +Issuances of common stock in connection with convertible notes +On November 2, 2017, in conjunction with the securities purchase agreement to sell the November 5% Convertible Note in the principal amount of $1,111, the Company issued 300,000 shares of restricted common stock to the institutional investor. +On December 4, 2017, in conjunction with the securities purchase agreement to sell the 5% Convertible Note in the principal amount of $550, the Company issued 150,000 shares of restricted common stock to the institutional investor. +Issuance of common stock for domain name +On July 7, 2017, the Company entered into an asset purchase agreement to acquire the intellectual property of Coolisys.com, consisting of the common law rights associated with the trademarks and name as well as the domain name and content of www.Coolisys.com . The aggregate purchase price of $81 was comprised of 50,000 shares of common stock, valued at $31 based on the closing price of the Common Stock on the date of the acquisition, and cash of $50. +Issuance of common stock and warrants in satisfaction of subsidiary debt +On December 5, 2017, the Company entered into an exchange agreement with several accredited investors for the cancellation of $690 in outstanding principal on the 10% Short-Term Notes. In December 2016, Microphase issued $705 in 10% Short-Term Notes. The 10% Short-Term Notes were due one year from the date of issuance. The amount due pursuant to the 10% Short-Term Notes is equal to the entire original principal amount multiplied by 125% (the “Loan Premium” ) plus accrued interest. In exchange for the cancellation of $690 of outstanding principal and $250 of accrued loan premiums and interest owed to the investors by Microphase Corporation, the Company entered into the exchange agreement pursuant to which the Company issued an aggregate of 1,523,852 shares of common stock and warrants to purchase 380,466 shares of common stock with an exercise price of $1.10 per share of common stock, (See Note 18f). +F-53 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Issuance of common stock for acquisition of debt due from related party +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson, pursuant to which the Company issued to WT Johnson convertible promissory notes in the principal amount of $2,268. During December 2017, the Company issued 600,000 shares of its common stock upon the conversion of the promissory notes . +24. INCOME TAXES +On December 22, 2017, the United States enacted significant changes to U.S. tax law following the passage and signing of H.R.1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Tax Act”). Introduced initially as the Tax Cuts and Jobs Act, the Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 (the “Act”) was enacted on December 22, 2017. The Act applies to corporations generally beginning with taxable years starting after December 31, 2017 and reduces the corporate tax rate from a graduated set of rates with a maximum 35% tax rate to a flat 21% tax rate. Additionally, the Act introduces other changes that impact corporations, including a net operating loss (“NOL”) deduction annual limitation, an interest expense deduction annual limitation, elimination of the alternative minimum tax, and immediate expensing of the full cost of qualified property. The Act also introduces an international tax reform that moves the U.S. toward a territorial system, in which income earned in other countries will generally not be subject to U.S. taxation. However, the accumulated foreign earnings of certain foreign corporations will be subject to a one-time transition tax, which can be elected to be paid over an eight-year tax transition period, using specified percentages, or in one lump sum. NOL and foreign tax credit (“FTC”) carryforwards can be used to offset the transition tax liability. The Company does not expect that this change will have an impact on the Company as it has not earned taxable income in the past and it has significant NOL carryforwards. The application of this rate reduction to the ending deferred tax assets and deferred tax liabilities impacted our expense for income taxes by $1,139 which was fully offset by a corresponding change to our valuation allowance in 2017. We are still analyzing the Tax Act and refining our calculations, which could potentially impact the measurement of our tax balances. The Tax Act contains several base broadening provisions that became effective on January 1, 2018, that we do not expect to have a material impact on future earnings. The 2017 impact of the enactment of the Tax Act is reflected in the tables below. +Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and income tax purposes. Significant components of the Company's deferred tax assets are as follows: +2017 +2016 +Deferred tax asset: +Net operating loss +$ +3,543 +$ +2,206 +Reserves and allowances +725 +295 +Tax credit carryforward +163 +153 +Property and equipment +231 +194 +Total deferred tax asset +4,662 +2,848 +Deferred tax liability: +Intangible assets, net +(653 +) +— +Total deferred tax liability +(653 +) +— +Valuation allowance +(4,009 +) +(2,848 +) +Deferred tax asset, net +$ +— +$ +— +The Company had Federal and state net operating loss carryforwards of approximately $12,024 and $3,229, respectively, available to offset future taxable income, expiring at various times from December 31, 2018 through December 31, 2037. In accordance with Section 382 of the Internal Revenue Code, the future utilization of the Company’s net operating loss to offset future taxable income may be subject to an annual limitation as a result of ownership changes that may have occurred previously or that could occur in the future. Management believes that such an ownership change may have occurred during the fourth quarter of 2017. The Company will be completing a Section 382 analysis of the Company’s net operating loss and the amount of the net operating loss could be significantly less. The Company has not yet determined whether such an ownership change has occurred; however, the Company will be completing a Section 382 analysis regarding the limitation of the net operating loss. +In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences representing net future deductible amounts become deductible. Management considers the scheduled reversal of deferred tax assets, projected future taxable income and tax planning strategies in making this assessment. After consideration of all of the information available and due to the last five years significant losses there is substantial doubt related to the Company’s ability to utilize its deferred tax assets, the Company recorded a full valuation allowance of the deferred tax asset. For the year ended December 31, 2017, the valuation allowance has increased by $1,161. +F-54 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The 2014 through 2017 tax years remain open to examination by the Internal Revenue Service ( “IRS” ) and the 2013 through 2017 tax years remain open to examination by the California Franchise Tax Board ( “FTB” ). The IRS and FTB have the authority to examine those tax years until the applicable statute of limitations expires. +As of December 31, 2017, the Company’s foreign subsidiary had accumulated losses for income tax purposes in the amount of approximately $1,403. All of the Company’s international accumulated losses were generated in the United Kingdom, which has a statutory tax rate of 20%. These net operating losses may be carried forward and offset against taxable income in the future for an indefinite period. The Company has not recognized a U.S. deferred income tax asset on non-U.S. losses because the Company plans to indefinitely reinvest such earnings outside the U.S. Remittances of non-U.S. earnings, if any, are based on estimates and judgments of projected cash flow needs, as well as the working capital and investment requirements of the Company’s non-U.S. and U.S. operations. Material changes in the Company’s estimates of cash, working capital, and investment needs could require repatriation of indefinitely reinvested non-U.S. earnings, which would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. +The net income tax benefit consists of the following: +2017 +2016 +Current +Foreign +$ +— +$ +20 +Federal +78 +— +State +— +— +Income tax (benefit) +$ +78 +$ +20 +The Company’s effective tax rates were (0.8%) and (1.7%) for the years ended December 31, 2017 and 2016, respectively. During the year ended December 31, 2017, the effective tax rate differed from the U.S. federal statutory rate primarily due to the change in the valuation allowance and the effect of changes in tax rates in future periods. The reconciliation of income tax attributable to operations computed at the U.S. Federal statutory income tax rate of 34% to income tax expense is as follows: +2017 +2016 +Tax benefit at U.S. Federal statutory tax rate +(34.0 +%) +(34.0 +%) +Increase (decrease) in tax rate resulting from: +Effect of change in tax rates +12.0 +% +— +Stock compensation expense +1.9 +% +12.1 +% +Taxes in respect of prior years +— +9.1 +% +Increase in valuation allowance +17.0 +% +8.3 +% +Nondeductible meals & entertainment expense and other +6.1 +% +4.4 +% +State taxes, net of federal benefit +(4.5 +%) +0.3 +% +Foreign rate differential +0.7 +% +(0.2 +%) +Foreign R&D credit +— +(1.7 +%) +Effective tax rate +0.8 +% +(1.7 +%) +F-55 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The Company accounts for uncertain tax positions in accordance with ASC No. 740-10-25. ASC No. 740-10-25 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2017 and 2016, there are no uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +25. RELATED PARTY TRANSACTION +a. +In anticipation of the acquisition of MTIX Ltd., an advanced materials and processing technology company located in Huddersfield, West Yorkshire, UK ( “MTIX” ) by AVLP and the expectation of future business generated by the Company from a strategic investment into AVLP, on October 5, 2016, November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with AVLP (the “AVLP Notes” ) in the principal amount of $525 each. The AVLP Notes included a 5% original issue discount, resulting in net loans to AVLP of $1,500 and an original issue discount of $75. The AVLP notes accrued interest at 12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of AVLP at approximately $0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 shares of the Company’s common stock . During the period from March 29, 2017 to August 16, 2017, the Company funded $1,809 in excess of the $1,500 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, the Company and AVLP entered into a Loan and Security Agreement ( “AVLP Loan Agreement” ) with an effective date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to $5,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019, subject to the terms and conditions stated in the Loan Agreement, including that the Company having available funds to grant such credit. +In consideration of entering into the AVLP Loan Agreement, the Company and AVLP cancelled the AVLP Notes and consolidated the AVLP Notes and prior advances totaling $3,309 plus original issue discount of $165 and issued a new Convertible Promissory Note in the aggregate principal amount of $3,474 (the “New Note” ) that is convertible into shares of AVLP at a conversion price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior interest accrued under the AVLP Notes and advances will continue to be an obligation of AVLP. The New Note contains standard events of defaults. In addition, concurrent to issuing the New Note, AVLP issued to the Company a five-year Warrant to purchase 6,948,800 shares of AVLP Common Stock at $0.50 per share. Further, the Company made additional advances under the AVLP Loan Agreement in the aggregate amount of $649,820. At December 31, 2017, in aggregate, the Company has provided loans to AVLP in the principal amount $4,124,220 and AVLP has issued to the Company warrants to purchase 8,248,440 shares of AVLP common stock. Future advances under the AVLP Loan Agreement, if any, will be evidenced by a convertible promissory containing a conversion price feature at $0.50 per share and warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. +During the years ended December 31, 2017 and 2016, the Company also acquired in the open market 221,333 shares of AVLP common stock for $192 and 250,900 shares of AVLP common stock for $85, respectively. At December 31, 2017, the closing market price of AVLP’s common stock was $1.75. The Company has determined that its investment in AVLP marketable equity securities are accounted for pursuant to the fair value method and based upon the closing market price of common stock at December 31, 2017, the Company has recognized an unrealized gain of $550. +F-56 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Philou is AVLP’s controlling shareholder. Mr. Ault is Chairman of AVLP’s Board of Directors and the Executive Chairman of the Company’s Board of Directors. Mr. William B. Horne is the Chief Financial Officer of AVLP and also the audit committee chairman of the Company. +On October 24, 2016, AVLP entered into a letter of intent to acquire MTIX and made an initial payment of $50 towards the purchase. On August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended on July 13, 2017 and August 21, 2017 (the “Exchange Agreement” ) with MTIX Limited, a company formed under the laws of England and Wales ( “MTIX” ) and the three (3) shareholders of MTIX (the “ Sellers ”), AVLP completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, AVLP acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “MTIX Shares” ) by the Sellers to AVLP in exchange (the “Exchange” ) for the issuance by AVLP of: (a) 7% secured convertible promissory notes (individually, a “Note” and collectively, the “Notes” ) in the aggregate principal face amount of $9,500 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages of MTIX’s ordinary shares, (b) (i) $500 in cash, $50, of which was paid on October 26, 2016, and (ii) 100,000 shares of AVLP’s newly designated shares of Class B Convertible Preferred Stock (the “Class B Shares” ) to the principal shareholder of MTIX (the “Majority Shareholder” ). +On the closing date, the fully-diluted AVLP shares shall be approximately 52 million shares of common stock, assuming that (i) the MTIX promissory notes are convertible into shares of AVLP common stock at a conversion price of $0.50 per share, (ii) the shares of AVLP Class B Convertible Preferred Stock are convertible into shares of AVLP common stock at a conversion rate of $0.50 per share and (iii) the issuance of stock options to purchase an aggregate of 531,919 shares of AVLP common stock to the members of the MTIX management group. +During March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the MLSE plasma-laser system. +During the year ended December 31, 2017, we recognized $174 in revenues resulting from our relationship with MTIX Limited, a company formed under the laws of England and Wales (“ MTIX ”). MTIX was acquired by Avalanche on August 22, 2017 and is therefore deemed to be a related party. In March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system. Management believes that the MLSE purchase order will be a source of revenue and generate significant cash flows for the Company . However, at December 31, 2017, the $924 in revenues had not yet been received and was reflected on the financial statements as accounts receivable, related party. +b. +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson two convertible promissory notes in the principal amount of $600 ( “Note A” ) and $1,668 ( “Note B” ), in exchange for cancellation of amounts due to WT Johnson by MTIX Ltd., a related party of the Company. +During December 2017, the Company issued 600,000 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently sold the 600,000 shares. The proceeds from the sale of Note A were sufficient to satisfy the entire $2,268 obligation as well as an additional $400 of value added tax due to WT Johnson. Concurrent with entering into the exchange agreement, the Company received a promissory note in the amount of $2,668 from MTIX. At December 31, 2017, the Company has valued the note receivable at $600, the carrying amount of Note A. The Company will recognize the remainder of the amount due from MTIX upon payment of the promissory note by MTIX . +F-57 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +c. +On September 22, 2016, the Company entered into consulting agreement with Mr. Ault to assist the Company in developing a business strategy, identifying new business opportunities, developing a capital raising program and implementing of a capital deployment program. For his services, Mr. Ault was paid $208 during the year ended December 31 , 2017 and $30 for the year ended December 31,2016 . +d. +On October 21, 2016, the Company entered into a 12% convertible secured note in the principal amount of $530 and warrants with the Barry Blank Living Trust, an existing stockholder of the Company, for $500 due on October 20, 2019. The principal amount of the 12% convertible secured note may be convertible into shares of the Company’s common stock at $0.55 per share. Subject to certain beneficial ownership limitations, the Barry Blank Living Trust may convert the principal amount of the convertible note at any time into common stock. During the year ended December 31, 2017 and 2016, the Company recorded interest expenses of $59 and $12, respectively, on the convertible note obligation. During the period from November 27, 2017 to December 6, 2017, the entire $530 of principal was satisfied through the issuance of 963,636 shares of the Company’s common. +e. +On December 29, 2016, the Company received a $250 short term loan from MCKEA. Kristine Ault, a director of the Company and the wife of Mr. Ault, is the managing member of MCKEA which, in turn, is the Manager of Philou, the majority stockholder of the Company. On March 24, 2017, the $250 loan was cancelled in consideration for the issuance of 25,000 shares of Series B preferred stock of the Company to Philou. During the year ended December 31, 2017 the Company recorded interest expenses of $3 on the short-term loan from MCKEA. +f. +In February 2017, the Company issued to eight accredited investors $400 in demand promissory notes bearing interest at a rate of 6% per annum. Of the eight accredited investors, one investor was deemed a related party. +g. +On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000 in the Company through the purchase of Series B Preferred Stock over 36 months. Between April 1, 2017 and June 2, 2017, Philou purchased 75,000 shares of Series B Preferred Stock pursuant to the terms of the Preferred Stock Purchase Agreement. Further, at December 31, 2017, Philou had made a $200 payment in the form of a short-term advance which will be converted into Series B Preferred Stock during the second quarter of 2018. +h. +On March 15, 2017, Company entered into a subscription agreement with a related party for the sale of 500,000 shares of common stock at $0.60 per share for the aggregate purchase price of $300. +i. +On March 20, 2017, the Company received a $250 short term loan from JLA Realty, an entity which owns 666,667 shares of the Company’s common stock, on behalf of Philou. The proceeds from this short-term loan comprised a portion of Philou’s purchase of Series B Preferred Stock. +j. +Between May 5, 2017 and June 30, 2017, the Company received additional short-term loans of $140 from four accredited investors of which $75 was from the Company’s corporate counsel, a related party. As additional consideration, the investors received five-year warrants to purchase 224,371 shares of common stock at a weighted average exercise price of $0.77 per share.On June 28, 2017, $52 in short-term loans that was received from the related party was converted into one of the Series C Units (See Note 18h) and on July 24, 2017, the remaining $23 in short-term loans was converted in 41,818 shares of the Company’s common stock in conjunction with the subscription agreements that the Company entered into with six investors (See Note 23). +k. +Between July 6, 2017 and December 31, 2017, Milton C. Ault, III, the Company’s Executive Chairman, personally guaranteed the repayment of (i) $2,585 to TVT Capital (ii) and $1,280 from the sale of the convertible promissory notes. These personal guarantees were necessary to facilitate the consummation of these financing transactions. Mr. Ault’s payment obligations would be triggered if the Company failed to perform under these financing obligations. Our board of directors has agreed to compensate Mr. Ault for his personal guarantees. The amount of annual compensation for each of these guarantees, which will be in the form of non-cash compensation, is approximately 2% of the amount of the obligation. +F-58 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +l. +During the year ended December 31, 2017, our President, Amos Kohn, purchased certain real property that will serve as a facility for the Company’s business operations in Israel. The Company made $300 of payments to the seller of the property and received a 28% undivided interest in the real property (“Property’). The Company’s subsidiary, Coolisys, entered into a Trust Agreement and Tenancy In Common Agreement with Roni Kohn, who owns a 72% interest in the Property, is the daughter of Mr. Kohn and is an Israeli citizen. The Property was purchased to serve as a residence/office facility for the Company in order to oversee its European operations and to expand its business in the hi-tech industry located in Israel. Pursuant to the Trust Agreement, the Ms. Kohn will hold and manage Coolisys’ undivided 28% interest in the Property. The trust will be in effect until it is terminated by mutual agreement of the parties. During the term of the trust, the Ms. Kohn will not sell, lease, sublease, transfer, grant, encumber, change or effect any other disposition with respect to the Property or the Coolisys’ interest without the Company’s approval. +Under the Tenancy In Common Agreement, Coolisys and its executive officers shall have the exclusive rights to use the Property for the Company and its affiliates’ business operations. The Property shall be managed by the Ms. Kohn. Further, pursuant to the Tenancy In Common Agreement, for each completed calendar month of employment of Mr. Kohn by the Company, Ms. Kohn shall have the right to purchase a portion of the Company’s interest in the Property. Such right shall fully vest at the end of five years of continuous employment and the Trustee shall have the right to purchase the Company’s 28% interest in the Property for a nominal value. The Company will amortize its $300 investment over ten years, subject to a cliff vesting after five years. In the event that Mr. Kohn is not employed by the Company, the Company shall have the right to demand that Ms. Kohn purchase the Company’s remaining interest in the Property that was not subject to vesting for the fair value market value of such unvested Property interest. +During the year ended December 31, 2017, DP Lending made loans to Alzamend Neuro, Inc. ( “Alzamend” ), in the amount of $44. AVLP is a party to a management services agreement pursuant to which Avalanche provides management, consulting and financial services to Alzamend. At December 31, 2017, the outstanding principal under these loans was $13. As additional consideration, the Company received a warrant to purchase 22,000 shares of Alzamend’s common stock at an exercise price of $0.30 per share of common stock. +26. SEGMENT, CUSTOMERS AND GEOGRAPHICAL INFORMATION +The Company has two reportable geographic segments; see Note 1 for a brief description of the Company’s business. +The following data presents the revenues, expenditures and other operating data of the Company’s geographic operating segments and presented in accordance with ASC No. 280. +Year ended December 31, 2017 +DPC +DPL +Eliminations +Total +Revenues +$ +7,890 +$ +2,111 +$ +— +$ +10,001 +Revenue, related party +$ +174 +$ +— +$ +— +$ +174 +Inter-segment revenues +$ +53 +$ +— +$ +(53 +) +$ +— +Total revenues +$ +8,117 +$ +2,111 +$ +(53 +) +$ +10,175 +Depreciation and amortization expense +$ +184 +$ +71 +$ +— +$ +255 +Loss from operations +$ +(5,558 +) +$ +(425 +) +$ +— +$ +(5,983 +) +Interest expense, net +$ +(4,990 +) +Income tax benefit +$ +78 +Net loss attributable to non-controlling interest +$ +279 +Net loss attributable to Digital Power Corp +$ +(10,616 +) +Capital expenditures for segment assets, as of +December 31, 2017 +$ +382 +$ +21 +$ +— +$ +403 +Identifiable assets as of December 31, 2017 +$ +28,781 +$ +1,729 +$ +— +$ +30,510 +F-59 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Year ended December 31, 2016 +DPC +DPL +Eliminations +Total +Revenues +$ +4,552 +$ +3,044 +$ +— +$ +7,596 +Inter-segment revenues +$ +145 +$ +— +$ +(145 +) +$ +— +Total revenues +$ +4,697 +$ +3,044 +$ +(145 +) +$ +7,596 +Depreciation and amortization expense +$ +75 +$ +86 +$ +— +$ +161 +Loss from operations +$ +(1,110 +) +$ +(109 +) +$ +— +$ +(1,219 +) +Interest income, net +$ +77 +Income tax benefit +$ +20 +Net loss +$ +(1,122 +) +Capital expenditures for segment assets, as of +December 31, 2016 +$ +32 +$ +53 +$ +— +$ +85 +Identifiable assets as of December 31, 2016 +$ +3,152 +$ +2,320 +$ +— +$ +5,472 +Concentration Risk: +The following table provides the percentage of total revenues attributable to a single customer from which 10% or more of total revenues are derived: +For the year ended December 31, 2017 +Total Revenues +by Major +Percentage of +Customers +Total Company +(in thousands) +Revenues +Customer A +$ +1,341 +13 +% +For the year ended December 31, 2016 +Total Revenues +by Major +Percentage of +Customers +Total Company +(in thousands) +Revenues +Customer A +$ +1,328 +17 +% +Customer B +$ +750 +10 +% +F-60 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Revenue from Customer A was attributable to Coolisys and revenue from Customer B attributable to DP Limited. +For the years ended December 31, 2017 and 2016, total revenues from external customers divided on the basis of the Company’s product lines are as follows: +2017 +2016 +Revenues: +Commercial products +$ +5,489 +$ +5,307 +Defense products +4,686 +2,289 +Total revenues +$ +10,175 +$ +7,596 +Financial data relating to geographic areas: +The Company’s total revenues are attributed to geographic areas based on the location. The following table presents total revenues for the years ended December 31, 2017 and 2016. Other than as shown, no foreign country contributed materially to revenues or long-lived assets for these periods: +2017 +2016 +Revenues: +North America +$ +6,638 +$ +4,541 +Europe +2,634 +1,845 +South Korea +231 +751 +Other +672 +459 +Total revenues +$ +10,175 +$ +7,596 +27. SUBSEQUENT EVENTS +In accordance with FASB ASC 855-10, the Company has analyzed its operations subsequent to December 31, 2017 and has determined that it does not have any material subsequent events to disclose in these financial statements except for the following. +Advances on Future Receipts +On January 10, 2018, the Company entered into two agreements for the purchase and sale of future receipts with TVT Capital LLC ( “TVT” ), pursuant to which the Company sold up to (i) $476 in future receipts of the Company for a purchase price in the amount of $350 ( “Agreement No. 1” ) and (ii) $1,700 in future receipts of the Company for a purchase price in the amount of $1,250 ( “Agreement No. 2” ). The agreements have been personally guaranteed by Milton Ault, III, the Company’s Chief Executive Officer and Chairman of the Board of Directors. +Under the terms of Agreement No. 1, the Company will be obligated to pay $9 on a weekly basis until the purchase price of $350 has been paid in full. In connection with entering into Agreement No. 1, the Company paid a $10 origination fee. Under the terms of Agreement No. 2, the Company will be obligated to pay $34 on a weekly basis until the purchase price of $1,250 has been paid in full. In connection with entering into Agreement No. 2, the Company paid a $37 origination fee. +F-61 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +On January 18, 2018, the Company and Libertas Funding LLC ( “Libertas” ), entered into a future receivables sale agreement pursuant to which the Company sold the rights of up to $594 in future receivables of the Company for $400. If the Company pays Libertas by March 18, 2018, the purchased amount will be discounted to $472. Until that date, no specific payment schedules are required. +On January 25, 2018, the Company entered into two agreements for the purchase and sale of future receipts with TVT, pursuant to which the Company sold up to (i) $562 in future receipts of the Company to TVT for a purchase price of $375 ( “Agreement No. 3” ) and (ii) $337 in future receipts of the Company for a purchase price of $225 ( “Agreement No. 4” ). The agreements have been personally guaranteed by Milton Ault, III, the Company’s Chief Executive Officer and Chairman of the Board of Directors. +Under the terms of Agreement No. 3, the Company will be obligated to pay $22 on a weekly basis until the purchase amount of $562 has been paid in full. In connection with entering into Agreement No.3, the Company paid an origination fee in the amount of $11. Agreement No. 3 also includes a warrant to purchase 56,250 shares of the Company’s common stock at an exercise price of $2.25 per share and a warrant to purchase 35,000 shares of the Company’s common stock at an exercise price of $2.50 per share. Under the terms of Agreement No. 4, the Company will be obligated to pay $13 on a weekly basis until the purchase amount of $337 has been paid in full. In connection with entering into Agreement No.4, the Company paid an origination fee in the amount of $7. Agreement No. 4 also includes warrants to purchase 56,250 shares of the Company’s common stock at an exercise price of $2.25 per share. +On January 25, 2018, the Company and Philou, as guarantor, entered into a future receivables sale agreement with Libertas, pursuant to which the Company sold up to $148 in future receivables of the Company to Libertas for a purchase price of $100. The Company will be obligated to pay $9 on a weekly basis until the purchase amount of $148 has been paid in full. In connection with entering into agreement, Libertas received an additional discount for due diligence in the amount of $3. The agreement also includes warrants to purchase 125,000 shares of the Company’s common stock at an exercise price of $2.50 per share. +On March 23, 2018, the Company entered into two agreements for the purchase and sale of future receipts with C6 Capital, LLC ( “C6” ), pursuant to which the Company sold up to (i) $979 in future receipts of the Company to TVT for a purchase price of $700 ( “Agreement No. 3” ) and (ii) $420 in future receipts of the Company for a purchase price of $300 ( “Agreement No. 4” ). The agreements have been personally guaranteed by Milton Ault, III, the Company’s Chief Executive Officer and Chairman of the Board of Directors. Under the terms of these two agreements, the Company will be obligated to pay $37 on a weekly basis until the purchase amount of $1,399 has been paid in full. In connection with entering into these two agreements, the Company paid an origination fee in the amount of $20. +On March 27, 2018, the Company entered into a future receivables sale agreement with Libertas, pursuant to which the Company sold up to $552 in future receivables of the Company to Libertas for a purchase price of $400. In connection with entering into this agreement, the Company paid an origination fee in the amount of $12. As additional consideration, the Company also issued to Libertas 150,000 shares of its common stock. This agreement has been personally guaranteed by Milton Ault, III, the Company’s Chief Executive Officer and Chairman of the Board of Directors. +Promissory Notes +On January 25, 2018, the Company issued two 5% promissory notes, each in the principal face amount of $2,500 for an aggregate debt of $5,000 to two institutional investors. The entire unpaid balance of the principal and accrued interest on each of the 5% Promissory Notes is due and payable on February 23, 2018, subject to a 30-day extension available to the Company. The proceeds from the promissory notes was used to purchase 1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with the Company’s mining operations. The Company received delivery of the Miners on February 1, 2018. On March 23, 2018, the Company paid $750 to each investor under the 5% promissory notes. On March 27, 2018, the Company paid the balance of the principal and accrued interest on each of the 5% promissory notes. +F-62 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +On February 20, 2018, the Company issued a promissory note in the principal face amount of $900 to an accredited investor. This promissory note included an OID of $150 resulting in net proceeds to the Company of $750. The principal and OID on this note was due and payable on March 22, 2018. On March 23, 2018, the parties entered into a new promissory note in the principal amount of $1,750 for a term of two months, subject to the Company’s ability to prepay within one month. The interest rate payable on this new promissory note shall be twenty percent per thirty calendar days, payable in a lump sum on the maturity date. The Company also issued to the lender a warrant to purchase 1,250,000 shares of common stock at an exercise price of $1.15 per share, pursuant to a consulting agreement. The principal amount of the new promissory note consisted of net proceeds of $1,000 and the cancellation of the principal of $750 from the February 20, 2018 promissory note. The interest on the February 20, 2018 note in the amount of $150 was paid to the lender. +On February 26, 2018, the Company issued a 10% promissory note in the principal face amount of $330 to an accredited investor. This promissory note included an OID of $30 resulting in net proceeds to the Company of $300. The principal and accrued interest on this note is due and payable on April 12, 2018, subject to a 30-day extension available to the Company. +On March 27, 2018, the Company issued a 10% promissory note in the principal face amount of $200 to an accredited investor . The principal and accrued interest on this note is due and payable on March 29, 2018. +On March 23, 2018, the Company entered into a securities purchase agreement to sell and issue a 12% promissory note and a warrant to purchase shares 300,000 shares of common stock to an accredited investor. The promissory note has been issued at a 10% original issue discount. The promissory note is in the principal amount of $1,000 and was sold for $900, bears interest at 12% simple interest on the principal amount, and is due on June 22, 2018. Interest only payments are due, in arrears, on a monthly basis commencing on April 23, 2018. The exercise price of the warrant is $1.15 per share. The promissory note is unsecured by any assets of the Company but is guaranteed by the Company’s Chief Executive Officer pursuant to a Guaranty Agreement. +Convertible Promissory Notes +On January 23, 2018, the Company entered into a securities purchase agreement with an institutional investor to sell, for an aggregate purchase price of $1,000, a 10% Senior Convertible Promissory Notes with an aggregate principal face amount of $1,250, a warrant to purchase an aggregate of 625,000 shares, subject to adjustment, of the Company’s common stock. The promissory note is convertible into shares of common stock at $2.00 per share, subject to adjustment. The exercise price of the warrant is $2.20 per share, subject to adjustment. +At The Market Offering +On February 27, 2018, the Company entered into a sales agreement with H.C. Wainwright & Co., LLC ( “HCW” ) to sell shares of its common stock, having an aggregate offering price of up to $50,000 from time to time, through an “at the market offering” program (the “ ATM Offering ”) under which HCW will act as sales agent. As of April 16, 2018, we had received net proceeds of $7,121 through the sale of 6,648,538 shares of our common stock through the ATM Offering. +The offer and sale of the shares through the ATM Offering will be made pursuant to the Company’s effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated February 27, 2018. +F-63 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +The Company will pay to HCW a commission in an amount equal to 5.0% of the gross sales price per share of common stock sold through it as sales agent under the sales agreement. In addition, the Company has agreed to reimburse HCW for certain expenses it incurs in the performance of its obligations under the sales agreement up to a maximum of $60 and $5 each calendar quarter. +Other Agreements +On March 8, 2018, Super Crypto Mining, Inc. (“SCM”), the Company’s wholly owned subsidiary, entered into an asset purchase agreement with Blockchain Mining Supply & Services Ltd. (“BMSS”). Pursuant to this agreement, SCM has agreed to acquire 1,100 Antminer S9s (the “Miners”) manufactured by Bitmain Technologies, Inc. (the “Bitmain”), in connection with SCM’s mining operations, from BMSS. Pursuant to the agreement, SCM will pay an aggregate of $3,200,000 to BMSS for the Miners.The Company intends to fund SCM’s acquisition of the Miners though the proceeds derived from its ongoing ATM Offering. +On March 22, 2018, SCM entered into a Master Services Agreement with a U.S. based entity, whereby SCM secured the right to 25 megawatts of power in support of SCM’s operations. +On April 13, 2018, the Company and Milton C. Ault, III, the Company’s Chief Executive Officer, entered into an Amended and Restated Independent Contractor Agreement pursuant to which the parties thereto agreed to amend and restate that certain Independent Contractor Agreement dated September 22, 2016, by and between the Company and Mr. Ault. In accordance with the terms set forth in the Agreement, Mr. Ault shall continue to serve as the Company’s Chief Executive Officer and Chairman of the Board of Directors in consideration of a monthly fee of $33,333.00, effective November 15, 2017. The Agreement shall terminate on April 30, 2018, and may be renewed on a monthly basis by written agreement between the parties thereto. +Issuances of Common Stock for Services +Between January 1, 2018 and February 7, 2018, the Company issued an aggregate of 1,683,059 shares of its common stock as payment for services to its consultant. The shares were valued at $3,179, an average of $1.89 per share. +Issuances of Common Stock upon Exercise of Stock Options +During January 2018, the Company issued a total of 60,000 shares of its common stock upon the cash exercise of options to purchase an aggregate of 60,000 shares of its common stock. These options were issued pursuant to the Company’s Plans. The Company received cash of $98 as a result of these option exercises. +F-64 \ No newline at end of file diff --git a/raw/filings/0000896493/2017/0001214659-18-002858/filing_metadata.csv b/raw/filings/0000896493/2017/0001214659-18-002858/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..53fa59d95c469919088819e1bc60902057713604 --- /dev/null +++ b/raw/filings/0000896493/2017/0001214659-18-002858/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2018-04-17,2017-12-31,2018-04-17T21:17:59.000Z,0001214659-18-002858,dpw33018010k.htm,,2856562,0,0,https://www.sec.gov/Archives/edgar/data/896493/000121465918002858/dpw33018010k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465918002858/,2017,2017,1 diff --git a/raw/filings/0000896493/2017/0001214659-18-002858/item1.txt b/raw/filings/0000896493/2017/0001214659-18-002858/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..a05e399e10758446c91e7d089f6a6aa801f06148 --- /dev/null +++ b/raw/filings/0000896493/2017/0001214659-18-002858/item1.txt @@ -0,0 +1,101 @@ +ITEM 1. +BUSINESS +General +We are a growth company seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy which we began implementing upon the change in control that was completed in September 2016. Our acquisition and development target strategy include companies that have developed a “new way of doing business” in mature, well-developed industries experiencing changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; companies whose business is related to our core business in the commercial and defense industries; and companies that will enhance our overall revenues. It is our goal to substantially increase our gross revenues in the near future. +We operate as a holding company with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed an investment company under the Investment Company Act of 1940, as amended (the "Investment Company Act" ). Generally, this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets will be invested in investment securities as such term is defined in the Investment Company Act. We are a diversified holding company owning subsidiaries engaged in the following operating businesses: commercial and defense solutions, commercial lending, cryptocurrency blockchain mining and advanced textile technology. We also maintain a large investment in Avalanche International, Corp., which is doing business as MTIX International. +Originally, we were primarily a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system solutions for the medical, military, telecom and industrial markets. Although we are actively seeking growth through acquisitions, we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. +We have operations located in Europe through our wholly-owned subsidiary, Digital Power Limited (“ DP Limited ”), Salisbury, England, which operates under the brand name of “Gresham Power Electronics” (“ Gresham ”). DP Limited designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products. +ii +On November 30, 2016, DPW Holdings formed Digital Power Lending, LLC (“ DP Lending ”), a wholly-owned subsidiary. DP Lending is engaged in providing commercial loans to companies throughout the United States to provide them with operating capital to finance the growth of their businesses. The loans will range in duration from six months to three years, DP Lending operates under California Finance Lending License #60DBO-77905. +On June 2, 2017, DPW Holdings purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is a design-to-manufacture original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. Microphase is headquartered in Shelton, Connecticut. +On April 25, 2017, DPW Holdings formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. The Company intends to operate its existing businesses in the customized and flexible power system solutions for the medical, military, telecom, commercial and industrial markets, other than the European markets which are primarily served by DP Limited, in Coolisys. The Company intends to transfer Digital Power North American operations, Digital Power Ltd. (“Gresham Power”), and Microphase Corporation as subsidiaries of Coolisys. +Further, on September 1, 2017, Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an extended sales organization for the Company’s overall flexible power system solutions. +We are a Delaware corporation, initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located in Silicon Valley at 48430 Lakeview Blvd, Fremont, California 94538-3158. Our phone number is 510-657-2635 and our website address is www.dpwholdings.com . +Recent Events +On September 18, 2017, the Board of Directors of Digital Power Corporation voted unanimously to recommend a number of proposals to be voted upon at its annual meeting (the “ Meeting ”), including a proposal to approve a change in domicile from California to Delaware (the “ Reincorporation ”). On December 27, 2017, Digital Power Corporation approved the Agreement and Plan of Merger (the “ Merger Agreement ”) providing for the merger (the “ Merger ”) of Digital Power Corporation with and into its wholly owned subsidiary DPW Holdings, Inc. (the “ Company ” or “ DPW ”). The Reincorporation, was approved at the Meeting, which was held on December 28, 2017. +The Reincorporation was consummated on December 29, 2017 pursuant to the Merger Agreement, whereby Digital Power Corporation merged with and into the Company with the Company as the surviving corporation operating as DPW Holdings, Inc. Following the Merger, the Company’s corporate existence is governed by the laws of the State of Delaware. +Upon consummation of the transactions contemplated by the Merger Agreement and resulting Reincorporation, the daily business operations of the Company continued as they were conducted by Digital Power Corporation immediately prior to the Reincorporation and the officers and directors of Digital Power Corporation became the officers and directors of the Company, except that Milton C. Ault III become the Company’s Chief Executive Officer and Amos Kohn remained as its President. +In January 2018, we formed Super Crypto Mining, Inc. ( “SCM ”), a wholly-owned subsidiary. SCM was established to operate our newly formed cryptocurrency business, which is pursuing a variety of digital currency. We are mining the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin and Ethereum. +3 +On January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2.5 million for an aggregate debt of $5 million to two institutional investors. The proceeds from these two promissory notes were used to purchase 1,000 Antminer S9s (“ Miners ”) manufactured by Bitmain Technologies, Inc. in connection with our crypto mining operations. We received delivery of the Miners on February 1, 2018. +On February 27, 2018, we entered into a sales agreement with H.C. Wainwright & Co., LLC (“ HCW ”) to sell shares of our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the “ ATM Offering ”) under which HCW will act as sales agent. As of April 13, 2018, we had received net proceeds of approximately $7.1 million through the sale of 6,648,538 shares of our common stock through the ATM Offering. The offer and sale of the shares through the ATM Offering are made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated February 27, 2018. We believe that the ATM Offering will be a significant source of capital to fund our business strategy during 2018. +Strategy +Our strategy to increase revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business of power system solutions for the military / aerospace, medical and industrial-telecommunication industries, we have determined that significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient sales and marketing force as a result of deferring research and development of new products because of limited working capital, and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution companies. +Therefore, we believe that the best strategy for us and our shareholders is to invest in our core business to support releases of advanced new power technologies and to expand our customer base and market share in our major markets. To support the organic growth, we have hired a number of additional personnel and are investing to enhance our product offerings with state of the art technology. While we implement our new organic growth strategy, we are focusing on finding and acquiring companies that have developed new technology but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies that enhance our overall revenues. Further, as discussed below, we have made a recent investment in Avalanche International, Corp. which acquired the rights to a cost effective and environmentally friendly material synthesis technology for textile applications. +As a result of this strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase in infrastructure expenses and investing in companies that demonstrate revenue potential but are initially incurring losses, we anticipate continuing to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Led by our Chairman and CEO, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global impact. We also use a traditional methodology for valuing stocks that primarily looks for deeply depressed prices. Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve shareholder value, to acquiring a controlling interest or outright ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s CFO, to provide analysis and guidance on all acquisition targets and throughout the acquisition process. +4 +Core Business – Power Systems Solutions +We provide the highest density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and modify-standard product solutions and value-added services to diverse industries and markets including military/aerospace, medical and industrial- telecommunications. We believe that our solutions leverage a combination of low leakage power emissions, very high-power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy is to be the supplier of choice to companies, including OEMs, that require high-quality power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that supports all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom design cost-effective products. Our target market segments include the industrial telecommunication, medical, and military/aerospace industries. +Custom Power System Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution technology includes full Digital Signal Processing (“ DSP ”) control, digital load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customers’ unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for virtually any plausible need. In the design of custom power solutions, we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development of our intellectual property (“ IP ”) portfolio. We believe that this business model provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any platform across our diversified market segments. +Value-Added Services . In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus eliminating the need for complex, time-consuming and costly system integration. We believe that this value-added service is well suited to those OEMs that wish to reduce their vendor base and minimize their investment in manufacturing, which would lead to increased fixed costs. Given access to these value-added services, the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Markets +We sell our custom power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas the European marketplace is served through DPL, another wholly-owned subsidiary. +5 +We sell products to our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market share through 2018. +Commercial Customers . We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental conditions. +Military/Defense Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture our military products through a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ ITAR ”) and is certified to perform such manufacturing services. We are compliant with the ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned Aerial Vehicle) – Very lightweight power systems. +Our military products meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary DPL develops and manufactures some military and defense products mainly being deployed in international naval fleets. +Digital Power Limited (Gresham Power Electronics) +Digital Power Limited, our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom, designs, manufactures, and distributes switching power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters for the commercial and military markets, under the name Gresham Power Electronics (“ Gresham ”). Frequency converters manufactured by Gresham are used by naval warships to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +6 +Microphase Corporation +Microphase designs, manufactures and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication systems. Such components include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s customers are comprised of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors and sub-contractors. Microphase’s recent technology innovations are used in many significant U.S. Government defense programs, including the Polaris submarine, the F-16, the F-35 and the Predator drone. Other notable programs in which Microphase’s products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile System, THAAD (or Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint strike fighter plane, and more recently drone programs including the Predator, the Reaper and the Shadow. +Microphase’s advanced technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in order to accurately recover the signals and facilitate use of the information received. These products include: +· +filters that sort and clarify microwave signals, including multiplexers that are a series of filters combined in a single package; +· +solid state amplifiers that amplify microwave signals; +· +detectors and limiters that are semiconductor devices for detection of radar signals and protection of receivers from damage from high power signals and jamming; +· +detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal detection systems; +· +integrated assemblies that combine multiple functions from a range of components and devices, including transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction assemblies; +· +electronic test and measurement probes; +· +universal test and measurement test platforms and fixtures; and +· +utility probes and antenna probes. +Manufacturing and Testing +Consistent with our strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual downward pressure on selling prices. In order to achieve our low-cost manufacturing goals with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and in Asia. +We are continually improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within our customer applications. +Compliance with international safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“ RoHS ”), which restricts the use of six hazardous materials in the manufacturing of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), which determines collection, recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +7 +Some of our products are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating results. Further, additional restrictions or charges may in the future be imposed by the United States or any other foreign country. In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs that are funded and governed by the e U.S. Foreign Military Financing program. +Sales and Marketing +We market our products directly through our internal sales force as well as through our channel partners including independent manufacturer representatives and distributors. Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, the manufacturing representatives have the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving their marketing and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales for retention, payable after products are shipped to the customer in the assigned territory. Typically, either we or the manufacturing representatives are entitled to terminate the manufacturing representative agreement upon 30 days’ written notice. +We provide comprehensive collateral including product data sheets, participation in trade shows, and our websites, www.digipwr.com and www.microphase.com . We use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our websites and accessible to the marketplace. We will continue to enhance our websites by adding more features and functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and product development efforts are primarily directed toward developing new products in connection with custom product design and modification of our standard power systems to provide a broad array of individual models. +Our new custom product solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of our product development projects to engineering partners in order to achieve the best technological and product design results for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the shelf (“ COTS ”) products and for other customized product requirements, when applicable. We continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering integrating laboratory located in California. +8 +Competition +The power system solutions industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products superior or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number of output product design platforms. We believe we have a competitive position with our targeted customers that need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very low non-recurring engineering (“ NRE ”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE expenses. +The markets in which Microphase operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors are larger than it is and maintain higher levels of expenditures for research and development. Principal competitive factors in Microphase’s markets are product quality and reliability; technological capabilities; service; past performance; ability to develop and implement complex, integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales channels in international markets; and cost-effectiveness. +In the RF Communications market, principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, MD; RS Microwave, a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith Group, a global technology company listed on the London Stock Exchange; and Delta Diversified Products, a private company based in Arizona. +In the Video amplifier segment, principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately held company headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, a privately held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company based in New York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +9 +Raw Materials +The raw materials for power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +In conjunction with our majority acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade name, which has been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +Research and Development +During the years ended December 31, 2017 and 2016, we spent approximately $1,120,000 and $709,000, respectively, on research and development. +Employees +As of December 31, 2017, we had 77 employees located in the United States and the United Kingdom, of whom 29 were engaged in engineering and product development, 13 in sales and marketing, 19 in general operations and 16 in general administration and finance. All but three of these employees are employed on a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be good. +10 \ No newline at end of file diff --git a/raw/filings/0000896493/2017/0001214659-18-002858/item13.txt b/raw/filings/0000896493/2017/0001214659-18-002858/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..37de5c790f3545f012f79cd93527c6a25143014b --- /dev/null +++ b/raw/filings/0000896493/2017/0001214659-18-002858/item13.txt @@ -0,0 +1,34 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information sets forth certain related transactions between us and certain of our shareholders or directors. Prior to September 22, 2016, Telkoor was our largest shareholder and Telkoor’s Chief Executive Officer, Benzi Diamant, was our Chairman of the Board. Effective September 22, 2016, Telkoor sold all of its shares of common stock of the Company to Philou Ventures, and as a result, Philou Ventures is our largest shareholder. Philou Ventures’ Manager is Kristine L. Ault, a former director. Ms. Ault is the spouse of Milton C. Ault, III, who is our Chief Executive Officer and Chairman of the Board. +Telkoor Telecom, Ltd. +As previously disclosed, on September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, and Telkoor pursuant to which Philou agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock. In consideration for such shares, Philou agreed to pay Telkoor $1.5 million. +71 +In conjunction with the securities purchase agreement, we entered into a rescission agreement with Telkoor in order to resolve all financial issues between the parties, including the repurchase by Telkoor of 1,136,666 shares of common stock of Telkoor beneficially owned by us for book value of $90,000. +Finally, as part of the securities purchase agreement, we have agreed to pay Mr. Diamant $7,500 for a period of eighteen months from September 5, 2016 for consulting services. +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest then shareholder, Telkoor, of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor sold its assets, including its subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the “ Manufacturing Agreement ”) with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016, Telkoor sold all its commercial IP to Advice Electronics Ltd. (“ Advice ”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under our branding until December 2020. +Philou Ventures, LLC +On March 9, 2017, we entered into a Preferred Stock Purchase Agreement (the “ Purchase Agreement ”) with Philou Ventures. Philou Ventures is the Company’s largest stockholder and Kristine L. Ault, a former director, controls and is a Manager of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures may invest up to $5,000,000 in us through the purchase of Series B Preferred Stock (“ Preferred Stock ”) over the Term, as specified herein. Each share of Preferred Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guarantees to purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE American. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares of Preferred Stock in a sufficient amount in order us to meet the NYSE American’s minimum stockholders’ equity continued listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “ Guaranteed Purchases ”). In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of Preferred Stock, up to the 500,000 share maximum (“ Voluntary Purchases ”). All consideration for Voluntary Purchases shall be delivered through a series of varying payments (“ Payments ”) by Philou Ventures, at its sole and absolute discretion, during the period commencing on the closing date and ending 36 months therefrom (the “ Term ”). We have the right to request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining the minimum stockholders’ equity required by the NYSE American. The Preferred Stock shall not be callable by us for 25 years from the closing date. +72 +In addition, for each share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price equal to $0.70 per share of common stock +Further, Philou Ventures shall have the right to participate in our future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest. Philou Ventures’ right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +On December 29, 2016, MCKEA Holdings, LLC ( “ MCKEA ”) lent us $250,000 in the form of a demand note bearing simple interest at 6.0%. MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling shareholder. Kristine L. Ault , a former director and the wife of Milton C. Ault III, Chief Executive Officer and Chairman of the Company’s Board of Directors , is the manager and owner of MCKEA. On March 24, 2017, MCKEA cancelled the $250,000 demand note to purchase 25,000 shares of Preferred Stock and received warrants to purchase 357,143 shares of common stock at $0.70 per share. +On March 20, 2017, Philou arranged for the Company to receive a $250 short-term loan. Between May 5, 2017 and June 2, 2017, Philou purchased an additional 75,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the cancellation of the Company debt due to Philou from the $250 short term loan and cash of $500. In addition, Philou received warrants to purchase 1,071,429 shares of common stock at an exercise price of $0.70 per share of common stock. +Avalanche International, Corp. +On October 5, 2016, November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with Avalanche (the “ AVLP Notes ”) in the principal amount of $525,000 each. The AVLP Notes included a 5% original issue discount, resulting in net loans to Avalanche of $1,500,000 and an original issue discount of $75,000. The AVLP notes accrued interest at 12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of Avalanche at approximately $0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 shares of the Company’s common stock . During the period from March 29, 2017 to August 16, 2017, the Company funded $1,808,952 in excess of the $1,500,000 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, the Company and Avalanche entered into a Loan and Security Agreement (“ AVLP Loan Agreement ”) with an effective date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to $5,000,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019. +In consideration of entering into the AVLP Loan Agreement, the Company and Avalanche cancelled the AVLP Notes and consolidated the AVLP Notes and prior advances totaling $3,308,952 plus original issue discount of $165,448 and issued a new Convertible Promissory Note in the aggregate principal amount of $3,474,400 (the “ New Note ”) that is convertible into shares of Avalanche at a conversion price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior interest accrued under the AVLP Notes and advances will continue to be an obligation of Avalanche. The New Note contains standard events of defaults. In addition, concurrent to issuing the New Note, Avalanche issued to the Company a five-year warrant to purchase 6,948,800 shares of Avalanche Common Stock at $0.50 per share. Future advances under the AVLP Loan Agreement, which totaled $649,820 at December 31, 2017, are evidenced by a convertible promissory note containing a conversion price feature of $0.50 per share and warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by Avalanche are secured by the assets of AVLP. +73 +At December 31, 2017, the Company had provided Avalanche with $4,124,220 pursuant to the non-revolving credit facility. The warrants issued in conjunction with the non-revolving credit facility entitles the Company to purchase up to 8,248,440 shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Avalanche is a holding company which on August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended on July 13, 2017 and August 21, 2017 (the “ Exchange Agreement ”) with MTIX Ltd., a company formed under the laws of England and Wales (“ MTIX ”) and the three (3) shareholders of MTIX (the “ Sellers ”), Avalanche completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, Avalanche acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “ MTIX Shares ”) by the Sellers to Avalanche in exchange (the “ Exchange ”) for the issuance by Avalanche of: (a) 7% secured convertible promissory notes (individually, a “ Note” and collectively, the “Notes ”) in the aggregate principal face amount of $9,500,000 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages of MTIX’s ordinary shares, (b) (i) $500,000 in cash, $50,000 of which was paid on October 26, 2016, and (ii) 100,000 shares of Avalanche’s newly designated shares of Class B Convertible Preferred Stock (the “ Class B Shares ”) to the principal shareholder of MTIX (the “ Majority Shareholder ”). +Milton C. Ault, III and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors, are directors of Avalanche. In addition, Philou Ventures is the controlling shareholder of Avalanche as well as our largest shareholder. +MTIX Limited +MTIX has developed a novel cost effective and environmentally friendly material synthesis technology for textile applications. Designed for global textile manufacturers, the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system uses a combination of plasma and photonic energy to effect material synthesis of a substrate surface. The laser and gasses from the system deliver a dry process to enhance the surface of fabric. During March 2017 the Company was awarded a 3-year, $50 million contract by MTIX to manufacture, install and service the MLSE plasma-laser system. The Company has recognized $923,751 in revenue from MTIX, all of which was reflected as accounts receivable, related party at December 31, 2017. +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson & Sons (Huddersfield) Limited (the “ Holder ”), pursuant to which the Company issued to the Holder, (a) a convertible promissory note in the principal amount of $600,000 (“ Note A ”), and (b) a convertible promissory note in the principal amount of $1,667,766 (“ Note B ”), in exchange for cancellation of (i) an outstanding loan made by the Holder to MTIX in the amount of $265,666; and (ii) cancellation of an aggregate of $2,002,500 owed by MTIX to the Holder pursuant to an Agreement for the Sale and Purchase of a Textile Multi-Laser Enhancement Technology Machine dated as of July 21, 2017 by and between MTIX and the Holder. +Note A is convertible into the Company’s common stock at a conversion price of $1.00 per share, does not bear interest, and matures two years from issuance. Note B is convertible into the Company’s common stock at a conversion price of $0.85 per share, does not bear interest, and matures two years from issuance. However, the Holder shall not have the right to convert any portion of Note B, following receipt by the Holder of an aggregate of $2,267,766 of gross proceeds from the sale of shares of Common Stock issued upon conversion of Note A or Note B. +During December 2017, the Company issued 600,000 shares of its common stock upon the conversion of Note A and the Holder notified the Company that gross proceeds during the month of December 2017 from sales of the 600,000 shares of common stock were sufficient to satisfy the entire $2,267,766 obligation. As a result of entering into the exchange agreement with the Holder, MTIX is obligated to pay the Company $2,668,266, consisting of the amount of the exchange agreement of $2,267,766 and a value added tax of $400,500 from the sale of the Textile Multi-Laser Enhancement Technology Machine . +74 \ No newline at end of file diff --git a/raw/filings/0000896493/2017/0001214659-18-002858/item9a.txt b/raw/filings/0000896493/2017/0001214659-18-002858/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..7c9617b23088ec5c25f5d785df4eec04cd6084a5 --- /dev/null +++ b/raw/filings/0000896493/2017/0001214659-18-002858/item9a.txt @@ -0,0 +1,26 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2017, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”). We have established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure. +Based upon that evaluation, our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our disclosure controls and procedures were not effective due to certain material weaknesses as described herein. +A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has identified the following two material weaknesses: +1. +We do not have sufficient resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a material weakness +2. +We have inadequate controls to ensure that information necessary to properly record transactions is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +Planned Remediation +Management, in coordination with the input, oversight and support of our Board of Directors, has identified the measures below to strengthen our control environment and internal control over financial reporting. +Until such time as we hire a new Chief Financial Officer, the Chairman of the Audit Committee shall perform the following: +· +assists with documentation and implementation of policies and procedures and monitoring of controls, +· +reviews all anticipated transactions that are not considered in the ordinary course of business to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s financial statements. +We are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. +60 +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) in Internal Control-Integrated 2013 Framework. The 2013 Framework is expected to help organizations design and implement internal control in light of many changes in business and operating environments since the issuance of the original framework, broaden the application of internal control in addressing operation and reporting objectives, and clarify the requirements for determining what constitutes effective internal controls. Our management has concluded that, as of December 31, 2017, our internal control over financial reporting was not effective. +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Changes in Internal Control over Financial Reporting +During the most recent fiscal quarter 2017 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2017/0001214659-18-002858/rp_note.txt b/raw/filings/0000896493/2017/0001214659-18-002858/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..32ab57b8d1ea5dbe3bddeb8f07698113a92c0b53 --- /dev/null +++ b/raw/filings/0000896493/2017/0001214659-18-002858/rp_note.txt @@ -0,0 +1,51 @@ +25. RELATED PARTY TRANSACTION +a. +In anticipation of the acquisition of MTIX Ltd., an advanced materials and processing technology company located in Huddersfield, West Yorkshire, UK ( “MTIX” ) by AVLP and the expectation of future business generated by the Company from a strategic investment into AVLP, on October 5, 2016, November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with AVLP (the “AVLP Notes” ) in the principal amount of $525 each. The AVLP Notes included a 5% original issue discount, resulting in net loans to AVLP of $1,500 and an original issue discount of $75. The AVLP notes accrued interest at 12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of AVLP at approximately $0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 shares of the Company’s common stock . During the period from March 29, 2017 to August 16, 2017, the Company funded $1,809 in excess of the $1,500 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, the Company and AVLP entered into a Loan and Security Agreement ( “AVLP Loan Agreement” ) with an effective date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to $5,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019, subject to the terms and conditions stated in the Loan Agreement, including that the Company having available funds to grant such credit. +In consideration of entering into the AVLP Loan Agreement, the Company and AVLP cancelled the AVLP Notes and consolidated the AVLP Notes and prior advances totaling $3,309 plus original issue discount of $165 and issued a new Convertible Promissory Note in the aggregate principal amount of $3,474 (the “New Note” ) that is convertible into shares of AVLP at a conversion price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior interest accrued under the AVLP Notes and advances will continue to be an obligation of AVLP. The New Note contains standard events of defaults. In addition, concurrent to issuing the New Note, AVLP issued to the Company a five-year Warrant to purchase 6,948,800 shares of AVLP Common Stock at $0.50 per share. Further, the Company made additional advances under the AVLP Loan Agreement in the aggregate amount of $649,820. At December 31, 2017, in aggregate, the Company has provided loans to AVLP in the principal amount $4,124,220 and AVLP has issued to the Company warrants to purchase 8,248,440 shares of AVLP common stock. Future advances under the AVLP Loan Agreement, if any, will be evidenced by a convertible promissory containing a conversion price feature at $0.50 per share and warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. +During the years ended December 31, 2017 and 2016, the Company also acquired in the open market 221,333 shares of AVLP common stock for $192 and 250,900 shares of AVLP common stock for $85, respectively. At December 31, 2017, the closing market price of AVLP’s common stock was $1.75. The Company has determined that its investment in AVLP marketable equity securities are accounted for pursuant to the fair value method and based upon the closing market price of common stock at December 31, 2017, the Company has recognized an unrealized gain of $550. +F-56 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +Philou is AVLP’s controlling shareholder. Mr. Ault is Chairman of AVLP’s Board of Directors and the Executive Chairman of the Company’s Board of Directors. Mr. William B. Horne is the Chief Financial Officer of AVLP and also the audit committee chairman of the Company. +On October 24, 2016, AVLP entered into a letter of intent to acquire MTIX and made an initial payment of $50 towards the purchase. On August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended on July 13, 2017 and August 21, 2017 (the “Exchange Agreement” ) with MTIX Limited, a company formed under the laws of England and Wales ( “MTIX” ) and the three (3) shareholders of MTIX (the “ Sellers ”), AVLP completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, AVLP acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “MTIX Shares” ) by the Sellers to AVLP in exchange (the “Exchange” ) for the issuance by AVLP of: (a) 7% secured convertible promissory notes (individually, a “Note” and collectively, the “Notes” ) in the aggregate principal face amount of $9,500 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages of MTIX’s ordinary shares, (b) (i) $500 in cash, $50, of which was paid on October 26, 2016, and (ii) 100,000 shares of AVLP’s newly designated shares of Class B Convertible Preferred Stock (the “Class B Shares” ) to the principal shareholder of MTIX (the “Majority Shareholder” ). +On the closing date, the fully-diluted AVLP shares shall be approximately 52 million shares of common stock, assuming that (i) the MTIX promissory notes are convertible into shares of AVLP common stock at a conversion price of $0.50 per share, (ii) the shares of AVLP Class B Convertible Preferred Stock are convertible into shares of AVLP common stock at a conversion rate of $0.50 per share and (iii) the issuance of stock options to purchase an aggregate of 531,919 shares of AVLP common stock to the members of the MTIX management group. +During March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the MLSE plasma-laser system. +During the year ended December 31, 2017, we recognized $174 in revenues resulting from our relationship with MTIX Limited, a company formed under the laws of England and Wales (“ MTIX ”). MTIX was acquired by Avalanche on August 22, 2017 and is therefore deemed to be a related party. In March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system. Management believes that the MLSE purchase order will be a source of revenue and generate significant cash flows for the Company . However, at December 31, 2017, the $924 in revenues had not yet been received and was reflected on the financial statements as accounts receivable, related party. +b. +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson two convertible promissory notes in the principal amount of $600 ( “Note A” ) and $1,668 ( “Note B” ), in exchange for cancellation of amounts due to WT Johnson by MTIX Ltd., a related party of the Company. +During December 2017, the Company issued 600,000 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently sold the 600,000 shares. The proceeds from the sale of Note A were sufficient to satisfy the entire $2,268 obligation as well as an additional $400 of value added tax due to WT Johnson. Concurrent with entering into the exchange agreement, the Company received a promissory note in the amount of $2,668 from MTIX. At December 31, 2017, the Company has valued the note receivable at $600, the carrying amount of Note A. The Company will recognize the remainder of the amount due from MTIX upon payment of the promissory note by MTIX . +F-57 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +c. +On September 22, 2016, the Company entered into consulting agreement with Mr. Ault to assist the Company in developing a business strategy, identifying new business opportunities, developing a capital raising program and implementing of a capital deployment program. For his services, Mr. Ault was paid $208 during the year ended December 31 , 2017 and $30 for the year ended December 31,2016 . +d. +On October 21, 2016, the Company entered into a 12% convertible secured note in the principal amount of $530 and warrants with the Barry Blank Living Trust, an existing stockholder of the Company, for $500 due on October 20, 2019. The principal amount of the 12% convertible secured note may be convertible into shares of the Company’s common stock at $0.55 per share. Subject to certain beneficial ownership limitations, the Barry Blank Living Trust may convert the principal amount of the convertible note at any time into common stock. During the year ended December 31, 2017 and 2016, the Company recorded interest expenses of $59 and $12, respectively, on the convertible note obligation. During the period from November 27, 2017 to December 6, 2017, the entire $530 of principal was satisfied through the issuance of 963,636 shares of the Company’s common. +e. +On December 29, 2016, the Company received a $250 short term loan from MCKEA. Kristine Ault, a director of the Company and the wife of Mr. Ault, is the managing member of MCKEA which, in turn, is the Manager of Philou, the majority stockholder of the Company. On March 24, 2017, the $250 loan was cancelled in consideration for the issuance of 25,000 shares of Series B preferred stock of the Company to Philou. During the year ended December 31, 2017 the Company recorded interest expenses of $3 on the short-term loan from MCKEA. +f. +In February 2017, the Company issued to eight accredited investors $400 in demand promissory notes bearing interest at a rate of 6% per annum. Of the eight accredited investors, one investor was deemed a related party. +g. +On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000 in the Company through the purchase of Series B Preferred Stock over 36 months. Between April 1, 2017 and June 2, 2017, Philou purchased 75,000 shares of Series B Preferred Stock pursuant to the terms of the Preferred Stock Purchase Agreement. Further, at December 31, 2017, Philou had made a $200 payment in the form of a short-term advance which will be converted into Series B Preferred Stock during the second quarter of 2018. +h. +On March 15, 2017, Company entered into a subscription agreement with a related party for the sale of 500,000 shares of common stock at $0.60 per share for the aggregate purchase price of $300. +i. +On March 20, 2017, the Company received a $250 short term loan from JLA Realty, an entity which owns 666,667 shares of the Company’s common stock, on behalf of Philou. The proceeds from this short-term loan comprised a portion of Philou’s purchase of Series B Preferred Stock. +j. +Between May 5, 2017 and June 30, 2017, the Company received additional short-term loans of $140 from four accredited investors of which $75 was from the Company’s corporate counsel, a related party. As additional consideration, the investors received five-year warrants to purchase 224,371 shares of common stock at a weighted average exercise price of $0.77 per share.On June 28, 2017, $52 in short-term loans that was received from the related party was converted into one of the Series C Units (See Note 18h) and on July 24, 2017, the remaining $23 in short-term loans was converted in 41,818 shares of the Company’s common stock in conjunction with the subscription agreements that the Company entered into with six investors (See Note 23). +k. +Between July 6, 2017 and December 31, 2017, Milton C. Ault, III, the Company’s Executive Chairman, personally guaranteed the repayment of (i) $2,585 to TVT Capital (ii) and $1,280 from the sale of the convertible promissory notes. These personal guarantees were necessary to facilitate the consummation of these financing transactions. Mr. Ault’s payment obligations would be triggered if the Company failed to perform under these financing obligations. Our board of directors has agreed to compensate Mr. Ault for his personal guarantees. The amount of annual compensation for each of these guarantees, which will be in the form of non-cash compensation, is approximately 2% of the amount of the obligation. +F-58 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2017 +U.S. dollars in thousands, except share and per share data +l. +During the year ended December 31, 2017, our President, Amos Kohn, purchased certain real property that will serve as a facility for the Company’s business operations in Israel. The Company made $300 of payments to the seller of the property and received a 28% undivided interest in the real property (“Property’). The Company’s subsidiary, Coolisys, entered into a Trust Agreement and Tenancy In Common Agreement with Roni Kohn, who owns a 72% interest in the Property, is the daughter of Mr. Kohn and is an Israeli citizen. The Property was purchased to serve as a residence/office facility for the Company in order to oversee its European operations and to expand its business in the hi-tech industry located in Israel. Pursuant to the Trust Agreement, the Ms. Kohn will hold and manage Coolisys’ undivided 28% interest in the Property. The trust will be in effect until it is terminated by mutual agreement of the parties. During the term of the trust, the Ms. Kohn will not sell, lease, sublease, transfer, grant, encumber, change or effect any other disposition with respect to the Property or the Coolisys’ interest without the Company’s approval. +Under the Tenancy In Common Agreement, Coolisys and its executive officers shall have the exclusive rights to use the Property for the Company and its affiliates’ business operations. The Property shall be managed by the Ms. Kohn. Further, pursuant to the Tenancy In Common Agreement, for each completed calendar month of employment of Mr. Kohn by the Company, Ms. Kohn shall have the right to purchase a portion of the Company’s interest in the Property. Such right shall fully vest at the end of five years of continuous employment and the Trustee shall have the right to purchase the Company’s 28% interest in the Property for a nominal value. The Company will amortize its $300 investment over ten years, subject to a cliff vesting after five years. In the event that Mr. Kohn is not employed by the Company, the Company shall have the right to demand that Ms. Kohn purchase the Company’s remaining interest in the Property that was not subject to vesting for the fair value market value of such unvested Property interest. +During the year ended December 31, 2017, DP Lending made loans to Alzamend Neuro, Inc. ( “Alzamend” ), in the amount of $44. AVLP is a party to a management services agreement pursuant to which Avalanche provides management, consulting and financial services to Alzamend. At December 31, 2017, the outstanding principal under these loans was $13. As additional consideration, the Company received a warrant to purchase 22,000 shares of Alzamend’s common stock at an exercise price of $0.30 per share of common stock. \ No newline at end of file diff --git a/raw/filings/0000896493/2017/0001214659-18-002858/rpt_disclosure.txt b/raw/filings/0000896493/2017/0001214659-18-002858/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..37de5c790f3545f012f79cd93527c6a25143014b --- /dev/null +++ b/raw/filings/0000896493/2017/0001214659-18-002858/rpt_disclosure.txt @@ -0,0 +1,34 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information sets forth certain related transactions between us and certain of our shareholders or directors. Prior to September 22, 2016, Telkoor was our largest shareholder and Telkoor’s Chief Executive Officer, Benzi Diamant, was our Chairman of the Board. Effective September 22, 2016, Telkoor sold all of its shares of common stock of the Company to Philou Ventures, and as a result, Philou Ventures is our largest shareholder. Philou Ventures’ Manager is Kristine L. Ault, a former director. Ms. Ault is the spouse of Milton C. Ault, III, who is our Chief Executive Officer and Chairman of the Board. +Telkoor Telecom, Ltd. +As previously disclosed, on September 5, 2016, we entered into a securities purchase agreement with Philou Ventures, and Telkoor pursuant to which Philou agreed to purchase all of Telkoor’s 2,714,610 shares of the common stock in the Company, constituting approximately 40.06% of the Company’s then outstanding shares of common stock. In consideration for such shares, Philou agreed to pay Telkoor $1.5 million. +71 +In conjunction with the securities purchase agreement, we entered into a rescission agreement with Telkoor in order to resolve all financial issues between the parties, including the repurchase by Telkoor of 1,136,666 shares of common stock of Telkoor beneficially owned by us for book value of $90,000. +Finally, as part of the securities purchase agreement, we have agreed to pay Mr. Diamant $7,500 for a period of eighteen months from September 5, 2016 for consulting services. +Purchase of IP by Digital Power Limited (“DPL”) from Telkoor Power Supplies (“TPS”) +On August 25, 2010, we and our wholly-owned subsidiary, DPL, entered into an agreement with TPS, a wholly-owned subsidiary of our largest then shareholder, Telkoor, of which Mr. Diamant is the Chief Executive Officer and controlling shareholder. Pursuant to such agreement, (1) TPS sold, assigned and conveyed to DPL all of its rights, title and interest in and to the intellectual property associated with the Compact Peripheral Component Interface 600 W AC/DC power supply series (the “Assets”) and (2) DPL granted to TPS an irrevocable license to sell the Assets in Israel on an exclusive basis. In consideration for the purchase of the Assets, DPL paid TPS $480,000. The consideration for the license provided to TPS to sell the Assets in Israel is a royalty fee of 15% of TPS's direct production costs of sales, due on a quarterly basis. In accordance with the agreement, the consideration for the IP may be reduced over a four-year period in the event annual sales for each year between 2011 and 2014 are less than a fixed threshold of units on an annual basis based upon an offset value per unit as described in the agreement. If there is a shortfall in sale of units in one annual period and in the subsequent period we sell more than the fixed unit threshold, this difference will be offset from any reduced consideration in any annual periods between 2011 and 2014. As a result of lower than anticipated sales by our DPL subsidiary of the Compact Peripheral Component Interface 600W AC/DC power supply series (CPCI 600W) through 2013, we amended our agreement with Telkoor (effective January 1, 2014 for the duration of the original agreement or until the shortfall of CPCI 600W product sales will be offset) to include additional products in addition to the original CPCI 600W product. As of December 31, 2015, the shortfall of sales of CPCI 600W products is greater than the outstanding royalties due. In January 2016, Telkoor sold its assets, including its subsidiary TPS, to Advice Electronics Ltd. Following this asset sale, the IP agreement between the Company and Telkoor was terminated. +Manufacturing Agreements with Telkoor and Advice Electronics Ltd. +On December 31, 2012, we entered into a Manufacturing Rights Agreement (the “ Manufacturing Agreement ”) with Telkoor, pursuant to which among other things, Telkoor granted us the non-exclusive right to directly place purchase orders for certain products from third party manufacturers for the purpose of marketing, selling and distributing the products for telecom, industrial, medical and military market segments in North and South America in consideration for the payment of royalty fees by us to Telkoor. The royalty fees paid by us to Telkoor under the Manufacturing Agreement are between 5% and 25%, depending on the product. The Manufacturing Agreement has a term of five years from the date of signature. During the agreement, Telkoor agreed not to directly or indirectly participate or engage or assist any other party in engaging or preparing to engage, our customers in North and South America in connection with the sale or distribution of any of the products under the Manufacturing Agreement. +In January 2016, Telkoor sold all its commercial IP to Advice Electronics Ltd. (“ Advice ”), an Israeli company. As part of the agreement with Advice, we entered into a new agreement with Advice, according to which our manufacturing rights for certain Telkoor products will be granted to us through August 2017 against royalty payments to Advice, after which we will be entitled to distribute the products under our branding until December 2020. +Philou Ventures, LLC +On March 9, 2017, we entered into a Preferred Stock Purchase Agreement (the “ Purchase Agreement ”) with Philou Ventures. Philou Ventures is the Company’s largest stockholder and Kristine L. Ault, a former director, controls and is a Manager of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures may invest up to $5,000,000 in us through the purchase of Series B Preferred Stock (“ Preferred Stock ”) over the Term, as specified herein. Each share of Preferred Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guarantees to purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE American. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares of Preferred Stock in a sufficient amount in order us to meet the NYSE American’s minimum stockholders’ equity continued listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “ Guaranteed Purchases ”). In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of Preferred Stock, up to the 500,000 share maximum (“ Voluntary Purchases ”). All consideration for Voluntary Purchases shall be delivered through a series of varying payments (“ Payments ”) by Philou Ventures, at its sole and absolute discretion, during the period commencing on the closing date and ending 36 months therefrom (the “ Term ”). We have the right to request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining the minimum stockholders’ equity required by the NYSE American. The Preferred Stock shall not be callable by us for 25 years from the closing date. +72 +In addition, for each share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price equal to $0.70 per share of common stock +Further, Philou Ventures shall have the right to participate in our future financings under substantially the same terms and conditions as other investors in those respective financings in order to maintain its then percentage ownership interest. Philou Ventures’ right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +On December 29, 2016, MCKEA Holdings, LLC ( “ MCKEA ”) lent us $250,000 in the form of a demand note bearing simple interest at 6.0%. MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling shareholder. Kristine L. Ault , a former director and the wife of Milton C. Ault III, Chief Executive Officer and Chairman of the Company’s Board of Directors , is the manager and owner of MCKEA. On March 24, 2017, MCKEA cancelled the $250,000 demand note to purchase 25,000 shares of Preferred Stock and received warrants to purchase 357,143 shares of common stock at $0.70 per share. +On March 20, 2017, Philou arranged for the Company to receive a $250 short-term loan. Between May 5, 2017 and June 2, 2017, Philou purchased an additional 75,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the cancellation of the Company debt due to Philou from the $250 short term loan and cash of $500. In addition, Philou received warrants to purchase 1,071,429 shares of common stock at an exercise price of $0.70 per share of common stock. +Avalanche International, Corp. +On October 5, 2016, November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with Avalanche (the “ AVLP Notes ”) in the principal amount of $525,000 each. The AVLP Notes included a 5% original issue discount, resulting in net loans to Avalanche of $1,500,000 and an original issue discount of $75,000. The AVLP notes accrued interest at 12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, to convert all or any portion of the principal and accrued interest into shares of common stock of Avalanche at approximately $0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 shares of the Company’s common stock . During the period from March 29, 2017 to August 16, 2017, the Company funded $1,808,952 in excess of the $1,500,000 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, the Company and Avalanche entered into a Loan and Security Agreement (“ AVLP Loan Agreement ”) with an effective date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to $5,000,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019. +In consideration of entering into the AVLP Loan Agreement, the Company and Avalanche cancelled the AVLP Notes and consolidated the AVLP Notes and prior advances totaling $3,308,952 plus original issue discount of $165,448 and issued a new Convertible Promissory Note in the aggregate principal amount of $3,474,400 (the “ New Note ”) that is convertible into shares of Avalanche at a conversion price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior interest accrued under the AVLP Notes and advances will continue to be an obligation of Avalanche. The New Note contains standard events of defaults. In addition, concurrent to issuing the New Note, Avalanche issued to the Company a five-year warrant to purchase 6,948,800 shares of Avalanche Common Stock at $0.50 per share. Future advances under the AVLP Loan Agreement, which totaled $649,820 at December 31, 2017, are evidenced by a convertible promissory note containing a conversion price feature of $0.50 per share and warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by Avalanche are secured by the assets of AVLP. +73 +At December 31, 2017, the Company had provided Avalanche with $4,124,220 pursuant to the non-revolving credit facility. The warrants issued in conjunction with the non-revolving credit facility entitles the Company to purchase up to 8,248,440 shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Avalanche is a holding company which on August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended on July 13, 2017 and August 21, 2017 (the “ Exchange Agreement ”) with MTIX Ltd., a company formed under the laws of England and Wales (“ MTIX ”) and the three (3) shareholders of MTIX (the “ Sellers ”), Avalanche completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, Avalanche acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “ MTIX Shares ”) by the Sellers to Avalanche in exchange (the “ Exchange ”) for the issuance by Avalanche of: (a) 7% secured convertible promissory notes (individually, a “ Note” and collectively, the “Notes ”) in the aggregate principal face amount of $9,500,000 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages of MTIX’s ordinary shares, (b) (i) $500,000 in cash, $50,000 of which was paid on October 26, 2016, and (ii) 100,000 shares of Avalanche’s newly designated shares of Class B Convertible Preferred Stock (the “ Class B Shares ”) to the principal shareholder of MTIX (the “ Majority Shareholder ”). +Milton C. Ault, III and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors, are directors of Avalanche. In addition, Philou Ventures is the controlling shareholder of Avalanche as well as our largest shareholder. +MTIX Limited +MTIX has developed a novel cost effective and environmentally friendly material synthesis technology for textile applications. Designed for global textile manufacturers, the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system uses a combination of plasma and photonic energy to effect material synthesis of a substrate surface. The laser and gasses from the system deliver a dry process to enhance the surface of fabric. During March 2017 the Company was awarded a 3-year, $50 million contract by MTIX to manufacture, install and service the MLSE plasma-laser system. The Company has recognized $923,751 in revenue from MTIX, all of which was reflected as accounts receivable, related party at December 31, 2017. +On December 5, 2017, the Company entered into an exchange agreement with WT Johnson & Sons (Huddersfield) Limited (the “ Holder ”), pursuant to which the Company issued to the Holder, (a) a convertible promissory note in the principal amount of $600,000 (“ Note A ”), and (b) a convertible promissory note in the principal amount of $1,667,766 (“ Note B ”), in exchange for cancellation of (i) an outstanding loan made by the Holder to MTIX in the amount of $265,666; and (ii) cancellation of an aggregate of $2,002,500 owed by MTIX to the Holder pursuant to an Agreement for the Sale and Purchase of a Textile Multi-Laser Enhancement Technology Machine dated as of July 21, 2017 by and between MTIX and the Holder. +Note A is convertible into the Company’s common stock at a conversion price of $1.00 per share, does not bear interest, and matures two years from issuance. Note B is convertible into the Company’s common stock at a conversion price of $0.85 per share, does not bear interest, and matures two years from issuance. However, the Holder shall not have the right to convert any portion of Note B, following receipt by the Holder of an aggregate of $2,267,766 of gross proceeds from the sale of shares of Common Stock issued upon conversion of Note A or Note B. +During December 2017, the Company issued 600,000 shares of its common stock upon the conversion of Note A and the Holder notified the Company that gross proceeds during the month of December 2017 from sales of the 600,000 shares of common stock were sufficient to satisfy the entire $2,267,766 obligation. As a result of entering into the exchange agreement with the Holder, MTIX is obligated to pay the Company $2,668,266, consisting of the amount of the exchange agreement of $2,267,766 and a value added tax of $400,500 from the sale of the Textile Multi-Laser Enhancement Technology Machine . +74 \ No newline at end of file diff --git a/raw/filings/0000896493/2018/0001214659-19-002759/filing.txt b/raw/filings/0000896493/2018/0001214659-19-002759/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..697b1142b5bc124b8030614b20978bd939ce9c0b --- /dev/null +++ b/raw/filings/0000896493/2018/0001214659-19-002759/filing.txt @@ -0,0 +1,9552 @@ +10-K +1 +dpw41019010k.htm +UNITED STATES SECURITIES +AND EXCHANGE COMMISSION +Washington, +D.C. 20549 +FORM 10-K +ANNUAL REPORT PURSUANT TO SECTION 13 +OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the Fiscal Year Ended December 31, +2018 +Commission file number 1-12711 +DPW HOLDINGS, +INC. +(Exact name of registrant as specified in +its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +201 Shipyard Way, Suite E Newport Beach, CA +92663 +(510) 657-2635 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered under Section 12(b) +of the Act: +Title of Each Class +Name of each exchange on which registered +Common Stock, $0.001 par value per share +NYSE American +Securities registered under Section 12(g) +of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No +þ +Indicate +by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange +Act. Yes ¨ No +þ +Indicate +by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the +Securities Exchange Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file +such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No +¨ +Indicate +by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant +to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that +the registrant was required to submit such files). Yes þ No +¨ +Indicate +by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is +not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information +statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨ +Indicate by check mark whether the registrant +is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth +company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting +company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ¨ +Accelerated filer ¨ +Non-accelerated filer ¨ +Smaller reporting company þ +Emerging growth company ¨ +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for +complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No +þ +As of June 29, 2018, the aggregate market +value of the registrant’s common stock held by non-affiliates of the registrant was $31,701,549 based on the closing sale +price as reported on the NYSE American of $10.84. Such determination should not be deemed an admission that such directors, +officers, or 10% beneficial owners are, in fact, affiliates of the registrant. +There were 23,189,615 shares of common +stock outstanding as of April 12, 2019. +Documents incorporated by reference: +None +1 +DPW HOLDINGS, INC. AND SUBSIDIARIES +FORM 10-K +FOR THE FISCAL YEAR ENDED DECEMBER 31, +2018 +INDEX +Page +PART I +Item 1. +Description of Business +3 +Item 1A. +Risk Factors +12 +Item 1B. +Unresolved Staff Comments +39 +Item 2. +Description of Properties +39 +Item 3. +Legal Proceedings +39 +Item 4. +Mine Safety Disclosures +40 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +40 +Item 6. +Selected Financial Data +42 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +42 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk. +50 +Item 8. +Financial Statements and Supplementary Data. +F-1 – F-76 +Item 9. +Changes in and Disagreements With Accountants on Accounting and Financial Disclosure +50 +Item 9A. +Controls and Procedures +50 +Item 9B. +Other Information +52 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +52 +Item 11. +Executive Compensation +5 6 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +61 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +62 +Item 14. +Principal Accountant Fees and Services +6 4 +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +65 +Item 16. +Form 10-K Summary +70 +S ignatures +71 +2 +NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “ Annual +Report ”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section +21E of the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. +We have attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” +“expects,” “can,” “continue,” “could,” “estimates,” “expects,” +“intends,” “may,” “plans,” “potential,” “predict,” “should” +or “will” or the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties +and other factors may cause our actual results, levels of activity, performance or achievements to be materially different from +any future results, levels or activity, performance or achievements expressed or implied by these forward-looking statements. Although +we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, +levels of activity, performance or achievements. Our expectations are as of the date this Annual Report is filed, and we do not +intend to update any of the forward-looking statements after the date this Annual Report is filed to confirm these statements to +actual results, unless required by law. +This Annual Report also contains estimates +and other statistical data made by independent parties and by us relating to market size and growth and other industry data. This +data involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have +not independently verified the statistical and other industry data generated by independent parties and contained in this Annual +Report and, accordingly, we cannot guarantee their accuracy or completeness, though we do generally believe the data to be reliable. +In addition, projections, assumptions and estimates of our future performance and the future performance of the industries in which +we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described +in “Risk Factors” and elsewhere in this Annual Report. These and other factors could cause results to differ materially +from those expressed in the estimates made by the independent parties and by us. +PART I +ITEM 1. BUSINESS +General +We are a growth company +seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy +which we began implementing upon the change in control that was completed in September 2016. Our acquisition and development target +strategy include companies that have developed a “new way of doing business” in mature, well-developed industries experiencing +changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; +companies whose business is related to our core business in the commercial and defense industries; and companies that will enhance +our overall revenues. We plan to substantially increase our gross revenues in the foreseeable future. +We operate as a holding +company with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed +an investment company under the Investment Company Act of 1940, as amended (the “ Investment Company Act ”). Generally, +this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total +assets will be invested in investment securities as such term is defined in the Investment Company Act. We +are a diversified holding company owning subsidiaries engaged in the following operating businesses: commercial and defense solutions, +commercial lending, cryptocurrency blockchain mining and advanced textile technology. We also maintain a large investment +in Avalanche International, Corp., which does business as MTIX International. +Originally, we were +primarily a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power +system solutions for the medical, military, telecom and industrial markets. Although we are actively seeking growth through acquisitions, +we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where +customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating +conditions. +We have operations +located in Europe through our wholly-owned subsidiary, Digital Power Limited (“ DP Limited ”), Salisbury, England, +which operates under the brand name of “Gresham Power Electronics” (“ Gresham ”). DP Limited designs, +manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power +distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European +defense business is specialized in the field of naval power distribution products. +3 +On November 30, 2016, +we formed Digital Power Lending, LLC (“ DP Lending ”), a wholly-owned subsidiary. DP Lending provides commercial +loans to companies throughout the United States to provide them with operating capital to finance the growth of their businesses. +The loans range in duration from six months to three years, DP Lending operates under California Finance Lending License #60DBO-77905. +On June 2, 2017, we +purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is +a design-to-manufacture original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio +frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies +and detector logarithmic video amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. +Microphase is headquartered in Shelton, Connecticut. +On April 25, 2017, +we formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. Coolisys operates its existing +businesses in the customized and flexible power system solutions for the medical, military, telecom, commercial and industrial +markets, other than the European markets which are primarily served by DP Limited, in Coolisys. We intend to reorganize our corporate +structure to make Digital Power North American operations, operated by our subsidiary Gresham, and Microphase, a subsidiary of +Coolisys and as such an indirect subsidiary of ours. +On September 1, 2017, +Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability +company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, +fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an +extended sales organization for our overall flexible power system solutions. +On +December 31, 2017, Coolisys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“MICT”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“EML”), +and Enertec Systems 2001 Ltd. (“Enertec”), an Israeli corporation and wholly owned subsidiary of EML, pursuant to which +Coolisys acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for the military +market. On May 23, 2018, Coolisys completed its acquisition of Enertec. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement to acquire 98.1% of I.AM, Inc. (“I.AM”), +for a purchase price of $981. I.AM owns and operates the Prep Kitchen brand restaurants located in the San Diego area. I.AM owed +DP Lending $1,715,330 in outstanding principal, pursuant to a loan and security agreement, between I.AM and DP Lending, that I.AM +used to acquire the restaurants. +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 201 Shipyard Way, Suite E Newport +Beach, CA 92663. Our phone number is 510-657-2635 and our website address is www.dpwholdings.com. +Recent Events +On September +18, 2017, the Board of Directors of Digital Power Corporation voted unanimously to recommend a number of proposals to be voted +upon at its annual meeting (the “ Meeting ”), including a proposal to approve a change in domicile from California +to Delaware (the “ Reincorporation ”). On December 27, 2017, Digital Power Corporation approved the Agreement +and Plan of Merger (the “ Merger Agreement ”) providing for the merger (the “ Merger ”) of Digital +Power Corporation with and into its wholly owned subsidiary DPW Holdings, Inc. (the “ Company ” or “ DPW ”). +The Reincorporation, was approved at the Meeting, which was held on December 28, 2017. +The +Reincorporation was consummated on December 29, 2017 pursuant to the Merger Agreement, whereby Digital Power Corporation merged +with and into the Company with the Company as the surviving corporation operating as DPW Holdings, Inc. Following the Merger, +the Company’s corporate existence is governed by the laws of the State of Delaware. +Upon +consummation of the transactions contemplated by the Merger Agreement and resulting Reincorporation, the daily business operations +of the Company continued as they were conducted by Digital Power Corporation immediately prior to the Reincorporation and the officers +and directors of Digital Power Corporation became the officers and directors of the Company, except that Milton C. Ault III become +the Company’s Chief Executive Officer and Amos Kohn remained as its President. +In +January 2018, we formed Super Crypto Mining, Inc., a wholly-owned subsidiary, which recently changed its name to Digital Farms, +Inc. (“ DFI ”). DFI was established to operate our newly formed cryptocurrency business, which is pursuing a variety +of digital currency. We mine the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin +and Ethereum. +On +January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2.5 million for an aggregate debt of +$5 million to two institutional investors. The proceeds from these two promissory notes were used to purchase 1,000 +Antminer S9s (“ Miners ”) manufactured by Bitmain Technologies, Inc. in connection with our crypto mining operations. +We received delivery of the Miners on February 1, 2018. +4 +On +February 27, 2018, we entered into a sales agreement with H.C. Wainwright & Co., LLC (“HCW”) to sell shares of +our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” +program (the “HCW ATM Offering”) under which HCW acted as sales agent. Through September 23, 2018, when the HCW ATM +Offering was terminated we had received net proceeds of approximately $18,059,187 through the sale of 1,062,096 shares of our common +stock through the HCW ATM Offering. The offer and sale of the shares through the ATM Offering were made pursuant to our then effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration +Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the +SEC on January 11, 2018, and a prospectus supplement related to the HCW ATM Offering, dated February 27, 2018. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I. AM, Inc. (“I. AM”), David +J. Krause and Deborah J. Krause. Pursuant to the securities purchase agreement, I. AM sold to DP Lending, 981 shares of common +stock for a purchase price of $981, representing, upon the closing, 98.1% of I. AM’s outstanding common stock. I. AM owns +and operates the Prep Kitchen brand restaurants located in the San Diego area. I.AM owed DP Lending $1,715,330 in outstanding principal, +pursuant to a loan and security agreement, between I. AM and DP Lending, which I. AM used to acquire the restaurants. The purchase +agreement provides that, as I. AM repays the outstanding loan to DP Lending in accordance with the loan agreement, DP Lending will +on a pro rata basis transfer shares of common stock of I. AM to David J. Krause, up to an aggregate of 471 shares. +On October 10, 2018, +DPW Holdings Inc. (the “Company”) entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) +with Wilson-Davis & Co., Inc., as sales agent (the “Agent”) to sell shares of its Common Stock, having an aggregate +offering price of up to $25,000,000 (the “Shares”) from time to time, through an “at the market offering” +program (the “WDCO ATM Offering”). Through April 1, 2019, when the WDCO ATM Offering was discontinued, we had received +net proceeds of $6,050,499 through the sale of 5,163,751 shares of our common stock through the WDCO ATM Offering. The offer and +sale of the shares through the WDCO ATM Offering were made pursuant to our then effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with +the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus +supplement related to the WDCO ATM Offering, dated October 15, 2018. +On March 14, 2019, +the stockholders approved a proposal permitting the Board of Directors to effect a reverse stock split (the “Reverse Split”) +of our issued and outstanding Common Stock. Thereafter, on March 14, 2019, the Board of Directors approved the Reverse Split with +a ratio of one for twenty. The Reverse Split did not affect the number of authorized shares of Common Stock or their par value +per share. As a result of the Reverse Split, the number of shares of Common Stock outstanding was reduced from 126,025,767 to 6,301,289. +The Reverse Split became effective in the State of Delaware on March 14, 2019. Beginning on March 18, 2019, the Common Stock traded +on the NYSE American on a split-adjusted basis. All references to Common Stock in this Annual Report have been retroactively restated. +On +March 29, 2019, we entered into an underwriting agreement with A.G.P./Alliance Global Partners (the “Underwriter”), +pursuant to which we agreed to issue and sell an aggregate of (a) 2,855,500 shares of Common Stock (the “Shares”) together +with warrants to purchase 2,855,500 shares of Common Stock and (the “Common Warrants”) and (b) pre-funded warrants +to purchase up to 12,700,000 shares of its Common Stock (the “Pre-Funded Warrants”) together with a number of +Common Warrants to purchase 12,700,000 shares of common stock (the “April 2019 Offering”). The Shares were sold to +the purchasers at the public offering price of $0.44 per share (the “Offering Price”). The Common Warrants +were sold at a public offering price of $0.01 per Common Warrant. The Pre-Funded Warrants were offered to each purchaser +whose purchase of the Shares and the Common Warrant in the April 2019 Offering would otherwise result in the purchaser, together +with its affiliates and certain related parties, beneficially owning more than 4.99% of outstanding Common Stock immediately following +the consummation of April 2019 Offering, in lieu of the Shares. The purchase price of each Pre-Funded Warrant equaled the Offering +Price, minus $0.01, and the exercise price of each Pre-Funded Warrant equaled $0.01 per share. +Strategy +Our strategy to increase +revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business +of power system solutions for the military/aerospace, medical and industrial-telecommunication industries, we have determined that +significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient +sales and marketing force as a result of deferring research and development of new products because of limited working capital, +and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution +companies. +5 +Therefore, we believe +that the best strategy for us and our stockholders is to invest in our core business to support releases of advanced new power +technologies and to expand our customer base and market share in our major markets. To support the organic growth, we have hired +a number of additional personnel and are investing to enhance our product offerings with state of the art technology. While we +implement our new organic growth strategy, we are focusing on finding and acquiring companies that have developed new technology +but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack +of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies +that enhance our overall revenues. Further, as discussed below, we have made an investment in Avalanche which acquired the rights +to a cost effective and environmentally friendly material synthesis technology for textile applications. +As a result of this +strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, +analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions +and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they +can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase +in infrastructure expenses and investing in companies that demonstrate revenue potential but are initially incurring losses, we +anticipate continuing to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Led by our Chairman +and CEO, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global impact. +We also use a traditional methodology for valuing stocks that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from +influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s Vice Chairman and CFO, to provide +analysis and guidance on all acquisition targets and throughout the acquisition process. +During the next several +years, we see a favorable opportunity to follow an activist strategy that centers on the purchase of target stock and the subsequent +removal of any barriers that might interfere with a friendly purchase offer from a strong buyer. Alternatively, in appropriate +circumstances, we or our subsidiaries may become the buyer of target companies, adding them to our portfolio of operating subsidiaries, +thereby expanding our operations through such opportunistic acquisitions. We believe that the companies that we target for our +activist activities are undervalued for many reasons, often including inexperienced management. Unfortunately for the individual +investor, in particular, and the economy, in general, many poor management teams are often unaccountable and very difficult to +remove. +Core Business – Power +Systems Solutions +We provide the highest +density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and +modify-standard product solutions and value-added services to diverse industries and markets including military/aerospace, medical +and industrial- telecommunications. We believe that our solutions leverage a combination of low leakage power emissions, +very high-power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy is to +be the supplier of choice to companies, including OEMs, that require high-quality power system solutions where custom design, superior +product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide +advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can +meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that supports all of their needs +for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation +in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom +design cost-effective products. Our target market segments include the industrial telecommunication, medical, and military/aerospace +industries. +Custom Power +System Solution. We provide high-grade custom power system solutions to several customers in multiple +industry segments. Our custom solution technology includes full Digital Signal Processing (“ DSP ”) control, digital +load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and +multiple outputs to meet each of our customers’ unique requirements. We combine our power design capabilities with the latest +circuit designs to provide complete power solutions for virtually any plausible need. In the design of custom power solutions, +we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with +any hosted platform. +Our standard contract +for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production +guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes +the development of our intellectual property (“ IP ”) portfolio. We believe that this business model +provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility +Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade +design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) +and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While +some of our customers have special requirements that include a full custom design, other customers may require only certain electrical +changes to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical +repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can +be easily integrated with any platform across our diversified market segments. +6 +Value-Added Services . +In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added +services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance +components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment +and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would +otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus +eliminating the need for complex, time-consuming and costly system integration. We believe that this value-added service is well +suited to those OEMs that wish to reduce their vendor base and minimize their investment in manufacturing, which would lead to +increased fixed costs. Given access to these value-added services, the OEMs do not need to build assembly facilities to manufacture +their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Markets +We sell our custom +power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse +range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our +current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve +the North American power electronics market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas +the European marketplace is served through DPL, another wholly-owned subsidiary. +We sell products to +our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our +sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship +with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding +new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional +sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market +share through 2019. +Commercial Customers . +We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of +applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally +extreme environmental conditions. +Military/Defense +Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the +ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications +and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture +our military products through a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ ITAR ”) +and is certified to perform such manufacturing services. We are compliant with the ITAR regulations and are an approved vendor +for the U.S. Air Force, Navy and Army. +At the core of every +military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will +operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, +function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; +Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications +and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned +Aerial Vehicle) – Very lightweight power systems. +Our military products +meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, +weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges +that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our +power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned +subsidiary DPL develops and manufactures some military and defense products mainly being deployed in international naval fleets. +Digital Power Limited (Gresham Power +Electronics) +Digital Power Limited, +our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom, designs, manufactures, and distributes switching +power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters for the commercial +and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships to convert +their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such +as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, +higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these +as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, +provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +7 +Microphase Corporation +Microphase designs, +manufactures and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication +systems. Such components include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, +switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s +customers are comprised of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors +and sub-contractors. Microphase’s recent technology innovations are used in many significant U.S. Government defense programs, +including the Polaris submarine, the F-16, the F-35 and the Predator drone. Other notable programs in which Microphase’s +products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile +System, THAAD (or Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, +EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint strike fighter plane, and more recently drone programs including +the Predator, the Reaper and the Shadow. +Microphase’s +advanced technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in +order to accurately recover the signals and facilitate use of the information received. These products include: +· filters that sort and clarify microwave signals, including multiplexers that are a series of filters +combined in a single package; +· solid state amplifiers that amplify microwave signals; +· detectors and limiters that are semiconductor devices for detection of radar signals and protection +of receivers from damage from high power signals and jamming; +· detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal +detection systems; +· integrated assemblies that combine multiple functions from a range of components and devices, including +transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction +assemblies; +· electronic test and measurement probes; +· universal test and measurement test platforms and fixtures; and +· utility probes and antenna probes. +Manufacturing and Testing +Consistent with our +strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of +flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers +to ensure that they will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships +will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power +supply industry has placed continual downward pressure on selling prices. In order to achieve our low-cost manufacturing goals +with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and +in Asia. +We are continually +improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and +consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test +procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies +right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within +our customer applications. +Compliance with international +safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. +Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements +and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract +manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where +specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we +market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“ RoHS ”), +which restricts the use of six hazardous materials in the manufacturing of certain electronic and electrical equipment, as well +as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), which determines collection, +recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements +in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components +may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +8 +Some of our products +are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only +the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export +of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject +to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for +products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating +results. Further, additional restrictions or charges may in the future be imposed by the United States or any other foreign country. +In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs +that are funded and governed by the U.S. Foreign Military Financing program. +Sales and Marketing +We market our products +directly through our internal sales force as well as through our channel partners including independent manufacturer representatives +and distributors. Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, +the manufacturing representatives have the opportunity to earn exclusive access to all potential customers in the assigned territory +as a result of achieving their marketing and sales goals as defined in the representative agreement. Our manufacturer representative +agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales +for retention, payable after products are shipped to the customer in the assigned territory. Typically, either we or the manufacturing +representatives are entitled to terminate the manufacturing representative agreement upon 30 days’ written notice. +We provide comprehensive +collateral including product data sheets, participation in trade shows, and our websites, www.digipwr.com and www.microphase.com. We +use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our websites +and accessible to the marketplace. We will continue to enhance our websites by adding more features and functionalities, such as +e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities +will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and +product development efforts are primarily directed toward developing new products in connection with custom product design and +modification of our standard power systems to provide a broad array of individual models. +Our new custom product +solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports +special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that +we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development +contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production +forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development +of our IP portfolio. +We also outsource some +of our product development projects to engineering partners in order to achieve the best technological and product design results +for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, +including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on +commercial off the shelf (“ COTS ”) products and for other customized product requirements, when applicable. We +continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market +demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) +filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and +customizing our existing product portfolio, using our engineering integrating laboratory located in California. +Competition +The power system solutions +industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located +throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer +products superior or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, +TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and +geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition +efforts with our customers. We also face competition from current and prospective customers who may decide to internally design +and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with +larger power supply manufacturers. +9 +We anticipate in the +current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could +thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell +our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by +providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously +improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our +power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the +latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume +ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures +to meet our customers’ requirements. +Another advantage of +our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a +selectable number of output product design platforms. We believe we have a competitive position with our targeted customers that +need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have +designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power +needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power +systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs +on “time to market.” It also results in very low non-recurring engineering (“ NRE ”) expenses. Because +of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s +specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE +expenses. +The markets in which +Microphase operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors +are larger than it is and maintain higher levels of expenditures for research and development. Principal competitive factors in +Microphase’s markets are product quality and reliability; technological capabilities; service; past performance; ability +to develop and implement complex, integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales +channels in international markets; and cost-effectiveness. +In the RF Communications +market, principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, +MD; RS Microwave, a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith +Group, a global technology company listed on the London Stock Exchange; and Delta Diversified Products, a private company based +in Arizona. +In the Video amplifier +segment, principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately +held company headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, +a privately held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company +based in New York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Raw Materials +The raw materials for +power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus +we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders +received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials +prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In +addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors +have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no +longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign +some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination +of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. +We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. +However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On +July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark +Office. +In conjunction with +our majority acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade +name, which has been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +10 +Research and Development +During the years ended +December 31, 2018 and 2017, we spent approximately $1,430,538 and $1,119,745, respectively, on research and development. +Employees +As of December 31, +2018, we had 248 employees located in the United States, the United Kingdom and Israel, of whom 73 were engaged in engineering +and product development, 10 in sales and marketing, 134 in general operations and 31 in general administration and finance. All +but 3 of these employees are employed on a full-time basis. None of our employees is currently represented by a trade union. We +consider our relations with our employees to be good. +11 +ITEM 1A. RISK FACTORS +An investment in our +common stock involves significant risks. You should carefully consider the following risks and all other information set forth +in this Annual Report before deciding to invest in our common stock. If any of the events or developments described below occurs, +our business, financial condition and results of operations may suffer. In that case, the value of our common stock may decline +and you could lose all or part of your investment. +You should consider +each of the following risk factors and any other information set forth in this Annual Report and the other reports filed by the +Company with the Securities and Exchange Commission (the “SEC”), including the Company’s financial statements +and related notes, in evaluating the Company’s business and prospects. The risks and uncertainties described below are not +the only ones that impact on the Company’s operations and business. Additional risks and uncertainties not presently known +to the Company, or that the Company currently considers immaterial, may also impair its business or operations. If any of the following +risks actually occurs, the Company’s business and financial condition, results or prospects could be harmed. Please also +read carefully the section “Forward-Looking Statements” at the beginning of this Annual Report. +Risks Related to Our Company +We have historically incurred significant +losses and our financial situation creates doubt whether we will continue as a going concern . +We have historically +experienced operating and net losses and anticipate continuing to experience such losses in the future. For the years ended December +31, 2018 and 2017, we had an operating loss of $19,605,456 and $5,983,045 and net losses of $32,982,201 and $10,895,049, respectively. +As of December 31, 2018 and 2017, we had a working capital deficiency of $18,445,302 and $2,234,695, respectively. There are no +assurances that we will be able to achieve a level of revenues adequate to generate sufficient cash flow from operations or obtain +additional financing through private placements, public offerings and/or bank financing necessary to support our working capital +requirements. To the extent that funds generated from any private placements, public offerings and/or bank financing are insufficient, +we will have to raise additional working capital. No assurance can be given that additional financing will be available, or if +available, will be on acceptable terms. These conditions raise substantial doubt about our ability to continue as a going concern. +If adequate working capital is not available we may be forced to discontinue operations, which would cause investors to lose their +entire investment. +We +expect to continue to incur losses for the foreseeable future and need to raise additional capital to continue business development +initiatives and to support our working capital requirements. For example, in March 2017, we were awarded a 3-year, $50 million +purchase order by MTIX Ltd. (“MTIX”) to manufacture, install and service the Multiplex Laser Surface Enhancement (“MLSE”) +plasma-laser system. We believe that the MLSE purchase order will be a source of revenue and generate significant cash flows for +us. However, if we are unable to raise additional capital, we may be required to curtail operations and take additional measures +to reduce costs, including reducing our workforce, eliminating outside consultants and reducing legal fees in order to conserve +cash in amounts sufficient to sustain operations and meet our obligations. As a result of these financing uncertainties, during +the year ended December 31, 2018, we recognized that our dependence on ongoing capital requirements to fund our operations raise +substantial doubt about our ability to continue as a going concern. Our ongoing capital requirements have only increased since +then, meaning that substantial doubt about our ability to continue as a going concern remains and will likely do so for the foreseeable +future. +We will need +to raise additional capital to fund our operations in furtherance of our business plan. +Until +we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business +plan. The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common +stock or preferred stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development +partners or some combination of each. Any additional equity financings may be financially dilutive to, and will be dilutive from +an ownership perspective to our stockholders, and such dilution may be significant based upon the size of such financing. Additionally, +we cannot assure that such funding will be available on a timely basis, in needed quantities, or on terms favorable to us, if at +all. +Our limited operating history makes +it difficult to evaluate our future business prospects and to make decisions based on of our historical performance . +Although our executive +officers have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our +current business until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate +our business on the basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future +results based upon our historical data. Reliance on our historical results may not be representative of the results we will achieve, +and for certain areas in which we operate, principally those unrelated to defense contracting, will not be indicative at all. Because +of the uncertainties related to our lack of historical operations, we may be hindered in our ability to anticipate and timely adapt +to increases or decreases in sales, product costs or expenses. If we make poor budgetary decisions as a result of unreliable historical +data, we could be less profitable or incur losses, which may result in a decline in our stock price. +12 +We have an evolving business model, which increases the complexity +of our business. +Our business model +has evolved in the past and continues to do so. In prior years we have added additional types of services and product offerings +and in some cases we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products +or services, and we do not know whether any of them will be successful. From time to time we have also modified aspects of our +business model relating to our product mix. We do not know whether these or any other modifications will be successful. The additions +and modifications to our business have increased the complexity of our business and placed significant strain on our management, +personnel, operations, systems, technical performance, financial resources, and internal financial control and reporting functions. +Future additions to or modifications of our business are likely to have similar effects. Further, any new business or website we +launch that is not favorably received by the market could damage our reputation or our brand. The occurrence of any of the foregoing +could have a material adverse effect on our business. +We are a holding company whose subsidiaries +are given certain degree of independence and our failure to integrate our subsidiaries may adversely affect our financial condition . +We have given our subsidiary +companies and their executives a certain degree of independence in decision-making. On the one hand, this independence may increase +the sense of ownership at all levels, on the other hand it has also increased the difficulty of the integration of operation and +management, which has resulted in increased difficulty of management integration. In the event we are not able to successfully +manage our subsidiaries this will result in operating difficulties and have a negative impact on our business. +Our independent auditors have expressed doubt about our ability +to continue as a going concern. If we do not continue as a going concern, investors will lose their entire investment . +In its report on our +financial statements included in this Annual Report, our independent auditors have expressed doubt about our ability to continue +as a going concern. Our ability to continue as a going concern is an issue raised as a result of ongoing operating losses and a +lack of financing commitments then in place to meet expected cash requirements. Our ability to continue as a going concern is subject +to our ability to generate a profit and/or obtain necessary funding from outside sources, including obtaining additional funding +from the sale of our securities, increasing sales or obtaining loans and grants from various financial institutions where possible. +If we do not continue as a going concern, investors will lose their entire investment. +Our inability +to successfully integrate new acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our +growth strategy through acquisitions is fraught with risk. On June 2, 2017, we acquired a majority interest in Microphase and on +May 23, 2018 we acquired Enertec Systems 2001 Ltd. (“ Enertec ”). Our strategy and business plan is dependent +on our ability to successfully integrate Microphase’s, Enertec’s and our other acquisition’s operations. In addition, +while we are based in Newport Beach, CA, Microphase’s operations are located in Shelton, Connecticut, Enertec’s operations +are located in Karmiel, Israel and DP Limited’s (doing business as Gresham Power Electronics) operations are located in Salisbury, +England. These distant locations and others that we may become involved with in the future will stretch our resources and management +time. Further, failure to quickly and adequately integrate all of these operations and personnel could adversely affect our combined +business and our ability to achieve our objectives and strategy. No assurance can be given that we will realize synergies in the +areas we currently operate. +If we make any additional acquisitions, they may disrupt +or have a negative impact on our business. +We have plans to eventually +make additional acquisitions beyond Microphase and Enertec. Whenever we make acquisitions, we could have difficulty integrating +the acquired companies’ personnel and operations with our own. In addition, the key personnel of the acquired business may +not be willing to work for us. We cannot predict the effect expansion may have on our core business. Regardless of whether we are +successful in making an acquisition, the negotiations could disrupt our ongoing business, distract our management and employees +and increase our expenses. In addition to the risks described above, acquisitions are accompanied by a number of inherent risks, +including, without limitation, the following: +· +difficulty of integrating acquired products, services or operations; +· +potential disruption of the ongoing businesses and distraction of our management and the management of acquired companies; +· +difficulty of incorporating acquired rights or products into our existing business; +· +difficulties in disposing of the excess or idle facilities of an acquired company or business and expenses in maintaining such facilities; +· +difficulties in maintaining uniform standards, controls, procedures and policies; +13 +· +potential impairment of relationships with employees and customers as a result of any integration of new management personnel; +· +potential inability or failure to achieve additional sales and enhance our customer base through cross-marketing of the products to new and existing customers; +· +effect of any government regulations which relate to the business acquired; and +· +potential unknown liabilities associated with acquired businesses or product lines, or the need to spend significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense of any litigation, whether or not successful, resulting from actions of the acquired company prior to our acquisition. +Our business could +be severely impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered +in connection with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our +ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. +No assurance of successful expansion of operations. +Our significant increase +in the scope and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher +operating expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make +significant demands on our management, finances and other resources. Our ability to manage the anticipated future growth, should +it occur, will depend upon a significant expansion of our accounting and other internal management systems and the implementation +and subsequent improvement of a variety of systems, procedures and controls. We cannot assure that significant problems in these +areas will not occur. Failure to expand these areas and implement and improve such systems, procedures and controls in an efficient +manner at a pace consistent with our business could have a material adverse effect on our business, financial condition and results +of operations. We cannot assure that attempts to expand our marketing, sales, manufacturing and customer support efforts will succeed +or generate additional sales or profits in any future period. As a result of the expansion of our operations and the anticipated +increase in our operating expenses, along with the difficulty in forecasting revenue levels, we expect to continue to experience +significant fluctuations in its results of operations. +We may be unable to successfully expand +our production capacity, which could result in material delays, quality issues, increased costs and loss of business opportunities, +which may negatively impact our product margins and profitability . +Part of our future +growth strategy is to increase our production capacity to meet increasing demand for our goods. Assuming we obtain sufficient funding +to increase our production capacity, any projects to increase such capacity may not be constructed on the anticipated timetable +or within budget. We may also experience quality control issues as we implement any production upgrades. Any material delay in +completing these projects, or any substantial cost increases or quality issues in connection with these projects could materially +delay our ability to bring our products to market and adversely affect our business, reduce our revenue, income and available cash, +all of which could harm our financial condition. +If we fail +to establish and maintain an effective system of internal control over financial reporting, we may not be able to report our financial +results accurately or prevent fraud. Any inability to report and file our financial results accurately and timely could harm our +reputation and adversely impact the trading price of our common stock. +Effective +internal control over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot +provide reliable financial reports or prevent fraud, we may not be able to manage our business as effectively as we would if an +effective control environment existed, and our business and reputation with investors may be harmed. As a result, our small size +and any current internal control deficiencies may adversely affect our financial condition, results of operations and access to +capital. We have also experienced complications reporting as a result of material weaknesses which resulted in the restatement +of our Form 10-Q for the quarterly period ended June 30, 2017, which was filed with the SEC on August 21, 2017, and amended on +November 14, 2017. We have carried out an evaluation under the supervision and with the participation of our management, including +our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure +controls and procedures as of the end of the most recent period covered by this report. Based on the foregoing, our principal executive +officer and principal financial officer concluded that our disclosure controls and procedures were not effective at the reasonable +assurance level due to the material weaknesses described below. +A +material weakness is a deficiency, or a combination of deficiencies, within the meaning of Public Company Accounting Oversight +Board (“ PCAOB ”) Audit Standard No. 5, in internal control over financial reporting, such that there is a reasonable +possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely +basis. Management has identified the following material weaknesses which have caused management to conclude that as of December +31, 2018 our internal controls over financial reporting (“ ICFR ”) were not effective at the reasonable assurance +level: +14 +1. +We do not have sufficient resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a material weakness. +2. +We have inadequate controls to ensure that information necessary to properly record transactions is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +Planned Remediation +Management, +in coordination with the input, oversight and support of our Board of Directors, has identified the measures below to strengthen +our control environment and internal control over financial reporting. +During +January 2018 we hired a new Chief Financial Officer and engaged the services of a financial accounting advisory firm. During September +2018, we hired a Chief Accounting Officer and in January 2019, we hired a Senior Vice President of Finance. We have tasked these +individuals with expanding and monitoring the Company’s internal controls, to provide an additional level of review of complex +financial issues and to assist with financial reporting. Further, as we continue to expand our internal accounting department, +the Chairman of the Audit Committee shall perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, +· reviews all anticipated transactions that are not considered in the ordinary course of business +to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s +financial statements +We +are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address +the material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls +and procedures. +If our accounting +controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously +harmed. +We +evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating +our internal control over financial reporting in order to comply with the Commission’s rules relating to internal control +over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control +over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future +periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance +with the policies or procedures may deteriorate. If we fail to maintain effective internal control over financial reporting or +our management does not timely assess the adequacy of such internal control, we may be subject to regulatory sanctions, and our +reputation may decline. +We face significant competition, including changes in pricing. +The markets for our +products are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing +resources, plus experience in research and development, and compete with us by offering lower prices. Competitors could develop +new technologies that compete with our products to achieve a lower unit price. If a competitor develops lower cost superior technology +or cost-effective alternatives to our products and services, our business could be seriously harmed. +The markets for some +of our products are also subject to specific competitive risks because these markets are highly price competitive. Our competitors +have competed in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering +our prices. This would reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also +impact sales and aggravate losses. +Many of our competitors are larger and +have greater financial and other resources than we do. +Our products compete +and will compete with similar if not identical products produced by our competitors. These competitive products could be marketed +by well-established, successful companies that possess greater financial, marketing, distribution personnel, and other resources +than we do. Using said resources, these companies can implement extensive advertising and promotional campaigns, both generally +and in response to specific marketing efforts by competitors. They can introduce new products to new markets more rapidly. In certain +instances, competitors with greater financial resources may be able to enter a market in direct competition with us, offering attractive +marketing tools to encourage the sale of products that compete with our products or present cost features that consumers may find +attractive. +15 +Our growth strategy is subject to +a significant degree of risk. +Our +growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition +targets or make a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. +Therefore, we may lose our investment in the event that these companies’ businesses do not develop as planned or that we +are unable to achieve the cost efficiencies or reduction of losses as anticipated. +Further, +in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement +our plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that +provide revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development +and investments will produce sufficient revenues to offset these increases in expenditures. +Our business and operations are growing +rapidly. If we fail to effectively manage our growth, our business and operating results could be harmed . +We have experienced, +and may continue to experience, rapid growth in our operations. This has placed, and may continue to place, significant demands +on our management, operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products +and services could suffer, which could negatively affect our operating results. To effectively manage our growth, we must continue +to improve our operational, financial and management controls and reporting systems and procedures. These systems improvements +may require significant capital expenditures and management resources. Failure to implement these improvements could hurt our ability +to manage our growth and our financial position. +Philou has certain rights to maintain its ownership interest +in us +In connection with +entering into a Series B Preferred Stock purchase agreement with Philou Ventures, LLC (“Philou”), we granted the right +to Philou to participate in future offerings under substantially the same term of such offerings in order to allow Philou to maintain +its ownership interest. If exercised by Philou, this contractual right granted to it has the effect of allowing Philou to maintain +its interest in us and dilute existing stockholders’ ownership interests. +We are heavily dependent on our senior management, and a +loss of a member of our senior management team could cause our stock price to suffer . +If we lose the services +of Milton C. Ault III, our Chief Executive Officer, William B. Horne, our Chief Financial Officer, Amos Kohn, our President and +the Chief Executive Officer of Coolisys, one of our principal subsidiaries and/or certain key employees, we may not be able to +find appropriate replacements on a timely basis, and our business could be adversely affected. Our existing operations and continued +future development depend to a significant extent upon the performance and active participation of these individuals and certain +key employees. Although we have entered into employment agreements with Messrs. Ault, Horne and Kohn, and we may enter into employment +agreements with additional key employees in the future, we cannot guarantee that we will be successful in retaining the services +of these individuals. If we were to lose any of these individuals, we may not be able to find appropriate replacements on a timely +basis and our financial condition and results of operations could be materially adversely affected. +We rely on highly skilled personnel +and the continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our +business may be severely disrupted. +Our performance largely +depends on the talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise +held by our Chief Executive Officer, Milton C. Ault III. His absence, were it to occur, would materially and adversely impact development +and implementation of our projects and businesses. Our future success depends on our continuing ability to identify, hire, develop, +motivate and retain highly skilled personnel for all areas of our organization. Our continued ability to compete effectively depends +on our ability to attract, among others, new technology developers and to retain and motivate our existing contractors. If one +or more of our executive officers are unable or unwilling to continue in their present positions, we may not be able to replace +them readily, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and +retain new officers. In addition, if any of our executives joins a competitor or forms a competing company, we may lose some customers. +16 +Our operating results may vary from quarter to quarter. +Our operating results +have in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may +increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding +for our products in our customers’ capital budgets. There is a trend for some of our customers to place large orders near +the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer +demand for our products driven by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, +and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. +In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, +have been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those +we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our +operating results for such quarter. It is possible that, in some quarters, our operating results will be below the expectations +of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common +stock may decline significantly. +We may be classified as an inadvertent investment company. +We are not engaged +in the business of investing, reinvesting, or trading in securities, and we do not hold ourselves out as being engaged in those +activities. Under the Investment Company Act, however, a company may be deemed an investment company under section 3(a)(1)(C) of +the Investment Company Act if the value of its investment securities is more than 40% of its total assets (exclusive of government +securities and cash items) on a consolidated basis. +We have commenced digital +asset mining, the output of which is cryptocurrencies, which the Commission has indicated it deems a security. In the event that +the digital assets held by us exceed 40% of our total assets, exclusive of cash, we inadvertently become an investment company. +An inadvertent investment company can avoid being classified as an investment company if it can rely on one of the exclusions under +the Investment Company Act. One such exclusion, Rule 3a-2 under the Investment Company Act, allows an inadvertent investment company +a grace period of one year from the earlier of (a) the date on which an issuer owns securities and/or cash having a value exceeding +50% of the issuer’s total assets on either a consolidated or unconsolidated basis and (b) the date on which an issuer owns +or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive +of government securities and cash items) on an unconsolidated basis. We are putting in place policies that we expect will work +to keep the investment securities held by us at less than 40% of our total assets, which may include acquiring assets with our +cash, liquidating our investment securities or seeking a no-action letter from the Commission if we are unable to acquire sufficient +assets or liquidate sufficient investment securities in a timely manner. +As Rule 3a-2 is available +to a company no more than once every three years, and assuming no other exclusion were available to us, we would have to keep within +the 40% limit for at least three years after we cease being an inadvertent investment company. This may limit our ability to make +certain investments or enter into joint ventures that could otherwise have a positive impact on our earnings. In any event, we +do not intend to become an investment company engaged in the business of investing and trading securities. +Classification as an +investment company under the Investment Company Act requires registration with the Commission. If an investment company fails to +register, it would have to stop doing almost all business, and its contracts would become voidable. Registration is time consuming +and restrictive and would require a restructuring of our operations, and we would be very constrained in the kind of business we +could do as a registered investment company. Further, we would become subject to substantial regulation concerning management, +operations, transactions with affiliated persons and portfolio composition, and would need to file reports under the Investment +Company Act regime. The cost of such compliance would result in our incurring substantial additional expenses, and the failure +to register if required would have a materially adverse impact to conduct our operations. +We will not be able to successfully +execute our business strategy if we are deemed to be an investment company under the Investment Company Act. +U.S. companies that +have more than 100 stockholders or are publicly traded in the U.S. and are, or hold themselves out as being, engaged primarily +in the business of investing, reinvesting or trading in securities are subject to regulation under the Investment Company Act. +Unless a substantial part of our assets consists of, and a substantial part of our income is derived from, interests in majority-owned +subsidiaries and companies that we primarily control, we may be required to register and become subject to regulation under the +Investment Company Act. If bitcoin and other virtual currencies were to be deemed securities for purposes of the Investment +Company Act, or if we were deemed to own but not operate one or more of our other subsidiaries, we would have difficulty avoiding +classification and regulation as an investment company. +If we were deemed to +be, and were required to register as, an investment company, we would be forced to comply with substantive requirements under the +Investment Company Act, including limitations on our ability to borrow, limitations on our capital structure; restrictions on acquisitions +of interests in associated companies, prohibitions on transactions with affiliates, restrictions on specific investments, and compliance +with reporting, record keeping, voting, proxy disclosure and other rules and regulations. If we were forced to comply with +the rules and regulations of the Investment Company Act, our operations would significantly change, and we would be prevented from +successfully executing our business strategy. To avoid regulation under the Investment Company Act and related rules promulgated +by the Commission, we could need to sell bitcoin and other assets which we would otherwise want to retain and could be unable to +sell assets which we would otherwise want to sell. In addition, we could be forced to acquire additional, or retain existing, +income-generating or loss-generating assets which we would not otherwise have acquired or retained and could need to forgo opportunities +to acquire bitcoin and other assets that would benefit our business. If we were forced to sell, buy or retain assets in this +manner, we could be prevented from successfully executing our business strategy. +17 +Securitization of our assets subjects us to various risks . +We may securitize assets +to generate cash for funding new investments. We refer to the term securitize to describe a form of leverage under which a company +(sometimes referred to as an “originator” or “sponsor”) transfers income producing assets to a single-purpose, +bankruptcy-remote subsidiary (also referred to as a “special purpose entity” or “SPE”), which is established +solely for the purpose of holding such assets and entering into a structured finance transaction. The SPE would then issue notes +secured by such assets. The special purpose entity may issue the notes in the capital markets either publicly or privately to a +variety of investors, including banks, non-bank financial institutions and other investors. There may be a single class of notes +or multiple classes of notes, the most senior of which carries less credit risk and the most junior of which may carry substantially +the same credit risk as the equity of the SPE. +An important aspect +of most debt securitization transactions is that the sale and/or contribution of assets into the SPE be considered a true sale +and/or contribution for accounting purposes and that a reviewing court would not consolidate the SPE with the operations of the +originator in the event of the originator's bankruptcy based on equitable principles. Viewed as a whole, a debt securitization +seeks to lower risk to the note purchasers by isolating the assets collateralizing the securitization in an SPE that is not subject +to the credit and bankruptcy risks of the originator. As a result of this perceived reduction of risk, debt securitization transactions +frequently achieve lower overall leverage costs for originators as compared to traditional secured lending transactions. +In accordance with +the above description, to securitize loans, we may create a wholly owned subsidiary and contribute a pool of our assets to such +subsidiary. The SPE may be funded with, among other things, whole loans or interests from other pools and such loans may or may +not be rated. The SPE would then sell its notes to purchasers whom we would expect to be willing to accept a lower interest rate +and the absence of any recourse against us to invest in a pool of income producing assets to which none of our creditors would +have access. We would retain all or a portion of the equity in the SPE. An inability to successfully securitize portions of our +portfolio or otherwise leverage our portfolio through secured and unsecured borrowings could limit our ability to grow our business +and fully execute our business strategy, and could decrease our earnings, if any. However, the successful securitization of portions +of our portfolio exposes us to a risk of loss for the equity we retain in the SPE and might expose us to greater risk on our remaining +portfolio because the assets we retain may tend to be those that are riskier and more likely to generate losses. A successful securitization +may also impose financial and operating covenants that restrict our business activities and may include limitations that could +hinder our ability to finance additional loans and investments. The Investment Company Act may also impose restrictions on the +structure of any securitizations. +Interests we hold in +the SPE, if any, will be subordinated to the other interests issued by the SPE. As such, we will only receive cash distributions +on such interests if the SPE has made all cash interest and other required payments on all other interests it has issued. In addition, +our subordinated interests will likely be unsecured and rank behind all of the secured creditors, known or unknown, of the SPE, +including the holders of the senior interests it has issued. Consequently, to the extent that the value of the SPE's portfolio +of assets has been reduced as a result of conditions in the credit markets, or as a result of defaults, the value of the subordinated +interests we retain would be reduced. Securitization imposes on us the same risks as borrowing except that our risk in a securitization +is limited to the amount of subordinated interests we retain, whereas in a borrowing or debt issuance by us directly we would be +at risk for the entire amount of the borrowing or debt issuance. +We may also engage +in transactions utilizing SPEs and securitization techniques where the assets sold or contributed to the SPE remain on our balance +sheet for accounting purposes. If, for example, we sell the assets to the SPE with recourse or provide a guarantee or other credit +support to the SPE, its assets will remain on our balance sheet. Consolidation would also generally result if we, in consultation +with the SEC, determine that consolidation would result in a more accurate reflection of our assets, liabilities and results of +operations. In these structures, the risks will be essentially the same as in other securitization transactions but the assets +will remain our assets for purposes of the limitations described above on investing in assets that are not qualifying assets and +the leverage incurred by the SPE will be treated as borrowings incurred by us for purposes of our limitation on the issuance of +senior securities. +We may not be able to utilize our net operating loss carry +forwards. +At December 31, 2018, +we had Federal net operating loss carry forwards (“NOLs”) for income tax purposes of approximately $43,051,999, expiring +through 2037. However, we do not know if or when we will have any earnings and capital gains against which we could apply these +carry forwards. Furthermore, as a result of changes in the ownership of our common stock, our ability to use our federal +NOLs will be limited under Internal Revenue Code Section 382. State NOLs are subject to similar limitations in many cases. +As a result, our substantial NOLs may not have any value to us. +18 +Changes in the U.S. tax and other laws and regulations may +adversely affect our business. +The U.S. government +may revise tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, +including modifications that could reduce the profits that we can effectively realize from our international operations, or that +could require costly changes to those operations, or the way in which they are structured. For example, the effective tax +rates for most U.S. companies reflect the fact that income earned and reinvested outside the U.S. is generally taxed at local rates, +which may be much lower than U.S. tax rates. If we expand abroad and there are changes in tax laws, regulations or interpretations +that significantly increase the tax rates on non-U.S. income, our effective tax rate could increase and our profits could be reduced. +If such increases resulted from our status as a U.S. company, those changes could place us at a disadvantage to our non-U.S. competitors +if those competitors remain subject to lower local tax rates. +Recently enacted U.S. +tax reform legislation known colloquially as the “Tax Cuts and Jobs Act,” among other things, makes significant changes +to the rules applicable to the taxation of corporations, such as changing the corporate tax rate to a flat 21% rate, modifying +the rules regarding limitations on certain deductions for executive compensation, introducing a capital investment deduction in +certain circumstances, placing certain limitations on the interest deduction, modifying the rules regarding the usability of certain +net operating losses, implementing a minimum tax on the “global intangible low-taxed income” of a “United States +stockholder” of a “controlled foreign corporation,” modifying certain rules applicable to United States stockholders +of controlled foreign corporations, imposing a deemed repatriation tax on certain earnings and adding certain anti-base erosion +rules. We are currently in the process of analyzing the effects of this new legislation on us and at this time the ultimate +outcome of the new legislation on our business and financial condition is uncertain. It is possible that the application +of these new rules may have a material and adverse impact on our operating results, cash flows and financial condition. +Risks Related to Our Business and Industry - Overview +Technology changes rapidly in our business, +and if we fail to anticipate new technologies, the quality, timeliness and competitiveness of our products will suffer. +Rapid technology changes +in our industry require us to anticipate, sometimes years in advance, which technologies and/or distribution platforms our products +must take advantage of in order to make them competitive in the market at the time they are released. Therefore, we usually start +our product development with a range of technical development goals that we hope to be able to achieve. We may not be able to achieve +these goals, or our competition may be able to achieve them more quickly than we can. In either case, our products may be technologically +inferior to competitive products, or less appealing to consumers, or both. If we cannot achieve our technology goals within the +original development schedule of our products, then we may delay products until these technology goals can be achieved, which may +delay or reduce revenue and increase our development expenses. Alternatively, we may increase the resources employed in research +and development in an attempt to accelerate our development of new technologies, either to preserve our product launch schedule +or to keep up with our competition, which would increase our development expenses and adversely affect our operations and financial +condition. +We are dependent upon our ability, and +our contract manufacturers’ ability, to timely procure electronic components. +Because of the global +economy, many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their +operations. As a result, there is a global shortage of certain electronic or mineral components, which may extend our production +lead-time and our production costs. Some materials are no longer available to support some of our products, thereby requiring us +to search for cross materials or, even worse, redesign some of our products to support currently-available materials. Such redesign +efforts may require certain regulatory and safety agency re-submittals, which may cause further production delays. While we have +initiated actions that we believe will limit our exposure to such problems, the dynamic business conditions in many of our markets +may challenge the solutions that have been put in place, and issues may recur in the future. +In addition, some of +our products are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While +we have had relationships with many of these third parties in the past, we cannot predict how or whether these relationships will +continue in the future. In addition, changes in management, financial viability, manufacturing demand or capacity, or other factors, +at these third parties could hurt our ability to manufacture our products. +Our strategic focus on our custom power +supply solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our +strategic focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing +custom power supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a +specific customer’s requirements. Failure to meet these customer product requirements or a failure to meet production schedules +and/or product quality standards may put us at risk with one or more of these customers. Moreover, changes in market conditions +and strategic changes at the direction of our customers may affect their decision to continue to purchase from us. The loss of +one or more of our significant custom power supply solution customers could have a material adverse impact on our revenues, business +or financial condition. +19 +We have also implemented +a series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, +they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes +in the market or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional +cost-reducing initiatives, including those involving our personnel, which may negatively impact quarterly earnings and profitability +as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term adverse +effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products or services, making +it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for +our solutions increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings +to be lower than they otherwise might be. +We depend +upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction +in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend +upon a few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or +cancel their orders scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, +diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their +reduced demand for our products, which could, in turn, have a material adverse effect on our business and results of operations. +If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment +capital due to any of these or other factors, a substantial decrease in our revenues would likely result. We are dependent on the +electronic equipment industry, and accordingly will be affected by the impact on that industry of current economic conditions. +Substantially all of +our existing customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological +change, obsolescence, and large fluctuations in demand. This industry is further characterized by intense competition and volatility. +The OEMs serving this industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar +demands on their suppliers, such as us, for increased product performance and lower prices. Such demands may adversely affect our +ability to successfully compete in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers +to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product +quality. +Since we do not own +significant manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers +to manufacture our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced +control over manufacturing costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, +and continued inflationary pressures on many of the raw materials used in the manufacturing of our power supply products. If we +were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays +caused by reduced manufacturing capacity, inability of our subcontract manufacturers to procure raw materials, the loss of key +assembly subcontractors, difficulties associated with the transition to our new subcontract manufacturers or other factors, we +could experience lost revenues, increased costs, and delays in, or cancellations or rescheduling of, orders or shipments, any of +which would materially harm our business. +We outsource, and are dependent upon +developer partners for, the development of some of our custom design products. +We made an operational +decision to outsource some of our custom design products to numerous developer partners. This business structure will remain in +place until the custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully +comply with the customer specifications and requirements might affect our ability to transition to a volume production stage of +the custom designed product where the revenue goals are dependent on the high volume of custom product production. Furthermore, +we rely on the design partners’ ability to provide high quality prototypes of the designed product for our customer approval +as a critical stage to approve production. +We face intense industry competition, +price erosion and product obsolescence, which, in turn, could reduce our profitability. +We operate in an industry +that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth +of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, +price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors +strive to retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be +written off and, therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing +our revenues and our gross margins. In fact, we have seen price erosion over the last several years on most of the products we +sell, and we expect additional price erosion in the future. +Our future results are dependent on +our ability to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell +our products through domestic and international OEM relationships and other distribution channels, such as manufacturers’ +representatives and distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships +with OEMs as well as with manufacturers’ representatives and distributors to sell our products. If, however, the third parties +with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, +or reduce the amount of their, business with us or otherwise fail to meet their own performance objectives, customer demand for +our products could be adversely affected, which would have an adverse effect on our revenues. +20 +We may not be able to procure necessary +key components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, +and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, +we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, +our suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials +that we require to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build +products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing +the levels of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence +should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase +too much inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which +could have a material adverse effect on our gross margins and on our results of operations. +Although we depend on sales of our legacy +products for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large +portion of our sales have historically been attributable to our legacy products. We expect that these products may continue to +account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining. Although we +are unable to predict future prices for our legacy products, we expect that prices for these products will continue to be subject +to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase +revenues will be dependent on our ability to expand our customer base, to increase unit sales volumes of these products and to +successfully, develop, introduce and sell new products such as custom design and value-added products. We cannot assure you that +we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell +new products. +Failure of our information technology +infrastructure to operate effectively could adversely affect our business. +We depend heavily on +information technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, +the resulting disruption could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise +carry on business in the normal course. Any such events could cause us to lose customers or revenue and could require us to incur +significant expense to remediate. +We are subject to certain governmental +regulatory restrictions relating to our international sales. +Some of our products +are subject to International Traffic In Arms Regulation (“ ITAR ”), which are interpreted, enforced and administered +by the U.S. Department of State. ITAR regulation controls not only the export, import and trade of certain products specifically +designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services +as well as foreign production. Any delays in obtaining the required export, import or trade licenses for products subject to ITAR +regulation and rules could have a material adverse effect on our business, financial condition, and/or operating results. In addition, +changes in United States export and import laws that require us to obtain additional export and import licenses or delays in obtaining +export or import licenses currently being sought could cause significant shipment delays and, if such delays are too great, could +result in the cancellation of orders. Any future restrictions or charges imposed by the United States or any other country on our +international sales or foreign subsidiary could have a materially adverse effect on our business, financial condition, and/or operating +results. In addition, from time to time, we have entered into contracts with the Israeli Ministry of Defense which were governed +by the U.S. Foreign Military Financing program (“ FMF ”). Any such future sales would be subject to these regulations. +Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial condition, and/or operating results. +We depend on international operations +for a substantial majority of our components and products. +We purchase a substantial +majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, +and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with +international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, +currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes +in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have +a materially adverse effect on our business, financial condition, and/or operating results. +21 +We depend on international sales for a portion of our revenues. +Sales to customers +outside of North America accounted for 29.9% and 34.8% of net revenues for the years ended December 31, 2018 and 2017, and we expect +that international sales will continue to represent a material portion of our total revenues. International sales are subject to +the risks of international business operations as described above, as well as generally longer payment cycles, greater difficulty +collecting accounts receivable, and currency restrictions. In addition, Gresham, our wholly-owned subsidiary in the United Kingdom, +supports our European and other international customers, distributors, and sales representatives, and therefore is also subject +to local regulation. International sales are also subject to the export laws and regulations of the United States and other countries. +Our sales and profitability may be affected +by changes in economic, business and industry conditions . +If the economic climate +in the United States or abroad deteriorates, customers or potential customers could reduce or delay their technology and entertainment +investments. Reduced or delayed technology and entertainment investments could decrease our sales and profitability. In this environment, +our customers may experience financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our +products and professional services. This may lead to longer sales cycles, delays in purchase decisions, payment and collection, +and can also result in downward price pressures, causing our sales and profitability to decline. In addition, general economic +uncertainty and general declines in capital spending in the information technology sector make it difficult to predict changes +in the purchasing requirements of our customers and the markets we serve. There are many other factors which could affect our business, +including: +· The introduction and market acceptance of new technologies, products and services; +· New competitors and new forms of competition; +· The size and timing of customer orders (for retail distributed physical product); +· The size and timing of capital expenditures by our customers; +· Adverse changes in the credit quality of our customers and suppliers; +· Changes in the pricing policies of, or the introduction of, new products and services by us or +our competitors; +· Changes in the terms of our contracts with our customers or suppliers; +· The availability of products from our suppliers; and +· Variations in product costs and the mix of products sold. +These +trends and factors could adversely affect our business, profitability and financial condition and diminish our ability to achieve +our strategic objectives. +The sale of our products is dependent +upon our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively +narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued +acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If +we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially +harmed. +The sale of our products is dependent +on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected +by the development, and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our +products. +Rapid technological +change, including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology +in place of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure +for our products and adversely affect the revenues from such products. +Our limited ability to protect our proprietary +information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property +rights of others, resulting in claims against us, the results of which could be costly. +Many of our products +consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination +of copyrights, trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation +of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially +equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary +rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized +in our products from third party infringement, we may be required to institute legal proceedings, which would be costly and would +divert our resources from the development of our business. If we are unable to successfully assert and defend our proprietary rights +in the technology utilized in our products, our future results could be adversely affected. +22 +Although we attempt +to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal +proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the +infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s +attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license +agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could +prevent us from selling our products in the United States or abroad. +If we are unable to satisfy our customers’ +specific product quality, certification or network requirements, our business could be disrupted and our financial condition could +be harmed. +Our customers demand +that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems +in satisfying such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product +quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products +to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects +or if we cannot effect such required product modifications, we could experience lost revenues, increased costs, including inventory +write-offs, warranty expense and costs associated with customer support, delays in, or cancellations or rescheduling of, orders +or shipments and product returns or discounts, any of which would harm our business. +If we ship products that contain defects, +the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from +us. +Our products are complex, +and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products +have been shipped to our customers and installed in their network or after product features or new versions are released. Any such +defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations +with our customers, resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs +and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our +control that may arise from the use of our products could result in financial or other damages to our customers. Our customers +could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate. +Some +of our business is subject to U.S. government procurement laws and regulations . +We must comply with certain laws and regulations relating to the formation, administration and performance +of federal government contracts. These laws and regulations affect how we conduct business with our federal government contracts, +including the business that we do as a subcontractor. In complying with these laws and regulations, we may incur additional costs, +and non-compliance may lead to the assessment of fines and penalties, including contractual damages, or the loss of business. +Risks Related to Our Business and Industry – Digital +Farms +We intend to develop an online cloud +mining platform which may subject us to additional liabilities from our customers. +We intend to develop +and offer a cloud mining platform to customers who prefer not to directly acquire and maintain crypto mining hardware. To date, +we have offered the cloud mining platform to selected customers prior to offering the platform to the general public. The success +of this business will be largely dependent on achieving sustainable revenues that are dependent on prices of the various currencies +and controlling costs, which are primarily power and computer hardware. In addition, through our management and administration +of crypto mining equipment on behalf of our customers, we may become subject to actions from our customers seeking to recover for +liabilities arising from, among other matters: +· erroneously accounting for proceeds from crypto mining activities; +· power, network or technology failures which prevent our miners from operating efficiently; +· delays in processing payments at times when there are significant fluctuations in the price of +the cryptocurrencies; and +· hackers or other malicious groups or organizations targeting and attempting to interfere with our +miners which could negatively affect the operations of such miners. +We may lose access to digital tokens +and any cryptocurrency due to loss of private key(s), custodial error, or purchaser error. +A private key, or a +combination of private keys, is necessary to control and dispose of cryptocurrency stored in a digital wallet or vault. Accordingly, +loss of requisite private key(s) associated with a digital wallet or vault storing cryptocurrency will result in loss of such cryptocurrency. +Moreover, any third party that gains access to such private key(s), including by gaining access to login credentials of a digital +wallet or secure services that we use, may be able to misappropriate any digital token or cryptocurrency held by us. Any errors +or malfunctions caused by or otherwise related to the digital wallet that we choose to receive and store cryptocurrency, including +our failure to properly maintain or use such digital wallet or secure service, may also result in the loss of any cryptocurrency +that we hold. Additionally, any failure on our part to follow precisely the procedures for buying and receiving cryptocurrency, +including, for instance, if it provides the wrong address for receiving cryptocurrency, may result in the loss of any cryptocurrency +held or purchased by us. +23 +Hackers or other malicious groups or +organizations may attempt to interfere with end users of digital tokens, or cryptocurrency, in a variety of ways. +Hackers or other malicious +groups or organizations may target and attempt to interfere with end users of digital tokens, or cryptocurrency, in a variety of +ways, including, but not limited to, end user attacks such as malware attacks, denial of service attacks, consensus-based attacks, +Sybil attacks, smurfing and spoofing. Furthermore, although we utilize a closed system to mine cryptocurrency, there is a risk +that a third party or one of our employees may intentionally or unintentionally introduce weaknesses into the core infrastructure, +which could negatively affect us and any cryptocurrency with which we are involved. +We have discretion over the maintenance, +storage and transmission of our cryptocurrency holdings. Currently investments and holdings in cryptocurrencies by our company +are uninsured and, as a result, we may lose all of our money invested in cryptocurrencies without any recourse. +Unlike bank accounts +or accounts at some other financial institutions, cryptocurrencies are generally uninsured unless an investor purchases private +insurance to insure them or holds them with a vendor which provides insurance. Thus, in the event of loss or loss of utility value, +there is no public insurer, such as the Securities Investor Protection Corporation or the Federal Deposit Insurance Corporation, +to offer recourse to any investor, including our company, unless covered independently by private insurance arranged by us. Further, +we have wide discretion over the storage of its cryptocurrency holdings. We intend to use various third party wallet providers, +trust companies or others to hold its cryptocurrency holdings. We may have a high concentration of its cryptocurrency holdings +in one location or with one third party wallet provider, which may be prone to losses arising out of hacking, loss of passwords, +compromised access credentials, malware, cyber-attacks or other factors. We may not do detailed diligence on third party wallet +providers and, as a result, may not be aware of all security vulnerabilities and risks. Certain third party wallet providers may +not indemnify us against any losses thereby hurting our ability to recover losses from third party wallet providers. The systems +in place to ensure the security of our company’s cryptocurrency holdings may not prevent the improper access to, damage or +theft of our company’s holdings in cryptocurrencies. Further, a loss due to the storage of our company’s cryptocurrencies +could harm our reputation or result in the loss of some or all of our company’s cryptocurrencies, including those assets +held on behalf of customers for our online cloud mining platform. +The regulatory status of cryptocurrency +and distributed ledger technology is unclear or unsettled in many jurisdictions and it is difficult to predict the impact future +regulation may have on either. +The regulatory status +of cryptocurrency and distributed ledger technology is unclear or unsettled in many jurisdictions. It is difficult to predict how +or whether regulatory agencies may apply existing regulation with respect to such technology and its applications. It is likewise +difficult to predict how or whether legislatures or regulatory agencies may implement changes to law and regulation affecting distributed +ledger technology and its applications, including applicable cryptocurrency protocols. Regulatory actions could negatively +impact any cryptocurrency in various ways, including, for purposes of illustration only, through a determination that cryptocurrency +are a regulated financial instrument that requires registration or licensing. +The tax characterization of cryptocurrency is uncertain. +Cryptocurrency holders +may be required to pay taxes associated with the transactions contemplated herein, whether in the United States or in their home +countries. It is the sole responsibility of cryptocurrency holders to comply with the tax laws of the United States and other jurisdictions +applicable to them and pay all relevant taxes. The sale or other exchange of cryptocurrency, or the use of cryptocurrency to pay +for goods or services, or holding cryptocurrency as an investment, generally has tax consequences that could result in tax liability. +In 2014, the Internal Revenue Service issued guidance on the tax treatment of transactions using cryptocurrency, such as Bitcoin +or other similar currencies. +The transfer of any cryptocurrency may +be restricted, which may adversely affect its liquidity and the price at which it may be sold. +Cryptocurrency has +not been, and will not be, registered under the Securities Act of 1933,as amended (the “ Securities Act ”) or +the securities laws of any other jurisdiction and, unless so registered, may not be offered or sold except pursuant to an exemption +from, or a transaction not subject to, the registration requirements of the Securities Act and any other applicable laws and regulations. +These restrictions may limit the ability of investors to resell cryptocurrency. It is the responsibility of any holder of a digital +token or a cryptocurrency to ensure that all offers and sales of cryptocurrency within the United States and other jurisdictions +comply with all applicable laws and regulations. +24 +Cryptocurrency confers no governance rights in any entity. +Because cryptocurrencies +confer no governance rights of any kind with respect to any entity with which such digital token or cryptocurrency may be associated, +all decisions involving a related company will be made by the management and/or stockholders of such company at their sole discretion. +These decisions could adversely affect the utility or value of any applicable digital token or cryptocurrency. +There are unanticipated and unknown +risks in buying and holding cryptocurrency and/or cryptographic tokens. +Digital tokens and +various cryptocurrencies are a relatively new and untested technology. In addition to the risks specified in these risk factors, +there are other risks associated with either our company’s purchase, holding and use of digital tokens and cryptocurrency +cannot be anticipated. Such risks may further materialize as unanticipated variations or combinations of the risks discussed in +this annual report. Since the price of Bitcoin reached its zenith in December of 2017, it has until very recently steadily declined, +and has in management’s opinion been the principal cause of the very considerable decline in the market price of our common +stock ever since. +Our decision to deal in cryptocurrencies, +such as Bitcoin, may subject us to exchange risk and additional tax and regulatory requirements. +Bitcoin is not considered +legal tender or backed by any government, and it has experienced price volatility, technological glitches and various law enforcement +and regulatory interventions. The use of cryptocurrencies such as bitcoin has been prohibited or effectively prohibited in some +countries. If we fail to comply with regulations or prohibitions applicable to us, we could face regulatory or other enforcement +actions and potential fines and other consequences. From time to time, we may hold bitcoin and other cryptocurrencies directly, +and we have exchange rate risk on the amounts we hold as well as the risks that regulatory or other developments may adversely +affect the value of the cryptocurrencies we hold. The uncertainties regarding legal and regulatory requirements relating to cryptocurrencies +or transactions utilizing cryptocurrencies, as well as potential accounting and tax issues, or other requirements relating to cryptocurrencies +could have a material adverse effect on our business. +Various cryptocurrencies facilitate +the use of anonymous transactions which could adversely affect us. +Although bitcoin and +other cryptocurrency transaction details are logged on the blockchain, a buyer or seller of bitcoin may never know to whom the +public key belongs or the true identity of the party with whom it is transacting. Some public key addresses are randomized sequences +of alphanumeric characters that, standing alone, do not provide sufficient information to identify users. Transacting with a counterparty +that is unknown to us, such as a party making illicit use of cryptocurrencies, could have an adverse effect on us or our reputation. +Our investment in Digital Farms, Inc. +may expose us to risks under laws and regulations with which we do not have significant experience. +In 2017, we established +our cryptocurrency business, which is pursuing a variety of digital currency. We anticipate mining the top ten cryptocurrencies +for our own account. These include Bitcoin, Bitcoin Cash, Litecoin and Ethereum, along with other currencies that we consider to +be in the top ten by market capitalization. Virtually every state in the U.S. regulates money transmitters and money services businesses. +In some states the licensing requirements and regulations expressly cover companies engaged in digital currency activities; in +other states it is not clear whether or how the existing laws and regulations apply to digital currency activities. Further, U.S. +federal law requires registration of most such businesses with the Financial Crimes Enforcement Network (“ FinCEN ”). +These licenses and registrations subject companies to various anti-money laundering, know-your-customer, record-keeping, reporting +and capital and bonding requirements, limitations on the investment of customer funds, and inspection by state and federal regulatory +agencies. Under U.S. federal law, it is a crime for a person, entity or business that is required to be registered with FinCEN +or licensed in any state to fail to do so, even if the person, entity or business was unaware of the licensing requirement. Further, +under U.S. federal law, anyone who owns all or part of an unlicensed money transmitting business is subject to civil and criminal +penalties. The business in which we have invested has represented to us that it has not taken any action that could subject it +to registration with FinCEN or to the licensing requirements in any state and has agreed that it will not do so until it has become +properly licensed in all required states and registered with FinCEN. However, if the business makes an error, even inadvertently, +we could be subject to potential civil and criminal penalties as a result. Any such penalties, or even the allegation of criminal +activities, could have a material adverse effect on us and our business. Further, all of our foreign business activities expose +us to a variety of risks, including risks under the Foreign Corrupt Practices Act. +U.S. and international regulatory changes +or actions may restrict the use of or impose heightened regulatory burdens on cryptocurrency or the operation of cryptocurrency +network based on currency, securities, or commodities regulations in a manner that adversely affects an investment in us. +Until recently, little +or no regulatory attention has been directed toward cryptocurrency and the cryptocurrency networks by U.S. federal and state governments, +foreign governments, and self-regulatory agencies. As cryptocurrency has grown in popularity and in market size, the Federal Reserve +Board, U.S. Congress, and certain U.S. agencies (e.g., FinCEN and the Federal Bureau of Investigation) have begun to examine the +operations of cryptocurrency networks, cryptocurrency users, and cryptocurrency exchange markets. Local state regulators such as +the California Department of Financial Institutions and the New York State Department of Financial Services have also initiated +examinations of Bitcoins, the Bitcoin Network, and the regulation thereof. Additionally, a U.S. federal magistrate judge in the +U.S. District Court for the Eastern District of Texas has ruled that “Bitcoin is a currency or form of money,” two +CFTC commissioners publicly expressed a belief that derivatives based on Bitcoins are subject to the same regulation as those based +on commodities, and the IRS released guidance treating cryptocurrency as property that is not currency for U.S. federal income +tax purposes, although there is no indication yet whether other courts or federal or state regulators will follow these asset classifications. +There is a possibility of future regulatory change altering, perhaps to a material extent, the nature of an investment in us or +our ability to continue to operate. +25 +Currently, the SEC +has not formally asserted regulatory authority over cryptocurrency, cryptocurrency networks, or cryptocurrency trading and ownership. +However, in testimony before the U.S. Senate Committee on Agriculture, Nutrition and Forestry on December 10, 2014, CFTC Chairman +Timothy Massad stated that the CFTC believed it had jurisdiction over derivative instruments such as futures and swaps based on +digital currencies. In 2015, the CFTC found virtual currencies such as Bitcoin to be commodities subject to oversight under its +authority under the Commodity Exchange Act. Since then, the CFTC has taken action against unregistered Bitcoin futures exchanges; +enforced the laws prohibiting wash trading and prearranged trades on a derivatives platform; issued proposed guidance on what is +a derivative market and what is a spot market in the virtual currency context; issued warnings about valuations and volatility +in spot virtual currency markets; and addressed a virtual currency Ponzi scheme. On May 21, 2018, the CFTC issued a joint staff +advisory that gives exchanges and clearinghouses registered with the CFTC guidance for listing virtual currency derivative products. +The advisory provides guidance on certain enhancements when listing a derivative contract based on virtual currency and clarifies +the CFTC staffs’ priorities and expectations in its review of new virtual currency derivatives to be listed on a designated +contract market or swap execution facility, or to be cleared by a derivatives clearing organization. Further, on September 26, +2018, the U.S. District Court for the District of Massachusetts entered an order holding that the CFTC has the power to prosecute +fraud involving virtual currency, which order is consistent with certain prior judicial decisions. +On July 25, 2017, the +SEC issued an investigative report, stating that offers and sales of digital assets by “virtual” organizations +using distributed ledger or cryptocurrency technology (i.e., Initial Coin Offerings or Token Sales) are subject to the requirements +of the federal securities laws. On June 6, 2018, the Chairman of the SEC clarified the agency’s position, stating that while +Bitcoin is a commodity, the SEC does not deem it and similar cryptocurrency coins to be securities, in contrast to initial coin +offerings of tokens do fall within the definition of a security and will be regulated as such. In March of 2019, the SEC announced +that it is it is looking for an “attorney advisor” to operate as a “Crypto Specialist,” which many observers +interpret as an indication that SEC is stepping up its efforts to regulate cryptocurrencies. Furthermore, the SEC has raised concerns +with instances of public companies changing their business models to reflect a focus on cryptocurrency or blockchain technology +and is looking closely at the disclosures of public companies that shift their business models to capitalize on the perceived promise +of distributed ledger technology and whether the disclosures comply with the federal securities laws, particularly in the context +of a securities offering, and in a few instances halted the trading of companies. To the extent that Bitcoin, Ethereum, or Litecoins, +themselves are determined to be a security, commodity future or other regulated asset, or to the extent that a US or foreign government +or quasi-governmental agency exerts regulatory authority over the Bitcoin, Ethereum, or Litecoin Networks, or cryptocurrency trading +and ownership, trading or ownership in cryptocurrency may be adversely affected, which could adversely affect an investment in +our company. +To the extent that +future regulatory actions or policies limit the ability to exchange cryptocurrency or utilize them for payments, the demand for +cryptocurrency will be reduced. Furthermore, regulatory actions may limit the ability of end-users to convert cryptocurrency into +fiat currency (e.g., U.S. Dollars) or use cryptocurrency to pay for goods and services. Such regulatory actions or policies could +adversely affect an investment in us. +Cryptocurrency currently +faces an uncertain regulatory landscape in not only the United States but also in many foreign jurisdictions such as the European +Union, China and Russia. While certain governments such as Germany—where the Ministry of Finance has declared Bitcoins to +be “Rechnungseinheiten” (a form of private money that is recognized as a unit of account, but not recognized in the +same manner as fiat currency) — have issued guidance as to how to treat bitcoins and/or other cryptocurrencies, most regulatory +bodies have not yet issued official statements regarding intention to regulate or determinations on regulation of cryptocurrency, +the cryptocurrency networks, and cryptocurrency users. Among those for which preliminary guidance has been issued in some form, +Canada and Taiwan have labeled cryptocurrency as a digital or virtual currency, distinct from fiat currency, while Sweden and Norway +are among those to categorize cryptocurrency as a form of virtual asset or commodity. In China, authorities have recently banned +use of bitcoins and/or other cryptocurrencies and ordered Beijing-based cryptocurrency exchanges to cease trading and immediately +notify users of their closures. Similarly, Russia has indicated an intention to ban use of bitcoins and/or other cryptocurrencies +and Russia’s Central Bank stated that at this stage they will not approve any cryptocurrency trading on any official exchange, +nor will it approve the use of the technology for infrastructure purposes. In May 2014, the Central Bank of Bolivia banned the +use of Bitcoins as a means of payment. In the summer and fall of 2014, Ecuador announced plans for its own state-backed electronic +money, while passing legislation that reportedly prohibits the use of decentralized digital currencies. Conversely, regulatory +bodies in some countries such as India and Switzerland have declined to exercise regulatory authority when afforded the opportunity. +Various foreign jurisdictions may, in the near future, adopt laws, regulations, or directives that affect cryptocurrency networks +and its users, particularly cryptocurrency exchanges and service providers that fall within such jurisdictions’ regulatory +scope. Other countries such as Malaysia and Australia have been considering regulation, classification, and potential bans. Such +laws, regulations, or directives may conflict with those of the United States and may negatively impact the acceptance of cryptocurrency +by users, merchants, and service providers outside of the United States and may, therefore, impede the growth of the cryptocurrency +economy. +26 +The effect of any future regulatory change +on our company or cryptocurrency is impossible to predict, but such change could be substantial and adverse to us and could adversely +affect an investment in us. +It may be illegal now, or in the future, +to acquire, own, hold, sell or use cryptocurrency in one or more countries, and ownership of, holding or trading in or company’s +securities may also be considered illegal and subject to sanction. +Although currently +cryptocurrency is not regulated or are lightly regulated in most countries, including the United States, one or more countries +may take regulatory actions in the future that severely restricts the right to acquire, own, hold, sell or use cryptocurrency or +to exchange cryptocurrency for fiat currency. Such restrictions may adversely affect an investment in our company. +Cryptocurrency transactions are irrevocable +and stolen or incorrectly transferred cryptocurrency may be irretrievable. As a result, any incorrectly executed cryptocurrency +transactions could render the company liable to lawsuits or criminal charges to the extent company facilitates bad transactions, +and thus, adversely affect an investment in us. +Cryptocurrency transactions +are not, from an administrative perspective, reversible without the consent and active participation of the recipient of the transaction +or, in theory, control or consent of a majority of the processing power on the cryptocurrency network. Once a transaction has been +verified and recorded in a block that is added to the blockchain, an incorrect transfer of cryptocurrency or a theft of cryptocurrency +generally will not be reversible and we may not be capable of seeking compensation for any such transfer or theft. Although our +transfers of cryptocurrency will regularly be made to or from vendors, consultants, services providers, etc. it is possible that, +through computer or human error, or through theft or criminal action, our cryptocurrency could be transferred from us in incorrect +amounts or to unauthorized third parties. To the extent that we are unable to seek a corrective transaction with such third-party +or are incapable of identifying the third-party that has received our cryptocurrency through error or theft, we will be unable +to revert or otherwise recover incorrectly transferred company cryptocurrency. To the extent that we are unable to seek redress +for such error or theft, such loss could adversely affect an investment in us. In addition, incorrectly executed cryptocurrency +transactions could render company liable to lawsuits or criminal charges to the extent company facilitates bad transactions, and +thus, adversely affect an investment in us. +The cryptocurrency exchanges on which +cryptocurrencies trade are relatively new and, in most cases, largely unregulated and may therefore be more exposed to fraud and +failure than established, regulated exchanges for other products. To the extent that the cryptocurrency exchanges representing +a substantial portion of the volume in cryptocurrency trading are involved in fraud or experience security failures or other operational +issues, such cryptocurrency exchanges’ failures may result in a reduction in the price of cryptocurrency and can adversely +affect an investment in us. +The cryptocurrency +exchanges on which cryptocurrency trade are new and, in most cases, largely unregulated. Furthermore, many cryptocurrency exchanges +do not provide the public with significant information regarding their ownership structure, management teams, corporate practices, +or regulatory compliance. As a result, the marketplace may lose confidence in, or may experience problems relating to, cryptocurrency +exchanges, including prominent exchanges handling a significant portion of the volume of cryptocurrency trading. These potential +consequences of a cryptocurrency exchange’s failure could reduce the demand and use of cryptocurrency, reduce the value of +cryptocurrency, and/or adversely affect an investment in us. +In the past, many cryptocurrency +exchanges have been closed due to fraud, failure, or security breaches. In many of these instances, the customers of such cryptocurrency +exchanges were not compensated or made whole for the partial or complete losses of their account balances in such cryptocurrency +exchanges. While smaller cryptocurrency exchanges are less likely to have the infrastructure and capitalization that make larger +cryptocurrency exchanges more stable, larger cryptocurrency exchanges are more likely to be appealing targets for hackers and “malware” +(i.e., software used or programmed by attackers to disrupt computer operation, gather sensitive information, or gain access to +private computer systems). +If the awards of cryptocurrency for +solving blocks and transaction fees for recording transactions are not sufficiently high to incentivize miners, miners may respond +in a way that reduces confidence in the cryptocurrency networks, which could adversely affect an investment in our company. +If the award of new +cryptocurrency for solving blocks declines and transaction fees are not sufficiently high, miners may not have an adequate incentive +to continue mining cryptocurrency and may cease their crypto mining operations. Miners ceasing operations would reduce the +collective processing power on the cryptocurrency networks, which would adversely affect the confirmation process for transactions +(i.e., temporarily decreasing the speed at which blocks are added to the blockchain until the next scheduled adjustment in difficulty +for block solutions) and make the cryptocurrency networks more vulnerable to a malicious actor or botnet obtaining control in excess +of 50 percent of the processing power on the cryptocurrency networks. Any reduction in confidence in the confirmation process or +processing power of cryptocurrency networks may adversely impact Digital Farms, Inc., as well as an investment in us. +27 +In addition, to the +extent to which the value of cryptocurrency mined by a professionalized crypto mining operation exceeds the allocable capital and +operating costs determines the profit margin of such operation. A professionalized crypto mining operation may be more likely to +sell a higher percentage of its newly mined cryptocurrency rapidly if it is operating at a low profit margin—and it may partially +or completely cease operations if its profit margin is negative. In a low profit margin environment, a higher percentage of the +new cryptocurrency mined each day will be sold into the cryptocurrency exchange markets more rapidly, thereby reducing cryptocurrency +prices. Lower cryptocurrency prices will result in further tightening of profit margins, particularly for professionalized crypto +mining operations with higher costs and more limited capital reserves, creating a network effect that may further reduce the price +of cryptocurrency until crypto mining operations with higher operating costs become unprofitable and remove mining power from the +cryptocurrency networks. The network effect of reduced profit margins resulting in greater sales of newly mined cryptocurrency +could result in a reduction in the price of cryptocurrency that could adversely impact Digital Farms, Inc., as well as an investment +in our company. +To the extent that any miners cease +to record transactions in solved blocks, transactions that do not include the payment of a transaction fee will not be recorded +on the blockchain until a block is solved by a miner who does not require the payment of transaction fees. Any widespread delays +in the recording of transactions could result in a loss of confidence in the cryptocurrency networks, which could adversely impact +an investment in us. +To the extent that +any miners cease to record transactions in solved blocks, such transactions will not be recorded on the blockchain. Currently, +there are no known incentives for miners to elect to exclude the recording of transactions in solved blocks; however, to the extent +that any such incentives arise (e.g., a collective movement among miners or one or more mining pools forcing cryptocurrency users +to pay transaction fees as a substitute for or in addition to the award of new cryptocurrency upon the solving of a block), actions +of miners solving a significant number of blocks could delay the recording and confirmation of transactions on the blockchain. +Any systemic delays in the recording and confirmation of transactions on the blockchain could result in greater exposure to double-spending +transactions and a loss of confidence in cryptocurrency networks, which could adversely impact an investment in our company. +Intellectual property rights claims may adversely affect +the operation of cryptocurrency networks. +Third parties may assert +intellectual property claims relating to the holding and transfer of digital currencies and their source code. Regardless of the +merit of any intellectual property or other legal action, any threatened action that reduces confidence in cryptocurrency networks’ +long-term viability or the ability of end-users to hold and transfer cryptocurrency may adversely affect an investment in us. Additionally, +a meritorious intellectual property claim could prevent us and other end-users from accessing cryptocurrency networks or holding +or transferring their cryptocurrency. As a result, an intellectual property claim against us or other large cryptocurrency network +participants could adversely affect an investment in us. +Currently, there is relatively small +use of cryptocurrency in the marketplace in comparison to relatively large use by speculators, thus contributing to price volatility +that could adversely affect an investment in us. +As relatively new products +and technologies, cryptocurrency has only recently become widely accepted as a means of payment for goods and services, and use +of cryptocurrency by remains limited. Conversely, a significant portion of cryptocurrency demand is generated by speculators and +investors seeking to profit from the short- or long-term holding of cryptocurrency. A lack of expansion by cryptocurrency into +our markets, or a contraction of such use, may result in increased volatility or a reduction in the price of cryptocurrencies, +either of which could adversely impact an investment in us. +The acceptance of Bitcoin Network, Ethereum +Network, or Litecoin Network software patches or upgrades by a significant, but not overwhelming, percentage of the users and miners +in the respective networks could result in a “fork” in the blockchain, resulting in the operation of two separate networks +until such time as the forked blockchains are merged. The temporary or permanent existence of forked blockchains could adversely +impact Digital Farms, Inc. as well as an investment in our company. +Bitcoin, Ethereum, +and Litecoin are open source projects and, although there is an influential group of leaders in the cryptocurrency community, there +is no official developer or group of developers that formally controls the Bitcoin, Ethereum, or Litecoin Networks. Any individual +can download the particular cryptocurrency network software and make any desired modifications, which are proposed to users and +miners on the respective network through software downloads and upgrades. A substantial majority of miners and the particular cryptocurrency +users must consent to those software modifications by downloading the altered software or upgrade that implements the changes; +otherwise, the changes do not become a part of the cryptocurrency network. Generally, changes to various cryptocurrency networks +have been accepted by the vast majority of users and miners, ensuring that the cryptocurrency networks remain coherent economic +systems; however, a developer or group of developers could potentially propose a modification to a cryptocurrency network that +is not accepted by a vast majority of miners and users, but that is nonetheless accepted by a substantial population of participants +in the respective cryptocurrency network. In such a case, and if the modification is material and/or not backwards compatible with +the prior version of the respective cryptocurrency network software, a “fork” in the blockchain could develop and two +separate networks of the same cryptocurrency could result, one running the pre-modification software program and the other running +the modified version (e.g., a second bitcoin network). Such a fork in the blockchain typically would be addressed by community-led +efforts to merge the forked blockchains, and several prior forks have been so merged without any material impact on the price of +Bitcoin, although there can be no assurance that this will always be the case upon a fork. This kind of split in a Bitcoin, Ethereum, +or Litecoin Network could materially and adversely impact an investment in us and, in the worst case scenario, harm the sustainability +of the respective network’s economy. +28 +The open-source structure of cryptocurrency +network protocol means that the developers and other contributors to the protocol are generally not directly compensated for their +contributions in maintaining and developing the protocol. A failure to properly monitor and upgrade the protocol could damage the +cryptocurrency network and an investment in us. +The Bitcoin, Ethereum, +and Litecoin Networks operate based on an open-source protocol maintained by certain core developers and other contributors. The +core developers are those developers employed by MIT Media Lab’s Digital Currency Initiative who oversee the Bitcoin Network. +As these network protocols are not sold and the networks’ use does not generate revenues for its development team, the core +developers and contributors are generally not compensated for maintaining and updating the respective cryptocurrency network protocol. +To the extent that material issues arise with the Bitcoin, Ethereum, or Litecoin Network protocols, and the core developers and +open-source contributor community are unable to address the issues adequately or in a timely manner, the respective cryptocurrency +network, Digital Farms, Inc. and an investment in us may be adversely affected. +The further development and acceptance +of cryptocurrency networks, which represents a new and rapidly changing industry, are subject to a variety of factors that are +difficult to evaluate. The slowing or stopping of the development or acceptance of digital currency systems may adversely affect +our business. +Digital currencies +may be used, among other things, to buy and sell goods and services are a new and rapidly evolving industry. The growth of the +digital currency industry in general, and in particular the Bitcoin industry, Ethereum industry, and Litecoin industry, are subject +to a high degree of uncertainty. The factors affecting the further development of the digital currencies industry, as well as the +Bitcoin, Ethereum and Litecoin industries, include: +· Continued worldwide growth in the adoption and use of Bitcoins, Ethereum, and Litecoins, and other +cryptocurrency; +· Government and quasi-government regulation of Bitcoin, Ethereum, and Litecoin, and other cryptocurrency +and their use, or restrictions on or regulation of access to and operation of cryptocurrency networks and system; +· The maintenance and development of the open-source software protocol of various cryptocurrency +networks; +· The availability and popularity of other forms or methods of buying and selling goods and services, +including new means of using fiat currencies; +· General economic conditions and the regulatory environment relating to digital currencies; and +· A decline in the popularity or acceptance of the top cryptocurrencies or their networks could adversely +affect an investment in us. +The value of cryptocurrency and fluctuations +in the price of cryptocurrency could materially and adversely affect the business of Digital Farms, Inc. +Several factors may +affect the value of cryptocurrency, including, but not limited to: +· Total cryptocurrency in existence; +· Global cryptocurrency demand, which is influenced by the growth of retail merchants’ and +commercial businesses’ acceptance of cryptocurrency as payment for goods and services, the security of online cryptocurrency +exchanges and digital wallets that hold cryptocurrency, the perception that the use and holding of cryptocurrency is safe and secure, +the lack of regulatory restrictions on their use and the reputation of cryptocurrency for illicit use; +· Global cryptocurrency supply, which is influenced by similar factors as global cryptocurrency demand, +in addition to fiat currency needs by miners (for example, to invest in equipment or pay electricity bills) and taxpayers who may +liquidate cryptocurrency holdings around tax deadlines to meet tax obligations; +· Investors’ expectations with respect to the rate of inflation or deflation of fiat currencies +or cryptocurrency; +· Interest rates; +· Currency exchange rates, including the rates at which cryptocurrency may be exchanged for fiat +currencies; +· Fiat currency withdrawal and deposit policies of cryptocurrency exchanges and liquidity of such +cryptocurrency exchanges; +· Interruptions in service from or failures of major cryptocurrency exchanges; +· Cyber theft of cryptocurrency from online cryptocurrency wallet providers, or news of such theft +from such providers, or from individuals’ cryptocurrency wallets; +· Investment and trading activities of large investors, including private and registered funds, that +may directly or indirectly invest in cryptocurrency; +· Monetary policies of governments, trade restrictions, currency devaluations and revaluations; +29 +· Regulatory measures, if any, that restrict the use of cryptocurrency as a form of payment or the +purchase of cryptocurrency on the cryptocurrency market; +· The availability and popularity of businesses that provide cryptocurrency -related services; +· The maintenance and development of the open source software protocol of certain cryptocurrency +networks; +· Increased competition from other forms of cryptocurrency or payments services; +· Global or regional political, economic, or financial events and situations; +· Expectations among cryptocurrency economy participants that the value of cryptocurrency will soon +change; and +· Fees associated with processing a cryptocurrency transaction. +For example, we have paid for a number +of miners at prices that appeared attractive at the time. However, as a result of the decline in the price of Bitcoin and other +cryptocurrencies that began, generally speaking, in early 2018, using these machines to mine cryptocurrencies is no longer profitable. +In addition see “Item 3, Legal Proceedings.” +Banks and financial +institutions may not provide banking services, or may cut off services, to businesses that provide cryptocurrency-related services +or that accept cryptocurrencies as payment, including financial institutions of investors in our securities. +A +number of companies that provide bitcoin and/or other cryptocurrency-related services have been unable to find banks or financial +institutions that are willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals +or businesses associated with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services +discontinued with financial institutions. We also may be unable to obtain or maintain these services for our business. The difficulty +that many businesses that provide bitcoin and/or other cryptocurrency-related services have and may continue to have in finding +banks and financial institutions willing to provide them services may be decreasing the usefulness of cryptocurrencies as a payment +system and harming public perception of cryptocurrencies and could decrease its usefulness and harm its public perception in the +future. Similarly, the usefulness of cryptocurrencies as a payment system and the public perception of cryptocurrencies could be +damaged if banks or financial institutions were to close the accounts of businesses providing bitcoin and/or other cryptocurrency-related +services. This could occur as a result of compliance risk, cost, government regulation or public pressure. The risk applies +to securities firms, clearance and settlement firms, national securities and commodities exchanges, the over the counter market +and the Depository Trust Company, which, if any of such entities adopts or implements similar policies, rules or regulations, could +result in the inability of our investors to open or maintain stock or commodities accounts, including the ability to deposit, maintain +or trade our securities. Such factors would have a material adverse effect on the ability of our to continue as a going concern +or to pursue its cryptocurrency business segment at all, which would have a material adverse effect on our business, prospects +or operations and harm investors. +Possibility of cryptocurrency algorithms +or protocols changing, such as a transition by some networks to proof of stake validation, and other crypto mining related risks +could have an adverse impact on our business prospects. +The +underlying cryptocurrency algorithms, protocols and other important factors are constantly changing. It is possible that these +changes could negatively impact our business and business plans. Should the top cryptocurrencies that we intend to focus on shift +their underlying protocols, algorithms, validation methods or other material factors (for instance from a proof of work validation +method to a proof of stake method, which is an alternative method to proof of work for validating cryptocurrency transactions), +it could adversely impact our business prospects. A shift from proof of work validation method to a proof of stake method could +render any company that maintains advantages in the current climate (for example from lower priced electric, processing, real estate, +or hosting) less competitive Any major changes related to the top cryptocurrencies could have an adverse impact on the ability +of Digital Farms, Inc. to continue as going concerns or to pursue this segment at all, which would have a material adverse effect +on our business, prospects or operations of and potentially the value of any cryptocurrencies that we hold or expect to acquire +for our own account. +The profitability +and success of crypto mining is constantly changing due to various factors. These changes and our choices related to which cryptocurrencies +to focus on for their own account or for customers could adversely affect our business results. +The +miners that we have purchased allow us to decide which cryptocurrency to mine. The factors that affect the success of mining an +individual cryptocurrency change rapidly. Should we choose the wrong cryptocurrency to focus our crypto mining operations on, it +could adversely impact our business prospects. +To the extent +that the profit margins of cryptocurrency mining operations are not high, operators of cryptocurrency mining operations are more +likely to immediately sell cryptocurrency earned by mining in the market, resulting in a reduction in the price of cryptocurrencies +that could adversely impact us and similar actions could affect other cryptocurrencies. +Over +the years, crypto mining operations have evolved from individual users mining with computer processors, graphics processing units +and first generation application-specific integrated circuit (“ ASIC ”) servers. Currently, new processing power +is predominantly added by incorporated and unincorporated “professionalized” crypto mining operations. Professionalized +crypto mining operations may use proprietary hardware or sophisticated ASIC machines acquired from ASIC manufacturers. They require +the investment of significant capital for the acquisition of this hardware, the leasing of operating space (often in data centers +or warehousing facilities), incurring of electricity costs and the employment of technicians to operate the cryptocurrency mining +farms. +30 +As +a result, professionalized crypto mining operations are of a greater scale than prior miners and have more defined, regular expenses +and liabilities. These regular expenses and liabilities require professionalized crypto mining operations to more immediately sell +cryptocurrencies earned from crypto mining operations, whereas it is believed that individual miners in past years were more likely +to hold newly mined bitcoins and/or other cryptocurrencies for more extended periods. The immediate selling of newly mined bitcoins +and/or other cryptocurrencies greatly increases the supply of bitcoins and/or other cryptocurrencies for sale, creating downward +pressure on the price of bitcoins and/or other cryptocurrencies. +The +extent to which the value of bitcoins and/or other cryptocurrencies mined by a professionalized crypto mining operation exceeds +the allocable capital and operating costs determines the profit margin of such operation. A professionalized crypto mining operation +may be more likely to sell a higher percentage of its newly mined bitcoins and/or other cryptocurrencies rapidly if it is operating +at a low profit margin—and it may partially or completely cease operations if its profit margin is negative. In a low profit +margin environment, a higher percentage could be sold more rapidly, thereby potentially reducing bitcoin and/or other cryptocurrencies +prices. Lower bitcoin and/or other cryptocurrencies prices could result in further tightening of profit margins, particularly for +professionalized crypto mining operations with higher costs and more limited capital reserves, creating a network effect that may +further reduce the price of bitcoin until crypto mining operations with higher operating costs become unprofitable and remove mining +power. The network effect of reduced profit margins resulting in greater sales of newly mined bitcoins and/or other cryptocurrencies +could result in a reduction in the price of bitcoins and/or other cryptocurrencies that could adversely impact business of Digital +Farms, Inc. and our company. +The +foregoing risks associated with bitcoin could be equally applicable to other cryptocurrencies, existing now or introduced in the +future. Such circumstances would have a material adverse effect on our ability to continue as a going concern or to pursue +this segment at all, which would have a material adverse effect on our business, prospects or operations and potentially the value +of any cryptocurrencies that we may hold or acquire for our own account and harm investors. +Should new +services/software embodying new technologies emerge, our or our investments’ ability to recognize the value of the use of +existing hardware and equipment and its underlying technology, may become obsolete and require substantial capital to replace such +equipment. +The +increase in interest and demand for cryptocurrencies has led to a shortage of crypto mining hardware as individuals purchase equipment +for mining at home and large scale mining evolved. Equipment in Digital Farms, Inc.’s crypto mining facilities will require +replacement from time to time and new technological innovations could render our current equipment obsolete at any time. Shortages +of graphics processing units may lead to unnecessary downtime for miners and limit the availability or accessibility of cryptocurrency +mining processing capabilities in the industry. Such events would have a material adverse effect on our ability to continue as +a going concern or to pursue this segment at all, which would have a material adverse effect on our business, prospects or operations +and potentially the value of any cryptocurrencies that we may hold or expect to acquire for our own account. +We have an evolving business model. +As Digital Assets and +blockchain technologies become more widely available, we expect the services and products associated with them to evolve. Very +recently, the Commission issued a report that promoters that use initial coin offerings or token sales to raise capital may be +engaged in the offer and sale of securities in violation of the Securities Act and the Securities Exchange Act of 1934 (the “ Exchange +Act ”). This may cause us to potentially change our future business in order to comply fully with the federal securities +laws as well as applicable state securities laws. As a result, to stay current with the industry, our business model may need to +evolve as well. From time to time we may modify aspects of our business model relating to our product mix and service offerings. +We cannot offer any assurance that these or any other modifications will be successful or will not result in harm to the business. +We may not be able to manage growth effectively, which could damage our reputation, limit our growth and negatively affect our +operating results. +“Digital Asset” +— Collectively, all digital assets based upon a computer-generated math-based and/or cryptographic protocol that may, among +other things, be used to buy and sell goods or pay for services. Bitcoins represent one type of Digital Asset. +“Digital Security” +— A type of Digital Asset that is offered by a promoter as an investment contract, which is a type of security defined by +Section 2(a)(1) of the Securities Act. +Since there +has been limited precedence set for financial accounting of Bitcoin, Ethereum, and other digital assets, it is unclear how we will +be required to account for digital assets transactions in the future. +Since +there has been limited precedence set for the financial accounting of digital assets, it is unclear how we will be required to +account for digital asset transactions or assets. Furthermore, a change in regulatory or financial accounting standards could result +in the necessity to restate our financial statements. Such a restatement could negatively impact our business, prospects, financial +condition and results of operation. Such circumstances would have a material adverse effect on our ability to continue as a going +concern or to pursue this segment at all, which would have a material adverse effect on our business, prospects or operations and +potentially the value of any cryptocurrencies that we hold or acquire for our own account and harm investors. +31 +Demand for +bitcoins is driven, in part, by its status as the most prominent and secure digital asset. It is possible that a digital asset +other than bitcoins could have features that make it more desirable to a material portion of the digital asset user base, resulting +in a reduction in demand for bitcoins, which could have a negative impact on the price of bitcoins and adversely affect an investment +in our securities. +The +Bitcoin Network and bitcoins, as an asset, hold a “first-to-market” advantage over other digital assets. This first-to-market +advantage is driven in large part by having the largest user base and, more importantly, the largest combined mining power in use +to secure the blockchain and transaction verification system. Having a large crypto mining network results in greater +user confidence regarding the security and long-term stability of a digital asset’s network and its blockchain; as a result, +the advantage of more users and miners makes a digital asset more secure, which makes it more attractive to new users and miners, +resulting in a network effect that strengthens the first-to-market advantage. +There +are thousands of alternate digital assets (or altcoins). Bitcoin enjoys significantly greater acceptance and usage than other altcoin +networks in the retail and commercial marketplace, due in large part to the relatively well-funded efforts of payment processing +companies including BitPay and Coinbase. +Despite +the marked first-mover advantage of the Bitcoin Network over other digital assets, it is possible that an altcoin could become +materially popular due to either a perceived or exposed shortcoming of the Bitcoin Network protocol that is not immediately addressed +by the core developers of Bitcoin or a perceived advantage of an altcoin that includes features not incorporated into Bitcoin. +If an altcoin obtains significant market share (either in market capitalization, mining power or use as a payment technology), +this could reduce Bitcoin’s market share and have a negative impact on the demand for, and price of, bitcoins, which in turn, +may materially and adversely affect the business, prospects or operations of the Digital Farms, Inc. and our company. +Risks Related to Our Business and Industry - Microphase +Microphase has a history of losses and +our future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on our business and the +value of our company. +During the past three +fiscal years Microphase has incurred losses from operations. These losses are attributable to lower volumes of its products sold +to major defense contractors partially as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. +Since the financial crisis of 2008, Microphase has been significantly short of capital needed to acquire parts for production of +its products to complete orders for such products. At times, Microphase has not had the cash available to make advance payments +for the purchase of parts, and then, as a consequence, Microphase would not receive the parts from its vendors required to finish +a customer order. This would then delay the delivery of products to customers, and would also delay recognition of the resulting +revenues and the receipt of cash from the customer. Sometimes after experiencing a delay in delivery of an order from Microphase, +the customer would not place its next order with Microphase, resulting in a loss of business. +Microphase’s +future profitability depends upon many factors, including several that are beyond its control. These factors include, without limitation: +· changes in the demand for ITS products and services; +· loss of key customers or contracts; +· the introduction of competitive products; +· the failure to gain market acceptance of ITS new and existing products; and +· the failure to successfully and cost effectively develop, introduce and market new products, services +and product enhancements in a timely manner. +In addition, Microphase +is incurring significant legal, accounting, and other expenses related to being a reporting company without there being a trading +market for any of its securities. As a result of these expenditures, Microphase will have to generate and sustain increased revenue +to achieve and maintain future profitability. +A large percentage of Microphase’s +current revenue is derived from prime defense contractors to the U.S. government and its allies, and the loss of these relationships, +a reduction in U.S. government funding or a change in U.S. government spending priorities or bidding processes could have an adverse +impact on its business, financial condition, results of operations and cash flows. +32 +Microphase is highly +dependent on sales to major defense contractors of the U.S. military and its allies, including Lockheed Martin, Raytheon, BAE Systems +and SAAB. The percentages of its revenue that were derived from sales to these named major defense contractors and directly to +the U.S. Government were 55.6% in fiscal 2018 and 59.0% in fiscal 2017. Therefore, any significant disruption or deterioration +of Microphase’s relationship with any such major defense contractors or the U.S. Government could materially reduce its revenue. +During the year ended December 31, 2018 there were two customers that accounted for more than 10% of sales: BAE Systems, +Saab and Lockheed Martin. During the year ended December 31, 2017 there were two customers that accounted for more than 10% +of sales: BAE Systems and SAAB. Microphase’s competitors continuously engage in efforts to expand their business relationships +with the same major defense contractors and the U.S. Government and will continue these efforts in the future, and the U.S. Government +may choose to use other contractors. Microphase expects that a majority of the business that it seeks will be awarded through competitive +bidding. Microphase operates in highly competitive markets and its competitors have more extensive or more specialized engineering, +manufacturing and marketing capabilities than Microphase does in many areas, and Microphase may not be able to continue to win +competitively awarded contracts or to obtain task orders under multi-award contracts. Further, the competitive bidding process +involves significant cost and managerial time to prepare bids and proposals for contracts that may not be awarded to Microphase, +as well as the risk that Microphase may fail to accurately estimate the resources and costs required to fulfill any contract awarded +to us. Following any contract award, Microphase may experience significant expense or delay, contract modification or contract +rescission as a result of its competitors protesting or challenging contracts awarded to it in competitive bidding. Major defense +contractors to whom Microphase supplies components for systems must compete with other major defense contractors (to which Microphase +may not supply components) for military orders from the U.S. Government. +In addition, Microphase +competes with other policy needs, which may be viewed as more necessary, for limited resources and an ever-changing amount of available +funding in the budget and appropriation process. Budget and appropriations decisions made by the U.S. Government are outside of +Microphase control and have long-term consequences for its business. U.S. Government spending priorities and levels remain uncertain +and difficult to predict and are affected by numerous factors, including until recently sequestration (automatic, across-the-board +U.S. Government budgetary spending cuts), and the purchase of our products could be superseded by alternate arrangements. While +the US defense budget was recently increased, there can be no assurance that this increase will be maintained for the foreseeable +future. A change in U.S. Government spending priorities or an increase in non-procurement spending at the expense of our programs, +or a reduction in total U.S. Government spending, could have material adverse consequences on Microphase’s future business. +Microphase’s U.S. government contracts +may be terminated by the federal government at any time prior to their completion, which could lead to unexpected loss of sales +and reduction in Microphase’s backlog. +Under the terms of Microphase’s U.S. +government contracts, the U.S. government may unilaterally: +· terminate or modify existing contracts; +· reduce the value of existing contracts through partial termination; and +· delay the payment of Microphase’s invoices by government payment offices. +The federal government +can terminate or modify any of its contracts with Microphase or its prime contractors either for the federal government’s +convenience, or if Microphase or its prime contractors default, by failing to perform under the terms of the applicable contract. +A termination arising out of Microphase’s default could expose it to liability and have a material adverse effect on its +ability to compete for future federal government contracts and subcontracts. If the federal government or its prime contractors +terminate and/or materially modify any of Microphase’s contracts or if any applicable options are not exercised, Microphase’s +failure to replace sales generated from such contracts would result in lower sales and would adversely affect its earnings, which +could have a material adverse effect on Microphase’s business, results of operations and financial condition. Microphase’s +backlog as of December 31, 2018 was approximately $7.3 million. Microphase’s backlog could be adversely affected if contracts +are modified or terminated. +Microphase’s products with military +applications are subject to export regulations, and compliance with these regulations may be costly. +Microphase is required +to obtain export licenses before filling foreign orders for many of its products that have military or other governmental applications. +United States Export Administration regulations control technology exports like its products for reasons of national security and +compliance with foreign policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for +the security of a destination country. Thus, any foreign sales of its products requiring export licenses must comply with these +general policies. Compliance with these regulations is costly, and these regulations are subject to change, and any such change +may require Microphase to improve its technologies, incur expenses or both in order to comply with such regulations. +Microphase depends on U.S. government +contracts issued to major defense contractors, which often are only partially funded, subject to immediate termination, and heavily +regulated and audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could +have an adverse impact on Microphase’s business. +33 +Over its lifetime, +a U.S. Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts +and subcontracts. The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts +may be authorized and appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year +basis. Procurement funds are typically made available for obligations over the course of one to three years. Consequently, programs +often receive only partial funding initially, and additional funds are designated only as Congress authorizes further appropriations. +The termination of funding for a U.S. Government program with respect to major defense contractors for which Microphase is a subcontractor +would result in a loss of anticipated future revenue attributable to that program, which could have an adverse impact on its operations. +In addition, the termination of, or failure to commit additional funds to, a program for which Microphase is a subcontractor could +result in lost revenue and increase its overall costs of doing business. +Generally, U.S. Government +contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to Microphase’s +contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already +reimbursed must be refunded. Microphase has recorded contract revenues based on costs Microphase expect to realize upon final audit. +However, Microphase does not know the outcome of any future audits and adjustments, and Microphase may be required to materially +reduce its revenues or profits upon completion and final negotiation of audits. Negative audit findings could also result in termination +of a contract, forfeiture of profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting +or subcontracting for a period of time. +In addition, U.S. Government +contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s +convenience upon the payment only for work done and commitments made at the time of termination. Microphase can give no assurance +that one or more of the U.S. Government contracts with a major defense contractor under which Microphase provides component products +will not be terminated under these circumstances. Also, Microphase can give no assurance that it will be able to procure new contracts +to offset the revenue or backlog lost as a result of any termination of its U.S. Government contracts. Because a significant portion +of Microphase’s revenue is dependent on its performance and payment under its U.S. Government contracts, the loss of one +or more large contracts could have a material adverse impact on its business, financial condition, results of operations and cash +flows. +Microphase’s +government business also is subject to specific procurement regulations and other requirements. These requirements, though customary +in U.S. Government contracts, increase its performance and compliance costs. In addition, these costs might increase in the future, +thereby reducing Microphase’s margins, which could have an adverse effect on its business, financial condition, results of +operations and cash flows. Failure to comply with these regulations and requirements could lead to fines, penalties, repayments, +or compensatory or treble damages, or suspension or debarment from U.S. Government contracting or subcontracting for a period of +time. Among the causes for debarment are violations of various laws, including those related to procurement integrity, export control, +U.S. Government security regulations, employment practices, protection of the environment, accuracy of records, proper recording +of costs and foreign corruption. The termination of a U.S. Government contract or relationship as a result of any of these acts +would have an adverse impact on Microphase’s operations and could have an adverse effect on its standing and eligibility +for future U.S. Government contracts. +Microphase’s business could be +negatively impacted by cybersecurity threats and other security threats and disruptions. +As a U.S. Government +defense contractor, Microphase faces certain security threats, including threats to its information technology infrastructure, +attempts to gain access to its proprietary or classified information, threats to physical security, and domestic terrorism events. +Microphase’s information technology networks and related systems are critical to the operation of its business and essential +to its ability to successfully perform day-to-day operations. Microphase is also involved with information technology systems for +certain customers and other third parties, which generally face similar security threats. Cybersecurity threats in particular, +are persistent, evolve quickly and include, but are not limited to, computer viruses, attempts to access information, denial of +service and other electronic security breaches. Microphase believes that it has implemented appropriate measures and controls and +has invested in skilled information technology resources to appropriately identify threats and mitigate potential risks, but there +can be no assurance that such actions will be sufficient to prevent disruptions to mission critical systems, the unauthorized release +of confidential information or corruption of data. A security breach or other significant disruption involving these types of information +and information technology networks and related systems could: +· disrupt the proper functioning of these networks and systems and therefore its operations and/or +those of certain of its customers; +· result in the unauthorized access to, and destruction, loss, theft, misappropriation or release +of, proprietary, confidential, sensitive or otherwise valuable information of Microphase or its customers, including trade secrets, +which others could use to compete against Microphase or for disruptive, destructive or otherwise harmful purposes and outcomes; +· compromise national security and other sensitive government functions; +· require significant management attention and resources to remedy the damages that result; +· subject Microphase to claims for breach of contract, damages, credits, penalties or termination; +and +· damage Microphase’s reputation with its customers (particularly agencies of the U.S. Government) +and the public generally. +34 +Any +or all of the foregoing could have a negative impact on its business, financial condition, results of operations and cash flows. +Microphase enters into fixed-price contracts +that could subject it to losses in the event of cost overruns or a significant increase in inflation. +Microphase has a number +of fixed-price contracts which allow it to benefit from cost savings but subject it to the risk of potential cost overruns, particularly +for firm fixed-price contracts, because Microphase assumes the entire cost burden. If its initial estimates are incorrect, Microphase +can lose money on these contracts. U.S. Government contracts can expose Microphase to potentially large losses because the U.S. +Government can hold Microphase responsible for completing a project or, in certain circumstances, paying the entire cost of its +replacement by another provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. +Because many of these contracts involve new technologies and applications, unforeseen events such as technological difficulties, +fluctuations in the price of raw materials, problems with its suppliers and cost overruns, can result in the contractual price +becoming less favorable or even unprofitable to Microphase. The U.S. and other countries also may experience a significant increase +in inflation. A significant increase in inflation rates could have a significant adverse impact on the profitability of these contracts. +Furthermore, if Microphase does not meet contract deadlines or specifications, Microphase may need to renegotiate contracts on +less favorable terms, be forced to pay penalties or liquidated damages or suffer major losses if the customer exercises its right +to terminate. In addition, some of its contracts have provisions relating to cost controls and audit rights, and if Microphase +fails to meet the terms specified in those contracts Microphase may not realize their full benefits. Microphase’s results +of operations are dependent on its ability to maximize its earnings from its contracts. Cost overruns could have an adverse impact +on its financial results. +Risks Related to Our Business and Industry - Enertec +Potential political, economic and military instability in +Israel could adversely affect our operations. +Enertec’s operating facilities are +located in Israel. Accordingly, political, economic and military conditions in Israel directly affect Enertec’s operations. +Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab +neighbors. A state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. Since October +2000, there has been an increase in hostilities between Israel and the Palestinian Arabs, which has adversely affected the peace +process and has negatively influenced Israel’s relationship with its Arab citizens and several Arab countries, including +the Israel-Gaza conflict. Such ongoing hostilities may hinder Israel’s international trade relations and may limit the geographic +markets where Enertec can sell its products and solutions. Hostilities involving or threatening Israel, or the interruption or +curtailment of trade between Israel and its present trading partners, could materially and adversely affect Enertec’s operations. +In addition, Israel-based companies and +companies doing business with Israel have been the subject of an economic boycott by members of the Arab League and certain other +predominantly Muslim countries since Israel’s establishment. Although Israel has entered into various agreements with certain +Arab countries and the Palestinian Authority, and various declarations have been signed in connection with efforts to resolve some +of the economic and political problems in the Middle East, we cannot predict whether or in what manner these problems will be resolved. +Wars and acts of terrorism have resulted in significant damage to the Israeli economy, including reducing the level of foreign +and local investment. +Furthermore, certain of our officers and +employees may be obligated to perform annual reserve duty in the Israel Defense Forces and are subject to being called up for active +military duty at any time. All Israeli male citizens who have served in the army are subject to an obligation to perform reserve +duty until they are between 40 and 49 years old, depending upon the nature of their military service. +Enertec may become subject to claims for remuneration or +royalties for assigned service invention rights by its employees, which could result in litigation and harm our business. +A significant portion of the intellectual +property covered by Enertec’s products has been developed by Enertec’s employees in the course of their employment +for Enertec. Under the Israeli Patent Law, 5727-1967, or the Patent Law, and recent decisions by the Israeli Supreme Court and +the Israeli Compensation and Royalties Committee, a body constituted under the Patent Law, Israeli employees may be entitled to +remuneration for intellectual property that they develop for us unless they explicitly waive any such rights. To the extent that +Enertec is unable to enter into agreements with its future employees pursuant to which they agree that any inventions created in +the scope of their employment or engagement are owned exclusively by Enertec (as it has done in the past), Enertec may face claims +demanding remuneration. As a consequence of such claims, Enertec could be required to pay additional remuneration or royalties +to its current and former employees, or be forced to litigate such claims, which could negatively affect its business. +35 +Risks Related to Ownership of Our Common Stock +If we +do not continue to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +The +listing of our common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for +continued listing. On December 18, 2015, we were notified by the NYSE American that we were no longer in compliance with the NYSE +American continued listing standards because our reported stockholders' equity was below continued listing standards. The NYSE +American requires that a listed company's stockholders' equity be $4.0 million or more if it has reported losses from continuing +operations and/or net losses in three of its four most recent fiscal years. Subsequently, the NYSE American informed us that we +are required to attain stockholders’ equity of $6.0 million or more because we experienced a loss for the year ended December +31, 2016. +Following +submission of our compliance plan demonstrating how we intend to regain compliance with the continued listing standards, we were +notified on March 9, 2016, that the NYSE American granted us a listing extension on the basis of our plan until June 19, 2017. +We are subject to periodic review by NYSE American staff during the extension period. Failure to make progress consistent with +the plan or to regain compliance with the continued listing standards by the end of the extension period could result in our common +stock being delisted from the NYSE American. +On +June 19, 2017, we filed a Form 8-K report with the Commission announcing that our Stockholders' Equity was approximately $6,409,000 +on a pro-forma basis. In a letter dated June 20, 2017, the NYSE American notified us that we had successfully regained compliance +with the NYSE American continued listing standards. Notwithstanding the foregoing, in light of our continue losses, there is no +assurance that we will be able to continue to meet the NYSE American continued listing standard. Failure to meet the NYSE American +listing requirement, we may be subject to delisting by the NYSE American. In the event our common stock is no longer listed for +trading on the NYSE American, our trading volume and share price may decrease and we may experience further difficulties in raising +capital which could materially affect our operations and financial results. +On +November 20, 2017, we received a letter from NYSE Regulation indicating that the NYSE American had concluded that we failed to +comply with Section 401(a) of the NYSE American’s Company Guide, which section requires that a listed company “make +immediate public disclosure of all material information concerning its affairs” The letter, which relates to our disclosure +of certain personnel changes to our board of directors and officers, provided that such letter constituted a warning letter issued +to us pursuant to Section 1009(a)(i) of the NYSE American Company Guide. On October 12, 2017, we filed a Form 8-K that disclosed +that certain personnel changes to our board of directors and executive officers were effective October 6, 2017. On November 6, +2017, we filed an amendment to the above referenced Form 8-K that disclosed that the personnel changes had not in fact occurred. +After discussion with the NYSE American, on November 8, 2017, we filed a subsequent Form 8-K that further clarified that we had +determined to rescind the personnel changes as of October 23, 2017. In that Form 8-K, we provided additional disclosure explaining +why the personnel changes were not undertaken. +On +November 29, 2017, we notified the NYSE American, LLC that we were no longer in compliance with Rule 801(h) of the NYSE American +Company Guide because, as a smaller reporting company, our Board of Directors was not comprised of at least 50% independent directors. +On November 28, 2017, our Board of Directors approved the issuance of cash compensation, and 10,000 shares of common stock and +warrants to purchase 50,000 shares of common stock subject to vesting and stockholder approval, to Mr. William Horne, a director +of our company, for services. As a result of this compensation, Mr. Horne may not be deemed independent within the meaning of Section +803A(2) of the NYSE American Company Guide. Mr. Horne has resigned from the audit committee of the Board of Directors. Robert Smith +has been appointed as chair of the audit committee. On December 8, 2017, our board of directors rescinded the equity compensation +granted to Mr. Horne. We believe that we are therefore presently in compliance with Rule 801(h) of the NYSE American Company +Guide. +On +January 4, 2019, we received a deficiency letter from NYSE American indicating that we were not in compliance with the continued +listing standards as set forth in Section 1003(f)(v) of the NYSE American Company Guide (the “ Company Guide ”). +Specifically, the letter informed the Company that the Exchange has determined that the shares of our common stock have been selling +for a low price per share for a substantial period of time and, pursuant to Section 1003(f)(v) of the Company Guide, the Company's +continued listing is predicated on the Company effecting a reverse stock split of our common stock or otherwise demonstrating sustained +price improvement within a reasonable period of time, which the NYSE American determined to be no later than July 4, 2019. As noted +above, on March 18, 2019 we effectuated a reverse split whereby each twenty (20) shares of our common stock were combined into +one such share, which increased the market price to a level where we regained compliance with the Company Guide. However, since +that time our common stock has declined significantly and there can be no assurance that it will not continue to do so. If the +decline is sufficiently marked, we will in all likelihood receive another letter similar to the one referenced above; however, +there can be no assurance that we could in that event successfully conduct another reverse split on a timely basis, if at all, +or that the NYSE Exchange will not take more drastic action, up to and including delisting our shares of common stock from the +exchange. +36 +Our common stock price is volatile. +Our common stock is +listed on the NYSE American. In the past, our trading price has fluctuated widely, depending on many factors that may have little +to do with our operations or business prospects. The exercise of outstanding options and warrants may adversely affect our stock +price and a stockholder’s percentage of ownership. As of December 31, 2018, we had outstanding options to purchase an aggregate +of 373,000 shares of common stock, with a weighted average exercise price of $20.60 per share, exercisable at prices ranging from +$11.40 to $46.40 per share and warrants to purchase up to 936,381 shares of common stock, with a weighted average exercise price +of $20.20 per share, at exercise prices ranging from $0.20 to $50.00 per share. +On March 29, 2019, +as referenced above, we issued an aggregate of 36,399,870 shares of common stock, including shares of common stock underlying warrants. +The sale of these shares of our common stock, including those underlying the warrants (assuming exercise thereof), is likely to +have a material and adverse effect on the market price of our common stock. +In addition, we have +previously agreed to register shares of common stock, and common stock underlying outstanding warrants and convertible debt in +connection with private placement of our securities that are not being registered in this annual report. Our shares of common stock +are thinly traded. Therefore, the resale of a large number of shares of common stock and common stock underlying warrants and convertible +debt by the selling stockholders may adversely affect the market price of our common stock. +Volatility in our common stock price may subject us to securities +litigation. +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our common stock +may continue to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, +coupled with depressed economic conditions, could continue to have a depressing effect on the market price of our common stock. +The following factors, many of which are beyond our control, may influence our stock price: +· the status of our growth strategy including the development of new products with any proceeds we +may be able to raise in the future; +· announcements of technological or competitive developments; +· regulatory developments affecting us, our customers or our competitors; +· announcements regarding patent or other intellectual property litigation or the issuance of patents +to us or our competitors or updates with respect to the enforceability of patents or other intellectual property rights generally +in the US or internationally; +· actual or anticipated fluctuations in our quarterly operating results; +· changes in financial estimates by securities research analysts; +· changes in the economic performance or market valuations of our competitors; +· additions or departures of our executive officers; and +· sales or perceived sales of additional shares of our common stock. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common +stock and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market +price of a company’s securities, stockholders have often instituted securities class action litigation against that company. +If we were involved in a class action suit or other securities litigation, it would divert the attention of our senior management, +require us to incur significant expense and, whether or not adversely determined, have a material adverse effect on our business, +financial condition, results of operations and prospects. +We have a substantial +number of convertible notes, warrants, options and preferred stock outstanding that could affect our price. +Due +to a number of financings, we have a substantial number of shares that are subject to issuance pursuant to outstanding convertible +debt, warrants and options. These conversion prices and exercise prices range from $0.20 to $50.00 per share of common stock. As +of December 31, 2018, the number of shares of common stock subject to convertible notes, warrants, options and preferred stock +were 999,641, 936,381, 373,000 and 127,551, respectively. The issuance of common stock pursuant to convertible notes, warrants, +options and preferred stock at conversion or exercise prices less than market prices may have the effect of limiting an increase +in market price of our common stock until all of these underling shares have been issued. +We have a number +of shares of common stock subject to registration rights. +Due +to a number of financings, we have contractually agreed to register with the Commission shares of common stock, and common stock +underlying outstanding warrants and convertible debt in connection with private placements of our securities. The potential resale +at the same time of a large number of shares of common stock and common stock underlying warrants and convertible debt by the selling +stockholders may adversely affect the market price of our common stock. +37 +Sales of additional +shares of our common stock could cause the price of our common stock to decline. +Sales +of substantial amounts of our common stock in the public market, or the availability of such shares for sale, by us or others, +including the issuance of common stock upon exercise of outstanding options and warrants, could adversely affect the price of our +common stock. We and our directors and officers may sell shares into the market, which could adversely affect the market price +of shares of our common stock. +The rights of the holders of common +stock may be impaired by the potential issuance of preferred stock. +Our certificate of +incorporation gives our board of directors the right to create new series of preferred stock. As a result, the board of directors +may, without stockholder approval, issue preferred stock with voting, dividend, conversion, liquidation or other rights which could +adversely affect the voting power and equity interest of the holders of common stock. Preferred stock, which could be issued with +the right to more than one vote per share, could be utilized as a method of discouraging, delaying or preventing a change of control. +The possible impact on takeover attempts could adversely affect the price of our common stock. Although we have no present intention +to issue any shares of preferred stock or to create a series of preferred stock, we may issue such shares in the future. +The requirements of being a public company +may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company +and subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among +other things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley +Act requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial +reporting. For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of +our internal controls structure and procedures for financial reporting. Section 404 compliance may divert internal resources +and will take a significant amount of time and effort to complete. If we fail to maintain compliance under Section 404, or +if in the future management determines that our internal control over financial reporting are not effective as defined under +Section 404, we could be subject to sanctions or investigations by the NYSE American should we in the future be listed on +this market, the Commission, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and +this could cause a decline in the market price of our common stock. Any failure of our internal controls could have a material +adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively +or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on +internal controls from our independent auditors. We may need to hire a number of additional employees with public accounting and +disclosure experience in order to meet our ongoing obligations as a public company, particularly if we become fully subject to +Section 404 and its auditor attestation requirements, which will increase costs. Our management team and other personnel will need +to devote a substantial amount of time to new compliance initiatives and to meeting the obligations that are associated with being +a public company, which may divert attention from other business concerns, which could have a material adverse effect on our business, +financial condition and results of operations. +If we fail to comply with the rules under +the Sarbanes-Oxley Act of 2002 related to accounting controls and procedures, or if we discover material weaknesses and deficiencies +in our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more +difficult. +If we fail to comply +with the rules under the Sarbanes-Oxley Act of 2002 related to disclosure controls and procedures, or, if we discover material +weaknesses and other deficiencies in our internal control and accounting procedures, our stock price could decline significantly +and raising capital could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments +of the effectiveness of our internal control over financial reporting. If material weaknesses or significant deficiencies are discovered +or if we otherwise fail to achieve and maintain the adequacy of our internal control, we may not be able to ensure that we can +conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 +of the Sarbanes-Oxley Act. Moreover, effective internal controls are necessary for us to produce reliable financial reports and +are important to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business +and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price +of our common stock could drop significantly. +If securities or industry analysts do +not publish research or reports about our business, or if they change their recommendations regarding our stock adversely, our +stock price and trading volume could decline. +The trading market +for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our +business. Our research coverage by industry and financial analysts is currently limited. Even if our analyst coverage increases, +if one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these +analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, +which in turn could cause our stock price or trading volume to decline. +The elimination of monetary liability +against our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, +officers and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers +and employees. +38 +Our certificate of +incorporation contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders +for damages for the breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have +contractual indemnification obligations under any future employment agreements with our officers. The foregoing indemnification +obligations could result in us incurring substantial expenditures to cover the cost of settlement or damage awards against directors +and officers, which we may be unable to recoup. These provisions and the resulting costs may also discourage us from bringing a +lawsuit against directors and officers for breaches of their fiduciary duties, and may similarly discourage the filing of derivative +litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit +us and our stockholders. +We do not anticipate paying dividends +on our common stock and, accordingly, stockholders must rely on stock appreciation for any return on their investment. +We have never declared +or paid cash dividends on our common stock and do not expect to do so in the foreseeable future. The declaration of dividends is +subject to the discretion of our board of directors and will depend on various factors, including our operating results, financial +condition, future prospects and any other factors deemed relevant by our board of directors. You should not rely on an investment +in our company if you require dividend income from your investment in our company. The success of your investment will likely depend +entirely upon any future appreciation of the market price of our common stock, which is uncertain and unpredictable. There is no +guarantee that our common stock will appreciate in value. +ITEM 1B. UNRESOLVED STAFF COMMENTS. +Not applicable. +ITEM 2. PROPERTIES +Our corporate headquarters +utilize 12,396 square foot of leased office, engineering, laboratory, and warehouse space in Fremont, California. Our headquarter +lease commenced on November 1, 2012 and expires on June 30, 2019. The annual base rent under the lease, payable on a monthly basis, +increases during the term of the lease from approximately $138,000 during the first year to approximately $157,000 during the final +year. The lease also provides for one option to renew for a term of five years. +In addition, we lease +43,062 square-feet of other space domestically that includes office, engineering, laboratory and warehouse space in both California +and Connecticut. The annual base rent under these leases, payable on a monthly basis, is approximately 1,032,000 during 2019. These +leases expire between May 2018 and January 2028. +We also lease facilities +internationally. In September, 2010, our wholly-owned subsidiary, DPL, entered into a fifteen-year lease for its 25,000 square-foot +facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military +power products for the European market. Sales and service support staff for its European network of distributors are located within +the building together with other functions, such as engineering and administration. DPL’s rent expense is approximately $13,000 +per month, and DPL has the option to cancel the lease after ten years. Further, in June 2011, Enertec entered into a ten-year lease +for its 32,900 square-foot facility in Karmiel, Israel, where it manufactures specialized electronic systems for the Israel military +market. Enertec’s rent expense is approximately $20,000 per month, +We currently anticipate +that the current leased space will be sufficient to support our current and foreseen future needs. +ITEM 3. LEGAL PROCEEDINGS +On July 31, 2018 a +stockholder derivative complaint was filed in the United States District Court for the Central District of California against the +Company as the nominal defendant, as well as its current directors and a former director styled Ethan Young and Greg Young, +Derivatively on Behalf of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, +Mordechai Rosenberg, Robert O. Smith, and Kristine Ault and DPW Holdings, Inc. , as the nominal defendant (Case No. 18-cv-6587) +(the “Complaint”). No hearings have been scheduled as of the date hereof. +The Complaint alleges +violations of state law and breaches of fiduciary duty, unjust enrichment and gross mismanagement by the individual defendants +as, in the view of the plaintiffs, we had entered into poorly advised loan transactions and related party transactions. We believe +that these claims are without merit and intend to vigorously defend them. We moved to dismiss the Complaint and on February 25, +2019, the Court granted the motion to dismiss but granted plaintiffs leave to amend their Complaint. On March 11, 2019, plaintiffs +filed their amended complaint asserting violations of breaches of fiduciary duties and unjust enrichment claims based on the previously +pled transactions. On March 25, 2019, we filed a motion to dismiss the amended complaint. The motion to dismiss is returnable +before the Court on May 6, 2019. +39 +Based on our assessment +of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot estimate the +reasonably possible loss or range of loss that may result from this action. However, an unfavorable outcome may have a material +adverse effect on our business, financial condition and results of operations. +On November 28, 2018, +Blockchain Mining Supply and Services, Ltd , a vendor who sold computers to our subsidiary, filed in the United States District +Court for the Southern District of New York against us and our subsidiary, Super Crypto Mining, Inc. (Case No. 18-cv-11099). The +Complaint asserted claims for breach of contract and promissory estoppel against the us and our subsidiary arising from the subsidiary’s +failure to satisfy a purchase agreement. The Complaint seeks damages in the amount of $1,388,495. +On February 4, 2019, +pursuant to the Court’s Rules, we requested a pre-motion Conference with the Court. The time to file our motion to +dismiss is stayed until the Court’ holds the pre-motion Conference, which has not yet been scheduled by the Court. +Based on the our assessment +of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot estimate the +reasonably possible loss or range of loss that may result from this action. However, we have established a reserve in the amount +of the unpaid portion of the purchase agreement. An unfavorable outcome may have a material adverse effect on our business, financial +condition and results of operations. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is +listed on the NYSE American under the symbol DPW. The following table sets forth our high and low sale prices per share of our +common stock as reported by www.nasdaq.com on the NYSE American through April 12, 2019 and for each quarter for the past two fiscal +years. +Fiscal Year Ended December 31, 2017 +High +Low +First Quarter +$35.00 +$10.00 +Second Quarter +$21.00 +$8.00 +Third Quarter +$19.20 +$10.00 +Fourth Quarter +$119.00 +$10.20 +First Quarter of 2018 +$72.00 +$15.20 +Fiscal Year Ended December 31, 2018 +High +Low +First Quarter +$72.00 +$15.20 +Second Quarter +$30.00 +$9.80 +Third Quarter +$13.4 +$7.80 +Fourth Quarter +$8.80 +$1.80 +First Quarter of 2018 +$3.20 +$0.28 +Second Quarter of 2018 through April 10, 2019 +$0.34 +$0.24 +40 +On April 12, 2018, +the last sales price per share of our common stock was $0.28. +Record Holders +As of April 12, 2019, +23,189,615 shares of our common stock were issued and outstanding and were owned by approximately 69 holders of record. A number +of holders of our common stock are “street name” or beneficial holders whose shares of record are held by banks, brokers, +and other financial institutions. +Dividend Policy +We have not declared +or paid any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration +of dividends in the future, if any, will be at the discretion of our Board of Directors and will depend upon our earnings, capital +requirements, and financial position. +Equity Compensation Information +The following table summarizes information +about our equity compensation plans as of December 31, 2018. +Number of Shares +Number of Options +of Common Stock +Weighted- +Remaining Available for +to be Issued +Average +Future Issuance Under +upon Exercise +Exercise Price +Equity Compensation Plans +of Outstanding +of Outstanding +(excluding securities +Options +Options +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation plans approved by stockholders (1) +388,873 +$ 20.3847 +$ +507,789 +(1) Includes warrants to purchase 15,873 shares of common stock at an exercise price of $0.20 per share of common stock that were +issued to Mr. Kohn and approved the Company’s stockholders in December 2017 and options to purchase 199,875 shares of common +stock at an average exercise price of $26.09 per share of common stock that were issued to the Company’s officers and directors +and approved the Company’s stockholders in December 2017 and 2018. +Recent Sales of Unregistered Securities +On October 11, 2018, +we entered into a Securities Purchase Agreement with a certain institutional investor providing for the issuance of (i) an Original +Issue Discount Promissory Note in the principal face amount of $565,000 due December 8, 2018, for a purchase price of $510,000, +and (ii) 20,000 shares of common stock to be issued by the Company. +During October 2018, +in accordance with the terms of 12% term promissory notes in the principal face amount of $789,473, the Company issued 22,500 shares +of its common stock to the investors. +These securities were +sold in reliance upon the exemption provided by Section 4(a)(2) of the Securities Act and the safe harbor of Rule 506 under Regulation +D promulgated under the Securities Act. +Issuer Repurchases of Equity Securities +The Company repurchased 2,750 shares of +its common stock for $57,748 during the year ended December 31, 2018. +41 +ITEM 6. SELECTED FINANCIAL DATA. +As a Smaller Reporting +Company, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested +by this Item. +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +CAUTIONARY NOTE REGARDING FORWARD-LOOKING +STATEMENTS +This Annual Report +on Form 10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed +to be, forward-looking statements. Such forward-looking statements include statements regarding, among others, (a) our expectations +about possible business combinations, (b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs +for working capital. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations, +are generally identifiable by use of the words “may,” “will,” “should,” “expect,” +“anticipate,” “approximate,” “estimate,” “believe,” “intend,” “plan,” +“budget,” “could,” “forecast,” “might,” “predict,” “shall” +or “project,” or the negative of these words or other variations on these words or comparable terminology. This information +may involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements +to be materially different from the future results, performance, or achievements expressed or implied by any forward-looking statements. +These statements may be found in this Annual Report on Form 10-K. +Forward-looking statements +are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other +future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, +risks, and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated +by the forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk +Factors” in this 10-K, changes in local, regional, national or global political, economic, business, competitive, market +(supply and demand) and regulatory conditions and the following: +· Adverse economic conditions; +· Our ability to effectively execute our business plan; +· Inability to raise sufficient additional capital to operate our business; +· Our ability to manage our expansion, growth and operating expenses; +· Our ability to evaluate and measure our business, prospects and performance metrics; +· Our ability to compete and succeed in highly competitive and evolving industries; +· Our ability to respond and adapt to changes in technology and customer behavior; +· Our ability to protect our intellectual property and to develop, maintain and enhance a strong +brand; and +· Other specific risks referred to in the section entitled “ Risk Factors ”. +We caution you therefore +that you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances +of future performance. All forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake +no obligation to update any forward-looking statements or other information contained herein unless required by law. +Information regarding +market and industry statistics contained in this Annual Report is included based on information available to us that we believe +is accurate. It is generally based on academic and other publications that are not produced for purposes of securities offerings +or economic analysis. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications +and the additional uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and +services. Except as required by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect +actual results or changes in assumptions or other factors that could affect those statements. See the section entitled “ Risk +Factors ” for a more detailed discussion of risks and uncertainties that may have an impact on our future results. +The amounts reported within our “Management’s +Discussion and Analysis of Financial Condition and Results of Operations” are in U.S. dollars in thousands, except shares +and per share data. +In this quarterly report, +the “Company,” “DPW Holdings,” “we,” “us” and “our” refer to DPW Holdings, +Inc., a Delaware corporation, our wholly-owned subsidiaries, Coolisys Technologies, Inc., Power-Plus Technical Distributors, LLC, +Digital Power Lending, LLC, Super Crypto Mining, Inc., Digital Power Limited, Enertec Systems 2001 Ltd. and our majority owned +subsidiaries, Microphase Corporation and I.AM, LLC. +42 +Recent Developments +On February 27, 2018, +we entered into a Sales Agreement with H.C. Wainwright & Co., LLC (“ HCW ”) to sell shares of our common stock +having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program +(the “ HWC ATM Offering ”) under which HCW acted as sales agent. The offer and sale of our common stock was made +pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained +therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared +effective by the SEC on January 11, 2018, and a prospectus supplement related to the HCW ATM Offering, dated February 27, 2018. +The HCW ATM Offering was terminated effective September 23, 2018. +On October 15, 2018, +we entered into an At-The-Market Issuance Sales Agreement with Wilson-Davis & Co., Inc., (“ WDCO ”) as sales +agent to sell shares of our common stock, having an aggregate offering price of up to $25 million from time to time, through an +“at the market offering” program (the “ WDCO ATM Offering ”). The offer and sale of our common stock +was made pursuant to the Company’s effective “shelf” registration statement on Form S-3 and an accompanying base +prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January +8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated +October 15, 2018. Subject to the terms and conditions of the At-The-Market Issuance Sales Agreement, WDCO used commercially reasonable +efforts to sell shares of our common stock, based upon our instructions, consistent with its normal trading and sales practices +and applicable state and federal laws, rules and regulations and rules of the NYSE American. We paid to WDCO a commission in an +amount equal to 4.0% of the gross sales price per share of common stock sold through the WDCO ATM Offering as sales agent under +the At-The-Market Issuance Sales Agreement. The WDCO ATM Offering was terminated effective April 1, 2019. +GENERAL +We are a growth company +seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy +which we began implementing upon the change in control that was completed on September 22, 2016. Our acquisition and development +target strategy include companies that have developed a “new way of doing business” in mature, well-developed industries +experiencing changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction +of costs; companies that are related to our core business in the commercial and defense industries; and companies that will enhance +our overall revenues. It is our goal to substantially increase our gross revenues in the near future. +We were originally +a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system +solutions for the medical, military, telecom and industrial markets. Although we intend to seek growth through acquisitions, we +will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where +customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating +conditions. +We have operations +located in Europe through our wholly-owned subsidiary, Digital Power Limited (“ DP Limited ”), Salisbury, England, +which operates under the brand name of “Gresham Power Electronics” (“ Gresham ”). DP Limited designs, +manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power +distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European +defense business is specialized in the field of naval power distribution products. +On November 30, 2016, +DPW Holdings formed Digital Power Lending, LLC (“ DP Lending ”), a wholly-owned subsidiary. DP Lending is engaged +in providing commercial loans to companies throughout the United States to provide them with operating capital to finance the growth +of their businesses. The loans will primarily be short-term, ranging from six to twelve months, but may be of longer duration. +On June 2, 2017, DPW +Holdings purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase +is a design-to-manufacture original equipment manufacturer, or OEM, industry leader delivering world-class radio frequency (“ RF ”) +and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video +amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. Microphase is headquartered +in Shelton, Connecticut. +On April 25, 2017, +DPW Holdings formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. The Company intends +to operate its existing businesses in the customized and flexible power system solutions for the medical, military, telecom and +industrial markets, other than the European markets which are primarily served by DP Limited, in Coolisys. +Further, on September +1, 2017, Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California +limited liability company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply +solutions, UPS systems, fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus +will serve as an extended sales organization for the Company’s overall flexible power system solutions. +43 +On +December 31, 2017, Coolisys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“ MICT ”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“ EML ”), +and Enertec Systems 2001 Ltd. (“ Enertec ”), an Israeli corporation and wholly owned subsidiary of EML, pursuant +to which Coolisys acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for +the military market. On May 23, 2018, Coolisys acquired Enertec for an aggregate cash purchase price of $4,850,099. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement to acquire 98.1% of I.AM, Inc. (“ I.AM ”), +for a purchase price of $981. I.AM owns and operates the Prep Kitchen brand restaurants located in the San Diego area. I.AM owed +DP Lending $1,715,330 in outstanding principal, pursuant to a loan and security agreement, between I.AM and DP Lending, that I.AM +used to acquire the restaurants. The purchase agreement provides that, as I.AM repays the outstanding loan to DP Lending in accordance +with the loan agreement, DP Lending will on a pro rata basis transfer shares of common stock of I.AM to David J. Krause, up +to an aggregate of 471 shares. +We are a Delaware corporation +with our corporate office located at 201 Shipyard Way, Suite E, Newport Beach, California 92663. Our phone number is 510-657-2635 +and our website address is www.dpwholdings.com. +Results of Operations +RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2018 +AND 2017 +The following table summarizes the results +of our operations for the years ended December 31, 2018 and 2017. +For the Years Ended +December 31, +2018 +2017 +Revenue +$ 17,762,217 +$ 10,000,749 +Revenue, cryptocurrency mining +1,675,549 +— +Revenue, related party +3,907,280 +173,751 +Revenue, restaurant operations +3,462,140 +— +Revenue, lending activities +347,033 +— +Total revenue +27,154,219 +10,174,500 +Cost of revenue +21,774,658 +6,325,027 +Gross profit +5,379,561 +3,849,473 +Total operating expenses +24,985,017 +9,832,518 +Loss from operations +(19,605,456 ) +(5,983,045 ) +Interest expense +(13,453,344 ) +(4,990,397 ) +Loss before income taxes +(33,058,800 ) +(10,973,442 ) +Income tax benefit +76,599 +78,393 +Net loss +(32,982,201 ) +(10,895,049 ) +Less: Net loss attributable to non-controlling interest +748,320 +278,818 +Net loss attributable to DPW Holdings +$ (32,233,881 ) +$ (10,616,231 ) +Preferred deemed dividends on Series B and Series C Preferred Stock +(108,049 ) +(584,182 ) +Preferred dividends on Series C Preferred Stock +— +(54,059 ) +Net loss available to common stockholders +$ (32,341,930 ) +$ (11,254,472 ) +Basic and diluted net loss per common share +$ (11.15 ) +$ (18.05 ) +Basic and diluted weighted average common shares outstanding +2,899,888 +623,583 +Comprehensive Loss +Loss available to common stockholders +$ (32,341,930 ) +$ (11,254,472 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +(377,823 ) +152,078 +Net unrealized (loss) gain on securities available-for-sale +(8,027,746 ) +5,171,743 +Other comprehensive income (loss) +(8,405,569 ) +5,323,821 +Total Comprehensive loss +$ (40,747,499 ) +$ (5,930,651 ) +44 +Revenues +Our revenues increased +by $16,979,719 or 166.9% to $27,154,219 for the year ended December 31, 2018, from $10,174,500 for the year ended December 31, +2017. The increase in revenue was primarily due to our four acquisitions completed during 2017 and 2018. Revenues generated by +these four acquisitions during the year ended December 31, 2018, represented $13,174,615 of our increase in revenues. Excluding +the increase in revenues that were generated by our recent acquisitions, the Company generated revenues of $13,979,604, which represented +an increase of $7,309,882. As discussed below, the increase of $7,309,882 from the year ended December 31, 2017, was primarily +due to our cryptocurrency mining operations and on revenues generated from a related-party from the manufacture of the Multiplex +Laser Surface Enhancement (“ MLSE ”) plasma-laser system. +Revenues, cryptocurrency mining +In January 2018, we +formed Digital Farms. During the year ended December 31, 2018, we recognized $1,675,549 of revenues generated by Digital Farms. +Revenues, related party +During the years ended +December 31, 2018 and 2017, we recognized $3,907,280 and $173,751, respectively, in revenues resulting from our relationship with +MTIX, a related party. In March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, +install and service the MLSE plasma-laser system. +Gross Margins +Gross margins decreased +to 19.8% for the year ended December 31, 2018 compared to 37.8% for the year ended December 31, 2017. The decrease in gross margins +was partially attributable to the lower margin revenue of $3,907,280 from MTIX, a related party, with gross margins of 21.5% combined +with negative margins of (202.7%) on revenues of $1,675,549 at Digital Farms. The negative gross margins at Digital Farms are attributed +to monthly recurring fixed costs at our colocation facilities which temporarily exceed the revenues from our mining operations +while we place our miners in service. If we had not recognized revenue, and the related cost of revenue, from Digital Farms and +our contract with MTIX, then our adjusted gross margins for the year ended December 31, 2018 would have been 36.8%. The decrease +in gross margins from 37.8% to 36.8% is mainly attributable to an increase in costs of our commercial products sold in our U.S. +operations, which historically have had much greater gross margins, offset by higher gross margins related to restaurant operations. +Engineering and Product Development +Engineering and product +development expenses increased by $310,793 to $1,430,538 for the year ended December 31, 2018 from $1,119,745 for the year ended +December 31, 2017. The increase is primarily attributed to our acquisitions of Microphase and Enertec. The closing of the acquisitions +of Microphase and Enertec occurred on June 2, 2017 and May 23, 2018, respectively. Enertec incurred engineering and product development +expenses for the period May 23, 2018 to December 31, 2018 of $135,964. During the prior-year period, Microphase reported $293,775 +in engineering and product development expenses as opposed to $466,575 during the year ended December 31, 2018. In aggregate, these +acquisitions resulted an increase in engineering and product development expenses of $308,764. +Selling and Marketing +Selling and marketing +expenses were $3,010,790 for the year ended December 31, 2018 compared to $1,721,050 for the year ended December 31, 2017, an increase +of $1,289,740. Our acquisition of Microphase, Power-Plus, Enertec and I.AM accounted for $1,111,987, of the increase in selling +and marketing expenses. The remaining increase of $177,753 is attributed to an increase in personnel costs directly attributed +to sales and marketing personnel at our U.S. and UK based operations. Throughout the quarter ended March 31, 2017, we augmented +our sales and marketing team in the U.S. with the addition of a Vice President of Business Development and two regional sales managers. +The increase in selling and marketing expenses is partially attributed to the increase in salaries and benefits and travel related +costs for these three new sales and marketing positions. Further, during December 2017, we hired a Sales Director at our UK operations. +General and Administrative +General and administrative +expenses were $19,842,378 for the year ended December 31, 2018 compared to $6,991,723 for the year ended December 31, 2017, an +increase of $12,850,655. Our acquisitions of Microphase, Enertec and I.AM accounted for $3,929,639 of the increase in general and +administrative expenses. The adjusted increase of $8,921,016 from the comparative prior period was mainly due to higher stock-based +compensation expenses, an increase in legal and audit costs, an increase in investor relationship costs and hiring of additional +consultants to build an infrastructure in anticipation of our future growth and the increase in cost attributed to the hiring of +a new chief financial officer. The remaining increase in general and administrative expenses is due to various costs, none of which +are significant individually. +45 +· +In +aggregate, we incurred $4,719,265 of stock-based compensation during the year ended December 31, 2018. Of this amount, $2,951,978 +was from issuances of equity-based awards pursuant to our Plans and $1,767,287 was from stock, options and warrants which were +issued outside the Plans. It has been our policy to allocate the majority of stock-based compensation to general and administrative +expense. During the year ended December 31, 2018 and 2017, and inclusive of equity-based awards issued outside the Plans, we recorded +$4,688,819 and $1,754,939, respectively, of stock-based compensation in general and administrative expense. +· We experienced an aggregate increase of $135,017 in audit and legal fees due to an overall increase +in the operations conducted and the level of complexity and significant number of the transactions entered into during the year +ended December 31, 2018. +· Beginning during the quarter ended December 31, 2016, we spent significant effort on expanding +our investor base and on hiring additional consultants to assist building an infrastructure to support our anticipated growth. +These efforts were continued during the year ended December 31, 2018 and resulted in an increase of $331,995 in costs attributed +to investor relations and other consulting fees. +· During January 2018 we hired a new Chief Financial Officer and in September 2017 we hired a senior +executive to assist in management at Coolisys. These two hires resulted in an overall increase in payroll expense of approximately +$395,000 during the year ended December 31, 2018. +· Finally, we recently established Digital Farms, our digital currency blockchain mining subsidiary, +and DP Lending, our commercial lending subsidiary. During the year ended December 31, 2018, general and administrative costs attributed +to these subsidiaries were $2,981,527. +Interest (expense) income, net +Interest expense was +$13,453,344 for the year ended December 31, 2018 compared to $4,990,397 for the year ended December 31, 2017. The increase in interest +expense for the year ended December 31, 2018 is primarily related to the amortization of debt discount, in the aggregate amount +of $11,191,056 resulting from original issue discount on the issuance of warrants in conjunction with the sale of debt instruments +in the aggregate amount of $25,443,760. During the year ended December 31, 2018, as a result of these issuances, non-cash interest +expense of $11,191,056 was recorded from the amortization of debt discount and debt financing costs. The remaining increase in +interest expense was due to an increase in the amount of the Company’s total borrowings and which was primarily offset by +interest income and the accretion of original issue discount pursuant to the Loan and Security Agreement entered into on September +6, 2017, between the Company and AVLP (“AVLP Loan Agreement”) of $2,034,358. +Operating Loss +The Company recorded +an operating loss of $19,605,456 for the year ended December 31, 2018 compared to an operating loss of $5,983,045 for the year +ended December 31, 2017. The increase in operating loss is mostly attributable from the increase of general and administrative +expenses. +Net Loss +For the foregoing +reasons, our net loss for the year ended December 31, 2018, was $32,982,201 compared to a net loss of $10,895,049 for the year +ended December 31, 2017. After taking into consideration the loss attributable to the non-controlling interest of the minority +stockholders of Microphase of $430,265 and $278,818 and preferred dividends of $108,049 and $638,241 during the years ended December +31, 2018 and 2017, respectively, the net loss available to common stockholders during the years ended December 31, 2018 and 2017, +was $32,341,930 and $11,254,472, respectively. +As reflected in our +consolidated statement of cash flows for the years ended December 31, 2018 and 2017, our reported net loss is comprised of non-cash +charges of $16,812,868 and $6,334,058, respectively. A summary of these non-cash charges is as follows: +For the Years Ended +December 31, +2018 +2017 +Interest expense – debt discount +$ 11,191,056 +$ 4,688,630 +Stock-based compensation +4,719,266 +1,831,435 +Depreciation and amortization +2,906,905 +254,006 +Interest expense on conversion of promissory notes to common stock +— +13,333 +Accretion of original issue discount on notes receivable – related party +(2,004,358 ) +(453,346 ) +Non-cash items included in net loss +$ 16,812,868 +$ 6,334,058 +46 +Other comprehensive income (loss) +Other comprehensive +income (loss) was ($8,405,569) and $5,323,821, respectively, for the years ended December 31, 2018 and 2017. Other comprehensive +loss for the year ended December 31, 2018, which decreased our equity, reflects the impact of the weakening of the British Pound +on the equity of DP Limited combined with unrealized losses in our investments in marketable securities, primarily in the warrants +that we received as a result of our investment in AVLP, a related party. During the year ended December 31, 2017, unrealized gains +in our investment in the AVLP warrants was the principal component of other comprehensive income. +LIQUIDITY AND CAPITAL RESOURCES +On December 31, 2018, +we had cash and cash equivalents of $902,329. This compares with cash and cash equivalents of $1,478,147 at December 31, 2017. +The decrease in cash and cash equivalents was primarily due to cash provided by financing activities being slightly less than the +amount of cash used in operating and investing activities. +Net cash used in operating +activities totaled $10,422,404 for the year ended December 31, 2018, compared to net cash used by operating activities of $4,116,564 +for the year ended December 31, 2017. During the year ended December 31, 2018, the increase in net cash used in operating activities +compared to the year ended December 31, 2017 was mainly due to the net loss for the year ended December 31, 2018 of $32,982,201. +The net loss was partially offset by a number of non-cash charges, the amortization of debt discount of $11,191,055 and stock-based +compensation of $4,719,266, an increase in accounts receivable, related party of $3,713,903 and accounts payable and accrued expenses +of $7,797,395 and decreases in our accounts receivable of $2,754,631. +Net cash used in investing +activities was $20,618,928 for the year ended December 31, 2018 compared to $8,673,963 of net cash used in investing activities +for the year ended December 31, 2017. The increase of the net usage of cash from investing activities was primarily attributed +to the purchase of property and equipment at Digital Farms, the investment in AVLP, the acquisition of Enertec and investments +in debt and equity securities. +Net cash provided +by financing activities was $30,537,688 and $13,223,500 for the years ended December 31, 2018 and 2017, respectively. The financing +activities primarily related to the sale of 1,640,935 shares of common stock through a registered direct offering and from our +ATM Offering for gross proceeds of $23,884,470, net proceeds from the Company’s debt financings and from advances of future +receipts of $28,794,037 which was offset by payments on debt instruments of $20,974,155 and proceeds from the exercise of options +and warrants of $964,966. +Historically, we have +financed our operations principally through issuances of convertible debt, promissory notes and equity securities. During 2018, +as reflected below, we continued to successfully obtain additional equity and debt financing and in restructuring existing debt. +· On January 23, 2018, we entered into a securities purchase agreement with an institutional investor +to sell, for an aggregate purchase price of $1,000,000, a 10% senior convertible promissory note (the “Note”) with +an aggregate principal face amount of $1,250,000, a warrant to purchase an aggregate of 31,250 shares of our common stock and 27,174 +shares of our common stock. The transactions contemplated by the securities purchase agreement closed on February 8, 2018. The +Note is convertible into 31,250 shares of our common stock, a conversion price of $40.00 per share, subject to adjustment. The +exercise price of the warrant to purchase 31,250 shares of our common stock is $44.00 per share, subject to adjustment. On February +9, 2018, in addition to the 543,478 shares of common stock provided for pursuant to the securities purchase agreement, we issued +to the investor an aggregate of 34,597 shares of our common stock upon the conversion of the entire outstanding principal and accrued +interest on the Note of $1,383,884. +· On January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2,500,000 +for an aggregate debt of $5,000,000 to two institutional investors. The proceeds from the two promissory notes was used to purchase +1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with our mining operations. We received delivery of +the Miners on February 1, 2018. On March 27, 2018, we paid the principal and accrued interest on each of the 5% promissory notes. +· On February 20, 2018, we issued a promissory note in the principal face amount of $900,000 to an +accredited investor. This promissory note included an original issue discount (“OID”) of $150,000 resulting in net +proceeds of $750,000. The principal and OID on this note was due and payable on March 22, 2018. On March 23, 2018, we entered into +a new promissory note in the principal amount of $1,750,000 for a term of two months, subject to our ability to prepay within one +month. The interest rate payable on this new promissory note was twenty percent per thirty calendar days, payable in a lump sum +on the maturity date. We also issued to the lender a warrant to purchase 62,500 shares of our common stock at an exercise price +of $23.00 per share, pursuant to a consulting agreement. The principal amount of the new promissory note consisted of net proceeds +of $1,000,000 and the cancellation of the principal of $750,000 from the February 20, 2018 promissory note. The interest on the +February 20, 2018 note in the amount of $150,000 was paid to the lender prior to entering into the new promissory note. On April +23, 2018, we paid the entire outstanding principal and accrued interest on the new promissory note of $2,100,000. +47 +· On February 26, 2018, we issued a 10% promissory note in the principal face amount of $330,000 +to an accredited investor. This promissory note included an OID of $30,000 resulting in net proceeds to us of $300,000. The principal +and accrued interest on this note was due and payable on April 12, 2018, subject to a 30-day extension available to us. This +10% promissory note was paid on April 27, 2018. +· On February 27, 2018, we entered into a Sales Agreement with H.C. Wainwright & Co., LLC (“HCW”) +to sell shares of common stock having an aggregate offering price of up to $50 million (the “Shares”) from time to +time, through an “at the market offering” program (the “HCW ATM Offering”) under which HCW acted as sales +agent. The offer and sale of the Shares was made pursuant to our effective “shelf” registration statement on Form S-3 +and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, +2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to +the HCW ATM Offering, dated February 27, 2018. The HCW ATM Offering was terminated effective September 23, 2018. +· On March 23, 2018, we entered into a securities purchase agreement to sell and issue a 12% promissory +note and a warrant to purchase 22,500 shares of common stock to an accredited investor. The promissory note was issued with a 10% +OID. The promissory note is in the principal amount of $1,000,000 and was sold for $900,000, bears interest at 12% simple interest +on the principal amount, and is due on June 22, 2018. Interest only payments are due, in arrears, on a monthly basis commencing +on April 23, 2018. The exercise price of the warrant is $23.00 per share. The promissory note is unsecured by any of our assets +but is guaranteed by our Chief Executive Officer. +· On March 27, 2018, we issued a 10% promissory note in the principal face amount of $200,000 to +an accredited investor. The principal and accrued interest on this note was due and payable on March 29, 2018. Between March 29 +and April 24, 2018, we paid the entire outstanding principal on this 10% promissory note of $200,000. +· On April 16, 2018, we entered into securities purchase agreements with three institutional investors +to sell, for an aggregate purchase price of $1,550,000, 12% secured convertible promissory notes (“Convertible Notes”) +with an aggregate principal face amount of $1,722,222, warrants to purchase an aggregate of 49,679 shares of our common stock, +and an aggregate of 10,046 shares of our common stock. The Convertible Notes bear simple interest at 12% on the principal amount +with a guarantee of interest during the initial six months in the amount of $103,333. Beginning on May 16, 2018, we were required +to make six monthly cash payments in the aggregate amount of $304,259 until the Convertible Notes are satisfied in full, which +was to occur on October 16, 2018. On August 31, 2018, the Company made its final payment and in aggregate paid principal and accrued +interest of $1,722,222 and $103,333, respectively, on the 12% April 2018 Convertible Notes. The warrants entitle the holders to +purchase, in the aggregate, up to 49,679 shares of our common stock at an exercise price of $26.00 per share for a period of five +years subject to certain beneficial ownership limitations. +· On May 15, 2018, we entered into securities purchase agreements with certain investors for the +sale and issuance of an aggregate of 384,589 shares of our Class A common stock, and five-year warrants to purchase such number +of shares of common stock equal to the shares of common stock purchased by the investors. We received aggregate consideration of +$5,999,584, consisting of cash and the cancellation of short-term advances of $3,225,000 and $2,774,584, respectively. These securities +were issued pursuant to our registration statement filed with the Securities and Exchange Commission (File No. 333-222132) which +became effective on January 11, 2018. +· On May 15, 2018, we entered into a securities purchase agreement with an institutional investor +providing for the issuance of (i) a 10% senior secured convertible promissory note (the “10% Convertible Note”) with +a principal face amount of $6,000,000, (ii) a five-year warrant to purchase 55,556 shares of the Company’s common stock (the +“Series A Warrant Shares”) at an exercise price of $27.00 (the “Series A Warrant”), (iii) a five-year warrant +to purchase 86,207 shares of the Company’s common stock (the “Series B Warrant Shares” and with the Series A +Warrant Shares, the “Warrant Shares”) at an exercise price of $17.40 per share (the “Series B Warrant” +and together with the Series A Warrant, the “Warrants”), and (iv) 17,241 shares of our common stock. Initially, the +10% Convertible Note was convertible into our common stock at $15.00 per share, but could only be converted if an event of default +thereunder had occurred and not been cured on a timely basis. Pursuant to an amendment dated as of August 31, 2018, we reduced +the conversion price to $8.00 from $15.00. Further, on September 25, 2018, we entered into an agreement to amend the maturity date +on the 10% Convertible Note, pursuant to which amendment the amortization schedule of the 10% Convertible Note provides for 13 +monthly payments in the amount of $309,193, and for the fourteenth payment to be in the amount of $1,011,427, plus accrued and +unpaid interest. Each such amortization payment shall be made in cash or Bitcoin +48 +In connection with the financing, +pursuant to an engagement agreement with Alliance Global Partners (“AGP”), a licensed broker-dealer with FINRA, we +agreed to pay to AGP a cash fee, or placement agent fee, equal to 5% of the aggregate gross proceeds raised. Such fee was paid +at the closing of the offering. In addition, AGP shall receive a cash fee equal to 5% of such cash exercise price proceeds received +by us, payable within 48 hours of our receipt of any cash exercise price proceeds from the exercise of any warrants sold, provided +that no such fee is due and payable hereunder in the event the warrants are not exercised for cash. AGP is also entitled to receive +a warrant to purchase 7,500 shares of common stock with an exercise price of $20.00, which warrant shall be exercisable for 5-years +via cashless exercise until registered and via cash thereafter. +· On July 2, 2018, we entered into a securities purchase agreement with an institutional investor +providing for the issuance of (i) a second 10% senior secured convertible promissory note (the “Second 10% Convertible Note”) +with a principal face amount of $1,000,000, which Second 10% Convertible Note was initially convertible into our common stock at +$15.00 per share and (ii) an additional 20,000 of the Company’s common stock to be issued in connection with the 10% Convertible +Note. Pursuant to an amendment dated as of August 31, 2018, we reduced the conversion price to $8.00 from $15.00. The Second 10% +Convertible Note matures on January 1, 2019. +· On August 31, 2018, we entered into a securities purchase agreement with the institutional investor +providing for the issuance of (i) a third 10% convertible note (the “Third 10% Convertible Note” and with the 10% Convertible +Note and the Second 10% Convertible Note, the “10% Convertible Notes”) with a principal face amount of $2,000,000, +which Third Convertible Note is convertible into 250,000 shares of our common stock at $8.00 per share and (ii) an additional 31,000 +of our common stock. The shares of common stock issuable pursuant to the Third 10% Convertible Note have not yet been issued to +the institutional investor. The Third 10% Convertible Note matures on February 15, 2019. +· On August 10, 2018, DP Lending issued a 12% promissory note in the principal amount of $550,000 +to an accredited investor. This promissory note included an OID of $50,000 resulting in net proceeds of $500,000. The principal +and accrued interest on this note is due and payable on August 10, 2019. +· On August 16, 2018, we entered into a securities purchase agreement with certain institutional +investors providing for the issuance of (i) secured promissory notes (the “Notes”) in the aggregate principal face +amount of $1,212,000 due February 15, 2019, at an interest rate of eight percent (8%) per annum for which we received an aggregate +of $1,010,000, and (ii) an aggregate of 20,000 shares of common stock to be issued by us, subject to approval of the NYSE American. +· On August 23, 2018, DP Lending issued a promissory note in the principal amount of $85,000 to an +accredited investor. This promissory note included an OID of $10,000 resulting in net proceeds of $75,000. The principal and accrued +interest on this note was due and payable on September 24, 2018. +· On August 28, 2018, DP Lending issued a promissory note in the principal amount of $115,000 to +an accredited investor. This promissory note included an OID of $15,000 resulting in net proceeds of $100,000. The principal and +accrued interest on this note was due and payable on September 14, 2018. This promissory note was paid on September 21, 2018. +· During September 2018, we issued to institutional investors 12% term promissory notes in the principal +face amount of $789,473, with an interest rate of 12% for a purchase price of $749,999. The outstanding principal face amount, +plus any accrued and unpaid interest, was due by December 31, 2018, or as otherwise provided in accordance with the terms set forth +therein. In accordance with the notes, we also agreed to issue 22,500 shares of our common stock to the investors. The notes contain +standard and customary events of default. +· On October 11, 2018, we entered into a Securities Purchase Agreement with a certain institutional +investor providing for the issuance of (i) an Original Issue Discount Promissory Note in the principal face amount of $565,000 +due December 8, 2018, for a purchase price of $510,000, and (ii) 20,000 shares of common stock to be issued by the Company, subject +to approval of the NYSE American. +· On October 15, 2018, we entered into an At-The-Market Issuance Sales Agreement with Wilson-Davis +& Co., Inc. (“WDCO”) to sell shares of our common stock, having an aggregate offering price of up to $25 million +from time to time, through an “at the market offering” program (the “WDCO ATM Offering”) under which WDCO +acts as sales agent. The offer and sale of the shares through the WDCO ATM Offering was made pursuant to our effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) +filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and +a prospectus supplement related to the WDCO ATM Offering, dated October 15, 2018. +49 +We expect to continue +to incur losses for the foreseeable future and will be required to raise additional capital to continue to support our working +capital requirements. We believe that the MLSE purchase order contract of $50 million and revenue generated by Digital Farms +will generate meaningful revenue and corresponding cash in 2019. In addition, we have been successful over the last 12 months in +raising capital to support our working capital requirements. We anticipate that we will continue to raise capital through public +and private equity offerings, debt financings, or other means. If we are unable to secure additional capital, we may be required +to curtail our current operations and take additional measures to reduce costs expenses, including reducing our workforce, eliminating +outside consultants, ceasing or reducing our due diligence of potential future acquisitions, including the associated legal fees, +in order to conserve cash in order to sustain operations and meet our obligations. +Based on the above, +these matters raise substantial doubt about the Company’s ability to continue as a going concern. +Critical Accounting Policies +See Note 3, Basis of Presentation and Significant +Accounting Policies, to the Company’s consolidated financial statements for the year ended December 31, 2018 included in +this Annual Report. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller +reporting company, this section is not applicable +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements +required by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not +required to provide supplementary financial information. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and +Procedures +As of December 31, +2018, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our +principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure +controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange +Act ”). We have established disclosure controls and procedures designed to ensure that information required to be disclosed +in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods +specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and +principal financial officer, to allow timely decisions regarding required disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined +in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined +that our disclosure controls and procedures were not effective due to certain material weaknesses as described herein. +Management’s Annual Report on +Internal Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange +Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability +of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted +accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain +to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the +assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial +statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being +made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance +regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have +a material effect on the financial statements. +Because of its inherent +limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation +of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, +or that the degree of compliance with the policies or procedures may deteriorate. +50 +Our management assessed +the effectiveness of our internal control over financial reporting as of December 31, 2018. In making this assessment, our management +used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) +in Internal Control-Integrated 2013 Framework. Our management has concluded that, as of December 31, 2018, our internal control +over financial reporting was not effective. +A material weakness +is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) +or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual +or interim financial statements will not be prevented or detected. Management has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting function, which restricts our ability to +gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size +and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to +the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed +by separate individuals. Management evaluated the impact of our failure to have segregation of duties during our assessment of +our disclosure controls and procedures and concluded that the control deficiency that resulted represented a material weakness +2. We have inadequate controls to ensure that information necessary to properly record transactions +is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management +evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment +of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +3. We did not design or maintain effective general information technology (“IT”) controls +over certain information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets. +Specifically, we did not design and implement: +· Program change management controls for certain financially +relevant systems to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, (ii) digital +currency mining equipment, (iii) digital currency hardware wallets, and (iv) underlying accounting records, are identified, tested, +authorized and implemented appropriately; and +· Physical security controls to ensure that the (i) digital +currency hardware wallets, (ii) digital currency hardware wallet master seed phrases, (iii) digital currency hardware wallet pin +codes, and (iv) the digital currency mining equipment were safeguarded, monitored, validated, and restorable, both physically and +electronically. +Planned Remediation +Management, +in coordination with the input, oversight and support of our Audit Committee, has identified the measures below to strengthen +our control environment and internal control over financial reporting. +In +January 2018 we hired a new Chief Financial Officer and engaged the services of a financial accounting advisory firm. In September +2018, we hired a Chief Accounting Officer and in January 2019, we hired a Senior Vice President of Finance. We have tasked these +individuals with expanding and monitoring the Company’s internal controls, to provide an additional level of review of complex +financial issues and to assist with financial reporting. Further, as we continue to expand our internal accounting department, +the Chairman of the Audit Committee shall perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, +· reviews all anticipated transactions that are not considered in the ordinary course of business +to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in our financial statements +We +are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address +the material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls +and procedures. +This Annual Report +does not include an attestation report of our independent registered public accounting firm regarding internal control over financial +reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant +to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated +filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +51 +Changes in Internal Control over Financial +Reporting +During the most recent +fiscal quarter 2018 there were no significant changes in our internal control over financial reporting (as such term is defined +in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect +our internal control over financial reporting. +ITEM 9B. OTHER +INFORMATION. +None +PART III +Item 10. +Directors, Executive Officers and Corporate Governance. +The following table +sets forth the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. Ault, III (1) +49 +Chief Executive Officer, Chairman of the Board and Director +2017 +William B. Horne (2) +50 +Chief Financial Officer and Director +2016 +Amos Kohn +59 +President and Director +2003 +Robert O. Smith (3) (5) +75 +Director +2016 +Moti Rosenberg (5) +70 +Director +2015 +Jeffrey A. Bentz (4) (5) +59 +Director +2018 +(1) +Effective March 16, 2017, Mr. Ault was appointed to the Board. +(2) +On October 13, 2016, William B. +Horne was appointed to the Board. Pursuant to a securities purchase agreement dated September 5, 2016 by and among the Company, +Philou +Ventures, and Telkoor. Philou Ventures has the right to appoint one member to the Board of Directors. +(3) +On September 22, 2016, Mr. Robert O. Smith was appointed to the board. +(4) +On January 24, 2018, Mr. Jeffrey A. Bentz was appointed to the board. +(5) +Independent Director and Member of the Audit, Compensation and Nominating and Governance Committees. +Each of the directors +named above will serve until the next annual meeting of our stockholders or until his respective successor is elected and qualified. +Subject to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Mr. Milton C. Ault, III +On March 16, 2017, +Mr. Ault was appointed Executive Chairman of the Board and on December 28, 2017, Mr. Ault was appointed Chief Executive Officer. +Mr. Ault is a seasoned business professional and entrepreneur that has spent more than twenty-seven years identifying value in +various financial markets including equities, fixed income, commodities, and real estate. Mr. Ault founded on February 25, 2016 +Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s Disease +and has served as its Chairman since. Mr. Ault has served as Chairman of Ault & Company, a holding company since December 2015, +and as Chairman of Avalanche International Corp since September 2014, a “voluntary filer” under the Exchange Act. Since +January, 2011, Mr. Ault has been the Vice President of Business Development for MCKEA Holdings, LLC, a family office. Through this +position, Mr. Ault has consulted for a few publicly traded and privately held companies, providing each of them the benefit of +his diversified experience, that range from development stage to seasoned businesses. He was the President, Chief Executive Officer, +Director and Chairman of the Board of Zealous, Inc. from August 2007 until June 4, 2010 and again from February 2011 through May +1, 2011. Mr. Ault was a registered representative at Strome Securities, LP, from July 1998 until December 2005, where he was involved +in portfolio management and worked on several activism campaigns including Taco Cabana, Jack In The Box (formerly Foodmaker), and +21st Century Holdings Co. Mr. Ault became majority stockholder of Franklin Capital Corp and was elected to its board of directors +in July 2004 and became its Chairman and Chief Executive Officer in October 2004 serving until January 2006, and again from July +2006 to January 2007. In April 2005, the company changed its name to Patient Safety Technologies, Inc. (OTCBB:PSTX, OTCQB:PSTX) +(“PST”) and purchased SurgiCount Medical, Inc. Stryker Corporation (NYSE:SYK) acquired PST at the beginning of 2014 +in a deal valued at approximately one hundred twenty million dollars ($120,000,000). PST’s wholly owned operating subsidiary, +SurgiCount Medical, Inc., is the company that developed the SafetySponge® System; a bar coding technology for inventory +control that aims to detect and prevent the incidence of foreign objects left in the body after surgery. We believe that Mr. Ault’s +business background demonstrates he has the qualifications to serve as one of our directors and as Chairman. +52 +Amos Kohn +Mr. Kohn has served +as a member of our board of directors since 2003, as our President since 2008. Mr. Kohn also served at our Chief Executive Officer +from 2008 to December 2017. From March 2011 until August 2013 and again from July 2017 until January 2018, Mr. Kohn also served +as interim Chief Financial Officer. Mr. Kohn has more than 20 years of successful global executive management experience, including +multiple C-level roles across private and established publicly-traded companies. Mr. Kohn has successfully managed cross-functional +teams, driven corporations to high profitability, built customer loyalty and led businesses through expansion and sustained growth. +His areas of expertise include operations, technology innovation, manufacturing, strategic analysis and planning and M&A. +Mr. Kohn was Vice President of Business Development at Scopus Video Networks, Inc., a Princeton, New Jersey company that develops +and markets digital video networking products (2006-2007); Vice President of Solutions Engineering at ICTV Inc., a leading provider +of network-based streaming media technology solutions for digital video and web-driven programming, located in Los Gatos, California +(2003-2006); Chief Architect at Liberate Technologies, a leading company in the development of a full range of digital media processing +for telecom and cable TV industries, located in San Carlos, California (2000-2003); and Executive Vice President of Engineering +and Technology at Golden Channel & Co., the largest cable television multiple-systems operator (MSO) in Israel, where he had +executive responsibility for developing and implementing the entire nationwide cable TV system (1989-2000). Mr. Kohn holds a degree +in electrical and electronics engineering and is named as an inventor on several United States and international patents. We believe +that Mr. Kohn’s extensive executive-level management experience in diversified industries, including, but not limited to, +power electronics, telecommunications, cable television, broadcast and wireless, as well as his service as a director on our board +since 2003, give him the qualifications and skills to serve as one of our directors. +William B. Horne +Mr. Horne has served +as a member of our board of directors since October 2016. On January 25, 2018, Mr. Horne was appointed as our Chief Financial Officer. +Prior to his appointment as our Chief Financial Officer, Mr. Horne served as one our independent directors. He has served as the +Chief Financial Officer of Targeted Medical Pharma, Inc. (OTCBB: TRGM) since August 2013. Mr. Horne is a director of and Chief +Financial Officer to Avalanche International, Corp., a “voluntary filer” under the Exchange Act. Mr. Horne previously +held the position of Chief Financial Officer in various companies in the healthcare and high-tech field, including OptimisCorp, +from January 2008 to May 2013, a privately held, diversified healthcare technology company located in Los Angeles, California. +Mr. Horne served as the Chief Financial Officer of Patient Safety Technologies, Inc. (OTCBB: PSTX), a medical device company located +in Irvine, California, from June 2005 to October 2008 and as the interim Chief Executive Officer from January 2007 to April 2008. +In his dual role at Patient Safety Technologies, Mr. Horne was directly responsible for structuring the divestiture of non-core +assets, capital financings and debt restructuring. Mr. Horne held the position of Managing Member & Chief Financial Officer +of Alaska Wireless Communications, LLC, a privately held, advanced cellular communications company, from its inception in May 2002 +until November 2007. Mr. Horne was responsible for negotiating the sale of Alaska Wireless to General Communication Inc. (NASDAQ: +GNCMA). From November 1996 to December 2001, Mr. Horne held the position of Chief Financial Officer of The Phoenix Partners, a +venture capital limited partnership located in Seattle, Washington. Mr. Horne has also held supervisory positions at Price Waterhouse, +LLP and has a Bachelor of Arts Magna Cum Laude in Accounting from Seattle University. We believe that Mr. Horne's extensive financial +and accounting experience in diversified industries and with companies involving complex transactions give him the qualifications +and skills to serve as one of our directors. +Robert O. Smith +Mr. Smith serves as +one of our independent directors. Previously, he served as a member of our Board of Directors from November 2010 until May 2015, +and served as a member of our Advisory Board from 2002 until 2015. He is currently a C-level executive consultant working with +Bay Area high-tech firms on various strategic initiatives in all aspects of their business. From 2004 to 2007, he served on the +Board of Directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman of the +Board. From 1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of +their Compower/Boschert Division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with +the JM Smucker Company. Mr. Smith received his BBA degree in Accounting from Ohio University. We believe that Mr. Smith’s +executive-level experience, including his previous service as our President, Chief Executive Officer and Chairman of the Board, +his extensive experience in the accounting industry, and his service on our Board from November 2010 until May 2015, give him the +qualifications and skills to serve as one of our directors. +53 +Mordechai Rosenberg +Mr. Rosenberg serves +as one of our independent directors. He has served as an independent consultant to various companies in the design and implementation +of homeland security systems in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate +Ltd., a manufacturer of armor protection systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From +2000 to 2003, Mr. Rosenberg was the general manager of ZIV U.P.V.C Products Ltd.'s doors and window factory. Mr. Rosenberg is an +active reserve officer and a retired colonel from the Israeli Defense Force (IDF), where he served for 26 years and was involved +in the development of weapon systems. In the IDF, Mr. Rosenberg served in various capacities, including platoon, company, battalion +and brigade commander, head of the training center for all IDF infantry, and head of the Air Force's Special Forces. Mr. Rosenberg +received a B.A in History from the University of Tel Aviv and a Master of Arts in Political Science from the University of Haifa +in Israel. We believe that Mr. Rosenberg’s business background give him the qualifications to serve as one of our directors. +Mr. Jeffrey Bentz +Mr. Bentz is an experienced +businessman who has served since 1994 as President of North Star Terminal & Stevedore Company, a full-service stevedoring +company located in Alaska and whose major areas of business include terminal operations and management, stevedore services, and +heavy equipment operations. He also has served as a director and advisor to several private companies and agencies. Mr. Bentz +obtained a B.A. in Business and Finance from Western Washington University in 1981. We believe that Mr. Bentz’s executive-level +experience, including his operational and financial oversight of companies with multiple profit centers and his extensive experience +in the real estate and commercial services industries give him the qualifications and skills to serve as one of our directors. +Corporate Governance +Our Board is currently +composed of six members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; +and (3) the Nominating and Governance Committee. The membership and the function of each of the committees are described below. +Our Board may, from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current +copies of the charters for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found +on our website at https://dpwholdings.com . +Audit Committee +Messrs. Smith, Bentz +and Rosenberg currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of +the Audit Committee satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE +American. Our Board has also determined that Mr. Smith qualifies as an “audit committee financial expert” as defined +in SEC regulations and satisfies the financial sophistication requirements set forth in the NYSE American Rules. +The Audit Committee +is responsible for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any +non-audit services to be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent +auditors and the progress and results of their work; reviewing our financial statements, internal accounting and auditing procedures, +and corporate programs to ensure compliance with applicable laws; and reviewing the services performed by our independent auditors +to determine if the services rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Bentz +and Rosenberg currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members +of the Compensation Committee meets the requirements for independence under the standards of the NYSE American. Mr. Smith serves +as Chairman of the Compensation Committee. +The Compensation Committee +is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving +salaries, bonuses and other benefits paid to our officers, including our Chief Executive Officer and Chief Financial Officer; and +administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith, Bentz, +and Rosenberg currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the +current members of the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE +American. Mr. Rosenberg serves as Chairman of the Nominating and Governance Committee. +The Nominating and +Governance Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and +recommending nominees for each annual meeting of stockholders to the Board; developing and recommending governance principles applicable +to our Board; overseeing the evaluation of our Board and management; and recommending potential members for each Board committee +to our Board. +54 +The Nominating and +Governance Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s +broad-based business and professional skills, experiences and global business and social perspective. +In addition, the Committee +seeks directors who exhibit personal integrity and a concern for the long-term interests of stockholders, as well as those who +have time available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we +seek to attract and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +Involvement in Certain Legal Proceedings +Except as set forth +below, to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former +director, executive officer, or employee: +· been convicted in a criminal proceeding +or been subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +· had any bankruptcy petition filed by or +against the business or property of the person, or of any partnership, corporation or business association of which he was a general +partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time; +· been subject to any order, judgment, or +decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, +permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, +futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged +in any such activity; +· been found by a court of competent jurisdiction +in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities +law, and the judgment has not been reversed, suspended, or vacated; +· been the subject of, or a party to, any +federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated +(not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or +state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies +including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or +temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire +fraud or fraud in connection with any business entity; +· or been the subject of, or a party to, +any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section +3(a)(26) of the Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent +exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member. +1. Mr. Ault held series 7, 24, and 63 licenses and managed four domestic hedge +funds and one bond fund from 1998 through 2008. On April 26, 2012, as a result from an investigation by FINRA involving activities +during 2008, Mr. Ault agreed to a settlement with FINRA in which he did not admit to any liability or violation of any laws or +regulatory rules and that included restitution and a suspension from association with a FINRA member firm for a period of 2 years. +As part of that settlement, Mr. Ault agreed that before he would reapply for association with FINRA, if at all, he would make restitution +to certain investors. Mr. Ault was able to speak with and pay restitution to one of the investors, but no others. As a result, +Mr. Ault is neither eligible, nor does he intend, to apply for association with FINRA. +2. Mr. Ault was CEO, President and Chairman of Zealous Holdings, Inc. that filed +for bankruptcy protection under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) on February +20, 2009, in the U.S. Bankruptcy Court, Central District of California. This Chapter 11 filing was subsequently converted to a +Chapter 7 filing by order of the Bankruptcy Court. Zealous Holdings, Inc. was not an entity that was entitled to a discharge under +the bankruptcy code. As such Zealous Holdings, Inc. did not receive a discharge. Ultimately, Zealous Holdings, Inc. ceased doing +business and was permanently closed. +3. Mr. Ault filed for bankruptcy protection under Chapter 11 of Title 11 +of the United States Code (the “Bankruptcy Code”) on December 8, 2009, in the U.S. Bankruptcy Court, Central District +of California. This Chapter 13 filing was subsequently converted to a Chapter 7 filing by order of the Bankruptcy Court +and months later, the petition being withdrawn and dismissed without prejudice. +55 +Except as set forth in our discussion below +in “Certain Relationships and Related Transactions,” none of our directors or executive officers has been involved +in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed +pursuant to the rules and regulations of the SEC. +Family Relationships +There are no family relationships among +our directors and executive officers. +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange Act requires +our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities to +file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, +directors and ten percent stockholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they +file. Based solely upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting +persons, we believe that during the during current fiscal year and the year ended December 31, 2018, all such filing requirements +applicable to our officers, directors and ten percent stockholders were fulfilled with the following exceptions: During the fiscal +year of 2018, Mr. Bentz inadvertently filed one late Form 4 reporting two transactions; Mr. Ault inadvertently filed one late Form +4 reporting an issuance of a warrant by the Company to Ault & Company, Inc., a Delaware corporation; and Mr. Horne inadvertently +filed one late Form 4. +Code of Ethics +We have adopted the +Code of Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, +controller or person performing similar functions (collectively, the “Financial Managers”). The Code of Ethical Conduct +is designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations. +The full text of our Code of Ethical Conduct is published on our website at https://dpwholdings.com . We will disclose +any substantive amendments to the Code of Ethical Conduct or any waivers, explicit or implicit, from a provision of the Code on +our website or in a current report on Form 8-K. Upon request to our President, Amos Kohn, we will provide without charge, a copy +of our Code of Ethical Conduct. +ITEM 11. EXECUTIVE COMPENSATION . +Summary Compensation Table +The following Summary +Compensation Table sets forth all compensation earned in all capacities during the years ended December 31, 2018 and 2017, by our +Chief Executive Officer (the “ Named Executive Officer ”). Because we are a Smaller Reporting Company, we only +have to report information of our Chief Executive Officer as no other officer met the definition of Named Executive Officer within +the meaning of the SEC rules. +SUMMARY COMPENSATION TABLE +Name and principal position +Year +Salary ($) +Bonus ($) +Stock Awards +($) (1) +Option +Awards ($) (I) +All Other +Compensation ($) +Total ($) +Milton C. Ault, III +2018 +0 +0 +630,000 +253,465 +400,000 +1,283,465 +Chief Executive Officer (3) +2017 +0 +0 +0 +461,250 +207,500 +668,750 +William B. Home +2018 +246,436 +25,000 +2,230,000 +940,180 +12,857 (2) +3,454,473 +Chief Financial Officer (4) +2017 +0 +0 +0 +92,250 +80,000 +172,250 +Amos Kohn +2018 +350,000 +0 +0 +0 +34,887 (2) +384,687 +President (5) +2017 +300,000 +0 +0 +92,250 +33,000 (2) +425,250 +(1) +The values reported in the “Stock Awards” and “Option Awards” columns represent the aggregate grant date fair value, computed in accordance with Accounting Standards +Codification (“ ASC ”) 718 Share Based Payments , of grants of stock options and stock awards to our named executive officer in the years shown. +(2) +The amounts in “All Other Compensation” consist of health insurance benefits, long-term and short-term disability insurance benefits, and 401K matching amounts. +(4) +Mr. Ault was appointed as our Chief Executive Officer on December 28, 2017. Amounts included in “All Other Compensation” consist of cash fees earned as an independent +contractor. +(4) +Mr. Horne was appointed as our Chief Financial Officer on January 25, 2018. Amounts included in “All Other Compensation” consist of cash fees earned as a director. +(3) +Mr. Kohn also served as our Chief Executive Officer until December 28, 2017. +56 +Employment Agreement with Milton C. Ault, III +On +June 17, 2018, the Company entered into a ten year executive employment agreement with Milton C. Ault, III, to serve as Chief Executive +Officer of the Company. For his services, Mr. Ault will be paid a base salary of $400,000 per annum (the “Base Salary”). +Pursuant +to the terms and subject to the conditions set forth in the agreement, if the Company meets or exceeds criteria adopted by the +Company’s compensation committee (the “Compensation Committee”) for earning bonuses which shall be adopted by +the Compensation Committee annually, Mr. Ault shall be eligible to receive an annual bonus, which percentage shall be based on +achievement of applicable performance goals determined by the Compensation Committee. +Further, +Mr. Ault is entitled to receive equity participation as follows: (A) a grant of restricted stock in the aggregate amount of 50,000 +shares of common stock, which shares shall vest ratably over 48 months beginning on January 1, 2020, provided, however, that such +shares may, in whole or in part, in the discretion of the Compensation Committee, vest immediately upon the filing of an Annual +Report on Form 10-K with the Securities and Exchange Commission (the “SEC”) that shows that the Company’s +revenues for the applicable fiscal year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates +any such vesting, the Company’s Compensation Committee must prior thereto have obtained the consent of Mr. Ault, which consent +may be withheld in his discretion, and (B) an option to purchase 25,000 shares of common stock of the Company at a per share price +equal to $16.00, which option will vest over 60 months. +In +addition, Mr. Ault shall be eligible to receive a performance-based award (the “CEO Performance Award”), provided that +the Company, for any given fiscal year during the term of this agreement, meets the following criteria: (A) an increase in revenue, +as calculated under GAAP over the previous fiscal year as reported in the Annual Report on Form 10-K or successor form for such +fiscal year; provided that any increase less than thirty-five percent (35%) (the “Revenue Percentage”) shall reduce +the CEO Performance Award correspondingly; (B) positive net income, as calculated under GAAP, as reported in the Annual Report +on Form 10-K or successor form for such fiscal year, provided that any increase less than five percent (5%) (the “Net Income +Percentage”) shall reduce the CEO Performance Award correspondingly; and (C) positive net cash flow from operations on a +year-to-year basis, where cash flow is defined as the net amount of cash and cash-equivalents being transferred into and out of +the Company. The CEO Performance Award shall consist of a number of shares of the Company’s common stock having a maximum +value equal to ten percent (10%) of any appreciation in the Company’s Market Capitalization above the High Water Mark (as +such terms are defined in the agreement) as measured by the daily average closing bid price of the Company’s common stock +for the applicable fiscal year subject to proration obtained by the product of Revenue Percentage and the Net Income Percentage. +If the CEO Performance Award in a fiscal year is less than ten percent (10%) due to a reduction caused by an annual shortfall in +either the Revenue Percentage or the Net Income Percentage, the prior year’s targets would be deemed to have been achieved +if a corresponding overage in a subsequent fiscal year results in the achievement of the cumulative targets. The annual and +cumulative targets for revenue and net income, which are provided solely for the purpose of establishing cumulative totals, are +set forth in the agreement. +Upon +termination of Mr. Ault’s employment (other than upon the expiration of the employment), Mr. Ault shall be entitled to receive: +(A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any +accrued but unused vacation time. +Further, +unless Mr. Ault’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Ault’s employment, the Company shall pay to Mr. Ault +a “Separation Payment” as follows: (A) an amount equal to four (4) weeks of base salary for +each full year of service and credit for his service commencing from September 22, 2016, (B) should Mr. Ault provide the Company +with a separation, waiver and release agreement within 60 days of termination, then the Company shall: (i) pay his base +salary until the last to occur (the “Separation Period”) of (1) the expiration of the remaining portion of the initial +term or the then applicable renewal term, as the case may be, but in no event an amount greater than the Base Salary payable should +either such period expire within two years, or (2) the 12-month period commencing on the date Mr. Ault is terminated, payable +in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life insurance; +and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Ault would have been +otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the +entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity +awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a +change in control, Mr. Ault will be paid an amount equal to the greater of: (i) five times his then current Base Salary or (ii) +the Separation Payment amount set forth above, without regard to whether Mr. Ault continues in the employ of the Company or its +successor. +57 +Employment agreement with William B. Horne +On +January 25, 2018, we entered into a five-year employment agreement with William Horne to serve as Chief Financial Officer and Executive +Vice President of the Company and its subsidiaries. For his services, Mr. Horne will be paid a base salary of $250,000 per +annum. Upon signing of the employment agreement, Mr. Horne is entitled to a signing bonus in the amount of $25,000. In addition, +Mr. Horne shall be eligible to receive an annual cash bonus equal to a percentage of his annual base salary based on achievement +of applicable performance goals determined by the Company’s compensation committee. +Further, +Mr. Horne is entitled to receive equity participation as follows: (i) a grant of restricted stock in the aggregate amount of 50,000 +shares of common stock, which shares shall vest in installments of ten thousand (10,000) shares annually over five (5) years beginning +on January 1, 2019, provided, however, that such shares may, in whole or in part, in the discretion of the Compensation Committee, +vest immediately upon the filing of an Annual Report on Form 10-K with the SEC that shows that the Company’s revenues +for the applicable fiscal year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates +any such vesting, the Company’s Compensation Committee must prior thereto have obtained the consent of Mr. Horne, which +consent may be withheld in his discretion, and (ii) an option to purchase 100,000 shares of common stock of the Company at a per +share price equal to $46.40, the closing market price of the shares of common stock on January 24, 2018, which option will vest +over 60 months. +Upon +termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to +receive: (i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and +(iii) any accrued but unused vacation time. +Further, +unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne +a “Separation Payment” as follows: (A) an amount equal to four weeks of base salary for each +full year of service, (B) should Mr. Horne provide the Company with a separation, waiver and release agreement within 60 +days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “Separation Period”) +of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or +(2) the 12-month period commencing on the date Mr. Horne is terminated, payable in one lump sum; (ii) provide during the Separation +Period the same medical, dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained +by multiplying (x) the maximum annual bonus as Mr. Horne would have been otherwise entitled to receive by (y) the fraction in +which the numerator is the number of calendar months worked including the entire month in which severance occurred and the denominator +of which is 12; and (iv) all outstanding options and other equity awards shall immediately vest and become fully exercisable for +a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will be paid an amount equal to four +times his Separation Payment. +Employment Agreement with Amos Kohn +On November 30, 2016, +as amended on February 22, 2017, the Company entered into an employment agreement with Amos Kohn to serve as President and Chief +Executive Officer with an effective date of September 22, 2016. +For his services, Mr. +Kohn will be paid a salary of $300,000 per annum increasing to $350,000 per annum provided that the Company achieves revenues in +the aggregate amount of at least $10,000,000 as determined in accordance with U.S. GAAP for the trailing four calendar quarters. +In addition, Mr. Kohn +shall be eligible for an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance +goals determined by the Company’s compensation committee after conferring with Mr. Kohn. The target amount of Mr. Kohn’s +annual performance bonus shall be 25% to 50% of his then annual base salary but may be greater upon mutual agreement between Mr. +Kohn and the compensation committee. +Further, Mr. Kohn is +entitled to receive equity participation as follows: (i) ten-year warrants to purchase 15,873 shares of the Company's Common +Stock (the “Warrant Grant”) at an exercise price of $0.20 per share subject to vesting quarterly over two years effective +January 1, 2017; and (ii) ten-year options to purchase 50,000 shares of the Company’s Common Stock at an exercise price of +$13.00 per share. The option to purchase 50,000 shares of Common Stock is subject to the following vesting schedule: (1) options +to purchase 25,000 shares of Common Stock shall vest upon the effective date; (2) options to purchase 12,500 shares of Common Stock +shall vest ratably over six months beginning with the first month after the effective date; and (3) options to purchase 12,500 +shares of common stock shall vest ratably over twelve months beginning with the first month after the effective date. As part of +the grant of the options to purchase 50,000 shares, Mr. Kohn forfeited options to purchase 26,750 shares of common stock previously +granted to him under the Company’s Incentive Share Option Plans. +58 +In the event that Mr. +Kohn is terminated by the Company without cause, or if Mr. Kohn resigns for good reason, Mr. Kohn shall be entitled to (i) all +annual salary earned prior to the termination date, any earned but unpaid portion of Mr. Kohn’s annual performance bonus +for the year preceding in which such termination occurred and any earned but unpaid paid time off; (ii) an amount equal to 100% +of Mr. Kohn’s then in effect annual base salary plus an additional 1/12th of Mr. Kohn’s annual base salary for each +year of employment with the Company prior to such termination; (iii) an amount equal to the average of Mr. Kohn’s two prior +years’ annual bonuses (with such average not to exceed 50% of Mr. Kohn’s annual base salary in effect at the time of +termination) prorated for the portion of the year that executive was employed; (iv) accelerated vesting of all outstanding unvested +stock options and other equity arrangements subject to vesting and held by Mr. Kohn through the termination date and the Company’s +right to repurchase Mr. Kohn’s restricted stock shall cease; and (v) to the extent required by COBRA, continuation of group +health benefits pursuant to the Company's standard programs or in effect at the termination date at Company expense for a period +of not less than 18 months. +If Mr. Kohn is terminated +without cause, or resigns for good reason within 12 months of a change of control, Mr. Kohn shall be entitled to receive: (i) +payment in a lump sum of Mr. Kohn’s annual base salary for 24 months and any accrued, unused paid time-off; (ii) accelerated +vesting of all outstanding unvested stock options and other equity arrangements subject to vesting and the Company’s right +to repurchase Mr. Kohn restricted stock shall cease; and (iii) to the extent required by COBRA, continuation of group health benefits +pursuant to the Company's standard programs or in effect at the termination date at the Company’s expense for a period of +not less than 18 months. +Advisory Vote on Executive Compensation +At the annual meeting +of stockholders on December 28, 2016, the stockholders approved, on an advisory basis, the compensation paid to the Company’s +named executive officers. In addition, stockholders voted, on an advisory basis, that an advisory vote on executive compensation +should be held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding equity +awards as of December 31, 2018 to the Named Executive Officer. +OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2018 +OPTION AWARDS +Name +Number of +Securities +Underlying +Unexercised +Options (#) +Exercisable +Number of +Securities +Underlying +Unexercised +Options (#) +Unexercisable +Equity Incentive Plan +Awards: Number of +Securities Underlying +Unexercised +Unearned Options (#) +Option +Exercise +Price ($) +Option +Expiration +Date +Milton C. Ault III +6,771 (1) +18,229 +— +$27.60 +11/28/2027 +3,125 (2) +21,875 +— +$16.00 +6/17/2018 +William B. Horne +1,354 (3) +3,646 +— +$27.60 +11/28/2027 +4,583 (4) +20,417 +— +$46.40 +1/25/2018 +Amos Kohn +50,000 (5) +— +— +$13.00 +11/3/2026 +15,873 (6) +— +— +$0.20 +11/3/2026 +1,354 (7) +3,646 +— +$27.60 +11/28/2027 +(1) Represents options to purchase 25,000 shares of the Company's Common Stock at an exercise price +of $27.60 per share subject to vesting monthly over four years beginning November 28, 2017 granted to Mr. Ault. +(2) Represents options to purchase 25,000 shares of the Company's Common Stock at an exercise price +of $16.00 per share subject to vesting monthly over four years beginning June 17, 2018 granted to Mr. Ault. +(3) Represents options to purchase 5,000 shares of the Company's Common Stock at an exercise price +of $27.60 per share subject to vesting monthly over four years beginning November 28, 2017 granted to Mr. Horne. +(4) Represents options to purchase 25,000 shares of the Company's Common Stock at an exercise price +of $46.40 per share subject to vesting monthly over five years beginning January 25, 2018 granted to Mr. Horne. +59 +(5) On November 3, 2016, Mr. Kohn was granted options to 50,000 shares of Common Stock at $13.00 per +share. The options to purchase 50,000 shares of Common Stock are subject to the following vesting schedule: (1) options to purchase +25,000 shares of Common Stock shall vest upon the effective date; (2) options to purchase 12,500 shares of Common Stock shall vest +ratably over six months beginning with the first month after the effective date; and (3) options to purchase 12,500 shares of common +stock shall vest ratably over twelve months beginning with the first month after the effective date. In connection with the grant +of options to purchase 50,000 shares of Common Stock, Mr. Kohn forfeited options to purchase 26,750 shares of common stock previously +granted to him under the Company’s 2012 Plan. +(6) Represents warrants to purchase 15,873 shares of the Company's Common Stock at an exercise price +of $0.20 per share subject to vesting quarterly over two years beginning January 1, 2017 granted to Mr. Kohn in connection with +his employment agreement. +(7) Represents options to purchase 5,000 shares of the Company's Common Stock at an exercise price +of $27.60 per share subject to vesting monthly over four years beginning November 28, 2017 granted to Mr. Kohn. +Director Compensation +Beginning July 1, 2018, +the Company pays each independent director an annual base amount of $35,000 annually, other than Mr. Smith, who will receive a +base amount of $45,000 annually due to anticipated additional services to be provided by Mr. Smith as a lead independent director. +Additionally, our Board makes recommendations for adjustments to an independent director’s compensation when the level of +services provided are significantly above what was anticipated. +The table below sets +forth, for each non-employee director, the total amount of compensation related to his or her service during the year ended December +31, 2018: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($) +Total ($) +Robert O. Smith +37,500 +— +117,861 (1) +— +155,361 +Kristine Ault (2) +5,000 +— +— +— +5,000 +Jeffrey A. Bentz (3) +28,264 +— +590,708 (4) +— +618,972 +Mordechai Rosenberg +27,500 +— +147,010 (5) +— +174,510 +(1) On June 17, 2018, Mr. Smith was granted options to purchase 11,625 shares of Common Stock at $16.00 +per share. The options shall vest ratably over forty-eight (48) months beginning with the first month after the effective date. +(2) Ms. Ault resigned from the Board on January 24, 2018. +(3) Mr. Bentz was appointed as Director on January 24, 2018 +(4) On January 24, 2018, Mr. Bentz was granted options to purchase 13,750 shares of Common Stock at +$46.40 per share and on June 17, 2018, Mr. Bentz was granted options to purchase 5,000 shares of Common Stock at $16.00 per share. +The options shall vest ratably over forty-eight (48) months beginning with the first month after the effective date. +(5) On June 17, 2018, Mr. Rosenberg was granted options to purchase 14,500 shares of Common Stock at +$16.00 per share. The options shall vest ratably over forty-eight (48) months beginning with the first month after the effective +date. +Stock Option Plans +On December 28, 2018, +the stockholder’s approved the 2018 Stock Incentive Plan (the “2018 Stock Incentive Plan”), under which +options to acquire up to 500,000 shares of common stock may be granted to the Company's directors, officers, employees and consultants. +The 2018 Stock Incentive Plan is in addition to the Company’s (i) 2017 Stock Incentive Plan (the “2017 Plan”), +under which options to acquire up to 100,000 shares of common stock may be granted to the Company's directors, officers, employees +and consultants, (ii) 2016 Stock Incentive Plan (the “2016 Stock Incentive Plan”), under which options to acquire up +to 200,000 shares of common stock may be granted to the Company's directors, officers, employees and consultants, and (ii) 2012 +Stock Option Plan, as amended (the “2012 Plan”), which provides for the issuance of a maximum of 68,632 shares of the +Company’s common stock to be offered to the Company’s directors, officers, employees, and consultants (collectively +the “Plans”). +60 +The purpose of the +Plans is to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial +responsibility for the direction and management of the Company, as well as certain directors and consultants of the Company, additional +incentives to exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, +to reward outstanding performance and to provide a means to attract and retain persons of outstanding ability to the service of +the Company. +As of December 31, +2018, options to purchase 173,125 shares of common stock were issued and outstanding, and 507,789 shares are available for future +issuance under the Plans. +401(k) Plan +We have adopted a tax-qualified +employee savings and retirement plan, or 401(k) plan, which generally covers all of our full-time employees. Pursuant to the 401(k) +plan, eligible employees may make voluntary contributions to the plan up to a maximum of 5% of eligible compensation. The 401(k) +plan permits, but does not require, matching contributions by the Company on behalf of plan participants. We match contributions +at the rate of (1) $1.00 for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, +up to 5% of the base salary. We are also permitted under the plan to make discretionary contributions. The 401(k) plan is intended +to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. Contributions to such a qualified +plan are deductible by the Company when made, and neither the contributions nor the income earned on those contributions is taxable +to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained in trust. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. +Except as otherwise +indicated below, the following table sets forth certain information regarding beneficial ownership of our common stock as of April +10, 2019 by (1) each of our current directors; (2) each of the named executive officers listed in the Summary Compensation Table +located above in the section entitled “Executive Compensation”; (3) each person known to us to be the beneficial owner +of more than 5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of +our directors and executive officers as a group. As of April 10, 2019, there were 22,692,365 shares of our common stock issued +and outstanding. +Beneficial ownership +is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common +stock subject to options or warrants that are currently exercisable or exercisable within 60 days of the Record Date are deemed +to be outstanding and to be beneficially owned by the person or group holding such options or warrants for the purpose of computing +the percentage ownership of such person or group, but are not treated as outstanding for the purpose of computing the percentage +ownership of any other person or group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table +have sole voting and sole investment power with respect to all common stock shown as beneficially owned by them, subject to applicable +community property laws. Unless otherwise indicated below, the address of each beneficial owner listed below is c/o DPW Holdings, +Inc., 201 Shipyard Way, Newport Beach, California 92663. +Name and address of beneficial owner +Number of +shares +beneficially +owned +Approximate +Percent +of class +Greater than 5% Beneficial Owners : +Philou Ventures, LLC +314,864 +(2) +1.38% +Ault & Company, Inc. +333,882 +(3) +1.46% +Directors and executive officers: (1) +Milton Ault, III +347,695 +(4) +1.52% +Amos Kohn +79,601 +(5) +* +Robert Smith +19,846 +(6) +* +William Horne +29,750 +(7) +* +Moti Rosenberg +14,385 +(8) +* +Jeffrey A. Bentz +6,635 +(9) +* +All directors and executive officers as a group (six persons) +497,913 +2.19% +* +Less than one percent. +(1) +Unless otherwise indicated, the business address of each of the individuals is c/o DPW Holdings, Inc., 201 Shipyard Way, Newport Beach, CA 92663. +61 +(2) +Includes 125,000 shares of Series B Preferred Stock that are convertible into 89,285 of common stock and warrants to purchase 89,285 shares of common stock that are exercisable within 60 days of the Record Date. Each share of Series B carries the voting power of 0.71 shares of common stock. Philou Ventures’ address is P.O. Box 3587 Tustin, CA 92705. +(3) +Includes shares beneficially owned by Philou Ventures of which Ault & Company, Inc. is the Manager. Also includes options to purchase 3,750 shares of common stock that are exercisable within 60 days of April 10, 2019. +(4) +Includes 314,864 shares beneficially owned by Philou Ventures, 15,268 shares and warrants to purchase 3,750 shares of common stock beneficially owned by Ault & Company, Inc. (“ Ault & Company ”) that are exercisable within 60 days of the Record Date, which may be deemed beneficially owned by Mr. Ault. Also includes 1,730 shares and options owned by Mr. Ault to purchase 12,083 shares of common stock that are exercisable within 60 days of April 10, 2019. Mr. Ault is the Chief Executive Officer of Ault & Company. +(5) +Includes options to purchase 51,667 shares and warrants to purchase 20,206 shares of common stock exercisable within 60 days of April 10, 2019. +(6) +Includes options and warrants to purchase 17,680 shares of common stock that are exercisable within 60 days of April 10, 2019. +(7) +Includes options to purchase 17,500 shares of common stock that are exercisable within 60 days of April 10, 2019. +(8) +Consists of options to purchase shares of common stock that are exercisable within 60 days of April 10, 2019. +(9) +Includes options to purchase 6,285 shares of common stock that are exercisable within 60 days of April 10, 2019. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. On September 22, 2016, Philou +Ventures became our largest stockholder when it acquired all of the common stock of a prior stockholder, Telkoor Telecom, Ltd. +Philou Ventures’ Manager is Kristine L. Ault, a former director. Ms. Ault is the spouse of Milton C. Ault, III, who is our +Chief Executive Officer and Chairman of the Board. +Philou Ventures, LLC +On March 9, 2017, we +entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Philou Ventures. Philou Ventures +is the Company’s largest single stockholder. Milton C. Ault is the Chief Executive Officer of Ault & Company, the Manager +of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures may invest up to $5,000,000 in us through +the purchase of Series B Preferred Stock (“Preferred Stock”) over the Term, as specified herein. Each share of Preferred +Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guaranteed to +purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred +Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE +American. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares +of Preferred Stock in a sufficient amount in order us to meet the NYSE American’s minimum stockholders’ equity continued +listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “Guaranteed Purchases”). +In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of +Preferred Stock, up to the 500,000 share maximum (“Voluntary Purchases”). All consideration for Voluntary Purchases +shall be delivered through a series of varying payments (“Payments”) by Philou Ventures, at its sole and absolute discretion, +during the period commencing on the closing date and ending 36 months therefrom (the “Term”). We have the right to +request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining +the minimum stockholders’ equity required by the NYSE American. The Preferred Stock shall not be callable by us for 25 years +from the closing date. +In addition, for each +share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock +in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price +equal to $14.00 per share of common stock +Further, Philou Ventures +shall have the right to participate in our future financings under substantially the same terms and conditions as other investors +in those respective financings in order to maintain its then percentage ownership interest. Philou Ventures’ right to participate +in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +On December 29, 2016, +MCKEA Holdings, LLC ( “ MCKEA ”) lent us $250,000 in the form of a demand note bearing simple interest at +6.0%. MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling stockholder. Kristine L. Ault, +a former director and the wife of Milton C. Ault III, Chief Executive Officer and Chairman of the Company’s Board of Directors, +is the manager and owner of MCKEA. On March 24, 2017, MCKEA cancelled the $250,000 demand note to purchase 25,000 shares of Preferred +Stock and received warrants to purchase 25,510 shares of common stock at $14.00 per share. +62 +On March 20, 2017, +Philou arranged for the Company to receive a $250,000 short-term loan. Between May 5, 2017 and June 2, 2017, Philou purchased an +additional 75,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the +cancellation of the Company debt due to Philou from the $250,000 short term loan and cash of $500,000. In addition, Philou received +warrants to purchase 76,531 shares of common stock at an exercise price of $14.00 per share of common stock. On April 24, 2018, +Philou purchased an additional 25,000 shares of Series B Preferred Stock in consideration of the cancellation of short-term advances +due to Philou in the aggregate amount of $250,000. In addition, Philou received warrants to purchase 25,510 shares of common stock +at an exercise price of $14.00 per share of common stock. +Avalanche International, Corp. +On October 5, 2016, +November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with Avalanche (the +“ AVLP Notes ”) in the principal amount of $525,000 each. The AVLP Notes included a 5% original issue discount, +resulting in net loans to Avalanche of $1,500,000 and an original issue discount of $75,000. The AVLP notes accrued interest at +12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, +to convert all or any portion of the principal and accrued interest into shares of common stock of Avalanche at approximately +$0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 +shares of the Company’s common stock. During the period from March 29, 2017 to August 16, 2017, the Company funded $1,808,952 +in excess of the $1,500,000 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, +the Company and Avalanche entered into a Loan and Security Agreement (“ AVLP Loan Agreement ”) with an effective +date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to +$5,000,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019. +In consideration of +entering into the AVLP Loan Agreement, the Company and Avalanche cancelled the AVLP Notes and consolidated the AVLP Notes and prior +advances totaling $3,308,952 plus original issue discount of $165,448 and issued a new Convertible Promissory Note in the aggregate +principal amount of $3,474,400 (the “ New Note ”) that is convertible into shares of Avalanche at a conversion +price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior +interest accrued under the AVLP Notes and advances will continue to be an obligation of Avalanche. The New Note contains standard +events of defaults. In addition, concurrent to issuing the New Note, Avalanche issued to the Company a five-year warrant to purchase +6,948,800 shares of Avalanche Common Stock at $0.50 per share. Future advances under the AVLP Loan Agreement, which totaled $649,820 +at December 31, 2017, are evidenced by a convertible promissory note containing a conversion price feature of $0.50 per share and +warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by Avalanche +are secured by the assets of AVLP. +At December 31, 2017, +the Company had provided Avalanche with $4,124,220 pursuant to the non-revolving credit facility. The warrants issued in conjunction +with the non-revolving credit facility entitles the Company to purchase up to 8,248,440 shares of Avalanche common stock at an +exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary +stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Avalanche is a holding +company which on August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended +on July 13, 2017 and August 21, 2017 (the “ Exchange Agreement ”) with MTIX Ltd., a company formed under the laws +of England and Wales (“ MTIX ”) and the three (3) stockholders of MTIX (the “ Sellers ”), Avalanche +completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, Avalanche +acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “ MTIX Shares ”) +by the Sellers to Avalanche in exchange (the “ Exchange ”) for the issuance by Avalanche of: (a) 7% secured convertible +promissory notes (individually, a “ Note” and collectively, the “Notes ”) in the aggregate +principal face amount of $9,500,000 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages +of MTIX’s ordinary shares, (b) (i) $500,000 in cash, $50,000 of which was paid on October 26, 2016, and (ii) 100,000 shares +of Avalanche’s newly designated shares of Class B Convertible Preferred Stock (the “ Class B Shares ”) to +the principal stockholder of MTIX (the “ Majority Stockholder ”). +Milton C. Ault, III +and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors +of Avalanche. In addition, Philou Ventures is the controlling stockholder of Avalanche as well as our largest single stockholder. +MTIX Limited +MTIX has developed +a novel cost effective and environmentally friendly material synthesis technology for textile applications. Designed for global +textile manufacturers, the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system uses a combination +of plasma and photonic energy to effect material synthesis of a substrate surface. The laser and gasses from the system deliver +a dry process to enhance the surface of fabric. During March 2017 the Company was awarded a 3-year, $50 million contract by MTIX +to manufacture, install and service the MLSE plasma-laser system. The Company has recognized $923,751 in revenue from MTIX, all +of which was reflected as accounts receivable, related party at December 31, 2017. +63 +On December 5, 2017, +the Company entered into an exchange agreement with WT Johnson & Sons (Huddersfield) Limited (the “ Holder ”), +pursuant to which the Company issued to the Holder, (a) a convertible promissory note in the principal amount of $600,000 (“ Note +A ”), and (b) a convertible promissory note in the principal amount of $1,667,766 (“ Note B ”), in exchange +for cancellation of (i) an outstanding loan made by the Holder to MTIX in the amount of $265,766; and (ii) cancellation of an aggregate +of $2,002,000 owed by MTIX to the Holder pursuant to an Agreement for the Sale and Purchase of a Textile Multi-Laser Enhancement +Technology Machine dated as of July 21, 2017 by and between MTIX and the Holder. +Note A is convertible +into the Company’s common stock at a conversion price of $1.00 per share, does not bear interest, and matures two years from +issuance. Note B is convertible into the Company’s common stock at a conversion price of $0.85 per share, does not bear interest, +and matures two years from issuance. However, the Holder shall not have the right to convert any portion of Note B, following +receipt by the Holder of an aggregate of $2,267,766 of gross proceeds from the sale of shares of Common Stock issued upon conversion +of Note A or Note B. +During December 2017, +the Company issued 600,000 shares of its common stock upon the conversion of Note A and the Holder notified the Company that gross +proceeds during the month of December 2017 from sales of the 30,000 shares of common stock were sufficient to satisfy the entire +$2,267,766 obligation. As a result of entering into the exchange agreement with the Holder, MTIX is obligated to pay the Company +$2,668,266, consisting of the amount of the exchange agreement of $2,267,766 and a value added tax of $400,500 from the sale of +the Textile Multi-Laser Enhancement Technology Machine. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. +Marcum LLP serves as +our independent registered public accounting firm for the year ended December 31, 2018 and 2017. +Fees and Services +The following table +shows the aggregate fees billed to us for professional services by Marcum LLP, respectively, for the years ended December 31, 2018 +and 2017: +2018 +2017 +Audit Services +$ +610,564 +$ 313,986 +Audit Related Services +$ — +$ — +Tax Services +$ — +$ — +All Other Services +$ — +$ — +Total +$ +610,564 +$ 313,986 +Audit Fee. This +category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the +years ended December 31, 2018 and 2017, for the reviews of the financial statements included in our quarterly reports on Form 10-Q +during 2018 and 2017, and for other services that are normally provided by the independent auditors in connection with statutory +and regulatory filings or engagements for the relevant years. +Audit-Related Fees. This +category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent +auditors that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported +above under “Audit Fees,” and generally consist of fees for other engagements under professional auditing standards, +accounting and reporting consultations, internal control-related matters, and audits of employee benefit plans. +Tax Fees . This +category includes the aggregate fees billed in each of the last two years for professional services rendered by the independent +auditors for tax compliance, tax planning and tax advice. +All Other Fees. This +category includes the aggregate fees billed in each of the last two years for products and services provided by the independent +auditors that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s +policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related +services, tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. +Our independent auditors are required to report periodically to the Audit Committee regarding the extent of services they provide +in accordance with such pre-approval. +64 +PART IV +ITEM 15. EXHIBITS +Exhibit +Number +Description +2.1 +Share Exchange Agreement between the Company, Microphase Corporation, Microphase Holding Company, RCKJ Trust, Ergul Family Limited Partnership, and To Hong Yam and Eagle Advisers, LLC, dated April 28, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 2.1 thereto. +2.2 +Agreement and Plan of Merger between the Company and Digital Power Corporation, dated December 27, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 2.1 thereto. +2.3 +State of Delaware, Certificate of Merger of the Company and Digital Power Corporation, dated December 28, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 2.2 thereto. +2.4 +Share Purchase Agreement between Coolisys Technologies, Inc., Enertec Management Ltd., Micronet Enertec Technologies, Inc., and Enertec Systems 2001 Ltd., dated December 31, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on January 2, 2018 as Exhibit 2.1 thereto. +3.1 +Amended and Restated Articles of Incorporation of the Company, dated September 29, 1992. Incorporated by reference to Exhibit 3.1 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on October 16, 1996. +3.2 +Certificate of Amendment to Articles of Incorporation of the Company, dated September 9, 1996. Incorporated by reference to Exhibit 3.2 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on October 16, 1996. +3.3 +Bylaws. Incorporated by reference to Exhibit 3.3 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on October 16, 1996. +3.4 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series B Convertible Preferred Stock, dated March 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 3.1 thereto. +3.5 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series D Convertible Preferred Stock. Incorporated by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 3.1 thereto. +3.6 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series E Convertible Preferred Stock. Incorporated by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 3.2 thereto. +3.7 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series C Convertible Preferred Stock, dated May 15, 2017. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 3.1 thereto. +3.8 +Certification of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.1 thereto. +3.9 +Bylaws, dated September 25, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.2 thereto. +65 +Exhibit +Number +Description +4.1 +Form of Secured Convertible Note, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.1 thereto. +4.2 +Form of Common Stock Purchase Warrant, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.2 thereto. +4.3 +Form of Common Stock Purchase Warrant, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.3 thereto. +4.4 +Form of Common Stock Purchase Warrant, dated November 15, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on November 16, 2016 as Exhibit 4.1 thereto. +4.5 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 4.1 thereto. +4.6 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as Exhibit 4.1 thereto. +4.7 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 4.1 thereto. +4.8 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on June 8, 2017 as Exhibit 4.1 thereto. +4.9 +Form of Common Stock Purchase Warrant, dated July 27, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 26, 2017 as Exhibit 4.1 thereto. +4.1 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.1 thereto. +4.11 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.2 thereto. +4.12 +Form of Convertible Note, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.2 thereto. +4.13 +Form of Common Stock Purchase Warrant, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.3 thereto. +4.14 +Form of Common Stock Purchase Warrant, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 4.1 thereto. +4.15 +Form of Senior Convertible Promissory Note, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 10.2 thereto. +4.16 +Common Stock Purchase Warrant issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 4.1 thereto. +4.17 +Convertible Promissory Note issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.2 thereto. +4.18 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 4.1 thereto. +4.19 +Form of 10% Original Issue Discount Convertible Debenture. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 10.2 thereto. +66 +Exhibit +Number +Description +4.2 +Form of 10% Original Issue Discount Debenture, dated December 4, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.21 +Convertible Promissory Note issued by WT Johnson & Sons (Huddersfield) Ltd. to the Company, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.22 +Convertible Promissory Note issued by WT Johnson & Sons (Huddersfield) Ltd. to the Company, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.2 thereto. +4.23 +Form of Common Stock Purchase Warrant, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.24 +Form of Senior Convertible Promissory Note, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 4.1 thereto. +4.25 +Form of Common Stock Purchase Warrant, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 4.2 thereto. +4.26 +Form of Common Stock Purchase Warrant, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 4.1 thereto. +10.1 +Securities Purchase Agreement between the Company, Philou Ventures, LLC and Telkoor Telecom Ltd., dated September 4, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on September 7, 2016 as Exhibit 10.1 thereto. +10.2 +Rescission Agreement between the Company, Telkoor Telecom Ltd. and Telkoor Power Supplies Ltd., dated September 4, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on September 7, 2016 as Exhibit 10.2 thereto. +10.3 +Waiver Letter to Securities Purchase Agreement between the Company, Philou Ventures, LLC and Telkoor Telecom Ltd., dated September 20, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on September 22, 2016 as Exhibit 10.1 thereto. +10.4 +Registration Rights Agreement, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on October 27, 2016 as Exhibit 10.4 thereto. +10.5 +Form of Subscription Agreement. Incorporated herein by reference to the Current Report on Form 8-K filed on November 16, 2016 as Exhibit 10.1 thereto. +10.6 +Form of Registration Rights Agreement, dated November 15, 2016. Incorporated by reference to the Current Report on Form 8-K filed on November 16, 2016 as Exhibit 10.2 thereto. +10.7* +Employment Agreement for Amos Kohn, dated November 30, 2016. Incorporated by reference to the Current Report on Form 8-K filed on December 5, 2016 as Exhibit 10.1 thereto. +10.8 +2016 Stock Incentive Plan. Incorporated by reference to the Current Report on Form 8-K filed on December 30, 2016 as Exhibit 10.1 thereto. +10.9 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on February 17, 2017 as Exhibit 10.1 thereto. +10.10* +Amendment No. 1 to Executive Employment Agreement. Amos Kohn, dated February 22, 2017. Incorporated by reference to the Current Report on Form 8-K filed on February 27, 2017 as Exhibit 10.1 thereto. +67 +Exhibit +Number +Description +10.11 +Preferred Stock Purchase Agreement between the Company and Philou Ventures, LLC, dated March 9, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 10.1 thereto. +10.12 +Registration Rights Agreement between the Company and Philou Ventures, LLC. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 10.2 thereto. +10.13 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as Exhibit 10.1 thereto. +10.14 +Form of Subscription Agreement, dated May 1, 2017. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 10.1 thereto. +10.15 +Form of Registration Rights Agreement. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 10.2 thereto. +10.16 +Promissory Note issued by Microphase Corporation to the Company, dated June 2, 2017. Incorporated by reference to the Current Report on Form 8-K filed on June 8, 2017 as Exhibit 10.1 thereto. +10.17 +Promissory Note issued by Microphase Corporation to the Company, dated June 2, 2017. Incorporated by reference to the Current Report on Form 8-K filed on June 8, 2017 as Exhibit 10.2 thereto. +10.18 +Form of Securities Purchase Agreement, dated July 25, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 26, 2017 as Exhibit 10.1 thereto. +10.19 +Form of Exchange Agreement, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 10.1 thereto. +10.20 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 10.2 thereto. +10.21 +Form of Securities Purchase Agreement, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 10.3 thereto. +10.22 +Securities Purchase Agreement between William H. Gordon, Power-Plus Technical Distributors, LLC, and CooliSys Technologies Inc., dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.1 thereto. +10.23 +Form of Securities Purchase Agreement, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.1 thereto. +10.24 +Form of Securities Purchase Agreement, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 10.1 thereto. +10.25 +Form of Registration Rights Agreement, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 10.3 thereto. +10.26 +Loan and Security Agreement between the Company and Avalanche International Corp., dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.1 thereto. +10.27* +Executive Employment Agreement for William Horne, dated October 6, 2017. Incorporated by reference to the Current Report on Form 8-K filed on October 12, 2017 as Exhibit 10.1 thereto. +10.28 +Form of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on October 19, 2017 as Exhibit 10.1 thereto. +68 +Exhibit +Number +Description +10.29 +Agreement for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated October 23, 2017. Incorporated by reference to the Current Report on Form 8-K filed on October 23, 2017 as Exhibit 10.1 thereto. +10.3 +Form of Securities Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 10.1 thereto. +10.31 +Form of Registration Rights Agreement. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 10.3 thereto. +10.32 +Form of Loan and Security Agreement between the Company and LAM, Inc., dated November 2, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 7, 2017 as Exhibit 10.1 thereto. +10.33 +Form of Subscription Agreement, dated November 6, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2017 as Exhibit 10.1 thereto. +10.34 +Trust Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.1 thereto. +10.35 +Tenancy-In-Common Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.2 thereto. +10.36 +Form of Securities Purchase Agreement, dated December 4, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.37 +Form of Registration Rights Agreement, dated December 4, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.2 thereto. +10.38 +Exchange Agreement between the Company and WT Johnson & Sons (Huddersfield) Limited, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.39 +Form of Exchange Agreement, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.40 +Form of Subscription Agreement, dated December 1, 2017. Incorporated by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.41 +Form of Consulting Agreement. Incorporated by reference to the Current Report on Form 8-K filed on January 2, 2018 as Exhibit 10.1 thereto. +10.42 +Agreement for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated January 10, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 16, 2018 as Exhibit 10.1 thereto. +10.43 +Agreement for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated January 10, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 16, 2018 as Exhibit 10.2 thereto. +10.44 +Form of Securities Purchase Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 10.1 thereto. +10.45 +Form of Registration Rights Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 24, 2018 as Exhibit 10.2 thereto. +10.46* +Executive Employment Agreement for William Horne, dated January 25, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 25, 2018 as Exhibit 10.1 thereto. +69 +Exhibit +Number +Description +10.47 +Form of Securities Purchase Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on February 12, 2018 as Exhibit 10.1 thereto. +10.48 +Amendment to Securities Purchase Agreement, dated January 23, 2018, between the Company and Twitchell Fund, LLC. Incorporated by reference to the Current Report on Form 8-K filed on February 12, 2018 as Exhibit 10.2 thereto. +10.49 +Sales Agreement between the Company and H.C. Wainwright & Co., LLC, dated February 27, 2018. Incorporated by reference to the Current Report on Form 8-K filed on February 27, 2018 as Exhibit 10.1 thereto. +10.50 +Asset Purchase Agreement between Super Crypto Mining, Inc. and Blockchain Supply & Services Ltd., dated March 8, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2018 as Exhibit 10.1 thereto. +10.51 +Amended and Restated Master Services Agreement dated March 21, 2018 but effective March 1, 2018. Filed herewith. Confidential Portions have been redacted and a Request for Confidential Treatment has been filed separately with the Commission. Incorporated by reference to the Annual Report on Form 10-K filed on April 17, 2018 as Exhibit 10.51 thereto. +10.52 +Form of Securities Purchase Agreement, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 10.1 thereto. +10.53 +Form of Note, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 10.2 thereto. +10.54 +Form of Amended and Restated Independent Contractor Agreement, dated April 13, 2018. Incorporated by reference to the Current Report on Form 8-K filed on April 13, 2018 as Exhibit 10.1 thereto. +21*** +List of subsidiaries. +23.1*** +Consent of Marcum LLP. +23.2*** +Consent of Ziv Haft, BDO member firm. +31.1*** +Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) +31.2*** +Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) +32.1**** +Certification of Chief Executive and Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code +101.INS*** +XBRL Instance Document +101.SCH*** +XBRL Taxonomy Extension Schema Document +101.CAL*** +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF*** +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB*** +XBRL Taxonomy Extension Label Linkbase Document +101.PRE*** +XBRL Taxonomy Extension Presentation Linkbase Document +* Indicates management contract or compensatory plan or arrangement. +** Confidential treatment is being sought for this agreement, which has been filed separately with the SEC. The confidential portions +of this Exhibit have been omitted and are marked by asterisks. +*** Filed herewith. +**** Furnished herewith. +ITEM 16. FORM 10–K SUMMARY. +None. +70 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) +of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned +thereunto duly authorized. +Dated: April 16, 2019 +DPW HOLDINGS, INC. +By: +/s/ Milton C. Ault, III +Milton C. Ault, III +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ William B. Horne +William B. Horne +Chief Financial Officer +(Principal Accounting Officer) +Pursuant to the requirements of the Securities Exchange +Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +April 16, 2019 +/s/ Milton C. Ault, III +Milton +C. Ault, III, Chief Executive Officer and Executive +Chairman +of the Board +April 16, 2019 +/s/ William B. Horne +William B. Horne, Chief Financial Officer and Director +April 16, 2019 +/s/ Amos Kohn +Amos Kohn, President and Director +April 16, 2019 +/s/ Robert O. Smith +Robert O. Smith, Director +April 16, 2019 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, Director +April 16, 2019 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +71 +ITEM 8. FINANCIAL STATEMENTS +DPW HOLDINGS, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Reports of Independent Registered Public Accounting Firm – Marcum LLP +F-2 +Report of Independent Registered Public Accounting Firm – Ziv Haft. +F-3 +Consolidated Balance Sheets as of December 31, 2018 and 2017 +F-4 - F-5 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2018 and 2017 +F-6 +Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2018 and 2017 +F-7 - F-10 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2018 and 2017 +F-11 - F-13 +Notes to Consolidated Financial Statements +F-14 - F-76 +F- 1 +REPORT OF INDEPENDENT REGISTERED PUBLIC +ACCOUNTING FIRM +To the Shareholders and Board of Directors +of +DPW Holdings, Inc. and Subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated +balance sheets of DPW Holdings, Inc. and Subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related +consolidated statements of operations, comprehensive loss, changes in stockholders’ equity and cash flows for each of the +two years in the period ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). +In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of +December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the two years in the period ended +December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. +We did not audit the financial statements +of Enertec Systems 2001 Ltd., a wholly-owned subsidiary, which statements reflect total assets and revenues constituting 19 percent +and 20 percent, respectively, of the related consolidated totals. Those statements were audited by other auditors whose report +has been furnished to us, and our opinion, insofar as it relates to the amounts included for Enertec Systems 2001 Ltd., is based +solely on the report of the other auditors. +Explanatory Paragraph – Going Concern +The accompanying consolidated financial +statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the +Company has a significant working capital deficiency, has incurred significant losses and needs to raise additional funds to meet +its obligations and sustain its operations. These conditions raise substantial doubt about the Company's ability to continue as +a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements +do not include any adjustments that might result from the outcome of this uncertainty. +Basis for Opinion +These financial statements are the responsibility +of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. +We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") +and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable +rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with +the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether +the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, +nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required +to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the +effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures +to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures +that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures +in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made +by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a +reasonable basis for our opinion. +/s/ Marcum llp +Marcum llp +We have served as the Company’s auditor since 2016. +New York, NY +April 16, 2019 +F- 2 +REPORT OF INDEPENDENT REGISTERED PUBLIC +ACCOUNTING FIRM +To the Board of Directors and Management of +ENERTEC SYSTEMS 2001 LTD +Opinion on the Financial Statements +We have audited the accompanying balance sheet of ENERTEC SYSTEMS +2001 LTD ("the company") as of December 31, 2018, the related statements of comprehensive loss, shareholders’ equity, +and cash flows for the period from May 22, 2018 ended December 31, 2018, and the related notes (collectively, the financial statements). +In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of +December 31, 2018, and the results of its operations and its cash flows for each of the period started May 22, 2018 and ended December +31, 2018 in conformity with U.S. generally accepted accounting principles. +Going Concern +The accompanying financial statements have been prepared assuming +that the Company will continue as a going concern. As more fully described in Note 1, the Company has a working capital deficiency, +has incurred significant losses and needs to raise additional funds to meet its obligations and sustain its operations. These conditions +raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters +are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this +uncertainty. +Basis for Opinion +These financial statements are the responsibility of the Company’s +management. Our responsibility is to express an opinion on these financial statements based on our audits. We are a public accounting +firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with +respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities +and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of +the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial +statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged +to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding +of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s +internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks +of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to +those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial +statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as +well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis +for our opinion. +We have served as the Company’s auditor since 2012. +/s/ Ziv Haft. +Ziv Haft. +Certified Public Accountants (Isr.) +BDO Member Firm +Tel-Aviv, Israel +April 16, 2019 +F- 3 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2018 +2017 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ 902,329 +$ 1,478,147 +Marketable securities +178,597 +1,834,570 +Accounts receivable +1,930,971 +1,898,241 +Accounts and other receivable, related party +3,887,654 +173,751 +Accrued revenue +1,353,411 +— +Inventories +3,261,126 +1,992,865 +Prepaid expenses and other current assets +775,981 +1,407,104 +TOTAL CURRENT ASSETS +12,290,069 +8,784,678 +Intangible assets +4,359,798 +2,898,013 +Digital currencies +1,535 +— +Goodwill +8,463,070 +3,651,984 +Property and equipment, net +9,313,299 +1,216,847 +Investments - related party, net of original issue discount of $2,336,693 +and $2,115,710, respectively +5,611,621 +2,332,910 +Investments in warrants and common stock - related party +3,043,499 +7,728,001 +Investments in preferred stock of private company +480,000 +1,000,000 +Investments in real estate +1,969,000 +— +Other investments +2,572,230 +1,637,672 +Other investments, related parties +862,500 +915,464 +Other assets +459,259 +343,325 +TOTAL ASSETS +$ 49,425,880 +$ 30,508,894 +LIABILITIES AND STOCKHOLDERS' EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ 13,065,838 +$ 4,273,242 +Accounts payable and accrued expenses, related party +57,752 +69,855 +Advances on future receipts +2,085,807 +1,962,965 +Short term advances +— +2,438,667 +Short term advances, related party +73,761 +245,000 +Revolving credit facility +285,605 +387,572 +Notes payable +6,388,787 +402,234 +Notes payable, related party +166,925 +133,569 +Convertible notes payable +6,742,494 +397,878 +Other current liabilities +1,868,402 +708,391 +TOTAL CURRENT LIABILITIES +30,735,371 +11,019,373 +LONG TERM LIABILITIES +Notes payable +483,659 +525,492 +Notes payable, related parties +142,059 +175,748 +TOTAL LIABILITIES +31,361,089 +11,720,613 +The accompanying notes are an integral +part of these consolidated financial statements. +F- 4 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +December 31, +2018 +2017 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS' EQUITY +Series A Convertible Preferred Stock, $25.00 stated value per share, +1 +— +$0.001 par value – 1,000,000 shares authorized; 1,434 and nil shares issued and +outstanding at December 31, 2018 and 2017 (redemption amount and liquidation +preference of $35,850 and nil as of December 31, 2018 and 2017) +Series B Convertible Preferred Stock, $10 stated value per share, +125 +100 +share, $0.001 par value – 500,000 shares authorized; 125,000 and 100,000 shares +issued and outstanding at December 31, 2018 and 2017, respectively +(liquidation preference of $1,250,000 and $1,000,000 at December 31, 2018 and +2017, respectively) +Series D Convertible Preferred Stock, $0.01 stated value per +— +379 +share, $0.001 par value – 378,776 shares authorized; nil and 378,776 +shares issued and outstanding at December 31, 2018 and 2017, +respectively (liquidation preference of $3,788 at December 31, 2017) +Preferred Stock, $0.001 par value – 23,121,224 shares authorized; nil shares +— +— +issued and outstanding at December 31, 2018 and 2017 +Class A Common Stock, $0.001 par value – 500,000,000 shares authorized; +4,036 +1,511 +4,036,407 and 1,511,115 shares issued and outstanding at December 31, 2018 +and 2017, respectively +Class B Common Stock, $0.001 par value – 25,000,000 shares authorized; +— +— +nil shares issued and outstanding at December 31, 2018 and 2017 +Additional paid-in capital +77,643,609 +36,916,659 +Accumulated deficit +(55,721,115 ) +(23,414,151 ) +Accumulated other comprehensive loss +(3,902,523 ) +4,503,046 +TOTAL DPW HOLDINGS STOCKHOLDERS' EQUITY +18,024,132 +18,007,544 +Non-controlling interest +40,658 +780,737 +TOTAL STOCKHOLDERS' EQUITY +18,064,790 +18,788,281 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ 49,425,880 +$ 30,508,894 +The accompanying notes are an integral part +of these consolidated financial statements. +F- 5 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +AND COMPREHNSIVE LOSS +For the Year Ended +December 31, +2018 +2017 +Revenue +$ 17,762,217 +$ 10,000,749 +Revenue, cryptocurrency mining +1,675,549 +— +Revenue, related party +3,907,280 +173,751 +Revenue, restaurant operations +3,462,140 +— +Revenue, lending activities +347,033 +— +Total revenue +27,154,219 +10,174,500 +Cost of revenue +21,774,658 +6,325,027 +Gross profit +5,379,561 +3,849,473 +Operating expenses +Engineering and product development +1,430,538 +1,119,745 +Selling and marketing +3,010,790 +1,721,050 +General and administrative +19,842,378 +6,991,723 +Impairment loss on intangible assets +700,000 +— +Impairment loss on digital currency +1,311 +— +Total operating expenses +24,985,017 +9,832,518 +Loss from operations +(19,605,456 ) +(5,983,045 ) +Interest expense +(13,453,344 ) +(4,990,397 ) +Loss before income taxes +(33,058,800 ) +(10,973,442 ) +Income tax benefit +76,599 +78,393 +Net loss +(32,982,201 ) +(10,895,049 ) +Less: Net loss attributable to +non-controlling interest +748,320 +278,818 +Net loss attributable to DPW Holdings +(32,233,881 ) +(10,616,231 ) +Preferred deemed dividends on Series B +and Series C Preferred Stock +(108,049 ) +(584,182 ) +Preferred dividends on Series C Preferred Stock +— +(54,059 ) +Net loss available to common stockholders +$ (32,341,930 ) +$ (11,254,472 ) +Basic and diluted net loss per common share +$ (11.15 ) +$ (18.05 ) +Basic and diluted weighted average common +shares outstanding +2,899,888 +623,583 +Comprehensive Loss +Loss available to common stockholders +$ (32,341,930 ) +$ (11,254,472 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +(377,823 ) +152,078 +Net unrealized (loss) gain on securities available-for-sale +(8,027,746 ) +5,171,743 +Other comprehensive income (loss) +(8,405,569 ) +5,323,821 +Total Comprehensive loss +$ (40,747,499 ) +$ (5,930,651 ) +The accompanying notes are an integral +part of these consolidated financial statements. +F- 6 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN +STOCKHOLDERS’ EQUITY +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Equity +BALANCES, January 1, 2017 +— +$ — +383,882 +$ 384 +$ 16,534,243 +$ (12,159,679 ) +$ (820,775 ) +$ — +$ 3,554,173 +Compensation expense due to stock option +issuances +— +— +— +485,198 +— +— +— +485,198 +Compensation expense due to warrant +issuances +— +— +— +93,918 +— +— +— +93,918 +Issuance of common stock and warrants +for cash +— +136,482 +136 +1,962,549 +— +— +— +1,962,685 +Issuance of common stock for services +— +108,067 +108 +1,662,594 +— +— +— +1,662,702 +Issuance of common stock for conversion +of debt +— +337,990 +338 +4,036,263 +— +— +— +4,036,601 +Issuance of common stock upon exercise +of stock options +— +18,073 +18 +556,999 +— +— +— +557,017 +Issuance of common stock upon exercise +of warrants +— +177,305 +177 +2,245,761 +— +— +— +2,245,938 +Issuance of Series B preferred stock for +cash and warrants +50,000 +50 +— +— +499,950 +— +— +— +500,000 +Issuance of Series B preferred stock for +conversion of debt +50,000 +50 +— +— +499,950 +— +— +— +500,000 +Issuance of Series C preferred stock for +cash and warrants +433,335 +433 +— +— +897,607 +— +— +— +898,040 +Issuance of Series C preferred stock for +conversion of debt +21,667 +22 +— +— +51,978 +— +— +— +52,000 +Issuance of common stock for conversion +of Series C preferred stock +(455,002 ) +(455 ) +91,000 +91 +364 +— +— +— +— +Issuance of Series D preferred stock and +common stock in acquisition of Microphase +378,776 +379 +92,122 +92 +1,450,569 +— +— +944,555 +2,395,595 +Issuance of Series E preferred stock and +common stock in acquisition of Microphase +10,000 +10 +— +— +— +— +— +— +10 +The accompanying notes are an integral +part of these consolidated financial statements. +F- 7 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN +STOCKHOLDERS’ EQUITY +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Equity +Issuance of common stock for conversion +of Series E preferred stock +(10,000 ) +(10 ) +30,000 +30 +470,870 +— +— +— +470,890 +Issuance of common stock in connection +with convertible notes +— +22,500 +23 +399,488 +— +— +— +399,511 +Issuance of common stock for domain name +— +2,500 +3 +30,950 +— +— +— +30,953 +Issuance of common stock and warrants +in satisfaction of subsidiary debt +— +76,193 +76 +940,247 +— +— +— +940,323 +Issuance of common stock for acquisition +of debt due from related party +— +30,000 +30 +599,970 +— +— +— +600,000 +Beneficial conversion feature in connection +with convertible notes +— +— +— +786,797 +— +— +— +786,797 +Fair value of warrants issued in connection with +convertible notes +— +— +— +2,133,822 +— +— +— +2,133,822 +Fair value of personal guarantees in connection +with debt financings +— +— +— +75,259 +— +— +— +75,259 +Issuance of common stock for conversion of +debt +owed by subsidiary to former stakeholder +— +— +— +— +— +— +115,000 +115,000 +Issuance of common stock and cash for +exchange fees and other financing costs +— +5,000 +5 +(82,869 ) +— +— +— +(82,864 ) +Comprehensive loss: +Net loss +— +— +— +— +(10,616,231 ) +— +— +(10,616,231 ) +Preferred dividends +— +— +— +— +(54,059 ) +— +— +(54,059 ) +Preferred deemed dividends +— +— +— +584,182 +(584,182 ) +— +— +— +Net unrealized gain on securities +available-for-sale, net of income taxes +— +— +— +— +— +5,171,743 +— +5,171,743 +Foreign currency translation adjustments +— +— +— +— +— +152,078 +— +152,078 +Net loss attributable to non-controlling interest +— +— +— +— +— +— +(278,818 ) +(278,818 ) +BALANCES, December 31, 2017 +478,776 +$ 479 +1,511,115 +$ 1,511 +$ 36,916,659 +$ (23,414,151 ) +$ 4,503,046 +$ 780,737 +$ 18,788,281 +The accompanying notes are an integral part +of these consolidated financial statements. +F- 8 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN +STOCKHOLDERS’ EQUITY +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Equity +Compensation expense due to stock +option issuances +— +— +— +1,043,908 +— +— +— +1,043,908 +Compensation expense due to warrant issuances +— +— +— +93,914 +— +— +— +93,914 +Issuance of common stock and warrants +for +cash +— +1,640,935 +1,641 +23,882,829 +— +— +— +23,884,470 +Issuance of common stock for services +— +184,153 +184 +3,740,704 +— +— +— +3,740,888 +Issuance of common stock for conversion +of debt +— +211,225 +212 +2,445,905 +— +— +— +2,446,117 +Issuance of common stock for conversion +of short-term advances +— +181,608 +182 +2,819,402 +— +— +— +2,819,584 +Issuance of common stock upon exercise +of stock options +— +3,000 +3 +97,797 +— +— +— +97,800 +Issuance of common stock upon exercise +of warrants +— +107,282 +107 +867,059 +— +— +— +867,166 +Issuance of Series A preferred stock for +cash +1,434 +1 +— +— +35,849 +— +— +— +35,849 +Issuance of Series B preferred stock for +conversion of short-term advances +25,000 +25 +— +— +249,975 +— +— +— +250,000 +Issuance of common stock for conversion +of Series E preferred stock +(378,776 ) +(379 ) +37,878 +38 +341 +— +— +— +— +Issuance of common stock in connection +with convertible notes +— +136,961 +136 +1,540,972 +— +— +— +1,541,108 +Repurchase of common stock +— +(2,750 ) +(3 ) +(57,745 ) +— +— +— +(57,748 ) +Beneficial conversion feature in connection +with convertible notes +— +— +— +2,555,952 +— +— +— +2,555,952 +Fair value of warrants issued in connection +with convertible notes +— +— +— +3,408,665 +— +— +— +3,408,665 +The accompanying notes are an integral part +of these consolidated financial statements. +F- 9 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN +STOCKHOLDERS’ EQUITY +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Equity +Cash for exchange fees and other financing costs +— +25,000 +25 +(2,107,607 ) +— +— +— +(2,107,582 ) +Non-controlling interest from acquisition of I. AM +— +— +— +981 +— +— +33,241 +34,222 +Non-controlling interest from Microphase +— +— +— +— +— +— +(25,000 ) +(25,000 ) +Comprehensive loss: +Net loss +— +— +— +— +(32,233,881 ) +— +— +(32,233,881 ) +Preferred deemed dividends +— +— +— +108,049 +(108,049 ) +— +— +— +Net unrealized loss on securities +available-for-sale, net of income taxes +— +— +— +— +— +(8,027,746 ) +— +(8,027,746 ) +Foreign currency translation adjustments +— +— +— +— +34,966 +(377,823 ) +— +(342,857 ) +Net loss attributable +to non-controlling interest +— +— +— +— +— +— +(748,320 ) +(748,320 ) +BALANCES, December 31, 2018 +126,434 +$ 126 +4,036,407 +$ 4,036 +$ +77,643,609 +$ (55,721,115 ) +$ (3,902,523 ) +$ 40,658 +$ 18,028,941 +The above Consolidated Statements of Stockholders’ +Equity reflects a 1 for 20 reverse stock split effective March 14, 2019, see Note 1 for further information. +The accompanying notes are an integral part +of these consolidated financial statements. +F- 10 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +For the Years Ended December 31, +2018 +2017 +Cash flows from operating activities: +Net loss +$ (32,982,201 ) +$ (10,895,049 ) +Adjustments to reconcile net loss to net cash used in operating activities: +Depreciation +2,447,249 +193,671 +Amortization +459,656 +60,335 +Interest expense – debt discount +11,191,055 +4,688,630 +Impairment of intangible assets +700,000 +— +Accretion of original issue discount on notes receivable – related party +(2,004,358 ) +(453,346 ) +Accretion of original issue discount on notes receivable +(175,921 ) +— +Interest expense on conversion of promissory notes to common stock +— +13,333 +Deferred taxes +— +(225,488 ) +Provision for bad debts +— +(32,729 ) +Stock-based compensation +4,719,266 +1,831,435 +Realized losses on sale of digital currencies +127,602 +— +Realized losses on sale of marketable securities +175,405 +— +Unrealized losses on trading securities +77,133 +— +Changes in operating assets and liabilities: +Accounts receivable +2,754,631 +285,146 +Accounts receivable, related party +(3,713,903 ) +(173,751 ) +Accrued revenue +(1,353,411 ) +— +Digital currencies +(1,633,630 ) +— +Inventories +13,137 +100,156 +Prepaid expenses and other current assets +1,210,933 +(763,559 ) +Other investments, related party +— +(335,040 ) +Other assets +(232,442 ) +(70,846 ) +Accounts payable and accrued expenses +6,850,263 +1,515,870 +Accounts payable, related parties +(12,103 ) +69,855 +Other current liabilities +959,235 +74,813 +Net cash used in operating activities +(10,422,404 ) +(4,116,564 ) +Cash flows from investing activities: +Purchase of property and equipment +(8,919,532 ) +(402,779 ) +Proceeds from sale of property and equipment +— +16,595 +Loss on dispositon of asset +22,172 +— +Purchase of intangible asset +(3,025 ) +(50,000 ) +Purchase of Power Plus +— +(377,661 ) +Purchase of Enertec +(4,936,562 ) +— +Cash received on acquisitions +293,041 +110,982 +Investments – related party +(1,244,353 ) +(3,200,554 ) +Related party investment in real property +(1,969,000 ) +— +Investment in real property +— +(300,000 ) +Investments in warrants and common stock - related party +(2,672,510 ) +— +Investments in marketable securities +(858,458 ) +(1,485,652 ) +Sales of marketable securities +2,188,292 +63,606 +Sales of digital currencies +64,587 +— +Investments - others +(25,000 ) +— +Loans to third party +— +— +Loans to related parties +— +(44,000 ) +Proceeds from loans to related parties +12,520 +35,000 +Investments in debt and equity securities +(2,571,100 ) +(3,039,500 ) +Net cash used in investing activities +$ (20,618,928 ) +$ (8,673,963 ) +The accompanying notes are an integral part +of these consolidated financial statements. +F- 11 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(continued) +For the Years Ended December 31, +2018 +2017 +Cash flows from financing activities: +Gross proceeds from sales of common stock and warrants +$ 23,884,470 +$ 2,035,147 +Repurchase of common stock +(57,747 ) +— +Proceeds from issuance of Series A Convertible Preferred Stock +33,699 +— +Proceeds from issuance of Series B and C Convertible Preferred Stock +— +1,540,000 +Financing cost in connection with sales of equity securities +(2,107,582 ) +(297,341 ) +Proceeds from stock option exercises +97,800 +557,360 +Proceeds from warrant exercises +867,166 +2,245,938 +Proceeds from convertible notes payable +11,550,000 +2,918,200 +Proceeds from notes payable – related party +— +350,000 +Proceeds from notes payable +12,994,999 +857,000 +Proceeds from short-term advances – related party +136,761 +— +Proceeds from short-term advances +762,000 +2,439,000 +Payments on short-term advances +(646,500 ) +— +Payments on notes payable – related party +(333 ) +— +Payments on short-term advances – related party +(13,000 ) +245,000 +Payments on notes payable +(12,133,140 ) +(190,000 ) +Payments on convertible notes payable +(2,362,281 ) +(157,000 ) +Proceeds from advances on future receipts +3,350,277 +2,889,175 +Payments on advances on future receipts +(5,505,079 ) +(1,526,125 ) +Payments of preferred dividends +— +(35,494 ) +Financing cost in connection with sales of debt securities +— +(122,650 ) +Payments on revolving credit facilities, net +(313,822 ) +(524,710 ) +Net cash provided by financing activities +30,537,688 +13,223,500 +Effect of exchange rate changes on cash and cash equivalents +(72,174 ) +49,000 +Net increase (decrease) in cash and cash equivalents +(575,818 ) +481,973 +Cash and cash equivalents at beginning of period +1,478,147 +996,174 +Cash and cash equivalents at end of period +$ 902,329 +$ 1,478,147 +The accompanying notes are an integral part +of these consolidated financial statements. +F- 12 +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(continued) +For the Years Ended December 31, +2018 +2017 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ 760,208 +$ 271,129 +Non-cash investing and financing activities: +Cancellation of convertible note payable into shares of common stock +$ 2,446,116 +$ 2,497,721 +Cancellation of convertible note payable, related party into shares of common stock +$ - +$ 530,000 +Cancellation of short term advances into shares of common stock +$ 2,554,167 +$ — +Cancellation of short term advances, related party into shares of common stock +$ 45,000 +$ — +Cancellation of short term advances, related party into shares of Series B Preferrred Stock +$ 250,000 +$ — +Payment of debt with digital currency +$ 739,967 +$ — +Purchase of assets with digital currency +$ 250,460 +$ — +Payment of accounts payable with digital currency +$ 449,479 +$ — +Issuance of common stock for prepaid services +$ 50,000 +$ — +Cancellation of notes payable – related party into shares of +common stock +$ — +$ 369,334 +Cancellation of notes payable into shares of common stock +$ — +$ 2,204,365 +Cancellation of note payable – related party into series B +convertible preferred stock +$ — +$ 500,000 +Issuance of common stock for domain name +$ — +$ 31,000 +Issuance of common stock for prepaid services +$ — +$ 410,000 +In connection with the Company's acquisition of Microphase Corporation, equity instruments were +issued and liabilities assumed during 2017 as follows: +Fair value of assets acquired +$ 7,907,744 +Equity instruments issued +(1,451,040 ) +Non-controlling interest +(945,555 ) +Liabilities assumed +$ 5,511,149 +The accompanying notes are an integral +part of these consolidated financial statements. +F- 13 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +1. DESCRIPTION OF BUSINESS +DPW Holdings, Inc., +a Delaware corporation (“DPW” or the “Company”), formerly known as Digital Power Corporation, was incorporated +in September 2017. The Company is a diversified holding company owning subsidiaries engaged in the +following operating businesses: commercial and defense solutions, commercial lending, cryptocurrency blockchain mining, advanced +textile technology and restaurant operations. The Company’s wholly-owned subsidiaries are Coolisys Technologies, Inc. +(“Coolisys”), Digital Power Limited (“DP Limited”), Enertec Systems +2001 Ltd (“ Enertec ”), Power-Plus Technical Distributors, LLC (“Power-Plus”), +Digital Power Lending, LLC (“DP Lending”) and Digital Farms, Inc. (“Digital Farms”), formerly known as +Super Crypto Mining, Inc . The Company also has controlling interests in Microphase +Corporation (“Microphase”) and I. AM, Inc. (“I.AM”) . The Company +has five reportable segments – North America with operations conducted by Microphase, Coolisys, Power-Plus and DP Lending, +Europe with operations through DP Limited, Middle East with operations through Enertec, digital currency blockchain mining through +Digital Farms and restaurant operations through I.AM. +On March 14, 2019, pursuant +to the authorization provided by the Company’s stockholders at a Special Meeting of Stockholders, the Company’s +Board of Directors approved the Certificate of Incorporation Amendment (the “COI Amendment”) to effectuate a reverse +stock split of the Common Stock affecting both the authorized and issued and outstanding number of such shares by a ratio of one-for-twenty +(the “Reverse Stock Split”) . +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +The accompanying consolidated +financial statements have been prepared on the basis that the Company will continue as a going concern. As +of December 31, 2018, the Company had cash and cash equivalents of $902,329, an accumulated deficit of $55,721,115 and a negative +working capital of $18,445,302. The Company has incurred recurring losses and reported losses for the years ended December 31, +2018 and 2017, totaled $32,233,881 and $10,616,231, respectively. In the past, the Company has financed its operations principally +through issuances of convertible debt, promissory notes and equity securities. During 2018, the Company continued to successfully +obtain additional equity and debt financing and in restructuring existing debt. +The Company expects +to continue to incur losses for the foreseeable future and needs to raise additional capital to continue its business development +initiatives and to support its working capital requirements. In March 2017, the Company was awarded a 3-year, $50 million purchase +order by MTIX Ltd. (“MTIX”) to manufacture, install and service the Multiplex Laser Surface Enhancement (“MLSE”) +plasma-laser system. Currently, the Company has subcontracted out a significant amount of these services to third parties. Management +believes that the MLSE purchase order will be a source of revenue and generate significant cash flows for the Company. Additionally, +on April 2, 2019, the Company received gross proceeds of approximately $7 million in a public offering of its securities (See Note +28). Management believes that the Company has access to capital resources through potential public or private issuances of debt +or equity securities. However, if the Company is unable to raise additional capital, it may be required to curtail operations and +take additional measures to reduce costs, including reducing its workforce, eliminating outside consultants and reducing legal +fees to conserve its cash in amounts sufficient to sustain operations and meet its obligations. These matters raise substantial +doubt about the Company’s ability to continue as a going concern. The accompanying financial statements do not include any +adjustments that might become necessary should the Company be unable to continue as a going concern. +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated +financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America +(“U.S. GAAP”). +F- 14 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Principles of Consolidation +The consolidated financial +statements include the accounts of DPW and its wholly-owned subsidiaries, Coolisys, DP Limited, Power-Plus, Enertec, DP Lending +and Digital Farms and its majority-owned subsidiaries, Microphase and I.AM. All significant intercompany accounts and transactions +have been eliminated in consolidation. +Accounting Estimates +The preparation of +financial statements, in conformity with U.S. GAAP, requires management to make estimates, judgments and assumptions. The Company's +management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time +they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure +of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses +during the reporting periods. Actual results could differ from those estimates. Key estimates include acquisition accounting, fair +value of certain financial instruments, reserve for trade receivables and inventories, carrying amounts of investments, fair value +of digital currencies, accruals of certain liabilities including product warranties, useful lives and depreciation, and deferred +income taxes and related valuation allowance. +Revenue Recognition +The Company recognizes +revenue under ASC 606, Revenue from Contracts with Customers . The core principle of the new revenue standard is that a company +should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration +to which the company expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve +that core principle: +· Step 1: Identify the contract with the +customer, +· Step 2: Identify the performance obligations +in the contract, +· Step 3: Determine the transaction price, +· Step 4: Allocate the transaction price +to the performance obligations in the contract, and +· Step 5: Recognize revenue when the company +satisfies a performance obligation. +The Company’s disaggregated revenues +consist of the following for the year ended December 31, 2018: +Year ended December 31, 2018 +Digital +DPC +DPL +Enertec +Farms +I.AM +Total +Primary Geographical +Markets +North America +$ 13,875,883 +$ 11,804 +$ — +$ 1,675,549 +$ 3,462,140 +$ 19,025,376 +Europe +159,350 +1,656,516 +— +— +— +1,815,866 +Middle East +— +— +5,226,075 +— +— +5,226,075 +Other +718,692 +368,210 +— +— +— +1,086,902 +$ 14,753,925 +$ 2,036,530 +$ 5,226,075 +$ 1,675,549 +$ 3,462,140 +$ 27,154,219 +Major Goods +RF/Microwave Filters +$ 3,331,575 +$ — +$ — +$ — +$ — +$ 3,331,575 +Detector logarithmic +video amplifiers +1,338,912 +— +— +— +— +1,338,912 +Power Supply Units +5,829,125 +— +— +— +— +5,829,125 +Power Supply Systems +— +2,036,530 +— +— +— +2,036,530 +Healthcare diagnostic systems +— +— +1,715,512 +— +— +1,715,512 +Defense systems +— +— +3,510,563 +— +— +3,510,563 +Digital Currency Mining +— +— +— +1,675,549 +— +1,675,549 +Restaurant operations +— +— +— +— +3,462,140 +3,462,140 +Lending activities +347,033 +— +— +— +— +347,033 +MLSE Systems +3,907,280 +— +— +— +— +3,907,280 +$ 14,753,925 +$ 2,036,530 +$ 5,226,075 +$ 1,675,549 +$ 3,462,140 +$ 27,154,219 +Timing of Revenue +Recognition +Goods transferred at a +a point in time +$ 10,846,645 +$ 1,411,798 +$ — +$ 1,675,549 +$ 3,462,140 +$ 17,396,132 +Services transferred over time +3,907,280 +624,732 +5,226,075 +— +— +9,758,087 +$ 14,753,925 +$ 2,036,530 +$ 5,226,075 +$ 1,675,549 +$ 3,462,140 +$ 27,154,219 +F- 15 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Sales of Products +The Company generates +revenues from the sale of its products through a direct and indirect sales force. The Company’s performance obligations +to deliver products are satisfied at the point in time when products are received by the customer, which is when the customer has +title and the significant risks and rewards of ownership. The Company provides standard assurance warranties, which are not separately +priced, that the products function as intended. The Company primarily receives fixed consideration for sales of product. Some of +the Company’s contracts with distributors include stock rotation rights after six months for slow moving inventory, which +represents variable consideration. The Company uses an expected value method to estimate variable consideration and constrains +revenue for estimated stock rotations until it is probable that a significant reversal in the amount of cumulative revenue recognized +will not occur. To date, returns have been insignificant. The Company’s customers generally pay within 30 days from the receipt +of a valid invoice. +Because the Company’s +product sales agreements have an expected duration of one year or less, the Company has elected to adopt the practical expedient +in ASC 606-10-50-14(a) of not disclosing information about its remaining performance obligations. +Manufacturing Services +The Company provides +manufacturing services in exchange primarily for fixed fees, however, the initial two MLSE units are subject to variable pricing +under the $50 million purchase order from MTIX. Under the terms of the MLSE purchase order, the Company shall be entitled to cost +plus $100,000 for the manufacture of the first two MLSE units. The Company has determined that the costs of manufacturing the MLSE +units will decline over time due to the effects of a learning curve which will result in a great amount of revenue being recognized +for these initial two MLSE units. +For manufacturing services, +which include revenues generated by Enertec and in certain instances revenues generated by DPL, the Company’s performance +obligation for manufacturing services is satisfied over time as the Company creates or enhances an asset that the customer controls +as the asset is created or enhanced. Generally, the Company recognizes revenue based upon proportional performance over time using +a cost to cost method which measures progress based on the costs incurred to total expected costs in satisfying its performance +obligation. This method provides a depiction of the progress in providing the manufacturing service because there is a direct relationship +between the costs incurred by the Company and the transfer of the manufacturing service to the customer. Manufacturing services +that are recognized based upon the proportional performance method are included in the above table as services transferred over +time and to the extent the customer has not been invoiced for these revenues, as accrued revenue in the accompanying consolidated +balance sheets. Revisions to the Company’s estimates may result in increases or decreases to revenues and income and are +reflected in the consolidated financial statements in the periods in which they are first identified. +The Company has elected +the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component +to the extent that the period between when the Company transfers its promised good or service to the customer and when the customer +pays is one year or less. +F- 16 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The aggregate amount of the transaction price allocated to the performance obligation that is partially +unsatisfied as of December 31, 2018 for the MLSE units was approximately $48 million. The Company expects to recognize the remaining +revenue related to the partially unsatisfied performance obligation over the next two and a half years. The Company will be paid +in installments for this performance obligation over the next two and a half years. +Blockchain Mining +The Company derives +its revenue by providing transaction verification services within the digital currency networks of cryptocurrencies, such as Bitcoin, +Bitcoin Cash and Litecoin. The Company satisfies its performance obligation at the point in time that which the Company is awarded +a unit of digital currency through its participation in the applicable network and network participants benefit from the Company’s +verification service. In consideration for these services, the Company receives digital currencies which are recorded as revenue, +using the closing U. S. dollar price of the related cryptocurrency on the date of receipt. Expenses associated with running the +cryptocurrency mining business, such as equipment deprecation and electricity cost are recorded as a component of cost of revenues. +Restaurant Operations +The Company records +revenue from restaurant sales at the time of sale, net of discounts, coupons, employee meals and complimentary meals and gift cards. +Restaurant cost of sales primarily includes the cost of good, beverages, and merchandise and disposable paper and plastic goods +used in preparing and selling the Company’s menu items, and exclude depreciation and amortization. Vendor allowances received +in connection with the purchase of a vendor’s products are recognized as a reduction of the related food and beverage costs +as earned. +Foreign Currency Translation +A substantial portion +of the Company’s revenues are generated in U.S. dollars (“U.S. dollar”). In addition, a substantial portion +of the Company’s costs are incurred in U.S. dollars. Company management has determined that the U.S. dollar is the functional +currency of the primary economic environment in which it operates. +Accordingly, monetary +accounts maintained in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with Financial Accounting +Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) No. 830, Foreign Currency +Matters (“ASC No. 830”). All transaction gains and losses from the re-measurement of monetary balance sheet items +are reflected in the statements of operations as financial income or expenses as appropriate. +The financial statements +of DPL and Enertec, whose functional currencies have been determined to be their local currencies, the British Pound (“GBP”) +and the Israeli Shekel (“ILS”), have been translated into U.S. dollars in accordance with ASC No. 830. All +balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations +amounts have been translated using the average exchange rate in effect for the reporting period. The resulting translation adjustments +are reported as other comprehensive income (loss) in the consolidated statement of comprehensive income (loss) and accumulated +comprehensive income (loss) in statement of changes in stockholders' equity (deficit). +F- 17 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Cash and Cash Equivalents +The Company considers +all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial +instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s +cash is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. +These balances may, at times, exceed the U.S. Federal Deposit Insurance Corporation insurance limits. The Company has cash and +cash equivalents of $409,945 and $292,153 at December 31, 2018 and 2017, respectively, in the United Kingdom (“U.K”) +and $60,040 and nil, respectively, in Israel. The Company has not experienced any losses on deposits of cash and cash equivalents. +Accounts Receivable and Allowance +for Doubtful Accounts +The Company’s +receivables are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount +of the Company’s receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. +The Company individually reviews all accounts receivable balances and based upon an assessment of current creditworthiness, estimates +the portion, if any, of the balance that will not be collected. The Company estimates the allowance for doubtful accounts based +on historical collection trends, age of outstanding receivables and existing economic conditions. If events or changes in circumstances +indicate that a specific receivable balance may be impaired, further consideration is given to the collectability of those balances +and the allowance is adjusted accordingly. A customer’s receivable balance is considered past-due based on its contractual +terms. Past-due receivable balances are written-off when the Company’s internal collection efforts have been unsuccessful +in collecting the amount due. Based on an assessment as of December 31, 2018 and 2017, of the collectability of invoices, accounts +receivable are presented net of an allowance for doubtful accounts of $5,000 and $5,000, respectively. +Inventories +Inventories are stated +at the lower of cost or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or +technological obsolescence. +Cost of inventories is determined +as follows: +Raw materials, +parts and supplies - using the “first-in, first-out” method. +Work-in-progress and finished products +- on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically +assesses its inventories valuation in respect of obsolete and slow-moving items by reviewing revenue forecasts and technological +obsolescence. When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at +the time of the review was not expected to be sold, is written off. +During the years ended +December 31, 2018 and 2017, the Company did not record inventory write-offs within the cost of revenue. +Property and Equipment, Net +Property and equipment +as well as an intangible asset are stated at cost, net of accumulated depreciation and amortization. Repairs and maintenance costs +are expensed as incurred. Depreciation and amortization are calculated using the straight-line method over the estimated useful +lives of the assets, at the following annual rates: +Useful lives (in years) +Computer, software and related equipment +3 - 5 +Office furniture and equipment +5 - 10 +Leasehold improvements +Over the term of the lease or the life of the asset, whichever is shorter. +F- 18 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Goodwill +The Company evaluates +its goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other . Goodwill is recorded +when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible +assets acquired. +The Company tests the +recorded amount of goodwill for impairment on an annual basis on December 31 of each fiscal year or more frequently if there are +indicators that the carrying amount of the goodwill exceeds its carried value. At December 31, 2018, the Company had five reporting +units. The Company performed a qualitative assessment and concluded that no impairment existed as of December 31, 2018. +Intangible Assets +The Company acquired +amortizable intangibles assets as part of three asset purchase agreements consisting of customer lists and non-compete agreements. +The Company also has the trade names and trademarks associated with the acquisitions of Microphase and I.AM which were determined +to have an indefinite life. The Company’s intangible assets, net also include definite lived intangible assets, which are +being amortized on a straight-line basis over their estimated useful lives as follows: +Useful lives (in years) +Customer list +5 - 14 +Non-competition agreements +3 +Domain name and other intangible assets +3 +The Company reviews +intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the +assets might not be recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant +underperformance of the business in relation to expectations, significant negative industry or economic trends, and significant +changes or planned changes in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, +the Company compares forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived +asset to its carrying value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result +from the use of an asset are less than its carrying amount. The impairment loss would be based on the excess of the carrying value +of the impaired asset over its fair value, determined based on discounted cash flows. No impairments were recorded on intangible +assets as no impairment indicators were noted for the periods presented in these consolidated financial statements. +Long-Lived Assets +The long-lived assets +of the Company are reviewed for impairment in accordance with ASC No. 360, Property, Plant, and Equipment , whenever +events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets +to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected +to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the +amount by which the carrying amount of the assets exceeds the fair value of the assets. As of December 31, 2018 and 2017, no impairment +charges were necessary. +F- 19 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Warranty +The Company offers +a warranty period for all its manufactured products. Warranty periods range from one to two years depending on the product. The +Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the +time product revenue is recognized. Factors that affect the Company's warranty liability include the number of units sold, historical +rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability +and adjusts the amounts as necessary. As of December 31, 2018 and 2017, the Company’s accrued warranty liability was $86,495. +Income Taxes +The Company determines +its income taxes under the asset and liability method in accordance with FASB ASC No. 740, Income Taxes , which requires +recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in +the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between +the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which +the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes +it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted +tax rates expected to apply to taxable income in the fiscal years in which those temporary differences are expected to be recovered +or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Statements of Income +and Comprehensive Income in the period that includes the enactment date. +The Company accounts +for uncertain tax positions in accordance with ASC No. 740-10-25 . ASC No. 740-10-25 addresses the determination of +whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC +No. 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that +the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The +tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized +upon ultimate settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, such +differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related +to accrued liabilities for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management +to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions that +more likely than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated +tax positions taken by the Company and has concluded that as of December 31, 2018 and 2017, there are no uncertain tax positions +taken, or expected to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +The Company has not yet filed its 2016 or 2017 tax returns. +Common Stock Purchase Warrants and +Other Derivative Financial Instruments +The Company classifies +common stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require +physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its +own shares (physical settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement +(including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company), +(ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), +or (iii) contain reset provisions as either an asset or a liability. The Company assesses classification of its freestanding +derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. +The Company determined that certain freestanding derivatives, which principally consist of issuance of warrants to purchase shares +of common stock in connection with convertible notes and to employees of the Company, satisfy the criteria for classification as +equity instruments as these warrants do not contain cash settlement features or variable settlement provision that cause them to +not be indexed to the Company’s own stock. +F- 20 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Stock-Based Compensation +The Company accounts +for stock-based compensation in accordance with ASC No. 718, Compensation – Stock Compensation ( “ASC No. +718” ). Under ASC No. 718, compensation expense related to stock-based payments is recorded over the requisite service +period based on the grant date fair value of the awards. Compensation previously recorded for unvested stock options that are forfeited +is reversed upon forfeiture. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for +stock-based awards. The Black-Scholes model requires the use of assumptions which determine the fair value of stock-based awards, +including the option’s expected term and the price volatility of the underlying stock. +The Company’s +accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions +of ASC No. 505-50, Equity Based Payments to Non-Employees . Accordingly, the measurement date for the fair value of the equity +instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor +is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments +issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement. +Convertible Instruments +The Company accounts +for hybrid contracts that feature conversion options in accordance with ASC No. 815, Derivatives and Hedging Activities +( “ASC No. 815” ). ASC No. 815 requires companies to bifurcate conversion options from their host instruments +and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances +in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related +to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded +derivative instrument and the host contract is not re-measured at fair value under otherwise applicable GAAP with changes in fair +value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument +would be considered a derivative instrument. +Conversion options +that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity +or equity linked securities at exercise prices more favorable than that featured in the hybrid contract generally result in their +bifurcation from the host instrument. +The Company accounts +for convertible instruments, when the Company has determined that the embedded conversion options should not be bifurcated from +their host instruments, in accordance with ASC No. 470-20, Debt with Conversion and Other Options ( “ASC No. +470-20” ). Under ASC No. 470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic +value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common +stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts +for convertible instruments (when the Company has determined that the embedded conversion options should be bifurcated from their +host instruments) in accordance with ASC No. 815. +Concentration of Credit Risk +Financial instruments +that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade +receivables. +Cash and cash equivalents +are invested in banks in the U.S., UK and Israel. Such deposits in the United States may be in excess of insured limits and are +not insured in other jurisdictions. +Trade receivables of +the Company and its subsidiaries are mainly derived from sales to customers located primarily in the U.S., Europe and Israel. The +Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance +for doubtful accounts is determined with respect to those amounts that the Company and its subsidiaries have determined to be doubtful +of collection. +F- 21 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Comprehensive Income (Loss) +The Company reports +comprehensive loss in accordance with ASC No. 220, Comprehensive Income . This statement establishes standards for the reporting +and presentation of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive +loss generally represents all changes in equity during the period except those resulting from investments by, or distributions +to, stockholders. The Company determined that its items of other comprehensive loss relate to changes in foreign currency translation +adjustments, unrealized gains on its marketable securities and unrealized gains and losses in its warrants and common stock in +AVLP, a related party. +Fair value of Financial Instruments +In accordance with +ASC No. 820, Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would +be received for the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of +the measurement date. +The guidance also establishes +a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable +inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants +would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. +Unobservable inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use +in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +Level 1: Quoted market prices in active +markets for identical assets or liabilities. +Level 2: Inputs other than Level 1 that +are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets +that are not active; or model-derived valuations. All significant inputs used in our valuations are observable or can be derived +principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level +2 inputs also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally +developed models such as a discounted cash flow models. +Level 3: Unobservable inputs that are supported +by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts +of financial instruments carried at cost, including cash and cash equivalents, accounts receivables and accounts and other receivable +– related party, investments, notes receivable, trade payables and trade payables – related party approximate their +fair value due to the short-term maturities of such instruments. +As of December +31, 2018 and 2017, the fair value of the Company’s investments were $3,256,468 and $9,562,571, respectively, and were +concentrated in equity securities of Avalanche International Corp., which we refer to as AVLP, a related party (See Note 10), which +are classified as available-for-sale investments. At December 31, 2018, the Company's investment in AVLP included marketable equity +securities of $812,858 and warrants to purchase 13,887,993 shares of AVLP common stock at an exercise price of $0.50 per share +of common stock with an aggregate fair value of $3,043,499. At December 31, 2017, the Company's investment in AVLP included marketable +equity securities of $826,408 and warrants to purchase 8,248,440 shares of AVLP common stock at an exercise price of $0.50 per +share of common stock with an aggregate fair value of $7,728,001. For investments in marketable equity securities, the Company +took into consideration general market conditions, the duration and extent to which the fair value is above cost, and the Company’s +ability and intent to hold the investment for a sufficient period of time to allow for recovery of value in the foreseeable future. +As a result of this analysis, the Company has determined that its investment in AVLP’s marketable equity securities are valued +based upon the closing market price of common stock at December 31, 2018 and 2017, which resulted in an unrealized gain of $119,329 +and $550,048, respectively. +F- 22 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +At December 31, 2018, +the Company held shares of common stock in one company that it had purchased at the market, for a total cost of $220,880 with an +aggregate fair value of $178,597. In accordance with ASC No. 320-10, this investment is accounted for based upon the closing market +price of the respective common stock at December 31, 2018 and 2017, resulting in an unrealized loss of $42,283 and unrealized gain +of $133,067, respectively. +The categorization of a financial instrument +within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following +table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within +the fair value hierarchy: +Fair Value Measurement at December 31, 2018 +Total +Level 1 +Level 2 +Level 3 +Investments in common stock and warrants of +AVLP – a related party +$ 3,043,499 +$ 812,858 +$ — +$ 2,230,641 +Investments in marketable securities +178,597 +178,597 +— +— +Investments in warrants of public companies +34,372 +— +— +34,372 +Total Investments +$ 3,256,468 +$ 991,455 +$ — +$ 2,265,013 +Fair Value Measurement at December 31, 2017 +Total +Level 1 +Level 2 +Level 3 +Investments in common stock and warrants of +AVLP – a related party +$ 7,728,001 +$ 826,408 +$ — +$ 6,901,593 +Investments in marketable securities +1,834,570 +1,834,570 +— +$ — +Total Investments +$ 9,562,571 +$ 2,660,978 +$ — +$ 6,901,593 +We assess the inputs used to measure fair +value using thee three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market. +Debt Discounts +The Company accounts +for debt discount according to ASC No. 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through +periodic charges to interest expense over the term of the related financial instrument using the effective interest method. During +the years ended December 31, 2018 and 2017, the Company recorded amortization of debt discounts of $11,191,056 and $4,688,630, +respectively. +Net Loss per Share +Net loss per share +is computed by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation +of the basic and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock +equivalents is anti-dilutive due to the Company’s net loss position for all periods presented. Anti-dilutive securities, +which are convertible into the Company’s Class A common stock, consist of the following at December 31, 2018 and 2017: +2018 +2017 +Stock options +373,000 +192,125 +Warrants +936,381 +219,443 +Convertible notes +999,641 +64,197 +Preferred stock +127,551 +109,306 +Total +2,436,573 +585,071 +F- 23 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Reclassifications +Certain prior year +amounts have been reclassified for comparative purposes to conform to the current-year financial statement presentation. These +reclassifications had no effect on previously reported results of operations. In addition, certain prior year amounts from the +restated amounts have been reclassified for consistency with the current period presentation. +Recently Issued Accounting Standards +In May 2014, the FASB +issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) , (“ASU +2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC 605 - Revenue Recognition (“ASC 605”) +and most industry-specific guidance throughout ASC 605. The FASB has issued numerous updates that provide clarification on a number +of specific issues as well as requiring additional disclosures. The core principle of ASC 606 requires that an entity recognize +revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which +the company expects to be entitled in exchange for those goods or services. +The Company adopted +ASC 606 effective January 1, 2018 to all contracts using the modified retrospective approach. The adoption of ASU 2014-09 did not +have a material impact on the Company’s consolidated financial position, results of operations, equity or cash flows. +In February 2016, the +FASB issued ASU 2016-02, Leases (Topic 842) , (“ASU 2016-02”) in order to increase transparency and comparability +among organizations by, among other provisions, recognizing lease assets and lease liabilities on the balance sheet for those leases +classified as operating leases under previous U.S. GAAP. For public companies, ASU 2016-02 is effective for fiscal years beginning +after December 15, 2018 (including interim periods within those periods) using a modified retrospective approach and early adoption +is permitted. In transition, entities may also elect a package of practical expedients that must be applied in its entirety +to all leases commencing before the adoption date, unless the lease is modified, and permits entities to not reassess (a) the existence +of a lease, (b) lease classification or (c) determination of initial direct costs, as of the adoption date, which effectively allows +entities to carryforward accounting conclusions under previous U.S. GAAP. In July 2018, the FASB issued ASU 2018-11, Leases +(Topic 842): Targeted Improvements , which provides entities an optional transition method to apply the guidance under Topic +842 as of the adoption date, rather than as of the earliest period presented. The Company adopted Topic 842 on January 1, +2019, using the optional transition method to apply the new guidance as of January 1, 2019, rather than as of the earliest period +presented, and elected the package of practical expedients described above. The Company expects to recognize additional operating +liabilities of approximately $4.2 million, with corresponding ROU assets of approximately the same amount as of January 1, 2019 +based on the present value of the remaining lease payments. +In July 2017, the FASB +issued ASU No. 2017-11, Earnings per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives +and Hedging (Topic 815) (“ASU 2017-11”). ASU 2017-11 consists of two parts. The amendments in Part I of this update +change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. +When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round +feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. +The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked +financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as +a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require +entities that present earnings per share (“EPS”) in accordance with Topic 260 to recognize the effect of the down round +feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common stockholders +in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized +guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), +including related EPS guidance (in Topic 260). The amendments in Part II of this update re-characterize the indefinite deferral +of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments +do not have an accounting effect. For public business entities, the amendments in Part I of this update are effective for fiscal +years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments +in Part I of this update are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years +beginning after December 15, 2020. Early adoption is permitted for all entities, including adoption in an interim period. If an +entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal +year that includes that interim period. The amendments in Part II of this update do not require any transition guidance because +those amendments do not have an accounting effect. The Company is currently evaluating the impact of adopting this standard on +its consolidated financial statements and related disclosures but does not expect it to have a material impact. +F- 24 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +In June 2018, the FASB +issued ASU No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting , (“ASU 2018-07”). ASU +2018-07 simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under ASU 2018-07, most +of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. +The changes take effect for public companies for fiscal years starting after Dec. 15, 2018, including interim periods within that +fiscal year. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim +periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than an entity’s +adoption date of Topic 606. The Company is currently evaluating the impact of adopting this standard on its consolidated financial +statements and related disclosures but does not expect it to have a material impact. +4. Digital Currencies +The following table +presents additional information about digital currencies: +Digital +Currencies +Balance at January 1, 2017 +$ — +Additions of digital currencies +1,634,941 +Payment on convertible notes payable +(739,967 ) +Payments to vendors +(449,479 ) +Purchase of fixed assets +(250,460 ) +Realized loss on sale of digital currencies +(127,602 ) +Cash proceeds +(64,587 ) +Unrealized loss on digital currencies +(1,311 ) +Balance at December 31, 2018 +$ 1,535 +At December 31, 2018, +the Company’s digital currencies consisted of Bitcoin Cash and Litecoin. Digital currencies are recorded at cost on the date +they are received as revenues and are tested for impairment at each reporting date. Fair value is determined by taking the closing +price from the most liquid exchanges. +F- 25 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +5. Marketable Securities +Marketable securities in equity securities +with readily determinable market prices consisted of the following as of December 31, 2018 and December 31, 2017: +Available-for-sale securities at December 31, 2018 +Gross unrealized +Gross realized +Cost +gains (losses) +gains (losses) +Fair value +Common shares +$ 220,880 +($42,283) +$ +— +$ 178,597 +Available-for-sale securities at December 31, 2017 +Gross unrealized +Gross realized +Cost +gains (losses) +gains (losses) +Fair value +Common shares +$ 1,701,503 +$133,067 +$ +— +$ 1,834,570 +The following table presents additional information about marketable +securities: +Balance at January 1, 2018 +$ 1,834,570 +Purchases of marketable securities +858,458 +Sales of marketable securities +(2,188,292 ) +Realized losses on marketable securities +(175,405 ) +Unrealized gains on marketable securities +(150,734 ) +Balance at December 31, 2018 +$ 178,597 +Available-for-sale Securities +At December 31, 2018 +and 2017, the Company had invested in the marketable securities of certain publicly traded companies. At December 31, 2018 and +2017, the Company recorded an unrealized loss of $42,283 and an unrealized gain of $133,067, respectively, representing the difference +between the cost basis and the estimated fair value, as accumulated other comprehensive income in the stockholder's equity section +of the Company’s consolidated balance sheet and as a change in unrealized gains and losses on marketable securities in the +Company’s consolidated statements of comprehensive income (loss). The Company’s investment in marketable securities +will be revalued on each balance sheet date. The fair value of the Company’s holdings in marketable securities +at December 31, 2018 and 2017 is a Level 1 measurement based on quoted prices in an active market. +6. INVENTORIES +At December 31, 2018 and 2017, +inventories consist of: +2018 +2017 +Raw materials, parts and supplies +$ 2,026,839 +$ 541,816 +Work-in-progress +483,706 +685,410 +Finished products +750,581 +765,639 +Total inventories +$ 3,261,126 +$ 1,992,865 +7. PROPERTY AND EQUIPMENT, NET +At December 31, 2018 and 2017, +property and equipment consist of: +2018 +2017 +Cryptocurrency machines and related equipment +$ 9,168,928 +$ — +Computer, software and related equipment +2,495,470 +2,431,906 +Restaurant equipment +752,103 +— +Office furniture and equipment +287,583 +289,288 +Leasehold improvements +1,274,865 +788,057 +13,978,949 +3,509,251 +Accumulated depreciation and amortization +(4,665,650 ) +(2,292,404 ) +Property and equipment, net +$ 9,313,299 +$ 1,216,847 +F- 26 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +For the years ended +December 31, 2018, depreciation expense amounted to $2,447,249 and $193,671, respectively. +8. INTANGIBLE ASSETS, NET +At December 31, 2018 and 2017 +intangible assets consist of: +2018 +2017 +Trade name and trademark +$ 1,562,332 +$ 1,739,307 +Customer list +2,388,139 +988,041 +Non-competition agreements +150,000 +150,000 +Domain name and other intangible assets +762,807 +81,000 +4,863,278 +2,958,348 +Accumulated depreciation and amortization +(503,480 ) +(60,335 ) +Property and equipment, net +$ 4,359,798 +$ 2,898,013 +During the years ended +December 31, 2018 and 2017, the Company acquired the trade names and trademarks of I.AM and Microphase, both which were determined +to have an indefinite life, for $520,000 and $1,739,307, respectively. The remaining definite lived intangible assets are being +amortized on a straight-line basis over their estimated useful lives. Amortization expense was $459,656 and $60,335 for the years +ended December 31, 2018 and 2017, respectively. +The customer +list and non-competition agreements are subject to amortization over their estimated useful lives, which range between +3 and 14 years. The following table presents estimated amortization expense for each of the succeeding five calendar years and +thereafter. +2019 +$ 506,271 +2020 +382,251 +2021 +242,503 +2022 +224,003 +2023 +210,670 +Thereafter +1,044,254 +$ 2,609,952 +9. GOODWILL +The Company’s +goodwill relates to the acquisitions of a controlling interest in Microphase on June 2, 2017 and I. AM, Inc. (“I. AM”) +on May 23, 2018, the acquisition of Enertec Systems 2001 Ltd. (“Enertec”) on May 22, 2018, and the acquisition of all +of the outstanding membership interests in Power Plus on September 1, 2017. +F- 27 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +10. INVESTMENTS – RELATED PARTIES +Investments in AVLP at December 31, 2018 +and 2017, are comprised of the following: +December 31, +2018 +2017 +Investment in convertible promissory note of AVLP +$ 6,943,997 +$ 4,124,220 +Investment in warrants of AVLP +2,230,641 +6,901,593 +Investment in common stock of AVLP +812,858 +826,408 +Accrued interest in convertible promissory note of AVLP +1,004,317 +324,400 +Total investment in AVLP – Gross +10,991,813 +12,176,621 +Less: original issue discount +(2,336,693 ) +(2,115,710 ) +Total investment in AVLP – Net +$ 8,655,120 +$ 10,060,911 +The following table +summarizes the changes in our investments in AVLP during the year ended December 31, 2018: +Investment in +Investment in +warrants and +convertible +Total +common stock +promissory +investment +of AVLP +note of AVLP +in AVLP – Net +Balance at January 1, 2017 +$ 84,578 +$ 952,073 +$ 1,036,651 +Investment in convertible promissory notes of AVLP +— +620,091 +620,091 +Investment in common stock of AVLP +191,782 +— +191,782 +Fair value of warrants issued by AVLP +2,388,681 +— +2,388,681 +Unrealized gain in warrants of AVLP +4,512,912 +— +4,512,912 +Unrealized gain in common stock of AVLP +550,048 +— +550,048 +Accretion of discount +— +436,346 +436,346 +Accrued Interest +— +324,400 +324,400 +Balance at December 31, 2018 +$ 7,728,001 +$ 2,332,910 +$ 10,060,911 +Investment in convertible promissory notes of AVLP +— +1,671,936 +1,671,936 +Payment of convertible promissory notes of AVLP +— +(1,107,500 ) +(1,107,500 ) +Investment in common stock of AVLP +417,169 +— +417,169 +Fair value of warrants issued by AVLP +2,255,341 +— +2,255,341 +Unrealized loss in warrants of AVLP +(6,926,293 ) +— +(6,926,293 ) +Unrealized loss in common stock of AVLP +(430,719 ) +— +(430,719 ) +Accretion of discount +— +2,034,358 +2,034,358 +Accrued Interest +— +679,917 +679,917 +Balance at December 31, 2018 +$ 3,043,499 +$ 5,611,621 +$ 8,655,120 +The Company has made +a strategic decision to invest in AVLP, a related party controlled by Philou Ventures, LLC, or Philou, a significant stockholder +of the Company. The Company’s investments in AVLP consist of convertible promissory notes, warrants and shares of common +stock of AVLP. On September 6, 2017, the Company and AVLP entered into a Loan and Security Agreement (“AVLP Loan Agreement”) +with an effective date of August 21, 2017 pursuant to which the Company will provide AVLP a non-revolving credit facility +of up to $10 million for a period ending on August 21, 2019, subject to the terms and conditions stated in the Loan Agreement, +including the Company having available funds to grant such credit. At December 31, 2018, the Company has provided loans to AVLP +in the principal amount $6,943,997 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants +to purchase 13,887,994 shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP to the +Company are secured by the assets of AVLP. +F- 28 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The warrants entitle +the Company to purchase up to 13,887,994 shares of AVLP common stock at an exercise price of $0.50 per share for a period of five +years. The exercise price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar +events. The warrant may be exercised for cash or on a cashless basis. At December 31, 2018 and 2017, the Company recorded an unrealized +gain (loss) on its investment in warrants of AVLP of ($6,926,293) and $4,512,912 respectively, representing the difference between +the cost basis and the estimated fair value of the warrants in the Company’s accumulated other comprehensive income in the +stockholder's equity section of the Company’s consolidated balance sheet and as a change in net unrealized gains on securities +available-for-sale in the Company’s consolidated statements of comprehensive loss. During the years ended December 31, 2018 +and 2017, the Company recognized, in other comprehensive income (loss), net unrealized gain (loss) on securities available-for-sale +of ($8,027,746) and $5,171,743, respectively. The Company’s investment in warrants and common stock of AVLP represented ($7,357,012) +and $5,062,960, respectively, of the net unrealized gain (loss) on securities available-for-sale. The Company’s investment +in AVLP will be revalued on each balance sheet date. The fair value of the Company’s holdings in the AVLP warrants was estimated +using the Black-Scholes option-pricing method. The risk-free rate, which ranged between 1.92% and 2.98%, was derived from the U.S. +Treasury yield curve, matching the term of our investment, in effect at the measurement date. The volatility factor which ranged +between 68.7% and 80.4% was determined based on historical stock prices for similar technology companies with market capitalizations +under $100 million. The warrant valuation is a Level 3 measurement. +In accordance with +ASC No. 310, Receivables (“ASC 310”), the Company accounts for its convertible promissory notes in +AVLP at amortized cost, which represents the amount at which the convertible promissory notes were acquired, adjusted for accrued +interest and accretion of original issue discount and discount attributed to the fair value of the 13,887,994 warrants that the +Company received in conjunction with its investment. Interest is accreted using the effective interest method. The Company records +interest on an accrual basis and recognizes it as earned in accordance with the contractual terms of the convertible promissory +notes, to the extent that such amounts are expected to be collected. The original issue discount of $165,448 and the discount attributed +to the fair value of the warrants of $4,644,022 are being amortized as interest income through the maturity date. During the years +ended December 31, 2018 and 2017, the Company recorded $2,034,358 and $436,346, respectively, of interest income for the discount +accretion. During the years ended December 31, 2018 and 2017, the Company recorded contractual interest receivable attributed to +the AVLP Notes and AVLP Loan Agreement of $679,917 and $324,400, respectively. +The Company evaluated +the collectability of both interest and principal for the convertible promissory notes in AVLP to determine whether there was an +impairment. Based on current information and events, the Company determined that it is probable that it will be able to collect +amounts due according to the existing contractual terms. Impairment assessments require significant judgments and are based on +significant assumptions related to the borrower’s credit risk, financial performance, expected sales, and estimated fair +value of the collateral. +During the years ended +December 31, 2018 and 2017, the Company also acquired in the open market 430,942 shares of AVLP common stock for $417,169 and 221,333 +shares of AVLP common stock for $191,782, respectively. At December 31, 2018, the closing market price of AVLP’s common stock +was $0.90, a decline from $1.75 at December 31, 2017. The Company has determined that its investment in AVLP marketable equity +securities are accounted for pursuant to the fair value method and based upon the closing market price of AVLP common stock at +December 31, 2018, the Company’s investment in AVLP common stock had an unrealized gain of $119,329. +11. INVESTMENTS IN PREFERRED STOCK OF PRIVATE COMPANY AND +OTHER INVESTMENTS +We hold a portfolio of investments in equity +and debt securities in other entities that are accounted for under the cost method. +Investment in Preferred Stock of Private +Company +On December +15, 2017, the Company and Sandstone Diagnostics, Inc. (“Sandstone”) entered into a Series A1 Preferred Stock Purchase +Agreement (“Loan Agreement”) pursuant to which the Company purchased 976,286 shares of Sandstone’s Series A1 +Preferred Shares for $1,000,000. Sandstone is a medical device company focused on a data-driven approach to men’s reproductive +health. Founded in 2012 in part by government scientists from Sandia National Laboratories, Sandstone’s mission is to provide +innovative, data-driven tools to help men assess, manage, and improve their reproductive health. The funding from the Series +A1 Preferred Stock financing will support sales growth and continued product development leveraging the company’s unique +technology platform, Sandstone’s Trak™ Male Fertility Testing System. +F- 29 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The Company followz +the guidance of ASC No. 321, Equity Securities (“ASC 321”), which provides a measurement alternative to +the requirement to carry equity interests at fair value in accordance with ASC 820, Fair value measurement, for certain equity +interests without readily determinable fair values. Equity interests measured in accordance with the measurement alternative in +ASC 321 are not required to be included within the fair value hierarchy. The Company’s equity investment in Sandstone is +recorded at cost. However, any change to the carrying amount will be subsequently adjusted up or down for observable price changes +(i.e., prices in orderly transactions for the identical investment or similar investment of the same issuer) and any adjustments +to the carrying amount shall be recorded in net income. +Other Investments +On November 1, +2017, the Company and I. AM, Inc. (“I. AM”) entered into a Loan and Security Agreement pursuant to which the Company +provided I. AM with a non-revolving credit facility of up to $1,600,000. On May 23, 2018, DP Lending entered into and closed a +securities purchase agreement with I. AM. At the date of the acquisition, I. AM owed DP Lending $1,715,330 in outstanding principal, +pursuant to the loan and security agreement. The purchase agreement provides that as I. AM repays the outstanding loan to DP Lending +in accordance with the loan agreement, DP Lending will on a pro rata basis transfer shares of common stock of I. AM to David +J. Krause, up to an aggregate of 471 shares (see Note 14). +The Company, primarily +through DP Lending, has made additional investments in debt and equity securities of various entities. At December 31, 2018 and +2017, the outstanding balance of these investments was $2,572,230 and $1,637,672, respectively. +12. INVESTMENTS IN REAL ESTATE +On June 8, 2018, the +Company entered into a limited partnership agreement, in which it agreed to become a limited partner in the partnership (the “ NY +Partnership ”). The NY Partnership is a limited partner in the partnership that is responsible for the construction and +related activities of a hotel in New York City. In connection with this transaction, the Company has agreed to finance a portion +of the capital required by the NY Partnership. The Company used $1,000,000 from the proceeds of the August 16, 2018 Notes as an +additional capital contribution in the partnership. As of December 31, 2018, the Company had invested an aggregate of $1,869,000 +in the NY Partnership and $100,000 in another real estate investment. Subject to the occurrence of certain events and other conditions +over which the Company has no control, it was required to make monthly capital contributions of $500,000 every thirty days until +the Company’s commitment of $10 million is funded in full. The Company has received a waiver for its obligation to make monthly +capital contributions through September 30, 2019. +13. OTHER INVESTMENTS, RELATED PARTIES +The Company’s +other related party investments primarily consist of two investments. +MTIX, Ltd. +On December 5, 2017, +the Company entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson two convertible +promissory notes in the principal amount of $600,000 (“Note A”) and $1,667,766 (“Note B”), in exchange +for cancellation of amounts due to WT Johnson by MTIX Ltd., a related party of the Company. +F- 30 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +During December 2017, +the Company issued 30,000 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently +sold the 30,000 shares. The proceeds from the sale of shares of common stock received upon the conversion of Note A were sufficient +to satisfy the entire $2,267,766 obligation as well as an additional $400,500 of value added tax due to WT Johnson. Concurrent +with entering into the exchange agreement, the Company received a promissory note in the amount of $2,668,266 from MTIX and cancelled +Note B. At December 31, 2018 and 2017, the Company has valued the note receivable at $600,000, the carrying amount of Note A. The +Company will recognize the remainder of the amount due from MTIX upon payment of the promissory note by MTIX. +Israeli Property +During the year ended +December 31, 2017, our President, Amos Kohn, purchased certain real property that serves as a facility for the Company’s +business operations in Israel. The Company made $300,000 of payments to the seller of the property and received a 28% undivided +interest in the real property (“Property”). The Company’s subsidiary, Coolisys, entered into a Trust Agreement +and Tenancy In Common Agreement with Roni Kohn, who owns a 72% interest in the Property, the daughter of Mr. Kohn and an Israeli +citizen. The Property was purchased to serve as a residence/office facility for the Company in order to oversee its Israeli operations +and to expand its business in the hi-tech industry located in Israel. Pursuant to the Trust Agreement, Ms. Kohn will hold and manage +Coolisys’ undivided 28% interest in the Property. The trust will be in effect until it is terminated by mutual agreement +of the parties. During the term of the trust, Ms. Kohn will not sell, lease, sublease, transfer, grant, encumber, change or effect +any other disposition with respect to the Property or Coolisys’ interest without the Company’s approval. +Under the Tenancy In +Common Agreement, Coolisys and its executive officers shall have the exclusive rights to use the Property for the Company and its +affiliates’ business operations. The Property shall be managed by Ms. Kohn. Further, pursuant to the Tenancy In Common Agreement, +for each completed calendar month of employment of Mr. Kohn by the Company, Ms. Kohn shall have the right to purchase a portion +of the Company’s interest in the Property. Such right shall fully vest at the end of five years of continuous employment +and the Trustee shall have the right to purchase the Company’s 28% interest in the Property for a nominal value. The Company +will amortize its $300,000 investment over ten years, subject to a cliff vesting after five years. During the years ended December +31, 2018 and 2017, the Company recognized $30,000 and $7,500, respectively, in amortization expense. In the event that Mr. Kohn +is not employed by the Company, the Company shall have the right to demand that Ms. Kohn purchase the Company’s remaining +interest in the Property that was not subject to vesting for the fair market value of such unvested Property interest. +Other investments and interest receivable +During the year ended +December 31, 2017, DP Lending made loans to Alzamend Neuro, Inc. (“Alzamend”), in the amount of $44,000, these loans +were repaid during 2018. AVLP is a party to a management services agreement pursuant to which AVLP provides management, consulting +and financial services to Alzamend. As additional consideration, the Company received a warrant to purchase 22,000 shares of Alzamend’s +common stock at an exercise price of $0.30 per share of common stock. The warrants were determined to have a de minimis value. +14. BUSINESS COMBINATIONS +Business +combinations are accounted for under the acquisition method of accounting in accordance with ASC No. 805, Business Combinations . +Under the acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values. Goodwill is +recorded to the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired +less liabilities assumed at the date of acquisition. Two acquisitons were completed during 2018: Enertec Systems 2001 Ltd. (“Enertec”) +and I. AM, Inc. (“I. AM”). The final accounting for the acquisition of Enertec was completed during 2018 whereas the +initial accounting for the acquisition of I. AM is not yet complete and the Company is still performing procedures to determine +the appropriate accounting. +F- 31 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Acquisitions during 2018 +Enertec Systems +2001 Ltd. +On +December 31, 2017, CooliSys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“MICT”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“EML” +and, together with MICT, the “Seller Parties”), and Enertec Systems 2001 Ltd. (“Enertec”), an Israeli corporation, +pursuant to which Coolisys acquired Enertec (the “Acquisition”). Enertec is a manufacturer of specialized electronic +systems for the military market. On May 23, 2018, Coolisys acquired Enertec for an aggregate cash purchase price of $4,850,099. +I. AM, Inc. +On May 23, 2018, +DP Lending entered into and closed a securities purchase agreement with I. AM, David J. Krause and Deborah J. Krause. Pursuant +to the securities purchase agreement, I. AM sold to DPL, 981 shares of common stock for a purchase price of $981, representing, +upon the closing, 98.1% of I. AM’s outstanding common stock. +I. AM owns and +operates the Prep Kitchen brand restaurants located in the San Diego area. I.AM owed DP Lending $1,715,330 in outstanding principal, +pursuant to a loan and security agreement, between I. AM and DP Lending, which I. AM used to acquire the restaurants. The purchase +agreement provides that, as I. AM repays the outstanding loan to DP Lending in accordance with the loan agreement, DP Lending will +on a pro rata basis transfer shares of common stock of I. AM to David J. Krause, up to an aggregate of 471 shares. +Components of the purchase price for acquisitions +completed during the year ended December 31, 2018: +Enertec +I. AM +Accounts receivable +$ 3,184,227 +$ 29,319 +Inventories +1,343,053 +40,581 +Property and equipment +648,649 +700,291 +Trade name and trademark +2,094,741 +520,000 +Domain name and other intangible assets +— +90,000 +Other assets +29,056 +1,492 +Accounts payable and accrued expenses +(2,702,306 ) +(103,961 ) +Deferred tax liability +(160,311 ) +— +Notes payable +(4,235,725 ) +— +Accrued severance pay +(131,811 ) +— +Net assets assumed +69,573 +1,277,722 +Goodwill +4,780,526 +265,252 +Non-controlling interest +— +(33,242 ) +Purchase price +$ 4,850,099 +$ 1,509,732 +Acquisitions during 2017 +Microphase Corporation +On April 28, 2017, +the Company entered into a share exchange agreement +with Microphase; Microphase Holding Company LLC, a limited liability company organized under the laws of Connecticut (“MHC”), +Ergul Family Limited Partnership, a partnership organized under the laws of Connecticut (“EFLP”) RCKJ Trust, a trust +organized under the laws of New Jersey (“RCKJ” and with MHC and EFLP, the “Significant Stockholders”) +and those additional persons who have executed the share exchange agreement (collectively, the “Minority Stockholders” +and with the Significant Stockholders, the “Stockholders”). Upon the terms and subject to the conditions +set forth in the share exchange agreement, the Company acquired 1,603,434 shares (the “Subject Shares”) of the issued +and outstanding common stock of Microphase (the “MPC Common Stock”), from the Stockholders in exchange for the issuance +by the Company of 92,122 shares of DPW common stock (“Common Stock”) and 378,776 shares of DPW Series D Preferred +Stock (collectively, the “Exchange Shares”), which shares of DPW Series D Preferred Stock are convertible into an +aggregate of 757,552 shares of Common Stock and warrants to purchase an aggregate of 50,000 shares of Common Stock. At the time +of the closing of the acquisition the Exchange Shares constituted 56.4% of the outstanding equity interests of Microphase Corporation. +The operating results of Microphase from the closing date of the acquisition, June 2, 2017, are included in the consolidated financial +statements. +F- 32 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +At +closing, the purchase price of the Company’s 56.4% interest in Microphase was determined to be $1,451,040 comprised of the +Exchange Shares, valued at $1,222,000 based on the closing price of the Company’s common stock on June 2, 2017 of $9.40 +per share, and the warrants, valued at $229,040. The +Company computed the fair value of these warrants using the Black-Scholes option pricing model. The risk-free rate of 1.4% was +derived from the U.S. Treasury yield curve, matching the warrant’s term, in effect at the measurement date. The volatility +factor of 105.9% was determined based on the Company’s historical stock prices. +Power-Plus Technical Distributors +On August 3, 2017, +Coolisys entered into a Securities Purchase Agreement to acquire all the outstanding membership Interests of Power-Plus. Power-Plus +is an industrial distributor of value-added power supply solutions, UPS systems, fans, filters, line cords, and other power-related +components. On September 1, 2017, Coolisys completed the acquisition. +Under the terms +of the agreement, Coolisys Technologies acquired all the membership Interests of Power-Plus for a price of $850,000, which was +reduced by certain debts of Power-Plus in the amount of $185,927. The purchase price of $664,073 was paid by (i) a two-year promissory +note in the amount of $255,000 payable in 24 monthly installments; and (ii) cash at closing of $409,073 resulting in a net purchase +price of $664,073. +Components of the purchase price for acquisitions +completed during the year ended December 31, 2017: +Microphase +Power-Plus +Cash and cash equivalents +$ 10,982 +$ 31,411 +Accounts receivable +438,456 +235,358 +Inventories +667,020 +240,843 +Prepaid expenses and other current assets +139,665 +2,068 +Restricted cash +100,000 +— +Intangible assets +2,627,348 +250,000 +Property and equipment +406,432 +22,925 +Other investments +303,333 +— +Deposits and loans +43,479 +— +Accounts payable and accrued expenses +(1,577,281 ) +(388,746 ) +Deferred tax liability +(225,488 ) +— +Revolving credit facility +(879,666 ) +(210,739 ) +Notes payable +(2,203,835 ) +— +Notes payable, related parties +(406,194 ) +— +Convertible notes payable +— +— +Other current liabilities +(219,685 ) +— +Net (liabilities) assets assumed +(775,434 ) +183,119 +Goodwill +3,171,029 +480,953 +Non-controlling interest +(944,555 ) +— +Purchase price +$ 1,451,040 +$ 664,073 +F- 33 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The +following pro forma data for the years ended December 31, 2018 and 2017 summarizes the results of operations for the period indicated +as if the Microphase, Power-Plus and Enertec acquisitions, which closed on June 2, 2017, September 1, 2017, and May 23, 2018, respectively, +had been completed as of the beginning of each period presented. At the time of the acquisition, I. AM was not material to the +Company’s operations and has not been included in the pro forma data. The pro forma data gives effect to actual operating +results prior to the acquisition. These pro forma amounts do not purport to be indicative of the results that would have actually +been obtained if the acquisition occurred as of the beginning of each period presented or that may be obtained in future periods: +For the Years Ended +December 31, +2018 +2017 +Total Revenue +$ 28,691,641 +$ 20,807,590 +Net loss +$ (35,627,242 ) +$ (16,877,041 ) +Less: Net loss attributable +to non-controlling interest +748,320 +772,596 +Net loss attributable to +common stockholders +$ (34,878,922 ) +$ (16,104,445 ) +Preferred deemed dividends +(108,049 ) +(584,182 ) +Preferred dividends +— +(54,059 ) +Loss available to common shareholders +$ (34,986,971 ) +$ (16,742,686 ) +Basic and diluted net loss per common share +$ (12.06 ) +$ (26.85 ) +Basic and diluted weighted average +common shares outstanding +2,899,888 +623,583 +Comprehensive Loss +Loss available to common shareholders +$ (34,986,971 ) +$ (16,742,686 ) +Other comprehensive income (loss) +Change in net foreign currency +translation adjustments +(377,823 ) +152,078 +Net unrealized gain (loss) on +securities available-for-sale +(8,027,746 ) +5,171,743 +Other comprehensive income (loss) +(8,405,569 ) +5,323,821 +Total Comprehensive loss +$ (43,392,540 ) +$ (11,418,865 ) +15. STOCK-BASED COMPENSATION +Under the Company's +2018 Stock Incentive Plan (the “2018 Plan”), 2017 Stock Incentive Plan (the “2017 Plan”), 2016 Stock Incentive +Plan (the “2016 Plan”) and the 2012 Stock Option Plan, as amended (the “2012 Plan”) (collectively, the +“Plans”), options may be granted to employees, officers, consultants, service providers and directors of the Company. +The Plans, as amended, provide for the issuance of a maximum of 868,632 shares of the Company’s common stock. The Company +also has 1,500 outstanding options that were granted between 2009 and 2011 pursuant to the terms of the Company's 2002 Stock Option +Plan (the “2002 Plan”). Options granted pursuant to the 2002 Plan expire between December 2020 and February 2021. +Options granted under +the Plans have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and +become exercisable based on a vesting schedule determined at the date of grant. Typically, options granted generally become +fully vested after four years. Any options that are forfeited or cancelled before expiration become available for future grants. +The options expire between 5 and 10 years from the date of grant. Restricted stock awards granted under the Plans are subject +to a vesting period determined at the date of grant. As of December 31, 2018, an aggregate of 507,789 of the Company's options +are still available for future grant. +F- 34 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +During the year ended +December 31, 2018, the Company granted 50,000 options to its employees from the Plans and also granted 144,875 options outside +of the Plans. During the year ended December 31, 2017, the Company granted 40,500 options from the Plans. These options become +fully vested after four years. The Company estimated the grant date fair value of options granted utilizing the Black-Scholes option +pricing model during the year ended December 31, 2018 and 2017 was $513,510 and $482,055, respectively, which is being recognized +as stock-based compensation expense over the requisite four-year service period. During the year ended December 31, 2018 and 2017, +the Company also issued 79,153 and 97,440, respectively, shares of common stock to its consultants and service providers pursuant +to the Plans. The Company estimated the grant date fair value of these shares of common stock was $2,640,102 and $1,532,702, respectively, +which was determined from the closing price of the Company’s common stock on the date of issuance. +The Company has valued +the options at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables +such as the options’ term, exercise price, current stock price, risk-free interest rate estimated over the expected term +and estimated volatility of our stock over the expected term of the options. The risk-free interest rate used in the calculations +is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the +options as calculated using the simplified method. The estimated volatility was determined based on the historical volatility of +our common stock. +During the year ended +December 31, 2018 and 2017, the Company estimated the fair value of stock options granted using the Black-Scholes option pricing +model with the following weighted average assumptions: +2018 +2017 +Weighted average risk-free interest rate +2.41% — 2.80% +1.73% — 2.14% +Weighted average life (in years) +4.70 +5.0 +Volatility +124.7% — 131.7% +98.4% — 115.8% +Expected dividend yield +0% +0% +Weighted average grant-date fair value per share of +options granted +$ 15.61 +$ 12.00 +The options outstanding +as of December 31, 2018, have been classified by exercise price, as follows: +Outstanding +Exercisable +x +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$11.40 - $16.00 +161,500 +7.54 +$13.37 +92,876 +$13.32 +$20.00 - $27.60 +8,500 +8.52 +$27.46 +3,031 +$27.20 +$30.20 - $33.80 +3,125 +3.71 +$32.73 +3,125 +$32.73 +$11.40 - $33.80 +173,125 +7.52 +$14.41 +99,032 +$14.35 +Issuances outside of Plans +$16.00 - $46.40 +199,875 +7.39 +$26.09 +36,842 +$29.36 +Total Options +$11.40 - 46.40 +373,000 +7.45 +$20.67 +135,874 +$18.42 +F- 35 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The total stock-based +compensation expense related to stock options and stock awards issued pursuant to the Plans to the Company’s employees, consultants +and directors, included in reported net loss for the years ended December 31, 2018 and 2017, is comprised as follows: +2018 +2017 +Cost of revenues +$ 4,874 +$ 8,466 +Engineering and product development +13,650 +21,449 +Selling and marketing +11,922 +46,431 +General and administrative +2,921,532 +1,501,544 +Stock-based compensation from Plans +$ 2,951,978 +$ 1,577,890 +Stock-based compensation from issuances outside of Plans +1,767,287 +253,395 +Total stock-based compensation +$ 4,719,265 +$ 1,831,285 +The combination of +stock-based compensation of $2,951,978 from the issuances of equity-based awards pursuant to the Plans and stock-based compensation +attributed to stock awards of $965,220 and warrants and options of $802,066, which were issued outside of the Plans, resulted in +aggregate stock-based compensation of $4,719,265 during the year ended December 31, 2018. During the years ended December 31, 2018 +and 2017, the Company issued 144,875 and 55,000 options, respectively, to purchase shares of common stock at an average exercise +price of $26.09 per share to its directors and officers. During the year ended December 31, 2017, stock-based compensation was +comprised of $1,577,890 from the issuances of equity-based awards pursuant to the Plans and stock-based compensation attributed +to stock awards of $130,000 and warrants and options of $123,395, which were issued outside of the Plans. +A summary of option +activity under the Company's stock option plans as of December 31, 2018 and 2017, and changes during the years ended are as follows: +Outstanding Options +Weighted +Weighted +Average +Shares +Average +Remaining +Aggregate +Available +Number +Exercise +Contractual +Intrinsic +for Grant +of Shares +Price +Life (years) +Value +January 1, 2017 +161,382 +118,300 +$16.59 +9.08 +$0 +Adoption of 2017 SIP +100,000 +— +Restricted stock awards +(97,440 ) +— +Granted +(40,500 ) +40,500 +$16.84 +Forfeited +3,500 +(3,500 ) +$12.57 +Exercised +— +(18,175 ) +$31.26 +December 31, 2017 +126,942 +137,125 +$15.43 +8.80 +$6,688 +Adoption of 2018 SIP +500,000 +— +Restricted stock awards +(79,153 ) +— +Granted +(50,000 ) +50,000 +$14.00 +Forfeited 1 +10,000 +(11,000 ) +$20.27 +Exercised +— +(3,000 ) +$32.60 +December 31, 2018 +507,789 +173,125 +$14.41 +7.52 +$0 +1 Includes 1,000 options that were issued +pursuant to the Company’s 2002 Plan and are not available for future issuance. +The aggregate intrinsic +value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December +31, 2018 of $2.00 and the exercise price, multiplied by the number of in-the-money-options). +F- 36 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +As of December 31, +2018, there was $752,529 of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted +under the Plans. That cost is expected to be recognized over a weighted average period of 3.2 years. +16. WARRANTS +During the years ended +December 31, 2018 and 2017, the Company issued a total of 1,166,681 warrants at an average exercise price of $19.80 per share. +Warrant issuances during 2017 +During the year ended +December 31, 2017, the Company issued a total of 431,543 warrants at an average exercise price of $16.60 per share. +(i) In February 2017, the Company issued five-year warrants to purchase 16,667 shares of common stock +at a per share exercise price of $14.00 in connection with $400,000 of 6% demand promissory notes entered into by the Company (See +Note 20o). +(ii) Between March 24, 2017 and June 2, 2017, the Company issued warrants to purchase 71,429 shares +of common stock, at an exercise price of $14.00 per share of common stock, in connection with preferred stock purchase agreements +to purchase 100,000 shares of Series B Preferred Stock by Philou (See Note 24). +(iii) On April 5, 2017, the Company issued warrants to purchase 9,000 shares of common stock, at an exercise +price of $18.00 per share of common stock, in connection with the cancellation of $270,000 in demand promissory notes (See Note +20p). +(iv) On April 17, 2017, the Company issued warrants to purchase 8,333 shares of common stock, at an +exercise price of $18.00 per share of common stock, in connection with the issuance of two 7% convertible notes in the aggregate +principal amount of $250,000. On July 25, 2017, the Company agreed to reduce the exercise price of warrants to purchase 4,167 shares +of common stock from $18.00 per share to $11.00 per share and on July 28, 2017, the Company issued a new warrant to purchase 4,167 +shares of common stock at $11.00 per share and cancelled the prior warrant to purchase 4,167 shares of common stock at $18.00 per +share (See Note 22h). +(v) On April 26, 2017, the Company issued warrants to purchase 8,000 shares of common stock, at an +exercise price of $16.00 per share of common stock, in connection with the issuance of a 7% convertible note in the aggregate principal +amount of $104,000 (See Note 22i). +(vi) Between May 5, 2017 and June 30, 2017, the Company issued warrants to purchase 11,219 shares of +common stock in connection with the issuance of short-term loans of $140,000 that the Company entered into with four accredited +investors (See Note 20n) of which $75,000 was from the Company’s corporate counsel, a related party. The exercise price was +$15.00 per share of common stock for 6,795 warrants and $16.00 per share of common stock for the remaining 4,423 warrants. +(vii) Between May 24, 2017 and June 19, 2017, the Company issued warrants to purchase 91,000 shares of +common stock issued in connection with the sale of twenty-one units (the “Units”) at a purchase price of $52,000 per +Unit raising in the aggregate $1,092,000. Each Unit consisted of 21,667 shares of Series C Preferred Stock and Warrants to purchase +4,333 shares of common stock, at an exercise price of $20.00 per share of common stock (See Note 24). +F- 37 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(viii) The Company engaged Divine Capital Markets, LLC (“Divine”) to act as Placement Agent +(the “Placement Agent”) for the private placement of the Series C Preferred Stock and Warrants. For its services, the +Placement Agent received, in addition to a 10.0% commission on the sale of each Unit and a 3.0% non-refundable expense allowance, +warrants to purchase 10% of the Units sold at 120% of the Unit purchase price. The warrants to purchase 2.1 Units equates to a +warrant to purchase 9,100 shares of the Company’s common stock at $14.40 per share and a second warrant to purchase 9,100 +shares of the Company’s common stock at $20.00 per share (See Note 24). +(ix) On June 2, 2017, the Company issued warrants to purchase 50,000 shares of common stock, at an exercise +price of $22.00 per share of common stock, pursuant to the terms of a share exchange agreement (See Note 14). +(x) On July 25, 2017, the Company issued warrants to purchase an aggregate of 8,182 shares of +common stock at an exercise price equal to $11.00 per share of common stock in connection with a private placement agreement under +which we issued and sold 13,636 shares of common stock to the investor at $11.00 per share for an aggregate purchase price of $150,000. +(See Note 24). +(xi) On July 28, 2017, the Company entered into an exchange agreement related to a 7% Convertible Note +in the principal amount of $125,000 in which the Company exchanged the 7% Convertible Note for three new promissory notes in the +principal amounts of $110,000 due August 1, 2017; $35,000 due August 1, 2017; and $34,000 due August 8, 2017 (individually an Exchange +Note and collectively the Exchange Notes). Concurrent with entering into the exchange agreement, the investor entered into a subscription +agreement under which the Company issued and sold in a registered direct offering 10,000 shares of common stock at $11.00 per share +for an aggregate purchase price of $110,000. The 10,000 shares of common stock were purchased through the cancellation of the Exchange +Note in the principal amount of $110,000. Further, the Company issued a warrant to purchase 6,000 shares of common stock at +$11.00 per share (See Note 22h). +(xii) On August 3, 2017, the Company issued warrants to purchase an aggregate of 33,333 shares of +common stock at an exercise price equal to $14.00 per share of common stock in connection with the issuance of a 12% Convertible +Promissory Note in the aggregate principal amount of $400,000 (See Note 22c). +(xiii) On August 10, 2017, the Company issued warrants to purchase an aggregate of 73,750 shares of the +common stock at an exercise price equal to $13.20 per share of common stock in connection with the issuance of 10% Convertible +Promissory Notes in the aggregate principal amount of $880,000 (See Note 22g). +(xiv) On November 2, 2017, the Company paid to Aegis Capital Corp. (“Aegis”), its financial +advisor, a cash fee of $80,800 and issued to Aegis a warrant to purchase 7,407 shares of common stock with an exercise price of +$13.20 per share of common stock in connection with the issuance of 10% Convertible Promissory Notes in the aggregate principal +amount of $1,111,000 (See Note 22f). +(xv) On December 5, 2017, the Company entered into an exchange agreement (the “Exchange Agreement”) +with several accredited investors, pursuant to which the Company issued an aggregate of 76,193 shares of common stock and warrants +to purchase 19,023 shares of common stock with an exercise price of $22.00 per share of common stock, in exchange for cancellation +of $690,000 of outstanding debt owed to the investors by Microphase Corporation (See Note 20l). +F- 38 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Warrant issuances during 2018 +During the year ended +December 31, 2018, the Company issued a total of 735,291 warrants at an average exercise price of $21.80 per share. +(i) On January 23, 2018, the Company issued warrants to purchase an aggregate of 31,250 shares +of common stock at an exercise price equal to $44.00 per share of common stock in connection with the issuance of a 10% senior +convertible promissory note in the aggregate principal amount of $1,250,000 (See Note 22e). +(ii) On January 25, 2018, the Company entered into three agreements for the Purchase and Sale of Future +Receipt, pursuant to which the Company sold up to (i) $562,125 of the Company’s future receipts for a purchase price of $375,000, +(ii) $337,275 in future receipts for a purchase price of $225,000 and (iii) $118,000 in future receipts for a purchase price of +$100,000. Under the terms of these agreements, the Company issued warrants to purchase an aggregate of 5,625 shares of common stock +at an exercise price of $45.00 per share of common stock and warrants to purchase 8,125 shares of common stock at an exercise price +of $50.00 per share of common stock (See Note 18). +(iii) On March 22, 2018, the Company issued warrants to purchase an aggregate of 62,500 shares of +common stock at an exercise price equal to $23.00 per share of common stock in connection with the issuance of a promissory +note in the principal amount of $1,750,000 with a term of two months, subject to the Company’s ability to prepay within one +month (See Note 20s) . +(iv) On March 23, 2018, the Company entered into a securities purchase agreement to sell and issue a +12% promissory note in the principal amount of $1,000,000 and a warrant to purchase 15,000 shares of common stock to an accredited +investor. Since the promissory note was not paid in full on or before May 23, 2018, the +Company issued an additional warrant to purchase 7,500 shares of common stock, at an exercise price of $23.00 per share of common +stock (See Note 20a). +(v) On April 16, 2018, the Company issued warrants to purchase an aggregate of 49,679 shares of +common stock at an exercise price equal to $26.00 per share of common stock in connection with the issuance of 12% secured convertible +promissory notes in the aggregate principal amount of $1,722,222 (See Note 22d). +(vi) On April 24, 2018, the Company issued warrants to purchase 25,510 shares of common stock, at an +exercise price of $14.00 per share of common stock, in connection with the Preferred Stock Purchase Agreement to purchase 25,000 +shares of Series B Preferred Stock by Philou (See Note 24). +(vii) On October 5, 2017, Ault & Company purchased 3,750 shares of the Company’s common stock +at $12.00 per share and a warrant to purchase up to 3,750 shares of the Company’s common stock at $12.00 per share for an +aggregate purchase price of $45,000. The shares and warrants were issued by the Company on May 8, 2018, the date all necessary +approvals to issue the shares were received. Ault & Company is controlled by Mr. Milton Ault, the Company’s Chairman +and Chief Executive Officer (See Note 24). +(viii) On May 15, 2018, the Company entered into securities purchase agreements with certain investors +in which it sold an aggregate of 384,589 shares of its common stock for aggregate consideration of $6,000,000. In connection with +this financing, the Company issued (i) five-year warrants to purchase 96,147 shares of the Company’s Class A common stock +and (ii) five-year warrants to purchase 288,442 shares of the Company’s Class A common stock. The warrants were issued at +an exercise price of $18.80 per share of common stock (See Note 24) . +F- 39 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(ix) On May 15, 2018, the Company entered into a securities purchase agreement with an institutional +investor to sell and issue a senior secured convertible promissory note with a principal face amount of $6,000,000 and (i) a five-year +warrant to purchase 55,556 shares of the Company’s Class A common stock at an exercise price of $27.00 per share of Class +A common stock (the “Series A Warrant”) and (ii) a five-year warrant to purchase 86,207 shares of the Company’s +Class B common stock at an exercise price of $17.40 per share of Class A common stock (See Note 22a). In connection with the financing, +the Company issued the placement agent a warrant to purchase 7,500 shares of common stock with an exercise price of $20.00. +The following table +summarizes information about common stock warrants outstanding at December 31, 2018: +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$0.20 +15,873 +7.84 +$0.20 +15,873 +$0.20 +$11.00 +14,182 +3.86 +$11.00 +14,182 +$11.00 +$12.00 +3,750 +4.33 +$12.00 +3,750 +$12.00 +$13.20 +7,407 +3.84 +$13.20 +7,407 +$13.20 +$14.00 +106,286 +3.87 +$14.00 +106,286 +$14.00 +$15.00 +6,795 +3.37 +$15.00 +6,795 +$15.00 +$16.00 +24,083 +1.69 +$16.00 +24,083 +$16.00 +$17.40 +86,207 +4.37 +$17.40 +86,207 +$17.40 +$18.80 +384,589 +4.38 +$18.80 +384,589 +$18.80 +$20.00 +14,000 +3.94 +$20.00 +14,000 +$20.00 +$22.00 +37,974 +2.68 +$22.00 +37,974 +$22.00 +$23.00 +85,000 +4.24 +$23.00 +85,000 +$23.00 +$26.00 +49,679 +4.29 +$26.00 +49,679 +$26.00 +$27.00 +55,556 +4.37 +$27.00 +55,556 +$27.00 +$44.00 +31,250 +4.06 +$44.00 +31,250 +$44.00 +$45.00 +5,625 +4.07 +$45.00 +5,625 +$45.00 +$50.00 +8,125 +4.07 +$50.00 +8,125 +$50.00 +$0.20 - $50.00 +936,381 +4.18 +$20.19 +936,381 +$20.19 +The Company has valued +the warrants at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables +such as the warrants’ term, exercise price, current stock price, risk-free interest rate and estimated volatility of our +stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based on the implied yield +available on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +The Company utilized +the Black-Scholes option pricing model and the assumptions used during the years ended December 31, 2018 and 2017: +2018 +2017 +Weighted average risk-free interest rate +2.41% — 2.94% +1.42% — 2.01% +Weighted average life (in years) +4.8 +4.8 +Volatility +124.8% — 138.4% +98.5% — 128.7% +Expected dividend yield +0% +0% +Weighted average grant-date fair value per +share of warrants granted +$ 15.80 +$ 8.20 +F- 40 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +17. OTHER CURRENT LIABILITIES +Other current liabilities at +December 31, 2018 and 2017 consist of: +2018 +2017 +Accrued payroll and payroll taxes +$ 1,497,470 +$ 359,512 +Warranty liability +86,495 +86,495 +Other accrued expenses +284,437 +262,384 +$ 1,868,402 +$ 708,391 +18. ADVANCES ON FUTURE RECEIPTS +During +2017, the Company received funding as a result of entering into multiple Agreements for the Purchase and Sale of Future +Receipts (collectively, the “Agreements on Future Receipts”) pursuant to which the Company sold in the aggregate $4,068,352 +in future receipts of the Company for $2,889,175. Future receipts include cash, check, ACH, credit card, debit card, bank card, +charge card or other form of monetary payment. During 2017, the Company had repaid $1,525,547 and during the year ended December +31, 2018, the Company entered into a total of nine additional Agreements on Future Receipts pursuant to which the Company sold +up to $5,632,400 in future receipts for a purchase price in the amount of $4,100,000. The Agreements on Future Receipts have been +personally guaranteed by the Company’s Chief Executive Officer and in one instance has also been guaranteed by Philou. +During +2018, the Company recorded a discount in the amount of $1,651,193 in connection with these nine additional agreements, based upon +the difference between the amount of future receipts sold and the actual proceeds received by the Company. Under the terms of these +agreements, the Company also issued warrants to purchase an aggregate of 5,625 shares of common stock at an exercise price of $45.00 +per share of common stock and warrants to purchase 8,125 shares of common stock at an exercise price of $50.00 per share of common +stock. The Company recorded an additional discount of $258,370 based on the estimated fair value of these warrants. The Company +computed the fair value of these warrants using the Black-Scholes option pricing model. These discounts are reflected as a reduction +on the outstanding liability and are being amortized as non-cash interest expense over the term of the agreement. During the years +ended December 31, 2018 and 2017, non-cash interest expense of $2,489,403 and $599,337, respectively, was recorded from the amortization +of debt discounts. +19. REVOLVING CREDIT FACILITY +Microphase entered +into a revolving loan agreement with Gerber Finance, Inc. (“Gerber”) in February of 2012, as amended in September 2015 +and July 2017 (the “Revolving Credit Facility”). Under the Revolving Credit Facility, Microphase received funds +based on a borrowing base, which consisted of a percentage of eligible accounts receivable, up to a maximum revolving amount of +$1,400,000 (the “Maximum Revolving Amount”). Interest accrued at the prime rate plus three and three-quarters percent +(3.75%) on the unpaid principal. Effective June 15, 2017, the prime rate was increased from 4.00% to 4.25% resulting in a base +rate of 8.00%. In December 2017, the Company paid off the Revolving Credit Facility in cash. +F- 41 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +On November 6, 2017, +Microphase entered into a factoring agreement with CSNK Working Capital Finance Corp. (the “Factoring Agreement”). +Under the Factoring Agreement, Microphase received funds based on a borrowing base, which consisted solely of eligible accounts +receivable. +20. NOTES PAYABLE +Notes Payable at December +31, 2018 and 2017, are comprised of the following. +2018 +2017 +12% short-term promissory note (a) +$ 1,000,000 +$ — +Other short-term notes payable (b) +1,033,553 +— +Notes payable to Wells Fargo (c) +291,988 +300,130 +Note payable to Dept. of Economic and Community Development (d) +260,169 +292,509 +Power-Plus Credit Facilities (e) +— +170,473 +Note payable to Power-Plus Member (f) +13,250 +130,125 +Note payable to People's United Bank (g) +18,589 +19,489 +8% short-term promissory note (h) +1,272,600 +— +12% September 2018 short-term promissory note (i) +789,473 +— +October '18 short-term promissory note (j) +565,000 +Microphase December 2018 short-term promissory note (k) +200,000 +10% short-term promissory notes (l) +— +15,000 +Short term bank credit (m) +1,558,197 +— +Total notes payable +7,002,819 +927,726 +Less: +Unamortized debt discounts +(151,499 ) +— +Unamortized financing cost +(7,541 ) +— +Total notes payable, net of financing cost +$ 6,843,779 +$ 927,726 +Less: current portion +(6,360,120 ) +(402,234 ) +Notes payable – long-term portion +$ 483,659 +$ 525,492 +(a) On March 23, 2018, the Company entered into a securities purchase agreement pursuant to which it +issued a 12% promissory note and a warrant to purchase 22,500 shares of common stock to an accredited investor . +The promissory note was issued with a 10% OID. The promissory note is in the principal amount of $1,000,000, was sold for +$900,000, accrued simple interest at 12% and was due on June 22, 2018. The Company is in negotiations with the investor to amend +the payment terms on this 12% promissory note, however, since payment was not made on the specified maturity date this unsecured +12% promissory note is currently in default. Interest only payments are due, in arrears, on a monthly basis commencing on April +23, 2018. The exercise price of the warrant is $23.00 per share. The Company recorded debt discount in the amount of $271,565 based +on the estimated fair value of these warrants. The Company computed the fair value of these warrants using the Black-Scholes option +pricing model. The debt discount was amortized as non-cash interest expense over the term of the debt. During the year ended December +31, 2018, non-cash interest expense of $271,565 was recorded from the amortization of debt discount and interest expense of $100,000 +was recorded from the amortization of the OID on this 12% promissory note. The 12% promissory note is unsecured by any of the Company’s +assets but is guaranteed by our Chief Executive Officer. +(b) During the year ended December 31, 2018, the Company entered into the following short-term promissory +notes: +(i) On February 7, 2018, the Company issued demand promissory +notes in the aggregate principal face amount of $440,000 to accredited investors. These promissory notes included an OID +of $40,000 resulting in net proceeds to the Company of $400,000. The principal and OID on +these notes were due and payable on demand after April 24, 2018. These loans were paid on April 27, 2018. During the year ended +December 31, 2018, the Company recognized $40,000 from the amortization of OID on these demand promissory notes. +F- 42 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(ii) On February 26, 2018, the Company issued a 10% promissory +note in the principal amount of $330,000 to an accredited investor. This promissory note included an OID of $30,000 resulting +in net proceeds to the Company of $300,000. The principal and accrued interest on this note +was due and payable on April 12, 2018, subject to a 30-day extension available to the Company. This 10% promissory note was paid +on April 27, 2018. During the year ended December 31, 2018, the Company recognized $35,991 from interest and the amortization +of OID on this 10% promissory note. +(iii) On March 27, 2018, the Company issued a 10% promissory note +in the principal amount of $200,000 to an accredited investor . Between March 29, 2018 +and April 24, 2018, the Company paid the outstanding principal amount of $200,000 on this 10% promissory note. +(iv) On May 23, 2018, the Company issued a promissory note in +the aggregate principal face amount of $81,000 to an accredited investor. The promissory note included an OID of $6,000 +resulting in net proceeds to the Company of $75,000 and was due and payable on August 20, +2018. This promissory note was paid on July 25, 2018. During the year ended December 31, 2018, the Company recognized $6,000 from +the amortization of OID on this promissory note. +(v) On May 23, 2018, the Company issued a promissory note in +the aggregate principal face amount of $360,000 to an accredited investor. The promissory note included an OID of $60,000 +resulting in net proceeds to the Company of $300,000 and was due and payable on June 22, +2018. The outstanding balance on this note was paid on July 2, 2018. During the year ended December 31, 2018, the Company recognized +$60,000 from the amortization of OID on this promissory note. +(vi) +On June 5, 2018, the Company received loans in the aggregate amount of $75,000 from accredited investors. +The principal and interest on these loans was paid on July 16, 2018 . +(vii) On June 8, 2018, the Company issued a promissory note in +the aggregate principal face amount of $511,750 to an accredited investor. The promissory note included an OID of $66,750 +resulting in net proceeds to the Company of $445,000 and was due and payable on July 9, 2018. +At December 31, 2018, the outstanding principal balance on this note was $54,750. Since payment was not made on the specified +maturity date this unsecured promissory note is currently in default. During the year ended +December 31, 2018, the Company recognized $66,750 from the amortization of OID on this promissory note. On +August 3, 2018, the Company and lender entered into an agreement to extend the maturity date from July 9, 2018 to August 31, 2018. +The Company agreed to pay the lender an extension fee of 100,000 shares of common stock. The Company remains in default and continues +to negotiate with the investor on extended payment terms. +(viii) On July 13, 2018, the Company issued a 15% promissory note in the principal amount of $176,000 +to an accredited investor. This promissory note included an OID of $16,000 and debt issuance costs of $5,000 resulting in net proceeds +of $155,000. At December 31, 2018, the outstanding balance on this note was $124,303. The +principal and accrued interest on this note was due and payable on October 11, 2018 and is currently in default. Mr. Ault personally +guaranteed the repayment of this note. +F- 43 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(ix) On August 10, 2018, DP Lending issued a 12% promissory note in the principal amount of $550,000 +to an accredited investor. This promissory note included an OID of $50,000 resulting in net proceeds of $500,000. The principal +and accrued interest on this note is due and payable on August 10, 2019. +(x) On August 16, 2018, the Company issued an 8% promissory note in the principal amount of $225,000 +to an accredited investor. This promissory note included an OID of $25,000 resulting in net proceeds of $200,000. At +December 31, 2018, the outstanding balance on this note was $159,500. This note was due and payable on October 5, 2018 and +is currently in default. Mr. Ault personally guaranteed the repayment of this note. +(xi) On August 23, 2018, DP Lending issued a promissory note in the principal amount of $85,000 to an +accredited investor. This promissory note included an OID of $10,000 resulting in net proceeds of $75,000. At +December 31, 2018, the outstanding balance on this note was $85,000. This note was due and payable on September 24, 2018, +subject to a 28-day extension available to DP Lending. However, since payment was not made on the specified maturity date this +unsecured promissory note is currently in default. +(xii) On August 28, 2018, DP Lending issued a promissory note in the principal amount of $115,000 to +an accredited investor. This promissory note included an OID of $15,000 resulting in net proceeds of $100,000. The principal and +accrued interest on this note was due and payable on September 14, 2018, subject to a 10-business day cure period available to +DP Lending. This promissory note was paid on September 21, 2018. +(xiii) On October 9, 2018, DP Lending issued a promissory note in the principal amount of $60,000 to an +accredited investor. This promissory note included an OID of $10,000 resulting in net proceeds of $50,000. At +December 31, 2018, the outstanding balance on this note was $60,000. This note was due and payable on October 23, 2018. +However, since payment was not made on the specified maturity date this unsecured promissory note is currently in default. +(c) At December 31, 2018, Microphase had guaranteed the repayment of two equity lines of credit in +the aggregate amount of $291,988 with Wells Fargo Bank, NA (“Wells Fargo”) (collectively, the “Wells Fargo Notes”). +These loans originated prior to the Company’s acquisition of Microphase and Microphase was the recipient of the actual proceeds +from the loans. Microphase had previously guaranteed the payment under the first Wells Fargo equity line during 2008, the proceeds +of which Microphase had received from a concurrent loan from Edson Realty Inc., a related party owned real estate holding company. +As of December 31, 2018, the first line of credit, which is secured by residential real estate owned by a former officer, had an +outstanding balance of $210,822, with an annual interest rate of 4.00%. Microphase had guaranteed the payment under the second +Wells Fargo equity line in 2014. Microphase had received working capital loans from the former CEO from funds that were drawn against +the second Wells Fargo equity line. As of December 31, 2018, the second line of credit, secured by the former CEO’s principal +residence, had an outstanding balance of $81,166, with an annual interest rate of 3.00%. During the years ended December 31, 2018, +Microphase incurred $17,629 of interest on the Wells Fargo Notes. +(d) +In August 2016, Microphase received a $300,000 loan, of which $39,831 has been repaid, pursuant to the +State of Connecticut Small Business Express Job Creation Incentive Program which is administered through the Department of Economic +and Community Development (“DECD”) (the “DECD Note”). The DECD Note accrues interest +at a rate of 3% per annum and is due in August 2026. Payment of principal and interest commenced in September 2017, payable in +equal monthly installments over the remaining term. During the year ended December 31, 2018, Microphase incurred $9,286 of interest +on the DECD Note. +(e) At December 31, 2017, Power-Plus had guaranteed the repayment of two lines of credit in the aggregate +amount of $170,473 with Bank of America NA and Wells Fargo (collectively, the “Power-Plus Lines”). During 2018, the +Power-Plus Lines had been paid. +F- 44 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(f) Pursuant to the terms of the Purchase Agreement with Power-Plus, the Company entered into a two-year +promissory note in the amount of $255,000 payable to the former owner as part of the purchase consideration. The $255,000 note +is payable in 24 equal monthly installments. On October 18, 2017, for cancellation of debt, the Company entered into a subscription +agreement with the former owner under which the Company sold 6,940 shares of common stock at $13.40 per share for an aggregate +purchase price of $93,000. The outstanding balance on this note was $13,250 at December 31, 2018. During the year ended December +31, 2018, the Company paid $116,875 in principal payments. +(g) In December 2016, Microphase utilized a $20,000 overdraft credit line at People’s United +Bank with an annual interest rate of 15%. As of December 31, 2018, the balance of that overdraft credit line was $18,589. +(h) On August 16, 2018, the Company entered into a securities purchase agreement with certain institutional +investors providing for the issuance of (i) secured promissory notes in the aggregate principal face amount of $1,212,000 due February +15, 2019, at an interest rate of eight percent (8%) per annum for which the Company received an aggregate of $1,010,000, and (ii) +issued an aggregate of 20,000 shares of common stock to the investors. On November 29, 2018, these 8% short-term promissory notes +were amended and the Company incurred an additional OID of $60,600 resulting in an outstanding principal balance of $1,272,600 +at December 31, 2018. +(i) During September 2018, the Company issued to institutional investors 12% term promissory notes +in the principal face amount of $789,473, with an interest rate of 12% for a purchase price of $750,000. The outstanding principal +face amount, plus any accrued and unpaid interest, was due by December 31, 2018. During October 2018, in accordance with the notes, +the Company issued 22,500 shares of its common stock to the investors. Since payment was not made on the specified maturity date +these 12% term promissory notes are currently in default. +(j) On October 11, 2018, the Company entered into a securities purchase agreement with an institutional +investor providing for the issuance of (i) a secured promissory note in the aggregate principal face amount of $565,000 due December +8, 2018, for which the Company received an aggregate of $510,000, and (ii) issued an aggregate of 20,000 shares of common stock +to the investor. Upon maturity, the Company was required to pay $27,500 of interest. The note was not paid on the maturity date +and was in default at December 31, 2018. +(k) On December 28, 2018, Microphase entered into a secured promissory note with an institutional investor +providing for the issuance of (i) a secured promissory note in the aggregate principal face amount of $200,000, with an interest +rate of 10% per annum and a maturity date of March 31, 2019. In connection with the Microphase Note, Mr. Ault entered into a personal +guarantee agreement for the benefit of the investor. +(l) In December 2016, Microphase issued $705,000 in 10% short-term promissory notes to nineteen accredited +investors which, after deducting $70,500 of placement fees to its selling agent, Spartan Capital Securities, LLC (“Spartan”), +resulted in $634,500 in net proceeds to Microphase (the “10% Short-Term Notes”). The 10% Short-Term Notes were due +one year from the date of issuance. The amount due pursuant to the 10% Short-Term Notes was equal to the entire original principal +amount multiplied by 125% (the “Loan Premium”) plus accrued interest. On December 5, 2017, in exchange for the cancellation +of $690,000 of outstanding principal and $250,323 of accrued interest owed to the investors by Microphase Corporation, the Company +entered into an Exchange Agreement pursuant to which the Company issued an aggregate of 76,193 shares of common stock and warrants +to purchase 19,023 shares of common stock with an exercise price of $22.00 per share of common stock. During 2018, the Company +paid the remaining balance of principal and accrued interest of $15,000 and $5,615, respectively. +F- 45 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(m) At December 31, 2018, Enertec had short term bank credit of $1,558,197 that bears interest at prime +plus 0.7% through 3.85% paid either on a monthly or weekly basis. Further, the Company has undertaken to comply with certain covenants +under its bank loan. During the period May 22 to December 31, 2018, the Company incurred $47,076 of interest from Enertec’s +short term bank credit. +Other Notes Payable +(n) Between May 5, 2017 and December 31, 2017, the Company received additional short-term loans of +$297,000 from five accredited investors, of which $75,000 was from the Company’s corporate counsel, a related party. As additional +consideration, the investors received five-year warrants to purchase 11,219 shares of common stock at a weighted average exercise +price of $15.40 per share. The warrants are exercisable commencing six months after the issuance date and are subject to +certain beneficial ownership limitations. The exercise price of these warrants is subject to adjustment for customary stock splits, +stock dividends, combinations and other standard anti-dilution events. The warrants may be exercised for cash or on a cashless +basis. During the quarter ended June 30, 2017, the Company recorded debt discount in the amount of $95,000 based on the estimated +fair value of these warrants. The Company computed the fair value of these warrants using the Black-Scholes option pricing model. +As a result of the short-term feature of these loans and advances, the debt discount was amortized as non-cash interest expense +upon issuance of the warrants using the effective interest method. +During June 2017, the holders +of $55,000 of these short-term loans agreed to cancel their notes for the purchase of 5,000 shares of the Company’s common +stock at a price of $11.00 per share. An additional $75,000 in short-term loans from the Company’s corporate counsel was +converted into the Company’s equity securities; $52,000 was converted into one of the Series C Units and $23,000 was converted +into the Company’s common stock. The Company did not record any additional interest expense as a result of the extinguishment +of $130,000 in short-term loans since the carrying amount of the short-term loans was equivalent to the fair value of the consideration +transferred, which was determined from the closing price of the Company’s equity securities on the date of extinguishment. +During the year ended December 31, 2017, the Company also repaid $157,000 in short-term loans. +(o) In February 2017, the Company issued to eight accredited investors $400,000 in demand promissory +notes bearing interest at a rate of 6% per annum. Of the eight accredited investors, one investor was deemed a related party. As +additional consideration, the investors received five-year warrants to purchase 16,667 shares of common stock at an exercise price +of $14.00 per share (the “Feb. 2017 Warrants”). The Feb. 2017 Warrants are exercisable commencing six months after +the issuance date. The exercise price of the Feb. 2017 Warrants is subject to adjustment for customary stock splits, stock dividends, +combinations and other standard anti-dilution events. The Feb. 2017 Warrants may be exercised for cash or on a cashless basis. +During the quarter ended March 31, 2017, the Company recorded debt discount in the amount of $151,000 based on the estimated fair +value of the Feb. 2017 Warrants. The Company computed the fair value of these warrants using the Black-Scholes option pricing model. +As a result of the due on demand feature of the promissory notes, the debt discount was amortized as non-cash interest expense +upon issuance of the Feb. 2017 Warrants using the effective interest method. +Between February 16, 2017 and +February 23, 2017, the holders of the $400,000 in demand promissory notes agreed to cancel their demand promissory notes for the +purchase of 33,333 shares of the Company’s common stock, an extinguishment price of $12.00 per share. During the quarter +ended March 31, 2017, the Company recorded additional interest expense of $13,333 as a result of the extinguishment of the $400,000 +in demand promissory notes based on the difference of the carrying amount of the demand promissory notes and the +fair value of the consideration transferred, which was determined from the closing price of the Company’s common stock on +the date of extinguishment. +F- 46 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(p) On March 28, 2017, the Company issued $270,000 in demand promissory notes to several investors. +These demand promissory notes accrued interest at the rate of 6% per annum. On April 5, 2017, the Company canceled these promissory +notes by issuing to the investors 18,000 shares of common stock, at $15.00 per share, and warrants to purchase 9,000 shares of +common stock at $18.00 per share. During the quarter ended June 30, 2017, the Company recorded additional interest expense of $109,000 +as a result of the extinguishment of the $270,000 in demand promissory notes based on the difference of the carrying amount of +the demand promissory notes and the fair value of the consideration transferred, which was determined from the closing price of +the Company’s common stock on the date of extinguishment. +(q) On June 2, 2017, pursuant to the terms of the Share Exchange Agreement and in consideration of +legal services, Microphase issued a $450,000 8% promissory note with a maturity date of November 25, 2017 to Lucosky Brookman, +LLP (the “Lucosky Note”). In conjunction with the issuance of the Lucosky Note, the Company issued Lucosky Brookman +10,000 shares of redeemable convertible Series E preferred stock (the “Series E Preferred Stock”) with a stated value +of $45 per share as an alternative to providing a guarantee for the amount of the Lucosky Note. The Company, at its option, had +the right to redeem for cash the outstanding shares of Series E Preferred Stock, upon written notice to the holder of the shares, +at a cash redemption price equal to $45 multiplied by the number of shares being redeemed. Any such optional redemption by the +Company would have resulted in a credit against the Lucosky Note. During the period June 3, 2017 to December 29, 2017, Microphase +incurred $21,000 of interest on the Lucosky Note. On December 29, 2017, the Lucosky Note was satisfied through the conversion of +the 10,000 shares of Series E Preferred Stock into 30,000 shares of the Company’s common stock (See Note 24). +(r) On January 25, 2018, the Company issued two 5% promissory notes, each in the principal face amount +of $2,500,000 for an aggregate debt of $5,000,000 to two institutional investors. The entire unpaid balance of the principal +and accrued interest on each of the 5% promissory notes was due and payable on February 23, 2018, subject to a 30-day extension +available to the Company. The proceeds from these two 5% promissory notes were used +to purchase 1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with +our crypto mining operations. The Company repaid the entire outstanding principal and accrued interest on the 5% promissory +notes of $5,101,127 during 2018. +(s) On February 20, 2018, the Company issued a promissory note +in the principal face amount of $900,000 to an accredited investor. This promissory note included an original issue discount +(“OID”) of $150,000 resulting in net proceeds of $750,000. The principal and +OID on this note was due and payable on March 22, 2018. On March 23, 2018, the Company entered into a new promissory note in the +principal amount of $2,100,000 for a term of two months, subject to the Company’ ability to prepay within one month. The +new promissory note included an OID of $350,000, resulting in net proceeds of $1,750,000. The +Company also issued to the lender a warrant to purchase 62,500 shares of the Company’s common stock at an exercise price +of $23.00 per share. The principal amount of the new promissory note consisted of cash of $1,000,000 and the cancellation +of principal of $750,000 from the February 20, 2018 promissory note. The interest on the February 20, 2018 note in the amount of +$150,000 was paid to the lender prior to entering into the new promissory note. The warrants are exercisable commencing on the +issuance date for a term of three years. The exercise price of these warrants is subject to adjustment for customary stock splits, +stock dividends, combinations and other standard anti-dilution events. The warrants may be exercised for cash or on a cashless +basis. The Company recorded debt discount in the amount of $604,227 based on the estimated fair value of these warrants. The Company +computed the fair value of these warrants using the Black-Scholes option pricing model. The debt discount was amortized as non-cash +interest expense over the term of the debt. During the year ended December 31, 2018, non-cash interest expense of $604,227 was +recorded from the amortization of debt discount and interest expense of $350,000 was recorded from the amortization of the OID +on the new promissory note. On April 23, 2018, the Company paid the entire outstanding principal +on the new promissory note of $2,100,000 . The new promissory note had been guaranteed by our Chief Executive Officer and +had also been guaranteed by Philou. +F- 47 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +21. NOTES PAYABLE – RELATED PARTIES +Notes Payable – +Related parties at December 31, 2018 and 2017, are comprised of the following: +2018 +2017 +Notes payable to former officer and employee (a) +$ 308,984 +$ 309,317 +Total notes payable +308,984 +309,317 +Less: current portion +(166,925 ) +(133,569 ) +Notes payable – long-term portion +$ 142,059 +$ 175,748 +(a) Microphase is a party to several notes payable agreements with seven of its past officers, employees +and their family members. As of December 31, 2018, the aggregate outstanding balance pursuant to these notes payable agreements, +inclusive of $57,752 of accrued interest, was $366,736, with annual interest rates ranging between 3.00% and 6.00%. During the +year ended December 31, 2018, Microphase incurred $10,897 of interest on these notes payable agreements. In July 2016, one of these +noteholders initiated litigation to collect the balance owed under the terms of his respective agreement. In October 2017, Microphase +and the noteholder entered into a settlement agreement whereby Microphase agreed to pay the outstanding principal and interest +of $122,000 and $43,000, respectively, by issuing to the noteholder 95,834 shares of Microphase common stock valued at $115,000 +and paying $25,000 in cash. The value of the Microphase common stock was derived from the Company’s recent acquisition of +a majority interest in Microphase. Further, the parties agreed a final $25,000 would be paid within 18 months of the settlement +agreement or Microphase would be required to pay the noteholder an additional $25,000. +(b) On December 29, 2016, the Company entered into an agreement with MCKEA Holdings, LLC (“MCKEA”). +MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling stockholder. Kristine L. Ault, a +director and the wife of Milton C. Ault III, Executive Chairman of the Company’s Board of Directors, is the manager and owner +of MCKEA, for a demand promissory note (The “MCKEA Note”) in the amount of $250,000 bearing interest at the rate of +6% per annum on unpaid principal. On March 24, 2017, the MCKEA Note was cancelled to purchase the Company’s Series B Preferred +Stock pursuant to the terms of the Preferred Stock Purchase Agreement entered into on March 9, 2017 (See Note 24). Since there +was no difference between the reacquisition price and the net carrying value of the cancelled debt, no gain or loss was recognized +as a result of this transaction. +22. CONVERTIBLE NOTES +Convertible Notes Payable +at December 31, 2018 and 2017, are comprised of the following: +2018 +2017 +10% Convertible secured notes (a) +$ 7,997,126 +$ — +5% Convertible secured notes (b) +— +550,000 +12% Convertible secured note (c) (d) (e) +— +202,000 +Total convertible notes payable +7,997,126 +752,000 +Less: +Unamortized debt discounts +(1,189,276 ) +(351,573 ) +Unamortized financing cost +(65,356 ) +(2,549 ) +Total convertible notes payable, net of financing cost +$ 6,742,494 +$ 397,878 +(a) On May 15, 2018, the Company entered into a securities purchase agreement to sell (i) a 10% convertible +note (the “10% Convertible Note”), (ii) a five-year warrant to purchase 55,556 shares of the Company’s common +stock at an exercise price of $27.00 per share; (iii) a five-year warrant to purchase 86,207 shares of the Company’s Class +A common stock at an exercise price of $17.40 per share; and (iv) 17,241 shares of the Company’s common stock to an institutional +investor. Initially, the 10% Convertible Note was convertible into the Company’s common stock at $15.00 per share, but could +only be converted if an event of default thereunder had occurred and not been cured on a timely basis. On September 25, 2018, the +Company entered into an agreement to amend the maturity date on the 10% Convertible Note, pursuant to which amendment the amortization +schedule of the 10% Convertible Note provides for 13 monthly payments in the amount of $309,193, and for the fourteenth payment +to be in the amount of $1,011,427, plus accrued and unpaid interest. Each such amortization payment shall be made in cash or Bitcoin. +F- 48 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The 10% Convertible Note is in +the principal amount of $6,000,000 and bears interest at 10% simple interest on the principal amount with 50% of the total interest +due on the principal payable at the closing and the remaining 50% payable over the term of the 10% Convertible Note. In connection +with the financing, the Company agreed to pay the placement agent, Alliance Global Partners, a cash fee of $300,000 and a warrant +to purchase 7,500 shares of the Company’s common stock with an exercise price of $20.00 per share. +The Company computed the fair +value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount +in the amount of $1,397,389 based on the estimated fair value of the warrants. The Company estimated that the grant date fair value +of the shares of common stock was $405,024, which was determined from the closing price of the Company’s common stock on +the dates of issuance. In aggregate, the Company recorded debt discount in the amount of $2,169,613 based on the relative fair +values of the warrants, common stock and debt issuance costs of $367,200. During the year ended December 31, 2018, non-cash interest +expense of $2,169,613 was recorded from the amortization of debt discounts. The fair value of the warrants was estimated using +the Black-Scholes option-pricing method. The risk-free rate of 2.94% was derived from the U.S. Treasury yield curve, matching the +term of the warrant, in effect at the measurement date. The volatility factor of 127.9% was determined based on the Company’s +historical stock prices. +On July 2, 2018, the Company +entered into a securities purchase agreement with the institutional investor providing for the issuance of (i) a second 10% convertible +note (the “Second 10% Convertible Note”) with a principal face amount of $1,000,000 which Second 10% Convertible Note +was convertible into the Company’s common stock at $15.00 per share and (ii) an additional 20,000 of the Company’s +common stock to be issued in connection with the 10% Convertible Note. The Second 10% Convertible Note, as amended, matures on +February 15, 2019, as to fifty percent (50%) of the amount due thereunder, and the remaining fifty percent (50%) due thereunder +to May 15, 2019. +On August 31, 2018, the Company +entered into a securities purchase agreement with the institutional investor providing for the issuance of a third 10% convertible +note (the “Third 10% Convertible Note” and with the 10% Convertible Note and the Second 10% Convertible Note, the “10% +Convertible Notes”) with a principal face amount of $2,000,000, which Third Convertible Note is convertible into 250,000 +shares of the Company’s common stock at $8.00 per share and (ii) an additional 31,000 of the Company’s common stock. +The shares of common stock issuable pursuant to the Third 10% Convertible Note have not been issued to the institutional investor. +The Third 10% Convertible Note, as amended, matures on February 15, 2019, as to fifty percent (50%) of the amount due thereunder, +and the remaining fifty percent (50%) due thereunder to May 15, 2019. +At the time of issuance of the +Third 10% Convertible Note, the closing price of the Company’s common stock was in excess of the conversion price, resulting +in a beneficial conversion feature (“BCF”). The BCF embedded in the Third 10% Convertible Note is accounted for under +ASC No. 470, De bt (“ASC 470”). At issuance, the intrinsic value of the BCF totaled $910,419, based on the +difference between the effective conversion price and the fair value of the Company’s common stock at the commitment date +of the transaction, and the relative fair value of the 31,000 shares of common stock was $259,919. Initially, the Company was prohibited +from issuing the 31,000 shares of common stock or the shares of common stock issuable pursuant to the Third 10% Convertible Note +until stockholder approval of such issuance of securities is obtained as required by applicable NYSE American listing rules, which +was received on December 28, 2018. +F- 49 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The Company recorded debt issuance +costs of $200,500 from the Third 10% Convertible Note. The debt issuance costs are being amortized as non-cash interest expense +over the term of the debt. During the year ended December 31, 2018, non-cash interest expense of $135,144 was recorded from the +amortization of the debt issuance costs. +Pursuant to an amendment dated +as of August 31, 2018 to the 10% Convertible Note and the Second 10% Convertible Note, the Company reduced the conversion price +to $8.00 from $15.00. The amendment to the embedded conversion options of the 10% Convertible Note and the Second 10% Convertible +Note caused a material change in the fair value of the embedded conversion options on these two notes and resulted in a loss on +extinguishment of $665,346. At the time of the amendment, the closing price of the Company’s common stock was in excess of +the conversion price, resulting in a BCF. The intrinsic value of the BCF was $1,131,960 on the 10% Convertible Note and $225,000 +on the Second 10% Convertible Note based on the difference between the effective conversion price and the fair value of the Company’s +common stock. During the year ended December 31, 2018, non-cash interest expense of $1,356,960 was recorded from the amortization +of debt discounts attributed to the August 31, 2018 amendment of to the 10% Convertible Note and the Second 10% Convertible Note. +Pursuant to the terms of an amendment +dated December 7, 2018, the Company agreed that if the investor elects to convert three monthly payments in the principal amount +of $309,193 into shares of the Company’s common stock at the stated conversion price of $8.00 and the proceeds from the sale +of the shares did not result in net proceeds to the investor of 103% of the principal, interest and penalties due, then the Company +would pay the investor the difference in cash (the “True-Up Payment). During December 2018, the Company issued to the investor +109,724 shares of its common stock at $8.00 per share upon the conversion of $877,793 in principal, accrued interest and penalties. +During December 2018, the investor received $304,608 from the sale of the shares of common stock, which approximated the value +of the shares of common stock on the date of issuance, resulting in a True-Up Payment due to the investor of $599,519. +(b) On December 4, 2017, the Company entered into a securities purchase agreement to sell a 5% Convertible +Note (the “5% Convertible Note”) and 7,500 shares of restricted common stock to an institutional investor. The principal +of the 5% Convertible Note and interest thereon was convertible into shares of common stock at $12.00 per share of common stock, +subject to adjustments for lower priced issuances, stock splits, stock dividends, combinations or similar events. The 5% Convertible +Note was in the principal amount of $550,000, included an OID of $50,000 resulting in net proceeds to the Company of $500,000, +accrued interest at 5% simple interest on the principal amount, and was due on August 13, 2018. Interest only payments were due +on a quarterly basis and the principal was due on June 3, 2018. +At the time of issuance of the +5% Convertible Note, the closing price of the Company’s common stock was in excess of the conversion price, resulting in +a BCF accounted for under ASC 470. At issuance, the intrinsic value of the BCF totaled $244,260 based on the difference between +the effective conversion price and the fair value of the Company’s common stock at the commitment date of the transaction. +The intrinsic value of the BCF exceeded the proceeds allocated to the relative fair value of the 5% Convertible Note. The BCF was +amortized to interest expense over the term of the 5% Convertible Note using the effective interest method. The valuation of the +BCF was calculated based on the effective conversion price compared with the market price of the Company’s common stock on +the date of issuance of the 5% Convertible Note. +In the aggregate, the Company +recorded debt discount in the amount of $550,000 based on the relative fair values of the 7,500 shares of common stock of $25,740, +BCF of $244,260 and OID of $50,000. The debt discount is being amortized as non-cash interest expense over the term of the debt. +During the year ended December 31, 2017, non-cash interest expense of $380,769 was recorded from the amortization of debt discounts. +In January 2018, the 5% Convertible Note was converted into 46,082 shares of the Company’s common stock based upon the contractual +rights included in the 5% Convertible Note (See Note 24). +F- 50 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(c) On August 3, 2017, the Company entered into a securities purchase agreement to sell a 12% Convertible +Note (the “12% Convertible Note”) and a warrant to purchase 33,333 shares of common stock to an accredited investor. +The principal of the 12% Convertible Note may be converted into shares of common stock at $11.00 per share and under the terms +of the Warrant, up to 33,333 shares of common stock may be purchased at an exercise price of $14.00 per share. +The 12% Convertible Note was +in the principal amount of $400,000, included an OID of $40,000 resulting in net proceeds to the Company of $360,000, accrued interest +at 12% simple interest on the principal amount, and was due on August 13, 2018. Interest only payments were due on a quarterly +basis and the principal was due on August 3, 2018. The principal may be converted into shares of the Company’s common stock +at $11.00 per share. +The Company computed the fair +value of the 33,333 warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount +in the amount of $167,203 based on the estimated fair value of the 33,333 warrants. +The BCF embedded in the 12% +Convertible Note is accounted for under ASC 470. At issuance, the intrinsic value of the BCF totaled $186,797. The Company, however, +was prohibited from issuing shares of common stock pursuant to the 12% Convertible Note until stockholder approval of such issuance +of securities was obtained as required by applicable NYSE American listing rules. The Company received stockholder approval for +the share issuances on December 28, 2017. The intrinsic value of the BCF was amortized to interest expense over the term of the +12% Convertible Note using the effective interest method. The valuation of the BCF was calculated based on the effective conversion +price compared with the market price of the Company’s common stock on the date of issuance of the 12% Convertible Note. +In aggregate, the Company recorded debt discount in the amount of $394,000 based on the relative fair values of the 33,333 warrants, +BCF and OID of $40,000. During the year ended December 31, 2017, non-cash interest expense of $211,658 was recorded from the amortization +of debt discounts. +On December 28, 2017, principal +and accrued interest of $198,000 and $4,818, respectively, on the 12% Convertible Note was satisfied through the issuance of 18,438 +shares of the Company’s common stock and the remaining balance of $202,000 was converted into 18,884 shares of the Company’s +common stock on January 10, 2018 (See Note 24). The fair value of the warrants was estimated using the Black-Scholes option-pricing +method. The risk-free rate of 1.79% was derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect +at the measurement date. The volatility factor of 107.3% was determined based on the Company’s historical stock prices. +(d) On April 16, 2018, the Company entered into securities purchase agreements to sell (i) a 12% convertible +note (the “12% April 2018 Convertible Note”), (ii) a five-year warrant to purchase 49,679 shares of the Company’s +common stock at an exercise price of $26.00 per share; and (iii) 10,046 shares of the Company’s common stock to three institutional +investors. The 12% April 2018 Convertible Note is convertible into common stock at $14.00 per share, but may only be converted +if an event of default thereunder has occurred and not been cured on a timely basis. +The 12% April 2018 Convertible +Note is in the principal amount of $1,722,222, included an OID of $172,222 resulting in net proceeds to the Company of $1,550,000 +and bears interest at 12% simple interest on the principal amount. The Company is required to make monthly principal and interest +payments until the 12% April 2018 Convertible Note is satisfied in full on October 16, 2018. +The Company computed the fair +value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount +in the amount of $539,360 based on the estimated fair value of the warrants. The Company estimated that the grant date fair value +of the shares of common stock was $128,524, which was determined from the closing price of the Company’s common stock on +the date of issuance. +F- 51 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +In aggregate, the Company recorded +debt discount in the amount of $885,106 based on the relative fair values of the warrants, common stock, OID and debt issuance +costs of $45,000. During the year ended December 31, 2018, non-cash interest expense of $885,106 was recorded from the amortization +of debt discounts. The fair value of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate +of 2.94% was derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The +volatility factor of 127.9% was determined based on the Company’s historical stock prices. Beginning on May 16, 2018, the +Company was required to make six monthly cash payments in the aggregate amount of $304,259. On August 31, 2018, the Company made +its final payment and in aggregate paid principal and accrued interest of $1,722,222 and $103,333, respectively, on the 12% April +2018 Convertible Note. +(e) On January 23, 2018, we entered into a securities purchase agreement with an institutional investor +to sell, for an aggregate purchase price of $1,000,000, a 10% senior convertible promissory note (the “January 2018 10% Convertible +Note”) with an aggregate principal face amount of $1,250,000, a warrant to purchase an aggregate of 31,250 shares of our +common stock and 27,174 shares of our common stock. The transactions contemplated by the securities purchase agreement closed on +February 8, 2018. The January 2018 10% Convertible Note was convertible into 31,250 shares of the Company’s common +stock, a conversion price of $40.00 per share. The exercise price of the warrant to purchase 31,250 shares of the Company’s +common stock is $44.00 per share. On February 9, 2018, in addition to the 27,174 shares of common stock provided for pursuant to +the securities purchase agreement, the Company issued to the investor an aggregate of 34,597 shares of the Company’s common +stock upon the conversion of the entire outstanding principal and accrued interest on the January 2018 10% Convertible Note of +$1,383,884 (See Note 24). +Convertible Notes Converted into Common +Stock during 2017 +(f) On November 2, 2017, the Company entered into a securities purchase agreement to sell a 5% Convertible +Note (the “November 5% Convertible Note”) and 15,000 shares of restricted common stock to an institutional investor. +The principal of the November 5% Convertible Note and interest thereon was convertible into shares of common stock at $12.00 per +share of common stock, subject to adjustments for lower priced issuances, stock splits, stock dividends, combinations or similar +events. The November 5% Convertible Note was in the principal amount of $1,111,000 and included an original issue discount (“OID”) +of $101,000 and debt issuance costs of $105,800, resulting in net proceeds to the Company of $904,200. The November 5% Convertible +Note provided for 5% simple interest on the principal amount. +In connection with the November +5% Convertible Note, the Company paid to Aegis Capital Corp. (“Aegis”), its financial advisor, a cash fee of $80,800 +and issued to Aegis a warrant to purchase up to 7,407 shares of common stock with an exercise price of $13.20 per share, subject +to adjustment for stock splits, stock dividends, combinations or similar events. The warrant is exercisable at any time commencing +six months from the date of issuance through five years from the date of issuance and may be exercised for cash or on a “cashless” +basis if there is no effective registration statement registering, or no current prospectus available for the resale of, all of +the shares of common stock underlying the warrant. +The debt conversion features +embedded in the November 5% Convertible Note is accounted +for under ASC No. 470, De bt. At the time of issuance, the intrinsic value of the debt conversion features utilizing +the Black Scholes option pricing model totaled $423,593. The intrinsic value of the debt conversion feature combined with the +amount of the original issue discount and the relative value of the 15,000 shares of common stock and warrants to purchase 7,407 +shares of common stock exceeded the proceeds allocated to the relative fair value of the November 5% Convertible Note and resulted +in aggregate debt discount of $722,868. The respective debt discount of $722,868 was amortized to interest expense over the term +of the November 5% Convertible Note using the effective interest method. In addition, the Company incurred $105,800 of debt issuance +costs which are also being amortized as non-cash interest expense over the term of the debt. +F- 52 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +On December 13, 2017 and December +14, 2017, the entire $1,111,000 of principal on the November 5% Convertible Note was satisfied through the issuance of 92,583 shares +of the Company’s common stock based upon the contractual rights provided for in the November 5% Convertible Note (See Note +14). +During the year ended December +31, 2017, non-cash interest expense of $828,668 was recorded from the amortization of debt discounts and debt financing cost. +(g) On August 10, 2017, the Company, entered into securities purchase agreements with five institutional +investors to sell for an aggregate purchase price of $800,000, 10% Senior Convertible Promissory Notes (the “10% Convertible +Notes”) with an aggregate principal face amount of $880,000 and warrants to purchase an aggregate of 73,750 shares of common +stock. The principal of the 10% Convertible Notes and interest earned thereon may be converted into shares of common stock at $12.00 +per share and under the terms of the Warrant, up to 73,750 shares of common stock may be purchased at an exercise price of $13.20 +per share. +The 10% Convertible Notes are +in the aggregate principal amount of $880,000, included an OID of $80,000 resulting in net proceeds to the Company of $800,000, +bear simple interest at 10% on the principal amount, and principal and interest are due on February 10, 2018. Subject to certain +beneficial ownership limitations, each investor may convert the principal amount of the 10% Convertible Notes and accrued interest +earned thereon at any time into shares of common stock at $12.00 per share. The conversion price of the 10% Convertible Notes is +subject to adjustment for customary stock splits, stock dividends, combinations or similar events. +The Company computed the fair +value of the 73,750 warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt +discount in the amount of $356,691 based on the estimated intrinsic value of the 73,750 warrants. The intrinsic value of the warrants +was estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.78% was derived from the U.S. Treasury yield +curve, matching the term of the warrant, in effect at the measurement date. The volatility factor of 107.3% was determined based +on the Company’s historical stock prices. +The BCF embedded in the 10% +Convertible Notes is accounted for under ASC No. 470, De bt. At issuance, the estimated fair value of the BCF totaled +$326,809. The fair value of the BCF was allocated from the net proceeds of the 10% Convertible Notes and was amortized to interest +expense over the term of the 10% Convertible Notes using the effective interest method. The valuation of the BCF was calculated +based on the effective conversion price compared with the market price of the Company’s common stock on the date of issuance +of the 10% Convertible Notes. In aggregate, the Company recorded debt discount in the amount of $763,500 based on the relative +fair values of the 73,750 warrants of $356,961, BCF of $326,809 and OID of $80,000. During the years ended December 31, 2017, +non-cash interest expense of $763,500 was recorded from the amortization of debt discounts. +During December 2017, the entire +principal and accrued interest of $880,000 and $54,450, respectively, on the 10% Convertible Notes was satisfied through the issuance +of 77,871 shares of the Company’s common stock based upon the contractual rights provided for in the 10% Convertible Note +(See Note 14). +Other Convertible Notes Payable +(h) On April 17, 2017, the Company entered into two 7% convertible notes (the “7% Convertible +Notes”) each in the aggregate principal amount of $125,000 for a total of $250,000. The 7% Convertible Notes accrued interest +at 7% simple interest on the principal amount and were due on June 2, 2017. The principal was convertible into shares of the Company’s +common stock at $15.00 per share. The noteholder could convert the principal amount of the 7% Convertible Notes at any +time into common stock. The 7% Convertible Notes contained standard and customary events of default including, but not limited +to, failure to make payments when due under the 7% Convertible Note agreements and bankruptcy or insolvency of the Company. The +Company had the right to prepay the 7% Convertible Notes. The 7% Convertible Notes were repaid during July 2017. +F- 53 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +As additional consideration, +the investors received five and a half year warrants to purchase 8,333 shares of common stock at an exercise price of $18.00 per +share (collectively the “7% Convertible Note Warrants”). The 7% Convertible Note Warrants are exercisable commencing +six months after the issuance date. The exercise price of the 7% Convertible Note Warrants is subject to adjustment for customary +stock splits, stock dividends, combinations and other standard anti-dilution events. The 7% Convertible Note Warrants may be exercised +for cash or on a cashless basis. The Company computed the fair value of the 7% Convertible Note Warrants using the Black-Scholes +option pricing model and, as a result of this calculation, recorded debt discount in the amount of $61,304 based on the estimated +fair value of the 7% Convertible Note Warrants. +The BCF embedded in the 7% Convertible +Notes is accounted for under ASC No. 470, De bt. At issuance, the estimated fair value of the BCF totaled $31,304. The +fair value of the BCF was allocated from the net proceeds of the 7% Convertible Note and was amortized to interest expense over +the term of the 7% Convertible Notes using the effective interest method. The valuation of the BCF was calculated based on the +effective conversion price compared with the market price of the Company’s common stock on the date of issuance of the Convertible +Note. In aggregate, the Company recorded debt discount in the amount of $93,607 based on the relative fair values of the 7% Convertible +Note Warrants of $61,304 and BCF of $31,304. During the three months ended June 30, 2017, the entire non-cash interest expense +of $92,607 was recorded from the amortization of debt discounts. +On July 25, 2017, the Company +repaid one of the 7% Convertible Notes. Due to the event of default, the Company agreed to reduce the exercise price of warrants +to purchase 83,334 shares of common stock from $18.00 per share to $11.00 per share and made a payment of $144,000. As a result +of this transaction, the Company recorded additional interest expense of $17,226 and recorded an additional $2,641 in non-cash +interest expense based upon the change in the fair value of the warrants due to the adjustment to the exercise price. +On July 28, 2017, the Company +entered into an exchange agreement related to the second 7% Convertible Note. Under the terms of the exchange agreement, the Company +exchanged the 7% Convertible Note for three new promissory notes in the principal amounts of $110,000 due August 1, 2017; $35,000 +due August 1, 2017; and $34,000 due August 8, 2017 (individually an Exchange Note and collectively the Exchange Notes) and issued +a new warrant to purchase 4,167 shares of common stock at $11.00 per share and cancelled the prior warrant to purchase 4,167 shares +of common stock at $18.00 per share. The Company recorded a $54,583 extinguishment charge as a result of this transaction. +Concurrent with entering into +the exchange agreement, the investor entered into a subscription agreement under which the Company issued and sold in a registered +direct offering 10,000 shares of common stock at $11.00 per share for an aggregate purchase price of $110,000. The 10,000 shares +of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $110,000. In addition, +in a concurrent private placement, the investor entered into a separate securities purchase agreement under which the Company issued +and sold 3,180 shares of common stock at $11.00 per share for an aggregate of purchase price of $35,000. The 3,180 shares of common +stock were purchased through the cancellation of the Exchange Note in the principal amount of $35,000. Further, the Company +issued a warrant to purchase 6,000 shares of common stock at $11.00 per share. The final Exchange Note in the principal amount +of $34,000 was repaid. In aggregate, and including the $54,583 extinguishment charge above, the Company recorded an additional +non-cash interest expense of $110,421 as a result of the extinguishment of the $125,000 7% Convertible Note based on the difference +of the carrying amount of the 7% Convertible Note and the fair value of the consideration transferred, which was determined from +the closing price of the Company’s common stock on the date of extinguishment and based upon (i) the change in the fair value +of the warrants due to the exchange of the warrant with an exercise price of $18.00 per share with a new warrant with an exercise +price of $11.00 per share, (ii) the fair value of the warrant to purchase 6,000 shares of common stock and (iii) the value of the +shares of cash and common stock in excess of the amount owed pursuant to the 7% Convertible Note. +F- 54 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +(i) On April 26, 2017, the Company entered into a 7% convertible note in the aggregate principal amount +of $104,000. On June 28, 2017, the noteholder converted the outstanding balance into 9,455 shares of the Company’s common +stock. The Company did not record any additional interest expense as a result of the extinguishment since the carrying amount of +the convertible notes was equivalent to the fair value of the consideration transferred, which was determined from the closing +price of the Company’s equity securities on the date of extinguishment. +As additional consideration, +the investor received a five-year warrant to purchase 8,000 shares of common stock at an exercise price of $16.00 per share. The +warrants are exercisable commencing six months after the issuance date. The exercise price of the warrants is subject to adjustment +for customary stock splits, stock dividends, combinations and other standard anti-dilution events. The warrants may be exercised +for cash or on a cashless basis. The Company computed the fair value of these warrants using the Black-Scholes option pricing model +and, as a result of this calculation, recorded debt discount in the amount of $24,912 based on the estimated fair value of the +warrants. +The BCF embedded in this convertible +note is accounted for under ASC No. 470, De bt. At issuance, the estimated fair value of the BCF totaled $26,512. The +fair value of the BCF was allocated from the net proceeds of the convertible note and was amortized to interest expense over the +term of the convertible note using the effective interest method. The valuation of the BCF was calculated based on the effective +conversion price compared with the market price of the Company’s common stock on the date of issuance of the convertible +note. In aggregate, the Company recorded debt discount in the amount of $51,424 based on the relative fair values of the warrants +of $24,912 and BCF of $26,512. During 2017, non-cash interest expense of $51,424 was recorded from the amortization of debt discounts. +The intrinsic value of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.84% was +derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The volatility +factor of 104.7% was determined based on the Company’s historical stock prices. +23. COMMITMENTS AND CONTINGENCIES +On July 31, 2018 a +stockholder derivative complaint was filed in the United States District Court for the Central District of California against the +Company as the nominal defendant, as well as its current directors and a former director styled Ethan Young and Greg Young, +Derivatively on Behalf of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, +Mordechai Rosenberg, Robert O. Smith, and Kristine Ault and DPW Holdings, Inc. , as the nominal defendant (Case No. 18-cv-6587) +(the “Complaint”). No hearings have been scheduled as of the date hereof. +The Complaint alleges +violations of state law and breaches of fiduciary duty, unjust enrichment and gross mismanagement by the individual defendants +as, in the view of the plaintiffs, the Company has entered into poorly advised loan transactions and related party transactions. +The Company and the individual defendants believe that these claims are without merit and intend to vigorously defend themselves. +The Company and the individual defendants moved to dismiss the Complaint and on February 25, 2019, the Court granted the motion +to dismiss but granted plaintiffs leave to amend their Complaint. On March 11, 2019, plaintiffs filed their amended complaint +asserting violations of breaches of fiduciary duties and unjust enrichment claims based on the previously pled transactions. On +March 25, 2019, the Company and the individual defendants filed a motion to dismiss the amended complaint. The motion to +dismiss is returnable before the Court on May 6, 2019. +Based on the Company’s +assessment of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, the Company +cannot estimate the reasonably possible loss or range of loss that may result from this action. However, an unfavorable outcome +may have a material adverse effect on the Company’s business, financial condition and results of operations. +F- 55 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +On November 28, 2018, +Blockchain Mining Supply and Services, Ltd , a vendor who sold computers to the Company’s subsidiary, filed in the +United States District Court for the Southern District of New York against Super Crypto Mining, Inc. and the Company (Case No. +18-cv-11099). The Complaint asserted claims for breach of contract and promissory estoppel against the Company and its subsidiary +arising from the subsidiary’s failure to satisfy a purchase agreement. The Complaint seeks damages in the amount of +$1,388,495. +On February 4, 2019, +pursuant to the Court’s Rules, the Company requested a pre-motion Conference with the Court. The Company’s time +to file its motion to dismiss is stayed until the Court’ holds the pre-motion Conference, which has not yet been scheduled +by the Court. +Based on the Company’s +assessment of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, the Company +cannot estimate the reasonably possible loss or range of loss that may result from this action. However, the Company has established +a reserve in the amount of the unpaid portion of the purchase agreement. An unfavorable outcome may have a material adverse effect +on the Company’s business, financial condition and results of operations. +In November 2012, +the Company signed an operating lease agreement for the US headquarters for a period of 7 years with an option to extend for an +additional 5 years. In September 2009, the Company's United Kingdom subsidiary signed an agreement for a lease in respect of the +UK facility for a period of 15 years with an option to cancel the lease after 10 years on September 2019. In June 201, the Company’s +Israeli subsidiary signed an agreement for a lease in respect of the Israel facility for a period of 10 years. In addition, the +Company leases 43,062 square-feet of other space domestically that includes office, engineering, laboratory, restaurant and warehouse +space in both California and Connecticut. The annual base rent under these leases, payable on a monthly basis, is approximately +$1,272,000 during 2019. These leases expire between May 2019 and January 2028. +Future non-cancellable rental +commitments under operating leases are as follows: +2019 +$ 1,272,957 +2020 +1,032,302 +2021 +801,305 +2022 +501,411 +2023 +514,895 +Thereafter +1,582,120 +$ 5,704,990 +Total rent expense +for the years ended December 31, 2018 and 2017 was approximately $1,086,031 and $291,092, respectively. +24. STOCKHOLDERS’ EQUITY +Preferred Stock +The +Company is authorized to issue 25,000,000 shares of Preferred Stock $0.001 par value. The Board of Directors has designated 1,000,000 +shares as Series A Convertible Preferred Stock (the “Series A Preferred Stock”), 500,000 shares as Series B Convertible +Preferred Stock (the “Series B Preferred Stock”). On February 27, 2019, subsequent to December 31, 2018, the Board +of Directors designated 2,500 shares as Series C Convertible Redeemable Preferred Stock and the Company filed a Certificate of +Designations of Rights and Preferences of Series C Convertible Redeemable Preferred Stock with the Secretary of State of the State +of Delaware. +On +December 21, 2018, the Company filed with the Delaware Secretary of State a Certificate of Elimination eliminating its previous +Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock (collectively, the “Preferred Shares”) +and returning them to authorized but undesignated shares of the Company’s preferred stock. None of the Preferred Shares was +outstanding. The rights, preferences, privileges and restrictions on the remaining authorized 23,497,500 shares of Preferred Stock +have not been determined. The Company’s Board of Directors is authorized to create a new series of preferred shares and determine +the number of shares, as well as the rights, preferences, privileges and restrictions granted to or imposed upon any series of +preferred shares. As of December 31, 2018, there were 125,000 shares of Series B Preferred +Stock and no other shares of Preferred Stock issued or outstanding. +F- 56 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Series A Preferred Stock +On +September 13, 2018, the Company filed a Certificate of Designations of Rights and Preferences (the “Certificate of Designations”) +to its Amended and Restated Certificate of Incorporation with the Secretary of State of the State of Delaware to establish the +preferences, limitations and relative rights of the 10% Series A Cumulative Redeemable Perpetual Preferred Stock (the “Series +A Preferred Stock”). +Dividends on the Series A Preferred Stock shall accrue daily and be cumulative from, and including, +the date of original issue and shall be payable monthly on the last day of each calendar month, subject to the terms and conditions +set forth in the Certificate of Designations. Dividends accrue at the annual rate of 10%, which is equivalent to $2.50 per annum +per share, based on the $25.00 liquidation preference from, and including, the date of original issuance to, but not including, +September 30, 2023, or such other date fixed for redemption. +On +and after September 30, 2023, the Company may, at its option, upon not less than thirty (30) days nor more than sixty (60) days’ +written notice, redeem the Series A Preferred Stock, in whole or in part, at any time or from time to time, for cash at a redemption +price of $25.00 per share of Series A Preferred Stock, plus any accumulated and unpaid dividends thereon to, but not including, +the date fixed for redemption. In addition, upon the occurrence of a change of control, subject to certain restrictions, the Company +may, at its option, upon not less than thirty (30) days’ nor more than sixty (60) days’ written notice, redeem +the Series A Preferred Stock, in whole or in part, within one hundred twenty (120) days after the first date on which such change +of control occurred, for cash at a redemption price of $25.00 per share, plus any accumulated and unpaid dividends thereon to, +but not including, the date fixed for redemption. There is no mandatory redemption of the Series A Preferred Stock. +Holders of the Series A Preferred Stock generally have no voting rights except as set forth in the Certificate +of Designations or as otherwise required by law. The holders of Series A Preferred Stock, together with the holders of shares of +every other series of Parity Stock upon which like voting rights have been conferred and are exercisable, voting together as a +single class regardless of series, shall be entitled to elect two directors to the Company’s board of directors at any annual +meeting of stockholders or special meeting held in place thereof. When the Series A Preferred Stock is entitled to vote, such shares +are entitled to one vote per share. In any matter in which the Series A Preferred Stock may vote as a single class with any other +series of Preferred Stock (as may be required by law), each share of Series A Preferred Stock shall be entitled to one vote per +$25.00 of stated liquidation preference. +Series B Preferred Stock +On March 9, 2017, the +Company entered into a Preferred Stock Purchase Agreement with Philou, a related party. Pursuant to the terms of the Preferred +Stock Purchase Agreement, Philou may invest up to $5,000,000 in the Company through the purchase of Series B Preferred Stock over +the term of 36 months. +Each share of Series +B Preferred Stock has a stated value of $10.00 per share. Each share of Series B Preferred Stock may be convertible at the holder’s +option into shares of common stock of the Company at a conversion rate of $14.00 per share, upon the earlier to occur of: (i) 60 +months from the closing date, or (ii) upon the filing by the Company of one or more periodic reports that, singly or collectively, +evidence that the Company’s gross revenues have reached no less than $10 million in the aggregate, on a consolidated reporting +basis, over four consecutive quarters in accordance with U.S. GAAP. The conversion price will be subject to standard anti-dilution +provisions in connection with any stock split, stock dividend, subdivision or similar reclassification of the common stock. +F- 57 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Each share of Series +B Preferred Stock shall have the right to receive dividends equal to one ten millionth (0.0000001) of earnings before interest, +taxes, depreciation, amortization and stock-based compensation (“EBITDAS”) calculated for a particular calendar year. +Assuming the purchase of the entire $5,000,000 of shares of Preferred Stock, the holders thereof will be entitled to receive dividends +equal to five percent (5%) in the aggregate of EBITDAS. Payment of dividends shall be calculated for a calendar year, payable +on a quarterly basis, with payments to occur no later than 90 days in arrears from each reporting period subject to a year-end +reconciliation. EBITDAS shall mean earnings before interest, taxes, depreciation, amortization, and stock-based compensation. +At such time as (i) +all shares of common stock issuable upon conversion of all outstanding shares of Series B Preferred Stock (the “Conversion +Shares”) shall have been registered for resale pursuant to an effective Registration Statement covering such Conversion Shares, +(ii) but no earlier than the twenty-fifth (25th) anniversary of the effective date, the shares of Series B Preferred Stock shall +be subject to redemption in cash at the option of the Company in an amount per share equal to 120% of the greater of (a) the stated +value plus all accrued and unpaid dividends, if any and (b) the fair market value of such shares of Series B Preferred Stock. +In addition, for each +share of Series B Preferred Stock purchased, Philou will receive warrants to purchase shares of common stock in a number equal +to the stated value of each share of Series B Preferred Stock purchased divided by $0.70, at an exercise price equal to $14.00 +per share of common stock. The warrants do not require a net cash-settlement or provide the holder with a choice of net-cash settlement. +The warrants also do not contain a variable settlement provision. Accordingly, any warrants issued to Philou pursuant to the terms +of the Preferred Stock Purchase Agreement shall be classified as equity instruments. +Further, Philou shall +have the right to participate in the Company’s future financings under substantially the same terms and conditions as other +investors in those respective financings in order to maintain its then percentage ownership interest in the Company. Philou’s +right to participate in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Series +B Preferred Stock. +Between March 24, 2017 +and June 2, 2017, Philou purchased 100,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement +in consideration of the cancellation of the Company debt due to Philou in the aggregate amount of $500,000 and cash of $500,000. +In addition, Philou received warrants to purchase 102,041 shares of common stock at an exercise price of $14.00 per share of common +stock, which have been classified as equity instruments. The Company determined that the estimated relative fair value of these +warrants, which are classified as equity, was $401,399 using the Black-Scholes option pricing model. Since the warrants were classified +as equity securities, the Company allocated the $1,000,000 purchase price based on the relative fair values of the Series B Preferred +Stock and the warrants following the guidance in ASC No. 470, Debt . +On April 24, 2018, +pursuant to the terms of the Preferred Stock Purchase Agreement, Philou purchased an additional 25,000 shares of Series B Preferred +Stock in consideration of the cancellation of short-term advances due to Philou in the aggregate amount of $250,000. In addition, +Philou received warrants to purchase 25,510 shares of common stock at an exercise price of $14.00 per share of common stock. The +Company determined that the estimated relative fair value of these warrants, which are classified as equity, was $141,951 using +the Black-Scholes option pricing model. Since the warrants were classified as equity securities, the Company allocated the $250,000 +purchase price based on the relative fair values of the Series B Preferred Stock and the warrants. +The Series B Convertible +Preferred Stock is convertible at any time, in whole or in part, at the option of Philou, into shares of common stock at a fixed +conversion price, which is subject to adjustment for stock splits, stock dividends, combinations or similar events, of $14.00 per +share. As the effective conversion price of the Series B Convertible Preferred Stock on a converted basis was below the market +price of the Company’s common stock on the date of issuance, it was determined that these discounts represent beneficial +conversion features. During the years ended December 31, 2018 and 2017, the Company valued the BCF at $108,049 and 265,054, respectively, +based on the difference between the effective conversion price and the market price of the Company’s common stock on the +date of issuance. These features are analogous to preference dividends and are recorded as a non-cash return to preferred stockholders +through accumulated deficit. +F- 58 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Series C Preferred Stock +Between May 24, 2017 +and June 19, 2017, the Company entered into subscription agreements (the “Series C Subscription Agreement”) with approximately +twenty accredited investors (the “Series C Investors”) in connection with the sale of twenty-one Units at a purchase +price of $52,000 per Unit raising in the aggregate $1,092,000 with each Unit consisting of 21,667 shares of Series C Preferred +Stock and Warrants to purchase 4,333 shares of common stock. Divine acted as the Company’s placement agent. +Each share of Series +C Preferred Stock had a stated value of $2.40 per share. Five shares of Series C Preferred Stock were convertible at the holder’s +option into one share of Common Stock of the Company. As the effective conversion price of the Series C Convertible Preferred Stock +on a converted basis was below the market price of the Company’s common stock on the date of issuance, it was determined +that these discounts represent beneficial conversion features, which were valued at $319,128 and recognized as a deemed dividend, +based on the difference between the effective conversion price and the market price of the Company’s common stock on the +date of issuance. +Each share of Series +C Preferred Stock had the right to receive dividends equal $0.24 per share per annum as declared by the Company’s Board of +Directors. The dividends were payable on a quarterly basis on the 20th day following each calendar quarter. +During December 2017, +pursuant to the conversion terms of the Series C Preferred Stock, all of the Series C Investors elected to convert their 455,002 +shares of Series C Preferred Stock into 91,000 shares of the Company’s common stock. Additionally, of the 91,000 warrants +that were issued in conjunction with the Series C Subscription Agreements, the Company issued 80,167 shares of its common stock +upon cash-based exercises that resulted in gross proceeds to the Company of $1,603,000 and issued 3,545 shares of its common stock +upon the cashless exercise of a warrant to purchase 4,333 shares of common stock. +Series D Preferred Stock +On June 2, 2017, +pursuant to the terms of the Share Exchange Agreement, the Company acquired 1,603,434 shares of the issued and outstanding common +stock of Microphase Common Stock in exchange for the issuance by the Company of 92,122 shares of the Company’s Common Stock, +378,776 shares of the Company’s Series D Preferred Stock and warrants to purchase an aggregate of 50,000 shares of the Company’s +Common Stock. +In the event the Company +shall liquidate, dissolve or wind up, the holders of Series D Preferred Stock shall be entitled to receive, prior and in preference +to any distribution of any of the assets of the Company to the holders of the Common Stock, the Company’s Series A Preferred +Stock, or to the holders of any other junior series of preferred stock, by reason of their ownership thereof and subject to the +rights of the Company’s Series B Preferred Stock, Series C Preferred Stock and any other class or series of Company stock +subsequently issued that ranks senior to the Series D Preferred Stock, an amount per share in cash or equivalent value in securities +or other consideration equal to its Stated Value of $0.01 per share. +The holders of Series +D Preferred Stock shall not be entitled to receive dividends and shall have no voting rights except as otherwise required by law. +Upon the stockholders of DPW Common Stock approving the conversion of the Series D Preferred Stock into shares of DPW Common Stock +in connection with the acquisition of MPC Common Stock and for purposes of compliance with Rule 713 of the NYSE American, then +each share of Series D Preferred Stock shall automatically be converted into 37,878 shares of DPW Common Stock. +F- 59 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Series E Preferred Stock +On June 2, 2017, pursuant +to the terms of the Share Exchange Agreement and in consideration of legal services, Microphase issued a $450,000 8% promissory +note with a maturity date of November 25, 2017 to an unsecured creditor, Lucosky Brookman, LLP (the “Lucosky Note”). +In conjunction with the issuance of the Lucosky Note, the Company issued Lucosky Brookman 10,000 shares of Series E Preferred +Stock with a stated value equal to forty-five dollars ($45.00) per share. The Company, at its option, may redeem for cash, in +whole or in part, at any time and from time to time, the shares of Series E Preferred Stock at the time outstanding, upon written +notice to the holder of the shares, at a cash redemption price equal to $45 multiplied by the number of shares being redeemed. +Any such optional redemption by the Company shall be credited against the Lucosky Note. +In the event the Company +shall liquidate, dissolve or wind up, the holders of Series E Preferred Stock shall be entitled to receive, prior and in preference +to any distribution of any of the assets of the Company to the holders of the DPW Common Stock, the Company’s Series A Preferred +Stock, or to the holders of any other junior series of preferred stock, by reason of their ownership thereof and subject to the +rights of the Company’s Series B Preferred Stock, Series C Preferred Stock and any other class or series of Company stock +subsequently issued that ranks senior to the Series E Preferred Stock an amount per share in cash or equivalent value in securities +or other consideration equal to $0.01 per share. The holders of Series E Preferred Stock shall not be entitled to receive dividends +and shall have no voting rights except as otherwise required by law. Subject to the stockholders of DPW Common Stock of the Company +approving the conversion of the Series E Preferred Stock into shares of Common Stock in connection with the acquisition of MPC +Common Stock and for purposes of compliance with Rule 713 of the NYSE American, then each share of Series E Preferred Stock may +be converted into sixty (60) shares of DPW Common Stock, for an aggregate of 30,000 shares of DPW Common Stock. On December 29, +2017, the Lucosky Note was satisfied through the conversion of the 10,000 shares of Series E Preferred Stock into 30,000 shares +of the Company’s common stock. +Common Stock +Common stock confers +upon the holders the rights to receive notice to participate and vote in the general meeting of stockholders of the Company, to +receive dividends, if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. +The Class B common stock carries the voting power of 10 shares of Class A common stock. +2018 Issuances +Issuance of Common Stock pursuant to +the At the Market Offering +On +February 27, 2018, the Company entered into a sales agreement with H.C. Wainwright & Co., LLC (“HCW”) to sell shares +of the Company’s common stock, having an aggregate offering price of up to $50 million from time to time, through an “at +the market offering” program (the “HCW ATM Offering”) under which HCW acts as sales agent. Between February 27, +2018 and December 31, 2018, the Company had received gross proceeds of $19,022,416 through the sale of 1,062,096 shares of the +Company’s common stock through the HCW ATM Offering. The offer and sale of the shares through the HCW ATM Offering were made +pursuant to the Company’s effective “shelf” registration statement on Form S-3 and an accompanying base +prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January +8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the HCW ATM Offering, dated +February 27, 2018. The HCW ATM Offering was terminated effective September 23, 2018. +In +connection with the termination of the HCW ATM Offering, HCW released DPW from the right of first refusal provisions set forth +in the sales agreement. In consideration for the release, the Company issued HCW 25,000 shares of its common stock, which have +been recorded in additional paid in capital, and to pay HCW a fee until February 28, 2020 of three percent fee of aggregate gross +proceeds received on future financings by the Company and a one percent fee of aggregate gross proceeds received on future financings +by the Company’s subsidiaries. +F- 60 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +On October 10, 2018, +the Company entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Wilson-Davis & +Co., Inc., as sales agent (the “Agent”) to sell shares of its Common Stock, having an aggregate offering price of +up to $25,000,000 (the “Shares”) from time to time, through an “at the market offering” program (the “WDCO +ATM Offering”). Through December 31, 2018, we had received gross proceeds of $1,637,054 through the sale of 372,109 shares +of our common stock through the WDCO ATM Offering. The offer and sale of the shares through the WDCO ATM Offering were made pursuant +to our then effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained +therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and +declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the WDCO ATM Offering, dated October +15, 2018. +Issuance of Common Stock for Services +During the year ended +December 31, 2018, the Company issued to its consultants a total 184,153 shares of its common stock with an aggregate value of +$3,740,888, an average of $20.31 per share for services rendered. +Issuance of common stock for conversion +of debt +On January 3, 2018, +accrued interest of $23,250 on the 10% Convertible Notes was satisfied through the issuance of 1,938 shares of the Company’s +common stock. +On January 10, 2018, +principal and accrued interest of $202,000 and $5,723, respectively, on the 12% Convertible Note was satisfied through the issuance +of 18,884 shares of the Company’s common stock (See Note 22c). +On January 12, 2018, +principal and accrued interest of $550,000 and $2,987, respectively, on the 5% Convertible Note was satisfied through the issuance +of 46,082 shares of the Company’s common stock (See Note 22b). +On February 9, 2018, +principal and accrued interest of $1,250,000 and $133,884, respectively, on the January 2018 10% Convertible Note was satisfied +through the issuance of 34,597 shares of the Company’s common stock (See Note 22e). +During December 2018, +principal and accrued interest of $18,865 and $259,408, respectively, on the 10% Convertible Note was satisfied through the issuance +of 109,724 shares of the Company’s common stock (See Note 22a). +Issuances of Common Stock upon Exercise +of Stock Options +During January 2018, +the Company issued a total of 3,000 shares of its common stock upon the cash exercise of options. These options were issued pursuant +to the Company’s Plans. The Company received cash of $97,800 as a result of these option exercises. +Issuances of Common Stock upon Exercise +of Warrants +During January 2018, +the Company issued a total of 93,324 shares of its common stock upon the cash and cashless exercise of warrants to purchase an +aggregate of 109,382 shares of its common stock. These warrants were issued between August 2017 and December 2017 in conjunction +with various common stock and debt financings. The Company received cash of $867,166 as a result of these warrant exercises. +On May 8, 2018, the +Company issued 13,958 shares of common stock pursuant a cashless exercise of warrants issued to Divine Capital Markets, LLC, its +Placement Agent (the “Placement Agent”) for the 2017 private placement of the Series C Preferred Stock and warrants. +For its services, the Placement Agent received, a warrant to purchase 9,100 shares of the Company’s common stock at $14.40 +per share and a second warrant to purchase 9,100 shares of the Company’s common stock at $20.00 per share. +F- 61 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Issuances of common stock in connection +with convertible notes +On February 9, 2018, +in conjunction with the securities purchase agreement to sell the January 2018 10% Convertible Note in the principal amount of +$1,250,000 the Company issued 27,174 shares of restricted common stock to the institutional investor (See Note 22b). +On April 16, 2018, +in conjunction with the securities purchase agreements to sell the 12% April 2018 Convertible Note in the principal amount of $1,722,222, +the Company issued 10,046 shares of restricted common stock to the institutional investor (See Note 22d). +On May 15, 2018, in +conjunction with the securities purchase agreement to sell the 10% Convertible Note in the principal amount of $6,000,000 the Company +issued 17,241 shares of restricted common stock to the institutional investor (See Note 22a). On August 10, 2018, pursuant to an +amendment to the 10% Convertible Note entered into on July 2, 2018, the Company is required to issue an additional 31,000 shares +of restricted common stock to the holder of the note. +On July 2, 2018, in +conjunction with the securities purchase agreement to sell the Second 10% Convertible Note in the principal amount of $1,000,000 +the Company issued 20,000 shares of restricted common stock to the institutional investor (See Note 22a). +On August 16, 2018, +in conjunction with the securities purchase agreements to sell secured promissory notes in the aggregate principal face amount +of $1,272,600, the Company issued 20,000 shares of restricted common stock to the institutional investors (See Note 20h). +During September 2018, +in conjunction with the securities purchase agreements to sell secured promissory notes in the aggregate principal face amount +of $789,473, the Company issued 22,500 shares of restricted common stock to the institutional investors (See Note 20i). +On October 11, 2018, +in conjunction with the securities purchase agreements to secured promissory note in the aggregate principal face amount of $565,000, +the Company issued 20,000 shares of restricted common stock to the institutional investor (See Note 20j). +Issuances of Common Stock upon Conversion +of Series D Preferred Stock +During the year ended +December 31, 2018, pursuant to the conversion terms of the Series D Preferred Stock, 378,776 shares of the Series D Preferred Stock +were converted into 37,878 shares of the Company’s common stock. +Issuances of +Common Stock for cash and cancellation of short-term advances +On October 5, 2017, +Ault & Company purchased 3,750 shares of the Company’s common stock at $12.00 per share and a warrant to purchase up +to 3,750 shares of the Company’s common stock at $12.00 per share for an aggregate purchase price of $45,000. The shares +and warrants were issued by the Company on May 8, 2018. Ault & Company is controlled by Mr. Milton Ault, the Company’s +Chairman and Chief Executive Officer. +On May 15, 2018, the +Company entered into securities purchase agreements with certain investors in which the Company sold an aggregate of 384,589 shares +of its common stock, 206,730 for cash and 177,858 for the cancellation of short-term advances, and five-year warrants to purchase +such number of shares of common stock equal to the shares of common stock purchased by the investors. The Company received aggregate +consideration of $5,999,584, consisting of cash and the cancellation of short-term advances of $3,225,000 and $2,774,584, respectively. +These securities were issued pursuant to our registration statement filed with the Securities and Exchange Commission (File No. +333-222132) which became effective on January 11, 2018. +F- 62 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Treasury Stock +The Company utilizes the cost method of +accounting for treasury stock. The cost of reissued shares is determined under the last-in, first-out method. The Company purchased +2,750 shares for $57,748 during the year ended December 31, 2018. +2017 Issuances +Issuances of Common Stock for Cash or +a Combination of Cash and Cancellation of Debt +On March 15, 2017, +Company entered into a subscription agreement with a related party for the sale of 25,000 shares of common stock at $12.00 per +share for the aggregate purchase price of $300,000. +On July 24, 2017, we +entered into subscription agreements with six investors, and on July 25, 2017 we entered into a securities purchase agreement with an +institutional investor, under which we agreed to issue and sell in the aggregate 42,568 shares of common stock to the investors +at $11.00 per share for an aggregate purchase price of $468,250. Of the aggregate purchase price of $468,250, $445,250 was paid +in cash and $23,000, which represented 2,091 of the total shares of common stock sold, was in consideration for the cancellation +of debt of the Company. The company granted warrants to purchase 5,455 shares of common stock to two of the investors that +entered into the subscription agreements at $15.00 per share. In a concurrent private placement, we sold to the institutional investor +warrants to purchase an aggregate of 8,182 shares of the Company’s common stock at an exercise price equal to $11.00 +per share. +On October 18, +2017, the Company entered into subscription agreements with five investors, under which we agreed to issue and sell in the +aggregate 22,612 shares of common stock to the investors at $13.40 per share for an aggregate purchase price of $303,000. +$210,000 of the purchase price was paid in cash and $93,000, which represented 6,940 of the total shares of common stock +sold, was paid through the cancellation of debt incurred by the Company. +On November 7, +2017, the Company entered into subscription agreements with investors under which the Company agreed to issue and sell in the aggregate +36,250 shares of common stock to the investors at $12.00 per share for an aggregate purchase price of $435,000. $280,000 of the +aggregate purchase price was paid in cash and $155,000, which represented 12,917 of the total shares of common stock sold, was +paid through the cancellation of debt incurred by the Company. +On December 5, +2017, the Company entered into subscription agreements with investors for the sale of 32,000 shares of common stock at $25.00 per +share for the aggregate purchase price of $800,000. The direct offering closed December 13, 2017. +In aggregate, the above +transactions resulted in the issuance of 136,482 shares of common stock for cash proceeds, net of $72,769 in financing costs, of +$1,962,481 and the issuance of 21,498 shares of common stock for the cancellation of $271,000 in debt incurred by the Company. +Issuances of Common Stock for Services +On March 8, 2017, the +Company issued an aggregate of 12,547 shares of its common stock as payment for services to a consultant. The shares were valued +at $10, an average of $0.80 per share. +Between May 9, 2017 +and June 18, 2017, the Company issued an aggregate of 47,808 shares of its common stock as payment for services to its consultant. +The shares were valued at $498,769, an average of $10.40 per share. +Between August 21, +2017 and September 5, 2017, the Company issued an aggregate of 29,032 shares of its common stock as payment for services to its +consultants. The shares were valued at $363,613, an average of $12.40 per share. +F- 63 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Between October 3, 2017 and December 28, 2017, the Company issued an aggregate of +30,600 shares of its common stock as payment for services to its consultants. The shares were valued at $790,320, an average of +$25.80 per share. +In aggregate, during +the year ended December 31, 2017, the Company issued a total of 108,067 shares of its common stock, with a value of $1,662,702, +to its consultants for services. +Issuance of common stock for conversion +of debt +Between February 16, 2017 and February 23, 2017, the Company issued 33,333 shares of its common stock, +an extinguishment price of $12.00 per share, for the cancellation of $400,000 in demand promissory notes. +On April 5, 2017, the +Company issued 18,000 shares of its common stock, at a price of $15.00 per share, for the cancellation of $270,000 in demand promissory +notes. +On June 28, 2017, the +Company issued 9,455 shares of its common stock, at a price of $11.00 per share, for the cancellation of a 7% convertible promissory +note in the principal amount of $104,000. +On June 28, 2017, the +holders of $55,000 of in short-term loans agreed to cancel their notes for the purchase of 5,000 shares of the Company’s +common stock at a price of $11.00 per share. +On July 28, 2017, an +institutional investor agreed to cancel two promissory notes in the aggregate amount of $145,000 for the issuance of 13,180 shares +of the Company’s common stock at a price of $11.00 per share. +During the period from +November 27, 2017 to December 6, 2017, the entire $530,000 of principal on the Convertible Note was satisfied through the issuance +of 48,182 shares of the Company’s common stock (See Note 20). +On December 13, 2017 +and December 14, 2017, the entire $1,111,000 of principal on the November 5% Convertible Note was satisfied through the issuance +of 92,583 shares of the Company’s common stock (See Note 22f). +On December 28, 2017, +principal and accrued interest of $198,000 and $4,818, respectively, on the 12% Convertible Note was satisfied through the issuance +of 18,438 shares of the Company’s common stock (See Note 22c). +During December 2017, +the entire principal and accrued interest of $880,000 and $54,452, respectively, on the 10% Convertible Notes was satisfied through +the issuance of 77,871 shares of the Company’s common stock (See Note 22g). +Issuances of Common Stock upon Exercise +of Stock Options +Between December 4, +2017 and December 22, 2017, the Company issued a total of 361,458 shares of its common stock upon the cash and cashless exercise +of options to purchase an aggregate of 363,500 shares of its common stock. These options were issued pursuant to the Company’s +Plans. The Company received cash of $557,360 as a result of these option exercises. +Issuances of Common Stock upon Exercise +of Warrants +Between November 27, +2017 and December 28, 2017, the Company issued a total of 93,593 shares of its common stock upon the cash and cashless exercise +of warrants to purchase an aggregate of 105,673 shares of its common stock. These warrants were issued between November 2016 and +August 2017 in conjunction with various common stock and debt financings. The Company received cash of $642,603 as a result of +these warrant exercises. +F- 64 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +During December 2017, +in conjunction with the Series C Subscription Agreements, the Company issued 80,167 shares of its common stock upon cash-based +exercises that resulted in gross proceeds to the Company of $1,603,335 and issued 3,545 shares of its common stock upon the cashless +exercise of a warrant to purchase 4,333 shares of common stock. +In aggregate, the Company +received gross proceeds of $2,245,938 from the issuance of 177,305 shares of common stock in connection with warrant exercises. +Issuances of common stock in connection +with convertible notes +On November 2, 2017, +in conjunction with the securities purchase agreement to sell the November 5% Convertible Note in the principal amount of $1,111,000 +the Company issued 15,000 shares of restricted common stock to the institutional investor. +On December 4, 2017, +in conjunction with the securities purchase agreement to sell the 5% Convertible Note in the principal amount of $550,000, the +Company issued 7,500 shares of restricted common stock to the institutional investor. +Issuance of common stock for domain +name +On July 7, 2017, the +Company entered into an asset purchase agreement to acquire the intellectual property of Coolisys.com, consisting of the common +law rights associated with the trademarks and name as well as the domain name and content of www.Coolisys.com . The aggregate +purchase price of $81,000 was comprised of 2,500 shares of common stock, valued at $31,000 based +on the closing price of the Common Stock on the date of the acquisition, and cash of $50,000. +Issuance of common stock and warrants +in satisfaction of subsidiary debt +On +December 5, 2017, the Company entered into an exchange agreement with several accredited investors for the cancellation of $690,000 +in outstanding principal on the 10% Short-Term Notes. In +December 2016, Microphase issued $705,000 in 10% Short-Term Notes. The 10% Short-Term Notes were due one year from the date of +issuance. The amount due pursuant to the 10% Short-Term Notes is equal to the entire original principal amount multiplied by 125% +(the “Loan Premium”) plus accrued interest. In exchange for the cancellation of $690,000 of outstanding principal +and $250,000 of accrued loan premiums and interest owed to the investors by Microphase Corporation, the Company entered into the +exchange agreement pursuant to which the Company issued an aggregate of 76,193 shares of common stock and warrants to purchase +19,023 shares of common stock with an exercise price of $22.00 per share of common stock, (See Note 20l). +Issuance of common stock for acquisition +of debt due from related party +On December 5, 2017, +the Company entered into an exchange agreement with WT Johnson, pursuant to which the Company issued to WT Johnson convertible +promissory notes in the principal amount of $2,267,766. During December 2017, the Company issued 30,000 shares of its common stock +upon the conversion of the promissory notes. +25. INCOME TAXES +On +December 22, 2017, the United States enacted significant changes to U.S. tax law following the passage and signing of H.R.1, “An +Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” +(the “Tax Act”). Introduced initially as the Tax Cuts and Jobs Act, the Act to Provide for Reconciliation +Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 (the “Act”) was enacted +on December 22, 2017. The Act applies to corporations generally beginning with taxable years starting after December 31, 2017 and +reduces the corporate tax rate from a graduated set of rates with a maximum 35% tax rate to a flat 21% tax rate. Additionally, +the Act introduces other changes that impact corporations, including a net operating loss (“NOL”) deduction annual +limitation, an interest expense deduction annual limitation, elimination of the alternative minimum tax, and immediate expensing +of the full cost of qualified property. The Act also introduces an international tax reform that moves the U.S. toward a territorial +system, in which income earned in other countries will generally not be subject to U.S. taxation. However, the accumulated foreign +earnings of certain foreign corporations will be subject to a one-time transition tax, which can be elected to be paid over an +eight-year tax transition period, using specified percentages, or in one lump sum. NOL and foreign tax credit (“FTC”) +carryforwards can be used to offset the transition tax liability. The Company does not expect that this change will have an impact +on the Company as it has not earned taxable income in the past and it has significant NOL carryforwards. The +application of this rate reduction to the ending deferred tax assets and deferred tax liabilities impacted our expense for income +taxes in 2017 by $1,138,845 which was fully offset by a corresponding change to our valuation allowance. We applied +the guidance in SAB 118 when accounting for the enactment-date effects of the Act in 2017 and throughout 2018. At December 31, +2017, we had not completed our accounting for all of the enactment-date income tax effects of the Act under ASC 740, Income Taxes. +At December 31, 2018, we have now completed our accounting for all of the enactment-date income tax effects of the Act. During +2018 we did not need to adjust to the provisional amounts recorded at December 31, 2017. The +2017 and 2018 impacts of the enactment of the Tax Act are reflected in the tables below. +F- 65 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Deferred income taxes +reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting +purposes and income tax purposes. Significant components of the Company's deferred tax assets are as follows: +2018 +2017 +Current +Foreign +$ 134,017 +$ — +Federal +— +— +State +— +— +Total Current +$ 134,017 +Deferred +Foreign +(52,134 ) +$ — +Federal +(158,482 ) +(78,393 ) +State +— +— +Total Deferred +$ (210,616 ) +$ (78,393 ) +Income tax (benefit) +$ (76,599 ) +$ (78,393 ) +The Company had Federal +and state net operating loss carryforwards of approximately $43,051,999 and $7,960,184 at December 31, 2018 and December 31, 2017 +respectively, available to offset future taxable income, expiring at various times starting in 2022 through 2039. The net operating +loss generated in 2018 will carryforward indefinitely. In accordance with Section 382 of the Internal Revenue Code, the future +utilization of the Company’s net operating loss to offset future taxable income may be subject to an annual limitation as +a result of ownership changes that may have occurred previously or that could occur in the future. Management believes that such +an ownership change may have occurred during 2017. The Company has estimated the Section 382 annual limitation due to this ownership +change to be approximately $157,433. This has been used to reduce the amount of the net operating losses that have limited carryforward +periods. +In assessing the realization +of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets +will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income +during the periods in which temporary differences representing net future deductible amounts become deductible. Management considers +the scheduled reversal of deferred tax assets, projected future taxable income and tax planning strategies in making this assessment. +After consideration of all of the information available and due to the last five years significant losses there is substantial +doubt related to the Company’s ability to utilize its deferred tax assets, the Company recorded a full valuation allowance +of the deferred tax asset. For the year ended December 31, 2018, the valuation allowance has increased by $4,887,148. +F- 66 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The 2015 tax year remains +open to examination by the Internal Revenue Service ( “IRS” ) and the 2014 through 2015 tax years remain open +to examination by the California Franchise Tax Board ( “FTB” ) and the Connecticut Department of Revenue (“CDR” ). +The IRS, FTB and CDR have the authority to examine those tax years until the applicable statute of limitations expires and the +years with net operating loss carryovers when such carryovers are used. Returns for tax years 2016, 2017 and 2018 have not been +filed. +As of December 31, +2018, the Company’s foreign subsidiaries had accumulated losses for income tax purposes in the amount of approximately $1,808,466. All +of the Company’s international accumulated losses were generated in the United Kingdom and Israel which have statutory tax +rates of 20% and 7.5% respectively. These net operating losses may be carried forward and offset against taxable income +in the future for an indefinite period. +The net income tax benefit consists +of the following: +2018 +2017 +Current +Foreign +$ 134,017 +$ — +Federal +— +— +State +— +— +Total Current +$ 134,017 +Deferred +Foreign +(52,134 ) +$ — +Federal +(158,482 ) +(78,393 ) +State +— +— +Total Deferred +$ (210,616 ) +$ (78,393 ) +Income tax (benefit) +$ (76,599 ) +$ (78,393 ) +The Company’s +effective tax rates were (0.3%) and (0.8%) for the years ended December 31, 2018 and 2017, respectively. During the year +ended December 31, 2018, the effective tax rate differed from the U.S. federal statutory rate primarily due to the change in the +valuation allowance and the effect of changes in tax rates in future periods. The reconciliation of income tax attributable to +operations computed at the 2018 and 2017 U.S. Federal statutory income tax rates of 21% and 34% respectively to income tax expense +is as follows: +2018 +2017 +Tax benefit at U.S. Federal statutory tax rate +(21.0 %) +(34.0 %) +Increase (decrease) in tax rate resulting from: +Effect of change in tax rates +1.8 % +12.0 % +Effect of Section 382 limitation +4.9 % +0.0 % +Increase in valuation allowance +15.1 % +17.0 % +Nondeductible meals & entertainment expense and other +0.9 % +6.1 % +State taxes, net of federal benefit +(2.4 %) +(4.5 %) +Foreign rate differential +0.3 % +0.7 % +Stock compensation expense +(0.1 %) +1.9 % +Effective tax rate +(0.3 %) +(0.8 %) +The Company accounts +for uncertain tax positions in accordance with ASC No. 740-10-25. ASC No. 740-10-25 addresses the determination of whether tax +benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, +the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position +will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit to be +recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate +settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, such differences impact +income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities +for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management to evaluate tax positions +taken by the Company and recognize a liability if the Company has taken uncertain tax positions that more likely than not would +not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated tax positions taken +by the Company and has concluded that as of December 31, 2018 and 2017, there are no uncertain tax positions taken, or expected +to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +F- 67 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +26. RELATED PARTY TRANSACTIONS +a. The Company has made a strategic investment in AVLP in expectation of future business generated +by the Company from MTIX Ltd., an advanced materials and processing technology company located in Huddersfield, West Yorkshire, +UK (“MTIX”), a wholly-owned subsidiary of AVLP. The Company’s investments in AVLP consist of convertible promissory +notes, warrants and shares of common stock of AVLP. On September 6, 2017, the Company and AVLP entered into a Loan and Security +Agreement (“AVLP Loan Agreement”) with an effective date of August 21, 2017 pursuant to which the Company +will provide AVLP a non-revolving credit facility of up to $10 million for a period ending on August 21, 2019, subject to the terms +and conditions stated in the Loan Agreement, including that the Company having available funds to grant such credit. At December +31, 2018, the Company has provided loans to AVLP in the principal amount $6,943,997 and, in addition to the 12% convertible promissory +notes, AVLP has issued to the Company warrants to purchase 13,887,994 shares of AVLP common stock. Under the terms of the AVLP +Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. As of December 31, 2018 and 2017, the Company recorded +contractual interest receivable attributed to the AVLP Loan Agreement of $1,004,317 and $324,000, respectively. +During the year ended December +31, 2018 and 2017, the Company also acquired in the +open market 430,942 shares of AVLP common stock for $417,169 and 221,333 shares of AVLP common stock for $191,782 respectively. +At December 31, 2018, the closing market price of AVLP’s common stock was $0.90, a decline from $1.75 at December 31, 2017. +The Company has determined that its investment in AVLP marketable equity securities are accounted for pursuant to the fair value +method and based upon the closing market price of common stock at December 31, 2018, the amount of the Company’s unrealized +gain is $119,329. +Philou is AVLP’s controlling +stockholder. Mr. Ault is Chairman of AVLP’s Board of Directors and the Chairman of the Company’s Board of Directors. +Mr. William B. Horne is the Chief Financial Officer of AVLP and the Chief Financial Officer and a director of the Company. +During the years ended December +31, 2018 and 2017, the Company recognized $3,907,280 and $173,751, respectively, in revenues resulting from its relationship with +MTIX, which was acquired by AVLP on August 22, 2017 and is therefore deemed to be a related party. In March 2017, the Company was +awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement +(“MLSE”) plasma-laser system. Management believes that the MLSE purchase order will be a source of revenue and generate +significant cash flows for the Company. However, at December 31, 2018, $3,887,000 in revenues recognized during the years ended +December 31, 2018 and 2017, had not yet been received and was reflected on the financial statements as accounts receivable, related +party. Subsequent to year end the Company received $2,676,219 for manufacturing services performed on the first MLSE system. +b. +On April 13, 2018, the Company entered into an amended and restated consulting agreement with Mr. Ault +pursuant to which the parties thereto agreed to amend and restate that certain independent contractor agreement dated September +22, 2016, by and between the Company and Mr. Ault. In +accordance with the terms set forth in the Agreement, Mr. Ault shall continue to serve as the Company’s Chief Executive Officer +and Chairman of the Board of Directors in consideration of a monthly fee of $33,333, effective November 15, 2017. On June 17, 2018, +the Company entered into a ten-year executive employment agreement with Mr. Ault. For his services, Mr. Ault will be paid +a base salary of $400,000 per annum. For his services, Mr. Ault was paid $400,000 and $207,500, respectively, during the years +ended December 31, 2018 and 2017. +F- 68 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +c. On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant +to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000,000 in the Company through the purchase +of Series B Preferred Stock over 36 months. Philou has purchased 125,000 shares of Series +B Preferred Stock pursuant to the terms of the Purchase Agreement, the most recent purchase having occurred on April 24, 2018 for +the purchase of 25,000 shares of Series B Preferred Stock . +d. Between July 6, 2017 and September 30, 2018, Milton C. Ault, III, the Company’s Chairman +and Chief Executive Officer, personally guaranteed the repayment of (i) $8,218,000 from the sale of Advances on Future Receipts +(ii) and $4,781,000 from the sale of the promissory notes. These personal guarantees were necessary to facilitate the consummation +of these financing transactions. Mr. Ault’s payment obligations would be triggered if the Company failed to perform under +these financing obligations. Our board of directors has agreed to compensate Mr. Ault for his personal guarantees. The amount of +annual compensation for each of these guarantees, which will be in the form of non-cash compensation, is approximately 1.5% of +the amount of the obligation. +e. During the year ended December 31, 2017, DP Lending made loans to Alzamend Neuro, Inc. (“Alzamend”), +in the amount of $44,000. AVLP is a party to a management services agreement pursuant to which AVLP provides management, consulting +and financial services to Alzamend. The outstanding principal under these loans was repaid during 2018. As additional consideration, +the Company received a warrant to purchase 22,000 shares of Alzamend’s common stock at an exercise price of $0.30 per share +of common stock. +f. +On +December 5, 2017, the Company entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson +two convertible promissory notes in the principal amount of $600,000 (“Note A”) and $1,667,766 (“Note B”), +in exchange for cancellation of amounts due to WT Johnson by MTIX Ltd., a related party of the Company. +During December 2017, the Company +issued 30,000 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently sold +the 30,000 shares. The proceeds from the sale of Note A were sufficient to satisfy the entire $2,267,766 obligation as well as +an additional $400,500 of value added tax due to WT Johnson. Concurrent with entering into the exchange agreement, the Company +received a promissory note in the amount of $2,667,766 from MTIX. At December 31, 2017, the Company has valued the note receivable +at $600,000, the carrying amount of Note A. The Company will recognize the remainder of the amount due from MTIX upon payment of +the promissory note by MTIX. +g. +Between May 5, 2017 and June 30, 2017, the Company received additional short-term loans of $140,000 from +four accredited investors of which $75,000 was from the Company’s corporate counsel, a related party. As additional consideration, +the investors received five-year warrants to purchase 11,219 shares of common stock at a weighted average exercise price of $15.40 +per share. On June 28, 2017, $52,000 in short-term loans that was received from the related party was converted into one of +the Series C Units (See Note 24) and on July 24, 2017, the remaining $23,000 in short-term loans was converted in 2,091 shares +of the Company’s common stock in conjunction with +the subscription agreements that the Company entered into with six investors (See Note 20h). +h. During the year ended December 31, 2017, our President, Amos Kohn, purchased certain real property +that will serve as a facility for the Company’s business operations in Israel. The Company made $300,000 of payments to the +seller of the property and received a 28% undivided interest in the real property (“Property’). The Company’s +subsidiary, Coolisys, entered into a Trust Agreement and Tenancy In Common Agreement with Roni Kohn, who owns a 72% interest in +the Property, is the daughter of Mr. Kohn and is an Israeli citizen. The Property was purchased to serve as a residence/office +facility for the Company in order to oversee its European operations and to expand its business in the hi-tech industry located +in Israel. Pursuant to the Trust Agreement, Ms. Kohn will hold and manage Coolisys’ undivided 28% interest in the Property. +The trust will be in effect until it is terminated by mutual agreement of the parties. During the term of the trust, the Ms. Kohn +will not sell, lease, sublease, transfer, grant, encumber, change or effect any other disposition with respect to the Property +or the Coolisys’ interest without the Company’s approval. +F- 69 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +27. SEGMENT, CUSTOMERS AND GEOGRAPHICAL INFORMATION +The Company has five +reportable segments as of December 31, 2018 and had two reportable segments as of December 3, 2017; see Note 1 for a brief description +of the Company’s business. +The following data presents the revenues, +expenditures and other operating data of the Company’s geographic operating segments and presented in accordance with ASC +No. 280. +Year ended December 31, 2018 +DPC +DPL +Enertec +Digital Farms +I.AM +Eliminations +Total +Revenue +$ 10,499,612 +$ 2,036,530 +$ 5,226,075 +$ — +$ — +$ — +$ 17,762,217 +Revenue, cryptocurrency +mining +— +— +— +1,675,549 +— +— +1,675,549 +Revenue, related party +3,907,280 +— +— +— +— +— +3,907,280 +Revenue, restaurant operations +— +— +— +— +3,462,140 +— +3,462,140 +Revenue, lending activities +347,033 +— +— +— +— +— +347,033 +Inter-segment revenues +36,833 +— +— +— +— +(36,833 ) +— +Total revenues +$ 14,790,758 +$ 2,036,530 +$ 5,226,075 +$ 1,675,549 +$ 3,462,140 +$ (36,833 ) +$ 27,154,219 +Depreciation and +amortization expense +$ 300,326 +$ 65,046 +$ 389,808 +$ 2,151,505 +$ — +$ — +$ 2,906,685 +Loss from operations +$ (3,608,828 ) +$ (586,107 ) +$ (431,320 ) +$ (6,369,138 ) +$ (81,264 ) +$ — +$ (11,076,657 ) +Capital expenditures for +segment assets, as of +December 31, 2018 +$ 44,190 +$ 1,301 +$ 48,826 +$ 8,891,928 +$ 184,377 +$ — +$ 9,169,992 +Identifiable assets as of +December 31, 2018 +$ 28,623,729 +$ 1,458,699 +$ 10,251,816 +$ 7,018,958 +$ 2,072,678 +$ — +$ 49,425,880 +Year ended December 31, 2017 +DPC +DPL +Eliminations +Total +Revenues +$ 7,889,731 +$ 2,111,018 +$ — +$ 10,000,749 +Revenue, related party +173,751 +— +— +173,751 +Inter-segment revenues +53,501 +— +(53,501 ) +— +Total revenues +$ 8,116,983 +$ 2,111,018 +$ (53,501 ) +$ 10,174,500 +Depreciation and amortization expense +$ 183,252 +$ 70,754 +$ — +$ 254,006 +Loss from operations +$ (5,558,272 ) +$ (424,773 ) +$ — +$ (5,983,045 ) +Capital expenditures for segment assets, as of +December 31, 2017 +$ 382,250 +$ 20,529 +$ — +$ 402,779 +Identifiable assets as of December 31, 2017 +$ 28,780,371 +$ 1,728,523 +$ — +$ 30,508,894 +F- 70 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Concentration Risk: +The following table +provides the percentage of total revenues attributable to a single customer from which 10% or more of total revenues are derived: +For the Year Ended +December 31, 2018 +Total Revenues +by Major +Percentage of +Customers +Total Company +(in thousands) +Revenues +Customer A +$ +3,907,280 +14 % +For the Year Ended +December 31, 2017 +Total Revenues +by Major +Percentage of +Customers +Total Company +(in thousands) +Revenues +Customer B +$ +1,340,766 +13 +% +Revenue from Customer +A is related party revenue attributable to Coolisys and revenue from Customer B is also attributable to Coolisys. At December 31, +2018, MTIX represented all of the Company’s accounts and other receivable, related party. +For the years ended +December 31, 2018 and 2017, total revenues from external customers divided on the basis of the Company’s product lines are +as follows: +For the Years Ended +December 31, +2018 +2017 +Revenues: +Commercial products +$ 10,597,256 +$ 5,488,657 +Defense products +16,556,963 +4,685,843 +Total revenues +$ 27,154,219 +$ 10,174,500 +Financial data relating to geographic +areas: +The Company’s +total revenues are attributed to geographic areas based on the location. The following table presents total revenues for the years +ended December 31, 2018 and 2017. Other than as shown, no foreign country or region contributed materially to revenues or long-lived +assets for these periods: +For the Years Ended +December 31, +2018 +2017 +Revenues: +North America +$ 19,113,226 +$ 6,636,954 +Europe +1,765,991 +2,634,166 +Middle East +5,226,075 +672,256 +Other +1,048,927 +231,124 +Total revenues +$ 27,154,219 +$ 10,174,500 +F- 71 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +28. SUBSEQUENT EVENTS +In accordance with +FASB ASC 855-10, the Company has analyzed its operations subsequent to December 31, 2018 and thru the date of this report being +issued and has determined that it does not have any material subsequent events to disclose in these financial statements except +for the following. +Amendments +to Certificate of Incorporation +On January 3, 2019, +the Company filed a certificate of amendment (the “Certificate of Amendment”) to its Certificate of Incorporation, +with the Secretary of State of the State of Delaware, to effectuate an increase to the number of authorized shares of common stock +of the Company. Pursuant to the Certificate of Amendment, the Company increased the number of authorized shares of its Class A +common stock, par value $0.001, to 500,000,000 from 200,000,000 (the “Authorized Increase”). The number of authorized +shares of the Company’s Class B common stock remains at 25,000,000 and the number of authorized shares of the Company’s +preferred stock remains at 25,000,000. As a result of the increase of authorized shares of its Class A common stock, the aggregate +number of the Company’s authorized shares is 550,000,000. The Authorized Increase was approved by the Company’s board +of directors as of December 28, 2018, and approved by a vote of the stockholders of the Company at the December 28, 2018 Annual +Meeting of Stockholders. The Certificate of Amendment became effective upon filing with the State of Delaware on January 3, 2019. +On +February 27, 2019, the Company filed a Certificate of Designations of Rights and Preferences of Series C Convertible Redeemable +Preferred Stock (the “Certificate of Designations”) to its Certificate of Incorporation, as amended on January 2, 2019, +with the Secretary of State of the State of Delaware to establish the preferences, limitations and relative rights of the Series +C Convertible Redeemable Preferred Stock. The Series C Redeemable Preferred Stock issued and outstanding sixty (60) months from +the from their date of issuance (the “Redemption Date”), shall be mandatorily redeemed and repurchased by the Company +at the Stated Value. +On March 14, 2019, pursuant +to the authorization provided by the Company’s stockholders at a Special Meeting of Stockholders, the Company’s +Board of Directors approved the Certificate of Incorporation Amendment (the “COI Amendment”) to effectuate a reverse +stock split of the Common Stock affecting both the authorized and issued and outstanding number of such shares by a ratio of one-for-twenty +(the “Reverse Stock Split”). The Company filed the COI Amendment to its Certificate of Incorporation with the State +of Delaware effectuating the Reverse Stock Split on March 14, 2019. As a result of the Reverse Stock Split, each twenty (20) shares +of Common Stock issued and outstanding prior to the Reverse Stock Split were converted into one (1) share of Common Stock, with +no change in authorized shares or par value per share. +Amendments +to 10% Convertible Note +On January 9, 2019, +the Company and the Investor of the 10% Convertible Note entered into an amendment, which revised the amortization schedule of +the 10% Convertible Note such that the monthly amortization payments in the principal amount $309,193, at the request of the holder, +shall be satisfied by the issuance of shares of the Company’s common stock. The shares of common stock shall be issued at +a price equal to the greater of (i) $2.40 per share (the closing price of the Company’s common stock on January 9, 2019) +or (ii) 80% of the lowest daily VWAP in the three days prior to the date of issuance, but not to exceed $8.00 per share. However, +the Company shall have the right to pay the monthly amortization payment in cash within 72 hours by advising the investor via email +within two hours of receipt of any conversion notice. Between January 4, 2019 and February 21, 2019, the Company issued to the +investor 336,486 shares of its common stock at $1.96 per share upon the conversion of $1,053,351 in principal and accrued interest. +The investor received $660,337 from the sale of the shares of common stock, which approximated the value of the shares of common +stock on the date of issuance, resulting in a True-Up Payment due to the investor of $393,014. +F- 72 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +Public Offering +On +March 29, 2019, the entered into an underwriting agreement (the “Underwriting Agreement”) with A.G.P./Alliance Global +Partners (the “Underwriter”), pursuant to which the Company agreed to issue and sell an aggregate of (a) 2,855,500 +shares of its common stock (the “Shares”) together with warrants to purchase 2,855,500 shares of common stock (the +“Common Warrants”) and (b) pre-funded warrants to purchase up to an aggregate of 12,700,000 shares of its +common stock (the “Pre-Funded Warrants”) together with a number of Common Warrants to purchase 12,700,000 shares +of common stock (the “Offering”). The Shares were sold to the purchasers at the public offering price of $0.44 per +share (the “Offering Price”). The Common Warrants were sold at a public offering price of $0.01 per Common Warrant. +The Pre-Funded Warrants were offered to each purchaser whose purchase of the Shares and the Common Warrant in the Offering would +otherwise result in the purchaser, together with its affiliates and certain related parties, beneficially owning more than 4.99% +(or, at the election of the purchaser, 9.99%) of the Company’s outstanding common stock immediately following the consummation +of the Offering. The purchase price of each Pre-Funded Warrant equaled the Offering Price at which the Shares were sold to the +public in the Offering, minus $0.01, and the exercise price of each Pre-Funded Warrant equaled $0.01 per share. +Pursuant to the Underwriting +Agreement, the Company also granted the Underwriter the option to purchase up to 428,325 additional shares of common stock, and/or +Pre-funded Warrants to purchase up to 1,905,000 additional shares of common stock and/or Common Warrants to purchase up to 2,333,325 +additional shares of common stock to cover over-allotments, if any. The option is exercisable 45 days after entry into the Underwriting +Agreement. The Offering was made pursuant to the shelf registration statement on Form S-3 (File No. 333-222132), +as amended, that was filed by the Company with the SEC on January 8, 2019 and declared effective by the SEC on January 11, +2018, and a related prospectus supplement. +The Common Warrants +are exercisable at any time after the date of issuance at an exercise price of $0.45 per share and will expire on the fifth anniversary +of the original issuance date. If at the time of exercise, there is no effective registration statement registering, or no current +prospectus available for, the issuance of the shares of common stock underlying the Common Warrants, then the Common Warrant may +be exercised through a cashless exercise, in which case the holder would receive upon such exercise the net number of shares of +common stock determined according to the formula set forth in the Common Warrant. If on any date on or after May 2, 2019, the volume +weighted average price of the Company’s common stock fails to exceed the exercise price of the Common Warrant in effect on +such date, the Common Warrant may be exercised such that the holder will receive one common share for each warrant held. +The Pre-Funded Warrants +are exercisable at any time after the date of issuance and may be exercised at any time until all of the Pre-Funded Warrants are +exercised in full. As an alternative to payment in immediately available funds, the holder may elect to exercise the Pre-Funded +Warrant through a cashless exercise. +In +addition, the Company has also issued the Underwriter a warrant to purchase a maximum of 622,220 additional shares of common stock +(equal to 4% of the Shares sold in the Offering plus the number of shares of common stock underlying the Pre-Funded Warrants) at +an initial exercise price of $0.50 per share, with a term of five years (the “Underwriter’s Warrant”). The Underwriter’s +Warrant contains demand and piggy-back registration rights. If at the time of exercise, there is no effective registration statement +registering, or no current prospectus available for, the issuance of the shares of common stock underlying the Underwriter’s +Warrant, then the Underwriter’s Warrant may be exercised through a cashless exercise. +The +Company received net proceeds from the Offering of approximately $6 million, after deducting underwriting discounts and commissions +and estimated Offering expenses, and assuming no exercise of the Underwriter’s option to purchase additional shares. The +Company used the net proceeds from the Offering for the repayment of debt, working capital and other general corporate purposes. +F- 73 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The +Offering closed on April 2, 2019 and as of April 12, 2019 the Company had issued a total of 12,555,500 shares of its common stock, +inclusive of shares issued pursuant to the exercise of a total of 9,700,000 Pre-Funded Warrants. +WDCO ATM Offering +Between +January 1, 2019 and April 12, 2018, the Company had received net proceeds of $4,469,630 through the sale of 4,791,642 shares of +the Company’s common stock through the WDCO ATM Offering. The offer and sale of the shares through the WDCO ATM Offering +were made pursuant to the Company’s effective “shelf” registration statement on Form S-3 and an accompanying +base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended +on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, +dated October 15, 2018. +Series C Convertible +Redeemable Preferred Stock +On +February 27, 2019, the Company entered into a Securities Purchase Agreement with Ault & Company, Inc., a Delaware corporation +and a stockholder of the Company (“Ault & Company”). Pursuant to the terms of the Agreement, Ault & Company +will invest at its sole and absolute discretion up to $2,500,000 in the Company through the purchase of the Company’s Series +C Convertible Redeemable Preferred Stock (“The Series C Preferred Stock”), during the period commencing on the Closing +Date and ending on December 31, 2019. Each share of Series C Preferred Stock shall be purchased at $1,000 (the “Stated Value”) +for up to a maximum issuance of 2,500 shares of Preferred Stock. Each share of Preferred Stock shall become convertible after the +eighteen months from the date from the date of issuance into such number of fully paid and non-assessable shares of the Company’s +common stock (“Common Stock”) for $2.40 per share, subject to adjustments (the “Conversion Price”). The +Preferred Stock is mandatorily redeemable by the Company after five years from the date of issuance. +January 2019 +Exchange Agreement +On +January 23, 2019 the Company entered into an Exchange Agreement (the “January ’19 Exchange Agreement”) with an +institutional investor pursuant to which the Company issued to the investor two new 8% promissory notes in the aggregate principal +amount of $1,043,799 (the “New Notes”) the Secured Promissory Note issued by the Company to the investor on October +10, 2018 (the “October Note”) and that certain Secured Promissory Note issued by the Company to the investor on August +16, 2018, as amended on November 29, 2018 (the “November Note”, and together with the October Note, the “Old +Notes”). +Pursuant +to the January ’19 Exchange Agreement, the investor may elect to receive from the Company shares of Common Stock of the Company +issued under the Company’s Registration Statement on Form S-3 (File No. 333-222132). Any Common Stock issued to the investor +in accordance therewith shall reduce the outstanding sums due under the New Notes by an amount equal to the number of shares of +Common Stock issued multiplied by the applicable issuance price. The number of shares of Common Stock issuable upon delivery of +issuance notices by the investor to the Company shall be determined by dividing the amount of the New Note to be drawn down by +the greater of $2.40 or 80% of the lowest daily VWAP in the three trading days prior to the acquisition of the Common Stock. In +addition, in the event the investor’s proceeds from the sale of all Common Stock received by the investor pursuant to the +terms of the February ’19 Exchange Agreement, do not equal at least 100% of the deemed payment of the outstanding principal +balance of the New Note, the Company shall owe the difference to the investor in cash or through the delivery of free trading shares +of Common Stock. +Subject +to the conditions set forth in the Exchange Agreement, on or after April 15, 2019, unless the New Notes have been paid in full, +the Investor may be issued a secured convertible promissory note (the “Convertible Note”) in exchange for the November +Note. +F- 74 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +The +Convertible Note, if issued, will be issued on or about April 15, 2019, with a maturity date of July 15, 2019, and will bear interest +at 8% per annum payable by the Company to the Investor, in cash, within seven days of the end of each calendar quarter while the +Convertible Note remains outstanding. The number of shares of Common Stock issuable upon conversion of the Convertible Note shall +be determined by dividing the amount to be converted by the greater of $2.40 or 80% of the lowest daily VWAP in the three trading +days prior to the conversion, subject to certain conditions. The Convertible Note contains standard and customary events of default +including, but not limited to, failure to make payments when due under the Convertible Note, failure to comply with certain covenants +contained in the Convertible Note, or bankruptcy or insolvency of the Company. +On +February 11, 2019 and March 22, 2019, pursuant to the January ’19 Exchange Agreement, the Company issued to the investor +436,753 and 102,041 shares, respectively, of the Company’s common stock for an aggregate reduction in the note of $876,324, +resulting in a remaining balance due of $171,883. +February 2019 Exchange Agreement +On +February 20, 2019 the Company entered into an Exchange Agreement (the “February ’19 Exchange Agreement”) with +an institutional investor pursuant to which the Company issued to the investor a new 8% promissory note in the principal amount +of $433,884 (the “New Note”) in exchange for the Secured Promissory Note issued by the Company to the investor on August +16, 2018, as amended on November 29, 2018 (the “Old Note”). +Pursuant +to the February ’19 Exchange Agreement, the investor may elect to receive from the Company shares of Common Stock of the +Company issued under the Company’s Registration Statement on Form S-3 (File No. 333-222132). Any Common Stock issued to the +investor in accordance therewith shall reduce the outstanding sums due under the New Note by an amount equal to the number of shares +of Common Stock issued multiplied by the applicable issuance price. The number of shares of Common Stock issuable upon delivery +of issuance notices by the investor to the Company shall be determined by dividing the amount of the New Note to be drawn down +by the greater of $2.40 or 80% of the lowest daily VWAP in the three trading days prior to the acquisition of the Common Stock. +In addition, in the event the investor’s proceeds from the sale of all Common Stock received by the investor pursuant to +the terms of the February ’19 Exchange Agreement, do not equal at least 100% of the deemed payment of the outstanding principal +balance of the New Note, the Company shall owe the difference to the investor in cash or through the delivery of free trading shares +of Common Stock. +On +March 18, 2019 and April 4, 2019, pursuant to the February ’19 Exchange Agreement, the Company issued to the investor 180,785 +and 375,000 shares of the Company’s common stock for an aggregate reduction in the note of $250.062, resulting in a remaining +balance due of $183,822. +Issuances of +Common Stock for Services +Between January 7, +2019 and March 20, 2019, the Company issued an aggregate of 375,000 shares of its common stock as payment for services to its consultant. +The shares were valued at $482,500, an average of $1.29 per share. +Short-term Promissory Notes +On +December 28, 2018, Enertec entered into a $500,000 Secured Promissory Note (the “Enertec Note”), whereby Enertec agreed +to pay interest in an amount of 10% per annum in cash to the investor, beginning on January 15, 2019, on a monthly basis, until +the Enertec Note is paid in full. The maturity date of the Enertec Note shall be the earlier of June 15, 2019 or as otherwise provided +in the terms of the Enertec Note. The proceeds from the Enertec Note were received in January 2019. The Enertec Note was paid from +proceeds received in the Offering. +On +December 28, 2018, Microphase entered into a $200,000 Secured Promissory Note (the “Microphase Note”), whereby Microphase +agreed to pay interest in an amount of 10% per annum in cash to the investor, beginning on January 15, 2019, on a monthly basis, +until the Microphase Note is paid in full. The maturity date of the Microphase Note shall be the earlier of March 31, 2019, or +as otherwise provided in the terms of the Microphase Note. The Microphase Note was paid from proceeds received in the Offering. +F- 75 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +In +connection with the Enertec Note and the Microphase Note, Milton C. Ault III provided a personal guarantee for the benefit of the +investor. +Payment of +related party receivable +During the years ended +December 31, 2018 and 2017, the Company recognized $3,907,280 and $173,751 in revenues from MTIX, a related party, to manufacture +the Multiplex Laser Surface Enhancement (“MLSE”) plasma-laser systems. On April 12, 2019, the Company received payment +of $2,676,219 for manufacturing services performed on the first MLSE system. +F-76 \ No newline at end of file diff --git a/raw/filings/0000896493/2018/0001214659-19-002759/filing_metadata.csv b/raw/filings/0000896493/2018/0001214659-19-002759/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b28e01b82b336502a5c7b33ab8c940240d519618 --- /dev/null +++ b/raw/filings/0000896493/2018/0001214659-19-002759/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2019-04-16,2018-12-31,2019-04-16T21:21:00.000Z,0001214659-19-002759,dpw41019010k.htm,,15678338,1,0,https://www.sec.gov/Archives/edgar/data/896493/000121465919002759/dpw41019010k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465919002759/,2018,2018,1 diff --git a/raw/filings/0000896493/2018/0001214659-19-002759/item1.txt b/raw/filings/0000896493/2018/0001214659-19-002759/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..ef3ad8ad86c2f689e2142e1dd1e485fc639fe666 --- /dev/null +++ b/raw/filings/0000896493/2018/0001214659-19-002759/item1.txt @@ -0,0 +1,463 @@ +ITEM 1. BUSINESS +General +We are a growth company +seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy +which we began implementing upon the change in control that was completed in September 2016. Our acquisition and development target +strategy include companies that have developed a “new way of doing business” in mature, well-developed industries experiencing +changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; +companies whose business is related to our core business in the commercial and defense industries; and companies that will enhance +our overall revenues. We plan to substantially increase our gross revenues in the foreseeable future. +We operate as a holding +company with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed +an investment company under the Investment Company Act of 1940, as amended (the “ Investment Company Act ”). Generally, +this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total +assets will be invested in investment securities as such term is defined in the Investment Company Act. We +are a diversified holding company owning subsidiaries engaged in the following operating businesses: commercial and defense solutions, +commercial lending, cryptocurrency blockchain mining and advanced textile technology. We also maintain a large investment +in Avalanche International, Corp., which does business as MTIX International. +Originally, we were +primarily a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power +system solutions for the medical, military, telecom and industrial markets. Although we are actively seeking growth through acquisitions, +we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where +customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating +conditions. +We have operations +located in Europe through our wholly-owned subsidiary, Digital Power Limited (“ DP Limited ”), Salisbury, England, +which operates under the brand name of “Gresham Power Electronics” (“ Gresham ”). DP Limited designs, +manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power +distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European +defense business is specialized in the field of naval power distribution products. +3 +On November 30, 2016, +we formed Digital Power Lending, LLC (“ DP Lending ”), a wholly-owned subsidiary. DP Lending provides commercial +loans to companies throughout the United States to provide them with operating capital to finance the growth of their businesses. +The loans range in duration from six months to three years, DP Lending operates under California Finance Lending License #60DBO-77905. +On June 2, 2017, we +purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is +a design-to-manufacture original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio +frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies +and detector logarithmic video amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. +Microphase is headquartered in Shelton, Connecticut. +On April 25, 2017, +we formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. Coolisys operates its existing +businesses in the customized and flexible power system solutions for the medical, military, telecom, commercial and industrial +markets, other than the European markets which are primarily served by DP Limited, in Coolisys. We intend to reorganize our corporate +structure to make Digital Power North American operations, operated by our subsidiary Gresham, and Microphase, a subsidiary of +Coolisys and as such an indirect subsidiary of ours. +On September 1, 2017, +Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability +company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, +fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an +extended sales organization for our overall flexible power system solutions. +On +December 31, 2017, Coolisys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“MICT”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“EML”), +and Enertec Systems 2001 Ltd. (“Enertec”), an Israeli corporation and wholly owned subsidiary of EML, pursuant to which +Coolisys acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for the military +market. On May 23, 2018, Coolisys completed its acquisition of Enertec. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement to acquire 98.1% of I.AM, Inc. (“I.AM”), +for a purchase price of $981. I.AM owns and operates the Prep Kitchen brand restaurants located in the San Diego area. I.AM owed +DP Lending $1,715,330 in outstanding principal, pursuant to a loan and security agreement, between I.AM and DP Lending, that I.AM +used to acquire the restaurants. +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 201 Shipyard Way, Suite E Newport +Beach, CA 92663. Our phone number is 510-657-2635 and our website address is www.dpwholdings.com. +Recent Events +On September +18, 2017, the Board of Directors of Digital Power Corporation voted unanimously to recommend a number of proposals to be voted +upon at its annual meeting (the “ Meeting ”), including a proposal to approve a change in domicile from California +to Delaware (the “ Reincorporation ”). On December 27, 2017, Digital Power Corporation approved the Agreement +and Plan of Merger (the “ Merger Agreement ”) providing for the merger (the “ Merger ”) of Digital +Power Corporation with and into its wholly owned subsidiary DPW Holdings, Inc. (the “ Company ” or “ DPW ”). +The Reincorporation, was approved at the Meeting, which was held on December 28, 2017. +The +Reincorporation was consummated on December 29, 2017 pursuant to the Merger Agreement, whereby Digital Power Corporation merged +with and into the Company with the Company as the surviving corporation operating as DPW Holdings, Inc. Following the Merger, +the Company’s corporate existence is governed by the laws of the State of Delaware. +Upon +consummation of the transactions contemplated by the Merger Agreement and resulting Reincorporation, the daily business operations +of the Company continued as they were conducted by Digital Power Corporation immediately prior to the Reincorporation and the officers +and directors of Digital Power Corporation became the officers and directors of the Company, except that Milton C. Ault III become +the Company’s Chief Executive Officer and Amos Kohn remained as its President. +In +January 2018, we formed Super Crypto Mining, Inc., a wholly-owned subsidiary, which recently changed its name to Digital Farms, +Inc. (“ DFI ”). DFI was established to operate our newly formed cryptocurrency business, which is pursuing a variety +of digital currency. We mine the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin +and Ethereum. +On +January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2.5 million for an aggregate debt of +$5 million to two institutional investors. The proceeds from these two promissory notes were used to purchase 1,000 +Antminer S9s (“ Miners ”) manufactured by Bitmain Technologies, Inc. in connection with our crypto mining operations. +We received delivery of the Miners on February 1, 2018. +4 +On +February 27, 2018, we entered into a sales agreement with H.C. Wainwright & Co., LLC (“HCW”) to sell shares of +our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” +program (the “HCW ATM Offering”) under which HCW acted as sales agent. Through September 23, 2018, when the HCW ATM +Offering was terminated we had received net proceeds of approximately $18,059,187 through the sale of 1,062,096 shares of our common +stock through the HCW ATM Offering. The offer and sale of the shares through the ATM Offering were made pursuant to our then effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration +Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the +SEC on January 11, 2018, and a prospectus supplement related to the HCW ATM Offering, dated February 27, 2018. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I. AM, Inc. (“I. AM”), David +J. Krause and Deborah J. Krause. Pursuant to the securities purchase agreement, I. AM sold to DP Lending, 981 shares of common +stock for a purchase price of $981, representing, upon the closing, 98.1% of I. AM’s outstanding common stock. I. AM owns +and operates the Prep Kitchen brand restaurants located in the San Diego area. I.AM owed DP Lending $1,715,330 in outstanding principal, +pursuant to a loan and security agreement, between I. AM and DP Lending, which I. AM used to acquire the restaurants. The purchase +agreement provides that, as I. AM repays the outstanding loan to DP Lending in accordance with the loan agreement, DP Lending will +on a pro rata basis transfer shares of common stock of I. AM to David J. Krause, up to an aggregate of 471 shares. +On October 10, 2018, +DPW Holdings Inc. (the “Company”) entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) +with Wilson-Davis & Co., Inc., as sales agent (the “Agent”) to sell shares of its Common Stock, having an aggregate +offering price of up to $25,000,000 (the “Shares”) from time to time, through an “at the market offering” +program (the “WDCO ATM Offering”). Through April 1, 2019, when the WDCO ATM Offering was discontinued, we had received +net proceeds of $6,050,499 through the sale of 5,163,751 shares of our common stock through the WDCO ATM Offering. The offer and +sale of the shares through the WDCO ATM Offering were made pursuant to our then effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with +the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus +supplement related to the WDCO ATM Offering, dated October 15, 2018. +On March 14, 2019, +the stockholders approved a proposal permitting the Board of Directors to effect a reverse stock split (the “Reverse Split”) +of our issued and outstanding Common Stock. Thereafter, on March 14, 2019, the Board of Directors approved the Reverse Split with +a ratio of one for twenty. The Reverse Split did not affect the number of authorized shares of Common Stock or their par value +per share. As a result of the Reverse Split, the number of shares of Common Stock outstanding was reduced from 126,025,767 to 6,301,289. +The Reverse Split became effective in the State of Delaware on March 14, 2019. Beginning on March 18, 2019, the Common Stock traded +on the NYSE American on a split-adjusted basis. All references to Common Stock in this Annual Report have been retroactively restated. +On +March 29, 2019, we entered into an underwriting agreement with A.G.P./Alliance Global Partners (the “Underwriter”), +pursuant to which we agreed to issue and sell an aggregate of (a) 2,855,500 shares of Common Stock (the “Shares”) together +with warrants to purchase 2,855,500 shares of Common Stock and (the “Common Warrants”) and (b) pre-funded warrants +to purchase up to 12,700,000 shares of its Common Stock (the “Pre-Funded Warrants”) together with a number of +Common Warrants to purchase 12,700,000 shares of common stock (the “April 2019 Offering”). The Shares were sold to +the purchasers at the public offering price of $0.44 per share (the “Offering Price”). The Common Warrants +were sold at a public offering price of $0.01 per Common Warrant. The Pre-Funded Warrants were offered to each purchaser +whose purchase of the Shares and the Common Warrant in the April 2019 Offering would otherwise result in the purchaser, together +with its affiliates and certain related parties, beneficially owning more than 4.99% of outstanding Common Stock immediately following +the consummation of April 2019 Offering, in lieu of the Shares. The purchase price of each Pre-Funded Warrant equaled the Offering +Price, minus $0.01, and the exercise price of each Pre-Funded Warrant equaled $0.01 per share. +Strategy +Our strategy to increase +revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business +of power system solutions for the military/aerospace, medical and industrial-telecommunication industries, we have determined that +significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient +sales and marketing force as a result of deferring research and development of new products because of limited working capital, +and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution +companies. +5 +Therefore, we believe +that the best strategy for us and our stockholders is to invest in our core business to support releases of advanced new power +technologies and to expand our customer base and market share in our major markets. To support the organic growth, we have hired +a number of additional personnel and are investing to enhance our product offerings with state of the art technology. While we +implement our new organic growth strategy, we are focusing on finding and acquiring companies that have developed new technology +but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack +of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies +that enhance our overall revenues. Further, as discussed below, we have made an investment in Avalanche which acquired the rights +to a cost effective and environmentally friendly material synthesis technology for textile applications. +As a result of this +strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, +analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions +and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they +can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase +in infrastructure expenses and investing in companies that demonstrate revenue potential but are initially incurring losses, we +anticipate continuing to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Led by our Chairman +and CEO, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global impact. +We also use a traditional methodology for valuing stocks that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from +influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s Vice Chairman and CFO, to provide +analysis and guidance on all acquisition targets and throughout the acquisition process. +During the next several +years, we see a favorable opportunity to follow an activist strategy that centers on the purchase of target stock and the subsequent +removal of any barriers that might interfere with a friendly purchase offer from a strong buyer. Alternatively, in appropriate +circumstances, we or our subsidiaries may become the buyer of target companies, adding them to our portfolio of operating subsidiaries, +thereby expanding our operations through such opportunistic acquisitions. We believe that the companies that we target for our +activist activities are undervalued for many reasons, often including inexperienced management. Unfortunately for the individual +investor, in particular, and the economy, in general, many poor management teams are often unaccountable and very difficult to +remove. +Core Business – Power +Systems Solutions +We provide the highest +density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and +modify-standard product solutions and value-added services to diverse industries and markets including military/aerospace, medical +and industrial- telecommunications. We believe that our solutions leverage a combination of low leakage power emissions, +very high-power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy is to +be the supplier of choice to companies, including OEMs, that require high-quality power system solutions where custom design, superior +product, high quality, time to market and very competitive prices are critical to business success. We believe that we provide +advanced custom product design services to deliver high-grade products that reach a high level of efficiency and density and can +meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that supports all of their needs +for designing and manufacturing power solutions and products. By implementing our advanced core technology, including process implementation +in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom +design cost-effective products. Our target market segments include the industrial telecommunication, medical, and military/aerospace +industries. +Custom Power +System Solution. We provide high-grade custom power system solutions to several customers in multiple +industry segments. Our custom solution technology includes full Digital Signal Processing (“ DSP ”) control, digital +load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and +multiple outputs to meet each of our customers’ unique requirements. We combine our power design capabilities with the latest +circuit designs to provide complete power solutions for virtually any plausible need. In the design of custom power solutions, +we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with +any hosted platform. +Our standard contract +for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production +guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes +the development of our intellectual property (“ IP ”) portfolio. We believe that this business model +provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility +Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade +design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) +and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While +some of our customers have special requirements that include a full custom design, other customers may require only certain electrical +changes to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical +repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can +be easily integrated with any platform across our diversified market segments. +6 +Value-Added Services . +In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added +services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance +components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment +and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would +otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus +eliminating the need for complex, time-consuming and costly system integration. We believe that this value-added service is well +suited to those OEMs that wish to reduce their vendor base and minimize their investment in manufacturing, which would lead to +increased fixed costs. Given access to these value-added services, the OEMs do not need to build assembly facilities to manufacture +their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Markets +We sell our custom +power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse +range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our +current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve +the North American power electronics market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas +the European marketplace is served through DPL, another wholly-owned subsidiary. +We sell products to +our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our +sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship +with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding +new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional +sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market +share through 2019. +Commercial Customers . +We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of +applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally +extreme environmental conditions. +Military/Defense +Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the +ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications +and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture +our military products through a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ ITAR ”) +and is certified to perform such manufacturing services. We are compliant with the ITAR regulations and are an approved vendor +for the U.S. Air Force, Navy and Army. +At the core of every +military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will +operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, +function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; +Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications +and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned +Aerial Vehicle) – Very lightweight power systems. +Our military products +meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, +weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges +that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our +power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned +subsidiary DPL develops and manufactures some military and defense products mainly being deployed in international naval fleets. +Digital Power Limited (Gresham Power +Electronics) +Digital Power Limited, +our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom, designs, manufactures, and distributes switching +power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters for the commercial +and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships to convert +their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such +as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, +higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these +as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, +provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +7 +Microphase Corporation +Microphase designs, +manufactures and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication +systems. Such components include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, +switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s +customers are comprised of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors +and sub-contractors. Microphase’s recent technology innovations are used in many significant U.S. Government defense programs, +including the Polaris submarine, the F-16, the F-35 and the Predator drone. Other notable programs in which Microphase’s +products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile +System, THAAD (or Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, +EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint strike fighter plane, and more recently drone programs including +the Predator, the Reaper and the Shadow. +Microphase’s +advanced technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in +order to accurately recover the signals and facilitate use of the information received. These products include: +· filters that sort and clarify microwave signals, including multiplexers that are a series of filters +combined in a single package; +· solid state amplifiers that amplify microwave signals; +· detectors and limiters that are semiconductor devices for detection of radar signals and protection +of receivers from damage from high power signals and jamming; +· detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal +detection systems; +· integrated assemblies that combine multiple functions from a range of components and devices, including +transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction +assemblies; +· electronic test and measurement probes; +· universal test and measurement test platforms and fixtures; and +· utility probes and antenna probes. +Manufacturing and Testing +Consistent with our +strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of +flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers +to ensure that they will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships +will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power +supply industry has placed continual downward pressure on selling prices. In order to achieve our low-cost manufacturing goals +with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and +in Asia. +We are continually +improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and +consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test +procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies +right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within +our customer applications. +Compliance with international +safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. +Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements +and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract +manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where +specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we +market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“ RoHS ”), +which restricts the use of six hazardous materials in the manufacturing of certain electronic and electrical equipment, as well +as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), which determines collection, +recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements +in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components +may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +8 +Some of our products +are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only +the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export +of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject +to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for +products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating +results. Further, additional restrictions or charges may in the future be imposed by the United States or any other foreign country. +In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs +that are funded and governed by the U.S. Foreign Military Financing program. +Sales and Marketing +We market our products +directly through our internal sales force as well as through our channel partners including independent manufacturer representatives +and distributors. Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, +the manufacturing representatives have the opportunity to earn exclusive access to all potential customers in the assigned territory +as a result of achieving their marketing and sales goals as defined in the representative agreement. Our manufacturer representative +agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales +for retention, payable after products are shipped to the customer in the assigned territory. Typically, either we or the manufacturing +representatives are entitled to terminate the manufacturing representative agreement upon 30 days’ written notice. +We provide comprehensive +collateral including product data sheets, participation in trade shows, and our websites, www.digipwr.com and www.microphase.com. We +use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our websites +and accessible to the marketplace. We will continue to enhance our websites by adding more features and functionalities, such as +e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities +will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and +product development efforts are primarily directed toward developing new products in connection with custom product design and +modification of our standard power systems to provide a broad array of individual models. +Our new custom product +solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports +special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that +we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development +contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production +forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development +of our IP portfolio. +We also outsource some +of our product development projects to engineering partners in order to achieve the best technological and product design results +for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, +including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on +commercial off the shelf (“ COTS ”) products and for other customized product requirements, when applicable. We +continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market +demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) +filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and +customizing our existing product portfolio, using our engineering integrating laboratory located in California. +Competition +The power system solutions +industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located +throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer +products superior or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, +TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and +geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition +efforts with our customers. We also face competition from current and prospective customers who may decide to internally design +and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with +larger power supply manufacturers. +9 +We anticipate in the +current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could +thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell +our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by +providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously +improving quality and reliability levels, and offering flexible and reliable delivery schedules. +We believe that our +power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the +latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume +ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures +to meet our customers’ requirements. +Another advantage of +our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a +selectable number of output product design platforms. We believe we have a competitive position with our targeted customers that +need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have +designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power +needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power +systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs +on “time to market.” It also results in very low non-recurring engineering (“ NRE ”) expenses. Because +of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s +specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE +expenses. +The markets in which +Microphase operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors +are larger than it is and maintain higher levels of expenditures for research and development. Principal competitive factors in +Microphase’s markets are product quality and reliability; technological capabilities; service; past performance; ability +to develop and implement complex, integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales +channels in international markets; and cost-effectiveness. +In the RF Communications +market, principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, +MD; RS Microwave, a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith +Group, a global technology company listed on the London Stock Exchange; and Delta Diversified Products, a private company based +in Arizona. +In the Video amplifier +segment, principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately +held company headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, +a privately held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company +based in New York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Raw Materials +The raw materials for +power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus +we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders +received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials +prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In +addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors +have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no +longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign +some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination +of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. +We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. +However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On +July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark +Office. +In conjunction with +our majority acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade +name, which has been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +10 +Research and Development +During the years ended +December 31, 2018 and 2017, we spent approximately $1,430,538 and $1,119,745, respectively, on research and development. +Employees +As of December 31, +2018, we had 248 employees located in the United States, the United Kingdom and Israel, of whom 73 were engaged in engineering +and product development, 10 in sales and marketing, 134 in general operations and 31 in general administration and finance. All +but 3 of these employees are employed on a full-time basis. None of our employees is currently represented by a trade union. We +consider our relations with our employees to be good. +11 \ No newline at end of file diff --git a/raw/filings/0000896493/2018/0001214659-19-002759/item13.txt b/raw/filings/0000896493/2018/0001214659-19-002759/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..6e4ae71d378cbfee1f1ffcf89197ed5afeeeb7f0 --- /dev/null +++ b/raw/filings/0000896493/2018/0001214659-19-002759/item13.txt @@ -0,0 +1,121 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. On September 22, 2016, Philou +Ventures became our largest stockholder when it acquired all of the common stock of a prior stockholder, Telkoor Telecom, Ltd. +Philou Ventures’ Manager is Kristine L. Ault, a former director. Ms. Ault is the spouse of Milton C. Ault, III, who is our +Chief Executive Officer and Chairman of the Board. +Philou Ventures, LLC +On March 9, 2017, we +entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Philou Ventures. Philou Ventures +is the Company’s largest single stockholder. Milton C. Ault is the Chief Executive Officer of Ault & Company, the Manager +of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures may invest up to $5,000,000 in us through +the purchase of Series B Preferred Stock (“Preferred Stock”) over the Term, as specified herein. Each share of Preferred +Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guaranteed to +purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred +Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE +American. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares +of Preferred Stock in a sufficient amount in order us to meet the NYSE American’s minimum stockholders’ equity continued +listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “Guaranteed Purchases”). +In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of +Preferred Stock, up to the 500,000 share maximum (“Voluntary Purchases”). All consideration for Voluntary Purchases +shall be delivered through a series of varying payments (“Payments”) by Philou Ventures, at its sole and absolute discretion, +during the period commencing on the closing date and ending 36 months therefrom (the “Term”). We have the right to +request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining +the minimum stockholders’ equity required by the NYSE American. The Preferred Stock shall not be callable by us for 25 years +from the closing date. +In addition, for each +share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock +in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price +equal to $14.00 per share of common stock +Further, Philou Ventures +shall have the right to participate in our future financings under substantially the same terms and conditions as other investors +in those respective financings in order to maintain its then percentage ownership interest. Philou Ventures’ right to participate +in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +On December 29, 2016, +MCKEA Holdings, LLC ( “ MCKEA ”) lent us $250,000 in the form of a demand note bearing simple interest at +6.0%. MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling stockholder. Kristine L. Ault, +a former director and the wife of Milton C. Ault III, Chief Executive Officer and Chairman of the Company’s Board of Directors, +is the manager and owner of MCKEA. On March 24, 2017, MCKEA cancelled the $250,000 demand note to purchase 25,000 shares of Preferred +Stock and received warrants to purchase 25,510 shares of common stock at $14.00 per share. +62 +On March 20, 2017, +Philou arranged for the Company to receive a $250,000 short-term loan. Between May 5, 2017 and June 2, 2017, Philou purchased an +additional 75,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the +cancellation of the Company debt due to Philou from the $250,000 short term loan and cash of $500,000. In addition, Philou received +warrants to purchase 76,531 shares of common stock at an exercise price of $14.00 per share of common stock. On April 24, 2018, +Philou purchased an additional 25,000 shares of Series B Preferred Stock in consideration of the cancellation of short-term advances +due to Philou in the aggregate amount of $250,000. In addition, Philou received warrants to purchase 25,510 shares of common stock +at an exercise price of $14.00 per share of common stock. +Avalanche International, Corp. +On October 5, 2016, +November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with Avalanche (the +“ AVLP Notes ”) in the principal amount of $525,000 each. The AVLP Notes included a 5% original issue discount, +resulting in net loans to Avalanche of $1,500,000 and an original issue discount of $75,000. The AVLP notes accrued interest at +12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, +to convert all or any portion of the principal and accrued interest into shares of common stock of Avalanche at approximately +$0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 +shares of the Company’s common stock. During the period from March 29, 2017 to August 16, 2017, the Company funded $1,808,952 +in excess of the $1,500,000 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, +the Company and Avalanche entered into a Loan and Security Agreement (“ AVLP Loan Agreement ”) with an effective +date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to +$5,000,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019. +In consideration of +entering into the AVLP Loan Agreement, the Company and Avalanche cancelled the AVLP Notes and consolidated the AVLP Notes and prior +advances totaling $3,308,952 plus original issue discount of $165,448 and issued a new Convertible Promissory Note in the aggregate +principal amount of $3,474,400 (the “ New Note ”) that is convertible into shares of Avalanche at a conversion +price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior +interest accrued under the AVLP Notes and advances will continue to be an obligation of Avalanche. The New Note contains standard +events of defaults. In addition, concurrent to issuing the New Note, Avalanche issued to the Company a five-year warrant to purchase +6,948,800 shares of Avalanche Common Stock at $0.50 per share. Future advances under the AVLP Loan Agreement, which totaled $649,820 +at December 31, 2017, are evidenced by a convertible promissory note containing a conversion price feature of $0.50 per share and +warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by Avalanche +are secured by the assets of AVLP. +At December 31, 2017, +the Company had provided Avalanche with $4,124,220 pursuant to the non-revolving credit facility. The warrants issued in conjunction +with the non-revolving credit facility entitles the Company to purchase up to 8,248,440 shares of Avalanche common stock at an +exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary +stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Avalanche is a holding +company which on August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended +on July 13, 2017 and August 21, 2017 (the “ Exchange Agreement ”) with MTIX Ltd., a company formed under the laws +of England and Wales (“ MTIX ”) and the three (3) stockholders of MTIX (the “ Sellers ”), Avalanche +completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, Avalanche +acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “ MTIX Shares ”) +by the Sellers to Avalanche in exchange (the “ Exchange ”) for the issuance by Avalanche of: (a) 7% secured convertible +promissory notes (individually, a “ Note” and collectively, the “Notes ”) in the aggregate +principal face amount of $9,500,000 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages +of MTIX’s ordinary shares, (b) (i) $500,000 in cash, $50,000 of which was paid on October 26, 2016, and (ii) 100,000 shares +of Avalanche’s newly designated shares of Class B Convertible Preferred Stock (the “ Class B Shares ”) to +the principal stockholder of MTIX (the “ Majority Stockholder ”). +Milton C. Ault, III +and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors +of Avalanche. In addition, Philou Ventures is the controlling stockholder of Avalanche as well as our largest single stockholder. +MTIX Limited +MTIX has developed +a novel cost effective and environmentally friendly material synthesis technology for textile applications. Designed for global +textile manufacturers, the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system uses a combination +of plasma and photonic energy to effect material synthesis of a substrate surface. The laser and gasses from the system deliver +a dry process to enhance the surface of fabric. During March 2017 the Company was awarded a 3-year, $50 million contract by MTIX +to manufacture, install and service the MLSE plasma-laser system. The Company has recognized $923,751 in revenue from MTIX, all +of which was reflected as accounts receivable, related party at December 31, 2017. +63 +On December 5, 2017, +the Company entered into an exchange agreement with WT Johnson & Sons (Huddersfield) Limited (the “ Holder ”), +pursuant to which the Company issued to the Holder, (a) a convertible promissory note in the principal amount of $600,000 (“ Note +A ”), and (b) a convertible promissory note in the principal amount of $1,667,766 (“ Note B ”), in exchange +for cancellation of (i) an outstanding loan made by the Holder to MTIX in the amount of $265,766; and (ii) cancellation of an aggregate +of $2,002,000 owed by MTIX to the Holder pursuant to an Agreement for the Sale and Purchase of a Textile Multi-Laser Enhancement +Technology Machine dated as of July 21, 2017 by and between MTIX and the Holder. +Note A is convertible +into the Company’s common stock at a conversion price of $1.00 per share, does not bear interest, and matures two years from +issuance. Note B is convertible into the Company’s common stock at a conversion price of $0.85 per share, does not bear interest, +and matures two years from issuance. However, the Holder shall not have the right to convert any portion of Note B, following +receipt by the Holder of an aggregate of $2,267,766 of gross proceeds from the sale of shares of Common Stock issued upon conversion +of Note A or Note B. +During December 2017, +the Company issued 600,000 shares of its common stock upon the conversion of Note A and the Holder notified the Company that gross +proceeds during the month of December 2017 from sales of the 30,000 shares of common stock were sufficient to satisfy the entire +$2,267,766 obligation. As a result of entering into the exchange agreement with the Holder, MTIX is obligated to pay the Company +$2,668,266, consisting of the amount of the exchange agreement of $2,267,766 and a value added tax of $400,500 from the sale of +the Textile Multi-Laser Enhancement Technology Machine. \ No newline at end of file diff --git a/raw/filings/0000896493/2018/0001214659-19-002759/item9a.txt b/raw/filings/0000896493/2018/0001214659-19-002759/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..79f3ecad25fb17f58bc11a9ab9ee21660a6697e0 --- /dev/null +++ b/raw/filings/0000896493/2018/0001214659-19-002759/item9a.txt @@ -0,0 +1,93 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and +Procedures +As of December 31, +2018, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our +principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure +controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange +Act ”). We have established disclosure controls and procedures designed to ensure that information required to be disclosed +in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods +specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and +principal financial officer, to allow timely decisions regarding required disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined +in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined +that our disclosure controls and procedures were not effective due to certain material weaknesses as described herein. +Management’s Annual Report on +Internal Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange +Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability +of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted +accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain +to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the +assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial +statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being +made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance +regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have +a material effect on the financial statements. +Because of its inherent +limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation +of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, +or that the degree of compliance with the policies or procedures may deteriorate. +50 +Our management assessed +the effectiveness of our internal control over financial reporting as of December 31, 2018. In making this assessment, our management +used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) +in Internal Control-Integrated 2013 Framework. Our management has concluded that, as of December 31, 2018, our internal control +over financial reporting was not effective. +A material weakness +is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) +or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual +or interim financial statements will not be prevented or detected. Management has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting function, which restricts our ability to +gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size +and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to +the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed +by separate individuals. Management evaluated the impact of our failure to have segregation of duties during our assessment of +our disclosure controls and procedures and concluded that the control deficiency that resulted represented a material weakness +2. We have inadequate controls to ensure that information necessary to properly record transactions +is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management +evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment +of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +3. We did not design or maintain effective general information technology (“IT”) controls +over certain information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets. +Specifically, we did not design and implement: +· Program change management controls for certain financially +relevant systems to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, (ii) digital +currency mining equipment, (iii) digital currency hardware wallets, and (iv) underlying accounting records, are identified, tested, +authorized and implemented appropriately; and +· Physical security controls to ensure that the (i) digital +currency hardware wallets, (ii) digital currency hardware wallet master seed phrases, (iii) digital currency hardware wallet pin +codes, and (iv) the digital currency mining equipment were safeguarded, monitored, validated, and restorable, both physically and +electronically. +Planned Remediation +Management, +in coordination with the input, oversight and support of our Audit Committee, has identified the measures below to strengthen +our control environment and internal control over financial reporting. +In +January 2018 we hired a new Chief Financial Officer and engaged the services of a financial accounting advisory firm. In September +2018, we hired a Chief Accounting Officer and in January 2019, we hired a Senior Vice President of Finance. We have tasked these +individuals with expanding and monitoring the Company’s internal controls, to provide an additional level of review of complex +financial issues and to assist with financial reporting. Further, as we continue to expand our internal accounting department, +the Chairman of the Audit Committee shall perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, +· reviews all anticipated transactions that are not considered in the ordinary course of business +to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in our financial statements +We +are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address +the material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls +and procedures. +This Annual Report +does not include an attestation report of our independent registered public accounting firm regarding internal control over financial +reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant +to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated +filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +51 +Changes in Internal Control over Financial +Reporting +During the most recent +fiscal quarter 2018 there were no significant changes in our internal control over financial reporting (as such term is defined +in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect +our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2018/0001214659-19-002759/rp_note.txt b/raw/filings/0000896493/2018/0001214659-19-002759/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..1c4c7002bd4a3bc451142d6a27a025fa6515e2c1 --- /dev/null +++ b/raw/filings/0000896493/2018/0001214659-19-002759/rp_note.txt @@ -0,0 +1,94 @@ +26. RELATED PARTY TRANSACTIONS +a. The Company has made a strategic investment in AVLP in expectation of future business generated +by the Company from MTIX Ltd., an advanced materials and processing technology company located in Huddersfield, West Yorkshire, +UK (“MTIX”), a wholly-owned subsidiary of AVLP. The Company’s investments in AVLP consist of convertible promissory +notes, warrants and shares of common stock of AVLP. On September 6, 2017, the Company and AVLP entered into a Loan and Security +Agreement (“AVLP Loan Agreement”) with an effective date of August 21, 2017 pursuant to which the Company +will provide AVLP a non-revolving credit facility of up to $10 million for a period ending on August 21, 2019, subject to the terms +and conditions stated in the Loan Agreement, including that the Company having available funds to grant such credit. At December +31, 2018, the Company has provided loans to AVLP in the principal amount $6,943,997 and, in addition to the 12% convertible promissory +notes, AVLP has issued to the Company warrants to purchase 13,887,994 shares of AVLP common stock. Under the terms of the AVLP +Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. As of December 31, 2018 and 2017, the Company recorded +contractual interest receivable attributed to the AVLP Loan Agreement of $1,004,317 and $324,000, respectively. +During the year ended December +31, 2018 and 2017, the Company also acquired in the +open market 430,942 shares of AVLP common stock for $417,169 and 221,333 shares of AVLP common stock for $191,782 respectively. +At December 31, 2018, the closing market price of AVLP’s common stock was $0.90, a decline from $1.75 at December 31, 2017. +The Company has determined that its investment in AVLP marketable equity securities are accounted for pursuant to the fair value +method and based upon the closing market price of common stock at December 31, 2018, the amount of the Company’s unrealized +gain is $119,329. +Philou is AVLP’s controlling +stockholder. Mr. Ault is Chairman of AVLP’s Board of Directors and the Chairman of the Company’s Board of Directors. +Mr. William B. Horne is the Chief Financial Officer of AVLP and the Chief Financial Officer and a director of the Company. +During the years ended December +31, 2018 and 2017, the Company recognized $3,907,280 and $173,751, respectively, in revenues resulting from its relationship with +MTIX, which was acquired by AVLP on August 22, 2017 and is therefore deemed to be a related party. In March 2017, the Company was +awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement +(“MLSE”) plasma-laser system. Management believes that the MLSE purchase order will be a source of revenue and generate +significant cash flows for the Company. However, at December 31, 2018, $3,887,000 in revenues recognized during the years ended +December 31, 2018 and 2017, had not yet been received and was reflected on the financial statements as accounts receivable, related +party. Subsequent to year end the Company received $2,676,219 for manufacturing services performed on the first MLSE system. +b. +On April 13, 2018, the Company entered into an amended and restated consulting agreement with Mr. Ault +pursuant to which the parties thereto agreed to amend and restate that certain independent contractor agreement dated September +22, 2016, by and between the Company and Mr. Ault. In +accordance with the terms set forth in the Agreement, Mr. Ault shall continue to serve as the Company’s Chief Executive Officer +and Chairman of the Board of Directors in consideration of a monthly fee of $33,333, effective November 15, 2017. On June 17, 2018, +the Company entered into a ten-year executive employment agreement with Mr. Ault. For his services, Mr. Ault will be paid +a base salary of $400,000 per annum. For his services, Mr. Ault was paid $400,000 and $207,500, respectively, during the years +ended December 31, 2018 and 2017. +F- 68 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 +c. On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou. Pursuant +to the terms of the Preferred Stock Purchase Agreement, Philou may invest up to $5,000,000 in the Company through the purchase +of Series B Preferred Stock over 36 months. Philou has purchased 125,000 shares of Series +B Preferred Stock pursuant to the terms of the Purchase Agreement, the most recent purchase having occurred on April 24, 2018 for +the purchase of 25,000 shares of Series B Preferred Stock . +d. Between July 6, 2017 and September 30, 2018, Milton C. Ault, III, the Company’s Chairman +and Chief Executive Officer, personally guaranteed the repayment of (i) $8,218,000 from the sale of Advances on Future Receipts +(ii) and $4,781,000 from the sale of the promissory notes. These personal guarantees were necessary to facilitate the consummation +of these financing transactions. Mr. Ault’s payment obligations would be triggered if the Company failed to perform under +these financing obligations. Our board of directors has agreed to compensate Mr. Ault for his personal guarantees. The amount of +annual compensation for each of these guarantees, which will be in the form of non-cash compensation, is approximately 1.5% of +the amount of the obligation. +e. During the year ended December 31, 2017, DP Lending made loans to Alzamend Neuro, Inc. (“Alzamend”), +in the amount of $44,000. AVLP is a party to a management services agreement pursuant to which AVLP provides management, consulting +and financial services to Alzamend. The outstanding principal under these loans was repaid during 2018. As additional consideration, +the Company received a warrant to purchase 22,000 shares of Alzamend’s common stock at an exercise price of $0.30 per share +of common stock. +f. +On +December 5, 2017, the Company entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson +two convertible promissory notes in the principal amount of $600,000 (“Note A”) and $1,667,766 (“Note B”), +in exchange for cancellation of amounts due to WT Johnson by MTIX Ltd., a related party of the Company. +During December 2017, the Company +issued 30,000 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently sold +the 30,000 shares. The proceeds from the sale of Note A were sufficient to satisfy the entire $2,267,766 obligation as well as +an additional $400,500 of value added tax due to WT Johnson. Concurrent with entering into the exchange agreement, the Company +received a promissory note in the amount of $2,667,766 from MTIX. At December 31, 2017, the Company has valued the note receivable +at $600,000, the carrying amount of Note A. The Company will recognize the remainder of the amount due from MTIX upon payment of +the promissory note by MTIX. +g. +Between May 5, 2017 and June 30, 2017, the Company received additional short-term loans of $140,000 from +four accredited investors of which $75,000 was from the Company’s corporate counsel, a related party. As additional consideration, +the investors received five-year warrants to purchase 11,219 shares of common stock at a weighted average exercise price of $15.40 +per share. On June 28, 2017, $52,000 in short-term loans that was received from the related party was converted into one of +the Series C Units (See Note 24) and on July 24, 2017, the remaining $23,000 in short-term loans was converted in 2,091 shares +of the Company’s common stock in conjunction with +the subscription agreements that the Company entered into with six investors (See Note 20h). +h. During the year ended December 31, 2017, our President, Amos Kohn, purchased certain real property +that will serve as a facility for the Company’s business operations in Israel. The Company made $300,000 of payments to the +seller of the property and received a 28% undivided interest in the real property (“Property’). The Company’s +subsidiary, Coolisys, entered into a Trust Agreement and Tenancy In Common Agreement with Roni Kohn, who owns a 72% interest in +the Property, is the daughter of Mr. Kohn and is an Israeli citizen. The Property was purchased to serve as a residence/office +facility for the Company in order to oversee its European operations and to expand its business in the hi-tech industry located +in Israel. Pursuant to the Trust Agreement, Ms. Kohn will hold and manage Coolisys’ undivided 28% interest in the Property. +The trust will be in effect until it is terminated by mutual agreement of the parties. During the term of the trust, the Ms. Kohn +will not sell, lease, sublease, transfer, grant, encumber, change or effect any other disposition with respect to the Property +or the Coolisys’ interest without the Company’s approval. +F- 69 +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018 \ No newline at end of file diff --git a/raw/filings/0000896493/2018/0001214659-19-002759/rpt_disclosure.txt b/raw/filings/0000896493/2018/0001214659-19-002759/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..6e4ae71d378cbfee1f1ffcf89197ed5afeeeb7f0 --- /dev/null +++ b/raw/filings/0000896493/2018/0001214659-19-002759/rpt_disclosure.txt @@ -0,0 +1,121 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. On September 22, 2016, Philou +Ventures became our largest stockholder when it acquired all of the common stock of a prior stockholder, Telkoor Telecom, Ltd. +Philou Ventures’ Manager is Kristine L. Ault, a former director. Ms. Ault is the spouse of Milton C. Ault, III, who is our +Chief Executive Officer and Chairman of the Board. +Philou Ventures, LLC +On March 9, 2017, we +entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Philou Ventures. Philou Ventures +is the Company’s largest single stockholder. Milton C. Ault is the Chief Executive Officer of Ault & Company, the Manager +of Philou Ventures. Pursuant to the terms of the Purchase Agreement, Philou Ventures may invest up to $5,000,000 in us through +the purchase of Series B Preferred Stock (“Preferred Stock”) over the Term, as specified herein. Each share of Preferred +Stock shall be purchased at $10.00 up to a maximum issuance of 500,000 shares of Preferred Stock. Philou Ventures guaranteed to +purchase by May 31, 2017, the greater of: (i) 100,000 shares of Preferred Stock or (ii) a sufficient number of shares of Preferred +Stock to ensure that we have sufficient stockholders’ equity to meet the minimum continued listing standards of the NYSE +American. In addition, for as long as the Preferred Stock is outstanding, Philou Ventures agrees to purchase additional shares +of Preferred Stock in a sufficient amount in order us to meet the NYSE American’s minimum stockholders’ equity continued +listing requirement subject to the maximum number of 500,000 shares of Preferred Stock (collectively, “Guaranteed Purchases”). +In addition, at any time during the Term, Philou Ventures may in its sole and absolute discretion purchase additional shares of +Preferred Stock, up to the 500,000 share maximum (“Voluntary Purchases”). All consideration for Voluntary Purchases +shall be delivered through a series of varying payments (“Payments”) by Philou Ventures, at its sole and absolute discretion, +during the period commencing on the closing date and ending 36 months therefrom (the “Term”). We have the right to +request, with 90-day written notice to Philou Ventures, that Guaranteed Purchases be accelerated to meet deadlines for maintaining +the minimum stockholders’ equity required by the NYSE American. The Preferred Stock shall not be callable by us for 25 years +from the closing date. +In addition, for each +share of Preferred Stock purchased by Philou Ventures, Philou Ventures will receive warrants to purchase shares of common stock +in a number equal to the stated value of each share of Preferred Stock of $10.00 purchased divided by $0.70 at an exercise price +equal to $14.00 per share of common stock +Further, Philou Ventures +shall have the right to participate in our future financings under substantially the same terms and conditions as other investors +in those respective financings in order to maintain its then percentage ownership interest. Philou Ventures’ right to participate +in such financings shall accrue and accumulate provided that it still owns at least 100,000 shares of Preferred Stock. +On December 29, 2016, +MCKEA Holdings, LLC ( “ MCKEA ”) lent us $250,000 in the form of a demand note bearing simple interest at +6.0%. MCKEA is the majority member of Philou Ventures, LLC, which is the Company’s controlling stockholder. Kristine L. Ault, +a former director and the wife of Milton C. Ault III, Chief Executive Officer and Chairman of the Company’s Board of Directors, +is the manager and owner of MCKEA. On March 24, 2017, MCKEA cancelled the $250,000 demand note to purchase 25,000 shares of Preferred +Stock and received warrants to purchase 25,510 shares of common stock at $14.00 per share. +62 +On March 20, 2017, +Philou arranged for the Company to receive a $250,000 short-term loan. Between May 5, 2017 and June 2, 2017, Philou purchased an +additional 75,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of the +cancellation of the Company debt due to Philou from the $250,000 short term loan and cash of $500,000. In addition, Philou received +warrants to purchase 76,531 shares of common stock at an exercise price of $14.00 per share of common stock. On April 24, 2018, +Philou purchased an additional 25,000 shares of Series B Preferred Stock in consideration of the cancellation of short-term advances +due to Philou in the aggregate amount of $250,000. In addition, Philou received warrants to purchase 25,510 shares of common stock +at an exercise price of $14.00 per share of common stock. +Avalanche International, Corp. +On October 5, 2016, +November 30, 2016, and February 22, 2017, the Company entered into three 12% Convertible Promissory Notes with Avalanche (the +“ AVLP Notes ”) in the principal amount of $525,000 each. The AVLP Notes included a 5% original issue discount, +resulting in net loans to Avalanche of $1,500,000 and an original issue discount of $75,000. The AVLP notes accrued interest at +12% per annum and were due on or before two years from the origination dates of each note. The Company had the right, at its option, +to convert all or any portion of the principal and accrued interest into shares of common stock of Avalanche at approximately +$0.74536 per share. Subject to adjustment, the AVLP Notes, inclusive of the original issue discount, were convertible into 2,113,086 +shares of the Company’s common stock. During the period from March 29, 2017 to August 16, 2017, the Company funded $1,808,952 +in excess of the $1,500,000 net loan amount required pursuant to the terms of the AVLP Notes +On September 6, 2017, +the Company and Avalanche entered into a Loan and Security Agreement (“ AVLP Loan Agreement ”) with an effective +date of August 21, 2017 pursuant to which the Company will provide Avalanche a non-revolving credit facility of up to +$5,000,000, inclusive of prior amounts loaned to AVLP, for a period ending on August 21, 2019. +In consideration of +entering into the AVLP Loan Agreement, the Company and Avalanche cancelled the AVLP Notes and consolidated the AVLP Notes and prior +advances totaling $3,308,952 plus original issue discount of $165,448 and issued a new Convertible Promissory Note in the aggregate +principal amount of $3,474,400 (the “ New Note ”) that is convertible into shares of Avalanche at a conversion +price of $0.50 per share. The New Note is due in two years and accrues interest at 12% per annum on the principal amount. Prior +interest accrued under the AVLP Notes and advances will continue to be an obligation of Avalanche. The New Note contains standard +events of defaults. In addition, concurrent to issuing the New Note, Avalanche issued to the Company a five-year warrant to purchase +6,948,800 shares of Avalanche Common Stock at $0.50 per share. Future advances under the AVLP Loan Agreement, which totaled $649,820 +at December 31, 2017, are evidenced by a convertible promissory note containing a conversion price feature of $0.50 per share and +warrant with an exercise price of $0.50 per share. Further, under the terms of the AVLP Loan Agreement, any notes issued by Avalanche +are secured by the assets of AVLP. +At December 31, 2017, +the Company had provided Avalanche with $4,124,220 pursuant to the non-revolving credit facility. The warrants issued in conjunction +with the non-revolving credit facility entitles the Company to purchase up to 8,248,440 shares of Avalanche common stock at an +exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary +stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Avalanche is a holding +company which on August 22, 2017, pursuant to the terms of a Share Exchange Agreement dated as of March 3, 2017, and as amended +on July 13, 2017 and August 21, 2017 (the “ Exchange Agreement ”) with MTIX Ltd., a company formed under the laws +of England and Wales (“ MTIX ”) and the three (3) stockholders of MTIX (the “ Sellers ”), Avalanche +completed its acquisition of MTIX. Upon the terms and subject to the conditions set forth in the Exchange Agreement, Avalanche +acquired MTIX from the Sellers through the transfer of all issued and outstanding ordinary shares of MTIX (the “ MTIX Shares ”) +by the Sellers to Avalanche in exchange (the “ Exchange ”) for the issuance by Avalanche of: (a) 7% secured convertible +promissory notes (individually, a “ Note” and collectively, the “Notes ”) in the aggregate +principal face amount of $9,500,000 to the Sellers in pro rata amounts commensurate with their current respective ownership percentages +of MTIX’s ordinary shares, (b) (i) $500,000 in cash, $50,000 of which was paid on October 26, 2016, and (ii) 100,000 shares +of Avalanche’s newly designated shares of Class B Convertible Preferred Stock (the “ Class B Shares ”) to +the principal stockholder of MTIX (the “ Majority Stockholder ”). +Milton C. Ault, III +and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors +of Avalanche. In addition, Philou Ventures is the controlling stockholder of Avalanche as well as our largest single stockholder. +MTIX Limited +MTIX has developed +a novel cost effective and environmentally friendly material synthesis technology for textile applications. Designed for global +textile manufacturers, the Multiplex Laser Surface Enhancement (“ MLSE ”) plasma-laser system uses a combination +of plasma and photonic energy to effect material synthesis of a substrate surface. The laser and gasses from the system deliver +a dry process to enhance the surface of fabric. During March 2017 the Company was awarded a 3-year, $50 million contract by MTIX +to manufacture, install and service the MLSE plasma-laser system. The Company has recognized $923,751 in revenue from MTIX, all +of which was reflected as accounts receivable, related party at December 31, 2017. +63 +On December 5, 2017, +the Company entered into an exchange agreement with WT Johnson & Sons (Huddersfield) Limited (the “ Holder ”), +pursuant to which the Company issued to the Holder, (a) a convertible promissory note in the principal amount of $600,000 (“ Note +A ”), and (b) a convertible promissory note in the principal amount of $1,667,766 (“ Note B ”), in exchange +for cancellation of (i) an outstanding loan made by the Holder to MTIX in the amount of $265,766; and (ii) cancellation of an aggregate +of $2,002,000 owed by MTIX to the Holder pursuant to an Agreement for the Sale and Purchase of a Textile Multi-Laser Enhancement +Technology Machine dated as of July 21, 2017 by and between MTIX and the Holder. +Note A is convertible +into the Company’s common stock at a conversion price of $1.00 per share, does not bear interest, and matures two years from +issuance. Note B is convertible into the Company’s common stock at a conversion price of $0.85 per share, does not bear interest, +and matures two years from issuance. However, the Holder shall not have the right to convert any portion of Note B, following +receipt by the Holder of an aggregate of $2,267,766 of gross proceeds from the sale of shares of Common Stock issued upon conversion +of Note A or Note B. +During December 2017, +the Company issued 600,000 shares of its common stock upon the conversion of Note A and the Holder notified the Company that gross +proceeds during the month of December 2017 from sales of the 30,000 shares of common stock were sufficient to satisfy the entire +$2,267,766 obligation. As a result of entering into the exchange agreement with the Holder, MTIX is obligated to pay the Company +$2,668,266, consisting of the amount of the exchange agreement of $2,267,766 and a value added tax of $400,500 from the sale of +the Textile Multi-Laser Enhancement Technology Machine. \ No newline at end of file diff --git a/raw/filings/0000896493/2019/0001214659-20-005205/filing.txt b/raw/filings/0000896493/2019/0001214659-20-005205/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..f556a622b83d3639f8aad65acf5e7262f4cd7bcd --- /dev/null +++ b/raw/filings/0000896493/2019/0001214659-20-005205/filing.txt @@ -0,0 +1,10050 @@ +10-K +1 +s51920110k.htm +UNITED STATES SECURITIES +AND EXCHANGE COMMISSION +Washington, +D.C. 20549 +FORM 10-K +ANNUAL REPORT PURSUANT TO SECTION 13 +OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the Fiscal Year Ended December 31, +2019 +Commission file number 1-12711 +DPW HOLDINGS, +INC. +(Exact name of registrant as specified in +its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +201 Shipyard Way, Suite E Newport Beach, CA +92663 +(949) 444-5464 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered under Section +12(b) of the Act: +Title of Each Class +Name of each exchange on which registered +Common Stock, $0.001 par value per share +NYSE American +Securities registered under Section +12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No +þ +Indicate +by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Exchange Act. Yes ¨ No +þ +Indicate +by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the +Securities Exchange Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file +such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No +¨ +Indicate +by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant +to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that +the registrant was required to submit such files). Yes þ No +¨ +Indicate by check mark whether the +registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging +growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting +company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ¨ +Accelerated filer ¨ +Non-accelerated filer ¨ +Smaller reporting company þ +Emerging growth company ¨ +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for +complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ +Indicate +by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness +of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered +public accounting firm that prepared or issued its audit report. ¨ +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No +þ +As of June 28, 2019, the aggregate market +value of the registrant’s common stock held by non-affiliates of the registrant was $12,357,300 based on the closing sale +price as reported on the NYSE American of $12.00. Such determination should not be deemed an admission that such directors, +officers, or 10% beneficial owners are, in fact, affiliates of the registrant. +There were 5,771,634 shares of common stock +outstanding as of May 25, 2020. +Documents incorporated by reference: +None +EXPLANATORY NOTE +The Company relied on the following order +issued by the Securities and Exchange Commission: +SECURITIES EXCHANGE ACT OF 1934 Release +No. 34-88318 / March 4, 2020 ORDER UNDER SECTION 36 OF THE SECURITIES EXCHANGE ACT OF 1934 GRANTING EXEMPTIONS FROM SPECIFIED PROVISIONS +OF THE EXCHANGE ACT AND CERTAIN RULES THEREUNDER +Which order was subsequently amended by: +SECURITIES EXCHANGE ACT OF 1934 Release +No. 34-88465 / March 25, 2020 ORDER UNDER SECTION 36 OF THE SECURITIES EXCHANGE ACT OF 1934 MODIFYING EXEMPTIONS FROM THE REPORTING +AND PROXY DELIVERY REQUIREMENTS FOR PUBLIC COMPANIES +Pursuant to the Order, on which the Company +has relied, the Company reports that the Company’s staff, working remotely because of the exigencies of COVID-19, was significantly +disrupted and accordingly the Company was unable to file this Annual Report by the prescribed filing date. +The Company also subsequently filed Form +12b-25 with respect to the delayed filing of the Form 10-K. +i +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +FORM 10-K +FOR THE FISCAL YEAR ENDED DECEMBER 31, +2019 +INDEX +Page +PART I +Item 1. +Description of Business +1 +Item 1A. +Risk Factors +13 +Item 1B. +Unresolved Staff Comments +36 +Item 2. +Description of Properties +36 +Item 3. +Legal Proceedings +36 +Item 4. +Mine Safety Disclosures +38 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +39 +Item 6. +Selected Financial Data +40 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +40 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk. +48 +Item 8. +Financial Statements and Supplementary Data. +F-1 – F-67 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +48 +Item 9A. +Controls and Procedures +48 +Item 9B. +Other Information +49 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +50 +Item 11. +Executive Compensation +54 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +59 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +60 +Item 14. +Principal Accountant Fees and Services +60 +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +62 +Item 16. +Form 10-K Summary +70 +Signatures +71 +Table of Contents +NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “ Annual +Report ”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section +21E of the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. +We have attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” +“expects,” “can,” “continue,” “could,” “estimates,” “expects,” +“intends,” “may,” “plans,” “potential,” “predict,” “should” +or “will” or the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties +and other factors may cause our actual results, levels of activity, performance or achievements to be materially different from +any future results, levels or activity, performance or achievements expressed or implied by these forward-looking statements. Although +we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, +levels of activity, performance or achievements. Our expectations are as of the date this Annual Report is filed, and we do not +intend to update any of the forward-looking statements after the date this Annual Report is filed to confirm these statements to +actual results, unless required by law. +This Annual Report also contains estimates +and other statistical data made by independent parties and by us relating to market size and growth and other industry data. This +data involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have +not independently verified the statistical and other industry data generated by independent parties and contained in this Annual +Report and, accordingly, we cannot guarantee their accuracy or completeness, though we do generally believe the data to be reliable. +In addition, projections, assumptions and estimates of our future performance and the future performance of the industries in +which we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those +described in “Risk Factors” and elsewhere in this Annual Report. These and other factors could cause results to differ +materially from those expressed in the estimates made by the independent parties and by us. +PART I +ITEM 1. BUSINESS +General +DPW Holdings, Inc. +is a diversified holding company that owns operating subsidiaries and divisions engaged in a number of diversified business operations +including the defense, aerospace, commercial, health/medical, finance and commercial lending sectors. The Company’s largest +subsidiary is Gresham Worldwide, which provides advanced bespoke military and commercial applications. The Company began implementing +its strategy in late 2016 led by its Chairman and CEO, Milton “Todd” Ault, III and Vice Chairman and CFO, William B. +Horne. The Company is presently led by its Executive Committee, the members of which are the Company’s Chairman and CEO, +Vice Chairman and Executive Vice President & General Counsel. +We operate as a holding +company with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed +an investment company under the Investment Company Act of 1940, as amended (the “ Investment Company Act ”). Generally, +this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total +assets will be invested in investment securities as such term is defined in the Investment Company Act. Pursuant to the Investment +Company Act, companies such as our subsidiary DP Lending are excluded from the definition of an investment company since its business +consists of making small loans and industrial banking. We also maintain a large investment in Avalanche International, Corp., which +does business as MTIX International. +Originally, we were +primarily a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power +system solutions for the medical, military, telecom and industrial markets. Although we are actively seeking growth through acquisitions, +we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where +customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating +conditions. +We have operations +located in Europe through our wholly-owned subsidiary, Gresham Power Electronics (f/k/a Digital Power Limited) (“ Gresham +Power ”), Salisbury, England. Gresham Power designs, manufactures and sells power products and system solutions mainly +for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters +and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution +products. +1 +Table of Contents +On November 30, 2016, +we formed DP Lending, a wholly-owned subsidiary. DP Lending provides commercial loans to companies throughout the United States +to provide them with operating capital to finance the growth of their businesses. The loans range in duration from six months to +three years, DP Lending operates under California Finance Lending License #60DBO-77905. +On June 2, 2017, we +purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is +a design-to-manufacture original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio +frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies +and detector logarithmic video amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. +Microphase is headquartered in Shelton, Connecticut. +On April 25, 2017, +we formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. Coolisys operates its existing +businesses in the customized and flexible power system solutions for the medical, military, telecom, commercial and industrial +markets, other than the European markets which are primarily served by Gresham Power, in Coolisys. We intend to reorganize our +corporate structure to make Digital Power North American operations, operated by our subsidiary Gresham, and Microphase, a subsidiary +of Coolisys and as such an indirect subsidiary of ours. +On September 1, 2017, +Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability +company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, +fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an +extended sales organization for our overall flexible power system solutions. +On +December 31, 2017, Coolisys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“ MICT ”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“ EML ”), +and Enertec Systems 2001 Ltd. (“ Enertec ”), an Israeli corporation and wholly owned subsidiary of EML, pursuant +to which Coolisys acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for +the military market. On May 23, 2018, Coolisys completed its acquisition of Enertec. +In +January 2018, we formed Super Crypto Mining, Inc., a wholly-owned subsidiary, which recently changed its name to Digital Farms, +Inc. (“ DFI ”). DFI was established to operate our newly formed cryptocurrency business, which is pursuing a variety +of digital currency. We mine the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin +and Ethereum. DFI’s operations were discontinued in the first quarter of 2020. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I. AM, Inc. (“ I. AM ”), +David J. Krause and Deborah J. Krause. Pursuant to the securities purchase agreement, I. AM sold to DP Lending, 981 shares of common +stock for a purchase price of $981, representing, upon the closing, 98.1% of I. AM’s outstanding common stock. I.AM owed +DP Lending $1,715,330 in outstanding principal, pursuant to a loan and security agreement, between I. AM and DP Lending. The purchase +agreement provides that, as I. AM repays the outstanding loan to DP Lending in accordance with the loan agreement, DP Lending will +on a pro rata basis transfer shares of common stock of I. AM to David J. Krause, up to an aggregate of 471 shares. I. +AM’s operations were discontinued in the first quarter of 2020. +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 201 Shipyard Way, Suite E Newport +Beach, CA 92663. Our phone number is (949) 444-5464 and our website address is www.dpwholdings.com. +Recent Events +On March 14, 2019, +the stockholders approved a proposal permitting the Board of Directors (the “ Board ”) to effect a reverse stock +split (the “ Reverse Split ”) of our issued and outstanding Common Stock. Thereafter, on March 14, 2019, the Board +approved the Reverse Split with a ratio of one for twenty. The Reverse Split did not affect the number of authorized shares of +Common Stock or their par value per share. As a result of the Reverse Split, the number of shares of Common Stock outstanding was +reduced from 126,025,767 to 6,301,289. The Reverse Split became effective in the State of Delaware on March 14, 2019. Beginning +on March 18, 2019, the Common Stock traded on the NYSE American on a split-adjusted basis. +On +March 29, 2019, we entered into an underwriting agreement with A.G.P./Alliance Global Partners (the “ Underwriter ”), +pursuant to which we agreed to issue and sell an aggregate of (a) 71,388 shares of Common Stock (the “ Offering Shares ”) +together with warrants to purchase 71,388 shares of Common Stock and (the “ Common Warrants ”) and (b) pre-funded warrants +to purchase up to 317,500 shares of our Common Stock (the “ Pre-Funded Warrants ”) together with a number +of Common Warrants to purchase 317,500 shares of Common Stock (the “ Offering ”). The Offering Shares were sold +to the purchasers at the public offering price of $17.60 per share (the “ Offering Price ”). The Common Warrants +were sold at a public offering price of $0.40 per Common Warrant. The Pre-Funded Warrants were offered to each purchaser whose +purchase of the Offering Shares and the Common Warrants in the Offering would otherwise result in the purchaser, together with +its affiliates and certain related parties, beneficially owning more than 4.99% of outstanding Common Stock immediately following +the consummation of the Offering, in lieu of the Offering Shares. The purchase price of each Pre-Funded Warrants equaled the Offering +Price, minus $0.40, and the exercise price of each Pre-Funded Warrant equaled $0.40 per share. In addition, we also issued the +Underwriter a warrant to purchase a maximum of 15,550 additional shares of Common Stock at an initial exercise price of $19.80 +per share, with a term of five years. +2 +Table of Contents +On +May 13, 2019, we entered into a Note Purchase Agreement, whereby we sold and issued to an investor a promissory note in the +principal amount of $575,000 (the “ First Note ”) for the purchase price of $500,000, plus a 15% loan fee in the +amount of $75,000. The principal amount shall be due and payable on or prior to August 9, 2019, subject to extensions as set forth +in the First Note. Subsequently, on May 21, 2019, we entered into a second Note Purchase Agreement, pursuant to which we sold and +issued an additional promissory note in the principal amount of $230,000 (the “ Second Note ”), for a purchase +price of $200,000, plus a 15% loan fee in the amount of $30,000. An aggregate total of $700,000 has been raised from these two +notes. The principal amount of the Second Note shall be due and payable on or prior to August 21, 2021, subject to extensions as +set forth therein. These notes do not accrue any interest and may be prepaid by the Company at any time, without notice, premium +or penalty. At present, we owe approximately $60,000 to this investor. +On +May 20, 2019, we entered into a Securities Purchase Agreement with an institutional investor to sell, for a purchase price of $500,000, +a 4% Original Issue Discount Convertible Promissory Note (the “ May 2019 Note ”) with an aggregate principal face +amount of $660,000 and a warrant to purchase an aggregate of 12,500 shares, subject to adjustment of our Common Stock. The principal +of the May 2019 Note and interest earned thereon may be converted into shares of our Common Stock at $8.80 per share, subject to +adjustment. The exercise price of the warrant is $12.00 per share, subject to adjustment. The issuance of shares of our Common +Stock upon conversion of the May 2019 Note and exercise of the warrant was subject to approval by the NYSE American, which approval +was obtained. In addition, our Chief Executive Officer provided a personal guarantee for the Company’s obligation to repay +the May 2019 Note. +On +June 18, 2019 we entered into a Securities Purchase Agreement with Dominion Capital, LLC (“ Dominion ”) to consummate +a refinancing (the “ Refinancing ”) pursuant to which, in consideration for the extinguishment of a 10% convertible +note dated May 15, 2018, with a remaining balance due of $1,800,000, we (i) sold a 10% Senior Secured Promissory Note with a principal +face amount of $2,800,000, plus an original issue discount in the amount of $100,000 and (ii) issued 12,500 shares of our Common +Stock subject to the approval thereof by the NYSE American, which approval was obtained. In addition, Ault & Company, Inc. +guaranteed to Dominion and its successors, endorsees, transferees and assigns, the prompt and complete payment and performance +when due (whether at the stated maturity, by acceleration or otherwise) of our obligations pursuant to the Refinancing. +On +July 2, 2019 we entered into an exchange agreement with Bellridge Capital, LP (“ Bellridge ”), pursuant to which, +in exchange for a term promissory note issued by us to Bellridge on September 21, 2018 in the principal face amount of $526,316, +we sold to Bellridge a new convertible promissory note in the principal amount of $783,031 with an interest rate of 12% per annum +and a maturity date of December 31, 2019. This note was convertible into shares of Common Stock, commencing on July 15, 2019, at +conversion price equal to the greater of (A) $8.80 or (B) 80% of the lowest daily VWAP in the three trading days prior to the date +of conversion. On September 26, 2019, we entered into a second exchange agreement with Bellridge pursuant to which, in exchange +for the note referred to immediately above (the “ Prior Note ”), we sold to Bellridge a new convertible promissory +note in the principal amount of $815,218 with an interest rate of 12% per annum (the “ New Note ”). The New Note +is convertible into shares of Common Stock (the “ Conversion Shares ”), commencing on October 31, 2019, at conversion +price equal to $4.00 (the “ Conversion Price ”), or 203,805 such shares. In connection with this exchange agreement, +we and Bellridge entered into a forbearance agreement pursuant to which Bellridge agreed to forbear through the close of business +on October 31, 2019 from exercising the rights and remedies it is entitled to under the Prior Note, and any and all transaction +documents related thereto, in consideration for our issuance of the New Note. +On +July 2, 2019, we entered into an exchange agreement with an institutional investor pursuant to which, in exchange for (i) a term +promissory note issued by DP Lending to the investor on August 10, 2018 in the principal face amount of $550,000 and (ii) a term +promissory note issued by us on August 16, 2018, as amended on November 29, 2018, in the principal face amount of $318,150, we +sold to the investor a new convertible promissory note in the principal amount of $1,250,000 (subject to adjustments) with an interest +rate of 8% per annum and a maturity date of December 31, 2019. This note was convertible into shares of Common Stock at a conversion +price of $8.80. As a result of the ACM Sales Agreement discussed below, commencing on the first day of the ACM ATM Offering, the +conversion price of the investor’s note was reduced to $4.00 per share. +On +July 3, 2019, we entered into an exchange agreement with an institutional investor pursuant to which, in exchange for a term promissory +note issued by us to the investor on March 23, 2018 in the principal face amount of $1,000,000, we sold (i) a convertible promissory +note in the principal face amount of $1,292,000 plus a default premium of $200,000, and (ii) a five-year warrant to purchase up +to 25,000 shares of our Common Stock at an exercise price of $8.80 per share. This convertible promissory note is in the aggregate +principal amount of $1,492,000 and bears interest at 12% per annum, which principal and all accrued and unpaid interest are due +on January 22, 2020, and which interest is payable in cash, in arrears, on the first business day of each month, with the first +payment of interest due on August 1, 2019. Commencing on July 15, 2019, subject to certain beneficial ownership limitations, the +investor may convert the principal amount of this note and accrued interest earned thereon at any time into shares of our Common +Stock at $8.80 per share. During the year ended December 31, 2019, we issued 99,753 shares of our common stock in payment of principal +and interest in the amount of $877,837. +3 +Table of Contents +On July 19, 2019, the +stockholders approved a proposal permitting the Board of Directors to effect a reverse stock split (the “ Reverse Split ”) +of our issued and outstanding Common Stock. Thereafter, on July 23, 2019, the Board of Directors approved the Reverse Split with +a ratio of one for forty. The Reverse Split did not affect the number of authorized shares of Common Stock or their par value per +share. As a result of the Reverse Split, the number of shares of Common Stock outstanding was reduced from 43,124,144 to 1,078,104. +The Reverse Split became effective in the State of Delaware on August 5, 2019. Beginning on August 6, 2019, the Common Stock traded +on the NYSE American on a split-adjusted basis. All references to Common Stock in this Annual Report have been retroactively restated. +On August 6, 2019, +we entered into an At-The-Market Issuance Sales Agreement (the “ ACM Sales Agreement ”) with Ascendiant Capital +Markets, LLC, as sales agent (the “ Agent ”) to sell shares of Common Stock having an aggregate offering price +of up to $5,500,000 (the “ Shares ”) from time to time, through an “at the market offering” program +(the “ ACM ATM Offering ”). The offer and sale of the Shares was made pursuant to the Company’s effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration +Statement No. 333-222132) filed with the SEC on December 18, 2017, as amended on January 8, 2018, and declared effective by +the SEC on January 11, 2018, and a prospectus supplement related to the ACM ATM Offering, dated August 6, 2019. +On +November 4, 2019 we entered into an exchange agreement with a lender pursuant to which, in exchange for a term promissory note +issued by us to the investor on July 25, 2019 in the principal face amount of $250,000 we sold a convertible promissory note in +the principal face amount of $350,000. This convertible promissory note bears interest at 12% per annum, which principal and all +accrued and unpaid interest are due on July 4, 2020. The lender may convert the principal amount of this note and accrued interest +earned thereon into shares of our Common Stock at $1.20 per share beginning six months from the issuance date of the term promissory +note. +During +November 2019, we entered into a short term promissory note in the aggregate principal amount of $360,000. The promissory note +contained an original issue discount of $60,000 resulting in net proceeds of $300,000. The interest rate on the promissory note +is 12% per annum and is payable on the maturity date, February 14, 2020. +On +November 15, 2019, we entered into an exchange agreement with a lender pursuant to which, in exchange for those certain promissory +notes (i) in the original principal amount of $575,000 issued on May 10, 2019, and (ii) in the original principal amount of $230,000 +issued on May 21, 2019 (collectively, the “ Original Note ”), we sold a convertible promissory note in the principal +face amount of $935,772. This convertible promissory note bears interest at 8% per annum, which principal and all accrued and unpaid +interest are due on November 15, 2020. Subject to certain beneficial ownership limitations, the lender may convert the principal +amount of this note and accrued interest earned thereon at any time into shares of our Common Stock at $1.80 per share. +Commencing in October +and continuing through February of 2020, the Company reorganized its corporate structure pursuant to a series of transactions by +and among the Company and its directly and indirectly owned subsidiaries. The purpose of the reorganization was to align the Company’s +various businesses by the products and services that constitute the majority of each subsidiaries’ revenues. As a result +of the foregoing transactions, the Company’s corporate structure is as follows: +4 +Table of Contents +On January 7, 2020, +we formed Coolisys Technologies Corp. (“ CTC ”) in order to hold Digital Power Corporation. Coolisys is presently +owned by GWW and owns Microphase Corporation, Gresham Power Electronics and Enertec Systems. We may dispose of Coolisys in the +future, leaving GWW as the direct owner of the three foregoing subsidiaries. +On December 23, 2019, +the Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of +the NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. +As a result, at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, +or up to 19.99% of the Common Stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, shall +be due and payable on August 5, 2020. The Note shall be convertible into shares of the Company’s common stock, par value +$0.001 per share (the “ Common Stock ”) at a conversion price of +$1.45 per share, subject to the approval of the Company’s stockholders at a special meeting thereof, as required by Rule +713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American. This special meeting is presently +scheduled to occur on June 8, 2020. +On February 10, 2020, +we entered into a Master Exchange Agreement (the “ Exchange Agreement ”) with Esousa Holdings, LLC (the “ Credito r”) +that acquired approximately $4.2 million dollars in principal amount, plus accrued but unpaid interest, of certain promissory notes +that had been previously issued by us to Dominion Capital, LLC, a Connecticut limited liability company (the “ Dominion +Note ”) and the Canadian Special Opportunity Fund, LP (the “ CSOF Note ” and with the Dominion Note, +the “ Purchased Notes ”) in separate transactions. The Creditor also agreed to purchase additional notes up to +an additional principal amount, plus accrued but unpaid interest, of $3.5 million (the “ Additional Notes ” and +collectively, with the Purchased Notes, the “ Notes ”). Pursuant to the Exchange Agreement, the Creditor has the +unilateral right to acquire, among other things set forth therein, shares of the Company’s common stock (the “ Exchange +Shares ”) in exchange for the Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness +of the Company. This special meeting is presently scheduled to occur on June 8, 2020. +Settlement of Derivative Litigation +As previously announced, +on February 24, 2020, we entered into a definitive settlement agreement (the “ Settlement Agreement ”) that is +intended to settle the previously disclosed derivative litigation captioned Ethan Young and Greg Young, Derivatively on Behalf +of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, +Robert O. Smith, and Kristine Ault and DPW Holdings, Inc., as the nominal defendant (Case No. 18-cv-6587) (as amended on March +11, 2019, the “ Amended Complaint ”) against the Company and certain of its officers and directors pending in +the United States District Court for the Central District of California (the “ Court ”). As previously disclosed, +the Amended Complaint alleges violations including breaches of fiduciary duties and unjust enrichment claims based on the previously +pled transactions. +5 +Table of Contents +On April 15, 2020, +the Court issued an Order (the “ Order ”) approving a Motion for Preliminary Approval of Settlement in the Derivative +Action filed against DPW as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018. +Under the terms of +the Order approving the Agreement, the Board shall adopt and/or maintain resolutions and amendments to committee charters and/or +the Company’s bylaws to ensure adherence to certain corporate governance policies (collectively, the “ Reforms ”), +which shall remain in effect for no less than five (5) years, subject to any of the following: (a) a determination by a majority +of the independent directors that the Reform is no longer in the best interest of the Company, including, but not limited to, due +to circumstances making the Reform no longer applicable, feasible, or available on commercially reasonable terms, or (b) modifications +which the Company reasonably believes are required by applicable law or regulation. +In connection with +the Settlement Agreement, the parties have agreed upon a payment of attorneys’ fees in the amount of $600,000 payable by +the Company’s Director & Officer liability insurance. The Settlement Agreement contains no admission of wrongdoing. The +Company has always maintained and continues to believe that it did not engage in any wrongdoing or otherwise commit any violation +of federal or state securities laws or other laws. While the Settlement Agreement has been approved by the Court, there can be +no assurance that the settlement will be finalized and approved by the Court or properly objected to by any shareholders and, even +if approved, whether the conditions to closing will be satisfied, and the actual outcome of this matter may differ materially from +the terms of the settlement described herein. +Strategy +Our strategy to increase +revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business +of power system solutions for the military/aerospace, medical and industrial-telecommunication industries, we have determined that +significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient +sales and marketing force as a result of deferring research and development of new products because of limited working capital, +and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution +companies. +Therefore, we believe +that the best strategy for us and our stockholders is to invest in our core business to support releases of advanced new power +technologies and to expand our customer base and market share in our major markets. To support the organic growth, we have hired +a number of additional personnel and are investing to enhance our product offerings with state of the art technology. While we +implement our new organic growth strategy, we are focusing on finding and acquiring companies that have developed new technology +but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack +of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies +that enhance our overall revenues. Further, as discussed below, we have made an investment in Avalanche which acquired the rights +to a cost effective and environmentally friendly material synthesis technology for textile applications. +As a result of this +strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, +analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions +and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they +can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase +in infrastructure expenses and investing in companies that demonstrate revenue potential but are initially incurring losses, we +anticipate continuing to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Led by our Chairman +and CEO, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global impact. +We also use a traditional methodology for valuing stocks that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from +influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s Vice Chairman and CFO and Henry +Nisser, the Company’s General Counsel and Executive Vice President, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +During the next several +years, we see a favorable opportunity to follow an activist strategy that centers on the purchase of target stock and the subsequent +removal of any barriers that might interfere with a friendly purchase offer from a strong buyer. Alternatively, in appropriate +circumstances, we or our subsidiaries may become the buyer of target companies, adding them to our portfolio of operating subsidiaries, +thereby expanding our operations through such opportunistic acquisitions. We believe that the companies that we target for our +activist activities are undervalued for many reasons, often including inexperienced management. Unfortunately for the individual +investor, in particular, and the economy, in general, many poor management teams are often unaccountable and very difficult to +remove. +6 +Table of Contents +Markets +We sell our custom +power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse +range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our +current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve +the North American power electronics market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas +the European marketplace is served through DPL, another wholly-owned subsidiary. +We sell products to +our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our +sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship +with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding +new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional +sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market +share through 2019. +Commercial Customers . +We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of +applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally +extreme environmental conditions. +Military/Defense +Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the +ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications +and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture +our military products through a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ ITAR ”) +and is certified to perform such manufacturing services. We are compliant with the ITAR regulations and are an approved vendor +for the U.S. Air Force, Navy and Army. +At the core of every +military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will +operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, +function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; +Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications +and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned +Aerial Vehicle) – Very lightweight power systems. +Our military products +meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, +weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges +that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our +power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary +Gresham Power develops and manufactures some military and defense products mainly being deployed in several naval fleets. +Our Subsidiaries and their Businesses +Coolisys Technologies Corp. and Digital +Power Corporation +We provide the highest +density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and +modify-standard product solutions and value-added services to diverse industries and markets including military/aerospace, medical +and industrial- telecommunications. We believe that our solutions leverage a combination of low leakage power emissions, +very high-power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy with +respect to Coolisys Technologies Corp. or CTC, is to be the supplier of choice to companies, including OEMs, that require high-quality +power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical +to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach +a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship +with us that supports all of their needs for designing and manufacturing power solutions and products. By implementing our advanced +core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing +their existing power sources with our custom design cost-effective products. Our target market segments include the industrial +telecommunication, medical, and military/aerospace industries. +7 +Table of Contents +Custom Power +System Solution. We provide high-grade custom power system solutions to several customers in multiple +industry segments. Our custom solution technology includes full Digital Signal Processing (“ DSP ”) control, digital +load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and +multiple outputs to meet each of our customers’ unique requirements. We combine our power design capabilities with the latest +circuit designs to provide complete power solutions for virtually any plausible need. In the design of custom power solutions, +we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with +any hosted platform. +Our standard contract +for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production +guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes +the development of our intellectual property (“ IP ”) portfolio. We believe that this business model +provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility +Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade +design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) +and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While +some of our customers have special requirements that include a full custom design, other customers may require only certain electrical +changes to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical +repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can +be easily integrated with any platform across our diversified market segments. +Value-Added Services . +In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added +services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance +components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment +and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would +otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus +eliminating the need for complex, time-consuming and costly system integration. We believe that this value-added service is well +suited to those OEMs that wish to reduce their vendor base and minimize their investment in manufacturing, which would lead to +increased fixed costs. Given access to these value-added services, the OEMs do not need to build assembly facilities to manufacture +their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Gresham Power Electronics (formerly +known as Digital Power Limited) +Gresham Power Electronics, +our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom, designs, manufactures, and distributes switching +power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters for the commercial +and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships to convert +their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such +as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, +higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these +as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, +provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +Microphase Corporation +Microphase designs, +manufactures and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication +systems. Such components include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, +switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s +customers are comprised of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors +and sub-contractors. Microphase’s recent technology innovations are used in many significant U.S. Government defense programs, +including the Polaris submarine, the F-16, the F-35 and the Predator drone. Other notable programs in which Microphase’s +products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile +System, THAAD (or Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, +EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint strike fighter plane, and more recently drone programs including +the Predator, the Reaper and the Shadow. +Microphase’s +advanced technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in +order to accurately recover the signals and facilitate use of the information received. These products include: +· filters that sort and clarify microwave signals, including multiplexers that are a series of filters +combined in a single package; +· solid state amplifiers that amplify microwave signals; +· detectors and limiters that are semiconductor devices for detection of radar signals and protection +of receivers from damage from high power signals and jamming; +8 +Table of Contents +· detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal +detection systems; +· integrated assemblies that combine multiple functions from a range of components and devices, including +transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction +assemblies; +· electronic test and measurement probes; +· universal test and measurement test platforms and fixtures; and +· utility probes and antenna probes. +Manufacturing and Testing +Consistent with our +strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of +flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers +to ensure that they will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships +will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power +supply industry has placed continual downward pressure on selling prices. In order to achieve our low-cost manufacturing goals +with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and +in Asia. +We are continually +improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and +consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test +procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies +right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within +our customer applications. +Compliance with international +safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. +Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements +and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract +manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where +specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we +market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“ RoHS ”), +which restricts the use of six hazardous materials in the manufacturing of certain electronic and electrical equipment, as well +as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), which determines collection, +recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements +in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components +may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products +are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only +the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export +of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject +to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for +products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating +results. Further, additional restrictions or charges may in the future be imposed by the United States or any other foreign country. +In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs +that are funded and governed by the U.S. Foreign Military Financing program. +Enertec Systems 2001 Ltd. +Based in Israel, Enertec +designs, develops, manufactures and maintains advanced end-to-end high technology electronic solutions for military, medical, telecommunications +and industrial markets. Those solutions include custom computer-based automated test equipment and turnkey systems to ensure combat +readiness, provide command and control, and direct and deploy resources in military operations in harsh environments and battlefield +conditions. The Company also designs, develops, manufactures and maintains high precision calibration equipment for lifesaving +medical operations for a global health care products company as well as advance power systems for electric vehicle, telecom and +other industrial applications. Enertec delivers complete end-to-end project management with requirements definition, systems engineering, +design/development, production, testing, integration, field support, maintenance and optimization. Its custom engineered solutions +enable and support mission critical air, land and sea military platforms, e.g., missiles, UAVs, combat aircraft, boats, submarines, +trailers and satellites. +9 +Table of Contents +Enertec’s primary +customers include the Israeli Ministry of Defense and the 3 major defense contractors in Israel – Israel Air Industries (IAI), +Rafael and Elbit Systems. In addition, Enertec has a strategic partnership with Cyient to build and deliver solutions for the Indian +military. High tech capabilities to deliver advance electronics solutions create opportunities for other Gresham Worldwide operating +subsidiaries – Microphase and Gresham Power – to supply components for Enertec solutions. Enertec also provides geographic +reach into the Middle East and India to broaden Gresham WorldWide’s footprint in delivering the highest quality and most +advance technology solutions across the globe. +Sales and Marketing +We market our products +directly through our internal sales force as well as through our channel partners including independent manufacturer representatives +and distributors. Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, +the manufacturing representatives have the opportunity to earn exclusive access to all potential customers in the assigned territory +as a result of achieving their marketing and sales goals as defined in the representative agreement. Our manufacturer representative +agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales +for retention, payable after products are shipped to the customer in the assigned territory. Typically, either we or the manufacturing +representatives are entitled to terminate the manufacturing representative agreement upon 30 days’ written notice. +We provide comprehensive +collateral including product data sheets, participation in trade shows, and our websites, www.digipwr.com and www.microphase.com. We +use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our websites +and accessible to the marketplace. We will continue to enhance our websites by adding more features and functionalities, such as +e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities +will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and +product development efforts are primarily directed toward developing new products in connection with custom product design and +modification of our standard power systems to provide a broad array of individual models. +Our new custom product +solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports +special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that +we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development +contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production +forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development +of our IP portfolio. +We also outsource some +of our product development projects to engineering partners in order to achieve the best technological and product design results +for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, +including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on +commercial off the shelf (“ COTS ”) products and for other customized product requirements, when applicable. We +continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market +demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) +filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and +customizing our existing product portfolio, using our engineering integrating laboratory located in California. +Competition +The power system solutions +industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located +throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer +products superior or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, +TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and +geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition +efforts with our customers. We also face competition from current and prospective customers who may decide to internally design +and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with +larger power supply manufacturers. +We anticipate in the +current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could +thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell +our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by +providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously +improving quality and reliability levels, and offering flexible and reliable delivery schedules. +10 +Table of Contents +We believe that our +power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the +latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume +ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures +to meet our customers’ requirements. +Another advantage of +our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a +selectable number of output product design platforms. We believe we have a competitive position with our targeted customers that +need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have +designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power +needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power +systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs +on “time to market.” It also results in very low non-recurring engineering (“ NRE ”) expenses. Because +of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s +specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE +expenses. +The markets in which +Microphase operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors +are larger than it is and maintain higher levels of expenditures for research and development. Principal competitive factors in +Microphase’s markets are product quality and reliability; technological capabilities; service; past performance; ability +to develop and implement complex, integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales +channels in international markets; and cost-effectiveness. +In the RF Communications +market, principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, +MD; RS Microwave, a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith +Group, a global technology company listed on the London Stock Exchange; and Delta Diversified Products, a private company based +in Arizona. +In the Video amplifier +segment, principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately +held company headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, +a privately held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company +based in New York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Raw Materials +The raw materials for +power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus +we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders +received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials +prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In +addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors +have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no +longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign +some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination +of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. +We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. +However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On +July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark +Office. +In conjunction with +our majority acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade +name, which has been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +Research and Development +During the years ended +December 31, 2019 and 2018, we spent approximately $1,861,103 and $1,430,538, respectively, on research and development. +11 +Table of Contents +Employees +As of December 31, +2019, we had 210 employees located in the United States, the United Kingdom and Israel, of whom 52 were engaged in engineering +and product development, 12 in sales and marketing, 106 in general operations and 40 in general administration and finance. All +but 9 of these employees are employed on a full-time basis. None of our employees is currently represented by a trade union. We +consider our relations with our employees to be good. +12 +Table of Contents +ITEM 1A. RISK FACTORS +An investment in our +common stock involves significant risks. You should carefully consider the following risks and all other information set forth +in this Annual Report before deciding to invest in our common stock. If any of the events or developments described below occurs, +our business, financial condition and results of operations may suffer. In that case, the value of our common stock may decline +and you could lose all or part of your investment. +You should consider +each of the following risk factors and any other information set forth in this Annual Report and the other reports filed by the +Company with the Securities and Exchange Commission (the “ SEC ”), including the Company’s financial statements +and related notes, in evaluating the Company’s business and prospects. The risks and uncertainties described below are not +the only ones that impact on the Company’s operations and business. Additional risks and uncertainties not presently known +to the Company, or that the Company currently considers immaterial, may also impair its business or operations. If any of the following +risks actually occurs, the Company’s business and financial condition, results or prospects could be harmed. Please also +read carefully the section “Forward-Looking Statements” at the beginning of this Annual Report. +Risks Related to Our Company +We have historically incurred significant +losses and our financial situation creates doubt whether we will continue as a going concern . +We have historically +experienced operating and net losses and anticipate continuing to experience such losses in the future. For the years ended December +31, 2019 and 2018, we had an operating loss of $26,941,797 and $19,605,456 and net losses of $32,945,828 and $32,982,201, respectively. +As of December 31, 2019 and 2018, we had a working capital deficiency of $19,150,075 and $18,445,302, respectively. There are no +assurances that we will be able to achieve a level of revenues adequate to generate sufficient cash flow from operations or obtain +additional financing through private placements, public offerings and/or bank financing necessary to support our working capital +requirements. To the extent that funds generated from any private placements, public offerings and/or bank financing are insufficient, +we will have to raise additional working capital. No assurance can be given that additional financing will be available, or if +available, will be on acceptable terms. These conditions raise substantial doubt about our ability to continue as a going concern. +If adequate working capital is not available we may be forced to discontinue operations, which would cause investors to lose their +entire investment. +We +expect to continue to incur losses for the foreseeable future and need to raise additional capital to continue business development +initiatives and to support our working capital requirements. However, if we are unable to raise additional capital, we may be required +to curtail operations and take additional measures to reduce costs, including reducing our workforce, eliminating outside consultants +and reducing legal fees in order to conserve cash in amounts sufficient to sustain operations and meet our obligations. As a result +of these financing uncertainties, during the year ended December 31, 2019, we recognized that our dependence on ongoing capital +requirements to fund our operations raise substantial doubt about our ability to continue as a going concern. Our ongoing capital +requirements have only increased since then, meaning that substantial doubt about our ability to continue as a going concern remains +and will likely do so for the foreseeable future. +We will need +to raise additional capital to fund our operations in furtherance of our business plan. +Until +we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business +plan. The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common +stock or preferred stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development +partners or some combination of each. Any additional equity financings may be financially dilutive to, and will be dilutive from +an ownership perspective to our stockholders, and such dilution may be significant based upon the size of such financing. Additionally, +we cannot assure that such funding will be available on a timely basis, in needed quantities, or on terms favorable to us, if at +all. +We have substantial amounts of indebtedness. +This indebtedness and the covenants contained in our loan documents with senior creditors substantially limit our financial and +operating flexibility +We have entered into +a number of loan documents, including security and similar agreements, with senior lenders (the “ Senior Lenders ”). +These loan documents (the “ Senior Loan Documents ”) grant priority security interests in all of our assets to +the Senior Lenders. Such Senior Loan Documents contain restrictions that substantially limit our financial flexibility. These Senior +Loan Documents place limits on our ability to (i) incur additional indebtedness even if such indebtedness is subordinated to the +debt instruments issued to the Senior Lenders, and (ii) grant security to third persons, among other matters. These restrictions +limit the Company’s ability to finance its future operations and capital needs. Absent the consent of the Senior Lenders, +we would be unable to, among other things, obtain additional debt to raise additional capital, implement our business strategy, +establish corporate infrastructure and in any other way fund the development of its business. In addition, our substantial indebtedness +could require us to dedicate a substantial portion of our cash flow from the anticipated operations to making payments on our indebtedness +and other liabilities, which would limit the availability of funds for working capital and other general corporate purposes; limit +our flexibility in reacting to changes in the various industries in which we or any of our subsidiaries operates or in our competitive +environment; place us at a competitive disadvantage compared to those of our competitors who have less debt than we do, and limit +our ability to borrow additional funds and increase the costs of any such additional borrowings. If we are unable to pay our debts, +we would become insolvent. +13 +Table of Contents +Servicing our debt will require a significant +amount of cash, and we may not have sufficient cash flow from our business to pay our debt. We have defaulted on certain prior +repayment obligations. +Our ability to make +scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, including the DPW Notes, depends on +our future performance, which is subject to economic, financial, competitive and other factors beyond our control. In addition, +we have defaulted on certain prior repayment obligations as set forth below: +● On March 23, 2018, we entered into a securities purchase agreement pursuant to which we issued +a note in the amount of $1,000,000 to an investor. Pursuant to the terms of the note, we were required to pay interest on a monthly +basis. The maturity date of this note was June 22, 2018. We did not pay the interest on a timely basis or pay the note in full +on the maturity date. On July 3, 2019, we reached an agreement with the investor to repay the note under renegotiated terms with +a maturity date of January 22, 2020. As of the filing date of this Form 10-K, the current principal amount outstanding on the note +is $632,000. +● On September 21, 2018, we entered into a securities purchase agreement pursuant to which we issued +a note in the amount of $526,316 to an investor. The maturity date of this note was December 31, 2018. We did not pay the principal +or accrued interest in full on the maturity date. On July 2, 2019, we entered into an exchange agreement with the investor pursuant +to which, in exchange for the note issued by us to the investor, we sold to the investor a new convertible promissory note in the +principal amount of $783,031 with an interest rate of 12% per annum and a maturity date of December 31, 2019. On September 26, +2019, principal and interest on the 12% Convertible Note was exchanged for a convertible promissory note in the principal amount +of $815,218 with an interest rate of 12% per annum and a maturity date of December 31, 2019. Further, On February 5, 2020, we entered +into an exchange agreement with the investor pursuant to which, in exchange for the September 26, 2019 note issued by us to the +investor, we sold to the investor a new convertible promissory note in the principal amount of $295,000 and a new promissory note +in the principal amount of $585,919. Both of these notes have an interest rate of 12% per annum and a maturity date of December +31, 2019. We issued 203,448 shares of our common stock on February 25, 2020 in satisfaction of the February 5, 2020 convertible +promissory note. +● During 2018, we received funding as a result of entering into multiple Agreements for +the Purchase and Sale of Future Receipts (collectively, the “ Agreements on Future Receipts ”) pursuant to which +we sold in the aggregate $5,632,400 in future receipts for a purchase price in the amount of $4,100,000. Pursuant to the terms +of the Agreements on Future Receipts, we were required to make payments on a daily basis until the balance of the amount sold was +fully repaid. We did not make these daily payments on a timely basis. We reached an agreement with the investor to repay the Agreements +on Future Receipts under renegotiated terms. As of the filing date of this Form 10-K, the amount outstanding on the Agreements +on Future Receipts is $2,210,392. +● On November 28, 2018, Blockchain Mining Supply and Services, Ltd , a vendor who sold computers +to our subsidiary Digital Farms, Inc. (t/k/a Super Crypto Mining, Inc.), filed in the United States District Court for the Southern +District of New York against us and our subsidiary (Case No. 18-cv-11099). The Complaint asserted claims for breach of contract +and promissory estoppel against us and our subsidiary arising from the subsidiary’s failure to satisfy a purchase agreement. +The Complaint seeks damages in the amount of $1,388,495, which approximates the amount of the reserve that we have established. +To date, the Court has not set a briefing schedule in connection with our anticipated motion to dismiss. +Our business may not +generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If we +are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring +debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness +will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities +or engage in these activities on desirable terms, which could result in a default on our debt obligations. +We face business +disruption and related risks resulting from the recent outbreak of the novel coronavirus 2019 (“ COVID-19 ”), +which could have a material adverse effect on our business and results of operations and curtail our ability to raise financing. +14 +Table of Contents +Our business has been +disrupted and materially adversely affected by the recent outbreak of COVID-19. As a result of measures imposed by the governments +in affected regions, businesses and schools have been suspended due to quarantines intended to contain this outbreak and many people +have been forced to work from home in those areas. The spread of COVID-19 from China to other countries has resulted in the Director +General of the World Health Organization declaring the outbreak of COVID-19 as a Public Health Emergency of International Concern, +based on the advice of the Emergency Committee under the International Health Regulations (2005), and the Centers for Disease Control +and Prevention in the U.S. issued a warning on February 25, 2020 regarding the likely spread of COVID-19 to the U.S. While the +COVID-19 outbreak is still in its early stages, international stock markets have begun to reflect the uncertainty associated with +the slow-down in the American, Israeli and UK economies and the reduced levels of international travel experienced since the beginning +of January and the significant decline in the Dow Industrial Average at the end of February 2020 was largely attributed to the +effects of COVID-19. We are still assessing our business operations and system supports and the impact COVID-19 may have on our +results and financial condition, but there can be no assurance that this analysis will enable us to avoid part or all of any impact +from the spread of COVID-19 or its consequences, including downturns in business sentiment generally or in our sectors in particular. +Our +operations are located in Alameda County, CA, Orange County, CA, Fairfield County, CT, the United Kingdom, Israel and members of +our senior management work in Seattle, WA and New York, NY, which is also the location of the offices of the Company’s +independent auditor . The Company has been following the recommendations of local health authorities +to minimize exposure risk for its employees for the past several weeks, including the temporary closures of its offices and having +employees work remotely to the extent possible , which has to an extent adversely affected their efficiency. +Updates by business unit are as follows: +· DPW Holdings’ corporate headquarters, located in Newport Beach, CA, has begun working remotely, +based on the occupancy and social distancing order from the Orange County Health Officer (http://www.ochealthinfo.com/phs/about/epidasmt/epi/dip/prevention/novel_coronavirus). +The headquarters staff has tested the secure remote access systems and technology infrastructure to adjust working arrangements +for its employees and believes it has adequate internal communications system and can remain operational with a remote staff. +· Coolisys Technologies Corp., located in Fremont, CA, has temporarily suspended operations as a +result of the Alameda County Public Health Department’s order to cease all activities at facilities located within the County. +· Microphase Corporation, located in Shelton, CT, has developed an emergency plan to ensure that +its mission critical manufacturing and logistical functions are up and running. Microphase has implemented additional steps to +ensure a higher level of cleanliness in its facility. Employees at greater risk of major health issues from COVID-19 are not required +to work on site. The crisis management team meets regularly to monitor the situation, and modifies and communicates the plan as +the need arises. Once the COVID-19 crisis has passed, the team will work on transitioning Microphase back to normal operations. +· Gresham Power Electronics Limited, located in Salisbury, UK, temporarily suspended operations on +March 19, 2020. +· Enertec Systems 2001 Ltd., located in Karmiel, Israel, has been granted a waiver by the Israeli +government to remain open to complete key projects that impact national security. Approximately 50% of the Enertec workforce is +working remotely. +Due to the unprecedented +market conditions domestically and internationally, and the effect COVID-19 has had and will continue to have on the Company’s +operations and financial performance, the extent of which is not currently known, the Company is temporarily suspending guidance +for 2020. The Company will monitor the situation rigorously and provide business updates as circumstances warrant and resume providing +guidance on the Company’s business when management believes that such information would be both reliable and substantively +informative. +The +duration and extent of the impact from the COVID-19 pandemic depends on future developments that cannot be accurately predicted +at this time, such as the severity and transmission rate of the virus, the extent and effectiveness of containment actions and +the impact of these and other factors on our employees, customers, partners and vendors. If we are not able to respond to and manage +the impact of such events effectively, our business will be harmed. +As +noted above, we rely to a great extent on external financing to fund our operations. The outbreak of COVD-19 has had a materially +adverse impact on our ability to raise financing for our operations. Unless investors’ outlook improves dramatically in the +near future, it will further inhibit our ability to raise the funds we need to sustain our operations. No assurance can be given +that additional financing will be available, or if available, will be on acceptable terms. +Our limited operating history makes +it difficult to evaluate our future business prospects and to make decisions based on our historical performance . +15 +Table of Contents +Although our executive +officers have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our +current business until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate +our business on the basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future +results based upon our historical data. Reliance on our historical results may not be representative of the results we will achieve, +and for certain areas in which we operate, principally those unrelated to defense contracting, will not be indicative at all. Because +of the uncertainties related to our lack of historical operations, we may be hindered in our ability to anticipate and timely adapt +to increases or decreases in sales, product costs or expenses. If we make poor budgetary decisions as a result of unreliable historical +data, we could be less profitable or incur losses, which may result in a decline in our stock price. +We have an evolving business model, which increases the complexity +of our business. +Our business model +has evolved in the past and continues to do so. In prior years we have added additional types of services and product offerings +and in some cases we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products +or services, and we do not know whether any of them will be successful. From time to time we have also modified aspects of our +business model relating to our product mix. We do not know whether these or any other modifications will be successful. The additions +and modifications to our business have increased the complexity of our business and placed significant strain on our management, +personnel, operations, systems, technical performance, financial resources, and internal financial control and reporting functions. +Future additions to or modifications of our business are likely to have similar effects. Further, any new business or website we +launch that is not favorably received by the market could damage our reputation or our brand. The occurrence of any of the foregoing +could have a material adverse effect on our business. +We are a holding company whose subsidiaries +are given certain degree of independence and our failure to integrate our subsidiaries may adversely affect our financial condition . +We have given our subsidiary +companies and their executives a certain degree of independence in decision-making. On the one hand, this independence may increase +the sense of ownership at all levels, on the other hand it has also increased the difficulty of the integration of operation and +management, which has resulted in increased difficulty of management integration. In the event we are not able to successfully +manage our subsidiaries this will result in operating difficulties and have a negative impact on our business. +Our independent auditors have expressed doubt about our ability +to continue as a going concern. If we do not continue as a going concern, investors will lose their entire investment . +In its report on our +financial statements included in this Annual Report, our independent auditors have expressed doubt about our ability to continue +as a going concern. Our ability to continue as a going concern is an issue raised as a result of ongoing operating losses and a +lack of financing commitments then in place to meet expected cash requirements. Our ability to continue as a going concern is subject +to our ability to generate a profit and/or obtain necessary funding from outside sources, including obtaining additional funding +from the sale of our securities, increasing sales or obtaining loans and grants from various financial institutions where possible. +If we do not continue as a going concern, investors will lose their entire investment. +We received an order and a subpoena +from the Commission in the investigation now known as “ In the Matter of DPW Holdings, Inc . ,” the +consequences of which are unknown. +We received an order +and related subpoena from the Commission that stated that the staff of the Commission is conducting an investigation now known +as “ In the Matter of DPW Holdings, Inc. ,” and that the subpoena was issued as part of an investigation +as to whether we and certain of our officers, directors, employees, partners, subsidiaries and/or affiliates, and/or other persons +or entities, directly or indirectly, violated certain provisions of the Securities Act and the Exchange Act, in connection with +the offer and sale of our securities. Although the order states that the Commission may have information relating to such alleged +violations, the subpoena expressly provides that the inquiry is not to be construed as an indication by the Commission or its staff +that any violations of the federal securities laws have occurred. [We have produced documents in response to the subpoena.] The +Commission may in the future require us to produce additional documents or information, or seek testimony from other members of +our management team. +We are unaware of the +scope or timing of the Commissioner’s investigation. As a result, we do not know how the Commission’s investigation +is proceeding, when the investigation will be concluded. We also are unable to predict what action, if any, might be taken in the +future by the Commission or its staff as a result of the matters that are the subject to its investigation or what impact, if any, +the cost of continuing to respond to subpoenas might have on our financial position, results of operations, or cash flows. We have +not established any provision for losses in respect of this matter In addition, complying with any such future requests by the +Commission for documents or testimony could distract the time and attention of our officers and directors or divert our resources +away from ongoing business matters. This investigation could result in significant legal expenses, the diversion of management’s +attention from our business, damage to our business and reputation, and could subject us to a wide range of remedies, including +an enforcement action by the Commission. There can be no assurance that any final resolution of this and any similar matters will +not have a material adverse effect on our financial condition or results of operations. +16 +Table of Contents +Our inability +to successfully integrate new acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our +growth strategy through acquisitions is fraught with risk. On June 2, 2017, we acquired a majority interest in Microphase and on +May 23, 2018 we acquired Enertec Systems 2001 Ltd. (“ Enertec ”). Our strategy and business plan are dependent +on our ability to successfully integrate Microphase’s, Enertec’s and our other acquisition’s operations. In addition, +while we are based in Newport Beach, CA, Microphase’s operations are located in Shelton, Connecticut, Enertec’s operations +are located in Karmiel, Israel and Gresham Power’s operations are located in Salisbury, England. These distant locations +and others that we may become involved with in the future will stretch our resources and management time. Further, failure to quickly +and adequately integrate all of these operations and personnel could adversely affect our combined business and our ability to +achieve our objectives and strategy. No assurance can be given that we will realize synergies in the areas we currently operate. +If we make any additional acquisitions, they may disrupt +or have a negative impact on our business. +We have plans to eventually +make additional acquisitions beyond Microphase and Enertec. Whenever we make acquisitions, we could have difficulty integrating +the acquired companies’ personnel and operations with our own. In addition, the key personnel of the acquired business may +not be willing to work for us. We cannot predict the effect expansion may have on our core business. Regardless of whether we are +successful in making an acquisition, the negotiations could disrupt our ongoing business, distract our management and employees +and increase our expenses. In addition to the risks described above, acquisitions are accompanied by a number of inherent risks, +including, without limitation, the following: +· difficulty of integrating acquired products, services or operations; +· potential disruption of the ongoing businesses and distraction of +our management and the management of acquired companies; +· difficulty of incorporating acquired rights or products into our existing +business; +· difficulties in disposing of the excess or idle facilities of an acquired +company or business and expenses in maintaining such facilities; +· difficulties in maintaining uniform standards, controls, procedures +and policies; +· potential impairment of relationships with employees and customers +as a result of any integration of new management personnel; +· potential inability or failure to achieve additional sales and enhance +our customer base through cross-marketing of the products to new and existing customers; +· effect of any government regulations which relate to the business +acquired; and +· potential unknown liabilities associated with acquired businesses +or product lines, or the need to spend significant amounts to retool, reposition or modify the marketing and sales of acquired +products or the defense of any litigation, whether or not successful, resulting from actions of the acquired company prior to our +acquisition. +Our business could +be severely impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered +in connection with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our +ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. +No assurance of successful expansion of operations. +Our significant increase +in the scope and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher +operating expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make +significant demands on our management, finances and other resources. Our ability to manage the anticipated future growth, should +it occur, will depend upon a significant expansion of our accounting and other internal management systems and the implementation +and subsequent improvement of a variety of systems, procedures and controls. We cannot assure that significant problems in these +areas will not occur. Failure to expand these areas and implement and improve such systems, procedures and controls in an efficient +manner at a pace consistent with our business could have a material adverse effect on our business, financial condition and results +of operations. We cannot assure that attempts to expand our marketing, sales, manufacturing and customer support efforts will succeed +or generate additional sales or profits in any future period. As a result of the expansion of our operations and the anticipated +increase in our operating expenses, along with the difficulty in forecasting revenue levels, we expect to continue to experience +significant fluctuations in its results of operations. +We may be unable to successfully expand +our production capacity, which could result in material delays, quality issues, increased costs and loss of business opportunities, +which may negatively impact our product margins and profitability . +17 +Table of Contents +Part of our future +growth strategy is to increase our production capacity to meet increasing demand for our goods. Assuming we obtain sufficient funding +to increase our production capacity, any projects to increase such capacity may not be constructed on the anticipated timetable +or within budget. We may also experience quality control issues as we implement any production upgrades. Any material delay in +completing these projects, or any substantial cost increases or quality issues in connection with these projects could materially +delay our ability to bring our products to market and adversely affect our business, reduce our revenue, income and available cash, +all of which could harm our financial condition. +If we fail to establish and maintain +an effective system of internal control over financial reporting, we may not be able to report our financial results accurately +or prevent fraud. Any inability to report and file our financial results accurately and timely could harm our reputation and adversely +impact the trading price of our common stock. +Effective internal +control over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide +reliable financial reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective +control environment existed, and our business and reputation with investors may be harmed. As a result, our small size and any +current internal control deficiencies may adversely affect our financial condition, results of operations and access to capital. +We have carried out an evaluation under the supervision and with the participation of our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures +as of the end of the most recent period covered by this report. Based on the foregoing, our principal executive officer and principal +financial officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level due +to the material weaknesses described below. +A +material weakness is a deficiency, or a combination of deficiencies, within the meaning of Public Company Accounting Oversight +Board (“ PCAOB ”) Audit Standard No. 5, in internal control over financial reporting, such that there is a reasonable +possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely +basis. Management has identified the following material weaknesses which have caused management to conclude that as of December +31, 2019 our internal control over financial reporting (“ ICFR ”) was not effective at the reasonable assurance +level: +1. +We do not have sufficient resources in our accounting function, +which restricts our ability to gather, analyze and properly review information related to financial reporting, including fair value +estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be +possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of +assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure +to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency +that resulted represented a material weakness. +2. We have inadequate controls to ensure that information necessary to properly record transactions is adequately communicated +on a timely basis from non-financial personnel to those responsible for financial reporting. Management evaluated the impact of +the lack of timely communication between non–financial and financial personnel on our assessment of our reporting controls +and procedures and has concluded that the control deficiency represented a material weakness. +3. We did not design or maintain effective general information technology (“IT”) controls +over certain information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets. +Specifically, we did not design and implement p rogram change management controls for certain +financially relevant systems to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, (iii) digital currency hardware wallets, and (iv) underlying accounting records, are identified, +tested, authorized and implemented appropriately. +Planned Remediation +Management, +in coordination with the input, oversight and support of our Board of Directors, has identified the measures below to strengthen +our control environment and internal control over financial reporting. +In +January 2018, we hired a new Chief Financial Officer and engaged the services of a financial accounting advisory firm. In September +2018, we hired a Chief Accounting Officer and in January 2019, we hired a Senior Vice President of Finance. Finally, in May 2019, +we hired an Executive Vice President and General Counsel. We have tasked these individuals with expanding and monitoring the Company’s +internal controls, to provide an additional level of review of complex financial issues and to assist with financial reporting. +On October 7, 2019, we created an Executive Committee comprised of our Chief Executive Officer, Chief Financial Officer and Executive +Vice President and General Counsel. The Executive Committee meets on a daily basis to address the Company’s critical needs +and provide a forum to approve transactions. Further, as we continue to expand our internal accounting department, the Chairman +of the Audit Committee shall perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, +· reviews all anticipated transactions that are not considered in the ordinary course of business +to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s +financial statements +18 +Table of Contents +We +are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address +the material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls +and procedures. These material weaknesses will not be considered to be remediated until the applicable remediated controls are +operating for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. +If our accounting +controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously +harmed. +We +evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating +our internal control over financial reporting in order to comply with the Commission’s rules relating to internal control +over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control +over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future +periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance +with the policies or procedures may deteriorate. If we fail to maintain effective internal control over financial reporting or +our management does not timely assess the adequacy of such internal control, we may be subject to regulatory sanctions, and our +reputation may decline. +We face significant competition, including changes in pricing. +The markets for our +products are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing +resources, plus experience in research and development, and compete with us by offering lower prices. Competitors could develop +new technologies that compete with our products to achieve a lower unit price. If a competitor develops lower cost superior technology +or cost-effective alternatives to our products and services, our business could be seriously harmed. +The markets for some +of our products are also subject to specific competitive risks because these markets are highly price competitive. Our competitors +have competed in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering +our prices. This would reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also +impact sales and aggravate losses. +Many of our competitors are larger and +have greater financial and other resources than we do. +Our products compete +and will compete with similar if not identical products produced by our competitors. These competitive products could be marketed +by well-established, successful companies that possess greater financial, marketing, distribution personnel, and other resources +than we do. Using said resources, these companies can implement extensive advertising and promotional campaigns, both generally +and in response to specific marketing efforts by competitors. They can introduce new products to new markets more rapidly. In certain +instances, competitors with greater financial resources may be able to enter a market in direct competition with us, offering attractive +marketing tools to encourage the sale of products that compete with our products or present cost features that consumers may find +attractive. +Our growth strategy is subject to +a significant degree of risk. +Our +growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition +targets or make a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. +Therefore, we may lose our investment in the event that these companies’ businesses do not develop as planned or that we +are unable to achieve the cost efficiencies or reduction of losses as anticipated. +Further, +in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement +our plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that +provide revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development +and investments will produce sufficient revenues to offset these increases in expenditures. +Our business and operations are growing +rapidly. If we fail to effectively manage our growth, our business and operating results could be harmed . +We have experienced, +and may continue to experience, rapid growth in our operations. This has placed, and may continue to place, significant demands +on our management, operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products +and services could suffer, which could negatively affect our operating results. To effectively manage our growth, we must continue +to improve our operational, financial and management controls and reporting systems and procedures. These systems improvements +may require significant capital expenditures and management resources. Failure to implement these improvements could hurt our ability +to manage our growth and our financial position. +We are heavily dependent on our senior management, and a +loss of a member of our senior management team could cause our stock price to suffer . +19 +Table of Contents +If we lose the services +of Milton C. Ault III, our Chief Executive Officer, William B. Horne, our Chief Financial Officer, Amos Kohn, our President and +the Chief Executive Officer of CTC, one of our principal subsidiaries, or Henry Nisser, our General Counsel and Executive Vice +President, and/or certain key employees, we may not be able to find appropriate replacements on a timely basis, and our business +could be adversely affected. Our existing operations and continued future development depend to a significant extent upon the performance +and active participation of these individuals and certain key employees. Although we have entered into employment agreements with +Messrs. Ault, Horne, Kohn and Nisser, and we may enter into employment agreements with additional key employees in the future, +we cannot guarantee that we will be successful in retaining the services of these individuals. If we were to lose any of these +individuals, we may not be able to find appropriate replacements on a timely basis and our financial condition and results of operations +could be materially adversely affected. +We rely on highly skilled personnel +and the continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our +business may be severely disrupted. +Our performance largely +depends on the talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise +held by our Chief Executive Officer, Milton C. Ault III. His absence, were it to occur, would materially and adversely impact development +and implementation of our projects and businesses. Our future success depends on our continuing ability to identify, hire, develop, +motivate and retain highly skilled personnel for all areas of our organization. Our continued ability to compete effectively depends +on our ability to attract, among others, new technology developers and to retain and motivate our existing contractors. If one +or more of our executive officers are unable or unwilling to continue in their present positions, we may not be able to replace +them readily, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and +retain new officers. In addition, if any of our executives joins a competitor or forms a competing company, we may lose some customers. +Our operating results may vary from quarter to quarter. +Our operating results +have in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may +increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding +for our products in our customers’ capital budgets. There is a trend for some of our customers to place large orders near +the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer +demand for our products driven by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, +and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. +In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, +have been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those +we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our +operating results for such quarter. It is possible that, in some quarters, our operating results will be below the expectations +of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common +stock may decline significantly. +We may be classified as an inadvertent investment company. +We are not engaged +in the business of investing, reinvesting, or trading in securities, and we do not hold ourselves out as being engaged in those +activities. Under the Investment Company Act, however, a company may be deemed an investment company under section 3(a)(1)(C) of +the Investment Company Act if the value of its investment securities is more than 40% of its total assets (exclusive of government +securities and cash items) on a consolidated basis. +Our lending subsidiary, +Digital Power Lending, LLC (“ DP Lending ”), operates under California Finance Lending License #60DBO-77905. Per +the Investment Company Act of 1940 companies with substantially all their business confined to making small loans, industrial banking +or similar business, such as DP Lending, are excluded from the definition of an investment company. +We have commenced digital +asset mining, the output of which is cryptocurrencies, which the Commission has indicated it deems a security. In the event that +the digital assets held by us exceed 40% of our total assets, exclusive of cash, we inadvertently become an investment company. +An inadvertent investment company can avoid being classified as an investment company if it can rely on one of the exclusions under +the Investment Company Act. One such exclusion, Rule 3a-2 under the Investment Company Act, allows an inadvertent investment company +a grace period of one year from the earlier of (a) the date on which an issuer owns securities and/or cash having a value exceeding +50% of the issuer’s total assets on either a consolidated or unconsolidated basis and (b) the date on which an issuer owns +or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive +of government securities and cash items) on an unconsolidated basis. We are putting in place policies that we expect will work +to keep the investment securities held by us at less than 40% of our total assets, which may include acquiring assets with our +cash, liquidating our investment securities or seeking a no-action letter from the Commission if we are unable to acquire sufficient +assets or liquidate sufficient investment securities in a timely manner. +As Rule 3a-2 is available +to a company no more than once every three years, and assuming no other exclusion were available to us, we would have to keep within +the 40% limit for at least three years after we cease being an inadvertent investment company. This may limit our ability to make +certain investments or enter into joint ventures that could otherwise have a positive impact on our earnings. In any event, we +do not intend to become an investment company engaged in the business of investing and trading securities. +20 +Table of Contents +Classification as an +investment company under the Investment Company Act requires registration with the Commission. If an investment company fails to +register, it would have to stop doing almost all business, and its contracts would become voidable. Registration is time consuming +and restrictive and would require a restructuring of our operations, and we would be very constrained in the kind of business we +could do as a registered investment company. Further, we would become subject to substantial regulation concerning management, +operations, transactions with affiliated persons and portfolio composition, and would need to file reports under the Investment +Company Act regime. The cost of such compliance would result in our incurring substantial additional expenses, and the failure +to register if required would have a materially adverse impact to conduct our operations. +We will not be able to successfully +execute our business strategy if we are deemed to be an investment company under the Investment Company Act. +U.S. companies that +have more than 100 stockholders or are publicly traded in the U.S. and are, or hold themselves out as being, engaged primarily +in the business of investing, reinvesting or trading in securities are subject to regulation under the Investment Company Act. +Unless a substantial part of our assets consists of, and a substantial part of our income is derived from, interests in majority-owned +subsidiaries and companies that we primarily control, we may be required to register and become subject to regulation under the +Investment Company Act. If bitcoin and other virtual currencies were to be deemed securities for purposes of the Investment +Company Act, or if we were deemed to own but not operate one or more of our other subsidiaries, we would have difficulty avoiding +classification and regulation as an investment company. +If we were deemed to +be, and were required to register as, an investment company, we would be forced to comply with substantive requirements under the +Investment Company Act, including limitations on our ability to borrow, limitations on our capital structure; restrictions on acquisitions +of interests in associated companies, prohibitions on transactions with affiliates, restrictions on specific investments, and compliance +with reporting, record keeping, voting, proxy disclosure and other rules and regulations. If we were forced to comply with +the rules and regulations of the Investment Company Act, our operations would significantly change, and we would be prevented from +successfully executing our business strategy. To avoid regulation under the Investment Company Act and related rules promulgated +by the Commission, we could need to sell bitcoin and other assets which we would otherwise want to retain and could be unable to +sell assets which we would otherwise want to sell. In addition, we could be forced to acquire additional, or retain existing, +income-generating or loss-generating assets which we would not otherwise have acquired or retained and could need to forgo opportunities +to acquire bitcoin and other assets that would benefit our business. If we were forced to sell, buy or retain assets in this +manner, we could be prevented from successfully executing our business strategy. +Securitization of our assets subjects us to various risks . +We may securitize assets +to generate cash for funding new investments. We refer to the term securitize to describe a form of leverage under which a company +(sometimes referred to as an “originator” or “sponsor”) transfers income producing assets to a single-purpose, +bankruptcy-remote subsidiary (also referred to as a “special purpose entity” or “ SPE ”), which is +established solely for the purpose of holding such assets and entering into a structured finance transaction. The SPE would then +issue notes secured by such assets. The special purpose entity may issue the notes in the capital markets either publicly or privately +to a variety of investors, including banks, non-bank financial institutions and other investors. There may be a single class of +notes or multiple classes of notes, the most senior of which carries less credit risk and the most junior of which may carry substantially +the same credit risk as the equity of the SPE. +An important aspect +of most debt securitization transactions is that the sale and/or contribution of assets into the SPE be considered a true sale +and/or contribution for accounting purposes and that a reviewing court would not consolidate the SPE with the operations of the +originator in the event of the originator's bankruptcy based on equitable principles. Viewed as a whole, a debt securitization +seeks to lower risk to the note purchasers by isolating the assets collateralizing the securitization in an SPE that is not subject +to the credit and bankruptcy risks of the originator. As a result of this perceived reduction of risk, debt securitization transactions +frequently achieve lower overall leverage costs for originators as compared to traditional secured lending transactions. +In accordance with +the above description, to securitize loans, we may create a wholly owned subsidiary and contribute a pool of our assets to such +subsidiary. The SPE may be funded with, among other things, whole loans or interests from other pools and such loans may or may +not be rated. The SPE would then sell its notes to purchasers whom we would expect to be willing to accept a lower interest rate +and the absence of any recourse against us to invest in a pool of income producing assets to which none of our creditors would +have access. We would retain all or a portion of the equity in the SPE. An inability to successfully securitize portions of our +portfolio or otherwise leverage our portfolio through secured and unsecured borrowings could limit our ability to grow our business +and fully execute our business strategy, and could decrease our earnings, if any. However, the successful securitization of portions +of our portfolio exposes us to a risk of loss for the equity we retain in the SPE and might expose us to greater risk on our remaining +portfolio because the assets we retain may tend to be those that are riskier and more likely to generate losses. A successful securitization +may also impose financial and operating covenants that restrict our business activities and may include limitations that could +hinder our ability to finance additional loans and investments. The Investment Company Act may also impose restrictions on the +structure of any securitizations. +21 +Table of Contents +Interests we hold in +the SPE, if any, will be subordinated to the other interests issued by the SPE. As such, we will only receive cash distributions +on such interests if the SPE has made all cash interest and other required payments on all other interests it has issued. In addition, +our subordinated interests will likely be unsecured and rank behind all of the secured creditors, known or unknown, of the SPE, +including the holders of the senior interests it has issued. Consequently, to the extent that the value of the SPE's portfolio +of assets has been reduced as a result of conditions in the credit markets, or as a result of defaults, the value of the subordinated +interests we retain would be reduced. Securitization imposes on us the same risks as borrowing except that our risk in a securitization +is limited to the amount of subordinated interests we retain, whereas in a borrowing or debt issuance by us directly we would be +at risk for the entire amount of the borrowing or debt issuance. +We may also engage +in transactions utilizing SPEs and securitization techniques where the assets sold or contributed to the SPE remain on our balance +sheet for accounting purposes. If, for example, we sell the assets to the SPE with recourse or provide a guarantee or other credit +support to the SPE, its assets will remain on our balance sheet. Consolidation would also generally result if we, in consultation +with the SEC, determine that consolidation would result in a more accurate reflection of our assets, liabilities and results of +operations. In these structures, the risks will be essentially the same as in other securitization transactions but the assets +will remain our assets for purposes of the limitations described above on investing in assets that are not qualifying assets and +the leverage incurred by the SPE will be treated as borrowings incurred by us for purposes of our limitation on the issuance of +senior securities. +We may not be able to utilize our net operating loss carry +forwards. +At December 31, 2019, +we had Federal net operating loss carry forwards (“ NOLs ”) for income tax purposes of approximately $52,884,756. +Approximately $12,302,381 of NOLs generated prior to 2018 will begin to expire in 2020. The Coronavirus Aid, Relief, and Economic +Security Act (“CARES Act”) signed in to law on March 27, 2020 provided that NOLs generated in a taxable year beginning +in 2018, 2019, or 2020, may now be carried back five years and forward indefinitely. In addition, the 80% taxable income limitation +is temporarily removed, allowing NOLs to fully offset net taxable income. However, we do not know if or when we will have any earnings +and capital gains against which we could apply these carry forwards. Furthermore, as a result of changes in the ownership +of our common stock, our ability to use our federal NOLs will be limited under Internal Revenue Code Section 382. State NOLs +are subject to similar limitations in many cases. As a result, our substantial NOLs may not have any value to us. +Changes in the U.S. tax and other laws and regulations may +adversely affect our business. +The U.S. government +may revise tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, +including modifications that could reduce the profits that we can effectively realize from our international operations, or that +could require costly changes to those operations, or the way in which they are structured. For example, the effective tax +rates for most U.S. companies reflect the fact that income earned and reinvested outside the U.S. is generally taxed at local rates, +which may be much lower than U.S. tax rates. If we expand abroad and there are changes in tax laws, regulations or interpretations +that significantly increase the tax rates on non-U.S. income, our effective tax rate could increase and our profits could be reduced. +If such increases resulted from our status as a U.S. company, those changes could place us at a disadvantage to our non-U.S. competitors +if those competitors remain subject to lower local tax rates. +Risks Related to Related Party Transactions +General +There may be conflicts +of interest between our company and certain of our related parties and their respective directors and officers which might not +be resolved in our favor. More importantly, there may be conflicts between certain of our related parties and their respective +directors and officers which might not be resolved in our favor. These risks are set forth below appurtenant to the relevant related +party. +22 +Table of Contents +Ault & Company +Our relationship with Ault & Company +may enhance the difficulty inherent in obtaining financing for us as well as expose us to certain conflicts of interest. +At May 27, 2020, Ault +& Company, of which Milton C. Ault is the chief executive officer, beneficially owned 1,362,795 shares of our common stock, +consisting of 665,174 shares owned outright, 689,655 shares of common stock underlying the 8% Convertible Promissory Note in the +principal amount of $1,000,000 sold by us to Ault & Company on February 5, 2020, assuming no conversion of accrued but unpaid +interest on this note, warrants to purchase 94 shares of Common Stock that are exercisable within 60 days of the date hereof and +shares owned by Philou Ventures of which Ault & Company, Inc., is the Manager, consisting of: (i) 125,000 shares of Series +B Preferred Stock that are convertible into 2,232 shares of Common Stock, (ii) warrants to purchase 2,232 shares of Common Stock +that are exercisable within 60 days of the date hereof and (iii) 3,408 shares of Common Stock. Ault & Company may not convert +the note absent stockholder approval, though the Company expects that a proposal to approve such conversion will occur at its special +meeting of stockholders presently scheduled to occur on June 8, 2020. Assuming Ault & Company were able to convert its note +on the date of this Annual Report, Ault & Company would own a number of shares of common stock equal to 21.1% of the number +of shares of common stock on the date hereof. +Further, Ault & +Company and the Company are negotiating the terms of a proposed purchase by Ault & Company of a certain number of shares of +Series C Preferred Stock. Presently, neither the number nor the terms of any such Series C Preferred Stock has been determined, +and any such purchase would have to be approved by the Company’s stockholders before Ault & Company would be able to +vote or convert such shares of Series C Preferred Stock. Notwithstanding the presently indeterminate nature of any such acquisition +of Series Preferred Stock, you should be aware that the consummation of such a transaction, assuming the receipt by the Company +of its stockholders approval thereof, could substantially increase Ault & Company’s beneficial ownership of our shares +of common stock. +Given the close relationship +between Ault & Company on the one hand, and our company on the other, it is far from inconceivable that we could enter into +additional securities purchase agreements with Ault & Company. +Although we have relied +on Philou to finance us in the past, which no longer beneficially owns any meaningful number of our shares of common stock, and +anticipate that Ault & Company may purchase shares of our Series C Preferred Stock under an agreement providing for the purchase +thereof, we cannot assure you that either Philou or Ault & Company will assist us in the future. We would far prefer to rely +on these entities’ assistance compared to other sources of financing as the terms they provide us are in general more favorable +to us than we could obtain elsewhere. However, both Messrs. Ault and Horne could face a conflict of interest in that they serve +on the board of directors of each of Ault & Company and our company. If they determine that an investment in our company is +not in Ault & Company’s best interest(s) we could be forced to seek financing from other sources that would not necessarily +be likely to provide us with equally favorable terms. It should be noted in this context that while Mr. Nisser does not serve as +a director of our company, he is its General Counsel and Executive Vice President as well as a director and the President of Ault +& Company. +Other conflicts of +interest between us, on the one hand, and Ault & Company, on the other hand, may arise relating to commercial or strategic +opportunities or initiatives. Mr. Ault, as the controlling shareholder of Ault & Company, may not resolve such conflicts in +our favor. For example, we cannot assure you that Ault & Company would not pursue opportunities to provide financing to other +entities whether or not it currently has a relationship with such other entities. Furthermore, our ability to explore alternative +sources of financing other than Ault & Company may be constrained due to Mr. Ault’s vision for us and he may not wish +for us to receive any financing at all other than from entities that he controls. +Avalanche International Corp . +We have lent a substantial amount of +funds to Avalanche, a related party, whose ability to repay us is subject to significant doubt and it may not be in our stockholders’ +best interest to convert the notes into shares of Avalanche common stock even if we had a reasonably viable means of doing so. +On September 6, 2017, +we entered into a Loan and Security Agreement with Avalanche (“ AVLP Loan Agreement ”) with an effective date +of August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility of up to $10,000,000 for a period +ending on August 21, 2021. +At December 31, 2019, +we had provided Avalanche with $9,595,079 pursuant to the non-revolving credit facility. The warrants issued in conjunction with +the non-revolving credit facility entitles us to purchase up to 19,190,158 shares of Avalanche common stock at an exercise price +of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, +stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +While Avalanche received +funds from a third party in the amount of $2,750,000 in early April of 2019 in consideration for its issuance of a convertible +promissory note to such third party (the “ Third Party Note ”), $2,676,220 was used to pay an outstanding receivable +due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. There is doubt as to whether +Avalanche will be able to repay this amount on a timely basis, if at all, unless it generates significant net income from its operations +or receives additional financing from another source; even then, unless such financing consists solely of the issuance by Avalanche +of its equity securities, it will only add to the amount that Avalanche owes other parties, which would in all likelihood not be +provided unless we agreed to subordinate our right to repayment to such other third party source. +23 +Table of Contents +There is currently +no liquid market for the Avalanche common stock. Consequently, even if we were inclined to convert the debt owed us by Avalanche +into shares of its common stock, our ability to sell such shares is severely limited. Avalanche is not current in its filings with +the Commission and is not required to register the shares of its common stock underlying the New Note or any other loan arrangement +we have made with Avalanche described above. Further, even if Avalanche were willing to register such shares, it would not be permitted +to do so until it has registered the shares of its common stock underlying the Third Party Note. +As a result, there +is a doubt as to whether Avalanche will ever have the ability to repay its debts to us, or if we convert the debt owed us by Avalanche +into shares of its common stock, our ability to convert such shares into cash through the sale of such shares would be severely +limited until such time, if ever, a liquid market for Avalanche’s common stock develops. If we are unable to recoup our investment +in Avalanche in the foreseeable future or at all, such failure would have a materially adverse effect on our financial condition +and future prospects. +Originally, the loans we made to Avalanche +were secured by a lien on all of Avalanche’s assets. Presently, we only have third priority interest. +Originally, the loans +we made to Avalanche were secured by a lien on all of Avalanche’s assets. When Avalanche entered into the Exchange Agreement +with MTIX (see below), the former owners of MTIX were granted a first priority interest in all of MTIX’s assets, which constitute +virtually all of Avalanche’s assets and reduced our interest to that of a second position, greatly diminishing its value. +When Avalanche issued the Third Party Note referred to above, it granted the third party a first priority security interest in +all its assets, to include those comprised of MTIX. Both we and the former owners of MTIX consented to the subordination of our +respective security interests. Since our security interests have been reduced to a third position, we will have no ability to use +Avalanche’s assets to offset any default in Avalanche’s debt obligations to us unless and until the two other security +interests are terminated, which would not occur until Avalanche’s debts to the senior creditors have been repaid. We do not +anticipate that Avalanche will repay its debts to these creditors within the foreseeable future and will therefore have no recourse +should Avalanche default on its debts to us during this period of time. Any failure by Avalanche to repay us would therefore have +a materially adverse effect on our results of operations, financial condition and future prospects. +Milton C. Ault, III and William Horne, +our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors of Avalanche. In +addition, Philou is the controlling stockholder of Avalanche. +Milton C. Ault, III +and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors +of Avalanche. In addition, Philou is the controlling stockholder of Avalanche. Certain conflicts of interest between us, on the +one hand, and Avalanche, on the other hand, may arise relating to commercial or strategic opportunities or initiatives, in addition +to the conflicts related to the debt that Avalanche owes us. For example, Messrs. Ault and Horne may find it difficult to determine +how to meet their fiduciary duties to us as well as Avalanche, which could result in a less favorable result for us than would +be the case if they were solely directors of our company. Further, even if Messrs. Ault and Horne were able to successfully meet +their fiduciary obligations to us and Avalanche, the fact that are members of the board of directors of both companies could attenuate +their ability to focus on our business and best interests, possibly to the detriment of both companies. Mr. Ault’s control +of Philou through Ault & Company only enhances the risk inherent in having Messrs. Ault and Horne serve as directors of both +our company and Avalanche. +Risks Related to Our Business and Industry - Overview +Technology changes rapidly in our business, +and if we fail to anticipate new technologies, the quality, timeliness and competitiveness of our products will suffer. +Rapid technology changes +in our industry require us to anticipate, sometimes years in advance, which technologies and/or distribution platforms our products +must take advantage of in order to make them competitive in the market at the time they are released. Therefore, we usually start +our product development with a range of technical development goals that we hope to be able to achieve. We may not be able to achieve +these goals, or our competition may be able to achieve them more quickly than we can. In either case, our products may be technologically +inferior to competitive products, or less appealing to consumers, or both. If we cannot achieve our technology goals within the +original development schedule of our products, then we may delay products until these technology goals can be achieved, which may +delay or reduce revenue and increase our development expenses. Alternatively, we may increase the resources employed in research +and development in an attempt to accelerate our development of new technologies, either to preserve our product launch schedule +or to keep up with our competition, which would increase our development expenses and adversely affect our operations and financial +condition. +24 +Table of Contents +We are dependent upon our ability, and +our contract manufacturers’ ability, to timely procure electronic components. +Because of the global +economy, many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their +operations. As a result, there is a global shortage of certain electronic or mineral components, which may extend our production +lead-time and our production costs. Some materials are no longer available to support some of our products, thereby requiring us +to search for cross materials or, even worse, redesign some of our products to support currently-available materials. Such redesign +efforts may require certain regulatory and safety agency re-submittals, which may cause further production delays. While we have +initiated actions that we believe will limit our exposure to such problems, the dynamic business conditions in many of our markets +may challenge the solutions that have been put in place, and issues may recur in the future. +In addition, some of +our products are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While +we have had relationships with many of these third parties in the past, we cannot predict how or whether these relationships will +continue in the future. In addition, changes in management, financial viability, manufacturing demand or capacity, or other factors, +at these third parties could hurt our ability to manufacture our products. +Our strategic focus on our custom power +supply solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our +strategic focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing +custom power supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a +specific customer’s requirements. Failure to meet these customer product requirements or a failure to meet production schedules +and/or product quality standards may put us at risk with one or more of these customers. Moreover, changes in market conditions +and strategic changes at the direction of our customers may affect their decision to continue to purchase from us. The loss of +one or more of our significant custom power supply solution customers could have a material adverse impact on our revenues, business +or financial condition. +We have also implemented +a series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, +they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes +in the market or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional +cost-reducing initiatives, including those involving our personnel, which may negatively impact quarterly earnings and profitability +as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term adverse +effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products or services, making +it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for +our solutions increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings +to be lower than they otherwise might be. +We depend +upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction +in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend +upon a few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or +cancel their orders scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, +diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their +reduced demand for our products, which could, in turn, have a material adverse effect on our business and results of operations. +If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment +capital due to any of these or other factors, a substantial decrease in our revenues would likely result. We are dependent on the +electronic equipment industry, and accordingly will be affected by the impact on that industry of current economic conditions. +Substantially all of +our existing customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological +change, obsolescence, and large fluctuations in demand. This industry is further characterized by intense competition and volatility. +The OEMs serving this industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar +demands on their suppliers, such as us, for increased product performance and lower prices. Such demands may adversely affect our +ability to successfully compete in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers +to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product +quality. +Since we do not own +significant manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers +to manufacture our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced +control over manufacturing costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, +and continued inflationary pressures on many of the raw materials used in the manufacturing of our power supply products. If we +were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays +caused by reduced manufacturing capacity, inability of our subcontract manufacturers to procure raw materials, the loss of key +assembly subcontractors, difficulties associated with the transition to our new subcontract manufacturers or other factors, we +could experience lost revenues, increased costs, and delays in, or cancellations or rescheduling of, orders or shipments, any of +which would materially harm our business. +25 +Table of Contents +We outsource, and are dependent upon +developer partners for, the development of some of our custom design products. +We made an operational +decision to outsource some of our custom design products to numerous developer partners. This business structure will remain in +place until the custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully +comply with the customer specifications and requirements might affect our ability to transition to a volume production stage of +the custom designed product where the revenue goals are dependent on the high volume of custom product production. Furthermore, +we rely on the design partners’ ability to provide high quality prototypes of the designed product for our customer approval +as a critical stage to approve production. +We face intense industry competition, +price erosion and product obsolescence, which, in turn, could reduce our profitability. +We operate in an industry +that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth +of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, +price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors +strive to retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be +written off and, therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing +our revenues and our gross margins. In fact, we have seen price erosion over the last several years on most of the products we +sell, and we expect additional price erosion in the future. +Our future results are dependent on +our ability to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell +our products through domestic and international OEM relationships and other distribution channels, such as manufacturers’ +representatives and distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships +with OEMs as well as with manufacturers’ representatives and distributors to sell our products. If, however, the third parties +with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, +or reduce the amount of their, business with us or otherwise fail to meet their own performance objectives, customer demand for +our products could be adversely affected, which would have an adverse effect on our revenues. +We may not be able to procure necessary +key components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, +and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, +we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, +our suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials +that we require to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build +products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing +the levels of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence +should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase +too much inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which +could have a material adverse effect on our gross margins and on our results of operations. +Although we depend on sales of our legacy +products for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large +portion of our sales have historically been attributable to our legacy products. We expect that these products may continue to +account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining. Although we +are unable to predict future prices for our legacy products, we expect that prices for these products will continue to be subject +to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase +revenues will be dependent on our ability to expand our customer base, to increase unit sales volumes of these products and to +successfully, develop, introduce and sell new products such as custom design and value-added products. We cannot assure you that +we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell +new products. +Failure of our information technology +infrastructure to operate effectively could adversely affect our business. +We depend heavily on +information technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, +the resulting disruption could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise +carry on business in the normal course. Any such events could cause us to lose customers or revenue and could require us to incur +significant expense to remediate. +26 +Table of Contents +We are subject to certain governmental +regulatory restrictions relating to our international sales. +Some of our products +are subject to International Traffic In Arms Regulation (“ ITAR ”), which are interpreted, enforced and administered +by the U.S. Department of State. ITAR regulation controls not only the export, import and trade of certain products specifically +designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services +as well as foreign production. Any delays in obtaining the required export, import or trade licenses for products subject to ITAR +regulation and rules could have a material adverse effect on our business, financial condition, and/or operating results. In addition, +changes in United States export and import laws that require us to obtain additional export and import licenses or delays in obtaining +export or import licenses currently being sought could cause significant shipment delays and, if such delays are too great, could +result in the cancellation of orders. Any future restrictions or charges imposed by the United States or any other country on our +international sales or foreign subsidiary could have a materially adverse effect on our business, financial condition, and/or operating +results. In addition, from time to time, we have entered into contracts with the Israeli Ministry of Defense which were governed +by the U.S. Foreign Military Financing program (“ FMF ”). Any such future sales would be subject to these regulations. +Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial condition, and/or operating results. +We depend on international operations +for a substantial majority of our components and products. +We purchase a substantial +majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, +and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with +international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, +currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes +in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have +a materially adverse effect on our business, financial condition, and/or operating results. +We depend on international sales for a portion of our revenues. +Sales to customers +outside of North America accounted for 56.9% and 29.9% of net revenues for the years ended December 31, 2019 and 2018, and we expect +that international sales will continue to represent a material portion of our total revenues. International sales are subject to +the risks of international business operations as described above, as well as generally longer payment cycles, greater difficulty +collecting accounts receivable, and currency restrictions. In addition, Gresham, our wholly-owned subsidiary in the United Kingdom, +supports our European and other international customers, distributors, and sales representatives, and therefore is also subject +to local regulation. International sales are also subject to the export laws and regulations of the United States and other countries. +Our sales and profitability may be affected +by changes in economic, business and industry conditions . +If the economic climate +in the United States or abroad deteriorates, customers or potential customers could reduce or delay their technology and entertainment +investments. Reduced or delayed technology and entertainment investments could decrease our sales and profitability. In this environment, +our customers may experience financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our +products and professional services. This may lead to longer sales cycles, delays in purchase decisions, payment and collection, +and can also result in downward price pressures, causing our sales and profitability to decline. In addition, general economic +uncertainty and general declines in capital spending in the information technology sector make it difficult to predict changes +in the purchasing requirements of our customers and the markets we serve. There are many other factors which could affect our business, +including: +· The introduction and market acceptance of new technologies, products and services; +· New competitors and new forms of competition; +· The size and timing of customer orders (for retail distributed physical product); +· The size and timing of capital expenditures by our customers; +· Adverse changes in the credit quality of our customers and suppliers; +· Changes in the pricing policies of, or the introduction of, new products and services by us or +our competitors; +· Changes in the terms of our contracts with our customers or suppliers; +· The availability of products from our suppliers; and +· Variations in product costs and the mix of products sold. +These +trends and factors could adversely affect our business, profitability and financial condition and diminish our ability to achieve +our strategic objectives. +The sale of our products is dependent +upon our ability to satisfy the proprietary requirements of our customers. +27 +Table of Contents +We depend upon a relatively +narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued +acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If +we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially +harmed. +The sale of our products is dependent +on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected +by the development, and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our +products. +Rapid technological +change, including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology +in place of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure +for our products and adversely affect the revenues from such products. +Our limited ability to protect our proprietary +information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property +rights of others, resulting in claims against us, the results of which could be costly. +Many of our products +consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination +of copyrights, trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation +of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially +equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary +rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized +in our products from third party infringement, we may be required to institute legal proceedings, which would be costly and would +divert our resources from the development of our business. If we are unable to successfully assert and defend our proprietary rights +in the technology utilized in our products, our future results could be adversely affected. +Although we attempt +to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal +proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the +infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s +attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license +agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could +prevent us from selling our products in the United States or abroad. +If we are unable to satisfy our customers’ +specific product quality, certification or network requirements, our business could be disrupted and our financial condition could +be harmed. +Our customers demand +that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems +in satisfying such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product +quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products +to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects +or if we cannot effect such required product modifications, we could experience lost revenues, increased costs, including inventory +write-offs, warranty expense and costs associated with customer support, delays in, or cancellations or rescheduling of, orders +or shipments and product returns or discounts, any of which would harm our business. +If we ship products that contain defects, +the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from +us. +Our products are complex, +and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products +have been shipped to our customers and installed in their network or after product features or new versions are released. Any such +defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations +with our customers, resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs +and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our +control that may arise from the use of our products could result in financial or other damages to our customers. Our customers +could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate. +Some +of our business is subject to U.S. government procurement laws and regulations . +We +must comply with certain laws and regulations relating to the formation, administration and performance of federal government contracts. +These laws and regulations affect how we conduct business with our federal government contracts, including the business that we +do as a subcontractor. In complying with these laws and regulations, we may incur additional costs, and non-compliance may lead +to the assessment of fines and penalties, including contractual damages, or the loss of business. +28 +Table of Contents +Risks Related to Our Business and Industry - Microphase +Microphase has a history of losses and +our future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on our business and the +value of our company. +During the past three +fiscal years Microphase has incurred losses from operations. These losses are attributable to lower volumes of its products sold +to major defense contractors partially as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. +Since the financial crisis of 2008, Microphase has been significantly short of capital needed to acquire parts for production of +its products to complete orders for such products. At times, Microphase has not had the cash available to make advance payments +for the purchase of parts, and then, as a consequence, Microphase would not receive the parts from its vendors required to finish +a customer order. This would then delay the delivery of products to customers, and would also delay recognition of the resulting +revenues and the receipt of cash from the customer. Sometimes after experiencing a delay in delivery of an order from Microphase, +the customer would not place its next order with Microphase, resulting in a loss of business. +Microphase’s +future profitability depends upon many factors, including several that are beyond its control. These factors include, without limitation: +· changes in the demand for ITS products and services; +· loss of key customers or contracts; +· the introduction of competitive products; +· the failure to gain market acceptance of ITS new and existing products; and +· the failure to successfully and cost effectively develop, introduce and market new products, services +and product enhancements in a timely manner. +In addition, Microphase +is incurring significant legal, accounting, and other expenses related to being a reporting company without there being a trading +market for any of its securities. As a result of these expenditures, Microphase will have to generate and sustain increased revenue +to achieve and maintain future profitability. +A large percentage of Microphase’s +current revenue is derived from prime defense contractors to the U.S. government and its allies, and the loss of these relationships, +a reduction in U.S. government funding or a change in U.S. government spending priorities or bidding processes could have an adverse +impact on its business, financial condition, results of operations and cash flows. +Microphase is highly +dependent on sales to major defense contractors of the U.S. military and its allies, including Lockheed Martin, Raytheon, BAE Systems +and SAAB. The percentages of its revenue that were derived from sales to these named major defense contractors and directly to +the U.S. Government were 51.5% in fiscal 2019 and 55.6% in fiscal 2018. Therefore, any significant disruption or deterioration +of Microphase’s relationship with any such major defense contractors or the U.S. Government could materially reduce its revenue. +During the year ended December 31, 2019 there were three customers that accounted for more than 10% of sales: BAE Systems, +Raytheon Company and Lockheed Martin. During the year ended December 31, 2018 there were four customers that accounted for +more than 10% of sales: BAE Systems, Raytheon Company, Saab and Lockheed Martin. Microphase’s competitors continuously engage +in efforts to expand their business relationships with the same major defense contractors and the U.S. Government and will continue +these efforts in the future, and the U.S. Government may choose to use other contractors. Microphase expects that a majority of +the business that it seeks will be awarded through competitive bidding. Microphase operates in highly competitive markets and its +competitors have more extensive or more specialized engineering, manufacturing and marketing capabilities than Microphase does +in many areas, and Microphase may not be able to continue to win competitively awarded contracts or to obtain task orders under +multi-award contracts. Further, the competitive bidding process involves significant cost and managerial time to prepare bids and +proposals for contracts that may not be awarded to Microphase, as well as the risk that Microphase may fail to accurately estimate +the resources and costs required to fulfill any contract awarded to us. Following any contract award, Microphase may experience +significant expense or delay, contract modification or contract rescission as a result of its competitors protesting or challenging +contracts awarded to it in competitive bidding. Major defense contractors to whom Microphase supplies components for systems must +compete with other major defense contractors (to which Microphase may not supply components) for military orders from the U.S. +Government. +In addition, Microphase +competes with other policy needs, which may be viewed as more necessary, for limited resources and an ever-changing amount of available +funding in the budget and appropriation process. Budget and appropriations decisions made by the U.S. Government are outside of +Microphase control and have long-term consequences for its business. U.S. Government spending priorities and levels remain uncertain +and difficult to predict and are affected by numerous factors, including until recently sequestration (automatic, across-the-board +U.S. Government budgetary spending cuts), and the purchase of our products could be superseded by alternate arrangements. While +the US defense budget was recently increased, there can be no assurance that this increase will be maintained for the foreseeable +future, particularly in light of the recent federal expenditures the federal government has made with a view to ameliorating the +economic damage suffered as a result of COVID-19. A change in U.S. Government spending priorities or an increase in non-procurement +spending at the expense of our programs, or a reduction in total U.S. Government spending, could have material adverse consequences +on Microphase’s future business. +29 +Table of Contents +Microphase’s U.S. government contracts +may be terminated by the federal government at any time prior to their completion, which could lead to unexpected loss of sales +and reduction in Microphase’s backlog. +Under the terms of Microphase’s U.S. +government contracts, the U.S. government may unilaterally: +· terminate or modify existing contracts; +· reduce the value of existing contracts through partial termination; and +· delay the payment of Microphase’s invoices by government payment offices. +The federal government +can terminate or modify any of its contracts with Microphase or its prime contractors either for the federal government’s +convenience, or if Microphase or its prime contractors default, by failing to perform under the terms of the applicable contract. +A termination arising out of Microphase’s default could expose it to liability and have a material adverse effect on its +ability to compete for future federal government contracts and subcontracts. If the federal government or its prime contractors +terminate and/or materially modify any of Microphase’s contracts or if any applicable options are not exercised, Microphase’s +failure to replace sales generated from such contracts would result in lower sales and would adversely affect its earnings, which +could have a material adverse effect on Microphase’s business, results of operations and financial condition. Microphase’s +backlog as of December 31, 2019 was approximately $6.4 million. Microphase’s backlog could be adversely affected if contracts +are modified or terminated. +Microphase’s products with military +applications are subject to export regulations, and compliance with these regulations may be costly. +Microphase is required +to obtain export licenses before filling foreign orders for many of its products that have military or other governmental applications. +United States Export Administration regulations control technology exports like its products for reasons of national security and +compliance with foreign policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for +the security of a destination country. Thus, any foreign sales of its products requiring export licenses must comply with these +general policies. Compliance with these regulations is costly, and these regulations are subject to change, and any such change +may require Microphase to improve its technologies, incur expenses or both in order to comply with such regulations. +Microphase depends on U.S. government +contracts issued to major defense contractors, which often are only partially funded, subject to immediate termination, and heavily +regulated and audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could +have an adverse impact on Microphase’s business. +Over its lifetime, +a U.S. Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts +and subcontracts. The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts +may be authorized and appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year +basis. Procurement funds are typically made available for obligations over the course of one to three years. Consequently, programs +often receive only partial funding initially, and additional funds are designated only as Congress authorizes further appropriations. +The termination of funding for a U.S. Government program with respect to major defense contractors for which Microphase is a subcontractor +would result in a loss of anticipated future revenue attributable to that program, which could have an adverse impact on its operations. +In addition, the termination of, or failure to commit additional funds to, a program for which Microphase is a subcontractor could +result in lost revenue and increase its overall costs of doing business. +Generally, U.S. Government +contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to Microphase’s +contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already +reimbursed must be refunded. Microphase has recorded contract revenues based on costs Microphase expect to realize upon final audit. +However, Microphase does not know the outcome of any future audits and adjustments, and Microphase may be required to materially +reduce its revenues or profits upon completion and final negotiation of audits. Negative audit findings could also result in termination +of a contract, forfeiture of profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting +or subcontracting for a period of time. +In addition, U.S. Government +contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s +convenience upon the payment only for work done and commitments made at the time of termination. Microphase can give no assurance +that one or more of the U.S. Government contracts with a major defense contractor under which Microphase provides component products +will not be terminated under these circumstances. Also, Microphase can give no assurance that it will be able to procure new contracts +to offset the revenue or backlog lost as a result of any termination of its U.S. Government contracts. Because a significant portion +of Microphase’s revenue is dependent on its performance and payment under its U.S. Government contracts, the loss of one +or more large contracts could have a material adverse impact on its business, financial condition, results of operations and cash +flows. +30 +Table of Contents +Microphase’s +government business also is subject to specific procurement regulations and other requirements. These requirements, though customary +in U.S. Government contracts, increase its performance and compliance costs. In addition, these costs might increase in the future, +thereby reducing Microphase’s margins, which could have an adverse effect on its business, financial condition, results of +operations and cash flows. Failure to comply with these regulations and requirements could lead to fines, penalties, repayments, +or compensatory or treble damages, or suspension or debarment from U.S. Government contracting or subcontracting for a period of +time. Among the causes for debarment are violations of various laws, including those related to procurement integrity, export control, +U.S. Government security regulations, employment practices, protection of the environment, accuracy of records, proper recording +of costs and foreign corruption. The termination of a U.S. Government contract or relationship as a result of any of these acts +would have an adverse impact on Microphase’s operations and could have an adverse effect on its standing and eligibility +for future U.S. Government contracts. +Microphase’s business could be +negatively impacted by cybersecurity threats and other security threats and disruptions. +As a U.S. Government +defense contractor, Microphase faces certain security threats, including threats to its information technology infrastructure, +attempts to gain access to its proprietary or classified information, threats to physical security, and domestic terrorism events. +Microphase’s information technology networks and related systems are critical to the operation of its business and essential +to its ability to successfully perform day-to-day operations. Microphase is also involved with information technology systems for +certain customers and other third parties, which generally face similar security threats. Cybersecurity threats in particular, +are persistent, evolve quickly and include, but are not limited to, computer viruses, attempts to access information, denial of +service and other electronic security breaches. Microphase believes that it has implemented appropriate measures and controls and +has invested in skilled information technology resources to appropriately identify threats and mitigate potential risks, but there +can be no assurance that such actions will be sufficient to prevent disruptions to mission critical systems, the unauthorized release +of confidential information or corruption of data. A security breach or other significant disruption involving these types of information +and information technology networks and related systems could: +· disrupt the proper functioning of these networks and systems and therefore its operations and/or +those of certain of its customers; +· result in the unauthorized access to, and destruction, loss, theft, misappropriation or release +of, proprietary, confidential, sensitive or otherwise valuable information of Microphase or its customers, including trade secrets, +which others could use to compete against Microphase or for disruptive, destructive or otherwise harmful purposes and outcomes; +· compromise national security and other sensitive government functions; +· require significant management attention and resources to remedy the damages that result; +· subject Microphase to claims for breach of contract, damages, credits, penalties or termination; +and +· damage Microphase’s reputation with its customers (particularly agencies of the U.S. Government) +and the public generally. +Any +or all of the foregoing could have a negative impact on its business, financial condition, results of operations and cash flows. +Microphase enters into fixed-price contracts +that could subject it to losses in the event of cost overruns or a significant increase in inflation. +Microphase has a number +of fixed-price contracts which allow it to benefit from cost savings but subject it to the risk of potential cost overruns, particularly +for firm fixed-price contracts, because Microphase assumes the entire cost burden. If its initial estimates are incorrect, Microphase +can lose money on these contracts. U.S. Government contracts can expose Microphase to potentially large losses because the U.S. +Government can hold Microphase responsible for completing a project or, in certain circumstances, paying the entire cost of its +replacement by another provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. +Because many of these contracts involve new technologies and applications, unforeseen events such as technological difficulties, +fluctuations in the price of raw materials, problems with its suppliers and cost overruns, can result in the contractual price +becoming less favorable or even unprofitable to Microphase. The U.S. and other countries also may experience a significant increase +in inflation. A significant increase in inflation rates could have a significant adverse impact on the profitability of these contracts. +Furthermore, if Microphase does not meet contract deadlines or specifications, Microphase may need to renegotiate contracts on +less favorable terms, be forced to pay penalties or liquidated damages or suffer major losses if the customer exercises its right +to terminate. In addition, some of its contracts have provisions relating to cost controls and audit rights, and if Microphase +fails to meet the terms specified in those contracts Microphase may not realize their full benefits. Microphase’s results +of operations are dependent on its ability to maximize its earnings from its contracts. Cost overruns could have an adverse impact +on its financial results. +Risks Related to Our Business and Industry - Enertec +Potential political, economic and military +instability in Israel could adversely affect our operations. +31 +Table of Contents +Enertec’s operating +facilities are located in Israel. Accordingly, political, economic and military conditions in Israel directly affect Enertec’s +operations. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel +and its Arab neighbors. A state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. +Since October 2000, there has been an increase in hostilities between Israel and the Palestinian Arabs, which has adversely affected +the peace process and has negatively influenced Israel’s relationship with its Arab citizens and several Arab countries, +including the Israel-Gaza conflict. Such ongoing hostilities may hinder Israel’s international trade relations and may limit +the geographic markets where Enertec can sell its products and solutions. Hostilities involving or threatening Israel, or the interruption +or curtailment of trade between Israel and its present trading partners, could materially and adversely affect Enertec’s +operations. +In addition, Israel-based +companies and companies doing business with Israel have been the subject of an economic boycott by members of the Arab League and +certain other predominantly Muslim countries since Israel’s establishment. Although Israel has entered into various agreements +with certain Arab countries and the Palestinian Authority, and various declarations have been signed in connection with efforts +to resolve some of the economic and political problems in the Middle East, we cannot predict whether or in what manner these problems +will be resolved. Wars and acts of terrorism have resulted in significant damage to the Israeli economy, including reducing the +level of foreign and local investment. +Furthermore, certain +of our officers and employees may be obligated to perform annual reserve duty in the Israel Defense Forces and are subject to being +called up for active military duty at any time. All Israeli male citizens who have served in the army are subject to an obligation +to perform reserve duty until they are between 40 and 49 years old, depending upon the nature of their military service. +Enertec may become subject to claims +for remuneration or royalties for assigned service invention rights by its employees, which could result in litigation and harm +our business. +A significant portion +of the intellectual property covered by Enertec’s products has been developed by Enertec’s employees in the course +of their employment for Enertec. Under the Israeli Patent Law, 5727-1967, or the Patent Law, and recent decisions by the Israeli +Supreme Court and the Israeli Compensation and Royalties Committee, a body constituted under the Patent Law, Israeli employees +may be entitled to remuneration for intellectual property that they develop for us unless they explicitly waive any such rights. +To the extent that Enertec is unable to enter into agreements with its future employees pursuant to which they agree that any inventions +created in the scope of their employment or engagement are owned exclusively by Enertec (as it has done in the past), Enertec may +face claims demanding remuneration. As a consequence of such claims, Enertec could be required to pay additional remuneration or +royalties to its current and former employees, or be forced to litigate such claims, which could negatively affect its business. +Risks Related to Ownership of Our +Common Stock +If we +do not continue to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +The +listing of our common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for +continued listing. On December 18, 2015, we were notified by the NYSE American that we were no longer in compliance with the NYSE +American continued listing standards because our reported stockholders' equity was below continued listing standards. The NYSE +American requires that a listed company's stockholders' equity be $4.0 million or more if it has reported losses from continuing +operations and/or net losses in three of its four most recent fiscal years. Subsequently, the NYSE American informed us that we +are required to attain stockholders’ equity of $6.0 million or more because we experienced a loss for the year ended December +31, 2016. +Following +submission of our compliance plan demonstrating how we intend to regain compliance with the continued listing standards, we were +notified on March 9, 2016, that the NYSE American granted us a listing extension on the basis of our plan until June 19, 2017. +We are subject to periodic review by NYSE American staff during the extension period. Failure to make progress consistent with +the plan or to regain compliance with the continued listing standards by the end of the extension period could result in our common +stock being delisted from the NYSE American. +On +June 19, 2017, we filed a Form 8-K report with the Commission announcing that our Stockholders' Equity was approximately $6,409,000 +on a pro-forma basis. In a letter dated June 20, 2017, the NYSE American notified us that we had successfully regained compliance +with the NYSE American continued listing standards. Notwithstanding the foregoing, in light of our continued losses, there is no +assurance that we will be able to continue to meet the NYSE American continued listing standard. If we fail to meet the NYSE American +listing requirement, we may be subject to delisting by the NYSE American. In the event our common stock is no longer listed for +trading on the NYSE American, our trading volume and share price may decrease and we may experience further difficulties in raising +capital which could materially affect our operations and financial results. +32 +Table of Contents +On +November 20, 2017, we received a letter from NYSE Regulation indicating that the NYSE American had concluded that we failed to +comply with Section 401(a) of the NYSE American’s Company Guide, which section requires that a listed company “make +immediate public disclosure of all material information concerning its affairs” The letter, which relates to our disclosure +of certain personnel changes to our board of directors and officers, provided that such letter constituted a warning letter issued +to us pursuant to Section 1009(a)(i) of the NYSE American Company Guide. On October 12, 2017, we filed a Form 8-K that disclosed +that certain personnel changes to our board of directors and executive officers were effective October 6, 2017. On November 6, +2017, we filed an amendment to the above referenced Form 8-K that disclosed that the personnel changes had not in fact occurred. +After discussion with the NYSE American, on November 8, 2017, we filed a subsequent Form 8-K that further clarified that we had +determined to rescind the personnel changes as of October 23, 2017. In that Form 8-K, we provided additional disclosure explaining +why the personnel changes were not undertaken. +On +November 29, 2017, we notified the NYSE American, LLC that we were no longer in compliance with Rule 801(h) of the NYSE American +Company Guide because, as a smaller reporting company, our Board of Directors was not comprised of at least 50% independent directors. +On November 28, 2017, our Board of Directors approved the issuance of cash compensation, and 10,000 shares of common stock and +warrants to purchase 50,000 shares of common stock subject to vesting and stockholder approval, to Mr. William Horne, a director +of our company, for services. As a result of this compensation, Mr. Horne may not be deemed independent within the meaning of Section +803A(2) of the NYSE American Company Guide. Mr. Horne has resigned from the audit committee of the Board of Directors. Robert Smith +has been appointed as chair of the audit committee. On December 8, 2017, our board of directors rescinded the equity compensation +granted to Mr. Horne. We believe that we were therefore in compliance with Rule 801(h) of the NYSE American Company Guide +and that we remain so. +On +January 4, 2019, we received a deficiency letter from NYSE American indicating that we were not in compliance with the continued +listing standards as set forth in Section 1003(f)(v) of the NYSE American Company Guide (the “ Company Guide ”). +Specifically, the letter informed the Company that the Exchange has determined that the shares of our common stock have been selling +for a low price per share for a substantial period of time and, pursuant to Section 1003(f)(v) of the Company Guide, the Company's +continued listing is predicated on the Company effecting a reverse stock split of our common stock or otherwise demonstrating sustained +price improvement within a reasonable period of time, which the NYSE American determined to be no later than July 4, 2019. As noted +above, on March 18, 2019 we effectuated a reverse split whereby each twenty (20) shares of our common stock were combined into +one such share, which increased the market price to a level where we regained compliance with the Company Guide (the “ March +Split ”). However, since that time our common stock has declined significantly and there can be no assurance that it will +not continue to do so. If the decline is sufficiently marked, we will in all likelihood receive another letter similar to the one +referenced above; however, there can be no assurance that we could in that event successfully conduct another reverse split on +a timely basis, if at all, or that the NYSE Exchange will not take more drastic action, up to and including delisting our shares +of common stock from the exchange. +While we believed at +the time that the March Split achieved its intended objectives, as the closing market price of the Common Stock on that date was +$1.68, substantially above the $1.00 market price that the NYSE American prefers the issuers listed on the NYSE American maintain, +and well above the market prices that lead it to issue letters of various kinds to its listed issuers, we also believed it to be +in our own and our stockholders’ best interest to effectuate another reverse stock split due to certain deleterious events +that occurred subsequent to March 14, 2019. +The first to occur +of these events was a precipitous drop in the market price near the end of the trading day of March 15, 2019. As noted above, the +closing market price on March 14, 2019 was $1.68. While this price level was not fully sustained during the trading day of March +15, 2019, in the last few minutes the price dropped precipitously, with the CMP being $0.71. +The second event that +caused a significant slide in the market price of the Common Stock was our press release dated March 29, 2019, which announced +the pricing of a public offering. On April 3, 2019, we announced that this public offering had closed on April 2, 2019. On March +28, 2019, the closing market price was approximately $0.71, only slightly lower than the closing market price on March 15, 2019, +meaning that the CMP was substantially steady for the two weeks following the March Split. On March 29, 2019, however, the closing +market price fell to approximately $0.29. This drop in the market price was clearly occasioned by the announcement of the pricing +of the public offering and was entirely unrelated to the March Split. As of May 31, 2019, the closing market price was approximately +$0.15, substantially below the level required by the NYSE American and very significantly below its preferred minimum level of +$1.00. +On +July 23, 2019, pursuant to the authorization provided by our stockholders at our reconvened +2019 Annual Meeting of Stockholders on July 19, 2019, our Board approved an amendment to our Certificate of Incorporation (the +“ Amendment ”) to effectuate a reverse stock split of our common stock that reduced the issued and outstanding +number of such shares by a ratio of one-for-forty (the “ July Split ”). The July Split became effective in the +State of Delaware on August 5, 2019. Since that time, the market price of our shares of common stock has been in compliance with +the NYSE’s listing standards. +If we should fail to +maintain compliance with NYSE American low-priced continued listing standards in the future, then our common stock securities will +be subject to delisting. Delisting could have a material adverse effect on our business, liquidity and on the trading of the common +stock. If our common stock were to be delisted, then it could be quoted on the OTCQB market or on the “pink sheets” +maintained by the OTC Markets Group. However, such alternatives are generally considered to be less efficient markets. Further, +delisting from the NYSE American could also have other negative effects, including potential loss of confidence by partners, lenders, +suppliers and employees and could also trigger various defaults under our lending agreements and other outstanding agreements. +Finally, delisting could make it harder for us to raise capital and sell securities. +33 +Table of Contents +Our common stock price is volatile. +Our common stock is +listed on the NYSE American. In the past, our trading price has fluctuated widely, depending on many factors that may have little +to do with our operations or business prospects. The exercise of outstanding options and warrants may adversely affect our stock +price and a stockholder’s percentage of ownership. As of December 31, 2019, we had outstanding options to purchase an aggregate +of 2,763 shares of common stock, with a weighted average exercise price of $731.62 per share, exercisable at prices ranging from +$480 to $1,856 per share and warrants to purchase up to 72,518 shares of common stock, with a weighted average exercise price of +$206.57 per share, at exercise prices ranging from $8 to $2,000 per share. +On April 2, 2019, pursuant +to the underwriting agreement with A.G.P./Alliance Global Partners entered into on March 29, 2019, as referenced above, we issued +an aggregate of 793,325 shares of common stock, including shares of common stock underlying warrants. The sale of these shares +of our common stock, including those underlying the warrants (assuming exercise thereof), has had a material and adverse effect +on the market price of our common stock. +In addition, we have +previously agreed to register shares of common stock, and common stock underlying outstanding warrants and convertible debt in +connection with private placement of our securities that are not being registered in this annual report. Our shares of common stock +are thinly traded. Therefore, the resale of a large number of shares of common stock and common stock underlying warrants and convertible +debt by the selling stockholders may adversely affect the market price of our common stock. +Volatility in our common stock price may subject us to securities +litigation. +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our common stock +may continue to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, +coupled with depressed economic conditions, could continue to have a depressing effect on the market price of our common stock. +The following factors, many of which are beyond our control, may influence our stock price: +· the status of our growth strategy including the development of new products with any proceeds we +may be able to raise in the future; +· announcements of technological or competitive developments; +· regulatory developments affecting us, our customers or our competitors; +· announcements regarding patent or other intellectual property litigation or the issuance of patents +to us or our competitors or updates with respect to the enforceability of patents or other intellectual property rights generally +in the US or internationally; +· actual or anticipated fluctuations in our quarterly operating results; +· changes in financial estimates by securities research analysts; +· changes in the economic performance or market valuations of our competitors; +· additions or departures of our executive officers; and +· sales or perceived sales of additional shares of our common stock. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common +stock and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market +price of a company’s securities, stockholders have often instituted securities class action litigation against that company. +If we were involved in a class action suit or other securities litigation, it would divert the attention of our senior management, +require us to incur significant expense and, whether or not adversely determined, have a material adverse effect on our business, +financial condition, results of operations and prospects. +We have a substantial +number of convertible notes, warrants, options and preferred stock outstanding that could affect our price. +Due +to a number of financings, we have a substantial number of shares that are subject to issuance pursuant to outstanding convertible +debt, warrants and options. These conversion prices and exercise prices range from $8 to $2,000 per share of common stock. As of December +31, 2019, the number of shares of common stock subject to convertible notes, warrants, options and preferred stock were 1,252,163, +72,518, 2,763 and 2,232, respectively. The issuance of common stock pursuant to convertible notes, warrants, options and preferred +stock at conversion or exercise prices less than market prices may have the effect of limiting an increase in market price of our +common stock until all of these underling shares have been issued. +We have a number +of shares of common stock subject to registration rights. +34 +Table of Contents +Due +to a number of financings, we have contractually agreed to register with the Commission shares of common stock, and common stock +underlying outstanding warrants and convertible debt in connection with private placements of our securities. The potential resale +at the same time of a large number of shares of common stock and common stock underlying warrants and convertible debt by the selling +stockholders may adversely affect the market price of our common stock. +Sales of additional +shares of our common stock could cause the price of our common stock to decline. +Sales +of substantial amounts of our common stock in the public market, or the availability of such shares for sale, by us or others, +including the issuance of common stock upon exercise of outstanding options and warrants, could adversely affect the price of our +common stock. We and our directors and officers may sell shares into the market, which could adversely affect the market price +of shares of our common stock. +The rights of the holders of common +stock may be impaired by the potential issuance of preferred stock. +Our certificate of +incorporation gives our board of directors the right to create new series of preferred stock. As a result, the board of directors +may, without stockholder approval, issue preferred stock with voting, dividend, conversion, liquidation or other rights which could +adversely affect the voting power and equity interest of the holders of common stock. Preferred stock, which could be issued with +the right to more than one vote per share, could be utilized as a method of discouraging, delaying or preventing a change of control. +The possible impact on takeover attempts could adversely affect the price of our common stock. Although we have no present intention +to issue any shares of preferred stock or to create a series of preferred stock, we may issue such shares in the future. +The requirements of being a public company +may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company +and subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among +other things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley +Act requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial +reporting. For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of +our internal controls structure and procedures for financial reporting. Section 404 compliance may divert internal resources +and will take a significant amount of time and effort to complete. If we fail to maintain compliance under Section 404, or +if in the future management determines that our internal control over financial reporting are not effective as defined under +Section 404, we could be subject to sanctions or investigations by the NYSE American should we in the future be listed on +this market, the Commission, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and +this could cause a decline in the market price of our common stock. Any failure of our internal controls could have a material +adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively +or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on +internal controls from our independent auditors. We may need to hire a number of additional employees with public accounting and +disclosure experience in order to meet our ongoing obligations as a public company, particularly if we become fully subject to +Section 404 and its auditor attestation requirements, which will increase costs. Our management team and other personnel will need +to devote a substantial amount of time to new compliance initiatives and to meeting the obligations that are associated with being +a public company, which may divert attention from other business concerns, which could have a material adverse effect on our business, +financial condition and results of operations. +If we fail to comply with the rules under +the Sarbanes-Oxley Act of 2002 related to accounting controls and procedures, or if we discover material weaknesses and deficiencies +in our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more +difficult. +If we fail to comply +with the rules under the Sarbanes-Oxley Act of 2002 related to disclosure controls and procedures, or, if we discover material +weaknesses and other deficiencies in our internal control and accounting procedures, our stock price could decline significantly +and raising capital could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments +of the effectiveness of our internal control over financial reporting. If material weaknesses or significant deficiencies are discovered +or if we otherwise fail to achieve and maintain the adequacy of our internal control, we may not be able to ensure that we can +conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 +of the Sarbanes-Oxley Act. Moreover, effective internal controls are necessary for us to produce reliable financial reports and +are important to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business +and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price +of our common stock could drop significantly. +If securities or industry analysts do +not publish research or reports about our business, or if they change their recommendations regarding our stock adversely, our +stock price and trading volume could decline. +The trading market +for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our +business. Our research coverage by industry and financial analysts is currently limited. Even if our analyst coverage increases, +if one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these +analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, +which in turn could cause our stock price or trading volume to decline. +35 +Table of Contents +The elimination of monetary liability +against our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, +officers and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers +and employees. +Our certificate of +incorporation contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders +for damages for the breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have +contractual indemnification obligations under any future employment agreements with our officers. The foregoing indemnification +obligations could result in us incurring substantial expenditures to cover the cost of settlement or damage awards against directors +and officers, which we may be unable to recoup. These provisions and the resulting costs may also discourage us from bringing a +lawsuit against directors and officers for breaches of their fiduciary duties, and may similarly discourage the filing of derivative +litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit +us and our stockholders. +We do not anticipate paying dividends +on our common stock and, accordingly, stockholders must rely on stock appreciation for any return on their investment. +We have never declared +or paid cash dividends on our common stock and do not expect to do so in the foreseeable future. The declaration of dividends is +subject to the discretion of our board of directors and will depend on various factors, including our operating results, financial +condition, future prospects and any other factors deemed relevant by our board of directors. You should not rely on an investment +in our company if you require dividend income from your investment in our company. The success of your investment will likely depend +entirely upon any future appreciation of the market price of our common stock, which is uncertain and unpredictable. There is no +guarantee that our common stock will appreciate in value. +ITEM 1B. UNRESOLVED STAFF COMMENTS. +Not applicable. +ITEM 2. PROPERTIES +Our corporate headquarters +utilize 2,983 square foot of leased office space in Newport Beach, California. Our headquarter lease commenced in March 2018 and +expires in February 2021. The annual base rent under the lease, payable on a monthly basis, increases during the term of the lease +from approximately $122,000 during the first year to approximately $128,000 during the final year. +In addition, we lease +52,595 square-feet of other space domestically that includes office, engineering, laboratory and warehouse space in both California +and Connecticut. The annual base rent under these leases, payable on a monthly basis, was approximately 903,000 during 2019. These +leases expire between April 2020 and January 2028. +We also lease facilities +internationally. In September 2010, our wholly-owned subsidiary, Gresham Power Electronics, entered into a fifteen-year lease for +its 25,000 square-foot facility in Salisbury, United Kingdom, where it designs, develops, manufactures, markets and distributes +commercial and military power products for the European market. Sales and service support staff for its European network of distributors +are located within the building together with other functions, such as engineering and administration. Gresham Power Electronics’ +rent expense is approximately $13,000 per month, and Gresham Power Electronics exercised the option to extend the lease through +September 2024. Further, in June 2011, Enertec entered into a ten-year lease for its 32,900 square-foot facility in Karmiel, Israel, +where it manufactures specialized electronic systems for the Israel military market. Enertec’s rent expense is approximately +$20,000 per month, +We currently anticipate +that the current leased space will be sufficient to support our current and foreseen future needs. +ITEM 3. LEGAL PROCEEDINGS +Derivative Action +On July 31, 2018, Ethan +Young and Greg Young (collectively, “ Plaintiffs ”) filed a stockholder derivative complaint (the “ Complaint ”) +in the United States District Court for the Central District of California (the “ Court ”) against the Company +as the nominal defendant, as well as its current directors and a former director, in action captioned, Ethan Young and Greg +Young, Derivatively on Behalf of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff +Bentz, Mordechai Rosenberg, Robert O. Smith, and Kristine Ault and DPW Holdings, Inc. , as the nominal defendant, Case No. 18-cv-6587 +(the “ Derivative Action ”). +36 +Table of Contents +The Complaint alleged +violations of state law and breaches of fiduciary duty, unjust enrichment and gross mismanagement by the individual defendants, +in connection with various transactions entered into by us. +We moved to dismiss +the Complaint, and on February 25, 2019, the Court granted our motion to dismiss, in its entirety, without prejudice, and also +granted Plaintiffs leave to amend their Complaint. +On March 11, 2019, +plaintiffs filed an amended complaint asserting violations of breaches of fiduciary duties and unjust enrichment claims based on +the previously pled transactions (the “ Amended Complaint ”). +On March 25, 2019, +we filed a motion to dismiss the Amended Complaint. On May 21, 2019, the Court granted in part, and denied part, our motion to +dismiss the Amended Complaint. As previously announced, on February 24, 2020, the Company entered into a definitive settlement +agreement (the “ Settlement Agreement ”) with Plaintiffs to settle the claims asserted in the Amended Complaint. +On April 15, 2020, +the Court issued an Order (the “ Order ”) approving a Motion for Preliminary Approval of Settlement in the Derivative +Action. Pursuant to the terms of the Order, the Board shall adopt and/or maintain certain resolutions and amendments to the Company’s +committee charters and/or bylaws, to ensure adherence to certain corporate governance policies (collectively, the “ Reforms ”). +The Order further provides that such Reforms shall remain in effect for a period of no less than five (5) years and shall be subject +to any of the following: (a) a determination by a majority of the independent directors that the Reform is no longer in the best +interest of the Company, including, but not limited to, due to circumstances making the Reforms no longer applicable, feasible, +or available on commercially reasonable terms, or (b) modifications which the Company reasonably believes are required by applicable +law or regulation. +In connection with +the Settlement Agreement, the parties have agreed upon a payment of attorneys’ fees in the amount of $600,000, which sum +shall be payable by our Director & Officer liability insurance. The Settlement Agreement contains no admission of wrongdoing. +We have always maintained +and continue to believe that neither us nor our current or former directors engaged in any wrongdoing or otherwise committed any +violation of federal or state securities laws or any other laws or regulations. +Although the Settlement +Agreement has been approved by the Court, there can be no assurance that the settlement will be finalized and approved by the Court +or that the Settlement Agreement will be properly objected to by any of our shareholders and, even if approved, whether the conditions +to closing will be satisfied, and the actual outcome of this matter may differ materially from the terms of the settlement described +herein. +Blockchain Mining Supply and Services, +Ltd. +On November 28, 2018, +Blockchain Mining Supply and Services, Ltd. (“ Blockchain Mining ”) a vendor who sold computers to our subsidiary, +filed a Complaint (the “ Complaint ”) in the United States District Court for the Southern District of New York +against us and our subsidiary, Super Crypto Mining, Inc., in an action captioned Blockchain Mining Supply and Services, Ltd. +v. Super Crypto Mining, Inc. and DPW Holdings, Inc. , Case No. 18-cv-11099. +The Complaint asserts +claims for breach of contract and promissory estoppel against the us and our subsidiary arising from the subsidiary’s alleged +failure to honor its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $1,388,495, plus +attorneys’ fees and costs. +We believe that these +claims are without merit and intend to vigorously defend them. +On April 13, 2020, +we and our subsidiary, jointly filed a motion to dismiss the Complaint in its entirety as against us, and the promissory estoppel +claim as against our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Complaint in connection with +the breach of contract claim. +On April 29, 2020, +Blockchain Mining filed an amended complaint (the “ Amended Complaint ”). The Amended Complaint asserts the same +causes of action and seeks the same damages as the initial Complaint. +On May 13, 2020, we +and our subsidiary, jointly filed a motion to dismiss the Amended Complaint in its entirety as against us, and the promissory estoppel +claim as against of our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Amended Complaint in connection +with the breach of contract claim. +Based on our assessment +of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably +estimate the potential loss or range of loss that may result from this action. Notwithstanding, we have established a reserve in +the amount of the unpaid portion of the purchase agreement. An unfavorable outcome may have a material adverse effect on our business, +financial condition and results of operations. +37 +Table of Contents +Ding Gu (a/k/a Frank Gu) and Xiaodan +Wang Litigation +On January 17, 2020, +Ding Gu (a/k/a Frank Gu) (“ Gu ”) and Xiaodan Wang (“ Wang ” and with “ Gu ” +collectively, “ Plaintiffs ”), filed a Complaint (the “ Complaint ”) in the Supreme Court of +the State of New York, County of New York against us and our Chief Executive Officer, Milton C. Ault, III, in an action captioned +Ding Gu (a/k/a Frank Gu) and Xiaodan Wang v. DPW Holdings, Inc. and Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd +Ault) , Index No. 650438/2020. +The Complaint asserts +causes of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent +injunction, enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions +entered into between Gu and us, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs +and DPW, in or about July 2019. The Complaint seeks, among other things, monetary damages in excess of $1,100,000, plus a decree +of specific performance directing DPW to deliver unrestricted shares of DPW’s common stock to Gu, plus attorneys’ fees +and costs. +We believe that these +claims are without merit and intend to vigorously defend them. +On May 4, 2020, we +and Ault, jointly filed a motion to dismiss the Complaint in its entirety, with prejudice. +The motion to dismiss +is returnable before the Court on June 26, 2020. +Based on our assessment +of the facts underlying the above claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably +estimate the potential loss or range of loss that may result from this action. An unfavorable outcome may have a material adverse +effect on our business, financial condition and results of operations. +The Company is involved +in litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory +and government investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such +claims, suits, regulatory and government investigations, and other proceedings could result in fines, civil penalties, or other +adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable +that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and +the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters +that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses +disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and +the estimated amount of a loss related to such matters. +With respect to our +other outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will +not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results +of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +38 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is +listed on the NYSE American under the symbol DPW. The following table sets forth our high and low sale prices per share of our +common stock as reported by www.nasdaq.com on the NYSE American through May 27, 2020 and for each quarter for the past two fiscal +years. +Fiscal Year Ended December 31, 2018 +High +Low +First Quarter +$2,880.00 +$609.44 +Second Quarter +$1,200.00 +$392.88 +Third Quarter +$532.08 +$311.20 +Fourth Quarter +$348.00 +$72.00 +Fiscal Year Ended December 31, 2019 +High +Low +First Quarter +$128.00 +$11.18 +Second Quarter +$15.16 +$4.88 +Third Quarter +$11.60 +$1.57 +Fourth Quarter +$2.50 +$0.65 +First Quarter of 2020 +$2.48 +$0.83 +Second Quarter of 2020 through May 26, 2020 +$1.95 +$0.71 +On May 26, 2020, the +last sales price per share of our common stock was $1.06. +Record Holders +As of May 26, 2020, +shares of our common stock were issued and outstanding and were owned by approximately 34 holders of record. A number of holders +of our common stock are “street name” or beneficial holders whose shares of record are held by banks, brokers, and +other financial institutions. +Dividend Policy +We have not declared +or paid any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration +of dividends in the future, if any, will be at the discretion of our Board of Directors and will depend upon our earnings, capital +requirements, and financial position. +Equity Compensation Information +The following table summarizes information +about our equity compensation plans as of December 31, 2019. +Number of Shares +Number of Options +of Common Stock +Weighted- +Remaining Available for +to be Issued +Average +Future Issuance Under +upon Exercise +Exercise Price +Equity Compensation Plans +of Outstanding +of Outstanding +(excluding securities +Options +Options +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation plans +approved by stockholders (1) +3,160 +$ 640.71 +103,105 +(1) Includes warrants to purchase 397 shares of common stock at an exercise price of $8.00 per share of common stock that were +issued to Mr. Kohn and approved by the Company’s stockholders in December 2017 and options to purchase 1,375 shares of common +stock at an average exercise price of $827.64 per share of common stock that were issued to the Company’s officers and directors +and approved by the Company’s stockholders in December 2017 and 2018. +Recent Sales of Unregistered Securities +On February 25, 2020, +principal of $295,000 from a debt security issued on February 5, 2020 was satisfied through the issuance of 203,448 shares of our +common stock. The foregoing issuance was exempt from registration upon reliance of Section 4(a)(2) and Regulation D promulgated +thereunder. +39 +Table of Contents +Issuer Repurchases of Equity Securities +Not applicable. +ITEM 6. SELECTED FINANCIAL DATA. +As a Smaller Reporting +Company, we are electing to follow scaled disclosure reporting obligations and therefore are not required to provide the information +requested by this Item. +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +CAUTIONARY NOTE REGARDING FORWARD-LOOKING +STATEMENTS +This Annual Report +on Form 10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed +to be, forward-looking statements. Such forward-looking statements include statements regarding, among others, (a) our expectations +about possible business combinations, (b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs +for working capital. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations, +are generally identifiable by use of the words “may,” “will,” “should,” “expect,” +“anticipate,” “approximate,” “estimate,” “believe,” “intend,” “plan,” +“budget,” “could,” “forecast,” “might,” “predict,” “shall” +or “project,” or the negative of these words or other variations on these words or comparable terminology. This information +may involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements +to be materially different from the future results, performance, or achievements expressed or implied by any forward-looking statements. +These statements may be found in this Annual Report on Form 10-K. +Forward-looking statements +are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other +future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, +risks, and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated +by the forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk +Factors” in this 10-K, changes in local, regional, national or global political, economic, business, competitive, market +(supply and demand) and regulatory conditions and the following: +· Adverse economic conditions; +· Our ability to effectively execute our business plan; +· Inability to raise sufficient additional capital to operate our business; +· Our ability to manage our expansion, growth and operating expenses; +· Our ability to evaluate and measure our business, prospects and performance metrics; +· Our ability to compete and succeed in highly competitive and evolving industries; +· Our ability to respond and adapt to changes in technology and customer behavior; +· Our ability to protect our intellectual property and to develop, maintain and enhance a strong +brand; and +· Other specific risks referred to in the section entitled “ Risk Factors ”. +We caution you therefore +that you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances +of future performance. All forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake +no obligation to update any forward-looking statements or other information contained herein unless required by law. +Information regarding +market and industry statistics contained in this Annual Report is included based on information available to us that we believe +is accurate. It is generally based on academic and other publications that are not produced for purposes of securities offerings +or economic analysis. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications +and the additional uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and +services. Except as required by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect +actual results or changes in assumptions or other factors that could affect those statements. See the section entitled “ Risk +Factors ” for a more detailed discussion of risks and uncertainties that may have an impact on our future results. +In this Annual Report, +the “Company,” “DPW Holdings,” “we,” “us” and “our” refer to DPW Holdings, +Inc., a Delaware corporation, our wholly-owned subsidiaries, Coolisys Technologies, Inc., Coolisys Technologies Corp., Digital +Power Corp., Digital Power Lending, LLC, Digital Farms, Inc., Gresham Worldwide, Inc., Gresham Power Electronics Ltd., Enertec +Systems 2001 Ltd. and our majority owned subsidiaries, Microphase Corporation and I.AM, Inc. +40 +Table of Contents +Recent Developments +Public Offering +On +March 29, 2019, we entered into an underwriting agreement (the “ Underwriting Agreement ”) with A.G.P./Alliance +Global Partners (the “ Underwriter ”), pursuant to which we agreed to issue and sell an aggregate of (a) 71,388 +shares of our common stock (the “ Shares ”) together with warrants to purchase 71,388 shares of common stock (the +“ Common Warrants ”) and (b) pre-funded warrants to purchase up to 317,500 shares of its common stock +(the “ Pre-Funded Warrants ”) together with a number of Common Warrants to purchase 317,500 shares of common +stock (the “ Offering ”). The Shares were sold to the purchasers at the public offering price of $17.60 per +share (the “ Offering Price ”). The Common Warrants were sold at a public offering price of $0.40 per Common Warrant. +The Pre-Funded Warrants were offered to each purchaser whose purchase of the Shares and the Common Warrant in the Offering would +otherwise result in the purchaser, together with its affiliates and certain related parties, beneficially owning more than 4.99% +(or, at the election of the purchaser, 9.99%) of our outstanding common stock immediately following the consummation of the Offering. +The purchase price of each Pre-Funded Warrant equaled the Offering Price at which the Shares were sold to the public in the Offering, +minus $0.40, and the exercise price of each Pre-Funded Warrant equaled $0.40 per share. In +addition, we have also issued the Underwriter a warrant to purchase a maximum of 15,550 additional shares of common stock at an +initial exercise price of $19.80 per share, with a term of five years (the “ Underwriter Warrants ”). The +Offering closed on April 2, 2019 and as of December 31, 2019, we had issued a total of 771,275 shares of its common stock, inclusive +of shares issued pursuant to the exercise of 317,500 Pre-Funded Warrants and 382,387 shares issued pursuant to the cashless exercise +of the Common Warrants. +On January 7, 2020, +we formed Coolisys Technologies Corp. (“ CTC ”), a wholly-owned subsidiary, in order to hold Digital Power Corporation +which designs, develops, manufactures and sells high-grade customized and flexible power system solutions. Coolisys is presently +owned by Gresham Worldwide, Inc. ( “GWW ”) and owns Microphase Corporation, Gresham Power Electronics and Enertec +Systems. We may dispose of Coolisys in the future, leaving GWW as the direct owner of the three foregoing subsidiaries. +On December 23, 2019, +the Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of +the NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. +As a result, at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, +or up to 19.99% of the Common Stock then outstanding. +On +February 5, 2020, we sold an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, is +due and payable on August 5, 2020. The Note, which was funded between December 2019 and January 2020, and reflected as short term +advances, related party on our consolidated balance sheets, shall be convertible into shares of the Company’s common stock, +par value $0.001 per share (the “ Common Stock ”) at a conversion +price of $1.45 per share, subject to the approval of the Company’s stockholders at a special meeting thereof, as required +by Rule 713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American. This special meeting is presently +scheduled to occur on June 8, 2020. +On February 10, 2020, +we entered into a Master Exchange Agreement (the “ Exchange Agreement ”) with Esousa Holdings, LLC (the “ Credito r”) +that acquired approximately $4.2 million dollars in principal amount, plus accrued but unpaid interest, of certain promissory notes +that had been previously issued by us to Dominion Capital, LLC, a Connecticut limited liability company (the “ Dominion +Note ”) and the Canadian Special Opportunity Fund, LP (the “ CSOF Note ” and with the Dominion Note, +the “ Purchased Notes ”) in separate transactions. The Creditor also agreed to purchase additional notes up to +an additional principal amount, plus accrued but unpaid interest, of $3.5 million (the “ Additional Notes ” and +collectively, with the Purchased Notes, the “ Notes ”). Pursuant to the Exchange Agreement, the Creditor has the +unilateral right to acquire, among other things set forth therein, shares of the Company’s common stock (the “ Exchange +Shares ”) in exchange for the Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness +of the Company. Since the Exchange Agreement provided the Creditor with a substantive conversion feature, the debt instruments +were determined to be substantially different and the promissory notes acquired by Esousa will be accounted for as an extinguishment. +This special meeting is presently scheduled to occur on June 8, 2020. +Settlement of Derivative Litigation +As previously announced, +on February 24, 2020, we entered into a definitive settlement agreement (the “ Settlement Agreement ”) that is +intended to settle the previously disclosed derivative litigation captioned Ethan Young and Greg Young, Derivatively on Behalf +of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, +Robert O. Smith, and Kristine Ault and DPW Holdings, Inc., as the nominal defendant (Case No. 18-cv-6587) (as amended on March +11, 2019, the “ Amended Complaint ”) against the Company and certain of its officers and directors pending in +the United States District Court for the Central District of California (the “ Court ”). As previously disclosed, +the Amended Complaint alleges violations including breaches of fiduciary duties and unjust enrichment claims based on the previously +pled transactions. +On April 15, 2020, +the Court issued an Order (the “ Order ”) approving a Motion for Preliminary Approval of Settlement in the Derivative +Action filed against DPW as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018. +41 +Table of Contents +Under the terms of +the Order approving the Agreement, the Board shall adopt and/or maintain resolutions and amendments to committee charters and/or +the Company’s bylaws to ensure adherence to certain corporate governance policies (collectively, the “ Reforms ”), +which shall remain in effect for no less than five (5) years, subject to any of the following: (a) a determination by a majority +of the independent directors that the Reform is no longer in the best interest of the Company, including, but not limited to, due +to circumstances making the Reform no longer applicable, feasible, or available on commercially reasonable terms, or (b) modifications +which the Company reasonably believes are required by applicable law or regulation. +In connection with +the Settlement Agreement, the parties have agreed upon a payment of attorneys’ fees in the amount of $600,000 payable by +the Company’s Director & Officer liability insurance. The Settlement Agreement contains no admission of wrongdoing. The +Company has always maintained and continues to believe that it did not engage in any wrongdoing or otherwise commit any violation +of federal or state securities laws or other laws. While the Settlement Agreement has been approved by the Court, there can be +no assurance that the settlement will be finalized and approved by the Court or properly objected to by any shareholders and, even +if approved, whether the conditions to closing will be satisfied, and the actual outcome of this matter may differ materially from +the terms of the settlement described herein. +Other Matters +In +January 2018, we formed Super Crypto Mining, Inc., a wholly-owned subsidiary, which recently changed its name to Digital Farms, +Inc. (“ DFI ”). DFI was established to operate our newly formed cryptocurrency business, which mined a variety +of digital currency for our own account. These cryptocurrencies include Bitcoin, Litecoin and Ethereum. DFI’s operations +were discontinued in the first quarter of 2020. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I. AM, Inc. (“ I. AM ”). +I. AM’s operations were discontinued in the first quarter of 2020. +GENERAL +As a holding company, +our business strategy is designed to increase shareholder value. Under this strategy, we are focused on managing and financially +supporting our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing +the value returned to shareholders. We have, are and will consider initiatives including, among others: public offerings, the sale +of individual partner companies, the sale of certain or all partner company interests in secondary market transactions, or a combination +thereof, as well as other opportunities to maximize shareholder value. We anticipate returning value to shareholders after satisfying +our debt obligations and working capital needs. +From time to time, +we engage in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries +or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development +can best be supported by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, +we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of privately +negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s securities +and, in the case of publicly traded partner companies, sales of their securities in the open market. Our plans may include taking +subsidiaries or partner companies public through rights offerings and directed share subscription programs. We will continue to +consider these (or similar) programs and the sale of certain subsidiary or partner company interests in secondary market transactions +to maximize value for our shareholders. +Over the recent past +we have provided capital and relevant expertise to fuel the growth of businesses in defense/aerospace, industrial, telecommunications, +medical, crypto-mining, textiles and a select portfolio of commercial hospitality properties. We have provided capital to subsidiaries +as well as partner companies in which we have an equity interest or may be actively involved, influencing development through board +representation and management support. +We were originally +a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system +solutions for the medical, military, telecom and industrial markets. Although we intend to seek growth through acquisitions, we +will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where +customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating +conditions. +We have operations +located in Europe through our wholly-owned subsidiary, Gresham Power Electronics Ltd. (“ Gresham Power ”), which +is located in Salisbury, England. Gresham Power designs, manufactures and sells power products and system solutions mainly for +the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters +and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution +products. +42 +Table of Contents +On November 30, 2016, +we formed Digital Power Lending, LLC (“ DP Lending ”), a wholly-owned subsidiary. DP Lending is engaged in providing +commercial loans to companies throughout the United States to provide them with operating capital to finance the growth of their +businesses. The loans will primarily be short-term, ranging from six to twelve months, but may be of longer duration. Through DP +Lending, we have launched an online fintech portal, MonthlyInterest.com, that facilitates investments that pay monthly interest. +As a holding company, we have been developing DP Lending to enable the capacity to fund entrepreneurs, our subsidiaries and partner +companies. We believe MonthlyInterest.com will provide investors the opportunity to invest directly into companies and technology +that will have a global impact, bypassing traditional banking and lending institutions. +On June 2, 2017, DPW +Holdings purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase +is a design-to-manufacture original equipment manufacturer, or OEM, industry leader delivering world-class radio frequency (“ RF ”) +and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video +amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. Microphase is headquartered +in Shelton, Connecticut. +On April 25, 2017, +DPW Holdings formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. The Company intends +to operate its existing businesses in the customized and flexible power system solutions for the medical, military, telecom and +industrial markets, other than the European markets which are primarily served by Gresham Power, in Coolisys. +Further, on September +1, 2017, Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California +limited liability company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply +solutions, UPS systems, fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus +will serve as an extended sales organization for the Company’s overall flexible power system solutions. +On +December 31, 2017, Coolisys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“ MICT ”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“ EML ”), +and Enertec Systems 2001 Ltd. (“ Enertec ”), an Israeli corporation and wholly owned subsidiary of EML, pursuant +to which Coolisys acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for +the military market. On May 23, 2018, Coolisys acquired Enertec for an aggregate cash purchase price of $4,850,099. +During the first quarter +of 2020, the Company discontinued the operations of Digital Farms and I. AM. The Company continuously assess the composition of +its business operations to ensure they are aligned with its strategic objectives and positioned to maximize growth and return to +its shareholders. On March 16, 2020, to try and mitigate the spread of the novel coronavirus, San Diego County health officials +issued orders mandating that all restaurants must end dine-in services. As a result of these temporary closures and the deteriorating +business conditions at both the Company’s cryptocurrency mining and restaurant businesses, the Company concluded that discontinuing +these operations was ultimately in its best interest. Accordingly, during the first quarter of 2020, the Company will begin to +separately report the results of the cryptocurrency mining and restaurant businesses as discontinued operations in its consolidated +statements of operations and present the related assets and liabilities as held for sale in its consolidated balance sheets. +We are a Delaware corporation +with our corporate office located at 201 Shipyard Way, Suite E, Newport Beach, California 92663. Our phone number is 949-444-5464 +and our website address is www.dpwholdings.com. +Results of Operations +43 +Table of Contents +RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2019 +AND 2018 +The following table summarizes the results +of our operations for the years ended December 31, 2019 and 2018. +For the Years Ended +December 31, +2019 +2018 +Revenue +$ 21,057,509 +$ 17,762,217 +Revenue, cryptocurrency mining +641,745 +1,675,549 +Revenue, related party +— +3,907,280 +Revenue, restaurant operations +4,149,646 +3,462,140 +Revenue, lending activities +662,740 +347,033 +Total revenue +26,511,640 +27,154,219 +Cost of revenue +20,452,292 +21,774,658 +Gross profit +6,059,348 +5,379,561 +Total operating expenses +33,001,145 +24,985,017 +Loss from operations +(26,941,797 ) +(19,605,456 ) +Interest income +3,351,226 +2,736,932 +Interest expense +(7,262,646 ) +(16,190,276 ) +Change in fair value of marketable equity securities +(596,242 ) +— +Loss on extinguishment of convertible debt +(966,134 ) +— +Loss on issuance of warrants +(1,763,481 ) +— +Change in fair value of warrant liability +1,124,953 +— +Loss before income taxes +(33,054,121 ) +(33,058,800 ) +Income tax benefit +108,293 +76,599 +Net loss +(32,945,828 ) +(32,982,201 ) +Less: Net loss attributable to non-controlling interest +32,416 +748,320 +Net loss attributable to DPW Holdings +$ (32,913,412 ) +$ (32,233,881 ) +Preferred deemed dividends on Series B Preferred Stock +— +(108,049 ) +Preferred dividends +(15,938 ) +— +Net loss available to common stockholders +$ (32,929,350 ) +$ (32,341,930 ) +Basic and diluted net loss per common share +$ (22.97 ) +$ (446.11 ) +Basic and diluted weighted average common shares outstanding +1,433,464 +72,498 +Comprehensive Loss +Loss available to common stockholders +$ (32,929,350 ) +$ (32,341,930 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +341,774 +(377,823 ) +Net unrealized loss on derivative securities of related party +(1,950,168 ) +(8,027,746 ) +Other comprehensive income (loss) +(1,609,101 ) +(8,405,569 ) +Total Comprehensive loss +$ (34,538,451 ) +$ (40,747,499 ) +Revenues +Our revenues decreased +by $642,579, or 2.4%, to $26,511,640 for the year ended December 31, 2019, from $27,154,219 for the year ended December 31, 2018. +During the years ended December 31, 2019 and 2018, Enertec and I.AM, which was discontinued during the quarter ended March 31, +2020, represented $13,000,830 and $8,688,215, respectively, of our revenues. Excluding revenues from these acquisitions, we would +have recognized revenues of $13,510,810 and $18,466,004, respectively, during the years ended December 31, 2019 and 2018, a decrease +of $4,955,194. As discussed below, the decrease of $4,955,194 from the year ended December 31, 2018, was primarily due to a decrease +in revenue from our restaurant operations, from the manufacture of the MLSE plasma-laser system and from our cryptocurrency mining +operations. The following table shows revenue for the years ended December 31, 2019 and 2018, generated from acquisitions completed +during the year ended December 31, 2018. +For the Year Ended December 31, +Company acquired +Date of +Acquisition +2019 +2018 +Enertec Systems 2001 Ltd. +May 22, 2018 +$ 8,851,184 +$ 5,226,075 +I.AM, Inc. +May 23, 2018 +4,149,646 +3,462,140 +$ 13,000,830 +$ 8,688,215 +44 +Table of Contents +Revenues, cryptocurrency mining +In January 2018, we +formed Digital Farms, a wholly-owned subsidiary. Digital Farms was established to operate our cryptocurrency business, which pursued +a variety of digital currencies. We mined the top three cryptocurrencies for our own account, consisting of Bitcoin, Litecoin and +Ethereum. The market prices of digital currencies declined during the year ended December 31, 2019 compared to the prior year. +Further, due to power cost considerations, we reduced the number of active miners during the year ended December 31, 2019. These +factors, coupled with a significant increase in the difficulty factor, which determines how hard it is to mine one block of cryptocurrency, +resulted in a decrease in revenues of $1,033,804 from our cryptocurrency mining operations. We discontinued our cryptocurrency +mining operations during the quarter ended March 31, 2020. +Revenues, related party +During the year ended +December 31, 2018, we recognized $3,907,280 in revenues resulting from our purchase order with MTIX. Conversely, we did not recognize +any revenues from MTIX during year ended December 31, 2019. MTIX was acquired by AVLP on August 22, 2017, and is therefore a related +party. The lack of revenue during the year ended December 31, 2019, was due to an emphasis on reducing the debt obligations incurred +in May 2018 to acquire Enertec. Payments, and the related manufacturing services, that otherwise would have gone to subcontractors +of the MLSE plasma-laser system have been delayed in order to enable us to restructure and reduce our overall debt obligations. +Gross Margins +Gross margins decreased +to 22.9% for the year ended December 31, 2019, compared to 19.8% for the year ended December 31, 2018. Our gross margins during +the year ended December 31, 2018, of 19.8%, were affected by the lower margin related party revenue of $3,907,280 from MTIX combined +with negative margins on revenues of $1,675,549 at Digital Farms. Excluding the effects of Digital Farms and our contract with +MTIX, our adjusted gross margins for the year ended December 31, 2018, would have been 36.8%. +Our gross margin of +22.9% recognized during the year ended December 31, 2019, was also impacted by the negative margins at Digital Farms and the provision +for credit losses of $1,550,000 at DP Lending. Excluding the effects of Digital Farms and credit losses at DP Lending, our adjusted +gross margin for the year ended December 31, 2019 would have been 37.7%, which is consistent with our historical average which +has typically ranged between 33% and 37%, with slight variations depending on the overall composition of our revenue. +Engineering and Product Development +Engineering and product +development expenses increased by $430,565 to $1,861,103 for the year ended December 31, 2019, from $1,430,538 for the year ended +December 31, 2018. The increase in engineering and product development expenses is attributable to our acquisition of Enertec, +which due to the timing of the acquisition was partially excluded from the prior period amount. +Selling and Marketing +Selling and marketing +expenses were $1,631,809 for the year ended December 31, 2019, compared to $3,010,790 for the year ended December 31, 2018, a decrease +of $1,378,981. Our acquisition of Enertec and I.AM resulted in an increase of $173,121. This increase was offset by decreases in +personnel costs directly attributed to a reduction in sales and marketing personnel throughout our operations. +General and Administrative +General and administrative +expenses were $19,670,995 for the year ended December 31, 2019 compared to $19,842,378 for the year ended December 31, 2018, a +decrease of $171,383. Our acquisitions of Enertec and I.AM resulted in an increase of $2,000,080 in general and administrative +expenses. This increase was offset by lower stock compensation expense and legal fees partially offset by an increase in cost attributed +to the hiring of an Executive Vice President and General Counsel, Chief Accounting Officer and Senior Vice President of Finance. +Asset Impairment Charges +Asset impairment charges of $4,315,856 were +recognized during the year ended December 31, 2019. The impairment charges related to impairments of our cryptocurrency equipment. +Impairment loss on goodwill and intangible +assets +During the year ended +December 31, 2019, we performed a qualitative assessment and concluded that the goodwill at our Coolisys and I.AM subsidiaries +was impaired and recorded an impairment of $746,205. Further, during the year ended December 31, 2019, we also recorded an impairment +loss of $780,692 related to intangible assets primarily comprised of trade names, customer lists and a non-competition agreement +at these two subsidiaries. +Provision for credit losses +Loans +are generally carried at the amount of unpaid principal, adjusted for unearned loan fees and original issue discount , +which are amortized over the term of the loan using the effective interest rate method. Interest on loans is accrued based on the +principal amounts outstanding. During the years ended December 31, 2019 and 2018, we evaluated the collectability of both +interest and principal for the convertible promissory notes in AVLP to determine whether there was an impairment. Based on current +information and events, primarily the value of the underlying conversion feature and current +economic events, we concluded that an impairment existed at December 31, 2019. Accordingly, we recorded a $4,000,000 provision +for credit losses. +45 +Table of Contents +Interest Income +Interest income was +$3,351,226 for the year ended December 31, 2019 compared to $2,736,932 for the year ended December 31, 2018. The increase in interest +income for the year ended December 31, 2019 is primarily related to an increase in interest income pursuant to the Loan and Security +Agreement entered into on September 6, 2017, with AVLP, a related party. +Interest expense +Interest expense was +$7,262,646 for the year ended December 31, 2019, compared to $16,190,276 for the year ended December 31, 2018. The decrease in +interest expense for the year ended December 31, 2019 is primarily related to a reduction of amortization of debt discount resulting +from original issue discount from the issuance of warrants in conjunction with the sale of debt instruments. During the year ended +December 31, 2019 and 2018, as a result of these issuances, non-cash interest expense of $3,709,993 and $11,191,055, respectively, +was recorded from the amortization of debt discount and debt financing costs. +Loss on issuance of warrants +We recognized a loss +on issuance of warrants of $1,763,481 for the year ended December 31, 2019, based upon the fair value of the warrants issued in +our Offering in excess of the proceeds received from the Offering. +Change in fair value of warrant liability +During the year ended +December 31, 2019, the fair value of the warrants that were issued in our Offering decreased by $1,124,953. The fair value of these +warrants is re-measured at each financial reporting period and immediately before exercise, with any changes in fair value recorded +as change in fair value of warrant liability in the Consolidated Statements of Operations and Comprehensive Loss. +Net Loss +For the foregoing reasons, +our net loss for the year ended December 31, 2019, was $32,945,828 compared to a net loss of $32,982,201 for the year ended December +31, 2018. After taking into consideration the loss attributable to the non-controlling interest of the minority shareholders of +Microphase during the year ended December 31, 2019 and 2018, of $32,416 and $748,320, respectively, and preferred dividends of +$15,935 and $108,049, respectively, the net loss available to common shareholders during the years ended December 31, 2019 and +2018, was $32,929,350 and $32,341,930, respectively. +As reflected in our +consolidated statement of cash flows for the years ended December 31, 2019 and 2018, our reported net loss includes a significant +number of non-cash charges of $11,435,682 and $16,812,868, respectively. A summary of these non-cash charges is as follows: +For the Years Ended +December 31, +2019 +2018 +Interest expense – debt discount +$ 3,709,993 +$ 11,191,055 +Stock-based compensation +1,583,991 +4,719,266 +Depreciation and amortization +3,465,091 +2,906,905 +Impairment of property and equipment +4,315,856 +— +Accretion of original issue discount on notes receivable – related party +(2,277,777 ) +(2,004,358 ) +Fair value in excess of proceeds upon issuance of warrants +1,763,481 +— +Change in fair value of warrant liability +(1,124,953 ) +— +Non-cash items included in net loss +$ 11,435,682 +$ 16,812,868 +Other comprehensive loss +Other comprehensive +loss was $34,538,451 and $40,747,499, respectively, for the years ended December 31, 2019 and 2018. Other comprehensive loss for +the year ended December 31, 2019, which decreased our equity, was primarily due to unrealized losses in the warrant derivative +securities that we received as a result of our investment in AVLP, a related party. During the year ended December 31, 2018, unrealized +losses in the warrant derivative securities of AVLP was also the primary component of other comprehensive loss. +46 +Table of Contents +LIQUIDITY AND CAPITAL RESOURCES +On December 31, 2019, +we had cash and cash equivalents of $488,553. This compares with cash and cash equivalents of $902,329 at December 31, 2018. The +decrease in cash and cash equivalents was primarily due to cash provided by financing activities being slightly less of the amount +of cash used in operating and investing activities with the remaining variance attributed to the effect of exchange rates caused +by a decrease in exchange rates between the U.S. dollar and the Israeli Shekel. +Net cash used in operating +activities totaled $10,296,036 for the year ended December 31, 2019, compared to $10,422,404 for the year ended December 31, 2018. +During the year ended December 31, 2019, the decrease in net cash used in operating activities compared to the year ended December +31, 2018, was mainly due to several non-cash charges, a decrease in amortization of debt discount of $7,481,062 and stock-based +compensation of $3,135,275, an increase in depreciation and amortization of $558,186, an increase in provision for loan losses +of $5,550,000 and a decrease in accounts receivable, related party due to a payment of $2,676,219 in April 2019. +Net cash used in investing +activities was $2,863,113 for the year ended December 31, 2019, compared to $20,618,928 for the year ended December 31, 2018. The +decrease of the net usage of cash from investing activities was primarily attributed to the purchase of property and equipment +at Digital Farms and our acquisition of Enertec during the year ended December 31, 2018. +Net cash provided by +financing activities was $12,925,203 and $30,537,688 for the year ended December 31, 2019 and 2018, respectively. Financing activities +during the year ended December 31, 2019, primarily related to the sale of shares of our common stock through an “at the market +offering” program and through an underwriting agreement with A.G.P./Alliance Global Partners. The proceeds that we received +from the sale of our shares of common stock was partially offset by net cash outflows of $2,900,950 associated with our debt arrangements. +Historically, we have +financed our operations principally through issuances of convertible debt, promissory notes and equity securities. During 2019, +as reflected below, we continued to successfully obtain additional equity and debt financing and in restructuring existing debt. +· On October 15, 2018, we entered into an At-The-Market Issuance Sales Agreement with WDCO (the “WDCO +ATM Offering”) to sell shares of our common stock. Between January 1, 2019 and April 1, 2019, the date the WDCO ATM Offering +was terminated, the Company received gross proceeds of $4,656,050 through the sale of 119,791 shares of our common stock through +the WDCO ATM Offering. +· On March 29, 2019, we entered into an underwriting agreement pursuant to which we sold 71,388 shares +of our common stock, warrants to purchase 388,888 shares of our common stock and pre-funded warrants to purchase 317,500 shares +of our common stock on April 2, 2019. We received gross proceeds from this offering of $6,999,555 and used approximately $6,000,000 +of the proceeds from this offering for the repayment of debt. +· On August 6, 2019, we entered into an At-The-Market Issuance Sales Agreement with Ascendiant Capital +Markets, LLC, as sales agent in which we sold 1,140,330 shares of our common stock having an aggregate offering price of $5,500,000 +(the “ATM Offering”). The offer and sale of our common stock was made pursuant to our effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) +filed with the Commission on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, +and a prospectus supplement related to the ATM Offering, dated August 6, 2019. +· On February 10, 2020, we entered into a Master Exchange Agreement (the “ Exchange Agreement ”) +with an entity (the “ Creditor ”) that acquired approximately $4.2 million dollars in principal amount, plus accrued +but unpaid interest, of certain promissory notes that had been previously issued by the Company. The Creditor also agreed to purchase +additional notes up to an additional principal amount, plus accrued but unpaid interest, of $3.5 million (collectively, the “ Notes ”). +Pursuant to the Exchange Agreement, the Creditor has the unilateral right to acquire, among other things set forth therein, shares +of the Company’s common stock in exchange for the Notes. We anticipate the second exchange to acquire an additional $3.5 +million of certain promissory notes if the Company receives stockholder approval at a special meeting thereof for the Exchange +Agreement, as required by Rule 713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American. This +special meeting is presently scheduled to occur on June 8, 2020. If we receive stockholder approval of the Exchange Agreement at +the June 8, 2020 special meeting, we believe the Creditor will make a direct investment in us. +We expect to continue +incurring losses for the foreseeable future and will be required to raise additional capital to continue to support our working +capital requirements. We have been successful over the last 12 months in raising capital to support our working capital requirements. +We anticipate that we will continue to raise capital through public and private equity offerings, debt financings, or other means. +If we are unable to secure additional capital, we may be required to curtail our current operations and take additional measures +to reduce costs expenses, including reducing our workforce, eliminating outside consultants, ceasing or reducing our due diligence +of potential future acquisitions, including the associated legal fees, in order to conserve cash in order to sustain operations +and meet our obligations. +47 +Table of Contents +Based on the above, +these matters raise substantial doubt about our ability to continue as a going concern and amounts reported in our financial statements +do not reflect the effects of any adjustments to the carrying amounts of our assets and liabilities should we be unable to continue +as a going concern. +Critical Accounting Policies +See Note 3, Basis of Presentation and Significant +Accounting Policies, to the Company’s consolidated financial statements for the year ended December 31, 2019 included in +this Annual Report. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller +reporting company, this section is not applicable +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements +required by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not +required to provide supplementary financial information. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and +Procedures +As of December 31, +2019, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our +principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure +controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange +Act ”). We have established disclosure controls and procedures designed to ensure that information required to be disclosed +in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods +specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and +principal financial officer, to allow timely decisions regarding required disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined +in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined +that our disclosure controls and procedures were not effective due to certain material weaknesses as described herein. +Management’s Annual Report on +Internal Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange +Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability +of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted +accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain +to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the +assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial +statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being +made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance +regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have +a material effect on the financial statements. +Because of its inherent +limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation +of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, +or that the degree of compliance with the policies or procedures may deteriorate. +48 +Table of Contents +Our management assessed +the effectiveness of our internal control over financial reporting as of December 31, 2019. In making this assessment, our management +used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) +in Internal Control-Integrated 2013 Framework. Our management has concluded that, as of December 31, 2019, our internal control +over financial reporting was not effective. +A material weakness +is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or +combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or +interim financial statements will not be prevented or detected. Management has identified the following material weaknesses: +1. +We do not have sufficient resources in our accounting function, +which restricts our ability to gather, analyze and properly review information related to financial reporting, including fair value +estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be +possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of +assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure +to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency +that resulted represented a material weakness +2. We have inadequate controls to ensure that information necessary to properly record transactions +is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management +evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment +of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +3. We did not design or maintain effective general information technology (“IT”) controls +over certain information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets. +Specifically, we did not design and implement p rogram change management controls for certain +financially relevant systems to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, (iii) digital currency hardware wallets, and (iv) underlying accounting records, are identified, +tested, authorized and implemented appropriately. +Planned Remediation +Management, +in coordination with the input, oversight and support of our Audit Committee, has identified the measures below to strengthen our +control environment and internal control over financial reporting. +In +January 2018, we hired a new Chief Financial Officer and engaged the services of a financial accounting advisory firm. In September +2018, we hired a Chief Accounting Officer and in January 2019, we hired a Senior Vice President of Finance. Finally, in May 2019, +we hired an Executive Vice President and General Counsel. We have tasked these individuals with expanding and monitoring the Company’s +internal controls, to provide an additional level of review of complex financial issues and to assist with financial reporting. +On October 7, 2019, we created an Executive Committee comprised of our Chief Executive Officer, Chief Financial Officer and Executive +Vice President and General Counsel. The Executive Committee meets on a daily basis to address the Company’s critical needs +and provide a forum to approve transactions. Further, as we continue to expand our internal accounting department, the Chairman +of the Audit Committee shall perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, +· reviews all anticipated transactions that are not considered in the ordinary course of business +to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s +financial statements +We are currently working to improve and +simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in our +internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period +of time and management has concluded, through testing, that these controls are operating effectively. +This Annual Report +does not include an attestation report of our independent registered public accounting firm regarding internal control over financial +reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant +to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated +filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Changes in Internal Control over Financial +Reporting +During the most recent +fiscal quarter covered by this report there were no significant changes in our internal control over financial reporting (as such +term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to +materially affect our internal control over financial reporting. +ITEM 9B. OTHER INFORMATION. +None +49 +Table of Contents +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +The following table +sets forth the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. Ault, III (1) +50 +Chairman of the Board and Chief Executive Officer +2017 +William B. Horne (2) +51 +Chief Financial Officer and Director +2016 +Amos Kohn +60 +President and Director +2003 +Robert O. Smith (3) (6) +76 +Director +2016 +Moti Rosenberg (6) +71 +Director +2015 +Jeffrey A. Bentz (4) (6) +60 +Director +2018 +Jodi Brichan (5) (6) +52 +Director +2019 +Henry Nisser +51 +Executive Vice President and General Counsel +2019 +(1) Effective March 16, 2017, Mr. Ault was appointed to the Board. +(2) On October 13, 2016, William B. Horne was appointed to the Board. Pursuant to a securities purchase +agreement dated September 5, 2016 by and among the Company, Philou Ventures, and Telkoor. Philou Ventures has the right to appoint +one member to the Board of Directors. +(3) On September 22, 2016, Mr. Robert O. Smith was appointed to the board. +(4) On January 24, 2018, Mr. Jeffrey A. Bentz was appointed to the board. +(5) On December 30, 2019, Ms. Brichan was appointed to the board. +(6) Independent Director and Member of the Audit, Compensation and Nominating and Governance Committees. +Each of the directors +named above will serve until the next annual meeting of our stockholders or until his respective successor is elected and qualified. +Subject to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Mr. Milton C. Ault, III +On March 16, 2017, +Mr. Ault was appointed Executive Chairman of the Board and on December 28, 2017, Mr. Ault was appointed Chief Executive Officer. +Mr. Ault is a seasoned business professional and entrepreneur that has spent more than twenty-seven years identifying value in +various financial markets including equities, fixed income, commodities, and real estate. Mr. Ault founded on February 25, 2016 +Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s Disease +and has served as its Chairman since. Mr. Ault has served as Chairman of Ault & Company, a holding company since December 2015, +and as Chairman of Avalanche International Corp since September 2014, a “voluntary filer” under the Exchange Act. Since +January, 2011, Mr. Ault has been the Vice President of Business Development for MCKEA Holdings, LLC, a family office. Through this +position, Mr. Ault has consulted for a few publicly traded and privately held companies, providing each of them the benefit of +his diversified experience, that range from development stage to seasoned businesses. He was the President, Chief Executive Officer, +Director and Chairman of the Board of Zealous, Inc. from August 2007 until June 4, 2010 and again from February 2011 through May +1, 2011. Mr. Ault was a registered representative at Strome Securities, LP, from July 1998 until December 2005, where he was involved +in portfolio management and worked on several activism campaigns including Taco Cabana, Jack In The Box (formerly Foodmaker), and +21st Century Holdings Co. Mr. Ault became majority stockholder of Franklin Capital Corp and was elected to its board of directors +in July 2004 and became its Chairman and Chief Executive Officer in October 2004 serving until January 2006, and again from July +2006 to January 2007. In April 2005, the company changed its name to Patient Safety Technologies, Inc. (OTCBB:PSTX, OTCQB:PSTX) +(“PST”) and purchased SurgiCount Medical, Inc. Stryker Corporation (NYSE:SYK) acquired PST at the beginning of 2014 +in a deal valued at approximately one hundred twenty million dollars ($120,000,000). PST’s wholly owned operating subsidiary, +SurgiCount Medical, Inc., is the company that developed the SafetySponge® System; a bar coding technology for inventory +control that aims to detect and prevent the incidence of foreign objects left in the body after surgery. We believe that Mr. Ault’s +business background demonstrates he has the qualifications to serve as one of our directors and as Chairman. +50 +Table of Contents +Amos Kohn +Mr. Kohn has served +as a member of our board of directors since 2003, as our President since 2008. Mr. Kohn also served at our Chief Executive Officer +from 2008 to December 2017. From March 2011 until August 2013 and again from July 2017 until January 2018, Mr. Kohn also served +as interim Chief Financial Officer. Mr. Kohn has more than 20 years of successful global executive management experience, including +multiple C-level roles across private and established publicly-traded companies. Mr. Kohn has successfully managed cross-functional +teams, driven corporations to high profitability, built customer loyalty and led businesses through expansion and sustained growth. +His areas of expertise include operations, technology innovation, manufacturing, strategic analysis and planning and M&A. Mr. +Kohn was Vice President of Business Development at Scopus Video Networks, Inc., a Princeton, New Jersey company that develops and +markets digital video networking products (2006-2007); Vice President of Solutions Engineering at ICTV Inc., a leading provider +of network-based streaming media technology solutions for digital video and web-driven programming, located in Los Gatos, California +(2003-2006); Chief Architect at Liberate Technologies, a leading company in the development of a full range of digital media processing +for telecom and cable TV industries, located in San Carlos, California (2000-2003); and Executive Vice President of Engineering +and Technology at Golden Channel & Co., the largest cable television multiple-systems operator (MSO) in Israel, where he had +executive responsibility for developing and implementing the entire nationwide cable TV system (1989-2000). Mr. Kohn holds a degree +in electrical and electronics engineering and is named as an inventor on several United States and international patents. We believe +that Mr. Kohn’s extensive executive-level management experience in diversified industries, including, but not limited to, +power electronics, telecommunications, cable television, broadcast and wireless, as well as his service as a director on our board +since 2003, give him the qualifications and skills to serve as one of our directors. +William B. Horne +Mr. Horne has served +as a member of our board of directors since October 2016. On January 25, 2018, Mr. Horne was appointed as our Chief Financial Officer. +Prior to his appointment as our Chief Financial Officer, Mr. Horne served as one our independent directors. He has served as the +Chief Financial Officer of Targeted Medical Pharma, Inc. (OTCBB: TRGM) since August 2013. Mr. Horne is a director of and Chief +Financial Officer to Avalanche International, Corp., a “voluntary filer” under the Exchange Act. Mr. Horne previously +held the position of Chief Financial Officer in various companies in the healthcare and high-tech field, including OptimisCorp, +from January 2008 to May 2013, a privately held, diversified healthcare technology company located in Los Angeles, California. +Mr. Horne served as the Chief Financial Officer of Patient Safety Technologies, Inc. (OTCBB: PSTX), a medical device company located +in Irvine, California, from June 2005 to October 2008 and as the interim Chief Executive Officer from January 2007 to April 2008. +In his dual role at Patient Safety Technologies, Mr. Horne was directly responsible for structuring the divestiture of non-core +assets, capital financings and debt restructuring. Mr. Horne held the position of Managing Member & Chief Financial Officer +of Alaska Wireless Communications, LLC, a privately held, advanced cellular communications company, from its inception in May 2002 +until November 2007. Mr. Horne was responsible for negotiating the sale of Alaska Wireless to General Communication Inc. (NASDAQ: +GNCMA). From November 1996 to December 2001, Mr. Horne held the position of Chief Financial Officer of The Phoenix Partners, a +venture capital limited partnership located in Seattle, Washington. Mr. Horne has also held supervisory positions at Price Waterhouse, +LLP and has a Bachelor of Arts Magna Cum Laude in Accounting from Seattle University. We believe that Mr. Horne's extensive financial +and accounting experience in diversified industries and with companies involving complex transactions give him the qualifications +and skills to serve as one of our directors. +Robert O. Smith +Mr. Smith serves as +one of our independent directors. Previously, he served as a member of our Board of Directors from November 2010 until May 2015, +and served as a member of our Advisory Board from 2002 until 2015. He is currently a C-level executive consultant working with +Bay Area high-tech firms on various strategic initiatives in all aspects of their business. From 2004 to 2007, he served on the +Board of Directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman of the +Board. From 1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of +their Compower/Boschert Division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with +the JM Smucker Company. Mr. Smith received his BBA degree in Accounting from Ohio University. We believe that Mr. Smith’s +executive-level experience, including his previous service as our President, Chief Executive Officer and Chairman of the Board, +his extensive experience in the accounting industry, and his service on our Board from November 2010 until May 2015, give him the +qualifications and skills to serve as one of our directors. +Mordechai Rosenberg +Mr. Rosenberg serves +as one of our independent directors. He has served as an independent consultant to various companies in the design and implementation +of homeland security systems in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate +Ltd., a manufacturer of armor protection systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From +2000 to 2003, Mr. Rosenberg was the general manager of ZIV U.P.V.C Products Ltd.'s doors and window factory. Mr. Rosenberg is an +active reserve officer and a retired colonel from the Israeli Defense Force (IDF), where he served for 26 years and was involved +in the development of weapon systems. In the IDF, Mr. Rosenberg served in various capacities, including platoon, company, battalion +and brigade commander, head of the training center for all IDF infantry, and head of the Air Force's Special Forces. Mr. Rosenberg +received a B.A in History from the University of Tel Aviv and a Master of Arts in Political Science from the University of Haifa +in Israel. We believe that Mr. Rosenberg’s business background gives him the qualifications to serve as one of our directors. +51 +Table of Contents +Jeffrey Bentz +Mr. Bentz is an experienced +businessman who has served since 1994 as President of North Star Terminal & Stevedore Company, a full-service stevedoring company +located in Alaska and whose major areas of business include terminal operations and management, stevedore services, and heavy equipment +operations. He also has served as a director and advisor to several private companies and agencies. Mr. Bentz obtained a B.A. in +Business and Finance from Western Washington University in 1981. We believe that Mr. Bentz’s executive-level experience, +including his operational and financial oversight of companies with multiple profit centers and his extensive experience in the +real estate and commercial services industries give him the qualifications and skills to serve as one of our directors. +Jodi Brichan +Ms. Brichan currently +has more than 25 years of experience in product commercialization, clinical research, marketing communications, sales planning +and product launches. Since January 1, 2019, Ms. Brichan has been serving as Chief Executive Officer of AdvaVet, Inc., a wholly-owned +subsidiary of Oasmia Pharmaceutical AB, a Sweden-based pharmaceutical company engaged in the field of human and veterinary oncology. +From 2008 to 2016, Ms. Brichan held senior positions with Omnicom Health Group, a global healthcare marketing and communications +company, including acting as Global Client Leader and as a Senior Vice President. From 2003 through 2008, Ms. Brichan held senior +management positions with Publicis Health, a healthcare communications network, including as SVP of Client Services. Currently, +she serves as a consultant to companies in the life sciences, biotechnology, pharmaceutical and device industries and is a board +member of the Healthcare Businesswomen's Association in San Francisco, California. Ms. Brichan brings significant experience in +building businesses, diverse healthcare background, and history of successful product launches and award-winning advertising campaigns . +We believe that Ms. Brichan’s business background gives her the qualifications to serve as one of our directors. +Henry Nisser +From October 31, 2011 +through April 26, 2019, Mr. Nisser was an associate and subsequently a partner with Sichenzia Ross Ference LLP (“SRF”), +a law firm based in New York City. While with SRF, his practice was concentrated in national and international corporate law, with +a particular focus on U.S. securities compliance, public as well as private M&A, equity and debt financings and corporate governance. +Mr. Nisser drafted and negotiated a variety of agreements related to reorganizations, share and asset purchases, indentures, public +and private offerings, tender offers and going private transactions. Mr. Nisser also represented clients’ special committees +established to evaluate M&A transactions and advised such committees’ members with respect to their fiduciary duties. +Mr. Nisser is fluent in French and Swedish as well as conversant in Italian. Mr. Nisser received his B.A. from Connecticut College +in 1992, where he majored in International Relations and Economics. He received his LLB from the University of Buckingham School +of Law in 1999. +Corporate Governance +Our Board is currently +composed of six members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; +and (3) the Nominating and Governance Committee. The membership and the function of each of the committees are described below. +Our Board may, from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current +copies of the charters for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found +on our website at https://dpwholdings.com . +Audit Committee +Messrs. Smith, Bentz +and Rosenberg currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of +the Audit Committee satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE +American. Our Board has also determined that Mr. Smith qualifies as an “audit committee financial expert” as defined +in SEC regulations and satisfies the financial sophistication requirements set forth in the NYSE American Rules. +The Audit Committee +is responsible for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any +non-audit services to be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent +auditors and the progress and results of their work; reviewing our financial statements, internal accounting and auditing procedures, +and corporate programs to ensure compliance with applicable laws; and reviewing the services performed by our independent auditors +to determine if the services rendered are compatible with maintaining the independent auditors’ impartial opinion. +52 +Table of Contents +Compensation Committee +Messrs. Smith, Bentz +and Rosenberg currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members +of the Compensation Committee meets the requirements for independence under the standards of the NYSE American. Mr. Bentz serves +as Chairman of the Compensation Committee. +The Compensation Committee +is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving +salaries, bonuses and other benefits paid to our officers, including our Chief Executive Officer and Chief Financial Officer; and +administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith and Bentz, +as well as Ms. Brichan currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each +of the current members of the Nominating and Governance Committee meets the requirements for independence under the standards of +the NYSE American. Ms. Brichan serves as Chairman of the Nominating and Governance Committee. +The Nominating and +Governance Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and +recommending nominees for each annual meeting of stockholders to the Board; developing and recommending governance principles applicable +to our Board; overseeing the evaluation of our Board and management; and recommending potential members for each Board committee +to our Board. +The Nominating and +Governance Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s +broad-based business and professional skills, experiences and global business and social perspective. +In addition, the Committee +seeks directors who exhibit personal integrity and a concern for the long-term interests of stockholders, as well as those who +have time available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we +seek to attract and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +Involvement in Certain Legal Proceedings +Except as set forth +below, to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former +director, executive officer, or employee: +· been convicted in a criminal proceeding +or been subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +· had any bankruptcy petition filed by or +against the business or property of the person, or of any partnership, corporation or business association of which he was a general +partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time; +· been subject to any order, judgment, or +decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, +permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, +futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged +in any such activity; +· been found by a court of competent jurisdiction +in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities +law, and the judgment has not been reversed, suspended, or vacated; +· been the subject of, or a party to, any +federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated +(not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or +state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies +including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or +temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire +fraud or fraud in connection with any business entity; +· or been the subject of, or a party to, +any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section +3(a)(26) of the Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent +exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member. +53 +Table of Contents +1. Mr. Ault held series 7, 24, and 63 licenses and managed four domestic hedge +funds and one bond fund from 1998 through 2008. On April 26, 2012, as a result from an investigation by FINRA involving activities +during 2008, Mr. Ault agreed to a settlement with FINRA in which he did not admit to any liability or violation of any laws or +regulatory rules and that included restitution and a suspension from association with a FINRA member firm for a period of 2 years. +As part of that settlement, Mr. Ault agreed that before he would reapply for association with FINRA, if at all, he would make restitution +to certain investors. Mr. Ault was able to speak with and pay restitution to one of the investors, but no others. As a result, +Mr. Ault is neither eligible, nor does he intend, to apply for association with FINRA. +Except as set forth in our discussion below +in “Certain Relationships and Related Transactions,” none of our directors or executive officers has been involved +in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed +pursuant to the rules and regulations of the SEC. +Family Relationships +There are no family relationships among +our directors and executive officers. +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the +Exchange Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our +equity securities to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive +officers, directors and ten percent stockholders are also required by SEC rules to furnish us with copies of all Section 16(a) +forms they file. Based solely upon our review of Forms 3, 4 and 5 received by us, or written representations from certain +reporting persons, we believe that during the during current fiscal year and the year ended December 31, 2019, all such filing +requirements applicable to our officers, directors and ten percent stockholders were fulfilled with the following exception: During +the fiscal year of 2019, Mr. Nisser inadvertently filed one late Form 4 reporting one transaction. +Code of Ethics +We have adopted the +Code of Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, +controller or person performing similar functions. The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest +and ethical conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published +on our website at https://dpwholdings.com . We will disclose any substantive amendments to the Code of Ethical Conduct +or any waivers, explicit or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request +to our President, Amos Kohn, we will provide without charge, a copy of our Code of Ethical Conduct. +ITEM 11. EXECUTIVE COMPENSATION . +Summary Compensation Table +The following Summary +Compensation Table sets forth all compensation earned in all capacities during the years ended December 31, 2019 and 2018, by our +Chief Executive Officer. Because we are a Smaller Reporting Company, we only have to report information of our Chief Executive +Officer and our two other most highly compensated executive officers. +54 +Table of Contents +SUMMARY COMPENSATION TABLE +Name and principal position +Year +Salary ($) +Bonus ($) +Stock Awards ($) (1) +Option +Awards ($) (1) +All Other Compensation ($) (2) +Total ($) +Milton C. Ault, III +2019 +400,000 +0 +0 +0 +18,832 +418,832 +Chief Executive Officer (3) +2018 +0 +0 +630,000 +253,465 +400,000 +1,283,465 +William B. Horne +2019 +300,000 +10,000 +0 +0 +17,856 +327,856 +Chief Financial Officer (4) +2018 +246,436 +25,000 +2,230,000 +940,180 +12,857 +3,454,473 +Amos Kohn +2019 +350,000 +0 +0 +0 +47,902 +397,902 +President +2018 +350,000 +0 +0 +0 +34,887 +384,687 +Henry C. Nisser +2019 +133,333 +50,000 +0 +0 +5,807 +189,140 +General Counsel and Executive Vice +President (5) +2018 +0 +0 +0 +0 +0 +0 +(1) The values reported in the “Stock Awards” and “Option Awards” columns represent +the aggregate grant date fair value, computed in accordance with Accounting Standards Codification (“ ASC ”) 718 +Share Based Payments , of grants of stock options and stock awards to our named executive officer in the years shown. +(2) The amounts in “All Other Compensation” consist of health insurance benefits, vehicle +allowance, long-term and short-term disability insurance benefits, and 401K matching amounts. +(3) Mr. Ault was appointed as our Chief Executive Officer on December 28, 2017. Amounts included in +“All Other Compensation” during 2018 consist of cash fees earned as an independent contractor. +(4) Mr. Horne was appointed as our Chief Financial Officer on January 25, 2018. Amounts included in +“All Other Compensation” during 2018 consist of cash fees earned as a director. +(5) Mr. Nisser was appointed as our General Counsel and Executive Vice President on May 1, 2019. +Employment Agreement with Milton C. Ault, III +On +June 17, 2018, the Company entered into a ten year executive employment agreement with Milton C. Ault, III, to serve as Chief Executive +Officer of the Company. For his services, Mr. Ault will be paid a base salary of $400,000 per annum (the “Base Salary”). +Pursuant +to the terms and subject to the conditions set forth in the agreement, if the Company meets or exceeds criteria adopted by the +Company’s compensation committee (the “Compensation Committee”) for earning bonuses which shall be adopted by +the Compensation Committee annually, Mr. Ault shall be eligible to receive an annual bonus, which percentage shall be based on +achievement of applicable performance goals determined by the Compensation Committee. +Further, +Mr. Ault is entitled to receive equity participation as follows: a grant of restricted stock in the aggregate amount of 1,250 shares +of common stock, which shares shall vest ratably over 48 months beginning on January 1, 2020, provided, however, that such shares +may, in whole or in part, in the discretion of the Compensation Committee, vest immediately upon the filing of an Annual Report +on Form 10-K with the Securities and Exchange Commission (the “SEC”) that shows that the Company’s revenues +for the applicable fiscal year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates +any such vesting, the Company’s Compensation Committee must prior thereto have obtained the consent of Mr. Ault, which consent +may be withheld in his discretion. +In +addition, Mr. Ault shall be eligible to receive a performance-based award (the “CEO Performance Award”), provided that +the Company, for any given fiscal year during the term of this agreement, meets the following criteria: (A) an increase in revenue, +as calculated under GAAP over the previous fiscal year as reported in the Annual Report on Form 10-K or successor form for such +fiscal year; provided that any increase less than thirty-five percent (35%) (the “Revenue Percentage”) shall reduce +the CEO Performance Award correspondingly; (B) positive net income, as calculated under GAAP, as reported in the Annual Report +on Form 10-K or successor form for such fiscal year, provided that any increase less than five percent (5%) (the “Net Income +Percentage”) shall reduce the CEO Performance Award correspondingly; and (C) positive net cash flow from operations on a +year-to-year basis, where cash flow is defined as the net amount of cash and cash-equivalents being transferred into and out of +the Company. The CEO Performance Award shall consist of a number of shares of the Company’s common stock having a maximum +value equal to ten percent (10%) of any appreciation in the Company’s Market Capitalization above the High Water Mark (as +such terms are defined in the agreement) as measured by the daily average closing bid price of the Company’s common stock +for the applicable fiscal year subject to proration obtained by the product of Revenue Percentage and the Net Income Percentage. +If the CEO Performance Award in a fiscal year is less than ten percent (10%) due to a reduction caused by an annual shortfall in +either the Revenue Percentage or the Net Income Percentage, the prior year’s targets would be deemed to have been achieved +if a corresponding overage in a subsequent fiscal year results in the achievement of the cumulative targets. The annual and +cumulative targets for revenue and net income, which are provided solely for the purpose of establishing cumulative totals, are +set forth in the agreement. +55 +Table of Contents +Upon +termination of Mr. Ault’s employment (other than upon the expiration of the employment), Mr. Ault shall be entitled to receive: +(A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any +accrued but unused vacation time. +Further, +unless Mr. Ault’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Ault’s employment, the Company shall pay to Mr. Ault +a “Separation Payment” as follows: (A) an amount equal to four (4) weeks of base salary for +each full year of service and credit for his service commencing from September 22, 2016, (B) should Mr. Ault provide the Company +with a separation, waiver and release agreement within 60 days of termination, then the Company shall: (i) pay his base +salary until the last to occur (the “Separation Period”) of (1) the expiration of the remaining portion of the initial +term or the then applicable renewal term, as the case may be, but in no event an amount greater than the Base Salary payable should +either such period expire within two years, or (2) the 12-month period commencing on the date Mr. Ault is terminated, payable +in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life insurance; +and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Ault would have been +otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the +entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity +awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a +change in control, Mr. Ault will be paid an amount equal to the greater of: (i) five times his then current Base Salary or (ii) +the Separation Payment amount set forth above, without regard to whether Mr. Ault continues in the employ of the Company or its +successor. +Employment agreement with William B. Horne +On +January 25, 2018, we entered into a five-year employment agreement with William Horne to serve as Chief Financial Officer and Executive +Vice President of the Company and its subsidiaries. For his services, Mr. Horne will be paid a base salary of $250,000 per +annum. Upon signing of the employment agreement, Mr. Horne is entitled to a signing bonus in the amount of $25,000. In addition, +Mr. Horne shall be eligible to receive an annual cash bonus equal to a percentage of his annual base salary based on achievement +of applicable performance goals determined by the Company’s compensation committee. +Further, +Mr. Horne is entitled to receive equity participation as follows: a grant of restricted stock in the aggregate amount of 1,250 +shares of common stock, which shares shall vest in installments of two hundred fifty (250) shares annually over five (5) years +beginning on January 1, 2019, provided, however, that such shares may, in whole or in part, in the discretion of the Compensation +Committee, vest immediately upon the filing of an Annual Report on Form 10-K with the SEC that shows that the Company’s +revenues for the applicable fiscal year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates +any such vesting, the Company’s Compensation Committee must prior thereto have obtained the consent of Mr. Horne, which consent +may be withheld in his discretion. +Upon +termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to +receive: (i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and +(iii) any accrued but unused vacation time. +Further, +unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne +a “Separation Payment” as follows: (A) an amount equal to four weeks of base salary for each +full year of service, (B) should Mr. Horne provide the Company with a separation, waiver and release agreement within 60 +days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “Separation Period”) +of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or +(2) the 12-month period commencing on the date Mr. Horne is terminated, payable in one lump sum; (ii) provide during the Separation +Period the same medical, dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained +by multiplying (x) the maximum annual bonus as Mr. Horne would have been otherwise entitled to receive by (y) the fraction in which +the numerator is the number of calendar months worked including the entire month in which severance occurred and the denominator +of which is 12; and (iv) all outstanding options and other equity awards shall immediately vest and become fully exercisable for +a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will be paid an amount equal to four +times his Separation Payment. +56 +Table of Contents +Employment Agreement with Amos Kohn +On November 30, 2016, +as amended on February 22, 2017, the Company entered into an employment agreement with Amos Kohn to serve as President and Chief +Executive Officer with an effective date of September 22, 2016. +For his services, Mr. +Kohn will be paid a salary of $300,000 per annum increasing to $350,000 per annum provided that the Company achieves revenues in +the aggregate amount of at least $10,000,000 as determined in accordance with U.S. GAAP for the trailing four calendar quarters. +In addition, Mr. Kohn +shall be eligible for an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance +goals determined by the Company’s compensation committee after conferring with Mr. Kohn. The target amount of Mr. Kohn’s +annual performance bonus shall be 25% to 50% of his then annual base salary but may be greater upon mutual agreement between Mr. +Kohn and the compensation committee. +Further, Mr. Kohn is +entitled to receive equity participation as follows: ten-year warrants to purchase 397 shares of the Company's Common Stock +(the “Warrant Grant”) at an exercise price of $8.00 per share subject to vesting quarterly over two years effective +January 1, 2017. +In the event that Mr. +Kohn is terminated by the Company without cause, or if Mr. Kohn resigns for good reason, Mr. Kohn shall be entitled to (i) all +annual salary earned prior to the termination date, any earned but unpaid portion of Mr. Kohn’s annual performance bonus +for the year preceding in which such termination occurred and any earned but unpaid paid time off; (ii) an amount equal to 100% +of Mr. Kohn’s then in effect annual base salary plus an additional 1/12th of Mr. Kohn’s annual base salary for each +year of employment with the Company prior to such termination; (iii) an amount equal to the average of Mr. Kohn’s two prior +years’ annual bonuses (with such average not to exceed 50% of Mr. Kohn’s annual base salary in effect at the time of +termination) prorated for the portion of the year that executive was employed; (iv) accelerated vesting of all outstanding unvested +stock options and other equity arrangements subject to vesting and held by Mr. Kohn through the termination date and the Company’s +right to repurchase Mr. Kohn’s restricted stock shall cease; and (v) to the extent required by COBRA, continuation of group +health benefits pursuant to the Company's standard programs or in effect at the termination date at Company expense for a period +of not less than 18 months. +If Mr. Kohn is terminated +without cause, or resigns for good reason within 12 months of a change of control, Mr. Kohn shall be entitled to receive: (i) payment +in a lump sum of Mr. Kohn’s annual base salary for 24 months and any accrued, unused paid time-off; (ii) accelerated vesting +of all outstanding unvested stock options and other equity arrangements subject to vesting and the Company’s right to repurchase +Mr. Kohn restricted stock shall cease; and (iii) to the extent required by COBRA, continuation of group health benefits pursuant +to the Company's standard programs or in effect at the termination date at the Company’s expense for a period of not less +than 18 months. +Advisory Vote on Executive Compensation +At the annual meeting +of stockholders on July 2, 2019, the stockholders approved, on an advisory basis, the compensation paid to the Company’s +named executive officers. In addition, stockholders voted, on an advisory basis, that an advisory vote on executive compensation +should be held every three years. +57 +Table of Contents +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding equity +awards as of December 31, 2019 to the Named Executive Officer. +OUTSTANDING +EQUITY AWARDS AT DECEMBER 31, 2019 +OPTION AWARDS +Name +Number of +Securities +Underlying +Unexercised +Options (#) +Exercisable +Number of +Securities +Underlying +Unexercised +Options (#) +Unexercisable +Equity Incentive Plan +Awards: Number of +Securities Underlying +Unexercised +Unearned Options (#) +Option +Exercise +Price ($) +Option +Expiration +Date +Milton C. Ault III +— +— +— +— +— +William B. Horne +— +— +— +— +— +Amos Kohn +— +— +— +— +— +Henry Nisser +— +— +— +— +— +Director Compensation +Beginning July 1, 2018, +the Company pays each independent director an annual base amount of $35,000 annually, other than Mr. Smith, who will receive a +base amount of $45,000 annually due to anticipated additional services to be provided by Mr. Smith as a lead independent director. +Additionally, our Board makes recommendations for adjustments to an independent director’s compensation when the level of +services provided are significantly above what was anticipated. +The table below sets +forth, for each non-employee director, the total amount of compensation related to his or her service during the year ended December +31, 2019: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($) +Total ($) +Robert O. Smith +45,000 +— +— +— +45,000 +Jeffrey A. Bentz +35,000 +— +— +— +35,000 +Mordechai Rosenberg +35,000 +— +— +— +35,000 +Jodi Brichan (1) +— +— +— +— +— +(1) Ms. Brichan was appointed as an independent director on December 30, 2019 and is not entitled to +any compensation therefor during the fiscal year ended December 31, 2019. +Stock Option Plans +On December 28, 2018, +the stockholders approved the 2018 Stock Incentive Plan (as amended on May 5, 2019), which amendment was approved by the stockholders +on July 19, 2019, the “ 2018 Stock Incentive Plan ”), under which options to acquire up to 12,500, as increased +to 175,000 pursuant to the foregoing amendment thereto, shares of common stock may be granted to the Company's directors, officers, +employees and consultants. The 2018 Stock Incentive Plan is in addition to the Company’s (i) 2017 Stock Incentive Plan (the +“ 2017 Plan ”), under which options to acquire up to 2,500 shares of common stock may be granted to the Company's +directors, officers, employees and consultants, (ii) 2016 Stock Incentive Plan (the “ 2016 Plan ”), under which +options to acquire up to 5,000 shares of common stock may be granted to the Company's directors, officers, employees and consultants, +and (ii) 2012 Stock Option Plan, as amended (the “ 2012 Plan ”), which provides for the issuance of a maximum +of 1,716 shares of the Company’s common stock to be offered to the Company’s directors, officers, employees, and consultants +(collectively the “ Plans ”). +The purpose of the +Plans is to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial +responsibility for the direction and management of the Company, as well as certain directors and consultants of the Company, additional +incentives to exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, +to reward outstanding performance and to provide a means to attract and retain persons of outstanding ability to the service of +the Company. +58 +Table of Contents +As of December 31, +2019, options to purchase 1,388 shares of common stock were issued and outstanding, and 103,105 shares are available for future +issuance under the Plans. +401(k) Plan +We have adopted a tax-qualified +employee savings and retirement plan, or 401(k) plan, which generally covers all of our full-time employees. Pursuant to the 401(k) +plan, eligible employees may make voluntary contributions to the plan up to a maximum of 5% of eligible compensation. The 401(k) +plan permits, but does not require, matching contributions by the Company on behalf of plan participants. We match contributions +at the rate of (1) $1.00 for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, +up to 5% of the base salary. We are also permitted under the plan to make discretionary contributions. The 401(k) plan is intended +to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. Contributions to such a qualified +plan are deductible by the Company when made, and neither the contributions nor the income earned on those contributions is taxable +to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained in trust. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. +Except as otherwise +indicated below, the following table sets forth certain information regarding beneficial ownership of our common stock as of May +26, 2020 by (1) each of our current directors; (2) each of the executive officers; (3) each person known to us to be the beneficial +owner of more than 5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) +all of our directors and executive officers as a group. As of May 26, 2020, there were 5,771,634 shares of our common stock issued +and outstanding. +Beneficial ownership +is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common +stock subject to options or warrants that are currently exercisable or exercisable within 60 days of May 26, 2020, are deemed to +be outstanding and to be beneficially owned by the person or group holding such options or warrants for the purpose of computing +the percentage ownership of such person or group, but are not treated as outstanding for the purpose of computing the percentage +ownership of any other person or group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table +have sole voting and sole investment power with respect to all common stock shown as beneficially owned by them, subject to applicable +community property laws. Unless otherwise indicated below, the address of each beneficial owner listed below is c/o DPW Holdings, +Inc., 201 Shipyard Way, Newport Beach, California 92663. +Name and address of beneficial owner +Number of +shares +beneficially +owned +Approximate +Percent +of class +Greater than 5% Beneficial Owners: +Ault & Company, Inc. +673,140 (2) +11.7 % +Directors and executive officers: (1) +Milton Ault, III +673,183 (3) +11.7 % +Henry Nisser +3,906 (4) +* +Amos Kohn +698 (5) +* +Robert Smith +108 (6) +* +William Horne +556 (7) +* +Mordechai Rosenberg +0 +* +Jeffrey A. Bentz +9 +* +Jodi Brichan +0 +* +All directors and executive officers as a group (eight persons) +678,460 +11.7 % +* Less than one percent. +(1) Unless otherwise indicated, the business address of each of the individuals is c/o DPW Holdings, +Inc., 201 Shipyard Way, Suite E, Newport Beach, California 92663. +(2) Includes shares owned by Philou Ventures of which Ault & Company, Inc., is the Manager, consisting +of: (i) 125,000 shares of Series B Preferred Stock that are convertible into 2,232 shares of Common Stock, (ii) warrants to purchase +2,232 shares of Common Stock that are exercisable within 60 days of the date hereof and (iii) 3,408 shares of Common Stock. Also +includes warrants to purchase 94 shares of Common Stock that are exercisable within 60 days of the date hereof. Excludes 717,241 +shares of Common Stock issuable upon conversion of the Ault Note. +59 +Table of Contents +(3) Mr. Ault is the Chief Executive Officer of Ault & Company, Inc. Includes 673,140 shares beneficially +owned by Ault & Company, which may be deemed beneficially owned by Mr. Ault. Also includes 43 shares of Common Stock. Excludes +717,241 shares of Common Stock issuable upon conversion of the Ault Note. +(4) Includes 3,906 shares of Common Stock issuable pursuant to a stock incentive grant. +(5) Includes warrants to purchase 505 shares of Common Stock that are exercisable within 60 days of +the date hereof. +(6) Includes warrants to purchase 54 shares of Common Stock that are exercisable within 60 days of +the date hereof. +(7) Includes 250 shares of Common Stock issuable pursuant to a stock incentive grant. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our +Chief Executive Officer and Chairman of the Board, is also the Chief Executive Officer of Ault & Company, Inc. +Ault & Company, Inc. +On December 23, 2019, +the Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of +the NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. +As a result, at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, +or up to 19.99% of the Common Stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, shall +be due and payable on August 5, 2020. The Note shall be convertible into shares of the Company’s common stock, par value +$0.001 per share (the “ Common Stock ”) at a conversion price of +$1.45 per share, subject to the approval of the Company’s stockholders at a special meeting thereof, as required by Rule +713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American. This special meeting is presently +scheduled to occur on June 8, 2020. +Avalanche International, Corp. +On September 6, 2017, +we entered into a Loan and Security Agreement with Avalanche (“ AVLP Loan Agreement ”) with an effective date +of August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility of up to $10,000,000 for a period +ending on August 21, 2021. +At December 31, 2019, +we had provided Avalanche with $9,595,079 pursuant to the non-revolving credit facility. The warrants issued in conjunction with +the non-revolving credit facility entitles us to purchase up to 19,190,158 shares of Avalanche common stock at an exercise price +of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, +stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Milton C. Ault, III +and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors +of Avalanche. In addition, Philou Ventures, of which Ault & Company, Inc., is the Manager, is the controlling stockholder of +Avalanche. Mr. Ault is the Chief Executive Officer of Ault & Company, Inc. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. +Marcum LLP serves as +our independent registered public accounting firm for the years ended December 31, 2019 and 2018. Ziv Haft, a BDO Member Firm, +serves as the independent registered public accounting firm of Enertec Systems 2001 Ltd., our wholly-owned subsidiary. +Fees and Services +The following table +shows the aggregate fees billed to us for professional services by Marcum LLP and Ziv Haft for the years ended December 31, 2019 +and 2018: +60 +Table of Contents +2019 +2018 +Audit Services +$ 878,370 +$ 610,564 +Audit Related Services +$ — +$ — +Tax Services +$ — +$ — +All Other Services +$ — +$ — +Total +$ 878,370 +$ 610,564 +Audit Fee. This +category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the +years ended December 31, 2019 and 2018, for the reviews of the financial statements included in our quarterly reports on Form 10-Q +during 2019 and 2018, and for other services that are normally provided by the independent auditors in connection with statutory +and regulatory filings or engagements for the relevant years. +Audit-Related Fees. This +category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent +auditors that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported +above under “Audit Fees,” and generally consist of fees for other engagements under professional auditing standards, +accounting and reporting consultations, internal control-related matters, and audits of employee benefit plans. +Tax Fees . This +category includes the aggregate fees billed in each of the last two years for professional services rendered by the independent +auditors for tax compliance, tax planning and tax advice. +All Other Fees. This +category includes the aggregate fees billed in each of the last two years for products and services provided by the independent +auditors that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s +policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related +services, tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. +Our independent auditors are required to report periodically to the Audit Committee regarding the extent of services they provide +in accordance with such pre-approval. +61 +Table of Contents +PART IV +ITEM 15. EXHIBITS +Exhibit +Number +Description +2.1 +Share +Exchange Agreement between the Company, Microphase Corporation, Microphase Holding Company, RCKJ Trust, Ergul Family Limited +Partnership, and To Hong Yam and Eagle Advisers, LLC, dated April 28, 2017. Incorporated herein by reference to +the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 2.1 thereto. +2.2 +Agreement +and Plan of Merger between the Company and Digital Power Corporation, dated December 27, 2017. Incorporated herein +by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 2.1 thereto. +2.3 +State +of Delaware, Certificate of Merger of the Company and Digital Power Corporation, dated December 28, 2017. Incorporated +herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 2.2 thereto. +2.4 +Share +Purchase Agreement between Coolisys Technologies, Inc., Enertec Management Ltd., Micronet Enertec Technologies, Inc., and +Enertec Systems 2001 Ltd., dated December 31, 2017. Incorporated herein by reference to the Current Report on Form +8-K filed on January 2, 2018 as Exhibit 2.1 thereto. +2.5 +Securities +Purchase Agreement, dated May 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 24, 2018 +as Exhibit 2.1 thereto. +2.6 +Share +Exchange Agreement by and among DPW Holdings, Inc., DPW Financial Group, Inc., the Acquirees signatories thereto and the Holders +signatories thereto dated as of December 27, 2019. (The schedules and certain exhibits to the Agreement are omitted pursuant +to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally to the Commission, upon request, a copy +of any omitted schedule or exhibit.) Incorporated by reference to the Current Report on Form 8-K filed on January 2, 2020 +as Exhibit 2.1 thereto. +3.1 +Amended +and Restated Articles of Incorporation of the Company, dated September 29, 1992. Incorporated by +reference to Exhibit 3.1 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange +Commission on October 16, 1996. +3.2 +Certificate +of Amendment to Articles of Incorporation of the Company, dated September 9, 1996. Incorporated +by reference to Exhibit 3.2 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange +Commission on October 16, 1996. +3.3 +Bylaws. Incorporated +by reference to Exhibit 3.3 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange +Commission on October 16, 1996. +3.4 +Form +of Certificate of Determination of Preferences, Rights and Limitations of Series B Convertible Preferred Stock, dated March +3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 3.1 thereto. +3.5 +Form +of Certificate of Determination of Preferences, Rights and Limitations of Series D Convertible Preferred Stock. Incorporated +by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 3.1 thereto. +3.6 +Form +of Certificate of Determination of Preferences, Rights and Limitations of Series E Convertible Preferred Stock. Incorporated +by reference to the Current Report on Form 8-K filed on May 3, 2017 as Exhibit 3.2 thereto. +3.7 +Form +of Certificate of Determination of Preferences, Rights and Limitations of Series C Convertible Preferred Stock, dated May +15, 2017. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 3.1 thereto. +3.8 +Certification +of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K +filed on December 29, 2017 as Exhibit 3.1 thereto. +3.9 +Bylaws, +dated September 25, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December +29, 2017 as Exhibit 3.2 thereto. +3.10 +Certificate +of Designations of Rights and Preferences of 10% Series A Cumulative Redeemable Perpetual Preferred Stock, dated September +13, 2018. Incorporated herein by reference to the Current Report on Form 8-K filed on September 14, 2018 as Exhibit 3.1 thereto. +3.11 +Certificate +of Elimination, dated December 21, 2018. Incorporated by reference to the Current Report on Form 8-K filed on December 27, +2018 as Exhibit 3.1 thereto. +3.12 +Certificate +of Amendment to Certificate of Incorporation, dated January 2, 2019. Incorporated by reference to the Current Report on Form +8-K filed on January 3, 2019 as Exhibit 3.1 thereto. +3.13 +Certificate +of Designations of Rights and Preferences of Series C Convertible Redeemable Preferred Stock, dated February 27, 2019. Incorporated +herein by reference to the Current Report on Form 8-K filed on February 28, 2019 as Exhibit 3.1 thereto. +3.14 +Certificate +of Amendment to Certificate of Incorporation (1-for-20 Reverse Stock Split of Common Stock), dated March 14, 2019. Incorporated +herein by reference to the Current Report on Form 8-K filed on March 14, 2019 as Exhibit 3.1 thereto. +3.15 +Certificate +of Amendment to Certificate of Incorporation filed with the Delaware Secretary of State on July 29, 2019. +Incorporated by reference to the Current Report on Form 8-K filed on August 5, 2019 as Exhibit +3.1 thereto. +4.1 +Form +of Secured Convertible Note, dated October 21, 2016. Incorporated herein by reference to the Current Report on +Form 8-K filed on October 27, 2016 as Exhibit 10.1 thereto. +4.2 +Form +of Common Stock Purchase Warrant, dated October 21, 2016. Incorporated herein by reference to the Current Report +on Form 8-K filed on October 27, 2016 as Exhibit 10.2 thereto. +4.3 +Form +of Common Stock Purchase Warrant, dated October 21, 2016. Incorporated herein by reference to the Current Report +on Form 8-K filed on October 27, 2016 as Exhibit 10.3 thereto. +4.4 +Form +of Common Stock Purchase Warrant, dated November 15, 2016. Incorporated herein by reference to the Current Report +on Form 8-K filed on November 16, 2016 as Exhibit 4.1 thereto. +62 +Table of Contents +Exhibit +Number +Description +4.5 +Form +of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on March 9, +2017 as Exhibit 4.1 thereto. +4.6 +Form +of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on April 4, +2017 as Exhibit 4.1 thereto. +4.7 +Form +of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on May 31, +2017 as Exhibit 4.1 thereto. +4.8 +Form +of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on June 8, +2017 as Exhibit 4.1 thereto. +4.9 +Form +of Common Stock Purchase Warrant, dated July 27, 2017. Incorporated by reference to the Current Report on Form +8-K filed on July 26, 2017 as Exhibit 4.1 thereto. +4.10 +Form +of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form +8-K filed on July 31, 2017 as Exhibit 4.1 thereto. +4.11 +Form +of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form +8-K filed on July 31, 2017 as Exhibit 4.2 thereto. +4.12 +Form +of Convertible Note, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on +August 9, 2017 as Exhibit 10.2 thereto. +4.13 +Form +of Common Stock Purchase Warrant, dated August 3, 2017. Incorporated by reference to the Current Report on Form +8-K filed on August 9, 2017 as Exhibit 10.3 thereto. +4.14 +Form +of Common Stock Purchase Warrant, dated August 10, 2017. Incorporated by reference to the Current Report on Form +8-K filed on August 11, 2017 as Exhibit 4.1 thereto. +4.15 +Form +of Senior Convertible Promissory Note, dated August 10, 2017. Incorporated by reference to the Current Report on +Form 8-K filed on August 11, 2017 as Exhibit 10.2 thereto. +4.16 +Common +Stock Purchase Warrant issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated +by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 4.1 thereto. +4.17 +Convertible +Promissory Note issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by +reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.2 thereto. +4.18 +Form +of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November +2, 2017 as Exhibit 4.1 thereto. +4.19 +Form +of 10% Original Issue Discount Convertible Debenture. Incorporated by reference to the Current Report on Form 8-K +filed on November 2, 2017 as Exhibit 10.2 thereto. +4.20 +Form +of 10% Original Issue Discount Debenture, dated December 4, 2017. Incorporated by reference to the Current Report +on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.21 +Convertible +Promissory Note issued by WT Johnson & Sons (Huddersfield) Ltd. to the Company, dated December 5, 2017. Incorporated +by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.22 +Convertible +Promissory Note issued by WT Johnson & Sons (Huddersfield) Ltd. to the Company, dated December 5, 2017. Incorporated +by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 4.2 thereto. +4.23 +Form +of Common Stock Purchase Warrant, dated December 5, 2017. Incorporated by reference to the Current Report on Form +8-K filed on December 8, 2017 as Exhibit 4.1 thereto. +4.24 +Form +of Senior Convertible Promissory Note, dated January 23, 2018. Incorporated by reference to the Current Report +on Form 8-K filed on January 24, 2018 as Exhibit 4.1 thereto. +4.25 +Form +of Common Stock Purchase Warrant, dated January 23, 2018. Incorporated by reference to the Current Report on Form +8-K filed on January 24, 2018 as Exhibit 4.2 thereto. +4.26 +Form +of Common Stock Purchase Warrant, dated March 23, 2018. Incorporated by reference to the Current Report on Form +8-K filed on March 26, 2018 as Exhibit 4.1 thereto. +4.27 +Form +of Common Stock Purchase Warrant, dated April 16, 2018. Incorporated by reference to the Current Report on Form 8-K +filed on April 16, 2018 as Exhibit 4.1 thereto. +4.28 +Form +of Series A Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form +8-K filed on May 16, 2018 as Exhibit 4.1 thereto. +4.29 +Form +of Series B Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form +8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.30 +Form +of Senior Secured Convertible Promissory Note, dated May 15, 2018. Incorporated by reference to the Current Report on +Form 8-K filed on May 16, 2018 as Exhibit 4.1 thereto. +4.31 +Form +of Series A Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form +8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.32 +Form +of Series B Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form +8-K filed on May 16, 2018 as Exhibit 4.3 thereto. +4.33 +Form +of Registration Rights Agreement, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on May 16, 2018 as Exhibit 4.4 thereto. +63 +Table of Contents +Exhibit +Number +Description +4.34 +Form +of 10% Senior Secured Convertible Promissory Note, dated July 2, 2018. Incorporated by reference to the Current Report on +Form 8-K filed on July 2, 2018 as Exhibit 4.1 thereto. +4.35 +Form +of Registration Rights Agreement, dated July 2, 2018. Incorporated by reference to the Current Report on Form 8-K filed on +July 2, 2018 as Exhibit 4.2 thereto. +4.36 +Form +of Secured Promissory Note, dated August 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed on August +16, 2018 as Exhibit 4.1 thereto. +4.37 +Form +of 10% Senior Secured Convertible Promissory Note, dated August 31, 2018. Incorporated by reference to the Current Report +on Form 8-K filed on September 4, 2018 as Exhibit 4.1 thereto. +4.38 +Form +of Registration Rights Agreement, dated August 31, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on September 4, 2018 as Exhibit 4.2 thereto. +4.39 +Form +of Term Promissory Note, dated September 21, 2018. Incorporated by reference to the Current Report on Form 8-K filed on September +21, 2018 as Exhibit 4.1 thereto. +4.40 +Form +of Original Issue Discount Promissory Note, dated October 11, 2018. Incorporated by reference to the Current Report on Form +8-K filed on October 11, 2018 as Exhibit 4.1 thereto. +4.41 +Form +of 12% Convertible Promissory Note dated October 5, 2016. Incorporated by reference to the Pre-Effective Amendment No. 2 to +the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 4.4 thereto. +4.42 +Form +of 12% Convertible Promissory Note dated November 30, 2016. Incorporated by reference to the Pre-Effective Amendment No. 2 +to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 4.5 thereto. +4.43 +Form +of 12% Convertible Promissory Note dated February 22, 2017. Incorporated by reference to the Pre-Effective Amendment No. 2 +to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 4.6 thereto. +4.44 +Form +of Common Stock Purchase Warrant entered into on January 25, 2018, with an issuance date of January 23, 2018, issued to Libertas +Funding, LLC. Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed +on November 1, 2018 as Exhibit 4.13 thereto. +4.45 +Form +of Common Stock Purchase Warrant entered into on January 25, 2018, with an issuance date of January 23, 2018, issued to TVT +Capital, LLC. Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed +on November 1, 2018 as Exhibit 4.14 thereto. +4.46 +Form +of Term Note dated March 22, 2018. Incorporated by reference to the Registration Statement on Form S-3 filed on December 7, +2018 as Exhibit 4.3 thereto. +4.47 +Form +of Common Stock Purchase Warrant dated March 22, 2018. Incorporated by reference to the Registration Statement on Form S-3 +filed on December 7, 2018 as Exhibit 4.4 thereto. +4.48 +Form +of Secured Promissory Note 1, dated January 23, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +January 24, 2019 as Exhibit 4.1 thereto. +4.49 +Form +of Secured Promissory Note 2, dated January 23, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +January 24, 2019 as Exhibit 4.2 thereto. +4.50 +Form +of Secured Convertible Promissory Note, dated January 23, 2019. Incorporated by reference to the Current Report on Form 8-K +filed on January 24, 2019 as Exhibit 4.3 thereto. +4.51 +Form +of Promissory Note, dated February 20, 2019. Incorporated by reference to the Current Report on Form 8-K filed on February +20, 2019 as Exhibit 4.1 thereto. +4.52 +Form +of Common Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on April 1, +2019 as Exhibit 4.1 thereto. +4.53 +Form +of Pre-Funded Warrant, dated March 29, 2019. Incorporated by reference to the Current Report on Form 8-K filed on April +1, 2019 as Exhibit 4.2 thereto. +4.54 +Form +of Underwriter’s Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on April 1, 2019 as Exhibit 4.3 thereto. +4.55 +Form +of Common Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K/A filed on April +4, 2019 as Exhibit 4.1 thereto. +4.56 +Form +of Convertible Promissory Note, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May +20, 2019 as Exhibit 4.1 thereto. +4.57 +Form +of Warrant, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit +4.2 thereto. +4.58 +Form +of 10% Senior Secured Promissory Note, dated June 18, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on June 18, 2019 as Exhibit 4.1 thereto. +4.59 +Form +of Registration Rights Agreement, dated June 18, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +June 18, 2019 as Exhibit 4.2 thereto. +4.60 +Form +of Warrant, dated May 14, 2019. Incorporated by reference to the Current Report on Form 8-K/A filed on June 27, 2019 as Exhibit +4.2 thereto. +4.61 +Form +of Convertible Promissory Note, dated July 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on July +2, 2019 as Exhibit 4.1 thereto. +64 +Table of Contents +Exhibit +Number +Description +4.62 +Form +of Convertible Promissory Note, dated July 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on July +2, 2019 as Exhibit 4.1 thereto. +4.63 +Form +of 4% Convertible Promissory Note, dated July 3, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +July 5, 2019 as Exhibit 4.1 thereto. +4.64 +Form +of Common Stock Purchase Warrant, dated July 3, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +July 5, 2019 as Exhibit 4.2 thereto. +4.65 +Form +of DPW Note. Incorporated by reference to the Regulation A Offering Statement on Form 1-A filed on August 14, 2019 as Exhibit +3.65 thereto. +4.66 +Form +of Amendment to 4% Convertible Promissory Note, dated September 19, 2019. Incorporated by reference to the Current Report +on Form 8-K filed on September 20, 2019 as Exhibit 4.3 thereto. +4.67 +Form +of Convertible Promissory Note, dated September 26, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on September 26, 2019 as Exhibit 4.1 thereto. +4.68 +Form +of Convertible Promissory Note, dated November 4, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on November 4, 2019 as Exhibit 4.1 thereto. +4.69 +Form +of Convertible Promissory Note, dated November 15, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on November 18, 2019 as Exhibit 4.1 thereto. +10.1 +Securities +Purchase Agreement between the Company, Philou Ventures, LLC and Telkoor Telecom Ltd., dated September 4, 2016. Incorporated +herein by reference to the Current Report on Form 8-K filed on September 7, 2016 as Exhibit 10.1 thereto. +10.2 +Rescission +Agreement between the Company, Telkoor Telecom Ltd. and Telkoor Power Supplies Ltd., dated September 4, 2016. Incorporated +herein by reference to the Current Report on Form 8-K filed on September 7, 2016 as Exhibit 10.2 thereto. +10.3 +Waiver +Letter to Securities Purchase Agreement between the Company, Philou Ventures, LLC and Telkoor Telecom Ltd., dated September +20, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed on September 22, 2016 as Exhibit +10.1 thereto. +10.4 +Registration +Rights Agreement, dated October 21, 2016. Incorporated herein by reference to the Current Report on Form 8-K filed +on October 27, 2016 as Exhibit 10.4 thereto. +10.5 +Form +of Subscription Agreement. Incorporated herein by reference to the Current Report on Form 8-K filed on November 16, 2016 as +Exhibit 10.1 thereto. +10.6 +Form +of Registration Rights Agreement, dated November 15, 2016. Incorporated by reference to the Current Report on Form +8-K filed on November 16, 2016 as Exhibit 10.2 thereto. +10.7* +Employment +Agreement for Amos Kohn, dated November 30, 2016. Incorporated by reference to the Current Report on Form 8-K filed +on December 5, 2016 as Exhibit 10.1 thereto. +10.8 +2016 +Stock Incentive Plan. Incorporated by reference to the Current Report on Form 8-K filed on December 30, 2016 as +Exhibit 10.1 thereto. +10.9 +Form +of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on February 17, 2017 +as Exhibit 10.1 thereto. +10.10* +Amendment +No. 1 to Executive Employment Agreement. Amos Kohn dated February 22, 2017. Incorporated by reference to the Current +Report on Form 8-K filed on February 27, 2017 as Exhibit 10.1 thereto. +10.11 +Preferred +Stock Purchase Agreement between the Company and Philou Ventures, LLC, dated March 9, 2017. Incorporated by reference +to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 10.1 thereto. +10.12 +Registration +Rights Agreement between the Company and Philou Ventures, LLC. Incorporated by reference to the Current Report on Form 8-K +filed on March 9, 2017 as Exhibit 10.2 thereto. +10.13 +Form +of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as +Exhibit 10.1 thereto. +10.14 +Form +of Subscription Agreement, dated May 1, 2017. Incorporated by reference to the Current Report on Form 8-K filed +on May 31, 2017 as Exhibit 10.1 thereto. +10.15 +Form +of Registration Rights Agreement. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit +10.2 thereto. +10.16 +Promissory +Note issued by Microphase Corporation to the Company, dated June 2, 2017. Incorporated by reference to the Current +Report on Form 8-K filed on June 8, 2017 as Exhibit 10.1 thereto. +10.17 +Promissory +Note issued by Microphase Corporation to the Company, dated June 2, 2017. Incorporated by reference to the Current +Report on Form 8-K filed on June 8, 2017 as Exhibit 10.2 thereto. +10.18 +Form +of Securities Purchase Agreement, dated July 25, 2017. Incorporated by reference to the Current Report on Form +8-K filed on July 26, 2017 as Exhibit 10.1 thereto. +10.19 +Form +of Exchange Agreement, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on +July 31, 2017 as Exhibit 10.1 thereto. +10.20 +Form +of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as +Exhibit 10.2 thereto. +10.21 +Form +of Securities Purchase Agreement, dated July 28, 2017. Incorporated by reference to the Current Report on Form +8-K filed on July 31, 2017 as Exhibit 10.3 thereto. +65 +Table of Contents +Exhibit +Number +Description +10.22 +Securities +Purchase Agreement between William H. Gordon, Power-Plus Technical Distributors, LLC, and Coolisys Technologies Inc., dated +August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit +10.1 thereto. +10.23 +Form +of Securities Purchase Agreement, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed +on August 9, 2017 as Exhibit 10.1 thereto. +10.24 +Form +of Securities Purchase Agreement, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed +on August 11, 2017 as Exhibit 10.1 thereto. +10.25 +Form +of Registration Rights Agreement, dated August 10, 2017. Incorporated by reference to the Current Report on Form +8-K filed on August 11, 2017 as Exhibit 10.3 thereto. +10.26 +Loan +and Security Agreement between the Company and Avalanche International Corp., dated August 21, 2017. Incorporated +by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.1 thereto. +10.27* +Executive +Employment Agreement for William Horne, dated October 6, 2017. Incorporated by reference to the Current Report +on Form 8-K filed on October 12, 2017 as Exhibit 10.1 thereto. +10.28 +Form +of Subscription Agreement. Incorporated by reference to the Current Report on Form 8-K filed on October 19, 2017 +as Exhibit 10.1 thereto. +10.29 +Agreement +for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated October 23, 2017. Incorporated +by reference to the Current Report on Form 8-K filed on October 23, 2017 as Exhibit 10.1 thereto. +10.30 +Form +of Securities Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on November +2, 2017 as Exhibit 10.1 thereto. +10.31 +Form +of Registration Rights Agreement. Incorporated by reference to the Current Report on Form 8-K filed on November +2, 2017 as Exhibit 10.3 thereto. +10.32 +Form +of Loan and Security Agreement between the Company and LAM, Inc., dated November 2, 2017. Incorporated by reference +to the Current Report on Form 8-K filed on November 7, 2017 as Exhibit 10.1 thereto. +10.33 +Form +of Subscription Agreement, dated November 6, 2017. Incorporated by reference to the Current Report on Form 8-K +filed on November 8, 2017 as Exhibit 10.1 thereto. +10.34 +Trust +Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the +Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.1 thereto. +10.35 +Tenancy-In-Common +Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the +Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.2 thereto. +10.36 +Form +of Securities Purchase Agreement, dated December 4, 2017. Incorporated by reference to the Current Report on Form +8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.37 +Form +of Registration Rights Agreement, dated December 4, 2017. Incorporated by reference to the Current Report on Form 8-K filed +on December 8, 2017 as Exhibit 10.2 thereto. +10.38 +Exchange +Agreement between the Company and WT Johnson & Sons (Huddersfield) Limited, dated December 5, 2017. Incorporated +by reference to the Current Report on Form 8-K filed on December 8, 2017 as Exhibit 10.1 thereto. +10.39 +Form +of Exchange Agreement, dated December 5, 2017. Incorporated by reference to the Current Report on Form 8-K filed +on December 8, 2017 as Exhibit 10.1 thereto. +10.40 +Form +of Subscription Agreement, dated December 1, 2017. Incorporated by reference to the Current Report on Form 8-K +filed on December 8, 2017 as Exhibit 10.1 thereto. +10.41 +Form +of Consulting Agreement. Incorporated by reference to the Current Report on Form 8-K filed on January 2, 2018 as +Exhibit 10.1 thereto. +10.42 +Agreement +for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated January 10, 2018. Incorporated +by reference to the Current Report on Form 8-K filed on January 16, 2018 as Exhibit 10.1 thereto. +10.43 +Agreement +for the Purchase and Sale of Future Receipts between the Company and TVT Capital, LLC, dated January 10, 2018. Incorporated +by reference to the Current Report on Form 8-K filed on January 16, 2018 as Exhibit 10.2 thereto. +10.44 +Form +of Securities Purchase Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form +8-K filed on January 24, 2018 as Exhibit 10.1 thereto. +10.45 +Form +of Registration Rights Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form +8-K filed on January 24, 2018 as Exhibit 10.2 thereto. +10.46* +Executive +Employment Agreement for William Horne, dated January 25, 2018. Incorporated by reference to the Current Report +on Form 8-K filed on January 25, 2018 as Exhibit 10.1 thereto. +10.47 +Form +of Securities Purchase Agreement, dated January 23, 2018. Incorporated by reference to the Current Report on Form +8-K filed on February 12, 2018 as Exhibit 10.1 thereto. +10.48 +Amendment +to Securities Purchase Agreement, dated January 23, 2018, between the Company and Twitchell Fund, LLC. Incorporated +by reference to the Current Report on Form 8-K filed on February 12, 2018 as Exhibit 10.2 thereto. +10.49 +Sales +Agreement between the Company and H.C. Wainwright & Co., LLC, dated February 27, 2018. Incorporated by reference +to the Current Report on Form 8-K filed on February 27, 2018 as Exhibit 10.1 thereto. +10.50 +Asset +Purchase Agreement between Super Crypto Mining, Inc. and Blockchain Supply & Services Ltd., dated March 8, 2018. Incorporated +by reference to the Current Report on Form 8-K filed on March 9, 2018 as Exhibit 10.1 thereto. +66 +Table of Contents +Exhibit +Number +Description +10.51 +Amended +and Restated Master Services Agreement dated March 21, 2018 but effective March 1, 2018. Filed herewith. Confidential +Portions have been redacted and a Request for Confidential Treatment has been filed separately with the Commission. Incorporated +by reference to the Annual Report on Form 10-K filed on April 17, 2018 as Exhibit 10.51 thereto. +10.52 +Form +of Securities Purchase Agreement, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on March 26, 2018 as Exhibit 10.1 thereto. +10.53 +Form +of Amended and Restated Independent Contractor Agreement, dated April 13, 2018. Incorporated by reference to the +Current Report on Form 8-K filed on April 13, 2018 as Exhibit 10.1 thereto. +10.54 +Form +of Securities Purchase Agreement, dated April 16, 2018. Incorporated by reference to the Current Report on Form 8-K +filed on April 16, 2018 as Exhibit 10.1 thereto. +10.55 +Form +of 12% Secured Convertible Promissory Note, dated April 16, 2018. Incorporated by reference to the Current Report on Form +8-K filed on April 16, 2018 as Exhibit 10.2 thereto. +10.56 +Form +of Security Agreement, dated April 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed on April +16, 2018 as Exhibit 10.3 thereto. +10.57 +Form +of Securities Purchase Agreement, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on May 16, 2018 as Exhibit 10.1 thereto. +10.58 +Form +of Securities Purchase Agreement, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on May 16, 2018 as Exhibit 10.1 thereto. +10.59 +Form +of Security Agreement, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May +16, 2018 as Exhibit 10.2 thereto. +10.60 +Form +of Security and Pledge Agreement, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on May 16, 2018 as Exhibit 10.3 thereto. +10.61 +Form +of Intellectual Property Security Agreement, dated May 15, 2018. Incorporated by reference to the Current Report on +Form 8-K filed on May 16, 2018 as Exhibit 10.4 thereto. +10.62 +Form +of Subsidiary Guarantee, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May +16, 2018 as Exhibit 10.5 thereto. +10.63 +Form +of Lock-Up Agreement, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, +2018 as Exhibit 10.6 thereto. +10.64 +Agreement +to Organize and Operate a Joint Venture, dated June 14, 2018. Incorporated by reference to the Current Report on Form 8-K +filed on June 18, 2018 as Exhibit 10.1 thereto. +10.65 +Executive +Employment Agreement with Milton C. Ault, III, dated June 17, 2018. Incorporated by reference to the Current Report on Form +8-K filed on June 18, 2018 as Exhibit 10.1 thereto. +10.66 +Extension +of Agreement to Organize and Operate a Joint Venture, dated June 29, 2018. Incorporated by reference to the Current Report +on Form 8-K filed on July 2, 2018 as Exhibit 10.1 thereto. +10.67 +Amendment +No. 1 to Securities Purchase Agreement, dated June 28, 2018, among Digital Power Lending, LLC, I.AM INC., David J. Krause, +and Deborah J. Krause. Incorporated by reference to the Current Report on Form 8-K filed on July 2, 2018 as Exhibit 10.1 thereto. +10.68 +Securities +Purchase Agreement, dated July 2, 2018. Incorporated by reference to the Current Report on Form 8-K filed on July 2, 2018 +as Exhibit 10.1 thereto. +10.69 +Form +of Amendment No. 3 Agreement, dated July 2, 2018. Incorporated by reference to the Current Report on Form 8-K filed on July +2, 2018 as Exhibit 10.2 thereto. +10.70 +Form +of Amendment No. 4 Agreement, dated July 2, 2018. Incorporated by reference to the Current Report on Form 8-K filed on July +2, 2018 as Exhibit 10.3 thereto. +10.71 +Extension +of Agreement to Organize and Operate a Joint Venture dated July 16, 2018. Incorporated by reference to the Current Report +on Form 8-K filed on July 17, 2018 as Exhibit 10.1 thereto. +10.72 +Amendment +No. 2 to Securities Purchase Agreement, dated July 30, 2018, among Digital Power Lending, LLC, I.AM INC., David J. Krause, +and Deborah J. Krause. Incorporated by reference to the Current Report on Form 8-K filed on August 3, 2018 as Exhibit 10.1 +thereto. +10.73 +Form +of Securities Purchase Agreement, dated August 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on August 16, 2018 as Exhibit 10.1 thereto. +10.74 +Form +of Security and Pledge Agreement, dated August 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on August 16, 2018 as Exhibit 10.2 thereto. +10.75 +Extension +of Agreement to Organize and Operate a Joint Venture dated August 17, 2018. Incorporated by reference to the Current Report +on Form 8-K filed on August 23, 2018 as Exhibit 10.1 thereto. +10.76 +Securities +Purchase Agreement, dated August 31, 2018. Incorporated by reference to the Current Report on Form 8-K filed on September +4, 2018 as Exhibit 10.1 thereto. +10.77 +Form +of Amendment No. 5 Agreement, dated August 31, 2018. Incorporated by reference to the Current Report on Form 8-K filed on +September 4, 2018 as Exhibit 10.2 thereto. +10.78 +Form +of Amendment No. 6 Agreement, dated August 31, 2018. Incorporated by reference to the Current Report on Form 8-K filed on +September 4, 2018 as Exhibit 10.3 thereto. +67 +Table of Contents +Exhibit +Number +Description +10.79 +Purchase +Agreement Amendment, dated September 1, 2018. Incorporated by reference to the Current Report on Form 8-K filed on September +4, 2018 as Exhibit 10.1 thereto. +10.80 +Amendment +No. 7, dated September 25, 2018. Incorporated by reference to the Current Report on Form 8-K filed on September 25, 2018 as +Exhibit 10.1 thereto. +10.81 +Revolving +Loan Agreement, dated October 3, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 3, 2018 +as Exhibit 10.1 thereto. +10.82 +Promissory +Note, dated October 3, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 3, 2018 as Exhibit +10.2 thereto. +10.83 +Security +Agreement, dated October 3, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 3, 2018 as +Exhibit 10.3 thereto. +10.84 +Control +Agreement, dated October 3, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 3, 2018 as +Exhibit 10.4 thereto. +10.85 +Intercreditor +Agreement, dated October 3, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 3, 2018 as +Exhibit 10.5 thereto. +10.86 +Purchase +Agreement Amendment, dated October 2, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 5, +2018 as Exhibit 10.1 thereto. +10.87 +Management +Agreement, dated October 5, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 9, 2018 as +Exhibit 10.1 thereto. +10.88 +Guarantee, +dated October 5, 2018. Incorporated by reference to the Current Report on Form 8-K filed on October 9, 2018 as Exhibit 10.2 +thereto. +10.89 +Form +of Securities Purchase Agreement, dated October 11, 2018. Incorporated by reference to the Current Report on Form 8-K filed +on October 11, 2018 as Exhibit 10.1 thereto. +10.90 +At-The-Market +Issuance Sales Agreement, dated October 15, 2018, with Wilson Davis & Co., Inc. Incorporated by reference to the Current +Report on Form 8-K filed on October 16, 2018 as Exhibit 10.1 thereto. +10.91 +Form +of Guaranty Agreement dated March 23, 2018, made by Milton C. Ault, III. Incorporated by reference to the Pre-Effective Amendment +No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.11 thereto. +10.92 +Share +Exchange Agreement by and among Avalanche International Corp., MTIX, Ltd. and the Sellers signatories thereto dated March +3, 2017 (The schedules and certain exhibits to the Agreement are omitted pursuant to Item 601(b)(2) of Regulation S-K. The +Company agrees to furnish supplementally to the SEC, upon request, a copy of any omitted schedule or exhibit ). Incorporated +by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit +10.12 thereto. +10.93 +Loan +and Security Agreement by and between Avalanche International Corp. and Digital Power Corporation dated September 6, 2017 +with an effective date as of August 21, 2017. Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration +Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.13 thereto. +10.94 +Convertible +Promissory Note dated September 6, 2017 with an effective date as of August 21, 2017 issued by Avalanche International Corp. +Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November +1, 2018 as Exhibit 10.14 thereto. +10.95 +Common +Stock Purchase Warrant dated September 6, 2017 with an effective date as of August 21, 2017 Avalanche International Corp. +Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November +1, 2018 as Exhibit 10.15 thereto. +10.96 +Form +of Guaranty Agreement dated January 10, 2018, made by Milton C. Ault, III. Incorporated by reference to the Pre-Effective +Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.18 thereto. +10.97 +Form +of Personal Guaranty entered into on January 10, 2018, made by Milton C. Ault, III. Incorporated by reference to the Pre-Effective +Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.19 thereto. +10.98 +Form +of Future Receivables Sale Agreement dated January 18, 2018. Incorporated by reference to the Pre-Effective Amendment No. +2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.20 thereto. +10.99 +Form +of Security Agreement and Guaranty dated January 18, 2018, made by Philou Ventures, LLC. Incorporated by reference to the +Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.21 thereto. +10.100 +Form +of Agreement for the Purchase and Sale of Future Receipts entered into on January 25, 2018. Incorporated by reference to the +Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.22 thereto. +10.101 +Form +of Agreement for the Purchase and Sale of Future Receipts entered into on January 25, 2018. Incorporated by reference to the +Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.23 thereto. +10.102 +Form +of Future Receivables Sale Agreement entered into on January 25, 2018. Incorporated by reference to the Pre-Effective Amendment +No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.24 thereto. +10.103 +Form +of Personal Guaranty entered into on January 25, 2018, made by Milton C. Ault, III. Incorporated by reference to the Pre-Effective +Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.25 thereto. +10.104 +Form +of Personal Guaranty entered into on January 25, 2018, made by Milton C. Ault, III. Incorporated by reference to the Pre-Effective +Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.26 thereto. +10.105 +Form +of Security Agreement and Guaranty entered into on January 25, 2018, made by Milton C. Ault, III, and Philou Ventures, LLC. +Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November +1, 2018 as Exhibit 10.27 thereto. +68 +Table of Contents +Exhibit +Number +Description +10.106 +Form +of Agreement for the Purchase and Sale of Future Receipts entered into on March 23, 2018. Incorporated by reference to the +Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.28 thereto. +10.107 +Form +of Agreement for the Purchase and Sale of Future Receipts entered into on March 23, 2018. Incorporated by reference to the +Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.29 thereto. +10.108 +Form +of Personal Guaranty entered into on March 23, 2018, made by Milton C. Ault, III. Incorporated by reference to the Pre-Effective +Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.30 thereto. +10.109 +Form +of Personal Guaranty entered into on March 23, 2018, made by Milton C. Ault, III. Incorporated by reference to the Pre-Effective +Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.31 thereto. +10.110 +Form +of Future Receivables Sale Agreement entered into on March 27, 2018. Incorporated by reference to the Pre-Effective Amendment +No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.32 thereto. +10.111 +Form +of Security Agreement and Guaranty entered into on March 27, 2018, made by Milton C. Ault, III, and Kristine Ault. Incorporated +by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit +10.33 thereto. +10.112 +Purchase +Order, dated March 14, 2018. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2018 as Exhibit +10.1 thereto. +10.113 +Amendment +No. 8 Agreement, dated November 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed on November 16, +2018 as Exhibit 10.1 thereto. +10.114 +Form +of Exchange Agreement dated February 28, 2018, and executed on March 15, 2018. Incorporated by reference to the Registration +Statement on Form S-3 filed on December 7, 2018 as Exhibit 10.2 thereto. +10.115 +Form +of Consulting Agreement dated March 22, 2018. Incorporated by reference to the Registration Statement on Form S-3 filed on +December 7, 2018 as Exhibit 10.5 thereto. +10.116 +Form +of Escrow Agreement dated March 22, 2018. Incorporated by reference to the Registration Statement on Form S-3 filed on December +7, 2018 as Exhibit 10.6 thereto. +10.117 +Form +of Media Advertising Agreement dated April 27, 2018. Incorporated by reference to the Registration Statement on Form S-3 filed +on December 7, 2018 as Exhibit 10.9 thereto. +10.118 +Amendment +No. 9 Agreement, dated December 7, 2018. Incorporated by reference to the Current Report on Form 8-K filed on December 10, +2018 as Exhibit 10.1 thereto. +10.119 +Amendment +No. 10 Agreement, dated December 20, 2018. Incorporated by reference to the Current Report on Form 8-K filed on December 20, +2018 as Exhibit 10.1 thereto. +10.120 +$500,000 +Secured Promissory Note dated as of December 28, 2018, by Enertec Systems 2001 Ltd. Incorporated by reference to the Current +Report on Form 8-K filed on December 31, 2018 as Exhibit 10.1 thereto. +10.100 +$200,000 +Secured Promissory Note dated as of December 28, 2018, by Microphase Corporation. Incorporated by reference to the Current +Report on Form 8-K filed on December 31, 2018 as Exhibit 10.2 thereto. +10.101 +Personal +Guaranty Agreement dated as of December 28, 2018, by Milton C. Ault III and Dominion Capital, LLC. Incorporated by reference +to the Current Report on Form 8-K filed on December 31, 2018 as Exhibit 10.3 thereto. +10.102 +Performance +Guaranty Agreement dated as of December 28, 2018, by DPW Holdings, Inc., Microphase Corporation, Enertec Systems 2001 Ltd. +and Dominion Capital, LLC. Incorporated by reference to the Current Report on Form 8-K filed on December 31, 2018 as Exhibit +10.4 thereto. +10.103 +Security +Agreement dated as of December 28, 2018, by Enertec Systems 2001 Ltd and Dominion Capital, LLC. Incorporated by reference +to the Current Report on Form 8-K filed on December 31, 2018 as Exhibit 10.5 thereto. +10.104 +Security +Agreement dated as of December 28, 2018, by Microphase Corporation and Dominion Capital, LLC. Incorporated by reference to +the Current Report on Form 8-K filed on December 31, 2018 as Exhibit 10.6 thereto. +10.105 +Amendment +No. 11 Agreement, dated January 9, 2019. Incorporated by reference to the Current Report on Form 8-K filed on January 10, +2019 as Exhibit 10.1 thereto. +10.106 +Form +of Exchange Agreement, dated January 23, 2019. Incorporated by reference to the Current Report on Form 8-K filed on January +24, 2019 as Exhibit 10.1 thereto. +10.107 +Form +of Security Agreement, dated January 23, 2019. Incorporated by reference to the Current Report on Form 8-K filed on January +24, 2019 as Exhibit 10.2 thereto. +10.108 +Form +of Exchange Agreement, dated February 20, 2019. Incorporated by reference to the Current Report on Form 8-K filed on February +20, 2019 as Exhibit 10.1 thereto. +10.109 +Form +of Securities Purchase Agreement, dated February 27, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on February 28, 2019 as Exhibit 10.1 thereto. +10.110 +Executive +Employment Agreement with Henry Nisser dated April 12, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on April 16, 2018 as Exhibit 10.1 thereto. +10.111 +Form +of Securities Purchase Agreement, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +May 20, 2019 as Exhibit 10.1 thereto. +10.112 +Form +of Guarantee, dated May 10, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit +10.2 thereto. +69 +Table of Contents +Exhibit +Number +Description +10.113 +Form +of Note Purchase Agreement, dated May 21, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 28, +2019 as Exhibit 10.1 thereto. +10.114 +Form +of Promissory Note, dated May 21, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 28, 2019 +as Exhibit 10.2 thereto. +10.115 +Securities +Purchase Agreement, dated June 18, 2019. Incorporated by reference to the Current Report on Form 8-K filed on June 18, 2019 +as Exhibit 10.1 thereto. +10.116 +Form +of Guaranty, dated June 18, 2019. Incorporated by reference to the Current Report on Form 8-K filed on June 18, 2019 as Exhibit +10.2 thereto. +10.117 +Form +of Exchange Agreement, dated July 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on July 2, 2019 +as Exhibit 10.1 thereto. +10.118 +Form +of Registration Rights Agreement, dated July 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +July 2, 2019 as Exhibit 10.2 thereto. +10.119 +Form +of Exchange Agreement, dated July 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on July 2, 2019 +as Exhibit 10.1 thereto. +10.120 +Form +of Securities Purchase Agreement, dated July 3, 2019. Incorporated by reference to the Current Report on Form 8-K filed on +July 5, 2019 as Exhibit 10.1 thereto. +10.121 +At-The-Market +Issuance Sales Agreement, dated August 6, 2019, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current +Report on Form 8-K filed on August 6, 2019 as Exhibit 10.1 thereto. +10.122 +Form +of Subscription Agreement. Incorporated by reference to the Regulation A Offering Statement on Form 1-A filed on August 14, +2019 as Exhibit 4,1 thereto. +10.123 +Form +of Exchange Agreement, dated September 26, 2019. Incorporated by reference to the Current Report on Form 8-K filed on September +26, 2019 as Exhibit 10.1 thereto. +10.124 +Form +of Registration Rights Agreement, dated September 26, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on September 26, 2019 as Exhibit 10.2 thereto. +10.125 +Form +of Forbearance Agreement, dated September 26, 2019. Incorporated by reference to the Current Report on Form 8-K filed on September +26, 2019 as Exhibit 10.3 thereto. +10.126 +Form +of Exchange Agreement, dated November 4, 2019. Incorporated by reference to the Current Report on Form 8-K filed on November +4, 2019 as Exhibit 10.1 thereto. +10.127 +Form +of Exchange Agreement, dated November 15, 2019. Incorporated by reference to the Current Report on Form 8-K filed on November +18, 2019 as Exhibit 10.1 thereto. +10.128 +Form +of Securities Purchase Agreement, dated December 22, 2019. Incorporated by reference to the Current Report on Form 8-K filed +on December 23, 2019 as Exhibit 10.1 thereto. +21*** +List of subsidiaries. +23.1*** +Consent of Marcum LLP. +23.2*** +Consent of Ziv Haft, BDO member firm. +31.1*** +Certification of Chief Executive Officer +required by Rule 13a-14(a) or Rule 15d-14(a) +31.2*** +Certification of Chief Financial Officer +required by Rule 13a-14(a) or Rule 15d-14(a) +32.1**** +Certification of Chief Executive and Financial +Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code +101.INS*** +XBRL Instance Document +101.SCH*** +XBRL Taxonomy Extension Schema Document +101.CAL*** +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF*** +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB*** +XBRL Taxonomy Extension Label Linkbase Document +101.PRE*** +XBRL Taxonomy Extension Presentation Linkbase Document +* +Indicates management contract or compensatory plan or arrangement. +** +Confidential treatment is being sought for this agreement, which has been filed separately with the SEC. The confidential portions of this Exhibit have been omitted and are marked by asterisks. +*** +Filed herewith. +**** +Furnished herewith. +ITEM 16. FORM 10–K SUMMARY. +None. +70 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) +of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned +thereunto duly authorized. +Dated: May 29, 2020 +DPW HOLDINGS, INC. +By: +/s/ Milton C. Ault, III +Milton C. Ault, III +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ William B. Horne +William B. Horne +Chief Financial Officer +(Principal Accounting Officer) +Pursuant to the requirements of the Securities Exchange +Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +May 29, 2020 +/s/ Milton C. Ault, III +Milton +C. Ault, III, Chief Executive Officer and Executive +Chairman +of the Board +May 29, 2020 +/s/ William B. Horne +William B. Horne, Chief Financial Officer and Director +May 29, 2020 +/s/ Amos Kohn +Amos Kohn, President and Director +May 29, 2020 +/s/ Robert O. Smith +Robert O. Smith, Director +May 29, 2020 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, Director +May 29, 2020 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +May 29, 2020 +/s/ Jodi Brichan +Jodi Brichan, Director +71 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS +DPW HOLDINGS, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Reports of Independent Registered Public Accounting Firm – Marcum LLP +F-2 +Report of Independent Registered Public Accounting Firm – Ziv Haft. +F-3 +Consolidated Balance Sheets as of December 31, 2019 and 2018 +F-4 - F-5 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2019 and 2018 +F-6 +Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2019 and 2018 +F-7 - F-8 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and 2018 +F-9 - F-10 +Notes to Consolidated Financial Statements +F-11 - F-67 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC +ACCOUNTING FIRM +To the Shareholders and Board of Directors +of +DPW Holdings, Inc. and Subsidiaries +Opinion on the Financial Statements +We have audited the +accompanying consolidated balance sheets of DPW Holdings, Inc. and Subsidiaries (the “Company”) as of December +31, 2019 and 2018, the related consolidated statements of operations and comprehensive loss, changes in stockholders’ +equity and cash flows for each of the two years in the period ended December 31, 2019, and the related notes (collectively +referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all +material respects, the consolidated financial position of the Company as of December 31, 2019 and 2018, and the results of +its operations and its cash flows for each of the two years in the period ended December 31, 2019, in conformity with +accounting principles generally accepted in the United States of America. +We did not audit the December +31, 2019 and 2018 financial statements of Enertec Systems 2001 Ltd., a wholly-owned subsidiary, which statements reflect 28 percent +and 19 percent of the total assets as of December 31, 2019 and 2018, respectively and revenues for the year ended December 31, +and 2018 constituting 33 percent and 20 percent, respectively, of the related consolidated totals. Those statements were audited +by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Enertec +Systems 2001 Ltd., is based solely on the report of the other auditors. +Change in Accounting Principle +As discussed in Note 3 to the consolidated +financial statements, the Company has changed its method of accounting for leases in 2019 due to the adoption of the guidance in +ASC Topic 842, Leases +Explanatory Paragraph – Going Concern +The accompanying consolidated financial +statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the +Company has a significant working capital deficiency, has incurred significant losses and needs to raise additional funds to meet +its obligations and sustain its operations. These conditions raise substantial doubt about the Company's ability to continue as +a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this +uncertainty. +Basis for Opinion +These financial statements are the responsibility +of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. +We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") +and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable +rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with +the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether +the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required +to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are +required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion +on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures +to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures +that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures +in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made +by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits +provide a reasonable basis for our opinion. +/s/ Marcum llp +Marcum llp +We have served as the Company’s auditor since 2016. +New York, NY +May 29, 2020 +F- 2 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC +ACCOUNTING FIRM +To the Board of Directors and Management of +ENERTEC SYSTEMS 2001 LTD +Opinion on the Financial Statements +We have audited the accompanying balance +sheet of ENERTEC SYSTEMS 2001 LTD ("the company") as of December 31, 2019 and 2018, the related statements of comprehensive +loss, shareholders’ equity, and cash flows for the period from May 22, 2018 to December 31, 2018 and the year ended December +31, 2019, and the related notes (collectively, the financial statements). In our opinion, the financial statements present fairly, +in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations +and its cash flows for the period from May 22, 2018 to December 31, 2018 and the year ended December 31, 2019 in conformity with +U.S. generally accepted accounting principles. +Going Concern +The accompanying financial statements have +been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company has a +working capital deficiency, has incurred significant losses and needs to raise additional funds to meet its obligations and sustain +its operations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might +result from the outcome of this uncertainty. +Basis for Opinion +These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. +We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required +to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and +regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with +the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether +the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, +nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required +to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the +effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures +to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures +that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures +in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made +by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a +reasonable basis for our opinion. +We have served as the Company’s auditor since 2012. +/s/ Ziv Haft. +Ziv Haft. +Certified Public Accountants (Isr.) +BDO Member Firm +Tel-Aviv, Israel +May 29, 2020 +F- 3 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2019 +2018 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ 488,553 +$ 902,329 +Marketable equity securities +639,647 +178,597 +Accounts receivable +2,522,139 +1,930,971 +Accounts and other receivable, related party +1,196,379 +3,887,654 +Accrued revenue +2,226,570 +1,353,411 +Inventories, net +2,541,852 +3,261,126 +Prepaid expenses and other current assets +1,456,117 +775,981 +TOTAL CURRENT ASSETS +11,071,257 +12,290,069 +Intangible assets +3,206,988 +4,359,798 +Digital currencies +2,106 +1,535 +Goodwill +8,100,947 +8,463,070 +Property and equipment, net +2,292,195 +9,313,299 +Right-of-use assets +5,276,056 +— +Investments - related party, net of original issue discount of nil +and $2,336,693, respectively +6,540,720 +5,611,621 +Investments in derivative liabilities and common stock - related party +2,128,224 +3,043,499 +Equity investments in private companies +261,767 +480,000 +Investment in limited partnership +1,969,000 +1,969,000 +Loans receivable +795,481 +2,572,230 +Other investments, related parties +832,500 +862,500 +Other assets +273,167 +459,259 +TOTAL ASSETS +$ 42,750,408 +$ 49,425,880 +LIABILITIES AND STOCKHOLDERS' EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ 15,166,164 +$ 13,065,838 +Accounts payable and accrued expenses, related party +64,604 +57,752 +Operating lease liability, current +714,393 +— +Advances on future receipts +2,210,392 +2,085,807 +Short term advances, related party +1,409,331 +73,761 +Revolving credit facility +221,705 +285,605 +Notes payable, net +5,505,015 +6,388,787 +Notes payable, related parties +169,153 +166,925 +Convertible notes payable +2,732,990 +6,742,494 +Other current liabilities +2,027,585 +1,868,402 +TOTAL CURRENT LIABILITIES +30,221,332 +30,735,371 +LONG TERM LIABILITIES +Operating lease liability, non-current +4,677,565 +— +Notes payable +482,624 +483,659 +Notes payable, related parties +115,164 +142,059 +Convertible notes payable +304,773 +— +TOTAL LIABILITIES +35,801,458 +31,361,089 +The accompanying notes are an integral part +of these consolidated financial statements. +F- 4 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +December 31, +2019 +2018 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS' EQUITY +Series A Convertible Preferred Stock, $25.00 stated value per share, +7 +1 +$0.001 par value – 1,000,000 shares authorized; 7,040 and 1,434 shares +issued and outstanding at December 31, 2019 and 2018, respectively +(redemption amount and liquidation preference of $176,000 +and $35,850 as of December 31, 2019 and 2018, respectively) +Series B Convertible Preferred Stock, $10 stated value per share, +125 +125 +share, $0.001 par value – 500,000 shares authorized; 125,000 shares issued +and outstanding at December 31, 2019 and 2018 (liquidation +preference of $1,250,000 at December 31, 2019 and 2018) +Class A Common Stock, $0.001 par value – 500,000,000 shares authorized; +3,318 +101 +3,318,390 and 100,910 shares issued and outstanding at December 31, 2019 +and 2018, respectively +Class B Common Stock, $0.001 par value – 25,000,000 shares authorized; +— +— +nil shares issued and outstanding at December 31, 2019 and 2018 +Additional paid-in capital +101,099,347 +77,647,544 +Accumulated deficit +(88,650,465 ) +(55,721,115 ) +Accumulated other comprehensive loss +(5,511,624 ) +(3,902,523 ) +TOTAL DPW HOLDINGS STOCKHOLDERS' EQUITY +6,940,708 +18,024,133 +Non-controlling interest +8,242 +40,658 +TOTAL STOCKHOLDERS' EQUITY +6,948,950 +18,064,791 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ 42,750,408 +$ 49,425,880 +The accompanying notes are an integral part +of these consolidated financial statements. +F- 5 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +AND COMPREHENSIVE LOSS +For the Year Ended +December 31, +2019 +2018 +Revenue +$ 21,057,509 +$ 17,762,217 +Revenue, cryptocurrency mining +641,745 +1,675,549 +Revenue, related party +— +3,907,280 +Revenue, restaurant operations +4,149,646 +3,462,140 +Revenue, lending activities +662,740 +347,033 +Total revenue +26,511,640 +27,154,219 +Cost of revenue +20,452,292 +21,774,658 +Gross profit +6,059,348 +5,379,561 +Operating expenses +Engineering and product development +1,861,103 +1,430,538 +Selling and marketing +1,631,809 +3,010,790 +General and administrative +19,670,995 +19,842,378 +Impairment of property and equipment +4,315,856 +— +Impairment loss on goodwill and intangible assets +1,526,897 +700,000 +Provision for credit losses +4,000,000 +— +(Gain) loss on digital currency +(5,515 ) +1,311 +Total operating expenses +33,001,145 +24,985,017 +Loss from operations +(26,941,797 ) +(19,605,456 ) +Interest income +3,351,226 +2,736,932 +Interest expense +(7,262,646 ) +(16,190,276 ) +Change in fair value of marketable equity securities +(596,242 ) +— +Loss on extinguishment of convertible debt +(966,134 ) +— +Loss on issuance of warrants +(1,763,481 ) +— +Change in fair value of warrant liability +1,124,953 +— +Loss before income taxes +(33,054,121 ) +(33,058,800 ) +Income tax benefit +108,293 +76,599 +Net loss +(32,945,828 ) +(32,982,201 ) +Less: Net loss attributable to non-controlling interest +32,416 +748,320 +Net loss attributable to DPW Holdings +(32,913,412 ) +(32,233,881 ) +Preferred deemed dividends on Series B Preferred Stock +— +(108,049 ) +Preferred dividends +(15,938 ) +— +Net loss available to common stockholders +$ (32,929,350 ) +$ (32,341,930 ) +Basic and diluted net loss per common share +$ (22.97 ) +$ (446.11 ) +Basic and diluted weighted average common shares outstanding +1,433,464 +72,498 +Comprehensive Loss +Loss available to common stockholders +$ (32,929,350 ) +$ (32,341,930 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +341,774 +(377,823 ) +Net unrealized gain (loss) on derivative securities of related party +(1,950,875 ) +(8,027,746 ) +Other comprehensive income (loss) +(1,609,101 ) +(8,405,569 ) +Total Comprehensive loss +$ (34,538,451 ) +$ (40,747,499 ) +The accompanying notes are an integral part +of these consolidated financial statements. +F- 6 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN +STOCKHOLDERS’ EQUITY +Accumulated +Additional +Other +Total +Preferred Stock +Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income (Loss) +Interest +Equity +BALANCES, Jan uary 1, 2018 +478,776 +$ 479 +37,778 +$ 38 +$ 36,918,132 +$ (23,414,151 ) +$ 4,503,046 +$ 780,737 +$ 18,788,281 +Stock based compensation: +Options +— +— +— +1,043,908 +— +— +— +1,043,908 +Warrants +— +— +— +93,914 +— +— +— +93,914 +Common stock +— +4,604 +5 +3,740,883 +— +— +— +3,740,888 +Issuance of common stock and +warrants for cash +— +41,023 +41 +23,884,429 +— +— +— +23,884,470 +Issuance of common stock for +conversion +of debt +— +5,281 +6 +2,446,111 +— +— +— +2,446,117 +Issuance of common stock for +conversion +of short-term advances +— +4,540 +4 +2,819,580 +— +— +— +2,819,584 +Issuance of common stock upon +exercise +of stock options +— +75 +- +97,800 +— +— +— +97,800 +Issuance of common stock upon +exercise +of warrants +— +2,682 +3 +867,163 +— +— +— +867,166 +Issuance of Series A +preferred stock for cash +1,434 +1 +— +— +35,849 +— +— +— +35,850 +Issuance of Series B +preferred stock for +conversion of +short-term advances +25,000 +25 +— +— +249,975 +— +— +— +250,000 +Issuance of common stock for +conversion +of Series E preferred +stock +(378,776 ) +(379 ) +947 +1 +378 +— +— +— +— +Issuance of common stock in +connection +with convertible +notes +— +3,425 +2 +1,541,106 +— +— +— +1,541,108 +Repurchase of common +stock +— +(70 ) +- +(57,748 ) +— +— +— +(57,748 ) +Beneficial conversion +feature in connection +with convertible +notes +— +— +— +2,555,952 +— +— +— +2,555,952 +Fair value of warrants +issued in connection +with convertible +notes +— +— +— +3,408,665 +— +— +— +3,408,665 +Cash and stock for exchange +fees and +other financing costs +— +625 +1 +(2,107,583 ) +— +— +— +(2,107,582 ) +Non-controlling interest +from acquisition of I. AM +— +— +— +981 +— +— +33,241 +34,222 +Non-controlling interest +from Microphase +— +— +— +— +— +— +(25,000 ) +(25,000 ) +Comprehensive loss: +Net loss +— +— +— +— +(32,233,881 ) +— +— +(32,233,881 ) +Preferred deemed dividends +— +— +— +108,049 +(108,049 ) +— +— +— +Net unrealized gain +on securities +available-for-sale, +net of income taxes +— +— +— +— +— +(8,027,746 ) +— +(8,027,746 ) +Foreign currency translation +adjustments +— +— +— +— +34,966 +(377,823 ) +— +(342,857 ) +Net +loss attributable to non-controlling interest +— +— +— +— +— +— +(748,320 ) +(748,320 ) +BALANCES, December 31, 2018 +126,434 +$ 126 +100,910 +$ 101 +$ 77,647,544 +$ (55,721,115 ) +$ (3,902,523 ) +$ 40,658 +$ 18,064, 791 +The accompanying notes are an integral part +of these consolidated financial statements. +F- 7 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN +STOCKHOLDERS’ EQUITY (continued) +Accumulated +Additional +Other +Total +Preferred +Stock +Common +Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income +(Loss) +Interest +Equity +Stock based compensation: +Options +— +— +— +— +754,752 +— +— +— +754,752 +Common stock +— +— +69,375 +69 +338,550 +— +— +— +338,619 +Issuance of common stock for cash +— +— +2,011,005 +2,012 +10,951,731 +— +— +— +10,953,743 +Issuance of common stock in payment of +accrued liabilities +— +— +66,740 +66 +175,311 +— +— +— +175,377 +Issuance of common stock for conversion +of debt +— +— +370,473 +370 +4,735,925 +— +— +— +4,736,295 +Issuance of common stock upon exercise +of warrants +— +— +699,887 +700 +6,620,325 +— +— +— +6,621,025 +Issuance of Series A preferred stock for +cash +5,606 +6 +— +— +140,144 +— +— +— +140,150 +Beneficial conversion feature in connection +with convertible notes +— +— +— +— +821,452 +— +— +— +821,452 +Fair value of warrants issued in connection +with convertible notes +— +— +— +200,518 +— +— +— +200,518 +Cash for exchange fees and other financing +costs +— +— +— +— +(1,445,255 ) +— +— +— +(1,445,255 ) +Loss on debt extinguishment +158,350 +158,350 +Comprehensive loss: +Net loss +— +— +— +— +(32,913,412 ) +— +— +(32,913,412 ) +Preferred dividends +— +— +— +— +— +(15,938 ) +— +— +(15,938 ) +Net unrealized loss on derivatives +in related party +— +— +— +— +— +— +(1,950,875 ) +— +(1,950,875 ) +Foreign currency translation adjustments +— +— +— +— +— +— +341,774 +— +341,774 +Net loss attributable +to non-controlling interest +— +— +— +— +— +— +— +(32,416 ) +(32,416 ) +BALANCES, December 31, 2019 +132,040 +$ 132 +3,318,390 +$ 3,318 +$ 101,099,347 +$ (88,650,465 ) +$ (5,511,624 ) +$ 8,242 +$ 6,948,950 +The above Consolidated Statements of Stockholders’ +Equity reflects a 1 for 40 reverse stock split effective August 5, 2019, see Note 1 for further information. +The accompanying notes are an integral part +of these consolidated financial statements. +F- 8 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +For the Years Ended December 31, +2019 +2018 +Cash flows from operating activities: +Net loss +$ (32,945,828 ) +$ (32,982,201 ) +Adjustments to reconcile net loss to net cash used in operating activities: +Depreciation +2,962,435 +2,447,249 +Amortization +502,656 +459,656 +Amortization of right-of-use assets +1,025,053 +— +Interest expense – debt discount +3,709,993 +11,191,055 +Fair value in excess of proceeds upon issuance of warrants +1,763,481 +— +Change in fair value of warrant liability +(1,124,953 ) +— +Accretion of original issue discount on notes receivable – related party +(2,277,777 ) +(2,004,358 ) +Accretion of original issue discount on notes receivable +(90,489 ) +(175,921 ) +Accretion of interest income on notes receivable – related party +(1,021,158 ) +— +Stock-based compensation +1,583,991 +4,719,266 +Impairment of property and equipment +4,315,856 +— +Impairment of intangible assets +780,692 +700,000 +Impairment of goodwill +746,205 +— +Realized (gains) losses on sale of digital currencies +(524 ) +127,602 +Realized (gains) losses on sale of marketable securities +(95,340 ) +175,405 +Realized losses on equity securities in private companies +215,813 +— +Unrealized (gains) losses on marketable equity securities +(258,905 ) +77,133 +Unrealized gains on equity securities – related party +276,450 +— +Unrealized gains on equity securities +363,996 +— +Provision for loan losses +5,550,000 +— +Changes in operating assets and liabilities: +Accounts receivable +(533,065 ) +2,754,631 +Accounts receivable, related party +2,691,275 +(3,713,903 ) +Accrued revenue +(737,960 ) +(1,353,411 ) +Digital currencies +(647,260 ) +(1,633,630 ) +Inventories +836,924 +13,137 +Prepaid expenses and other current assets +(1,134,576 ) +1,210,933 +Other assets +(221,264 ) +(232,442 ) +Accounts payable and accrued expenses +4,157,998 +6,850,263 +Accounts payable, related parties +6,852 +(12,103 ) +Other current liabilities +212,544 +959,235 +Lease liabilities +(909,151 ) +— +Net cash used in operating activities +(10,296,036 ) +(10,422,404 ) +Cash flows from investing activities: +Purchase of property and equipment +(201,360 ) +(8,919,532 ) +Loss on disposition of asset +— +22,172 +Purchase of intangible asset +— +(3,025 ) +Purchase of Enertec +— +(4,936,562 ) +Cash received on acquisitions +— +293,041 +Investments – related party +(1,600,164 ) +(1,244,353 ) +Related party investment in real property +— +(1,969,000 ) +Investments in warrants and common stock - related party +(1,130,567 ) +(2,672,510 ) +Investments in marketable equity securities +— +(858,458 ) +Sales of marketable equity securities +580,721 +2,188,292 +Sales of digital currencies +— +64,587 +Investments - others +— +(25,000 ) +Proceeds from loans to related parties +— +12,520 +Investments in debt and equity securities +(511,743 ) +(2,571,100 ) +Net cash used in investing activities +$ (2,863,113 ) +$ (20,618,928 ) +The accompanying notes are an integral part +of these consolidated financial statements. +F- 9 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(continued) +For the Years Ended December 31, +2019 +2018 +Cash flows from financing activities: +Gross proceeds from sales of common stock and warrants +$ 17,028,605 +$ 23,884,470 +Repurchase of common stock +— +(57,747 ) +Proceeds from issuance of Series A Convertible Preferred Stock +131,741 +33,699 +Financing cost in connection with sales of equity securities +(1,445,255 ) +(2,107,582 ) +Proceeds from stock option exercises +— +97,800 +Proceeds from warrant exercises +127,000 +867,166 +Proceeds from convertible notes payable +500,000 +11,550,000 +Proceeds from notes payable +5,230,418 +12,994,999 +Proceeds from short-term advances – related party +1,305,570 +136,761 +Proceeds from short-term advances +— +762,000 +Payments on short-term advances +— +(646,500 ) +Payments on notes payable – related party +— +(333 ) +Payments on short-term advances – related party +— +(13,000 ) +Payments on notes payable +(2,117,252 ) +(12,133,140 ) +Payments on convertible notes payable +(7,069,547 ) +(2,362,281 ) +Proceeds from advances on future receipts +941,804 +3,350,277 +Payments on advances on future receipts +(1,590,925 ) +(5,505,079 ) +Payments of preferred dividends +(15,938 ) +— +Payments on revolving credit facilities, net +(101,018 ) +(313,822 ) +Net cash provided by financing activities +12,925,203 +30,537,688 +Effect of exchange rate changes on cash and cash equivalents +(179,830 ) +(72,174 ) +Net decrease in cash and cash equivalents +(413,776 ) +(575,818 ) +Cash and cash equivalents at beginning of period +902,329 +1,478,147 +Cash and cash equivalents at end of period +$ 488,553 +$ 902,329 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ 1,867,925 +$ 760,208 +Non-cash investing and financing activities: +Cancellation of convertible note payable into shares of common stock +$ 4,736,295 +$ 2,446,116 +Payment of debt with digital currency +$ — +$ 739,967 +Purchase of assets with digital currency +$ — +$ 250,460 +Payment of accounts payable with digital currency +$ 647,213 +$ 449,479 +Issuance of common stock for prepaid services +$ — +$ 50,000 +Issuance of common stock in payment of liability +$ 175,377 +$ — +Cancellation of short term advances into shares of common stock +$ — +$ 2,554,167 +Cancellation of short term advances, related party into shares +of common stock +$ — +$ 45,000 +Cancellation of short term advances, related party into shares +of Series B Preferred Stock +$ — +$ 250,000 +Conversion of loans receivable for marketable equity securities +$ 485,000 +$ — +Conversion of loans receivable for investments in warrants and +common stock - related party +$ 181,483 +$ — +Cancellation of notes payable into short term advances, related party +$ +30,000 +$ — +The accompanying notes are an integral part +of these consolidated financial statements. +F- 10 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2019 +1. DESCRIPTION OF BUSINESS +DPW Holdings, Inc., +a Delaware corporation (“DPW” or the “Company”), formerly known as Digital Power Corporation, was incorporated +in September 2017. The Company is a diversified holding company owning subsidiaries engaged in the +following operating businesses: commercial and defense solutions, commercial lending, cryptocurrency blockchain mining, advanced +textile technology and restaurant operations. The Company’s wholly-owned subsidiaries are Gresham Worldwide, Inc. +(“GWW”), Coolisys Technologies, Inc. (“Coolisys”), Gresham Power Electronics Ltd. (f/k/a Digital Power +Limited) (“Gresham Power”), Enertec Systems 2001 Ltd (“ Enertec ”) , +Digital Power Lending, LLC (“DP Lending”) and Digital Farms, Inc. (“Digital Farms”). The Company also has +controlling interests in Microphase Corporation (“Microphase”) and I. AM, Inc. +(“I.AM”) . The Company has five reportable segments – defense solution through GWW with operations conducted +by Microphase, Enertec and Gresham Power, commercial solution through Coolisys, commercial lending through DP Lending, digital +currency blockchain mining through Digital Farms and restaurant operations through I.AM. +On March 14, 2019, pursuant +to the authorization provided by the Company’s stockholders at a Special Meeting of Stockholders, the Company’s +Board of Directors (the “Board”) approved the Certificate of Incorporation Amendment (the “COI Amendment”) +to effectuate a reverse stock split of the Common Stock of the Company’s issued and outstanding number of such shares by +a ratio of one-for-twenty (the “First Stock Split”) . At the Company’s +2019 reconvened Annual Meeting of Stockholders, the Company’s stockholders approved a proposal permitting the Board to effectuate +a second reverse stock split (the “Second Stock Split”) of the Company’s issued and outstanding Common Stock. +Thereafter, on July 23, 2019, the Board approved the Second Stock Split with a ratio of one-for-forty. The Second Stock Split did +not affect the number of authorized shares of Common Stock or their par value per share. As a result of the Second Stock Split, +each forty shares of common stock issued and outstanding prior to the Second Stock Split were converted into one share of common +stock. The Second Stock Split became effective in the State of Delaware on August 5, 2019. All share amounts in these financial +statements have been updated to reflect these reverse stock splits. +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +The accompanying consolidated +financial statements have been prepared on the basis that the Company will continue as a going concern. As of December 31, 2019, +the Company had cash and cash equivalents of $488,553, an accumulated deficit of $88,650,465 and a negative working capital of +$19,150,075. The Company has incurred recurring losses and reported losses for the years ended December 31, 2019 and 2018, totaled +$32,913,412 and $32,233,881, respectively. In the past, the Company has financed its operations principally through issuances of +convertible debt, promissory notes and equity securities. During 2019, the Company continued to successfully obtain additional +equity and debt financing and in restructuring existing debt. +The Company expects +to continue to incur losses for the foreseeable future and needs to raise additional capital to continue its business development +initiatives and to support its working capital requirements. On April 2, 2019, the Company received gross proceeds of approximately +$7 million in a public offering of its securities (see Note 22). Subsequent to December 31, 2019, the Company entered into a Master +Exchange Agreement with an entity that, subject to shareholder approval, has agreed to purchase up to approximately $7.7 million +in certain promissory notes previously issued by the Company. Further, as a result of temporary restaurant closures in San Diego, +California, and the deteriorating business conditions at the Company’s cryptocurrency mining operations, the Company concluded +that discontinuing these operations was ultimately in its best interest (see Note 26). Management believes that the Company has +access to capital resources through potential public or private issuances of debt or equity securities. However, if the Company +is unable to raise additional capital, which could be adversely affected by the recent outbreak of COVID-19, it may be required +to curtail operations and take additional measures to reduce costs, including reducing its workforce, eliminating outside consultants +and reducing legal fees to conserve its cash in amounts sufficient to sustain operations and meet its obligations. These matters +raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial statements +do not include any adjustments that might become necessary should the Company be unable to continue as a going concern. +F- 11 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated +financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America +(“U.S. GAAP”). +Principles of Consolidation +The consolidated financial +statements include the accounts of DPW and its wholly-owned subsidiaries, Digital Power Corporation, Gresham Power, Enertec, DP +Lending and Digital Farms and its majority-owned subsidiaries, Microphase and I.AM. All significant intercompany accounts and transactions +have been eliminated in consolidation. +Accounting Estimates +The preparation of +financial statements, in conformity with U.S. GAAP, requires management to make estimates, judgments and assumptions. The Company's +management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time +they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure +of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses +during the reporting periods. Actual results could differ from those estimates. Key estimates include acquisition accounting, fair +value of certain financial instruments, reserves for trade receivables and inventories, carrying amounts of investments, carrying +amounts of digital currencies, accruals of certain liabilities including product warranties, useful lives and the recoverability +of long-lived assets, impairment analysis of intangibles and goodwill, and deferred income taxes and related valuation allowance. +Impairment of long-lived assets: +Management reviews +long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may +not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset +to undiscounted expected future cash flows expected to be generated by the asset. If such assets are considered to be impaired, +the impairment to be recognized is measured by comparing the amount by which the carrying amount of the assets to their fair value. Based +on its reviews, management determined that its digital currency miners were impaired by a total of $4,315,856 based upon an assessment +as of September 30, 2019, including consideration of the decline in bitcoin values which occurred throughout 2019. +Revenue Recognition +The Company recognizes +revenue under ASC 606, Revenue from Contracts with Customers . The core principle of the new revenue standard is that a company +should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration +to which the company expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve +that core principle: +· Step 1: Identify the contract with the +customer, +· Step 2: Identify the performance obligations +in the contract, +· Step 3: Determine the transaction price, +· Step 4: Allocate the transaction price +to the performance obligations in the contract, and +· Step 5: Recognize revenue when the company +satisfies a performance obligation. +F- 12 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The Company’s disaggregated revenues +consist of the following for the year ended December 31, 2019: +Year ended December 31, 2019 +GWW +Coolisys +DP Lending +Digital Farms +I.AM +Total +Primary Geographical +Markets +North America +$ 4,342,565 +$ 5,276,096 +$ 662,740 +$ 641,745 +$ 4,149,646 +$ 15,072,792 +Europe +1,672,489 +5,767 +— +— +— +1,678,256 +Middle East +8,659,675 +21,348 +— +— +— +8,681,023 +Other +557,114 +522,455 +— +— +— +1,079,569 +$ 15,231,843 +$ 5,825,666 +$ 662,740 +$ 641,745 +$ 4,149,646 +$ 26,511,640 +Major Goods +RF/Microwave Filters +$ 2,245,748 +$ — +$ — +$ — +$ — +$ 2,245,748 +Detector logarithmic +video amplifiers +558,155 +— +— +— +— +558,155 +Power Supply Units +1,656,162 +5,825,666 +— +— +— +7,481,828 +Power Supply Systems +1,920,594 +— +— +— +— +1,920,594 +Healthcare diagnostic systems +1,711,050 +— +— +— +— +1,711,050 +Defense systems +7,140,134 +— +— +— +— +7,140,134 +Digital Currency Mining +— +— +— +641,745 +— +641,745 +Restaurant operations +— +— +— +— +4,149,646 +4,149,646 +Lending activities +— +— +662,740 +— +— +662,740 +$ 15,231,843 +$ 5,825,666 +$ 662,740 +$ 641,745 +$ 4,149,646 +$ 26,511,640 +Timing of Revenue +Recognition +Goods transferred at a +a point in time +$ 6,243,758 +$ 5,825,666 +$ 662,740 +$ 641,745 +$ 4,149,646 +$ 17,523,555 +Services transferred over time +8,988,085 +— +— +— +— +8,988,085 +$ 15,231,843 +$ 5,825,666 +$ 662,740 +$ 641,745 +$ 4,149,646 +$ 26,511,640 +Sales of Products +The Company generates +revenues from the sale of its products through a direct and indirect sales force. The Company’s performance obligations +to deliver products are satisfied at the point in time when products are received by the customer, which is when the customer obtains +control over the goods. The Company provides standard assurance warranties, which are not separately priced, that the products +function as intended. The Company primarily receives fixed consideration for sales of product. Some of the Company’s contracts +with distributors include stock rotation rights after six months for slow moving inventory, which represents variable consideration. +The Company uses an expected value method to estimate variable consideration and constrains revenue for estimated stock rotations +until it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. To date, returns +have been insignificant. The Company’s customers generally pay within 30 days from the receipt of a valid invoice. +Because the Company’s +product sales agreements have an expected duration of one year or less, the Company has elected to adopt the practical expedient +in ASC 606-10-50-14(a) of not disclosing information about its remaining performance obligations. +F- 13 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Manufacturing Services +The Company provides +manufacturing services in exchange primarily for fixed fees; however, the initial two MLSE units are subject to variable pricing +under the $50 million purchase order from MTIX. Under the terms of the MLSE purchase order, the Company shall be entitled to cost +plus $100,000 for the manufacture of the first two MLSE units. The Company has determined that the costs of manufacturing the MLSE +units will decline over time because of a learning curve which will result in a greater amount of revenue being recognized for +these initial two MLSE units. +For manufacturing services, +which include revenues generated by Enertec and in certain instances revenues generated by Gresham Power, the Company’s performance +obligation for manufacturing services is satisfied over time as the Company creates or enhances an asset based on criteria that +are unique to the customer and that the customer controls as the asset is created or enhanced. Generally, the Company recognizes +revenue based upon proportional performance over time using a cost to cost method which measures progress based on the costs incurred +to total expected costs in satisfying its performance obligation. This method provides a depiction of the progress in providing +the manufacturing service because there is a direct relationship between the costs incurred by the Company and the transfer of +the manufacturing service to the customer. Manufacturing services that are recognized based upon the proportional performance method +are included in the above table as services transferred over time and to the extent the customer has not been invoiced for these +revenues, as accrued revenue in the accompanying consolidated balance sheets. Revisions to the Company’s estimates may result +in increases or decreases to revenues and income and are reflected in the consolidated financial statements in the periods in which +they are first identified. +The Company has elected +the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component +to the extent that the period between when the Company transfers its promised good or service to the customer and when the customer +pays in one year or less. +The aggregate amount +of the transaction price allocated to the performance obligation that is partially unsatisfied as of December 31, 2019, for the +MLSE units was approximately $48 million, representing 24 MLSE units. Based on our expectations regarding funding of the production +process and our experience building the first machines, the Company expects to recognize the remaining revenue related to the partially +unsatisfied performance obligation over the next three years. The Company will be paid in installments for this performance obligation +over the next three years. +Lending Activities +DP Lending generates +revenue from lending activities primarily through interest, origination fees and late/other fees. Interest income on these products +is calculated based on the contractual interest rate and recorded as interest income as earned. The origination fees or original +issue discounts are recognized over the life of the loan using the effective interest method. +Blockchain Mining +The Company has entered +into digital asset mining pools by executing contracts with the mining pool operators to provide computing power to the mining +pool. The contracts are terminable at any time by either party and the Company’s enforceable right to compensation only begins +when the Company provides computing power to the mining pool operator. In exchange for providing computing power, the Company is +entitled to a fractional share of the fixed digital currency award the mining pool operator receives (less digital asset transaction +fees to the mining pool operator which are recorded as a component of cost of revenues), for successfully adding a block to the +blockchain. The Company’s factional share is based on the proportion of computing power the Company contributed to the mining +pool operator to the total computing power contributed by all mining pool participants in solving the current algorithm. +Providing computing +power in digital asset transaction verification services is an output of the Company’s ordinary activities. The provision +of providing such computing power is the only performance obligation in the Company’s contracts with mining pool operators. +The transaction consideration the Company receives, if any, is noncash consideration, which the Company measures at fair value +on the date received, which is not materially different than the fair value at contract inception or the time the Company has earned +the award from the pools. The consideration is all variable. Because it is not probable that a significant reversal of cumulative +revenue will not occur, the consideration is constrained until the mining pool operator successfully places a block (by being the +first to solve an algorithm) and the Company receives confirmation of the consideration it will receive, at which time revenue +is recognized. There is no significant financing component in these transactions. +F- 14 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Fair value of the digital +currency award received is determined using the market rate of the related digital currency at the time of receipt. +There is currently +no specific definitive guidance under GAAP or alternative accounting framework for the accounting for digital currencies recognized +as revenue or held, and management has exercised significant judgment in determining the appropriate accounting treatment. In the +event authoritative guidance is enacted by the FASB, the Company may be required to change its policies, which could have an effect +on the Company’s consolidated financial position and results from operations. +Expenses associated +with running the cryptocurrency mining business, such as equipment deprecation and electricity cost are recorded as a component +of cost of revenues. +We intend to use the +digital assets primarily for operating expenses of Digital Farms. Historically, the Company used digital assets for debt reduction, +capital purchases, consulting fees, data center costs and other operating expenses. Digital +Farms’ operations were discontinued in the first quarter of 2020 (see note 26). +Restaurant Operations +The Company records +revenue from restaurant sales at the time of sale, net of discounts, coupons, employee meals and complimentary meals and gift cards. +Restaurant cost of sales primarily includes the cost of goods, beverages, and merchandise and disposable paper and plastic goods +used in preparing and selling the Company’s menu items and exclude depreciation and amortization. Vendor allowances received +in connection with the purchase of a vendor’s products are recognized as a reduction of the related food and beverage costs +as earned. The restaurant operations were discontinued in the first quarter of 2020 (see +note 26). +Foreign Currency Translation +A substantial portion +of the Company’s revenues are generated in U.S. dollars (“U.S. dollar”). In addition, a substantial portion +of the Company’s costs are incurred in U.S. dollars. Company management has determined that the U.S. dollar is the functional +currency of the primary economic environment in which it operates. +Accordingly, monetary +accounts maintained in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with Financial Accounting +Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) No. 830, Foreign Currency +Matters (“ASC No. 830”). All transaction gains and losses from the re-measurement of monetary balance sheet items +are reflected in the statements of operations as financial income or expenses as appropriate. +The financial statements +of Gresham Power and Enertec, whose functional currencies have been determined to be their local currencies, the British Pound +(“GBP”) and the Israeli Shekel (“ILS”), have been translated into U.S. dollars in accordance with ASC No. +830. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement +of operations amounts have been translated using the average exchange rate in effect for the reporting period. The resulting translation +adjustments are reported as other comprehensive income (loss) in the consolidated statement of comprehensive income (loss) and +accumulated comprehensive income (loss) in statement of changes in stockholders' equity (deficit). +F- 15 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Cash and Cash Equivalents +The Company considers +all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial +instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s +cash is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. +These balances may, at times, exceed the U.S. Federal Deposit Insurance Corporation insurance limits. The Company has cash and +cash equivalents of $288,428 and $409,945 at December 31, 2019 and 2018, respectively, in the United Kingdom (“U.K”) +and $47,062 and $60,040, respectively, in Israel. The Company has not experienced any losses on deposits of cash and cash equivalents. +Accounts Receivable and Allowance +for Doubtful Accounts +The Company’s +receivables are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount +of the Company’s receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. +The Company individually reviews all accounts receivable balances and based upon an assessment of current creditworthiness, estimates +the portion, if any, of the balance that will not be collected. The Company estimates the allowance for doubtful accounts based +on historical collection trends, age of outstanding receivables and existing economic conditions. If events or changes in circumstances +indicate that a specific receivable balance may be impaired, further consideration is given to the collectability of those balances +and the allowance is adjusted accordingly. A customer’s receivable balance is considered past-due based on its contractual +terms. Past-due receivable balances are written-off when the Company’s internal collection efforts have been unsuccessful +in collecting the amount due. Based on an assessment as of December 31, 2019 and 2018, of the collectability of invoices, accounts +receivable are presented net of an allowance for doubtful accounts of $5,000 and $5,000, respectively. +Inventories +Inventories are stated +at the lower of cost or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or +technological obsolescence. +Cost of inventories is determined +as follows: +Raw materials, +parts and supplies - using the “first-in, first-out” method. +Work-in-progress and finished products +- on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically +assesses its inventories valuation in respect of obsolete and slow-moving items by reviewing revenue forecasts and technological +obsolescence. When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at +the time of the review was not expected to be sold, is written off. +During the years ended +December 31, 2019 and 2018, the Company did not record inventory write-offs within the cost of revenue. +F- 16 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Property and Equipment, Net +Property and equipment +are stated at cost, net of accumulated depreciation. Repairs and maintenance costs are expensed as incurred. Depreciation is calculated +using the straight-line method over the estimated useful lives of the assets, at the following annual rates: +Useful lives (in years) +Computer, software and related equipment +3 - 5 +Office furniture and equipment +5 - 10 +Leasehold improvements +Over the term of the lease or the life of the asset, whichever is shorter. +Goodwill +The Company evaluates +its goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other . Goodwill is recorded +when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible +assets acquired. +The Company tests the +recorded amount of goodwill for impairment on an annual basis on December 31 of each fiscal year or more frequently if there are +indicators that the carrying amount of the goodwill exceeds its carried value. At December 31, 2019, the Company had five reporting +units. The Company performed a qualitative assessment and concluded that goodwill at the Company’s Coolisys and I.AM subsidiaries +was impaired by a total of $746,205 based upon an assessment as of December 31, 2019. As a result of this assessment, the Company +recorded an impairment of $746,205 +Intangible Assets +The Company acquired +amortizable intangibles assets as part of three asset purchase agreements consisting of customer lists and non-compete agreements. +The Company also has the trade names and trademarks associated with the acquisition of Microphase which were determined to have +an indefinite life. The Company’s intangible assets, net also include definite lived intangible assets, which are being amortized +on a straight-line basis over their estimated useful lives as follows: +Useful lives (in years) +Customer list +5 - 14 +Non-competition agreements +3 +Domain name and other intangible assets +3 +The Company reviews +intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the +assets might not be recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant +underperformance of the business in relation to expectations, significant negative industry or economic trends, and significant +changes or planned changes in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, +the Company compares forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived +asset to its carrying value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result +from the use of an asset are less than its carrying amount. The impairment loss would be based on the excess of the carrying value +of the impaired asset over its fair value, determined based on discounted cash flows. During the years ended December 31, 2019 +and 2018, the Company recorded an impairment loss of $780,692 and 700,000, respectively, as impairment indicators were noted for +the periods presented in these consolidated financial statements. +F- 17 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Long-Lived Assets +The long-lived assets +of the Company are reviewed for impairment in accordance with ASC No. 360, Property, Plant, and Equipment , whenever +events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets +to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected +to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the +amount by which the carrying amount of the assets exceeds the fair value of the assets. As of December 31, 2019 and 2018, no impairment +charges were necessary. +Warranty +The Company offers +a warranty period for all its manufactured products. Warranty periods range from one to two years depending on the product. The +Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the +time product revenue is recognized. Factors that affect the Company's warranty liability include the number of units sold, historical +rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability +and adjusts the amount, as necessary. As of December 31, 2019 and 2018, the Company’s accrued warranty liability was $80,412 +and $86,495, respectively. +Income Taxes +The Company determines +its income taxes under the asset and liability method in accordance with FASB ASC No. 740, Income Taxes , which requires +recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in +the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between +the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which +the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes +it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted +tax rates expected to apply to taxable income in the fiscal years in which those temporary differences are expected to be recovered +or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Statements of Income +and Comprehensive Income in the period that includes the enactment date. +The Company accounts +for uncertain tax positions in accordance with ASC No. 740-10-25 . ASC No. 740-10-25 addresses the determination of +whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC +No. 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that +the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The +tax benefit to be recognized is measured as the largest amount of benefit that has a greater than fifty percent likelihood of being +realized upon ultimate settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, +such differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related +to accrued liabilities for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management +to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions that +more likely than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated +tax positions taken by the Company and has concluded that as of December 31, 2019 and 2018, there are no uncertain tax positions +taken, or expected to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +The Company has not yet filed its 2018 or 2019 tax returns. +Common Stock Purchase Warrants and +Other Derivative Financial Instruments +The Company classifies +common stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require +physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its +own shares (physical settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement +(including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company), +(ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), +or (iii) contain reset provisions as either an asset or a liability. The Company assesses classification of its freestanding +derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. +The Company determined that certain freestanding derivatives, which principally consist of issuance of warrants to purchase shares +of common stock in connection with convertible notes and to employees of the Company, satisfy the criteria for classification as +equity instruments as these warrants do not contain cash settlement features or variable settlement provision that cause them to +not be indexed to the Company’s own stock. +F- 18 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Stock-Based Compensation +The Company accounts +for stock-based compensation in accordance with ASC No. 718, Compensation – Stock Compensation ( “ASC No. +718” ). Under ASC No. 718, compensation expense related to stock-based payments is recorded over the requisite service +period based on the grant date fair value of the awards. Compensation previously recorded for unvested stock options that are forfeited +is reversed upon forfeiture. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for +stock-based awards. The Black-Scholes model requires the use of assumptions which determine the fair value of stock-based awards, +including the option’s expected term and the price volatility of the underlying stock. +The Company’s +accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions +of ASC No. 505-50, Equity Based Payments to Non-Employees . Accordingly, the measurement date for the fair value of the equity +instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor +is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments +issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement. +Convertible Instruments +The Company accounts +for hybrid contracts that feature conversion options in accordance with ASC No. 815, Derivatives and Hedging Activities +( “ASC No. 815” ). ASC No. 815 requires companies to bifurcate conversion options from their host instruments +and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances +in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related +to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded +derivative instrument and the host contract is not re-measured at fair value under otherwise applicable GAAP with changes in fair +value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument +would be considered a derivative instrument. +Conversion options +that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity +or equity linked securities at exercise prices more favorable than that featured in the hybrid contract generally result in their +bifurcation from the host instrument. +The Company accounts +for convertible instruments, when the Company has determined that the embedded conversion options should not be bifurcated from +their host instruments, in accordance with ASC No. 470-20, Debt with Conversion and Other Options ( “ASC No. +470-20” ). Under ASC No. 470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic +value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common +stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts +for convertible instruments (when the Company has determined that the embedded conversion options should be bifurcated from their +host instruments) in accordance with ASC No. 815. +Concentration of Credit Risk +Financial instruments +that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade +receivables. +F- 19 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Cash and cash equivalents +are invested in banks in the U.S., UK and Israel. Such deposits in the United States may be in excess of insured limits and are +not insured in other jurisdictions. +Trade receivables of +the Company and its subsidiaries are mainly derived from sales to customers located primarily in the U.S., Europe and Israel. The +Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance +for doubtful accounts is determined with respect to those amounts that the Company and its subsidiaries have determined to be doubtful +of collection. +Comprehensive Income (Loss) +The Company reports +comprehensive loss in accordance with ASC No. 220, Comprehensive Income . This statement establishes standards for the reporting +and presentation of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive +loss generally represents all changes in equity during the period except those resulting from investments by, or distributions +to, stockholders. The Company determined that its items of other comprehensive loss relate to changes in foreign currency translation +adjustments and unrealized gains and losses in its warrants in Avalanche International Corp. (“AVLP”), a related party. +Fair value of Financial Instruments +In accordance with +ASC No. 820, Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would +be received for the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of +the measurement date. +The guidance also establishes +a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable +inputs by requiring that the most observable inputs be used when available. Observable inputs include those that market participants +would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. +Unobservable inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use +in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +Level 1: Quoted market prices in active +markets for identical assets or liabilities. +Level 2: Inputs other than Level 1 that +are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets +that are not active; or model-derived valuations. All significant inputs used in our valuations are observable or can be derived +principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level +2 inputs also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally +developed models such as a discounted cash flow model. +Level 3: Unobservable inputs that are supported +by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts +of financial instruments carried at cost, including cash and cash equivalents, accounts receivables and accounts and other receivable +– related party, investments, notes receivable, trade payables and trade payables – related party approximate their +fair value due to the short-term maturities of such instruments. +F- 20 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The categorization +of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair +value measurement. The following table sets forth the Company’s financial instruments (see Note 4 and Note 7) that were measured +at fair value on a recurring basis by level within the fair value hierarchy: +Fair Value Measurement at December 31, 2019 +Total +Level 1 +Level 2 +Level 3 +Investments in convertible promissory note of +AVLP – a related party +$ 6,540,720 +$ — +$ — +$ 6,540,720 +Investments in common stock and derivative +instruments of AVLP – a related party +1,569,286 +238,602 +$ — +1,330,684 +Investment in common stock of Alzamend – a +related party +558,938 +— +— +558,938 +Investments in marketable equity securities +639,647 +639,647 +— +— +Investments in warrants of public companies +9,174 +— +— +9,174 +Total Investments +$ 9,317,765 +$ 878,249 +$ — +$ 8,439,516 +Fair Value Measurement at December 31, 2018 +Total +Level 1 +Level 2 +Level 3 +Investments in common stock and derivative +instruments of AVLP – a related party +$ 3,043,499 +$ 812,858 +$ — +$ 2,230,641 +Investments in marketable equity securities +178,597 +178,597 +— +— +Investments in warrants of public companies +34,372 +— +— +34,372 +Total Investments +$ 3,256,468 +$ 991,455 +$ — +$ 2,265,013 +We assess the inputs used to measure fair +value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market. +Debt Discounts +The Company accounts +for debt discount according to ASC No. 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through +periodic charges to interest expense over the term of the related financial instrument using the effective interest method. During +the years ended December 31, 2019 and 2018, the Company recorded amortization of debt discounts of $3,709,993 and $11,191,055, +respectively. +Leases +Effective January 1, +2019, the Company accounts for its leases under ASC 842, Leases . Under this guidance, arrangements meeting the definition +of a lease are classified as operating or financing leases. As of January 1, 2019, we only had operating leases. Operating leases +are recognized as Operating lease right-of-use (“ROU”) assets, Operating lease liabilities, current, and Operating +lease liabilities, non-current on our consolidated balance sheets. Lease assets and liabilities are recognized based on the present +value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an implicit +rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present +value of future payments. In certain of our lease agreements, we receive rent holidays and other incentives. We recognize lease +costs on a straight-line basis over the lease term without regard to deferred payment terms, such as rent holidays, that defer +the commencement date of required payments. Our lease terms may include options to extend or terminate the lease when it is reasonably +certain that we will exercise that option. Leasehold improvements are capitalized at cost and amortized over the lesser of their +expected useful life or the life of the lease, without assuming renewal features, if any, are exercised. We do not separate lease +and non-lease components for our leases. +The Company continues +to account for leases in the prior period financial statements under ASC Topic 840. +F- 21 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Net Loss per Share +Net loss per share +is computed by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation +of the basic and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock +equivalents is anti-dilutive due to the Company’s net loss position for all periods presented. The Company has included 6,500 +warrants, which are exercisable for shares of the Company’s common stock on a one-for-one basis, in its earnings per share +calculation for the year ended December 31, 2019. Anti-dilutive securities, which are convertible into or exercisable for the Company’s +common stock, consist of the following at December 31, 2019 and 2018: +December 31, +2019 +2018 +Stock options +2,763 +9,325 +Warrants (1) +72,518 +23,410 +Convertible notes +1,252,163 +24,991 +Conversion of preferred stock +2,232 +2,232 +Total +1,329,676 +59,958 +(1) The Company has excluded 6,500 warrants issued in April 2019, which may be exercised by means of +a cashless exercise into 6,500 shares of the Company’s common stock, in its anti-dilutive securities but included the warrants +in its weighted average shares outstanding. +Reclassifications +Certain prior year +amounts have been reclassified for comparative purposes to conform to the current-year financial statement presentation. These +reclassifications had no effect on previously reported results of operations. In addition, certain prior year amounts from the +restated amounts have been reclassified for consistency with the current period presentation. +Recently Issued and Adopted Accounting +Standards +In February 2016, the +Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases +(Topic 842) , in order to increase transparency and comparability among organizations by, among other provisions, recognizing +lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous U.S. GAAP. +For public companies, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 (including interim periods within +those periods) using a modified retrospective approach and early adoption is permitted. In transition, entities may also elect +a package of practical expedients that must be applied in its entirety to all leases commencing before the adoption date, unless +the lease is modified, and permits entities to not reassess (a) the existence of a lease, (b) lease classification or (c) determination +of initial direct costs, as of the adoption date, which effectively allows entities to carryforward accounting conclusions under +previous U.S. GAAP. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements , which provides +entities an optional transition method to apply the guidance under Topic 842 as of the adoption date, rather than as of the earliest +period presented. The Company adopted Topic 842 on January 1, 2019, using the optional transition method to apply the new guidance +as of January 1, 2019, rather than as of the earliest period presented, and elected the package of practical expedients described +above. Upon adoption the Company recognized cumulative operating lease liabilities and operating right-of-use assets of approximately $4.2 +million. The adoption did not have any impact on retained earnings. +F- 22 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +In July 2017, the FASB +issued ASU No. 2017-11, Earnings per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives +and Hedging (Topic 815) (“ASU 2017-11”). ASU 2017-11 consists of two parts. The amendments in Part I of this update +change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. +When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round +feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. +The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked +financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as +a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require +entities that present earnings per share (“EPS”) in accordance with Topic 260 to recognize the effect of the down round +feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common stockholders +in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized +guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), +including related EPS guidance (in Topic 260). The amendments in Part II of this update re-characterize the indefinite deferral +of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments +do not have an accounting effect. For public business entities, the amendments in Part I of this update are effective for fiscal +years, and interim periods within those fiscal years, beginning after December 15, 2018. The amendments in Part II of this update +do not require any transition guidance because those amendments do not have an accounting effect. The Company adopted this standard +on January 1, 2019, and the adoption did not have any impact on its consolidated financial statements and related disclosures. +In June 2018, the FASB +issued ASU No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting , (“ASU 2018-07”). ASU +2018-07 simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under ASU 2018-07, most +of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. +The changes took effect for public companies for fiscal years starting after December 15, 2018, including interim periods within +that fiscal year. The Company adopted this standard on January 1, 2019, and the adoption did not have any impact on its consolidated +financial statements and related disclosures. +In August 2018, +the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure +Requirements for Fair Value Measurement” (“ASU 2018-13”), which makes a number of changes meant to add, +modify or remove certain disclosure requirements associated with the movement amongst or hierarchy associated with Level 1, Level +2 and Level 3 fair value measurements. This guidance is effective for fiscal years, +and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted upon issuance of +the update. The Company adopted ASU 2018-13 on January 1, 2020 and +its adoption did not have any impact on the Company’s consolidated financial statements and related disclosures. +In December 2019, the +FASB issued ASU No. 2019-12, “ Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), +which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions +to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This +guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with +early adoption permitted. The Company is currently evaluating the impact of this standard on its consolidated financial statements +and related disclosures. +4. Marketable Securities +Marketable securities +in equity securities with readily determinable market prices consisted of the following as of December 31, 2019 and 2018: +Marketable equity securities at December 31, 2019 +Gross unrealized +Gross realized +Cost +gains (losses) +gains (losses) +Fair value +Common shares +$ 423,025 +$ 216,622 +$ — +$ 639,647 +Marketable equity securities at December 31, 2018 +Gross unrealized +Gross realized +Cost +gains (losses) +gains (losses) +Fair value +Common shares +$ 220,880 +$ (42,283 ) +$ — +$ 178,597 +F- 23 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The following table presents additional information about marketable +equity securities: +Marketable +Equity Securities +Balance at January 1, 2018 +$ 1,834,570 +Purchases of marketable equity securities +858,458 +Sales of marketable equity securities +(2,188,292 ) +Realized losses on marketable equity securities +(175,405 ) +Unrealized losses on marketable equity securities +(150,734 ) +Balance at December 31, 2018 +$ 178,597 +Purchases of marketable equity securities +485,000 +Marketable equity securities received upon warrant exercise +381 +Marketable equity securities received upon conversion of preferred stock +202,145 +Sales of marketable equity securities +(580,721 ) +Realized gains on marketable equity securities +95,340 +Unrealized gains on marketable equity securities +258,905 +Balance at December 31, 2019 +$ 639,647 +At December 31, 2019 +and 2018, the Company had invested in the marketable equity securities of certain publicly traded companies. During the year ended +December 31, 2019, unrealized gains of $258,905 were included in net income as a component of change in fair value of equity securities. +The Company’s investment in marketable equity securities will be revalued on each balance sheet date. The fair +value of the Company’s holdings in marketable equity securities at December 31, 2019 and 2018 is a Level 1 measurement based +on quoted prices in an active market. +At December 31, 2019 +and 2018, the Company also held equity investments in private companies and an investment in a limited partnership. These investments +do not have readily determinable fair values and have been measured at cost less impairment, if any, and adjusted for observable +price changes for identical or similar investments of the issuer. +5. INVENTORIES +At December 31, 2019 and 2018, +inventories consist of: +2019 +2018 +Raw materials, parts and supplies +$ 1,582,423 +$ 2,026,839 +Work-in-progress +534,937 +483,706 +Finished products +424,492 +750,581 +Total inventories +$ 2,541,852 +$ 3,261,126 +F- 24 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +6. PROPERTY AND EQUIPMENT, NET +At December 31, 2019 and 2018, +property and equipment consist of: +2019 +2018 +Cryptocurrency machines and related equipment +$ 567,216 +$ 9,168,928 +Computer, software and related equipment +2,542,399 +2,495,470 +Restaurant equipment +763,275 +752,103 +Office furniture and equipment +441,613 +287,583 +Leasehold improvements +1,339,646 +1,274,865 +5,654,149 +13,978,949 +Accumulated depreciation and amortization +(3,361,954 ) +(4,665,650 ) +Property and equipment, net +$ 2,292,195 +$ 9,313,299 +For the years ended +December 31, 2019 and 2018, depreciation expense amounted to $2,962,435 and $2,447,249, respectively. +7. INTANGIBLE ASSETS, NET +At December 31, 2019 and 2018 +intangible assets consist of: +2019 +2018 +Trade name and trademark +$ 1,039,307 +$ 1,562,332 +Customer list +2,406,434 +2,388,139 +Non-competition agreements +— +150,000 +Domain name and other intangible assets +641,809 +762,807 +4,087,550 +4,863,278 +Accumulated depreciation and amortization +(880,562 ) +(503,480 ) +Intangible assets, net +$ 3,206,988 +$ 4,359,798 +The +Company’s trade names and trademarks were determined to have an indefinite life. The remaining definite lived +intangible assets are primarily being amortized on a straight-line basis over their estimated useful lives. Amortization +expense was $502,656 and $459,656, respectively, for the years ended December 31, 2019 and 2018. +The customer +lists are subject to amortization over their estimated useful lives, which range between 3 and 14 years. The following +table presents estimated amortization expense for each of the succeeding five calendar years and thereafter. +2020 +$ 315,885 +2021 +260,717 +2022 +203,442 +2023 +203,442 +2024 +203,442 +Thereafter +980,753 +$ 2,167,681 +8. GOODWILL +The +Company’s goodwill relates to the acquisition of a controlling interest in Microphase on June 2, 2017 and the acquisition +of Enertec Systems 2001 Ltd. (“Enertec”) on May 22, 2018. +F- 25 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +9. INVESTMENTS – RELATED PARTIES +Investments in AVLP +and Alzamend Neuro, Inc. (“Alzamend”) at December 31, 2019 and 2018, are comprised of the following: +December 31, +2019 +2018 +Investment in convertible promissory note of AVLP +$ 9,595,079 +$ 6,943,997 +Accrued interest in convertible promissory note of AVLP +2,025,475 +1,004,317 +Total investment in convertible promissory note of AVLP – Gross +11,620,554 +7,948,314 +Less: provision for loan losses +(5,079,834 ) +— +Less: original issue discount +— +(2,336,693 ) +Total investment in convertible promissory note of AVLP +$ 6,540,720 +$ 5,611,621 +Investment in derivative instruments of AVLP +1,330,684 +2,230,641 +Investment in common stock of AVLP +238,602 +812,858 +Investment in common stock of Alzamend +558,938 +— +Investment in derivative instruments and common stock of AVLP and +Alzamend +$ 2,128,224 +$ 3,043,499 +Total investment in AVLP and Alzamend – Net +$ 8,668,944 +$ 8,655,120 +Investment in warrants and common stock of AVLP and Alzamend +$ 2,128,224 +$ 3,043,499 +Investment in convertible promissory note of AVLP +6,540,720 +5,611,621 +Total investment in AVLP and Alzamend – Net +$ 8,668,944 +$ 8,655,120 +The following table +summarizes the changes in our investments in AVLP and Alzamend during the years ended December 31, 2019 and 2018: +Investment in +warrants and +Investment in +Total +common stock +convertible +investment +of AVLP and +promissory +in AVLP and +Alzamend +note of AVLP +Alzamend – Net +Balance at January 1, 2018 +$ 7,728,001 +$ 2,332,910 +$ 10,060,911 +Investment in convertible promissory notes of AVLP +— +1,671,936 +1,671,936 +Payment of convertible promissory notes of AVLP +— +(1,107,500 ) +(1,107,500 ) +Investment in common stock of AVLP +417,169 +— +417,169 +Fair value of warrants issued by AVLP +2,255,341 +— +2,255,341 +Unrealized loss in warrants of AVLP +(6,926,293 ) +— +(6,926,293 ) +Unrealized loss in common stock of AVLP +(430,719 ) +— +(430,719 ) +Accretion of discount +— +2,034,358 +2,034,358 +Accrued Interest +— +679,917 +679,917 +Balance at December 31, 2018 +$ 3,043,499 +$ 5,611,621 +$ 8,655,120 +Investment in convertible promissory notes of AVLP +— +1,600,164 +1,600,164 +Investment in common stock of AVLP and Alzamend +261,132 +— +261,132 +Fair value of derivative instruments issued by AVLP +1,050,918 +— +1,050,918 +Unrealized loss in derivative instruments of AVLP +(1,950,875 ) +— +(1,950,875 ) +Unrealized loss in common stock of AVLP and Alzamend +(276,450 ) +— +(276,450 ) +Provision for loan losses +— +(4,000,000 ) +(4,000,000 ) +Accretion of discount +— +2,307,777 +2,307,777 +Accrued Interest +— +1,021,158 +1,021,158 +Balance at December 31, 2019 +$ 2,128,224 +$ 6,540,720 +$ 8,668,944 +F- 26 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The Company’s +investments in AVLP, a related party controlled by Philou Ventures, LLC, or Philou, an affiliate of the Company, consist of convertible +promissory notes, derivative instruments and shares of AVLP common stock. At December 31, 2019, the Company has provided loans +to AVLP in the principal amount $9,595,079 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company +warrants to purchase 19,190,158 shares of AVLP common stock. The warrants entitle the Company to purchase up to 19,190,158 shares +of AVLP common stock at an exercise price of $0.50 per share for a period of five years. The warrants were determined by the issuer +to be derivative financial instruments. At December 31, 2019 and 2018, the Company recorded a cumulative unrealized loss on its +investment in warrants of AVLP of $4,364,256 and $2,413,381, respectively, representing the difference between the cost basis and +the estimated fair value of the warrants in the Company’s accumulated other comprehensive income in the stockholder's equity +section of the Company’s consolidated balance sheet. During the years ended December 31, 2019 and 2018, the Company recognized, +in other comprehensive loss, net unrealized loss on derivative securities of related party of $1,950,875 and $6,926,293, respectively. +The Company’s investment in AVLP will be revalued on each balance sheet date. The fair value of the Company’s holdings +in the AVLP warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate, which ranged between 1.42% +and 2.60%, was derived from the U.S. Treasury yield curve, matching the term of our investment, in effect at the measurement date. +The volatility factor which ranged between 68.7% and 89.4% was determined based on historical stock prices for similar technology +companies with market capitalizations under $100 million. The warrant valuation is a Level 3 measurement. +In accordance with +ASC No. 310, Receivables (“ASC 310”), the Company had accounted for its convertible promissory notes +in AVLP at amortized cost, which represents the amount at which the convertible promissory notes were acquired, adjusted for accrued +interest and accretion of original issue discount and discount attributed to the fair value of the 19,190,158 warrants that the +Company received in conjunction with its investment. Interest is accreted using the effective interest method. The Company records +interest on an accrual basis and recognizes it as earned in accordance with the contractual terms of the convertible promissory +notes, to the extent that such amounts are expected to be collected. An aggregate of $5,822,222 of original issue discount and +discount attributed to the fair value of the warrants is being amortized as interest income through the maturity date. During the +years ended December 31, 2019 and 2018, the Company recorded $2,307,777 and $2,034,358, respectively, of interest income for the +discount accretion. During the years ended December 31, 2019 and 2018, the Company recorded contractual interest attributed to +the AVLP Notes and AVLP Loan Agreement of $1,021,158 and $679,917, respectively. +The Company evaluated +the collectability of both interest and principal for the convertible promissory notes in AVLP to determine whether there was +an impairment. Based on current information and events, primarily the value of the underlying +conversion feature and current economic events, the Company concluded that an impairment existed at December 31, 2019 and +determined that the fair value of the convertible promissory notes in AVLP was approximately $6,540,720. The Company’s determination +of fair value was based upon the present value of a future liquidity event combined with the closing price of AVLP’s common +stock at December 31, 2019. Based upon decreases in the closing price of the AVLP’s common stock during the quarter ended +March 31, 2020, the Company expects to recognize an additional impairment charge during the first quarter of 2020. Accordingly, +the Company recorded a $4,000,000 provision for credit losses. Impairment assessments require significant judgments and are based +on significant assumptions related to the borrower’s credit risk, financial performance, expected sales, and estimated fair +value of the collateral. +During the years ended +December 31, 2019 and 2018, the Company also acquired in the open market 91,000 shares of AVLP common stock for $53,032 and 430,942 +shares of AVLP common stock for $417,169, respectively. At December 31, 2019, the closing market price of AVLP’s common stock +was $0.24, a decline from $0.90 at December 31, 2018. The Company has determined that its investment in AVLP marketable equity +securities are accounted for in accordance with ASC No. 820, Fair Value Measurements and Disclosures and based upon the +closing market price of AVLP common stock at December 31, 2019, the Company’s investment in AVLP common stock had an unrealized +loss of $507,959. +In aggregate, the Company +has 994,175 shares of AVLP common stock which represents 18.0% of AVLP’s outstanding shares of common stock. The Company +has determined that AVLP is a variable interest entity (“VIE”) as it does not have sufficient equity at risk. The Company +does not consolidate AVLP because the Company is not the primary beneficiary and does not have a controlling financial interest. +To be a primary beneficiary, an entity must have the power to direct the activities of a VIE that most significantly impact the +VIE's economic performance, among other factors. Although the Company has made a significant investment in AVLP, the Company has +determined that Philou, which controls AVLP through the voting power conferred by its equity investment and which is deemed to +be more closely associated with AVLP, is the primary beneficiary. As a result, AVLP’s financial position and results of operations +are not consolidated in our financial position and results of operations. +F- 27 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +10. INVESTMENTS IN LIMITED PARTNERSHIP +On June 8, 2018, the +Company entered into a limited partnership agreement, in which it agreed to become a limited partner in the partnership (the “NY +Partnership”). The NY Partnership is a limited partner in the partnership that is responsible for the construction and related +activities of a hotel in New York City. In connection with this transaction, the Company has agreed to finance a portion of the +capital required by the NY Partnership. As of December 31, 2019, the Company had invested an aggregate of $1,869,000 in the NY +Partnership and $100,000 in another real estate investment. The Company was initially required to make monthly capital contributions +of $500,000 every thirty days until the Company’s commitment of $10 million was funded in full. The Company had received +a waiver for its obligation to make monthly capital contributions through September 30, 2019 and on June 12, 2019, the agreement +was restructured whereby DPW no longer has any further funding obligations until the hotel is open for business to the public. +11. OTHER INVESTMENTS, RELATED PARTIES +The Company’s +other related party investments primarily consist of two investments. +MTIX, Ltd. +On December 5, 2017, +the Company entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson two convertible +promissory notes in the principal amounts of $600,000 (“Note A”) and $1,667,766 (“Note B”), in exchange +for cancellation of amounts due to WT Johnson by MTIX Ltd., a related party of the Company. +During December 2017, +the Company issued 750 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently +sold the 750 shares. The proceeds from the sale of shares of common stock received upon the conversion of Note A were sufficient +to satisfy the entire $2,267,766 obligation as well as an additional $400,500 of value added tax due to WT Johnson. Concurrent +with entering into the exchange agreement, the Company received a promissory note in the amount of $2,668,266 from MTIX and cancelled +Note B. At December 31, 2019 and 2018, the Company has valued the note receivable at $600,000, the carrying amount of Note A. The +Company will recognize the remainder of the amount due from MTIX upon payment of the promissory note by MTIX. +Israeli Property +During the year ended +December 31, 2017, our President, Amos Kohn, purchased certain real property that serves as a facility for the Company’s +business operations in Israel. The Company made $300,000 of payments to the seller of the property and received a 28% undivided +interest in the real property (the “Property”). The Company’s subsidiary, Coolisys, entered into a Trust Agreement +and Tenancy in Common Agreement with Roni Kohn, who owns a 72% interest in the Property, the daughter of Mr. Kohn and an Israeli +citizen. The Property was purchased to serve as a residence/office facility for the Company in order to oversee its Israeli operations +and to expand its business in the high-tech industry located in Israel. Pursuant to the Trust Agreement, Ms. Kohn will hold and +manage Coolisys’ undivided 28% interest in the Property. The trust will be in effect until it is terminated by mutual agreement +of the parties. During the term of the trust, Ms. Kohn will not sell, lease, sublease, transfer, grant, encumber, change or effect +any other disposition with respect to the Property or Coolisys’ interest without the Company’s approval. +F- 28 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Under the Tenancy in +Common Agreement, Coolisys and its executive officers shall have the exclusive rights to use the Property for the Company and its +affiliates’ business operations. The Property shall be managed by Ms. Kohn. Further, pursuant to the Tenancy in Common Agreement, +for each completed calendar month of employment of Mr. Kohn by the Company, Ms. Kohn shall have the right to purchase a portion +of the Company’s interest in the Property. Such right shall fully vest at the end of five years of continuous employment +and the Trustee shall have the right to purchase the Company’s 28% interest in the Property for a nominal price. The Company +will amortize its $300,000 investment over ten years, subject to a cliff vesting after five years. During the years ended December +31, 2019 and 2018, the Company recognized $30,000 in amortization expense. At December 31, 2019 and 2018, the unamortized balance +of the Israeli Property was $232,500 and $262,500, respectively. If Mr. Kohn is not employed by the Company, the Company shall +have the right to demand that Ms. Kohn purchase the Company’s remaining interest in the Property that was not subject to +vesting for the fair market value of such unvested Property interest. +12. ACQUISITIONS +Business +combinations are accounted for under the acquisition method of accounting in accordance with ASC No. 805, Business Combinations . +Under the acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values. Goodwill is +recorded to the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired +less liabilities assumed at the date of acquisition. Two acquisitions were completed during 2018: Enertec and I.AM. +Acquisitions during 2018 +Enertec Systems +2001 Ltd. +On +December 31, 2017, Coolisys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“MICT”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“EML” +and, together with MICT, the “Seller Parties”), and Enertec Systems 2001 Ltd. (“Enertec”), an Israeli corporation, +pursuant to which Coolisys acquired Enertec (the “Acquisition”). Enertec is a manufacturer of specialized electronic +systems for the military market. On May 23, 2018, Coolisys acquired Enertec for an aggregate cash purchase price of $4,850,099. +I.AM, Inc. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I.AM, David J. Krause and Deborah J. Krause. +Pursuant to the securities purchase agreement, I.AM sold to DPL, 981 shares of common stock for a purchase price of $981, representing, +upon the closing, 98.1% of I.AM’s outstanding common stock. +I.AM +owns and operates the Prep Kitchen brand restaurants located in the San Diego area. I.AM owed DP Lending $1,715,330 in outstanding +principal, pursuant to a loan and security agreement, between I.AM and DP Lending, which I.AM used to acquire the restaurants. +The purchase agreement provides that, as I.AM repays the outstanding loan to DP Lending in accordance with the loan agreement, +DP Lending will on a pro rata basis transfer shares of common stock of I.AM to David J. Krause, up to an aggregate of 471 +shares. +F- 29 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Components of the purchase price for acquisitions +completed during the year ended December 31, 2018: +Enertec +I. AM +Accounts receivable +$ 3,184,227 +$ 29,319 +Inventories +1,343,053 +40,581 +Property and equipment +648,649 +700,291 +Trade name and trademark +2,094,741 +520,000 +Domain name and other intangible assets +— +90,000 +Other assets +29,056 +1,492 +Accounts payable and accrued expenses +(2,702,306 ) +(103,961 ) +Deferred tax liability +(160,311 ) +— +Notes payable +(4,235,725 ) +— +Accrued severance pay +(131,811 ) +— +Net liabilities assumed +69,573 +1,277,722 +Goodwill +4,780,526 +265,252 +Non-controlling interest +— +(33,242 ) +Purchase price +$ 4,850,099 +$ 1,509,732 +The +following pro forma data for the year ended December 31, 2018, summarizes the results of operations for the period indicated as +if the Enertec acquisition, which closed on May 23, 2018, had been completed as of the beginning of the period presented. The pro +forma data gives effect to actual operating results prior to the acquisition. These pro forma amounts do not purport to be indicative +of the results that would have been obtained if the acquisition occurred as of the beginning of the period presented or that may +be obtained in future periods: +For the Year Ended +December 31, 2018 +Total Revenue +$ 28,691,641 +Net loss +$ (35,627,242 ) +Less: Net loss attributable +to non-controlling interest +748,320 +Net loss attributable to DPW Holdings +(34,878,922 ) +Preferred deemed dividends on Series B +Preferred Stock +(108,049 ) +Net loss available to common stockholders +$ (34,986,971 ) +Basic and diluted net loss per common share +$ (482.60 ) +Basic and diluted weighted average +common shares outstanding +72,498 +Comprehensive Loss +Loss available to common shareholders +$ (34,986,971 ) +Other comprehensive income (loss) +Change in net foreign currency +translation adjustments +(377,823 ) +Net unrealized loss on derivative +securities of related party +(8,027,746 ) +Other comprehensive income (loss) +(8,405,569 ) +Total Comprehensive loss +$ (43,392,540 ) +F- 30 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +13. STOCK-BASED COMPENSATION +Under the Company's +2018 Stock Incentive Plan (the “2018 Plan”), 2017 Stock Incentive Plan (the “2017 Plan”), 2016 Stock Incentive +Plan (the “2016 Plan”) and the 2012 Stock Option Plan, as amended (the “2012 Plan”) (collectively, the +“Plans”), options may be granted to employees, officers, consultants, service providers and directors of the Company. +On July 19, 2019, the Company’s stockholders approved an amendment to the 2018 Plan which increased the number of shares +of the Company’s common stock that may be issued thereunder to a total of 175,000 shares. The Plans, as amended, provide +for the issuance of a maximum of 184,216 shares of the Company’s common stock. +Options granted under +the Plans have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and +become exercisable based on a vesting schedule determined at the date of grant. Typically, options granted generally become +fully vested after four years. Any options that are forfeited or cancelled before expiration become available for future grants. +The options expire between 5 and 10 years from the date of grant. Restricted stock awards granted under the Plans are subject +to a vesting period determined at the date of grant. As of December 31, 2019, an aggregate of 103,105 of the Company's options +are still available for future grant. +During the year ended +December 31, 2019, the Company did not grant any options under the Plans and during the year ended December 31, 2018, the Company +granted 1,250 options to its employees from the Plans and also granted 3,622 options outside of the Plans. These options become +fully vested after four years. The Company estimated that the grant date fair value of options granted utilizing the Black-Scholes +option pricing model during the year ended December 31, 2018 was $513,510, which is being recognized as stock-based compensation +expense over the requisite four-year service period. During the years ended December 31, 2019 and 2018, the Company also issued +69,375 and 1,979, respectively, shares of common stock to its consultants and service providers. The grant date fair value of these +shares amounted to $338,619 and $2,640,102 respectively, which was determined from the closing price of the Company’s common +stock on the date of issuance. +The Company has valued +the options at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables +such as the options’ term, exercise price, current stock price, risk-free interest rate estimated over the expected term +and estimated volatility of our stock over the expected term of the options. The risk-free interest rate used in the calculations +is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the +options as calculated using the simplified method. The estimated volatility was determined based on the historical volatility of +our common stock. +During the year ended +December 31, 2018, the Company estimated the fair value of stock options granted using the Black-Scholes option pricing model with +the following weighted average assumptions: +Year Ended +December 31, 2018 +Weighted average risk-free interest rate +2.41% — 2.80% +Weighted average life (in years) +4.7 +Volatility +124.7% — 131.7% +Expected dividend yield +0% +Weighted average grant-date fair value per share of +options granted +$ 624.33 +F- 31 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The options outstanding as of December 31, 2019, have been classified +by exercise price, as follows: +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$480.00 - $560.00 +1,169 +6.14 +$542.67 +630 +$543.72 +$1,056.00 - $1,104.00 +188 +7.92 +$1,104.00 +98 +$1,104.00 +$1,208.00 - $1,352.00 +31 +3.63 +$1,339.20 +31 +$1,339.20 +$480.00 - $1,352.00 +1,388 +6.33 +$636.47 +759 +$648.62 +Issuances outside of Plans +$640.00 - $1,856.00 +1,375 +4.78 +$827.64 +313 +$921.60 +Total Options +$480.00 - 1,856.00 +2,763 +5.56 +$731.62 +1,072 +$728.26 +On +December 31, 2019 and 2018, there was no aggregate intrinsic value of stock options that were outstanding and exercisable. +The intrinsic value for stock options is calculated based on the exercise price of the underlying awards and the fair value of +such awards as of the period-end date +The total stock-based +compensation expense related to stock options and stock awards issued pursuant to the Plans to the Company’s employees, consultants +and directors, included in reported net loss for the years ended December 31, 2019 and 2018, is comprised as follows: +Years Ended December 31, +2019 +2018 +Cost of revenues +$ - +$ 4,874 +Engineering and product development +- +13,650 +Selling and marketing +- +11,922 +General and administrative +715,877 +2,921,532 +Stock-based compensation from Plans +$ 715,877 +$ 2,951,978 +Stock-based compensation from issuances +outside of Plans +868,114 +1,767,287 +Total Stock-based compensation +$ 1,583,991 +$ 4,719,265 +The combination of +stock-based compensation of $715,877 from the issuances of equity-based awards pursuant to the Plans and stock-based compensation +attributed to stock awards of $253,019 and options of $615,095, which were issued outside of the Plans, resulted in aggregate stock-based +compensation of $1,583,991 during the year ended December 31, 2019. +F- 32 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +A summary of option +activity under the Company's stock option plans as of December 31, 2019 and 2018, and changes during the years ended are as follows: +Outstanding Options +Weighted +Weighted +Average +Shares +Average +Remaining +Aggregate +Available +Number +Exercise +Contractual +Intrinsic +for Grant +of Shares +Price +Life (years) +Value +January 1, 2018 +3,174 +3,428 +$ 617.20 +8.80 +$ 6,688 +Adoption of 2018 SIP +12,500 +— +Restricted stock awards +(1,979 ) +— +Granted +(1,250 ) +1,250 +$ 560.00 +Forfeited 1 +250 +(275 ) +$ 810.80 +Exercised +— +(75 ) +$ 1,304.00 +January 1, 2019 +12,695 +4,328 +$ 576.40 +7.52 +$ 0 +Amendment to 2018 SIP +162,500 +— +Restricted stock awards +(75,000 ) +— +Forfeited 1 +2,910 +(2,940 ) +$ 853.47 +December 31, 2019 +103,105 +1,388 +$ 636.47 +6.33 +$ 0 +1 Includes options that were issued pursuant +to the Company’s 2002 Plan and are not available for future issuance. +As of December 31, +2019, there was $281,288 of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted +under the Plans. That cost is expected to be recognized over a weighted average period of 2.35 years. +14. WARRANTS +During the years ended +December 31, 2019 and 2018, the Company issued a total of 777,822 warrants at an average exercise price of $30.55 per share. +Warrant issuances during 2018 +During the year ended +December 31, 2018, the Company issued a total of 18,379 warrants at an average exercise price of $868 per share. +(i) On January 23, 2018, the Company issued warrants to purchase an aggregate of 781 shares of +common stock at an exercise price equal to $1,760 per share of common stock in connection with the issuance of a 10% senior convertible +promissory note in the aggregate principal amount of $1,250,000 (see Note 20). +(ii) On January 25, 2018, the Company entered into three agreements for the Purchase and Sale of Future +Receipt, pursuant to which the Company sold up to (i) $562,125 of the Company’s future receipts for a purchase price of $375,000, +(ii) $337,275 in future receipts for a purchase price of $225,000 and (iii) $118,000 in future receipts for a purchase price of +$100,000. Under the terms of these agreements, the Company issued warrants to purchase an aggregate of 140 shares of common stock +at an exercise price of $1,800 per share of common stock and warrants to purchase 203 shares of common stock at an exercise price +of $2,000 per share of common stock (see Note 18). +(iii) On March 22, 2018, the Company issued warrants to purchase an aggregate of 1,563 shares of +common stock at an exercise price equal to $920 per share of common stock in connection with the issuance of a promissory +note in the principal amount of $2,100,000 with a term of two months, subject to the Company’s ability to prepay within one +month (see Note 18) . +F- 33 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +(iv) On March 23, 2018, the Company entered into a securities purchase agreement to sell and issue a +12% promissory note in the principal amount of $1,000,000 and a warrant to purchase 375 shares of common stock to an accredited +investor. Since the promissory note was not paid in full on or before May 23, 2018, the +Company issued an additional warrant to purchase 188 shares of common stock, at an exercise price of $920 per share of common stock +for a total of 563 warrants (see Note 18). +(v) On April 16, 2018, the Company issued warrants to purchase an aggregate of 1,243 shares of +common stock at an exercise price equal to $1,040 per share of common stock in connection with the issuance of 12% secured convertible +promissory notes in the aggregate principal amount of $1,722,222 (see Note 20). +(vi) On April 24, 2018, the Company issued warrants to purchase 446 shares of common stock, at an exercise +price of $560 per share of common stock, in connection with the Preferred Stock Purchase Agreement to purchase 25,000 shares of +Series B Preferred Stock by Philou (see Note 22). +(vii) On October 5, 2017, Ault & Company purchased 94 shares of the Company’s common stock +at $480 per share and a warrant to purchase up to 94 shares of the Company’s common stock at $480 per share for an aggregate +purchase price of $45,000. The shares and warrants were issued by the Company on May 8, 2018, the date all necessary approvals +to issue the shares were received. Ault & Company is controlled by Mr. Milton Ault, the Company’s Chairman and +Chief Executive Officer (see Note 22). +(viii) On May 15, 2018, the Company entered into securities purchase agreements with certain investors +in which it sold an aggregate of 9,614 shares of its common stock for aggregate consideration of $6,000,000. In connection with +this financing, the Company issued (i) five-year warrants to purchase 2,404 shares of the Company’s Class A common stock +and (ii) five-year warrants to purchase 7,211 shares of the Company’s Class A common stock. The warrants were issued at an +exercise price of $752 per share of common stock (see Note 22) . +(ix) On May 15, 2018, the Company entered into a securities purchase agreement with an institutional +investor to sell and issue a senior secured convertible promissory note with a principal face amount of $6,000,000 and (i) a five-year +warrant to purchase 1,389 shares of the Company’s Class A common stock at an exercise price of $1,080 per share of Class +A common stock (the “Series A Warrant”) and (ii) a five-year warrant to purchase 2,155 shares of the Company’s +Class B common stock at an exercise price of $696 per share of Class A common stock (see Note 20). In connection with the financing, +the Company issued the placement agent a warrant to purchase 188 shares of common stock with an exercise price of $800. +Warrant issuances during 2019 +During the year ended +December 31, 2019, the Company issued a total of 759,443 warrants at an average exercise price of $10.28 per share. +(i) On April 2, 2019, the Company issued warrants to purchase an aggregate of 388,888 shares of +Common Stock at an initial exercise price of $18.00 per share and (the “Common Warrants”) and (b) pre-funded warrants +to purchase up to 317,500 shares of our Common Stock at an initial exercise price of $0.40 per share (the “Pre-Funded Warrants”) +in connection with an underwriting agreement with A.G.P./Alliance Global Partners (the “Underwriter”). In addition, +the Company has also issued the Underwriter a warrant to purchase a maximum of 15,555 additional shares of common stock at an initial +exercise price of $19.80 per share (see Note 22). +F- 34 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +(ii) On May 20, 2019, the Company issued warrants to purchase an aggregate of 12,500 shares of +common stock at an exercise price equal to $12.00 per share of common stock in connection with the issuance of a 4% Original Issue +Discount Convertible Promissory Note in the aggregate principal amount of $660,000 (see Note 20). +(iii) On July 3, 2019, the Company issued warrants to purchase an aggregate of 25,000 shares of +common stock at an exercise price equal to $8.80 per share of common stock in connection with the issuance of a 12% Convertible +Promissory Note in the aggregate principal amount of $1,492,000 (see Note 20). +The following table +summarizes information about common stock warrants outstanding at December 31, 2019: +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ — +6,500 +4.25 +$ — +6,500 +$ — +$ 8.00 +397 +6.84 +$ 8.00 +397 +$ 8.00 +$ 8.80 +25,000 +4.50 +$ 8.80 +25,000 +$ 8.80 +$ 12.00 +12,500 +4.36 +$ 12.00 +12,500 +$ 12.00 +$ 19.80 +15,555 +4.25 +$ 19.80 +15,555 +$ 19.80 +$ 440.00 +355 +2.86 +$ 440.00 +355 +$ 440.00 +$ 480.00 +94 +3.33 +$ 480.00 +94 +$ 480.00 +$ 528.00 +186 +2.84 +$ 528.00 +186 +$ 528.00 +$ 560.00 +2,657 +2.87 +$ 560.00 +2,657 +$ 560.00 +$ 600.00 +170 +2.37 +$ 600.00 +170 +$ 600.00 +$ 640.00 +200 +2.32 +$ 640.00 +200 +$ 640.00 +$ 752.00 +9,614 +3.38 +$ 752.00 +9,614 +$ 752.00 +$ 800.00 +350 +2.94 +$ 800.00 +350 +$ 800.00 +$ 880.00 +947 +1.67 +$ 880.00 +947 +$ 880.00 +$ 920.00 +2,126 +3.24 +$ 920.00 +2,126 +$ 920.00 +$ 1,040.00 +1,243 +3.29 +$ 1,040.00 +1,243 +$ 1,040.00 +$ 1,760.00 +781 +3.06 +$ 1,760.00 +781 +$ 1,760.00 +$ 1,800.00 +140 +3.07 +$ 1,800.00 +140 +$ 1,800.00 +$ 2,000.00 +203 +3.07 +$ 2,000.00 +203 +$ 2,000.00 +$8.00 - $2,000.00 +79,018 +3.74 +$ 206.57 +79,018 +$ 206.57 +The Company has valued +the warrants at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables +such as the warrants’ term, exercise price, current stock price, risk-free interest rate and estimated volatility of our +stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based on the implied yield +available on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +F- 35 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The Company utilized +the Black-Scholes option pricing model and the assumptions used during the years ended December 31, 2019 and 2018: +2019 +2018 +Weighted average risk free interest rate +1.75% — 2.28% +2.41% — 2.94% +Weighted average life (in years) +5.0 +4.8 +Volatility +85.5% — 87.5% +124.8% — 138.4% +Expected dividend yield +0% +0% +Weighted average grant-date fair value per +share of warrants granted +$ 10.34 +$ 629.64 +15. OTHER CURRENT LIABILITIES +Other current liabilities at +December 31, 2019 and 2018 consist of: +2019 +2018 +Accrued payroll and payroll taxes +$ 1,719,429 +$ 1,497,470 +Warranty liability +80,412 +86,495 +Other accrued expenses +227,744 +284,437 +$ 2,027,585 +$ 1,868,402 +16. LEASES +We have operating leases +for office space and restaurant locations. Our leases have remaining lease terms of 4 months to 11 years, some of +which may include options to extend the leases perpetually, and some of which may include options to terminate the leases within +1 year. +The following table +provides a summary of leases by balance sheet category as of December 31, 2019: +December 31, 2019 +Operating right-of-use assets +$ 5,276,056 +Operating lease liability - current +714,393 +Operating lease liability - non-current +4,677,565 +The components of lease +expenses for the year ended December 31, 2019, were as follows: +Year Ended +December 31, 2019 +Operating lease cost +$ 934,766 +Short-term lease cost +- +Variable lease cost +468,655 +The following tables +provides a summary of other information related to leases for the year ended December 31, 2019: +December 31, 2019 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ 1,291,919 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ - +Weighted-average remaining lease term - operating leases +7.8 years +Weighted-average discount rate - operating leases +10 % +F- 36 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The Company determined +that using a discount rate of 10% is reasonable, as this is consistent with the mortgage rates for commercial properties for the +time period commensurate with the terms of the leases. +Maturity of lease liabilities +under our non-cancellable operating leases as of December 31, 2019, are as follows: +Payments due by period +2020 +$ 1,220,437 +2021 +1,094,515 +2022 +929,674 +2023 +943,159 +2024 +914,942 +Thereafter +2,746,189 +Total lease payments +7,848,916 +Less interest +(2,456,959 ) +Present value of lease liabilities +$ 5,391,957 +17. ADVANCES ON FUTURE RECEIPTS +During +2018, the Company received funding as a result of entering into multiple Agreements for the Purchase and Sale of Future +Receipts (the “Agreements on Future Receipts”) pursuant to which the Company sold in the aggregate $5,632,400 in future +receipts for a purchase price of $4,100,000. During 2019, the Company entered into six additional Agreements on Future Receipts +and sold in the aggregate $1,517,847 in future receipts of the Company for $1,017,170. Future receipts include cash, check, ACH, +credit card, debit card, bank card, charge card or other form of monetary payment. The Agreements on Future Receipts have been +personally guaranteed by the Company’s Chief Executive Officer and in one instance has also been guaranteed by Philou. +During +the years ended December 31, 2019 and 2018, based upon the difference between the amount of future receipts sold and the actual +proceeds received, the Company recorded a discount in the amount of $500,677 and $1,651,193, respectively, in connection with these +agreements. Under the terms of the agreements entered into during the year ended December 31, 2018, the Company also issued warrants +to purchase an aggregate of 140 shares of common stock at an exercise price of $1,800 per share of common stock and warrants to +purchase 203 shares of common stock at an exercise price of $2,000 per share of common stock. The Company recorded an additional +discount of $258,370 based on the estimated fair value of these warrants. The Company computed the fair value of these warrants +using the Black-Scholes option pricing model. These discounts were reflected as a reduction on the outstanding liability and were +amortized as non-cash interest expense over the term of the agreement. During the years ended December 31, 2019 and 2018, non-cash +interest expense of $495,361 and $2,489,403, respectively, was recorded from the amortization of debt discounts. +The +Company has defaulted on certain prior repayment obligations on these Agreements on Future Receipts but has received a forbearance +on the repayment of the outstanding amount until May 5, 2020. +18. NOTES PAYABLE +Notes Payable at December +31, 2019 and 2018, are comprised of the following. +December 31, +2019 +2018 +Dominion June 2019 short-term promissory note +$ 2,510,173 +$ — +12% short-term promissory note +— +1,000,000 +Other short-term notes payable +1,020,199 +1,033,553 +12% September short-term promissory notes +— +789,473 +8% short-term promissory notes +318,150 +1,272,600 +October short-term promissory note +— +565,000 +Notes payable to Wells Fargo +290,560 +291,988 +Note payable to Dept. of Economic and Community Development +229,096 +260,169 +Microphase short-term promissory note +— +200,000 +Note payable to Power-Plus Member +13,250 +13,250 +Note payable to People's United Bank +16,890 +18,589 +Enertec Short term bank credit +1,622,337 +1,586,864 +Total notes payable +6,020,655 +7,031,486 +Less: +Unamortized debt discounts +(29,348 ) +(151,499 ) +Unamortized financing cost +(3,668 ) +(7,541 ) +Total notes payable, net of financing cost +$ 5,987,639 +$ 6,872,446 +Less: current portion +(5,505,015 ) +(6,388,787 ) +Notes payable – long-term portion +$ 482,624 +$ 483,659 +F- 37 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Dominion Short-Term Promissory Note +On +June 18, 2019, the Company entered into a securities purchase agreement with Dominion Capital, LLC, a Connecticut limited liability +company (“Dominion”), to sell a 10% senior secured promissory note with a principal face amount of $2,900,000 and issue +12,500 shares of the Company’s common stock. In addition, Ault & Company has guaranteed the prompt and complete payment +and performance of the obligations of the Company pursuant to this senior secured promissory note. The Dominion short-term promissory +note has a principal face amount of $2,900,000 with a purchase price of $2,800,000, and bears interest at 10% per annum. Pursuant +to the terms of the note, the Company was required to make six monthly amortization payments beginning on July 18, 2019. The Company +did not make these payments and this note was in default at December 31, 2019. On February 10, 2020, the Dominion Short-Term Promissory +Note was acquired pursuant to the terms of a Master Exchange Agreement (see note 26). +12% Short-Term +Promissory Note +On +March 23, 2018, the Company entered into a securities purchase agreement pursuant to which it issued a 12% promissory note and +warrants to purchase 563 shares of common stock to an accredited investor . The promissory +note was issued with a 10% OID. The promissory note was in the principal amount of $1,000,000, was sold for $900,000, accrued simple +interest at 12% and was due on June 22, 2018. The exercise price of the warrant is $920.00 per share. The Company recorded debt +discount in the amount of $271,565 based on the estimated fair value of these warrants. The Company computed the fair value of +these warrants using the Black-Scholes option pricing model. The debt discount was amortized as non-cash interest expense over +the term of the debt. The 12% promissory note was unsecured by any of the Company’s assets but was guaranteed by our Chief +Executive Officer. On July 3, 2019, the Company entered into an exchange agreement with the institutional investor pursuant to +which the Company issued the 12% July 2019 convertible promissory note (see note 20). +Other Short-Term Notes Payable +During +the years ended December 31, 2019 and 2018, the Company entered into the following short-term promissory notes: +(i) On June 8, 2018, the Company issued a promissory note in +the aggregate principal face amount of $511,750 to an accredited investor. The promissory note included an OID of $66,750 +resulting in net proceeds to the Company of $445,000 and was due and payable on July 9, 2018. +At December 31, 2018, the outstanding principal balance on this note was $54,750 and since payment was not made on the specified +maturity date this unsecured promissory note was in default. During the year ended December +31, 2019, the Company paid the remaining outstanding balance of $54,750. +(ii) On July 13, 2018, the Company issued a 15% promissory note in the principal amount of $176,000 +to an accredited investor. This promissory note included an OID of $16,000 and debt issuance costs of $5,000, resulting in net +proceeds of $155,000. At December 31, 2018, the outstanding balance on this note was $124,303. +The principal and accrued interest on this note was due and payable on October 11, 2018 and was in default at December 31, +2018. Mr. Ault personally guaranteed the repayment of this note. During the year ended December +31, 2019, the Company paid the remaining outstanding balance of $124,303. +F- 38 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +(iii) On August 10, 2018, DP Lending issued a 12% promissory note in the principal amount of $550,000 +to an accredited investor. This promissory note included an OID of $50,000 resulting in net proceeds of $500,000. The principal +and accrued interest on this note was due and payable on August 10, 2019. The principal and accrued interest on this 12% promissory +note was exchanged pursuant to the terms of the July 2019 Exchange Agreement discussed below. +(iv) On August 16, 2018, the Company issued an 8% promissory note in the principal amount of $225,000 +to an accredited investor. This promissory note included an OID of $25,000 resulting in net proceeds of $200,000. At +December 31, 2018, the outstanding balance on this note was $159,500. This note was due and payable on October 5, 2018 and +was in default at December 31, 2018. Mr. Ault personally guaranteed the repayment of this note. During +the year ended December 31, 2019, the Company paid the remaining outstanding balance of $159,500. +(v) On August 23, 2018, DP Lending issued a promissory note in the principal amount of $85,000 to an +accredited investor. This promissory note included an OID of $10,000 resulting in net proceeds of $75,000. At +December 31, 2018, the outstanding balance on this note was $85,000. This note was due and payable on September 24, 2018, +subject to a 28-day extension available to DP Lending. However, since payment was not made on the specified maturity date this +unsecured promissory note is currently in default. During the year ended December 31, 2019, +the Company made principal payments of $46,500 leaving a remaining outstanding balance of $38,500. +(vi) On October 9, 2018, DP Lending issued a promissory note in the principal amount of $60,000 to an +accredited investor. This promissory note included an OID of $10,000 resulting in net proceeds of $50,000. At +December 31, 2018, the outstanding balance on this note was $60,000. This note was due and payable on October 23, 2018. +However, since payment was not made on the specified maturity date this unsecured promissory note is currently in default. During +the year ended December 31, 2019, the Company made principal payments of $33,301 leaving a remaining outstanding balance of $26,699. +(vii) On July 11, 2019, the Company entered into a non-binding term sheet with Ding Gu to sell, for a +purchase price of $400,000, a 12% original issue discount promissory note with an aggregate principal face amount of $440,000. +Definitive documents have not been executed and a dispute has arisen over transaction. On January 17, 2020, Mr. Gu. filed a complaint +in the Supreme Court of the State of New York (see note 21 ) regarding the terms of this non-binding term sheet and those of a +4% convertible promissory note (see note 20). +(viii) Between September 2019 and December 2019, DP Lending entered into a series of 12% three year term +promissory notes in the aggregate amount of $155,000. +(ix) During November 2019, we entered into a short term promissory note in the aggregate principal amount +of $360,000. The promissory note contained an original issue discount of $60,000 resulting in net proceeds of $300,000. The interest +rate on the promissory note is 12% per annum and is payable on the maturity date, February 14, 2020. +F- 39 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +12% September +short-term promissory notes +During September 2018, +the Company issued to institutional investors 12% term promissory notes in the principal face amount of $789,473, with an interest +rate of 12% for a purchase price of $750,000. The outstanding principal face amount, plus any accrued and unpaid interest, was +due by December 31, 2018. During October 2018, in accordance with the notes, the Company issued 563 shares of its common stock +to the investors. The Company estimated that the grant date fair value of the shares of common stock was $151,994, which was determined +from the closing price of the Company’s common stock on the dates of issuance. Since payment was not made on the specified +maturity date these 12% term promissory notes were in default at December 31, 2018. During the first half of 2019, the Company +made principal payments in the aggregate amount of $263,157 and on July 2, 2019, the remaining balance of the $526,316 was exchanged +for a 12% convertible promissory note pursuant to the terms of an exchange agreement (see note 20). +8% short-term +promissory notes +On +August 16, 2018, as amended on November 29, 2018, the Company entered into a securities purchase agreement with four institutional +investors providing for the issuance of 8% promissory notes, each in the principal amount of $318,150, for an aggregate principal +face amount of $1,272,600, due February 15, 2019 (individually the “8% Short-Term Promissory Note” and collectively +the “8% Short-Term Promissory Notes”). The 8% Short-Term Promissory Notes contained an OID of $262,600 resulting in +net proceeds to the Company of $1,010,000. In conjunction with these notes, the Company issued an aggregate of 500 shares of common +stock to the investors. The Company estimated that the grant date fair value of the shares of common stock was $137,544, which +was determined from the closing price of the Company’s common stock on the dates of issuance. During the year ended December +31, 2019, the Company entered into a series of exchange agreements, referred to below as the January 2019 Exchange Agreement, February +2019 Exchange Agreement and the July 2019 Exchange Agreement in which the Company exchanged the principal balance of the $954,450 +for a series of 8% convertible promissory notes. Further, on February 10, 2020, the final 8% short-term promissory note in the +principal amount of $318,150 was acquired pursuant to the terms of a Master Exchange Agreement (see note 26). +October short-term +promissory note +On +October 11, 2018, the Company entered into a securities purchase agreement with an institutional investor providing for the issuance +of (i) a secured promissory note in the aggregate principal face amount of $565,000 due December 8, 2018, for which the Company +received an aggregate of $510,000, and (ii) issued an aggregate of 500 shares of common stock to the investor. Upon maturity, the +Company was required to pay $27,500 of interest. The note was not paid on the maturity date and was in default at December 31, +2018. The Company estimated that the grant date fair value of the shares of common stock was $104,430, which was determined from +the closing price of the Company’s common stock on the dates of issuance. The October short-term promissory note was exchanged +pursuant to the terms of the January 2019 Exchange Agreement. +Notes payable +to Wells Fargo +At +December 31, 2019 and 2018, Microphase had guaranteed the repayment of two equity lines of credit in the aggregate amount of $290,560 +and $291,988, respectively, with Wells Fargo Bank, NA (“Wells Fargo”) (collectively, the “Wells Fargo Notes”). +These loans originated prior to the Company’s acquisition of Microphase and Microphase was the recipient of the actual proceeds +from the loans. Microphase had previously guaranteed the payment under the first Wells Fargo equity line during 2008, the proceeds +of which Microphase had received from a concurrent loan from Edson Realty Inc., a related party owned real estate holding company. +As of December 31, 2019, the first line of credit, which is secured by residential real estate owned by a former officer, had an +outstanding balance of $210,512, with an annual interest rate of 4.00%. Microphase had guaranteed the payment under the second +Wells Fargo equity line in 2014. Microphase had received working capital loans from the former CEO from funds that were drawn against +the second Wells Fargo equity line. As of December 31, 2019, the second line of credit, secured by the former CEO’s principal +residence, had an outstanding balance of $80,048, with an annual interest rate of 3.00%. +F- 40 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Note payable +to Dept. of Economic and Community Development +In +August 2016, Microphase received a $300,000 loan, of which $70,904 has been repaid, pursuant to the State of Connecticut Small +Business Express Job Creation Incentive Program which is administered through the Department of Economic and Community Development +(“DECD”) (the “DECD Note”). The DECD Note accrues interest at a rate of 3% per annum and is due in August +2026. Payment of principal and interest commenced in September 2017, payable in equal monthly installments over the remaining term. +Microphase short-term promissory note +On +December 28, 2018, Microphase entered into a $200,000 Secured Promissory Note (the “Microphase Note”), whereby Microphase +agreed to pay interest in an amount of 10% per annum in cash to the investor, beginning on January 15, 2019, on a monthly basis, +until the Microphase Note is paid in full. The maturity date of the Microphase Note shall be the earlier of March 31, 2019, or +as otherwise provided in the terms of the Microphase Note. The Microphase Note was paid from proceeds received in the April 2, +2019 public offering (see note 22). In connection with the Microphase Note, Milton C. Ault III provided a personal guarantee for +the benefit of the investor. +Note payable +to Power-Plus Member +Pursuant +to the terms of the Purchase Agreement with Power-Plus, the Company entered into a two-year promissory note in the amount of $255,000 +payable to the former owner as part of the purchase consideration. On October 18, 2017, for cancellation of debt, the Company +entered into a subscription agreement with the former owner under which the Company sold 173 shares of common stock at $537.57 per +share for an aggregate purchase price of $93,000. At December 31, 2019 and 2019, the outstanding balance on this note was $13,250. +Note Payable to People's United Bank +Microphase utilizes +a $20,000 overdraft credit line at People’s United Bank with an annual interest rate of 15%. At December 31, 2019 and 2018, +the balance of that overdraft credit line was $16,890 and $18,589, respectively. +Enertec Short Term Bank Credit and Secured Promissory Note +At +December 31, 2019 and 2019, Enertec had short term bank credit of $1,622,337 and $1,586,864, respectively, that bears interest +at prime plus 0.7% through 3.85% paid either on a monthly or weekly basis. Further, the Company has undertaken to comply with certain +covenants under its bank loan. +On +December 28, 2018, Enertec entered into a $500,000 secured promissory note (the “Enertec Note”), whereby Enertec agreed +to pay interest in an amount of 10% per annum in cash to the investor, beginning on January 15, 2019, on a monthly basis, until +the Enertec Note was paid in full. The proceeds from the Enertec Note were received in January 2019. The Enertec Note was paid +from proceeds received in the April 2, 2019 public offering (see note 22). In connection with the Enertec Note, Milton C. Ault +III provided a personal guarantee for the benefit of the investor. +Exchange Agreements +January 2019 +Exchange Agreement +On +January 23, 2019, the Company entered into an exchange agreement (the “January Exchange Agreement”) with an institutional +investor pursuant to which the Company issued to the investor two new 8% promissory notes in the aggregate principal amount of +$1,043,799 (the “New Notes”) in exchange for one of the 8% Short-Term Promissory Notes in the aggregate principal amount +of $318,150, the October short-term promissory note in the aggregate principal amount of $565,000 and accrued interest of $160,649. +F- 41 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Pursuant +to the January Exchange Agreement, the investor received 10,918 shares of common stock of the Company issued under the Company’s +Registration Statement on Form S-3 (File No. 333-222132) in satisfaction of the New Notes. Further, since the investor’s +proceeds from the sale of all 10,918 shares of common stock received were not equal to the outstanding principal balance of the +New Notes, the Company was required to pay to the investor the difference, which amounted to $244,898, in cash or through the delivery +of free trading shares of common stock. The Company recognized additional interest expense for the difference of $244,898. On March +19, 2019, the Company issued to the investor an additional 2,551 shares of the Company’s common stock, with a value of $73,016, +in partial satisfaction of the liability, resulting in a remaining balance due of $171,882 which was paid during June 2019. +February 2019 Exchange Agreement +On +February 20, 2019, the Company entered into an exchange agreement (the “February Exchange Agreement”) with an institutional +investor pursuant to which the Company issued to the investor a new 8% promissory note in the principal amount of $433,884 (the +“New Note”) in exchange for one of the 8% Short-Term Promissory Notes in the aggregate principal amount of $318,150 +and accrued interest of $115,734 (the “Old Note”). +Pursuant +to the February Exchange Agreement, the investor received 4,520 shares of common stock of the Company issued under the Company’s +Registration Statement on Form S-3 (File No. 333-222132) in satisfaction of the New Note. Further, since the investor’s proceeds +from the sale of all 4,520 shares of common stock received were not equal to the outstanding principal balance of the New Note, +the Company was required to pay the difference, which amounted to $289,954, to the investor in cash or through the delivery of +free trading shares of common stock. The Company recognized additional interest expense for the difference of $289,954. On April +4, 2019, the Company issued to the investor an additional 9,375 shares of the Company’s common stock, with a value of $108,523, +in partial satisfaction of the liability, resulting in a remaining balance due of $183,822 which was paid during June 2019. +July 2019 Exchange Agreement +On July 2, 2019, the +Company entered into an exchange agreement with an institutional investor pursuant to which, in exchange for (i) a term promissory +note issued by DP Lending to the investor on August 10, 2018 in the principal face amount of $550,000 and (ii) one of the 8% Short-Term +Promissory Notes in the aggregate principal amount of $318,150, the Company sold to the investor a new convertible promissory note +in the principal amount of $1,250,000 with an interest rate of 8% per annum and a maturity date of December 31, 2019. This note +shall be convertible into shares of the Company’s common stock at conversion price of $8.80. Since the exchange provided +the institutional investor with a substantive conversion feature, the debt instruments were determined to be substantially different +and a loss on extinguishment of $54,465 was recognized. +Other Notes Payable +(a) On January 25, 2018, the Company issued two 5% promissory notes, each in the principal face amount +of $2,500,000 for an aggregate debt of $5,000,000 to two institutional investors. The entire unpaid balance of the principal +and accrued interest on each of the 5% promissory notes was due and payable on February 23, 2018, subject to a 30-day extension +available to the Company. The proceeds from these two 5% promissory notes were used +to purchase 1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with +our crypto mining operations. The Company repaid the entire outstanding principal and accrued interest on the 5% promissory +notes of $5,101,127 during 2018. +(b) On February 20, 2018, the Company issued a promissory note +in the principal face amount of $900,000 to an accredited investor. This promissory note included an original issue discount +(“OID”) of $150,000 resulting in net proceeds of $750,000. The principal and +OID on this note was due and payable on March 22, 2018. On March 23, 2018, the Company entered into a new promissory note in the +principal amount of $2,100,000 for a term of two months, subject to the Company’ ability to prepay within one month. The +new promissory note included an OID of $350,000, resulting in net proceeds of $1,750,000. The +Company also issued to the lender a warrant to purchase 1,563 shares of the Company’s common stock at an exercise price of +$920 per share. The principal amount of the new promissory note consisted of cash of $1,000,000 and the cancellation of +principal of $750,000 from the February 20, 2018 promissory note. The interest on the February 20, 2018 note in the amount of $150,000 +was paid to the lender prior to entering into the new promissory note. The warrants are exercisable commencing on the issuance +date for a term of three years. The exercise price of these warrants is subject to adjustment for customary stock splits, stock +dividends, combinations and other standard anti-dilution events. The warrants may be exercised for cash or on a cashless basis. +The Company recorded debt discount in the amount of $604,227 based on the estimated fair value of these warrants. The Company computed +the fair value of these warrants using the Black-Scholes option pricing model. The debt discount was amortized as non-cash interest +expense over the term of the debt. On April 23, 2018, the Company paid the entire outstanding +principal on the new promissory note of $2,100,000 . The new promissory note had been guaranteed by our Chief Executive Officer +and had also been guaranteed by Philou. +F- 42 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +19. NOTES PAYABLE – RELATED PARTIES +Notes Payable – +Related parties at December 31, 2019 and 2018, are comprised of the following: +December 31, +2019 +2018 +Notes payable, related parties +$ 284,317 +$ 308,984 +Less: current portion +(169,153 ) +(166,925 ) +Notes payable, related parties – long-term portion +$ 115,164 +$ 142,059 +Microphase is a party +to several notes payable agreements with seven of its past officers, employees and their family members. As of December 31, 2019, +the aggregate outstanding balance pursuant to these notes payable agreements, inclusive of $64,604 of accrued interest, was $348,921, +with annual interest rates ranging between 3.00% and 6.00%. During the year ended December 31, 2019, Microphase incurred $6,852 +of interest on these notes. +20. CONVERTIBLE NOTES +Convertible Notes Payable +at December 31, 2019 and 2018, are comprised of the following: +December 31, +2019 +2018 +10% Convertible secured notes +$ — +$ 7,997,126 +8% Convertible promissory note +935,772 +— +12% Convertible promissory note +815,218 +— +4% Convertible promissory note +660,000 +— +12% July 2019 convertible promissory note +632,000 +— +12% November 2019 convertible promissory note +350,000 +— +Total convertible notes payable +3,392,990 +7,997,126 +Less: +Unamortized debt discounts +(355,227 ) +(1,189,276 ) +Unamortized financing cost +— +(65,356 ) +Total convertible notes payable, net of financing cost +$ 3,037,763 +$ 6,742,494 +Less: current portion +(2,732,990 ) +(6,742,494 ) +Convertible notes payable, net of financing cost – long-term portion +$ 304,773 +$ — +F- 43 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +10% Convertible Secured Notes +On May 15, 2018, the +Company entered into a securities purchase agreement with an institutional investor to sell a 10% convertible note (the “10% +Convertible Note”) in the principal amount of $6,000,000. On July 2, 2018 and August 31, 2018, the Company entered into securities +purchase agreements with the institutional investor providing for the sale of a second 10% convertible note with a principal face +amount of $1,000,000 (the “Second 10% Convertible Note”) and a third 10% convertible note with a principal face amount +of $2,000,000 (the “Third 10% Convertible Note” and with 10% Convertible Note and the Second 10% Convertible Note, +the “10% Convertible Secured Notes”). +In conjunction with +the sale of the 10% convertible note, the Company issued (i) a five-year warrant to purchase 1,389 shares of the Company’s +common stock at an exercise price of $1,080 per share; (ii) a five-year warrant to purchase 2,155 shares of the Company’s +common stock at an exercise price of $696 per share; and (iii) 431 shares of the Company’s common stock to the institutional +investor. Upon an event of default, the 10% Convertible Note was convertible into the Company’s common stock at $600 per +share. Further, the Company paid the placement agent a cash fee of $300,000 and issued a warrant to purchase 188 shares of the +Company’s common stock with an exercise price of $800 per share. +The Company computed +the fair value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt +discount in the amount of $1,397,389 based on the estimated fair value of the warrants. The Company estimated that the grant date +fair value of the shares of common stock was $405,024, which was determined from the closing price of the Company’s common +stock on the dates of issuance. In aggregate, the Company recorded debt discount in the amount of $2,169,613 based on the relative +fair values of the warrants, common stock and debt issuance costs of $367,200. The fair value of the warrants was estimated using +the Black-Scholes option-pricing method. The risk-free rate of 2.94% was derived from the U.S. Treasury yield curve, matching the +term of the warrant, in effect at the measurement date. The volatility factor of 127.9% was determined based on the Company’s +historical stock prices. +The Second 10% Convertible +Note was convertible into the Company’s common stock at $600 per share and resulted in the issuances of an additional 500 +shares of the Company’s common stock. The Third 10% Convertible Note was convertible into 6,250 shares of the Company’s +common stock at $320 per share. At the time of issuance of the Third 10% Convertible Note, the closing price of the Company’s +common stock was in excess of the conversion price, resulting in a beneficial conversion feature (“BCF”). The BCF embedded +in the Third 10% Convertible Note is accounted for under ASC No. 470, De bt (“ASC 470”). At issuance, the +intrinsic value of the BCF totaled $910,419, based on the difference between the effective conversion price and the fair value +of the Company’s common stock at the commitment date of the transaction. The Company recorded debt issuance costs of $200,500 +from the Third 10% Convertible Note. The debt issuance costs are being amortized as non-cash interest expense over the term of +the debt. +Pursuant to an amendment +dated as of August 31, 2018 to the 10% Convertible Note and the Second 10% Convertible Note, the Company reduced the conversion +price from $600 to $320 per share. The amendment to the embedded conversion options of the 10% Convertible Note and the Second +10% Convertible Note caused a material change in the fair value of the embedded conversion options on these two notes and resulted +in a loss on extinguishment of $665,346. At the time of the amendment, the closing price of the Company’s common stock was +in excess of the conversion price, resulting in a BCF. The intrinsic value of the BCF was $1,131,960 on the 10% Convertible Note +and $225,000 on the Second 10% Convertible Note based on the difference between the effective conversion price and the fair value +of the Company’s common stock on the date of the amendment. +Pursuant to the terms +of an amendment dated December 7, 2018, the Company agreed that if the institutional investor elected to convert three monthly +payments in the principal amount of $309,193 into shares of the Company’s common stock at the stated conversion price of +$320 and the proceeds from the sale of the shares did not result in net proceeds to the investor of at least 103% of the principal, +interest and penalties due, then the Company would pay the investor the difference in cash (the “True-Up Payment”). +During December 2018, the Company issued to the investor 2,743 shares of its common stock at $320 per share upon the conversion +of $877,793 in principal, accrued interest and penalties. During December 2018, the investor received $304,608 from the sale of +the shares of common stock, which approximated the value of the shares of common stock on the date of issuance, resulting in a +True-Up Payment due to the investor of $599,519. +F- 44 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +On January 9, 2019, +the 10% Convertible Note was amended to revise the amortization schedule such that the conversion price on eleven monthly amortization +payments in the principal amount of $309,193 each, at the request of the holder, would be satisfied by the issuance of shares of +the Company’s common stock (“Common Stock”). The conversion price on these monthly amortization payments was +reduced from $320 per share of Common Stock to a price equal to the greater of (i) $96 per share (the closing price of the Common +Stock on January 9, 2019) or (ii) 80% of the lowest daily volume weighted average price (“VWAP”) in the three days +prior to the date of issuance, but not to exceed $320 per share. The amendment to the embedded conversion option of the 10% Convertible +Note caused a material change in the fair value of the embedded conversion options and resulted in a loss on extinguishment of +$807,784. +During 2019, the Company +repaid the 10% Convertible Secured Notes, a portion of which was repaid through the issuance of 8,413 shares of Common Stock upon +the conversion of $1,053,351 in principal and accrued interest. The institutional investor received $660,337 from the sale of these +shares of Common Stock. In accordance with the January 9, 2019 amendment, the Company was required to pay the difference between +the conversion amount and the proceeds received from the subsequent sale of the shares by the investor, which amounted to $393,014. +The Company recognized additional interest expense in the amount of $393,014. +8% Convertible Promissory Note +On +November 15, 2019, the Company entered into an exchange agreement with a lender pursuant to which the Company issued to the lender +a convertible promissory note in the principal amount of $935,772 with an interest rate of 8% per annum, in exchange for two promissory +notes (i) in the original principal amount of $575,000 issued on May 10, 2019, and (ii) in the original principal amount of $230,000 +issued on May 21, 2019 held by the lender. The 8% convertible promissory note is convertible into shares of the Company’s +common stock at conversion price of $1.80. Since the exchange provided the lender with a substantive conversion feature, the debt +instruments were determined to be substantially different and a loss on extinguishment of $27,151 was recognized. +12% Convertible Promissory Note +On July 2, 2019, the +Company entered into an exchange agreement with an institutional investor pursuant to which, in exchange for a term promissory +note issued by the Company to the investor on September 21, 2018, in the principal face amount of $526,316, the Company sold to +the investor a new convertible promissory note in the principal amount of $783,031 with an interest rate of 12% per annum and a +maturity date of December 31, 2019. This note was convertible into shares of Common Stock at a conversion price equal to the greater +of (A) $8.80 or (B) 80% of the lowest daily VWAP in the three trading days prior to the date of conversion. Since the exchange +provided the institutional investor with a substantive conversion feature, the debt instruments were determined to be substantially +different and a loss on extinguishment of $36,999 was recognized. +Further, +at the time of issuance of the 12% Convertible Note, the closing price of the Company’s common stock was in excess of the +conversion price, resulting in a BCF. At issuance, the intrinsic value of the BCF totaled $71,185, based on the difference between +the effective conversion price and the fair value of the Company’s common stock at the commitment date of the transaction. +During the year ended December 31, 2019, non-cash interest expense of $71,185 was recorded from the amortization of debt discounts +attributed to the 12% Convertible Note. +On September 26, 2019, +principal and interest on the 12% Convertible Note was exchanged for a convertible promissory note in the principal amount of $815,218 +with an interest rate of 12% per annum and a maturity date of December 31, 2019. This note is convertible into shares of Common +Stock at a conversion price of $4.00. The Company recognized an additional loss on extinguishment of $11,647. +F- 45 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +4% Convertible Promissory Note +On May 20, 2019, the +Company entered into a Securities Purchase Agreement with an investor to sell, for a purchase price of $500,000, a 4% Original +Issue Discount (“OID”) Convertible Promissory Note with an aggregate principal face amount of $660,000 and a five-year +warrant to purchase an aggregate of 12,500 shares of the Company’s common stock. The Company is required to make quarterly +interest payments and the principal amount of the note is due on May 20, 2024. The Note is convertible into shares of the Company’s +common stock at $4.00 per share. The exercise price of the Warrant is $12.00 per share. In addition, the Chief Executive Officer +of the Company agreed to guarantee and act as surety for the Company’s obligation to repay the Note pursuant to a Personal +Guarantee (the “Guarantee”). +The Company computed +the fair value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt +discount in the amount of $58,448 based on the estimated fair value of the warrants. At the time of issuance of the note, the closing +price of the Company’s common stock was in excess of the effective conversion price, resulting in a BCF of $188,448, based +on the difference between the effective conversion price and the fair value of the Company’s common stock at the commitment +date of the transaction +In aggregate, the Company +recorded a debt discount in the amount of $406,896 based on the relative fair values of the warrants, BCF and OID. During the year +ended December 31, 2019, non-cash interest expense of $51,669 was recorded from the amortization of debt discounts. The fair value +of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 2.18% was derived from the U.S. +Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The volatility factor of 87.51% was +determined based on historical stock prices of similar technology companies. +12% July 2019 +Convertible Promissory Note +On +July 3, 2019, the Company into an exchange agreement with an institutional investor pursuant to which, in exchange for a term promissory +note issued by us to the investor on March 23, 2018 in the principal face amount of $1,000,000, we sold a convertible promissory +note in the principal face amount of $1,292,000 plus a default premium of $200,000, and (ii) a five-year warrant to purchase of +25,000 shares of our common stock at an exercise price of $8.80 per share. +This +convertible promissory note is in the aggregate principal amount of $1,492,000 and bears interest at 12% per annum. The principal +and all accrued and unpaid interest are due on January 22, 2020. Interest is payable in cash, in arrears, on the first business +day of each month, with the first payment of interest due on August 1, 2019. Commencing on July 15, 2019, subject to certain beneficial +ownership limitations, the investor may convert the principal amount of this note and accrued interest earned thereon at any time +into shares of our common stock at $8.80 per share. +The Company computed +the fair value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt +discount in the amount of $142,070 based on the estimated fair value of the warrants. At the time of issuance of the note, the +closing price of the Company’s common stock was in excess of the effective conversion price, resulting in a BCF of $209,888, +based on the difference between the effective conversion price and the fair value of the Company’s common stock at the commitment +date of the transaction +In aggregate, the Company +recorded debt discount in the amount of $351,958 based on the relative fair values of the warrants and BCF. During the year ended +December 31, 2019, non-cash interest expense of $351,958 was recorded from the amortization of debt discounts. The fair value of +the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.75% was derived from the U.S. +Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The volatility factor of 85.47% was +determined based on historical stock prices of similar technology companies. +F- 46 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +12% November +2019 Convertible Promissory Note +On +November 4, 2019, the Company entered into an exchange agreement with a certain investor pursuant to which, in exchange for an +original issue discount promissory note issued by the Company for the benefit of the investor on July 25, 2019, as amended, the +Company sold to the investor a new convertible promissory note in the principal amount of $350,000 with an interest rate of 12% +per annum. The note is convertible into shares of the Company’s common stock at conversion price of $1.20 per share, subject +to adjustments. Principal and interest on this note is due on July 4, 2020. Since the exchange provided the institutional investor +with a substantive conversion feature, the debt instruments were determined to be substantially different and a loss on extinguishment +of $30,053 was recognized. +12% April 2018 Convertible Promissory +Note +On April 16, 2018, +the Company entered into securities purchase agreements to sell (i) a 12% convertible note (the “12% April 2018 Convertible +Promissory Note”), (ii) a five-year warrant to purchase 1,242 shares of the Company’s common stock at an exercise price +of $1,040 per share; and (iii) 251 shares of the Company’s common stock to three institutional investors. Upon an event of +default, the 12% April 2018 Convertible Promissory Note was convertible into common stock at $560 per share. The 12% April 2018 +Convertible Promissory Note was in the principal amount of $1,722,222 and included an OID of $172,222, resulting in net proceeds +to the Company of $1,550,000. +The Company computed +the fair value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt +discount in the amount of $539,360 based on the estimated fair value of the warrants. The Company estimated that the grant date +fair value of the shares of common stock was $128,524, which was determined from the closing price of the Company’s common +stock on the date of issuance. +In aggregate, the Company +recorded debt discount in the amount of $885,106 based on the relative fair values of the warrants, common stock, OID and debt +issuance costs of $45,000. The fair value of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free +rate of 2.94% was derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect at the measurement date. +The volatility factor of 127.9% was determined based on the Company’s historical stock prices. Beginning on May 16, 2018, +the Company was required to make six monthly cash payments in the aggregate amount of $304,259. On August 31, 2018, the Company +made its final payment and in aggregate paid principal and accrued interest of $1,722,222 and $103,333, respectively, on the 12% +April 2018 Convertible Promissory Note. +January 2018 10% Convertible Promissory +Note +On January 23, 2018, +we entered into a securities purchase agreement with an institutional investor to sell, for an aggregate purchase price of $1,000,000, +a 10% senior convertible promissory note (the “January 2018 10% Convertible Promissory Note”) with an aggregate principal +face amount of $1,250,000, a warrant to purchase an aggregate of 781 shares of our common stock and 680 shares of our common stock. +The transactions contemplated by the securities purchase agreement closed on February 8, 2018. The January 2018 10% Convertible +Promissory Note was convertible into 781 shares of the Company’s common stock, a conversion price of $1,600 per share. The +exercise price of the warrant to purchase 781 shares of the Company’s common stock is $1,760 per share. On February 9, 2018, +in addition to the 680 shares of common stock provided for pursuant to the securities purchase agreement, the Company issued to +the investor an aggregate of 865 shares of the Company’s common stock upon the conversion of the entire outstanding principal +and accrued interest on the January 2018 10% Convertible Promissory Note of $1,383,884 (See Note 22). +21. COMMITMENTS AND CONTINGENCIES +Derivative Action +F- 47 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +On July 31, 2018, Ethan +Young and Greg Young (collectively, “Plaintiffs”) filed a stockholder derivative complaint (the “Complaint”) +in the United States District Court for the Central District of California (the “Court”) against the Company as the +nominal defendant, as well as its current directors and a former director, in action captioned, Ethan Young and Greg Young, +Derivatively on Behalf of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, +Mordechai Rosenberg, Robert O. Smith, and Kristine Ault and DPW Holdings, Inc. , as the nominal defendant, Case No. 18-cv-6587 +(the “Derivative Action”). +The Complaint alleged +violations of state law and breaches of fiduciary duty, unjust enrichment and gross mismanagement by the individual defendants, +in connection with various transactions entered into by us. +We moved to dismiss +the Complaint, and on February 25, 2019, the Court granted our motion to dismiss, in its entirety, without prejudice, and also +granted Plaintiffs leave to amend their Complaint. +On March 11, 2019, +plaintiffs filed an amended complaint asserting violations of breaches of fiduciary duties and unjust enrichment claims based on +the previously pled transactions (the “Amended Complaint”). +On March 25, 2019, +we filed a motion to dismiss the Amended Complaint. On May 21, 2019, the Court granted in part, and denied part, our motion to +dismiss the Amended Complaint. As previously announced, on February 24, 2020, the Company entered into a definitive settlement +agreement (the “Settlement Agreement”) with Plaintiffs to settle the claims asserted in the Amended Complaint. +On April 15, 2020, +the Court issued an Order (the “Order”) approving a Motion for Preliminary Approval of Settlement in the Derivative +Action. Pursuant to the terms of the Order, the Board shall adopt and/or maintain certain resolutions and amendments to the Company’s +committee charters and/or bylaws, to ensure adherence to certain corporate governance policies (collectively, the “Reforms”). +The Order further provides that such Reforms shall remain in effect for a period of no less than five (5) years and shall be subject +to any of the following: (a) a determination by a majority of the independent directors that the Reform is no longer in the best +interest of the Company, including, but not limited to, due to circumstances making the Reforms no longer applicable, feasible, +or available on commercially reasonable terms, or (b) modifications which the Company reasonably believes are required by applicable +law or regulation. +In connection with +the Settlement Agreement, the parties have agreed upon a payment of attorneys’ fees in the amount of $600,000, which sum +shall be payable by our Director & Officer liability insurance. The Settlement Agreement contains no admission of wrongdoing. +We have always maintained +and continue to believe that neither us nor our current or former directors engaged in any wrongdoing or otherwise committed any +violation of federal or state securities laws or any other laws or regulations. +Although the Settlement +Agreement has been approved by the Court, there can be no assurance that the settlement will be finalized and approved by the Court +or that the Settlement Agreement will be properly objected to by any of our shareholders and, even if approved, whether the conditions +to closing will be satisfied, and the actual outcome of this matter may differ materially from the terms of the settlement described +herein. +Blockchain Mining Supply and Services, +Ltd. +On November 28, 2018, +Blockchain Mining Supply and Services, Ltd. (“Blockchain Mining”) a vendor who sold computers to our subsidiary, filed +a Complaint (the “Complaint”) in the United States District Court for the Southern District of New York against us +and our subsidiary, Super Crypto Mining, Inc., in an action captioned Blockchain Mining Supply and Services, Ltd. v. Super Crypto +Mining, Inc. and DPW Holdings, Inc. , Case No. 18-cv-11099. +F- 48 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The Complaint asserts +claims for breach of contract and promissory estoppel against the us and our subsidiary arising from the subsidiary’s alleged +failure to honor its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $1,388,495, plus +attorneys’ fees and costs. +We believe that these +claims are without merit and intend to vigorously defend them. +On April 13, 2020, +we and our subsidiary, jointly filed a motion to dismiss the Complaint in its entirety as against us, and the promissory estoppel +claim as against our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Complaint in connection with +the breach of contract claim. +On April 29, 2020, +Blockchain Mining filed an amended complaint (the “Amended Complaint”). The Amended Complaint asserts the same causes +of action and seeks the same damages as the initial Complaint. +On May 13, 2020, we +and our subsidiary, jointly filed a motion to dismiss the Amended Complaint in its entirety as against us, and the promissory estoppel +claim as against of our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Amended Complaint in connection +with the breach of contract claim. +Based on our assessment +of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably +estimate the potential loss or range of loss that may result from this action. Notwithstanding, we have established a reserve in +the amount of the unpaid portion of the purchase agreement. An unfavorable outcome may have a material adverse effect on our business, +financial condition and results of operations. +Ding Gu (a/k/a Frank Gu) and Xiaodan +Wang Litigation +On January 17, 2020, +Ding Gu (a/k/a Frank Gu) (“Gu”) and Xiaodan Wang (“Wang” and with “Gu” collectively, “Plaintiffs”), +filed a Complaint (the “Complaint”) in the Supreme Court of the State of New York, County of New York against us and +our Chief Executive Officer, Milton C. Ault, III, in an action captioned Ding Gu (a/k/a Frank Gu) and Xiaodan Wang v. DPW Holdings, +Inc. and Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd Ault) , Index No. 650438/2020. +The Complaint asserts +causes of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent +injunction, enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions +entered into between Gu and us, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs +and DPW, in or about July 2019. The Complaint seeks, among other things, monetary damages in excess of $1,100,000, plus a decree +of specific performance directing DPW to deliver unrestricted shares of DPW’s common stock to Gu, plus attorneys’ fees +and costs. +We believe that these +claims are without merit and intend to vigorously defend them. +On May 4, 2020, we +and Ault, jointly filed a motion to dismiss the Complaint in its entirety, with prejudice. +The motion to dismiss +is returnable before the Court on June 26, 2020. +Based on our assessment +of the facts underlying the above claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably +estimate the potential loss or range of loss that may result from this action. An unfavorable outcome may have a material adverse +effect on our business, financial condition and results of operations. +The Company is involved +in litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory +and government investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such +claims, suits, regulatory and government investigations, and other proceedings could result in fines, civil penalties, or other +adverse consequences. +F- 49 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable +that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and +the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters +that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses +disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and +the estimated amount of a loss related to such matters. +With respect to our +other outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will +not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results +of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. +Subpoena +The Company received +a subpoena from the SEC for the voluntary production of documents. The Company is fully cooperating with this non-public, fact-finding +inquiry and Management believe that the Company has operated our business in compliance with all applicable laws. The subpoena +expressly provides that the inquiry is not to be construed as an indication by the Commission or its staff that any violations +of the federal securities laws have occurred, nor should it be considered a reflection upon any person, entity or security. However, +there can be no assurance as to the outcome of this matter. +Other Litigation Matters +During the year ended +December 31, 2019, several non-trade creditors of the Company commenced litigation against the Company for payment of approximately +$4.0 million of debt obligations not paid according to contractual terms. The Company has since repaid approximately $3.6 million +of such debt obligations and entered into settlement agreements for the remaining amount of approximately $400,000 which are included +within future receipts obligations in the accompanying consolidated balance sheet at December 31, 2019. The Company also recorded +an aggregate of approximately $450,000 of trade liabilities for judgments settled in favor of two trade creditors during the year +ended December 31, 2019 and is currently a defendant in several other claims made by trade creditors in which the maximum loss +exposure is currently estimated to be approximately $350,000. The outcome of any matters relating to unresolved trade credit +obligations cannot be predicted at this time. +Operating Leases +In November 2012, the +Company signed an operating lease agreement for the US headquarters for a period of 7 years with an option to extend for an additional +5 years. In September 2009, the Company's United Kingdom subsidiary signed an agreement for a lease in respect of the UK facility +for a period of 15 years with an option to cancel the lease after 10 years in September 2019. In June 2010, the Company’s +Israeli subsidiary signed an agreement for a lease in respect of the Israel facility for a period of 10 years. In addition, the +Company leases 43,062 square-feet of other space domestically that includes office, engineering, laboratory, restaurant and warehouse +space in both California and Connecticut. The annual base rent under these leases, payable on a monthly basis, is approximately +$1,272,000 during 2019. These leases expire between May 2019 and January 2028 (see note 16). +22. STOCKHOLDERS’ EQUITY +Amendments +to Certificate of Incorporation +On January 3, 2019, +the Company filed a certificate of amendment (the “Certificate of Amendment”) to its Certificate of Incorporation, +with the Secretary of State of the State of Delaware, to effectuate an increase to the number of authorized shares of common stock +of the Company. Pursuant to the Certificate of Amendment, the Company increased the number of authorized shares of its Class A +common stock to 500,000,000 from 200,000,000 (the “Authorized Increase”). The number of authorized shares of the Company’s +Class B common stock remains at 25,000,000 and the number of authorized shares of the Company’s preferred stock remains at +25,000,000. As a result of the increase of authorized shares of the Company’s Class A common stock, the aggregate number +of the Company’s authorized shares is 550,000,000. The Authorized Increase was approved by the Company’s Board of Directors +(the “Board”) as of December 28, 2018, and approved by a vote of the stockholders of the Company at the December 28, +2018 Annual Meeting of Stockholders. The Certificate of Amendment became effective upon filing with the State of Delaware on January +3, 2019. +F- 50 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +On March 14, 2019, pursuant +to the authorization provided by the Company’s stockholders at a Special Meeting of Stockholders, the Company’s +Board approved the Certificate of Incorporation Amendment (the “COI Amendment”) to effectuate a reverse stock split +of the common stock of the Company’s issued and outstanding number of such shares by a ratio of one-for-twenty (the “Reverse +Stock Split”) . The Company filed the COI Amendment to its Certificate of Incorporation +with the State of Delaware effectuating the Reverse Stock Split on March 14, 2019. As a result of the Reverse Stock Split, each +twenty (20) shares of common stock issued and outstanding prior to the Reverse Stock Split were converted into one (1) share of +common stock, with no change in authorized shares or par value per share. +At the Company’s +reconvened 2019 Annual Meeting of Stockholders, the Company’s stockholders approved a proposal permitting the Board to effectuate +a second reverse stock split (the “Second Reverse Stock Split”) of the Company’s issued and outstanding common +stock. Thereafter, on July 23, 2019, the Board approved the Second Reverse Stock Split with a ratio of one-for-forty. As a result +of the Second Reverse Stock Split, each forty (40) shares of common stock issued and outstanding prior to the Second Reverse Stock +Split were converted into one (1) share of common stock, with no change in authorized +shares or par value per share. The Second Reverse Stock Split became effective in the State of Delaware on August 5, 2019. +Preferred Stock +The +Company is authorized to issue 25,000,000 shares of Preferred Stock $0.001 par value. The Board has designated 1,000,000 shares +as Series A Convertible Preferred Stock (the “Series A Preferred Stock”), 500,000 shares as Series B Convertible Preferred +Stock (the “Series B Preferred Stock”) and 2,500 shares as Series C Convertible Redeemable Preferred Stock (the “Series +C Preferred Stock”). The rights, preferences, privileges and restrictions on the remaining authorized 23,497,500 shares of +Preferred Stock have not been determined. The Board is authorized to designate a new series of preferred shares and determine the +number of shares, as well as the rights, preferences, privileges and restrictions granted to or imposed upon any series of preferred +shares. As of December 31, 2019, there were 7,040 shares of Series A Preferred Stock, 125,000 +shares of Series B Preferred Stock and no other shares of Preferred Stock issued or outstanding. +On December 21, 2018, +the Company filed with the Delaware Secretary of State a Certificate of Elimination eliminating its previous Series C Preferred +Stock, Series D Preferred Stock and Series E Preferred Stock (collectively, the “Preferred Shares”) and returning them +to authorized but undesignated shares of the Company’s preferred stock. None of the Preferred Shares were outstanding. +Series A Preferred Stock +On +September 13, 2018, the Company filed a Certificate of Designations of Rights and Preferences (the “Certificate of Designations”) +to its Amended and Restated Certificate of Incorporation with the Secretary of State of the State of Delaware to establish the +preferences, limitations and relative rights of the 10% Series A Cumulative Redeemable Perpetual Preferred Stock (the “Series +A Preferred Stock”). +Dividends +on the Series A Preferred Stock shall accrue daily and be cumulative from, and including, the date of original issue and shall +be payable monthly on the last day of each calendar month, subject to the terms and conditions set forth in the Certificate of +Designations. Dividends accrue at the annual rate of 10%, which is equivalent to $2.50 per annum per share, based on the $25.00 +liquidation preference from, and including, the date of original issuance to, but not including, September 30, 2023, or such other +date fixed for redemption. +On +and after September 30, 2023, the Company may, at its option, upon not less than thirty (30) days nor more than sixty (60) days’ +written notice, redeem the Series A Preferred Stock, in whole or in part, at any time or from time to time, for cash at a redemption +price of $25.00 per share of Series A Preferred Stock, plus any accumulated and unpaid dividends thereon to, but not including, +the date fixed for redemption. In addition, upon the occurrence of a change of control, subject to certain restrictions, the Company +may, at its option, upon not less than thirty (30) days’ nor more than sixty (60) days’ written notice, redeem +the Series A Preferred Stock, in whole or in part, within one hundred twenty (120) days after the first date on which such change +of control occurred, for cash at a redemption price of $25.00 per share, plus any accumulated and unpaid dividends thereon to, +but not including, the date fixed for redemption. There is no mandatory redemption of the Series A Preferred Stock. +F- 51 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Holders +of the Series A Preferred Stock generally have no voting rights except as set forth in the Certificate of Designations or as otherwise +required by law. The holders of Series A Preferred Stock, together with the holders of shares of every other series of Parity Stock +upon which like voting rights have been conferred and are exercisable, voting together as a single class regardless of series, +shall be entitled to elect two directors to the Company’s board of directors at any annual meeting of stockholders or special +meeting held in place thereof. When the Series A Preferred Stock is entitled to vote, such shares are entitled to one vote per +share. In any matter in which the Series A Preferred Stock may vote as a single class with any other series of Preferred Stock +(as may be required by law), each share of Series A Preferred Stock shall be entitled to one vote per $25.00 of stated liquidation +preference. +During the years ended +December 31, 2019 and 2018, the Company issued 5,606 and 1,434 shares of Series A Preferred Stock for $131,741 and $33,699, respectively. +Series B Preferred Stock +On March 9, 2017, the +Company entered into a Preferred Stock Purchase Agreement with Philou, a related party. Pursuant to the terms of the Preferred +Stock Purchase Agreement, Philou invested $1,250,000 in the Company through the purchase of 125,000 shares of Series B Preferred +Stock. +Each share of Series +B Preferred Stock has a stated value of $10.00 per share and may be convertible at the holder’s option into shares of common +stock of the Company at a conversion rate of $560 per share, subject to standard anti-dilution provisions in connection with any +stock split, stock dividend, subdivision or similar reclassification of the common stock. Each share of Series B Preferred Stock +shall have the right to receive dividends equal to one ten millionth (0.0000001) of earnings before interest, taxes, depreciation, +amortization and stock-based compensation (“EBITDAS”) calculated for a particular calendar year. Thus, the holders +of the 125,000 shares of Series B Preferred Stock will be entitled to receive dividends equal to one and a quarter percent (1.25%) +in the aggregate of EBITDAS. +At such time as (i) +all shares of common stock issuable upon conversion of all outstanding shares of Series B Preferred Stock (the “Conversion +Shares”) shall have been registered for resale pursuant to an effective Registration Statement covering such Conversion Shares, +(ii) but no earlier than the twenty-fifth (25th) anniversary of the effective date, the shares of Series B Preferred Stock shall +be subject to redemption in cash at the option of the Company in an amount per share equal to 120% of the greater of (a) the stated +value plus all accrued and unpaid dividends, if any and (b) the fair market value of such shares of Series B Preferred Stock. +On April 24, 2018, +Philou purchased 25,000 shares of Series B Preferred Stock in consideration of the cancellation of short-term advances due to Philou +in the aggregate amount of $250,000. In addition, Philou received warrants to purchase 446 shares of common stock at an exercise +price of $560 per share of common stock. The Company determined that the estimated relative fair value of these warrants, which +are classified as equity, was $141,951 using the Black-Scholes option pricing model. Since the warrants were classified as equity +securities, the Company allocated the $250,000 purchase price based on the relative fair values of the Series B Preferred Stock +and the warrants following the guidance in ASC No. 470, Debt . +As the effective conversion +price of the Series B Convertible Preferred Stock on a converted basis was below the market price of the Company’s common +stock on the date of issuance, it was determined that these discounts represent beneficial conversion features. During the years +ended December 31, 2018, the Company valued the BCF at $108,049, based on the difference between the effective conversion price +and the market price of the Company’s common stock on the date of issuance. These features are analogous to preference dividends +and are recorded as a non-cash return to preferred stockholders through accumulated deficit. +F- 52 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Series C Preferred Stock +The +Series C Preferred Stock, par value $0.001, has a stated value of $1,000 per share for up to a maximum issuance of 2,500 shares +of Series C Preferred Stock. Each share of Preferred Stock shall become convertible after eighteen (18) months from the date of +issuance into such number of fully paid and non-assessable shares of the Company’s common stock for $96 per share, subject +to adjustments. The Series C Preferred Stock is mandatorily redeemable by the Company after five years from the date of issuance. +Common Stock +Common stock confers +upon the holders the rights to receive notice to participate and vote at any meeting of stockholders of the Company, to receive +dividends, if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. The +Class B common stock carries the voting power of 10 shares of Class A common stock. +2018 Issuances +Issuance of Common Stock pursuant to +the At the Market Offering +On +February 27, 2018, the Company entered into a sales agreement with H.C. Wainwright & Co., LLC (“HCW”) to sell shares +of the Company’s common stock, having an aggregate offering price of up to $50 million from time to time, through an “at +the market offering” program (the “HCW ATM Offering”) under which HCW acted as sales agent. Between February +27, 2018 and December 31, 2018, the Company had received gross proceeds of $19,022,416 through the sale of 26,552 shares of the +Company’s common stock through the HCW ATM Offering. The offer and sale of the shares through the HCW ATM Offering were made +pursuant to the Company’s effective “shelf” registration statement on Form S-3 and an accompanying base +prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January +8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the HCW ATM Offering, dated +February 27, 2018. The HCW ATM Offering was terminated effective September 23, 2018. +In +connection with the termination of the HCW ATM Offering, HCW released DPW from the right of first refusal provisions set forth +in the sales agreement. In consideration for the release, the Company issued HCW 625 shares of its common stock, which have been +recorded in additional paid in capital, and agreed to pay HCW a fee until February 28, 2020 of three percent of the aggregate gross +proceeds received on future financings by the Company and a one percent fee of aggregate gross proceeds received on future financings +by the Company’s subsidiaries. +On October 10, 2018, +the Company entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Wilson-Davis & +Co., Inc., as sales agent (the “Agent”) to sell shares of its Common Stock, having an aggregate offering price of up +to $25,000,000 (the “Shares”) from time to time, through an at the market offering program (the “WDCO ATM Offering”). +Through December 31, 2018, we had received gross proceeds of $1,637,054 through the sale of 9,303 shares of our common stock through +the WDCO ATM Offering. The offer and sale of the shares through the WDCO ATM Offering were made pursuant to our then effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration +Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the +SEC on January 11, 2018, and a prospectus supplement related to the WDCO ATM Offering, dated October 15, 2018. +Issuance of Common Stock for Services +During the year ended +December 31, 2018, the Company issued to its consultants a total 4,604 shares of its common stock with an aggregate value of $3,740,888, +an average of $812.53 per share for services rendered. +F- 53 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Issuance of Common Stock for Conversion +of Debt +On January 3, 2018, +accrued interest of $23,250 on the 10% Convertible Notes was satisfied through the issuance of 49 shares of the Company’s +common stock. +On January 10, 2018, +principal and accrued interest of $202,000 and $5,723, respectively, on the 12% Convertible Note was satisfied through the issuance +of 472 shares of the Company’s common stock (see Note 20). +On January 12, 2018, +principal and accrued interest of $550,000 and $2,987, respectively, on the 5% Convertible Note was satisfied through the issuance +of 1,152 shares of the Company’s common stock (see Note 20). +On February 9, 2018, +principal and accrued interest of $1,250,000 and $133,884, respectively, on the January 2018 10% Convertible Note was satisfied +through the issuance of 865 shares of the Company’s common stock (see Note 20). +During December 2018, +principal and accrued interest of $18,865 and $259,408, respectively, on the 10% Convertible Note was satisfied through the issuance +of 2,743 shares of the Company’s common stock (see Note 20). +Issuances of Common Stock upon Exercise +of Stock Options +During January 2018, +the Company issued a total of 75 shares of its common stock upon the cash exercise of options. These options were issued pursuant +to the Company’s Plans. The Company received cash of $97,800 as a result of these option exercises. +Issuances of Common Stock upon Exercise +of Warrants +During January 2018, +the Company issued a total of 2,333 shares of its common stock upon the cash and cashless exercise of warrants to purchase an aggregate +of 2,735 shares of its common stock. These warrants were issued between August 2017 and December 2017 in conjunction with various +common stock and debt financings. The Company received cash of $867,166 as a result of these warrant exercises. +On May 8, 2018, the +Company issued 349 shares of common stock pursuant a cashless exercise of warrants issued to Divine Capital Markets, LLC, its Placement +Agent (the “Placement Agent”) for the 2017 private placement of the Series C Preferred Stock and warrants. For its +services, the Placement Agent received, a warrant to purchase 228 shares of the Company’s common stock at $576 per share +and a second warrant to purchase 228 shares of the Company’s common stock at $800 per share. +Issuances of Common Stock in connection +with Convertible Notes +On February 9, 2018, +in conjunction with the securities purchase agreement to sell the January 2018 10% Convertible Note in the principal amount of +$1,250,000 the Company issued 680 shares of restricted common stock to the institutional investor (see Note 20). +On April 16, 2018, +in conjunction with the securities purchase agreements to sell the 12% April 2018 Convertible Note in the principal amount of $1,722,222, +the Company issued 251 shares of restricted common stock to the institutional investor (see Note 20). +On May 15, 2018, in +conjunction with the securities purchase agreement to sell the 10% Convertible Note in the principal amount of $6,000,000 the Company +issued 431 shares of restricted common stock to the institutional investor (see Note 20). +On July 2, 2018, in +conjunction with the securities purchase agreement to sell the Second 10% Convertible Note in the principal amount of $1,000,000 +the Company issued 500 shares of restricted common stock to the institutional investor (see Note 20). +F- 54 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +On August 16, 2018, +in conjunction with the securities purchase agreements to sell secured promissory notes in the aggregate principal face amount +of $1,272,600, the Company issued 500 shares of restricted common stock to the institutional investors (see Note 18). +During September 2018, +in conjunction with the securities purchase agreements to sell secured promissory notes in the aggregate principal face amount +of $789,473, the Company issued 563 shares of restricted common stock to the institutional investors (see Note 18). +On October 11, 2018, +in conjunction with the securities purchase agreements to sell a secured promissory note in the aggregate principal face amount +of $565,000, the Company issued 500 shares of restricted common stock to the institutional investor (see Note 18). +Issuances of Common Stock upon Conversion +of Series D Preferred Stock +During the year ended +December 31, 2018, pursuant to the conversion terms of the Series D Preferred Stock, 378,776 shares of the Series D Preferred Stock +were converted into 947 shares of the Company’s common stock. +Issuances of +Common Stock for cash and cancellation of short-term advances +On October 5, 2017, +Ault & Company purchased 94 shares of the Company’s common stock at $480 per share and a warrant to purchase up to 94 +shares of the Company’s common stock at $480 per share for an aggregate purchase price of $45,000. The shares and warrants +were issued by the Company on May 8, 2018. Ault & Company is controlled by Mr. Milton Ault, the Company’s Chairman +and Chief Executive Officer. +On May 15, 2018, the +Company entered into securities purchase agreements with certain investors in which the Company sold an aggregate of 9,614 shares +of its common stock, 5,168 for cash and 4,446 for the cancellation of short-term advances, and five-year warrants to purchase such +number of shares of common stock equal to the shares of common stock purchased by the investors. The Company received aggregate +consideration of $5,999,584, consisting of cash and the cancellation of short-term advances of $3,225,000 and $2,774,584, respectively. +These securities were issued pursuant to our registration statement filed with the Securities and Exchange Commission (File No. +333-222132) which became effective on January 11, 2018. +2019 Issuances +Issuance of Common Stock pursuant to +the At the Market Offering +On October 10, 2018, +the Company entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Wilson-Davis & +Co., Inc., as sales agent (the “Agent”) to sell shares of its common stock, having an aggregate offering price of up +to $25,000,000 (the “Shares”) from time to time, through an “at the market offering” program (the “WDCO +ATM Offering”). During the year ended December 31, 2019, the Company had received gross proceeds of $4,656,051 through the +sale of 119,791 shares of the Company’s common stock through the WDCO ATM Offering. The offer and sale of the shares through +the WDCO ATM Offering were made pursuant to our then effective “shelf” registration statement on Form S-3 and +an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, +2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to +the WDCO ATM Offering, dated October 15, 2018. +F- 55 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Public Offering +On +March 29, 2019, the Company entered into an underwriting agreement (the “Underwriting Agreement”) with A.G.P./Alliance +Global Partners (the “Underwriter”), pursuant to which the Company agreed to issue and sell an aggregate of (a) 71,388 +shares of its common stock (the “Shares”) together with warrants to purchase 71,388 shares of common stock (the “Common +Warrants”) and (b) pre-funded warrants to purchase up to 317,500 shares of its common stock (the “Pre-Funded Warrants”) +together with a number of Common Warrants to purchase 317,500 shares of common stock (the “Offering”). The Shares were +sold to the purchasers at the public offering price of $17.60 per share (the “Offering Price”). The Common Warrants +were sold at a public offering price of $0.40 per Common Warrant. The Pre-Funded Warrants were offered to each purchaser +whose purchase of the Shares and the Common Warrant in the Offering would otherwise result in the purchaser, together with its +affiliates and certain related parties, beneficially owning more than 4.99% (or, at the election of the purchaser, 9.99%) of the +Company’s outstanding common stock immediately following the consummation of the Offering. The purchase price of each Pre-Funded +Warrant equaled the Offering Price at which the Shares were sold to the public in the Offering, minus $0.40, and the exercise price +of each Pre-Funded Warrant equaled $0.40 per share. In addition, the Company has also issued +the Underwriter a warrant to purchase a maximum of 15,550 additional shares of common stock at an initial exercise price of $19.80 +per share, with a term of five years (the “Underwriter Warrants”). +The Common Warrants +are exercisable at any time after the date of issuance at an exercise price of $0.45 per share. However, since the volume weighted +average price of the Company’s common stock on or after May 2, 2019, was less than $0.45 per share, the Common Warrant is +exercisable by means of a cashless exercise such that the holder of the Common Warrant shall receive one common share for each +warrant held. +Upon +issuance, the Common Warrants, Pre-Funded Warrants and Underwriter Warrants (the “Offering Warrants”) were recorded +at fair value and classified as a liability due to the attributes of the warrants, which included both cash settlement features +and registration obligations. Since the fair value of the Offering Warrants exceeded the proceeds from the Offering the Company +recognized a loss on issuance of warrants of $1,763,481. The fair value of the Offering Warrants was re-measured at each financial +reporting period and immediately before exercise, with any changes in fair value recorded as change in fair value of warrant liability +in the Consolidated Statements of Operations and Comprehensive Loss. The fair value at issuance was calculated using a Black-Scholes +option pricing model using a risk-free interest rate of 2.28%, an expected life of 5 years, expected dividends of zero and expected +volatility of 87.51%. +The +Company received net proceeds from the Offering of $6,204,717, after deducting underwriting discounts and commissions and offering +expenses. The Company used the net proceeds from the Offering primarily for the repayment of debt. +The +Offering closed on April 2, 2019 and as of December 31, 2019, the Company had issued a total of 771,275 shares of its common stock, +inclusive of shares issued pursuant to the exercise of 317,500 Pre-Funded Warrants and 382,387 shares issued pursuant to the cashless +exercise of the Common Warrants. +Ascendiant ATM Offering +On August 6, 2019, +the Company entered into an At-The-Market Issuance Sales Agreement with Ascendiant Capital Markets, LLC, as sales agent to sell +shares of the Company’s common stock having an aggregate offering price of up to $5,500,000 (the “ATM Offering”). +The offer and sale of the Company’s common stock will be made pursuant to the Company’s effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) +filed with the Securities and Exchange Commission (the “Commission”) on December 18, 2017, amended on January 8, 2018, +and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated August 6, +2019. Through December 31, 2019, the Company had received gross proceeds of $5,499,999 through the sale of 1,819,826 shares of +the Company’s common stock from the ATM Offering. +Issuance of Common Stock for Services +During the year ended +December 31, 2019, the Company issued to its consultants a total 69,375 shares of its common stock with an aggregate value of $338,619, +an average of $4.88 per share for services rendered. +F- 56 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Issuance of common stock for conversion +of debt +During the year ended +December 31, 2019, principal and accrued interest of $4,238,878 and $497,417, respectively, on the Company’s debt securities +was satisfied through the issuance of 370,473 shares of the Company’s common stock. +Issuance of common stock in payment +of accrued liability +During the year ended +December 31, 2019, the Company issued 66,740 shares of its common stock in satisfaction of accrued liabilities of $175,377. +Treasury Stock +The Company utilizes the cost method of +accounting for treasury stock. The cost of reissued shares is determined under the last-in, first-out method. The Company purchased +2,750 shares for $57,748 during the year ended December 31, 2018. +23. INCOME TAXES +Deferred income taxes +reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting +purposes and income tax purposes. Significant components of the Company's deferred tax assets are as follows: +2019 +2018 +Deferred tax asset: +Allowance for doubtful accts +$ 163,123 +$ 1,318 +UNICAP +16,314 +22,558 +Obsolete Inventory +41,131 +41,046 +Reserves +1,641,874 +1,577,415 +Warrant Liability +2,330 +3,351 +Accrued Compensation +89,089 +43,111 +Deferred rent liability +— +4,759 +Credit carryforwards +142,484 +142,484 +Stock Compensation +430,274 +425,603 +Fixed Assets, net +1,278,863 +300,240 +Contribution, Carryforward +62 +66 +Accrued interest expense +22,414 +30,822 +Net operating loss carryforwards +11,602,532 +6,924,325 +Lease Liability +899,722 +— +Credit Loss +995,184 +— +Total deferred tax asset +17,325,396 +9,517,098 +Deferred tax liability: +ROU assets +(870,886 ) +— +Intangible Assets, net +(209,044 ) +(567,923 ) +Total deferred income tax liabilities +(1,079,930 ) +(567,923 ) +Net deferred income tax assets +16,245,466 +8,949,175 +Valuation allowance +(16,308,197 ) +(9,054,147 ) +Deferred tax asset (liability), net +$ (62,731 ) +$ (104,972 ) +F- 57 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +At December 31, 2019, +the Company had Federal net operating loss carry forwards (“NOLs”) for income tax purposes of approximately $52,884,756. +Approximately $12,302,381 of NOLs generated prior to 2018 will begin to expire in 2020. The Coronavirus Aid, Relief, and Economic +Security Act (“CARES Act”) signed in to law on March 27, 2020, provided that NOLs generated in a taxable year beginning +in 2018, 2019, or 2020, may now be carried back five years and forward indefinitely. In addition, the 80% taxable income limitation +is temporarily removed, allowing NOLs to fully offset net taxable income. In accordance with Section 382 of the Internal Revenue +Code, the future utilization of the Company’s net operating loss to offset future taxable income may be subject to an annual +limitation as a result of ownership changes that may have occurred previously or that could occur in the future. Management believes +that such an ownership change may have occurred during 2017. The Company has estimated the Section 382 annual limitation due to +this ownership change to be approximately $157,433. This has been used to reduce the amount of the net operating losses that have +limited carryforward periods. +At December 31, 2019, +Microphase, an entity not consolidated for income tax purposes, had NOLs of approximately $12,064,563. Approximately $11,684,781 +of NOLs generated prior to 2018 will begin to expire in 2020. NOLs generated in a taxable year beginning in 2018, 2019, or 2020, +may be carried back five years and forward indefinitely. In accordance with Section 382 of the Internal Revenue Code, the future +utilization of the Company’s net operating loss to offset future taxable income may be subject to an annual limitation as +a result of ownership changes that may have occurred previously or that could occur in the future. +In assessing the realization +of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets +will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income +during the periods in which temporary differences representing net future deductible amounts become deductible. Management considers +the scheduled reversal of deferred tax assets, projected future taxable income and tax planning strategies in making this assessment. +After consideration of all of the information available and due to the last five years significant losses there is substantial +doubt related to the Company’s ability to utilize its deferred tax assets, the Company recorded a full valuation allowance +of the deferred tax asset. For the year ended December 31, 2019, the valuation allowance has increased by $7,254,050. +The 2016 and 2017 tax +year remains open to examination by the Internal Revenue Service (“IRS”) and the 2016 through 2017 tax years remain +open to examination by the California Franchise Tax Board (“FTB”) and the Connecticut Department of Revenue (“CDR”). +The IRS, FTB and CDR have the authority to examine those tax years until the applicable statute of limitations expires and the +years with net operating loss carryovers when such carryovers are used. Returns for tax year 2018 have not been filed. +As of December 31, +2019, the Company’s foreign subsidiaries had accumulated losses for income tax purposes in the amount of approximately $2,220,361. All +of the Company’s international accumulated losses were generated in the United Kingdom and Israel which have statutory tax +rates of 19% and 7.5% respectively. These net operating losses may be carried forward and offset against taxable income +in the future for an indefinite period. +The net income tax benefit consists +of the following: +2019 +2018 +Current +US Federal +$ — +$ — +US State +— +— +Foreign +— +134,017 +Total current provision +— +134,017 +Deferred +US Federal +— +(158,482 ) +US State +— +— +Foreign +(108,293 ) +(52,134 ) +Total deferred benefit +(108,293 ) +(210,616 ) +Total provision for income taxes +$ (108,293 ) +$ (76,599 ) +F- 58 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The Company’s +effective tax rates were 0.4% and 0.3% for the years ended December 31, 2019 and 2018, respectively. During the year ended +December 31, 2019, the effective tax rate differed from the U.S. federal statutory rate primarily due to the change in the valuation +allowance and the effect of changes in tax rates in future periods. The reconciliation of income tax attributable to operations +computed at U.S. Federal statutory income tax rates of 21% to income tax expense is as follows: +2019 +2018 +Expected federal income tax benefit +21.0 % +21.0 % +Beneficial conversion feature +(0.6 %) +(1.1 %) +State taxes net of federal benefit +3.5 % +2.4 % +Foreign rate differential +(0.2 %) +(0.3 %) +Section 382 limitation +— +(4.9 %) +Effect of change in tax rates +— +(1.8 %) +Effect of change in valuation allowance +(21.9 %) +(15.1 %) +Other +(1.4 %) +0.1 % +Income taxes provision (benefit) +0.4 % +0.3 % +The Company accounts +for uncertain tax positions in accordance with ASC No. 740-10-25. ASC No. 740-10-25 addresses the determination of whether tax +benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, +the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position +will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit to be +recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate +settlement. To the extent that the final tax outcome of these matters is different than the amount recorded, such differences impact +income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities +for potential tax assessments are included in income tax expense. ASC No. 740-10-25 also requires management to evaluate tax positions +taken by the Company and recognize a liability if the Company has taken uncertain tax positions that more likely than not would +not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated tax positions taken +by the Company and has concluded that as of December 31, 2019 and 2018, there are no uncertain tax positions taken, or expected +to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +24. RELATED PARTY TRANSACTIONS +a. The Company and AVLP entered into a Loan and Security Agreement (“AVLP Loan Agreement”) +with an effective date of August 21, 2017, pursuant to which the Company will provide AVLP a non-revolving credit facility +of up to $10,000,000 for a period ending on August 21, 2021, subject to the terms and conditions stated in the Loan Agreement, +including that the Company having available funds to grant such credit. At December 31, 2019, the Company has provided loans to +AVLP in the principal amount $9,595,079 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company +warrants to purchase 19,190,158 shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP +are secured by the assets of AVLP. As of December 31, 2019, the Company recorded contractual interest receivable attributed to +the AVLP Loan Agreement of $2,025,475. +During the years ended December +31, 2019 and 2018, the Company also acquired in the open market 91,000 shares of AVLP common stock for $53,032 and 430,942 shares +of AVLP common stock for $417,169, respectively. At December 31, 2019, the Company’s investment in AVLP common stock had +an unrealized loss of $507,959. +F- 59 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Philou is AVLP’s controlling +shareholder. Mr. Ault is Chairman of AVLP’s Board of Directors and the Chairman of the Board. Mr. William B. Horne is the +Chief Financial Officer and a director of AVLP and the Company. +In March 2017, the Company was +awarded a $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“MLSE”) +plasma-laser system. During the years ended December 31, 2019 and 2018, the Company recognized nil and $3,907,280, respectively, +in revenues from MTIX to manufacture the Multiplex Laser Surface Enhancement (“MLSE”) plasma-laser systems. On April +12, 2019, the Company received payment of $2,676,219 for manufacturing services performed on the first MLSE system. At December +31, 2019, the Company had recorded a receivable from MTIX of $1,238,856. +b. During the year ended December 31, 2019, the Company acquired 372,625 shares of common stock of +Alzamend from a third party for $208,100 consisting of the cancellation of principal and interest due the Company of $181,483 and +cash of $26,617. During the year ended December 31, 2019, the Company recognized an unrealized gain of $350,838 resulting from +its investment in Alzamend common stock. +c. During the year ended December 31, 2019, Ault & Company, Inc. (“Ault & Company”) +has provided $1,335,570 in short-term advances. Ault and Company is the Manager of Philou which presently owns 125,000 shares of +the Company’s Series B Preferred Stock. Mr. Ault and Mr. Horne serve as the Chief Executive Officer and Chief Financial Officer, +respectively, of Ault & Company. +d. On December 22, 2019, the Company entered into a securities +purchase agreement with Ault & Company. Pursuant to the terms of the agreement, Ault & Company shall purchase an aggregate +of 660,667 shares of the Company’s common stock for a total purchase price of $739,948, at a purchase price per share of +$1.12, subject to the approval of the NYSE American. The NYSE American approved the purchase on January 15, 2020 (see Note 26). +e. Ault & Company guaranteed the prompt and complete payment and performance of the Dominion short-term +promissory note with a principal face amount of $2,900,000. +f. On March 9, 2017, the Company entered into a preferred stock purchase agreement with Philou. Pursuant +to the terms of the preferred stock purchase agreement, Philou may invest up to $5,000,000 in the Company through the purchase +of Series B Preferred Stock over 36 months. Philou has purchased 125,000 shares of Series +B Preferred Stock pursuant to the terms of the purchase agreement, the most recent purchase having occurred on April 24, 2018 for +the purchase of 25,000 shares of Series B Preferred Stock . +g. Between July 6, 2017 and September 30, 2018, Milton C. Ault, III, the Company’s Chairman +and Chief Executive Officer, personally guaranteed the repayment of (i) $8,218,000 from the sale of Advances on Future Receipts +(ii) and $4,781,000 from the sale of the promissory notes. These personal guarantees were necessary to facilitate the consummation +of these financing transactions. Mr. Ault’s payment obligations would be triggered if the Company failed to perform under +these financing obligations. Our board of directors has agreed to compensate Mr. Ault for his personal guarantees. The amount of +annual compensation for each of these guarantees, which will be in the form of non-cash compensation, is approximately 1.5% of +the amount of the obligation. +25. SEGMENT, CUSTOMERS AND GEOGRAPHICAL INFORMATION +The Company has five +reportable segments as of December 31, 2019 and 2018; see Note 1 for a brief description of the Company’s business. +F- 60 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The following data presents the revenues, +expenditures and other operating data of the Company’s geographic operating segments and presented in accordance with ASC +No. 280. +Year ended December 31, 2019 +GWW +Coolisys +DP Lending +Digital Farms +I.AM +Total +Revenue +$ 15,231,843 +$ 5,825,666 +$ — +$ — +$ — +$ 21,057,509 +Revenue, cryptocurrency +mining +— +— +— +641,745 +— +641,745 +Revenue, restaurant +operations +— +— +— +— +4,149,646 +4,149,646 +Revenue, lending activities +— +— +$ 662,740 +— +— +662,740 +Total revenues +$ 15,231,843 +$ 5,825,666 +$ 662,740 +$ 641,745 +$ 4,149,646 +$ 26,511,640 +Depreciation and +amortization expense +$ 705,873 +$ 121,618 +$ — +$ 2,245,676 +$ 391,924 +$ 3,465,091 +Loss from operations +$ (828,424 ) +$ (1,327,259 ) +$ (1,673,065 ) +$ (6,939,212 ) +$ (2,243,879 ) +$ (13,011,839 ) +Capital expenditures for +segment assets, as of +December 31, 2019 +$ 34,899 +$ 133,198 +$ 21,203 +$ — +$ 12,060 +$ 201,360 +Identifiable assets as of +December 31, 2019 +$ 20,847,352 +$ 18,901,630 +$ 1,727,275 +$ 487,997 +$ 786,154 +$ 42,750,408 +Year ended December 31, 2018 +GWW +Coolisys +DP Lending +Digital Farms +I.AM +Eliminations +Total +Revenue +$ 11,933,092 +$ 5,829,125 +$ — +$ — +$ — +$ — +$ 17,762,217 +Revenue, cryptocurrency +mining +— +— +— +1,675,549 +— +— +1,675,549 +Revenue, related party +— +3,907,280 +— +— +— +— +3,907,280 +Revenue, restaurant +operations +— +— +— +— +3,462,140 +— +3,462,140 +Revenue, lending activities +— +— +347,033 +— +— +— +347,033 +Inter-segment revenues +— +36,833 +— +— +— +(36,833 ) +— +Total revenues +$ 11,933,092 +$ 9,773,238 +$ 347,033 +$ 1,675,549 +$ 3,462,140 +$ (36,833 ) +$ 27,154,219 +Depreciation and +amortization expense +$ 615,503 +$ 139,897 +$ — +$ 2,151,505 +$ — +$ — +$ 2,906,905 +Loss from operations +$ (2,251,686 ) +$ (2,194,809 ) +$ (179,760 ) +$ (6,369,138 ) +$ (81,264 ) +$ — +$ (11,076,657 ) +Capital expenditures for +segment assets, as of +December 31, 2018 +$ 52,319 +$ 41,998 +$ — +$ 8,891,928 +$ 183,747 +$ — +$ 9,169,992 +Identifiable assets as of +December 31, 2018 +$ 18,400,343 +$ 19,173,587 +$ 2,760,314 +$ 7,018,958 +$ 2,072,678 +$ — +$ 49,425,880 +F- 61 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Concentration Risk: +The following table +provides the percentage of total revenues attributable to a single customer from which 10% or more of total revenues are derived: +For the Years Ended +December 31, 2019 +Total Revenues +Percentage of +by Major +Total Company +Customers +Revenues +Customer A +$ 6,319,221 +24 % +For the Years Ended +December 31, 2018 +Total Revenues +Percentage of +by Major +Total Company +Customers +Revenues +Customer B +$ 3,907,280 +14 % +Revenue from Customer +A is attributable to Enertec. Revenue from Customer B relates to MTIX, a related party, and is attributable to Coolisys. Further, +at December 31, 2019, MTIX represented all the Company’s accounts and other receivable, related party. +For the years ended +December 31, 2019 and 2018, total revenues from external customers divided on the basis of the Company’s product lines are +as follows: +For the Years Ended +December 31, +2019 +2018 +Revenues: +Commercial products +$ 13,103,036 +$ 10,597,256 +Defense products +13,408,604 +16,556,963 +Total revenues +$ 26,511,640 +$ 27,154,219 +Financial data relating to geographic +areas: +The Company’s +total revenues are attributed to geographic areas based on the location. The following table presents total revenues for the years +ended December 31, 2019 and 2018. Other than as shown, no foreign country or region contributed materially to revenues or long-lived +assets for these periods: +For the Years Ended +December 31, +2019 +2018 +Revenues: +North America +$ 15,072,792 +$ 19,113,226 +Middle East +8,681,023 +5,226,075 +Europe +1,678,256 +1,765,991 +Other +1,079,569 +1,048,927 +Total revenues +$ 26,511,640 +$ 27,154,219 +F- 62 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +26. SUBSEQUENT EVENTS +In accordance with +FASB ASC 855-10, the Company has analyzed its operations subsequent to December 31, 2018 and thru the date of this report being +issued and has determined that it does not have any material subsequent events to disclose in these financial statements except +for the following. +Sale of Common +Stock, Related Party +On +December 23, 2019, the Company entered into a securities purchase agreement with Ault & Company. Pursuant to the terms of this +agreement, Ault & Company agreed to purchase an aggregate of 660,667 shares of the Company’s common stock for a total +purchase price of $739,948 at a purchase price per share of $1.12, subject to the approval of the NYSE American. +The +sale was authorized by the NYSE American on January 15, 2020. As a result, at the closing on January 15, 2020, Ault & Company +became the beneficial owner of 666,945 shares of Common Stock, or up to 19.99% of the Common Stock then outstanding. +Convertible +Note, Related Party +On +February 5, 2020, (the “ Closing Date ”), the Company sold +and issued an 8% convertible promissory note in the principal amount of $1,000,000 to Ault & Company. The principal amount +of this note, plus any accrued and unpaid interest at a rate of 8% per annum, shall be due and payable on August 5, 2020. The Note +shall be convertible into shares of the Company’s common stock at a conversion price of $1.45 per share, subject to the approval +of the Company’s stockholders at a special meeting thereof, as required by Rule 713(a)(ii) of the NYSE Company Guide, and +subsequently, authorization from the NYSE American. +Master Exchange +Agreement +On February 10, 2020, +the Company entered into a master exchange agreement (the “ Master Exchange Agreement ”) with Esousa Holdings, +LLC (the “Creditor”) which acquired approximately $4.2 million dollars in principal amount, plus accrued but unpaid +interest, of certain promissory notes that had been previously issued by us to Dominion (the “Dominion Short-Term Promissory +Note”) and the Canadian Special Opportunity Fund, LP (the “CSOF Note” and with the Dominion Short-Term Promissory +Note, the “Purchased Notes”) in separate transactions. The Creditor also agreed to purchase additional notes up to +an additional principal amount, plus accrued but unpaid interest, of $3.5 million (the “Additional Notes” and collectively, +with the Purchased Notes, the “Notes”). Pursuant to the Master Exchange Agreement, the Creditor has the unilateral +right to acquire, among other things set forth therein, shares of the Company’s common stock (the “Exchange Shares”) +in exchange for the Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness of the Company. +The first exchange +occurred on the date of the Master Exchange Agreement upon which the Creditor may exchange, in whole or in part, the Dominion Note +for the Exchange Shares (the “Initial Exchange”) and the second exchange (the “Second Exchange” and together +with the Initial Exchange, the “Exchange”) shall occur if, within sixty days after the Initial Exchange, the Company +receives stockholder approval at a special meeting thereof for the Exchange of the Additional Notes for the Company’s common +stock, as required by Rule 713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American (together, +the “Required Approvals”). +The Exchange Agreement +provides for two pricing periods, the first of which shall commence after the date on which the Creditor receives the Exchange +Shares pursuant to the Initial Exchange and ending on the date that is 90 days after such receipt thereof, subject to extension +as provided for in the Exchange Agreement, and the second of which shall commence on the date on which the Creditor receives the +Exchange Shares pursuant to the Second Exchange and ending on the date that is 90 days after such receipt thereof, in either case, +unless earlier terminated by the Creditor by written notice. +F- 63 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +The number of shares +to be issued upon each Exchange will be equal to (x) the principal and accrued but unpaid interest due on the Notes being exchanged +multiplied by 1.35, divided by (y) the closing bid price effective on each date of an exchange notice, provided, however, that +the Company shall theretofore have obtained the Required Approvals (the “Exchange Price”). The total number of shares +of the Company’s common stock to be issued to Creditor in connection with the applicable Exchange shall be adjusted on the +Business Day immediately following the Pricing Period based upon the volume weighted average price (“VWAP”) of the +Company’s common stock over the applicable Pricing Period (the “VWAP Shares”). VWAP Shares means the number of +shares determined by dividing (x) the Exchange Amount of the applicable Exchange, multiplied by 1.1, by (y) the greater of (I) +seventy-five percent (75.0%) of the VWAP of the Company’s common stock over the applicable Pricing Period, or (II) $0.30 +per share. +Pursuant to the Master +Exchange Agreement, the Company has agreed to issue to the Creditor warrants to purchase shares of the Company’s common stock +equal to (i) the amount of the Additional Notes, multiplied by 0.83, and divided by (ii) the Closing Bid Price of the Company’s +common stock as of the date immediately prior to the Initial Exchange (the “Purchase Warrant”), or $1.30. The Purchase +Warrant shall be exercisable, commencing on the date upon which the Company receives the Required Approvals thereof, for the exercise +price of one hundred ten percent (110%) of the Closing Bid Price of the Company’s common stock as of the date immediately +prior to the Initial Exchange, or $1.43. In connection therewith, the Company has agreed to file a registration statement to register +the sale of the shares of common stock underlying the exercise of the Purchase Warrant by the Creditor pursuant to the Master Exchange +Agreement. In the event that the Creditor does not purchase all of the Additional Notes, the Company shall have the option to acquire +a portion of the Purchase Warrants from the Creditor for an aggregate price of $1.00. +Between +February 20 and April 2020, the Company issued to the investor an aggregate of 861,580 shares of the Company’s common stock +upon the exchange of principal in the amount of $836,845. +Settlement of Derivative Litigation +On February 24, 2020, +the Company, entered into a definitive settlement agreement (the “Settlement Agreement”) that is intended to settle +the previously disclosed derivative litigation captioned Ethan Young and Greg Young, Derivatively on Behalf of Nominal Defendant, +DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, Robert O. Smith, and Kristine +Ault and DPW Holdings, Inc., as the nominal defendant (Case No. 18-cv-6587) (as amended on March 11, 2019, the “Amended +Complaint”) against the Company and certain of its officers and directors pending in the United States District Court for +the Central District of California (the “Court”). As previously disclosed, the Amended Complaint alleges violations +including breaches of fiduciary duties and unjust enrichment claims based on the previously pled transactions. +Under the terms of +the settlement agreement, the Company’s Board of Directors (the “ Board ”) shall adopt and/or maintain resolutions +and amendments to committee charters and/or the Company’s bylaws within thirty (30) days of issuance of an Order and Final +Judgment entered by the Court approving the settlement (the “ Order ”) to ensure adherence to certain corporate +governance policies (collectively, the “ Reform(s) ”), which shall remain in effect for no less than five (5) +years, subject to any of the following: (a) a determination by a majority of the independent directors that the Reform is no longer +in the best interest of the Company, including, but not limited to, due to circumstances making the Reform no longer applicable, +feasible, or available on commercially reasonable terms, or (b) modifications which the Company reasonably believes are required +by applicable law or regulation. +In connection with +the settlement agreement, the parties have agreed upon a payment of attorneys’ fees in the amount of $600,000 payable by +the Company’s Director & Officer liability insurance. +The settlement agreement +contains no admission of wrongdoing. The Company has always maintained and continues to believe that it did not engage in any wrongdoing +or otherwise commit any violation of federal or state securities laws or other laws. +F- 64 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Pursuant to the settlement +agreement, the Company and certain of its officers and directors will be released from the claims that were asserted or could have +been asserted in the Amended Complaint by the plaintiffs therein. The settlement is subject to the implementation of certain Reforms, +including, among others, (i) the resignation of a current director and the appointment of two (2) new independent directors to +the Board and the Company’s three-member Nomination and Governance Committee (the “Governance Committee”), one +of whom shall also be appointed to the Company’s three-member Audit Committee as an audit committee financial expert (the +“Expert”) as such term is defined by the SEC, (ii) certain amendments to the Company’s bylaws setting forth the +composition of its directors and requirements of an independent director, (iii) the creation of a policy for related party transactions +to be administered by the Company’s Governance Committee, (iv) certain amendments to the Audit Committee Charter, (v) the +adoption of a written policy protecting whistleblowers, and (vi) within six (6) months of the Order, a resolution by the Board +adopting a clawback policy for accounting restatements to financial statements included in a quarterly or annual report filed with +the Commission. In addition, the settlement is subject to the preliminary and final Court approval, funding of the $600,000 in +cash by the Company’s insurance carrier, and other customary closing conditions. There can be no assurance that the settlement +will be finalized and approved by the Court and, even if approved, whether the conditions to closing will be satisfied, and the +actual outcome of this matter may differ materially from the terms of the settlement described herein. +Coronavirus +disease 2019 pandemic +In March 2020, the +World Health Organization declared the outbreak of a novel coronavirus (“COVID-19”) as a pandemic which continues to +spread throughout the United States and the World. The Company is monitoring the outbreak of COVID-19 and the related business +and travel restrictions and changes to behavior intended to reduce its spread, and its impact on operations, financial position, +cash flows, inventory, supply chains, customer purchasing trends, customer payments, and the industry in general, in addition to +the impact on its employees. Due to the rapid development and fluidity of this situation, the magnitude and duration of the pandemic +and its impact on the Company's operations and liquidity is uncertain as of the date of this report. +However, the Company’s +business has been disrupted and materially adversely affected by the recent outbreak of COVID-19. Consequently, the Company is +relying on the order issued by the SEC on March 25, 2020, providing an additional 45 days from the original due date to file this +Form 10-K. We are still assessing our business operations and system supports and the impact COVID-19 may have on our results and +financial condition, but there can be no assurance that this analysis will enable us to avoid part or all of any impact from the +spread of COVID-19 or its consequences, including downturns in business sentiment generally or in our sectors in particular. +Our +operations are located in Alameda County, CA, Orange County, CA, Fairfield County, CT, the United Kingdom, Israel and members of +our senior management work in Seattle, WA and New York, NY, which is also the location of the offices of the Company’s +independent auditor . The Company has been following the recommendations of local health authorities +to minimize exposure risk for its employees, including the temporary closures of its offices and having employees work remotely +to the extent possible , which has to an extent adversely affected their efficiency. +Updates by business +unit are as follows: +· DPW Holdings’ corporate headquarters, located in Newport Beach, CA, has begun working remotely, +based on the occupancy and social distancing order from the Orange County Health Officer (http://www.ochealthinfo.com/phs/about/epidasmt/epi/dip/prevention/novel_coronavirus). +The headquarters staff has tested the secure remote access systems and technology infrastructure to adjust working arrangements +for its employees and believes it has adequate internal communications system and can remain operational with a remote staff. +· Coolisys Technologies Corp., located in Fremont, CA, has temporarily suspended operations as a +result of the Alameda County Public Health Department’s order to cease all activities at facilities located within the County. +F- 65 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +· Microphase Corporation, located in Shelton, CT, has developed an emergency plan to ensure that +its mission critical manufacturing and logistical functions are up and running. Microphase has implemented additional steps to +ensure a higher level of cleanliness in its facility. Employees at greater risk of major health issues from COVID-19, which include +key members of its finance department, are not required to work on site. The crisis management team meets regularly to monitor +the situation, and modifies and communicates the plan as the need arises. Once the COVID-19 crisis has passed, the team will work +on transitioning Microphase back to normal operations. +· Gresham Power Electronics Limited, located in Salisbury, UK, temporarily suspended operations on +March 19, 2020. +· Enertec Systems 2001 Ltd., located in Karmiel, Israel, has been granted a waiver by the Israeli +government to remain open to complete key projects that impact national security. Approximately 50% of the Enertec workforce is +working remotely. +Discontinued +Operations +The Company continuously +assess the composition of its business operations to ensure they are aligned with its strategic objectives and positioned to maximize +growth and return to its shareholders. On March 16, 2020, to try and mitigate the spread of COVID-19, San Diego County health +officials issued orders mandating that all restaurants must end dine-in services. As a result of these temporary closures and the +deteriorating business conditions at both the Company’s cryptocurrency mining and restaurant businesses, the Company concluded +that discontinuing these operations was ultimately in its best interest. During the first quarter of 2020, the Company discontinued +the operations of Digital Farms and I. AM. Digital Farms was established to pursue a variety +of digital currency and mined the top three cryptocurrencies for its own account. I.AM owns and operates the Prep Kitchen +brand restaurants located in the San Diego area. Accordingly, during the first quarter of 2020, the Company will begin to separately +report the results of the cryptocurrency mining and restaurant businesses as discontinued operations in its consolidated statements +of operations and present the related assets and liabilities as held for sale in its consolidated balance sheets. +Paycheck Protection +Program +In +March 2020, U.S. lawmakers agreed on the passage of a $2 trillion stimulus bill called +the CARES (Coronavirus Aid, Relief, and Economic Security) Act to blunt the impact +of an economic downturn set in motion by the global coronavirus pandemic. On March 27, 2020, President Trump signed the bill into +law. The main driver of small business stimulus in the CARES Act is contained in the +Paycheck Protection Program (PPP). PPP Loans may be used to cover payroll, benefits, and salaries, as well as interest payments, +rent, and utilities. Fees are waived , and collateral and personal guarantees are not required. Payments +are deferred for a minimum of six months, up to one year, and there are no prepayment penalties. +During +April 2020, the Company received loans under the PPP in the principal amount of $715,101. The principal of the loan may be forgiven +up to the total cost of payroll, mortgage interest payments, rent and utility payments made during the eight-week period after +origination. In addition to meeting the size requirement (500 or fewer employees for most +companies), the Company was required to demonstrate that its business had been negatively impacted by COVID-19. +F- 66 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +February 2020 Exchange Agreement +On +February 5, 2020 the Company entered into an exchange agreement (the “February ‘20 Exchange Agreement”) with +an institutional investor pursuant to which the Company issued to the investor a 12% convertible promissory note in the principal +amount of $295,000 with a conversion price of $1.45 per share of common stock and a 12% promissory note in the principal amount +of $585,919. These two notes were issued upon the exchange of the 12% Convertible Note, in the principal amount of $815,218, issued +on September 26, 2019 (see note 20). On February 25, 2020, the Company issued to the investor 203,448 shares of the Company’s +common stock upon the conversion of principal of $295,000. +Issuances of Common Stock for conversion +of Debt +Between January and +April 2020, the Company issued 650,049 shares of its common stock pursuant to the terms of the 8% Convertible Promissory Note, +in the principal face amount of $935,772, issued on November 15, 2019 (see note 20). +Issuances of +Common Stock for Services +During March 2020, +the Company issued 65,000 shares of its common stock as payment for services to its consultants. The shares were valued at $73,450, +an average of $1.13 per share. +Issuances of Common Stock in connection +with Promissory Note +On March 4, 2020, pursuant +to the terms of the securities purchase agreement for the sale of the Dominion short-term promissory note, the Company issued to +Dominion 12,500 shares of its common stock (see note 18). +F-67 \ No newline at end of file diff --git a/raw/filings/0000896493/2019/0001214659-20-005205/filing_metadata.csv b/raw/filings/0000896493/2019/0001214659-20-005205/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..f125ef7639274e21f742610be3b2f9b013a7b37c --- /dev/null +++ b/raw/filings/0000896493/2019/0001214659-20-005205/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2020-05-29,2019-12-31,2020-05-29T21:25:18.000Z,0001214659-20-005205,s51920110k.htm,,15047345,1,0,https://www.sec.gov/Archives/edgar/data/896493/000121465920005205/s51920110k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465920005205/,2019,2019,1 diff --git a/raw/filings/0000896493/2019/0001214659-20-005205/item1.txt b/raw/filings/0000896493/2019/0001214659-20-005205/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..38ad03a5af44bf70896238644825836b6afe4a08 --- /dev/null +++ b/raw/filings/0000896493/2019/0001214659-20-005205/item1.txt @@ -0,0 +1,610 @@ +ITEM 1. BUSINESS +General +DPW Holdings, Inc. +is a diversified holding company that owns operating subsidiaries and divisions engaged in a number of diversified business operations +including the defense, aerospace, commercial, health/medical, finance and commercial lending sectors. The Company’s largest +subsidiary is Gresham Worldwide, which provides advanced bespoke military and commercial applications. The Company began implementing +its strategy in late 2016 led by its Chairman and CEO, Milton “Todd” Ault, III and Vice Chairman and CFO, William B. +Horne. The Company is presently led by its Executive Committee, the members of which are the Company’s Chairman and CEO, +Vice Chairman and Executive Vice President & General Counsel. +We operate as a holding +company with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed +an investment company under the Investment Company Act of 1940, as amended (the “ Investment Company Act ”). Generally, +this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total +assets will be invested in investment securities as such term is defined in the Investment Company Act. Pursuant to the Investment +Company Act, companies such as our subsidiary DP Lending are excluded from the definition of an investment company since its business +consists of making small loans and industrial banking. We also maintain a large investment in Avalanche International, Corp., which +does business as MTIX International. +Originally, we were +primarily a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power +system solutions for the medical, military, telecom and industrial markets. Although we are actively seeking growth through acquisitions, +we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where +customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating +conditions. +We have operations +located in Europe through our wholly-owned subsidiary, Gresham Power Electronics (f/k/a Digital Power Limited) (“ Gresham +Power ”), Salisbury, England. Gresham Power designs, manufactures and sells power products and system solutions mainly +for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters +and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution +products. +1 +Table of Contents +On November 30, 2016, +we formed DP Lending, a wholly-owned subsidiary. DP Lending provides commercial loans to companies throughout the United States +to provide them with operating capital to finance the growth of their businesses. The loans range in duration from six months to +three years, DP Lending operates under California Finance Lending License #60DBO-77905. +On June 2, 2017, we +purchased 56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is +a design-to-manufacture original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio +frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies +and detector logarithmic video amplifiers (“ DLVA ”) to the military, aerospace and telecommunications industries. +Microphase is headquartered in Shelton, Connecticut. +On April 25, 2017, +we formed Coolisys Technologies, Inc. (“ Coolisys ”), a wholly-owned subsidiary. Coolisys operates its existing +businesses in the customized and flexible power system solutions for the medical, military, telecom, commercial and industrial +markets, other than the European markets which are primarily served by Gresham Power, in Coolisys. We intend to reorganize our +corporate structure to make Digital Power North American operations, operated by our subsidiary Gresham, and Microphase, a subsidiary +of Coolisys and as such an indirect subsidiary of ours. +On September 1, 2017, +Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability +company (“ Power-Plus ”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, +fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an +extended sales organization for our overall flexible power system solutions. +On +December 31, 2017, Coolisys entered into a share purchase agreement with Micronet Enertec Technologies, Inc. (“ MICT ”), +a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“ EML ”), +and Enertec Systems 2001 Ltd. (“ Enertec ”), an Israeli corporation and wholly owned subsidiary of EML, pursuant +to which Coolisys acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for +the military market. On May 23, 2018, Coolisys completed its acquisition of Enertec. +In +January 2018, we formed Super Crypto Mining, Inc., a wholly-owned subsidiary, which recently changed its name to Digital Farms, +Inc. (“ DFI ”). DFI was established to operate our newly formed cryptocurrency business, which is pursuing a variety +of digital currency. We mine the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin +and Ethereum. DFI’s operations were discontinued in the first quarter of 2020. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I. AM, Inc. (“ I. AM ”), +David J. Krause and Deborah J. Krause. Pursuant to the securities purchase agreement, I. AM sold to DP Lending, 981 shares of common +stock for a purchase price of $981, representing, upon the closing, 98.1% of I. AM’s outstanding common stock. I.AM owed +DP Lending $1,715,330 in outstanding principal, pursuant to a loan and security agreement, between I. AM and DP Lending. The purchase +agreement provides that, as I. AM repays the outstanding loan to DP Lending in accordance with the loan agreement, DP Lending will +on a pro rata basis transfer shares of common stock of I. AM to David J. Krause, up to an aggregate of 471 shares. I. +AM’s operations were discontinued in the first quarter of 2020. +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 201 Shipyard Way, Suite E Newport +Beach, CA 92663. Our phone number is (949) 444-5464 and our website address is www.dpwholdings.com. +Recent Events +On March 14, 2019, +the stockholders approved a proposal permitting the Board of Directors (the “ Board ”) to effect a reverse stock +split (the “ Reverse Split ”) of our issued and outstanding Common Stock. Thereafter, on March 14, 2019, the Board +approved the Reverse Split with a ratio of one for twenty. The Reverse Split did not affect the number of authorized shares of +Common Stock or their par value per share. As a result of the Reverse Split, the number of shares of Common Stock outstanding was +reduced from 126,025,767 to 6,301,289. The Reverse Split became effective in the State of Delaware on March 14, 2019. Beginning +on March 18, 2019, the Common Stock traded on the NYSE American on a split-adjusted basis. +On +March 29, 2019, we entered into an underwriting agreement with A.G.P./Alliance Global Partners (the “ Underwriter ”), +pursuant to which we agreed to issue and sell an aggregate of (a) 71,388 shares of Common Stock (the “ Offering Shares ”) +together with warrants to purchase 71,388 shares of Common Stock and (the “ Common Warrants ”) and (b) pre-funded warrants +to purchase up to 317,500 shares of our Common Stock (the “ Pre-Funded Warrants ”) together with a number +of Common Warrants to purchase 317,500 shares of Common Stock (the “ Offering ”). The Offering Shares were sold +to the purchasers at the public offering price of $17.60 per share (the “ Offering Price ”). The Common Warrants +were sold at a public offering price of $0.40 per Common Warrant. The Pre-Funded Warrants were offered to each purchaser whose +purchase of the Offering Shares and the Common Warrants in the Offering would otherwise result in the purchaser, together with +its affiliates and certain related parties, beneficially owning more than 4.99% of outstanding Common Stock immediately following +the consummation of the Offering, in lieu of the Offering Shares. The purchase price of each Pre-Funded Warrants equaled the Offering +Price, minus $0.40, and the exercise price of each Pre-Funded Warrant equaled $0.40 per share. In addition, we also issued the +Underwriter a warrant to purchase a maximum of 15,550 additional shares of Common Stock at an initial exercise price of $19.80 +per share, with a term of five years. +2 +Table of Contents +On +May 13, 2019, we entered into a Note Purchase Agreement, whereby we sold and issued to an investor a promissory note in the +principal amount of $575,000 (the “ First Note ”) for the purchase price of $500,000, plus a 15% loan fee in the +amount of $75,000. The principal amount shall be due and payable on or prior to August 9, 2019, subject to extensions as set forth +in the First Note. Subsequently, on May 21, 2019, we entered into a second Note Purchase Agreement, pursuant to which we sold and +issued an additional promissory note in the principal amount of $230,000 (the “ Second Note ”), for a purchase +price of $200,000, plus a 15% loan fee in the amount of $30,000. An aggregate total of $700,000 has been raised from these two +notes. The principal amount of the Second Note shall be due and payable on or prior to August 21, 2021, subject to extensions as +set forth therein. These notes do not accrue any interest and may be prepaid by the Company at any time, without notice, premium +or penalty. At present, we owe approximately $60,000 to this investor. +On +May 20, 2019, we entered into a Securities Purchase Agreement with an institutional investor to sell, for a purchase price of $500,000, +a 4% Original Issue Discount Convertible Promissory Note (the “ May 2019 Note ”) with an aggregate principal face +amount of $660,000 and a warrant to purchase an aggregate of 12,500 shares, subject to adjustment of our Common Stock. The principal +of the May 2019 Note and interest earned thereon may be converted into shares of our Common Stock at $8.80 per share, subject to +adjustment. The exercise price of the warrant is $12.00 per share, subject to adjustment. The issuance of shares of our Common +Stock upon conversion of the May 2019 Note and exercise of the warrant was subject to approval by the NYSE American, which approval +was obtained. In addition, our Chief Executive Officer provided a personal guarantee for the Company’s obligation to repay +the May 2019 Note. +On +June 18, 2019 we entered into a Securities Purchase Agreement with Dominion Capital, LLC (“ Dominion ”) to consummate +a refinancing (the “ Refinancing ”) pursuant to which, in consideration for the extinguishment of a 10% convertible +note dated May 15, 2018, with a remaining balance due of $1,800,000, we (i) sold a 10% Senior Secured Promissory Note with a principal +face amount of $2,800,000, plus an original issue discount in the amount of $100,000 and (ii) issued 12,500 shares of our Common +Stock subject to the approval thereof by the NYSE American, which approval was obtained. In addition, Ault & Company, Inc. +guaranteed to Dominion and its successors, endorsees, transferees and assigns, the prompt and complete payment and performance +when due (whether at the stated maturity, by acceleration or otherwise) of our obligations pursuant to the Refinancing. +On +July 2, 2019 we entered into an exchange agreement with Bellridge Capital, LP (“ Bellridge ”), pursuant to which, +in exchange for a term promissory note issued by us to Bellridge on September 21, 2018 in the principal face amount of $526,316, +we sold to Bellridge a new convertible promissory note in the principal amount of $783,031 with an interest rate of 12% per annum +and a maturity date of December 31, 2019. This note was convertible into shares of Common Stock, commencing on July 15, 2019, at +conversion price equal to the greater of (A) $8.80 or (B) 80% of the lowest daily VWAP in the three trading days prior to the date +of conversion. On September 26, 2019, we entered into a second exchange agreement with Bellridge pursuant to which, in exchange +for the note referred to immediately above (the “ Prior Note ”), we sold to Bellridge a new convertible promissory +note in the principal amount of $815,218 with an interest rate of 12% per annum (the “ New Note ”). The New Note +is convertible into shares of Common Stock (the “ Conversion Shares ”), commencing on October 31, 2019, at conversion +price equal to $4.00 (the “ Conversion Price ”), or 203,805 such shares. In connection with this exchange agreement, +we and Bellridge entered into a forbearance agreement pursuant to which Bellridge agreed to forbear through the close of business +on October 31, 2019 from exercising the rights and remedies it is entitled to under the Prior Note, and any and all transaction +documents related thereto, in consideration for our issuance of the New Note. +On +July 2, 2019, we entered into an exchange agreement with an institutional investor pursuant to which, in exchange for (i) a term +promissory note issued by DP Lending to the investor on August 10, 2018 in the principal face amount of $550,000 and (ii) a term +promissory note issued by us on August 16, 2018, as amended on November 29, 2018, in the principal face amount of $318,150, we +sold to the investor a new convertible promissory note in the principal amount of $1,250,000 (subject to adjustments) with an interest +rate of 8% per annum and a maturity date of December 31, 2019. This note was convertible into shares of Common Stock at a conversion +price of $8.80. As a result of the ACM Sales Agreement discussed below, commencing on the first day of the ACM ATM Offering, the +conversion price of the investor’s note was reduced to $4.00 per share. +On +July 3, 2019, we entered into an exchange agreement with an institutional investor pursuant to which, in exchange for a term promissory +note issued by us to the investor on March 23, 2018 in the principal face amount of $1,000,000, we sold (i) a convertible promissory +note in the principal face amount of $1,292,000 plus a default premium of $200,000, and (ii) a five-year warrant to purchase up +to 25,000 shares of our Common Stock at an exercise price of $8.80 per share. This convertible promissory note is in the aggregate +principal amount of $1,492,000 and bears interest at 12% per annum, which principal and all accrued and unpaid interest are due +on January 22, 2020, and which interest is payable in cash, in arrears, on the first business day of each month, with the first +payment of interest due on August 1, 2019. Commencing on July 15, 2019, subject to certain beneficial ownership limitations, the +investor may convert the principal amount of this note and accrued interest earned thereon at any time into shares of our Common +Stock at $8.80 per share. During the year ended December 31, 2019, we issued 99,753 shares of our common stock in payment of principal +and interest in the amount of $877,837. +3 +Table of Contents +On July 19, 2019, the +stockholders approved a proposal permitting the Board of Directors to effect a reverse stock split (the “ Reverse Split ”) +of our issued and outstanding Common Stock. Thereafter, on July 23, 2019, the Board of Directors approved the Reverse Split with +a ratio of one for forty. The Reverse Split did not affect the number of authorized shares of Common Stock or their par value per +share. As a result of the Reverse Split, the number of shares of Common Stock outstanding was reduced from 43,124,144 to 1,078,104. +The Reverse Split became effective in the State of Delaware on August 5, 2019. Beginning on August 6, 2019, the Common Stock traded +on the NYSE American on a split-adjusted basis. All references to Common Stock in this Annual Report have been retroactively restated. +On August 6, 2019, +we entered into an At-The-Market Issuance Sales Agreement (the “ ACM Sales Agreement ”) with Ascendiant Capital +Markets, LLC, as sales agent (the “ Agent ”) to sell shares of Common Stock having an aggregate offering price +of up to $5,500,000 (the “ Shares ”) from time to time, through an “at the market offering” program +(the “ ACM ATM Offering ”). The offer and sale of the Shares was made pursuant to the Company’s effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration +Statement No. 333-222132) filed with the SEC on December 18, 2017, as amended on January 8, 2018, and declared effective by +the SEC on January 11, 2018, and a prospectus supplement related to the ACM ATM Offering, dated August 6, 2019. +On +November 4, 2019 we entered into an exchange agreement with a lender pursuant to which, in exchange for a term promissory note +issued by us to the investor on July 25, 2019 in the principal face amount of $250,000 we sold a convertible promissory note in +the principal face amount of $350,000. This convertible promissory note bears interest at 12% per annum, which principal and all +accrued and unpaid interest are due on July 4, 2020. The lender may convert the principal amount of this note and accrued interest +earned thereon into shares of our Common Stock at $1.20 per share beginning six months from the issuance date of the term promissory +note. +During +November 2019, we entered into a short term promissory note in the aggregate principal amount of $360,000. The promissory note +contained an original issue discount of $60,000 resulting in net proceeds of $300,000. The interest rate on the promissory note +is 12% per annum and is payable on the maturity date, February 14, 2020. +On +November 15, 2019, we entered into an exchange agreement with a lender pursuant to which, in exchange for those certain promissory +notes (i) in the original principal amount of $575,000 issued on May 10, 2019, and (ii) in the original principal amount of $230,000 +issued on May 21, 2019 (collectively, the “ Original Note ”), we sold a convertible promissory note in the principal +face amount of $935,772. This convertible promissory note bears interest at 8% per annum, which principal and all accrued and unpaid +interest are due on November 15, 2020. Subject to certain beneficial ownership limitations, the lender may convert the principal +amount of this note and accrued interest earned thereon at any time into shares of our Common Stock at $1.80 per share. +Commencing in October +and continuing through February of 2020, the Company reorganized its corporate structure pursuant to a series of transactions by +and among the Company and its directly and indirectly owned subsidiaries. The purpose of the reorganization was to align the Company’s +various businesses by the products and services that constitute the majority of each subsidiaries’ revenues. As a result +of the foregoing transactions, the Company’s corporate structure is as follows: +4 +Table of Contents +On January 7, 2020, +we formed Coolisys Technologies Corp. (“ CTC ”) in order to hold Digital Power Corporation. Coolisys is presently +owned by GWW and owns Microphase Corporation, Gresham Power Electronics and Enertec Systems. We may dispose of Coolisys in the +future, leaving GWW as the direct owner of the three foregoing subsidiaries. +On December 23, 2019, +the Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of +the NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. +As a result, at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, +or up to 19.99% of the Common Stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, shall +be due and payable on August 5, 2020. The Note shall be convertible into shares of the Company’s common stock, par value +$0.001 per share (the “ Common Stock ”) at a conversion price of +$1.45 per share, subject to the approval of the Company’s stockholders at a special meeting thereof, as required by Rule +713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American. This special meeting is presently +scheduled to occur on June 8, 2020. +On February 10, 2020, +we entered into a Master Exchange Agreement (the “ Exchange Agreement ”) with Esousa Holdings, LLC (the “ Credito r”) +that acquired approximately $4.2 million dollars in principal amount, plus accrued but unpaid interest, of certain promissory notes +that had been previously issued by us to Dominion Capital, LLC, a Connecticut limited liability company (the “ Dominion +Note ”) and the Canadian Special Opportunity Fund, LP (the “ CSOF Note ” and with the Dominion Note, +the “ Purchased Notes ”) in separate transactions. The Creditor also agreed to purchase additional notes up to +an additional principal amount, plus accrued but unpaid interest, of $3.5 million (the “ Additional Notes ” and +collectively, with the Purchased Notes, the “ Notes ”). Pursuant to the Exchange Agreement, the Creditor has the +unilateral right to acquire, among other things set forth therein, shares of the Company’s common stock (the “ Exchange +Shares ”) in exchange for the Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness +of the Company. This special meeting is presently scheduled to occur on June 8, 2020. +Settlement of Derivative Litigation +As previously announced, +on February 24, 2020, we entered into a definitive settlement agreement (the “ Settlement Agreement ”) that is +intended to settle the previously disclosed derivative litigation captioned Ethan Young and Greg Young, Derivatively on Behalf +of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, +Robert O. Smith, and Kristine Ault and DPW Holdings, Inc., as the nominal defendant (Case No. 18-cv-6587) (as amended on March +11, 2019, the “ Amended Complaint ”) against the Company and certain of its officers and directors pending in +the United States District Court for the Central District of California (the “ Court ”). As previously disclosed, +the Amended Complaint alleges violations including breaches of fiduciary duties and unjust enrichment claims based on the previously +pled transactions. +5 +Table of Contents +On April 15, 2020, +the Court issued an Order (the “ Order ”) approving a Motion for Preliminary Approval of Settlement in the Derivative +Action filed against DPW as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018. +Under the terms of +the Order approving the Agreement, the Board shall adopt and/or maintain resolutions and amendments to committee charters and/or +the Company’s bylaws to ensure adherence to certain corporate governance policies (collectively, the “ Reforms ”), +which shall remain in effect for no less than five (5) years, subject to any of the following: (a) a determination by a majority +of the independent directors that the Reform is no longer in the best interest of the Company, including, but not limited to, due +to circumstances making the Reform no longer applicable, feasible, or available on commercially reasonable terms, or (b) modifications +which the Company reasonably believes are required by applicable law or regulation. +In connection with +the Settlement Agreement, the parties have agreed upon a payment of attorneys’ fees in the amount of $600,000 payable by +the Company’s Director & Officer liability insurance. The Settlement Agreement contains no admission of wrongdoing. The +Company has always maintained and continues to believe that it did not engage in any wrongdoing or otherwise commit any violation +of federal or state securities laws or other laws. While the Settlement Agreement has been approved by the Court, there can be +no assurance that the settlement will be finalized and approved by the Court or properly objected to by any shareholders and, even +if approved, whether the conditions to closing will be satisfied, and the actual outcome of this matter may differ materially from +the terms of the settlement described herein. +Strategy +Our strategy to increase +revenues through acquisitions was developed after a review of our current business. While we continue to maintain our core business +of power system solutions for the military/aerospace, medical and industrial-telecommunication industries, we have determined that +significant organic growth in these industries will be challenging due to our limited releases of new products offerings, insufficient +sales and marketing force as a result of deferring research and development of new products because of limited working capital, +and lack of financial size in industries traditionally dominated by more large, well established and capitalized power system solution +companies. +Therefore, we believe +that the best strategy for us and our stockholders is to invest in our core business to support releases of advanced new power +technologies and to expand our customer base and market share in our major markets. To support the organic growth, we have hired +a number of additional personnel and are investing to enhance our product offerings with state of the art technology. While we +implement our new organic growth strategy, we are focusing on finding and acquiring companies that have developed new technology +but have been unable to exploit the technology because the lack of capital; companies that are run inefficiently due to the lack +of experience or mismanagement; companies that can benefit from our expertise in the commercial and defense industries or companies +that enhance our overall revenues. Further, as discussed below, we have made an investment in Avalanche which acquired the rights +to a cost effective and environmentally friendly material synthesis technology for textile applications. +As a result of this +strategy of revenue growth through acquisitions, we have hired a number of additional personnel and consultants to assist in identifying, +analyzing, negotiating and acquiring potential companies and we will need to raise a substantial amount of capital for acquisitions +and for supporting our infrastructure. We may invest in and continue to invest in companies that may experience losses until they +can be integrated with our operations or until our cost reduction and efficiency changes can be implemented. Because of our increase +in infrastructure expenses and investing in companies that demonstrate revenue potential but are initially incurring losses, we +anticipate continuing to experience losses in the near future until revenues from these acquisitions exceed our expenses. +Led by our Chairman +and CEO, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global impact. +We also use a traditional methodology for valuing stocks that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from +influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s Vice Chairman and CFO and Henry +Nisser, the Company’s General Counsel and Executive Vice President, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +During the next several +years, we see a favorable opportunity to follow an activist strategy that centers on the purchase of target stock and the subsequent +removal of any barriers that might interfere with a friendly purchase offer from a strong buyer. Alternatively, in appropriate +circumstances, we or our subsidiaries may become the buyer of target companies, adding them to our portfolio of operating subsidiaries, +thereby expanding our operations through such opportunistic acquisitions. We believe that the companies that we target for our +activist activities are undervalued for many reasons, often including inexperienced management. Unfortunately for the individual +investor, in particular, and the economy, in general, many poor management teams are often unaccountable and very difficult to +remove. +6 +Table of Contents +Markets +We sell our custom +power system solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse +range of commercial and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our +current customer base consists of approximately 220 companies, some of which are served through our partner channels. We serve +the North American power electronics market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas +the European marketplace is served through DPL, another wholly-owned subsidiary. +We sell products to +our OEM customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our +sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship +with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding +new product requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional +sales channels of manufacturer representatives and distributors. We plan to continue to build more channels and increase our market +share through 2019. +Commercial Customers . +We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of +applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally +extreme environmental conditions. +Military/Defense +Customers . We have developed a broad range of rugged product solutions for the military and defense market, featuring the +ability to withstand harsh environments. These ruggedized product solutions, which include both custom modifications +and full custom designs, are designed for combat environments and meet the requirements of our defense customers. We manufacture +our military products through a domestic manufacturer that complies with US International Traffic in Arms Regulations (“ ITAR ”) +and is certified to perform such manufacturing services. We are compliant with the ITAR regulations and are an approved vendor +for the U.S. Air Force, Navy and Army. +At the core of every +military electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will +operate and survive the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, +function effectively in these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; +Naval – Naval power conversion and distribution; Mobile and Ground Communications – Active Protection, Communications +and Navigation; Artillery – Gyro modular azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned +Aerial Vehicle) – Very lightweight power systems. +Our military products +meet the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, +weight, output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges +that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our +power supplies are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary +Gresham Power develops and manufactures some military and defense products mainly being deployed in several naval fleets. +Our Subsidiaries and their Businesses +Coolisys Technologies Corp. and Digital +Power Corporation +We provide the highest +density, highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and +modify-standard product solutions and value-added services to diverse industries and markets including military/aerospace, medical +and industrial- telecommunications. We believe that our solutions leverage a combination of low leakage power emissions, +very high-power density with superior power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy with +respect to Coolisys Technologies Corp. or CTC, is to be the supplier of choice to companies, including OEMs, that require high-quality +power system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical +to business success. We believe that we provide advanced custom product design services to deliver high-grade products that reach +a high level of efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship +with us that supports all of their needs for designing and manufacturing power solutions and products. By implementing our advanced +core technology, including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing +their existing power sources with our custom design cost-effective products. Our target market segments include the industrial +telecommunication, medical, and military/aerospace industries. +7 +Table of Contents +Custom Power +System Solution. We provide high-grade custom power system solutions to several customers in multiple +industry segments. Our custom solution technology includes full Digital Signal Processing (“ DSP ”) control, digital +load sharing intelligent power management and customizable firmware. The products feature high power density, special layout and +multiple outputs to meet each of our customers’ unique requirements. We combine our power design capabilities with the latest +circuit designs to provide complete power solutions for virtually any plausible need. In the design of custom power solutions, +we work closely with our customers’ engineering teams to develop mechanical enclosures to ensure 100% compatibility with +any hosted platform. +Our standard contract +for custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production +guarantees (and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes +the development of our intellectual property (“ IP ”) portfolio. We believe that this business model +provides an incentive to our customers to be committed to high-volume production orders. +High-Grade Flexibility +Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade +design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) +and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While +some of our customers have special requirements that include a full custom design, other customers may require only certain electrical +changes to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical +repackaging tailored to fit the specific application. We offer a wide range of standard and modified standard products that can +be easily integrated with any platform across our diversified market segments. +Value-Added Services . +In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added +services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance +components into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment +and specifically tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would +otherwise attach to, or integrate with, our power systems, and provide the OEM with the integration and installation service, thus +eliminating the need for complex, time-consuming and costly system integration. We believe that this value-added service is well +suited to those OEMs that wish to reduce their vendor base and minimize their investment in manufacturing, which would lead to +increased fixed costs. Given access to these value-added services, the OEMs do not need to build assembly facilities to manufacture +their own power sub-assemblies and thus are not required to purchase individual parts from many vendors. +Gresham Power Electronics (formerly +known as Digital Power Limited) +Gresham Power Electronics, +our wholly-owned subsidiary organized and headquartered in Salisbury, United Kingdom, designs, manufactures, and distributes switching +power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters for the commercial +and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships to convert +their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment such +as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, +higher power rectifiers are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these +as part of overall helicopter start and servicing systems. We believe that Gresham products add diversity to our product line, +provide greater access to the United Kingdom and European markets, and strengthen our engineering and technical resources. +Microphase Corporation +Microphase designs, +manufactures and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication +systems. Such components include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, +switch filters, integrated assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s +customers are comprised of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors +and sub-contractors. Microphase’s recent technology innovations are used in many significant U.S. Government defense programs, +including the Polaris submarine, the F-16, the F-35 and the Predator drone. Other notable programs in which Microphase’s +products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile +System, THAAD (or Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, +EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint strike fighter plane, and more recently drone programs including +the Predator, the Reaper and the Shadow. +Microphase’s +advanced technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in +order to accurately recover the signals and facilitate use of the information received. These products include: +· filters that sort and clarify microwave signals, including multiplexers that are a series of filters +combined in a single package; +· solid state amplifiers that amplify microwave signals; +· detectors and limiters that are semiconductor devices for detection of radar signals and protection +of receivers from damage from high power signals and jamming; +8 +Table of Contents +· detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal +detection systems; +· integrated assemblies that combine multiple functions from a range of components and devices, including +transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction +assemblies; +· electronic test and measurement probes; +· universal test and measurement test platforms and fixtures; and +· utility probes and antenna probes. +Manufacturing and Testing +Consistent with our +strategy of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of +flexibility in our manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers +to ensure that they will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships +will eventually give us access to new markets and beneficial cross-licensing opportunities. The competitive nature of the power +supply industry has placed continual downward pressure on selling prices. In order to achieve our low-cost manufacturing goals +with labor-intensive products, we have entered into manufacturing agreements with certain contract manufacturers domestically and +in Asia. +We are continually +improving our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and +consistent manufacturing of our power solutions. We test all of our products under stress operating conditions per defined test +procedures we developed as part of the production process. This approach ensures that our customers can use our power supplies +right out of the box. Customer specific testing services are offered with custom designed test stands to simulate operation within +our customer applications. +Compliance with international +safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. +Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements +and are appropriately documented to expedite safety approval processes. +Regulatory Requirements +We and our contract +manufacturing partners are required to meet applicable regulatory, environmental, emissions, safety and other requirements where +specified by the customer and accepted by us or as required by local regulatory or legal requirements. The products that we +market and sell in Europe may be subject to the 2003 European Directive on Restriction of Hazardous Substances (“ RoHS ”), +which restricts the use of six hazardous materials in the manufacturing of certain electronic and electrical equipment, as well +as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), which determines collection, +recycling and recovery goals for electrical goods. In July 2006, our industry began phasing in RoHS and WEEE requirements +in most geographical markets with specific emphasis on consumer-based products. We believe that RoHS and WEEE-compliant components +may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +Some of our products +are subject to ITAR regulation and restrictions, which is administered by the U.S. Department of State. ITAR controls not only +the export of certain products specifically designed, modified, configured or adapted for military systems, but also the export +of related technical data and defense services and foreign production. We obtain required export licenses for any exports subject +to ITAR. Compliance with ITAR may require a prolonged period of time; if the process of obtaining required export licenses for +products subject to ITAR is delayed, it could have a materially adverse effect on our business, financial condition, and operating +results. Further, additional restrictions or charges may in the future be imposed by the United States or any other foreign country. +In addition, from time to time, we enter into defense contracts to supply technology and products to foreign countries for programs +that are funded and governed by the U.S. Foreign Military Financing program. +Enertec Systems 2001 Ltd. +Based in Israel, Enertec +designs, develops, manufactures and maintains advanced end-to-end high technology electronic solutions for military, medical, telecommunications +and industrial markets. Those solutions include custom computer-based automated test equipment and turnkey systems to ensure combat +readiness, provide command and control, and direct and deploy resources in military operations in harsh environments and battlefield +conditions. The Company also designs, develops, manufactures and maintains high precision calibration equipment for lifesaving +medical operations for a global health care products company as well as advance power systems for electric vehicle, telecom and +other industrial applications. Enertec delivers complete end-to-end project management with requirements definition, systems engineering, +design/development, production, testing, integration, field support, maintenance and optimization. Its custom engineered solutions +enable and support mission critical air, land and sea military platforms, e.g., missiles, UAVs, combat aircraft, boats, submarines, +trailers and satellites. +9 +Table of Contents +Enertec’s primary +customers include the Israeli Ministry of Defense and the 3 major defense contractors in Israel – Israel Air Industries (IAI), +Rafael and Elbit Systems. In addition, Enertec has a strategic partnership with Cyient to build and deliver solutions for the Indian +military. High tech capabilities to deliver advance electronics solutions create opportunities for other Gresham Worldwide operating +subsidiaries – Microphase and Gresham Power – to supply components for Enertec solutions. Enertec also provides geographic +reach into the Middle East and India to broaden Gresham WorldWide’s footprint in delivering the highest quality and most +advance technology solutions across the globe. +Sales and Marketing +We market our products +directly through our internal sales force as well as through our channel partners including independent manufacturer representatives +and distributors. Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, +the manufacturing representatives have the opportunity to earn exclusive access to all potential customers in the assigned territory +as a result of achieving their marketing and sales goals as defined in the representative agreement. Our manufacturer representative +agreements provide for a commission equal to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales +for retention, payable after products are shipped to the customer in the assigned territory. Typically, either we or the manufacturing +representatives are entitled to terminate the manufacturing representative agreement upon 30 days’ written notice. +We provide comprehensive +collateral including product data sheets, participation in trade shows, and our websites, www.digipwr.com and www.microphase.com. We +use our website to emphasize our capabilities and marketing direction. All products specifications are uploaded onto our websites +and accessible to the marketplace. We will continue to enhance our websites by adding more features and functionalities, such as +e-commerce, that will allow our customers to make direct purchases through our website. Our future promotional activities +will likely include advertising in industry-specific publications, as well as public relations for our new products. +Engineering and Technology +Our engineering and +product development efforts are primarily directed toward developing new products in connection with custom product design and +modification of our standard power systems to provide a broad array of individual models. +Our new custom product +solutions are driven by our ability to provide to our customers advanced technology that meets their product needs and supports +special operation and environmental requirements, with a short turnaround time and a very competitive price point. We believe that +we are successfully executing our strategic account focus, as evidenced by the award of second and third generation product development +contracts from some of these customers. Our standard contract for custom power solutions includes a multi-year high-volume production +forecast that could allow us to secure long-term production guarantees while providing an environment that promotes the development +of our IP portfolio. +We also outsource some +of our product development projects to engineering partners in order to achieve the best technological and product design results +for the targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, +including, but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on +commercial off the shelf (“ COTS ”) products and for other customized product requirements, when applicable. We +continually seek to improve our product power density, adaptability, and efficiency, while attempting to anticipate changing market +demands for increased functionality, such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) +filtering. We continue to attempt to differentiate all of our products from commodity-type products by enhancing, modifying and +customizing our existing product portfolio, using our engineering integrating laboratory located in California. +Competition +The power system solutions +industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located +throughout the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer +products superior or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, +TDK-Lambda, Delta Electronics, Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and +geographic presence than we do. If we are successful in increasing our revenues, competitors may notice and increase competition +efforts with our customers. We also face competition from current and prospective customers who may decide to internally design +and manufacture power supplies needed for their products. Furthermore, certain larger OEMs tend to contract only with +larger power supply manufacturers. +We anticipate in the +current economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could +thus become more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell +our products are acquired by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by +providing reliable manufacturing, offering customer-driven engineering services including custom design and manufacturing, continuously +improving quality and reliability levels, and offering flexible and reliable delivery schedules. +10 +Table of Contents +We believe that our +power system solutions and advanced technology is superior to our competitors’ power supplies mainly because they use the +latest power technology processing and controls which make these power supplies highly customized and efficient. The power-to-volume +ratio, makes our power solutions more compact compared to what is offered by our competitors and is suitable in custom infrastructures +to meet our customers’ requirements. +Another advantage of +our power system solutions product line is based on the “Flexible” series that employs adjustable power range and a +selectable number of output product design platforms. We believe we have a competitive position with our targeted customers that +need a high-quality, compact product, which can be readily modified to meet the customer’s unique requirements. We have +designed the base model power system platform so that it can be quickly and economically modified and adapted to the specific power +needs of any hosting platform or OEM. This “flexibility” approach has allowed us to provide samples of modified power +systems to OEM customers only a few days after initial consultation, an important capability given the emphasis placed by OEMs +on “time to market.” It also results in very low non-recurring engineering (“ NRE ”) expenses. Because +of reduced NRE expenses, we do not generally charge our OEM customers for NRE related to tailoring a power system to a customer’s +specific requirements. We believe this gives us an advantage over our competitors, many of which charge their customers for NRE +expenses. +The markets in which +Microphase operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors +are larger than it is and maintain higher levels of expenditures for research and development. Principal competitive factors in +Microphase’s markets are product quality and reliability; technological capabilities; service; past performance; ability +to develop and implement complex, integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales +channels in international markets; and cost-effectiveness. +In the RF Communications +market, principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, +MD; RS Microwave, a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith +Group, a global technology company listed on the London Stock Exchange; and Delta Diversified Products, a private company based +in Arizona. +In the Video amplifier +segment, principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately +held company headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, +a privately held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company +based in New York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Raw Materials +The raw materials for +power supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus +we are not dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders +received or forecasts to minimize our risk of unusable inventory. To the extent necessary, we may allow them to procure materials +prior to orders received to obtain shorter lead times and to achieve quantity discounts following a risk assessment. In +addition, we have decided to directly procure certain long lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors +have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no +longer available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign +some of our products to conform to currently available materials. +Intellectual Property +We rely upon a combination +of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. +We believe that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. +However, in the future, as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On +July 10, 2012, our trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark +Office. +In conjunction with +our majority acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade +name, which has been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +Research and Development +During the years ended +December 31, 2019 and 2018, we spent approximately $1,861,103 and $1,430,538, respectively, on research and development. +11 +Table of Contents +Employees +As of December 31, +2019, we had 210 employees located in the United States, the United Kingdom and Israel, of whom 52 were engaged in engineering +and product development, 12 in sales and marketing, 106 in general operations and 40 in general administration and finance. All +but 9 of these employees are employed on a full-time basis. None of our employees is currently represented by a trade union. We +consider our relations with our employees to be good. +12 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000896493/2019/0001214659-20-005205/item13.txt b/raw/filings/0000896493/2019/0001214659-20-005205/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..904d8589af1de6b4e0ea97c5d2b8ab4766106cc9 --- /dev/null +++ b/raw/filings/0000896493/2019/0001214659-20-005205/item13.txt @@ -0,0 +1,33 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our +Chief Executive Officer and Chairman of the Board, is also the Chief Executive Officer of Ault & Company, Inc. +Ault & Company, Inc. +On December 23, 2019, +the Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of +the NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. +As a result, at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, +or up to 19.99% of the Common Stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, shall +be due and payable on August 5, 2020. The Note shall be convertible into shares of the Company’s common stock, par value +$0.001 per share (the “ Common Stock ”) at a conversion price of +$1.45 per share, subject to the approval of the Company’s stockholders at a special meeting thereof, as required by Rule +713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American. This special meeting is presently +scheduled to occur on June 8, 2020. +Avalanche International, Corp. +On September 6, 2017, +we entered into a Loan and Security Agreement with Avalanche (“ AVLP Loan Agreement ”) with an effective date +of August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility of up to $10,000,000 for a period +ending on August 21, 2021. +At December 31, 2019, +we had provided Avalanche with $9,595,079 pursuant to the non-revolving credit facility. The warrants issued in conjunction with +the non-revolving credit facility entitles us to purchase up to 19,190,158 shares of Avalanche common stock at an exercise price +of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, +stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Milton C. Ault, III +and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors +of Avalanche. In addition, Philou Ventures, of which Ault & Company, Inc., is the Manager, is the controlling stockholder of +Avalanche. Mr. Ault is the Chief Executive Officer of Ault & Company, Inc. \ No newline at end of file diff --git a/raw/filings/0000896493/2019/0001214659-20-005205/item9a.txt b/raw/filings/0000896493/2019/0001214659-20-005205/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e119ddf3983ce535debfda1be497e96377ad50f4 --- /dev/null +++ b/raw/filings/0000896493/2019/0001214659-20-005205/item9a.txt @@ -0,0 +1,95 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and +Procedures +As of December 31, +2019, we have carried out an evaluation, under the supervision of, and with the participation of, our management, including our +principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure +controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange +Act ”). We have established disclosure controls and procedures designed to ensure that information required to be disclosed +in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods +specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and +principal financial officer, to allow timely decisions regarding required disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined +in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined +that our disclosure controls and procedures were not effective due to certain material weaknesses as described herein. +Management’s Annual Report on +Internal Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange +Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability +of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted +accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain +to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the +assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial +statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being +made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance +regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have +a material effect on the financial statements. +Because of its inherent +limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation +of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, +or that the degree of compliance with the policies or procedures may deteriorate. +48 +Table of Contents +Our management assessed +the effectiveness of our internal control over financial reporting as of December 31, 2019. In making this assessment, our management +used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) +in Internal Control-Integrated 2013 Framework. Our management has concluded that, as of December 31, 2019, our internal control +over financial reporting was not effective. +A material weakness +is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or +combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or +interim financial statements will not be prevented or detected. Management has identified the following material weaknesses: +1. +We do not have sufficient resources in our accounting function, +which restricts our ability to gather, analyze and properly review information related to financial reporting, including fair value +estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be +possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of +assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure +to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency +that resulted represented a material weakness +2. We have inadequate controls to ensure that information necessary to properly record transactions +is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management +evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment +of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. +3. We did not design or maintain effective general information technology (“IT”) controls +over certain information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets. +Specifically, we did not design and implement p rogram change management controls for certain +financially relevant systems to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, (iii) digital currency hardware wallets, and (iv) underlying accounting records, are identified, +tested, authorized and implemented appropriately. +Planned Remediation +Management, +in coordination with the input, oversight and support of our Audit Committee, has identified the measures below to strengthen our +control environment and internal control over financial reporting. +In +January 2018, we hired a new Chief Financial Officer and engaged the services of a financial accounting advisory firm. In September +2018, we hired a Chief Accounting Officer and in January 2019, we hired a Senior Vice President of Finance. Finally, in May 2019, +we hired an Executive Vice President and General Counsel. We have tasked these individuals with expanding and monitoring the Company’s +internal controls, to provide an additional level of review of complex financial issues and to assist with financial reporting. +On October 7, 2019, we created an Executive Committee comprised of our Chief Executive Officer, Chief Financial Officer and Executive +Vice President and General Counsel. The Executive Committee meets on a daily basis to address the Company’s critical needs +and provide a forum to approve transactions. Further, as we continue to expand our internal accounting department, the Chairman +of the Audit Committee shall perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, +· reviews all anticipated transactions that are not considered in the ordinary course of business +to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s +financial statements +We are currently working to improve and +simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in our +internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period +of time and management has concluded, through testing, that these controls are operating effectively. +This Annual Report +does not include an attestation report of our independent registered public accounting firm regarding internal control over financial +reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant +to a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated +filers from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +Changes in Internal Control over Financial +Reporting +During the most recent +fiscal quarter covered by this report there were no significant changes in our internal control over financial reporting (as such +term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to +materially affect our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2019/0001214659-20-005205/rp_note.txt b/raw/filings/0000896493/2019/0001214659-20-005205/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..9a0b433ab157f3612e216d7f42ed6361f53a05b2 --- /dev/null +++ b/raw/filings/0000896493/2019/0001214659-20-005205/rp_note.txt @@ -0,0 +1,54 @@ +24. RELATED PARTY TRANSACTIONS +a. The Company and AVLP entered into a Loan and Security Agreement (“AVLP Loan Agreement”) +with an effective date of August 21, 2017, pursuant to which the Company will provide AVLP a non-revolving credit facility +of up to $10,000,000 for a period ending on August 21, 2021, subject to the terms and conditions stated in the Loan Agreement, +including that the Company having available funds to grant such credit. At December 31, 2019, the Company has provided loans to +AVLP in the principal amount $9,595,079 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company +warrants to purchase 19,190,158 shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP +are secured by the assets of AVLP. As of December 31, 2019, the Company recorded contractual interest receivable attributed to +the AVLP Loan Agreement of $2,025,475. +During the years ended December +31, 2019 and 2018, the Company also acquired in the open market 91,000 shares of AVLP common stock for $53,032 and 430,942 shares +of AVLP common stock for $417,169, respectively. At December 31, 2019, the Company’s investment in AVLP common stock had +an unrealized loss of $507,959. +F- 59 +Table of Contents +DPW HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(Continued) +DECEMBER 31, 2019 +Philou is AVLP’s controlling +shareholder. Mr. Ault is Chairman of AVLP’s Board of Directors and the Chairman of the Board. Mr. William B. Horne is the +Chief Financial Officer and a director of AVLP and the Company. +In March 2017, the Company was +awarded a $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“MLSE”) +plasma-laser system. During the years ended December 31, 2019 and 2018, the Company recognized nil and $3,907,280, respectively, +in revenues from MTIX to manufacture the Multiplex Laser Surface Enhancement (“MLSE”) plasma-laser systems. On April +12, 2019, the Company received payment of $2,676,219 for manufacturing services performed on the first MLSE system. At December +31, 2019, the Company had recorded a receivable from MTIX of $1,238,856. +b. During the year ended December 31, 2019, the Company acquired 372,625 shares of common stock of +Alzamend from a third party for $208,100 consisting of the cancellation of principal and interest due the Company of $181,483 and +cash of $26,617. During the year ended December 31, 2019, the Company recognized an unrealized gain of $350,838 resulting from +its investment in Alzamend common stock. +c. During the year ended December 31, 2019, Ault & Company, Inc. (“Ault & Company”) +has provided $1,335,570 in short-term advances. Ault and Company is the Manager of Philou which presently owns 125,000 shares of +the Company’s Series B Preferred Stock. Mr. Ault and Mr. Horne serve as the Chief Executive Officer and Chief Financial Officer, +respectively, of Ault & Company. +d. On December 22, 2019, the Company entered into a securities +purchase agreement with Ault & Company. Pursuant to the terms of the agreement, Ault & Company shall purchase an aggregate +of 660,667 shares of the Company’s common stock for a total purchase price of $739,948, at a purchase price per share of +$1.12, subject to the approval of the NYSE American. The NYSE American approved the purchase on January 15, 2020 (see Note 26). +e. Ault & Company guaranteed the prompt and complete payment and performance of the Dominion short-term +promissory note with a principal face amount of $2,900,000. +f. On March 9, 2017, the Company entered into a preferred stock purchase agreement with Philou. Pursuant +to the terms of the preferred stock purchase agreement, Philou may invest up to $5,000,000 in the Company through the purchase +of Series B Preferred Stock over 36 months. Philou has purchased 125,000 shares of Series +B Preferred Stock pursuant to the terms of the purchase agreement, the most recent purchase having occurred on April 24, 2018 for +the purchase of 25,000 shares of Series B Preferred Stock . +g. Between July 6, 2017 and September 30, 2018, Milton C. Ault, III, the Company’s Chairman +and Chief Executive Officer, personally guaranteed the repayment of (i) $8,218,000 from the sale of Advances on Future Receipts +(ii) and $4,781,000 from the sale of the promissory notes. These personal guarantees were necessary to facilitate the consummation +of these financing transactions. Mr. Ault’s payment obligations would be triggered if the Company failed to perform under +these financing obligations. Our board of directors has agreed to compensate Mr. Ault for his personal guarantees. The amount of +annual compensation for each of these guarantees, which will be in the form of non-cash compensation, is approximately 1.5% of +the amount of the obligation. \ No newline at end of file diff --git a/raw/filings/0000896493/2019/0001214659-20-005205/rpt_disclosure.txt b/raw/filings/0000896493/2019/0001214659-20-005205/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..904d8589af1de6b4e0ea97c5d2b8ab4766106cc9 --- /dev/null +++ b/raw/filings/0000896493/2019/0001214659-20-005205/rpt_disclosure.txt @@ -0,0 +1,33 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our +Chief Executive Officer and Chairman of the Board, is also the Chief Executive Officer of Ault & Company, Inc. +Ault & Company, Inc. +On December 23, 2019, +the Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of +the NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. +As a result, at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, +or up to 19.99% of the Common Stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, shall +be due and payable on August 5, 2020. The Note shall be convertible into shares of the Company’s common stock, par value +$0.001 per share (the “ Common Stock ”) at a conversion price of +$1.45 per share, subject to the approval of the Company’s stockholders at a special meeting thereof, as required by Rule +713(a)(ii) of the NYSE Company Guide, and subsequently, authorization from the NYSE American. This special meeting is presently +scheduled to occur on June 8, 2020. +Avalanche International, Corp. +On September 6, 2017, +we entered into a Loan and Security Agreement with Avalanche (“ AVLP Loan Agreement ”) with an effective date +of August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility of up to $10,000,000 for a period +ending on August 21, 2021. +At December 31, 2019, +we had provided Avalanche with $9,595,079 pursuant to the non-revolving credit facility. The warrants issued in conjunction with +the non-revolving credit facility entitles us to purchase up to 19,190,158 shares of Avalanche common stock at an exercise price +of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, +stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +Milton C. Ault, III +and William Horne, our Chief Executive Officer and Chief Financial Officer, respectively, and two of our directors are directors +of Avalanche. In addition, Philou Ventures, of which Ault & Company, Inc., is the Manager, is the controlling stockholder of +Avalanche. Mr. Ault is the Chief Executive Officer of Ault & Company, Inc. \ No newline at end of file diff --git a/raw/filings/0000896493/2020/0001214659-21-004221/filing.txt b/raw/filings/0000896493/2020/0001214659-21-004221/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..b37f267effe2dfd98659a27ede43ecead4828136 --- /dev/null +++ b/raw/filings/0000896493/2020/0001214659-21-004221/filing.txt @@ -0,0 +1,9341 @@ +10-K +1 +ag32421010k.htm +UNITED STATES SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES +EXCHANGE ACT OF 1934 +For the Fiscal Year Ended December 31, 2020 +Commission file number 1-12711 +AULT GLOBAL HOLDINGS, INC. +(Exact name of registrant as specified in its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +11411 Southern Highlands Pkwy, Suite 240, +Las Vegas, NV +89141 +(949) 444-5464 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered under Section 12(b) of the Act: +Title of Each Class +Name of each exchange on which registered +Common Stock, $0.001 par value per share +NYSE American +Securities registered under Section 12(g) of the Act: None +Indicate by check +mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No +þ +Indicate by check +mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No +þ +Indicate by check +mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange +Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file such reports), and (2) has +been subject to such filing requirements for the past 90 days. Yes þ No +¨ +Indicate by check +mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of +Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required +to submit such files). Yes þ No +¨ +Indicate by check mark whether the registrant is a large accelerated +filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions +of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging +growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ¨ +Accelerated filer ¨ +Non-accelerated filer ¨ +Smaller reporting company þ +Emerging growth company ¨ +If an emerging growth +company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or +revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ +Indicate by check +mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal +control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting +firm that prepared or issued its audit report. ¨ +Indicate by check +mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No +þ +As of June 30, 2020, the aggregate market value of the registrant’s +common stock held by non-affiliates of the registrant was $13,335,311 based on the closing sale price as reported on the NYSE American +of $2.45. Such determination should not be deemed an admission that the registrant’s directors, officers, or 10% beneficial +owners are, in fact, affiliates of the registrant. +There were 49,498,676 shares of common stock outstanding as of April +14, 2021. +Documents incorporated by reference: None +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +FORM 10-K +FOR THE FISCAL YEAR ENDED DECEMBER 31, 2020 +INDEX +Page +PART I +Item 1. +Description of Business +1 +Item 1A. +Risk Factors +20 +Item 1B. +Unresolved Staff Comments +47 +Item 2. +Properties +47 +Item 3. +Legal Proceedings +48 +Item 4. +Mine Safety Disclosures +51 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +51 +Item 6. +Selected Financial Data +52 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +53 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk. +64 +Item 8. +Financial Statements and Supplementary Data. +F-1 – F-64 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +64 +Item 9A. +Controls and Procedures +64 +Item 9B. +Other Information +67 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +67 +Item 11. +Executive Compensation +73 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +78 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +79 +Item 14. +Principal Accountant Fees and Services +80 +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +82 +Item 16. +Form 10-K Summary +85 +Signatures +86 +NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “ Annual +Report ”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E +of the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. We have +attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” +“can,” “continue,” “could,” “estimates,” “expects,” “intends,” +“may,” “plans,” “potential,” “predict,” “should” or “will” or +the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties and other factors may +cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels or +activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations +reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Our expectations are as of the date this Annual Report is filed, and we do not intend to update any of the forward-looking statements +after the date this Annual Report is filed to confirm these statements to actual results, unless required by law. +This Annual Report also contains estimates and +other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves +a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified +the statistical and other industry data generated by independent parties and contained in this Annual Report and, accordingly, we cannot +guarantee their accuracy or completeness, though we do generally believe the data to be reliable. In addition, projections, assumptions +and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a +high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere +in this Annual Report. These and other factors could cause results to differ materially from those expressed in the estimates made by +the independent parties and by us. +RISK FACTOR SUMMARY +Below is a summary of the principal factors that +make an investment in our common stock speculative. This summary does not address all of the risks that we face. Additional discussion +of the risks summarized in this risk factor summary, and other risks that we face, can be found below under the heading “Risk Factors” +and should be carefully considered, together with other information in this Annual Report and our other filings with the Securities and +Exchange Commission, or SEC, before making investment decisions regarding our common stock. +· We will need to raise additional capital to fund our operations in furtherance of our business plan. +· We face business disruption and related risks resulting from the outbreak of COVID-19, which could have +a material adverse effect on our business and results of operations and curtail our ability to raise financing. +· We have an evolving business model, which increases the complexity of our business. +· We received an order and a subpoena from the Commission in the investigation now known as “In the +Matter of DPW Holdings, Inc.,” the consequences of which are unknown. +· If we make any additional acquisitions, they may disrupt or have a negative impact on our business. +· Our growth strategy is subject to a significant degree of risk. +· We are heavily dependent on our senior management, and a loss of a member of our senior management team +could cause our stock price to suffer. +· If we fail to anticipate and adequately respond to rapid technological changes in our industry, including +evolving industry-wide standards, in a timely and cost-effective manner, our business, financial condition and results of operations would +be materially and adversely affected. +· We depend upon a few major customers for a majority of our revenues, and the loss of any of these customers, +or the substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. +· If we do not continue to satisfy the NYSE American continued listing requirements, our common stock could +be delisted from NYSE American. +· Our +common stock price is volatile. +PART I +ITEM 1. BUSINESS +General +Ault Global Holdings, Inc., a Delaware corporation formerly known as +DPW Holdings (“Ault Global,” the “Company” or “we”), was incorporated in September 2017. The Company +is a diversified holding company owning subsidiaries engaged in, among others, the following operating businesses: commercial and defense +solutions, commercial lending and advanced textile technology. The Company’s direct and indirect wholly-owned subsidiaries include +Gresham Worldwide, Inc. (“GWW”), Coolisys Technologies Corp. (“Coolisys”), Digital Power Corporation, Gresham +Power Electronics Ltd. (f/k/a Digital Power Limited) (“Gresham Power”), Enertec Systems 2001 Ltd (“Enertec”), +Relec Electronics Ltd., Digital Power Lending, LLC (“DP Lending”), Ault Alliance, Inc. (“Ault Alliance”), and +Tansocial LLC (“Tansocial”). The Company also has a controlling interest in Microphase Corporation (“Microphase”) +and Ault Alliance has a controlling interest in and Alliance Cloud Services, LLC (“ACS”). Ault Global Holdings was founded +by Milton “Todd” Ault III, its Executive Chairman and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and +Vice Chairman and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages the +day-to-day operations of the holding company. The Company’s long-term objective is to maximize per share intrinsic value. All major +investment and capital allocation decisions are made for the Company by Mr. Ault and the Executive Committee. The Company has three reportable +segments: +· GWW +– defense solutions with operations conducted by Microphase, Enertec, Gresham Power and Relec, +· Coolisys +– commercial electronics solutions with operations conducted by Digital Power Corporation, and +· Ault Alliance – commercial lending through DP Lending, data center operations through ACS, digital +marketing through Tansocial and digital learning. +We operate as a holding company +with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed an investment +company under the Investment Company Act of 1940, as amended (the “ Investment Company Act ”). Generally, this means +that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets will be +invested in investment securities, as that term is defined in the Investment Company Act. Pursuant to the Investment Company Act, companies +such as our subsidiary DP Lending are excluded from the definition of an investment company since its business consists of making small +loans and industrial banking. We also maintain a considerable investment in Avalanche International, Corp., which +does business as MTIX International. +Originally, we were primarily +a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system solutions +for the medical, military, telecom and industrial markets. Although we actively seek growth through acquisitions, we will also continue +to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high +density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. +We have operations located +in Europe through our wholly-owned subsidiary, Gresham Power Electronics (f/k/a Digital Power Limited) (“ Gresham Power ”), +located in Salisbury, England. Gresham Power designs, manufactures and sells power products and system solutions mainly for the European +marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted +Power Supply) products. Our European defense business is specialized in the field of naval power distribution products. +On November 30, 2016, we formed +DP Lending, a wholly-owned subsidiary. DP Lending provides commercial loans to companies throughout the United States to provide them +with operating capital to finance the growth of their businesses. The loans range in duration from six months to three years, DP Lending +loans made or arranged pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +On June 2, 2017, we purchased +56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is a design-to-manufacture +original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio frequency (“ RF ”) +and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers +(“ DLVA ”) to the military, aerospace and telecommunications industries. Microphase is headquartered in Shelton, Connecticut. +On January 7, 2020, we formed +Coolisys Technologies Corp. (“ Coolisys ”), a wholly-owned subsidiary. Coolisys operates its existing businesses in the +customized and flexible power system solutions for the automotive, medical, military, telecom, commercial and industrial markets, other +than the European markets, which are primarily served by Gresham Power. +On September 1, 2017, Digital +Power Corporation, a Delaware corporation (“ DPC ”), a subsidiary of Coolisys since January 20, 2020, acquired all of +the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability company (“ Power-Plus ”). +Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related +components. In addition to its current business, Power-Plus will serve as an extended sales organization for our overall flexible power +system solutions. +On +December 31, 2017, Coolisys Technologies, Inc., a Delaware corporation (“ CTI ”) entered into a share purchase agreement +with Micronet Enertec Technologies, Inc. (“ MICT ”), a Delaware corporation, Enertec Management Ltd., an Israeli corporation +and wholly owned subsidiary of MICT (“ EML ”), and Enertec Systems 2001 Ltd. (“ Enertec ”), an Israeli +corporation and wholly owned subsidiary of EML, pursuant to which CTI acquired Enertec. Enertec is Israel’s largest private manufacturer +of specialized electronic systems for the military market. On May 23, 2018, CTI completed its acquisition of Enertec. +In +January 2018, we formed Super Crypto Mining, Inc., a wholly-owned subsidiary, which changed its name to Digital Farms, Inc. (“ DFI ”) +on January 18, 2019. DFI was established to operate our newly formed cryptocurrency business, which is pursuing a variety of digital currency. +We used to mine the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin and Ethereum. DFI’s +operations were discontinued in the first quarter of 2020. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I. AM, Inc. (“ I. AM ”), David +J. Krause and Deborah J. Krause. Pursuant to the securities purchase agreement, I. AM sold to DP Lending, 981 shares of common stock for +a purchase price of $981, representing, upon the closing, 98.1% of I. AM’s outstanding common stock. I.AM owed DP Lending $1,715,330 +in outstanding principal, pursuant to a loan and security agreement, between I. AM and DP Lending. The purchase agreement provides that, +as I. AM repays the outstanding loan to DP Lending in accordance with the loan agreement, DP Lending will on a pro rata basis transfer +shares of common stock of I. AM to David J. Krause, up to an aggregate of 471 shares. I. AM’s +operations were discontinued in the first quarter of 2020. +Gresham +Worldwide, Inc. was incorporated under the laws of the State of Delaware on November 21, 2018 as DPW Technologies Group, Inc. and effected +a name change on December 6, 2019. +On +November 30, 2020, we acquired Relec, a privately held company based in Wareham, the United Kingdom. The transaction was structured as +a stock purchase under which we paid approximately $4,000,000 with additional contingent cash payments up to approximately $665,000 based +on Relec’s future financial performance. The acquisition of Relec has enhanced our presence in industrial and transportation markets +in the United Kingdom and Europe and considerably broadened our product portfolio, including high-quality power conversion and display +product offerings. Relec specializes in AC-DC power supplies, DC-DC converters, displays and EMC filters. +On +January 29, 2021, Alliance Cloud Services, LLC, a majority-owned subsidiary of its wholly-owned subsidiary, Ault Alliance, closed on the +acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan for a purchase price of +$3,991,497. The purchase price was paid by the Company using its own working capital. +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.aultglobal.com. +Recent Events +On +January 19, 2021, the Company changed its name from DPW Holdings, Inc., to Ault Global Holdings, Inc. (the “Name Change”). +The Name Change was effected through a parent/subsidiary short form merger pursuant to an Agreement and Plan of Merger dated January 7, +2021. Neither the merger nor resulting Name Change affected the rights of security holders of the Company. The Company’s common +stock continues to be quoted on the NYSE American under the symbol “DPW.” Existing stock certificates that reflect the Company’s +prior corporate name will continue to be valid. Certificates reflecting the new corporate name will be issued in due course as old stock +certificates are tendered for exchange or transfer to the Company’s transfer agent. Concurrently with the change in our name, Milton +C. Ault, III was appointed as our Executive Chairman, William B. Horne was appointed as our Chief Executive Officer and remains as Vice +Chairman of our board of directors, and Henry Nisser was appointed as our President and remains as our General Counsel. +2 +Commencing in October of 2019 +and continuing through February of 2020, the Company reorganized its corporate structure pursuant to a series of transactions by and among +the Company and its directly and indirectly owned subsidiaries. The purpose of the reorganization was to align the Company’s various +businesses by the products and services that constitute the majority of each subsidiaries’ revenues. As a result of the foregoing +transactions, the Company’s corporate structure is as follows: +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of the NYSE +American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, at +the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, or up to 19.99% of +the Common Stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, shall be +due and payable on August 5, 2020. The Note shall be convertible into shares of the Company’s common stock, par value $0.001 per +share (the “ Common Stock ”) at a conversion price of $1.45 per share, subject +to the approval of the Company’s stockholders at a special meeting thereof, as required by Rule 713(a)(ii) of the NYSE Company Guide, +and subsequently, authorization from the NYSE American. +On February 10, 2020, we entered +into a Master Exchange Agreement (the “ Master Exchange Agreement ”) with Esousa Holdings, LLC (“ Esousa ” +or the “ Credito r”) that acquired approximately $4.2 million in principal amount, plus accrued but unpaid interest, +of certain promissory notes that had been previously issued by us to Dominion Capital, LLC, a Connecticut limited liability company (the +“ Dominion Note ”) and the Canadian Special Opportunity Fund, LP (the “ CSOF Note ” and with the Dominion +Note, the “ Esousa Purchased Notes ”) in separate transactions. The Creditor also agreed to purchase additional notes +up to an additional principal amount, plus accrued but unpaid interest, of $3.5 million (the “ Additional Notes ” and +collectively, with the Esousa Purchased Notes, the “ Notes ”). Pursuant to the Exchange Agreement, the Creditor has the +unilateral right to acquire shares of the Company’s common stock (the “ Exchange Shares ”) in exchange for the +Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness of the Company. In aggregate, we have issued +to Esousa a total of 8,332,904 Exchange Shares. +3 +The first exchange occurred +on the date of the Master Exchange Agreement when the Creditor exchanged a portion of the Esousa Purchased Notes for the Exchange Shares +and the second exchange began July 8, 2020 when the Company received stockholder approval at a special meeting thereof for the Exchange +of the Esousa Additional Purchased Notes for the Company’s common stock, and subsequently, authorization from the NYSE American. +On March 4, 2020, pursuant +to the terms of the securities purchase agreement for the sale of the Dominion short-term promissory note, the Company issued to Dominion +12,500 shares of its common stock (see Note 17). +On April 13, 2020, the Company +issued a convertible promissory note in the principal amount of $100,000 with an interest rate of 10% per annum and a five-year warrant +to purchase shares of the Company’s common stock equal to 50% of the number of shares of common stock issuable pursuant to the convertible +promissory note, at an exercise price equal to $1.17 per share of common stock. +On May 28, 2020, the Company +entered into a securities purchase and exchange agreement with an institutional investor. Pursuant to the agreement, the Company exchanged +a 12% short-term promissory note in the principal amount of $235,796 for a new note due and payable on June 30, 2020 (the “Exchanged +Note”) that would become convertible into common stock of the Company should the Company be in default under the terms of the Exchanged +Note. In addition, pursuant to the agreement, the Company issued to the investor a note due and payable on November 28, 2020 in the principal +amount of $200,000 that became convertible into the Company’s common stock commencing June 30, 2020 with an original issue discount +of twenty percent (20%). In conjunction with the issuance of the Convertible Note, the Company also issued to the investor a warrant to +purchase an aggregate of 400,000 shares of Common Stock at an exercise price of $1.07. +On June 26, 2020, the Company +issued to several institutional investors unsecured 12% short-term promissory notes in the aggregate principal amount of $800,000 and +seventeen month warrants to purchase an aggregate of 361,991 shares of the Company’s common stock at an exercise price of $2.43 +per share of common stock. +On August 5, 2020, the Company +received $2,000,000 from Esousa and on October 22, 2020, the Company issued to Esousa a promissory note in the principal face amount of +$2,000,000, with an interest rate of 13%. +On +August 20, 2020, the Company issued 413,793 shares of its common stock upon the conversion of $600,000 in principal on the Ault +& Company Convertible Note. +Between +August 2020 and October 2020, the Company also received $3,200,000 in loans from Esousa pursuant to which the Company agreed to issue +unsecured short-term promissory notes with interest rates of 13% and 14% and warrants with terms of approximately one and a half years +to purchase an aggregate of 1,303,863 shares of Common Stock at an average exercise price of $2.70 per share of Common Stock. +On October 2, 2020, we entered +into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC to sell shares +of common stock having an aggregate offering price of up to $8,975,000 from time to time, through an “at the market offering” +program (the “2020 ATM Offering”). On December 1, 2020, we filed an amendment to the prospectus supplement with the SEC to +increase the amount of common stock that may be offered and sold in the ATM Offering, as amended under the Sales Agreement to $40,000,000 +in the aggregate, inclusive of the up to $8,975,000 in shares of common stock previously sold in the 2020 ATM Offering. The offer and +sale of shares of common stock from the 2020 ATM Offering was made pursuant to our effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) which became effective on January +11, 2018. Through December 31, 2020, we had received gross proceeds of $39,978,350 through the sale of 12,582,000 shares of common stock +from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, 2020. +On +October 26, 2020, the Company announced that it had successfully converted all of its secured debt, totaling just under $5 million, +to equity thus improving the Company’s net equity. +On +November 2, 2020, I.AM, Inc. filed a voluntary petition for bankruptcy under Chapter 7 in the United States Bankruptcy Court in the Central +District of California, Santa Ana Division, case number 8:20-bk-13076. +4 +Settlement of Derivative Litigation +On February 24, 2020, we entered +into a definitive settlement agreement (the “ Settlement Agreement ”) intended to settle the previously disclosed derivative +litigation captioned Ethan Young and Greg Young, Derivatively on Behalf of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, +III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, Robert O. Smith, and Kristine Ault and DPW Holdings, Inc., as the nominal +defendant (Case No. 18-cv-6587) (as amended on March 11, 2019, the “ Amended Complaint ”) against the Company and +certain of its officers and directors pending in the United States District Court for the Central District of California (the “ Court ”). +As previously disclosed, the Amended Complaint alleges violations including breaches of fiduciary duties and unjust enrichment claims +based on the previously pled transactions. +On April 15, 2020, the Court +issued an Order (the “ Order ”) approving a Motion for Preliminary Approval of Settlement in the Derivative Action. On +July 16, 2020, the Court issued an Order (the “ Final Order ”) approving a Motion for Final Approval of Settlement in +the Derivative Action filed against DPW as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018 +who were not dismissed from the action as a result of the Court’s partial grant of the Motion. +On July 16, 2020, the Court +entered a Judgement based upon the Final Order. +Under the terms of the Final +Order approving the Agreement, the Board shall adopt and/or maintain resolutions and amendments to committee charters and/or the Company’s +bylaws to ensure adherence to certain corporate governance policies (collectively, the “ Reforms ”), which shall remain +in effect for no less than five (5) years, subject to any of the following: (a) a determination by a majority of the independent directors +that the Reform is no longer in the best interest of the Company, including, but not limited to, due to circumstances making the Reform +no longer applicable, feasible, or available on commercially reasonable terms, or (b) modifications which the Company reasonably believes +are required by applicable law or regulation. +In connection with the Settlement +Agreement, the parties agreed upon a payment of attorneys’ fees in the amount of $600,000 payable by the Company’s Director +& Officer liability insurance, which sum was paid. The Settlement Agreement contains no admission of wrongdoing. The Company has always +maintained and continues to believe that it did not engage in any wrongdoing or otherwise commit any violation of federal or state securities +laws or other laws. +Strategy +As a holding company, our business strategy is designed to increase +shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and partner companies, +with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are and will consider +initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain or all partner company +interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize shareholder value, such +as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working capital needs. +On October 7, 2019, we created an Executive Committee which is comprised +of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets on a daily basis to address the Company’s +critical needs and provides a forum to approve transactions which are communicated to our Chief Financial Officer and Senior Vice President +of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves and manages our investment and trading +strategy. The Executive Committee has decades of experience in financial, investing and securities transactions. Led by our Founder and +Executive Chairman, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global +impact. We also use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an +investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, +from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s Vice Chairman and Chief Executive Officer +and Henry Nisser, the Company’s President and General Counsel, to provide analysis and guidance on all acquisition targets and throughout +the acquisition process. +5 +From time to time, we engage in discussions with other companies interested +in our subsidiaries or partner companies, either in response to inquiries or as part of a process we initiate. To the extent we believe +that a subsidiary partner company’s further growth and development can best be supported by a different ownership structure or if +we otherwise believe it is in our shareholders’ best interests, we will seek to sell some or all of our position in the subsidiary +or partner company. These sales may take the form of privately negotiated sales of stock or assets, mergers and acquisitions, public offerings +of the subsidiary or partner company’s securities and, in the case of publicly traded partner companies, transactions in their securities +in the open market. Our plans may include taking subsidiaries or partner companies public through rights offerings and directed share +subscription programs. We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner +company interests in secondary market transactions to maximize value for our shareholders. +Our Executive Committee acts +as the underwriting committee for our subsidiary DP Lending and approves all lending transactions. Under its business model, DP Lending +generates revenue through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income +from appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants +issued to DP Lending in any particular financing. DP Lending’s activities are more fully described elsewhere in this Annual Report; +see page 10. +As a holding company, our business strategy is designed to increase +shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and partner companies, +with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are and will consider +initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain or all partner company +interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize shareholder value. We +anticipate returning value to shareholders after satisfying our debt obligations and working capital needs. +Over the recent past we have +provided capital and relevant expertise to fuel the growth of businesses in defense/aerospace, industrial, telecommunications, medical +and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity interest or may be actively +involved, influencing development through board representation and management support. +Markets +We sell our custom power system +solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial +and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base +consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics +market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas the European marketplace is served through +Gresham Worldwide, another wholly-owned subsidiary. +Gresham Worldwide’s +operations focus exclusively on the market for electronic solutions that support the defense industry and other mission critical applications. +The essential nature of these applications provides a degree of insulation from volatility associated with other segments of the global +economy while accounting for stability and steady growth of the addressable market opportunities available to Gresham Worldwide in segments +that it serves. Demand for solutions to meet these requirements continues unaffected, and in many instances increases, in times of global +crisis. Total defense spending in the three countries in which Gresham Worldwide currently operates will total more than an estimated +$813 billion in 2021. Gresham Worldwide sells to the militaries and defense contractors in 18 other countries as well. Overall global +defense spending is expected to grow at a compound annual growth rate, or CAGR, of 3% through 2023, with US spending growing at almost +a 5% CAGR in the same period. +The drive for increased situational +awareness and close coordination of air, land, sea, space and cyber operations will fuel an increase in defense electronics subsystems +and components with total spending in 2020 of $131 billion and a projected CAGR of 5.6% through 2024, according to Global Defense Electronics +Market, Trends, Driver and Outlook for 2020 and Beyond, Renaissance Strategic Advisors, September 2020. The drive for greater connectivity +and analytics will in turn increase demand for RF communications, power solutions and electronic control systems content in new major +military platforms, right in the sweet spot of Gresham Worldwide operating units. +Tens of thousands of companies +compete in this market to deliver electronics solutions to meet defense and other mission critical applications. However, Gresham Worldwide’s +operating units have longstanding relationships with dominant defense contractors in the US (Lockheed, BAE Systems, L3Harris, Raytheon, +Boeing), in the UK (BAE, Rolls Royce, Thales, Bombardier) and in Israel (IAI, Rafael, Elbit) which hold contracts for major defense platforms +with very long life cycles. These relationships enable Gresham Worldwide to narrow the field of competition considerably and thereby to +grow based on repeat business with relatively low selling costs. +6 +Beyond the defense arena, +initiatives to complete $50 billion in upgrades to the current National Railway System in the UK over the next five years while spending +$130 billion over the next 10 years to build a high speed rail to link London with the Midlands cities of Birmingham, Leeds and Manchester +will generate significant opportunities for growth in demand for power solutions to upgrade and replace current infrastructure, both in +rolling stock and track side controls. Relec Electronics’ current relationships and track record for supplying power solutions to +the UK rail industry position Gresham Worldwide ideally to capitalize on these ongoing refurbishment and expansion efforts. A similarly +robust market in the medical power supply markets with a CAGR at 5.4%, to reach $4.4 billion in 2022, creates tremendous growth opportunities +for our Relec Electronics subsidiary in the UK. +We sell products to our OEM +customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our +sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with +such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product +requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer +representatives and distributors. We plan to continue to build more channels and increase our market share through 2021. +Commercial Customers . +We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications +and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental +conditions. Our commercial customers include Elma GmbH, BioSense Webster, a subsidiary of Johnson & Johnson, RS Components, Farnell, +Parker Hannifin, Vanderbilt, Bombardier. +Military/Defense Customers . +We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh +environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat +environments and meet the requirements of our defense customers. We manufacture our military products through a domestic manufacturer +that complies with US International Traffic in Arms Regulations (“ ITAR ”) and is certified to perform such manufacturing +services. We are compliant with the ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military +electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive +the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in +these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; Naval – Naval power conversion +and distribution; Mobile and Ground Communications – Active Protection, Communications and Navigation; Artillery – Gyro modular +azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned Aerial Vehicle) – Very lightweight power +systems. +Our military products meet +the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, +output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military +power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies +are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary +Gresham Power develops and manufactures some military and defense products mainly being deployed in several naval fleets. +Our Subsidiaries and their Businesses +Coolisys +We provide the highest density, +highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and modify-standard +product solutions and value-added services to diverse industries and markets including automotive, medical, military, telecom, commercial +and industrial. We believe that our solutions leverage a combination of low leakage power emissions, very high-power density with superior +power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy with respect +to Coolisys Technologies Corp., or CTC, is to be the supplier of choice to companies, including OEMs, that require high-quality power +system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business +success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of +efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that +supports all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, +including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power +sources with our custom design cost-effective products. +7 +Electric Vehicle (“EV”) +Market. Coolisys‘ electric vehicle supply equipment including its EV charging stations product line is well positioned to +address the expected rapid expansion of infrastructure required to support broad adoption of electric vehicles globally. Coolisys has +strong reputations for delivering high-reliability power solutions designed to serve mission critical applications in the harshest environments. +Coolisys’ innovative charging solution can produce a full charge for an EV with a 150-mile range battery in just 30 minutes. It +includes a wide range of solutions including level 2 AC EV charger station that are 208-240 volt compatible with the SAE J1772 standard +and range of heavy duty level 3 DC fast EV charger station that is 150-1500VDC compatible with chargers equipped Combined Charging System +or CCS, CHAdeMO and SAE J1772 charging plugs. Coolisys EVSE series can charge virtually any type of electrical vehicles, such as, Honda, +Nissan, Mitsubishi, Toyota, Kia, Subaru, Ford, General Motors, Volkswagen, Audi, Jaguar and Tesla (with the appropriate Tesla charging +adapter). +Custom Power System +Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution +technology includes full Digital Signal Processing (“ DSP ”) control, digital load sharing intelligent power management +and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customers’ +unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for +virtually any plausible need. In the design of custom power solutions, we work closely with our customers’ engineering teams +to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for +custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees +(and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development +of our intellectual property (“ IP ”) portfolio. We believe that this business model provides an incentive to our customers +to be committed to high-volume production orders. +High-Grade Flexibility +Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade +design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) +and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some +of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes +to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical repackaging tailored +to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any +platform across our diversified market segments. +Value-Added Services . +In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added +services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components +into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically +tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, +our power systems, and provide the OEM with the integration and installation service, thus eliminating the need for complex, time-consuming +and costly system integration. We believe that this value-added service is well suited to those OEMs that wish to reduce their vendor +base and minimize their investment in manufacturing, which would lead to increased fixed costs. Given access to these value-added services, +the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase +individual parts from many vendors. +Gresham Worldwide, Inc. +Gresham Worldwide provides defense solutions with +operations conducted by Microphase, Enertec, Gresham Power and Relec +Gresham Power (formerly known as Digital Power +Limited) +Gresham Power designs, manufactures, +and distributes switching power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters +for the commercial and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships +to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment +such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers +are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter +start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United +Kingdom and European markets, and strengthen our engineering and technical resources. +8 +Gresham Power specializes +in engineering, designing and developing power conversion and distribution solutions for Naval applications, with equipment installed +on virtually all of the UK Royal Navy’s submarine and surface fleet. Many of Gresham Power’s ultra-reliable offerings support +shipboard distribution of electrical power in emergencies (such as loss of main ship’s power) to enable continued operation of weapons +systems, tactical communications and lighting. Gresham Power specializes in a comprehensive range of activities from PCB and Mechanical +Design through prototype development to board and system assembly and test. Its engineers ruggedize Marine power products to meet high +levels of shock, vibration, harsh climate conditions and the most rigorous MIL STD requirements. Gresham Power also has deployed its equipment +on vessels of the navies of 15 other countries, include Australia, Malaysia, Oman, Spain, Turkey and Japan. +Microphase Corporation +Microphase designs, manufactures +and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication systems. Such components +include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated +assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s customers are comprised of the U.S. +military and allied militaries, and contractors to the U.S. military including prime contractors and sub-contractors. Microphase’s +recent technology innovations are used in many significant U.S. Government defense programs, including the Polaris submarine, the F-16, +the F-35 and the Predator drone. Other notable programs in which Microphase’s products are or were used include the Atlas Missile, +Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile System, THAAD (or Terminal High Altitude Area Defense), +the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint +strike fighter plane, and more recently drone programs including the Predator, the Reaper and the Shadow. +Microphase’s advanced +technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in order to accurately +recover the signals and facilitate use of the information received. These products include: +· filters that sort and clarify microwave signals, including multiplexers that are a series of filters combined +in a single package; +· solid state amplifiers that amplify microwave signals; +· detectors and limiters that are semiconductor devices for detection of radar signals and protection of +receivers from damage from high power signals and jamming; +· detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal detection +systems; +· integrated assemblies that combine multiple functions from a range of components and devices, including +transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction +assemblies; +· electronic test and measurement probes; +· universal test and measurement test platforms and fixtures; and +· utility probes and antenna probes. +Manufacturing and Testing +Consistent with our strategy +of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our +manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they +will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access +to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual +downward pressure on selling prices. In order to achieve our low-cost manufacturing goals with labor-intensive products, we have entered +into manufacturing agreements with certain contract manufacturers domestically and in Asia. +We are continually improving +our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing +of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part +of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific +testing services are offered with custom designed test stands to simulate operation within our customer applications. +9 +Compliance with international +safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. +Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and +are appropriately documented to expedite safety approval processes. +Enertec Systems 2001 Ltd. +Based in Israel, Enertec designs, +develops, manufactures and maintains advanced end-to-end high technology electronic solutions for military, medical, telecommunications +and industrial markets. Those solutions include custom computer-based automated test equipment and turnkey systems to ensure combat readiness, +provide command and control, and direct and deploy resources in military operations in harsh environments and battlefield conditions. +The Company also designs, develops, manufactures and maintains high precision calibration equipment for lifesaving medical operations +for a global health care products company as well as advance power systems for electric vehicle, telecom and other industrial applications. +Enertec delivers complete end-to-end project management with requirements definition, systems engineering, design/development, production, +testing, integration, field support, maintenance and optimization. Its custom engineered solutions enable and support mission critical +air, land and sea military platforms, e.g., missiles, UAVs, combat aircraft, boats, submarines, trailers and satellites. +Enertec’s primary customers +include the Israeli Ministry of Defense and the 3 major defense contractors in Israel – Israel Air Industries (IAI), Rafael and +Elbit Systems. In addition, Enertec has a strategic partnership with Cyient to build and deliver solutions for the Indian military. High +tech capabilities to deliver advance electronics solutions create opportunities for other Gresham Worldwide operating subsidiaries – +Microphase and Gresham Power – to supply components for Enertec solutions. Enertec also provides geographic reach into the Middle +East and India to broaden Gresham Worldwide’s footprint in delivering the highest quality and most advance technology solutions +across the globe. +Enertec is Israel’s +largest, most well-established manufacturer of test equipment and simulators. We develop and manufacture test systems and simulators for +all types of weapons systems at all levels of maintenance, development, and integration. We are currently working on developing a new +generation of electronics cards and assemblies to build a new generation of test systems. +Enertec complies with all +information security requirements included in it customer contracts as well as all the confidentiality laws that the State of Israel mandates +for work related to defense of the country. +Relec Electronics Ltd. +Relec Electronics Ltd was +established in 1978 with the aim of providing specialist power conversion and display products to support professionals in the electronics +industry. Relec markets and distributes power electronics and display solutions for mission critical rail, industrial, medical, telecoms +and military applications. Relec develops custom solutions for various applications ranging from light industrial to heavily ruggedized +for the harshest of environments. Relec exerts its utmost effort to customize a product or a feature to achieve optimum performance and +service delivery. Relec continues to be guided by this philosophy and currently operates in specific fields, specializing in AC-DC Power +Supplies, DC-DC Converters, Displays and EMC Filters. +Ault Alliance, Inc. +Ault Alliance provides commercial +lending through DP Lending, data center operations through ACS, digital marketing through Tansocial and digital learning. +DP Lending +DP Lending provides funding +to businesses through loans and investments. DP Lending offers a variety of loan types including commercial loans, convertible notes and +revolving lines of credit. DP Lending is engaged in providing commercial loans to companies throughout the United States to provide them +with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to twelve months, +but may be of longer duration. These terms are subject to change as market needs dictate, and DP Lending anticipates offering additional +products in the future. +10 +DP Lending uses its considerable financial experience, data analytics, +and a credit scoring model to assess the creditworthiness of each small business borrower applicant. If the business meets DP Lending’s +criteria, DP Lending sets the initial interest rate according to its credit and financial models. The final interest rate offered to the +borrower will be determined by DP Lending’s interpretation of the marketplace. In order to borrow from DP Lending, borrowers must +display characteristics indicative of durable business and financial situations. These include factors such as revenue, time in business, +number of employees, and financial and credit variables. In order to qualify, business borrower applicants must be approved through DP +Lending’s underwriting process, which analyzes credit and financial data of both the business and the business owner. DP Lending +takes into account several business factors (including revenue, age of business, cash flows, and other variables). The underwriting process +determines the loan amount to approve, how loans will be priced, and whether to include a blanket lien is based on the above analysis, +as well as additional factors (including length of loan, estimated default rates by type and grade, and general economic environment). +Our Executive Committee, which is comprised of our Executive Chairman, +Chief Executive Officer and President, acts as the underwriting committee for DP Lending and approves all lending transactions. The Executive +Committee has decades of experience in financial, investing and securities transactions. Under its business model, DP Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to DP Lending in any particular financing. +As noted above, we will from time to time, through DP Lending, engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +During 2021, we anticipate +providing significant new funding to expand DP Lending’s loan and investment portfolio. DP Lending loans made or arranged pursuant +to a California Financing Law license (Lic.no. 60 DBO77905). +ACS +ACS operates a data center +and conducts bitcoin mining at a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan with the +ability to offer up to 300MWs of critical power capacity. The data center was acquired on February 1, 2021 and revenue from the existing +commercial real estate operations began being recognized during the quarter ending March 31, 2021 and, upon completion of the initial +buildout of 30,000 square feet, or the equivalent of 1,000 cabinets capable of housing over 40,000 servers, recognition of revenue from +the enterprise cloud data center is expected to begin during the quarter ending June 30, 2021. +The buildout of the initial +30,000 square feet will be for colocation services, including build-to-suit arrangements, in which customers will be provided with secure, +reliable and robust environments for hardware and access to network connectivity that are necessary to aggregate and distribute information. +By initially focusing on colocation services that range from a single rack to multi-megawatt hyperscale requirements, we will be able +to minimize our capital and operating expenses and also provide an attractive alternative to companies that either host internally and +need additional capacity or are evaluating build vs. buy alternatives. We expect that revenues from the colocation services will be primarily +based on a recurring revenue model comprised of colocation for a predetermined amount of allocated power and related interconnection offerings. +Ultimately, we intend to expand our service offerings to include managed cloud computing, in other words the on-demand availability of +various technology resources, such as compute, storage and network. While we believe the Facility and its anticipated future operations +will be successful, there is a risk that its expectations will not materialize in a timely manner, if at all. +11 +Tansocial +Tansocial is an early-stage +marketing company leveraging innovative digital tools to provide lead generation, influencer promotion and marketing, client acquisition +training systems, social media branding/content, digital marketing consulting, and text message marketing. +Sales and Marketing +We market our products directly +through our internal sales force as well as through our channel partners including independent manufacturer representatives and distributors. +Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, the manufacturing representatives +have the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving their marketing +and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal +to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales for retention, payable after products are shipped +to the customer in the assigned territory. Typically, either we or the manufacturing representatives are entitled to terminate the manufacturing +representative agreement upon 30 days’ written notice. +Gresham Power Electronics +makes limited use of channel partners including independent manufacturer representatives and strategic operating partners in the Middle +East, India and Australia. These representatives promote our products and serve as the customer interface for Gresham Power in specific +parts of the world as agreed. Typically, either we or the manufacturing representatives are entitled to terminate the manufacturer representative +agreement upon 30 days’ written notice. +Our Relec subsidiary advertises +in highly targeted industry-specific publications such as Electronics Weekly, New Electronics, Electronic Product Design & Test, Electronics +Specifier, Components In Electronics, Design Products & Applications, Rail Technology Magazine, Rail Engineer, Rail Professional. +In addition, Relec also posts regular podcasts on topics of interest to customers and prospect as well as running an active PR campaign +to get placements of earned media and coverage in a wide range of media. We look to replicate similar campaigns in other operating subsidiaries +to generate inquiries/leads, raise awareness of Gresham Worldwide and support talent recruiting efforts. +We provide comprehensive +collateral materials including product data sheets, participation in trade shows, and our websites, www.digipwr.com and +www.microphase.com. We use our website to emphasize our capabilities and marketing direction. All products specifications are +uploaded onto our websites and accessible to the marketplace. We will continue to enhance our websites by adding more features and +functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future +promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new +products. +Engineering and Technology +Our engineering and product +development efforts are primarily directed toward developing new products in connection with custom product design and modification of +our standard power systems to provide a broad array of individual models. +Our new custom product solutions +are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation +and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing +our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these +customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us +to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of +our product development projects to engineering partners in order to achieve the best technological and product design results for the +targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, +but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the +shelf (“ COTS ”) products and for other customized product requirements, when applicable. We continually seek to improve +our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, +such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate +all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering +integrating laboratory located in California. +12 +Competition +The power system solutions +industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout +the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products superior +or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, +Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If +we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also +face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for +their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current +economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become +more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell our products are acquired +by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, +offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability +levels, and offering flexible and reliable delivery schedules. +We believe that our power +system solutions and advanced technology is superior to our competitors’ power supplies mainly because we use the latest power technology +processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio makes our power solutions +more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power +system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number +of output product design platforms. We believe we have a competitive position with our targeted customers that need a high-quality, compact +product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system +platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This +“flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after +initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very +low non-recurring engineering (“ NRE ”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM +customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage +over our competitors, many of which charge their customers for NRE expenses. +The markets in which Microphase +operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors are larger than it +is and maintain higher levels of expenditures for research and development. Principal competitive factors in Microphase’s markets +are product quality and reliability; technological capabilities; service; past performance; ability to develop and implement complex, +integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales channels in international markets; and +cost-effectiveness. +In the RF Communications market, +principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, MD; RS Microwave, +a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith Group, a global technology +company listed on the London Stock Exchange; and Delta Diversified Products, a private company based in Arizona. +In the Video amplifier segment, +principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately held company +headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, a privately +held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company based in New +York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Our Enertec subsidiary faces +direct competition from smaller firms than itself such as Nir Or, EPS, MER, Alexander Schneider, Symcotech and Chaban, which specialize +in components of electronic solutions. Offering end-to-end, turnkey solutions gives Enertec a competitive advantage over other private +contractors competing to provide the Israeli MOD and major OEMs with electronic systems and components. That competitive advantage renders +roughly 80% of Enertec’s business de facto “sole source” work without other viable competition. +Gresham Power confronts competition +from Ultra Electronics and Rolls Royce. As in the case of Microphase, elegant designs, strong engineering and a long track record for +delivering ultra-reliable high quality power electronics solutions enables Gresham Power to compete effectively. +13 +Relec competes against many +other distributors of power electronics and display offerings, facing competition from the likes of Fidus Power Ltd, Mouser Electronics +and Avnet Abacus as well as power supply and electronics manufacturers like XP and ABB who sell direct, many of which have significantly +more fiscal and marketing resources than Relec. However, a high touch, customer-focused approach enables Relec to compete effectively +against high volume distributors and direct selling manufacturers. Optimizing and designing solutions into customer product lines has +proven tremendously effective in building relationships with customers and suppliers alike that endure over time, generating regular repeat +business and builds a reputation for customer service that provides a strong competitive advantage when pursuing new customers. +We also face competition from +current and prospective customers who may decide to design and manufacture power electronics, communications components and electronic +solutions needed to satisfy their internal programmatic requirements. +Consolidation in the defense +technology solutions market, including through mergers, acquisitions and/or strategic alliances among major entities to which we sell +our products, has the potential to intensify the competitive pressures that we face. Many of our existing and potential competitors may +be better positioned than we are to acquire other companies, technologies or products. We believe we compete favorably on the basis of +multiple factors, including product quality and reliability, technological capabilities, service, past performance, design flexibility +and ability to develop and implement complex, integrated solutions customized to our customers’ needs, and cost-effectiveness. Focusing +on bespoke technology offerings with relatively low volumes and high margins enables our operating subsidiaries to compete favorably on +price against larger companies with much high indirect cost structures. Finally, the fragmentation of the defense technology market also +creates opportunities the Gresham Worldwide to grow through acquiring competitors and/or potential competitors. +Raw Materials +The raw materials for power +supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not +dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize +our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter +lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long +lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors +have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no longer +available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign some of our +products to conform to currently available materials. +Intellectual Property +We rely upon a combination +of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe +that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. It is our policy +to enter into confidentiality and invention assignment agreements with our employees and contractors as well as nondisclosure agreements +with our suppliers and strategic partners in order to limit access to and disclosure of our proprietary information. However, in the future, +as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our +trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +In conjunction with our majority +acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade name, which has +been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +Microphase and Enertec typically +design custom products to our customer specifications as “work for hire” and therefore own no intellectual property in the +design. As the ultimate end user, the U.S. DoD and the Israeli MOD typically acquire and retain rights in all such technical data. Microphase +does acquire and own intellectual property in the fabrication, assembly, tuning and testing protocols followed the production of the products. +And, as they conduct more independent research and development to new technology solutions, both companies plan to file for patents to +protect their intellectual property. +14 +In the UK, Gresham Power typically +will retain ownership of the intellectual property of the designs of products developed for defense applications. However, neither Relec +nor Gresham Power typically retains intellectual property in any of the standard power products that they sell on the commercial market. +Compliance with Material Government (Not Just +Environmental) Regulations +Coolisys +Coolisys’ businesses are heavily regulated in most of its markets. +Coolisys handles power electronics products mainly in the form of power conversion. Coolisys must take into account several standards +for electronic safety to protect the health of humans and animals. Coolisys serves diverse markets including automotive, defense/aerospace, +medical/healthcare, industrial and telecommunications, each of which has its own set of their safety regulations and standard that Coolisys +must comply with. +Government Contracts . +The U.S. government, and other governments, may terminate any of Coolisys’ government contracts at their convenience, as well as +for default based on our failure to meet specified performance requirements. If any of Coolisys’ U.S. government contracts were +to be terminated for convenience, Coolisys would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of Coolisys’ government contracts were to be terminated for default, generally the U.S. government +would pay only for the work that has been accepted and could require Coolisys to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. government can also hold +Coolisys liable for damages resulting from the default. +Medical device power supplies . +Coolisys’ medical power supplies must incorporate one or more means of protection (“ MOP ”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. Coolisys must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an AP and unconscious when the fault occurs. +Environmental . Coolisys +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. Coolisys continually assesses its compliance status and +management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of Coolisys’ operations. +Non-U.S. Sales . Coolisys’ +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Gresham +Gresham’s businesses +are heavily regulated in most of its markets. Gresham transacts with numerous U.S. government agencies and entities, including but not +limited to the Department of Defense, branches of the U.S. military and the Department of Homeland Security. Similar government authorities +exercise similar regulatory oversight in Gresham’s non-U.S. markets. +Government Contracts . +The governments of the U.S., UK and Israel may terminate any of Gresham’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of Gresham’s contracts for convenience, Gresham generally would be entitled to receive payment for work completed and allowable +termination or cancellation costs. If any of Gresham’s government contracts were to be terminated for default, generally the U.S. +government would pay only for the work that has been accepted and could require Gresham to pay the difference between the original contract +price and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. government can also +hold Gresham liable for damages resulting from the default. Similar provisions apply to Gresham’s contracts with other governments +and to Gresham’s subcontractors with major defense contractors who provide systems or military platforms directly to the government. +15 +Power Electronics . +In all of Gresham’s markets in the U.S., Gresham’s commercial power electronics offerings must comply with safety, energy +use and operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. +In the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the UK, Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, Gresham’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . Gresham +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies or as applicable +local regulations or laws require. The products that Gresham markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“ RoHS ”), which restricts the use of six hazardous materials in the manufacture +of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, Gresham’s industry began phasing in +RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. Gresham believes that RoHS +and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +REACH (Registration, Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 +December 2006. REACH addresses the production and use of chemical substances, and their potential impacts on both human health and the +environment. +These regulatory mandates +apply to all of Gresham’s operating subsidiaries. Gresham has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +Non-U.S. Sales . Gresham’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Alliance Cloud Services +ACS is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. ACS continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While ACS’s regulatory compliance costs +are currently not considered material, it is reasonably possible that costs incurred to ensure continued environmental compliance could +have a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +Security Clearance +As a U.S. Government contractor, +we are required to maintain facility and personnel security clearances complying with the DoD and other Federal agency requirements. Microphase +maintains strict protocols for handling classified information and Confidential Unclassified Information associated with its work for +the United States Department of Defense and has built a “Secure Compartmented Information Facility” within its Shelton production +facility certified for generating, storing and reviewing classified information. +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the UK Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +16 +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “ DCAA ”), +the Defense Contract Management Agency (the “ DCMA ”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the Department of Justice and Congressional Committees. From time-to-time, these and other agencies +investigate or conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. +The DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the MOD does most of its business. All +of its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +UK Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the customer +the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government and +typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified and Confidential Unclassified Information (CUI) from disclosure and unauthorized access. That mandate +includes a requirement that Microphase formulate and implement a System Security Plan with 110 different elements and protocols for handling +and protecting classified information and CUI. Over the next 3 years, the DoD will require all participants in the defense supply chain +to demonstrate compliance with the Capability Model Maturity Cybersecurity as verified through an independent third party auditor. Compliance +with these mandates requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance +requires extensive security controls on access to Microphase IT systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Compliant.” Cyber Essentials is a Government-backed, industry-supported scheme +to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials program criteria. +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Issues +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December +31, 2020 and 2019, we spent approximately $1,848,866 and $1,861,103, respectively, on research and development. +17 +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries and others operate in industries deemed essential by the DoD and therefore remained +at work during the COVID-19 pandemic. +Employee Profile +As of December 31, 2020, we +had 154 employees located in the United States, the United Kingdom and Israel, of whom 54 were engaged in engineering and product development, +14 in sales and marketing, 46 in general operations and 40 in general administration and finance. All but 10 of these employees are employed +on a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to +be good. +As of December 31, 2020, approximately +36% of our current workforce is female, 64% male, and our average tenure is 10.0 years, an increase of 3.7% from an average tenure of +9.7 years as of December 31, 2019. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of ten years as +of the end of the fiscal year 2020 reflects the engagement of our employees in this core talent system tenet. +The Company believes it complies +with all applicable state, local and international laws governing nondiscrimination in employment in every location in which the Company +operates. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, +national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees' needs. We plan to conduct annual confidential employee surveys +as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. Our +employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new stretch +goals. +Objectives and key results +are used to drive our business strategy. All our teams participate in an annual strategic planning process to identify objectives for +business growth and innovation. Our teams and employees set goals quarterly to achieve the Company’s annual objectives. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members, reflect and reinforce our most important values +and align team member interests with shareholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +18 +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, health savings and flexible spending accounts, paid time off, family leave, family care resources and flexible work +schedules. We anticipate establishing a Company-wide augmented employee stock purchase plan and a Company matched 401(k) plan during 2021. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +In response to the COVID-19 pandemic, we implemented significant operating environment changes that we determined were in the best interest +of our employees, as well as the communities in which we operate, and which comply with government regulations. This includes having a +significant portion of our employees work from home, while implementing additional safety measures for employees continuing critical on-site +work. For further information on this subject and how COVID-19 has affected our company and our subsidiaries, see “Impact of Coronavirus +on Our Operations.” +19 +ITEM 1A. RISK FACTORS +An investment in our common +stock involves significant risks. You should carefully consider the following risks and all other information set forth in this Annual +Report before deciding to invest in our common stock. If any of the events or developments described below occurs, our business, financial +condition and results of operations may suffer. In that case, the value of our common stock may decline and you could lose all or part +of your investment. +You should consider each of +the following risk factors and any other information set forth in this Annual Report and the other reports filed by the Company with the +Securities and Exchange Commission (the “ SEC ”), including the Company’s financial statements and related notes, +in evaluating the Company’s business and prospects. The risks and uncertainties described below are not the only ones that impact +on the Company’s operations and business. Additional risks and uncertainties not presently known to the Company, or that the Company +currently considers immaterial, may also impair its business or operations. If any of the following risks actually occurs, the Company’s +business and financial condition, results or prospects could be harmed. Please also read carefully the section entitled “Note About +Forward-Looking Statements” at the beginning of this Annual Report. +Risks Related to Our Company +We will need to raise +additional capital to fund our operations in furtherance of our business plan. +Until +we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business plan. +The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred +stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development partners or some combination +of each. Any additional equity financings may be financially dilutive to, and will be dilutive from an ownership perspective to, our stockholders, +and such dilution may be significant based upon the size of such financing. Additionally, we cannot assure that such funding will be available +on a timely basis, in needed quantities, or on terms favorable to us, if at all. +We face business disruption +and related risks resulting from the outbreak of the novel coronavirus 2019 (“ COVID-19 ”), which could have a material +adverse effect on our business and results of operations and curtail our ability to raise financing. +Our business has been disrupted +and materially adversely affected by the outbreak of COVID-19. As a result of measures imposed by the governments in affected regions, +businesses and schools have been suspended due to quarantines intended to contain this outbreak and many people have been forced to work +from home in those areas. The spread of COVID-19 from China to other countries resulted in the Director General of the World Health Organization +declaring the outbreak of COVID-19 as a Public Health Emergency of International Concern, based on the advice of the Emergency Committee +under the International Health Regulations (2005), and the Centers for Disease Control and Prevention in the U.S. issued a warning on +February 25, 2020 regarding the likely spread of COVID-19 to the U.S. Since the initial outbreak of COVID-19, international stock markets +have reflected the uncertainty associated with the slow-down in the American, Israeli and UK economies. We are still assessing our business +operations and system supports and the impact COVID-19 may have on our results and financial condition, but there can be no assurance +that this analysis will enable us to avoid part or all of any impact from the spread of COVID-19 or its consequences, including downturns +in business sentiment generally or in our sectors in particular. +Our +operations are located in Alameda County, CA, Orange County, CA, Las Vegas, NV, Fairfield County, CT, the United Kingdom, Israel and members +of our senior management work in Seattle, WA and New York, NY, which is also the location of the offices of the Company’s +independent auditor . The Company has been following the recommendations of local health authorities +to minimize exposure risk for its employees for the past several weeks, including the temporary closures of its offices and having employees +work remotely to the extent possible , which has to an extent adversely affected their efficiency. +Updates by business unit are as follows: +· Ault Global’s corporate headquarters, located in Las Vegas, NV, largely operates normally with adherence +to the governor’s Directives and Declarations. Certain individuals deemed to be high risk may work remotely, as required. +20 +· +Ault Global’s finance and accounting offices, located in Newport +Beach, CA, have begun working remotely, based on the occupancy and social distancing order from the Orange County Health Officer (http://www.ochealthinfo.com/phs/about/epidasmt/epi/dip/prevention/novel_coronavirus). +The administrative staff has tested the secure remote access systems and technology infrastructure to adjust working arrangements for +its employees and believes it has adequate internal communications system and can remain operational with a remote staff. +· +Coolisys, located in Milpitas, CA, has largely returned to normal operations +with adherence to guidelines published by the Santa Clara Public Health Department. Certain individuals deemed to be high risk may work +remotely as required. Coolisys has experienced disruption in its supply chain as a result of the COVID-19 impact on its vendors. +· Microphase operates a production facility in Connecticut. In March 2020, the Defense Department designated +Microphase an “essential” operation of critical infrastructure workers as part of the defense industrial base. To limit the +impact of the COVID-19 pandemic, Microphase implemented a series of protocols to limit access to the facility, heighten sanitization, +facilitate social distancing and require face coverings. The Company asked workers to travel only as necessary and limit exposure to others. +All employees, including management, that do not have to be in the facility work remotely whenever possible. Any employees who come in +contact or potential contact with anyone who has tested positive for COVID-19 or who traveled outside the immediate area went into quarantine +and must provide proof of negative tests before returning to work. Rigorous adherence to these protocols enabled Microphase to operate +without disruption for 10 months. +In December +2020, five employees tested positive for COVID-19. Microphase temporarily shut down the production facility in Connecticut for a week +for deep cleaning and to have all employees tested for COVID-19. Since the outbreak disproportionately affected assembly workers, Microphase’s +assembly operations remained shut down for three weeks until all assembly workers had at least 2 negative tests. Operations resumed as +workers gradually in late December and the workforce returned to full strength in mid-January 2021. +The disruption +to production operations deferred order completion and delayed shipments with a significant decrease in revenue from forecast for December +of 2020 and a lingering, but only partial and less substantial, effect on January 2021 and February 2021 revenue. Disruption of production +added costs from paying employees who could not work and deferred revenue from delayed shipments. +Microphase +continues to follow CDC guidelines for social distancing, face coverings and heightened sanitizing to keep the workforce safe and healthy. +Microphase has strictly limited access to its facility and mandated that all employees minimize exposure to the others. All Microphase +employees who can work from home will do so while COVID-19 levels remain high in the surrounding communities. However, some workers may +still need to work in proximity to others. Management is working with state and federal authorities to get all employees vaccinated on +a priority basis as “essential workers” whom the DoD has officially designated as “critical infrastructure workforce” +as part of the “defense industrial base.” Some employees have already received vaccinations and we expect all employees to +have both vaccinations by the end of March 2021. +· Gresham Power suspended production operations +in its Salisbury, UK facility from mid-March through June 2020 before resuming production until a subsequent shutdown in November 2020. +Notwithstanding the current lockdown, production operations have resumed to complete work on order for products critically needed for +military operations. However, engineers, back office staff and management have worked from home as much as possible throughout the pandemic +period and continue to do so. The pandemic has disrupted production at times and delayed contract actions as well as other customer decision +making, which decreased revenue realized in 2020. +· Relec, which does not operate any manufacturing +or assembly facilities, has not experienced any material COVID-19 related disruptions to date and continues normal operations notwithstanding +the lockdown in the United Kingdom. All employees who can work from home do so. Others who must work at the Wareham site to move product +or access systems continue to do so under strict safety protocols with face coverings, social distancing and heightened attention to sanitization. +The principal impact on Relec’s operations has come from deferral of some orders and modest decrease in revenue year-over-year. +We presently expect business to rebound and resume a steady growth pattern in the third quarter of 2021, although the pandemic may impact +this outlook. +21 +· The Israeli government exempted Enertec from +pandemic-related lockdown orders to keep production operations open for key projects that impact national security. Approximately 50% +of the Enertec’s workforce is working remotely. Enertec incurred additional costs for increased sanitizing costs, personal +protective equipment, increased virtual operations, measures to facilitate social distancing and other precautions to avoid the spread +of COVID-19. The pandemic also affected Enertec’s customers and supply chain partners, slowing order processing, materials and parts +delivery and service order completion. The principal impact on Enertec’s business has come from deferral of customer decisions and +order issuance. We presently expect business to rebound and resume substantial growth in second quarter of 2021 as orders increase +to address deferred, pent up demand. +Due to the unprecedented market +conditions domestically and internationally, and the effect COVID-19 has had and will continue to have on the Company’s operations +and financial performance, the extent of which is not currently known, the Company is temporarily suspending guidance for 2021. The Company +will monitor the situation rigorously and provide business updates as circumstances warrant and resume providing guidance on the Company’s +business when management believes that such information would be both reliable and substantively informative. +The duration +and extent of the impact from the COVID-19 pandemic depends on future developments that cannot be accurately predicted at this time, such +as the severity and transmission rate of the virus or variants thereof, the extent and effectiveness of containment actions and the impact +of these and other factors on our employees, customers, partners and vendors. If we are not able to respond to and manage the impact of +such events effectively, our business will be harmed. +We have an evolving business model, which increases the complexity +of our business. +Our business model has evolved +in the past and continues to do so. In prior years we have added additional types of services and product offerings and in some cases, +we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products or services, and +we do not know whether any of them will be successful. From time to time we have also modified aspects of our business model relating +to our product mix. We do not know whether these or any other modifications will be successful. The additions and modifications to our +business have increased the complexity of our business and placed significant strain on our management, personnel, operations, systems, +technical performance, financial resources, and internal financial control and reporting functions. Future additions to or modifications +of our business are likely to have similar effects. Further, any new business or website we launch that is not favorably received by the +market could damage our reputation or our brand. The occurrence of any of the foregoing could have a material adverse effect on our business. +We are a holding company whose subsidiaries +are given certain degree of independence and our failure to integrate our subsidiaries may adversely affect our financial condition . +We have given our subsidiary +companies and their executives a certain degree of independence in decision-making. On the one hand, this independence may increase the +sense of ownership at all levels, on the other hand it has also increased the difficulty of the integration of operation and management, +which has resulted in increased difficulty of management integration. In the event we are not able to successfully manage our subsidiaries +this will result in operating difficulties and have a negative impact on our business. +We received an order and a subpoena from the +Commission in the investigation now known as “ In the Matter of DPW Holdings, Inc . ,” the consequences +of which are unknown. +We received an order and related +subpoena in November of 2019 from the Commission that stated that the staff of the Commission is conducting an investigation now known +as “ In the Matter of DPW Holdings, Inc. ,” and that the subpoena was issued as part of an investigation +as to whether we and certain of our officers, directors, employees, partners, subsidiaries and/or affiliates, and/or other persons or +entities, directly or indirectly, violated certain provisions of the Securities Act and the Exchange Act, in connection with the offer +and sale of our securities. Certain affiliates and related parties of ours have also been subpoenaed. Although the order states that the +Commission may have information relating to such alleged violations, the subpoena expressly provides that the inquiry is not to be construed +as an indication by the Commission or its staff that any violations of the federal securities laws have occurred. We have produced documents +in response to the subpoena. Since the original subpoena was issued, we received a second subpoena in July of 2020. The Commission may +in the future require us to produce additional documents or information, or seek testimony from other members of our management team. +22 +We are unaware of the scope +or timing of the Commissioner’s investigation. As a result, we do not know how the Commission’s investigation is proceeding, +or when it will be concluded. We also are unable to predict what action, if any, might be taken in the future by the Commission or its +staff as a result of the matters that are the subject to its investigation or what impact, if any, the cost of continuing to respond to +subpoenas might have on our financial position or results of operations. We have not established any provision for losses in respect of +this matter. In addition, complying with any such future requests by the Commission for documents or testimony could distract the time +and attention of our officers and directors or divert our resources away from ongoing business matters. This investigation could result +in significant legal expenses, the diversion of management’s attention from our business, damage to our business and reputation, +and could subject us to a wide range of remedies, including an enforcement action by the Commission. There can be no assurance that any +final resolution of this and any similar matters will not have a material adverse effect on our financial condition or results of operations. +Our inability to successfully integrate new +acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our +growth strategy through acquisitions is fraught with risk. On June 2, 2017, we acquired a majority interest in Microphase, on May 23, +2018 we acquired Enertec, on November 30, 2020 we acquired Relec and on January 29, 2021, we acquired the Facility in Michigan. Our strategy +and business plan are dependent on our ability to successfully integrate Microphase’s, Enertec’s and our other acquisition’s +operations, particularly those of Relec and Gresham Power. In addition, while we are based in Las Vegas, NV, our Finance Department is +in Newport Beach, CA, Microphase’s operations are located in Shelton, Connecticut, Enertec’s operations are located in Karmiel, +Israel and Gresham Power’s operations are located in Salisbury, England. These distant locations and others that we may become involved +with in the future will stretch our resources and management time. Further, failure to quickly and adequately integrate all of these operations +and personnel could adversely affect our combined business and our ability to achieve our objectives and strategy. No assurance can be +given that we will realize synergies in the areas we currently operate. +We are heavily dependent on our senior management, and a loss of +a member of our senior management team could cause our stock price to suffer . +If we lose the services of +Milton C. Ault III, our Executive Chairman, William B. Horne, our Chief Executive Officer, Ken Cragun, our Chief Financial Officer or +Henry Nisser, our President and General Counsel, and/or certain key employees, we may not be able to find appropriate replacements on +a timely basis, and our business could be adversely affected. Our existing operations and continued future development depend to a significant +extent upon the performance and active participation of these individuals and certain key employees. Although we have entered into employment +agreements with Messrs. Ault, Horne and Nisser, and we may enter into employment agreements with additional key employees in the future, +we cannot guarantee that we will be successful in retaining the services of these individuals. If we were to lose any of these individuals, +we may not be able to find appropriate replacements on a timely basis and our financial condition and results of operations could be materially +adversely affected. +We rely on highly skilled personnel and the +continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our business may be +severely disrupted. +Our performance largely depends +on the talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise held by our Executive +Chairman, Milton C. Ault III. His absence, were it to occur, would materially and adversely impact development and implementation of our +projects and businesses. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled +personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract, among others, +new technology developers and to retain and motivate our existing contractors. If one or more of our executive officers are unable or +unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may be +severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives joins +a competitor or forms a competing company, we may lose some customers. +We may be classified as an inadvertent investment company. +We are not engaged in the +business of investing, reinvesting, or trading in securities, and we do not hold ourselves out as being engaged in those activities. Under +the Investment Company Act, however, a company may be deemed an investment company under section 3(a)(1)(C) of the Investment Company +Act if the value of its investment securities is more than 40% of its total assets (exclusive of government securities and cash items) +on a consolidated basis. +Our lending subsidiary, Digital +Power Lending, LLC (“ DP Lending ”), operates under California Finance Lending License #60DBO-77905. Per the Investment +Company Act of 1940 companies with substantially all their business confined to making small loans, industrial banking or similar business, +such as DP Lending, are excluded from the definition of an investment company. +23 +We have commenced digital +asset mining, the output of which is cryptocurrencies, which the Commission has indicated it deems a security. In the event that the digital +assets held by us exceed 40% of our total assets, exclusive of cash, we inadvertently become an investment company. An inadvertent investment +company can avoid being classified as an investment company if it can rely on one of the exclusions under the Investment Company Act. +One such exclusion, Rule 3a-2 under the Investment Company Act, allows an inadvertent investment company a grace period of one year from +the earlier of (a) the date on which an issuer owns securities and/or cash having a value exceeding 50% of the issuer’s total assets +on either a consolidated or unconsolidated basis and (b) the date on which an issuer owns or proposes to acquire investment securities +having a value exceeding 40% of the value of such issuer’s total assets (exclusive of government securities and cash items) on an +unconsolidated basis. We are putting in place policies that we expect will work to keep the investment securities held by us at less than +40% of our total assets, which may include acquiring assets with our cash, liquidating our investment securities or seeking a no-action +letter from the Commission if we are unable to acquire sufficient assets or liquidate sufficient investment securities in a timely manner. +As Rule 3a-2 is available +to a company no more than once every three years, and assuming no other exclusion were available to us, we would have to keep within the +40% limit for at least three years after we cease being an inadvertent investment company. This may limit our ability to make certain +investments or enter into joint ventures that could otherwise have a positive impact on our earnings. In any event, we do not intend to +become an investment company engaged in the business of investing and trading securities. +Classification as an investment +company under the Investment Company Act requires registration with the Commission. If an investment company fails to register, it would +have to stop doing almost all business, and its contracts would become voidable. Registration is time consuming and restrictive and would +require a restructuring of our operations, and we would be very constrained in the kind of business we could do as a registered investment +company. Further, we would become subject to substantial regulation concerning management, operations, transactions with affiliated persons +and portfolio composition, and would need to file reports under the Investment Company Act regime. The cost of such compliance would result +in our incurring substantial additional expenses, and the failure to register if required would have a materially adverse impact to conduct +our operations. +We will not be able to successfully execute +our business strategy if we are deemed to be an investment company under the Investment Company Act. +U.S. companies that have more +than 100 stockholders or are publicly traded in the U.S. and are, or hold themselves out as being, engaged primarily in the business of +investing, reinvesting or trading in securities are subject to regulation under the Investment Company Act. Unless a substantial part +of our assets consists of, and a substantial part of our income is derived from, interests in majority-owned subsidiaries and companies +that we primarily control, we may be required to register and become subject to regulation under the Investment Company Act. If bitcoin +and other virtual currencies were to be deemed securities for purposes of the Investment Company Act, or if we were deemed to own but +not operate one or more of our other subsidiaries, we would have difficulty avoiding classification and regulation as an investment company. +If we were deemed to be, and +were required to register as, an investment company, we would be forced to comply with substantive requirements under the Investment Company +Act, including limitations on our ability to borrow, limitations on our capital structure; restrictions on acquisitions of interests in +associated companies, prohibitions on transactions with affiliates, restrictions on specific investments, and compliance with reporting, +record keeping, voting, proxy disclosure and other rules and regulations. If we were forced to comply with the rules and regulations of +the Investment Company Act, our operations would significantly change, and we would be prevented from successfully executing our business +strategy. To avoid regulation under the Investment Company Act and related rules promulgated by the Commission, we could need to sell +bitcoin and other assets which we would otherwise want to retain and could be unable to sell assets which we would otherwise want to sell. +In addition, we could be forced to acquire additional, or retain existing, income-generating or loss-generating assets which we would +not otherwise have acquired or retained and could need to forgo opportunities to acquire bitcoin and other assets that would benefit our +business. If we were forced to sell, buy or retain assets in this manner, we could be prevented from successfully executing our business +strategy. +Securitization of our assets subjects us to various risks . +We may securitize assets to +generate cash for funding new investments. We refer to the term securitize to describe a form of leverage under which a company (sometimes +referred to as an “originator” or “sponsor”) transfers income producing assets to a single-purpose, bankruptcy-remote +subsidiary (also referred to as a “special purpose entity” or “ SPE ”), which is established solely for the +purpose of holding such assets and entering into a structured finance transaction. The SPE would then issue notes secured by such assets. +The special purpose entity may issue the notes in the capital markets either publicly or privately to a variety of investors, including +banks, non-bank financial institutions and other investors. There may be a single class of notes or multiple classes of notes, the most +senior of which carries less credit risk and the most junior of which may carry substantially the same credit risk as the equity of the +SPE. +24 +An important aspect of most +debt securitization transactions is that the sale and/or contribution of assets into the SPE be considered a true sale and/or contribution +for accounting purposes and that a reviewing court would not consolidate the SPE with the operations of the originator in the event of +the originator's bankruptcy based on equitable principles. Viewed as a whole, a debt securitization seeks to lower risk to the note purchasers +by isolating the assets collateralizing the securitization in an SPE that is not subject to the credit and bankruptcy risks of the originator. +As a result of this perceived reduction of risk, debt securitization transactions frequently achieve lower overall leverage costs for +originators as compared to traditional secured lending transactions. +In accordance with the above +description, to securitize loans, we may create a wholly owned subsidiary and contribute a pool of our assets to such subsidiary. The +SPE may be funded with, among other things, whole loans or interests from other pools and such loans may or may not be rated. The SPE +would then sell its notes to purchasers whom we would expect to be willing to accept a lower interest rate and the absence of any recourse +against us to invest in a pool of income producing assets to which none of our creditors would have access. We would retain all or a portion +of the equity in the SPE. An inability to successfully securitize portions of our portfolio or otherwise leverage our portfolio through +secured and unsecured borrowings could limit our ability to grow our business and fully execute our business strategy, and could decrease +our earnings, if any. However, the successful securitization of portions of our portfolio exposes us to a risk of loss for the equity +we retain in the SPE and might expose us to greater risk on our remaining portfolio because the assets we retain may tend to be those +that are riskier and more likely to generate losses. A successful securitization may also impose financial and operating covenants that +restrict our business activities and may include limitations that could hinder our ability to finance additional loans and investments. +The Investment Company Act may also impose restrictions on the structure of any securitizations. +Interests we hold in the SPE, +if any, will be subordinated to the other interests issued by the SPE. As such, we will only receive cash distributions on such interests +if the SPE has made all cash interest and other required payments on all other interests it has issued. In addition, our subordinated +interests will likely be unsecured and rank behind all of the secured creditors, known or unknown, of the SPE, including the holders of +the senior interests it has issued. Consequently, to the extent that the value of the SPE's portfolio of assets has been reduced as a +result of conditions in the credit markets, or as a result of defaults, the value of the subordinated interests we retain would be reduced. +Securitization imposes on us the same risks as borrowing except that our risk in a securitization is limited to the amount of subordinated +interests we retain, whereas in a borrowing or debt issuance by us directly we would be at risk for the entire amount of the borrowing +or debt issuance. +We may also engage in transactions +utilizing SPEs and securitization techniques where the assets sold or contributed to the SPE remain on our balance sheet for accounting +purposes. If, for example, we sell the assets to the SPE with recourse or provide a guarantee or other credit support to the SPE, its +assets will remain on our balance sheet. Consolidation would also generally result if we, in consultation with our auditors, determine +that consolidation would result in a more accurate reflection of our assets, liabilities and results of operations. In these structures, +the risks will be essentially the same as in other securitization transactions but the assets will remain our assets for purposes of the +limitations described above on investing in assets that are not qualifying assets and the leverage incurred by the SPE will be treated +as borrowings incurred by us for purposes of our limitation on the issuance of senior securities. +We may not be able to utilize our net operating loss carry forwards. +At December 31, 2020, we had Federal net operating loss carry forwards +(“ NOLs ”) for income tax purposes of approximately $18,568,667 after taking into consideration of the §382 limitation. +The Coronavirus Aid, Relief, and Economic Security Act signed in to law on March 27, 2020 provided that NOLs generated in a taxable year +beginning in 2018, 2019, or 2020, may now be carried back five years and forward indefinitely. In addition, the 80% taxable income limitation +is temporarily removed, allowing NOLs to fully offset net taxable income. However, we do not know if or when we will have any earnings +and capital gains against which we could apply these carry forwards. Furthermore, as a result of changes in the ownership of our common +stock, our ability to use our federal NOLs will be limited under Internal Revenue Code Section 382. State NOLs are subject to similar +limitations in many cases. As a result, our substantial NOLs may not have any value to us. +Our corporate structure and intercompany arrangements +are subject to the tax laws of various jurisdictions, and we could face greater than anticipated tax liabilities, which would harm our +results of operations. +We are subject to tax laws +in the U.S. and certain foreign jurisdictions, including Israel and the United Kingdom. Our income tax obligations are based in part on +our corporate structure and intercompany arrangements. The tax laws applicable to our business are increasingly complex, are subject to +interpretation and their application can be uncertain. The amount of taxes we pay in the jurisdictions in which we operate could increase +substantially as a result of changes in the applicable tax principles, including increased tax rates, new tax laws or revised interpretations +of existing tax laws and precedents. +25 +We are subject to the examination +of our income tax returns by the Internal Revenue Service and foreign tax authorities in the jurisdictions in which we operate, and we +may be subject to assessments or audits in the future in any such jurisdictions. The tax authorities in these jurisdictions may aggressively +interpret their laws in an effort to raise additional tax revenue and may claim that various withholding requirements apply to us or our +subsidiaries, challenge the availability to us or our subsidiaries of certain benefits under tax treaties, and challenge our methodologies +for valuing developed technology or intercompany arrangements or our revenue recognition policies, which could result in an increase of +our worldwide effective tax rate and have a material adverse effect on our financial condition and operating results. +If we are required to recognize non-cash impairment +charges related to goodwill, it could have a material adverse impact on our operating results. +We carry a significant amount +of goodwill on our balance sheet. We have recorded approximately $9.6 million of goodwill in connection with several acquisitions, including +the acquisition of Microphase in 2017, the acquisition of Enertec in 2018 and the acquisition of Relec in November 2020. We assess goodwill +for impairment at least annually during the fourth fiscal quarter and whenever facts or circumstances indicate that the carrying value +of goodwill may be impaired. Impairment analysis involves comparing the estimated fair value of a reporting unit to its carrying value. +If the carrying value of a reporting unit exceeds its estimated fair value, we record an impairment charge. Determination of fair value +requires considerable judgment and is sensitive to changes in underlying assumptions, estimates and market factors. Those assessments +may be affected by significant negative industry or general economic trends, disruptions to our business and unexpected significant changes +or planned changes in our use of the assets. To the extent any of our acquisitions, including Relec, do not perform as anticipated and +our underlying assumptions and estimates related to the fair value determination are not met, the value of such assets may be negatively +affected and we may be required to record impairment charges. If we are required to recognize noncash charges related to impairment of +goodwill, our results of operations would be materially and adversely affected. +Risks Related to Related Party Transactions +There may be conflicts of +interest between our company and certain of our related parties and their respective directors and officers which might not be resolved +in our favor. More importantly, there may be conflicts between certain of our related parties and their respective directors and officers +which might not be resolved in our favor. These risks are set forth below appurtenant to the relevant related party. +Ault & Company +Our relationship with Ault & Company may +enhance the difficulty inherent in obtaining financing for us as well as expose us to certain conflicts of interest. +At December 31,2020, Ault +& Company, of which Milton C. Ault is the chief executive officer, beneficially owned 1,362,795 shares of our common stock, consisting +of 1,078,967 shares of common stock owned, 275,862 shares of common stock underlying the 8% Convertible Promissory Note in the outstanding +principal amount of $400,000 sold by us to Ault & Company on February 5, 2020, assuming no conversion of accrued, unpaid interest +on this note, warrants to purchase 94 shares of common stock that are currently exercisable and shares owned by Philou Ventures, of which +Ault & Company, Inc. is the Manager, consisting of: (i) 125,000 shares of Series B Preferred Stock that are convertible into 2,232 +shares of common stock, (ii) warrants to purchase 2,232 shares of common stock that are exercisable within 60 days of the date hereof +and (iii) 3,408 shares of common stock. Assuming Ault & Company converted its note on the date of this Annual Report, Ault & Company +would own a number of shares of common stock equal to 4.9% of the number of shares of common stock issued and outstanding on the date +hereof. +Given the close relationship +between Ault & Company on the one hand, and our company on the other, it is far from inconceivable that we could enter into additional +securities purchase agreements with Ault & Company. +Although we have relied on +Philou, which no longer beneficially owns a meaningful number of our shares of common stock, to finance us in the past, and anticipate +that Ault & Company may purchase shares of our Series C Preferred Stock under an agreement providing for the purchase thereof, we +cannot assure you that either Philou or Ault & Company will assist us in the future. We would far prefer to rely on these entities’ +assistance compared to other sources of financing as the terms they provide us are in general more favorable to us than we could obtain +elsewhere. However, Messrs. Ault, Horne and Nisser could face a conflict of interest in that they serve on the board of directors of each +of Ault & Company and our company. If they determine that an investment in our company is not in Ault & Company’s best interest, +we could be forced to seek financing from other sources that would not necessarily be likely to provide us with equally favorable terms. +26 +Other conflicts of interest +between us, on the one hand, and Ault & Company, on the other hand, may arise relating to commercial or strategic opportunities or +initiatives. Mr. Ault, as the controlling shareholder of Ault & Company, may not resolve such conflicts in our favor. For example, +we cannot assure you that Ault & Company would not pursue opportunities to provide financing to other entities whether or not it currently +has a relationship with such other entities. Furthermore, our ability to explore alternative sources of financing other than Ault & +Company may be constrained due to Mr. Ault’s vision for us and he may not wish for us to receive any financing at all other than +from entities that he controls. +Alzamend Neuro, Inc. +Our relationship with Alzamend Neuro may expose +us to certain conflicts of interest. +In August 2020, Alzamend Neuro +entered into a securities purchase agreement with our company to sell a convertible promissory note of Alzamend Neuro, in the aggregate +principal amount of $50,000 and issue a 5-year warrant to purchase 16,667 of shares of its common stock. The convertible promissory note +bears interest at 8% per annum, which principal and all accrued and unpaid interest are due six months after the date of issuance. The +principal and interest earned on the convertible promissory note may be converted into shares of the Alzamend Neuro’s common stock +at $1.50 per share. The exercise price of the warrant is $3.00 per share. +In December 2020, we provided +Alzamend Neuro $750,000 in short-term advances and in March of 2021 we entered into an agreement with Alzamend under which we purchased +$4 million worth of shares of Alzamend Neuro’s common stock, with the ability to purchase another $6 million worth of such shares, +provided that Alzamend Neuro meets certain milestones. +Messrs. Ault, Horne and Nisser +could face a conflict of interest in that they serve on the board of directors of each of Alzamend Neuro and our company. Mr. Cragun, +our chief financial officer is also the chief financial officer of Alzamend Neuro. +Avalanche International Corp . +We have lent a substantial amount of funds +to Avalanche, a related party, whose ability to repay us is subject to significant doubt and it may not be in our stockholders’ +best interest to convert the notes into shares of Avalanche common stock even if we had a reasonably viable means of doing so. +On September 6, 2017, we entered +into a Loan and Security Agreement with Avalanche (as amended, the “ AVLP Loan Agreement ”) with an effective date of +August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility. The AVLP Loan Agreement was recently increased +to up to $15,000,000 and extended to December 31, 2023. +At December 31, 2020, we had +provided Avalanche with $11,269,136 pursuant to the AVLP Loan Agreement. The warrants issued in conjunction with the non-revolving credit +facility entitles us to purchase up to 22,538,272 shares of Avalanche common stock at an exercise price of $0.50 per share for a period +of five years. The exercise price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar +events. The warrants may be exercised for cash or on a cashless basis. +While Avalanche received funds +from a third party in the amount of $2,750,000 in early April of 2019 in consideration for its issuance of a convertible promissory note +to such third party (the “ Third Party Note ”), $2,676,220 was used to pay an outstanding receivable due us and no amount +was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. There is doubt as to whether Avalanche will be able +to repay this amount on a timely basis, if at all, unless it generates significant net income from its operations or receives additional +financing from another source; even then, unless such financing consists solely of the issuance by Avalanche of its equity securities, +it will only add to the amount that Avalanche owes other parties, which would in all likelihood not be provided unless we agreed to subordinate +our right to repayment to such other third party source. +There is currently no liquid +market for the Avalanche common stock. Consequently, even if we were inclined to convert the debt owed us by Avalanche into shares of +its common stock, our ability to sell such shares would be severely limited. Avalanche is not current in its filings with the Commission +and is not required to register the shares of its common stock underlying the New Note or any other loan arrangement we have made with +Avalanche described above. Further, even if Avalanche were willing to register such shares, it would not be permitted to do so until it +has registered the shares of its common stock underlying the Third Party Note. +27 +As a result, there is some +doubt as to whether Avalanche will ever have the ability to repay its debt to us, or if we convert the debt owed us by Avalanche into +shares of its common stock, our ability to convert such shares into cash through the sale of such shares would be severely limited until +such time, if ever, a liquid market for Avalanche’s common stock develops. If we are unable to recoup our investment in Avalanche +in the foreseeable future or at all, such failure would have a materially adverse effect on our financial condition and future prospects. +Originally, the loans we made to Avalanche +were secured by a lien on all of Avalanche’s assets. Presently, we only have third priority interest. +Originally, the loans we made +to Avalanche were secured by a lien on all of Avalanche’s assets. When Avalanche entered into the Exchange Agreement with MTIX (see +below), the former owners of MTIX were granted a first priority interest in all of MTIX’s assets, which constitute virtually all +of Avalanche’s assets and reduced our interest to that of a second position, greatly diminishing its value. When Avalanche issued +the Third Party Note referred to above, it granted the third party a first priority security interest in all its assets, to include those +comprised of MTIX. Both we and the former owners of MTIX consented to the subordination of our respective security interests. Since our +security interests have been reduced to a third position, we will have no ability to use Avalanche’s assets to offset any default +in Avalanche’s debt obligations to us unless and until the two other security interests are terminated, which would not occur until +Avalanche’s debts to the senior creditors have been repaid. We do not anticipate that Avalanche will repay its debts to these creditors +within the foreseeable future and will therefore have no recourse should Avalanche default on its debts to us during this period of time. +Any failure by Avalanche to repay us would therefore have a materially adverse effect on our results of operations, financial condition +and future prospects. +Milton C. Ault, III and William Horne, our +Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, Philou +is the controlling stockholder of Avalanche. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors, are also directors of Avalanche. In +addition, Philou is the controlling stockholder of Avalanche. Certain conflicts of interest between us, on the one hand, and Avalanche, +on the other hand, may arise relating to commercial or strategic opportunities or initiatives, in addition to the conflicts related to +the debt that Avalanche owes us. For example, Messrs. Ault and Horne may find it difficult to determine how to meet their fiduciary duties +to us as well as Avalanche, which could result in a less favorable result for us than would be the case if they were solely directors +of our company. Further, even if Messrs. Ault and Horne were able to successfully meet their fiduciary obligations to us and Avalanche, +the fact that they are members of the board of directors of both companies could attenuate their ability to focus on our business and +best interests, possibly to the detriment of both companies. Mr. Ault’s control of Philou through Ault & Company only enhances +the risk inherent in having Messrs. Ault and Horne serve as directors of both our company and Avalanche. +Risks Related to Our Business and Industry - Overview +If we fail to anticipate and adequately respond +to rapid technological changes in our industry, including evolving industry-wide standards, in a timely and cost-effective manner, our +business, financial condition and results of operations would be materially and adversely affected. +The markets in which we operate are characterized +by technological changes. Such changes, including evolving industry standards, changes in customer requirements and new product introductions +and enhancements, could render our products obsolete. Accordingly, we are required to constantly monitor and anticipate technological +changes in our industry and develop new product offerings and technologies or adapt or modify our existing offerings and technologies +to keep pace with technological advances in our industry and remain competitive. +Our ability to implement our business strategy +and continue to grow our revenues will depend on a number of factors, including our continuing ability to: +· identify emerging technological trends in our current and target markets; +· identify additional uses for our existing technology to address customer needs in our current and future +markets; +· enhance our offerings by adding innovative features that differentiate our offerings from those of our +competitors; and +· design, develop, manufacture, assemble, test, market and support new products and enhancements in a timely +and cost-effective manner. +28 +We believe that, to remain competitive in the +future, we will need to continue to invest significant financial resources in developing new offerings and technologies or to adapt or +modify our existing offerings and technologies, including through internal research and development, strategic acquisitions and joint +ventures or other arrangements. However, these efforts may be more costly than we anticipate and there can be no assurance that they will +be successful. +If we are unable to identify, attract, train +and retain qualified personnel, especially our design and technical personnel, our business and results of operations would be materially +and adversely affected and we may not be able to effectively execute our business strategy. +Our performance and future +success largely depends on our continuing ability to identify, attract, train, retain and motivate qualified personnel, including our +management, sales and marketing, finance and in particular our engineering, design and technical personnel. For example, we currently +have limited number of qualified personnel for the assembling and testing processes. We do not know whether we will be able to retain +all these personnel as we continue to pursue our business strategy. Our engineering, design and technical personnel represent a significant +asset. The competition for qualified personnel in our industry is intense and constrains our ability to attract qualified personnel. The +loss of the services of one or more of our key employees, especially of our key engineering, design and technical personnel, or our inability +to attract, retain and motivate qualified personnel could have a material adverse effect on our business, financial condition and operating +results. +Our future results will depend on our ability +to maintain and expand our existing sales channels and to build out marketing, business development and sales functions for the operating +subsidiaries. +To grow our business, we must +add new customers for our products in addition to retaining and increasing sales to our current customers. Currently, only Relec, the +operating subsidiary that we acquired in November 2020, has an effective sales force focused on establishing relationships with customers +that we expect to endure over time. In other subsidiaries, we have historically relied on key executives to drive growth through return +business with existing customers. Building out marketing, business development and sales functions in all operating subsidiaries is critical +to drive significant growth in line with our strategic plans. We plan to contract for marketing services to improve our websites, manage +public relations and optimize our social media presence. Failure to recruit and retain the business development and sale personnel to +execute on outreach and capture of new business, or the failure of those new hires or marketing services to perform as expected, will +limit our ability to achieve our growth targets. +We are dependent upon our ability, and our +contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, +many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As +a result, there is a global shortage of certain electronic or mineral components, which may extend our production lead-time and our production +costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, +even worse, redesign some of our products to support currently-available materials. Such redesign efforts may require certain regulatory +and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit +our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in +place, and issues may recur in the future. +In addition, some of our products +are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While we have had relationships +with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, +changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our +ability to manufacture our products. +We depend +upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the +quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon a +few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or cancel their orders +scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, diversions in the capital +spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, +which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more +of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, +a substantial decrease in our revenues would likely result. We are dependent on the electronic equipment industry, and accordingly will +be affected by the impact on that industry of current economic conditions. +29 +Substantially all of our existing +customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, +and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this +industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, +such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete +in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers to +manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant +manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture +our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing +costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures +on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing +components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our +subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition +to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations +or rescheduling of, orders or shipments, any of which would materially harm our business. +We outsource, and are dependent upon developer +partners for, the development of some of our custom design products. +We made an operational decision +to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the +custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer +specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where +the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability +to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +We face intense industry competition, price erosion and product +obsolescence, which, in turn, could reduce our profitability. +We operate in an industry that is generally characterized +by intense competition. We believe that the principal bases of competition in our markets are breadth of product line, quality of products, +stability, reliability and reputation of the provider, along with cost. Quantity discounts, price erosion, and rapid product obsolescence +due to technological improvements are therefore common in our industry as competitors strive to retain or expand market share. Product +obsolescence can lead to increases in unsaleable inventory that may need to be written off and, therefore, could reduce our profitability. +Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross margins. In fact, we have seen price erosion +over the last several years on most of the products we sell, and we expect additional price erosion in the future. +Our future results are dependent on our ability +to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell our products +through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and +distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as +with manufacturers’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered +into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business +with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which +would have an adverse effect on our revenues. +We may not be able to procure necessary key +components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, +and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, +we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, our +suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that we require +to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build products for our customers +could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for +certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail +to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong +inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect +on our gross margins and on our results of operations. +30 +Although we depend on sales of our legacy products +for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large portion +of our sales have historically been attributable to our legacy products. We expect that these products may continue to account for a meaningful +percentage of our revenues for the foreseeable future. However, these sales are declining. Although we are unable to predict future prices +for our legacy products, we expect that prices for these products will continue to be subject to significant downward pressure in certain +markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to +expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and sell new products +such as custom design and value-added products. We cannot assure you that we will be able to expand our customer base, increase unit sales +volumes of existing products or develop, introduce and/or sell new products. +Failure of our information technology infrastructure +to operate effectively could adversely affect our business. +We depend heavily on information +technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption +could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal +course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory +restrictions relating to our international sales. +Some of our products are +subject to International Traffic In Arms Regulation (“ ITAR ”), which are interpreted, enforced and administered by +the U.S. Department of State. ITAR regulation controls not only the export, import and trade of certain products specifically designed, +modified, configured or adapted for military systems, but also the export of related technical data and defense services as well as foreign +production. Any delays in obtaining the required export, import or trade licenses for products subject to ITAR regulation and rules could +have a material adverse effect on our business, financial condition, and/or operating results. In addition, changes in United States +export and import laws that require us to obtain additional export and import licenses or delays in obtaining export or import licenses +currently being sought could cause significant shipment delays and, if such delays are too great, could result in the cancellation of +orders. Any future restrictions or charges imposed by the United States or any other country on our international sales or foreign subsidiary +could have a materially adverse effect on our business, financial condition, and/or operating results. In addition, from time to time, +we have entered into contracts with the Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program +(“ FMF ”). Any such future sales would be subject to these regulations. Failure to comply with ITAR or FMF rules could +have a material adverse effect on our financial condition, and/or operating results. +We depend on international operations for a +substantial majority of our components and products. +We purchase a substantial +majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, +and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international +business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange +fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, +or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect +on our business, financial condition, and/or operating results. +We depend on international sales for a portion of our revenues. +Sales to customers outside +of North America accounted for 52% and 56.9% of net revenues for the years ended December 31, 2020 and 2019, and we expect that international +sales will continue to represent a material portion of our total revenues. International sales are subject to the risks of international +business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts receivable, +and currency restrictions. In addition, Gresham, our wholly-owned subsidiary in the United Kingdom, supports our European and other international +customers, distributors, and sales representatives, and therefore is also subject to local regulation. International sales are also subject +to the export laws and regulations of the United States and other countries. +31 +Because a significant portion of our revenues +and expenses is denominated in foreign currencies, fluctuations in exchange rates could have a material adverse effect on our operating +results. +We face foreign exchange risks +because a significant portion of our revenue and expenses is denominated in foreign currencies. Further, some suppliers to Enertec and +Relec require payment in U.S. dollars, which exposes us to risk. Generally, U.S. dollar strength adversely impacts the translation of +the portion of our revenue that is generated in foreign currencies into the U.S. dollar. For the years ended December 31, 2020 and +2019, approximately 46.9% and 48.2% of our revenue, respectively, was denominated in currencies other than U.S. dollars. Our results of +operations could also be negatively impacted by a strengthening of the U.S. dollar as a large portion of our costs are U.S. dollar denominated. +We also have foreign exchange risk exposure with respect to certain of our assets, that are denominated in currencies other than the functional +currency of our subsidiaries, and our financial results are affected by the re-measurement and translation of these non-U.S. currencies +into U.S. dollars, which is reflected in the effect of exchange rate changes on cash, cash equivalents, and restricted cash on the consolidated +statements of cash flows. For the years ended December 31, 2020 and 2019, the effects of exchange rates on our cash, cash equivalents, +and restricted cash totaled $122,980 and $179,830, due to fluctuations in exchange rates and the strengthening of the U.S. dollar. While +we may choose to enter into transactions to hedge portions of our foreign currency translation and balance sheet exposure in the future, +it is impossible to predict or eliminate the effects of foreign exchange rate exposure. Strengthening of the U.S. dollar could materially +adversely affect our results of operations and financial condition. +Our insurance coverage and indemnity may be +insufficient to cover potential liabilities we may face due to the risks inherent in the products and services we provide. +We are exposed to liabilities +that are unique to the products and services we provide. A significant portion of our business relates to designing, developing and manufacturing, +components, integrated assemblies and subsystems for advanced defense, medical, transportation, industrial, technology and communications +systems and products. New technologies associated with these systems and products may be untested or unproven. Components of certain of +the defense systems and products we develop are inherently dangerous. Failures of satellites, missile systems, air traffic control systems, +homeland security applications and aircraft have the potential to cause loss of life and extensive property damage. In most circumstances, +we may receive indemnification from the government end users of our defense offerings in the United States, the United Kingdom and Israel. +In addition, failures of products and systems that we manufacture or distribute for medical devices, transportation controls or industrial +systems also have the potential to result in loss of life, personal injury and/or extensive property damage. +While we maintain insurance +for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and we may be forced to +bear substantial costs from an accident or incident. It also is not possible for us to obtain insurance to protect against all operational +risks and liabilities. Substantial claims resulting from an incident in excess of government indemnity and our insurance coverage would +harm our financial condition, results of operations and cash flows. Moreover, any accident or incident for which we are liable, even if +fully insured, could negatively affect our standing with our customers and the public, thereby making it more difficult for us to compete +effectively, and could significantly impact the cost and availability of adequate insurance in the future. +If we are unable to satisfy our customers’ +specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be +harmed. +Our customers demand that +our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying +such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance +and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products +to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such +required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and +costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, +any of which would harm our business. +Some +of our business is subject to U.S. government procurement laws and regulations . +We +must comply with certain laws and regulations relating to the formation, administration and performance of federal government contracts. +These laws and regulations affect how we conduct business with our federal government contracts, including the business that we do as +a subcontractor. In complying with these laws and regulations, we may incur additional costs, and non-compliance may lead to the assessment +of fines and penalties, including contractual damages, or the loss of business. +32 +Failure to comply with anti-bribery, anti-corruption, +anti-money laundering laws, and similar laws, or allegations of such failure, could have a material adverse effect on our business, financial +condition and operating results. +We are subject to various +anti-bribery, anti-corruption, anti-money laundering laws, including the U.S. Foreign Corrupt Practices Act of 1977, as amended (the “ FCPA ”), +the U.S. Travel Act, the USA PATRIOT Act, the United Kingdom Bribery Act 2010, the Proceeds of Crime Act 2002, Chapter 9 (sub-chapter +5) of the Israeli Penal Law, 1977, the Israeli Prohibition on Money Laundering Law–2000, and possibly other similar laws in countries +outside of the United States in which we conduct our business. Anti-corruption and anti-bribery laws have been enforced aggressively in +recent years and are interpreted broadly to generally prohibit companies, their employees, agents, representatives, business partners, +and third-party intermediaries from authorizing, offering, or providing, directly or indirectly, improper payments or benefits to recipients +in the public or private sector. +We, our employees, agents, +representatives, business partners and third-party intermediaries may have direct or indirect interactions with officials and employees +of government agencies or state-owned or affiliated entities and may be held liable for the corrupt or other illegal activities of these +employees, agents, representatives, business partners or third-party intermediaries even if we do not explicitly authorize such activities. +These laws also require that +we keep accurate records and maintain internal controls and compliance procedures designed to prevent any such actions. While we have +policies and procedures to address compliance with such laws, we cannot assure you that none of our employees, agents, representatives, +business partners or third-party intermediaries will take actions in violation of our policies and applicable law, for which we may be +ultimately held responsible. In addition, we may be held liable for violations committed of the FCPA or similar foreign laws by companies +that we acquire. +Any alleged or actual violation +of the FCPA or other applicable anti-bribery, anti-corruption laws, and anti-money laundering laws could result in whistleblower complaints, +investigations, enforcement actions, fines and other criminal or civil sanctions, adverse media coverage, loss of export privileges, or +suspension or termination of government contracts. Responding to any investigation or enforcement action would require significant attention +of our management and resources, including significant defense costs and other professional fees. Failure to comply with anti-bribery, +anti-corruption, anti-money laundering laws, and similar laws, or allegations of such failure, could therefore have a material adverse +effect on our business, results of operations, financial condition and future prospects. +Risks Related to Our Business and Industry - Microphase +Microphase has a history of losses and our +future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on our business and the value of our +company. +During the past three fiscal +years Microphase has incurred losses from operations. These losses are attributable to lower volumes of its products sold to major defense +contractors partially as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. Since the financial +crisis of 2008, Microphase has been significantly short of capital needed to acquire parts for production of its products to complete +orders for such products. At times, Microphase has not had the cash available to make advance payments for the purchase of parts, and +then, as a consequence, Microphase would not receive the parts from its vendors required to finish a customer order. This would then delay +the delivery of products to customers, and would also delay recognition of the resulting revenues and the receipt of cash from the customer. +Sometimes after experiencing a delay in delivery of an order from Microphase, the customer would not place its next order with Microphase, +resulting in a loss of business. +Microphase’s future +profitability depends upon many factors, including several that are beyond its control. These factors include, without limitation: +· changes in the demand for ITS products and services; +· loss of key customers or contracts; +· the introduction of competitive products; +· the failure to gain market acceptance of ITS new and existing products; and +· the failure to successfully and cost effectively develop, introduce and market new products, services +and product enhancements in a timely manner. +In addition, Microphase is +incurring significant legal, accounting, and other expenses related to being a reporting company without there being a trading market +for any of its securities. As a result of these expenditures, Microphase will have to generate and sustain increased revenue to achieve +and maintain future profitability. +33 +A large percentage of Microphase’s current +revenue is derived from prime defense contractors to the U.S. government and its allies, and the loss of these relationships, a reduction +in U.S. government funding or a change in U.S. government spending priorities or bidding processes could have an adverse impact on its +business, financial condition, results of operations and cash flows. +Microphase is +highly dependent on sales to major defense contractors of the U.S. military and its allies, including Lockheed Martin, Raytheon, BAE Systems +and SAAB. The percentages of its revenue that were derived from sales to these named major defense contractors and directly to the U.S. +Government were 50.7% in fiscal 2020 and 51.5% in fiscal 2019. Therefore, any significant disruption or deterioration of Microphase’s +relationship with any such major defense contractors or the U.S. Government could materially reduce its revenue. During the year ended +December 31, 2020 there were five customers that accounted for more than 10% of Microphase’s sales: BAE Systems, Boeing/Argonist, +Inc., DFAS Columbus Center, Raytheon Company and Sierra Nevada Corporation. During the year ended December 31, 2019 there were two customers +that accounted for more than 10% of Microphase’s sales: BAE Systems and DFAS Columbus Center. Microphase’s competitors continuously +engage in efforts to expand their business relationships with the same major defense contractors and the U.S. Government and will continue +these efforts in the future, and the U.S. Government may choose to use other contractors. Microphase expects that a majority of the business +that it seeks will be awarded through competitive bidding. Microphase operates in highly competitive markets and its competitors have +more extensive or more specialized engineering, manufacturing and marketing capabilities than Microphase does in many areas, and Microphase +may not be able to continue to win competitively awarded contracts or to obtain task orders under multi-award contracts. Further, the +competitive bidding process involves significant cost and managerial time to prepare bids and proposals for contracts that may not be +awarded to Microphase, as well as the risk that Microphase may fail to accurately estimate the resources and costs required to fulfill +any contract awarded to us. Following any contract award, Microphase may experience significant expense or delay, contract modification +or contract rescission as a result of its competitors protesting or challenging contracts awarded to it in competitive bidding. Major +defense contractors to whom Microphase supplies components for systems must compete with other major defense contractors (to which Microphase +may not supply components) for military orders from the U.S. Government. +In addition, Microphase competes +with other policy needs, which may be viewed as more necessary, for limited resources and an ever-changing amount of available funding +in the budget and appropriation process. Budget and appropriations decisions made by the U.S. Government are outside of Microphase control +and have long-term consequences for its business. U.S. Government spending priorities and levels remain uncertain and difficult to predict +and are affected by numerous factors, including until recently sequestration (automatic, across-the-board U.S. Government budgetary spending +cuts), and the purchase of our products could be superseded by alternate arrangements. While the US defense budget was recently increased, +there can be no assurance that this increase will be maintained for the foreseeable future, particularly in light of the recent federal +expenditures the federal government has made with a view to ameliorating the economic damage suffered as a result of COVID-19. A change +in U.S. Government spending priorities or an increase in non-procurement spending at the expense of our programs, or a reduction in total +U.S. Government spending, could have material adverse consequences on Microphase’s future business. +Microphase’s U.S. government contracts +may be terminated by the federal government at any time prior to their completion, which could lead to unexpected loss of sales and reduction +in Microphase’s backlog. +Under the terms of Microphase’s U.S. government +contracts, the U.S. government may unilaterally: +· terminate or modify existing contracts; +· reduce the value of existing contracts through partial termination; and +· delay the payment of Microphase’s invoices by government payment offices. +The federal government can +terminate or modify any of its contracts with Microphase or its prime contractors either for the federal government’s convenience, +or if Microphase or its prime contractors default, by failing to perform under the terms of the applicable contract. A termination arising +out of Microphase’s default could expose it to liability and have a material adverse effect on its ability to compete for future +federal government contracts and subcontracts. If the federal government or its prime contractors terminate and/or materially modify any +of Microphase’s contracts or if any applicable options are not exercised, Microphase’s failure to replace sales generated +from such contracts would result in lower sales and would adversely affect its earnings, which could have a material adverse effect on +Microphase’s business, results of operations and financial condition. Microphase’s backlog as of December 31, 2020 was +approximately $5.5 million. Microphase’s backlog could be adversely affected if contracts are modified or terminated. +34 +Microphase’s products with military applications +are subject to export regulations, and compliance with these regulations may be costly. +Microphase is required to +obtain export licenses before filling foreign orders for many of its products that have military or other governmental applications. United +States Export Administration regulations control technology exports like its products for reasons of national security and compliance +with foreign policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of +a destination country. Thus, any foreign sales of its products requiring export licenses must comply with these general policies. Compliance +with these regulations is costly, and these regulations are subject to change, and any such change may require Microphase to improve its +technologies, incur expenses or both in order to comply with such regulations. +Microphase depends on U.S. government contracts +issued to major defense contractors, which often are only partially funded, subject to immediate termination, and heavily regulated and +audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could have an adverse impact +on Microphase’s business. +Over its lifetime, a U.S. +Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts and subcontracts. +The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts may be authorized and +appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year basis. Procurement funds are +typically made available for obligations over the course of one to three years. Consequently, programs often receive only partial funding +initially, and additional funds are designated only as Congress authorizes further appropriations. The termination of funding for a U.S. +Government program with respect to major defense contractors for which Microphase is a subcontractor would result in a loss of anticipated +future revenue attributable to that program, which could have an adverse impact on its operations. In addition, the termination of, or +failure to commit additional funds to, a program for which Microphase is a subcontractor could result in lost revenue and increase its +overall costs of doing business. +Generally, U.S. Government +contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to Microphase’s +contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed +must be refunded. Microphase has recorded contract revenues based on costs Microphase expect to realize upon final audit. However, Microphase +does not know the outcome of any future audits and adjustments, and Microphase may be required to materially reduce its revenues or profits +upon completion and final negotiation of audits. Negative audit findings could also result in termination of a contract, forfeiture of +profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting or subcontracting for a period of +time. +In addition, U.S. Government +contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s +convenience upon the payment only for work done and commitments made at the time of termination. Microphase can give no assurance that +one or more of the U.S. Government contracts with a major defense contractor under which Microphase provides component products will not +be terminated under these circumstances. Also, Microphase can give no assurance that it will be able to procure new contracts to offset +the revenue or backlog lost as a result of any termination of its U.S. Government contracts. Because a significant portion of Microphase’s +revenue is dependent on its performance and payment under its U.S. Government contracts, the loss of one or more large contracts could +have a material adverse impact on its business, financial condition, results of operations and cash flows. +Microphase’s government +business also is subject to specific procurement regulations and other requirements. These requirements, though customary in U.S. Government +contracts, increase its performance and compliance costs. In addition, these costs might increase in the future, thereby reducing Microphase’s +margins, which could have an adverse effect on its business, financial condition, results of operations and cash flows. Failure to comply +with these regulations and requirements could lead to fines, penalties, repayments, or compensatory or treble damages, or suspension or +debarment from U.S. Government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various +laws, including those related to procurement integrity, export control, U.S. Government security regulations, employment practices, protection +of the environment, accuracy of records, proper recording of costs and foreign corruption. The termination of a U.S. Government contract +or relationship as a result of any of these acts would have an adverse impact on Microphase’s operations and could have an adverse +effect on its standing and eligibility for future U.S. Government contracts. +35 +Microphase’s business could be negatively +impacted by cybersecurity threats and other security threats and disruptions. +As a U.S. Government defense +contractor, Microphase faces certain security threats, including threats to its information technology infrastructure, attempts to gain +access to its proprietary or classified information, threats to physical security, and domestic terrorism events. Microphase’s information +technology networks and related systems are critical to the operation of its business and essential to its ability to successfully perform +day-to-day operations. Microphase is also involved with information technology systems for certain customers and other third parties, +which generally face similar security threats. Cybersecurity threats in particular, are persistent, evolve quickly and include, but are +not limited to, computer viruses, attempts to access information, denial of service and other electronic security breaches. Microphase +believes that it has implemented appropriate measures and controls and has invested in skilled information technology resources to appropriately +identify threats and mitigate potential risks, but there can be no assurance that such actions will be sufficient to prevent disruptions +to mission critical systems, the unauthorized release of confidential information or corruption of data. A security breach or other significant +disruption involving these types of information and information technology networks and related systems could: +· disrupt the proper functioning of these networks and systems and therefore its operations and/or those +of certain of its customers; +· result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of, proprietary, +confidential, sensitive or otherwise valuable information of Microphase or its customers, including trade secrets, which others could +use to compete against Microphase or for disruptive, destructive or otherwise harmful purposes and outcomes; +· compromise national security and other sensitive government functions; +· require significant management attention and resources to remedy the damages that result; +· subject Microphase to claims for breach of contract, damages, credits, penalties or termination; and +· damage Microphase’s reputation with its customers (particularly agencies of the U.S. Government) +and the public generally. +Any +or all of the foregoing could have a negative impact on its business, financial condition, results of operations and cash flows. +Microphase enters into fixed-price contracts +that could subject it to losses in the event of cost overruns or a significant increase in inflation. +Microphase has a number of +fixed-price contracts which allow it to benefit from cost savings but subject it to the risk of potential cost overruns, particularly +for firm fixed-price contracts, because Microphase assumes the entire cost burden. If its initial estimates are incorrect, Microphase +can lose money on these contracts. U.S. Government contracts can expose Microphase to potentially large losses because the U.S. Government +can hold Microphase responsible for completing a project or, in certain circumstances, paying the entire cost of its replacement by another +provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. Because many of these +contracts involve new technologies and applications, unforeseen events such as technological difficulties, fluctuations in the price of +raw materials, problems with its suppliers and cost overruns, can result in the contractual price becoming less favorable or even unprofitable +to Microphase. The U.S. and other countries also may experience a significant increase in inflation. A significant increase in inflation +rates could have a significant adverse impact on the profitability of these contracts. Furthermore, if Microphase does not meet contract +deadlines or specifications, Microphase may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated +damages or suffer major losses if the customer exercises its right to terminate. In addition, some of its contracts have provisions relating +to cost controls and audit rights, and if Microphase fails to meet the terms specified in those contracts Microphase may not realize their +full benefits. Microphase’s results of operations are dependent on its ability to maximize its earnings from its contracts. Cost +overruns could have an adverse impact on its financial results. +Compliance with the regulations, standards, +and contractual obligations related to privacy, data protection, and data security, may cause us to incur additional expenses and failure +to comply with such obligations could harm our business and future results of operations. +We expect that the regulatory +framework for privacy, data protection and data security will continue to evolve, which may result in additional operating costs for internal +compliance and risks to our business. In the European Union, the General Data Protection Regulation (“ GDPR ”) contains +robust obligations on data processors and heavy documentation requirements for data protection compliance programs by companies. Among +other requirements, the GDPR regulates the transfer of personal data subject to the GDPR to third countries that have not been found to +provide adequate protection to such personal data, including the United States. In the European Union, informed consent may be required +for the use of cookies and direct electronic marketing. The GDPR also imposes conditions on obtaining valid consent. Failure to comply +with the GDPR could result in penalties for noncompliance (including possible fines of up to the greater of EUR20 million and 4% of our +global annual revenue for the preceding financial year for the most serious violations, as well as the right to compensation for financial +or non-financial damages claimed by individuals under Article 82 of the GDPR). +36 +In addition to the GDPR, the +European Commission has another draft regulation in the approval process that focuses on the right to privacy. The proposed regulation, +known as the ePrivacy Regulation would replace the member state laws that implement the current European Union ePrivacy Directive. The +ePrivacy Regulation will significantly increase fines for non-compliance. +The United Kingdom has enacted +a Data Protection Act substantially implementing the GDPR, effective in May 2018, which was further amended to align more substantially +with the GDPR following Brexit. It is unclear how United Kingdom data protection laws or regulations will develop and how data transfers +to and from the United Kingdom will be regulated in the future. +Risks Related to Our Business and Industry - Enertec +Potential political, economic and military +instability in Israel could adversely affect our operations. +A significant portion +of our business is conducted through Enertec, our Israeli subsidiary. Accordingly, political, economic and military conditions in Israel +and the surrounding region may directly affect our Israeli operations. In recent years, Israel has been involved in sporadic armed conflicts +with Hamas, an Islamist terrorist group that controls the Gaza Strip, with Hezbollah, an Islamist terrorist group that controls large +portions of Southern Lebanon, and with Iranian-backed military forces in Syria. Some of these hostilities were accompanied by missile +strikes from the Gaza Strip against civilian targets in various parts of Israel, including areas in which our facilities are located, +and negatively affected business conditions in Israel. The change in the United States Presidency may change the dynamics in the Middle +East as forces hostile to the existence of Israel seek to reverse the recent stability and commercial opportunities created by the Abraham +Accords. For example, there have been increasing concerns related to a potential attack by Iran. The tension between Israel and Iran and/or +these groups may escalate in the future and turn even more violent, which could affect the Israeli economy in general and us in particular. +Our commercial insurance does +not cover losses that may occur as a result of events associated with war and terrorism. Although the Israeli government currently covers +the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government +coverage will be maintained or that it will sufficiently cover our potential damages. Any losses or damages incurred by us could have +a material adverse effect on our business. +In addition, Israel-based +companies and companies doing business with Israel have been the subject of an economic boycott by members of the Arab League and certain +other predominantly Muslim countries since Israel’s establishment. Although Israel has entered into various agreements with certain +Arab countries and the Palestinian Authority, and various declarations have been signed in connection with efforts to resolve some of +the economic and political problems in the Middle East, we cannot predict whether or in what manner these problems will be resolved. Wars +and acts of terrorism have resulted in significant damage to the Israeli economy, including reducing the level of foreign and local investment. +Additionally, Israel has had +three elections over the past 18 months and its coalition government collapsed in December 2020 following the failure by the parliament +to pass an annual budget. A new election for the Knesset occurred on March 23, 2021 with no party able to win a parliamentary majority. +This turmoil has negatively impacted and could in the future continue to impact the ability of the Israeli Ministry of Defense to adopt +a new budget, enter into new programs and make timely payments to its suppliers, which in turn could adversely affect our operations in +Israel and our operating results. +Many of our Enertec employees are obligated +to perform military reserve duty in Israel, which could have a disruptive impact on our business. +Generally, Israeli adult male +and certain female citizens and permanent residents are obligated to perform annual military reserve duty in the Israel Defense Forces +up to a specified age. They also may be called to active military duty at any time under emergency circumstances. These military service +obligations could have a disruptive impact on our business, if hostilities develop in the future. +37 +Enertec may become subject to claims for remuneration +or royalties for assigned service invention rights by its employees, which could result in litigation and harm our business. +A significant portion of the +intellectual property covered by Enertec’s products has been developed by Enertec’s employees in the course of their employment +for Enertec. Under the Israeli Patent Law, 5727-1967, or the Patent Law, and recent decisions by the Israeli Supreme Court and the Israeli +Compensation and Royalties Committee, a body constituted under the Patent Law, Israeli employees may be entitled to remuneration for intellectual +property that they develop for us unless they explicitly waive any such rights. To the extent that Enertec is unable to enter into agreements +with its future employees pursuant to which they agree that any inventions created in the scope of their employment or engagement are +owned exclusively by Enertec (as it has done in the past), Enertec may face claims demanding remuneration. As a consequence of such claims, +Enertec could be required to pay additional remuneration or royalties to its current and former employees, or be forced to litigate such +claims, which could negatively affect its business. +Compliance with the regulations, standards, +and contractual obligations related to privacy, data protection, and data security, may cause us to incur additional expenses and failure +to comply with such obligations could harm our business and future results of operations. +In Israel, the Ministry of +Justice has recently published a draft bill proposing to amend the Israeli Privacy Protection Law 5741-1981 to align it more closely with +the European data privacy regulatory framework, and further changes may be introduced in the near future. Adoption of a GDPR-like regime +in Israel would require Enertec to sign agreements with entities with whom it shares personal data covered under such regime and provide +notice of the collection of such data as well as the use of “cookies” along with posting “opt out” provisions +on its website. Compliance with these requirements may require amendments to Enertec internal policies, business practices and data handling +protocols. +If we were to be found in +violation of any applicable laws or regulations relating to privacy, data protection, or security, our business may be materially and +adversely affected, and we would likely have to change our business practices. In addition, these laws and regulations could impose significant +costs on us and could constrain our ability to use and process data in a commercially desirable manner. In addition, if a breach of data +security, or a violation of laws and regulations relating to privacy, data protection or data security were to occur or to be alleged +to have occurred, our reputation would be damaged, and our business and results of operations could be materially and adversely affected. +Risks Related to Our Business and Industry – Relec +The third parties on which we rely to supply +certain products are located outside the United States. +Relec distributes products +from foreign manufacturers located in Asia. Our future operating results will depend, among other things, on our ability to continue to +rely on these arrangements. If we are no longer able to rely on these or other similar arrangements for the supply of certain products, +or if our cost of relying on such arrangements materially increases, as the result of the imposition of or changes in customs, tariffs, +quotas, trade barriers, or other trade protection measures, or otherwise, it could have a materially adverse effect on our business, financial +condition, and operating results. +Our strategic focus on our custom power supply +solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic +focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power +supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s +requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards +may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction +of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply +solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a +series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may +not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market +or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, +including those involving our personnel, which may negatively impact quarterly earnings and profitability as we account for severance +and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing +our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, +limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire +and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +38 +Risks Related to Ownership of Our Common +Stock +If we do not continue +to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +The +listing of our common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for continued +listing. On July 24, 2020, we were notified by the NYSE American that we were no longer in compliance with the NYSE American continued +listing standards because our reported stockholders' equity was below continued listing standards. The NYSE American requires that a listed +company's stockholders' equity be $6.0 million or more if it has reported losses from continuing operations and/or net losses in its five +most recent fiscal years. +Following +submission of our compliance plan demonstrating how we intend to regain compliance with the continued listing standards, we were notified +on October 8, 2020, that the NYSE American granted us a listing extension on the basis of our plan until January 24, 2022. We are subject +to periodic review by NYSE American staff during the extension period. Failure to make progress consistent with the plan or to regain +compliance with the continued listing standards by the end of the extension period could result in our common stock being delisted from +the NYSE American. On January 4, 2021, we were notified by the NYSE American we failed to comply with the NYSE American continued listing +standards because of our inability to hold an annual meeting of stockholders no later than one year after the end of our last fiscal year. +In light of our continued losses and inability to obtain quorum for our annual meeting, there is no assurance that we will be able to +regain compliance with the NYSE American continued listing standards. If we fail to meet the NYSE American listing requirement, we may +be subject to delisting by the NYSE American. In the event our common stock is no longer listed for trading on the NYSE American, our +trading volume and share price may decrease and we may experience further difficulties in raising capital which could materially affect +our operations and financial results. Further, delisting from the NYSE American could also have other negative effects, including potential +loss of confidence by partners, lenders, suppliers and employees and could also trigger various defaults under our lending agreements +and other outstanding agreements. Finally, delisting could make it harder for us to raise capital and sell securities. You may experience +future dilution as a result of future equity offerings. In order to raise additional capital, we may in the future offer additional shares +of our common stock or other securities convertible into or exchangeable for our common stock at prices that may not be the same as the +price per share in this offering. We may sell shares or other securities in any other offering at a price per share that is less than +the price per share paid by investors in this offering, and investors purchasing shares or other securities in the future could have rights +superior to existing stockholders. The price per share at which we sell additional shares of our common stock, or securities convertible +or exchangeable into common stock, in future transactions may be higher or lower than the price per share paid by investors in this offering. +Our common stock price is volatile; Volatility in our common stock +price may subject us to securities litigation. +Our common stock is listed on the NYSE American. In the past, our trading +price has fluctuated widely, depending on many factors that may have little to do with our operations or business prospects. During the +past year, through April 12, 2021, our stock price traded between $0.53 per share and $10.94 per share as reported on Nasdaq.com. Further, +during the first quarter of 2018, our common stock closed at a high of $2,880.00 per share as reported on Nasdaq.com. On April 12, 2021, +our common stock closed at $2.98. +Stock markets, in general, have experienced, and +continue to experience, significant price and volume volatility, and the market price of our common stock may continue to be subject to +similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, coupled with depressed economic +conditions, could continue to have a depressive effect on the market price of our common stock. The following factors, many of which are +beyond our control, may influence our stock price: +· the status of our growth strategy including the development of new products with any proceeds we may be +able to raise in the future; +· announcements of technological or competitive developments; +· announcements or expectations of additional financing efforts; +· our ability to market new and enhanced products on a timely basis; +· changes in laws and regulations affecting our business; +commencement of, or involvement in, +litigation involving us; +· regulatory developments affecting us, our customers or our competitors; +· announcements regarding patent or other intellectual property litigation or the issuance of patents to +us or our competitors or updates with respect to the enforceability of patents or other intellectual property rights generally in the +US or internationally; +39 +· actual or anticipated fluctuations in our quarterly financial results or the quarterly financial results +of companies perceived to be similar to us; +· changes in the market’s expectations about our operating results; +· our operating results failing to meet the expectations of securities analysts or investors in a particular +period; +· changes in the economic performance or market valuations of our competitors; +· additions or departures of our executive officers; +· sales or perceived sales of our common stock by us, our insiders or our other stockholders; +· share price and volume fluctuations attributable to inconsistent trading volume levels of our shares; +and +· general economic, industry, political and market conditions and overall fluctuations in the financial +markets in the United States and abroad, including as a result of ongoing COVID-19 pandemic. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock +and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of a company’s +securities, stockholders have often instituted securities class action litigation against that company. If we were involved in a class +action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense +and, whether or not adversely determined, have a material adverse effect on our business, financial condition, results of operations and +prospects. +We have a substantial +number of convertible notes, warrants, options and preferred stock outstanding that could affect our price. +Due +to a number of financings, we have a substantial number of shares that are subject to issuance pursuant to outstanding convertible debt, +warrants and options. These conversion prices and exercise prices range from $0.88 to $2,000 per share of common stock. As of the date +of this Annual Report, the number of shares of common stock subject to convertible notes, warrants, options and preferred stock were 440,862, +3,309,060, 850,925 and 2,232, respectively. The issuance of common stock pursuant to convertible notes, warrants, options and preferred +stock at conversion or exercise prices less than market prices may have the effect of limiting an increase in market price of our common +stock until all of these underling shares have been issued. +The issuance of shares +of our Class B Common Stock to our management or others could provide such persons with voting control leaving our other stockholders +unable to elect our directors and the holders of our shares of common stock will have little influence over our Management. +Although +there are currently no shares of our Class B Common Stock issued and outstanding, our certificate of incorporation authorizes the issuance +of 25,000,000 shares of Class B Common Stock. Each share of Class B Common Stock provides the holder thereof with ten (10) votes on all +matters submitted to a stockholder vote. Our certificate of incorporation does not provide for cumulative voting for the election of directors. +Any person or group who controls or can obtain more than 50% of the votes cast for the election of each director will control the election +of directors and the other stockholders will not be able to elect any directors or exert any influence over management decisions. As a +result of the super-voting rights of our shares of Class B Common Stock, the issuance of such shares to our management or others could +provide such persons with voting control and our other stockholders will not be able to elect our directors and will have little influence +over our management. While we are listed on the NYSE American or any other national securities exchange it is highly unlikely that we +would issue any shares of Class B Common Stock as doing so would jeopardize our continued listing on any such exchange. However, if were +to be delisted for some other reason and our shares of Class A Common Stock trade on an over-the-counter market, then we would face no +restriction on issuing shares of Class B Common Stock. +General Risk Factors +Our limited operating history makes it difficult +to evaluate our future business prospects and to make decisions based on our historical performance . +Although our executive officers +have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our current business +until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate our business on the +basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future results based upon our historical +data. Reliance on our historical results may not be representative of the results we will achieve, and for certain areas in which we operate, +principally those unrelated to defense contracting, will not be indicative at all. Because of the uncertainties related to our lack of +historical operations, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in sales, product costs +or expenses. If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, +which may result in a decline in our stock price. +40 +If we make any additional acquisitions, they may disrupt or have +a negative impact on our business. +We have plans to eventually +make additional acquisitions beyond Microphase, Enertec, Relec and the Facility. Whenever we make acquisitions, we could have difficulty +integrating the acquired companies’ personnel and operations with our own. In addition, the key personnel of the acquired business +may not be willing to work for us. We cannot predict the effect expansion may have on our core business. Regardless of whether we are +successful in making an acquisition, the negotiations could disrupt our ongoing business, distract our management and employees and increase +our expenses. In addition to the risks described above, acquisitions are accompanied by a number of inherent risks, including, without +limitation, the following: +· If Relec senior management and/or management +of future acquired companies terminate their employment prior to our completion of integration; +· difficulty of integrating acquired products, +services or operations; +· integration of new employees and management into +our culture while maintaining focus on operating efficiently and providing consistent, high-quality goods and services; +· potential disruption of the ongoing businesses +and distraction of our management and the management of acquired companies; +· unanticipated issues with transferring customer +relationships; +· complexity associated with managing our combined +company; +· difficulty of incorporating acquired rights or +products into our existing business; +· difficulties in disposing of the excess or idle +facilities of an acquired company or business and expenses in maintaining such facilities; +· difficulties in maintaining uniform standards, +controls, procedures and policies; +· potential impairment of relationships with employees +and customers as a result of any integration of new management personnel; +· potential inability or failure to achieve additional +sales and enhance our customer base through cross-marketing of the products to new and existing customers; +· effect of any government regulations which relate +to the business acquired; and +· potential unknown liabilities associated with +acquired businesses or product lines, or the need to spend significant amounts to retool, reposition or modify the marketing and sales +of acquired products or the defense of any litigation, whether or not successful, resulting from actions of the acquired company prior +to our acquisition. +Our business could be severely +impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection +with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract +our management and employees, increase our expenses and adversely affect our results of operations. +We may not be able to successfully identify +suitable acquisition targets and complete acquisitions to meet our growth strategy, and even if we are able to do so, we may not realize +the full anticipated benefits of such acquisitions, and our business, financial conditions and results of operations may suffer. +Increasing revenues through +acquisitions is one of the key components of our growth strategy. Identifying suitable acquisition candidates can be difficult, time-consuming +and costly, and we may not be able to identify suitable candidates or complete acquisitions in a timely manner, on a cost-effective basis +or at all. +We will have to pay cash, +incur debt, or issue equity as consideration in any future acquisitions, each of which could adversely affect our financial condition +or the market price of our common stock. The sale of equity or issuance of equity-linked debt to finance any future acquisitions could +result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could limit our +flexibility in managing our business due to covenants or other restrictions contained in debt instruments. +Further, we may not be able +to realize the anticipated benefits of completed acquisitions. Some acquisition targets may not have a developed business or are experiencing +inefficiencies and incur losses. Additionally, small defense contractors which we consider suitable acquisition targets may be uniquely +dependent on their prior owners and the loss of such owners’ services following the completion of acquisitions may adversely affect +their business. Therefore, we may lose our investment in the event that the acquired businesses do not develop as planned or that we are +unable to achieve the anticipated cost efficiencies or reduction of losses. +41 +Additionally, our acquisitions +have previously required, and any similar future transactions may also require, significant management efforts and expenditures. Regardless +of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, divert the attention of our +management and key employees and increase our expenses. +No assurance of successful expansion of operations. +Our significant increase in +the scope and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher operating +expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make significant demands +on our management, finances and other resources. Our ability to manage the anticipated future growth, should it occur, will depend upon +a significant expansion of our accounting and other internal management systems and the implementation and subsequent improvement of a +variety of systems, procedures and controls. We cannot assure that significant problems in these areas will not occur. Failure to expand +these areas and implement and improve such systems, procedures and controls in an efficient manner at a pace consistent with our business +could have a material adverse effect on our business, financial condition and results of operations. We cannot assure that attempts to +expand our marketing, sales, manufacturing and customer support efforts will succeed or generate additional sales or profits in any future +period. As a result of the expansion of our operations and the anticipated increase in our operating expenses, along with the difficulty +in forecasting revenue levels, we expect to continue to experience significant fluctuations in its results of operations. +We may be unable to successfully expand our +production capacity, which could result in material delays, quality issues, increased costs and loss of business opportunities, which +may negatively impact our product margins and profitability . +Part of our future growth +strategy is to increase our production capacity to meet increasing demand for our goods. Assuming we obtain sufficient funding to increase +our production capacity, any projects to increase such capacity may not be constructed on the anticipated timetable or within budget. +We may also experience quality control issues as we implement any production upgrades. Any material delay in completing these projects, +or any substantial cost increases or quality issues in connection with these projects could materially delay our ability to bring our +products to market and adversely affect our business, reduce our revenue, income and available cash, all of which could harm our financial +condition. +If we fail to establish and maintain an effective +system of internal control over financial reporting, we may not be able to report our financial results accurately or prevent fraud. Any +inability to report and file our financial results accurately and timely could harm our reputation and adversely impact the trading price +of our common stock. +Effective internal control +over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial +reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, +and our business and reputation with investors may be harmed. As a result, our small size and any current internal control deficiencies +may adversely affect our financial condition, results of operations and access to capital. We have carried out an evaluation under the +supervision and with the participation of our management, including our principal executive officer and principal financial officer, of +the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent period covered +by this report. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure +controls and procedures were not effective at the reasonable assurance level due to the material weaknesses described below. +A material weakness is a deficiency, +or a combination of deficiencies, within the meaning of Public Company Accounting Oversight Board (“PCAOB”) Audit Standard +No. 5, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual +or interim financial statements will not be prevented or detected on a timely basis. Management has identified the following material +weakness which has caused management to conclude that as of December 31, 2020 our internal control over financial reporting (“ICFR”) +was not effective at the reasonable assurance level: +We do not have sufficient +resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial +reporting, including fair value estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting +duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, +the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of +our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control +deficiency that resulted represented a material weakness. +42 +Planned Remediation +Management, in coordination +with the input, oversight and support of our Board of Directors, has identified the measures below to strengthen our control environment +and internal control over financial reporting. +On +August 19, 2020, Mr. Horne resigned as our Chief Financial Officer and was appointed our President, and later became our Chief Executive +Officer. Mr. Cragun, who had served as the Company’s Chief Accounting Officer since October 1, 2018, succeeded Mr. Horne as the +Chief Financial Officer of the Company. In January 2018, we engaged the services of a financial accounting advisory firm. In January 2019, +we hired a Senior Vice President of Finance. In May 2019, we hired an Executive Vice President and General Counsel, who later became our +President and General Counsel. Finally, in January 2021, we hired a Director of Reporting. These individuals were tasked with expanding +and monitoring the Company’s internal controls, to provide an additional level of review of complex financial issues and to assist +with financial reporting. On October 7, 2019, we created an Executive Committee which is currently comprised of our Executive Chairman, +Chief Executive Officer and President. The Executive Committee meets on a daily basis to address the Company’s critical needs and +provides a forum to approve transactions which are communicated to the Company’s Chief Financial Officer and Senior Vice President +of Finance on a bi-weekly basis by our Chief Executive Officer, who also reviews all of the Company’s material transactions and +reviews the financial performance of each of our subsidiaries. On December 16, 2020, in consultation with the Chairman of the Audit Committee, +we engaged a professional services firm to review management’s assessment of compliance with Section 404 of the Sarbanes-Oxley Act +of 2002 and to identify internal control process improvement opportunities. While these changes have improved and simplified our internal +processes and resulted in enhanced controls, these enhancements have not been operating for a sufficient period of time for management +to conclude, through testing, that these controls are operating effectively. Further, as we continue to expand our internal accounting +department, the Chairman of the Audit Committee shall perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, and +· reviews all anticipated transactions that are not considered in the ordinary course of business to assist +in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s financial statements. +We are currently working to +further improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weakness +in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. This material +weakness will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +If our accounting +controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We +evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and annually review and evaluate our internal control +over financial reporting in order to comply with the Commission’s rules relating to internal control over financial reporting adopted +pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent +or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls +may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such +internal control, we may be subject to regulatory sanctions, and our reputation may decline. +We face significant competition, including changes in pricing. +The markets for our products +are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing resources, plus +experience in research and development, and compete with us by offering lower prices. Competitors could develop new technologies that +compete with our products to achieve a lower unit price. If a competitor develops lower cost and/or superior technology or cost-effective +alternatives to our products and services, our business could be seriously harmed. +43 +The markets for some of our +products are also subject to specific competitive risks because these markets are highly price sensitive. Our competitors have competed +in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering our prices. This would +reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also impact sales and aggravate +losses. +Many of our competitors are larger and have +greater financial and other resources than we do. +Our products compete and will +compete with similar if not identical products produced by our competitors. These competitive products could be marketed by well-established, +successful companies that possess greater financial, marketing, distribution personnel, and other resources than we do. Using said resources, +these companies can implement extensive advertising and promotional campaigns, both generally and in response to specific marketing efforts +by competitors. They can introduce new products to new markets more rapidly. In certain instances, competitors with greater financial +resources may be able to enter a market in direct competition with us, offering attractive marketing tools to encourage the sale of products +that compete with our products or present cost features that consumers may find attractive. +Our growth strategy is subject to a significant +degree of risk. +Our +growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition +targets or made a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. Therefore, +we may lose our investment in the event that these companies’ businesses do not develop as planned or that they are unable to achieve +the anticipated cost efficiencies or reduction of losses. +Further, +in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement our +plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that provide +revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development and investments +will produce sufficient revenues to offset these increases in expenditures. +Our business and operations are growing rapidly. +If we fail to effectively manage our growth, our business and operating results could be harmed . +We have experienced, and may +continue to experience, rapid growth in our operations. This has placed, and may continue to place, significant demands on our management, +operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products and services could suffer, +which could negatively affect our operating results. To effectively manage our growth, we must continue to improve our operational, financial +and management controls and reporting systems and procedures. These systems improvements may require significant capital expenditures +and management resources. Failure to implement these improvements could hurt our ability to manage our growth and our financial position. +Our operating results may vary from quarter to quarter. +Our operating results have +in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in +magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products +in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or +fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven +by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you +that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of +large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, +and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. +The loss or deferral of one or more significant sales in a quarter could harm our operating results for such quarter. It is possible that, +in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the +event adverse conditions prevail, the market price of our common stock may decline significantly. +44 +Changes in the U.S. tax and other laws and regulations may adversely +affect our business. +The U.S. government may revise +tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, including modifications +that could reduce the profits that we can effectively realize from our international operations, or that could require costly changes +to those operations, or the way in which they are structured. For example, the effective tax rates for most U.S. companies reflect the +fact that income earned and reinvested outside the U.S. is generally taxed at local rates, which may be much lower than U.S. tax rates. +If we expand abroad and there are changes in tax laws, regulations or interpretations that significantly increase the tax rates on non-U.S. +income, our effective tax rate could increase and our profits could be reduced. If such increases resulted from our status as a U.S. company, +those changes could place us at a disadvantage to our non-U.S. competitors if those competitors remain subject to lower local tax rates. +Our sales and profitability may be affected by changes in +economic, business and industry conditions . +If the economic climate in +the United States or abroad deteriorates, customers or potential customers could reduce or delay their technology investments. Reduced +or delayed technology and entertainment investments could decrease our sales and profitability. In this environment, our customers may +experience financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and professional +services. This may lead to longer sales cycles, delays in purchase decisions, payment and collection, and can also result in downward +price pressures, causing our sales and profitability to decline. In addition, general economic uncertainty and general declines in capital +spending in the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and +the markets we serve. There are many other factors which could affect our business, including: +· The introduction and market acceptance of new technologies, products and services; +· New competitors and new forms of competition; +· The size and timing of customer orders (for retail distributed physical product); +· The size and timing of capital expenditures by our customers; +· Adverse changes in the credit quality of our customers and suppliers; +· Changes in the pricing policies of, or the introduction of, new products and services by us or our competitors; +· Changes in the terms of our contracts with our customers or suppliers; +· The availability of products from our suppliers; and +· Variations in product costs and the mix of products sold. +These +trends and factors could adversely affect our business, profitability and financial condition and diminish our ability to achieve our +strategic objectives. +The sale of our products is dependent upon +our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively +narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance +by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to +satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our +ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, +and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, +including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place +of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products +and adversely affect the revenues from such products. +Our limited ability to protect our proprietary +information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property +rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist +entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, +trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual +property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior +to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent +as the laws of the United States. In order to defend our proprietary rights in the technology utilized in our products from third party +infringement, we may be required to institute legal proceedings, which would be costly and would divert our resources from the development +of our business. If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, +our future results could be adversely affected. +45 +Although we attempt to avoid +infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and +claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party +proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require +us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to +us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the United +States or abroad. +If we ship products that contain defects, the +market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, +and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have +been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, +error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, +resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In +addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the +use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. +Although we maintain product liability insurance, it may not be adequate. +The rights of the holders of common stock may +be impaired by the potential issuance of preferred stock. +Our certificate of incorporation +gives our board of directors the right to create new series of preferred stock. As a result, the board of directors may, without stockholder +approval, issue preferred stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting +power and equity interest of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote +per share, could be utilized as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover +attempts could adversely affect the price of our common stock. Although we have no present intention to issue any shares of preferred +stock or to create a series of preferred stock, we may issue such shares in the future. +The requirements of being a public company +may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company and +subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among other +things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act +requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial reporting. +For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of our internal controls +structure and procedures for financial reporting. Section 404 compliance may divert internal resources and will take a significant +amount of time and effort to complete. If we fail to maintain compliance under Section 404, or if in the future management determines +that our internal control over financial reporting are not effective as defined under Section 404, we could be subject to sanctions +or investigations by the NYSE American should we in the future be listed on this market, the Commission, or other regulatory authorities. +Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our common stock. Any +failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. If +we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results +and could result in an adverse opinion on internal controls from our independent auditors. We may need to hire a number of additional +employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company, particularly +if we become fully subject to Section 404 and its auditor attestation requirements, which will increase costs. Our management team and +other personnel will need to devote a substantial amount of time to new compliance initiatives and to meeting the obligations that are +associated with being a public company, which may divert attention from other business concerns, which could have a material adverse effect +on our business, financial condition and results of operations. +46 +If we fail to comply with the rules under +the Sarbanes-Oxley Act of 2002 related to accounting controls and procedures, or if we discover material weaknesses and deficiencies in +our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more difficult. +If we fail to comply with +the rules under the Sarbanes-Oxley Act of 2002 related to disclosure controls and procedures, or, if we discover material weaknesses +and other deficiencies in our internal control and accounting procedures, our stock price could decline significantly and raising capital +could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our +internal control over financial reporting. If material weaknesses or significant deficiencies are discovered or if we otherwise fail to +achieve and maintain the adequacy of our internal control, we may not be able to ensure that we can conclude on an ongoing basis that +we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, +effective internal controls are necessary for us to produce reliable financial reports and are important to helping prevent financial +fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors +could lose confidence in our reported financial information, and the trading price of our common stock could drop significantly. +If securities or industry analysts do not publish +research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading +volume could decline. +The trading market for our +common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. Our +research coverage by industry and financial analysts is currently limited. Even if our analyst coverage increases, if one or more of the +analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our +company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock +price or trading volume to decline. +The elimination of monetary liability against +our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, officers +and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees. +Our certificate of incorporation +contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders for damages for the +breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have contractual indemnification +obligations under any future employment agreements with our officers. The foregoing indemnification obligations could result in us incurring +substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. +These provisions and the resulting costs may also discourage us from bringing a lawsuit against directors and officers for breaches of +their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and +officers even though such actions, if successful, might otherwise benefit us and our stockholders. +We do not anticipate paying dividends on our +common stock and, accordingly, stockholders must rely on stock appreciation for any return on their investment. +We have never declared or +paid cash dividends on our common stock and do not expect to do so in the foreseeable future. The declaration of dividends is subject +to the discretion of our board of directors and will depend on various factors, including our operating results, financial condition, +future prospects and any other factors deemed relevant by our board of directors. You should not rely on an investment in our company +if you require dividend income from your investment in our company. The success of your investment will likely depend entirely upon any +future appreciation of the market price of our common stock, which is uncertain and unpredictable. There is no guarantee that our common +stock will appreciate in value. +ITEM 1B. UNRESOLVED STAFF COMMENTS. +Not applicable. +ITEM 2. PROPERTIES +Our corporate headquarters +office utilizes 7,102 square foot of leased office space in Las Vega, Nevada. Our Las Vegas lease commenced in January 2021 and expires +in December 2022. The annual base rent under the lease, payable on a monthly basis, is $238,526 during the first year to $242,816 during +the second year. +Our Newport Beach office utilizes +2,983 square foot of leased office space in Newport Beach, California. Our Newport Beach lease commenced in March 2018 and expired in +February 2021. Currently, we rent this location on a month-to-month basis. The annual base rent under the lease, payable on a monthly +basis, increases during the term of the lease from approximately $122,000 during the first year to approximately $128,000 during the final +year. +47 +In addition, we lease 35,178 +square-feet of other space domestically that includes office, engineering, laboratory and warehouse space in both California and Connecticut. +The annual base rent under these leases, payable on a monthly basis, was approximately $468,000 during 2020. These leases expire between +June 2021 and May 2026. +We also lease facilities internationally. +In September 2010, our wholly-owned subsidiary, Gresham Power, entered into a fifteen-year lease for its 25,000 square-foot facility in +Salisbury, the United Kingdom, where it designs, develops, manufactures, markets and distributes commercial and military power products +for the European market. Sales and service support staff for its European network of distributors are located within the building together +with other functions, such as engineering and administration. Gresham Power Electronics’ rent expense is approximately $11,600 per +month, and Gresham Power Electronics exercised the option to extend the lease through September 2024. Further, in June 2011, Enertec entered +into a ten-year lease for its 32,900 square-foot facility in Karmiel, Israel, where it manufactures specialized electronic systems for +the Israel military market. Enertec’s rent expense is approximately $20,000 per month, In November 2020, we acquired Relec. +In July 2020, Relec entered into a ten-year lease for its 7,490 square-foot facility in Dorset, the United Kingdom, where it markets and +distributes power electronics and display solutions for mission critical rail, industrial, medical, telecoms and military applications. +Relec’s rent expense is approximately $5,000 per month. +We currently anticipate that +the current leased space will be sufficient to support our current and foreseen future needs. +ITEM 3. LEGAL PROCEEDINGS +Derivative Action +On July 31, 2018, Ethan Young +and Greg Young (collectively, “Plaintiffs”) filed a stockholder derivative complaint (the “Complaint”) in the +United States District Court for the Central District of California (the “Court”) against the Company as the nominal defendant, +as well as its current directors and a former director, in action captioned, Ethan Young and Greg Young, Derivatively on Behalf of +Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, Robert O. +Smith, and Kristine Ault and DPW Holdings, Inc. , as the nominal defendant, (collectively, “Defendants”) Case No. 18-cv-6587 +(the “Derivative Action”). +The Complaint alleged violations +of state law and breaches of fiduciary duty, unjust enrichment and gross mismanagement by the individual defendants, in connection with +various transactions entered into by the Company. +The Defendants moved to dismiss +the Complaint, and on February 25, 2019, the Court granted Defendants motion to dismiss, in its entirety, without prejudice, and also +granted Plaintiffs leave to amend their Complaint. +On March 11, 2019, Plaintiffs +filed an amended complaint asserting violations of breaches of fiduciary duties and unjust enrichment claims based on the previously pled +transactions (the “Amended Complaint”). +On March 25, 2019, Defendants +filed a motion to dismiss (the “Motion”) the Amended Complaint. On May 21, 2019, the Court granted in part, and denied in +part, the Defendants’ Motion. On February 24, 2020, the Company entered into a definitive settlement agreement (the “Settlement +Agreement”) with Plaintiffs to settle the claims asserted in the Amended Complaint. +On April 15, 2020, the Court +issued an Order (the “Order”) approving a Motion for Preliminary Approval of Settlement in the Derivative Action. On July +16, 2020, the Court issued an Order (the “Final Order”) approving a Motion for Final Approval of Settlement in the Derivative +Action filed against DPW as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018 who were not dismissed +from the action as a result of the Court’s partial grant of the Motion. +On July 16, 2020, the Court +entered a Judgment based upon the Final Order. +Under the terms of the Final +Order, the Board shall adopt and/or maintain certain resolutions and amendments to the Company’s committee charters and/or bylaws, +to ensure adherence to certain corporate governance policies (collectively, the “Reforms”). The Final Order further provides +that such Reforms shall remain in effect for a period of no less than five (5) years and shall be subject to any of the following: (a) +a determination by a majority of the independent directors that the Reforms are no longer in the best interest of the Company, including, +but not limited to, due to circumstances making the Reforms no longer applicable, feasible, or available on commercially reasonable terms, +or (b) modifications which the Company reasonably believes are required by applicable law or regulation. +48 +In connection with the Settlement +Agreement, the parties have agreed upon a payment of attorneys’ fees in the amount of $600,000, which sum was paid by our Director +& Officer liability insurance. The Settlement Agreement contains no admission of wrongdoing. +We have always maintained +and continue to believe that neither we nor our current or former directors engaged in any wrongdoing or otherwise committed any violation +of federal or state securities laws or any other laws or regulations. +Blockchain Mining Supply and Services, Ltd. +On November 28, 2018, Blockchain +Mining Supply and Services, Ltd. (“Blockchain Mining”) a vendor who sold computers to our subsidiary, filed a Complaint (the +“Complaint”) in the United States District Court for the Southern District of New York against us and our subsidiary, Digital +Farms, Inc. (f/k/a Super Crypto Mining, Inc.), in an action captioned Blockchain Mining Supply and Services, Ltd. v. Super Crypto Mining, +Inc. and DPW Holdings, Inc. , Case No. 18-cv-11099. +The Complaint asserts claims +for breach of contract and promissory estoppel against us and our subsidiary arising from the subsidiary’s alleged failure to honor +its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $1,388,495, plus attorneys’ fees +and costs. +We believe that these claims +are without merit and intend to vigorously defend them. +On April 13, 2020, we and +our subsidiary, jointly filed a motion to dismiss the Complaint in its entirety as against us, and the promissory estoppel claim as against +our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Complaint in connection with the breach of contract +claim. +On April 29, 2020, Blockchain +Mining filed an amended complaint (the “Amended Complaint”). The Amended Complaint asserts the same causes of action and seeks +the same damages as the initial Complaint. +On May 13, 2020, we and our +subsidiary, jointly filed a motion to dismiss the Amended Complaint in its entirety as against us, and the promissory estoppel claim as +against of our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Amended Complaint in connection with the +breach of contract claim. +In its partial Answer, the +Company’s subsidiary admitted to the validity of the contract at issue and also asserted numerous affirmative defenses concerning +the proper calculation of damages. +On December 4, 2020, the Court +issued an Order directing the Parties to engage in limited discovery (the “Limited Discovery”) which was completed on March +4, 2021. In connection therewith, the Court also denied Defendants’ Motion to Dismiss without prejudice. +Upon completion of Limited +Discovery, the Company and its subsidiary anticipate filing a motion to dismiss the Amended Complaint. +Based on our assessment of +the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably estimate the +potential loss or range of loss that may result from this action. Notwithstanding, we have established a reserve in the amount of the +unpaid portion of the purchase agreement. An unfavorable outcome may have a material adverse effect on our business, financial condition +and results of operations. +Ding Gu (a/k/a Frank Gu) and Xiaodan Wang Litigation +On January 17, 2020, Ding +Gu (a/k/a Frank Gu) (“Gu”) and Xiaodan Wang (“Wang” and with “Gu” collectively, “Plaintiffs”), +filed a Complaint (the “Complaint”) in the Supreme Court of the State of New York, County of New York against us and our Chief +Executive Officer, Milton C. Ault, III, in an action captioned Ding Gu (a/k/a Frank Gu) and Xiaodan Wang v. DPW Holdings, Inc. and +Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd Ault) , Index No. 650438/2020. +49 +The Complaint asserts causes +of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent injunction, +enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions entered into +between Gu and us, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs and DPW, in or +about July 2019. The Complaint seeks, among other things, monetary damages in excess of $1,100,000, plus a decree of specific performance +directing DPW to deliver unrestricted shares of DPW’s common stock to Gu, plus attorneys’ fees and costs. +We believe that these claims +are without merit and intend to vigorously defend them. +On May 4, 2020, we and Ault +jointly filed a motion to dismiss the Complaint in its entirety, with prejudice. +On July 24, 2020, Plaintiffs +filed their opposition papers to our joint motion to dismiss. +The motion to dismiss has +been fully briefed and is currently pending before the court. +Based on our assessment of +the facts underlying the above claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably estimate +the potential loss or range of loss that may result from this action. An unfavorable outcome may have a material adverse effect on our +business, financial condition and results of operations. +Subpoena +The Company received a subpoena +from the SEC for the voluntary production of documents. The Company is fully cooperating with this non-public, fact-finding inquiry and +managements believe that the Company has operated its business in compliance with all applicable laws. The subpoena expressly provides +that the inquiry is not to be construed as an indication by the Commission or its staff that any violations of the federal securities +laws have occurred, nor should it be considered a reflection upon any person, entity or security. However, there can be no assurance as +to the outcome of this matter. +I.AM Bankruptcy Filing +On November 2, 2020, I.AM, +Inc. filed a voluntary petition for bankruptcy under Chapter 7 in the United States Bankruptcy Court in the Central District of California, +Santa Ana Division, case number 8:20-bk-13076. +Sichenzia Ross Ference LLP +On November 20, 2020, the Company’s former +counsel, Sichenzia Ross Ference LLP as successor to Sichenzia Ross Ference Kesner LLP (“SRF”) filed a Complaint in the United +States District Court for the Southern District of New York against the Company and two of its subsidiaries (collectively, the “Company +Defendants”), in an action captioned Sichenzia Ross Ference LLP as successor to Sichenzia Ross Ference Kesner LLP v. Digital Power +Corporation, et al., Case No. 20-CV-09811-JGK. The Complaint asserts claims for breach of contract, account stated, unjust enrichment +and quantum meruit, against the Company Defendants, and seeks monetary damages in the amount of $2,558,122 plus interest thereon. +On January 4, 2021, the Company Defendants filed +a motion for a more definite statement. +On January 11, 2021, the Court held a conference +in connection with the Company Defendants’ Motion wherein the Court denied the Company Defendants’ Motion as moot, ordered +SRF to amend its Complaint by on or before January 25, 2021, and referred the matter to mediation. +On January 25, 2021, SRF filed a First Amended +Complaint in the action and dropped the two subsidiaries as parties to the action. The First Amended Complaint asserts claims for breach +of contract, account stated, unjust enrichment and quantum meruit, against the Company, and seeks monetary damages in the amount of $2,518,468 +plus interest thereon. +On or about February 18, 2021, SRF, the Company +Defendants, and various of the Company Defendants’ related parties entered into a confidential settlement agreement. +On or about February 23, 2021, SRF filed, on behalf of itself and the Company Defendants, a stipulation of voluntary +dismissal, with prejudice. +50 +Other Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory and government +investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, suits, regulatory +and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable +that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss +or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could +affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and +make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount +of a loss related to such matters. +With respect to our other +outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either +individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, +or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY +SECURITIES +Market Information +Our common stock is listed +on the NYSE American under the symbol DPW. The following table sets forth our high and low sale prices per share of our common stock as +reported by www.nasdaq.com on the NYSE American through March 31, 2021 and for each quarter for the +past two fiscal years. +Fiscal Year Ended December 31, 2019 +High +Low +First Quarter +$128.00 +$11.18 +Second Quarter +$15.16 +$4.88 +Third Quarter +$11.60 +$1.57 +Fourth Quarter +$2.50 +$0.65 +Fiscal Year Ended December 31, 2020 +High +Low +First Quarter +$2.48 +$0.53 +Second Quarter +$6.55 +$0.71 +Third Quarter +$5.24 +$1.55 +Fourth Quarter +$10.94 +$1.44 +Fiscal Year Ended December 31, 2021 +High +Low +First Quarter +$7.99 +$2.61 +On March 31, 2021, the last +sales price per share of our common stock was $3.29. +51 +Record Holders +As of December 31, 2021, shares +of our common stock were issued and outstanding and were owned by approximately 84 holders of record. A number of holders of our common +stock are “street name” or beneficial holders whose shares of record are held by banks, brokers, and other financial institutions. +Dividend Policy +We have not declared or paid +any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends +in the future, if any, will be at the discretion of our Board of Directors and will depend upon our earnings, capital requirements, and +financial position. +Equity Compensation Information +The +information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 +of this Annual Report on Form 10-K. +Recent Sales of Unregistered Securities +On February 25, 2020, principal +of $295,000 from a debt security issued on February 5, 2020 was satisfied through the issuance of 203,448 shares of our common stock. +The foregoing issuance was exempt from registration upon reliance of Section 4(a)(2) of the Securities Act. +Issuer Repurchases of Equity Securities +Not applicable. +ITEM 6. SELECTED FINANCIAL DATA. +As a Smaller Reporting Company, +we are electing to follow scaled disclosure reporting obligations and therefore are not required to provide the information requested +by this Item. +52 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form +10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking +statements. Such forward-looking statements include statements regarding, among others, (a) our expectations about possible business combinations, +(b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs for working capital. Forward-looking statements, +which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words +“may,” “will,” “should,” “expect,” “anticipate,” “approximate,” +“estimate,” “believe,” “intend,” “plan,” “budget,” “could,” “forecast,” +“might,” “predict,” “shall” or “project,” or the negative of these words or other variations +on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that +may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements +expressed or implied by any forward-looking statements. These statements may be found in this Annual Report. +Forward-looking statements +are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other future +conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks, +and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking +statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in this +Annual Report, changes in local, regional, national or global political, economic, business, competitive, market (supply and demand) and +regulatory conditions and the following: +· Adverse economic conditions; +· Our ability to effectively execute our business plan; +· Inability to raise sufficient additional capital to operate our business; +· Our ability to manage our expansion, growth and operating expenses; +· Our ability to evaluate and measure our business, prospects and performance metrics; +· Our ability to compete and succeed in highly competitive and evolving industries; +· Our ability to respond and adapt to changes in technology and customer behavior; +· Our ability to protect our intellectual property and to develop, maintain and enhance a strong brand; +and +· Other specific risks referred to in the section entitled “ Risk Factors ”. +We caution you therefore that +you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances of future +performance. All forward-looking statements speak only as of the date of this Annual Report. We undertake no obligation to update any +forward-looking statements or other information contained herein unless required by law. +Information regarding market +and industry statistics contained in this Annual Report is included based on information available to us that we believe is accurate. +It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. +Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional +uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services. Except as required +by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect actual results or changes in assumptions +or other factors that could affect those statements. See the section entitled “ Risk Factors ” for a more detailed discussion +of risks and uncertainties that may have an impact on our future results. +In this Annual Report, the +“Company,” “ Ault Global ,” “we,” “us” and +“our” refer to Ault Global Holdings, Inc., a Delaware corporation, our wholly-owned subsidiaries, Gresham Worldwide, Inc. +(“GWW”), Coolisys Technologies Corp. (“Coolisys”), Gresham Power Electronics Ltd. (f/k/a Digital Power Limited) +(“Gresham Power”), Enertec Systems 2001 Ltd (“Enertec”), Relec Electronics Ltd., Digital Power Lending, LLC (“DP +Lending”), Ault Alliance, Inc. (“Ault Alliance”), Tansocial, LLC and Digital Farms, Inc. (“Digital Farms”) +and our majority owned subsidiaries, Microphase Corporation and Alliance Cloud Services. +53 +Recent Developments +Reorganization of Our Corporate Structure +Commencing in October and +continuing through February 2021, we reorganized our corporate structure pursuant to a series of transactions among our company and our +directly and indirectly-owned subsidiaries. The purpose of the reorganization was to align our various businesses by the products and +services that constitute the majority of each subsidiaries’ revenues. As a result of the foregoing transactions, our corporate structure +is as follows: +Other Matters +On August 5, 2020, we received +$2,000,000 from Esousa Holdings, LLC (“Esousa”) and on October 22, 2020, we issued to Esousa a promissory note in the principal +face amount of $2,000,000, with an interest rate of 13%. The outstanding principal face amount, plus any accrued and unpaid interest, +is due by November 3, 2020, or as otherwise provided in accordance with the terms set forth therein. In connection therewith, we delivered +to Esousa a warrant to purchase 729,927 shares of common stock at an exercise price of $3.01. The exercise of the warrant is subject to +approval of the NYSE American. The foregoing debt was paid off in December of 2020. +On October 2, 2020, we entered +into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC to sell shares +of common stock having an aggregate offering price of up to $8,975,000 from time to time, through an “at the market offering” +program (the “2020 ATM Offering”). On December 1, 2020, we filed an amendment to the prospectus supplement with the SEC to +increase the amount of common stock that may be offered and sold in the ATM Offering, as amended under the Sales Agreement to $40,000,000 +in the aggregate, inclusive of the up to $8,975,000 in shares of common stock previously sold in the 2020 ATM Offering. The offer and +sale of shares of common stock from the 2020 ATM Offering was made pursuant to our effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) which became effective on January +11, 2018. Through December 31, 2020, we had received gross proceeds of $39,978,350 through the sale of 12,582,000 shares of common stock +from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, 2020. +54 +On October 27, 2020, we issued +to Esousa two unsecured promissory notes in the aggregate principal face amount of $1,200,000, of which $850,000 was received prior to +September 30, 2020. The principal amount of $850,000 of the first note dated October 27, 2020, together with all accrued unpaid interest +at an annual rate of 14%, was due and payable on December 28, 2020. The principal amount of $350,000 of the second note dated October +27, 2020, together with all accrued unpaid interest at an annual rate of 14%, was due and payable on January 7, 2021. Both unsecured promissory +notes were repaid on December 14, 2020. In connection with the two promissory notes, we delivered to the Esousa (i) a warrant dated October +27, 2020, to purchase 425,000 shares of common stock at an exercise price of $2.20, and (ii) a warrant dated October 27, 2020, to purchase +148,936 shares of common stock at an exercise price of $2.59. The exercise of the warrants is subject to approval of the NYSE American. +On November 9, 2020, our wholly-owned +subsidiary Gresham Worldwide, Inc. (“GWW”) entered into a stock purchase agreement with Tabard Holdings Inc., a Delaware corporation +and wholly owned subsidiary of GWW (“Tabard”), the legal and beneficial owners (the “Sellers”) of 100% of the +issued shares in the capital of Relec Electronics Ltd., a corporation organized under the laws of England and Wales (“Relec”), +and Peter Lappin, in his capacity as the representative of the Sellers. Upon the terms and subject to the conditions set forth in the +stock purchase agreement, Tabard agreed to acquire Relec pursuant to the stock purchase agreement whereby the Sellers will sell to Tabard +(i) 100% of the issued shares of Relec. The purchase price is approximately £3,000,000 plus an amount equal to Relec’s cash +balance immediately prior to closing of the acquisition. The acquisition of Relec was consummated on November 30, 2020. +On November 19, 2020, we issued +to Esousa and two other institutional investors unsecured promissory notes in the aggregate principal face amount of $2,250,000, with +an interest rate of 12%. The outstanding principal face amount, plus any accrued and unpaid interest, was due by February 18, 2021, or +as otherwise provided in accordance with the terms set forth therein. These unsecured promissory notes were repaid on December 28, 2020. +In connection therewith, we delivered warrants to purchase an aggregate of 1,323,531 shares of common stock at an exercise price of $1.87, +subject to adjustments. Exercise of the warrants is subject to approval of the NYSE American. +On +January 29, 2021, Alliance Cloud Services, LLC, a majority-owned subsidiary of its wholly-owned subsidiary, Ault Alliance, closed on the +acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan for a purchase price of +$3,991,497. The purchase price was paid by the Company using its own working capital. +Settlement of Derivative Litigation +On February 24, 2020, we entered +into a definitive settlement agreement (the “Settlement Agreement”) intended to settle the previously disclosed derivative +litigation captioned Ethan Young and Greg Young, Derivatively on Behalf of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, +Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, Robert O. Smith, and Kristine Ault and DPW Holdings, Inc., as the nominal +defendant (Case No. 18-cv-6587) (as amended on March 11, 2019, the “Amended Complaint”) against us and certain of our officers +and directors pending in the United States District Court for the Central District of California (the “Court”). As previously +disclosed, the Amended Complaint alleges violations including breaches of fiduciary duties and unjust enrichment claims based on the previously +pled transactions. +On April 15, 2020, the Court +issued an Order (the “Order”) approving a Motion for Preliminary Approval of Settlement in the Derivative Action. On July +16, 2020, the Court issued an Order (the “Final Order”) approving a Motion for Final Approval of Settlement in the Derivative +Action filed against DPW as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018 who were not dismissed +from the action as a result of the Court’s partial grant of the Motion. +In accordance with the terms +of the Final Order, the Board has adopted certain resolutions and amendments to our committee charters and/or bylaws, to ensure adherence +to certain corporate governance policies (collectively, the “Reforms”). The Final Order further provides that such Reforms +shall remain in effect for a period of no less than five (5) years and shall be subject to any of the following: (a) a determination by +a majority of the independent directors that the Reforms are no longer in our best interest, including, but not limited to, due to circumstances +making the Reforms no longer applicable, feasible, or available on commercially reasonable terms, or (b) modifications which we reasonably +believe are required by applicable law or regulation. +In connection with the Settlement +Agreement, the parties agreed to a payment of attorneys’ fees in the amount of $600,000, which sum was paid by our directors & +officers liability insurance. The Settlement Agreement contains no admission of wrongdoing. +We have always maintained +and continue to believe that neither we nor our current or former directors engaged in any wrongdoing or otherwise committed any violation +of federal or state securities laws or any other laws or regulations. +55 +Impact of Coronavirus on Our Operations +Our business has been disrupted +and materially adversely affected by the recent outbreak of COVID-19. As a result of measures imposed by the governments in affected regions, +businesses and schools have been suspended due to quarantines intended to contain this outbreak and many people have been forced to work +from home in those areas. The spread of COVID-19 from China to other countries has resulted in the Director General of the World Health +Organization declaring the outbreak of COVID-19 as a Public Health Emergency of International Concern, based on the advice of the Emergency +Committee under the International Health Regulations (2005), and the Centers for Disease Control and Prevention in the U.S. issued a warning +on February 25, 2020 regarding the likely spread of COVID-19 to the U.S. While the COVID-19 outbreak is still in its early stages, international +stock markets have begun to reflect the uncertainty associated with the slow-down in the American, Israeli and UK economies and the reduced +levels of international travel experienced since the beginning of January and the significant decline in the Dow Industrial Average at +the end of February 2020 was largely attributed to the effects of COVID-19. We are still assessing our business operations and system +supports and the impact COVID-19 may have on our results and financial condition, but there can be no assurance that this analysis will +enable us to avoid part or all of any impact from the spread of COVID-19 or its consequences, including downturns in business sentiment +generally or in our sectors in particular. +Our +operations are located in Alameda County, CA, Orange County, CA, Fairfield County, CT, the United Kingdom, Israel and members of our senior +management work in Seattle, WA and New York, NY, which is also the location of the offices of the Company’s independent auditor. +We have been following the recommendations of local health authorities to minimize exposure risk for its employees for the past several +weeks, including the temporary closures of our offices and having employees work remotely to the extent possible, which has to an extent +adversely affected their efficiency. +Updates by business unit +are as follows: +· Ault Global’s corporate headquarters, located in Las Vegas, NV, largely operates normally with adherence +to the governor’s Directives and Declarations. Certain individuals deemed to be high risk may work remotely, as required. +· Ault Global’s finance and accounting offices, located in Newport Beach, CA, has begun working remotely, +based on the occupancy and social distancing order from the Orange County Health Officer (http://www.ochealthinfo.com/phs/about/epidasmt/epi/dip/prevention/novel_coronavirus). +The administrative staff has tested the secure remote access systems and technology infrastructure to adjust working arrangements for +its employees and believes it has adequate internal communications system and can remain operational with a remote staff. +· Coolisys, located in Milpitas, CA, had largely returned to normal operations with adherence to guidelines +published by the Santa Clara Public Health Department. Certain individuals deemed to be high risk may work remotely as required. Coolisys +has experienced disruption in its supply chain as a result of the COVID-19 impact on its vendors. +· Microphase operates a production facility in Connecticut. In March 2020, the Defense Department designated +Microphase an “essential” operation of critical infrastructure workers as part of the defense industrial base. To limit the +impact of the COVID-19 pandemic, Microphase implemented a series of protocols to limit access to the facility, heighten sanitization, +facilitate social distancing and require face coverings. The Company asked workers to travel only as necessary and limit exposure to others. +All employees, including management, that do not have to be in the facility work remotely whenever possible. Any employees who come in +contact or potential contact with anyone who has tested positive for COVID-19 or who traveled outside the immediate area went into quarantine +and must provide proof of negative tests before returning to work. Rigorous adherence to these protocols enabled Microphase to operate +without disruption for 10 months. +In December +2020, five employees tested positive for COVID-19. Microphase temporarily shut down the production facility in Connecticut for a week +for deep cleaning and to have all employees tested for COVID-19. Since the outbreak disproportionately affected assembly workers, Microphase’s +assembly operations remained shut down for three weeks until all assembly workers had at least 2 negative tests. Operations resumed as +workers gradually in late December and the workforce returned to full strength in mid-January 2021. +The disruption +to production operations deferred order completion and delayed shipments with a significant decrease in revenue from forecast for December +of 2020 and a lingering, but only partial and less substantial, effect on January 2021 and February 2021 revenue. Disruption of production +added costs from paying employees who could not work and deferred revenue from delayed shipments. +56 +Microphase +continues to follow CDC guidelines for social distancing, face coverings and heightened sanitizing to keep the workforce safe and healthy. +Microphase has strictly limited access to its facility and mandated that all employees minimize exposure to the others. All Microphase +employees who can work from home will do so while COVID-19 levels remain high in the surrounding communities. However, some workers may +still need to work in proximity to others. Management is working with state and federal authorities to get all employees vaccinated on +a priority basis as “essential workers” whom the DoD has officially designated as “critical infrastructure workforce” +as part of the “defense industrial base.” Some employees have already received vaccinations and we expect all employees to +have both vaccinations by the end of March 2021. +· Gresham Power suspended production operations +in its Salisbury, UK facility from mid-March through June 2020 before resuming production until a subsequent shutdown in November 2020. +Notwithstanding the current lockdown, production operations have resumed to complete work on order for products critically needed for +military operations. However, engineers, back office staff and management have worked from home as much as possible throughout the pandemic +period and continue to do so. The pandemic has disrupted production at times and delayed contract actions as well as other customer decision +making, which decreased revenue realized in 2020. +· Relec, which does not operate any manufacturing +or assembly facilities, has not experienced any material COVID-19 related disruptions to date and continues normal operations notwithstanding +the lockdown in the United Kingdom. All employees who can work from home do so. Others who must work at the Wareham site to move product +or access systems continue to do so under strict safety protocols with face coverings, social distancing and heightened attention to sanitization. +The principal impact on Relec’s operations has come from deferral of some orders and modest decrease in revenue year-over-year. +We presently expect business to rebound and resume a steady growth pattern in the third quarter of 2021, although the pandemic may impact +this outlook. +· The Israeli government exempted Enertec from +pandemic-related lockdown orders to keep production operations open for key projects that impact national security. Approximately 50% +of the Enertec’s workforce is working remotely. Enertec incurred additional costs for increased sanitizing costs, personal +protective equipment, increased virtual operations, measures to facilitate social distancing and other precautions to avoid the spread +of COVID-19. The pandemic also affected Enertec’s customers and supply chain partners, slowing order processing, materials and parts +delivery and service order completion. The principal impact on Enertec’s business has come from deferral of customer decisions and +order issuance. We presently expect business to rebound and resume substantial growth in second quarter of 2021 as orders increase +to address deferred, pent up demand. +The COVID-19 global pandemic has been unprecedented +and unpredictable and is likely to continue to result in significant national and global economic disruption, which may adversely affect +our business. Based on the Company’s current assessment, however, the Company does not expect any material impact on its long-term +strategic plans, its operations, or its liquidity due to the worldwide spread of the COVID-19 virus. However, the Company is actively +monitoring this situation and the possible effects on its financial condition, liquidity, operations, suppliers, and industry. +GENERAL +As a holding company, our +business strategy is designed to increase shareholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to shareholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize shareholder value. We anticipate returning value to shareholders after satisfying our debt obligations +and working capital needs. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, sales of their securities in the open market. Our plans may include taking subsidiaries or partner companies public +through rights offerings and directed share subscription programs. We will continue to consider these (or similar) programs and the sale +of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +57 +Over the recent past we have +provided capital and relevant expertise to fuel the growth of businesses in defense/aerospace, industrial, telecommunications, medical, +crypto-mining, textiles and a select portfolio of commercial hospitality properties. We have provided capital to subsidiaries as well +as partner companies in which we have an equity interest or may be actively involved, influencing development through board representation +and management support. +We are a Delaware corporation +with our corporate office located at 11411 Southern Highlands Pkwy, Suite 240, Las Vegas, NV 89141. Our phone number is 949-444-5464 and +our website address is www.aultglobal.com. +58 +Results of Operations +RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2020 AND +2019 +The following table summarizes the results of our +operations for the years ended December 31, 2020 and 2019. +For the Year Ended +December +2020 +2019 +Revenue +$ 23,628,859 +$ 21,057,509 +Revenue, cryptocurrency mining +- +641,745 +Revenue, lending activities +242,418 +662,740 +Total revenue +23,871,277 +22,361,994 +Cost of revenue +16,356,741 +19,302,647 +Gross profit +7,514,536 +3,059,347 +Total operating expenses +13,548,009 +27,757,265 +Loss from continuing operations +(6,033,473 ) +(24,697,918 ) +Interest income +104,869 +3,351,226 +Interest expense +(9,648,820 ) +(7,261,857 ) +Change in fair value of marketable equity securities +919,083 +(596,242 ) +Loss on extinguishment of debt +(18,706,488 ) +(966,134 ) +Loss on issuance of warrants +- +(1,763,481 ) +Change in fair value of warrant liability +(48,842 ) +1,124,953 +Loss from continuing operations before income taxes +(33,413,671 ) +(30,809,453 ) +Income tax benefit +23,794 +108,293 +Net loss from continuing operations +(33,389,877 ) +(30,701,160 ) +Net gain (loss) from discontinued operations, net of taxes +661,248 +(2,244,668 ) +Net loss +(32,728,629 ) +(32,945,828 ) +Less: Net loss attributable to non-controlling interest +- +32,416 +Net loss attributable to Ault Global Holdings +(32,728,629 ) +(32,913,412 ) +Preferred dividends +(17,621 ) +(15,938 ) +Net loss available to common stockholders +$ (32,746,250 ) +$ (32,929,350 ) +Basic and diluted net loss per common share: +Continuing operations +$ (3.48 ) +$ (21.41 ) +Discontinued operations +0.07 +(1.57 ) +Net loss per common share +$ (3.41 ) +$ (22.97 ) +Weighted average common shares outstanding, basic and diluted +9,606,493 +1,433,464 +Comprehensive loss +Loss available to common stockholders +$ (32,746,250 ) +$ (32,929,350 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +481,596 +341,774 +Net unrealized gain (loss) on derivative securities of related party +3,312,094 +(1,950,875 ) +Other comprehensive income (loss) +3,793,690 +(1,609,101 ) +Total comprehensive loss +$ (28,952,560 ) +$ (34,538,451 ) +59 +Revenues +Revenues by segment for the +years ended December 31, 2020 and 2019 are as follows: +For the Year Ended +December +Increase +2020 +2019 +(Decrease) +% +GWW +$ 18,212,721 +$ 15,231,843 +$ 2,980,878 +20 % +Coolisys +5,416,138 +5,825,666 +(409,528 ) +-7 % +Ault Alliance: +Revenue, cryptocurrency mining +- +641,745 +(641,745 ) +-100 % +Revenue, lending and investing activities +242,418 +662,740 +(420,322 ) +-63 % +Total revenue +$ 23,871,277 +$ 22,361,994 +$ 1,509,283 +7 % +Our revenues increased by +$1,509,283, or 7%, to $23,871,277 for the year ended December 31, 2020, from $22,361,994 for the year ended December 31, 2019. +GWW +GWW revenues increased by +$2,980,878, or 20%, to $18,212,721 for the year ended December 31, 2020, from $15,231,843 for the year ended December 31, 2019. The increase +in revenue from our Gresham Worldwide segment for customized solutions for the military markets reflected the benefit of capital that +was allocated to our defense business during the second half of 2019. GWW revenue in 2020 includes $598,500 from Relec, which was acquired +on November 30, 2020. Revenue from Enertec, which largely consists of revenue recognized over time, for the year ended December 31, 2020 +increased $421,974 or 5% from the prior year. +Coolisys +Coolisys revenues decreased +by $409,528, or 7%, to $5,416,138 for the year ended December 31, 2020, from $5,825,666 for the year ended December 31, 2019. +Ault Alliance +Revenues from our cryptocurrency +mining operations revenues decreased by $641,745, or 100% from the year ended December 31, 2019, due to our decision to cease our cryptocurrency +mining operations. During the first quarter of 2020, due to deteriorating business conditions in the cryptocurrency mining sector, we +ceased operations at Digital Farms. Our decision to cease cryptocurrency mining operations in 2020 was based on several factors, which +had negatively affected the number of active miners we operated, including the market prices of digital currencies at the time, power +cost considerations available to Digital Farms, and a significant increase in the difficulty of mining blocks of cryptocurrency. +Revenues from our lending +and investing activities decreased by $420,322, or 63%, to $242,418 for the year ended December 31, 2020, from $662,740 for the year ended +December 31, 2019 attributed to a reduction in our loan portfolio. +Gross Margins +Gross margins increased to +31.5% for the year ended December 31, 2020, compared to 13.7% for the year ended December 31, 2019. Our gross margin of 13.7% recognized +during the year ended December 31, 2019, was impacted by the approximate $2.1 million negative margins at Digital Farms and the provision +for credit losses of $1,550,000 at DP Lending, compared to no provision for credit losses during the year ended December 31, 2020. Excluding +the effects of Digital Farms and credit losses at DP Lending, our adjusted gross margin for the year ended December 31, 2019 would have +been 31.1%. +Engineering and Product Development +Engineering and product development +expenses decreased slightly by $12,237 to $1,848,866 for the year ended December 31, 2020, from $1,861,103 for the year ended December +31, 2019. +60 +Selling and Marketing +Selling and marketing expenses +were $1,177,321 for the year ended December 31, 2020, compared to $1,409,996 for the year ended December 31, 2019, a decrease of $232,675. +This decrease was the result of decreases in personnel costs directly attributed to a reduction in sales and marketing personnel primarily +at Coolisys. +General and Administrative +General and administrative +expenses were $12,526,855 for the year ended December 31, 2020 compared to $15,524,180 for the year ended December 31, 2019, a decrease +of $2,997,325. General and administrative expenses decreased from the comparative prior period, mainly due to lower legal fees, stock +compensation expense, other third-party fees and travel related costs, which decreased during the year ended December 30, 2020 due to +travel restrictions related to the COVID-19 pandemic. +Asset Impairment Charges +There were no asset impairment +charges recognized during the year ended December 31, 2020, compared to $4,315,856 for year ended December 31, 2019. The impairment charges +for the year ended December 31, 2019 related to impairments of our cryptocurrency mining equipment. +Impairment loss on goodwill and intangible +assets +During the year ended December 31, 2019, +we performed a qualitative assessment and concluded that the goodwill at Coolisys was impaired and recorded an impairment of $480,953. +Further, during the year ended December 31, 2019, we also recorded an impairment loss of $170,692 related to intangible assets primarily +comprised of trade names, customer relationships and a non-competition agreement at Coolisys. For the year ended December 31, 2020, the +Company did not record any impairment loss. +Provision for credit losses +Loans +are generally carried at the amount of unpaid principal, adjusted for unearned loan fees and original issue discount, which are amortized +over the term of the loan using the effective interest rate method. Interest on loans is accrued based on the principal amounts outstanding. +During the years ended December 31, 2020 and 2019, we evaluated the collectability of both interest and principal for the convertible +promissory notes in AVLP to determine whether there was an impairment. As of December 31, 2019, based on information and events available +at that time, primarily the value of the underlying conversion feature and recent economic events, we concluded that an impairment existed +and, accordingly, we recorded a $4,000,000 provision for credit losses. As of December 31, 2020, due to an increase in the value of the +underlying conversion feature, we reduced the provision by $2,000,000. +Interest Income +Interest income was $104,869 +for the year ended December 31, 2020 compared to $3,351,226 for the year ended December 31, 2019. The decrease in interest income for +the year ended December 31, 2020 is related to a decrease in interest income pursuant to the AVLP Loan Agreement entered into on September +6, 2017, with AVLP, a related party, as subsequently amended. Due to the impaired status of the loan, no interest was recognized during +the year ended December 31, 2020. +Interest expense +Interest expense was $9,648,820 +for the year ended December 31, 2020, compared to $7,261,857 for the year ended December 31, 2019. The increase in interest expense for +the year ended December 31, 2020 is primarily related to an increase of amortization of debt discount resulting from original issue discount +from the issuance of warrants in conjunction with the sale of debt instruments. During the year ended December 31, 2020 and 2019, as a +result of these issuances, non-cash interest expense of $7,251,365 and $3,709,993, respectively, was recorded from the amortization of +debt discount and debt financing costs. +61 +Loss on issuance of warrants +On March 29, 2019, the Company +entered into an underwriting agreement (the “Underwriting Agreement”) with A.G.P./Alliance Global Partners (the “Underwriter”), +pursuant to which the Company agreed to issue and sell an aggregate of (a) 71,388 shares of its common stock (the “Shares”) +together with warrants to purchase 71,388 shares of common stock (the “Common Warrants”) and (b) pre-funded warrants to purchase +up to 317,500 shares of its common stock (the “Pre-Funded Warrants”) together with a number of Common Warrants to purchase +317,500 shares of common stock (the “Offering”). The Shares were sold to the purchasers at the public offering price of $17.60 +per share (the “Offering Price”). The Common Warrants were sold at a public offering price of $0.40 per Common Warrant. The +Pre-Funded Warrants were offered to each purchaser whose purchase of the Shares and the Common Warrant in the Offering would otherwise +result in the purchaser, together with its affiliates and certain related parties, beneficially owning more than 4.99% (or, at the election +of the purchaser, 9.99%) of the Company’s outstanding common stock immediately following the consummation of the Offering. The purchase +price of each Pre-Funded Warrant equaled the Offering Price at which the Shares were sold to the public in the Offering, minus $0.40, +and the exercise price of each Pre-Funded Warrant equaled $0.40 per share. In addition, the Company has also issued the Underwriter a +warrant to purchase a maximum of 15,550 additional shares of common stock at an initial exercise price of $19.80 per share, with a term +of five years (the “Underwriter Warrants”). +We recognized a loss on issuance +of warrants of $1,763,481 for the year ended December 31, 2019, based upon the fair value of the warrants issued in our March 2019 underwritten +public offering of common stock and warrants (the “Offering”) in excess of the proceeds received from the Offering. +Change in fair value of warrant liability +During the year ended December +31, 2020, the fair value of the warrants that were issued in our Offering increased by $48,842 whereas during the year ended December +31, 2019, the fair value of the warrants decreased by $1,124,953. The fair value of these warrants is re-measured at each financial reporting +period and immediately before exercise, with any changes in fair value recorded as change in fair value of warrant liability in the Condensed +Consolidated Statements of Operations and Comprehensive Loss. +Loss on extinguishment of debt +Loss on extinguishment of debt was $18,706,488 +for the year ended December 31, 2020 compared to $966,134 for the year ended December 31, 2019. During the year ended December 31, 2020, +principal and accrued interest of $6,411,795 and $2,196,599, respectively, on the Company’s debt securities was satisfied through +the issuance of 9,632,219 shares of Common Stock. The Company recognized a loss on extinguishment of $15,572,326 as a result of these +issuances. The remaining loss on extinguishment is primarily due to the estimated fair value of warrants to purchase an aggregate of 1,700,361 +shares of common stock that were issued to Esousa pursuant to the Master Exchange Agreement. +Net gain (loss) from discontinued operations +As a result of temporary closures +of restaurants in San Diego County and the deteriorating business conditions at the Company’s restaurant businesses, during the +first quarter of 2020, the Company concluded that discontinuing the operations of I.AM was ultimately in its best interest. Management +determined that the permanent closing of the restaurant operations met the criteria for presentation as discontinued operations. Accordingly, +the results of the restaurant operations are presented as discontinued operations in our consolidated statements of operations and comprehensive +loss and are excluded from continuing operations for all periods presented. Additionally, on November 2, 2020, I.AM filed a voluntary +petition for bankruptcy under Chapter 7 in the United States Bankruptcy Court in the Central District of California, Santa Ana Division, +case number 8:20-bk-13076. As a result of I.AM’s bankruptcy filing on November 2, 2020, Ault Global ceded authority for managing +the business to the Bankruptcy Court. For this reason, we concluded that Ault Global had lost control of I.AM, and no longer had significant +influence over I.AM. Therefore, we deconsolidated I.AM effective with the filing of the Chapter 11 bankruptcy in November 2020 and recorded +a gain on deconsolidation of 2,358,992. +Net Loss +For the foregoing reasons, +our net loss for the year ended December 31, 2020, was $32,728,629 compared to a net loss of $32,945,828 for the year ended December 31, +2019. After taking into consideration the loss attributable to the non-controlling interest of the minority shareholders of Microphase +during the years ended December 31, 2020 and 2019, of $0 and $32,416, respectively, and preferred dividends of $17,621 and $15,938, respectively, +the net loss available to common shareholders during the years ended December 31, 2020 and December 31, 2019, was $32,746,250 and $32,929,350, +respectively. +62 +As reflected in our consolidated +statement of cash flows for the years ended December 31, 2020 and 2019, our reported net loss includes a significant number of non-cash +charges of $29,325,236 and $11,435,682, respectively. A summary of these non-cash charges is as follows: +For the Year Ended +December 31, +2020 +2019 +Loss on extinguishment of debt +$ 18,706,488 +$ - +Interest expense – debt discount +7,251,365 +3,709,993 +Stock-based compensation +1,105,688 +1,583,991 +Depreciation and amortization +727,373 +3,465,091 +Impairment of property and equipment +1,525,316 +4,315,856 +Accretion of original issue discount on notes receivable – related party +21,998 +(2,277,777 ) +Accretion of original issue discount on notes receivable +(61,834 ) +- +Fair value in excess of proceeds upon issuance of warrants +- +1,763,481 +Change in fair value of warrant liability +48,842 +(1,124,953 ) +Non-cash items included in net loss +$ +29,352,236 +$ 11,435,682 +Other comprehensive loss +Other comprehensive loss was $28,952,560 and $34,538,451, respectively, +for the years ended December 31, 2020 and 2019. Other comprehensive income for the year ended December 31, 2020, which increased our equity, +was primarily due to unrealized gains in the warrant derivative securities that we received as a result of our investment in Avalanche +International, Corp., or AVLP, a related party, and from fluctuations in exchange rates between the U.S. dollar and the Israeli Shekel. +During the year ended December 31, 2019, unrealized losses in the warrant derivative securities of AVLP was the primary component of other +comprehensive loss. +LIQUIDITY AND CAPITAL RESOURCES +On December 31, 2020, we had +cash and cash equivalents of $18,679,848. This compares with cash and cash equivalents of $483,383 at December 31, 2019. The increase +in cash and cash equivalents was primarily due to cash provided by financing activities with the remaining variance attributed to fluctuations +in exchange rates between the U.S. dollar and the Israeli Shekel. +Net cash used in continuing operating activities totaled $11,182,225 +for the year ended December 31, 2020, compared to $10,262,733 for the year ended December 31, 2019. The most significant change was a +decrease in cash provided from payments on accounts receivable, related party. During April 2019, we received a payment $2,676,219 and +no such payments were received during the year ended December 30, 2020. Cash flow from operating activities during the year ended December +31, 2020 benefited from improved operating results compared to the prior year period, including improved gross margins from ceasing the +negative margin cryptocurrency mining operations and lower general and administrative expenses from lower third-party fees and travel +related costs. +Net cash used in investing activities was $7,783,215 for the year ended +December 31, 2020, compared to $2,851,055 for the year ended December 31, 2019. The increase of the net usage of cash from investing activities +was primarily attributed to $3,627,534 cash used for the acquisition of Relec, net of cash acquired, $2,118,411 related party investments +in AVLP and Alzamend, and $1,425,341 related to the purchase of marketable equity securities. +Net cash provided by financing +activities was $37,283,639 and $12,925,203 for the year ended December 31, 2020 and 2019, respectively. Net cash provided by financing +activities for the year ended December 31, 2020, primarily related to net proceeds from the sale of shares of common stock through our +at-the-market offerings, net proceeds from our debt financings, partially offset by net payments related to advances on future receipts. +Net cash provided by financing activities for the year ended December 31, 2019, primarily related to net proceeds from the sale of shares +of common stock through our at-the-market offering, partially offset by net payments related to our debt financings and advances on future +receipts. +Historically, we have financed +our operations principally through issuances of convertible debt, promissory notes and equity securities. During 2020, as reflected below, +we continued to successfully obtain additional equity and debt financing and in restructuring existing debt. +· On February 10, 2020, we entered into a Master Exchange Agreement with Esousa, +which acquired approximately $4.2 million dollars in principal amount from previous noteholders, plus accrued but unpaid interest, of +certain promissory notes that had been previously issued by us. Esousa also agreed to purchase additional notes and during the three months +ended September 30, 2020, Esousa acquired $2,240,015 in principal amount, plus accrued but unpaid interest, of certain additional promissory +notes that had been previously issued by us (collectively, the “ Notes ”). Pursuant to the Master Exchange Agreement, +Esousa has the unilateral right to acquire shares of the Company’s common stock in exchange for the Notes . +63 +· Between +August 2020 and September 2020, the Company received $2,850,000 in loans from Esousa pursuant +to which the Company agreed to issue unsecured short-term promissory notes with interest +rates of 13% and 14%. Pursuant to these loans, and an additional loan of $350,000 received +during October 2020, we issued two unsecured promissory notes in the aggregate principal +face amount of $1,200,000 with an interest rate of 14% and issued a promissory note in the +principal face amount of $2,000,000 with an interest rate of 13%. +· On +October 2, 2020, the Company entered into an At-The-Market Issuance Sales Agreement (the +“2020 Sales Agreement”) with Ascendiant Capital Markets, LLC to sell shares of +its common stock having an aggregate offering price of up to $8,975,000 from time to time, +through an “at the market offering” program (the “2020 ATM Offering”). +On December 1, 2020, the Company filed an amendment to the prospectus supplement with the +SEC to increase the amount of common stock that may be offered and sold in the 2020 ATM Offering, +as amended under the Sales Agreement to $40,000,000 in the aggregate, inclusive of the up +to $8,975,000 in shares of common stock previously sold in the 2020 ATM Offering. The offer +and sale of shares of common stock from the 2020 ATM Offering was made pursuant to our effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus +contained therein (Registration Statement No. 333-222132) which became effective on January +11, 2018. Through December 31, 2020, the Company had received gross proceeds of $39,978,350 +through the sale of 12,582,000 shares of common stock from the 2020 ATM Offering. The 2020 +ATM Offering was terminated on December 31, 2020. +· On +January 22, 2021, the Company entered into an At-The-Market Issuance Sales Agreement (the +“2021 Sales Agreement”), with Ascendiant Capital Markets, LLC, or the sales agent, +relating to the sale of shares of Common Stock offered by a prospectus supplement and the +accompanying prospectus, as amended by the amendment to the 2021 Sales Agreement dated February +16, 2021, or the amended sales agreement. In accordance with the terms of the amended sales +agreement, the Company may offer and sell shares of Common Stock having an aggregate offering +price of up to $125,000,000 from time to time through the sales agent. As of February 22, +2021, the Company had sold an aggregate of 21,561,900 shares of its common stock pursuant +to the sales agreement for gross proceeds of $124,983,305. +The Company believes its current +cash on hand is sufficient to meet its operating and capital requirements for at least the next twelve months from the date the financial +statements for its fiscal year ended December 31, 2020 are issued. +Critical Accounting Policies +Fair value of Financial Instruments +In accordance with ASC No. +820, Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for +the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +The guidance also establishes +a three-tier hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable +inputs by requiring that the most observable inputs be used when available. Observable inputs include those that market participants would +use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable +inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset +or liability. +We assess the inputs used +to measure fair value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in +the market. +The Company’s investments in AVLP, a related party controlled +by Philou, an affiliate of the Company, consist of convertible promissory notes, derivative instruments and shares of AVLP common stock. +As of December 31, 2020, the Company has provided loans to AVLP in the principal amount $11,269,136 and, in addition to the 12% convertible +promissory notes, AVLP has issued to the Company warrants to purchase 22,537,871 shares of AVLP common stock at an exercise price of $0.50 +per share for a period of five years. Management used both a market and income approach to quantify the carrying amount of the convertible +notes, including credit risk. The market approach considered the fair value of AVLP’s common stock adjusted for a lack of marketability +discount and the time value of money based on expectation as to the timing of a potential liquidity event which could affect the timing +of a settlement of the convertible notes. The income approach was primarily based on a discounted cash flow analysis with assumptions +regarding forecasted revenues, operating margins and a risk-adjusted discount rate to compute the net present value of such cash flows. +In determining the revenue +and expense assumptions that were used in the discounted cash flow analysis, the Company considered the disruptive nature of AVLP’s +Multiplex Laser Surface Enhancement (“MLSE”) plasma-laser system, the size of the market for the treatment of textiles, customer +demand, existing treatment methods, the performance capabilities of the MLSE system and the risk of business execution and the adoption +of AVLP’s disruptive technology. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller reporting +company, this section is not applicable. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements required +by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not required to provide +supplementary financial information. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2020, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +64 +Based upon that evaluation, our principal executive officer and principal +financial officer, with the assistance of other members of the Company's management, have evaluated the effectiveness of the design and +operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) +as of the end of the period covered by this annual report and has determined that our disclosure controls and procedures were not effective +due to the material weakness as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records +that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide +reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2020. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) in Internal +Control-Integrated 2013 Framework. Our management has concluded that, as of December 31, 2020, our internal control over financial reporting +was not effective. +A material weakness is a control +deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control +deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will +not be prevented or detected. Management has identified the following material weakness: +1. +We do not have sufficient resources in our accounting function, which +restricts our ability to gather, analyze and properly review information related to financial reporting, including applying complex accounting +principles relating to consolidation accounting and fair value estimates, in a timely manner. In addition, due to our size and nature, +segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, +the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management +evaluated the impact of our failure to have segregation of duties during our assessment of our disclosure controls and procedures and +concluded that the control deficiency that resulted represented a material weakness. +Changes in Internal Controls over Financial +Reporting +Management, with the participation +of our Chief Executive Officer and Chief Financial Officer, has assessed whether any changes in our internal control over financial reporting +that occurred during the year ended December 31, 2020 have materially affected, or are reasonably likely to materially affect, our internal +control over financial reporting. Significant changes were implemented and tested during the latter half of fiscal 2020 through the date +of this report to remediate our material weaknesses in internal control over financial reporting. Management believes that such measures +we have implemented to remediate the material weaknesses in our disclosure controls and procedures and internal control over financial +reporting have had a favorable impact on our internal control over financial reporting. Changes in our internal control over financial +reporting through the date of this report that have materially affected, or are reasonably likely to materially affect, our internal control +over financial reporting are described below. +65 +Material Weaknesses Remediated +at December 31, 2020: +1. Control activities related to the timely communication of information necessary to properly record transactions. +We did not have adequate controls to ensure that information necessary to properly record transactions was adequately communicated on +a timely basis from non-financial personnel to those responsible for financial reporting. +2. Control activities related to general information technology (“IT”) controls over certain +information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets. Specifically, we the +design and implement program change management controls for certain financially relevant systems to ensure that IT program and data changes +affecting the Company’s (i) financial IT applications, (ii) digital currency mining equipment, (iii) digital currency hardware wallets, +and (iv) underlying accounting records, are identified, tested, authorized and implemented appropriately. +Planned Remediation +Management, in coordination with the input, oversight +and support of our Audit Committee, has identified the measures below to strengthen our control environment and internal control over +financial reporting. +On +August 19, 2020, Mr. Horne resigned as our Chief Financial Officer and was appointed our President, and later became our Chief Executive +Officer. Mr. Cragun, who had served as the Company’s Chief Accounting Officer since October 1, 2018, succeeded Mr. Horne as the +Chief Financial Officer of the Company. In January 2018, we engaged the services of a financial accounting advisory firm. In January 2019, +we hired a Senior Vice President of Finance. In May 2019, we hired an Executive Vice President and General Counsel, who later became our +President and General Counsel. Finally, in January 2021, we hired a Director of Reporting. These individuals were tasked with expanding +and monitoring the Company’s internal controls, to provide an additional level of review of complex financial issues and to assist +with financial reporting. On October 7, 2019, we created an Executive Committee which is currently comprised of our Executive Chairman, +Chief Executive Officer and President. The Executive Committee meets on a daily basis to address the Company’s critical needs and +provides a forum to approve transactions which are communicated to the Company’s Chief Financial Officer and Senior Vice President +of Finance on a bi-weekly basis by our Chief Executive Officer, who also reviews all of the Company’s material transactions and +reviews the financial performance of each of our subsidiaries. On December 16, 2020, in consultation with the Chairman of the Audit Committee, +we engaged a professional services firm to review management’s assessment of compliance with Section 404 of the Sarbanes-Oxley Act +of 2002 and to identify internal control process improvement opportunities. These changes have improved and simplified our internal processes +and resulted in enhanced controls. While these changes have improved and simplified our internal processes and resulted in enhanced controls, +these enhancements have not been operating for a sufficient period of time for management to conclude, through testing, that these controls +are operating effectively. Further, as we continue to expand our internal accounting department, the Chairman of the Audit Committee shall +perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, and +· reviews all anticipated transactions that are not considered in the ordinary course of business to assist +in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s financial statements. +We +are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the +material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and +procedures. These material weaknesses will not be considered to be remediated until the applicable remediated controls are operating for +a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. +This Annual Report does not +include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. +Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision +under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from +complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +66 +Changes in Internal Control over Financial +Reporting +During the most recent fiscal +quarter 2018 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) +and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over +financial reporting. +ITEM 9B. OTHER INFORMATION. +None +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +The following table sets forth +the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. Ault, III (1) +51 +Executive Chairman of the Board +2017 +William B. Horne (1) +52 +Chief Executive Officer, Vice Chairman and Director +2016 +Henry Nisser (1)(2) +52 +President, General Counsel and Director +2019 +Kenneth S. Cragun (1)(3) +60 +Chief Financial Officer +2020 +Robert O. Smith +76 +Lead Independent Director +2016 +Moti Rosenberg +73 +Director +2015 +Jeffrey A. Bentz +61 +Director +2018 +Jodi Brichan +52 +Director +2019 +Howard Ash (4) +61 +Director +2020 +(1) Executive Officer. +(2) Mr. Nisser was appointed to our Board of Directors on September 17, 2020. +(3) Mr. Cragun was appointed as our Chief Financial Officer on August 20, 2020. +(4) Mr. Ash was appointed to our Board of Directors on August 13, 2020. +Each of the directors named +above will serve until the next annual meeting of our stockholders or until his respective successor is elected and qualified. Subject +to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Mr. Milton C. Ault, III +On January 19, 2021, Mr. Ault resigned as Chief +Executive Officer and was appointed as the Executive Chairman of the board of directors. On December 28, 2017, Mr. Ault was appointed +Chief Executive Officer. On March 16, 2017, Mr. Ault was appointed Executive Chairman of the board of directors. Mr. Ault entered into +an employment agreement with us on June 17, 2018. Mr. Ault is a seasoned business professional and entrepreneur who has spent more than +twenty-seven years identifying value in various financial markets including equities, fixed income, commodities, and real estate. On February +25, 2016, Mr. Ault founded Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s +Disease and has served as its Chairman ever since. Mr. Ault has served as Chairman of Ault & Company, Inc., a Delaware holding company, +since December 2015, and as Chairman of Avalanche International Corp., a publicly traded Nevada company and a “voluntary filer,” +which as such is not required to file periodic reports, since September 2014. Since January 2011, Mr. Ault has been the Vice President +of Business Development for MCKEA Holdings, LLC, a family office. Throughout his career, Mr. Ault has consulted for a few publicly traded +and privately held companies, providing each of them the benefit of his diversified experience, that range from development stage to seasoned +businesses. We believe that Mr. Ault’s business background demonstrates he has the qualifications to serve as one of our directors +and as Executive Chairman. +67 +William B. Horne +Mr. Horne has served as a member of our board +of directors since October 2016. On January 19, 2021, Mr. Horne resigned as President and was appointed as the Chief Executive Officer. +On August 19, 2020, Mr. Horne resigned as our Chief Financial Officer and was appointed as our President. He was appointed as our Chief +Financial Officer on January 25, 2018. Prior to his appointment as our Chief Financial Officer, Mr. Horne served as one of our independent +directors. He served as the Chief Financial Officer of Targeted Medical Pharma, Inc. (OTCBB: TRGM) from August 2013 to May 2019. Mr. Horne +is a director and Chief Financial Officer of Avalanche International, Corp., a “voluntary filer” under the Exchange Act. Mr. +Horne has served on the board of directors of Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention +and cure for Alzheimer’s Disease, since June 1, 2016. Mr. Horne previously held the position of Chief Financial Officer in various +public and private companies in the healthcare and high-tech field. Mr. Horne has a Bachelor of Arts Magna Cum Laude in Accounting from +Seattle University. We believe that Mr. Horne's extensive financial and accounting experience in diversified industries and with companies +involving complex transactions give him the qualifications and skills to serve as one of our directors. +Henry Nisser +Mr. Nisser has served as a member of our board +of directors since September 17, 2020 and was appointed as our Executive Vice President and General counsel on May 1, 2019. On January +19, 2021, Mr. Nisser resigned as Executive Vice President and was appointed as the President. Mr. Nisser is the Executive Vice President +and General Counsel of Avalanche International, Corp., a “voluntary filer” under the Exchange Act. Mr. Nisser has served on +the board of directors of Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s +Disease, since September 1, 2020 and has served as its Executive Vice President and General Counsel since May 1, 2019. From October 31, +2011 through April 26, 2019, Mr. Nisser was an associate and subsequently a partner with Sichenzia Ross Ference LLP (“SRF”), +a law firm based in New York City. While with SRF, his practice was concentrated in national and international corporate law, with a particular +focus on U.S. securities compliance, public as well as private M&A, equity and debt financings and corporate governance. Mr. Nisser +drafted and negotiated a variety of agreements related to reorganizations, share and asset purchases, indentures, public and private offerings, +tender offers and going private transactions. Mr. Nisser also represented clients’ special committees established to evaluate M&A +transactions and advised such committees’ members with respect to their fiduciary duties. Mr. Nisser is fluent in French and Swedish +as well as conversant in Italian. Mr. Nisser received his B.A. from Connecticut College in 1992, where he majored in International Relations +and Economics. He received his LLB from the University of Buckingham School of Law in 1999. We believe that Mr. Nisser’s extensive +legal experience involving complex transactions and comprehensive knowledge of securities laws and corporate governance requirements applicable +to listed companies give him the qualifications and skills to serve as one of our directors. +Kenneth S. Cragun +Mr. Cragun was appointed as our Chief Financial +Officer on August 19, 2020. Prior to his appointment as Chief Financial Officer, Mr. Cragun served as our Chief Accounting Officer since +October 1, 2018. Mr. Cragun has been the Chief Financial Officer of Alzamend Neuro, Inc., a development stage entity seeking to prevent, +treat and cure Alzheimer’s Disease, since October of 2018. He served as a CFO Partner at Hardesty, LLC, a national executive services +firm since October 2016. His assignments at Hardesty included serving as CFO of CorVel Corporation, a $1.1 billion market cap publicly +traded company (NASDAQ: CRVL) and a nationwide leader in technology driven, healthcare-related, risk management programs and of RISA Tech, +Inc. a private structural design and optimization software company. Mr. Cragun was also CFO of two NASDAQ-listed companies, Local Corporation, +from April 2009 to September 2016, which operated Local.com, a U.S. top 100 website, and Modtech Holdings, Inc., from June 2006 to March +2009, a supplier of modular buildings. Prior thereto, he had financial leadership roles with increasing responsibilities at MIVA, Inc., +ImproveNet, Inc., NetCharge Inc., C-Cube Microsystems, Inc, and 3-Com Corporation. Mr. Cragun serves on the Board of Directors and Chairman +of the Audit Committee of Verb Technology Company, Inc. (NASDAQ: VERB). Mr. Cragun began his professional career at Deloitte. Mr. Cragun +holds a Bachelor of Science degree in accounting from Colorado State University-Pueblo. Mr. Cragun’s industry experience is vast, +with extensive experience in fast-growth environments and building teams in more than 20 countries. Mr. Cragun has led multiple financing +transactions, including IPOs, PIPEs, convertible debt, term loans and lines of credit. +Robert O. Smith +Mr. Smith serves as one of our independent directors. +Previously, he served as a member of our board of directors from November 2010 until May 2015, and served as a member of our Advisory +Board from 2002 until 2015. He is currently a C-level executive consultant working with Bay Area high-tech firms on various strategic +initiatives in all aspects of their business. From 2004 to 2007, he served on the Board of Directors of Castelle Corporation. From 1990 +to 2002, he was our President, Chief Executive Officer and Chairman of our board of directors. From 1980 to 1990, he held several management +positions with Computer Products, Inc., the most recent being President of their Compower/Boschert Division. From 1970 to 1980, he held +managerial accounting positions with Ametek/Lamb Electric and with the JM Smucker Company. Mr. Smith received his BBA degree in Accounting +from Ohio University. We believe that Mr. Smith’s executive-level experience, including his previous service as our President, Chief +Executive Officer and Chairman of our board of directors, his extensive experience in the accounting industry, and his service on our +Board from November 2010 until May 2015, give him the qualifications and skills to serve as one of our directors. +68 +Mordechai Rosenberg +Mr. Rosenberg serves as one of our independent +directors. He has served as an independent consultant to various companies in the design and implementation of homeland security systems +in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate Ltd., a manufacturer of armor protection +systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg was the general manager +of ZIV U.P.V.C Products Ltd.’s doors and window factory. Mr. Rosenberg is an active reserve officer and a retired colonel from the +Israeli Defense Force (IDF), where he served for 26 years and was involved in the development of weapon systems. In the IDF, Mr. Rosenberg +served in various capacities, including, company, battalion and brigade commander, head of the training center for all IDF infantry, and +head of the Air Force’s Special Forces. Mr. Rosenberg received a B.A in History from the University of Tel Aviv and a Master of +Arts in Political Science from the University of Haifa in Israel. Mr. Rosenberg graduated from the course of Directors & Officers +at the College of Management, Tel Aviv. We believe that Mr. Rosenberg’s business background give him the qualifications to serve +as one of our directors. +Jeffrey Bentz +Mr. Bentz serves as one of our independent directors. +Mr. Bentz is an experienced businessman who has served since 1994 as President of North Star Terminal & Stevedore Company, a full-service +stevedoring company located in Alaska and whose major areas of business include terminal operations and management, stevedore services, +and heavy equipment operations. He also has served as a director and advisor to several private companies and agencies. Mr. Bentz obtained +a B.A. in Business and Finance from Western Washington University in 1981. We believe that Mr. Bentz’s executive-level experience, +including his operational and financial oversight of companies with multiple profit centers and his extensive experience in the real estate +and commercial services industries give him the qualifications and skills to serve as one of our directors. +Jodi Brichan +Ms. Brichan serves as one of our independent directors. +Ms. Brichan has more than 25 years of experience in product commercialization, clinical research, marketing communications, sales planning +and product launches. From February through November of 2020, Ms. Brichan served as the Chief Growth Officer of Greater Than One, Inc., +a San Francisco-based media company. From January through September of 2019, Ms. Brichan served as the Chief Executive Officer of AdvaVet, +Inc., a wholly-owned subsidiary of Oasmia Pharmaceutical AB, a Sweden-based pharmaceutical company engaged in the field of human and veterinary +oncology. From 2008 to 2016, Ms. Brichan held senior positions with Omnicom Health Group, a global healthcare marketing and communications +company, including acting as Global Client Leader and as a Senior Vice President. From 2003 through 2008, Ms. Brichan held senior management +positions with Publicis Health, a healthcare communications network, including as SVP of Client Services. Currently, she serves as a consultant +to companies in the life sciences, biotechnology, pharmaceutical and device industries and is a board member of the Healthcare Businesswomen's +Association in San Francisco, California. Ms. Brichan brings significant experience in building businesses, diverse healthcare background, +and history of successful product launches and award-winning advertising campaigns. We believe that Ms. Brichan’s business background +gives her the qualifications to serve as one of our directors. +Howard Ash +Mr. Ash serves as one of our independent directors. +Mr. Ash is an accomplished executive with extensive experience in business and finance, who served as CEO, COO and CFO to a variety of +high profile, international companies. Mr. Ash continues to serve as Chairman of Claridge Management since 2000. Mr. Ash was a director +of Net Element, Inc. (NASDAQ-NETE) from June 13, 2016 through July 13, 2020, serving as Chairman of both the Audit and Compensation committees, +as well as the Nominating and Governance Committees during his tenure. He served as Chief Operating Officer of BioCard Corporation from +1997 to 2007. He served as Chief Operating Officer of CITA Americas, Inc. from 1996 to 1997. Mr. Ash served as Chief Executive Officer +of IEDC Marketing, Inc. from 1992 to 1996. He held a CFO/Chief Strategist position at Abrams, Ash & Associates from 1990 to 1992. +Mr. Ash currently serves on the Advisory Board of the UK based E2Exchange, the Institute of Entrepreneurs, since 2011, and is the only +non-UK citizen holding that position. Mr. Ash served from 2009 to 2014 in a senior development and strategic capacity for One Laptop Per +Child, a global NGO created to provide educational opportunities providing laptops to the world’s poorest children. Prior Chairmanships +include the 2009 through 2012 term for the Sturge Weber Foundation, a non-profit organization dedicated to curing this rare but fatal +syndrome affecting children. Previously, Mr. Ash was an Advisory Board Member to Edge Global Investment Limited which forged a strategic +partnership with the Africa Forum, consisting of 37 former Heads of State and Government. Mr. Ash started an interest-free micro-loan +society in 1987 that has provided more than $15 million in micro-loans throughout the United States and Israel. In 1999, Mr. Ash founded +the Circle of Life Resource Center, Inc., a food bank in Miami, Florida that feeds several hundred families per week. Mr. Ash earned a +Bachelor of Commerce degree, with Honors in Accounting and Law from the University of Witwatersrand (South Africa) in 1980. We believe +that Mr. Ash’s extensive experience as a business and finance executive and member of multiple oversight bodies, provides him with +the necessary skills to be qualified to serve as one of our directors. +69 +Corporate Governance +Our Board is currently composed +of eight members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) +the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, +from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters +for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at https://aultglobal.com . +Audit Committee +Messrs. Ash, Smith and Bentz +currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee +satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE American. Our Board has +also determined that Messrs. Ash and Smith qualify as an “audit committee financial expert” as defined in SEC regulations +and satisfies the financial sophistication requirements set forth in the NYSE American Rules. +The Audit Committee is responsible +for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to +be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress +and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to +ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services +rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Bentz and Rosenberg +as well as Ms. Brichan currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members +of the Compensation Committee meets the requirements for independence under the standards of the NYSE American. Mr. Bentz serves as Chairman +of the Compensation Committee. +The Compensation Committee +is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving +salaries, bonuses and other benefits paid to our officers, including our Chief Executive Officer, President and Chief Financial Officer; +and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Ash and Rosenberg, +as well as Ms. Brichan currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of +the current members of the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE +American. Ms. Brichan serves as Chairman of the Nominating and Governance Committee. +The Nominating and Governance +Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees +for each annual meeting of stockholders to the Board; developing and recommending governance principles applicable to our Board; overseeing +the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +The Nominating and Governance +Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based +business and professional skills, experiences and global business and social perspective. +70 +In addition, the Committee +seeks directors who exhibit personal integrity and a concern for the long-term interests of stockholders, as well as those who have time +available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract +and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +Executive Committee +As a holding company, our +business strategy is designed to increase shareholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to shareholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize shareholder value, such as activist trading. We anticipate returning value to shareholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer +Our Executive Committee approves +and manages our trading strategy. The Executive Committee has decades of experience in financial, investing and securities transactions. +Led by our Executive Chairman, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with +a global impact. We also use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making +an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, +from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s Vice Chairman and Chief Executive Officer +and Henry Nisser, the Company’s President and General Counsel, to provide analysis and guidance on all acquisition targets and throughout +the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +Our Executive Committee acts as the underwriting committee for our +subsidiary Digital Power Lending LLC (“DP Lending”) and approves all lending transactions. Under its business model, DP Lending +generates revenue through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income +from appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants +issued to DP Lending in any particular financing. DP Lending’s activities are more fully described elsewhere in this Annual Report; +see page 10. +Involvement in Certain Legal Proceedings +Except as set forth below, +to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former director, +executive officer, or employee: +· been convicted in a criminal proceeding or been +subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +71 +· had any bankruptcy petition filed by or against +the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or +executive officer, either at the time of the bankruptcy filing or within two years prior to that time; +· been subject to any order, judgment, or decree, +not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or +temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, +investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; +· been found by a court of competent jurisdiction +in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities +law, and the judgment has not been reversed, suspended, or vacated; +· been the subject of, or a party to, any federal +or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including +any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or +commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited +to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist +order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business +entity; +· or been the subject of, or a party to, any sanction +or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the +Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, +entity or organization that has disciplinary authority over its members or persons associated with a member. +1. Mr. Ault held series 7, 24, and 63 licenses and managed four domestic hedge funds +and one bond fund from 1998 through 2008. On April 26, 2012, as a result from an investigation by FINRA involving activities during 2008, +Mr. Ault agreed to a settlement with FINRA in which he did not admit to any liability or violation of any laws or regulatory rules and +that included restitution and a suspension from association with a FINRA member firm for a period of 2 years. As part of that settlement, +Mr. Ault agreed that before he would reapply for association with FINRA, if at all, he would make restitution to certain investors. Mr. +Ault was able to speak with and pay restitution to one of the investors, but no others. As a result, Mr. Ault is neither eligible, nor +does he intend, to apply for association with FINRA. +2. On June 23, 2015, Local Corporation, a Delaware corporation, filed a voluntary petition +for reorganization under Chapter 11 of the US Bankruptcy Code. Mr. Cragun, our chief financial officer, was chief financial officer +of Local Corporation at the time of filing. +Except as set forth in our discussion below in +“Certain Relationships and Related Transactions,” none of our directors or executive officers has been involved in any transactions +with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules +and regulations of the SEC. +Family Relationships +There are no family relationships among our directors +and executive officers. +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange +Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities +to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, directors +and ten percent stockholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based solely +upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting persons, we believe that during +the current fiscal year and the year ended December 31, 2020, all such filing requirements applicable to our officers, directors and ten +percent stockholders were fulfilled with the following exception: During the fiscal year of 2020, all of our directors inadvertently filed +one late Form 4 reporting one transaction. +72 +Code of Ethics +We have adopted the Code of +Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller +or person performing similar functions. The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical +conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website +at https://aultglobal.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit +or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request to our President, Amos Kohn, +we will provide without charge, a copy of our Code of Ethical Conduct. +ITEM 11. EXECUTIVE COMPENSATION . +Summary Compensation Table +The following Summary Compensation +Table sets forth all compensation earned in all capacities during the years ended December 31, 2020 and 2019, by our Chief Executive Officer. +Because we are a Smaller Reporting Company, we only have to report information of our Chief Executive Officer and our two other most highly +compensated executive officers. +SUMMARY COMPENSATION TABLE +Name and principal position +Year +Salary ($) +Bonus ($) +Stock Awards ($) (1) +Option +Awards ($) (1) +All Other Compensation ($) (2) +Total ($) +Milton C. Ault, III +2020 +400,000 +200,000 +0 +0 +30,202 +630,202 +Executive Chairman of the Board +2019 +400,000 +0 +0 +0 +18,832 +418,832 +William B. Horne +2020 +300,000 +150,000 +0 +0 +45,164 +495,164 +Chief Executive Officer +2019 +300,000 +10,000 +0 +0 +17,856 +327,856 +Amos Kohn +2020 +350,000 +0 +0 +0 +30,247 +380,247 +President +2019 +350,000 +0 +0 +0 +47,902 +397,902 +Henry C. Nisser +2020 +225,000 +100,000 +0 +0 +11,825 +336,825 +President and General Counsel (3) +2019 +133,333 +50,000 +0 +0 +5,807 +189,140 +Kenneth S. Cragun +2020 +200,000 +25,000 +0 +0 +21,398 +246,398 +Chief Financial Officer (4) +(1) The values reported in the “Stock Awards” and “Option Awards” columns represent the aggregate grant date fair +value, computed in accordance with Accounting Standards Codification (“ ASC ”) 718 Share Based Payments , of +grants of stock options and stock awards to our named executive officer in the years shown. +(2) The amounts in “All Other Compensation” consist of health insurance benefits, vehicle allowance, long-term and short-term +disability insurance benefits, and 401K matching amounts. +(3) Mr. Nisser was appointed as our General Counsel and Executive Vice President on May 1, 2019. Effective October 1, 2020, Mr. Nisser’s +salary was increased to $300,000 per annum. +(4) Mr. Cragun was appointed as our Chief Financial Officer on August 20, 2020. Mr. Cragun’s compensation reflects total amount +paid for the full year as Mr. Cragun was our Chief Accounting Officer prior to his appointment as Chief Financial Officer. +Employment Agreement with Milton C. Ault, III +On +June 17, 2018, the Company entered into a ten year executive employment agreement with Milton C. Ault, III, to serve as Chief Executive +Officer of the Company. For his services, Mr. Ault will be paid a base salary of $400,000 per annum (the “Base Salary”). +73 +Pursuant +to the terms and subject to the conditions set forth in the agreement, if the Company meets or exceeds criteria adopted by the Company’s +compensation committee (the “Compensation Committee”) for earning bonuses which shall be adopted by the Compensation Committee +annually, Mr. Ault shall be eligible to receive an annual bonus, which percentage shall be based on achievement of applicable performance +goals determined by the Compensation Committee. +Further, +Mr. Ault is entitled to receive equity participation as follows: a grant of restricted stock in the aggregate amount of 1,250 shares of +common stock, which shares shall vest ratably over 48 months beginning on January 1, 2020, provided, however, that such shares may, in +whole or in part, in the discretion of the Compensation Committee, vest immediately upon the filing of an Annual Report on Form 10-K with +the Securities and Exchange Commission (the “SEC”) that shows that the Company’s revenues for the applicable fiscal +year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates any such vesting, the Company’s +Compensation Committee must prior thereto have obtained the consent of Mr. Ault, which consent may be withheld in his discretion. +In +addition, Mr. Ault shall be eligible to receive a performance-based award (the “CEO Performance Award”), provided that the +Company, for any given fiscal year during the term of this agreement, meets the following criteria: (A) an increase in revenue, as calculated +under GAAP over the previous fiscal year as reported in the Annual Report on Form 10-K or successor form for such fiscal year; provided +that any increase less than thirty-five percent (35%) (the “Revenue Percentage”) shall reduce the CEO Performance Award correspondingly; +(B) positive net income, as calculated under GAAP, as reported in the Annual Report on Form 10-K or successor form for such fiscal year, +provided that any increase less than five percent (5%) (the “Net Income Percentage”) shall reduce the CEO Performance Award +correspondingly; and (C) positive net cash flow from operations on a year-to-year basis, where cash flow is defined as the net amount +of cash and cash-equivalents being transferred into and out of the Company. The CEO Performance Award shall consist of a number of shares +of the Company’s common stock having a maximum value equal to ten percent (10%) of any appreciation in the Company’s Market +Capitalization above the High Water Mark (as such terms are defined in the agreement) as measured by the daily average closing bid price +of the Company’s common stock for the applicable fiscal year subject to proration obtained by the product of Revenue Percentage +and the Net Income Percentage. If the CEO Performance Award in a fiscal year is less than ten percent (10%) due to a reduction caused +by an annual shortfall in either the Revenue Percentage or the Net Income Percentage, the prior year’s targets would be deemed to +have been achieved if a corresponding overage in a subsequent fiscal year results in the achievement of the cumulative targets. +The annual and cumulative targets for revenue and net income, which are provided solely for the purpose of establishing cumulative totals, +are set forth in the agreement. +Upon +termination of Mr. Ault’s employment (other than upon the expiration of the employment), Mr. Ault shall be entitled to receive: +(A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued +but unused vacation time. +Further, +unless Mr. Ault’s employment is terminated as a result of his death or disability or for cause or he terminates his employment without +good reason, then upon the termination or non-renewal of Mr. Ault’s employment, the Company shall pay to Mr. Ault a “Separation +Payment” as follows: (A) an amount equal to four (4) weeks of base salary for each full year of service and +credit for his service commencing from September 22, 2016, (B) should Mr. Ault provide the Company with a separation, waiver and release +agreement within 60 days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “Separation +Period”) of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may +be, but in no event an amount greater than the Base Salary payable should either such period expire within two years, or (2) the 12-month +period commencing on the date Mr. Ault is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, +dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum +annual bonus as Mr. Ault would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar +months worked including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options +and other equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence +of a change in control, Mr. Ault will be paid an amount equal to the greater of: (i) five times his then current Base Salary or (ii) the +Separation Payment amount set forth above, without regard to whether Mr. Ault continues in the employ of the Company or its successor. +74 +Employment agreement with William B. Horne +On January 25, 2018, we entered +into a five-year employment agreement with William Horne to serve as Chief Financial Officer and Executive Vice President of the Company +and its subsidiaries. For his services, Mr. Horne will be paid a base salary of $250,000 per annum. Upon signing of the employment +agreement, Mr. Horne is entitled to a signing bonus in the amount of $25,000. In addition, Mr. Horne shall be eligible to receive +an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by +the Company’s compensation committee. +Further, +Mr. Horne is entitled to receive equity participation as follows: a grant of restricted stock in the aggregate amount of 1,250 shares +of common stock, which shares shall vest in installments of two hundred fifty (250) shares annually over five (5) years beginning on January +1, 2019, provided, however, that such shares may, in whole or in part, in the discretion of the Compensation Committee, vest immediately +upon the filing of an Annual Report on Form 10-K with the SEC that shows that the Company’s revenues for the applicable fiscal +year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates any such vesting, the Company’s +Compensation Committee must prior thereto have obtained the consent of Mr. Horne, which consent may be withheld in his discretion. +Upon +termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to receive: +(i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and (iii) any accrued +but unused vacation time. +Further, +unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne a “Separation +Payment” as follows: (A) an amount equal to four weeks of base salary for each full year of service, (B) should +Mr. Horne provide the Company with a separation, waiver and release agreement within 60 days of termination, then the Company shall: +(i) pay his base salary until the last to occur (the “Separation Period”) of (1) the expiration of the remaining portion of +the initial term or the then applicable renewal term, as the case may be, or (2) the 12-month period commencing on the date Mr. Horne +is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life +insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Horne would have been +otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the entire +month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity awards shall immediately +vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will +be paid an amount equal to four times his Separation Payment. +Employment Agreement with Henry Nisser +On April 12, 2019, the Company +entered into a four-year employment agreement (the “Agreement”) with Henry Nisser to serve as General Counsel and Executive +Vice President of the DPW Holdings, Inc. (the “Company”) and its subsidiaries. The effective date of the Agreement is May +1, 2019. Pursuant to the Agreement, Mr. Nisser will be paid a base salary of $200,000 per annum (the “Base Salary”). +Upon the effective date of +the Agreement, Mr. Nisser is entitled to a signing bonus in the amount of $50,000, with $25,000 being payable upon the effective date +and $25,000 being payable no later than September 1, 2019. In addition, Mr. Nisser shall be eligible to receive an annual cash bonus equal +to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s compensation +committee, which bonus shall not exceed 300% of the Base Salary. +Further, Mr. Nisser is entitled +to receive equity participation as follows: (A) a grant of restricted stock in the aggregate amount of 250,000 shares of common stock, +which shares shall vest ratably over 48 months beginning with the first month after the effective date, and (B) an option to purchase +200,000 shares of common stock at a per share exercise price equal to the closing market price on the effective date, which option shall +have a term of seven (7) years. +Mr. Nisser’s bonuses, +if any, and all stock based compensation shall be subject to “Company Clawback Rights” if during the period that Mr. Nisser +is employed by the Company and upon the termination of Mr. Nisser’s employment and for a period of two years thereafter, there is +a restatement of any of the Company’s financial results from which any bonuses and stock based compensation to Mr. Nisser shall +have been determined. +75 +Upon termination of Mr. Nisser’s +employment (other than upon the expiration of the employment), Mr. Nisser shall be entitled to receive: (A) any earned but unpaid base +salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued but unused vacation time. +Further, +unless Mr. Nisser’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Nisser’s employment, the Company shall pay to Mr. Nisser a +“Separation Payment” as follows: (a) an amount equal to four weeks of base salary for each full year of service, (b) commencing +on the date that shall be one (1) year from the effective date, should Mr. Nisser provide the Company with a separation, waiver and release +agreement within 30 days of termination, then the Company shall pay to Mr. Nisser the Base Salary (in effect immediately prior to the +termination date) an amount equal to the lesser of what Mr. Nisser would have received if the employment period ended after (1) the expiration +of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or (2) the 18-month period commencing +on the date Executive is terminated, payable in one lump sum; (ii) provide during the separation period the same medical, dental, long-term +disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. +Nisser would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked +including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other +equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change +in control, Mr. Nisser will be paid an amount equal to four times his Separation Payment. +Advisory Vote on Executive Compensation +At the annual meeting of stockholders +on July 2, 2019, the stockholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. +In addition, stockholders voted, on an advisory basis, that an advisory vote on executive compensation should be held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding equity awards +as of December 31, 2020 to the Named Executive Officer. +OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2020 +OPTION AWARDS +Name +Number of +Securities +Underlying +Unexercised +Options (#) +Exercisable +Number of +Securities +Underlying +Unexercised +Options (#) +Unexercisable +Equity Incentive Plan +Awards: Number of +Securities Underlying +Unexercised +Unearned Options (#) +Option +Exercise +Price ($) +Option +Expiration +Date +Milton C. Ault III +— +— +— +— +— +William B. Horne +— +— +— +— +— +Amos Kohn +— +— +— +— +— +Henry C. Nisser +— +— +— +— +— +Kenneth S. Cragun +— +— +— +— +— +Director Compensation +Beginning July 1, 2019, the +Company pays each independent director an annual base amount of $35,000 annually, other than Mr. Smith, who will receive a base amount +of $45,000 annually due to anticipated additional services to be provided by Mr. Smith as a lead independent director and Mr. Ash, who +will receive a base amount of $45,000 annually due to anticipated additional services provided by Mr. Ash as Audit Committee Chairman. +Additionally, our Board makes recommendations for adjustments to an independent director’s compensation when the level of services +provided are significantly above what was anticipated. +76 +The table below sets forth, +for each non-employee director, the total amount of compensation related to his or her service during the year ended December 31, 2020: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($) +Total ($) +Robert O. Smith +70,000 +— +— +— +70,000 +Jeffrey A. Bentz +60,000 +— +— +— +60,000 +Mordechai Rosenberg +60,000 +— +— +— +60,000 +Jodi Brichan +55,000 +— +— +— +55,000 +Howard Ash (1) +38,750 +— +— +— +38,750 +(1) Mr. Ash was appointed as an independent director on August 13, 2020 and earned compensation from that +date. +On December 28, 2018, the +stockholders approved the 2018 Stock Incentive Plan (as amended on May 5, 2019), which amendment was approved by the stockholders on July +19, 2019, the “ 2018 Stock Incentive Plan ”), under which options to acquire up to 12,500, as increased to 175,000 +pursuant to the foregoing amendment thereto, shares of common stock may be granted to the Company's directors, officers, employees and +consultants. The 2018 Stock Incentive Plan is in addition to the Company’s (i) 2017 Stock Incentive Plan (the “ 2017 Plan ”), +under which options to acquire up to 2,500 shares of common stock may be granted to the Company's directors, officers, employees and consultants, +(ii) 2016 Stock Incentive Plan (the “ 2016 Plan ”), under which options to acquire up to 5,000 shares of common stock +may be granted to the Company's directors, officers, employees and consultants, and (ii) 2012 Stock Option Plan, as amended (the “ 2012 +Plan ”), which provides for the issuance of a maximum of 1,716 shares of the Company’s common stock to be offered to the +Company’s directors, officers, employees, and consultants (collectively the “ Plans ”). +The purpose of the Plans is +to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial responsibility +for the direction and management of the Company, as well as certain directors and consultants of the Company, additional incentives to +exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, to reward outstanding +performance and to provide a means to attract and retain persons of outstanding ability to the service of the Company. +As of December 31, 2020, options +to purchase 925 shares of common stock were issued and outstanding, and 6,693 shares are available for future issuance under the Plans. +401(k) Plan +Our subsidiaries, Coolisys +and Microphase, have adopted tax-qualified employee savings and retirement plan, or 401(k) plan, which generally covers all of their full-time +employees. Pursuant to the 401(k) plan, eligible employees may make voluntary contributions to the plan up to a maximum of pursuant to +the current Internal Revenue Code limits. The Microphase 401(k) plan permits, but does not require, matching contributions by them on +behalf of plan participants. The Coolisys 401(k) plan, includes matching contributions at the rate of (1) $1.00 for each $1.00 contributed, +up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary and permits make discretionary +contributions. The 401(k) plans are intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. +Contributions to such a qualified plan are deductible by the Company when made, and neither the contributions nor the income earned on +those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained +in trust. +77 +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. +Except as otherwise indicated +below, the following table sets forth certain information regarding beneficial ownership of our common stock as of March 10, 2021 by (1) +each of our current directors; (2) each of the executive officers; (3) each person known to us to be the beneficial owner of more than +5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and +executive officers as a group. As of March 10, 2021, there were 49,498,676 shares of our common stock issued and outstanding. +Beneficial ownership is determined +in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to +options or warrants that are currently exercisable or exercisable within 60 days of March 10, 2021 are deemed to be outstanding and to +be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of +such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or +group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table have sole voting and sole investment power +with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. Unless otherwise +indicated below, the address of each beneficial owner listed below is c/o Ault Global Holdings, Inc., 11411 Southern Highlands Pkwy, #240, +Las Vegas, NV 89141. +Name and address of beneficial owner +Number of +shares +beneficially +owned +Approximate +percent +of class +Greater than 5% Beneficial Owners: +Philou Ventures, LLC +7,872 (2) +* +P.O. Box 3587 Tustin, CA 92705 +Ault & Company, Inc. +1,362,795 (3) +2.74 % +Directors and Officers: (1) +Milton Ault, III +1,365,255 (4) +2.74 % +William Horne +806 (7) +* +Henry Nisser +4,622 (5) +* +Ken Cragun +0 +* +Robert Smith +54 (6) +* +Mordechai Rosenberg +0 +* +Jeffrey A. Bentz +9 +* +Jodi Brichan +0 +* +Howard Ash +0 +* +All directors and executive officers as a group (nine persons) +1,370,746 +2.75 % +* Less than one percent. +(1) Unless otherwise indicated, the business address of each of the individuals is c/o Ault Global Holdings, +Inc., 11411 Southern Heights Pkwy, Suite240, Las Vegas, NV 89141. +(2) Included 125,000 shares of Series B Preferred Stock that are convertible in 2,232 shares of common stock +and warrants to purchase 2,232 share of common stock that are exercisable within 60 days of March 30, 2021. Also includes 3,408 shares +of common stock. +(3) Includes shares owned by Philou Ventures of which Ault & Company, Inc., is the Manager, 275,862 shares +of common stock issuable upon conversion of a convertible promissory note and warrants to purchase 94 shares of common stock that are +exercisable within 60 days of March 30, 2021. Also includes 1,078,967 shares of common stock. +(4) Mr. Ault is the Chief Executive Officer of Ault & Company, Inc. Includes 7,872 shares owned by Philou +Ventures and 1,354,923 shares owned by Ault & Company which may be deemed beneficially owned by Mr. Ault. Also includes 417 shares +of common stock issuable pursuant to a stock incentive grant and 2,043 shares of common stock. +(5) Includes 4,622 shares of common stock issuable pursuant to a stock incentive grant. +(6) Includes warrants to purchase 54 shares of common stock that are exercisable within 60 days of March 30, +2021. +78 +(7) Includes 806 shares of common stock issuable pursuant to a stock incentive grant. +Equity Compensation Information +The following table summarizes information about +our equity compensation plans as of December 31, 2020. +Number of securities +Number of securities +Weighted- +remaining available for +to be issued +average +future issuance under +upon exercise +exercise price +equity compensation plans +of outstanding +of outstanding +(excluding securities +options, warrants and rights +options, warrants and rights +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation +plans approved by +stockholders (1) +1,322 +$ 440.72 +6,693 +Equity compensation +plans not approved by +stockholders +850,000 +$ 1.79 +- +Total +851,322 +$ 2.71 +6,693 +(1) Includes warrants to purchase 397 shares of common stock at an exercise price of $8.00 per share +of common stock that were issued to Mr. Kohn and approved by the Company’s stockholders in December 2017. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our board of directors, monitors and reviews issues involving potential conflicts of interest +and approves all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of +such transactions that must be approved by our Audit Committee or a special committee of our board of directors include, but are not limited +to any transaction, arrangement, relationship (including any indebtedness) in which: +• the aggregate amount involved is determined to by the Audit Committee to be material; +• we are a participant; and +• any of the following has or will have a direct or indirect interest in the transaction: +• an executive officer, director, or nominee for election as a director; +• a greater than five percent beneficial owner of our common stock; or +• any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our board of directors formed for that purpose applies the standards +for evaluating conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company, Inc. +Ault & Company, Inc. +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of our common stock at a purchase price per share of $1.12, subject to the approval of the +NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, +at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, or up to 19.99% +of our common stock then outstanding. +79 +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, was due +and payable on August 5, 2020. The Note is convertible into shares of our common stock, par value $0.001 per share at a conversion price +of $1.45 per share. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer of Ault & Company, Inc. William +B. Horne, our Chief Executive Officer, Vice Chairman and Director, is also Chief Financial Officer of Ault & Company, Inc. Henry Nisser, +our President, General Counsel and a member of our board of directors, is also the President, General Counsel and a director of Ault & +Company, Inc. +Avalanche International, Corp. +On September 6, 2017, we entered +into a Loan and Security Agreement with Avalanche (as amended, the “ AVLP Loan Agreement ”) with an effective date of +August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility. The AVLP Loan Agreement was recently increased +to up to $15,000,000 and extended to December 31, 2023. +At December 31, 2020, we had +provided Avalanche with $11,269,136 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants +to purchase 22,537,871 shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by +the assets of AVLP. As of December 31, 2020, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2,025,475 +and a provision for loan losses of $3,423,608. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 22,537,871 shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company, Inc., is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive +Chairman of Avalanche. Further, our President, General Counsel and one of our directors, is the Executive Vice President and General Counsel +of Avalanche. +Director Independence +Independent +Audit +Committee +Member +Nominating +and +Governance +Committee +Compensation +Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert Smith +Yes +X +X +Howard Ash +Yes +C +X +Jodi Brichan +Yes +C +X +Jeffrey A. Bentz +Yes +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairperson of committee +X – Member of committee +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. +Marcum LLP serves as our independent +registered public accounting firm for the years ended December 31, 2020 and 2019. Ziv Haft, a BDO Member Firm, serves as the independent +registered public accounting firm of Enertec Systems 2001 Ltd., our wholly-owned subsidiary. +80 +Fees and Services +The following table shows +the aggregate fees billed to us for professional services by Marcum LLP and Ziv Haft for the years ended December 31, 2020 and 2019: +2020 +2019 +Audit Services +$ 896,094 +$ 878,370 +Audit Related Services +— +— +Tax Services +— +— +All Other Services +— +— +Total +$ 896,094 +$ 878,370 +Audit Fee. This +category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years +ended December 31, 2020 and 2019, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2020 +and 2019, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings +or engagements for the relevant years. +Audit-Related Fees. This +category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors +that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under “Audit +Fees,” and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, +internal control-related matters, and audits of employee benefit plans. +Tax Fees . This category +includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax +compliance, tax planning and tax advice. +All Other Fees. This +category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors +that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s +policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related +services, tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our +independent auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance +with such pre-approval. +81 +PART IV +ITEM 15. EXHIBITS +3.1 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series B Convertible Preferred Stock, dated March 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 3.1 thereto. +3.2 +Certification of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.1 thereto. +3.3 +Certificate of Designations of Rights and Preferences of 10% Series A Cumulative Redeemable Perpetual Preferred Stock, dated September 13, 2018. Incorporated herein by reference to the Current Report on Form 8-K filed on September 14, 2018 as Exhibit 3.1 thereto. +3.4 +Certificate of Designations of Rights and Preferences of Series C Convertible Redeemable Preferred Stock, dated February 27, 2019. Incorporated herein by reference to the Current Report on Form 8-K filed on February 28, 2019 as Exhibit 3.1 thereto. +3.5 +Form of Amended & Restated Certificate of Designations of Rights and Preferences of Series C Convertible Preferred Stock. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2020 as Exhibit 3.1 thereto. +3.6 +Bylaws effective as of August 13, 2020. Incorporated by reference to the Current Report on Form 8-K filed on August 14, 2020 as Exhibit 3.1 thereto. +3.7 +Certificate of Ownership and Merger. Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 2.1 thereto. +4.1 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 4.1 thereto. +4.2 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as Exhibit 4.1 thereto. +4.3 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 4.1 thereto. +4.4 +Form of Common Stock Purchase Warrant, dated July 27, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 26, 2017 as Exhibit 4.1 thereto. +4.5 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.1 thereto. +4.6 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.2 thereto. +4.7 +Form of Common Stock Purchase Warrant, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.3 thereto. +4.8 +Form of Common Stock Purchase Warrant, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 4.1 thereto. +4.9 +Common Stock Purchase Warrant issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 4.1 thereto. +4.10 +Convertible Promissory Note issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.2 thereto. +4.11 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 4.1 thereto. +4.12 +Form of Common Stock Purchase Warrant, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 4.1 thereto. +4.13 +Form of Common Stock Purchase Warrant, dated April 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed on April 16, 2018 as Exhibit 4.1 thereto. +4.14 +Form of Series A Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.1 thereto. +4.15 +Form of Series B Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.16 +Form of Series A Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.17 +Form of Series B Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.3 thereto. +4.18 +Form of Underwriter’s Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on April 1, 2019 as Exhibit 4.3 thereto. +4.19 +Form of Common Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K/A filed on April 4, 2019 as Exhibit 4.1 thereto. +4.20 +Form of Convertible Promissory Note, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 4.1 thereto. +4.21 +Form of Warrant, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 4.2 thereto. +82 +Exhibit +Number +Description +4.22 +Form of Warrant, dated as of May 28, 2020. Incorporated by reference to the Current Report on Form 8-K filed on May 29, 2020 as Exhibit 4.3 thereto. +4.23 +Form of Warrant, dated June 26, 2020. Incorporated by reference to the Current Report on Form 8-K filed on June 29, 2020 as Exhibit 4.2 thereto. +4.24 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on July 17, 2020 as Exhibit 4.2 thereto. +4.25 +Form of Warrant, dated October 22, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 23, 2020 as Exhibit 4.2 thereto. +4.26 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.3 thereto. +4.27 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.4 thereto. +4.28 +Form of Warrant issued to Esousa Holdings, LLC, dated November 19, 2020. Incorporated by reference to the Current Report on Form 8-K filed on November 20, 2020 as Exhibit 4.3 thereto. +4.29*** +Description of Capital Stock. +10.1* +2012 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on October 22, 2012 as Exhibit A thereto. +10.2* +2016 Stock Incentive Plan. Incorporated by reference to the Current Report on Form 8-K filed on December 30, 2016 as Exhibit 10.1 thereto. +10.3 +Preferred Stock Purchase Agreement between the Company and Philou Ventures, LLC, dated March 9, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 10.1 thereto. +10.4 +Registration Rights Agreement between the Company and Philou Ventures, LLC. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 10.2 thereto. +10.5 +Loan and Security Agreement between the Company and Avalanche International Corp., dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.1 thereto. +10.6* +2017 Stock Incentive Plan. Incorporated by reference to the Definitive Proxy Statement on Form DEF 14A filed on November 17, 2017 as Appendix E thereto. +10.7 +Trust Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.1 thereto. +10.8 +Tenancy-In-Common Agreement between Coolisys Technologies Inc. and Roni Kohn, dated May 14, 2017. Incorporated by reference to the Current Report on Form 8-K filed on November 22, 2017 as Exhibit 10.2 thereto. +10.9* +Executive Employment Agreement with William Horne, dated January 25, 2018. Incorporated by reference to the Current Report on Form 8-K filed on January 25, 2018 as Exhibit 10.1 thereto. +10.10 +Asset Purchase Agreement between Super Crypto Mining, Inc. and Blockchain Supply & Services Ltd., dated March 8, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2018 as Exhibit 10.1 thereto. +10.11* +Executive Employment Agreement with Milton C. Ault, III, dated June 17, 2018. Incorporated by reference to the Current Report on Form 8-K filed on June 18, 2018 as Exhibit 10.1 thereto. +10.12 +Loan and Security Agreement by and between Avalanche International Corp. and Digital Power Corporation dated September 6, 2017 with an effective date as of August 21, 2017. Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.13 thereto. +10.13 +Convertible Promissory Note dated September 6, 2017 with an effective date as of August 21, 2017 issued by Avalanche International Corp. Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.14 thereto. +10.14 +Common Stock Purchase Warrant dated September 6, 2017 with an effective date as of August 21, 2017 Avalanche International Corp. Incorporated by reference to the Pre-Effective Amendment No. 2 to the Registration Statement on Form S-3 filed on November 1, 2018 as Exhibit 10.15 thereto. +10.15 +Purchase Order, dated March 14, 2018. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2018 as Exhibit 10.1 thereto. +10.16* +Executive Employment Agreement with Henry Nisser dated April 12, 2019. Incorporated by reference to the Current Report on Form 8-K filed on April 16, 2018 as Exhibit 10.1 thereto. +10.17 +2018 Stock Incentive Plan. Incorporated by reference to the Definitive Proxy Statement on Form DEF 14A filed on November 19, 2018 as Appendix B thereto. +10.18 +Form of Securities Purchase Agreement, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 10.1 thereto. +10.19 +Form of Guarantee, dated May 10, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 10.2 thereto. +10.20 +Amendment to MTIX Limited Purchase Order Number 2121. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2020 as Exhibit 10.2 thereto. +10.21 +Amendment No. 2 to At-The-Market Issuance Sales Agreement, dated March 5, 2021, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on March 5, 2021 as Exhibit 10.1 thereto. +83 +Exhibit +Number +Description +21*** +List of subsidiaries. +23.1*** +Consent of Marcum LLP. +23.2*** +Consent of Ziv Haft, BDO member firm. +31.1*** +Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) +31.2*** +Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) +32.1**** +Certification of Chief Executive and Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code +101.INS*** +XBRL Instance +Document +101.SCH*** +XBRL Taxonomy +Extension Schema Document +101.CAL*** +XBRL Taxonomy +Extension Calculation Linkbase Document +101.DEF*** +XBRL Taxonomy +Extension Definition Linkbase Document +101.LAB*** +XBRL Taxonomy +Extension Label Linkbase Document +101.PRE*** +XBRL Taxonomy +Extension Presentation Linkbase Document +* +Indicates management contract or compensatory plan or arrangement. +** +Confidential treatment is being sought for this agreement, which has been filed separately with the SEC. The confidential portions of this Exhibit have been omitted and are marked by asterisks. +*** +Filed herewith. +**** +Furnished herewith. +84 +ITEM 16. FORM 10–K SUMMARY. +None. +85 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) +of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned +thereunto duly authorized. +Dated: April 15, 2021 +AULT GLOBAL HOLDINGS, INC. +By: +/s/ William B. Horne +William B. Horne +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ Kenneth S. Cragun +Kenneth S. Cragun +Chief Financial Officer +(Principal Financial and Accounting Officer) +Pursuant to the requirements of the Securities Exchange +Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +April 15, 2021 +/s/ Milton C. Ault, III +Milton C. Ault, III, Executive Chairman of the Board +April 15, 2021 +/s/ William B. Horne +William B. Horne, Chief Executive Officer and Director +April 15, 2021 +/s/ Henry Nisser +Henry Nisser, President, General Counsel and Director +April 15, 2021 +/s/ Howard Ash +Howard Ash, Director +April 15, 2021 +/s/ Robert O. Smith +Robert O. Smith, Director +April 15, 2021 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, Director +April 15, 2021 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +April 15, 2021 +/s/ Jodi Brichan +Jodi Brichan, Director +86 +ITEM 8. FINANCIAL STATEMENTS +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Reports of Independent Registered Public Accounting Firm – Marcum LLP +F-2 +- F-3 +Report of Independent Registered Public Accounting Firm – Ziv Haft. +F-4 - F-5 +Consolidated Balance Sheets as of December 31, 2020 and 2019 +F-6 - F-7 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2020 and 2019 +F-8 +Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2020 and 2019 +F-9 - F-10 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2020 and 2019 +F-11 - F-12 +Notes to Consolidated Financial Statements +F-13 - F-64 +F- 1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Shareholders and Board of Directors of +Ault Global Holdings, Inc. and +Subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated +balance sheets of Ault Global Holdings, Inc. (formerly known as DPW Holdings, Inc.) and Subsidiaries (the “Company”) as of +December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity +and cash flows for each of the two years in the period ended December 31, 2020, and the related notes (collectively referred to as the +“financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial +position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the two years +in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. +We did not audit the December 31, 2020 and 2019 +financial statements of Enertec Systems 2001 Ltd., a wholly-owned subsidiary, which statements reflect 18 percent and 28 percent of the +total consolidated assets as of December 31, 2020 and 2019, respectively and 39 percent and 33 percent of total consolidated revenues +for the years ended December 31, 2020 and 2019, respectively. Those statements were audited by other auditors whose report has been furnished +to us, and our opinion, insofar as it relates to the amounts included for Enertec Systems 2001 Ltd., is based solely on the report of +the other auditors. +Basis for Opinion +These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. +We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and +are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules +and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the +standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial +statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged +to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding +of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s +internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below +are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to +the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our +especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion +on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions +on the critical audit matters or on the accounts or disclosures to which they relate. +The accompanying notes are an integral part of these consolidated financial statements. +F- 2 +Description of the Matter +As described in Notes 3 and 10 to the consolidated +financial statements, the Company has made investments in Avalanche International Corp. (“AVLP”), a related party controlled +by Philou Ventures, LLC, which is an entity affiliated with the Company by common ownership through Milton C. Ault, III who is the Company’s +Executive Chairman of the Board. These investments include convertible notes with a net carrying amount of approximately $9.9 million, +warrants to purchase up to 22.5 million shares of common stock with a carrying amount of approximately $4.9 million and 999,175 shares +of common stock with a carrying amount of approximately $500,000. The aggregate carrying amount of these investments amounted to approximately +$15.3 million at December 31, 2020 and required management to make subjective and complex judgments relating to the fair value of these +securities and credit risk with respect to the convertible notes. Changes in these estimates, including conditions that affect credit +risk, could have a significant impact on the Company’s consolidated financial statements. +We identified the Company’s investments +in AVLP as a critical audit matter because that entity has undertaken a plan to commercialize a new textile manufacturing technology. +The Company also has entered into an agreement with AVLP to provide contract manufacturing services relating the production of this machinery. +Management exercised significant judgment in determining the carrying amounts of the AVLP notes and warrants including the application +of fair value measurements and evaluating credit risk. The Company exercised these judgments within the context of AVLP being a related +party that is both a debtor to the Company and customer with a trade relationship. Management used both a market and income approach +to quantify the carrying amount of the convertible notes, including credit risk. Significant assumptions used by management in applying +the market approach include the fair value of AVLP’s common stock adjusted for a lack of marketability discount and the time value +of money based on management’s expectation as to when there may be a liquidity event which could affect the timing of a settlement +of the convertible notes. The income approach included the use of a discounted cash flow analysis with assumptions regarding forecasted +revenues, operating margins and a risk-adjusted discount rate to compute the net present value of such cash flows. The AVLP common stock +purchase warrants were valued using the Black-Scholes option pricing model with subjective inputs including the fair value of AVLP’s +common stock adjusted for lack of marketability discount as described herein, risk free interest rates and expected volatility. +How We Addressed the Matter in Our Audit +The primary procedures we performed to address +this critical audit matter included the following: +(i) Gaining an understating of the Company’s internal control and processes used to develop fair value +estimates, +(ii) Reading relevant agreements, +(iii) Confirming balances due to the Company with AVLP’s management, +(iv) Reviewing information provided to us about AVLP’s historical sources and uses of cash as a means +of evaluating its revenue and expense forecast and the attainability of its business plan, +(v) Interviewing AVLP’s management regarding the status and expectations regarding +its business plan, +(vi) Comparing the fair value of AVLP’s common stock to public quotes, and +(vii) Utilizing a valuation specialist to assist the engagement team with the following: +· Evaluating the reasonableness of the lack of marketability discount used by management to quantify the +carrying amount of the convertible notes using the market approach and as input to the Black-Scholes option pricing model, +· Evaluating the reasonableness of the risk free interest and volatility rates used by management as input +to the Black-Scholes option pricing model, +· Testing the mathematical accuracy of the discounted cash flow analysis, +· Assessing the reasonableness of the revenue and expense assumptions and their consistency with other +audit evidence, and +· Evaluating the appropriateness of the discount rate used in the cash flow forecast discounted cash flow +analysis. +/s/ Marcum llp +Marcum llp +We have served as the Company’s auditor since 2016. +New York, NY +April 15, 2021 +The accompanying notes are an integral part of these consolidated financial statements. +F- 3 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Board of Directors and Management of +ENERTEC SYSTEMS 2001 LTD +Opinion on the Financial Statements +We have audited the accompanying balance sheet +of ENERTEC SYSTEMS 2001 LTD ("the company") as of December 31, 2020 and 2019, the related statements of comprehensive loss, +shareholders’ equity, and cash flows for each of the two years in the period ended +December 31, 2020, and the related notes (collectively, the financial statements). In our opinion, the financial statements present fairly, +in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and +its cash flows for each of the two years in the period ended December 31, 2020, in conformity +with U.S. generally accepted accounting principles. +Basis for Opinion +These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are +a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be +independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of +the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the +standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial +statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged +to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding +of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s +internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below +are matters arising from the current period audit of the financial statements that were communicated and that: (1) relate to accounts +or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. +The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a +whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or +on the accounts or disclosures to which they relate. +Estimation of total contract costs to be incurred for fixed-price +long-term contract revenue +As discussed in Note 2 to the financial +statements, almost all company revenue's recognized under long-term contracts for the year ended December 31, 2020. For those +long-term contracts that are fixed-price in nature, the Company recognizes revenue over time based on the ratio of (1) actual +contract costs incurred to date to (2) the Company’s estimate of total contract costs to be incurred. We identified the +evaluation of the estimate of total contract costs to be incurred for fixed-price long-term contracts as a critical audit matter. In +particular, evaluating the Company’s judgments regarding the amount of time and budget to complete the contracts, including +the assessment of the nature and complexity of the work to be performed, involved a high degree of subjective judgment. +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +The primary procedures we performed to address +this critical audit matter included the following. We tested the estimates of total contract costs to be incurred, including the assessment +of the nature and complexity of the work to be performed. We evaluated factors including the value and stage of completion and selected +a sample of customer contracts to challenge the Company’s assumptions underlying the estimate of total contract costs to be incurred. +We examined the sampled contracts to evaluate the Company’s identification of performance obligations and the determined method +for measuring contract progress. We compared the Company’s original or prior period estimate of total contract costs to be incurred +to the actual costs incurred for the finished contracts to assess the Company’s ability to accurately estimate costs. We interviewed +the Company to evaluate progress to date, the estimate of remaining costs to be incurred, and factors impacting the amount of time and +cost to complete the sampled contracts, including the assessment of the nature and complexity of the work to be performed. +We have served as the Company’s auditor since 2012. +/s/ Ziv Haft. +Ziv Haft. +Certified Public Accountants (Isr.) +BDO Member Firm +Tel-Aviv, Israel +April 15, 2021 +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +2020 +2019 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ 18,679,848 +$ 483,383 +Marketable equity securities +2,562,983 +639,647 +Accounts receivable +3,852,033 +2,438,254 +Accounts and other receivable, related party +1,196,379 +1,196,379 +Accrued revenue +1,695,905 +2,226,570 +Inventories, net +3,373,851 +2,481,511 +Prepaid expenses and other current assets +2,988,080 +1,324,161 +Current assets held for sale +- +281,352 +TOTAL CURRENT ASSETS +34,349,079 +11,071,257 +Intangible assets, net +4,390,388 +3,206,988 +Goodwill +9,645,686 +8,100,947 +Property and equipment, net +2,122,730 +1,787,393 +Right-of-use assets +4,317,778 +4,177,590 +Investments - related party +10,668,470 +6,540,720 +Investments in derivative liabilities and common stock - related parties +6,139,391 +2,128,224 +Equity investments in private companies +261,767 +261,767 +Investment in limited partnership +1,869,000 +1,969,000 +Loans receivable +750,174 +795,481 +Other investments, related parties +802,500 +832,500 +Other assets +326,419 +275,273 +Noncurrent assets held for sale +- +1,603,268 +TOTAL ASSETS +$ 75,643,382 +$ 42,750,408 +LIABILITIES AND STOCKHOLDERS’ EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ 10,579,501 +$ 14,284,563 +Accounts payable and accrued expenses, related party +35,687 +64,604 +Operating lease liability, current +524,326 +484,819 +Advances on future receipts +- +2,210,392 +Short term advances, related party +- +1,409,331 +Revolving credit facility +125,188 +221,705 +Notes payable, net +4,048,009 +6,137,015 +Notes payable, related parties +187,818 +169,153 +Convertible notes payable +- +2,100,990 +Convertible notes payable, related party +400,000 +- +Warrant liability +4,192,052 +9,364 +Other current liabilities +1,789,825 +1,535,846 +Current liabilities held for sale +- +1,593,550 +TOTAL CURRENT LIABILITIES +21,882,406 +30,221,332 +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +December 31, +2020 +2019 +LONG TERM LIABILITIES +Operating lease liability, non-current +3,854,573 +3,726,493 +Notes payable +336,500 +482,624 +Notes payable, related parties +51,537 +115,164 +Convertible notes payable +386,283 +304,773 +Noncurrent liabilities held for sale +- +951,072 +TOTAL LIABILITIES +26,511,299 +35,801,458 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS’ EQUITY +Series A Convertible Preferred Stock, $25.00 stated value per share, +7 +7 +$0.001 par value – 1,000,000 shares authorized; 7,040 shares +issued and outstanding at December 31, 2020 and 2019, respectively +(redemption amount and liquidation preference of $176,000 +as of December 31, 2020 and 2019) +Series B Convertible Preferred Stock, $10 stated value per share, +125 +125 +share, $0.001 par value – 500,000 shares authorized; 125,000 shares issued +and outstanding at December 31, 2020 and 2019 (liquidation +preference of $1,250,000 at December 31, 2020 and 2019) +Class A Common Stock, $0.001 par value – 500,000,000 shares authorized; +27,754 +3,318 +27,753,562 and 3,318,390 shares issued and outstanding at December 31, 2020 +and 2019, respectively +Class B Common Stock, $0.001 par value – 25,000,000 shares authorized; +- +- +nil shares issued and outstanding at December 31, 2020 and 2019 +Additional paid-in capital +171,397,199 +101,099,347 +Accumulated deficit +(121,396,715 ) +(88,650,465 ) +Accumulated other comprehensive loss +(1,717,934 +) +(5,511,624 ) +TOTAL AULT GLOBAL HOLDINGS STOCKHOLDERS’ EQUITY +48,310,436 +6,940,708 +Non-controlling interest +821,647 +8,242 +TOTAL STOCKHOLDERS’ EQUITY +49,132,083 +6,948,950 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ 75,643,382 +$ 42,750,408 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE +LOSS +For the Year Ended +December 31, +2020 +2019 +Revenue +$ 23,628,859 +$ 21,057,509 +Revenue, cryptocurrency mining +- +641,745 +Revenue, lending activities +242,418 +662,740 +Total revenue +23,871,277 +22,361,994 +Cost of revenue +16,356,741 +19,302,647 +Gross profit +7,514,536 +3,059,347 +Operating expenses +Engineering and product development +1,848,866 +1,861,103 +Selling and marketing +1,177,321 +1,409,996 +General and administrative +12,526,855 +15,524,180 +Impairment of property and equipment +- +4,315,856 +Impairment loss on goodwill and intangible assets +- +651,645 +(Benefit) provision for credit losses +(2,000,000 ) +4,000,000 +Gain on digital currency +(5,033 ) +(5,515 ) +Total operating expenses +13,548,009 +27,757,265 +Loss from continuing operations +(6,033,473 ) +(24,697,918 ) +Other income (expenses) +Interest income +104,869 +3,351,226 +Interest expense +(9,648,820 ) +(7,261,857 ) +Change in fair value of marketable equity securities +919,083 +(596,242 ) +Loss on extinguishment of debt +(18,706,488 ) +(966,134 ) +Loss on issuance of warrants +- +(1,763,481 ) +Change in fair value of warrant liability +(48,842 ) +1,124,953 +Total other expenses, net +(27,380,198 ) +(6,111,535 ) +Loss from continuing operations before income taxes +(33,413,671 ) +(30,809,453 ) +Income tax benefit +23,794 +108,293 +Net loss from continuing operations +(33,389,877 ) +(30,701,160 ) +Net gain (loss) from discontinued operations, net of taxes +661,248 +(2,244,668 ) +Net loss +(32,728,629 ) +(32,945,828 ) +Less: Net loss attributable to non-controlling interest +- +32,416 +Net loss attributable to Ault Global Holdings +(32,728,629 ) +(32,913,412 ) +Preferred dividends +(17,621 ) +(15,938 ) +Net loss available to common stockholders +$ (32,746,250 ) +$ (32,929,350 ) +Basic and diluted net loss per common share: +Continuing operations +$ (3.48 ) +$ (21.41 ) +Discontinued operations +0.07 +(1.57 ) +Net loss per common share +$ (3.41 ) +$ (22.97 ) +Weighted average common shares outstanding, basic and diluted +9,606,493 +1,433,464 +Comprehensive loss +Loss available to common stockholders +$ (32,746,250 ) +$ (32,929,350 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +481,596 +341,774 +Net unrealized gain (loss) on derivative securities of related party +3,312,094 +(1,950,875 ) +Other comprehensive income (loss) +3,793,690 +(1,609,101 ) +Total comprehensive loss +$ +(28,952,560 +) +$ (34,538,451 ) +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Series +A & B +Additional +Other +Total +Preferred +Stock +Common +Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income +(Loss) +Interest +Equity +BALANCES, January +1, 2019 +126,434 +$ 126 +100,910 +$ 101 +$ 77,647,544 +$ (55,721,115 ) +$ (3,902,523 ) +$ 40,658 +$ 18,064,791 +Stock +based compensation: +Options +— +— +— +— +754,752 +— +— +— +754,752 +Common +stock +— +— +69,375 +69 +338,550 +— +— +— +338,619 +Issuance +of common stock and warrants for +cash +— +— +2,011,005 +2,012 +10,951,731 +— +— +— +10,953,743 +Issuance +of common stock in payment of +accrued +liabilities +— +— +66,740 +66 +175,311 +— +— +— +175,377 +Issuance +of common stock for conversion +of debt +— +— +370,473 +370 +4,735,925 +— +— +— +4,736,295 +Issuance +of common stock upon exercise +of warrants +— +— +699,887 +700 +6,620,325 +— +— +— +6,621,025 +Issuance +of Series A preferred stock for cash +5,606 +6 +— +— +140,144 +— +— +— +140,150 +Beneficial +conversion feature in connection +with +convertible notes +— +— +— +— +821,452 +— +— +— +821,452 +Fair value +of warrants issued in connection +with +convertible notes +— +— +— +200,518 +— +— +— +200,518 +Cash for +exchange fees and other financing +costs +— +— +— +— +(1,445,255 ) +— +— +— +(1,445,255 ) +Loss on +debt extinguishment +— +— +— +— +158,350 +— +— +— +158,350 +Comprehensive +loss: +Net loss +— +— +— +— +(32,913,412 ) +— +— +(32,913,412 ) +Preferred +dividends +— +— +— +— +— +(15,938 ) +— +— +(15,938 ) +Net unrealized +loss on derivatives +in +related party +— +— +— +— +— +— +(1,950,875 ) +— +(1,950,875 ) +Foreign +currency translation adjustments +— +— +— +— +— +— +341,774 +— +341,774 +Net +loss attributable to non-controlling interest +— +— +— +— +— +— +— +(32,416 ) +(32,416 ) +BALANCES, +December 31, 2019 +132,040 +$ 132 +3,318,390 +$ 3,318 +$ 101,099,347 +$ (88,650,465 ) +$ (5,511,624 ) +$ 8,242 +$ 6,948,950 +The above Consolidated Statements of Stockholders’ Equity reflects +first and second reverse stock splits effective March 14, 2019 and August 5, 2019, respectively. See Note 1 for further information. +The accompanying notes are an integral part of these consolidated financial statements. +F- 9 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Series +A & B +Additional +Other +Total +Preferred +Stock +Common +Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders' +Shares +Amount +Shares +Amount +Capital +Deficit +Income +(Loss) +Interest +Equity +BALANCES, January +1, 2020 +132,040 +$ 132 +3,318,390 +$ 3,318 +$ 101,099,347 +$ (88,650,465 ) +$ (5,511,624 ) +$ 8,242 +$ 6,948,950 +Stock +based compensation: +Options +— +— +— +— +80,351 +— +— +— +80,351 +Common +stock +— +— +102,500 +102 +182,473 +— +— +— +182,575 +Issuance +of common stock for cash +— +— +12,582,000 +12,582 +39,965,768 +— +— +— +39,978,350 +Issuance +of common stock in payment of +short +term advances, related party +— +— +660,667 +661 +739,287 +— +— +— +739,948 +Issuance +of common stock in payment of +accrued +liabilities +— +— +229,898 +230 +712,915 +— +— +— +713,145 +Issuance +of common stock for conversion +of debt +— +— +10,046,012 +10,047 +24,770,673 +— +— +— +24,780,720 +Issuance +of common stock upon exercise +of warrants +— +— +814,095 +814 +876,361 +— +— +— +877,175 +Issuance +of Enertec warrants +— +— +— +— +— +— +— +813,405 +813,405 +Beneficial +conversion feature in connection +with +convertible notes +— +— +— +— +81,621 +— +— +— +81,621 +Fair value +of warrants issued in connection +with +convertible notes +— +— +— +— +4,540,238 +— +— +— +4,540,238 +Cash for +exchange fees and other financing costs +— +— +— +— +(1,651,835 ) +— +— +— +(1,651,835 ) +Comprehensive +loss: +Net loss +— +— +— +— +— +(32,728,629 ) +— +— +(32,728,629 ) +Preferred +dividends +— +— +— +— +— +(17,621 ) +— +— +(17,621 ) +Net unrealized +gain on derivatives +in +related party +— +— +— +— +— +— +3,312,094 +— +3,312,094 +Foreign +currency translation adjustments +— +— +— +— +— +— +481,596 +— +481,596 +BALANCES, +December 31, 2020 +132,040 +$ 132 +27,753,562 +$ 27,754 +$ 171,397,199 +$ (121,396,715 ) +$ ( 1,717,934 ) +$ 821,647 +$ 49,132,083 +The above Consolidated Statements of Stockholders’ Equity reflects +first and second reverse stock splits effective March 14, 2019 and August 5, 2019, respectively. See Note 1 for further information. +The accompanying notes are an integral part of these consolidated financial statements. +F- 10 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +For the Year Ended December 31, +2020 +2019 +Cash flows from operating activities: +Net loss +$ (32,728,629 ) +$ (32,945,828 ) +Less: Net gain (loss) from discontinued operations +661,248 +(2,244,668 ) +Net loss from continuing operations +(33,389,877 ) +(30,701,160 ) +Adjustments to reconcile net loss to net cash (used in) operating activities: +Depreciation +391,597 +2,570,511 +Amortization +335,776 +502,656 +Amortization of right-of-use assets +(140,188 ) +2,123,519 +Interest expense – debt discount +7,251,365 +3,709,993 +Loss on extinguish debt +18,706,488 +— +Fair value in excess of proceeds upon issuance of warrants +— +1,763,481 +Change in fair value of warrant liability +48,842 +(1,124,953 ) +Accretion of original issue discount on notes receivable – related party +21,998 +(2,277,777 ) +Accretion of original issue discount on notes receivable +(61,834 ) +(90,489 ) +Increase in accrued interest on notes receivable – related party +(1,337 ) +(1,021,158 ) +Stock-based compensation +1,105,688 +1,583,991 +Impairment of property and equipment +— +4,315,856 +Impairment of intangible assets +— +170,692 +Impairment of goodwill +— +480,953 +Realized losses on other investments +39,141 +— +Realized (gains) losses on sale of digital currencies +— +(524 ) +Realized (gains) losses on sale of marketable securities +(75,346 ) +(95,340 ) +Realized (gains) losses on equity securities in private companies +— +215,813 +Unrealized (gains) losses on marketable equity securities +(796,009 ) +(258,905 ) +Unrealized (gains) losses on equity securities – related party +(297,943 ) +276,450 +Unrealized (gains) losses on equity securities +73,079 +363,996 +Provision for loan losses +(2,000,000 ) +5,550,000 +Changes in operating assets and liabilities: +Accounts receivable +(641,087 ) +(540,820 ) +Accounts receivable, related party +— +2,691,275 +Accrued revenue +644,729 +(737,960 ) +Digital currencies +(14 ) +(647,260 ) +Inventories +183,331 +824,703 +Prepaid expenses and other current assets +(1,612,731 ) +(1,018,466 ) +Other assets +(92,753 ) +(221,264 ) +Accounts payable and accrued expenses +(364,195 ) +3,682,230 +Accounts payable, related parties +(28,917 ) +6,852 +Other current liabilities +(649,615 ) +(269,831 ) +Lease liabilities +167,587 +(2,089,797 ) +Net cash used in continuing operating activities +(11,182,225 +) +(10,262,733 ) +Net cash provided by discontinued operating activities +1,246 +82,179 +Net cash used in operating activities +(11,180,979 +) +(10,180,554 ) +Cash flows from investing activities: +Purchase of property and equipment +(582,092 ) +(189,302 ) +Acquisition of Relec, net of cash acquired +(3,627,534 ) +- +Investments – related party +(2,118,411 ) +(1,600,164 ) +Investments in warrants and common stock - related party +(354,370 ) +(1,130,567 ) +Purchase of marketable equity securities +(1,425,341 ) +- +Sales of marketable equity securities +373,360 +580,721 +Proceeds from loans receivable +139,933 +— +Investments in debt and equity securities +(188,760 ) +(511,743 ) +Net cash used in investing activities +$ (7,783,215 ) +$ (2,851,055 ) +The accompanying notes are an integral part of these consolidated financial statements. +F- 11 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) +For the Year Ended December 31, +2020 +2019 +Cash flows from financing activities: +Gross proceeds from sales of common stock and warrants +$ 39,978,350 +$ 17,028,605 +Proceeds from issuance of Series A Convertible Preferred Stock +— +131,741 +Financing cost in connection with sales of equity securities +(1,651,835 ) +(1,445,255 ) +Proceeds from warrant exercises +52,826 +127,000 +Proceeds from convertible notes payable +100,000 +500,000 +Proceeds from notes payable +9,722,434 +5,230,418 +Proceeds from short-term advances +570,000 +— +Payments on short-term advances +(570,000 ) +— +Proceeds from short-term advances – related party +653,124 +1,305,570 +Payments on short-term advances – related party +(322,507 ) +— +Payments on notes payable +(8,783,976 ) +(2,117,252 ) +Payments on convertible notes payable +— +(7,069,547 ) +Proceeds from advances on future receipts +— +941,804 +Payments on advances on future receipts +(2,350,639 ) +(1,590,925 ) +Payments of preferred dividends +(17,621 ) +(15,938 ) +Payments on revolving credit facilities, net +(96,517 ) +(101,018 ) +Net cash provided by financing activities +37,283,639 +12,925,203 +Effect of exchange rate changes on cash and cash equivalents +(122,980 +) +(179,830 ) +Net increase (decrease) in cash and cash equivalents +18,196,465 +(286,236 ) +Cash and cash equivalents at beginning of period +483,383 +769,619 +Cash and cash equivalents at end of period +$ 18,679,848 +$ 483,383 +For the Year Ended December 31, +2020 +2019 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ 658,042 +$ 1,867,925 +Non-cash investing and financing activities: +Cancellation of convertible note payable into shares of common stock +$ 24,780,720 +$ 4,736,295 +Payment of accounts payable with digital currency +$ — +$ 647,213 +Issuance of common stock in payment of accrued liability +$ 1,537,494 +$ 175,377 +Cancellation of short-term advances, related party into shares +of common stock +$ 739,948 +$ — +Conversion of loans receivable for marketable equity securities +$ — +$ 485,000 +Conversion of loans receivable for investments in warrants and +common stock - related party +$ — +$ 181,483 +Issuance of notes payable and convertible notes payable in +payment of accrued expenses +$ 420,000 +$ — +Cancellation of notes payable into short term advances, related parties +$ — +$ 30,000 +Issuance of common stock on conversion of note +$ 600,000 +$ - +The accompanying notes are an integral part of these consolidated financial statements. +F- 12 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2020 +1. DESCRIPTION OF BUSINESS +Ault Global Holdings, Inc., +a Delaware corporation (“Ault Global” or the “Company”), formerly known as DPW Holdings, Inc., was incorporated +in September 2017. The Company is a diversified holding company owning subsidiaries engaged in, among others, the following operating +businesses: commercial and defense solutions, commercial lending and advanced textile technology. The Company’s direct and indirect +wholly-owned subsidiaries include Gresham Worldwide, Inc. (“GWW”), Coolisys Technologies Corp. (“Coolisys”), Digital +Power Corporation, Gresham Power Electronics Ltd. (f/k/a Digital Power Limited) (“Gresham Power”), Enertec Systems 2001 Ltd +(“Enertec”), Relec Electronics Ltd., Digital Power Lending, LLC (“DP Lending”), Ault Alliance, Inc. (“Ault +Alliance”), and Tansocial LLC (“Tansocial”). The Company also has a controlling interest in Microphase Corporation (“Microphase”) +and Ault Alliance has a controlling interest in and Alliance Cloud Services, LLC (“ACS”). The Company has three reportable +segments: +· GWW – defense solutions with operations conducted by Microphase, Enertec, Gresham Power and Relec; +· Coolisys – commercial electronics solutions with operations conducted by Digital Power Corporation; +and +· Ault Alliance – commercial lending through DP Lending, data center operations through ACS, digital +marketing through Tansocial and digital learning. +During March 2020, the Company +ceased operations at Digital Farms, Inc. (“Digital Farms”), the Company’s blockchain mining subsidiary, and I.AM, Inc. +(“I.AM”). Management determined that the permanent closing of the restaurant operations at I.AM, which owned and operated +the Prep Kitchen brand restaurants located in the San Diego area, met the criteria for presentation as discontinued operations. Accordingly, +the results of the restaurant operations segment are presented as discontinued operations in our condensed consolidated statements of +operations and comprehensive loss and are excluded from continuing operations for all periods presented. +On March 14, 2019, pursuant +to the authorization provided by the Company’s stockholders at a Special Meeting of Stockholders, the Company’s Board +of Directors (the “Board”) approved an amendment to the Certificate of Incorporation (the “COI Amendment”) to +effectuate a reverse stock split of the of the Company’s issued and outstanding common stock, $0.001 par value per share, (“Common +Stock”) by a ratio of one-for-twenty (the “First Stock Split”) . At the +Company’s 2019 reconvened Annual Meeting of Stockholders, the Company’s stockholders approved a proposal permitting the Board +to effectuate a second reverse stock split (the “Second Stock Split”) of the issued and outstanding Common Stock. Thereafter, +on July 23, 2019, the Board approved the Second Stock Split with a ratio of one-for-forty. The Second Stock Split did not affect the number +of authorized shares of common stock or their par value per share. As a result of the Second Stock Split, each forty shares of common +stock issued and outstanding prior to the Second Stock Split were converted into one share of common stock. The Second Stock Split became +effective in the State of Delaware on August 5, 2019. All share amounts in these financial statements have been updated to reflect these +reverse stock splits. +On +January 19, 2021, the Company changed its name from DPW Holdings, Inc., to Ault Global Holdings, Inc. The Name Change was effected through +a parent/subsidiary short-form merger pursuant to an agreement and plan of merger dated January 7, 2021. The merger and resulting name +change do not affect the rights of security holders of the Company. The Common Stock continues to be listed on the NYSE American and trades +under the symbol “DPW”. +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +The accompanying consolidated +financial statements have been prepared on the basis that the Company will continue as a going concern. As of December 31, 2020, the Company +had cash and cash equivalents of $18,679,848, an accumulated deficit of $121,396,715 and working capital of $12,466,673. The Company has +incurred recurring losses and reported losses attributable to Ault Global for the years ended December 31, 2020 and 2019, of $32,728,629 +and $32,913,412, respectively. In the past, the Company has financed its operations principally through issuances of convertible debt, +promissory notes and equity securities. During 2020, the Company continued to successfully obtain additional equity and debt financing +and in restructured existing debt. +F- 13 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +2020 ATM Offering +On October 2, 2020, the Company +entered into an At-The-Market Issuance Sales Agreement (the “2020 Sales Agreement”) with Ascendiant Capital Markets, LLC to +sell shares of Common Stock having an aggregate offering price of up to $8,975,000 from time to time, through an “at the market +offering” program (the “2020 ATM Offering”). On December 1, 2020, the Company filed an amendment to the prospectus supplement +with the SEC to increase the amount of common stock that may be offered and sold in the 2020 ATM Offering, as amended under the Sales +Agreement to $40,000,000 in the aggregate, inclusive of the up to $8,975,000 in shares of common stock previously sold in the 2020 ATM +Offering. The offer and sale of shares of common stock from the 2020 ATM Offering was made pursuant to the Company’s effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) which +became effective on January 11, 2018. Through December 31, 2020, the Company had received gross proceeds of $39,978,350 through the sale +of 12,582,000 shares of common stock from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, 2020. +Impact of Coronavirus +on the Company’s Operations +The Company’s business +has been disrupted and materially adversely affected by the recent outbreak of COVID-19. As a result of measures imposed by the governments +in affected regions, businesses and schools have been suspended due to quarantines intended to contain this outbreak and many people have +been forced to work from home in those areas. The spread of COVID-19 from China to other countries has resulted in the Director General +of the World Health Organization declaring the outbreak of COVID-19 as a Public Health Emergency of International Concern, based on the +advice of the Emergency Committee under the International Health Regulations (2005), and the Centers for Disease Control and Prevention +in the U.S. issued a warning on February 25, 2020 regarding the likely spread of COVID-19 to the U.S. While the COVID-19 outbreak is no +longer in its early stages, international stock markets continue to reflect the uncertainty associated with the slow-down in the American, +Israeli and UK economies and the reduced levels of international travel experienced since the beginning of January and the significant +volatility in the Dow Industrial Average throughout 2020 was largely attributed to the effects of COVID-19. The Company continues to monitor +and assess its business operations and system supports and the impact COVID-19 may have on its results and financial condition, but there +can be no assurance that this analysis will enable the Company to avoid part or all of any impact from the continuing spread of COVID-19 +or its consequences, including downturns in business sentiment generally or in the Company’s sectors in particular. +The +Company’s operations are located in Alameda County, CA, Orange County, CA, Fairfield County, CT, the United Kingdom, Israel and +members of its senior management work in Seattle, WA and New York, NY. The Company has been following the recommendations of local health +authorities to minimize exposure risk for its employees, including the temporary and sporadic closures of its offices and having employees +work remotely to the extent possible, which has to an extent adversely affected their efficiency. +Updates by business unit +are as follows: +· Ault Global’s corporate headquarters, located in Las Vegas, NV, has largely returned to normal operations +with adherence to the Governor’s Directives and Declarations. Certain individuals deemed to be high risk may work remotely, as required. +· Ault Global’s finance and accounting office, located in Newport Beach, CA, is primarily working +remotely, based on the occupancy and social distancing order from the Orange County Health Officer (http://www.ochealthinfo.com/phs/about/epidasmt/epi/dip/prevention/novel_coronavirus). +The administrative staff has tested the secure remote access systems and technology infrastructure to adjust working arrangements for +its employees and believes it has adequate internal communications system and can remain operational with a remote staff. +· Coolisys, located in Milpitas, CA, has largely returned to normal operations with adherence to guidelines +published by the Santa Clara Public Health Department. Certain individuals deemed to be high risk may work remotely as required. Coolisys +has experienced disruption in its supply chain as a result of the COVID-19 impact on its vendors. +F- 14 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +· Microphase operates a production facility in Connecticut. In March 2020, the Defense Department designated +Microphase an “essential” operation of critical infrastructure workers as part of the defense industrial base. To limit the +impact of the COVID-19 pandemic, Microphase implemented a series of protocols to limit access to the facility, heighten sanitization, +facilitate social distancing and require face coverings. Microphase has requested that workers limit their travel and exposure to others. +All employees, including management, that do not have to be in the facility work remotely whenever possible. Any employees who come in +contact or potential contact with anyone who has tested positive for COVID-19 or who traveled outside the immediate area are quarantined +and must provide proof of negative tests before returning to work. Rigorous adherence to these protocols has generally enabled Microphase +to operate with minimal disruption. +In December +2020, five Microphase employees tested positive for COVID-19. Microphase temporarily shut down its production facility for a week for +deep cleaning and to have all employees tested for COVID-19. Since the outbreak disproportionately affected assembly workers, Microphase’s +assembly operations remained shut down for three weeks until all assembly workers had at least 2 negative tests. Operations gradually +resumed in late December 2020 and the workforce returned to full strength in mid-January 2021. +The disruption +to production operations deferred order completion and delayed shipments with a significant decrease in revenue from forecast for December +of 2020 and a lingering, but only partial and less substantial, effect on January and February revenue. No customers cancelled orders +or imposed penalties for late delivery. Disruption of production added costs from paying employees who could not work and deferred revenue +from delayed shipments. However, the entire workforce has remained healthy with heightened precautions and hygiene protocols in place, +rendering the outbreak’s impact on production a temporary phenomenon. +Microphase +continues to follow CDC guidelines for social distancing, face coverings and heightened sanitizing to keep the workforce safe and healthy. +Microphase has strictly limited access to its facility and mandated that all employees minimize exposure to the others. All Microphase +employees who can work from home will do so while COVID-19 levels remain high in the surrounding communities. However, some workers may +still need to work in proximity to others. Management is working with state and federal authorities to get all employees vaccinated on +a priority basis as “essential workers” whom the U.S. Department of Defense (the “DoD”) has officially designated +as “critical infrastructure workforce” as part of the “defense industrial base.” Some employees have already received +vaccinations and we expect all employees to have both vaccinations by the end of March 2021. +· Gresham Power suspended production operations +in its Salisbury, UK facility from mid-March through June 2020 before resuming production until a subsequent shutdown in November 2020. +Notwithstanding the current lockdown, production operations have resumed to complete work on order for products critically needed for +military operations. However, engineers, back office staff and management have worked from home as much as possible throughout the pandemic +period and continue to do so. The pandemic has disrupted production at times and delayed contract actions as well as other customer decision +making, which decreased revenue realized in 2020. However, the Company expects that these delays shall only defer orders and that +business will rebound strongly with pent up demand in the latter half of 2021. +· Relec, which does not operate any manufacturing +or assembly facilities, has not experienced any material COVID-19 related disruptions to date and continues normal operations notwithstanding +the lockdown in the United Kingdom. All employees who can work from home do so. Others who must work at the Wareham, UK site to move product +or access systems continue to do so under strict safety protocols with face coverings, social distancing and heightened attention to sanitization. +The principal impact on Relec’s operations has come from the deferral of some orders and a modest decrease in revenue year-over-year. +The Company presently expects business to rebound and resume a steady growth pattern in the third quarter of 2021, although the pandemic +may impact this outlook. +· The Israeli government exempted Enertec from +pandemic-related lockdown orders to keep production operations open for key projects that impact national security. Approximately 50% +of Enertec’s workforce is working remotely. Enertec incurred additional costs for increased sanitizing costs, personal protective +equipment, increased virtual operations, measures to facilitate social distancing and other precautions to avoid the spread of COVID-19. +The pandemic also affected Enertec’s customers and supply chain partners, slowing order processing, materials and parts delivery +and service order completion. The principal impact on Enertec’s business has come from deferral of customer decisions and order +issuance. With 50% of the population vaccinated as January 31, 2021, Israel now leads the world in COVID-19 vaccine distribution, +which should further mitigate risks from COVID-19. The Company presently expects business to rebound and resume substantial growth in +second quarter of 2021 as orders increase to address deferred, pent up demand. +F- 15 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The COVID-19 global pandemic has been unprecedented +and unpredictable and is likely to continue to result in significant national and global economic disruption, which may adversely affect +the Company’s business. Based on the Company’s current assessment, however, the Company does not expect any material impact +on its long-term strategic plans, its operations, or its liquidity due to the worldwide spread of the COVID-19 virus. However, the Company +is actively monitoring this situation and the possible effects on its financial condition, liquidity, operations, suppliers, and industry. +The Company believes its current cash on hand +is sufficient to meet its operating and capital requirements for at least the next twelve months from the date these financial statements +are issued. +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated +financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial +statements include the accounts of Ault Global Holdings and its wholly-owned subsidiaries, GWW, Coolisys, Digital Power Corporation (a +wholly owned subsidiary of Coolisys), Gresham Power, Enertec, Relec, DP Lending, Ault Alliance, and Digital Farms and its majority-owned +subsidiaries, Microphase, I.AM and Alliance Cloud Services. All significant intercompany accounts and transactions have been eliminated +in consolidation. +Accounting Estimates +The preparation of financial +statements, in conformity with U.S. GAAP, requires management to make estimates, judgments and assumptions. The Company's management believes +that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. These estimates, +judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities +at the dates of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results +could differ from those estimates. Key estimates include acquisition accounting, fair value of certain financial instruments, reserves +for trade receivables and inventories, carrying amounts of investments, accruals of certain liabilities including product warranties, +useful lives and the recoverability of long-lived assets, impairment analysis of intangibles and goodwill, and deferred income taxes and +related valuation allowance. +Impairment of long-lived assets: +Management reviews long-lived +assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. +Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future +cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured +by comparing the carrying amount of the assets to their fair value. During the first quarter of 2020, based upon the deteriorating business +conditions for restaurants in the San Diego County as a result of the spread of COVID-19 and the decline in projected cash flows over +the life of the restaurant long-lived assets, the Company performed an undiscounted cash flow test to determine if the restaurant equipment +and right-of-use assets were impaired. The undiscounted cash flows were less than the carrying amount of the Company’s restaurant +equipment and right-of-use assets and therefore, the carrying amount of the assets were compared to the fair value of the assets, and +the Company determined that there were impairment charges to be recorded on the restaurant long-lived assets. Impairment charges for the +year ended December 31, 2020 related to restaurant equipment were in an amount equal to the cost of the Company’s restaurant equipment, +net of depreciation of $504,802 and the impairment related to the right-of-use assets attributed to the discontinued restaurant operations +was the full carrying amount of $1,020,514. The restaurant-related impairment charges are included as a component of net loss from discontinued +operations (see Note 4). +F- 16 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Revenue Recognition +The Company recognizes revenue +under ASC 606, Revenue from Contracts with Customers . The core principle of the new revenue standard is that a company should recognize +revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company +expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve that core principle: +· Step 1: Identify the contract with the customer, +· Step 2: Identify the performance obligations +in the contract, +· Step 3: Determine the transaction price, +· Step 4: Allocate the transaction price to the +performance obligations in the contract, and +· Step 5: Recognize revenue when the company satisfies +a performance obligation. +The Company’s disaggregated revenues consist +of the following for the year ended December 31, 2020: +Year ended December 31, 2020 +GWW +Coolisys +Ault Alliance +Total +Primary Geographical Markets +North America +$ 6,717,843 +$ 4,500,175 +$ 242,418 +$ 11,460,436 +Europe +1,878,782 +450,053 +- +2,328,835 +Middle East +9,273,158 +- +- +9,273,158 +Other +342,938 +465,910 +- +808,848 +$ 18,212,721 +$ 5,416,138 +$ 242,418 +$ 23,871,277 +Major Goods +RF/Microwave Filters +$ 4,330,091 +$ — +$ — +$ 4,330,091 +Detector logarithmic video amplifiers +473,150 +— +— +473,150 +Power Supply Units +2,655,723 +5,416,138 +— +8,071,861 +Power Supply Systems +1,481,922 +— +— +1,481,922 +Healthcare diagnostic systems +1,011,574 +— +— +1,011,574 +Defense systems +8,260,261 +— +— +8,260,261 +Lending activities +— +— +242,418 +242,418 +$ 18,212,721 +$ 5,416,138 +$ 242,418 +$ 23,871,277 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 8,940,886 +$ 5,416,138 +$ 242,418 +$ 14,599,442 +Services transferred over time +9,271,835 +— +— +9,271,835 +$ 18,212,721 +$ 5,416,138 +$ 242,418 +$ 23,871,277 +F- 17 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The Company’s disaggregated revenues consist +of the following for the year ended December 31, 2019: +Year ended December 31, 2019 +GWW +Coolisys +Ault Alliance +Total +Primary Geographical Markets +North America +$ 4,342,565 +$ 5,276,096 +$ 1,304,485 +$ 10,923,146 +Europe +1,672,489 +5,767 +— +1,678,256 +Middle East +8,659,675 +21,348 +— +8,681,023 +Other +557,114 +522,455 +— +1,079,569 +$ 15,231,843 +$ 5,825,666 +$ 1,304,485 +$ 22,361,994 +Major Goods +RF/Microwave filters +$ 2,245,748 +$ — +$ — +$ 2,245,748 +Detector logarithmic video amplifiers +558,155 +— +— +558,155 +Power supply units +1,656,162 +5,825,666 +— +7,481,828 +Power supply systems +1,920,594 +— +— +1,920,594 +Healthcare diagnostic systems +1,711,050 +— +— +1,711,050 +Defense systems +7,140,134 +— +— +7,140,134 +Lending activities +— +— +662,740 +662,740 +Digital currency mining +— +— +641,745 +641,745 +$ 15,231,843 +$ 5,825,666 +$ 1,304,485 +$ 22,361,994 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 6,243,758 +$ 5,825,666 +$ 1,304,485 +$ 13,373,909 +Services transferred over time +8,988,085 +— +— +8,988,085 +$ 15,231,843 +$ 5,825,666 +$ 1,304,485 +$ 22,361,994 +Sales of Products +The Company generates revenues +from the sale of its products through a direct and indirect sales force. The Company’s performance obligations to deliver products +are satisfied at the point in time when products are received by the customer, which is when the customer obtains control over the goods. +The Company provides standard assurance warranties, which are not separately priced, that the products function as intended. The Company +primarily receives fixed consideration for sales of product. Some of the Company’s contracts with distributors include stock rotation +rights after six months for slow moving inventory, which represents variable consideration. The Company uses an expected value method +to estimate variable consideration and constrains revenue for estimated stock rotations until it is probable that a significant reversal +in the amount of cumulative revenue recognized will not occur. To date, returns have been insignificant. The Company’s customers +generally pay within 30 days from the receipt of a valid invoice. +Because the Company’s +product sales agreements have an expected duration of one year or less, the Company has elected to adopt the practical expedient in ASC +606-10-50-14(a) of not disclosing information about its remaining performance obligations. +F- 18 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Manufacturing Services +The Company provides manufacturing +services in exchange primarily for fixed fees; however, the initial two MLSE units are subject to variable pricing under the $50 million +purchase order from MTIX. Under the terms of the MLSE purchase order, the Company shall be entitled to cost plus $100,000 for the manufacture +of the first two MLSE units. The Company has determined that the costs of manufacturing the MLSE units will decline over time because +of a learning curve which will result in a greater amount of revenue being recognized for these initial two MLSE units. +For manufacturing services, +which include revenues generated by Enertec and in certain instances revenues generated by Gresham Power, the Company’s performance +obligation for manufacturing services is satisfied over time as the Company creates or enhances an asset based on criteria that are unique +to the customer and that the customer controls as the asset is created or enhanced. Generally, the Company recognizes revenue based upon +proportional performance over time using a cost to cost method which measures progress based on the costs incurred to total expected costs +in satisfying its performance obligation. This method provides a depiction of the progress in providing the manufacturing service because +there is a direct relationship between the costs incurred by the Company and the transfer of the manufacturing service to the customer. +Manufacturing services that are recognized based upon the proportional performance method are included in the above table as services +transferred over time and to the extent the customer has not been invoiced for these revenues, as accrued revenue in the accompanying +consolidated balance sheets. Revisions to the Company’s estimates may result in increases or decreases to revenues and income and +are reflected in the consolidated financial statements in the periods in which they are first identified. +The Company has elected the +practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component to the extent +that the period between when the Company transfers its promised good or service to the customer and when the customer pays in one year +or less. +The aggregate amount of the +transaction price allocated to the performance obligation that is partially unsatisfied as of December 31, 2020, for the MLSE units was +approximately $48 million, representing 24 MLSE units. Based on our expectations regarding funding of the production process and our experience +building the first machines, the Company expects to recognize the remaining revenue related to the partially unsatisfied performance obligation +over the next three years. The Company will be paid in installments for this performance obligation over the estimated period that the +remaining revenue is recognized. +Lending Activities and Trading Activities +Ault Alliance, through DP +Lending, generates revenue from lending activities primarily through interest, origination fees and late/other fees. Interest income on +these products is calculated based on the contractual interest rate and recorded as interest income as earned. The origination fees or +original issue discounts are recognized over the life of the loan using the effective interest method. +Financial instruments utilized +in trading activities are carried at fair value. Fair value is generally based on quoted market prices for the same or similar assets +and liabilities. If these market prices are not available, fair values are estimated based on dealer quotes, pricing models, discounted +cash flow methodologies, or similar techniques where the determination of fair value may require significant management judgment or estimation. +Realized gains and losses are recorded on a trade-date basis. Realized and unrealized gains and losses are recognized in revenue from +lending activities. +Blockchain Mining +The Company has entered into +digital asset mining pools by executing contracts with the mining pool operators to provide computing power to the mining pool. The contracts +are terminable at any time by either party and the Company’s enforceable right to compensation only begins when the Company provides +computing power to the mining pool operator. In exchange for providing computing power, the Company is entitled to a fractional share +of the fixed digital currency award the mining pool operator receives (less digital asset transaction fees to the mining pool operator +which are recorded as a component of cost of revenues), for successfully adding a block to the blockchain. The Company’s factional +share is based on the proportion of computing power the Company contributed to the mining pool operator to the total computing power contributed +by all mining pool participants in solving the current algorithm. +F- 19 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Providing computing power +in digital asset transaction verification services is an output of the Company’s ordinary activities. The provision of providing +such computing power is the only performance obligation in the Company’s contracts with mining pool operators. The transaction consideration +the Company receives, if any, is noncash consideration, which the Company measures at fair value on the date received, which is not materially +different than the fair value at contract inception or the time the Company has earned the award from the pools. The consideration is +all variable. Because it is not probable that a significant reversal of cumulative revenue will not occur, the consideration is constrained +until the mining pool operator successfully places a block (by being the first to solve an algorithm) and the Company receives confirmation +of the consideration it will receive, at which time revenue is recognized. There is no significant financing component in these transactions. +Fair value of the digital +currency award received is determined using the market rate of the related digital currency at the time of receipt. +There is currently no specific +definitive guidance under GAAP or alternative accounting framework for the accounting for digital currencies recognized as revenue or +held, and management has exercised significant judgment in determining the appropriate accounting treatment. In the event authoritative +guidance is enacted by the FASB, the Company may be required to change its policies, which could have an effect on the Company’s +consolidated financial position and results from operations. +Expenses associated with running +the cryptocurrency mining business, such as equipment deprecation and electricity cost are recorded as a component of cost of revenues. +Historically, the Company +used digital assets for debt reduction, capital purchases, consulting fees, data center costs and other operating expenses. +During March 2020, the Company +ceased operations at Digital Farms, the Company’s blockchain mining subsidiary +Foreign Currency Translation +A substantial portion of the +Company’s revenues are generated in U.S. dollars (“U.S. dollar”). In addition, a substantial portion of the Company’s +costs are incurred in U.S. dollars. Company management has determined that the U.S. dollar is the functional currency of the primary economic +environment in which it operates. +Accordingly, monetary accounts +maintained in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with Financial Accounting Standards +Board (“FASB”) issued Accounting Standards Codification (“ASC”) No. 830, Foreign Currency Matters (“ASC +No. 830”). All transaction gains and losses from the re-measurement of monetary balance sheet items are reflected in the statements +of operations as financial income or expenses as appropriate. +The financial statements of +Gresham Power and Enertec, whose functional currencies have been determined to be their local currencies, the British Pound (“GBP”) +and the Israeli Shekel (“ILS”), respectively, have been translated into U.S. dollars in accordance with ASC No. 830. All balance +sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have +been translated using the average exchange rate in effect for the reporting period. The resulting translation adjustments are reported +as other comprehensive income (loss) in the consolidated statement of comprehensive income (loss) and accumulated comprehensive income +(loss) in statement of changes in stockholders' equity (deficit). +F- 20 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Cash and Cash Equivalents +The Company considers all +highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments +that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash +is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. These balances +exceed the U.S. Federal Deposit Insurance Corporation insurance limits. The Company has cash and cash equivalents of $884,859 and $288,428 +at December 31, 2020 and 2019, respectively, in the United Kingdom (“U.K”) and $18,874 and $47,062, respectively, in Israel. +The Company has not experienced any losses on deposits of cash and cash equivalents. +Accounts Receivable and Allowance for Doubtful +Accounts +The Company’s receivables +are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount of the Company’s +receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. The Company individually reviews +all accounts receivable balances and based upon an assessment of current creditworthiness, estimates the portion, if any, of the balance +that will not be collected. The Company estimates the allowance for doubtful accounts based on historical collection trends, age of outstanding +receivables and existing economic conditions. If events or changes in circumstances indicate that a specific receivable balance may be +impaired, further consideration is given to the collectability of those balances and the allowance is adjusted accordingly. A customer’s +receivable balance is considered past-due based on its contractual terms. Past-due receivable balances are written-off when the Company’s +internal collection efforts have been unsuccessful in collecting the amount due. Based on an assessment as of December 31, 2020 and 2019, +of the collectability of invoices, accounts receivable are presented net of an allowance for doubtful accounts of $4,415 and $5,000, respectively. +Inventories +Inventories are stated at +the lower of cost or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological +obsolescence. +Cost of inventories is determined as +follows: +Raw materials, parts +and supplies - using the “first-in, first-out” method. +Work-in-progress and finished products +- on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically assesses +its inventories valuation in respect of obsolete and slow-moving items by reviewing revenue forecasts and technological obsolescence. +When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at the time of the review +was not expected to be sold, is written off. +During the years ended December +31, 2020 and 2019, the Company did not record inventory write-offs within the cost of revenue. +F- 21 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Property and Equipment, Net +Property and equipment are +stated at cost, net of accumulated depreciation. Repairs and maintenance costs are expensed as incurred. Depreciation is calculated using +the straight-line method over the estimated useful lives of the assets, at the following annual rates: +Useful lives (in years) +Computer, software and related equipment +3 - 5 +Office furniture and equipment +5 - 10 +Leasehold improvements +Over the term of the lease or the life of the asset, whichever is shorter. +Goodwill +The Company evaluates its +goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other . Goodwill is recorded when the +purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. +The Company tests the recorded +amount of goodwill for impairment on an annual basis on December 31 of each fiscal year or more frequently if there are indicators that +the carrying amount of the goodwill exceeds its carried value. At December 31, 2020, the Company had three reporting units. The Company +performed a qualitative assessment and concluded that goodwill at the Company’s Coolisys subsidiary was impaired by a total of $480,953 +based upon an assessment as of December 31, 2019. The Company shows no impairment at December 31, 2020. Goodwill impairment charges for +the years ended December 31, 2020 and 2019 related to the Company’s discontinued operations were nil and $265,252, respectively. +Intangible Assets +The Company acquired amortizable +intangibles assets as part of four asset purchase agreements consisting of customer relationships and non-compete agreements. The Company +also has the trade names and trademarks associated with the acquisitions of Microphase, I.AM and Relec which were determined to have an +indefinite life. The customer relationships and non-compete agreements, definite lived intangible assets, are being amortized on a straight-line +basis over their estimated useful lives as follows: +Useful lives (in years) +Customer relationships +5 - 14 +Non-competition agreements +3 +Domain name and other intangible assets +3 +The Company reviews intangible +assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets might not be +recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant underperformance +of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes +in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares +forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying +value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset +are less than its carrying amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its +fair value, determined based on discounted cash flows. During the years ended December 31, 2020 and 2019, the Company recorded an impairment +loss from continuing operations of nil and $170,692, respectively. Impairment charges for intangible assets for the years ended December +31, 2020 and 2019 related to the Company’s discontinued operations were nil and $610,000, respectively. +Long-Lived Assets +The long-lived assets of the +Company are reviewed for impairment in accordance with ASC No. 360, Property, Plant, and Equipment , whenever events or changes +in circumstances indicate that the carrying amount of an asset may not be recoverable. +F- 22 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Management reviews long-lived +assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. +Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future +cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured +by comparing the amount by which the carrying amount of the assets to their fair value. During the first quarter of 2020, based upon the +deteriorating business conditions for restaurants in the San Diego County as result of the spread of COVID-19 and the decline in projected +cash flows over the life of the restaurant long-lived assets, the Company performed an undiscounted cash flow test to determine if the +restaurant equipment and right-of-use assets were impaired. The undiscounted cash flows were less than the carrying amount of the Company’s +restaurant equipment and right-of-use assets and therefore, the carrying amount of the assets were compared to the fair value of the assets, +and the Company determined that there were impairment charges to be recorded on the restaurant long-lived assets. Impairment charges for +the year ended December 31, 2020 related to restaurant equipment were in an amount equal to the cost of the Company’s restaurant +equipment, net of depreciation of $504,802 and the impairment related to the right-of-use assets attributed to the discontinued restaurant +operations was the full carrying amount of $1,020,514. The restaurant-related impairment charges are included as a component of net loss +from discontinued operations (see Note 4). +Warranty +The Company offers a warranty +period for all its manufactured products. Warranty periods range from one to two years depending on the product. The Company estimates +the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. +Factors that affect the Company's warranty liability include the number of units sold, historical rates of warranty claims and cost per +claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amount, as necessary. As of December +31, 2020 and 2019, the Company’s accrued warranty liability was $90,640 and $80,412, respectively. +Income Taxes +The Company determines its +income taxes under the asset and liability method in accordance with FASB ASC No. 740, Income Taxes , which requires recognition +of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements +or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and +tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. +Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets +will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in +the fiscal years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities +of a change in tax rates is recognized in the Statements of Income and Comprehensive Income in the period that includes the enactment +date. +The Company accounts for uncertain +tax positions in accordance with ASC No. 740-10-25 . ASC No. 740-10-25 addresses the determination of whether tax benefits +claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, the Company +may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained +on examination by the taxing authorities, based on the technical merits of the position. The tax benefit to be recognized is measured +as the largest amount of benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. To the extent +that the final tax outcome of these matters is different than the amount recorded, such differences impact income tax expense in the period +in which such determination is made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are +included in income tax expense. ASC No. 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize +a liability if the Company has taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable +taxing authorities. Management of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, +2020 and 2019, there are no uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that +would require disclosure in the financial statements. +F- 23 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Common Stock Purchase Warrants and Other +Derivative Financial Instruments +The Company classifies common +stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical +settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical +settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement +to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty +a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions +as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine +whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, +which principally consist of issuance of warrants to purchase shares of common stock in connection with convertible notes and to employees +of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features +or variable settlement provision that cause them to not be indexed to the Company’s own stock. +Stock-Based Compensation +The Company accounts for stock-based +compensation in accordance with ASC No. 718, Compensation – Stock Compensation ( “ASC No. 718” ). +Under ASC No. 718, compensation expense related to stock-based payments is recorded over the requisite service period based on the grant +date fair value of the awards. Compensation expense previously recorded for unvested stock options that are forfeited is reversed upon +forfeiture. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The +Black-Scholes model requires the use of assumptions which determine the fair value of stock-based awards, including the option’s +expected term and the price volatility of the underlying stock. +The Company’s accounting +policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of ASC No. 505-50, +Equity Based Payments to Non-Employees . Accordingly, the measurement date for the fair value of the equity instruments issued is +determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date +at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value +of the equity instrument is recognized over the term of the consulting agreement. +Convertible Instruments +The Company accounts for hybrid +contracts that feature conversion options in accordance with ASC No. 815, Derivatives and Hedging Activities ( “ASC No. +815” ). ASC No. 815 requires companies to bifurcate conversion options from their host instruments and account for them as freestanding +derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics +and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host +contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured +at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument +with the same terms as the embedded derivative instrument would be considered a derivative instrument. +Conversion options that contain +variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities +at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible +instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, +in accordance with ASC No. 470-20, Debt with Conversion and Other Options ( “ASC No. 470-20” ). Under ASC No. +470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt +instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction +and the effective conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined +that the embedded conversion options should be bifurcated from their host instruments) in accordance with ASC No. 815. +F- 24 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Concentration of Credit Risk +Financial instruments that +potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. +Cash and cash equivalents +are invested in banks in the U.S., UK and Israel. Such deposits in the United States may be in excess of insured limits and are not insured +in other jurisdictions. +Trade receivables of the Company +and its subsidiaries are mainly derived from sales to customers located primarily in the U.S., Europe and Israel. The Company performs +ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is +determined with respect to those amounts that the Company and its subsidiaries have determined to be doubtful of collection. +Comprehensive Income (Loss) +The Company reports comprehensive +loss in accordance with ASC No. 220, Comprehensive Income . This statement establishes standards for the reporting and presentation +of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents +all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined +that its items of other comprehensive loss relate to changes in foreign currency translation adjustments and unrealized gains and losses +in its warrants in AVLP. +Fair value of Financial Instruments +In accordance with ASC No. +820, Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for +the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +The guidance also establishes +a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable +inputs by requiring that the most observable inputs be used when available. Observable inputs include those that market participants would +use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable +inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset +or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +Level 1: Quoted market prices in active markets +for identical assets or liabilities. +Level 2:Inputs other than Level 1 that are +observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are +not active; or model-derived valuations. All significant inputs used in our valuations are observable or can be derived principally from +or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs also include +quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed models such +as a discounted cash flow model. +Level 3: Unobservable inputs that are supported +by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts of financial +instruments carried at cost, including cash and cash equivalents, accounts receivables and accounts and other receivable – related +party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the +short-term maturities of such instruments. +F- 25 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The categorization of a financial +instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The +following table sets forth the Company’s financial instruments (see Note 5 and Note 10) that were measured at fair value on a recurring +basis by level within the fair value hierarchy: +Fair Value Measurement at December 31, 2020 +Total +Level 1 +Level 2 +Level 3 +Investments in convertible promissory notes and +advances of AVLP and Alzamend – related +parties +$ 10,668,470 +$ — +$ — +$ 10,668,470 +Investments in common stock and derivative +instruments of AVLP – a related party +5,486,140 +499,588 +— +4,986,552 +Investment in common stock and warrants of +Alzamend – a related party +653,251 +— +— +653,251 +Investments in marketable equity securities +2,562,983 +2,562,983 +— +— +Total Investments +$ 19,370,844 +$ 3,062,571 +$ — +$ 16,308,273 +Fair Value Measurement at December 31, 2019 +Total +Level 1 +Level 2 +Level 3 +Investments in convertible promissory note of AVLP – a +related party +$ 6,540,720 +$ — +$ — +$ 6,540,720 +Investments in common stock and derivative instruments +of AVLP – a related party +1,569,286 +238,602 +— +1,330,684 +Investment in common stock of Alzamend – a related +party +558,938 +— +— +558,938 +Investments in marketable equity securities +639,647 +639,647 +— +— +Investments in warrants of public companies +9,174 +— +— +9,174 +Total Investments +$ 9,317,765 +$ 878,249 +$ — +$ 8,439,516 +We assess the inputs used to measure fair value +using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market. See Note +10 for activity related to investments in convertible promissory notes and advances of AVLP and Alzamend – related parties, investments +in common stock and derivative instruments of AVLP – a related party, and investment in common stock and warrants of Alzamend – +a related party. The decline in investment in warrants of public companies was due to a decrease upon remeasurement of fair value of the +underlying warrants. +Debt Discounts +The Company accounts for debt +discount according to ASC No. 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through periodic charges +to interest expense over the term of the related financial instrument using the effective interest method. During the years ended December +31, 2020 and 2019, the Company recorded amortization of debt discounts of $7,251,365 and $3,709,993, respectively. +Leases +Effective January 1, 2019, +the Company accounts for its leases under ASC 842, Leases . Under this guidance, arrangements meeting the definition of a lease +are classified as operating or financing leases. As of January 1, 2019, we only had operating leases. Operating leases are recognized +as Right-of-use (“ROU”) assets, Operating lease liability, current, and Operating lease liability, non-current on our consolidated +balance sheets. Lease assets and liabilities are recognized based on the present value of the future minimum lease payments over the lease +term at commencement date. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information +available at commencement date in determining the present value of future payments. In certain of our lease agreements, we receive rent +holidays and other incentives. We recognize lease costs on a straight-line basis over the lease term without regard to deferred payment +terms, such as rent holidays, that defer the commencement date of required payments. Our lease terms may include options to extend or +terminate the lease when it is reasonably certain that we will exercise that option. Leasehold improvements are capitalized at cost and +amortized over the lesser of their expected useful life or the life of the lease, without assuming renewal features, if any, are exercised. +We do not separate lease and non-lease components for our leases. +F- 26 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Net Loss per Share +Net loss per share is computed +by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation of the basic +and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock equivalents is anti-dilutive +due to the Company’s net loss position for all periods presented. The Company has included 6,500 warrants, which are exercisable +for shares of Common Stock on a one-for-one basis, in its earnings per share calculation for the years ended December 31, 2020 and 2019. +Anti-dilutive securities, which are convertible into or exercisable for Common Stock, consist of the following at December 31, 2020 and +2019: +December 31, +2020 +2019 +Stock options +850,925 +2,763 +Warrants (1) +3,309,060 +72,518 +Convertible notes +440,862 +1,252,163 +Conversion of preferred stock +2,232 +2,232 +Total +4,603,079 +1,329,676 +(1) The +Company has excluded 6,500 warrants issued in April 2019, which may be exercised by means of a cashless exercise into 6,500 shares of +Common Stock, in its anti-dilutive securities but included the warrants in its weighted average shares outstanding. +Reclassifications +Certain prior year amounts +have been reclassified for comparative purposes to conform to the current-year financial statement presentation. These reclassifications +had no effect on previously reported results of operations. In addition, certain prior year amounts from the restated amounts have been +reclassified for consistency with the current period presentation. +Recently Adopted Accounting Pronouncements +In August 2018, the Financial +Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-13, Disclosure Framework – +Changes to the Disclosure Requirements for Fair Value Measurement, which will modify the disclosure requirements on fair value measurements +in Topic 820, Fair Value Measurement, including the removal of certain disclosure requirements. The amendments in ASU 2018-13 are effective +for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company adopted +the new disclosure requirements for the period ending March 31, 2020. The additional components of this release did not have a material +impact on the Company’s consolidated financial statements. +In June 2016, the FASB issued +ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU +2016-13”). ASU 2016-13 changes how entities will measure credit losses for most financial assets and other instruments that are +not measured at fair value through net income. This update introduces the current expected credit loss (“CECL”) model, which +will require an entity to measure credit losses for certain financial instruments and financial assets, including trade receivables. Under +this update, on initial recognition and at each reporting period, an entity will be required to recognize an allowance that reflects the +entity’s current estimate of credit losses expected to be incurred over the life of the financial instrument. ASU 2016-13 is effective +for public companies in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company +has completed its evaluation process and the January 1, 2020 adoption did not have a material impact to the Company’s consolidated +financial statements for the year ended December 31, 2020. +F- 27 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Recently Issued Accounting Standards +In December 2019, the FASB +issued ASU No. 2019-12, “ Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), +which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions +to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This guidance +is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. +The Company is currently evaluating the impact of this standard on its consolidated financial statements and related disclosures. +4. Discontinued +Operations and Deconsolidation of I.AM +On March 16, 2020, to try +and mitigate the spread of COVID-19, San Diego County health officials issued orders mandating that all restaurants must end dine-in services. +As a result of these temporary closures and the deteriorating business conditions at the Company’s restaurant businesses, during +the first quarter of 2020, the Company concluded that discontinuing the operations of I.AM was ultimately in its best interest. In addition, +during the first quarter of 2020, due to deteriorating business conditions in the cryptocurrency mining sector, the Company ceased operations +at Digital Farms. The Company’s decision to cease cryptocurrency mining operations in 2020 was based several factors, which had +negatively affected the number of active miners the Company operated, including the market prices of digital currencies at the time, power +cost considerations available to Digital Farms, and a significant increase in the difficulty of mining blocks of cryptocurrency. +Digital +Farms was established to pursue a variety of digital currencies and mined the top three cryptocurrencies for its own account. Although +the Company has ceased operations at Digital Farms, since the assets and operations have not yet been abandoned, sold or distributed, +these assets do not yet meet the requirement for presentation as discontinued operations. In the first quarter of 2020, management determined +that the permanent closing of the restaurant operations met the criteria for presentation as discontinued operations. Accordingly, the +results of the restaurant operations are presented as discontinued operations in our consolidated statements of operations and comprehensive +loss and are excluded from continuing operations for all periods presented. In addition, the assets and liabilities of the restaurant +operations are classified as held for sale in our consolidated balance sheets for all periods presented. +On November 2, 2020, I.AM +filed a voluntary petition for bankruptcy under Chapter 7 in the United States Bankruptcy Court in the Central District of California, +Santa Ana Division, case number 8:20-bk-13076. As a result of I.AM’s bankruptcy filing on November 2, 2020, Ault Global ceded authority +for managing the business to the Bankruptcy Court. For this reason, the Company concluded that Ault Global had lost control of I.AM, and +no longer had significant influence over I.AM. Therefore, the Company deconsolidated I.AM effective with the filing of the Chapter 11 +bankruptcy in November 2020 and recorded a gain on deconsolidation of 2,358,992. +The following tables summarize +the major classes of assets and liabilities included as part of discontinued operations as of December 31, 2019: +December 31, 2019 +Current assets +Cash and cash equivalents +$ 5,170 +Accounts receivable +83,885 +Inventories, net +60,341 +Prepaid expenses and other current assets +131,956 +Total current assets classified as held for sale +281,352 +Property and equipment, net +504,802 +Right-of-use assets +1,098,466 +Total assets classified as held for sale +$ 1,884,620 +Current liabilities +Accounts payable and accrued expenses +$ 881,601 +Operating lease liability, current +229,574 +Other current liabilities +482,375 +Total current liabilities classified as held for sale +1,593,550 +Long term liabilities +Operating lease liability, non-current +951,072 +Total liabilities classified as held for sale +$ 2,544,622 +F- 28 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The restaurant operations +are included in our results as discontinued operations through March 16, 2020, the date of closing of the restaurants. The following tables +summarize the major classes of line items included in loss from discontinued operations: +For the Year Ended +December 31, +2020 +2019 +Revenue +$ 543,327 +$ 4,149,646 +Cost of revenue +(160,310 ) +(1,149,645 ) +Selling and marketing +— +(221,813 ) +General and administrative +(555,445 ) +(4,146,815 ) +Impairment of property and equipment and right-of-use assets +(1,525,316 ) +— +Impairment of Impairment of intangible assets +— +(610,000 ) +Impairment of goodwill +— +(265,252 ) +Gain on deconsolidation of I.AM +2,358,992 +— +Interest expense +— +(789 ) +Income (loss) from discontinued operations +$ 661,248 +$ (2,244,668 ) +5. Marketable Securities +Marketable securities in equity +securities with readily determinable market prices consisted of the following as of December 31, 2020 and 2019: +Marketable equity securities at December 31, 2020 +Gross unrealized +Gross realized +Cost +gains (losses) +gains (losses) +Fair value +Common shares +$ 1,505,686 +$ +1,083,532 +$ +(26,235) +$ 2,562,983 +Marketable equity securities at December 31, 2019 +Gross unrealized +Gross realized +Cost +gains (losses) +gains (losses) +Fair value +Common shares +$ 423,025 +$ +216,622 +$ +- +$ 639,647 +The following table presents additional information about marketable +equity securities: +Marketable +Equity Securities +Balance at January 1, 2019 +$ 178,597 +Purchases of marketable equity securities +485,000 +Marketable equity securities received upon warrant exercise +381 +Marketable equity securities received upon conversion of preferred stock +202,145 +Sales of marketable equity securities +(580,721 ) +Realized gains on marketable equity securities +95,340 +Unrealized gains on marketable equity securities +258,905 +Balance at January 1, 2020 +$ 639,647 +Purchases of marketable equity securities +1,425,341 +Sales of marketable equity securities +(373,360 ) +Realized gains on marketable equity securities +75,346 +Unrealized gains on marketable equity securities +796,009 +Balance at December 31, 2020 +$ 2,562,983 +F- 29 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +At December 31, 2020 and 2019, +the Company had invested in the marketable equity securities of certain publicly traded companies. During the year ended December 31, +2020, unrealized gains of $796,009 were included in net income as a component of change in fair value of equity securities. The Company’s +investment in marketable equity securities will be revalued on each balance sheet date. The fair value of the Company’s holdings +in marketable equity securities at December 31, 2020 and 2019 is a Level 1 measurement based on quoted prices in an active market. +At December 31, 2020 and 2019, +the Company also held equity investments in private companies and an investment in a limited partnership. These investments do not have +readily determinable fair values and have been measured at cost less impairment, if any, and adjusted for observable price changes for +identical or similar investments of the issuer. +6. INVENTORIES +At December 31, 2020 and 2019, inventories +consist of: +2020 +2019 +Raw materials, parts and supplies +$ 1,188,616 +$ 1,522,082 +Work-in-progress +1,923,426 +534,937 +Finished products +261,809 +424,492 +Total inventories +$ 3,373,851 +$ 2,481,511 +7. PROPERTY AND EQUIPMENT, NET +At December 31, 2020 and 2019, property +and equipment consist of: +December 31, +2020 +2019 +Cryptocurrency machines and related equipment +$ 567,216 +$ 567,216 +Computer, software and related equipment +3,056,711 +2,518,187 +Office furniture and equipment +489,315 +441,613 +Leasehold improvements +1,352,124 +1,230,407 +5,465,366 +4,757,423 +Accumulated depreciation and amortization +(3,342,636 ) +(2,970,030 ) +Property and equipment, net +$ 2,122,730 +$ 1,787,393 +Under the guidance of ASC +360, Impairment or Disposal of Long-lived Assets, a long-lived asset or asset group (including intangibles) will be tested for recoverability +whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. During the first quarter of 2020, +based upon the deteriorating business conditions for restaurants in the San Diego County as result of the spread of COVID-19 and the decline +in projected cash flows over the life of the restaurant equipment, the Company performed an undiscounted cash flow test to determine if +the restaurant equipment was impaired. The undiscounted cash flows were less than the carrying amount of the Company’s restaurant +equipment and therefore, the carrying amount of the assets were compared to the fair value of the restaurant equipment, and the Company +determined that there were impairment charges to be recorded on the restaurant equipment. Impairment charges for the year ended December +31, 2020 were in an amount equal to the cost of the Company’s restaurant equipment, net of depreciation of $504,802, and are included +as a component of net loss from discontinued operations (see Note 4). +F- 30 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +For the years ended December +31, 2020 and 2019, depreciation expense amounted to $391,597 and $2,570,511, respectively. +8. INTANGIBLE ASSETS, NET +At December 31, 2020 and 2019 intangible +assets consist of: +December 31, +December 31, +2020 +2019 +Trade name and trademark +$ 1,551,197 +$ 1,039,307 +Customer relationships +3,441,654 +2,406,434 +Domain name and other intangible assets +689,920 +641,809 +5,682,771 +4,087,550 +Accumulated depreciation and amortization +(1,292,383 ) +(880,562 ) +Intangible assets, net +$ 4,390,388 +$ 3,206,988 +The Company’s trade +names and trademarks were determined to have an indefinite life. The remaining definite lived intangible assets are primarily being amortized +on a straight-line basis over their estimated useful lives. Amortization expense was $335,776 and $502,656, respectively, for the years +ended December 31, 2020 and 2019. +The customer +relationships are subject to amortization over their estimated useful lives, which range between 3 and 14 years. The following +table presents estimated amortization expense for each of the succeeding five calendar years and thereafter. +2021 +$ 369,790 +2022 +318,793 +2023 +318,793 +2024 +318,793 +2025 +318,793 +Thereafter +1,194,229 +$ 2,839,191 +9. GOODWILL +The Company’s goodwill +relates to the acquisition of a controlling interest in Microphase on June 2, 2017 and the acquisitions of Enertec on May 22, 2018, and +Relec on November 30, 2020. The following table summarizes the changes in our goodwill for the years ended December 31, 2020 and 2019: +Goodwill +Balance as of January 1, 2019 +$ 8,197,818 +Impairment +(480,953 ) +Effect of exchange rate changes +384,082 +Balance as of December 31, 2019 +8,100,947 +Acquisition of Relec +1,147,894 +Effect of exchange rate changes +396,485 +Balance as of December 31, 2020 +$ 9,645,686 +F- 31 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +10. INVESTMENTS – RELATED PARTIES +Investments in AVLP and Alzamend +Neuro, Inc. (“Alzamend”) at December 31, 2020 and 2019, are comprised of the following: +December 31, +December 31, +2020 +2019 +Investment in convertible promissory note of AVLP +$ 11,269,136 +$ 9,595,079 +Short term advance in Alzamend +750,000 +— +Investment in convertible promissory note of Alzamend +50,000 +— +Accrued interest in convertible promissory notes of AVLP and Alzamend +2,026,812 +2,025,475 +Total investment in convertible promissory note of AVLP – Gross +14,095,948 +11,620,554 +Less: original issue discount +(3,870 ) +— +Less: provision for loan losses +(3,423,608 ) +(5,079,834 ) +Total investment in convertible promissory note of AVLP and Alzamend +10,668,470 +6,540,720 +Investment in derivative instruments of AVLP +4,986,552 +1,330,684 +Investment in common stock of AVLP +499,588 +238,602 +Investment in common stock and warrants of Alzamend +653,251 +558,938 +Investment in derivative instruments and common stock of AVLP and Alzamend +6,139,391 +2,128,224 +Total investment in AVLP and Alzamend – Net +$ 16,807,861 +$ 8,668,944 +Investment in warrants and common stock of AVLP and Alzamend +$ 6,139,391 +$ 2,128,224 +Investment in convertible promissory notes and advances of AVLP and Alzamend +10,668,470 +6,540,720 +Total investment in AVLP and Alzamend – Net +$ 16,807,861 +$ 8,668,944 +The following table summarizes +the changes in our investments in AVLP and Alzamend during the years ended December 31, 2020 and 2019: +Investment in +Investment in +convertible +warrants and +promissory notes +Total +common stock +and advances +investment +of AVLP and +of AVLP and +in AVLP and +Alzamend +Alzamend +Alzamend – Net +Balance at January 1, 2019 +$ 3,043,499 +$ 5,611,621 +$ 8,655,120 +Investment in convertible promissory notes of AVLP +— +1,600,164 +1,600,164 +Investment in common stock of AVLP and Alzamend +261,132 +— +261,132 +Fair value of derivative instruments issued by AVLP +1,050,918 +— +1,050,918 +Unrealized loss in derivative instruments of AVLP +(1,950,875 ) +— +(1,950,875 ) +Unrealized loss in common stock of AVLP and Alzamend +(276,450 ) +— +(276,450 ) +Provision for loan losses +— +(4,000,000 ) +(4,000,000 ) +Accretion of discount +— +2,307,777 2,307,777 +2,307,777 +Accrued Interest +— +1,021,158 +1,021,158 +Balance at December 31, 2019 +$ 2,128,224 +$ 6,540,720 +$ 8,668,944 +Investment in convertible promissory notes of AVLP +— +1,330,283 +1,330,283 +Investment in convertible promissory note of Alzamend +— +38,128 +38,128 +Investment in common stock of AVLP and Alzamend +45,484 +— +45,484 +Investment in warrants of Alzamend +11,872 +— +11,872 +Short term advance in Alzamend +— +750,000 +750,000 +Fair value of derivative instruments issued by AVLP +343,774 +— +343,774 +Unrealized gain in derivative instruments of AVLP +3,312,094 +— +3,312,094 +Unrealized gain in common stock of AVLP and +Alzamend +297,943 +— +297,943 +Accretion of discount +— +8,002 +8,002 +Provision for loan losses +— +2,000,000 +2,000,000 +Accrued Interest +— +1,337 +1,337 +Balance at December 31, 2020 +$ 6,139,391 +$ 10,668,470 +$ 16,807,861 +F- 32 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Investments in AVLP +The Company’s investments in AVLP, a related party controlled +by Philou Ventures, LLC (“Philou”), an affiliate of the Company, consist of convertible promissory notes, derivative instruments +and shares of AVLP common stock. As of December 31, 2020, the Company has provided loans to AVLP in the principal amount $11,269,136 and, +in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants to purchase 22,537,871 shares of AVLP common +stock at an exercise price of $0.50 per share for a period of five years. The warrants were determined by the issuer to be derivative +financial instruments. At December 31, 2020, the Company recorded a cumulative unrealized loss on its investment in warrants of AVLP of +$1,052,162 compared to a cumulative unrealized loss of $4,364,256 at December 31, 2019 representing the difference between the cost basis +and the estimated fair value of the warrants in the Company’s accumulated other comprehensive income in the stockholder's equity +section of the Company’s consolidated balance sheet. During the year ended December 31, 2020, the Company recognized, in other comprehensive +loss, net unrealized gain on derivative securities of related party of $3,312,094 compared to a net unrealized loss on derivative securities +of related party of $1,950,875 during the year ended December 31, 2019. The Company’s investment in AVLP will be revalued on each +balance sheet date. The fair value of the Company’s holdings in the AVLP warrants was estimated using the Black-Scholes option-pricing +method. The risk-free rate, which ranged between 0.13% and 2.98%, was derived from the U.S. Treasury yield curve, matching the term of +our investment, in effect at the measurement date. The volatility factor which ranged between 68.7% and 104.6% was determined based on +historical stock prices for similar technology companies with market capitalizations under $100 million. The warrant valuation is a Level +3 measurement. +In accordance with ASC No. +310, Receivables (“ASC 310”), the Company had accounted for its convertible promissory notes in AVLP at amortized +cost, which represents the amount at which the convertible promissory notes were acquired, adjusted for accrued interest and accretion +of original issue discount and discount attributed to the fair value of the warrants that the Company received in conjunction with its +investment. Interest was accreted using the effective interest method. The Company recorded interest on an accrual basis and recognized +it as earned in accordance with the contractual terms of the convertible promissory notes, to the extent that such amounts are expected +to be collected. During the year ended December 31, 2019, the Company recorded $2,307,777 of interest income for the discount accretion and +$1,021,158 of interest income from the contractual 12% rate provided for by the convertible promissory notes. During the years ended December +31, 2020, no interest income was recognized from the Company’s investment in AVLP. +The Company evaluated the +collectability of both interest and principal for the convertible promissory notes in AVLP to determine whether there was an impairment. +Based on current information and events, primarily the value of the underlying conversion feature +and current economic events, the Company concluded that an impairment existed at December 31, 2019. At December 31, 2020, the Company +determined that the fair value of the convertible promissory notes in AVLP was approximately $9,872,340. The Company’s determination +of fair value was based upon the estimated present value of a future liquidity event combined with the closing price of AVLP’s common +stock at December 31, 2020. Impairment assessments require significant judgments and are based on significant assumptions related to the +borrower’s credit risk, financial performance, expected sales, and estimated fair value of the collateral. +During the years ended December +31, 2020 and 2019, the Company acquired 5,000 shares of AVLP common stock for $1,274 and 91,000 shares of AVLP common stock for $53,032, +respectively, in each case in the open market. At December 31, 2020, the closing market price of AVLP’s common stock was $0.50, +an increase from $0.24 at December 31, 2019. The Company has determined that its investment in AVLP marketable equity securities should +be accounted for in accordance with ASC No. 820, Fair Value Measurements and Disclosures . Based upon the closing market price +of AVLP common stock at December 31, 2020, the Company’s investment in AVLP common stock had an unrealized loss of $248,248. +F- 33 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +In aggregate, the Company +has 999,175 shares of AVLP common stock which represents 18.0% of AVLP’s outstanding shares of common stock. The Company has determined +that AVLP is a variable interest entity (“VIE”) as it does not have sufficient equity at risk. The Company does not consolidate +AVLP because the Company is not the primary beneficiary and does not have a controlling financial interest. To be a primary beneficiary, +an entity must have the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, among +other factors. Although the Company has made a significant investment in AVLP, the Company has determined that Philou, which controls +AVLP through the voting power conferred by its equity investment and which is deemed to be more closely associated with AVLP, is the primary +beneficiary. As a result, AVLP’s financial position and results of operations are not consolidated in our financial position and +results of operations. +Investments in Alzamend +The Company’s investments +in Alzamend, a related party, consist of a convertible promissory note, short-term advance, warrants and shares of Alzamend common stock. +At December 31, 2020, the Company has provided Alzamend a short-term advance of $750,000 and invested $50,000 in an 8% convertible promissory +note. In conjunction with the issuance of the 8% convertible promissory note, Alzamend issued to the Company warrants to purchase 16,667 +shares of Alzamend common stock at an exercise price of $3.00 per share for a period of five years. The Company computed the fair value +of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded discount in the amount of +$11,872 based on the estimated fair value of the warrants. At December 31, 2020, the Company recorded a cumulative unrealized loss on +its investment in warrants of Alzamend of $453, representing the difference between the cost basis and the estimated fair value of the +warrants in the Company’s net loss from continuing operations on the Company’s consolidated statements of operations and comprehensive +loss. The Company’s investment in Alzamend will be revalued on each balance sheet date. The fair value of the Company’s holdings +in the Alzamend warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 0.28% was derived from the +U.S. Treasury yield curve, matching the term of our investment, in effect at the measurement date. The volatility factor of 103.7% was +determined based on historical stock prices for similar companies with market capitalizations under $100 million. The warrant valuation +is a Level 3 measurement. +In accordance with ASC No. +310, Receivables (“ASC 310”), the Company had accounted for its convertible promissory notes in Alzamend +at amortized cost, which represents the amount at which the convertible promissory notes were acquired, adjusted for accrued interest +and accretion of the discount attributed to the fair value of the warrants that the Company received in conjunction with its investment. +Interest was accreted using the effective interest method. The Company recorded interest on an accrual basis and recognized it as earned +in accordance with the contractual terms of the convertible promissory notes, to the extent that such amounts are expected to be collected. +During the year ended December 31, 2020, the Company recorded $8,002 of interest income for the discount accretion and $1,337 of +interest income from the contractual 8% rate provided for by the convertible promissory notes. +The Company evaluated the +collectability of both interest and principal for the convertible promissory notes in Alzamend to determine whether there was an impairment. +Based on current information and events, primarily the value of the underlying conversion feature +and current economic events, the Company concluded that no impairment existed at December 31, 2020. +During the years ended December +31, 2020 and 2019, the Company also acquired 55,263 shares of Alzamend common stock for $44,210 and 372,625 shares of Alzamend common +stock for $208,100, respectively. At December 31, 2020, the estimated fair value of Alzamend’s common stock was $1.50. The Company +has determined that its investment in Alzamend marketable equity securities should be accounted for in accordance with ASC No. 820, Fair +Value Measurements and Disclosures and based upon the estimated fair value of Alzamend common stock at December 31, 2020, the Company’s +investment in Alzamend common stock had an unrealized gain of $389,522. +11. INVESTMENTS IN LIMITED PARTNERSHIP +On June 8, 2018, the Company +entered into a limited partnership agreement, in which it agreed to become a limited partner in the partnership (the “NY Partnership”). +The NY Partnership is a limited partner in the partnership that is responsible for the construction and related activities of a hotel +in New York City. In connection with this transaction, the Company has agreed to finance a portion of the capital required by the NY Partnership. +As of December 31, 2020, the Company had invested an aggregate of $1,869,000 in the NY Partnership. The Company has no further required +funding obligations related to the hotel. +F- 34 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +12. OTHER INVESTMENTS, RELATED PARTIES +The Company’s other +related party investments primarily consist of two investments. +MTIX, Ltd. +On December 5, 2017, the Company +entered into an exchange agreement with WT Johnson pursuant to which the Company issued to WT Johnson two convertible promissory notes +in the principal amounts of $600,000 (“Note A”) and $1,667,766 (“Note B”), in exchange for cancellation of amounts +due to WT Johnson by MTIX Ltd., a related party of the Company. +During December 2017, the +Company issued 750 shares of its common stock to WT Johnson & Sons upon the conversion of Note A and WT Johnson subsequently sold +the 750 shares. The proceeds from the sale of shares of common stock received upon the conversion of Note A were sufficient to satisfy +the entire $2,267,766 obligation as well as an additional $400,500 of value added tax due to WT Johnson. Concurrent with entering into +the exchange agreement, the Company received a promissory note in the amount of $2,668,266 from MTIX and cancelled Note B. At December +31, 2020 and 2019, the Company has valued the note receivable at $600,000, the carrying amount of Note A. The Company will recognize the +remainder of the amount due from MTIX upon payment of the promissory note by MTIX. +Israeli Property +During the year ended December +31, 2017, our former President, Amos Kohn, purchased certain real property that serves as a facility for the Company’s business +operations in Israel. The Company made $300,000 of payments to the seller of the property and received a 28% undivided interest in the +real property (the “Property”). The Company’s subsidiary, Coolisys Technologies, Inc., entered into a Trust Agreement +and Tenancy in Common Agreement with Roni Kohn, who owns a 72% interest in the Property, the daughter of Mr. Kohn and an Israeli citizen. +The Property was purchased to serve as a residence/office facility for the Company in order to oversee its Israeli operations and to expand +its business in the high-tech industry located in Israel. Pursuant to the Trust Agreement, Ms. Kohn will hold and manage Coolisys’ +undivided 28% interest in the Property. The trust will be in effect until it is terminated by mutual agreement of the parties. During +the term of the trust, Ms. Kohn will not sell, lease, sublease, transfer, grant, encumber, change or effect any other disposition with +respect to the Property or Coolisys’ interest without the Company’s approval. +Under the Tenancy in Common +Agreement, Coolisys and its executive officers shall have the exclusive rights to use the Property for the Company and its affiliates’ +business operations. The Property shall be managed by Ms. Kohn. Further, pursuant to the Tenancy in Common Agreement, for each completed +calendar month of employment of Mr. Kohn by the Company, Ms. Kohn shall have the right to purchase a portion of the Company’s interest +in the Property. Such right shall fully vest at the end of five years of continuous employment and the Trustee shall have the right to +purchase the Company’s 28% interest in the Property for a nominal price. The Company will amortize its $300,000 investment over +the ten-year right of use period, subject to a cliff vesting after five years. During the years ended December 31, 2020 and 2019, the +Company recognized $30,000 in amortization expense. At December 31, 2020 and 2019, the unamortized balance of the Israeli Property was +$202,500 and $232,500, respectively. If Mr. Kohn is not employed by the Company, the Company shall have the right to demand that Ms. Kohn +purchase the Company’s remaining interest in the Property that was not subject to vesting for the fair market value of such unvested +Property interest. +13. ACQUISITIONS +Business +combinations are accounted for under the acquisition method of accounting in accordance with ASC No. 805, Business Combinations . +Under the acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values. Goodwill is recorded +to the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired less liabilities +assumed at the date of acquisition. +F- 35 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Acquisition during 2020 +Relec Electronics +Ltd +On November 9, 2020, GWW entered into a Stock Purchase Agreement (the +“Agreement”) with Tabard Holdings Inc., a Delaware corporation and wholly owned subsidiary of GWW (“Tabard”), +the legal and beneficial owners (the “Sellers”) of 100% of the issued shares in the capital of Relec Electronics Ltd., a corporation +organized under the laws of England and Wales (“Relec”), and Peter Lappin, in his capacity as the representative of the Sellers +(the “Sellers’ Representative”). Relec was established in 1978 and provides specialist power conversion and display +products. The acquisition of Relec expands GWW’s product offering and geographic reach. On November 30, 2020, the acquisition of +Relec closed for an aggregate cash purchase price of $3,765,084, net of cash acquired, of which $3,627,534 had been paid at December 31, +2020. Pursuant to the Agreement, Tabard may be required to pay the Sellers a maximum of £500,000, or approximately $667,000, during +2021, 2022 and 2023. These earn-out payments are based on a combination of Relec’s gross margin and its minimum earnings before +income taxes, depreciation and amortization. +Upon initial measurement, components of the purchase +price are as follows: +Relec +Accounts receivable +$ 632,910 +Prepaid and other current assets +53,127 +Inventories, net +993,968 +Property and equipment +94,167 +Customer relationships +900,000 +Trade name +500,000 +Accounts payable and accrued expenses +(556,982 ) +Net assets acquired +2,617,190 +Goodwill +1,147,894 +Purchase price +$ +3,765,084 +14. STOCK-BASED COMPENSATION +Under the Company's 2018 Stock +Incentive Plan (the “2018 Plan”), 2017 Stock Incentive Plan (the “2017 Plan”), 2016 Stock Incentive Plan (the +“2016 Plan”) and the 2012 Stock Option Plan, as amended (the “2012 Plan”) (collectively, the “Plans”), +options may be granted to employees, officers, consultants, service providers and directors of the Company. On July 19, 2019, the Company’s +stockholders approved an amendment to the 2018 Plan which increased the number of shares of the Company’s common stock that may +be issued thereunder to a total of 175,000 shares. The Plans, as amended, provide for the issuance of a maximum of 184,216 shares of the +Company’s common stock. +Options granted under the +Plans have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and become exercisable +based on a vesting schedule determined at the date of grant. Typically, options granted generally become fully vested after four +years. Any options that are forfeited or cancelled before expiration become available for future grants. The options expire between 5 +and 10 years from the date of grant. Restricted stock awards granted under the Plans are subject to a vesting period determined at +the date of grant. As of December 31, 2020, an aggregate of 6,693 of the Company's options are still available for future grant. +During the years ended December +31, 2020 and 2019, the Company did not grant any options under the Plans. Generally, options granted under the Plans become fully vested +after four years. During the years ended December 31, 2020 and 2019, the Company issued 102,500 and 69,375, respectively, shares of common +stock to its consultants and service providers. The grant date fair value of these shares amounted to $182,575 and $338,619 respectively, +which was determined from the closing price of the Company’s common stock on the date of issuance. +The options outstanding as +of December 31, 2020, have been classified by exercise price, as follows: +F- 36 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$480 - $560 +894 +4.95 +$ 537.34 +592 +$ 534.25 +$1,208 - $1,352 +31 +2.63 +$ 1,339.20 +31 +$ 1,339.20 +$480 - $1,352 +925 +4.87 +$ 564.43 +623 +$ 574.60 +Issuances outside of Plans +$1.79 +850,000 +9.72 +$ 1.79 +0 +$ 0.00 +Total Options +$480 - 1,856 +850,925 +9.71 +$ 2.40 +623 +$ 574.60 +On +December 31, 2020 and 2019, the aggregate intrinsic value of stock options outstanding was $2,176,000 and nil, respectively. On December +31, 2020 and 2019, there was no aggregate intrinsic value of stock options that were exercisable. The intrinsic value for stock options +is calculated based on the exercise price of the underlying awards and the fair value of the Company’s common stock as of the period-end +date. +The total stock-based compensation +expense related to stock options and stock awards issued pursuant to the Plans to the Company’s employees, consultants and directors, +included in reported net loss for the years ended December 31, 2020 and 2019, is comprised as follows: +Year Ended December 31, +2020 +2019 +Stock-based compensation from Plans +$ 260,033 +$ 715,877 +Stock-based compensation from issuances outside of Plans +32,250 +868,114 +Total Stock-based compensation +$ 292,283 +$ 1,583,991 +A summary of option activity +under the Company's stock option plans as of December 31, 2020 and 2019, and changes during the years ended are as follows: +Outstanding Options +Weighted +Weighted +Average +Shares +Average +Remaining +Aggregate +Available +Number +Exercise +Contractual +Intrinsic +for Grant +of Shares +Price +Life (years) +Value +January 1, 2019 +12,695 +4,328 +$ 576.40 +7.52 +$ 0 +Amendment to 2018 +SIP +162,500 +— +Restricted stock awards +(75,000 ) +— +Forfeited 1 +2910 +(2,940 ) +$ 853.47 +January 1, 2020 +103,105 +1,388 +$ 636.47 +6.33 +$ 0 +Restricted stock awards +(96,875 ) +— +Forfeited +463 +(463 ) +$ 780.54 +December 31, 2020 +6,693 +925 +$ 564.43 +4.87 +$ 0 +1 Includes +options that were issued pursuant to the Company’s 2002 Plan and are not available for future issuance. +F- 37 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +As of December 31, 2020, there +was $122,613 of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Plans. That +cost is expected to be recognized over a weighted average period of 1.61 years. +On December 31, 2020, Enertec +issued Zvika Avni, the Chief Executive Officer of Enertec, a warrant to purchase 27,889 shares of Enertec common stock, at an exercise +price per share of $0.01. On the date of issuance 251,000 shares of Enertec common stock were issued and outstanding. The warrant is immediately +exercisable with a ten-year life. The stock-based compensation expense related to the warrant included in reported net loss for the year +ended December 31, 2020 was $813,405, based on the estimated fair value of the warrant on the date of issuance. The estimated fair value +of the warrant was based on observable market prices of the Company’s stock and extrapolated to Enertec based upon its relative +fair value within the Company as determined by equal weighting of revenues, operating income, and net tangible assets between the Company’s +subsidiaries. +15. WARRANTS +During the years ended December +31, 2020 and 2019, the Company issued a total of 7,542,987 warrants at an average exercise price of $2.64 per share. +Warrant issuances during 2019 +During the year ended December +31, 2019, the Company issued a total of 759,443 warrants at an average exercise price of $10.28 per share. +(i) On April 2, 2019, the Company issued warrants to purchase an aggregate of 388,888 shares of Common +Stock at an initial exercise price of $18.00 per share and (the “Common Warrants”) and (b) pre-funded warrants to +purchase up to 317,500 shares of Common Stock at an initial exercise price of $0.40 per share (the “Pre-Funded Warrants”) +in connection with an underwriting agreement with A.G.P./Alliance Global Partners (the “Underwriter”). In addition, the Company +has also issued the Underwriter a warrant to purchase a maximum of 15,555 additional shares of Common Stock at an initial exercise price +of $19.80 per share (see Note 24). +(ii) On May 20, 2019, the Company issued warrants to purchase an aggregate of 12,500 shares of Common +Stock at an exercise price equal to $12.00 per share of Common Stock in connection with the issuance of a 4% Convertible Promissory Note +in the aggregate principal amount of $660,000 (see Note 21). +(iii) On July 3, 2019, the Company issued warrants to purchase an aggregate of 25,000 shares of Common +Stock at an exercise price equal to $8.80 per share of Common Stock in connection with the issuance of a 12% Convertible Promissory Note +in the aggregate principal amount of $1,492,000. +Warrant issuances during 2020 +During the year ended December +31, 2020, the Company issued a total of 6,783,544 warrants at an average exercise price of $1.79 per share. +(i) On February 20, 2020, pursuant to the Master Exchange Agreement, the Company issued warrants to purchase +an aggregate of 1,700,361 shares of Common Stock at an average exercise price equal to $1.43 per share of Common Stock (see Note +19). +(ii) During the year ended December 30, 2020, the Company issued warrants to purchase an aggregate of 1,536,655 +shares of Common Stock at an average exercise price equal to $1.43 per share of Common Stock in connection with the issuance of the Esousa +12% short-term promissory notes in the aggregate principal amount of $2,000,000 (see Note 19). +F- 38 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +(iii) On April 13, 2020, the Company issued warrants to purchase up to +157,143 shares of Common Stock at an exercise price equal to $1.17 per share of Common Stock in connection with the issuance of +a 10% Convertible Promissory Note in the principal amount of $100,000 (see Note 21 ). +(iv) On May 28, 2020, the Company issued warrants to purchase an aggregate of 400,000 shares of Common +Stock at an exercise price equal to $1.07 per share of Common Stock in connection with the issuance of a promissory note in the principal +amount of $200,000 (see Note 19 ). +(v) On June 26, 2020, the Company issued warrants to purchase +an aggregate of 361,991 shares of Common Stock at an exercise price equal to $2.43 per share of Common Stock in connection with the +issuance of promissory notes in the aggregate principal face amount of $800,000 (see Note +19) . +Warrant issuances during 2020 requiring shareholder approval +Rule 713 of the NYSE American, +the national securities exchange on which the Common Stock is listed, requires stockholder approval of a transaction, other than a public +offering, involving the sale, issuance or potential issuance by an issuer of Common Stock (or securities convertible into or exercisable +for Common Stock) at a price less than the greater of book or market value which together with sales by officers, directors or principal +stockholders of the issuer equals 20% or more of presently outstanding Common Stock, or equal to 20% or more of presently outstanding +stock for less than the greater of book or market value of the stock, or when the issuance or potential issuance of additional shares +will result in a change of control of the issuer. Accordingly, absent shareholder approval, the holders of warrants issued between October +22, 2020 and November 19, 2020 to purchase an aggregate of 2,627,394 shares of Common Stock are prohibited from exercising the warrants +and receiving shares of Common Stock unless stockholder approval is obtained for the warrants. The Company anticipates seeking stockholder +approval for the exercise of all the warrants during the quarter ended June 30, 2021. +(vi) On October 22, 2020, the Company issued warrants to purchase +an aggregate of 729,927 shares of common stock at an exercise price equal to $3.01 per share of common stock in connection with the +issuance of a promissory note in the aggregate principal face amount of $2,000,000 (see Note +19) . +(vii) On October 27, 2020, the Company issued warrants to purchase +an aggregate of 425,000 shares of common stock at an exercise price equal to $2.20 per share of common stock in connection with the +issuance of promissory notes in the aggregate principal face amount of $850,000 (see Note +19) . +(viii) On October 27, 2020, the Company issued warrants to purchase +an aggregate of 148,936 shares of common stock at an exercise price equal to $2.59 per share of common stock in connection with the +issuance of promissory notes in the aggregate principal face amount of $350,000 (see Note +19) . +(ix) On November 19, 2020, the Company issued warrants to purchase +an aggregate of 1,323,531 shares of common stock at an exercise price equal to $1.87 per share of common stock in connection with +the issuance of promissory notes in the aggregate principal face amount of $2,250,000 (see +Note 19) . +The following table summarizes +information about common stock warrants outstanding at December 31, 2020: +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$— +6,500 +3.25 +$ — +6,500 +$— +$0.88 - $1.91 +3,237,016 +4.30 +$ 1.43 +3,237,016 +$0.88 - $1.91 +$8.00 - $19.80 +53,452 +3.37 +$ 12.74 +53,452 +$8.00 - $19.80 +$440 - $920 +16,225 +2.19 +$ 733.40 +16,225 +$440 - $920 +$1,040 - $2,000 +2,367 +2.18 +$ 1,404.85 +2,367 +$1,040 - $2,000 +$0.88 - $2,000 +3,315,560 +4.27 +$ 6.19 +3,315,560 +$6.19 +F- 39 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The Company has valued the +warrants at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables such +as the warrants’ term, exercise price, current stock price, risk-free interest rate and estimated volatility of our stock over the +contractual term of the warrants. The risk-free interest rate used in the calculations is based on the implied yield available on U.S. +Treasury issues with an equivalent term approximating the contractual life of the warrants. +The Company utilized the Black-Scholes +option pricing model and the assumptions used during the years ended December 31, 2020 and 2019: +Year Ended +December 31, 2020 +December 31, 2019 +Weighted average risk free interest rate +0.12% — 1.38% +1.75% — 2.28% +Weighted average life (in years) +1.42 — 5 +5.0 +Volatility +86.3% — 104.6 +85.5% —87.5% +Expected dividend yield +0 % +0 % +Weighted average grant-date fair value per +share of warrants granted +$ 1.21 +$ 10.34 +16. OTHER CURRENT LIABILITIES +Other current liabilities at December +31, 2020 and 2019 consist of: +December 31, +2020 +2019 +Accrued payroll and payroll taxes +$ 1,411,728 +$ 1,237,054 +Warranty liability +90,640 +80,412 +Other accrued expenses +287,457 +218,380 +$ 1,789,825 +$ 1,535,846 +17. LEASES +We have operating leases for +office space and restaurant locations. Our leases have remaining lease terms of 2 months to 11 years, some of which may include +options to extend the leases perpetually, and some of which may include options to terminate the leases within 1 year. +The following table provides +a summary of leases by balance sheet category as of December 31, 2020: +December 31, 2020 +Operating right-of-use assets +$ 4,317,778 +Operating lease liability - current +524,326 +Operating lease liability - non-current +3,854,573 +F- 40 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The components of lease expenses +for the year ended December 31, 2020, were as follows: +Year Ended +December 31, 2020 +Operating lease cost +$ 951,196 +Short-term lease cost +- +Variable lease cost +106,927 +The following tables provides +a summary of other information related to leases for the year ended December 31, 2020: +December 31, 2020 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ 1,024,478 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ - +Weighted-average remaining lease term - operating leases +7.3 years +Weighted-average discount rate - operating leases +10 % +Maturity of lease liabilities +under our non-cancellable operating leases as of December 31, 2020, are as follows: +Payments due by period +2021 +$ 938,240 +2022 +929,925 +2023 +952,526 +2024 +914,693 +2025 +697,692 +Thereafter +1,793,975 +Total lease payments +6,227,051 +Less interest +(1,848,152 ) +Present value of lease liabilities +$ 4,378,899 +18. ADVANCES ON FUTURE RECEIPTS +Advances +on future receipts as of December 31, 2020 and 2019 were nil and $2,210,392. Future receipts include cash, check, ACH, credit card, debit +card, bank card, charge card or other form of monetary payment. The Agreements on Future Receipts had been personally guaranteed by the +Company’s Executive Chairman and in one instance had also been guaranteed by Philou. During the years ended December 31, 2020 and +2019, non-cash interest expense of $86,506 and $495,361, respectively, was recorded from the amortization of debt discounts that were +recognized at inception of the agreements based primarily upon the difference between the amount of future receipts sold and the actual +proceeds received. +19. NOTES PAYABLE +Notes Payable at December +31, 2020 and 2019, are comprised of the following. +December 31, +2020 +2019 +Esousa purchased notes +$ - +$ 2,828,323 +Esousa additional purchased notes +200,000 +632,000 +Other short-term notes payable +1,088,899 +1,050,339 +Notes payable to Wells Fargo +182,615 +290,560 +Note payable to Dept. of Economic and Community Development +196,597 +229,096 +Paycheck Protection Program Loans +1,162,302 +— +SBA Economic Injury Disaster Loan +150,000 +— +Enertec Short term bank credit +1,404,096 +1,622,337 +Total notes payable +4,384,509 +6,652,655 +Less: +Unamortized debt discounts +— +(29,348 ) +Unamortized financing cost +— +(3,668 ) +Total notes payable, net of financing cost +4,384,509 +6,619,639 +Less: current portion +(4,048,009 ) +(6,137,015 ) +Notes payable – long-term portion +$ 336,500 +$ 482,624 +F- 41 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Master Exchange Agreement +On February 10, 2020, the +Company entered into a master exchange agreement (the “Master Exchange Agreement”) with Esousa Holdings, LLC (“Esousa” +or the “Creditor”) which acquired $4,163,481 in principal amount, plus accrued but unpaid interest, of certain promissory +notes that had been previously issued by the Company to Dominion Capital LLC (the “Dominion Short-Term Promissory Note”) and +the Canadian Special Opportunity Fund, LP (the “CSOF Short-Term Promissory Note” and with the Dominion Short-Term Promissory +Note, the “Esousa Purchased Notes”) in separate transactions. The Creditor also agreed to purchase additional notes and during +the three months ended September 30, 2020, Esousa acquired $2,240,015 in principal amount, plus accrued but unpaid interest, of certain +additional promissory notes that had been previously issued by us (the “Esousa Additional Purchased Notes” and collectively, +with the Esousa Purchased Notes, the “Notes”). Pursuant to the Master Exchange Agreement, the Creditor has the unilateral +right to acquire shares of the Company’s common stock (the “Exchange Shares”) in exchange for the Notes. +The following debt securities were acquired by +Esousa pursuant to the Master Exchange Agreement: +Dominion short-term promissory +note +On +June 18, 2019, the Company entered into a securities purchase agreement with Dominion Capital, LLC, a Connecticut limited liability company +(“Dominion”), to sell a 10% senior secured promissory note with a principal face amount of $2,900,000 and issue 12,500 shares +of the Company’s common stock (see Note 24). In addition, Ault & Company had guaranteed the prompt and complete payment and +performance of the obligations of the Company pursuant to this senior secured promissory note. Pursuant to the terms of the note, the +Company was required to make six monthly amortization payments beginning on July 18, 2019. The Company did not make these payments. On +February 10, 2020, the Dominion short-term promissory note was acquired pursuant to the terms of a Master Exchange Agreement. +8% +short-term promissory note +On +August 16, 2018, as amended on November 29, 2018, the Company entered into a securities purchase agreement with an institutional investor +providing for the issuance of an 8% promissory note in the principal amount of $318,150, due February 15, 2019. On February 10, 2020, +the 8% short-term promissory note in the principal amount of $318,150 was acquired pursuant to the terms of the Master Exchange Agreement. +May 2020 promissory notes +On +May 28, 2020, the Company entered into a securities purchase and exchange agreement with an institutional investor. Pursuant to the agreement, +the Company exchanged a 12% short-term promissory note in the principal amount of $235,796 plus accrued interest of $118,985 for a new +note due and payable on June 30, 2020. In addition, pursuant to the agreement, the Company issued to the investor a note due and payable +on November 28, 2020, for a purchase price of $160,000, with an aggregate principal face amount of $200,000 and an original issue discount +(“OID”) of twenty percent (20%). The Company also issued to the investor a five-year warrant to purchase an aggregate of 400,000 +shares of Common Stock at an exercise price of $1.07. On July 30, 2020, the May 2020 promissory notes in the principal amount of $554,781 +plus accrued interest of $44,734 were acquired pursuant to the terms of the Master Exchange Agreement. +F- 42 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +12% +promissory note +On +February 5, 2020, the Company issued a 12% promissory note in the principal face amount of $585,919. The 12% promissory note was issued +pursuant an exchange agreement (the “February 2020 Exchange Agreement”) with an institutional investor (see Note 21) and was +due upon issuance. On August 7, 2020, the 12% promissory note in the principal amount of $585,919 plus accrued interest of $162,863 was +acquired pursuant to the terms of the Master Exchange Agreement. +12% +July 2019 convertible promissory note +On March 23, 2018, the Company entered into a securities purchase agreement +pursuant to which it issued a 12% promissory note including a 10% OID. The promissory note was in the principal amount of $1,000,000, +was sold for $900,000, accrued simple interest at 12% and was due on June 22, 2018. On July 3, 2019, the Company entered into an exchange +agreement with the institutional investor pursuant to which, in exchange for the term promissory note issued by the Company to the investor +on March 23, 2018, we sold a convertible promissory note in the principal face amount of $1,292,000 plus a default premium of $200,000, +and (ii) a five-year warrant to purchase of 25,000 shares of our common stock at an exercise price of $8.80 per share. +This +convertible promissory note was in the aggregate principal amount of $1,492,000 and accrued interest at 12% per annum. The principal and +all accrued and unpaid interest was due on January 22, 2020. Subject to certain beneficial ownership limitations, the investor had the +right to convert the principal amount of this note and accrued interest earned thereon at any time into shares of Common Stock at $8.80 +per share. During the year ended December 31, 2019, the Company issued 99,753 shares of Common Stock +in payment of principal and interest in the amount of $860,000 and $17,837, respectively. On September 2, 2020, the remaining amount +due under the 12% July 2019 convertible promissory note in the principal amount of $632,000, plus accrued interest of $258,788 was acquired +pursuant to the terms of the Master Exchange Agreement. +The Company computed +the fair value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount +in the amount of $142,070 based on the estimated fair value of the warrants. At the time of issuance of the note, the closing price of +Common Stock was in excess of the effective conversion price, resulting in a BCF of $209,888, based on the difference between the effective +conversion price and the fair value of the Company’s common stock at the commitment date of the transaction +In aggregate, the +Company recorded debt discount in the amount of $351,958 based on the fair values of the warrants and BCF. During the year ended December +31, 2019, non-cash interest expense of $351,958 was recorded from the amortization of debt discounts. The fair value of the warrants was +estimated using the Black-Scholes option-pricing method. The risk-free rate of 1.75% was derived from the U.S. Treasury yield curve, matching +the term of the warrant, in effect at the measurement date. The volatility factor of 85.47% was determined based on historical stock prices +of similar technology companies. +The first exchange occurred +on the date of the Master Exchange Agreement when the Creditor exchanged a portion of the Esousa Purchased Notes for the Exchange Shares +(the “Initial Exchange”) and the second exchange (the “Second Exchange” and together with the Initial Exchange, +the “Exchange”) began July 8, 2020 when the Company received stockholder approval at a special meeting thereof for the Exchange +of the Esousa Additional Purchased Notes for the Company’s common stock, and subsequently, authorization from the NYSE American +(together, the “Required Approvals”). +The Exchange Agreement provides +for two pricing periods, the first of which commenced after the date on which the Creditor received the Exchange Shares pursuant to the +Initial Exchange and ended on the date that was 90 days after receipt thereof, and the second of which shall commence on the date on which +the Creditor receives the Exchange Shares pursuant to the Second Exchange and ending on the date that is 90 days after receipt thereof, +in either case, unless earlier terminated by the Creditor by written notice. +F- 43 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The number of shares to be +issued upon each Exchange will be equal to (x) the principal and accrued but unpaid interest due on the Notes being exchanged multiplied +by 1.35, divided by (y) the closing bid price effective on each date of an exchange notice, provided, however, that the Company shall +theretofore have obtained the Required Approvals (the “Exchange Price”). The total number of shares of the Company’s +common stock to be issued to Creditor in connection with the applicable Exchange shall be adjusted on the Business Day immediately following +the Pricing Period based upon the volume weighted average price (“VWAP”) of the Company’s common stock over the applicable +Pricing Period (the “VWAP Shares”). VWAP Shares means the number of shares determined by dividing (x) the Exchange Amount +of the applicable Exchange, multiplied by 1.1, by (y) the greater of (I) seventy-five percent (75.0%) of the VWAP of the Company’s +common stock over the applicable Pricing Period, or (II) $0.30 per share. +Pursuant to the Master Exchange +Agreement, the Company issued warrants to purchase an aggregate of 1,832,597 shares of common stock at an average exercise price +equal to $1.43 per share of common stock. The warrants became exercisable in July 2020. In connection therewith, the Company agreed to +file a registration statement to register the sale of the shares of common stock underlying the exercise of the warrants by the Creditor +pursuant to the Master Exchange Agreement. Since the Creditor did not purchase all of the additional notes, the Company has the option +to acquire a portion of the warrants from the Creditor for an aggregate price of $1.00. Consequently, at December 31, 2020, the option +represented the right to acquire 132,236 of the warrants from the Creditor. Therefore, only 1,700,360 options are deemed outstanding at +December 31, 2020. +The Company computed the fair +value of the 1,700,360 warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded a loss on +extinguishment in the amount of $2,713,874 based on the estimated fair value of the warrants. The fair value of the warrants was estimated +using the Black-Scholes option-pricing method. The risk-free rate of 0.23% to 1.38% was derived from the U.S. Treasury yield curve, matching +the term of the warrants, in effect at the measurement dates. The volatility factor of 86.31% to 100.82% was determined based on historical +stock prices of similar technology companies. +During the year ended December +31, 2020, the Company issued to the investor an aggregate of 8,332,904 shares of the Company’s common stock upon the exchange of +principal and interest in the amount of $4,401,023 and $2,142,504, respectively. A loss on extinguishment of $15,488,644 was recognized +on the issuances of common stock based on the fair value of the Company’s common stock at the date of the exchanges. During January +2021, the remaining outstanding principal and accrued interest of $200,000 and $15,948, respectively, of debt securities acquired by Esousa +was satisfied through the issuance of 183,214 shares of Common Stock. The Company recognized a loss on extinguishment of $551,718 as a +result of this issuance (see Note 28). +Esousa short-term promissory notes +During the year ended December +31, 2020, the Company issued to Esousa 12% short-term promissory notes in the aggregate principal amount of $2,000,000 and five-year warrants +to purchase an aggregate of 1,536,655 shares of Common Stock at an average exercise price equal to $1.43 per share of Common Stock. +The Esousa 12% short-term promissory notes had a term of three months and were repaid at December 31, 2020. +The Company computed the fair +value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the +amount of $836,725 based on the estimated fair value of the warrants. During the year ended December 31, 2020, the entire amount of debt +discount was amortized as non-cash interest expense. The fair value of the warrants was estimated using the Black-Scholes option-pricing +method. The risk-free rates ranged from 0.34% and 1.11% and were derived from the U.S. Treasury yield curve, matching the term of the +warrants, in effect at the measurement dates. The volatility factor was between 86.31% and 100.82% and was determined based on historical +stock prices of similar technology companies. +Between August 2020 and October +2020, the Company also received $3,200,000 in loans from Esousa pursuant to which the Company agreed to issue unsecured short-term promissory +notes with interest rates of 13% and 14% and warrants with terms of approximately one and a half years to purchase an aggregate of 1,303,863 +shares of Common Stock at an average exercise price of $2.70 per share of Common Stock. The notes had a term of three months from the +date the Company received the proceeds and were repaid at December 31, 2020. The Company is prohibited from issuing the Common Stock issuable +upon exercise of the warrants until stockholder approval of such issuance of securities is obtained as required by applicable NYSE American +listing rules and subsequently, authorization from the NYSE American (the “Required Approvals”). The Company shall seek stockholder +approval at its annual meeting of stockholders expected to be held during the quarter ended June 30, 2021. If the Required Approvals are +received, the warrants shall be immediately exercisable, including, at the option of Esousa, by means of a cashless exercise. These warrants +to purchase common stock do not qualify to be treated as equity, and accordingly, were recorded as a liability. The Company is required +to present these instruments at fair value at each reporting date and any changes in fair values shall be recorded as an adjustment to +earnings. +F- 44 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The Company computed the fair +value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the +amount of $3,062,644 based on the estimated fair value of the warrants. During the year ended December 31, 2020, the entire amount of +debt discount was amortized as non-cash interest expense. The fair value of the warrants was estimated using the Black-Scholes option-pricing +method. The risk-free rates ranged from 0.12% and 0.17% and were derived from the U.S. Treasury yield curve, matching the term of the +warrants, in effect at the measurement dates. The volatility factor of 104.56% was determined based on historical stock prices of similar +technology companies. +Other short-term notes payable +(i) On August 23, 2018, DP Lending issued an unsecured promissory note in the principal amount of $85,000 +to an accredited investor. During the year ended December 31, 2019, the Company made principal payments +of $46,500 resulting in a remaining outstanding balance of $38,500. This note was not repaid on the specified maturity date and +is currently in default . +(ii) On October 9, 2018, DP Lending issued a promissory note in the principal amount of $60,000 to an accredited +investor. During the year ended December 31, 2019, the Company made principal payments of $33,301 +resulting in an outstanding balance of $26,699 which was repaid during the year ended December 31, 2020. +(iii) On July 11, 2019, the Company entered into a non-binding term sheet with Ding Gu to sell, for a purchase +price of $400,000, a 12% original issue discount promissory note with an aggregate principal face amount of $440,000. Definitive documents +have not been executed and a dispute has arisen over the transaction. On January 17, 2020, Mr. Gu. filed a complaint in the Supreme Court +of the State of New York (see note 23) regarding the terms of this non-binding term sheet and those of a 4% convertible promissory note, +in the amount of $660,000 (see note 21), seeking, among other things, monetary damages in excess of $1,100,000. +(iv) Between September 2019 and December 2019, DP Lending entered into a series of 12% three year term promissory +notes in the aggregate amount of $155,000. These notes remain outstanding at December 31, 2020. +(v) During November 2019, the Company entered into a short term promissory note in the aggregate principal +amount of $360,000. The promissory note contained an original issue discount of $60,000 resulting in net proceeds of $300,000. The interest +rate on the promissory note was 12% per annum and was payable on the maturity date, February 14, 2020. +(vi) Pursuant to the terms of the purchase agreement with Power-Plus, the Company entered into a two-year promissory +note in the amount of $255,000 payable to the former owner as part of the purchase consideration. On October 18, 2017, for cancellation +of debt, the Company entered into a subscription agreement with the former owner under which the Company sold 173 shares of common stock +at $537.57 per share for an aggregate purchase price of $93,000. At December 31, 2020 and 2019, the outstanding balance on this note +was $13,250. +(vii) Microphase utilizes a $20,000 overdraft credit line at People’s United Bank with an annual interest +rate of 15%. At December 31, 2020 and 2019, the balance of that overdraft credit line was $17,101 and $16,890, respectively. +F- 45 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Notes payable to Wells +Fargo +At +December 31, 2020 and 2019, Microphase had guaranteed the repayment of certain equity lines of credit in the aggregate amount of $182,615 +and $290,560, respectively, with Wells Fargo Bank, NA (“Wells Fargo”) (collectively, the “Wells Fargo Notes”). +These loans originated prior to the Company’s acquisition of Microphase and Microphase was the recipient of the actual proceeds +from the loans. As of December 31, 2020, the first line of credit, which is secured by residential real estate owned by a former officer, +had an outstanding balance of $182,615, with an annual interest rate of 4.00%. The second Wells Fargo equity line originated in 2014 when +Microphase had received working capital loans from the former CEO from funds that were drawn against the second Wells Fargo equity line. +During the year ended December 31, 2020, the second Wells Fargo equity line was repaid by the estate of Microphase’s former CEO. +Note payable to Dept. +of Economic and Community Development +In +August 2016, Microphase received a $300,000 loan, of which $103,403 has been repaid, pursuant to the State of Connecticut Small Business +Express Job Creation Incentive Program which is administered through the Department of Economic and Community Development (“DECD”) +(the “DECD Note”). The DECD Note accrues interest at a rate of 3% per annum and is due in August 2026. Payment of principal +and interest commenced in September 2017, payable in equal monthly installments over the remaining term. +Paycheck +Protection Program +In +March 2020, U.S. lawmakers agreed on the passage of a $2 trillion stimulus bill called the +CARES (Coronavirus Aid, Relief, and Economic Security) Act to blunt the impact of an +economic downturn set in motion by the global coronavirus pandemic. The main driver of small business stimulus in the CARES Act +is contained in the Paycheck Protection Program (“PPP”). PPP Loans may be used +to cover payroll, benefits, and salaries, as well as interest payments, rent, and utilities. Fees are waived , +and collateral and personal guarantees are not required. Payments are deferred for a minimum of six months, up to one year, and there +are no prepayment penalties. +During April +2020, the Company received loans under the PPP in the principal amount of $715,101 and the Company’s majority owned subsidiary, +Microphase, received loans in the principal amount of $467,333. The principal of the loan may be forgiven up to the total cost of payroll, +mortgage interest payments, rent and utility payments made during the eight-week period after origination. In +addition to meeting the size requirement (500 or fewer employees for most companies), the Company was required to demonstrate that its +business had been negatively impacted by COVID-19. The Company expects that the entire amount received under the PPP is eligible for loan +forgiveness. +Economic Injury Disaster Loan +On +May 27, 2020, the Company received an Economic Injury Disaster Loan in the principal amount of $150,000 with an annual interest rate of +3.75%. The Company shall begin making p rincipal and interest payments of $731 every month +beginning on May 27, 2021. All remaining principal and interest is due and payable thirty years from the date of the note. +June +‘20 short-term promissory notes +On +June 26, 2020, the Company issued to several institutional investors unsecured 12% short-term promissory notes in the aggregate principal +amount of $800,000 and seventeen month warrants to purchase an aggregate of 361,991 shares of Common Stock at an exercise price of $2.43 +per share of Common Stock. These notes had a term of three months and were repaid during the quarter ended December 31, 2020. The warrants +were exercised on a cashless basis which resulted in the issuance of 438,077 shares of Common Stock (see Note 24). These warrants to purchase +Common Stock did not qualify to be treated as equity, and accordingly, were recorded as a liability. The Company was required to present +these instruments at fair value at each reporting date and any changes in fair values were recorded as an adjustment to earnings. +The Company computed the fair +value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the +amount of $765,082 based on the estimated fair value of the warrants. During the year ended December 31, 2020, the entire amount of debt +discount was amortized as non-cash interest expense. The risk-free rate was 0.32% and was derived from the U.S. Treasury yield curve, +matching the term of the warrants, in effect at the measurement date. The volatility factor of 135% was derived from the stated terms +of the warrants. +F- 46 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Enertec short-term bank credit and secured promissory note +At +December 31, 2020 and 2019, Enertec had short term bank credit of $1,404,096 and $1,622,337, respectively, that bears interest at prime +plus 0.7% through 3.85% paid either on a monthly or weekly basis. Further, the Company has undertaken to comply with certain covenants +under its bank loan. +On +December 28, 2018, Enertec entered into a $500,000 secured promissory note (the “Enertec Note”), whereby Enertec agreed to +pay interest in an amount of 10% per annum in cash to the investor, beginning on January 15, 2019, on a monthly basis, until the Enertec +Note was paid in full. The proceeds from the Enertec Note were received in January 2019. The Enertec Note was paid from proceeds received +in the April 2, 2019 public offering (see note 24). In connection with the Enertec Note, the Company’s Executive Chairman provided +a personal guarantee for the benefit of the investor. +20. NOTES PAYABLE – RELATED PARTIES +Notes Payable – Related +parties at December 31, 2020 and 2019, are comprised of the following: +December 31, +2020 +2019 +Notes payable, related parties +$ 239,355 +$ 284,317 +Less: current portion +(187,818 ) +(169,153 ) +Notes payable, related parties – long-term portion +$ 51,537 +$ 115,164 +Microphase is party to several +notes payable agreements with its past officers, employees and their family members. As of December 31, 2020, the aggregate outstanding +balance pursuant to these notes payable agreements, inclusive of $35,351 of accrued interest, was $274,706, with annual interest rates +ranging between 3.00% and 6.00%. During the years ended December 31, 2020 and 2019, Microphase incurred $8,865 and $6,852, respectively, +of interest on these notes. +21. CONVERTIBLE NOTES +Convertible Notes Payable +at December 31, 2020 and 2019, are comprised of the following: +December 31, +2020 +2019 +8% Convertible promissory note +$ — +$ 935,772 +12% Convertible promissory note +— +815,218 +4% Convertible promissory note +660,000 +660,000 +12% November 2019 convertible promissory note +— +350,000 +Total convertible notes payable +660,000 +2,760,990 +Less: +Unamortized debt discounts +(273,717 ) +(355,227 ) +Total convertible notes payable, net of financing cost +$ 386,283 +$ 2,405,763 +Less: current portion +— +(2,100,990 ) +Convertible notes payable, net of financing cost – long-term portion +$ 386,283 +$ 304,773 +8% Convertible Promissory Note +On +November 15, 2019, the Company entered into an exchange agreement with a lender pursuant to which the Company issued to the lender a convertible +promissory note in the principal amount of $935,772 with an interest rate of 8% per annum. The 8% convertible promissory note was convertible +into shares of Common Stock at a conversion price of $1.80 per share. During the year ended December 31, 2020, the Company issued 529,425 +shares of Common Stock upon the conversion of principal and interest of $952,965. Since the proceeds received by the investor from the +sales of common stock were less than the amount of principal and accrued interest, the investor was due a true up payment in the amount +of $210,049, which was recognized as additional interest expense. +F- 47 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +12% Convertible Promissory Note +On +February 5, 2020 the Company entered into the February 2020 Exchange Agreement with an institutional investor pursuant to which the Company +issued to the investor a 12% convertible promissory note in the principal amount of $295,000 with a conversion price of $1.45 per share +of Common Stock and a 12% promissory note in the principal amount of $585,919. These two notes were issued upon the exchange of the 12% +convertible promissory note, in the principal amount of $815,218, issued on September 26, 2019 (the “September 2019 Exchange Agreement”). +Since the exchange provided the institutional investor with a substantive conversion feature, the debt instruments were determined to +be substantially different and a loss on extinguishment of $20,345 was recognized. On February 25, 2020, the Company issued to the investor +203,448 shares of Common Stock upon the conversion of principal of $295,000. During the year ended December 31, 2020, Esousa purchased +the 12% promissory note in the principal amount of $585,919 from the institutional investor (See Note 19). +4% Convertible Promissory Note +On May 20, 2019, the Company +entered into a securities purchase agreement with an investor to sell, for a purchase price of $500,000, a 4% original issue discount +(“OID”) convertible promissory note with an aggregate principal face amount of $660,000 and a five-year warrant to purchase +an aggregate of 12,500 shares of the Company’s common stock. The Company is required to make quarterly interest payments and the +principal amount of the note is due on May 20, 2024. The note is convertible into shares of Common Stock at $4.00 per share. The exercise +price of the warrant is $12.00 per share. In addition, the Executive Chairman of the Company agreed to guarantee and act as surety for +the Company’s obligation to repay the note pursuant to a personal guarantee. +The Company computed the fair +value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the +amount of $58,448 based on the estimated fair value of the warrants. At the time of issuance of the note, the closing price of the Common +Stock was in excess of the effective conversion price, resulting in a beneficial conversion feature +(“BCF”) of $188,448, based on the difference between the effective conversion price and the fair value of the Company’s +common stock at the commitment date of the transaction. +In aggregate, the Company +recorded a debt discount in the amount of $406,896 based on the relative fair values of the warrants, BCF and OID. During the years ended +December 31, 2020 and 2019, non-cash interest expense of $81,510 and $51,669, respectively, was recorded from the amortization of debt +discounts. The fair value of the warrants was estimated using the Black-Scholes option-pricing method. The risk-free rate of 2.18% was +derived from the U.S. Treasury yield curve, matching the term of the warrant, in effect at the measurement date. The volatility factor +of 87.51% was determined based on historical stock prices of similar technology companies. +12% November 2019 +Convertible Promissory Note +On +November 4, 2019, the Company entered into an exchange agreement with an investor pursuant to which, in exchange for an OID promissory +note issued by the Company for the benefit of the investor on July 25, 2019, as amended, the Company sold to the investor a new convertible +promissory note in the principal amount of $350,000 with an interest rate of 12% per annum. The note was convertible into shares of Common +Stock at a conversion price of $1.20 per share, subject to adjustments. Principal and interest on this note was due on July 4, 2020. Since +the exchange provided the institutional investor with a substantive conversion feature, the debt instruments were determined to be substantially +different and a loss on extinguishment of $30,053 was recognized. During the year ended December +31, 2020, the Company issued 320,483 shares of Common Stock upon the conversion of principal and interest in the amount of $350,000 +and $31,585, respectively . +F- 48 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +10% Convertible Promissory Note +On April 13, 2020, the Company +issued a convertible promissory note in the principal amount of $100,000 with an interest rate of 10% per annum and a five-year warrant +to purchase shares of Common Stock equal to the lesser of 157,143 or 50% of the number of shares of Common Stock issuable pursuant to +the convertible promissory note, at an exercise price equal to $1.17 per share of Common Stock. During the year ended December 31, 2020, +pursuant to the terms of the convertible promissory note, the Company issued to the investor 90,299 shares of Common Stock upon the exchange +of principal and interest in the amount of $100,000 and $5,317, respectively. A loss on extinguishment of $83,682 was recognized on the +issuance of Common Stock based on the fair value of the Common Stock at the date of the exchange. +The Company computed the fair +value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the +amount of $53,763 based on the estimated fair value of the warrants. During the year ended December 31, 2020, the entire amount of debt +discount was amortized as non-cash interest expense. The fair value of the warrants was estimated using the Black-Scholes option-pricing +method. The risk-free rate was 0.44% and was derived from the U.S. Treasury yield curve, matching the term of the warrants, in effect +at the measurement date. The volatility factor of 94.51% was determined based on historical stock prices for similar technology companies. +During +December 2020, the Company issued 45,150 shares of Common Stock, the equivalent of 50% of the number of shares of Common Stock issued +upon conversion of the convertible promissory note, upon the cash exercise of these warrants (see Note 24). These warrants to purchase +Common Stock did not qualify to be treated as equity, and accordingly, were recorded as a liability. The Company was required to present +these instruments at fair value at each reporting date and any changes in fair values were recorded as an adjustment to earnings. +September 2019 Exchange +Agreement +On July 2, 2019, the Company +entered into an exchange agreement with an institutional investor pursuant to which, in exchange for a term promissory note issued by +the Company to the investor on September 21, 2018, in the principal face amount of $526,316, the Company sold to the investor a new convertible +promissory note in the principal amount of $783,031 with an interest rate of 12% per annum and a maturity date of December 31, 2019. This +note was convertible into shares of Common Stock at a conversion price equal to the greater of (A) $8.80 or (B) 80% of the lowest daily +VWAP in the three trading days prior to the date of conversion. Since the exchange provided the institutional investor with a substantive +conversion feature, the debt instruments were determined to be substantially different and a loss on extinguishment of $36,999 was recognized. +Further, +at the time of issuance of the 12% Convertible Note, the closing price of the Company’s common stock was in excess of the conversion +price, resulting in a BCF. At issuance, the intrinsic value of the BCF totaled $71,185, based on the difference between the effective +conversion price and the fair value of the Company’s common stock at the commitment date of the transaction. During the year ended +December 31, 2019, non-cash interest expense of $71,185 was recorded from the amortization of debt discounts attributed to the 12% Convertible +Note. +On September 26, 2019, principal +and interest on the 12% Convertible Note was exchanged for a convertible promissory note in the principal amount of $815,218 with an interest +rate of 12% per annum and a maturity date of December 31, 2019. This note is convertible into shares of Common Stock at a conversion price +of $4.00. The Company recognized an additional loss on extinguishment of $11,647. +22. CONVERTIBLE NOTE – RELATED PARTY +On +February 5, 2020, the Company issued an 8% convertible promissory note in the principal amount of $1,000,000 to Ault & Company, +Inc. (“ Ault & Company” and the “Ault & Company Convertible Note”). +The principal amount of this note, plus any accrued and unpaid interest at a rate of 8% per annum, was due and payable on August 5, 2020. +The Ault & Company Convertible Note is convertible into Common Stock at a conversion price of $1.45 per share. +F- 49 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +At +the time of issuance of the Ault & Company Convertible Note, the closing price of the Company’s Common Stock was in excess of +the conversion price, resulting in a beneficial conversion feature (“BCF”). The BCF embedded in the Ault & Company Convertible +Note is accounted for under ASC No. 470, De bt +(“ASC 470”). At issuance, the intrinsic value of the BCF totaled $68,966, based on the difference between the effective conversion +price and the fair value of the Common Stock at the commitment date of the transaction. The Company was prohibited from issuing the shares +of Common Stock issuable pursuant to the Ault & Company Convertible Note unless stockholder approval of such issuance of securities +was obtained. The Company received stockholder approval on July 8, 2020. On August 20, 2020, the Company issued 413,793 shares +of Common Stock upon the conversion of $600,000 in principal . +23. COMMITMENTS AND CONTINGENCIES +Derivative Action +On July 31, 2018, Ethan Young +and Greg Young (collectively, “Plaintiffs”) filed a stockholder derivative complaint (the “Complaint”) in the +United States District Court for the Central District of California (the “Court”) against the Company as the nominal defendant, +as well as its current directors and a former director, in action captioned, Ethan Young and Greg Young, Derivatively on Behalf of +Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, Robert O. +Smith, and Kristine Ault and DPW Holdings, Inc. , as the nominal defendant, (collectively, “Defendants”) Case No. 18-cv-6587 +(the “Derivative Action”). +The Complaint alleged violations +of state law and breaches of fiduciary duty, unjust enrichment and gross mismanagement by the individual defendants, in connection with +various transactions entered into by the Company. +The Defendants moved to dismiss +the Complaint, and on February 25, 2019, the Court granted Defendants motion to dismiss, in its entirety, without prejudice, and also +granted Plaintiffs leave to amend their Complaint. +On March 11, 2019, Plaintiffs +filed an amended complaint asserting violations of breaches of fiduciary duties and unjust enrichment claims based on the previously pled +transactions (the “Amended Complaint”). +On March 25, 2019, Defendants +filed a motion to dismiss (the “Motion”) the Amended Complaint. On May 21, 2019, the Court granted in part, and denied in +part, the Defendants’ Motion. On February 24, 2020, the Company entered into a definitive settlement agreement (the “Settlement +Agreement”) with Plaintiffs to settle the claims asserted in the Amended Complaint. +On April 15, 2020, the Court +issued an Order (the “Order”) approving a Motion for Preliminary Approval of Settlement in the Derivative Action. On July +16, 2020, the Court issued an Order (the “Final Order”) approving a Motion for Final Approval of Settlement in the Derivative +Action filed against the Company as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018 who were +not dismissed from the action as a result of the Court’s partial grant of the Motion. +On July 16, 2020, the Court +entered a Judgment based upon the Final Order. +Under the terms of the Final +Order, the Board adopted and shall maintain certain resolutions and amendments to the Company’s committee charters and/or bylaws, +to ensure adherence to certain corporate governance policies (collectively, the “Reforms”). The Final Order further provides +that such Reforms shall remain in effect for a period of no less than five (5) years and shall be subject to any of the following: (a) +a determination by a majority of the independent directors that the Reforms are no longer in the best interest of the Company, including, +but not limited to, due to circumstances making the Reforms no longer applicable, feasible, or available on commercially reasonable terms, +or (b) modifications which the Company reasonably believes are required by applicable law or regulation. +In connection with the Settlement +Agreement, the parties agreed upon a payment of attorneys’ fees in the amount of $600,000, which sum was paid by our Director & +Officer liability insurance. The Settlement Agreement contains no admission of wrongdoing. +The Company has always maintained +and continues to believe that neither it nor any of its current or former directors engaged in any wrongdoing or otherwise committed any +violation of federal or state securities laws or any other laws or regulations. +F- 50 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Blockchain Mining Supply and Services, Ltd. +On November 28, 2018, Blockchain +Mining Supply and Services, Ltd. (“Blockchain Mining”) a vendor who sold computers to a subsidiary of the Company, filed a +Complaint (the “Complaint”) in the United States District Court for the Southern District of New York against the Company +and its subsidiary, Digital Farms, Inc. (f/k/a Super Crypto Mining, Inc.), in an action captioned Blockchain Mining Supply and Services, +Ltd. v. Super Crypto Mining, Inc. and DPW Holdings, Inc. , Case No. 18-cv-11099. +The Complaint asserts claims +for breach of contract and promissory estoppel against the Company and its subsidiary arising from the subsidiary’s alleged failure +to honor its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $1,388,495, plus attorneys’ +fees and costs. +The Company believes that +these claims are without merit and intend to vigorously defend them. +On April 13, 2020, the Company +and its subsidiary jointly filed a motion to dismiss the Complaint in its entirety as against the Company, and the promissory estoppel +claim as against its subsidiary. On the same day, the Company’s subsidiary also filed a partial Answer to the Complaint in connection +with the breach of contract claim. +On April 29, 2020, Blockchain +Mining filed an amended complaint (the “Amended Complaint”). The Amended Complaint asserts the same causes of action and seeks +the same damages as the initial Complaint. +On May 13, 2020, the Company +and its subsidiary, jointly filed a motion to dismiss the Amended Complaint in its entirety as against the Company, and the promissory +estoppel claim as against of its subsidiary. On the same day, the Company’s subsidiary also filed a partial Answer to the Amended +Complaint in connection with the breach of contract claim. +In its partial Answer, the +Company’s subsidiary admitted to the validity of the contract at issue and also asserted numerous affirmative defenses concerning +the proper calculation of damages. +On December 4, 2020, the Court +issued an Order directing the Parties to engage in limited discovery (the “Limited Discovery”) which was completed on March +4, 2021. In connection therewith, the Court also denied Defendants’ Motion to Dismiss without prejudice. +The Company and its subsidiary +have informed the Court that they intend to file a revised motion to dismiss the Amended Complaint and anticipate filing such motion to +dismiss when the Court issues a briefing schedule. +Based on the Company’s +assessment of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, the Company cannot +reasonably estimate the potential loss or range of loss that may result from this action. Notwithstanding, the Company has established +a reserve in the amount of the unpaid portion of the purchase agreement. An unfavorable outcome may have a material adverse effect on +our business, financial condition and results of operations. +Ding Gu (a/k/a Frank Gu) and Xiaodan Wang Litigation +On January 17, 2020, Ding +Gu (a/k/a Frank Gu) (“Gu”) and Xiaodan Wang (“Wang” and with “Gu” collectively, “Plaintiffs”), +filed a Complaint (the “Complaint”) in the Supreme Court of the State of New York, County of New York against the Company +and its Executive Chairman, Milton C. Ault, III, in an action captioned Ding Gu (a/k/a Frank Gu) and Xiaodan Wang v. DPW Holdings, +Inc. and Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd Ault) , Index No. 650438/2020. +The Complaint asserts causes +of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent injunction, +enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions entered into +between Gu and the Company, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs and the +Company, in or about July 2019. The Complaint seeks, among other things, monetary damages in excess of $1,100,000, plus a decree of specific +performance directing the Company to deliver unrestricted shares of Common Stock to Gu, plus attorneys’ fees and costs. +F- 51 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The Company believes that +these claims are without merit and intend to vigorously defend them. +On May 4, 2020, the Company +and Ault jointly filed a motion to dismiss the Complaint in its entirety, with prejudice. +On July 24, 2020, Plaintiffs +filed their opposition papers to the Company’s joint motion to dismiss. +The motion to dismiss has +been fully briefed and is currently pending before the court. +Based on the Company’s +assessment of the facts underlying the above claims, the uncertainty of litigation, and the preliminary stage of the case, the Company +cannot reasonably estimate the potential loss or range of loss that may result from this action. An unfavorable outcome may have a material +adverse effect on our business, financial condition and results of operations. +Subpoena +The Company received a subpoena +from the SEC for the voluntary production of documents. The Company is fully cooperating with this non-public, fact-finding inquiry and +management believes that the Company has operated its business in compliance with all applicable laws and regulations. The subpoena expressly +provides that the inquiry is not to be construed as an indication by the Commission or its staff that any violations of the federal securities +laws have occurred, nor should it be considered a reflection upon any person, entity or security. However, there can be no assurance as +to the outcome of this matter. +I.AM Bankruptcy Filing +On November 2, 2020, I.AM, +Inc. filed a voluntary petition for bankruptcy under Chapter 7 in the United States Bankruptcy Court in the Central District of California, +Santa Ana Division, case number 8:20-bk-13076. +Sichenzia Ross Ference LLP +On November 20, 2020, the Company’s former counsel, Sichenzia +Ross Ference LLP as successor to Sichenzia Ross Ference Kesner LLP (“SRF”) filed a Complaint in the United States District +Court for the Southern District of New York against the Company and two of its subsidiaries (collectively, the “Company Defendants”), +in an action captioned Sichenzia Ross Ference LLP as successor to Sichenzia Ross Ference Kesner LLP v. Digital Power Corporation, et al., +Case No. 20-CV-09811-JGK. The Complaint asserts claims for breach of contract, account stated, unjust enrichment and quantum meruit, against +the Company Defendants, and seeks monetary damages in the amount of $2,558,121 plus interest thereon. +On January 4, 2021, the Company Defendants filed +a motion for a more definite statement. +On January 11, 2021, the Court held a conference +in connection with the Company Defendants’ Motion wherein the Court denied the Company Defendants’ Motion as moot, ordered +SRF to amend its Complaint by on or before January 25, 2021, and referred the matter to mediation. +On January 25, 2021, SRF filed a First Amended Complaint in +the action and dropped the two subsidiaries as parties to the action. The First Amended Complaint asserts claims for breach of contract, +account stated, unjust enrichment and quantum meruit, against the Company, and seeks monetary damages in the amount of $2,518,468 plus +interest thereon. +On or about February 18, 2021, SRF, the Company +Defendants, and various of the Company Defendants’ related parties entered into a confidential settlement agreement. +On or about February 23, 2021, SRF filed, on behalf +of itself and the Company Defendants, a stipulation of voluntary dismissal, with prejudice. +F- 52 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Other Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory and government +investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, suits, regulatory +and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. The Company records a liability when it believes that it is +probable that a loss has been incurred and the amount can be reasonably estimated. If the Company determines that a loss is reasonably +possible and the loss or range of loss can be estimated, the Company discloses the reasonably possible loss. The Company evaluates developments +in its legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably +possible losses disclosed, and makes adjustments as appropriate. Significant judgment is required to determine both likelihood of there +being and the estimated amount of a loss related to such matters. +With respect to the Company’s +other outstanding matters, based on the Company’s current knowledge, the Company believes that the amount or range of reasonably +possible loss will not, either individually or in aggregate, have a material adverse effect on the Company’s business, consolidated +financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject +to significant uncertainties. +24. STOCKHOLDERS’ EQUITY +Amendments to Certificate +of Incorporation +On January 3, 2019, the Company +filed a certificate of amendment (the “Certificate of Amendment”) to its Certificate of Incorporation, with the Secretary +of State of the State of Delaware, to effectuate an increase to the number of authorized shares of common stock of the Company. Pursuant +to the Certificate of Amendment, the Company increased the number of authorized shares of its Class A common stock to 500,000,000 from +200,000,000 (the “Authorized Increase”). The number of authorized shares of the Company’s Class B common stock remains +at 25,000,000 and the number of authorized shares of the Company’s preferred stock remains at 25,000,000. As a result of the increase +of authorized shares of the Company’s Class A common stock, the aggregate number of the Company’s authorized shares is 550,000,000. +The Authorized Increase was approved by the Company’s board of directors as of December 28, 2018, and approved by a vote of the +stockholders of the Company at the December 28, 2018 Annual Meeting of Stockholders. The Certificate of Amendment became effective upon +filing with the State of Delaware on January 3, 2019. +On March 14, 2019, pursuant +to the authorization provided by the Company’s stockholders at a Special Meeting of Stockholders, the Company’s Board +approved the Certificate of Incorporation Amendment (the “COI Amendment”) to effectuate a reverse stock split of the common +stock of the Company’s issued and outstanding number of such shares by a ratio of one-for-twenty (the “Reverse Stock Split”) . +The Company filed the COI Amendment to its Certificate of Incorporation with the State of Delaware effectuating the Reverse Stock Split +on March 14, 2019. As a result of the Reverse Stock Split, each twenty (20) shares of common stock issued and outstanding prior to the +Reverse Stock Split were converted into one (1) share of common stock, with no change in authorized +shares or par value per share. +At the Company’s reconvened +2019 Annual Meeting of Stockholders, the Company’s stockholders approved a proposal permitting the Board to effectuate a second +reverse stock split (the “Second Reverse Stock Split”) of the Company’s issued and outstanding common stock. Thereafter, +on July 23, 2019, the Board approved the Second Reverse Stock Split with a ratio of one-for-forty. As a result of the Second Reverse Stock +Split, each forty (40) shares of common stock issued and outstanding prior to the Second Reverse Stock Split were converted into one (1) +share of common stock, with no change in authorized shares or par value per share. The +Second Reverse Stock Split became effective in the State of Delaware on August 5, 2019. +Preferred Stock +The +Company is authorized to issue 25,000,000 shares of Preferred Stock $0.001 par value. The Board has designated 1,000,000 shares as Series +A Convertible Preferred Stock (the “Series A Preferred Stock”), 500,000 shares as Series B Convertible Preferred Stock (the +“Series B Preferred Stock”) and 2,500 shares as Series C Convertible Redeemable Preferred Stock (the “Series C Preferred +Stock”). The rights, preferences, privileges and restrictions on the remaining authorized 23,497,500 shares of Preferred Stock have +not been determined. The Board is authorized to designate a new series of preferred shares and determine the number of shares, as well +as the rights, preferences, privileges and restrictions granted to or imposed upon any series of preferred shares. As +of December 31, 2020, there were 7,040 shares of Series A Preferred Stock, 125,000 shares of Series B Preferred Stock and no other shares +of Preferred Stock issued or outstanding. +F- 53 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Common Stock +Common stock confers upon +the holders the rights to receive notice to participate and vote at any meeting of stockholders of the Company, to receive dividends, +if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. The Class B common stock +carries the voting power of 10 shares of Class A common stock, referred to herein as the Common Stock. +2019 Issuances +Wilson-Davis & Co. ATM Offering +On October 10, 2018, the Company +entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Wilson-Davis & Co., Inc., as sales +agent (the “Agent”) to sell shares of its common stock, having an aggregate offering price of up to $25,000,000 (the “Shares”) +from time to time, through an “at the market offering” program (the “WDCO ATM Offering”). During the year ended +December 31, 2019, the Company had received gross proceeds of $4,656,051 through the sale of 119,791 shares of the Company’s common +stock through the WDCO ATM Offering. The offer and sale of the shares through the WDCO ATM Offering were made pursuant to our then effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. +333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, +and a prospectus supplement related to the WDCO ATM Offering, dated October 15, 2018. +Public Offering +On March 29, 2019, the Company +entered into an underwriting agreement (the “Underwriting Agreement”) with A.G.P./Alliance Global Partners (the “Underwriter”), +pursuant to which the Company agreed to issue and sell an aggregate of (a) 71,388 shares of its common stock (the “Shares”) +together with warrants to purchase 71,388 shares of common stock (the “Common Warrants”) and (b) pre-funded warrants to purchase +up to 317,500 shares of its common stock (the “Pre-Funded Warrants”) together with a number of Common Warrants to purchase +317,500 shares of common stock (the “Offering”). The Shares were sold to the purchasers at the public offering price of $17.60 +per share (the “Offering Price”). The Common Warrants were sold at a public offering price of $0.40 per Common Warrant. The +Pre-Funded Warrants were offered to each purchaser whose purchase of the Shares and the Common Warrant in the Offering would otherwise +result in the purchaser, together with its affiliates and certain related parties, beneficially owning more than 4.99% (or, at the election +of the purchaser, 9.99%) of the Company’s outstanding common stock immediately following the consummation of the Offering. The purchase +price of each Pre-Funded Warrant equaled the Offering Price at which the Shares were sold to the public in the Offering, minus $0.40, +and the exercise price of each Pre-Funded Warrant equaled $0.40 per share. In addition, the Company has also issued the Underwriter a +warrant to purchase a maximum of 15,550 additional shares of common stock at an initial exercise price of $19.80 per share, with a term +of five years (the “Underwriter Warrants”). +The Common Warrants are exercisable +at any time after the date of issuance at an exercise price of $0.45 per share. However, since the volume weighted average price of the +Company’s common stock on or after May 2, 2019, was less than $0.45 per share, the Common Warrant is exercisable by means of a cashless +exercise such that the holder of the Common Warrant shall receive one common share for each warrant held. +Upon issuance, the Common +Warrants, Pre-Funded Warrants and Underwriter Warrants (the “Offering Warrants”) were recorded at fair value and classified +as a liability due to the attributes of the warrants, which included both cash settlement features and registration obligations. Since +the fair value of the Offering Warrants exceeded the proceeds from the Offering the Company recognized a loss on issuance of warrants +of $1,763,481. The fair value of the Offering Warrants was re-measured at each financial reporting period and immediately before exercise, +with any changes in fair value recorded as change in fair value of warrant liability in the Consolidated Statements of Operations and +Comprehensive Loss. The fair value at issuance was calculated using a Black-Scholes option pricing model using a risk-free interest rate +of 2.28%, an expected life of 5 years, expected dividends of zero and expected volatility of 87.51%. +F- 54 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +The Company received net proceeds +from the Offering of $6,204,717, after deducting underwriting discounts and commissions and offering expenses. The Company used the net +proceeds from the Offering primarily for the repayment of debt. +The Offering closed on April +2, 2019 and as of December 31, 2019, the Company had issued a total of 771,275 shares of its common stock, inclusive of shares issued +pursuant to the exercise of 317,500 Pre-Funded Warrants and 382,387 shares issued pursuant to the cashless exercise of the Common Warrants. +2019 Ascendiant ATM Offering +On August 6, 2019, the Company +entered into an At-The-Market Issuance Sales Agreement with Ascendiant Capital Markets, LLC, as sales agent to sell shares of the Company’s +common stock having an aggregate offering price of up to $5,500,000 (the “ATM Offering”). The offer and sale of the Company’s +common stock was made pursuant to the Company’s effective “shelf” registration statement on Form S-3 and an accompanying +base prospectus contained therein (Registration Statement No. 333-222132) filed with the Securities and Exchange Commission (the “Commission”) +on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement +related to the ATM Offering, dated August 6, 2019. Through December 31, 2019, the Company had received gross proceeds of $5,499,999 through +the sale of 1,819,826 shares of the Company’s common stock from the ATM Offering. +Issuance of Common Stock for Services +During the year ended December +31, 2019, the Company issued to its consultants a total 69,375 shares of its Common Stock with an aggregate value of $338,619, an average +of $4.88 per share for services rendered. +Issuance of common stock for conversion of +debt +During the year ended December +31, 2019, principal and accrued interest of $4,238,878 and $497,417, respectively, on the Company’s debt securities was satisfied +through the issuance of 370,473 shares of Common Stock. +Issuance of common stock in payment of accrued +liability +During the year ended December +31, 2019, the Company issued 66,740 shares of Common Stock in satisfaction of accrued liabilities of $175,377. +2020 Issuances +2020 Ascendiant ATM Offering +On October 2, 2020, the Company +entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC to sell +shares of Common Stock having an aggregate offering price of up to $8,975,000 from time to time, through an “at the market offering” +program (the “2020 ATM Offering”). On December 1, 2020, the Company filed an amendment to the prospectus supplement with the +SEC to increase the amount of Common Stock that may be offered and sold in the ATM Offering, as amended under the Sales Agreement to $40,000,000 +in the aggregate, inclusive of the up to $8,975,000 in shares of Common Stock previously sold in the 2020 ATM Offering. The offer and +sale of shares of Common Stock from the 2020 ATM Offering was made pursuant to the Company’s effective “shelf” registration +statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) which became effective +on January 11, 2018. Through December 31, 2020, the Company had received gross proceeds of $39,978,350 through the sale of 12,582,000 +shares of Common Stock from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, 2020. +F- 55 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Issuances of Common +Stock for Services +During the year ended December +31, 2020, the Company issued 102,500 shares of Common Stock as payment for services to its consultants. The shares were valued at $182,575, +an average of $1.78 per share. +Issuance of common +stock in payment of short term advances, related party +On +December 23, 2019, the Company entered into a securities purchase agreement with Ault & Company. Pursuant to the terms of this agreement, +Ault & Company agreed to purchase an aggregate of 660,667 shares of Common Stock for a total purchase price of $739,948 at a purchase +price per share of $1.12, subject to the approval of the NYSE American. The sale was authorized by the NYSE American on January 15, 2020. +As a result, at the closing on January 15, 2020, Ault & Company became the beneficial owner of 660,667 shares of Common Stock. +Issuance of common stock in payment of +accrued liability +On March 4, 2020, pursuant +to the terms of the securities purchase agreement for the sale of the Dominion short-term promissory note, the Company issued to Dominion +12,500 shares of Common Stock in satisfaction of accrued liabilities of $73,154 (see Note 19). +During the year ended December +31, 2020, the Company issued 217,398 shares of Common Stock in satisfaction of accrued liabilities of $639,991. +Issuance of common stock for conversion +of debt +During the year ended December +31, 2020, principal and accrued interest of $6,411,795 and $2,196,599, respectively, on the Company’s debt securities was satisfied +through the issuance of 9,632,219 shares of Common Stock. The Company recognized a loss on extinguishment of $15,572,326 as a result of +these issuances. +On +August 20, 2020, the Company issued 413,793 shares of Common Stock upon the conversion of $600,000 in principal on the Ault & +Company Convertible Note. +Issuance of common stock upon exercise +of warrants +Between November 24, 2020 +and December 17, 2020, the Company issued a total of 814,095 shares of Common Stock upon the cash and cashless exercise of warrants to +purchase an aggregate of 919,134 shares of Common Stock. These warrants were issued in conjunction with the following debt financings: +(i) the 10% Convertible Promissory Note issued on April 13, 2020 (see Note 21), (ii) the May 2020 Promissory Notes issued on May 28, 2020 +(see Note 19) and (iii) the June ’20 Short-Term Promissory Notes issued on June 26, 2020 (see Note 19). The Company received cash +of $52,826 and extinguished warrant liabilities of $824,349 as a result of these warrant exercises. +F- 56 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +25. INCOME TAXES +Deferred income taxes reflect +the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and +income tax purposes. Significant components of the Company's deferred tax assets are as follows: +2020 +2019 +Deferred tax asset: +Allowance for doubtful accts +$ 359,598 +$ 163,123 +UNICAP +9,904 +16,314 +Obsolete inventory +2,811 +41,131 +Reserves +— +1,641,874 +Warrant liability +— +2,330 +Accrued compensation +138,283 +89,089 +Credit carryforwards +142,484 +142,484 +Stock compensation +880,766 +430,274 +Fixed assets, net +483,923 +1,278,863 +Contribution, carryforward +70 +62 +Accrued interest expense +68,148 +22,414 +Net operating loss carryforwards +5,912,511 +11,602,532 +Lease liability +798,047 +899,722 +Credit loss +559,593 +995,184 +Accrued expenses +461,973 +Excess of capital losses over capital gains +123,297 +Total deferred tax asset +9,941,408 +17,325,396 +Deferred tax liability: +ROU assets +(756,204 ) +(870,886 ) +Intangible assets, net +(160,318 ) +(209,044 ) +State taxes +(1,119 ) +— +Total deferred income tax liabilities +(917,641 ) +(1,079,930 ) +Net deferred income tax assets +9,023,766 +16,245,466 +Valuation allowance +(9,037,861 ) +(16,308,197 ) +Deferred tax asset (liability), net +$ (14,095 ) +$ (62,731 ) +At December 31, 2020, the Company had Federal net operating loss carry +forwards (“NOLs”) for income tax purposes of approximately $18,568,667 after applying the §382 limitation. The Coronavirus +Aid, Relief, and Economic Security Act (“CARES Act”) signed in to law on March 27, 2020, provided that NOLs generated in a +taxable year beginning in 2018, 2019, or 2020, may now be carried back five years and forward indefinitely. In addition, the 80% taxable +income limitation is temporarily removed, allowing NOLs to fully offset net taxable income. In accordance with Section 382 of the Internal +Revenue Code, the future utilization of the Company’s net operating loss to offset future taxable income is subject to an annual +limitation as a result of ownership changes that have occurred previously. Management believes that such an ownership change may have +occurred at various points in 2019 and 2020. The Company has estimated the Section 382 annual limitation due to this ownership change +to be approximately $41,969,444. This has been used to reduce the amount of the net operating losses for which deferred tax assets have +been recognized as of December 31, 2020. +At December 31, 2020, Microphase, an entity not consolidated for income +tax purposes, had NOLs of approximately $1,949,316 after applying the §382 limitation. NOLs generated in a taxable year beginning +in 2018, 2019, or 2020, may be carried back five years and forward indefinitely. In accordance with Section 382 of the Internal Revenue +Code, the future utilization of the Company’s net operating loss to offset future taxable income have been limited as a result of +ownership changes that have occurred previously. +In assessing the realization of deferred tax assets, management considers +whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization +of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences representing +net future deductible amounts become deductible. Management considers the scheduled reversal of deferred tax assets, projected future +taxable income and tax planning strategies in making this assessment. After consideration of all of the information available and due +to the last five years significant losses there is substantial doubt related to the Company’s ability to utilize its deferred tax +assets, the Company recorded a full valuation allowance of the deferred tax asset. For the year ended December 31, 2020, the valuation +allowance has decreased by $7,270,336. +The 2016 through 2019 tax +years remains open to examination by the Internal Revenue Service (“IRS”), the California Franchise Tax Board (“FTB”) +and the Connecticut Department of Revenue (“CDR”). The IRS, FTB and CDR have the authority to examine those tax years until +the applicable statute of limitations expires and the years with net operating loss carryovers when such carryovers are used. +F- 57 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +As of December 31, 2020, the +Company’s foreign subsidiaries had accumulated losses for income tax purposes in the amount of approximately $2,977,113. All +of the Company’s international accumulated losses were generated in the United Kingdom and Israel which have statutory tax rates +of 19% and 7.5% respectively. These net operating losses may be carried forward and offset against taxable income in the future +for an indefinite period. +The net income tax benefit consists +of the following: +2020 +2019 +Current +US Federal +$ +— +$ +— +US State +— +— +Foreign +24,842 +— +Total current provision +24,842 +— +Deferred +US Federal +— +— +US State +— +— +Foreign +(48,636 ) +(108,293 ) +Total deferred benefit +(23,794 ) +(108,293 ) +Total provision for income taxes +$ (23,794 ) +$ (108,293 ) +The Company’s effective tax rates were 0.1% and 0.4% for the +years ended December 31, 2020 and 2019, respectively. During the year ended December 31, 2020, the effective tax rate differed from +the U.S. federal statutory rate primarily due to the change in the valuation allowance and the effect of changes in tax rates in future +periods. The reconciliation of income tax attributable to operations computed at U.S. Federal statutory income tax rates of 21% to income +tax expense is as follows: +2020 +2019 +Expected federal income tax benefit +21.0 % +21.0 % +Beneficial conversion feature +(0.1 %) +(0.6 %) +Deconsolidation of I.AM +1.5 % +Loss on extinguishment of debt +(9.8 %) +State taxes net of federal benefit +8.1 % +3.5 % +Foreign rate differential +(0.3 %) +(0.2 %) +Section 382 limitation +(34.7 %) +— +Return to provision adjustment +(7.8 %) +Effect of change in valuation allowance +21.1 % +(21.9 %) +Other +1.1 % +(1.4 %) +Income tax benefit +0.1 % +0.4 % +The Company accounts for uncertain +tax positions in accordance with ASC No. 740-10-25. ASC No. 740-10-25 addresses the determination of whether tax benefits claimed or expected +to be claimed on a tax return should be recorded in the financial statements. Under ASC No. 740-10-25, the Company may recognize the tax +benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the +taxing authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount +of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome +of these matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination +is made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. +ASC No. 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has +taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management +of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2020 and 2019, there are no +uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in +the financial statements. +F- 58 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +26. RELATED PARTY TRANSACTIONS +a. The Company and AVLP entered into a Loan and Security Agreement (“AVLP Loan Agreement”) with +an effective date of August 21, 2017. At December 31, 2020, the Company has provided loans to AVLP in the principal amount $11,269,136 +and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants to purchase 22,537,871 shares of AVLP +common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. As of December 31, +2020, the Company recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2,025,475, and a provision for loan +loss of $3,423,608. +During the years ended December 31, +2020 and 2019, the Company also acquired in the open market 5,000 shares of AVLP common stock for $1,274 and 91,000 shares of AVLP common +stock for $53,032, respectively. At December 31, 2020, the Company’s investment in AVLP common stock had an unrealized loss of $248,248. +Philou is AVLP’s controlling shareholder. +Mr. Ault is Chairman of AVLP’s Board of Directors and the Executive Chairman of the Company. Mr. Horne is the Chief Financial Officer +and a director of AVLP and Chief Executive Officer and the Vice Chairman of the Company. Mr. Nisser is General Counsel of AVLP and President, +General Counsel and a director of the Company. +In March 2017, the Company was awarded +a $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“MLSE”) +plasma-laser system. On April 12, 2019, the Company received payment of $2,676,219 for manufacturing services performed on the first MLSE +system. At December 31, 2020, the Company had recorded a receivable from MTIX of $1,196,379. +b. At December 31, 2020, the Company has provided Alzamend a short-term advance of $750,000 and invested +$50,000 in an 8% convertible promissory note. In conjunction with the issuance of the 8% convertible promissory note, Alzamend issued +to the Company warrants to purchase 16,667 shares of Alzamend common stock at an exercise price of $3.00 per share for a period of five +years. The Company computed the fair value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, +recorded discount in the amount of $11,872 based on the estimated fair value of the warrants. During the year ended December 31, 2020, +the Company recorded $8,002 of interest income for the discount accretion and $1,337 of interest income from the contractual 8% rate +provided for by the convertible promissory notes. At December 31, 2020, the Company recorded a cumulative unrealized loss on its investment +in warrants of Alzamend of $453, representing the difference between the cost basis and the estimated fair value of the warrants in the +Company’s net loss from continuing operations on the Company’s consolidated statements of operations and comprehensive loss. +During the years ended December 31, +2020 and 2019, the Company also acquired 55,263 shares of Alzamend common stock for $44,210 and 372,625 shares of Alzamend common stock +for $208,100, respectively. At December 31, 2020, the unrealized gain of $38,684 estimated fair value of Alzamend’s common stock +was $1.50. The Company has determined that its investment in Alzamend marketable equity securities should be accounted for in accordance +with ASC No. 820, Fair Value Measurements and Disclosures and based upon the estimated fair value of Alzamend common stock at December +31, 2020, the Company’s investment in AVLP common stock had an unrealized gain of $389,522. +Mr. Ault is Executive Chairman of Alzamend’s +Board of Directors and the Executive Chairman of the Company. Mr. Horne is a director of Alzamend and Chief Executive Officer and the +Vice Chairman of the Company. Mr. Nisser is General Counsel and a director of Alzamend and President, General Counsel and a director of +the Company. Kenneth S. Cragun is Chief Financial Officer of Alzamend and the Company. +c. During the year ended December 31, 2020, Ault & Company has provided $256,507 in short-term advances, +of which $256,507 was repaid and the balance as of December 31, 2020, was zero. Ault and Company is the Manager of Philou which presently +owns 125,000 shares of the Company’s Series B Preferred Stock. Mr. Ault and Mr. Horne serve as the Chief Executive Officer and Chief +Financial Officer, respectively, of Ault & Company. +F- 59 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +d. On December 22, 2019, the Company entered into a securities purchase +agreement with Ault & Company. Pursuant to the terms of the agreement, Ault & Company purchased an aggregate of 660,667 shares +of the Common Stock for a total purchase price of $739,948, at a purchase price per share of $1.12, subject to the approval of the NYSE +American. The NYSE American approved the purchase on January 15, 2020. +e. On February 5, 2020, the Company issued +an 8% convertible promissory note in the principal amount of $1,000,000 and a maturity date of August 5, 2020 to Ault & Company (see +Note 20). On August 20, 2020, the Company issued 413,793 shares of Common Stock upon the conversion of $600,000 in principal on +the Ault & Company Convertible Note. +f. On June 18, 2019, Ault & Company guaranteed the prompt and complete payment and performance of a 10% +senior secured promissory note with a principal face amount of $2,900,000 . +g. During January 2020, Milton C. Ault, III, the Company’s Executive Chairman of the Board and MCKEA +guaranteed the Company’s obligation to repay a 12% short-term promissory note in the principal amount of $235,796. MCKEA is the +majority member of Philou and Kristine L. Ault, the wife of Mr. Ault III, is the manager and owner of MCKEA. +27. SEGMENT, CUSTOMERS AND GEOGRAPHICAL INFORMATION +The Company has three reportable +segments as of December 31, 2020 and 2019; see Note 1 for a brief description of the Company’s business. +The following data presents +the revenues, expenditures and other operating data of the Company’s operating segments and presented in accordance with ASC No. +280. The total loss from operations of the Company’s reportable segments is less than the Company’s consolidated loss from +operations due to Ault Global Holdings corporate expenses. +Year ended December 31, 2020 +GWW +Coolisys +Ault Alliance +Total +Revenue +$ 18,212,721 +$ 5,416,138 +$ — +$ 23,628,859 +Revenue, lending activities +— +— +242,418 +242,418 +Total revenues +$ 18,212,721 +$ 5,416,138 +$ 242,418 +$ 23,871,277 +Depreciation and +amortization expense +$ 586,850 +$ 33,010 +$ 107,513 +$ 727,373 +Loss from operations +$ +(955,299 +) +$ (117,067 ) +$ 19,200 +$ +(1,053,166 +) +Capital expenditures for +segment assets, as of +December 30, 2020 +$ 552,923 +$ 26,425 +$ 2,744 +$ 582,092 +Identifiable assets as of +December 31, 2020 +$ 27,897,772 +$ 1,894,892 +$ 45,850,718 +$ 75,643,382 +F- 60 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Year ended December 31, 2019 +GWW +Coolisys +Ault Alliance +Total +Revenue +$ 15,231,843 +$ 5,825,666 +$ — +$ 21,057,509 +Revenue, cryptocurrency +mining +— +— +641,745 +641,745 +Revenue, lending activities +— +— +662,740 +662,740 +Total revenues +$ 15,231,843 +$ 5,825,666 +$ 1,304,485 +$ 22,361,994 +Depreciation and +amortization expense +$ 705,873 +$ 121,618 +$ 2,245,676 +$ 3,073,167 +Loss from operations +$ (828,424 ) +$ (1,327,259 ) +$ (8,612,277 ) +$ (10,767,960 ) +Capital expenditures for +segment assets, as of +December 31, 2019 +$ 34,899 +$ 133,198 +$ 21,205 +$ 189,302 +Identifiable assets as of +December 31, 2019 +$ 20,847,352 +$ 18,901,630 +$ 3,001,426 +$ 42,750,408 +Concentration Risk: +The following table provides +the percentage of total revenues attributable to a single customer from which 10% or more of total revenues are derived: +For the Year Ended +December 31, 2020 +Total Revenues +Percentage of +by Major +Total Company +Customers +Revenues +Customer A +$ 7,741,858 +32 % +Customer B +$ 2,502,264 +10 % +For the Years Ended +December 31, 2019 +Total Revenues +Percentage of +by Major +Total Company +Customers +Revenues +Customer A +$ 6,319,221 +28 % +Revenue from Customer A is +attributable to Enertec. Revenue from Customer B is attributable to Microphase. +For the years ended December +31, 2020 and 2019, total revenues from external customers divided on the basis of the Company’s product lines are as follows: +F- 61 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +For the Year Ended +December 31, +2020 +2019 +Revenues: +Commercial products +$ 7,040,390 +$ 8,953,390 +Defense products +16,830,887 +13,408,604 +Total revenues +$ +23,871,277 +$ 22,361,994 +Financial data relating to geographic +areas: +The Company’s total +revenues are attributed to geographic areas based on the location. The following table presents total revenues for the years ended December +31, 2020 and 2019. Other than as shown, no foreign country or region contributed materially to revenues or long-lived assets for these +periods: +For the Year Ended +December 31, +2020 +2019 +Revenues: +North America +$ 11,460,436 +$ 10,923,146 +Europe +2,328,835 +8,681,023 +Middle East +9,273,158 +1,678,256 +Other +808,848 +1,079,569 +Total revenues +$ +23,871,277 +$ 22,361,994 +28. SUBSEQUENT EVENTS +In accordance with FASB ASC +855-10, the Company has analyzed its operations subsequent to December 31, 2020, and thru the date of this report being issued and has +determined that it does not have any material subsequent events to disclose in these financial statements except for the following. +2021 ATM Offering +On January 22, 2021, the Company +entered into an At-The-Market Issuance Sales Agreement, as amended on February 17, 2021 and thereafter on March 5, 2021 (the “2021 +Sales Agreement”) with Ascendiant Capital Markets, LLC, or the sales agent, relating to the sale of shares of Common Stock offered +by a prospectus supplement and the accompanying prospectus, as amended by the amendments to the sales agreement dated February 16, 2021 +and March 5, 2021. In accordance with the terms of the 2021 Sales Agreement, the Company may offer and sell shares of Common Stock having +an aggregate offering price of up to $200,000,000 from time to time through the sales agent. As of March 5, 2021, the Company had sold +an aggregate of 21,561,900 shares of Common Stock pursuant to the sales agreement for gross proceeds of $124,983,305. +Issuance of common stock for conversion +of debt +During January 2021, principal +and accrued interest of $200,000 and $15,948, respectively, on the Company’s debt securities was satisfied through the issuance +of 183,214 shares of Common Stock. The Company recognized a loss on extinguishment of $551,718 as a result of this issuance. +F- 62 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +Acquisition of Michigan +Cloud Data Center +On January 29, 2021, Alliance Cloud Services, LLC, a majority-owned +subsidiary of its wholly-owned subsidiary, Ault Alliance, closed on the acquisition of a 617,000 square foot energy-efficient facility +located on a 34.5 acre site in southern Michigan for a purchase price of $3,991,497. The purchase price was paid by the Company using +its own working capital. The facility is subject to a final corrective measures plan with the Environment Protection Agency. The seller +performed remedial activities at the Michigan facility relating to historical soil and groundwater contamination and the Company is responsible +for ongoing monitoring and final remediation plans. The Company’s estimated cost of the environmental remediation obligation is +approximately $300,000 and reflects its best estimate of probable future costs for remediation based on the current assessment data and +regulatory obligations. Future costs will depend on many factors, including the extent of work necessary to implement monitoring and final +remediation plans and the Company’s time frame for remediation. The Company may incur actual costs in the future that are materially +different than this estimate and such costs could have a material impact on results of operations, financial condition, and cash flows +during the period in which they are recorded. +Investment in Alzamend +Neuro, Inc. +On March 12, 2021, the Company announced that its wholly owned subsidiary, +DP Lending, entered into a securities purchase agreement with Alzamend, a related party, to invest $10,000,000 in Alzamend common stock +and warrants, subject to the achievement of certain milestones. The Company agreed to fund $4,000,000 upon execution of the securities +purchase agreement, consisting of approximately $3,200,000 in cash and the conversion of short term advances and a convertible promissory +note in the aggregate amount of $800,000, and to fund the balance upon Alzamend achieving certain milestones related to the U.S. Food +and Drug Administration approval of Alzamend’s Investigational New Drug application and Phase 1a human clinical trials for Alzamend’s +lithium based ionic cocrystal therapy, known as AL001. Under the securities purchase agreement, Alzamend has agreed to sell up to 6,666,667 +shares of its common stock to DP Lending for $10,000,000, or $1.50 per share, and issue to DP Lending warrants to acquire up to 3,333,334 +shares of Alzamend common stock with an exercise price of $3.00 per share. The transaction was approved by the Company’s independent +directors after receiving a third-party valuation report of Alzamend. +Investment in Ault +& Company, Inc. +On +February 25, 2021, Ault & Company, a related party, sold and issued an 8% Secured Promissory Note in the principal amount of $2,500,000 +to the Company. The principal amount of the Secured Promissory Note, plus any accrued and unpaid interest at a rate of 8% per annum, is +due and payable on February 25, 2022. +Executive Chairman +relocation benefit +On February 23, 2021, as part +of a relocation benefit for our Executive Chairman, Milton C. Ault, III, related to the Company moving its corporate headquarters from +Newport Beach, CA to Las Vegas, NV, the Company agreed to purchase Mr. Ault’s California residence for $2,670,000. The transaction +was structured such that upon the closing of the subsequent sale of the residence, the Company shall have not recognized a gain or a loss +on the transaction. The Company and Mr. Ault agreed to escrow $254,200 of the purchase price in the event of a loss on the subsequent +sale of the residence. The Company has entered into an agreement for the subsequent sale of the residence, which is currently in escrow. +Extension of AVLP Loan Agreement +On April 13, 2021, the AVLP Loan Agreement +was increased to up to $15,000,000 and extended to December 31, 2023. As of April 14, 2021, the Company has provided loans to AVLP in +the principal amount $13,924,136 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants to +purchase 27,848,272 shares of AVLP common stock at an exercise price of $0.50 per share for a period of five years. +Forgiveness of Debt +On +January 11, 2021, the Company received forgiveness of a loan under the PPP in the principal amount of $715,101 . +Ikonics Corporation +1. Ault Global filed a Schedule 13D with the Commission on January 14, 2021 disclosing that Ault Global had, +through its subsidiary DP Lending, purchased 140,719 shares (the “IKNX Shares”), or approximately 7.12% of all issued and +outstanding IKNX Shares, of common stock of Ikonics Corporation (“IKNX”) at a weighted average price (“WAP”) per +share of $8.48. +F- 63 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +2. Ault Global filed a Schedule 13D/A with the Commission on January 27, 2021, disclosing that Ault Global +had increased its position to 166,182 IKNX Shares, or approximately 8.41% of all issued and outstanding IKNX Shares at a WAP per share +of $10.30. +3. Ault Global filed a Schedule 13D/A with the Commission on January 28, 2021, disclosing that Ault Global +had increased its position to 197,634 IKNX Shares, or approximately 9.99% of all issued and outstanding IKNX Shares at a WAP per share +of $9.72. +SilverSun Technologies, +Inc. +1. Ault Global filed a Schedule 13D with the Commission on February 1, 2021 disclosing that Ault Global had, +through DP Lending, purchased 436,255 shares (the “SSNT Shares”), or approximately 9.69% of all issued and outstanding SSNT +Shares, of common stock of SilverSun Technologies, Inc. (“SSNT) at a WAP per share of $4.33. In addition, the Schedule 13D disclosed +that Milton C. Ault had purchased 10,000 SSNT Shares at a WAP per share of $3.57. +2. Ault Global filed a Schedule 13D/A with the Commission on March 1, 2021, disclosing that Ault Global had +decreased its position to 397,937 SSNT Shares, or approximately 8.84% of all issued and outstanding SSNT Shares at a WAP per share of +$9.28. +3. Ault Global filed a Schedule 13D/A with the Commission on March 4, 2021, disclosing that Ault Global had +decreased its position to 387,426 SSNT Shares, or approximately 8.61% of all issued and outstanding SSNT Shares at a WAP per share of +$7.24. +4. Ault Global filed a Schedule 13D/A with the Commission on March 18, 2021, disclosing that Ault Global +had decreased its position to 276,774 SSNT Shares, or approximately 6.15% of all issued and outstanding SSNT Shares at a WAP per share +of $7.48. +5. Ault Global filed a Schedule 13D/A with the Commission on March 26, 2021, disclosing that Ault Global +had decreased its position to 75,000 SSNT Shares, or approximately 1.67% of all issued and outstanding SSNT Shares at a WAP per share +of $7.11. +6. Ault Global filed a Schedule 13D with the Commission on April 5, 2021, disclosing that Ault Global had +increased its position to 305,500 SSNT Shares, or approximately 6.04% of all issued and outstanding SSNT Shares at a WAP per share of +$6.14. Further, the Schedule 13D disclosed that Mr. Ault had decreased his position to 8,800 SSNT Shares. +Naked Brand Group, +Ltd. +1. Ault Global filed a Schedule 13D with the Commission on April 8, 2021 disclosing that Ault Global had, +through DP Lending, acquired 41,141,660 ordinary shares (the “NAKD Shares”), or approximately 6.41% of all issued and outstanding +NAKD Shares, of Naked Brand Group Limited (“NAKD”). +F-64 \ No newline at end of file diff --git a/raw/filings/0000896493/2020/0001214659-21-004221/filing_metadata.csv b/raw/filings/0000896493/2020/0001214659-21-004221/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..d2b6b9dd6c5922901fdb93e9914d26d80e91ecb7 --- /dev/null +++ b/raw/filings/0000896493/2020/0001214659-21-004221/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2021-04-15,2020-12-31,2021-04-15T20:55:08.000Z,0001214659-21-004221,ag32421010k.htm,,13001991,1,0,https://www.sec.gov/Archives/edgar/data/896493/000121465921004221/ag32421010k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465921004221/,2020,2020,1 diff --git a/raw/filings/0000896493/2020/0001214659-21-004221/item1.txt b/raw/filings/0000896493/2020/0001214659-21-004221/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e2e53e79f4ef30951dc42c130c5473d899a6dce8 --- /dev/null +++ b/raw/filings/0000896493/2020/0001214659-21-004221/item1.txt @@ -0,0 +1,911 @@ +ITEM 1. BUSINESS +General +Ault Global Holdings, Inc., a Delaware corporation formerly known as +DPW Holdings (“Ault Global,” the “Company” or “we”), was incorporated in September 2017. The Company +is a diversified holding company owning subsidiaries engaged in, among others, the following operating businesses: commercial and defense +solutions, commercial lending and advanced textile technology. The Company’s direct and indirect wholly-owned subsidiaries include +Gresham Worldwide, Inc. (“GWW”), Coolisys Technologies Corp. (“Coolisys”), Digital Power Corporation, Gresham +Power Electronics Ltd. (f/k/a Digital Power Limited) (“Gresham Power”), Enertec Systems 2001 Ltd (“Enertec”), +Relec Electronics Ltd., Digital Power Lending, LLC (“DP Lending”), Ault Alliance, Inc. (“Ault Alliance”), and +Tansocial LLC (“Tansocial”). The Company also has a controlling interest in Microphase Corporation (“Microphase”) +and Ault Alliance has a controlling interest in and Alliance Cloud Services, LLC (“ACS”). Ault Global Holdings was founded +by Milton “Todd” Ault III, its Executive Chairman and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and +Vice Chairman and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages the +day-to-day operations of the holding company. The Company’s long-term objective is to maximize per share intrinsic value. All major +investment and capital allocation decisions are made for the Company by Mr. Ault and the Executive Committee. The Company has three reportable +segments: +· GWW +– defense solutions with operations conducted by Microphase, Enertec, Gresham Power and Relec, +· Coolisys +– commercial electronics solutions with operations conducted by Digital Power Corporation, and +· Ault Alliance – commercial lending through DP Lending, data center operations through ACS, digital +marketing through Tansocial and digital learning. +We operate as a holding company +with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed an investment +company under the Investment Company Act of 1940, as amended (the “ Investment Company Act ”). Generally, this means +that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets will be +invested in investment securities, as that term is defined in the Investment Company Act. Pursuant to the Investment Company Act, companies +such as our subsidiary DP Lending are excluded from the definition of an investment company since its business consists of making small +loans and industrial banking. We also maintain a considerable investment in Avalanche International, Corp., which +does business as MTIX International. +Originally, we were primarily +a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system solutions +for the medical, military, telecom and industrial markets. Although we actively seek growth through acquisitions, we will also continue +to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high +density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions. +We have operations located +in Europe through our wholly-owned subsidiary, Gresham Power Electronics (f/k/a Digital Power Limited) (“ Gresham Power ”), +located in Salisbury, England. Gresham Power designs, manufactures and sells power products and system solutions mainly for the European +marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted +Power Supply) products. Our European defense business is specialized in the field of naval power distribution products. +On November 30, 2016, we formed +DP Lending, a wholly-owned subsidiary. DP Lending provides commercial loans to companies throughout the United States to provide them +with operating capital to finance the growth of their businesses. The loans range in duration from six months to three years, DP Lending +loans made or arranged pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +On June 2, 2017, we purchased +56.4% of the outstanding equity interests of Microphase Corporation (“ Microphase ”). Microphase is a design-to-manufacture +original equipment manufacturer (“ OEM ”) industry leader delivering world-class radio frequency (“ RF ”) +and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers +(“ DLVA ”) to the military, aerospace and telecommunications industries. Microphase is headquartered in Shelton, Connecticut. +On January 7, 2020, we formed +Coolisys Technologies Corp. (“ Coolisys ”), a wholly-owned subsidiary. Coolisys operates its existing businesses in the +customized and flexible power system solutions for the automotive, medical, military, telecom, commercial and industrial markets, other +than the European markets, which are primarily served by Gresham Power. +On September 1, 2017, Digital +Power Corporation, a Delaware corporation (“ DPC ”), a subsidiary of Coolisys since January 20, 2020, acquired all of +the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability company (“ Power-Plus ”). +Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related +components. In addition to its current business, Power-Plus will serve as an extended sales organization for our overall flexible power +system solutions. +On +December 31, 2017, Coolisys Technologies, Inc., a Delaware corporation (“ CTI ”) entered into a share purchase agreement +with Micronet Enertec Technologies, Inc. (“ MICT ”), a Delaware corporation, Enertec Management Ltd., an Israeli corporation +and wholly owned subsidiary of MICT (“ EML ”), and Enertec Systems 2001 Ltd. (“ Enertec ”), an Israeli +corporation and wholly owned subsidiary of EML, pursuant to which CTI acquired Enertec. Enertec is Israel’s largest private manufacturer +of specialized electronic systems for the military market. On May 23, 2018, CTI completed its acquisition of Enertec. +In +January 2018, we formed Super Crypto Mining, Inc., a wholly-owned subsidiary, which changed its name to Digital Farms, Inc. (“ DFI ”) +on January 18, 2019. DFI was established to operate our newly formed cryptocurrency business, which is pursuing a variety of digital currency. +We used to mine the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin and Ethereum. DFI’s +operations were discontinued in the first quarter of 2020. +On +May 23, 2018, DP Lending entered into and closed a securities purchase agreement with I. AM, Inc. (“ I. AM ”), David +J. Krause and Deborah J. Krause. Pursuant to the securities purchase agreement, I. AM sold to DP Lending, 981 shares of common stock for +a purchase price of $981, representing, upon the closing, 98.1% of I. AM’s outstanding common stock. I.AM owed DP Lending $1,715,330 +in outstanding principal, pursuant to a loan and security agreement, between I. AM and DP Lending. The purchase agreement provides that, +as I. AM repays the outstanding loan to DP Lending in accordance with the loan agreement, DP Lending will on a pro rata basis transfer +shares of common stock of I. AM to David J. Krause, up to an aggregate of 471 shares. I. AM’s +operations were discontinued in the first quarter of 2020. +Gresham +Worldwide, Inc. was incorporated under the laws of the State of Delaware on November 21, 2018 as DPW Technologies Group, Inc. and effected +a name change on December 6, 2019. +On +November 30, 2020, we acquired Relec, a privately held company based in Wareham, the United Kingdom. The transaction was structured as +a stock purchase under which we paid approximately $4,000,000 with additional contingent cash payments up to approximately $665,000 based +on Relec’s future financial performance. The acquisition of Relec has enhanced our presence in industrial and transportation markets +in the United Kingdom and Europe and considerably broadened our product portfolio, including high-quality power conversion and display +product offerings. Relec specializes in AC-DC power supplies, DC-DC converters, displays and EMC filters. +On +January 29, 2021, Alliance Cloud Services, LLC, a majority-owned subsidiary of its wholly-owned subsidiary, Ault Alliance, closed on the +acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan for a purchase price of +$3,991,497. The purchase price was paid by the Company using its own working capital. +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.aultglobal.com. +Recent Events +On +January 19, 2021, the Company changed its name from DPW Holdings, Inc., to Ault Global Holdings, Inc. (the “Name Change”). +The Name Change was effected through a parent/subsidiary short form merger pursuant to an Agreement and Plan of Merger dated January 7, +2021. Neither the merger nor resulting Name Change affected the rights of security holders of the Company. The Company’s common +stock continues to be quoted on the NYSE American under the symbol “DPW.” Existing stock certificates that reflect the Company’s +prior corporate name will continue to be valid. Certificates reflecting the new corporate name will be issued in due course as old stock +certificates are tendered for exchange or transfer to the Company’s transfer agent. Concurrently with the change in our name, Milton +C. Ault, III was appointed as our Executive Chairman, William B. Horne was appointed as our Chief Executive Officer and remains as Vice +Chairman of our board of directors, and Henry Nisser was appointed as our President and remains as our General Counsel. +2 +Commencing in October of 2019 +and continuing through February of 2020, the Company reorganized its corporate structure pursuant to a series of transactions by and among +the Company and its directly and indirectly owned subsidiaries. The purpose of the reorganization was to align the Company’s various +businesses by the products and services that constitute the majority of each subsidiaries’ revenues. As a result of the foregoing +transactions, the Company’s corporate structure is as follows: +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of Common Stock at a purchase price per share of $1.12, subject to the approval of the NYSE +American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, at +the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, or up to 19.99% of +the Common Stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, shall be +due and payable on August 5, 2020. The Note shall be convertible into shares of the Company’s common stock, par value $0.001 per +share (the “ Common Stock ”) at a conversion price of $1.45 per share, subject +to the approval of the Company’s stockholders at a special meeting thereof, as required by Rule 713(a)(ii) of the NYSE Company Guide, +and subsequently, authorization from the NYSE American. +On February 10, 2020, we entered +into a Master Exchange Agreement (the “ Master Exchange Agreement ”) with Esousa Holdings, LLC (“ Esousa ” +or the “ Credito r”) that acquired approximately $4.2 million in principal amount, plus accrued but unpaid interest, +of certain promissory notes that had been previously issued by us to Dominion Capital, LLC, a Connecticut limited liability company (the +“ Dominion Note ”) and the Canadian Special Opportunity Fund, LP (the “ CSOF Note ” and with the Dominion +Note, the “ Esousa Purchased Notes ”) in separate transactions. The Creditor also agreed to purchase additional notes +up to an additional principal amount, plus accrued but unpaid interest, of $3.5 million (the “ Additional Notes ” and +collectively, with the Esousa Purchased Notes, the “ Notes ”). Pursuant to the Exchange Agreement, the Creditor has the +unilateral right to acquire shares of the Company’s common stock (the “ Exchange Shares ”) in exchange for the +Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness of the Company. In aggregate, we have issued +to Esousa a total of 8,332,904 Exchange Shares. +3 +The first exchange occurred +on the date of the Master Exchange Agreement when the Creditor exchanged a portion of the Esousa Purchased Notes for the Exchange Shares +and the second exchange began July 8, 2020 when the Company received stockholder approval at a special meeting thereof for the Exchange +of the Esousa Additional Purchased Notes for the Company’s common stock, and subsequently, authorization from the NYSE American. +On March 4, 2020, pursuant +to the terms of the securities purchase agreement for the sale of the Dominion short-term promissory note, the Company issued to Dominion +12,500 shares of its common stock (see Note 17). +On April 13, 2020, the Company +issued a convertible promissory note in the principal amount of $100,000 with an interest rate of 10% per annum and a five-year warrant +to purchase shares of the Company’s common stock equal to 50% of the number of shares of common stock issuable pursuant to the convertible +promissory note, at an exercise price equal to $1.17 per share of common stock. +On May 28, 2020, the Company +entered into a securities purchase and exchange agreement with an institutional investor. Pursuant to the agreement, the Company exchanged +a 12% short-term promissory note in the principal amount of $235,796 for a new note due and payable on June 30, 2020 (the “Exchanged +Note”) that would become convertible into common stock of the Company should the Company be in default under the terms of the Exchanged +Note. In addition, pursuant to the agreement, the Company issued to the investor a note due and payable on November 28, 2020 in the principal +amount of $200,000 that became convertible into the Company’s common stock commencing June 30, 2020 with an original issue discount +of twenty percent (20%). In conjunction with the issuance of the Convertible Note, the Company also issued to the investor a warrant to +purchase an aggregate of 400,000 shares of Common Stock at an exercise price of $1.07. +On June 26, 2020, the Company +issued to several institutional investors unsecured 12% short-term promissory notes in the aggregate principal amount of $800,000 and +seventeen month warrants to purchase an aggregate of 361,991 shares of the Company’s common stock at an exercise price of $2.43 +per share of common stock. +On August 5, 2020, the Company +received $2,000,000 from Esousa and on October 22, 2020, the Company issued to Esousa a promissory note in the principal face amount of +$2,000,000, with an interest rate of 13%. +On +August 20, 2020, the Company issued 413,793 shares of its common stock upon the conversion of $600,000 in principal on the Ault +& Company Convertible Note. +Between +August 2020 and October 2020, the Company also received $3,200,000 in loans from Esousa pursuant to which the Company agreed to issue +unsecured short-term promissory notes with interest rates of 13% and 14% and warrants with terms of approximately one and a half years +to purchase an aggregate of 1,303,863 shares of Common Stock at an average exercise price of $2.70 per share of Common Stock. +On October 2, 2020, we entered +into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC to sell shares +of common stock having an aggregate offering price of up to $8,975,000 from time to time, through an “at the market offering” +program (the “2020 ATM Offering”). On December 1, 2020, we filed an amendment to the prospectus supplement with the SEC to +increase the amount of common stock that may be offered and sold in the ATM Offering, as amended under the Sales Agreement to $40,000,000 +in the aggregate, inclusive of the up to $8,975,000 in shares of common stock previously sold in the 2020 ATM Offering. The offer and +sale of shares of common stock from the 2020 ATM Offering was made pursuant to our effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) which became effective on January +11, 2018. Through December 31, 2020, we had received gross proceeds of $39,978,350 through the sale of 12,582,000 shares of common stock +from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, 2020. +On +October 26, 2020, the Company announced that it had successfully converted all of its secured debt, totaling just under $5 million, +to equity thus improving the Company’s net equity. +On +November 2, 2020, I.AM, Inc. filed a voluntary petition for bankruptcy under Chapter 7 in the United States Bankruptcy Court in the Central +District of California, Santa Ana Division, case number 8:20-bk-13076. +4 +Settlement of Derivative Litigation +On February 24, 2020, we entered +into a definitive settlement agreement (the “ Settlement Agreement ”) intended to settle the previously disclosed derivative +litigation captioned Ethan Young and Greg Young, Derivatively on Behalf of Nominal Defendant, DPW Holdings, Inc. v. Milton C. Ault, +III, Amos Kohn, William B. Horne, Jeff Bentz, Mordechai Rosenberg, Robert O. Smith, and Kristine Ault and DPW Holdings, Inc., as the nominal +defendant (Case No. 18-cv-6587) (as amended on March 11, 2019, the “ Amended Complaint ”) against the Company and +certain of its officers and directors pending in the United States District Court for the Central District of California (the “ Court ”). +As previously disclosed, the Amended Complaint alleges violations including breaches of fiduciary duties and unjust enrichment claims +based on the previously pled transactions. +On April 15, 2020, the Court +issued an Order (the “ Order ”) approving a Motion for Preliminary Approval of Settlement in the Derivative Action. On +July 16, 2020, the Court issued an Order (the “ Final Order ”) approving a Motion for Final Approval of Settlement in +the Derivative Action filed against DPW as a Nominal Defendant and its directors who served on its board of directors on July 31, 2018 +who were not dismissed from the action as a result of the Court’s partial grant of the Motion. +On July 16, 2020, the Court +entered a Judgement based upon the Final Order. +Under the terms of the Final +Order approving the Agreement, the Board shall adopt and/or maintain resolutions and amendments to committee charters and/or the Company’s +bylaws to ensure adherence to certain corporate governance policies (collectively, the “ Reforms ”), which shall remain +in effect for no less than five (5) years, subject to any of the following: (a) a determination by a majority of the independent directors +that the Reform is no longer in the best interest of the Company, including, but not limited to, due to circumstances making the Reform +no longer applicable, feasible, or available on commercially reasonable terms, or (b) modifications which the Company reasonably believes +are required by applicable law or regulation. +In connection with the Settlement +Agreement, the parties agreed upon a payment of attorneys’ fees in the amount of $600,000 payable by the Company’s Director +& Officer liability insurance, which sum was paid. The Settlement Agreement contains no admission of wrongdoing. The Company has always +maintained and continues to believe that it did not engage in any wrongdoing or otherwise commit any violation of federal or state securities +laws or other laws. +Strategy +As a holding company, our business strategy is designed to increase +shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and partner companies, +with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are and will consider +initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain or all partner company +interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize shareholder value, such +as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working capital needs. +On October 7, 2019, we created an Executive Committee which is comprised +of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets on a daily basis to address the Company’s +critical needs and provides a forum to approve transactions which are communicated to our Chief Financial Officer and Senior Vice President +of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves and manages our investment and trading +strategy. The Executive Committee has decades of experience in financial, investing and securities transactions. Led by our Founder and +Executive Chairman, Milton “Todd” Ault III, we seek to find undervalued companies and disruptive technologies with a global +impact. We also use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an +investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, +from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. Mr. Ault relies heavily on Mr. William B. Horne, the Company’s Vice Chairman and Chief Executive Officer +and Henry Nisser, the Company’s President and General Counsel, to provide analysis and guidance on all acquisition targets and throughout +the acquisition process. +5 +From time to time, we engage in discussions with other companies interested +in our subsidiaries or partner companies, either in response to inquiries or as part of a process we initiate. To the extent we believe +that a subsidiary partner company’s further growth and development can best be supported by a different ownership structure or if +we otherwise believe it is in our shareholders’ best interests, we will seek to sell some or all of our position in the subsidiary +or partner company. These sales may take the form of privately negotiated sales of stock or assets, mergers and acquisitions, public offerings +of the subsidiary or partner company’s securities and, in the case of publicly traded partner companies, transactions in their securities +in the open market. Our plans may include taking subsidiaries or partner companies public through rights offerings and directed share +subscription programs. We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner +company interests in secondary market transactions to maximize value for our shareholders. +Our Executive Committee acts +as the underwriting committee for our subsidiary DP Lending and approves all lending transactions. Under its business model, DP Lending +generates revenue through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income +from appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants +issued to DP Lending in any particular financing. DP Lending’s activities are more fully described elsewhere in this Annual Report; +see page 10. +As a holding company, our business strategy is designed to increase +shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and partner companies, +with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are and will consider +initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain or all partner company +interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize shareholder value. We +anticipate returning value to shareholders after satisfying our debt obligations and working capital needs. +Over the recent past we have +provided capital and relevant expertise to fuel the growth of businesses in defense/aerospace, industrial, telecommunications, medical +and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity interest or may be actively +involved, influencing development through board representation and management support. +Markets +We sell our custom power system +solutions, high-grade flexibility series power supply products and value-added services to customers in a diverse range of commercial +and defense industries and markets throughout the world, with an emphasis on North America and Europe. Our current customer base +consists of approximately 220 companies, some of which are served through our partner channels. We serve the North American power electronics +market primarily through our domestic wholly owned subsidiary Digital Power Corporation, whereas the European marketplace is served through +Gresham Worldwide, another wholly-owned subsidiary. +Gresham Worldwide’s +operations focus exclusively on the market for electronic solutions that support the defense industry and other mission critical applications. +The essential nature of these applications provides a degree of insulation from volatility associated with other segments of the global +economy while accounting for stability and steady growth of the addressable market opportunities available to Gresham Worldwide in segments +that it serves. Demand for solutions to meet these requirements continues unaffected, and in many instances increases, in times of global +crisis. Total defense spending in the three countries in which Gresham Worldwide currently operates will total more than an estimated +$813 billion in 2021. Gresham Worldwide sells to the militaries and defense contractors in 18 other countries as well. Overall global +defense spending is expected to grow at a compound annual growth rate, or CAGR, of 3% through 2023, with US spending growing at almost +a 5% CAGR in the same period. +The drive for increased situational +awareness and close coordination of air, land, sea, space and cyber operations will fuel an increase in defense electronics subsystems +and components with total spending in 2020 of $131 billion and a projected CAGR of 5.6% through 2024, according to Global Defense Electronics +Market, Trends, Driver and Outlook for 2020 and Beyond, Renaissance Strategic Advisors, September 2020. The drive for greater connectivity +and analytics will in turn increase demand for RF communications, power solutions and electronic control systems content in new major +military platforms, right in the sweet spot of Gresham Worldwide operating units. +Tens of thousands of companies +compete in this market to deliver electronics solutions to meet defense and other mission critical applications. However, Gresham Worldwide’s +operating units have longstanding relationships with dominant defense contractors in the US (Lockheed, BAE Systems, L3Harris, Raytheon, +Boeing), in the UK (BAE, Rolls Royce, Thales, Bombardier) and in Israel (IAI, Rafael, Elbit) which hold contracts for major defense platforms +with very long life cycles. These relationships enable Gresham Worldwide to narrow the field of competition considerably and thereby to +grow based on repeat business with relatively low selling costs. +6 +Beyond the defense arena, +initiatives to complete $50 billion in upgrades to the current National Railway System in the UK over the next five years while spending +$130 billion over the next 10 years to build a high speed rail to link London with the Midlands cities of Birmingham, Leeds and Manchester +will generate significant opportunities for growth in demand for power solutions to upgrade and replace current infrastructure, both in +rolling stock and track side controls. Relec Electronics’ current relationships and track record for supplying power solutions to +the UK rail industry position Gresham Worldwide ideally to capitalize on these ongoing refurbishment and expansion efforts. A similarly +robust market in the medical power supply markets with a CAGR at 5.4%, to reach $4.4 billion in 2022, creates tremendous growth opportunities +for our Relec Electronics subsidiary in the UK. +We sell products to our OEM +customers through direct sales or through our sales channels, including our manufacturers’ representatives and distributors. Our +sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship with +such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new product +requirements. In striving for additional market share, we simultaneously seek to strengthen our traditional sales channels of manufacturer +representatives and distributors. We plan to continue to build more channels and increase our market share through 2021. +Commercial Customers . +We serve global commercial markets including medical, telecom, and industrial companies. Our products are used in a variety of applications +and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme environmental +conditions. Our commercial customers include Elma GmbH, BioSense Webster, a subsidiary of Johnson & Johnson, RS Components, Farnell, +Parker Hannifin, Vanderbilt, Bombardier. +Military/Defense Customers . +We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh +environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat +environments and meet the requirements of our defense customers. We manufacture our military products through a domestic manufacturer +that complies with US International Traffic in Arms Regulations (“ ITAR ”) and is certified to perform such manufacturing +services. We are compliant with the ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military +electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive +the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in +these severe military environments, including Missiles – Ground-to-Air, Air-to-Air and Sea-to-Air; Naval – Naval power conversion +and distribution; Mobile and Ground Communications – Active Protection, Communications and Navigation; Artillery – Gyro modular +azimuth position and navigation system; Surveillance, test equipment; and UAV (Unmanned Aerial Vehicle) – Very lightweight power +systems. +Our military products meet +the relevant defense standards MIL-STD in accordance with the Defense Standardization Program Policies and Procedures. Space, weight, +output power, electromagnetic compatibility, power density and multiple output requirements are only part of the challenges that any military +power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our power supplies +are a critical component of many major weapon systems worldwide. +Our wholly-owned subsidiary +Gresham Power develops and manufactures some military and defense products mainly being deployed in several naval fleets. +Our Subsidiaries and their Businesses +Coolisys +We provide the highest density, +highest efficiency and high-grade flexibility power supply products and systems. We provide full custom, standard and modify-standard +product solutions and value-added services to diverse industries and markets including automotive, medical, military, telecom, commercial +and industrial. We believe that our solutions leverage a combination of low leakage power emissions, very high-power density with superior +power efficiency, flexible design leveraging customize firmware and short time to market. +Our strategy with respect +to Coolisys Technologies Corp., or CTC, is to be the supplier of choice to companies, including OEMs, that require high-quality power +system solutions where custom design, superior product, high quality, time to market and very competitive prices are critical to business +success. We believe that we provide advanced custom product design services to deliver high-grade products that reach a high level of +efficiency and density and can meet rigorous environmental requirements. Our customers benefit from a direct relationship with us that +supports all of their needs for designing and manufacturing power solutions and products. By implementing our advanced core technology, +including process implementation in integrated circuits, we can provide cost reductions to our customers by replacing their existing power +sources with our custom design cost-effective products. +7 +Electric Vehicle (“EV”) +Market. Coolisys‘ electric vehicle supply equipment including its EV charging stations product line is well positioned to +address the expected rapid expansion of infrastructure required to support broad adoption of electric vehicles globally. Coolisys has +strong reputations for delivering high-reliability power solutions designed to serve mission critical applications in the harshest environments. +Coolisys’ innovative charging solution can produce a full charge for an EV with a 150-mile range battery in just 30 minutes. It +includes a wide range of solutions including level 2 AC EV charger station that are 208-240 volt compatible with the SAE J1772 standard +and range of heavy duty level 3 DC fast EV charger station that is 150-1500VDC compatible with chargers equipped Combined Charging System +or CCS, CHAdeMO and SAE J1772 charging plugs. Coolisys EVSE series can charge virtually any type of electrical vehicles, such as, Honda, +Nissan, Mitsubishi, Toyota, Kia, Subaru, Ford, General Motors, Volkswagen, Audi, Jaguar and Tesla (with the appropriate Tesla charging +adapter). +Custom Power System +Solution. We provide high-grade custom power system solutions to several customers in multiple industry segments. Our custom solution +technology includes full Digital Signal Processing (“ DSP ”) control, digital load sharing intelligent power management +and customizable firmware. The products feature high power density, special layout and multiple outputs to meet each of our customers’ +unique requirements. We combine our power design capabilities with the latest circuit designs to provide complete power solutions for +virtually any plausible need. In the design of custom power solutions, we work closely with our customers’ engineering teams +to develop mechanical enclosures to ensure 100% compatibility with any hosted platform. +Our standard contract for +custom power solutions includes a multi-year high-volume production forecast that allows us to secure long-term production guarantees +(and therefore possible savings on manufacturing costs for volume orders) while providing an environment that promotes the development +of our intellectual property (“ IP ”) portfolio. We believe that this business model provides an incentive to our customers +to be committed to high-volume production orders. +High-Grade Flexibility +Series Power Supply Product . We offer our feature rich based power rectifiers that support flexible configuration and high-grade +design implementation. This includes innovative designs and implementation including DSP control for Power Factor Correction (“ PFC ”) +and DC/DC, synchronous rectifier outputs under DSP control, two phase PFC, hot pluggable, current sharing and other features. While some +of our customers have special requirements that include a full custom design, other customers may require only certain electrical changes +to standard power supply products, such as modified output voltages, unique status and control signals, and mechanical repackaging tailored +to fit the specific application. We offer a wide range of standard and modified standard products that can be easily integrated with any +platform across our diversified market segments. +Value-Added Services . +In addition to our custom solutions and high-grade flexibility series proprietary products that we offer, we also provide value-added +services to OEMs. We incorporate an OEM’s selected electronic components, enclosures, cable assemblies and other compliance components +into our power system solutions to produce a power subassembly that is compatible with the OEM’s own equipment and specifically +tailored to meet the OEM’s needs. We purchase parts and components that the OEM itself would otherwise attach to, or integrate with, +our power systems, and provide the OEM with the integration and installation service, thus eliminating the need for complex, time-consuming +and costly system integration. We believe that this value-added service is well suited to those OEMs that wish to reduce their vendor +base and minimize their investment in manufacturing, which would lead to increased fixed costs. Given access to these value-added services, +the OEMs do not need to build assembly facilities to manufacture their own power sub-assemblies and thus are not required to purchase +individual parts from many vendors. +Gresham Worldwide, Inc. +Gresham Worldwide provides defense solutions with +operations conducted by Microphase, Enertec, Gresham Power and Relec +Gresham Power (formerly known as Digital Power +Limited) +Gresham Power designs, manufactures, +and distributes switching power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters +for the commercial and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships +to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment +such as gyro, compass, and weapons systems. Gresham also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers +are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter +start and servicing systems. We believe that Gresham products add diversity to our product line, provide greater access to the United +Kingdom and European markets, and strengthen our engineering and technical resources. +8 +Gresham Power specializes +in engineering, designing and developing power conversion and distribution solutions for Naval applications, with equipment installed +on virtually all of the UK Royal Navy’s submarine and surface fleet. Many of Gresham Power’s ultra-reliable offerings support +shipboard distribution of electrical power in emergencies (such as loss of main ship’s power) to enable continued operation of weapons +systems, tactical communications and lighting. Gresham Power specializes in a comprehensive range of activities from PCB and Mechanical +Design through prototype development to board and system assembly and test. Its engineers ruggedize Marine power products to meet high +levels of shock, vibration, harsh climate conditions and the most rigorous MIL STD requirements. Gresham Power also has deployed its equipment +on vessels of the navies of 15 other countries, include Australia, Malaysia, Oman, Spain, Turkey and Japan. +Microphase Corporation +Microphase designs, manufactures +and sells microwave electronics components for radar, electronic warfare (“ EW ”) and communication systems. Such components +include radio frequency (“ RF ”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated +assemblies and detector logarithmic video amplifiers (“ DLVAs ”). Microphase’s customers are comprised of the U.S. +military and allied militaries, and contractors to the U.S. military including prime contractors and sub-contractors. Microphase’s +recent technology innovations are used in many significant U.S. Government defense programs, including the Polaris submarine, the F-16, +the F-35 and the Predator drone. Other notable programs in which Microphase’s products are or were used include the Atlas Missile, +Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile System, THAAD (or Terminal High Altitude Area Defense), +the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the FB-111, EA-6B, F-14, F-16, F-18, JAS Gripen fighter, and the F-35 joint +strike fighter plane, and more recently drone programs including the Predator, the Reaper and the Shadow. +Microphase’s advanced +technology products enable the ultra-sensitive detection and high precision video amplification that are necessary in order to accurately +recover the signals and facilitate use of the information received. These products include: +· filters that sort and clarify microwave signals, including multiplexers that are a series of filters combined +in a single package; +· solid state amplifiers that amplify microwave signals; +· detectors and limiters that are semiconductor devices for detection of radar signals and protection of +receivers from damage from high power signals and jamming; +· detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal detection +systems; +· integrated assemblies that combine multiple functions from a range of components and devices, including +transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction +assemblies; +· electronic test and measurement probes; +· universal test and measurement test platforms and fixtures; and +· utility probes and antenna probes. +Manufacturing and Testing +Consistent with our strategy +of focusing on custom design products and high-grade flexibility series products, we aim to maintain a high degree of flexibility in our +manufacturing through the use of strategically focused contract manufacturers. We select contract manufacturers to ensure that they +will meet our near-term cost, delivery, and quality goals. In addition, we believe these relationships will eventually give us access +to new markets and beneficial cross-licensing opportunities. The competitive nature of the power supply industry has placed continual +downward pressure on selling prices. In order to achieve our low-cost manufacturing goals with labor-intensive products, we have entered +into manufacturing agreements with certain contract manufacturers domestically and in Asia. +We are continually improving +our internal processes, while monitoring the processes of our contract manufacturers, to ensure the highest quality and consistent manufacturing +of our power solutions. We test all of our products under stress operating conditions per defined test procedures we developed as part +of the production process. This approach ensures that our customers can use our power supplies right out of the box. Customer specific +testing services are offered with custom designed test stands to simulate operation within our customer applications. +9 +Compliance with international +safety agency standards is critical in every application, and power solutions play a major role in meeting these compliance requirements. +Our safety engineers and quality assurance teams help ensure that our custom products are designed to meet all safety requirements and +are appropriately documented to expedite safety approval processes. +Enertec Systems 2001 Ltd. +Based in Israel, Enertec designs, +develops, manufactures and maintains advanced end-to-end high technology electronic solutions for military, medical, telecommunications +and industrial markets. Those solutions include custom computer-based automated test equipment and turnkey systems to ensure combat readiness, +provide command and control, and direct and deploy resources in military operations in harsh environments and battlefield conditions. +The Company also designs, develops, manufactures and maintains high precision calibration equipment for lifesaving medical operations +for a global health care products company as well as advance power systems for electric vehicle, telecom and other industrial applications. +Enertec delivers complete end-to-end project management with requirements definition, systems engineering, design/development, production, +testing, integration, field support, maintenance and optimization. Its custom engineered solutions enable and support mission critical +air, land and sea military platforms, e.g., missiles, UAVs, combat aircraft, boats, submarines, trailers and satellites. +Enertec’s primary customers +include the Israeli Ministry of Defense and the 3 major defense contractors in Israel – Israel Air Industries (IAI), Rafael and +Elbit Systems. In addition, Enertec has a strategic partnership with Cyient to build and deliver solutions for the Indian military. High +tech capabilities to deliver advance electronics solutions create opportunities for other Gresham Worldwide operating subsidiaries – +Microphase and Gresham Power – to supply components for Enertec solutions. Enertec also provides geographic reach into the Middle +East and India to broaden Gresham Worldwide’s footprint in delivering the highest quality and most advance technology solutions +across the globe. +Enertec is Israel’s +largest, most well-established manufacturer of test equipment and simulators. We develop and manufacture test systems and simulators for +all types of weapons systems at all levels of maintenance, development, and integration. We are currently working on developing a new +generation of electronics cards and assemblies to build a new generation of test systems. +Enertec complies with all +information security requirements included in it customer contracts as well as all the confidentiality laws that the State of Israel mandates +for work related to defense of the country. +Relec Electronics Ltd. +Relec Electronics Ltd was +established in 1978 with the aim of providing specialist power conversion and display products to support professionals in the electronics +industry. Relec markets and distributes power electronics and display solutions for mission critical rail, industrial, medical, telecoms +and military applications. Relec develops custom solutions for various applications ranging from light industrial to heavily ruggedized +for the harshest of environments. Relec exerts its utmost effort to customize a product or a feature to achieve optimum performance and +service delivery. Relec continues to be guided by this philosophy and currently operates in specific fields, specializing in AC-DC Power +Supplies, DC-DC Converters, Displays and EMC Filters. +Ault Alliance, Inc. +Ault Alliance provides commercial +lending through DP Lending, data center operations through ACS, digital marketing through Tansocial and digital learning. +DP Lending +DP Lending provides funding +to businesses through loans and investments. DP Lending offers a variety of loan types including commercial loans, convertible notes and +revolving lines of credit. DP Lending is engaged in providing commercial loans to companies throughout the United States to provide them +with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to twelve months, +but may be of longer duration. These terms are subject to change as market needs dictate, and DP Lending anticipates offering additional +products in the future. +10 +DP Lending uses its considerable financial experience, data analytics, +and a credit scoring model to assess the creditworthiness of each small business borrower applicant. If the business meets DP Lending’s +criteria, DP Lending sets the initial interest rate according to its credit and financial models. The final interest rate offered to the +borrower will be determined by DP Lending’s interpretation of the marketplace. In order to borrow from DP Lending, borrowers must +display characteristics indicative of durable business and financial situations. These include factors such as revenue, time in business, +number of employees, and financial and credit variables. In order to qualify, business borrower applicants must be approved through DP +Lending’s underwriting process, which analyzes credit and financial data of both the business and the business owner. DP Lending +takes into account several business factors (including revenue, age of business, cash flows, and other variables). The underwriting process +determines the loan amount to approve, how loans will be priced, and whether to include a blanket lien is based on the above analysis, +as well as additional factors (including length of loan, estimated default rates by type and grade, and general economic environment). +Our Executive Committee, which is comprised of our Executive Chairman, +Chief Executive Officer and President, acts as the underwriting committee for DP Lending and approves all lending transactions. The Executive +Committee has decades of experience in financial, investing and securities transactions. Under its business model, DP Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to DP Lending in any particular financing. +As noted above, we will from time to time, through DP Lending, engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +During 2021, we anticipate +providing significant new funding to expand DP Lending’s loan and investment portfolio. DP Lending loans made or arranged pursuant +to a California Financing Law license (Lic.no. 60 DBO77905). +ACS +ACS operates a data center +and conducts bitcoin mining at a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan with the +ability to offer up to 300MWs of critical power capacity. The data center was acquired on February 1, 2021 and revenue from the existing +commercial real estate operations began being recognized during the quarter ending March 31, 2021 and, upon completion of the initial +buildout of 30,000 square feet, or the equivalent of 1,000 cabinets capable of housing over 40,000 servers, recognition of revenue from +the enterprise cloud data center is expected to begin during the quarter ending June 30, 2021. +The buildout of the initial +30,000 square feet will be for colocation services, including build-to-suit arrangements, in which customers will be provided with secure, +reliable and robust environments for hardware and access to network connectivity that are necessary to aggregate and distribute information. +By initially focusing on colocation services that range from a single rack to multi-megawatt hyperscale requirements, we will be able +to minimize our capital and operating expenses and also provide an attractive alternative to companies that either host internally and +need additional capacity or are evaluating build vs. buy alternatives. We expect that revenues from the colocation services will be primarily +based on a recurring revenue model comprised of colocation for a predetermined amount of allocated power and related interconnection offerings. +Ultimately, we intend to expand our service offerings to include managed cloud computing, in other words the on-demand availability of +various technology resources, such as compute, storage and network. While we believe the Facility and its anticipated future operations +will be successful, there is a risk that its expectations will not materialize in a timely manner, if at all. +11 +Tansocial +Tansocial is an early-stage +marketing company leveraging innovative digital tools to provide lead generation, influencer promotion and marketing, client acquisition +training systems, social media branding/content, digital marketing consulting, and text message marketing. +Sales and Marketing +We market our products directly +through our internal sales force as well as through our channel partners including independent manufacturer representatives and distributors. +Each manufacturing representative promotes our products in a particular assigned geographic territory. Generally, the manufacturing representatives +have the opportunity to earn exclusive access to all potential customers in the assigned territory as a result of achieving their marketing +and sales goals as defined in the representative agreement. Our manufacturer representative agreements provide for a commission equal +to 5% of gross sales of new “design-in” and 1.75% to 2.0% of gross sales for retention, payable after products are shipped +to the customer in the assigned territory. Typically, either we or the manufacturing representatives are entitled to terminate the manufacturing +representative agreement upon 30 days’ written notice. +Gresham Power Electronics +makes limited use of channel partners including independent manufacturer representatives and strategic operating partners in the Middle +East, India and Australia. These representatives promote our products and serve as the customer interface for Gresham Power in specific +parts of the world as agreed. Typically, either we or the manufacturing representatives are entitled to terminate the manufacturer representative +agreement upon 30 days’ written notice. +Our Relec subsidiary advertises +in highly targeted industry-specific publications such as Electronics Weekly, New Electronics, Electronic Product Design & Test, Electronics +Specifier, Components In Electronics, Design Products & Applications, Rail Technology Magazine, Rail Engineer, Rail Professional. +In addition, Relec also posts regular podcasts on topics of interest to customers and prospect as well as running an active PR campaign +to get placements of earned media and coverage in a wide range of media. We look to replicate similar campaigns in other operating subsidiaries +to generate inquiries/leads, raise awareness of Gresham Worldwide and support talent recruiting efforts. +We provide comprehensive +collateral materials including product data sheets, participation in trade shows, and our websites, www.digipwr.com and +www.microphase.com. We use our website to emphasize our capabilities and marketing direction. All products specifications are +uploaded onto our websites and accessible to the marketplace. We will continue to enhance our websites by adding more features and +functionalities, such as e-commerce, that will allow our customers to make direct purchases through our website. Our future +promotional activities will likely include advertising in industry-specific publications, as well as public relations for our new +products. +Engineering and Technology +Our engineering and product +development efforts are primarily directed toward developing new products in connection with custom product design and modification of +our standard power systems to provide a broad array of individual models. +Our new custom product solutions +are driven by our ability to provide to our customers advanced technology that meets their product needs and supports special operation +and environmental requirements, with a short turnaround time and a very competitive price point. We believe that we are successfully executing +our strategic account focus, as evidenced by the award of second and third generation product development contracts from some of these +customers. Our standard contract for custom power solutions includes a multi-year high-volume production forecast that could allow us +to secure long-term production guarantees while providing an environment that promotes the development of our IP portfolio. +We also outsource some of +our product development projects to engineering partners in order to achieve the best technological and product design results for the +targeted application customer requirements. When required, we also modify standard products to meet specific customer requirements, including, +but not limited to, redesigning commercial products to meet MIL-STD requirements for military applications based on commercial off the +shelf (“ COTS ”) products and for other customized product requirements, when applicable. We continually seek to improve +our product power density, adaptability, and efficiency, while attempting to anticipate changing market demands for increased functionality, +such as PFC controlled DSP, customized firmware and improved EMI (electromagnetic interference) filtering. We continue to attempt to differentiate +all of our products from commodity-type products by enhancing, modifying and customizing our existing product portfolio, using our engineering +integrating laboratory located in California. +12 +Competition +The power system solutions +industry is highly fragmented and characterized by intense competition. Our competition includes hundreds of companies located throughout +the world, some of which have advantages over us in terms of labor and component costs, and some of which may offer products superior +or comparable in quality to ours. Many of our competitors, including Bel Fuse, Artesyn Embedded Technologies, TDK-Lambda, Delta Electronics, +Murata and Mean-Well Power Supplies, have substantially greater fiscal and marketing resources and geographic presence than we do. If +we are successful in increasing our revenues, competitors may notice and increase competition efforts with our customers. We also +face competition from current and prospective customers who may decide to internally design and manufacture power supplies needed for +their products. Furthermore, certain larger OEMs tend to contract only with larger power supply manufacturers. +We anticipate in the current +economic situation, that additional competitors may enter into strategic alliances or even acquisitions. Competition could thus become +more problematic if consolidation trends in the electronics industry continue and some of the OEMs to which we sell our products are acquired +by larger OEMs. To remain competitive, we must continue to compete favorably on the basis of value by providing reliable manufacturing, +offering customer-driven engineering services including custom design and manufacturing, continuously improving quality and reliability +levels, and offering flexible and reliable delivery schedules. +We believe that our power +system solutions and advanced technology is superior to our competitors’ power supplies mainly because we use the latest power technology +processing and controls which make these power supplies highly customized and efficient. The power-to-volume ratio makes our power solutions +more compact compared to what is offered by our competitors and is suitable in custom infrastructures to meet our customers’ requirements. +Another advantage of our power +system solutions product line is based on the “Flexible” series that employs adjustable power range and a selectable number +of output product design platforms. We believe we have a competitive position with our targeted customers that need a high-quality, compact +product, which can be readily modified to meet the customer’s unique requirements. We have designed the base model power system +platform so that it can be quickly and economically modified and adapted to the specific power needs of any hosting platform or OEM. This +“flexibility” approach has allowed us to provide samples of modified power systems to OEM customers only a few days after +initial consultation, an important capability given the emphasis placed by OEMs on “time to market.” It also results in very +low non-recurring engineering (“ NRE ”) expenses. Because of reduced NRE expenses, we do not generally charge our OEM +customers for NRE related to tailoring a power system to a customer’s specific requirements. We believe this gives us an advantage +over our competitors, many of which charge their customers for NRE expenses. +The markets in which Microphase +operates is also highly competitive and sensitive to technological advances. Many of Microphase’s competitors are larger than it +is and maintain higher levels of expenditures for research and development. Principal competitive factors in Microphase’s markets +are product quality and reliability; technological capabilities; service; past performance; ability to develop and implement complex, +integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales channels in international markets; and +cost-effectiveness. +In the RF Communications market, +principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, MD; RS Microwave, +a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith Group, a global technology +company listed on the London Stock Exchange; and Delta Diversified Products, a private company based in Arizona. +In the Video amplifier segment, +principal competitors for Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately held company +headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, a privately +held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company based in New +York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Our Enertec subsidiary faces +direct competition from smaller firms than itself such as Nir Or, EPS, MER, Alexander Schneider, Symcotech and Chaban, which specialize +in components of electronic solutions. Offering end-to-end, turnkey solutions gives Enertec a competitive advantage over other private +contractors competing to provide the Israeli MOD and major OEMs with electronic systems and components. That competitive advantage renders +roughly 80% of Enertec’s business de facto “sole source” work without other viable competition. +Gresham Power confronts competition +from Ultra Electronics and Rolls Royce. As in the case of Microphase, elegant designs, strong engineering and a long track record for +delivering ultra-reliable high quality power electronics solutions enables Gresham Power to compete effectively. +13 +Relec competes against many +other distributors of power electronics and display offerings, facing competition from the likes of Fidus Power Ltd, Mouser Electronics +and Avnet Abacus as well as power supply and electronics manufacturers like XP and ABB who sell direct, many of which have significantly +more fiscal and marketing resources than Relec. However, a high touch, customer-focused approach enables Relec to compete effectively +against high volume distributors and direct selling manufacturers. Optimizing and designing solutions into customer product lines has +proven tremendously effective in building relationships with customers and suppliers alike that endure over time, generating regular repeat +business and builds a reputation for customer service that provides a strong competitive advantage when pursuing new customers. +We also face competition from +current and prospective customers who may decide to design and manufacture power electronics, communications components and electronic +solutions needed to satisfy their internal programmatic requirements. +Consolidation in the defense +technology solutions market, including through mergers, acquisitions and/or strategic alliances among major entities to which we sell +our products, has the potential to intensify the competitive pressures that we face. Many of our existing and potential competitors may +be better positioned than we are to acquire other companies, technologies or products. We believe we compete favorably on the basis of +multiple factors, including product quality and reliability, technological capabilities, service, past performance, design flexibility +and ability to develop and implement complex, integrated solutions customized to our customers’ needs, and cost-effectiveness. Focusing +on bespoke technology offerings with relatively low volumes and high margins enables our operating subsidiaries to compete favorably on +price against larger companies with much high indirect cost structures. Finally, the fragmentation of the defense technology market also +creates opportunities the Gresham Worldwide to grow through acquiring competitors and/or potential competitors. +Raw Materials +The raw materials for power +supplies principally consist of electronic components. These raw materials are available from a variety of sources, and thus we are not +dependent on any one supplier. We generally allow our subcontractors to purchase components based on orders received or forecasts to minimize +our risk of unusable inventory. To the extent necessary, we may allow them to procure materials prior to orders received to obtain shorter +lead times and to achieve quantity discounts following a risk assessment. In addition, we have decided to directly procure certain long +lead-time electronic components in an effort to reduce our lead-time. +Many raw material vendors +have reduced capacities, closed production lines and, in some cases, discontinued operations. As a result, some materials are no longer +available to support some of our products requiring us to search for cross materials or, in certain circumstances, redesign some of our +products to conform to currently available materials. +Intellectual Property +We rely upon a combination +of trade secrets, industry expertise, confidential procedures, and contractual provisions to protect our intellectual property. We believe +that because our products are continually updated and revised, obtaining patents would be costly and not beneficial. It is our policy +to enter into confidentiality and invention assignment agreements with our employees and contractors as well as nondisclosure agreements +with our suppliers and strategic partners in order to limit access to and disclosure of our proprietary information. However, in the future, +as we continue to develop unique core technology, we may seek to obtain patents for some of the core technology. On July 10, 2012, our +trademark, “DP Digital Power Flexible Power” was registered with the United States Patent and Trademark Office. +In conjunction with our majority +acquisition of Microphase, we concluded that because of the industry recognition of the Microphase trademark and trade name, which has +been around for nearly 60 years, the tradename and trademark represented a significant intellectual property asset. +Microphase and Enertec typically +design custom products to our customer specifications as “work for hire” and therefore own no intellectual property in the +design. As the ultimate end user, the U.S. DoD and the Israeli MOD typically acquire and retain rights in all such technical data. Microphase +does acquire and own intellectual property in the fabrication, assembly, tuning and testing protocols followed the production of the products. +And, as they conduct more independent research and development to new technology solutions, both companies plan to file for patents to +protect their intellectual property. +14 +In the UK, Gresham Power typically +will retain ownership of the intellectual property of the designs of products developed for defense applications. However, neither Relec +nor Gresham Power typically retains intellectual property in any of the standard power products that they sell on the commercial market. +Compliance with Material Government (Not Just +Environmental) Regulations +Coolisys +Coolisys’ businesses are heavily regulated in most of its markets. +Coolisys handles power electronics products mainly in the form of power conversion. Coolisys must take into account several standards +for electronic safety to protect the health of humans and animals. Coolisys serves diverse markets including automotive, defense/aerospace, +medical/healthcare, industrial and telecommunications, each of which has its own set of their safety regulations and standard that Coolisys +must comply with. +Government Contracts . +The U.S. government, and other governments, may terminate any of Coolisys’ government contracts at their convenience, as well as +for default based on our failure to meet specified performance requirements. If any of Coolisys’ U.S. government contracts were +to be terminated for convenience, Coolisys would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of Coolisys’ government contracts were to be terminated for default, generally the U.S. government +would pay only for the work that has been accepted and could require Coolisys to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. government can also hold +Coolisys liable for damages resulting from the default. +Medical device power supplies . +Coolisys’ medical power supplies must incorporate one or more means of protection (“ MOP ”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. Coolisys must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an AP and unconscious when the fault occurs. +Environmental . Coolisys +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. Coolisys continually assesses its compliance status and +management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of Coolisys’ operations. +Non-U.S. Sales . Coolisys’ +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Gresham +Gresham’s businesses +are heavily regulated in most of its markets. Gresham transacts with numerous U.S. government agencies and entities, including but not +limited to the Department of Defense, branches of the U.S. military and the Department of Homeland Security. Similar government authorities +exercise similar regulatory oversight in Gresham’s non-U.S. markets. +Government Contracts . +The governments of the U.S., UK and Israel may terminate any of Gresham’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of Gresham’s contracts for convenience, Gresham generally would be entitled to receive payment for work completed and allowable +termination or cancellation costs. If any of Gresham’s government contracts were to be terminated for default, generally the U.S. +government would pay only for the work that has been accepted and could require Gresham to pay the difference between the original contract +price and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. government can also +hold Gresham liable for damages resulting from the default. Similar provisions apply to Gresham’s contracts with other governments +and to Gresham’s subcontractors with major defense contractors who provide systems or military platforms directly to the government. +15 +Power Electronics . +In all of Gresham’s markets in the U.S., Gresham’s commercial power electronics offerings must comply with safety, energy +use and operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. +In the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the UK, Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, Gresham’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . Gresham +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies or as applicable +local regulations or laws require. The products that Gresham markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“ RoHS ”), which restricts the use of six hazardous materials in the manufacture +of certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“ WEEE ”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, Gresham’s industry began phasing in +RoHS and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. Gresham believes that RoHS +and WEEE-compliant components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. +REACH (Registration, Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 +December 2006. REACH addresses the production and use of chemical substances, and their potential impacts on both human health and the +environment. +These regulatory mandates +apply to all of Gresham’s operating subsidiaries. Gresham has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +Non-U.S. Sales . Gresham’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Alliance Cloud Services +ACS is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. ACS continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While ACS’s regulatory compliance costs +are currently not considered material, it is reasonably possible that costs incurred to ensure continued environmental compliance could +have a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +Security Clearance +As a U.S. Government contractor, +we are required to maintain facility and personnel security clearances complying with the DoD and other Federal agency requirements. Microphase +maintains strict protocols for handling classified information and Confidential Unclassified Information associated with its work for +the United States Department of Defense and has built a “Secure Compartmented Information Facility” within its Shelton production +facility certified for generating, storing and reviewing classified information. +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the UK Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +16 +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “ DCAA ”), +the Defense Contract Management Agency (the “ DCMA ”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the Department of Justice and Congressional Committees. From time-to-time, these and other agencies +investigate or conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. +The DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the MOD does most of its business. All +of its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +UK Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the customer +the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government and +typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified and Confidential Unclassified Information (CUI) from disclosure and unauthorized access. That mandate +includes a requirement that Microphase formulate and implement a System Security Plan with 110 different elements and protocols for handling +and protecting classified information and CUI. Over the next 3 years, the DoD will require all participants in the defense supply chain +to demonstrate compliance with the Capability Model Maturity Cybersecurity as verified through an independent third party auditor. Compliance +with these mandates requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance +requires extensive security controls on access to Microphase IT systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Compliant.” Cyber Essentials is a Government-backed, industry-supported scheme +to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials program criteria. +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Issues +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December +31, 2020 and 2019, we spent approximately $1,848,866 and $1,861,103, respectively, on research and development. +17 +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries and others operate in industries deemed essential by the DoD and therefore remained +at work during the COVID-19 pandemic. +Employee Profile +As of December 31, 2020, we +had 154 employees located in the United States, the United Kingdom and Israel, of whom 54 were engaged in engineering and product development, +14 in sales and marketing, 46 in general operations and 40 in general administration and finance. All but 10 of these employees are employed +on a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to +be good. +As of December 31, 2020, approximately +36% of our current workforce is female, 64% male, and our average tenure is 10.0 years, an increase of 3.7% from an average tenure of +9.7 years as of December 31, 2019. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of ten years as +of the end of the fiscal year 2020 reflects the engagement of our employees in this core talent system tenet. +The Company believes it complies +with all applicable state, local and international laws governing nondiscrimination in employment in every location in which the Company +operates. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, +national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees' needs. We plan to conduct annual confidential employee surveys +as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. Our +employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new stretch +goals. +Objectives and key results +are used to drive our business strategy. All our teams participate in an annual strategic planning process to identify objectives for +business growth and innovation. Our teams and employees set goals quarterly to achieve the Company’s annual objectives. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members, reflect and reinforce our most important values +and align team member interests with shareholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +18 +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, health savings and flexible spending accounts, paid time off, family leave, family care resources and flexible work +schedules. We anticipate establishing a Company-wide augmented employee stock purchase plan and a Company matched 401(k) plan during 2021. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +In response to the COVID-19 pandemic, we implemented significant operating environment changes that we determined were in the best interest +of our employees, as well as the communities in which we operate, and which comply with government regulations. This includes having a +significant portion of our employees work from home, while implementing additional safety measures for employees continuing critical on-site +work. For further information on this subject and how COVID-19 has affected our company and our subsidiaries, see “Impact of Coronavirus +on Our Operations.” +19 \ No newline at end of file diff --git a/raw/filings/0000896493/2020/0001214659-21-004221/item13.txt b/raw/filings/0000896493/2020/0001214659-21-004221/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..1e4049120355fecb2b02f48620e1d083baa5c31a --- /dev/null +++ b/raw/filings/0000896493/2020/0001214659-21-004221/item13.txt @@ -0,0 +1,95 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our board of directors, monitors and reviews issues involving potential conflicts of interest +and approves all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of +such transactions that must be approved by our Audit Committee or a special committee of our board of directors include, but are not limited +to any transaction, arrangement, relationship (including any indebtedness) in which: +• the aggregate amount involved is determined to by the Audit Committee to be material; +• we are a participant; and +• any of the following has or will have a direct or indirect interest in the transaction: +• an executive officer, director, or nominee for election as a director; +• a greater than five percent beneficial owner of our common stock; or +• any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our board of directors formed for that purpose applies the standards +for evaluating conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company, Inc. +Ault & Company, Inc. +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of our common stock at a purchase price per share of $1.12, subject to the approval of the +NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, +at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, or up to 19.99% +of our common stock then outstanding. +79 +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, was due +and payable on August 5, 2020. The Note is convertible into shares of our common stock, par value $0.001 per share at a conversion price +of $1.45 per share. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer of Ault & Company, Inc. William +B. Horne, our Chief Executive Officer, Vice Chairman and Director, is also Chief Financial Officer of Ault & Company, Inc. Henry Nisser, +our President, General Counsel and a member of our board of directors, is also the President, General Counsel and a director of Ault & +Company, Inc. +Avalanche International, Corp. +On September 6, 2017, we entered +into a Loan and Security Agreement with Avalanche (as amended, the “ AVLP Loan Agreement ”) with an effective date of +August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility. The AVLP Loan Agreement was recently increased +to up to $15,000,000 and extended to December 31, 2023. +At December 31, 2020, we had +provided Avalanche with $11,269,136 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants +to purchase 22,537,871 shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by +the assets of AVLP. As of December 31, 2020, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2,025,475 +and a provision for loan losses of $3,423,608. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 22,537,871 shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company, Inc., is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive +Chairman of Avalanche. Further, our President, General Counsel and one of our directors, is the Executive Vice President and General Counsel +of Avalanche. +Director Independence +Independent +Audit +Committee +Member +Nominating +and +Governance +Committee +Compensation +Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert Smith +Yes +X +X +Howard Ash +Yes +C +X +Jodi Brichan +Yes +C +X +Jeffrey A. Bentz +Yes +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairperson of committee +X – Member of committee \ No newline at end of file diff --git a/raw/filings/0000896493/2020/0001214659-21-004221/item9a.txt b/raw/filings/0000896493/2020/0001214659-21-004221/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..82c2cced93426d2bc6af0a12dc9b3344d8561412 --- /dev/null +++ b/raw/filings/0000896493/2020/0001214659-21-004221/item9a.txt @@ -0,0 +1,113 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2020, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +64 +Based upon that evaluation, our principal executive officer and principal +financial officer, with the assistance of other members of the Company's management, have evaluated the effectiveness of the design and +operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) +as of the end of the period covered by this annual report and has determined that our disclosure controls and procedures were not effective +due to the material weakness as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records +that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide +reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2020. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“ COSO ”) in Internal +Control-Integrated 2013 Framework. Our management has concluded that, as of December 31, 2020, our internal control over financial reporting +was not effective. +A material weakness is a control +deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control +deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will +not be prevented or detected. Management has identified the following material weakness: +1. +We do not have sufficient resources in our accounting function, which +restricts our ability to gather, analyze and properly review information related to financial reporting, including applying complex accounting +principles relating to consolidation accounting and fair value estimates, in a timely manner. In addition, due to our size and nature, +segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, +the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management +evaluated the impact of our failure to have segregation of duties during our assessment of our disclosure controls and procedures and +concluded that the control deficiency that resulted represented a material weakness. +Changes in Internal Controls over Financial +Reporting +Management, with the participation +of our Chief Executive Officer and Chief Financial Officer, has assessed whether any changes in our internal control over financial reporting +that occurred during the year ended December 31, 2020 have materially affected, or are reasonably likely to materially affect, our internal +control over financial reporting. Significant changes were implemented and tested during the latter half of fiscal 2020 through the date +of this report to remediate our material weaknesses in internal control over financial reporting. Management believes that such measures +we have implemented to remediate the material weaknesses in our disclosure controls and procedures and internal control over financial +reporting have had a favorable impact on our internal control over financial reporting. Changes in our internal control over financial +reporting through the date of this report that have materially affected, or are reasonably likely to materially affect, our internal control +over financial reporting are described below. +65 +Material Weaknesses Remediated +at December 31, 2020: +1. Control activities related to the timely communication of information necessary to properly record transactions. +We did not have adequate controls to ensure that information necessary to properly record transactions was adequately communicated on +a timely basis from non-financial personnel to those responsible for financial reporting. +2. Control activities related to general information technology (“IT”) controls over certain +information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets. Specifically, we the +design and implement program change management controls for certain financially relevant systems to ensure that IT program and data changes +affecting the Company’s (i) financial IT applications, (ii) digital currency mining equipment, (iii) digital currency hardware wallets, +and (iv) underlying accounting records, are identified, tested, authorized and implemented appropriately. +Planned Remediation +Management, in coordination with the input, oversight +and support of our Audit Committee, has identified the measures below to strengthen our control environment and internal control over +financial reporting. +On +August 19, 2020, Mr. Horne resigned as our Chief Financial Officer and was appointed our President, and later became our Chief Executive +Officer. Mr. Cragun, who had served as the Company’s Chief Accounting Officer since October 1, 2018, succeeded Mr. Horne as the +Chief Financial Officer of the Company. In January 2018, we engaged the services of a financial accounting advisory firm. In January 2019, +we hired a Senior Vice President of Finance. In May 2019, we hired an Executive Vice President and General Counsel, who later became our +President and General Counsel. Finally, in January 2021, we hired a Director of Reporting. These individuals were tasked with expanding +and monitoring the Company’s internal controls, to provide an additional level of review of complex financial issues and to assist +with financial reporting. On October 7, 2019, we created an Executive Committee which is currently comprised of our Executive Chairman, +Chief Executive Officer and President. The Executive Committee meets on a daily basis to address the Company’s critical needs and +provides a forum to approve transactions which are communicated to the Company’s Chief Financial Officer and Senior Vice President +of Finance on a bi-weekly basis by our Chief Executive Officer, who also reviews all of the Company’s material transactions and +reviews the financial performance of each of our subsidiaries. On December 16, 2020, in consultation with the Chairman of the Audit Committee, +we engaged a professional services firm to review management’s assessment of compliance with Section 404 of the Sarbanes-Oxley Act +of 2002 and to identify internal control process improvement opportunities. These changes have improved and simplified our internal processes +and resulted in enhanced controls. While these changes have improved and simplified our internal processes and resulted in enhanced controls, +these enhancements have not been operating for a sufficient period of time for management to conclude, through testing, that these controls +are operating effectively. Further, as we continue to expand our internal accounting department, the Chairman of the Audit Committee shall +perform the following: +· assists with documentation and implementation of policies and procedures and monitoring of controls, and +· reviews all anticipated transactions that are not considered in the ordinary course of business to assist +in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s financial statements. +We +are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the +material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and +procedures. These material weaknesses will not be considered to be remediated until the applicable remediated controls are operating for +a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. +This Annual Report does not +include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. +Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to a provision +under the Dodd-Frank Wall Street Reform and Consumer Protection Act which grants a permanent exemption for non-accelerated filers from +complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. +66 +Changes in Internal Control over Financial +Reporting +During the most recent fiscal +quarter 2018 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) +and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over +financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2020/0001214659-21-004221/rp_note.txt b/raw/filings/0000896493/2020/0001214659-21-004221/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..5855179fbbfda3727542344c0ec52bff952212a4 --- /dev/null +++ b/raw/filings/0000896493/2020/0001214659-21-004221/rp_note.txt @@ -0,0 +1,58 @@ +26. RELATED PARTY TRANSACTIONS +a. The Company and AVLP entered into a Loan and Security Agreement (“AVLP Loan Agreement”) with +an effective date of August 21, 2017. At December 31, 2020, the Company has provided loans to AVLP in the principal amount $11,269,136 +and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants to purchase 22,537,871 shares of AVLP +common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. As of December 31, +2020, the Company recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2,025,475, and a provision for loan +loss of $3,423,608. +During the years ended December 31, +2020 and 2019, the Company also acquired in the open market 5,000 shares of AVLP common stock for $1,274 and 91,000 shares of AVLP common +stock for $53,032, respectively. At December 31, 2020, the Company’s investment in AVLP common stock had an unrealized loss of $248,248. +Philou is AVLP’s controlling shareholder. +Mr. Ault is Chairman of AVLP’s Board of Directors and the Executive Chairman of the Company. Mr. Horne is the Chief Financial Officer +and a director of AVLP and Chief Executive Officer and the Vice Chairman of the Company. Mr. Nisser is General Counsel of AVLP and President, +General Counsel and a director of the Company. +In March 2017, the Company was awarded +a $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“MLSE”) +plasma-laser system. On April 12, 2019, the Company received payment of $2,676,219 for manufacturing services performed on the first MLSE +system. At December 31, 2020, the Company had recorded a receivable from MTIX of $1,196,379. +b. At December 31, 2020, the Company has provided Alzamend a short-term advance of $750,000 and invested +$50,000 in an 8% convertible promissory note. In conjunction with the issuance of the 8% convertible promissory note, Alzamend issued +to the Company warrants to purchase 16,667 shares of Alzamend common stock at an exercise price of $3.00 per share for a period of five +years. The Company computed the fair value of the warrants using the Black-Scholes option pricing model and, as a result of this calculation, +recorded discount in the amount of $11,872 based on the estimated fair value of the warrants. During the year ended December 31, 2020, +the Company recorded $8,002 of interest income for the discount accretion and $1,337 of interest income from the contractual 8% rate +provided for by the convertible promissory notes. At December 31, 2020, the Company recorded a cumulative unrealized loss on its investment +in warrants of Alzamend of $453, representing the difference between the cost basis and the estimated fair value of the warrants in the +Company’s net loss from continuing operations on the Company’s consolidated statements of operations and comprehensive loss. +During the years ended December 31, +2020 and 2019, the Company also acquired 55,263 shares of Alzamend common stock for $44,210 and 372,625 shares of Alzamend common stock +for $208,100, respectively. At December 31, 2020, the unrealized gain of $38,684 estimated fair value of Alzamend’s common stock +was $1.50. The Company has determined that its investment in Alzamend marketable equity securities should be accounted for in accordance +with ASC No. 820, Fair Value Measurements and Disclosures and based upon the estimated fair value of Alzamend common stock at December +31, 2020, the Company’s investment in AVLP common stock had an unrealized gain of $389,522. +Mr. Ault is Executive Chairman of Alzamend’s +Board of Directors and the Executive Chairman of the Company. Mr. Horne is a director of Alzamend and Chief Executive Officer and the +Vice Chairman of the Company. Mr. Nisser is General Counsel and a director of Alzamend and President, General Counsel and a director of +the Company. Kenneth S. Cragun is Chief Financial Officer of Alzamend and the Company. +c. During the year ended December 31, 2020, Ault & Company has provided $256,507 in short-term advances, +of which $256,507 was repaid and the balance as of December 31, 2020, was zero. Ault and Company is the Manager of Philou which presently +owns 125,000 shares of the Company’s Series B Preferred Stock. Mr. Ault and Mr. Horne serve as the Chief Executive Officer and Chief +Financial Officer, respectively, of Ault & Company. +F- 59 +AULT GLOBAL HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +DECEMBER 31, 2020 +d. On December 22, 2019, the Company entered into a securities purchase +agreement with Ault & Company. Pursuant to the terms of the agreement, Ault & Company purchased an aggregate of 660,667 shares +of the Common Stock for a total purchase price of $739,948, at a purchase price per share of $1.12, subject to the approval of the NYSE +American. The NYSE American approved the purchase on January 15, 2020. +e. On February 5, 2020, the Company issued +an 8% convertible promissory note in the principal amount of $1,000,000 and a maturity date of August 5, 2020 to Ault & Company (see +Note 20). On August 20, 2020, the Company issued 413,793 shares of Common Stock upon the conversion of $600,000 in principal on +the Ault & Company Convertible Note. +f. On June 18, 2019, Ault & Company guaranteed the prompt and complete payment and performance of a 10% +senior secured promissory note with a principal face amount of $2,900,000 . +g. During January 2020, Milton C. Ault, III, the Company’s Executive Chairman of the Board and MCKEA +guaranteed the Company’s obligation to repay a 12% short-term promissory note in the principal amount of $235,796. MCKEA is the +majority member of Philou and Kristine L. Ault, the wife of Mr. Ault III, is the manager and owner of MCKEA. \ No newline at end of file diff --git a/raw/filings/0000896493/2020/0001214659-21-004221/rpt_disclosure.txt b/raw/filings/0000896493/2020/0001214659-21-004221/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..1e4049120355fecb2b02f48620e1d083baa5c31a --- /dev/null +++ b/raw/filings/0000896493/2020/0001214659-21-004221/rpt_disclosure.txt @@ -0,0 +1,95 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our board of directors, monitors and reviews issues involving potential conflicts of interest +and approves all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of +such transactions that must be approved by our Audit Committee or a special committee of our board of directors include, but are not limited +to any transaction, arrangement, relationship (including any indebtedness) in which: +• the aggregate amount involved is determined to by the Audit Committee to be material; +• we are a participant; and +• any of the following has or will have a direct or indirect interest in the transaction: +• an executive officer, director, or nominee for election as a director; +• a greater than five percent beneficial owner of our common stock; or +• any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our board of directors formed for that purpose applies the standards +for evaluating conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company, Inc. +Ault & Company, Inc. +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company, Inc. +would purchase an aggregate of 660,667 shares of our common stock at a purchase price per share of $1.12, subject to the approval of the +NYSE American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, +at the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of Common Stock, or up to 19.99% +of our common stock then outstanding. +79 +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “ Note ”) +to Ault & Company, Inc. The principal amount of the Note, plus any accrued and unpaid interest at a rate of 8% per annum, was due +and payable on August 5, 2020. The Note is convertible into shares of our common stock, par value $0.001 per share at a conversion price +of $1.45 per share. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer of Ault & Company, Inc. William +B. Horne, our Chief Executive Officer, Vice Chairman and Director, is also Chief Financial Officer of Ault & Company, Inc. Henry Nisser, +our President, General Counsel and a member of our board of directors, is also the President, General Counsel and a director of Ault & +Company, Inc. +Avalanche International, Corp. +On September 6, 2017, we entered +into a Loan and Security Agreement with Avalanche (as amended, the “ AVLP Loan Agreement ”) with an effective date of +August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility. The AVLP Loan Agreement was recently increased +to up to $15,000,000 and extended to December 31, 2023. +At December 31, 2020, we had +provided Avalanche with $11,269,136 and, in addition to the 12% convertible promissory notes, AVLP has issued to the Company warrants +to purchase 22,537,871 shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by +the assets of AVLP. As of December 31, 2020, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2,025,475 +and a provision for loan losses of $3,423,608. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 22,537,871 shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company, Inc., is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive +Chairman of Avalanche. Further, our President, General Counsel and one of our directors, is the Executive Vice President and General Counsel +of Avalanche. +Director Independence +Independent +Audit +Committee +Member +Nominating +and +Governance +Committee +Compensation +Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert Smith +Yes +X +X +Howard Ash +Yes +C +X +Jodi Brichan +Yes +C +X +Jeffrey A. 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+us-gaap:SalesRevenueNetMember +us-gaap:CustomerConcentrationRiskMember +dpw:CustomerBMember +2020-01-01 +2020-12-31 +iso4217:USD +xbrli:shares +iso4217:USD +xbrli:shares +xbrli:pure +dpw:Number +utr:sqft +UNITED STATES SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES +EXCHANGE ACT OF 1934 +For the Fiscal Year Ended December 31, 2021 +o TRANSITION +REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from _____________ to ___________________ +Commission file number 1-12711 +BITNILE HOLDINGS, INC. +(Exact name of registrant as specified in its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +11411 Southern Highlands Pkwy , Suite 240 , +Las Vegas , NV +89141 +( 949 ) 444-5464 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered under Section 12(b) of the +Act: +Title of each class +Trading symbol(s) +Name of each exchange on which registered +Common Stock, $0.001 par value per share +NILE +NYSE American +Securities registered under Section 12(g) of the +Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No +☑ +Indicate +by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange +Act. Yes ☐ No +☑ +Indicate +by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities +Exchange Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file such reports), and +(2) has been subject to such filing requirements for the past 90 days. Yes ☑ No +☐ +Indicate +by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule +405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant +was required to submit such files). Yes ☑ No +☐ +Indicate by check mark whether the registrant +is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. +See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” +and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☑ +Smaller reporting company ☑ +Emerging growth company ¨ +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying +with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate +by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of +its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public +accounting firm that prepared or issued its audit report. ☐ +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No +☑ +As of June 30, 2021, the aggregate market value +of the registrant’s common stock held by non-affiliates of the registrant was $ 154,512,117 based on the closing sale price as reported +on the NYSE American of $2.82. Such determination should not be deemed an admission that the registrant’s directors, officers, +or 10% beneficial owners are, in fact, affiliates of the registrant. +There were 268,307,612 shares of common stock +outstanding as of April 11, 2022. +Documents incorporated by reference: None +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +FORM 10-K +FOR THE FISCAL YEAR ENDED DECEMBER 31, 2021 +INDEX +Page +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +38 +Item 1B. +Unresolved Staff Comments +80 +Item 2. +Properties +80 +Item 3. +Legal Proceedings +81 +Item 4. +Mine Safety Disclosures +82 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +83 +Item 6. +Reserved +84 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +84 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +96 +Item 8. +Financial Statements and Supplementary Data +F-1 – F-54 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +96 +Item 9A. +Controls and Procedures +96 +Item 9B. +Other Information +98 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +98 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +98 +Item 11. +Executive Compensation +104 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +109 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +110 +Item 14. +Principal Accountant Fees and Services +112 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +113 +Item 16. +Form 10-K Summary +116 +Signatures +117 +NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “ Annual +Report ”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E +of the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. We have +attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” +“can,” “continue,” “could,” “estimates,” “expects,” “intends,” +“may,” “plans,” “potential,” “predict,” “should” or “will” or +the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties and other factors may +cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels or +activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations +reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Our expectations are as of the date this Annual Report is filed, and we do not intend to update any of the forward-looking statements +after the date this Annual Report is filed to confirm these statements to actual results, unless required by law. +This Annual Report also contains estimates and +other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves +a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified +the statistical and other industry data generated by independent parties and contained in this Annual Report and, accordingly, we cannot +guarantee their accuracy or completeness, though we do generally believe the data to be reliable. In addition, projections, assumptions +and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a +high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere +in this Annual Report. These and other factors could cause results to differ materially from those expressed in the estimates made by +the independent parties and by us. +RISK FACTOR SUMMARY +Below is a summary of the principal factors that +make an investment in our common stock speculative. This summary does not address all of the risks that we face. Additional discussion +of the risks summarized in this risk factor summary, and other risks that we face, can be found below under the heading “Risk Factors” +and should be carefully considered, together with other information in this Annual Report and our other filings with the Securities and +Exchange Commission (the “Commission” or the “SEC”), before making investment decisions regarding our common stock. +● We will need to raise additional +capital to fund our operations in furtherance of our business plan. +● We have an evolving business model, which increases the complexity of our +business. +● We received a subpoena from the Commission in the investigation +now known as “In the Matter of DPW Holdings, Inc.,” the consequences of which are unknown. +● Our Bitcoin mining operations present a number of risks, which are delineated +in the Risk factors section. +● Our holding company model presents certain additional risks, which are delineated +in the Risk factors section. +● Our growth strategy is subject to a significant degree of risk. +● We are heavily dependent on our senior management, and a loss of a member +of our senior management team could cause our stock price to suffer. +● If we fail to anticipate and adequately respond to rapid technological changes +in our industry, including evolving industry-wide standards, in a timely and cost-effective manner, our business, financial condition +and results of operations would be materially and adversely affected. +● If we do not continue to satisfy the NYSE American continued listing requirements, +our common stock could be delisted from NYSE American. +● Our common stock price is volatile. +PART I +ITEM 1. BUSINESS +Company Overview +BitNile Holdings, Inc., a +Delaware corporation formerly known as Ault Global Holdings, Inc., was incorporated in September 2017 (sometimes referred to as “BitNile,” +the “Company,” “we” or “us”). We are a diversified holding company owning subsidiaries engaged in, +among others, the following operating businesses: commercial and defense solutions, commercial lending, data center operations, Bitcoin +mining and advanced textile technology. Our direct and indirect wholly owned subsidiaries include Gresham Worldwide, Inc. (“GWW”), +TurnOnGreen, Inc., formerly known as Coolisys Technologies Corp. (“TOGI”), TOG Technologies, Inc. (“TOG Technologies”), +Digital Power Corporation (“Digital Power”), Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems +2001 Ltd. (“Enertec”), Relec Electronics Ltd. (“Relec”), Digital Power Lending, LLC (“DP Lending”), +Ault Alliance, Inc. (“Ault Alliance”), Ault Global Real Estate Equities, Inc. (“AGREE”) and BitNile, Inc. (“BNI”). +We also have a controlling interest in Microphase Corporation (“Microphase”), BNI has a controlling interest in Alliance Cloud +Services, LLC (“ACS”), and Ault Alliance has a significant investment in Avalanche International Corp. (“Avalanche” +or “AVLP”). +BitNile was founded by Milton +C. (Todd) Ault, III, its Executive Chairman, and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and Vice Chairman, +and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages the day-to-day operations +of the holding company. The Company’s long-term objective is to maximize per share intrinsic value. All major investment and capital +allocation decisions are made for us by Mr. Ault and the Executive Committee. We have four reportable segments: +● Ault Alliance digital learning, commercial lending and trading through DP Lending, real estate investing +through AGREE, and textile treatment through Avalanche; +● BNI: Bitcoin mining operation and data center operations through ACS; +● GWW: defense solutions with operations conducted by Microphase, Enertec, Gresham Power and Relec; and +● TOGI: commercial electronics solutions with operations conducted by Digital Power, and EV charging solutions +through TOG Technologies. +We operate as a holding company +with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed an investment +company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). Generally, this means that we +do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets will be invested +in investment securities, as that term is defined in the Investment Company Act. Pursuant to the Investment Company Act, companies such +as our subsidiary DP Lending are excluded from the definition of an investment company since its business consists of making loans and +industrial banking. We also maintain a considerable investment in Avalanche, which does business as MTIX +International (“MTIX”). +Originally, we were primarily +a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system solutions +for the medical, military, telecom and industrial markets. Currently, this business is conducted by Digital Power. Although we actively +seek growth through acquisitions, we will also continue to focus on high-grade and custom product designs for the commercial, medical +and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or +military mission critical operating conditions. +We have operations located +in Europe through our wholly owned subsidiaries, Gresham Power and Relec, each of which is located in England. Gresham Power designs, +manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution +equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business +is specialized in the field of naval power distribution products. On November 30, 2020, we acquired Relec pursuant to a stock purchase, +under which we paid approximately $4,000,000 with additional contingent cash payments up to approximately $665,000 based on Relec’s +future financial performance. Relec specializes in AC/DC power supplies, DC-DC converters, displays and electromagnetic compatibility +(“EMC”) filters. +1 +We have operations based in +Israel through our wholly owned subsidiary Enertec, which designs, develops, manufactures and maintains advanced end-to-end high technology +electronic solutions for military, medical, telecommunications and industrial markets. +On November 30, 2016, we formed +DP Lending, a wholly owned subsidiary. DP Lending provides commercial loans to companies throughout the U.S. to provide them with operating +capital to finance the growth of their businesses. The loans range in duration from six months to three years, DP Lending loans made or +arranged pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +On June 2, 2017, we purchased +56.4% of the outstanding equity interests of Microphase. Microphase is a design-to-manufacture original equipment manufacturer (“OEM”) +industry leader delivering world-class radio frequency (“RF”) and microwave filters, diplexers, multiplexers, detectors, switch +filters, integrated assemblies and detector logarithmic video amplifiers (“DLVAs”) to the military, aerospace and telecommunications +industries. Microphase is headquartered in Shelton, Connecticut. +On January 7, 2020, we formed +TOGI, a wholly owned subsidiary. TOGI operates its existing businesses in the customized and flexible power system solutions for the automotive, +medical, military, telecom, commercial and industrial markets, other than the European markets, which are primarily served by Gresham +Power. In April 2021, TOGI formed TOG Technologies as a Nevada corporation to provide flexible and scalable EV charging solutions with +a portfolio of residential, commercial and ultra-fast charging products, and comprehensive charging management software and network services. +On +December 31, 2017, Coolisys Technologies, Inc., a Delaware corporation (“CTI”), entered into a share purchase agreement with +Micronet Enertec Technologies, Inc. (“MICT”), a Delaware corporation, Enertec Management Ltd., an Israeli corporation and +wholly owned subsidiary of MICT (“EML”), and Enertec, an Israeli corporation and wholly owned subsidiary of EML, pursuant +to which CTI acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for the military +market. On May 23, 2018, CTI completed its acquisition of Enertec. Effective as of December 30, 2021, CTI was merged with and into GWW +as a result which upstream merger CTI ceased to exist. +GWW +was incorporated under the laws of the State of Delaware on November 21, 2018 as DPW Technologies Group, Inc. and effected a name change +on December 6, 2019. +Recent Events and Developments +On February 10, 2020, we entered +into a Master Exchange Agreement (the “Master Exchange Agreement”) with Esousa Holdings, LLC (“Esousa”) that acquired +approximately $4.2 million in principal amount, plus accrued but unpaid interest, of certain promissory notes that had been previously +issued by us to Dominion Capital, LLC, a Connecticut limited liability company (the “Dominion Note”) and the Canadian Special +Opportunity Fund, LP (the “CSOF Note” and, with the Dominion Note, the “Esousa Purchased Notes”) in separate transactions. +Esousa also agreed to purchase additional notes up to an additional principal amount, plus accrued but unpaid interest, of $3.5 million +(the “Additional Notes” and collectively, with the Esousa Purchased Notes, the “Notes”). Pursuant to the Master +Exchange Agreement, Esousa had the unilateral right to acquire shares of our common stock (the “Exchange Shares”) in exchange +for the Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness of the Company. In aggregate, we +issued to Esousa a total of 8,332,904 Exchange Shares. +Between +August 2020 and November 2020, we received $5,450,000 in loans from Esousa and certain affiliates pursuant to which we agreed to issue +unsecured short-term promissory notes with interest rates of 13% and 14% and warrants with terms of approximately one and a half years +to purchase an aggregate of 3,850,220 shares of common stock at an average exercise price of $2.28 per share. +On October 2, 2020, we entered +into an At-The-Market Issuance Sales Agreement (the “2020 Sales Agreement”) with Ascendiant Capital Markets, LLC (“Ascendiant”) +to sell shares of common stock having an aggregate offering price of up to $8,975,000 from time to time, through an “at the market +offering” program (the “2020 ATM Offering”). On December 1, 2020, we filed an amendment to the prospectus supplement +with the SEC to increase the amount of common stock that may be offered and sold in the 2020 ATM Offering, as amended under the 2020 Sales +Agreement to $40,000,000 in the aggregate, inclusive of the up to $8,975,000 in shares of common stock previously sold in the 2020 ATM +Offering. The offer and sale of shares of common stock from the 2020 ATM Offering was made pursuant to our effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration No. 333-222132), which became effective +on January 11, 2018. Through December 31, 2020, we had received gross proceeds of $39,978,350 through the sale of 12,582,000 shares of +our common stock from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, 2020. +2 +On January 22, 2021, we entered +into an At-The-Market Issuance Sales Agreement (the “2021 Sales Agreement”) with Ascendiant to sell shares of common stock +having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the +“2021 ATM Offering”). On February 16, 2021, we filed an amendment to the prospectus supplement with the SEC to increase the +amount of common stock that may be offered and sold in the 2021 ATM Offering, as amended under the 2021 Sales Agreement to $125 million +in the aggregate, inclusive of the up to $50 million in shares of common stock previously sold in the 2021 ATM Offering. On March 5, 2021, +we filed a second amendment to the prospectus supplement with the SEC to further increase the amount of common stock that may be offered +and sold in the 2021 ATM Offering, as amended under the 2021 Sales Agreement to $200 million in the aggregate, inclusive of the up to +$125 million in shares of common stock previously sold in the 2021 ATM Offering. The offer and sale of shares of common stock from the +2021 ATM Offering was made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus +contained therein (Registration Statement No. 333-251995) which became effective on January 20, 2021. Through December 31, 2021, we had +received gross proceeds of $200 million through the sale of 52,552,353 shares of common stock from the 2021 ATM Offering. The 2021 ATM +Offering was terminated in December 2021. +On +January 29, 2021, ACS closed on the acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern +Michigan for a purchase price of $3,991,497 (the “Facility”). The purchase price was paid by our own working capital. Ownership +of the Facility was subsequent assigned to BNI. +On March 9, 2021, DP Lending +entered into a securities purchase agreement with Alzamend Neuro, Inc. (“Alzamend”), a related party, to invest $10 million +in Alzamend common stock and warrants, subject to the achievement of certain milestones. We agreed to fund $4 million upon execution of +the securities purchase agreement and to fund the balance upon Alzamend achieving certain milestones related to the U.S. Food and Drug +Administration approval of Alzamend’s Investigational New Drug application and Phase 1a human clinical trials for Alzamend’s +lithium based ionic cocrystal therapy, known as AL001. As of the date of this Annual Report, we have funded an aggregate of $6 million +pursuant to the securities purchase agreement. Under the securities purchase agreement, Alzamend has agreed to sell up to 6,666,667 shares +of its common stock to DP Lending for $10 million, or $1.50 per share, and issue to DP Lending warrants to acquire up to 3,333,334 shares +of Alzamend common stock with an exercise price of $3.00 per share. The transaction was approved by our independent directors after receiving +a third-party valuation report of Alzamend. +On May 12, 2021, we issued +275,862 shares of common stock to Ault & Company, Inc. (“A&C”), a related party, upon the conversion of $400,000 of +principal on an 8% Convertible Promissory Note dated February 5, 2020. +On June 11, 2021, we entered +into a securities purchase agreement with A&C, pursuant to which A&C is entitled to purchase 1,000,000 shares of our common stock +for a total purchase price of $2,990,000, at a purchase price per share of $2.99, which was $0.05 per share above the closing stock price +on June 10, 2021. +On June 15, 2021, Alzamend +closed an initial public offering at a price to the public of $5.00 per share. DP Lending purchased 2,000,000 shares of Alzamend’s +common stock in the initial public offering for an aggregate of $10,000,000. Alzamend’s common stock is listed on The Nasdaq Capital +Market under the ticker symbol “ALZN.” +During +the quarter ended September 30, 2021, we executed contracts to purchase 4,000 Antminer S-19 Pro Bitcoin miners. The gross purchase price +is $27.3 million. In November 2021, we executed contracts to purchase an aggregate of 16,000 Bitcoin miners for $121 million. The purchase +includes both the environmentally friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) +with an energy consumption of 3.01 kilowatt-hours (“kWh”) and the S19j Pro Antminers that feature a processing power of 100 +TH/s with an energy consumption of 2.95 kWh. As of March 31, 2022, 4,754 were in our possession, and the remaining miners are expected +to be shipped between April 2022 and September 2022. Approximately $92.4 million of the gross purchase price has been paid as of March +24, 2022 with the balance scheduled to be paid between April 2022 and November 2022. +On December 13, 2021, BNI +closed an investment of Series A preferred stock of Earnity Inc. (“Earnity”), a decentralized finance (“DeFi”) +marketplace based in San Mateo, California. BNI paid approximately $11.5 million for the shares of Earnity’s Series A preferred +stock. Following the investment, BNI beneficially owned approximately 19.99% of Earnity’s common stock. +On December 15, 2021, DP Lending +entered into an exchange agreement with Imperalis Holding Corp. (“IMHC”) pursuant to which IMHC issued us a convertible promissory +note (the “IMHC Note”) in the principal amount of $101,528.77, in exchange for those certain promissory notes dated August +18, 2021 and November 5, 2021 previously issued by IMHC to DP Lending in the aggregate principal amount of $100,000, which prior notes +had accrued interest of $1,528.77 as of the December 15, 2021. The IMHC Note accrues interest at 10% per annum, is due on December 15, +2023, and the principal, together with any accrued but unpaid interest on the amount of principal, is convertible into shares of IMHC’s +common stock at DP Lending’s option at a conversion price of $0.01 per share. +3 +On December 16, 2021, we entered +into a stock purchase agreement (the “Agreement”) with the majority stockholders of IMHC. Pursuant to the Agreement, we purchased +129,363,756 shares of IMHC’s common stock from the sellers in exchange for $200,000. Upon the closing of the Agreement, we owned +a majority of IMHC’s common stock, resulting in a change in control of IMHC. +On +December 22, 2021 (the “Closing Date”), AGREE Madison, LLC, a wholly owned subsidiary of AGREE (“AGREE Madison”), +through various wholly owned subsidiaries (the “Property Owners”), entered into construction loan agreements (the “Loan +Agreements”) in the aggregate amount of $68,750,000 (the “Loans”) in connection with the acquisition of four hotel properties +(the “Properties”). The Properties were acquired on the Closing Date for an aggregate purchase price of $69,200,000, of which +$2,500,000 was previously funded on deposit, $21,378,000 was paid by the Company on the Closing Date, and the remaining amounts were funded +from the Loans. The remaining $23,428,000 of the Loans are available to be drawn upon by the Property Owners towards the completion of +the $13,700,000 in property improvement plans (“PIPs”) the Property Owners agreed to undertake, as well as to fund working +capital, interest reserves, franchise fees and other costs and expenses related to the acquisition. The Loans are due on January 1, 2025 +(the “Maturity Date”), but may be extended by the Property Owners for two additional 12-month terms, subject to certain terms +and conditions as set forth in the Loan Agreements. The Loans accrue interest at a rate equal to the greater of (i) the LIBOR Rate plus +675 basis points or (ii) 7% per annum. The Property Owners will make monthly installment payments of interest only, starting January 1, +2022. +On +December 27, 2021, the Company and GWW entered into a Share Exchange Agreement (the “Exchange Agreement”) with Giga-tronics +Incorporated, a California corporation (“GIGA”). Pursuant to the Exchange Agreement, GIGA will acquire all of the outstanding +shares of capital stock of GWW in exchange for (i) issuing to the Company 2,920,085 shares of GIGA’s common stock (“GIGA Common +Stock”) and 514.8 shares of a new series of preferred stock (“GIGA Preferred Stock”) which are convertible into an aggregate +of 3,960,043 shares of GIGA Common Stock, subject to adjustment, and (ii) the assumption of GWW’s equity awards representing, on +an as-assumed basis, 249,875 shares of GIGA Common Stock (the “Exchange Transaction”). Completion of the Exchange Transaction +is subject to the approval of GIGA’s shareholders and customary closing conditions. +Immediately +following the completion of the Exchange Transaction, GWW will be a wholly owned subsidiary of GIGA. In addition, the Exchange Agreement +provides that the Company shall loan to GIGA $4.25 million pursuant to a convertible promissory note (“Closing Date Loan”) +upon the closing of the Exchange Transaction (the “Closing”), and following the Closing, GIGA will repurchase or redeem all +of its shares of Series B, Series C, Series D and Series E preferred stock currently outstanding (the “Outstanding Preferred”). +Assuming the repurchase of the Outstanding Preferred and based upon 2,725,010 shares of GIGA Common Stock currently outstanding, following +the issuance to the Company of the shares of GIGA Common Stock and GIGA Preferred Stock pursuant to the Exchange Transaction, the Company +would hold approximately 68% of the outstanding voting power and capital stock of GIGA, and existing holders of GIGA Common Stock would +hold approximately 32%. +On +December 30, 2021, Third Avenue Apartments LLC (“Third Avenue Apartments”), which is a wholly owned subsidiary of AGREE Madison, +closed upon the acquisition of certain real property located in St. Petersburg, Florida (the “Real Property”) together with +all improvements on the Real Property and all singular rights and appurtenances pertaining thereto, including, but not limited to, (i) all +entitlements, easements, rights, mineral rights, oil and gas rights, water, water rights, air rights, development rights and privileges +appurtenant to the Real Property, (ii) all tangible personal property, owned and assignable by Seller, located on or used in connection +with the Real Property, including, without limitation, engineering studies, soils reports, (iii) all warranties, guaranties, indemnities +and other similar rights relating to the Real Property and/or the assets transferred hereby, (iv) all permits, licenses, consents, +approvals and entitlements related to the Real Property, (v) any rights of way, appendages appurtenances, easements, sidewalks, alleys, +gores or strips of land adjoining or appurtenant to the Real Property or any portion thereof, if any, and used in conjunction therewith, +and (vi) all intangible rights directly relating to the Real Property (collectively, with the Real Property, the “Property”). +The +Property was acquired from Third Avenue at St Petersburg LLC (the “Seller”) pursuant to a contract of entered into by Third +Avenue Apartments and the Seller. The purchase price for the Property was $15,500,000, of which $1,500,000 was previously funded on deposit +and the remaining $14,000,000 was paid by the Company on the closing date. We plan to use the Property for the development of a high-rise +multi-family project. +4 +On +December 30, 2021, we issued of (i) secured promissory notes (individually, a “Note” and collectively, the “Notes”) +with an aggregate principal face amount of approximately $66,000,000; (ii) five-year Class A warrants to purchase an aggregate of 14,095,350 +shares of our common stock at an exercise price of $2.50, subject to adjustment; and (iii) five-year Class B warrants to purchase an aggregate +of 1,942,508 shares of our common stock at an exercise price of $2.50 per share, subject to adjustment. We agreed to file a registration +statement to register the shares of common stock underlying the foregoing warrants and certain other shares underlying previously issued +warrants to one of the investors. +We, +certain of our subsidiaries and Esousa, as the collateral agent on behalf of the investors (the “Agent”) entered into a security +agreement, pursuant to which we (i) pledged the equity interests in substantially all of our U.S. based subsidiaries and (ii) granted +to the investors a security interest in substantially all of our deposit accounts, securities accounts, chattel paper, documents, equipment, +general intangibles, instruments and inventory, and all proceeds therefrom. The entirety of the loan, including the original issue discount +and accrued but unpaid interest, was fully paid off on March 30, 2022. +On +February 4, 2022, we and Ault Alliance entered into a securities purchase agreement providing for our purchase of BNI from Ault Alliance. +As a result of this transaction, both BNI and Ault Alliance are each stand-alone wholly owned subsidiaries of ours. +On +February 10, 2022, consistent with our objective to have BNI operate the entirety of our business that relates to cryptocurrencies, Ault +Alliance assigned the entirety of its interest in ACS to BNI. +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant to sell shares of common stock +having an aggregate offering price of up to $200 million from time to time, through an “at the market offering” program (the +“2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering was made pursuant to our effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. +333-260618) which became effective on November 12, 2021. Through March 31, 2022, we had received gross proceeds of approximately $110 +million through the sale of 140,658,096 shares of common stock from the 2022 ATM Offering. +On +March 20, 2022, we and IMHC entered into a securities purchase agreement (the “Acquisition Agreement”) with TOGI. According +to the Acquisition Agreement, we will (i) deliver to IMHC all of the outstanding shares of common stock of TOGI that we own, and (ii) +forgive and eliminate the intracompany accounts between us and TOGI evidencing historical equity investments made by us in TOGI, in the +approximate amount of $25,000,000, in consideration for the issuance by IMHC to us (the “Transaction”) of an aggregate of +25,000 newly designated shares of Series A Preferred Stock (the “IMHC Preferred Stock”), with each such share having a stated +value of $1,000. The closing of the Transaction is subject to our delivery to IMHC of audited financial statements of TOGI and other customary +closing conditions. Immediately following the completion of the Transaction, TOGI will be a wholly owned subsidiary of IMHC. The parties +to the Agreement have agreed that, upon completion of the Transaction, IMHC will change its name to TurnOnGreen, Inc., and, through an +upstream merger whereby the current TOGI shall cease to exist, IMHC shall own TOGI’s two operating subsidiaries, TOG Technologies +and Digital Power. Promptly following the closing of the Transaction, IMHC will dissolve its three dormant subsidiaries. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.bitnile.com. +Our Corporate Structure +On January 19, 2021, we changed +our corporate name from DPW Holdings, Inc. to Ault Global Holdings, Inc. and, on December 13, 2021, we changed our corporate name from +Ault Global Holdings, Inc. to BitNile Holdings, Inc. (together, the “Name Changes”). The Name Changes were each effected through +a parent/subsidiary short form merger pursuant to an Agreement and Plan of Merger dated January 7, 2021 and December 1, 2021, respectively. +Neither of the mergers nor the corresponding Name Changes affected the rights of our security holders. Our common stock is traded on the +NYSE American under the symbol “NILE.” Existing stock certificates that reflect our prior corporate names continue to be valid. +Certificates reflecting the new corporate name are issued as old stock certificates are tendered for exchange or transfer to our transfer +agent. Concurrently with the change in our name to Ault Global Holdings, Inc., Milton C. Ault III was appointed as our Executive Chairman, +William B. Horne was appointed as our Chief Executive Officer and remains as Vice Chairman of our board of directors (the “Board”), +and Henry Nisser was appointed as our President and remains as our General Counsel. +5 +Commencing in October 2019 +and continuing through February 2022, we reorganized our corporate structure pursuant to a series of transactions by and among BitNile +and its directly and indirectly owned subsidiaries. The purpose of the reorganization was to align our various businesses by the products +and services that constitute the majority of each subsidiaries’ revenues. As a result of the foregoing transactions, our streamlined +corporate structure is currently as follows: +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +6 +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for DP Lending and approves all lending transactions. Under its business model, DP Lending generates revenue +through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income from appreciation +of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued to DP Lending +in any particular financing. +Over the recent past, we have +provided capital and relevant expertise to fuel the growth of businesses in cryptocurrency mining, DeFi, defense/aerospace, industrial, +telecommunications, medical and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity +interest or may be actively involved, influencing development through board representation and management support. +Our Subsidiaries and their Businesses +BitNile, Inc. +BNI conducts data center operations +and Bitcoin mining through ACS. +Overview +BNI is a blockchain technology +company focused on mining of Bitcoin, among other activities. We mine using purpose-built computers (or “miners”) to solve +complex cryptographic algorithms (or “verify” or “solve” blocks) in the blockchain in exchange for rewards and +fees denominated in the native token of that blockchain network. +We will evaluate each digital +asset in our portfolio, or that we propose to acquire in the future (including by mining), to determine whether it would likely be considered +a security under U.S. federal securities laws, in consultation with outside counsel, as applicable. We will base our analysis on relevant +caselaw, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance by the SEC and +its staff. See “Risk Factors —  Risks Related to Our Bitcoin Operations – Legal and Regulatory —  +A particular digital asset’s status as a ‘security’ in any relevant jurisdiction is subject to a high degree of uncertainty +and if a regulator disagrees with our characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines +and penalties, which may adversely affect our business, operating results and financial condition. A determination that Bitcoin that we +own or mine is a ‘security’ may adversely affect the value of Bitcoin and our business.” +Since commencement of our +mining operations in 2021 at the Facility, we have mined 45.7 Bitcoin for our own account through December 31, 2021. While we mine for +cryptocurrency for sale in the ordinary course of business, we believe that cryptocurrency represents an attractive, appreciating investment +opportunity, and as such we have historically held cryptocurrency assets that we do not otherwise sell to fund our operating expenses. +On December 31, 2021, we held 46.75 Bitcoin valued at approximately $2.2 million based on prices as of such date. Our total revenue +from mining operation was $3.5 million during the fiscal year ended December 31, 2021. Our mining operations generated net income +of $1.5 million during the fiscal year ended December 31, 2021. As of December 31, 2021, the carrying value of our approximately +46.75 Bitcoins was $2.2 million, representing 0.4% of our total assets of $490.8 million as of such date. +7 +Our Vision +Traditional finance has historically +had poor customer service and a less than desirable user experience in mobile and web-based platforms, which opens the door to massive +disruption through digital technologies. Additionally, central bank intervention in the financial markets has increasingly turned to money +printing through quantitative easing, which increasingly dilutes the buying power of the global fiat currency market and leads the world +to seek more scarce alternatives. The first phase of the digital transformation has been through the creation of blockchain-based digital +assets. We believe the second phase of this transition will be take form in bridges being built between DeFi and traditional finance to +help improve customer service and user experience in traditional finance. +We foresee a time when traditional +banking is done in the palm of our hands in community-based, peer-to-peer transactions as opposed through financial intermediaries. This +community-based, peer-to-peer network is otherwise known as DeFi. Although we do not believe DeFi will replace traditional finance in +the near- to medium-term, we believe this transition will happen rapidly over the next 20 years as Millennials and Gen-Xers become the +power class and the Baby Boomers retire. DeFi is a concept whereby traditional financial intermediaries are not required to process transactions. +The proliferation of blockchain-based protocols will enable participants to offer novel financial products to banking customers. For instance, +in a world where traditional finance provides savings account rates less than 1%, DeFi protocols can provide savings accounts with significantly +higher yields. Traditional financial platforms are not currently designed to distribute these products to its customers. We believe that +in the near-term integrating a traditional broker dealer could help facilitate the distribution of these decentralized finance protocols +to a broad base of customers. While we recognize DeFi is in its infancy stage, we believe blockchain will be integral to its advancement. +We recognize the uncertainties in DeFi and its effect on our economy both in the U.S. and globally, and acknowledge that this is a new +evolving area that may not evolve as we anticipate and in which we may never be a material participant. +Cryptocurrency and Cryptocurrency Mining Overview +Blockchain and Cryptocurrencies Overview +Cryptocurrencies are a type +of digital asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). +Cryptocurrencies operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized +digital ledger that enables the secure use and transfer of digital assets. We believe cryptocurrencies and associated blockchain technologies +have potential advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate +settlement of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” Recently, cryptocurrencies +have gained widespread mainstream attention and have begun to experience greater adoption by both retail and institutional investors and +the broader financial markets. For example, Bitcoin’s aggregate market value exceeded $800 trillion in February 2022, $1 trillion +in February 2021 compared to $160 billion in February 2020, based on Bitcoin prices quoted on major exchanges. As cryptocurrencies, +and blockchain technologies more generally, have entered the mainstream, prices of digital assets have reached all-time highs and the +broader ecosystem has continued to develop. While we expect the value of Bitcoin to remain volatile, we believe this increase in aggregate +market value signals institutionalization and wider adoption of cryptocurrency. +Cryptocurrencies are decentralized +currencies that enable near instantaneous transfers. Transactions occur via an open source, cryptographic protocol platform which uses +peer-to-peer technology to operate with no central authority. The online network hosts the public transaction ledger, known as the +blockchain, and each cryptocurrency is associated with a source code that comprises the basis for the cryptographic and algorithmic protocols +governing the blockchain. In a cryptocurrency network, every peer has its own copy of the blockchain, which contains records of every +historical transaction — effectively containing records of all account balances. Each account is identified solely by +its unique public key (making it effectively anonymous) and is secured with its associated private key (kept secret, like a password). +The combination of private and public cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing +strong control of ownership. +8 +No single entity owns or operates +the network. The infrastructure is collectively maintained by a decentralized public user base. As the network is decentralized, it does +not rely on either governmental authorities or financial institutions to create, transmit or determine the value of the currency units. +Rather, the value is determined by market factors, supply and demand for the units, the prices being set in transfers by mutual agreement +or barter among transacting parties, as well as the number of merchants that may accept the cryptocurrency. Since transfers do not require +involvement of intermediaries or third parties, there are currently little to no transaction costs in direct peer-to-peer transactions. +Units of cryptocurrency can be converted to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as +Binance, Coinbase, FTX, Kraken, Gemini, and others. Cryptocurrency prices are quoted on various exchanges and fluctuate with extreme volatility. +We believe cryptocurrencies +offer many advantages over traditional, fiat currencies, although many of these factors also present potential disadvantages and may introduce +additional risks, including: +● acting as a fraud deterrent, as cryptocurrencies are digital and cannot be counterfeited or reversed arbitrarily +by a sender; +● immediate settlement; +● elimination of counterparty risk; +● no trusted intermediary required; +● lower fees; +● identity theft prevention; +● accessible by everyone; +● transactions are verified and protected through a confirmation process, which prevents the problem of +double spending; +● decentralized — no central authority (government or financial institution); and +● not recognized universally and not bound by government imposed or market exchange rates. +However, cryptocurrencies may not provide all +of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, +there are two factors that may affect all digital asset mining companies and Bitcoin in particular: (i) limitations on the supply of the +cryptocurrency being mined; and (ii) the market price of the cryptocurrency. +The blockchain’s method +for creating new Bitcoins is mathematically determined in a manner so that the supply of Bitcoins grows at a limited rate pursuant to +a pre-set schedule. Specifically, the number of Bitcoins awarded for solving a new block is automatically halved for every 210,000 +blocks that are solved. The current fixed reward for solving a new block is 6.25 Bitcoins per block, which was reduced from 12.5 Bitcoins +in May 2020. This deliberately controlled rate of Bitcoin creation means that the number of Bitcoins in existence will never exceed 21 million +and that Bitcoins cannot be devalued through excessive production unless the Bitcoin network’s source code and the underlying protocol +for Bitcoin issuance is altered. This also means, however, that our revenue prospects will decline unless the price of a Bitcoin increases +commensurately or we acquire more miners. +We currently only mine Bitcoin. +Our ability to generate revenue from our mining operations will be dependent on the price of Bitcoin. On September 24, 2021, the +Bank of China announced that all cryptocurrency trading and mining are illegal in China. Bitcoin and Ethereum, the second largest digital +currency, fell 5% and 7%, respectively. The prices of cryptocurrencies, specifically Bitcoin, have experienced substantial volatility, +including fluctuation patterns which may reflect “bubble” type volatility, meaning that high or low prices at a given time +may not be indicative of the current or future value of Bitcoin. The price of a Bitcoin may be subject to rapidly changing investor and +market sentiment, and may be influenced by factors such as technology, regulatory developments and media coverage. Further, Bitcoin’s +value, like that of other cryptocurrencies, may be based on various factors, including their acceptance as a means of exchange or purchasing +power by consumers and vendors, volume, liquidity and transferability and market demand. Bitcoin’s current price reflects, in part, +the belief by some that Bitcoin could become a widely accepted form of currency, however if this prediction turns out to be incorrect +its price could decrease dramatically, as would our prospects for future revenue and profits. See “Risk Factors – Risks Related +to Our Bitcoin Operations” for more information on the risks we face due to our mining of Bitcoin and its speculative and volatile +nature. +9 +Cryptocurrency Mining and Mining Pools +As a cryptocurrency miner, +we use specialized miners to solve cryptographic math problems necessary to record and “publish” cryptocurrency transactions +to blockchain ledgers. Generally, each cryptocurrency has its own blockchain, which consists of software code (also known as a protocol), +which is run by all the computers on the network for such blockchain. Within this code, transactions are collated into blocks, and these +blocks must meet certain requirements to be verified by the blockchain software, added to the blockchain or ledger of all transactions +and published to all participants on the network that are running the blockchain software. After a transaction is verified, it is combined +with other transactions to create a new block of data for the blockchain. For proof-of-work blockchains, the process of verifying valid +blocks requires computational effort to solve a cryptographic equation, and this computational effort protects the integrity of the blockchain +ledger. This process is referred to as “mining.” As a reward for verifying a new block, miners receive payment in the form +of the native cryptocurrency of the network (e.g., Bitcoin). This payment is comprised of a block reward (i.e., the automatic issue of +new cryptocurrency tokens) and the aggregated transaction fees for the transactions included in the block (paid in existing cryptocurrency +tokens by the participants to the transactions). The block reward payments and the aggregated transaction fees are what provide the incentive +for miners to contribute hash rate to the network. +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific cryptocurrency, and the blockchain-wide hash rate for a specific cryptocurrency can be understood as the aggregate +of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +and other cryptocurrencies are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known +as the “mining difficulty,” which is the level of computational activity required before a new block is solved and verified. +For example, on the Bitcoin blockchain the protocol is coded such that a new block is solved and verified approximately every ten minutes, +while on Ethereum blocks are designed to be solved approximately every twelve to fifteen seconds. As such, to the extent the hash power +on the network is increased or decreased due to, for example, fluctuations in the number of active miners online, mining difficulty is +correspondingly increased or decreased to maintain the preset interval for the verification of new blocks. +On certain cryptocurrency +networks, including Bitcoin, the rewards for solving a block are also subject to periodic incremental halving. Halving is a process designed +to control the overall supply and reduce the risk of inflation in cryptocurrencies using a proof-of-work consensus algorithm. After a +predetermined number of blocks are added to the blockchain, the mining reward is cut in half, hence the term “halving.” The +last halving for Bitcoin occurred on May 11, 2020. The next halving for Bitcoin is expected to occur in 2024, and as such, absent +any changes to the Bitcoin protocols, the block reward will remain stable until then. By contrast, Ethereum does not have a maximum supply +limit or pre-determined reduction in reward amounts. Rather, Ethereum currently has a fixed issuance schedule of 2.0 Ether per block mined. +However, Ethereum has on two separate occasions reduced the quantity of ETH rewarded per block and may make additional changes in the +future, whether or not Ethereum ultimately transitions to a proof-of-stake consensus mechanism. Transaction fees are variable and depend +on the level of activity on the network. Generally, transaction fees increase during times of network congestion, as miners will prefer +transactions with higher fees, and therefore a higher fee can reduce the time to process a transaction, and decrease when there are fewer +transactions on the network. +As the total amount of available +hash rate has increased (particularly on the Bitcoin network), it has become increasingly difficult for any individual miner to independently +solve a block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool, rather than an individual miner, receives +the block reward and related transaction fees. The mining pool is organized by a third party who, in return for a percentage of the +earned block rewards and transaction fees as a fee, administers the pool and ensures that the participants in the pool receive their share +of the block reward and related transaction fees, generally pro-rata to their contributed hash rate. Mining pools offer miners more predictable +and consistent revenue compared to mining individually. We participate in mining pools. +Our Strategy +Smart Growth +We aim to optimize our mining +by identifying and purchasing the most profitable miners with industry-leading returns on investment and actively monitoring and adjusting +the operation of those machines to enhance their performance. When planning our short- and long-term operating strategies and capital +expenditures, we carefully monitor fluctuations and longer-term trends in the value of certain cryptocurrencies, which impacts the return +on investment of machines. We also regularly evaluate potential innovations in geography, physical footprint, computing technology and +similar areas to improve our operations and productivity. We believe this smart-growth strategy, including our commitment to mining efficiency +and return on investment in miners, will enable us to build value over the long term. +10 +Own and Operate Our Mining Facilities +We are investing heavily in +purchasing, building and operating our mining facilities. By owning and operating our miners at facilities that offer competitive advantages, +including access to reliable, low-cost, renewable power and room for expansion, we expect to have greater control over the timing of the +purchase and deployment of our miners. We also may enhance our ability to intelligently and quickly adapt our operating model and reap +savings compared to paying for outsourced operations and infrastructure. We anticipate that we will continue to consider other opportunities +to integrate our operations, including with respect to both the software utilized by our fleet and the associated hardware. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in cryptocurrency mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable +amounts of electrical energy to perform their functions and mine Bitcoin; consequently, a critical aspect of operating in the cryptocurrency +mining industry is obtaining a reliable supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased +the Facility, which currently has access to 28 megawatts of power in preparation for the planned purchase of Bitcoin mining equipment. +Since the purchase of the Facility, we have invested in infrastructure improvements and began both ramping up the sites power capacity +and installing S19jPro miners. To date, we have increased power load from 1.5 megawatts to 14 megawatts and expect to have 28 megawatts +installed at this location by July 2022. In addition, we have received a commitment by the utility company that currently provides our +power to expand the site’s capacity up to 297 megawatts, for which we are currently working on setting forth in a formal agreement. +Our relationship with the utility company has grown as we have demonstrated our ability to upgrade and use power at our site effectively. +We are in the midst of finalizing those expansion details with the utility company, engineers, and Economic Development Agency. This planned +expansion would allow the operation of up to as many as 90,000 Bitcoin miners at the Facility. +We continue to evaluate other +sites, locations, and partnerships for additional and alternative support of future mining operations. While we have not at present entered +into any other agreements, we will continue to explore and evaluate additional facilities that that would enable us to expand our mining +operations as needed. +We expect to enter into power +agreements that will allow us to have one of the highest carbon-free energy footprints at a price equal to or less than the current cost +of fossil fuel energy in other locations, based on current market power costs as of the date of this Annual Report. +Our Mining Operations +On January 29, 2021, ACS closed +on the acquisition of the 617,000 square foot energy-efficient Facility for a purchase price of $4.0 million. The purchase price was paid +by our own working capital. The Facility has been remodeled and converted over the past year into a site focused on three types of business +(commercial real estate, enterprise data center, and high-density computing). +The buildout of the initial +30,000 square feet will be used primarily for our Bitcoin mining operations. While we believe the Facility and its anticipated future +operations will be successful, there is a risk that its expectations will not materialize in a timely manner, if at all. +11 +During the fiscal year ended +December 31, 2021, we executed contracts to purchase 4,000 Antminer S-19 Pro Bitcoin miners. As of February 15, 2022, we have 2,160 Bitcoin +miners in operation. The remaining units are expected to be delivered at a rate of approximately 300 units per month through July 2022. +The total purchase price is $27.3 million. In November 2021, we executed contracts to purchase 16,600 Bitcoin miners for $128 million. +The purchase includes both the environmentally friendly S19 XP Antminers that feature a processing power of 140 terahashes per second +(TH/s) with an energy consumption of 3.01 kilowatt-hours (kWh) and the S19j Pro Antminers that feature a processing power of 100 TH/s +with an energy consumption of 2.95 kWh. Based on current delivery schedules, we expect that the 16,600 newly purchased miners will be +shipped by Bitmain Technologies Limited (“Bitmain”) between approximately April 2022 and September 2022. Approximately $89 +million of the total purchase price has been paid as of March 8, 2022 with the balance scheduled to be paid between March 2022 and November +2022. The supplier, Bitmain, does not disclose when the miners are manufactured. We have a futures purchase contract and Bitmain has been +supplying equipment according to the scheduled delivery as outlined in these agreements. All dollar amounts provided in this paragraph +include fees payable in connection with obtaining the ability to enter into the contracts, and not solely the cost of the miners. +Our strategy includes identifying +less expensive, clean power for our Bitcoin mining operations. Management of the company has considered the issues surrounding the environmental +impact of our Bitcoin mining operations. Based on this review, we have concluded that the environmental impact of our mining operations +is not material given that approximately 85% of the energy we use is “green,” meaning it is sourced from nuclear, wind or +solar power. In addition to our continued expansion investments at the Facility, we also seek out new locations to support our Bitcoin +mining business. We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but also +leasing buildings and facilities, hosting relationships and strategic partnerships. At this time, we have not entered into any new mining +agreements at locations other than the Facility. We currently mine Bitcoin only. +Coins that are mined are held +in a custodial account as digital assets. We securely store assets at NYDIG ABL LLC (“NYDIG”), a regulated, audited and insured +cryptocurrency custodian. The custody arrangements require that we mine to a custodial wallet address where the private key is held by +the custodian and all keys for the wallet are held in cold storage. This provides a layer of protection in both the transaction and liquidation +phases of the operations by using multi-factor and multi-person approval processes, to include Know Your Customer and Anti-Money Laundering +procedures of the receiving party. We will either hold the digital assets or may choose to convert those assets into fiat currency depending +on financial needs and plans. When we opt to convert the digital assets we sell or exchange our Bitcoin through NYDIG, the custodian of +our digital wallet. When we elect to make a sale or exchange our Senior Vice President - Finance submits a request to NYDIG’s execution +department to exchange Bitcoin for U.S. dollars. NYDIG sends an approval email to our CEO to approve. Once approved by our CEO, NYDIG +executes the sale/exchange on its trading platform at current market prices, less commissions, and deposits the U.S. dollars into our +bank account. +Currently, we are converting +Bitcoin received from our mining activities into fiat currency on a bimonthly basis, on average, to pay for operating costs and purchase +commitments for new mining equipment. We are not currently holding any digital assets for investment. +Our Contracts with Bitmain +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain, as follows: +● Pursuant to the Bitmain Agreement dated July 23, 2021, Bitmain agreed to sell 1,000 Antminer S-19 Pro +miners for the estimated total purchase price of $2,550,000, which miners have been delivered; +● Pursuant to the Bitmain Agreement, dated September 12, 2021, Bitmain agreed to sell 3,000 Antminer S-19 +Pro miners for the estimated total purchase price of $20,509,500, which miners have been delivered; +● Pursuant to the Bitmain Agreement dated November 10, 2021, Bitmain agreed +to sell 4,000 S19 XP miners for the estimated total purchase price of $45,360,000, which miners are expected to be shipped monthly +between July and September 2022 ; +● Pursuant to the Bitmain Agreement dated November 17, 2021, Bitmain agreed +to sell 12,000 S19j miners for the estimated total purchase price of $76,000,000, of which 754 have miners have been delivered +and the balance of the miners are expected to be shipped monthly between April and August 2022; and +● Pursuant to the Bitmain Agreement dated November 17, 2021, Bitmain agreed +to sell 6 00 S19XP miners for the estimated total purchase price of $6,510,000, which miners are expected to be shipped monthly +between July and December 2022. +12 +Within seven days after the +signing of each Bitmain Agreement, we paid Bitmain a down payment within the range of 25% and 31.86% of the estimated total purchase price, +and an additional prepayment within the range of 28.14% and 35% of the actual purchase price for each monthly batch scheduled for shipment, +which is due six months prior to shipment. The actual purchase price for such batch to be shipped six months later will be provided by +Bitmain one month prior to the shipment of the current batch, provided that the actual purchase price will not be higher than the total +purchase price set forth in the payment schedules in the Bitmain Agreements. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +Regulation +The laws and regulations applicable +to cryptocurrency are evolving and subject to interpretation and change. Governments around the world have reacted differently to cryptocurrencies; +certain governments, such as the People’s Republic of China, have deemed them illegal, and others have allowed their use and trade +without restriction, while in some jurisdictions, such as in the U.S., cryptocurrencies are subject to extensive, and in some cases overlapping, +unclear and evolving regulatory requirements. As cryptocurrencies have grown in both popularity and market value, the U.S. Congress and +a number of U.S. federal and state agencies, including the Financial Crimes Enforcement Network (the “FinCEN”), the SEC, the +Commodity Futures Trading Commission (the “CFTC”), the Financial Industry Regulatory Authority (the “FINRA”), +the Consumer Financial Protection Bureau (the “CFTC”), the Department of Justice (the “DOJ”), the Department of +Homeland Security, the Federal Bureau of Investigation, the Internal Revenue Service and state financial regulators, have been examining +the operations of cryptocurrency networks, cryptocurrency users and cryptocurrency exchange markets, with particular focus on the extent +to which cryptocurrencies can be used to launder the proceeds of illegal activities or fund criminal or terrorist enterprises and the +safety and soundness and consumer-protective safeguards of exchanges or other service-providers that hold, transfer, trade or exchange +digital assets for users. For instance, the Cyber-Digital Task Force of the DOJ published a report entitled “Cryptocurrency: An +Enforcement Framework” in October 2020. This report provides a comprehensive overview of the possible threats and enforcement challenges +the DOJ views as associated with the use and prevalence of cryptocurrency, as well as the regulatory and investigatory means the DOJ has +at its disposal to deal with these possible threats and challenges. +Many of these federal and +state agencies have issued consumer advisories regarding the risks posed by cryptocurrencies to investors. In addition, federal and state +agencies, and other countries have issued rules or guidance about the treatment of cryptocurrency transactions or requirements for businesses +engaged in activities related to cryptocurrencies. Depending on the regulatory characterization of the cryptocurrencies we mine, the markets +for those cryptocurrencies in general, and our activities in particular, may be subject to one or more regulators in the U.S. and globally. +Ongoing and future regulatory actions may alter, perhaps to a materially adverse extent, the nature of cryptocurrency markets and our +cryptocurrency operations. Additionally, U.S. state and federal, and foreign regulators and legislatures have taken action against cryptocurrency +businesses or enacted restrictive regimes in response to adverse publicity arising from hacks, consumer harm, or criminal activity stemming +from cryptocurrency activity. There is also increasing attention being paid by U.S. federal and state energy regulatory authorities as +the total load of crypto-mining grows and potentially alters the supply and dispatch functionality of the wholesale grid and retail distribution +systems. Many state legislative bodies are also actively reviewing the impact of crypto-mining in their respective states. +We are unable to predict the +effect that any future regulatory change, or any overlapping or unclear regulations, may have on us, but such change, overlap or lack +of clarity could be substantial and make it difficult for us to operate our business or materially impact the market for cryptocurrencies +that we mine or may mine in the future. FinCEN has issued guidance stating its position that it does not differentiate between fiat currency +(which FinCEN calls “real currency”) and cryptocurrencies that are convertible into fiat currency or other forms of convertible +virtual currencies (which FinCEN calls “virtual currency”) for purposes of determining whether a person or entity is engaging +in “money transmission services.” Persons and entities engaging in virtual currency activities that amount to “money +transmission services,” or otherwise cause them to be deemed a “money services business” under FinCEN’s regulations, +must register as a money services business, implement an “effective” anti-money laundering program and comply with FinCEN’s +reporting and recordkeeping requirements. +13 +In May 2019, FinCEN issued +guidance relating to how the U.S. Bank Secrecy Act (“BSA”) and its implementing regulations relating to money services businesses +apply to certain businesses that transact in convertible virtual currencies. Although the guidance generally indicates that certain mining +and mining pool operations will not be treated as money transmission, the guidance also addresses when certain activities, including certain +services offered in connection with operating mining pools such as hosting convertible virtual currency wallets on behalf of pool members +or purchasers of computer mining power, may be subject to regulation. Although we believe that our mining activities do not presently +trigger FinCEN registration requirements under the BSA, if our activities cause us to be deemed a “money transmitter,” “money +services business” or equivalent designation, under federal law, we may be required to register at the federal level and comply +with laws that may include the implementation of anti-money laundering programs, reporting and recordkeeping regimes, and other operational +requirements. In that event, to the extent we decide to proceed with some or all of our operations, the required registration and regulatory +compliance steps may result in extraordinary, non-recurring expenses to us, as well as on-going recurring compliance costs, possibly affecting +operating results or financial condition in a material and adverse manner. Failure to comply with these requirements may expose us to +fines, penalties and/or interruptions in our operations that could have a material adverse effect on our financial position, results of +operations and cash flows. +According to the CFTC, at +least some cryptocurrencies, including Bitcoin, fall within the definition of a “commodity” under the U.S. Commodities Exchange +Act of 1936, as amended (the “CEA”). Under the CEA, the CFTC has broad enforcement authority to police market manipulation +and fraud in spot cryptocurrency markets in which we may transact. Beyond instances of fraud or manipulation, the CFTC generally does +not oversee cash or spot market exchanges or transactions involving cryptocurrencies that do not utilize margin, leverage, or financing. +The National Futures Association (“NFA”) is the self-regulatory agency for the U.S. futures industry, and as such has jurisdiction +over Bitcoin futures contracts and certain other cryptocurrency derivatives. However, the NFA does not have regulatory oversight authority +for the cash or spot market for cryptocurrency trading or transactions. In addition, CFTC regulations and CFTC oversight and enforcement +authority apply with respect to futures, swaps, other derivative products, and certain retail leveraged commodity transactions involving +cryptocurrencies, including the markets on which these products trade. +The SEC has taken the position +that many cryptocurrencies may be securities under U.S. federal securities laws. Some senior members of the staff of the SEC have expressed +the view that Bitcoin and Ethereum are not securities under U.S. federal securities laws. However, such statements are not official policy +statements by the SEC and reflect only the speakers’ views, which are not binding on the SEC or any other agency or court and cannot +be generalized to any other cryptocurrency. The SEC’s Strategic Hub for Innovation and Financial Technology published a framework +for analyzing whether any given cryptocurrency is a security in April 2019. However, this framework is also not a rule, regulation +or statement of the SEC and is similarly not binding on the SEC. Notwithstanding that the SEC has not asserted regulatory authority over +Bitcoin or trading or ownership of Bitcoin and has not expressed the view that Bitcoin should be classified or treated as a security for +purposes of U.S. federal securities laws, the SEC has commented on Bitcoin and Bitcoin-related market developments and has taken action +against investment schemes involving Bitcoin. For example, the SEC has charged at least three Bitcoin mining companies in connection with +a Ponzi scheme to defraud investors in their mining operation. The SEC has also repeatedly denied proposed rule changes by exchanges to +list and trade shares of certain Bitcoin-related investment vehicles on public markets, citing significant investor protection concerns +regarding the markets for cryptocurrencies, including the potential for market manipulation and fraud. Although the SEC has not stated +that mining Bitcoin is itself a regulated activity, to the extent any cryptocurrencies we mine are deemed to be securities, the offer, +sale, and trading of those cryptocurrencies would be subject to the U.S. federal securities laws. +In addition to the SEC, state +securities regulators and several foreign governments have also issued warnings that certain cryptocurrencies may be classified as securities +in their jurisdictions, and that transactions in such cryptocurrencies may be subject to applicable securities regulations. Furthermore, +certain state securities regulators have taken the position that certain cryptocurrency mining operations may involve the offer of securities. +For example, the Texas State Securities Board has taken enforcement action against the operator of a cloud mining company, whereby customers +could purchase hash rate managed by the cloud mining company in exchange for a share of the mining reward, for offering unregistered securities. +State financial regulators, +such as the New York State Department of Financial Services (“NYDFS”), have also implemented licensure regimes, or repurposed +pre-existing fiat money transmission licensure regimes, for the supervision, examination and regulation companies that engage in certain +cryptocurrency activities. The NYDFS requires that businesses apply for and receive a license, known as the “BitLicense,” +to participate in a “virtual currency business activity” in New York or with New York customers, and prohibits any person +or entity involved in such activity from conducting activities without a license. Louisiana also has enacted a licensure regime for companies +engaging in a “virtual currency business activity,” and other states are considering proposed laws to establish licensure +regimes for certain cryptocurrency businesses as well. Some state legislatures have amended their money transmitter statutes to require +businesses engaging in certain cryptocurrency activities to seek licensure as a money transmitter, and some state financial regulators +have issued guidance applying existing money transmitter licensure requirements to certain cryptocurrency businesses. The Conference of +State Bank Supervisors also has proposed a model statute for state level cryptocurrency regulation. Although we believe that our mining +activities do not presently trigger these state licensing requirements in any state in which we operate or plan to operate, if our activities +cause us to be deemed a “money transmitter,” “money services business” or equivalent designation under the law +of any state in which we operate or plan to operate, we may be required to seek a license or register at the state level and comply with +laws that may include the implementation of anti-money laundering programs, reporting and recordkeeping regimes, consumer protective safeguards, +and other operational requirements. In such an event, to the extent we decide to proceed with some or all of our operations, the required +registrations, licensure and regulatory compliance steps may result in extraordinary, non-recurring expenses to us, as well as on-going +recurring compliance costs, possibly affecting our net income in a material and adverse manner. Failure to comply with these requirements +may expose us to fines, penalties and/or interruptions in our operations that could have a material adverse effect on our financial position, +results of operations and cash flows. +14 +Competition +Our business environment is +constantly evolving, and cryptocurrency miners can range from individual enthusiasts to professional mining operations with dedicated +data centers. We compete with other companies that focus all or a portion of their activities on cryptocurrency mining activities at scale. +We face significant competition in every aspect of our business, including, but not limited to, the acquisition of new miners, the ability +to raise capital, obtaining the lowest cost of electricity, obtaining access to energy sites with reliable sources of power, and evaluating +new technology developments in the industry. +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this Annual Report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies +which we have identified as our competitors: +● Argo Blockchain PLC; +● Bit Digital, Inc.; +● Bitcoin Investment Trust; +● Bitfarms Technologies Ltd. (formerly Blockchain Mining Ltd); +● Blockchain Industries, Inc. (formerly Omni Global Technologies, Inc.); +● Digihost International, Inc.; +● DMG Blockchain Solutions Inc.; +● Galaxy Digital Holdings Ltd.; +● GMO Internet, Inc.; +● Greenidge Generation Holdings Inc.; +● HashChain Technology, Inc.; +● Hive Blockchain Technologies Inc.; +● Hut 8 Mining Corp.; +● Iris Energy Limited; +● Layer1 Technologies, Inc.; +● Marathon Digital Holdings, Inc.; +● MGT Capital Investments, Inc.; +● Northern Data AG; +● Riot Blockchain, Inc.; +● Overstock.com Inc.; +● SBI Holdings; +● SOS Limited; and +● Stronghold Digital Mining, Inc. +Intellectual Property +We plan to use specific hardware +and software for our cryptocurrency mining operations. In certain cases, source code and other software assets may be subject to an open +source license, as much technology development underway in this sector is open source. For these works, we intend to adhere to the terms +of any license agreements that may be in place. +15 +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. In addition, we have developed and may further +develop certain proprietary software applications for purposes of our planned cryptocurrency mining operations. +Accounting for Digital Currencies +Digital currencies are included +in current assets in the combined balance sheet. Digital currencies are recorded at cost less any impairment. An intangible asset with +an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances +occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount +exceeds its fair value. In testing for impairment, we have the option to first perform a qualitative assessment to determine whether it +is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, +a quantitative impairment test is not necessary. If we conclude otherwise, we will be required to perform a quantitative impairment test. +To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment +losses is not permitted. We account for our mining-related gains or losses in accordance with the first-in, first-out method of accounting. +Blockchain Background +Blockchain technology first +came to public attention in 2008 as the database technology that underpins Bitcoin, the world’s first cryptocurrency. Blockchains +are generally open-source, peer-to-peer software programs that act as decentralized digital ledgers, each comprising a series of data +“blocks” that are linked and secured using cryptography in a “chain.” The blockchain program consists of a software +protocol with several functions. The software protocol is run by multiple computer systems or “nodes.” For many blockchain +networks, each node has its own copy of the blockchain ledger, which contains a historical record of every transaction. The digital ledger +continuously grows as new blocks are added to it to record the most recent transactions in a linear, chronological order. The same information +is stored across a network of computers all over the world, and this record makes it possible to track the ownership and transfer of cryptocurrency +from the creation of the blockchain to its current state, and effectively, records of all account balances (as you can identify what account +holds what value through the decentralized ledger). +The blockchain protocol allows +users to submit transactions to the network for confirmation. However, a transaction will not be accepted by the protocol if the inputs +to the transaction have previously been used in another transaction. This prevention of “double spending” is a key security +feature of blockchain networks. +Another key function of the +blockchain that protects the integrity of the network is the hashing process, which acts as a tamper-evident seal that confirms the validity +of the new block and all earlier blocks. Hashing is the process of a block being posted to the network. Hashing results from miners, who +are responsible for receiving broadcast transactions, processing those transactions into new blocks and updating the blockchain with the +new blocks through hashing. The hashing process ties every new block to the existing block on the blockchain to ensure each is a continuous +record of verified transactions. +The hashing algorithm on +a proof-of-work blockchain network is a mathematical transformation function with two key properties. The first important function of +hashing is that the algorithm accepts any alphanumeric dataset as an input and produces a unique output code. The smallest change in the +dataset results in a significant change in the unique code. Any tampering of the dataset can be detected by re-hashing the data and checking +for a change in the unique code. Any user that runs the hash algorithm on the same data will derive the same unique code. Consequently, +the data on the distributed ledger can be run through a series of hash algorithms to create a unique code, which would reveal if any changes +to the ledger have been made. +Second, whenever a new set +or “block” of transactions is added to the ledger, it is appended with the code from the prior state of the ledger before +it is hashed. Thus, the hash created from the new block will incorporate the hash from the previous block. An alteration made to an earlier +block would make the hashes of all subsequent blocks invalid, as the discrepancy would be easily detected by future miners through the +protocols governing the blockchain. If a hacker were to attempt to make a change to an earlier block and broadcast it along with following +blocks to the other nodes on the network, that broadcast would be discarded in favor of one from a different node which complied with +the requirements of the protocol. +16 +Thus, in addition to creating +new block, miners “vote” with their computer power, expressing their acceptance of valid blocks by working on adding them +to the blockchain, and rejecting invalid blocks by refusing to work on them. If a miner’s proposed block is added to the blockchain +by a majority of the nodes on the network, it is considered part of the blockchain. The nodes on the network synchronize with each other +to ensure that once a block is accepted by the majority, the new block will eventually be added to all the nodes. Thus the historical +state of the ledger can be changed if control of more than 50% of the network is obtained; however, in the case of widely held cryptocurrencies +with non-trivial valuations, it may be economically prohibitive for any actor or group of actors acting in concert to obtain computing +power that consists of more than 50% of the network. +Unlike proof-of-work networks, +in which miners expend computational resources to compete to validate transactions and are rewarded cryptocurrency in proportion to the +amount of computational resources expended, in a proof-of-stake network, miners (sometimes called validators) risk or “stake” +assets to compete to be randomly selected to validate transactions and are rewarded cryptocurrency in proportion to the amount of assets +staked. Any malicious activity, such as mining multiple blocks, disagreeing with the eventual consensus or otherwise violating protocol +rules, results in the forfeiture or “slashing” of a portion of the staked assets. Proof-of-stake is viewed by some as more +energy efficient and scalable than proof-of-work. +Blockchain technology enables +the secure use and transfer of digital assets. “Digital asset” is a broad term that encompasses additional applications, including +ownership, transaction tracking, identity management, and smart contracts. A digital asset can represent physical or virtual assets, a +value, or a use right/service (e.g., computer storage space). +Whereas digital assets can +take many forms and be used for a variety of functions, cryptocurrencies are a type of digital asset that primarily function as a medium +of exchange, a unit of account, and/or a store of value. Cryptocurrencies allow anyone who holds a compatible wallet, anywhere in the +world, to hold and transfer that cryptocurrency without the need for an intermediary or trusted third party. Units of a cryptocurrency +may exist only as data on the internet, and often are not issued or controlled by any single institution, authority or government. Whereas +most of the world’s money currently exists in the form of electronic records managed by central authorities such as banks, units +of a non-government cryptocurrency exist as electronic records in a decentralized blockchain database. Because cryptocurrencies have no +inherent intrinsic value, the value of cryptocurrencies is determined by the value that various market participants place on them through +their transactions. Bitcoin, Ethereum and other cryptocurrencies have historically exhibited high price volatility relative to more traditional +asset classes. +Private entities also issue +digital assets called “stablecoins” that are designed to represent an underlying fiat currency or other physical asset and +therefore less susceptible to volatility. Stablecoins can be backed by fiat money, physical assets, or other crypto assets. Government +institutions are also reportedly testing and considering issuing Central Bank Digital Currencies (“CBDC’s”). While stablecoins +or CBDC’s may exhibit less price volatility than other cryptocurrencies, both rely on a central authority to establish the value +of the asset, and therefore represent an exception to the general discussion of the design of cryptocurrencies herein. +Each cryptocurrency has a +source code that comprises the basis for the cryptographic and algorithmic protocols, which govern the blockchain. The source code is +commonly open source and therefore can be inspected by anyone, and is maintained on an ongoing basis through contributors proposing amendments +to the protocol, which are peer reviewed and adopted by consensus among participants on the blockchain network. These protocols govern +the functioning of the network, including the ownership and transfer of the cryptocurrency, and are executed on the decentralized peer-to-peer +blockchain infrastructure. The peer-to-peer infrastructure on which a blockchain operates is not owned or operated by a single entity. +Instead, the infrastructure is collectively maintained by a decentralized user base. Each peer user is generally known as a “node” +or “miner,” and each miner processes transactions on the network in accordance with the protocols of the relevant cryptocurrency. +As a result, these cryptocurrencies +do not rely on either governmental authorities or financial institutions to create, transmit or determine the value of units of cryptocurrency. +Rather: +● the creation of units of cryptocurrency generally is governed by the source code, not a central entity; +● the transmission of a cryptocurrency is governed by the source code and processed by the decentralized +peer-to-peer network of nodes or miners; and +● the value of a cryptocurrency is generally determined by the market supply of and demand for the cryptocurrency, +with prices set in transfers by mutual agreement or barter, as well as through acceptance directly by merchants in exchange for goods +and services. +17 +Cryptocurrencies may be open +source projects with no official developer or group of developers that control the network. However, certain networks’ development +may be overseen informally by a core group of developers that may propose quasi-official releases of updates and other changes to the +network’s source code. The release of updates to a blockchain network’s source code does not guarantee that the updates will +be automatically adopted. Users and miners must accept any changes made to the source code by downloading the proposed modification of +the network’s source code. A modification of the network’s source code is effective only with respect to the users and miners +that download it. If a modification is accepted by only a percentage of users and miners, a division in the network will occur such +that one network will run the pre-modification source code and the other network will run the modified source code. Such a division is +known as a “fork.” Consequently, a modification to the source code becomes part of a blockchain network only if accepted by +participants collectively having most of the processing power on the network. +Each “account” +on a blockchain network is identified by its unique public key, and is secured with its associated private key (which the account holder +must keep secret, like a password). Cryptocurrencies are treated as bearer assets, because possession of the private key generally determines +who controls or owns a cryptocurrency. Protecting private keys from unwarranted access and theft is critically important, as once the +private key is taken, in most circumstances, control over the related cryptocurrency is gone. The combination of private and public cryptographic +keys constitutes a secure digital identity in the form of a digital signature. As long as the private key is kept private (i.e., confidential +to the owner of the account) it provides strong control of ownership. +Ault Alliance +We +acquire controlling or non-controlling interests in and actively manage businesses that we generally believe (i) are undervalued and have +disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, (iii) have +positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, and (v) have strong +management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading middle-market businesses +in the niche-industrial and branded-consumer sectors. +We +use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an investment, we often +become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing +the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. +We +believe that private company operators and corporate parents looking to sell their business units may consider us an attractive purchaser +because of our ability to: +● provide ongoing strategic and financial support for their businesses, including professionalization of +our subsidiaries at scale; +● maintain a long-term outlook as to the ownership of those businesses; +● sustainably invest in growth capital and/or add-on acquisitions where appropriate; and +● consummate transactions efficiently without being dependent on third-party transaction financing. +In +particular, we believe that our outlook on length of ownership and active management on our part may alleviate the concern that many private +company operators and parent companies may have with regard to their businesses going through multiple sale processes in a short period +of time. We believe this outlook enhances our ability to develop a comprehensive strategy to grow the earnings and cash flows of each +of our businesses. +Finally, +it has been our experience that our ability to acquire businesses without the cumbersome delays and conditions typical of third party +transactional financing is appealing to sellers of businesses who are interested in confidentiality, speed and certainty to close. +18 +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2021, we believe that these businesses have strong +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Our Subsidiaries +The following is a brief +summary of the businesses in which Ault Alliance owns a controlling interest at December 31, 2021: +DP Lending +DP Lending provides funding +to businesses through loans and investments. DP Lending offers a variety of loan types including commercial loans, convertible notes and +revolving lines of credit. DP Lending is engaged in providing commercial loans to companies throughout the U.S. to provide them with operating +capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to twelve months, but may be of +longer duration. These terms are subject to change as market needs dictate, and DP Lending anticipates offering additional products in +the future. +DP Lending uses its considerable +financial experience, data analytics, and a credit scoring model to assess the creditworthiness of each small business borrower applicant. +If the business meets DP Lending’s criteria, DP Lending sets the initial interest rate according to its credit and financial models. +The final interest rate offered to the borrower will be determined by DP Lending’s interpretation of the marketplace. In order to +borrow from DP Lending, borrowers must display characteristics indicative of durable business and financial situations. These include +factors such as revenue, time in business, number of employees, and financial and credit variables. In order to qualify, business borrower +applicants must be approved through DP Lending’s underwriting process, which analyzes credit and financial data of both the business +and the business owner. DP Lending takes into account several business factors (including revenue, age of business, cash flows, and other +variables). The underwriting process determines the loan amount to approve, how loans will be priced, and whether to include a blanket +lien is based on the above analysis, as well as additional factors (including length of loan, estimated default rates by type and grade, +and general economic environment). +Our Executive Committee, which +is comprised of our Executive Chairman, Chief Executive Officer and President, acts as the underwriting committee for DP Lending and approves +all lending transactions. The Executive Committee has decades of experience in financial, investing and securities transactions. Under +its business model, DP Lending generates revenue through origination fees charged to borrowers and interest generated from each loan. +DP Lending may also generate income from appreciation of investments in marketable securities as well as any shares of common stock underlying +convertible notes or warrants issued to DP Lending in any particular financing. +As noted above, we will from +time to time, through DP Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2022, we anticipate +providing significant new funding to expand DP Lending’s loan and investment portfolio. DP Lending loans made or arranged pursuant +to a California Financing Law license (Lic.no. 60 DBO77905). +19 +Ault Alpha +DP Lending is the principal +owner of Ault Alpha, a term we use that comprises an investment fund, a general partner and an investment manager all formed on July 15, +2021. Ault Alpha generally seeks to invest in public companies or private companies with public debt that have strong relative value metrics +but poor Wall Street recognition; such companies can often experience valuation inefficiencies. Ault Alpha seeks to identify and invest +in these undervalued companies. In certain companies, Ault Alpha will actively intervene to assist management to maximize stockholder +value. Ault Alpha believes that an activist role can result in the creation of significant value and larger than average returns on investment. +Ault Alpha will own a concentrated portfolio, and typically invest with a long-term perspective. Further, Ault Alpha will employ a systematic +process, developed over decades of collective experience in the capital and credit markets, to seek specific value-creating events and/or +special situations, to provide compelling return potential and generate competitive capital appreciation and total return by making investments +in three key categories: (i) undervalued or overvalued assets; (ii) activist trading; and (iii) volatility trading and arbitrage. Ault +Alpha has purchased the Company’s common stock in open-market transactions. +AGREE +AGREE seeks to invest in various +classes of commercial and residential real estate including hospitality, multifamily, and industrial properties targeting the middle market +segment in locations demonstrating relative value. AGREE’s objective is to generate risk adjusted returns through development, capital +investment and operational improvement, leveraging the management team’s expertise and well-established relationships with real +estate investment professionals, brokers, lenders and developers. The focus will be in U.S. tertiary markets with growing populations, +income growth and access to highly populated metropolitan areas as primary demand drivers. AGREE is one of BitNile’s strategies +to invest in inflation-resistant undervalued assets and realize capital appreciation through cap rate compression over time. AGREE owns +and operates both Third Avenue Apartments and AGREE Madison. +Ault Media Group +Ault +Media Group (“AMG”) is comprised of a diverse team of media professionals with expertise in creating all forms of media, communications, +and content including web development, corporate communications, social media, scripted, and unscripted television. Our online virtual +training courses (via the LightSpeedVT platform) also offer in-depth business learning. AMG’s specialized team of producers brings +years of university-proven training methods and a history of developing educational materials up to a Master's degree level. AMG’s +first course, relating to initial public offerings, is currently in the final stages of production, with more courses soon to follow. +Along +with training and communications strategies, AMG also offers comprehensive consulting for the development and execution of large and small +scale conferences and event planning. From event space acquisition to digital ticketing, keynote speakers, lighting, stage crews, and +advertising media buys, AMG will provide the necessary contacts and guidance to assure a successful and smooth-running event. +Our +Strategy +Our business strategy is designed +to increase shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +shareholder value, such as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell +some or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock +or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly +traded partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +20 +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase cash flows +and stockholder value. Ault Alliance actively oversees and supports the management teams of each of our businesses by, among other things: +● recruiting and retaining talented managers to operate our businesses using structured incentive compensation +programs, including non-controlling equity ownership, tailored to each business; +● regularly monitoring financial and operational performance, instilling consistent financial discipline, +and supporting management in the development and implementation of information systems to effectively achieve these goals; +● identifying and aligning with external policy and performance tailwinds such as those influenced by growing +climate, health, and social justice concerns (and similar environmental, social and governance (“ESG”) drivers); +● assisting management in their analysis and pursuit of prudent organic growth strategies; +● identifying and working with management to execute attractive external growth and acquisition opportunities; +● assisting management in controlling and right-sizing overhead costs; +● nurturing an internal culture of transparency, alignment, accountability and governance, including regular +reporting; +● professionalizing our subsidiaries at scale; and +● forming strong subsidiary level boards of directors to supplement management in their development and +implementation of strategic goals and objectives. +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Ault Alliance to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +● making selective capital investments to expand geographic reach, increase capacity, or reduce manufacturing +costs of our businesses; +● investing in product research and development for new products, processes or services for customers; +● improving and expanding existing sales and marketing programs; +● pursuing reductions in operating costs through improved operational efficiency or outsourcing of certain +processes and products; and +● consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +● leverage manufacturing and distribution operations; +● leverage branding and marketing programs, as well as customer relationships; +● add experienced management or management expertise; +● increase market share and penetrate new markets; and +● realize cost synergies by allocating the corporate overhead expenses of our businesses across a larger +number of businesses and by implementing and coordinating improved management practices. +Acquisition Strategy +Our +acquisition strategy is to acquire businesses that we believe to be to undervalued and have disruptive technologies with a global impact +that we expect to produce stable and growing earnings and cash flow. In this respect, we expect to make acquisitions in industries other +than those in which our businesses currently operate if we believe an acquisition presents an attractive opportunity. We believe that +attractive opportunities will continue to present themselves, as private sector owners seek to monetize their interests in long-standing +and privately-held businesses and large corporate parents seek to dispose of their “non-core” operations. +21 +Our +ideal acquisition candidate has the following characteristics: +● is a leading branded consumer or niche industrial company headquartered in North America; +● maintains highly defensible position in the markets it serves and with customers; +● operates in an industry with favorable long-term macroeconomic trends; +● has a strong management team, either currently in place or previously identified, and meaningful incentives; +● has low technological and/or product obsolescence risk; and +● maintains a diversified customer and supplier base. +We +benefit from Ault Alliance’s ability to identify potential diverse acquisition opportunities in a variety of industries. In addition, +we rely upon our Executive Committee and other members of our management team’s experience and expertise in researching and valuing +prospective target businesses, as well as negotiating the ultimate acquisition of such target businesses. In particular, because there +may be a lack of information available about these target businesses, which may make it more difficult to understand or appropriately +value such target businesses, Ault Alliance: +● engages in a substantial level of internal and third-party due diligence; +● critically evaluates the target management team; +● identifies and assesses any financial and operational strengths and weaknesses of the target business; +● analyzes comparable businesses to assess financial and operational performances relative to industry competitors; +● actively researches and evaluates information on the relevant industry; and +● thoroughly negotiates appropriate terms and conditions of any acquisition. +The +process of acquiring new businesses is both time-consuming and complex. Our management team historically has taken from two to +six months to perform due diligence, negotiate and close acquisitions. Although our management team is at various stages of evaluating +several transactions at any given time, there may be periods of time during which our management team does not recommend any new acquisitions. +Even if an acquisition is recommended by our management team, our Board may not approve it. +A +component of our acquisition financing strategy that we utilize in acquiring the businesses we own and manage is to provide both equity +capital and debt capital. We believe, and it has been our experience, that having the ability to finance our acquisitions with capital +resources raised by us, rather than negotiating separate third-party financing, provides us with an advantage in successfully acquiring +attractive businesses by minimizing delay and closing conditions that are often related to acquisition-specific financings. In addition, +our strategy of providing this intercompany debt financing within the capital structure of the businesses we acquire and manage allows +us the ability to distribute cash to the parent company through monthly interest payments and amortization of principle on these intercompany +loans. +Upon +acquisition of a new business, we rely on our management team’s experience and expertise to work efficiently and effectively with +the management of the new business to jointly develop and execute a successful business plan. +Strategic Advantages +Based +on the experience of our management team and its ability to identify and negotiate acquisitions, we believe we are well-positioned to +acquire additional businesses. Our management team has strong relationships with business brokers, investment and commercial bankers, +accountants, attorneys and other potential sources of acquisition opportunities. In addition, our management team has a successful track +record of acquiring and managing businesses in various industries. In negotiating these acquisitions, we believe our management team has +been able to successfully navigate complex situations surrounding acquisitions, including corporate spin-offs, transitions of family-owned +businesses, management buy-outs and reorganizations. +Our +management team has a large ne twork of deal interme diaries whom we expect to expose us to +potential acquisitions. Through this network, as well as our management team’s proprietary transaction sourcing efforts, we have +a substantial pipeline of potential acquisition targets. Our management team also has a well-established network of contacts, including +professional managers, attorneys, accountants and other third-party consultants and advisors, who may be available to assist us in the +performance of due diligence and the negotiation of acquisitions, as well as the management and operation of our acquired businesses. +22 +Valuation and Due Diligence +When +evaluating businesses or assets for acquisition, our management team performs rigorous due diligence and a financial evaluations process +including an evaluation of the operations of the target business and the outlook for its industry. While valuation of a business is a +subjective process, we define valuations under a variety of analyses, including: +● discounted cash flow analyses; +● evaluation of trading values of comparable companies; +● expected value matrices; and +● examination of comparable recent transactions. +One +outcome of this process is a projection of the expected cash flows from the target business. A further outcome is an understanding of +the types and levels of risk associated with those projections. While future performance and projections are always uncertain, we believe +that with detailed due diligence, future cash flows will be better estimated and the prospects for operating the business in the future +better evaluated. To assist us in identifying material risks and validating key assumptions in our financial and operational analysis, +in addition to our own analysis, we engage, as necessary, third-party experts to review key risk areas, including legal, tax, regulatory, +accounting, insurance and environmental. We also engage technical, operational or industry consultants, as necessary. +A +further critical component of the evaluation of potential target businesses is the assessment of the capability of the existing management +team, including recent performance, expertise, experience, culture and incentives to perform. Where necessary, and consistent with our +management strategy, we actively seek to augment, supplement or replace existing members of management who we believe are not likely to +execute our business plan for the target business. Similarly, we analyze and evaluate the financial and operational information systems +of target businesses and, where necessary, we enhance and improve those existing systems that are deemed to be inadequate or insufficient +to support our business plan for the target business. +Financing +We +incur third party debt financing almost entirely at the parent company level, which we use, in combination with our equity capital, to +provide debt financing to each of our businesses and to acquire additional businesses. We believe this financing structure is beneficial +to the financial and operational activities of each of our businesses by aligning our interests as both equity holders of, and lenders +to, our businesses, in a manner that we believe is more efficient than each of our businesses borrowing from third-party lenders. +Ault Disruptive Technologies Corporation +Ault Disruptive Technologies +Corporation, a Delaware corporation (“ADTC”), is a recently-organized special purpose acquisition company, or SPAC, incorporated +in February 2021 whose business purpose is to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization +or similar business combination with one or more businesses, which ADTC refers to as its initial business combination. To date, ADTC’s +efforts have been limited to organizational activities, activities related to its initial public offering and preliminary discussions +with certain parties that could become ACTC’s target company. ADTC has not selected any specific business combination target and +it has not, nor has anyone on its behalf, engaged in any substantive discussions, directly or indirectly, with any business combination +target with respect to an initial business combination with ADTC. +While ADTC may pursue an initial +business combination opportunity in any business, industry, sector or geographical location, ADTC intends to focus on opportunities to +acquire companies with innovative and emerging technologies, products or services that have the potential to transform major industries +and radically impact society. ADTC intends to acquire a target business or businesses with disruptive technologies that our management +team believes can achieve mainstream adoption and create opportunities for long-term appreciation in value. ADTC’s sponsor, Ault +Disruptive Technologies Company, LLC, is a wholly owned subsidiary of BitNile. +IMHC +On March 20, 2022, we, TOGI +and IMHC entered into the Acquisition Agreement whereby TOGI will, upon closing, become a subsidiary of IMHC (the “Acquisition”). +Upon completion of the Acquisition, +which is contingent upon the completion of an audit of TOGI and each party’s satisfaction or waiver of certain customary closing +conditions set forth in the Acquisition Agreement, IMHC will change its name to TurnOnGreen and, through an upstream merger whereby the +current TOGI shall cease to exist, have two operating subsidiaries, TOG Technologies and Digital Power. Promptly following the closing +of the Acquisition, IMHC will dissolve its three dormant subsidiaries. Subsequent to the Acquisition, we will assist TurnOnGreen in pursuing +an uplisting to the Nasdaq Capital Market, subject to Nasdaq’s seasoning rules and other criteria for listing. +23 +We anticipate that our stockholders +will in due course receive a dividend of securities of TOGI. We expect to distribute to our stockholders approximately 140 million common +shares of IMHC we own and an equal number of warrants to purchase such shares of IMHC at the time of the record date to be set therefor, +subject to regulatory approval and compliance with U.S. federal securities laws. +TOGI +TOGI, through Digital Power +and TOG Technologies, is engaged in the design, development, manufacture and sale of highly engineered, feature-rich, high-grade power +conversion and power system solutions for mission-critical applications and processes. For more than 50 years, Digital Power has been +devoted to the perfection of our power solution products that have enabled customer innovation in complex product applications covering +a wide range of industries. A natural outgrowth of our development of these power systems has been our effort to apply our proprietary +core power technologies to optimizing the design and performance of electric vehicle (“EV”) charging solutions. We introduced +our product line of residential and commercial high-speed EV charging solutions in late 2021. We believe that our EV charging solutions +represent an entire new generation of new chargers due to dramatic improvements in electronic circuitry size reduction, power conversion +efficiency, modular topology, and output density. We believe that our feature-rich EV chargers address the specific needs of multifamily +unit home dwellers and single family homeowners by providing adjustable electric current options, restricted user access, LCD touch screen +for simple point of operation use, Bluetooth connectivity and programmable RFID card features. By leveraging our experience and expertise +in power conversion and generation, we believe we can rapidly become a meaningful participant in the high growth EV charging solution +market. +At Digital Power, we currently +provide a comprehensive range of integrated power system solutions that are designed to meet the diverse and precise needs of our customers +with the highest levels of efficiency, flexibility , and scalability. We design, develop, and manufacture +custom-made power systems incorporating our products to meet performance and/or form factor requirements that cannot be met with standard +products. These power system solutions are designed to function reliably in harsh environments for defense and aerospace applications +and are capable of being utilized under other environmental conditions in specialized product applications ranging from industrial equipment +to medical instrumentation. Our products are highly adaptive and feature soft configurations to meet the requirements of both our customers +and OEMs. These products include our Open-Frame series of products, which are the industry’s smallest open frame AC/DC switchers, +high-performance AC/DC desktop adaptor power supplies and a full range of compact AC or DC power supplies. We have been advised by our +customers that our power supply products have achieved general recognition as quality products. +We recently formed TOG Technologies, +following more than two years of engineering design and product prototypes, to provide EV drivers of all types with easy access to convenient, +reliable, and high-speed EV charging. We offer a Level 2 AC charging infrastructure for use at home, work and at play, and a Level 3 DC +Fast charger infrastructure for high traffic, high density urban, suburban, and exurban locations. Our EV charging solutions are designed +to address the expected rapid expansion of infrastructure required to support broad adoption of EVs globally. Our innovative +charging solutions produce a full charge for an EV with a 150-mile range battery in approximately 30 minutes. We provide a wide +range of EV charging solutions, including a Level 2 AC charging product line compatible with the SAE J1772 +standard, and a Level 3 DC Fast charging product line compatible with the Combined Charging System and CHArge de MOve industry +standards. +Our charging network is capable +of natively charging all EV models and supports all charging standards currently available in the U.S., including Tesla models, with SAE +J1772 adapters typically included with the purchase or with third-party adapters that may be purchased separately. This network can serve +a wide variety of private, retail and commercial customers. Our charging systems have been tested and certified by nationally recognized +testing laboratories including Underwriters Laboratories, Intertek and TÜV Rheinland for operating safety according to the highest +standards in the market coordinated by the American National Standards Institute, an independent organization. We anticipate rapid growth +in the number of EVs in North America, in part in response to consumer demand for vehicles with greater fuel efficiency and lower environmental +emissions. We intend to expand our network of charging stations to accommodate this growth while prioritizing development of locations +with favorable traffic and utilization characteristics. +We are currently in the process +of installing our DC Fast chargers at multiple Tim Hortons locations (North America’s fourth largest publicly traded quick service +restaurant chain) in Canada pursuant to a pilot program agreement with Okanogan TH Holdings Ltd., a licensed franchisee of that chain. +During the pilot period, EV charging net revenues are split between us and the franchisee. The agreement will allow TOGI to retain 100% +of the gross revenue until our capital expenditures are fully recovered and subsequently we will share 50% of the net revenue with the +franchisee. We will own and operate the electric vehicle supply equipment (“EVSE”) at +select locations and be responsible for the costs associated with designing, manufacturing, installing and maintaining the EV chargers. +24 +Our “go to market” +strategy is to be supplier of choice across numerous specialized markets that require high-quality power system solutions where custom +design, product quality, responsiveness and reliability are critical to business success. We believe that we provide advanced custom product +design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. +We believe this integrated approach, which many of our competitors do not provide, allows our customers to obtain all their needs for +designing and manufacturing power solutions and products from a single source, enabling us to establish an ongoing relationship with our +customers to provide for their future requirements. By implementing our proprietary core technology, including process implementation +in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom-designed +and engineered products. +Looking ahead, our mission +is to maintain our core power electronics business and existing relationships while leveraging the experience and expertise we have gained +in the development of power system solutions to introduce EV charging solutions. By offering EV charging solutions, as well as a convenient, +reliable and affordable EV charging e-mobility network through TOG Technologies, we intend to drive sustainable, mission-driven growth +related to powering environmentally beneficial EVs while continuing to be recognized as a trusted provider of advanced power supply technology. +Our Growth Strategies +Our power products and charging +solutions are sold in the form of hardware, extended warranty purchases, recurring network subscriptions, operations and maintenance plans, +and other related services. We will continue to optimize our operating model, combining high quality power and charging hardware and related +services with appealing business models for our customers. We believe that this approach creates significant customer network effects +and provides the potential for recurring revenues. Key elements of our growth strategies include: +Ø Continue to Innovate and Enhance Our EV +Products . While maintaining our core power electronics business in existing product markets, we intend to support the growth of +the company by introducing advanced, new power technologies with respect to our eMobility network and EV charging infrastructures. Specifically, +we intend to take advantage of a significant increase in eMobility market opportunities that we expect to see over the next five to ten +years for our non-networked and networked Level 2 AC chargers and our high-power Level 3 DC Fast charging solutions. Subject to obtaining +sufficient capital, we intend to invest in EV charging station components for use in connection with installations of charging solutions +at customer sites. We will expand our eMobility charging services through our TurnOnGreen Served (“TOGS”) Software Platform +as a Service (“SPaaS”) for commercial and fleet customers and continue to design and develop innovative products and services +leveraging our knowledge of power electronics technology and advanced charging network management. +Ø Develop Our Strategic Channel Partnership +Network . To achieve our goals, particularly with respect to the rapid deployment of our EV charging products, we will evaluate +and enter strategic channel partnerships and independent distribution arrangements that facilitate our ability to bring solutions to a +wider network of EV drivers than we would be able to reach on our own. For example, we are an approved vendor for Consolidated Electrical +Distributors, Inc. (“CED”), a large privately owned electrical distribution company with locations throughout the U.S. We +are currently supplying our EV charging equipment to CED centers on the West coast and in several southern states. +Ø Expand Within Existing Customers . +We are focused on maintaining our customer retention model, which encourages existing customers to increase their utilization of our power +products and establishing an ongoing relationship to provide for their future requirements. We expect additional growth to result from +the breadth of ecosystem integrations that are enabled through our TOGS SPaaS charging services. This eMobility network would integrate +platforms such as in-vehicle infotainment systems, consumer mobile applications, payment systems, mapping tools, home automation assistants, +fleet fuel cards and residential utility programs. +Ø Make Opportunistic Investments in Marketing . +We intend to continue to aggressively market and sell our core power products through our existing domestic and international markets, +with an emphasis on the North American market. We also intend to generate revenues by our eMobility charging services through various +strategic channel partnerships and business models to reach new customers, in each case coordinated through our dedicated sales groups. +Ø Pursue Strategic Business Acquisitions +for Growth . Through selective acquisitions of, or investments in, complementary businesses, products, services and technologies +in the power electronics, EV charging solutions and other electronics-driven industries, we aim to broaden our existing product and technology +base, build on our long-standing industry relationships and enhance our ability to penetrate new markets. We are experienced at evaluating +prospective operations to increase efficiencies and capitalize on market and technological synergies. We currently have no commitments +or agreements with respect to any such acquisitions or investments. +25 +Our Power System Markets and Customers +Our power systems sell as +integrated solutions to diverse customers to address a wide range of product applications in the specialized markets we serve, including +medical and healthcare, defense and aerospace, and industrial and telecommunications. We also sell our products as stand-alone products +to our commercial customers, which are frequently custom made to specifications. Our current commercial customer base consists of approximately +220 companies, which are served through our direct sales team and our strategic channel partnerships. Successful marketing of our products +is dependent on the maintenance of strong relationships in the following key markets. +Medical and Healthcare . +Our power solutions are ideal for healthcare and medical applications that require a high level of reliability and performance due to +their quality, output power and high-power density. Our power supplies meet the rigorous medical safety requirements and major industrial +safety standards related to such products to major industrial safety standards, including the EN60601-1-2 4.1 series of technical standards +for medical equipment and the EMC compliance requirements, and facilitate medical device and system manufacturers’ compliance testing +of their own products. Our third-party qualification testing facilities are also approved by various safety agencies to test and qualify +power products to be used in medical devices. We have obtained the medical quality management systems ISO 13485 certification to support +rigorous design requirements and high-quality manufacturing of our medical power systems. Our medical power products help OEMs minimize +the risk of encountering unexpected development problems outside of their own areas of expertise. Representative applications that utilize +or incorporate our power products in the medical and healthcare industry include portable oxygen concentrators, patient monitoring systems, +pulsed lasers drivers for dental and surgical treatment, DNA sequencers, medical beds and ultrasounds. +Defense and Aerospace . +We offer a broad range of rugged power solutions for the defense and aerospace market. These solutions feature the ability to withstand +harsh environments. For more than 50 years, we provided rugged commercial off the shelf (“COTS”) products and custom power +solutions designed for end-to-end military and aerospace applications. We offer a wide variety of units designed to comply with the most +demanding MIL-STDs. Our military products meet all relevant military standards in accordance with the Defense Standardization Program +Policies and Procedures. This includes specifications related to space, weight, output power, electromagnetic compatibility, power density +and multiple output requirements, all of which we meet due to the decades of experience held by our engineering team. Certain of our products +that are specifically designed, modified, configured or adapted for military systems are subject to the U.S. International Traffic in +Arms Regulations (“ITAR”), which are administered by the U.S. Department of State. We obtain required export licenses for +any exports subject to ITAR. Our third-party defense manufacturing facilities are compliant with the AS9100 international Quality Management +System standard for the aviation, space and defense industry. Representative applications that utilize or incorporate our power products +in the defense and aerospace industry include mobile and ground communications, naval power conversion, automated test and simulation +equipment for weapon systems, combat and airborne power supplies, radar arrays power source, tactical gyro position and navigation systems +and active protection of tactical vehicles. +Industrial and Telecommunications. +We build products for custom and standard applications used in industrial and telecommunication markets to the highest standards in flexibility, +efficiency, and reliability. Our compact, high-density, and flexible power supplies and power converters are designed for optimal performance, +functionality , and reduced cost. Due to the breadth of our experience, our products have proven to meet +stringent design requirements. Our industrial power solutions are designed to stand up to the extreme temperatures, input surges, vibration +and shock found through uses such as industrial automation, material handling, industrial lasers, robotics, agriculture, oil and gas, +mining, and outdoor applications. Our proprietary technology is designed for thermal management, reliability, electromagnetic interference +(“EMI”) and EMC specifications and power density, with rugged performance that is typically unavailable in standard supplies +from our competitors. Representative applications that utilize or incorporate our power products in the industrial and telecommunications +industry include packaging equipment, laboratory and diagnostic equipment, industrial laser drivers, datacenter computing and turbomachinery +control solutions. +The EV Charging Industry and Our Revenue Models +The market for battery electric +vehicles (“BEVs”) and plug-in hybrid electric vehicles (“PHEVs”) has experienced substantial growth in the past +five years, and we believe that growth will increase significantly over the next five years. As the economic and environmental costs of +fossil fuel burning automobiles increases each year, consumer demand for vehicles with greater fuel efficiency, greater performance and +with lower or no environmental emissions has also increased. With a variety of federal, state and municipal incentive +programs for both EV drivers and EV supply equipment infrastructure construction, we anticipate a significant increase in the demand for +BEV and PHEV charging solutions at home, work and in public settings. +26 +The market +for sustained growth of the EV charging industry is substantial and continuing worldwide. Multiple states and municipalities have set +ambitious zero emission vehicle goals for the next ten years. In order to meet these goals, mandates for EV sales have been established +by states like California, New York, Oregon and Washington. At the same time, oil and gas prices continue to rise and EV battery +technology continues to improve and become more affordable. The average consumer cost to acquire an EV declined 13.5% from 2018 to 2019, +according to general industry statistics, and continues to fall as more automobile manufacturers introduce new EV models to the market +each year. +According +to the Electric Drive Transportation Association, sales of plug-in vehicles since introduction to the market in 2010 is over 500,000 vehicles +and, according to a third-party research firm, sales are expected to grow by a factor of 12 to over 4,000,000 vehicles in 2025. +The cost to maintain an EV is half of what it costs to maintain an internal combustion engine (“ICE”) automobile, according +to third party research, and the cost to add 200 miles of range to an ICE car is roughly twice the cost of its all-electric counterpart. +The final +barrier to widespread BEV and PHEV adoption is the current status of the EV charging infrastructure. We believe that the demand for EV +charging is increasing each day. Utility companies are upgrading their grid infrastructure in preparation for the increased +demand. We expect the demand from businesses, municipalities and individuals to outpace supply over the next five years, creating +a highly favorable environment for EVSE companies. +We believe that providing +energy efficiency in all our power supply and EV charging products leads to long term environmental benefits for society. Increasing consumer +demand for EVs provides an opportunity for our charging infrastructure and solutions to be used for powering vehicles with little to no +tailpipe emissions or other pollutants. With a shared mission to do our part to fight climate change, we strive to bring to established +and emerging markets innovative electronics-driven solutions that provide value for our company and stockholders. +EV Charging Revenue Models +We +intend to generate revenues with TOG Technologies primarily through the sale of networked charging hardware, combined with cloud-based +services that provide end users the ability to locate and transact with EV chargers, and provide site host customers with the ability +to operate and manage their chargers (the “TOG Network” or “TOG Network Services”). TOG Network Services, and +an optional extended warranty, are billed as an annual subscription, and access to the network is available through each of our commercial +charging ports. We expect that the revenue contribution for recurring TOG Network or extended warranty sales will equal the revenue contribution +from one-time EV1100 charger sales for commercial use after approximately seven years. TOG Technologies also offers a hardware portfolio +powered by software, which cannot be accessed without a TOG Network subscription. +EV Charging Unit Sales . +We recognize revenues through the sale of our charging solutions in the form of hardware sales and extended warranty purchases. We intend +to employ various business models with customers for our EV charging unit sales based on which party bears the costs of installation, +equipment and maintenance, and the relative percentages of the continuing, long-term revenue-sharing arrangement. +EV Charging Network Services . +We intend to provide EV charging network services, including management of user authentication, billing and payments, and power management +(also called load balancing). These services will be made available through a recurring subscription business model or through a revenue +sharing arrangement that enables us to retain a percentage of the revenue generated from EV charging. +OEM Charging and Related +Services. Through discussions with OEM partners, we are pioneering innovative revenue models to meet a wide variety of OEM objectives +related to the availability of charging infrastructure and provisioning charging services for EV drivers. We are contracting directly +with OEMs to provide charging services to drivers who have purchased or leased EVs from such OEMs and who access our public charger network. +Retail Charging. We +intend to sell electricity directly to EV drivers who access our publicly available networked chargers. We offer various pricing plans +for customers. Drivers have the choice of charging either as members (with monthly fees and reduced per-minute pricing) through a subscription +service, or on a per-use basis as non-members. Drivers locate chargers through our mobile application, their vehicle’s in-dash navigation +system, or third-party databases that license charger location information from us. We aim to install our chargers in parking spaces owned +or leased by commercial or public entity site hosts that desire to provide our charging services at their locations. Commercial suite +hosts include retail centers, offices, medical complexes, airports and convenience stores. We offer charging hosts a range of revenue-sharing +arrangements. +27 +Commercial Charging. +High volume fleet customers, such as delivery services, can access our charging infrastructure through our public network. Pricing for +charging services is to be negotiated directly between us and the fleet owner based on business needs and usage patterns of the fleet, +and we will typically contract with and bill the fleet owner directly rather than the individual fleet drivers who utilize our chargers. +Access to our public network enables fleet and rideshare operators to support mass adoption of transportation electrification and achieve +sustainability goals while avoiding direct capital investments in charging infrastructure or the incurrence of operating costs associated +with charging equipment. +Our Competitive Strengths +We offer highly engineered, +feature-rich, high-grade power conversion and power system solutions on a global scale. We believe that we differentiate ourselves from +our competition and have been able to grow our business because of the following key competitive strengths: +Ø Proprietary Custom-Designed and Engineered +Products . We have designed our base model power system platform so that it can be quickly and economically adapted to the specific +power needs of any hosting platform or OEM, which minimizes the time between customer consultation and delivery of our power products +and systems. +Ø End-to-End Solutions for Customers . +We provide end-to-end solutions for the business needs of our customers, from product design and development to multi-year warranty, +technical support and ongoing services. +Ø Specialized Technical Expertise and Experience . +We have more than 50 years of expertise in power technologies and energy generation, which has given us a wealth of experience in designing +and manufacturing AC/DC and DC/DC power conversion solutions, and positions us to benefit from the ongoing transformation towards eMobility +with smarter and greener EV charging infrastructure solutions. +Ø Diverse Product and Customer Base and Revenue +Streams . We have a diverse power supply product and customer base. With our growing EV charging solution product line, we will +receive additional revenue streams through a range of different sources such as energy sales, hardware sales, network management services, +advertising sales and energy services. We will also offer customers a variety of business model options, particularly with respect to +our EV charging solution installation and maintenance services. +Ø Minimal Non-Recurring Engineering Expenses . +Our ability to seamlessly modify our base model power system platform to produce bespoke products for our customer needs results in minimal +non-recurring engineering (“NRE”) expenses, meaning we generally avoid charging our OEM customers for those expenses. +Ø Emphasis on Product Design and Development +Efforts . Our design and development efforts are focused at the present time on the optimization of the design and performance +of our power system and EV charging solutions. This enables us to develop cutting-edge products to support highly complex and evolving +markets such as eMobility, cloud computing, military and aerospace. +Ø Commitment to Domestic Production. +The Federal government is the largest consumer of electricity in the U.S. and has committed to purchase 100% zero emission vehicles for +its 600,000-vehicle fleet by 2035. Subject to obtaining sufficient capital, we intend to lease and equip a new manufacturing and assembly +plant to focus on developing our domestic production capabilities to produce Level 2 EV chargers and bid on future Federal EV infrastructure +projects. +GWW +GWW provides defense solutions +with operations conducted by Gresham Power, Microphase, Enertec and Relec. +Gresham Power (formerly known as Digital Power +Limited) +28 +Gresham Power designs, manufactures, +and distributes switching power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters +for the commercial and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships +to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment +such as gyro, compass, and weapons systems. Gresham Power also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers +are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter +start and servicing systems. We believe that Gresham Power products add diversity to our product line, provide greater access to the U.K. +and European markets, and strengthen our engineering and technical resources. +Gresham Power specializes +in engineering, designing and developing power conversion and distribution solutions for Naval applications, with equipment installed +on virtually all the U.K. Royal Navy’s submarine and surface fleet. Many of Gresham Power’s ultra-reliable offerings support +shipboard distribution of electrical power in emergencies (such as loss of main ship’s power) to enable continued operation of weapons +systems, tactical communications and lighting. Gresham Power specializes in a comprehensive range of activities from printed circuit board +and mechanical design through prototype development to board and system assembly and test. Its engineers ruggedize Marine power products +to meet high levels of shock, vibration, harsh climate conditions and the most rigorous MIL-STD requirements. Gresham Power also has deployed +its equipment on vessels of the navies of 15 other countries, including Australia, Malaysia, Oman, Spain, Turkey and Japan. +Microphase +Microphase designs, manufactures +and sells microwave electronics components for radar, electronic warfare and communication systems. Such components include RF and microwave +filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and DLVAs. Microphase’s customers are comprised +of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors and sub-contractors. Microphase’s +recent technology innovations are used in many significant U.S. Government defense programs, including the Polaris submarine, the F-16, +the F-35 and the Predator drone. Other notable programs in which Microphase’s products are or were used include the Atlas Missile, +Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile System, THAAD (or Terminal High Altitude Area Defense), +the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, F-18, JAS Gripen fighter and the Tornado fighter as well as various land-based +improvised explosive devices countermeasures programs and UAV programs including the Predator, the Reaper and the Shadow. +Microphase’s advanced +technology products enable the ultra-sensitive detection and high precision video amplification that are necessary to accurately recover +the signals and facilitate use of the information received. These products include: +● filters that sort and clarify microwave signals, +including multiplexers with a series of filters combined in a single package; +● solid state amplifiers that amplify microwave +signals; +● detectors and limiters that are semiconductor +devices for detection of radar signals and protection of receivers from damage from high power signals and jamming; +● detector log video amplifiers that are fully +integrated, ruggedized, MIL-STD signal detection systems; and +● integrated assemblies that combine multiple functions +from a range of components and devices, including transmitters, receivers, filters, amplifiers, detectors, and other functionality into +single, efficient, high performance, multifunction assemblies. +Manufacturing and Testing +Microphase continually improves +internal processes to ensure the highest quality and consistent manufacturing of all our RF, microwave and millimeter wave electronics +solutions. We test all our products under stress operating conditions per defined test procedures that we have developed in collaboration +with our customers. This approach ensures that our customers can implement our component solutions in broader systems and platforms. Customer +specific testing services are offered with custom designed test standards to simulate operation within customer applications. +Compliance with international +safety agency standards is critical in every mission critical application that Microphase supports, and electronics solutions play a major +role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are +designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +29 +Enertec +Based in Israel, Enertec designs, +develops, manufactures and maintains advanced end-to-end high technology electronic solutions for military, medical, telecommunications +and industrial markets. Those solutions include custom computer-based automated test equipment and turnkey systems to ensure combat readiness, +provide command and control, and direct and deploy resources in military operations in harsh environments and battlefield conditions. +Enertec also designs, develops, manufactures and maintains high precision calibration equipment for lifesaving medical operations for +a global health care products company as well as advance power systems for EV, telecom and other industrial applications. Enertec delivers +complete end-to-end project management with requirements definition, systems engineering, design/development, production, testing, integration, +field support, maintenance and optimization. Its custom engineered solutions enable and support mission critical air, land and sea military +platforms, e.g., missiles, UAVs, combat aircraft, boats, submarines, trailers and satellites. +Enertec’s primary customers +include the three major defense contractors in Israel – Israel Air Industries, Rafael and Elbit Systems. In addition, Enertec has +a strategic partnership with Cyient to build and deliver solutions for the Indian military. High tech capabilities to deliver advance +electronics solutions create opportunities for other GWW operating subsidiaries – Microphase, Relec and Gresham Power – to +possibly supply components for future Enertec high technology electronic solutions. Enertec also provides geographic reach into the Middle +East and India to broaden GWW’s footprint in delivering the highest quality and most advance technology solutions across the globe. +Enertec is one of Israel’s +largest, most well-established manufacturer of test equipment and simulators. Enertec develops and manufactures test systems and simulators +for all types of weapons systems at all levels of maintenance, development, and integration. We are currently working on developing a +new generation of electronics cards and assemblies to build a new generation of test systems. +Enertec complies with all +information security requirements included in its customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Relec +Relec was established in 1978 +with the aim of providing specialist power conversion and display solutions to support professionals in the electronics industry. Relec +markets and distributes power electronics and display solutions for mission critical rail, industrial, medical, telecoms and military +applications. Relec develops custom solutions for various applications ranging from light industrial to heavily ruggedized for the harshest +of environments. Relec exerts its utmost effort to customize a product or a feature to achieve optimum performance and service delivery. +Relec continues to be guided by this philosophy and currently operates in specific fields, specializing in AC-DC power supplies, DC-DC +converters, displays and EMC filters. +Markets +GWW’s operating subsidiaries +design, manufacture, and distribute specialized electronic solutions, automated test solutions, power electronics, supply and distribution +solutions, and radio, microwave and millimeter wave communication systems and components, with a focus on supporting the global defense +industry and mission critical applications in the medical, industrial, transportation and telecommunications markets. The essential nature +of these applications provides a degree of insulation from volatility associated with other segments of the global economy while accounting +for stability and steady growth of the addressable market opportunities available in market segments that GWW serves. Demand for solutions +to meet these requirements continues unaffected, and in many instances increases, in times of global crisis. GWW’s current business +base consists of approximately 500 customers in 45 countries situated all over the world. +Total defense spending in +the three countries in which GWW currently operates will total more than an estimated $856 billion in 2022. GWW sells to the militaries +and defense contractors in 18 other countries as well. Overall global defense spending is expected to grow at a compound annual growth +rate (“CAGR”), of 3% through 2028, with U.S. defense spending continuing to lead the world in the same period, according to +ASD Reports, Global Defense Budget Analysis—Forecast to 2028. The current conflict in the Ukraine has intensified interest +and investment in defense platforms throughout the United Kingdom (U.K.”) and Europe. +We believe that the drive +for increased situational awareness and close coordination of air, land, sea, space and cyber operations will fuel an increase in defense +electronics subsystems and components with total spending in 2022 of $130 billion and a projected CAGR of 5.6% through 2024, according +to Global Defense Electronics Market, Trends, Driver and Outlook for 2020 and Beyond , Renaissance Strategic Advisors, September +2020. The drive for greater connectivity and analytics will in turn increase demand for RF communications, power solutions and electronic +control systems content in new major military platforms, right in the sweet spot of GWW’s operating units. +30 +Tens of thousands of companies +compete in this market to deliver electronics solutions to meet defense and other mission critical applications. However, GWW’s +operating units have longstanding relationships with dominant defense contractors in the U.S. (Lockheed, BAE Systems, L3Harris, Raytheon, +Boeing), in the U.K. (BAE, Rolls Royce, Thales, Babcock) and in Israel (Israeli Air Industries, Rafael, Elbit Systems), which hold contracts +for major defense platforms with very long life cycles. These relationships enable GWW to narrow the field of competition considerably +and thereby to grow based on repeat business with relatively low selling costs. +Beyond the defense arena, +initiatives to complete $63 billion in upgrades to the current National Railway System in the U.K. over the next five years while spending +$130 billion over the next 10 years to build a high speed rail to link London with the Midlands cities of Birmingham, Leeds and Manchester +will generate significant opportunities for growth in demand for power solutions to upgrade and replace current infrastructure, both in +rolling stock and track side controls. Relec’s current relationships and track record for supplying power solutions to the U.K. +rail industry position GWW ideally to capitalize on these ongoing refurbishment and expansion efforts. A similarly robust market in the +medical power supply markets with a CAGR at 6.9%, to reach $1.8 billion in 2025, creates tremendous growth opportunities for our Relec +subsidiary in the U.K. The coronavirus pandemic has put healthcare and the medical device industry front and center in the U.S., Europe +and Asia, fueling intense interest in the power electronics and display solutions that Relec distributes. +We sell products to our OEM +customers through direct sales or through our sales channels, including manufacturers’ representatives for our Gresham Power subsidiary. +Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship +with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new +product requirements. +Commercial Customers . +We serve global commercial markets including transportation, medical, telecom, and industrial companies. Our products are used in a variety +of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme +environmental conditions. Our commercial customers include Elma GmbH, BioSense Webster, a subsidiary of Johnson & Johnson, RS Components, +Premier Farnell, Parker Hannifin, Vanderbilt, Zollner, Spectrum Medical and Comnet Communications. +Military/Defense Customers . +We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh +environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat +environments and meet the requirements of our defense customers. We manufacture our military products through a domestic manufacturer +that complies with US International Traffic in Arms Regulations (“ITAR”) and is certified to perform such manufacturing services. +We are compliant with the ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military +electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive +the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in +these severe military environments, including missiles – ground-to-air, air-to-air and sea-to-air; naval – naval power conversion +and distribution; mobile and ground communications – active protection, communications and navigation; artillery – gyro modular +azimuth position and navigation system; surveillance, test equipment; and unmanned aerial vehicle (“UAV”) – Very lightweight +power systems. +Our military products meet +the relevant U.S. and international Military Standards (“MIL-STDs”) in accordance with the Defense Standardization Program +Policies and Procedures. Space, weight, output power, EMC, power density and multiple output requirements are only part of the challenges +that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our +power supplies are a critical component of many major weapon systems worldwide. +Gresham Power develops and +manufactures some military and defense products mainly being deployed in several naval fleets. +31 +Sales and Marketing +GWW markets electronics products +and solutions directly to customers primarily through the internal sales forces and executives of its operating subsidiaries. +Gresham Power makes limited +use strategic operating partners in the Middle East, India and Australia. These representatives promote Gresham Power products and serve +as the customer interface in specific parts of the world as agreed. Typically, either Gresham Power or the manufacturing representatives +are entitled to terminate the manufacturer representative agreement upon 30 days’ written notice. +Relec advertises in highly +targeted industry-specific publications such as Electronics Weekly, New Electronics, Electronic Product Design & Test, Electronics +Specifier, Components in Electronics, Design Products & Applications, Rail Technology Magazine, Rail Engineer, and Rail Professional. +In addition, Relec also posts regular podcasts on topics of interest to customers and prospects as well as running an active public relations +campaign to get placements of earned media and coverage in a wide range of media. We look to replicate similar campaigns in other operating +subsidiaries to generate inquiries/leads, raise awareness of GWW and support talent recruiting efforts. +We provide comprehensive collateral +materials including product data sheets, participation in trade shows, and our websites, www.greshamwordwide.com , www.relec.co.uk , +www.microphase.com and www.greshampower.com . We use our websites to describe our capabilities and emphasize our offerings +of bespoke technology solutions to draw inquiries from prospective customers. Our future promotional activities will likely include advertising +in industry-specific publications, earned media placements of articles, regular public relations releases and social media postings as +well as direct outreach to prospective customers at trade shows, conferences and small group seminars and/or virtual webinars. +Competition +The markets in which Microphase +operates is highly competitive and sensitive to technological advances. Many of Microphase’s competitors are larger than it is and +maintain higher levels of expenditures for research and development. Principal competitive factors in Microphase’s markets are product +quality and reliability; technological capabilities; service; past performance; ability to develop and implement complex, integrated solutions; +ability to meet delivery schedules; the effectiveness of third-party sales channels in international markets; and cost-effectiveness. +In the RF Communications market, +principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, MD; RS Microwave, +a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith Group, a global technology +company listed on the London Stock Exchange; and Delta Diversified Products, a private company based in Arizona. +In the video amplifier segment, +principal competitors for DLVA sensor products include American Microwave Corporation, a privately held company headquartered in Frederick, +MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, a privately held company based in Frederick, +MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company based in New York, NY; and Signal Technology, +a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Our Enertec subsidiary faces +direct competition from smaller firms than itself such as Nir Or, EPS, MER, Alexander Schneider, Symcotech and Chaban, which specialize +in components of electronic solutions. Offering end-to-end, turnkey solutions gives Enertec a competitive advantage over other private +contractors competing to provide the Israeli Ministry of Defense and major OEMs with electronic systems and components. That competitive +advantage results in a significant portion of Enertec’s business being de facto “sole source” work without other viable +competition. +Gresham Power confronts competition +from Ultra Electronics and Rolls Royce. As in the case of Microphase, elegant designs, strong engineering and a long track record for +delivering ultra-reliable high quality power electronics solutions enables Gresham Power to compete effectively. +Relec competes against many +other distributors of power electronics and display offerings, facing competition from the likes of Fidus Power Ltd, Mouser Electronics +and Avnet Abacus as well as power supply and electronics manufacturers like XP and ABB who sell direct, many of which have significantly +more fiscal and marketing resources than Relec. However, a high touch, customer-focused approach enables Relec to compete effectively +against high volume distributors and direct selling manufacturers. Optimizing and designing solutions into customer product lines has +proven tremendously effective in building relationships with customers and suppliers alike that endure over time, generating regular repeat +business and builds a reputation for customer service that provides a strong competitive advantage when pursuing new customers. +32 +We also face competition from +current and prospective customers who may decide to design and manufacture power electronics, communications components and electronic +solutions needed to satisfy their internal programmatic requirements. +Consolidation in the defense +technology solutions market, including through mergers, acquisitions and/or strategic alliances among major entities to which we sell +our products, has the potential to intensify the competitive pressures that we face. Many of our existing and potential competitors may +be better positioned than we are to acquire other companies, technologies or products. We believe we compete favorably on the basis of +multiple factors, including product quality and reliability, technological capabilities, service, past performance, design flexibility +and ability to develop and implement complex, integrated solutions customized to our customers’ needs, and cost-effectiveness. Focusing +on bespoke technology offerings with relatively low volumes and high margins enables our operating subsidiaries to compete favorably on +price against larger companies with much high indirect cost structures. Finally, the fragmentation of the defense technology market also +creates opportunities for GWW to grow through acquiring competitors and/or potential competitors. +Compliance with Material Government (Including +Environmental) Regulations +ACS +ACS is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. ACS continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While ACS’s regulatory compliance costs +are currently not considered material, it is reasonably possible that costs incurred to ensure continued environmental compliance could +have a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Facility is subject to +a final corrective measures plan with the Environment Protection Agency. The seller performed remedial activities at the Facility relating +to historical soil and groundwater contamination and ACS is responsible for ongoing monitoring and final remediation plans. We estimate +cost of the environmental remediation obligation is approximately $369,000 and reflects our best estimate of probable future costs for +remediation based on the current assessment data and regulatory obligations. Future costs will depend on many factors, including the extent +of work necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. We may incur actual +costs in the future that are materially different than this estimate and such costs could have a material impact on results of operations, +financial condition, and cash flows during the period in which they are recorded. +TOGI +TOGI’s businesses are +heavily regulated in most of its markets. TOGI handles power electronics products mainly in the form of power conversion. TOGI must take +into account several standards for electronic safety to protect the health of humans and animals. TOGI serves diverse markets including +automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set of their safety regulations +and standard that TOGI must comply with. +Government Contracts . +The U.S. Government, and other governments, may terminate any of TOGI’s government contracts at their convenience, as well as for +default based on our failure to meet specified performance requirements. If any of TOGI’s U.S. Government contracts were to be terminated +for convenience, TOGI would generally be entitled to receive payment for work completed and allowable termination or cancellation costs. +If any of TOGI’s government contracts were to be terminated for default, generally the U.S. Government would pay only for the work +that has been accepted and could require TOGI to pay the difference between the original contract price and the cost to re-procure the +contract items, net of the work accepted from the original contract. The U.S. Government can also hold TOGI liable for damages resulting +from the default. +Medical device power supplies . +TOGI’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. A MOP +can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. These +can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through safety +insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination of +these techniques. TOGI must comply with a standard that treats operators and patients, resulting in the classifications “means of +operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +33 +Environmental . TOGI +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TOGI continually assesses its compliance status and management +of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. Investigation, +remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a normal, recurring +part of TOGI’s operations. +Non-U.S. Sales . TOGI’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +GWW +GWW’s businesses are +heavily regulated in most of its markets. GWW transacts with numerous U.S. Government agencies and entities, including but not limited +to the U.S. Department of Defense (“DoD”), branches of the U.S. military and the Department of Homeland Security. Similar +government authorities exercise similar regulatory oversight in GWW’s non-U.S. markets. +Government Contracts . +The governments of the U.S., U.K. and Israel may terminate any of GWW’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of GWW’s contracts for convenience, GWW generally would be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of GWW’s government contracts were to be terminated for default, generally the U.S. government would +pay only for the work that has been accepted and could require GWW to pay the difference between the original contract price and the cost +to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold GWW liable for +damages resulting from the default. Similar provisions apply to GWW’s contracts with other governments and to GWW’s subcontractors +with major defense contractors who provide systems or military platforms directly to the government. +Power Electronics . +In all of GWW’s markets in the U.S., GWW’s commercial power electronics offerings must comply with safety, energy use and +operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. In +the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the U.K., Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, GWW’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . GWW +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies, or as applicable +local regulations or laws require. The products that GWW markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of +certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, GWW’s industry began phasing in RoHS +and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. GWW believes that RoHS and WEEE-compliant +components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. REACH (Registration, +Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 December 2006. REACH +addresses the production and use of chemical substances, and their potential impacts on both human health and the environment. +These regulatory mandates +apply to all of GWW’s operating subsidiaries. GWW has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +34 +Non-U.S. Sales . GWW’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Security Clearance +As a U.S. Government contractor +working on classified projects, Microphase is required to maintain facility and personnel security clearances complying with the DoD and +other federal agency requirements. Microphase maintains strict protocols for handling classified information and Confidential Unclassified +Information (“CUI”) associated with its work for the DoD and has built a secure restricted area within its Shelton production +facility certified for generating, storing and reviewing classified information. +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the U.K. Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “DCAA”), +the Defense Contract Management Agency (the “DCMA”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the DOJ and Congressional Committees. From time-to-time, these and other agencies investigate or +conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. The +DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the Ministry of Defense does most of +its business. All its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +the U.K. Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the +customer the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government +and typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified information and CUI from disclosure and unauthorized access. That mandate includes a requirement that +Microphase formulate and implement a system security plan with 110 different elements and protocols for handling and protecting classified +information and CUI. Over the next three years, the DoD will require all participants in the defense supply chain to demonstrate compliance +with the Capability Model Maturity Cybersecurity as verified through an independent third-party auditor. Compliance with these mandates +requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance requires extensive +security controls on access to Microphase information technology systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Plus Compliant.” Cyber Essentials Plus is a government-backed, industry-supported +scheme to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials Plus program criteria. +35 +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December 31, 2021 and 2020, we spent approximately +$2.0 million and $1.8 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries and others operate in industries deemed essential by the DoD and therefore remained +at work during the COVID-19 pandemic. +Employee Profile +As of December 31, 2021, we +had 323 employees located in the U.S., the U.K. and Israel, of whom 44 were engaged in engineering and product development, 35 in sales +and marketing, 175 in general operations and 69 in general administration and finance. All but 10 of these employees are employed on a +full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be good. +As of December 31, 2021, approximately +45% of our current workforce is female, 55% male, and our average tenure is 6.2 years, a decrease of 38% from an average tenure of 10 +years as of December 31, 2020. The decrease is primarily due to the addition of 102 employees related to our hotel operations acquired +in December 2021. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of 6.2 years as +of the end of the fiscal year 2021 reflects the engagement of our employees in this core talent system tenet. +The Company believes it materially +complies with all applicable state, local and international laws governing nondiscrimination in employment in every location in which +the Company operates. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, +religion, national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran +status. +36 +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees' needs. We plan to conduct annual confidential employee surveys +as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. Our +employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new stretch +goals. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021 and plan to establish a Company-wide augmented employee stock purchase plan in 2022. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +In response to the COVID-19 pandemic, we implemented significant operating environment changes that we determined were in the best interest +of our employees, as well as the communities in which we operate, and which comply with government regulations. This includes having a +significant portion of our employees work from home, while implementing additional safety measures for employees continuing critical on-site +work. +37 +ITEM 1A. RISK FACTORS +An investment in our common +stock involves significant risks. You should carefully consider the following risks and all other information set forth in this Annual +Report before deciding to invest in our common stock. If any of the events or developments described below occurs, our business, financial +condition and results of operations may suffer. In that case, the value of our common stock may decline and you could lose all or part +of your investment. +You should consider each of +the following risk factors and any other information set forth in this Annual Report and the other reports filed by the Company with the +SEC, including the Company’s financial statements and related notes, in evaluating the Company’s business and prospects. The +risks and uncertainties described below are not the only ones that impact on the Company’s operations and business. Additional risks +and uncertainties not presently known to the Company, or that the Company currently considers immaterial, may also impair its business +or operations. If any of the following risks actually occurs, the Company’s business and financial condition, results or prospects +could be harmed. Please also read carefully the section entitled “Note About Forward-Looking Statements” at the beginning +of this Annual Report. +Risks Related to Our Company +We will need to raise +additional capital to fund our operations in furtherance of our business plan. +Until +we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business plan. +The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred +stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development partners or some combination +of each. Any additional equity financings may be financially dilutive to, and will be dilutive from an ownership perspective to, our stockholders, +and such dilution may be significant based upon the size of such financing. Additionally, we cannot assure that such funding will be available +on a timely basis, in needed quantities, or on terms favorable to us, if at all. +We have an evolving business model, which increases the complexity +of our business. +Our business model has evolved +in the past and continues to do so. In prior years we have added additional types of services and product offerings and in some cases, +we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products or services, and +we do not know whether any of them will be successful. From time to time we have also modified aspects of our business model relating +to our product mix. We do not know whether these or any other modifications will be successful. The additions and modifications to our +business have increased the complexity of our business and placed significant strain on our management, personnel, operations, systems, +technical performance, financial resources, and internal financial control and reporting functions. Future additions to or modifications +of our business are likely to have similar effects. Further, any new business or website we launch that is not favorably received by the +market could damage our reputation or our brand. The occurrence of any of the foregoing could have a material adverse effect on our business. +We received a subpoena from the Commission +in the investigation now known as “ In the Matter of DPW Holdings, Inc . ,” the consequences of which are +unknown. +We received a subpoena in +November of 2019 from the Commission that stated that the staff of the Commission is conducting an investigation now known as “ In +the Matter of DPW Holdings, Inc. ” We understand that the subpoena was issued as part of an investigation as to whether we +and certain of our officers, directors, employees, partners, subsidiaries and/or affiliates, and/or other persons or entities, directly +or indirectly, violated certain provisions of the Securities Act and the Exchange Act, in connection with the offer and sale of our securities. +Certain affiliates and related parties of ours have also been subpoenaed. Although the order states that the Commission may have information +relating to such alleged violations, the subpoena expressly provides that the inquiry is not to be construed as an indication by the Commission +or its staff that any violations of the federal securities laws have occurred. We have produced documents in response to the subpoena. +Since the original subpoena was issued, we have received further subpoenas seeking additional documents and testimony from certain members +of our management team. +38 +We do not know when the Commission’s +investigation will be concluded nor what action, if any, might be taken in the future by the Commission or its staff as a result of the +matters that are the subject to its investigation or what impact, if any, the cost of continuing to respond to subpoenas might have on +our financial position or results of operations. We have not established any provision for losses in respect of this matter. In addition, +complying with any such future requests by the Commission for documents or testimony would distract the time and attention of our officers +and directors or divert our resources away from ongoing business matters. This investigation has resulted in, and may continue to result, +in significant legal expenses, the diversion of management’s attention from our business, could cause damage to our business and +reputation, and could subject us to a wide range of remedies, including enforcement actions by the Commission. There can be no assurance +that any final resolution of this and any similar matters will not have a material adverse effect on our financial condition or results +of operations. +We are heavily dependent on our senior management, and a loss +of a member of our senior management team could cause our stock price to suffer . +If we lose the services of +Milton C. Ault, III, our Executive Chairman, William B. Horne, our Chief Executive Officer, Henry Nisser, our President and General Counsel, +or Ken Cragun, our Chief Financial Officer and/or certain key employees, we may not be able to find appropriate replacements on a timely +basis, and our business could be adversely affected. Our existing operations and continued future development depend to a significant +extent upon the performance and active participation of these individuals and certain key employees. Although we have entered into employment +agreements with Messrs. Ault, Horne and Nisser, and we may enter into employment agreements with additional key employees in the future, +we cannot guarantee that we will be successful in retaining the services of these individuals. If we were to lose any of these individuals, +we may not be able to find appropriate replacements on a timely basis and our financial condition and results of operations could be materially +adversely affected. +We rely on highly skilled personnel and the +continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our business may be +severely disrupted. +Our performance largely depends +on the talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise held by our Executive +Chairman, Milton C. Ault, III. His absence, were it to occur, would materially and adversely impact development and implementation of +our projects and businesses. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly +skilled personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract, among +others, new technology developers and to retain and motivate our existing contractors. If one or more of our executive officers are unable +or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may +be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives +joins a competitor or forms a competing company, we may lose some customers. +We may be classified as an inadvertent investment company. +We are not engaged in the +business of investing, reinvesting, or trading in securities, and we do not hold ourselves out as being engaged in those activities. Under +the Investment Company Act, however, a company may be deemed an investment company under section 3(a)(1)(C) of the Investment Company +Act if the value of its investment securities is more than 40% of its total assets (exclusive of government securities and cash items) +on a consolidated basis. +Our lending subsidiary, DP +Lending, operates under California Finance Lending License #60DBO-77905. Per the Investment Company Act of 1940 companies with substantially +all their business confined to making small loans, industrial banking or similar business, such as DP Lending, are excluded from the definition +of an investment company. +We have commenced digital +asset mining, the output of which is Bitcoin, which the Commission has not indicated it deems a security. In the event that the digital +assets that are securities held by us exceed 40% of our total assets, exclusive of cash, we inadvertently become an investment company. +An inadvertent investment company can avoid being classified as an investment company if it can rely on one of the exclusions under the +Investment Company Act. One such exclusion, Rule 3a-2 under the Investment Company Act, allows an inadvertent investment company a grace +period of one year from the earlier of (a) the date on which an issuer owns securities and/or cash having a value exceeding 50% of the +issuer’s total assets on either a consolidated or unconsolidated basis and (b) the date on which an issuer owns or proposes to acquire +investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive of government securities +and cash items) on an unconsolidated basis. We are putting in place policies that we expect will work to keep the investment securities +held by us at less than 40% of our total assets, which may include acquiring assets with our cash, liquidating our investment securities +or seeking a no-action letter from the Commission if we are unable to acquire sufficient assets or liquidate sufficient investment securities +in a timely manner. +39 +As Rule 3a-2 is available +to a company no more than once every three years, and assuming no other exclusion were available to us, we would have to keep within the +40% limit for at least three years after we cease being an inadvertent investment company. This may limit our ability to make certain +investments or enter into joint ventures that could otherwise have a positive impact on our earnings. In any event, we do not intend to +become an investment company engaged in the business of investing and trading securities. +Classification as an investment +company under the Investment Company Act requires registration with the Commission. If an investment company fails to register, it would +have to stop doing almost all business, and its contracts would become voidable. Registration is time consuming and restrictive and would +require a restructuring of our operations, and we would be very constrained in the kind of business we could do as a registered investment +company. Further, we would become subject to substantial regulation concerning management, operations, transactions with affiliated persons +and portfolio composition, and would need to file reports under the Investment Company Act regime. The cost of such compliance would result +in our incurring substantial additional expenses, and the failure to register if required would have a materially adverse impact to conduct +our operations. +We will not be able to successfully execute +our business strategy if we are deemed to be an investment company under the Investment Company Act. +U.S. companies that have more +than 100 stockholders or are publicly traded in the U.S. and are, or hold themselves out as being, engaged primarily in the business of +investing, reinvesting or trading in securities are subject to regulation under the Investment Company Act. Unless a substantial part +of our assets consists of, and a substantial part of our income is derived from, interests in majority-owned subsidiaries and companies +that we primarily control, we may be required to register and become subject to regulation under the Investment Company Act. If Bitcoin +and other virtual currencies were to be deemed securities for purposes of the Investment Company Act, or if we were deemed to own but +not operate one or more of our other subsidiaries, we would have difficulty avoiding classification and regulation as an investment company. +If we were deemed to be, and +were required to register as, an investment company, we would be forced to comply with substantive requirements under the Investment Company +Act, including limitations on our ability to borrow, limitations on our capital structure; restrictions on acquisitions of interests in +associated companies, prohibitions on transactions with affiliates, restrictions on specific investments, and compliance with reporting, +record keeping, voting, proxy disclosure and other rules and regulations. If we were forced to comply with the rules and regulations of +the Investment Company Act, our operations would significantly change, and we would be prevented from successfully executing our business +strategy. To avoid regulation under the Investment Company Act and related rules promulgated by the Commission, we could need to sell +Bitcoin and other assets which we would otherwise want to retain and could be unable to sell assets which we would otherwise want to sell. +In addition, we could be forced to acquire additional, or retain existing, income-generating or loss-generating assets which we would +not otherwise have acquired or retained and could need to forgo opportunities to acquire Bitcoin and other assets that would benefit our +business. If we were forced to sell, buy or retain assets in this manner, we could be prevented from successfully executing our business +strategy. +Securitization of our assets subjects us to various risks . +We may securitize assets to +generate cash for funding new investments. We refer to the term securitize to describe a form of leverage under which a company (sometimes +referred to as an “originator” or “sponsor”) transfers income producing assets to a single-purpose, bankruptcy-remote +subsidiary (also referred to as a “special purpose entity” or “SPE”), which is established solely for the purpose +of holding such assets and entering into a structured finance transaction. The SPE would then issue notes secured by such assets. The +special purpose entity may issue the notes in the capital markets either publicly or privately to a variety of investors, including banks, +non-bank financial institutions and other investors. There may be a single class of notes or multiple classes of notes, the most senior +of which carries less credit risk and the most junior of which may carry substantially the same credit risk as the equity of the SPE. +An important aspect of most +debt securitization transactions is that the sale and/or contribution of assets into the SPE be considered a true sale and/or contribution +for accounting purposes and that a reviewing court would not consolidate the SPE with the operations of the originator in the event of +the originator's bankruptcy based on equitable principles. Viewed as a whole, a debt securitization seeks to lower risk to the note purchasers +by isolating the assets collateralizing the securitization in an SPE that is not subject to the credit and bankruptcy risks of the originator. +As a result of this perceived reduction of risk, debt securitization transactions frequently achieve lower overall leverage costs for +originators as compared to traditional secured lending transactions. +40 +In accordance with the above +description, to securitize loans, we may create a wholly owned subsidiary and contribute a pool of our assets to such subsidiary. The +SPE may be funded with, among other things, whole loans or interests from other pools and such loans may or may not be rated. The SPE +would then sell its notes to purchasers whom we would expect to be willing to accept a lower interest rate and the absence of any recourse +against us to invest in a pool of income producing assets to which none of our creditors would have access. We would retain all or a portion +of the equity in the SPE. An inability to successfully securitize portions of our portfolio or otherwise leverage our portfolio through +secured and unsecured borrowings could limit our ability to grow our business and fully execute our business strategy, and could decrease +our earnings, if any. However, the successful securitization of portions of our portfolio exposes us to a risk of loss for the equity +we retain in the SPE and might expose us to greater risk on our remaining portfolio because the assets we retain may tend to be those +that are riskier and more likely to generate losses. A successful securitization may also impose financial and operating covenants that +restrict our business activities and may include limitations that could hinder our ability to finance additional loans and investments. +The Investment Company Act may also impose restrictions on the structure of any securitizations. +Interests we hold in the SPE, +if any, will be subordinated to the other interests issued by the SPE. As such, we will only receive cash distributions on such interests +if the SPE has made all cash interest and other required payments on all other interests it has issued. In addition, our subordinated +interests will likely be unsecured and rank behind all of the secured creditors, known or unknown, of the SPE, including the holders of +the senior interests it has issued. Consequently, to the extent that the value of the SPE's portfolio of assets has been reduced as a +result of conditions in the credit markets, or as a result of defaults, the value of the subordinated interests we retain would be reduced. +Securitization imposes on us the same risks as borrowing except that our risk in a securitization is limited to the amount of subordinated +interests we retain, whereas in a borrowing or debt issuance by us directly we would be at risk for the entire amount of the borrowing +or debt issuance. +We may also engage in transactions +utilizing SPEs and securitization techniques where the assets sold or contributed to the SPE remain on our balance sheet for accounting +purposes. If, for example, we sell the assets to the SPE with recourse or provide a guarantee or other credit support to the SPE, its +assets will remain on our balance sheet. Consolidation would also generally result if we, in consultation with our auditors, determine +that consolidation would result in a more accurate reflection of our assets, liabilities and results of operations. In these structures, +the risks will be essentially the same as in other securitization transactions but the assets will remain our assets for purposes of the +limitations described above on investing in assets that are not qualifying assets and the leverage incurred by the SPE will be treated +as borrowings incurred by us for purposes of our limitation on the issuance of senior securities. +We may not be able to utilize our net operating loss carry forwards. +At December 31, 2021, we had +federal and state net operating loss carry forwards (“NOLs”) for income tax purposes of approximately $25.3 million and $19.2 +million after application of limitation set forth in Section 382 of the Internal Revenue Code (“§382”). In accordance +with §382, future utilization of our NOLs is subject to an annual limitation as a result of ownership changes that occurred previously. +We also maintain NOLs in various foreign jurisdictions. +Our corporate structure and intercompany arrangements +are subject to the tax laws of various jurisdictions, and we could face greater than anticipated tax liabilities, which would harm our +results of operations. +We are subject to tax laws +in the U.S. and certain foreign jurisdictions, including Israel and the U.K. Our income tax obligations +are based in part on our corporate structure and intercompany arrangements. The tax laws applicable to our business are increasingly complex, +are subject to interpretation and their application can be uncertain. The amount of taxes we pay in the jurisdictions in which we operate +could increase substantially as a result of changes in the applicable tax principles, including increased tax rates, new tax laws or revised +interpretations of existing tax laws and precedents. +We are subject to the examination +of our income tax returns by the Internal Revenue Service and foreign tax authorities in the jurisdictions in which we operate, and we +may be subject to assessments or audits in the future in any such jurisdictions. The tax authorities in these jurisdictions may aggressively +interpret their laws in an effort to raise additional tax revenue and may claim that various withholding requirements apply to us or our +subsidiaries, challenge the availability to us or our subsidiaries of certain benefits under tax treaties, and challenge our methodologies +for valuing developed technology or intercompany arrangements or our revenue recognition policies, which could result in an increase of +our worldwide effective tax rate and have a material adverse effect on our financial condition and operating results. +Risks Related to Our Bitcoin Operations +Risks Related to Our Bitcoin Operations – General +Acceptance and/or widespread use of Bitcoin +is uncertain. +41 +Currently, there is a limited +use of any Bitcoin in the retail and commercial marketplace, thus contributing to price volatility that could adversely affect an investment +in our securities. Banks and other established financial institutions may refuse to process funds for Bitcoin transactions or process +wire transfers to or from Bitcoin exchanges, Bitcoin-related companies or service providers, which we have experienced, or maintain accounts +for persons or entities transacting in Bitcoin. Conversely, a significant portion of Bitcoin demand is generated by investors seeking +a long-term store of value or speculators seeking to profit from the short- or long-term holding of the asset. Price volatility undermines +any Bitcoin’s role as a medium of exchange, as retailers are much less likely to accept it as a form of payment. Market capitalization +for a Bitcoin as a medium of exchange and payment method may always be low. +The relative lack of acceptance +of Bitcoins in the retail and commercial marketplace, or a reduction of such use, limits the ability of end users to use them to pay for +goods and services. Such lack of acceptance or decline in acceptances could have a material adverse effect on our ability to continue +as a going concern or to pursue our business strategy at all, which could have a material adverse effect on our business, prospects or +operations and potentially the value of Bitcoins we mine or otherwise acquire or hold for our own account. +The development and acceptance of cryptographic +and algorithmic protocols governing the issuance of and transactions in cryptocurrencies is subject to a variety of special economic, +geopolitical and regulatory factors, which could slow the growth of the industry in general and our company as a result. +The use of cryptocurrencies, +including Bitcoin, to, among other things, buy and sell goods and services and complete transactions, is part of a new and rapidly evolving +industry that employs cryptocurrency assets based upon a computer-generated mathematical and/or cryptographic protocol. Large-scale acceptance +of cryptocurrencies as a means of payment has not, and may never, occur. The growth of this industry in general, and the use of Bitcoin +in particular, is subject to a high degree of uncertainty, and the slowing or stopping of the development or acceptance of developing +protocols may occur unpredictably. The factors include, but are not limited to: +● the progress of worldwide growth in the adoption and use of Bitcoin and other cryptocurrencies as a medium +of exchange; +● the experience of businesses in using Bitcoin; +● the impact from prominent business leaders in criticizing Bitcoin’s potential harm to the environment +and the effect of announcements critical of Bitcoin, such as those that occurred with Elon Musk of Tesla; +● governmental and organizational regulation of Bitcoin and other cryptocurrencies and their use, or restrictions +on or regulation of access to and operation of the network or similar cryptocurrency systems (such as the recent ban in China); +● changes in consumer demographics and public tastes and preferences, including as may result from coverage +of Bitcoin or other cryptocurrencies by journalists and other sources of information and media; +● the maintenance and development of the open-source software protocol of the network; +● the increased consolidation of contributors to the Bitcoin blockchain through mining pools and scaling +of mining equipment by well-capitalized market participants; +● the availability and popularity of other forms or methods of buying and selling goods and services, including +new means of using fiat currencies; +● the use of the networks supporting Bitcoin or other cryptocurrencies for developing smart contracts and +distributed applications; +● general economic conditions and the regulatory environment relating to Bitcoin and other cryptocurrencies; +● the impact of regulators focusing on cryptocurrencies and the costs, financial and otherwise, associated +with such regulatory oversight; and +● a decline in the popularity or acceptance of Bitcoin could adversely affect an investment in us. +42 +The outcome of these factors +could have negative effects on our ability to continue as a going concern or to pursue our business strategy, which could have a material +adverse effect on our business, prospects or operations as well as potentially negative effects on the value of any Bitcoin or other cryptocurrencies +we mine or otherwise acquire, which would harm investors in our securities. If Bitcoin or other cryptocurrencies we mine do not gain widespread +market acceptance or accrete in value over time, our prospects and your investment in us would diminish. +We rely on a sole supplier for our Bitcoin +mining machines, and may not be able to find replacements or immediately transition to alternative suppliers. If we were to lose Bitmain +as a supplier, or if Bitmain were unable or unwilling to fulfill our orders, any delay or interruption in planned delivery could seriously +interrupt our business. +We rely on Bitmain as the +sole supplier for our Bitcoin miners. According to Bitmain, it supplies approximately 80% of the global market for ASIC miners, which +are used to mine Bitcoin. Currently, we have contracts with Bitmain for the delivery of 20,600 miners, of which approximately 4,754 have +been delivered to date, with the remaining miners scheduled to be delivered monthly through December 2022. The market price and availability +of new mining machines fluctuates with the price of Bitcoin and can be volatile. Higher Bitcoin prices increase the demand for mining +equipment and increases the cost. In addition, as more companies seek to enter the mining industry, the demand for machines may outpace +supply and create mining machine equipment shortages. Any future purchase orders with Bitmain for additional miners are subject to availability +and price considerations. If we were to lose Bitmain as a supplier, or if Bitmain were unable or unwilling to fulfill our orders or make +miners available to use in the future on terms acceptable to us, there can be no assurance that we will be able to identify or enter into +agreements with alternative suppliers on a timely basis or on acceptable terms, if at all. Any delay or interruption in the planned delivery +of our contracted miners could significantly affect our business, financial condition and results of operations. +Political or economic crises may motivate large-scale sales +of cryptocurrencies, which could result in a reduction in values of cryptocurrencies such as Bitcoin and adversely affect an investment +in us. +Geopolitical crises, in particular +major ones such as Russia’s invasion of Ukraine, may motivate large-scale purchases of Bitcoin and other cryptocurrencies, which +could increase the price of Bitcoin and other cryptocurrencies rapidly. This may increase the likelihood of a subsequent price decrease +as crisis-driven purchasing behavior dissipates, adversely affecting the value of our Bitcoin following such downward adjustment. Such +risks are similar to the risks of purchasing commodities in general uncertain times, such as the risk of purchasing, holding or selling +gold. Alternatively, as an emerging asset class with limited acceptance as a payment system or commodity, global crises and general economic +downturn may discourage investment in cryptocurrencies as investors focus their investment on less volatile asset classes as a means of +hedging their investment risk. +As an alternative to fiat +currencies that are backed by central governments, cryptocurrencies, which are relatively new, are subject to supply and demand forces. +How such supply and demand will be impacted by geopolitical events is largely uncertain but could be harmful to us and investors in our +common stock. Political or economic crises may motivate large-scale acquisitions or sales of cryptocurrencies either globally or locally. +Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which +could have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin or any other cryptocurrencies +we mine or otherwise acquire or hold for our own account. +Negative media attention and public perception +surrounding energy consumption by cryptocurrency mining may adversely affect our reputation and, consequently, our stock price; particularly +in the eyes of some of our investors who may be more interested in our non-crypto operations as a holding company. +Cryptocurrency mining has +experienced negative media attention surrounding its perceived high electricity use and environmental impact, which has adversely influenced +public perception of the industry as a whole. We believe these factors are overstated for the cryptocurrency mining industry because of +the informational disparity between cryptocurrency mining and other energy intensive industries. Cryptocurrency miners (particularly Bitcoin +miners) have freely and publicly disclosed their energy consumption statistics because electricity usage, and the associated utility fees, +is a cost of production. As increasing numbers of publicly traded cryptocurrency miners enter the market, more data, reliably disclosed +in compliance with GAAP, has become available; however, such data has not been made as readily available for competitive payment systems +and fiat currencies. +Nevertheless, this negative +media attention and public perception may materially and adversely affect our reputation and, consequently, our stock price, particularly +in the eyes of our investors who are more interested in our non-crypto operations as a holding company. As a single company within the +broader cryptocurrency industry, we are likely incapable of effectively countering this negative media attention and affecting public +perception. Therefore, we may not be able to adequately respond to these external pressures, which may cause a significant decline in +the price of our common stock. +43 +Banks and financial institutions may not provide +banking services, or may cut off services, to businesses like us that engage in cryptocurrency-related activities. +A number of companies that +engage in Bitcoin and/or other cryptocurrency-related activities have been unable to find banks or financial institutions that are +willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated +with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial +institutions in response to government action. The difficulty that many businesses that provide Bitcoin and/or derivatives on other cryptocurrency-related activities +have and may continue to have in finding banks and financial institutions willing to provide them services may be decreasing the usefulness +of cryptocurrencies as a payment system and harming public perception of cryptocurrencies, and could decrease their usefulness and harm +their public perception in the future. +The usefulness of cryptocurrencies +as a payment system and the public perception of cryptocurrencies could be damaged if banks or financial institutions were to close the +accounts of businesses engaging in Bitcoin and/or other cryptocurrency-related activities. This could occur as a result of compliance +risk, cost, government regulation or public pressure. The risk applies to securities firms, clearance and settlement firms, national securities +exchanges and derivatives on commodities exchanges, the over-the-counter market, and the Depository Trust Company (“DTC”), +which, if any of such entities adopts or implements similar policies, rules or regulations, could negatively affect our relationships +with financial institutions and impede our ability to convert cryptocurrencies to fiat currencies. Such factors could have a material +adverse effect on our ability to continue as a going concern or to monetize our mining efforts, which could have a material adverse effect +on our business, prospects or operations and harm investors. +The price of cryptocurrencies may be affected +by the sale of such cryptocurrencies by other vehicles investing in cryptocurrencies or tracking cryptocurrency markets. Such events could +have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin we mine. +The global market for cryptocurrency +is characterized by supply constraints that differ from those present in the markets for commodities or other assets such as gold and +silver. The mathematical protocols under which certain cryptocurrencies are mined permit the creation of a limited, predetermined amount +of digital currency, while others have no limit established on total supply. Increased numbers of miners and deployed mining power globally +will likely continue to increase the available supply of Bitcoin and other cryptocurrencies, which may depress their market price. Further, +large “block sales” involving significant numbers of Bitcoin following appreciation in the market price of Bitcoin may also +increase the supply of Bitcoin available on the market, which, without a corresponding increase in demand, may cause its price to fall. +Additionally, to the extent that other vehicles investing in cryptocurrencies or tracking cryptocurrency markets form and come to represent +a significant proportion of the demand for cryptocurrencies, large redemptions of the securities of those vehicles and the subsequent +sale of cryptocurrencies by such vehicles could negatively affect cryptocurrency prices and therefore affect the value of the cryptocurrency +inventory we hold. Such events could have a material adverse effect on our business, prospects or operations and potentially the value +of any Bitcoin or other cryptocurrencies we mine. +Tariffs have increased costs of digital asset +mining equipment, and new or additional tariffs or other restrictions on the import of equipment necessary for digital asset mining could +have a material adverse effect on our business, financial condition and results of operations. +Equipment necessary for digital +asset mining is almost entirely manufactured outside of the U.S. There is currently significant uncertainty about the future relationship +between the U.S. and various other countries, including Russia, China, the European Union, Canada, and Mexico, with respect to trade policies, +treaties, tariffs and customs duties, and taxes. For example, since 2019, the U.S. Government has implemented significant changes to U.S. +trade policy with respect to China. These tariffs have subjected certain digital asset mining equipment manufactured overseas to additional +import duties of up to 25%. The amount of the additional tariffs and the number of products subject to them has changed numerous times +based on action by the U.S. Government. These tariffs have increased costs of digital asset mining equipment, and new or additional tariffs +or other restrictions on the import of equipment necessary for digital asset mining could have a material adverse effect on our business, +financial condition and results of operations. +Because there has been limited precedent set +for financial accounting for Bitcoin and other digital assets, the determinations that we have made for how to account for digital assets +transactions may be subject to change. +Because there has been limited +precedent set for the financial accounting for Bitcoin and other digital assets and related revenue recognition and no official guidance +has yet been provided by the Financial Accounting Standards Board or the SEC, it is unclear how companies may in the future be required +to account for digital asset transactions and assets and related revenue recognition. A change in regulatory or financial accounting standards +could result in the necessity to change the accounting methods we currently intend to employ in respect of our anticipated revenues and +assets and restate any financial statements produced based on those methods. Such a restatement could adversely affect our business, prospects, +financial condition and results of operation. +44 +Risks Related to Our Bitcoin Operations – Operational and +Financial +Our results of operations are expected to be +impacted by fluctuations in the price of Bitcoin because a significant portion of our revenue is expected to come from Bitcoin mining +production. +The price of Bitcoin has experienced +significant fluctuations over its relatively short existence and may continue to fluctuate significantly in the future. Bitcoin prices +ranged from approximately $7,220 per coin as of December 31, 2019 and $28,922 per coin as of December 31, 2020 to $46,306 per coin as +of December 31, 2021, with a high of $68,790 per coin and a low of $28,804 per coin during 2021, according to Coin Market Cap. +We expect our results of operations +to continue to be affected by the Bitcoin price as a significant portion of our revenue is expected to come from Bitcoin mining production. +Any future significant reductions in the price of Bitcoin will likely have a material and adverse effect on our results of operations +and financial condition. We cannot assure you that the Bitcoin price will remain high enough to sustain our operations or that the price +of Bitcoin will not decline significantly in the future. Further, fluctuations in the Bitcoin price can have an immediate impact on the +trading price of our shares even before our financial performance is affected, if at all. +Various factors, mostly beyond +our control, could impact the Bitcoin price. For example, the usage of Bitcoins in the retail and commercial marketplace is relatively +low in comparison with the usage for speculation, which contributes to Bitcoin’s price volatility. Additionally, the reward for +Bitcoin mining will decline over time, with the most recent halving event having occurred in May 2020 and the next one expected to occur +in 2024, which may further contribute to Bitcoin price volatility. +Because of our focus on Bitcoin mining, the +trading price of shares of our common stock may increase or decrease with the trading price of Bitcoin, which subjects investors to pricing +risks, including “bubble” type risks, and volatility. +The trading prices of our +common stock may at times be tied to the trading prices of Bitcoin. Specifically, we may experience adverse effects on our stock price +when the value of Bitcoin drops. Furthermore, if the market for Bitcoin mine operators’ shares or the stock market in general experiences +a loss of investor confidence, the trading price of our stock could decline for reasons unrelated to our business, operating results or +financial condition. The trading price of our common stock could be subject to arbitrary pricing factors that are not necessarily associated +with traditional factors that influence stock prices or the value of non-cryptocurrency assets such as revenue, cash flows, profitability, +growth prospects or business activity since the value and price, as determined by the investing public, may be influenced by uncertain +contingencies such as future anticipated adoption or appreciation in value of cryptocurrencies or blockchains generally, and other factors +over which we have little or no influence or control. +Bitcoin and other cryptocurrency +market prices, which have historically been volatile and are impacted by a variety of factors, are determined primarily using data from +various exchanges, over-the-counter markets and derivative platforms. Furthermore, such prices may be subject to factors such as +those that impact commodities, more so than business activities, which could be affected by additional influence from fraudulent or illegitimate +actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue +to result in, speculation regarding future appreciation in the value of cryptocurrencies, or our share price, making their market prices +more volatile or creating “bubble” type risks for the trading price of Bitcoin. +The price of Bitcoin has experienced +significant fluctuations over its relatively short existence and may continue to fluctuate significantly in the future. Bitcoin prices +ranged from approximately $7,220 per coin as of December 31, 2019 and $28,922 per coin as of December 31, 2020 to $46,306 per coin as +of December 31, 2021, with a high of $68,790 per coin and a low of $28,804 per coin during 2021, according to Coin Market Cap. There can +be no assurance that similar fluctuations in the trading price of Bitcoin will not occur in the future. Accordingly, since our revenue +will depend in part on the price of Bitcoin, and the trading price of our securities may therefore at times be connected to the trading +price of Bitcoin, if the trading price of Bitcoin again experiences a significant decline, we could experience a similar decline in revenue +and/or in the trading price for shares of our common stock. If this occurs, you may lose some or all of your investment. +45 +Our future success will depend in large part +upon the value of Bitcoin. The value of Bitcoin may be subject to pricing risk and has historically been subject to wide swings. +Our operating results from +this sector will depend in large part upon the value of Bitcoin because it is the sole digital asset we currently mine. Specifically, +our revenues from our Bitcoin mining operations are principally based upon two factors: the number of Bitcoin rewards we successfully +mine and the value of Bitcoin. We also receive transaction fees paid in Bitcoin by participants who initiated transactions associated +with new blocks that we mine. In addition, our operating results are directly impacted by changes in the value of Bitcoin, because under +the value measurement model, both realized and unrealized changes will be reflected in our statement of operations (i.e., we will be marking +Bitcoin to fair value each quarter). This means that our operating results will be subject to swings based upon increases or decreases +in the value of Bitcoin. Our strategy currently focuses primarily on Bitcoin (as opposed to other digital assets). Further, our miners +are principally utilized for mining Bitcoin and cannot mine other digital assets, such as ETH, that are not mined utilizing the “SHA-256 +algorithm.” If other digital assets were to achieve acceptance at the expense of Bitcoin, causing the value of Bitcoin to decline, +or if Bitcoin were to switch its proof of work algorithm from SHA-256 to another algorithm for which our miners are not specialized, or +the value of Bitcoin were to decline for other reasons, particularly if such decline were significant or over an extended period of time, +our operating results would be adversely affected, and there could be a material adverse effect on our ability to continue as a going +concern or to pursue our business strategy at all, which could have a material adverse effect on our business, prospects or operations, +and harm investors. +Bitcoin and other cryptocurrency +market prices, which have historically been volatile and are impacted by a variety of factors are determined primarily using data from +various exchanges, over-the-counter markets and derivative platforms. Such prices may be subject to factors such as those that impact +commodities, more so than business activities, which could be subject to additional influence from fraudulent or illegitimate actors, +real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue to +result in, speculation regarding future appreciation in the value of digital assets, or our share price, inflating and making their market +prices more volatile or creating “bubble” type risks for both Bitcoin and our shares of common stock. +We lack a significant operating history +in the cryptocurrency mining space, and our focus on this relatively new business is subject to a number of significant risks and uncertainties +that could affect our future viability. +We recently transferred all +our mining activity from Ault Alliance to BNI, both of which are wholly owned subsidiaries of our company. As of the date of this Annual +Report, we have invested approximately $127 million and agreed to invest approximately $49 million towards the development of +our new Bitcoin mining business. BNI was formed to, and has assumed the agreements for the acquisition of miners from Bitmain and other +agreements for the acquisition of equipment and services originally entered into by Ault Alliance, but has only recently commenced cryptocurrency +mining operations. In order to proceed, we have installed miners and mining infrastructure at our mining facility in Michigan, as well +as entered into a long-term contract to purchase electric power from the power grid in our data center in Michigan and use the power +to mine cryptocurrencies. Among the risks and uncertainties are: +● We are currently in discussions with a number of key players in this industry, but have not yet executed +any agreements to purchase the power needed over the 28 megawatts (“MW”) we currently possess. While we are in negotiations +with one entity in particular that we believe would increase our available power to approximately 300 MW’s at our Michigan facility, +we cannot assure you that we will reach an agreement satisfactory to us with this provider on a timely basis, if at all. Even if we do +obtain that level of energy at our Michigan facility, we will need to obtain more capacity at a different location to be able to install +and power 12,000 of the additional miners we have purchased and will receive from Bitmain over the next six to twelve months. If we are +able to enter into agreements for additional power, the terms may not be as attractive as we currently expect, which may inhibit the profitability +of this venture; +● There is a limited number of available miners and the demand from competitors is fierce; +● Because of supply chain disruptions including those relating to computer chips, we could in the future +encounter delivery delays or other difficulties with the purchase, installing and operating of our mining equipment at our facility, which +would adversely affect our ability to generate material revenue from our operations; +● There are a growing number of well capitalized cryptocurrency mining companies including some that have +agreed to merge with special purpose acquisition companies, which competitors have significant capital resources, a large supply of miners +and operators with experience in cryptocurrency mining. For example, in 2021 Cipher Mining Inc. and Core Scientific, large cryptocurrency +mining companies, entered into business combinations Nasdaq-listed special purpose acquisition vehicles; +46 +● Bans from governments such as China, together with pending legislation in Congress and other regulatory +initiatives threaten the ability to use cryptocurrencies as a medium of exchange; and +● We may not be able to liquidate our holdings of cryptocurrencies at our desired prices if a precipitous +decline in market prices occurs and this could negatively impact our future operations. +For all of these reasons, +our cryptocurrency mining business may not be successful. +The emergence of competing blockchain platforms +or technologies may harm our business as presently conducted by preventing us from realizing the anticipated profits from our investments +and forcing us to expend additional capital in an effort to adapt. +If blockchain platforms or +technologies which compete with Bitcoin and its blockchain, including competing cryptocurrencies which our miners may not be able to mine, +such as cryptocurrencies being developed or may be developed by popular social media platforms, online retailers, or government sponsored +cryptocurrencies, consumers may use such alternative platforms or technologies. If that were to occur, we would face difficulty adapting +to such emergent digital ledgers, blockchains, or alternative platforms, cryptocurrencies or other digital assets. This may adversely +affect us by preventing us from realizing the anticipated profits from our investments and forcing us to expend additional capital in +an effort to adapt. Further, to the extent we cannot adapt, be it due to our specialized miners or otherwise, we could be forced to cease +our mining or other cryptocurrency-related operations. Such circumstances would have a material adverse effect on our business, and +in turn your investment in our securities. +There is a risk that some or all of the Bitcoin +we mine could be lost or stolen. +There is a risk that some +or all of the Bitcoin we mine could be lost or stolen. In general, cryptocurrencies are stored in cryptocurrency sites commonly referred +to as “wallets” by holders of cryptocurrencies which may be accessed to exchange a holder’s cryptocurrency assets. Access +to our Bitcoin could also be restricted by cybercrime (such as a denial of service attack). While we plan to take steps to attempt to +secure the Bitcoin we hold, there can be no assurance our efforts to protect our cryptocurrencies will be successful. +Hackers or malicious actors +may launch attacks to steal, compromise or secure cryptocurrencies, such as by attacking the cryptocurrency network source code, exchange +miners, third-party platforms, cold and hot storage locations or software, or by other means. Any of these events may adversely affect +our operations and, consequently, our ability to generate revenue and become profitable. The loss or destruction of a private key required +to access our digital wallets may be irreversible and we may be denied access for all time to our Bitcoin holdings. Our loss of access +to our private keys or our experience of a data loss relating to our digital wallets could adversely affect our business. +Cryptocurrencies are controllable +only by the possessor of both the unique public and private keys relating to the local or online digital wallet in which they are held, +which wallet’s public key or address is reflected in the network’s public blockchain. We will be required to publish the public +key relating to digital wallets in use when we verify the receipt of transfers and disseminate such information into the network, but +we will need to safeguard the private keys relating to such digital wallets. To the extent such private keys are lost, destroyed or otherwise +compromised, we will be unable to access our Bitcoin rewards and such private keys may not be capable of being restored by any network. +Any loss of private keys relating to digital wallets used to store our mined Bitcoin could have a material adverse effect on our results +of operations and ability to continue as a going concern, which could have a material adverse effect on our business, prospects or operations +and potentially the value of any Bitcoin we mine. For example, the New York Times reported in January 2021 that about 20% of +existing Bitcoin appears to be “lost” due to password issues. +We rely on one or more third parties for depositing, +storing and withdrawing the Bitcoin we mine, which could result in a loss of assets, disputes and other liabilities or risks which could +adversely impact our business. +We currently use a custodial +wallet to store the Bitcoin we mine. In order to own, transfer and use Bitcoin on the blockchain network, we must have a private and public +key pair associated with a network address, commonly referred to as a “wallet.” Each wallet is associated with a unique “public +key” and “private key” pair, each of which is a string of alphanumerical characters. To deposit Bitcoin into our digital +wallet, we must direct the transaction to the public key of a wallet that our NYDIG custodial account controls and provides to us, and +broadcast the deposit transaction onto the underlying blockchain network. To withdraw Bitcoin from our custodial account, an assigned +account representative must initiate the transaction from our custodial account, then an approver must approve the transaction. Once the +custodian has verified that the request is valid and who the recipient is through Know Your Customer/Anti-Money Laundering protocols, +the custodian then “signs” a transaction authorizing the transfer. In addition, some cryptocurrency networks require additional +information to be provided in connection with any transfer of cryptocurrency such as Bitcoin. +47 +A number of errors or other +adverse events can occur in the process of depositing, storing or withdrawing Bitcoin into or from our custodial account, such as typos, +mistakes or the failure to include the information required by the blockchain network. For instance, a user may incorrectly enter our +wallet’s public key or the desired recipient’s public key when depositing and withdrawing Bitcoin. Additionally, our reliance +on third parties such as NYDIG and the maintenance of keys to access and utilize our digital wallet will expose us to enhanced cybersecurity +risks from unauthorized third parties employing illicit operations such as hacking, phishing and social engineering, notwithstanding the +security systems and safeguards employed by us and others. Cyberattacks upon systems across a variety of industries, including the cryptocurrency +industry, are increasing in frequency, persistence and sophistication and, in many cases, are being conducted by sophisticated, well-funded, +and organized groups and individuals. For example, attacks may be designed to deceive employees and service providers into releasing control +of the systems on which we depend to a hacker, while others may aim to introduce computer viruses or malware into such systems with a +view to stealing confidential or proprietary data. These attacks may occur on our digital wallet or the systems of our third-party service +providers or partners, which could result in asset losses and other adverse consequences. Alternatively, we may inadvertently transfer +Bitcoin to a wallet address that we do not own, control or hold the private keys to. In addition, a Bitcoin wallet address can only be +used to send and receive Bitcoin, and if the Bitcoin is inadvertently sent to an Ethereum or other cryptocurrency wallet address, or if +any of the foregoing errors occur, all of the Bitcoin will be permanently and irretrievably lost with no means of recovery. Such incidents +could result in asset loss or disputes, any of which could materially and adversely affect our business. +If a malicious actor or botnet obtains control +of more than 50% of the processing power on a cryptocurrency network, such actor or botnet could manipulate blockchains to adversely affect +us, which would adversely affect an investment in our company and our ability to operate. +If a malicious actor or botnet +(a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority +of the processing power dedicated to mining a cryptocurrency, it may be able to alter blockchains on which transactions of cryptocurrency +reside and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. The +malicious actor or botnet could control, exclude or modify the ordering of transactions, though it could not generate new units or transactions +using such control. The malicious actor could “double-spend” its own cryptocurrency (i.e., spend the same Bitcoin in more +than one transaction) and prevent the confirmation of other users’ transactions for as long as it maintained control. To the extent +that such malicious actor or botnet does not yield its control of the processing power on the network or the cryptocurrency community +does not reject the fraudulent blocks as malicious, reversing any changes made to blockchains may not be possible. The foregoing description +is not the only means by which the entirety of blockchains or cryptocurrencies may be compromised but is only an example. +Although we are unaware of +any reports of malicious activity or control of blockchains achieved through controlling over 50% of the processing power on the network, +it is believed that certain mining pools may have exceeded the 50% threshold in Bitcoin. The possible crossing of the 50% threshold indicates +a greater risk that a single mining pool could exert authority over the validation of Bitcoin transactions. To the extent that the Bitcoin +community, and the administrators of mining pools, do not act to ensure greater decentralization of Bitcoin mining processing power, the +feasibility of a botnet or malicious actor obtaining control of the blockchain’s processing power will increase, because such botnet +or malicious actor could more readily infiltrate and seize control over the blockchain by compromising a single mining pool, if the mining +pool compromises more than 50% of the mining power on the blockchain, than it could if the mining pool had a smaller share of the blockchain’s +total hashing power. Conversely, if the blockchain remains decentralized it is inherently more difficult for the botnet or malicious actor +to aggregate enough processing power to gain control of the blockchain. If this were to occur, the public may lose confidence in the Bitcoin +blockchain, and blockchain technology more generally. This would likely have a material and adverse effect on the price of Bitcoin, which +could have a material adverse effect on our business, financial results and operations, and harm investors. +Risks Related to Our Bitcoin Operations – Legal and Regulatory +A particular digital asset’s status as +a “security” in any relevant jurisdiction is subject to a high degree of uncertainty and if a regulator disagrees with our +characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines and penalties, which may adversely +affect our business, operating results and financial condition. A determination that Bitcoin is a “security” may adversely +affect the value of Bitcoin and our business. +48 +The SEC and its staff have +taken the position that certain digital assets fall within the definition of a “security” under U.S. federal securities laws. +The legal test for determining whether any given digital asset is a security is a highly complex, fact-driven analysis that may evolve +over time, and the outcome is difficult to predict. Our determination that the digital assets we hold are not securities is a risk-based +assessment and not a legal standard or one binding on regulators. The SEC generally does not provide advance guidance or confirmation +on the status of any particular digital asset as a security. Furthermore, the SEC’s views in this area have evolved over time and +it is difficult to predict the direction or timing of any continuing evolution. It is also possible that a change in the governing administration +or the appointment of new SEC commissioners could substantially impact the views of the SEC and its staff. Public statements made by senior +officials at the SEC indicate that the SEC does not intend to take the position that Bitcoin is a security (as currently offered and sold; +in this context, it should be noted that we have no intention of conducting any initial coin offerings). However, such statements are +not official policy statements by the SEC and reflect only the speakers’ views, which are not binding on the SEC or any other agency +or court and cannot be generalized to any other digital asset. As of the date of this Annual Report, with the exception of certain centrally +issued digital assets that have received “no-action” letters from the SEC staff, Bitcoin and Ethereum’s ether are the +only digital assets which senior officials at the SEC have publicly stated are unlikely to be considered securities. As a Bitcoin mining +company, we do not believe we are an issuer of any “securities” as defined under the federal securities laws. Our internal +process for determining whether the digital assets we hold or plan to hold is based upon the public statements of the SEC and existing +case law. Similarly, though the SEC’s Strategic Hub for Innovation and Financial Technology published a framework for analyzing +whether any given digital asset is a security in April 2019, this framework is also not a rule, regulation or statement of the SEC and +is not binding on the SEC. +The classification of a digital +asset as a security under applicable law has wide-ranging implications for the regulatory obligations that flow from the offer, sale, +trading, and clearing of such assets. For example, a digital asset that is a security may generally only be offered or sold pursuant to +a registration statement filed with the SEC or in an offering that qualifies for an exemption from registration. Persons that effect transactions +in digital assets that are securities may be subject to registration with the SEC as a “broker” or “dealer.” Platforms +that bring together purchasers and sellers to trade digital assets that are securities are generally subject to registration as national +securities exchanges, or must qualify for an exemption, such as by being operated by a registered broker-dealer as an alternative trading +system (“ATS”), in compliance with rules for ATS’s. Persons facilitating clearing and settlement of securities may be +subject to registration with the SEC as a clearing agency. +We analyze whether the digital +assets that we mine, hold and sell for our own account could be deemed to be a +“security” under applicable laws. Our procedures do not constitute a legal standard, but rather represent our management’s +assessment regarding the likelihood that a particular digital asset could be deemed a “security” under applicable laws. Regardless +of our conclusions, we could be subject to legal or regulatory action in the event the SEC, a foreign regulatory authority, or a court +were to determine that a digital asset currently held by us is a “security” under applicable laws. If the digital assets mined +and held by us are deemed securities, it could limit distributions, transfers, or other actions involving such digital assets, including +mining. +There can be no assurances +that we will properly characterize any given digital asset as a security or non-security for purposes of determining which digital assets +to mine, hold and trade, or that the SEC, or a court, if the question was presented to it, would agree with our assessment. We could be +subject to judicial or administrative sanctions for failing to offer or sell digital assets in compliance with the registration requirements, +or for acting as a broker or dealer without appropriate registration. Such an action could result in injunctions, cease and desist orders, +as well as civil monetary penalties, fines, and disgorgement, criminal liability, and reputational harm. For instance, all transactions +in such supported digital asset would have to be registered with the SEC, or conducted in accordance with an exemption from registration, +which could severely limit its liquidity, usability and transactability. Further, it could draw negative publicity and a decline in the +general acceptance of the digital asset. Also, it may make it difficult for such digital asset to be traded, cleared, and custodied as +compared to other digital assets that are not considered to be securities. +Current interpretations require the regulation +of Bitcoin under the Commodity Exchange Act by the Commodity Futures Trading Commission, and we may be required to register and comply +with such regulations. Any disruption of our operations in response to the changed regulatory circumstances may be at a time that is disadvantageous +to our investors. +Current and future legislation, +regulation by the Commodity Futures Trading Commission (the “CFTC”) and other regulatory developments, including interpretations +released by a regulatory authority, may impact the manner in which Bitcoin and other cryptocurrencies are treated for classification and +clearing purposes. In particular, derivatives on these assets are not excluded from the definition of “commodity future” by +the CFTC. We cannot be certain as to how future regulatory developments will impact the treatment of Bitcoin and other cryptocurrencies +under the law. +Bitcoin has been deemed to +fall within the definition of a commodity and, we may be required to register and comply with additional regulation under the Commodity +Exchange Act, including additional periodic report and disclosure standards and requirements. Moreover, we may be required to register +as a commodity pool operator and to register as a commodity pool with the CFTC through the National Futures Association. Such additional +registrations may result in extraordinary, non-recurring expenses, thereby materially and adversely impacting an investment in us. +If we determine not to comply with such additional regulatory and registration requirements, we may seek to cease certain of our operations. +Any such action may adversely affect an investment in us. +Additionally, governments +may develop and deploy their own blockchain-based digital assets, which may have a material adverse impact on Bitcoin’s price +and utility. +49 +Governmental action against digital assets +and Bitcoin mining may have a materially adverse effect on the industry, and could affect us if widely adopted. +We and the cryptocurrencies +on which our operations will depend are and could become subject to bans and other regulations aimed at preventing what are perceived +as some of the negative attributes of Bitcoin and Bitcoin mining. For example, on September 24, 2021, China declared all transactions +in and mining of cryptocurrencies, including Bitcoin, illegal. While the ultimate long-term effect of this ban remains uncertain, +it could significantly hinder our prospects by limiting a large market for cryptocurrencies within a growing economy. In the hours +following China’s announcement of the ban, the price of Bitcoin, which is tied to some extent to public perception of its future +value as a form of currency, dropped by nearly $4,000. The ban followed piecemeal regulatory action within China against cryptocurrencies, +which was due in part to concerns about the potential for manipulative practices and excessive energy consumption. This could demonstrate +the beginning of a regional or global regulatory trend in response to these or other concerns surrounding cryptocurrencies, and similar +action in a jurisdiction in which we operate or in general could have devastating effects to our operations. If further regulation follows, +it is possible that our industry may not be able to adjust to a sudden and dramatic overhaul to our ability to deploy energy towards the +operation of mining equipment. +Because we are unable to influence +or predict future regulatory actions taken by governments, we may face difficulty monitoring and responding to rapid regulatory developments +affecting Bitcoin mining, which may have a materially adverse effect on our industry and, therefore, our business and results of operations. +If further regulatory action is taken by governments in the U.S., our business may be materially harmed, and you could lose some or all +of your investment. +The markets for Bitcoin and other cryptocurrencies +and the existing markets may be under-regulated and, as a result, the market price of Bitcoin may be subject to significant volatility +or manipulation, which could decrease consumer confidence in cryptocurrencies and have a materially adverse effect on our business and +results of operations. +Cryptocurrencies that are +represented and trade on a ledger-based platform and those who hold them may not enjoy the same benefits as traditional securities +available on trading markets and their investors. Stock exchanges have listing requirements and vet issuers, requiring them to be subjected +to rigorous listing standards and rules, and monitor investors transacting on such platform for fraud and other improprieties. These conditions +may not necessarily be replicated on a distributed ledger platform, depending on the platform’s controls and other policies. The +more lax a distributed ledger platform is about vetting issuers of cryptocurrency assets or users that transact on the platform, the higher +the potential risk for fraud or the manipulation of the ledger due to a control event. We believe that Bitcoin is not a security under +federal and state law. +Bitcoin and other cryptocurrency +market prices have historically been volatile, are impacted by a variety of factors, and are determined primarily using data from various +exchanges, over-the-counter markets and derivative platforms. Furthermore, such prices may be subject to factors such as those that +impact commodities, more so than business activities, which could be subjected to additional influence from fraudulent or illegitimate +actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue +to result in, speculation regarding future appreciation in the value of cryptocurrencies, or our share price, making their market prices +more volatile or creating “bubble” type risks for both Bitcoin and shares of our common stock. +These factors may inhibit +consumer trust in and market acceptance of cryptocurrencies as a means of exchange which could have a material adverse effect on our business, +prospects, or operations and potentially the value of any Bitcoin or other cryptocurrencies we mine or otherwise acquire. +We are subject to risks associated with our +need for significant electrical power. Government regulators may potentially restrict the ability of electricity suppliers to provide +electricity to mining operations, such as ours. +The operation of a Bitcoin +or other Bitcoin mine can require massive amounts of electrical power. We presently have access to 28 megawatt capacity at our Facility, +but require an additional 37 megawatt capacity to operate the miners that we expect to receive from Bitmain during 2022. Our mining operations +can only be successful and ultimately profitable if the costs, including electrical power costs, associated with mining a Bitcoin are +lower than the price of a Bitcoin. As a result, any mine we establish can only be successful if we can obtain sufficient electrical power +for that mine on a cost-effective basis, and our establishment of new mines requires us to find locations where that is the case. There +may be significant competition for suitable mine locations, and government regulators may potentially restrict the ability of electricity +suppliers to provide electricity to mining operations in times of electricity shortage or may otherwise potentially restrict or prohibit +the provision or electricity to mining operations. Any shortage of electricity supply or increase in electricity cost in a jurisdiction +may negatively impact the viability and the expected economic return for Bitcoin mining activities in that jurisdiction. +50 +Our interactions with a blockchain may expose +us to SDN or blocked persons or cause us to violate provisions of law that did not contemplate distributed ledger technology. +The Office of Financial Assets +Control of the U.S. Department of Treasury (“OFAC”) requires us to comply with its sanction program and not conduct business +with persons named on its specially designated nationals (“SDN”) list. However, because of the pseudonymous nature of blockchain +transactions, we may inadvertently and without our knowledge engage in transactions with persons named on OFAC’s SDN list. Our internal +policies prohibit any transactions with such SDN individuals, but we may not be adequately capable of determining the ultimate identity +of the individual with whom we transact with respect to selling digital assets. In addition, in the future OFAC or another regulator may +require us to screen transactions for OFAC addresses or other bad actors before including such transactions in a block, which may increase +our compliance costs, decrease our anticipated transaction fees and lead to decreased traffic on our network. Any of these factors, consequently, +could have a material adverse effect on our business, prospects, financial condition, and operating results. +Moreover, federal law prohibits +any U.S. person from knowingly or unknowingly possessing any visual depiction commonly known as child pornography. Recent media reports +have suggested that persons have imbedded such depictions on one or more blockchains. Because our business requires us to download and +retain one or more blockchains to effectuate our ongoing business, it is possible that such digital ledgers contain prohibited depictions +without our knowledge or consent. To the extent government enforcement authorities literally enforce these and other laws and regulations +that are impacted by decentralized distributed ledger technology, we may be subject to investigation, administrative or court proceedings, +and civil or criminal monetary fines and penalties, all of which could harm our reputation and could have a material adverse effect on +our business, prospects, financial condition, and operating results. +Risks Related to Our Bitcoin Operations – Technological +Cryptocurrencies face significant +scaling obstacles that can lead to high fees or slow transaction settlement times and attempts to increase the volume of transactions +may not be effective, which could adversely affect an investment in our securities. +Cryptocurrencies face significant +scaling obstacles that can lead to high fees or slow transaction settlement times and attempts to increase the volume of transactions +may not be effective. Scaling cryptocurrencies is essential to the widespread acceptance of cryptocurrencies as a means of payment, which +widespread acceptance is necessary to the continued growth and development of our business. Many Bitcoin networks face significant scaling +challenges. For example, cryptocurrencies are limited with respect to how many transactions can occur per second. Participants in the +Bitcoin ecosystem debate potential approaches to increasing the average number of transactions per second that the network can handle +and have implemented mechanisms or are researching ways to increase scale, such as increasing the allowable sizes of blocks, and therefore +the number of transactions per block, and sharding (a horizontal partition of data in a database or search engine), which would not require +every single transaction to be included in every single miner’s or validator’s block. However, there is no guarantee that +any of the mechanisms in place or being explored for increasing the scale of settlement of Bitcoin transactions will be effective, or +how long they will take to become effective, which could adversely affect an investment in our securities. +There is a possibility of Bitcoin mining algorithms +transitioning to proof of stake validation and other mining related risks, which could make us less competitive and ultimately adversely +affect our business and the value of our shares. +The protocol pursuant to which +transactions are confirmed automatically on the Bitcoin blockchain through mining is known as proof of work. Proof of stake is an alternative +method in validating digital asset transactions. Should the Bitcoin algorithm shift from a proof of work validation method to a proof +of stake method, mining would require less energy and may render any company that maintains advantages in the current climate (for example, +from lower priced electricity, processing, real estate, or hosting) less competitive. We, as a result of our efforts to optimize and improve +the efficiency of our Bitcoin mining operations, may be exposed to the risk in the future of losing the benefit of our capital investments +and the competitive advantage we hope to gain from this as a result, and may be negatively impacted if a switch to proof of stake validation +were to occur. This may additionally have an impact on other various investments of ours. Such events could have a material adverse effect +on our ability to continue as a going concern or to pursue our business strategy at all, which could have a material adverse effect on +our business, prospects or operations and potentially the value of any Bitcoin or other digital assets we mine or otherwise acquire or +hold for our own account. +51 +Bitcoin is subject to halving, meaning that +the Bitcoin rewarded for solving a block will be reduced in the future and its value may not commensurately adjust to compensate us for +such reductions, and the overall supply of Bitcoin is finite. +Bitcoin is subject to “halving,” +which is the process by which the Bitcoin reward for solving a block is reduced by 50% for every 210,000 blocks that are solved. This +means that the amount of Bitcoin we (or any other mining company) are rewarded for solving a block in the blockchain is permanently cut +in half. For example, the latest halving having occurred in May 2020, with a revised payout of 6.25 Bitcoin per block solved, down +from the previous reward rate of 12.5 Bitcoin per block solved. There can be no assurance that the price of Bitcoin will sufficiently +increase to justify the increasingly high costs of mining for Bitcoin given the halving feature. If a corresponding and proportionate +increase in the trading price of these cryptocurrencies does not follow these anticipated halving events, the revenue we earn from our +mining operations would see a corresponding decrease, which would have a material adverse effect on our business and operations. To illustrate, +even if the price of Bitcoin remains at its current price, all other factors being equal (including the same number of miners and a stable +hash rate), our revenue would decrease substantially upon the next halving. +Further, due to the halving +process, unless the underlying code of the Bitcoin blockchain is altered (which may be unlikely given its decentralized nature), the supply +of Bitcoin is finite. Once 21 million Bitcoin have been generated by virtue of solving blocks in the blockchain, the network will +stop producing more which is anticipated to occur in approximately 2140. Currently, there are approximately 19 million Bitcoin in +circulation representing about 90% of the total supply of Bitcoin under the current source code. For the foregoing reasons, the halving +feature exposes us to inherent uncertainty and reliance upon the historically volatile price of Bitcoin, rendering an investment in us +particularly speculative, especially in the long-term. If the price of Bitcoin does not significantly increase in value, your investment +in our common stock could decline significantly. +Bitcoin has forked multiple times and additional +forks may occur in the future which may affect the value of Bitcoin that we hold or mine. +To the extent that a significant +majority of users and mining companies on a cryptocurrency network install software that changes the cryptocurrency network or properties +of a cryptocurrency, including the irreversibility of transactions and limitations on the mining of new cryptocurrency, the cryptocurrency +network would be subject to new protocols and software. However, if less than a significant majority of users and mining companies on +the cryptocurrency network consent to the proposed modification, and the modification is not compatible with the software prior to its +modification, the consequence would be what is known as a “fork” of the network, with one prong running the pre-modified software +and the other running the modified software. The effect of such a fork would be the existence of two versions of the cryptocurrency running +in parallel yet lacking interchangeability and necessitating exchange-type transaction to convert currencies between the two forks. +Additionally, it may be unclear following a fork which fork represents the original cryptocurrency and which is the new cryptocurrency. +Different metrics adopted by industry participants to determine which is the original asset include: referring to the wishes of the core +developers of a cryptocurrency, blockchains with the greatest amount of hashing power contributed by miners or validators; or blockchains +with the longest chain. A fork in the network of a particular cryptocurrency could adversely affect an investment in our securities or +our ability to operate. +Since August 1, 2017, +Bitcoin’s blockchain was forked multiple times creating alternative versions of the cryptocurrency such as Bitcoin Cash, Bitcoin +Gold and Bitcoin SV. The forks resulted in a new blockchain being created with a shared history, and a new path forward. The value +of the newly created versions including Bitcoin Cash, Bitcoin Gold and Bitcoin SV may or may not have value in the long run and may affect +the price of Bitcoin if interest is shifted away from Bitcoin to the newly created cryptocurrencies. The value of Bitcoin after the creation +of a fork is subject to many factors including the value of the fork product, market reaction to the creation of the fork product, and +the occurrence of forks in the future. As such, the value of Bitcoin could be materially reduced if existing and future forks have a negative +effect on Bitcoin’s value. +Incorrect or fraudulent cryptocurrency transactions +may be irreversible and it is possible that, through computer or human error, or through theft or criminal action, our cryptocurrency +rewards could be transferred in incorrect amounts or to unauthorized third parties. +Cryptocurrency transactions +are irrevocable and stolen or incorrectly transferred cryptocurrencies may be irretrievable. As a result, any incorrectly executed or +fraudulent cryptocurrency transactions, such as a result of a cybersecurity breach against our Bitcoin holdings, could adversely affect +our investments and assets. This is because cryptocurrency transactions are not, from an administrative perspective, reversible without +the consent and active participation of the recipient of the cryptocurrencies from the transaction. Once a transaction has been verified +and recorded in a block that is added to a blockchain, an incorrect transfer of a cryptocurrency or a theft thereof generally will not +be reversible and we may not have sufficient recourse to recover our losses from any such transfer or theft. Further, it is possible that, +through computer or human error, or through theft or criminal action, our cryptocurrency rewards could be transferred in incorrect amounts +or to unauthorized third parties, or to uncontrolled accounts. If an errant or fraudulent transaction in our Bitcoin were to occur, we +would have very limited means of seeking to reverse the transaction or seek recourse. To the extent that we are unable to recover our +losses from such action, error or theft, such events could have a material adverse effect on our business. +52 +Because many of our digital assets may in the +future be held by digital asset exchanges, we could face heightened risks from cybersecurity attacks and financial stability of digital +asset exchanges . +We may transfer our digital +assets from our wallet to digital asset exchanges prior to selling them. Digital assets not held in our wallet are subject to the risks +encountered by digital asset exchanges including a DDoS Attack or other malicious hacking, a sale of the digital asset exchange, loss +of the digital assets by the digital asset exchange and other risks similar to those described herein. We do not expect to maintain a +custodian agreement with any of the digital asset exchanges that may in the future hold our digital assets. These digital asset exchanges +do not provide insurance and may lack the resources to protect against hacking and theft. If this were to occur, we may be materially +and adversely affected. +Our use of third-party +mining pools exposes us to additional risks. +We +receive Bitcoin rewards from our mining activity through third-party mining pool operators. Mining pools allow miners to combine their +processing power, increasing their chances of solving a block and getting paid by the network. The rewards are distributed by the pool +operator, proportionally to our contribution to the pool’s overall mining power, used to solve a block on the Bitcoin blockchain. +Should the pool operator’s system suffer downtime due to a cyber-attack, software malfunction or other issue, it will negatively +impact our ability to mine and receive revenue. Furthermore, we are dependent on the accuracy of the mining pool operator’s record +keeping to accurately record the total processing power provided to the pool for a given Bitcoin mining application in order to assess +the proportion of that total processing power we provided. While we have internal methods of tracking both the hash rate we provide and +the total used by the pool, the mining pool operator uses its own record-keeping to determine our proportion of a given reward, which +may not match our own. If we are unable to consistently obtain accurate proportionate rewards from our mining pool operators, we may experience +reduced reward for our efforts, which would have an adverse effect on our business and operations. +Risks Relates to Our Status as a Holding +Company +Our inability to successfully integrate new +acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our +growth strategy through acquisitions is fraught with risk. On June 2, 2017, we acquired a majority interest in Microphase, on May 23, +2018 we acquired Enertec, on November 30, 2020 we acquired Relec, on January 29, 2021 we acquired the Facility in Michigan, on December +16, 2021, we acquired a majority interest in IMHC, on December 22, 2021 we acquired the four Properties in and around Madison and on December +30, 2021, we acquired certain real property located in St. Petersburg, Florida. Our strategy and business plan are dependent on our ability +to successfully integrate Microphase’s, Enertec’s and our other acquisition’s operations, particularly those of Relec +and Gresham Power. In addition, while we are based in Las Vegas, NV, our finance department is in Newport Beach, CA, Microphase’s +operations are located in Shelton, Connecticut, Enertec’s operations are located in Karmiel, Israel, Gresham Power’s operations +are located in Salisbury, England, Madison is located in or near Wisconsin and the St. Petersburg property is located in Florida. These +distant locations and others that we may become involved with in the future will stretch our resources and management time. Further, failure +to quickly and adequately integrate all of these operations and personnel could adversely affect our combined business and our ability +to achieve our objectives and strategy. No assurance can be given that we will realize synergies in the areas we currently operate. +If we make any additional acquisitions, they may disrupt or have +a negative impact on our business. +We have plans to eventually +make additional acquisitions beyond Microphase, Enertec, Relec, the Facility, IMHC, the Madison Properties and the St. Petersburg property. Whenever +we make acquisitions, we could have difficulty integrating the acquired companies’ personnel and operations with our own. In addition, +the key personnel of the acquired business may not be willing to work for us. We cannot predict the effect expansion may have on our core +business. Regardless of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, distract +our management and employees and increase our expenses. In addition to the risks described above, acquisitions are accompanied by a number +of inherent risks, including, without limitation, the following: +53 +● If senior management and/or management of future acquired companies terminate their employment prior to +our completion of integration; +● difficulty of integrating acquired products, services or operations; +● integration of new employees and management into our culture while maintaining focus on operating efficiently +and providing consistent, high-quality goods and services; +● potential disruption of the ongoing businesses and distraction of our management and the management of +acquired companies; +● unanticipated issues with transferring customer relationships; +● complexity associated with managing our combined company; +● difficulty of incorporating acquired rights or products into our existing business; +● difficulties in disposing of the excess or idle facilities of an acquired company or business and expenses +in maintaining such facilities; +● difficulties in maintaining uniform standards, controls, procedures and policies; +● potential impairment of relationships with employees and customers as a result of any integration of new +management personnel; +● potential inability or failure to achieve additional sales and enhance our customer base through cross-marketing +of the products to new and existing customers; +● effect of any government regulations which relate to the business acquired; and +● potential unknown liabilities associated with acquired businesses or product lines, or the need to spend +significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense of any litigation, whether +or not successful, resulting from actions of the acquired company prior to our acquisition. +Our business could be severely +impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection +with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract +our management and employees, increase our expenses and adversely affect our results of operations. +We may not be able to successfully identify +suitable acquisition targets and complete acquisitions to meet our growth strategy, and even if we are able to do so, we may not realize +the full anticipated benefits of such acquisitions, and our business, financial conditions and results of operations may suffer. +Increasing revenues through +acquisitions is one of the key components of our growth strategy. Identifying suitable acquisition candidates can be difficult, time-consuming +and costly, and we may not be able to identify suitable candidates or complete acquisitions in a timely manner, on a cost-effective basis +or at all. +We will have to pay cash, +incur debt, or issue equity as consideration in any future acquisitions, each of which could adversely affect our financial condition +or the market price of our common stock. The sale of equity or issuance of equity-linked debt to finance any future acquisitions could +result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could limit our +flexibility in managing our business due to covenants or other restrictions contained in debt instruments. +Further, we may not be able +to realize the anticipated benefits of completed acquisitions. Some acquisition targets may not have a developed business or are experiencing +inefficiencies and incur losses. Additionally, small defense contractors which we consider suitable acquisition targets may be uniquely +dependent on their prior owners and the loss of such owners’ services following the completion of acquisitions may adversely affect +their business. Therefore, we may lose our investment in the event that the acquired businesses do not develop as planned, we cannot retain +key employees or that we are unable to achieve the anticipated cost efficiencies or reduction of losses. +Additionally, our acquisitions +have previously required, and any similar future transactions may also require, significant management efforts and expenditures. Regardless +of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, divert the attention of our +management and key employees and increase our expenses. +We face risks with respect to the evaluation and management of future +platform or add-on acquisitions . +A component of our strategy +is to continue to acquire additional add-on businesses for our existing businesses. Generally, because such acquisition targets are held +privately, we may experience difficulty in evaluating potential target businesses as the information concerning these businesses is not +publicly available. In addition, we and our subsidiary companies may have difficulty effectively managing or integrating acquisitions. +We may experience greater than expected costs or difficulties relating to such acquisition, in which case we might not achieve the anticipated +returns from any particular acquisition, which may have a material adverse effect on our financial condition, business and results of +operations. +54 +We may not be able to successfully fund future +acquisitions of new businesses due to the lack of availability of debt or equity financing at the parent company level on acceptable terms, +which could impede the implementation of our acquisition strategy and materially adversely impact our financial condition, business and +results of operations . +In order to make future acquisitions, +we intend to raise capital primarily through debt financing, additional equity offerings, the sale of stock or assets of our businesses, +or by undertaking a combination of any of the above. Since the timing and size of acquisitions cannot be readily predicted, we may need +to be able to obtain funding on short notice to benefit fully from attractive acquisition opportunities. Such funding may not be available +on acceptable terms, if at all. In addition, the level of our indebtedness that we may incur may impact our ability to borrow. Another +source of capital for us may be the sale of additional shares, subject to market conditions and investor demand for the shares at prices +that we consider to be in the interests of our stockholders. These risks may materially adversely affect our ability to pursue our acquisition +strategy successfully and materially adversely affect our financial condition, business and results of operations. +To service any future indebtedness and other +obligations, we will require a significant amount of cash. +Our ability to generate cash +depends on many factors beyond our control, and any failure to meet our debt service obligations, of which we currently have very few +but may in the future incur, including our obligations under our indebtedness or future outstanding shares of preferred stock, could harm +our business, financial condition and results of operations. Our ability to make payments on and to refinance any indebtedness and outstanding +preferred stock and to fund working capital needs and planned capital expenditures will depend on our ability to generate cash in the +future. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other +factors that are beyond our control. +If our business does not generate +sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to enable us and our subsidiaries +to pay our indebtedness or make dividend payments with respect to our any shares of preferred stock that we may issue, or to fund our +other liquidity needs, we may need to refinance all or a portion of our indebtedness or redeem the preferred stock, on or before the maturity +thereof, sell assets, reduce or delay capital investments or seek to raise additional capital, any of which could have a material adverse +effect on us. +In addition, we may not be +able to effect any of these actions, if necessary, on commercially reasonable terms or at all. Our ability to restructure or refinance +our indebtedness or redeem the preferred stock will depend on the condition of the capital markets and our financial condition at such +time. Any refinancing of our debt or financings related to the redemption of any shares of preferred stock that we may issue could be +at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. +The terms of future debt instruments or preferred stock may limit or prevent us from taking any of these actions. In addition, any failure +to make scheduled payments of interest and principal on any future outstanding indebtedness or dividend payments on any shares of preferred +stock that we may issue could harm our ability to incur additional indebtedness or otherwise raise capital on commercially reasonable +terms or at all. Our inability to generate sufficient cash flow to satisfy any future debt service and other obligations, or to refinance +or restructure our obligations on commercially reasonable terms or at all, would have an adverse effect, which could be material, on our +business, financial condition and results of operations. +Because we face significant competition for +acquisition and business opportunities, including from numerous companies with a business plan similar to ours, it may be difficult for +us to fully execute our business strategy. Additionally, our subsidiaries also operate in highly competitive industries, limiting their +ability to gain or maintain their positions in their respective industries. +We expect to encounter intense +competition for acquisition and business opportunities from both strategic investors and other entities having a business objective similar +to ours, such as private investors (which may be individuals or investment partnerships), blank check companies including special purpose +acquisition companies, and other entities, domestic and international, competing for the type of businesses that we may acquire. Many +of these competitors possess greater technical, human and other resources, or more local industry knowledge, or greater access to capital, +than we do, and our financial resources may be relatively limited when contrasted with those of many of these competitors. These factors +may place us at a competitive disadvantage in successfully completing future acquisitions and investments. +In addition, while we believe +that there are numerous target businesses that we could potentially acquire or invest in, our ability to compete with respect to the acquisition +of certain target businesses that are sizable will be limited by our available financial resources. We may need to obtain additional financing +in order to consummate future acquisitions and investment opportunities and cannot assure you that any additional financing will be available +to us on acceptable terms, or at all, or that the terms of our existing financing arrangements will not limit our ability to do so. This +inherent competitive limitation gives others an advantage in pursuing acquisition and investment opportunities. +55 +Furthermore, our subsidiaries +also face competition from both traditional and new market entrants that may adversely affect them as well, as discussed elsewhere in +these risk factors. +We may be required to expend substantial sums +in order to bring the companies we have acquired or may acquire in the future, into compliance with the various reporting requirements +applicable to public companies and/or to prepare required financial statements, and such efforts may harm our operating results or be +unsuccessful altogether. +The Sarbanes-Oxley Act requires +our management to assess the effectiveness of the internal control over financial reporting for the companies we acquire and our external +auditor to audit these companies. In order to comply with the Sarbanes-Oxley Act, we will need to implement or enhance internal control +over financial reporting at acquired companies and evaluate the internal controls. We do not conduct a formal evaluation of companies’ +internal control over financial reporting prior to an acquisition. We may be required to hire additional staff and incur substantial costs +to implement the necessary new internal controls at the companies we acquire. Any failure to implement required internal controls, or +difficulties encountered in their implementation, could harm our operating results or increase the risk of material weaknesses in internal +controls, which could, if not remediated, adversely affect our ability to report our financial condition and results of operations in +a timely and accurate manner. +Future acquisitions or business opportunities +could involve unknown risks that could harm our business and adversely affect our financial condition and results of operations . +We are a diversified holding +company that owns interests in a number of different businesses across several industries. We have in the past, and intend in the future, +to acquire businesses or make investments, directly or indirectly through our subsidiaries, that involve unknown risks, some of which +will be particular to the industry in which the investment or acquisition targets operate, including risks in industries with which we +are not familiar or experienced. There can be no assurance our due diligence investigations will identify every matter that could have +a material adverse effect on us or the entities that we may acquire. We may be unable to adequately address the financial, legal and operational +risks raised by such investments or acquisitions, especially if we are unfamiliar with the relevant industry, which can lead to significant +losses on material investments. The realization of any unknown risks could expose us to unanticipated costs and liabilities and prevent +or limit us from realizing the projected benefits of the investments or acquisitions, which could adversely affect our financial condition +and liquidity. In addition, our financial condition, results of operations and the ability to service our debt may be adversely impacted +depending on the specific risks applicable to any business we invest in or acquire and our ability to address those risks. +We face certain risks associated with the acquisition +or disposition of businesses and lack of control over certain of our investments. +In pursuing our corporate +strategy, we may acquire, dispose of or exit businesses or reorganize existing investments. The success of this strategy is dependent +upon our ability to identify appropriate opportunities, negotiate transactions on favorable terms and ultimately complete such transactions. +In the course of our acquisitions, +we may not acquire 100% ownership of certain of our operating subsidiaries or we may face delays in completing certain acquisitions, including +in acquiring full ownership of certain of our operating companies. Once we complete acquisitions or reorganizations there can be no assurance +that we will realize the anticipated benefits of any transaction, including revenue growth, operational efficiencies or expected synergies. +If we fail to recognize some or all of the strategic benefits and synergies expected from a transaction, goodwill and intangible assets +may be impaired in future periods. The negotiations associated with the acquisition and disposition of businesses could also disrupt our +ongoing business, distract management and employees or increase our expenses. +In addition, we may not be +able to integrate acquisitions successfully and we could incur or assume unknown or unanticipated liabilities or contingencies, which +may impact our results of operations. If we dispose of or otherwise exit certain businesses, there can be no assurance that we will not +incur certain disposition related charges, or that we will be able to reduce overhead related to the divested assets. +56 +In the ordinary course of +our business, we evaluate the potential disposition of assets and businesses that may no longer help us meet our objectives or that no +longer fit with our broader strategy, such as the planned merger between TOGI and IMHC. When we decide to sell assets or a business, we +may encounter difficulty in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the +accomplishment of our strategic objectives, or we may dispose of a business at a price or on terms which are less than we had anticipated. +In addition, there is a risk that we sell a business whose subsequent performance exceeds our expectations, in which case our decision +would have potentially sacrificed enterprise value. +Our development stage companies may never produce +revenues or income. +We have made investments in +and own stakes, either majority or minority, in a certain development stage companies. Each of these companies is at an early stage of +development and is subject to all business risks associated with a new enterprise, including constraints on their financial and personnel +resources, lack of established credit, the need to establish meaningful and beneficial vendor and customer relationships and uncertainties +regarding product development and future revenues. We anticipate that many of these companies will continue to incur substantial additional +operating losses for at least the next several years and expect their losses to increase as research and development efforts expand. There +can be no assurance as to when or whether any of these companies will be able to develop significant sources of revenue or that any of +their respective operations will become profitable, even if any of them is able to commercialize any products. As a result, we may not +realize any returns on our investments in these companies for a significant period of time, if at all, which could adversely affect our +business, results of operations, financial condition or liquidity. +Divestitures and contingent liabilities from +divested businesses could adversely affect our business and financial results . +We continually evaluate the +performance and strategic fit of all of our businesses and may sell businesses or product lines. Divestitures involve risks, including +difficulties in the separation of operations, services, products and personnel, the diversion of management's attention from other business +concerns, the disruption of our business, the potential loss of key employees and the retention of uncertain contingent liabilities, including +environmental liabilities, related to the divested business. When we decide to sell assets or a business, we may encounter difficulty +in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the achievement of our strategic +objectives. We may also dispose of a business at a price or on terms that are less desirable than we had anticipated, which could result +in significant asset impairment charges, including those related to goodwill and other intangible assets, that could have a material adverse +effect on our financial condition and results of operations. In addition, we may experience greater dis-synergies than expected, the impact +of the divestiture on our revenue growth may be larger than projected, and some divestitures may be dilutive to earnings. There can be +no assurance whether the strategic benefits and expected financial impact of the divestiture will be achieved. We cannot assure you that +we will be successful in managing these or any other significant risks that we encounter in divesting a business or product line, and +any divestiture we undertake could materially and adversely affect our business, financial condition, results of operations and cash flows. +Risks Related to Related Party Transactions +There may be conflicts of +interest between our company and certain of our related parties and their respective directors and officers which might not be resolved +in our favor. More importantly, there may be conflicts between certain of our related parties and their respective directors and officers +which might not be resolved in our favor. These risks are set forth below appurtenant to the relevant related party. +Ault & Company +Our relationship with Ault & Company may +enhance the difficulty inherent in obtaining financing for us as well as expose us to certain conflicts of interest. +At April 11, 2022, Ault & +Company, of which Milton C. Ault is the chief executive officer, beneficially owned 9,766,882 shares of our common stock, consisting of +(i) 1,658,916 shares of common stock owned, (ii) warrants to purchase 94 shares of common stock that are currently exercisable, (iii) +1,000,000 shares of common stock purchasable by Ault & Company pursuant to a securities purchase agreement entered into on June 11, +2021 between Ault & Company and BitNile, (iv) 7,100,000 shares owned by Ault Alpha, of which Ault & Company is the sole member +of Ault Alpha GP LLC, the general partner of Ault Alpha, and (v) 7,872 shares owned by Philou Ventures, LLC (“Philou”), of +which Ault & Company is the Manager, consisting of: (A) 125,000 shares of Series B Preferred Stock that are convertible into 2,232 +shares of common stock, (B) warrants to purchase 2,232 shares of common stock that are currently exercisable and (C) 3,408 shares of common +stock. As April 11, 2022, Ault & Company beneficially owns 3.6% of our common stock. +Given the close relationship +between Ault & Company on the one hand, and our company on the other, it is not inconceivable that we could enter into additional +securities purchase agreements with Ault & Company. +57 +Although we have relied on +Philou, which no longer beneficially owns a meaningful number of our shares of common stock, to finance us in the past, we cannot assure +you that either Philou or Ault & Company will assist us in the future. We would far prefer to rely on these entities’ assistance +compared to other sources of financing as the terms they provide us are in general more favorable to us than we could obtain elsewhere. +However, Messrs. Ault, Horne and Nisser could face a conflict of interest in that they serve on the board of directors of each of Ault +& Company and our company. If they determine that an investment in our company is not in Ault & Company’s best interest, +we could be forced to seek financing from other sources that would not necessarily be likely to provide us with equally favorable terms. +Other conflicts of interest +between us, on the one hand, and Ault & Company, on the other hand, may arise relating to commercial or strategic opportunities or +initiatives. Mr. Ault, as the controlling stockholder of Ault & Company, may not resolve such conflicts in our favor. For example, +we cannot assure you that Ault & Company would not pursue opportunities to provide financing to other entities whether or not it currently +has a relationship with such other entities. Furthermore, our ability to explore alternative sources of financing other than Ault & +Company may be constrained due to Mr. Ault’s vision for us and he may not wish for us to receive any financing at all other than +from entities that he controls. +Alzamend +Our relationship with Alzamend may expose us +to certain conflicts of interest. +In August 2020, Alzamend entered +into a securities purchase agreement with our company to sell a convertible promissory note of Alzamend, in the aggregate principal amount +of $50,000 and issue a 5-year warrant to purchase 16,667 of shares of its common stock. The convertible promissory note bears interest +at 8% per annum, which principal and all accrued and unpaid interest was due six months after the date of issuance. The principal and +interest earned on the convertible promissory note was convertible into shares of Alzamend’s common stock at $1.50 per share. The +exercise price of the warrant is $3.00 per share. +In December 2020, we provided +Alzamend $750,000 in short-term advances and in March of 2021 we entered into an agreement with Alzamend under which we purchased $10 +million worth of shares of Alzamend’s common stock. We paid for the last tranche of $4 million with a note on February 17, 2022, +which becomes due and payable on April 29, 2022. +Messrs. Horne and Nisser could +face a conflict of interest in that they serve on the board of directors of each of Alzamend and our company. +Avalanche +We have lent a substantial amount of funds +to Avalanche, a related party, whose ability to repay us is subject to significant doubt and it may not be in our stockholders’ +best interest to convert the notes into shares of Avalanche common stock even if we had a reasonably viable means of doing so. +On September 6, 2017, we entered +into a Loan and Security Agreement with Avalanche (as amended, the “AVLP Loan Agreement”) with an effective date of August +21, 2017 pursuant to which we will provide Avalanche a non-revolving credit facility. The AVLP Loan Agreement was increased to up to $20.0 +million in June of 2021 and extended to December 31, 2023. We current hold a convertible note issued to us by AVLP in the amount of $17.8 +million (the “AVLP Note”). +At December 31, 2020, we had +provided Avalanche with $11.3 million pursuant to the AVLP Loan Agreement. The warrants issued in conjunction with the non-revolving credit +facility entitles us to purchase up to 22,538,272 shares of Avalanche common stock at an exercise price of $0.50 per share for a period +of five years. The exercise price is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. +The warrants may be exercised for cash or on a cashless basis. +While Avalanche received funds +from a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of a convertible promissory +note to such third party (the “Third Party Note”), $2.7 million was used to pay an outstanding receivable due us and no amount +was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, Ault Alpha, an affiliate of ours, +repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. In consideration +therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note matures on June 30, 2022. +58 +There is doubt as to whether +Avalanche will be able to repay this amount on a timely basis, if at all, unless it generates significant net income from its operations +or receives additional financing from another source; even then, unless such financing consists solely of the issuance by Avalanche of +its equity securities, it will only add to the amount that Avalanche owes other parties, which would in all likelihood not be provided +unless we agreed to subordinate our right to repayment to such other third party source. +There is currently no liquid +market for the Avalanche common stock. Consequently, even if we were inclined to convert the debt owed us by Avalanche into shares of +its common stock, our ability to sell such shares would be severely limited. Avalanche is not current in its filings with the Commission +and is not required to register the shares of its common stock underlying the AVLP Note or any other loan arrangement we have made with +Avalanche described above +As a result, there is some +doubt as to whether Avalanche will ever have the ability to repay its debt to us, or if we convert the debt owed us by Avalanche into +shares of its common stock, our ability to convert such shares into cash through the sale of such shares would be severely limited until +such time, if ever, a liquid market for Avalanche’s common stock develops. If we are unable to recoup our investment in Avalanche +in the foreseeable future or at all, such failure would have a materially adverse effect on our financial condition and future prospects. +Originally, the loans we made to Avalanche +were secured by a lien on all of Avalanche’s assets. Presently, we only have a second priority interest. +Originally, the loans we made +to Avalanche were secured by a lien on all of Avalanche’s assets. When Avalanche entered into the exchange agreement with MTIX, +the former owners of MTIX were granted a first priority interest in all of MTIX’s assets, which constitute virtually all of Avalanche’s +assets and reduced our interest to that of a second position, greatly diminishing its value. Since our security interests have been reduced +to a second position, we will have no ability to use Avalanche’s assets to offset any default in Avalanche’s debt obligations +to us unless and until the other security interest is terminated, which would not occur until Avalanche’s debts to the senior creditor +has been repaid. We do not anticipate that Avalanche will repay its debts to this creditor within the foreseeable future and we will therefore +have no recourse should Avalanche default on its debts to us during this period of time. Any failure by Avalanche to repay us would therefore +have a materially adverse effect on our results of operations, financial condition and future prospects. +Milton C. Ault, III and William Horne, our +Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, Philou +is the controlling stockholder of Avalanche. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors, are also directors of Avalanche. In +addition, Philou is the controlling stockholder of Avalanche. Certain conflicts of interest between us, on the one hand, and Avalanche, +on the other hand, may arise relating to commercial or strategic opportunities or initiatives, in addition to the conflicts related to +the debt that Avalanche owes us. For example, Messrs. Ault and Horne may find it difficult to determine how to meet their fiduciary duties +to us as well as Avalanche, which could result in a less favorable result for us than would be the case if they were solely directors +of our company. Further, even if Messrs. Ault and Horne were able to successfully meet their fiduciary obligations to us and Avalanche, +the fact that they are members of the board of directors of both companies could attenuate their ability to focus on our business and +best interests, possibly to the detriment of both companies. Mr. Ault’s control of Philou through Ault & Company only enhances +the risk inherent in having Messrs. Ault and Horne serve as directors of both our company and Avalanche. +Risks Related to Our Business and Industry - Overview +If we fail to anticipate and adequately respond +to rapid technological changes in our industry, including evolving industry-wide standards, in a timely and cost-effective manner, our +business, financial condition and results of operations would be materially and adversely affected. +The markets in which we operate +are characterized by technological changes. Such changes, including evolving industry standards, changes in customer requirements and +new product introductions and enhancements, could render our products obsolete. Accordingly, we are required to constantly monitor and +anticipate technological changes in our industry and develop new product offerings and technologies or adapt or modify our existing offerings +and technologies to keep pace with technological advances in our industry and remain competitive. +59 +Our ability to implement +our business strategy and continue to grow our revenues will depend on a number of factors, including our continuing ability to: +● identify emerging technological trends in our current and target markets; +● identify additional uses for our existing technology to address customer needs in our current and future +markets; +● enhance our offerings by adding innovative features that differentiate our offerings from those of our +competitors; and +● design, develop, manufacture, assemble, test, market and support new products and enhancements in a timely +and cost-effective manner. +We believe that, to remain competitive in the +future, we will need to continue to invest significant financial resources in developing new offerings and technologies or to adapt or +modify our existing offerings and technologies, including through internal research and development, strategic acquisitions and joint +ventures or other arrangements. However, these efforts may be more costly than we anticipate and there can be no assurance that they will +be successful. +If we are unable to identify, attract, train +and retain qualified personnel, especially our design and technical personnel, our business and results of operations would be materially +and adversely affected and we may not be able to effectively execute our business strategy. +Our performance and future +success largely depends on our continuing ability to identify, attract, train, retain and motivate qualified personnel, including our +management, sales and marketing, finance and in particular our engineering, design and technical personnel. For example, we currently +have limited number of qualified personnel for the assembling and testing processes. We do not know whether we will be able to retain +all these personnel as we continue to pursue our business strategy. Our engineering, design and technical personnel represent a significant +asset. The competition for qualified personnel in our industries is intense and constrains our ability to attract qualified personnel. +The loss of the services of one or more of our key employees, especially of our key engineering, design and technical personnel, or our +inability to attract, retain and motivate qualified personnel could have a material adverse effect on our business, financial condition +and operating results. +Our future results will depend on our ability +to maintain and expand our existing sales channels and to build out marketing, business development and sales functions for the operating +subsidiaries. +To grow our legacy businesses, +we must add new customers for our products in addition to retaining and increasing sales to our current customers. Currently, only Relec, +the operating subsidiary that we acquired in November 2020, has an effective sales force focused on establishing relationships with customers +that we expect to endure over time. In other subsidiaries, we have historically relied on key executives to drive growth through return +business with existing customers. Building out marketing, business development and sales functions in all operating subsidiaries is critical +to drive significant growth in line with our strategic plans. While we perform certain of these activities ourselves, we may contract +for marketing services to improve our websites, manage public relations and optimize our social media presence. Failure to recruit and +retain the business development and sale personnel to execute on outreach and capture of new business, or the failure of those new hires +or marketing services to perform as expected, will limit our ability to achieve our growth targets. +We are dependent upon our ability, and our +contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, +many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As +a result, there is a global shortage of certain electronic or mineral components, which may extend our production lead-time and our production +costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, +even worse, redesign some of our products to support currently-available materials. Such redesign efforts may require certain regulatory +and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit +our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in +place, and issues may recur in the future. +In addition, some of our products +are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While we have had relationships +with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, +changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our +ability to manufacture our products. +60 +We depend +upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the +quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon a +few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or cancel their orders +scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, diversions in the capital +spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, +which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more +of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, +a substantial decrease in our revenues would likely result. We are dependent on the electronic equipment industry, and accordingly will +be affected by the impact on that industry of current economic conditions. +Substantially all of our existing +customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, +and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this +industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, +such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete +in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers to +manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant +manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture +our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing +costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures +on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing +components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our +subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition +to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations +or rescheduling of, orders or shipments, any of which would materially harm our business. +We outsource, and are dependent upon developer +partners for, the development of some of our custom design products. +We made an operational decision +to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the +custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer +specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where +the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability +to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +We face intense industry competition, price erosion and product +obsolescence, which, in turn, could reduce our profitability. +We operate in an industry +that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth +of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price +erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to +retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, +therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross +margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price +erosion in the future. +Our future results are dependent on our ability +to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell our products +through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and +distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as +with manufacturers’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered +into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business +with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which +would have an adverse effect on our revenues. +61 +We may not be able to procure necessary key +components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, +and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, +we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, our +suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that we require +to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build products for our customers +could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for +certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail +to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong +inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect +on our gross margins and on our results of operations. +Although we depend on sales of our legacy products +for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large portion +of our sales have historically been attributable to our legacy products. However, these sales are declining. Although we are unable to +predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward +pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent +on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and +sell new products such as custom design and value-added products. We cannot assure you that we will be able to expand our customer base, +increase unit sales volumes of existing products or develop, introduce and/or sell new products. +Failure of our information technology infrastructure +to operate effectively could adversely affect our business. +We depend heavily on information +technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption +could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal +course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory +restrictions relating to our international sales. +Some of our products are subject +to International Traffic In Arms Regulation (“ITAR”), which are interpreted, enforced and administered by the U.S. Department +of State. ITAR regulation controls not only the export, import and trade of certain products specifically designed, modified, configured +or adapted for military systems, but also the export of related technical data and defense services as well as foreign production. Any +delays in obtaining the required export, import or trade licenses for products subject to ITAR regulation and rules could have a material +adverse effect on our business, financial condition, and/or operating results. In addition, changes in U.S. export and import laws that +require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could +cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions +or charges imposed by the U.S. or any other country on our international sales or foreign subsidiary could have a materially adverse effect +on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the +Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program (“FMF”). Any such future sales +would be subject to these regulations. Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial +condition, and/or operating results. +We depend on international operations for a +substantial majority of our components and products. +We purchase a substantial +majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, +and tested by subcontractors located outside the U.S. These activities are subject to the uncertainties associated with international +business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange +fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, +or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect +on our business, financial condition, and/or operating results. +62 +We depend on international sales for a portion of our revenues. +Sales to customers outside +of North America accounted for 37% and 52% of net revenues for the years ended December 31, 2021 and 2020, respectively, and we expect +that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks +of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts +receivable, and currency restrictions. In addition, GWW supports our European and other international customers, distributors, and sales +representatives, and therefore is also subject to local regulation. International sales are also subject to the export laws and regulations +of the U.S. and other countries. +Because a significant portion of our revenues +and expenses is denominated in foreign currencies, fluctuations in exchange rates could have a material adverse effect on our operating +results. +We face foreign exchange risks +because a significant portion of our revenue and expenses is denominated in foreign currencies. Further, some suppliers to Enertec and +Relec require payment in U.S. dollars, which exposes us to risk. Generally, U.S. dollar strength adversely impacts the translation of +the portion of our revenue that is generated in foreign currencies into the U.S. dollar. For the years ended December 31, 2021 and +2020, approximately 35.9% and 46.9% of our revenue, respectively, was denominated in currencies other than U.S. dollars. Our results of +operations could also be negatively impacted by a strengthening of the U.S. dollar as a large portion of our costs are U.S. dollar denominated. +We also have foreign exchange risk exposure with respect to certain of our assets, that are denominated in currencies other than the functional +currency of our subsidiaries, and our financial results are affected by the re-measurement and translation of these non-U.S. currencies +into U.S. dollars, which is reflected in the effect of exchange rate changes on cash, cash equivalents, and restricted cash on the consolidated +statements of cash flows. For the years ended December 31, 2021 and 2020, the effects of exchange rates on our cash, cash equivalents, +and restricted cash totaled $266,000 and $123,000, respectively, due to fluctuations in exchange rates and the strengthening of the U.S. +dollar. While we may choose to enter into transactions to hedge portions of our foreign currency translation and balance sheet exposure +in the future, it is impossible to predict or eliminate the effects of foreign exchange rate exposure. Strengthening of the U.S. dollar +could materially adversely affect our results of operations and financial condition. +Our insurance coverage and indemnity may be +insufficient to cover potential liabilities we may face due to the risks inherent in the products and services we provide. +We are exposed to liabilities +that are unique to the products and services we provide. A significant portion of our business relates to designing, developing and manufacturing, +components, integrated assemblies and subsystems for advanced defense, medical, transportation, industrial, technology and communications +systems and products. New technologies associated with these systems and products may be untested or unproven. Components of certain of +the defense systems and products we develop are inherently dangerous. Failures of satellites, missile systems, air traffic control systems, +homeland security applications and aircraft have the potential to cause loss of life and extensive property damage. In most circumstances, +we may receive indemnification from the government end users of our defense offerings in the U.S., the U.K. and +Israel. In addition, failures of products and systems that we manufacture or distribute for medical devices, transportation controls or +industrial systems also have the potential to result in loss of life, personal injury and/or extensive property damage. +While we maintain insurance +for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and we may be forced to +bear substantial costs from an accident or incident. It also is not possible for us to obtain insurance to protect against all operational +risks and liabilities. Substantial claims resulting from an incident in excess of government indemnity and our insurance coverage would +harm our financial condition, results of operations and cash flows. Moreover, any accident or incident for which we are liable, even if +fully insured, could negatively affect our standing with our customers and the public, thereby making it more difficult for us to compete +effectively, and could significantly impact the cost and availability of adequate insurance in the future. +If we are unable to satisfy our customers’ +specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be +harmed. +Our customers demand that +our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying +such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance +and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products +to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such +required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and +costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, +any of which would harm our business. +63 +Some +of our business is subject to U.S. Government procurement laws and regulations . +We +must comply with certain laws and regulations relating to the formation, administration and performance of federal government contracts. +These laws and regulations affect how we conduct business with our federal government contracts, including the business that we do as +a subcontractor. In complying with these laws and regulations, we may incur additional costs, and non-compliance may lead to the assessment +of fines and penalties, including contractual damages, or the loss of business. +Failure to comply with anti-bribery, anti-corruption, +anti-money laundering laws, and similar laws, or allegations of such failure, could have a material adverse effect on our business, financial +condition and operating results. +We are subject to various +anti-bribery, anti-corruption, anti-money laundering laws, including the U.S. Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”), +the U.S. Travel Act, the USA PATRIOT Act, the United Kingdom Bribery Act 2010, the Proceeds of Crime Act 2002, Chapter 9 (sub-chapter +5) of the Israeli Penal Law, 1977, the Israeli Prohibition on Money Laundering Law–2000, and possibly other similar laws in countries +outside of the U.S. in which we conduct our business. Anti-corruption and anti-bribery laws have been enforced aggressively in recent +years and are interpreted broadly to generally prohibit companies, their employees, agents, representatives, business partners, and third-party +intermediaries from authorizing, offering, or providing, directly or indirectly, improper payments or benefits to recipients in the public +or private sector. +We, our employees, agents, +representatives, business partners and third-party intermediaries may have direct or indirect interactions with officials and employees +of government agencies or state-owned or affiliated entities and may be held liable for the corrupt or other illegal activities of these +employees, agents, representatives, business partners or third-party intermediaries even if we do not explicitly authorize such activities. +These laws also require that +we keep accurate records and maintain internal controls and compliance procedures designed to prevent any such actions. While we have +policies and procedures to address compliance with such laws, we cannot assure you that none of our employees, agents, representatives, +business partners or third-party intermediaries will take actions in violation of our policies and applicable law, for which we may be +ultimately held responsible. In addition, we may be held liable for violations committed of the FCPA or similar foreign laws by companies +that we acquire. +Any alleged or actual violation +of the FCPA or other applicable anti-bribery, anti-corruption laws, and anti-money laundering laws could result in whistleblower complaints, +investigations, enforcement actions, fines and other criminal or civil sanctions, adverse media coverage, loss of export privileges, or +suspension or termination of government contracts. Responding to any investigation or enforcement action would require significant attention +of our management and resources, including significant defense costs and other professional fees. Failure to comply with anti-bribery, +anti-corruption, anti-money laundering laws, and similar laws, or allegations of such failure, could therefore have a material adverse +effect on our business, results of operations, financial condition and future prospects. +Compliance with the regulations, standards, +and contractual obligations promulgated by the European Union related to privacy, data protection, and data security, may cause Gresham +Power and Relec to incur additional expenses and failure to comply with such obligations could harm our business and future results of +operations. +The European Union General +Data Protection Regulation (“GDPR”) contains robust obligations on data “controllers” and data “processors” +with heavy documentation requirements for data protection compliance programs that apply to both Gresham Power and Relec. Among other +requirements, the GDPR regulates the transfer of personal data subject to the GDPR to third countries that have not been found to provide +adequate protection to such personal data, including the U.S. In the U.K., the GDPR requires informed consent for disclosure of names, +transfer of email addresses, the use of cookies and direct electronic marketing. The GDPR also imposes conditions on obtaining valid consent +to transfer of any personal data that Gresham Power or Relec collect or process. Failure to comply with the GDPR could result in penalties +for noncompliance (including possible fines of up to the greater of £8.7 million and 2% of our global annual revenue for the preceding +financial year for the violations, as well as the right to compensation for financial or non-financial damages claimed by individuals +under Article 82 of the GDPR). +The U.K. has enacted a Data +Protection Act substantially implementing the GDPR, effective in May 2018, which was further amended to align more substantially with +the GDPR following Brexit. The latest revisions of the GDPR in the U.K. post-Brexit have resulted in even more stringent restrictions +on the transfer of data about a person. Data considered in the public domain in the U.S. now falls within the protections of GDPR, which +complicates documenting business, marketing, sales outreach, securing infrastructure, audit and business management. +64 +Compliance with the regulations, +standards, and contractual obligations promulgated by the U.K. related to privacy, data protection, and data security, may cause Gresham +Power and Relec to incur additional expenses and failure to comply with such obligations could harm our business and future results of +operations. +Risks Related to Our Business and Industry – Hotel Properties +We operate in a highly +competitive industry. +The +lodging industry is highly competitive. Our principal competitors are other owners and investors in full-service hotels as well as major +hospitality chains with well-established and recognized brands. Our hotels face competition for individual guests, group reservations +and conference business. We also compete against smaller hotel chains and independent and local hotel owners and operators. Additionally, +we face competition from peer-to-peer inventory sources that allow travelers to stay at homes and apartments booked from owners. New hotels +may be constructed, and these additions create new competitors, in some cases without corresponding increases in demand for hotel rooms. +Our competitors may have greater commercial, financial and marketing resources and more efficient technology platforms, which could allow +them to improve their properties and expand and improve their marketing efforts in ways that could affect our ability to compete for guests +effectively and adversely affect our revenues and profitability as well as limit or slow our future growth. +The +growth of internet reservation channels is another source of competition that could adversely affect our business. A significant percentage +of hotel rooms for individual customers are booked through internet travel intermediaries. As intermediary bookings increase, they may +be able to obtain higher commissions, reduced room rates or other significant contract concessions from our hotels. While internet travel +intermediaries traditionally have competed to attract transient business rather than group and convention business, in recent years they +have expanded their business to include marketing to large group and convention business. If that expansion continues, it could both divert +group and convention business away from our hotels and increase our cost of sales for group and convention business and materially adversely +affect our revenues and profitability. +Our franchisors and +brand managers require us to make capital expenditures pursuant to property improvement plans (“PIPs”), and any failure on +our part to make the expenditures required under the PIPs or to comply with brand standards could cause the franchisors or hotel brands +to terminate the franchise, management or operating lease agreements. +In +connection with our acquisition of the Properties in December 2021, our franchisors and brand managers required us to agree to undertake +PIPs in the amount of $13.7 million. If we do not satisfy the PIP renovation requirements, the franchisor or hotel brand may have the +right to terminate the applicable agreement. In addition, in the event that we are in default under any franchise agreement as a result +of our failure to comply with the PIP requirements, in general, we will be required to pay the franchisor liquidated damages, generally +equal to a percentage of gross room revenue for the preceding two-, three- or five-year period for the hotel or a percentage of gross +revenue for the preceding twelve-month period for all hotels operated under the franchised brand if the hotel has not been operating for +at least two years. In addition, our franchisors and brand managers may require that we make renovations to certain of our hotels in connection +with revisions to our franchise, management or operating lease agreements. In addition, upon regular inspection of our hotels, our franchisors +and hotel brands may determine that additional renovations are required to bring the physical condition of our hotels into compliance +with the specifications and standards each franchisor or hotel brand has developed. +All of our hotels +operate under a brand owned by Marriott or Hilton. Should either of these brands experience a negative event, or receive negative publicity, +our operating results may be harmed. +All +of our hotels are operated under nationally recognized brands, either Marriott or Hilton, which are among the most respected and widely +recognized brands in the lodging industry. As a result, a significant concentration of our success is dependent in part on the success +of Marriott and Hilton. Consequently, if market recognition or the positive perception of Marriott and/or Hilton is reduced or compromised, +the goodwill associated with our Marriott and/or Hilton branded hotels may be adversely affected, which may have an adverse effect on +our results of operations. Additionally, any negative perceptions or negative impact to operating results from any proposed or future +consolidations between nationally recognized brands could have an adverse effect on our results of operations. +65 +Our franchisors and +brand managers may change certain policies or cost allocations that could negatively impact our hotels. +Our +franchisors and brand managers incur certain costs that are allocated to our hotels subject to our franchise, management, or operating +lease agreements. Those costs may increase over time or our franchisors and brand managers may elect to introduce new programs that could +increase costs allocated to our hotels. In addition, certain policies, such as our third-party managers’ frequent guest programs, +may be altered resulting in reduced revenue or increased costs to our hotels. +Because our hotels +are operated under franchise agreements or are brand managed, termination of these franchise, management or operating lease agreements +could cause us to lose business at our hotels or lead to a default or acceleration of our obligations under certain of our debt instruments. +All +of our hotels are operated under franchise, management or operating lease agreements with franchisors or hotel management companies, such +as Marriott and Hilton. In general, under these arrangements, the franchisor or brand manager provides marketing services and room reservations +and certain other operating assistance, but requires us to pay significant fees to it and to maintain the hotel in a required condition. +If we fail to maintain these required standards, then the franchisor or hotel brand may terminate its agreement with us and obtain damages +for any liability we may have caused. Moreover, from time to time, we may receive notices from franchisors or the hotel brands regarding +our alleged non-compliance with the franchise agreements or brand standards, and we may disagree with these claims that we are not in +compliance. Any disputes arising under these agreements could also lead to a termination of a franchise, management or operating lease +agreement and a payment of liquidated damages. Such a termination may trigger a default or acceleration of our obligations under some +of our debt instruments. In addition, as our franchise, management or operating lease agreements expire, we may not be able to renew them +on favorable terms or at all. If we were to lose a franchise or hotel brand for a particular hotel, it could harm the operation, financing +or value of that hotel due to the loss of the franchise or hotel brand name, marketing support and centralized reservation system. Furthermore, +the loss of a franchise license at a particular hotel could harm our relationship with the franchisor or brand manager and cause us to +incur significant costs to obtain a new franchise license or brand management agreement for the particular hotel. Accordingly, if we lose +one or more franchise licenses or brand management agreements, it could materially and adversely affect our results of operations and +profitability as well as limit or slow our future growth. +Our hotels are geographically +concentrated and, accordingly, we could be disproportionately harmed by adverse changes to these markets, natural disasters, regulations, +or terrorist attacks. +Our +hotels are located in a single geographic market, which exposes us to greater risk to local economic or business conditions, changes in +hotel supply in this market, and other conditions than more geographically diversified hotel owners. An economic downturn, an increase +in hotel supply, a force majeure event, a natural disaster, changing weather patterns, a terrorist attack or similar event in this market +likely would cause a decline in the hotel market and adversely affect occupancy rates, the financial performance of our hotels and our +overall results of operations, which could be material, and could significantly increase our costs. +The need for business-related travel, and, +therefore, demand for rooms in our hotels may be adversely affected by the increased use of business-related technology. +During 2020 and 2021, the +COVID-19 pandemic caused a significant decrease in business-related travel as companies turned to virtual meetings in order to protect +the health and safety of their employees. While business transient demand improved in 2021 as compared to 2020, it remains well below +pre-pandemic levels. The increased use of teleconferencing and video-conference technology by businesses may continue in the future, which +could result in further decreases in business travel as companies become accustomed to the use of technologies that allow multiple parties +from different locations to participate in meetings without traveling to a centralized meeting location, such as our hotels. To the extent +that such technologies, or new technologies, play an increased role in day-to-day business interactions and the necessity for business-related +travel decreases, demand for hotel rooms may decrease and our hotels could be adversely affected. +Rising operating expenses or low occupancy +rates could reduce cash flow. +Our hotels, and any hotels +we may buy in the future, are and will be subject to operating risks common to the lodging industry in general. If any hotel is not occupied +at a level sufficient to cover our operating expenses, then we could be required to spend additional funds for that hotel’s operating +expenses. For example, during 2020 and 2021, operations at many hotels were either temporarily suspended or reduced due to the COVID-19 +pandemic, and hotel owners were required to fund hotel payroll expenses, maintenance expenses, fixed hotel costs such as ground rent, +insurance expenses, property taxes and scheduled debt payments. Hotels may be subject to increases in real estate and other tax rates, +utility costs, operating expenses including labor and employee-related benefits, insurance costs, repairs and maintenance and administrative +expenses, which could reduce cash flow. +66 +Laws and governmental regulations may restrict +the ways in which we use our hotel properties and increase the cost of compliance with such regulations. Noncompliance with such regulations +could subject us to penalties, loss of value of our properties or civil damages. +Our hotel properties are subject +to various federal, state and local laws relating to the environment, fire and safety and access and use by disabled persons. Under these +laws, courts and government agencies have the authority to require us, if we are the owner of a contaminated property, to clean up the +property, even if we did not know of or were not responsible for the contamination. These laws also apply to persons who owned a property +at the time it became contaminated. In addition to the costs of cleanup, environmental contamination can affect the value of a property +and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property. Under such environmental +laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, such +as a landfill or an incinerator, pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment. +Furthermore, various court +decisions have established that third parties may recover damages for injury caused by property contamination. For instance, a person +exposed to asbestos while staying in or working at a hotel may seek to recover damages for injuries suffered. Additionally, some of these +environmental laws restrict the use of a property or place conditions on various activities. For example, some laws require a business +using chemicals (such as swimming pool chemicals at our hotels) to manage them carefully and to notify local officials that the chemicals +are being used. +We could be responsible for +the types of costs discussed above. The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental +laws could be material and could reduce the funds available for distribution to our stockholders. Future laws or regulations may impose +material environmental liabilities on us, or the current environmental condition of our hotel properties may be affected by the condition +of the properties in the vicinity of our hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated +to us. +Our hotel properties are also +subject to the Americans with Disabilities Act (“ADA”). Under the ADA, all public accommodations must meet various federal +requirements related to access and use by disabled persons. Compliance with the ADA’s requirements could require removal of access +barriers and non-compliance could result in the U.S. government imposing fines or in private litigants’ winning damages. If we are +required to make substantial modifications to our hotels, whether to comply with the ADA or other changes in governmental rules and +regulations, our financial condition and results of operations could be harmed. In addition, we are required to operate our hotel properties +in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental +agencies and become applicable to our properties. +Risks Related to Our Business and Industry - Microphase +Microphase has a history of losses and our +future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on our business and the value of our +company. +Microphase has incurred losses +from operations during 2019. These losses are attributable to lower volumes of its products sold to major defense contractors partially +as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. While Microphase has been profitable, +to a certain extent, during 2020 and 2021, there is always the possibility that its results of operations could worsen in the future, +whether as a result of new outbreaks of COVID-19, supply chain issues or any of a number of other factors. Since the financial crisis +of 2008, Microphase has been significantly short of capital needed to acquire parts for production of its products to complete orders +for such products. At times, Microphase has not had the cash available to make advance payments for the purchase of parts, and then, as +a consequence, Microphase would not receive the parts from its vendors required to finish a customer order. This would then delay the +delivery of products to customers, and would also delay recognition of the resulting revenues and the receipt of cash from the customer. +Sometimes after experiencing a delay in delivery of an order from Microphase, the customer would not place its next order with Microphase, +resulting in a loss of business. +Microphase’s future +profitability depends upon many factors, including several that are beyond its control. These factors include, without limitation: +● economic dislocation, supply chain disruption or mandated shutdowns attributable to the COVID-19 pandemic; +● changes in the demand for its products and services; +● loss of key customers or contracts; +● the introduction of competitive products; +67 +● the failure to gain market acceptance of its new and existing products; and +● the failure to successfully and cost effectively develop, introduce and market new products, services +and product enhancements in a timely manner. +A large percentage of Microphase’s current +revenue is derived from prime defense contractors to the U.S. Government and its allies, and the loss of these relationships, a reduction +in U.S. Government funding or a change in U.S. Government spending priorities or bidding processes could have an adverse impact on its +business, financial condition, results of operations and cash flows. +Microphase is +highly dependent on sales to major defense contractors of the U.S. military and its allies, including Lockheed Martin, Raytheon, BAE Systems +and SAAB. The percentages of its revenue that were derived from sales to these named major defense contractors and directly to the U.S. +Government were 78.1% in fiscal 2021 and 50.7% in fiscal 2020. Therefore, any significant disruption or deterioration of Microphase’s +relationship with any such major defense contractors or the U.S. Government could materially reduce its revenue. During the year ended +December 31, 2020 there were five customers that accounted for more than 10% of Microphase’s sales: BAE Systems; Boeing/Argonist, +Inc.; DFAS Columbus Center; Raytheon Company and Sierra Nevada Corporation. During the year ended December 31, 2021 there were two customers +that accounted for more than 10% of Microphase’s sales: BAE Systems; and Lockheed Martin. Microphase’s competitors continuously +engage in efforts to expand their business relationships with the same major defense contractors and the U.S. Government and will continue +these efforts in the future, and the U.S. Government may choose to use other contractors. Microphase expects that a majority of the business +that it seeks will be awarded through competitive bidding. Microphase operates in highly competitive markets and its competitors have +more extensive or more specialized engineering, manufacturing and marketing capabilities than Microphase does in many areas, and Microphase +may not be able to continue to win competitively awarded contracts or to obtain task orders under multi-award contracts. Further, the +competitive bidding process involves significant cost and managerial time to prepare bids and proposals for contracts that may not be +awarded to Microphase, as well as the risk that Microphase may fail to accurately estimate the resources and costs required to fulfill +any contract awarded to us. Following any contract award, Microphase may experience significant expense or delay, contract modification +or contract rescission as a result of its competitors protesting or challenging contracts awarded to it in competitive bidding. Major +defense contractors to whom Microphase supplies components for systems must compete with other major defense contractors (to which Microphase +may not supply components) for military orders from the U.S. Government. +In addition, Microphase competes +with other policy needs, which may be viewed as more necessary, for limited resources and an ever-changing amount of available funding +in the budget and appropriations process. Budget and appropriations decisions made by the U.S. Government are outside of Microphase control +and have long-term consequences for its business. U.S. Government spending priorities and levels remain uncertain and difficult to predict +and are affected by numerous factors, including until recently sequestration (automatic, across-the-board U.S. Government budgetary spending +cuts), and the purchase of our products could be superseded by alternate arrangements. While the US defense budget was recently increased, +there can be no assurance that this increase will be maintained for the foreseeable future, particularly in light of the recent federal +expenditures the federal government has made with a view to ameliorating the economic damage suffered as a result of COVID-19. A change +in U.S. Government spending priorities or an increase in non-procurement spending at the expense of our programs, or a reduction in total +U.S. Government spending, could have material adverse consequences on Microphase’s future business. +Microphase’s U.S. Government contracts +may be terminated by the federal government at any time prior to their completion, which could lead to unexpected loss of sales and reduction +in Microphase’s backlog. +Under the terms of Microphase’s U.S. Government +contracts, the U.S. Government may unilaterally: +● terminate or modify existing contracts; +● reduce the value of existing contracts through partial termination; and +● delay the payment of Microphase’s invoices by government payment offices. +The federal government can +terminate or modify any of its contracts with Microphase or its prime contractors either for the federal government’s convenience, +or if Microphase or its prime contractors default, by failing to perform under the terms of the applicable contract. A termination arising +out of Microphase’s default could expose it to liability and have a material adverse effect on its ability to compete for future +federal government contracts and subcontracts. If the federal government or its prime contractors terminate and/or materially modify any +of Microphase’s contracts or if any applicable options are not exercised, Microphase’s failure to replace sales generated +from such contracts would result in lower sales and would adversely affect its earnings, which could have a material adverse effect on +Microphase’s business, results of operations and financial condition. Microphase’s backlog as of December 31, 2021 was +approximately $9.6 million. Microphase’s backlog could be adversely affected if contracts are modified or terminated. +68 +Microphase’s products with military applications +are subject to export regulations, and compliance with these regulations may be costly. +Microphase is required to +obtain export licenses before filling foreign orders for many of its products that have military or other governmental applications. U.S. +Export Administration regulations control technology exports like its products for reasons of national security and compliance with foreign +policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of a destination +country. Thus, any foreign sales of its products requiring export licenses must comply with these general policies. Compliance with these +regulations is costly, and these regulations are subject to change, and any such change may require Microphase to improve its technologies, +incur expenses or both in order to comply with such regulations. +Microphase depends on U.S. Government contracts +issued to major defense contractors, which often are only partially funded, subject to immediate termination, and heavily regulated and +audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could have an adverse impact +on Microphase’s business. +Over its lifetime, a U.S. +Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts and subcontracts. +The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts may be authorized and +appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year basis. Procurement funds are +typically made available for obligations over the course of one to three years. Consequently, programs often receive only partial funding +initially, and additional funds are designated only as Congress authorizes further appropriations. The termination of funding for a U.S. +Government program with respect to major defense contractors for which Microphase is a subcontractor would result in a loss of anticipated +future revenue attributable to that program, which could have an adverse impact on its operations. In addition, the termination of, or +failure to commit additional funds to, a program for which Microphase is a subcontractor could result in lost revenue and increase its +overall costs of doing business. +Generally, U.S. Government +contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to Microphase’s +contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed +must be refunded. Microphase has recorded contract revenues based on costs Microphase expect to realize upon final audit. However, Microphase +does not know the outcome of any future audits and adjustments, and Microphase may be required to materially reduce its revenues or profits +upon completion and final negotiation of audits. Negative audit findings could also result in termination of a contract, forfeiture of +profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting or subcontracting for a period of +time. +In addition, U.S. Government +contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s +convenience upon the payment only for work done and commitments made at the time of termination. Microphase can give no assurance that +one or more of the U.S. Government contracts with a major defense contractor under which Microphase provides component products will not +be terminated under these circumstances. Also, Microphase can give no assurance that it will be able to procure new contracts to offset +the revenue or backlog lost as a result of any termination of its U.S. Government contracts. Because a significant portion of Microphase’s +revenue is dependent on its performance and payment under its U.S. Government contracts, the loss of one or more large contracts could +have a material adverse impact on its business, financial condition, results of operations and cash flows. +Microphase’s government +business also is subject to specific procurement regulations and other requirements. These requirements, though customary in U.S. Government +contracts, increase its performance and compliance costs. In addition, these costs might increase in the future, thereby reducing Microphase’s +margins, which could have an adverse effect on its business, financial condition, results of operations and cash flows. Failure to comply +with these regulations and requirements could lead to fines, penalties, repayments, or compensatory or treble damages, or suspension or +debarment from U.S. Government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various +laws, including those related to procurement integrity, export control, U.S. Government security regulations, employment practices, protection +of the environment, accuracy of records, proper recording of costs and foreign corruption. The termination of a U.S. Government contract +or relationship as a result of any of these acts would have an adverse impact on Microphase’s operations and could have an adverse +effect on its standing and eligibility for future U.S. Government contracts. +69 +Microphase’s business could be negatively +impacted by cybersecurity threats and other security threats and disruptions. +As a U.S. Government defense +contractor, Microphase faces certain security threats, including threats to its information technology infrastructure, attempts to gain +access to its proprietary or classified information, threats to physical security, and domestic terrorism events. Microphase’s information +technology networks and related systems are critical to the operation of its business and essential to its ability to successfully perform +day-to-day operations. Microphase is also involved with information technology systems for certain customers and other third parties, +which generally face similar security threats. Cybersecurity threats in particular, are persistent, evolve quickly and include, but are +not limited to, computer viruses, attempts to access information, denial of service and other electronic security breaches. Microphase +believes that it has implemented appropriate measures and controls and has invested in skilled information technology resources to appropriately +identify threats and mitigate potential risks, but there can be no assurance that such actions will be sufficient to prevent disruptions +to mission critical systems, the unauthorized release of confidential information or corruption of data. A security breach or other significant +disruption involving these types of information and information technology networks and related systems could: +● disrupt the proper functioning of these networks and systems and therefore its operations and/or those +of certain of its customers; +● result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of, proprietary, +confidential, sensitive or otherwise valuable information of Microphase or its customers, including trade secrets, which others could +use to compete against Microphase or for disruptive, destructive or otherwise harmful purposes and outcomes; +● compromise national security and other sensitive government functions; +● require significant management attention and resources to remedy the damages that result; +● subject Microphase to claims for breach of contract, damages, credits, penalties or termination; and +● damage Microphase’s reputation with its customers (particularly agencies of the U.S. Government) +and the public generally. +Any or all of the foregoing +could have a negative impact on its business, financial condition, results of operations and cash flows. Compliance with Defense Department +requirements for information security require Microphase to invest significant resources to implement and maintain cyber defenses against +compromise of information technology architecture, malicious attacks and data breaches. +Microphase enters into fixed-price contracts +that could subject it to losses in the event of cost overruns or a significant increase in inflation. +Microphase has a number of +fixed-price contracts which allow it to benefit from cost savings but subject it to the risk of potential cost overruns, particularly +for firm fixed-price contracts, because Microphase assumes the entire cost burden. If its initial estimates are incorrect, Microphase +can lose money on these contracts. U.S. Government contracts can expose Microphase to potentially large losses because the U.S. Government +can hold Microphase responsible for completing a project or, in certain circumstances, paying the entire cost of its replacement by another +provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. Because many of these +contracts involve new technologies and applications, unforeseen events such as technological difficulties, fluctuations in the price of +raw materials, problems with its suppliers and cost overruns, can result in the contractual price becoming less favorable or even unprofitable +to Microphase. The U.S. and other countries also may experience a significant increase in inflation. A significant increase in inflation +rates could have a significant adverse impact on the profitability of these contracts. Furthermore, if Microphase does not meet contract +deadlines or specifications, Microphase may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated +damages or suffer major losses if the customer exercises its right to terminate. In addition, some of its contracts have provisions relating +to cost controls and audit rights, and if Microphase fails to meet the terms specified in those contracts Microphase may not realize their +full benefits. Microphase’s results of operations are dependent on its ability to maximize its earnings from its contracts. Cost +overruns could have an adverse impact on its financial results. +Compliance with the regulations, standards, +and contractual obligations related to privacy, data protection, and data security, may cause us to incur additional expenses and failure +to comply with such obligations could harm our business and future results of operations. +We expect that the regulatory +framework for privacy, data protection and data security will continue to evolve, which may result in additional operating costs for internal +compliance and risks to our business. Nearly all of Microphase’s current contracts include provisions that require compliance with +detailed cyber security standards laid out in NIST 800-171, which mandates implementation of security controls to protect Microphase’s +information systems from compromise, malicious attacks and/or data breaches. Microphase must maintain a System Security Plan with a Plan +of Action & Milestones for any controls not yet implemented. To continue doing business with the DoD or major prime contractors working +with DoD, Microphase must ultimately achieve Cybersecurity Model Maturity Certification not later than 2026. In addition, Microphase maintains +a certified restricted area and must obtain and maintain authority to operate equipment to perform work on classified projects. Compliance +with all of these mandates will require Microphase to invest substantial resources to implement, maintain and monitor information systems +security controls, facility clearances, personnel clearance and authorities to operate classified systems, which adds to the costs of +operating the business. +70 +Risks Related to Our Business and Industry - Enertec +Potential political, economic and military +instability in Israel could adversely affect our operations. +A significant portion +of our business is conducted through Enertec, our Israeli subsidiary. Accordingly, political, economic and military conditions in Israel +and the surrounding region may directly affect our Israeli operations. In recent years, Israel has been involved in sporadic armed conflicts +with Hamas, an Islamist terrorist group that controls the Gaza Strip, with Hezbollah, an Islamist terrorist group that controls large +portions of Southern Lebanon, and with Iranian-backed military forces in Syria. Some of these hostilities were accompanied by missile +strikes from the Gaza Strip against civilian targets in various parts of Israel, including areas in which our facilities are located, +and negatively affected business conditions in Israel. The change in the U.S. Presidency may continue to change the dynamics in the Middle +East as forces hostile to the existence of Israel seek to reverse the recent stability and commercial opportunities created by the Abraham +Accords. For example, there have been increasing concerns related to a potential attack by Iran. The tension between Israel and Iran and/or +these groups may escalate in the future and turn even more violent, which could affect the Israeli economy in general and us in particular. +Our commercial insurance does +not cover losses that may occur as a result of events associated with war and terrorism. Although the Israeli government currently covers +the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government +coverage will be maintained or that it will sufficiently cover our potential damages. Any losses or damages incurred by us could have +a material adverse effect on our business. +In addition, Israel-based +companies and companies doing business with Israel have been the subject of an economic boycott by members of the Arab League and certain +other predominantly Muslim countries since Israel’s establishment. Although Israel has entered into various agreements with certain +Arab countries and the Palestinian Authority, and various declarations have been signed in connection with efforts to resolve some of +the economic and political problems in the Middle East, we cannot predict whether or in what manner these problems will be resolved. Wars +and acts of terrorism have resulted in significant damage to the Israeli economy, including reducing the level of foreign and local investment. +Many of our Enertec employees are obligated +to perform military reserve duty in Israel, which could have a disruptive impact on our business. +Generally, Israeli adult male +and certain female citizens and permanent residents are obligated to perform annual military reserve duty in the Israel Defense Forces +up to a specified age. They also may be called to active military duty at any time under emergency circumstances. These military service +obligations could have a disruptive impact on our business, if hostilities develop in the future. +Enertec may become subject to claims for remuneration +or royalties for assigned service invention rights by its employees, which could result in litigation and harm our business. +A significant portion of the +intellectual property covered by Enertec’s products has been developed by Enertec’s employees in the course of their employment +for Enertec. Under the Israeli Patent Law, 5727-1967, or the Patent Law, and recent decisions by the Israeli Supreme Court and the Israeli +Compensation and Royalties Committee, a body constituted under the Patent Law, Israeli employees may be entitled to remuneration for intellectual +property that they develop for us unless they explicitly waive any such rights. To the extent that Enertec is unable to enter into agreements +with its future employees pursuant to which they agree that any inventions created in the scope of their employment or engagement are +owned exclusively by Enertec (as it has done in the past), Enertec may face claims demanding remuneration. As a consequence of such claims, +Enertec could be required to pay additional remuneration or royalties to its current and former employees, or be forced to litigate such +claims, which could negatively affect its business. +71 +Risks Related to Our Business and Industry – Relec +The third parties on which we rely to supply +certain products are located outside the United States. +Relec distributes products +from foreign manufacturers located in Europe, Asia and North America. Our future operating results will depend, among other things, on +our ability to continue to rely on these arrangements. If we are no longer able to rely on these or other similar arrangements for the +supply of certain products, or if our cost of relying on such arrangements materially increases, as the result of the imposition of or +changes in customs, tariffs, quotas, trade barriers, or other trade protection measures, or otherwise, it could have a materially adverse +effect on our business, financial condition, and operating results. +Our strategic focus on our custom power supply +and display solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic +focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power +supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s +requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards +may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction +of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply +solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a +series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may +not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market +or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, +including those involving our personnel, which may negatively impact quarterly earnings and profitability as we account for severance +and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing +our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, +limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire +and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +Risks Related to Ownership of Our Common +Stock +If we do not continue +to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +The +listing of our common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for continued +listing. While we are presently in compliance with all such conditions, it is possible that we will fail to meet one or more of these +conditions in the future. +If +we were to fail to meet a NYSE American listing requirement, we may be subject to delisting by the NYSE American. In the event our common +stock is no longer listed for trading on the NYSE American, our trading volume and share price may decrease and we may experience further +difficulties in raising capital which could materially affect our operations and financial results. Further, delisting from the NYSE American +could also have other negative effects, including potential loss of confidence by partners, lenders, suppliers and employees and could +also trigger various defaults under our lending agreements and other outstanding agreements. Finally, delisting could make it harder for +us to raise capital and sell securities. You may experience future dilution as a result of future equity offerings. In order to raise +additional capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable +for our common stock. +Our common stock price is volatile; volatility +in our common stock price may subject us to securities litigation. +Our common stock is listed +on the NYSE American. In the past, our trading price has fluctuated widely, depending on many factors that may have little to do with +our operations or business prospects. During the past 52-week period (through April 11, 2022), our stock closed at prices between $3.70 +per share and $0.50 per share, as reported on Nasdaq.com. On April 11, 2022, the price of our common stock closed at $0.58 per share. +72 +Stock +markets, in general, have experienced, and continue to experience, significant price and volume volatility, and the market price of our +common stock may continue to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased +volatility, coupled with depressed economic conditions, could continue to have a depressive effect on the market price of our common stock. +The following factors, many of which are beyond our control, may influence our stock price: +● the status of our growth strategy including the development of new products with any proceeds we may be +able to raise in the future; +● announcements of technological or competitive developments; +● announcements or expectations of additional financing efforts; +● our ability to market new and enhanced products on a timely basis; +● changes in laws and regulations affecting our business; +commencement of, or involvement in, +litigation involving us; +● regulatory developments affecting us, our customers or our competitors; +● announcements regarding patent or other intellectual property litigation or the issuance of patents to +us or our competitors or updates with respect to the enforceability of patents or other intellectual property rights generally in the +U.S. or internationally; +● actual or anticipated fluctuations in our quarterly financial results or the quarterly financial results +of companies perceived to be similar to us; +● changes in the market’s expectations about our operating results; +● our operating results failing to meet the expectations of securities analysts or investors in a particular +period; +● changes in the economic performance or market valuations of our competitors; +● additions or departures of our executive officers; +● sales or perceived sales of our common stock by us, our insiders or our other stockholders; +● share price and volume fluctuations attributable to inconsistent trading volume levels of our shares; +and +● general economic, industry, political and market conditions and overall fluctuations in the financial +markets in the U.S. and abroad, including as a result of ongoing COVID-19 pandemic. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock +and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of a company’s +securities, stockholders have often instituted securities class action litigation against that company. If we were involved in a class +action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense +and, whether or not adversely determined, have a material adverse effect on our business, financial condition, results of operations and +prospects. +We have a substantial +number of convertible notes, warrants, options and preferred stock outstanding that could affect our price. +Due +to a number of financings, we have a substantial number of shares that are subject to issuance pursuant to outstanding convertible debt, +warrants and options. These conversion prices and exercise prices range from $0.88 to $2,000 per share of common stock. As of the date +of this Annual Report, the number of shares of common stock subject to convertible notes, warrants, options, restricted stock grants, +and preferred stock were 165,000, 20,014,787, 6,395,919, 2,062,504 and 2,232, respectively. The issuance of common stock pursuant to convertible +notes, warrants, options and preferred stock at conversion or exercise prices less than market prices may have the effect of limiting +an increase in market price of our common stock until all of these underling shares have been issued. +The issuance of shares +of our Class B common stock to our management or others could provide such persons with voting control leaving our other stockholders +unable to elect our directors and the holders of our shares of common stock will have little influence over our Management. +Although +there are currently no shares of our Class B common stock issued and outstanding, our certificate of incorporation authorizes the issuance +of 25,000,000 shares of Class B common stock. Each share of Class B common stock provides the holder thereof with ten (10) votes on all +matters submitted to a stockholder vote. Our certificate of incorporation does not provide for cumulative voting for the election of directors. +Any person or group who controls or can obtain more than 50% of the votes cast for the election of each director will control the election +of directors and the other stockholders will not be able to elect any directors or exert any influence over management decisions. As a +result of the super-voting rights of our shares of Class B common stock, the issuance of such shares to our management or others could +provide such persons with voting control and our other stockholders will not be able to elect our directors and will have little influence +over our management. While we are listed on the NYSE American or any other national securities exchange it is highly unlikely that we +would issue any shares of Class B common stock as doing so would jeopardize our continued listing on any such exchange. However, if were +to be delisted for some other reason and our shares of Class A common stock trade on an over-the-counter market, then we would face no +restriction on issuing shares of Class B common stock. +73 +General Risk Factors +Our limited operating history makes it difficult +to evaluate our future business prospects and to make decisions based on our historical performance . +Although our executive officers +have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our current business +until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate our business on the +basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future results based upon our historical +data. Reliance on our historical results may not be representative of the results we will achieve, and for certain areas in which we operate, +principally those unrelated to defense contracting, will not be indicative at all. Because of the uncertainties related to our lack of +historical operations, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in sales, product costs +or expenses. If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, +which may result in a decline in our stock price. +Deterioration of global economic conditions +could adversely affect our business . +The global economy and capital +and credit markets have experienced exceptional turmoil and upheaval over the past several years. Ongoing concerns about the systemic +impact of potential long-term and widespread recession and potentially prolonged economic recovery, volatile energy costs, fluctuating +commodity prices and interest rates, volatile exchange rates, geopolitical issues, including the recent outbreak of armed conflict in +Ukraine, natural disasters and pandemic illness, instability in credit markets, cost and terms of credit, consumer and business confidence +and demand, a changing financial, regulatory and political environment, and substantially increased unemployment rates have all contributed +to increased market volatility and diminished expectations for many established and emerging economies, including those in which we operate. +Furthermore, austerity measures that certain countries may agree to as part of any debt crisis or disruptions to major financial trading +markets may adversely affect world economic conditions and have an adverse impact on our business. These general economic conditions could +have a material adverse effect on our cash flow from operations, results of operations and overall financial condition. +The availability, cost and +terms of credit also have been and may continue to be adversely affected by illiquid markets and wider credit spreads. Concern about the +stability of the markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors +to reduce credit to businesses and consumers. These factors have led to a decrease in spending by businesses and consumers over the past +several years, and a corresponding slowdown in global infrastructure spending. +Continued uncertainty in the +U.S. and international markets and economies and prolonged stagnation in business and consumer spending may adversely affect our liquidity +and financial condition, and the liquidity and financial condition of our customers, including our ability to access capital markets and +obtain capital lease financing to meet liquidity needs. +No assurance of successful expansion of operations. +Our significant increase in +the scope and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher operating +expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make significant demands +on our management, finances and other resources. Our ability to manage the anticipated future growth, should it occur, will depend upon +a significant expansion of our accounting and other internal management systems and the implementation and subsequent improvement of a +variety of systems, procedures and controls. We cannot assure that significant problems in these areas will not occur. Failure to expand +these areas and implement and improve such systems, procedures and controls in an efficient manner at a pace consistent with our business +could have a material adverse effect on our business, financial condition and results of operations. We cannot assure that attempts to +expand our marketing, sales, manufacturing and customer support efforts will succeed or generate additional sales or profits in any future +period. As a result of the expansion of our operations and the anticipated increase in our operating expenses, along with the difficulty +in forecasting revenue levels, we expect to continue to experience significant fluctuations in its results of operations. +74 +If we fail to establish and maintain an effective +system of internal control over financial reporting, we may not be able to report our financial results accurately or prevent fraud. Any +inability to report and file our financial results accurately and timely could harm our reputation and adversely impact the trading price +of our common stock. +Effective internal control +over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial +reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, +and our business and reputation with investors may be harmed. As a result, our small size and any current internal control deficiencies +may adversely affect our financial condition, results of operations and access to capital. We have carried out an evaluation under the +supervision and with the participation of our management, including our principal executive officer and principal financial officer, of +the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent period covered +by this report. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure +controls and procedures were not effective at the reasonable assurance level due to the material weakness described below. +A material weakness is a deficiency, +or a combination of deficiencies, within the meaning of Public Company Accounting Oversight Board (“PCAOB”) Audit Standard +No. 5, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual +or interim financial statements will not be prevented or detected on a timely basis. Management has identified the following material +weakness which has caused management to conclude that as of December 31, 2021 our internal control over financial reporting (“ICFR”) +was not effective at the reasonable assurance level: +We do not have sufficient +resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial +reporting, including fair value estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting +duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, +the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of +our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the resulting +control deficiency represented a material weakness. +We are currently working to +improve and simplify our internal processes and implement enhanced controls to address the material weakness in our internal control over +financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. This material weakness will not be considered +to be remediated until the applicable remediated controls are operating for a sufficient period of time and management has concluded, +through testing, that these controls are operating effectively. +If our accounting +controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We +evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and annually review and evaluate our internal control +over financial reporting in order to comply with the Commission’s rules relating to internal control over financial reporting adopted +pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent +or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls +may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such +internal control, we may be subject to regulatory sanctions, and our reputation may decline. +Our internal computer +systems may fail or suffer security breaches, which could result in a material disruption of our operations . +Like +any other business, we rely on e-mail and other digital communications methods as part of our normal operations. As such, our internal +computer systems and servers could fail or suffer security breaches, possibly resulting in a material disruption to our operations. The +secure operation of our IT networks and systems as well as the secure processing and maintenance of information is critical to our operations +and business strategy. Notwithstanding these priorities, we have experienced attempts at cybercrime such as phishing and other electronic +fraud, including efforts to misdirect payments to imposter vendors and service providers. After experiencing a financial loss due to e-mail +fraud in November 2021, we have instituted greater internal controls and procedures, both electronic and non-electronic, to combat such +fraudulent conduct. We also maintain an insurance policy to cover any losses or injuries suffered from cybercrime of this nature; however, +it may not be sufficient to cover all damages. Despite our efforts, attempts at fraud such as spoofed e-mails, requests for payment and +similar deceptions have become commonplace in the world of e-commerce and are expected to continue. If we are unable to prevent such security +breaches in the future, these events or circumstances could materially and adversely affect our operations, financial condition and operating +results and impair our ability to execute our business strategy. +75 +We face significant competition, including changes in pricing. +The markets for our products +are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing resources, plus +experience in research and development, and compete with us by offering lower prices. Competitors could develop new technologies that +compete with our products to achieve a lower unit price. If a competitor develops lower cost and/or superior technology or cost-effective +alternatives to our products and services, our business could be seriously harmed. +The markets for some of our +products are also subject to specific competitive risks because these markets are highly price sensitive. Our competitors have competed +in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering our prices. This would +reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also impact sales and aggravate +losses. +Many of our competitors are larger and have +greater financial and other resources than we do. +Our products compete and will +compete with similar if not identical products produced by our competitors. These competitive products could be marketed by well-established, +successful companies that possess greater financial, marketing, distribution personnel, and other resources than we do. Using said resources, +these companies can implement extensive advertising and promotional campaigns, both generally and in response to specific marketing efforts +by competitors. They can introduce new products to new markets more rapidly. In certain instances, competitors with greater financial +resources may be able to enter a market in direct competition with us, offering attractive marketing tools to encourage the sale of products +that compete with our products or present cost features that consumers may find attractive. +Our growth strategy is subject to a significant +degree of risk. +Our +growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition +targets or made a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. Therefore, +we may lose our investment in the event that these companies’ businesses do not develop as planned or that they are unable to achieve +the anticipated cost efficiencies or reduction of losses. +Further, +in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement our +plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that provide +revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development and investments +will produce sufficient revenues to offset these increases in expenditures. +Our business and operations are growing rapidly. +If we fail to effectively manage our growth, our business and operating results could be harmed . +We have experienced, and may +continue to experience, rapid growth in our operations. This has placed, and may continue to place, significant demands on our management, +operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products and services could suffer, +which could negatively affect our operating results. To effectively manage our growth, we must continue to improve our operational, financial +and management controls and reporting systems and procedures. These systems improvements may require significant capital expenditures +and management resources. Failure to implement these improvements could hurt our ability to manage our growth and our financial position. +Our operating results may vary from quarter to quarter. +Our operating results have +in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in +magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products +in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or +fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven +by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you +that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of +large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, +and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. +The loss or deferral of one or more significant sales in a quarter could harm our operating results for such quarter. It is possible that, +in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the +event adverse conditions prevail, the market price of our common stock may decline significantly. +76 +Changes in the U.S. tax and other laws and regulations may adversely +affect our business. +The U.S. Government may revise +tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, including modifications +that could reduce the profits that we can effectively realize from our international operations, or that could require costly changes +to those operations, or the way in which they are structured. For example, the effective tax rates for most U.S. companies reflect the +fact that income earned and reinvested outside the U.S. is generally taxed at local rates, which may be much lower than U.S. tax rates. +If we expand abroad and there are changes in tax laws, regulations or interpretations that significantly increase the tax rates on non-U.S. +income, our effective tax rate could increase and our profits could be reduced. If such increases resulted from our status as a U.S. company, +those changes could place us at a disadvantage to our non-U.S. competitors if those competitors remain subject to lower local tax rates. +Our sales and profitability may be affected by changes in +economic, business and industry conditions . +If the economic climate in +the U.S. or abroad deteriorates, customers or potential customers could reduce or delay their technology investments. Reduced or delayed +technology and entertainment investments could decrease our sales and profitability. In this environment, our customers may experience +financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and professional services. +This may lead to longer sales cycles, delays in purchase decisions, payment and collection, and can also result in downward price pressures, +causing our sales and profitability to decline. In addition, general economic uncertainty and general declines in capital spending in +the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and the markets +we serve. There are many other factors which could affect our business, including: +● The introduction and market acceptance of new technologies, products and services; +● New competitors and new forms of competition; +● The size and timing of customer orders (for retail distributed physical product); +● The size and timing of capital expenditures by our customers; +● Adverse changes in the credit quality of our customers and suppliers; +● Changes in the pricing policies of, or the introduction of, new products and services by us or our competitors; +● Changes in the terms of our contracts with our customers or suppliers; +● The availability of products from our suppliers; and +● Variations in product costs and the mix of products sold. +These +trends and factors could adversely affect our business, profitability and financial condition and diminish our ability to achieve our +strategic objectives. +The sale of our products is dependent upon +our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively +narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance +by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to +satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our +ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, +and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, +including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place +of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products +and adversely affect the revenues from such products. +77 +Our limited ability to protect our proprietary +information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property +rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist +entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, +trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual +property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior +to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent +as the laws of the U.S. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, +we may be required to institute legal proceedings, which would be costly and would divert our resources from the development of our business. +If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results +could be adversely affected. +Although we attempt to avoid +infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and +claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party +proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require +us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to +us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the U.S. +or abroad. +If we ship products that contain defects, the +market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, +and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have +been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, +error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, +resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In +addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the +use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. +Although we maintain product liability insurance, it may not be adequate. +The rights of the holders of common stock may +be impaired by the potential issuance of preferred stock. +Our certificate of incorporation +gives our Board the right to create new series of preferred stock. As a result, the Board may, without stockholder approval, issue preferred +stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting power and equity interest +of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote per share, could be utilized +as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect +the price of our common stock. We may issue shares of preferred stock in the future. +The requirements of being a public company +may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company and +subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among other +things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act +requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial reporting. +For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of our internal controls +structure and procedures for financial reporting. Section 404 compliance may divert internal resources and will take a significant +amount of time and effort to complete. If we fail to maintain compliance under Section 404, or if our internal control over financial +reporting continues to not be effective as defined under Section 404, we could be subject to sanctions or investigations by the NYSE +American, the Commission, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could +cause a decline in the market price of our common stock. Any failure of our internal controls could have a material adverse effect on +our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could +harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent +auditors. We may need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing +obligations as a public company, particularly if we become fully subject to Section 404 and its auditor attestation requirements, which +will increase costs. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives +and to meeting the obligations that are associated with being a public company, which may divert attention from other business concerns, +which could have a material adverse effect on our business, financial condition and results of operations. +78 +We have identified material weaknesses in our +internal control over financial reporting and may identify additional material weaknesses in the future or otherwise fail to maintain +an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to +meet our periodic reporting obligations. +We are required to comply with certain provisions +of Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”). Section 404 requires that we document and test our +internal control over financial reporting and issue management’s assessment of our internal control over financial reporting. Management +assessed the effectiveness of our internal control over financial reporting as of December 31, 2021. In making this assessment, we used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated +Framework. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that +there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or +detected on a timely basis. Based on our assessment, as of December 31, 2021, we concluded that our internal control over financial reporting +contained material weaknesses. +The weakness will not be considered remediated, +however, until the applicable controls operate for a sufficient period of time and our management has concluded, through testing, that +these controls are operating effectively. If we fail to comply with the requirements of Section 404 of the Sarbanes-Oxley Act, the accuracy +and timeliness of the filing of our annual and quarterly reports may be materially adversely affected and could cause investors to lose +confidence in our reported financial information, which could have a negative effect on the trading price of our common stock. In addition, +a material weakness in the effectiveness of our internal control over financial reporting could result in an increased chance of fraud +and the loss of customers, reduce our ability to obtain financing and require additional expenditures to comply with these requirements, +each of which could have a material adverse effect on our business, results of operations and financial condition. +If we fail to comply with the rules under +the Sarbanes-Oxley Act of 2002 related to accounting controls and procedures, or if we discover material weaknesses and deficiencies in +our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more difficult. +If we fail to comply with +the rules under the Sarbanes-Oxley Act of 2002 related to disclosure controls and procedures, or, if we discover material weaknesses +and other deficiencies in our internal control and accounting procedures, our stock price could decline significantly and raising capital +could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our +internal control over financial reporting. If material weaknesses or significant deficiencies are discovered or if we otherwise fail to +achieve and maintain the adequacy of our internal control, we may not be able to ensure that we can conclude on an ongoing basis that +we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, +effective internal controls are necessary for us to produce reliable financial reports and are important to helping prevent financial +fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors +could lose confidence in our reported financial information, and the trading price of our common stock could drop significantly. +If securities or industry analysts do not publish +research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading +volume could decline. +The trading market for our +common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. Our +research coverage by industry and financial analysts is currently limited. Even if our analyst coverage increases, if one or more of the +analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our +company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock +price or trading volume to decline. +The elimination of monetary liability against +our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, officers +and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees. +Our certificate of incorporation +contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders for damages for the +breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have contractual indemnification +obligations under any future employment agreements with our officers. The foregoing indemnification obligations could result in us incurring +substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. +These provisions and the resulting costs may also discourage us from bringing a lawsuit against directors and officers for breaches of +their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and +officers even though such actions, if successful, might otherwise benefit us and our stockholders. +79 +We do not anticipate paying dividends on our +common stock and, accordingly, stockholders must rely on stock appreciation for any return on their investment. +We have never declared or +paid cash dividends on our common stock and do not expect to do so in the foreseeable future. The declaration of dividends is subject +to the discretion of our Board and will depend on various factors, including our operating results, financial condition, future prospects +and any other factors deemed relevant by our Board. You should not rely on an investment in our company if you require dividend income +from your investment in our company. The success of your investment will likely depend entirely upon any future appreciation of the market +price of our common stock, which is uncertain and unpredictable. There is no guarantee that our common stock will appreciate in value. +ITEM 1B. UNRESOLVED STAFF COMMENTS +Not applicable. +ITEM 2. PROPERTIES +Our corporate headquarters +office utilizes 9,560 square feet of leased office space in Las Vegas, Nevada. Our Las Vegas leases commenced in January 2021 and August +2021, and expire in December 2022 and August 2024, respectively. The annual base rent under the leases, payable on a monthly basis, was +approximately $272,000 during 2021. +We also lease additional corporate +offices in Costa Mesa, California and New York, New York. Our leases expire between April 2023 and December 2024. The annual base rent +under the leases, payable on a monthly basis, was approximately $119,000 during 2021. +We own a 617,000 square foot +data center in Dowagiac, Michigan, in which we operate our cryptocurrency mining operations for our BNI segment, in addition to renting +commercial office and warehouse space. +Our GWW segment leases 28,068 +square feet of office, engineering, laboratory and warehouse space in Scottsdale, Arizona and Shelton, Connecticut. Our leases expire +between September 2022 and May 2026. The annual base rent under the leases, payable on a monthly basis, was approximately $343,000 during +2021. +Our TOGI segment leases 40,850 +square feet or office, engineering, laboratory and warehouse space in Milpitas, California, and Sonora, California. Our leases expire +between September 2022 and November 2024. The annual base rent under the leases, payable on a monthly basis, was approximately $133,000 +during 2021. +Our real estate segment owns +and operates three hotels in Middleton, Wisconsin, a hotel and undeveloped land in Rockford, Illinois, all of which are subject to a mortgage, +and a parcel of land in St. Peterburg, Florida. +We also lease facilities internationally. +In September 2010, our wholly owned subsidiary, Gresham Power, entered into a fifteen-year lease for its 25,000 square-foot facility in +Salisbury, the U.K. , where it designs, develops, manufactures, markets and distributes commercial +and military power products for the European market. Sales and service support staff for its European network of distributors are located +within the building together with other functions, such as engineering and administration. Gresham Power Electronics’ rent expense +is approximately $11,600 per month, and Gresham Power Electronics exercised the option to extend the lease through September 2024. Further, +in June 2021, Enertec entered into a five-year lease with an option to extend the lease for an additional five-year term for its 32,900 +square-foot facility in Karmiel, Israel, where it manufactures specialized electronic systems for the Israel military market. Enertec’s +rent expense on the initial five-year lease is approximately $27,000 per month, In November 2020, we acquired Relec. In July 2020, +Relec entered into a ten-year lease for its 7,490 square-foot facility in Dorset, the U.K. , where +it markets and distributes power electronics and display solutions for mission critical rail, industrial, medical, telecoms and military +applications. Relec’s rent expense is approximately $5,000 per month. +We currently anticipate that +the current leased space will be sufficient to support our current and foreseeable future needs. +80 +ITEM 3. LEGAL PROCEEDINGS +Blockchain Mining Supply and Services, Ltd. +On November 28, 2018, Blockchain +Mining Supply and Services, Ltd. (“Blockchain Mining”) a vendor who sold computers to our subsidiary, filed a Complaint (the +“Complaint”) in the United States District Court for the Southern District of New York against us and our subsidiary, Digital +Farms, Inc. (f/k/a Super Crypto Mining, Inc.), in an action captioned Blockchain Mining Supply and Services, Ltd. v. Super Crypto Mining, +Inc. and DPW Holdings, Inc. , Case No. 18-cv-11099. +The Complaint asserts claims +for breach of contract and promissory estoppel against us and our subsidiary arising from the subsidiary’s alleged failure to honor +its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $1.4 million , plus attorneys’ fees +and costs. +We believe that these claims +are without merit and intend to vigorously defend them. +On April 13, 2020, we and +our subsidiary, jointly filed a motion to dismiss the Complaint in its entirety as against us, and the promissory estoppel claim as against +our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Complaint in connection with the breach of contract +claim. +On April 29, 2020, Blockchain +Mining filed an amended complaint (the “Amended Complaint”). The Amended Complaint asserts the same causes of action and seeks +the same damages as the initial Complaint. +On May 13, 2020, we and our +subsidiary, jointly filed a motion to dismiss the Amended Complaint in its entirety as against us, and the promissory estoppel claim as +against of our subsidiary. On the same day, our subsidiary also filed a partial Answer to the Amended Complaint in connection with the +breach of contract claim. +In its partial Answer, the +Company’s subsidiary admitted to the validity of the contract at issue and also asserted numerous affirmative defenses concerning +the proper calculation of damages. +On December 4, 2020, the Court +issued an Order directing the Parties to engage in limited discovery (the “Limited Discovery”) which was completed on March +4, 2021. In connection therewith, the Court also denied the previously filed motion to dismiss without prejudice. +On June 2, 2021, we and our +subsidiary filed a motion to dismiss (the “Motion to Dismiss”) the Amended Complaint in its entirety as against us, and the +promissory estoppel claim as against the subsidiary. +The Motion to Dismiss has +been fully briefed and is currently pending before the Court. +Based on our assessment of +the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably estimate the +potential loss or range of loss that may result from this action. Notwithstanding, we have established a reserve in the amount of the +unpaid portion of the purchase agreement. An unfavorable outcome may have a material adverse effect on our business, financial condition +and results of operations. +Ding Gu (a/k/a Frank Gu) and Xiaodan Wang Litigation +On January 17, 2020, Ding +Gu (a/k/a Frank Gu) (“Gu”) and Xiaodan Wang (“Wang” and with “Gu” collectively, “Plaintiffs”), +filed a Complaint (the “Complaint”) in the Supreme Court of the State of New York, County of New York against us and our Chief +Executive Officer, Milton C. Ault, III, in an action captioned Ding Gu (a/k/a Frank Gu) and Xiaodan Wang v. DPW Holdings, Inc. and +Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd Ault) , Index No. 650438/2020. +The Complaint asserts causes +of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent injunction, +enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions entered into +between Gu and us, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs and DPW, in or +about July 2019. The Complaint seeks, among other things, monetary damages in excess of $1.1 million, plus a decree of specific performance +directing DPW to deliver unrestricted shares of DPW’s common stock to Gu, plus attorneys’ fees and costs. +81 +We believe that these claims +are without merit and intend to vigorously defend them. +On May 4, 2020, we and Ault +jointly filed a motion to dismiss the Complaint in its entirety, with prejudice (the “Motion to Dismiss”). +On July 28, 2021, the Court +conducted oral argument (the “Oral Argument”), via Microsoft Teams, in connection with the Motion to Dismiss. During +the Oral Argument, the Court informed the parties that the Court would be dismissing the fraud claim, in its entirety, and provided Plaintiffs +an opportunity to amend their fraud claim within sixty days of the date of the Oral Argument. The Court reserved decision on the +other causes of action. +On December 14, 2021, the +Court entered a Decision and Order in connection with the Motion to Dismiss (the “Order”) whereby the Court dismissed Plaintiff’s +causes of action for specific performance, conversion, permanent injunction, and reiterated its prior determination that the fraud claim +was also dismissed. The Court denied the Motion to Dismiss in connection with the other causes of action asserted in the Complaint. +On January 26, 2022, we and +Ault filed an Answer to the Complaint and asserted numerous affirmative defenses. +Based on our assessment of +the facts underlying the above claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably estimate +the potential loss or range of loss that may result from this action. An unfavorable outcome may have a material adverse effect on our +business, financial condition and results of operations. +Subpoena +The Company and certain affiliates +and related parties have received several subpoenas from the SEC for the production of documents and testimony. The Company is fully cooperating +with this non-public, fact-finding inquiry and management believes that the Company has operated its business in compliance with all applicable +laws. The subpoenas expressly provide that the inquiry is not to be construed as an indication by the Commission or its staff that any +violations of the federal securities laws have occurred, nor should they be considered a reflection upon any person, entity or security. +However, there can be no assurance as to the outcome of this matter. +Other Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory and government +investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, suits, regulatory +and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable +that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss +or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could +affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and +make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount +of a loss related to such matters. +With respect to our other +outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either +individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, +or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +82 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is listed +on the NYSE American under the symbol NILE. Prior to December 13, 2021, our common stock was listed on the NYSE American under the symbol +DPW. The following table sets forth our high and low closing sale prices per share of our common stock as reported by www.nasdaq.com +on the NYSE American through March 31, 2022 and for each quarter for the past two fiscal years. +Fiscal Year Ended December 31, 2020 +High +Low +First Quarter +$2.48 +$0.53 +Second Quarter +$6.55 +$0.71 +Third Quarter +$5.24 +$1.55 +Fourth Quarter +$10.94 +$1.44 +Fiscal Year Ended December 31, 2021 +High +Low +First Quarter +$7.84 +$2.97 +Second Quarter +$3.27 +$2.09 +Third Quarter +$2.83 +$2.18 +Fourth Quarter +$2.47 +$1.19 +Fiscal Year Ending December 31, 2022 +High +Low +First Quarter +$1.34 +$0.53 +On April 11, 2022, the closing +sale price per share of our common stock was $0.58. +Record Holders +As of December 31, 2021, shares +of our common stock were issued and outstanding and were owned by 35 holders of record. A number of holders of our common stock are “street +name” or beneficial holders whose shares of record are held by banks, brokers, and other financial institutions. +Dividend Policy +We have not declared or paid +any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends +in the future, if any, will be at the discretion of our Board and will depend upon our earnings, capital requirements, and financial position. +Equity Compensation Information +The +information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 +of this Annual Report on Form 10-K. +83 +Recent Sales of Unregistered Securities +Not applicable. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +Not applicable with respect +to the Company. However, as of December 31, 2021, +Ault Alpha had purchased 6.1 million shares of our common stock at an average price of $2.16. +ITEM 6. RESERVED +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form +10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking +statements. Such forward-looking statements include statements regarding, among others, (a) our expectations about possible business combinations, +(b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs for working capital. Forward-looking statements, +which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words +“may,” “will,” “should,” “expect,” “anticipate,” “approximate,” +“estimate,” “believe,” “intend,” “plan,” “budget,” “could,” “forecast,” +“might,” “predict,” “shall” or “project,” or the negative of these words or other variations +on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that +may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements +expressed or implied by any forward-looking statements. These statements may be found in this Annual Report. +Forward-looking statements +are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other future +conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks, +and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking +statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in this +Annual Report, changes in local, regional, national or global political, economic, business, competitive, market (supply and demand) and +regulatory conditions and the following: +● Adverse economic conditions; +● Our ability to effectively execute our business plan; +● Inability to raise sufficient additional capital to operate our business; +● Our ability to manage our expansion, growth and operating expenses; +● Our ability to evaluate and measure our business, prospects and performance metrics; +● Our ability to compete and succeed in highly competitive and evolving industries; +● Our ability to respond and adapt to changes in technology and customer behavior; +● Our ability to protect our intellectual property and to develop, maintain and enhance a strong brand; +and +● Other specific risks referred to in the section entitled “ Risk Factors ”. +We caution you therefore that +you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances of future +performance. All forward-looking statements speak only as of the date of this Annual Report. We undertake no obligation to update any +forward-looking statements or other information contained herein unless required by law. +Information regarding market +and industry statistics contained in this Annual Report is included based on information available to us that we believe is accurate. +It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. +Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional +uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services. Except as required +by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect actual results or changes in assumptions +or other factors that could affect those statements. See the section entitled “ Risk Factors ” for a more detailed discussion +of risks and uncertainties that may have an impact on our future results. +84 +In this Annual Report, the +“Company,” “ BitNile ,” “we,” “us” and “our” +refer to BitNile Holdings, Inc., a Delaware corporation formerly known as Ault Global Holdings, which was incorporated in September 2017. +We are a diversified holding company owning subsidiaries engaged in, among others, the following operating businesses: commercial and +defense solutions, commercial lending, data center operations, Bitcoin mining and advanced textile technology. Our direct and indirect +wholly owned subsidiaries include Gresham Worldwide, Inc. (“GWW”), TurnOnGreen, Inc., formerly known as Coolisys Technologies +Corp. (“TOGI”), TOG Technologies, Inc. (“TOG Technologies”), Digital Power Corporation (“Digital Power”), +Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems 2001 Ltd. (“Enertec”), Relec Electronics Ltd. +(“Relec”), Digital Power Lending, LLC (“DP Lending”), Ault Alliance, Inc. (“Ault Alliance”), Ault +Global Real Estate Equities, Inc. (“AGREE”) and BitNile, Inc. (“BNI”). We also have a controlling interest in +Microphase Corporation (“Microphase”), BNI has a controlling interest in Alliance Cloud Services, LLC (“ACS”), +and Ault Alliance has a significant investment in Avalanche International Corp. (“Avalanche”). +Recent Events and Developments +On January 22, 2021, we entered +into an At-The-Market Issuance Sales Agreement, as amended on February 17, 2021 and thereafter on March 5, 2021 (the “2021 Sales +Agreement”), with Ascendiant Capital Markets, LLC, acting as the sales agent, relating to the sale of shares of common stock offered +by a prospectus supplement and the accompanying prospectus, as amended by the amendments to the sales agreement dated February 16, 2021 +and March 5, 2021. During the year ended December 31, 2021, in accordance with the terms of the 2021 Sales Agreement, we sold an aggregate +of 52,552,353 shares of common stock from time to time through the sales agent for gross proceeds of $200 million. +On +January 29, 2021, ACS, a majority-owned subsidiary of our wholly owned subsidiary, Ault Alliance, closed on the acquisition of a 617,000 +square foot energy-efficient facility located on a 34.5 acre site in southern Michigan for a purchase price of $4.0 million (the “Facility”). +The purchase price was paid by our own working capital. Ownership of the Facility was subsequent assigned to BNI, another of our wholly +owned subsidiaries. +On March 9, 2021, our wholly +owned subsidiary, DP Lending, entered into a securities purchase agreement with Alzamend Neuro, Inc. (“Alzamend”), a related +party, to invest $10 million in Alzamend common stock and warrants, subject to the achievement of certain milestones. We agreed to fund +$4 million upon execution of the securities purchase agreement and to fund the balance upon Alzamend achieving certain milestones related +to the U.S. Food and Drug Administration approval of Alzamend’s Investigational New Drug application and Phase 1a human clinical +trials for Alzamend’s lithium based ionic cocrystal therapy, known as AL001. As of the date of this Annual Report, we have funded +an aggregate of $6 million pursuant to the securities purchase agreement. Under the securities purchase agreement, Alzamend has agreed +to sell up to 6,666,667 shares of its common stock to DP Lending for $10 million, or $1.50 per share, and issue to DP Lending warrants +to acquire up to 3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. The transaction was approved by +our independent directors after receiving a third-party valuation report of Alzamend. +On May 12, 2021, we issued +275,862 shares of common stock to A&C upon the conversion of $400,000 of principal on an 8% Convertible Promissory Note dated February +5, 2020. +On June 11, 2021, we entered +into a securities purchase agreement with Ault & Company, Inc., a Delaware corporation and a stockholder of ours (“A&C”). +Pursuant to the terms of the agreement, A&C is entitled to purchase 1,000,000 shares of our common stock for a total purchase price +of $2,990,000, at a purchase price per share of $2.99, which was $0.05 per share above the closing stock price on June 10, 2021. +On June 15, 2021, Alzamend +closed an initial public offering at a price to the public of $5.00 per share. DP Lending purchased 2,000,000 shares of Alzamend’s +common stock in the initial public offering for an aggregate of $10,000,000. Alzamend’s common stock is listed on The Nasdaq Capital +Market under the ticker symbol “ALZN.” +On July 28, 2021, Alzamend +received from the U.S. Food and Drug Administration a “Study May Proceed” letter for a Phase 1 study under the Alzamend’s +Investigational New Drug application for AL001, a lithium-based ionic cocrystal oral therapy for patients with dementia related to mild, +moderate, and severe cognitive impairment associated with Alzheimer’s disease. +85 +During +the quarter ended September 30, 2021, we executed contracts to purchase 4,000 Antminer S-19 Pro Bitcoin miners. As of September 30, 2021, +we had received 1,000 of the Bitcoin miners. The remaining 3,000 units are expected to be delivered at a rate of 300 units per month between +October 2021 and July 2022. The gross purchase price is $27.3 million. In November 2021, we executed contracts to purchase an aggregate +of 16,000 Bitcoin miners for $121 million. The purchase includes both the environmentally friendly S19 XP Antminers that feature a processing +power of 140 terahashes per second (TH/s) with an energy consumption of 3.01 kilowatt-hours (kWh) and the S19j Pro Antminers that feature +a processing power of 100 TH/s with an energy consumption of 2.95 kWh. Based on current delivery schedules, we expect that the 16,000 +newly purchased miners will be shipped by Bitmain between March 2022 and September 2022. Approximately $92.4 million of the gross purchase +price has been paid as of March 24, 2022 with the balance scheduled to be paid between April 2022 and November 2022. +On December 13, 2021, BNI +closed an investment of Series A preferred stock of Earnity Inc., a decentralized finance (“DeFi”) marketplace based in San +Mateo, California. BNI paid approximately $11.5 million for the shares of Earnity’s Series A preferred stock. Following the investment, +BNI beneficially owned approximately 19.99% of Earnity’s common stock. +On December 15, 2021, our +wholly owned subsidiary DP Lending entered into an exchange agreement with Imperalis Holding Corp (“IMHC”) pursuant to which +IMHC issued us a convertible promissory note (the “Note”) in the principal amount of $101,528.77, in exchange for those certain +promissory notes dated August 18, 2021 and November 5, 2021 previously issued by IMHC to DP Lending in the aggregate principal amount +of $100,000, which prior notes had accrued interest of $1,528.77 as of the December 15, 2021. The Note accrues interest at 10% per annum, +is due on December 15, 2023, and the principal, together with any accrued but unpaid interest on the amount of principal, is convertible +into shares of IMHCs common stock at DP Lending’s option at a conversion price of $0.01 per share. +On December 16, 2021, we entered +into a stock purchase agreement (the “Agreement”) with the majority stockholders of IMHC. Pursuant to the Agreement, we purchased +129,363,756 shares of IMHC’s common stock from the sellers in exchange for $200,000. Upon the closing of the Agreement, we owned +a majority of IMHC’s Common Stock, resulting in a change in control of IMHC. +On +December 22, 2021 (the “Closing Date”), AGREE Madison, LLC, a wholly owned subsidiary of AGREE, a wholly owned subsidiary +of Ault Alliance, through various wholly owned subsidiaries (the “Property Owners”), entered into construction loan agreements +(the “Loan Agreements”) in the aggregate amount of $68,750,000 (the “Loans”) in connection with the acquisition +of four hotel properties (the “Properties”). The Properties were acquired on the Closing Date for an aggregate purchase price +of $69,200,000, of which $2,500,000 was previously funded on deposit, $21,378,000 was paid by the Company on the Closing Date, and the +remaining amounts were funded from the Loans. The remaining $23,428,000 of the Loans are available to be drawn upon by the Property Owners +towards the completion of the $13,700,000 in property improvement plans (“PIPs”) the Property Owners agreed to undertake, +as well as to fund working capital, interest reserves, franchise fees and other costs and expenses related to the acquisition. The Loans +are due on January 1, 2025 (the “Maturity Date”), but may be extended by the Property Owners for two additional 12-month terms, +subject to certain terms and conditions as set forth in the Loan Agreements. The Loans accrue interest at a rate equal to the greater +of (i) the LIBOR Rate plus 675 basis points or (ii) 7% per annum. The Property Owners will make monthly installment payments of interest +only, starting January 1, 2022. +On +December 27, 2021, the Company and GWW entered into a Share Exchange Agreement (the “Exchange Agreement”) with Giga-tronics +Incorporated, a California corporation (“GIGA”). Pursuant to the Exchange Agreement, GIGA will acquire all of the outstanding +shares of capital stock of GWW in exchange for (i) issuing to the Company 2,920,085 shares of GIGA’s common stock (“GIGA Common +Stock”) and 514.8 shares of a new series of preferred stock (“GIGA Preferred Stock”) which are convertible into an aggregate +of 3,960,043 shares of GIGA Common Stock, subject to adjustment, and (ii) the assumption of GWW’s equity awards representing, on +an as-assumed basis, 249,875 shares of GIGA’s restricted shares of common stock (the “Exchange Transaction”). Completion +of the Exchange Transaction is subject to the approval of GIGA’s shareholders and customary closing conditions. +Immediately +following the completion of the Exchange Transaction, GWW will be a wholly owned subsidiary of GIGA. In addition, the Exchange Agreement +provides that, the Company shall loan to GIGA $4.25 million pursuant to a convertible promissory note (“Closing Date Loan”) +upon the closing of the Exchange Transaction (the “Closing”), and following the Closing, GIGA will repurchase or redeem all +of its shares of Series B, Series C, Series D and Series E preferred stock currently outstanding (the “Outstanding Preferred”). +Assuming the repurchase of the Outstanding Preferred and based upon 2,725,010 shares of GIGA Common Stock currently outstanding, following +the issuance to the Company of the shares of GIGA Common Stock and GIGA Preferred Stock pursuant to the Exchange Transaction, the Company +would hold approximately 68% of the outstanding voting power and capital stock of GIGA, and existing holders of GIGA Common Stock would +hold approximately 32%. +86 +On +December 30, 2021, Third Avenue Apartments LLC (“Third Avenue Apartments”), which is a wholly owned subsidiary of AGREE Madison, +LLC, closed upon the acquisition of certain real property located in St. Petersburg, Florida (the “Real Property”) together +with all improvements on the Real Property and all singular rights and appurtenances pertaining thereto, including, but not limited to, +(i) all entitlements, easements, rights, mineral rights, oil and gas rights, water, water rights, air rights, development rights +and privileges appurtenant to the Real Property, (ii) all tangible personal property, owned and assignable by Seller, located on +or used in connection with the Real Property, including, without limitation, engineering studies, soils reports, (iii) all warranties, +guaranties, indemnities and other similar rights relating to the Real Property and/or the assets transferred hereby, (iv) all permits, +licenses, consents, approvals and entitlements related to the Real Property, (v) any rights of way, appendages appurtenances, easements, +sidewalks, alleys, gores or strips of land adjoining or appurtenant to the Real Property or any portion thereof, if any, and used in conjunction +therewith, and (vi) all intangible rights directly relating to the Real Property (collectively, with the Real Property, the “Property”). +The +Property was acquired from Third Avenue at St Petersburg LLC (the “Seller”) pursuant to a contract of entered into by Third +Avenue Apartments and the Seller. The purchase price for the property was $15,500,000, of which $1,500,000 was previously funded on deposit +and the remaining $14,000,000 was paid by the Company on the Closing Date. The Company plans to use the Property for the development of +a high-rise multi-family project. +On +December 30, 2021, we issued of (i) secured promissory notes (individually, a “Note” and collectively, the “Notes”) +with an aggregate principal face amount of approximately $66,000,000; (ii) five-year Class A warrants to purchase an aggregate of 14,095,350 +shares of our common stock at an exercise price of $2.50, subject to adjustment; and (iii) five-year Class B warrants to purchase an aggregate +of 1,942,508 shares of our common stock at an exercise price of $2.50 per share, subject to adjustment. +We +agreed to file a registration statement to register the shares of common stock underlying the foregoing warrants and certain other shares +underlying previously issued warrants to one of the investors. +We, +certain of our subsidiaries and Esousa Holdings, LLC, as the collateral agent on behalf of the investors (the “Agent”) entered +into a security agreement, pursuant to which we (i) pledged the equity interests in substantially all of our U.S. based subsidiaries and +(ii) granted to the investors a security interest in substantially all of our deposit accounts, securities accounts, chattel paper, documents, +equipment, general intangibles, instruments and inventory, and all proceeds therefrom. The entirety of the loan, including the original +issue discount and accrued but unpaid interest, was fully paid off on March 30, 2022. +On +February 4, 2022, we and our wholly owned subsidiary Ault Alliance entered into a securities purchase agreement providing for our purchase +of BNI from Ault Alliance. As a result of this transaction, both BNI and Ault Alliance are each stand-alone wholly owned subsidiaries +of ours. +On +February 10, 2022, consistent with our objective to have BNI operate the entirety of our business that relates to cryptocurrencies, Ault +Alliance assigned the entirety of its interest in ACS to BNI. +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”), with Ascendiant Capital Markets, LLC, acting +as the sales agent, relating to the sale of shares of common stock offered by a prospectus supplement and the accompanying prospectus. +Through March 31, 2022 and in accordance with the terms of the 2022 Sales Agreement, we sold an aggregate of 140,658,096 shares of common +stock from time to time through the sales agent for gross proceeds of approximately $110 million. +On +March 20, 2022, we and our majority owned subsidiary IMHC entered into a securities purchase agreement (the “Agreement”) with +TOGI, a wholly owned subsidiary of ours. According to the Agreement, we will (i) deliver to IMHC all of the outstanding shares of common +stock of TOGI that we own, and (ii) forgive and eliminate the intracompany accounts between us and TOGI evidencing historical equity investments +made by us in TOGI, in the approximate amount of $25,000,000, in consideration for the issuance by IMHC to us (the “Transaction”) +of an aggregate of 25,000 newly designated shares of Series A Preferred Stock (the “IMHC Preferred Stock”), with each such +share having a stated value of $1,000. The closing of the Transaction is subject to our delivery to IMHC of audited financial statements +of TOGI and other customary closing conditions. Immediately following the completion of the Transaction, TOGI will be a wholly owned subsidiary +of IMHC. The parties to the Agreement have agreed that, upon completion of the Transaction, IMHC will change its name to TurnOnGreen, +Inc., and, through an upstream merger whereby the current TOGI shall cease to exist, IMHC shall have TOGI’s two operating subsidiaries, +TOG Technologies Inc. and Digital Power Corporation. Promptly following the closing of the Transaction, IMHC will dissolve its three dormant +subsidiaries. +87 +Our Corporate Structure +On January 19, 2021, we changed +our corporate name from DPW Holdings, Inc. to Ault Global Holdings, Inc. and, on December 13, 2021, we changed our corporate name from +Ault Global Holdings, Inc. to BitNile Holdings, Inc. (together, the “Name Changes”). The Name Changes were each effected through +a parent/subsidiary short form merger pursuant to an Agreement and Plan of Merger dated January 7, 2021 and December 1, 2021, respectively. +Neither of the mergers nor the corresponding Name Change affected the rights of our security holders. Our common stock is traded on the +NYSE American under the symbol “NILE.” Existing stock certificates that reflect our prior corporate name continue to be valid. +Certificates reflecting the new corporate name are issued as old stock certificates are tendered for exchange or transfer to our transfer +agent. Concurrently with the change in our name to Ault Global Holdings, Inc., Milton C. Ault III was appointed as our Executive Chairman, +William B. Horne was appointed as our Chief Executive Officer and remains as Vice Chairman of our Board, and Henry Nisser was appointed +as our President and remains as our General Counsel. +Commencing in October 2019 +and continuing through February 2022, we reorganized our corporate structure pursuant to a series of transactions by and among BitNile +Holdings and our directly and indirectly owned subsidiaries. The purpose of the reorganization was to align our various businesses by +the products and services that constitute the majority of each subsidiaries’ revenues. As a result of the foregoing transactions, +our streamlined corporate structure is currently as follows: +General +As a holding company, our +business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value. We anticipate returning value to stockholders after satisfying our debt obligations +and working capital needs. +88 +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, sales of their securities in the open market. Our plans may include taking subsidiaries or partner companies public +through rights offerings and directed share subscription programs. We will continue to consider these (or similar) programs and the sale +of certain subsidiary or partner company interests in secondary market transactions to maximize value for our stockholders. +Over the recent past we have +provided capital and relevant expertise to fuel the growth of businesses in defense/aerospace, industrial, telecommunications, medical, +crypto-mining, textiles and a select portfolio of commercial hospitality properties. We have provided capital to subsidiaries as well +as partner companies in which we have an equity interest or may be actively involved, influencing development through board representation +and management support. +We are a Delaware corporation +with our corporate office located at 11411 Southern Highlands Pkwy, Suite 240, Las Vegas, NV 89141. Our phone number is 949-444-5464 and +our website address is www.bitnile.com. +Results of Operations +Results of Operations for the Years ended December 31, 2021 and +2020 +The following table summarizes +the results of our operations for the years ended December 31, 2021 and 2020. +For the Year Ended +December 31, +2021 +2020 +Revenue +$ 32,096,000 +$ 23,629,000 +Revenue, cryptocurrency mining, net +3,450,000 +- +Revenue, lending and trading activities +16,854,000 +242,000 +Total revenue +52,400,000 +23,871,000 +Cost of revenue +23,858,000 +16,357,000 +Gross profit +28,542,000 +7,514,000 +Total operating expenses +46,903,000 +13,547,000 +Loss from continuing operations +(18,361,000 ) +(6,033,000 ) +Interest and other income +808,000 +105,000 +Impairment of debt securities, net +(5,090,000 ) +- +Interest expense +(1,871,000 ) +(9,648,000 ) +Change in fair value of marketable equity securities +(1,327,000 ) +919,000 +Realized gain on marketable securities +1,924,000 +- +Loss from equity investment +(311,000 ) +- +Gain (loss) on extinguishment of debt +929,000 +(18,706,000 ) +Change in fair value of warrant liability +(542,000 ) +(49,000 ) +Loss from continuing operations before income taxes +(23,841,000 ) +(33,412,000 ) +Income tax (provision) benefit +(130,000 ) +24,000 +Loss from continuing operations +(23,971,000 ) +(33,388,000 ) +Net income from discontinued operations, net of taxes +- +661,000 +Net loss +(23,971,000 ) +(32,727,000 ) +Less: Net gain attributable to non-controlling interest +(213,000 ) +- +Net loss attributable to BitNile Holdings +(24,184,000 ) +(32,727,000 ) +Preferred dividends +(18,000 ) +(18,000 ) +Net loss available to common stockholders +$ (24,202,000 ) +$ (32,745,000 ) +Comprehensive loss +Net loss available to common stockholders +$ (24,202,000 ) +$ (32,745,000 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +85,000 +482,000 +Net unrealized gain (loss) on derivative securities of related party +(7,773,000 ) +3,312,000 +Impairment of debt securities +9,300,000 +- +Other comprehensive income +1,612,000 +3,794,000 +Total comprehensive loss +$ (22,590,000 ) +$ (28,951,000 ) +89 +Revenues +Revenues by segment for the +years ended December 31, 2021 and 2020 are as follows: +For the Year Ended December 31, +Increase +2021 +2020 +(Decrease) +% +GWW +$ 25,581,000 +$ 18,213,000 +$ 7,368,000 +40 % +TOGI +5,346,000 +5,416,000 +(70,000 ) +-1 % +Ault Alliance: +Revenue, cryptocurrency mining, net +3,450,000 +- +3,450,000 +- +Revenue, lending and trading activities +16,854,000 +242,000 +16,612,000 +6864 % +Other +1,169,000 +- +1,169,000 +- +Total revenue +$ 52,400,000 +$ 23,871,000 +$ 28,529,000 +120 % +Our revenues increased by +$28.5 million, or 120%, to $52.4 million for the year ended December 31, 2021, from $23.9 million for the year ended December 31, +2020. +GWW +GWW revenues increased by +$7.4 million, or 40%, to $25.6 million for the year ended December 31, 2021, from $18.2 million for the year ended December 31, 2020. +The increase in GWW revenue in 2021 includes an increase of $6.4 million from Relec, which was acquired on November 30, 2020. In the prior +year period, revenue was constrained by a lack of working capital. The increase in revenue from our GWW segment for customized solutions +for the military markets reflects our improved liquidity in 2021, as we were able to allocate additional funds to our defense business +to improve its ability to fulfill backlog orders. Revenue from Enertec, which largely consists of revenue recognized over time, was $10.9 +million for the year ended December 31, 2021, an increase of $1.7 million, or 17.9%, from $9.3 million in the prior-year period. +TOGI +TOGI revenues for the year +ended December 31, 2021 of $5.3 million declined $70,000, or 1%, from $5.4 million for the year ended December 31, 2020. +Ault Alliance +While BNI acquired the Bitcoin +mining operation from Ault Alliance on February 10, 2022, for purposes of this Annual Report, such operations are presented as being carried +out under the name of Ault Alliance since this section discusses matters occurring during the fiscal year ended December 31, 2021. +Revenues from our cryptocurrency +mining operations were $3.5 million for the year ended December 31, 2021, compared to nil for year ended December 31, 2020, as we resumed +our cryptocurrency mining operations during the first quarter of 2021. Our decision to resume cryptocurrency mining operations in 2021 +was based on several factors, which positively affected the number of active miners we operated, including the market prices of digital +currencies, and favorable power costs available at the Facility. +Revenues from our lending +and trading activities increased to $16.9 million for the year ended December 31, 2021, from $0.2 million for the year ended December +31, 2020, which is attributable to a significant allocation of capital from our equity financing transactions to our loan and investment +portfolio. During the year ended December 31, 2021, DP Lending generated significant income from appreciation of investments in marketable +securities as well as shares of common stock underlying convertible notes and warrants issued to DP Lending in certain financing transactions. +Under its business model, DP Lending also generates revenue through origination fees charged to borrowers and interest generated from +each loan. +Based +upon the fair value of Alzamend common stock at December 31, 2021, which was $1.90 based on its closing price on such date, for the year +ended December 31, 2021, we recorded an unrealized loss of $5.6 million related to our investment in Alzamend common stock. +90 +Revenues +from our trading activities during the year ended December 31, 2021 included significant net gains on equity securities, including unrealized +gains and losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in +our periodic earnings. +Gross Margins +Gross margins increased to +54.5% for the year ended December 31, 2021 compared to 31.5% for the year ended December 31, 2020. Our gross margins have typically ranged +between 33% and 37%, with slight variations depending on the overall composition of our revenue. During 2022, we expect our gross margins +will increase significantly from Bitcoin mining, which is expected to have significantly higher gross margins. +Our gross margins of 54.5% +recognized during the year ended December 31, 2021, were impacted by the favorable margins from our lending and trading activities. Excluding +the effects of margin from our lending and trading activities, our adjusted gross margins for the year ended December 31, 2021, would +have been 32.9%, consistent with our historical range. +Research and Development +Research and development expenses +increased by $0.2 million to $2.0 million for the year ended December 31, 2021, from $1.8 million for the year ended December 31, 2020. +The increase in research and development expenses is due to costs incurred at TOGI related to the development of our EV charger products. +Selling and Marketing +Selling and marketing expenses +were $7.8 million for the year ended December 31, 2021, compared to $1.2 million for the year ended December 31, 2020, an increase of +$6.6 million, or 560%. The increase was the result of increases in personnel costs directly attributed to an increase in sales and marketing +personnel, consultants and advertising spending primarily at Ault Alliance related to digital marketing and digital learning initiatives. +The increase is also attributable to costs incurred at TOGI to grow our selling and marketing infrastructure related to our EV charger +products. +General and Administrative +General and administrative +expenses were $36.7 million for the year ended December 31, 2021, compared to $12.5 million for the year ended December 31, 2020, +an increase of $24.2 million, or 193%. General and administrative expenses increased from the comparative prior period, mainly due to: +● non-cash stock compensation costs of $7.8 million; +● the accrual of a $5.1 million performance bonus related to realized gains on trading activities during +the period; +● general and administrative costs of $1.4 million from Relec, which was acquired on November 30, 2020; +● increased costs related to the Facility, operated by ACS; and +● higher consulting, audit, legal and insurance costs. +Loss From Continuing Operations +We recorded a loss from continuing +operations of $18.4 million for the year ended December 31, 2021, compared to a loss from continuing operations of $6.0 million for the +year ended December 31, 2020. The change in operating results is attributable to the increase in operating expenses, primarily general +and administrative expenses partially offset by the increase in revenue and gross margins. +Interest and Other Income +Interest and other income was +$0.8 million for the year ended December 31, 2021 compared to $0.1 million for the year ended December 31, 2020. Other income for the +year ended December 31, 2021 included a $0.4 million gain related to the release of certain escrow funds related to the 2017 acquisition +of Enertec. +91 +Impairment of Debt Securities, Net +Debt securities are evaluated +periodically to determine whether a decline in their value is other than temporary. We utilize criteria such as the magnitude and duration +of the decline, in addition to the reason underlying the decline, to determine whether the loss in value is other than temporary. The +term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects for +a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater +than, the carrying value of the investment. Once a decline in value is determined to be other than temporary, the value of the security +is reduced and a corresponding charge to earnings is recognized. +Impairment of debt securities +consisted of the following as of December 31, 2021 and 2020: +For the Year Ended +December 31, +2021 +2020 +Impairment of debt securities +$ (9,300,000 ) +$ - +Accretion of discount on note receivable, related party +4,210,000 +- +Total +$ (5,090,000 ) +$ - +During the fourth quarter +of 2021, we determined that the decline in value fair value of the warrant derivative securities that we received as a result of our investment +in AVLP was other than temporary. We recorded an impairment of debt securities of $9.3 million with a corresponding adjustment to other +comprehensive income reducing prior unrealized losses. +Accretion of discount on note +receivable, related party was $4.2 million for the year ended December 31, 2021, compared to nil for the year ended December 31, 2020, +due to the significant decline in the value of warrants in AVLP, accretion of the warrant discount was accelerated, resulting in a discount +of nil related to warrants issued in conjunction with the convertible promissory note of AVLP as of December 31, 2021. +Interest Expense +Interest expense was $1.9 million +for the year ended December 31, 2021, compared to $4.4 million for the year ended December 31, 2020. The decrease in interest expense +for the year ended December 31, 2021 was primarily related to the decrease in our average level of borrowings during the year. The significant +borrowings during the year ended December 31, 2021 were made during the month of December 2021. +Change in Fair Value of Warrant Liability +During the year ended December +31, 2021, the fair value of the warrants that were issued during 2021 in a series of debt financings increased by $0.5 million. The fair +value of these warrants is re-measured at each financial reporting period and immediately before exercise, with any changes in fair value +recorded as change in fair value of warrant liability in the Consolidated Statements of Operations and Comprehensive Loss. +Change in Fair Value of Marketable Equity Securities +Change in fair value of marketable +equity securities was a loss of $1.3 million for the year ended December 31, 2021, compared to a loss of $0.9 million for the year ended +December 31, 2020. +Realized Gain on Marketable Securities +Realized gain on marketable +securities was $1.9 million for the year ended December 31, 2021, compared to nil for the year ended December 31, 2020. +Gain (Loss) on Extinguishment of Debt +Gain on extinguishment of +debt was $0.9 million for the year ended December 31, 2021, as we received forgiveness of loans made under +the Paycheck Protection Program. Loss on extinguishment of debt was $18.7 million for the year ended December 31, 2020, as principal +and accrued interest of $6.4 million and $2.2 million, respectively, on our debt securities was satisfied through the issuance of 9.6 +million shares of common stock. We recognized a loss on extinguishment of $15.6 million as a result of these issuances. The remaining +loss on extinguishment is primarily due to the estimated fair value of warrants to purchase an aggregate of 1.7 million shares of common +stock that were issued to Esousa pursuant to the Master Exchange Agreement. +92 +Net Gain From Discontinued Operations +During the first quarter of +2020, we discontinued the restaurant operations of I.AM. Management determined that the permanent closing of the restaurant operations +met the criteria for presentation as discontinued operations. Accordingly, the results of the restaurant operations are presented as discontinued +operations in our consolidated statements of operations and comprehensive loss and are excluded from continuing operations for all periods +presented. In November 2020, I.AM filed a voluntary petition for bankruptcy under Chapter 7 and we ceded authority for managing the business +to the Bankruptcy Court, resulting in the deconsolidation I.AM. +Net Loss +For the foregoing reasons, +our net loss for the year ended December 31, 2021 was $24.2 million compared to a net loss of $32.7 million for the year ended December +31, 2020. +Other Comprehensive Income +Other comprehensive income +was $1.6 million and $3.8 million for the years ended December 31, 2021 and 2020, respectively. During the fourth quarter of 2021, we +determined that the decline in value fair value of the warrant derivative securities that we received as a result of our investment in +AVLP was other than temporary. We recorded an impairment of debt securities of $9.3 million with a corresponding adjustment to other comprehensive +income reducing prior unrealized losses, including $7.8 million of unrealized losses for the year ended December 31, 2021. During the +year ended December 31, 2020, unrealized gains in the warrant derivative securities of AVLP was the primary component of other comprehensive +income. +Liquidity and Capital Resources +On December 31, 2021, we had +cash and cash equivalents and restricted cash of $21.2 million. This compares with cash and cash equivalents of $18.7 million at December +31, 2020. The increase in cash and cash equivalents was primarily due to cash provided by financing activities related to our 2021 ATM +Offering and debt offerings. Our cash and cash equivalents as of April 1, 2022 were approximately $30 million +Net cash used in continuing +operating activities totaled $61.7 million for the year ended December 31, 2021, compared to $11.2 million for the year ended December +31, 2020. Cash used for operating activities included $29.4 million net cash used for marketable securities related to trading activities +related to the operations of DP Lending. +Net cash used in investing +activities was $355.5 million for the year ended December 31, 2021, compared to $7.8 million for the year ended December 31, 2020 and +reflects the following transactions: +● Capital Expenditures for Bitcoin Mining Equipment – $75.0 million of capital expenditures +related to Bitcoin mining equipment at Ault Alliance, $64.1 million of which represents deposits to secure the delivery of Bitcoin +miners. The purchase agreements include 4,600 environmentally friendly S19 XP Antminers from Bitmain that feature a processing power of +140 TH/s and 16,000 S19j Pro Antminers that feature a processing power of 100 TH/s. As of December 31, 2021, we had received 1,885 S19j +Pro Antminers. During the year ended December 31, 2021, we capitalized $1.0 million of shipping costs and $1.2 million of third-party +commissions related to cryptocurrency machines and related equipment. We expect to receive delivery of the full 20,600 Bitcoin miners +by December 2022. Beginning in March of 2022, we expected to receive approximately 2,300 miners per month. +● Acquisition of Hotels – On December 22, 2021, our real estate segment acquired four hotel +properties for $71.3 million consisting of a 136-room Courtyard by Marriott, a 133-room Hilton Garden Inn and a 122-room Residence Inn +by Marriott in Middleton, WI, as well as a 135-room Hilton Garden Inn in Rockford, IL. The purchase price consisted of $69.2 million paid +to the seller and $2.1 million of direct transaction costs. +● Acquisition of St. Peterburg Land – On December 30, 2021, our real estate segment acquired +certain real property located at the southeast corner of 5th Street North and 3rd Avenue North in St. Petersburg, FL. The purchase price +for the property was $15.5 million. We plan to use the property for the development of a high-rise multi-family project. +93 +● Acquisition of Michigan Cloud Data Center – On January 29, 2021, ACS closed on the acquisition +of the Facility, which is located on a 34.5 acre site in southern Michigan, for a purchase price of $3.9 million. We have invested an +additional $6.8 million to upgrade the facility, primarily to build out the 30,000 square foot data center within the facility. +● Investment in Alzamend – On March 9, 2021, DP Lending, entered into a securities purchase +agreement with Alzamend, a related party, to invest $10 million in Alzamend common stock and warrants, subject to the achievement +of certain milestones. We funded $4 million upon execution of the securities purchase agreement, $2 million in July 2021 upon Alzamend +achieving U.S. Food and Drug Administration approval of Alzamend’s Investigational New Drug application for +its Phase Ia clinical trials for AL001, and agreed to fund the final $4 million based upon Alzamend’s completion of its Phase Ia +clinical trials for AL001, which was announced in March 2022. Under the securities purchase agreement, Alzamend sold to DP Lending +an aggregate of 6,666,667 shares of its common stock to DP Lending for $10 million, or $1.50 per share, and issued warrants to acquire +up to 3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. The transaction was approved by our independent +directors after receiving a third-party valuation report of Alzamend. +● Investment in Ault & Company – On February 25, +2021, Ault & Company, a related party, sold and issued an 8% secured promissory note in the principal amount of $2.5 million to us. +The principal amount of the secured promissory note, plus any accrued and unpaid interest at a rate of 8% per annum, is due and payable +on December 31, 2022. +● Investment of ADTC initial public offering proceeds – During December 2021, we invested $116.7 +million in cash and marketable securities in a trust account. Cash and marketable securities held in the trust account represents cash +and U.S. treasury bills that were purchased with funds raised through the initial public offering of ADTC, a consolidated SPAC. The funds +raised are held in a trust account that is restricted for use and may only be used for purposes of completing an initial business combination +or redemption of the common stock of ADTC, as set forth in the trust agreement. +Historically, we have financed +our operations principally through issuances of convertible debt, promissory notes and equity securities. During 2021, we continued to +successfully obtain additional debt and equity financing. Net cash provided by financing activities was $419.9 million for the year ended +December 31, 2021, compared to $37.3 million for the year ended December 31, 2020, and reflects the following transactions: +● 2021 ATM offering – On January 22, 2021, we entered into the 2021 Sales Agreement with Ascendiant +to sell shares of common stock having an aggregate offering price of up to $50 million from time to time, through the 2021 ATM Offering. +On February 16, 2021, we filed an amendment to the prospectus supplement with the SEC to increase the amount of common stock that may +be offered and sold in the 2021 ATM Offering, as amended under the 2021 Sales Agreement to $125 million in the aggregate, inclusive of +the up to $50 million in shares of common stock previously sold in the 2021 ATM Offering. On March 5, 2021, we filed a second amendment +to the prospectus supplement with the SEC to further increase the amount of common stock that may be offered and sold in the 2021 ATM +Offering, as amended under the 2021 Sales Agreement to $200 million in the aggregate, inclusive of the up to $125 million in shares of +common stock previously sold in the 2021 ATM Offering. The offer and sale of shares of common stock from the 2021 ATM Offering was made +pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein +(Registration Statement No. 333-251995) which became effective on January 20, 2021. Through December 31, 2021, we had received gross proceeds +of $200 million through the sale of 52,552,353 shares of common stock from the 2021 ATM Offering. The 2021 ATM Offering was terminated +in December 2021. +● December 2021 Secured Promissory Notes – On December 30, 2021, we entered into a securities +purchase agreement with certain sophisticated investors providing for the issuance of secured promissory notes that bear interest at 8% +per annum with an aggregate principal face amount of approximately $66 million including a 10% original issue discount. The secured promissory +notes were repaid in March 2022. +● AGREE Madison Construction Loan Agreements – On December 22, 2021, our real estate segment +entered into the Loan Agreements. The outstanding balances under the Loans was $55.1 million as of December 31, 2021. The Loans are due +on January 1, 2025, but may be extended for two additional 12-month terms, subject to certain terms and conditions as set forth in the +Loan Agreements. The Loans accrue interest at a rate equal to the greater of (i) the LIBOR Rate plus 675 basis points or (ii) 7% per annum. +The real estate segment subsidiaries began making monthly installment payments of interest only, starting January 1, 2022. +● Proceeds from initial public offering of ADTC – In December 2021, we received $112.1 million +in gross proceeds from the initial public offering of ADTC. +94 +Subsequent to December 31, +2021, on February 25, 2022, we entered into the 2022 Sales Agreement with Ascendiant to sell shares of common stock having an aggregate +offering price of up to $200 million from time to time, through the 2022 ATM Offering. The offer and sale of shares of common stock from +the 2022 ATM Offering was made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base +prospectus contained therein (Registration Statement No. 333-260618) which became effective on November 12, 2021. As of March 31, 2022, +the Company had sold an aggregate of 140.7 million shares of common stock pursuant to the 2022 ATM Offering for gross proceeds of $110.4 +million. The shares were sold at an average price of $0.78 per share. +We believe our current cash +on hand combined with the proceeds from the 2022 ATM Offering are sufficient to meet our operating and capital requirements for at least +the next twelve months from the date the financial statements for the year ended December 31, 2021 are issued. +Critical Accounting Policies +Variable Interest Entities +For VIEs, we assess whether +we are the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. The primary beneficiary of a VIE +is the party that has the power to direct the activities that most significantly impact the performance of the entity and the obligation +to absorb the losses or the right to receive the benefits that could potentially be significant to the entity. +We evaluate our business relationships +with related parties to identify potential VIEs under Accounting Standards Codification (“ASC”) 810, Consolidation . +We consolidate VIEs in which we are considered to be the primary beneficiary. Entities are considered to be the primary beneficiary if +they have both of the following characteristics: (i) the power to direct the activities that, when taken together, most significantly +impact the VIE’s performance; and (ii) the obligation to absorb losses and right to receive the returns from the VIE that would +be significant to the VIE. Our judgment with respect to our level of influence or control of an entity involves the consideration of various +factors including the form of our ownership interest, our representation in the entity’s governance, the size of our investment, +estimates of future cash flows, our ability to participate in policy making decisions and the rights of the other investors to participate +in the decision making process and to replace us as manager and/or liquidate the joint venture, if applicable. +Variable Interest Entity Considerations - Avalanche +We have determined that AVLP +is a VIE as it does not have sufficient equity at risk. We do not consolidate AVLP because we are not the primary beneficiary and do not +have a controlling financial interest. To be a primary beneficiary, an entity must have the power to direct the activities of a VIE that +most significantly impact the VIE’s economic performance, among other factors. Although we have made a significant investment in +AVLP, we have determined that Philou, which controls AVLP through the voting power conferred by its equity investment and which is deemed +to be more closely associated with AVLP, is the primary beneficiary. As a result, AVLP’s financial position and results of operations +are not consolidated in our financial position and results of operations. +Equity +Investment in Unconsolidated Entity +As +of December 31, 2021, our ownership percentage of AVLP was less than 20%. During the fourth quarter of 2021, we made additional advances +to AVLP under the existing loan agreement and our consolidated VIE, Ault Alpha, entered into a loan agreement with AVLP totaling $3.6 +million. Due to our cumulative lending position to AVLP and the facts and circumstances surrounding the terms of loan agreements, we reevaluated +our level of influence over AVLP and determined that the equity ownership in AVLP should be accounted for under the equity method of accounting. +The +basis of our previously held interest in AVLP was remeasured to fair value immediately before adopting the equity method of accounting. +Our interest in AVLP as of December 31, 2020 has been presented as an equity investment in an unconsolidated entity, consistent with the +current year presentation. +95 +We +have invested in AVLP based on the potential global impact of the novel technology of AVLP. AVLP has developed a novel cost effective +and environmentally friendly material synthesis technology for textile applications. AVLP’s Multiplex Laser Surface Enhancement +is a unique technology that has the ability to treat both natural and synthetic textiles for a wide variety of functionalities, including +dyeability and printing enhancements, hydrophilicity, hydrophobicity, fire retardancy and anti-microbial properties. The use of water, +harmful chemicals and energy is significantly reduced in comparison to conventional textile treatment methods. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller reporting +company, this section is not applicable. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements required +by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not required to provide +supplementary financial information. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2021, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, have +evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) +and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our disclosure +controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records +that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide +reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2021. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2021, our internal control over financial reporting was not effective. +96 +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting function, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting and fair value estimates, in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +3. Our primary user access controls (i.e. provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +97 +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis. +· +Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls, +· +Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· +Continuing to increase headcount across the Company, with a particular +focus on hiring individuals with strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Controls over Financial Reporting +During the most recent fiscal +quarter 2021 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) +and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over +financial reporting. +ITEM 9B. OTHER INFORMATION +None. +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +No applicable. +PART III +ITEM 10. DIRECTORS, +EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The following table sets forth +the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. Ault, III (1) +52 +Executive Chairman of the Board +2017 +William B. Horne (1) +53 +Chief Executive Officer, Vice Chairman and Director +2016 +Henry Nisser (1) +53 +President, General Counsel and Director +2019 +Kenneth S. Cragun (1) +61 +Chief Financial Officer +2020 +Robert O. Smith +77 +Lead Independent Director +2016 +Moti Rosenberg +74 +Director +2015 +Jeffrey A. Bentz +62 +Director +2018 +Howard Ash +62 +Director +2020 +(1) Executive Officer. +98 +Each of the directors named +above will serve until the next annual meeting of our stockholders or until his respective successor is elected and qualified. Subject +to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Mr. Milton C. Ault, III +On January 19, 2021, Mr. Ault +resigned as Chief Executive Officer and was appointed as the Executive Chairman of the Board. On December 28, 2017, Mr. Ault was appointed +Chief Executive Officer. On March 16, 2017, Mr. Ault was appointed Executive Chairman of the Board. Mr. Ault entered into an employment +agreement with us on June 17, 2018. Mr. Ault is a seasoned business professional and entrepreneur who has spent more than twenty-seven +years identifying value in various financial markets including equities, fixed income, commodities, and real estate. Mr. Ault has served +as the Chairman of the Board of ADTC, an NYSE listed Special Purpose Acquisition Company, or SPAC, since its incorporation in February +2021. On February 25, 2016, Mr. Ault founded Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention +and cure for Alzheimer’s Disease and has served as its Chairman until its IPO, when he became Alzamend’s Chairman Emeritus +and a consultant. Mr. Ault has served as Chairman and Chief executive Officer of Ault & Company, Inc., a Delaware holding company, +since December 2015, and as Chairman of Avalanche International Corp., a publicly traded Nevada company and a “voluntary filer,” +which as such is not required to file periodic reports, since September 2014. Since January 2011, Mr. Ault has been the Vice President +of Business Development for MCKEA Holdings, LLC, a family office. Throughout his career, Mr. Ault has consulted for a few publicly traded +and privately held companies, providing each of them the benefit of his diversified experience, that range from development stage to seasoned +businesses. We believe that Mr. Ault’s business background demonstrates he has the qualifications to serve as one of our directors +and as Executive Chairman. +William B. Horne +Mr. Horne has served as a +member of our Board since October 2016. On January 19, 2021, Mr. Horne resigned as President and was appointed as the Chief Executive +Officer. On August 19, 2020, Mr. Horne resigned as our Chief Financial Officer and was appointed as our President. He was appointed as +our Chief Financial Officer on January 25, 2018. Prior to his appointment as our Chief Financial Officer, Mr. Horne served as one of our +independent directors. He served as the Chief Financial Officer of Targeted Medical Pharma, Inc. (OTCBB: TRGM) from August 2013 to May +2019. Mr. Horne has served as the Chief Executive Officer and on the board of directors of ADTC, an NYSE listed SPAC, since its incorporation +in February 2021. Mr. Horne is a director and Chief Financial Officer of Avalanche International, Corp., a “voluntary filer” +under the Exchange Act. Mr. Horne has served on the board of directors of Alzamend Neuro, Inc., a biotechnology firm dedicated to finding +the treatment, prevention and cure for Alzheimer’s Disease, since June 1, 2016 and became its Chairman of the board upon consummation +of its IPO. Mr. Horne previously held the position of Chief Financial Officer in various public and private companies in the healthcare +and high-tech field. Mr. Horne has a Bachelor of Arts Magna Cum Laude in Accounting from Seattle University. We believe that Mr. Horne's +extensive financial and accounting experience in diversified industries and with companies involving complex transactions give him the +qualifications and skills to serve as one of our directors. +Henry Nisser +Mr. Nisser has served as a +member of our Board since September 17, 2020 and was appointed as our Executive Vice President and General counsel on May 1, 2019. On +January 19, 2021, Mr. Nisser resigned as Executive Vice President and was appointed as our President. Mr. Nisser is the Executive Vice +President and General Counsel of Avalanche International, Corp., a “voluntary filer” under the Exchange Act. Mr. Nisser has +served as the President, General Counsel and on the board of directors of ADTC, an NYSE listed SPAC, since its incorporation in February +2021. Mr. Nisser has served on the board of directors of Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, +prevention and cure for Alzheimer’s Disease, since September 1, 2020 and has served as its Executive Vice President and General +Counsel since May 1, 2019. From October 31, 2011 through April 26, 2019, Mr. Nisser was an associate and subsequently a partner with Sichenzia +Ross Ference LLP (“SRF”), a law firm based in New York City. While with SRF, his practice was concentrated in national and +international corporate law, with a particular focus on U.S. securities compliance, public as well as private M&A, equity and debt +financings and corporate governance. Mr. Nisser drafted and negotiated a variety of agreements related to reorganizations, share and asset +purchases, indentures, public and private offerings, tender offers and going private transactions. Mr. Nisser also represented clients’ +special committees established to evaluate M&A transactions and advised such committees’ members with respect to their fiduciary +duties. Mr. Nisser is fluent in French and Swedish as well as conversant in Italian. Mr. Nisser received his B.A. from Connecticut College +in 1992, where he majored in International Relations and Economics. He received his LLB from the University of Buckingham School of Law +in 1999. We believe that Mr. Nisser’s extensive legal experience involving complex transactions and comprehensive knowledge of securities +laws and corporate governance requirements applicable to listed companies give him the qualifications and skills to serve as one of our +directors. +99 +Kenneth S. Cragun +Mr. Cragun was appointed as +our Chief Financial Officer on August 19, 2020. Prior to his appointment as Chief Financial Officer, Mr. Cragun served as our Chief Accounting +Officer since October 1, 2018. Mr. Cragun has served as the Chief Financial Officer of ADTC, an NYSE listed SPAC, since its incorporation +in February 2021. Mr. Cragun has been the Chief Financial Officer of Alzamend Neuro, Inc., a development stage entity seeking to prevent, +treat and cure Alzheimer’s Disease, since October of 2018. He served as a CFO Partner at Hardesty, LLC, a national executive services +firm since October 2016. His assignments at Hardesty included serving as CFO of CorVel Corporation, a $1.1 billion market cap publicly +traded company (NASDAQ: CRVL) and a nationwide leader in technology driven, healthcare-related, risk management programs and of RISA Tech, +Inc. a private structural design and optimization software company. Mr. Cragun was also CFO of two NASDAQ-listed companies, Local Corporation, +from April 2009 to September 2016, which operated Local.com, a U.S. top 100 website, and Modtech Holdings, Inc., from June 2006 to March +2009, a supplier of modular buildings. Prior thereto, he had financial leadership roles with increasing responsibilities at MIVA, Inc., +ImproveNet, Inc., NetCharge Inc., C-Cube Microsystems, Inc, and 3-Com Corporation. Mr. Cragun serves on the board of directors and Chairman +of the Audit Committee of Verb Technology Company, Inc. (NASDAQ: VERB). Mr. Cragun began his professional career at Deloitte. Mr. Cragun +holds a Bachelor of Science degree in accounting from Colorado State University-Pueblo. Mr. Cragun’s industry experience is vast, +with extensive experience in fast-growth environments and building teams in more than 20 countries. Mr. Cragun has led multiple financing +transactions, including IPOs, PIPEs, convertible debt, term loans and lines of credit. +Robert O. Smith +Mr. Smith serves as our lead +independent director. Previously, he served as a member of our Board from November 2010 until May 2015, and served as a member of our +Advisory Board from 2002 until 2015. He is currently a C-level executive consultant working with Bay Area high-tech firms on various strategic +initiatives in all aspects of their business. Mr. Smith has served on the board of directors of ADTC, an NYSE listed SPAC, since its IPO +in December 2021. From 2004 to 2007, he served on the board of directors of Castelle Corporation. From 1990 to 2002, he was our President, +Chief Executive Officer and Chairman of our Board. From 1980 to 1990, he held several management positions with Computer Products, Inc., +the most recent being President of their Compower/Boschert Division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb +Electric and with the JM Smucker Company. Mr. Smith received his BBA degree in Accounting from Ohio University. We believe that Mr. Smith’s +executive-level experience, including his previous service as our President, Chief Executive Officer and Chairman of our Board, his extensive +experience in the accounting industry, and his service on our Board from November 2010 until May 2015, give him the qualifications and +skills to serve as one of our directors. +Mordechai Rosenberg +Mr. Rosenberg serves as one +of our independent directors. He has served as an independent consultant to various companies in the design and implementation of homeland +security systems in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate Ltd., a manufacturer +of armor protection systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg +was the general manager of ZIV U.P.V.C Products Ltd.’s doors and window factory. Mr. Rosenberg is an active reserve officer and +a retired colonel from the Israeli Defense Force (IDF), where he served for 26 years and was involved in the development of weapon systems. +In the IDF, Mr. Rosenberg served in various capacities, including, company, battalion and brigade commander, head of the training center +for all IDF infantry, and head of the Air Force’s Special Forces. Mr. Rosenberg received a B.A in History from the University of +Tel Aviv and a Master of Arts in Political Science from the University of Haifa in Israel. Mr. Rosenberg graduated from the course of +Directors & Officers at the College of Management, Tel Aviv. We believe that Mr. Rosenberg’s business background give him the +qualifications to serve as one of our directors. +Jeffrey Bentz +Mr. Bentz serves as one of +our independent directors. Mr. Bentz is an experienced businessman who has served since 1994 as President of North Star Terminal & +Stevedore Company, a full-service stevedoring company located in Alaska and whose major areas of business include terminal operations +and management, stevedore services, and heavy equipment operations. Mr. Bentz has served on the board of directors of ADTC, an NYSE listed +SPAC, since its IPO in December 2021. He also has served as a director and advisor to several private companies and agencies. Mr. Bentz +obtained a B.A. in Business and Finance from Western Washington University in 1981. We believe that Mr. Bentz’s executive-level +experience, including his operational and financial oversight of companies with multiple profit centers and his extensive experience in +the real estate and commercial services industries give him the qualifications and skills to serve as one of our directors. +100 +Howard Ash +Mr. Ash serves as one of our +independent directors. Mr. Ash is an accomplished executive with extensive experience in business and finance, who served as CEO, COO +and CFO to a variety of high profile, international companies. Mr. Ash continues to serve as Chairman of Claridge Management since 2000. +Mr. Ash was a director of Net Element, Inc. (NASDAQ-NETE) from June 13, 2016 through July 13, 2020, serving as Chairman of both the Audit +and Compensation committees, as well as the Nominating and Governance Committees during his tenure. He served as Chief Operating Officer +of BioCard Corporation from 1997 to 2007. He served as Chief Operating Officer of CITA Americas, Inc. from 1996 to 1997. Mr. Ash served +as Chief Executive Officer of IEDC Marketing, Inc. from 1992 to 1996. He held a CFO/Chief Strategist position at Abrams, Ash & Associates +from 1990 to 1992. Mr. Ash currently serves on the Advisory Board of the U.K. based E2Exchange, the Institute of Entrepreneurs, since +2011, and is the only non-UK citizen holding that position. Mr. Ash served from 2009 to 2014 in a senior development and strategic capacity +for One Laptop Per Child, a global NGO created to provide educational opportunities providing laptops to the world’s poorest children. +Prior Chairmanships include the 2009 through 2012 term for the Sturge Weber Foundation, a non-profit organization dedicated to curing +this rare but fatal syndrome affecting children. Previously, Mr. Ash was an Advisory Board Member to Edge Global Investment Limited which +forged a strategic partnership with the Africa Forum, consisting of 37 former Heads of State and Government. Mr. Ash started an interest-free +micro-loan society in 1987 that has provided more than $15 million in micro-loans throughout the U.S. and Israel. In 1999, Mr. Ash founded +the Circle of Life Resource Center, Inc., a food bank in Miami, Florida that feeds several hundred families per week. Mr. Ash earned a +Bachelor of Commerce degree, with Honors in Accounting and Law from the University of Witwatersrand (South Africa) in 1980. We believe +that Mr. Ash’s extensive experience as a business and finance executive and member of multiple oversight bodies, provides him with +the necessary skills to be qualified to serve as one of our directors. +Corporate Governance +Our Board is currently composed +of seven members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) +the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, +from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters +for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at https://bitnile.com . +Audit Committee +Messrs. Ash, Smith and Bentz +currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee +satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE American. Our Board has +also determined that Messrs. Ash and Smith qualify as an “audit committee financial expert” as defined in SEC regulations +and satisfies the financial sophistication requirements set forth in the NYSE American Rules. Mr. Ash serves as the Chairman of the Audit +Committee. +The Audit Committee is responsible +for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to +be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress +and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to +ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services +rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Bentz and Rosenberg +currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation +Committee meets the requirements for independence under the standards of the NYSE American. Mr. Bentz serves as Chairman of the Compensation +Committee. +The Compensation Committee +is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving +salaries, bonuses and other benefits paid to our officers, including our Executive Chairman, Chief Executive Officer, President and Chief +Financial Officer; and administering our stock option plans and other benefit plans. +101 +Nominating and Governance Committee +Messrs. Smith, Ash, Rosenberg +and Bentz currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members +of the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE American. Mr. Smith +serves as Chairman of the Nominating and Governance Committee. +The Nominating and Governance +Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees +for each annual meeting of stockholders to the Board; developing and recommending governance principles applicable to our Board; overseeing +the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +The Nominating and Governance +Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based +business and professional skills, experiences and global business and social perspective. +In addition, the Committee +seeks directors who exhibit personal integrity and a concern for the long-term interests of stockholders, as well as those who have time +available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract +and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +Executive Committee +As a holding company, our +business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for DP Lending and approves all lending transactions. Under its business model, DP Lending generates revenue +through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income from appreciation +of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued to DP Lending +in any particular financing. DP Lending’s activities are more fully described elsewhere in this Annual Report; see page 10. +102 +Involvement in Certain Legal Proceedings +Except as set forth below, +to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former director, +executive officer, or employee: +● been convicted in a criminal proceeding or been +subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +● had any bankruptcy petition filed by or against +the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or +executive officer, either at the time of the bankruptcy filing or within two years prior to that time; +● been subject to any order, judgment, or decree, +not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or +temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, +investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; +● been found by a court of competent jurisdiction +in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities +law, and the judgment has not been reversed, suspended, or vacated; +● been the subject of, or a party to, any federal +or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including +any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or +commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited +to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist +order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business +entity; +● or been the subject of, or a party to, any sanction +or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the +Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, +entity or organization that has disciplinary authority over its members or persons associated with a member. +1. Mr. Ault held series 7, 24, and 63 licenses and managed four domestic hedge funds +and one bond fund from 1998 through 2008. On April 26, 2012, as a result from an investigation by FINRA involving activities during 2008, +Mr. Ault agreed to a settlement with FINRA in which he did not admit to any liability or violation of any laws or regulatory rules and +that included restitution and a suspension from association with a FINRA member firm for a period of 2 years. As part of that settlement, +Mr. Ault agreed that before he would reapply for association with FINRA, if at all, he would make restitution to certain investors. Mr. +Ault was able to speak with and pay restitution to one of the investors, but no others. As a result, Mr. Ault is neither eligible, nor +does he intend, to apply for association with FINRA. +2. On June 23, 2015, Local Corporation, a Delaware corporation, filed a voluntary petition +for reorganization under Chapter 11 of the US Bankruptcy Code. Mr. Cragun, our chief financial officer, was chief financial officer +of Local Corporation at the time of filing. +Except as set forth in our discussion below in +“Certain Relationships and Related Transactions,” none of our directors or executive officers has been involved in any transactions +with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules +and regulations of the SEC. +103 +Family Relationships +There are no family relationships among our directors +and executive officers. +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange +Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities +to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, directors +and ten percent stockholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based solely +upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting persons, we believe that during +the current fiscal year and the year ended December 31, 2021, all such filing requirements applicable to our officers, directors and ten +percent stockholders were fulfilled with the following exception: During the fiscal year of 2021, all of our directors inadvertently filed +one late Form 4 reporting one transaction. +Code of Ethics +We have adopted the Code of +Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller +or person performing similar functions. The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical +conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website +at https://bitnile.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit +or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request to our President, Henry Nisser, +we will provide without charge, a copy of our Code of Ethical Conduct. +ITEM 11. EXECUTIVE COMPENSATION +Summary Compensation Table +The following Summary Compensation +Table sets forth all compensation earned in all capacities during the years ended December 31, 2021 and 2020, by our Chief Executive Officer. +Because we are a Smaller Reporting Company, we only have to report information of our Chief Executive Officer and our two other most highly +compensated executive officers. +SUMMARY COMPENSATION TABLE +Name and principal position +Year +Salary ($) +Bonus ($) +Stock +Awards ($) (1) +Option +Awards ($) (1) +All +Other Compensation ($) (2) +Total ($) +Milton C. Ault, III +2021 +400,000 +821,667 +1,632,000 +1,301,440 +39,918 +4,195,025 +Executive +Chairman of the Board (3) +2020 +400,000 +200,000 +0 +0 +30,202 +630,202 +William B. Horne +2021 +300,000 +617,500 +1,632,000 +1,301,440 +41,798 +3,892,738 +Chief Executive Officer +2020 +300,000 +150,000 +0 +0 +45,164 +495,164 +Henry C. Nisser +2021 +300,000 +217,500 +1,632,000 +1,301,440 +18,800 +3,469,740 +President +and General Counsel (4) +2020 +225,000 +100,000 +0 +0 +11,825 +336,825 +(1) +The values reported in the “Stock Awards” and “Option Awards” columns represent the aggregate grant date fair value, computed in accordance with Accounting Standards Codification (“ ASC ”) 718 Share Based Payments , of grants of stock options and stock awards to our named executive officer in the years shown. +(2) +The amounts in “All Other Compensation” consist of health insurance benefits, vehicle allowance, long-term and short-term disability insurance benefits, and 401K matching amounts. +(3) +Mr. Ault was appointed as our Executive Chairman of the Board on January on January 19, 2021. Prior to the time, he was our Chief Executive Officer. +(4) +Mr. Nisser was appointed as our President on January 19, 2021. Effective October 1, 2020, Mr. Nisser’s salary was increased to $300,000 per annum. +104 +Employment Agreements +Milton C. Ault, III +On +June 17, 2018, the Company entered into a ten year executive employment agreement with Milton C. Ault, III, to serve as Chief Executive +Officer of the Company. For his services, Mr. Ault will be paid a base salary of $400,000 per annum (the “Base Salary”). +Pursuant +to the terms and subject to the conditions set forth in the agreement, if the Company meets or exceeds criteria adopted by the Company’s +compensation committee (the “Compensation Committee”) for earning bonuses which shall be adopted by the Compensation Committee +annually, Mr. Ault shall be eligible to receive an annual bonus, which percentage shall be based on achievement of applicable performance +goals determined by the Compensation Committee. +Further, +Mr. Ault is entitled to receive equity participation as follows: a grant of restricted stock in the aggregate amount of 1,250 shares of +common stock, which shares shall vest ratably over 48 months beginning on January 1, 2020, provided, however, that such shares may, in +whole or in part, in the discretion of the Compensation Committee, vest immediately upon the filing of an Annual Report on Form 10-K with +the SEC that shows that the Company’s revenues for the applicable fiscal year reached or exceeded $100,000,000; notwithstanding +the foregoing, before the Company accelerates any such vesting, the Company’s Compensation Committee must prior thereto have obtained +the consent of Mr. Ault, which consent may be withheld in his discretion. +In +addition, Mr. Ault shall be eligible to receive a performance-based award (the “CEO Performance Award”), provided that the +Company, for any given fiscal year during the term of this agreement, meets the following criteria: (A) an increase in revenue, as calculated +under GAAP over the previous fiscal year as reported in the Annual Report on Form 10-K or successor form for such fiscal year; provided +that any increase less than thirty-five percent (35%) (the “Revenue Percentage”) shall reduce the CEO Performance Award correspondingly; +(B) positive net income, as calculated under GAAP, as reported in the Annual Report on Form 10-K or successor form for such fiscal year, +provided that any increase less than five percent (5%) (the “Net Income Percentage”) shall reduce the CEO Performance Award +correspondingly; and (C) positive net cash flow from operations on a year-to-year basis, where cash flow is defined as the net amount +of cash and cash-equivalents being transferred into and out of the Company. The CEO Performance Award shall consist of a number of shares +of the Company’s common stock having a maximum value equal to ten percent (10%) of any appreciation in the Company’s Market +Capitalization above the High Water Mark (as such terms are defined in the agreement) as measured by the daily average closing bid price +of the Company’s common stock for the applicable fiscal year subject to proration obtained by the product of Revenue Percentage +and the Net Income Percentage. If the CEO Performance Award in a fiscal year is less than ten percent (10%) due to a reduction caused +by an annual shortfall in either the Revenue Percentage or the Net Income Percentage, the prior year’s targets would be deemed to +have been achieved if a corresponding overage in a subsequent fiscal year results in the achievement of the cumulative targets. +The annual and cumulative targets for revenue and net income, which are provided solely for the purpose of establishing cumulative totals, +are set forth in the agreement. +Upon +termination of Mr. Ault’s employment (other than upon the expiration of the employment), Mr. Ault shall be entitled to receive: +(A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued +but unused vacation time. +Further, +unless Mr. Ault’s employment is terminated as a result of his death or disability or for cause or he terminates his employment without +good reason, then upon the termination or non-renewal of Mr. Ault’s employment, the Company shall pay to Mr. Ault a “Separation +Payment” as follows: (A) an amount equal to four (4) weeks of base salary for each full year of service and +credit for his service commencing from September 22, 2016, (B) should Mr. Ault provide the Company with a separation, waiver and release +agreement within 60 days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “Separation +Period”) of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may +be, but in no event an amount greater than the Base Salary payable should either such period expire within two years, or (2) the 12-month +period commencing on the date Mr. Ault is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, +dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum +annual bonus as Mr. Ault would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar +months worked including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options +and other equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence +of a change in control, Mr. Ault will be paid an amount equal to the greater of: (i) five times his then current Base Salary or (ii) the +Separation Payment amount set forth above, without regard to whether Mr. Ault continues in the employ of the Company or its successor. +105 +William B. Horne +On January 25, 2018, we entered +into a five-year employment agreement with William Horne to serve as Chief Financial Officer and Executive Vice President of the Company +and its subsidiaries. For his services, Mr. Horne will be paid a base salary of $250,000 per annum. Upon signing of the employment +agreement, Mr. Horne is entitled to a signing bonus in the amount of $25,000. In addition, Mr. Horne shall be eligible to receive +an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by +the Company’s compensation committee. +Further, +Mr. Horne is entitled to receive equity participation as follows: a grant of restricted stock in the aggregate amount of 1,250 shares +of common stock, which shares shall vest in installments of two hundred fifty (250) shares annually over five (5) years beginning on January +1, 2019, provided, however, that such shares may, in whole or in part, in the discretion of the Compensation Committee, vest immediately +upon the filing of an Annual Report on Form 10-K with the SEC that shows that the Company’s revenues for the applicable fiscal +year reached or exceeded $100,000,000; notwithstanding the foregoing, before the Company accelerates any such vesting, the Company’s +Compensation Committee must prior thereto have obtained the consent of Mr. Horne, which consent may be withheld in his discretion. +Upon +termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to receive: +(i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and (iii) any accrued +but unused vacation time. +Further, +unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne a “Separation +Payment” as follows: (A) an amount equal to four weeks of base salary for each full year of service, (B) should +Mr. Horne provide the Company with a separation, waiver and release agreement within 60 days of termination, then the Company shall: +(i) pay his base salary until the last to occur (the “Separation Period”) of (1) the expiration of the remaining portion of +the initial term or the then applicable renewal term, as the case may be, or (2) the 12-month period commencing on the date Mr. Horne +is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life +insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Horne would have been +otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the entire +month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity awards shall immediately +vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will +be paid an amount equal to four times his Separation Payment. +Henry Nisser +On April 12, 2019, the Company +entered into a four-year employment agreement (the “Agreement”) with Henry Nisser to serve as General Counsel and Executive +Vice President of the Company and its subsidiaries. The effective date of the Agreement is May 1, 2019. Pursuant to the Agreement, Mr. +Nisser was to be paid a base salary of $200,000 per annum (the “Base Salary”). +Upon the effective date of +the Agreement, Mr. Nisser was entitled to a signing bonus in the amount of $50,000, with $25,000 being payable upon the effective date +and $25,000 being payable no later than September 1, 2019. In addition, Mr. Nisser is eligible to receive an annual cash bonus equal to +a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s compensation +committee, which bonus shall not exceed 300% of the Base Salary. +106 +Further, Mr. Nisser is entitled +to receive equity participation as follows: (A) a grant of restricted stock in the aggregate amount of 250,000 shares of common stock, +which shares shall vest ratably over 48 months beginning with the first month after the effective date, and (B) an option to purchase +200,000 shares of common stock at a per share exercise price equal to the closing market price on the effective date, which option shall +have a term of seven (7) years. +Mr. Nisser’s bonuses, +if any, and all stock based compensation shall be subject to “Company Clawback Rights” if during the period that Mr. Nisser +is employed by the Company and upon the termination of Mr. Nisser’s employment and for a period of two years thereafter, there is +a restatement of any of the Company’s financial results from which any bonuses and stock based compensation to Mr. Nisser shall +have been determined. +Upon termination of Mr. Nisser’s +employment (other than upon the expiration of the employment), Mr. Nisser shall be entitled to receive: (A) any earned but unpaid base +salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued but unused vacation time. +Further, +unless Mr. Nisser’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Nisser’s employment, the Company shall pay to Mr. Nisser a +“Separation Payment” as follows: (a) an amount equal to four weeks of base salary for each full year of service, (b) commencing +on the date that shall be one (1) year from the effective date, should Mr. Nisser provide the Company with a separation, waiver and release +agreement within 30 days of termination, then the Company shall pay to Mr. Nisser the Base Salary (in effect immediately prior to the +termination date) an amount equal to the lesser of what Mr. Nisser would have received if the employment period ended after (1) the expiration +of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or (2) the 18-month period commencing +on the date Executive is terminated, payable in one lump sum; (ii) provide during the separation period the same medical, dental, long-term +disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. +Nisser would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked +including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other +equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change +in control, Mr. Nisser will be paid an amount equal to four times his Separation Payment. +Advisory Vote on Executive Compensation +At the annual meeting of stockholders +on July 2, 2019, the stockholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. +In addition, stockholders voted, on an advisory basis, that an advisory vote on executive compensation should be held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding +equity awards as of December 31, 2021 to the named executive officers. +OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2021 +OPTION AWARDS +Name +Number of Securities +Underlying +Unexercised Options +(#) Exercisable +Number of Securities +Underlying +Unexercised Options +(#) Unexercisable +Equity Incentive Plan +Awards: Number of +Securities Underlying +Unexercised +Unearned Options (#) +Option +Exercise +Price ($) +Option +Expiration +Date +Milton C. Ault, III +128,767 +71,233 +71,233 +1.79 +9/17/2030 +0 +400,000 +400,000 +2.55 +4/26/2031 +William B. Horne +128,767 +71,233 +71,233 +1.79 +9/17/2030 +0 +400,000 +400,000 +2.55 +4/26/2031 +Henry C. Nisser +128,767 +71,233 +71,233 +1.79 +9/17/2030 +0 +400,000 +400,000 +2.55 +4/26/2031 +107 +Director Compensation +Beginning July 1, 2019, the +Company pays each independent director an annual base amount of $35,000 annually, other than Mr. Smith, who receives a base amount of +$45,000 annually due to the additional services to be provided by Mr. Smith as a lead independent director and Mr. Ash, who will receive +a base amount of $45,000 annually due to anticipated additional services provided by Mr. Ash as Audit Committee Chairman. Additionally, +our Board makes recommendations for adjustments to an independent director’s compensation when the level of services provided are +significantly above what was anticipated. +The table below sets forth, +for each non-employee director, the total amount of compensation related to his service during the year ended December 31, 2021: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($) +Total ($) +Robert O. Smith +110,000 +408,000 +431,430 +— +949,430 +Jeffrey A. Bentz +100,000 +408,000 +431,430 +— +939,430 +Mordechai Rosenberg +100,000 +408,000 +431,430 +— +939,430 +Howard Ash +110,000 +408,000 +431,430 +— +949,430 +Stock Incentive Plans +On December 28, 2018, the +stockholders approved the 2018 Stock Incentive Plan (as amended on May 5, 2019), which amendment was approved by the stockholders on July +19, 2019, the “2018 Stock Incentive Plan”), under which options to acquire up to 175,000 shares of common stock may be +granted to the Company's directors, officers, employees and consultants. The 2018 Stock Incentive Plan is in addition to the Company’s +(i) 2017 Stock Incentive Plan, under which options to acquire up to 2,500 shares of common stock may be granted to the Company's directors, +officers, employees and consultants, (ii) 2016 Stock Incentive Plan, under which options to acquire up to 5,000 shares of common stock +may be granted to the Company's directors, officers, employees and consultants, (iii) 2012 Stock Option Plan, as amended, which provides +for the issuance of a maximum of 1,716 shares of common stock to be offered to the Company’s directors, officers, employees, and +consultants, (iv) 2021 Stock Incentive Plan, under which 7,500,000 stock options, restricted stock, stock appreciation rights, restricted +stock units, and other stock-based compensation. be granted to the Company's directors, officers, employees and consultants, and (v) 2021 +Employee Stock Purchase Plan, intended to assist our employees in acquiring share ownership up to an aggregate of 980,000 shares of common +stock (collectively the “Plans”). +The purpose of the Plans is +to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial responsibility +for the direction and management of the Company, as well as certain directors and consultants of the Company, additional incentives to +exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, to reward outstanding +performance and to provide a means to attract and retain persons of outstanding ability to the service of the Company. +As of December 31, 2021, options +to purchase 3,395,919 shares of common stock were issued and outstanding, and 2,841,699 shares are available for future issuance under +the Plans. +401(k) Plan +BitNile, TOGI and Microphase +have adopted tax-qualified employee savings and retirement plan, or 401(k) plans, which generally covers all of their full-time employees. +Pursuant to the 401(k) plans, eligible employees may make voluntary contributions to the plan up to a maximum of pursuant to the current +Internal Revenue Code limits. The Microphase 401(k) plan permits, but does not require, matching contributions by them on behalf of plan +participants. The BitNile and TOGI 401(k) plans, includes matching contributions at the rate of (1) $1.00 for each $1.00 contributed, +up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary and permits make discretionary +contributions. The 401(k) plans are intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended. +Contributions to such a qualified plan are deductible by the Company when made, and neither the contributions nor the income earned on +those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited to separate accounts maintained +in trust. +108 +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +Except as otherwise indicated +below, the following table sets forth certain information regarding beneficial ownership of our common stock as of March 31, 2022 by (1) +each of our current directors; (2) each of the executive officers; (3) each person known to us to be the beneficial owner of more than +5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and +executive officers as a group. As of April 11, 2022, there were 268,307,612 shares of our common stock issued and outstanding. +Beneficial ownership is determined +in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to +options or warrants that are currently exercisable or exercisable within 60 days of April 11, 2022 are deemed to be outstanding and to +be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of +such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or +group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table have sole voting and sole investment power +with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. +Number of +shares +Approximate +beneficially +percent +Name and address of beneficial owner +owned +of class +Directors and Officers: (1) +Milton C. Ault, III +10,224,008 (2) +3.79 % +William Horne +436,640 (3) +* +Henry Nisser +439,584 (4) +* +Ken Cragun +176,042 (5) +* +Robert Smith +225,887 (6) +* +Mordechai Rosenberg +245,833 (7) +* +Jeffrey A. Bentz +245,842 (7) +* +Howard Ash +200,833 (7) +* +All directors and executive officers as a group (eight persons) +12,194,669 +4.50 % +* Less than one percent. +(1) Unless otherwise indicated, the business address of each of the individuals is c/o BitNile Holdings, Inc., +11411 Southern Heights Pkwy, Suite240, Las Vegas, NV 89141. +(2) Includes 7,872 shares owned by Philou Ventures, 1,658,916 shares owned by Ault & Company, 94 shares +underlying warrants held by Ault & Company, 1,000,000 shares beneficially owned by Ault & Company and 7,100,000 shares owned by +Ault Alpha, all of which may be deemed beneficially owned by Mr. Ault. Also includes 66,667 shares of common stock issuable pursuant to +stock incentive grants, options to purchase 233,334 shares of common stock that are exercisable within 60 days of March 31, 2022, and +157,125 shares of common stock. +(3) Includes 66,667 shares of common stock issuable pursuant to stock incentive grants and options to purchase +233,334 shares of common stock that are exercisable within 60 days of March 31, 2022. +(4) Includes 66,667 shares of common stock issuable pursuant to stock incentive grants and options to purchase +233,334 shares of common stock that are exercisable within 60 days of March 31, 2022. +(5) Includes 25,000 shares of common stock issuable pursuant to a stock incentive grant and options to purchase +126,042 shares of common stock that are exercisable within 60 days of March 31, 2022. +(6) Includes 12,500 shares of common stock issuable pursuant to a stock incentive grant, options to purchase +133,333 shares of common stock and warrants to purchase 54 shares of common stock that are exercisable within 60 days of March 31, 2022. +(7) Includes 12,500 shares of common stock issuable pursuant to a stock incentive grant and options to purchase +133,333 shares of common stock that are exercisable within 60 days of March 31, 2022. +109 +Equity Compensation Information +The following table summarizes information about +our equity compensation plans as of December 31, 2021. +Number of securities +Number of securities +Weighted- +remaining available for +to be issued +average +future issuance under +upon exercise +exercise price +equity compensation plans +of outstanding +of outstanding +(excluding securities +options, warrants and rights +options, warrants and rights +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation plans approved by stockholders +3,396,316 +2.52 +2,841,699 +Equity compensation plans not approved by stockholders +3,000,000 +2.33 +- +Total +6,396,316 +2.43 +2,841,699 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +● the aggregate amount involved is determined to by the Audit Committee to be material; +● we are a participant; and +● any of the following has or will have a direct or indirect interest in the transaction: +● an executive officer, director, or nominee for election as a director; +● a greater than five percent beneficial owner of our common stock; or +● any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company. +Ault & Company +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company would +purchase an aggregate of 660,667 shares of our common stock at a purchase price per share of $1.12, subject to the approval of the NYSE +American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, at +the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of common stock, or up to 19.99% of +our common stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “2020 Note ”) +to Ault & Company. The principal amount of the 2020 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was due +and payable on August 5, 2020. The 2020 Note is convertible into shares of our common stock, par value $0.001 per share at a conversion +price of $1.45 per share. +110 +On +February 25, 2021, we sold and issued an 8% Secured Promissory Note in the principal amount of $2,500,000 (the “2021 Note ”) +to Ault & Company. The principal amount of the 2021 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was originally +due and payable on August 5, 2021 but the maturity date subsequently extended to December 31, 2022. The 2021 Note is not convertible. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer of Ault & Company. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief Financial Officer of Ault & Company. Henry Nisser, our President, +General Counsel and a member of our board of directors, is also the President, General Counsel and a director of Ault & Company. +Avalanche +On September 6, 2017, we entered +into the AVLP Loan Agreement with an effective date of August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit +facility. The AVLP Loan Agreement has been increased to up to $20.0 million and extended to December 31, 2023. +At December 31, 2021, we had +provided Avalanche with $17.8 million and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase +35.6 million shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets +of AVLP. As of December 31, 2021, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and +a provision for loan losses of $2.0 million. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 35.6 million shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +Avalanche received funds from +a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of the Third Party Note, $2.6 million +was used to pay an outstanding receivable due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan +Agreement. On October 12, 2021, Ault Alpha, an affiliate of ours, repaid the Third Party Note in full and also acquired a warrant to purchase +1.6 million shares of AVLP common stock. In consideration therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 +million, which term note matures on June 30, 2022. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is an affiliate +of our company. See immediately above for its involvement with respect to the Third Party Note. As of December 31, 2021, Ault Alpha had +purchased 6.1 million shares of our common stock at an average price of $2.16. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. Bentz +Yes +X +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairman of committee +X – Member of committee +111 +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +Marcum LLP served as our independent +registered public accounting firm for the years ended December 31, 2021 and 2020. Ziv Haft, a BDO Member Firm, served as the independent +registered public accounting firm of Enertec for the years ended December 31, 2021 and 2020. +Fees and Services +The following table shows +the aggregate fees billed to us for professional services by Marcum LLP and Ziv Haft for the years ended December 31, 2021 and 2020: +2021 +2020 +Audit Services +$ 1,293,000 +$ 896,000 +Audit Related Services +— +— +Tax Services +— +— +All Other Services +— +— +Total +$ 1,293,000 +$ 896,000 +Audit Fees. This +category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years +ended December 31, 2021 and 2020, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2021 +and 2020, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings +or engagements for the relevant years. +Audit-Related Fees. This +category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors +that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under “Audit +Fees,” and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, +internal control-related matters, and audits of employee benefit plans. +Tax Fees . This category +includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax +compliance, tax planning and tax advice. +All Other Fees. This +category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors +that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s +policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, +tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent +auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such +pre-approval. +112 +PART IV +ITEM 15. EXHIBITS +Exhibit +Number +Description +2.1 +Agreement and Plan of Merger dated January 7, 2021 . Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 2.1 thereto. +2.2 +Real Estate Sale Contract by and between Prairie Ronde Realty Company and Alliance Cloud Services, LLC, dated as of December 20, 2020. Incorporated by reference to the Current Report on Form 8-K filed on December 21, 2020 as Exhibit 10.1. +2.3 +Agreement and Plan of Merger dated December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 2.1 thereto. +3.1 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series B Convertible Preferred Stock, dated March 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 3.1 thereto. +3.2 +Certification of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.1 thereto. +3.3 +Certificate of Designations of Rights and Preferences of 10% Series A Cumulative Redeemable Perpetual Preferred Stock, dated September 13, 2018. Incorporated herein by reference to the Current Report on Form 8-K filed on September 14, 2018 as Exhibit 3.1 thereto. +3.4 +Certificate of Amendment to Certificate of Incorporation, dated January 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2019 as Exhibit 3.1 thereto. +3.5 +Certificate of Designations of Rights and Preferences of Series C Convertible Redeemable Preferred Stock, dated February 27, 2019. Incorporated herein by reference to the Current Report on Form 8-K filed on February 28, 2019 as Exhibit 3.1 thereto. +3.6 +Certificate of Amendment to Certificate of Incorporation (1-for-20 Reverse Stock Split of Common Stock), dated March 14, 2019. Incorporated herein by reference to the Current Report on Form 8-K filed on March 14, 2019 as Exhibit 3.1 thereto. +3.7 +Form of Amended & Restated Certificate of Designations of Rights and Preferences of Series C Convertible Preferred Stock. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2020 as Exhibit 3.1 thereto. +3.8 +Bylaws effective as of August 13, 2020. Incorporated by reference to the Current Report on Form 8-K filed on August 14, 2020 as Exhibit 3.1 thereto. +3.9 +Certificate of Ownership and Merger. Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 3.1 thereto. +3.10 +Amended and Restated Bylaws of BitNile Holdings, Inc., effective as of November 2, 2021. Incorporated by reference to the Current Report on Form 8-K filed on November 3, 2021 as Exhibit 3.1 thereto. +3.11 +Certificate of Ownership and Merger, as filed with the Secretary of State of the State of Delaware on December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 3.1 thereto. +4.1 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 4.1 thereto. +4.2 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as Exhibit 4.1 thereto. +4.3 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 4.1 thereto. +4.4 +Form of Common Stock Purchase Warrant, dated July 27, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 26, 2017 as Exhibit 4.1 thereto. +4.5 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.1 thereto. +4.6 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.2 thereto. +4.7 +Form of Common Stock Purchase Warrant, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.3 thereto. +4.8 +Form of Common Stock Purchase Warrant, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 4.1 thereto. +4.9 +Common Stock Purchase Warrant issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 4.1 thereto. +4.10 +Convertible Promissory Note issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.2 thereto. +4.11 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 4.1 thereto. +4.12 +Form of Common Stock Purchase Warrant, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 4.1 thereto. +113 +Exhibit +Number +Description +4.13 +Form of Common Stock Purchase Warrant, dated April 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed on April 16, 2018 as Exhibit 4.1 thereto. +4.14 +Form of Series A Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.1 thereto. +4.15 +Form of Series B Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.16 +Form of Series A Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.17 +Form of Series B Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.3 thereto. +4.18 +Form of Underwriter’s Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on April 1, 2019 as Exhibit 4.3 thereto. +4.19 +Form of Common Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K/A filed on April 4, 2019 as Exhibit 4.1 thereto. +4.20 +Form of Convertible Promissory Note, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 4.1 thereto. +4.21 +Form of Warrant, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 4.2 thereto. +4.22 +Form of Warrant, dated as of May 28, 2020. Incorporated by reference to the Current Report on Form 8-K filed on May 29, 2020 as Exhibit 4.3 thereto. +4.23 +Form of Warrant, dated June 26, 2020. Incorporated by reference to the Current Report on Form 8-K filed on June 29, 2020 as Exhibit 4.2 thereto. +4.24 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on July 17, 2020 as Exhibit 4.2 thereto. +4.25 +Form of Warrant, dated October 22, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 23, 2020 as Exhibit 4.2 thereto. +4.26 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.3 thereto. +4.27 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.4 thereto. +4.28 +Form of Warrant issued to Esousa Holdings, LLC, dated November 19, 2020. Incorporated by reference to the Current Report on Form 8-K filed on November 20, 2020 as Exhibit 4.3 thereto. +4.29 +Form of Senior Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.1 thereto. +4.30 +Form of Subordinated Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.2 thereto. +4.31 +Form of Note , dated December 15, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 16, 2021 as Exhibit 4.1 thereto. +4.32 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on December 22, 2021 as Exhibit 4.1 thereto. +4.33 +Form of Note, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.1 thereto. +4.34 +Form of Class A Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.2 thereto. +4.35 +Form of Class B Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.3 thereto. +4.36 +Form of Amendment to Class B Warrant. Incorporated by reference to the Current Report on Form 8-K filed on January 21, 2022 as Exhibit 10.2 thereto. +4.37 +Description of Capital Stock. Incorporated by reference to the Annual Report on Form 10-K filed on April 15, 2021 as Exhibit 4.29 thereto. +10.1 +Loan and Security Agreement between the Company and Avalanche International Corp., dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.1 thereto. +10.2 +Amendment to MTIX Limited Purchase Order Number 2121. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2020 as Exhibit 10.2 thereto. +10.3 +At-The-Market Issuance Sales Agreement, dated January 22, 2021, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on January 25, 2021 as Exhibit 10.1 thereto. +114 +Exhibit +Number +Description +10.4 +Amendment No. 1 dated February 17, 2021 to At-The-Market Issuance Sales Agreement, dated January 22, 2021, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on February 17, 2021 as Exhibit 10.1 thereto. +10.5 +Amendment No. 2 dated March 5, 2021 to At-The-Market Issuance Sales Agreement, dated January 22, 2021, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on March 5, 2021 as Exhibit 10.1 thereto. +10.6 +Termination Agreement, dated December 31, 2020. Incorporated by reference to the Current Report on Form 8-K filed on January 4, 2021 as Exhibit 10.1 thereto. +10.7 +Form of Securities Purchase Agreement, dated June 10, 2021. Incorporated by reference to the Current Report on Form 8-K filed on June 15, 2021 as Exhibit 10.1 thereto. +10.8* +Executive Employment Agreement with Christopher K. Wu dated June 22, 2021. Incorporated by reference to the Current Report on Form 8-K filed on June 23, 2021 as Exhibit 10.1 thereto. +10.9* +2021 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix B thereto . +10.10* +2021 Employee Stock Purchase Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix C thereto. +10.11* +Form of Stock Option Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.3 thereto. +10.12* +Form of Restricted Stock Unit Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.4 thereto. +10.13 +Form of Non-Fixed Price Sales and Purchase Agreement, by and between Ault Alliance, Inc. and Bitmain Technologies Limited, dated September 12, 2021. Incorporated by reference to the Current Report on Form 8-K filed on September 15, 2021 as Exhibit 10.1 thereto. +10.14 +Form of Non-Fixed Price Sales and Purchase Agreement, by and between Ault Alliance, Inc. and Bitmain Technologies Limited. Incorporated by reference to the Current Report on Form 8-K filed on November 17, 2021 as Exhibit 10.1 thereto. +10.15 +Form of Non-Fixed Price Sales and Purchase Agreement, by and between Ault Alliance, Inc. and Bitmain Technologies Limited. Incorporated by reference to the Current Report on Form 8-K filed on November 18, 2021 as Exhibit 10.1 thereto. +10.16 +Form of Note Purchase Agreement, dated December 15, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 16, 2021 as Exhibit 10.1 thereto. +10.17 +Form of Note Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 22, 2021 as Exhibit 10.1 thereto. +10.18 +Form of Construction Loan Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.1 thereto. +10.19 +Form of Mortgage, Assignment of Rents and Leases, Security Agreement and Fixture Filing. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.2 thereto. +10.20 +Form of Assignment of Leases, Rents and Profits. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.3 thereto. +10.21 +Form of Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.4 thereto. +10.22 +Share Exchange Agreement dated as of December 27, 2021 by and among Giga-tronics Incorporated, BitNile Holdings, Inc. and Gresham Worldwide, Inc. Incorporated by reference to the Current Report on Form 8-K filed on December 28, 2021 as Exhibit 10.1 thereto. +10.23 +Form of Securities Purchase Agreement, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.1 thereto. +10.24 +Form of Security Agreement, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.2 thereto. +10.25 +Form of A&C Guaranty, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.3 thereto. +10.26 +Form of Subsidiary Guaranty, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.4 thereto. +10.27 +Form of Contract of Sale. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.1 thereto . +10.28 +At-The-Market Issuance Sales Agreement, dated February 25, 2022, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2022 as Exhibit 10.1 thereto. +21** +List of subsidiaries. +23.1** +Consent of Marcum LLP. +23.2** +Consent of Ziv Haft, BDO member firm. +31.1** +Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a). +115 +Exhibit +Number +Description +31.2** +Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a). +32.1*** +Certification of Chief Executive and Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. +101.INS** +Inline XBRL Instance Document. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH** +Inline XBRL Taxonomy Extension Schema Document. +101.CAL** +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF** +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB** +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE** +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +* Indicates management contract or compensatory plan or arrangement. +** Filed herewith. +*** Furnished herewith. +ITEM 16. FORM 10–K SUMMARY +None. +116 +SIGNATURES +Pursuant to the requirements of Section 13 +or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned +thereunto duly authorized. +Dated: April 15, 2022 +BITNILE HOLDINGS, INC. +By: +/s/ William B. Horne +William B. Horne +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ Kenneth S. Cragun +Kenneth S. Cragun +Chief Financial Officer +(Principal Financial and Accounting Officer) +Pursuant to the requirements of the Securities +Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +April 15, 2022 +/s/ Milton C. Ault, III +Milton C. Ault, III, Executive Chairman of the Board +April 15, 2022 +/s/ William B. Horne +William B. Horne, Chief Executive Officer and Director +April 15, 2022 +/s/ Henry Nisser +Henry Nisser, President, General Counsel and Director +April 15, 2022 +/s/ Howard Ash +Howard Ash, Director +April 15, 2022 +/s/ Robert O. Smith +Robert O. Smith, Director +April 15, 2022 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, Director +April 15, 2022 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +117 +ITEM 8. FINANCIAL STATEMENTS +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm – Marcum LLP (PCAOB ID Number 688 ) +F-2 +Report of Independent Registered Public Accounting Firm – Ziv Haft. (PCAOB ID Number 1185) +F-5 +Consolidated Balance Sheets as of December 31, 2021 and 2020 +F-7 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, +2021 and 2020 +F-9 +Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2021 +and 2020 +F-10 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2021 and 2020 +F-12 +Notes to Consolidated Financial Statements +F-13 – F-54 +F- 1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Shareholders and Board of Directors of +BitNile Holdings, Inc. and Subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated +balance sheets of BitNile Holdings, Inc. (formerly known as Ault Global Holdings, Inc.) and Subsidiaries (the “Company”) as +of December 31, 2021 and 2020, the related consolidated statements of operations and comprehensive loss, changes in stockholders’ +equity and cash flows for each of the two years in the period ended December 31, 2021, and the related notes (collectively referred to +as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial +position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the two years +in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. +We did not audit the December 31, 2021 and 2020 +financial statements of Enertec Systems 2001 Ltd., a wholly-owned subsidiary, which statements reflect 3% and 18% of the total consolidated +assets as of December 31, 2021 and 2020, respectively, and 21% and 39% of the total consolidated revenues for the years ended December +31, 2021 and 2020, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, +insofar as it relates to the amounts included for Enertec Systems 2001 Ltd., is based solely on the report of the other auditors. +Basis for Opinion +These financial statements are the responsibility +of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit s . +We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and +are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules +and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit s in accordance with +the standards of the PCAOB . Those standards require that we plan and perform the audit s to obtain reasonable assurance about +whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, +nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit s we are required +to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness +of the Company's internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below +are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to +the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our +especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion +on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions +on the critical audit matters or on the accounts or disclosures to which they relate. +F- 2 +Accounting for investments in variable interest +entities +Description of the Matter +As discussed in the consolidated +financial statement, the Company holds interests in an entities that meet the characteristics of a variable interest entity (“VIE”). +The Company determines whether it is the primary beneficiary of a VIE at the time it becomes involved with +a VIE, which requires consolidation based upon the following criteria: +a) the power to direct the activities of the entity that most significantly impact its economic success, +b) the obligation to absorb the economic losses of the entity, or +c) the right to receive the expected residual returns of the entity; or +d) the voting rights of some investors in the entity are not proportions to their economic interests and +the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest. +We identified +the accounting for investment in the variable interest entities to be a critical audit matter. Evaluating the Company’s judgments +in determining whether an entity is a VIE and the primary beneficiary of the VIE required a high degree of complex auditor judgment. +How +We Addressed the Matter in Our Audit +Our audit +procedures related to accounting for investment in variable interest entity to address this critical audit matter included the following: +· We gained an understanding of the Company’s process to identify and account for a VIE. +· We obtained and read the agreements in which the Company evaluated and compared the terms of the agreements +to the Company’s assessment. +· We reviewed the Company’s VIE analysis to determine if the VIE met the criteria for consolidation +in accordance with Accounting Standards Codification (“ASC”) 810, Consolidations. +· We evaluated the factors considered to determine whether the Company omitted any significant potential +variable interests in their analysis. +Equity Investment in Unconsolidated Entity +As discussed in Note 3 and 13 to the consolidated +financial statements, the Company’s investment in Avalanche International Corp. (AVLP) is accounted for under the equity method +of accounting. AVLP is a related party controlled by Philou Ventures, LLC, which is an entity affiliated with the Company through Milton +C. Ault, III who is the Company’s Executive Chairman of the Board. The Company’s investments in AVLP include convertible promissory +notes of $21.4 million and other assets of $0.6 million. The Company also has entered into an agreement with AVLP to provide contract +manufacturing services relating the production of this machinery. +Management exercised significant judgment in determining +the carrying amounts of the AVLP by evaluating projected operating results and credit risk. The Company exercised these judgments within +the context of AVLP being a related party that is both a debtor to the Company and customer with a trade relationship. Management evaluated +projected revenue and expenses to evaluate collectability of its investment. +The Company determines whether the equity method +of accounting is required based on the following criteria: +a) the control the investor has over the investee +b) the election of fair value options for the investment +c) the assessment of whether the investment is common stock or in substance common stock +d) the significant influence the investor has +We identified +the accounting for AVLP investments to be a critical audit matter. Evaluating the Company’s judgments in determining whether an +entity should be accounting for under the equity method in addition to assessing the recoverability of those investments requires a high +degree of judgment. +F- 3 +How +We Addressed the Matter in Our Audit +Our audit +procedures related to accounting for the equity investment in unconsolidated entity to address this critical audit matter included the +following: +· We gained an understanding of the Company’s process to identify and account for equity investments. +· We obtained and read the agreements in which the Company evaluated and compared the terms of the agreements +to the Company’s assessment. +· We reviewed the Company’s equity method analysis to determine if the investment met the criteria +for equity method accounting. +· We evaluated the factors considered to determine whether the Company omitted any other significant investments +in their analysis. +· Testing the mathematical accuracy of the discounted cash flow analysis, +· Assessing the reasonableness of the revenue and expense assumptions and their consistency with other audit +evidence +/s/ Marcum llp +Marcum LLP +We have served as the Company’s auditor since 2016. +New +York , New York +April 15, 2022 +F- 4 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Board of Directors and Management of Enertec systems 2001 Ltd. +Karmiel, Israel. +Opinion on the Financial Statements +We have audited the accompanying Statements of +financial position of Enertec systems 2001 Ltd. ("the Company") as of December 31, 2021 and 2020, the related statements of +comprehensive profit /(loss), Statements of changes in shareholders' equity, and cash flows for each +of the years then ended, and the related notes (collectively, the financial statements). In our opinion, the financial statements +present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its +operations and its cash flows for the years then ended , in conformity with U.S. generally +accepted accounting principles. +Basis for Opinion +These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are +a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be +independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of +the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the +standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial +statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged +to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding +of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s +internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below +are matters arising from the current period audit of the financial statements that were communicated and that: (1) relate to accounts +or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. +The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we +are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts +or disclosures to which they relate. +Estimation of total contract costs to be incurred for fixed-price +long-term contract revenue +As discussed in Note 2 to the financial statements, +almost all company revenue is recognized under long-term contracts for the year ended December 31, 2021. For those long-term contracts +that are fixed-price in nature, the Company recognizes revenue over time based on the ratio of (1) actual contract costs incurred to date +to (2) the Company’s estimate of total contract costs to be incurred. +We identified the evaluation of the estimate of +total contract costs to be incurred for fixed-price long-term contracts as a critical audit matter. In particular, evaluating the Company’s +judgments regarding the amount of time and budget to complete the contracts, including the assessment of the nature and complexity of +the work to be performed, involved a high degree of subjective judgment. +F- 5 +The procedures we performed to address this critical +audit matter included the following. +We examined the sampled contracts to evaluate +the Company’s identification of performance obligations and the determined method for measuring contract progress. We tested consistency +of the estimated total contract costs projected in the current year versus the original or prior period for sampled contracts. We interviewed +the Company to evaluate progress to date, the estimate of remaining costs to be incurred, and factors impacting the amount of time and +cost to complete the sampled contracts. We examined the company's estimates of the total contract costs project (budget) by analytical +analysis - we received from the company segmented profitability of projects according to the nature of the projects, and examined that +indeed the projects average gross profitability for the continuation of a sampled project is reasonable relative to the average gross +profitability of projects in that segmentation as of today. +We performed a retrospective examination - We compared the Company’s +original or prior period estimate of total contract costs to be incurred to the actual costs incurred for the finished contracts to assess +the Company’s ability to accurately estimate costs. +We have received projected budgets for all projects +signed and approved by the project manager. +All procedures we performed was performed only +for projects was sampled by us. +Ziv Haft. +Certified Public Accountants (Isr.) +BDO Member Firm +We have served as the Company’s auditor since 2012. +Tel-Aviv, Israel +April 15, 2022 +F- 6 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +December 31, +2021 +2020 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ 15,912,000 +$ 18,680,000 +Restricted cash +5,321,000 +- +Marketable equity securities +40,380,000 +2,563,000 +Digital currencies +2,165,000 +7,000 +Accounts receivable +5,259,000 +3,852,000 +Accounts and other receivable, related party +1,196,000 +1,196,000 +Accrued revenue +2,283,000 +1,696,000 +Inventories +5,482,000 +3,374,000 +Prepaid expenses and other current assets +15,436,000 +2,988,000 +TOTAL CURRENT ASSETS +93,434,000 +34,356,000 +Cash and marketable securities held in trust account +116,725,000 +- +Intangible assets, net +4,035,000 +4,390,000 +Goodwill +10,090,000 +9,646,000 +Property and equipment, net +174,025,000 +2,123,000 +Right-of-use assets +5,243,000 +4,318,000 +Investment in promissory notes and other, related parties +2,842,000 +1,000,000 +Investments in common stock, related parties +13,230,000 +653,000 +Investments in equity securities +30,482,000 +262,000 +Investment in limited partnership +1,869,000 +1,869,000 +Investment in unconsolidated entity +22,130,000 +15,957,000 +Loans receivable +14,337,000 +750,000 +Other assets +1,844,000 +319,000 +TOTAL ASSETS +$ 490,286,000 +$ 75,643,000 +LIABILITIES AND STOCKHOLDERS’ EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ 22,702,000 +$ 17,014,000 +Accounts payable and accrued expenses, related party +53,000 +36,000 +Investment in margin accounts payable +18,488,000 +- +Operating lease liability, current +1,123,000 +524,000 +Revolving credit facility +- +125,000 +Notes payable, net +39,554,000 +3,595,000 +Notes payable, related parties +- +188,000 +Convertible notes payable, related party +- +400,000 +TOTAL CURRENT LIABILITIES +81,920,000 +21,882,000 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +December 31, +December 31, +2021 +2020 +LONG TERM LIABILITIES +Operating lease liability, non-current +4,213,000 +3,855,000 +Notes payable +55,055,000 +336,000 +Notes payable, related parties +- +52,000 +Convertible notes payable +468,000 +386,000 +Deferred underwriting commissions of Ault Disruptive subsidiary +3,450,000 +- +TOTAL LIABILITIES +145,106,000 +26,511,000 +COMMITMENTS AND CONTINGENCIES +Redeemable noncontrolling interests in equity of subsidiaries +116,725,000 +- +STOCKHOLDERS’ EQUITY +Series A Convertible Preferred Stock, $25.00 stated value per share, +- +- +$ 0.001 par value – 1,000,000 shares authorized; 7,040 shares +issued and outstanding at December 31, 2021 and 2020 +(redemption amount and liquidation preference of $ 176,000 as of +December 31, 2021 and 2020) +Series B Convertible Preferred Stock, $10 stated value per share, +- +- +share, $ 0.001 par value – 500,000 shares authorized; 125,000 shares issued +and outstanding at December 31, 2021 and 2020 (liquidation +preference of $ 1,250,000 at December 31, 2021 and 2020) +Class A Common Stock, $ 0.001 par value – 500,000,000 shares authorized; +84,000 +28,000 +84,344,607 and 27,753,562 shares issued and outstanding at December 31, +2021 and 2020, respectively +Class B Common Stock, $ 0.001 par value – 25,000,000 shares authorized; +- +- +nil shares issued and outstanding at December 31, 2021 and 2020 +Additional paid-in capital +385,644,000 +171,396,000 +Accumulated deficit +( 145,600,000 ) +( 121,396,000 ) +Accumulated other comprehensive loss +( 106,000 ) +( 1,718,000 ) +Treasury stock, at cost +( 13,180,000 ) +- +TOTAL BITNILE HOLDINGS STOCKHOLDERS’ EQUITY +226,842,000 +48,310,000 +Non-controlling interest +1,613,000 +822,000 +TOTAL STOCKHOLDERS’ EQUITY +228,455,000 +49,132,000 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ 490,286,000 +$ 75,643,000 +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE +LOSS +For the Year Ended +December 31, +2021 +2020 +Revenue +$ 32,096,000 +$ 23,629,000 +Revenue, cryptocurrency mining, net +3,450,000 +- +Revenue, lending and trading activities +16,854,000 +242,000 +Total revenue +52,400,000 +23,871,000 +Cost of revenue +23,858,000 +16,357,000 +Gross profit +28,542,000 +7,514,000 +Operating expenses +Research and development +2,041,000 +1,849,000 +Selling and marketing +7,773,000 +1,177,000 +General and administrative +36,686,000 +12,521,000 +Benefit for credit losses +- +( 2,000,000 ) +Impairment of mined cryptocurrency +403,000 +- +Total operating expenses +46,903,000 +13,547,000 +Loss from continuing operations +( 18,361,000 ) +( 6,033,000 ) +Other income (expenses) +Interest income +808,000 +105,000 +Impairment of debt securities, net +( 5,090,000 ) +- +Interest expense +( 1,871,000 ) +( 9,648,000 ) +Change in fair value of marketable equity securities +( 1,327,000 ) +919,000 +Realized gain on marketable securities +1,924,000 +- +Loss from equity investment +( 311,000 ) +- +Gain (loss) on extinguishment of debt +929,000 +( 18,706,000 ) +Change in fair value of warrant liability +( 542,000 ) +( 49,000 ) +Total other income (expenses), net +( 5,480,000 ) +( 27,379,000 ) +Loss from continuing operations before income taxes +( 23,841,000 ) +( 33,412,000 ) +Income tax (provision) benefit +( 130,000 ) +24,000 +Net loss from continuing operations +( 23,971,000 ) +( 33,388,000 ) +Net income from discontinued operations, net of taxes +- +661,000 +Net loss +( 23,971,000 ) +( 32,727,000 ) +Net loss attributable to non-controlling interest +( 213,000 ) +- +Net loss attributable to BitNile Holdings +( 24,184,000 ) +( 32,727,000 ) +Preferred dividends +( 18,000 ) +( 18,000 ) +Net loss available to common stockholders +$ ( 24,202,000 ) +$ ( 32,745,000 ) +Basic and diluted net income (loss) per common share: +Continuing operations +$ ( 0.44 ) +$ ( 3.48 ) +Discontinued operations +- +0.07 +Net loss per common share +$ ( 0.44 ) +$ ( 3.41 ) +Weighted average common shares outstanding, basic and diluted +55,444,000 +9,606,000 +Comprehensive loss +Net loss available to common stockholders +$ ( 24,202,000 ) +$ ( 32,745,000 ) +Other comprehensive income (loss) +Foreign currency translation adjustment +85,000 +482,000 +Net unrealized gain (loss) on derivative securities of related party +( 7,773,000 ) +3,312,000 +Impairment of debt securities +9,300,000 +3,312,000 +Other comprehensive income +1,612,000 +3,794,000 +Total comprehensive loss +$ ( 22,590,000 ) +$ ( 28,951,000 ) +The accompanying notes are an integral part of these consolidated financial statements. +F- 9 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Series A & B +Additional +Other +Total +Preferred +Stock +Common +Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Stockholders’ +Shares +Amount +Shares +Amount +Capital +Deficit +Loss +Interest +Equity +BALANCES, January 1, 2020 +132,040 +$ - +3,318,390 +$ 3,000 +$ 101,099,000 +$ ( 88,650,000 ) +$ ( 5,511,000 ) +$ 8,000 +$ 6,949,000 +Stock-based compensation: +Options +- +- +- +- +80,000 +- +- +- +80,000 +Common stock +- +- +102,500 +- +182,000 +- +- +- +182,000 +Issuance of common stock for cash +- +- +12,582,000 +13,000 +39,965,000 +- +- +- +39,978,000 +Issuance of common stock in payment of +short term advances, related party +- +- +660,667 +1,000 +739,000 +- +- +- +740,000 +Issuance of common stock in payment of +accrued liabilities +- +- +229,898 +- +714,000 +- +- +- +714,000 +Issuance of common stock for conversion +of debt +- +- +10,046,012 +10,000 +24,771,000 +- +- +- +24,781,000 +Issuance of common stock upon exercise +of warrants +- +- +814,095 +1,000 +876,000 +- +- +- +877,000 +Issuance of Enertec warrants +- +- +- +- +- +- +- +814,000 +814,000 +Beneficial conversion feature in connection +with convertible notes +- +- +- +- +82,000 +- +- +- +82,000 +Fair value of warrants issued in connection +with convertible notes +- +- +- +- +4,540,000 +- +- +- +4,540,000 +Cash for exchange fees and other financing costs +- +- +- +- +( 1,652,000 ) +- +- +- +( 1,652,000 ) +Comprehensive loss: +Net loss +- +- +- +- +- +( 32,727,000 ) +- +- +( 32,727,000 ) +Preferred dividends +- +- +- +- +- +( 18,000 ) +- +- +( 18,000 ) +Net unrealized loss on derivatives +in related party +- +- +- +- +- +- +3,312,000 +- +3,312,000 +Foreign currency translation adjustments +- +- +- +- +- +482,000 +- +482,000 +Other +- +- +- +- +- +( 1,000 ) +( 1,000 ) +- +( 2,000 ) +BALANCES, December 31, 2020 +132,040 +$ - +27,753,562 +$ 28,000 +$ 171,396,000 +$ ( 121,396,000 ) +$ ( 1,718,000 ) +$ 822,000 +$ 49,132,000 +The accompanying notes are an integral part of these consolidated financial statements. +F- 10 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Series A & B +Additional +Other +Total +Preferred +Stock +Common +Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Treasury +Stockholders’ +Shares +Amount +Shares +Amount +Capital +Deficit +Loss +Interest +Stock +Equity +BALANCES, January 1, 2021 +132,040 +$ - +27,753,562 +$ 28,000 +$ 171,396,000 +$ ( 121,396,000 ) +$ ( 1,718,000 ) +$ 822,000 +$ - +$ 49,132,000 +Issuance of common stock for restricted stock awards +- +- +1,193,749 +1,000 +( 1,000 ) +- +- +- +- +- +Stock-based compensation: +Options +- +- +- +- +3,153,000 +- +- +- +- +3,153,000 +Restricted stock awards +- +- +- +- +3,968,000 +- +- +- +- +3,968,000 +Issuance of stock options at Gresham +Worldwide +- +- +- +- +- +- +- +629,000 +- +629,000 +Issuance of common stock for cash +- +- +52,552,353 +53,000 +200,000,000 +- +- +- +- +200,053,000 +Financing cost in connection with sales of common +stock +- +- +- +- +( 5,941,000 ) +- +- +- +- +( 5,941,000 ) +Non-controlling position at Imperalis subsidiary acquired +- +- +- +- +- +- +- +( 50,000 ) +- +( 50,000 ) +Adjustment to treasury stock for holdings in investment +partnerships +- +- +- +- +- +- +- +- +( 13,180,000 ) +( 13,180,000 ) +Issuance of common stock for conversion +- +- +- +of convertible notes payable +- +- +183,214 +- +449,000 +- +- +- +- +449,000 +Issuance of common stock for conversion +- +- +- +of convertible notes payable, related party +- +- +275,862 +- +400,000 +- +- +- +- +400,000 +Issuance of common stock upon exercise of warrants +- +- +2,385,867 +2,000 +4,722,000 +- +- +- +- +4,724,000 +Fair value of warrants issued in connection with notes +- +- +- +- +16,310,000 +- +- +- +- +16,310,000 +Proceeds +allocated to public warrants of Ault Disruptive +subsidiary, net of offering costs +- +- +- +- +4,092,000 +- +- +- +- +4,092,000 +Remeasurement of Ault Disruptive subsidiary temporary +equity +- +- +- +- +( 12,904,000 ) +- +- +- +- +( 12,904,000 ) +Comprehensive loss: +- +- +- +Net loss +- +- +- +- +- +( 24,184,000 ) +- +- +- +( 24,184,000 ) +Preferred dividends +- +- +- +- +( 18,000 ) +- +- +- +( 18,000 ) +Net unrealized loss on derivatives in related +party +- +- +- +- +- +- +( 7,773,000 ) +- +- +( 7,773,000 ) +Impairment of debt securities +- +- +- +- +- +- +9,300,000 +- +- +9,300,000 +Foreign currency translation adjustments +- +- +- +- +- +- +85,000 +- +- +85,000 +Net income attributable to non-controlling interest +- +- +- +- +- +- +- +213,000 +- +213,000 +Other +- +- +- +- +( 2,000 ) +- +( 1,000 ) +- +( 3,000 ) +BALANCES, December 31, 2021 +132,040 +$ - +84,344,607 +$ 84,000 +$ 385,644,000 +$ ( 145,600,000 ) +$ ( 106,000 ) +$ 1,613,000 +$ ( 13,180,000 ) +$ 228,455,000 +The accompanying notes are an integral part of these consolidated financial statements. +F- 11 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +For the Year Ended December 31, +2021 +2020 +Cash flows from operating activities: +Net loss +$ ( 23,971,000 ) +$ ( 32,727,000 ) +Less: Net income from discontinued operations +- +661,000 +Net loss from continuing operations +( 23,971,000 ) +( 33,388,000 ) +Adjustments to reconcile net loss to net cash used in operating activities: +Depreciation +2,103,000 +392,000 +Amortization +375,000 +336,000 +Amortization of right-of-use assets +950,000 +( 140,000 ) +Amortization, related party +30,000 +- +Interest expense – debt discount +1,076,000 +7,251,000 +(Gain) loss on extinguishment of debt +( 929,000 ) +18,706,000 +Change in fair value of warrant liability +542,000 +49,000 +Accretion of original issue discount on notes receivable +- +22,000 +Impairment of debt securities, net +5,090,000 +- +Accretion of original issue discount on notes receivable +21,000 +( 62,000 ) +Increase in accrued interest on notes receivable – related party +( 235,000 ) +( 1,000 ) +Stock-based compensation +7,750,000 +1,106,000 +Impairment of cryptocurrencies +403,000 +( 5,000 ) +Realized losses on other investments +- +39,000 +Realized gains on sale of marketable securities +( 21,187,000 ) +( 75,000 ) +Unrealized (gains) losses on marketable equity securities +14,127,000 +( 796,000 ) +Unrealized (gains) losses on equity securities – related party +5,754,000 +( 298,000 ) +Unrealized (gains) losses on equity securities +( 10,734,000 ) +73,000 +Loss from equity investment +311,000 +- +Provision for loan losses +- +( 2,000,000 ) +Changes in operating assets and liabilities: +Marketable equity securities +( 29,398,000 ) +- +Accounts receivable +( 1,407,000 ) +( 641,000 ) +Accrued revenue +( 498,000 ) +645,000 +Inventories +( 2,031,000 ) +183,000 +Prepaid expenses and other current assets +( 5,548,000 ) +( 1,613,000 ) +Digital currencies +( 3,450,000 ) +- +Other assets +( 1,526,000 ) +( 88,000 ) +Accounts payable and accrued expenses +1,613,000 +( 364,000 ) +Accounts payable, related parties +17,000 +( 28,000 ) +Other current liabilities +- +( 650,000 ) +Lease liabilities +( 919,000 ) +168,000 +Net cash used in continuing operating activities +( 61,671,000 ) +( 11,179,000 ) +Net cash provided by discontinued operating activities +— +1,000 +Net cash used in operating activities +( 61,671,000 ) +( 11,178,000 ) +Cash flows from investing activities: +Purchase of property and equipment +( 151,993,000 ) +( 582,000 ) +Acquisition of Relec, net of cash acquired +- +( 3,628,000 ) +Investments in convertible promissory notes of AVLP and Alzamend, related parties +( 7,344,000 ) +( 2,118,000 ) +Investment in term promissory note of Ault & Company, related party +( 2,500,000 ) +- +Investments in common stock and warrants, related parties +( 20,163,000 ) +( 354,000 ) +Investment in real property, related party +( 2,670,000 ) +- +Proceeds from sale of investment in real property, related party +2,670,000 +- +Acquisition of Imperalis, net of cash acquired +( 165,000 ) +- +Purchase of marketable equity securities +( 2,765,000 ) +( 1,425,000 ) +Sales of marketable equity securities +4,062,000 +373,000 +Investments in loans receivable +( 18,235,000 ) +- +Proceeds from loans receivable +- +140,000 +Investment of Ault Disruptive initial public offering proceeds into trust account +( 116,725,000 ) +- +Investments in equity securities +( 17,623,000 ) +( 189,000 ) +Net cash used in investing activities +( 333,451,000 ) +( 7,783,000 ) +The accompanying notes are an integral part of these consolidated financial statements. +F- 12 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) +For the Year Ended December 31, +2021 +2020 +Cash flows from financing activities: +Gross proceeds from sales of common stock +$ 200,053,000 +$ 39,978,000 +Financing cost in connection with sales of equity securities +( 5,941,000 ) +( 1,652,000 ) +Proceeds from warrant exercises +4,724,000 +53,000 +Proceeds from convertible notes payable +- +100,000 +Proceeds from notes payable +84,909,000 +9,722,000 +Proceeds from short-term advances +- +570,000 +Payments on short-term advances +- +( 570,000 ) +Proceeds from margin accounts +18,488,000 +- +Proceeds from short-term advances – related party +- +653,000 +Payments on short-term advances – related party +- +( 323,000 ) +Payments on notes payable +( 2,461,000 ) +( 8,784,000 ) +Payments on advances on future receipts +- +( 2,351,000 ) +Payments of preferred dividends +( 18,000 ) +( 18,000 ) +Purchase of treasury stock +( 13,180,000 ) +- +Proceeds from initial public offering of Ault Disruptive +112,125,000 +- +Payment of deferred offering costs of Ault Disruptive initial public offering +( 633,000 ) +- +Payments on revolving credit facilities, net +( 125,000 ) +( 97,000 ) +Net cash provided by financing activities +397,941,000 +37,281,000 +Effect of exchange rate changes on cash and cash equivalents +( 266,000 ) +( 123,000 ) +Net increase in cash and cash equivalents and restricted cash +2,553,000 +18,197,000 +Cash and cash equivalents and restricted cash at beginning of period +18,680,000 +483,000 +Cash and cash equivalents and restricted cash at end of period +$ 21,233,000 +$ 18,680,000 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ 257,000 +$ 658,000 +Non-cash investing and financing activities: +Conversion of convertible notes payable into shares of common stock +$ 449,000 +$ 24,781,000 +Payment of accounts payable with digital currency +$ 890,000 +$ - +Issuance of common stock in payment of liability +$ - +$ 1,537,000 +Cancellation of short-term advances, related party into shares of common stock +$ - +$ 740,000 +Issuance of notes payable and convertible notes payable in payment of accrued expenses +$ - +$ 420,000 +Conversion of equity securities to marketable securities +$ 2,656,000 +$ - +Conversion of loans receivable to equity securities +$ 4,250,000 +$ - +Conversion of convertible notes payable, related party into shares of common stock +$ 400,000 +$ 600,000 +Remeasurement of Ault Disruptive temporary equity +$ 1,712,000 +$ - +Deferred offering costs of Ault Disruptive +$ 3,579,000 +$ - +Recognition of new operating lease right-of-use assets and lease liabilities +$ 1,875,000 +$ - +Fair value of warrants issued in connection with notes +$ 16,310,000 +$ - +Amounts receivable from issuance of promissory notes +$ 6,900,000 +$ - +Issuance of notes payable for purchase of property and equipment +$ 22,000,000 +$ - +Deferred underwriter commissions payable of Ault Disruptive subsidiary +$ +3,450,000 +$ - +The accompanying notes are an integral part of these consolidated financial statements. +F- 13 +BITNILE HOLDINGS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2021 +1. DESCRIPTION OF BUSINESS +BitNile Holdings, Inc., a +Delaware corporation (“BitNile” or the “Company”), formerly known as Ault Global Holdings, Inc., which was formerly +known as DPW Holdings, Inc., was incorporated in September 2017. BitNile is a diversified holding company pursuing growth by acquiring +undervalued businesses and disruptive technologies with a global impact. Through its wholly- and majority-owned subsidiaries and strategic +investments, the Company owns and operates a data center at which it mines Bitcoin, and provides mission-critical products that support +a diverse range of industries, including defense/aerospace, industrial, automotive, telecommunications, medical/biopharma, and textiles. +In addition, the Company extends credit to select entrepreneurial businesses through a licensed lending subsidiary. BitNile was founded +by Milton “Todd” Ault, III, its Executive Chairman and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and +Vice Chairman and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages the +day-to-day operations of the Company. The Company’s long-term objective is to maximize per share intrinsic value. All major investment +and capital allocation decisions are made for the Company by Mr. Ault and the Executive Committee. The Company has six reportable segments: +● BitNile, Inc. – cryptocurrency mining operations, +● Ault Alliance, Inc. (“Ault Alliance”) – commercial lending, activist investing, media, +and digital learning, +● Gresham Worldwide, Inc. (“GWW”) – defense solutions, +● TurnOnGreen, Inc. (“TurnOnGreen”) – commercial electronics solutions, +● Real Estate – hotel operations and other commercial real estate holdings, and +● Ault Disruptive Technologies Corporation (“Ault Disruptive”) – a special purpose acquisition +company (“SPAC”). +On +December 13, 2021, the Company changed its name from Ault Global Holdings, Inc. to BitNile Holdings, Inc. The name change did not affect +the rights of security holders of the Company. The common stock continues to be listed on the NYSE American and trades under the symbol +“NILE”. +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +As of December 31, 2021, the Company had cash +and cash equivalents of $ 15.9 million and working capital of $ 11.5 million . In the +past, the Company financed its operations principally through issuances of convertible debt, promissory notes and equity securities. During +the year ended December 31, 2021, the Company continued to strengthen its liquidity and financial condition through additional equity +financing from its 2021 At-the-Market Offering (the “2021 ATM Offering”); see Note 29 for a discussion of the Company’s +2021 ATM Offering. +The Company believes its current cash on hand +is sufficient to meet its operating and capital requirements for at least the next twelve months from the date these financial statements +are issued. +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated +financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). +F- 14 +Principles of Consolidation +The consolidated financial +statements include the accounts of BitNile and its wholly-owned and majority-owned subsidiaries. The consolidated financial statements +also include the accounts of Ault Disruptive and Ault Alpha LP (the “Alpha Fund”) of which the Company is the primary beneficiary +as discussed in Note 16. All intercompany accounts and transactions have been eliminated upon consolidation. +The accounting guidance requires +an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling +financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary +of a Variable Interest Entity (“VIE”); to eliminate the solely quantitative approach previously required for determining the +primary beneficiary of a VIE; to add an additional reconsideration event for determining whether an entity is a VIE when any changes in +facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar +rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; +and to require enhanced disclosures that will provide readers of financial statements with more transparent information about an enterprise’s +involvement in a VIE. +Variable Interest Entities +For VIEs, the Company assesses +whether it is the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. +The Company evaluates its +business relationships with related parties to identify potential VIEs under Accounting Standards Codification (“ASC”) 810, +Consolidation . The Company consolidates VIEs in which it is considered to be the primary beneficiary. Entities are considered to +be the primary beneficiary if they have both of the following characteristics: (i) the power to direct the activities that, when taken +together, most significantly impact the VIE’s performance; and (ii) the obligation to absorb losses and right to receive the returns +from the VIE that would be significant to the VIE. The Company’s judgment with respect to its level of influence or control of an +entity involves the consideration of various factors including the form of its ownership interest, its representation in the entity’s +governance, the size of its investment, estimates of future cash flows, its ability to participate in policy making decisions and the +rights of the other investors to participate in the decision making process and to replace the Company as manager and/or liquidate the +joint venture, if applicable. +Variable Interest Entity Considerations - Avalanche +International, Corp. +The Company has determined +that Avalanche International, Corp. (“ AVLP”) is a VIE as it does not have sufficient +equity at risk. The Company does not consolidate AVLP because the Company is not the primary beneficiary and does not have a controlling +financial interest. To be a primary beneficiary, an entity must have the power to direct the activities of a VIE that most significantly +impact the VIE’s economic performance, among other factors. Although the Company has made a significant investment in AVLP, the +Company has determined that Philou Ventures, LLC, which controls AVLP through the voting power conferred by its equity investment and +which is deemed to be more closely associated with AVLP, is the primary beneficiary. As a result, AVLP’s financial position and +results of operations are not consolidated in the Company’s financial position and results of operations. +Equity +Investment in Unconsolidated Entity +As +of December 31, 2021, the Company’s ownership percentage of AVLP was less than 20%. During the fourth quarter of 2021, BitNile made +additional advances to AVLP under the existing loan agreement and the Company’s consolidated VIE, Ault Alpha, entered into a loan +agreement with AVLP totaling $3.6 million. Due to the cumulative lending position of BitNile and the facts and circumstances surrounding +the terms of loan agreements, BitNile reevaluated its level of influence over AVLP and determined that the equity ownership in AVLP should +be accounted for under the equity method of accounting. +The +basis of the Company’s previously held interest in AVLP was remeasured to fair value immediately before adopting the equity method +of accounting. The Company’s interest in AVLP as of December 31, 2020 has been presented as an equity investment in an unconsolidated +entity, consistent with the current year presentation. +The +Company has invested in AVLP based on the potential global impact of the novel technology of AVLP’s subsidiary, MTIX, Ltd. (“MTIX”). +MTIX has developed a novel cost effective and environmentally friendly material synthesis technology for textile applications. MTIX’s +Multiplex Laser Surface Enhancement is a unique technology that has the ability to treat both natural and synthetic textiles for a wide +variety of functionalities, including dyeability and printing enhancements, hydrophilicity, hydrophobicity, fire retardancy and anti-microbial +properties. The use of water, harmful chemicals and energy is significantly reduced in comparison to conventional textile treatment methods. +F- 15 +Treasury Stock +The shares of Company common +stock attributable to the Company’s limited partner interest in Ault Alpha are considered treasury stock on the consolidated balance +sheet and thereby deemed not to be included in the calculation of weighted average common shares outstanding. However, these shares are +legally outstanding. +Accounting Estimates +The preparation of financial +statements, in conformity with GAAP, requires management to make estimates, judgments and assumptions. The Company’s management +believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. +These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets +and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. +Actual results could differ from those estimates. Key estimates include acquisition accounting, fair value of certain financial instruments, +reserves for trade receivables and inventories, carrying amounts of investments, accruals of certain liabilities including product warranties, +useful lives and the recoverability of long-lived assets, impairment analysis of intangibles and goodwill, and deferred income taxes and +related valuation allowance. +Impairment of Long-lived Assets +Management reviews long-lived +assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. +Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future +cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured +by comparing the carrying amount of the assets to their fair value. During the first quarter of 2020, based upon the deteriorating business +conditions for restaurants in the San Diego County as a result of the spread of COVID-19 and the decline in projected cash flows over +the life of the restaurant long-lived assets, the Company performed an undiscounted cash flow test to determine if the restaurant equipment +and right-of-use (“ROU”) assets were impaired. The undiscounted cash flows were less than the carrying amount of the Company’s +restaurant equipment and ROU assets and therefore, the carrying amount of the assets were compared to the fair value of the assets, and +the Company determined that there were impairment charges to be recorded on the restaurant long-lived assets. Impairment charges for the +year ended December 31, 2020 related to restaurant equipment were in an amount equal to the cost of the Company’s restaurant equipment, +net of depreciation of $0.5 million and the impairment related to the ROU assets attributed to the discontinued restaurant operations +was the full carrying amount of $1.0 million. The restaurant-related impairment charges are included as a component of net loss from discontinued +operations (see Note 5). +Revenue Recognition +The Company recognizes revenue +under ASC 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 is that a company should +recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which +the company expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve that core +principle: +● Step 1: Identify the contract with the customer, +● Step 2: Identify the performance obligations +in the contract, +● Step 3: Determine the transaction price, +● Step 4: Allocate the transaction price to the +performance obligations in the contract, and +● Step 5: Recognize revenue when the company satisfies +a performance obligation. +F- 16 +Sales of Products +The Company generates revenues +from the sale of its products through a direct and indirect sales force. The Company’s performance obligations to deliver products +are satisfied at the point in time when title transfers to the customer. Generally, products are shipped FOB shipping point and title +transfers to the customer at the time the products are placed on a common carrier. The Company provides standard assurance warranties, +which are not separately priced, that the products function as intended. The Company primarily receives fixed consideration for sales +of product. Some of the Company’s contracts with distributors include stock rotation rights after six months for slow moving inventory, +which represents variable consideration. The Company uses an expected value method to estimate variable consideration and constrains revenue +for estimated stock rotations until it is probable that a significant reversal in the amount of cumulative revenue recognized will not +occur. To date, returns have been insignificant. The Company’s customers generally pay within 30 days from the receipt of an invoice. +Because the Company’s +product sales agreements have an expected duration of one year or less, the Company has elected to adopt the practical expedient in ASC +606-10-50-14(a) of not disclosing information about its remaining performance obligations. +Manufacturing Services +For manufacturing services, +which include revenues generated by the Company’s subsidiary, Enertec Systems 2001 Ltd. (“Enertec”), and in certain +instances, revenues generated by the Company’s subsidiary, Gresham Power Electronics Ltd. (“Gresham Power”), the Company’s +performance obligation for manufacturing services is satisfied over time as the Company creates or enhances an asset based on criteria +that are unique to the customer and that the customer controls as the asset is created or enhanced. Generally, the Company recognizes +revenue based upon proportional performance over time using a cost-to-cost method which measures progress based on the costs incurred +to total expected costs in satisfying its performance obligation. This method provides a depiction of the progress in providing the manufacturing +service because there is a direct relationship between the costs incurred by the Company and the transfer of the manufacturing service +to the customer. Manufacturing services that are recognized based upon the proportional performance method are considered revenue from +services transferred over time and to the extent the customer has not been invoiced for these revenues, as accrued revenue in the accompanying +consolidated balance sheets. Revisions to the Company’s estimates may result in increases or decreases to revenues and income and +are reflected in the consolidated financial statements in the periods in which they are first identified. +The Company has elected the +practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component to the extent +that the period between when the Company transfers its promised good or service to the customer and when the customer pays in one year +or less. +Lending and Trading Activities +Lending Activities +Ault Alliance, through its wholly-owned +subsidiary Digital Power Lending, LLC (“DP Lending”), generates revenue from lending activities primarily through interest, +origination fees and late/other fees. Interest income on these products is calculated based on the contractual interest rate and recorded +as interest income as earned. The origination fees or original issue discounts are recognized over the life of the loan using the effective +interest method. +Trading Activities +Ault Alliance, through DP Lending, generates +revenue from trading activities primarily through sales of securities and unrealized gains and losses from held securities. Financial +instruments utilized in trading activities are carried at fair value. Fair value is generally based on quoted market prices for the same +or similar assets and liabilities. If these market prices are not available, fair values are estimated based on dealer quotes, pricing +models, discounted cash flow methodologies, or similar techniques where the determination of fair value may require significant management +judgment or estimation. Realized gains and losses are recorded on a trade-date basis. Realized and unrealized gains and losses are recognized +in revenue from trading activities. +Blockchain Mining +The Company has executed contracts +with digital asset mining pools to provide computing power to the mining pool. The contracts are terminable at any time by either party +and the Company’s enforceable right to compensation only begins when the Company provides computing power to the mining pool operator. +The mining pool applies the Full Pay Per Share (“FPPS”) model. Under the FPPS model, in exchange for providing computing power, +the Company is entitled to a fractional share of the fixed digital currency award the mining pool operator receives (less digital asset +transaction fees to the mining pool operator which are recorded as a an offset to revenues), for successfully adding a block to the blockchain. +The Company’s fractional share is based on the proportion of computing power the Company contributed to the mining pool operator +to the total computing power contributed by all mining pool participants in solving the current algorithm to add a block to the blockchain. +F- 17 +Providing computing power +in digital asset transaction verification services is an output of the Company’s ordinary activities. The provision of providing +such computing power is the only performance obligation in the Company’s contracts with mining pool operators. The transaction consideration +the Company receives, if any, is noncash consideration, which the Company measures at fair value on the date received, which is not materially +different than the fair value at contract inception or the time the Company has earned the award from the pools. All consideration is +variable. The Company cannot determine, during the course of solving for a block, that a reversal of revenue is not probable and therefore +revenue is recognized when the mining pool operator successfully places a block (by being the first to solve an algorithm) and the Company +receives confirmation of the consideration it will receive. +Because it is not probable +that a significant reversal of cumulative revenue will not occur, the consideration is constrained until the mining pool operator successfully +places a block (by being the first to solve an algorithm) and the Company receives confirmation of the consideration it will receive, +at which time revenue is recognized. There is no significant financing component in these transactions. +Fair value of the digital +currency award received is determined using the market rate of the related digital currency at the time of receipt, which is not materially +different than the fair value at the time of contract inception or the time the Company has earned the award from the pool. +Expenses associated with running +the cryptocurrency mining business, such as equipment depreciation and electricity costs, are recorded as a component of cost of revenues. +Accounts Receivable and Allowance for Doubtful +Accounts +The Company’s receivables +are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount of the Company’s +receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. The Company individually reviews +all accounts receivable balances and based upon an assessment of current creditworthiness, estimates the portion, if any, of the balance +that will not be collected. The Company estimates the allowance for doubtful accounts based on historical collection trends, age of outstanding +receivables and existing economic conditions. If events or changes in circumstances indicate that a specific receivable balance may be +impaired, further consideration is given to the collectability of those balances and the allowance is adjusted accordingly. A customer’s +receivable balance is considered past-due based on its contractual terms. Past-due receivable balances are written-off when the Company’s +internal collection efforts have been unsuccessful in collecting the amount due. +Accrued Revenue +Manufacturing services that +are recognized as revenue based upon the proportional performance method are considered revenue based on services transferred over time +and to the extent the customer has not been invoiced for these revenues, as accrued revenue in the accompanying consolidated balance sheets. +As of December 31, 2021 and 2020, accrued revenue was $ 2.3 million and $ 1.7 million , respectively. +Fair Value of Financial Instruments +In accordance with ASC 820, +Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for the +sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +F- 18 +The guidance also establishes +a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable +inputs by requiring that the most observable inputs be used when available. Observable inputs include those that market participants would +use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable +inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset +or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +Level 1: Quoted market prices in active markets +for identical assets or liabilities. +Level 2: Inputs other than Level 1 that are +observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are +not active; or model-derived valuations. All significant inputs used in the Company’s valuations are observable or can be derived +principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs +also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed +models such as a discounted cash flow model. +Level 3: Unobservable inputs that are supported +by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts of financial +instruments carried at cost, including cash and cash equivalents, accounts receivables and accounts and other receivable – related +party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the +short-term maturities of such instruments. +The +categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to +the fair value measurement. +Equity Investments +The +following discusses the Company’s marketable equity securities, non-marketable equity securities, and gains and losses on marketable +and non-marketable equity securities. +The +Company’s marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 +and 2 in the fair value hierarchy because the Company uses quoted prices for identical assets in active markets or inputs that are based +upon quoted prices for similar instruments in active markets. +The +Company’s non-marketable equity securities are investments in privately held companies without readily determinable market values. +The carrying value of the Company’s non-marketable equity securities is adjusted to fair value upon observable transactions for +identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). Non-marketable equity +securities that have been remeasured during the period based on observable transactions are classified within Level 2 or Level 3 in the +fair value hierarchy because the Company estimates the value based on valuation methods which may include a combination of the observable +transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities +the Company holds. The fair value of non-marketable equity securities that have been remeasured due to impairment are classified within +Level 3. +The +Company performs a qualitative assessment on a periodic basis and recognizes an impairment if there are sufficient indicators that the +fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. +Impairment of Debt Securities +Debt securities are evaluated +periodically to determine whether a decline in their value is other than temporary. The Company utilizes criteria such as the magnitude +and duration of the decline, in addition to the reason underlying the decline, to determine whether the loss in value is other than temporary. +The term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects +for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, +or greater than, the carrying value of the investment. Once a decline in value is determined to be other than temporary, the value of +the security is reduced and a corresponding charge to earnings is recognized. During the fourth quarter of 2021, the Company determined +that the decline in value fair value of the warrant derivative securities that it received as a result of its investment in AVLP was other +than temporary. The Company recorded an impairment of debt securities of $9.3 million with a corresponding adjustment to other comprehensive +income, reducing prior unrealized losses. +Foreign Currency Translation +A substantial portion of the +Company’s revenues are generated in U.S. dollars. In addition, a substantial portion of the Company’s costs are incurred in +U.S. dollars. Company management has determined that the U.S. dollar is the functional currency of the primary economic environment in +which it operates. +F- 19 +Accordingly, monetary accounts +maintained in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with FASB issued ASC 830, Foreign +Currency Matters (“ASC 830”). All transaction gains and losses from the re-measurement of monetary balance sheet +items are reflected in the statements of operations as financial income or expenses as appropriate. +The financial statements of +Gresham Power, Relec Electronics Ltd. (“Relec”), and Enertec, whose functional currencies have been determined to be their +local currencies, the British Pound (“GBP”), GBP, and the Israeli Shekel (“ILS”), respectively, have been translated +into U.S. dollars in accordance with ASC 830. All balance sheet accounts have been translated using the exchange rates in effect at the +balance sheet date. Statement of operations amounts have been translated using the average exchange rate in effect for the reporting period. +The resulting translation adjustments are reported as other comprehensive loss in the consolidated statement of comprehensive loss and +accumulated comprehensive loss in statement of changes in stockholders’ equity. +Cash and Cash Equivalents +The Company considers all +highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments +that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash +is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. These balances +exceed the U.S. Federal Deposit Insurance Corporation insurance limits. The Company had cash and cash equivalents of $ 933,000 and $ 885,000 +at December 31, 2021 and 2020, respectively, in the United Kingdom (“U.K.”), and $ 58,000 and $ 19,000 , respectively, in Israel. +The Company has not experienced any losses on deposits of cash and cash equivalents. +Restricted Cash +As +of December 31, 2021, restricted cash included $3.8 million of cash collateral for notes payable, $783,000 of cash held in escrow +related to the purchase of the four hotels in the Madison, Wisconsin area, and $738,000 of cash held in trust related to environmental +contingencies related to the Michigan data center. +Cash, +cash equivalents and restricted cash consist of the following: +December 31, +December 31, +2021 +2020 +Cash and cash equivalents +$ 15,912,000 +$ 18,680,000 +Restricted cash +5,321,000 +- +Total cash, cash equivalents and restricted cash +$ 21,233,000 +$ 18,680,000 +Cash and Marketable Securities Held +in Trust Account +As +of December 31, 2021, the Company held $ 116,725,000 in cash and marketable securities in a trust account. Cash and marketable securities +held in the trust account represents cash and money market funds that primarily invest in U.S. treasury bills that were purchased with funds raised through the initial public offering +of Ault Disruptive, a consolidated SPAC. The funds raised are held in a trust account that is restricted for use and may only be used +for purposes of completing an initial business combination or redemption of the common stock of Ault Disruptive, as set forth in the trust +agreement. The funds held in trust are included within Level 1 of the fair value hierarchy. +Inventories +Inventories are stated at +the lower of cost or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological +obsolescence. +Cost of inventories is determined as +follows: +Raw materials, parts +and supplies - using the “first-in, first-out” method; and +Work-in-progress and finished products +- on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +F- 20 +The Company periodically assesses +its inventories valuation in respect of obsolete and slow-moving items by reviewing revenue forecasts and technological obsolescence. +When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at the time of the review +was not expected to be sold, is written off. At December 31, 2021 and 2020, the Company recorded an allowance for obsolescence of $ 1.4 +million and $ 9,000 respectively +During the years ended December +31, 2021 and 2020, the Company did not record inventory write-offs within the cost of revenue. +Digital +Currencies +Digital +currencies are included in current assets in the consolidated balance sheets as an indefinite lived intangible asset. Digital currencies +are recorded at cost less impairment. In performing the quantitative impairment test of the mined Bitcoin balances as well as recordation +of daily revenues, as described in ASC 350-30-35-19, the Company utilizes the pricing of Bitcoin on a nightly basis from reliable +pricing sources, which is not materially different than the fair value at the time of contract inception or the time the Company has earned +the award from the pool. +An +intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events +or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists +when the carrying amount exceeds its fair value. In testing for impairment, the Company has the option to first perform a qualitative +assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely than +not that an impairment exists, a quantitative impairment test is not necessary. If the Company concludes otherwise, it is required to +perform a quantitative impairment test. To the extent an impairment loss is recognized, the loss establishes the new cost basis of the +asset. Subsequent reversal of impairment losses is not permitted. +Property and Equipment, Net +Property and equipment are +stated at cost, net of accumulated depreciation. Gains or losses on disposals of property and equipment are recorded within income from +operations. Repairs and maintenance costs are expensed as incurred. Depreciation is calculated using the straight-line method over the +estimated useful lives of the assets, at the following annual rates: +Schedule Of Estimated Useful Life of +Property, Plant and Equipment +Useful lives (in years) +Computer, software and related equipment +3 – 5 +Office furniture and equipment +5 – 10 +Building +29 – 39 +Leasehold improvements +Over the term of the lease or the life of the asset, whichever is shorter. +Goodwill +The Company evaluates its +goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other . Goodwill is recorded when the +purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. +The Company tests the recorded +amount of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount +of the goodwill exceeds its carried value. At December 31, 2021, the Company had six reporting units. During the years ended December +31, 2021 and 2020, the Company recognized no impairment of goodwill. +F- 21 +Intangible Assets +The Company acquired amortizable +intangibles assets as part of asset purchase agreements consisting of customer relationships and non-compete agreements. The Company also +has the trade names and trademarks associated with the acquisitions of Microphase Corporation (“Microphase”) and Relec, which +were determined to have an indefinite life. The customer relationships and non-compete agreements, definite lived intangible assets, are +being amortized on a straight-line basis over their estimated useful lives as follows: +Useful lives (in years) +Customer relationships +5 - +14 +Non-competition agreements +3 +Domain name and other intangible assets +3 +The Company reviews intangible +assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets might not be +recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant underperformance +of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes +in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares +forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying +value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset +are less than its carrying amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its +fair value, determined based on discounted cash flows. During the years ended December 31, 2021 and 2020, the Company recognized no impairment +of intangibles. +Long-Lived Assets +The long-lived assets of the +Company are reviewed for impairment in accordance with ASC 360, Property, Plant, and Equipment , whenever events or changes +in circumstances indicate that the carrying amount of an asset may not be recoverable. +Management reviews long-lived +assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. +Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future +cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured +by comparing the amount by which the carrying amount of the assets to their fair value. During the first quarter of 2020, based upon the +deteriorating business conditions for restaurants in the San Diego County as result of the spread of COVID-19 and the decline in projected +cash flows over the life of the restaurant long-lived assets, the Company performed an undiscounted cash flow test to determine if the +restaurant equipment and ROU assets were impaired. The undiscounted cash flows were less than the carrying amount of the Company’s +restaurant equipment and ROU assets and therefore, the carrying amount of the assets were compared to the fair value of the assets, and +the Company determined that there were impairment charges to be recorded on the restaurant long-lived assets. Impairment charges for the +year ended December 31, 2020 related to restaurant equipment were in an amount equal to the cost of the Company’s restaurant equipment, +net of depreciation of $ 0.5 million and the impairment related to the ROU assets attributed to the discontinued restaurant operations +was the full carrying amount of $ 1.0 million . The restaurant-related impairment charges are included as a component of net loss from discontinued +operations in 2020 (see Note 5). +Redeemable +Noncontrolling Interests in Equity of Subsidiary +The +Company records redeemable noncontrolling interests in equity of subsidiaries to reflect the economic interests of the common stockholders +in Ault Disruptive. These interests are presented as redeemable noncontrolling interests in equity of subsidiaries within the consolidated +balance sheets, outside of the permanent equity section. The common stockholders in Ault Disruptive have redemption rights that are considered +to be outside of the Company’s control. As of December 31, 2021, the carrying amount of the redeemable noncontrolling interest in +equity of subsidiaries was recorded at its redemption value of $ 116.7 million . Remeasurements to the redemption value of the redeemable +noncontrolling interest in equity of subsidiaries are recorded within additional paid-in capital. Such remeasurements totaled $ 12.9 million , +comprising of offering costs incurred in connection with the sale of common stock of Ault Disruptive in the amount of $ 116.7 million and +initial valuation of the public warrants of Ault Disruptive in the amount of $ 4.1 million . +Income Taxes +The Company determines its +income taxes under the asset and liability method in accordance with FASB ASC 740, Income Taxes , which requires recognition +of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements +or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and +tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. +Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets +will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in +the fiscal years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities +of a change in tax rates is recognized in the Statements of Income and Comprehensive Income in the period that includes the enactment +date. +F- 22 +The Company accounts for uncertain +tax positions in accordance with ASC 740-10-25, which addresses the determination of whether tax benefits claimed or expected to be claimed +on a tax return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit from an +uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, +based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that +has a greater than fifty percent likelihood of being realized upon ultimate settlement. To the extent that the final tax outcome of these +matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is +made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. +ASC 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has +taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management +of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2021 and 2020, there were no +uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in +the financial statements. +Common Stock Purchase Warrants and Other +Derivative Financial Instruments +The Company classifies common +stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical +settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical +settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement +to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty +a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions, +as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine +whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, +which principally consist of issuance of warrants to purchase shares of common stock in connection with convertible notes and to employees +of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features +or variable settlement provision that cause them to not be indexed to the Company’s own stock. +Stock-Based Compensation +The Company accounts for stock-based +compensation in accordance with ASC 718, Compensation – Stock Compensation (“ASC 718”). +Under ASC 718: +● the Company recognizes stock-based expenses related to stock option awards on a straight-line basis over +the requisite service period of the awards, which is generally the vesting term of two to four years, +● stock-based expenses are recognized net of forfeitures as they occur, +● the expected term assumption, using the simplified method, reflects the period for which the Company believes +the option will remain outstanding, +● the Company determined the volatility of its stock by looking at the historic volatility of its stock, +and +● the risk-free rate reflects the U.S. Treasury yield for a similar expected life instrument in effect at +the time of the grant. +The Company uses the Black-Scholes +option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions +which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying +stock. +F- 23 +Convertible Instruments +The Company accounts for hybrid +contracts that feature conversion options in accordance with ASC 815, Derivatives and Hedging Activities (“ASC 815”). +ASC 815 requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative +financial instruments according to certain criteria. The criteria include circumstances in which (a) the economic characteristics +and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host +contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured +at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument +with the same terms as the embedded derivative instrument would be considered a derivative instrument. +Conversion options that contain +variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities +at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible +instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, +in accordance with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”). Under ASC 470-20 the Company +records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based +upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective +conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded +conversion options should be bifurcated from their host instruments) in accordance with ASC 815. +Debt Discounts +The Company accounts for debt +discount according to ASC 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through periodic charges +to interest expense over the term of the related financial instrument using the effective interest method. +Concentration of Credit Risk +Financial instruments that +potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. +Cash and cash equivalents +are invested in banks in the U.S., U.K. and Israel. Such deposits in the United States may be in excess of insured limits and are not +insured in other jurisdictions. +Trade receivables of the Company +and its subsidiaries are mainly derived from sales to customers located primarily in the U.S., Europe and Israel. The Company performs +ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is +determined with respect to those amounts that the Company and its subsidiaries have determined to be doubtful of collection. +Comprehensive Loss +The Company reports comprehensive +loss in accordance with ASC 220, Comprehensive Income . This statement establishes standards for the reporting and presentation +of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents +all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined +that its items of other comprehensive loss relate to changes in foreign currency translation adjustments and unrealized gains and losses +in its warrants in AVLP. +F- 24 +Leases +Effective January 1, 2019, +the Company accounts for its leases under ASC 842, Leases . Under this guidance, arrangements meeting the definition of a lease +are classified as operating or financing leases. As of January 1, 2019, the Company only had operating leases. Operating leases are recognized +as ROU assets, operating lease liability, current, and operating lease liability, non-current on the Company’s consolidated balance +sheets. Lease assets and liabilities are recognized based on the present value of the future minimum lease payments over the lease term +at commencement date. As most of the Company’s leases do not provide an implicit rate, the Company uses the Company’s incremental +borrowing rate based on the information available at commencement date in determining the present value of future payments. In certain +of the Company’s lease agreements, the Company receives rent holidays and other incentives. The Company recognizes lease costs on +a straight-line basis over the lease term without regard to deferred payment terms, such as rent holidays, that defer the commencement +date of required payments. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably +certain that the Company will exercise that option. Leasehold improvements are capitalized at cost and amortized over the lesser of their +expected useful life or the life of the lease, without assuming renewal features, if any, are exercised. The Company does not separate +lease and non-lease components for the Company’s leases. +Reclassifications +Certain prior year amounts +have been reclassified for comparative purposes to conform to the current-year financial statement presentation. These reclassifications +had no effect on previously reported results of operations. In addition, certain prior year amounts from the restated amounts have been +reclassified for consistency with the current period presentation. +Recent +Accounting Standards +Not +Yet Adopted +In +March 2020, the FASB issued Accounting Standards Update (“ASU”) No. 2020-04, Reference Rate Reform (“Topic +848”), which provided optional guidance for a limited period of time to ease potential accounting impacts associated +with transitioning away from reference rates that are expected to be discontinued, such as the London Interbank Offered Rate (“LIBOR”). +The amendments applied only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference +rate expected to be discontinued. In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform , which refined the +scope of Topic 848 through optional expedients and exceptions when accounting for derivative contracts and certain hedging relationships. The +amendments are effective December 31, 2022. The Company is currently assessing the potential impacts of these ASUs and does not expect +it to have any material impact on its consolidated results of operations, cash flows, financial position or disclosures. +In +October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities +from Contracts with Customers to require acquiring entities to apply Topic 606 when recognizing and measuring contract assets +and contract liabilities instead of only recognizing such items at fair value on the acquisition date. The update addressed diversity +in practice related to the acquired contract liability and payment terms and their effect on subsequent revenue recognized by the acquirer. +The amendments in this update are effective the Company beginning with fiscal year 2023, with early adoption permitted, and should be +applied prospectively to business combinations after the adoption date. The Company is currently assessing the potential impacts +of this ASU and does not expect it to have any material impact on its consolidated results of operations, cash flows, financial position +or disclosures. +Recently +Adopted +In +December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes . This standard +simplifies the accounting for income taxes by removing certain exceptions for recognizing deferred taxes on investments, performing intra-period +allocations, and calculating income taxes in interim periods. The ASU also adds guidance to reduce the complexity in certain areas, including +recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. Most amendments within the standard +are required to be applied on a prospective basis, while certain amendments must be applied on a retrospective or modified retrospective +basis. The Company adopted the ASU effective January 1, 2021. The impact of adopting the ASU was immaterial to the consolidated results +of operations, cash flows, financial position, and disclosures. +In +January 2020, the FASB issued ASU 2020-01, Investments—Equity Securities (Topic 321), Investments—Equity Method and +Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)—Clarifying the Interactions between Topic 321, Topic 323, and +Topic 815 to address accounting for the transition into and out of the equity method and measuring certain purchased options +and forward contracts to acquire investments. Entities are required to remeasure its investment immediately before the transition from +the measurement alternative for an equity investment under ASC 321 to the equity method due to an observable transaction. Similarly, entities +are required to remeasure its investment immediately after the transition from the equity method to ASC 321 due to an observable transaction. The +amendments in this update should be applied prospectively and at the beginning of the period that includes the adoption date. The +Company adopted the ASU effective January 1, 2020. The impact of adopting the ASU was immaterial to the consolidated results of operations, +cash flows, financial position, and disclosures. +F- 25 +In +August 2020, the FASB issued ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives +and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s +Own Equity to simplify the accounting for certain financial instruments with characteristics of liabilities and equity, including +convertible instruments and contracts on an entity’s own equity. The Company adopted the ASU effective January 1, 2021. The +amendments in this update can be applied through either a modified retrospective method or fully retrospective method of transition. The +impact of adopting the ASU was immaterial to the consolidated results of operations, cash flows, financial position, and disclosures. +In +October 2020, the FASB issued ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables-Nonrefundable Fees and Other +Costs . The amendments in this update clarify that an entity should reevaluate whether a callable debt security is within the scope +of paragraph 310-20-35-33 for each reporting period. The Company adopted the ASU effective January 1, 2021. The amendments in this +update should be applied prospectively and at the beginning of the period that includes the adoption date. The impact of adopting +the ASU was immaterial to the consolidated results of operations, cash flows, financial position, and disclosures. +In +October 2020, the FASB issued ASU 2020-09, Debt (Topic 470): Amendments to SEC Paragraphs Pursuant to SEC Release No. 33-10762 . +The amendments mostly apply to Topic 470 and relate to financial disclosure requirements for SEC registrants and other entities required +to furnish information with the SEC. The Company adopted the ASU effective January 4, 2021. The impact of adopting the ASU was immaterial +to the consolidated results of operations, cash flows, financial position, and disclosures. +In +October 2020, the FASB issued ASU 2020-10, Codification Improvements to make incremental improvements to GAAP and address +stakeholder suggestions, including, among other things, clarifying that the requirement to provide comparative information in the financial +statements extends to the corresponding disclosures section. The Company adopted the ASU effective January 1, 2021. The amendments +in this update should be applied retrospectively and at the beginning of the period that includes the adoption date. The impact of +adopting the ASU was immaterial to the consolidated results of operations, cash flows, financial position, and disclosures. +In +August 2021, the FASB issued ASU 2021-06, Presentation of Financial Statements (Topic 205) Financial Services—Depositary +and Lending (Topic 942), and Financial Services— Investment Companies (Topic 946). This update amends certain SEC paragraphs +from the Codification in response to the issuance of SEC Final Rule Nos. 33-10786, Amendments to Financial Disclosures About Acquired +and Disposed Businesses , which modified the significance test and improved disclosure requirements for acquired businesses and pro +forma financial information. The SEC Final Rule was effective January 1, 2021, and the ASU was adopted immediately by the Company. The +impact of adopting the ASU was immaterial to the consolidated results of operations, cash flows, financial position, and disclosures. +F- 26 +4. REVENUE DISAGGREGATION +The following tables summarize +disaggregated customer contract revenues and the source of the revenue for the years ended December 31, 2021 and 2020. Revenues from lending +and trading activities included in consolidated revenues were primarily interest, dividend and other investment income, which are not +considered to be revenues from contracts with customers under GAAP. +The Company’s disaggregated +revenues consist of the following for the year ended December 31, 2021: +Year +ended December 31, 2021 +GWW +TurnOnGreen +Ault +Alliance +Cryptocurrency +Real +Estate +Total +Primary Geographical Markets +North America +$ 6,788,000 +$ 4,536,000 +$ 192,000 +$ 4,238,000 +$ 189,000 +$ 15,943,000 +Europe +7,492,000 +457,000 +- +- +- +7,949,000 +Middle East +10,803,000 +- +- +- +- +10,803,000 +Other +498,000 +353,000 +- +- +- +851,000 +Revenue from contracts with customers +25,581,000 +5,346,000 +192,000 +4,238,000 +189,000 +35,546,000 +Revenue, lending and trading +activities +(North America) +- +- +16,854,000 +- +- +16,854,000 +Total revenue +$ 25,581,000 +$ 5,346,000 +$ 17,046,000 +$ 4,238,000 +$ 189,000 +$ 52,400,000 +Major Goods +RF/microwave filters +$ 4,905,000 +$ - +$ - +$ - +$ - +$ 4,905,000 +Detector logarithmic video amplifiers +1,888,000 +- +- +- +- +1,888,000 +Power supply units +7,613,000 +5,328,000 +- +- +- +12,941,000 +Power supply systems +241,000 +- +- +- +- +241,000 +Healthcare diagnostic systems +794,000 +- +- +- +- +794,000 +EV Chargers +- +18,000 +- +- +- +18,000 +Defense systems +10,140,000 +- +- +- +- +10,140,000 +Digital currency mining +- +- +- +3,450,000 +- +3,450,000 +Other +- +- +192,000 +788,000 +189,000 +1,169,000 +Revenue from contracts with customers +25,581,000 +5,346,000 +192,000 +4,238,000 +189,000 +35,546,000 +Revenue, lending and trading +activities +- +- +16,854,000 +- +- +16,854,000 +Total revenue +$ 25,581,000 +$ 5,346,000 +$ 17,046,000 +$ 4,238,000 +$ 189,000 +$ 52,400,000 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 13,825,000 +$ 5,346,000 +$ 192,000 +$ 4,238,000 +$ 189,000 +$ 23,790,000 +Services transferred over time +11,756,000 +- +- +- +- +11,756,000 +Revenue from contracts with +customers +$ 25,581,000 +$ 5,346,000 +$ 192,000 +$ 4,238,000 +$ 189,000 +$ 35,546,000 +F- 27 +The Company’s disaggregated +revenues consist of the following for the year ended December 31, 2020: +Year +ended December 31, 2020 +GWW +TurnOnGreen +Ault +Alliance +Cryptocurrency +Real +Estate +Total +Primary Geographical Markets +North America +$ 6,718,000 +$ 4,500,000 +$ - +$ - +$ - +$ 11,218,000 +Europe +1,879,000 +450,000 +- +2,329,000 +Middle East +9,273,000 +- +- +- +- +9,273,000 +Other +343,000 +466,000 +- +- +- +809,000 +Revenue from contracts with customers +18,213,000 +5,416,000 +- +23,629,000 +Revenue, lending and trading +activities +(North America) +- +- +242,000 +- +- +242,000 +Total revenue +$ 18,213,000 +$ 5,416,000 +$ 242,000 +$ - +$ - +$ 23,871,000 +Major Goods +RF/microwave filters +$ 4,330,000 +$ - +$ - +$ - +$ - +$ 4,330,000 +Detector logarithmic video amplifiers +473,000 +- +- +- +- +473,000 +Power supply units +2,656,000 +5,416,000 +- +- +- +8,072,000 +Power supply systems +1,482,000 +- +- +- +- +1,482,000 +Healthcare diagnostic systems +1,012,000 +- +- +- +- +1,012,000 +EV Chargers +- +- +Defense systems +8,260,000 +- +- +- +- +8,260,000 +Digital currency mining +- +- +- +- +- +- +Other +- +- +- +- +- +- +Revenue from contracts with customers +18,213,000 +5,416,000 +- +23,629,000 +Revenue, lending and trading +activities +- +- +242,000 +- +- +242,000 +Total revenue +$ 18,213,000 +$ 5,416,000 +$ 242,000 +$ - +$ - +$ 23,871,000 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 8,941,000 +$ 5,416,000 +$ - +$ - +$ - +$ 14,357,000 +Services transferred over time +9,272,000 +- +- +- +- +9,272,000 +Revenue from contracts with +customers +$ 18,213,000 +$ 5,416,000 +$ - +$ - +$ - +$ 23,629,000 +5. Discontinued +Operations +In +the first quarter of 2020, management determined that the permanent closing of the restaurant operations met the criteria for presentation +as discontinued operations. Accordingly, the results of the restaurant operations are presented as discontinued operations in the Company’s +consolidated statements of operations and comprehensive loss and are excluded from continuing operations for all periods presented. On +March 16, 2020, to try and mitigate the spread of COVID-19, San Diego County health officials issued orders mandating that all restaurants +must end dine-in services. As a result of these temporary closures and the deteriorating business conditions at the Company’s restaurant +businesses, the Company concluded that discontinuing the operations of I.AM, Inc. (“I.AM”) was ultimately in its best interest. +The +restaurant operations are included in the Company’s results as discontinued operations through March 16, 2020, the date of +closing of the restaurants. The following tables summarize the major classes of line items included in loss from discontinued operations: +For the Year Ended +December 31, +2021 +2020 +Revenue +$ — +$ 543,000 +Cost of revenue +— +( 160,000 ) +General and administrative +— +( 556,000 ) +Impairment of property and equipment and right-of-use assets +— +( 1,525,000 ) +Gain on deconsolidation of I.AM +— +2,359,000 +Income from discontinued operations +$ — +$ 661,000 +F- 28 +6. FAIR VALUE OF FINANCIAL +INSTRUMENTS +The +following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within +the fair value hierarchy: +Fair Value Measurement at December 31, 2021 +Total +Level 1 +Level 2 +Level 3 +Investment in term promissory note of Ault & +Company, Inc. (“Ault & Company”) and other +– a related party +$ 2,842,000 +$ - +$ - +$ 2,842,000 +Investment in common stock of Alzamend – a +related party +13,230,000 +13,230,000 +- +- +Investments in marketable equity securities +40,380,000 +40,380,000 +- +- +Cash and marketable securities held in trust +account +116,725,000 +116,725,000 +- +- +Investments in equity securities +30,482,000 +- +- +30,482,000 +Total assets measured at fair value +$ 203,659,000 +$ 170,335,000 +$ - +$ 33,324,000 +Fair Value Measurement at December 31, 2020 +Total +Level 1 +Level 2 +Level 3 +Investments in convertible promissory notes and +advances of Alzamend – related parties +$ 797,000 +$ - +$ - +$ 797,000 +Investments in marketable equity securities +653,000 +- +- +653,000 +Investments in marketable equity securities +2,563,000 +2,563,000 +- +- +Investments in equity securities +262,000 +- +- +262,000 +Total assets measured at fair value +$ 4,275,000 +$ 2,563,000 +$ - +$ 1,712,000 +The Company assesses the inputs +used to measure fair value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable +in the market. See Note 13 for activity related to investments in convertible promissory notes and advances of Alzamend – related +parties, and investment in common stock and warrants of Alzamend – a related party. The decline in investment in warrants of public +companies was due to a decrease upon remeasurement of fair value of the underlying warrants. +The +following table summarizes the changes in investments in equity securities measured and carried at fair value on a recurring +basis with the use of significant unobservable inputs (Level 3) for the year ended December 31, 2021: +Investments in +equity +securities +Balance at January 1, 2021 +$ 262,000 +Investment in convertible preferred stock +14,950,000 +Investment in warrants +2,673,000 +Change in fair value of warrants +8,224,000 +Conversion of loans to equity securities +3,520,000 +Unrealized gains on equity securities +2,510,000 +Conversion to marketable securities +( 1,657,000 ) +Balance at December 31, 2021 +$ 30,482,000 +See +Note 13 for the changes in investments in Alzamend and Ault & Company measured and carried at fair value on a recurring basis with +the use of significant unobservable inputs (Level 3) during the year ended December 31, 2021. +F- 29 +7. Marketable Securities +Marketable securities in equity +securities with readily determinable market prices consisted of the following as of December 31, 2021 and 2020: +Marketable equity securities at December 31, 2021 +Gross unrealized +Gross unrealized +Cost +gains +losses +Fair value +Common shares +$ 53,475,000 +$ 32,000 +$ ( 13,127,000 ) +$ 40,380,000 +Marketable equity securities at December 31, 2020 +Gross unrealized +Gross unrealized +Cost +gains +gains losses +Fair value +Common shares +$ 1,506,000 +$ 1,083,000 +$ ( 26,000 ) +$ 2,563,000 +The following table presents additional information +about marketable equity securities: +Marketable +Equity Securities +Balance at January 1, 2020 +$ 640,000 +Purchases of marketable equity securities +1,425,000 +Sales of marketable equity securities +( 373,000 ) +Realized gains on marketable equity securities +75,000 +Unrealized gains on marketable equity securities +796,000 +Balance at January 1, 2021 +2,563,000 +Purchases of marketable equity securities in operations +385,235,000 +Purchases of marketable equity securities +2,765,000 +Conversion of debt securities to marketable securities +2,656,000 +Sales of marketable equity securities in operations +( 355,837,000 ) +Sales of marketable equity securities +( 4,062,000 ) +Realized gains on marketable equity securities +27,377,000 +Realized losses on marketable equity securities +( 6,190,000 ) +Unrealized losses on marketable equity securities +( 14,127,000 ) +Balance at December 31, 2021 +$ 40,380,000 +At December 31, 2021 and 2020, +the Company had invested in the marketable equity securities of certain publicly traded companies. The Company’s investment in marketable +equity securities will be revalued on each balance sheet date. +8. DIGITAL CURRENCIES +Activities related to digital +currency were not considered material for the year ended December 31, 2020. The following table presents the activities of the digital +currencies for the year ended December 31, 2021: +Digital +Currencies +Balance at January 1, 2021 +$ 7,000 +Additions of mined digital currencies +3,450,000 +Payments to vendors +(889,000 ) +Impairment of mined cryptocurrency +(403,000 ) +Balance at December 31, 2021 +$ 2,165,000 +9. INVENTORIES +At December 31, 2021 and 2020, inventories +consisted of: +December 31, +December 31, +2021 +2020 +Raw materials, parts and supplies +$ 2,421,000 +$ 1,189,000 +Work-in-progress +1,107,000 +1,923,000 +Finished products +1,954,000 +262,000 +Total inventories +$ 5,482,000 +$ 3,374,000 +F- 30 +10. PROPERTY AND EQUIPMENT, NET +At December 31, 2021 and 2020, +property and equipment consisted of: +December 31, +2021 +December 31, +2020 +Cryptocurrency machines and related equipment +$ 10,763,000 +$ 567,000 +Deposits on cryptocurrency machines +64,117,000 +— +Computer, software and related equipment +8,884,000 +3,057,000 +Office furniture and equipment +702,000 +490,000 +Land +25,696,000 +— +Building +67,209,000 +— +Leasehold improvements +1,750,000 +1,352,000 +179,121,000 +5,466,000 +Accumulated depreciation and amortization +( 5,096,000 ) +( 3,343,000 ) +Property and equipment, net +$ 174,025,000 +$ 2,123,000 +For the years ended December +31, 2021 and 2020, depreciation expense amounted to $ 2.1 million and $ 0.4 million , respectively. +11. INTANGIBLE ASSETS, NET +At December 31, 2021 and 2020, intangible +assets consisted of: +Useful Life +December 31, +2021 +December 31, +2020 +Trade name and trademark +Indefinite life +$ 1,546,000 +$ 1,551,000 +Customer list +10 - 14 years +3,486,000 +3,441,000 +Domain name and other intangible assets +5 years +714,000 +690,000 +5,746,000 +5,682,000 +Accumulated depreciation and amortization +( 1,711,000 ) +( 1,292,000 ) +Intangible assets, net +$ 4,035,000 +$ 4,390,000 +The Company’s trade +names and trademarks were determined to have an indefinite life. The remaining definite lived intangible assets are primarily being amortized +on a straight-line basis over their estimated useful lives. Amortization expense was $ 375,000 and $ 336,000 , respectively, for the years +ended December 31, 2021 and 2020. +The customer +relationships are subject to amortization over their estimated useful lives, which range between 3 and 14 years. The following +table presents estimated amortization expense for each of the succeeding five calendar years and thereafter. +2022 +$ 319,000 +2023 +319,000 +2024 +319,000 +2025 +319,000 +2026 +319,000 +Thereafter +894,000 +Estimated amortization expense +$ 2,489,000 +F- 31 +12. GOODWILL +The Company’s goodwill +relates to the acquisition of a controlling interest in Microphase on June 2, 2017 and Imperalis Holding Corp. (“Imperalis”) +on December 16, 2021, and the acquisitions of Enertec on May 22, 2018, and Relec on November 30, 2020. The following table summarizes +the changes in the Company’s goodwill for the years ended December 31, 2021 and 2020: +Goodwill +Balance as of January 1, 2020 +$ 8,101,000 +Acquisition of Relec +1,148,000 +Effect of exchange rate changes +397,000 +Balance as of January 1, 2021 +9,646,000 +Acquisition of Imperalis +278,000 +Effect of exchange rate changes +166,000 +Balance as of December, 2021 +$ 10,090,000 +13. INVESTMENTS – RELATED PARTIES +Investments in Alzamend and +Ault & Company at December 31, 2021 and 2020, were comprised of the following: +Investment in Promissory Notes, Related +Parties +Interest +Due +December 31, +December 31, +Rate +Date +2021 +2020 +Short-term advance in Alzamend +$ - +$ 750,000 +Investment in convertible promissory note of Alzamend +- +50,000 +Investment in promissory note of Ault & Company +8 % +December 31, 2022 +2,500,000 +- +Accrued interest receivable Ault & Company and Alzamend +169,000 +1,000 +Other +173,000 +203,000 +Total investment in promissory notes, related parties – gross +2,842,000 +1,004,000 +Less: original issue discount +- +( 4,000 ) +Total investment in promissory notes, related parties +$ 2,842,000 +$ 1,000,000 +Investment in Common Stock and Warrants, +Related Parties +Weighted Avg. +Remaining +December 31, +December 31, +Contractual Term +2021 +2020 +Investment in warrants of Alzamend +4.4 years +$ - +$ 11,000 +Investment in common stock and options of Alzamend +13,230,000 +642,000 +Total investment in common stock, options, and warrants of Alzamend +$ 13,230,000 +$ 653,000 +F- 32 +The following table summarizes +the changes in the Company’s investments in Alzamend and Ault & Company during the years ended December 31, 2021 and 2020: +Investment in +warrants and +common stock +of ALZN +Investment in +promissory notes +and advances of +ALZN and Ault & +Company and Other +Total investment in +ALZN and Ault & +Company, net and +Other +Balance at January 1, 2020 +$ 559,000 +$ 233,000 +$ 792,000 +Investment in convertible promissory note of Alzamend +- +38,000 +38,000 +Investment in common stock of Alzamend +44,000 +- +44,000 +Investment in warrants of Alzamend +12,000 +- +12,000 +Short term advance in Alzamend +- +750,000 +750,000 +Unrealized gain in common stock of Alzamend +38,000 +- +38,000 +Accretion of discount +- +8,000 +8,000 +Amortization of related party investment +- +( 30,000 ) +( 30,000 ) +Accrued interest +- +1,000 +1,000 +Balance at January 1, 2021 +653,000 +1,000,000 +1,653,000 +Alzamend note and advances converted into common stock +- +( 800,000 ) +( 800,000 ) +Investment in promissory note of Ault & Company +- +2,500,000 +2,500,000 +Investment in common stock and options of Alzamend +18,181,000 +- +18,181,000 +Unrealized loss in common stock of Alzamend +( 5,604,000 ) +- +( 5,604,000 ) +Accretion of discount +- +4,000 +4,000 +Amortization of related party investment +- +( 30,000 ) +( 30,000 ) +Accrued interest +- +168,000 +168,000 +Balance at December 31, 2021 +$ 13,230,000 +$ 2,842,000 +$ 16,072,000 +F- 33 +Investments in +Alzamend Common Stock +The +following table summarizes the changes in the Company’s investments in Alzamend common stock during the year ended December 31, +2021: +Shares of +Per Share +Investment in +Common Stock +Price +Common Stock +Balance at January 1, 2021 +428,000 +$ 1.50 +$ 642,000 +Purchase of shares from an Alzamend shareholder +62,000 +$ 0.81 +50,000 +March 9, 2021 securities purchase agreement * +4,000,000 +$ 1.50 +6,000,000 +Investment in Alzamend initial public offering +2,000,000 +$ 5.00 +10,000,000 +Open market purchases after initial public offering +457,000 +$ 4.67 +2,132,000 +Unrealized loss in common stock of Alzamend +(5,625,000 ) +Investment in Alzamend common stock +6,947,000 +$ 1.90 +13,199,000 +Investment in Alzamend options +31,000 +Balance at December 31, 2021 +$ 13,230,000 +* Pursuant to the March 9, 2021 securities purchase agreement, in aggregate, Alzamend agreed to sell up +to 6,666,667 shares of its common stock to DP Lending for $10.0 million, or $1.50 per share, and issue to DP Lending warrants to acquire +3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. As of December 31, 2021, DP Lending funded $6.0 million, +including the conversion of notes and advances of $0.8 million, and the remaining $4.0 million will be funded upon Alzamend achieving +certain milestones. +14. INVESTMENT IN UNCONSOLIDATED ENTITY – +AVLP +Equity Investments in Unconsolidated Entity +– AVLP +Equity investments in an unconsolidated +entity, AVLP, at December 31, 2021 and 2020, were comprised of the following: +Investment in Promissory Notes +Interest +Due +December 31, +December 31, +Rate +Date +2021 +2020 +Investment in convertible promissory notes +12% +2022-2026 +$ 21,399,000 +$ 11,269,000 +Accrued interest receivable* +2,092,000 +2,025,000 +Other +600,000 +600,000 +Total investment in promissory notes, gross +24,091,000 +13,894,000 +Less: provision for loan losses +( 2,000,000 ) +( 3,424,000 ) +Total investment in promissory note +$ 22,091,000 +$ 10,470,000 +* During the years ended +December 31, 2021 and 2020, no interest income was recognized from the Company’s investment in AVLP. +Investment in Common Stock and Warrants +Weighted Avg. +Remaining +December 31, +December 31, +Contractual Term +2021 +2020 +Investment in warrants +2.7 years +$ - +$ 4,987,000 +Investment in common stock +39,000 +500,000 +Total investment in common stock and warrants +$ 39,000 +$ 5,487,000 +F- 34 +The following table summarizes +the changes in the Company’s equity investments in an unconsolidated entity, AVLP, during the years ended December 30, 2021 and +2020: +Investment in +Investment in +warrants and +promissory notes +Total +common stock +and advances +investment +Balance at January 1, 2020 +$ 1,569,000 +$ 7,141,000 +$ 8,710,000 +Investment in convertible promissory notes +- +1,330,000 +1,330,000 +Investment in common stock +1,000 +- +1,000 +Fair value of derivative instruments +344,000 +- +344,000 +Unrealized gain in derivative instruments +3,312,000 +- +3,312,000 +Unrealized gain in common stock +260,000 +- +260,000 +Provision for loan losses +- +2,000,000 +2,000,000 +Balance at January 1, 2021 +5,486,000 +10,471,000 +15,957,000 +Investment in convertible promissory notes +- +7,344,000 +7,344,000 +Fair value of warrants issued +2,786,000 +- +2,786,000 +Unrealized loss in warrants +( 7,772,000 ) +- +( 7,772,000 ) +Unrealized gain in common stock +( 150,000 ) +- +( 150,000 ) +Loss from equity investment +( 311,000 ) +- +( 311,000 ) +Accretion of discount +- +4,210,000 +4,210,000 +Accrued interest +- +66,000 +66,000 +Balance at December 31, 2021 +$ 39,000 +$ 22,091,000 +$ 22,130,000 +Extension of AVLP +Loan Agreement +On +April 13, 2021, the AVLP Loan Agreement was increased to up to $ 15 million and extended to December 31, 2023. On June 4, 2021, +the AVLP Loan Agreement was increased to up to $ 20 million. +15. INVESTMENTS IN LIMITED PARTNERSHIP +On June 8, 2018, the Company +entered into a limited partnership agreement, in which it agreed to become a limited partner in the partnership (the “NY Partnership”). +The NY Partnership is a limited partner in the partnership that is responsible for the construction and related activities of a hotel +in New York City. In connection with this transaction, the Company has agreed to finance a portion of the capital required by the NY Partnership. +As of December 31, 2021, the Company had invested an aggregate of $ 1.9 million in the NY Partnership. The Company has no further required +funding obligations related to the hotel. This investment does not have a readily determinable fair value and has been measured at cost +less impairment, if any, and adjusted for observable price changes for identical or similar investments. +16. CONSOLIDATED VARIABLE INTEREST ENTITY - +ALPHA FUND +Investments in the Alpha Fund +During the year ended December +31, 2021, the Company invested in the Alpha Fund. The Alpha Fund operates as a private investment fund. The general partner of the Alpha +Fund, Ault Alpha GP LLC (“Alpha GP”) is owned by Ault Capital Management LLC (the “Investment Manager”), which +also acts as the investment manager to the Alpha Fund. The Investment Manager is owned by Ault & Company. Messrs. Ault, Horne, Nisser +and Cragun, who serve as executive officers and/or directors of the Company, are executive officers of the Investment Manager, and Messrs. +Ault, Horne and Nisser are executive officers and directors of Ault & Company. +As of December 31, 2021, the +Company subscribed for $ 17 million or 100 % of the limited partnership interests in the Alpha Fund, the full amount of which was funded. +These investments are subject to a rolling five-year lock-up period, provided that after three years, Alpha GP will waive the last twenty-four +(24) months of the lock-up period upon receipt of written notice from an executive officer of the Company that a withdrawal of capital +is required to prevent a going concern opinion from the Company’s auditors, under the terms of the Alpha Fund’s partnership +agreement and side letter entered into between the Company and the Alpha Fund. +The Company consolidates Alpha +Fund as a VIE due to its significant level of influence and control of Alpha Fund, the size of its investment, and its ability to participate +in policy making decisions, the Company is considered the primary beneficiary of the VIE. +F- 35 +Investments by Alpha Fund – Treasury +Stock +The Alpha Fund has purchased +shares of the Company’s common stock in open market transactions at an average purchase price of $ 2.16 per share. As of December +31, 2021, the Alpha Fund owned 6,100,000 shares of the Company’s common stock, accounted for as treasury stock as of December 31, +2021. +17. ACQUISITIONS +Business +combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations . +Under the acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values. Goodwill is recorded +to the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired less liabilities +assumed at the date of acquisition. +Acquisition during 2020 +On +November 9, 2020, GWW entered into a Stock Purchase Agreement (the “Agreement”) with Tabard Holdings Inc., a Delaware corporation +and wholly owned subsidiary of GWW (“Tabard”), the legal and beneficial owners (the “Sellers”) of 100% of the +issued shares in the capital of Relec, and Peter Lappin, in his capacity as the representative of the Sellers (the “Sellers’ +Representative”). Relec was established in 1978 and provides specialist power conversion and display products. The acquisition of +Relec expands GWW’s product offering and geographic reach. On November 30, 2020, the acquisition of Relec closed for an aggregate +cash purchase price of $ 3.8 million , net of cash acquired, of which $ 3.6 million had been paid at December 31, 2020. Pursuant to the Agreement, +Tabard may be required to pay the Sellers a maximum of £ 500,000 , or approximately $ 667,000 , during 2021, 2022 and 2023. These earn-out +payments are based on a combination of Relec’s gross margin and its minimum earnings before income taxes, depreciation and amortization. +There was no earn-out payment due related to 2021. +Upon initial measurement, components of the purchase +price are as follows: +Relec +Accounts receivable +$ 633,000 +Prepaid and other current assets +53,000 +Inventories, net +994,000 +Property and equipment +94,000 +Customer relationships +900,000 +Trade name +500,000 +Accounts payable and accrued expenses +( 557,000 ) +Net assets acquired +2,617,000 +Goodwill +1,148,000 +Purchase price +$ 3,765,000 +Asset Acquisitions During 2021 +Acquisition of +Michigan Cloud Data Center +On +January 29, 2021, Alliance Cloud Services, LLC, a majority-owned subsidiary of its wholly-owned subsidiary, Ault Alliance, closed on the +acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan for a purchase price of +$4.0 million. The purchase price was paid by the Company using its own working capital. The facility is subject to a final corrective +measures plan with the Environment Protection Agency. The seller performed remedial activities at the Michigan facility relating to historical +soil and groundwater contamination and the Company is responsible for ongoing monitoring and final remediation plans. The Company’s +estimated cost of the environmental remediation obligation is approximately $0.4 million and reflects its best estimate of probable future +costs for remediation based on the current assessment data and regulatory obligations. Future costs will depend on many factors, including +the extent of work necessary to implement monitoring and final remediation plans and the Company’s time frame for remediation. The +Company may incur actual costs in the future that are materially different than this estimate and such costs could have a material impact +on results of operations, financial condition, and cash flows during the period in which they are recorded. +F- 36 +Acquisition of Hotels +On +December 22, 2021, the Company, through real estate segment, acquired four hotel properties for $71.3 million consisting of a 136-room +Courtyard by Marriott, a 133-room Hilton Garden Inn and a 122-room Residence Inn by Marriott in Middleton, WI, as well as a 135-room Hilton +Garden Inn in Rockford, IL. +The allocation of the purchase +price of the hotel acquisitions is based on the estimated fair value of the assets acquired. The Company accounted for these transactions +as acquisitions of assets. +The Company has performed +a valuation analysis of the fair market value of the assets acquired. The accounted for these transactions as acquisitions of assets. +The following table summarizes the preliminary allocation of the purchase price as of the date of the Acquisition. The purchase price +consists of $69.2 million paid to the seller and $2.1 million of direct transaction costs. +Schedule of acquisation +Land and improvements +$ 9,021,000 +Building improvements +60,265,000 +Furniture, fixtures and equipment +2,048,000 +Assets acquired +$ 71,334,000 +F- 37 +Acquisition of St. Peterburg Land +On +December 30, 2021, the Company, through Third Avenue Apartments, LLC, a wholly owned subsidiary of AGREE Madison, LLC (“AGREE Madison”), +a wholly owned subsidiary of Ault Global Real Estate Equities, Inc., a wholly owned subsidiary of Ault Alliance, acquired certain real +property located at the southeast corner of 5th Street North and 3rd Avenue North in St. Petersburg, Florida. The purchase price for the +property was $15.5 million. The Company plans to use the property for the development of a high-rise multi-family project. +18. EXECUTIVE CHAIRMAN RELOCATION BENEFIT +On +February 23, 2021, as part of a relocation benefit for the Company’s Executive Chairman, Milton C. Ault, III, related to +the Company moving its corporate headquarters from Newport Beach, CA to Las Vegas, NV, the Company agreed to purchase Mr. Ault’s +California residence for $ 2.7 million . The transaction was structured such that upon the closing of the subsequent sale of +the residence, the Company shall have not recognized a gain or a loss on the transaction. The Company and Mr. Ault agreed to escrow +$ 254,000 of the purchase price in the event of a loss on the subsequent sale of the residence. During April 2021, the Company +entered into an agreement for the subsequent sale of the residence, which closed on April 19, 2021. +19. STOCK-BASED COMPENSATION +The Company provides stock-based +compensation to directors, employees and consultants under the 2021 Stock Incentive Plan, which was approved by stockholders on August +13, 2021 at the 2021 Annual Meeting of Stockholders and which reserved 7,500,000 shares of common stock for grant of awards under the +plan. +Options granted under the +plan have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and become exercisable +based on a vesting schedule determined at the date of grant. Typically, options granted generally become fully vested after four +years. Any options that are forfeited or cancelled before expiration become available for future grants. The options expire between 5 +and 10 years from the date of grant. Restricted stock awards granted under the plan are subject to a vesting period determined at +the date of grant. As of December 31, 2021, an aggregate of 2,841,699 shares of the Company’s common stock were available for future +grant. +The options outstanding as +of December 31, 2021, have been classified by exercise price, as follows: +Schedule of exercise price +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ 2.15 - $ 2.62 +3,395,000 +9.75 +$ 2.35 +266,152 +$ 2.51 +$ 480 - $ 560 +894 +3.95 +$ 537.34 +814 +$ 535.12 +$ 1,208 - $ 1,352 +25 +2.25 +$ 1,336.00 +25 +$ 1,336.00 +$ 2.15 - $ 1,352 +3,395,919 +9.75 +$ 2.50 +266,991 +$ 4.26 +Issuances outside of the Plan +1.79 +850,000 +8.72 +$ 1.79 +708,221 +$ 1.79 +$ 2.46 - $ 2.55 +2,150,000 +9.33 +$ 2.54 +- +- +$ 1.79 - $ 2.55 +3,000,000 +9.16 +$ 2.33 +708,221 +$ 1.79 +Total Options +$ 1.79 - $ 1,352 +6,395,919 +9.47 +$ 2.42 +975,212 +$ 2.47 +F- 38 +The total stock-based compensation +expense related to stock options and stock awards issued to the Company’s employees, consultants and directors, included in reported +net loss for the year ended December 31, 2021 and 2020, was comprised as follows: +Year Ended December 31, +2021 +2020 +General and administrative +$ 7,750,000 +$ 1,106,000 +Total stock-based compensation +$ 7,750,000 +$ 1,106,000 +A summary of option activity +under the Company’s stock option plans as of December 31, 2021 and 2020, and changes during the years ended are as follows: +Outstanding Options +Weighted +Weighted +Average +Shares +Average +Remaining +Aggregate +Available +Number +Exercise +Contractual +Intrinsic +for Grant +of Options +Price +Life (years) +Value +January 1, 2020 +103,105 +1,388 +$ 636 +6.33 +$ 0 +Restricted stock awards +( 96,875 ) +— +Forfeited +463 +( 463 ) +$ 781 +January 1, 2021 +6,693 +925 +$ 564 +4.87 +$ 0 +Authorized +7,500,000 +Stock options granted +( 3,395,000 ) +3,395,000 +$ 2.35 +Restricted stock awards +( 1,270,000 ) +— +Forfeited +6 +( 6 ) +$ 1,352 +December 31, 2021 +2,841,699 +3,395,919 +$ 2.52 +9.75 +$ 0 +As of December 31, 2021, there +was $ 11.6 million of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the plan. +That cost is expected to be recognized over a weighted average period of 2.1 years. +Enertec Stock-Based Compensation +On December 31, 2020, Enertec +issued its Chief Executive Officer a warrant to purchase 27,889 shares of Enertec common stock. The stock-based compensation expense related +to the warrant included in reported net loss for the year ended December 31, 2020 was $ 813,405 , based on the estimated fair value of the +warrants on the date of issuance. +GWW Stock-Based +Compensation +On May 25, 2021, GWW issued +its executives options to purchase an aggregate total of 100,000 shares of GWW Class A common stock, at an exercise price per share of +$ 14.64 . The options vest over a four-year period. Additionally, the executives were granted a restricted stock award to acquire an aggregate +of 50,000 shares of GWW Class A common stock, vesting annually over a three-year term. The stock-based compensation expense related to +the options included in reported net loss for the year ended December 31, 2021 was $ 629,000 , based on the estimated fair value of the +options on the date of issuance. As of December 31, 2021, there was $ 429,000 of unrecognized compensation cost related to non-vested stock-based +compensation arrangements with Messrs. Read and Long. That cost is expected to be recognized over a weighted average period of 2.4 years. +F- 39 +20. WARRANTS +A summary of warrant activity +for the years ended December 31, 2021 and 2020 is presented below. +Schedule of warrants +Warrants +Weighted- +Average +Exercise Price +Weighted- +Average +Remaining +Contractual +Life (Years) +Aggregate +Intrinsic +Value +Outstanding at January 1, 2020 +79,018 +$ 206.57 +3.74 +$ 7,735 +Granted +4,156,150 +1.47 +Forfeited +( 474 ) +880.00 +Exercised +( 919,134 ) +1.62 +Outstanding at December 31, 2020 +3,315,560 +6.19 +4.27 +4,220,327 +Granted +18,665,252 +2.47 +Forfeited +( 397 ) +8.00 +Exercised +( 1,965,628 ) +2.42 +Outstanding at December 31, 2021 +20,014,787 +$ 3.09 +4.67 +$ 4,256,888 +The following table summarizes +information about common stock warrants outstanding at December 31, 2021: +Schedule of common stock warrants outstanding +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ — +6,500 +2.25 +$ — +6,500 +$— +$ 0.88 - $ 3.01 +19,936,640 +4.68 +$ 2.31 +19,936,640 +$ 0.88 - $ 3.01 +$ 8.00 - $ 19.80 +53,055 +2.39 +$ 12.78 +53,055 +$ 8.00 - $ 19.80 +$ 440 - $ 920 +16,225 +1.20 +$ 733.40 +16,225 +$ 440 - $ 920 +$ 1,040 - $ 2,000 +2,367 +1.18 +$ 1,404.85 +2,367 +$ 1,040 - $ 2,000 +$ — - $ 2,000.00 +20,014,787 +4.67 +$ 3.09 +20,014,787 +$ 3.09 +Warrant Issuances During 2021 +On December 30, 2021, the +Company issued warrants to purchase an aggregate of 16,037,858 shares of common stock at an exercise price equal to $ 2.50 per share +in connection with the issuance of promissory notes in the aggregate principal face amount of $ 66 +million (see Note 24) . If the trading price of the common stock is less than $2.50 per share +90 days after December 30, 2021, the exercise price will be reduced to 110% of the closing price of the common stock on that date, subject +to a floor price of $1.00 per share. +The Company has valued the +14,095,350 Series A warrants issued in connection with the issuance of promissory notes in the aggregate +principal face amount of $66 million (see Note 24) at their date of grant utilizing a Monte Carlo simulation valuation model. The +Company has valued the other warrants issued at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent +upon several variables such as the warrants’ remaining contractual term, exercise price, current stock price, risk-free interest +rate and estimated volatility of the Company’s stock over the contractual term of the warrants. The risk-free interest rate used +in the calculations is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the contractual +life of the warrants. +The Company utilized a variety +of pricing models and the weighted average assumptions used during the years ended December 31, 2021 and 2020 were as follows: +December 31, +2021 +December 31, +2020 +Exercise price +$ 2.29 +$ 1.79 +Remaining contractual term +4.7 +4.1 +Volatility +150 % +99 % +Dividend yield +0 % +0 % +Risk-free interest rate +1.0 % +0.4 % +F- 40 +21. ACCOUNTS PAYABLE AND ACCRUED EXPENSES +Other current liabilities at December +31, 2021 and 2020 consisted of: +Schedule of other current liabilities +December 31, +2021 +2020 +Accounts payable +$ 6,902,000 +$ 7,043,000 +Accrued payroll and payroll taxes +5,027,000 +1,412,000 +Financial instruments +4,249,000 +4,192,000 +Accrued legal +2,637,000 +1,777,000 +Other accrued expenses +3,887,000 +2,590,000 +total +$ 22,702,000 +$ 17,014,000 +Financial Instruments +Under authoritative guidance +used by the FASB on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock, instruments that +do not have fixed settlement provisions are deemed to be derivative instruments. In prior years, the Company granted certain warrants +that resulted in these warrants being accounted for as a financial instrument in accordance with ASC 815 and being re-measured every reporting +period with the change in value reported in the statement of operations. +The financial +instruments were valued using a variety of pricing models with the following valuation assumptions: +Schedule of Financial Instrument +December 31, +2021 +December 31, +2020 +Stock price +$ 2.50 +$ 2.28 +Exercise price +$ 2.50 +$ 2.28 +Contractually defined remaining term +5.0 +5.0 +Contractually defined volatility +135 % +135 % +Dividend yield +0 % +0 % +Risk-free interest rate +1.270 % +0.381 % +Per the terms of +the warrant agreements underlying the financial instruments, the value to the warrant holders is defined within the agreement based on +a stock price, contractual term, volatility factor and dividend rate as defined in the warrant agreement, and not indexed to the company’s +stock, resulting in the financial instrument accounting. The risk-free interest rate was based on rates established by the Federal Reserve +Bank. +The following table sets forth +a summary of the changes in the estimated fair value of the financial instruments during the years ended December 31, 2021 and 2020: +Schedule of fair value of the financial instruments +December 31, +2021 +2020 +Beginning balance +$ 4,192,000 +$ 9,000 +Recognition of financial instruments +4,239,000 +4,958,000 +Change in fair value +542,000 +49,000 +Extinguishment +( 4,724,000 ) +( 824,000 ) +Ending balance +$ 4,249,000 +$ 4,192,000 +22. INVESTMENT MARGIN ACCOUNTS PAYABLE +During the year ended December +31, 2021, the Company entered into leverage agreements on certain brokerage accounts whereby it borrowed $ 18.5 million . During the year +ended December 31, 2021, the interest expense on these borrowings was $ 55,000 . +F- 41 +23. LEASES +The Company has operating +leases for office space. The Company’s leases have remaining lease terms of 12 months to 9.5 years, some of which may +include options to extend the leases perpetually, and some of which may include options to terminate the leases within 1 year. +The following table provides +a summary of leases by balance sheet category as of December 31, 2021 and 2020: +Schedule of supplemental balance sheet information related to leases +December 31, +2021 +December 31, +2020 +Operating right-of-use assets +$ 5,243,000 +$ 4,318,000 +Operating lease liability - current +1,123,000 +524,000 +Operating lease liability - non-current +4,213,000 +3,855,000 +The components of lease expenses +for the years ended December 31, 2021 and 2020, were as follows: +Schedule of lease expenses +Year Ended December 31, +2021 +2020 +Operating lease cost +$ 1,406,000 +$ 951,000 +Short-term lease cost +- +- +Variable lease cost +- +107,000 +The following tables provides +a summary of other information related to leases for the years ended December 31, 2021 and 2020: +Schedule of supplemental cash flow information related to leases +December 31, 2021 +December 31, 2020 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ 1,008,000 +$ 1,024,000 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ 1,875,000 +$ - +Weighted-average remaining lease term - operating leases +6.1 years +7.3 years +Weighted-average discount rate - operating leases +8.0 % +10.0 % +F- 42 +Maturity of lease liabilities +under the Company’s non-cancellable operating leases as of December 31, 2021, are as follows: +Schedule of maturities of operating lease liabilities +Payments due by period +2022 +$ 1,684,000 +2023 +1,404,000 +2024 +1,298,000 +2025 +914,000 +2026 +712,000 +Thereafter +1,817,000 +Total lease payments +7,829,000 +Less interest +( 2,493,000 ) +Present value of lease liabilities +$ 5,336,000 +24. NOTES PAYABLE +Notes payable at December +31, 2021 and 2020, were comprised of the following. +Schedule of notes payable +Interest +Rate +Due Date +December 31, +2021 +December 31, +2020 +Esousa purchased notes +$ - +$ 200,000 +Short-term notes payable +12.0 % +2022 +118,000 +1,148,000 +10% original issue discount senior secured notes +8.0 % +March 31, 2022 +65,972,000 +- +AGREE Madison secured construction loans +7.0 % +January 1, 2025 +55,055,000 +Paycheck Protection Program Loans +1.0 % +- +1,162,000 +Short-term bank line of credit +3.9 % +2021 +960,000 +1,421,000 +Total notes payable +$ 122,105,000 +$ 3,931,000 +Less: +Unamortized debt discounts +( 27,496,000 ) +- +Total notes payable, net +$ 94,609,000 +$ 3,931,000 +Less: current portion +(39,554,000 ) +(3,595,000 ) +Other +- +336,000 +Notes payable – long-term portion +$ 55,055,000 +$ 336,000 +During the years ended December +31, 2021 and 2020, the Company recorded amortization of debt discounts of $ 1.1 million and $ 7.3 million , respectively. +December 2021 Secured Promissory Notes +On December 30, 2021, the Company entered into +a securities purchase agreement with certain sophisticated investors providing for the issuance of: +● secured promissory notes (the “Secured Promissory Notes”) that bear interest at 8 % per annum +with an aggregate principal face amount of approximately $ 66 million including a 10 % original issue discount; +● five-year warrants to purchase an aggregate of 14,095,350 shares of the Company’s common stock at +an exercise price of $ 2.50 , subject to adjustment; and +● five-year warrants to purchase an aggregate of 1,942,508 shares of Common Stock (the “Class B Warrant +Shares”) at an exercise price of $ 2.50 per share, subject to adjustment. The Class B Warrant Shares are deemed to be a derivative +instrument. +The Secured Promissory Notes +were repaid in March 2022 (see Note 33). +F- 43 +AGREE Madison Construction Loan Agreements +On December 22, 2021, AGREE +Madison, through various wholly-owned subsidiaries, entered into construction loan agreements. The outstanding balances under the construction +loans was $ 55.1 million as of December 31, 2021. The construction loans are due on January 1, 2025, but may be extended for two additional +12-month terms, subject to certain terms and conditions as set forth in the construction loan agreements. The loans accrue interest at +a rate equal to the greater of (i) the LIBOR Rate plus 675 basis points or (ii) 7% per annum . The AGREE Madison subsidiaries will make +monthly installment payments of interest only, starting January 1, 2022. Ault Alliance also provided a completion guaranty to the lenders +for the completion of the property improvement plans. +Notes Payable Maturities +The contractual maturities of the Company’s +notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s option, as of December 31, 2021 +were: +Schedule Of Maturities +Year +2022 +$ 67,504,000 +2023 +- +2024 +- +2025 +55,055,000 +Total +$ 122,559,000 +25. NOTES PAYABLE – RELATED PARTIES +Notes payable – related +parties at December 31, 2021 and 2020, were comprised of the following: +December 31, +2021 +2020 +Notes payable, related parties +$ - +$ 240,000 +Less: current portion +- +( 188,000 ) +Notes payable, related parties – long-term portion +$ - +$ 52,000 +Microphase +was party to several notes payable agreements with six of its past officers, employees and their family members. As of December 31, 2021, +the related party notes payable were paid in full. +26. CONVERTIBLE NOTES +Convertible Notes Payable +at December 31, 2021 and 2020, were comprised of the following: +Conversion +Price Per +Share +Interest +Rate +Due Date +December 31, +2021 +December 31, +2020 +4% Convertible promissory note +$ 4.00 +(BitNile) +4 % +2024 +$ 660,000 +$ 660,000 +Less: Unamortized debt discounts +( 192,000 ) +( 274,000 ) +Total convertible notes payable, net of financing cost, long term +$ 468,000 +$ 386,000 +27. CONVERTIBLE NOTE – RELATED PARTY +On +February 5, 2020, the Company issued an 8% convertible promissory note in the principal amount of $ 1,000,000 to Ault & Company +(the “Ault & Company Convertible Note”). The principal amount of this note, plus any accrued and unpaid interest at a +rate of 8 % per annum, was due and payable on August 5, 2020 . The Ault & Company Convertible Note was convertible into Common Stock +at a conversion price of $ 1.45 per share. During the years ended December 31, 2021 and 2020, the Ault & Company Convertible Note was +converted into 0.3 million and 0.4 million shares, respectively, in full satisfaction thereof. +F- 44 +28. COMMITMENTS AND CONTINGENCIES +Giga-tronics, Incorporated Share Exchange +Agreement +On December 27, 2021, the +Company and GWW entered into a share exchange agreement with Giga-tronics Incorporated, a California corporation (“GIGA”). +Pursuant to the exchange agreement, GIGA will acquire all of the outstanding shares of capital stock of GWW in exchange for issuing to +the Company 2,920,085 shares of GIGA’s common stock and 514.8 shares of a new series of preferred stock which are convertible into +an aggregate of 3,960,043 shares of GIGA common stock, subject to adjustment, and the assumption of GWW’s equity awards representing, +on an as-assumed basis, 249,875 shares of GIGA’s restricted shares of common stock (the “Exchange Transaction”). Completion +of the Exchange Transaction is subject to the approval of GIGA’s shareholders and customary closing conditions. +Immediately following the +completion of the Exchange Transaction, GWW will be a wholly-owned subsidiary of GIGA. In addition, the Exchange Agreement provides that +the Company will loan GIGA $4.25 million pursuant to a convertible promissory note upon the closing of the Exchange Transaction, and following +the closing, GIGA will repurchase or redeem all of its shares of Series B, Series C, Series D and Series E preferred stock currently outstanding. +Assuming the repurchase of the outstanding preferred and based upon 2,725,010 shares of GIGA common stock outstanding, following the issuance +to the Company of the shares of GIGA common stock and the GIGA preferred stock pursuant, the Company would hold approximately 68% of the +outstanding voting power and capital stock of GIGA, and existing holders of GIGA common stock would hold approximately 32%. +Advertising Sponsorship Agreement +The Company entered into an +advertising sponsorship agreement. The sponsorship fee is $5.5 million per year, subject to certain termination provisions. +Blockchain Mining Supply and Services, Ltd. +On November 28, 2018, Blockchain +Mining Supply and Services, Ltd. (“Blockchain Mining”) a vendor who sold computers to one of the Company’s subsidiaries, +filed a Complaint (the “Complaint”) in the United States District Court for the Southern District of New York against the +Company and the Company’s subsidiary, Digital Farms, Inc. (f/k/a Super Crypto Mining, Inc.), in an action captioned Blockchain +Mining Supply and Services, Ltd. v. Super Crypto Mining, Inc. and DPW Holdings, Inc. , Case No. 18-cv-11099. +The Complaint asserts claims +for breach of contract and promissory estoppel against the Company and its subsidiary arising from the subsidiary’s alleged failure +to honor its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $ 1,388,495 , plus attorneys’ +fees and costs. +The Company intends to vigorously +defend against the claims asserted against it in this action. +On April 13, 2020, the Company +and its subsidiary, jointly filed a motion to dismiss the Complaint in its entirety as against us, and the promissory estoppel claim as +against its subsidiary. On the same day, the Company’s subsidiary also filed a partial Answer to the Complaint in connection with +the breach of contract claim. +On April 29, 2020, Blockchain +Mining filed an amended complaint (the “Amended Complaint”). The Amended Complaint asserts the same causes of action and seeks +the same damages as the initial Complaint. +On May 13, 2020, the Company +and its subsidiary, jointly filed a motion to dismiss the Amended Complaint in its entirety as against the Company, and the promissory +estoppel claim as against of its subsidiary. On the same day, the Company’s subsidiary also filed a partial Answer to the Amended +Complaint in connection with the breach of contract claim. +In its partial Answer, the +Company’s subsidiary admitted to the validity of the contract at issue and also asserted numerous affirmative defenses concerning +the proper calculation of damages. +F- 45 +On December 4, 2020, the Court +issued an Order directing the parties to engage in limited discovery (the “Limited Discovery”) to be completed by March 4, +2021. In connection therewith, the Court also denied the defendants’ motion to dismiss without prejudice. +On June 2, 2021, the Company +and its subsidiary filed a motion to dismiss the amended complaint in its entirety as against the Company, and the promissory estoppel +claim as against the subsidiary. +The motion to dismiss has +been fully briefed and is currently pending before the Court. +Based on the Company’s +assessment of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, the Company cannot +reasonably estimate the potential loss or range of loss that may result from this action. Notwithstanding, the Company has established +a reserve in the amount of the unpaid portion of the purchase agreement, which is included in accounts payable and accrued expenses. An +unfavorable outcome may have a material adverse effect on the Company’s business, financial condition and results of operations. +Ding Gu (a/k/a Frank Gu) and Xiaodan Wang +Litigation +On January 17, 2020, Ding +Gu (a/k/a Frank Gu) (“Gu”) and Xiaodan Wang (“Wang” and with “Gu” collectively, “Plaintiffs”), +filed a Complaint (the “Complaint”) in the Supreme Court of the State of New York, County of New York against the Company +and the Company’s Chief Executive Officer, Milton C. Ault, III, in an action captioned Ding Gu (a/k/a Frank Gu) and Xiaodan Wang +v. DPW Holdings, Inc. and Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd Ault) , Index No. 650438/2020. +The Complaint asserts causes +of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent injunction, +enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions entered into +between Gu and us, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs and the Company, +in or about July 2019. The Complaint seeks, among other things, monetary damages in excess of $ 1.1 million , plus a decree of specific +performance directing the Company to deliver unrestricted shares of common stock to Gu, plus attorneys’ fees and costs. +The Company intends to vigorously +defend against the claims asserted against it in this action. +On May 4, 2020, the Company +and Ault jointly filed a motion to dismiss the Complaint in its entirety, with prejudice. +On July 28, 2021, the Court +conducted oral argument in connection with the motion to dismiss. During the oral argument, the Court informed the parties that the Court +was dismissing the fraud claim, in its entirety, and provided Plaintiffs an opportunity to amend their fraud claim within sixty days of +the date of the oral argument. The Court reserved decision on the other causes of action. +On December 14, 2021, the +Court entered a decision and order in connection with the motion to dismiss whereby the Court dismissed Plaintiff’s causes of action +for specific performance, conversion, permanent injunction, and reiterated its prior determination that the fraud claim was also dismissed. +The Court denied the motion to dismiss in connection with the other causes of action asserted in the complaint. +On January 26, 2022, the Company +and Mr. Ault filed an answer to the complaint and asserted numerous affirmative defenses. +Based on the Company’s +assessment of the facts underlying the above claims, the uncertainty of litigation, and the preliminary stage of the case, the Company +cannot reasonably estimate the potential loss or range of loss that may result from this action. An unfavorable outcome may have a material +adverse effect on the Company’s business, financial condition and results of operations. +Subpoena +The Company and certain affiliates +and related parties have received several subpoenas from the SEC for the production of documents and testimony. The Company is fully cooperating +with this non-public, fact-finding inquiry and management believes that the Company has operated its business in compliance with all applicable +laws. The subpoenas expressly provide that the inquiry is not to be construed as an indication by the SEC or its staff that any violations +of the federal securities laws have occurred, nor should they be considered a reflection upon any person, entity or security. However, +there can be no assurance as to the outcome of this matter. +F- 46 +Other Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. The Company is regularly subject to claims, suits, regulatory +and government investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, +suits, regulatory and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. The Company records a liability when it believes that it is +probable that a loss has been incurred and the amount can be reasonably estimated. If the Company determines that a loss is reasonably +possible and the loss or range of loss can be estimated, the Company discloses the reasonably possible loss. The Company evaluates developments +in its legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably +possible losses disclosed, and makes adjustments as appropriate. Significant judgment is required to determine both likelihood of there +being and the estimated amount of a loss related to such matters. +With respect to the Company’s +other outstanding matters, based on the Company’s current knowledge, the Company believes that the amount or range of reasonably +possible loss will not, either individually or in aggregate, have a material adverse effect on the Company’s business, consolidated +financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject +to significant uncertainties. +29. STOCKHOLDERS’ EQUITY +Preferred Stock +The +Company is authorized to issue 25,000,000 shares of Preferred Stock $ 0.001 par value. The Board has designated 1,000,000 shares as Series +A Convertible Preferred Stock (the “Series A Preferred Stock”), 500,000 shares as Series B Convertible Preferred Stock (the +“Series B Preferred Stock”) and 2,500 shares as Series C Convertible Redeemable Preferred Stock (the “Series C Preferred +Stock”). The rights, preferences, privileges and restrictions on the remaining authorized 23,497,50 0 shares of Preferred Stock have +not been determined. The Board is authorized to designate a new series of preferred shares and determine the number of shares, as well +as the rights, preferences, privileges and restrictions granted to or imposed upon any series of preferred shares. As +of December 31, 2021, there were 7,040 shares of Series A Preferred Stock, 125,000 shares of Series B Preferred Stock and no other shares +of Preferred Stock issued or outstanding. +Common Stock +Common stock confers upon +the holders the rights to receive notice to participate and vote at any meeting of stockholders of the Company, to receive dividends, +if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. The Class B common stock +carries the voting power of 10 shares of Class A common stock, referred to herein as the common stock. +2020 Issuances +2020 Ascendiant ATM Offering +On October 2, 2020, the Company +entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC (“Ascendiant +Capital”) to sell shares of common stock having an aggregate offering price of up to $ 8,975,000 from time to time, through an “at +the market offering” program (the “2020 ATM Offering”). On December 1, 2020, the Company filed an amendment to the prospectus +supplement with the SEC to increase the amount of common stock that may be offered and sold in the 2020 ATM Offering, as amended under +the Sales Agreement to $ 40,000,000 in the aggregate, inclusive of the up to $ 8,975,000 in shares of common stock previously sold in the +2020 ATM Offering. The offer and sale of shares of common stock from the 2020 ATM Offering was made pursuant to the Company’s effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. +333-222132) which became effective on January 11, 2018. Through December 31, 2020, the Company had received gross proceeds of $ 39,978,350 +through the sale of 12,582,000 shares of common stock from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, +2020. +F- 47 +Issuances of Common Stock for Services +During the year ended December +31, 2020, the Company issued 102,500 shares of common stock as payment for services to its consultants. The shares were valued at $ 182,575 , +an average of $ 1.78 per share. +Issuance of Common Stock in Payment of Short +Term Advances, Related Party +On December 23, 2019, the +Company entered into a securities purchase agreement with Ault & Company. Pursuant to the terms of this agreement, Ault & Company +agreed to purchase an aggregate of 660,667 shares of common stock for a total purchase price of $ 739,948 at a purchase price per share +of $ 1.12 , subject to the approval of the NYSE American. The sale was authorized by the NYSE American on January 15, 2020. As a result, +at the closing on January 15, 2020, Ault & Company became the beneficial owner of 660,667 shares of common stock. +Issuance of Common Stock in Payment of +Accrued Liability +On March 4, 2020, pursuant +to the terms of the securities purchase agreement for the sale of the Dominion short-term promissory note, the Company issued to Dominion +12,500 shares of common stock in satisfaction of accrued liabilities of $ 73,154 . +During the year ended December +31, 2020, the Company issued 217,398 shares of common stock in satisfaction of accrued liabilities of $ 639,991 . +Issuance of Common Stock for Conversion +of Debt +During the year ended December +31, 2020, principal and accrued interest of $ 6,411,795 and $ 2,196,599 , respectively, on the Company’s debt securities was satisfied +through the issuance of 9,632,219 shares of common stock. The Company recognized a loss on extinguishment of $ 15,572,326 as a result of +these issuances. +On August 20, 2020, the Company +issued 413,793 shares of common stock upon the conversion of $ 600,000 in principal on the Ault & Company Convertible Note. +Issuance of Common Stock Upon Exercise +of Warrants +Between November 24, 2020 +and December 17, 2020, the Company issued a total of 814,095 shares of common stock upon the cash and cashless exercise of warrants to +purchase an aggregate of 919,134 shares of common stock. These warrants were issued in conjunction with the following debt financings: +(i) the 10% Convertible Promissory Note issued on April 13, 2020, (ii) the May 2020 Promissory Notes issued on May 28, 2020and (iii) the +June ‘20 Short-Term Promissory Notes issued on June 26, 2020. The Company received cash of $ 52,826 and extinguished warrant liabilities +of $824,349 as a result of these warrant exercises. +2021 Issuances +2021 ATM Offering +On January 22, 2021, the Company +entered into an At-The-Market Issuance Sales Agreement (the “2021 Sales Agreement”) with Ascendiant Capital to sell shares +of common stock having an aggregate offering price of up to $ 50 million from time to time, through an “at the market offering” +program (the “2021 ATM Offering”). On February 16, 2021, the Company filed an amendment to the prospectus supplement with +the SEC to increase the amount of common stock that may be offered and sold in the 2021 ATM Offering, as amended under the Sales Agreement +to $ 125 million in the aggregate, inclusive of the up to $50 million in shares of common stock previously sold in the 2021 ATM Offering. +On March 5, 2021, the Company filed a second amendment to the prospectus supplement with the SEC to further increase the amount of common +stock that may be offered and sold in the 2021 ATM Offering, as amended under the Sales Agreement to $200 million in the aggregate, inclusive +of the up to $ 125 million in shares of common stock previously sold in the 2021 ATM Offering. The offer and sale of shares of common stock +from the 2021 ATM Offering was made pursuant to the Company’s effective “shelf” registration statement on Form S-3 and +an accompanying base prospectus contained therein (Registration Statement No. 333-251995) which became effective on January 20, 2021. +Through December 31, 2021, the Company had received gross proceeds of $ 200 million through the sale of 52.6 million shares of common stock +from the 2021 ATM Offering. The 2021 ATM Offering was terminated in December 2021. +F- 48 +Issuance of Common Stock for Conversion +of Debt +During January 2021, the Company +issued to Esousa Holdings, LLC an aggregate of 183,214 shares of the Company’s common stock upon the exchange of principal +and interest in the amount of $ 200,000 and $ 16,000 , respectively. A loss on extinguishment of $ 234,000 was recognized on the +issuance of common stock based on the fair value of the Company’s common stock at the date of the exchanges. +Issuance of Common Stock for Convertible Promissory +Note, Related Party +On +May 12, 2021, the Company issued 275,862 shares of common stock to Ault & Company upon the conversion of $ 400,000 of +principal on an 8% convertible promissory note dated February 5, 2020. +Issuance of Common Stock Upon Exercise of Warrants +During +the year ended December 31, 2021, the Company issued 2.4 million shares of common stock upon the exercise of warrants. +Issuance of Common Stock for Restricted Stock +Awards +During +the year ended December 31, 2021, the Company issued 1.2 million shares of common stock upon vesting of restricted stock awards. +Securities Purchase +Agreement, Related Party +On +June 11, 2021, the Company entered into a securities purchase agreement with Ault & Company. Under the terms of the agreement, Ault +& Company agreed to purchase an aggregate of 1,000,000 shares of the Company’s common stock for a total purchase price +of $ 2.99 million , at a purchase price per share of $ 2.99 , which was $0.05 per share above the closing stock price on June 10, 2021, +subject to the approval of the NYSE American. +F- 49 +30. INCOME TAXES +The following is a geographical breakdown of income/loss +before the provision for income tax, for the years ended December 31, 2021 and 2020 : +2021 +2020 +Pre-tax income (loss) +U.S. Federal +$ ( 24,644,000 ) +$ ( 32,382,000 ) +Foreign +803,000 +( 1,030,000 ) +Total +$ ( 23,841,000 ) +$ ( 33,412,000 ) +Deferred income taxes reflect +the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and +income tax purposes. Significant components of the Company’s deferred tax assets are as follows: +Schedule of deferred tax assets +2021 +2020 +Deferred tax asset: +Allowance for doubtful accounts +$ 361,000 +$ 359,000 +Unrealized losses +5,413,000 +10,000 +Obsolete inventory +375,000 +3,000 +Stock compensation +1,915,000 +881,000 +Other carryforwards +132,000 +484,000 +Net operating loss carryforwards +8,716,000 +5,913,000 +Lease liability +888,000 +798,000 +Credit loss +560,000 +559,000 +Accrued expenses +2,157,000 +934,000 +Total deferred tax asset +20,517,000 +9,941,000 +Deferred tax liability: +Right-of-use assets +( 857,000 ) +( 756,000 ) +Fixed assets, net +( 3,937,000 ) +( 160,000 ) +Intangible assets, net +( 256,000 ) +( 1,000 ) +Total deferred income tax liabilities +( 5,050,000 ) +( 917,000 ) +Net deferred income tax assets +15,467,000 +9,024,000 +Valuation allowance +( 15,467,000 ) +( 9,038,000 ) +Deferred tax asset (liability), net +$ - +$ ( 14,000 ) +At +December 31, 2021, the Company had federal and state net operating loss carry forwards (“NOLs”) for income tax purposes of +approximately $ 25.6 million and $ 19.4 million after application of limitation set forth in Section 382 of the Internal Revenue Code (“§382”). +In accordance with § 382, future utilization of the Company’s +NOLs is subject to an annual limitation as a result of ownership changes that occurred previously. The Company also maintains NOLs in +various foreign jurisdictions. +At December 31, 2021, Microphase, +an entity not consolidated for income tax purposes, utilized its remaining NOLs. The Company has not completed a formal §382 study +and completion of such an analysis in future periods may yield income tax provision impacts in subsequent financial statements. +In assessing the realization +of deferred tax assets, management considers whether it is more likely than not some portion or all deferred tax assets will not be realized. +The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which +temporary differences representing net future deductible amounts become deductible. Management considers the scheduled reversal of deferred +tax assets, projected future taxable income and tax planning strategies in making this assessment. After consideration of all positive +and negative evidence, including the Company’s generation of NOLs in current and prior periods, there is substantial doubt regarding +the Company’s ability to utilize its deferred tax assets, therefore, the Company recorded a full valuation allowance. For the year +ended December 31, 2021, the valuation allowance increased by $ 6.4 million . +F- 50 +The net income tax provision (benefit) +consisted of the following: +Schedule of net income tax benefit +2021 +2020 +Current +U.S. Federal +$ 69,000 +$ - +U.S. State +35,000 +- +Foreign +26,000 +25,000 +Total current provision +130,000 +25,000 +Deferred +U.S. Federal +- +- +U.S. State +- +- +Foreign +- +( 49,000 ) +Total deferred provision (benefit) +130,000 +( 24,000 ) +Total provision (benefit) for income taxes +$ 130,000 +$ ( 24,000 ) +The Company’s effective +tax rates were 0.9 % and ( 0.1 %) for the years ended December 31, 2021 and 2020, respectively. During the year ended December 31, 2021, +the effective tax rate differed from the U.S. federal statutory rate primarily due to the change in valuation allowance. The reconciliation +of income tax attributable to operations computed at U.S. Federal statutory income tax rates of 21 % to income tax expense is as follows: +Schedule of reconciliation of income tax attributable to operations +2021 +2020 +Expected federal income tax benefit +21.0 % +21.0 % +State taxes net of federal benefit +6.1 % +8.1 % +Foreign rate differential +0.3 % +- 0.3 % +Section 382 limitation +0.0 % +- 34.7 % +PPP forgiveness +0.4 % +0.0 % +Effect of change in valuation allowance +- 26.0 % +21.1 % +Beneficial conversion feature +0.0 % +- 0.1 % +Deconsolidation of I.AM +0.0 % +1.5 % +Loss on extinguishment of debt +0.0 % +- 9.8 % +Return to provision adjustment +0.0 % +- 7.8 % +Permanent differences +- 0.1 % +0.0 % +IRC Section 162(m) compensation limitation +- 0.7 % +0.0 % +Excess tax benefit - windfall/(shortfall) +0.7 % +0.0 % +Other +- 2.6 % +0.9 % +Income tax benefit +- 0.9 % +- 0.1 % +The Company accounts for uncertain +tax positions in accordance with ASC 740-10-25. ASC 740-10-25 addresses the determination of whether tax benefits claimed or expected +to be claimed on a tax return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit +from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing +authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit +that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these +matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is +made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. +ASC 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken +uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management +of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2021 and 2020, there are no +uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in +the financial statements. +The Company’s statute +of limitations remains open for various taxable years, in various U.S. federal, U.S. state and foreign jurisdictions. Earnings in all +foreign jurisdictions are permanently reinvested. +F- 51 +31. NET LOSS PER SHARE +Net loss per share is computed +by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation of the basic +and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock equivalents is anti-dilutive +due to the Company’s net loss position for all periods presented. Anti-dilutive securities, which are convertible into or exercisable +for common stock, consisted of the following at December 31, 2021 and 2020: +Net +Loss Per Share +December 31, +2021 +2020 +Stock options +6,396,000 +851,000 +Restricted stock grants +2,775,000 +- +Warrants +20,015,000 +3,309,000 +Convertible notes +165,000 +441,000 +Conversion of preferred stock +2,000 +2,000 +Total +29,353,000 +4,603,000 +F- 52 +32. SEGMENT AND CUSTOMERS INFORMATION +The Company has three reportable +segments as of December 31, 2021 and 2020; see Note 1 for a brief description of the Company’s business. +The following data presents +the revenues, expenditures and other operating data of the Company’s operating segments and presented in accordance with ASC 280. +Segment information for the +year ended December 31, 2021: +GWW +TurnOnGreen +Ault +Alliance +Crypto- +currency +Real +Estate +Ault +Disruptive +Holding +Company +Total +Revenue +$ 25,581,000 +$ 5,346,000 +$ 192,000 +$ - +$ - +$ - +$ - +$ 31,119,000 +Revenue, cryptocurrency mining, net +- +- +- +3,450,000 +- +- +- +3,450,000 +Revenue, commercial real estate +leases +- +- +- +788,000 +- +- +- +788,000 +Revenue, lending and trading +activities +- +- +16,854,000 +- +- +- +- +16,854,000 +Revenue, hotel +- +- +- +- +189,000 +- +- +189,000 +Total revenues +$ 25,581,000 +$ 5,346,000 +$ 17,046,000 +$ 4,238,000 +$ 189,000 +$ - +$ - +$ 52,400,000 +Depreciation and amortization +expense +$ 876,000 +$ 25,000 +$ - +$ 1,384,000 +$ 138,000 +$ - +$ 55,000 +$ 2,478,000 +Income (loss) from operations +$ ( 1,298,000 ) +$ ( 1,518,000 ) +$ 3,794,000 +$ 1,541,000 +$ ( 194,000 ) +$ ( 20,000 ) +$ ( 20,666,000 ) +$ ( 18,361,000 ) +Capital expenditures for the year +ended December 31, 2021 +$ 947,000 +$ 18,000 +$ - +$ 85,927,000 +$ 86,884,000 +$ - +$ 217,000 +$ 173,993,000 +Identifiable assets as of December +31, 2021 +$ 33,716,000 +$ 4,601,000 +$ 81,415,000 +$ 99,590,000 +$ 93,838,000 +$ 119,335,000 +$ 57,791,000 +$ 490,286,000 +Segment information for the +year ended December 31, 2020: +GWW +TurnOnGreen +Ault +Alliance +Holding +Company +Total +Revenue +$ 18,213,000 +$ 5,416,000 +$ - +$ - +$ 23,629,000 +Revenue, lending and trading activities +- +- +242,000 +- +242,000 +Total revenues +$ 18,213,000 +$ 5,416,000 +$ 242,000 +$ - +$ 23,871,000 +Depreciation and amortization expense +$ 508,000 +$ 33,000 +$ 175,000 +$ 12,000 +$ 728,000 +Income (loss) from operations +$ ( 955,000 ) +$ ( 117,000 ) +$ 19,000 +$ ( 4,980,000 ) +$ ( 6,033,000 ) +Capital expenditures for the year ended December 31, 2021 +$ 550,000 +$ 26,000 +$ 3,000 +$ 3,000 +$ 582,000 +Identifiable assets as of December 31, 2020 +$ 30,194,000 +$ 2,207,000 +$ 4,515,000 +$ 38,727,000 +$ 75,643,000 +Concentration Risk: +The following table provides +the percentage of total revenues attributable to a single customer from which 10% or more of total revenues are derived: +For the Year Ended +December 31, 2021 +Total Revenues +Percentage of +by Major +Total Company +Customers +Revenues +Customer A $ +9,575,000 +18 % +F- 53 +For the Year Ended +December 31, 2020 +Total Revenues +Percentage of +by Major +Total Company +Customers +Revenues +Customer A $ +7,742,000 +32 % +Customer B $ +2,502,000 +10 % +Revenue from Customer A is +attributable to Enertec. Revenue from Customer B is attributable to Microphase. +33. SUBSEQUENT EVENTS +2022 ATM Offering +On February 25, 2022, the +Company entered into an At-The-Market issuance sales agreement with Ascendiant Capital to sell shares of common stock having an aggregate +offering price of up to $200 million (the “2022 ATM Offering”). As of April 1, 2022, the Company had sold an aggregate of +146.0 million shares of common stock pursuant to the 2022 ATM Offering for gross proceeds of $114.6 million. +Repayment of Senior +Secured Notes +On March 30, 2022, the Company +fully paid its $66 million senior secured notes and accrued interest. The 10% original issuance discount promissory notes were sold in +December 2021 and were due and payable on March 31, 2022. +Investments in Alpha Fund +During the period between +January 1, 2022 through April 5, 2022, the Company purchased an additional $3.0 million of limited partnership interests in the Alpha +Fund. As of April 5, 2022, the Company had subscribed for $20.0 million of limited partnership interests in the Alpha Fund, of which $19 +million was funded. +Investments by Alpha Fund +During the period between +January 1, 2022 and April 5, 2022, Alpha Fund purchased 1,000,000 shares of the Company’s common stock in open market transactions +at an average purchase price of $0.97 per share. As of April 5, 2021, the Alpha Fund owned 7,100,000 shares of the Company’s common +stock. +Amendment to GIGA Share Exchange Agreement +On April 5, 2022, the Company +and GWW amended its share exchange agreement with GIGA amending and restating the related term note to reflect that DP Lending has loaned +to Giga an aggregate of $1.3 million thereunder. +F-54 \ No newline at end of file diff --git a/raw/filings/0000896493/2021/0001214659-22-005320/filing_metadata.csv b/raw/filings/0000896493/2021/0001214659-22-005320/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..43479a224f14ded666af7fd9aa7967c9f15e6273 --- /dev/null +++ b/raw/filings/0000896493/2021/0001214659-22-005320/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2022-04-15,2021-12-31,2022-04-15T18:27:26.000Z,0001214659-22-005320,d4722010k.htm,,14196138,1,1,https://www.sec.gov/Archives/edgar/data/896493/000121465922005320/d4722010k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465922005320/,2021,2021,1 diff --git a/raw/filings/0000896493/2021/0001214659-22-005320/item1.txt b/raw/filings/0000896493/2021/0001214659-22-005320/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..c24895c41dab7a10af895fa8942946657fe998ad --- /dev/null +++ b/raw/filings/0000896493/2021/0001214659-22-005320/item1.txt @@ -0,0 +1,1837 @@ +ITEM 1. BUSINESS +Company Overview +BitNile Holdings, Inc., a +Delaware corporation formerly known as Ault Global Holdings, Inc., was incorporated in September 2017 (sometimes referred to as “BitNile,” +the “Company,” “we” or “us”). We are a diversified holding company owning subsidiaries engaged in, +among others, the following operating businesses: commercial and defense solutions, commercial lending, data center operations, Bitcoin +mining and advanced textile technology. Our direct and indirect wholly owned subsidiaries include Gresham Worldwide, Inc. (“GWW”), +TurnOnGreen, Inc., formerly known as Coolisys Technologies Corp. (“TOGI”), TOG Technologies, Inc. (“TOG Technologies”), +Digital Power Corporation (“Digital Power”), Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems +2001 Ltd. (“Enertec”), Relec Electronics Ltd. (“Relec”), Digital Power Lending, LLC (“DP Lending”), +Ault Alliance, Inc. (“Ault Alliance”), Ault Global Real Estate Equities, Inc. (“AGREE”) and BitNile, Inc. (“BNI”). +We also have a controlling interest in Microphase Corporation (“Microphase”), BNI has a controlling interest in Alliance Cloud +Services, LLC (“ACS”), and Ault Alliance has a significant investment in Avalanche International Corp. (“Avalanche” +or “AVLP”). +BitNile was founded by Milton +C. (Todd) Ault, III, its Executive Chairman, and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and Vice Chairman, +and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages the day-to-day operations +of the holding company. The Company’s long-term objective is to maximize per share intrinsic value. All major investment and capital +allocation decisions are made for us by Mr. Ault and the Executive Committee. We have four reportable segments: +● Ault Alliance digital learning, commercial lending and trading through DP Lending, real estate investing +through AGREE, and textile treatment through Avalanche; +● BNI: Bitcoin mining operation and data center operations through ACS; +● GWW: defense solutions with operations conducted by Microphase, Enertec, Gresham Power and Relec; and +● TOGI: commercial electronics solutions with operations conducted by Digital Power, and EV charging solutions +through TOG Technologies. +We operate as a holding company +with operations conducted primarily through our subsidiaries. We conduct our activities in a manner so as not to be deemed an investment +company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). Generally, this means that we +do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets will be invested +in investment securities, as that term is defined in the Investment Company Act. Pursuant to the Investment Company Act, companies such +as our subsidiary DP Lending are excluded from the definition of an investment company since its business consists of making loans and +industrial banking. We also maintain a considerable investment in Avalanche, which does business as MTIX +International (“MTIX”). +Originally, we were primarily +a solution-driven organization that designed, developed, manufactured and sold high-grade customized and flexible power system solutions +for the medical, military, telecom and industrial markets. Currently, this business is conducted by Digital Power. Although we actively +seek growth through acquisitions, we will also continue to focus on high-grade and custom product designs for the commercial, medical +and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or +military mission critical operating conditions. +We have operations located +in Europe through our wholly owned subsidiaries, Gresham Power and Relec, each of which is located in England. Gresham Power designs, +manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution +equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business +is specialized in the field of naval power distribution products. On November 30, 2020, we acquired Relec pursuant to a stock purchase, +under which we paid approximately $4,000,000 with additional contingent cash payments up to approximately $665,000 based on Relec’s +future financial performance. Relec specializes in AC/DC power supplies, DC-DC converters, displays and electromagnetic compatibility +(“EMC”) filters. +1 +We have operations based in +Israel through our wholly owned subsidiary Enertec, which designs, develops, manufactures and maintains advanced end-to-end high technology +electronic solutions for military, medical, telecommunications and industrial markets. +On November 30, 2016, we formed +DP Lending, a wholly owned subsidiary. DP Lending provides commercial loans to companies throughout the U.S. to provide them with operating +capital to finance the growth of their businesses. The loans range in duration from six months to three years, DP Lending loans made or +arranged pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +On June 2, 2017, we purchased +56.4% of the outstanding equity interests of Microphase. Microphase is a design-to-manufacture original equipment manufacturer (“OEM”) +industry leader delivering world-class radio frequency (“RF”) and microwave filters, diplexers, multiplexers, detectors, switch +filters, integrated assemblies and detector logarithmic video amplifiers (“DLVAs”) to the military, aerospace and telecommunications +industries. Microphase is headquartered in Shelton, Connecticut. +On January 7, 2020, we formed +TOGI, a wholly owned subsidiary. TOGI operates its existing businesses in the customized and flexible power system solutions for the automotive, +medical, military, telecom, commercial and industrial markets, other than the European markets, which are primarily served by Gresham +Power. In April 2021, TOGI formed TOG Technologies as a Nevada corporation to provide flexible and scalable EV charging solutions with +a portfolio of residential, commercial and ultra-fast charging products, and comprehensive charging management software and network services. +On +December 31, 2017, Coolisys Technologies, Inc., a Delaware corporation (“CTI”), entered into a share purchase agreement with +Micronet Enertec Technologies, Inc. (“MICT”), a Delaware corporation, Enertec Management Ltd., an Israeli corporation and +wholly owned subsidiary of MICT (“EML”), and Enertec, an Israeli corporation and wholly owned subsidiary of EML, pursuant +to which CTI acquired Enertec. Enertec is Israel’s largest private manufacturer of specialized electronic systems for the military +market. On May 23, 2018, CTI completed its acquisition of Enertec. Effective as of December 30, 2021, CTI was merged with and into GWW +as a result which upstream merger CTI ceased to exist. +GWW +was incorporated under the laws of the State of Delaware on November 21, 2018 as DPW Technologies Group, Inc. and effected a name change +on December 6, 2019. +Recent Events and Developments +On February 10, 2020, we entered +into a Master Exchange Agreement (the “Master Exchange Agreement”) with Esousa Holdings, LLC (“Esousa”) that acquired +approximately $4.2 million in principal amount, plus accrued but unpaid interest, of certain promissory notes that had been previously +issued by us to Dominion Capital, LLC, a Connecticut limited liability company (the “Dominion Note”) and the Canadian Special +Opportunity Fund, LP (the “CSOF Note” and, with the Dominion Note, the “Esousa Purchased Notes”) in separate transactions. +Esousa also agreed to purchase additional notes up to an additional principal amount, plus accrued but unpaid interest, of $3.5 million +(the “Additional Notes” and collectively, with the Esousa Purchased Notes, the “Notes”). Pursuant to the Master +Exchange Agreement, Esousa had the unilateral right to acquire shares of our common stock (the “Exchange Shares”) in exchange +for the Notes, which Notes evidence an aggregate of up to approximately $7.7 million of indebtedness of the Company. In aggregate, we +issued to Esousa a total of 8,332,904 Exchange Shares. +Between +August 2020 and November 2020, we received $5,450,000 in loans from Esousa and certain affiliates pursuant to which we agreed to issue +unsecured short-term promissory notes with interest rates of 13% and 14% and warrants with terms of approximately one and a half years +to purchase an aggregate of 3,850,220 shares of common stock at an average exercise price of $2.28 per share. +On October 2, 2020, we entered +into an At-The-Market Issuance Sales Agreement (the “2020 Sales Agreement”) with Ascendiant Capital Markets, LLC (“Ascendiant”) +to sell shares of common stock having an aggregate offering price of up to $8,975,000 from time to time, through an “at the market +offering” program (the “2020 ATM Offering”). On December 1, 2020, we filed an amendment to the prospectus supplement +with the SEC to increase the amount of common stock that may be offered and sold in the 2020 ATM Offering, as amended under the 2020 Sales +Agreement to $40,000,000 in the aggregate, inclusive of the up to $8,975,000 in shares of common stock previously sold in the 2020 ATM +Offering. The offer and sale of shares of common stock from the 2020 ATM Offering was made pursuant to our effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration No. 333-222132), which became effective +on January 11, 2018. Through December 31, 2020, we had received gross proceeds of $39,978,350 through the sale of 12,582,000 shares of +our common stock from the 2020 ATM Offering. The 2020 ATM Offering was terminated on December 31, 2020. +2 +On January 22, 2021, we entered +into an At-The-Market Issuance Sales Agreement (the “2021 Sales Agreement”) with Ascendiant to sell shares of common stock +having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the +“2021 ATM Offering”). On February 16, 2021, we filed an amendment to the prospectus supplement with the SEC to increase the +amount of common stock that may be offered and sold in the 2021 ATM Offering, as amended under the 2021 Sales Agreement to $125 million +in the aggregate, inclusive of the up to $50 million in shares of common stock previously sold in the 2021 ATM Offering. On March 5, 2021, +we filed a second amendment to the prospectus supplement with the SEC to further increase the amount of common stock that may be offered +and sold in the 2021 ATM Offering, as amended under the 2021 Sales Agreement to $200 million in the aggregate, inclusive of the up to +$125 million in shares of common stock previously sold in the 2021 ATM Offering. The offer and sale of shares of common stock from the +2021 ATM Offering was made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus +contained therein (Registration Statement No. 333-251995) which became effective on January 20, 2021. Through December 31, 2021, we had +received gross proceeds of $200 million through the sale of 52,552,353 shares of common stock from the 2021 ATM Offering. The 2021 ATM +Offering was terminated in December 2021. +On +January 29, 2021, ACS closed on the acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern +Michigan for a purchase price of $3,991,497 (the “Facility”). The purchase price was paid by our own working capital. Ownership +of the Facility was subsequent assigned to BNI. +On March 9, 2021, DP Lending +entered into a securities purchase agreement with Alzamend Neuro, Inc. (“Alzamend”), a related party, to invest $10 million +in Alzamend common stock and warrants, subject to the achievement of certain milestones. We agreed to fund $4 million upon execution of +the securities purchase agreement and to fund the balance upon Alzamend achieving certain milestones related to the U.S. Food and Drug +Administration approval of Alzamend’s Investigational New Drug application and Phase 1a human clinical trials for Alzamend’s +lithium based ionic cocrystal therapy, known as AL001. As of the date of this Annual Report, we have funded an aggregate of $6 million +pursuant to the securities purchase agreement. Under the securities purchase agreement, Alzamend has agreed to sell up to 6,666,667 shares +of its common stock to DP Lending for $10 million, or $1.50 per share, and issue to DP Lending warrants to acquire up to 3,333,334 shares +of Alzamend common stock with an exercise price of $3.00 per share. The transaction was approved by our independent directors after receiving +a third-party valuation report of Alzamend. +On May 12, 2021, we issued +275,862 shares of common stock to Ault & Company, Inc. (“A&C”), a related party, upon the conversion of $400,000 of +principal on an 8% Convertible Promissory Note dated February 5, 2020. +On June 11, 2021, we entered +into a securities purchase agreement with A&C, pursuant to which A&C is entitled to purchase 1,000,000 shares of our common stock +for a total purchase price of $2,990,000, at a purchase price per share of $2.99, which was $0.05 per share above the closing stock price +on June 10, 2021. +On June 15, 2021, Alzamend +closed an initial public offering at a price to the public of $5.00 per share. DP Lending purchased 2,000,000 shares of Alzamend’s +common stock in the initial public offering for an aggregate of $10,000,000. Alzamend’s common stock is listed on The Nasdaq Capital +Market under the ticker symbol “ALZN.” +During +the quarter ended September 30, 2021, we executed contracts to purchase 4,000 Antminer S-19 Pro Bitcoin miners. The gross purchase price +is $27.3 million. In November 2021, we executed contracts to purchase an aggregate of 16,000 Bitcoin miners for $121 million. The purchase +includes both the environmentally friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) +with an energy consumption of 3.01 kilowatt-hours (“kWh”) and the S19j Pro Antminers that feature a processing power of 100 +TH/s with an energy consumption of 2.95 kWh. As of March 31, 2022, 4,754 were in our possession, and the remaining miners are expected +to be shipped between April 2022 and September 2022. Approximately $92.4 million of the gross purchase price has been paid as of March +24, 2022 with the balance scheduled to be paid between April 2022 and November 2022. +On December 13, 2021, BNI +closed an investment of Series A preferred stock of Earnity Inc. (“Earnity”), a decentralized finance (“DeFi”) +marketplace based in San Mateo, California. BNI paid approximately $11.5 million for the shares of Earnity’s Series A preferred +stock. Following the investment, BNI beneficially owned approximately 19.99% of Earnity’s common stock. +On December 15, 2021, DP Lending +entered into an exchange agreement with Imperalis Holding Corp. (“IMHC”) pursuant to which IMHC issued us a convertible promissory +note (the “IMHC Note”) in the principal amount of $101,528.77, in exchange for those certain promissory notes dated August +18, 2021 and November 5, 2021 previously issued by IMHC to DP Lending in the aggregate principal amount of $100,000, which prior notes +had accrued interest of $1,528.77 as of the December 15, 2021. The IMHC Note accrues interest at 10% per annum, is due on December 15, +2023, and the principal, together with any accrued but unpaid interest on the amount of principal, is convertible into shares of IMHC’s +common stock at DP Lending’s option at a conversion price of $0.01 per share. +3 +On December 16, 2021, we entered +into a stock purchase agreement (the “Agreement”) with the majority stockholders of IMHC. Pursuant to the Agreement, we purchased +129,363,756 shares of IMHC’s common stock from the sellers in exchange for $200,000. Upon the closing of the Agreement, we owned +a majority of IMHC’s common stock, resulting in a change in control of IMHC. +On +December 22, 2021 (the “Closing Date”), AGREE Madison, LLC, a wholly owned subsidiary of AGREE (“AGREE Madison”), +through various wholly owned subsidiaries (the “Property Owners”), entered into construction loan agreements (the “Loan +Agreements”) in the aggregate amount of $68,750,000 (the “Loans”) in connection with the acquisition of four hotel properties +(the “Properties”). The Properties were acquired on the Closing Date for an aggregate purchase price of $69,200,000, of which +$2,500,000 was previously funded on deposit, $21,378,000 was paid by the Company on the Closing Date, and the remaining amounts were funded +from the Loans. The remaining $23,428,000 of the Loans are available to be drawn upon by the Property Owners towards the completion of +the $13,700,000 in property improvement plans (“PIPs”) the Property Owners agreed to undertake, as well as to fund working +capital, interest reserves, franchise fees and other costs and expenses related to the acquisition. The Loans are due on January 1, 2025 +(the “Maturity Date”), but may be extended by the Property Owners for two additional 12-month terms, subject to certain terms +and conditions as set forth in the Loan Agreements. The Loans accrue interest at a rate equal to the greater of (i) the LIBOR Rate plus +675 basis points or (ii) 7% per annum. The Property Owners will make monthly installment payments of interest only, starting January 1, +2022. +On +December 27, 2021, the Company and GWW entered into a Share Exchange Agreement (the “Exchange Agreement”) with Giga-tronics +Incorporated, a California corporation (“GIGA”). Pursuant to the Exchange Agreement, GIGA will acquire all of the outstanding +shares of capital stock of GWW in exchange for (i) issuing to the Company 2,920,085 shares of GIGA’s common stock (“GIGA Common +Stock”) and 514.8 shares of a new series of preferred stock (“GIGA Preferred Stock”) which are convertible into an aggregate +of 3,960,043 shares of GIGA Common Stock, subject to adjustment, and (ii) the assumption of GWW’s equity awards representing, on +an as-assumed basis, 249,875 shares of GIGA Common Stock (the “Exchange Transaction”). Completion of the Exchange Transaction +is subject to the approval of GIGA’s shareholders and customary closing conditions. +Immediately +following the completion of the Exchange Transaction, GWW will be a wholly owned subsidiary of GIGA. In addition, the Exchange Agreement +provides that the Company shall loan to GIGA $4.25 million pursuant to a convertible promissory note (“Closing Date Loan”) +upon the closing of the Exchange Transaction (the “Closing”), and following the Closing, GIGA will repurchase or redeem all +of its shares of Series B, Series C, Series D and Series E preferred stock currently outstanding (the “Outstanding Preferred”). +Assuming the repurchase of the Outstanding Preferred and based upon 2,725,010 shares of GIGA Common Stock currently outstanding, following +the issuance to the Company of the shares of GIGA Common Stock and GIGA Preferred Stock pursuant to the Exchange Transaction, the Company +would hold approximately 68% of the outstanding voting power and capital stock of GIGA, and existing holders of GIGA Common Stock would +hold approximately 32%. +On +December 30, 2021, Third Avenue Apartments LLC (“Third Avenue Apartments”), which is a wholly owned subsidiary of AGREE Madison, +closed upon the acquisition of certain real property located in St. Petersburg, Florida (the “Real Property”) together with +all improvements on the Real Property and all singular rights and appurtenances pertaining thereto, including, but not limited to, (i) all +entitlements, easements, rights, mineral rights, oil and gas rights, water, water rights, air rights, development rights and privileges +appurtenant to the Real Property, (ii) all tangible personal property, owned and assignable by Seller, located on or used in connection +with the Real Property, including, without limitation, engineering studies, soils reports, (iii) all warranties, guaranties, indemnities +and other similar rights relating to the Real Property and/or the assets transferred hereby, (iv) all permits, licenses, consents, +approvals and entitlements related to the Real Property, (v) any rights of way, appendages appurtenances, easements, sidewalks, alleys, +gores or strips of land adjoining or appurtenant to the Real Property or any portion thereof, if any, and used in conjunction therewith, +and (vi) all intangible rights directly relating to the Real Property (collectively, with the Real Property, the “Property”). +The +Property was acquired from Third Avenue at St Petersburg LLC (the “Seller”) pursuant to a contract of entered into by Third +Avenue Apartments and the Seller. The purchase price for the Property was $15,500,000, of which $1,500,000 was previously funded on deposit +and the remaining $14,000,000 was paid by the Company on the closing date. We plan to use the Property for the development of a high-rise +multi-family project. +4 +On +December 30, 2021, we issued of (i) secured promissory notes (individually, a “Note” and collectively, the “Notes”) +with an aggregate principal face amount of approximately $66,000,000; (ii) five-year Class A warrants to purchase an aggregate of 14,095,350 +shares of our common stock at an exercise price of $2.50, subject to adjustment; and (iii) five-year Class B warrants to purchase an aggregate +of 1,942,508 shares of our common stock at an exercise price of $2.50 per share, subject to adjustment. We agreed to file a registration +statement to register the shares of common stock underlying the foregoing warrants and certain other shares underlying previously issued +warrants to one of the investors. +We, +certain of our subsidiaries and Esousa, as the collateral agent on behalf of the investors (the “Agent”) entered into a security +agreement, pursuant to which we (i) pledged the equity interests in substantially all of our U.S. based subsidiaries and (ii) granted +to the investors a security interest in substantially all of our deposit accounts, securities accounts, chattel paper, documents, equipment, +general intangibles, instruments and inventory, and all proceeds therefrom. The entirety of the loan, including the original issue discount +and accrued but unpaid interest, was fully paid off on March 30, 2022. +On +February 4, 2022, we and Ault Alliance entered into a securities purchase agreement providing for our purchase of BNI from Ault Alliance. +As a result of this transaction, both BNI and Ault Alliance are each stand-alone wholly owned subsidiaries of ours. +On +February 10, 2022, consistent with our objective to have BNI operate the entirety of our business that relates to cryptocurrencies, Ault +Alliance assigned the entirety of its interest in ACS to BNI. +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant to sell shares of common stock +having an aggregate offering price of up to $200 million from time to time, through an “at the market offering” program (the +“2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering was made pursuant to our effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. +333-260618) which became effective on November 12, 2021. Through March 31, 2022, we had received gross proceeds of approximately $110 +million through the sale of 140,658,096 shares of common stock from the 2022 ATM Offering. +On +March 20, 2022, we and IMHC entered into a securities purchase agreement (the “Acquisition Agreement”) with TOGI. According +to the Acquisition Agreement, we will (i) deliver to IMHC all of the outstanding shares of common stock of TOGI that we own, and (ii) +forgive and eliminate the intracompany accounts between us and TOGI evidencing historical equity investments made by us in TOGI, in the +approximate amount of $25,000,000, in consideration for the issuance by IMHC to us (the “Transaction”) of an aggregate of +25,000 newly designated shares of Series A Preferred Stock (the “IMHC Preferred Stock”), with each such share having a stated +value of $1,000. The closing of the Transaction is subject to our delivery to IMHC of audited financial statements of TOGI and other customary +closing conditions. Immediately following the completion of the Transaction, TOGI will be a wholly owned subsidiary of IMHC. The parties +to the Agreement have agreed that, upon completion of the Transaction, IMHC will change its name to TurnOnGreen, Inc., and, through an +upstream merger whereby the current TOGI shall cease to exist, IMHC shall own TOGI’s two operating subsidiaries, TOG Technologies +and Digital Power. Promptly following the closing of the Transaction, IMHC will dissolve its three dormant subsidiaries. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.bitnile.com. +Our Corporate Structure +On January 19, 2021, we changed +our corporate name from DPW Holdings, Inc. to Ault Global Holdings, Inc. and, on December 13, 2021, we changed our corporate name from +Ault Global Holdings, Inc. to BitNile Holdings, Inc. (together, the “Name Changes”). The Name Changes were each effected through +a parent/subsidiary short form merger pursuant to an Agreement and Plan of Merger dated January 7, 2021 and December 1, 2021, respectively. +Neither of the mergers nor the corresponding Name Changes affected the rights of our security holders. Our common stock is traded on the +NYSE American under the symbol “NILE.” Existing stock certificates that reflect our prior corporate names continue to be valid. +Certificates reflecting the new corporate name are issued as old stock certificates are tendered for exchange or transfer to our transfer +agent. Concurrently with the change in our name to Ault Global Holdings, Inc., Milton C. Ault III was appointed as our Executive Chairman, +William B. Horne was appointed as our Chief Executive Officer and remains as Vice Chairman of our board of directors (the “Board”), +and Henry Nisser was appointed as our President and remains as our General Counsel. +5 +Commencing in October 2019 +and continuing through February 2022, we reorganized our corporate structure pursuant to a series of transactions by and among BitNile +and its directly and indirectly owned subsidiaries. The purpose of the reorganization was to align our various businesses by the products +and services that constitute the majority of each subsidiaries’ revenues. As a result of the foregoing transactions, our streamlined +corporate structure is currently as follows: +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +6 +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for DP Lending and approves all lending transactions. Under its business model, DP Lending generates revenue +through origination fees charged to borrowers and interest generated from each loan. DP Lending may also generate income from appreciation +of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued to DP Lending +in any particular financing. +Over the recent past, we have +provided capital and relevant expertise to fuel the growth of businesses in cryptocurrency mining, DeFi, defense/aerospace, industrial, +telecommunications, medical and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity +interest or may be actively involved, influencing development through board representation and management support. +Our Subsidiaries and their Businesses +BitNile, Inc. +BNI conducts data center operations +and Bitcoin mining through ACS. +Overview +BNI is a blockchain technology +company focused on mining of Bitcoin, among other activities. We mine using purpose-built computers (or “miners”) to solve +complex cryptographic algorithms (or “verify” or “solve” blocks) in the blockchain in exchange for rewards and +fees denominated in the native token of that blockchain network. +We will evaluate each digital +asset in our portfolio, or that we propose to acquire in the future (including by mining), to determine whether it would likely be considered +a security under U.S. federal securities laws, in consultation with outside counsel, as applicable. We will base our analysis on relevant +caselaw, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance by the SEC and +its staff. See “Risk Factors —  Risks Related to Our Bitcoin Operations – Legal and Regulatory —  +A particular digital asset’s status as a ‘security’ in any relevant jurisdiction is subject to a high degree of uncertainty +and if a regulator disagrees with our characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines +and penalties, which may adversely affect our business, operating results and financial condition. A determination that Bitcoin that we +own or mine is a ‘security’ may adversely affect the value of Bitcoin and our business.” +Since commencement of our +mining operations in 2021 at the Facility, we have mined 45.7 Bitcoin for our own account through December 31, 2021. While we mine for +cryptocurrency for sale in the ordinary course of business, we believe that cryptocurrency represents an attractive, appreciating investment +opportunity, and as such we have historically held cryptocurrency assets that we do not otherwise sell to fund our operating expenses. +On December 31, 2021, we held 46.75 Bitcoin valued at approximately $2.2 million based on prices as of such date. Our total revenue +from mining operation was $3.5 million during the fiscal year ended December 31, 2021. Our mining operations generated net income +of $1.5 million during the fiscal year ended December 31, 2021. As of December 31, 2021, the carrying value of our approximately +46.75 Bitcoins was $2.2 million, representing 0.4% of our total assets of $490.8 million as of such date. +7 +Our Vision +Traditional finance has historically +had poor customer service and a less than desirable user experience in mobile and web-based platforms, which opens the door to massive +disruption through digital technologies. Additionally, central bank intervention in the financial markets has increasingly turned to money +printing through quantitative easing, which increasingly dilutes the buying power of the global fiat currency market and leads the world +to seek more scarce alternatives. The first phase of the digital transformation has been through the creation of blockchain-based digital +assets. We believe the second phase of this transition will be take form in bridges being built between DeFi and traditional finance to +help improve customer service and user experience in traditional finance. +We foresee a time when traditional +banking is done in the palm of our hands in community-based, peer-to-peer transactions as opposed through financial intermediaries. This +community-based, peer-to-peer network is otherwise known as DeFi. Although we do not believe DeFi will replace traditional finance in +the near- to medium-term, we believe this transition will happen rapidly over the next 20 years as Millennials and Gen-Xers become the +power class and the Baby Boomers retire. DeFi is a concept whereby traditional financial intermediaries are not required to process transactions. +The proliferation of blockchain-based protocols will enable participants to offer novel financial products to banking customers. For instance, +in a world where traditional finance provides savings account rates less than 1%, DeFi protocols can provide savings accounts with significantly +higher yields. Traditional financial platforms are not currently designed to distribute these products to its customers. We believe that +in the near-term integrating a traditional broker dealer could help facilitate the distribution of these decentralized finance protocols +to a broad base of customers. While we recognize DeFi is in its infancy stage, we believe blockchain will be integral to its advancement. +We recognize the uncertainties in DeFi and its effect on our economy both in the U.S. and globally, and acknowledge that this is a new +evolving area that may not evolve as we anticipate and in which we may never be a material participant. +Cryptocurrency and Cryptocurrency Mining Overview +Blockchain and Cryptocurrencies Overview +Cryptocurrencies are a type +of digital asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). +Cryptocurrencies operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized +digital ledger that enables the secure use and transfer of digital assets. We believe cryptocurrencies and associated blockchain technologies +have potential advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate +settlement of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” Recently, cryptocurrencies +have gained widespread mainstream attention and have begun to experience greater adoption by both retail and institutional investors and +the broader financial markets. For example, Bitcoin’s aggregate market value exceeded $800 trillion in February 2022, $1 trillion +in February 2021 compared to $160 billion in February 2020, based on Bitcoin prices quoted on major exchanges. As cryptocurrencies, +and blockchain technologies more generally, have entered the mainstream, prices of digital assets have reached all-time highs and the +broader ecosystem has continued to develop. While we expect the value of Bitcoin to remain volatile, we believe this increase in aggregate +market value signals institutionalization and wider adoption of cryptocurrency. +Cryptocurrencies are decentralized +currencies that enable near instantaneous transfers. Transactions occur via an open source, cryptographic protocol platform which uses +peer-to-peer technology to operate with no central authority. The online network hosts the public transaction ledger, known as the +blockchain, and each cryptocurrency is associated with a source code that comprises the basis for the cryptographic and algorithmic protocols +governing the blockchain. In a cryptocurrency network, every peer has its own copy of the blockchain, which contains records of every +historical transaction — effectively containing records of all account balances. Each account is identified solely by +its unique public key (making it effectively anonymous) and is secured with its associated private key (kept secret, like a password). +The combination of private and public cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing +strong control of ownership. +8 +No single entity owns or operates +the network. The infrastructure is collectively maintained by a decentralized public user base. As the network is decentralized, it does +not rely on either governmental authorities or financial institutions to create, transmit or determine the value of the currency units. +Rather, the value is determined by market factors, supply and demand for the units, the prices being set in transfers by mutual agreement +or barter among transacting parties, as well as the number of merchants that may accept the cryptocurrency. Since transfers do not require +involvement of intermediaries or third parties, there are currently little to no transaction costs in direct peer-to-peer transactions. +Units of cryptocurrency can be converted to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as +Binance, Coinbase, FTX, Kraken, Gemini, and others. Cryptocurrency prices are quoted on various exchanges and fluctuate with extreme volatility. +We believe cryptocurrencies +offer many advantages over traditional, fiat currencies, although many of these factors also present potential disadvantages and may introduce +additional risks, including: +● acting as a fraud deterrent, as cryptocurrencies are digital and cannot be counterfeited or reversed arbitrarily +by a sender; +● immediate settlement; +● elimination of counterparty risk; +● no trusted intermediary required; +● lower fees; +● identity theft prevention; +● accessible by everyone; +● transactions are verified and protected through a confirmation process, which prevents the problem of +double spending; +● decentralized — no central authority (government or financial institution); and +● not recognized universally and not bound by government imposed or market exchange rates. +However, cryptocurrencies may not provide all +of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, +there are two factors that may affect all digital asset mining companies and Bitcoin in particular: (i) limitations on the supply of the +cryptocurrency being mined; and (ii) the market price of the cryptocurrency. +The blockchain’s method +for creating new Bitcoins is mathematically determined in a manner so that the supply of Bitcoins grows at a limited rate pursuant to +a pre-set schedule. Specifically, the number of Bitcoins awarded for solving a new block is automatically halved for every 210,000 +blocks that are solved. The current fixed reward for solving a new block is 6.25 Bitcoins per block, which was reduced from 12.5 Bitcoins +in May 2020. This deliberately controlled rate of Bitcoin creation means that the number of Bitcoins in existence will never exceed 21 million +and that Bitcoins cannot be devalued through excessive production unless the Bitcoin network’s source code and the underlying protocol +for Bitcoin issuance is altered. This also means, however, that our revenue prospects will decline unless the price of a Bitcoin increases +commensurately or we acquire more miners. +We currently only mine Bitcoin. +Our ability to generate revenue from our mining operations will be dependent on the price of Bitcoin. On September 24, 2021, the +Bank of China announced that all cryptocurrency trading and mining are illegal in China. Bitcoin and Ethereum, the second largest digital +currency, fell 5% and 7%, respectively. The prices of cryptocurrencies, specifically Bitcoin, have experienced substantial volatility, +including fluctuation patterns which may reflect “bubble” type volatility, meaning that high or low prices at a given time +may not be indicative of the current or future value of Bitcoin. The price of a Bitcoin may be subject to rapidly changing investor and +market sentiment, and may be influenced by factors such as technology, regulatory developments and media coverage. Further, Bitcoin’s +value, like that of other cryptocurrencies, may be based on various factors, including their acceptance as a means of exchange or purchasing +power by consumers and vendors, volume, liquidity and transferability and market demand. Bitcoin’s current price reflects, in part, +the belief by some that Bitcoin could become a widely accepted form of currency, however if this prediction turns out to be incorrect +its price could decrease dramatically, as would our prospects for future revenue and profits. See “Risk Factors – Risks Related +to Our Bitcoin Operations” for more information on the risks we face due to our mining of Bitcoin and its speculative and volatile +nature. +9 +Cryptocurrency Mining and Mining Pools +As a cryptocurrency miner, +we use specialized miners to solve cryptographic math problems necessary to record and “publish” cryptocurrency transactions +to blockchain ledgers. Generally, each cryptocurrency has its own blockchain, which consists of software code (also known as a protocol), +which is run by all the computers on the network for such blockchain. Within this code, transactions are collated into blocks, and these +blocks must meet certain requirements to be verified by the blockchain software, added to the blockchain or ledger of all transactions +and published to all participants on the network that are running the blockchain software. After a transaction is verified, it is combined +with other transactions to create a new block of data for the blockchain. For proof-of-work blockchains, the process of verifying valid +blocks requires computational effort to solve a cryptographic equation, and this computational effort protects the integrity of the blockchain +ledger. This process is referred to as “mining.” As a reward for verifying a new block, miners receive payment in the form +of the native cryptocurrency of the network (e.g., Bitcoin). This payment is comprised of a block reward (i.e., the automatic issue of +new cryptocurrency tokens) and the aggregated transaction fees for the transactions included in the block (paid in existing cryptocurrency +tokens by the participants to the transactions). The block reward payments and the aggregated transaction fees are what provide the incentive +for miners to contribute hash rate to the network. +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific cryptocurrency, and the blockchain-wide hash rate for a specific cryptocurrency can be understood as the aggregate +of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +and other cryptocurrencies are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known +as the “mining difficulty,” which is the level of computational activity required before a new block is solved and verified. +For example, on the Bitcoin blockchain the protocol is coded such that a new block is solved and verified approximately every ten minutes, +while on Ethereum blocks are designed to be solved approximately every twelve to fifteen seconds. As such, to the extent the hash power +on the network is increased or decreased due to, for example, fluctuations in the number of active miners online, mining difficulty is +correspondingly increased or decreased to maintain the preset interval for the verification of new blocks. +On certain cryptocurrency +networks, including Bitcoin, the rewards for solving a block are also subject to periodic incremental halving. Halving is a process designed +to control the overall supply and reduce the risk of inflation in cryptocurrencies using a proof-of-work consensus algorithm. After a +predetermined number of blocks are added to the blockchain, the mining reward is cut in half, hence the term “halving.” The +last halving for Bitcoin occurred on May 11, 2020. The next halving for Bitcoin is expected to occur in 2024, and as such, absent +any changes to the Bitcoin protocols, the block reward will remain stable until then. By contrast, Ethereum does not have a maximum supply +limit or pre-determined reduction in reward amounts. Rather, Ethereum currently has a fixed issuance schedule of 2.0 Ether per block mined. +However, Ethereum has on two separate occasions reduced the quantity of ETH rewarded per block and may make additional changes in the +future, whether or not Ethereum ultimately transitions to a proof-of-stake consensus mechanism. Transaction fees are variable and depend +on the level of activity on the network. Generally, transaction fees increase during times of network congestion, as miners will prefer +transactions with higher fees, and therefore a higher fee can reduce the time to process a transaction, and decrease when there are fewer +transactions on the network. +As the total amount of available +hash rate has increased (particularly on the Bitcoin network), it has become increasingly difficult for any individual miner to independently +solve a block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool, rather than an individual miner, receives +the block reward and related transaction fees. The mining pool is organized by a third party who, in return for a percentage of the +earned block rewards and transaction fees as a fee, administers the pool and ensures that the participants in the pool receive their share +of the block reward and related transaction fees, generally pro-rata to their contributed hash rate. Mining pools offer miners more predictable +and consistent revenue compared to mining individually. We participate in mining pools. +Our Strategy +Smart Growth +We aim to optimize our mining +by identifying and purchasing the most profitable miners with industry-leading returns on investment and actively monitoring and adjusting +the operation of those machines to enhance their performance. When planning our short- and long-term operating strategies and capital +expenditures, we carefully monitor fluctuations and longer-term trends in the value of certain cryptocurrencies, which impacts the return +on investment of machines. We also regularly evaluate potential innovations in geography, physical footprint, computing technology and +similar areas to improve our operations and productivity. We believe this smart-growth strategy, including our commitment to mining efficiency +and return on investment in miners, will enable us to build value over the long term. +10 +Own and Operate Our Mining Facilities +We are investing heavily in +purchasing, building and operating our mining facilities. By owning and operating our miners at facilities that offer competitive advantages, +including access to reliable, low-cost, renewable power and room for expansion, we expect to have greater control over the timing of the +purchase and deployment of our miners. We also may enhance our ability to intelligently and quickly adapt our operating model and reap +savings compared to paying for outsourced operations and infrastructure. We anticipate that we will continue to consider other opportunities +to integrate our operations, including with respect to both the software utilized by our fleet and the associated hardware. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in cryptocurrency mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable +amounts of electrical energy to perform their functions and mine Bitcoin; consequently, a critical aspect of operating in the cryptocurrency +mining industry is obtaining a reliable supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased +the Facility, which currently has access to 28 megawatts of power in preparation for the planned purchase of Bitcoin mining equipment. +Since the purchase of the Facility, we have invested in infrastructure improvements and began both ramping up the sites power capacity +and installing S19jPro miners. To date, we have increased power load from 1.5 megawatts to 14 megawatts and expect to have 28 megawatts +installed at this location by July 2022. In addition, we have received a commitment by the utility company that currently provides our +power to expand the site’s capacity up to 297 megawatts, for which we are currently working on setting forth in a formal agreement. +Our relationship with the utility company has grown as we have demonstrated our ability to upgrade and use power at our site effectively. +We are in the midst of finalizing those expansion details with the utility company, engineers, and Economic Development Agency. This planned +expansion would allow the operation of up to as many as 90,000 Bitcoin miners at the Facility. +We continue to evaluate other +sites, locations, and partnerships for additional and alternative support of future mining operations. While we have not at present entered +into any other agreements, we will continue to explore and evaluate additional facilities that that would enable us to expand our mining +operations as needed. +We expect to enter into power +agreements that will allow us to have one of the highest carbon-free energy footprints at a price equal to or less than the current cost +of fossil fuel energy in other locations, based on current market power costs as of the date of this Annual Report. +Our Mining Operations +On January 29, 2021, ACS closed +on the acquisition of the 617,000 square foot energy-efficient Facility for a purchase price of $4.0 million. The purchase price was paid +by our own working capital. The Facility has been remodeled and converted over the past year into a site focused on three types of business +(commercial real estate, enterprise data center, and high-density computing). +The buildout of the initial +30,000 square feet will be used primarily for our Bitcoin mining operations. While we believe the Facility and its anticipated future +operations will be successful, there is a risk that its expectations will not materialize in a timely manner, if at all. +11 +During the fiscal year ended +December 31, 2021, we executed contracts to purchase 4,000 Antminer S-19 Pro Bitcoin miners. As of February 15, 2022, we have 2,160 Bitcoin +miners in operation. The remaining units are expected to be delivered at a rate of approximately 300 units per month through July 2022. +The total purchase price is $27.3 million. In November 2021, we executed contracts to purchase 16,600 Bitcoin miners for $128 million. +The purchase includes both the environmentally friendly S19 XP Antminers that feature a processing power of 140 terahashes per second +(TH/s) with an energy consumption of 3.01 kilowatt-hours (kWh) and the S19j Pro Antminers that feature a processing power of 100 TH/s +with an energy consumption of 2.95 kWh. Based on current delivery schedules, we expect that the 16,600 newly purchased miners will be +shipped by Bitmain Technologies Limited (“Bitmain”) between approximately April 2022 and September 2022. Approximately $89 +million of the total purchase price has been paid as of March 8, 2022 with the balance scheduled to be paid between March 2022 and November +2022. The supplier, Bitmain, does not disclose when the miners are manufactured. We have a futures purchase contract and Bitmain has been +supplying equipment according to the scheduled delivery as outlined in these agreements. All dollar amounts provided in this paragraph +include fees payable in connection with obtaining the ability to enter into the contracts, and not solely the cost of the miners. +Our strategy includes identifying +less expensive, clean power for our Bitcoin mining operations. Management of the company has considered the issues surrounding the environmental +impact of our Bitcoin mining operations. Based on this review, we have concluded that the environmental impact of our mining operations +is not material given that approximately 85% of the energy we use is “green,” meaning it is sourced from nuclear, wind or +solar power. In addition to our continued expansion investments at the Facility, we also seek out new locations to support our Bitcoin +mining business. We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but also +leasing buildings and facilities, hosting relationships and strategic partnerships. At this time, we have not entered into any new mining +agreements at locations other than the Facility. We currently mine Bitcoin only. +Coins that are mined are held +in a custodial account as digital assets. We securely store assets at NYDIG ABL LLC (“NYDIG”), a regulated, audited and insured +cryptocurrency custodian. The custody arrangements require that we mine to a custodial wallet address where the private key is held by +the custodian and all keys for the wallet are held in cold storage. This provides a layer of protection in both the transaction and liquidation +phases of the operations by using multi-factor and multi-person approval processes, to include Know Your Customer and Anti-Money Laundering +procedures of the receiving party. We will either hold the digital assets or may choose to convert those assets into fiat currency depending +on financial needs and plans. When we opt to convert the digital assets we sell or exchange our Bitcoin through NYDIG, the custodian of +our digital wallet. When we elect to make a sale or exchange our Senior Vice President - Finance submits a request to NYDIG’s execution +department to exchange Bitcoin for U.S. dollars. NYDIG sends an approval email to our CEO to approve. Once approved by our CEO, NYDIG +executes the sale/exchange on its trading platform at current market prices, less commissions, and deposits the U.S. dollars into our +bank account. +Currently, we are converting +Bitcoin received from our mining activities into fiat currency on a bimonthly basis, on average, to pay for operating costs and purchase +commitments for new mining equipment. We are not currently holding any digital assets for investment. +Our Contracts with Bitmain +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain, as follows: +● Pursuant to the Bitmain Agreement dated July 23, 2021, Bitmain agreed to sell 1,000 Antminer S-19 Pro +miners for the estimated total purchase price of $2,550,000, which miners have been delivered; +● Pursuant to the Bitmain Agreement, dated September 12, 2021, Bitmain agreed to sell 3,000 Antminer S-19 +Pro miners for the estimated total purchase price of $20,509,500, which miners have been delivered; +● Pursuant to the Bitmain Agreement dated November 10, 2021, Bitmain agreed +to sell 4,000 S19 XP miners for the estimated total purchase price of $45,360,000, which miners are expected to be shipped monthly +between July and September 2022 ; +● Pursuant to the Bitmain Agreement dated November 17, 2021, Bitmain agreed +to sell 12,000 S19j miners for the estimated total purchase price of $76,000,000, of which 754 have miners have been delivered +and the balance of the miners are expected to be shipped monthly between April and August 2022; and +● Pursuant to the Bitmain Agreement dated November 17, 2021, Bitmain agreed +to sell 6 00 S19XP miners for the estimated total purchase price of $6,510,000, which miners are expected to be shipped monthly +between July and December 2022. +12 +Within seven days after the +signing of each Bitmain Agreement, we paid Bitmain a down payment within the range of 25% and 31.86% of the estimated total purchase price, +and an additional prepayment within the range of 28.14% and 35% of the actual purchase price for each monthly batch scheduled for shipment, +which is due six months prior to shipment. The actual purchase price for such batch to be shipped six months later will be provided by +Bitmain one month prior to the shipment of the current batch, provided that the actual purchase price will not be higher than the total +purchase price set forth in the payment schedules in the Bitmain Agreements. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +Regulation +The laws and regulations applicable +to cryptocurrency are evolving and subject to interpretation and change. Governments around the world have reacted differently to cryptocurrencies; +certain governments, such as the People’s Republic of China, have deemed them illegal, and others have allowed their use and trade +without restriction, while in some jurisdictions, such as in the U.S., cryptocurrencies are subject to extensive, and in some cases overlapping, +unclear and evolving regulatory requirements. As cryptocurrencies have grown in both popularity and market value, the U.S. Congress and +a number of U.S. federal and state agencies, including the Financial Crimes Enforcement Network (the “FinCEN”), the SEC, the +Commodity Futures Trading Commission (the “CFTC”), the Financial Industry Regulatory Authority (the “FINRA”), +the Consumer Financial Protection Bureau (the “CFTC”), the Department of Justice (the “DOJ”), the Department of +Homeland Security, the Federal Bureau of Investigation, the Internal Revenue Service and state financial regulators, have been examining +the operations of cryptocurrency networks, cryptocurrency users and cryptocurrency exchange markets, with particular focus on the extent +to which cryptocurrencies can be used to launder the proceeds of illegal activities or fund criminal or terrorist enterprises and the +safety and soundness and consumer-protective safeguards of exchanges or other service-providers that hold, transfer, trade or exchange +digital assets for users. For instance, the Cyber-Digital Task Force of the DOJ published a report entitled “Cryptocurrency: An +Enforcement Framework” in October 2020. This report provides a comprehensive overview of the possible threats and enforcement challenges +the DOJ views as associated with the use and prevalence of cryptocurrency, as well as the regulatory and investigatory means the DOJ has +at its disposal to deal with these possible threats and challenges. +Many of these federal and +state agencies have issued consumer advisories regarding the risks posed by cryptocurrencies to investors. In addition, federal and state +agencies, and other countries have issued rules or guidance about the treatment of cryptocurrency transactions or requirements for businesses +engaged in activities related to cryptocurrencies. Depending on the regulatory characterization of the cryptocurrencies we mine, the markets +for those cryptocurrencies in general, and our activities in particular, may be subject to one or more regulators in the U.S. and globally. +Ongoing and future regulatory actions may alter, perhaps to a materially adverse extent, the nature of cryptocurrency markets and our +cryptocurrency operations. Additionally, U.S. state and federal, and foreign regulators and legislatures have taken action against cryptocurrency +businesses or enacted restrictive regimes in response to adverse publicity arising from hacks, consumer harm, or criminal activity stemming +from cryptocurrency activity. There is also increasing attention being paid by U.S. federal and state energy regulatory authorities as +the total load of crypto-mining grows and potentially alters the supply and dispatch functionality of the wholesale grid and retail distribution +systems. Many state legislative bodies are also actively reviewing the impact of crypto-mining in their respective states. +We are unable to predict the +effect that any future regulatory change, or any overlapping or unclear regulations, may have on us, but such change, overlap or lack +of clarity could be substantial and make it difficult for us to operate our business or materially impact the market for cryptocurrencies +that we mine or may mine in the future. FinCEN has issued guidance stating its position that it does not differentiate between fiat currency +(which FinCEN calls “real currency”) and cryptocurrencies that are convertible into fiat currency or other forms of convertible +virtual currencies (which FinCEN calls “virtual currency”) for purposes of determining whether a person or entity is engaging +in “money transmission services.” Persons and entities engaging in virtual currency activities that amount to “money +transmission services,” or otherwise cause them to be deemed a “money services business” under FinCEN’s regulations, +must register as a money services business, implement an “effective” anti-money laundering program and comply with FinCEN’s +reporting and recordkeeping requirements. +13 +In May 2019, FinCEN issued +guidance relating to how the U.S. Bank Secrecy Act (“BSA”) and its implementing regulations relating to money services businesses +apply to certain businesses that transact in convertible virtual currencies. Although the guidance generally indicates that certain mining +and mining pool operations will not be treated as money transmission, the guidance also addresses when certain activities, including certain +services offered in connection with operating mining pools such as hosting convertible virtual currency wallets on behalf of pool members +or purchasers of computer mining power, may be subject to regulation. Although we believe that our mining activities do not presently +trigger FinCEN registration requirements under the BSA, if our activities cause us to be deemed a “money transmitter,” “money +services business” or equivalent designation, under federal law, we may be required to register at the federal level and comply +with laws that may include the implementation of anti-money laundering programs, reporting and recordkeeping regimes, and other operational +requirements. In that event, to the extent we decide to proceed with some or all of our operations, the required registration and regulatory +compliance steps may result in extraordinary, non-recurring expenses to us, as well as on-going recurring compliance costs, possibly affecting +operating results or financial condition in a material and adverse manner. Failure to comply with these requirements may expose us to +fines, penalties and/or interruptions in our operations that could have a material adverse effect on our financial position, results of +operations and cash flows. +According to the CFTC, at +least some cryptocurrencies, including Bitcoin, fall within the definition of a “commodity” under the U.S. Commodities Exchange +Act of 1936, as amended (the “CEA”). Under the CEA, the CFTC has broad enforcement authority to police market manipulation +and fraud in spot cryptocurrency markets in which we may transact. Beyond instances of fraud or manipulation, the CFTC generally does +not oversee cash or spot market exchanges or transactions involving cryptocurrencies that do not utilize margin, leverage, or financing. +The National Futures Association (“NFA”) is the self-regulatory agency for the U.S. futures industry, and as such has jurisdiction +over Bitcoin futures contracts and certain other cryptocurrency derivatives. However, the NFA does not have regulatory oversight authority +for the cash or spot market for cryptocurrency trading or transactions. In addition, CFTC regulations and CFTC oversight and enforcement +authority apply with respect to futures, swaps, other derivative products, and certain retail leveraged commodity transactions involving +cryptocurrencies, including the markets on which these products trade. +The SEC has taken the position +that many cryptocurrencies may be securities under U.S. federal securities laws. Some senior members of the staff of the SEC have expressed +the view that Bitcoin and Ethereum are not securities under U.S. federal securities laws. However, such statements are not official policy +statements by the SEC and reflect only the speakers’ views, which are not binding on the SEC or any other agency or court and cannot +be generalized to any other cryptocurrency. The SEC’s Strategic Hub for Innovation and Financial Technology published a framework +for analyzing whether any given cryptocurrency is a security in April 2019. However, this framework is also not a rule, regulation +or statement of the SEC and is similarly not binding on the SEC. Notwithstanding that the SEC has not asserted regulatory authority over +Bitcoin or trading or ownership of Bitcoin and has not expressed the view that Bitcoin should be classified or treated as a security for +purposes of U.S. federal securities laws, the SEC has commented on Bitcoin and Bitcoin-related market developments and has taken action +against investment schemes involving Bitcoin. For example, the SEC has charged at least three Bitcoin mining companies in connection with +a Ponzi scheme to defraud investors in their mining operation. The SEC has also repeatedly denied proposed rule changes by exchanges to +list and trade shares of certain Bitcoin-related investment vehicles on public markets, citing significant investor protection concerns +regarding the markets for cryptocurrencies, including the potential for market manipulation and fraud. Although the SEC has not stated +that mining Bitcoin is itself a regulated activity, to the extent any cryptocurrencies we mine are deemed to be securities, the offer, +sale, and trading of those cryptocurrencies would be subject to the U.S. federal securities laws. +In addition to the SEC, state +securities regulators and several foreign governments have also issued warnings that certain cryptocurrencies may be classified as securities +in their jurisdictions, and that transactions in such cryptocurrencies may be subject to applicable securities regulations. Furthermore, +certain state securities regulators have taken the position that certain cryptocurrency mining operations may involve the offer of securities. +For example, the Texas State Securities Board has taken enforcement action against the operator of a cloud mining company, whereby customers +could purchase hash rate managed by the cloud mining company in exchange for a share of the mining reward, for offering unregistered securities. +State financial regulators, +such as the New York State Department of Financial Services (“NYDFS”), have also implemented licensure regimes, or repurposed +pre-existing fiat money transmission licensure regimes, for the supervision, examination and regulation companies that engage in certain +cryptocurrency activities. The NYDFS requires that businesses apply for and receive a license, known as the “BitLicense,” +to participate in a “virtual currency business activity” in New York or with New York customers, and prohibits any person +or entity involved in such activity from conducting activities without a license. Louisiana also has enacted a licensure regime for companies +engaging in a “virtual currency business activity,” and other states are considering proposed laws to establish licensure +regimes for certain cryptocurrency businesses as well. Some state legislatures have amended their money transmitter statutes to require +businesses engaging in certain cryptocurrency activities to seek licensure as a money transmitter, and some state financial regulators +have issued guidance applying existing money transmitter licensure requirements to certain cryptocurrency businesses. The Conference of +State Bank Supervisors also has proposed a model statute for state level cryptocurrency regulation. Although we believe that our mining +activities do not presently trigger these state licensing requirements in any state in which we operate or plan to operate, if our activities +cause us to be deemed a “money transmitter,” “money services business” or equivalent designation under the law +of any state in which we operate or plan to operate, we may be required to seek a license or register at the state level and comply with +laws that may include the implementation of anti-money laundering programs, reporting and recordkeeping regimes, consumer protective safeguards, +and other operational requirements. In such an event, to the extent we decide to proceed with some or all of our operations, the required +registrations, licensure and regulatory compliance steps may result in extraordinary, non-recurring expenses to us, as well as on-going +recurring compliance costs, possibly affecting our net income in a material and adverse manner. Failure to comply with these requirements +may expose us to fines, penalties and/or interruptions in our operations that could have a material adverse effect on our financial position, +results of operations and cash flows. +14 +Competition +Our business environment is +constantly evolving, and cryptocurrency miners can range from individual enthusiasts to professional mining operations with dedicated +data centers. We compete with other companies that focus all or a portion of their activities on cryptocurrency mining activities at scale. +We face significant competition in every aspect of our business, including, but not limited to, the acquisition of new miners, the ability +to raise capital, obtaining the lowest cost of electricity, obtaining access to energy sites with reliable sources of power, and evaluating +new technology developments in the industry. +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this Annual Report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies +which we have identified as our competitors: +● Argo Blockchain PLC; +● Bit Digital, Inc.; +● Bitcoin Investment Trust; +● Bitfarms Technologies Ltd. (formerly Blockchain Mining Ltd); +● Blockchain Industries, Inc. (formerly Omni Global Technologies, Inc.); +● Digihost International, Inc.; +● DMG Blockchain Solutions Inc.; +● Galaxy Digital Holdings Ltd.; +● GMO Internet, Inc.; +● Greenidge Generation Holdings Inc.; +● HashChain Technology, Inc.; +● Hive Blockchain Technologies Inc.; +● Hut 8 Mining Corp.; +● Iris Energy Limited; +● Layer1 Technologies, Inc.; +● Marathon Digital Holdings, Inc.; +● MGT Capital Investments, Inc.; +● Northern Data AG; +● Riot Blockchain, Inc.; +● Overstock.com Inc.; +● SBI Holdings; +● SOS Limited; and +● Stronghold Digital Mining, Inc. +Intellectual Property +We plan to use specific hardware +and software for our cryptocurrency mining operations. In certain cases, source code and other software assets may be subject to an open +source license, as much technology development underway in this sector is open source. For these works, we intend to adhere to the terms +of any license agreements that may be in place. +15 +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. In addition, we have developed and may further +develop certain proprietary software applications for purposes of our planned cryptocurrency mining operations. +Accounting for Digital Currencies +Digital currencies are included +in current assets in the combined balance sheet. Digital currencies are recorded at cost less any impairment. An intangible asset with +an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances +occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount +exceeds its fair value. In testing for impairment, we have the option to first perform a qualitative assessment to determine whether it +is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, +a quantitative impairment test is not necessary. If we conclude otherwise, we will be required to perform a quantitative impairment test. +To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment +losses is not permitted. We account for our mining-related gains or losses in accordance with the first-in, first-out method of accounting. +Blockchain Background +Blockchain technology first +came to public attention in 2008 as the database technology that underpins Bitcoin, the world’s first cryptocurrency. Blockchains +are generally open-source, peer-to-peer software programs that act as decentralized digital ledgers, each comprising a series of data +“blocks” that are linked and secured using cryptography in a “chain.” The blockchain program consists of a software +protocol with several functions. The software protocol is run by multiple computer systems or “nodes.” For many blockchain +networks, each node has its own copy of the blockchain ledger, which contains a historical record of every transaction. The digital ledger +continuously grows as new blocks are added to it to record the most recent transactions in a linear, chronological order. The same information +is stored across a network of computers all over the world, and this record makes it possible to track the ownership and transfer of cryptocurrency +from the creation of the blockchain to its current state, and effectively, records of all account balances (as you can identify what account +holds what value through the decentralized ledger). +The blockchain protocol allows +users to submit transactions to the network for confirmation. However, a transaction will not be accepted by the protocol if the inputs +to the transaction have previously been used in another transaction. This prevention of “double spending” is a key security +feature of blockchain networks. +Another key function of the +blockchain that protects the integrity of the network is the hashing process, which acts as a tamper-evident seal that confirms the validity +of the new block and all earlier blocks. Hashing is the process of a block being posted to the network. Hashing results from miners, who +are responsible for receiving broadcast transactions, processing those transactions into new blocks and updating the blockchain with the +new blocks through hashing. The hashing process ties every new block to the existing block on the blockchain to ensure each is a continuous +record of verified transactions. +The hashing algorithm on +a proof-of-work blockchain network is a mathematical transformation function with two key properties. The first important function of +hashing is that the algorithm accepts any alphanumeric dataset as an input and produces a unique output code. The smallest change in the +dataset results in a significant change in the unique code. Any tampering of the dataset can be detected by re-hashing the data and checking +for a change in the unique code. Any user that runs the hash algorithm on the same data will derive the same unique code. Consequently, +the data on the distributed ledger can be run through a series of hash algorithms to create a unique code, which would reveal if any changes +to the ledger have been made. +Second, whenever a new set +or “block” of transactions is added to the ledger, it is appended with the code from the prior state of the ledger before +it is hashed. Thus, the hash created from the new block will incorporate the hash from the previous block. An alteration made to an earlier +block would make the hashes of all subsequent blocks invalid, as the discrepancy would be easily detected by future miners through the +protocols governing the blockchain. If a hacker were to attempt to make a change to an earlier block and broadcast it along with following +blocks to the other nodes on the network, that broadcast would be discarded in favor of one from a different node which complied with +the requirements of the protocol. +16 +Thus, in addition to creating +new block, miners “vote” with their computer power, expressing their acceptance of valid blocks by working on adding them +to the blockchain, and rejecting invalid blocks by refusing to work on them. If a miner’s proposed block is added to the blockchain +by a majority of the nodes on the network, it is considered part of the blockchain. The nodes on the network synchronize with each other +to ensure that once a block is accepted by the majority, the new block will eventually be added to all the nodes. Thus the historical +state of the ledger can be changed if control of more than 50% of the network is obtained; however, in the case of widely held cryptocurrencies +with non-trivial valuations, it may be economically prohibitive for any actor or group of actors acting in concert to obtain computing +power that consists of more than 50% of the network. +Unlike proof-of-work networks, +in which miners expend computational resources to compete to validate transactions and are rewarded cryptocurrency in proportion to the +amount of computational resources expended, in a proof-of-stake network, miners (sometimes called validators) risk or “stake” +assets to compete to be randomly selected to validate transactions and are rewarded cryptocurrency in proportion to the amount of assets +staked. Any malicious activity, such as mining multiple blocks, disagreeing with the eventual consensus or otherwise violating protocol +rules, results in the forfeiture or “slashing” of a portion of the staked assets. Proof-of-stake is viewed by some as more +energy efficient and scalable than proof-of-work. +Blockchain technology enables +the secure use and transfer of digital assets. “Digital asset” is a broad term that encompasses additional applications, including +ownership, transaction tracking, identity management, and smart contracts. A digital asset can represent physical or virtual assets, a +value, or a use right/service (e.g., computer storage space). +Whereas digital assets can +take many forms and be used for a variety of functions, cryptocurrencies are a type of digital asset that primarily function as a medium +of exchange, a unit of account, and/or a store of value. Cryptocurrencies allow anyone who holds a compatible wallet, anywhere in the +world, to hold and transfer that cryptocurrency without the need for an intermediary or trusted third party. Units of a cryptocurrency +may exist only as data on the internet, and often are not issued or controlled by any single institution, authority or government. Whereas +most of the world’s money currently exists in the form of electronic records managed by central authorities such as banks, units +of a non-government cryptocurrency exist as electronic records in a decentralized blockchain database. Because cryptocurrencies have no +inherent intrinsic value, the value of cryptocurrencies is determined by the value that various market participants place on them through +their transactions. Bitcoin, Ethereum and other cryptocurrencies have historically exhibited high price volatility relative to more traditional +asset classes. +Private entities also issue +digital assets called “stablecoins” that are designed to represent an underlying fiat currency or other physical asset and +therefore less susceptible to volatility. Stablecoins can be backed by fiat money, physical assets, or other crypto assets. Government +institutions are also reportedly testing and considering issuing Central Bank Digital Currencies (“CBDC’s”). While stablecoins +or CBDC’s may exhibit less price volatility than other cryptocurrencies, both rely on a central authority to establish the value +of the asset, and therefore represent an exception to the general discussion of the design of cryptocurrencies herein. +Each cryptocurrency has a +source code that comprises the basis for the cryptographic and algorithmic protocols, which govern the blockchain. The source code is +commonly open source and therefore can be inspected by anyone, and is maintained on an ongoing basis through contributors proposing amendments +to the protocol, which are peer reviewed and adopted by consensus among participants on the blockchain network. These protocols govern +the functioning of the network, including the ownership and transfer of the cryptocurrency, and are executed on the decentralized peer-to-peer +blockchain infrastructure. The peer-to-peer infrastructure on which a blockchain operates is not owned or operated by a single entity. +Instead, the infrastructure is collectively maintained by a decentralized user base. Each peer user is generally known as a “node” +or “miner,” and each miner processes transactions on the network in accordance with the protocols of the relevant cryptocurrency. +As a result, these cryptocurrencies +do not rely on either governmental authorities or financial institutions to create, transmit or determine the value of units of cryptocurrency. +Rather: +● the creation of units of cryptocurrency generally is governed by the source code, not a central entity; +● the transmission of a cryptocurrency is governed by the source code and processed by the decentralized +peer-to-peer network of nodes or miners; and +● the value of a cryptocurrency is generally determined by the market supply of and demand for the cryptocurrency, +with prices set in transfers by mutual agreement or barter, as well as through acceptance directly by merchants in exchange for goods +and services. +17 +Cryptocurrencies may be open +source projects with no official developer or group of developers that control the network. However, certain networks’ development +may be overseen informally by a core group of developers that may propose quasi-official releases of updates and other changes to the +network’s source code. The release of updates to a blockchain network’s source code does not guarantee that the updates will +be automatically adopted. Users and miners must accept any changes made to the source code by downloading the proposed modification of +the network’s source code. A modification of the network’s source code is effective only with respect to the users and miners +that download it. If a modification is accepted by only a percentage of users and miners, a division in the network will occur such +that one network will run the pre-modification source code and the other network will run the modified source code. Such a division is +known as a “fork.” Consequently, a modification to the source code becomes part of a blockchain network only if accepted by +participants collectively having most of the processing power on the network. +Each “account” +on a blockchain network is identified by its unique public key, and is secured with its associated private key (which the account holder +must keep secret, like a password). Cryptocurrencies are treated as bearer assets, because possession of the private key generally determines +who controls or owns a cryptocurrency. Protecting private keys from unwarranted access and theft is critically important, as once the +private key is taken, in most circumstances, control over the related cryptocurrency is gone. The combination of private and public cryptographic +keys constitutes a secure digital identity in the form of a digital signature. As long as the private key is kept private (i.e., confidential +to the owner of the account) it provides strong control of ownership. +Ault Alliance +We +acquire controlling or non-controlling interests in and actively manage businesses that we generally believe (i) are undervalued and have +disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, (iii) have +positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, and (v) have strong +management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading middle-market businesses +in the niche-industrial and branded-consumer sectors. +We +use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an investment, we often +become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing +the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. +We +believe that private company operators and corporate parents looking to sell their business units may consider us an attractive purchaser +because of our ability to: +● provide ongoing strategic and financial support for their businesses, including professionalization of +our subsidiaries at scale; +● maintain a long-term outlook as to the ownership of those businesses; +● sustainably invest in growth capital and/or add-on acquisitions where appropriate; and +● consummate transactions efficiently without being dependent on third-party transaction financing. +In +particular, we believe that our outlook on length of ownership and active management on our part may alleviate the concern that many private +company operators and parent companies may have with regard to their businesses going through multiple sale processes in a short period +of time. We believe this outlook enhances our ability to develop a comprehensive strategy to grow the earnings and cash flows of each +of our businesses. +Finally, +it has been our experience that our ability to acquire businesses without the cumbersome delays and conditions typical of third party +transactional financing is appealing to sellers of businesses who are interested in confidentiality, speed and certainty to close. +18 +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2021, we believe that these businesses have strong +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Our Subsidiaries +The following is a brief +summary of the businesses in which Ault Alliance owns a controlling interest at December 31, 2021: +DP Lending +DP Lending provides funding +to businesses through loans and investments. DP Lending offers a variety of loan types including commercial loans, convertible notes and +revolving lines of credit. DP Lending is engaged in providing commercial loans to companies throughout the U.S. to provide them with operating +capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to twelve months, but may be of +longer duration. These terms are subject to change as market needs dictate, and DP Lending anticipates offering additional products in +the future. +DP Lending uses its considerable +financial experience, data analytics, and a credit scoring model to assess the creditworthiness of each small business borrower applicant. +If the business meets DP Lending’s criteria, DP Lending sets the initial interest rate according to its credit and financial models. +The final interest rate offered to the borrower will be determined by DP Lending’s interpretation of the marketplace. In order to +borrow from DP Lending, borrowers must display characteristics indicative of durable business and financial situations. These include +factors such as revenue, time in business, number of employees, and financial and credit variables. In order to qualify, business borrower +applicants must be approved through DP Lending’s underwriting process, which analyzes credit and financial data of both the business +and the business owner. DP Lending takes into account several business factors (including revenue, age of business, cash flows, and other +variables). The underwriting process determines the loan amount to approve, how loans will be priced, and whether to include a blanket +lien is based on the above analysis, as well as additional factors (including length of loan, estimated default rates by type and grade, +and general economic environment). +Our Executive Committee, which +is comprised of our Executive Chairman, Chief Executive Officer and President, acts as the underwriting committee for DP Lending and approves +all lending transactions. The Executive Committee has decades of experience in financial, investing and securities transactions. Under +its business model, DP Lending generates revenue through origination fees charged to borrowers and interest generated from each loan. +DP Lending may also generate income from appreciation of investments in marketable securities as well as any shares of common stock underlying +convertible notes or warrants issued to DP Lending in any particular financing. +As noted above, we will from +time to time, through DP Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2022, we anticipate +providing significant new funding to expand DP Lending’s loan and investment portfolio. DP Lending loans made or arranged pursuant +to a California Financing Law license (Lic.no. 60 DBO77905). +19 +Ault Alpha +DP Lending is the principal +owner of Ault Alpha, a term we use that comprises an investment fund, a general partner and an investment manager all formed on July 15, +2021. Ault Alpha generally seeks to invest in public companies or private companies with public debt that have strong relative value metrics +but poor Wall Street recognition; such companies can often experience valuation inefficiencies. Ault Alpha seeks to identify and invest +in these undervalued companies. In certain companies, Ault Alpha will actively intervene to assist management to maximize stockholder +value. Ault Alpha believes that an activist role can result in the creation of significant value and larger than average returns on investment. +Ault Alpha will own a concentrated portfolio, and typically invest with a long-term perspective. Further, Ault Alpha will employ a systematic +process, developed over decades of collective experience in the capital and credit markets, to seek specific value-creating events and/or +special situations, to provide compelling return potential and generate competitive capital appreciation and total return by making investments +in three key categories: (i) undervalued or overvalued assets; (ii) activist trading; and (iii) volatility trading and arbitrage. Ault +Alpha has purchased the Company’s common stock in open-market transactions. +AGREE +AGREE seeks to invest in various +classes of commercial and residential real estate including hospitality, multifamily, and industrial properties targeting the middle market +segment in locations demonstrating relative value. AGREE’s objective is to generate risk adjusted returns through development, capital +investment and operational improvement, leveraging the management team’s expertise and well-established relationships with real +estate investment professionals, brokers, lenders and developers. The focus will be in U.S. tertiary markets with growing populations, +income growth and access to highly populated metropolitan areas as primary demand drivers. AGREE is one of BitNile’s strategies +to invest in inflation-resistant undervalued assets and realize capital appreciation through cap rate compression over time. AGREE owns +and operates both Third Avenue Apartments and AGREE Madison. +Ault Media Group +Ault +Media Group (“AMG”) is comprised of a diverse team of media professionals with expertise in creating all forms of media, communications, +and content including web development, corporate communications, social media, scripted, and unscripted television. Our online virtual +training courses (via the LightSpeedVT platform) also offer in-depth business learning. AMG’s specialized team of producers brings +years of university-proven training methods and a history of developing educational materials up to a Master's degree level. AMG’s +first course, relating to initial public offerings, is currently in the final stages of production, with more courses soon to follow. +Along +with training and communications strategies, AMG also offers comprehensive consulting for the development and execution of large and small +scale conferences and event planning. From event space acquisition to digital ticketing, keynote speakers, lighting, stage crews, and +advertising media buys, AMG will provide the necessary contacts and guidance to assure a successful and smooth-running event. +Our +Strategy +Our business strategy is designed +to increase shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +shareholder value, such as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell +some or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock +or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly +traded partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +20 +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase cash flows +and stockholder value. Ault Alliance actively oversees and supports the management teams of each of our businesses by, among other things: +● recruiting and retaining talented managers to operate our businesses using structured incentive compensation +programs, including non-controlling equity ownership, tailored to each business; +● regularly monitoring financial and operational performance, instilling consistent financial discipline, +and supporting management in the development and implementation of information systems to effectively achieve these goals; +● identifying and aligning with external policy and performance tailwinds such as those influenced by growing +climate, health, and social justice concerns (and similar environmental, social and governance (“ESG”) drivers); +● assisting management in their analysis and pursuit of prudent organic growth strategies; +● identifying and working with management to execute attractive external growth and acquisition opportunities; +● assisting management in controlling and right-sizing overhead costs; +● nurturing an internal culture of transparency, alignment, accountability and governance, including regular +reporting; +● professionalizing our subsidiaries at scale; and +● forming strong subsidiary level boards of directors to supplement management in their development and +implementation of strategic goals and objectives. +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Ault Alliance to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +● making selective capital investments to expand geographic reach, increase capacity, or reduce manufacturing +costs of our businesses; +● investing in product research and development for new products, processes or services for customers; +● improving and expanding existing sales and marketing programs; +● pursuing reductions in operating costs through improved operational efficiency or outsourcing of certain +processes and products; and +● consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +● leverage manufacturing and distribution operations; +● leverage branding and marketing programs, as well as customer relationships; +● add experienced management or management expertise; +● increase market share and penetrate new markets; and +● realize cost synergies by allocating the corporate overhead expenses of our businesses across a larger +number of businesses and by implementing and coordinating improved management practices. +Acquisition Strategy +Our +acquisition strategy is to acquire businesses that we believe to be to undervalued and have disruptive technologies with a global impact +that we expect to produce stable and growing earnings and cash flow. In this respect, we expect to make acquisitions in industries other +than those in which our businesses currently operate if we believe an acquisition presents an attractive opportunity. We believe that +attractive opportunities will continue to present themselves, as private sector owners seek to monetize their interests in long-standing +and privately-held businesses and large corporate parents seek to dispose of their “non-core” operations. +21 +Our +ideal acquisition candidate has the following characteristics: +● is a leading branded consumer or niche industrial company headquartered in North America; +● maintains highly defensible position in the markets it serves and with customers; +● operates in an industry with favorable long-term macroeconomic trends; +● has a strong management team, either currently in place or previously identified, and meaningful incentives; +● has low technological and/or product obsolescence risk; and +● maintains a diversified customer and supplier base. +We +benefit from Ault Alliance’s ability to identify potential diverse acquisition opportunities in a variety of industries. In addition, +we rely upon our Executive Committee and other members of our management team’s experience and expertise in researching and valuing +prospective target businesses, as well as negotiating the ultimate acquisition of such target businesses. In particular, because there +may be a lack of information available about these target businesses, which may make it more difficult to understand or appropriately +value such target businesses, Ault Alliance: +● engages in a substantial level of internal and third-party due diligence; +● critically evaluates the target management team; +● identifies and assesses any financial and operational strengths and weaknesses of the target business; +● analyzes comparable businesses to assess financial and operational performances relative to industry competitors; +● actively researches and evaluates information on the relevant industry; and +● thoroughly negotiates appropriate terms and conditions of any acquisition. +The +process of acquiring new businesses is both time-consuming and complex. Our management team historically has taken from two to +six months to perform due diligence, negotiate and close acquisitions. Although our management team is at various stages of evaluating +several transactions at any given time, there may be periods of time during which our management team does not recommend any new acquisitions. +Even if an acquisition is recommended by our management team, our Board may not approve it. +A +component of our acquisition financing strategy that we utilize in acquiring the businesses we own and manage is to provide both equity +capital and debt capital. We believe, and it has been our experience, that having the ability to finance our acquisitions with capital +resources raised by us, rather than negotiating separate third-party financing, provides us with an advantage in successfully acquiring +attractive businesses by minimizing delay and closing conditions that are often related to acquisition-specific financings. In addition, +our strategy of providing this intercompany debt financing within the capital structure of the businesses we acquire and manage allows +us the ability to distribute cash to the parent company through monthly interest payments and amortization of principle on these intercompany +loans. +Upon +acquisition of a new business, we rely on our management team’s experience and expertise to work efficiently and effectively with +the management of the new business to jointly develop and execute a successful business plan. +Strategic Advantages +Based +on the experience of our management team and its ability to identify and negotiate acquisitions, we believe we are well-positioned to +acquire additional businesses. Our management team has strong relationships with business brokers, investment and commercial bankers, +accountants, attorneys and other potential sources of acquisition opportunities. In addition, our management team has a successful track +record of acquiring and managing businesses in various industries. In negotiating these acquisitions, we believe our management team has +been able to successfully navigate complex situations surrounding acquisitions, including corporate spin-offs, transitions of family-owned +businesses, management buy-outs and reorganizations. +Our +management team has a large ne twork of deal interme diaries whom we expect to expose us to +potential acquisitions. Through this network, as well as our management team’s proprietary transaction sourcing efforts, we have +a substantial pipeline of potential acquisition targets. Our management team also has a well-established network of contacts, including +professional managers, attorneys, accountants and other third-party consultants and advisors, who may be available to assist us in the +performance of due diligence and the negotiation of acquisitions, as well as the management and operation of our acquired businesses. +22 +Valuation and Due Diligence +When +evaluating businesses or assets for acquisition, our management team performs rigorous due diligence and a financial evaluations process +including an evaluation of the operations of the target business and the outlook for its industry. While valuation of a business is a +subjective process, we define valuations under a variety of analyses, including: +● discounted cash flow analyses; +● evaluation of trading values of comparable companies; +● expected value matrices; and +● examination of comparable recent transactions. +One +outcome of this process is a projection of the expected cash flows from the target business. A further outcome is an understanding of +the types and levels of risk associated with those projections. While future performance and projections are always uncertain, we believe +that with detailed due diligence, future cash flows will be better estimated and the prospects for operating the business in the future +better evaluated. To assist us in identifying material risks and validating key assumptions in our financial and operational analysis, +in addition to our own analysis, we engage, as necessary, third-party experts to review key risk areas, including legal, tax, regulatory, +accounting, insurance and environmental. We also engage technical, operational or industry consultants, as necessary. +A +further critical component of the evaluation of potential target businesses is the assessment of the capability of the existing management +team, including recent performance, expertise, experience, culture and incentives to perform. Where necessary, and consistent with our +management strategy, we actively seek to augment, supplement or replace existing members of management who we believe are not likely to +execute our business plan for the target business. Similarly, we analyze and evaluate the financial and operational information systems +of target businesses and, where necessary, we enhance and improve those existing systems that are deemed to be inadequate or insufficient +to support our business plan for the target business. +Financing +We +incur third party debt financing almost entirely at the parent company level, which we use, in combination with our equity capital, to +provide debt financing to each of our businesses and to acquire additional businesses. We believe this financing structure is beneficial +to the financial and operational activities of each of our businesses by aligning our interests as both equity holders of, and lenders +to, our businesses, in a manner that we believe is more efficient than each of our businesses borrowing from third-party lenders. +Ault Disruptive Technologies Corporation +Ault Disruptive Technologies +Corporation, a Delaware corporation (“ADTC”), is a recently-organized special purpose acquisition company, or SPAC, incorporated +in February 2021 whose business purpose is to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization +or similar business combination with one or more businesses, which ADTC refers to as its initial business combination. To date, ADTC’s +efforts have been limited to organizational activities, activities related to its initial public offering and preliminary discussions +with certain parties that could become ACTC’s target company. ADTC has not selected any specific business combination target and +it has not, nor has anyone on its behalf, engaged in any substantive discussions, directly or indirectly, with any business combination +target with respect to an initial business combination with ADTC. +While ADTC may pursue an initial +business combination opportunity in any business, industry, sector or geographical location, ADTC intends to focus on opportunities to +acquire companies with innovative and emerging technologies, products or services that have the potential to transform major industries +and radically impact society. ADTC intends to acquire a target business or businesses with disruptive technologies that our management +team believes can achieve mainstream adoption and create opportunities for long-term appreciation in value. ADTC’s sponsor, Ault +Disruptive Technologies Company, LLC, is a wholly owned subsidiary of BitNile. +IMHC +On March 20, 2022, we, TOGI +and IMHC entered into the Acquisition Agreement whereby TOGI will, upon closing, become a subsidiary of IMHC (the “Acquisition”). +Upon completion of the Acquisition, +which is contingent upon the completion of an audit of TOGI and each party’s satisfaction or waiver of certain customary closing +conditions set forth in the Acquisition Agreement, IMHC will change its name to TurnOnGreen and, through an upstream merger whereby the +current TOGI shall cease to exist, have two operating subsidiaries, TOG Technologies and Digital Power. Promptly following the closing +of the Acquisition, IMHC will dissolve its three dormant subsidiaries. Subsequent to the Acquisition, we will assist TurnOnGreen in pursuing +an uplisting to the Nasdaq Capital Market, subject to Nasdaq’s seasoning rules and other criteria for listing. +23 +We anticipate that our stockholders +will in due course receive a dividend of securities of TOGI. We expect to distribute to our stockholders approximately 140 million common +shares of IMHC we own and an equal number of warrants to purchase such shares of IMHC at the time of the record date to be set therefor, +subject to regulatory approval and compliance with U.S. federal securities laws. +TOGI +TOGI, through Digital Power +and TOG Technologies, is engaged in the design, development, manufacture and sale of highly engineered, feature-rich, high-grade power +conversion and power system solutions for mission-critical applications and processes. For more than 50 years, Digital Power has been +devoted to the perfection of our power solution products that have enabled customer innovation in complex product applications covering +a wide range of industries. A natural outgrowth of our development of these power systems has been our effort to apply our proprietary +core power technologies to optimizing the design and performance of electric vehicle (“EV”) charging solutions. We introduced +our product line of residential and commercial high-speed EV charging solutions in late 2021. We believe that our EV charging solutions +represent an entire new generation of new chargers due to dramatic improvements in electronic circuitry size reduction, power conversion +efficiency, modular topology, and output density. We believe that our feature-rich EV chargers address the specific needs of multifamily +unit home dwellers and single family homeowners by providing adjustable electric current options, restricted user access, LCD touch screen +for simple point of operation use, Bluetooth connectivity and programmable RFID card features. By leveraging our experience and expertise +in power conversion and generation, we believe we can rapidly become a meaningful participant in the high growth EV charging solution +market. +At Digital Power, we currently +provide a comprehensive range of integrated power system solutions that are designed to meet the diverse and precise needs of our customers +with the highest levels of efficiency, flexibility , and scalability. We design, develop, and manufacture +custom-made power systems incorporating our products to meet performance and/or form factor requirements that cannot be met with standard +products. These power system solutions are designed to function reliably in harsh environments for defense and aerospace applications +and are capable of being utilized under other environmental conditions in specialized product applications ranging from industrial equipment +to medical instrumentation. Our products are highly adaptive and feature soft configurations to meet the requirements of both our customers +and OEMs. These products include our Open-Frame series of products, which are the industry’s smallest open frame AC/DC switchers, +high-performance AC/DC desktop adaptor power supplies and a full range of compact AC or DC power supplies. We have been advised by our +customers that our power supply products have achieved general recognition as quality products. +We recently formed TOG Technologies, +following more than two years of engineering design and product prototypes, to provide EV drivers of all types with easy access to convenient, +reliable, and high-speed EV charging. We offer a Level 2 AC charging infrastructure for use at home, work and at play, and a Level 3 DC +Fast charger infrastructure for high traffic, high density urban, suburban, and exurban locations. Our EV charging solutions are designed +to address the expected rapid expansion of infrastructure required to support broad adoption of EVs globally. Our innovative +charging solutions produce a full charge for an EV with a 150-mile range battery in approximately 30 minutes. We provide a wide +range of EV charging solutions, including a Level 2 AC charging product line compatible with the SAE J1772 +standard, and a Level 3 DC Fast charging product line compatible with the Combined Charging System and CHArge de MOve industry +standards. +Our charging network is capable +of natively charging all EV models and supports all charging standards currently available in the U.S., including Tesla models, with SAE +J1772 adapters typically included with the purchase or with third-party adapters that may be purchased separately. This network can serve +a wide variety of private, retail and commercial customers. Our charging systems have been tested and certified by nationally recognized +testing laboratories including Underwriters Laboratories, Intertek and TÜV Rheinland for operating safety according to the highest +standards in the market coordinated by the American National Standards Institute, an independent organization. We anticipate rapid growth +in the number of EVs in North America, in part in response to consumer demand for vehicles with greater fuel efficiency and lower environmental +emissions. We intend to expand our network of charging stations to accommodate this growth while prioritizing development of locations +with favorable traffic and utilization characteristics. +We are currently in the process +of installing our DC Fast chargers at multiple Tim Hortons locations (North America’s fourth largest publicly traded quick service +restaurant chain) in Canada pursuant to a pilot program agreement with Okanogan TH Holdings Ltd., a licensed franchisee of that chain. +During the pilot period, EV charging net revenues are split between us and the franchisee. The agreement will allow TOGI to retain 100% +of the gross revenue until our capital expenditures are fully recovered and subsequently we will share 50% of the net revenue with the +franchisee. We will own and operate the electric vehicle supply equipment (“EVSE”) at +select locations and be responsible for the costs associated with designing, manufacturing, installing and maintaining the EV chargers. +24 +Our “go to market” +strategy is to be supplier of choice across numerous specialized markets that require high-quality power system solutions where custom +design, product quality, responsiveness and reliability are critical to business success. We believe that we provide advanced custom product +design services to deliver high-grade products that reach a high level of efficiency and density and can meet rigorous environmental requirements. +We believe this integrated approach, which many of our competitors do not provide, allows our customers to obtain all their needs for +designing and manufacturing power solutions and products from a single source, enabling us to establish an ongoing relationship with our +customers to provide for their future requirements. By implementing our proprietary core technology, including process implementation +in integrated circuits, we can provide cost reductions to our customers by replacing their existing power sources with our custom-designed +and engineered products. +Looking ahead, our mission +is to maintain our core power electronics business and existing relationships while leveraging the experience and expertise we have gained +in the development of power system solutions to introduce EV charging solutions. By offering EV charging solutions, as well as a convenient, +reliable and affordable EV charging e-mobility network through TOG Technologies, we intend to drive sustainable, mission-driven growth +related to powering environmentally beneficial EVs while continuing to be recognized as a trusted provider of advanced power supply technology. +Our Growth Strategies +Our power products and charging +solutions are sold in the form of hardware, extended warranty purchases, recurring network subscriptions, operations and maintenance plans, +and other related services. We will continue to optimize our operating model, combining high quality power and charging hardware and related +services with appealing business models for our customers. We believe that this approach creates significant customer network effects +and provides the potential for recurring revenues. Key elements of our growth strategies include: +Ø Continue to Innovate and Enhance Our EV +Products . While maintaining our core power electronics business in existing product markets, we intend to support the growth of +the company by introducing advanced, new power technologies with respect to our eMobility network and EV charging infrastructures. Specifically, +we intend to take advantage of a significant increase in eMobility market opportunities that we expect to see over the next five to ten +years for our non-networked and networked Level 2 AC chargers and our high-power Level 3 DC Fast charging solutions. Subject to obtaining +sufficient capital, we intend to invest in EV charging station components for use in connection with installations of charging solutions +at customer sites. We will expand our eMobility charging services through our TurnOnGreen Served (“TOGS”) Software Platform +as a Service (“SPaaS”) for commercial and fleet customers and continue to design and develop innovative products and services +leveraging our knowledge of power electronics technology and advanced charging network management. +Ø Develop Our Strategic Channel Partnership +Network . To achieve our goals, particularly with respect to the rapid deployment of our EV charging products, we will evaluate +and enter strategic channel partnerships and independent distribution arrangements that facilitate our ability to bring solutions to a +wider network of EV drivers than we would be able to reach on our own. For example, we are an approved vendor for Consolidated Electrical +Distributors, Inc. (“CED”), a large privately owned electrical distribution company with locations throughout the U.S. We +are currently supplying our EV charging equipment to CED centers on the West coast and in several southern states. +Ø Expand Within Existing Customers . +We are focused on maintaining our customer retention model, which encourages existing customers to increase their utilization of our power +products and establishing an ongoing relationship to provide for their future requirements. We expect additional growth to result from +the breadth of ecosystem integrations that are enabled through our TOGS SPaaS charging services. This eMobility network would integrate +platforms such as in-vehicle infotainment systems, consumer mobile applications, payment systems, mapping tools, home automation assistants, +fleet fuel cards and residential utility programs. +Ø Make Opportunistic Investments in Marketing . +We intend to continue to aggressively market and sell our core power products through our existing domestic and international markets, +with an emphasis on the North American market. We also intend to generate revenues by our eMobility charging services through various +strategic channel partnerships and business models to reach new customers, in each case coordinated through our dedicated sales groups. +Ø Pursue Strategic Business Acquisitions +for Growth . Through selective acquisitions of, or investments in, complementary businesses, products, services and technologies +in the power electronics, EV charging solutions and other electronics-driven industries, we aim to broaden our existing product and technology +base, build on our long-standing industry relationships and enhance our ability to penetrate new markets. We are experienced at evaluating +prospective operations to increase efficiencies and capitalize on market and technological synergies. We currently have no commitments +or agreements with respect to any such acquisitions or investments. +25 +Our Power System Markets and Customers +Our power systems sell as +integrated solutions to diverse customers to address a wide range of product applications in the specialized markets we serve, including +medical and healthcare, defense and aerospace, and industrial and telecommunications. We also sell our products as stand-alone products +to our commercial customers, which are frequently custom made to specifications. Our current commercial customer base consists of approximately +220 companies, which are served through our direct sales team and our strategic channel partnerships. Successful marketing of our products +is dependent on the maintenance of strong relationships in the following key markets. +Medical and Healthcare . +Our power solutions are ideal for healthcare and medical applications that require a high level of reliability and performance due to +their quality, output power and high-power density. Our power supplies meet the rigorous medical safety requirements and major industrial +safety standards related to such products to major industrial safety standards, including the EN60601-1-2 4.1 series of technical standards +for medical equipment and the EMC compliance requirements, and facilitate medical device and system manufacturers’ compliance testing +of their own products. Our third-party qualification testing facilities are also approved by various safety agencies to test and qualify +power products to be used in medical devices. We have obtained the medical quality management systems ISO 13485 certification to support +rigorous design requirements and high-quality manufacturing of our medical power systems. Our medical power products help OEMs minimize +the risk of encountering unexpected development problems outside of their own areas of expertise. Representative applications that utilize +or incorporate our power products in the medical and healthcare industry include portable oxygen concentrators, patient monitoring systems, +pulsed lasers drivers for dental and surgical treatment, DNA sequencers, medical beds and ultrasounds. +Defense and Aerospace . +We offer a broad range of rugged power solutions for the defense and aerospace market. These solutions feature the ability to withstand +harsh environments. For more than 50 years, we provided rugged commercial off the shelf (“COTS”) products and custom power +solutions designed for end-to-end military and aerospace applications. We offer a wide variety of units designed to comply with the most +demanding MIL-STDs. Our military products meet all relevant military standards in accordance with the Defense Standardization Program +Policies and Procedures. This includes specifications related to space, weight, output power, electromagnetic compatibility, power density +and multiple output requirements, all of which we meet due to the decades of experience held by our engineering team. Certain of our products +that are specifically designed, modified, configured or adapted for military systems are subject to the U.S. International Traffic in +Arms Regulations (“ITAR”), which are administered by the U.S. Department of State. We obtain required export licenses for +any exports subject to ITAR. Our third-party defense manufacturing facilities are compliant with the AS9100 international Quality Management +System standard for the aviation, space and defense industry. Representative applications that utilize or incorporate our power products +in the defense and aerospace industry include mobile and ground communications, naval power conversion, automated test and simulation +equipment for weapon systems, combat and airborne power supplies, radar arrays power source, tactical gyro position and navigation systems +and active protection of tactical vehicles. +Industrial and Telecommunications. +We build products for custom and standard applications used in industrial and telecommunication markets to the highest standards in flexibility, +efficiency, and reliability. Our compact, high-density, and flexible power supplies and power converters are designed for optimal performance, +functionality , and reduced cost. Due to the breadth of our experience, our products have proven to meet +stringent design requirements. Our industrial power solutions are designed to stand up to the extreme temperatures, input surges, vibration +and shock found through uses such as industrial automation, material handling, industrial lasers, robotics, agriculture, oil and gas, +mining, and outdoor applications. Our proprietary technology is designed for thermal management, reliability, electromagnetic interference +(“EMI”) and EMC specifications and power density, with rugged performance that is typically unavailable in standard supplies +from our competitors. Representative applications that utilize or incorporate our power products in the industrial and telecommunications +industry include packaging equipment, laboratory and diagnostic equipment, industrial laser drivers, datacenter computing and turbomachinery +control solutions. +The EV Charging Industry and Our Revenue Models +The market for battery electric +vehicles (“BEVs”) and plug-in hybrid electric vehicles (“PHEVs”) has experienced substantial growth in the past +five years, and we believe that growth will increase significantly over the next five years. As the economic and environmental costs of +fossil fuel burning automobiles increases each year, consumer demand for vehicles with greater fuel efficiency, greater performance and +with lower or no environmental emissions has also increased. With a variety of federal, state and municipal incentive +programs for both EV drivers and EV supply equipment infrastructure construction, we anticipate a significant increase in the demand for +BEV and PHEV charging solutions at home, work and in public settings. +26 +The market +for sustained growth of the EV charging industry is substantial and continuing worldwide. Multiple states and municipalities have set +ambitious zero emission vehicle goals for the next ten years. In order to meet these goals, mandates for EV sales have been established +by states like California, New York, Oregon and Washington. At the same time, oil and gas prices continue to rise and EV battery +technology continues to improve and become more affordable. The average consumer cost to acquire an EV declined 13.5% from 2018 to 2019, +according to general industry statistics, and continues to fall as more automobile manufacturers introduce new EV models to the market +each year. +According +to the Electric Drive Transportation Association, sales of plug-in vehicles since introduction to the market in 2010 is over 500,000 vehicles +and, according to a third-party research firm, sales are expected to grow by a factor of 12 to over 4,000,000 vehicles in 2025. +The cost to maintain an EV is half of what it costs to maintain an internal combustion engine (“ICE”) automobile, according +to third party research, and the cost to add 200 miles of range to an ICE car is roughly twice the cost of its all-electric counterpart. +The final +barrier to widespread BEV and PHEV adoption is the current status of the EV charging infrastructure. We believe that the demand for EV +charging is increasing each day. Utility companies are upgrading their grid infrastructure in preparation for the increased +demand. We expect the demand from businesses, municipalities and individuals to outpace supply over the next five years, creating +a highly favorable environment for EVSE companies. +We believe that providing +energy efficiency in all our power supply and EV charging products leads to long term environmental benefits for society. Increasing consumer +demand for EVs provides an opportunity for our charging infrastructure and solutions to be used for powering vehicles with little to no +tailpipe emissions or other pollutants. With a shared mission to do our part to fight climate change, we strive to bring to established +and emerging markets innovative electronics-driven solutions that provide value for our company and stockholders. +EV Charging Revenue Models +We +intend to generate revenues with TOG Technologies primarily through the sale of networked charging hardware, combined with cloud-based +services that provide end users the ability to locate and transact with EV chargers, and provide site host customers with the ability +to operate and manage their chargers (the “TOG Network” or “TOG Network Services”). TOG Network Services, and +an optional extended warranty, are billed as an annual subscription, and access to the network is available through each of our commercial +charging ports. We expect that the revenue contribution for recurring TOG Network or extended warranty sales will equal the revenue contribution +from one-time EV1100 charger sales for commercial use after approximately seven years. TOG Technologies also offers a hardware portfolio +powered by software, which cannot be accessed without a TOG Network subscription. +EV Charging Unit Sales . +We recognize revenues through the sale of our charging solutions in the form of hardware sales and extended warranty purchases. We intend +to employ various business models with customers for our EV charging unit sales based on which party bears the costs of installation, +equipment and maintenance, and the relative percentages of the continuing, long-term revenue-sharing arrangement. +EV Charging Network Services . +We intend to provide EV charging network services, including management of user authentication, billing and payments, and power management +(also called load balancing). These services will be made available through a recurring subscription business model or through a revenue +sharing arrangement that enables us to retain a percentage of the revenue generated from EV charging. +OEM Charging and Related +Services. Through discussions with OEM partners, we are pioneering innovative revenue models to meet a wide variety of OEM objectives +related to the availability of charging infrastructure and provisioning charging services for EV drivers. We are contracting directly +with OEMs to provide charging services to drivers who have purchased or leased EVs from such OEMs and who access our public charger network. +Retail Charging. We +intend to sell electricity directly to EV drivers who access our publicly available networked chargers. We offer various pricing plans +for customers. Drivers have the choice of charging either as members (with monthly fees and reduced per-minute pricing) through a subscription +service, or on a per-use basis as non-members. Drivers locate chargers through our mobile application, their vehicle’s in-dash navigation +system, or third-party databases that license charger location information from us. We aim to install our chargers in parking spaces owned +or leased by commercial or public entity site hosts that desire to provide our charging services at their locations. Commercial suite +hosts include retail centers, offices, medical complexes, airports and convenience stores. We offer charging hosts a range of revenue-sharing +arrangements. +27 +Commercial Charging. +High volume fleet customers, such as delivery services, can access our charging infrastructure through our public network. Pricing for +charging services is to be negotiated directly between us and the fleet owner based on business needs and usage patterns of the fleet, +and we will typically contract with and bill the fleet owner directly rather than the individual fleet drivers who utilize our chargers. +Access to our public network enables fleet and rideshare operators to support mass adoption of transportation electrification and achieve +sustainability goals while avoiding direct capital investments in charging infrastructure or the incurrence of operating costs associated +with charging equipment. +Our Competitive Strengths +We offer highly engineered, +feature-rich, high-grade power conversion and power system solutions on a global scale. We believe that we differentiate ourselves from +our competition and have been able to grow our business because of the following key competitive strengths: +Ø Proprietary Custom-Designed and Engineered +Products . We have designed our base model power system platform so that it can be quickly and economically adapted to the specific +power needs of any hosting platform or OEM, which minimizes the time between customer consultation and delivery of our power products +and systems. +Ø End-to-End Solutions for Customers . +We provide end-to-end solutions for the business needs of our customers, from product design and development to multi-year warranty, +technical support and ongoing services. +Ø Specialized Technical Expertise and Experience . +We have more than 50 years of expertise in power technologies and energy generation, which has given us a wealth of experience in designing +and manufacturing AC/DC and DC/DC power conversion solutions, and positions us to benefit from the ongoing transformation towards eMobility +with smarter and greener EV charging infrastructure solutions. +Ø Diverse Product and Customer Base and Revenue +Streams . We have a diverse power supply product and customer base. With our growing EV charging solution product line, we will +receive additional revenue streams through a range of different sources such as energy sales, hardware sales, network management services, +advertising sales and energy services. We will also offer customers a variety of business model options, particularly with respect to +our EV charging solution installation and maintenance services. +Ø Minimal Non-Recurring Engineering Expenses . +Our ability to seamlessly modify our base model power system platform to produce bespoke products for our customer needs results in minimal +non-recurring engineering (“NRE”) expenses, meaning we generally avoid charging our OEM customers for those expenses. +Ø Emphasis on Product Design and Development +Efforts . Our design and development efforts are focused at the present time on the optimization of the design and performance +of our power system and EV charging solutions. This enables us to develop cutting-edge products to support highly complex and evolving +markets such as eMobility, cloud computing, military and aerospace. +Ø Commitment to Domestic Production. +The Federal government is the largest consumer of electricity in the U.S. and has committed to purchase 100% zero emission vehicles for +its 600,000-vehicle fleet by 2035. Subject to obtaining sufficient capital, we intend to lease and equip a new manufacturing and assembly +plant to focus on developing our domestic production capabilities to produce Level 2 EV chargers and bid on future Federal EV infrastructure +projects. +GWW +GWW provides defense solutions +with operations conducted by Gresham Power, Microphase, Enertec and Relec. +Gresham Power (formerly known as Digital Power +Limited) +28 +Gresham Power designs, manufactures, +and distributes switching power supplies, uninterruptible power supplies and power conversion and distribution equipment frequency converters +for the commercial and military markets, under the name Gresham. Frequency converters manufactured by Gresham are used by naval warships +to convert their generated 60-cycle electricity supply to 400 cycles. This 400-cycle supply is used to power their critical equipment +such as gyro, compass, and weapons systems. Gresham Power also designs and manufactures transformer rectifiers for naval use. Typically, +these provide battery supported back up for critical DC systems, such as machinery and communications. In addition, higher power rectifiers +are used for the starting and servicing of helicopters on naval vessels, and Gresham now supplies these as part of overall helicopter +start and servicing systems. We believe that Gresham Power products add diversity to our product line, provide greater access to the U.K. +and European markets, and strengthen our engineering and technical resources. +Gresham Power specializes +in engineering, designing and developing power conversion and distribution solutions for Naval applications, with equipment installed +on virtually all the U.K. Royal Navy’s submarine and surface fleet. Many of Gresham Power’s ultra-reliable offerings support +shipboard distribution of electrical power in emergencies (such as loss of main ship’s power) to enable continued operation of weapons +systems, tactical communications and lighting. Gresham Power specializes in a comprehensive range of activities from printed circuit board +and mechanical design through prototype development to board and system assembly and test. Its engineers ruggedize Marine power products +to meet high levels of shock, vibration, harsh climate conditions and the most rigorous MIL-STD requirements. Gresham Power also has deployed +its equipment on vessels of the navies of 15 other countries, including Australia, Malaysia, Oman, Spain, Turkey and Japan. +Microphase +Microphase designs, manufactures +and sells microwave electronics components for radar, electronic warfare and communication systems. Such components include RF and microwave +filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and DLVAs. Microphase’s customers are comprised +of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors and sub-contractors. Microphase’s +recent technology innovations are used in many significant U.S. Government defense programs, including the Polaris submarine, the F-16, +the F-35 and the Predator drone. Other notable programs in which Microphase’s products are or were used include the Atlas Missile, +Vanguard Missile, Polaris Missile System, SHRIKE Missile, ARM Missile, Patriot Missile System, THAAD (or Terminal High Altitude Area Defense), +the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, F-18, JAS Gripen fighter and the Tornado fighter as well as various land-based +improvised explosive devices countermeasures programs and UAV programs including the Predator, the Reaper and the Shadow. +Microphase’s advanced +technology products enable the ultra-sensitive detection and high precision video amplification that are necessary to accurately recover +the signals and facilitate use of the information received. These products include: +● filters that sort and clarify microwave signals, +including multiplexers with a series of filters combined in a single package; +● solid state amplifiers that amplify microwave +signals; +● detectors and limiters that are semiconductor +devices for detection of radar signals and protection of receivers from damage from high power signals and jamming; +● detector log video amplifiers that are fully +integrated, ruggedized, MIL-STD signal detection systems; and +● integrated assemblies that combine multiple functions +from a range of components and devices, including transmitters, receivers, filters, amplifiers, detectors, and other functionality into +single, efficient, high performance, multifunction assemblies. +Manufacturing and Testing +Microphase continually improves +internal processes to ensure the highest quality and consistent manufacturing of all our RF, microwave and millimeter wave electronics +solutions. We test all our products under stress operating conditions per defined test procedures that we have developed in collaboration +with our customers. This approach ensures that our customers can implement our component solutions in broader systems and platforms. Customer +specific testing services are offered with custom designed test standards to simulate operation within customer applications. +Compliance with international +safety agency standards is critical in every mission critical application that Microphase supports, and electronics solutions play a major +role in meeting these compliance requirements. Our safety engineers and quality assurance teams help ensure that our custom products are +designed to meet all safety requirements and are appropriately documented to expedite safety approval processes. +29 +Enertec +Based in Israel, Enertec designs, +develops, manufactures and maintains advanced end-to-end high technology electronic solutions for military, medical, telecommunications +and industrial markets. Those solutions include custom computer-based automated test equipment and turnkey systems to ensure combat readiness, +provide command and control, and direct and deploy resources in military operations in harsh environments and battlefield conditions. +Enertec also designs, develops, manufactures and maintains high precision calibration equipment for lifesaving medical operations for +a global health care products company as well as advance power systems for EV, telecom and other industrial applications. Enertec delivers +complete end-to-end project management with requirements definition, systems engineering, design/development, production, testing, integration, +field support, maintenance and optimization. Its custom engineered solutions enable and support mission critical air, land and sea military +platforms, e.g., missiles, UAVs, combat aircraft, boats, submarines, trailers and satellites. +Enertec’s primary customers +include the three major defense contractors in Israel – Israel Air Industries, Rafael and Elbit Systems. In addition, Enertec has +a strategic partnership with Cyient to build and deliver solutions for the Indian military. High tech capabilities to deliver advance +electronics solutions create opportunities for other GWW operating subsidiaries – Microphase, Relec and Gresham Power – to +possibly supply components for future Enertec high technology electronic solutions. Enertec also provides geographic reach into the Middle +East and India to broaden GWW’s footprint in delivering the highest quality and most advance technology solutions across the globe. +Enertec is one of Israel’s +largest, most well-established manufacturer of test equipment and simulators. Enertec develops and manufactures test systems and simulators +for all types of weapons systems at all levels of maintenance, development, and integration. We are currently working on developing a +new generation of electronics cards and assemblies to build a new generation of test systems. +Enertec complies with all +information security requirements included in its customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Relec +Relec was established in 1978 +with the aim of providing specialist power conversion and display solutions to support professionals in the electronics industry. Relec +markets and distributes power electronics and display solutions for mission critical rail, industrial, medical, telecoms and military +applications. Relec develops custom solutions for various applications ranging from light industrial to heavily ruggedized for the harshest +of environments. Relec exerts its utmost effort to customize a product or a feature to achieve optimum performance and service delivery. +Relec continues to be guided by this philosophy and currently operates in specific fields, specializing in AC-DC power supplies, DC-DC +converters, displays and EMC filters. +Markets +GWW’s operating subsidiaries +design, manufacture, and distribute specialized electronic solutions, automated test solutions, power electronics, supply and distribution +solutions, and radio, microwave and millimeter wave communication systems and components, with a focus on supporting the global defense +industry and mission critical applications in the medical, industrial, transportation and telecommunications markets. The essential nature +of these applications provides a degree of insulation from volatility associated with other segments of the global economy while accounting +for stability and steady growth of the addressable market opportunities available in market segments that GWW serves. Demand for solutions +to meet these requirements continues unaffected, and in many instances increases, in times of global crisis. GWW’s current business +base consists of approximately 500 customers in 45 countries situated all over the world. +Total defense spending in +the three countries in which GWW currently operates will total more than an estimated $856 billion in 2022. GWW sells to the militaries +and defense contractors in 18 other countries as well. Overall global defense spending is expected to grow at a compound annual growth +rate (“CAGR”), of 3% through 2028, with U.S. defense spending continuing to lead the world in the same period, according to +ASD Reports, Global Defense Budget Analysis—Forecast to 2028. The current conflict in the Ukraine has intensified interest +and investment in defense platforms throughout the United Kingdom (U.K.”) and Europe. +We believe that the drive +for increased situational awareness and close coordination of air, land, sea, space and cyber operations will fuel an increase in defense +electronics subsystems and components with total spending in 2022 of $130 billion and a projected CAGR of 5.6% through 2024, according +to Global Defense Electronics Market, Trends, Driver and Outlook for 2020 and Beyond , Renaissance Strategic Advisors, September +2020. The drive for greater connectivity and analytics will in turn increase demand for RF communications, power solutions and electronic +control systems content in new major military platforms, right in the sweet spot of GWW’s operating units. +30 +Tens of thousands of companies +compete in this market to deliver electronics solutions to meet defense and other mission critical applications. However, GWW’s +operating units have longstanding relationships with dominant defense contractors in the U.S. (Lockheed, BAE Systems, L3Harris, Raytheon, +Boeing), in the U.K. (BAE, Rolls Royce, Thales, Babcock) and in Israel (Israeli Air Industries, Rafael, Elbit Systems), which hold contracts +for major defense platforms with very long life cycles. These relationships enable GWW to narrow the field of competition considerably +and thereby to grow based on repeat business with relatively low selling costs. +Beyond the defense arena, +initiatives to complete $63 billion in upgrades to the current National Railway System in the U.K. over the next five years while spending +$130 billion over the next 10 years to build a high speed rail to link London with the Midlands cities of Birmingham, Leeds and Manchester +will generate significant opportunities for growth in demand for power solutions to upgrade and replace current infrastructure, both in +rolling stock and track side controls. Relec’s current relationships and track record for supplying power solutions to the U.K. +rail industry position GWW ideally to capitalize on these ongoing refurbishment and expansion efforts. A similarly robust market in the +medical power supply markets with a CAGR at 6.9%, to reach $1.8 billion in 2025, creates tremendous growth opportunities for our Relec +subsidiary in the U.K. The coronavirus pandemic has put healthcare and the medical device industry front and center in the U.S., Europe +and Asia, fueling intense interest in the power electronics and display solutions that Relec distributes. +We sell products to our OEM +customers through direct sales or through our sales channels, including manufacturers’ representatives for our Gresham Power subsidiary. +Our sales strategy is to identify and focus on strategic accounts. This strategy allows us to maintain a close and direct relationship +with such accounts, which positions us as the supplier of choice for these customers’ challenging, innovative and demanding new +product requirements. +Commercial Customers . +We serve global commercial markets including transportation, medical, telecom, and industrial companies. Our products are used in a variety +of applications and operate in a broad range of systems where customers require mission critical power reliability and occasionally extreme +environmental conditions. Our commercial customers include Elma GmbH, BioSense Webster, a subsidiary of Johnson & Johnson, RS Components, +Premier Farnell, Parker Hannifin, Vanderbilt, Zollner, Spectrum Medical and Comnet Communications. +Military/Defense Customers . +We have developed a broad range of rugged product solutions for the military and defense market, featuring the ability to withstand harsh +environments. These ruggedized product solutions, which include both custom modifications and full custom designs, are designed for combat +environments and meet the requirements of our defense customers. We manufacture our military products through a domestic manufacturer +that complies with US International Traffic in Arms Regulations (“ITAR”) and is certified to perform such manufacturing services. +We are compliant with the ITAR regulations and are an approved vendor for the U.S. Air Force, Navy and Army. +At the core of every military +electronic system is a power supply. Mission critical systems require rugged high performance power platforms that will operate and survive +the harsh environmental conditions placed upon such systems. Our power supplies, which include the following, function effectively in +these severe military environments, including missiles – ground-to-air, air-to-air and sea-to-air; naval – naval power conversion +and distribution; mobile and ground communications – active protection, communications and navigation; artillery – gyro modular +azimuth position and navigation system; surveillance, test equipment; and unmanned aerial vehicle (“UAV”) – Very lightweight +power systems. +Our military products meet +the relevant U.S. and international Military Standards (“MIL-STDs”) in accordance with the Defense Standardization Program +Policies and Procedures. Space, weight, output power, EMC, power density and multiple output requirements are only part of the challenges +that any military power supply design faces. With many decades of experience, our engineering teams meet these tough challenges. Our +power supplies are a critical component of many major weapon systems worldwide. +Gresham Power develops and +manufactures some military and defense products mainly being deployed in several naval fleets. +31 +Sales and Marketing +GWW markets electronics products +and solutions directly to customers primarily through the internal sales forces and executives of its operating subsidiaries. +Gresham Power makes limited +use strategic operating partners in the Middle East, India and Australia. These representatives promote Gresham Power products and serve +as the customer interface in specific parts of the world as agreed. Typically, either Gresham Power or the manufacturing representatives +are entitled to terminate the manufacturer representative agreement upon 30 days’ written notice. +Relec advertises in highly +targeted industry-specific publications such as Electronics Weekly, New Electronics, Electronic Product Design & Test, Electronics +Specifier, Components in Electronics, Design Products & Applications, Rail Technology Magazine, Rail Engineer, and Rail Professional. +In addition, Relec also posts regular podcasts on topics of interest to customers and prospects as well as running an active public relations +campaign to get placements of earned media and coverage in a wide range of media. We look to replicate similar campaigns in other operating +subsidiaries to generate inquiries/leads, raise awareness of GWW and support talent recruiting efforts. +We provide comprehensive collateral +materials including product data sheets, participation in trade shows, and our websites, www.greshamwordwide.com , www.relec.co.uk , +www.microphase.com and www.greshampower.com . We use our websites to describe our capabilities and emphasize our offerings +of bespoke technology solutions to draw inquiries from prospective customers. Our future promotional activities will likely include advertising +in industry-specific publications, earned media placements of articles, regular public relations releases and social media postings as +well as direct outreach to prospective customers at trade shows, conferences and small group seminars and/or virtual webinars. +Competition +The markets in which Microphase +operates is highly competitive and sensitive to technological advances. Many of Microphase’s competitors are larger than it is and +maintain higher levels of expenditures for research and development. Principal competitive factors in Microphase’s markets are product +quality and reliability; technological capabilities; service; past performance; ability to develop and implement complex, integrated solutions; +ability to meet delivery schedules; the effectiveness of third-party sales channels in international markets; and cost-effectiveness. +In the RF Communications market, +principal competitors for filter components products include K& L Microwave, a Dover company located in Salisbury, MD; RS Microwave, +a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith Group, a global technology +company listed on the London Stock Exchange; and Delta Diversified Products, a private company based in Arizona. +In the video amplifier segment, +principal competitors for DLVA sensor products include American Microwave Corporation, a privately held company headquartered in Frederick, +MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries, a privately held company based in Frederick, +MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly traded company based in New York, NY; and Signal Technology, +a subsidiary of Crane Co., a publicly traded company based in Stamford, CT. +Our Enertec subsidiary faces +direct competition from smaller firms than itself such as Nir Or, EPS, MER, Alexander Schneider, Symcotech and Chaban, which specialize +in components of electronic solutions. Offering end-to-end, turnkey solutions gives Enertec a competitive advantage over other private +contractors competing to provide the Israeli Ministry of Defense and major OEMs with electronic systems and components. That competitive +advantage results in a significant portion of Enertec’s business being de facto “sole source” work without other viable +competition. +Gresham Power confronts competition +from Ultra Electronics and Rolls Royce. As in the case of Microphase, elegant designs, strong engineering and a long track record for +delivering ultra-reliable high quality power electronics solutions enables Gresham Power to compete effectively. +Relec competes against many +other distributors of power electronics and display offerings, facing competition from the likes of Fidus Power Ltd, Mouser Electronics +and Avnet Abacus as well as power supply and electronics manufacturers like XP and ABB who sell direct, many of which have significantly +more fiscal and marketing resources than Relec. However, a high touch, customer-focused approach enables Relec to compete effectively +against high volume distributors and direct selling manufacturers. Optimizing and designing solutions into customer product lines has +proven tremendously effective in building relationships with customers and suppliers alike that endure over time, generating regular repeat +business and builds a reputation for customer service that provides a strong competitive advantage when pursuing new customers. +32 +We also face competition from +current and prospective customers who may decide to design and manufacture power electronics, communications components and electronic +solutions needed to satisfy their internal programmatic requirements. +Consolidation in the defense +technology solutions market, including through mergers, acquisitions and/or strategic alliances among major entities to which we sell +our products, has the potential to intensify the competitive pressures that we face. Many of our existing and potential competitors may +be better positioned than we are to acquire other companies, technologies or products. We believe we compete favorably on the basis of +multiple factors, including product quality and reliability, technological capabilities, service, past performance, design flexibility +and ability to develop and implement complex, integrated solutions customized to our customers’ needs, and cost-effectiveness. Focusing +on bespoke technology offerings with relatively low volumes and high margins enables our operating subsidiaries to compete favorably on +price against larger companies with much high indirect cost structures. Finally, the fragmentation of the defense technology market also +creates opportunities for GWW to grow through acquiring competitors and/or potential competitors. +Compliance with Material Government (Including +Environmental) Regulations +ACS +ACS is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. ACS continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While ACS’s regulatory compliance costs +are currently not considered material, it is reasonably possible that costs incurred to ensure continued environmental compliance could +have a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Facility is subject to +a final corrective measures plan with the Environment Protection Agency. The seller performed remedial activities at the Facility relating +to historical soil and groundwater contamination and ACS is responsible for ongoing monitoring and final remediation plans. We estimate +cost of the environmental remediation obligation is approximately $369,000 and reflects our best estimate of probable future costs for +remediation based on the current assessment data and regulatory obligations. Future costs will depend on many factors, including the extent +of work necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. We may incur actual +costs in the future that are materially different than this estimate and such costs could have a material impact on results of operations, +financial condition, and cash flows during the period in which they are recorded. +TOGI +TOGI’s businesses are +heavily regulated in most of its markets. TOGI handles power electronics products mainly in the form of power conversion. TOGI must take +into account several standards for electronic safety to protect the health of humans and animals. TOGI serves diverse markets including +automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set of their safety regulations +and standard that TOGI must comply with. +Government Contracts . +The U.S. Government, and other governments, may terminate any of TOGI’s government contracts at their convenience, as well as for +default based on our failure to meet specified performance requirements. If any of TOGI’s U.S. Government contracts were to be terminated +for convenience, TOGI would generally be entitled to receive payment for work completed and allowable termination or cancellation costs. +If any of TOGI’s government contracts were to be terminated for default, generally the U.S. Government would pay only for the work +that has been accepted and could require TOGI to pay the difference between the original contract price and the cost to re-procure the +contract items, net of the work accepted from the original contract. The U.S. Government can also hold TOGI liable for damages resulting +from the default. +Medical device power supplies . +TOGI’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. A MOP +can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. These +can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through safety +insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination of +these techniques. TOGI must comply with a standard that treats operators and patients, resulting in the classifications “means of +operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +33 +Environmental . TOGI +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TOGI continually assesses its compliance status and management +of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. Investigation, +remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a normal, recurring +part of TOGI’s operations. +Non-U.S. Sales . TOGI’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +GWW +GWW’s businesses are +heavily regulated in most of its markets. GWW transacts with numerous U.S. Government agencies and entities, including but not limited +to the U.S. Department of Defense (“DoD”), branches of the U.S. military and the Department of Homeland Security. Similar +government authorities exercise similar regulatory oversight in GWW’s non-U.S. markets. +Government Contracts . +The governments of the U.S., U.K. and Israel may terminate any of GWW’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of GWW’s contracts for convenience, GWW generally would be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of GWW’s government contracts were to be terminated for default, generally the U.S. government would +pay only for the work that has been accepted and could require GWW to pay the difference between the original contract price and the cost +to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold GWW liable for +damages resulting from the default. Similar provisions apply to GWW’s contracts with other governments and to GWW’s subcontractors +with major defense contractors who provide systems or military platforms directly to the government. +Power Electronics . +In all of GWW’s markets in the U.S., GWW’s commercial power electronics offerings must comply with safety, energy use and +operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. In +the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the U.K., Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, GWW’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . GWW +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies, or as applicable +local regulations or laws require. The products that GWW markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of +certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, GWW’s industry began phasing in RoHS +and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. GWW believes that RoHS and WEEE-compliant +components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. REACH (Registration, +Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 December 2006. REACH +addresses the production and use of chemical substances, and their potential impacts on both human health and the environment. +These regulatory mandates +apply to all of GWW’s operating subsidiaries. GWW has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +34 +Non-U.S. Sales . GWW’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Security Clearance +As a U.S. Government contractor +working on classified projects, Microphase is required to maintain facility and personnel security clearances complying with the DoD and +other federal agency requirements. Microphase maintains strict protocols for handling classified information and Confidential Unclassified +Information (“CUI”) associated with its work for the DoD and has built a secure restricted area within its Shelton production +facility certified for generating, storing and reviewing classified information. +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the U.K. Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “DCAA”), +the Defense Contract Management Agency (the “DCMA”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the DOJ and Congressional Committees. From time-to-time, these and other agencies investigate or +conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. The +DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the Ministry of Defense does most of +its business. All its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +the U.K. Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the +customer the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government +and typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified information and CUI from disclosure and unauthorized access. That mandate includes a requirement that +Microphase formulate and implement a system security plan with 110 different elements and protocols for handling and protecting classified +information and CUI. Over the next three years, the DoD will require all participants in the defense supply chain to demonstrate compliance +with the Capability Model Maturity Cybersecurity as verified through an independent third-party auditor. Compliance with these mandates +requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance requires extensive +security controls on access to Microphase information technology systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Plus Compliant.” Cyber Essentials Plus is a government-backed, industry-supported +scheme to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials Plus program criteria. +35 +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December 31, 2021 and 2020, we spent approximately +$2.0 million and $1.8 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries and others operate in industries deemed essential by the DoD and therefore remained +at work during the COVID-19 pandemic. +Employee Profile +As of December 31, 2021, we +had 323 employees located in the U.S., the U.K. and Israel, of whom 44 were engaged in engineering and product development, 35 in sales +and marketing, 175 in general operations and 69 in general administration and finance. All but 10 of these employees are employed on a +full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be good. +As of December 31, 2021, approximately +45% of our current workforce is female, 55% male, and our average tenure is 6.2 years, a decrease of 38% from an average tenure of 10 +years as of December 31, 2020. The decrease is primarily due to the addition of 102 employees related to our hotel operations acquired +in December 2021. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of 6.2 years as +of the end of the fiscal year 2021 reflects the engagement of our employees in this core talent system tenet. +The Company believes it materially +complies with all applicable state, local and international laws governing nondiscrimination in employment in every location in which +the Company operates. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, +religion, national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran +status. +36 +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees' needs. We plan to conduct annual confidential employee surveys +as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. Our +employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new stretch +goals. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021 and plan to establish a Company-wide augmented employee stock purchase plan in 2022. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +In response to the COVID-19 pandemic, we implemented significant operating environment changes that we determined were in the best interest +of our employees, as well as the communities in which we operate, and which comply with government regulations. This includes having a +significant portion of our employees work from home, while implementing additional safety measures for employees continuing critical on-site +work. +37 \ No newline at end of file diff --git a/raw/filings/0000896493/2021/0001214659-22-005320/item13.txt b/raw/filings/0000896493/2021/0001214659-22-005320/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a59db05582d1ed78b19b5ea317c08baf1fe88ba --- /dev/null +++ b/raw/filings/0000896493/2021/0001214659-22-005320/item13.txt @@ -0,0 +1,101 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +● the aggregate amount involved is determined to by the Audit Committee to be material; +● we are a participant; and +● any of the following has or will have a direct or indirect interest in the transaction: +● an executive officer, director, or nominee for election as a director; +● a greater than five percent beneficial owner of our common stock; or +● any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company. +Ault & Company +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company would +purchase an aggregate of 660,667 shares of our common stock at a purchase price per share of $1.12, subject to the approval of the NYSE +American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, at +the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of common stock, or up to 19.99% of +our common stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “2020 Note ”) +to Ault & Company. The principal amount of the 2020 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was due +and payable on August 5, 2020. The 2020 Note is convertible into shares of our common stock, par value $0.001 per share at a conversion +price of $1.45 per share. +110 +On +February 25, 2021, we sold and issued an 8% Secured Promissory Note in the principal amount of $2,500,000 (the “2021 Note ”) +to Ault & Company. The principal amount of the 2021 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was originally +due and payable on August 5, 2021 but the maturity date subsequently extended to December 31, 2022. The 2021 Note is not convertible. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer of Ault & Company. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief Financial Officer of Ault & Company. Henry Nisser, our President, +General Counsel and a member of our board of directors, is also the President, General Counsel and a director of Ault & Company. +Avalanche +On September 6, 2017, we entered +into the AVLP Loan Agreement with an effective date of August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit +facility. The AVLP Loan Agreement has been increased to up to $20.0 million and extended to December 31, 2023. +At December 31, 2021, we had +provided Avalanche with $17.8 million and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase +35.6 million shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets +of AVLP. As of December 31, 2021, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and +a provision for loan losses of $2.0 million. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 35.6 million shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +Avalanche received funds from +a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of the Third Party Note, $2.6 million +was used to pay an outstanding receivable due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan +Agreement. On October 12, 2021, Ault Alpha, an affiliate of ours, repaid the Third Party Note in full and also acquired a warrant to purchase +1.6 million shares of AVLP common stock. In consideration therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 +million, which term note matures on June 30, 2022. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is an affiliate +of our company. See immediately above for its involvement with respect to the Third Party Note. As of December 31, 2021, Ault Alpha had +purchased 6.1 million shares of our common stock at an average price of $2.16. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. Bentz +Yes +X +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairman of committee +X – Member of committee +111 \ No newline at end of file diff --git a/raw/filings/0000896493/2021/0001214659-22-005320/item9a.txt b/raw/filings/0000896493/2021/0001214659-22-005320/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..1148271ee422ed14ea216f9abf2ad108a343095f --- /dev/null +++ b/raw/filings/0000896493/2021/0001214659-22-005320/item9a.txt @@ -0,0 +1,84 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2021, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, have +evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) +and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our disclosure +controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records +that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide +reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2021. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2021, our internal control over financial reporting was not effective. +96 +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting function, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting and fair value estimates, in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +3. Our primary user access controls (i.e. provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +97 +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis. +· +Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls, +· +Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· +Continuing to increase headcount across the Company, with a particular +focus on hiring individuals with strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Controls over Financial Reporting +During the most recent fiscal +quarter 2021 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) +and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over +financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2021/0001214659-22-005320/rp_note.txt b/raw/filings/0000896493/2021/0001214659-22-005320/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..0ec5ec962b21e1f17a886316994ad1cc3428f83e --- /dev/null +++ b/raw/filings/0000896493/2021/0001214659-22-005320/rp_note.txt @@ -0,0 +1,193 @@ +13. INVESTMENTS – RELATED PARTIES +Investments in Alzamend and +Ault & Company at December 31, 2021 and 2020, were comprised of the following: +Investment in Promissory Notes, Related +Parties +Interest +Due +December 31, +December 31, +Rate +Date +2021 +2020 +Short-term advance in Alzamend +$ - +$ 750,000 +Investment in convertible promissory note of Alzamend +- +50,000 +Investment in promissory note of Ault & Company +8 % +December 31, 2022 +2,500,000 +- +Accrued interest receivable Ault & Company and Alzamend +169,000 +1,000 +Other +173,000 +203,000 +Total investment in promissory notes, related parties – gross +2,842,000 +1,004,000 +Less: original issue discount +- +( 4,000 ) +Total investment in promissory notes, related parties +$ 2,842,000 +$ 1,000,000 +Investment in Common Stock and Warrants, +Related Parties +Weighted Avg. +Remaining +December 31, +December 31, +Contractual Term +2021 +2020 +Investment in warrants of Alzamend +4.4 years +$ - +$ 11,000 +Investment in common stock and options of Alzamend +13,230,000 +642,000 +Total investment in common stock, options, and warrants of Alzamend +$ 13,230,000 +$ 653,000 +F- 32 +The following table summarizes +the changes in the Company’s investments in Alzamend and Ault & Company during the years ended December 31, 2021 and 2020: +Investment in +warrants and +common stock +of ALZN +Investment in +promissory notes +and advances of +ALZN and Ault & +Company and Other +Total investment in +ALZN and Ault & +Company, net and +Other +Balance at January 1, 2020 +$ 559,000 +$ 233,000 +$ 792,000 +Investment in convertible promissory note of Alzamend +- +38,000 +38,000 +Investment in common stock of Alzamend +44,000 +- +44,000 +Investment in warrants of Alzamend +12,000 +- +12,000 +Short term advance in Alzamend +- +750,000 +750,000 +Unrealized gain in common stock of Alzamend +38,000 +- +38,000 +Accretion of discount +- +8,000 +8,000 +Amortization of related party investment +- +( 30,000 ) +( 30,000 ) +Accrued interest +- +1,000 +1,000 +Balance at January 1, 2021 +653,000 +1,000,000 +1,653,000 +Alzamend note and advances converted into common stock +- +( 800,000 ) +( 800,000 ) +Investment in promissory note of Ault & Company +- +2,500,000 +2,500,000 +Investment in common stock and options of Alzamend +18,181,000 +- +18,181,000 +Unrealized loss in common stock of Alzamend +( 5,604,000 ) +- +( 5,604,000 ) +Accretion of discount +- +4,000 +4,000 +Amortization of related party investment +- +( 30,000 ) +( 30,000 ) +Accrued interest +- +168,000 +168,000 +Balance at December 31, 2021 +$ 13,230,000 +$ 2,842,000 +$ 16,072,000 +F- 33 +Investments in +Alzamend Common Stock +The +following table summarizes the changes in the Company’s investments in Alzamend common stock during the year ended December 31, +2021: +Shares of +Per Share +Investment in +Common Stock +Price +Common Stock +Balance at January 1, 2021 +428,000 +$ 1.50 +$ 642,000 +Purchase of shares from an Alzamend shareholder +62,000 +$ 0.81 +50,000 +March 9, 2021 securities purchase agreement * +4,000,000 +$ 1.50 +6,000,000 +Investment in Alzamend initial public offering +2,000,000 +$ 5.00 +10,000,000 +Open market purchases after initial public offering +457,000 +$ 4.67 +2,132,000 +Unrealized loss in common stock of Alzamend +(5,625,000 ) +Investment in Alzamend common stock +6,947,000 +$ 1.90 +13,199,000 +Investment in Alzamend options +31,000 +Balance at December 31, 2021 +$ 13,230,000 +* Pursuant to the March 9, 2021 securities purchase agreement, in aggregate, Alzamend agreed to sell up +to 6,666,667 shares of its common stock to DP Lending for $10.0 million, or $1.50 per share, and issue to DP Lending warrants to acquire +3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. As of December 31, 2021, DP Lending funded $6.0 million, +including the conversion of notes and advances of $0.8 million, and the remaining $4.0 million will be funded upon Alzamend achieving +certain milestones. \ No newline at end of file diff --git a/raw/filings/0000896493/2021/0001214659-22-005320/rpt_disclosure.txt b/raw/filings/0000896493/2021/0001214659-22-005320/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a59db05582d1ed78b19b5ea317c08baf1fe88ba --- /dev/null +++ b/raw/filings/0000896493/2021/0001214659-22-005320/rpt_disclosure.txt @@ -0,0 +1,101 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +● the aggregate amount involved is determined to by the Audit Committee to be material; +● we are a participant; and +● any of the following has or will have a direct or indirect interest in the transaction: +● an executive officer, director, or nominee for election as a director; +● a greater than five percent beneficial owner of our common stock; or +● any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company. +Ault & Company +On December 23, 2019, the +Company announced that it had entered into an agreement whereby Ault & Company would +purchase an aggregate of 660,667 shares of our common stock at a purchase price per share of $1.12, subject to the approval of the NYSE +American, for a total purchase price of $739,948. The purchase was authorized by the NYSE American on January 15, 2020. As a result, at +the closing on January 15, 2020, Ault & Company became the beneficial owner of 666,945 shares of common stock, or up to 19.99% of +our common stock then outstanding. +On +February 5, 2020, we sold and issued an 8% Convertible Promissory Note in the principal amount of $1,000,000 (the “2020 Note ”) +to Ault & Company. The principal amount of the 2020 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was due +and payable on August 5, 2020. The 2020 Note is convertible into shares of our common stock, par value $0.001 per share at a conversion +price of $1.45 per share. +110 +On +February 25, 2021, we sold and issued an 8% Secured Promissory Note in the principal amount of $2,500,000 (the “2021 Note ”) +to Ault & Company. The principal amount of the 2021 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was originally +due and payable on August 5, 2021 but the maturity date subsequently extended to December 31, 2022. The 2021 Note is not convertible. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer of Ault & Company. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief Financial Officer of Ault & Company. Henry Nisser, our President, +General Counsel and a member of our board of directors, is also the President, General Counsel and a director of Ault & Company. +Avalanche +On September 6, 2017, we entered +into the AVLP Loan Agreement with an effective date of August 21, 2017 pursuant to which we will provide Avalanche a non-revolving credit +facility. The AVLP Loan Agreement has been increased to up to $20.0 million and extended to December 31, 2023. +At December 31, 2021, we had +provided Avalanche with $17.8 million and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase +35.6 million shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets +of AVLP. As of December 31, 2021, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and +a provision for loan losses of $2.0 million. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 35.6 million shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +Avalanche received funds from +a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of the Third Party Note, $2.6 million +was used to pay an outstanding receivable due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan +Agreement. On October 12, 2021, Ault Alpha, an affiliate of ours, repaid the Third Party Note in full and also acquired a warrant to purchase +1.6 million shares of AVLP common stock. In consideration therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 +million, which term note matures on June 30, 2022. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is an affiliate +of our company. See immediately above for its involvement with respect to the Third Party Note. As of December 31, 2021, Ault Alpha had +purchased 6.1 million shares of our common stock at an average price of $2.16. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. 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+0000896493 +ault:AlphaFundMember +2022-12-01 +2022-12-29 +0000896493 +us-gaap:SubsequentEventMember +ault:SecurityPurchaseAgreementMember +2023-03-28 +0000896493 +us-gaap:SubsequentEventMember +ault:SecurityPurchaseAgreementMember +us-gaap:SeriesEPreferredStockMember +2023-03-28 +0000896493 +us-gaap:SubsequentEventMember +ault:SecurityPurchaseAgreementMember +us-gaap:SeriesFPreferredStockMember +2023-03-28 +0000896493 +us-gaap:SubsequentEventMember +ault:SecurityPurchaseAgreementMember +us-gaap:SeriesGPreferredStockMember +2023-03-28 +0000896493 +us-gaap:SubsequentEventMember +ault:N12TermNoteMember +2023-04-05 +0000896493 +us-gaap:SubsequentEventMember +ault:N12TermNoteMember +2023-04-01 +2023-04-05 +0000896493 +us-gaap:SubsequentEventMember +ault:SecuredPromissoryNoteMember +2023-04-01 +2023-04-06 +iso4217:USD +xbrli:shares +iso4217:USD +xbrli:shares +xbrli:pure +UNITED STATES SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x ANNUAL +REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the Fiscal Year Ended December 31 , 2022 +or +o +TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For +the transition period from _____________ to ________________ +Commission file number 1-12711 +AULT ALLIANCE, INC. +(Exact name of registrant as specified in its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +11411 Southern Highlands Pkwy , Suite 240 , +Las Vegas , NV +89141 +(949) 444-5464 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) +of the Act: +Title of each class +Trading symbol(s) +Name of each exchange on which registered +Common Stock, $0.001 par value per share +AULT +NYSE American +13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, par value $0.001 per share +AULT PRD +NYSE American +Securities registered pursuant to Section 12(g) +of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No +x +Indicate +by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange +Act. Yes o No +x +Indicate +by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities +Exchange Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file such reports), and +(2) has been subject to such filing requirements for the past 90 days. Yes x No +o +Indicate +by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule +405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant +was required to submit such files). Yes x No +o +Indicate by check mark whether the registrant +is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. +See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” +and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o +Accelerated filer o +Non-accelerated filer x +Smaller reporting company x +Emerging growth company o +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying +with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate +by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of +its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public +accounting firm that prepared or issued its audit report. o +If securities are registered pursuant to Section +12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction +of an error to previously issued financial statements. o +Indicate by check mark whether any of those error +corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s +executive officers during the relevant recovery period pursuant to §240.10D-1(b). o +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No +x +As of June 30, 2022, the aggregate market value +of the registrant’s common stock held by non-affiliates of the registrant was $ 79.0 million based on the closing sale price +as reported on the NYSE American of $0.2655. Shares of the registrant’s common stock held by executive officers, directors +or 10% beneficial owners and by each other person who may be deemed to be an affiliate of the registrant have been excluded from this +computation. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose. +There were 415,746,694 shares of common stock +outstanding as of April 17, 2023. +Documents incorporated by reference: None +AULT ALLIANCE, INC. AND +SUBSIDIARIES +FORM 10-K +FOR THE FISCAL YEAR ENDED DECEMBER 31, 2022 +INDEX +Page +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +37 +Item 1B. +Unresolved Staff Comments +100 +Item 2. +Properties +100 +Item 3. +Legal Proceedings +101 +Item 4. +Mine Safety Disclosures +102 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +103 +Item 6. +Reserved +104 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +104 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +119 +Item 8. +Financial Statements and Supplementary Data +F-1 – F-58 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +119 +Item 9A. +Controls and Procedures +120 +Item 9B. +Other Information +121 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +121 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +122 +Item 11. +Executive Compensation +128 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +132 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +134 +Item 14. +Principal Accountant Fees and Services +135 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +137 +Item 16. +Form 10-K Summary +141 +Signatures +142 +NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “Annual +Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of +the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. We have +attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” +“can,” “continue,” “could,” “estimates,” “expects,” “intends,” +“may,” “plans,” “potential,” “predict,” “should” or “will” or +the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties and other factors may +cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels or +activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations +reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Our expectations are as of the date this Annual Report is filed, and we do not intend to update any of the forward-looking statements +after the date this Annual Report is filed to confirm these statements to actual results, unless required by law. +This Annual Report also contains estimates and +other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves +a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified +the statistical and other industry data generated by independent parties and contained in this Annual Report and, accordingly, we cannot +guarantee their accuracy or completeness, though we do generally believe the data to be reliable. In addition, projections, assumptions +and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a +high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere +in this Annual Report. These and other factors could cause results to differ materially from those expressed in the estimates made by +the independent parties and by us. +RISK FACTOR SUMMARY +Below +is a summary of the principal factors that make an investment in our common stock speculative. This summary does not address all of the +risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found +below under the heading “Risk Factors” and should be carefully considered, together with other information in this annual +report and our other filings with the SEC before making investment decisions regarding our common stock. +● We will need to raise additional capital to fund our operations in furtherance of our business plan. +● We have an evolving business model, which increases the complexity of our business. +● We received a subpoena from the Commission in the investigation now known as “In the Matter of DPW Holdings, Inc.,” the +consequences of which are unknown. +● Our Bitcoin mining operations present a number of risks, which are delineated in the Risk factors section. +● We are highly dependent on the price of Bitcoin and the level of demand and financial performance of the crypto asset industry. +● Our holding company model presents certain additional risks, which are delineated in the Risk factors section. +● Our growth strategy is subject to a significant degree of risk. +● We are heavily dependent on our senior management, and a loss of a member of our senior management team could cause our stock price +to suffer. +● If we fail to anticipate and adequately respond to rapid technological changes in our industry, including evolving industry-wide standards, +in a timely and cost-effective manner, our business, financial condition and results of operations would be materially and adversely affected. +● We may be significantly impacted by developments and changes in laws and regulations, including increased regulation of the crypto +asset industry through legislative action and revised rules and standards applied by The Financial Crimes Enforcement Network under the +authority of the U.S. Bank Secrecy Act and the Investment Company Act. +● If we do not continue to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +● Our common stock price is volatile. +PART I +ITEM 1. BUSINESS +Company Overview +Ault Alliance, Inc., a Delaware +corporation formerly known as BitNile Holdings, Inc., was incorporated in September 2017 (sometimes referred to as “AAI,” +the “Company,” “we” or “us”). AAI is a diversified holding company pursuing growth by acquiring undervalued +businesses and disruptive technologies with a global impact. Through our wholly- and majority-owned subsidiaries and strategic investments, +we own and operate a data center at which we mine Bitcoin, and provide mission-critical products that support a diverse range of industries, +including crane services, oil exploration, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics, hotel operations +and textiles. In addition, we extend credit to select entrepreneurial businesses through a licensed lending subsidiary. +Our direct and indirect wholly +owned subsidiaries include (i) Ault Lending, LLC (“Ault Lending,” formerly known as Digital Power Lending, LLC), (ii) Ault +Global Real Estate Equities, Inc. (“AGREE”), which wholly owns AGREE Madison, LLC (“AGREE Madison”) and Third +Avenue Apartments LLC (“Third Avenue Apartments”), (iii) Ault Disruptive Technologies Company, LLC (“ADTC”), (iv) +BitNile, Inc. (“BNI”), which wholly owns Alliance Cloud Services, LLC (“ACS”) and BNI Montana, LLC (“BNI +Montana”), (v) Circle 8 Holdco LLC, a Delaware limited liability company (“Circle 8 Holdco”), (vi) Ault Energy, LLC +(“Ault Energy”), and (vii) Ault Aviation, LLC (“Ault Aviation”). We also have a direct controlling interest in +(i) Imperalis Holding Corp. (“IMHC” or “TurnOnGreen”), which wholly owns TOG Technologies, Inc. (“TOG Technologies”) +and Digital Power Corporation (“Digital Power”), (ii) Giga-tronics Incorporated (“GIGA”), which wholly owns Gresham +Worldwide, Inc. (“GWW”), which in turn wholly owns Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems +2001 Ltd. (“Enertec”), Relec Electronics Ltd. (“Relec”) and has a controlling interest in Microphase Corporation +(“Microphase”) and (iii) Avalanche International Corp. (“Avalanche” or “AVLP”). Ault Lending has a +controlling interest in The Singing Machine Company, Inc. (“SMC”), Circle 8 Holdco has a controlling interest in Circle 8 +Newco LLC (“Circle 8”), and ADTC is the sponsor of Ault Disruptive Technologies Corporation (“Ault Disruptive”). +AAI was founded by Milton +“Todd” Ault, III, our Executive Chairman and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and Vice Chairman +and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages our day-to-day operations. +All major investment and capital allocation decisions are made by Mr. Ault and the other members of the Executive Committee. We have eight +reportable segments: +· Energy and Infrastructure (“Energy”) – crane operations, advanced textiles processing +and oil exploration; +· Technology and Finance (“Fintech”) –commercial lending, activist investing, media, and +digital learning; +· SMC – consumer electronics; +· BNI – cryptocurrency mining operations; +· GIGA – defense solutions; +· TurnOnGreen – commercial electronics solutions; +· AGREE – hotel operations and other commercial real estate holdings; and +· Ault Disruptive – a special purpose acquisition company (“SPAC”). +On +January 3, 2023, the Company, then known as BitNile Holdings, Inc., merged its wholly owned subsidiary, Ault Alliance, Inc. with and into +the Company. In connection with this upstream merger, Ault Alliance, Inc. was merged out of existence and the business of the Company +continued as it was being conducted. Further, on January 3, 2023, the effective date of the merger, we changed our name to Ault Alliance, +Inc. and our ticker was changed to “AULT.” The name change did not affect the rights of our security holders. +1 +We operate as a holding +company with operations conducted primarily through our subsidiaries. We intend to conduct our activities in a manner so as not to be +deemed an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). Generally, +this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets +will be invested in investment securities, as that term is defined in the Investment Company Act. Pursuant to the Investment Company Act, +we believe that our subsidiary Ault Lending is excluded from the definition of an investment company. +Although we actively seek +growth through acquisitions, we will also continue to focus on high-grade and custom product designs for the commercial, medical and military/defense +markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical +operating conditions. +Recent Events and Developments +2021 Updates +On +January 29, 2021, ACS closed on the acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern +Michigan for a purchase price of $3,991,497 (the “Facility”). The purchase price was paid from our own working capital. Ownership +of the Facility was subsequently assigned to BNI. +On March 9, 2021, Ault Lending +entered into a securities purchase agreement with Alzamend Neuro, Inc. (“Alzamend”), a related party, to invest $10 million +in Alzamend common stock and warrants, subject to the achievement of certain milestones. We agreed to fund $4 million upon execution of +the securities purchase agreement and to fund the balance upon Alzamend achieving certain milestones related to the U.S. Food and Drug +Administration’s approval of Alzamend’s Investigational New Drug application and Phase 1a human clinical trials for Alzamend’s +lithium based ionic cocrystal therapy, known as AL001. Under the securities purchase agreement, Alzamend agreed to sell up to 6,666,667 +shares of its common stock to Ault Lending in consideration for the $10 million, or $1.50 per share, and issue to Ault Lending warrants +to acquire up to 3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. The transaction was approved by +our independent directors after receiving a third-party valuation report of Alzamend. As of the date of this annual report, we have funded +an aggregate of $10 million pursuant to the securities purchase agreement and have thus acquired all of the shares and warrants issuable +by Alzamend to us under the agreement. We retain the right to acquire an additional 6,666,667 shares and 3,333,334 warrants at an exercise +price of $3.00 per share until October 26, 2023 for an aggregate payment to Alzamend of $10 million. +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain. We have received 20,645 Antminers, fulfilling the first five of seven Bitmain Agreements including 4,628 environmentally +friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) and 16,017 S19j Pro Antminers +that feature a processing power of 100 TH/s. The 20,645 Antminers in our possession, once installed and energized, will generate a combined +processing power of approximately 2.25 exahashes per second (“EH/s”), the computational power that is being used to mine Bitcoin. +Beyond the first five contracts +with Bitmain, we have two more purchase agreements for an additional 1,325 S19j Pro Antminers estimated to be delivered over the second +quarter 2023 and 1,140 S19 XP Hydro Antminers anticipated to be delivered during the summer of 2023. Once all of the miners are fully +deployed and operational, we expect to achieve a mining production capacity of approximately 2.67 EH/s. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +On December 13, 2021, BNI +closed an investment of Series A preferred stock of Earnity Inc. (“Earnity”), a decentralized finance (“DeFi”) +marketplace based in San Mateo, California. BNI paid approximately $11.5 million for the shares of Earnity’s Series A preferred +stock. Following the investment, BNI beneficially owned approximately 19.99% of Earnity’s common stock. The transaction we entered +into with Earnity is an investment only, not the precursor to an acquisition. We have no present intention of incorporating Earnity’s +business or operations, or that of any other DeFi platform, with our own. Prior to the closing of the transaction with BitNile Metaverse, +Inc. (“BMI”) discussed below, our beneficial ownership of Earnity was assigned to BitNile.com, Inc. (“BNC”); as +such, BMI is presently the beneficial owner of these shares. +2 +On December 15, 2021, Ault +Lending entered into an exchange agreement with Imperalis Holding Corp. (“IMHC”) pursuant to which IMHC issued us a convertible +promissory note (the “IMHC Note”) in the principal amount of $0.1 million, in exchange for those certain promissory notes +dated August 18, 2021 and November 5, 2021 previously issued by IMHC to Ault Lending in the aggregate principal amount of $0.1 million, +which prior notes had accrued interest of $1,529 as of December 15, 2021. The IMHC Note accrued interest at 10% per annum, was due on +December 15, 2023, and the principal, together with any accrued but unpaid interest on the amount of principal, is convertible into shares +of IMHC’s common stock at Ault Lending’s option at a conversion price of $0.01 per share. The IMHC Note was converted into +11.0 million shares of IMHC’s common stock on October 12, 2022. +On December 16, 2021, we entered +into a stock purchase agreement (the “Agreement”) with the majority stockholders of IMHC. Pursuant to the Agreement, we purchased +129.4 million shares of IMHC’s common stock from the sellers in exchange for $0.2 million. Upon the closing of the Agreement, we +owned a majority of IMHC’s common stock, resulting in a change in control of IMHC. +On December 22, 2021 (the +“Closing Date”), AGREE Madison, LLC, a wholly owned subsidiary of AGREE (“AGREE Madison”), through various wholly +owned subsidiaries (the “Property Owners”), entered into construction loan agreements (the “Loan Agreements”) +in the aggregate amount of $68.8 million (the “Loans”) in connection with the acquisition of four hotel properties (the “Properties”). +The Properties were acquired on the Closing Date for an aggregate purchase price of $69.2 million, of which $2.5 million was previously +funded on deposit, $21.4 million was paid by the Company on the Closing Date, and the remaining amounts were funded from the Loans. The +remaining $23.4 million of the Loans are available to be drawn upon by the Property Owners towards the completion of the $13.7 million +in property improvement plans (“PIPs”) the Property Owners agreed to undertake, as well as to fund working capital, interest +reserves, franchise fees and other costs and expenses related to the acquisition. The Loans are due on January 1, 2025 (the “Maturity +Date”), but may be extended by the Property Owners for two additional 12-month terms, subject to certain terms and conditions as +set forth in the Loan Agreements. The Loans accrue interest at a rate equal to the greater of (i) the LIBOR Rate plus 675 basis points +or (ii) 7% per annum. The Property Owners have since January 1, 2022 made and will continue to make monthly installment payments of interest +only. +On +December 27, 2021, the Company and GWW entered into a Share Exchange Agreement (the “Exchange Agreement”) with Giga-tronics +Incorporated, a California corporation (“GIGA”). Pursuant to the Exchange Agreement, which closed on September 8, 2022, GIGA +acquired all of the outstanding shares of capital stock of GWW in exchange for (i) issuing to the Company 2.9 million shares of GIGA’s +common stock (“GIGA Common Stock”) and 514.8 shares of a new series of preferred stock (“GIGA Preferred Stock”) +which are convertible into an aggregate of 4.0 million shares of GIGA Common Stock, subject to adjustment, and (ii) the assumption of +GWW’s equity awards representing, on an as-assumed basis, 249,875 shares of GIGA Common Stock (the “Exchange Transaction”). +As +a result of the consummation of the Exchange Transaction, GWW has become a wholly owned subsidiary of GIGA. In accordance with the Exchange +Agreement, we loaned GIGA $4.25 million pursuant to a convertible promissory note (“Closing Date Loan”) upon the closing of +the Exchange Transaction (the “Closing”). Following the Closing, GIGA repurchased all of its shares of Series B, Series C, +Series D and Series E preferred stock that were outstanding prior to the Closing (the “Outstanding Preferred”). Based upon +2,725,010 shares of GIGA Common Stock outstanding at the Closing, and following the issuance to the Company of the shares of GIGA Common +Stock and GIGA Preferred Stock pursuant to the Exchange Transaction, the Company holds approximately 68% of the outstanding voting power +and capital stock of GIGA, and existing holders of GIGA Common Stock hold approximately 32%. On December 31, 2022, the Closing Date Loan +was exchanged for a new convertible promissory note with a maturity date of December 31, 2024. In addition, Ault Lending also entered +into a Securities Purchase Agreement with GIGA, whereby GIGA issued Ault Lending a 10% Senior Secured Convertible Promissory Note in the +principal amount of $6.8 million and five-year warrants to purchase 2.0 million shares of GIGA’s common stock. +2022 Updates +We, +certain of our subsidiaries and Esousa, as the collateral agent on behalf of the investors (the “Agent”) entered into a security +agreement, pursuant to which we (i) pledged the equity interests in substantially all of our U.S. based subsidiaries and (ii) granted +to the investors a security interest in substantially all of our deposit accounts, securities accounts, chattel paper, documents, equipment, +general intangibles, instruments and inventory, and all proceeds therefrom. The entirety of the loan, including the original issue discount +and accrued but unpaid interest, was fully paid off on March 30, 2022. +On +February 4, 2022, we and our former subsidiary Ault Alliance, Inc. (the “Former AAI”) entered into a securities purchase agreement +providing for our purchase of BNI from the Former AAI. As a result of this transaction, both BNI and the Former AAI became stand-alone +wholly owned subsidiaries of ours. The Former AAI was merged out of existence on January 3, 2023 in connection with the change in our +name from BitNile Holdings, Inc. to Ault Alliance, Inc. +3 +On +February 10, 2022, consistent with our objective to have BNI operate the entirety of our business that relates to cryptocurrencies, the +Former AAI assigned the entirety of its interest in ACS to BNI. +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant to sell shares of common stock +having an aggregate offering price of up to $200 million from time to time, through an “at the market offering” program (the +“2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering was made pursuant to our effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. +333-260618) which became effective on November 12, 2021. Through March 13, 2023, we received gross proceeds of approximately $177 million +through the sale of approximately 317.9 million shares of common stock from the 2022 ATM Offering. The 2022 Sales Agreement has been terminated. +On March 20, 2022, we and +IMHC entered into a securities purchase agreement (the “Acquisition Agreement”) with TurnOnGreen, Inc., formerly known as +Coolisys Technologies Corp. (“TOGI”), which closed on September 6, 2022 (the “Closing Date”). According to the +Acquisition Agreement, we (i) delivered to IMHC all of the outstanding shares of common stock of TOGI that we owned, and (ii) forgave +and eliminated the intracompany accounts between us and TOGI evidencing historical equity investments made by us in TOGI, in the approximate +amount of $36.0 million, in consideration for the issuance by IMHC to us (the “Transaction”) of an aggregate of 25,000 newly +designated shares of Series A Preferred Stock (the “IMHC Preferred Stock”), with each such share having a stated value of +$1,000. Immediately following the Closing Date, TOGI became a wholly owned subsidiary of IMHC. The parties to the Agreement have agreed +that, upon completion of the Transaction but subject to IMHC’s compliance with the federal securities laws, IMHC will change its +name to TurnOnGreen, Inc. Further, through an upstream merger whereby the current TOGI ceased to exist, which was consummated on September +8, 2022, IMHC owns the former TOGI’s two operating subsidiaries, TOG Technologies and Digital Power. IMHC intends to dissolve its +dormant subsidiary. +On +September 5, 2022, we, IMHC and TOGI entered into an amendment to the Acquisition Agreement (the “Amendment”), pursuant to +which IMHC agreed to (i) use commercially reasonable efforts to effectuate a distribution by us of approximately 140 million shares of +Common Stock that we beneficially own (the “Distribution”), including the filing of a registration statement (the “Distribution +Registration Statement”) with the SEC, (ii) to issue to us warrants to purchase an equivalent number of shares of Common Stock to +be issued in the Distribution (the “Warrants”), and (iii) to register the Warrants and the shares of Common Stock issuable +upon exercise of the Warrants on the Distribution Registration Statement. +On June 1, 2022, the Company +converted the principal amount under the convertible promissory notes issued to it by AVLP and accrued but unpaid interest into common +stock of AVLP. The Company converted $20.0 million in principal and $5.9 million of accrued interest receivable at a conversion price +of $0.50 per share and received 51,889,168 shares of common stock increasing its common stock ownership of AVLP from less than 20% to +approximately 92%. +On +June 8, 2022, Ault Lending entered into a securities purchase agreement with BMI whereby Ault Lending agreed to purchase $12.0 million +of a new series of convertible preferred stock of BMI, which transaction closed on June 29, 2022. As part of the transaction we were issued +102,881 shares of BMI’s common stock and a warrant to purchase forty-nine percent (49%) of BMI’s common stock calculated on +a fully-diluted basis, subject to certain terms and conditions. Pursuant to a mutually agreed upon use of proceeds, BMI intends to deploy +significant proceeds via its subsidiary White River Holdings Corp. (“White River”) towards an oil drilling program across +its cumulative 30,000 acres of active mineral leases at both shallow, intermediate, and deep levels. BMI will also deploy additional proceeds +via its subsidiary Agora Digital Holdings, Inc. (“Agora Digital”) to provide us with up to 78 megawatts (“MW”) +of power within the State of Texas for digital asset mining capacity, subject to our election to proceed with this facility after having +conducted the requisite due diligence. +On +December 6, 2022, BNI entered into a hosting agreement with Agora Digital securing up to 78 MW of power. Agora Digital will initially +provide up to 12 MW of electricity for our use, which will enable us to initially power 3,750 S19j Pro miners in the second quarter of +2023. The Agora Digital power capacity would, if the project proceeds as presently anticipated, expedite our recently announced plans +to significantly expand our Bitcoin mining production capacity, including growing our number of deployed Bitcoin miners to approximately +23,065, representing an expected mining production capacity of approximately 2.67 exahashes per second. +On June 10, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Preferred Sales Agreement”) with Ascendiant to sell shares of our +13.00% Series D Cumulative Redeemable Preferred Stock (the “Preferred Shares”) having an aggregate offering price of up to +$46.4 million from time to time, through an “at the market offering” program (the “2022 ATM Preferred Offering”). +The offer and sale of Preferred Shares from the 2022 ATM Preferred Offering was made pursuant to our effective “shelf” registration +statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) which became effective +on November 12, 2021. Through March 31, 2023, we had received gross proceeds of approximately $1.7 million through the sale of 118,586 +Preferred Shares in the 2022 ATM Preferred Offering. +4 +In June 2022, Ault Lending +purchased a majority of the issued and outstanding shares of SMC in open market transactions. SMC is a Nasdaq-listed company that is +a worldwide leader in consumer karaoke products. The first to provide karaoke systems for home entertainment in the United +States, SMC sells its products worldwide through major mass merchandisers and online retailers. SMC +products incorporate the latest technology for singing practice, music listening, entertainment and social sharing and provides access +to over 100,000 songs for streaming and download. +On July 11, 2022, we announced +the formation of Ault Energy, a wholly owned subsidiary of ours. Ault Energy will partner with White River, a majority owned subsidiary +of BMI on drilling projects across 30,000 acres in Texas, Louisiana and Mississippi. Ault Energy, as Ault Lending’s designee, has +the right to purchase up to 25%, or such higher percentages at the discretion of White River, in various drilling projects of White River. +In August 2022, Ault Energy committed to purchasing 40% of the first drilling project offered, at a cost to Ault Energy of approximately +$1 million. +On August 10, 2022, we, through +our BNI and Ault Lending subsidiaries, entered into a note purchase agreement providing for the issuance of secured promissory notes with +an aggregate principal face amount of $11.0 million and an interest rate of 10%. The purchase price for the secured promissory notes was +$10.0 million. The holders of the secured promissory notes have a security interest in marketable securities, investments and certain +Bitcoin mining equipment. The secured promissory notes are further secured by a guaranty provided by us, as well as by Milton C. Ault, +our Executive Chairman. The maturity date of the secured promissory notes is August 10, 2023. BNI is required to make monthly payments +(principal and interest) of $1.0 million on the tenth calendar day of each month, starting in September 2022. After six months, BNI may +elect to pay a forbearance fee of $0.3 million in lieu of a monthly payment, which would extend the maturity date of the related secured +promissory notes one month for each forbearance. +On +August 15, 2022, BNI entered into a hosting agreement with Compute North LLC (“Compute North”). On September 22, 2022, Compute +North filed for bankruptcy protection, effectively rendering this hosting agreement null and void. We have retained counsel to assist +in this matter. We have removed the Bitcoin miners that were installed at the hosting facility in Texas. +On November 7, 2022, we and +certain of our subsidiaries borrowed $18.9 million of principal amount of term loans (the “Loans”) from a group of institutional +investors (the “Financing”). The Loans mature in 18 months, which may be extended to 24 months, accrue interest at the rate +of 8.5% per annum and are secured by certain of our and certain of our subsidiaries’ assets. Starting in January 2023, the lenders +have the right to require us to make monthly payments of $0.6 million, which will increase to $1.1 million in November 2023. The Loans +were issued with an original issue discount of $1.89 million. +The lenders received warrants +to purchase approximately 4.5 million shares of our common stock, exercisable for four years at $0.45 per share and warrants to purchase +another approximately 4.5 million shares of our common stock, exercisable for four years at $0.75 per share, subject to adjustment. +On November 7, 2022, Ault +Aviation, LLC, a wholly owned subsidiary of the Company (“Ault Aviation”), used proceeds from the Loans to purchase a private +aircraft for a total purchase price of $15.8 million. In addition, the Company and certain of its subsidiaries entered into various +agreements as collateral for the repayment of the Loans, including (i) a security interest in certain Bitcoin mining equipment, (ii) a +pledge of the membership interests of Third Avenue Apartments, (iii) a pledge of the membership interests of ACS, (iv) a pledge of the +membership interests of Ault Aviation, (v) a pledge in a segregated deposit account of $1.5 million of cash, (vi) a mortgage and security +agreement by Third Avenue Apartments on the real estate property owned by Third Avenue Apartments in St. Petersburg, Florida, (vii) a +future advance mortgage by ACS on the real estate property owned by ACS in Dowagiac, Michigan, and (viii) an aircraft mortgage and security +agreement by Ault Aviation on the private aircraft purchased by Ault Aviation on November 7, 2022. The Loans are guaranteed by Ault Lending, +LLC, Ault & Company, Inc., an affiliate of the Company, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive +Officer of Ault & Company, Inc. +On November 18, 2022, Circle +8 LLC, a newly formed Delaware limited liability company (“Circle 8”), entered into an Asset Purchase Agreement (the “Asset +Purchase Agreement”) with Circle 8 Crane Services LLC, a Delaware limited liability company (“Circle 8 Crane Services”) +pursuant to which Circle 8 agreed to purchase substantially all of the assets (the “Acquired Assets”) and assume certain specified +liabilities of Circle 8 Crane Services (the “Circle 8 Transaction”). Circle 8 is a wholly owned subsidiary of Circle 8 Holdco +LLC, a Delaware limited liability company (“Circle 8 Holdco”). +5 +On +December 19, 2022, the Asset Purchase Agreement referred to above closed and Circle 8 purchased the Acquired Assets. As consideration +for the acquisition of the Acquired Assets, Circle 8 Crane Services received Class D equity interests in Circle 8 Holdco and is eligible +to receive cash earnout payments in an aggregate maximum amount of up to $2.1 million based on the achievement by Circle 8 of certain +EBITDA targets over the three year period following the completion of the acquisition of the Acquired Assets by Circle 8. We contributed +$12 million to Circle 8, and an independent third party contributed $4 million, of which approximately $11.7 million was used to pay down +a portion of the Circle 8 Crane Services’ senior debt facility at the closing, $3.0 million of which was used to pay off Circle +8 Crane Services’ subordinated debt facility in full at the closing and $1.4 million was used to pay the expenses of Circle 8 and +Circle 8 Crane Services. In addition, Circle 8 assumed a new line of credit issued by Circle 8 Crane Services’ current senior lender. +Circle 8 Holdco is a subsidiary of the former AAI, a Delaware corporation but is presently directly owned by us. We own a controlling +interest in Circle 8 Holdco. +On +December 16, 2022 we entered into a Securities Purchase Agreement (the “SPA”) with an accredited investor (the “Investor”) +providing for the issuance of a secured promissory note (the “Note”) with an aggregate principal face amount of $14.7 million +(the “Financing”). On December 29, 2022, the Company and the accredited investor entered into an amended and restated amendment +to the SPA, pursuant to which the total amount of the financing was increased to $17.5 million and the Company sold an additional note +to a second accredited investor. +Under the SPA, we are obligated +to repay, while the Note remains outstanding, (i) eighty percent (80%) of the proceeds we may receive from any financing conducted, other +than at-the-market offerings and (ii) one hundred percent (100%) of the proceeds we may receive from the sale of marketable securities +by Ault Lending. In addition, if Third Avenue Apartments, LLC (“Third Avenue”), our wholly owned subsidiary, sells the property +it owns in St. Peterburg, Florida, then we will use the net proceeds from the sale of such property in excess of $10 million, to repay +the Note. In addition, we agreed to issue 11.6 million shares of our common stock to the Investor in exchange for the cancellation of +all outstanding warrants previously issued to the Investor, which warrants were exercisable for 11.6 million shares of our common stock. +2023 Updates +On January 23, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable +preferred stock (“Series C Preferred Stock”) which, effective upon filing, eliminated the Series C Preferred Stock. +On February 8, 2023, we entered +into a Share Exchange Agreement (the “Agreement”) with BMI and the other signatories thereto. The Agreement provides that, +subject to the terms and conditions set forth therein, BMI will acquire all of the outstanding shares of capital stock of our then subsidiary, +BitNile.com, Inc. (“BitNile.com”), of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders +(the “Minority Shareholders”), as well as Ault Iconic (f/k/a Ault Media Group) and the securities of Earnity beneficially +owned by BitNile.com (which represented approximately 19.9% of the outstanding equity securities of Earnity as of the date of the Agreement), +in exchange for the following: (i) 8,637.5 shares of newly designated Series B Convertible Preferred Stock of BMI to be issued to our +company (the “Series B Preferred”), and (ii) 1,362.5 shares of newly designated Series C Convertible Preferred Stock of BMI +to be issued to the to the Minority Shareholders (the “Series C Preferred,” and together with the Series B Preferred, the +“Preferred Stock”). The Series B Preferred and the Series C Preferred each have a stated value of $10,000 per share (the “Stated +Value”), for a combined stated value of the Preferred Stock to be issued by BMI of $100 million, and subject to adjustment, are +convertible into an aggregate of 400 million shares of common stock of BMI (the “BMI Common Stock”), which represent and pursuant +to the Agreement will represent approximately 92.4% of BMI’s outstanding BMI Common Stock on a fully-diluted basis. However, pending +approval of the transaction by BMI’s shareholders, the Preferred Stock combined are subject to a 19.9% beneficial ownership limitation. +The Agreement provides that BMI will seek shareholder approval (the “Shareholder Approval”) following the closing. +6 +Pursuant to the Certificates +of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred +Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of BMI Common Stock determined by +dividing the Stated Value by $0.25 (the “Conversion Price”), or 40,000 shares of BMI Common Stock. The Conversion Price will +be subject to certain adjustments, including potential downward adjustment if BMI closes a qualified financing resulting in at least $25 +million in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock +will be entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend +Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather +than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If +BMI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as +long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the +event of a liquidation, change of control event, dissolution or winding up of BMI, and will rank senior to all other capital stock of +BMI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred +was originally entitled to vote with the BMI Common Stock at a rate of 10 votes per share of Common Stock into which the Series B Preferred +is convertible, but that provision was subsequently eliminated. Other than certain rights granted to the Company relating to amendments +or waiver of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially +identical. +The Agreement closed on March +6, 2023. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.ault.com. +Our Corporate Structure +On January 19, 2021, we changed +our name from DPW Holdings, Inc. to Ault Global Holdings, Inc., on December 13, 2021, we changed our corporate name from Ault Global Holdings, +Inc. to BitNile Holdings, Inc. and on January 3, 2023, we changed our name from BitNile Holdings, Inc. to Ault Alliance, Inc (together, +the “Name Changes”). The Name Changes were each effected through a parent/subsidiary short form merger pursuant to an Agreement +and Plan of Merger dated January 7, 2021, December 1, 2021 and December 20, 2022, respectively. None of the mergers or the corresponding +Name Change affected the rights of our security holders. Our common stock is traded on the NYSE American under the symbol “AULT.” +Existing stock certificates that reflect our prior corporate names continue to be valid. Certificates reflecting the new corporate name +are issued as old stock certificates are tendered for exchange or transfer to our transfer agent. Concurrent with the change in our name +to Ault Global Holdings, Inc., Milton C. Ault III was appointed as our Executive Chairman, William B. Horne was appointed as our Chief +Executive Officer and remains as Vice Chairman of our board of directors (the “Board”), and Henry Nisser was appointed as +our President and remains as our General Counsel. +7 +Our corporate structure is +currently as follows: +Our Corporate Structure +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +8 +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for Ault Lending and approves all lending transactions. Under its business model, Ault Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to Ault Lending in any particular financing. +Over the recent past, we have +provided capital and relevant expertise to fuel the growth of businesses in cryptocurrency mining, DeFi, defense/aerospace, industrial, +telecommunications, medical and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity +interest or may be actively involved, influencing development through board representation and management support. +Our Principal Subsidiaries and their Businesses +The following is a brief +summary of the businesses in which we own a controlling interest as of the date of this annual report: +Circle 8 +History +In 2007, Philip and Allen +Bryson founded Circle 8 Fluid Services, Inc., which later became Circle 8 Crane Services, LLC in 2018 (“Former Circle 8”) +as a niche chemical provider to oilfield production and completion companies. In 2008, Former +Circle 8 began purchasing cranes to service the expanding natural gas drilling and completion +market. From 2009 through 2011, Former Circle 8 expanded +to East Texas and Western Louisiana. In 2012, Former Circle 8 opened operations in the Eagle +Ford Shale in South Texas, establishing an office and terminal in Corpus Christi. Former Circle 8 continued +expansion opening terminals in Houston, Texas and Clinton, Oklahoma. By 2013, Former Circle 8’s fleet grew to forty-seven +cranes and entered into master service agreements with well-established oil producers. In 2014, it purchased another 26 new all-terrain +mobile cranes, rendering its fleet size to 73, manned by over 300 non-union employees, and work orders from 397 new customers in 2014. +The COVID-19 pandemic and +the downturn in domestic oil market during 2020 and 2021, led Former Circle 8 to reduce its fleet throughout 2021. In December 2022, it +sold substantially all the operating assets to Circle 8, a newly formed joint venture between Circle 8 Holdco, with 64% ownership, and +Paramount Lifting Solutions, LLC (“PLS”), with 36% ownership. In connection with the acquisition of Former Circle 8 assets, +Circle 8 refinanced the existing debt owed by Former Circle 8 to CIT Northbridge Credit, LLC (“CITN”), in a $16 million senior +secured asset backed revolving line of credit, and Circle 8 assumed $10.6 million of outstanding equipment notes owed to De Lage Landen +Group, LLC (“DLL”). +Description of the Business +Headquartered in Houston, +Circle 8 is a premier lifting services provider serving clients in Texas, Oklahoma, Louisiana and Oklahoma with three strategically located +branches in Texas and Oklahoma. Its modern fleet consists of 54 mobile all-terrain and hydraulic cranes, with lifting capacities of up +to 350 tons that provides services across the Eagle Ford, Permian, Anadarko and Haynesville basins. Circle 8 is poised for organic growth +through a strengthened financial profile following its recapitalization in December 2022. Circle 8’s fleet consists of Grove, Xuzhou +Construction Machinery Group (“XCMG”) and other leading original equipment manufacturers. +Circle 8 provides experienced +professionally certified operators to deliver customized solutions to lifting clients in oil field services, construction, commercial, +refining / marketing and wind energy markets. Circle 8 maintains an industry leading safety record. Safety personnel hold certifications +and undergo in-house training. +9 +New Management +By teaming up with PLS in +the formation of Circle 8, three key management members from PLS, with significant industry experience, joined the team at Circle 8. In +April 2023, Circle 8 hired Arnold Mabee as its new CEO. Mr. Mabee has a longstanding, successful track record, as he was previously the +President of Sterling Crane USA, LLC (“Sterling Crane”), which has a portfolio of diverse cranes and locations serving multiple +business segments. As such, Mr. Babee is responsible for one of the larger mobile crane companies in the US. +Prior to joining Sterling +Crane, Mr. Mabee was the Partner in Charge / Administration at R.S. Phillips Steel LLC, a fourth-generation family-owned Steel Service +Center that serves the Tri-State Area of New York, New Jersey and Pennsylvania. During his time there, Mr. Babee pioneered several new +innovative ideas to enhance safety, compliance and productivity. +Mr. Mabee has thirty years +of operations and senior level management experience in a variety of industries including all aspects mobile crane & heavy haul services, +steel service centers and other industrial services businesses. Mr. Mabee has a long history of improving profitability, significantly +growing businesses, and where appropriate, taking them through successful restructuring and segmentation events. +With the appointment of Mr. +Mabee as CEO of Circle 8, Phillip Bryson continues on with Circle 8 as President. +Competitive Advantage +Circle 8’s operating +experience and the mid-sized diverse fleet that it has developed serves the oil services and petrochemical industries, providing full-service +lifting solutions with an industry leading safety record. Key strengths of Circle 8 include: +- Leading lifting solutions platform +o Leading provider of comprehensive lifting solutions to diversified end markets, including oil & gas +and with expanding operations in infrastructure, plant turn-around and commercial / industrial construction +o Leading market position with five branches strategically located throughout Texas and Oklahoma +- Industry leading safety record, commitment and policy +o Safety is a core value and Circle 8 is a market leader in employee training and practices +o Dedicated team focused on safety programs. +- Proven strength of management, recently enhanced and augmented +o Proven ability to navigate a secular downturn by maintaining strong customer relationships and scale operations +to capture additional market share +o Seasoned industry leaders who have positioned Circle 8 for future growth +o Additional advisory team to supplement full time management with strategic industry knowledge, contacts +and corporate transaction capability +- High quality fleet with the opportunity to expand by 100% creates a barrier to entry +o Current fleet of 54 cranes, comprised of 46 all-terrain cranes and 6 hydraulic truck cranes, with a combined +average age of 6.2 years and capacity of up to 350 tons +- Diversified blue-chip customers +o Entrenched provider to leading, well-capitalized oil and gas industry operators in Texas and Oklahoma +o Diverse customer base with minimal customer concentration risk +o Longstanding relationships enable company to easily scale up operations with customers’ demands +in the oilfield (upstream), commercial, construction, refining & marketing (downstream) and wind energy markets. +- Compelling utilization and financial profile +o Recently downsized underutilized cranes to return to pre-pandemic fleet utilization over 160% +o Substantial upside remains as Circle 8 efficiently relocates and repurposes its fleet across geographies +and end markets. +Industry +There continues to be some +consolidation within the industry recently, including the acquisitions of Rental Services Corporation, NES Rentals, Neff Corporation and +Ahern Rentals by United Rentals, Inc. (“URI”) and the acquisitions of Contractors Building Supply Co. and Cloverdale Equipment +Co. by Herc Holdings, Inc. (“HRI”). However, the U.S. lifting solution equipment distribution and rental industry remains +highly fragmented and consists mainly of a small number of multi-location regional or national operators and a large number of relatively +small, independent businesses serving discrete local markets. The industry is driven by a broad range of economic factors including total +U.S. residential and non-residential construction trends, construction machinery demand, demand for rental equipment and additional, region-specific +factors. Lifting solutions equipment is largely distributed to end users through two channels: equipment rental companies and equipment +dealers. Examples of equipment rental companies include URI, Sunbelt Rentals, and HRI. Examples of equipment dealers include Finning and +Toromont. Circle 8 operates substantially in a segment of the rental business whereby Circle 8 provides all labor and consumables to complete +a project or an assignment. Like Circle 8, many other pure equipment rental companies may also provide parts and service support to customers. +10 +Sales and Marketing +Lead by Phillip and Brett +Rhuland, the sales force is highly specialized in lifting solutions sales to oil services customers, seeking long term purchase orders +and master service agreements. Circle 8 plans to continue the extensive training program which involves OEM training sessions on operations +and maintenance to ensure the entire sales force knows the fleet inside and out. +Circle 8 will be working with +continuing management to implement a back-office content resource management system that will be heavily focused on data collection so +that it can continue to improve margin and help streamline scheduling, operations and fleet management to optimize utilization. +Competitive Business Strategy +The oil services’ lifting +solutions demand has historically been one of the leading sub-segments of the industry for profitability due to high utilization rates +that coincide with the continuous workstreams of extraction. Circle 8 plans to expand this business line in both topline sales through +optimizing service and quality operations with a strong safety record. +In addition to expanding the +existing business, Circle 8 will seek to make additional forays into the infrastructure construction, the refinery and manufacturing plant +turn-around and industrial facility construction with the availability of new cranes as they become available. +Customers +With a focus on the oil services +sub-segment of the lifting solutions business in the Eagle Ford, Haynesville, Permian and Anadarko basins, Circle 8 has a diversified +base of blue-chip customers in TX and OK. While about a third of its sales are expected to be made up from six of the largest players +in the industry, the remaining two thirds of sales will be highly diversified, leading to minimal concentration risk. With its longstanding +relationships with blue-chip customers and incoming fleet units, Circle 8 believes it has the ability to scale up sales with these customers +locally and most likely into other adjacent areas. +Competition +Due to the highly skilled +nature and competitive nature of the lifting solutions business, the sector typically consists of companies like Circle 8 that provide +full service lifting solutions on rental or contract basis, including the manpower required to operate the equipment or companies that +require extensive lifting solutions straight purchasing the equipment and hiring crane operators directly. +The full-service lifting solutions +business is highly fragmented and local with only a few national service providers. In Circle 8’s existing subsegment of the lifting +solutions business to the petrochemical industry, the competition is not as strong as it is in others as the contract terms are usually +longer term and driven by maintaining strong customer relationships. The diversification strategy for Circle 8 into other subsegments +will be faced with competition that is largely driven based on availability, quality (including safety record), reliability and price. +Environmental and Safety Regulations +Circle 8’s equipment, +facilities and operations are subject to comprehensive and frequently changing federal, state and local environmental and occupational +health and safety laws, which may vary locally. These laws regulate (1) the handling, storage, use and disposal of hazardous materials +and waste and, if any, the associated cleanup of properties affected by pollutants; (2) air quality (emissions); and (3) wastewater. While +lifting solutions’ operations generally do not raise significant environmental risks, Circle 8 uses petroleum products, solvents +and other hazardous substances for fueling and maintaining its fleet and vehicles. Circle 8 has made, and will continue to make, capital +and other expenditures to comply with environmental requirements. Circle 8 does not currently anticipate any material adverse effect on +its business, financial condition or competitive position as a result of its efforts to comply with such requirements. +11 +In the future, federal, state +or local governments could enact new or more stringent laws or issue new or more stringent regulations concerning environmental and worker +health and safety matters, reporting and disclosure obligations, or effect a change in their enforcement of existing laws or regulations, +that could affect operations and increase operational and compliance expenditures. Also, in the future, contamination may be found to +exist at Circle 8’s facilities or off-site locations where waste has been sent. There can be no assurance that Circle 8, or various +environmental regulatory agencies, will not discover previously unknown environmental non-compliance or contamination. Circle 8 could +be held liable for such newly discovered non-compliance or contamination. It is possible that changes in environmental and worker health +and safety laws or liabilities from newly discovered non-compliance or contamination could have a material adverse effect on Circle 8’s +business, financial condition and results of operations. +BitNile, Inc. +BNI conducts data center operations +and Bitcoin mining through ACS. +Overview +BNI is a blockchain technology +company focused on mining of Bitcoin. We mine using purpose-built computers (or “miners”) to solve complex cryptographic algorithms +(or “verify” or “solve” blocks) in the blockchain in exchange for rewards and fees denominated in the native token +of that blockchain network. Our miners provide computing power to a Bitcoin mining pool operator, in which all the participants’ +machines mine Bitcoin as a collective group, and we get paid the expected value of both the block reward and transaction fees for doing +so, rather than mine directly for our own account. The mine pool operators receive block rewards and transaction fees paid in Bitcoin +by the blockchain when the mine pool finds new blocks. The reward and transaction fees are then shared by the pool participants based +on their hash rate contributions to the pool, less a small amount of fees. +We will evaluate each digital +asset in our portfolio, or that we propose to acquire in the future (including by mining), to determine whether it would likely be considered +a security under U.S. federal securities laws, in consultation with outside counsel, as applicable. We will base our analysis on relevant +case law, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance by the SEC and +its staff. See “Risk Factors —  Risks Related to Our Bitcoin Operations – Legal and Regulatory —  +A particular digital asset’s status as a ‘security’ in any relevant jurisdiction is subject to a high degree of uncertainty +and if a regulator disagrees with our characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines +and penalties, which may adversely affect our business, operating results and financial condition. A determination that Bitcoin that we +own or mine is a ‘security’ may adversely affect the value of Bitcoin and our business.” +Our Vision +Traditional finance has historically +had poor customer service and a less than desirable user experience in mobile and web-based platforms, which opens the door to massive +disruption through digital technologies. Additionally, central bank intervention in the financial markets has increasingly turned to money +printing through quantitative easing, which increasingly dilutes the buying power of the global fiat currency market and leads the world +to seek more scarce alternatives. The first phase of the digital transformation has been through the creation of blockchain-based digital +assets. We believe the second phase of this transition will be take form in bridges being built between DeFi and traditional finance to +help improve customer service and user experience in traditional finance. +We foresee a time when traditional +banking is done in the palm of our hands in community-based, peer-to-peer transactions as opposed through financial intermediaries. This +community-based, peer-to-peer network is otherwise known as DeFi. Although we do not believe DeFi will replace traditional finance in +the near- to medium-term, we believe this transition will happen over the next 20 years as Millennials and Gen-Xers become the power class +and the Baby Boomers retire. DeFi is a concept whereby traditional financial intermediaries are not required to process transactions. +The proliferation of blockchain-based protocols will enable participants to offer novel financial products to banking customers. For instance, +in a world where traditional finance provides savings account rates less than 1%, DeFi protocols can provide savings accounts with significantly +higher yields. Traditional financial platforms are not currently designed to distribute these products to its customers. We believe that +in the near-term integrating a traditional broker dealer could help facilitate the distribution of these decentralized finance protocols +to a broad base of customers. While we recognize DeFi is in its infancy stage, we believe blockchain will be integral to its advancement. +We recognize the uncertainties in DeFi and its effect on our economy both in the U.S. and globally, and acknowledge that this is a new +evolving area that may not evolve as we anticipate and in which we may never be a material participant. +12 +We have no present intention +of incorporating Earnity’s business or operations, or that of any other DeFi platform, with our own. On March 6, 2023, our beneficial +ownership in Earnity was transferred to BMI. +Cryptocurrency and Cryptocurrency Mining Overview +Blockchain and Cryptocurrencies Overview +Cryptocurrencies are a type +of digital asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). +Cryptocurrencies operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized +digital ledger that enables the secure use and transfer of digital assets. We believe cryptocurrencies and associated blockchain technologies +have potential advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate +settlement of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” Recently, cryptocurrencies +have gained widespread mainstream attention and have begun to experience greater adoption by both retail and institutional investors and +the broader financial markets. As cryptocurrencies, and blockchain technologies more generally, have entered the mainstream, prices of +digital assets have reached all-time highs and the broader ecosystem has continued to develop. While we expect the value of Bitcoin to +remain volatile, we believe the general increase in aggregate market value signals institutionalization and wider adoption of cryptocurrency. +Cryptocurrencies are generally +decentralized currencies that enable near instantaneous transfers. Transactions occur via an open source, cryptographic protocol platform +which uses peer-to-peer technology to operate with no central authority. The online network hosts the public transaction ledger, +known as the blockchain, and each cryptocurrency is associated with a source code that comprises the basis for the cryptographic and algorithmic +protocols governing the blockchain. In a cryptocurrency network, every peer has its own copy of the blockchain, which contains records +of every historical transaction — effectively containing records of all account balances. Each account is identified solely +by its unique public key (making it effectively anonymous) and is secured with its associated private key (kept secret, like a password). +The combination of private and public cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing +strong control of ownership. +In a cryptocurrency network, +generally no single entity owns or operates the network. The infrastructure is typically collectively maintained by a decentralized public +user base. If the network is decentralized, it will not rely on either governmental authorities or financial institutions to create, transmit +or determine the value of the currency units. Rather, the value is determined by market factors, supply and demand for the units, the +prices being set in transfers by mutual agreement or barter among transacting parties, as well as the number of merchants that may accept +the cryptocurrency. Since transfers generally do not require involvement of intermediaries or third parties, there are only nominal transaction +costs in direct peer-to-peer transactions. For example: +● In terms of conventional peer-to-peer transactions, there either are no fees or they are de minimis (Source: +https://www.kraken.com/en-us); +● For purposes of traditional networks, there are nominal fees associated with any transaction (Source: +https://bitinfocharts.com/bitcoin); and +● +As +of April 15, 2023, the average Bitcoin network fee is $1.20 per transaction, which is still +very low compared to conventional transaction fees charged by banks and other more traditional +financial institutions (https://bitinfocharts.com/bitcoin). +The network fee is separate +and distinct from the pool fee we pay Antpool for its services in acting as a pool operator, discussed below. The network fee is applicable +to anyone who transacts on the blockchain. +Although fees are generally +low, block space continues to be a key issue in regards to the volume of transactions on a blockchain. Mining fees can and often do fluctuate +from transaction to transaction as a result of “congestion.” However, this congestion does not negate any of the statements +made immediately above. +Units of cryptocurrency can +be converted to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as Binance, Coinbase, Kraken, +Gemini and others. Cryptocurrency prices are quoted on various exchanges and fluctuate with extreme volatility. +13 +We believe cryptocurrencies, +particularly Bitcoin, the only cryptocurrency we receive for providing computing power to a mining pool operator, offer many advantages +over traditional, fiat currencies, although many of these factors also present potential disadvantages and may introduce additional risks, +including: +● Acting as a fraud deterrent, as cryptocurrencies are digital and cannot be counterfeited or reversed arbitrarily +by a sender; +● Immediate settlement; +● Elimination of counterparty risk; +● No trusted intermediary required; +● Lower fees; +● Identity theft prevention; +● Accessible by everyone; +● Transactions are verified and protected through a confirmation process, which prevents the problem of +double spending; +● Decentralized — no central authority (government or financial institution); and +● Not recognized universally and not bound by government imposed or market exchange rates. +However, cryptocurrencies may not provide all +of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, +there are many factors that can affect all digital asset mining companies and Bitcoin in particular: +· Limitations on the supply of the cryptocurrency being mined; +· The market price of the cryptocurrency; +· Cost of power: +· Mining difficulty and overall network hashrate; +· Regulatory oversight; and +· Hosting availability. +The Bitcoin halving is a phenomenon +that occurs approximately every four years on the Bitcoin network. The halving is a key part of the Bitcoin protocol, and it serves to +control the overall supply and reduce the risk of inflation in digital assets using a Proof-of-Work consensus algorithm. At a predetermined +block, the mining reward is cut in half, hence the term “halving”. For Bitcoin the reward was initially set at 50 Bitcoin +currency rewards per block. The Bitcoin blockchain has undergone halving three times since its inception as follows: (1) on November 28, +2012 at block height 210,000; (2) on July 9, 2016 at block height 420,000; (3) on May 11, 2020 at block height 630,000, when the reward +was reduced to its current level of 6.25 Bitcoin per block. The next halving for the Bitcoin blockchain is anticipated to occur on or +around March 2024 at block height 840,000. This process will reoccur until the total amount of Bitcoin currency rewards issued reaches +21 million and the theoretical supply of new Bitcoin is exhausted, which is expected to occur around 2140. +We currently only participate +in mining pools that mine Bitcoin. Our business is heavily dependent on the price of Bitcoin. The prices of digital assets, including +Bitcoin, have experienced substantial volatility, meaning that high or low prices may be based on speculation and incomplete information, +may be subject to rapidly changing investor sentiment, and may be influenced by factors such as technology, regulatory void or changes, +fraudulent actors, manipulation, and media reporting. Bitcoin may have value based on various factors, including their acceptance as a +means of exchange by consumers and producers, scarcity, and market demand which are beyond our control. See “Risk Factors – +Risks Related to Our Bitcoin Operations” for more information on the risks we face due to our mining of Bitcoin and its speculative +and volatile nature. +Cryptocurrency Mining and Mining Pools +As a participant in a cryptocurrency +mining pool, we use specialized miners to solve cryptographic math problems necessary to record and “publish” cryptocurrency +transactions to blockchain ledgers. Generally, each cryptocurrency has its own blockchain, which consists of software code (also known +as a protocol), which is run by all the computers on the network for such blockchain. Within this code, transactions are collated into +blocks, and these blocks must meet certain requirements to be verified by the blockchain software, added to the blockchain or ledger of +all transactions and published to all participants on the network that are running the blockchain software. After a transaction is verified, +it is combined with other transactions to create a new block of data for the blockchain. For proof-of-work blockchains, the process of +verifying valid blocks requires computational effort to solve a cryptographic equation, and this computational effort protects the integrity +of the blockchain ledger. This process is referred to as “mining.” As a reward for verifying a new block, miners receive payment +in the form of the native cryptocurrency of the network (e.g., Bitcoin). This payment is comprised of a block reward (i.e., the automatic +issue of new cryptocurrency tokens) and the aggregated transaction fees for the transactions included in the block (paid in existing cryptocurrency +tokens by the participants to the transactions). The block reward payments and the aggregated transaction fees are what provide the incentive +for miners to contribute hash rate to the network. +14 +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific cryptocurrency, and the blockchain-wide hash rate for a specific cryptocurrency can be understood as the aggregate +of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +and other cryptocurrencies are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known +as the “mining difficulty,” which is the level of computational activity required before a new block is solved and verified. +For example, on the Bitcoin blockchain the protocol is coded such that a new block is solved and verified approximately every ten minutes, +while on Ethereum blocks are designed to be solved approximately every twelve to fifteen seconds. As such, to the extent the hash power +on the network is increased or decreased due to, for example, fluctuations in the number of active miners online, mining difficulty is +correspondingly increased or decreased to maintain the preset interval for the verification of new blocks. +On certain cryptocurrency +networks, including Bitcoin, the rewards for solving a block are also subject to periodic incremental halving. Halving is a process designed +to control the overall supply and reduce the risk of inflation in cryptocurrencies using a proof-of-work consensus algorithm. After a +predetermined number of blocks are added to the blockchain, the mining reward is cut in half, hence the term “halving.” The +last halving for Bitcoin occurred on May 11, 2020. The next halving for Bitcoin is expected to occur in 2024, and as such, absent +any changes to the Bitcoin protocols, the block reward will remain stable until then. Transaction fees are variable and depend on the +level of activity on the network. Generally, transaction fees increase during times of network congestion, as miners will prefer transactions +with higher fees, and therefore a higher fee can reduce the time to process a transaction, and decrease when there are fewer transactions +on the network. +As the total amount of available +hash rate has increased (particularly on the Bitcoin network), it has become increasingly difficult for any individual miner to independently +solve a block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool operator, rather than an individual miner, +validates the block and receives the block reward and related transaction fees. The mining pool is organized by a third party, in our +case Antpool.com. In consideration for receiving a percentage of the earned block rewards and transaction fees, Antpool.com administers +the pool and ensures that the participants in the pool receive their share of the block reward and related transaction fees, generally +pro-rata to their contributed hash rate. Mining pools offer miners more predictable and consistent revenue compared to mining individually. +We participate in mining pools by providing what the industry refers to as “hashrate” to the pool. Hashrate is defined as +the computing power that our mining equipment produces when helping to validate a block that the mining pool is trying to solve. We use +the FPPS, or Full Pay-Per-Share, method when mining with Antpool.com. Pursuant to the “Full Pay Per Share” model, both the +block reward and the mining service charge are settled according to the theoretical profit. It includes the calculation of a standard +transaction fee within a certain period and distributes it to mining pool participants according to their hash power contributions in +the pool. It increases the mining pool participants’ earnings by sharing transaction fees. Standard transaction fees are calculated +using a certain period which are then distributed to miners according to their hash power contributions in the pool. Antpool.com currently +charges us a 0.3% mining fee. +We provide computing power +to the mining pool, which is run by the mining pool operator with whom we contract, who in turn provides transaction verification services. +Based on the terms of the agreement, in our judgment, the mining pool operator is considered the principal in providing mining pool services. +We recognize revenue, net of certain transaction fees from the mining pool operator, which are not considered material. To date, we have +only used one mining pool operator. Our current mining pool agreement is cancelable at any time by either party without penalty. Revenue +received from for providing computing power would be directly impacted positively or negatively should we start and stop providing computing +power to the mining pool operator within a given reporting period. +15 +Our Strategy +Smart Growth +We aim to optimize our mining +by actively monitoring and adjusting the operation of mining machines to enhance their performance. When planning our short- and long-term +operating strategies and capital expenditures, we carefully monitor fluctuations and longer-term trends in the value of certain cryptocurrencies, +which impacts the return on investment of machines. We also regularly evaluate potential innovations in geography, physical footprint, +computing technology and similar areas to improve our operations and productivity. We believe this smart growth strategy, including our +commitment to mining efficiency and return on investment in miners, will enable us to build value over the long term. +Own and Operate Our Mining Facilities +We have made significant investments +in purchasing, building and operating our mining facilities. By owning and operating our miners at facilities that offer competitive advantages, +including access to reliable, low-cost, renewable power and room for expansion, we expect to have greater control over the timing of the +purchase and deployment of our miners. We also may enhance our ability to intelligently and quickly adapt our operating model and reap +savings compared to paying for outsourced operations and infrastructure. We anticipate that we will continue to consider other opportunities +to integrate our operations, including with respect to both the software utilized by our fleet and the associated hardware. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in cryptocurrency mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable amounts of electrical energy to perform +their functions and mine Bitcoin; consequently, a critical aspect of operating in the cryptocurrency mining industry is obtaining a reliable +supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased the Facility, which currently has +access to 28 megawatts of power in preparation for the planned purchase of Bitcoin mining equipment. Since the purchase of the Facility, +we have invested in infrastructure improvements and began both ramping up the sites power capacity and installing S19j Pro miners. To +date, we have increased power load from 1.5 megawatts to 28 megawatts . In addition, we are +working on a formal agreement with the utility company that currently provides our power to expand the site’s capacity up to 297 +megawatts, which could take up to 24 months to complete such an expansion. Our relationship with the utility company has grown +as we have demonstrated our ability to upgrade and use power at our site effectively. We are in the midst of finalizing those expansion +details with the utility company, engineers, and the Economic Development Agency. This planned expansion would allow the operation of +up to as many as 90,000 Bitcoin miners at the Facility. +We continue to evaluate other +sites, locations, and partnerships for additional and alternative support of future mining operations. While we have not at present entered +into any other agreements, we will continue to explore and evaluate additional facilities that that would enable us to expand our mining +operations as needed. +Our Mining Operations +On January 29, 2021, ACS closed +on the acquisition of the 617,000 square foot energy-efficient Facility for a purchase price of $4.0 million. The purchase price was paid +using our own working capital. The Facility has been remodeled and converted over the past year into a site focused on three types of +business (commercial real estate, enterprise data center, and high-density computing). +The buildout of the initial +30,000 square feet will be used primarily for our Bitcoin mining operations. While we believe the Facility and its anticipated future +operations will be successful, there is a risk that our expectations will not materialize in a timely manner, if at all. +16 +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain. We have received 20,645 Antminers, fulfilling the first five of seven Bitmain Agreements including 4,628 environmentally +friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) and 16,017 S19j Pro Antminers +that feature a processing power of 100 TH/s. The 20,645 Antminers in our possession, once installed and energized, will generate a combined +processing power of approximately 2.25 exahashes per second (“EH/s”), the computational power that is being used to mine Bitcoin. +Beyond the first five contracts +with Bitmain, we have two more purchase agreements for an additional 1,325 S19j Pro Antminers estimated to be delivered over the second +quarter 2023 and 1,140 S19 XP Hydro Antminers anticipated to be delivered during the summer of 2023. Once all of the miners are fully +deployed and operational, we expect to achieve a mining production capacity of approximately 2.67 EH/s. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +Our strategy includes identifying +less expensive, clean power for our Bitcoin mining operations. Management of the company has considered the issues surrounding the environmental +impact of our Bitcoin mining operations. Based on this review, we have concluded that the environmental impact of our mining operations +is not material given that approximately 85% of the energy we use is “green,” meaning it is sourced from nuclear, wind or +solar power. In addition to our continued expansion investments at the Facility, we also seek out new locations to support our Bitcoin +mining business. We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but also +leasing buildings and facilities, hosting relationships and strategic partnerships. At this time, we have not entered into any new mining +agreements at locations other than the Facility. We currently mine Bitcoin only. +Coins that are mined are held +in a custodial account as digital assets. We transitioned from NYDIG to Gemini Trust Company, LLC (“Gemini”) as custodian +and securely store our digital assets at Gemini, a regulated, audited and insured cryptocurrency custodian. The custody arrangements require +that we mine to a custodial wallet address where the private key is held by the custodian and all keys for the wallet are held in cold +storage. This provides a layer of protection in both the transaction and liquidation phases of the operations by using multi-factor and +multi-person approval processes, to include Know Your Customer and Anti-Money Laundering procedures of the receiving party. We will either +hold the digital assets or may choose to convert those assets into fiat currency depending on financial needs and plans. When we opt to +convert the digital assets we sell or exchange our Bitcoin through Gemini, the custodian of our digital wallet. When we elect to make +a sale or exchange our Senior Vice President - Finance submits a request to Gemini’s execution department to exchange Bitcoin for +U.S. dollars. Gemini sends an approval email to our CEO to approve. Once approved by our CEO, Gemini executes the sale/exchange on its +trading platform at current market prices, less commissions, and deposits the U.S. dollars into our bank account. +Beyond the foregoing, our +custody agreement with Gemini provides that: +● Gemini provides a unique custody account in which all our blockchain assets are held, which are segregated +from all others’ assets and are verifiable through the blockchain; and +● Gemini charges us fees in Bitcoin, which is deducted from our digital assets on the last business day +of every month. +Currently, we are converting +Bitcoin received from our mining activities into fiat currency on a bimonthly basis, on average, to pay for operating costs and purchase +commitments for new mining equipment. We are not currently holding any digital assets for investment. +Our Contracts with Bitmain +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain. We have received 20,645 Antminers, fulfilling the first five of seven Bitmain Agreements including 4,628 environmentally +friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) and 16,017 S19j Pro Antminers +that feature a processing power of 100 TH/s. The 20,645 Antminers in our possession, once installed and energized, will generate a combined +processing power of approximately 2.25 exahashes per second (“EH/s”), the computational power that is being used to mine Bitcoin. +17 +Beyond the first five contracts +with Bitmain, we have two more purchase agreements for an additional 1,325 S19j Pro Antminers estimated to be delivered over the second +quarter 2023 and 1,140 S19 XP Hydro Antminers anticipated to be delivered during the summer of 2023. Once all of the miners are fully +deployed and operational, we expect to achieve a mining production capacity of approximately 2.67 EH/s. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +Regulation +Cryptocurrency mining is largely an unregulated +activity at both the state and federal level. We anticipate that cryptocurrency mining will be a focus for increased regulation in the +near- and long-term, and we cannot predict how future regulations may affect our business or operations. +In March 2022, the United States announced plans +to establish a unified federal regulatory regime for cryptocurrency, and a group of United States Senators sent a letter to the United +States Treasury Department asking Treasury Secretary Yellen to investigate Treasury’s ability to monitor and restrict the use of +cryptocurrencies to evade sanctions imposed by the United States. We are unable to predict the impact that any new regulations may have +on our business at the time of filing this Annual Report. We continue to monitor and proactively engage in dialogue on legislative matters +related to our industry. +In September 2022, the White House issued a report +regarding the Climate and Energy Implications of Crypto-Assets in the United States. The report states that the Department of Energy and +Environmental Protection Agency should initiate a process to solicit data and develop environmental performance and energy conservation +standards for crypto-asset technologies, including mining equipment. Should such measures prove ineffective at achieving the Administration’s +environmental goals, the report calls for the Administration to explore executive actions and legislation to limit or eliminate the use +of high energy intensity consensus mechanisms for crypto-asset mining. +We are unable to predict the impact that any new +standards, legislation, or regulations may have on our business at the time of filing this Annual Report. We continue to monitor and proactively +engage in dialogue on regulatory and legislative matters related to our industry. +Further, in December 2022 the SEC’s Division +of Corporation Finance issued guidance advising companies to disclose exposure and risk to the cryptocurrency market. While the focus +is on digital asset managers and exchanges, and not Bitcoin miners, the failure of such large asset managers and exchanges may create +increased price volatility of Bitcoin. +In January 2023, the Federal Reserve, Office of +the Comptroller of the Currency, and Federal Deposit Insurance Corporation issued a joint statement discouraging banks from doing business +with clients in crypto-asset industries. In January 2023, the Federal Reserve also issued a policy statement broadening its authority +to cover state-chartered banks. +Also in January 2023, the House of Representatives +announced its first ever Financial Services Subcommittee on Digital Assets and the intention to develop a regulatory framework for the +digital asset industry. Bipartisan leadership of the Senate Banking Committee announced that goal as well. +As the regulatory and legal environment evolves, +we may become subject to new laws, such as further regulation by the SEC and other agencies, which may affect our mining and other activities. +For additional discussion regarding our belief about the potential risks existing and future regulation pose to our business, see Part +I, Item 1A. “Risk Factors” of this Annual Report. +Competition +Our business environment is +constantly evolving, and cryptocurrency miners can range from individual enthusiasts to professional mining operations with dedicated +data centers. We compete with other companies that focus all or a portion of their activities on cryptocurrency mining activities at scale. +We face significant competition in every aspect of our business, including, but not limited to, the acquisition of new miners, the ability +to raise capital, obtaining the lowest cost of electricity, obtaining access to energy sites with reliable sources of power, and evaluating +new technology developments in the industry. +18 +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this annual report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies +which we have identified as our competitors: +● Argo Blockchain PLC; +● Bit Digital, Inc.; +● Bitfarms Technologies Ltd. (formerly Blockchain Mining Ltd); +● Cipher Mining Inc.; +● Core Scientific, Inc.; +● Digihost International, Inc.; +● DMG Blockchain Solutions Inc.; +● Galaxy Digital Holdings Ltd.; +● Greenidge Generation Holdings Inc.; +● HashChain Technology, Inc.; +● Hive Blockchain Technologies Inc.; +● Hut 8 Mining Corp.; +● Iris Energy Limited; +● Layer1 Technologies, Inc.; +● Marathon Digital Holdings, Inc.; +● MGT Capital Investments, Inc.; +● Northern Data AG; +● Riot Blockchain, Inc.; +● Overstock.com Inc.; and +● Stronghold Digital Mining, Inc. +Intellectual Property +We plan to use specific hardware +and software for our cryptocurrency mining operations. In certain cases, source code and other software assets may be subject to an open +source license, as much technology development underway in this sector is open source. For these works, we intend to adhere to the terms +of any license agreements that may be in place. +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. +Accounting for Digital Currencies +Digital currencies are included +in current assets in the combined balance sheet. Digital currencies are recorded at cost less any impairment. An intangible asset with +an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances +occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount +exceeds its fair value. In testing for impairment, we have the option to first perform a qualitative assessment to determine whether it +is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, +a quantitative impairment test is not necessary. If we conclude otherwise, we will be required to perform a quantitative impairment test. +To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment +losses is not permitted. We account for our mining-related gains or losses in accordance with the first-in, first-out method of accounting. +19 +Ault Lending +Ault +Lending acquires controlling or non-controlling interests in and actively manages businesses that we generally believe (i) are undervalued +and have disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, +(iii) have positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, and (v) have +strong management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading middle-market businesses +in the niche-industrial and branded-consumer sectors. +Ault +Lending uses a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing +the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. +Ault +Lending believes that private company operators and corporate parents looking to sell their business units may consider us an attractive +purchaser because of our ability to: +● provide ongoing strategic and financial support for their businesses, including professionalization of +our subsidiaries at scale; +● maintain a long-term outlook as to the ownership of those businesses; +● sustainably invest in growth capital and/or add-on acquisitions where appropriate; and +● consummate transactions efficiently without being dependent on third-party transaction financing. +In +particular, we believe that our outlook on length of ownership and active management on our part may alleviate the concern that many private +company operators and parent companies may have with regard to their businesses going through multiple sale processes in a short period +of time. We believe this outlook enhances our ability to develop a comprehensive strategy to grow the earnings and cash flows of each +of our businesses. +Finally, +it has been our experience that our ability to acquire businesses without the cumbersome delays and conditions typical of third party +transactional financing is appealing to sellers of businesses who are interested in confidentiality, speed and certainty to close. +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2022, we believe that these businesses have strong +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Ault Lending provides funding +to businesses through loans and investments. Ault Lending offers a variety of loan types including commercial loans, convertible notes +and revolving lines of credit. Ault Lending is engaged in providing commercial loans to companies throughout the United States to provide +them with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to 12 months, +but may be of longer duration. These terms are subject to change as market needs dictate, and Ault Lending anticipates offering additional +products in the future. +Ault Lending uses its considerable +financial experience, data analytics, and a credit scoring model to assess the creditworthiness of each small business borrower applicant. +If the business meets Ault Lending’s criteria, Ault Lending sets the initial interest rate according to its credit and financial +models. The final interest rate offered to the borrower will be determined by Ault Lending’s interpretation of the marketplace. +In order to borrow from Ault Lending, borrowers must display characteristics indicative of durable business and financial situations. +These include factors such as revenue, time in business, number of employees, and financial and credit variables. In order to qualify, +business borrower applicants must be approved through Ault Lending’s underwriting process, which analyzes credit and financial data +of both the business and the business owner. Ault Lending takes into account several business factors (including revenue, age of business, +cash flows, and other variables). The underwriting process determines the loan amount to approve, how loans will be priced, and whether +to include a blanket lien is based on the above analysis, as well as additional factors (including length of loan, estimated default rates +by type and grade, and general economic environment). +20 +Our Executive Committee, which +is comprised of our Executive Chairman, Chief Executive Officer and President, acts as the underwriting committee for Ault Lending and +approves all lending transactions. The Executive Committee has decades of experience in financial, investing and securities transactions. +Under its business model, Ault Lending generates revenue through origination fees charged to borrowers and interest generated from each +loan. Ault Lending may also generate income from appreciation of investments in marketable securities as well as any shares of common +stock underlying convertible notes or warrants issued to Ault Lending in any particular financing. +As noted above, we will from +time to time, through Ault Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2023, we anticipate +providing significant new funding to expand Ault Lending’s loan and investment portfolio. Ault Lending loans are made or arranged +pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +Ault Alpha +Ault Lending is the principal +owner of Ault Alpha, a term we use that comprises an investment fund, a general partner and an investment manager all formed on July 15, +2021. Ault Alpha generally seeks to invest in public companies or private companies with public debt that have strong relative value metrics +but poor Wall Street recognition; such companies can often experience valuation inefficiencies. Ault Alpha seeks to identify and invest +in these undervalued companies. In certain companies, Ault Alpha will actively intervene to assist management to maximize stockholder +value. Ault Alpha believes that an activist role can result in the creation of significant value and larger than average returns on investment. +Ault Alpha will own a concentrated portfolio, and typically invest with a long-term perspective. Further, Ault Alpha will employ a systematic +process, developed over decades of collective experience in the capital and credit markets, to seek specific value-creating events and/or +special situations, to provide compelling return potential and generate competitive capital appreciation and total return by making investments +in three key categories: (i) undervalued or overvalued assets; (ii) activist trading; and (iii) volatility trading and arbitrage. Ault +Alpha has purchased the Company’s common stock in open-market transactions. +BitNile Metaverse, Inc . +As discussed above, we +recently transferred our entire ownership of BitNile.com, or BNC, to BitNile Metaverse, or BMI. As part of that transaction, we also transferred +our ownership of Ault Iconic and all of our beneficial ownership of Earnity to BMI. +Overview +BNC, an entity in the embryonic +stage of development, represents a groundbreaking development in the online metaverse landscape, offering immersive, interconnected digital +experiences that are inclusive, engaging, and dynamic. By integrating various elements such as virtual markets, real world goods marketplaces, +gaming, social activities, sweepstakes, gambling, and more, BNC aims to revolutionize the way people interact online. BNC’s rapidly +growing virtual world, BitNile.com (the “Platform”) is accessible via any device using any web browser, without requiring +permissions, downloads, or apps, and the Platform can be enjoyed without the need for bulky and costly virtual reality headsets. +BNC’s business strategy +revolves around creating a seamless, all-encompassing Platform that caters to various user needs and interests. The Platform’s strategic +pillars include: +· Leveraging cutting-edge technology to offer a +user-friendly, browser-based platform compatible with VR headsets and other modern devices; +· Providing a diverse range of products and experiences +that cater to users with different interests and preferences; +· Fostering global connections and a sense of community +among users, encouraging socialization and collaboration; and +· Ensuring continuous innovation to stay ahead +of industry trends and customer expectations. +21 +Customers +BNC targets a broad audience, +including: +· Tech-savvy individuals seeking immersive digital +experiences; +· Gamers of all skill levels interested in a diverse +array of gaming options; +· Collectors and traders of digital assets, such +as virtual real estate, digital art, and unique collectibles; +· Shoppers seeking a convenient, intuitive platform +for purchasing real world goods; and +· Users seeking social interaction and global connectivity +in a virtual environment. +Products +BNC offers an extensive range +of products and experiences, including: +· Virtual markets: Sales of digital assets from +BNC as well as third party vendors like virtual real estate, digital art, user customizations, and unique collectibles; +· Real world goods marketplaces: A platform for +shopping a diverse range of real world products; +· Gaming: a selection of gaming options, including +participation in games, sweepstakes, and social gaming experiences; +· Sweepstakes gaming: A dedicated gaming zone for +sweepstakes gaming, offering opportunities to win virtual and real money; +· Contests of skill: competitions where users can +showcase their talents and win prizes; +· Building private spaces: A feature allowing users +to construct and customize their dream homes or private spaces; +· Social hubs for users to interact with individuals +from around the world; and +· Unique virtual and real world experiences, such +as live and virtual concerts, conferences, and other events. +Industry +The metaverse industry is +experiencing rapid growth and expansion, driven by advancements in technology, increased interest in virtual experiences, and the rise +of digital economies. Key trends include: +· The integration of virtual and physical worlds; +· The emergence of virtual economies and markets; +and +· The growing importance of socialization and community-building +in digital spaces. +Competition +BNC faces competition from +existing metaverse platforms and new entrants. Key competitors include: +· Established metaverse platforms, such as Decentraland, +The Sandbox, and Second Life, as well as companies that focus on development of metaverse tools and platforms such as META; +· Gaming-focused platforms, like Fortnite and Roblox; +and +· Social media platforms that integrate metaverse +elements, such as Facebook’s Horizon Workrooms. +Regulatory Environment +BNC operates within a complex and evolving regulatory +landscape, with key considerations including: +· Data privacy and protection regulations, such +as GDPR and CCPA; +· Compliance with gaming and gambling regulations +in various jurisdictions; and +· Intellectual property rights and digital asset +ownership. +22 +BNC intends to offer a transformative +digital experience by combining elements of virtual markets, real world goods marketplaces, gaming, social activities, and sweepstakes +gaming. This unique integration establishes BNC as a pioneering Platform in the metaverse industry, catering to diverse user interests +and needs. We believe that as the industry evolves and expands, BNC’s commitment to providing immersive and interconnected digital +experiences will place it at the forefront of the metaverse revolution, poised to redefine online interaction and engagement for users +around the globe. By continuously innovating and adapting to the ever-changing digital landscape, BNC aims to offer limitless possibilities +and opportunities for users, setting the stage for a truly inclusive and dynamic metaverse. +Business Strategy +BNC’s business strategy +focuses on delivering a comprehensive, immersive, and interconnected metaverse experience that stands out from the competition. To achieve +this, the platform has identified several core strategic initiatives that will guide its growth and development. +Technological Innovation and User Experience +BNC places a strong emphasis +on leveraging cutting-edge technology to create a seamless, user-friendly experience. By offering a browser-based platform that is compatible +with VR headsets and other modern devices, BNC ensures accessibility and convenience for users across various platforms. BNC intends to +continuously invest in research and development to stay at the forefront of technological advancements in the metaverse space, ensuring +that users enjoy an unparalleled experience. +Diversification and Personalization +BNC’s strategy focuses +on providing a diverse range of products and experiences that caters to users with different interests and preferences. By offering a +wide variety of activities, from virtual markets and real world goods marketplaces to gaming, social interaction, and live and virtual +events, the platform aims to attract a broad user base and promote user engagement. Additionally, BNC intends to emphasize personalization, +allowing users to customize their experiences and tailor the platform to suit their unique needs and tastes. +Community Building and Global Connections +The Platform recognizes the +importance of fostering a strong sense of community and global connectivity among its users. BNC intends to implement various features +and initiatives designed to encourage socialization, collaboration, and networking among users from around the world. This will include +the creation of social hubs, support for user-generated content, and the promotion of events and activities that bring users together. +Monetization and Revenue Generation +BNC’s business strategy +includes developing diverse revenue streams to ensure the Platform’s long-term sustainability and growth. Potential monetization +strategies include charging fees for premium features, from sales and transactions on virtual markets and real world goods marketplaces, +social sweepstakes gaming, real and virtual concerts and events, and offering advertising opportunities for brands within the metaverse. +Additionally, the Platform will explore partnerships and collaborations with other businesses and organizations to create new revenue-generating +opportunities. +Compliance and Regulatory Management +To navigate the complex and +evolving regulatory landscape, BNC will prioritize compliance with relevant laws and regulations in all jurisdictions where it operates. +This includes data privacy and protection regulations, gaming and sweepstakes regulations, and intellectual property rights. By maintaining +a strong focus on regulatory compliance, BNC aims to minimize potential legal risks and build trust with users and partners. +23 +Continuous Improvement and Adaptability +Finally, BNC’s business +strategy emphasizes the importance of continuously evaluating and refining its offerings in response to changing market trends and user +preferences. The platform will actively seek user feedback and monitor industry developments to inform its ongoing product development +and feature enhancements. This adaptability will allow BNC to maintain its competitive edge and continue delivering a compelling metaverse +experience for users. +Customers and Product Interaction +BNC aims to serve a diverse +customer base by offering an extensive range of products and experiences designed to cater to various interests and preferences. The Platform +seeks to create a highly engaging environment, encouraging users to interact with its offerings in multiple ways. This section provides +insights into BNC’s target customers and how they interact with the various products and experiences available on the Platform. +Tech-savvy Individuals +Tech-savvy individuals are +drawn to BNC due to its innovative, cutting-edge technology and immersive virtual experiences. These users are likely to engage with the +Platform’s virtual markets, trading digital assets like virtual real estate, digital art and unique collectibles. They may also +be early adopters of VR headsets, using them to explore the metaverse and interact with other users in social hubs. +Gamers of All Skill Levels +BNC appeals to gamers by offering +an extensive selection of gaming options, from casual games to competitive contests of skill. Gamers can participate in various gaming +experiences, such as: +· Sweepstakes gaming: Gamers can enter sweepstakes +games to compete for virtual and real money prizes, testing their skills against other players in a secure, fair environment; +· Social gaming experiences: Users can engage with +others in single player games with chat features as well as multiplayer games, fostering collaboration and communication while enjoying +a shared gaming experience; and +· Contests of skill: Competitive gamers can showcase +their abilities by participating in contests of skill, earning recognition, and winning prizes. +Collectors and Traders of Digital Assets +BNC’s virtual markets +cater to users interested in collecting, trading, and investing in digital assets. These users can interact with the Platform’s +offerings by: +· Buying, selling, and trading digital assets, +such as virtual real estate, digital art, and unique collectibles; +· Exploring and engaging with the digital art galleries +and museums featured in the metaverse; and +· Attending virtual events and auctions for exclusive +digital asset releases and limited-edition collectibles. +Shoppers Seeking Real world Goods +Users looking for a convenient, +intuitive platform to purchase real world goods can explore BNC’s real world goods marketplaces, which offer a diverse range of +products. These users can: +· Browse and purchase items from categories such +as fashion, electronics, travel, and home goods; +· Interact with virtual showrooms and product demonstrations +to gain a better understanding of the products they’re interested in; and +· Participate in virtual events, sales, and promotions +to discover new products and take advantage of special offers. +24 +Social Seekers and Global Connectors +We believe BNC will appeal +to users who value social interaction and global connectivity in a virtual environment. These users can engage with the Platform’s +offerings by: +· Participating in various social hubs to meet +and interact with individuals from around the world. +· Collaborating on projects, sharing ideas, and +forming new friendships within the metaverse. +· Building and customizing private spaces to host +gatherings, parties, or events for their friends and online communities. +· Attending virtual events, concerts, and conferences +to connect with others who share their interests and passions. +By understanding its target +customers and the ways in which they interact with BNC’s various products and experiences, the Platform can effectively tailor its +offerings to meet the needs and preferences of its diverse user base. +Products and Experiences +BNC intends to offer an extensive +range of products and experiences designed to cater to a diverse audience with varied interests and preferences. By providing a comprehensive +suite of offerings, the Platform aims to attract and engage users, creating a vibrant and dynamic metaverse environment. The following +is an expanded list of BNC’s products and experiences, most of which remain in development: +· Virtual markets: Facilitating the trading of +digital assets like digital skins, a graphic download that changes the appearance of characters in video games, for avatar customization +virtual real estate, digital art, and unique collectibles, enabling users to participate in a thriving digital economy; +· Real world goods marketplaces: Offering a platform +for users to shop for a diverse range of real world products, including fashion, electronics, and home goods, seamlessly connecting the +virtual and physical worlds; +· Gaming: Providing an extensive selection of gaming +options for users of all skill levels, including participation in games, sweepstakes, and social gaming experiences; +· Sweepstakes gaming: Featuring a dedicated gaming +zone for users to engage in sweepstakes gaming, with opportunities to win both virtual and real money prizes; +· Contests of skill: Organizing competitions for +users to showcase their talents and compete against others for prizes and recognition in various disciplines; +· Building private spaces: Allowing users to construct +and customize their dream homes or private spaces, tailoring their environments with an array of design options and sharing their creations +with others or keeping them as personal retreats; +· Socialization and connectivity: Fostering global +connections by enabling users to interact with individuals from around the world, forming new friendships, collaborating on projects, +or engaging in conversations within various social hubs; and +· Real and virtual concerts: Hosting live and virtual +concerts within the metaverse, featuring performances from both real world and virtual artists, allowing users to attend and enjoy shows +in an immersive environment. +By offering a diverse and +comprehensive range of products and experiences, BNC aims to create a vibrant and engaging metaverse platform that appeals to users with +a wide array of interests and preferences. +Industry Overview and Key Trends +The metaverse industry is +witnessing rapid growth and expansion, driven by a combination of technological advancements, increased interest in virtual experiences, +and the emergence of digital economies. As the industry continues to evolve, it is important to consider user adoption, growth, and other +factors that contribute to the metaverse landscape. +25 +User Adoption and Growth +The growing popularity of +virtual experiences and digital platforms has led to a surge in user adoption and engagement in the metaverse industry. A number of factors +contribute to this growth, including: +· Increased accessibility of virtual reality (“VR”) +and augmented reality (“AR”) technologies, making immersive experiences more affordable and widely available. +· The ongoing digitization of various aspects of +everyday life, from work and education to entertainment and socialization, driving users to seek out new digital experiences. +· The COVID-19 pandemic, which has accelerated +the adoption of digital platforms and virtual experiences as people adapt to remote work, learning, and social distancing measures. +Integration of Virtual and Physical Worlds +One of the key trends in the +metaverse industry is the growing integration of virtual and physical worlds, enabling users to seamlessly transition between digital +and real world experiences. This trend is evident in: +· The emergence of virtual marketplaces where users +can trade digital assets and purchase real world goods; +· The incorporation of AR and VR technologies in +retail, entertainment, and other industries, providing immersive, interactive experiences that blur the lines between the digital and +physical realms; and +· The development of virtual environments that +replicate real world locations, allowing users to explore and interact with digital versions of familiar places. +Virtual Economies and Markets +The metaverse industry is +witnessing the rise of virtual economies and markets, where users can trade digital assets, such as virtual real estate, digital art, +and unique collectibles. Key factors driving this trend include: +· The increasing acceptance and adoption of cryptocurrencies +and blockchain technology, enabling secure, transparent transactions in digital markets; +· Growing interest in non-fungible tokens (“NFT’s”) +and digital collectibles, which has led to the creation of new marketplaces and trading platforms for these assets; and +· The realization of the potential for virtual +goods to hold and accrue value over time, leading to increased investment and speculation in digital markets. +Socialization and Community Building in Digital +Spaces +The importance of socialization +and community building in digital spaces is another significant trend in the metaverse industry. As users spend more time in virtual environments, +platforms are placing a greater emphasis on fostering connections and interactions among users. This trend can be observed in: +· The creation of social hubs, virtual events, +and gatherings designed to bring users together and encourage networking, collaboration, and communication; +· The integration of social media and messaging +features within metaverse platforms, allowing users to stay connected with friends and communities while exploring virtual worlds; and +· The development of user-generated content and +customization tools, empowering users to create unique experiences and contribute to the growth and expansion of the metaverse. +The metaverse industry is +experiencing rapid growth and transformation, driven by technological advancements, increased user adoption, and the emergence of virtual +economies and markets. As the industry continues to evolve, it will be essential that BNC stay informed of key trends and driving forces +shaping the future of the metaverse landscape, and adapt to those trends as they arise. +Competition in the Metaverse Industry +The metaverse industry is +becoming increasingly competitive as more companies and platforms emerge to capitalize on the growing interest in virtual experiences +and digital economies. +26 +Key Players in the Metaverse Industry +The metaverse industry features +an eclectic mix of established technology companies, gaming giants, and innovative startups, each bringing unique offerings and perspectives +to the market. Some of the key players in the industry include: +· Meta (formerly Facebook): With its ambitious +plans for the metaverse and significant investments in VR technology, Meta is a major player in the industry. The company’s Oculus +platform and Horizon Workrooms are prime examples of its commitment to shaping the future of the metaverse; +· Epic Games: The creator of the popular game Fortnite, +Epic Games has made significant strides in the metaverse space by developing the Unreal Engine, a powerful platform for creating virtual +worlds and experiences; +· Roblox Corporation: Roblox has successfully created +a user-generated content platform that allows millions of players to create, share, and engage in virtual experiences, making it a significant +player in the metaverse landscape; and +· Linden Lab: As the creator of Second Life, one +of the earliest and most successful virtual worlds, Linden Lab has a long history in the metaverse industry and continues to evolve and +expand its offerings. +Market Segments and Niches +The metaverse industry can +be broadly divided into several market segments and niches, each catering to different user needs and preferences: +· Gaming-focused metaverse platforms: These platforms, +such as Fortnite and Roblox, primarily cater to gamers and offer a wide range of gaming experiences and social interaction opportunities +within virtual environments; +· VR and AR platforms: Companies like Meta and +Microsoft focus on developing hardware and software solutions to enable immersive VR and AR experiences, driving the adoption of these +technologies in the metaverse; +· Social and community-driven metaverse platforms: +Platforms like Second Life and BNC emphasize socialization, community building, and user-generated content, fostering connections and +collaboration among users; and +· NFT and digital asset marketplaces: These platforms, +such as OpenSea and Decentraland, facilitate the trading of digital assets like virtual real estate, digital art, and unique collectibles, +contributing to the growth of virtual economies. +Differentiating Factors +With the increasing competition +in the metaverse industry, it is crucial for platforms to differentiate themselves by offering unique features, experiences, or technologies. +Some potential differentiating factors include: +· Seamless integration of virtual and real world +experiences: Platforms that successfully bridge the gap between the digital and physical realms, allowing users to easily transition between +the two, are likely to stand out in the competitive landscape; +· Innovative and user-friendly technology: Companies +that prioritize cutting-edge technology and deliver a seamless, intuitive user experience will have a competitive edge in the metaverse +market; +· Personalization and customization: Platforms +that empower users to create and customize their own experiences, environments, and avatars are likely to appeal to a broader audience +and foster greater user engagement; and +· Diverse offerings and experiences: Platforms +that cater to a wide range of interests and preferences, such as gaming, shopping, socializing, and trading digital assets, can attract +a more extensive and diverse user base. +The metaverse industry is +characterized by a competitive landscape with numerous players, market segments, and niches. To succeed in this rapidly evolving market, +companies must continuously innovate and differentiate themselves by offering unique features, experiences, and technologies that cater +to the diverse needs and preferences of users. +Regulatory Environment: Present and Future +Challenges +As the metaverse industry +continues to grow and evolve, regulatory challenges and considerations are becoming increasingly important. The unique nature of the metaverse, +which often combines elements of virtual reality, gaming, social networking, and digital economies, presents a complex landscape for regulators +to navigate. +27 +Present Regulatory Challenges +The metaverse industry is +currently grappling with several regulatory challenges, including: +· Data Privacy and Security: As users share personal +information and engage in transactions within the metaverse, concerns about data privacy and security are paramount. Regulators must ensure +that platforms adhere to existing data protection regulations, such as the General Data Protection Regulation (“GDPR”) and +the California Consumer Privacy Act (“CCPA”); +· Intellectual Property Rights: The metaverse’s +reliance on user-generated content and digital assets raises questions about intellectual property rights and the enforcement of copyright, +trademark, and patent laws in virtual environments; +· Taxation and Financial Regulations: The growth +of virtual economies and the increasing popularity of cryptocurrencies and NFT’s have raised questions about taxation and financial +regulations. Regulators must determine how to classify and tax digital assets and transactions, as well as ensure compliance with anti-money +laundering and know-your-customer regulations; and +· Content Moderation and Liability: Metaverse platforms +face challenges in moderating content and managing user behavior, raising questions about the platforms’ liability for user-generated +content and potential violations of existing laws, such as those related to hate speech, harassment, and misinformation. +Future Regulatory Challenges +As the metaverse industry +continues to develop and expand, several future regulatory challenges are likely to emerge, including: +· Cross-border jurisdictional issues: With the +metaverse being a global, borderless environment, determining jurisdiction and applying national laws to activities and transactions within +the metaverse will become increasingly complex; +· Virtual reality and augmented reality regulations: +As VR and AR technologies become more integrated into the metaverse, new regulations may be needed to address issues related to safety, +privacy, and ethical considerations in the use of these technologies +· Decentralization and governance: The increasing +trend towards decentralized metaverse platforms raises questions about governance and regulatory oversight, as traditional regulatory +mechanisms may not be applicable or effective in these environments; and +· Ethics and inclusivity: As the metaverse becomes +more intertwined with daily life, ethical considerations related to inclusivity, accessibility, and the potential for digital divides +will become increasingly important for regulators to address. +Ault Iconic +Ault +Iconic, formerly known as Ault Media Group is comprised of a diverse team of media professionals with expertise in creating all forms +of media, communications, and content including web development, corporate communications, social media, scripted, and unscripted television. +Our online virtual training courses (via the LightSpeedVT platform) also offer in-depth business learning. Ault Iconic’s specialized +team of producers brings years of university-proven training methods and a history of developing educational materials up to a master’s +degree level. Ault Iconic’s first course, relating to initial public offerings, is currently in the final stages of production, +with more courses soon to follow. +Along +with training and communications strategies, Ault Iconic also offers comprehensive consulting for the development and execution of large +and small scale conferences and event planning. From event space acquisition to digital ticketing, keynote speakers, lighting, stage crews, +and advertising media buys, Ault Iconic will provide the necessary contacts and guidance to assure a successful and smooth-running event. +AGREE +AGREE seeks to invest in various +classes of commercial and residential real estate including hospitality, multifamily, and industrial properties targeting the middle market +segment in locations demonstrating relative value. AGREE’s objective is to generate risk adjusted returns through development, capital +investment and operational improvement, leveraging the management team’s expertise and well-established relationships with real +estate investment professionals, brokers, lenders and developers. The focus will be in U.S. tertiary markets with growing populations, +income growth and access to highly populated metropolitan areas as primary demand drivers. AGREE is one of BitNile’s strategies +to invest in inflation-resistant undervalued assets and realize capital appreciation through cap rate compression over time. AGREE owns +and operates both Third Avenue Apartments and AGREE Madison. +28 +Circle 8 +On +December 19, 2022, Circle 8 closed on the asset purchase agreement with Circle 8 Crane Services pursuant to which Circle 8 agreed to purchase +substantially all of the assets and assume certain specified liabilities of Circle 8 Crane Services. Circle 8 Crane Services was +a crane rental and lifting solutions provider founded in 2007 and headquartered in Corpus Christi, TX with multiple locations throughout +the South-Central region of the U.S. It maintains a large modern fleet of mobile cranes for its customers’ heavy lifting needs. +Specifically, Circle 8 provides crane operators, engineering, custom rigging and transportation services for oilfield, construction, commercial +and infrastructure markets. Circle 8 maintains an industry leading safety record. +Our +Strategy +Our business strategy is designed +to increase shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +shareholder value, such as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase +cash flows and stockholder value. Ault Alliance actively oversees and supports the management teams of each of our businesses by, among +other things: +● recruiting and retaining talented managers to operate our businesses using structured incentive compensation +programs, including non-controlling equity ownership, tailored to each business; +● regularly monitoring financial and operational performance, instilling consistent financial discipline, +and supporting management in the development and implementation of information systems to effectively achieve these goals; +● identifying and aligning with external policy and performance tailwinds such as those influenced by growing +climate, health, and social justice concerns (and similar environmental, social and governance (“ESG”) drivers); +● assisting management in their analysis and pursuit of prudent organic growth strategies; +● identifying and working with management to execute attractive external growth and acquisition opportunities; +● assisting management in controlling and right-sizing overhead costs; +● nurturing an internal culture of transparency, alignment, accountability and governance, including regular +reporting; +● professionalizing our subsidiaries at scale; and +● forming strong subsidiary level boards of directors to supplement management in their development and +implementation of strategic goals and objectives. +29 +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Ault Alliance to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +● making selective capital investments to expand geographic reach, increase capacity, or reduce manufacturing +costs of our businesses; +● investing in product research and development for new products, processes or services for customers; +● improving and expanding existing sales and marketing programs; +● pursuing reductions in operating costs through improved operational efficiency or outsourcing of certain +processes and products; and +● consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +● leverage manufacturing and distribution operations; +● leverage branding and marketing programs, as well as customer relationships; +● add experienced management or management expertise; +● increase market share and penetrate new markets; and +● realize cost synergies by allocating the corporate overhead expenses of our businesses across a larger +number of businesses and by implementing and coordinating improved management practices. +Acquisition Strategy +Our +acquisition strategy is to acquire businesses that we believe to be to undervalued and have disruptive technologies with a global impact +that we expect to produce stable and growing earnings and cash flow. In this respect, we expect to make acquisitions in industries other +than those in which our businesses currently operate if we believe an acquisition presents an attractive opportunity. We believe that +attractive opportunities will continue to present themselves, as private sector owners seek to monetize their interests in long-standing +and privately held businesses and large corporate parents seek to dispose of their “non-core” operations. +Our +ideal acquisition candidate has the following characteristics: +● is a leading branded consumer or niche industrial company headquartered in North America; +● maintains highly defensible position in the markets it serves and with customers; +● operates in an industry with favorable long-term macroeconomic trends; +● has a strong management team, either currently in place or previously identified, and meaningful incentives; +● has low technological and/or product obsolescence risk; and +● maintains a diversified customer and supplier base. +We +benefit from Ault Alliance’s ability to identify potential diverse acquisition opportunities in a variety of industries. In addition, +we rely upon our Executive Committee and other members of our management team’s experience and expertise in researching and valuing +prospective target businesses, as well as negotiating the ultimate acquisition of such target businesses. In particular, because there +may be a lack of information available about these target businesses, which may make it more difficult to understand or appropriately +value such target businesses, Ault Alliance: +● engages in a substantial level of internal and third-party due diligence; +● critically evaluates the target management team; +● identifies and assesses any financial and operational strengths and weaknesses of the target business; +● analyzes comparable businesses to assess financial and operational performances relative to industry competitors; +● actively researches and evaluates information on the relevant industry; and +● thoroughly negotiates appropriate terms and conditions of any acquisition. +30 +The +process of acquiring new businesses is both time-consuming and complex. Our management team historically has taken from two to +six months to perform due diligence, negotiate and close acquisitions. Although our management team is at various stages of evaluating +several transactions at any given time, there may be periods of time during which our management team does not recommend any new acquisitions. +Even if an acquisition is recommended by our management team, our Board may not approve it. +A +component of our acquisition financing strategy that we utilize in acquiring the businesses we own and manage is to provide both equity +capital and debt capital. We believe, and it has been our experience, that having the ability to finance our acquisitions with capital +resources raised by us, rather than negotiating separate third-party financing, provides us with an advantage in successfully acquiring +attractive businesses by minimizing delay and closing conditions that are often related to acquisition-specific financings. In addition, +our strategy of providing this intercompany debt financing within the capital structure of the businesses we acquire and manage allows +us the ability to distribute cash to the parent company through monthly interest payments and amortization of principle on these intercompany +loans. +Upon +acquisition of a new business, we rely on our management team’s experience and expertise to work efficiently and effectively with +the management of the new business to jointly develop and execute a successful business plan. +Strategic Advantages +Based +on the experience of our management team and its ability to identify and negotiate acquisitions, we believe we are well-positioned to +acquire additional businesses. Our management team has strong relationships with business brokers, investment and commercial bankers, +accountants, attorneys and other potential sources of acquisition opportunities. In addition, our management team has a successful track +record of acquiring and managing businesses in various industries. In negotiating these acquisitions, we believe our management team has +been able to successfully navigate complex situations surrounding acquisitions, including corporate spin-offs, transitions of family-owned +businesses, management buy-outs and reorganizations. +Our management team has a +large ne twork of deal interme diaries whom we expect to expose us to potential acquisitions. +Through this network, as well as our management team’s proprietary transaction sourcing efforts, we have a substantial pipeline +of potential acquisition targets. Our management team also has a well-established network of contacts, including professional managers, +attorneys, accountants and other third-party consultants and advisors, who may be available to assist us in the performance of due diligence +and the negotiation of acquisitions, as well as the management and operation of our acquired businesses. +Valuation and Due Diligence +When +evaluating businesses or assets for acquisition, our management team performs rigorous due diligence and a financial evaluations process +including an evaluation of the operations of the target business and the outlook for its industry. While valuation of a business is a +subjective process, we define valuations under a variety of analyses, including: +● discounted cash flow analyses; +● evaluation of trading values of comparable companies; +● expected value matrices; and +● examination of comparable recent transactions. +One +outcome of this process is a projection of the expected cash flows from the target business. A further outcome is an understanding of +the types and levels of risk associated with those projections. While future performance and projections are always uncertain, we believe +that with detailed due diligence, future cash flows will be better estimated and the prospects for operating the business in the future +better evaluated. To assist us in identifying material risks and validating key assumptions in our financial and operational analysis, +in addition to our own analysis, we engage, as necessary, third-party experts to review key risk areas, including legal, tax, regulatory, +accounting, insurance and environmental. We also engage technical, operational or industry consultants, as necessary. +A further critical component of the evaluation +of potential target businesses is the assessment of the capability of the existing management team, including recent performance, expertise, +experience, culture and incentives to perform. Where necessary, and consistent with our management strategy, we actively seek to augment, +supplement or replace existing members of management who we believe are not likely to execute our business plan for the target business. +Similarly, we analyze and evaluate the financial and operational information systems of target businesses and, where necessary, we enhance +and improve those existing systems that are deemed to be inadequate or insufficient to support our business plan for the target business. +31 +Financing +We +incur third party debt financing almost entirely at the parent company level, which we use, in combination with our equity capital, to +provide debt financing to each of our businesses and to acquire additional businesses. We believe this financing structure is beneficial +to the financial and operational activities of each of our businesses by aligning our interests as both equity holders of, and lenders +to, our businesses, in a manner that we believe is more efficient than each of our businesses borrowing from third-party lenders. +Compliance with Material Government (Including +Environmental) Regulations +ACS +ACS is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. ACS continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While ACS’s regulatory compliance costs +are currently not considered material, it is reasonably possible that costs incurred to ensure continued environmental compliance could +have a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Facility is subject to +a final corrective measures plan with the Environment Protection Agency. The seller performed remedial activities at the Facility relating +to historical soil and groundwater contamination and ACS is responsible for ongoing monitoring and final remediation plans. We estimate +cost of the environmental remediation obligation is approximately $0.4 million and reflects our best estimate of probable future costs +for remediation based on the current assessment data and regulatory obligations. Future costs will depend on many factors, including the +extent of work necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. We may incur +actual costs in the future that are materially different than this estimate and such costs could have a material impact on results of +operations, financial condition, and cash flows during the period in which they are recorded. +TurnOnGreen +TurnOnGreen’s businesses +are heavily regulated in most of its markets. TurnOnGreen handles power electronics products mainly in the form of power conversion. TurnOnGreen +must take into account several standards for electronic safety to protect the health of humans and animals. TurnOnGreen serves diverse +markets including automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set +of their safety regulations and standard that TurnOnGreen must comply with. +Government Contracts . +The U.S. Government, and other governments, may terminate any of TurnOnGreen’s government contracts at their convenience, as well +as for default based on our failure to meet specified performance requirements. If any of TurnOnGreen’s U.S. Government contracts +were to be terminated for convenience, TurnOnGreen would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of TurnOnGreen’s government contracts were to be terminated for default, generally the U.S. Government +would pay only for the work that has been accepted and could require TurnOnGreen to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold +TurnOnGreen liable for damages resulting from the default. +Medical device power supplies . +TurnOnGreen’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. TurnOnGreen must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +Environmental . TurnOnGreen +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TurnOnGreen continually assesses its compliance status +and management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of TurnOnGreen’s operations. +32 +Non-U.S. Sales . TurnOnGreen’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +GIGA +GIGA’s businesses are +heavily regulated in most of its markets. GIGA transacts with numerous U.S. Government agencies and entities, including but not limited +to the U.S. Department of Defense (“DoD”), branches of the U.S. military and the Department of Homeland Security. Similar +government authorities exercise similar regulatory oversight in GIGA’s non-U.S. markets. +Government Contracts . +The governments of the U.S., U.K. and Israel may terminate any of GIGA’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of GIGA’s contracts for convenience, GIGA generally would be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of GIGA’s government contracts were to be terminated for default, generally the U.S. government would +pay only for the work that has been accepted and could require GIGA to pay the difference between the original contract price and the +cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold GIGA liable +for damages resulting from the default. Similar provisions apply to GIGA’s contracts with other governments and to GIGA’s +subcontractors with major defense contractors who provide systems or military platforms directly to the government. +Power Electronics . +In all of GIGA’s markets in the U.S., GIGA’s commercial power electronics offerings must comply with safety, energy use and +operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. In +the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the U.K., Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, GIGA’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . GIGA +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies, or as applicable +local regulations or laws require. The products that GIGA markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of +certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, GIGA’s industry began phasing in RoHS +and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. GIGA believes that RoHS and WEEE-compliant +components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. REACH (Registration, +Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 December 2006. REACH +addresses the production and use of chemical substances, and their potential impacts on both human health and the environment. +These regulatory mandates +apply to all of GIGA’s operating subsidiaries. GIGA has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +Non-U.S. Sales . GIGA’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Security Clearance +As a U.S. Government contractor +working on classified projects, Microphase is required to maintain facility and personnel security clearances complying with the DoD and +other federal agency requirements. Microphase maintains strict protocols for handling classified information and Confidential Unclassified +Information (“CUI”) associated with its work for the DoD and has built a secure restricted area within its Shelton production +facility certified for generating, storing and reviewing classified information. +33 +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the U.K. Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “DCAA”), +the Defense Contract Management Agency (the “DCMA”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the DOJ and Congressional Committees. From time-to-time, these and other agencies investigate or +conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. The +DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the Ministry of Defense does most of +its business. All its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +the U.K. Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the +customer the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government +and typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified information and CUI from disclosure and unauthorized access. That mandate includes a requirement that +Microphase formulate and implement a system security plan with 110 different elements and protocols for handling and protecting classified +information and CUI. Over the next three years, the DoD will require all participants in the defense supply chain to demonstrate compliance +with the Capability Model Maturity Cybersecurity as verified through an independent third-party auditor. Compliance with these mandates +requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance requires extensive +security controls on access to Microphase information technology systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Plus Compliant.” Cyber Essentials Plus is a government-backed, industry-supported +scheme to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials Plus program criteria. +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +34 +Research and Development +During the years ended December +31, 2022 and 2021, we spent approximately $2.8 million and $2.0 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries and others operate in industries deemed essential by the DoD and therefore remained +at work during the COVID-19 pandemic. +Employee Profile +As of December 31, 2022, we +had 615 employees located in the U.S., the U.K. and Israel, of whom 83 were engaged in engineering and product development, 46 in sales +and marketing, 386 in general operations and 100 in general administration and finance. All but 17 of these employees are employed on +a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be +good. +As of December 31, 2021, approximately +33% of our current workforce is female, 67% male, and our average tenure is 7.7 years, an increase of 24% from an average tenure +of 6.2 years as of December 31, 2020. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of 7.7 years as +of the end of the fiscal year 2022 reflects the engagement of our employees in this core talent system tenet. +The Company believes it materially +complies with all applicable state, local and international laws governing nondiscrimination in employment in every location in which +the Company operates. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, +religion, national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran +status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees' needs. We plan to conduct annual confidential employee surveys +as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. Our +employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new stretch +goals. +35 +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021 and plan to establish a Company-wide augmented employee stock purchase plan in 2022. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +In response to the COVID-19 pandemic, we implemented significant operating environment changes that we determined were in the best interest +of our employees, as well as the communities in which we operate, and which comply with government regulations. This includes having a +significant portion of our employees work from home, while implementing additional safety measures for employees continuing critical on-site +work. +36 +ITEM 1A. RISK FACTORS +An investment in our common +stock involves significant risks. You should carefully consider the following risks and all other information set forth in this Annual +Report before deciding to invest in our common stock. If any of the events or developments described below occurs, our business, financial +condition and results of operations may suffer. In that case, the value of our common stock may decline and you could lose all or part +of your investment. +You should consider each of +the following risk factors and any other information set forth in this Annual Report and the other reports filed by the Company with the +SEC, including the Company’s financial statements and related notes, in evaluating the Company’s business and prospects. The +risks and uncertainties described below are not the only ones that impact on the Company’s operations and business. Additional risks +and uncertainties not presently known to the Company, or that the Company currently considers immaterial, may also impair its business +or operations. If any of the following risks actually occurs, the Company’s business and financial condition, results or prospects +could be harmed. Please also read carefully the section entitled “Note About Forward-Looking Statements” at the beginning +of this Annual Report. +Risks Related to Our Company +We will need to raise additional capital to +fund our operations in furtherance of our business plan. +Until +we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business plan. +The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred +stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development partners or some combination +of each. Any additional equity financings may be financially dilutive to, and will be dilutive from an ownership perspective to, our stockholders, +and such dilution may be significant based upon the size of such financing. Additionally, we cannot assure that such funding will be available +on a timely basis, in needed quantities, or on terms favorable to us, if at all. +We have an evolving business model, which increases the complexity +of our business. +Our business model has evolved +in the past and continues to do so. In prior years we have added additional types of services and product offerings and in some cases, +we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products or services, and +we do not know whether any of them will be successful. From time to time we have also modified aspects of our business model relating +to our product mix. We do not know whether these or any other modifications will be successful. The additions and modifications to our +business have increased the complexity of our business and placed significant strain on our management, personnel, operations, systems, +technical performance, financial resources, and internal financial control and reporting functions. Future additions to or modifications +of our business are likely to have similar effects. Further, any new business or website we launch that is not favorably received by the +market could damage our reputation or our brand. The occurrence of any of the foregoing could have a material adverse effect on our business. +We received a subpoena from the Commission +in the investigation now known as “ In the Matter of DPW Holdings, Inc . ,” the consequences of which are unknown. +We received a subpoena in +November of 2019 from the Commission that stated that the staff of the Commission is conducting an investigation now known as “In +the Matter of DPW Holdings, Inc. ” We understand that the subpoena was issued as part of an investigation as to whether we and +certain of our officers, directors, employees, partners, subsidiaries and/or affiliates, and/or other persons or entities, directly or +indirectly, violated certain provisions of the Securities Act and the Exchange Act, in connection with the offer and sale of our securities. +Certain affiliates and related parties of ours have also been subpoenaed. Although the order states that the Commission may have information +relating to such alleged violations, the subpoena expressly provides that the inquiry is not to be construed as an indication by the Commission +or its staff that any violations of the federal securities laws have occurred. We have produced documents in response to the subpoena. +Since the original subpoena was issued, we have received further subpoenas seeking additional documents and testimony from certain members +of our management team. +We do not know when the Commission’s +investigation will be concluded or what action, if any, might be taken in the future by the Commission or its staff as a result of the +matters that are the subject to its investigation or what impact, if any, the cost of continuing to respond to subpoenas might have on +our financial position or results of operations. We have not established any provision for losses in respect of this matter. In addition, +complying with any such future requests by the Commission for documents or testimony would distract the time and attention of our officers +and directors or divert our resources away from ongoing business matters. This investigation has resulted in, and may continue to result +in, significant legal expenses, the diversion of management’s attention from our business, could cause damage to our business and +reputation, and could subject us to a wide range of remedies, including enforcement actions by the Commission. There can be no assurance +that any final resolution of this or any similar matters will not have a material adverse effect on our financial condition or results +of operations. +37 +We are heavily dependent on our senior management, +and a loss of a member of our senior management team could cause our stock price to suffer . +If we lose the services of +Milton C. Ault, III, our Executive Chairman, William B. Horne, our Chief Executive Officer, Henry Nisser, our President and General Counsel, +or Ken Cragun, our Chief Financial Officer and/or certain key employees, we may not be able to find appropriate replacements on a timely +basis, and our business could be adversely affected. Our existing operations and continued future development depend to a significant +extent upon the performance and active participation of these individuals and certain key employees. Although we have entered into employment +agreements with Messrs. Ault, Horne and Nisser, and we may enter into employment agreements with additional key employees in the future, +we cannot guarantee that we will be successful in retaining the services of these individuals. If we were to lose any of these individuals, +we may not be able to find appropriate replacements on a timely basis and our financial condition and results of operations could be materially +adversely affected. +We rely on highly skilled personnel and the +continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our business may be +severely disrupted. +Our performance largely depends +on the talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise held by our Executive +Chairman, Milton C. Ault, III. His absence, were it to occur, would materially and adversely impact development and implementation of +our projects and businesses. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly +skilled personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract, among +others, new technology developers and to retain and motivate our existing contractors. If one or more of our executive officers are unable +or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may +be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives +joins a competitor or forms a competing company, we may lose some customers. +We may be classified as an inadvertent investment company. +We are not engaged in the business of investing, +reinvesting, or trading in securities, and we do not hold ourselves out as being engaged in those activities. Under the Investment Company +Act, however, a company may be deemed an investment company under Section 3(a)(1)(C) of the Investment Company Act if the value of its +investment securities is more than 40% of its total assets (exclusive of government securities and cash items) on an unconsolidated basis. +Further, per the Investment Company Act of 1940 companies who are not making, and do not propose to make, a public offering of its securities +and whose outstanding securities (other than short-term paper) are beneficially owned by fewer than 100 persons are excluded from the +definition of an investment company. +Our lending subsidiary, Ault +Lending, operates under California Finance Lending License #60DBO-77905 and is regulated by the California Department of Financial Protection +and Innovation as a finance lender. Substantially all of Ault Lending’s business consists of providing funding to smaller businesses +through making small loans and, in some cases, investments. Ault Lending offers a variety of loan types including commercial loans, convertible +notes and revolving lines of credit. Ault Lending is engaged in providing commercial loans to smaller companies throughout the United +States to provide them with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from +six to 12 months (but may be longer in duration), and are generally in an amount of not more than $4.0 million. We believe Ault Lending +qualifies for the exemption from being an “investment company” pursuant to Section 3(c)(4) of the Investment Company Act. +Under this exemption, “any person substantially all of whose business is confined to making small loans, industrial banking, or +similar businesses” is not an investment company. We believe that Ault Lending is subject to this exemption from registration under +the Investment Company Act because it is in the business of making small loans. Additionally, by being licensed and regulated under California’s +financing laws, Ault Lending’s business will not be in need of safeguards of the sort that the Investment Company Act imposes on +the operations and investment policies of investment companies. +We have commenced digital +asset mining, the output of which is Bitcoin, which the SEC has not indicated it deems a security. In the event that securities we hold, +including any digital assets that may in the future be deemed securities, exceed 40% of our total assets, exclusive of cash, we would +inadvertently become an investment company. An inadvertent investment company can avoid being classified as an investment company if it +can rely on one of the exclusions under the Investment Company Act. One such exclusion, Rule 3a-2 under the Investment Company Act, allows +an inadvertent investment company a grace period of one year from the earlier of (a) the date on which an issuer owns securities and/or +cash having a value exceeding 50% of the issuer’s total assets on either a consolidated or unconsolidated basis and (b) the date +on which an issuer owns or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s +total assets (exclusive of government securities and cash items) on an unconsolidated basis. We are putting in place policies that we +expect will work to keep the investment securities held by us at less than 40% of our total assets, which may include acquiring assets +with our cash, liquidating our investment securities or seeking a no-action letter from the SEC if we are unable to acquire sufficient +assets or liquidate sufficient investment securities in a timely manner. +38 +As Rule 3a-2 is available +to a company no more than once every three years, and assuming no other exclusion were available to us, we would have to keep within the +40% limit for at least three years after we cease being an inadvertent investment company. This may limit our ability to make certain +investments or enter into joint ventures that could otherwise have a positive impact on our earnings. In any event, we do not intend to +become an investment company engaged in the business of investing and trading securities. +Classification as an investment +company under the Investment Company Act requires registration with the SEC. If an investment company fails to register, it would have +to stop doing almost all business, and its contracts would become voidable. Registration is time consuming and restrictive and would require +a restructuring of our operations, and we would be very constrained in the kind of business we could do as a registered investment company. +Further, we would become subject to substantial regulation concerning management, operations, transactions with affiliated persons and +portfolio composition, and would need to file reports under the Investment Company Act regime. The cost of such compliance would result +in our incurring substantial additional expenses, and the failure to register if required would have a materially adverse impact to conduct +our operations. +We will not be able to successfully execute +our business strategy if we are deemed to be an investment company under the Investment Company Act. +U.S. companies that (i) are, +or hold themselves out as being, engaged primarily in the business of investing, reinvesting or trading in securities (Section 3(a)(1)(A)), +(ii) are engaged or propose to engage in the business of issuing face-amount certificates of the installment type (or have been engaged +in such business and have any such certificate outstanding) (Section 3(a)(1)(B)) or (iii) are engaged or propose to engage in the business +of investing, reinvesting, owning, holding or trading securities, and own or propose to acquire investment securities having a value exceeding +40 percent of the value of the company’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis +(Section 3(a)(1)(C)) are subject to regulation under the Investment Company Act, unless the company is able to satisfy an exemption from +the definition of “investment company” in either Section 3(b) or 3(c) of the Investment Company Act (or the rules adopted +thereunder) or is otherwise not required to register as an “investment company” under the Investment Company Act. +To qualify for a Section 3(b)(1) +exemption from the Act, a company must demonstrate that it is primarily engaged in a business other than investing or trading in securities. +To make such a determination, the SEC and the courts have analyzed five factors: (1) a company’s historical development; (2) its +public representations of policy; (3) the activities of its officers and directors; (4) the nature of its present assets; and (5) the +source of its present income. +Generally, if a company has +historically been engaged in an operating business, if the vast majority of its officers, directors and employees are engaged in that +operating business, if less than 45% of its assets are comprised of securities, and if less than 45% of the company’s income is +generated by investments in securities, the company may qualify for an exemption from the Act, notwithstanding an investment in securities +which exceeds 40% of the company’s assets. Section 3(a)(1) of the Act defines an investment company as a company which either is +or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading +in securities. The SEC and the courts have applied the same five factor analysis under Section 3(a)(1), which they have used in determining +the availability of a Section 3(b)(1) exemption. +In applying the tests under +Section 3(a)(1) and (3) of the Act to our company, we believe it is clear that we are primarily engaged in businesses other than investing +in securities and a substantial part of our assets consists of, and a substantial part of our income is derived from, interests in wholly +owned and majority-owned subsidiaries and companies that we primarily control. Further, because Bitcoin is not deemed to be a security, +we do not fall under the 40% investment securities test in Section 3(a)(1)(C) for purposes of the Investment Company Act. +39 +Regardless, if Bitcoin and +other virtual currencies were to be deemed securities for purposes of the Investment Company Act, or if we were to own minority positions +in or otherwise not operate one or more of our subsidiaries, we would have difficulty avoiding classification and regulation as an investment +company. As such, we would be forced to comply with substantive requirements under the Act, including limitations on our ability to borrow, +limitations on our capital structure; restrictions on acquisitions of interests in associated companies, prohibitions on transactions +with affiliates, restrictions on specific investments, and compliance with reporting, record keeping, voting, proxy disclosure and other +rules and regulations. If we were forced to comply with the rules and regulations of the Investment Company Act, our operations +would significantly change, and we would be prevented from successfully executing our business strategy. To avoid regulation under +the Investment Company Act and related rules promulgated by the Commission, we would need to sell Bitcoin and other assets which we would +otherwise want to retain and could be unable to sell assets which we would otherwise want to sell. In addition, we could be forced +to acquire additional, or retain existing, income-generating or loss-generating assets which we would not otherwise have acquired or retained +and could need to forgo opportunities to acquire Bitcoin and other assets that would benefit our business. If we were forced to +sell, buy or retain assets in this manner, we could be prevented from successfully executing our business strategy. +Securitization of our assets subjects us to various risks . +We may securitize assets to +generate cash for funding new investments. We refer to the term securitize to describe a form of leverage under which a company (sometimes +referred to as an “originator” or “sponsor”) transfers income producing assets to a single-purpose, bankruptcy-remote +subsidiary (also referred to as a “special purpose entity” or “SPE”), which is established solely for the purpose +of holding such assets and entering into a structured finance transaction. The SPE would then issue notes secured by such assets. The +special purpose entity may issue the notes in the capital markets either publicly or privately to a variety of investors, including banks, +non-bank financial institutions and other investors. There may be a single class of notes or multiple classes of notes, the most senior +of which carries less credit risk and the most junior of which may carry substantially the same credit risk as the equity of the SPE. +An important aspect of most +debt securitization transactions is that the sale and/or contribution of assets into the SPE be considered a true sale and/or contribution +for accounting purposes and that a reviewing court would not consolidate the SPE with the operations of the originator in the event of +the originator's bankruptcy based on equitable principles. Viewed as a whole, a debt securitization seeks to lower risk to the note purchasers +by isolating the assets collateralizing the securitization in an SPE that is not subject to the credit and bankruptcy risks of the originator. +As a result of this perceived reduction of risk, debt securitization transactions frequently achieve lower overall leverage costs for +originators as compared to traditional secured lending transactions. +In accordance with the above +description, to securitize loans, we may create a wholly owned subsidiary and contribute a pool of our assets to such subsidiary. The +SPE may be funded with, among other things, whole loans or interests from other pools and such loans may or may not be rated. The SPE +would then sell its notes to purchasers whom we would expect to be willing to accept a lower interest rate and the absence of any recourse +against us to invest in a pool of income producing assets to which none of our creditors would have access. We would retain all or a portion +of the equity in the SPE. An inability to successfully securitize portions of our portfolio or otherwise leverage our portfolio through +secured and unsecured borrowings could limit our ability to grow our business and fully execute our business strategy, and could decrease +our earnings, if any. However, the successful securitization of portions of our portfolio exposes us to a risk of loss for the equity +we retain in the SPE and might expose us to greater risk on our remaining portfolio because the assets we retain may tend to be those +that are riskier and more likely to generate losses. A successful securitization may also impose financial and operating covenants that +restrict our business activities and may include limitations that could hinder our ability to finance additional loans and investments. +The Investment Company Act may also impose restrictions on the structure of any securitizations. +Interests we hold in the SPE, +if any, will be subordinated to the other interests issued by the SPE. As such, we will only receive cash distributions on such interests +if the SPE has made all cash interest and other required payments on all other interests it has issued. In addition, our subordinated +interests will likely be unsecured and rank behind all of the secured creditors, known or unknown, of the SPE, including the holders of +the senior interests it has issued. Consequently, to the extent that the value of the SPE's portfolio of assets has been reduced as a +result of conditions in the credit markets, or as a result of defaults, the value of the subordinated interests we retain would be reduced. +Securitization imposes on us the same risks as borrowing except that our risk in a securitization is limited to the amount of subordinated +interests we retain, whereas in a borrowing or debt issuance by us directly we would be at risk for the entire amount of the borrowing +or debt issuance. +We may also engage in transactions +utilizing SPEs and securitization techniques where the assets sold or contributed to the SPE remain on our balance sheet for accounting +purposes. If, for example, we sell the assets to the SPE with recourse or provide a guarantee or other credit support to the SPE, its +assets will remain on our balance sheet. Consolidation would also generally result if we, in consultation with our auditors, determine +that consolidation would result in a more accurate reflection of our assets, liabilities and results of operations. In these structures, +the risks will be essentially the same as in other securitization transactions but the assets will remain our assets for purposes of the +limitations described above on investing in assets that are not qualifying assets and the leverage incurred by the SPE will be treated +as borrowings incurred by us for purposes of our limitation on the issuance of senior securities. +40 +We may not be able to utilize our net operating loss carry forwards. +As of December 31, 2022, we +had federal and state net operating loss carry forwards (“NOLs”) for income tax purposes of approximately $23.7 million and +$104.2 million, respectively, after application of the limitations set forth in Section 382 of the Internal Revenue Code. In accordance +with Section 382, future utilization of our NOLs is subject to an annual limitation as a result of ownership changes that occurred previously. +We also maintain NOLs in various foreign jurisdictions. +Our corporate structure and intercompany arrangements +are subject to the tax laws of various jurisdictions, and we could face greater than anticipated tax liabilities, which would harm our +results of operations. +We are subject to tax laws +in the U.S. and certain foreign jurisdictions, including Israel and the U.K. Our income tax obligations +are based in part on our corporate structure and intercompany arrangements. The tax laws applicable to our business are increasingly complex, +are subject to interpretation and their application can be uncertain. The amount of taxes we pay in the jurisdictions in which we operate +could increase substantially as a result of changes in the applicable tax principles, including increased tax rates, new tax laws or revised +interpretations of existing tax laws and precedents. +We are subject to the examination +of our income tax returns by the Internal Revenue Service and foreign tax authorities in the jurisdictions in which we operate, and we +may be subject to assessments or audits in the future in any such jurisdictions. The tax authorities in these jurisdictions may aggressively +interpret their laws in an effort to raise additional tax revenue and may claim that various withholding requirements apply to us or our +subsidiaries, challenge the availability to us or our subsidiaries of certain benefits under tax treaties, and challenge our methodologies +for valuing developed technology or intercompany arrangements or our revenue recognition policies, which could result in an increase of +our worldwide effective tax rate and have a material adverse effect on our financial condition and operating results. +Risks Related to Circle 8 +Circle 8 uses substantial leverage in its capital +structure which could adversely affect its financial condition. Although Circle 8’s debt-to-EBITDA ratio is below the industry median, +operational disruptions or economic shocks could hinder Circle 8’s ability to service its debt and impact its solvency. Additionally, +the industry tends to heavily rely on debt to finance expansionary initiatives, whether through organic growth or acquisitions. +Circle 8 currently has a substantial +amount of outstanding debt. As of December 31, 2022, it had total outstanding indebtedness of approximately $25.6 million, of which $15.1 +million was borrowed from CIT Northbridge Credit, LLC (“CITN”) in a senior secured asset-based revolving line of credit and +$10.6 million consists of outstanding equipment notes transferred from De Lage Landen Group, LLC (“DLL”). Circle 8 has the +ability to increase the CITN loan by $10 million. Circle 8 may further increase its debt balance where permitted by incumbent lenders +for growth and expansionary purposes. Circle 8’s substantial indebtedness could have important consequences. For example, it may: +• increase Circle 8’s vulnerability to general adverse economic, industry and competitive conditions; +• require management to dedicate a substantial portion of Circle 8’s cash flow from operations to +interest payments and principal repayment, thereby reducing the availability of cash flow to fund working capital, capital expenditures, +acquisitions, dividend payments to its owners and other general corporate purposes; +• limit Circle 8’s flexibility in planning for, or reacting to, changes in Circle 8’s specific +business and the industry in which it operates; +• place Circle 8 at a competitive disadvantage compared to its competitors that have less debt; and +• limit Circle 8’s ability to obtain additional financing for working capital, capital expenditures, +acquisitions or general corporate purposes. +Circle 8 expects to use cash +flow from operations and borrowings under the CITN commitment to meet current and future financial obligations, including funding operations, +debt service and capital expenditures. Circle 8’s ability to make these payments depends on future operational performance, which +will be affected by financial, business, economic and other factors, many of which Circle 8 cannot control. Circle 8’s business +may not generate sufficient cash flow from operations in the future or be able to appropriately adjust operations to suit organic industry +developments, which could result in Circle 8’s inability to service its debt obligations, or to fund other liquidity needs. If Circle +8 has insufficient capital to cover its debt obligations, it may be forced to reduce or delay ongoing or growth activities and capital +expenditures, sell assets, obtain additional debt or dilutive equity capital or restructure or refinance all or a portion of its debt, +including the incumbent CITN and DLL loans, and any other incremental loans, on or before maturity. There can be no assurance that Circle +8 will be able to accomplish any of these alternatives on terms acceptable to it or to us, if at all. In addition, the terms of existing +or future indebtedness, including the agreements governing the incumbent loans, may limit Circle 8’s ability to pursue any of other +alternatives. +41 +While Circle 8 has had an industry-leading +safety record throughout its history, it operates in a potentially hazardous industry, and any safety incident could significantly impact +its operations. A blemish on Circle 8’s safety record could lead to direct consequences such as fines, levies, and increased insurance +premiums, as well as indirect consequences such as customers preferring competitors with better safety records. +The lifting solutions business +is inherently risky, and accidents can occur due to a variety of factors, including negligence and unforeseeable events. Despite this, +Circle 8 has maintained an industry-leading safety record and has not experienced any incidents that have significantly impacted its operations. +While Circle 8 has a safety program in place, it cannot guarantee protection against unforeseeable events or “acts of God.” +Any safety transgressions can have a material impact on sales and operating results, leading to fines and levies, and potentially causing +customers to prefer competitors with better safety records. Therefore, Circle 8 places a great emphasis on maintaining its safety program +and continually improving its practices to minimize the risk of incidents occurring. +The lifting solutions business is dependent +on the domestic oil markets’ activity, oil pricing, construction and industrial activities, and the overall economic conditions. +Any downturn in these areas could adversely affect the demand for lifting solutions, leading to decreased sales and lower lifting solutions +prices, which may result in a decline in Circle 8’s revenues, gross margins and operating results. +Circle 8 primarily provides +lifting solutions for the U.S. domestic oil market. As such, any downturn in the U.S. domestic oil market or the economy as a whole could +result in reduced demand for its services or lower sales prices. Additionally, its business may face temporary or long-term negative impacts +due to: +• a reduction in extraction levels by customers due to increased costs and break-even oil price and lower +levels of reserves due to depletion of existing reserves and resources; +• exploration and drilling are capital intensive and results are uncertain, which may limit Circle 8’s +current clients’ demand for Circle 8’s services and adversely affect its ability to generate new clients; +• until it executes on its expansion program, dependence on a limited number of clients in a niche oil services +market could make Circle 8 vulnerable compared to larger industry incumbents with greater client diversity; +• unfavorable credit and equity markets affecting end-user access to capital or cost of capital, also potentially +increasing the all-in cash costs and break-even oil prices may make operations of its current and future clients no longer economically +viable; +• adverse changes in federal, state, tribal and local government infrastructure spending; +• an increase in the cost of consumables and construction materials related to oil extraction and infrastructure +construction; +• adverse weather conditions or natural disasters which may affect a particular region; +• a decrease in the level of exploration, development, production activity and capital spending by oil and +natural gas companies; +• an increase in inflationary pressure on materials and labor; +• labor issues such as strikes or worker shortages; +• a prolonged shutdown of the U.S. government; +• an increase in interest rates; +• supply chain disruptions; +• changes in federal and state regulations related to climate change and greenhouse gas emissions may materially +adversely impact Circle 8’s and/or its clients’ revenues, operating results and profitability; +• public health crises and epidemics, such as COVID-19; or +• terrorism or hostilities involving the United States and/or its allies. +Weakness or deterioration +in the oil services industry, renewables infrastructure construction, plant turn-around and public and industrial infrastructure construction +sectors caused by the above or other factors could have a material adverse effect on Circle 8’s financial position, results of operations +and cash flows in the future and may also have a material adverse effect on residual values realized on the disposition of the existing +and future rental fleet. +42 +Circle 8’s business is highly reliant +on the availability of specialized skilled labor, and this dependency is particularly pronounced given the current scarcity of domestic +U.S. skilled labor. This scarcity is at an all-time high, which is further compounded as labor requirements to operate in Circle 8 ‘s +business becomes even more specialized. +The lifting solutions business +requires licensed operators to operate safely and within U.S. domestic regulatory requirements. It takes several months and material funding +to be trained to become a licensed crane operator, making the availability of qualified labor scarce for the lifting solutions industry +in general and specifically in remote locations in which Circle 8’s client set operates its oil services. Availability of labor +may have a significant impact on Circle 8’s ability to service its current client set and to be able to execute on its expansion +program. +Additionally, the training +and licensing requirements for crane operators can vary by state and even by municipality, which can create further challenges for Circle +8 in sourcing and deploying qualified labor in different geographic locations. Moreover, the competitive labor market for skilled workers +in the oil services industry could potentially drive up labor costs for Circle 8, which would impact its profitability and competitiveness. +Circle 8’s business is, directly and +indirectly, dependent on a functioning global supply chain system. The oil and steel markets are global, and many suppliers, vendors, +OEM’s and parts manufacturers for Circle 8 and its clients’ industries are offshore. +The lifting solutions business +success is heavily dependent on the availability and efficient conversion to elevated utilization rates of the lifting assets. This metrics +can be fundamentally impacted by the functionality of the global supply chain, which plays several roles in the lifting solutions business. +For example, supply chain disruptions could delay the delivery of critical parts and components needed for maintenance and repair of lifting +assets, leading to longer downtime periods and reduced utilization rates. +In addition, fluctuations +in commodity prices could impact the cost of raw materials needed to manufacture lifting assets, potentially affecting the company’s +profitability. These fluctuations, among others, could impact the efficiency and profitability of Circle 8’s lifting solutions business +and can be impacted by a variety of factors, including the following: +• possible geopolitical unrest and conflict may impact ability to receive new parts or new cranes in a timely +manner, if at all, to optimize utilization and ultimately, profitability; +• reliance on foreign suppliers for cranes and exposure to trade embargoes could impede its ability to procure +necessary parts and equipment to execute its growth strategies and maintain its fleet; +• inflationary pressures resulting from supply chain disruptions and labor shortages could make it difficult +for Circle 8 to repair and replace its crane equipment at regular costs; +• fuel price escalation could have a material impact on gross profit since it is typically approximately +7% of the operating cost structure in recent history; +• oil market sanctions and political pressure on domestic production reduction may adversely impact Circle +8’s core clients and its revenues and profitability; or +• steel market sanctions, trade embargoes and other supply chain shocks may adversely impact public and +private infrastructure and renewables new construction and maintenance projects, ultimately slowing Circle 8’s strategic transition +to diversify its end markets and client base. +Furthermore, as Circle 8 expands +its operations, it may need to rely on suppliers and logistics partners in new geographic regions, which could expose the company to additional +supply chain risks. +Circle 8’s reliance on a limited number +of equipment manufacturers exposes the company to significant risks, as the termination or disruption of relationships with any of these +manufacturers could adversely impact Circle 8’s ability to obtain equipment in a timely or adequate manner, potentially leading +to operational disruptions and financial losses. +Circle 8 purchases most of +its equipment from a leading, nationally recognized original equipment manufacturer (“OEM”). For the year ended December 31, +2022, the company did not purchase any new equipment as it was in a period of restructuring and right sizing its fleet. Prior to that, +it purchased 100% of its equipment from Manitowoc. Circle 8 plans to diversify its supplier base going forward to alleviate this risk +to some extent. The termination of its existing relationship with any major supplier could have a material adverse effect on the business, +financial condition or results of operations if it were unable to obtain equipment in an adequate or timely manner. +43 +Circle 8 faces risks related to heightened +inflation, recession, financial and credit market disruptions and other economic conditions. +Circle 8 financial results, +operations and forecasts depend significantly on worldwide economic and geopolitical conditions, the demand for Circle 8’s products, +and the financial condition of its customers and suppliers. Economic weakness and geopolitical uncertainty have in the past resulted, +and may result in the future, in reduced demand for lifting solutions resulting in decreased sales, margins and earnings. In 2022, the +U.S. experienced significantly heightened inflationary pressures which have continued into 2023. It is difficult to fully mitigate the +impact of inflation through price increases passed through to customers that are operating in commodity sector with global end market +pricing mechanisms, productivity initiatives and cost savings, which could have an adverse effect on Circle 8’s financial results +and position. In addition, if the U.S. economy enters a recession, Circle 8’s sales may decline, which could have an adverse effect +on its overall business, operating results and financial condition. Similarly, disruptions in financial and/or credit markets may impact +Circle 8’s ability to manage normal commercial relationships with its customers, suppliers and creditors. Further, in the event +of a recession or threat of a recession, Circle 8’s customers and suppliers may suffer their own financial and economic challenges +and as a result they may demand pricing accommodations, delay payment, or become insolvent, which could harm Circle 8’s ability +to meet its customer demands or collect revenue or otherwise could harm the business and its ability to service incumbent loans, ultimately +leading to possible insolvency. An economic or credit crisis could occur and impair credit availability and Circle 8’s ability to +raise capital as required for ongoing working capital, maintenance capital and expansion capex. A disruption in the financial markets +could impair Circle 8’s banking or other business partners, on whom it relies for access to capital. In addition, changes in tax +or interest rates in the U.S. or other nations, whether due to recession, economic disruptions or other reasons, could have an adverse +effect on Circle 8’s operating results. Economic weakness and geopolitical uncertainty may also lead to asset impairment, restructuring +actions or adjust Circle 8’s operating strategy and reduce expenses in response to decreased sales or margins. Circle 8 may not +be able to adequately adjust its cost structure in a timely fashion, which could have an adverse effect on its operating results and financial +condition. Uncertainty about economic conditions may increase foreign currency volatility in markets in which it transacts business, which +could have an adverse effect on Circle 8 operating results. +The inability to forecast trends accurately +may have an adverse impact on Circle 8’s business and financial condition. +An economic downturn or economic +uncertainty makes it difficult to forecast trends. For example, the economic uncertainty caused by COVID-19, and its impact on Circle +8’s future operational and financial performance was highly dependent on the depth and duration of the pandemic, as well as the +government-mandated restrictions on economic activity and government economic stimulus packages passed in response to the economic downturn. +More recently, rising interest rates, higher than expected inflation, and several bank failures also underscore the potential impact of +ongoing economic risks to Circle 8’s operations and financial performance. These factors can lead to increased borrowing costs, +reduced consumer spending, and reduced access to credit, among other potential challenges. +This uncertainty makes it +difficult to forecast Circle 8’s future operating performance, cash flows and financial position, which could have an adverse impact +on its business and financial condition. Additionally, uncertainty regarding future oil and natural gas prices have negatively impacted +the exploration, production and construction activity of Circle 8’s customers in those markets. Uncertainty regarding future lifting +solutions demand could cause Circle 8 to maintain excess equipment inventory and increase its equipment inventory carrying costs, decrease +utilization and cause a technical default in certain covenants. Alternatively, difficulty forecasting, in addition to labor shortages +and supply chain disruptions could cause a shortage incremental rental equipment that could result in an inability to satisfy demand for +Circle 8 service and a loss of market share. +Circle 8’s revenue and operating results +may fluctuate, which could result in a decline in profitability and make it more difficult to grow the business. +Circle 8’s revenue and +operating results have historically varied from month to month and quarter to quarter. Periods of decline could result in an overall decline +in profitability and make it more difficult to adequately service indebtedness and grow the business using incremental leverage. It can +be expected that Circle 8’s quarterly results will continue to fluctuate in the future due to a number of factors, including the +following: +• general economic conditions in the markets in which the company operates; +44 +• the cyclical nature of Circle 8’s customers’ business, particularly Circle 8’s oil services +customer and prospective customers in the construction industry; +• sales patterns in general in the construction industry, with sales activity tending to be lower in the +winter months, which causes significant volatility in utilization; +• changes in the size of Circle 8’s fleet due to rapid growth followed by a slow-down and Circle 8’s +ability to service and maintain its fleet in a timely manner; +• an overcapacity of fleet in the crane services industry; +• severe weather and seismic conditions temporarily affecting the regions in which Circle 8 operates; +• supply chain or other disruptions that impact its ability to obtain equipment and other supplies from +key suppliers on acceptable terms or at all; +• changes in corporate spending for plants and facilities or changes in government spending for infrastructure +projects; +• changes in interest rates and related changes in Circle 8’s interest expense and debt service obligations; +or +• the possible need, from time to time, to record impairment charges or other write-offs or charges due +to a variety of occurrences, such as the impairment of assets, existing location divestitures, dislocation in the equity and/or credit +markets, consolidations or closings, restructurings, or the refinancing of existing indebtedness. +Circle 8 is subject to competition, which may +have a material adverse effect on its business by reducing its ability to increase or maintain revenues or profitability. +The full-service crane services +and lifting solutions industry is highly competitive and fragmented. Many of the markets in which Circle 8 operates are served by numerous +competitors, ranging from global, national and multi-regional equipment rental companies to small, independent businesses with a limited +number of locations. Circle 8 has historically competed on the bases of availability, quality, reliability, delivery and price. Some of +Circle 8’s competitors have significantly greater financial, marketing and other resources than it does, and may be able to reduce +rates. Circle 8 may encounter increased competition from existing competitors or new market entrants in the future, which could have a +material adverse effect on its business, financial condition and results of operations. +The cost of new Circle 8 rental fleet units +may increase and therefore may require a larger equity investment equipment. In some cases, it may not be possible to procure equipment +on a timely basis due to supplier constraints, among other reasons. +The cost of new equipment +from manufacturers of Circle 8 fleet may increase because of increased raw material costs, including increases in the cost of steel, which +is a primary material used in almost all of the equipment Circle 8 uses, labor shortages, supply chain disruptions or due to increased +regulatory requirements, such as those related to emissions. In addition, in an effort to combat climate change, Circle 8’s customers +may require Circle 8’s fleet to meet certain standards which may not be able to be met without capital intensive and time-consuming +fleet unit retrofits or ultimately cost prohibitive replacements. If such retrofits or replacements cannot be achieved in a timely manner, +or at all, Circle 8’s sales, financial results and financial position would be materially adversely impacted. These increases could +materially impact Circle 8 financial condition or results of operations in future periods if Circle 8 is not able to pass such cost increases +through to its customers. +Circle 8’s fleet is subject to residual +value risk upon disposition. +The market value of any given +piece of equipment could be less than its depreciated value at the time it is sold. The market value of used rental equipment depends +on several factors, including: +• the market price for new equipment of a like kind; +• wear and tear on the equipment relative to its age; +• the time of year that it is sold (prices are generally higher during the busy season); +• worldwide and domestic demands for used equipment; +• the supply of used equipment on the market; and +• general economic conditions. +Circle 8 typically includes +in operating income the difference between the sales price and the depreciated value of an item of equipment sold. Although for the year +ended December 31, 2022, Circle 8 sold used equipment from Circle 8 rental fleet reducing its fleet from 65 to 54 cranes at an average +selling price above of net orderly liquidation value, it cannot be assured that used equipment selling prices will not decline. Any significant +decline in the selling prices for used equipment could have a material adverse effect on Circle 8’s business, financial condition, +results of operations or cash flows. +45 +As Circle 8’s rental fleet ages, its +operating costs may increase, it may be unable to pass along such costs to customers, and earnings may decrease. The costs of new fleet +units may increase, requiring Circle 8 to spend more for replacement equipment or preventing it from procuring equipment on a timely basis. +If Circle 8’s rental +equipment ages, the costs of maintaining such equipment, if not replaced within a certain period of time, will likely increase. The costs +of maintenance may materially increase in the future and could lead to material adverse effects on Circle 8’s results of operations. +The cost of new equipment for use in Circle 8’s rental fleet could also increase due to increased material costs for its suppliers +(including tariffs on raw materials) or other factors beyond Circle 8’s control. Such increases could materially adversely impact +Circle 8’s financial condition and results of operations in future periods. Furthermore, changes in customer demand could cause +certain of Circle 8’s existing equipment to become obsolete and require Circle 8 to purchase new equipment at increased costs. +Labor disputes could disrupt Circle 8 ability +to serve its customers and/or lead to higher labor costs. +As of December 31, 2022, Circle +8 had approximately 110 employees in Texas, Louisiana and Oklahoma, none of whom is unionized. While Circle 8 has no current plans to +unionize any of its locations, it recognizes the possibility of a branch or group of branches in a state becoming unionized against Circle +8’s wishes in the future. However, Circle 8 is committed to maintaining positive and productive relationships with its employees +without union influence, prioritizing open communication and collaboration to address any concerns and ensure a positive work environment. +Circle 8. employee’s +union organizing efforts or collective bargaining negotiations could potentially lead to work stoppages and/or slowdowns or strikes by +certain of Circle 8 employees, which could adversely affect its ability to serve its customers. +Climate change, climate change regulations +and greenhouse effects may materially adversely impact Circle 8 operations and markets. +Climate change and its association +with greenhouse gas emissions is receiving increased attention from the scientific and political communities. The U.S. federal government, +certain U.S. states and certain other countries and regions have adopted or are considering legislation or regulation imposing overall +caps or taxes on greenhouse gas emissions from certain sectors or facility categories. Such new laws or regulations, or stricter enforcement +of existing laws and regulations, could increase the costs of operating Circle 8’s businesses, reduce the demand for its products +and services and impact the prices charged to customers, any or all of which could adversely affect Circle 8’s results of operations. +Failure to comply with any legislation or regulations could potentially result in substantial fines, criminal sanctions or operational +changes. Moreover, even without such legislation or regulation, the perspectives of Circle 8’s customers, employees and other stakeholders +regarding climate change are continuing to evolve, and increased awareness of, or any adverse publicity regarding, the effects of greenhouse +gases could harm Circle 8’s reputation or reduce customer demand for Circle 8’s products and services. Additionally, as severe +weather events become increasingly common, Circle 8’s and its customers’ operations may be disrupted, which could result in +increased operational costs or reduced demand for its products and services, which could have an adverse effect on Circle 8’s results +of operations. In addition, climate change may also reduce the availability or increase the cost of insurance for weather-related events +as well as may impact the global economy, including as a result of disruptions to supply chains. Circle 8 anticipates that climate change-related +risks will increase over time. +Risks Related to Our Bitcoin Operations +Risks Related to Our Bitcoin Operations – General +To remain competitive in our industry, we seek +to grow our hash rate to match the growing network hash rate and increasing network difficulty of the Bitcoin blockchain, and if we are +unable to grow our hash rate at pace with the network hash rate, our chance of earning Bitcoin from our Mining operations would decline. +As the adoption of Bitcoin +has increased, the price of Bitcoin has generally appreciated, causing the demand for new Bitcoin rewards for successfully solving blocks +on the Bitcoin blockchain to likewise increase. This has encouraged more miners to attempt to mine Bitcoin, which increases the global +network hash rate deployed in support of the Bitcoin blockchain. +46 +Because a miner’s relative +chance of successfully solving a block and earning a new Bitcoin reward is generally a function of the ratio the miner’s individual +hash rate bears to the global network hash rate, as the global network hash rate increases, a miner must increase its individual hash +rate to maintain its chances of earning new Bitcoin rewards. Therefore, as new miners enter the industry and as miners deploy greater +and greater numbers of increasingly powerful machines, existing miners must seek to continually increase their hash rate to remain competitive. +Thus, a feedback loop is created: as Bitcoin gains popularity and its relative market price increases, more miners attempt to mine Bitcoin +and the Bitcoin network hash rate is increased; in response, existing miners and new miners devote more and more hash rate to the Bitcoin +blockchain by deploying greater numbers of increasingly powerful machines in an attempt to ensure their ability to earn additional Bitcoin +rewards does not decrease. Compounding this feedback loop, the network difficulty of the Bitcoin network (i.e., the amount of work (measured +in hashes) necessary to solve a block) is periodically adjusted to maintain the pace of new block additions (with one new block added +to the blockchain approximately every ten minutes), and thereby control the supply of Bitcoin. As miners deploy more hash rate and the +Bitcoin network hash rate is increased, the Bitcoin network difficulty is adjusted upwards by requiring more hash rate to be deployed +to solve a block. Thus, miners are further incentivized to grow their hash rate to maintain their chance of earning new Bitcoin rewards. +In theory, these dual processes should continually replicate themselves until the supply of available Bitcoin is exhausted. In response, +miners have attempted to achieve greater hash rate by deploying increasingly sophisticated miners and expensive miners in ever greater +quantities. This has become the Bitcoin mining industry’s great “arms race.” Moreover, because there are very few manufacturers +of miners capable of producing a sufficient number of miners of adequate quality to meet this need, scarcity results, leading to higher +prices. Compounding this phenomenon, it has been observed that some manufacturers of Bitcoin miners may increase the prices for new miners +as the market price of Bitcoin increases. +Accordingly, to maintain our +chances of earning new Bitcoin rewards and remaining competitive in our industry, we must seek to continually add new miners to grow our +hash rate at pace with the growth in the Bitcoin network hash rate. However, as demand has increased and scarcity in the supply of new +miners has resulted, the price of new miners has increased sharply, and we expect this process to continue in the future as demand for +Bitcoin increases. Therefore, if the price of Bitcoin is not sufficiently high to allow us to fund our hash rate growth through new miner +acquisitions and if we are otherwise unable to access additional capital to acquire these miners, our hash rate may stagnate and we may +fall behind our competitors. If this happens, our chances of earning new Bitcoin rewards would decline and, as such, our results of operations +and financial condition may suffer. +Acceptance and/or widespread use of Bitcoin +is uncertain. +Currently, there is a limited +use of any Bitcoin in the retail and commercial marketplace, thus contributing to price volatility that could adversely affect an investment +in our securities. Banks and other established financial institutions may refuse to process funds for Bitcoin transactions or process +wire transfers to or from Bitcoin exchanges, Bitcoin-related companies or service providers, which we have experienced, or maintain accounts +for persons or entities transacting in Bitcoin. Conversely, a significant portion of Bitcoin demand is generated by investors seeking +a long-term store of value or speculators seeking to profit from the short- or long-term holding of the asset. Price volatility undermines +any Bitcoin’s role as a medium of exchange, as retailers are much less likely to accept it as a form of payment. Market capitalization +for a Bitcoin as a medium of exchange and payment method may always be low. +The relative lack of acceptance +of Bitcoins in the retail and commercial marketplace, or a reduction of such use, limits the ability of end users to use them to pay for +goods and services. Such lack of acceptance or decline in acceptances could have a material adverse effect on our ability to continue +as a going concern or to pursue our business strategy at all, which could have a material adverse effect on our business, prospects or +operations and potentially the value of Bitcoins we mine or otherwise acquire or hold for our own account. +The development and acceptance of cryptographic +and algorithmic protocols governing the issuance of and transactions in cryptocurrencies is subject to a variety of special economic, +geopolitical and regulatory factors, which could slow the growth of the industry in general and our company as a result. +The use of cryptocurrencies, +including Bitcoin, to, among other things, buy and sell goods and services and complete transactions, is part of a new and rapidly evolving +industry that employs cryptocurrency assets based upon a computer-generated mathematical and/or cryptographic protocol. Large-scale acceptance +of cryptocurrencies as a means of payment has not, and may never, occur. The growth of this industry in general, and the use of Bitcoin +in particular, is subject to a high degree of uncertainty, and the slowing or stopping of the development or acceptance of developing +protocols may occur unpredictably. The factors include, but are not limited to: +● the progress of worldwide growth in the adoption and use of Bitcoin and other cryptocurrencies as a medium +of exchange; +● the experience of businesses in using Bitcoin; +47 +● the impact from prominent business leaders in criticizing Bitcoin’s potential harm to the environment +and the effect of announcements critical of Bitcoin, such as those that occurred with Elon Musk of Tesla; +● governmental and organizational regulation of Bitcoin and other cryptocurrencies and their use, or restrictions +on or regulation of access to and operation of the network or similar cryptocurrency systems (such as the recent ban in China); +● changes in consumer demographics and public tastes and preferences, including as may result from coverage +of Bitcoin or other cryptocurrencies by journalists and other sources of information and media; +● the maintenance and development of the open-source software protocol of the network; +● the increased consolidation of contributors to the Bitcoin blockchain through mining pools and scaling +of mining equipment by well-capitalized market participants; +● the availability and popularity of other forms or methods of buying and selling goods and services, including +new means of using fiat currencies; +● the use of the networks supporting Bitcoin or other cryptocurrencies for developing smart contracts and +distributed applications; +● general economic conditions and the regulatory environment relating to Bitcoin and other cryptocurrencies; +● the impact of regulators focusing on cryptocurrencies and the costs, financial and otherwise, associated +with such regulatory oversight; and +● a decline in the popularity or acceptance of Bitcoin could adversely affect an investment in us. +The outcome of these factors +could have negative effects on our ability to continue as a going concern or to pursue our business strategy, which could have a material +adverse effect on our business, prospects or operations as well as potentially negative effects on the value of any Bitcoin or other cryptocurrencies +we mine or otherwise acquire, which would harm investors in our securities. If Bitcoin or other cryptocurrencies we mine do not gain widespread +market acceptance or accrete in value over time, our prospects and your investment in us would diminish. +There has been a recent disruption in the crypto +asset markets and a loss of confidence in the participants in the digital asset ecosystem, which may continue or could get worse. +Digital asset exchanges on +which cryptocurrencies trade are relatively new and, in most cases, largely unregulated. Many digital exchanges do not provide the public +with significant information regarding their ownership structure, management teams, corporate practices or regulatory compliance. As a +result, the marketplace and customer demand in particular may lose confidence in, or may experience problems relating to, cryptocurrency +exchanges, including prominent exchanges handling a significant portion of the volume of digital asset trading. During 2022 and more recently +in 2023, a number of companies in the crypto industry have declared bankruptcy, including Celsius Network, Voyager Digital, BlockFi, FTX +and Genesis Global. In June 2022, Celsius began pausing all withdrawals and transfers between accounts on its platform, and in July 2022, +it filed for Chapter 11 bankruptcy protection. Further, in November 2022, FTX, one of the major cryptocurrency exchanges, also filed for +Chapter 11 bankruptcy. Such bankruptcies have contributed, at least in part, to further price decreases in Bitcoin, a loss of confidence +in the participants of the digital asset ecosystem and negative publicity and reputational harm surrounding digital assets more broadly, +and other participants and entities in the digital asset industry, like our company, have been, and may continue to be, negatively affected. +These events have also negatively impacted the liquidity of the digital assets markets as certain entities affiliated with FTX engaged +in significant trading activity. These events have also contributed to the collapse of several banks and lenders that had conducted business +in the crypto market including Silvergate Capital, Silicon Valley Bank and Signature Bank. +Shortly FTX’s bankruptcy, +its CEO resigned and FTX and several affiliates of FTX filed for bankruptcy. The U.S. Department of Justice (“DOJ”) subsequently +brought criminal charges, including charges of fraud, violations of federal securities laws, money laundering, and campaign finance offenses, +against FTX’s former CEO and others. FTX is also under investigation by the SEC, the DOJ, and the CFTC, as well as by various regulatory +authorities in the Bahamas, Europe and other jurisdictions. In response to these events, the digital asset markets have experienced extreme +price volatility and declines in liquidity, and regulatory and enforcement scrutiny has increased, including from the DOJ, the SEC, the +CFTC, the White House and Congress. The SEC also brought charges against Genesis Global Capital, LLC and Gemini Trust Company, LLC on +January 12, 2023 for their alleged unregistered offer and sale of securities to retail investors. +48 +We are dependent on the overall +crypto assets industry, and such recent events have contributed, at least in part, to depreciation in and volatility to our and our peers +stock price as well as the price of Bitcoin. If the liquidity of the digital assets markets continues to be negatively impacted, digital +asset prices (including the price of bitcoin) may continue to experience significant volatility and confidence in the digital asset markets +may be further undermined. A perceived lack of stability in the digital asset exchange market and the closure or temporary shutdown of +digital asset exchanges due to business failure, hackers or malware, government-mandated regulation, or fraud, may reduce confidence in +digital asset networks and result in greater volatility in cryptocurrency values. These potential consequences of a digital asset exchange’s +failure could adversely affect an investment in our company. +We cannot provide any assurance +that we will not be materially impacted in the future by bankruptcies of participants in the crypto asset space, such as the recent bankruptcy +filings by Celsius Network, Voyager Digital, BlockFi, FTX and Genesis Global, or by potential liquidity or insolvency issues of our service +providers and other counterparties. We continue to monitor the digital assets industry as a whole, though these events are continuing +to develop and it is not possible at this time to predict all of the risks stemming from these events that may result to us, our service +providers, including custodians, our counterparties, and the broader industry as a whole. At this time, Gemini Trust Company, LLC is the +only company we use to store our digital assets, and we do not utilize any other custodians. In the past we have used other custodians +and may do so again in the future, subject to diligence on the security of any such custodian. +Any of these events may adversely +affect our operations and results of operations and, consequently, an investment in our company. +We rely on a sole supplier for our Bitcoin +mining machines, and may not be able to find replacements or immediately transition to alternative suppliers. If we were to lose Bitmain +as a supplier, or if Bitmain were unable or unwilling to fulfill our orders, any delay or interruption in planned delivery could seriously +interrupt our business. +We rely on Bitmain as the +sole supplier for our Bitcoin miners. According to Bitmain, it supplies approximately 80% of the global market for ASIC miners, which +are used to mine Bitcoin. Currently, we have contracts with Bitmain for the delivery of 20,600 miners, of which approximately 16,017 S19j +Pro Antminers and 4,424 S19 XP Antminers have been delivered to date with +another 204 S19 XP Antminers in the hands of our carrier and in route to our Facility, which brings us to a total of 20,645 S19j Pro and +S19 XP Antminers in our possession. The remaining miners scheduled to be delivered monthly through December 2023. The market price and +availability of new mining machines fluctuates with the price of Bitcoin and can be volatile. Higher Bitcoin prices increase the demand +for mining equipment and increases the cost. In addition, as more companies seek to enter the mining industry, the demand for machines +may outpace supply and create mining machine equipment shortages. Any future purchase orders with Bitmain for additional miners are subject +to availability and price considerations. If we were to lose Bitmain as a supplier, or if Bitmain were unable or unwilling to fulfill +our orders or make miners available to use in the future on terms acceptable to us, there can be no assurance that we will be able to +identify or enter into agreements with alternative suppliers on a timely basis or on acceptable terms, if at all. Any delay or interruption +in the planned delivery of our contracted miners, whether due to supply shortages, foreign country hostilities, extended national holidays +or otherwise, could significantly affect our business, financial condition and results of operations. +Political or economic crises may motivate large-scale sales +of cryptocurrencies, which could result in a reduction in values of cryptocurrencies such as Bitcoin and adversely affect an investment +in us. +Geopolitical crises, in particular +major ones such as Russia’s invasion of Ukraine, may motivate large-scale purchases of Bitcoin and other cryptocurrencies, which +could increase the price of Bitcoin and other cryptocurrencies rapidly. This may increase the likelihood of a subsequent price decrease +as crisis-driven purchasing behavior dissipates, adversely affecting the value of our Bitcoin following such downward adjustment. Such +risks are similar to the risks of purchasing commodities in general uncertain times, such as the risk of purchasing, holding or selling +gold. Alternatively, as an emerging asset class with limited acceptance as a payment system or commodity, global crises and general economic +downturn may discourage investment in cryptocurrencies as investors focus their investment on less volatile asset classes as a means of +hedging their investment risk. +49 +As an alternative to fiat +currencies that are backed by central governments, cryptocurrencies, which are relatively new, are subject to supply and demand forces. +How such supply and demand will be impacted by geopolitical events is largely uncertain but could be harmful to us and investors in our +common stock. Political or economic crises may motivate large-scale acquisitions or sales of cryptocurrencies either globally or locally. +Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which +could have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin or any other cryptocurrencies +we mine or otherwise acquire or hold for our own account. +Negative media attention and public perception +surrounding energy consumption by cryptocurrency mining may adversely affect our reputation and, consequently, our stock price; particularly +in the eyes of some of our investors who may be more interested in our non-crypto operations as a holding company. +Cryptocurrency mining has +experienced negative media attention surrounding its perceived high electricity use and environmental impact, which has adversely influenced +public perception of the industry as a whole. We believe these factors are overstated for the cryptocurrency mining industry because of +the informational disparity between cryptocurrency mining and other energy intensive industries. Cryptocurrency miners (particularly Bitcoin +miners) have freely and publicly disclosed their energy consumption statistics because electricity usage, and the associated utility fees, +is a cost of production. As increasing numbers of publicly traded cryptocurrency miners enter the market, more data, reliably disclosed +in compliance with GAAP, has become available; however, such data has not been made as readily available for competitive payment systems +and fiat currencies. +Nevertheless, this negative +media attention and public perception may materially and adversely affect our reputation and, consequently, our stock price, particularly +in the eyes of our investors who are more interested in our non-crypto operations as a holding company. As a single company within the +broader cryptocurrency industry, we are likely incapable of effectively countering this negative media attention and affecting public +perception. Therefore, we may not be able to adequately respond to these external pressures, which may cause a significant decline in +the price of our common stock. +Banks and financial institutions may not provide +banking services, or may cut off services, to businesses like us that engage in cryptocurrency-related activities. +A number of companies that +engage in Bitcoin and/or other cryptocurrency-related activities have been unable to find banks or financial institutions that are +willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated +with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial +institutions in response to government action. The difficulty that many businesses that provide Bitcoin and/or derivatives on other cryptocurrency-related activities +have and may continue to have in finding banks and financial institutions willing to provide them services may be decreasing the usefulness +of cryptocurrencies as a payment system and harming public perception of cryptocurrencies, and could decrease their usefulness and harm +their public perception in the future. +The usefulness of cryptocurrencies +as a payment system and the public perception of cryptocurrencies could be damaged if banks or financial institutions were to close the +accounts of businesses engaging in Bitcoin and/or other cryptocurrency-related activities. This could occur as a result of compliance +risk, cost, government regulation or public pressure. The risk applies to securities firms, clearance and settlement firms, national securities +exchanges and derivatives on commodities exchanges, the over-the-counter market, and the Depository Trust Company (“DTC”), +which, if any of such entities adopts or implements similar policies, rules or regulations, could negatively affect our relationships +with financial institutions and impede our ability to convert cryptocurrencies to fiat currencies. Such factors could have a material +adverse effect on our ability to continue as a going concern or to monetize our mining efforts, which could have a material adverse effect +on our business, prospects or operations and harm investors. +The price of cryptocurrencies may be affected +by the sale of such cryptocurrencies by other vehicles investing in cryptocurrencies or tracking cryptocurrency markets. Such events could +have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin we mine. +The global market for cryptocurrency +is characterized by supply constraints that differ from those present in the markets for commodities or other assets such as gold and +silver. The mathematical protocols under which certain cryptocurrencies are mined permit the creation of a limited, predetermined amount +of digital currency, while others have no limit established on total supply. Increased numbers of miners and deployed mining power globally +will likely continue to increase the available supply of Bitcoin and other cryptocurrencies, which may depress their market price. Further, +large “block sales” involving significant numbers of Bitcoin following appreciation in the market price of Bitcoin may also +increase the supply of Bitcoin available on the market, which, without a corresponding increase in customer demand, may cause its price +to fall. Currently, the loss of customer demand is also accentuated by disruptions in the crypto assets market. Additionally, to the extent +that other vehicles investing in cryptocurrencies or tracking cryptocurrency markets form and come to represent a significant proportion +of the customer demand for cryptocurrencies, large redemptions of the securities of those vehicles and the subsequent sale of cryptocurrencies +by such vehicles could negatively affect cryptocurrency prices and therefore affect the value of the cryptocurrency inventory we hold. +Such events could have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin or +other cryptocurrencies we may in the future mine. +50 +Tariffs have increased costs of digital asset +mining equipment, and new or additional tariffs or other restrictions on the import of equipment necessary for digital asset mining could +have a material adverse effect on our business, financial condition and results of operations. +Equipment necessary for digital +asset mining is almost entirely manufactured outside of the U.S. There is currently significant uncertainty about the future relationship +between the U.S. and various other countries, including Russia, China, the European Union, Canada, and Mexico, with respect to trade policies, +treaties, tariffs and customs duties, and taxes. For example, since 2019, the U.S. Government has implemented significant changes to U.S. +trade policy with respect to China. These tariffs have subjected certain digital asset mining equipment manufactured overseas to additional +import duties of up to 25%. The amount of the additional tariffs and the number of products subject to them has changed numerous times +based on action by the U.S. Government. These tariffs have increased costs of digital asset mining equipment, and new or additional tariffs +or other restrictions on the import of equipment necessary for digital asset mining could have a material adverse effect on our business, +financial condition and results of operations. +Because there has been limited precedent set +for financial accounting for Bitcoin and other digital assets, the determinations that we have made for how to account for digital assets +transactions may be subject to change. +Because there has been limited +precedent set for the financial accounting for Bitcoin and other digital assets and related revenue recognition and no official guidance +has yet been provided by the Financial Accounting Standards Board or the SEC, it is unclear how companies may in the future be required +to account for digital asset transactions and assets and related revenue recognition. A change in regulatory or financial accounting standards +could result in the necessity to change the accounting methods we currently intend to employ in respect of our anticipated revenues and +assets and restate any financial statements produced based on those methods. Such a restatement could adversely affect our business, prospects, +financial condition and results of operations. +Risks Related to Our Bitcoin Operations – Operational and +Financial +Our results of operations are expected to be +impacted by fluctuations in the price of Bitcoin because a significant portion of our revenue is expected to come from Bitcoin mining +production. +The price of Bitcoin has experienced +significant fluctuations over its relatively short existence and may continue to fluctuate significantly in the future. Bitcoin prices +ranged from approximately $29,002 per coin as of December 31, 2020 and $46,306 per coin as of December 31, 2021 to $16,548 per coin as +of December 31, 2022, with a high of $68,790 per coin and a low of $28,804 per coin during 2021, according to Coin Market Cap. The fluctuation +during 2022 ranged between a high of $48,087 to a low of $15,683, according to Coin Market Cap. As of April 14, 2023, the price of Bitcoin +was approximately $30,400. +We expect our results of operations +to continue to be affected by the Bitcoin price as a significant portion of our revenue is expected to come from Bitcoin mining production. +Any future significant reductions in the price of Bitcoin will likely have a material and adverse effect on our results of operations +and financial condition. We cannot assure you that the Bitcoin price will remain high enough to sustain our operations or that the price +of Bitcoin will not decline significantly in the future. Further, fluctuations in the Bitcoin price can have an immediate impact on the +trading price of our shares even before our financial performance is affected, if at all. +Various factors, mostly beyond +our control, could impact the Bitcoin price. For example, the usage of Bitcoins in the retail and commercial marketplace is relatively +low in comparison with the usage for speculation, which contributes to Bitcoin’s price volatility. Additionally, the reward for +Bitcoin mining will decline over time, with the most recent halving event having occurred in May 2020 and the next one expected to occur +in 2024, which may further contribute to Bitcoin price volatility. +Risk Related to Technological Advancements +and Obsolescence of Current Bitcoin Mining Equipment +Our operations are exposed +to the risk of rapid technological advancements in the development and production of Bitcoin mining equipment, which could render our +existing mining infrastructure obsolete and adversely impact our financial performance. +51 +The Bitcoin mining industry +is characterized by rapid technological change, with companies continually developing and deploying new mining equipment and techniques +to enhance computational efficiency and reduce energy consumption. These advancements may outpace our ability to adapt, maintain, and +upgrade our mining equipment, thereby negatively affecting our competitive position and operational efficiency. As a result, we may be +required to make significant capital investments to acquire and implement new technology to maintain our competitiveness. +If we are unable to anticipate +or adapt to such advancements, or if we fail to allocate our resources efficiently, we may be forced to rely on outdated equipment that +becomes increasingly inefficient and expensive to maintain. Moreover, the emergence of more advanced mining technologies could lead to +an increase in the overall mining difficulty, further reducing the effectiveness of our existing equipment and diminishing our mining +rewards. +Additionally, there is a risk +that our competitors, who may have greater financial resources and flexibility, will be better positioned to adopt emerging technologies +and gain a competitive advantage. This could result in a decline in our market share, revenue, and profitability. +Inability to manage these +risks could have a material adverse effect on our business, financial condition, and operating results. +Because of our focus on Bitcoin mining, the +trading price of shares of our common stock may increase or decrease with the trading price of Bitcoin, which subjects investors to pricing +risks, including “bubble” type risks, and volatility. +The trading prices of our +common stock may at times be tied to the trading prices of Bitcoin. Specifically, we may experience adverse effects on our stock price +when the value of Bitcoin drops. Furthermore, if the market for Bitcoin mine operators’ shares or the stock market in general experiences +a loss of investor confidence, the trading price of our stock could decline for reasons unrelated to our business, operating results or +financial condition. The trading price of our common stock could be subject to arbitrary pricing factors that are not necessarily associated +with traditional factors that influence stock prices or the value of non-cryptocurrency assets such as revenue, cash flows, profitability, +growth prospects or business activity since the value and price, as determined by the investing public, may be influenced by uncertain +contingencies such as future anticipated adoption or appreciation in value of cryptocurrencies or blockchains generally, and other factors +over which we have little or no influence or control. +Bitcoin and other cryptocurrency +market prices, which have historically been volatile and are impacted by a variety of factors, are determined primarily using data from +various exchanges, over-the-counter markets and derivative platforms. Furthermore, such prices may be subject to factors such as +those that impact commodities, more so than business activities, which could be affected by additional influence from fraudulent or illegitimate +actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue +to result in, speculation regarding future appreciation in the value of cryptocurrencies, or our share price, making their market prices +more volatile or creating “bubble” type risks for the trading price of Bitcoin. +The price of Bitcoin has experienced +significant fluctuations over its relatively short existence and may continue to fluctuate significantly in the future. Bitcoin prices +ranged from approximately $29,002 per coin as of December 31, 2020 and $46,306 per coin as of December 31, 2021 to $16,548 per coin as +of December 31, 2022, with a high of $68,790 per coin and a low of $28,804 per coin during 2021, according to Coin Market Cap. The fluctuation +during 2022 ranged between a high of $48,087 to a low of $15,683, according to Coin Market Cap. There can be no assurance that similar +fluctuations in the trading price of Bitcoin will not occur in 2023 and in the future. Accordingly, since our revenue will depend in part +on the price of Bitcoin, and the trading price of our securities may therefore at times be connected to the trading price of Bitcoin, +if the trading price of Bitcoin again experiences a significant decline, we could experience a similar decline in revenue and/or in the +trading price for shares of our common stock. If this occurs, you may lose some or all of your investment. +52 +Our future success will depend in large part +upon the value of Bitcoin. The value of Bitcoin may be subject to pricing risk and has historically been subject to wide swings. +Our operating results from this sector will depend +in large part upon the value of Bitcoin because it is the sole digital asset we currently mine. Specifically, our revenues from our Bitcoin +mining operations are principally based upon two factors: the number of Bitcoin rewards we successfully mine and the value of Bitcoin. +We also receive transaction fees paid in Bitcoin by participants who initiated transactions associated with new blocks that we mine. In +addition, our operating results are directly impacted by changes in the value of Bitcoin. Digital currencies are recorded at cost less +any impairment. An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, +when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. +Impairment exists when the carrying amount exceeds its fair value. Our operating results are subject to volatility based upon changes +in the value of Bitcoin that could lead to increased losses or impairments in our investments or other assets. Our strategy currently +focuses primarily on Bitcoin (as opposed to other digital assets). Further, our miners are principally utilized for mining Bitcoin and +cannot mine other digital assets, such as ETH, that are not mined utilizing the “SHA-256 algorithm.” If other digital assets +were to achieve acceptance at the expense of Bitcoin, causing the value of Bitcoin to decline, or if Bitcoin were to switch its proof +of work algorithm from SHA-256 to another algorithm for which our miners are not specialized, or the value of Bitcoin were to decline +for other reasons, particularly if such decline were significant or over an extended period of time, our operating results would be adversely +affected, and there could be a material adverse effect on our ability to continue as a going concern or to pursue our business strategy +at all, which could have a material adverse effect on our business, prospects or operations, and harm investors. +Bitcoin and other cryptocurrency +market prices, which have historically been volatile and are impacted by a variety of factors are determined primarily using data from +various exchanges, over-the-counter markets and derivative platforms. Such prices may be subject to factors such as those that impact +commodities, more so than business activities, which could be subject to additional influence from fraudulent or illegitimate actors, +real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue to +result in, speculation regarding future appreciation in the value of digital assets, or our share price, inflating and making their market +prices more volatile or creating “bubble” type risks for both Bitcoin and our shares of common stock. +We lack a significant operating history in +the cryptocurrency mining space, and our focus on this relatively new business is subject to a number of significant risks and uncertainties +that could affect our future viability. +We recently transferred all +our mining activity from former AAI to BNI. While the former AAI has been dissolved, BNI remains a wholly owned subsidiary of our company. +As of the date of this annual report, excluding the investment in our data center in Michigan, we have invested approximately $145 million +towards the development of our new Bitcoin mining business. These investments include the price of the Bitcoin miners, fees payable in +connection with obtaining the ability to enter into the Bitcoin miner purchase contracts, shipping of the Bitcoin miners and third-party +commissions. BNI was formed to conduct our Bitcoin operations, and has assumed the agreements for the acquisition of miners from Bitmain +and other agreements for the acquisition of equipment and services originally entered into by the Former AAI, but has only recently commenced +Bitcoin mining operations. In order to proceed, we have installed miners and mining infrastructure at our mining facility in Michigan, +as well as entered into a long-term contract to purchase electric power from the power grid in our data center in Michigan and use +the power to mine cryptocurrencies. Among the risks and uncertainties are: +● We are currently in discussions with a number of key players in this industry, but have not yet executed +any agreements to purchase the power needed over the 28 megawatts (“MW”) we currently possess. While we are in negotiations +with one entity in particular that we believe would increase our available power to approximately 300 MW’s at our Michigan facility, +we cannot assure you that we will reach an agreement satisfactory to us with this provider on a timely basis, if at all. Even if we do +obtain that level of energy at our Michigan facility, we will need to obtain more capacity at a different location to be able to install +and power the total of 23,065 miners purchased from Bitmain. If we are able to enter into agreements for additional power, the terms may +not be as attractive as we currently expect, which may inhibit the profitability of this venture; +● There is a limited number of available miners and the demand from competitors is fierce; +● Because of supply chain disruptions including those relating to computer chips, we could in the future +encounter delivery delays or other difficulties with the purchase, installing and operating of our mining equipment at our facility, which +would adversely affect our ability to generate material revenue from our operations; +● There are a growing number of well capitalized cryptocurrency mining companies including some that have +agreed to merge with special purpose acquisition companies, which competitors have significant capital resources, a large supply of miners +and operators with experience in cryptocurrency mining. For example, in 2021 Cipher Mining Inc. and Core Scientific, Inc., large cryptocurrency +mining companies, entered into business combinations with Nasdaq-listed special purpose acquisition vehicles; +● Bans from governments such as China, together with pending legislation in Congress and other regulatory +initiatives threaten the ability to use cryptocurrencies as a medium of exchange; and +● We may not be able to liquidate our holdings of cryptocurrencies at our desired prices if a precipitous +decline in market prices occurs and this could negatively impact our future operations. +For all of these reasons, +our cryptocurrency mining business may not be successful. +53 +We may be unable to raise additional capital needed to grow our +Bitcoin business. +We have operated and expect +to continue to operate at a loss as we continue to establish our business model and as Bitcoin prices continue to be low or decline further. +In addition, we expect to need to raise additional capital to fund our working capital requirements, expand our operations, pursue our +growth strategy and to respond to competitive pressures or working capital requirements. We may not be able to obtain additional debt +or equity financing on favorable terms, if at all, which could impair our growth and adversely affect our existing operations. The global +economy, including credit and financial markets, has recently experienced extreme volatility and disruptions, including diminished credit +availability, rising interest and inflation rates, declines in consumer confidence, declines in economic growth, increases in unemployment +rates and uncertainty about economic stability. Such macroeconomic conditions could also make it more difficult for us to incur additional +debt or obtain equity financing. If we raise additional equity financing, our stockholders may experience significant dilution of their +ownership interests, and the per share value of our common stock could decline. Further, if we engage in additional debt financing, the +holders of debt likely would have priority over the holders of our common stock on order of payment preference. We may be required to +accept terms that restrict our ability to incur additional indebtedness, take other actions including accepting terms that require us +to maintain specified liquidity or other ratios that could otherwise not be in the interests of our stockholders. Further, the crypto +assets industry has been negatively impacted by recent events such as the bankruptcies of Celsius Network, Voyager Digital, BlockFi, FTX +and Genesis Global. In response to these events, the digital asset markets, including the market for Bitcoin specifically, have experienced +extreme price volatility and several other entities in the digital asset industry have been, and may continue to be, negatively affected, +further undermining confidence in the digital assets markets and in Bitcoin. Increased credit pressures on the cryptocurrency industry, +such as banks, investors and other companies reducing or eliminating their exposure to the cryptocurrency industry through lending, have +had and may continue to have a material impact on our business. In light of conditions impacting our industry, it may be more difficult +for us to obtain equity or debt financing in the future. +The emergence of competing blockchain platforms +or technologies may harm our business as presently conducted by preventing us from realizing the anticipated profits from our investments +and forcing us to expend additional capital in an effort to adapt. +If blockchain platforms or +technologies which compete with Bitcoin and its blockchain, including competing cryptocurrencies which our miners may not be able to mine, +such as cryptocurrencies being developed or that may be developed by popular social media platforms, online retailers, or government sponsored +cryptocurrencies, consumers may use such alternative platforms or technologies. If that were to occur, we would face difficulty adapting +to such emergent digital ledgers, blockchains, or alternative platforms, cryptocurrencies or other digital assets. This may adversely +affect us by preventing us from realizing the anticipated profits from our investments and forcing us to expend additional capital in +an effort to adapt. Further, to the extent we cannot adapt, be it due to our specialized miners or otherwise, we could be forced to cease +our mining or other cryptocurrency-related operations. Such circumstances would have a material adverse effect on our business, and +in turn your investment in our securities. +There is a risk that some or all of the Bitcoin +we hold could be lost or stolen. +There is a risk that some +or all of the Bitcoin we hold could be lost or stolen. In general, cryptocurrencies are stored in cryptocurrency sites commonly referred +to as “wallets” by holders of cryptocurrencies which may be accessed to exchange a holder’s cryptocurrency assets. Access +to our Bitcoin could also be restricted by cybercrime (such as a denial of service attack). While we plan to take steps to attempt to +secure the Bitcoin we hold, there can be no assurance our efforts to protect our cryptocurrencies will be successful. +Hackers or malicious actors +may launch attacks to steal, compromise or secure cryptocurrencies, such as by attacking the cryptocurrency network source code, exchange +miners, third-party platforms, cold and hot storage locations or software, or by other means. Any of these events may adversely affect +our operations and, consequently, our ability to generate revenue and become profitable. The loss or destruction of a private key required +to access our digital wallets may be irreversible and we may be denied access for all time to our Bitcoin holdings. Our loss of access +to our private keys or our experience of a data loss relating to our digital wallets could adversely affect our business. +54 +Cryptocurrencies are controllable +only by the possessor of both the unique public and private keys relating to the local or online digital wallet in which they are held, +which wallet’s public key or address is reflected in the network’s public blockchain. We will be required to publish the public +key relating to digital wallets in use when we verify the receipt of transfers and disseminate such information into the network, but +we will need to safeguard the private keys relating to such digital wallets. To the extent such private keys are lost, destroyed or otherwise +compromised, we will be unable to access our Bitcoin rewards and such private keys may not be capable of being restored by any network. +Any loss of private keys relating to digital wallets used to store our mined Bitcoin could have a material adverse effect on our results +of operations and ability to continue as a going concern, which could have a material adverse effect on our business, prospects or operations +and potentially the value of any Bitcoin we mine. For example, the New York Times reported in January 2021 that about 20% of +existing Bitcoin appears to be “lost” due to password issues. +We rely on one or more third parties for depositing, +storing and withdrawing the Bitcoin we receive, which could result in a loss of assets, disputes and other liabilities or risks which +could adversely impact our business. +We currently use a custodial +wallet to store the Bitcoin we receive. In order to own, transfer and use Bitcoin on the blockchain network, we must have a private and +public key pair associated with a network address, commonly referred to as a “wallet.” Each wallet is associated with a unique +“public key” and “private key” pair, each of which is a string of alphanumerical characters. To deposit Bitcoin +into our digital wallet, we must direct the transaction to the public key of a wallet that our Gemini custodial account controls and provides +to us, and broadcast the deposit transaction onto the underlying blockchain network. To withdraw Bitcoin from our custodial account, an +assigned account representative must initiate the transaction from our custodial account, then an approver must approve the transaction. +Once the custodian has verified that the request is valid and who the recipient is through Know Your Customer/Anti-Money Laundering protocols, +the custodian then “signs” a transaction authorizing the transfer. In addition, some cryptocurrency networks require additional +information to be provided in connection with any transfer of cryptocurrency such as Bitcoin. +A number of errors or other +adverse events can occur in the process of depositing, storing or withdrawing Bitcoin into or from our custodial account, such as typos, +mistakes or the failure to include the information required by the blockchain network. For instance, a user may incorrectly enter our +wallet’s public key or the desired recipient’s public key when depositing and withdrawing Bitcoin. Additionally, our reliance +on third parties such as Gemini and the maintenance of keys to access and utilize our digital wallet will expose us to enhanced cybersecurity +risks from unauthorized third parties employing illicit operations such as hacking, phishing and social engineering, notwithstanding the +security systems and safeguards employed by us and others. Cyberattacks upon systems across a variety of industries, including the cryptocurrency +industry, are increasing in frequency, persistence and sophistication and, in many cases, are being conducted by sophisticated, well-funded, +and organized groups and individuals. For example, attacks may be designed to deceive employees and service providers into releasing control +of the systems on which we depend to a hacker, while others may aim to introduce computer viruses or malware into such systems with a +view to stealing confidential or proprietary data. These attacks may occur on our digital wallet or the systems of our third-party service +providers or partners, which could result in asset losses and other adverse consequences. Insurance held by third parties may not cover +related losses. Alternatively, we may inadvertently transfer Bitcoin to a wallet address that we do not own, control or hold the private +keys to. In addition, a Bitcoin wallet address can only be used to send and receive Bitcoin, and if the Bitcoin is inadvertently sent +to an Ethereum or other cryptocurrency wallet address, or if any of the foregoing errors occur, all of the Bitcoin will be permanently +and irretrievably lost with no means of recovery. Such incidents could result in asset loss or disputes, any of which could materially +and adversely affect our business. +If a malicious actor or botnet obtains control +of more than 50% of the processing power on a cryptocurrency network, such actor or botnet could manipulate blockchains to adversely affect +us, which would adversely affect an investment in our company and our ability to operate. +If a malicious actor or botnet +(a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority +of the processing power dedicated to mining a cryptocurrency, it may be able to alter blockchains on which transactions of cryptocurrency +reside and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. The +malicious actor or botnet could control, exclude or modify the ordering of transactions, though it could not generate new units or transactions +using such control. The malicious actor could “double-spend” its own cryptocurrency (i.e., spend the same Bitcoin in more +than one transaction) and prevent the confirmation of other users’ transactions for as long as it maintained control. To the extent +that such malicious actor or botnet does not yield its control of the processing power on the network or the cryptocurrency community +does not reject the fraudulent blocks as malicious, reversing any changes made to blockchains may not be possible. The foregoing description +is not the only means by which the entirety of blockchains or cryptocurrencies may be compromised but is only an example. +55 +Although we are unaware of +any reports of malicious activity or control of blockchains achieved through controlling over 50% of the processing power on the network, +it is believed that certain mining pools may have exceeded the 50% threshold in Bitcoin. The possible crossing of the 50% threshold indicates +a greater risk that a single mining pool could exert authority over the validation of Bitcoin transactions. To the extent that the Bitcoin +community, and the administrators of mining pools, do not act to ensure greater decentralization of Bitcoin mining processing power, the +feasibility of a botnet or malicious actor obtaining control of the blockchain’s processing power will increase, because such botnet +or malicious actor could more readily infiltrate and seize control over the blockchain by compromising a single mining pool, if the mining +pool compromises more than 50% of the mining power on the blockchain, than it could if the mining pool had a smaller share of the blockchain’s +total hashing power. Conversely, if the blockchain remains decentralized it is inherently more difficult for the botnet or malicious actor +to aggregate enough processing power to gain control of the blockchain. If this were to occur, the public may lose confidence in the Bitcoin +blockchain, and blockchain technology more generally. This would likely have a material and adverse effect on the price of Bitcoin, which +could have a material adverse effect on our business, financial results and operations, and harm investors. +Risks Related to Our Bitcoin Operations – Legal and Regulatory +We are subject to a highly evolving regulatory landscape and any +adverse changes to, or our failure to comply with, any laws and regulations could adversely affect our business, prospects or operations. +Our business is subject to +extensive laws, rules, regulations, policies and legal and regulatory guidance, including those governing securities, commodities, crypto +asset custody, exchange and transfer, data governance, data protection, cybersecurity and tax. Many of these legal and regulatory regimes +were adopted prior to the advent of the Internet, mobile technologies, crypto assets and related technologies. As a result, they do not +contemplate or address unique issues associated with the crypto economy, are subject to significant uncertainty, and vary widely across +U.S. federal, state and local and international jurisdictions. These legal and regulatory regimes, including the laws, rules and regulations +thereunder, evolve frequently and may be modified, interpreted and applied in an inconsistent manner from one jurisdiction to another, +and may conflict with one another. Moreover, the complexity and evolving nature of our business and the significant uncertainty surrounding +the regulation of the crypto economy requires us to exercise our judgement as to whether certain laws, rules and regulations apply to +us, and it is possible that governmental bodies and regulators may disagree with our conclusions. To the extent we have not complied with +such laws, rules and regulations, we could be subject to significant fines and other regulatory consequences, which could adversely affect +our business, prospects or operations. As Bitcoin has grown in popularity and in market size, the Federal Reserve Board, U.S. Congress +and certain U.S. agencies (e.g., the CFTC, SEC, the Financial Crimes Enforcement Network (“FinCEN”) and the Federal Bureau +of Investigation) have begun to examine the operations of the Bitcoin network, Bitcoin users and the Bitcoin exchange market. Regulatory +developments and/or our business activities may require us to comply with certain regulatory regimes. For example, to the extent that +our activities cause us to be deemed a money service business under the regulations promulgated by FinCEN under the authority of the U.S. +Bank Secrecy Act, we may be required to comply with FinCEN regulations, including those that would mandate us to implement certain anti-money +laundering programs, make certain reports to FinCEN and maintain certain records. +On November 23, 2022, the +governor of New York signed into law a two year moratorium on new or renewed permits for certain electricity-generating facilities that +use fossil fuel and provide energy for proof-of-work digital asset mining operations. While this action does not directly impact our current +operations, as our power generation plans are currently located in Michigan and we have no plans to establish any facilities in New York, +it may be the beginning of a new wave of climate change regulations aimed at preventing or reducing the growth of Bitcoin mining in jurisdictions +in the United States, including potentially jurisdictions in which we now operate or may in the future operate. The above-described developments +could also demonstrate the beginning of a regional or global regulatory trend in response to environmental and energy preservation or +other concerns surrounding crypto assets, and similar action in a jurisdiction in which we operate or in general could have a devastating +effect on our operations. If further regulation follows, it is possible that the Bitcoin mining industry may not be able to adjust to +a sudden and dramatic overhaul to our ability to deploy energy towards the operation of mining equipment. We are not currently aware of +any legislation in Michigan being a near-term possibility. If further regulatory action is taken by various governmental entities, our +business may suffer and investors in our securities may lose part or all of their investment. +We cannot quantify the effects +of this regulatory action on our industry as a whole. If further regulation follows, it is possible that our industry may not be able +to cope with the sudden and extreme loss of mining power. Because we are unable to influence or predict future regulatory actions taken +by governments in China, the United States, or elsewhere, we may have little opportunity or ability to respond to rapidly evolving regulatory +positions which may have a materially adverse effect on our industry and, therefore, our business and results of operations. +56 +Ongoing and future regulatory actions may impact +our ability to continue to operate, and such actions could affect our ability to continue as a going concern or to pursue our strategy +at all, which could have a material adverse effect on our business, prospects or operations. +The crypto economy is novel and has little to no access to policymakers +or lobbying organizations, which may harm our ability to effectively react to proposed legislation and regulation of crypto assets or +crypto asset platforms adverse to our business. +As crypto assets have grown +in both popularity and market size, various U.S. federal, state and local and foreign governmental organizations, consumer agencies and +public advocacy groups have been examining the operations of crypto networks, users and platforms, with a focus on how crypto assets can +be used to launder the proceeds of illegal activities, fund criminal or terrorist enterprises, and the safety and soundness of platforms +and other service providers that hold crypto assets for users. Many of these entities have called for heightened regulatory oversight, +and have issued consumer advisories describing the risks posed by crypto assets to users and investors. For instance, in July 2019, then-U.S. +Treasury Secretary Steven Mnuchin stated that he had “very serious concerns” about crypto assets. In recent months, members +of Congress have made inquiries into the regulation of crypto assets, and Gary Gensler, Chair of the Commission, has made public statements +regarding increased regulatory oversight of crypto assets. Outside the United States, several jurisdictions have banned so-called initial +coin offerings, such as China and South Korea, while Canada, Singapore, Hong Kong, have opined that token offerings may constitute securities +offerings subject to local securities regulations. In July 2019, the United Kingdom’s Financial Conduct Authority proposed rules +to address harm to retail customers arising from the sale of derivatives and exchange-traded notes that reference certain types of crypto +assets, contending that they are “ill-suited” to retail investors due to extreme volatility, valuation challenges and association +with financial crimes. In May 2021, the Chinese government called for a crackdown on Bitcoin mining and trading, and in September 2021, +Chinese regulators instituted a blanket ban on all crypto mining and transactions, including overseas crypto exchange services taking +place in China, effectively making all crypto-related activities illegal in China. In January 2022, the Central Bank of Russia called +for a ban on cryptocurrency activities ranging from mining to trading, and on March 8, 2022, President Biden announced an executive order +on cryptocurrencies which seeks to establish a unified federal regulatory regime for currencies. +The crypto economy is novel +and has little to no access to policymakers and lobbying organizations in many jurisdictions. Competitors from other, more established +industries, including traditional financial services, may have greater access to lobbyists or governmental officials, and regulators that +are concerned about the potential for crypto assets for illicit usage may affect statutory and regulatory changes with minimal or discounted +inputs from the crypto economy. As a result, new laws and regulations may be proposed and adopted in the United States and internationally, +or existing laws and regulations may be interpreted in new ways, that harm the crypto economy or crypto asset platforms, which could adversely +impact our business. +Pending regulation +related to electricity consumption by mining companies may impact our result of operation. +On +September 16, 2022, the U.S. Department of the Treasury (“Treasury”), the Department of Justice (the “DOJ”), and +other U.S. government agencies released eight reports (the “Reports”), including Action Plan to Address Illicit Financial +Risks of Digital Assets issued by Treasury, Crypto-Assets: Implications for Consumers, Investors and Businesses issued by Treasury, +The Future of Money and Payments issued by Treasury, Climate and Energy Implications of Crypto-Assets in the United States issued +by the White House, Policy Objectives for a U.S. Central Bank Digital Currency System issued by the White House, Technical Evaluation +for a U.S. Central Bank Digital Currency System issued by the White House, The Role of Law Enforcement in Directing, Investigating, +and Prosecuting Criminal Activity Related to Digital Assets issued by the DOJ, and Responsible Advancement of US Competitiveness +in Digital Assets issued by the U.S. Department of Commerce. The Reports were issued in response to White House Executive Order 14067 +on Ensuring Responsible Development of Digital Assets, which calls for a whole-of-government alignment of the federal government’s +approach to digital assets. +In December 2022, Senator +Edward J. Markey, Chair of the Senate Environment and Public Works Subcommittee on Clean Air, Climate, and Nuclear Safety, and Representative +Jared Huffman Senate introduced the Crypto-Asset Environmental Transparency Act. The legislation would require the Environmental Protection +Agency to conduct a comprehensive impact study of U.S. crypto mining activity and require the reporting of greenhouse gas emissions from +crypto mining operations that consume more than 5 megawatts of power. If the bill is passed by both the Senate and the House and +signed into law, mining facilities may be required to report greenhouse gas emissions and to obtain permits and the price to rent +mining facilities may increase. If the price increase significantly and if we are not able to find alternative facilities with reasonable +price acceptable to us, our operation will be disrupted and our results of operation will be negatively impact. +57 +A particular digital asset’s status as +a “security” in any relevant jurisdiction is subject to a high degree of uncertainty and if we did not or are unable to properly +characterize our digital assets, we may become subject to regulatory scrutiny, investigations, fines and other penalties, which may adversely +affect our business, operating results and financial condition. A determination that Bitcoin is a “security” may adversely +affect the value of Bitcoin and our business. +The SEC and its staff have +taken the position that certain digital assets fall within the definition of a “security” under U.S. federal securities laws. +The legal test for determining whether any given digital asset is a security is a highly complex, fact-driven analysis. Our determination +that the digital assets we hold are not securities is a risk-based assessment and not a legal standard or one binding on regulators. The +SEC generally does not provide advance guidance or confirmation on the status of any particular digital asset as a security. It is possible +that a change in the governing administration or the appointment of new SEC commissioners could impact the views of the SEC and its staff. +Public statements made by senior officials at the SEC indicate that the SEC does not intend to take the position that Bitcoin is a security +(as currently offered and sold; in this context, it should be noted that we have no intention of conducting any initial coin offerings). +However, such statements are not official policy statements by the SEC and reflect only the speakers’ views, which are not binding +on the SEC or any other agency or court and cannot be generalized to any other digital asset. As of April __, 2023, with the exception +of certain centrally issued digital assets that have received “no-action” letters from the SEC staff, Bitcoin and Ethereum’s +ether are the only digital assets which senior officials at the SEC have publicly stated are unlikely to be considered securities. As +a Bitcoin mining company, we do not believe we are an issuer of any “securities” as defined under U.S. federal securities +laws. Our internal process for determining whether the digital assets we hold or plan to hold is based upon the public statements of the +SEC and existing case law. Although the SEC’s Strategic Hub for Innovation and Financial Technology published a framework for analyzing +whether any given digital asset is a security in April 2019, this framework is not a rule, regulation or statement of the SEC and is not +binding on the SEC. +The classification of a digital +asset as a security under applicable law has wide-ranging implications for the regulatory obligations that flow from the offer, sale, +trading and clearing of such assets. For example, a digital asset that is a security may generally only be offered or sold pursuant to +a registration statement filed with the SEC or in an offering that qualifies for an exemption from registration. Persons that effect transactions +in digital assets that are securities may be subject to registration with the SEC as a “broker” or “dealer.” Platforms +that bring together purchasers and sellers to trade digital assets that are securities are generally subject to registration as national +securities exchanges, or must qualify for an exemption, such as by being operated by a registered broker-dealer as an alternative trading +system (“ATS”), in compliance with rules for ATS’s. Persons facilitating clearing and settlement of securities may be +subject to registration with the SEC as a clearing agency. +We analyze whether the digital +assets that we mine, hold and sell for our own account could be deemed to be a +“security” under applicable laws. Our procedures do not constitute a legal standard, but rather represent our management’s +assessment regarding the likelihood that a particular digital asset could be deemed a “security” under applicable laws. Regardless +of our conclusions, we could be subject to legal or regulatory action in the event the SEC, a foreign regulatory authority, or a court +were to determine that a digital asset currently held by us is a “security” under applicable laws. If the digital assets mined +and held by us are deemed securities, it could limit distributions, transfers or other actions involving such digital assets, including +mining. +There can be no assurances +that we have properly characterized any given digital asset as a security or non-security for purposes of determining which digital assets +to mine, hold and trade, or that the SEC, or a court, if the question was presented to it, would agree with our assessment. We could be +subject to judicial or administrative sanctions for failing to offer or sell digital assets in compliance with the registration requirements, +or for acting as a broker or dealer without appropriate registration. Such an action could result in injunctions, cease and desist orders, +as well as civil monetary penalties, fines, and disgorgement, criminal liability, and reputational harm. For instance, all transactions +in such supported digital asset would have to be registered with the SEC, or conducted in accordance with an exemption from registration, +which could severely limit its liquidity, usability and transactability. Further, it could draw negative publicity and a decline in the +general acceptance of the digital asset. Also, it may make it difficult for such digital asset to be traded, cleared and custodied as +compared to other digital assets that are not considered to be securities. +Several foreign jurisdictions +have taken a broad-based approach to classifying crypto assets as “securities,” while other foreign jurisdictions, such as +Switzerland, Malta, and Singapore, have adopted a narrower approach. As a result, certain crypto assets may be deemed to be a “security” +under the laws of some jurisdictions but not others. Various foreign jurisdictions may, in the future, adopt additional laws, regulations, +or directives that affect the characterization of crypto assets as “securities.” If Bitcoin or any other supported crypto +asset is deemed to be a security under any U.S. federal, state, or foreign jurisdiction, or in a proceeding in a court of law or otherwise, +it may have adverse consequences for such supported crypto asset. For instance, all transactions in such supported crypto asset would +have to be registered with the SEC or other foreign authority, or conducted in accordance with an exemption from registration, which could +severely limit its liquidity, usability and transactability. Moreover, the networks on which such supported crypto assets are utilized +may be required to be regulated as securities intermediaries, and subject to applicable rules, which could effectively render the network +impracticable for its existing purposes. +58 +Current interpretations require the regulation +of Bitcoin under the Commodity Exchange Act by the Commodity Futures Trading Commission, and we may be required to register and comply +with such regulations. Any disruption of our operations in response to the changed regulatory circumstances may be at a time that is disadvantageous +to our investors. +Current and future legislation, +regulation by the Commodity Futures Trading Commission (the “CFTC”) and other regulatory developments, including interpretations +released by a regulatory authority, may impact the manner in which Bitcoin and other cryptocurrencies are treated for classification and +clearing purposes. In particular, derivatives on these assets are not excluded from the definition of “commodity future” by +the CFTC. We cannot be certain as to how future regulatory developments will impact the treatment of Bitcoin and other cryptocurrencies +under the law. +Bitcoin has been deemed to +fall within the definition of a commodity and, we may be required to register and comply with additional regulation under the Commodity +Exchange Act, including additional periodic report and disclosure standards and requirements. Moreover, we may be required to register +as a commodity pool operator and to register as a commodity pool with the CFTC through the National Futures Association. Such additional +registrations may result in extraordinary, non-recurring expenses, thereby materially and adversely impacting an investment in us. +If we determine not to comply with such additional regulatory and registration requirements, we may seek to cease certain of our operations. +Any such action may adversely affect an investment in us. +Additionally, governments +may develop and deploy their own blockchain-based digital assets, which may have a material adverse impact on Bitcoin’s price +and utility. +Governmental action against digital assets +and Bitcoin mining may have a materially adverse effect on the industry, and could affect us if widely adopted. +We and the cryptocurrencies +on which our operations will depend are and could become subject to bans and other regulations aimed at preventing what are perceived +as some of the negative attributes of Bitcoin and Bitcoin mining. For example, on September 24, 2021, China declared all transactions +in and mining of cryptocurrencies, including Bitcoin, illegal. While the ultimate long-term effect of this ban remains uncertain, +it could significantly hinder our prospects by limiting a large market for cryptocurrencies within a growing economy. In the hours +following China’s announcement of the ban, the price of Bitcoin, which is tied to some extent to public perception of its future +value as a form of currency, dropped by nearly $4,000. The ban followed piecemeal regulatory action within China against cryptocurrencies, +which was due in part to concerns about the potential for manipulative practices and excessive energy consumption. This could demonstrate +the beginning of a regional or global regulatory trend in response to these or other concerns surrounding cryptocurrencies, and similar +action in a jurisdiction in which we operate or in general could have devastating effects to our operations. If further regulation follows, +it is possible that our industry may not be able to adjust to a sudden and dramatic overhaul to our ability to deploy energy towards the +operation of mining equipment. +Because we are unable to influence +or predict future regulatory actions taken by governments, we may face difficulty monitoring and responding to rapid regulatory developments +affecting Bitcoin mining, which may have a materially adverse effect on our industry and, therefore, our business and results of operations. +If further regulatory action is taken by governments in the U.S., our business may be materially harmed, and you could lose some or all +of your investment. +The markets for Bitcoin and other cryptocurrencies +and the existing markets may be under-regulated and, as a result, the market price of Bitcoin may be subject to significant volatility +or manipulation, which could decrease consumer confidence in cryptocurrencies and have a materially adverse effect on our business and +results of operations. +Cryptocurrencies that are +represented and trade on a ledger-based platform and those who hold them may not enjoy the same benefits as traditional securities +available on trading markets and their investors. Stock exchanges have listing requirements and vet issuers, requiring them to be subjected +to rigorous listing standards and rules, and monitor investors transacting on such platform for fraud and other improprieties. These conditions +may not necessarily be replicated on a distributed ledger platform, depending on the platform’s controls and other policies. The +more lax a distributed ledger platform is about vetting issuers of cryptocurrency assets or users that transact on the platform, the higher +the potential risk for fraud or the manipulation of the ledger due to a control event. We believe that Bitcoin is not a security under +federal and state law. +59 +Bitcoin and other cryptocurrency +market prices have historically been volatile, are impacted by a variety of factors, and are determined primarily using data from various +exchanges, over-the-counter markets and derivative platforms. Furthermore, such prices may be subject to factors such as those that +impact commodities, more so than business activities, which could be subjected to additional influence from fraudulent or illegitimate +actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue +to result in, speculation regarding future appreciation in the value of cryptocurrencies, or our share price, making their market prices +more volatile or creating “bubble” type risks for both Bitcoin and shares of our common stock. +These factors may inhibit +consumer trust in and market acceptance of cryptocurrencies as a means of exchange which could have a material adverse effect on our business, +prospects, or operations and potentially the value of any Bitcoin or other cryptocurrencies we mine or otherwise acquire. +We are subject to risks associated with our +need for significant electrical power. Government regulators may potentially restrict the ability of electricity suppliers to provide +electricity to mining operations, such as ours. +The operation of a Bitcoin +or other Bitcoin mine can require massive amounts of electrical power. We presently have access to 28 megawatt capacity at our Facility, +but require an additional 37 megawatt capacity to operate the miners that we expect to receive from Bitmain during 2022. Our mining operations +can only be successful and ultimately profitable if the costs, including electrical power costs, associated with mining a Bitcoin are +lower than the price of a Bitcoin. As a result, any mine we establish can only be successful if we can obtain sufficient electrical power +for that mine on a cost-effective basis, and our establishment of new mines requires us to find locations where that is the case. There +may be significant competition for suitable mine locations, and government regulators may potentially restrict the ability of electricity +suppliers to provide electricity to mining operations in times of electricity shortage or may otherwise potentially restrict or prohibit +the provision or electricity to mining operations. Any shortage of electricity supply or increase in electricity cost in a jurisdiction +may negatively impact the viability and the expected economic return for Bitcoin mining activities in that jurisdiction. +Our interactions with a blockchain may expose +us to specially designated nationals or blocked persons or cause us to violate provisions of law that did not contemplate distributed +ledger technology. +The Office of Financial Assets +Control of the U.S. Department of Treasury (“OFAC”) requires us to comply with its sanction program and not conduct business +with persons named on its specially designated nationals (“SDN”) list. However, because of the pseudonymous nature of blockchain +transactions, we may inadvertently and without our knowledge engage in transactions with persons named on OFAC’s SDN list. Our internal +policies prohibit any transactions with such SDN individuals, but we may not be adequately capable of determining the ultimate identity +of the individual with whom we transact with respect to selling digital assets. In addition, in the future OFAC or another regulator may +require us to screen transactions for OFAC addresses or other bad actors before including such transactions in a block, which may increase +our compliance costs, decrease our anticipated transaction fees and lead to decreased traffic on our network. Any of these factors, consequently, +could have a material adverse effect on our business, prospects, financial condition, and operating results. +Moreover, federal law prohibits +any U.S. person from knowingly or unknowingly possessing any visual depiction commonly known as child pornography. Recent media reports +have suggested that persons have imbedded such depictions on one or more blockchains. Because our business requires us to download and +retain one or more blockchains to effectuate our ongoing business, it is possible that such digital ledgers contain prohibited depictions +without our knowledge or consent. To the extent government enforcement authorities literally enforce these and other laws and regulations +that are impacted by decentralized distributed ledger technology, we may be subject to investigation, administrative or court proceedings, +and civil or criminal monetary fines and penalties, all of which could harm our reputation and could have a material adverse effect on +our business, prospects, financial condition, and operating results. +Risks Related to Our Bitcoin Operations – Technological +Cryptocurrencies face significant +scaling obstacles that can lead to high fees or slow transaction settlement times and attempts to increase the volume of transactions +may not be effective, which could adversely affect an investment in our securities. +Cryptocurrencies face significant +scaling obstacles that can lead to high fees or slow transaction settlement times and attempts to increase the volume of transactions +may not be effective. Scaling cryptocurrencies is essential to the widespread acceptance of cryptocurrencies as a means of payment, which +widespread acceptance is necessary to the continued growth and development of our business. Many Bitcoin networks face significant scaling +challenges. For example, cryptocurrencies are limited with respect to how many transactions can occur per second. Participants in the +Bitcoin ecosystem debate potential approaches to increasing the average number of transactions per second that the network can handle +and have implemented mechanisms or are researching ways to increase scale, such as increasing the allowable sizes of blocks, and therefore +the number of transactions per block, and sharding (a horizontal partition of data in a database or search engine), which would not require +every single transaction to be included in every single miner’s or validator’s block. However, there is no guarantee that +any of the mechanisms in place or being explored for increasing the scale of settlement of Bitcoin transactions will be effective, or +how long they will take to become effective, which could adversely affect an investment in our securities. +60 +There is a possibility of Bitcoin mining algorithms +transitioning to proof of stake validation and other mining related risks, which could make us less competitive and ultimately adversely +affect our business and the value of our shares. +The protocol pursuant to which +transactions are confirmed automatically on the Bitcoin blockchain through mining is known as proof of work. Proof of stake is an alternative +method in validating digital asset transactions. Should the Bitcoin algorithm shift from a proof of work validation method to a proof +of stake method, mining would require less energy and may render any company that maintains advantages in the current climate (for example, +from lower priced electricity, processing, real estate, or hosting) less competitive. We, as a result of our efforts to optimize and improve +the efficiency of our Bitcoin mining operations, may be exposed to the risk in the future of losing the benefit of our capital investments +and the competitive advantage we hope to gain from this as a result, and may be negatively impacted if a switch to proof of stake validation +were to occur. This may additionally have an impact on other various investments of ours. Such events could have a material adverse effect +on our ability to continue as a going concern or to pursue our business strategy at all, which could have a material adverse effect on +our business, prospects or operations and potentially the value of any Bitcoin or other digital assets we mine or otherwise acquire or +hold for our own account. +Bitcoin is subject to halving, meaning that +the Bitcoin rewarded for solving a block will be reduced in the future and its value may not commensurately adjust to compensate us for +such reductions, and the overall supply of Bitcoin is finite. +Bitcoin is subject to “halving,” +which is the process by which the Bitcoin reward for solving a block is reduced by 50% for every 210,000 blocks that are solved. This +means that the amount of Bitcoin we (or any other mining company) are rewarded for solving a block in the blockchain is permanently cut +in half. For example, the latest halving having occurred in May 2020, with a revised payout of 6.25 Bitcoin per block solved, down +from the previous reward rate of 12.5 Bitcoin per block solved. There can be no assurance that the price of Bitcoin will sufficiently +increase to justify the increasingly high costs of mining for Bitcoin given the halving feature. If a corresponding and proportionate +increase in the trading price of these cryptocurrencies does not follow these anticipated halving events, the revenue we earn from our +mining operations would see a corresponding decrease, which would have a material adverse effect on our business and operations. To illustrate, +even if the price of Bitcoin remains at its current price, all other factors being equal (including the same number of miners and a stable +hash rate), our revenue would decrease substantially upon the next halving. +Further, due to the halving +process, unless the underlying code of the Bitcoin blockchain is altered (which may be unlikely given its decentralized nature), the supply +of Bitcoin is finite. Once 21 million Bitcoin have been generated by virtue of solving blocks in the blockchain, the network will +stop producing more which is anticipated to occur in approximately 2140. Currently, there are approximately 19 million Bitcoin in +circulation representing about 90% of the total supply of Bitcoin under the current source code. For the foregoing reasons, the halving +feature exposes us to inherent uncertainty and reliance upon the historically volatile price of Bitcoin, rendering an investment in us +particularly speculative, especially in the long-term. If the price of Bitcoin does not significantly increase in value, your investment +in our common stock could decline significantly. +Bitcoin has forked multiple times and additional +forks may occur in the future which may affect the value of Bitcoin that we hold or mine. +To the extent that a significant +majority of users and mining companies on a cryptocurrency network install software that changes the cryptocurrency network or properties +of a cryptocurrency, including the irreversibility of transactions and limitations on the mining of new cryptocurrency, the cryptocurrency +network would be subject to new protocols and software. However, if less than a significant majority of users and mining companies on +the cryptocurrency network consent to the proposed modification, and the modification is not compatible with the software prior to its +modification, the consequence would be what is known as a “fork” of the network, with one prong running the pre-modified software +and the other running the modified software. The effect of such a fork would be the existence of two versions of the cryptocurrency running +in parallel yet lacking interchangeability and necessitating exchange-type transaction to convert currencies between the two forks. +Additionally, it may be unclear following a fork which fork represents the original cryptocurrency and which is the new cryptocurrency. +Different metrics adopted by industry participants to determine which is the original asset include: referring to the wishes of the core +developers of a cryptocurrency, blockchains with the greatest amount of hashing power contributed by miners or validators; or blockchains +with the longest chain. A fork in the network of a particular cryptocurrency could adversely affect an investment in our securities or +our ability to operate. +61 +Since August 1, 2017, +Bitcoin’s blockchain was forked multiple times creating alternative versions of the cryptocurrency such as Bitcoin Cash, Bitcoin +Gold and Bitcoin SV. The forks resulted in a new blockchain being created with a shared history, and a new path forward. The value +of the newly created versions including Bitcoin Cash, Bitcoin Gold and Bitcoin SV may or may not have value in the long run and may affect +the price of Bitcoin if interest is shifted away from Bitcoin to the newly created cryptocurrencies. The value of Bitcoin after the creation +of a fork is subject to many factors including the value of the fork product, market reaction to the creation of the fork product, and +the occurrence of forks in the future. As such, the value of Bitcoin could be materially reduced if existing and future forks have a negative +effect on Bitcoin’s value. +The characteristics of crypto assets have been, +and may in the future continue to be, exploited to facilitate illegal activity such as fraud, money laundering, tax evasion and ransomware +scams; if any of our customers do so or are alleged to have done so, it could adversely affect us. +Digital currencies and the +digital currency industry are relatively new and, in many cases, lightly regulated or largely unregulated. Some types of digital currency +have characteristics, such as the speed with which digital currency transactions can be conducted, the ability to conduct transactions +without the involvement of regulated intermediaries, the ability to engage in transactions across multiple jurisdictions, the irreversible +nature of certain digital currency transactions and encryption technology that anonymizes these transactions, that make digital currency +particularly susceptible to use in illegal activity such as fraud, money laundering, tax evasion and ransomware scams. Two prominent examples +of marketplaces that accepted digital currency payments for illegal activities include Silk Road, an online marketplace on the dark web +that, among other things, facilitated the sale of illegal drugs and forged legal documents using digital currencies and AlphaBay, another +darknet market that utilized digital currencies to hide the locations of its servers and identities of its users. Both of these marketplaces +were investigated and closed by U.S. law enforcement authorities. U.S. regulators, including the SEC, CFTC and Federal Trade Commission, +as well as non-U.S. regulators, have taken legal action against persons alleged to be engaged in Ponzi schemes and other fraudulent schemes +involving digital currencies. In addition, the FBI has noted the increasing use of digital currency in various ransomware scams. +While our board and management +believe that our risk management processes and policies in light of current crypto asset market conditions, which include thorough reviews +we conduct as part of our due diligence process, is reasonably designed to detect any such illicit activities conducted by our potential +or existing counterparties, we cannot ensure that we will be able to detect any such illegal activity in all instances. Because the speed, +irreversibility and anonymity of certain digital currency transactions make them more difficult to track, fraudulent transactions may +be more likely to occur. We or our potential banking counterparties may be specifically targeted by individuals seeking to conduct fraudulent +transfers, and it may be difficult or impossible for us to detect and avoid such transactions in certain circumstances. If one of our +customers (or in the case of digital currency exchanges, their customers) were to engage in or be accused of engaging in illegal activities +using digital currency, we could be subject to various fines and sanctions, including limitations on our activities, which could also +cause reputational damage and adversely affect our business, financial condition and results of operations. +Incorrect or fraudulent cryptocurrency transactions +may be irreversible and it is possible that, through computer or human error, or through theft or criminal action, our cryptocurrency +rewards could be transferred in incorrect amounts or to unauthorized third parties. +Cryptocurrency transactions +are irrevocable and stolen or incorrectly transferred cryptocurrencies may be irretrievable. As a result, any incorrectly executed or +fraudulent cryptocurrency transactions, such as a result of a cybersecurity breach against our Bitcoin holdings, could adversely affect +our investments and assets. This is because cryptocurrency transactions are not, from an administrative perspective, reversible without +the consent and active participation of the recipient of the cryptocurrencies from the transaction. Once a transaction has been verified +and recorded in a block that is added to a blockchain, an incorrect transfer of a cryptocurrency or a theft thereof generally will not +be reversible and we may not have sufficient recourse to recover our losses from any such transfer or theft. Further, it is possible that, +through computer or human error, or through theft or criminal action, our cryptocurrency rewards could be transferred in incorrect amounts +or to unauthorized third parties, or to uncontrolled accounts. If an errant or fraudulent transaction in our Bitcoin were to occur, we +would have very limited means of seeking to reverse the transaction or seek recourse. To the extent that we are unable to recover our +losses from such action, error or theft, such events could have a material adverse effect on our business. +62 +Because many of our digital assets may in the +future be held by digital asset exchanges, we could face heightened risks from cybersecurity attacks and financial stability of digital +asset exchanges . +We may transfer our digital +assets from our wallet to digital asset exchanges prior to selling them. Digital assets not held in our wallet are subject to the risks +encountered by digital asset exchanges including a DDoS Attack or other malicious hacking, a sale of the digital asset exchange, loss +of the digital assets by the digital asset exchange and other risks similar to those described herein. We do not expect to maintain a +custodian agreement with any of the digital asset exchanges that may in the future hold our digital assets. These digital asset exchanges +do not provide insurance and may lack the resources to protect against hacking and theft. If this were to occur, we may be materially +and adversely affected. +Our use of third-party +mining pools exposes us to additional risks. +We +receive Bitcoin rewards from our mining activity through third-party mining pool operators. Mining pools allow miners to combine their +processing power, increasing their chances of solving a block and getting paid by the network. The rewards are distributed by the pool +operator, proportionally to our contribution to the pool’s overall mining power, used to solve a block on the Bitcoin blockchain. +Should the pool operator’s system suffer downtime due to a cyber-attack, software malfunction or other issue, it will negatively +impact our ability to mine and receive revenue. Furthermore, we are dependent on the accuracy of the mining pool operator’s record +keeping to accurately record the total processing power provided to the pool for a given Bitcoin mining application in order to assess +the proportion of that total processing power we provided. While we have internal methods of tracking both the hash rate we provide and +the total used by the pool, the mining pool operator uses its own record-keeping to determine our proportion of a given reward, which +may not match our own. If we are unable to consistently obtain accurate proportionate rewards from our mining pool operators, we may experience +reduced reward for our efforts, which would have an adverse effect on our business and operations. +Risks Related to Our Status as a Holding +Company +Our inability to successfully integrate new +acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our +growth strategy through acquisitions is fraught with risk. On June 2, 2017, we acquired a majority interest in Microphase, on May 23, +2018 we acquired Enertec, on November 30, 2020 we acquired Relec, on January 29, 2021 we acquired the Facility in Michigan, on December +16, 2021, we acquired a majority interest in IMHC, on December 22, 2021 we acquired the four Properties in and around Madison, on December +30, 2021, we acquired certain real property located in St. Petersburg, Florida and in June 2022, we acquired a majority interest in SMC. +On December 19, 2022, we acquired substantially all the assets and certain specified liabilities of Circle 8 Crane Service. Our strategy +and business plan are dependent on our ability to successfully integrate Microphase’s, Enertec’s and our other acquisitions’ +operations, particularly those of Relec and Gresham Power. In addition, while we are based in Las Vegas, NV, our finance department is +in Newport Beach, CA, Microphase’s operations are located in Shelton, Connecticut, Enertec’s operations are located in Karmiel, +Israel, Gresham Power’s operations are located in Salisbury, England, Madison is located in or near Wisconsin and the St. Petersburg +property is located in Florida. These distant locations and others that we may become involved with in the future will stretch our resources +and management time. Further, failure to quickly and adequately integrate all of these operations and personnel could adversely affect +our combined business and our ability to achieve our objectives and strategy. No assurance can be given that we will realize synergies +in the areas we currently operate. +If we make any additional acquisitions, they may disrupt or have +a negative impact on our business. +We have plans to eventually +make additional acquisitions beyond Microphase, Enertec, Relec, the Facility, IMHC, the Madison Properties, the St. Petersburg property, +SMC and Circle 8 Crane Services. Whenever we make acquisitions, we could have difficulty integrating the acquired companies’ +personnel and operations with our own. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot +predict the effect expansion may have on our core business. Regardless of whether we are successful in making an acquisition, the negotiations +could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to the risks described +above, acquisitions are accompanied by a number of inherent risks, including, without limitation, the following: +● If senior management and/or management of future acquired companies terminate their employment prior to +our completion of integration; +● difficulty of integrating acquired products, services or operations; +● integration of new employees and management into our culture while maintaining focus on operating efficiently +and providing consistent, high-quality goods and services; +63 +● potential disruption of the ongoing businesses and distraction of our management and the management of +acquired companies; +● unanticipated issues with transferring customer relationships; +● complexity associated with managing our combined company; +● difficulty of incorporating acquired rights or products into our existing business; +● difficulties in disposing of the excess or idle facilities of an acquired company or business and expenses +in maintaining such facilities; +● difficulties in maintaining uniform standards, controls, procedures and policies; +● potential impairment of relationships with employees and customers as a result of any integration of new +management personnel; +● potential inability or failure to achieve additional sales and enhance our customer base through cross-marketing +of the products to new and existing customers; +● effect of any government regulations which relate to the business acquired; and +● potential unknown liabilities associated with acquired businesses or product lines, or the need to spend +significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense of any litigation, whether +or not successful, resulting from actions of the acquired company prior to our acquisition. +Our business could be severely +impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection +with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract +our management and employees, increase our expenses and adversely affect our results of operations. +We may not be able to successfully identify +suitable acquisition targets and complete acquisitions to meet our growth strategy, and even if we are able to do so, we may not realize +the full anticipated benefits of such acquisitions, and our business, financial conditions and results of operations may suffer. +Increasing revenues through +acquisitions is one of the key components of our growth strategy. Identifying suitable acquisition candidates can be difficult, time-consuming +and costly, and we may not be able to identify suitable candidates or complete acquisitions in a timely manner, on a cost-effective basis +or at all. +We will have to pay cash, +incur debt, or issue equity as consideration in any future acquisitions, each of which could adversely affect our financial condition +or the market price of our common stock. The sale of equity or issuance of equity-linked debt to finance any future acquisitions could +result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could limit our +flexibility in managing our business due to covenants or other restrictions contained in debt instruments. +Further, we may not be able +to realize the anticipated benefits of completed acquisitions. Some acquisition targets may not have a developed business or are experiencing +inefficiencies and incur losses. Additionally, small defense contractors which we consider suitable acquisition targets may be uniquely +dependent on their prior owners and the loss of such owners’ services following the completion of acquisitions may adversely affect +their business. Therefore, we may lose our investment in the event that the acquired businesses do not develop as planned, we cannot retain +key employees or that we are unable to achieve the anticipated cost efficiencies or reduction of losses. +Additionally, our acquisitions +have previously required, and any similar future transactions may also require, significant management efforts and expenditures. Regardless +of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, divert the attention of our +management and key employees and increase our expenses. +We face risks with respect to the evaluation and management of future +platform or add-on acquisitions . +A component of our strategy +is to continue to acquire additional add-on businesses for our existing businesses. Generally, because such acquisition targets are held +privately, we may experience difficulty in evaluating potential target businesses as the information concerning these businesses is not +publicly available. In addition, we and our subsidiary companies may have difficulty effectively managing or integrating acquisitions. +We may experience greater than expected costs or difficulties relating to such acquisition, in which case we might not achieve the anticipated +returns from any particular acquisition, which may have a material adverse effect on our financial condition, business and results of +operations. +64 +We may not be able to successfully fund future +acquisitions of new businesses due to the lack of availability of debt or equity financing at the parent company level on acceptable terms, +which could impede the implementation of our acquisition strategy and materially adversely impact our financial condition, business and +results of operations . +In order to make future acquisitions, +we intend to raise capital primarily through debt financing, additional equity offerings, the sale of stock or assets of our businesses, +or by undertaking a combination of any of the above. Since the timing and size of acquisitions cannot be readily predicted, we may need +to be able to obtain funding on short notice to benefit fully from attractive acquisition opportunities. Such funding may not be available +on acceptable terms, if at all. In addition, the level of our indebtedness that we may incur may impact our ability to borrow. Another +source of capital for us may be the sale of additional shares, subject to market conditions and investor demand for the shares at prices +that we consider to be in the interests of our stockholders. These risks may materially adversely affect our ability to pursue our acquisition +strategy successfully and materially adversely affect our financial condition, business and results of operations. +To service any future indebtedness and other +obligations, we will require a significant amount of cash. +Our ability to generate cash +depends on many factors beyond our control, and any failure to meet our debt service obligations, of which we currently have very few +but may in the future incur, including our obligations under our indebtedness or future outstanding shares of preferred stock, could harm +our business, financial condition and results of operations. Our ability to make payments on and to refinance any indebtedness and outstanding +preferred stock and to fund working capital needs and planned capital expenditures will depend on our ability to generate cash in the +future. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other +factors that are beyond our control. +If our business does not generate +sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to enable us and our subsidiaries +to pay our indebtedness or make dividend payments with respect to our any shares of preferred stock that we may issue, or to fund our +other liquidity needs, we may need to refinance all or a portion of our indebtedness or redeem the preferred stock, on or before the maturity +thereof, sell assets, reduce or delay capital investments or seek to raise additional capital, any of which could have a material adverse +effect on us. +In addition, we may not be +able to effect any of these actions, if necessary, on commercially reasonable terms or at all. Our ability to restructure or refinance +our indebtedness or redeem the preferred stock will depend on the condition of the capital markets and our financial condition at such +time. Any refinancing of our debt or financings related to the redemption of any shares of preferred stock that we may issue could be +at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. +The terms of future debt instruments or preferred stock may limit or prevent us from taking any of these actions. In addition, any failure +to make scheduled payments of interest and principal on any future outstanding indebtedness or dividend payments on any shares of preferred +stock that we may issue could harm our ability to incur additional indebtedness or otherwise raise capital on commercially reasonable +terms or at all. Our inability to generate sufficient cash flow to satisfy any future debt service and other obligations, or to refinance +or restructure our obligations on commercially reasonable terms or at all, would have an adverse effect, which could be material, on our +business, financial condition and results of operations. +Because we face significant competition for +acquisition and business opportunities, including from numerous companies with a business plan similar to ours, it may be difficult for +us to fully execute our business strategy. Additionally, our subsidiaries also operate in highly competitive industries, limiting their +ability to gain or maintain their positions in their respective industries. +We expect to encounter intense +competition for acquisition and business opportunities from both strategic investors and other entities having a business objective similar +to ours, such as private investors (which may be individuals or investment partnerships), blank check companies including special purpose +acquisition companies, and other entities, domestic and international, competing for the type of businesses that we may acquire. Many +of these competitors possess greater technical, human and other resources, or more local industry knowledge, or greater access to capital, +than we do, and our financial resources may be relatively limited when contrasted with those of many of these competitors. These factors +may place us at a competitive disadvantage in successfully completing future acquisitions and investments. +In addition, while we believe +that there are numerous target businesses that we could potentially acquire or invest in, our ability to compete with respect to the acquisition +of certain target businesses that are sizable will be limited by our available financial resources. We may need to obtain additional financing +in order to consummate future acquisitions and investment opportunities and cannot assure you that any additional financing will be available +to us on acceptable terms, or at all, or that the terms of our existing financing arrangements will not limit our ability to do so. This +inherent competitive limitation gives others an advantage in pursuing acquisition and investment opportunities. +65 +Furthermore, our subsidiaries +also face competition from both traditional and new market entrants that may adversely affect them as well, as discussed elsewhere in +these risk factors. +We may be required to expend substantial sums +in order to bring the companies we have acquired or may acquire in the future, into compliance with the various reporting requirements +applicable to public companies and/or to prepare required financial statements, and such efforts may harm our operating results or be +unsuccessful altogether. +The Sarbanes-Oxley Act requires +our management to assess the effectiveness of the internal control over financial reporting for the companies we acquire and our external +auditor to audit these companies. In order to comply with the Sarbanes-Oxley Act, we will need to implement or enhance internal control +over financial reporting at acquired companies and evaluate the internal controls. We do not conduct a formal evaluation of companies’ +internal control over financial reporting prior to an acquisition. We may be required to hire additional staff and incur substantial costs +to implement the necessary new internal controls at the companies we acquire. Any failure to implement required internal controls, or +difficulties encountered in their implementation, could harm our operating results or increase the risk of material weaknesses in internal +controls, which could, if not remediated, adversely affect our ability to report our financial condition and results of operations in +a timely and accurate manner. +Future acquisitions or business opportunities +could involve unknown risks that could harm our business and adversely affect our financial condition and results of operations . +We are a diversified holding +company that owns interests in a number of different businesses across several industries. We have in the past, and intend in the future, +to acquire businesses or make investments, directly or indirectly through our subsidiaries, that involve unknown risks, some of which +will be particular to the industry in which the investment or acquisition targets operate, including risks in industries with which we +are not familiar or experienced. There can be no assurance our due diligence investigations will identify every matter that could have +a material adverse effect on us or the entities that we may acquire. We may be unable to adequately address the financial, legal and operational +risks raised by such investments or acquisitions, especially if we are unfamiliar with the relevant industry, which can lead to significant +losses on material investments. The realization of any unknown risks could expose us to unanticipated costs and liabilities and prevent +or limit us from realizing the projected benefits of the investments or acquisitions, which could adversely affect our financial condition +and liquidity. In addition, our financial condition, results of operations and the ability to service our debt may be adversely impacted +depending on the specific risks applicable to any business we invest in or acquire and our ability to address those risks. +We face certain risks associated with the acquisition +or disposition of businesses and lack of control over certain of our investments. +In pursuing our corporate +strategy, we may acquire, dispose of or exit businesses or reorganize existing investments. The success of this strategy is dependent +upon our ability to identify appropriate opportunities, negotiate transactions on favorable terms and ultimately complete such transactions. +In the course of our acquisitions, +we may not acquire 100% ownership of certain of our operating subsidiaries or we may face delays in completing certain acquisitions, including +in acquiring full ownership of certain of our operating companies. Once we complete acquisitions or reorganizations there can be no assurance +that we will realize the anticipated benefits of any transaction, including revenue growth, operational efficiencies or expected synergies. +If we fail to recognize some or all of the strategic benefits and synergies expected from a transaction, goodwill and intangible assets +may be impaired in future periods. The negotiations associated with the acquisition and disposition of businesses could also disrupt our +ongoing business, distract management and employees or increase our expenses. +In addition, we may not be +able to integrate acquisitions successfully and we could incur or assume unknown or unanticipated liabilities or contingencies, which +may impact our results of operations. If we dispose of or otherwise exit certain businesses, there can be no assurance that we will not +incur certain disposition related charges, or that we will be able to reduce overhead related to the divested assets. +66 +In the ordinary course of +our business, we evaluate the potential disposition of assets and businesses that may no longer help us meet our objectives or that no +longer fit with our broader strategy, such as the planned merger between TOGI and IMHC. When we decide to sell assets or a business, we +may encounter difficulty in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the +accomplishment of our strategic objectives, or we may dispose of a business at a price or on terms which are less than we had anticipated. +In addition, there is a risk that we sell a business whose subsequent performance exceeds our expectations, in which case our decision +would have potentially sacrificed enterprise value. +Our development stage companies may never produce +revenues or income. +We have made investments in +and own stakes, either majority or minority, in a certain development stage companies. Each of these companies is at an early stage of +development and is subject to all business risks associated with a new enterprise, including constraints on their financial and personnel +resources, lack of established credit, the need to establish meaningful and beneficial vendor and customer relationships and uncertainties +regarding product development and future revenues. We anticipate that many of these companies will continue to incur substantial additional +operating losses for at least the next several years and expect their losses to increase as research and development efforts expand. There +can be no assurance as to when or whether any of these companies will be able to develop significant sources of revenue or that any of +their respective operations will become profitable, even if any of them is able to commercialize any products. As a result, we may not +realize any returns on our investments in these companies for a significant period of time, if at all, which could adversely affect our +business, results of operations, financial condition or liquidity. +Divestitures and contingent liabilities from +divested businesses could adversely affect our business and financial results . +We continually evaluate the +performance and strategic fit of all of our businesses and may sell businesses or product lines. Divestitures involve risks, including +difficulties in the separation of operations, services, products and personnel, the diversion of management's attention from other business +concerns, the disruption of our business, the potential loss of key employees and the retention of uncertain contingent liabilities, including +environmental liabilities, related to the divested business. When we decide to sell assets or a business, we may encounter difficulty +in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the achievement of our strategic +objectives. We may also dispose of a business at a price or on terms that are less desirable than we had anticipated, which could result +in significant asset impairment charges, including those related to goodwill and other intangible assets, that could have a material adverse +effect on our financial condition and results of operations. In addition, we may experience greater dis-synergies than expected, the impact +of the divestiture on our revenue growth may be larger than projected, and some divestitures may be dilutive to earnings. There can be +no assurance whether the strategic benefits and expected financial impact of the divestiture will be achieved. We cannot assure you that +we will be successful in managing these or any other significant risks that we encounter in divesting a business or product line, and +any divestiture we undertake could materially and adversely affect our business, financial condition, results of operations and cash flows. +Risks Related to Related Party Transactions +There may be conflicts of +interest between our company and certain of our related parties and their respective directors and officers which might not be resolved +in our favor. More importantly, there may be conflicts between certain of our related parties and their respective directors and officers +which might not be resolved in our favor. These risks are set forth below appurtenant to the relevant related party. +Ault & Company +Our relationship with Ault & Company may +enhance the difficulty inherent in obtaining financing for us as well as expose us to certain conflicts of interest. +As of April 17, 2023, Ault & Company, of which +Milton C. (Todd) Ault III is the chief executive officer, beneficially owned 52,666,882 shares of our common stock, consisting of (i) +1,658,916 shares of common stock owned, (ii) warrants to purchase 94 shares of common stock that are currently exercisable, (iii) 1,000,000 +shares of common stock purchasable by Ault & Company pursuant to a securities purchase agreement entered into on June 11, 2021 between +Ault & Company and BitNile, (iv) 50,000,000 shares owned by Ault Alpha, of which Ault & Company is the sole member of Ault Alpha +GP LLC, the general partner of Ault Alpha, and (v) 7,872 shares owned by Philou Ventures, LLC (“Philou”), of which Ault & +Company is the Manager, consisting of: (A) 125,000 shares of Series B Preferred Stock that are convertible into 2,232 shares of common +stock, (B) warrants to purchase 2,232 shares of common stock that are currently exercisable and (C) 3,408 shares of common stock. As of +April 17, 2023, Ault & Company beneficially owned 12.6% of our common stock. +67 +Given the close relationship +between Ault & Company, on the one hand, and our company, on the other, it is not inconceivable that we could enter into additional +securities purchase agreements with Ault & Company. +Although we have relied on +Philou, which no longer beneficially owns a meaningful number of our shares of common stock, to finance us in the past, we cannot assure +you that either Philou or Ault & Company will assist us in the future. We would far prefer to rely on these entities’ assistance +compared to other sources of financing as the terms they provide us are in general more favorable to us than we could obtain elsewhere. +However, Messrs. Ault, Horne and Nisser could face a conflict of interest in that they serve on the board of directors of each of Ault +& Company and our company. If they determine that an investment in our company is not in Ault & Company’s best interest, +we could be forced to seek financing from other sources that would not necessarily be likely to provide us with equally favorable terms. +Other conflicts of interest +between us, on the one hand, and Ault & Company, on the other hand, may arise relating to commercial or strategic opportunities or +initiatives. Mr. Ault, as the controlling stockholder of Ault & Company, may not resolve such conflicts in our favor. For example, +we cannot assure you that Ault & Company would not pursue opportunities to provide financing to other entities whether or not it currently +has a relationship with such other entities. Furthermore, our ability to explore alternative sources of financing other than Ault & +Company may be constrained due to Mr. Ault’s vision for us and he may not wish for us to receive any financing at all other than +from entities that he controls. +Alzamend +Our relationship with Alzamend may expose us +to certain conflicts of interest. +In August 2020, Alzamend +entered into a securities purchase agreement with our company to sell a convertible promissory note of Alzamend, in the aggregate principal +amount of $50,000 and issue a 5-year warrant to purchase 16,667 of shares of its common stock. The convertible promissory note bears interest +at 8% per annum, which principal and all accrued and unpaid interest was due six months after the date of issuance. The principal and +interest earned on the convertible promissory note was convertible into shares of Alzamend’s common stock at $1.50 per share. The +exercise price of the warrant is $3.00 per share. +In December 2020, we provided +Alzamend $0.8 million in short-term advances and in March of 2021 we entered into an agreement with Alzamend under which we agreed to +purchase $10 million worth of shares of Alzamend’s common stock. We paid for the last tranche of $4 million on April 26, 2022. Consequently, +as of the date of this annual report, we have funded an aggregate of $10 million pursuant to the securities purchase agreement and +have thus acquired all of the shares and warrants issuable by Alzamend to us under the agreement. +Messrs. Horne and Nisser could +face a conflict of interest in that they serve on the board of directors of each of Alzamend and our company. +Avalanche +We have lent a substantial amount of funds +to Avalanche, a related party, whose ability to repay us is subject to significant doubt; in addition, we currently beneficially own a +significant percentage of Avalanche’s issued and outstanding shares of common stock, for which there is presently no market. +On September 6, 2017, we entered +into a Loan and Security Agreement with Avalanche (as amended, the “AVLP Loan Agreement”) with an effective date of August +21, 2017 pursuant to which we provided Avalanche a non-revolving credit facility. The AVLP Loan Agreement was increased to up to $20.0 +million in June of 2021 and extended to December 31, 2023. Until recently, we held a convertible note issued to us by AVLP in the amount +of $20.0 million (the “Prior AVLP Note”). +While Avalanche received funds +from a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of a convertible promissory +note to such third party (the “Third Party Note”), $2.7 million was used to pay an outstanding receivable due us and no amount +was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, Ault Alpha, an affiliate of ours, +repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. In consideration +therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note had a maturity date of June 30, +2022. +68 +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for a 10% senior secured convertible note in the principal face amount of $3.8 million due June +15, 2024 (the “Ault Alpha Note”). The Ault Alpha Note is convertible, subject to adjustment, at $0.50 per share. AVLP also +issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise price of $0.50. Pursuant +to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the +foregoing parties, our company and certain other persons, Ault Alpha has a second priority interest in AVLP’s assets securing the +repayment of the Ault Alpha Note. +On July 11, 2022, AVLP issued +us a 10% senior secured convertible note in the principal face amount of $3.0 million due July 10, 2024 (the “AVLP Note”). +The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an aggregate of 41.0 +million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into by Avalanche and +Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and certain other persons, +we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +On June 1, 2022, we converted +the entire principal and accrued interest on the Prior AVLP Note into an aggregate of 51.9 million shares of common stock of Avalanche, +representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. There is currently no liquid market +for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common stock on the open market, our ability +to do so would be severely limited. Avalanche is not current in its filings with the Commission and is not required to register the shares +of its common stock underlying the Prior AVLP Note or any other loan arrangement we have made with Avalanche described above. +There is some doubt as to +whether Avalanche will ever have the ability to repay its debt to us, as well as our ability to sell the shares we beneficially own since +at present there is no market for these shares. If we are unable to recoup our investment in Avalanche in the foreseeable future or at +all, such failure would have a materially adverse effect on our financial condition and future prospects. +Milton C. Ault, III and William B. Horne, our +Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. +Milton C. Ault, III and William +B. Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors, are also directors of Avalanche. +Certain conflicts of interest between us, on the one hand, and Avalanche, on the other hand, may arise relating to commercial or strategic +opportunities or initiatives, in addition to the conflicts related to the debt that Avalanche owes us. For example, Messrs. Ault and Horne +may find it difficult to determine how to meet their fiduciary duties to us as well as Avalanche, which could result in a less favorable +result for us than would be the case if they were solely directors of our company. Further, even if Messrs. Ault and Horne were able to +successfully meet their fiduciary obligations to us and Avalanche, the fact that they are members of the board of directors of both companies +could attenuate their ability to focus on our business and best interests, possibly to the detriment of both companies. +Risks Related to +BNC +Risks Related to the +transaction with BitNile Metaverse +BitNile Metaverse +may not obtain approval of its shareholders to issue us the shares we are entitled to. +As +stated above, on February 8, 2023, we entered into a Share Exchange Agreement (the “Agreement”) with BitNile Metaverse (formerly +known as Ecoark Holdings, Inc.), or BMI, and the other signatories thereto. The Agreement provides that, subject to the terms and conditions +set forth therein, BMI will acquire all of the outstanding shares of capital stock of our then subsidiary, BNC, of which we owned approximately +86%, and the remaining 14% was owned by minority shareholders (the “Minority Shareholders”), as well as Ault Iconic (formerly +Ault Media Group) and the securities of Earnity beneficially owned by BNC (which represented approximately 19.9% of the outstanding equity +securities of Earnity as of the date of the Agreement), in exchange for the following: (i) 8,637.5 shares of newly designated Series B +Convertible Preferred Stock of BMI to be issued to our company (the “Series B Preferred”), and (ii) 1,362.5 shares of newly +designated Series C Convertible Preferred Stock of BMI to be issued to the to the Minority Shareholders (the “Series C Preferred,” +and together with the Series B Preferred, the “Preferred Stock”). The Series B Preferred and the Series C Preferred each have +a stated value of $10,000 per share (the “Stated Value”), for a combined stated value of the Preferred Stock to be issued +by BMI, of $100,000,000, and subject to adjustment, are convertible into an aggregate of 400,000,000 shares of common stock of BMI (the +“BMI Common Stock”), which would represent approximately 92.4% of the outstanding BMI Common Stock on a fully-diluted basis +as of the date of the Agreement. However, pending approval of the transaction by BMI’s shareholders, the Preferred Stock is subject +to a 19.9% beneficial ownership limitation, including the Series A Convertible Preferred Stock that we acquired from BMI in June of 2022. +The Agreement provides that BMI will seek shareholder approval (the “Shareholder Approval”) following the closing. +69 +However, +there can be no assurance that BMI will obtain Shareholder Approval on a timely basis, if at all, particularly since we will not be permitted +to vote on that proposal under Nasdaq’s rules. Should we not be able to be issued the shares of Preferred Stock that we are entitled +to under the Agreement, we will effectively have sold an asset we determined to be worth $100 million in consideration for shares of BMI +worth far less than that figure. +If BNC does not successfully +develop its business, the shares that we own as well as those we are entitled to may have very little value, if any. +We +sold BNC to BMI under the assumption that BNC is worth $100 million, of which we would receive shares of Series B Preferred valued at +$86 million, assuming BMI obtains Shareholder Approval, as discussed above. However, if BNC does not successfully develop its business +within the foreseeable future, it could be required to seek additional capital, which could result in a decrease in the value of our shares +of Series B Preferred, whether due to dilution or the terms of such financing. There can be no assurance that BMI would be able to raise +the requisite financing to maintain or develop its business on reasonably favorable terms, whether to it or to us, if at all. Further, +whether or not BNC seeks or receives additional financing, if its business never develops, then our shares of Series B Preferred will +in all likelihood have no value at all. +Risks Related to BNC’s +Product Offerings +If BNC fails to retain +existing users or add new users, or if BNC’s users decrease their level of engagement with BNC’s products, BNC’s revenue, +financial results, and business may be significantly harmed. +The +size of BNC’s user base and BNC’s users’ level of engagement across BNC’s products are critical to BNC’s +success. BNC’s financial performance will be significantly determined by BNC’s success in adding, retaining, and engaging +active users of BNC’s products that deliver ad impressions. User growth and engagement are also impacted by a number of other factors, +including competitive products and services, such as TikTok, that could reduce some users’ engagement with BNC’s products +and services, as well as global and regional business, macroeconomic, and geopolitical conditions. Any future declines in the size of +BNC’s active user base, which to date is minimal, may adversely impact BNC’s ability to deliver ad impressions and, in turn, +BNC’s financial performance. +If +people do not perceive BNC’s products to be useful, reliable, and trustworthy, BNC may not be able to attract or retain users or +otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved +early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee +that BNC will not experience a similar inability to generate a significant used baser or, if achieved, subsequent erosion of BNC’s +active user base or engagement levels. User engagement can be difficult to measure, particularly as BNC introduces new and different products +and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: +• users increasingly engage with other competitive products or services; +• BNC fails to introduce new features, products, or services that users find engaging or if BNC introduces +new products or services, or makes changes to existing products and services, that are not favorably received; +• users feel that their experience is diminished as a result of the decisions BNC makes with respect to +the frequency, prominence, format, size, and quality of ads that BNC displays; +• users have difficulty installing, updating, or otherwise accessing BNC’s products on mobile devices +as a result of actions by BNC or third parties that BNC relies on to distribute BNC’s products and deliver BNC’s services; +• BNC is unable to develop products for mobile devices that users find engaging, that work with a variety +of mobile operating systems and networks, and that achieve a high level of market acceptance; +• there are decreases in user sentiment due to questions about the quality or usefulness of BNC’s +products or BNC’s user data practices, concerns about the nature of content made available on BNC’s products, or concerns +related to privacy, safety, security, well-being, or other factors; +• BNC is unable to manage and prioritize information to ensure users are presented with content that is +appropriate, interesting, useful, and relevant to them; +• BNC is unable to obtain or attract engaging third-party content; +• BNC is unable to successfully maintain or grow usage of and engagement with applications that integrate +with BNC’s products; +70 +• users adopt new technologies where BNC’s products may be displaced in favor of other products or +services, or may not be featured or otherwise available; +• there are changes mandated by legislation, government and regulatory authorities, or litigation that adversely +affect BNC’s products or users; +• BNC is unable to offer a number of BNC’s products and services in Europe, or are otherwise limited +in BNC’s business operations, as a result of European regulators, courts, or legislative bodies determining that BNC’s reliance +on Standard Contractual Clauses or other legal bases BNC may rely upon to transfer user data from the European Union to the United States +is invalid; +• there is decreased engagement with BNC’s products, or failure to accept BNC’s terms of service, +as part of privacy-focused changes that BNC has implemented or may implement in the future, whether voluntarily, in connection with the +General Data Protection Regulation (“GDPR”), the European Union’s ePrivacy Directive, the California Privacy Rights +Act (“CPRA”), or other laws, regulations, or regulatory actions, or otherwise; +• technical or other problems prevent BNC from delivering its products in a rapid and reliable manner or +otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content, or users feel +their experience is diminished as a result of BNC’s efforts to protect the security and integrity of the Platform; +• BNC adopts terms, policies, or procedures related to areas such as sharing, content, user data, or advertising, +or BNC takes, or fails to take, actions to enforce BNC’s policies, that are perceived negatively by BNC’s users or the general +public; +• BNC elects to focus its product decisions on longer-term initiatives that do not prioritize near-term +user growth and engagement; +• BNC makes changes in its user account login or registration processes or changes in how BNC promotes different +products and services across its family of products; +• initiatives designed to attract and retain users and engagement, including the use of new technologies +such as artificial intelligence, are unsuccessful, whether as a result of actions by BNC, its competitors, or other third parties, or +otherwise; +• there is decreased engagement with BNC’s products as a result of taxes imposed on the use of social +media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility +of BNC’s products in their countries; +• BNC fails to provide adequate customer service to users, marketers, developers, or other partners; or +• BNC, developers whose products are integrated with BNC’s products, or other partners and companies +in BNC’s industry are the subject of adverse media reports or other negative publicity, including as a result of BNC’s or +its user data practices. +From +time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If BNC are +unable to maintain or increase BNC’s user base and user engagement, particularly for BNC’s significant revenue-generating +products like Facebook and Instagram, BNC’s revenue and financial results may be adversely affected. Any significant decrease in +user retention, growth, or engagement could render BNC’s products less attractive to users, marketers, and developers, which is +likely to have a material and adverse impact on BNC’s ability to deliver ad impressions and, accordingly, BNC’s revenue, business, +financial condition, and results of operations. As the size of BNC’s active user base fluctuates in one or more markets from time +to time, BNC will become increasingly dependent on BNC’s ability to maintain or increase levels of user engagement and monetization +in order to grow revenue. +BNC’s user growth, +engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, +products, and standards that BNC does not control. +The +substantial majority of BNC’s revenue is expected to be generated from advertising on mobile devices. There is no guarantee that +popular mobile devices will feature BNC’s products, or that mobile device users will ever use BNC’s products rather than competing +products. BNC is dependent on the interoperability of BNC’s products with popular mobile operating systems, networks, technologies, +products, and standards that BNC does not control, such as the Android and iOS operating systems and mobile browsers. Changes, bugs, or +technical issues in such systems, or changes in BNC’s relationships with mobile operating system partners, handset manufacturers, +browser developers, or mobile carriers, or in the content or application of their terms of service or policies that degrade BNC’s +products’ functionality, reduce or eliminate BNC’s ability to update or distribute BNC’s products, give preferential +treatment to competitive products, limit BNC’s ability to deliver, target, or measure the effectiveness of ads, or charge fees related +to the distribution of BNC’s products or BNC’s delivery of ads have in the past adversely affected, and could in the future +adversely affect, the usage of BNC’s products and monetization on mobile devices. +71 +BNC’s products +and changes to such products could fail to attract or retain users or generate revenue and profits, or otherwise adversely affect BNC’s +business. +BNC’s +ability to retain, increase, and engage its user base and to increase BNC’s revenue depends heavily on BNC’s ability to continue +to evolve BNC’s existing products and to create successful new products, both independently and in conjunction with developers or +other third parties. BNC may introduce significant changes to BNC’s products or acquire or introduce new and unproven products, +including using technologies with which BNC has little or no prior development or operating experience. For example, BNC does not have +significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect BNC’s +ability to successfully develop and market these products and technologies. BNC will incur substantial costs, and BNC may not be successful +in generating profits, in connection with these efforts. These efforts, including the introduction of new products or changes to existing +products, may result in new or enhanced governmental or regulatory scrutiny, litigation, ethical concerns, or other complications that +could adversely affect BNC’s business, reputation, or financial results. If BNC’s new products or changes to existing products +fail to engage users, marketers, or developers, or if BNC’s business plans are unsuccessful, BNC may fail to attract or retain users +or to generate sufficient revenue, operating margin, or other value to justify BNC’s investments, and BNC’s business may be +adversely affected. +BNC may not be successful +in its metaverse strategy and investments, which could adversely affect BNC’s business, reputation, or financial results. +BNC +believes that the metaverse, an embodied internet where people have immersive experiences beyond two-dimensional screens, is the next +evolution in social technology. BNC intends to focus on helping to bring the metaverse to life. BNC expects this will b e +a complex, evolving, and long-term initiative that will involve the development of new and emerging technologies, require significant +investment in infrastructure as well as pri vacy, safety, and security efforts, and collaboration with other companies, developers, +partners, and other participants. However, the metaverse may not develop in accordance with BNC’s expectations, and market acceptance +of features, products, or services BNC may build for the metaverse is uncertain. BNC intends to regularly evaluate BNC’s product +roadmaps and make significant changes as BNC’s understanding of the technological challenges and market landscape and BNC’s +product ideas and designs evolve. In addition, BNC has virtually no experience with consumer hardware products and virtual and augmented +reality technology, which may enable other companies to compete more effectively than it can. BNC may be unsuccessful in BNC’s future +research and product development efforts, including if BNC is unable to develop relationships with key participants in the metaverse or +develop products that operate effectively with metaverse technologies, products, systems, networks, or standards. BNC hopes to make investments +in virtual and augmented reality and other technologies to support these efforts, and BNC’s ability to support these efforts is +dependent on generating sufficient profits from BNC’s business. In addition, as BNC’s metaverse efforts evolve, BNC may be +subject to a variety of existing or new laws and regulations in the United States and international jurisdictions, including in the areas +of privacy, safety, competition, content regulation, consumer protection, and e-commerce, which may delay or impede the development of +BNC’s products and services, increase BNC’s operating costs, require significant management time and attention, or otherwise +harm BNC’s business. As a result of these or other factors, BNC’s metaverse strategy and investments may not be successful +in the foreseeable future, or at all, which could adversely affect BNC’s business, reputation, or financial results. +BNC may not be able +to successfully grow usage of and engagement with applications that integrate with BNC’s products. +BNC +hopes to make investments to enable developers to build, grow, and monetize applications that integrate with BNC’s products. Such +existing and prospective developers may not be successful in building, growing, or monetizing applications that create and maintain user +engagement. Additionally, developers may choose to build on other platforms, including platforms controlled by third parties, rather than +building products that integrate with BNC’s products. BNC is continuously seeking to balance the distribution objectives of BNC’s +developers with BNC’s desire to provide an optimal user experience, and BNC may not be successful in achieving a balance that attracts +or retains such developers. In addition, as part of BNC’s efforts related to privacy, safety, and security, BNC intends to conduct +investigations and audits of platform applications from time to time. In some instances, these actions will adversely affect BNC’s +relationships with developers. If BNC is not successful in BNC’s efforts to grow the number of developers that choose to build products +that integrate with BNC’s products or if BNC is unable to continue to build and maintain good relations with such developers, BNC’s +user growth and user engagement as well as its financial results may be adversely affected. +72 +Risks Related to BNC’s +Business Operations and Financial Results +Our business is highly +competitive. Competition presents an ongoing threat to the success of BNC’s business. +BNC +expects to compete with companies providing connection, sharing, discovery, and communication products and services to users online, as +well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing +advertising campaigns. BNC faces significant competition in every aspect of BNC’s business, including, but not limited to, companies +that facilitate the ability of users to create, share, communicate, and discover content and information online or enable marketers to +reach their existing or prospective audiences. BNC expects to compete to attract, engage, and retain people who use BNC’s products, +to attract and retain businesses that use BNC’s free or paid business and advertising services, and to attract and retain developers +who build compelling applications that integrate with BNC’s products. BNC also expects to compete with companies that develop and +deliver virtual and augmented reality products and services. As BNC introduces or acquires new products, or as other companies introduce +new products and services, including as part of efforts to develop the metaverse or innovate through the application of new technologies +such as artificial intelligence, BNC may become subject to additional competition. +Virtually +all BNC’s current and potential competitors have greater resources, experience, or stronger competitive positions in the product +segments, geographic regions, or user demographics in which BNC intends to operate than BNC does. For example, some of BNC’s competitors +may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively +than BNC could. These factors may allow BNC’s competitors to respond more effectively than BNC to new or emerging technologies and +changes in market conditions. In the event that users engage with other products and services, BNC may never see any growth in use and +engagement in key user demographics or more broadly, in which case BNC’s business would be harmed. +BNC’s +competitors may develop products, features, or services that are similar to its own or that achieve greater acceptance, may undertake +more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. Some +competitors may gain a competitive advantage against BNC, including: by making acquisitions; by limiting BNC’s ability to deliver, +target, or measure the effectiveness of ads; by imposing fees or other charges related to BNC’s delivery of ads; by making access +to BNC’s products more difficult or impossible; by making it more difficult to communicate with BNC’s users; or by integrating +competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, +or e-commerce platforms. BNC’s competitors may, and in some cases will, acquire and engage users or generate advertising or other +revenue at the expense of BNC’s own efforts, which would negatively affect BNC’s business and financial results. In addition, +from time to time, BNC may take actions in response to competitive threats, but BNC cannot assure you that these actions will be successful +or that they will not negatively affect BNC’s business and financial results. +Real or perceived +inaccuracies in BNC’s community and other metrics may harm BNC’s reputation and negatively affect BNC’s business. +The +numbers for BNC’s key metrics are calculated using internal company data based on the activity of user accounts, at times augmented +by other sources. While these numbers are based on what BNC believes to be reasonable estimates of BNC’s user base for the applicable +period of measurement, there are inherent challenges in measuring usage of BNC’s products across online and mobile populations around +the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other +technical errors. In addition, BNC is seeking to establish mechanisms to improve its estimates of its user base, and such estimates may +change due to improvements or changes in BNC’s methodology. BNC intends to regularly review BNC’s processes for calculating +these metrics, and from time to time BNC expects to discover inaccuracies in these metrics or make adjustments to improve their accuracy. +The lack of comprehensive +encryption for communications on the Platform may increase the impact of a data security incident. +Communications +on the Platform are not comprehensively encrypted at this time. As such, any data security incident that involves unauthorized access, +acquisition, disclosure, or use may be highly impactful to BNC’s business. BNC may experience considerable incident response forensics, +data recovery, legal fees, and costs of notification related to any such potential incident, and BNC may face an increased risk of reputational +harm, regulatory enforcement, and consumer litigation, which could further harm BNC’s business, financial condition, results of +operations, and future business opportunities. +73 +Risks Related to Government +Regulation and Enforcement +Actions by governments +that restrict access to BNC’s products in their countries, censor or moderate content on BNC’s products in their countries, +or otherwise impair BNC’s ability to sell advertising in their countries, could substantially harm BNC’s business and financial +results. +BNC +expects that governments will from time to time seek to censor or moderate content available on BNC’s products, should such products +ever be developed, distributed and used by customers, in their country, restrict access to BNC’s products from their country partially +or entirely, or impose other restrictions that may affect the accessibility of BNC’s products in their country for an extended period +of time or indefinitely. In addition, government authorities may seek to restrict user access to BNC’s products if they consider +us to be in violation of their laws or a threat to public safety or for other reasons. It is also possible that government authorities +could take action that impairs BNC’s ability to sell advertising, including in countries where access to BNC’s consumer-facing +products may be blocked or restricted. In the event that content shown on BNC’s products is subject to censorship, access to BNC’s +products is restricted, in whole or in part, in one or more countries, BNC would be required to or could elect to make changes to BNC’s +future operations, or other restrictions are imposed on BNC’s products, or BNC’s competitors are able to successfully penetrate +new geographic markets or capture a greater share of existing geographic markets that BNC cannot access or where BNC face other restrictions, +BNC’s ability to increase BNC’s user base, user engagement, or the level of advertising by marketers may be adversely affected, +and BNC may not be able to grow BNC’s revenue as anticipated, and BNC’s financial results could be adversely affected. +Our business is subject +to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, safety +and consumer protection, e-commerce, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, +and could result in claims, changes to BNC’s products and business practices, monetary penalties, increased cost of operations, +or declines in user growth or engagement, or otherwise harm BNC’s business. +BNC +is subject to a variety of laws and regulations in the United States and abroad that will involve matters central to BNC’s business, +including privacy, data use, data protection and personal information, biometrics, encryption, rights of publicity, content, integrity, +intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, +data disclosure, artificial intelligence and machine learning, electronic contracts and other communications, competition, protection +of minors, consumer protection, civil rights, accessibility, telecommunications, product liability, e-commerce, taxation, economic or +other trade controls including sanctions, anti-corruption and political law compliance, securities law compliance, and online payment +services. The introduction of new products, expansion of BNC’s activities in certain jurisdictions, or other actions that BNC may +take may subject it to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, +competition, consumer protection, and other laws and regulations can impose different obligations or be more restrictive than those in +the United States. +These +U.S. federal, state, and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government +entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement +of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which BNC operates, and may +be interpreted and applied inconsistently from jurisdiction to jurisdiction and inconsistently with BNC’s current policies and practices. +For example, regulatory or legislative actions or litigation affecting the manner in which BNC displays content to BNC’s users, +moderate content, or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect +the manner in which BNC provides its services or adversely affect BNC’s financial results. +As +its business develops, BNC expects to become subject to significant legislative and regulatory developments, and proposed or new legislation +and regulations could significantly affect BNC’s business in the future. For example, BNC intends to implement certain product changes +and controls as a result of requirements under the European General Data Protection Regulation (“GDPR”), and may implement +additional changes in the future. The interpretation of the GDPR is still evolving and draft decisions in investigations are subject to +review by several European privacy regulators as part of the GDPR’s consistency mechanism, which may lead to significant changes +in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and +amount of penalties for non-compliance, are subject to significant uncertainty. The California Consumer Privacy Act (“CCPA”), +as amended by the California Privacy Rights Act (“CPRA”), also establishes certain transparency rules and creates new data +privacy rights for users, including limitations on BNC’s use of certain sensitive personal information and more ability for users +to control the purposes for which their data is shared with third parties. Other states have proposed or enacted similar comprehensive +privacy laws that afford users with similar data privacy rights and controls. These laws and regulations are evolving and subject to interpretation, +and resulting limitations on BNC’s advertising services, or reductions of advertising by marketers, could adversely affect BNC’s +advertising business. +These +laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past +led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, loss of revenue, delays or impediments +in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time +and attention, and remedies that harm BNC’s business, including fines or demands or orders that BNC modify or cease existing business +practices. +74 +Changes in laws affecting gaming +and gambling or the public perception of gaming and gambling may adversely impact our or BNC’s business. +BNC offers a number of products and services, +which may include a selection of gaming options, including games, sweepstakes, gambling, and social gaming experiences. Social gaming +experiences have recently been the subject of civil lawsuits, and some jurisdictions have taken an adverse position to interactive social +gaming, including “social casinos” and sweepstakes-based gaming. This could lead to states adopting legislation or imposing +a regulatory framework to govern interactive social gaming or social casino or sweepstakes-based gaming specifically. These could also +result in a prohibition on interactive social gaming or social casino or sweepstakes-based gaming altogether, restrict BNC’s ability +to advertise its games, or substantially increase BNC or our costs to comply with these regulations, all of which could have an adverse +effect on our or BNC’s results of operations, cash flows and financial condition. It is not possible to predict the likelihood, +timing, scope, or terms of any such legislation or regulation or the extent to which they may affect our or BNC’s business. +Regulators in the future may pass additional +rules and regulations that could adversely affect our or BNC’s business. In May 2019, the World Health Organization adopted a new +edition of its International Classification of Diseases, which lists gaming addiction as a disorder. The American Psychiatric Association +(“APA”) and U.S. regulators have yet to decide whether gaming addiction should be considered a behavioral disorder, but the +APA has noted that research and the debate on its classification are ongoing. Certain countries, including China and South Korea, have +enacted regulations, such as imposing both gaming curfews and spending limits for minors, and established treatment programs +aimed at addressing gaming addiction. It is not possible to predict the likelihood, timing, scope, or terms of any similar regulations +in any of the markets in which BNC operates, or the extent to which implementation of such regulations may adversely affect our or BNC’s +reputation and business. +Consumer protection and health concerns +regarding games and gambling such as BNC’s have been raised in the past and may again be raised in the future. Such concerns could +lead to increased scrutiny over the manner in which BNC’s games are designed, developed, distributed, and presented. We and BNC +cannot predict the likelihood, timing or scope of any concern reaching a level that will impact its business, or whether it would suffer +any adverse impacts to our or BNC’s results of operations, cash flows and financial condition. +Our reputation may be harmed due +to unfamiliarity or negative press associated with activities BNC is undertaking, including the online metaverse landscape, virtual markets, +real world goods marketplaces, gaming, social activities, sweepstakes, gambling, and digital assets. +BNC is focused on the development of the +online metaverse landscape and is focused on immersive digital experiences, including virtual markets, real world goods marketplaces, +gaming, social activities, sweepstakes, gambling, and more. The activities BNC is undertaking are based on technology that is relatively +new. Many companies operating in similar industries are unlicensed, unregulated and/or operate without supervision by any governmental +authorities. As a result, users and the general public may lose confidence in BNC’s products and services. Companies like BNC that +deal in digital assets are appealing targets for hackers and malware and may also be more likely to be targets of regulatory enforcement +actions. Negative perception, a lack of stability and standardized regulation in the industries in which BNC operates and the failure +of similar companies due to fraud, business failure, hackers or malware, or government mandated regulation, may reduce confidence in our +or BNC’s business. Any of these events could have a material and adverse impact on our or BNC’s reputation and business. +We may be subject to regulatory +and other government investigations, enforcement actions, settlements, and other inquiries in the future, which could cause us to incur +substantial costs or require us or BNC to change its business practices in a manner materially adverse to its business. +Should BNC’s business ever expand +to a significant degree, we and BNC’s management expects to receive formal and informal inquiries from government authorities and +regulators regarding BNC’s compliance with laws and regulations, many of which are evolving and subject to interpretation. In such +a scenario, we and BNC expect to be the subject of investigations, inquiries, data requests, requests for information, actions, and audits +in the United States, particularly in the areas of privacy and data protection, including with respect to minors, law enforcement, consumer +protection, civil rights, content moderation, blockchain technologies, sweepstakes, promotions, gaming, gambling, and competition. In +addition, we or BNC may in the future be subject to regulatory orders or consent decrees. +75 +We or BNC may also +become subject to various litigation and formal and informal inquiries and investigations by competition authorities in the United States, +which may relate to many aspects of BNC’s future business, including with respect to users and advertisers, as well as BNC’s +industry. Such inquiries, investigations, and lawsuits concern, among other things, BNC’s business practices in the areas of social +networking or social media services, digital advertising, gambling, and sweepstakes activities and/or mobile or online applications. +Orders issued by, +or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us or BNC to incur substantial costs, +expose us to civil and criminal liability (including liability for personnel) or penalties (including substantial monetary remedies), +interrupt or require us or BNC to change its business practices in a manner materially adverse to our or BNC’s business (including +changes products or user data practices), result in negative publicity and reputational harm, divert resources and the time and attention +of management from our or BNC’s business, or subject us or BNC to other structural or behavioral remedies that adversely affect +our or BNC’s business. +BNC expects, should +its business ever develop, to be subject to regulatory and other government investigations, enforcement actions, settlements and other +inquiries in the future, which could cause us BNC incur substantial costs or require BNC to change its business practices in a manner +materially adverse to its business. +Should +BNC’s business ever expand and to a significant degree, its management expects it to receive formal and informal inquiries from +government authorities and regulators regarding BNC’s compliance with laws and regulations, many of which are evolving and subject +to interpretation. In such a scenario, BNC expects to be the subject of investigations, inquiries, data requests, requests for information, +actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy and data protection, including +with respect to minors, law enforcement, consumer protection, civil rights, content moderation, and competition. In addition, BNC may +in the future be subject to regulatory orders or consent decrees. +BNC +may also become subject to various litigation and formal and informal inquiries and investigations by competition authorities in the United +States, Europe, and other jurisdictions, which may relate to many aspects of BNC’s future business, including with respect to users +and advertisers, as well as BNC’s industry. Such inquiries, investigations, and lawsuits concern, among other things, BNC’s +business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications. +Orders +issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause BNC to incur substantial +costs, expose us to civil and criminal liability (including liability for BNC’s personnel) or penalties (including substantial monetary +remedies), interrupt or require BNC to change its business practices in a manner materially adverse to BNC’s business (including +changes to BNC’s products or user data practices), result in negative publicity and reputational harm, divert resources and the +time and attention of management from BNC’s business, or subject it to other structural or behavioral remedies that adversely affect +BNC’s business. +Payment transactions +may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm +BNC’s business. +Several +of BNC’s future products may offer payments functionality, including enabling BNC’s users to purchase tangible, virtual, +and digital goods from merchants and developers that offer applications using BNC’s payment infrastructure, send money to other +users, and make donations to certain charitable organizations, among other activities. BNC is or may become subject to a variety of laws +and regulations in the United States, Europe and elsewhere, including those governing anti-money laundering and counter-terrorist financing, +money transmission, stored value, gift cards and other prepaid access instruments, electronic funds transfer, virtual currency, consumer +protection, charitable fundraising, trade sanctions, and import and export restrictions. Depending on how BNC’s payment products +evolve, BNC may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, +the application or interpretation of these laws and regulations is not clear. BNC’s efforts to comply with these laws and regulations +could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that BNC is +found to be in violation of any such legal or regulatory requirements, BNC may be subject to monetary fines or other penalties such as +a cease and desist order, or BNC may be required to make product changes, any of which could have an adverse effect on BNC’s business +and financial results. +76 +Risks Related to Data, +Security, and Intellectual Property +Security breaches, +improper access to or disclosure of BNC’s data or user data, other hacking and phishing attacks on BNC’s systems, or other +cyber incidents could harm BNC’s reputation and adversely affect BNC’s business. +BNC’s +industry is prone to cyber-attacks by third parties seeking unauthorized access to BNC’s data or users’ data or to disrupt +BNC’s ability to provide service. BNC’s products and services involve the collection, storage, processing, and transmission +of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of BNC’s data +or user data, including personal information, content, or payment information from users, or information from marketers, could result +in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm BNC’s business and reputation +and diminish BNC’s competitive position. In addition, computer malware, viruses, social engineering (such as spear phishing attacks), +scraping, and general hacking continue to be prevalent in BNC’s industry and are expected to occur on BNC’s systems in the +future. BNC expects to regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions +on BNC’s platform for purposes such as spamming, spreading misinformation, or other objectionable ends. Such attacks may cause interruptions +to the services BNC intends to provide, degrade the user experience, cause users or marketers to lose confidence and trust in BNC’s +products, impair BNC’s internal systems, or result in financial harm to BNC. BNC’s efforts to protect its data or the information +BNC receives, and to disable undesirable activities on BNC’s platform, may also be unsuccessful due to software bugs or other technical +malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in BNC’s vendors’ +information technology systems or offerings; government surveillance; breaches of physical security of BNC’s facilities or technical +infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose +information in order to gain access to BNC’s data or BNC’s users’ data. Cyber-attacks continue to evolve in sophistication +and volume, and inherently may be difficult to detect for long periods of time. Although BNC intends to try to develop systems and processes +that are designed to protect BNC’s data and user data, to prevent data loss, to disable undesirable accounts and activities on BNC’s +platform, and to prevent or detect security breaches, BNC cannot assure you that such measures, if implemented, will provide adequate +security, that BNC will be able to react in a timely manner, or that BNC’s remediation efforts will be successful. The changes in +BNC’s work environment as a result of certain personnel working remotely could also impact the security of BNC’s systems, +as well as BNC’s ability to protect against attacks and detect and respond to them quickly. +In +addition, some of BNC’s developers or other partners, such as those that help us measure the effectiveness of ads, may receive or +store information provided by us or by BNC’s users through mobile or web applications integrated with BNC’s products. BNC +provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers +fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, BNC’s data or BNC’s +users’ data may be improperly accessed, used, or disclosed. +BNC +expects to experience such cyber-attacks and other security incidents of varying degrees from time to time, and BNC expects to incur significant +costs in protecting against or remediating such incidents. In addition, BNC is subject to a variety of laws and regulations in the United +States and abroad relating to cybersecurity and data protection. As a result, affected users or government authorities could initiate +legal or regulatory actions against BNC in connection with any actual or perceived security breaches or improper access to or disclosure +of data, which has occurred in the past and which could cause BNC to incur significant expense and liability or result in orders or consent +decrees forcing BNC to modify its business practices. Such incidents or BNC’s efforts to remediate such incidents may also result +in a decline in BNC’s active user base or engagement levels. Any of these events could have a material and adverse effect on BNC’s +business, reputation, or financial results. +We anticipate that +BNC’s efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data +or other undesirable activity by third parties on BNC’s platform. +In +addition to BNC’s efforts to mitigate cybersecurity risks, BNC intends to make investments in privacy, safety, security, and content +review efforts to combat misuse of BNC’s services and user data by third parties, including investigations and audits of platform +applications, as well as other enforcement efforts. As a result of these efforts BNC anticipates that BNC will discover and announce +additional incidents of misuse of user data or other undesirable activity by third parties. BNC may not discover all such incidents or +activity, whether as a result of BNC’s data or technical limitations, including BNC’s lack of visibility over BNC’s +encrypted services, the allocation of resources to other projects, or other factors, and BNC may be notified of such incidents or activity +by the FTC, the media or other third parties. Such incidents and activities may in the future include the use of user data or BNC’s +systems in a manner inconsistent with BNC’s terms, contracts or policies, the existence of false or undesirable user accounts, +improper advertising practices, activities that threaten people’s safety on or offline, or instances of spamming, scraping, data +harvesting, unsecured datasets, or spreading misinformation. BNC may also be unsuccessful in its efforts to enforce BNC’s policies +or otherwise remediate any such incidents. Consequences of any of the foregoing developments include negative effects on user trust and +engagement, harm to BNC’s reputation, changes to BNC’s business practices in a manner adverse to BNC’s business, and +adverse effects on BNC’s business and financial results. Any such developments may also subject BNC to additional litigation and +regulatory inquiries, which could subject BNC to monetary penalties and damages, divert management’s time and attention, and lead +to enhanced regulatory oversight. +77 +BNC’s products +and internal systems rely on software and hardware that is highly technical, and any errors, bugs, or vulnerabilities in these systems, +or failures to address or mitigate technical limitations in BNC’s systems, could adversely affect BNC’s business. +BNC’s +products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or +by third parties, that is highly technical and complex. In addition, BNC’s products and internal systems depend on the ability of +such software and hardware to store, retrieve, process, and manage considerable amounts of data. The software and hardware on which BNC +relies is expected to contain, errors, bugs, or vulnerabilities, and BNC’s systems are subject to certain technical limitations +that may compromise BNC’s ability to meet BNC’s objectives. Some errors, bugs, or vulnerabilities inherently may be difficult +to detect and may only be discovered after the code has been released for external or internal use. Errors, bugs, vulnerabilities, design +defects, or technical limitations within the software and hardware on which BNC relies, or human error in using such systems, may in the +future lead to outcomes including a negative experience for users and marketers who use BNC’s products, compromised ability of BNC’s +products to perform in a manner consistent with BNC’s terms, contracts, or policies, delayed product introductions or enhancements, +targeting, measurement, or billing errors, compromised ability to protect the data of BNC’s users and/or BNC’s intellectual +property or other data, or reductions in BNC’s ability to provide some or all of BNC’s services. In addition, any errors, +bugs, vulnerabilities, or defects in BNC’s systems or the software and hardware on which BNC relies, failures to properly address +or mitigate the technical limitations in BNC’s systems, or associated degradations or interruptions of service or failures to fulfill +BNC’s commitments to BNC’s users, are expected to lead to outcomes including damage to BNC’s reputation, loss of users, +loss of marketers, prevention of its ability to generate revenue, regulatory inquiries, litigation, or liability for fines, damages, or +other remedies, any of which could adversely affect BNC’s business and financial results. +If BNC is unable to +protect BNC’s intellectual property, the value of its brands and other intangible assets may be diminished, and its business may +be adversely affected. +BNC +relies, and expects to continue to rely on a combination of confidentiality, assignment, and license agreements with BNC’s employees, +consultants, and third parties with whom BNC has relationships, as well as intellectual property laws, to protect BNC’s proprietary +rights. In the United States and internationally, BNC expects to file various applications for protection of certain aspects of BNC’s +intellectual property. Third parties may knowingly or unknowingly infringe BNC’s proprietary rights, third parties may challenge +proprietary rights held by BNC in the future, and future trademark and patent applications may not be approved. In addition, effective +intellectual property protection may not be available in every country in which BNC operates or intends to operate. In any or all of these +cases, BNC may be required to expend significant time and expense in order to prevent infringement or to enforce BNC’s rights. Although +BNC expects to take measures to protect BNC’s proprietary rights, there can be no assurance that others will not offer products +or concepts that are substantially similar to BNC’s and compete with BNC’s business. If the protection of BNC’s proprietary +rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of BNC’s brands and other intangible +assets may be diminished and competitors may be able to more effectively mimic BNC’s products, services and methods of operations. +Any of these events could have an adverse effect on BNC’s business and financial results. +BNC expects to be +party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, +could have a significant impact on BNC’s business, financial condition, or results of operations. +Companies, +in particular established ones, in the internet, technology, and media industries typically own large numbers of patents, copyrights, +trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations +of intellectual property or other rights. In the event that BNC ever develops a significant intellectual property portfolio, it would +face similar challenges that established companies do. In addition, various "non-practicing entities" that own patents and other +intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, +from time to time BNC may introduce or acquire new products, which could increase BNC’s exposure to patent and other intellectual +property claims from competitors and non-practicing entities. +From time to time, BNC may receive notices from +patent holders and other parties alleging that certain of BNC’s products and services, or user content, infringe their intellectual +property rights. BNC expects, should its business ever develop, to be involved in a number of intellectual property lawsuits. Defending +patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there +can be no assurances that favorable final outcomes will be obtained in all or even most cases. In addition, plaintiffs may seek, and BNC +may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions +requiring us to cease some or all of BNC’s anticipated operations. BNC may seek, if possible, to settle such lawsuits and disputes +on terms that are unfavorable to it. Similarly, if any litigation to which BNC is a party is resolved adversely, BNC may be subject to +an unfavorable judgment that may not be reversed upon appeal, if appealed. The terms of such a settlement or judgment may require us to +cease some or all of BNC’s operations or require us pay substantial amounts to the other party, which we may not be able to afford. +In addition, BNC may have to seek a license to continue practices found to be in violation of a third party’s rights, which may +not be available on reasonable terms, or at all, and may significantly increase BNC’s operating costs and expenses. As a result, +BNC may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of +alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology +or practices or otherwise negatively affect the user experience, or may not be feasible. BNC’s business, financial condition, and +results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to +above +78 +Risks Related to Our Business and Industry – Hotel Properties +We operate in a highly +competitive industry. +The +lodging industry is highly competitive. Our principal competitors are other owners and investors in full-service hotels as well as major +hospitality chains with well-established and recognized brands. Our hotels face competition for individual guests, group reservations +and conference business. We also compete against smaller hotel chains and independent and local hotel owners and operators. Additionally, +we face competition from peer-to-peer inventory sources that allow travelers to stay at homes and apartments booked from owners. New hotels +may be constructed, and these additions create new competitors, in some cases without corresponding increases in demand for hotel rooms. +Our competitors may have greater commercial, financial and marketing resources and more efficient technology platforms, which could allow +them to improve their properties and expand and improve their marketing efforts in ways that could affect our ability to compete for guests +effectively and adversely affect our revenues and profitability as well as limit or slow our future growth. +The +growth of internet reservation channels is another source of competition that could adversely affect our business. A significant percentage +of hotel rooms for individual customers are booked through internet travel intermediaries. As intermediary bookings increase, they may +be able to obtain higher commissions, reduced room rates or other significant contract concessions from our hotels. While internet travel +intermediaries traditionally have competed to attract transient business rather than group and convention business, in recent years they +have expanded their business to include marketing to large group and convention business. If that expansion continues, it could both divert +group and convention business away from our hotels and increase our cost of sales for group and convention business and materially adversely +affect our revenues and profitability. +Our franchisors and +brand managers require us to make capital expenditures pursuant to property improvement plans (“PIPs”), and any failure on +our part to make the expenditures required under the PIPs or to comply with brand standards could cause the franchisors or hotel brands +to terminate the franchise, management or operating lease agreements. +In +connection with our acquisition of the Properties in December 2021, our franchisors and brand managers required us to agree to undertake +PIPs in the amount of $13.7 million. If we do not satisfy the PIP renovation requirements, the franchisor or hotel brand may have the +right to terminate the applicable agreement. In addition, in the event that we are in default under any franchise agreement as a result +of our failure to comply with the PIP requirements, in general, we will be required to pay the franchisor liquidated damages, generally +equal to a percentage of gross room revenue for the preceding two-, three- or five-year period for the hotel or a percentage of gross +revenue for the preceding twelve-month period for all hotels operated under the franchised brand if the hotel has not been operating for +at least two years. In addition, our franchisors and brand managers may require that we make renovations to certain of our hotels in connection +with revisions to our franchise, management or operating lease agreements. In addition, upon regular inspection of our hotels, our franchisors +and hotel brands may determine that additional renovations are required to bring the physical condition of our hotels into compliance +with the specifications and standards each franchisor or hotel brand has developed. +All of our hotels +operate under a brand owned by Marriott or Hilton. Should either of these brands experience a negative event, or receive negative publicity, +our operating results may be harmed. +All +of our hotels are operated under nationally recognized brands, either Marriott or Hilton, which are among the most respected and widely +recognized brands in the lodging industry. As a result, a significant concentration of our success is dependent in part on the success +of Marriott and Hilton. Consequently, if market recognition or the positive perception of Marriott and/or Hilton is reduced or compromised, +the goodwill associated with our Marriott and/or Hilton branded hotels may be adversely affected, which may have an adverse effect on +our results of operations. Additionally, any negative perceptions or negative impact to operating results from any proposed or future +consolidations between nationally recognized brands could have an adverse effect on our results of operations. +79 +Our franchisors and +brand managers may change certain policies or cost allocations that could negatively impact our hotels. +Our +franchisors and brand managers incur certain costs that are allocated to our hotels subject to our franchise, management, or operating +lease agreements. Those costs may increase over time or our franchisors and brand managers may elect to introduce new programs that could +increase costs allocated to our hotels. In addition, certain policies, such as our third-party managers’ frequent guest programs, +may be altered resulting in reduced revenue or increased costs to our hotels. +Because our hotels +are operated under franchise agreements or are brand managed, termination of these franchise, management or operating lease agreements +could cause us to lose business at our hotels or lead to a default or acceleration of our obligations under certain of our debt instruments. +All +of our hotels are operated under franchise, management or operating lease agreements with franchisors or hotel management companies, such +as Marriott and Hilton. In general, under these arrangements, the franchisor or brand manager provides marketing services and room reservations +and certain other operating assistance, but requires us to pay significant fees to it and to maintain the hotel in a required condition. +If we fail to maintain these required standards, then the franchisor or hotel brand may terminate its agreement with us and obtain damages +for any liability we may have caused. Moreover, from time to time, we may receive notices from franchisors or the hotel brands regarding +our alleged non-compliance with the franchise agreements or brand standards, and we may disagree with these claims that we are not in +compliance. Any disputes arising under these agreements could also lead to a termination of a franchise, management or operating lease +agreement and a payment of liquidated damages. Such a termination may trigger a default or acceleration of our obligations under some +of our debt instruments. In addition, as our franchise, management or operating lease agreements expire, we may not be able to renew them +on favorable terms or at all. If we were to lose a franchise or hotel brand for a particular hotel, it could harm the operation, financing +or value of that hotel due to the loss of the franchise or hotel brand name, marketing support and centralized reservation system. Furthermore, +the loss of a franchise license at a particular hotel could harm our relationship with the franchisor or brand manager and cause us to +incur significant costs to obtain a new franchise license or brand management agreement for the particular hotel. Accordingly, if we lose +one or more franchise licenses or brand management agreements, it could materially and adversely affect our results of operations and +profitability as well as limit or slow our future growth. +Our hotels are geographically +concentrated and, accordingly, we could be disproportionately harmed by adverse changes to these markets, natural disasters, regulations, +or terrorist attacks. +Our +hotels are located in a single geographic market, which exposes us to greater risk to local economic or business conditions, changes in +hotel supply in this market, and other conditions than more geographically diversified hotel owners. An economic downturn, an increase +in hotel supply, a force majeure event, a natural disaster, changing weather patterns, a terrorist attack or similar event in this market +likely would cause a decline in the hotel market and adversely affect occupancy rates, the financial performance of our hotels and our +overall results of operations, which could be material, and could significantly increase our costs. +The need for business-related travel, and, +therefore, demand for rooms in our hotels may be adversely affected by the increased use of business-related technology. +During 2020 and into 2023, +the COVID-19 pandemic caused a significant decrease in business-related travel as companies turned to virtual meetings in order to protect +the health and safety of their employees. While business transient demand improved in 2022 as compared to 2020, it remains below pre-pandemic +levels. The increased use of teleconferencing and video-conference technology by businesses may continue in the future, which could result +in further decreases in business travel as companies become accustomed to the use of technologies that allow multiple parties from different +locations to participate in meetings without traveling to a centralized meeting location, such as our hotels. To the extent that such +technologies, or new technologies, play an increased role in day-to-day business interactions and the necessity for business-related travel +decreases, demand for hotel rooms may decrease and our hotels could be adversely affected. +Rising operating expenses or low occupancy +rates could reduce cash flow. +Our hotels, and any hotels +we may buy in the future, are and will be subject to operating risks common to the lodging industry in general. If any hotel is not occupied +at a level sufficient to cover our operating expenses, then we could be required to spend additional funds for that hotel’s operating +expenses. For example, during 2020 and into 2022, operations at many hotels were either temporarily suspended or reduced due to the COVID-19 +pandemic, and hotel owners were required to fund hotel payroll expenses, maintenance expenses, fixed hotel costs such as ground rent, +insurance expenses, property taxes and scheduled debt payments. Hotels may be subject to increases in real estate and other tax rates, +utility costs, operating expenses including labor and employee-related benefits, insurance costs, repairs and maintenance and administrative +expenses, which could reduce cash flow. +80 +Laws and governmental regulations may restrict +the ways in which we use our hotel properties and increase the cost of compliance with such regulations. Noncompliance with such regulations +could subject us to penalties, loss of value of our properties or civil damages. +Our hotel properties are subject +to various federal, state and local laws relating to the environment, fire and safety and access and use by disabled persons. Under these +laws, courts and government agencies have the authority to require us, if we are the owner of a contaminated property, to clean up the +property, even if we did not know of or were not responsible for the contamination. These laws also apply to persons who owned a property +at the time it became contaminated. In addition to the costs of cleanup, environmental contamination can affect the value of a property +and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property. Under such environmental +laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, such +as a landfill or an incinerator, pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment. +Furthermore, various court +decisions have established that third parties may recover damages for injury caused by property contamination. For instance, a person +exposed to asbestos while staying in or working at a hotel may seek to recover damages for injuries suffered. Additionally, some of these +environmental laws restrict the use of a property or place conditions on various activities. For example, some laws require a business +using chemicals (such as swimming pool chemicals at our hotels) to manage them carefully and to notify local officials that the chemicals +are being used. +We could be responsible for +the types of costs discussed above. The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental +laws could be material and could reduce the funds available for distribution to our stockholders. Future laws or regulations may impose +material environmental liabilities on us, or the current environmental condition of our hotel properties may be affected by the condition +of the properties in the vicinity of our hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated +to us. +Our hotel properties are also +subject to the Americans with Disabilities Act (“ADA”). Under the ADA, all public accommodations must meet various federal +requirements related to access and use by disabled persons. Compliance with the ADA’s requirements could require removal of access +barriers and non-compliance could result in the U.S. government imposing fines or in private litigants’ winning damages. If we are +required to make substantial modifications to our hotels, whether to comply with the ADA or other changes in governmental rules and +regulations, our financial condition and results of operations could be harmed. In addition, we are required to operate our hotel properties +in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental +agencies and become applicable to our properties. +Risks Related to Our Business and Industry - Overview +If we fail to anticipate and adequately respond +to rapid technological changes in our industry, including evolving industry-wide standards, in a timely and cost-effective manner, our +business, financial condition and results of operations would be materially and adversely affected. +The markets in which we operate +are characterized by technological changes. Such changes, including evolving industry standards, changes in customer requirements and +new product introductions and enhancements, could render our products obsolete. Accordingly, we are required to constantly monitor and +anticipate technological changes in our industry and develop new product offerings and technologies or adapt or modify our existing offerings +and technologies to keep pace with technological advances in our industry and remain competitive. +Our ability to implement our +business strategy and continue to grow our revenues will depend on a number of factors, including our continuing ability to: +● identify emerging technological trends in our current and target markets; +● identify additional uses for our existing technology to address customer needs in our current and future +markets; +● enhance our offerings by adding innovative features that differentiate our offerings from those of our +competitors; and +● design, develop, manufacture, assemble, test, market and support new products and enhancements in a timely +and cost-effective manner. +81 +We believe that, to remain +competitive in the future, we will need to continue to invest significant financial resources in developing new offerings and technologies +or to adapt or modify our existing offerings and technologies, including through internal research and development, strategic acquisitions +and joint ventures or other arrangements. However, these efforts may be more costly than we anticipate and there can be no assurance that +they will be successful. +If we are unable to identify, attract, train +and retain qualified personnel, especially our design and technical personnel, our business and results of operations would be materially +and adversely affected and we may not be able to effectively execute our business strategy. +Our performance and future +success largely depends on our continuing ability to identify, attract, train, retain and motivate qualified personnel, including our +management, sales and marketing, finance and in particular our engineering, design and technical personnel. For example, we currently +have limited number of qualified personnel for the assembling and testing processes. We do not know whether we will be able to retain +all these personnel as we continue to pursue our business strategy. Our engineering, design and technical personnel represent a significant +asset. The competition for qualified personnel in our industries is intense and constrains our ability to attract qualified personnel. +The loss of the services of one or more of our key employees, especially of our key engineering, design and technical personnel, or our +inability to attract, retain and motivate qualified personnel could have a material adverse effect on our business, financial condition +and operating results. +Our future results will depend on our ability +to maintain and expand our existing sales channels and to build out marketing, business development and sales functions for the operating +subsidiaries. +To grow our legacy businesses, +we must add new customers for our products in addition to retaining and increasing sales to our current customers. Currently, only Relec, +the operating subsidiary that we acquired in November 2020, has an effective sales force focused on establishing relationships with customers +that we expect to endure over time. In other subsidiaries, we have historically relied on key executives to drive growth through return +business with existing customers. Building out marketing, business development and sales functions in all operating subsidiaries is critical +to drive significant growth in line with our strategic plans. While we perform certain of these activities ourselves, we may contract +for marketing services to improve our websites, manage public relations and optimize our social media presence. Failure to recruit and +retain the business development and sale personnel to execute on outreach and capture of new business, or the failure of those new hires +or marketing services to perform as expected, will limit our ability to achieve our growth targets. +We are dependent upon our ability, and our +contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, +many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As +a result, there is a global shortage of certain electronic or mineral components, which may extend our production lead-time and our production +costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, +even worse, redesign some of our products to support currently available materials. Such redesign efforts may require certain regulatory +and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit +our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in +place, and issues may recur in the future. +In addition, some of our products +are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While we have had relationships +with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, +changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our +ability to manufacture our products. +We depend +upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the +quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon +a few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or cancel their +orders scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, diversions in +the capital spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for +our products, which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition +of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these +or other factors, a substantial decrease in our revenues would likely result. We are dependent on the electronic equipment industry, +and accordingly will be affected by the impact on that industry of current economic conditions. +82 +Substantially all of our existing +customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, +and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this +industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, +such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete +in certain markets or our ability to sustain our gross margins. +Our reliance on subcontract manufacturers to +manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant +manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture +our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing +costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures +on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing +components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our +subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition +to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations +or rescheduling of, orders or shipments, any of which would materially harm our business. +We outsource, and are dependent upon developer +partners for, the development of some of our custom design products. +We made an operational decision +to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the +custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer +specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where +the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability +to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +We face intense industry competition, price +erosion and product obsolescence, which, in turn, could reduce our profitability. +We operate in an industry +that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth +of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price +erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to +retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, +therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross +margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price +erosion in the future. +Our future results are dependent on our ability +to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell our products +through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and +distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as +with manufacturers’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered +into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business +with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which +would have an adverse effect on our revenues. +83 +We may not be able to procure necessary key +components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, +and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, +we may not have adequate supplies of inventory on hand to satisfy our customers' needs. Furthermore, during these periods of growth, our +suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that we require +to build products so that we can meet our customers' needs. Our inability to secure sufficient components to build products for our customers +could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for +certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail +to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong +inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect +on our gross margins and on our results of operations. +Although we depend on sales of our legacy products +for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large portion +of our sales have historically been attributable to our legacy products. However, these sales are declining. Although we are unable to +predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward +pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent +on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and +sell new products such as custom design and value-added products. We cannot assure you that we will be able to expand our customer base, +increase unit sales volumes of existing products or develop, introduce and/or sell new products. +Failure of our information technology infrastructure +to operate effectively could adversely affect our business. +We depend heavily on information +technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption +could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal +course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory +restrictions relating to our international sales. +Some of our products are subject +to International Traffic In Arms Regulation (“ITAR”), which are interpreted, enforced and administered by the U.S. Department +of State. ITAR regulation controls not only the export, import and trade of certain products specifically designed, modified, configured +or adapted for military systems, but also the export of related technical data and defense services as well as foreign production. Any +delays in obtaining the required export, import or trade licenses for products subject to ITAR regulation and rules could have a material +adverse effect on our business, financial condition, and/or operating results. In addition, changes in U.S. export and import laws that +require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could +cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions +or charges imposed by the U.S. or any other country on our international sales or foreign subsidiary could have a materially adverse effect +on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the +Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program (“FMF”). Any such future sales +would be subject to these regulations. Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial +condition, and/or operating results. +We depend on international operations for a +substantial majority of our components and products. +We purchase a substantial +majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, +and tested by subcontractors located outside the U.S. These activities are subject to the uncertainties associated with international +business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange +fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, +or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect +on our business, financial condition, and/or operating results. +84 +We depend on international sales for a portion of our revenues. +Sales to customers outside +of North America accounted for 19% and 37% of net revenues for the years ended December 31, 2022 and 2021, respectively, and we expect +that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks +of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts +receivable, and currency restrictions. In addition, GIGA supports our European and other international customers, distributors, and sales +representatives, and therefore is also subject to local regulation. International sales are also subject to the export laws and regulations +of the U.S. and other countries. +Because a significant portion of our revenues +and expenses is denominated in foreign currencies, fluctuations in exchange rates could have a material adverse effect on our operating +results. +We face foreign exchange risks +because a significant portion of our revenue and expenses is denominated in foreign currencies. Further, some suppliers to Enertec and +Relec require payment in U.S. dollars, which exposes us to risk. Generally, U.S. dollar strength adversely impacts the translation of +the portion of our revenue that is generated in foreign currencies into the U.S. dollar. For the years ended December 31, 2022 and +2021, approximately 16.9% and 35.9% of our revenue, respectively, was denominated in currencies other than U.S. dollars. Our results of +operations could also be negatively impacted by a strengthening of the U.S. dollar as a large portion of our costs are U.S. dollar denominated. +We also have foreign exchange risk exposure with respect to certain of our assets, that are denominated in currencies other than the functional +currency of our subsidiaries, and our financial results are affected by the re-measurement and translation of these non-U.S. currencies +into U.S. dollars, which is reflected in the effect of exchange rate changes on cash, cash equivalents, and restricted cash on the consolidated +statements of cash flows. For the years ended December 31, 2022 and 2021, the effects of exchange rates on our cash, cash equivalents, +and restricted cash totaled $0.9 million and $0.3 million, respectively, due to fluctuations in exchange rates and the strengthening of +the U.S. dollar. While we may choose to enter into transactions to hedge portions of our foreign currency translation and balance sheet +exposure in the future, it is impossible to predict or eliminate the effects of foreign exchange rate exposure. Strengthening of the U.S. +dollar could materially adversely affect our results of operations and financial condition. +Our insurance coverage and indemnity may be +insufficient to cover potential liabilities we may face due to the risks inherent in the products and services we provide. +We are exposed to liabilities +that are unique to the products and services we provide. A significant portion of our business relates to designing, developing and manufacturing, +components, integrated assemblies and subsystems for advanced defense, medical, transportation, industrial, technology and communications +systems and products. New technologies associated with these systems and products may be untested or unproven. Components of certain of +the defense systems and products we develop are inherently dangerous. Failures of satellites, missile systems, air traffic control systems, +homeland security applications and aircraft have the potential to cause loss of life and extensive property damage. In most circumstances, +we may receive indemnification from the government end users of our defense offerings in the U.S., the U.K. +and Israel. In addition, failures of products and systems that we manufacture or distribute for medical devices, transportation +controls or industrial systems also have the potential to result in loss of life, personal injury and/or extensive property damage. +While we maintain insurance +for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and we may be forced to +bear substantial costs from an accident or incident. It also is not possible for us to obtain insurance to protect against all operational +risks and liabilities. Substantial claims resulting from an incident in excess of government indemnity and our insurance coverage would +harm our financial condition, results of operations and cash flows. Moreover, any accident or incident for which we are liable, even if +fully insured, could negatively affect our standing with our customers and the public, thereby making it more difficult for us to compete +effectively, and could significantly impact the cost and availability of adequate insurance in the future. +If we are unable to satisfy our customers’ +specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be +harmed. +Our customers demand that +our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying +such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance +and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products +to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect +such required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense +and costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or +discounts, any of which would harm our business. +85 +Some +of our business is subject to U.S. Government procurement laws and regulations . +We +must comply with certain laws and regulations relating to the formation, administration and performance of federal government contracts. +These laws and regulations affect how we conduct business with our federal government contracts, including the business that we do as +a subcontractor. In complying with these laws and regulations, we may incur additional costs, and non-compliance may lead to the assessment +of fines and penalties, including contractual damages, or the loss of business. +Failure to comply with anti-bribery, anti-corruption, +anti-money laundering laws, and similar laws, or allegations of such failure, could have a material adverse effect on our business, financial +condition and operating results. +We are subject to various +anti-bribery, anti-corruption, anti-money laundering laws, including the U.S. Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”), +the U.S. Travel Act, the USA PATRIOT Act, the United Kingdom Bribery Act 2010, the Proceeds of Crime Act 2002, Chapter 9 (sub-chapter +5) of the Israeli Penal Law, 1977, the Israeli Prohibition on Money Laundering Law–2000, and possibly other similar laws in countries +outside of the U.S. in which we conduct our business. Anti-corruption and anti-bribery laws have been enforced aggressively in recent +years and are interpreted broadly to generally prohibit companies, their employees, agents, representatives, business partners, and third-party +intermediaries from authorizing, offering, or providing, directly or indirectly, improper payments or benefits to recipients in the public +or private sector. +We, our employees, agents, +representatives, business partners and third-party intermediaries may have direct or indirect interactions with officials and employees +of government agencies or state-owned or affiliated entities and may be held liable for the corrupt or other illegal activities of these +employees, agents, representatives, business partners or third-party intermediaries even if we do not explicitly authorize such activities. +These laws also require that +we keep accurate records and maintain internal controls and compliance procedures designed to prevent any such actions. While we have +policies and procedures to address compliance with such laws, we cannot assure you that none of our employees, agents, representatives, +business partners or third-party intermediaries will take actions in violation of our policies and applicable law, for which we may be +ultimately held responsible. In addition, we may be held liable for violations committed of the FCPA or similar foreign laws by companies +that we acquire. +Any alleged or actual violation +of the FCPA or other applicable anti-bribery, anti-corruption laws, and anti-money laundering laws could result in whistleblower complaints, +investigations, enforcement actions, fines and other criminal or civil sanctions, adverse media coverage, loss of export privileges, or +suspension or termination of government contracts. Responding to any investigation or enforcement action would require significant attention +of our management and resources, including significant defense costs and other professional fees. Failure to comply with anti-bribery, +anti-corruption, anti-money laundering laws, and similar laws, or allegations of such failure, could therefore have a material adverse +effect on our business, results of operations, financial condition and future prospects. +Compliance with the regulations, standards, +and contractual obligations promulgated by the European Union related to privacy, data protection, and data security, may cause Gresham +Power and Relec to incur additional expenses and failure to comply with such obligations could harm our business and future results of +operations. +The European Union General +Data Protection Regulation (“GDPR”) contains robust obligations on data “controllers” and data “processors” +with heavy documentation requirements for data protection compliance programs that apply to both Gresham Power and Relec. Among other +requirements, the GDPR regulates the transfer of personal data subject to the GDPR to third countries that have not been found to provide +adequate protection to such personal data, including the U.S. In the U.K., the GDPR requires informed consent for disclosure of names, +transfer of email addresses, the use of cookies and direct electronic marketing. The GDPR also imposes conditions on obtaining valid consent +to transfer of any personal data that Gresham Power or Relec collect or process. Failure to comply with the GDPR could result in penalties +for noncompliance (including possible fines of up to the greater of £8.7 million and 2% of our global annual revenue for the preceding +financial year for the violations, as well as the right to compensation for financial or non-financial damages claimed by individuals +under Article 82 of the GDPR). +The U.K. has enacted a Data +Protection Act substantially implementing the GDPR, effective in May 2018, which was further amended to align more substantially with +the GDPR following Brexit. The latest revisions of the GDPR in the U.K. post-Brexit have resulted in even more stringent restrictions +on the transfer of data about a person. Data considered in the public domain in the U.S. now falls within the protections of GDPR, which +complicates documenting business, marketing, sales outreach, securing infrastructure, audit and business management. +86 +Compliance with the regulations, +standards, and contractual obligations promulgated by the U.K. related to privacy, data protection, and data security, may cause Gresham +Power and Relec to incur additional expenses and failure to comply with such obligations could harm our business and future results of +operations. +Risks Related to Our Business and Industry - Microphase +Microphase has a history of losses and our +future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on our business and the value of our +company. +Microphase has incurred losses +from operations during 2019. These losses are attributable to lower volumes of its products sold to major defense contractors partially +as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. While Microphase has been profitable, +to a certain extent, during 2021 and 2022, there is always the possibility that its results of operations could worsen in the future, +whether as a result of new outbreaks of COVID-19, supply chain issues or any of a number of other factors. Since the financial crisis +of 2008, Microphase has been significantly short of capital needed to acquire parts for production of its products to complete orders +for such products. At times, Microphase has not had the cash available to make advance payments for the purchase of parts, and then, as +a consequence, Microphase would not receive the parts from its vendors required to finish a customer order. This would then delay the +delivery of products to customers, and would also delay recognition of the resulting revenues and the receipt of cash from the customer. +Sometimes after experiencing a delay in delivery of an order from Microphase, the customer would not place its next order with Microphase, +resulting in a loss of business. +Microphase’s future +profitability depends upon many factors, including several that are beyond its control. These factors include, without limitation: +● economic dislocation, supply chain disruption or mandated shutdowns attributable to the COVID-19 pandemic; +● changes in the demand for its products and services; +● loss of key customers or contracts; +● the introduction of competitive products; +● the failure to gain market acceptance of its new and existing products; and +● the failure to successfully and cost effectively develop, introduce and market new products, services +and product enhancements in a timely manner. +A large percentage of Microphase’s current +revenue is derived from prime defense contractors to the U.S. Government and its allies, and the loss of these relationships, a reduction +in U.S. Government funding or a change in U.S. Government spending priorities or bidding processes could have an adverse impact on its +business, financial condition, results of operations and cash flows. +Microphase is highly dependent on sales to major +defense contractors of the U.S. military and its allies, including Lockheed Martin, Raytheon, BAE Systems and SAAB. The percentages of +its revenue that were derived from sales to these named major defense contractors and directly to the U.S. Government were 69.4% in fiscal +2022 and 78.1% in fiscal 2021. Therefore, any significant disruption or deterioration of Microphase’s relationship with any such +major defense contractors or the U.S. Government could materially reduce its revenue. During the year ended December 31, 2022, there was +one customers that accounted for more than 10% of Microphase’s sales: BAE Systems. During the year ended December 31, 2021, there +were two customers that accounted for more than 10% of Microphase’s sales: BAE Systems and Lockheed Martin. Microphase’s competitors +continuously engage in efforts to expand their business relationships with the same major defense contractors and the U.S. Government +and will continue these efforts in the future, and the U.S. Government may choose to use other contractors. Microphase expects that a +majority of the business that it seeks will be awarded through competitive bidding. Microphase operates in highly competitive markets +and its competitors have more extensive or more specialized engineering, manufacturing and marketing capabilities than Microphase does +in many areas, and Microphase may not be able to continue to win competitively awarded contracts or to obtain task orders under multi-award +contracts. Further, the competitive bidding process involves significant cost and managerial time to prepare bids and proposals for contracts +that may not be awarded to Microphase, as well as the risk that Microphase may fail to accurately estimate the resources and costs required +to fulfill any contract awarded to us. Following any contract award, Microphase may experience significant expense or delay, contract +modification or contract rescission as a result of its competitors protesting or challenging contracts awarded to it in competitive bidding. +Major defense contractors to whom Microphase supplies components for systems must compete with other major defense contractors (to which +Microphase may not supply components) for military orders from the U.S. Government. +87 +In addition, Microphase competes +with other policy needs, which may be viewed as more necessary, for limited resources and an ever-changing amount of available funding +in the budget and appropriations process. Budget and appropriations decisions made by the U.S. Government are outside of Microphase control +and have long-term consequences for its business. U.S. Government spending priorities and levels remain uncertain and difficult to predict +and are affected by numerous factors, including until recently sequestration (automatic, across-the-board U.S. Government budgetary spending +cuts), and the purchase of our products could be superseded by alternate arrangements. While the US defense budget was recently increased, +there can be no assurance that this increase will be maintained for the foreseeable future, particularly in light of the recent federal +expenditures the federal government has made with a view to ameliorating the economic damage suffered as a result of COVID-19. A change +in U.S. Government spending priorities or an increase in non-procurement spending at the expense of our programs, or a reduction in total +U.S. Government spending, could have material adverse consequences on Microphase’s future business. +Microphase’s U.S. Government contracts +may be terminated by the federal government at any time prior to their completion, which could lead to unexpected loss of sales and reduction +in Microphase’s backlog. +Under the terms of Microphase’s +U.S. Government contracts, the U.S. Government may unilaterally: +● terminate or modify existing contracts; +● reduce the value of existing contracts through partial termination; and +● delay the payment of Microphase’s invoices by government payment offices. +The federal government can +terminate or modify any of its contracts with Microphase or its prime contractors either for the federal government’s convenience, +or if Microphase or its prime contractors default, by failing to perform under the terms of the applicable contract. A termination arising +out of Microphase’s default could expose it to liability and have a material adverse effect on its ability to compete for future +federal government contracts and subcontracts. If the federal government or its prime contractors terminate and/or materially modify any +of Microphase’s contracts or if any applicable options are not exercised, Microphase’s failure to replace sales generated +from such contracts would result in lower sales and would adversely affect its earnings, which could have a material adverse effect on +Microphase’s business, results of operations and financial condition. Microphase’s backlog as of December 31, 2022 was +approximately $10.1 million. Microphase’s backlog could be adversely affected if contracts are modified or terminated. +Microphase’s products with military applications +are subject to export regulations, and compliance with these regulations may be costly. +Microphase is required to +obtain export licenses before filling foreign orders for many of its products that have military or other governmental applications. U.S. +Export Administration regulations control technology exports like its products for reasons of national security and compliance with foreign +policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of a destination +country. Thus, any foreign sales of its products requiring export licenses must comply with these general policies. Compliance with these +regulations is costly, and these regulations are subject to change, and any such change may require Microphase to improve its technologies, +incur expenses or both in order to comply with such regulations. +Microphase depends on U.S. Government contracts +issued to major defense contractors, which often are only partially funded, subject to immediate termination, and heavily regulated and +audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could have an adverse impact +on Microphase’s business. +Over its lifetime, a U.S. +Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts and subcontracts. +The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts may be authorized and +appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year basis. Procurement funds are +typically made available for obligations over the course of one to three years. Consequently, programs often receive only partial funding +initially, and additional funds are designated only as Congress authorizes further appropriations. The termination of funding for a U.S. +Government program with respect to major defense contractors for which Microphase is a subcontractor would result in a loss of anticipated +future revenue attributable to that program, which could have an adverse impact on its operations. In addition, the termination of, or +failure to commit additional funds to, a program for which Microphase is a subcontractor could result in lost revenue and increase its +overall costs of doing business. +88 +Generally, U.S. Government +contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to Microphase’s +contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed +must be refunded. Microphase has recorded contract revenues based on costs Microphase expect to realize upon final audit. However, Microphase +does not know the outcome of any future audits and adjustments, and Microphase may be required to materially reduce its revenues or profits +upon completion and final negotiation of audits. Negative audit findings could also result in termination of a contract, forfeiture of +profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting or subcontracting for a period of +time. +In addition, U.S. Government +contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s +convenience upon the payment only for work done and commitments made at the time of termination. Microphase can give no assurance that +one or more of the U.S. Government contracts with a major defense contractor under which Microphase provides component products will not +be terminated under these circumstances. Also, Microphase can give no assurance that it will be able to procure new contracts to offset +the revenue or backlog lost as a result of any termination of its U.S. Government contracts. Because a significant portion of Microphase’s +revenue is dependent on its performance and payment under its U.S. Government contracts, the loss of one or more large contracts could +have a material adverse impact on its business, financial condition, results of operations and cash flows. +Microphase’s government +business also is subject to specific procurement regulations and other requirements. These requirements, though customary in U.S. Government +contracts, increase its performance and compliance costs. In addition, these costs might increase in the future, thereby reducing Microphase’s +margins, which could have an adverse effect on its business, financial condition, results of operations and cash flows. Failure to comply +with these regulations and requirements could lead to fines, penalties, repayments, or compensatory or treble damages, or suspension or +debarment from U.S. Government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various +laws, including those related to procurement integrity, export control, U.S. Government security regulations, employment practices, protection +of the environment, accuracy of records, proper recording of costs and foreign corruption. The termination of a U.S. Government contract +or relationship as a result of any of these acts would have an adverse impact on Microphase’s operations and could have an adverse +effect on its standing and eligibility for future U.S. Government contracts. +Microphase’s business could be negatively +impacted by cybersecurity threats and other security threats and disruptions. +As a U.S. Government defense +contractor, Microphase faces certain security threats, including threats to its information technology infrastructure, attempts to gain +access to its proprietary or classified information, threats to physical security, and domestic terrorism events. Microphase’s information +technology networks and related systems are critical to the operation of its business and essential to its ability to successfully perform +day-to-day operations. Microphase is also involved with information technology systems for certain customers and other third parties, +which generally face similar security threats. Cybersecurity threats, in particular, are persistent, evolve quickly and include, but are +not limited to, computer viruses, attempts to access information, denial of service and other electronic security breaches. Microphase +believes that it has implemented appropriate measures and controls and has invested in skilled information technology resources to appropriately +identify threats and mitigate potential risks, but there can be no assurance that such actions will be sufficient to prevent disruptions +to mission critical systems, the unauthorized release of confidential information or corruption of data. A security breach or other significant +disruption involving these types of information and information technology networks and related systems could: +● disrupt the proper functioning of these networks and systems and therefore its operations and/or those +of certain of its customers; +● result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of, proprietary, +confidential, sensitive or otherwise valuable information of Microphase or its customers, including trade secrets, which others could +use to compete against Microphase or for disruptive, destructive or otherwise harmful purposes and outcomes; +● compromise national security and other sensitive government functions; +● require significant management attention and resources to remedy the damages that result; +● subject Microphase to claims for breach of contract, damages, credits, penalties or termination; and +● damage Microphase’s reputation with its customers (particularly agencies of the U.S. Government) +and the public generally. +Any or all of the foregoing could have a negative +impact on its business, financial condition, results of operations and cash flows. Compliance with Defense Department requirements for +information security require Microphase to invest significant resources to implement and maintain cyber defenses against compromise of +information technology architecture, malicious attacks and data breaches. +89 +Microphase enters into fixed-price contracts +that could subject it to losses in the event of cost overruns or a significant increase in inflation. +Microphase has a number of +fixed-price contracts which allow it to benefit from cost savings but subject it to the risk of potential cost overruns, particularly +for firm fixed-price contracts, because Microphase assumes the entire cost burden. If its initial estimates are incorrect, Microphase +can lose money on these contracts. U.S. Government contracts can expose Microphase to potentially large losses because the U.S. Government +can hold Microphase responsible for completing a project or, in certain circumstances, paying the entire cost of its replacement by another +provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. Because many of these +contracts involve new technologies and applications, unforeseen events such as technological difficulties, fluctuations in the price of +raw materials, problems with its suppliers and cost overruns, can result in the contractual price becoming less favorable or even unprofitable +to Microphase. The U.S. and other countries also may experience a significant increase in inflation. A significant increase in inflation +rates could have a significant adverse impact on the profitability of these contracts. Furthermore, if Microphase does not meet contract +deadlines or specifications, Microphase may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated +damages or suffer major losses if the customer exercises its right to terminate. In addition, some of its contracts have provisions relating +to cost controls and audit rights, and if Microphase fails to meet the terms specified in those contracts Microphase may not realize their +full benefits. Microphase’s results of operations are dependent on its ability to maximize its earnings from its contracts. Cost +overruns could have an adverse impact on its financial results. +Compliance with the regulations, standards, +and contractual obligations related to privacy, data protection, and data security, may cause us to incur additional expenses and failure +to comply with such obligations could harm our business and future results of operations. +We expect that the regulatory +framework for privacy, data protection and data security will continue to evolve, which may result in additional operating costs for internal +compliance and risks to our business. Nearly all of Microphase’s current contracts include provisions that require compliance with +detailed cyber security standards laid out in NIST 800-171, which mandates implementation of security controls to protect Microphase’s +information systems from compromise, malicious attacks and/or data breaches. Microphase must maintain a System Security Plan with a Plan +of Action & Milestones for any controls not yet implemented. To continue doing business with the DoD or major prime contractors working +with DoD, Microphase must ultimately achieve Cybersecurity Model Maturity Certification not later than 2026. In addition, Microphase maintains +a certified restricted area and must obtain and maintain authority to operate equipment to perform work on classified projects. Compliance +with all of these mandates will require Microphase to invest substantial resources to implement, maintain and monitor information systems +security controls, facility clearances, personnel clearance and authorities to operate classified systems, which adds to the costs of +operating the business. +Risks Related to Our Business and Industry - Enertec +Potential political, economic and military instability in +Israel could adversely affect our operations. +A significant portion of our +business is conducted through Enertec, our Israeli subsidiary. Accordingly, political, economic and military conditions in Israel and +the surrounding region may directly affect our Israeli operations. In recent years, Israel has been involved in sporadic armed conflicts +with Hamas, an Islamist terrorist group that controls the Gaza Strip, with Hezbollah, an Islamist terrorist group that controls large +portions of Southern Lebanon, and with Iranian-backed military forces in Syria. Some of these hostilities were accompanied by missile +strikes from the Gaza Strip against civilian targets in various parts of Israel, including areas in which our facilities are located, +and negatively affected business conditions in Israel. The change in the U.S. Presidency may continue to change the dynamics in the Middle +East as forces hostile to the existence of Israel seek to reverse the recent stability and commercial opportunities created by the Abraham +Accords. For example, there have been increasing concerns related to a potential attack by Iran. The tension between Israel and Iran and/or +these groups may escalate in the future and turn even more violent, which could affect the Israeli economy in general and us in particular. +A deterioration in the political and security situation in Israel (for example, the significant instability with regards to changes promoted +by the Israeli government in the judiciary branch) may have a negative effect on Israel’s economic situation and on Enertec’s +ability to execute new projects, to raise funding for its operations and plans. +Our commercial insurance +does not cover losses that may occur as a result of events associated with war and terrorism. Although the Israeli government currently +covers the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this +government coverage will be maintained or that it will sufficiently cover our potential damages. Any losses or damages incurred by us +could have a material adverse effect on our business. +90 +In addition, Israel-based +companies and companies doing business with Israel have been the subject of an economic boycott by members of the Arab League and certain +other predominantly Muslim countries since Israel’s establishment. Although Israel has entered into various agreements with certain +Arab countries and the Palestinian Authority, and various declarations have been signed in connection with efforts to resolve some of +the economic and political problems in the Middle East, we cannot predict whether or in what manner these problems will be resolved. Wars +and acts of terrorism have resulted in significant damage to the Israeli economy, including reducing the level of foreign and local investment. +Many of our Enertec employees are obligated +to perform military reserve duty in Israel, which could have a disruptive impact on our business. +Generally, Israeli adult male +and certain female citizens and permanent residents are obligated to perform annual military reserve duty in the Israel Defense Forces +up to a specified age. They also may be called to active military duty at any time under emergency circumstances. These military service +obligations could have a disruptive impact on our business, if hostilities develop in the future. +Enertec may become subject to claims for remuneration +or royalties for assigned service invention rights by its employees, which could result in litigation and harm our business. +A significant portion of the +intellectual property covered by Enertec’s products has been developed by Enertec’s employees in the course of their employment +for Enertec. Under the Israeli Patent Law, 5727-1967, or the Patent Law, and recent decisions by the Israeli Supreme Court and the Israeli +Compensation and Royalties Committee, a body constituted under the Patent Law, Israeli employees may be entitled to remuneration for intellectual +property that they develop for us unless they explicitly waive any such rights. To the extent that Enertec is unable to enter into agreements +with its future employees pursuant to which they agree that any inventions created in the scope of their employment or engagement are +owned exclusively by Enertec (as it has done in the past), Enertec may face claims demanding remuneration. As a consequence of such claims, +Enertec could be required to pay additional remuneration or royalties to its current and former employees, or be forced to litigate such +claims, which could negatively affect its business. +Risks Related to Our Business and Industry – Relec +The third parties on which we rely to supply +certain products are located outside the United States. +Relec distributes products +from foreign manufacturers located in Europe, Asia and North America. Our future operating results will depend, among other things, on +our ability to continue to rely on these arrangements. If we are no longer able to rely on these or other similar arrangements for the +supply of certain products, or if our cost of relying on such arrangements materially increases, as the result of the imposition of or +changes in customs, tariffs, quotas, trade barriers, or other trade protection measures, or otherwise, it could have a materially adverse +effect on our business, financial condition, and operating results. +Our strategic focus on our custom power supply +and display solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic +focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power +supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s +requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards +may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction +of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply +solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a +series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may +not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market +or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, +including those involving our personnel, which may negatively impact quarterly earnings and profitability as we account for severance +and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing +our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, +limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire +and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +91 +Risks Related to Ownership of Our +Common Stock and Future Offerings +If we do not continue +to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +The +listing of our common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for continued +listing. While we are presently in compliance with all such conditions, it is possible that we will fail to meet one or more of these +conditions in the future. +If +we were to fail to meet a NYSE American listing requirement, we may be subject to delisting by the NYSE American. In the event our common +stock is no longer listed for trading on the NYSE American, our trading volume and share price may decrease and we may experience further +difficulties in raising capital which could materially affect our operations and financial results. Further, delisting from the NYSE American +could also have other negative effects, including potential loss of confidence by partners, lenders, suppliers and employees and could +also trigger various defaults under our lending agreements and other outstanding agreements. Finally, delisting could make it harder for +us to raise capital and sell securities. You may experience future dilution as a result of future equity offerings. In order to raise +additional capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable +for our common stock at prices that may not be the same as the price per share in this offering. We may sell shares or other securities +in any other offering at a price per share that is less than the price per share paid by investors in this offering, and investors purchasing +shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional +shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower +than the price per share paid by investors in this offering. +You may experience future dilution as a result of future equity +offerings. +In order to raise additional +capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable for our +common stock at prices that may not be the same as the price per share in this offering. We may sell shares or other securities in any +other offering at a price per share that is less than the price per share paid by investors in this offering, and investors purchasing +shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional +shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower +than the price per share paid by investors in this offering. +Our common stock price is volatile. +Our common stock is listed on the NYSE American. In the past, our trading +price has fluctuated widely, depending on many factors that may have little to do with our operations or business prospects. During the +past 52-week period (through March __, 2023), our stock closed at prices between $1.34 per share and $0.09 per share, as reported on Nasdaq.com. +On April 14, 2023, the price of our common stock closed at $0.105 per share. +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our common stock may continue +to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, coupled with +depressed economic conditions, could continue to have a depressive effect on the market price of our common stock. The following factors, +many of which are beyond our control, may influence our stock price: +· the status of our growth strategy including the development of new products with any proceeds we may be +able to raise in the future; +· announcements of technological or competitive developments; +· announcements or expectations of additional financing efforts; +· our ability to market new and enhanced products on a timely basis; +· changes in laws and regulations affecting our business; +· commencement of, or involvement in, litigation involving us; +· regulatory developments affecting us, our customers or our competitors; +· announcements regarding patent or other intellectual property litigation or the issuance of patents to +us or our competitors or updates with respect to the enforceability of patents or other intellectual property rights generally in the +US or internationally; +· actual or anticipated fluctuations in our quarterly financial results or the quarterly financial results +of companies perceived to be similar to us; +92 +· changes in the market’s expectations about our operating results; +· our operating results failing to meet the expectations of securities analysts or investors in a particular +period; +· changes in the economic performance or market valuations of our competitors; +· additions or departures of our executive officers; +· sales or perceived sales of our common stock by us, our insiders or our other stockholders; +· share price and volume fluctuations attributable to inconsistent trading volume levels of our shares; +and +· general economic, industry, political and market conditions and overall fluctuations in the financial +markets in the United States and abroad, including as a result of ongoing COVID-19 pandemic. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock +and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of a company’s +securities, stockholders have often instituted securities class action litigation against that company. If we were involved in a class +action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense +and, whether or not adversely determined, have a material adverse effect on our business, financial condition, results of operations and +prospects. +Volatility in our common stock price may subject us to securities +litigation. +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our common stock may continue +to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, coupled with +depressed economic conditions, could have a depressing effect on the market price of our common stock. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock +and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of a company’s +securities, stockholders have often instituted securities class action litigation against that company. If we were involved in a class +action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense +and, whether or not adversely determined, have a material adverse effect on our business, financial condition, results of operations and +prospects. +We have a substantial +number of convertible notes, warrants, options and preferred stock outstanding that could affect our price. +Due to a number of financings, we have a substantial number of shares +that are subject to issuance pursuant to outstanding convertible debt, warrants and options. As +of the date of this annual report, the number of shares of common stock subject to convertible notes, warrants, options and Series +B Convertible Preferred Stock were 165,000, 15,525,581, 5,810,844 and 2,232 respectively. We had outstanding options to purchase an aggregate +of 5,810,844 shares of Common Stock, with a weighted average exercise price of $2.40 per share, exercisable at prices ranging from $1.79 +to $1,352 per share and warrants to purchase up to 15,525,581 shares of common stock, with a weighted average exercise price of 1.99 per +share, at exercise prices ranging from $0.40 to $1,040 per share. The issuance of common stock pursuant to convertible notes, warrants, +options and preferred stock at conversion or exercise prices less than market prices may have the effect of limiting an increase in market +price of our common stock until all of these underling shares have been issued. +A possible “short squeeze” due to a sudden increase +in demand of our common stock that largely exceeds supply may lead to price volatility in our common stock. +Investors may purchase our +common stock to hedge existing exposure in our common stock or to speculate on the price of our common stock. Speculation on the price +of our common stock may involve long and short exposures. To the extent aggregate short exposure exceeds the number of shares of our common +stock available for purchase in the open market, investors with short exposure may have to pay a premium to repurchase our common stock +for delivery to lenders of our common stock. Those repurchases may in turn, dramatically increase the price of our common stock until +investors with short exposure are able to purchase additional common shares to cover their short position. This is often referred to as +a “short squeeze.” A short squeeze could lead to volatile price movements in our common stock that are not directly correlated +to the performance or prospects of our company and once investors purchase the shares of common stock necessary to cover their short position +the price of our common stock may decline. +93 +The issuance of shares of our Class B common +stock to our management or others could provide such persons with voting control leaving our other stockholders unable to elect our directors +and the holders of our shares of common stock will have little influence over our management. +Although there are currently +no shares of our Class B common stock issued and outstanding, our certificate of incorporation authorizes the issuance of 25 million shares +of Class B common stock. Each share of Class B common stock provides the holder thereof with ten votes on all matters submitted to a stockholder +vote. Our certificate of incorporation does not provide for cumulative voting for the election of directors. Any person or group who controls +or can obtain more than 50% of the votes cast for the election of each director will control the election of directors and the other stockholders +will not be able to elect any directors or exert any influence over management decisions. As a result of the super-voting rights of our +shares of Class B common stock, the issuance of such shares to our management or others could provide such persons with voting control +and our other stockholders will not be able to elect our directors and will have little influence over our management. While we are listed +on the NYSE American or any other national securities exchange it is highly unlikely that we would issue any shares of Class B common +stock as doing so would jeopardize our continued listing on any such exchange. However, if were to be delisted for some other reason and +our shares of Class A common stock trade on an over-the-counter market, then we would face no restriction on issuing shares of Class B +common stock. +General Risk Factors +Our limited operating history makes it difficult +to evaluate our future business prospects and to make decisions based on our historical performance . +Although our executive officers +have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our current business +until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate our business on the +basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future results based upon our historical +data. Reliance on our historical results may not be representative of the results we will achieve, and for certain areas in which we operate, +principally those unrelated to defense contracting, will not be indicative at all. Because of the uncertainties related to our lack of +historical operations, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in sales, product costs +or expenses. If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, +which may result in a decline in our stock price. +Deterioration of global economic conditions +could adversely affect our business . +The global economy and capital +and credit markets have experienced exceptional turmoil and upheaval over the past several years. Ongoing concerns about the systemic +impact of potential long-term and widespread recession and potentially prolonged economic recovery, volatile energy costs, fluctuating +commodity prices and interest rates, volatile exchange rates, geopolitical issues, including the recent outbreak of armed conflict in +Ukraine, natural disasters and pandemic illness, instability in credit markets, cost and terms of credit, consumer and business confidence +and demand, a changing financial, regulatory and political environment, and substantially increased unemployment rates have all contributed +to increased market volatility and diminished expectations for many established and emerging economies, including those in which we operate. +Furthermore, austerity measures that certain countries may agree to as part of any debt crisis or disruptions to major financial trading +markets may adversely affect world economic conditions and have an adverse impact on our business. These general economic conditions could +have a material adverse effect on our cash flow from operations, results of operations and overall financial condition. +The availability, cost and +terms of credit also have been and may continue to be adversely affected by illiquid markets and wider credit spreads. Concern about +the stability of the markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors +to reduce credit to businesses and consumers. These factors have led to a decrease in spending by businesses and consumers over the past +several years, and a corresponding slowdown in global infrastructure spending. +94 +Continued uncertainty in the +U.S. and international markets and economies and prolonged stagnation in business and consumer spending may adversely affect our liquidity +and financial condition, and the liquidity and financial condition of our customers, including our ability to access capital markets and +obtain capital lease financing to meet liquidity needs. +No assurance of successful expansion of operations. +Our significant increase in +the scope and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher operating +expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make significant demands +on our management, finances and other resources. Our ability to manage the anticipated future growth, should it occur, will depend upon +a significant expansion of our accounting and other internal management systems and the implementation and subsequent improvement of a +variety of systems, procedures and controls. We cannot assure that significant problems in these areas will not occur. Failure to expand +these areas and implement and improve such systems, procedures and controls in an efficient manner at a pace consistent with our business +could have a material adverse effect on our business, financial condition and results of operations. We cannot assure that attempts to +expand our marketing, sales, manufacturing and customer support efforts will succeed or generate additional sales or profits in any future +period. As a result of the expansion of our operations and the anticipated increase in our operating expenses, along with the difficulty +in forecasting revenue levels, we expect to continue to experience significant fluctuations in its results of operations. +If we fail to establish and maintain an effective +system of internal control over financial reporting, we may not be able to report our financial results accurately or prevent fraud. Any +inability to report and file our financial results accurately and timely could harm our reputation and adversely impact the trading price +of our common stock. +Effective internal control +over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial +reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, +and our business and reputation with investors may be harmed. As a result, our small size and any current internal control deficiencies +may adversely affect our financial condition, results of operations and access to capital. We have carried out an evaluation under the +supervision and with the participation of our management, including our principal executive officer and principal financial officer, of +the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent period covered +by this report. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure +controls and procedures were not effective at the reasonable assurance level due to the material weakness described below. +A material weakness is a deficiency, +or a combination of deficiencies, within the meaning of Public Company Accounting Oversight Board (“PCAOB”) Audit Standard +No. 5, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual +or interim financial statements will not be prevented or detected on a timely basis. Management has identified the following material +weakness which has caused management to conclude that as of December 31, 2022, our internal control over financial reporting (“ICFR”) +was not effective at the reasonable assurance level. +We do not have sufficient +resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial +reporting, including fair value estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting +duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, +the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of +our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the resulting +control deficiency represented a material weakness. +We are currently working to +improve and simplify our internal processes and implement enhanced controls to address the material weakness in our internal control over +financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. This material weakness will not be considered +to be remediated until the applicable remediated controls are operating for a sufficient period of time and management has concluded, +through testing, that these controls are operating effectively. +If our accounting +controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We +evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and annually review and evaluate our internal control +over financial reporting in order to comply with the Commission’s rules relating to internal control over financial reporting adopted +pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent +or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls +may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such +internal control, we may be subject to regulatory sanctions, and our reputation may decline. +95 +Our internal computer +systems may fail or suffer security breaches, which could result in a material disruption of our operations . +Like +any other business, we rely on e-mail and other digital communications methods as part of our normal operations. As such, our internal +computer systems and servers could fail or suffer security breaches, possibly resulting in a material disruption to our operations. The +secure operation of our IT networks and systems as well as the secure processing and maintenance of information is critical to our operations +and business strategy. Notwithstanding these priorities, we have experienced attempts at cybercrime such as phishing and other electronic +fraud, including efforts to misdirect payments to imposter vendors and service providers. After experiencing a financial loss due to e-mail +fraud in November 2021, we have instituted greater internal controls and procedures, both electronic and non-electronic, to combat such +fraudulent conduct. We also maintain an insurance policy to cover any losses or injuries suffered from cybercrime of this nature; however, +it may not be sufficient to cover all damages. Despite our efforts, attempts at fraud such as spoofed e-mails, requests for payment and +similar deceptions have become commonplace in the world of e-commerce and are expected to continue. If we are unable to prevent such security +breaches in the future, these events or circumstances could materially and adversely affect our operations, financial condition and operating +results and impair our ability to execute our business strategy. +We face significant competition, including changes in pricing. +The markets for our products +are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing resources, plus +experience in research and development, and compete with us by offering lower prices. Competitors could develop new technologies that +compete with our products to achieve a lower unit price. If a competitor develops lower cost and/or superior technology or cost-effective +alternatives to our products and services, our business could be seriously harmed. +The markets for some of our +products are also subject to specific competitive risks because these markets are highly price sensitive. Our competitors have competed +in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering our prices. This would +reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also impact sales and aggravate +losses. +Many of our competitors are larger and have +greater financial and other resources than we do. +Our products compete and will +compete with similar if not identical products produced by our competitors. These competitive products could be marketed by well-established, +successful companies that possess greater financial, marketing, distribution personnel, and other resources than we do. Using said resources, +these companies can implement extensive advertising and promotional campaigns, both generally and in response to specific marketing efforts +by competitors. They can introduce new products to new markets more rapidly. In certain instances, competitors with greater financial +resources may be able to enter a market in direct competition with us, offering attractive marketing tools to encourage the sale of products +that compete with our products or present cost features that consumers may find attractive. +Our growth strategy is subject to a significant +degree of risk. +Our +growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition +targets or made a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. Therefore, +we may lose our investment in the event that these companies’ businesses do not develop as planned or that they are unable to achieve +the anticipated cost efficiencies or reduction of losses. +Further, +in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement our +plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that provide +revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development and investments +will produce sufficient revenues to offset these increases in expenditures. +96 +Our business and operations are growing rapidly. +If we fail to effectively manage our growth, our business and operating results could be harmed . +We have experienced, and may +continue to experience, rapid growth in our operations. This has placed, and may continue to place, significant demands on our management, +operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products and services could suffer, +which could negatively affect our operating results. To effectively manage our growth, we must continue to improve our operational, financial +and management controls and reporting systems and procedures. These systems improvements may require significant capital expenditures +and management resources. Failure to implement these improvements could hurt our ability to manage our growth and our financial position. +Our operating results may vary from quarter to quarter. +Our operating results have +in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in +magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products +in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or +fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven +by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you +that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of +large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, +and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. +The loss or deferral of one or more significant sales in a quarter could harm our operating results for such quarter. It is possible that, +in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the +event adverse conditions prevail, the market price of our common stock may decline significantly. +Changes in the U.S. tax and other laws and regulations may adversely +affect our business. +The U.S. Government may revise +tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, including modifications +that could reduce the profits that we can effectively realize from our international operations, or that could require costly changes +to those operations, or the way in which they are structured. For example, the effective tax rates for most U.S. companies reflect the +fact that income earned and reinvested outside the U.S. is generally taxed at local rates, which may be much lower than U.S. tax rates. +If we expand abroad and there are changes in tax laws, regulations or interpretations that significantly increase the tax rates on non-U.S. +income, our effective tax rate could increase and our profits could be reduced. If such increases resulted from our status as a U.S. company, +those changes could place us at a disadvantage to our non-U.S. competitors if those competitors remain subject to lower local tax rates. +Our sales and profitability may be affected by changes in +economic, business and industry conditions . +If the economic climate in +the U.S. or abroad deteriorates, customers or potential customers could reduce or delay their technology investments. Reduced or delayed +technology and entertainment investments could decrease our sales and profitability. In this environment, our customers may experience +financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and professional services. +This may lead to longer sales cycles, delays in purchase decisions, payment and collection, and can also result in downward price pressures, +causing our sales and profitability to decline. In addition, general economic uncertainty and general declines in capital spending in +the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and the markets +we serve. There are many other factors which could affect our business, including: +· The introduction and market acceptance of new technologies, products and services; +· New competitors and new forms of competition; +· The size and timing of customer orders (for retail distributed physical product); +· The size and timing of capital expenditures by our customers; +· Adverse changes in the credit quality of our customers and suppliers; +· Changes in the pricing policies of, or the introduction of, new products and services by us or our competitors; +· Changes in the terms of our contracts with our customers or suppliers; +· The availability of products from our suppliers; and +· Variations in product costs and the mix of products sold. +97 +These trends and factors could adversely affect +our business, profitability and financial condition and diminish our ability to achieve our strategic objectives. +The sale of our products is dependent upon +our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively +narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance +by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to +satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our +ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, +and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, +including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place +of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products +and adversely affect the revenues from such products. +Our limited ability to protect our proprietary +information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property +rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist +entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, +trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual +property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior +to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent +as the laws of the U.S. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, +we may be required to institute legal proceedings, which would be costly and would divert our resources from the development of our business. +If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results +could be adversely affected. +Although we attempt to avoid +infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and +claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party +proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require +us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to +us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the U.S. +or abroad. +If we ship products that contain defects, the +market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, +and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have +been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, +error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, +resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In +addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the +use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. +Although we maintain product liability insurance, it may not be adequate. +The rights of the holders of common stock may +be impaired by the potential issuance of preferred stock. +Our certificate of incorporation +gives our Board the right to create new series of preferred stock. As a result, the Board may, without stockholder approval, issue preferred +stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting power and equity interest +of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote per share, could be utilized +as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect +the price of our common stock. We may issue shares of preferred stock in the future. +98 +The requirements of being a public company +may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company and +subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among other +things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act +requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial reporting. +For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of our internal controls +structure and procedures for financial reporting. Section 404 compliance may divert internal resources and will take a significant +amount of time and effort to complete. If we fail to maintain compliance under Section 404, or if our internal control over financial +reporting continues to not be effective as defined under Section 404, we could be subject to sanctions or investigations by the NYSE +American, the Commission, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could +cause a decline in the market price of our common stock. Any failure of our internal controls could have a material adverse effect on +our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could +harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent +auditors. We may need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing +obligations as a public company, particularly if we become fully subject to Section 404 and its auditor attestation requirements, which +will increase costs. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives +and to meeting the obligations that are associated with being a public company, which may divert attention from other business concerns, +which could have a material adverse effect on our business, financial condition and results of operations. +We have identified material weaknesses in our +internal control over financial reporting and may identify additional material weaknesses in the future or otherwise fail to maintain +an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to +meet our periodic reporting obligations. +We are required to comply +with certain provisions of Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”). Section 404 requires that +we document and test our internal control over financial reporting and issue management’s assessment of our internal control over +financial reporting. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2021. In +making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) +in Internal Control — Integrated Framework. A material weakness is a deficiency, or a combination of deficiencies, in internal control +over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial +statements will not be prevented or detected on a timely basis. Based on our assessment, as of December 31, 2021, we concluded that our +internal control over financial reporting contained material weaknesses. +The weakness will not be considered +remediated, however, until the applicable controls operate for a sufficient period of time and our management has concluded, through testing, +that these controls are operating effectively. If we fail to comply with the requirements of Section 404 of the Sarbanes-Oxley Act, the +accuracy and timeliness of the filing of our annual and quarterly reports may be materially adversely affected and could cause investors +to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock. +In addition, a material weakness in the effectiveness of our internal control over financial reporting could result in an increased chance +of fraud and the loss of customers, reduce our ability to obtain financing and require additional expenditures to comply with these requirements, +each of which could have a material adverse effect on our business, results of operations and financial condition. +If we fail to comply with the rules under +the Sarbanes-Oxley Act of 2002 related to accounting controls and procedures, or if we discover material weaknesses and deficiencies in +our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more difficult. +If we fail to comply with +the rules under the Sarbanes-Oxley Act of 2002 related to disclosure controls and procedures, or, if we discover material weaknesses +and other deficiencies in our internal control and accounting procedures, our stock price could decline significantly and raising capital +could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our +internal control over financial reporting. If material weaknesses or significant deficiencies are discovered or if we otherwise fail +to achieve and maintain the adequacy of our internal control, we may not be able to ensure that we can conclude on an ongoing basis that +we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, +effective internal controls are necessary for us to produce reliable financial reports and are important to helping prevent financial +fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors +could lose confidence in our reported financial information, and the trading price of our common stock could drop significantly. +99 +If securities or industry analysts do not publish +research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading +volume could decline. +The trading market for our +common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. Our +research coverage by industry and financial analysts is currently limited. Even if our analyst coverage increases, if one or more of the +analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our +company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock +price or trading volume to decline. +The elimination of monetary liability against +our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, officers +and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees. +Our certificate of incorporation +contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders for damages for the +breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have contractual indemnification +obligations under any future employment agreements with our officers. The foregoing indemnification obligations could result in us incurring +substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. +These provisions and the resulting costs may also discourage us from bringing a lawsuit against directors and officers for breaches of +their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and +officers even though such actions, if successful, might otherwise benefit us and our stockholders. +We do not anticipate paying dividends on our +common stock and, accordingly, stockholders must rely on stock appreciation for any return on their investment. +We have never declared or +paid cash dividends on our common stock and do not expect to do so in the foreseeable future. The declaration of dividends is subject +to the discretion of our Board and will depend on various factors, including our operating results, financial condition, future prospects +and any other factors deemed relevant by our Board. You should not rely on an investment in our company if you require dividend income +from your investment in our company. The success of your investment will likely depend entirely upon any future appreciation of the market +price of our common stock, which is uncertain and unpredictable. There is no guarantee that our common stock will appreciate in value. +ITEM 1B. UNRESOLVED STAFF COMMENTS +Because we are a smaller reporting company, this +section is not applicable. +ITEM 2. PROPERTIES +Our corporate headquarters +office utilizes 9,560 square feet of leased office space in Las Vegas, Nevada. One of our Las Vegas leases commenced in January 2021, +expired in December 2022, and is currently leased on a month-to-month basis. Our other Las Vegas lease commenced in August 2021 and expires +in August 2024. The annual base rent under the leases, payable on a monthly basis, was approximately $0.3 million during 2022. +We also lease additional corporate +offices in Costa Mesa, California and New York, New York. Our leases expire between April 2023 and December 2024. The annual base rent +under the leases, payable on a monthly basis, was approximately $0.3 million during 2022. +We own a 617,000 square foot +data center in Dowagiac, Michigan, in which we operate our cryptocurrency mining operations for our BNI segment, in addition to renting +commercial office and warehouse space. +Our GIGA segment leases 47,771 +square feet of office, engineering, laboratory and warehouse space in Scottsdale, Arizona, Shelton, Connecticut and Dublin, California. +Our leases expire between August 2023 and May 2026. The annual base rent under the leases, payable on a monthly basis, was approximately +$0.5 million during 2022. Our GIGA segment also leases 65,390 square feet of office and manufacturing space internationally in Salisbury, +United Kingdom, Dorset, United Kingdom, and Karmeil, Israel. The annual base rent, payable on a monthly basis, was approximately $0.5 +million in 2022. The leases expire between September 2024 and May 2031. +100 +Our TurnOnGreen segment leases +39,965 square feet of office, engineering, laboratory and warehouse space in two locations in Milpitas, California. Our leases expire +between November 2024 and January 2026. The annual base rent under the leases, payable on a monthly basis, was approximately $0.5 million +during 2022. +Our SMC segment leases 92,500 +square feet of office and warehouse space in Ft. Lauderdale, Florida and Ontario, California. Our leases expire between August 2023 and +March 2024. The annual base rent under the leases, payable on a monthly basis, was approximately $93,000 during 2022. +Our AGREE segment owns and +operates three hotels in Middleton, Wisconsin, a hotel and undeveloped land in Rockford, Illinois, all of which are subject to a mortgage, +and a parcel of land in St. Peterburg, Florida. +Our Energy segment crane rental +business leases 27,909 of commercial buildings and 10 acres of land in Carthage, Texas,Clinton, Oklahoma, Houston, Texas, and Robstown, +Texas. Our leases expire between March 2024 and April 20227. The annual base rent under the leases, payable on a monthly basis, was approximately +$23,000 in 2022. +We currently anticipate that the current leased +space will be sufficient to support our current and foreseeable future needs. +ITEM 3. LEGAL PROCEEDINGS +Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory and government +investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, suits, regulatory +and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable +that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss +or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could +affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and +make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount +of a loss related to such matters. +With respect to our other +outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either +individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, +or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. +Blockchain Mining Supply and Services, Ltd. +On November 28, 2018, Blockchain +Mining Supply and Services, Ltd. (“Blockchain Mining”) a vendor who sold computers to our subsidiary, filed a Complaint (the +“Complaint”) in the United States District Court for the Southern District of New York against us and our subsidiary, Digital +Farms, Inc. (f/k/a Super Crypto Mining, Inc.), in an action captioned Blockchain Mining Supply and Services, Ltd. v. Super Crypto Mining, +Inc. and DPW Holdings, Inc. , Case No. 18-cv-11099. +The Complaint asserts claims +for breach of contract and promissory estoppel against us and our subsidiary arising from the subsidiary’s alleged failure to honor +its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $1.4 million, plus attorneys’ fees +and costs. +Based on our assessment of +the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, we cannot reasonably estimate the +potential loss or range of loss that may result from this action. Notwithstanding, we have established a $1.3 million reserve, the amount +of the unpaid portion of the purchase agreement, which is included in accounts payable and accrued expenses. An unfavorable outcome may +have a material adverse effect on our business, financial condition and results of operations. +101 +Ding Gu (a/k/a Frank Gu) and Xiaodan Wang Litigation +On January 17, 2020, Ding +Gu (a/k/a Frank Gu) (“Gu”) and Xiaodan Wang (“Wang” and with “Gu” collectively, “Plaintiffs”), +filed a Complaint (the “Complaint”) in the Supreme Court of the State of New York, County of New York against us and our Chief +Executive Officer, Milton C. Ault, III, in an action captioned Ding Gu (a/k/a Frank Gu) and Xiaodan Wang v. DPW Holdings, Inc. and +Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd Ault) , Index No. 650438/2020. +The Complaint asserts causes +of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent injunction, +enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions entered into +between Gu and us, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs and DPW, in or +about July 2019. The Complaint seeks, among other things, monetary damages in excess of $1.1 million, plus a decree of specific performance +directing DPW to deliver unrestricted shares of DPW’s common stock to Gu, plus attorneys’ fees and costs. +On or about November +28, 2022, we and Plaintiffs entered into a stipulation of settlement (the “Stipulation of Settlement”), which Stipulation +of Settlement was further amended by us and Plaintiffs, by amendments dated, January 12, 2023, February 2, 2023, and February 23, 2023. +On or about December +12, 2022, Plaintiffs and Mr. Ault entered into a stipulation of discontinuance, pursuant to which, among other things, Plaintiffs dismissed +all claims asserted against Mr. Ault in the action, with prejudice. +SEC Subpoena +The Company and certain affiliates +and related parties have received several subpoenas from the SEC for the production of documents and testimony. The Company is fully cooperating +with this non-public, fact-finding inquiry and management believes that the Company has operated its business in compliance with all applicable +laws. The subpoenas expressly provide that the inquiry is not to be construed as an indication by the Commission or its staff that any +violations of the federal securities laws have occurred, nor should they be considered a reflection upon any person, entity or security. +However, there can be no assurance as to the outcome of this matter. The Company recorded a $1.0 million loss contingency related to this +matter. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +102 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is listed +on the NYSE American under the symbol AULT. +Record Holders +As of April 17, 2023, 415,746,694 +shares of our common stock were issued and outstanding and were owned by 39 holders of record. A number of holders of our common stock +are “street name” or beneficial holders whose shares of record are held by banks, brokers, and other financial institutions. +Dividend Policy +We have not declared or paid +any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends +in the future, if any, will be at the discretion of our Board and will depend upon our earnings, capital requirements, and financial position. +Equity Compensation Information +The +information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 +of this Annual Report on Form 10-K. +Recent Sales of Unregistered Securities +Not applicable. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +From +October 1, 2022 through December 31, 2022, Ault Alpha LP purchased 4,950,129 shares of common stock and 151 shares of Series D Preferred +Stock. Ault Alpha LP may be deemed to be an “affiliated purchaser” as defined in Rule 10b-18(a)(3) under the Securities Exchange +Act of 1934, as amended. The purchases were made through open-market transactions. +Common Stock Purchased +Total +Number of +Shares +Purchased +Average +Price Paid +Per Share +Total Number of +Shares Purchased +as Part of Publicly +Announced Plans +or Programs +Maximum +Number of Shares +That May Yet Be +Purchased Under +Plans or Programs +October 1, 2022 – October 31, 2022 +1,034,776 +$ 0.18 +November 1, 2022 – November 30, 2022 +415,353 +$ 0.16 +December 1, 2022 – December 31, 2022 +3,500,000 +$ 0.11 +Total +4,950,129 +$ 0.13 +- +- +103 +Series D Preferred +Stock Purchased +Total +Number of +Shares +Purchased +Average Price +Paid Per +Share +Total Number of +Shares Purchased +as Part of Publicly +Announced Plans +or Programs +Maximum +Number of Shares +That May Yet Be +Purchased Under +Plans or Programs +October 1, 2022 – October 31, 2022 +151 +$ 13.5 +November 1, 2022 – November 30, 2022 +- +$ - +December 1, 2022 – December 31, 2022 +- +$ - +Total +151 +$ 13.5 +- +- +ITEM 6. RESERVED +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form +10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking +statements. Such forward-looking statements include statements regarding, among others, (a) our expectations about possible business combinations, +(b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs for working capital. Forward-looking statements, +which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words +“may,” “will,” “should,” “expect,” “anticipate,” “approximate,” +“estimate,” “believe,” “intend,” “plan,” “budget,” “could,” “forecast,” +“might,” “predict,” “shall” or “project,” or the negative of these words or other variations +on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that +may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements +expressed or implied by any forward-looking statements. These statements may be found in this Annual Report. +Forward-looking statements +are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other future +conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks, +and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking +statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in this +Annual Report, changes in local, regional, national or global political, economic, business, competitive, market (supply and demand) and +regulatory conditions and the following: +· Adverse economic conditions; +· Our ability to effectively execute our business plan; +· Inability to raise sufficient additional capital to operate our business; +· Our ability to manage our expansion, growth and operating expenses; +· Our ability to evaluate and measure our business, prospects and performance metrics; +· Our ability to compete and succeed in highly competitive and evolving industries; +· Our ability to respond and adapt to changes in technology and customer behavior; +· Our ability to protect our intellectual property and to develop, maintain and enhance a strong brand; +and +· Other specific risks referred to in the section entitled “ Risk Factors ”. +We caution you therefore that +you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances of future +performance. All forward-looking statements speak only as of the date of this Annual Report. We undertake no obligation to update any +forward-looking statements or other information contained herein unless required by law. +Information regarding market +and industry statistics contained in this Annual Report is included based on information available to us that we believe is accurate. +It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. +Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional +uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services. Except as required +by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect actual results or changes in assumptions +or other factors that could affect those statements. See the section entitled “ Risk Factors ” for a more detailed discussion +of risks and uncertainties that may have an impact on our future results. +104 +In this Annual Report, the +“Company,” “ AAI ,” “we,” “us” and “our” +refer to Ault Alliance, Inc., a Delaware corporation formerly known as BitNile Holdings, which was incorporated in September 2017. AAI +is a diversified holding company pursuing growth by acquiring undervalued businesses and disruptive technologies with a global impact. +Through our wholly- and majority-owned subsidiaries and strategic investments, we own and operate a data center at which we mine Bitcoin, +and provide mission-critical products that support a diverse range of industries, including crane services, oil exploration, defense/aerospace, +industrial, automotive, medical/biopharma, consumer electronics, hotel operations and textiles. In addition, we extend credit to select +entrepreneurial businesses through a licensed lending subsidiary. +Our direct and indirect wholly +owned subsidiaries include (i) Ault Lending, LLC (“Ault Lending,” formerly known as Digital Power Lending, LLC), (ii) Ault +Global Real Estate Equities, Inc. (“AGREE”), which wholly owns AGREE Madison, LLC (“AGREE Madison”) and Third +Avenue Apartments LLC (“Third Avenue Apartments”), (iii) Ault Disruptive Technologies Company, LLC (“ADTC”), (iv) +BitNile, Inc. (“BNI”), which wholly owns Alliance Cloud Services, LLC (“ACS”) and BNI Montana, LLC (“BNI +Montana”), (v) Circle 8 Holdco LLC, a Delaware limited liability company (“Circle 8 Holdco”), (vi) Ault Energy, LLC +(“Ault Energy”), and (vii) Ault Aviation, LLC (“Ault Aviation”). We also have a direct controlling interest in +(i) Imperalis Holding Corp. (“IMHC” or “TurnOnGreen”), which wholly owns TOG Technologies, Inc. (“TOG Technologies”) +and Digital Power Corporation (“Digital Power”), (ii) Giga-tronics Incorporated (“GIGA”), which wholly owns Gresham +Worldwide, Inc. (“GWW”), which in turn wholly owns Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems +2001 Ltd. (“Enertec”), Relec Electronics Ltd. (“Relec”) and has a controlling interest in Microphase Corporation +(“Microphase”) and (iii) Avalanche International Corp. (“Avalanche” or “AVLP”). Ault Lending has a +controlling interest in The Singing Machine Company, Inc. (“SMC”), Circle 8 Holdco has a controlling interest in Circle 8 +Newco LLC (“Circle 8”), and ADTC is the sponsor of Ault Disruptive Technologies Corporation (“Ault Disruptive”). +Recent Events and Developments +On +February 4, 2022, we and our former subsidiary Ault Alliance, Inc. (the “Former AAI”) entered into a securities purchase agreement +providing for our purchase of BNI from the Former AAI. As a result of this transaction, both BNI and the Former AAI became stand-alone +wholly owned subsidiaries of ours. The Former AAI was merged out of existence on January 3, 2023 in connection with the change in our +corporate name from BitNile Holdings, Inc. to Ault Alliance, Inc. +On +February 10, 2022, consistent with our objective to have BNI operate the entirety of our business that relates to cryptocurrencies, the +Former AAI assigned the entirety of its interest in ACS to BNI. +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant to sell shares of common stock +having an aggregate offering price of up to $200 million from time to time, through an “at the market offering” program (the +“2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering was made pursuant to our effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. +333-260618) which became effective on November 12, 2021. Through March 13, 2023, we received gross proceeds of approximately $177 million +through the sale of approximately 317.9 million shares of common stock from the 2022 ATM Offering. The 2022 Sales Agreement has been terminated. +On March 20, 2022, we and +IMHC entered into a securities purchase agreement (the “Acquisition Agreement”) with TOGI, which closed on September 6, 2022 +(the “Closing Date”). According to the Acquisition Agreement, we (i) delivered to IMHC all of the outstanding shares of common +stock of TOGI that we owned, and (ii) forgave and eliminated the intracompany accounts between us and TOGI evidencing historical equity +investments made by us in TOGI, in the approximate amount of $36 million, in consideration for the issuance by IMHC to us (the “Transaction”) +of an aggregate of 25,000 newly designated shares of Series A Preferred Stock (the “IMHC Preferred Stock”), with each such +share having a stated value of $1,000. Immediately following the Closing Date, TOGI became a wholly owned subsidiary of IMHC. The parties +to the Agreement have agreed that, upon completion of the Transaction but subject to IMHC’s compliance with the federal securities +laws, IMHC will change its name to TurnOnGreen, Inc. Further, through an upstream merger whereby the current TOGI ceased to exist, which +was consummated on September 8, 2022, IMHC owns the former TOGI’s two operating subsidiaries, TOG Technologies and Digital Power. +IMHC intends to dissolve its dormant subsidiary. +On +September 5, 2022, we, IMHC and TOGI entered into an amendment to the Acquisition Agreement (the “Amendment”), pursuant to +which IMHC agreed to (i) use commercially reasonable efforts to effectuate a distribution by us of approximately 140 million shares of +Common Stock that we beneficially own (the “Distribution”), including the filing of a registration statement (the “Distribution +Registration Statement”) with the SEC, (ii) to issue to us warrants to purchase an equivalent number of shares of Common Stock +to be issued in the Distribution (the “Warrants”), and (iii) to register the Warrants and the shares of Common Stock issuable +upon exercise of the Warrants on the Distribution Registration Statement. +105 +On June 1, 2022, the Company +converted the principal amount under the convertible promissory notes issued to it by AVLP and accrued but unpaid interest into common +stock of AVLP. The Company converted $20.0 million in principal and $5.9 million of accrued interest receivable at a conversion price +of $0.50 per share and received 51,889,168 shares of common stock increasing its common stock ownership of AVLP from less than 20% to +approximately 92%. +On +June 8, 2022, Ault Lending entered into a securities purchase agreement with BMI whereby Ault Lending agreed to purchase $12 million of +a new series of convertible preferred stock of BMI, which transaction closed on June 29, 2022. As part of the transaction we were issued +102,881 shares of BMI’s common stock and a warrant to purchase forty-nine percent (49%) of BMI’s common stock calculated on +a fully-diluted basis, subject to certain terms and conditions. Pursuant to a mutually agreed upon use of proceeds, BMI intends to deploy +significant proceeds via its subsidiary White River Holdings Corp. (“White River”) towards an oil drilling program across +its cumulative 30,000 acres of active mineral leases at both shallow, intermediate, and deep levels. BMI also intends to deploy additional +proceeds via its subsidiary Agora Digital Holdings, Inc. (“Agora Digital”) to provide us with up to 78 megawatts (“MW”) +of power within the State of Texas for digital asset mining capacity, subject to our election to proceed with this facility after having +conducted the requisite due diligence. +On +December 6, 2022, BNI entered into a hosting agreement with Agora Digital securing up to 78 MW of power. Agora Digital will initially +provide up to 12 MW of electricity for our use, which we believe will enable us to initially power 3,750 S19j Pro miners in the first +half of 2023. The Agora Digital power capacity would, if the project proceeds as presently anticipated, expedite our recently announced +plans to significantly expand our Bitcoin mining production capacity, including growing our number of deployed Bitcoin miners to approximately +23,065, representing an expected mining production capacity of approximately 2.67 exahashes per second. +On June 10, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Preferred Sales Agreement”) with Ascendiant to sell shares of our +13.00% Series D Cumulative Redeemable Preferred Stock (the “Preferred Shares”) having an aggregate offering price of up to +$46.4 million from time to time, through an “at the market offering” program (the “2022 ATM Preferred Offering”). +The offer and sale of Preferred Shares from the 2022 ATM Preferred Offering was made pursuant to our effective “shelf” registration +statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) which became effective +on November 12, 2021. Through March 31, 2023, we had received gross proceeds of approximately $1.7 million through the sale of 118,586 +Preferred Shares in the 2022 ATM Preferred Offering. +In June 2022, Ault Lending +purchased a majority of the issued and outstanding shares of SMC in open market transactions. SMC is a Nasdaq-listed company that is +a worldwide leader in consumer karaoke products. The first to provide karaoke systems for home entertainment in the United +States, SMC sells its products worldwide through major mass merchandisers and online retailers. SMC +products incorporate the latest technology for singing practice, music listening, entertainment and social sharing and provides access +to over 100,000 songs for streaming and download. +On July 11, 2022, we announced +the formation of Ault Energy, LLC (“Ault Energy”), a wholly owned subsidiary of ours. Ault Energy will partner with White +River, a majority owned subsidiary of BMI on drilling projects across 30,000 acres in Texas, Louisiana and Mississippi. Ault Energy, as +Ault Lending’s designee, has the right to purchase up to 25%, or such higher percentages at the discretion of White River, in various +drilling projects of White River. In August 2022, Ault Energy committed to purchasing 40% of the first drilling project offered, at a +cost to Ault Energy of approximately $1 million. +On August 10, 2022, we, through +our BNI and Ault Lending subsidiaries, entered into a note purchase agreement providing for the issuance of secured promissory notes +with an aggregate principal face amount of $11.0 million and an interest rate of 10%. The purchase price for the secured promissory notes +was $10.0 million. The holders of the secured promissory notes have a security interest in marketable securities, investments and certain +Bitcoin mining equipment. The secured promissory notes are further secured by a guaranty provided by us, as well as by Milton C. Ault, +our Executive Chairman. The maturity date of the secured promissory notes is August 10, 2023. BNI is required to make monthly payments +(principal and interest) of $1.0 million on the tenth calendar day of each month, starting in September 2022. After six months, BNI may +elect to pay a forbearance fee of $0.3 million in lieu of a monthly payment, which would extend the maturity date of the related secured +promissory notes. +106 +On +August 15, 2022, BNI entered into a hosting agreement with Compute North LLC (“Compute North”). On September 22, 2022, Compute +North filed for bankruptcy protection, effectively rendering this hosting agreement null and void. We have retained counsel to assist +in this matter. We have removed the Bitcoin miners that were installed at the hosting facility in Texas. +During +2022 and more recently in 2023, a number of companies in the crypto assets industry have declared bankruptcy, including Celsius Network +LLC, Voyager Digital Ltd., BlockFi Lending LLC, FTX Trading Ltd. and Genesis Global Holdco LLC. Such bankruptcies have contributed, at +least in part, to further price decreases in Bitcoin, a loss of confidence in the participants of the digital asset ecosystem and negative +publicity surrounding digital assets more broadly. To date, aside from BNI’s claim against Compute North under the hosting agreement, +the general decrease in the price of Bitcoin and in our and our peers’ stock price that may be indirectly attributable to the bankruptcies +in the crypto assets industry, we have not been indirectly or directly materially impacted by such bankruptcies. BNI has not failed to +recover any material assets due to the bankruptcies or otherwise lost or misappropriated any such assets. On December 6, 2022, as noted +above, BNI entered into a new hosting agreement with Agora Digital to replace the Compute North hosting agreement. We continue to conduct +diligence, including into liquidity or insolvency issues, on third parties in the crypto asset space with whom we have potential or ongoing +relationships. While we have not been materially impacted by any liquidity or insolvency issues with such third parties to date, there +is no guarantee that our counterparties will not experience liquidity or insolvency issues in the future. +On November 7, 2022, we and +certain of our subsidiaries borrowed $18.9 million of principal amount of term loans (the “Loans”) from a group of institutional +investors (the “Financing”). The Loans mature in 18 months, which may be extended to 24 months, accrue interest at the rate +of 8.5% per annum and are secured by certain of our and certain of our subsidiaries’ assets. Starting in January 2023, the lenders +have the right to require us to make monthly payments of $0.6 million, which will increase to $1.1 million in November 2023. The Loans +were issued with an original issue discount of $1.89 million. +The lenders received warrants +to purchase approximately 4.5 million shares of our common stock, exercisable for four years at $0.45 per share and warrants to purchase +another approximately 4.5 million shares of our common stock, exercisable for four years at $0.75 per share, subject to adjustment. +On November 7, 2022, Ault +Aviation, LLC, a wholly owned subsidiary of the Company (“Ault Aviation”), used proceeds from the Loans to purchase a private +aircraft for a total purchase price of $15.8 million. In addition, the Company and certain of its subsidiaries entered into various +agreements as collateral for the repayment of the Loans, including (i) a security interest in certain Bitcoin mining equipment, (ii) a +pledge of the membership interests of Third Avenue Apartments, (iii) a pledge of the membership interests of ACS, (iv) a pledge of the +membership interests of Ault Aviation, (v) a pledge in a segregated deposit account of $1.5 million of cash, (vi) a mortgage and security +agreement by Third Avenue Apartments on the real estate property owned by Third Avenue Apartments in St. Petersburg, Florida, (vii) a +future advance mortgage by ACS on the real estate property owned by ACS in Dowagiac, Michigan, and (viii) an aircraft mortgage and security +agreement by Ault Aviation on the private aircraft purchased by Ault Aviation on November 7, 2022. The Loans are guaranteed by Ault Lending, +LLC, Ault & Company, Inc., an affiliate of the Company, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive +Officer of Ault & Company, Inc. +On November 18, 2022, Circle +8 entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with Circle 8 Crane Services LLC, a Delaware limited +liability company (“Circle 8 Crane Services”) pursuant to which Circle 8 agreed to purchase substantially all of the assets +(the “Acquired Assets”) and assume certain specified liabilities of Circle 8 Crane Services (the “Circle 8 Transaction”). +Circle 8 is a wholly owned subsidiary of Circle 8 Holdco LLC, a Delaware limited liability company. +On +December 19, 2022, the Asset Purchase Agreement referred to above closed and Circle 8 purchased the Acquired Assets. As consideration +for the acquisition of the Acquired Assets, Circle 8 Crane Services received Class D equity interests in Circle 8 Holdco and is eligible +to receive cash earnout payments in an aggregate maximum amount of up to $2.1 million based on the achievement by Circle 8 of certain +EBITDA targets over the three year period following the completion of the acquisition of the Acquired Assets by Circle 8. We contributed +$12 million to Circle 8, and an independent third party contributed $4 million, of which approximately $11.7 million was used to +pay down a portion of the Circle 8 Crane Services’ senior debt facility at the closing, $3.0 million of which was used to pay off +Circle 8 Crane Services’ subordinated debt facility in full at the closing and $1.4 million was used to pay the expenses of Circle +8 and Circle 8 Crane Services. In addition, Circle 8 assumed a new line of credit issued by Circle 8 Crane Services’ current senior +lender. Circle 8 Holdco is a subsidiary of the former AAI, a Delaware corporation but is presently directly owned by us. We own a controlling +interest in Circle 8 Holdco. +On +December 16, 2022 we entered into a Securities Purchase Agreement (the “SPA”) with an accredited investor (the “Investor”) +providing for the issuance of a secured promissory note (the “Note”) with an aggregate principal face amount of $14.7 million +(the “Financing”). On December 29, 2022, the Company and the accredited investor entered into an amended and restated amendment +to the SPA, pursuant to which the total amount of the financing was increased to $17.5 million and the Company sold an additional note +to a second accredited investor. +107 +Under the SPA, we are obligated +to repay, while the Note remains outstanding, (i) eighty percent (80%) of the proceeds we may receive from any financing conducted, other +than at-the-market offerings and (ii) one hundred percent (100%) of the proceeds we may receive from the sale of marketable securities +by Ault Lending. In addition, if Third Avenue Apartments, LLC (“Third Avenue”), our wholly owned subsidiary, sells the property +it owns in St. Peterburg, Florida, then we will use the net proceeds from the sale of such property in excess of $10 million, to repay +the Note. In addition, we agreed to issue 11.6 million shares of our common stock to the Investor in exchange for the cancellation of +all outstanding warrants previously issued to the Investor, which warrants were exercisable for 11.6 million shares of our common stock. +On January 23, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable +preferred stock (“Series C Preferred Stock”) which, effective upon filing, eliminated the Series C Preferred Stock. +On February 8, 2023, we entered +into a Share Exchange Agreement (the “Agreement”) with BMI and the other signatories thereto. The Agreement provides that, +subject to the terms and conditions set forth therein, BMI will acquire all of the outstanding shares of capital stock of our then subsidiary, +BitNile.com, Inc. (“BitNile.com”), of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders +(the “Minority Shareholders”), as well as Ault Iconic, (formerly Ault Media Group) and the securities of Earnity beneficially +owned by BitNile.com (which represented approximately 19.9% of the outstanding equity securities of Earnity as of the date of the Agreement), +in exchange for the following: (i) 8,637.5 shares of newly designated Series B Convertible Preferred Stock of BMI to be issued to our +company (the “Series B Preferred”), and (ii) 1,362.5 shares of newly designated Series C Convertible Preferred Stock of BMI +to be issued to the to the Minority Shareholders (the “Series C Preferred,” and together with the Series B Preferred, the +“Preferred Stock”). The Series B Preferred and the Series C Preferred each have a stated value of $10,000 per share (the “Stated +Value”), for a combined stated value of the Preferred Stock to be issued by BMI of $100 million, and subject to adjustment, are +convertible into an aggregate of 400 million shares of common stock of BMI (the “BMI Common Stock”), which represent and pursuant +to the Agreement will represent approximately 92.4% of BMI’s outstanding BMI Common Stock on a fully-diluted basis as of the date +of the Agreement. However, pending approval of the transaction by BMI’s shareholders, the Preferred Stock is subject to a 19.9% +beneficial ownership limitation, including the Series A Convertible Preferred Stock that we acquired from BMI in June of 2022. The Agreement +provides that BMI will seek shareholder approval (the “Shareholder Approval”) following the closing. +Pursuant to the Certificates +of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred +Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of BMI Common Stock determined by +dividing the Stated Value by $0.25 (the “Conversion Price”), or 40,000 shares of BMI Common Stock. The Conversion Price will +be subject to certain adjustments, including potential downward adjustment if BMI closes a qualified financing resulting in at least $25 +million in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock +will be entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend +Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather +than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If +BMI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as +long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the +event of a liquidation, change of control event, dissolution or winding up of BMI, and will rank senior to all other capital stock of +BMI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred +was originally entitled to vote with the BMI Common Stock at a rate of 10 votes per share of Common Stock into which the Series B Preferred +is convertible, but that provision was subsequently eliminated. Other than certain rights granted to the Company relating to amendments +or waiver of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially +identical. The Agreement closed on March 6, 2023. +On March 28, 2023, we entered +into a securities purchase agreement (the “Purchase Agreement”) with certain institutional investors (the “Investors”), +pursuant to which we agreed to issue and sell, in a private placement, an aggregate of 100,000 shares of our preferred stock, with each +such share having a stated value of $100.00 and consisting of (i) 83,000 shares of Series E Convertible Preferred Stock (the “Series +E Preferred Stock”), (ii) 1,000 shares of Series F Convertible Preferred Stock (the “Series F Preferred Stock”) and +(iii) 16,000 shares of Series G Convertible Preferred Stock (the “Series G Preferred Stock” and collectively, the “Preferred +Shares”). The Preferred Shares will be convertible into shares of our common stock at the option of the holders and, in certain +circumstances, by us. +108 +Each share of Series E Preferred +Stock and Series F Preferred Stock had a purchase price of $100.00, equal to each such share’s stated value. The purchase price +of the Series E Preferred Stock and the Series F Preferred Stock was paid for by the Investors’ canceling outstanding secured promissory +notes in the principal amount of $8.4 million, whereas the purchase price of the shares of Series G Preferred Stock consisted of accrued +but unpaid interest on these notes, as well as for other good and valuable consideration. Each Preferred Share is convertible into shares +of our common stock at a conversion price equal to 85% of the closing sale price of our common stock on the trading day prior to the date +of conversion, subject to a floor price of $0.10. The Preferred Shares are convertible at the option of the holder at any time following +our receipt of stockholder approval of the Reverse Split (as defined below). The private placement closed on March 30, 2023. +We have called a special meeting +of stockholders to consider an amendment (the “Amendment”) to our certificate of incorporation to authorize a reverse split +of our common stock (the “Reverse Split”). The Investors agreed in the Purchase Agreement to not transfer, offer, sell, contract +to sell, hypothecate, pledge or otherwise dispose of the Preferred Shares until after the Reverse Split. Pursuant to the certificate of +designation of the Series E Preferred Stock, the shares of Series E Preferred Stock have the right to vote on such Amendment on an as +converted to common stock basis. In addition, pursuant to the certificate of designation of the Series F Preferred Stock, the shares of +Series F Preferred Stock have the right to vote on such Amendment. Each Investor has separately agreed to vote the shares of the Series +E Preferred Stock in favor of the Amendment and that the shares of the Series F Preferred Stock shall automatically be voted in a manner +that “mirrors” the proportions on which the shares of our common stock and Series E Preferred Stock are voted on the Amendment. +The Amendment requires the approval of the majority of the votes associated with our outstanding capital stock entitled to vote on the +proposal. Because the Series F Preferred Stock will automatically and without further action of the purchaser be voted in a manner that +“mirrors” the proportions on which the shares of common stock and Series E Preferred Stock are voted on the Reverse Split, +abstentions by common stockholders will not have any effect on the votes cast by the holders of the Series F Preferred Stock. The Series +G Preferred Stock does not carry any voting rights, except as required by law or expressly provided by its certificate of designation. +Our Corporate Structure +On January 19, 2021, we changed +our corporate name from DPW Holdings, Inc. to Ault Global Holdings, Inc. and, on December 13, 2021, we changed our corporate name from +Ault Global Holdings, Inc. to BitNile Holdings, Inc. (together, the “Name Changes”). The Name Changes were each effected through +a parent/subsidiary short form merger pursuant to an Agreement and Plan of Merger dated January 7, 2021 and December 1, 2021, respectively. +Neither of the mergers nor the corresponding Name Change affected the rights of our security holders. Our common stock is traded on the +NYSE American under the symbol “NILE.” Existing stock certificates that reflect our prior corporate name continue to be valid. +Certificates reflecting the new corporate name are issued as old stock certificates are tendered for exchange or transfer to our transfer +agent. Concurrently with the change in our name to Ault Global Holdings, Inc., Milton C. Ault III was appointed as our Executive Chairman, +William B. Horne was appointed as our Chief Executive Officer and remains as Vice Chairman of our Board, and Henry Nisser was appointed +as our President and remains as our General Counsel. +109 +Our corporate structure is +currently as follows: +General +As a holding company, our +business objective is designed to increase stockholder value. Under the strategy we have adopted, we are focused on managing and financially +supporting our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value +returned to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual +partner companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as +well as other opportunities to maximize stockholder value. We anticipate returning value to stockholders after satisfying our debt obligations +and working capital needs. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary or partner company’s further growth and development can best be +supported by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek +to sell some or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales +of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case +of publicly traded partner companies, sales of their securities in the open market. Our plans may include taking subsidiaries or partner +companies public through rights offerings and directed share subscription programs. We will continue to consider these (or similar) programs +and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our stockholders. +In recent years, we have provided +capital and relevant expertise to fuel the growth of businesses in oil exploration, defense/aerospace, industrial, automotive, medical/biopharma, +karaoke audio equipment, hotel operations and textiles. We have provided capital to subsidiaries as well as partner companies in which +we have an equity interest or may be actively involved, influencing development through board representation and management support. +110 +We are a Delaware corporation +with our corporate office located at 11411 Southern Highlands Pkwy, Suite 240, Las Vegas, NV 89141. Our phone number is 949-444-5464 and +our website address is www.ault.com. +Results of Operations +Results of Operations for the Years ended December 31, 2022 and +2021 +The following table summarizes +the results of our operations for the years ended December 31, 2022 and 2021. +For the Year Ended December 31, +2022 +2021 +Revenue +$ 61,561,000 +$ 32,096,000 +Revenue, cryptocurrency mining +16,693,000 +3,450,000 +Revenue, hotel operations +16,697,000 +- +Revenue, crane operations +2,739,000 +- +Revenue, lending and trading activities +36,644,000 +16,854,000 +Total revenue +134,334,000 +52,400,000 +Cost of revenue, products +44,508,000 +22,733,000 +Cost of revenue, cryptocurrency mining +21,508,000 +1,125,000 +Cost of revenue, hotel operations +11,406,000 +- +Cost of revenue, crane operations +940,000 +- +Total cost of revenue +78,362,000 +23,858,000 +Gross profit +55,972,000 +28,542,000 +Total operating expenses +196,140,000 +46,903,000 +Loss from operations +(140,168,000 ) +(18,361,000 ) +Other income (expense): +Interest and other income +2,594,000 +808,000 +Interest expense +(42,546,000 ) +(1,871,000 ) +Change in fair value of equity securities, related party +- +(7,773,000 ) +Accretion of discount on note receivable, related party +- +4,210,000 +Impairment of debt securities, net +- +(594,000 ) +Change in fair value of marketable equity securities +(2,144,000 ) +(1,327,000 ) +Gain on extinguishment of debt +- +929,000 +Realized (loss) gain on marketable securities +(419,000 ) +1,924,000 +Loss from investment in unconsolidated entity +(924,000 ) +(311,000 ) +Impairment of equity securities +(11,500,000 ) +- +Gain from bargain purchase of business +806,000 +- +Change in fair value of warrant liability +(17,000 ) +(542,000 ) +Loss before income taxes +(194,318,000 ) +(22,908,000 ) +Income tax (benefit) provision +(4,485,000 ) +130,000 +Net loss +(189,833,000 ) +(23,038,000 ) +Net loss (income) attributable to non-controlling interest +8,017,000 +(213,000 ) +Net loss attributable to Ault Alliance, Inc. +(181,816,000 ) +(23,251,000 ) +Preferred dividends +(393,000 ) +(18,000 ) +Net loss available to common stockholders +$ (182,209,000 ) +$ (23,269,000 ) +Comprehensive (loss) income +Net loss income available to common stockholders +$ (182,209,000 ) +$ (23,269,000 ) +Other comprehensive (loss) income +Foreign currency translation adjustment +(995,000 ) +85,000 +Impairment of debt securities +- +594,000 +Other comprehensive (loss) income +(995,000 ) +679,000 +Total comprehensive loss +$ (183,204,000 ) +$ (22,590,000 ) +111 +Revenues +Revenues by segment for the +years ended December 31, 2022 and 2021 were as follows: +For the Year Ended December 31, +Increase +2022 +2021 +(Decrease) +% +GIGA +$ 30,255,000 +$ 25,581,000 +$ 4,674,000 +18 % +TurnOnGreen +5,522,000 +5,346,000 +176,000 +3 % +SMC +24,224,000 +- +24,224,000 +— +BNI +Revenue, cryptocurrency mining +16,693,000 +3,450,000 +13,243,000 +384 % +Revenue, commercial real estate leases +1,105,000 +788,000 +317,000 +40 % +AGREE +16,697,000 +189,000 +16,508,000 +8734 % +Fintech: +Revenue, lending and trading activities +36,644,000 +16,854,000 +19,790,000 +117 % +Other +239,000 +192,000 +47,000 +24 % +Energy +2,955,000 +- +2,955,000 +— +Total revenue +$ 134,334,000 +$ 52,400,000 +$ 81,934,000 +156 % +Our revenues increased by +$81.9 million, or 156%, to $134.3 million for the year ended December 31, 2022, from $52.4 million for the year ended December 31, +2021. +GIGA +The $4.7 million increase +in our GIGA segment revenue in 2022 included $1.4 million attributable to our recent acquisition of Giga-tronics Incorporated on September +8, 2022. The improved economic environment following COVID-19 disruptions, along with increased military spending, drove growth in our +GIGA segment, which provides customized solutions for military markets. Additionally, revenue from Enertec, which is primarily recognized +over time, increased by 14.5% to $12.5 million in 2022, up $1.6 million from $10.9 million in the prior-year period. +TurnOnGreen +TurnOnGreen revenues were +up slightly for the year ended December 31, 2022 compared to the year ended December 31, 2021. +SMC +SMC revenues increased by +$24.2 million due to the acquisition of SMC in June 2022. +BNI +Revenues from BNI’s +cryptocurrency mining operations increased $13.2 million as we began to purchase Bitcoin mining equipment in 2021, which was primarily +delivered in 2022, and increased our cryptocurrency mining activities. +AGREE +AGREE revenues increased $16.5 +million as AGREE acquired four hotel properties on December 22, 2021 for $71.3 million, consisting +of a 136-room Courtyard by Marriott, a 133-room Hilton Garden Inn and a 122-room Residence Inn by Marriott in Middleton, WI, as well as +a 135-room Hilton Garden Inn in Rockford, IL. +Fintech +Revenues from our lending +and trading activities increased to $36.6 million due to significant realized and unrealized gains in the current year period and unrealized +losses in the prior year period from our investment portfolio. During the year ended December 31, 2022, Ault Lending generated significant +income from appreciation of investments in marketable securities as well as shares of common stock underlying convertible notes and warrants +issued to Ault Lending in certain financing transactions. Revenue from lending and trading activities during the year ended December 31, +2022 included an approximate $2.5 million unrealized gain from our investment in Alzamend. Under its business model, Ault Lending also +generates revenue through origination fees charged to borrowers and interest generated from each loan. +112 +Revenues +from our trading activities during the year ended December 31, 2021 included significant unrealized losses from market price changes related +to Alzamend. We recorded an unrealized losses of $12.7 million and $5.6 million related to our investment in Alzamend common stock during +the years ended December 31, 2022 and 2021, respectively. Our investment in Alzamend will be revalued on each balance sheet date. +Revenues +from our trading activities during the year ended December 31, 2022 included net gains on equity securities, including unrealized gains +and losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in our periodic +earnings. +Energy +Energy revenues increased +by $3.0 million primarily due to the acquisition of Circle 8 in December 2022 and our participation in drilling oil wells in 2022. +Gross Margins +Gross margins decreased to +41.7% for the year ended December 31, 2022, compared to 54.5% for the year ended December 31, 2021. Our gross margins have typically +ranged between 33% and 37%, with slight variations depending on the overall composition of our revenue. +Our gross margins of 42% recognized +during the year ended December 31, 2022 were impacted by the favorable margins from our lending and trading activities and negative margins +from our BNI cryptocurrency mining segment due to the decline in the price of Bitcoin coupled with an increase in Bitcoin mining difficulty +level. Excluding the effects of margin from our lending and trading activities and cryptocurrency mining operations, our adjusted gross +margins for the year ended December 31, 2022 and 2021 would have been 29% and 33%, respectively, with gross margins for the year ended +December 31, 2022, slightly lower than our historical averages due to gross margins from SMC, which were 22%. +Research and Development +Research and development expenses +increased by $0.7 million to $2.8 million for the year ended December 31, 2022, from $2.0 million for the year ended December 31, 2021. +The increase in research and development expenses was due to product development efforts at TurnOnGreen and GIGA. GIGA research and development +expense in 2022 includes $0.3 million from GIGA, which was acquired on September 8, 2022. +Selling and Marketing +Selling and marketing expenses +were $29.4 million for the year ended December 31, 2022, compared to $7.8 million for the year ended December 31, 2021, an increase of +$21.6 million, or 278%. The increase was the result of $18.9 million higher advertising and promotion costs at Ault Alliance, including +$13.1 million related to an advertising sponsorship agreement as well as a $2.0 million increase in sales and marketing personnel and +a $0.9 million increase in travel expense. The increase is also attributable to a $0.6 million increase in costs incurred at TurnOnGreen +to grow our selling and marketing infrastructure related to our electric vehicle charger products as well as a $2.0 million increases +in sales and marketing costs from SMC, which was acquired in June 2022. +General and Administrative +General and administrative +expenses were $67.3 million for the year ended December 31, 2022, compared to $36.7 million for the year ended December 31, 2021, +an increase of $30.6 million, or 84%. General and administrative expenses increased from the comparative prior period, mainly due to: +· general and administrative costs of $5.8 million from our hotel operations, which were acquired in December +2021; +· general and administrative costs of $5.1 million from SMC, which was acquired in June 2022; +113 +· general and administrative costs of $1.2 million from AVLP, which was acquired in June 2022; +· general and administrative costs of $1.0 million from Circle 8, which was acquired in December 2022; +· increased general and administrative costs of $1.4 million from Ault Disruptive, a SPAC which completed +its IPO in December 2021; +· increased general and administrative costs of $1.7 million from TurnOnGreen from higher rent expense and +legal fees; +· $2.9 million increase in the accrual of a performance bonus related to realized gains on trading activities +during the period; +· higher salaries of $1.8 million; +· higher audit fees of $2.0 million; +· increased costs of $2.8 million related to the Michigan data center and Bitcoin mining operations; and +· increased corporate and Ault Lending legal fees of $2.5 million, including $0.7 million related to the +efforts to acquire EYP, Inc. +Goodwill impairment +Impairment of SMC Goodwill +During the fourth quarter +of 2022, SMC experienced adverse changes in business climate, a significant decline in sales and a drop in the trading price of its common +stock. +Due to these factors, we determined +that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, 2022. The valuation +of the SMC reporting units was determined using a market approach with observable inputs, primarily based on the trading price of SMC’s +common stock plus an estimated control premium of approximately 20%. +The results of the quantitative +test indicated the fair value of the SMC reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $3.2 million carrying amount of SMC’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +Impairment of GIGA Goodwill +During the fourth quarter +of 2022, GIGA experienced a significant decline in sales and a drop in the trading price of its common stock. +Due to these factors, we determined +that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, 2022. The valuation +of the GIGA reporting units was determined using an income approach methodology of valuation. +The income approach is based +on the projected cash flows discounted to their present value using discount rates that in our judgment consider the timing and risk of +the forecasted cash flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the +average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. Other significant +assumptions include revenue growth rates, profitability projections, and terminal value growth rates. The market approach was also considered; +however, the income approach was chosen as the Company determined it is a better representation of GIGA’s projected long-term performance. +The results of the quantitative +test indicated the fair value of the GIGA reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $9.9 million carrying amount of GIGA’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +Impairment of Deposit due to Vendor Bankruptcy +Filing +On September 22, 2022, Compute +North filed for bankruptcy protection. We had a deposit of approximately $2.0 million with Compute North for services yet to be performed +by Compute North. The ultimate outcome of the bankruptcy process, and its impact on our deposit remains to be determined. We assessed +this financial exposure and recorded an impairment of the deposit totaling $2.0 million during the year ended December 31, 2022. +We have retained counsel to assist in this matter. We have removed the Bitcoin miners that were installed at the hosting facility in Texas. +114 +Impairment of Bitcoin Mining Equipment +During the year ended December +31, 2022, adverse changes in business climate, including decreases in the price of Bitcoin and resulting decrease in the market price +of miners, indicated that an impairment triggering event had occurred. Testing performed indicated the estimated fair value of our miners +to be less than their net carrying value as of December 31, 2022, and an impairment charge of $79.6 million was recognized, decreasing +the net carrying value of our Bitcoin mining equipment to their estimated fair value. +Realized Gain on Sale of Cryptocurrency +Realized gain on sale of cryptocurrency +was $1.0 million for the year ended December 31, 2022, compared to $0 for the year ended December 31, 2021. Realized gain for the year +ended December 31, 2022 related primarily to gains on the sale of Bitcoin by BNI. +Impairment of Mined Cryptocurrency +Impairment of mined cryptocurrency +for the years ended December 31, 2022 and 2021 was $3.1 million and $0.4 million, respectively, attributable to the decline in Bitcoin +values and increase in Bitcoin mined in 2022 as compared to 2021. +Loss From Operations +We recorded a loss from operations +of $140.2 million for the year ended December 31, 2022, compared to a loss from continuing operations of $18.4 million for the year ended +December 31, 2021. The change in operating results is attributable to the increase in operating expenses, primarily impairment of Bitcoin +mining equipment, goodwill impairment, and increased operating expenses from companies recently acquired partially offset by the increase +in revenue and gross margins. +Interest and Other Income +Interest and other income was +$2.6 million for the year ended December 31, 2022, compared to $0.8 million for the year ended December 31, 2021. The increase in interest +and other income is primarily due to income from Ault Disruptive from cash and marketable securities held in the trust account. Other +income for the year ended December 31, 2022 included a $2.8 million gain related to remeasurement of our previously held ownership interest +of SMC prior to the June 15, 2022 acquisition, based on the trading price of SMC common stock. In addition, other income for the year +ended December 31, 2022 included a $2.7 million loss related to remeasurement of our previously held ownership interest of AVLP prior +to the June 1, 2022 acquisition. Other income for the year ended December 31, 2021 included a $0.4 million gain related to the release +of certain escrow funds related to the 2017 acquisition of Enertec. +Change in Fair Value of Equity Securities, +Related Party +Change in fair value of equity +securities, related party resulting from the warrant securities that we received as a result of our investment in AVLP was a loss of $7.8 +million for the year ended December 31, 2021. In June 2022 we began consolidating the financial results of AVLP as we converted the principal +amount under our convertible promissory notes issued to us by AVLP and accrued unpaid interest into common stock of AVLP increasing our +common stock ownership of AVLP from less than 20% to approximately 92%. +Accretion of Discount on Note Receivable, Related +Party +Accretion of discount on note +receivable, related party was $4.2 million for the year ended December 31, 2021 due to the significant decline in the value of warrants +in AVLP, accretion of the warrant discount was accelerated, resulting in a discount of $0 related to warrants issued in conjunction with +the convertible promissory note of AVLP as of December 31, 2021. +Impairment of Debt Securities +During the year ended December +31, 2021 we impaired our debt securities as we noted a loss in value that was deemed other than temporary. +115 +Interest Expense +Interest expense was $42.5 +million for the year ended December 31, 2022, compared to $1.9 million for the year ended December 31, 2021. The increase in interest +expense for the year ended December 31, 2022 was primarily related to the increase in our average level of borrowings during the year. +The increase in interest expense in part relates primarily to the $66.0 million of Senior Notes issued in December 2021, which were fully +paid in March 2022. Interest expense from these Senior Notes included the amortization of debt discount of $26.3 million from the issuance +of warrants, a non-cash charge, and original issue discount, in connection with these Senior Notes. +Change in Fair Value of Marketable Equity Securities +Change in fair value of marketable +equity securities was a loss of $2.1 million for the year ended December 31, 2022, compared to a loss of $1.3 million for the year ended +December 31, 2021. The loss generated in the prior year period relates to an investment in marketable securities held by Microphase that +was fully sold in the fourth quarter of 2021 as well as the loss on an investment in AVLP common stock. +Gain on Extinguishment of Debt +Gain on extinguishment of +debt was $0 for the year ended December 31, 2022, compared to a gain of $0.9 million for the year ended December 31, 2021. The prior year +gain on extinguishment of debt represents forgiveness of Paycheck Protection Program loans. +Realized (Loss) Gain on Marketable Securities +Realized loss on marketable +securities was $0.4 million for the year ended December 31, 2022, compared to a gain of $1.9 million for the year ended December +31, 2021. Realized gains in the prior year period related to realized gains from an investment in marketable securities held by Microphase, +a portion of which was sold during the year ended December 31, 2021. +Loss From Investment in Unconsolidated Entity +Loss from investment in unconsolidated +entity was $0.9 million for the year ended December 31, 2022, compared to $0.3 million for the year ended December 31, 2021, representing +our share of losses from our equity method investment in AVLP prior to the June 1, 2022 acquisition. +Impairment of Equity Securities +Cumulative downward adjustments +for impairments for our equity securities without readily determinable fair values held at December 31, 2022 were $11.5 million. +Gain on Bargain Purchase of Business +In connection with the acquisition +of Circle 8, we recorded the $0.8 million excess of fair value of net assets acquired over consideration paid as a gain on bargain purchase. +Change in Fair Value of Warrant Liability +Change in fair value of warrant +liability was a loss of $17,000 for the year ended December 31, 2022, compared to a loss of $0.5 million for the year ended December +31, 2021. The fair value of warrant liabilities is re-measured at each financial reporting period and immediately before exercise, with +any changes in fair value recorded as change in fair value of warrant liability in the consolidated statements of operations and comprehensive +loss. +Net Loss +For the foregoing reasons, our net loss +for the year ended December 31, 2022 was $189.8 million, compared to a net loss of $23.0 million for the year ended December 31, 2021. +Other Comprehensive (Loss) Income +Other comprehensive loss was +$1.0 million compared to other comprehensive gain of $0.7 million for the years ended December 31, 2022 and 2021, respectively. The balance +of other comprehensive income for both years was caused by foreign currency translation adjustments between our functional currency, the +U.S. Dollar, and the British Pound and Israeli Shekel. +116 +Liquidity and Capital Resources +On December 31, 2022, we had +cash and cash equivalents of $10.5 million (excluding restricted cash of $3.6 million), compared to cash and cash equivalents of $15.9 +million (excluding restricted cash of $5.3 million) at December 31, 2021. The decrease in cash and cash equivalents was primarily due +the payment of debt and purchases of property and equipment partially offset by cash provided by financing activities related to the sale +of common and preferred stock, as well as proceeds from notes payable and cash provided by operating activities. +Net cash provided by operating +activities totaled $26.5 million for the year ended December 31, 2022, compared to net cash used in operating activities of $61.7 million +for the year ended December 31, 2021. Cash provided by operating activities for the year ended December 31, 2022 included $79.0 million +net cash provided by marketable securities from trading activities related to the operations of Ault Lending, partially offset by operating +losses and changes in working capital. +Net cash used in investing +activities was $158.6 million for the year ended December 31, 2022, compared to $333.5 million for the year ended December 31, 2021. Net +cash used in investing activities for the year ended December 31, 2022 included $108.4 million of capital expenditures primarily +related to Bitcoin mining equipment, $26.6 million for investments in equity securities, $11.1 million for the purchase of Circle 8, $8.2 +million for the purchase of SMC and $3.7 million for the purchase of GIGA, net of cash received, partially offset by $11.7 million proceeds +from the sale of marketable equity securities and $11.1 million principal payments received on loans receivable. +Net cash provided by financing +activities was $124.1 million for the year ended December 31, 2022, compared to $397.9 million for the year ended December 31, 2021, +and reflects the following transactions: +· 2022 Common ATM Offering – On February 25, 2022, we entered into an At-The-Market issuance +sales agreement with Ascendiant Capital to sell shares of common stock having an aggregate offering price of up to $200 million from time +to time, through the 2022 Common ATM Offering. During the year ended December 31, 2022, we sold an aggregate of 285.4 million shares of +common stock pursuant to the 2022 Common ATM Offering for gross proceeds of $172 million. Net proceeds to us, after payment of commissions, +were $168 million. +· Public Offering of Series D Preferred Stock – On June 3, 2022, we announced the closing of +our public offering of 144,000 shares of our Series D Preferred Stock at a price to the public of $25.00 per share. Gross proceeds from +the offering were approximately $3.6 million, before deducting offering expenses. Net proceeds to us, after payment of commissions, non-accountable +fees and offering expenses were $3.1 million. +· 2022 Preferred ATM Offering – On June 14, 2022, we entered into an At-The-Market equity offering +program with Ascendiant Capital under which we may sell, from time to time, shares of our Series D Preferred Stock for aggregate gross +proceeds of up to $46.4 million. As of December 31, 2022, we had sold an aggregate of 28,838 shares of Series D Preferred Stock pursuant +to the 2022 Preferred ATM Offering for gross proceeds of $0.5 million. +· December 2021 Secured Promissory Notes – On December 30, 2021, we entered into a securities +purchase agreement with certain accredited investors providing for the issuance of Senior Notes that bore interest at 8% per annum with +an aggregate principal face amount of $66.0 million. The Senior Notes were repaid in March 2022. +· Margin Accounts Payable – During the year ended December 31, 2021, we entered into leverage +agreements on certain brokerage accounts, whereby we borrowed $18.5 million. During the year ended December 31, 2022, net payments on +the margin accounts payable were $17.7 million. +· 10% Secured Promissory Notes – On August 10, 2022, we, through our BNI subsidiary, entered +into a note purchase agreement providing for the issuance of secured promissory notes with an aggregate principal face amount of $11.0 +million and an interest rate of 10%. The purchase price (proceeds to us) for the secured promissory notes was $10.0 million. The secured +promissory notes have a security interest in marketable securities, investments and certain Bitcoin mining equipment. The secured promissory +notes are further secured by a guaranty provided by us, Ault Lending and Milton C. Ault, our Executive Chairman. The maturity date of +the secured promissory notes is August 10, 2023. During the year ended December 31, 2022, we made $2.2 million in principal payments on +the 10% secured promissory notes. +117 +· SMC Credit and Security Agreement with Fifth Third Bank – On October 14, 2022 SMC entered +into a Credit and Security Agreement (the “Credit Agreement”) with Fifth Third Bank, National Association, as Lender (“Fifth +Third”). The Credit Agreement provides for a three-year secured revolving credit facility in an aggregate principal amount of up +to $15.0 million decreased to $7.5 million during the period of January 1 through July 31 of each year. The Credit Agreement matures on +October 14, 2025. As of December 31, 2022, SMC was in default under the Credit Agreement due to non-compliance with the fixed charge +coverage ratio covenant primarily due to the decrease in revenue for the three months ended December 31, 2022 and increased general and +administrative expenses. To date, Fifth Third has not taken action to accelerate SMC’s obligations under the Credit Agreement and +SMC is currently in negotiations with Fifth Third to obtain a waiver and renegotiate the fixed charge coverage ratio covenant. There can +be no assurance that the negotiations will be successful and that Fifth Third will grant SMC a waiver or renegotiate the covenant. +· Secured Debt Financing – On November 7, 2022, we and certain of our subsidiaries borrowed +$18.9 million of principal amount of term loans (the “Loans”) from a group of institutional investors (the “Financing”). +The Loans mature in 18 months, which may be extended to 24 months, accrue interest at the rate of 8.5% per annum and are secured by certain +of our assets and the assets of our various subsidiaries. Starting in January 2023, the lenders have the right to require us to make monthly +payments of $0.6 million, which will increase to $1.1 million in November 2023. The Loans were issued with an original issue discount +of $1.89 million. The lenders received warrants to purchase approximately 4.5 million shares of our common stock, exercisable for four +years at $0.45 per share and warrants to purchase another approximately 4.5 million shares of our common stock, exercisable for four years +at $0.75 per share, subject to adjustment. On November 7, 2022, Ault Aviation used proceeds from the Loans to purchase a private aircraft +for a total purchase price of $15.8 million. In addition, we and certain of our subsidiaries entered into various agreements as collateral +for the repayment of the Loans, including (i) a security interest in certain Bitcoin mining equipment, (ii) a pledge of the membership +interests of Third Avenue Apartments, LLC, our wholly owned subsidiary (“Third Apartments”), (iii) a pledge of the membership +interests of Alliance Cloud Services, LLC, our wholly owned subsidiary (“Alliance Cloud”), (iv) a pledge of the membership +interests of Ault Aviation, LLC, our wholly owned subsidiary (“Ault Aviation”), (v) a pledge in a segregated deposit account +of $1.5 million of cash, (vi) a mortgage and security agreement by Third Avenue on the real estate property owned by Third Avenue in St. +Petersburg, Florida, (vii) a future advance mortgage by Alliance Cloud on the real estate property owned by Alliance Cloud in Dowagiac, +Michigan, and (viii) an aircraft mortgage and security agreement by Ault Aviation on the private aircraft purchased by Ault Aviation on +November 7, 2022. The Loans are further secured by a guaranty provided by Ault Lending and Milton C. Ault, our Executive Chairman. +· 3% Secured Promissory Notes – On November 18, 2022, BNI entered into a note purchase agreement +with two investors providing for the issuance of the 3% Secured Promissory Notes (“November Notes”). The November Notes have +a principal face amount of $8,181,819 and bear interest at 3% per annum pursuant to the terms of the November Notes. The maturity date +of the November Notes is May 18, 2023. When BNI sells the collateral related to the November Notes, BNI is required to make a payment +towards the November Notes equal to 45% of the realized gains. After the November Notes have been repaid in full and until all of the +collateral is sold, when BNI sells any remaining collateral, BNI is required to give the investors a profits participation interest equal +to 45% of the realized gains. Pursuant to the note purchase agreement, BNI, Ault Lending and the Agent entered into security agreement +pursuant to which BNI and Ault Lending granted to the investors a security interest in the related collateral. +· Purchase of Treasury Stock – During the year ended December 31, 2022, Alpha Fund purchased +48.1 million shares of our common stock for $27.1 million and 91,184 shares of our Series D Preferred Stock for $2.2 million, accounted +for as treasury stock as of December 31, 2022. +Financing Transactions Subsequent to December +31, 2022 +Financing transactions subsequent +to December 31, 2022 include the following: +2022 Common ATM Offering +During the period between +January 1, 2023 through April 15, 2023, we sold an aggregate of 32.0 million shares of common stock pursuant to the 2022 Common ATM Offering +for gross proceeds of $4.2 million. +2022 Preferred ATM Offering +During the period between +January 1, 2023 through April 15, 2023, we sold an aggregate of 89,748 shares of Series D Preferred Stock pursuant to the 2022 Preferred +ATM Offering for gross proceeds of $1.2 million. +118 +We believe our current cash +on hand is not sufficient to fund our planned operations through one year after the date the consolidated financial statements are issued. +These factors create substantial doubt about our ability to continue as a going concern for at least one year after the date that our +audited Consolidated Financial Statements are issued. +March 28, 2023 Security Purchase Agreement +On +March 28, 2023, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with certain institutional investors +(the “Investors”), pursuant to which we agreed to issue and sell, in a private placement (the “Offering”), an +aggregate of 100,000 shares of our preferred stock, with each such share having a stated value of $100.00 and consisting of (i) 83,000 +shares of Series E Convertible Preferred Stock (the “Series E Preferred Stock”), (ii) 1,000 shares of Series F Convertible +Preferred Stock (the “Series F Preferred Stock”) and (iii) 16,000 shares of Series G Convertible Preferred Stock (the “Series +G Preferred Stock” and collectively, the “Preferred Shares”). The Preferred Shares will be convertible into shares of +our common stock at the option of the holders and, in certain circumstances, by us. +Each +share of Series E Preferred Stock and Series F Preferred Stock had a purchase price of $100.00, equal to each such share’s stated +value. The purchase price of the Series E Preferred Stock and the Series F Preferred Stock was paid for by the Investors’ canceling +outstanding secured promissory notes in the principal amount of $8.4 million, whereas the purchase price of the shares of Series G Preferred +Stock consisted of accrued but unpaid interest on these notes, as well as for other good and valuable consideration. Each Preferred Share +is convertible into shares of our common stock at a conversion price equal to 85% of the closing sale price of the common stock on the +trading day prior to the date of conversion, subject to a floor price of $0.10. +Critical Accounting Policies +Business Combination +We allocate the purchase price +of an acquired business to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values +on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. Acquired +customer relations, technology, trade names and know how are recognized at fair value. The purchase price allocation process requires +management to make significant estimates and assumptions, especially at the acquisition date with respect to intangible assets. Direct +transaction costs associated with the business combination are expensed as incurred. The allocation of the consideration transferred in +certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up +to one year from the acquisition date. We include the results of operations of the business that we have acquired in our consolidated +results prospectively from the date of acquisition. +If the business combination +is achieved in stages, the acquisition date carrying value of the acquirer’s previously held equity interest in the acquire is re-measured +to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized in profit or loss. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller reporting +company, this section is not applicable. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements required +by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not required to provide +supplementary financial information. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable. +119 +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2022, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, have +evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) +and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our disclosure +controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records +that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide +reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2022. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2022, our internal control over financial reporting was not effective. +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting department, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting, fair value estimates and analysis of financial instruments for proper classification in the consolidated financial statements, +in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +3. Our primary user access controls (i.e., provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +120 +4. The Company did not design and/or implement user access controls to ensure appropriate segregation of +duties or program change management controls for certain financially relevant systems impacting the Company’s processes around revenue +recognition and digital assets to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, and (iii) underlying accounting records, are identified, tested, authorized and implemented appropriately +to validate that data produced by its relevant IT system(s) were complete and accurate. Automated process-level controls and manual controls +that are dependent upon the information derived from such financially relevant systems were also determined to be ineffective as a result +of such deficiency. In addition, the Company has not effectively designed a manual key control to detect material misstatements in revenue. +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis: +· Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls; +· Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· Continuing to increase headcount across the Company, with a particular focus on hiring individuals with +strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Control over Financial Reporting +During the most recent fiscal +quarter 2022 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) +and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over +financial reporting. +ITEM 9B. OTHER INFORMATION +None. +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +No applicable. +121 +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The following table sets forth +the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. Ault, III (1) +53 +Executive Chairman of the Board +2017 +William B. Horne (1) +54 +Chief Executive Officer, Vice Chairman and Director +2016 +Henry Nisser (1) +54 +President, General Counsel and Director +2019 +Kenneth S. Cragun (1) +62 +Chief Financial Officer +2020 +Robert O. Smith +78 +Lead Independent Director +2016 +Moti Rosenberg +75 +Director +2015 +Jeffrey A. Bentz +63 +Director +2018 +Howard Ash +63 +Director +2020 +(1) Executive Officer. +Each of the directors named +above will serve until the next annual meeting of our stockholders or until his respective successor is elected and qualified. Subject +to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Milton C. Ault, III +On January 19, 2021, Mr. Ault +resigned as Chief Executive Officer and was appointed as the Executive Chairman of the Board. On December 28, 2017, Mr. Ault was appointed +Chief Executive Officer. On March 16, 2017, Mr. Ault was appointed Executive Chairman of the Board. Mr. Ault is a seasoned business professional +and entrepreneur who has spent more than twenty-seven years identifying value in various financial markets including equities, fixed income, +commodities, and real estate. Mr. Ault has served as Executive Chairman of SMC, a Nasdaq listed company that is the worldwide leader in +consumer karaoke products, since April 2023. Mr. Ault has served as the Chairman of the Board of ADTC, an NYSE listed Special Purpose +Acquisition Company, or SPAC, since its incorporation in February 2021. On February 25, 2016, Mr. Ault founded Alzamend Neuro, Inc., a +biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s Disease and has served as its Chairman +until its IPO, when he became Alzamend’s Chairman Emeritus and a consultant. Mr. Ault has served as Chairman and Chief Executive +Officer of Ault & Company, Inc., a Delaware holding company, since December 2015, and as Chairman of Avalanche International Corp., +a publicly traded Nevada company and a “voluntary filer,” which as such is not required to file periodic reports, since September +2014. Since January 2011, Mr. Ault has been the Vice President of Business Development for MCKEA Holdings, LLC, a family office. Throughout +his career, Mr. Ault has consulted for publicly traded and privately held companies, providing each of them the benefit of his diversified +experience, that range from development stage to seasoned businesses. We believe that Mr. Ault’s business background demonstrates +he has the qualifications to serve as one of our directors and as Executive Chairman. +William B. Horne +Mr. Horne has served as a +member of our Board since October 2016. On January 19, 2021, Mr. Horne resigned as President and was appointed as the Chief Executive +Officer. On August 19, 2020, Mr. Horne resigned as our Chief Financial Officer and was appointed as our President. He was appointed as +our Chief Financial Officer on January 25, 2018. Prior to his appointment as our Chief Financial Officer, Mr. Horne served as one of our +independent directors. Mr. Horne has served on the board of directors of GIGA, an OTCQB listed company that provides purpose-built electronic +technology solutions for defense and other mission critical applications, since September 2022. He served as the Chief Financial Officer +of Targeted Medical Pharma, Inc. (OTCBB: TRGM) from August 2013 to May 2019. Mr. Horne has served as the Chief Executive Officer and on +the board of directors of ADTC, an NYSE listed SPAC, since its incorporation in February 2021. Mr. Horne is a director and Chief Financial +Officer of Avalanche International, Corp., a “voluntary filer” under the Exchange Act. Mr. Horne has served on the board of +directors of Alzamend Neuro, Inc., a biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s +Disease, since June 1, 2016 and became its Chairman of the board upon consummation of its IPO. Mr. Horne previously held the position +of Chief Financial Officer in various public and private companies in the healthcare and high-tech field. Mr. Horne has a Bachelor of +Arts Magna Cum Laude in Accounting from Seattle University. We believe that Mr. Horne's extensive financial and accounting experience +in diversified industries and with companies involving complex transactions give him the qualifications and skills to serve as one of +our directors. +122 +Henry Nisser +Mr. Nisser has served as a +member of our Board since September 17, 2020 and was appointed as our Executive Vice President and General counsel on May 1, 2019. On +January 19, 2021, Mr. Nisser resigned as Executive Vice President and was appointed as our President. Mr. Nisser has served on the board +of directors of SMC, a Nasdaq listed company that is the worldwide leader in consumer karaoke products, since April 2023. Mr. Nisser has +served as the President, General Counsel and on the board of directors of BMI, a Nasdaq listed company that operates the BitNile.com metaverse +platform, since March 2023. Mr. Nisser is the Executive Vice President and General Counsel of Avalanche International, Corp., a “voluntary +filer” under the Exchange Act. Mr. Nisser has served as the President, General Counsel and on the board of directors of ADTC, an +NYSE listed SPAC, since its incorporation in February 2021. Mr. Nisser has served on the board of directors of Alzamend Neuro, Inc., a +biotechnology firm dedicated to finding the treatment, prevention and cure for Alzheimer’s Disease, since September 1, 2020 and +has served as its Executive Vice President and General Counsel since May 1, 2019. From October 31, 2011 through April 26, 2019, Mr. Nisser +was an associate and subsequently a partner with Sichenzia Ross Ference LLP (“SRF”), a law firm based in New York City. While +with SRF, his practice was concentrated in national and international corporate law, with a particular focus on U.S. securities compliance, +public as well as private M&A, equity and debt financings and corporate governance. Mr. Nisser drafted and negotiated a variety of +agreements related to reorganizations, share and asset purchases, indentures, public and private offerings, tender offers and going private +transactions. Mr. Nisser also represented clients’ special committees established to evaluate M&A transactions and advised such +committees’ members with respect to their fiduciary duties. Mr. Nisser is fluent in French and Swedish as well as conversant in +Italian. Mr. Nisser received his B.A. from Connecticut College in 1992, where he majored in International Relations and Economics. He +received his LLB from the University of Buckingham School of Law in 1999. We believe that Mr. Nisser’s extensive legal experience +involving complex transactions and comprehensive knowledge of securities laws and corporate governance requirements applicable to listed +companies give him the qualifications and skills to serve as one of our directors. +Kenneth S. Cragun +Mr. Cragun was appointed as +our Chief Financial Officer on August 19, 2020. Prior to his appointment as Chief Financial Officer, Mr. Cragun served as our Chief Accounting +Officer since October 1, 2018. Mr. Cragun has served as the Chief Financial Officer of ADTC, an NYSE listed SPAC, since its incorporation +in February 2021. Mr. Cragun has been the Chief Financial Officer of Alzamend Neuro, Inc., a development stage entity seeking to prevent, +treat and cure Alzheimer’s Disease, since October of 2018. He served as a CFO Partner at Hardesty, LLC, a national executive services +firm since October 2016. His assignments at Hardesty included serving as CFO of CorVel Corporation, a $1.1 billion market cap publicly +traded company (NASDAQ: CRVL) and a nationwide leader in technology driven, healthcare-related, risk management programs and of RISA Tech, +Inc. a private structural design and optimization software company. Mr. Cragun was also CFO of two NASDAQ-listed companies, Local Corporation, +from April 2009 to September 2016, which operated Local.com, a U.S. top 100 website, and Modtech Holdings, Inc., from June 2006 to March +2009, a supplier of modular buildings. Prior thereto, he had financial leadership roles with increasing responsibilities at MIVA, Inc., +ImproveNet, Inc., NetCharge Inc., C-Cube Microsystems, Inc, and 3-Com Corporation. Mr. Cragun has +served on the board of directors and is the chairman of the audit committee of Verb Technology Company, +Inc., a Nasdaq listed software-as-a-service applications platform developer, since September 2018, and also sits on the board of directors +of SMC, a Nasdaq listed company that is the worldwide leader in consumer karaoke products, since July 2022 . +Mr. Cragun began his professional career at Deloitte. Mr. Cragun holds a Bachelor of Science degree in accounting from Colorado State +University-Pueblo. Mr. Cragun’s industry experience is vast, with extensive experience in fast-growth environments and building +teams in more than 20 countries. Mr. Cragun has led multiple financing transactions, including IPOs, PIPEs, convertible debt, term loans +and lines of credit. +Robert O. Smith +Mr. Smith serves as our lead +independent director. Previously, he served as a member of our Board from November 2010 until May 2015, and served as a member of our +Advisory Board from 2002 until 2015. He is currently a C-level executive consultant working with Bay Area high-tech firms on various strategic +initiatives in all aspects of their business. Mr. Smith has served on the board of directors of GIGA, an OTCQB listed company that provides +purpose-built electronic technology solutions for defense and other mission critical applications, since September 2022. Mr. Smith has +served on the board of directors of ADTC, an NYSE listed SPAC, since its IPO in December 2021. From 2004 to 2007, he served on the board +of directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman of our Board. From +1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of their Compower/Boschert +Division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with the JM Smucker Company. Mr. Smith +received his BBA degree in Accounting from Ohio University. We believe that Mr. Smith’s executive-level experience, including his +previous service as our President, Chief Executive Officer and Chairman of our Board, his extensive experience in the accounting industry, +and his service on our Board from November 2010 until May 2015, give him the qualifications and skills to serve as one of our directors. +123 +Mordechai Rosenberg +Mr. Rosenberg serves as one +of our independent directors. He has served as an independent consultant to various companies in the design and implementation of homeland +security systems in Europe and Africa since 2010. From 2004 to 2009, he served as a special consultant to Bullet Plate Ltd., a manufacturer +of armor protection systems, and NovIdea Ltd., a manufacturer of perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg +was the general manager of ZIV U.P.V.C Products Ltd.’s doors and window factory. Mr. Rosenberg is an active reserve officer and +a retired colonel from the Israeli Defense Force (IDF), where he served for 26 years and was involved in the development of weapon systems. +In the IDF, Mr. Rosenberg served in various capacities, including, company, battalion and brigade commander, head of the training center +for all IDF infantry, and head of the Air Force’s Special Forces. Mr. Rosenberg received a B.A in History from the University of +Tel Aviv and a Master of Arts in Political Science from the University of Haifa in Israel. Mr. Rosenberg graduated from the course of +Directors & Officers at the College of Management, Tel Aviv. We believe that Mr. Rosenberg’s business background give him the +qualifications to serve as one of our directors. +Jeffrey Bentz +Mr. Bentz serves as one of +our independent directors. Mr. Bentz is an experienced businessman who served between 1994 and 2022 as President of North Star Terminal +& Stevedore Company, a full-service stevedoring company located in Alaska and whose major areas of business include terminal operations +and management, stevedore services, and heavy equipment operations. Mr. Bentz has served on the board of directors of GIGA, an OTCQB listed +company that provides purpose-built electronic technology solutions for defense and other mission critical applications, since September +2022. Mr. Bentz has served on the board of directors of ADTC, an NYSE listed SPAC, since its IPO in December 2021. He also has served +as a director and advisor to several private companies and agencies. Mr. Bentz obtained a B.A. in Business and Finance from Western Washington +University in 1981. We believe that Mr. Bentz’s executive-level experience, including his operational and financial oversight of +companies with multiple profit centers and his extensive experience in the real estate and commercial services industries give him the +qualifications and skills to serve as one of our directors. +Howard Ash +Mr. Ash serves as one of our +independent directors. Mr. Ash is an accomplished executive with extensive experience in business and finance, who served as CEO, COO +and CFO to a variety of high profile, international companies. Mr. Ash continues to serve as Chairman of Claridge Management since 2000. +Mr. Ash was a director of Net Element, Inc. (NASDAQ-NETE) from June 13, 2016 through July 13, 2020, serving as Chairman of both the Audit +and Compensation committees, as well as the Nominating and Governance Committees during his tenure. He served as Chief Operating Officer +of BioCard Corporation from 1997 to 2007. He served as Chief Operating Officer of CITA Americas, Inc. from 1996 to 1997. Mr. Ash served +as Chief Executive Officer of IEDC Marketing, Inc. from 1992 to 1996. He held a CFO/Chief Strategist position at Abrams, Ash & Associates +from 1990 to 1992. Mr. Ash currently serves on the Advisory Board of the U.K. based E2Exchange, the Institute of Entrepreneurs, since +2011, and is the only non-UK citizen holding that position. Mr. Ash served from 2009 to 2014 in a senior development and strategic capacity +for One Laptop Per Child, a global NGO created to provide educational opportunities providing laptops to the world’s poorest children. +Prior Chairmanships include the 2009 through 2012 term for the Sturge Weber Foundation, a non-profit organization dedicated to curing +this rare but fatal syndrome affecting children. Previously, Mr. Ash was an Advisory Board Member to Edge Global Investment Limited which +forged a strategic partnership with the Africa Forum, consisting of 37 former Heads of State and Government. Mr. Ash started an interest-free +micro-loan society in 1987 that has provided more than $15 million in micro-loans throughout the U.S. and Israel. In 1999, Mr. Ash founded +the Circle of Life Resource Center, Inc., a food bank in Miami, Florida that feeds several hundred families per week. Mr. Ash earned a +Bachelor of Commerce degree, with Honors in Accounting and Law from the University of Witwatersrand (South Africa) in 1980. We believe +that Mr. Ash’s extensive experience as a business and finance executive and member of multiple oversight bodies, give him the qualification +and skills to serve as one of our directors. +124 +Corporate Governance +Our Board is currently composed +of seven members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) +the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, +from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters +for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at https://www.ault.com . +Audit Committee +Messrs. Ash, Smith and Bentz +currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee +satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE American. Our Board has +also determined that Messrs. Ash and Smith qualify as an “audit committee financial expert” as defined in SEC regulations +and satisfies the financial sophistication requirements set forth in the NYSE American Rules. Mr. Ash serves as the Chairman of the Audit +Committee. +The Audit Committee is responsible +for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to +be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress +and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to +ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services +rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Bentz and Rosenberg +currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation +Committee meets the requirements for independence under the standards of the NYSE American. Mr. Bentz serves as Chairman of the Compensation +Committee. +The Compensation Committee +is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving +salaries, bonuses and other benefits paid to our officers, including our Executive Chairman, Chief Executive Officer, President and Chief +Financial Officer; and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith, Ash and Rosenberg +currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members of +the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE American. Mr. Smith serves +as Chairman of the Nominating and Governance Committee. +The Nominating and Governance +Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees +for each annual meeting of stockholders to the Board; developing and recommending governance principles applicable to our Board; overseeing +the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +The Nominating and Governance +Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based +business and professional skills, experiences and global business and social perspective. +In addition, the Committee +seeks directors who exhibit personal integrity and a concern for the long-term interests of stockholders, as well as those who have time +available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract +and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +125 +Executive Committee +As a holding company, our +business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for Ault Lending and approves all lending transactions. Under its business model, Ault Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to Ault Lending in any particular financing. Ault Lending’s activities are more fully described elsewhere in this Annual Report; +see page 10. +Involvement in Certain Legal Proceedings +Except as set forth below, +to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former director, +executive officer, or employee: +· been convicted in a criminal proceeding or been +subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +· had any bankruptcy petition filed by or against +the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or +executive officer, either at the time of the bankruptcy filing or within two years prior to that time; +· been subject to any order, judgment, or decree, +not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or +temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, +investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; +126 +· been found by a court of competent jurisdiction +in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities +law, and the judgment has not been reversed, suspended, or vacated; +· been the subject of, or a party to, any federal +or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including +any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or +commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited +to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist +order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business +entity; +· or been the subject of, or a party to, any sanction +or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the +Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, +entity or organization that has disciplinary authority over its members or persons associated with a member. +On June 23, 2015, Local Corporation, +a Delaware corporation, filed a voluntary petition for reorganization under Chapter 11 of the US Bankruptcy Code. Mr. Cragun, our +chief financial officer, was chief financial officer of Local Corporation at the time of filing. +Except as set forth in our +discussion below in “Certain Relationships and Related Transactions,” none of our directors or executive officers has been +involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed +pursuant to the rules and regulations of the SEC. +Family Relationships +There are no family relationships among our directors +and executive officers. +Section 16(a) Beneficial Ownership Reporting Compliance +Section 16(a) of the Exchange +Act requires our executive officers and directors and persons who own more than ten percent of a registered class of our equity securities +to file an initial report of ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the SEC. Executive officers, directors +and ten percent stockholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based solely +upon our review of Forms 3, 4 and 5 received by us, or written representations from certain reporting persons, we believe that during +the current fiscal year and the year ended December 31, 2022, all such filing requirements applicable to our officers, directors and ten +percent stockholders were fulfilled with the following exception: During the fiscal year of 2022, Messrs. Rosenberg, Bentz, Smith and +Bentz inadvertently filed 3, 2, 1 and 1, respectively, late Form 4s, each by one day. +Code of Ethics +We have adopted the Code of +Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller +or person performing similar functions. The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical +conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website +at https://www.ault.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit +or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request to our President, Henry Nisser, +we will provide without charge, a copy of our Code of Ethical Conduct. +127 +ITEM 11. EXECUTIVE COMPENSATION +Summary Compensation Table +The following Summary Compensation +Table sets forth all compensation earned in all capacities during the years ended December 31, 2022 and 2021, by our principal executive +officer. Because we are a Smaller Reporting Company, we only have to report information of our principal executive officer and our two +other most highly compensated executive officers. +SUMMARY COMPENSATION TABLE +Name and principal position +Year +Salary ($) +Bonus ($) +Stock Awards ($) (1) +Option +Awards ($) +(1) +All Other Compensation ($) (2) +Total ($) +Milton C. Ault, III +2022 +400,000 +1,716,667 +- +- +47,310 +2,163,976 +Executive Chairman of the Board (3) +2021 +400,000 +821,667 +1,632,000 +1,301,440 +39,918 +4,195,025 +William B. Horne +2022 +300,000 +1,812,500 +- +- +49,664 +2,162,164 +Chief Executive Officer (4) +2021 +300,000 +617,500 +1,632,000 +1,301,440 +41,798 +3,892,738 +Henry C. Nisser +2022 +300,000 +912,000 +- +- +25,832 +1,238,332 +President and General Counsel (5) +2021 +225,000 +217,500 +1,632,000 +1,301,440 +18,800 +3,469,740 +(1) The values reported in the “Stock Awards” and “Option Awards” columns represent the aggregate grant date fair +value, computed in accordance with Accounting Standards Codification (“ ASC ”) 718 Share Based Payments , of +grants of stock options and stock awards to our named executive officer in the years shown. +(2) The amounts in “All Other Compensation” consist of health insurance benefits, vehicle allowance, long-term and short-term +disability insurance benefits, and 401K matching amounts. +(3) Mr. Ault was appointed as our Executive Chairman of the Board on January 19, 2021. Prior to that time, he was our Chief +Executive Officer. +(4) Mr. Horne was appointed as our Chief Executive Officer on January 19, 2021. Prior to that time, he was our President. +(5) Mr. Nisser was appointed as our President on January 19, 2021. +Employment Agreements +Milton C. Ault, III +On +June 17, 2018, the Company entered into a ten year executive employment agreement with Milton C. Ault, III, to serve as Chief Executive +Officer of the Company. On January 19, 2021, Mr. Ault was appointed as Executive Chairman of the Company. For his services, Mr. +Ault will be paid a base salary of $400,000 per annum (the “Base Salary”). +Pursuant +to the terms and subject to the conditions set forth in the agreement, if the Company meets or exceeds criteria adopted by the Company’s +compensation committee (the “Compensation Committee”) for earning bonuses which shall be adopted by the Compensation Committee +annually, Mr. Ault shall be eligible to receive an annual bonus, which percentage shall be based on achievement of applicable performance +goals determined by the Compensation Committee. +In +addition, Mr. Ault shall be eligible to receive a performance-based award (the “CEO Performance Award”), provided that the +Company, for any given fiscal year during the term of this agreement, meets the following criteria: (A) an increase in revenue, as calculated +under GAAP over the previous fiscal year as reported in the Annual Report on Form 10-K or successor form for such fiscal year; provided +that any increase less than thirty-five percent (35%) (the “Revenue Percentage”) shall reduce the CEO Performance Award correspondingly; +(B) positive net income, as calculated under GAAP, as reported in the Annual Report on Form 10-K or successor form for such fiscal year, +provided that any increase less than five percent (5%) (the “Net Income Percentage”) shall reduce the CEO Performance Award +correspondingly; and (C) positive net cash flow from operations on a year-to-year basis, where cash flow is defined as the net amount +of cash and cash-equivalents being transferred into and out of the Company. The CEO Performance Award shall consist of a number of shares +of the Company’s common stock having a maximum value equal to ten percent (10%) of any appreciation in the Company’s Market +Capitalization above the High Water Mark (as such terms are defined in the agreement) as measured by the daily average closing bid price +of the Company’s common stock for the applicable fiscal year subject to proration obtained by the product of Revenue Percentage +and the Net Income Percentage. If the CEO Performance Award in a fiscal year is less than ten percent (10%) due to a reduction caused +by an annual shortfall in either the Revenue Percentage or the Net Income Percentage, the prior year’s targets would be deemed to +have been achieved if a corresponding overage in a subsequent fiscal year results in the achievement of the cumulative targets. +The annual and cumulative targets for revenue and net income, which are provided solely for the purpose of establishing cumulative totals, +are set forth in the agreement. +Upon +termination of Mr. Ault’s employment (other than upon the expiration of the employment), Mr. Ault shall be entitled to receive: +(A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued +but unused vacation time. +128 +Further, +unless Mr. Ault’s employment is terminated as a result of his death or disability or for cause or he terminates his employment without +good reason, then upon the termination or non-renewal of Mr. Ault’s employment, the Company shall pay to Mr. Ault a “Separation +Payment” as follows: (A) an amount equal to four (4) weeks of base salary for each full year of service and +credit for his service commencing from September 22, 2016, (B) should Mr. Ault provide the Company with a separation, waiver and release +agreement within 60 days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “Separation +Period”) of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may +be, but in no event an amount greater than the Base Salary payable should either such period expire within two years, or (2) the 12-month +period commencing on the date Mr. Ault is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, +dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum +annual bonus as Mr. Ault would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar +months worked including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options +and other equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence +of a change in control, Mr. Ault will be paid an amount equal to the greater of: (i) five times his then current Base Salary or (ii) the +Separation Payment amount set forth above, without regard to whether Mr. Ault continues in the employ of the Company or its successor. +William B. Horne +On January 25, 2018, we entered +into an employment agreement with William Horne to serve as Chief Financial Officer and Executive Vice President of the Company and its +subsidiaries for an initial term through September 30, 2022, which automatically renews thereafter for successive one-year terms unless +either party provides written notification at least four months prior to the end of a term of their desire to terminate. For 2022, +Mr. Horne’s base salary was $300,000 per annum. Mr. Horne is eligible to receive an annual cash bonus equal to a percentage of his +annual base salary based on achievement of applicable performance goals determined by the Company’s compensation committee. +Upon +termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to receive: +(i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and (iii) any accrued +but unused vacation time. +Further, +unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne a “Separation +Payment” as follows: (A) an amount equal to four weeks of base salary for each full year of service, (B) should +Mr. Horne provide the Company with a separation, waiver and release agreement within 60 days of termination, then the Company shall: +(i) pay his base salary until the last to occur (the “Separation Period”) of (1) the expiration of the remaining portion of +the initial term or the then applicable renewal term, as the case may be, or (2) the 12-month period commencing on the date Mr. Horne +is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life +insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Horne would have been +otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the entire +month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity awards shall immediately +vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will +be paid an amount equal to four times his Separation Payment. +Henry Nisser +On April 12, 2019, the Company +entered into an employment agreement (the “Agreement”) with Henry Nisser to serve as General Counsel and Executive Vice President +of the Company and its subsidiaries for an initial term through May 1, 20223 which automatically renews thereafter for successive one-year +terms unless either party provides written notification at least four months prior to the end of a term of their desire to terminate. +The effective date of the Agreement was May 1, 2019. For 2022, Mr. Nisser’s base salary was $300,000 per annum (the “Base +Salary”). +Mr. Nisser is eligible to +receive an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined +by the Company’s compensation committee. +Mr. Nisser’s bonuses, +if any, and all stock based compensation shall be subject to “Company Clawback Rights” if during the period that Mr. Nisser +is employed by the Company and upon the termination of Mr. Nisser’s employment and for a period of two years thereafter, there is +a restatement of any of the Company’s financial results from which any bonuses and stock based compensation to Mr. Nisser shall +have been determined. +129 +Upon termination of Mr. Nisser’s +employment (other than upon the expiration of the employment), Mr. Nisser shall be entitled to receive: (A) any earned but unpaid base +salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued but unused vacation time. +Further, +unless Mr. Nisser’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Nisser’s employment, the Company shall pay to Mr. Nisser a +“Separation Payment” as follows: (a) an amount equal to four weeks of base salary for each full year of service, (b) commencing +on the date that shall be one (1) year from the effective date, should Mr. Nisser provide the Company with a separation, waiver and release +agreement within 30 days of termination, then the Company shall pay to Mr. Nisser the Base Salary (in effect immediately prior to the +termination date) an amount equal to the lesser of what Mr. Nisser would have received if the employment period ended after (1) the expiration +of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or (2) the 18-month period commencing +on the date Executive is terminated, payable in one lump sum; (ii) provide during the separation period the same medical, dental, long-term +disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. +Nisser would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked +including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other +equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change +in control, Mr. Nisser will be paid an amount equal to four times his Separation Payment. +Advisory Vote on Executive Compensation +At the annual meeting of stockholders +on November 23, 2022, the stockholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. +An advisory vote on executive compensation is held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding +equity awards as of December 31, 2022 to the named executive officers. +OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2022 +OPTION AWARDS +Name +Number of Securities +Underlying +Unexercised Options +(#) Exercisable +Number of Securities +Underlying +Unexercised Options +(#) Unexercisable +Equity Incentive Plan +Awards: Number of +Securities Underlying +Unexercised +Unearned Options (#) +Option +Exercise +Price ($) +Option +Expiration +Date +Milton C. Ault, III +200,000 +199,726 +- +200,274 +- +200,274 +1.79 +2.55 +9/17/2030 +4/26/2031 +William B. Horne +200,000 +199,726 +- +200,274 +- +200,274 +1.79 +2.55 +9/17/2030 +4/26/2031 +Henry C. Nisser +200,000 +199,726 +- +200,274 +- +200,274 +1.79 +2.55 +9/17/2030 +4/26/2031 +Director Compensation +The Company pays each independent +director an annual base amount of $45,000 annually, other than Messrs. Smith and Ash, who each receive a base amount of $55,000 annually +due to the additional services provided by Mr. Smith as a lead independent director and Mr. Ash as Audit Committee Chairman. Additionally, +our Board makes recommendations for adjustments to an independent director’s compensation when the level of services provided are +significantly above what was anticipated. In addition, independent directors are eligible, at the Board’s discretion, to receive +a bonus. +130 +The table below sets forth, +for each non-employee director, the total amount of compensation related to his service during the year ended December 31, 2022: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($)(1) +Total ($) +Robert O. Smith +55,000 +— +— +215,000 +270,000 +Jeffrey A. Bentz +45,000 +— +— +215,000 +260,000 +Mordechai Rosenberg +45,000 +— +— +190,000 +235,000 +Howard Ash +55,000 +— +— +190,000 +245,000 +(1) Consists of cash bonus payments made to each independent director. +Stock Incentive Plans +On December 28, 2018, the +stockholders approved the 2018 Stock Incentive Plan (as amended on May 5, 2019), which amendment was approved by the stockholders on July +19, 2019, the “2018 Stock Incentive Plan”), under which options to acquire up to 175,000 shares of common stock may be +granted to the Company's directors, officers, employees and consultants. The 2018 Stock Incentive Plan is in addition to the Company’s +(i) 2017 Stock Incentive Plan, under which options to acquire up to 2,500 shares of common stock may be granted to the Company's directors, +officers, employees and consultants, (ii) 2016 Stock Incentive Plan, under which options to acquire up to 5,000 shares of common stock +may be granted to the Company's directors, officers, employees and consultants, (iii) 2012 Stock Option Plan, as amended, which provides +for the issuance of a maximum of 1,716 shares of common stock to be offered to the Company’s directors, officers, employees, and +consultants, (iv) 2021 Stock Incentive Plan, under which 7.5 million stock options, restricted stock, stock appreciation rights, restricted +stock units, and other stock-based compensation. be granted to the Company's directors, officers, employees and consultants, (v) 2021 +Employee Stock Purchase Plan, intended to assist our employees in acquiring share ownership up to an aggregate of 980,000 shares of common +stock, and (vi) 2022 Stock Incentive Plan, under which 75 million stock options, restricted stock, stock appreciation rights, restricted +stock units, and other stock-based compensation. be granted to the Company's directors, officers, employees and consultants (collectively +the “Plans”). +The purpose of the Plans is +to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial responsibility +for the direction and management of the Company, as well as certain directors and consultants of the Company, additional incentives to +exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, to reward outstanding +performance and to provide a means to attract and retain persons of outstanding ability to the service of the Company. +As of December 31, 2022, options +to purchase 3,160,844 shares of common stock were issued and outstanding, and 78,076,774 shares are available for future issuance under +the Plans. +401(k) Plans +Ault Alliance, TurnOnGreen +and Microphase have adopted tax-qualified employee savings and retirement plan, or 401(k) plans, which generally covers all of their full-time +employees. Pursuant to the 401(k) plans, eligible employees may make voluntary contributions to the plan up to a maximum of pursuant to +the current Internal Revenue Code limits. The Microphase 401(k) plan permits, but does not require, matching contributions by them on +behalf of plan participants. The Ault Alliance and TurnOnGreen 401(k) plans, includes matching contributions at the rate of (1) $1.00 +for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary +and permits discretionary contributions. The 401(k) plans are intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue +Code of 1986, as amended. Contributions to such a qualified plan are deductible by the Company when made, and neither the contributions +nor the income earned on those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited +to separate accounts maintained in trust. +Effective January 1, 2001, +SMC adopted a voluntary 401(k) plan. All SMC employees with at least one year of service are eligible to participate in the 401(k) plan. +SMC makes a matching contribution of 100% of salary deferral contributions up to 3% of pay, plus 50% of salary deferral contributions +from 3% to 5% of pay for each payroll period. +131 +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +Except as otherwise indicated +below, the following table sets forth certain information regarding beneficial ownership of our common stock as of April 17, 2023 by (1) +each of our current directors; (2) each of the executive officers; (3) each person known to us to be the beneficial owner of more than +5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and +executive officers as a group. As of April 17, 2023, there were 415,746,694 shares of our common stock issued and outstanding. +Beneficial ownership is determined +in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to +options or warrants that are currently exercisable or exercisable within 60 days of April 17, 2023 are deemed to be outstanding and to +be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of +such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or +group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table have sole voting and sole investment power +with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. +Name and address of beneficial owner +Number of +shares +beneficially +owned +Approximate +percent +of class +Greater than 5% Beneficial Owners: +Ault Alpha LP +50,000,000 +(2) +12.03 % +Ault & Company, Inc. +52,666,882 +(3) +12.64 % +Directors and Officers: (1) +Milton Ault, III +53,960,007 +(4) +12.93 % +William Horne +1,086,639 +(5) +* +Henry Nisser +1,089,583 +(6) +* +Ken Cragun +426,042 +(7) +* +Robert Smith +330,000 +(8) +* +Mordechai Rosenberg +350,000 +(9) +* +Jeffrey A. Bentz +350,000 +(9) +* +Howard Ash +300,000 +(10) +* +All directors and executive officers as a group (eight persons) +57,892,271 +13.81 % +* Less than one percent. +(1) Unless otherwise indicated, the business address of each of the individuals is c/o Ault Alliance, Inc., +11411 Southern Highlands Pkwy, Suite 240, Las Vegas, NV 89141. Percent of class refers to percentage of class beneficially owned as the +term “beneficial ownership” is defined in Rule 13d-3 under the Exchange Act and is based upon the 415,746,694 shares of Common +Stock outstanding as of the Record Date. +(2) Includes 50,000,000 shares of Common Stock. +(3) Includes (i) 1,658,916 shares of Common Stock, (ii) 94 shares of Common Stock underlying currently exercisable +warrants, (iii) 1,000,000 shares of Common Stock purchasable pursuant to a Securities Purchase Agreement entered into on June 11, 2021 +with Ault Alliance, (iv) 50,000,000 shares of Common Stock held by Ault Alpha LP (“AA”), (v) 3,408 shares of Common Stock +held by Philou Ventures, LLC (“Philou Ventures”), (vi) 2,232 shares of Common Stock underlying currently exercisable warrants +held by Philou Ventures, and (vii) 2,232 shares of Common Stock issuable upon the conversion of 125,000 shares of Series B Preferred Stock +held by Philou Ventures. Ault Alpha GP LLC (“Ault GP”) and Ault Capital Management LLC (“AC Management”) are the +general partner and investment manager of AA, respectively. Ault & Company, Inc. (“A&C”) is the Manager of Philou +Ventures. Mr. Ault is the Chief Executive Officer of A&C. Mr. Ault is the Manager of Ault GP and AC Management +132 +(4) Includes (i) 809,792 shares of Common Stock, (ii) 483,333 shares of Common Stock underlying stock options +that are exercisable within 60 days of the Record Date, (iii) 50,000,000 shares of Common Stock held by AA, (iv) 1,658,916 shares of Common +Stock held by A&C, (v) 94 shares of Common Stock underlying warrants that are exercisable within 60 days of the Record Date held by +A&C, (vi) 1,000,000 shares of Common Stock purchasable pursuant to a Securities Purchase Agreement entered into on June 11, 2021 between +A&C and Ault Alliance, (vii) 3,408 shares of Common Stock held by Philou Ventures, (viii) 2,232 shares of Common Stock underlying +warrants that are exercisable within 60 days of the Record Date held by Philou Ventures, and (ix) 2,232 shares of Common Stock issuable +upon the conversion of 125,000 shares of Series B Preferred Stock held by Philou Ventures. Ault GP and AC Management are the general partner +and investment manager to AA, respectively. A&C is the Manager of Philou Ventures. Mr. Ault is the Chief Executive Officer of A&C. +Mr. Ault is the Manager of Ault GP and AC Management. +(5) Includes (i) 603,306 shares of Common Stock and (ii) 483,333 shares of Common Stock underlying stock options +that are exercisable within 60 days of the Record Date. +(6) Includes (i) 606,250 shares of Common Stock and (ii) 483,333 shares of Common Stock underlying stock options +that are exercisable within 60 days of the Record Date. +(7) Includes (i) 200,000 shares of Common Stock and (ii) 226,042 shares of Common Stock underlying stock options +that are exercisable within 60 days of the Record Date. +(8) Includes (i) 130,000 shares of Common Stock and (ii) 200,000 shares of Common Stock underlying stock options +that are exercisable within 60 days of the Record Date. +(9) Includes (i) 150,000 shares of Common Stock and (ii) 200,000 shares of Common Stock underlying stock options +that are exercisable within 60 days of the Record Date. +(10) Includes (i) 100,000 shares of Common Stock and (ii) 200,000 shares of Common Stock underlying stock options +that are exercisable within 60 days of the Record Date. +Equity Compensation Information +The following table summarizes information about +our equity compensation plans as of December 31, 2022. +Number of securities +Number of securities +Weighted- +remaining available for +to be issued +average +future issuance under +upon exercise +exercise price +equity compensation plans +of outstanding +of outstanding +(excluding securities +options, warrants and rights +options, warrants and rights +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation plans approved by stockholders +3,160,844 +2.49 +78,076,774 +Equity compensation plans not approved by stockholders +2,650,000 +2.31 +- +Total +5,810,844 +2.40 +78,076,774 +133 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• the aggregate amount involved is determined to by the Audit Committee to be material; +• we are a participant; and +• any of the following has or will have a direct or indirect interest in the transaction: +• an executive officer, director, or nominee for election as a director; +• a greater than five percent beneficial owner of our common stock; or +• any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company. +Avalanche +On September 6, 2017, we entered +into the AVLP Loan Agreement with an effective date of August 21, 2017 pursuant to which we provided Avalanche a non-revolving credit +facility. The AVLP Loan Agreement has been increased to up to $20.0 million and extended to December 31, 2023. Until recently, we held +a convertible note issued to us by AVLP in the amount of $20.0 million (the “Prior AVLP Note”). +At December 31, 2021, we had +provided Avalanche with $17.8 million and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase +35.6 million shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets +of AVLP. As of December 31, 2021, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and +a provision for loan losses of $2.0 million. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 35.6 million shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +While +Avalanche received funds from a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of +a convertible promissory note to such third party (the “Third Party Note”), $2.7 million was used to pay an outstanding receivable +due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, Ault Alpha, +an affiliate of ours, repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. +In consideration therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note had a maturity +date of June 30, 2022. +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for a 10% senior secured convertible note in the principal face amount of $3.8 million due June +15, 2024 (the “Ault Alpha Note”). The Ault Alpha Note is convertible, subject to adjustment, at $0.50 per share. AVLP also +issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise price of $0.50. Pursuant +to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the +foregoing parties, our company and certain other persons, Ault Alpha has a second priority interest in AVLP’s assets securing the +repayment of the Ault Alpha Note. +On July 11, 2022, AVLP issued +us a 10% senior secured convertible note in the principal face amount of $3.0 million due July 10, 2024 (the “AVLP Note”). +The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an aggregate of 41.0 +million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into by Avalanche and +Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and certain other persons, +we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +On June 1, 2022, we converted +the entire principal and accrued interest on the Prior AVLP Note into an aggregate of 51.9 million shares of common stock of Avalanche, +representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. There is currently no liquid market +for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common stock on the open market, our ability +to do so would be severely limited. Avalanche is not current in its filings with the Commission and is not required to register the shares +of its common stock underlying the Prior AVLP Note or any other loan arrangement we have made with Avalanche described above. +134 +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is an affiliate +of our company. See immediately above for its involvement with respect to the Third Party Note. As of December 31, 2022, Ault Alpha had +purchased 50 million shares of our common stock at an average price of $0.55. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. Bentz +Yes +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairman of committee +X – Member of committee +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +Marcum LLP served as our independent +registered public accounting firm for the years ended December 31, 2022 and 2021. Ziv Haft, a BDO Member Firm, served as the independent +registered public accounting firm of Enertec for the years ended December 31, 2022 and 2021. +Fees and Services +The following table shows +the aggregate fees billed to us for professional services by Marcum LLP and Ziv Haft for the years ended December 31, 2022 and 2021: +2022 +2021 +Audit Services +$ 3,280,000 +$ 1,293,000 +Audit Related Services +— +— +Tax Services +— +— +All Other Services +— +— +Total +$ 3,280,000 +$ 1,293,000 +Audit Fees. This +category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years +ended December 31, 2022 and 2021, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2022 +and 2021, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings +or engagements for the relevant years. +Audit-Related Fees. This +category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors +that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under “Audit +Fees,” and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, +internal control-related matters, and audits of employee benefit plans. +135 +Tax Fees . This category +includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax +compliance, tax planning and tax advice. +All Other Fees. This +category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors +that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s +policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, +tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent +auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such +pre-approval. +136 +PART IV +ITEM 15. EXHIBITS +Exhibit +Number +Description +2.1 +Agreement and Plan of Merger dated January 7, 2021 . Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 2.1 thereto. +2.2 +Agreement and Plan of Merger dated December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 2.1 thereto. +2.3 +Agreement and Plan of Merger dated December 20, 2022. Incorporated by reference to the Current Report on Form 8-K filed on December 21, 2022 as Exhibit 2.1 thereto. +3.1 +Form of Certificate of Determination of Preferences, Rights and Limitations of Series B Convertible Preferred Stock, dated March 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 3.1 thereto. +3.2 +Certification of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.1 thereto. +3.3 +Certificate of Designations of Rights and Preferences of 10% Series A Cumulative Redeemable Perpetual Preferred Stock, dated September 13, 2018. Incorporated herein by reference to the Current Report on Form 8-K filed on September 14, 2018 as Exhibit 3.1 thereto. +3.4 +Certificate of Amendment to Certificate of Incorporation, dated January 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2019 as Exhibit 3.1 thereto. +3.5 +Certificate of Designations of Rights and Preferences of Series C Convertible Redeemable Preferred Stock, dated February 27, 2019. Incorporated herein by reference to the Current Report on Form 8-K filed on February 28, 2019 as Exhibit 3.1 thereto. +3.6 +Certificate of Amendment to Certificate of Incorporation (1-for-20 Reverse Stock Split of Common Stock), dated March 14, 2019. Incorporated herein by reference to the Current Report on Form 8-K filed on March 14, 2019 as Exhibit 3.1 thereto. +3.7 +Form of Amended & Restated Certificate of Designations of Rights and Preferences of Series C Convertible Preferred Stock. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2020 as Exhibit 3.1 thereto. +3.8 +Bylaws effective as of August 13, 2020. Incorporated by reference to the Current Report on Form 8-K filed on August 14, 2020 as Exhibit 3.1 thereto. +3.9 +Certificate of Ownership and Merger. Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 3.1 thereto. +3.10 +Amended and Restated Bylaws of BitNile Holdings, Inc., effective as of November 2, 2021. Incorporated by reference to the Current Report on Form 8-K filed on November 3, 2021 as Exhibit 3.1 thereto. +3.11 +Certificate of Ownership and Merger, as filed with the Secretary of State of the State of Delaware on December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 3.1 thereto. +3.12 +Certificate of Designation, Preferences and Rights relating to the 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated May 25, 2022. Incorporated by reference to the Registration Statement on Form 8-A filed on May 26, 2022 as Exhibit 3.6 thereto. +3.13 +Certificate of Increase of the Designated Number of Shares of 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated June 10, 2022. Incorporated by reference to the Current Report on Form 8-K filed on June 14, 2022 as Exhibit 3.1 thereto. +3.14 +Certificate of Correction to the Certificate of Designation, Rights and Preferences of 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated June 16, 2022. Incorporated by reference to the Current Report on Form 8-K filed on June 17, 2022 as Exhibit 3.1 thereto. +3.15 +Certificate of Ownership and Merger, as filed with the Secretary of State of the State of Delaware on December 20, 2022. Incorporated by reference to the Current Report on Form 8-K filed on December 21, 2022 as Exhibit 3.1 thereto. +3.16 +Certificate of Elimination of the Series C convertible redeemable preferred stock of Ault Alliance, Inc. Incorporated by reference to the Current Report on Form 8-K filed on January 27, 2023 as Exhibit 3.1 thereto. +3.17 +Certificate of Designation of Series E Convertible Preferred Stock . Incorporated by reference to the Current Report on Form 8-K filed on March 30, 2023 as Exhibit 3.1 thereto. +3.18 +Certificate of Designation of Series F Convertible Preferred Stock . Incorporated by reference to the Current Report on Form 8-K filed on March 30, 2023 as Exhibit 3.2 thereto. +3.19 +Certificate of Designation of Series G Convertible Preferred Stock . Incorporated by reference to the Current Report on Form 8-K filed on March 30, 2023 as Exhibit 3.3 thereto. +4.1 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on March 9, 2017 as Exhibit 4.1 thereto. +4.2 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on April 4, 2017 as Exhibit 4.1 thereto. +137 +Exhibit +Number +Description +4.3 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on May 31, 2017 as Exhibit 4.1 thereto. +4.4 +Form of Common Stock Purchase Warrant, dated July 27, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 26, 2017 as Exhibit 4.1 thereto. +4.5 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.1 thereto. +4.6 +Form of Common Stock Purchase Warrant, dated July 28, 2017. Incorporated by reference to the Current Report on Form 8-K filed on July 31, 2017 as Exhibit 4.2 thereto. +4.7 +Form of Common Stock Purchase Warrant, dated August 3, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 9, 2017 as Exhibit 10.3 thereto. +4.8 +Form of Common Stock Purchase Warrant, dated August 10, 2017. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2017 as Exhibit 4.1 thereto. +4.9 +Common Stock Purchase Warrant issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 4.1 thereto. +4.10 +Convertible Promissory Note issued by Avalanche International Corp. to the Company, dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.2 thereto. +4.11 +Form of Common Stock Purchase Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 2, 2017 as Exhibit 4.1 thereto. +4.12 +Form of Common Stock Purchase Warrant, dated March 23, 2018. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2018 as Exhibit 4.1 thereto. +4.13 +Form of Common Stock Purchase Warrant, dated April 16, 2018. Incorporated by reference to the Current Report on Form 8-K filed on April 16, 2018 as Exhibit 4.1 thereto. +4.14 +Form of Series A Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.1 thereto. +4.15 +Form of Series B Common Stock Purchase Warrant, dated May 17, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.16 +Form of Series A Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.2 thereto. +4.17 +Form of Series B Common Stock Purchase Warrant, dated May 15, 2018. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2018 as Exhibit 4.3 thereto. +4.18 +Form of Underwriter’s Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on April 1, 2019 as Exhibit 4.3 thereto. +4.19 +Form of Common Warrant, dated April 2, 2019. Incorporated by reference to the Current Report on Form 8-K/A filed on April 4, 2019 as Exhibit 4.1 thereto. +4.20 +Form of Convertible Promissory Note, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 4.1 thereto. +4.21 +Form of Warrant, dated May 13, 2019. Incorporated by reference to the Current Report on Form 8-K filed on May 20, 2019 as Exhibit 4.2 thereto. +4.22 +Form of Warrant, dated as of May 28, 2020. Incorporated by reference to the Current Report on Form 8-K filed on May 29, 2020 as Exhibit 4.3 thereto. +4.23 +Form of Warrant, dated June 26, 2020. Incorporated by reference to the Current Report on Form 8-K filed on June 29, 2020 as Exhibit 4.2 thereto. +4.24 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on July 17, 2020 as Exhibit 4.2 thereto. +4.25 +Form of Warrant, dated October 22, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 23, 2020 as Exhibit 4.2 thereto. +4.26 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.3 thereto. +4.27 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.4 thereto. +4.28 +Form of Warrant issued to Esousa Holdings, LLC, dated November 19, 2020. Incorporated by reference to the Current Report on Form 8-K filed on November 20, 2020 as Exhibit 4.3 thereto. +4.29 +Form of Senior Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.1 thereto. +4.30 +Form of Subordinated Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.2 thereto. +4.31 +Form of Note , dated December 15, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 16, 2021 as Exhibit 4.1 thereto. +138 +Exhibit +Number +Description +4.32 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on December 22, 2021 as Exhibit 4.1 thereto. +4.33 +Form of Note, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.1 thereto. +4.34 +Form of Class A Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.2 thereto. +4.35 +Form of Class B Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.3 thereto. +4.36 +Form of Amendment to Class B Warrant. Incorporated by reference to the Current Report on Form 8-K filed on January 21, 2022 as Exhibit 10.2 thereto. +4.37 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2022 as Exhibit 4.1 thereto. +4.38 +Form of Class A Warrant . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 4.1 thereto. +4.39 +Form of Class B Warrant . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 4.2 thereto. +4.40 +Form of Note . Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 4.1 thereto. +4.41** +Description of Capital Stock. +10.1 +Loan and Security Agreement between the Company and Avalanche International Corp., dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.1 thereto. +10.2 +Amendment to MTIX Limited Purchase Order Number 2121. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2020 as Exhibit 10.2 thereto. +10.3 +At-The-Market Issuance Sales Agreement, dated January 22, 2021, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on January 25, 2021 as Exhibit 10.1 thereto. +10.4 +Amendment No. 1 dated February 17, 2021 to At-The-Market Issuance Sales Agreement, dated January 22, 2021, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on February 17, 2021 as Exhibit 10.1 thereto. +10.5 +Amendment No. 2 dated March 5, 2021 to At-The-Market Issuance Sales Agreement, dated January 22, 2021, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on March 5, 2021 as Exhibit 10.1 thereto. +10.6 +Termination Agreement, dated December 31, 2020. Incorporated by reference to the Current Report on Form 8-K filed on January 4, 2021 as Exhibit 10.1 thereto. +10.7 +Form of Securities Purchase Agreement, dated June 10, 2021. Incorporated by reference to the Current Report on Form 8-K filed on June 15, 2021 as Exhibit 10.1 thereto. +10.8* +Executive Employment Agreement with Christopher K. Wu dated June 22, 2021. Incorporated by reference to the Current Report on Form 8-K filed on June 23, 2021 as Exhibit 10.1 thereto. +10.9* +2021 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix B thereto . +10.10* +2021 Employee Stock Purchase Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix C thereto. +10.11* +Form of Stock Option Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.3 thereto. +10.12* +Form of Restricted Stock Unit Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.4 thereto. +10.13 +Form of Non-Fixed Price Sales and Purchase Agreement, by and between Ault Alliance, Inc. and Bitmain Technologies Limited, dated September 12, 2021. Incorporated by reference to the Current Report on Form 8-K filed on September 15, 2021 as Exhibit 10.1 thereto. +10.14 +Form of Non-Fixed Price Sales and Purchase Agreement, by and between Ault Alliance, Inc. and Bitmain Technologies Limited. Incorporated by reference to the Current Report on Form 8-K filed on November 17, 2021 as Exhibit 10.1 thereto. +10.15 +Form of Non-Fixed Price Sales and Purchase Agreement, by and between Ault Alliance, Inc. and Bitmain Technologies Limited. Incorporated by reference to the Current Report on Form 8-K filed on November 18, 2021 as Exhibit 10.1 thereto. +10.16 +Form of Note Purchase Agreement, dated December 15, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 16, 2021 as Exhibit 10.1 thereto. +10.17 +Form of Note Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 22, 2021 as Exhibit 10.1 thereto. +10.18 +Form of Construction Loan Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.1 thereto. +139 +Exhibit +Number +Description +10.19 +Form of Mortgage, Assignment of Rents and Leases, Security Agreement and Fixture Filing. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.2 thereto. +10.20 +Form of Assignment of Leases, Rents and Profits. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.3 thereto. +10.21 +Form of Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.4 thereto. +10.22 +Share Exchange Agreement dated as of December 27, 2021 by and among Giga-tronics Incorporated, BitNile Holdings, Inc. and Gresham Worldwide, Inc. Incorporated by reference to the Current Report on Form 8-K filed on December 28, 2021 as Exhibit 10.1 thereto. +10.23 +Form of Securities Purchase Agreement, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.1 thereto. +10.24 +Form of Security Agreement, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.2 thereto. +10.25 +Form of A&C Guaranty, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.3 thereto. +10.26 +Form of Subsidiary Guaranty, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.4 thereto. +10.27 +Form of Contract of Sale. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 10.1 thereto . +10.28 +At-The-Market Issuance Sales Agreement, dated February 25, 2022, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2022 as Exhibit 10.1 thereto. +10.29 +Form of Asset Purchase Agreement . Incorporated by reference to the Current Report on Form 8-K filed on April 25, 2022 as Exhibit 10.1 thereto. +10.30 +Form of Senior Secured Superpriority Debtor-in-Possession Financing Term Sheet . Incorporated by reference to the Current Report on Form 8-K filed on April 25, 2022 as Exhibit 10.2 thereto. +10.31 +At-The-Market Issuance Sales Agreement, dated June 14, 2022, with Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on June 14, 2022 as Exhibit 10.1 thereto. +10.32 +Form of Note Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2022 as Exhibit 10.1 thereto. +10.33 +Form of Security Agreement. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2022 as Exhibit 10.2 thereto. +10.34 +Form of Subsidiary Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2022 as Exhibit 10.3 thereto. +10.35 +Form of Parent Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2022 as Exhibit 10.4 thereto. +10.36 +Form of Master Agreement. Incorporated by reference to the Current Report on Form 8-K filed on August 16, 2022 as Exhibit 10.1 thereto. +10.37+ +Form of Order Form. Incorporated by reference to the Current Report on Form 8-K filed on August 16, 2022 as Exhibit 10.2 thereto. +10.38* +2022 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on September 23, 2022 as Annex B thereto . +10.39 +Form of Loan and Purchase Agreement . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.1 thereto. +10.40 +Form of Security Agreement . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.2 thereto. +10.41 +Form of the Third Avenue Pledge . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.3 thereto. +10.42 +Form of the Alliance Cloud Pledge . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.4 thereto. +10.43 +Form of the Ault Aviation Pledge . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.5 thereto. +10.44 +Form of the Account Pledge . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.6 thereto. +10.45 +Form of the Florida Mortgage . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.7 thereto. +10.46 +Form of the Michigan Mortgage . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.8 thereto. +10.47 +Form of the Aircraft Mortgage . Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 10.9 thereto. +140 +Exhibit +Number +Description +10.48 +Asset Purchase Agreement, dated as of November 17, 2022, by and among Circle 8 Crane Services LLC, and Circle 8 Newco LLC. Schedules and exhibits to this document are omitted pursuant to Item 601(b)(2) of Regulation S-K. The registrant agrees to furnish supplementally a copy of any omitted schedule or exhibit to the Securities and Exchange Commission upon request. Incorporated by reference to the Current Report on Form 8-K filed on November 18, 2022 as Exhibit 2.1 thereto. +10.49+ +Form of Master Service Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 7, 2022 as Exhibit 10.1 thereto. +10.50 +Form of Securities Purchase Agreement . Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 10.1 thereto. +10.51 +Form of Security Agreement . Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 10.2 thereto. +10.52 +Form of Guaranty . Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 10.3 thereto. +10.53 +Form of Amended and Restated Amendment to Securities Purchase Agreement . Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2023 as Exhibit 10.4 thereto. +10.54 +Form of Share Exchange Agreement, entered into February 8, 2023 . Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.1 thereto. +10.55 +Form of Series B Preferred Stock Certificate of Designations . Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.2 thereto. +10.56 +Form of Series C Preferred Stock Certificate of Designations . Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.3 thereto. +10.57 +Form of Securities Purchase Agreement among the registrant and the Investors, dated March 28, 2023 . Incorporated by reference to the Current Report on Form 8-K filed on March 30, 2023 as Exhibit 10.1 thereto. +10.58 +Form of Side Letter among the registrant and the Investors, dated March 28, 2023 . Incorporated by reference to the Current Report on Form 8-K filed on March 30, 2023 as Exhibit 10.2 thereto. +21** +List of subsidiaries. +23.1** +Consent of Marcum LLP. +23.2** +Consent of Ziv Haft, BDO member firm. +31.1** +Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a). +31.2** +Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a). +32.1*** +Certification +of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 +of Title 18 of the United States Code. +101.INS** +Inline XBRL Instance Document. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH** +Inline XBRL Taxonomy Extension Schema Document. +101.CAL** +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF** +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB** +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE** +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +* Indicates management contract or compensatory plan or arrangement. +** Filed herewith. +*** Furnished herewith. ++ Certain information in this document +has been excluded pursuant to Regulation S-K, Item 601(b)(10). Such excluded information is not material and is the type that the registrant +treats as private or confidential. A copy of omitted information will be furnished to the Securities and Exchange Commission upon request; +provided, however, that the parties may request confidential treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, +as amended, for any document so furnished. +ITEM 16. FORM 10–K SUMMARY +None. +141 +SIGNATURES +Pursuant to the requirements of Section 13 +or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned +thereunto duly authorized. +Dated: April 17, 2023 +AULT ALLIANCE, INC. +By: +/s/ William B. Horne +William B. Horne +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ Kenneth S. Cragun +Kenneth S. Cragun +Chief Financial Officer +(Principal Financial and Accounting Officer) +Pursuant to the requirements of the Securities +Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +April 17, 2023 +/s/ Milton C. Ault, III +Milton C. Ault, III, Executive Chairman of the Board +April 17, 2023 +/s/ William B. Horne +William B. Horne, Chief Executive Officer and Director +April 17, 2023 +/s/ Henry Nisser +Henry Nisser, President, General Counsel and Director +April 17, 2023 +/s/ Howard Ash +Howard Ash, Director +April 17, 2023 +/s/ Robert O. Smith +Robert O. Smith, Director +April 17, 2023 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, Director +April 17, 2023 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +142 +ITEM 8. FINANCIAL STATEMENTS +AULT ALLIANCE, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm – Marcum LLP (PCAOB ID Number 688 ) +F-2 +Report of Independent Registered Public Accounting Firm – Ziv Haft. (PCAOB ID Number 1185) +F-5 +Consolidated Balance Sheets as of December 31, 2022 and 2021 +F-7 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2022 and 2021 +F-9 +Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2022 and 2021 +F-10 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2022 and 2021 +F-12 +Notes to Consolidated Financial Statements +F-14 – F-58 +F- 1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Stockholders and Board of Directors of +Ault Alliance, Inc. and Subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated +balance sheets of Ault Alliance, Inc. (f/k/a BitNile Holdings, Inc.) and subsidiaries (the “Company”) as of December 31, 2022 +and 2021, the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity and cash flows +for each of the two years in the period ended December 31 2022, and the related notes (collectively referred to as the “financial +statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company +as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years in the period ended December +31, 2022, in conformity with accounting principles generally accepted in the United States of America. +We did not audit the December 31, 2022 and 2021 +financial statements of Enertec Systems 2001 Ltd., a wholly-owned subsidiary, which statements reflect 3% and 3% of the total consolidated +assets as of December 31, 2022 and 2021, respectively, 9% and 21% of the total consolidated revenues for the year ended December +31, 2022 and 2021, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, +insofar as it relates to the amounts included for Enertec Systems 2001 Ltd., is based solely on the report of the other auditors. +Explanatory Paragraph – Going Concern +The accompanying consolidated financial statements +have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the Company has a working +capital deficiency, has incurred net losses and needs to raise additional funds to meet its obligations and sustain its operations. These +conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters +are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome +of this uncertainty. +Basis for Opinion +These financial statements are the responsibility +of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit s . +We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and +are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules +and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit s in accordance with +the standards of the PCAOB . Those standards require that we plan and perform the audit to obtain reasonable assurance about whether +the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were +we engaged to perform, an audit of its internal control over financial reporting. As part of our audit s we are required to obtain +an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of +the Company's internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below +are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to +the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our +especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion +on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions +on the critical audit matters or on the accounts or disclosures to which they relate. +F- 2 +Evaluation +of the Accounting for and Disclosure of Cryptocurrency Mining Revenue Recognized +We identified the accounting for and disclosure +of revenue recognized from Bitcoin Mining as a critical audit matter due to the complexities involved in auditing the completeness and +occurrence of this revenue recognized by the Company. During the year ended December 31, 2022, the Company recognized revenue from Bitcoin +Mining of approximately $16.7 million. The Company’s management has exercised significant judgment in their determination of how +existing accounting principles generally accepted in the United States should be applied to the accounting for and disclosure of revenue +recognized from Bitcoin Mining. In addition, the accounting for and disclosure of Bitcoin mining revenue recognized involved certain applications +subject to the general controls over the information technology environment of the Company. +The primary procedures we performed to address +this critical audit matter included the following: +· Evaluated the design and effectiveness of IT +general controls over the Company’s IT environment and key financially relevant systems; +· Evaluated the design of certain financial controls +pertaining to the Company’s processes for recognizing revenue from Bitcoin Mining; +· Performed site visitations of the facilities +where the Company’s mining hardware is located, which included an observation of the physical and environmental controls and mining +equipment inventory observation procedures; +· On a sample basis, tested the hashing power contributed +by the Company’s mining hardware; +· Performed certain substantive analytical procedures +using hashing power data and electricity consumption data to determine the completeness and occurrence of digital assets rewarded to the +Company as consideration for services rendered +· Evaluated management’s rationale for the +application of ASC 606 to account for its Bitcoin earned, which included evaluating the provisions of the contract between the Company +and the Mining Pool Operators; +· Evaluated management’s disclosures of its +Bitcoin activity in the financial statement footnotes; +· Evaluated and tested management’s rationale +and supporting documentation associated with the valuation of Bitcoin earned; +· Independently confirmed certain financial and +performance data directly with the blockchain network and the Mining Pool Operators; and +· Compared the Company’s digital wallet and +custody records to publicly available blockchain records. +Evaluation of the Accounting for and Fair Value +of a Related Party Business Combination +On June 1, 2022, the Company converted the principal +amount under the convertible promissory notes issued to it by Avalanche International Corp. (“AVLP”) and accrued unpaid interest +into common stock of AVLP. The Company converted $20.0 million in principal and $5.9 million of accrued interest receivable at a conversion +price of $0.50 per share and received 51,889,168 shares of common stock (the “Conversion”), increasing its common stock ownership +of AVLP from less than 20% to approximately 92%. +We have identified the Conversion as a critical +audit matter as a result of the existing related party relationship and the significant judgement used by the Company to determine the +accounting and reporting implications of this transaction, including determination of the fair value of consideration transferred, assets +acquired, and liabilities assumed. Auditing management’s models to determine the fair value was complex and required judgment, particularly +when evaluating inputs such as discount rates, royalty rates, comparable guideline public companies, and income projections. These assumptions +are affected by potential future outcomes, market and industry factors, as well as estimates of the AVLP’s future growth. +The primary procedures we performed to address +this critical audit matter included the following: +· We obtained an understanding of the design and +evaluated the implementation of controls associated with the Company’s process to establish a valuation methodology and determine +assumptions used in valuation models to conclude on fair value. We gained an understanding of management’s review controls over +the significant assumptions described above as well as over the data used in the valuation models; +· We evaluated the Company’s accounting position +regarding the Conversion to ensure appropriate accounting in consideration of the applicable accounting guidance; +· We gained an understanding of the Company’s +process used to develop projections and tested significant inputs including projected sales volume, gross margins, operating expenses, +and capital expenditures for reasonableness based on historical experience of AVLP or its comparable guideline public companies, or other +market data; and +F- 3 +· With assistance from our valuation specialists, +we evaluated the reasonableness of the valuation methodology and significant assumptions; and tested inputs for reasonableness, including +discount rates, royalty rates, and comparable guideline public companies; and corroborated with audit evidence from external sources or +comparisons to other companies in the industry. +/s/ Marcum llp +Marcum llp +We have served as the Company’s auditor +since 2016. +New York, New York +April 17, 2023 +F- 4 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Board of Directors and Management of Enertec systems 2001 Ltd. +Karmiel, Israel. +Opinion on the Financial Statements +We have audited the statements of financial position +of Enertec systems 2001 Ltd. ("the Company") as of December 31, 2022 and 2021, the related statements of comprehensive profit +/(loss), changes in shareholders' equity, and cash flows for each of the years then ended, and the related notes (collectively, the financial +statements (not presented herein)). In our opinion, the financial statements present fairly, in all material respects, the financial position +of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended, in conformity +with accounting principles generally accepted in the United States of America. +Basis for Opinion +These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are +a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be +independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of +the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the +standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require +that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, +whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over +financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but +not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, +we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is +a matter arising from the current period audit of the financial statements that was communicated and that: (1) relates to accounts or +disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. +The communication of critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we +are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts +or disclosures to which it relates. +Estimation of total contract +costs to be incurred for fixed-price long-term contract revenue +As described in Note 2 to the financial statements, +the Company recognizes a significant portion of its revenue over time using the cost-to-cost measure of progress, which measures a contract’s +progress toward completion based on the ratio of actual contract costs incurred to date to the Company’s estimated costs at completion. +The cost estimation process for these contracts is based on the knowledge and experience of the Company’s project managers, engineers, +and financial professionals. Changes in job performance, job conditions and management’s assessment of expected variable consideration +are factors that influence estimates of the total contract transaction price, total costs to complete those contracts and the Company’s +revenue recognition. +F- 5 +We identified estimated costs to complete on certain +revenue contracts as a critical audit matter. The determination of the total estimated cost and progress toward completion requires management +to make significant estimates and assumptions. Total estimated costs to complete projects include various costs such as direct labor, +material, and subcontract costs. Changes in these estimates can have a significant impact on the revenue recognized each period. Auditing +these estimates involved especially challenging auditor judgment in evaluating the reasonableness of management’s assumptions and +estimates over the duration of these contracts. +The primary procedures we performed to address +this critical audit matter included: +· Examining a sample of revenue contracts to evaluate the appropriateness of the Company’s identification +of performance obligations and the determination of method for measuring contract progress. +· Assessing the reasonableness of the estimated costs to complete by selecting a sample of open projects +and (i) testing consistency of the estimated total contract costs projected in the current year versus the original or prior period, (ii) +assessing the status of completion by testing of a sample of project costs incurred to date and interviewing the Company’s management +to evaluate progress to date, the estimate of remaining costs to be incurred, and factors impacting the amount of time and cost to complete. +· Assessing the reasonableness of changes in estimated costs to complete by comparing project profitability +estimates in the current period to historical estimates and actual performance and investigating reasons for changes in expected costs +and project margins. +· Evaluating the reasonableness of management’s budgeting process by selecting a sample of contract +budgets for projects that were completed during the period and performing a retrospective review of budget to actual variances. +/S/ Ziv +Haft. +Certified Public Accountants (Isr.) +BDO Member Firm +We have served as the Company’s auditor since 2012. +Tel-Aviv, Israel +April 17 , 2023 +F- 6 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +December 31, +2022 +2021 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ 10,492,000 +$ 15,912,000 +Restricted cash +3,563,000 +5,321,000 +Marketable equity securities, at fair value +6,590,000 +40,380,000 +Digital currencies +554,000 +2,165,000 +Accounts receivable +19,586,000 +6,455,000 +Accrued revenue +2,479,000 +2,283,000 +Inventories +22,080,000 +5,482,000 +Investment in promissory notes and other, related party +2,868,000 +2,842,000 +Loans receivable, current +7,385,000 +13,337,000 +Prepaid expenses and other current assets +11,711,000 +15,436,000 +TOTAL CURRENT ASSETS +87,308,000 +109,613,000 +Cash and marketable securities held in trust account +118,193,000 +116,725,000 +Intangible assets, net +34,786,000 +4,035,000 +Goodwill +27,902,000 +10,090,000 +Property and equipment, net +229,914,000 +174,025,000 +Right-of-use assets +8,419,000 +5,243,000 +Investments in common stock, related parties +6,449,000 +13,230,000 +Investments in other equity securities +42,494,000 +30,482,000 +Investment in unconsolidated entity +- +22,130,000 +Loans receivable, non-current +208,000 +1,000,000 +Other assets +5,841,000 +3,713,000 +TOTAL ASSETS +$ 561,514,000 +$ 490,286,000 +LIABILITIES AND STOCKHOLDERS’ EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ 62,644,000 +$ 22,755,000 +Investment margin accounts payable +767,000 +18,488,000 +Operating lease liability, current +2,975,000 +1,123,000 +Notes payable, net +39,621,000 +39,554,000 +Convertible notes payable, current +1,325,000 +- +TOTAL CURRENT LIABILITIES +107,332,000 +81,920,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 7 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +December 31, +December 31, +2022 +2021 +LONG TERM LIABILITIES +Operating lease liability, non-current +5,836,000 +4,213,000 +Notes payable +91,464,000 +55,055,000 +Convertible notes payable +11,451,000 +468,000 +Deferred underwriting commissions of Ault Disruptive subsidiary +3,450,000 +3,450,000 +TOTAL LIABILITIES +219,533,000 +145,106,000 +COMMITMENTS AND CONTINGENCIES +Redeemable noncontrolling interests in equity of subsidiaries, 11,500,000 shares of Ault Disruptive common stock at redemption value +117,993,000 +116,725,000 +STOCKHOLDERS’ EQUITY +Series A Convertible Preferred Stock, $ 25 stated value per share, $ 0.001 par value – 1,000,000 shares authorized; 7,040 shares issued and outstanding at December 31, 2022 and 2021 (liquidation preference of $ 176,000 as of December 31, 2022 and 2021) +- +- +Series B Convertible Preferred Stock, $ 10 stated value per share, share, $ 0.001 par value – 500,000 shares authorized; 125,000 shares issued and outstanding at December 31, 2022 and 2021 (liquidation preference of $ 1,190,000 at December 31, 2022 and 2021) +- +- +Series D Cumulative Redeemable Perpetual Preferred Stock, $ 25 stated value per share, $ 0.001 par value – 2,000,000 shares authorized; shares authorized, 172,838 shares and 0 shares issued and outstanding at December 31, 2022 and 2021, respectively (liquidation preference of $ 4,321,000 and $ 0 as of December 31, 2022 and 2021, respectively) +- +- +Class A Common Stock, $ 0.001 par value – 500,000,000 shares authorized; 382,247,203 and 84,344,607 shares issued and outstanding at December 31, 2022 and 2021, respectively +382,000 +84,000 +Class B Common Stock, $ 0.001 par value – 25,000,000 shares authorized; 0 shares issued and outstanding at December 31, 2022 and 2021 +- +- +Additional paid-in capital +565,523,000 +385,644,000 +Accumulated deficit +( 329,078,000 ) +( 145,600,000 ) +Accumulated other comprehensive loss +( 1,100,000 ) +( 106,000 ) +Treasury stock, at cost +( 29,235,000 ) +( 13,180,000 ) +TOTAL AULT ALLIANCE STOCKHOLDERS’ EQUITY +206,492,000 +226,842,000 +Non-controlling interest +17,496,000 +1,613,000 +TOTAL STOCKHOLDERS’ EQUITY +223,988,000 +228,455,000 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ 561,514,000 +$ 490,286,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 8 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE +LOSS +For the Year Ended +December 31, +2022 +2021 +Revenue, products +$ 61,561,000 +$ 32,096,000 +Revenue, cryptocurrency mining +16,693,000 +3,450,000 +Revenue, hotel operations +16,697,000 +- +Revenue, crane operations +2,739,000 +- +Revenue, lending and trading activities +36,644,000 +16,854,000 +Total revenue +134,334,000 +52,400,000 +Cost of revenue, products +44,508,000 +22,733,000 +Cost of revenue, cryptocurrency mining +21,508,000 +1,125,000 +Cost of revenue, hotel operations +11,406,000 +- +Cost of revenue, crane operations +940,000 +- +Total cost of revenue +78,362,000 +23,858,000 +Gross profit +55,972,000 +28,542,000 +Operating expenses +Research and development +2,773,000 +2,041,000 +Selling and marketing +29,364,000 +7,773,000 +General and administrative +67,329,000 +36,686,000 +Impairment of goodwill +13,064,000 +- +Impairment of deposit due to vendor bankruptcy filing +2,000,000 +- +Impairment of Bitcoin mining equipment +79,556,000 +- +Realized gain on sale of cryptocurrency +( 1,045,000 ) +- +Impairment of mined cryptocurrency +3,099,000 +403,000 +Total operating expenses +196,140,000 +46,903,000 +Loss from operations +( 140,168,000 ) +( 18,361,000 ) +Other income (expense): +Interest and other income +2,594,000 +808,000 +Interest expense +( 42,546,000 ) +( 1,871,000 ) +Change in fair value of equity securities, related party +- +( 7,773,000 ) +Accretion of discount on note receivable, related party +- +4,210,000 +Impairment of debt securities +- +( 594,000 ) +Change in fair value of marketable equity securities +( 2,144,000 ) +( 1,327,000 ) +Gain on extinguishment of debt +- +929,000 +Realized (loss) gain on marketable securities +( 419,000 ) +1,924,000 +Loss from investment in unconsolidated entity +( 924,000 ) +( 311,000 ) +Impairment of equity securities +( 11,500,000 ) +- +Gain from bargain purchase of business +806,000 +- +Change in fair value of warrant liability +( 17,000 ) +( 542,000 ) +Total other expenses, net +( 54,150,000 ) +( 4,547,000 ) +Loss before income taxes +( 194,318,000 ) +( 22,908,000 ) +Income tax (benefit) provision +( 4,485,000 ) +130,000 +Net loss +( 189,833,000 ) +( 23,038,000 ) +Net loss (income) attributable to non-controlling interest +8,017,000 +( 213,000 ) +Net loss attributable to Ault Alliance, Inc. +( 181,816,000 ) +( 23,251,000 ) +Preferred dividends +( 393,000 ) +( 18,000 ) +Net loss available to common stockholders +$ ( 182,209,000 ) +$ ( 23,269,000 ) +Basic net loss per common share +$ ( 0.74 ) +$ ( 0.42 ) +Diluted net loss per common share +$ ( 0.74 ) +$ ( 0.42 ) +Weighted average basic and diluted common shares outstanding +247,604,000 +55,444,000 +Comprehensive (loss) income +Net loss available to common stockholders +$ ( 182,209,000 ) +$ ( 23,269,000 ) +Other comprehensive (loss) income +Foreign currency translation adjustment +( 995,000 ) +85,000 +Impairment of debt securities +- +594,000 +Other comprehensive (loss) income +( 995,000 ) +679,000 +Total comprehensive loss +$ ( 183,204,000 ) +$ ( 22,590,000 ) +The accompanying +notes are an integral part of these consolidated financial statements. +F- 9 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Series A, B & +D +Additional +Other +Total +Preferred +Stock +Common +Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Treasury +Stockholders’ +Shares +Amount +Shares +Amount +Capital +Deficit +Loss +Interest +Stock +Equity +BALANCES, January 1, 2022 +132,040 +$ - +84,344,607 +$ 84,000 +$ 385,644,000 +$ ( 145,600,000 ) +$ ( 106,000 ) +$ 1,613,000 +$ ( 13,180,000 ) +$ 228,455,000 +Issuance of common stock for restricted stock awards +- +- +936,879 +1,000 +( 1,000 ) +- +- +- +- +- +Preferred stock issued +172,838 +- +- +- +4,321,000 +- +- +- +- +4,321,000 +Preferred stock offering costs +- +- +- +- +( 811,000 ) +- +- +- +- +( 811,000 ) +Stock-based compensation +6,363,000 +- +- +839,000 +- +7,202,000 +Issuance of Gresham Worldwide common stock for GIGA acquisition +- +- +- +- +1,669,000 +- +- +- +- +1,669,000 +Issuance of common stock for cash +- +- +285,359,804 +285,000 +171,968,000 +- +- +- +- +172,253,000 +Financing cost in connection with sales of common stock +- +- +- +- +( 4,210,000 ) +- +- +- +- +( 4,210,000 ) +Issuance of common stock upon exercise of warrants +- +- +11,605,913 +12,000 +1,184,000 +- +- +- +- +1,196,000 +Fair value of warrants issued in connection with notes payable +- +- +- +- +1,296,000 +- +- +- +- +1,296,000 +Remeasurement of Ault Disruptive subsidiary temporary equity +- +- +- +- +- +( 1,268,000 ) +- +- +- +( 1,268,000 ) +Increase in ownership interest of subsidiary +- +- +- +- +( 1,900,000 ) +- +- +( 2,365,000 ) +- +( 4,265,000 ) +Non-controlling interest from AVLP acquisition +- +- +- +- +- +- +- +7,790,000 +- +7,790,000 +Non-controlling interest from SMC acquisition +- +- +- +- +- +- +- +10,336,000 +- +10,336,000 +Non-controlling interest from GIGA acquisition +- +- +- +- +- +- +- +2,735,000 +- +2,735,000 +Non-controlling interest from Circle 8 acquisition +- +- +- +- +- +- +- +4,565,000 +- +4,565,000 +Purchase of treasury stock - Ault Alpha +- +- +- +- +- +- +- +- +( 16,054,000 ) +( 16,054,000 ) +Net loss +- +- +- +- +- +( 181,816,000 ) +- +- +- +( 181,816,000 ) +Preferred dividends +- +- +- +- +( 393,000 ) +- +- +- +( 393,000 ) +Foreign currency translation adjustments +- +- +- +- +- +- +( 995,000 ) +- +- +( 995,000 ) +Net loss attributable to non-controlling interest +- +- +- +- +- +- +- +( 8,017,000 ) +- +( 8,017,000 ) +Other +- +- +- +- +- +( 1,000 ) +1,000 +- +( 1,000 ) +( 1,000 ) +BALANCES, December 31, 2022 +304,878 +$ - +382,247,203 +$ 382,000 +$ 565,523,000 +$ ( 329,078,000 ) +$ ( 1,100,000 ) +$ 17,496,000 +$ ( 29,235,000 ) +$ 223,988,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 10 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Series A & B +Additional +Other +Total +Preferred +Stock +Common +Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Treasury +Stockholders’ +Shares +Amount +Shares +Amount +Capital +Deficit +Loss +Interest +Stock +Equity +BALANCES, January 1, 2021 +132,040 +$ - +27,753,562 +$ 28,000 +$ 171,396,000 +$ ( 122,329,000 ) +$ ( 785,000 ) +$ 822,000 +$ - +$ 49,132,000 +Issuance of common stock for restricted stock awards +- +- +1,193,749 +1,000 +( 1,000 ) +- +- +- +- +- +Stock-based compensation +- +- +- +- +7,121,000 +- +- +629,000 +- +7,750,000 +Issuance of common stock for cash +- +- +52,552,353 +53,000 +200,000,000 +- +- +- +- +200,053,000 +Financing cost in connection with sales of common stock +- +- +- +- +( 5,941,000 ) +- +- +- +- +( 5,941,000 ) +Non-controlling position at Imperalis subsidiary acquired +- +- +- +- +- +- +- +( 50,000 ) +- +( 50,000 ) +Adjustment to treasury stock for holdings in investment partnerships +- +- +- +- +- +- +- +- +( 13,180,000 ) +( 13,180,000 ) +Issuance of common stock for conversion of convertible notes payable +- +- +183,214 +- +449,000 +- +- +- +- +449,000 +Issuance of common stock for conversion of convertible notes payable, related +party +- +- +275,862 +- +400,000 +- +- +- +- +400,000 +Issuance of common stock upon exercise of warrants +- +- +2,385,867 +2,000 +4,722,000 +- +- +- +- +4,724,000 +Fair value of warrants issued in connection with notes +- +- +- +- +16,310,000 +- +- +- +- +16,310,000 +Proceeds allocated to public warrants of Ault Disruptive subsidiary, net +of offering costs +- +- +- +- +4,092,000 +- +- +- +- +4,092,000 +Remeasurement of Ault Disruptive subsidiary temporary equity +- +- +- +- +( 12,904,000 ) +- +- +- +- +( 12,904,000 ) +Net loss +- +- +- +- +- +( 23,251,000 ) +- +- +- +( 23,251,000 ) +Preferred dividends +- +- +- +- +( 18,000 ) +- +- +- +( 18,000 ) +Impairment of debt securities +- +- +- +- +- +- +594,000 +- +- +594,000 +Foreign currency translation adjustments +- +- +- +- +- +- +85,000 +- +- +85,000 +Net income attributable to non-controlling interest +- +- +- +- +- +- +- +213,000 +- +213,000 +Other +- +- +- +- +( 2,000 ) +- +( 1,000 ) +- +( 3,000 ) +BALANCES, December 31, 2021 +132,040 +$ - +84,344,607 +$ 84,000 +$ 385,644,000 +$ ( 145,600,000 ) +$ ( 106,000 ) +$ 1,613,000 +$ ( 13,180,000 ) +$ 228,455,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 11 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +For the Year Ended December 31, +2022 +2021 +Cash flows from operating activities: +Net loss +$ ( 189,833,000 ) +$ ( 23,038,000 ) +Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: +Depreciation and amortization +19,743,000 +3,458,000 +Interest expense – debt discount +29,972,000 +1,076,000 +Deferred tax benefit +( 5,000,000 ) +- +Accretion of original issue discount on notes receivable – related party +- +( 4,210,000 ) +Gain on extinguishment of debt +- +( 929,000 ) +Change in fair value of warrant liability +1,672,000 +542,000 +Impairment of debt securities, net +- +594,000 +Accretion of original issue discount on notes receivable +( 5,549,000 ) +21,000 +Increase in accrued interest on notes receivable – related party +( 198,000 ) +( 235,000 ) +Stock-based compensation +7,202,000 +7,750,000 +Impairment of goodwill +13,064,000 +- +Impairment of deposit due to vendor bankruptcy filing +2,000,000 +- +Impairment of cryptocurrencies +3,099,000 +403,000 +Impairment of Bitcoin mining equipment +79,556,000 +- +Impairment of equity securities +11,500,000 +- +Realized gain on the sale of cryptocurrencies +( 1,045,000 ) +- +Revenue, cryptocurrency mining +( 16,693,000 ) +( 3,450,000 ) +Realized gains on sale of marketable securities +( 12,111,000 ) +( 21,187,000 ) +Unrealized losses on marketable securities +13,889,000 +14,127,000 +Unrealized losses on investments in common stock, related parties +11,682,000 +13,527,000 +Unrealized gains on equity securities +( 41,994,000 ) +( 10,734,000 ) +Gain from bargain purchase of business +( 806,000 ) +Loss from investment in unconsolidated entity +924,000 +311,000 +Loss on remeasurement of investment in unconsolidated entity +2,700,000 +- +Changes in operating assets and liabilities: +Proceeds from the sale of cryptocurrencies +15,832,000 +- +Marketable equity securities +78,951,000 +( 29,398,000 ) +Accounts receivable +( 58,000 ) +( 1,407,000 ) +Accrued revenue +( 106,000 ) +( 498,000 ) +Inventories +( 1,068,000 ) +( 2,031,000 ) +Prepaid expenses and other current assets +3,559,000 +( 5,548,000 ) +Other assets +( 3,969,000 ) +( 1,526,000 ) +Accounts payable and accrued expenses +11,493,000 +1,630,000 +Other current liabilities +- +- +Lease liabilities +( 1,919,000 ) +( 919,000 ) +Net cash provided by (used in) operating activities +26,489,000 +( 61,671,000 ) +Cash flows from investing activities: +Purchase of property and equipment +( 108,416,000 ) +( 151,993,000 ) +Investment in promissory notes and other, related parties +( 2,200,000 ) +( 9,844,000 ) +Investments in common stock and warrants, related parties +( 4,901,000 ) +( 20,163,000 ) +Investment in real property, related party +- +( 2,670,000 ) +Proceeds from sale of investment in real property, related party +- +2,670,000 +Acquisition of Imperalis, net of cash acquired +- +( 165,000 ) +Purchase of SMC, net of cash received +( 8,239,000 ) +- +Purchase of GIGA, net of cash received +( 3,687,000 ) +- +Cash received upon acquisition of AVLP +1,245,000 +- +Purchase of Circle 8, net of cash received +( 11,101,000 ) +- +Acquisition of non-controlling interests +( 4,265,000 ) +- +Purchase of marketable equity securities +( 2,017,000 ) +( 2,765,000 ) +Sales of marketable equity securities +11,748,000 +4,062,000 +Investments in loans receivable +( 11,309,000 ) +( 18,235,000 ) +Principal payments on loans receivable +11,050,000 +- +Investment of Ault Disruptive initial public offering proceeds into trust account +- +( 116,725,000 ) +Investments in equity securities +( 26,551,000 ) +( 17,623,000 ) +Net cash used in investing activities +( 158,643,000 ) +( 333,451,000 ) +The accompanying +notes are an integral part of these consolidated financial statements. +F- 12 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) +For the Year Ended December 31, +2022 +2021 +Cash flows from financing activities: +Gross proceeds from sales of common stock +$ 172,253,000 +$ 200,053,000 +Financing cost in connection with sales of common stock +( 4,210,000 ) +( 5,941,000 ) +Proceeds from warrant exercises +- +4,724,000 +Proceeds from sales of preferred stock +4,321,000 +- +Financing cost in connection with sales of preferred stock +( 811,000 ) +- +Proceeds from notes payable +60,654,000 +84,909,000 +Repayment of margin accounts +( 17,721,000 ) +18,488,000 +Payments on notes payable +( 73,927,000 ) +( 2,461,000 ) +Payments of preferred dividends +( 393,000 ) +( 18,000 ) +Purchase of treasury stock +( 16,054,000 ) +( 13,180,000 ) +Proceeds from initial public offering of Ault Disruptive +- +112,125,000 +Payment of deferred offering costs of Ault Disruptive initial public offering +- +( 633,000 ) +Payments on revolving credit facilities, net +- +( 125,000 ) +Net cash provided by financing activities +124,112,000 +397,941,000 +Effect of exchange rate changes on cash and cash equivalents +864,000 +( 266,000 ) +Net (decrease) increase in cash and cash equivalents and restricted cash +( 7,178,000 ) +2,553,000 +Cash and cash equivalents and restricted cash at beginning of period +21,233,000 +18,680,000 +Cash and cash equivalents and restricted cash at end of period +$ 14,055,000 +$ 21,233,000 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ 13,107,000 +$ 257,000 +Non-cash investing and financing activities: +Conversion of convertible notes payable into shares of common stock +$ - +$ 449,000 +Settlement of accounts payable with digital currency +$ 418,000 +$ 890,000 +Conversion of investment in unconsolidated entity for acquisition of AVLP +$ 20,706,000 +$ - +Conversion of convertible notes payable, related party into shares of common stock +$ 400,000 +$ 400,000 +Conversion of debt and equity securities to marketable securities +$ 44,782,000 +$ 2,656,000 +Conversion of loans receivable to marketable securities +$ 11,502,000 +$ - +Conversion of interest receivable to marketable securities +$ 386,000 +$ - +Conversion of loans receivable to debt and equity securities +$ - +$ 4,520,000 +Recognition of new operating lease right-of-use assets and lease liabilities +$ 2,198,000 +$ 1,875,000 +Remeasurement of Ault Disruptive temporary equity +$ 1,268,000 +$ 1,712,000 +Deferred offering costs of Ault Disruptive +$ - +$ 3,579,000 +Fair value of warrants and common stock issued in connection with notes +$ 2,491,000 +$ 16,310,000 +Amounts receivable from issuance of promissory notes payable +$ - +$ 6,900,000 +Issuance of notes payable for purchase of property and equipment +$ - +$ 22,000,000 +Deferred underwriter commissions payable of Ault Disruptive subsidiary +$ - +$ 3,450,000 +Debt discount from accrued lender profit participation rights +$ 6,000,000 +$ - +Prepaid expenditures capitalized to property and equipment +$ 2,150,000 +$ - +The accompanying notes are an integral part of +these consolidated financial statements. +F- 13 +AULT ALLIANCE, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2022 +1. DESCRIPTION OF BUSINESS +Ault Alliance, Inc., a Delaware +corporation (“Ault Alliance” or the “Company”) was incorporated in September 2017. Ault Alliance is a diversified +holding company pursuing growth by acquiring undervalued businesses and disruptive technologies with a global impact. Through its wholly- +and majority-owned subsidiaries and strategic investments, the Company owns and operates a data center at which it mines Bitcoin, and +provides mission-critical products that support a diverse range of industries, including metaverse platform, oil exploration, crane services, +defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics, hotel operations and textiles. In addition, the Company +extends credit to select entrepreneurial businesses through a licensed lending subsidiary. Ault Alliance was founded by Milton “Todd” +Ault, III, its Executive Chairman and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and Vice Chairman and Henry Nisser, +its President and General Counsel. Together, they constitute the Executive Committee, which manages the day-to-day operations of the Company. +All major investment and capital allocation decisions are made for the Company by Mr. Ault and the other members of the Executive Committee. +The Company has the following eight reportable segments: +· Energy and Infrastructure (“Energy”) – crane operations, advanced textiles processing +and oil exploration; +· Technology and Finance (“Fintech”) –commercial lending, activist investing, media, and +digital learning; +· The Singing Machine Company, Inc. (“SMC”) – consumer electronics; +· BitNile, Inc. (“BNI”) – cryptocurrency mining operations; +· Giga-tronics Incorporated (“GIGA”) – defense solutions; +· Imperalis Holding Corp., also referred to as TurnOnGreen (“TurnOnGreen”) – commercial +electronics solutions; +· Ault Global Real Estate Equities, Inc. (“AGREE”) – hotel operations and other commercial +real estate holdings; and +· Ault Disruptive Technologies Corporation (“Ault Disruptive”) – a special purpose acquisition +company (“SPAC”). +On +January 3, 2023, the Company (then known as BitNile Holdings, Inc.) merged its wholly owned subsidiary, Ault Alliance, Inc. with and into +BitNile Holdings, Inc. In connection with this upstream merger, Ault Alliance, Inc. was merged out of existence and the business of the +Company continued as it was being conducted. Further, on January 3, 2023, the effective date of the merger, the Company changed its name +to Ault Alliance, Inc. and its ticker was changed to “AULT.” The name change did not affect the rights of security holders +of the Company. +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +As of December 31, 2022, the +Company had cash and cash equivalents of $ 10.5 million, which is not sufficient to fund the Company’s planned operations through +one year after the date the consolidated financial statements are issued. These factors create substantial doubt about the Company’s +ability to continue as a going concern for at least one year after the date that the Company’s audited consolidated financial statements +are issued. +The consolidated financial +statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. Accordingly, +the consolidated financial statements have been prepared on a basis that assumes the Company will continue as a going concern and which +contemplates the realization of assets and satisfaction of liabilities and commitments in the ordinary course of business. +In making this assessment +management performed a comprehensive analysis of the Company’s current circumstances including: its financial position, cash flow +and cash usage forecasts, and obligations and debts. Although management has a long history of successful capital raises, the analysis +used to determine the Company’s ability as a going concern does not include cash sources outside the Company’s direct control +that management expects to be available within the next 12 months. +F- 14 +Management expects that the +Company’s existing cash and cash equivalents, accounts receivable and marketable securities as of December 31, 2022, will not be +sufficient to enable the Company to fund its anticipated level of operations through one year from the date these financial statements +are issued. Management anticipates raising additional capital through the private and public sales of the Company’s equity or debt +securities and selling its marketable securities, or a combination thereof. Although management believes that such capital sources will +be available, there can be no assurances that financing will be available to the Company when needed in order to allow the Company to +continue its operations, or if available, on terms acceptable to the Company. If the Company does not raise sufficient capital in a timely +manner, among other things, the Company may be forced to scale back its operations or cease operations altogether. +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated +financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial +statements include the accounts of Ault Alliance and its wholly owned and majority-owned subsidiaries. The consolidated financial statements +also include the accounts of Ault Disruptive and Ault Alpha LP (the “Alpha Fund”) of which the Company is the primary beneficiary. +All intercompany accounts and transactions have been eliminated upon consolidation. +The accounting guidance requires +an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling +financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary +of a Variable Interest Entity (“VIE”); to eliminate the solely quantitative approach previously required for determining the +primary beneficiary of a VIE; to add an additional reconsideration event for determining whether an entity is a VIE when any changes in +facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar +rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; +and to require enhanced disclosures that will provide readers of financial statements with more transparent information about an enterprise’s +involvement in a VIE. +Variable Interest Entities +For VIEs, the Company assesses +whether it is the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. +The Company evaluates its +business relationships with related parties to identify potential VIEs under Accounting Standards Codification (“ASC”) 810, +Consolidation . The Company consolidates VIEs in which it is considered to be the primary beneficiary. Entities are considered to +be the primary beneficiary if they have both of the following characteristics: (i) the power to direct the activities that, when taken +together, most significantly impact the VIE’s performance; and (ii) the obligation to absorb losses and right to receive the returns +from the VIE that would be significant to the VIE. The Company’s judgment with respect to its level of influence or control of an +entity involves the consideration of various factors including the form of its ownership interest, its representation in the entity’s +governance, the size of its investment, estimates of future cash flows, its ability to participate in policy making decisions and the +rights of the other investors to participate in the decision making process and to replace the Company as manager and/or liquidate the +joint venture, if applicable. +Revenue Recognition +The Company recognizes revenue +under ASC 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 is that a company should +recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which +the company expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve that core +principle: +· Step 1: Identify the contract with the customer, +· Step 2: Identify the performance obligations +in the contract, +· Step 3: Determine the transaction price, +· Step 4: Allocate the transaction price to the +performance obligations in the contract, and +· Step 5: Recognize revenue when the company satisfies +a performance obligation. +F- 15 +Sales of Products +The Company generates revenues +from the sale of its products through a direct and indirect sales force. The Company’s performance obligations to deliver products +are satisfied at the point in time when title transfers to the customer. Generally, products are shipped FOB shipping point and title +transfers to the customer at the time the products are placed on a common carrier. The Company provides standard assurance warranties, +which are not separately priced, that the products function as intended. The Company primarily receives fixed consideration for sales +of product. Some of the Company’s contracts with distributors include stock rotation rights after six months for slow moving inventory, +which represents variable consideration. The Company uses an expected value method to estimate variable consideration and constrains revenue +for estimated stock rotations until it is probable that a significant reversal in the amount of cumulative revenue recognized will not +occur. To date, returns have been insignificant. The Company’s customers generally pay within 30 days from the receipt of an invoice. +Because the Company’s +product sales agreements have an expected duration of one year or less, the Company has elected to adopt the practical expedient in ASC +606-10-50-14(a) of not disclosing information about its remaining performance obligations. +Manufacturing Services +For manufacturing services, +which include revenues generated by the Company’s subsidiary, Enertec Systems 2001 Ltd. (“Enertec”), and in certain +instances, revenues generated by the Company’s subsidiary, Gresham Power Electronics Ltd. (“Gresham Power”), the Company’s +performance obligation for manufacturing services is satisfied over time as the Company creates or enhances an asset based on criteria +that are unique to the customer and that the customer controls as the asset is created or enhanced. Generally, the Company recognizes +revenue based upon proportional performance over time using a cost-to-cost method which measures progress based on the costs incurred +to total expected costs in satisfying its performance obligation. This method provides a depiction of the progress in providing the manufacturing +service because there is a direct relationship between the costs incurred by the Company and the transfer of the manufacturing service +to the customer. Manufacturing services that are recognized based upon the proportional performance method are considered revenue from +services transferred over time and to the extent the customer has not been invoiced for these revenues, as accrued revenue in the accompanying +consolidated balance sheets. Revisions to the Company’s estimates may result in increases or decreases to revenues and income and +are reflected in the consolidated financial statements in the periods in which they are first identified. +The Company has elected the +practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component to the extent +that the period between when the Company transfers its promised good or service to the customer and when the customer pays in one year +or less. +Lending and Trading Activities +Lending Activities +The Fintech segment, through Ault Lending, +LLC (“Ault Lending”), generates revenue from lending activities primarily through interest, origination fees and late/other +fees. Interest income on these products is calculated based on the contractual interest rate and recorded as interest income as earned. +The origination fees or original issue discounts are recognized over the life of the loan using the effective interest method. +Trading Activities +The Fintech segment, through Ault Lending, +generates revenue from trading activities primarily through sales of securities and unrealized gains and losses from held securities. +Financial instruments utilized in trading activities are carried at fair value. For more information on fair value, see Note 5. Fair Value +of Financial Instruments. Trading-related revenue can be volatile and is largely driven by general market conditions. Also, trading-related +revenue is dependent on the volume and type of transactions, the level of risk assumed, and the volatility of price and rate movements +at any given time within the ever-changing market environment. Realized and unrealized gains and losses are recognized in revenue from +trading activities. +Bitcoin Mining +The Company has entered into +a digital asset mining pool by executing a contract with a mining pool operator to provide computing power to the mining pool. The Company’s +enforceable right to compensation begins only when, and lasts as long as, the Company provides computing power to the mining pool operator +and is created as power is provided over time. The only consideration due to the Company relates to the provision of computing power. +The contracts are terminable at any time by and at no cost to the Company, and by the pool operator under certain conditions specified +in the contract. Providing computing power in digital asset transaction verification services is an output of the Company’s ordinary +activities. Providing such computing power is the only performance obligation in the Company’s contracts with mining pool operators. +F- 16 +The transaction consideration +the Company receives, if any, is non-cash consideration in the form of Bitcoin. Changes in the fair value of the non-cash consideration +due to form of the consideration (changes in the market price of Bitcoin) are not included in the transaction price and therefore, are +not included in revenue. The mining pool operator charges fees to cover the costs of maintaining the pool and are deducted from amounts +the Company may otherwise earn and are treated as a reduction to the consideration received. Fees fluctuate and historically have been +approximately 0.3% per reward earned, on average. +In exchange for providing +computing power, the Company is entitled to a Full-Pay-Per-Share payout of Bitcoin based on a contractual formula, which primarily calculates +the hash rate provided by the Company to the mining pool as a percentage of total network hash rate, and other inputs. The Company is +entitled to consideration even if a block is not successfully placed by the mining pool operator. The contract is in effect until terminated +by either party. +All consideration pursuant +to this arrangement is variable. It is not probable that a significant reversal of cumulative revenue will occur and the Company is able +to calculate the payout based on the contractual formula, non-cash revenue is estimated and recognized based on the spot price of Bitcoin +determined on Yahoo Finance for Bitcoin at the inception of each contract, which is determined to be daily. Non-cash consideration is +measured at fair value at contract inception. Fair value of the crypto asset consideration is determined using the quoted price on Yahoo +Finance for Bitcoin at the beginning of the contract period. This amount is estimated and recognized in revenue upon inception, which +is when hash rate is provided. +There is no significant financing +component in these transactions. +Expenses associated with running +the cryptocurrency mining business, such as equipment depreciation and electricity costs, are recorded as a component of cost of revenues. +Hotel Operations +The primary sources of revenue include room and +food and beverage revenue from the Company’s hotels. +Rooms revenue represents revenue +from the occupancy of our hotel rooms, which is driven by the occupancy and average daily rate charged. Rooms revenue includes revenue +from guest no-shows, daily use, and early/late departure fees. The contracts for room stays with customers are generally short in duration +and revenues are recognized as services are provided over the course of the hotel stay at the daily transaction price agreed to under +the contract. +Food and beverage revenue +consists of revenue from the restaurants and lounges, in room dining and mini bars, and banquet/catering revenue from group and social +functions. Payment of the transaction price is due immediately when the customer purchases the goods and services. Therefore, revenue +is recognized at a point in time when the physical possession has transferred to the customer. +Crane Operations - Heavy Lifting and Pump +Maintenance Services +The Company generates revenue +by providing heavy lifting and pump maintenance services to customers under various short-term agreements which may be hourly, daily, +weekly or monthly. Each service agreement includes a promise to complete the service at a specified location and time and identifies the +billing rate to be charged. Payment terms are identified in the terms of the contract and agreed to by both parties for each promised +service within the contract prior to the commencement or performance of said services. The collectability of payment is considered probable +based on management’s history with the certain type and class of customers and their ability and intention of payment. The customer +simultaneously receives and consumes the benefits as the company provides the hourly, daily, weekly or monthly service. +F- 17 +Cash and Cash Equivalents +The Company considers all +highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments +that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash +is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. These balances +exceed the U.S. Federal Deposit Insurance Corporation insurance limits. The Company had cash and cash equivalents of $ 1.5 million and +$ 0.9 million at December 31, 2022 and 2021, respectively, in the United Kingdom (“U.K.”), and $ 0.6 million and $ 0.1 million, +respectively, in Israel. The Company has not experienced any losses on deposits of cash and cash equivalents. +Restricted Cash +As +of December 31, 2022, restricted cash included $2.0 million of cash collateral for notes payable, $0.8 million of cash held in escrow +related to the purchase of the four hotels in the Madison, Wisconsin area, and $0.7 million of cash held in trust related to environmental +contingencies related to the Michigan data center. +Cash, +cash equivalents and restricted cash consisted of the following: +Schedule of cash equivalents and restricted cash +December 31, +December 31, +2022 +2021 +Cash and cash equivalents +$ 10,492,000 +$ 15,912,000 +Restricted cash +3,563,000 +5,321,000 +Total cash, cash equivalents and restricted cash +$ 14,055,000 +$ 21,233,000 +Cash and Marketable Securities Held +in Trust Account +As +of December 31, 2022, the Company held $ 118.2 million in cash and marketable securities in a trust account. Cash and marketable securities +held in the trust account represents cash and money market funds that primarily invest in U.S. treasury bills that were purchased with +funds raised through the initial public offering of Ault Disruptive, a consolidated SPAC. The funds raised are held in a trust account +that is restricted for use and may only be used for purposes of completing an initial business combination or redemption of the common +stock of Ault Disruptive, as set forth in the trust agreement. The funds held in trust are included within Level 1 of the fair value hierarchy. +Bitcoin +Bitcoin +awarded to the Company through its mining activities are accounted for in connection with the Company’s revenue recognition policy. +Bitcoin +held are accounted for as intangible assets with indefinite useful lives. Bitcoin is sold on a first-in first-out basis and measured for +impairment whenever indicators of impairment are identified based on the intraday low quoted price of Bitcoin. To the extent an impairment +loss is recognized, the loss establishes the new cost basis of the Bitcoin. Subsequent reversal of impairment losses is not permitted. +Bitcoin is classified on our balance sheet as a current asset due to the Company’s ability to sell it in a highly liquid marketplace +and its intent to liquidate its Bitcoin to support operations. +Sales +of Bitcoin by the Company and Bitcoin awarded to the Company are included within cash flows from operating activities on the consolidated +statements of cash flows. Realized gains or losses from sales of Bitcoin are included in loss from operations on the consolidated statements +of operations. +Fair Value of Financial Instruments +In accordance with ASC 820, +Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for the +sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +The guidance also establishes +a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable +inputs by requiring that the most observable inputs be used when available. Observable inputs include those that market participants +would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. +Unobservable inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing +the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +F- 18 +Level 1: Quoted market prices in active markets +for identical assets or liabilities. +Level 2: Inputs other than Level 1 that are +observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are +not active; or model-derived valuations. All significant inputs used in the Company’s valuations are observable or can be derived +principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs +also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed +models such as a discounted cash flow model. +Level 3: Unobservable inputs that are supported +by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts of financial +instruments carried at cost, including cash and cash equivalents, accounts receivables and accounts and other receivable – related +party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the +short-term maturities of such instruments. +The +categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to +the fair value measurement. +Equity Investments +The +Company’s marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 +and 2 in the fair value hierarchy because the Company uses quoted prices for identical assets in active markets or inputs that are based +upon quoted prices for similar instruments in active markets. +For +investments where little or no public market exists, management’s determination of fair value is based on the best available information +which may incorporate management’s own assumptions and involves a significant degree of judgment, taking into consideration various +factors including earnings history, financial condition, recent sales prices of the issuer’s securities and liquidity risks. +Other +equity securities also include investments in entities that do not have a readily determinable fair value and do not report net asset +value per share. These investments are accounted for using a measurement alternative under which they are measured at cost and adjusted +for observable price changes and impairments. Observable price changes result from, among other things, equity transactions for the same +issuer executed during the reporting period, including subsequent equity offerings or other reported equity transactions related to the +same issuer. For these transactions to be considered observable price changes of the same issuer, the Company evaluates whether these +transactions have similar rights and obligations, including voting rights, distribution preferences, conversion rights, and other factors, +to the investments the Company holds. Any investments adjusted to their fair value by applying the measurement alternative are disclosed +as nonrecurring fair value measurements, including the level in the fair value hierarchy that was used. +Accounts Receivable and Allowance for Doubtful Accounts +The Company’s receivables +are recorded when billed and represent claims against third parties that will be settled in cash. The carrying amount of the Company’s +receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. The Company individually reviews +all accounts receivable balances and based upon an assessment of current creditworthiness, estimates the portion, if any, of the balance +that will not be collected. The Company estimates the allowance for doubtful accounts based on historical collection trends, age of outstanding +receivables and existing economic conditions. If events or changes in circumstances indicate that a specific receivable balance may be +impaired, further consideration is given to the collectability of those balances and the allowance is adjusted accordingly. A customer’s +receivable balance is considered past-due based on its contractual terms. Past-due receivable balances are written-off when the Company’s +internal collection efforts have been unsuccessful in collecting the amount due. +Accrued Revenue +Manufacturing services that +are recognized as revenue based upon the proportional performance method are considered revenue based on services transferred over time +and to the extent the customer has not been invoiced for these revenues, as accrued revenue in the accompanying consolidated balance sheets. +As of December 31, 2022 and 2021, accrued revenue was $ 2.5 million and $ 2.3 million, respectively. +F- 19 +SMC Sales Return Reserve +SMC records a sales return +reserve. While SMC has no overstock return privileges in its vendor agreements with its customers, SMC does provide for variable consideration +contingent upon the occurrence of uncertain future events. Variable consideration is estimated at the expected value or at the most likely +amount depending on the type of consideration. Estimated amounts are included in the transaction price to the extent it is probable that +a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration +is resolved. SMC estimates variable consideration under its return allowance programs for goods returned from the customer for various +reasons, whereby a sales return reserve is recorded based on historic return amounts, specific events as identified and management estimates. +Concentration of Credit Risk +Financial instruments that +potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. +Cash and cash equivalents +are invested in banks in the U.S., U.K. and Israel. Such deposits in the United States may be in excess of insured limits and are not +insured in other jurisdictions. +Trade receivables of the Company +and its subsidiaries are mainly derived from sales to customers located primarily in the U.S., Europe and Israel. The Company performs +ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is +determined with respect to those amounts that the Company and its subsidiaries have determined to be doubtful of collection. +Inventories +Inventories are stated at +the lower of cost or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological +obsolescence. +Cost of inventories is determined as +follows: +Raw materials, parts +and supplies - using the “first-in, first-out” method; and +Work-in-progress and finished products +- on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +The Company periodically assesses +its inventories valuation in respect of obsolete and slow-moving items by reviewing revenue forecasts and technological obsolescence. +When inventories on hand exceed the foreseeable demand or become obsolete, the value of excess inventory, which at the time of the review +was not expected to be sold, is written off. At December 31, 2022 and 2021, the Company recorded an allowance for obsolescence of $ 1.4 +million and $ 9,000 , respectively. +During the years ended December +31, 2022 and 2021, the Company did not record inventory write-offs within the cost of revenue. +F- 20 +Property and Equipment, Net +Property and equipment are +stated at cost, net of accumulated depreciation. Gains or losses on disposals of property and equipment are recorded within income from +operations. Repairs and maintenance costs are expensed as incurred. Depreciation is calculated using the straight-line method over the +estimated useful lives of the assets, at the following annual rates: +Schedule of estimated useful life of property, plant and equipment +Useful lives (in years) +Bitcoin mining equipment +3 +Computer, software and related equipment +3 – 5 +Office furniture and equipment +5 – 10 +Crane rental equipment +7 – 10 +Aircraft +7 +Vehicles +5 – 7 +Building +29 – 39 +Leasehold improvements +Over the term of the lease or the life of the asset, whichever is shorter. +Leases +The Company accounts for its +leases under ASC 842, Leases . Under this guidance, arrangements meeting the definition of a lease are classified as operating or +financing leases. The Company only has operating leases. Operating leases are recognized as ROU assets, operating lease liability, current, +and operating lease liability, non-current on the Company’s consolidated balance sheets. Lease assets and liabilities are recognized +based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s +leases do not provide an implicit rate, the Company uses the Company’s incremental borrowing rate based on the information available +at commencement date in determining the present value of future payments. In certain of the Company’s lease agreements, the Company +receives periods of reduced rent or free rent and other incentives. The Company recognizes lease costs on a straight-line basis over the +lease term without regard to deferred payment terms, such as rent holidays, that defer the commencement date of required payments. The +Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise +that option. Leasehold improvements are capitalized at cost and amortized over the lesser of their expected useful life or the life of +the lease, without assuming renewal features, if any, are exercised. The Company does not separate lease and non-lease components for +the Company’s leases. +Impairment of Long-Lived Assets +Management reviews long-lived +assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. +Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future +cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured +by comparing the carrying amount of the assets to their fair value. +Impairment of Debt Securities +Debt securities are evaluated +periodically to determine whether a decline in their value is other than temporary. The Company utilizes criteria such as the magnitude +and duration of the decline, in addition to the reason underlying the decline, to determine whether the loss in value is other than temporary. +The term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects +for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, +or greater than, the carrying value of the investment. Once a decline in value is determined to be other than temporary, the value of +the security is reduced and a corresponding charge to earnings is recognized. +F- 21 +Business Combination +The +Company allocates the purchase price of an acquired business to the tangible and intangible assets acquired and liabilities assumed based +upon their estimated fair values on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired +is recorded as goodwill. The purchase price allocation process requires management to make significant estimates and assumptions at the +acquisition date with respect to intangible assets. The allocation of the consideration transferred in certain cases may be subject to +revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition +date. Direct transaction costs associated with the business combination are expensed as incurred. The Company includes the results of +operations of the business that it has acquired in its consolidated results prospectively from the date of acquisition. +If +the business combination is achieved in stages, the acquisition date carrying value of the acquirer’s previously held equity interest +in the acquirer is re-measured to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized +in profit or loss. +Goodwill +The Company evaluates its +goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other . Goodwill is recorded when the +purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. +The Company tests the recorded +amount of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount +of the goodwill exceeds its carried value. During the year ended December 31, +2022, the Company recognized $ 3.2 million and $ 9.9 million impairment of goodwill related to SMC and GIGA, respectively. During the year +ended December 31, 2021, the Company recognized no impairment of goodwill. +Intangible Assets +The Company acquired amortizable +intangibles assets as part of asset purchase agreements consisting of customer relationships, trade names and proprietary technology. +The Company also has the trade names and trademarks associated with the acquisitions of Microphase Corporation (“Microphase”) +and Relec Electronics Ltd. (“Relec”), which were determined to have an indefinite life. The customer relationships, trade +names and proprietary technology, definite lived intangible assets, are being amortized on a straight-line basis over their estimated +useful lives as follows: +Schedule of intangible assets useful lives +Useful lives (in years) +Customer relationships +8 – 10 +Trade names +9 – 10 +Proprietary technology +3 – 7 +The Company reviews intangible +assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets might not be +recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant underperformance +of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes +in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares +forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying +value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset +are less than its carrying amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its +fair value, determined based on discounted cash flows. During the years ended December 31, 2022 and 2021, the Company recognized no impairment +of intangibles. +Common Stock Purchase Warrants and Other +Derivative Financial Instruments +The Company classifies common +stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical +settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical +settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement +to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty +a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions, +as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine +whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, +which principally consist of issuance of warrants to purchase shares of common stock in connection with convertible notes and to employees +of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features +or variable settlement provisions that cause them to not be indexed to the Company’s own stock. +F- 22 +Warrant Valuation +The Company values warrants +issued at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables such as +the warrants’ remaining contractual term, exercise price, current stock price, risk-free interest rate and estimated volatility +of the Company’s stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based +on the implied yield available on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +Convertible Instruments +The Company accounts for hybrid +contracts that feature conversion options in accordance with ASC 815, Derivatives and Hedging Activities (“ASC 815”). +ASC 815 requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative +financial instruments according to certain criteria. The criteria include circumstances in which (a) the economic characteristics +and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host +contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured +at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument +with the same terms as the embedded derivative instrument would be considered a derivative instrument. +Conversion options that contain +variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities +at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible +instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, +in accordance with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”). Under ASC 470-20 the Company +records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based +upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective +conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded +conversion options should be bifurcated from their host instruments) in accordance with ASC 815. +Debt Discounts +The Company accounts for debt +discount according to ASC 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through periodic charges +to interest expense over the term of the related financial instrument using the effective interest method. +Redeemable +Noncontrolling Interests in Equity of Subsidiary +The +Company records redeemable noncontrolling interests in equity of subsidiaries to reflect the economic interests of the common stockholders +in Ault Disruptive. These interests are presented as redeemable noncontrolling interests in equity of subsidiaries within the consolidated +balance sheets, outside of the permanent equity section. The common stockholders in Ault Disruptive have redemption rights that are considered +to be outside of the Company’s control. As of December 31, 2022, the carrying amount of the redeemable noncontrolling interest in +equity of subsidiaries was recorded at its redemption value of $ 118.2 million. Remeasurements to the redemption value of the redeemable +noncontrolling interest in equity of subsidiaries are recorded within additional paid-in capital. Such remeasurements totaled $ 12.9 million, +comprising of offering costs incurred in connection with the sale of common stock of Ault Disruptive in the amount of $ 116.7 million and +initial valuation of the public warrants of Ault Disruptive in the amount of $ 4.1 million. +Treasury Stock +The shares of Company common +stock attributable to the Company’s limited partner interest in the Alpha Fund are considered treasury stock on the consolidated +balance sheet and thereby deemed not to be included in the calculation of weighted average common shares outstanding. However, these shares +are legally outstanding. +F- 23 +Stock-Based Compensation +The Company accounts for stock-based +compensation in accordance with ASC 718, Compensation – Stock Compensation (“ASC 718”). +The Company uses the Black-Scholes +option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions +which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying +stock. +Under ASC 718: +· the Company recognizes stock-based expenses related to stock option awards on a straight-line basis over +the requisite service period of the awards, which is generally the vesting term of two to four years; +· stock-based expenses are recognized net of forfeitures as they occur; +· the expected term assumption, using the simplified method, reflects the period for which the Company believes +the option will remain outstanding; +· the Company determined the volatility of its stock by looking at the historic volatility of its stock +over the expected term of the grant; and +· the risk-free rate reflects the U.S. Treasury yield for a similar expected term in effect at the time +of the grant. +Income Taxes +The Company determines its +income taxes under the asset and liability method in accordance with Financial Accounting Standards Board (“FASB”) ASC 740, Income +Taxes , which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have +been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences +between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which +the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it +is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates +expected to apply to taxable income in the fiscal years in which those temporary differences are expected to be recovered or settled. +The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Statements of Operations and Comprehensive +Loss in the period that includes the enactment date. +The Company accounts for uncertain +tax positions in accordance with ASC 740-10-25, which addresses the determination of whether tax benefits claimed or expected to be claimed +on a tax return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit from an +uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, +based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that +has a greater than fifty percent likelihood of being realized upon ultimate settlement. To the extent that the final tax outcome of these +matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is +made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. +ASC 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has +taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management +of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2022 and 2021, there were no +uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in +the financial statements. +F- 24 +Foreign Currency Translation +A substantial portion of the +Company’s revenues are generated in U.S. dollars. In addition, a substantial portion of the Company’s costs are incurred in +U.S. dollars. Company management has determined that the U.S. dollar is the functional currency of the primary economic environment in +which it operates. +Accordingly, monetary accounts +maintained in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with FASB issued ASC 830, Foreign +Currency Matters (“ASC 830”). All transaction gains and losses from the re-measurement of monetary balance sheet +items are reflected in the statements of operations as financial income or expenses as appropriate. +The financial statements of +Gresham Power, Relec, and Enertec, whose functional currencies have been determined to be their local currencies, the British Pound (“GBP”), +GBP, and the Israeli Shekel (“ILS”), respectively, have been translated into U.S. dollars in accordance with ASC 830. All +balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts +have been translated using the average exchange rate in effect for the reporting period. The resulting translation adjustments are reported +as other comprehensive loss in the consolidated statement of comprehensive loss and accumulated comprehensive loss in statement of changes +in stockholders’ equity. +Comprehensive Loss +The Company reports comprehensive +loss in accordance with ASC 220, Comprehensive Income . This statement establishes standards for the reporting and presentation +of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents +all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined +that its items of other comprehensive loss relate to changes in foreign currency translation adjustments and impairment of debt securities. +Accounting Estimates +The preparation of the consolidated +financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of +assets and liabilities at the date of the consolidated financial statements and reported amounts of revenue and expense during the reporting +period. Estimates are used when accounting for certain items such as valuation of securities, reserves for trade receivables and inventories, +the fair value of loans receivables, intangible assets and goodwill, useful lives and the recoverability of long-lived assets, share based +arrangements, contingent consideration, and deferred income taxes and related valuation allowance. Estimates are based on historical experience, +where applicable, and assumptions that management believes are reasonable under the circumstances. Due to the inherent uncertainty involved +with estimates, actual results may differ. +Reclassifications +Certain prior year amounts +have been reclassified for comparative purposes to conform to the current-year financial statement presentation. These reclassifications +had no effect on previously reported results of operations. The impact on any prior period disclosures was immaterial. +Recently +Issued Accounting Pronouncements +In June 2016, the FASB issued +ASU No. 2016-13, “Financial Instruments - Credit Losses,” (“ASU No. 2016-13”) to improve information on credit +losses for financial assets and net investment in leases that are not accounted for at fair value through net income. ASU 2016-13 replaces +the current incurred loss impairment methodology with a methodology that reflects expected credit losses. This guidance is effective for +the Company beginning on January 1, 2023. The Company is currently evaluating this guidance to determine the impact it may have on its +consolidated financial statements. +In October 2021, the FASB +issued ASU 2021-08, “Business Combinations (Topic 805), Accounting for Contract Assets and Contract Liabilities from Contracts with +Customers,” which requires contract assets and contract liabilities acquired in a business combination to be recognized and measured +by the acquirer on the acquisition date in accordance with ASC 606, “Revenue from Contracts with Customers.” The guidance +will result in the acquirer recognizing contract assets and contract liabilities at the same amounts recorded by the acquiree. The guidance +should be applied prospectively to acquisitions occurring on or after the effective date. The guidance is effective for fiscal years beginning +after December 15, 2022, including interim periods within those fiscal years. The Company is currently evaluating this guidance to determine +the impact it may have on its consolidated financial statements. +F- 25 +4. REVENUE DISAGGREGATION +The following tables summarize +disaggregated customer contract revenues and the source of the revenue for the years ended December 31, 2022 and 2021. Revenues from lending +and trading activities included in consolidated revenues were primarily interest, dividend and other investment income, which are not +considered to be revenues from contracts with customers under GAAP. +The Company’s disaggregated +revenues consisted of the following for the year ended December 31, 2022: +Schedule of disaggregated +revenues +Year +ended December 31, 2022 +GIGA +TurnOnGreen +Fintech +BNI +AGREE +SMC +Energy +Total +Primary Geographical Markets +North America +$ 7,317,000 +$ 4,514,000 +$ 239,000 +$ 17,798,000 +$ 16,697,000 +$ 23,217,000 +$ 2,739,000 +$ 72,521,000 +Europe +9,907,000 +115,000 +- +- +- +337,000 +216,000 +10,575,000 +Middle East and other +13,031,000 +893,000 +- +- +- +670,000 +- +14,594,000 +Revenue from contracts with customers +30,255,000 +5,522,000 +239,000 +17,798,000 +16,697,000 +24,224,000 +2,955,000 +97,690,000 +Revenue, lending and trading activities (North +America) +- +- +36,644,000 +- +- +- +- +36,644,000 +Total revenue +$ 30,255,000 +$ 5,522,000 +$ 36,883,000 +$ 17,798,000 +$ 16,697,000 +$ 24,224,000 +$ 2,955,000 +$ 134,334,000 +Major Goods or Services +RF/microwave filters +$ 5,070,000 +$ - +$ - +$ - +$ - +$ - +$ - +$ 5,070,000 +Detector logarithmic video amplifiers +1,060,000 +- +- +- +- +- +- +1,060,000 +Power supply units and systems +11,605,000 +5,215,000 +- +- +- +- +- +16,820,000 +Healthcare diagnostic systems +4,073,000 +- +- +- +- +- +- +4,073,000 +Electric vehicle chargers +- +307,000 +- +- +- +- +- +307,000 +Defense systems +8,447,000 +- +- +- +- +- +- +8,447,000 +Digital currency mining +- +- +- +16,693,000 +- +- +- +16,693,000 +Hotel operations +- +- +- +- +16,697,000 +- +- +16,697,000 +Karaoke machines and related +- +- +- +- +- +24,224,000 +- +24,224,000 +Crane rental +- +- +- +- +- +- +2,739,000 +2,739,000 +Other +- +- +239,000 +1,105,000 +- +- +216,000 +1,560,000 +Revenue from contracts with customers +30,255,000 +5,522,000 +239,000 +17,798,000 +16,697,000 +24,224,000 +2,955,000 +97,690,000 +Revenue, lending and trading activities +- +- +36,644,000 +- +- +- +- +36,644,000 +Total revenue +$ 30,255,000 +$ 5,522,000 +$ 36,883,000 +$ 17,798,000 +$ 16,697,000 +$ 24,224,000 +$ 2,955,000 +$ 134,334,000 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 18,430,000 +$ 5,519,000 +$ 239,000 +$ 17,798,000 +$ 16,697,000 +$ 24,224,000 +$ 216,000 +$ 83,123,000 +Services transferred over time +11,825,000 +3,000 +- +- +- +- +2,739,000 +14,567,000 +Revenue from contracts with customers +$ 30,255,000 +$ 5,522,000 +$ 239,000 +$ 17,798,000 +$ 16,697,000 +$ 24,224,000 +$ 2,955,000 +$ 97,690,000 +F- 26 +The Company’s disaggregated +revenues consisted of the following for the year ended December 31, 2021: +Year +ended December 31, 2021 +GIGA +TurnOnGreen +Fintech +BNI +AGREE +Total +Primary Geographical Markets +North America +$ 6,788,000 +$ 4,536,000 +$ 192,000 +$ 4,238,000 +$ 189,000 +$ 15,943,000 +Europe +7,492,000 +457,000 +- +- +- +7,949,000 +Middle East +10,803,000 +- +- +- +- +10,803,000 +Other +498,000 +353,000 +- +- +- +851,000 +Revenue from contracts with customers +25,581,000 +5,346,000 +192,000 +4,238,000 +189,000 +35,546,000 +Revenue, lending and trading activities (North +America) +- +- +16,854,000 +- +- +16,854,000 +Total revenue +$ 25,581,000 +$ 5,346,000 +$ 17,046,000 +$ 4,238,000 +$ 189,000 +$ 52,400,000 +Major Goods +RF/microwave filters +$ 4,905,000 +$ - +$ - +$ - +$ - +$ 4,905,000 +Detector logarithmic video amplifiers +1,888,000 +- +- +- +- +1,888,000 +Power supply units +7,613,000 +5,328,000 +- +- +- +12,941,000 +Power supply systems +241,000 +- +- +- +- +241,000 +Healthcare diagnostic systems +794,000 +- +- +- +- +794,000 +EV Chargers +- +18,000 +- +- +- +18,000 +Defense systems +10,140,000 +- +- +- +- +10,140,000 +Digital currency mining +- +- +- +3,450,000 +- +3,450,000 +Other +- +- +192,000 +788,000 +189,000 +1,169,000 +Revenue from contracts with customers +25,581,000 +5,346,000 +192,000 +4,238,000 +189,000 +35,546,000 +Revenue, lending and trading activities +- +- +16,854,000 +- +- +16,854,000 +Total revenue +$ 25,581,000 +$ 5,346,000 +$ 17,046,000 +$ 4,238,000 +$ 189,000 +$ 52,400,000 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 13,825,000 +$ 5,346,000 +$ 192,000 +$ 4,238,000 +$ 189,000 +$ 23,790,000 +Services transferred over time +11,756,000 +- +- +- +- +11,756,000 +Revenue from contracts with customers +$ 25,581,000 +$ 5,346,000 +$ 192,000 +$ 4,238,000 +$ 189,000 +$ 35,546,000 +5. FAIR VALUE OF FINANCIAL +INSTRUMENTS +The +following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within +the fair value hierarchy: +Fair value, assets measured on recurring basis +Fair Value Measurement at December 31, 2022 +Total +Level 1 +Level 2 +Level 3 +Investment in common stock of Alzamend Neuro, Inc. (“Alzamend”) – a related party +$ 6,449,000 +$ 6,449,000 +$ - +$ - +Investments in marketable equity securities +6,590,000 +6,590,000 +- +- +Cash and marketable securities held in trust account +118,193,000 +118,193,000 +- +- +Investments in other equity securities +13,340,000 +- +- +13,340,000 +Total assets measured at fair value +$ 144,572,000 +$ 131,232,000 +$ - +$ 13,340,000 +Fair Value Measurement at December 31, 2021 +Total +Level 1 +Level 2 +Level 3 +Investment in common stock of Alzamend – a related party +$ 13,230,000 +$ 13,230,000 +$ - +$ - +Investments in marketable equity securities +40,380,000 +40,380,000 +- +- +Cash and marketable securities held in trust account +116,725,000 +116,725,000 +- +- +Investments in other equity securities +9,215,000 +- +- +9,215,000 +Total assets measured at fair value +$ 179,550,000 +$ 170,335,000 +$ - +$ 9,215,000 +The Company assesses the inputs +used to measure fair value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable +in the market. For investments where little or no public market exists, management’s determination of fair value is based on the +best available information which may incorporate management’s own assumptions and involves a significant degree of judgment, taking +into consideration various factors including earnings history, financial condition, recent sales prices of the issuer’s securities +and liquidity risks. +F- 27 +The +following table summarizes the changes in investments in other equity securities measured and carried at fair value on a recurring basis +with the use of significant unobservable inputs (Level 3) for the year ended December 31, 2022: +Schedule of investments +Investments in +other equity +securities +Balance at January 1, 2022 +$ 9,215,000 +Investment in preferred stock +11,566,000 +Change in fair value of financial instruments +34,118,000 +Conversion to marketable securities +( 41,560,000 ) +Balance at December 31, 2022 +$ 13,339,000 +Equity Investments +for Which Measurement Alternative Has Been Selected +As +of December 31, 2022 and 2021, the Company held equity investments in other securities valued at $ 29.2 million and $ 21.1 million, respectively, +that were valued using a measurement alternative. These investments are included in other equity securities in the accompanying consolidated +balance sheets. +Measurement Alternative +Impairment +The +Company has made cumulative downward adjustments for impairments for equity securities that do not have readily determinable fair values +as of December 31, 2022, totaling $ 11.5 million. These adjustments have been reflected in other income (expense) on the consolidated statement +of operations and comprehensive loss. +6. Marketable Securities +Marketable securities in equity +securities with readily determinable market prices consisted of the following as of December 31, 2022 and 2021: +Schedule of marketable securities +Marketable equity securities at December 31, 2022 +Gross unrealized +Gross unrealized +Cost +gains +losses +Fair value +Common shares +$ 10,271,000 +$ 383,000 +$ ( 4,064,000 ) +$ 6,590,000 +Marketable equity securities at December 31, 2021 +Gross unrealized +Gross unrealized +Cost +gains +losses +Fair value +Common shares +$ 53,475,000 +$ 32,000 +$ ( 13,127,000 ) +$ 40,380,000 +F- 28 +The following table presents additional information +about marketable equity securities: +Schedule of marketable equity securities +Marketable +Equity Securities +Balance at January 1, 2021 +$ 2,563,000 +Purchases of marketable equity securities in operations +385,235,000 +Purchases of marketable equity securities +2,765,000 +Conversion of debt securities to marketable securities +2,656,000 +Sales of marketable equity securities in operations +( 355,837,000 ) +Sales of marketable equity securities +( 4,062,000 ) +Realized gains on marketable equity securities +27,377,000 +Realized losses on marketable equity securities +( 6,190,000 ) +Unrealized losses on marketable equity securities +( 14,127,000 ) +Balance at December 31, 2021 +40,380,000 +Purchases of marketable equity securities in operations +107,958,000 +Purchases of marketable equity securities +2,017,000 +Conversion of debt securities to marketable securities +44,782,000 +Conversion of loans receivable to marketable securities +11,502,000 +Conversion of interest receivable to marketable securities +386,000 +Sales of marketable equity securities in operations +( 186,909,000 ) +Sales of marketable equity securities +( 11,748,000 ) +Realized gains on marketable equity securities +44,307,000 +Realized losses on marketable equity securities +( 32,196,000 ) +Unrealized losses on marketable equity securities +( 13,889,000 ) +Balance at December 31, 2022 +$ 6,590,000 +At December 31, 2022 and 2021, +the Company had invested in the marketable equity securities of certain publicly traded companies. The Company’s investment in marketable +equity securities is revalued on each balance sheet date. +7. DIGITAL CURRENCIES +The following table presents +the activities of the digital currencies for the years ended December 31, 2022 and 2021: +Schedule of activities of the digital currencies +Digital +Currencies +Balance at January 1, 2021 +$ 7,000 +Additions of mined digital currencies +3,450,000 +Payments to vendors +( 889,000 ) +Impairment of mined cryptocurrency +( 403,000 ) +Balance at December 31, 2021 +2,165,000 +Additions of mined digital currencies +16,693,000 +Payments to vendors +( 418,000 ) +Impairment of mined cryptocurrency +( 3,099,000 ) +Sale of digital currencies +( 15,812,000 ) +Realized gain on sale of digital currencies +1,025,000 +Balance at December 31, 2022 +$ 554,000 +F- 29 +8. INVENTORIES +At December 31, 2022 and 2021, inventories +consisted of: +Schedule of inventories +December 31, +December 31, +2022 +2021 +Raw materials, parts and supplies +$ 3,653,000 +$ 2,421,000 +Work-in-progress +3,836,000 +1,107,000 +Finished products +14,591,000 +1,954,000 +Total inventories +$ 22,080,000 +$ 5,482,000 +9. PROPERTY AND EQUIPMENT, NET +At December 31, 2022 and 2021, +property and equipment consisted of: +Schedule of property and equipment +December 31, 2022 +December 31, 2021 +Building and improvements +$ 81,102,000 +$ 68,959,000 +Bitcoin mining equipment +54,438,000 +10,763,000 +Crane rental equipment +32,453,000 +- +Land +25,646,000 +25,696,000 +Computer, software and related equipment +23,168,000 +8,884,000 +Aircraft +15,983,000 +- +Vehicles +3,314,000 +- +Office furniture and equipment +2,854,000 +702,000 +Oil and natural gas properties, unproved properties +972,000 +- +239,960,000 +115,004,000 +Accumulated depreciation and amortization +( 21,344,000 ) +( 5,096,000 ) +Property and equipment placed in service, net +218,586,000 +109,908,000 +Deposits on cryptocurrency machines +11,328,000 +64,117,000 +Property and equipment, net +$ 229,914,000 +$ 174,025,000 +Summary of depreciation expense: +Schedule of depreciation +For the Year Ended December 31, +2022 +2021 +Depreciation expense +$ 17,262,000 +$ 2,103,000 +Ault Energy Oil and Gas Properties +On July 11, 2022, the Company +announced the formation of Ault Energy, LLC (“Ault Energy”), as an indirect wholly owned subsidiary of the Company. Ault Energy +is partnering with White River Holdings Corp. (“White River”), a majority owned subsidiary of BitNile Metaverse, Inc., formerly +known as Ecoark Holdings, Inc. (“BMI”), on expects to partner on multiple drilling projects across 30,000 acres in Texas, +Louisiana and Mississippi. Ault Energy, as the designee of Ault Lending, has the right to purchase up to 25%, or such higher percentages +at the discretion of White River, in various drilling projects of White River. In August 2022, Ault Energy purchased a 40% working interest +of the Harry O’Neal 20-9 No.1 drilling project in Mississippi for $1.0 million included in property and equipment. The Company has +not recorded any depletion as the Harry O’Neal 20-9 No.1 drilling project was considered an unproved property as of December 31, +2022. +Compute North Bankruptcy +On September 22, 2022, Compute +North Holdings, Inc. (along with its affiliated debtors, collectively, “Compute North”), filed for bankruptcy protection. +The Company has a deposit of approximately $2.0 million with Compute North for services yet to be performed by Compute North. The ultimate +outcome of the bankruptcy process, and its impact on the deposit held by the Company, remains to be determined. The Company assessed this +financial exposure and recorded an impairment of the deposit totaling $2 million during the year ended December 31, 2022. The Company +has removed the Bitcoin miners that were installed at the hosting facility in Texas. +F- 30 +Impairment of Bitcoin Mining Equipment +During the year ended December +31, 2022, adverse changes in business climate, including decreases in the price of Bitcoin and resulting decrease in the market price +of miners, indicated that an impairment triggering event had occurred. Testing performed indicated the estimated fair value of the Company’s +miners to be less than their net carrying value as of December 31, 2022, and an impairment charge of $79.6 million was recognized, decreasing +the net carrying value of the Company’s Bitcoin mining equipment to their estimated fair value. The estimated fair value of the +Company’s miners is classified in Level 2 of the fair value hierarchy due to the quoted market prices for similar assets. +10. INTANGIBLE ASSETS, NET +At December 31, 2022 and 2021, intangible +assets consisted of: +Schedule of intangible asset +Useful Life +December 31, +2022 +December 31, +2021 +Trade name and trademark +Indefinite life +$ 1,493,000 +$ 1,546,000 +Trade names +5 - 10 years +4,316,000 +- +Customer list +8 - 10 years +5,865,000 +3,486,000 +Developed technology +3 - 8 years +24,584,000 +- +Domain name and other intangible assets +5 years +630,000 +714,000 +36,888,000 +5,746,000 +Accumulated amortization +( 2,102,000 ) +( 1,711,000 ) +Intangible assets, net +$ 34,786,000 +$ 4,035,000 +The Company’s trade +names and trademarks were determined to have an indefinite life. The remaining definite lived intangible assets are primarily being amortized +on a straight-line basis over their estimated useful lives. Amortization expense was $ 1.0 million and $ 0.4 million, respectively, for +the years ended December 31, 2022 and 2021. +The customer relationships, developed technology and certain trade +names are subject to amortization over their estimated useful lives, which range between 5 and 10 years with an average remaining +useful life of 8.4 years. The following table presents estimated amortization expense for each of the succeeding five calendar years and +thereafter. +Schedule of estimated amortization expense +2023 +$ 4,471,000 +2024 +4,471,000 +2025 +4,371,000 +2026 +4,271,000 +2027 +4,271,000 +Thereafter +11,438,000 +Estimated amortization expense +$ 33,293,000 +F- 31 +11. GOODWILL +The following table summarizes +the changes in the Company’s goodwill for the years ended December 31, 2022 and 2021: +Schedule of goodwill +Goodwill +Balance as of January 1, 2021 +$ 9,646,000 +Acquisition of Imperalis +278,000 +Effect of exchange rate changes +166,000 +Balance as of December 31, 2021 +10,090,000 +Acquisition of AVLP +18,570,000 +Acquisition of SMC +3,184,000 +Acquisition of GIGA +9,881,000 +Impairment of goodwill +( 13,064,000 ) +Effect of exchange rate changes +( 759,000 ) +Balance as of December 31, 2022 +$ 27,902,000 +Impairment of SMC Goodwill +During the fourth quarter +of 2022, SMC experienced adverse changes in business climate, a significant decline in sales and a drop in the trading price of its common +stock. +Due to these factors, the +Company determined that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, +2022. The valuation of the SMC reporting units was determined using a market approach with observable inputs, primarily based on the trading +price of SMC’s common stock plus an estimated control premium of approximately 20%. +The results of the quantitative +test indicated the fair value of the SMC reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $ 3.2 million carrying amount of SMC’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +Impairment of GIGA Goodwill +During the fourth quarter +of 2022, GIGA experienced a significant decline in sales and a drop in the trading price of its common stock. +Due to these factors, the +Company determined that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, +2022. The valuation of the GIGA reporting units was determined using an income approach methodology of valuation. +The income approach is based on the projected cash flows discounted +to their present value using discount rates, that in the Company’s judgment, consider the timing and risk of the forecasted cash +flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated +value of a market participant’s cost of capital and debt, derived using customary market metrics. The analysis included assumptions +regarding GIGA’s revenue forecast, with negligible or declining growth rates and discount rates of 17.5% using a weighted average +cost of capital analysis. The market approach was also considered; however, the income approach was chosen as the Company determined it +is a better representation GIGA’s projected long-term performance. +The results of the quantitative +test indicated the fair value of the GIGA reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $ 9.9 million carrying amount of GIGA’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +F- 32 +12. INCREASE IN OWNERSHIP INTEREST OF SUBSIDIARIES +During the year ended December +31, 2022, the Company increased ownership in certain of its subsidiaries. The following table summarizes the increase in ownership interest +of subsidiaries during the years ended December 31, 2022: +Summarizes the increase in ownership interest +Additional +Total Increase in +Paid-In +Non-Controlling +Ownership Interest +Subsidiary +Capital +Interest +of Subsidiary +ACS +$ 1,800,000 +$ - +$ 1,800,000 +SMC +100,000 +2,111,000 +2,211,000 +AVLP +- +254,000 +254,000 +Total +$ 1,900,000 +$ 2,365,000 +$ 4,265,000 +13. INVESTMENTS – RELATED PARTIES +Investments in Ault & +Company, Inc. (“Ault & Company”) at December 31, 2022 and 2021, were comprised of the following: +Schedule of investment +Interest +Due +December 31, +December 31, +Rate +Date +2022 +2021 +Promissory note, related party +8 % +Dec. 31, 2023 +$ 2,500,000 +$ 2,500,000 +Accrued interest receivable, related party +368,000 +170,000 +Other +- +172,000 +Total investment in promissory notes and other, related parties – gross +$ 2,868,000 +$ 2,842,000 +The Company recorded related +party interest income of $ 0.2 million for each of the years ended December 31, 2022 and 2021 in interest income. +Investment in Common Stock, Related Parties +December 31, +December 31, +2022 +2021 +Total investment in common stock of Alzamend +$ 6,449,000 +$ 13,230,000 +The following table summarizes +the changes in the Company’s investments in Alzamend during the years ended December 31, 2022 and 2021: +Schedule of investment in warrants and common stock +Investment in +common stock of +Alzamend +Investment in +promissory notes and +advances of Alzamend +Balance at January 1, 2021 +$ 653,000 +$ 796,000 +Alzamend note and advances converted into common stock +- +( 800,000 ) +Investment in common stock of Alzamend +18,181,000 +- +Unrealized loss in common stock of Alzamend +( 5,604,000 ) +- +Accretion of discount +- +4,000 +Balance at December 31, 2021 +13,230,000 +- +Investment in common stock of Alzamend +4,901,000 +- +Alzamend stock received for marketing services +989,000 +- +Unrealized loss in common stock of Alzamend +( 12,671,000 ) +- +Balance at December 31, 2022 +$ 6,449,000 +$ - +F- 33 +Investments in +Alzamend Common Stock +The +following table summarizes the changes in the Company’s investments in Alzamend common stock during the year ended December 31, +2021: +Schedule of investment of common stock +Shares of +Per Share +Investment in +Common Stock +Price +Common Stock +Balance at January 1, 2021 +428,000 +$ 1.50 +$ 642,000 +Purchase of shares from an Alzamend shareholder +62,000 +$ 0.81 +50,000 +March 9, 2021 securities purchase agreement* +4,000,000 +$ 1.50 +6,000,000 +Investment in Alzamend initial public offering +2,000,000 +$ 5.00 +10,000,000 +Open market purchases after initial public offering +457,000 +$ 4.67 +2,132,000 +Unrealized loss in common stock of Alzamend +( 5,625,000 ) +Investment in Alzamend common stock +6,947,000 +$ 1.90 +13,199,000 +Investment in Alzamend options +31,000 +Balance at December 31, 2021 +$ 13,230,000 +The +following table summarizes the changes in the Company’s investments in Alzamend common stock during the year ended December 31, +2022: +Shares of +Per Share +Investment in +Common Stock +Price +Common Stock +Balance at January 1, 2022 +6,947,000 +$ 1.90 +$ 13,230,000 +March 9, 2021 securities purchase agreement* +2,667,000 +$ 1.50 +4,000,000 +Alzamend stock received for marketing services +933,000 +$ 1.06 +989,000 +Open market purchases after initial public offering +868,000 +$ 1.04 +901,000 +Unrealized loss in common stock of Alzamend +( 12,671,000 ) +Investment in Alzamend common stock +11,415,000 +$ 0.56 +$ 6,449,000 +* Pursuant to the March 9, 2021 securities purchase agreement, in aggregate, +Alzamend agreed to sell up to 6,666,667 shares of its common stock to Ault Lending for $10.0 million, or $1.50 per share, and issue +to Ault Lending warrants to acquire 3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. As of +December 31, 2022, Ault Lending had funded the full $10.0 million. +Alzamend Marketing and Brand Development +Services Agreement +On November 1, 2022, the Company +entered into a contract with Alzamend, a related party, to provide marketing and brand development services. The contract is effective +as of August 1, 2022, for a period of one year. The parties to the contract approved the contract on November 1, 2022, which is considered +contract inception. +Alzamend issued 933,334 shares +of its common stock to satisfy payment under the contract. +As the transaction consideration +received by the Company is non-cash consideration in the form of shares of Alzamend common stock, changes in the fair value of the non-cash +consideration due to form of the consideration (changes in the market price of Alzamend stock) are not included in the transaction price +and therefore, are not included in revenue. +The Company will recognize +revenue of approximately $ 1.0 million over the period from contract inception to the end of the contract term based on the number of shares +received and the trading price of Alzamend stock at contract inception. As of December 31, 2022, the Company has recognized approximately +$ 0.2 million in related party revenue and recorded $ 0.8 million as a contract liability related to this agreement. +F- 34 +14. INVESTMENT IN UNCONSOLIDATED ENTITY – +AVLP +Equity Investments in Unconsolidated Entity +– AVLP +Equity investments in an unconsolidated +entity, AVLP, at December 31, 2021, were comprised of the following: +Investment in Promissory Notes +Schedule of convertible promissory note +Interest +December 31, +rate +2021 +Investment in convertible promissory note +12 % +$ 17,799,000 +Investment in promissory note - Alpha Fund +8 % +3,600,000 +Accrued interest receivable* +2,092,000 +Other +600,000 +Total investment in promissory notes, gross +24,091,000 +Less: provision for loan losses +( 2,000,000 ) +Total investment in promissory note +$ 22,091,000 +* During the year ended December 31, 2021, no +interest income was recognized from the Company’s investment in AVLP. +Investment in Common Stock and Warrants +December 31, +2021 +Investment in common stock and warrants +$ 39,000 +The following table summarizes +the changes in the Company’s equity investments in an unconsolidated entity, AVLP, during the years ended December 31, 2022 and +2021: +Schedule of changes in the equity investments +Investment in +Investment in +warrants and +promissory notes +Total +common stock +and advances +investment +Balance at January 1, 2021 +$ 5,486,000 +$ 10,471,000 +$ 15,957,000 +Investment in convertible promissory notes +- +7,344,000 +7,344,000 +Fair value of warrants +2,786,000 +- +2,786,000 +Unrealized loss in warrants +( 7,772,000 ) +- +( 7,772,000 ) +Unrealized gain in common stock +( 150,000 ) +- +( 150,000 ) +Loss from equity investment +( 311,000 ) +- +( 311,000 ) +Accretion of discount +- +4,210,000 +4,210,000 +Accrued interest +- +66,000 +66,000 +Balance at December 31, 2021 +39,000 +22,091,000 +22,130,000 +Investment in convertible promissory notes +- +2,200,000 +2,200,000 +Loss from equity investment +( 39,000 ) +( 885,000 ) +( 924,000 ) +Accrued interest +- +143,000 +143,000 +Loss on remeasurement upon conversion +- +( 2,700,000 ) +( 2,700,000 ) +Conversion of AVLP convertible promissory notes +- +( 17,040,000 ) +( 17,040,000 ) +Elimination of intercompany debt after conversion +- +( 3,809,000 ) +( 3,809,000 ) +Balance at December 31, 2022 +$ - +$ - +$ - +F- 35 +15. INVESTMENTS IN LIMITED PARTNERSHIP +On June 8, 2018, the Company +entered into a limited partnership agreement, in which it agreed to become a limited partner in the partnership (the “NY Partnership”). +The NY Partnership is a limited partner in the partnership related to an investment in a hotel in New York City that opened +for operations in 2022. In connection with this transaction, the Company has agreed to finance a portion of the capital required by the +NY Partnership. As of December 31, 2022, the Company had invested an aggregate of $ 1.9 million in the NY Partnership. The Company +has no further required funding obligations related to the hotel. This investment does not have a readily determinable fair value and +has been measured at cost. +16. CONSOLIDATED VARIABLE INTEREST ENTITY - +ALPHA FUND +Alpha Fund – Consolidated Variable +Interest Entity +As of December 31, 2022 and +2021, the Company held an investment in the Alpha Fund. Alpha Fund operates as a private investment fund. The general partner of Alpha +Fund, Ault Alpha GP LLC (“Alpha GP”) is owned by Ault Capital Management LLC (the “Investment Manager”), which +also acts as the investment manager to Alpha Fund. The Investment Manager is owned by Ault & Company. Messrs. Ault, Horne, Nisser +and Cragun, who serve as executive officers and/or directors of the Company, are executive officers of the Investment Manager, and Messrs. +Ault, Horne and Nisser are executive officers and directors of Ault & Company. +As of December 31, 2022, Ault +Lending subscribed for $ 33 million or approximately 100 % of the limited partnership interests in Alpha Fund, the full amount of which +was funded, an increase of $16 million from the $ 17 million subscribed and funded as of December 31, 2021. These investments are subject +to a rolling five-year lock-up period, provided that after three years, Alpha GP will waive 24 months of the lock-up period upon receipt +of written notice from an executive officer of the Company that a withdrawal of capital is required to prevent a going concern opinion +from the Company’s auditors, under the terms of Alpha Fund’s partnership agreement and side letter entered into between the +Company and Alpha Fund. +The Company consolidates Alpha +Fund as a variable interest entity (a “VIE”) due to its significant level of influence and control of Alpha Fund, the size +of its investment, and its ability to participate in policy making decisions, the Company is considered the primary beneficiary of the +VIE. +Investments by Alpha Fund – Treasury +Stock +As of December 31, 2022, Alpha +Fund owned 48,086,223 shares of the Company’s common stock and 91,184 shares of the Company’s 13.00 % Series D Cumulative Redeemable +Perpetual Preferred Stock (the “Series D Preferred Stock”), accounted for as treasury stock as of December 31, 2022. +17. BUSINESS COMBINATIONS +Avalanche International Corp. (“AVLP”) +Acquisition +On June 1, 2022, the Company +converted the principal amount under the convertible promissory notes issued to it by AVLP and accrued unpaid interest into common stock +of AVLP. The Company converted $ 20.0 million in principal and $ 5.9 million of accrued interest receivable at a conversion price of $ 0.50 +per share and received 51,889,168 shares of common stock increasing its common stock ownership of AVLP from less than 20 % to approximately +92 %. +Prior to the conversion of +the convertible promissory notes, the Company accounted for its investment in AVLP as an investment in an unconsolidated entity under +the equity method of accounting. In connection with the conversion of the convertible promissory notes, the Company’s consolidated +financial statements now include all of the accounts of AVLP, and any significant intercompany balances and transactions have been eliminated +in consolidation. +The consideration transferred +for the Company’s approximate 92% ownership interest in connection with this acquisition aggregated $20.7 million, which represented +the fair value of the Company’s holdings in AVLP immediately prior to conversion. The carrying amount of the Company’s holdings +in AVLP immediately prior to conversion was $23.4 million, resulting in a $2.7 million loss for the related remeasurement, which was recognized +in interest and other income. +F- 36 +The Company estimated the +fair values of assets acquired and liabilities assumed using valuation techniques, such as the income, cost and market approaches. The +fair values are based on available historical information and on future expectations and assumptions deemed reasonable by management but +are inherently uncertain. The income method to measure the fair value of intangible assets, is based on forecasts of the expected future +cash flows attributable to the respective assets. Significant estimates and assumptions inherent in the valuations reflected a consideration +of other marketplace participants and included the amount and timing of future cash flows (including expected growth rates and profitability), +the underlying product or technology life cycles, economic barriers to entry and the discount rate applied to the cash flows. Unanticipated +market or macroeconomic events and circumstances could affect the accuracy or validity of the estimates and assumptions. +The tradenames and patents/developed +technology intangible assets were valued using the relief-from-royalty method. The relief-from-royalty method is one of the methods under +the income approach wherein estimates of a company’s earnings attributable to the intangible asset are based on the royalty rate +the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying royalty rates of +20% for patents and developed technology and 0.25% for trademarks. The resulting net annual royalty payments are then discounted to present +value using a discount factor of 24.6%. +Goodwill represents the excess +of the purchase price over the fair value of identifiable assets acquired and liabilities assumed at the acquisition date and is primarily +attributable to the assembled workforce and expected synergies at the time of the acquisition. The goodwill resulting from this acquisition +is not tax deductible. +The Company invested in AVLP +based on the potential global impact of the novel technology of AVLP. AVLP has developed a novel cost effective and environmentally friendly +material synthesis technology for textile applications. AVLP’s Multiplex Laser Surface Enhancement is a unique technology that has +the ability to treat both natural and synthetic textiles for a wide variety of functionalities, including dyeability and printing enhancements, +hydrophilicity, hydrophobicity, fire retardancy and anti-microbial properties. The use of water, harmful chemicals and energy is significantly +reduced in comparison to conventional textile treatment methods. +The following table presents +the allocation of the consideration transferred to the assets acquired and liabilities assumed based on their fair values. +Schedule of assets acquired and liabilities assumed based on their fair values +Allocation +Total purchase consideration +$ 22,143,000 +Fair value of non-controlling interest +7,790,000 +Total consideration +$ 29,933,000 +Identifiable net liabilities assumed: +Cash +$ 1,245,000 +Prepaid expenses and other current assets +55,000 +Property and equipment +5,057,000 +Intangible asset - patents/developed technology (not yet placed in service; upon being placed in service, 7 year estimated useful life) +23,984,000 +Intangible asset - trademarks ( 9 year estimated useful life) +816,000 +Accounts payable and accrued expenses +( 4,689,000 ) +Deferred tax liability +( 5,000,000 ) +Convertible notes payable, principal +( 10,104,000 ) +Net assets assumed +11,364,000 +Goodwill +$ 18,569,000 +The Company consolidates the +results of AVLP on a one-month lag, therefore the statements of operations include results for AVLP for the six months ended November +30, 2022. +AVLP Related Party Transaction +During the period from June 2022 to November 2022, +MTIX Ltd., a subsidiary of AVLP, incurred fees of $ 0.3 million from 313M Technology Ltd, a UK Company, (“313M”) for the use +of facilities and personnel. The Managing Director of 313M is Kristina Mistry, the daughter of Pravin Mistry, a director of AVLP and the +Chief Executive Officer of MTIX Ltd. +Overview of SMC Acquisition +Beginning in June 2022, the +Company, through its subsidiary Ault Lending, began making open market purchases of SMC common stock. These purchases granted the Company +a greater than 20% effective ownership on June 9, 2022, and subsequently, on June 15, 2022, the Company owned more than 50% of the issued +and outstanding common stock of SMC. The Company’s ownership of SMC stood at approximately 57% as of December 31, 2022. +SMC is a NASDAQ-listed global +leader in consumer karaoke products. This strategic acquisition aligns with the Company’s initiatives to expand its presence in +the hospitality and entertainment industry. SMC leverages a top-tier global distribution network through major mass merchandisers and +online retailers. The Company intends to capitalize on its existing relationships and sourcing capabilities to extend SMC’s reach +and product offerings, with the goal of increasing market share and revenues. +As of June 15, 2022 (“Acquisition +Date”), the purchase price of the common stock acquired totaled $ 7.4 million +and on June 15, 2022 a $ 3.1 +million gain was recognized in interest and other income for the remeasurement of the Company’s previously held ownership +interest to $ 10.5 +million, based on the trading price of SMC common stock. The Company also recognized non-controlling interest at fair value as +of the Acquisition Date in the amount of $ 10.3 +million. +F- 37 +The trade names and developed technology intangible assets were valued +using the relief-from-royalty method. The relief-from-royalty method is one of the methods under the income approach wherein estimates +of a company’s earnings attributable to the intangible asset are based on the royalty rate the company would have paid for the use +of the asset if it did not own it. Royalty payments are estimated by applying royalty rates between of 0.5% and 1.0% to the prospective +revenue attributable to the intangible asset. The resulting net annual royalty payments are then discounted to present value using a discount +factor of 12.0%. +The Company determined an +estimated fair value of customer relationships using an income approach utilizing a discounted cash flow methodology. The analysis included +assumptions regarding the development of new businesses and 3% organic growth rates, a discount rate of 12% using a weighted average cost +of capital analysis, and capital expenditure requirements associated with any new initiatives developed by SMC. Significant assumptions +utilized in the income approach were based on company specific information and projections which are not observable in the market and +are therefore considered Level 3 fair value measurements. +The goodwill resulting from +this acquisition is not tax deductible. +The following table presents +the allocation of the consideration transferred to the assets acquired and liabilities assumed based on their fair values. +Schedule of assets acquired and liabilities assumed based on their fair values +Allocation +Total purchase consideration +$ 10,517,000 +Fair value of non-controlling interest +10,336,000 +Total consideration +$ 20,853,000 +Identifiable net assets acquired: +Cash +$ 2,278,000 +Accounts receivable +9,891,000 +Prepaid expenses and other current assets +673,000 +Inventories +12,840,000 +Property and equipment, net +529,000 +Right-of-use assets +1,073,000 +Other assets +83,000 +Intangible assets: +Trade names ( 10 +year estimated useful life) +2,470,000 +Customer relationships ( 10 year estimated useful life) +1,380,000 +Proprietary technology ( 3 year estimated useful life) +600,000 +Accounts payable and accrued expenses +( 10,052,000 ) +Notes payable +( 2,972,000 ) +Lease liabilities +( 1,124,000 ) +Net assets acquired +17,669,000 +Goodwill +$ 3,184,000 +Overview of GIGA Acquisition +On September 8, 2022, GIGA +acquired +100% of the capital stock of Gresham Worldwide, Inc. (“GWW”) from the Company in exchange for 2.92 million shares of GIGA’s +common stock and 514.8 shares of GIGA’s Series F Convertible Preferred Stock (“Series F”) that are convertible +into an aggregate of 3.96 million shares of GIGA’s common stock. GIGA also assumed GWW’s outstanding equity awards representing +the right to receive up to 749,626 shares of GIGA’s common stock, on an as-converted basis. The transaction described above resulted +in a change of control of GIGA. Assuming the Company was to convert all of the Series F, the common stock owned by the Company after +such conversion would result in the Company owning approximately 71.2% of GIGA’s outstanding shares. +F- 38 +On September 8, 2022, the +Company loaned GIGA $ 4.25 million by purchasing a convertible note that carries an interest rate of 10 % per annum and matures on February +14, 2023. The convertible note between the Company and GIGA is eliminated in consolidation beginning on September 8, 2022. The Company +received the right to appoint four members of a seven member GIGA board of directors. These factors contributed to the Company’s +determination that GWW be treated as the accounting acquirer. +The Company believes there +are synergies between GIGA and GWW. GIGA manufactures specialized electronics equipment for use in both military test and airborne operational +applications. GIGA focuses on the design and manufacture of custom microwave products for military airborne, sea, and ground applications +as well as the design and manufacture of high-fidelity signal simulation and recording solutions for RADAR and electronic warfare test +applications. GIGA’s results of operations subsequent to the acquisition are included in the Company’s GIGA defense business +segment. +In respect of the above transactions, +the acquired assets and assumed liabilities, together with acquired processes and employees, represent a business as defined in ASC 805, +Business Combinations . The transactions were accounted for as a reverse acquisition using the acquisition method of accounting +with GIGA treated as the legal acquirer and GWW treated as the accounting acquirer. In identifying GWW as the acquiring entity for accounting +purposes, GIGA and GWW took into account a number of factors, including the relative voting rights, executive management and the corporate +governance structure of the Company. GWW is considered the accounting acquirer since the Company controls the board of directors of GIGA +following the transactions and received a 71.2% beneficial ownership interest in GIGA. However, no single factor was the sole determinant +in the overall conclusion that GWW is the acquirer for accounting purposes; rather all factors were considered in arriving at such conclusion. +The fair value of the purchase +consideration was $ 9.5 million, consisting of $ 4.0 million for GIGA’s common stock and prefunded warrants, $ 0.4 million fair value +of vested stock incentives, $ 3.7 million cash and $ 1.3 million related to an existing loan agreement between Ault Lending and GIGA, which +was deemed settled. +The total purchase price to +acquire GIGA has been allocated to the assets acquired and assumed liabilities based upon estimated fair values, with any excess purchase +price allocated to goodwill. The goodwill resulting from this acquisition is not tax deductible. The fair value of the acquired assets +and assumed liabilities as of the date of acquisition are based on reports from a third-party valuation expert. +The purchase price allocation +is as follows: +Schedule of preliminary purchase price +allocation +Allocation +Total purchase consideration +$ 6,763,000 +Fair value of non-controlling interest +2,735,000 +Total consideration +$ 9,498,000 +Identifiable net assets acquired (liabilities assumed): +Cash +$ 107,000 +Trade accounts receivable +536,000 +Inventories +2,930,000 +Prepaid expenses +116,000 +Accrued revenue +363,000 +Property and equipment +331,000 +Right-of-use asset +370,000 +Other long-term assets +446,000 +Accounts payable +( 2,831,000 ) +Loans payable, net of discounts and issuance costs +( 387,000 ) +Accrued payroll and benefits +( 1,488,000 ) +Lease obligations +( 491,000 ) +Other current liabilities +( 368,000 ) +Other non-current liabilities +( 17,000 ) +Net liabilities assumed +( 383,000 ) +Goodwill +$ 9,881,000 +F- 39 +Overview of Circle 8 Acquisition +On November 17, 2022, Circle +8 (“Buyer”), a wholly owned subsidiary of Circle 8 Holdco LLC entered into an asset purchase agreement (“Circle 8 Purchase +Agreement”) with Circle 8 Crane Services, LLC (“Seller”), to acquire substantially all of Circle 8’s operating +assets and the recapitalization of the business into Circle 8. The Company has a 65 % direct ownership in Circle 8 Holdco LLC and a 5.8 % +indirect ownership via Circle 8 Crane GP. +In accordance with the Circle +8 Purchase Agreement, on December 16, 2022 (“Closing Date”), the Buyer completed the acquisition and obtained control of Circle +8. The aggregate purchase price consideration transferred from the Buyer to the Seller totaled $31.5 million which included (i) extinguishment +of debt amounting to $29.2 million (ii) rollover equity issued to the seller with an estimated fair value of $0.6 million (iii) contingent +consideration of $0.9 million and (iv) Seller’s transaction expenses of $0.7 million. The following summarizes the fair value +of consideration transferred at the acquisition closing: +Schedule of business acquisitions by acquisition, contingent consideration +Extinguishment of debt +$ 29,234,000 +Rollover equity +565,000 +Contingent consideration – earn-out +922,000 +Sellers transaction expenses reimbursement +742,000 +Total consideration +$ 31,463,000 +In conjunction with the acquisition, +certain individuals of the Seller’s ownership group received rollover equity interest as purchase consideration. The rollover equity +includes the Buyer issuing to the Seller 6,000 Class D interests in Circle 8 Holdco LLC, which is the sole owner of the equity interests +of Circle 8. Management engaged a valuation specialist to estimate the fair value of the grants as of the Closing Date. +Pursuant to the terms of the +Circle 8 Purchase Agreement, additional purchase consideration would be paid by the Buyers to the Sellers, contingent upon achievement +of a minimum EBITDA threshold for a three-year earn-out measurement period beginning on the day following the Closing Date and ending +on the date that is the 36-month anniversary of the Closing Date, which would then increase for additional EBITDA performance up to a +maximum ceiling. Pursuant to the terms of the Circle 8 Purchase Agreement, the earn-out would be paid to the Sellers in an amount ranging +from $0 up to $0.7 million based on a pro rata basis for incremental EBITDA results starting at a minimum of $5.7 million. The fair value +of the earn-out was valued using the Monte Carlo Simulation which estimates the fair value based on an analysis of various future outcomes. +As such the fair value measurement includes significant unobservable inputs such as risk-adjusted discount rate and projected results +of operations over the earn-out period, and thus, represented a Level 3 measurement. The fair value of the earn-out as of the acquisition +date was $0.9 million. To date, the year one earn-out measurement period has not been surpassed and thus, no cash payments have been made +from the Buyers to the Sellers for contingent purchase consideration. +The acquisition was accounted +for as a business combination using the acquisition method of accounting in accordance with ASC 805, Business Combinations. In accordance +with ASU 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination, the Company +elected not to separately recognize intangible assets that would otherwise arise from customer-related intangible assets. The value of +these intangible assets is effectively subsumed into goodwill. +The purchase price has been +allocated to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date, +with the exception of the deferred income tax assets acquired and liabilities assumed which are recognized and measured in accordance +with ASC 740, Income Taxes. The excess of the fair value of purchase consideration over the values of the identifiable assets and liabilities +is recorded as goodwill. +The acquisition resulted in +the fair value of the net assets acquired exceeding the amount of consideration transferred, which occurred as a result of negotiations +with the Seller at a time of depressed EBITA as well as imposing a requirement on the Seller to provide preliminary net working capital +equal to or greater than $3.0 million without the ability for adjustments up or down. ASC 805 refers to this as a “bargain purchase” +and requires the Buyer to recognize a gain for the amount that the values assigned to the net assets acquired exceed the consideration +transferred and cannot recognize goodwill from the acquisition. +Consequently, the Company +reassessed the recognition and measurement of identifiable assets acquired, and liabilities assumed and concluded that all acquired assets +and assumed liabilities were recognized and that the valuation procedures and resulting measures were appropriate. As a result, the Company +recognized a gain of $0.8 million. The gain is included in the line item “gain from bargain purchase of business” in the consolidated +statement of operations. +F- 40 +The following table summarizes +the estimated fair values of the assets acquired and liabilities assumed at the acquisition date: +Schedule of recognized identified assets acquired and liabilities assumed +Assets +Cash and cash equivalents +$ 290,000 +Trade receivable, net +4,334,000 +Prepaids and other current assets +1,185,000 +Inventory +24,000 +Property and equipment, net +36,395,000 +Right-of-use assets +1,558,000 +Intangible assets – trade name ( 10 +year estimated useful life) +1,030,000 +Intangible assets – customer relationships ( 8 year estimated useful life) +1,290,000 +Other non-current assets +17,000 +Total Assets +$ 46,123,000 +Liabilities +Accounts payable +$ ( 548,000 ) +Accrued payroll and benefits +( 186,000 ) +Operating lease liabilities - current +( 436,000 ) +Other current liabilities +( 855,000 ) +Notes payable - Equipment notes +( 10,685,000 ) +Operating lease liabilities - non current +( 1,144,000 ) +Total Liabilities +$ ( 13,854,000 ) +Net assets acquired +$ 32,269,000 +The fair value of the acquired +trade accounts receivables approximates the carrying value due to the short-term nature of the expected timeframe to collect the amounts +due and the contractual cash flows, which are expected to be collected related to these receivables. +As part of the purchase +price allocation, the Company determined the identifiable intangible assets were: (i) trade name and (ii) customer relationships. +The fair value of the intangible assets was estimated using variations of the income approach. Specifically, the relief from royalty +method was utilized to estimate the fair value of the trade name and the multi-period excess earnings method was utilized to +estimate the fair value of the customer relationships. The trade name relates to the overall consolidated group name and related +industry recognition. The customer relationships represent a source of repeat business that is critical to the operations providing +crane operators, engineering, custom rigging and transportation services for oilfield, construction, commercial and infrastructure +markets. The discounted cash flows were based on estimates used to price the transaction, and the discount rates applied were +benchmarked with reference to the implied rate of return from the transaction model and the weighted average cost of capital. These +nonrecurring fair value measurements are primarily determined using unobservable inputs. Accordingly, these fair value measurements +are classified within Level 3 of the fair value hierarchy. +The consolidated financial +statements include results of operations following the consummation of the acquisition for the period December 16, 2022, through December +31, 2022. +Unaudited Pro Forma Financial Information +The following unaudited pro +forma consolidated results of operations for the year ended December 31, 2022 have been prepared as if the AVLP, SMC, GIGA and Circle +8 acquisitions had occurred on January 1, 2021. This table has been prepared for comparative purposes only and is not indicative of the +actual results that would have been attained had the acquisition occurred as of the beginning of the periods presented, nor is it indicative +of future results. +Business acquisition, pro forma information +For the Year Ended +December 31, +2022 +2021 +Total revenues +$ 214,636,000 +$ 135,582,000 +Net loss attributable to Ault Alliance, Inc. +$ ( 185,957,000 ) +$ ( 17,966,000 ) +F- 41 +Asset Acquisitions During 2021 +Acquisition of +Michigan Cloud Data Center +On +January 29, 2021, Alliance Cloud Services, LLC, a majority-owned subsidiary of its wholly owned subsidiary, Ault Alliance, closed on +the acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan for a purchase +price of $ 4.0 +million. The purchase price was paid by the Company using its own working capital. The facility is subject to a final corrective +measures plan with the Environment Protection Agency. The seller performed remedial activities at the Michigan facility relating to +historical soil and groundwater contamination and the Company is responsible for ongoing monitoring and final remediation plans. The +Company’s estimated cost of the environmental remediation obligation is approximately $ 0.4 +million and reflects its best estimate of probable future costs for remediation based on the current assessment data and regulatory +obligations. Future costs will depend on many factors, including the extent of work necessary to implement monitoring and final +remediation plans and the Company’s time frame for remediation. The Company may incur actual costs in the future that are +materially different than this estimate and such costs could have a material impact on results of operations, financial condition, +and cash flows during the period in which they are recorded. +Acquisition of Hotels +On +December 22, 2021, the Company, through AGREE, acquired four hotel properties for $ 71.3 million consisting of a 136-room Courtyard by +Marriott, a 133-room Hilton Garden Inn and a 122-room Residence Inn by Marriott in Middleton, WI, as well as a 135-room Hilton Garden +Inn in Rockford, IL. +The allocation of the purchase +price of the hotel acquisitions is based on the estimated fair value of the assets acquired. The Company accounted for these transactions +as acquisitions of assets. +The Company has performed +a valuation analysis of the fair market value of the assets acquired. The accounted for these transactions as acquisitions of assets. +The following table summarizes the allocation of the purchase price as of the date of the Acquisition. The purchase price +consisted of $ 69.2 million paid to the seller and $ 2.1 million of direct transaction costs. +Schedule of business acquisitions by acquisition, contingent consideration +Land and improvements +$ 9,021,000 +Building improvements +60,265,000 +Furniture, fixtures and equipment +2,048,000 +Assets acquired +$ 71,334,000 +Acquisition of St. Peterburg Land +On +December 30, 2021, the Company, through Third Avenue Apartments, LLC, a wholly owned subsidiary of AGREE Madison, LLC (“AGREE Madison”), +a wholly owned subsidiary of AGREE, acquired certain real property located at the southeast corner of 5th Street North and 3rd Avenue +North in St. Petersburg, Florida. The purchase price for the property was $ 15.5 million. The Company has obtained permits to develop the +property for a high-rise multi-family project. +18. EXECUTIVE CHAIRMAN RELOCATION BENEFIT +On February 23, 2021, as part +of a relocation benefit for the Company’s Executive Chairman, Milton C. Ault, III, related to the Company moving its corporate headquarters +from Newport Beach, CA to Las Vegas, NV, the Company agreed to purchase Mr. Ault’s California residence for $ 2.7 million. The +transaction was structured such that upon the closing of the subsequent sale of the residence, the Company shall have not recognized a +gain or a loss on the transaction. The Company and Mr. Ault agreed to escrow $ 0.3 million of the purchase price in the event of a +loss on the subsequent sale of the residence. During April 2021, the Company entered into an agreement for the subsequent sale of the +residence, which closed on April 19, 2021. +19. STOCK-BASED COMPENSATION +The Company provides stock-based +compensation to directors, employees and consultants under the 2021 Stock Incentive Plan, which was approved by stockholders on August +13, 2021 at the 2021 Annual Meeting of Stockholders and which reserved 7.5 million shares of common stock for grant of awards under +the plan. The 2022 Stock Incentive Plan, was approved by stockholders on November 23, 2022 at the 2022 Annual Meeting of Stockholders +which reserved 75 million shares of common stock for grant of awards under the plan. +F- 42 +Options granted under the +plan have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and become exercisable +based on a vesting schedule determined at the date of grant. Typically, options granted generally become fully vested after four +years. Any options that are forfeited or cancelled before expiration become available for future grants. The options expire between 5 +and 10 years from the date of grant. Restricted stock awards granted under the plan are subject to a vesting period determined at +the date of grant. As of December 31, 2022, an aggregate of 78.1 million shares of the Company’s common stock were available for +future grant. +The options outstanding as +of December 31, 2022, have been classified by exercise price, as follows: +Schedule of exercise price +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ 2.15 - $ 2.62 +3,160,000 +8.75 +$ 2.34 +1,192,092 +$ 2.36 +$ 480 - $ 560 +819 +2.99 +$ 535.27 +819 +$ 535.27 +$ 1,208 - $ 1,352 +25 +1.25 +$ 1,336.00 +25 +$ 1,336.00 +$ 2.15 - $ 1,352 +3,160,844 +8.75 +$ 2.49 +1,192,936 +$ 2.75 +Issuances outside of the Plan +1.79 +850,000 +7.72 +$ 1.79 +850,000 +$ 1.79 +$ 2.46 - $ 2.55 +1,800,000 +8.32 +$ 2.55 +898,766 +2.55 +$ 1.79 - $ 2.55 +2,650,000 +8.13 +$ 2.31 +1,748,766 +$ 2.18 +Total Options +$ 1.79 - $ 1,352 +5,810,844 +8.47 +$ 2.40 +2,941,702 +$ 2.41 +The total stock-based compensation +expense related to stock options and stock awards issued to the Company’s employees, consultants and directors, included in reported +net loss for the year ended December 31, 2022 and 2021, was comprised as follows: +Schedule of stock-based compensation expense +Year Ended December 31, +2022 +2021 +General and administrative +$ 7,147,000 +$ 7,750,000 +Total stock-based compensation +$ 7,147,000 +$ 7,750,000 +A summary of option activity +under the Company’s stock option plans as of December 31, 2022 and 2021, and changes during the years ended are as follows: +Schedule of option activity +Outstanding Options +Weighted +Weighted +Average +Shares +Average +Remaining +Aggregate +Available +Number +Exercise +Contractual +Intrinsic +for +Grant +of +Options +Price +Life (years) +Value +January 1, 2021 +6,693 +925 +$ 564 +4.9 +$ 0 +Authorized +7,500,000 +- +Stock options granted +( 3,395,000 ) +3,395,000 +$ 2.35 +Restricted stock awards +( 1,270,000 ) +- +Forfeited +6 +( 6 ) +$ 1,352 +December 31, 2021 +2,841,699 +3,395,919 +$ 2.52 +9.8 +$ 0 +Authorized +75,000,000 +- +Forfeited +235,075 +( 235,075 ) +$ 2.66 +December 31, 2022 +78,076,774 +3,160,844 +$ 2.49 +8.7 +$ 0 +As of December 31, 2022, there +was $ 5.7 million of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the plan. +That cost is expected to be recognized over a weighted average period of 2.3 years. +F- 43 +GWW Stock-Based +Compensation +On May 25, 2021, GWW issued +its executives options to purchase an aggregate total of 100,000 +shares of GWW Class A common stock, at an exercise price per share of $ 14.64 . +The options vest over a four-year period. Additionally, the executives were granted a restricted stock award to acquire an aggregate +of 50,000 shares of GWW Class A common stock, vesting annually over a three-year term. The stock-based compensation expense related to +the options included in reported net loss for the years ended December 31, 2022 and 2021 was $ 0.2 +million and $ 0.6 +million, respectively, based on the estimated fair value of the options on the date of issuance. As of December 31, 2022, there +was $ 0.3 +million of unrecognized compensation cost related to non-vested stock-based compensation arrangements with Messrs. Read and Long. +That cost is expected to be recognized over a weighted average period of 1.5 +years. +20. WARRANTS +A summary of warrant activity +for the years ended December 31, 2022 and 2021 is presented below. +Schedule of warrants +Warrants +Weighted- +Average +Exercise Price +Weighted- +Average +Remaining +Contractual +Life (Years) +Outstanding at January 1, 2021 +3,315,560 +$ 6.19 +4.3 +Granted +18,665,252 +2.47 +Forfeited +( 397 ) +8.00 +Exercised +( 1,965,628 ) +2.42 +Outstanding at December 31, 2021 +20,014,787 +3.09 +4.7 +Granted +9,066,666 +0.60 +Forfeited +( 3,998 ) +607.30 +Exercised +( 13,548,421 ) +2.22 +Outstanding at December 31, 2022 +15,529,034 +$ 2.24 +3.9 +The following table summarizes +information about common stock warrants outstanding at December 31, 2022: +Schedule of common stock warrants outstanding +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ 0.00 +6,500 +1.25 +$ 0.00 +6,500 +$ 0.00 +$ 0.45 - $ 2.50 +15,454,885 +3.91 +$ 1.38 +15,454,885 +$ 1.38 +$ 8.80 - $ 19.80 +53,055 +1.39 +$ 12.78 +53,055 +$ 12.78 +$ 480 - $ 920 +12,227 +0.34 +$ 774.63 +12,227 +$ 774.63 +$ 1,040 +- $ 2,000 +2,367 +0.18 +$ 1,404.85 +2,367 +$ 1,404.85 +$ 0.00 - $ 2,000.00 +15,529,034 +3.89 +$ 2.24 +15,529,034 +$ 2.24 +Warrant Issuances During 2021 +On December 30, 2021, the +Company issued warrants to purchase an aggregate of 16,037,858 shares of common stock at an exercise price equal to $ 2.50 per share in +connection with the issuance of promissory notes in the aggregate principal face amount of $ 66 million (see Note 24). If the trading price +of the common stock is less than $2.50 per share 90 days after December 30, 2021, the exercise price will be reduced to 110% of the closing +price of the common stock on that date, subject to a floor price of $1.00 per share. +The Company has valued the +14,095,350 Series A warrants issued in connection with the issuance of promissory notes in the aggregate principal face amount of $66 +million (see Note 24) at their date of grant utilizing a Monte Carlo simulation valuation model. The Company has valued the other warrants +issued at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables such as +the warrants’ remaining contractual term, exercise price, current stock price, risk-free interest rate and estimated volatility +of the Company’s stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based +on the implied yield available on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +F- 44 +Warrant Issuances During 2022 +On November 7, 2022, the +Company issued warrants to purchase 4,533,334 shares of common stock at exercise price equal to $0.45 per share and warrants to purchase +4,533,334 +shares of common stock at exercise price equal to $ 0.75 +per share, subject to adjustment in connection with the issuance of secured promissory notes +in the aggregate principal face amount of $ 18.9 +million (see Note 24) . +The Company has valued the +warrants issued at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables +such as the warrants’ remaining contractual term, exercise price, current stock price, risk-free interest rate and estimated volatility +of the Company’s stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based +on the implied yield available on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +The Company utilized a variety +of pricing models and the weighted average assumptions used during the years ended December 31, 2022 and 2021 were as follows: +Schedule of weighted average assumptions +December 31, +2022 +December 31, +2021 +Exercise price +$ 0.60 +$ 2.29 +Contractual term in years +4.0 +4.7 +Volatility +176 % +150 % +Dividend yield +0 % +0 % +Risk-free interest rate +4.5 % +1.0 % +21. ACCOUNTS PAYABLE AND ACCRUED EXPENSES +Other current liabilities at December +31, 2022 and 2021 consisted of: +Schedule of other current liabilities +December 31, +2022 +2021 +Accounts payable +$ 21,347,000 +$ 6,902,000 +Accrued payroll and payroll taxes +9,939,000 +5,027,000 +Accrued lender profit participation rights +6,000,000 +- +Interest payable +3,207,000 +187,000 +Accrued legal +3,168,000 +2,637,000 +Advances from related parties +352,000 +- +Financial instrument liabilities +651,000 +4,249,000 +Other accrued expenses +17,980,000 +3,753,000 +Total liabilities +$ 62,644,000 +$ 22,755,000 +Accrued Lender Profit Participation Rights +The accrued lender profit +participation rights relate to the November 18, 2022 secured promissory notes. The secured promissory notes have a security interest in +certain marketable securities to be acquired by BNI (the “Participation Collateral”). When the Company sells the Participation +Collateral, the Company is required to give the investors a profits participation interest equal to 45% of the realized gains. The Company +estimated the profit participation right resulting in a $6.0 million estimated liability based on 45% of the expected realized gain as +of December 31, 2022. +Financial Instruments +Under authoritative guidance +used by the FASB on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock, instruments that +do not have fixed settlement provisions are deemed to be derivative instruments. In prior years, the Company granted certain warrants +that resulted in these warrants being accounted for as a financial instrument in accordance with ASC 815 and being re-measured every reporting +period with the change in value reported in the statement of operations. +F- 45 +The financial instruments +were valued using a variety of pricing models with the following valuation assumptions for the year ended December 31, 2021: +Schedule of financial instrument +December 31, +2021 +Stock price +$ 2.50 +Exercise price +$ 2.50 +Contractually defined remaining term +5.0 +Contractually defined volatility +135 % +Dividend yield +0 % +Risk-free interest rate +1.3 % +Per the terms of +the warrant agreements underlying the financial instruments, the value to the warrant holders is defined within the agreement based on +a stock price, contractual term, volatility factor and dividend rate as defined in the warrant agreement, and not indexed to the company’s +stock, resulting in the financial instrument accounting. The risk-free interest rate was based on rates established by the Federal Reserve +Bank. +The following table sets forth +a summary of the changes in the estimated fair value of the financial instruments during the years ended December 31, 2022 and 2021: +Schedule of fair value of the financial instruments +December 31, +2022 +2021 +Beginning balance +$ 4,249,000 +$ 4,192,000 +Recognition of financial instruments +- +4,239,000 +Change in fair value +17,000 +542,000 +Extinguishment +( 4,266,000 ) +( 4,724,000 ) +Ending balance +$ - +$ 4,249,000 +Advances from Related Parties +As of December 31, 2022, the +balance of advances from related parties was $ 0.3 million. This amount consists of unsecured, non-interest-bearing loans due on demand, +which were borrowed in December 2022. $0.2 million of the balance was borrowed from Mr. Nisser, and $0.1 million was borrowed from Mr. +Horne. These loans are not subject to written agreements. +22. INVESTMENT MARGIN ACCOUNTS PAYABLE +During the year ended December +31, 2021, the Company entered into leverage agreements on certain brokerage accounts. As of December 31, 2022 and 2021, outstanding borrowings +on the leverage agreements on certain broker accounts were $ 0.8 million and $ 18.5 million, respectively. During the years ended December 31, +2022 and 2021, the interest expense on these borrowings was $ 72,000 and $ 55,000 , respectively. +23. LEASES +The Company has operating +leases for office space. The Company’s leases have remaining lease terms of 12 months to 9.5 years, some of which may +include options to extend the leases perpetually, and some of which may include options to terminate the leases within 1 year. +The following table provides +a summary of leases by balance sheet category as of December 31, 2022 and 2021: +Schedule of supplemental balance sheet information related to leases +December 31, +2022 +December 31, +2021 +Operating right-of-use assets +$ 8,419,000 +$ 5,243,000 +Operating lease liability - current +2,975,000 +1,123,000 +Operating lease liability - non-current +5,836,000 +4,213,000 +F- 46 +The components of lease expenses +for the years ended December 31, 2022 and 2021, were as follows: +Schedule of lease expenses +Year Ended December 31, +2022 +2021 +Operating lease cost +$ 2,716,000 +$ 1,406,000 +Short-term lease cost +- +- +Variable lease cost +- +- +The following tables provides +a summary of other information related to leases for the years ended December 31, 2022 and 2021: +Schedule of supplemental cash flow information related to leases +December 31, 2022 +December 31, 2021 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ 2,554,000 +$ 1,008,000 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ 3,791,000 +$ 1,875,000 +Weighted-average remaining lease term - operating leases +4.1 years +6.1 years +Weighted-average discount rate - operating leases +7.0 % +8.0 % +Maturity of lease liabilities +under the Company’s non-cancellable operating leases as of December 31, 2022, were as follows: +Schedule of maturities of operating lease liabilities +Payments due by period +2023 +$ 3,556,000 +2024 +2,394,000 +2025 +1,896,000 +2026 +1,027,000 +2027 +376,000 +Thereafter +1,144,000 +Total lease payments +10,393,000 +Less interest +( 1,582,000 ) +Present value of lease liabilities +$ 8,811,000 +24. NOTES PAYABLE +Notes payable at December +31, 2022 and 2021, were comprised of the following. +Schedule of notes payable +Interest +rate +Due date +December 31, +2022 +December 31, +2021 +Short-term notes payable +5.0 % +January 3, 2023 +$ 700,000 +$ 118,000 +10% original issue discount senior secured notes +- +65,972,000 +AGREE Madison secured construction loans +7.0 % +January 1, 2025 +62,395,000 +55,055,000 +SMC line of credit +8.0 % +October 14, 2025 +1,761,000 +- +SMC installment notes +7.6 % +June 18, 2024 +158,000 +- +SMC line of credit +8.4 % +December 16, 2025 +14,724,000 +- +SMC line of credit +7.2 % +November 16, 2026 +10,677,000 +- +XBTO note payable +12.5 % +December 30, 2023 +2,749,000 +- +16% senior secured promissory note +16.0 % +March 16, 2023 +17,456,000 +- +3% secured promissory notes +3.0 % +May 18, 2023 +5,672,000 +- +8.5% secured promissory notes +8.5 % +May 7, 2024 +17,389,000 +- +10% secured promissory notes +10.0 % +August 10, 2023 +8,789,000 +- +Short-term bank credit facilities +4.4 % +Renews monthly +1,702,000 +960,000 +Total notes payable +$ 144,172,000 +$ 122,105,000 +Less: +Unamortized debt discounts +( 13,087,000 ) +( 27,496,000 ) +Total notes payable, net +$ 131,085,000 +$ 94,609,000 +Less: current portion +( 39,621,000 ) +( 39,554,000 ) +Notes payable – long-term portion +$ 91,464,000 +$ 55,055,000 +F- 47 +During the years ended December +31, 2022 and 2021, the Company recorded amortization of debt discounts of $ 30.0 million and $ 7.3 million, respectively. +Notes Payable Maturities +The contractual maturities +of the Company’s notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s option, +as of December 31, 2022 were: +Schedule Of maturities +Year +2023 +$ 51,069,000 +2024 +13,807,000 +2025 +64,132,000 +2026 +15,164,000 +$ 144,172,000 +December 2021 Secured Promissory Notes +On December 30, 2021, the Company entered into +a securities purchase agreement with certain sophisticated investors providing for the issuance of: +· secured promissory notes (the “Secured Promissory Notes”) that bear interest at 8 % per annum +with an aggregate principal face amount of approximately $ 66 million including a 10 % original issue discount; +· five-year warrants to purchase an aggregate of 14,095,350 shares of the Company’s common stock at +an exercise price of $ 2.50 , subject to adjustment; and +· five-year warrants to purchase an aggregate of 1,942,508 shares of Common Stock (the “Class B Warrant +Shares”) at an exercise price of $ 2.50 per share, subject to adjustment. The Class B Warrant Shares are deemed to be a derivative +instrument. +In March 2022, the $ 66 +million Secured Promissory Notes were repaid and the Company fully amortized the related debt discount of $ 26.3 +million, which is included within interest expense on the consolidated statements of operations. +AGREE Madison Construction Loan Agreements +On December 22, 2021, +AGREE Madison, through various wholly owned subsidiaries, entered into construction loan agreements. The outstanding balances under +the construction loans was $ 62.4 million +as of December 31, 2021. The construction loans are due on January 1, 2025, but may be extended for two additional 12-month terms, +subject to certain terms and conditions as set forth in the construction loan agreements. The +loans accrue interest at a rate equal to the greater of (i) the LIBOR Rate plus 675 basis points or (ii) 7% per annum. The +AGREE Madison subsidiaries will make monthly installment payments of interest only, starting January 1, 2022. Ault Alliance also +provided a completion guaranty to the lenders for the completion of the property improvement plans. +10% Secured Promissory Notes +On August 10, 2022, the Company, +through its BNI subsidiary, entered into a note purchase agreement providing for the issuance of secured promissory notes with an aggregate +principal face amount of $ 11.0 million and an interest rate of 10 % . The purchase price (proceeds to the Company) for the secured promissory +notes was $ 10.0 million. The secured promissory notes have a security interest in $ 10 million of marketable securities and investments +and certain Bitcoin mining equipment with a carrying amount of $ 23.1 million. The secured promissory notes are further secured by +a guaranty provided by the Company, Ault Lending and by Milton C. Ault, the Executive Chairman of the Company. +The maturity date of the secured +promissory notes is August 10, 2023. The Company is required to make monthly payment (principal and interest) of $1.0 million on the tenth +calendar day of each month, starting in September 2022. Provided that the Company makes the first six monthly payments in full and on +a timely basis, after six months, the Company may elect to pay a forbearance fee of $0.3 million in lieu of a monthly payment, which would +extend the maturity date of the related secured promissory notes by one month for each forbearance. The Company may not elect forbearance +in consecutive months. +F- 48 +On November 18, 2022, the +Company’s BNI subsidiary entered into an amendment to the 10% secured promissory notes issued on August 10, 2022, whereby the investors +permitted the Company to (i) elect to utilize one of the six monthly forbearances under the notes for the November 2022 monthly payment +and (ii) make the forbearance payment with the December 2022 monthly payment. +As of December 31, 2022, the +Company was in default under the terms of the 10 % secured promissory notes because it did not hold the required $ 1.0 million worth of +Bitcoin as collateral. However, the lenders granted the Company a waiver for this default. The 10% secured promissory notes were subsequently +retired in March 2023 and replaced with preferred shares, as described in Note 33 – Subsequent Events. +SMC Credit and Security Agreement with Fifth +Third Bank +On October 14, 2022, SMC entered +into a Credit and Security Agreement (the “Credit Agreement”) with Fifth Third Bank, National Association, as Lender (“Fifth +Third”) replacing SMC’s credit facilities with Crestmark Bank and Iron Horse Credit that were terminated by the Company on +October 13, 2022. The Credit Agreement provides for a three-year secured revolving credit facility in an aggregate principal amount of +up to $15.0 million decreased to $7.5 million during the period of January 1 through July 31 of each year. The Credit Agreement matures +on October 14, 2025. +As of December 31, 2022, SMC +was in default under the Credit Agreement due to non-compliance with the fixed charge coverage ratio covenant primarily due to SMC’s +decrease in revenue in the fourth quarter of 2022 and increased general and administrative expenses. To date, Fifth Third has not taken +action to accelerate SMC’s obligations under the Credit Agreement and SMC is currently in negotiations with Fifth Third to obtain +a waiver and renegotiate the fixed charge coverage ratio covenant. There can be no assurance that the negotiations will be successful +and that Fifth Third will grant SMC a waiver or renegotiate the covenant. +The SMC debt is secured by +a perfected security interest in all SMC assets including a first-priority security interest in SMC accounts receivable and inventory. +Secured Debt Financing +On November 7, 2022, the +Company and certain of its subsidiaries borrowed $ 18.9 +million of principal amount of term loans (the “Loans”) from certain institutional investors (the +“Financing”). The Loans mature in 18 months from issuance, which may be extended to 24 months, accrue interest at the rate of 8.5 % +per annum and are secured by certain assets of the Company and various subsidiaries. Starting in January 2023, the lenders have the +right to require the Company to make monthly payments of $0.6 million, which will increase to $1.1 million in November 2023. The +Loans were issued with an original issue discount of $1.89 million. +The lenders received warrants +to purchase approximately 4.5 million shares of the Company’s common stock, exercisable for four years at $0.45 per share and warrants +to purchase another approximately 4.5 million shares of the Company’s common stock, exercisable for four years at $0.75 per share, +subject to adjustment. +On November 7, 2022, Ault +Aviation used proceeds from the Loans to purchase a private aircraft for a total purchase price of $15.8 million. In addition, the Company +and certain of its subsidiaries entered into various agreements as collateral for the repayment of the Loans, including (i) a security +interest in certain Bitcoin mining equipment, (ii) a pledge of the membership interests of Third Avenue Apartments, LLC, a wholly owned +subsidiary of the Company (“Third Apartments”), (iii) a pledge of the membership interests of Alliance Cloud Services, LLC, +a wholly owned subsidiary of the Company (“Alliance Cloud”), (iv) a pledge of the membership interests of Ault Aviation, LLC, +a wholly owned subsidiary of the Company (“Ault Aviation”), (v) a pledge in a segregated deposit account of $ 1.5 million of +cash, (vi) a mortgage and security agreement by Third Avenue on the real estate property owned by Third Avenue in St. Petersburg, Florida, +(vii) a future advance mortgage by Alliance Cloud on the real estate property owned by Alliance Cloud in Dowagiac, Michigan, and (viii) +an aircraft mortgage and security agreement by Ault Aviation on the private aircraft purchased by Ault Aviation on November 7, 2022. The +Loans are further secured by a guaranty provided by Ault Lending and Milton C. Ault, the Executive Chairman of the Company. +3% Secured Promissory Notes +On November 18, 2022, the +Company, through its BNI subsidiary, entered into a note purchase agreement providing for the issuance of secured promissory notes with +an aggregate principal face amount of $ 8,181,819 and an interest rate of 3 % . The purchase price (proceeds to the Company) for the secured +promissory notes was $ 8.2 million. The secured promissory notes have a security interest in certain marketable securities to be acquired +by BNI (the “Collateral”). +The maturity date of the secured +promissory notes is May 18, 2023. When the Company sells the Collateral, the Company is required to make a payment towards the secured +promissory notes equal to 45% of the realized gains. After the secured promissory notes have been repaid in full and until all of the +Collateral is sold, when the Company sells any remaining Collateral, the Company is required to give the investors a profits participation +interest equal to 45% of the realized gains. +F- 49 +16% Secured Promissory Notes +On December 16, 2022 the Company +entered into a Securities Purchase Agreement (the “SPA”) with an accredited investor (the “Initial Investor”) +providing for the issuance of a secured promissory note with an aggregate principal face amount of $ 14.7 million (the “Financing”). +On December 29, 2022, the Company and the Initial Investor entered into an amended and restated amendment to the SPA (the “Amendment”), +pursuant to which the total amount of the Financing was increased to $17.5 million and the Company sold an additional Note to a second +accredited investor (the “Subsequent Investor” and together with the Initial Investor, the “Investors”). +Under the SPA, the Company +shall repay, while the Note remains outstanding, (i) eighty percent (80%) of the proceeds it may receive from any financing conducted, +other than at-the-market offerings and (ii) one hundred percent (100%) of the proceeds it may receive from the sale of marketable securities +by Ault Lending. In addition, if Third Avenue Apartments, LLC sells the property it owns in St. Peterburg, Florida, the Company shall +use the net proceeds from the sale of such property in excess of $10 million to repay the Note. +In addition, the Company agreed +to issue 11,605,913 shares of the Company’s common stock (the “Registrable Shares”) to the Investor in exchange for +the cancellation of all outstanding warrants previously issued to the Investor, which warrants were exercisable for 11,605,913 shares +of the Company’s common stock. The Company agreed to file a registration statement on Form S-3 to register the Registrable Shares +and certain other shares owned by the Investor within ten (10) days of the Closing Date. The Company agreed to pay the Investor liquidated +damages of approximately $0.1 million per month that the Registrable Shares have not been registered. +Pursuant +to the SPA, the Company, Ault Lending, BNI and Esousa Group Holdings, LLC, as the collateral agent on behalf of the Investors entered +into a security agreement (the “Security Agreement”), pursuant to which (i) BNI granted to the Investor a security interest +in 12,000 Bitcoin miners and (ii) Ault Lending granted to the Investor a security interest in, among other items, substantially all of +the Ault Lending’s deposit accounts, securities accounts, chattel paper, documents, equipment, general intangibles, instruments +and inventory, and all proceeds therefrom (the “Assets”), as set forth in the Security Agreement, except for assets previously +granted security interests to other parties. +The Notes are further secured +by a guaranty (the “Guaranty”) provided by Ault Lending, BNI, Ault & Company, an affiliate of the Company, as well as +by Milton C. Ault, the Company’s Executive Chairman and the Chief Executive Officer of Ault & Company. +The Notes have a principal +face amount of $ 17.5 million and bear interest at 16 % per annum. The maturity date of the Notes is March 16, 2023, although if the Company +repays at least $14.3 million of principal payment on or before the maturity date, the Company may extend the maturity date by forty-five +(45) days by paying a fee of 10% of the outstanding balance owed on the Notes as of the original maturity date. The Notes contain standard +and customary events of default including, but not limited to, failure to make payments when due under the Notes, failure to comply with +certain covenants contained in the Notes, or bankruptcy or insolvency of the Company. The Company may prepay any or all outstanding principal +and accrued and unpaid interest at any time without penalty. The purchase price for the Notes was $16.1 million, of which $13.3 million +was paid in cash, $1.8 million was a non-accountable expense allowance and $1.0 million was the forgiveness of cash owed to the Subsequent +Investor for cashless exercise of warrants previously issued to the Subsequent Investor. +25. CONVERTIBLE NOTES +Convertible Notes Payable +at December 31, 2022 and 2021, were comprised of the following: +Schedule of convertible notes payable +Conversion Price +Per Share +Interest +Rate +Due Date +December 31, +2022 +December 31, +2021 +Convertible promissory note +$ 4.00 +4 % +May 10, 2024 +$ 660,000 +$ 660,000 +AVLP convertible promissory notes +$ 0.35 (AVLP stock)* +7 % +August 22, 2025 +9,911,000 +- +Fair value of embedded options and derivatives +2,316,000 +- +Less: Unamortized debt discounts +( 111,000 ) +( 192,000 ) +Total convertible notes payable, net of financing cost, long term +12,776,000 +468,000 +Less: current portion +( 1,325,000 ) +- +Convertible notes payable, net of financing costs – long-term portion +$ 11,451,000 +$ 468,000 +*Subject to price adjustments +upon certain contingent events +F- 50 +Significant +inputs associated with the embedded option include an exercise price of $ 0.35 , a remaining term of 2.7 years, a volatility factor of 75 % +and a risk free interest rate of 4 % . +26. CONVERTIBLE NOTE – RELATED PARTY +On +February 5, 2020, the Company issued an 8 % +convertible promissory note in the principal amount of $ 1.0 +million to Ault & Company (the “Ault & Company Convertible Note”). +The Ault & Company Convertible Note was convertible into Common Stock at a conversion price of $ 1.45 +per share. During the year ended December 31, 2021, the Ault & Company Convertible +Note was converted into 0.3 +million shares in full satisfaction thereof. Related party interest expense for the +year ended December 31, 2021 was $ 12,000 . +27. COMMITMENTS AND CONTINGENCIES +Commitments +Advertising Sponsorship Agreement +The Company entered into an +advertising sponsorship agreement. The sponsorship fee is $ 14 million for 2023, subject to certain termination provisions. The contract +terminates on December 31, 2023. +Contingencies +Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. The Company is regularly subject to claims, suits, regulatory +and government investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, +suits, regulatory and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. The Company records a liability when it believes that it is +probable that a loss has been incurred and the amount can be reasonably estimated. If the Company determines that a loss is reasonably +possible and the loss or range of loss can be estimated, the Company discloses the reasonably possible loss. The Company evaluates developments +in its legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably +possible losses disclosed, and makes adjustments as appropriate. Significant judgment is required to determine both likelihood of there +being and the estimated amount of a loss related to such matters. +With respect to the Company’s +other outstanding matters, based on the Company’s current knowledge, the Company believes that the amount or range of reasonably +possible loss will not, either individually or in aggregate, have a material adverse effect on the Company’s business, consolidated +financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject +to significant uncertainties. +As of December 31, 2022 the +Company has accrued $ 3.2 million as a loss contingency related to litigation matters. +Blockchain Mining Supply and Services, Ltd. +On November 28, 2018, Blockchain +Mining Supply and Services, Ltd. (“Blockchain Mining”) a vendor who sold computers to one of the Company’s subsidiaries, +filed a Complaint (the “Complaint”) in the United States District Court for the Southern District of New York against the +Company and the Company’s subsidiary, Digital Farms, Inc. +(f/k/a Super Crypto Mining, +Inc.), in an action captioned Blockchain Mining Supply and Services, Ltd. v. Super Crypto Mining, Inc. and DPW Holdings, Inc. , +Case No. 18-cv-11099. +The Complaint asserts claims +for breach of contract and promissory estoppel against the Company and its subsidiary arising from the subsidiary’s alleged failure +to honor its obligations under the purchase agreement. The Complaint seeks monetary damages in excess of $1.4 million, plus attorneys’ +fees and costs. +Based on the Company’s +assessment of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, the Company cannot +reasonably estimate the potential loss or range of loss that may result from this action. Notwithstanding, the Company has established +a $1.3 million reserve, the amount of the unpaid portion of the purchase agreement, which is included in accounts payable and accrued +expenses. An unfavorable outcome may have a material adverse effect on the Company’s business, financial condition and results of +operations. +F- 51 +Ding Gu (a/k/a Frank Gu) and Xiaodan Wang Litigation +On January 17, 2020, Ding +Gu (a/k/a Frank Gu) (“Gu”) and Xiaodan Wang (“Wang” and with “Gu” collectively, “Plaintiffs”), +filed a Complaint (the “Complaint”) in the Supreme Court of the State of New York, County of New York against the Company +and the Company’s Chief Executive Officer, Milton C. Ault, III, in an action captioned Ding Gu (a/k/a Frank Gu) and Xiaodan Wang +v. DPW Holdings, Inc. and Milton C. Ault III (a/k/a Milton Todd Ault III a/k/a Todd Ault) , Index No. 650438/2020. +The Complaint asserts causes +of action for declaratory judgment, specific performance, breach of contract, conversion, attorneys’ fees, permanent injunction, +enforcement of Guaranty, unjust enrichment, money had and received, and fraud arising from: (i) a series of transactions entered into +between Gu and the Company, as well as Gu and Ault, in or about May 2019; and (ii) a term sheet entered into between Plaintiffs and the +Company, in or about July 2019. The Complaint seeks, among other things, monetary damages in excess of $ 1.1 +million, plus a decree of specific performance directing the Company to deliver unrestricted shares of common stock to Gu, plus +attorneys’ fees and costs. +On or about November 28, 2022, +the Company and Plaintiffs entered into a stipulation of settlement, which was further amended by the Company and Plaintiffs, by amendments +dated, January 12, 2023, February 2, 2023, and February 23, 2023. +On or about December 12, 2022, +Plaintiffs and Mr. Ault entered into a stipulation of discontinuance, pursuant to which, among other things, Plaintiffs dismissed all +claims asserted against Mr. Ault in the action, with prejudice. +SEC Subpoena +The Company and certain affiliates +and related parties have received several subpoenas from the SEC for the production of documents and testimony. The Company is fully cooperating +with this non-public, fact-finding inquiry and management believes that the Company has operated its business in compliance with all applicable +laws. The subpoenas expressly provide that the inquiry is not to be construed as an indication by the SEC or its staff that any violations +of the federal securities laws have occurred, nor should they be considered a reflection upon any person, entity or security. However, +there can be no assurance as to the outcome of this matter. The Company recorded a $1.0 million loss contingency related to this matter. +28. STOCKHOLDERS’ EQUITY +Preferred Stock +The +Company is authorized to issue 25.0 million shares of Preferred Stock $0.001 par value. As of December 31, 2022, the Board has designated +1.0 million shares as Series A Convertible Preferred Stock (the “Series A Preferred Stock”), 500,000 shares as Series +B Convertible Preferred Stock (the “Series B Preferred Stock”), 2,500 shares as Series C Convertible Redeemable Preferred +Stock (the “Series C Preferred Stock”) and 2,000,000 shares as 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock +(the “Series D Preferred Stock”). As of December 31, 2022, the rights, preferences, privileges and restrictions on the remaining +authorized 21.5 million shares of Preferred Stock have not been determined. The Board is authorized to designate a new series of preferred +shares and determine the number of shares, as well as the rights, preferences, privileges and restrictions granted to or imposed upon +any series of preferred shares. +Common Stock +Common stock confers upon +the holders the rights to receive notice to participate and vote at any meeting of stockholders of the Company, to receive dividends, +if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. The Class B common stock +carries the voting power of 10 shares of Class A common stock, referred to herein as the common stock. +2021 Issuances +2021 ATM Offering +On January 22, 2021, the Company +entered into an At-The-Market Issuance Sales Agreement (the “2021 Sales Agreement”) with Ascendiant Capital Markets, LLC (“Ascendiant +Capital”) to sell shares of common stock having an aggregate offering price of up to $ 50 million from time to time, through an “at +the market offering” program (the “2021 ATM Offering”). On February 16, 2021, the Company filed an amendment to the +prospectus supplement with the SEC to increase the amount of common stock that may be offered and sold in the 2021 ATM Offering, as amended +under the Sales Agreement to $ 125 million in the aggregate, inclusive of the up to $50 million in shares of common stock previously sold +in the 2021 ATM Offering. On March 5, 2021, the Company filed a second amendment to the prospectus supplement with the SEC to further +increase the amount of common stock that may be offered and sold in the 2021 ATM Offering, as amended under the Sales Agreement to $200 +million in the aggregate, inclusive of the up to $ 125 million in shares of common stock previously sold in the 2021 ATM Offering. The +offer and sale of shares of common stock from the 2021 ATM Offering was made pursuant to the Company’s effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-251995) which +became effective on January 20, 2021. Through December 31, 2021, the Company had received gross proceeds of $ 200 million through the sale +of 52.6 million shares of common stock from the 2021 ATM Offering. The 2021 ATM Offering was terminated in December 2021. +F- 52 +Issuance of Common Stock for Conversion +of Debt +During January 2021, the Company +issued to Esousa Holdings, LLC an aggregate of 183,214 shares of the Company’s common stock upon the exchange of principal +and interest in the amount of $ 0.2 million and $ 16,000 , respectively. A loss on extinguishment of $0.2 million was recognized +on the issuance of common stock based on the fair value of the Company’s common stock at the date of the exchanges. +Issuance of Common Stock for Convertible Promissory +Note, Related Party +On +May 12, 2021, the Company issued 275,862 shares of common stock to Ault & Company upon the conversion of $ 0.4 million of +principal on an 8% convertible promissory note dated February 5, 2020. +Issuance of Common Stock Upon Exercise of Warrants +During +the year ended December 31, 2021, the Company issued 2.4 million shares of common stock upon the exercise of warrants. +Issuance of Common Stock for Restricted Stock +Awards +During +the year ended December 31, 2021, the Company issued 1.2 million shares of common stock upon vesting of restricted stock awards. +Securities Purchase +Agreement, Related Party +On +June 11, 2021, the Company entered into a securities purchase agreement with Ault & Company. Under the terms of the agreement, Ault +& Company agreed to purchase an aggregate of 1.0 million shares of the Company’s common stock for a total purchase +price of $ 2.99 million, at a purchase price per share of $ 2.99 , which was $0.05 per share above the closing stock price on June 10, +2021. +2022 Issuances +2022 ATM Offering – Common Stock +On February 25, 2022, the +Company entered into an At-The-Market issuance sales agreement with Ascendiant Capital to sell shares of common stock having an aggregate +offering price of up to $ 200 million from time to time, through an “at the market offering” program (the “2022 Common +ATM Offering”). As of December 31, 2022, the Company had sold an aggregate of 285.9 million shares of common stock pursuant to the +2022 Common ATM Offering for gross proceeds of $ 172.4 million. +Public Offering of Series D Preferred Stock +The Company has designated +2.0 million shares of preferred stock, par value $ 0.001 per share, of the Company as the Series D Preferred Stock. +On June 3, 2022, the Company +announced the closing of its public offering of 144,000 shares of its Series D Preferred Stock at a price to the public of $ 25.00 per +share. Gross proceeds from the offering were approximately $ 3.6 million, before deducting offering expenses. Net proceeds to the Company, +after payment of commissions, non-accountable fees and offering expenses were $ 3.1 million. +2022 ATM Offering – Preferred Stock +On June 14, 2022, the Company +entered into an At-The-Market equity offering program with Ascendiant Capital under which it may sell, from time to time, shares of its +Series D Preferred Stock for aggregate gross proceeds of up to $ 46.4 million (the “2022 Preferred ATM Offering”). As of December +31, 2022, the Company had sold an aggregate of 28,838 shares of Series D Preferred Stock pursuant to the 2022 Preferred ATM Offering for +gross proceeds of $0.5 million. +F- 53 +29. +INCOME TAXES +The following is a geographical +breakdown of income/loss before the provision for income tax, for the years ended December 31, 2022 and 2021: +Schedule of income loss before the provision for income tax +2022 +2021 +Pre-tax loss +U.S. Federal +$ +( 189,899,000 +) +$ ( 24,644,000 ) +Foreign +( 4,419,000 ) +803,000 +Total +$ ( 194,318,000 ) +$ ( 23,841,000 ) +Deferred income taxes reflect +the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and +income tax purposes. Significant components of the Company’s deferred tax assets are as follows: +Schedule of deferred tax assets +2022 +2021 +Deferred tax asset: +Allowance for doubtful accounts +$ +439,000 +$ 361,000 +Unrealized losses +11,082,000 +5,413,000 +Obsolete inventory +2,816,000 +375,000 +Stock compensation +3,581,000 +1,915,000 +Other carryforwards +317,000 +132,000 +Net operating loss carryforwards +17,878,000 +8,716,000 +Lease liability +1,979,000 +888,000 +Impairment +22,822,000 +560,000 +Accrued expenses +3,648,000 +2,157,000 +Interest Expense +8,668,000 +- +Other +404,000 +- +Total deferred tax asset +73,634,000 +20,517,000 +Deferred tax liability: +Right-of-use assets +( 1,865,000 +) +( 857,000 ) +Fixed assets, net +( 1,575,000 +) +( 3,937,000 ) +Intangible assets, net +( 6,638,000 +) +( 256,000 ) +Bargain Gain/Loss +( 225,000 +) +- +Total deferred income tax liabilities +( 10,303,000 +) +( 5,050,000 ) +Net deferred income tax assets +63,331,000 +15,467,000 +Valuation allowance +( 63,304,000 +) +( 15,467,000 ) +Deferred tax asset (liability), net +27,000 +$ - +At +December 31, 2022, the Company had federal and state net operating loss carry forwards (“NOLs”) for income tax purposes +of approximately $ 23.7 +million related to the year after December 31, 2017 that does not have an expiration under current tax law and $ 104.2 +million that expire between 2029 and 2042 after application of limitation set forth in Section 382 of the Internal Revenue Code +(“§382”). In accordance with § 382, future +utilization of the Company’s NOLs is subject to an annual limitation as a result of ownership changes that occurred +previously. The Company also maintains NOLs in various foreign jurisdictions. +At December 31, 2022, Ault +Disruptive Technologies Corp, an entity not consolidated for income tax purposes, utilized its remaining NOLs. The Company has not completed +a formal §382 study and completion of such an analysis in future periods may yield income tax provision impacts in subsequent financial +statements. +F- 54 +In assessing the realization +of deferred tax assets, management considers whether it is more likely than not some portion or all deferred tax assets will not be realized. +The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which +temporary differences representing net future deductible amounts become deductible. Management considers the scheduled reversal of deferred +tax assets, projected future taxable income and tax planning strategies in making this assessment. After consideration of all positive +and negative evidence, including the Company’s generation of NOLs in current and prior periods, there is substantial doubt regarding +the Company’s ability to utilize its deferred tax assets, therefore, the Company recorded a valuation allowance substantially against +its deferred tax assets with the exception of Ault Disruptive Technologies Corp deferred tax assets which are more likely than not to +be realized. For the year ended December 31, 2022, the valuation allowance increased by $ 47.8 million. +The net income tax provision (benefit) +consisted of the following: +Schedule of reconciliation of income tax attributable to operations +2022 +2021 +Current +U.S. Federal +$ +244,000 +$ 69,000 +U.S. State +143,000 +35,000 +Foreign +132,000 +26,000 +Total current provision +519,000 +130,000 +Deferred +U.S. Federal +( 4,977,000 ) +- +U.S. State +( 27,000 +) +- +Foreign +0 +- +Total deferred provision (benefit) +( 5,004,000 +) +- +Total provision (benefit) for income taxes +$ ( 4,485,000 ) +$ 130,000 +The Company’s +effective tax rates were 2.3 % and ( 0.9 %) for the years ended December 31, 2022 and 2021, respectively. During the year ended +December 31, 2022, the effective tax rate differed from the U.S. federal statutory rate primarily due to the change in valuation +allowance. The reconciliation of income tax attributable to operations computed at U.S. Federal statutory income tax rates of 21 % +to income tax expense is as follows: +Schedule of effective income tax rate reconciliation +2022 +2021 +Expected federal income tax benefit +21.0 % +21.0 % +State taxes net of federal benefit +7.3 % +6.1 % +Foreign rate differential +0.0 % +0.3 % +PPP forgiveness +0.0 % +0.4 % +Effect of change in valuation allowance +- 22.1 % +- 26.0 % +Permanent differences +- 1.0 % +- 0.1 % +Goodwill impairment +- 1.4 % +- +IRC Section 162(m) compensation limitation +- 0.3 % +- 0.7 % +Excess tax benefit - windfall/(shortfall) +- 0.2 % +0.7 % +Other +- 0.9 % +- 2.6 % +Income tax benefit +2.3 % +- 0.9 % +The Company accounts for uncertain +tax positions in accordance with ASC 740-10-25. ASC 740-10-25 addresses the determination of whether tax benefits claimed or expected +to be claimed on a tax return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit +from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing +authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit +that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these +matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is +made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. +ASC 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken +uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management +of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2022 and 2021, there are no +uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in +the financial statements. +In general, the Company’s +statute of limitations remains open for various taxable years, in various U.S. federal, U.S. state and foreign jurisdictions. However, +if and when the Company claims net operating loss carryforwards against future taxable income, those losses may be examined by taxing +authorities. The Company will perform an analysis to determine the effect, if any, of these loss limitations rules on the NOL carryforward +balances. Earnings in all foreign jurisdictions are permanently reinvested. +F- 55 +30. NET LOSS PER SHARE +Net loss per share is computed +by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation of the basic +and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock equivalents is anti-dilutive +due to the Company’s net loss position for all periods presented. Anti-dilutive securities, which are convertible into or exercisable +for common stock, consisted of the following at December 31, 2022 and 2021: +Schedule of net loss per share +December 31, +2022 +2021 +Stock options +5,811,000 +6,396,000 +Restricted stock grants +- +2,775,000 +Warrants +15,529,000 +20,015,000 +Convertible notes +165,000 +165,000 +Conversion of preferred stock +2,000 +2,000 +Total +21,507,000 +29,353,000 +31. SEGMENT AND CUSTOMERS INFORMATION +The Company has eight and +six reportable segments and the holding company as of December 31, 2022 and 2021, respectively; see Note 1 for a brief description of +the Company’s business. +The following data presents +the revenues, expenditures and other operating data of the Company’s operating segments and presented in accordance with ASC 280. +Segment information for the +year ended December 31, 2022: +Schedule of operating segments +GIGA +TurnOn +Green +Fintech +BNI +AGREE +Ault +Disruptive +SMC +Energy +Holding +Co. +Total +Revenue +$ 30,255,000 +$ 5,522,000 +$ 239,000 +$ - +$ - +$ - +$ 24,224,000 +$ 216,000 +$ - +$ 60,456,000 +Revenue, cryptocurrency mining +- +- +- +16,693,000 +- +- +- +- +- +16,693,000 +Revenue, commercial real estate leases +- +- +- +1,105,000 +- +- +- +- +- +1,105,000 +Revenue, lending and trading activities +- +- +36,644,000 +- +- +- +- +- +- +36,644,000 +Revenue, crane operations +- +- +- +- +- +- +- +2,739,000 +2,739,000 +Revenue, hotel operations +- +- +- +- +16,697,000 +- +- +- +- +16,697,000 +Total revenues +$ 30,255,000 +$ 5,522,000 +$ 36,883,000 +$ 17,798,000 +$ 16,697,000 +$ - +$ 24,224,000 +$ 2,955,000 +$ - +$ 134,334,000 +Depreciation and amortization +expense +$ 1,713,000 +$ 497,000 +$ 475,000 +$ 12,396,000 +$ 3,323,000 +$ - +$ 503,000 +$ 505,000 +$ 556,000 +$ 19,968,000 +Income (loss) from operations +$ ( 13,951,000 ) +$ ( 3,843,000 ) +$ 4,430,000 +$ ( 91,614,000 ) +$ ( 691,000 ) +$ ( 1,420,000 ) +$ ( 4,973,000 ) +$ ( 546,000 ) +$ ( 27,560,000 ) +$ ( 140,168,000 ) +Capital expenditures for the year ended December +31, 2022 +$ 600,000 +$ 266,000 +$ 17,374,000 +$ 80,799,000 +$ 9,112,000 +$ - +$ 93,000 +$ 31,000 +$ 141,000 +$ 108,416,000 +Identifiable assets as of December 31, 2022 +$ 38,520,000 +$ 6,959,000 +$ 82,944,000 +$ 75,731,000 +$ 98,495,000 +$ 118,791,000 +$ 27,508,000 +$ 90,805,000 +$ 16,311,000 +$ 556,064,000 +Segment information for the +year ended December 31, 2021: +GIGA +TurnOn +Green +Fintech +BNI +AGREE +Ault +Disruptive +Holding +Company +Total +Revenue +$ 25,581,000 +$ 5,346,000 +$ 192,000 +$ - +$ - +$ - +$ - +$ 31,119,000 +Revenue, cryptocurrency mining, net +- +- +- +3,450,000 +- +- +- +3,450,000 +Revenue, commercial real estate leases +- +- +- +788,000 +- +- +- +788,000 +Revenue, lending and trading activities +- +- +16,854,000 +- +- +- +- +16,854,000 +Revenue, hotel +- +- +- +- +189,000 +- +- +189,000 +Total revenues +$ 25,581,000 +$ 5,346,000 +$ 17,046,000 +$ 4,238,000 +$ 189,000 +$ - +$ - +$ 52,400,000 +Depreciation and amortization expense +$ 876,000 +$ 25,000 +$ - +$ 1,384,000 +$ 138,000 +$ - +$ 55,000 +$ 2,478,000 +Income (loss) from operations +$ ( 1,298,000 ) +$ ( 1,518,000 ) +$ 3,794,000 +$ 1,541,000 +$ ( 194,000 ) +$ ( 20,000 ) +$ ( 20,666,000 ) +$ ( 18,361,000 ) +Capital expenditures for the +year ended December 31, 2021 +$ 947,000 +$ 18,000 +$ - +$ 85,927,000 +$ 86,884,000 +$ - +$ 217,000 +$ 173,993,000 +Identifiable assets as of December 31, 2021 +$ 33,716,000 +$ 4,601,000 +$ 81,415,000 +$ 99,590,000 +$ 93,838,000 +$ 119,335,000 +$ 57,791,000 +$ 490,286,000 +F- 56 +32. CONCENTRATIONS +OF CREDIT AND REVENUE RISK +2022 Concentrations +of Credit and Revenue Risk +Accounts +receivable are concentrated with a certain large customer. At December 31, 2022, one SMC customer in North America accounted for 14 % of +consolidated accounts receivable. +For +the year ended December 31, 2022, one customer represented 16 % and one customer represented 12 % of consolidated revenues. +2021 Concentrations +of Credit and Revenue Risk +For +the year ended December 31, 2021, one customer attributable to Enertec represented 18 % of consolidated revenues. +33. SUBSEQUENT EVENTS +2022 Common ATM Offering +During the period between +January 1, 2023 through March 13, 2023, the Company sold an aggregate of 32.0 million shares of common stock pursuant to the 2022 Common +ATM Offering for gross proceeds of $ 4.2 million. On March 13, 2023, the Company announced that effective March 17, 2023, the 2022 Common +ATM Offering would be terminated and that the Company would not make any further sales thereunder, effective immediately. +2022 Preferred +ATM Offering +During +the period between January 1, 2023 through April 15, 2023, the Company sold an aggregate of 109,114 shares of Series D Preferred Stock +pursuant to the 2022 Preferred ATM Offering for gross proceeds of $ 1.4 million. +Investments in Alpha Fund +During the period between +January 1, 2023 through April 15, 2023, the Company purchased an additional $ 0.6 million of limited partnership interests in the Alpha +Fund. As of April 15, 2023, the Company had subscribed for and funded $ 33.9 million of limited partnership interests in the Alpha Fund. +Investments by Alpha Fund +On December 29, 2022, Alpha +Fund purchased 1.9 million shares of the Company’s common stock in open market transactions at an average purchase price of $ 0.10 +per share, which stock purchase settled in January 2023. +Share Exchange Agreement with BMI +The Company entered into +a Share Exchange Agreement (the “Agreement”) with BMI and sold to BMI all of the outstanding shares of capital stock of the +Company’s subsidiary, BitNile.com, Inc. (“BitNile.com”) as well as the securities of Earnity, Inc. (“Earnity”) +beneficially owned by BitNile.com as of the date of the Agreement (the “Transaction”). As consideration for the acquisition, +BMI issued shares of preferred stock convertible into common stock of BMI representing approximately 92.4% of BMI’s outstanding +common stock. Pending approval of the transaction by BMI’s shareholders, the preferred stock combined are subject to a 19.9% beneficial +ownership limitation. +The holders of preferred +stock will be entitled to receive dividends at a rate of 5% of the stated value of the preferred stock. +The Company is entitled to +appoint three members to the board of directors of BMI, and following shareholder approval, a majority of the Board. +March 28, 2023 Security Purchase Agreement +On +March 28, 2023, the Company, entered into a Securities Purchase Agreement (the “Purchase Agreement”) with certain institutional +investors (the “Investors”), pursuant to which the Company agreed to issue and sell, in a private placement (the “Offering”), +an aggregate of 100,000 shares of its preferred stock, with each such share having a stated value of $ 100.00 and consisting of (i) 83,000 +shares of Series E Convertible Preferred Stock (the “Series E Preferred Stock”), (ii) 1,000 shares of Series F Convertible +Preferred Stock (the “Series F Preferred Stock”) and (iii) 16,000 shares of Series G Convertible Preferred Stock (the “Series +G Preferred Stock” and collectively, the “Preferred Shares”). The Preferred Shares will be convertible into shares of +the Company’s common stock at the option of the holders and, in certain circumstances, by the Company. +F- 57 +Each +share of Series E Preferred Stock and Series F Preferred Stock had a purchase price of $100.00, equal to each such share’s stated +value. The purchase price of the Series E Preferred Stock and the Series F Preferred Stock was paid for by the Investors’ canceling +outstanding secured promissory notes in the principal amount of $8.4 million, whereas the purchase price of the shares of Series G Preferred +Stock consisted of accrued but unpaid interest on these notes, as well as other good and valuable consideration. Each Preferred Share +is convertible into shares of the Company’s common stock at a conversion price equal to 85% of the closing sale price of the common +stock on the trading day prior to the date of conversion, subject to a floor price of $0.10. +12% Term Note +On April 5, 2023, the Company issued a term note +with a principal amount of $ 1.1 million, bearing an interest rate of 12 % . The term note was issued at a discount, with net proceeds to +the Company amounting to $1.0 million. The note is scheduled to mature on June 5, 2023 . The Company has the option to extend the maturity +date by one month, upon payment of a $ 30,000 extension fee. Ault & Company, a related party, guaranteed the term note. +Amendment to 16% Secured Promissory Note +On April 6, 2023, the Company entered into an +amendment agreement, effective as of March 16, 2023, with the Initial Investor related to the December 2022 16% secured promissory note +extending the due date on the note to May 31, 2023, which will automatically extend to June 30, 2023 if the Company repays the balance +outstanding on the note as of the extension date, which was $8.3 million, by May 31, 2023. The Company agreed to increase the principal +amount of the note by approximately $2.0 million, reflecting a $1.7 million extension fee and $0.4 million of liquidated damages for failure +to obtain an effective registration statement. +F-58 \ No newline at end of file diff --git a/raw/filings/0000896493/2022/0001214659-23-005525/filing_metadata.csv b/raw/filings/0000896493/2022/0001214659-23-005525/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..f864ade1d2f9a2a4d0675c775b2319aa8417ec64 --- /dev/null +++ b/raw/filings/0000896493/2022/0001214659-23-005525/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2023-04-17,2022-12-31,2023-04-17T21:22:06.000Z,0001214659-23-005525,p41123010k.htm,,17690533,1,1,https://www.sec.gov/Archives/edgar/data/896493/000121465923005525/p41123010k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465923005525/,2022,2022,1 diff --git a/raw/filings/0000896493/2022/0001214659-23-005525/item1.txt b/raw/filings/0000896493/2022/0001214659-23-005525/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..45635cd3f6d08728b2fb2859f37d229fb040e899 --- /dev/null +++ b/raw/filings/0000896493/2022/0001214659-23-005525/item1.txt @@ -0,0 +1,1770 @@ +ITEM 1. BUSINESS +Company Overview +Ault Alliance, Inc., a Delaware +corporation formerly known as BitNile Holdings, Inc., was incorporated in September 2017 (sometimes referred to as “AAI,” +the “Company,” “we” or “us”). AAI is a diversified holding company pursuing growth by acquiring undervalued +businesses and disruptive technologies with a global impact. Through our wholly- and majority-owned subsidiaries and strategic investments, +we own and operate a data center at which we mine Bitcoin, and provide mission-critical products that support a diverse range of industries, +including crane services, oil exploration, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics, hotel operations +and textiles. In addition, we extend credit to select entrepreneurial businesses through a licensed lending subsidiary. +Our direct and indirect wholly +owned subsidiaries include (i) Ault Lending, LLC (“Ault Lending,” formerly known as Digital Power Lending, LLC), (ii) Ault +Global Real Estate Equities, Inc. (“AGREE”), which wholly owns AGREE Madison, LLC (“AGREE Madison”) and Third +Avenue Apartments LLC (“Third Avenue Apartments”), (iii) Ault Disruptive Technologies Company, LLC (“ADTC”), (iv) +BitNile, Inc. (“BNI”), which wholly owns Alliance Cloud Services, LLC (“ACS”) and BNI Montana, LLC (“BNI +Montana”), (v) Circle 8 Holdco LLC, a Delaware limited liability company (“Circle 8 Holdco”), (vi) Ault Energy, LLC +(“Ault Energy”), and (vii) Ault Aviation, LLC (“Ault Aviation”). We also have a direct controlling interest in +(i) Imperalis Holding Corp. (“IMHC” or “TurnOnGreen”), which wholly owns TOG Technologies, Inc. (“TOG Technologies”) +and Digital Power Corporation (“Digital Power”), (ii) Giga-tronics Incorporated (“GIGA”), which wholly owns Gresham +Worldwide, Inc. (“GWW”), which in turn wholly owns Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems +2001 Ltd. (“Enertec”), Relec Electronics Ltd. (“Relec”) and has a controlling interest in Microphase Corporation +(“Microphase”) and (iii) Avalanche International Corp. (“Avalanche” or “AVLP”). Ault Lending has a +controlling interest in The Singing Machine Company, Inc. (“SMC”), Circle 8 Holdco has a controlling interest in Circle 8 +Newco LLC (“Circle 8”), and ADTC is the sponsor of Ault Disruptive Technologies Corporation (“Ault Disruptive”). +AAI was founded by Milton +“Todd” Ault, III, our Executive Chairman and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and Vice Chairman +and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages our day-to-day operations. +All major investment and capital allocation decisions are made by Mr. Ault and the other members of the Executive Committee. We have eight +reportable segments: +· Energy and Infrastructure (“Energy”) – crane operations, advanced textiles processing +and oil exploration; +· Technology and Finance (“Fintech”) –commercial lending, activist investing, media, and +digital learning; +· SMC – consumer electronics; +· BNI – cryptocurrency mining operations; +· GIGA – defense solutions; +· TurnOnGreen – commercial electronics solutions; +· AGREE – hotel operations and other commercial real estate holdings; and +· Ault Disruptive – a special purpose acquisition company (“SPAC”). +On +January 3, 2023, the Company, then known as BitNile Holdings, Inc., merged its wholly owned subsidiary, Ault Alliance, Inc. with and into +the Company. In connection with this upstream merger, Ault Alliance, Inc. was merged out of existence and the business of the Company +continued as it was being conducted. Further, on January 3, 2023, the effective date of the merger, we changed our name to Ault Alliance, +Inc. and our ticker was changed to “AULT.” The name change did not affect the rights of our security holders. +1 +We operate as a holding +company with operations conducted primarily through our subsidiaries. We intend to conduct our activities in a manner so as not to be +deemed an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). Generally, +this means that we do not invest or intend to invest in securities as our primary business and that no more than 40% of our total assets +will be invested in investment securities, as that term is defined in the Investment Company Act. Pursuant to the Investment Company Act, +we believe that our subsidiary Ault Lending is excluded from the definition of an investment company. +Although we actively seek +growth through acquisitions, we will also continue to focus on high-grade and custom product designs for the commercial, medical and military/defense +markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical +operating conditions. +Recent Events and Developments +2021 Updates +On +January 29, 2021, ACS closed on the acquisition of a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern +Michigan for a purchase price of $3,991,497 (the “Facility”). The purchase price was paid from our own working capital. Ownership +of the Facility was subsequently assigned to BNI. +On March 9, 2021, Ault Lending +entered into a securities purchase agreement with Alzamend Neuro, Inc. (“Alzamend”), a related party, to invest $10 million +in Alzamend common stock and warrants, subject to the achievement of certain milestones. We agreed to fund $4 million upon execution of +the securities purchase agreement and to fund the balance upon Alzamend achieving certain milestones related to the U.S. Food and Drug +Administration’s approval of Alzamend’s Investigational New Drug application and Phase 1a human clinical trials for Alzamend’s +lithium based ionic cocrystal therapy, known as AL001. Under the securities purchase agreement, Alzamend agreed to sell up to 6,666,667 +shares of its common stock to Ault Lending in consideration for the $10 million, or $1.50 per share, and issue to Ault Lending warrants +to acquire up to 3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. The transaction was approved by +our independent directors after receiving a third-party valuation report of Alzamend. As of the date of this annual report, we have funded +an aggregate of $10 million pursuant to the securities purchase agreement and have thus acquired all of the shares and warrants issuable +by Alzamend to us under the agreement. We retain the right to acquire an additional 6,666,667 shares and 3,333,334 warrants at an exercise +price of $3.00 per share until October 26, 2023 for an aggregate payment to Alzamend of $10 million. +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain. We have received 20,645 Antminers, fulfilling the first five of seven Bitmain Agreements including 4,628 environmentally +friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) and 16,017 S19j Pro Antminers +that feature a processing power of 100 TH/s. The 20,645 Antminers in our possession, once installed and energized, will generate a combined +processing power of approximately 2.25 exahashes per second (“EH/s”), the computational power that is being used to mine Bitcoin. +Beyond the first five contracts +with Bitmain, we have two more purchase agreements for an additional 1,325 S19j Pro Antminers estimated to be delivered over the second +quarter 2023 and 1,140 S19 XP Hydro Antminers anticipated to be delivered during the summer of 2023. Once all of the miners are fully +deployed and operational, we expect to achieve a mining production capacity of approximately 2.67 EH/s. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +On December 13, 2021, BNI +closed an investment of Series A preferred stock of Earnity Inc. (“Earnity”), a decentralized finance (“DeFi”) +marketplace based in San Mateo, California. BNI paid approximately $11.5 million for the shares of Earnity’s Series A preferred +stock. Following the investment, BNI beneficially owned approximately 19.99% of Earnity’s common stock. The transaction we entered +into with Earnity is an investment only, not the precursor to an acquisition. We have no present intention of incorporating Earnity’s +business or operations, or that of any other DeFi platform, with our own. Prior to the closing of the transaction with BitNile Metaverse, +Inc. (“BMI”) discussed below, our beneficial ownership of Earnity was assigned to BitNile.com, Inc. (“BNC”); as +such, BMI is presently the beneficial owner of these shares. +2 +On December 15, 2021, Ault +Lending entered into an exchange agreement with Imperalis Holding Corp. (“IMHC”) pursuant to which IMHC issued us a convertible +promissory note (the “IMHC Note”) in the principal amount of $0.1 million, in exchange for those certain promissory notes +dated August 18, 2021 and November 5, 2021 previously issued by IMHC to Ault Lending in the aggregate principal amount of $0.1 million, +which prior notes had accrued interest of $1,529 as of December 15, 2021. The IMHC Note accrued interest at 10% per annum, was due on +December 15, 2023, and the principal, together with any accrued but unpaid interest on the amount of principal, is convertible into shares +of IMHC’s common stock at Ault Lending’s option at a conversion price of $0.01 per share. The IMHC Note was converted into +11.0 million shares of IMHC’s common stock on October 12, 2022. +On December 16, 2021, we entered +into a stock purchase agreement (the “Agreement”) with the majority stockholders of IMHC. Pursuant to the Agreement, we purchased +129.4 million shares of IMHC’s common stock from the sellers in exchange for $0.2 million. Upon the closing of the Agreement, we +owned a majority of IMHC’s common stock, resulting in a change in control of IMHC. +On December 22, 2021 (the +“Closing Date”), AGREE Madison, LLC, a wholly owned subsidiary of AGREE (“AGREE Madison”), through various wholly +owned subsidiaries (the “Property Owners”), entered into construction loan agreements (the “Loan Agreements”) +in the aggregate amount of $68.8 million (the “Loans”) in connection with the acquisition of four hotel properties (the “Properties”). +The Properties were acquired on the Closing Date for an aggregate purchase price of $69.2 million, of which $2.5 million was previously +funded on deposit, $21.4 million was paid by the Company on the Closing Date, and the remaining amounts were funded from the Loans. The +remaining $23.4 million of the Loans are available to be drawn upon by the Property Owners towards the completion of the $13.7 million +in property improvement plans (“PIPs”) the Property Owners agreed to undertake, as well as to fund working capital, interest +reserves, franchise fees and other costs and expenses related to the acquisition. The Loans are due on January 1, 2025 (the “Maturity +Date”), but may be extended by the Property Owners for two additional 12-month terms, subject to certain terms and conditions as +set forth in the Loan Agreements. The Loans accrue interest at a rate equal to the greater of (i) the LIBOR Rate plus 675 basis points +or (ii) 7% per annum. The Property Owners have since January 1, 2022 made and will continue to make monthly installment payments of interest +only. +On +December 27, 2021, the Company and GWW entered into a Share Exchange Agreement (the “Exchange Agreement”) with Giga-tronics +Incorporated, a California corporation (“GIGA”). Pursuant to the Exchange Agreement, which closed on September 8, 2022, GIGA +acquired all of the outstanding shares of capital stock of GWW in exchange for (i) issuing to the Company 2.9 million shares of GIGA’s +common stock (“GIGA Common Stock”) and 514.8 shares of a new series of preferred stock (“GIGA Preferred Stock”) +which are convertible into an aggregate of 4.0 million shares of GIGA Common Stock, subject to adjustment, and (ii) the assumption of +GWW’s equity awards representing, on an as-assumed basis, 249,875 shares of GIGA Common Stock (the “Exchange Transaction”). +As +a result of the consummation of the Exchange Transaction, GWW has become a wholly owned subsidiary of GIGA. In accordance with the Exchange +Agreement, we loaned GIGA $4.25 million pursuant to a convertible promissory note (“Closing Date Loan”) upon the closing of +the Exchange Transaction (the “Closing”). Following the Closing, GIGA repurchased all of its shares of Series B, Series C, +Series D and Series E preferred stock that were outstanding prior to the Closing (the “Outstanding Preferred”). Based upon +2,725,010 shares of GIGA Common Stock outstanding at the Closing, and following the issuance to the Company of the shares of GIGA Common +Stock and GIGA Preferred Stock pursuant to the Exchange Transaction, the Company holds approximately 68% of the outstanding voting power +and capital stock of GIGA, and existing holders of GIGA Common Stock hold approximately 32%. On December 31, 2022, the Closing Date Loan +was exchanged for a new convertible promissory note with a maturity date of December 31, 2024. In addition, Ault Lending also entered +into a Securities Purchase Agreement with GIGA, whereby GIGA issued Ault Lending a 10% Senior Secured Convertible Promissory Note in the +principal amount of $6.8 million and five-year warrants to purchase 2.0 million shares of GIGA’s common stock. +2022 Updates +We, +certain of our subsidiaries and Esousa, as the collateral agent on behalf of the investors (the “Agent”) entered into a security +agreement, pursuant to which we (i) pledged the equity interests in substantially all of our U.S. based subsidiaries and (ii) granted +to the investors a security interest in substantially all of our deposit accounts, securities accounts, chattel paper, documents, equipment, +general intangibles, instruments and inventory, and all proceeds therefrom. The entirety of the loan, including the original issue discount +and accrued but unpaid interest, was fully paid off on March 30, 2022. +On +February 4, 2022, we and our former subsidiary Ault Alliance, Inc. (the “Former AAI”) entered into a securities purchase agreement +providing for our purchase of BNI from the Former AAI. As a result of this transaction, both BNI and the Former AAI became stand-alone +wholly owned subsidiaries of ours. The Former AAI was merged out of existence on January 3, 2023 in connection with the change in our +name from BitNile Holdings, Inc. to Ault Alliance, Inc. +3 +On +February 10, 2022, consistent with our objective to have BNI operate the entirety of our business that relates to cryptocurrencies, the +Former AAI assigned the entirety of its interest in ACS to BNI. +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant to sell shares of common stock +having an aggregate offering price of up to $200 million from time to time, through an “at the market offering” program (the +“2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering was made pursuant to our effective +“shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. +333-260618) which became effective on November 12, 2021. Through March 13, 2023, we received gross proceeds of approximately $177 million +through the sale of approximately 317.9 million shares of common stock from the 2022 ATM Offering. The 2022 Sales Agreement has been terminated. +On March 20, 2022, we and +IMHC entered into a securities purchase agreement (the “Acquisition Agreement”) with TurnOnGreen, Inc., formerly known as +Coolisys Technologies Corp. (“TOGI”), which closed on September 6, 2022 (the “Closing Date”). According to the +Acquisition Agreement, we (i) delivered to IMHC all of the outstanding shares of common stock of TOGI that we owned, and (ii) forgave +and eliminated the intracompany accounts between us and TOGI evidencing historical equity investments made by us in TOGI, in the approximate +amount of $36.0 million, in consideration for the issuance by IMHC to us (the “Transaction”) of an aggregate of 25,000 newly +designated shares of Series A Preferred Stock (the “IMHC Preferred Stock”), with each such share having a stated value of +$1,000. Immediately following the Closing Date, TOGI became a wholly owned subsidiary of IMHC. The parties to the Agreement have agreed +that, upon completion of the Transaction but subject to IMHC’s compliance with the federal securities laws, IMHC will change its +name to TurnOnGreen, Inc. Further, through an upstream merger whereby the current TOGI ceased to exist, which was consummated on September +8, 2022, IMHC owns the former TOGI’s two operating subsidiaries, TOG Technologies and Digital Power. IMHC intends to dissolve its +dormant subsidiary. +On +September 5, 2022, we, IMHC and TOGI entered into an amendment to the Acquisition Agreement (the “Amendment”), pursuant to +which IMHC agreed to (i) use commercially reasonable efforts to effectuate a distribution by us of approximately 140 million shares of +Common Stock that we beneficially own (the “Distribution”), including the filing of a registration statement (the “Distribution +Registration Statement”) with the SEC, (ii) to issue to us warrants to purchase an equivalent number of shares of Common Stock to +be issued in the Distribution (the “Warrants”), and (iii) to register the Warrants and the shares of Common Stock issuable +upon exercise of the Warrants on the Distribution Registration Statement. +On June 1, 2022, the Company +converted the principal amount under the convertible promissory notes issued to it by AVLP and accrued but unpaid interest into common +stock of AVLP. The Company converted $20.0 million in principal and $5.9 million of accrued interest receivable at a conversion price +of $0.50 per share and received 51,889,168 shares of common stock increasing its common stock ownership of AVLP from less than 20% to +approximately 92%. +On +June 8, 2022, Ault Lending entered into a securities purchase agreement with BMI whereby Ault Lending agreed to purchase $12.0 million +of a new series of convertible preferred stock of BMI, which transaction closed on June 29, 2022. As part of the transaction we were issued +102,881 shares of BMI’s common stock and a warrant to purchase forty-nine percent (49%) of BMI’s common stock calculated on +a fully-diluted basis, subject to certain terms and conditions. Pursuant to a mutually agreed upon use of proceeds, BMI intends to deploy +significant proceeds via its subsidiary White River Holdings Corp. (“White River”) towards an oil drilling program across +its cumulative 30,000 acres of active mineral leases at both shallow, intermediate, and deep levels. BMI will also deploy additional proceeds +via its subsidiary Agora Digital Holdings, Inc. (“Agora Digital”) to provide us with up to 78 megawatts (“MW”) +of power within the State of Texas for digital asset mining capacity, subject to our election to proceed with this facility after having +conducted the requisite due diligence. +On +December 6, 2022, BNI entered into a hosting agreement with Agora Digital securing up to 78 MW of power. Agora Digital will initially +provide up to 12 MW of electricity for our use, which will enable us to initially power 3,750 S19j Pro miners in the second quarter of +2023. The Agora Digital power capacity would, if the project proceeds as presently anticipated, expedite our recently announced plans +to significantly expand our Bitcoin mining production capacity, including growing our number of deployed Bitcoin miners to approximately +23,065, representing an expected mining production capacity of approximately 2.67 exahashes per second. +On June 10, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Preferred Sales Agreement”) with Ascendiant to sell shares of our +13.00% Series D Cumulative Redeemable Preferred Stock (the “Preferred Shares”) having an aggregate offering price of up to +$46.4 million from time to time, through an “at the market offering” program (the “2022 ATM Preferred Offering”). +The offer and sale of Preferred Shares from the 2022 ATM Preferred Offering was made pursuant to our effective “shelf” registration +statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) which became effective +on November 12, 2021. Through March 31, 2023, we had received gross proceeds of approximately $1.7 million through the sale of 118,586 +Preferred Shares in the 2022 ATM Preferred Offering. +4 +In June 2022, Ault Lending +purchased a majority of the issued and outstanding shares of SMC in open market transactions. SMC is a Nasdaq-listed company that is +a worldwide leader in consumer karaoke products. The first to provide karaoke systems for home entertainment in the United +States, SMC sells its products worldwide through major mass merchandisers and online retailers. SMC +products incorporate the latest technology for singing practice, music listening, entertainment and social sharing and provides access +to over 100,000 songs for streaming and download. +On July 11, 2022, we announced +the formation of Ault Energy, a wholly owned subsidiary of ours. Ault Energy will partner with White River, a majority owned subsidiary +of BMI on drilling projects across 30,000 acres in Texas, Louisiana and Mississippi. Ault Energy, as Ault Lending’s designee, has +the right to purchase up to 25%, or such higher percentages at the discretion of White River, in various drilling projects of White River. +In August 2022, Ault Energy committed to purchasing 40% of the first drilling project offered, at a cost to Ault Energy of approximately +$1 million. +On August 10, 2022, we, through +our BNI and Ault Lending subsidiaries, entered into a note purchase agreement providing for the issuance of secured promissory notes with +an aggregate principal face amount of $11.0 million and an interest rate of 10%. The purchase price for the secured promissory notes was +$10.0 million. The holders of the secured promissory notes have a security interest in marketable securities, investments and certain +Bitcoin mining equipment. The secured promissory notes are further secured by a guaranty provided by us, as well as by Milton C. Ault, +our Executive Chairman. The maturity date of the secured promissory notes is August 10, 2023. BNI is required to make monthly payments +(principal and interest) of $1.0 million on the tenth calendar day of each month, starting in September 2022. After six months, BNI may +elect to pay a forbearance fee of $0.3 million in lieu of a monthly payment, which would extend the maturity date of the related secured +promissory notes one month for each forbearance. +On +August 15, 2022, BNI entered into a hosting agreement with Compute North LLC (“Compute North”). On September 22, 2022, Compute +North filed for bankruptcy protection, effectively rendering this hosting agreement null and void. We have retained counsel to assist +in this matter. We have removed the Bitcoin miners that were installed at the hosting facility in Texas. +On November 7, 2022, we and +certain of our subsidiaries borrowed $18.9 million of principal amount of term loans (the “Loans”) from a group of institutional +investors (the “Financing”). The Loans mature in 18 months, which may be extended to 24 months, accrue interest at the rate +of 8.5% per annum and are secured by certain of our and certain of our subsidiaries’ assets. Starting in January 2023, the lenders +have the right to require us to make monthly payments of $0.6 million, which will increase to $1.1 million in November 2023. The Loans +were issued with an original issue discount of $1.89 million. +The lenders received warrants +to purchase approximately 4.5 million shares of our common stock, exercisable for four years at $0.45 per share and warrants to purchase +another approximately 4.5 million shares of our common stock, exercisable for four years at $0.75 per share, subject to adjustment. +On November 7, 2022, Ault +Aviation, LLC, a wholly owned subsidiary of the Company (“Ault Aviation”), used proceeds from the Loans to purchase a private +aircraft for a total purchase price of $15.8 million. In addition, the Company and certain of its subsidiaries entered into various +agreements as collateral for the repayment of the Loans, including (i) a security interest in certain Bitcoin mining equipment, (ii) a +pledge of the membership interests of Third Avenue Apartments, (iii) a pledge of the membership interests of ACS, (iv) a pledge of the +membership interests of Ault Aviation, (v) a pledge in a segregated deposit account of $1.5 million of cash, (vi) a mortgage and security +agreement by Third Avenue Apartments on the real estate property owned by Third Avenue Apartments in St. Petersburg, Florida, (vii) a +future advance mortgage by ACS on the real estate property owned by ACS in Dowagiac, Michigan, and (viii) an aircraft mortgage and security +agreement by Ault Aviation on the private aircraft purchased by Ault Aviation on November 7, 2022. The Loans are guaranteed by Ault Lending, +LLC, Ault & Company, Inc., an affiliate of the Company, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive +Officer of Ault & Company, Inc. +On November 18, 2022, Circle +8 LLC, a newly formed Delaware limited liability company (“Circle 8”), entered into an Asset Purchase Agreement (the “Asset +Purchase Agreement”) with Circle 8 Crane Services LLC, a Delaware limited liability company (“Circle 8 Crane Services”) +pursuant to which Circle 8 agreed to purchase substantially all of the assets (the “Acquired Assets”) and assume certain specified +liabilities of Circle 8 Crane Services (the “Circle 8 Transaction”). Circle 8 is a wholly owned subsidiary of Circle 8 Holdco +LLC, a Delaware limited liability company (“Circle 8 Holdco”). +5 +On +December 19, 2022, the Asset Purchase Agreement referred to above closed and Circle 8 purchased the Acquired Assets. As consideration +for the acquisition of the Acquired Assets, Circle 8 Crane Services received Class D equity interests in Circle 8 Holdco and is eligible +to receive cash earnout payments in an aggregate maximum amount of up to $2.1 million based on the achievement by Circle 8 of certain +EBITDA targets over the three year period following the completion of the acquisition of the Acquired Assets by Circle 8. We contributed +$12 million to Circle 8, and an independent third party contributed $4 million, of which approximately $11.7 million was used to pay down +a portion of the Circle 8 Crane Services’ senior debt facility at the closing, $3.0 million of which was used to pay off Circle +8 Crane Services’ subordinated debt facility in full at the closing and $1.4 million was used to pay the expenses of Circle 8 and +Circle 8 Crane Services. In addition, Circle 8 assumed a new line of credit issued by Circle 8 Crane Services’ current senior lender. +Circle 8 Holdco is a subsidiary of the former AAI, a Delaware corporation but is presently directly owned by us. We own a controlling +interest in Circle 8 Holdco. +On +December 16, 2022 we entered into a Securities Purchase Agreement (the “SPA”) with an accredited investor (the “Investor”) +providing for the issuance of a secured promissory note (the “Note”) with an aggregate principal face amount of $14.7 million +(the “Financing”). On December 29, 2022, the Company and the accredited investor entered into an amended and restated amendment +to the SPA, pursuant to which the total amount of the financing was increased to $17.5 million and the Company sold an additional note +to a second accredited investor. +Under the SPA, we are obligated +to repay, while the Note remains outstanding, (i) eighty percent (80%) of the proceeds we may receive from any financing conducted, other +than at-the-market offerings and (ii) one hundred percent (100%) of the proceeds we may receive from the sale of marketable securities +by Ault Lending. In addition, if Third Avenue Apartments, LLC (“Third Avenue”), our wholly owned subsidiary, sells the property +it owns in St. Peterburg, Florida, then we will use the net proceeds from the sale of such property in excess of $10 million, to repay +the Note. In addition, we agreed to issue 11.6 million shares of our common stock to the Investor in exchange for the cancellation of +all outstanding warrants previously issued to the Investor, which warrants were exercisable for 11.6 million shares of our common stock. +2023 Updates +On January 23, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable +preferred stock (“Series C Preferred Stock”) which, effective upon filing, eliminated the Series C Preferred Stock. +On February 8, 2023, we entered +into a Share Exchange Agreement (the “Agreement”) with BMI and the other signatories thereto. The Agreement provides that, +subject to the terms and conditions set forth therein, BMI will acquire all of the outstanding shares of capital stock of our then subsidiary, +BitNile.com, Inc. (“BitNile.com”), of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders +(the “Minority Shareholders”), as well as Ault Iconic (f/k/a Ault Media Group) and the securities of Earnity beneficially +owned by BitNile.com (which represented approximately 19.9% of the outstanding equity securities of Earnity as of the date of the Agreement), +in exchange for the following: (i) 8,637.5 shares of newly designated Series B Convertible Preferred Stock of BMI to be issued to our +company (the “Series B Preferred”), and (ii) 1,362.5 shares of newly designated Series C Convertible Preferred Stock of BMI +to be issued to the to the Minority Shareholders (the “Series C Preferred,” and together with the Series B Preferred, the +“Preferred Stock”). The Series B Preferred and the Series C Preferred each have a stated value of $10,000 per share (the “Stated +Value”), for a combined stated value of the Preferred Stock to be issued by BMI of $100 million, and subject to adjustment, are +convertible into an aggregate of 400 million shares of common stock of BMI (the “BMI Common Stock”), which represent and pursuant +to the Agreement will represent approximately 92.4% of BMI’s outstanding BMI Common Stock on a fully-diluted basis. However, pending +approval of the transaction by BMI’s shareholders, the Preferred Stock combined are subject to a 19.9% beneficial ownership limitation. +The Agreement provides that BMI will seek shareholder approval (the “Shareholder Approval”) following the closing. +6 +Pursuant to the Certificates +of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred +Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of BMI Common Stock determined by +dividing the Stated Value by $0.25 (the “Conversion Price”), or 40,000 shares of BMI Common Stock. The Conversion Price will +be subject to certain adjustments, including potential downward adjustment if BMI closes a qualified financing resulting in at least $25 +million in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock +will be entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend +Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather +than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If +BMI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as +long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the +event of a liquidation, change of control event, dissolution or winding up of BMI, and will rank senior to all other capital stock of +BMI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred +was originally entitled to vote with the BMI Common Stock at a rate of 10 votes per share of Common Stock into which the Series B Preferred +is convertible, but that provision was subsequently eliminated. Other than certain rights granted to the Company relating to amendments +or waiver of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially +identical. +The Agreement closed on March +6, 2023. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.ault.com. +Our Corporate Structure +On January 19, 2021, we changed +our name from DPW Holdings, Inc. to Ault Global Holdings, Inc., on December 13, 2021, we changed our corporate name from Ault Global Holdings, +Inc. to BitNile Holdings, Inc. and on January 3, 2023, we changed our name from BitNile Holdings, Inc. to Ault Alliance, Inc (together, +the “Name Changes”). The Name Changes were each effected through a parent/subsidiary short form merger pursuant to an Agreement +and Plan of Merger dated January 7, 2021, December 1, 2021 and December 20, 2022, respectively. None of the mergers or the corresponding +Name Change affected the rights of our security holders. Our common stock is traded on the NYSE American under the symbol “AULT.” +Existing stock certificates that reflect our prior corporate names continue to be valid. Certificates reflecting the new corporate name +are issued as old stock certificates are tendered for exchange or transfer to our transfer agent. Concurrent with the change in our name +to Ault Global Holdings, Inc., Milton C. Ault III was appointed as our Executive Chairman, William B. Horne was appointed as our Chief +Executive Officer and remains as Vice Chairman of our board of directors (the “Board”), and Henry Nisser was appointed as +our President and remains as our General Counsel. +7 +Our corporate structure is +currently as follows: +Our Corporate Structure +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +8 +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for Ault Lending and approves all lending transactions. Under its business model, Ault Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to Ault Lending in any particular financing. +Over the recent past, we have +provided capital and relevant expertise to fuel the growth of businesses in cryptocurrency mining, DeFi, defense/aerospace, industrial, +telecommunications, medical and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity +interest or may be actively involved, influencing development through board representation and management support. +Our Principal Subsidiaries and their Businesses +The following is a brief +summary of the businesses in which we own a controlling interest as of the date of this annual report: +Circle 8 +History +In 2007, Philip and Allen +Bryson founded Circle 8 Fluid Services, Inc., which later became Circle 8 Crane Services, LLC in 2018 (“Former Circle 8”) +as a niche chemical provider to oilfield production and completion companies. In 2008, Former +Circle 8 began purchasing cranes to service the expanding natural gas drilling and completion +market. From 2009 through 2011, Former Circle 8 expanded +to East Texas and Western Louisiana. In 2012, Former Circle 8 opened operations in the Eagle +Ford Shale in South Texas, establishing an office and terminal in Corpus Christi. Former Circle 8 continued +expansion opening terminals in Houston, Texas and Clinton, Oklahoma. By 2013, Former Circle 8’s fleet grew to forty-seven +cranes and entered into master service agreements with well-established oil producers. In 2014, it purchased another 26 new all-terrain +mobile cranes, rendering its fleet size to 73, manned by over 300 non-union employees, and work orders from 397 new customers in 2014. +The COVID-19 pandemic and +the downturn in domestic oil market during 2020 and 2021, led Former Circle 8 to reduce its fleet throughout 2021. In December 2022, it +sold substantially all the operating assets to Circle 8, a newly formed joint venture between Circle 8 Holdco, with 64% ownership, and +Paramount Lifting Solutions, LLC (“PLS”), with 36% ownership. In connection with the acquisition of Former Circle 8 assets, +Circle 8 refinanced the existing debt owed by Former Circle 8 to CIT Northbridge Credit, LLC (“CITN”), in a $16 million senior +secured asset backed revolving line of credit, and Circle 8 assumed $10.6 million of outstanding equipment notes owed to De Lage Landen +Group, LLC (“DLL”). +Description of the Business +Headquartered in Houston, +Circle 8 is a premier lifting services provider serving clients in Texas, Oklahoma, Louisiana and Oklahoma with three strategically located +branches in Texas and Oklahoma. Its modern fleet consists of 54 mobile all-terrain and hydraulic cranes, with lifting capacities of up +to 350 tons that provides services across the Eagle Ford, Permian, Anadarko and Haynesville basins. Circle 8 is poised for organic growth +through a strengthened financial profile following its recapitalization in December 2022. Circle 8’s fleet consists of Grove, Xuzhou +Construction Machinery Group (“XCMG”) and other leading original equipment manufacturers. +Circle 8 provides experienced +professionally certified operators to deliver customized solutions to lifting clients in oil field services, construction, commercial, +refining / marketing and wind energy markets. Circle 8 maintains an industry leading safety record. Safety personnel hold certifications +and undergo in-house training. +9 +New Management +By teaming up with PLS in +the formation of Circle 8, three key management members from PLS, with significant industry experience, joined the team at Circle 8. In +April 2023, Circle 8 hired Arnold Mabee as its new CEO. Mr. Mabee has a longstanding, successful track record, as he was previously the +President of Sterling Crane USA, LLC (“Sterling Crane”), which has a portfolio of diverse cranes and locations serving multiple +business segments. As such, Mr. Babee is responsible for one of the larger mobile crane companies in the US. +Prior to joining Sterling +Crane, Mr. Mabee was the Partner in Charge / Administration at R.S. Phillips Steel LLC, a fourth-generation family-owned Steel Service +Center that serves the Tri-State Area of New York, New Jersey and Pennsylvania. During his time there, Mr. Babee pioneered several new +innovative ideas to enhance safety, compliance and productivity. +Mr. Mabee has thirty years +of operations and senior level management experience in a variety of industries including all aspects mobile crane & heavy haul services, +steel service centers and other industrial services businesses. Mr. Mabee has a long history of improving profitability, significantly +growing businesses, and where appropriate, taking them through successful restructuring and segmentation events. +With the appointment of Mr. +Mabee as CEO of Circle 8, Phillip Bryson continues on with Circle 8 as President. +Competitive Advantage +Circle 8’s operating +experience and the mid-sized diverse fleet that it has developed serves the oil services and petrochemical industries, providing full-service +lifting solutions with an industry leading safety record. Key strengths of Circle 8 include: +- Leading lifting solutions platform +o Leading provider of comprehensive lifting solutions to diversified end markets, including oil & gas +and with expanding operations in infrastructure, plant turn-around and commercial / industrial construction +o Leading market position with five branches strategically located throughout Texas and Oklahoma +- Industry leading safety record, commitment and policy +o Safety is a core value and Circle 8 is a market leader in employee training and practices +o Dedicated team focused on safety programs. +- Proven strength of management, recently enhanced and augmented +o Proven ability to navigate a secular downturn by maintaining strong customer relationships and scale operations +to capture additional market share +o Seasoned industry leaders who have positioned Circle 8 for future growth +o Additional advisory team to supplement full time management with strategic industry knowledge, contacts +and corporate transaction capability +- High quality fleet with the opportunity to expand by 100% creates a barrier to entry +o Current fleet of 54 cranes, comprised of 46 all-terrain cranes and 6 hydraulic truck cranes, with a combined +average age of 6.2 years and capacity of up to 350 tons +- Diversified blue-chip customers +o Entrenched provider to leading, well-capitalized oil and gas industry operators in Texas and Oklahoma +o Diverse customer base with minimal customer concentration risk +o Longstanding relationships enable company to easily scale up operations with customers’ demands +in the oilfield (upstream), commercial, construction, refining & marketing (downstream) and wind energy markets. +- Compelling utilization and financial profile +o Recently downsized underutilized cranes to return to pre-pandemic fleet utilization over 160% +o Substantial upside remains as Circle 8 efficiently relocates and repurposes its fleet across geographies +and end markets. +Industry +There continues to be some +consolidation within the industry recently, including the acquisitions of Rental Services Corporation, NES Rentals, Neff Corporation and +Ahern Rentals by United Rentals, Inc. (“URI”) and the acquisitions of Contractors Building Supply Co. and Cloverdale Equipment +Co. by Herc Holdings, Inc. (“HRI”). However, the U.S. lifting solution equipment distribution and rental industry remains +highly fragmented and consists mainly of a small number of multi-location regional or national operators and a large number of relatively +small, independent businesses serving discrete local markets. The industry is driven by a broad range of economic factors including total +U.S. residential and non-residential construction trends, construction machinery demand, demand for rental equipment and additional, region-specific +factors. Lifting solutions equipment is largely distributed to end users through two channels: equipment rental companies and equipment +dealers. Examples of equipment rental companies include URI, Sunbelt Rentals, and HRI. Examples of equipment dealers include Finning and +Toromont. Circle 8 operates substantially in a segment of the rental business whereby Circle 8 provides all labor and consumables to complete +a project or an assignment. Like Circle 8, many other pure equipment rental companies may also provide parts and service support to customers. +10 +Sales and Marketing +Lead by Phillip and Brett +Rhuland, the sales force is highly specialized in lifting solutions sales to oil services customers, seeking long term purchase orders +and master service agreements. Circle 8 plans to continue the extensive training program which involves OEM training sessions on operations +and maintenance to ensure the entire sales force knows the fleet inside and out. +Circle 8 will be working with +continuing management to implement a back-office content resource management system that will be heavily focused on data collection so +that it can continue to improve margin and help streamline scheduling, operations and fleet management to optimize utilization. +Competitive Business Strategy +The oil services’ lifting +solutions demand has historically been one of the leading sub-segments of the industry for profitability due to high utilization rates +that coincide with the continuous workstreams of extraction. Circle 8 plans to expand this business line in both topline sales through +optimizing service and quality operations with a strong safety record. +In addition to expanding the +existing business, Circle 8 will seek to make additional forays into the infrastructure construction, the refinery and manufacturing plant +turn-around and industrial facility construction with the availability of new cranes as they become available. +Customers +With a focus on the oil services +sub-segment of the lifting solutions business in the Eagle Ford, Haynesville, Permian and Anadarko basins, Circle 8 has a diversified +base of blue-chip customers in TX and OK. While about a third of its sales are expected to be made up from six of the largest players +in the industry, the remaining two thirds of sales will be highly diversified, leading to minimal concentration risk. With its longstanding +relationships with blue-chip customers and incoming fleet units, Circle 8 believes it has the ability to scale up sales with these customers +locally and most likely into other adjacent areas. +Competition +Due to the highly skilled +nature and competitive nature of the lifting solutions business, the sector typically consists of companies like Circle 8 that provide +full service lifting solutions on rental or contract basis, including the manpower required to operate the equipment or companies that +require extensive lifting solutions straight purchasing the equipment and hiring crane operators directly. +The full-service lifting solutions +business is highly fragmented and local with only a few national service providers. In Circle 8’s existing subsegment of the lifting +solutions business to the petrochemical industry, the competition is not as strong as it is in others as the contract terms are usually +longer term and driven by maintaining strong customer relationships. The diversification strategy for Circle 8 into other subsegments +will be faced with competition that is largely driven based on availability, quality (including safety record), reliability and price. +Environmental and Safety Regulations +Circle 8’s equipment, +facilities and operations are subject to comprehensive and frequently changing federal, state and local environmental and occupational +health and safety laws, which may vary locally. These laws regulate (1) the handling, storage, use and disposal of hazardous materials +and waste and, if any, the associated cleanup of properties affected by pollutants; (2) air quality (emissions); and (3) wastewater. While +lifting solutions’ operations generally do not raise significant environmental risks, Circle 8 uses petroleum products, solvents +and other hazardous substances for fueling and maintaining its fleet and vehicles. Circle 8 has made, and will continue to make, capital +and other expenditures to comply with environmental requirements. Circle 8 does not currently anticipate any material adverse effect on +its business, financial condition or competitive position as a result of its efforts to comply with such requirements. +11 +In the future, federal, state +or local governments could enact new or more stringent laws or issue new or more stringent regulations concerning environmental and worker +health and safety matters, reporting and disclosure obligations, or effect a change in their enforcement of existing laws or regulations, +that could affect operations and increase operational and compliance expenditures. Also, in the future, contamination may be found to +exist at Circle 8’s facilities or off-site locations where waste has been sent. There can be no assurance that Circle 8, or various +environmental regulatory agencies, will not discover previously unknown environmental non-compliance or contamination. Circle 8 could +be held liable for such newly discovered non-compliance or contamination. It is possible that changes in environmental and worker health +and safety laws or liabilities from newly discovered non-compliance or contamination could have a material adverse effect on Circle 8’s +business, financial condition and results of operations. +BitNile, Inc. +BNI conducts data center operations +and Bitcoin mining through ACS. +Overview +BNI is a blockchain technology +company focused on mining of Bitcoin. We mine using purpose-built computers (or “miners”) to solve complex cryptographic algorithms +(or “verify” or “solve” blocks) in the blockchain in exchange for rewards and fees denominated in the native token +of that blockchain network. Our miners provide computing power to a Bitcoin mining pool operator, in which all the participants’ +machines mine Bitcoin as a collective group, and we get paid the expected value of both the block reward and transaction fees for doing +so, rather than mine directly for our own account. The mine pool operators receive block rewards and transaction fees paid in Bitcoin +by the blockchain when the mine pool finds new blocks. The reward and transaction fees are then shared by the pool participants based +on their hash rate contributions to the pool, less a small amount of fees. +We will evaluate each digital +asset in our portfolio, or that we propose to acquire in the future (including by mining), to determine whether it would likely be considered +a security under U.S. federal securities laws, in consultation with outside counsel, as applicable. We will base our analysis on relevant +case law, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance by the SEC and +its staff. See “Risk Factors —  Risks Related to Our Bitcoin Operations – Legal and Regulatory —  +A particular digital asset’s status as a ‘security’ in any relevant jurisdiction is subject to a high degree of uncertainty +and if a regulator disagrees with our characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines +and penalties, which may adversely affect our business, operating results and financial condition. A determination that Bitcoin that we +own or mine is a ‘security’ may adversely affect the value of Bitcoin and our business.” +Our Vision +Traditional finance has historically +had poor customer service and a less than desirable user experience in mobile and web-based platforms, which opens the door to massive +disruption through digital technologies. Additionally, central bank intervention in the financial markets has increasingly turned to money +printing through quantitative easing, which increasingly dilutes the buying power of the global fiat currency market and leads the world +to seek more scarce alternatives. The first phase of the digital transformation has been through the creation of blockchain-based digital +assets. We believe the second phase of this transition will be take form in bridges being built between DeFi and traditional finance to +help improve customer service and user experience in traditional finance. +We foresee a time when traditional +banking is done in the palm of our hands in community-based, peer-to-peer transactions as opposed through financial intermediaries. This +community-based, peer-to-peer network is otherwise known as DeFi. Although we do not believe DeFi will replace traditional finance in +the near- to medium-term, we believe this transition will happen over the next 20 years as Millennials and Gen-Xers become the power class +and the Baby Boomers retire. DeFi is a concept whereby traditional financial intermediaries are not required to process transactions. +The proliferation of blockchain-based protocols will enable participants to offer novel financial products to banking customers. For instance, +in a world where traditional finance provides savings account rates less than 1%, DeFi protocols can provide savings accounts with significantly +higher yields. Traditional financial platforms are not currently designed to distribute these products to its customers. We believe that +in the near-term integrating a traditional broker dealer could help facilitate the distribution of these decentralized finance protocols +to a broad base of customers. While we recognize DeFi is in its infancy stage, we believe blockchain will be integral to its advancement. +We recognize the uncertainties in DeFi and its effect on our economy both in the U.S. and globally, and acknowledge that this is a new +evolving area that may not evolve as we anticipate and in which we may never be a material participant. +12 +We have no present intention +of incorporating Earnity’s business or operations, or that of any other DeFi platform, with our own. On March 6, 2023, our beneficial +ownership in Earnity was transferred to BMI. +Cryptocurrency and Cryptocurrency Mining Overview +Blockchain and Cryptocurrencies Overview +Cryptocurrencies are a type +of digital asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). +Cryptocurrencies operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized +digital ledger that enables the secure use and transfer of digital assets. We believe cryptocurrencies and associated blockchain technologies +have potential advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate +settlement of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” Recently, cryptocurrencies +have gained widespread mainstream attention and have begun to experience greater adoption by both retail and institutional investors and +the broader financial markets. As cryptocurrencies, and blockchain technologies more generally, have entered the mainstream, prices of +digital assets have reached all-time highs and the broader ecosystem has continued to develop. While we expect the value of Bitcoin to +remain volatile, we believe the general increase in aggregate market value signals institutionalization and wider adoption of cryptocurrency. +Cryptocurrencies are generally +decentralized currencies that enable near instantaneous transfers. Transactions occur via an open source, cryptographic protocol platform +which uses peer-to-peer technology to operate with no central authority. The online network hosts the public transaction ledger, +known as the blockchain, and each cryptocurrency is associated with a source code that comprises the basis for the cryptographic and algorithmic +protocols governing the blockchain. In a cryptocurrency network, every peer has its own copy of the blockchain, which contains records +of every historical transaction — effectively containing records of all account balances. Each account is identified solely +by its unique public key (making it effectively anonymous) and is secured with its associated private key (kept secret, like a password). +The combination of private and public cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing +strong control of ownership. +In a cryptocurrency network, +generally no single entity owns or operates the network. The infrastructure is typically collectively maintained by a decentralized public +user base. If the network is decentralized, it will not rely on either governmental authorities or financial institutions to create, transmit +or determine the value of the currency units. Rather, the value is determined by market factors, supply and demand for the units, the +prices being set in transfers by mutual agreement or barter among transacting parties, as well as the number of merchants that may accept +the cryptocurrency. Since transfers generally do not require involvement of intermediaries or third parties, there are only nominal transaction +costs in direct peer-to-peer transactions. For example: +● In terms of conventional peer-to-peer transactions, there either are no fees or they are de minimis (Source: +https://www.kraken.com/en-us); +● For purposes of traditional networks, there are nominal fees associated with any transaction (Source: +https://bitinfocharts.com/bitcoin); and +● +As +of April 15, 2023, the average Bitcoin network fee is $1.20 per transaction, which is still +very low compared to conventional transaction fees charged by banks and other more traditional +financial institutions (https://bitinfocharts.com/bitcoin). +The network fee is separate +and distinct from the pool fee we pay Antpool for its services in acting as a pool operator, discussed below. The network fee is applicable +to anyone who transacts on the blockchain. +Although fees are generally +low, block space continues to be a key issue in regards to the volume of transactions on a blockchain. Mining fees can and often do fluctuate +from transaction to transaction as a result of “congestion.” However, this congestion does not negate any of the statements +made immediately above. +Units of cryptocurrency can +be converted to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as Binance, Coinbase, Kraken, +Gemini and others. Cryptocurrency prices are quoted on various exchanges and fluctuate with extreme volatility. +13 +We believe cryptocurrencies, +particularly Bitcoin, the only cryptocurrency we receive for providing computing power to a mining pool operator, offer many advantages +over traditional, fiat currencies, although many of these factors also present potential disadvantages and may introduce additional risks, +including: +● Acting as a fraud deterrent, as cryptocurrencies are digital and cannot be counterfeited or reversed arbitrarily +by a sender; +● Immediate settlement; +● Elimination of counterparty risk; +● No trusted intermediary required; +● Lower fees; +● Identity theft prevention; +● Accessible by everyone; +● Transactions are verified and protected through a confirmation process, which prevents the problem of +double spending; +● Decentralized — no central authority (government or financial institution); and +● Not recognized universally and not bound by government imposed or market exchange rates. +However, cryptocurrencies may not provide all +of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, +there are many factors that can affect all digital asset mining companies and Bitcoin in particular: +· Limitations on the supply of the cryptocurrency being mined; +· The market price of the cryptocurrency; +· Cost of power: +· Mining difficulty and overall network hashrate; +· Regulatory oversight; and +· Hosting availability. +The Bitcoin halving is a phenomenon +that occurs approximately every four years on the Bitcoin network. The halving is a key part of the Bitcoin protocol, and it serves to +control the overall supply and reduce the risk of inflation in digital assets using a Proof-of-Work consensus algorithm. At a predetermined +block, the mining reward is cut in half, hence the term “halving”. For Bitcoin the reward was initially set at 50 Bitcoin +currency rewards per block. The Bitcoin blockchain has undergone halving three times since its inception as follows: (1) on November 28, +2012 at block height 210,000; (2) on July 9, 2016 at block height 420,000; (3) on May 11, 2020 at block height 630,000, when the reward +was reduced to its current level of 6.25 Bitcoin per block. The next halving for the Bitcoin blockchain is anticipated to occur on or +around March 2024 at block height 840,000. This process will reoccur until the total amount of Bitcoin currency rewards issued reaches +21 million and the theoretical supply of new Bitcoin is exhausted, which is expected to occur around 2140. +We currently only participate +in mining pools that mine Bitcoin. Our business is heavily dependent on the price of Bitcoin. The prices of digital assets, including +Bitcoin, have experienced substantial volatility, meaning that high or low prices may be based on speculation and incomplete information, +may be subject to rapidly changing investor sentiment, and may be influenced by factors such as technology, regulatory void or changes, +fraudulent actors, manipulation, and media reporting. Bitcoin may have value based on various factors, including their acceptance as a +means of exchange by consumers and producers, scarcity, and market demand which are beyond our control. See “Risk Factors – +Risks Related to Our Bitcoin Operations” for more information on the risks we face due to our mining of Bitcoin and its speculative +and volatile nature. +Cryptocurrency Mining and Mining Pools +As a participant in a cryptocurrency +mining pool, we use specialized miners to solve cryptographic math problems necessary to record and “publish” cryptocurrency +transactions to blockchain ledgers. Generally, each cryptocurrency has its own blockchain, which consists of software code (also known +as a protocol), which is run by all the computers on the network for such blockchain. Within this code, transactions are collated into +blocks, and these blocks must meet certain requirements to be verified by the blockchain software, added to the blockchain or ledger of +all transactions and published to all participants on the network that are running the blockchain software. After a transaction is verified, +it is combined with other transactions to create a new block of data for the blockchain. For proof-of-work blockchains, the process of +verifying valid blocks requires computational effort to solve a cryptographic equation, and this computational effort protects the integrity +of the blockchain ledger. This process is referred to as “mining.” As a reward for verifying a new block, miners receive payment +in the form of the native cryptocurrency of the network (e.g., Bitcoin). This payment is comprised of a block reward (i.e., the automatic +issue of new cryptocurrency tokens) and the aggregated transaction fees for the transactions included in the block (paid in existing cryptocurrency +tokens by the participants to the transactions). The block reward payments and the aggregated transaction fees are what provide the incentive +for miners to contribute hash rate to the network. +14 +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific cryptocurrency, and the blockchain-wide hash rate for a specific cryptocurrency can be understood as the aggregate +of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +and other cryptocurrencies are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known +as the “mining difficulty,” which is the level of computational activity required before a new block is solved and verified. +For example, on the Bitcoin blockchain the protocol is coded such that a new block is solved and verified approximately every ten minutes, +while on Ethereum blocks are designed to be solved approximately every twelve to fifteen seconds. As such, to the extent the hash power +on the network is increased or decreased due to, for example, fluctuations in the number of active miners online, mining difficulty is +correspondingly increased or decreased to maintain the preset interval for the verification of new blocks. +On certain cryptocurrency +networks, including Bitcoin, the rewards for solving a block are also subject to periodic incremental halving. Halving is a process designed +to control the overall supply and reduce the risk of inflation in cryptocurrencies using a proof-of-work consensus algorithm. After a +predetermined number of blocks are added to the blockchain, the mining reward is cut in half, hence the term “halving.” The +last halving for Bitcoin occurred on May 11, 2020. The next halving for Bitcoin is expected to occur in 2024, and as such, absent +any changes to the Bitcoin protocols, the block reward will remain stable until then. Transaction fees are variable and depend on the +level of activity on the network. Generally, transaction fees increase during times of network congestion, as miners will prefer transactions +with higher fees, and therefore a higher fee can reduce the time to process a transaction, and decrease when there are fewer transactions +on the network. +As the total amount of available +hash rate has increased (particularly on the Bitcoin network), it has become increasingly difficult for any individual miner to independently +solve a block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool operator, rather than an individual miner, +validates the block and receives the block reward and related transaction fees. The mining pool is organized by a third party, in our +case Antpool.com. In consideration for receiving a percentage of the earned block rewards and transaction fees, Antpool.com administers +the pool and ensures that the participants in the pool receive their share of the block reward and related transaction fees, generally +pro-rata to their contributed hash rate. Mining pools offer miners more predictable and consistent revenue compared to mining individually. +We participate in mining pools by providing what the industry refers to as “hashrate” to the pool. Hashrate is defined as +the computing power that our mining equipment produces when helping to validate a block that the mining pool is trying to solve. We use +the FPPS, or Full Pay-Per-Share, method when mining with Antpool.com. Pursuant to the “Full Pay Per Share” model, both the +block reward and the mining service charge are settled according to the theoretical profit. It includes the calculation of a standard +transaction fee within a certain period and distributes it to mining pool participants according to their hash power contributions in +the pool. It increases the mining pool participants’ earnings by sharing transaction fees. Standard transaction fees are calculated +using a certain period which are then distributed to miners according to their hash power contributions in the pool. Antpool.com currently +charges us a 0.3% mining fee. +We provide computing power +to the mining pool, which is run by the mining pool operator with whom we contract, who in turn provides transaction verification services. +Based on the terms of the agreement, in our judgment, the mining pool operator is considered the principal in providing mining pool services. +We recognize revenue, net of certain transaction fees from the mining pool operator, which are not considered material. To date, we have +only used one mining pool operator. Our current mining pool agreement is cancelable at any time by either party without penalty. Revenue +received from for providing computing power would be directly impacted positively or negatively should we start and stop providing computing +power to the mining pool operator within a given reporting period. +15 +Our Strategy +Smart Growth +We aim to optimize our mining +by actively monitoring and adjusting the operation of mining machines to enhance their performance. When planning our short- and long-term +operating strategies and capital expenditures, we carefully monitor fluctuations and longer-term trends in the value of certain cryptocurrencies, +which impacts the return on investment of machines. We also regularly evaluate potential innovations in geography, physical footprint, +computing technology and similar areas to improve our operations and productivity. We believe this smart growth strategy, including our +commitment to mining efficiency and return on investment in miners, will enable us to build value over the long term. +Own and Operate Our Mining Facilities +We have made significant investments +in purchasing, building and operating our mining facilities. By owning and operating our miners at facilities that offer competitive advantages, +including access to reliable, low-cost, renewable power and room for expansion, we expect to have greater control over the timing of the +purchase and deployment of our miners. We also may enhance our ability to intelligently and quickly adapt our operating model and reap +savings compared to paying for outsourced operations and infrastructure. We anticipate that we will continue to consider other opportunities +to integrate our operations, including with respect to both the software utilized by our fleet and the associated hardware. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in cryptocurrency mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable amounts of electrical energy to perform +their functions and mine Bitcoin; consequently, a critical aspect of operating in the cryptocurrency mining industry is obtaining a reliable +supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased the Facility, which currently has +access to 28 megawatts of power in preparation for the planned purchase of Bitcoin mining equipment. Since the purchase of the Facility, +we have invested in infrastructure improvements and began both ramping up the sites power capacity and installing S19j Pro miners. To +date, we have increased power load from 1.5 megawatts to 28 megawatts . In addition, we are +working on a formal agreement with the utility company that currently provides our power to expand the site’s capacity up to 297 +megawatts, which could take up to 24 months to complete such an expansion. Our relationship with the utility company has grown +as we have demonstrated our ability to upgrade and use power at our site effectively. We are in the midst of finalizing those expansion +details with the utility company, engineers, and the Economic Development Agency. This planned expansion would allow the operation of +up to as many as 90,000 Bitcoin miners at the Facility. +We continue to evaluate other +sites, locations, and partnerships for additional and alternative support of future mining operations. While we have not at present entered +into any other agreements, we will continue to explore and evaluate additional facilities that that would enable us to expand our mining +operations as needed. +Our Mining Operations +On January 29, 2021, ACS closed +on the acquisition of the 617,000 square foot energy-efficient Facility for a purchase price of $4.0 million. The purchase price was paid +using our own working capital. The Facility has been remodeled and converted over the past year into a site focused on three types of +business (commercial real estate, enterprise data center, and high-density computing). +The buildout of the initial +30,000 square feet will be used primarily for our Bitcoin mining operations. While we believe the Facility and its anticipated future +operations will be successful, there is a risk that our expectations will not materialize in a timely manner, if at all. +16 +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain. We have received 20,645 Antminers, fulfilling the first five of seven Bitmain Agreements including 4,628 environmentally +friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) and 16,017 S19j Pro Antminers +that feature a processing power of 100 TH/s. The 20,645 Antminers in our possession, once installed and energized, will generate a combined +processing power of approximately 2.25 exahashes per second (“EH/s”), the computational power that is being used to mine Bitcoin. +Beyond the first five contracts +with Bitmain, we have two more purchase agreements for an additional 1,325 S19j Pro Antminers estimated to be delivered over the second +quarter 2023 and 1,140 S19 XP Hydro Antminers anticipated to be delivered during the summer of 2023. Once all of the miners are fully +deployed and operational, we expect to achieve a mining production capacity of approximately 2.67 EH/s. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +Our strategy includes identifying +less expensive, clean power for our Bitcoin mining operations. Management of the company has considered the issues surrounding the environmental +impact of our Bitcoin mining operations. Based on this review, we have concluded that the environmental impact of our mining operations +is not material given that approximately 85% of the energy we use is “green,” meaning it is sourced from nuclear, wind or +solar power. In addition to our continued expansion investments at the Facility, we also seek out new locations to support our Bitcoin +mining business. We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but also +leasing buildings and facilities, hosting relationships and strategic partnerships. At this time, we have not entered into any new mining +agreements at locations other than the Facility. We currently mine Bitcoin only. +Coins that are mined are held +in a custodial account as digital assets. We transitioned from NYDIG to Gemini Trust Company, LLC (“Gemini”) as custodian +and securely store our digital assets at Gemini, a regulated, audited and insured cryptocurrency custodian. The custody arrangements require +that we mine to a custodial wallet address where the private key is held by the custodian and all keys for the wallet are held in cold +storage. This provides a layer of protection in both the transaction and liquidation phases of the operations by using multi-factor and +multi-person approval processes, to include Know Your Customer and Anti-Money Laundering procedures of the receiving party. We will either +hold the digital assets or may choose to convert those assets into fiat currency depending on financial needs and plans. When we opt to +convert the digital assets we sell or exchange our Bitcoin through Gemini, the custodian of our digital wallet. When we elect to make +a sale or exchange our Senior Vice President - Finance submits a request to Gemini’s execution department to exchange Bitcoin for +U.S. dollars. Gemini sends an approval email to our CEO to approve. Once approved by our CEO, Gemini executes the sale/exchange on its +trading platform at current market prices, less commissions, and deposits the U.S. dollars into our bank account. +Beyond the foregoing, our +custody agreement with Gemini provides that: +● Gemini provides a unique custody account in which all our blockchain assets are held, which are segregated +from all others’ assets and are verifiable through the blockchain; and +● Gemini charges us fees in Bitcoin, which is deducted from our digital assets on the last business day +of every month. +Currently, we are converting +Bitcoin received from our mining activities into fiat currency on a bimonthly basis, on average, to pay for operating costs and purchase +commitments for new mining equipment. We are not currently holding any digital assets for investment. +Our Contracts with Bitmain +Between July and November +2021, we entered into five separate Non-Fixed Price Sales and Purchase Agreements (collectively, the “Bitmain Agreements”) +with Bitmain. We have received 20,645 Antminers, fulfilling the first five of seven Bitmain Agreements including 4,628 environmentally +friendly S19 XP Antminers that feature a processing power of 140 terahashes per second (“TH/s”) and 16,017 S19j Pro Antminers +that feature a processing power of 100 TH/s. The 20,645 Antminers in our possession, once installed and energized, will generate a combined +processing power of approximately 2.25 exahashes per second (“EH/s”), the computational power that is being used to mine Bitcoin. +17 +Beyond the first five contracts +with Bitmain, we have two more purchase agreements for an additional 1,325 S19j Pro Antminers estimated to be delivered over the second +quarter 2023 and 1,140 S19 XP Hydro Antminers anticipated to be delivered during the summer of 2023. Once all of the miners are fully +deployed and operational, we expect to achieve a mining production capacity of approximately 2.67 EH/s. +All of the miners we are purchasing +are newly manufactured and not pre-owned. We are not aware if Bitmain is experiencing any supply side constraints in its ability to fulfill +the Bitmain Agreements; to date, Bitmain has timely delivered all miners pursuant to the delivery schedule in such agreements. +Regulation +Cryptocurrency mining is largely an unregulated +activity at both the state and federal level. We anticipate that cryptocurrency mining will be a focus for increased regulation in the +near- and long-term, and we cannot predict how future regulations may affect our business or operations. +In March 2022, the United States announced plans +to establish a unified federal regulatory regime for cryptocurrency, and a group of United States Senators sent a letter to the United +States Treasury Department asking Treasury Secretary Yellen to investigate Treasury’s ability to monitor and restrict the use of +cryptocurrencies to evade sanctions imposed by the United States. We are unable to predict the impact that any new regulations may have +on our business at the time of filing this Annual Report. We continue to monitor and proactively engage in dialogue on legislative matters +related to our industry. +In September 2022, the White House issued a report +regarding the Climate and Energy Implications of Crypto-Assets in the United States. The report states that the Department of Energy and +Environmental Protection Agency should initiate a process to solicit data and develop environmental performance and energy conservation +standards for crypto-asset technologies, including mining equipment. Should such measures prove ineffective at achieving the Administration’s +environmental goals, the report calls for the Administration to explore executive actions and legislation to limit or eliminate the use +of high energy intensity consensus mechanisms for crypto-asset mining. +We are unable to predict the impact that any new +standards, legislation, or regulations may have on our business at the time of filing this Annual Report. We continue to monitor and proactively +engage in dialogue on regulatory and legislative matters related to our industry. +Further, in December 2022 the SEC’s Division +of Corporation Finance issued guidance advising companies to disclose exposure and risk to the cryptocurrency market. While the focus +is on digital asset managers and exchanges, and not Bitcoin miners, the failure of such large asset managers and exchanges may create +increased price volatility of Bitcoin. +In January 2023, the Federal Reserve, Office of +the Comptroller of the Currency, and Federal Deposit Insurance Corporation issued a joint statement discouraging banks from doing business +with clients in crypto-asset industries. In January 2023, the Federal Reserve also issued a policy statement broadening its authority +to cover state-chartered banks. +Also in January 2023, the House of Representatives +announced its first ever Financial Services Subcommittee on Digital Assets and the intention to develop a regulatory framework for the +digital asset industry. Bipartisan leadership of the Senate Banking Committee announced that goal as well. +As the regulatory and legal environment evolves, +we may become subject to new laws, such as further regulation by the SEC and other agencies, which may affect our mining and other activities. +For additional discussion regarding our belief about the potential risks existing and future regulation pose to our business, see Part +I, Item 1A. “Risk Factors” of this Annual Report. +Competition +Our business environment is +constantly evolving, and cryptocurrency miners can range from individual enthusiasts to professional mining operations with dedicated +data centers. We compete with other companies that focus all or a portion of their activities on cryptocurrency mining activities at scale. +We face significant competition in every aspect of our business, including, but not limited to, the acquisition of new miners, the ability +to raise capital, obtaining the lowest cost of electricity, obtaining access to energy sites with reliable sources of power, and evaluating +new technology developments in the industry. +18 +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this annual report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies +which we have identified as our competitors: +● Argo Blockchain PLC; +● Bit Digital, Inc.; +● Bitfarms Technologies Ltd. (formerly Blockchain Mining Ltd); +● Cipher Mining Inc.; +● Core Scientific, Inc.; +● Digihost International, Inc.; +● DMG Blockchain Solutions Inc.; +● Galaxy Digital Holdings Ltd.; +● Greenidge Generation Holdings Inc.; +● HashChain Technology, Inc.; +● Hive Blockchain Technologies Inc.; +● Hut 8 Mining Corp.; +● Iris Energy Limited; +● Layer1 Technologies, Inc.; +● Marathon Digital Holdings, Inc.; +● MGT Capital Investments, Inc.; +● Northern Data AG; +● Riot Blockchain, Inc.; +● Overstock.com Inc.; and +● Stronghold Digital Mining, Inc. +Intellectual Property +We plan to use specific hardware +and software for our cryptocurrency mining operations. In certain cases, source code and other software assets may be subject to an open +source license, as much technology development underway in this sector is open source. For these works, we intend to adhere to the terms +of any license agreements that may be in place. +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. +Accounting for Digital Currencies +Digital currencies are included +in current assets in the combined balance sheet. Digital currencies are recorded at cost less any impairment. An intangible asset with +an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances +occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount +exceeds its fair value. In testing for impairment, we have the option to first perform a qualitative assessment to determine whether it +is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, +a quantitative impairment test is not necessary. If we conclude otherwise, we will be required to perform a quantitative impairment test. +To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment +losses is not permitted. We account for our mining-related gains or losses in accordance with the first-in, first-out method of accounting. +19 +Ault Lending +Ault +Lending acquires controlling or non-controlling interests in and actively manages businesses that we generally believe (i) are undervalued +and have disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, +(iii) have positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, and (v) have +strong management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading middle-market businesses +in the niche-industrial and branded-consumer sectors. +Ault +Lending uses a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing +the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. +Ault +Lending believes that private company operators and corporate parents looking to sell their business units may consider us an attractive +purchaser because of our ability to: +● provide ongoing strategic and financial support for their businesses, including professionalization of +our subsidiaries at scale; +● maintain a long-term outlook as to the ownership of those businesses; +● sustainably invest in growth capital and/or add-on acquisitions where appropriate; and +● consummate transactions efficiently without being dependent on third-party transaction financing. +In +particular, we believe that our outlook on length of ownership and active management on our part may alleviate the concern that many private +company operators and parent companies may have with regard to their businesses going through multiple sale processes in a short period +of time. We believe this outlook enhances our ability to develop a comprehensive strategy to grow the earnings and cash flows of each +of our businesses. +Finally, +it has been our experience that our ability to acquire businesses without the cumbersome delays and conditions typical of third party +transactional financing is appealing to sellers of businesses who are interested in confidentiality, speed and certainty to close. +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2022, we believe that these businesses have strong +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Ault Lending provides funding +to businesses through loans and investments. Ault Lending offers a variety of loan types including commercial loans, convertible notes +and revolving lines of credit. Ault Lending is engaged in providing commercial loans to companies throughout the United States to provide +them with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to 12 months, +but may be of longer duration. These terms are subject to change as market needs dictate, and Ault Lending anticipates offering additional +products in the future. +Ault Lending uses its considerable +financial experience, data analytics, and a credit scoring model to assess the creditworthiness of each small business borrower applicant. +If the business meets Ault Lending’s criteria, Ault Lending sets the initial interest rate according to its credit and financial +models. The final interest rate offered to the borrower will be determined by Ault Lending’s interpretation of the marketplace. +In order to borrow from Ault Lending, borrowers must display characteristics indicative of durable business and financial situations. +These include factors such as revenue, time in business, number of employees, and financial and credit variables. In order to qualify, +business borrower applicants must be approved through Ault Lending’s underwriting process, which analyzes credit and financial data +of both the business and the business owner. Ault Lending takes into account several business factors (including revenue, age of business, +cash flows, and other variables). The underwriting process determines the loan amount to approve, how loans will be priced, and whether +to include a blanket lien is based on the above analysis, as well as additional factors (including length of loan, estimated default rates +by type and grade, and general economic environment). +20 +Our Executive Committee, which +is comprised of our Executive Chairman, Chief Executive Officer and President, acts as the underwriting committee for Ault Lending and +approves all lending transactions. The Executive Committee has decades of experience in financial, investing and securities transactions. +Under its business model, Ault Lending generates revenue through origination fees charged to borrowers and interest generated from each +loan. Ault Lending may also generate income from appreciation of investments in marketable securities as well as any shares of common +stock underlying convertible notes or warrants issued to Ault Lending in any particular financing. +As noted above, we will from +time to time, through Ault Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2023, we anticipate +providing significant new funding to expand Ault Lending’s loan and investment portfolio. Ault Lending loans are made or arranged +pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +Ault Alpha +Ault Lending is the principal +owner of Ault Alpha, a term we use that comprises an investment fund, a general partner and an investment manager all formed on July 15, +2021. Ault Alpha generally seeks to invest in public companies or private companies with public debt that have strong relative value metrics +but poor Wall Street recognition; such companies can often experience valuation inefficiencies. Ault Alpha seeks to identify and invest +in these undervalued companies. In certain companies, Ault Alpha will actively intervene to assist management to maximize stockholder +value. Ault Alpha believes that an activist role can result in the creation of significant value and larger than average returns on investment. +Ault Alpha will own a concentrated portfolio, and typically invest with a long-term perspective. Further, Ault Alpha will employ a systematic +process, developed over decades of collective experience in the capital and credit markets, to seek specific value-creating events and/or +special situations, to provide compelling return potential and generate competitive capital appreciation and total return by making investments +in three key categories: (i) undervalued or overvalued assets; (ii) activist trading; and (iii) volatility trading and arbitrage. Ault +Alpha has purchased the Company’s common stock in open-market transactions. +BitNile Metaverse, Inc . +As discussed above, we +recently transferred our entire ownership of BitNile.com, or BNC, to BitNile Metaverse, or BMI. As part of that transaction, we also transferred +our ownership of Ault Iconic and all of our beneficial ownership of Earnity to BMI. +Overview +BNC, an entity in the embryonic +stage of development, represents a groundbreaking development in the online metaverse landscape, offering immersive, interconnected digital +experiences that are inclusive, engaging, and dynamic. By integrating various elements such as virtual markets, real world goods marketplaces, +gaming, social activities, sweepstakes, gambling, and more, BNC aims to revolutionize the way people interact online. BNC’s rapidly +growing virtual world, BitNile.com (the “Platform”) is accessible via any device using any web browser, without requiring +permissions, downloads, or apps, and the Platform can be enjoyed without the need for bulky and costly virtual reality headsets. +BNC’s business strategy +revolves around creating a seamless, all-encompassing Platform that caters to various user needs and interests. The Platform’s strategic +pillars include: +· Leveraging cutting-edge technology to offer a +user-friendly, browser-based platform compatible with VR headsets and other modern devices; +· Providing a diverse range of products and experiences +that cater to users with different interests and preferences; +· Fostering global connections and a sense of community +among users, encouraging socialization and collaboration; and +· Ensuring continuous innovation to stay ahead +of industry trends and customer expectations. +21 +Customers +BNC targets a broad audience, +including: +· Tech-savvy individuals seeking immersive digital +experiences; +· Gamers of all skill levels interested in a diverse +array of gaming options; +· Collectors and traders of digital assets, such +as virtual real estate, digital art, and unique collectibles; +· Shoppers seeking a convenient, intuitive platform +for purchasing real world goods; and +· Users seeking social interaction and global connectivity +in a virtual environment. +Products +BNC offers an extensive range +of products and experiences, including: +· Virtual markets: Sales of digital assets from +BNC as well as third party vendors like virtual real estate, digital art, user customizations, and unique collectibles; +· Real world goods marketplaces: A platform for +shopping a diverse range of real world products; +· Gaming: a selection of gaming options, including +participation in games, sweepstakes, and social gaming experiences; +· Sweepstakes gaming: A dedicated gaming zone for +sweepstakes gaming, offering opportunities to win virtual and real money; +· Contests of skill: competitions where users can +showcase their talents and win prizes; +· Building private spaces: A feature allowing users +to construct and customize their dream homes or private spaces; +· Social hubs for users to interact with individuals +from around the world; and +· Unique virtual and real world experiences, such +as live and virtual concerts, conferences, and other events. +Industry +The metaverse industry is +experiencing rapid growth and expansion, driven by advancements in technology, increased interest in virtual experiences, and the rise +of digital economies. Key trends include: +· The integration of virtual and physical worlds; +· The emergence of virtual economies and markets; +and +· The growing importance of socialization and community-building +in digital spaces. +Competition +BNC faces competition from +existing metaverse platforms and new entrants. Key competitors include: +· Established metaverse platforms, such as Decentraland, +The Sandbox, and Second Life, as well as companies that focus on development of metaverse tools and platforms such as META; +· Gaming-focused platforms, like Fortnite and Roblox; +and +· Social media platforms that integrate metaverse +elements, such as Facebook’s Horizon Workrooms. +Regulatory Environment +BNC operates within a complex and evolving regulatory +landscape, with key considerations including: +· Data privacy and protection regulations, such +as GDPR and CCPA; +· Compliance with gaming and gambling regulations +in various jurisdictions; and +· Intellectual property rights and digital asset +ownership. +22 +BNC intends to offer a transformative +digital experience by combining elements of virtual markets, real world goods marketplaces, gaming, social activities, and sweepstakes +gaming. This unique integration establishes BNC as a pioneering Platform in the metaverse industry, catering to diverse user interests +and needs. We believe that as the industry evolves and expands, BNC’s commitment to providing immersive and interconnected digital +experiences will place it at the forefront of the metaverse revolution, poised to redefine online interaction and engagement for users +around the globe. By continuously innovating and adapting to the ever-changing digital landscape, BNC aims to offer limitless possibilities +and opportunities for users, setting the stage for a truly inclusive and dynamic metaverse. +Business Strategy +BNC’s business strategy +focuses on delivering a comprehensive, immersive, and interconnected metaverse experience that stands out from the competition. To achieve +this, the platform has identified several core strategic initiatives that will guide its growth and development. +Technological Innovation and User Experience +BNC places a strong emphasis +on leveraging cutting-edge technology to create a seamless, user-friendly experience. By offering a browser-based platform that is compatible +with VR headsets and other modern devices, BNC ensures accessibility and convenience for users across various platforms. BNC intends to +continuously invest in research and development to stay at the forefront of technological advancements in the metaverse space, ensuring +that users enjoy an unparalleled experience. +Diversification and Personalization +BNC’s strategy focuses +on providing a diverse range of products and experiences that caters to users with different interests and preferences. By offering a +wide variety of activities, from virtual markets and real world goods marketplaces to gaming, social interaction, and live and virtual +events, the platform aims to attract a broad user base and promote user engagement. Additionally, BNC intends to emphasize personalization, +allowing users to customize their experiences and tailor the platform to suit their unique needs and tastes. +Community Building and Global Connections +The Platform recognizes the +importance of fostering a strong sense of community and global connectivity among its users. BNC intends to implement various features +and initiatives designed to encourage socialization, collaboration, and networking among users from around the world. This will include +the creation of social hubs, support for user-generated content, and the promotion of events and activities that bring users together. +Monetization and Revenue Generation +BNC’s business strategy +includes developing diverse revenue streams to ensure the Platform’s long-term sustainability and growth. Potential monetization +strategies include charging fees for premium features, from sales and transactions on virtual markets and real world goods marketplaces, +social sweepstakes gaming, real and virtual concerts and events, and offering advertising opportunities for brands within the metaverse. +Additionally, the Platform will explore partnerships and collaborations with other businesses and organizations to create new revenue-generating +opportunities. +Compliance and Regulatory Management +To navigate the complex and +evolving regulatory landscape, BNC will prioritize compliance with relevant laws and regulations in all jurisdictions where it operates. +This includes data privacy and protection regulations, gaming and sweepstakes regulations, and intellectual property rights. By maintaining +a strong focus on regulatory compliance, BNC aims to minimize potential legal risks and build trust with users and partners. +23 +Continuous Improvement and Adaptability +Finally, BNC’s business +strategy emphasizes the importance of continuously evaluating and refining its offerings in response to changing market trends and user +preferences. The platform will actively seek user feedback and monitor industry developments to inform its ongoing product development +and feature enhancements. This adaptability will allow BNC to maintain its competitive edge and continue delivering a compelling metaverse +experience for users. +Customers and Product Interaction +BNC aims to serve a diverse +customer base by offering an extensive range of products and experiences designed to cater to various interests and preferences. The Platform +seeks to create a highly engaging environment, encouraging users to interact with its offerings in multiple ways. This section provides +insights into BNC’s target customers and how they interact with the various products and experiences available on the Platform. +Tech-savvy Individuals +Tech-savvy individuals are +drawn to BNC due to its innovative, cutting-edge technology and immersive virtual experiences. These users are likely to engage with the +Platform’s virtual markets, trading digital assets like virtual real estate, digital art and unique collectibles. They may also +be early adopters of VR headsets, using them to explore the metaverse and interact with other users in social hubs. +Gamers of All Skill Levels +BNC appeals to gamers by offering +an extensive selection of gaming options, from casual games to competitive contests of skill. Gamers can participate in various gaming +experiences, such as: +· Sweepstakes gaming: Gamers can enter sweepstakes +games to compete for virtual and real money prizes, testing their skills against other players in a secure, fair environment; +· Social gaming experiences: Users can engage with +others in single player games with chat features as well as multiplayer games, fostering collaboration and communication while enjoying +a shared gaming experience; and +· Contests of skill: Competitive gamers can showcase +their abilities by participating in contests of skill, earning recognition, and winning prizes. +Collectors and Traders of Digital Assets +BNC’s virtual markets +cater to users interested in collecting, trading, and investing in digital assets. These users can interact with the Platform’s +offerings by: +· Buying, selling, and trading digital assets, +such as virtual real estate, digital art, and unique collectibles; +· Exploring and engaging with the digital art galleries +and museums featured in the metaverse; and +· Attending virtual events and auctions for exclusive +digital asset releases and limited-edition collectibles. +Shoppers Seeking Real world Goods +Users looking for a convenient, +intuitive platform to purchase real world goods can explore BNC’s real world goods marketplaces, which offer a diverse range of +products. These users can: +· Browse and purchase items from categories such +as fashion, electronics, travel, and home goods; +· Interact with virtual showrooms and product demonstrations +to gain a better understanding of the products they’re interested in; and +· Participate in virtual events, sales, and promotions +to discover new products and take advantage of special offers. +24 +Social Seekers and Global Connectors +We believe BNC will appeal +to users who value social interaction and global connectivity in a virtual environment. These users can engage with the Platform’s +offerings by: +· Participating in various social hubs to meet +and interact with individuals from around the world. +· Collaborating on projects, sharing ideas, and +forming new friendships within the metaverse. +· Building and customizing private spaces to host +gatherings, parties, or events for their friends and online communities. +· Attending virtual events, concerts, and conferences +to connect with others who share their interests and passions. +By understanding its target +customers and the ways in which they interact with BNC’s various products and experiences, the Platform can effectively tailor its +offerings to meet the needs and preferences of its diverse user base. +Products and Experiences +BNC intends to offer an extensive +range of products and experiences designed to cater to a diverse audience with varied interests and preferences. By providing a comprehensive +suite of offerings, the Platform aims to attract and engage users, creating a vibrant and dynamic metaverse environment. The following +is an expanded list of BNC’s products and experiences, most of which remain in development: +· Virtual markets: Facilitating the trading of +digital assets like digital skins, a graphic download that changes the appearance of characters in video games, for avatar customization +virtual real estate, digital art, and unique collectibles, enabling users to participate in a thriving digital economy; +· Real world goods marketplaces: Offering a platform +for users to shop for a diverse range of real world products, including fashion, electronics, and home goods, seamlessly connecting the +virtual and physical worlds; +· Gaming: Providing an extensive selection of gaming +options for users of all skill levels, including participation in games, sweepstakes, and social gaming experiences; +· Sweepstakes gaming: Featuring a dedicated gaming +zone for users to engage in sweepstakes gaming, with opportunities to win both virtual and real money prizes; +· Contests of skill: Organizing competitions for +users to showcase their talents and compete against others for prizes and recognition in various disciplines; +· Building private spaces: Allowing users to construct +and customize their dream homes or private spaces, tailoring their environments with an array of design options and sharing their creations +with others or keeping them as personal retreats; +· Socialization and connectivity: Fostering global +connections by enabling users to interact with individuals from around the world, forming new friendships, collaborating on projects, +or engaging in conversations within various social hubs; and +· Real and virtual concerts: Hosting live and virtual +concerts within the metaverse, featuring performances from both real world and virtual artists, allowing users to attend and enjoy shows +in an immersive environment. +By offering a diverse and +comprehensive range of products and experiences, BNC aims to create a vibrant and engaging metaverse platform that appeals to users with +a wide array of interests and preferences. +Industry Overview and Key Trends +The metaverse industry is +witnessing rapid growth and expansion, driven by a combination of technological advancements, increased interest in virtual experiences, +and the emergence of digital economies. As the industry continues to evolve, it is important to consider user adoption, growth, and other +factors that contribute to the metaverse landscape. +25 +User Adoption and Growth +The growing popularity of +virtual experiences and digital platforms has led to a surge in user adoption and engagement in the metaverse industry. A number of factors +contribute to this growth, including: +· Increased accessibility of virtual reality (“VR”) +and augmented reality (“AR”) technologies, making immersive experiences more affordable and widely available. +· The ongoing digitization of various aspects of +everyday life, from work and education to entertainment and socialization, driving users to seek out new digital experiences. +· The COVID-19 pandemic, which has accelerated +the adoption of digital platforms and virtual experiences as people adapt to remote work, learning, and social distancing measures. +Integration of Virtual and Physical Worlds +One of the key trends in the +metaverse industry is the growing integration of virtual and physical worlds, enabling users to seamlessly transition between digital +and real world experiences. This trend is evident in: +· The emergence of virtual marketplaces where users +can trade digital assets and purchase real world goods; +· The incorporation of AR and VR technologies in +retail, entertainment, and other industries, providing immersive, interactive experiences that blur the lines between the digital and +physical realms; and +· The development of virtual environments that +replicate real world locations, allowing users to explore and interact with digital versions of familiar places. +Virtual Economies and Markets +The metaverse industry is +witnessing the rise of virtual economies and markets, where users can trade digital assets, such as virtual real estate, digital art, +and unique collectibles. Key factors driving this trend include: +· The increasing acceptance and adoption of cryptocurrencies +and blockchain technology, enabling secure, transparent transactions in digital markets; +· Growing interest in non-fungible tokens (“NFT’s”) +and digital collectibles, which has led to the creation of new marketplaces and trading platforms for these assets; and +· The realization of the potential for virtual +goods to hold and accrue value over time, leading to increased investment and speculation in digital markets. +Socialization and Community Building in Digital +Spaces +The importance of socialization +and community building in digital spaces is another significant trend in the metaverse industry. As users spend more time in virtual environments, +platforms are placing a greater emphasis on fostering connections and interactions among users. This trend can be observed in: +· The creation of social hubs, virtual events, +and gatherings designed to bring users together and encourage networking, collaboration, and communication; +· The integration of social media and messaging +features within metaverse platforms, allowing users to stay connected with friends and communities while exploring virtual worlds; and +· The development of user-generated content and +customization tools, empowering users to create unique experiences and contribute to the growth and expansion of the metaverse. +The metaverse industry is +experiencing rapid growth and transformation, driven by technological advancements, increased user adoption, and the emergence of virtual +economies and markets. As the industry continues to evolve, it will be essential that BNC stay informed of key trends and driving forces +shaping the future of the metaverse landscape, and adapt to those trends as they arise. +Competition in the Metaverse Industry +The metaverse industry is +becoming increasingly competitive as more companies and platforms emerge to capitalize on the growing interest in virtual experiences +and digital economies. +26 +Key Players in the Metaverse Industry +The metaverse industry features +an eclectic mix of established technology companies, gaming giants, and innovative startups, each bringing unique offerings and perspectives +to the market. Some of the key players in the industry include: +· Meta (formerly Facebook): With its ambitious +plans for the metaverse and significant investments in VR technology, Meta is a major player in the industry. The company’s Oculus +platform and Horizon Workrooms are prime examples of its commitment to shaping the future of the metaverse; +· Epic Games: The creator of the popular game Fortnite, +Epic Games has made significant strides in the metaverse space by developing the Unreal Engine, a powerful platform for creating virtual +worlds and experiences; +· Roblox Corporation: Roblox has successfully created +a user-generated content platform that allows millions of players to create, share, and engage in virtual experiences, making it a significant +player in the metaverse landscape; and +· Linden Lab: As the creator of Second Life, one +of the earliest and most successful virtual worlds, Linden Lab has a long history in the metaverse industry and continues to evolve and +expand its offerings. +Market Segments and Niches +The metaverse industry can +be broadly divided into several market segments and niches, each catering to different user needs and preferences: +· Gaming-focused metaverse platforms: These platforms, +such as Fortnite and Roblox, primarily cater to gamers and offer a wide range of gaming experiences and social interaction opportunities +within virtual environments; +· VR and AR platforms: Companies like Meta and +Microsoft focus on developing hardware and software solutions to enable immersive VR and AR experiences, driving the adoption of these +technologies in the metaverse; +· Social and community-driven metaverse platforms: +Platforms like Second Life and BNC emphasize socialization, community building, and user-generated content, fostering connections and +collaboration among users; and +· NFT and digital asset marketplaces: These platforms, +such as OpenSea and Decentraland, facilitate the trading of digital assets like virtual real estate, digital art, and unique collectibles, +contributing to the growth of virtual economies. +Differentiating Factors +With the increasing competition +in the metaverse industry, it is crucial for platforms to differentiate themselves by offering unique features, experiences, or technologies. +Some potential differentiating factors include: +· Seamless integration of virtual and real world +experiences: Platforms that successfully bridge the gap between the digital and physical realms, allowing users to easily transition between +the two, are likely to stand out in the competitive landscape; +· Innovative and user-friendly technology: Companies +that prioritize cutting-edge technology and deliver a seamless, intuitive user experience will have a competitive edge in the metaverse +market; +· Personalization and customization: Platforms +that empower users to create and customize their own experiences, environments, and avatars are likely to appeal to a broader audience +and foster greater user engagement; and +· Diverse offerings and experiences: Platforms +that cater to a wide range of interests and preferences, such as gaming, shopping, socializing, and trading digital assets, can attract +a more extensive and diverse user base. +The metaverse industry is +characterized by a competitive landscape with numerous players, market segments, and niches. To succeed in this rapidly evolving market, +companies must continuously innovate and differentiate themselves by offering unique features, experiences, and technologies that cater +to the diverse needs and preferences of users. +Regulatory Environment: Present and Future +Challenges +As the metaverse industry +continues to grow and evolve, regulatory challenges and considerations are becoming increasingly important. The unique nature of the metaverse, +which often combines elements of virtual reality, gaming, social networking, and digital economies, presents a complex landscape for regulators +to navigate. +27 +Present Regulatory Challenges +The metaverse industry is +currently grappling with several regulatory challenges, including: +· Data Privacy and Security: As users share personal +information and engage in transactions within the metaverse, concerns about data privacy and security are paramount. Regulators must ensure +that platforms adhere to existing data protection regulations, such as the General Data Protection Regulation (“GDPR”) and +the California Consumer Privacy Act (“CCPA”); +· Intellectual Property Rights: The metaverse’s +reliance on user-generated content and digital assets raises questions about intellectual property rights and the enforcement of copyright, +trademark, and patent laws in virtual environments; +· Taxation and Financial Regulations: The growth +of virtual economies and the increasing popularity of cryptocurrencies and NFT’s have raised questions about taxation and financial +regulations. Regulators must determine how to classify and tax digital assets and transactions, as well as ensure compliance with anti-money +laundering and know-your-customer regulations; and +· Content Moderation and Liability: Metaverse platforms +face challenges in moderating content and managing user behavior, raising questions about the platforms’ liability for user-generated +content and potential violations of existing laws, such as those related to hate speech, harassment, and misinformation. +Future Regulatory Challenges +As the metaverse industry +continues to develop and expand, several future regulatory challenges are likely to emerge, including: +· Cross-border jurisdictional issues: With the +metaverse being a global, borderless environment, determining jurisdiction and applying national laws to activities and transactions within +the metaverse will become increasingly complex; +· Virtual reality and augmented reality regulations: +As VR and AR technologies become more integrated into the metaverse, new regulations may be needed to address issues related to safety, +privacy, and ethical considerations in the use of these technologies +· Decentralization and governance: The increasing +trend towards decentralized metaverse platforms raises questions about governance and regulatory oversight, as traditional regulatory +mechanisms may not be applicable or effective in these environments; and +· Ethics and inclusivity: As the metaverse becomes +more intertwined with daily life, ethical considerations related to inclusivity, accessibility, and the potential for digital divides +will become increasingly important for regulators to address. +Ault Iconic +Ault +Iconic, formerly known as Ault Media Group is comprised of a diverse team of media professionals with expertise in creating all forms +of media, communications, and content including web development, corporate communications, social media, scripted, and unscripted television. +Our online virtual training courses (via the LightSpeedVT platform) also offer in-depth business learning. Ault Iconic’s specialized +team of producers brings years of university-proven training methods and a history of developing educational materials up to a master’s +degree level. Ault Iconic’s first course, relating to initial public offerings, is currently in the final stages of production, +with more courses soon to follow. +Along +with training and communications strategies, Ault Iconic also offers comprehensive consulting for the development and execution of large +and small scale conferences and event planning. From event space acquisition to digital ticketing, keynote speakers, lighting, stage crews, +and advertising media buys, Ault Iconic will provide the necessary contacts and guidance to assure a successful and smooth-running event. +AGREE +AGREE seeks to invest in various +classes of commercial and residential real estate including hospitality, multifamily, and industrial properties targeting the middle market +segment in locations demonstrating relative value. AGREE’s objective is to generate risk adjusted returns through development, capital +investment and operational improvement, leveraging the management team’s expertise and well-established relationships with real +estate investment professionals, brokers, lenders and developers. The focus will be in U.S. tertiary markets with growing populations, +income growth and access to highly populated metropolitan areas as primary demand drivers. AGREE is one of BitNile’s strategies +to invest in inflation-resistant undervalued assets and realize capital appreciation through cap rate compression over time. AGREE owns +and operates both Third Avenue Apartments and AGREE Madison. +28 +Circle 8 +On +December 19, 2022, Circle 8 closed on the asset purchase agreement with Circle 8 Crane Services pursuant to which Circle 8 agreed to purchase +substantially all of the assets and assume certain specified liabilities of Circle 8 Crane Services. Circle 8 Crane Services was +a crane rental and lifting solutions provider founded in 2007 and headquartered in Corpus Christi, TX with multiple locations throughout +the South-Central region of the U.S. It maintains a large modern fleet of mobile cranes for its customers’ heavy lifting needs. +Specifically, Circle 8 provides crane operators, engineering, custom rigging and transportation services for oilfield, construction, commercial +and infrastructure markets. Circle 8 maintains an industry leading safety record. +Our +Strategy +Our business strategy is designed +to increase shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +shareholder value, such as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase +cash flows and stockholder value. Ault Alliance actively oversees and supports the management teams of each of our businesses by, among +other things: +● recruiting and retaining talented managers to operate our businesses using structured incentive compensation +programs, including non-controlling equity ownership, tailored to each business; +● regularly monitoring financial and operational performance, instilling consistent financial discipline, +and supporting management in the development and implementation of information systems to effectively achieve these goals; +● identifying and aligning with external policy and performance tailwinds such as those influenced by growing +climate, health, and social justice concerns (and similar environmental, social and governance (“ESG”) drivers); +● assisting management in their analysis and pursuit of prudent organic growth strategies; +● identifying and working with management to execute attractive external growth and acquisition opportunities; +● assisting management in controlling and right-sizing overhead costs; +● nurturing an internal culture of transparency, alignment, accountability and governance, including regular +reporting; +● professionalizing our subsidiaries at scale; and +● forming strong subsidiary level boards of directors to supplement management in their development and +implementation of strategic goals and objectives. +29 +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Ault Alliance to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +● making selective capital investments to expand geographic reach, increase capacity, or reduce manufacturing +costs of our businesses; +● investing in product research and development for new products, processes or services for customers; +● improving and expanding existing sales and marketing programs; +● pursuing reductions in operating costs through improved operational efficiency or outsourcing of certain +processes and products; and +● consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +● leverage manufacturing and distribution operations; +● leverage branding and marketing programs, as well as customer relationships; +● add experienced management or management expertise; +● increase market share and penetrate new markets; and +● realize cost synergies by allocating the corporate overhead expenses of our businesses across a larger +number of businesses and by implementing and coordinating improved management practices. +Acquisition Strategy +Our +acquisition strategy is to acquire businesses that we believe to be to undervalued and have disruptive technologies with a global impact +that we expect to produce stable and growing earnings and cash flow. In this respect, we expect to make acquisitions in industries other +than those in which our businesses currently operate if we believe an acquisition presents an attractive opportunity. We believe that +attractive opportunities will continue to present themselves, as private sector owners seek to monetize their interests in long-standing +and privately held businesses and large corporate parents seek to dispose of their “non-core” operations. +Our +ideal acquisition candidate has the following characteristics: +● is a leading branded consumer or niche industrial company headquartered in North America; +● maintains highly defensible position in the markets it serves and with customers; +● operates in an industry with favorable long-term macroeconomic trends; +● has a strong management team, either currently in place or previously identified, and meaningful incentives; +● has low technological and/or product obsolescence risk; and +● maintains a diversified customer and supplier base. +We +benefit from Ault Alliance’s ability to identify potential diverse acquisition opportunities in a variety of industries. In addition, +we rely upon our Executive Committee and other members of our management team’s experience and expertise in researching and valuing +prospective target businesses, as well as negotiating the ultimate acquisition of such target businesses. In particular, because there +may be a lack of information available about these target businesses, which may make it more difficult to understand or appropriately +value such target businesses, Ault Alliance: +● engages in a substantial level of internal and third-party due diligence; +● critically evaluates the target management team; +● identifies and assesses any financial and operational strengths and weaknesses of the target business; +● analyzes comparable businesses to assess financial and operational performances relative to industry competitors; +● actively researches and evaluates information on the relevant industry; and +● thoroughly negotiates appropriate terms and conditions of any acquisition. +30 +The +process of acquiring new businesses is both time-consuming and complex. Our management team historically has taken from two to +six months to perform due diligence, negotiate and close acquisitions. Although our management team is at various stages of evaluating +several transactions at any given time, there may be periods of time during which our management team does not recommend any new acquisitions. +Even if an acquisition is recommended by our management team, our Board may not approve it. +A +component of our acquisition financing strategy that we utilize in acquiring the businesses we own and manage is to provide both equity +capital and debt capital. We believe, and it has been our experience, that having the ability to finance our acquisitions with capital +resources raised by us, rather than negotiating separate third-party financing, provides us with an advantage in successfully acquiring +attractive businesses by minimizing delay and closing conditions that are often related to acquisition-specific financings. In addition, +our strategy of providing this intercompany debt financing within the capital structure of the businesses we acquire and manage allows +us the ability to distribute cash to the parent company through monthly interest payments and amortization of principle on these intercompany +loans. +Upon +acquisition of a new business, we rely on our management team’s experience and expertise to work efficiently and effectively with +the management of the new business to jointly develop and execute a successful business plan. +Strategic Advantages +Based +on the experience of our management team and its ability to identify and negotiate acquisitions, we believe we are well-positioned to +acquire additional businesses. Our management team has strong relationships with business brokers, investment and commercial bankers, +accountants, attorneys and other potential sources of acquisition opportunities. In addition, our management team has a successful track +record of acquiring and managing businesses in various industries. In negotiating these acquisitions, we believe our management team has +been able to successfully navigate complex situations surrounding acquisitions, including corporate spin-offs, transitions of family-owned +businesses, management buy-outs and reorganizations. +Our management team has a +large ne twork of deal interme diaries whom we expect to expose us to potential acquisitions. +Through this network, as well as our management team’s proprietary transaction sourcing efforts, we have a substantial pipeline +of potential acquisition targets. Our management team also has a well-established network of contacts, including professional managers, +attorneys, accountants and other third-party consultants and advisors, who may be available to assist us in the performance of due diligence +and the negotiation of acquisitions, as well as the management and operation of our acquired businesses. +Valuation and Due Diligence +When +evaluating businesses or assets for acquisition, our management team performs rigorous due diligence and a financial evaluations process +including an evaluation of the operations of the target business and the outlook for its industry. While valuation of a business is a +subjective process, we define valuations under a variety of analyses, including: +● discounted cash flow analyses; +● evaluation of trading values of comparable companies; +● expected value matrices; and +● examination of comparable recent transactions. +One +outcome of this process is a projection of the expected cash flows from the target business. A further outcome is an understanding of +the types and levels of risk associated with those projections. While future performance and projections are always uncertain, we believe +that with detailed due diligence, future cash flows will be better estimated and the prospects for operating the business in the future +better evaluated. To assist us in identifying material risks and validating key assumptions in our financial and operational analysis, +in addition to our own analysis, we engage, as necessary, third-party experts to review key risk areas, including legal, tax, regulatory, +accounting, insurance and environmental. We also engage technical, operational or industry consultants, as necessary. +A further critical component of the evaluation +of potential target businesses is the assessment of the capability of the existing management team, including recent performance, expertise, +experience, culture and incentives to perform. Where necessary, and consistent with our management strategy, we actively seek to augment, +supplement or replace existing members of management who we believe are not likely to execute our business plan for the target business. +Similarly, we analyze and evaluate the financial and operational information systems of target businesses and, where necessary, we enhance +and improve those existing systems that are deemed to be inadequate or insufficient to support our business plan for the target business. +31 +Financing +We +incur third party debt financing almost entirely at the parent company level, which we use, in combination with our equity capital, to +provide debt financing to each of our businesses and to acquire additional businesses. We believe this financing structure is beneficial +to the financial and operational activities of each of our businesses by aligning our interests as both equity holders of, and lenders +to, our businesses, in a manner that we believe is more efficient than each of our businesses borrowing from third-party lenders. +Compliance with Material Government (Including +Environmental) Regulations +ACS +ACS is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. ACS continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While ACS’s regulatory compliance costs +are currently not considered material, it is reasonably possible that costs incurred to ensure continued environmental compliance could +have a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Facility is subject to +a final corrective measures plan with the Environment Protection Agency. The seller performed remedial activities at the Facility relating +to historical soil and groundwater contamination and ACS is responsible for ongoing monitoring and final remediation plans. We estimate +cost of the environmental remediation obligation is approximately $0.4 million and reflects our best estimate of probable future costs +for remediation based on the current assessment data and regulatory obligations. Future costs will depend on many factors, including the +extent of work necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. We may incur +actual costs in the future that are materially different than this estimate and such costs could have a material impact on results of +operations, financial condition, and cash flows during the period in which they are recorded. +TurnOnGreen +TurnOnGreen’s businesses +are heavily regulated in most of its markets. TurnOnGreen handles power electronics products mainly in the form of power conversion. TurnOnGreen +must take into account several standards for electronic safety to protect the health of humans and animals. TurnOnGreen serves diverse +markets including automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set +of their safety regulations and standard that TurnOnGreen must comply with. +Government Contracts . +The U.S. Government, and other governments, may terminate any of TurnOnGreen’s government contracts at their convenience, as well +as for default based on our failure to meet specified performance requirements. If any of TurnOnGreen’s U.S. Government contracts +were to be terminated for convenience, TurnOnGreen would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of TurnOnGreen’s government contracts were to be terminated for default, generally the U.S. Government +would pay only for the work that has been accepted and could require TurnOnGreen to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold +TurnOnGreen liable for damages resulting from the default. +Medical device power supplies . +TurnOnGreen’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. TurnOnGreen must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +Environmental . TurnOnGreen +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TurnOnGreen continually assesses its compliance status +and management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of TurnOnGreen’s operations. +32 +Non-U.S. Sales . TurnOnGreen’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +GIGA +GIGA’s businesses are +heavily regulated in most of its markets. GIGA transacts with numerous U.S. Government agencies and entities, including but not limited +to the U.S. Department of Defense (“DoD”), branches of the U.S. military and the Department of Homeland Security. Similar +government authorities exercise similar regulatory oversight in GIGA’s non-U.S. markets. +Government Contracts . +The governments of the U.S., U.K. and Israel may terminate any of GIGA’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of GIGA’s contracts for convenience, GIGA generally would be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of GIGA’s government contracts were to be terminated for default, generally the U.S. government would +pay only for the work that has been accepted and could require GIGA to pay the difference between the original contract price and the +cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold GIGA liable +for damages resulting from the default. Similar provisions apply to GIGA’s contracts with other governments and to GIGA’s +subcontractors with major defense contractors who provide systems or military platforms directly to the government. +Power Electronics . +In all of GIGA’s markets in the U.S., GIGA’s commercial power electronics offerings must comply with safety, energy use and +operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. In +the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the U.K., Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, GIGA’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . GIGA +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies, or as applicable +local regulations or laws require. The products that GIGA markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of +certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, GIGA’s industry began phasing in RoHS +and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. GIGA believes that RoHS and WEEE-compliant +components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. REACH (Registration, +Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 December 2006. REACH +addresses the production and use of chemical substances, and their potential impacts on both human health and the environment. +These regulatory mandates +apply to all of GIGA’s operating subsidiaries. GIGA has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +Non-U.S. Sales . GIGA’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Security Clearance +As a U.S. Government contractor +working on classified projects, Microphase is required to maintain facility and personnel security clearances complying with the DoD and +other federal agency requirements. Microphase maintains strict protocols for handling classified information and Confidential Unclassified +Information (“CUI”) associated with its work for the DoD and has built a secure restricted area within its Shelton production +facility certified for generating, storing and reviewing classified information. +33 +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the U.K. Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “DCAA”), +the Defense Contract Management Agency (the “DCMA”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the DOJ and Congressional Committees. From time-to-time, these and other agencies investigate or +conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. The +DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the Ministry of Defense does most of +its business. All its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +the U.K. Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the +customer the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government +and typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified information and CUI from disclosure and unauthorized access. That mandate includes a requirement that +Microphase formulate and implement a system security plan with 110 different elements and protocols for handling and protecting classified +information and CUI. Over the next three years, the DoD will require all participants in the defense supply chain to demonstrate compliance +with the Capability Model Maturity Cybersecurity as verified through an independent third-party auditor. Compliance with these mandates +requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance requires extensive +security controls on access to Microphase information technology systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Plus Compliant.” Cyber Essentials Plus is a government-backed, industry-supported +scheme to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials Plus program criteria. +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +34 +Research and Development +During the years ended December +31, 2022 and 2021, we spent approximately $2.8 million and $2.0 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries and others operate in industries deemed essential by the DoD and therefore remained +at work during the COVID-19 pandemic. +Employee Profile +As of December 31, 2022, we +had 615 employees located in the U.S., the U.K. and Israel, of whom 83 were engaged in engineering and product development, 46 in sales +and marketing, 386 in general operations and 100 in general administration and finance. All but 17 of these employees are employed on +a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be +good. +As of December 31, 2021, approximately +33% of our current workforce is female, 67% male, and our average tenure is 7.7 years, an increase of 24% from an average tenure +of 6.2 years as of December 31, 2020. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of 7.7 years as +of the end of the fiscal year 2022 reflects the engagement of our employees in this core talent system tenet. +The Company believes it materially +complies with all applicable state, local and international laws governing nondiscrimination in employment in every location in which +the Company operates. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, +religion, national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran +status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees' needs. We plan to conduct annual confidential employee surveys +as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. Our +employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new stretch +goals. +35 +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021 and plan to establish a Company-wide augmented employee stock purchase plan in 2022. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +In response to the COVID-19 pandemic, we implemented significant operating environment changes that we determined were in the best interest +of our employees, as well as the communities in which we operate, and which comply with government regulations. This includes having a +significant portion of our employees work from home, while implementing additional safety measures for employees continuing critical on-site +work. +36 \ No newline at end of file diff --git a/raw/filings/0000896493/2022/0001214659-23-005525/item13.txt b/raw/filings/0000896493/2022/0001214659-23-005525/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..f970d95b83df8e713569066b7ed516062e505355 --- /dev/null +++ b/raw/filings/0000896493/2022/0001214659-23-005525/item13.txt @@ -0,0 +1,100 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• the aggregate amount involved is determined to by the Audit Committee to be material; +• we are a participant; and +• any of the following has or will have a direct or indirect interest in the transaction: +• an executive officer, director, or nominee for election as a director; +• a greater than five percent beneficial owner of our common stock; or +• any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company. +Avalanche +On September 6, 2017, we entered +into the AVLP Loan Agreement with an effective date of August 21, 2017 pursuant to which we provided Avalanche a non-revolving credit +facility. The AVLP Loan Agreement has been increased to up to $20.0 million and extended to December 31, 2023. Until recently, we held +a convertible note issued to us by AVLP in the amount of $20.0 million (the “Prior AVLP Note”). +At December 31, 2021, we had +provided Avalanche with $17.8 million and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase +35.6 million shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets +of AVLP. As of December 31, 2021, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and +a provision for loan losses of $2.0 million. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 35.6 million shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +While +Avalanche received funds from a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of +a convertible promissory note to such third party (the “Third Party Note”), $2.7 million was used to pay an outstanding receivable +due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, Ault Alpha, +an affiliate of ours, repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. +In consideration therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note had a maturity +date of June 30, 2022. +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for a 10% senior secured convertible note in the principal face amount of $3.8 million due June +15, 2024 (the “Ault Alpha Note”). The Ault Alpha Note is convertible, subject to adjustment, at $0.50 per share. AVLP also +issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise price of $0.50. Pursuant +to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the +foregoing parties, our company and certain other persons, Ault Alpha has a second priority interest in AVLP’s assets securing the +repayment of the Ault Alpha Note. +On July 11, 2022, AVLP issued +us a 10% senior secured convertible note in the principal face amount of $3.0 million due July 10, 2024 (the “AVLP Note”). +The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an aggregate of 41.0 +million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into by Avalanche and +Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and certain other persons, +we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +On June 1, 2022, we converted +the entire principal and accrued interest on the Prior AVLP Note into an aggregate of 51.9 million shares of common stock of Avalanche, +representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. There is currently no liquid market +for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common stock on the open market, our ability +to do so would be severely limited. Avalanche is not current in its filings with the Commission and is not required to register the shares +of its common stock underlying the Prior AVLP Note or any other loan arrangement we have made with Avalanche described above. +134 +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is an affiliate +of our company. See immediately above for its involvement with respect to the Third Party Note. As of December 31, 2022, Ault Alpha had +purchased 50 million shares of our common stock at an average price of $0.55. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. Bentz +Yes +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairman of committee +X – Member of committee \ No newline at end of file diff --git a/raw/filings/0000896493/2022/0001214659-23-005525/item9a.txt b/raw/filings/0000896493/2022/0001214659-23-005525/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..95253de217da74f9b1c11460c718e5a5a7952fb5 --- /dev/null +++ b/raw/filings/0000896493/2022/0001214659-23-005525/item9a.txt @@ -0,0 +1,88 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2022, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, have +evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) +and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our disclosure +controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records +that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide +reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2022. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2022, our internal control over financial reporting was not effective. +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting department, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting, fair value estimates and analysis of financial instruments for proper classification in the consolidated financial statements, +in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +3. Our primary user access controls (i.e., provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +120 +4. The Company did not design and/or implement user access controls to ensure appropriate segregation of +duties or program change management controls for certain financially relevant systems impacting the Company’s processes around revenue +recognition and digital assets to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, and (iii) underlying accounting records, are identified, tested, authorized and implemented appropriately +to validate that data produced by its relevant IT system(s) were complete and accurate. Automated process-level controls and manual controls +that are dependent upon the information derived from such financially relevant systems were also determined to be ineffective as a result +of such deficiency. In addition, the Company has not effectively designed a manual key control to detect material misstatements in revenue. +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis: +· Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls; +· Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· Continuing to increase headcount across the Company, with a particular focus on hiring individuals with +strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Control over Financial Reporting +During the most recent fiscal +quarter 2022 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) +and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over +financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2022/0001214659-23-005525/rp_note.txt b/raw/filings/0000896493/2022/0001214659-23-005525/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..881de0af5363a2afdb52aa3c0eaa14d1727876a5 --- /dev/null +++ b/raw/filings/0000896493/2022/0001214659-23-005525/rp_note.txt @@ -0,0 +1,170 @@ +13. INVESTMENTS – RELATED PARTIES +Investments in Ault & +Company, Inc. (“Ault & Company”) at December 31, 2022 and 2021, were comprised of the following: +Schedule of investment +Interest +Due +December 31, +December 31, +Rate +Date +2022 +2021 +Promissory note, related party +8 % +Dec. 31, 2023 +$ 2,500,000 +$ 2,500,000 +Accrued interest receivable, related party +368,000 +170,000 +Other +- +172,000 +Total investment in promissory notes and other, related parties – gross +$ 2,868,000 +$ 2,842,000 +The Company recorded related +party interest income of $ 0.2 million for each of the years ended December 31, 2022 and 2021 in interest income. +Investment in Common Stock, Related Parties +December 31, +December 31, +2022 +2021 +Total investment in common stock of Alzamend +$ 6,449,000 +$ 13,230,000 +The following table summarizes +the changes in the Company’s investments in Alzamend during the years ended December 31, 2022 and 2021: +Schedule of investment in warrants and common stock +Investment in +common stock of +Alzamend +Investment in +promissory notes and +advances of Alzamend +Balance at January 1, 2021 +$ 653,000 +$ 796,000 +Alzamend note and advances converted into common stock +- +( 800,000 ) +Investment in common stock of Alzamend +18,181,000 +- +Unrealized loss in common stock of Alzamend +( 5,604,000 ) +- +Accretion of discount +- +4,000 +Balance at December 31, 2021 +13,230,000 +- +Investment in common stock of Alzamend +4,901,000 +- +Alzamend stock received for marketing services +989,000 +- +Unrealized loss in common stock of Alzamend +( 12,671,000 ) +- +Balance at December 31, 2022 +$ 6,449,000 +$ - +F- 33 +Investments in +Alzamend Common Stock +The +following table summarizes the changes in the Company’s investments in Alzamend common stock during the year ended December 31, +2021: +Schedule of investment of common stock +Shares of +Per Share +Investment in +Common Stock +Price +Common Stock +Balance at January 1, 2021 +428,000 +$ 1.50 +$ 642,000 +Purchase of shares from an Alzamend shareholder +62,000 +$ 0.81 +50,000 +March 9, 2021 securities purchase agreement* +4,000,000 +$ 1.50 +6,000,000 +Investment in Alzamend initial public offering +2,000,000 +$ 5.00 +10,000,000 +Open market purchases after initial public offering +457,000 +$ 4.67 +2,132,000 +Unrealized loss in common stock of Alzamend +( 5,625,000 ) +Investment in Alzamend common stock +6,947,000 +$ 1.90 +13,199,000 +Investment in Alzamend options +31,000 +Balance at December 31, 2021 +$ 13,230,000 +The +following table summarizes the changes in the Company’s investments in Alzamend common stock during the year ended December 31, +2022: +Shares of +Per Share +Investment in +Common Stock +Price +Common Stock +Balance at January 1, 2022 +6,947,000 +$ 1.90 +$ 13,230,000 +March 9, 2021 securities purchase agreement* +2,667,000 +$ 1.50 +4,000,000 +Alzamend stock received for marketing services +933,000 +$ 1.06 +989,000 +Open market purchases after initial public offering +868,000 +$ 1.04 +901,000 +Unrealized loss in common stock of Alzamend +( 12,671,000 ) +Investment in Alzamend common stock +11,415,000 +$ 0.56 +$ 6,449,000 +* Pursuant to the March 9, 2021 securities purchase agreement, in aggregate, +Alzamend agreed to sell up to 6,666,667 shares of its common stock to Ault Lending for $10.0 million, or $1.50 per share, and issue +to Ault Lending warrants to acquire 3,333,334 shares of Alzamend common stock with an exercise price of $3.00 per share. As of +December 31, 2022, Ault Lending had funded the full $10.0 million. +Alzamend Marketing and Brand Development +Services Agreement +On November 1, 2022, the Company +entered into a contract with Alzamend, a related party, to provide marketing and brand development services. The contract is effective +as of August 1, 2022, for a period of one year. The parties to the contract approved the contract on November 1, 2022, which is considered +contract inception. +Alzamend issued 933,334 shares +of its common stock to satisfy payment under the contract. +As the transaction consideration +received by the Company is non-cash consideration in the form of shares of Alzamend common stock, changes in the fair value of the non-cash +consideration due to form of the consideration (changes in the market price of Alzamend stock) are not included in the transaction price +and therefore, are not included in revenue. +The Company will recognize +revenue of approximately $ 1.0 million over the period from contract inception to the end of the contract term based on the number of shares +received and the trading price of Alzamend stock at contract inception. As of December 31, 2022, the Company has recognized approximately +$ 0.2 million in related party revenue and recorded $ 0.8 million as a contract liability related to this agreement. +F- 34 \ No newline at end of file diff --git a/raw/filings/0000896493/2022/0001214659-23-005525/rpt_disclosure.txt b/raw/filings/0000896493/2022/0001214659-23-005525/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..f970d95b83df8e713569066b7ed516062e505355 --- /dev/null +++ b/raw/filings/0000896493/2022/0001214659-23-005525/rpt_disclosure.txt @@ -0,0 +1,100 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• the aggregate amount involved is determined to by the Audit Committee to be material; +• we are a participant; and +• any of the following has or will have a direct or indirect interest in the transaction: +• an executive officer, director, or nominee for election as a director; +• a greater than five percent beneficial owner of our common stock; or +• any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. Milton C. Ault, III, who is our Executive +Chairman, is also the Chief Executive Officer of Ault & Company. +Avalanche +On September 6, 2017, we entered +into the AVLP Loan Agreement with an effective date of August 21, 2017 pursuant to which we provided Avalanche a non-revolving credit +facility. The AVLP Loan Agreement has been increased to up to $20.0 million and extended to December 31, 2023. Until recently, we held +a convertible note issued to us by AVLP in the amount of $20.0 million (the “Prior AVLP Note”). +At December 31, 2021, we had +provided Avalanche with $17.8 million and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase +35.6 million shares of AVLP common stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets +of AVLP. As of December 31, 2021, we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and +a provision for loan losses of $2.0 million. The warrants issued in conjunction with the non-revolving credit facility entitles us to +purchase up to 35.6 million shares of Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise +price of $0.50 is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The warrants may +be exercised for cash or on a cashless basis. +While +Avalanche received funds from a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of +a convertible promissory note to such third party (the “Third Party Note”), $2.7 million was used to pay an outstanding receivable +due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, Ault Alpha, +an affiliate of ours, repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. +In consideration therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note had a maturity +date of June 30, 2022. +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for a 10% senior secured convertible note in the principal face amount of $3.8 million due June +15, 2024 (the “Ault Alpha Note”). The Ault Alpha Note is convertible, subject to adjustment, at $0.50 per share. AVLP also +issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise price of $0.50. Pursuant +to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the +foregoing parties, our company and certain other persons, Ault Alpha has a second priority interest in AVLP’s assets securing the +repayment of the Ault Alpha Note. +On July 11, 2022, AVLP issued +us a 10% senior secured convertible note in the principal face amount of $3.0 million due July 10, 2024 (the “AVLP Note”). +The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an aggregate of 41.0 +million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into by Avalanche and +Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and certain other persons, +we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +On June 1, 2022, we converted +the entire principal and accrued interest on the Prior AVLP Note into an aggregate of 51.9 million shares of common stock of Avalanche, +representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. There is currently no liquid market +for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common stock on the open market, our ability +to do so would be severely limited. Avalanche is not current in its filings with the Commission and is not required to register the shares +of its common stock underlying the Prior AVLP Note or any other loan arrangement we have made with Avalanche described above. +134 +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is an affiliate +of our company. See immediately above for its involvement with respect to the Third Party Note. As of December 31, 2022, Ault Alpha had +purchased 50 million shares of our common stock at an average price of $0.55. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. 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+us-gaap:SubsequentEventMember +us-gaap:SeriesAPreferredStockMember +2024-03-01 +2024-03-26 +0000896493 +us-gaap:SubsequentEventMember +2024-04-01 +2024-04-15 +iso4217:USD +xbrli:shares +iso4217:USD +xbrli:shares +xbrli:pure +UNITED STATES SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x ANNUAL +REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the Fiscal Year Ended December 31 , 2023 +or +¨ +TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For +the transition period from _____________ to ________________ +Commission file number 1-12711 +AULT ALLIANCE, INC. +(Exact name of registrant as specified in its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +11411 Southern Highlands Pkwy , Suite 240 , +Las Vegas , NV +89141 +(949) 444-5464 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) +of the Act: +Title of each class +Trading symbol(s) +Name of each exchange on which registered +Common Stock, $0.001 par value per share +AULT +NYSE American +13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, par value $0.001 per share +AULT PRD +NYSE American +Securities registered pursuant to Section 12(g) +of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No +þ +Indicate +by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange +Act. Yes ¨ No +þ +Indicate +by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities +Exchange Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file such reports), and +(2) has been subject to such filing requirements for the past 90 days. Yes þ No +¨ +Indicate +by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule +405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant +was required to submit such files). Yes þ No +¨ +Indicate by check mark whether the registrant +is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. +See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” +and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ¨ +Accelerated filer ¨ +Non-accelerated filer þ +Smaller reporting company þ +Emerging growth company ¨ +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying +with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ +Indicate +by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of +its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public +accounting firm that prepared or issued its audit report. ¨ +If securities are registered pursuant to Section +12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction +of an error to previously issued financial statements. ¨ +Indicate by check mark whether any of those error +corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s +executive officers during the relevant recovery period pursuant to §240.10D-1(b). ¨ +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No +þ +As of June 30, 2023, the aggregate market value +of the registrant’s common stock held by non-affiliates of the registrant was $ 6.3 million based on the closing sale price +as reported on the NYSE American of $118.7151. Shares of the registrant’s common stock held by executive officers, directors +or 10% beneficial owners and by each other person who may be deemed to be an affiliate of the registrant have been excluded from this +computation. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose. +There were 30,065,399 +shares of common stock outstanding as of April 15, 2024. +Documents incorporated by reference: None +AULT ALLIANCE, INC. AND +SUBSIDIARIES +FORM 10-K +FOR THE FISCAL YEAR ENDED DECEMBER 31, 2023 +INDEX +Page +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +46 +Item 1B. +Unresolved Staff Comments +114 +Item 1C. +Cybersecurity +114 +Item 2. +Properties +115 +Item 3. +Legal Proceedings +116 +Item 4. +Mine Safety Disclosures +116 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +117 +Item 6. +Reserved +118 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +118 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +134 +Item 8. +Financial Statements and Supplementary Data +F-1 – F-53 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +134 +Item 9A. +Controls and Procedures +135 +Item 9B. +Other Information +137 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +137 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +138 +Item 11. +Executive Compensation +144 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +151 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +153 +Item 14. +Principal Accountant Fees and Services +161 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +162 +Item 16. +Form 10-K Summary +164 +Signatures +165 +CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “Annual +Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of +the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. We have +attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” +“can,” “continue,” “could,” “estimates,” “expects,” “intends,” +“may,” “plans,” “potential,” “predict,” “should” or “will” or +the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties and other factors may +cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels or +activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations +reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Our expectations are as of the date this Annual Report is filed, and we do not intend to update any of the forward-looking statements +after the date this Annual Report is filed to confirm these statements to actual results, unless required by law. +This Annual Report also contains estimates and +other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves +a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified +the statistical and other industry data generated by independent parties and contained in this Annual Report and, accordingly, we cannot +guarantee their accuracy or completeness, though we do generally believe the data to be reliable. In addition, projections, assumptions +and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a +high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere +in this Annual Report. These and other factors could cause results to differ materially from those expressed in the estimates made by +the independent parties and by us. +RISK FACTOR SUMMARY +Below +is a summary of the principal factors that make an investment in our common stock speculative. This summary does not address all of the +risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found +below under the heading “Risk Factors” and should be carefully considered, together with other information in this Annual +Report and our other filings with the SEC before making investment decisions regarding our common stock. +· We will need to raise additional capital to fund our operations in furtherance +of our business plan. +· We have an evolving business model, which increases the complexity of our +business. +· Our Bitcoin mining operations present a number of risks, which are delineated +in the Risk Factors section. +· We are highly reliant on the price of Bitcoin and the level of demand for, +and financial performance of, the crypto-currency industry. +· Our holding company model presents certain additional risks, which are delineated +in the Risk factors section. +· Our growth strategy is subject to a significant degree of risk. +· We are heavily dependent on our senior management, and a loss of a member +of our senior management team could cause our stock price to suffer. +· If we fail to anticipate and adequately respond to rapid technological changes +in our industry, including evolving industry-wide standards, in a timely and cost-effective manner, our business, financial condition +and results of operations would be materially and adversely affected. +· We are subject to risks related to governmental +regulation and enforcement with respect to Bitcoin mining, including: +◦ Regulatory changes or actions may restrict the use of bitcoins or the operation of the Bitcoin network +in a manner that adversely affects an investment in our securities; +◦ Due to the unregulated nature and lack of transparency surrounding the operations of many bitcoin trading +venues, they may experience fraud, security failures or operational problems, which may adversely affect the value of our bitcoin; +◦ If regulatory changes or interpretations require the regulation of bitcoins under the Securities Act and +the Investment Company Act of 1940, as amended (the “Investment Act”) by the SEC, we may be required to register and comply +with such regulations. To the extent we decide to continue operations, the required registrations and regulatory compliance steps may +result in extraordinary, non-recurring expenses to us. We may also decide to cease certain operations. Any disruption of our operations +in response to the changed regulatory circumstances may be at a time that is disadvantageous to investors. This would likely have a material +adverse effect on us and investors may lose their investment; and +◦ Changing environmental regulation and public energy policy may expose our business to new risks. +· We may be significantly impacted by developments and changes in laws and +regulations, including increased regulation of the cryptocurrency industry through legislative action and revised rules and standards +applied by The Financial Crimes Enforcement Network under the authority of the U.S. Bank Secrecy Act (“BSA”) and the Investment +Company Act. +· If we do not continue to satisfy the NYSE American continued listing requirements, +our common stock could be delisted from NYSE American. +· Our common stock price is volatile. +PART I +ITEM 1. BUSINESS +Company Overview +Ault Alliance, Inc., a Delaware +corporation, was incorporated in September 2017 (sometimes referred to as “AAI,” the “Company,” “we” +or “us”). Through our wholly and majority-owned subsidiaries and strategic investments, we own and/or operate data centers +at which we mine Bitcoin and offer colocation and hosting services for the emerging artificial intelligence (“AI”) ecosystems +and other industries, and provide mission-critical products that support a diverse range of industries, including a metaverse platform, +oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics and textiles. Our +direct and indirect wholly owned subsidiaries include (i) Sentinum, Inc. (“Sentinum”), (ii) Alliance Cloud Services, LLC (“ACS”), +(iii) BNI Montana, LLC (“BNI Montana”), (iv) Ault Capital Group, Inc. (“Ault Capital”), (v) Ault Lending, LLC +(“Ault Lending”), (vii) Ault Global Real Estate Equities, Inc. (“AGREE”), (viii) Ault Disruptive Technologies +Company, LLC (“ADTC”), which is the sponsor, Manager and the majority owner of Ault Disruptive Technologies Corporation (“Ault +Disruptive”), (ix) Eco Pack Technologies, Inc. (“Eco Pack”), which has a controlling interest in Eco Pack Technologies +Limited, (x) Ault Aviation, LLC (“Ault Aviation”) and (xi) Third Avenue Apartments, LLC (“Third Avenue”). +We also have a direct controlling +interest in (i) Circle 8 Holdco LLC (“Circle 8 Holdco”), which wholly owns Circle 8 Crane Services, LLC (“Circle 8”), +(ii) TurnOnGreen, Inc., formerly known as Imperalis Holding Corp. (“TurnOnGreen”), which wholly owns TOG Technologies, Inc. +(“TOG Technologies”) and Digital Power Corporation (“Digital Power”), (iii) Gresham Worldwide, Inc., formerly +known as Giga-tronics Incorporated (“GIGA”), which wholly owns Gresham Holdings, Inc., formerly Gresham Worldwide, Inc. (“GWW”), +which in turn wholly owns Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems 2001 Ltd. (“Enertec”), +Relec Electronics Ltd. (“Relec”) and has a controlling interest in Microphase Corporation (“Microphase”) and (iv) +Avalanche International Corp. (“Avalanche” or “AVLP”), which does business as MTIX International (“MTIX”). +We have minority interests in (i) RiskOn International, Inc., formerly known as BitNile Metaverse, Inc. (“ROI”), which wholly +owns BitNile.com, Inc. (“BNC”), RiskOn 360, Inc., formerly known as Ault Iconic, Inc. (“RiskOn 360”), RiskOn Learning, +Inc. and GuyCare, Inc. (“GuyCare”) and (ii) The Singing Machine Company, Inc. (“SMC”). We consolidate each of +ROI and SMC as variable interest entities. +AAI was founded by Milton +C. (Todd) Ault, III, its Executive Chairman, and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and Vice Chairman, +and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages the day-to-day operations +of the holding company. The Company’s long-term objective is to maximize per share intrinsic value. All major investment and capital +allocation decisions are made for us by Mr. Ault and the Executive Committee. +We have the following reportable +segments: +· AAI directly conducts Fintech, commercial lending and trading through Ault Lending; +· Sentinum: Bitcoin mining operation and data center operations through ACS; +1 +· Circle 8: crane rental and lifting solutions provider for oilfield, construction, commercial and infrastructure +markets; +· ROI: operates a software-as-a-service platform called askROI.com, which is a unique, generative AI-driven +platform engineered to provide pertinent and unique data insights through integration with business specific data that pushes beyond the +conventional uses of existing large language models. ROI also owns 100% of BNC, which operates a metaverse platform and 100% of GuyCare, +Inc. which develops products designed to improve men’s health; +· GIGA: defense solutions with operations conducted by GWW’s subsidiaries Microphase, Enertec, Gresham +Power and Relec; +· TurnOnGreen: commercial electronics solutions with operations conducted by Digital Power, and electric +vehicle (“EV”) charging solutions through TOG Technologies; +· SMC: karaoke audio equipment; +· AVLP: advanced textiles processing technology; and +· Ault Disruptive: a special purpose acquisition company. +We operate as a holding company +with operations conducted primarily through our subsidiaries, which are described below. +Recent Events and Developments +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant Capital Markets, LLC (“Ascendiant”) +to sell shares of common stock having an aggregate offering price of up to $200 million from time to time, through an “at the market +offering” program (the “2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering +was made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained +therein (Registration Statement No. 333-260618) which became effective on November 12, 2021. Through March 13, 2023, we received gross +proceeds of approximately $177 million through the sale of 42,382 shares of common stock from the 2022 ATM Offering. The 2022 Sales Agreement +has been terminated. +On June 10, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Preferred Sales Agreement”) with Ascendiant to sell shares of our +13.00% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred Shares”) having an aggregate offering price +of up to $46.4 million from time to time, through an “at the market offering” program (the “2022 ATM Preferred Offering”). +The offer and sale of Series D Preferred Shares from the 2022 ATM Preferred Offering was made pursuant to our effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) which +became effective on November 12, 2021. Through June 16, 2023, we received gross proceeds of approximately $3.4 million through the sale +of 281,197 Series D Preferred Shares in the 2022 ATM Preferred Offering. The 2022 Preferred Sales Agreement has been terminated. +On November 7, 2022, we and +certain of our subsidiaries borrowed $18.9 million of principal amount of term loans (the “Term Loans”) from a group of institutional +investors (the “Financing”). The Term Loans matured in 18 months, which may have been extended to 24 months, accrued interest +at the rate of 8.5% per annum and were secured by certain of our and certain of our subsidiaries’ assets. Starting in January 2023, +the lenders had the right to require us to make monthly payments of $0.6 million, which increased to $1.1 million in November 2023. The +Term Loans were issued with an original issue discount of $1.89 million. +The lenders received warrants +to purchase 604 shares of our common stock, exercisable for four years at $3,375 per share and warrants to purchase another 604 shares +of our common stock, exercisable for four years at $5,625 per share, subject to adjustment. +On July 19, 2023, we along +with certain of our subsidiaries entered into a First Amendment and Joinder to Loan and Guarantee Agreement (the “Amendment”) +with the institutional investors pursuant to which the (i) Loan and Guarantee Agreement, dated November 7, 2022, entered into between +us and the institutional investors (the “Loan Agreement”) and (ii) Security Agreement, dated November 7, 2022, entered into +between the institutional investors and Sentinum (the “Security Agreement”) was amended. Pursuant to the Amendment, we borrowed +an additional $8.8 million. The net proceeds of the additional loan amount were $7.5 million and the aggregate size of the Term Loans +increased from $18.9 million to $24.3 million. The Term Loans were repaid in December 2023. +2 +On December 16, 2022 we entered +into a Securities Purchase Agreement (the “SPA”) with an accredited investor (the “December 2022 Investor”) providing +for the issuance of a secured promissory note (the “December 2022 Note”) with an aggregate principal face amount of $14,700,000. +On December 29, 2022, the Company and the December 2022 Investor entered into an amended and restated amendment to the SPA, pursuant to +which the total amount of the financing was increased to $17,456,245 and the Company sold an additional note to a second accredited investor. +Under the SPA, we were obligated +to repay, while the December 2022 Note remains outstanding, (i) eighty percent (80%) of the proceeds we may receive from any financing +conducted, other than at-the-market offerings and (ii) one hundred percent (100%) of the proceeds we may receive from the sale of marketable +securities by Ault Lending. In addition, if Third Avenue Apartments, LLC (“Third Avenue”), our wholly owned subsidiary, sold +the property it owns in St. Peterburg, Florida, then we would use the net proceeds from the sale of such property in excess of $10 million, +to repay the December 2022 Note. In addition, we agreed to issue 1,547 shares of our common stock to the December 2022 Investor in exchange +for the cancellation of all outstanding warrants previously issued to the December 2022 Investor, which warrants were exercisable for +1,547 shares of our common stock. +On January 23, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable +preferred stock which, effective upon filing, eliminated the Series C convertible redeemable preferred stock. +On February 8, 2023, we entered +into a Share Exchange Agreement (the “February 2023 Agreement”) with ROI and the other signatories thereto. The February 2023 +Agreement provided that, subject to the terms and conditions set forth therein, ROI would acquire all of the outstanding shares of capital +stock of our then subsidiary, BNC, of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders (the +“Minority Shareholders”), as well as RiskOn 360, in exchange for the following: (i) 8,637.5 shares of newly designated Series +B Convertible Preferred Stock of ROI that were issued to our company (the “Series B Preferred”), and (ii) 1,362.5 shares of +newly designated Series C Convertible Preferred Stock of ROI that were issued to the to the Minority Shareholders (the “Series C +Preferred,” and together with the Series B Preferred, the “Preferred Stock”). The Series B Preferred and the Series +C Preferred each have a stated value of $10,000 per share (the “Stated Value”), for a combined stated value of the Preferred +Stock to be issued by ROI, of $100,000,000, and subject to adjustment, are convertible into shares of common stock of ROI. However, pending +approval of the transaction by ROI’s shareholders, the Preferred Stock is subject to a 19.9% beneficial ownership limitation, including +the Series A Convertible Preferred Stock that we acquired from ROI in June of 2022. +Pursuant to the Certificates +of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred +Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of ROI common stock determined by +dividing the Stated Value by $0.25 (the “Conversion Price”), or 40,000 shares of ROI common stock. The Conversion Price will +be subject to certain adjustments, including potential downward adjustment if ROI closes a qualified financing resulting in at least $25,000,000 +in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock will be +entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend +Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather +than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If +ROI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as +long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the +event of a liquidation, change of control event, dissolution or winding up of ROI, and will rank senior to all other capital stock of +ROI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred +was originally entitled to vote with the ROI common stock at a rate of 10 votes per share of common stock into which the Series B Preferred +is convertible, but that provision was subsequently eliminated, as were the conventional voting rights of the Series C Preferred. Other +than certain rights granted to the Company relating to amendments or waiver of various negative covenants, the terms, rights, preferences +and limitations of the Preferred Stock Certificates are essentially identical. The February 2023 Agreement closed on March 6, 2023. +On February 24, 2023, BNI +Montana entered into an asset purchase agreement with TypeX, LLC (“TypeX”), to acquire two land lease agreements and two corresponding +power purchase agreements in Montana. The lease and power agreements run for a period of 10 years, with a 10-year renewal option. Sentinum +is building out and developing fully operational data centers dedicated to Bitcoin mining operations on the properties (the “Montana +Facilities”). We anticipate that upon completion, the Montana Facilities will provide up to a combined 20 megawatts of power, enabling +up to 6,500 S19j Pro Antminers to operate. The first 10 megawatts of power was connected to the utility electrical network in March 2024. +The substations providing power to the Montana Facilities have the ability to handle additional capacity and Sentinum has initiated a +load study to determine future capacity and, if economically viable, intends to acquire such additional power capacity. We are redeploying +S19j Pro Antminers that are currently mining in our Michigan data center, allowing us to focus on expansion at our Michigan site to support +the rapid growth of high-performance computing and AI use cases. +3 +On April 6, 2023, we issued +a term note with a principal amount of $1.1 million, bearing an interest rate of 12% (the “Term Note”). The Term Note was +issued at a discount, with net proceeds to us amounting to $1.0 million. The Term Note was scheduled to mature on June 5, 2023. We exercised +the option to extend the maturity date by one month, by paying a $30,000 extension fee. Ault & Company guaranteed repayment of the +Term Note. +On April 20, 2023, Sentinum +entered into an amended Master Services Agreement with Core Scientific, Inc. (“Core Scientific”) for hosting services related +to the deployment of Bitcoin miners. This agreement provides for the sale of Bitcoin mined on a daily basis with the proceeds from such +sales generally being applied to operations fees of $25 per miner, hosting services fees, other miscellaneous fees and then any remaining +amounts, if any, are distributed 60% to Sentinum and 40% to Core Scientific if the price of Bitcoin is consistently greater than $45,000 +at month’s end. If the price of Bitcoin is less than $45,000, then any remaining amounts, if any, are distributed 50% to Sentinum +and 50% to Core Scientific. We have deployed 10,200 S19 Pro and S19j Pro Antminers with Core Scientific, securing approximately 30 MW +of power. The agreement terminates on August 31, 2024, unless terminated sooner pursuant to the terms of the agreement. Notwithstanding +the foregoing, either party may terminate the agreement with respect to 1,000 units in any thirty (30) day period on thirty (30) days +written notice on or after November 30, 2023. The Core Scientific hosting services agreement expedited the deployment of our Bitcoin miners +to approximately 19,200, representing a mining production capacity of approximately 2.1 exahashes per second. Under the terms of the Core +Scientific hosting services agreement, we expect that Sentinum will pay Core Scientific a monthly fee for operations and hosting services +of approximately $1.1 million, which amount excludes the profit sharing arrangement described above between the parties. +On June 8, 2023, we entered +into a Loan Agreement (the “Credit Agreement”) with Ault & Company as the lender. The Credit Agreement provided for an +unsecured, non-revolving credit facility in an aggregate principal amount of up to $10,000,000. All loans under the Credit Agreement (collectively, +the “Advances”) were due within five business days after request by Ault & Company and Ault & Company was not obligated +to make any further Advances under the Credit Agreement after December 8, 2023. Advances under the Credit Agreement bore interest at the +rate of 9.5% per annum and may be repaid at any time without penalty or premium. +On June 9, 2023, we entered +into an At-the-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC, as sales agent +(the “Agent”) to sell shares of our common stock having an aggregate offering price of up to $10,000,000 (the “Shares”) +from time to time, through an “at the market offering” (the “ATM Offering”) as defined in Rule 415 under the Securities +Act. On June 9, 2023, we filed a prospectus supplement with the SEC relating to the offer and sale of up to $10,000,000 of common stock +in the ATM Offering. The offer and sale of the Shares are being made pursuant to our effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) filed with the SEC on October +29, 2021 and declared effective by the SEC on November 12, 2021. On July 13, 2023 and September 8, 2023, we filed prospectus supplements +increasing the size of the ATM Offering to $20,000,000 and $50,000,000, respectively. Through March 12, 2024, we received gross proceeds +of approximately $50 million through the sale of 29,945,147 shares of common stock from the ATM Offering. The Sales Agreement has been +terminated. +On June 26, 2023, we established +a record date for our initial distribution of securities of TurnOnGreen. Stockholders as of this date were entitled to 40 shares of TurnOnGreen +common stock, along with warrants to purchase 40 shares of TurnOnGreen common stock (the “TurnOnGreen Securities”) for every +share of our common stock they held on the record date. The initial distribution was finalized in July 2023. We distributed 58.7 million +TurnOnGreen Securities in the first distribution. +On July 24, 2023, we established +a record date for our second partial distribution of TurnOnGreen Securities. Stockholders as of this date were entitled to 15 shares of +TurnOnGreen Securities for every share of the Company’s common stock they held on the record date. The second distribution was finalized +on August 7, 2023. We distributed 56.4 million TurnOnGreen Securities in the second distribution. +Effective August 3, 2023, +we and certain holders of preferred stock (the “Investors”) entered into an Exchange Agreement (the “Exchange Agreement”) +pursuant to which the Investors exchanged all of their preferred shares as well as their demand notes (the “Demand Notes”) +issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount of approximately $0.8 +million for two new 10% Secured OID Promissory Notes (the “Exchange Notes”), each with a principal face amount of $5.3 million, +for an aggregate amount owed of $10.5 million (the “Principal Amount”). We and Mr. Ault, our Executive Chairman, entered into +guaranty agreements with the March 2023 Investors guaranteeing repayment by Ault & Company of the Exchange Notes. +Effective as of August 3, +2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, +we issued a 10% demand promissory note in the principal face amount of $10.5 million (the “First Ault & Company Demand Note”) +to Ault & Company. +4 +Effective as of August 10, +2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued +a 12% demand promissory note in the principal face amount of $1.1 million (the “Second Demand Note”) to Ault & Company. +On September 8, 2023, we issued +to an accredited investor a term note (the “Short-Term Note”) with a principal face amount of $2,200,000 with a maturity date +of September 25, 2023. The Short-Term Note was issued with an original issue discount of $200,000 and did not bear interest unless an +event of default occurred under the Short-Term Note. The maturity date of the Short-Term Note was September 25, 2023. The purchase price +for the Short-Term Note was $2 million. Repayment of the Short-Term Note was secured by a guaranty provided by Ault & Company as well +as by Milton C. Ault, our Executive Chairman of the Company and the Chief Executive Officer of Ault & Company. +On September 27, 2023 we entered +into a securities exchange agreement with the holder of the Short-Term Note, pursuant to which we issued and sold in a registered direct +offering to the investor, a $2.2 million principal face amount convertible promissory note (the “Convertible Note”). The Convertible +Note bears no interest (unless an event of default occurs) as it was issued in exchange for the Short-Term Note, which contained an original +issue discount. The Convertible Note is convertible into shares of common stock at a conversion price equal to 90% of the lowest volume +weighted average price of the common stock during the five consecutive trading days prior to the date of conversion. As of the date of +filing of this Annual Report, we had issued 84,632 shares of common stock on the conversion of approximately $0.5 million of the Convertible +Note and paid an additional $1.2 million. The Convertible Note matured on March 29, 2024, is presently in default and has an outstanding +balance of approximately $0.5 million. +On October 13, 2023, we entered +into a note purchase agreement with Ault & Company, pursuant to which we sold to Ault & Company (i) a senior secured convertible +promissory note in the principal face amount of $17.5 million (the “Senior Note”) and warrants (the “Warrants”) +to purchase shares of our common stock for a total purchase price of up to $17.5 million. +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the Credit +Agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming +liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares +of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault +& Company to us. +The Senior Note had a principal +face amount of $17.5 million and a maturity date of October 12, 2028. The Senior Note bore interest at the rate of 10% per annum. Interest +was payable, at Ault & Company’s option, in cash or shares of common stock at the applicable conversion price. Accrued interest +was payable on the maturity date, provided, however, that Ault & Company had the option, on not less than 10 calendar days’ +notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. +The Senior Note was convertible +into shares of common stock at a conversion price equal to the greater of (i) $0.10 per share (the “Floor Price”), and (ii) +the lesser of (A) $7.38 or (B) 105% of the volume weighted average price of the common stock during the ten trading days immediately prior +to the date of conversion. The conversion price was subject to adjustment in the event of an issuance of common stock at a price per share +lower than the conversion price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. +The Floor Price shall not be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +The Warrants grant Ault & +Company the right to purchase 1,907,440 shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary +of the closing date, and become exercisable on the first business day after the six-month anniversary of the closing date. The exercise +price of the Warrants is $0.35, which is subject to adjustment in the event of customary stock splits, stock dividends, combinations or +similar events or in the event of an issuance of Common Stock at a price per share lower than the exercise price. +In addition, we and various +of our subsidiaries granted Ault & Company a senior security interest in substantially all of our assets as collateral for the repayment +of the Senior Note, which was subordinated to the security interest granted to the holders of the outstanding secured promissory notes. +5 +On November 6, 2023, we entered +into a securities purchase agreement (the “November 2023 SPA”) with Ault & Company, pursuant to which we agreed to sell, +in one or more closings, to Ault & Company up to 50,000 shares of Series C convertible preferred stock and warrants to purchase up +to 14.8 million shares of common stock for a total purchase price of up to $50 million. The consummation of the transactions contemplated +by the November 2023 SPA, specifically the conversion of the Series C convertible preferred stock and the exercise of the warrants in +an aggregate number in excess of 19.99% on the execution date of the November 2023 SPA, are subject to various customary closing conditions +as well as regulatory and stockholder approval. In addition to customary closing conditions, the closing of the financing is also conditioned +upon the receipt by Ault & Company of financing to consummate the transaction. +On November 15, 2023, we purchased +from ROI 603.44 shares of ROI’s newly designated Series D convertible preferred stock (“ROI Series D Preferred”) for +a total purchase price of $15.1 million. The purchase price was paid by the cancellation of $15.1 million of cash advances made by us +to ROI between January 1, 2023 and November 9, 2023. Each share of ROI Series D Preferred has a stated value of $25,000 per share and +each share of ROI Series D Preferred is convertible into a number of shares of ROI’s common stock determined by dividing the stated +value by $0.51, subject to adjustment in the event of an issuance of ROI common stock at a price per share lower than the conversion price, +as well as upon customary stock splits, stock dividends, combinations or similar events. The ROI Series D Preferred holders are entitled +to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. In addition, for as long as at least 25% of the +ROI Series D Preferred remain outstanding, ROI must obtain our consent with respect to certain corporate events, including reclassifications, +fundamental transactions, stock redemptions or repurchases, increases in the number of directors, and declarations or payment of dividends, +and further ROI is subject to certain negative covenants, including covenants against issuing additional shares of capital stock or derivative +securities, incurring indebtedness, engaging in related party transactions, selling of properties having a value of over $50,000, altering +the number of directors, and discontinuing the business of any subsidiary, subject to certain exceptions and limitations. However, pending +approval of the transaction by ROI’s shareholders, the ROI Series D Preferred is subject to a 19.99% beneficial ownership limitation. +On December 8, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series B convertible preferred stock +which, effective upon filing, eliminated the Series B convertible preferred stock. +On December 14, 2023, pursuant +to the November 2023 SPA entered into with Ault & Company on November 6, 2023, we sold to Ault & Company, in three separate closings +that occurred on the closing date, an aggregate of 41,500 shares of Series C convertible preferred stock (the “Series C Convertible +Preferred Stock”), and warrants (the “Series C Warrants”) to purchase 12,269,031 shares of common stock, for a total +purchase price of $41.5 million. At the first closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred Stock +and Series C Warrants to purchase 6,356,245 shares of common stock, for a purchase price of $21.5 million, paid in cash (the “Initial +Closing”). Immediately upon the Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes +issued to the lenders pursuant to the Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +second closing (the “Second Closing”), Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock +and Series C Warrants to purchase 2,956,393 shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon +the Second Closing, we paid $10.0 million to partially satisfy the outstanding Senior Note. Promptly thereafter, at the third closing +(the “Third Closing”), Ault & Company purchased another 10,000 shares of Series C Convertible Preferred Stock and Series +C Warrants to purchase another 2,956,393 shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon +the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance on the outstanding Senior Note. +On December 14, 2023, we, +along with our wholly owned subsidiaries Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending, Ault Aviation and AGREE (collectively +with our company, Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending and Ault Aviation, the “Guarantors”) entered into +a Loan and Guaranty Agreement (the “Loan Agreement”) with institutional lenders, pursuant to which Ault & Company borrowed +$36 million and issued secured promissory notes to the lenders in the aggregate amount of $38.9 million (collectively, the “Secured +Notes”; and the transaction, the “Loan”). The Loan Agreement was amended as of April 15, 2024. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) 19,226 Antminers (the “Miners”), (b) all of the digital currency mined or otherwise generated +from the Miners and (c) the membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, +pursuant to which those entities granted to the lenders a security interest in substantially all of their assets, as well as a pledge +of equity interests in Ault Aviation, AGREE, Sentinum, Third Avenue, Ault Energy, LLC, our wholly owned subsidiary (“Ault Energy”), +ADTC, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue on the real estate property owned by Third +Avenue in St. Petersburg, Florida (the “Florida Property”), (iv) a future advance mortgage by ACS on the real estate property +owned by ACS in Dowagiac, Michigan (the “Michigan Property”), (v) an aircraft mortgage and security agreement by Ault Aviation +on a private aircraft owned by Ault Aviation (the “Aircraft”), and (vi) deposit account control agreements over certain bank +accounts held by certain of our subsidiaries. +6 +In addition, pursuant to the Loan Agreement, we agreed to establish +a segregated deposit account (the “Segregated Account”), which would be used as a further guarantee of repayment of the Secured +Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. We are required to have the minimum balance in the +Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and +two-year anniversaries of the closing date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million +monthly into the Segregated Account, which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into +the Segregated Account, (i) up to the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, +the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on +a per dividend basis) received from Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, +which shall not exceed $9 million in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans +or other investments made by Ault Lending (including but not limited to sales of loans or investments, dividends, interest payments and +amortization payments), which shall not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further +agreed to deposit funds into the Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida +Property, (ii) $11 million from the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, +subject to a de minimis threshold of $1 million, and (v) $10 million from the sale of Circle 8. +On January 12, 2024, pursuant +to the approval provided by our stockholders at the annual meeting of stockholders, we filed an Amendment to our Certificate of Incorporation +with the State of Delaware to effectuate a reverse stock split of our common stock affecting both the authorized and issued and outstanding +number of such shares by a ratio of one-for-twenty-five. The reverse stock split became effective on January 16, 2024. All share amounts +in this Annual Report have been updated to reflect the reverse stock split. +On January 31, 2024, Ault +Lending entered into a securities purchase agreement (the “January 2024 SPA”) with Alzamend Neuro, Inc. (“Alzamend”), +pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending up to 6,000 shares of Series B convertible preferred +stock (the “ALZN Series B Preferred”) and warrants to purchase up to 6.0 million shares of Alzamend common stock (the “ALZN +Series B Warrants”) for a total purchase price of up to $6.0 million. On January 31, 2024, +Ault Lending purchased 1,220 shares of ALZN Series B Preferred and warrants to purchase 1.22 million shares for a total purchase price +of $1.22 million. The purchase price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend +between November 9, 2023 and January 31, 2023. E ach share of ALZN Series B Preferred has a stated value of $1.00 per share and +is convertible into a number of shares of Alzamend’s common stock determined by dividing the stated value by $1.00, subject to adjustment +in the event of an issuance of Alzamend common stock at a price per share lower than the conversion price, as well as upon customary stock +splits, stock dividends, combinations or similar events. The ALZN Series B Warrants are +exercisable on the first business day after the six-month anniversary of issuance and have a five-year term, expiring on the fifth anniversary +of the initial exercise date. The exercise price of the ALZN Series B Warrants is $1.20, +subject to adjustment in the event of an issuance of Alzamend common stock at a price per share lower than the conversion price, +as well as upon customary stock splits, stock dividends, combinations or similar events. +On each of March 7, 2024, +March 8, 2024, March 18, 2024 and March 19, 2024, pursuant to the November 2023 SPA, we sold to Ault & Company 500 +shares of Series C Convertible Preferred Stock and Series C Warrants to +purchase 147,820 shares of common stock to the Purchaser, for a purchase price of $500,000. As +of April 15, 2024, Ault & Company has purchased an aggregate of 43,500 shares of Series C Convertible Preferred Stock and Series C +Warrants to purchase an aggregate of 12,860,311 shares of common stock, for an aggregate purchase price of $43.5 million. +On +March 11, 2024 we entered into a note purchase agreement (the “Purchase Agreement”) with two institutional investors (the +“Buyers”) pursuant to which the Buyers purchased from the Company, on March 12, 2024 in a registered direct offering to the +Buyers an aggregate of $2,000,000 principal face amount convertible promissory notes (the “Notes”). The Notes were sold to +the Buyers for an aggregate purchase price of $1,800,000, which reflects an original issue discount of $200,000. The Notes accrue interest +at the rate of 6% per annum, unless an event of default (as defined in the Notes) occurs, at which time the Notes would accrue interest +at 12% per annum. The Notes will mature on June 12, 2024, provided, however, that we have the right, upon written notice to the Buyers, +to extend the maturity date to September 12, 2024, for which we would increase the principal amount of the Notes then outstanding by 5%. +The Notes are convertible into shares of common stock at a conversion price of $0.35 per share. +7 +On March 26, 2024, pursuant +to the January 2024 SPA, Ault Lending purchased 780 shares of ALZN Series B Preferred Stock +and ALZN Series B Warrants to purchase 780,000 shares +of Alzamend common , for a purchase price of $780,000. As of April 15, 2024, Ault +Lending has purchased an aggregate of 2,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to +purchase an aggregate of 2.0 million shares of Alzamend common stock, for an aggregate purchase price of $2.0 million. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50,000,000.00 to $75,000,000.00 and (B) extended the date of on which the final closing may occur to June 30, +2024, subject to Ault & Company’s ability to further extended such date for ninety days. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.ault.com. +Our Corporate Structure +On January 3, 2023, we changed +our name from BitNile Holdings, Inc. to Ault Alliance, Inc. (the “Name Change”). The Name Change was effected through a parent/subsidiary +short form merger pursuant to an Agreement and Plan of Merger dated December 20, 2022. Neither the merger nor the Name Change affected +the rights of our security holders. Our common stock is traded on the NYSE American under the symbol “AULT.” Existing stock +certificates that reflect a prior corporate name continue to be valid. Certificates reflecting the new corporate name are issued as old +stock certificates are tendered for exchange or transfer to our transfer agent. +In March 2024, we reorganized +our corporate structure pursuant to a series of transactions by and among the Company and its directly and indirectly owned subsidiaries +as well as third parties. The purpose of the reorganization was to simplify our organizational and reporting structure to more accurately +reflect our business operations. As a result of the foregoing transactions, our corporate structure is currently as follows: +8 +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +9 +Our Executive Committee acts +as the underwriting committee for Ault Lending and approves all lending transactions. Under its business model, Ault Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to Ault Lending in any particular financing. +Over the recent past, we have +provided capital and relevant expertise to fuel the growth of businesses in cryptocurrency mining, generative AI and metaverse platform +development, oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics and textiles. +We have provided capital to subsidiaries as well as partner companies in which we have an equity interest or may be actively involved, +influencing development through board representation and management support. +Our Principal Subsidiaries and their Businesses +The following is a brief +summary of the businesses in which we own a controlling interest, or whose financial statements we consolidated in this Annual Report: +Sentinum, Inc. +Sentinum conducts data center +operations and Bitcoin mining through ACS. +Overview +Through +its owned and operated data centers, Sentinum’s mission is to support internal computing requirements and to empower AI-focused +businesses and other businesses requiring high-density power with reliable, scalable, and secure hosting solutions. We currently have +data centers in Michigan and Montana. The Michigan data center design and available power provides Sentinum the ability to create bespoke +solutions enabling it to seize growth opportunities within the broader data center services market. Sentinum can provide a range of service +options tailored to a customer’s needs, including high-performance computing (“HPC”) and AI. HPC and AI are synonymous +with applications requiring immense computational power to process complex models and perform real-time inferences. These use cases are +being adopted by a wide range of industries, such as healthcare, energy, automotive, robotics and other autonomous systems. We are exploring +the potential of working directly with end user companies as well as companies who we could team with to provide comprehensive solutions. +Sentinum’s +attentiveness to disruptive technologies such as HPC, AI and blockchain combined with the foundational elements of data centers, power +infrastructure, telecommunications and security enable it to support the internal operations for Bitcoin mining alongside non-mining solutions +for third party customers. The economies of scale created by Bitcoin mining operations provide a competitive advantage to Sentinum as +it seeks to add non-mining applications to its services portfolio. +We also mine Bitcoin using +purpose-built computers (or “miners”) to solve complex cryptographic algorithms (or “verify” or “solve” +blocks) in the blockchain in exchange for rewards and fees denominated in the native token of that blockchain network. Some of our miners +provide computing power to a Bitcoin mining pool operator, in which all the participants’ machines mine Bitcoin as a collective +group, and we get paid the expected value of both the block reward and transaction fees for doing so; the other miners mine directly for +our own account. The mine pool operators receive block rewards and transaction fees paid in Bitcoin by the blockchain when the mine pool +finds new blocks. The reward and transaction fees are then shared by the pool participants based on their hash rate contributions to the +pool, less a small amount of fees. +We will evaluate each digital +asset in our portfolio, or that we propose to acquire in the future (including by mining), to determine whether it would likely be considered +a security under U.S. federal securities laws, in consultation with outside counsel, as applicable. We will base our analysis on relevant +case law, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance by the SEC and +its staff. See “Risk Factors —  Risks Related to Our Bitcoin Operations – Legal and Regulatory —  +A particular digital asset’s status as a ‘security’ in any relevant jurisdiction is subject to a high degree of uncertainty +and if a regulator disagrees with our characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines +and penalties, which may adversely affect our business, operating results and financial condition. A determination that Bitcoin that we +own or mine is a ‘security’ may adversely affect the value of Bitcoin and our business.” +10 +We do not, however, acquire crypto currencies for investment purposes. +As of December 31, 2023, we held 16.7 Bitcoins valued at $0.5 million, based on cost less impairment as of such date. Our mining operations +generated a net loss of $2.6 million and revenue of $33.1 million during the year ended December 31, 2023 compared to a net loss +of $91.6 million and revenue of $16.7 million during the year ended December 31, 2022. As of December 31, 2023, the $0.5 million +carrying value of our 16.7 Bitcoins represented 0.2% of our total assets of $299.2 million as of such date. +Sentinum Breakeven Analysis +Since commencement of Sentinum’s +mining operations in 2021, we have received approximately 2,669.01 Bitcoin for providing computing power to a Bitcoin mining pool operator +and from hosted mining operations with Core Scientific through March 31, 2024. While the Bitcoin received is available for sale in the +ordinary course of business, we believe that cryptocurrency represents an attractive, appreciating investment opportunity, and as such +we have historically held cryptocurrency assets that we do not otherwise sell to fund our operating expenses. We believe that our integrated +model with close control over our power sources and owning our Bitcoin mining data center helps us to produce Bitcoin with attractive +cost efficiency that helps us to produce Bitcoin at a cost that we believe is attractive versus the price of Bitcoin, and generally below +the prevailing market price of power that many of our peers must pay and may have to pay in the future during periods of uncertain or +elevated power pricing. +Our net cost of power was +between approximately $42 to $62 per megawatt-hour (“MWh”) in the second half of 2023 to present, and we expect that our blended +power cost upon the relocation of approximately 6,500 miners to our Montana facilities, once fully operational, will be approximately +$46 per MWh. This $42 to $62 per MWh corresponds to approximately $23,050 per Bitcoin equivalent with modern miners and assuming a network +hash rate of approximately 2.1 exahash per second (“EH/s”). In addition to the cost of power, we recognize a significant amount +of expenses from depreciation on our investment in miners and hosting fees from Core Scientific. In the aggregate, excluding Sentinum’s +daily general and operating costs of approximately $15,000, these expenses result in a direct cost for each Bitcoin mined of approximately +$51,000. We believe this cost to mine is attractive versus the price of Bitcoin. For example, the price of Bitcoin ranged from approximately +$17,000 to approximately $44,000 during 2023, and was approximately $70,500 as of April 10, 2024, according to Coin Market Cap. +We anticipate that upon completion +of the initial phase of development, the Montana Facilities will provide up to a combined 20 MWs of power, enabling up to 6,500 S19j Pro +Antminers to operate. Inclusive of costs previously incurred to acquire two land lease agreements and two corresponding power purchase +agreements, we estimate that the Montana Facilities will cost approximately $7 million. Further, given the favorable cost differential +for power between Montana and Michigan, we expect the increase in operating costs and depreciation from capitalized expenditures will +approximate the power cost savings. As such, development of the Montana Facilities is not expected to have a negative impact on our operating +results. +Thus, if the price of Bitcoin, +level of difficulty to mine, the amount of the block reward or the amount of Bitcoin earned by miners for mining one block on the Bitcoin +blockchain remained constant, then we would expect that Sentinum would be profitable in 2024. However, given the pending block reward +halving, an event that occurs approximately every four years, we are currently unable to predict with any certainty what effect this will +have on revenues derived from our Bitcoin mining operations, the price of Bitcoin or the level of difficulty to mine. Currently miners +receive 6.5 Bitcoin for mining one block on the Bitcoin blockchain, which will decrease to 3.25 Bitcoin when the halving occurs. While +the pending halving may have an adverse effect on our profitability, the expected cash generated from our Bitcoin mining operations is +still expected to exceed that of our operating costs given the significance of depreciation charges, which is expected to account for +nearly 30% of Sentinum’s total costs of operations during 2024. +During 2024, we also anticipate +large expenditures in our Michigan Facility to facilitate the transition of the facility to support HPC and AI applications. Initially, +these expenditures will likely increase Sentinum’s loss unless we are able to pass these costs on to our future customers. These +uncertainties make it impossible to predict when, if ever, that Sentinum will achieve profitable operations. +During 2023, Sentinum reported a loss from operations of approximately +$2.6 million inclusive of depreciation and amortization of approximately $18.3 million. As such, after capital expenditure of approximately +$2 million, Sentinum generated approximately $15.3 in cash for the year ended December 31, 2023. The cash generated from operations was +used to pay for a portion of costs we incurred. +11 +Cryptocurrency and Cryptocurrency Mining Overview +Blockchain and Cryptocurrencies Overview +Cryptocurrencies are a type +of digital asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). +Cryptocurrencies operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized +digital ledger that enables the secure use and transfer of digital assets. We believe cryptocurrencies and associated blockchain technologies +have potential advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate +settlement of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” Recently, cryptocurrencies +have gained widespread mainstream attention and have begun to experience greater adoption by both retail and institutional investors and +the broader financial markets. For example, Bitcoin’s aggregate market value had appreciated to $1.4 trillion in April 2024 +compared to $512 billion in February 2023. All figures are derived from Yahoo Finance and data furnished by Messari.io, an independent +entity with which we have no relationship and that, in its own words, “brings transparency to the crypto economy.” As cryptocurrencies, +and blockchain technologies more generally, have entered the mainstream, prices of digital assets have reached all-time highs and the +broader ecosystem has continued to develop. While we expect the value of Bitcoin to remain volatile, we believe this increase in aggregate +market value signals institutionalization and wider adoption of cryptocurrency. For example, in January 2024, the SEC approved the listing +and trading of Bitcoin exchange-traded funds, of which, as of April 9, 2024, approximately 20 are trading with over $58 billion of Bitcoin +assets held. +Cryptocurrencies are decentralized +currencies that enable near instantaneous transfers. Transactions occur via an open-source, cryptographic protocol platform which uses +peer-to-peer technology to operate with no central authority. The online network hosts the public transaction ledger, known as the +blockchain, and each cryptocurrency is associated with a source code that comprises the basis for the cryptographic and algorithmic protocols +governing the blockchain. In a cryptocurrency network, every peer has its own copy of the blockchain, which contains records of every +historical transaction — effectively containing records of all account balances. Each account is identified solely by +its unique public key (making it effectively anonymous) and is secured with its associated private key (kept secret, like a password). +The combination of private and public cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing +strong control of ownership. +No single entity owns or operates +the network. The infrastructure is collectively maintained by a decentralized public user base. As the network is decentralized, it does +not rely on either governmental authorities or financial institutions to create, transmit or determine the value of the currency units. +Rather, the value is determined by market factors, supply and demand for the units, the prices being set in transfers by mutual agreement +or barter among transacting parties, as well as the number of merchants that may accept the cryptocurrency. Since transfers do not require +involvement of intermediaries or third parties, there are only nominal transaction costs in direct peer-to-peer transactions. For +example: +· In terms of conventional peer-to-peer transactions, there either are no fees +or they are de minimis (Source: https://www.kraken.com/en-us); +· For purposes of traditional networks, there are nominal fees associated with +any transaction (Source: https://bitinfocharts.com/bitcoin); and +· As of April 1, 2024, the average Bitcoin network fee is $5.82 per transaction, +which is still low compared to conventional transaction fees charged by banks and other more traditional financial institutions (https://bitinfocharts.com/bitcoin). +The network fee is separate +and distinct from the pool fee we pay Luxor Technology (“Luxor”) for its services in acting as a pool operator, discussed +below. The network fee is applicable to anyone who transacts on the blockchain. +Given that block space is +limited, mining fees can and often do fluctuate significantly from transaction to transaction as a result of “congestion.” +However, this congestion does not negate any of the statements made immediately above. +Units of cryptocurrency can +be converted to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as Binance, Coinbase, Bybit, +Kraken, Gemini and others. Cryptocurrency prices are quoted on various exchanges and fluctuate with extreme volatility. +12 +We believe cryptocurrencies, +particularly Bitcoin, the only cryptocurrency we receive for providing computing power to a mining pool operator, offer many advantages +over traditional, fiat currencies, although many of these factors also present potential disadvantages and may introduce additional risks, +including: +· Acting as a fraud deterrent, as cryptocurrencies +are digital and cannot be counterfeited or reversed arbitrarily by a sender; +· Immediate settlement; +· Elimination of counterparty risk; +· No trusted intermediary required; +· Lower fees; +· Identity theft prevention; +· Accessible by everyone; +· Transactions are verified and protected through +a confirmation process, which prevents the problem of double spending; +· Decentralized — no central authority +(government or financial institution); and +· Not recognized universally and not bound by government imposed or market +exchange rates. +However, cryptocurrencies +may not provide all of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, +there are two factors that may affect all digital asset mining companies and Bitcoin in particular: (i) limitations on the supply of the +cryptocurrency being mined; and (ii) the market price of the cryptocurrency. +The blockchain’s method +for creating new Bitcoins is mathematically determined in a manner so that the supply of Bitcoins grows at a limited rate pursuant to +a pre-set schedule. Specifically, the number of Bitcoins awarded for solving a new block is automatically halved for every 210,000 +blocks that are solved. The current fixed reward for solving a new block is 6.25 Bitcoins per block, which was reduced from 12.5 Bitcoins +in May 2020 and will be reduced further to 3.125 Bitcoins per block in April 2024. This deliberately controlled rate of Bitcoin creation +means that the number of Bitcoins in existence will never exceed 21 million and that Bitcoins cannot be devalued through excessive +production unless the Bitcoin network’s source code and the underlying protocol for Bitcoin issuance is altered. This also means, +however, that our revenue prospects will decline unless the price of a Bitcoin increases commensurately or we acquire more miners. +We currently only participate +in mining pools that mine Bitcoin. Our ability to generate revenue from these mining operations will be dependent on the price of Bitcoin. +The prices of cryptocurrencies, specifically Bitcoin, have experienced substantial volatility, including fluctuation patterns which may +reflect “bubble” type volatility, meaning that high or low prices at a given time may not be indicative of the current or +future value of Bitcoin. The price of a Bitcoin may be subject to rapidly changing investor and market sentiment, and may be influenced +by factors such as technology, regulatory developments and media coverage. Further, Bitcoin’s value, like that of other cryptocurrencies, +may be based on various factors, including their acceptance as a means of exchange or purchasing power by consumers and vendors, volume, +liquidity and transferability and market demand. Bitcoin’s current price reflects, in part, the belief by some that Bitcoin could +become a widely accepted form of currency; however, if this prediction turns out to be incorrect its price could decrease dramatically, +as would our prospects for future revenue and profits. See “Risk Factors – Risks Related to Our Bitcoin Operations” +for more information on the risks we face due to our mining of Bitcoin and its speculative and volatile nature. +13 +Cryptocurrency Mining and Mining Pools +As a participant in a cryptocurrency +mining pool, we use specialized miners to solve cryptographic math problems necessary to record and “publish” cryptocurrency +transactions to blockchain ledgers. Generally, each cryptocurrency has its own blockchain, which consists of software code (also known +as a protocol), which is run by all the computers on the network for such blockchain. Within this code, transactions are collated into +blocks, and these blocks must meet certain requirements to be verified by the blockchain software, added to the blockchain or ledger of +all transactions and published to all participants on the network that are running the blockchain software. After a transaction is verified, +it is combined with other transactions to create a new block of data for the blockchain. For proof-of-work blockchains, the process of +verifying valid blocks requires computational effort to solve a cryptographic equation, and this computational effort protects the integrity +of the blockchain ledger. This process is referred to as “mining.” As a reward for verifying a new block, miners receive payment +in the form of the native cryptocurrency of the network (e.g., Bitcoin). This payment is comprised of a block reward (i.e., the automatic +issue of new cryptocurrency tokens) and the aggregated transaction fees for the transactions included in the block (paid in existing cryptocurrency +tokens by the participants to the transactions). The block reward payments and the aggregated transaction fees are what provide the incentive +for miners to contribute hash rate to the network. +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific cryptocurrency, and the blockchain-wide hash rate for a specific cryptocurrency can be understood as the aggregate +of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +and other cryptocurrencies are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known +as the “mining difficulty,” which is the level of computational activity required before a new block is solved and verified. +For example, on the Bitcoin blockchain the protocol is coded such that a new block is solved and verified approximately every ten minutes. +As such, to the extent the hash power on the network is increased or decreased due to, for example, fluctuations in the number of active +miners online, mining difficulty is correspondingly increased or decreased to maintain the preset interval for the verification of new +blocks. +On certain cryptocurrency +networks, including Bitcoin, the rewards for solving a block are also subject to periodic incremental halving. Halving is a process designed +to control the overall supply and reduce the risk of inflation in cryptocurrencies using a proof-of-work consensus algorithm. After a +predetermined number of blocks are added to the blockchain, the mining reward is cut in half, hence the term “halving.” The +last halving for Bitcoin occurred on May 11, 2020 but the next halving is expected to occur in April 2024. Transaction fees are variable +and depend on the level of activity on the network. Generally, transaction fees increase during times of network congestion, as miners +will prefer transactions with higher fees, and therefore a higher fee can reduce the time to process a transaction, and decrease when +there are fewer transactions on the network. +As the total amount of available +hash rate has increased (particularly on the Bitcoin network), it has become increasingly difficult for any individual miner to independently +solve a block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool operator, rather than an individual miner, +validates the block and receives the block reward and related transaction fees. The mining pool is organized by a third party, in our +case, Luxor. In consideration for receiving a percentage of the earned block rewards and transaction fees, Luxor administers the +pool and ensures that the participants in the pool receive their share of the block reward and related transaction fees, generally pro-rata +to their contributed hash rate. Mining pools offer miners more predictable and consistent revenue compared to mining individually. We +participate in mining pools by providing what the industry refers to as “hashrate” to the pool. Hashrate is defined as the +computing power that our mining equipment produces when helping to validate a block that the mining pool is trying to solve. We use the +FPPS, or Full Pay-Per-Share, method when mining with Luxor. Pursuant to the “Full Pay-Per-Share” model, both the block reward +and the mining service charge are settled according to the theoretical profit. It includes the calculation of a standard transaction fee +within a certain period and distributes it to mining pool participants according to their hash power contributions in the pool. It increases +the mining pool participants’ earnings by sharing transaction fees. Standard transaction fees are calculated using a certain period +which are then distributed to miners according to their hash power contributions in the pool. Luxor currently charges us a 0.68% mining +fee. +14 +We provide computing power +to the mining pool, which is run by the mining pool operator with whom we contract, who in turn provides transaction verification services. +Based on the terms of the agreement, in our judgment, the mining pool operator is considered the principal in providing mining pool services. +We recognize revenue, net of certain transaction fees from the mining pool operator, which are not considered material. Our current mining +pool agreement is cancelable at any time by either party without penalty. Revenue received for providing computing power would be directly +impacted positively or negatively should we start and stop providing computing power to the mining pool operator within a given reporting +period. +Our Strategy +Smart Growth +We aim to optimize our mining +by identifying and purchasing the most profitable miners with industry-leading returns on investment and actively monitoring and adjusting +the operation of those machines to enhance their performance. Most recently, in April 2023, we acquired 664 S19 XP Antminers and currently +have no outstanding contracts to acquire additional miners at this time since our focus is primarily centered upon the expansion of our +Michigan and Montana facilities. When planning our short- and long-term operating strategies and capital expenditures, we carefully monitor +fluctuations and longer-term trends in the value of certain cryptocurrencies, which impacts the return on investment of machines. We also +regularly evaluate potential innovations in geography, physical footprint, computing technology and similar areas to improve our operations +and productivity. We believe this smart growth strategy, including our commitment to mining efficiency and return on investment in miners, +will enable us to build value over the long term. +Own and Operate Our Mining Facilities +We are investing heavily in +purchasing, building and operating our mining facilities. By owning and operating our miners at facilities that offer competitive advantages, +including access to reliable, low-cost, renewable power and room for expansion, we expect to have greater control over the timing of the +purchase and deployment of our miners. We also may enhance our ability to intelligently and quickly adapt our operating model and reap +savings compared to paying for outsourced operations and infrastructure. We anticipate that we will continue to consider other opportunities +to integrate our operations, including with respect to both the software utilized by our fleet and the associated hardware. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in cryptocurrency mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable +amounts of electrical energy to perform their functions and mine Bitcoin; consequently, a critical aspect of operating in the cryptocurrency +mining industry is obtaining a reliable supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased +a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan (the “Michigan Facility”). +Since the purchase of the Michigan Facility, we have invested in infrastructure improvements and began both ramping up the power capacity +and installing miners. To date, we have increased power load from 1.5 megawatts (MWs”) to approximately 30 MWs. In addition, we +have received a commitment from the utility company that currently provides our power to expand the Michigan Facility’s capacity +up to approximately 300 MWs, which we are currently evaluating. Our relationship with the utility company has grown as we have demonstrated +our ability to upgrade and use power at our site effectively. +We have also invested in a +data center through BNI Montana, which acquired two land lease agreements and two corresponding power purchase agreements in Montana in +2023. We have completed the build-out at one of the two sites (collectively, the “Montana Facilities”), which provides up +to 10 MWs of power. Once we complete the build-out of the second site, which is expected to occur later in 2024, the Montana Facilities +will provide up to a combined 20 MWs of power. We believe that the capacity of the Montana Facilities can be significantly expanded and +we have begun an electrical load study in collaboration with the local utility to explore potential power upgrades. We anticipate expanding +the capacity at the Montana Facilities to the extent possible, after determination of the completed load study, subject to additional +funding. +15 +We continue to evaluate other +sites, locations, and partnerships for additional and alternative support of future mining operations. While we have not at present entered +into any other agreements, we will continue to explore and evaluate additional facilities that would enable us to expand our mining operations +as needed. +Our Mining Operations +Currently, we have 4,397 S19j +Pro Antminers and 4,628 S19 XP Antminers in operation at our Michigan facility, two S19j Pro Antminers in operation at our Montana facility +and 3,549 S19 Antminers and 6,651 S19J Pro Antminers hosted with Core Scientific, with an aggregate mining production capacity of approximately +2.1 EH/s. +Our strategy includes identifying +less expensive, clean power for our Bitcoin mining operations. Management of the company has considered the issues surrounding the environmental +impact of our Bitcoin mining operations. Based on this review, we have concluded that the environmental impact of our mining operations +is not material given that approximately 85% of the energy we use is “green,” meaning it is sourced from nuclear, wind or +solar power. In addition to our continued expansion investments at the Michigan Facility, we also seek out new locations to support our +bitcoin mining business. We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but +also leasing buildings and facilities (as we have done with the Montana Facilities), hosting relationships and strategic partnerships. +At this time, we have not entered into any new mining agreements at locations other than the Michigan Facility and the Montana Facilities. +We currently mine Bitcoin only. +Coins that are mined are held +in a custodial account as digital assets. We securely store our digital assets at Gemini Trust Company, LLC (“Gemini”), a +regulated, audited and insured cryptocurrency custodian. The custody arrangements require that we mine to a custodial wallet address where +the private key is held by the custodian and all keys for the wallet are held in cold storage. This provides a layer of protection in +both the transaction and liquidation phases of the operations by using multi-factor and multi-person approval processes, to include Know +Your Customer and Anti-Money Laundering procedures of the receiving party. We will either hold the digital assets or may choose to convert +those assets into fiat currency depending on financial needs and plans. When we opt to convert the digital assets we sell or exchange +our Bitcoin through Gemini, the custodian of our digital wallet. When we elect to make a sale or exchange our Senior Vice President - +Finance submits a request to Gemini’s execution department to exchange Bitcoin for U.S. dollars. Gemini sends an approval email +to both our CEO and CFO to approve. Once approved by either our CEO or CFO, Gemini executes the sale/exchange on its trading platform +at current market prices, less commissions, and deposits the U.S. dollars into our bank account. +Beyond the foregoing, our +custody agreement with Gemini provides that: +· Gemini provides a unique custody account in which all our blockchain assets +are held, which are segregated from all others’ assets and are verifiable through the blockchain; and +· Gemini charges us fees in bitcoin, which is deducted from our digital assets +on the last business day of every month. +Currently, we are converting +Bitcoin received from our mining activities into fiat currency on a nearly daily basis to pay for operating costs and purchase commitments +for expansion activities at our facilities. In January 2024, we made a strategic decision to begin holding up to 20% and a minimum of +5% of the Bitcoin we mine for investment. +Regulation +The laws and regulations applicable +to cryptocurrency are evolving and subject to interpretation and change. Governments around the world have reacted differently to cryptocurrencies; +certain governments have deemed them illegal, and others have allowed their use and trade without restriction, while in some jurisdictions, +such as in the United States, cryptocurrencies are subject to extensive, and in some cases overlapping, unclear and evolving regulatory +requirements. As cryptocurrencies have grown in both popularity and market value, the U.S. Congress and a number of U.S. federal and state +agencies, including the Financial Crimes Enforcement Network (“FinCEN”), SEC, the Commodity Futures Trading Commission (“CFTC”), +Financial Industry Regulatory Authority (“FINRA”), the Consumer Financial Protection Bureau, the Department of Justice (“DOJ”), +the Department of Homeland Security, the Federal Bureau of Investigation (“FBI”), the Internal Revenue Service (“IRS”) +and state financial regulators, have been examining the operations of cryptocurrency networks, cryptocurrency users and cryptocurrency +exchange markets, with particular focus on the extent to which cryptocurrencies can be used to launder the proceeds of illegal activities +or fund criminal or terrorist enterprises and the safety and soundness and consumer-protective safeguards of exchanges or other service-providers +that hold, transfer, trade or exchange digital assets for users. Many of these state and federal agencies have issued consumer advisories +regarding the risks posed by cryptocurrencies to investors. In addition, federal and state agencies, and other countries have issued rules +or guidance about the treatment of cryptocurrency transactions or requirements for businesses engaged in activities related to cryptocurrencies. +Depending on the regulatory characterization of the cryptocurrencies we mine, the markets for those cryptocurrencies in general, and our +activities in particular, may be subject to one or more regulators in the United States and globally. Ongoing and future regulatory actions +may alter, perhaps to a materially adverse extent, the nature of cryptocurrency markets and our cryptocurrency operations. Additionally, +U.S. state and federal, and foreign regulators and legislatures have taken action against cryptocurrency businesses or enacted restrictive +regimes in response to adverse publicity arising from hacks, consumer harm, or criminal activity stemming from cryptocurrency activity. +There is also increasing attention being paid by U.S. federal and state energy regulatory authorities as the total load of crypto mining +grows and potentially alters the supply and dispatch functionality of the wholesale grid and retail distribution systems. Many state legislative +bodies are also actively reviewing the impact of crypto mining in their respective states. +16 +For instance, the Cyber-Digital +Task Force of the DOJ published a report entitled “Cryptocurrency: An Enforcement Framework” in October 2020. This report +provides a comprehensive overview of the possible threats and enforcement challenges the DOJ views as associated with the use and prevalence +of cryptocurrency, as well as the regulatory and investigatory means the DOJ has at its disposal to deal with these possible threats and +challenges. Further, in early March 2021, the SEC chairperson nominee expressed an intent to focus on investor protection issues raised +by bitcoin and other cryptocurrencies. Furthermore, on March 9, 2022, President Biden signed an executive order on cryptocurrencies. While +the executive order did not mandate any specific regulations, it instructs various federal agencies to consider potential regulatory measures, +including the evaluation of the creation of a U.S. Central Bank digital currency. +Additionally, we are unable +to predict the effect that any future regulatory change, or any overlapping or unclear regulations, may have on us, but such change, overlap +or lack of clarity could be substantial and make it difficult for us to operate our business or materially impact the market for cryptocurrencies +that we mine or may mine in the future. FinCEN has issued guidance stating its position that it does not differentiate between fiat currency +(which FinCEN calls “real currency”) and cryptocurrencies that are convertible into fiat currency or other forms of convertible +virtual currencies (which FinCEN calls “virtual currency”) for purposes of determining whether a person or entity is engaging +in “money transmission services.” Persons and entities engaging in virtual currency activities that amount to “money +transmission services,” or otherwise cause them to be deemed a “money services business” under FinCEN’s regulations, +must register as a money services business, implement an “effective” anti-money laundering program and comply with FinCEN’s +reporting and recordkeeping requirements. +In May 2019, FinCEN issued +guidance relating to how the BSA and its implementing regulations relating to money services businesses apply to certain businesses that +transact in convertible virtual currencies. Although the guidance generally indicates that certain mining and mining pool operations will +not be treated as money transmission, the guidance also addresses when certain activities, including certain services offered in connection +with operating mining pools such as hosting convertible virtual currency wallets on behalf of pool members or purchasers of computer mining +power, may be subject to regulation. Although we believe that our mining activities do not presently trigger FinCEN registration requirements +under the BSA, if our activities cause us to be deemed a “money transmitter,” “money services business” or equivalent +designation, under federal law, we may be required to register at the federal level and comply with laws that may include the implementation +of anti-money laundering programs, reporting and recordkeeping regimes, and other operational requirements. In such an event, the required +registration and regulatory compliance steps may result in extraordinary, non-recurring expenses to us, as well as on-going recurring +compliance costs, possibly affecting an investment in our shares of common stock, operating results or financial condition in a material +and adverse manner. Failure to comply with these requirements may expose us to fines, penalties and/or interruptions in our operations +that could have a material adverse effect on our financial position, results of operations and cash flows. +According to the CFTC, at +least some cryptocurrencies, including Bitcoin, fall within the definition of a “commodity” under the U.S. Commodities Exchange +Act of 1936, as amended (the “CEA”). Under the CEA, the CFTC has broad enforcement authority to police market manipulation +and fraud in spot cryptocurrency markets in which we may transact. Beyond instances of fraud or manipulation, the CFTC generally does +not oversee cash or spot market exchanges or transactions involving cryptocurrencies that do not utilize margin, leverage, or financing. +The National Futures Association (“NFA”) is the self-regulatory agency for the U.S. futures industry, and as such has jurisdiction +over Bitcoin futures contracts and certain other cryptocurrency derivatives. However, the NFA does not have regulatory oversight authority +for the cash or spot market for cryptocurrency trading or transactions. In addition, CFTC regulations and CFTC oversight and enforcement +authority apply with respect to futures, swaps, other derivative products, and certain retail leveraged commodity transactions involving +cryptocurrencies, including the markets on which these products trade. +17 +The SEC has taken the position +that many cryptocurrencies may be securities under U.S. federal securities laws. Some senior members of the staff of the SEC have expressed +the view that Bitcoin and Ethereum are not securities under U.S. federal securities laws. However, such statements are not official policy +statements by the SEC and reflect only the speakers’ views, which are not binding on the SEC or any other agency or court and cannot +be generalized to any other cryptocurrency. The SEC’s Strategic Hub for Innovation and Financial Technology published a framework +for analyzing whether any given cryptocurrency is a security in April 2019; however, this framework is also not a rule, regulation or +statement of the SEC and is similarly not binding on the SEC. Notwithstanding that the SEC has not asserted regulatory authority over +Bitcoin or trading or ownership of Bitcoin and has not expressed the view that Bitcoin should be classified or treated as a security for +purposes of U.S. federal securities laws, the SEC has commented on Bitcoin and Bitcoin-related market developments and has taken action +against investment schemes involving Bitcoin. For example, the SEC has charged at least three Bitcoin mining companies in connection with +a Ponzi scheme to defraud investors in their mining operation. The SEC has also repeatedly denied proposed rule changes by exchanges to +list and trade shares of certain Bitcoin-related investment vehicles on public markets, citing significant investor protection concerns +regarding the markets for cryptocurrencies, including the potential for market manipulation and fraud. Although the SEC has not stated +that mining Bitcoin is itself a regulated activity, to the extent any cryptocurrencies we mine are deemed to be securities, the offer, +sale, and trading of those cryptocurrencies would be subject to the U.S. federal securities laws. +In addition to the SEC, state +securities regulators and several foreign governments have also issued warnings that certain cryptocurrencies may be classified as securities +in their jurisdictions, and that transactions in such cryptocurrencies may be subject to applicable securities regulations. Furthermore, +certain state securities regulators have taken the position that certain cryptocurrency mining operations may involve the offer of securities. +For example, the Texas State Securities Board (“TSSB”) has taken enforcement action against the operator of a cloud mining +company, whereby customers could purchase hash rate managed by the cloud mining company in exchange for a share of the mining reward, +for offering unregistered securities. +State financial regulators +such as the New York State Department of Financial Services (“NYDFS”) have also implemented licensure regimes, or repurposed +pre-existing fiat money transmission licensure regimes, for the supervision, examination and regulation companies that engage in certain +cryptocurrency activities. The NYDFS requires that businesses apply for and receive a license, known as the “BitLicense,” +to participate in a “virtual currency business activity” in New York or with New York customers, and prohibits any person +or entity involved in such activity from conducting activities without a license. Louisiana also has enacted a licensure regime for companies +engaging in a “virtual currency business activity,” and other states are considering proposed laws to establish licensure +regimes for certain cryptocurrency businesses as well. Some state legislatures have amended their money transmitter statutes to require +businesses engaging in certain cryptocurrency activities to seek licensure as a money transmitter, and some state financial regulators +have issued guidance applying existing money transmitter licensure requirements to certain cryptocurrency businesses. The Conference of +State Bank Supervisors also has proposed a model statute for state level cryptocurrency regulation. Although we believe that our mining +activities do not presently trigger these state licensing requirements in any state in which we operate or plan to operate, if our activities +cause us to be deemed a “money transmitter,” “money services business” or equivalent designation under the law +of any state in which we operate or plan to operate, we may be required to seek a license or register at the state level and comply with +laws that may include the implementation of anti-money laundering programs, reporting and recordkeeping regimes, consumer protective safeguards, +and other operational requirements. In such an event, the required registrations, licensure and regulatory compliance steps may result +in extraordinary, non-recurring expenses to us, as well as on-going recurring compliance costs, possibly affecting an investment in our +shares of common stock, our net income in a material and adverse manner. Failure to comply with these requirements may expose us to fines, +penalties and/or interruptions in our operations that could have a material adverse effect on our financial position, results of operations +and cash flows. +Overall, presently, we do +not believe any U.S. or State regulatory body has taken any action or position adverse to Bitcoin with respect to its production, sale, +and use as a medium of exchange; however, future changes to existing regulations or entirely new regulations may affect our business in +ways it is not presently possible for us to predict with any reasonable degree of reliability. +Further, following the appreciation +of the market price of Bitcoin in the second half of 2020, we have observed increasing media attention directed at the environmental concerns +associated with cryptocurrency mining, particularly its energy-intensive nature. We do not believe any U.S.-based regulators have taken +a position adverse to Bitcoin mining thus far. +As the regulatory and legal +environment evolves, we may become subject to new laws, such as further regulation by the SEC and other agencies, which may affect our +mining and other activities. For additional discussion regarding our belief about the potential risks existing and future regulation pose +to our business, see the “Risk Factors” herein. +18 +Environmental +The +perceived threat of climate change continues to attract considerable attention in the United States and around the world. Numerous proposals +have been made and could continue to be made at the international, national, regional and state levels of government to monitor and limit +emissions of greenhouse gases (“GHGs”). These efforts have included consideration of cap-and-trade programs, carbon taxes, +GHG disclosure obligations and regulations that directly limit GHG emissions from certain sources. In addition, President Biden identified +addressing climate change and the energy transition as priorities under his Administration. He has issued, and may continue to issue, +executive orders and regulatory directives related to climate change, and has recommitted the United States to long-term international +goals to reduce emissions. In recent years, the U.S. Congress has considered legislation to reduce emissions of GHGs and has included +climate change considerations in its funding bills. For example, the Inflation Reduction Act of 2022, which appropriates significant federal +funding for renewable energy initiatives, was signed into law in August 2022 and could accelerate the transition away from fossil fuels. +These laws, initiatives, and associated regulations or other national or regional commitments to reduce GHG emissions could adversely +affect fossil fuel consumption, require the installation of emissions control technologies, and increase the expense associated with the +purchase of emissions reduction credits or allowances to comply with current or future emissions reduction programs. +At +the federal level, the Environmental Protection Agency (“EPA”) has also adopted rules that, among other things, establish +construction and operating permit reviews, emissions control standards, and monitoring and annual reporting for GHG emissions from certain +large stationary sources. In November 2021, the Biden Administration released “The Long-Term Strategy of the United States: Pathways +to Net-Zero Greenhouse Gas Emissions by 2050,” which establishes a roadmap to net zero emissions in the United States by 2050 through, +among other things, improving energy efficiency, decarbonizing energy sources via electricity, hydrogen and sustainable biofuels, eliminating +subsidies provided to the fossil fuel industry, reducing non-CO 2 GHG emissions and increasing the emphasis on climate-related +risks across government agencies and economic sectors. Additionally, from time to time the EPA has proposed, revised, and adopted rules +establishing new source performance standards for certain pollutants from coal-fueled electric generating plants. +We +note that the implementation of the rule depends, in part, on the widespread development, adoption, and availability of carbon capture +and storage technology and solutions, which may not be certain at this time. We also note that this proposed rule is subject to intense +political debate and its adoption or implementation could be impacted by the results of the 2024 election cycle. While no final rule has +been published to date, this proposed rule and any other new agency action or rulemaking that applies to our facilities could increase +our compliance costs or otherwise materially restrict our operations. +At +the international level, the United States re-entered the United Nations-sponsored “Paris Agreement,” a non-binding agreement +for nations to limit their greenhouse gas emissions through individually determined reduction goals every five years after 2020, shortly +after President Biden took office in February 2021. Then, in April 2021, President Biden announced a new, more rigorous nationally determined +emissions reduction level of 50%-52% reduction from 2005 levels in economy-wide net GHG emissions by 2030. The international community +has since gathered again in November 2021, November 2022, and December 2023 for the annual United Nations Climate Change Conference of +the Parties, where the U.S., the European Union, and other partners announced reaffirmed their emissions reduction commitments and made +further climate change goals. Most recently, the parties agreed to transition “away from fossil fuels in energy systems in a just, +orderly and equitable manner” and increase renewable energy capacity so as to achieve net zero by 2050, although no timeline for +doing so was set. The impacts of these orders, pledges, agreements and any legislation or regulation promulgated to fulfill the U.S.’s +commitments under the Paris Agreement or other international conventions cannot be predicted at this time. +Governmental, +scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing financial, political, +and litigation risks in the United States and we anticipate that initiatives to reduce GHG emissions and restrict fossil fuel production +and consumption will continue to develop. Certain states, municipalities, community coalitions, and other parties, including proponents +of renewable energy that are opposed to the burning of fossil fuels have sought to further restrict GHG emissions and recover damages +from fossil fuel companies through lawsuits regardless of federal legislative and regulatory initiatives on the matter. Moreover, financial +risks could increase, as stockholders and bondholders currently invested in fossil fuel energy companies concerned about the potential +effects of climate change may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors. +Institutional investors who provide financing to fossil fuel energy companies also have become more attentive to sustainability issues +and some of them may elect not to provide funding for fossil fuel energy companies in the future. These litigation and financial risks +may result in restrictions or cancellations in our development activities, reduce demand for energy from fossil fuels, or otherwise adversely +impact our ability to raise capital and develop power generation facilities. Enhanced public and private support for low-carbon power +sources and products could impact the public perception of our business. Additionally, there is increased competitiveness of alternative +energy sources (such as Tier I alternative energy sources, including wind and solar photovoltaic) that do not generally have the adverse +impact to the environment that is associated with the combustion of fossil fuels and also are not subject to as much regulatory scrutiny +as are facilities that combust fossil fuels. +19 +Additionally, +increasing concentrations of GHG in the Earth’s atmosphere may produce climate changes that have significant physical effects, such +as increased frequency and severity of storms, droughts, floods, rising sea levels and other climatic vents. These climatic events have +the potential to cause physical damage to our facilities or disrupt our supply chains. Consequently, one or more of these developments +could have an adverse effect on our business, financial condition, results of operations, and cash flows. +Finally, +crypto asset mining has become more heavily scrutinized from a climate change and energy consumption perspective in recent years. Politicians, +regulators, environmental groups, and climate activists alike have called for increased oversight, regulation, and reporting of energy +use and GHG emissions of crypto asset mining companies, among other measures. Certain members of the U.S. Congress and other non-governmental +organizations have made investigations into, and published claims and reports regarding, the crypto asset mining industry’s impact +on global GHG emissions and energy consumption and raised concerns over the diversion of power sources for crypto mining and possible +impacts on consumer electricity prices. These individuals and groups have also urged regulatory agencies to investigate energy and +climate impacts of mining companies and to consider regulations requiring the monitoring and reporting of emissions and energy consumption +by certain crypto asset operations. For example, the Crypto Asset Environmental Transparency Act was introduced to the U.S. Senate on +March 6, 2023, and, if passed, would impose emissions reporting obligations on mining operations that consume electricity above a specified +threshold and would direct the EPA to investigate the environmental and climate impacts of the crypto asset mining industry. Separately, +in September 2022, the Biden Administration released its report on Climate and Energy Implications of Crypto-Assets in the United States, +which recommends that the federal government take action to develop environmental performance standards for crypto asset technologies, +assess the impact of crypto asset mining on electricity system reliability, and minimize emissions and other environmental impacts associated +with crypto asset mining, among other recommendations. More recently, in January and February 2024 the U.S. Energy Information Administration +(“EIA”) initiated a mandatory commercial cryptocurrency miner energy use survey. However, a federal district court granted +a temporary restraining order prohibiting the EIA from collecting data from certain Texas-based cryptocurrency miners who filed a lawsuit +against the energy use survey. Concurrently, the EIA has voluntary paused the survey in the rest of the country. Certain state governments +have also introduced legislation imposing restrictions on the crypto asset mining industry, citing similar concerns. We are unable to +predict whether currently proposed legislation or regulatory initiatives will be implemented, but any action by the federal government +or states in which we operate to restrict, limit, condition, or otherwise regulate our power production or crypto asset mining operations, +whether as part of a climate change or energy transition policy initiative or otherwise, could adversely affect our business, financial +condition, and results of operations. Similarly, public statements by government officials and non-governmental organizations regarding +the impact of crypto asset mining on global energy consumption, GHG emissions and grid stability, whether valid or not, could harm our +reputation and stakeholder goodwill. +Competition +Our business environment is +constantly evolving, and cryptocurrency miners can range from individual enthusiasts to professional mining operations with dedicated +data centers. We compete with other companies that focus all or a portion of their activities on cryptocurrency mining activities at scale. +We face significant competition in every aspect of our business, including, but not limited to, the acquisition of new miners, the ability +to raise capital, obtaining the lowest cost of electricity, obtaining access to energy sites with reliable sources of power, and evaluating +new technology developments in the industry. +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this Annual Report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies: +· Argo Blockchain PLC; +· Bit Digital, Inc.; +20 +· Bitdeer Technologies Group; +· Bitfarms Technologies Ltd.; +· Cipher Mining Inc.; +· CleanSpark, Inc.; +· Core Scientific, Inc.; +· Digihost Technology Inc.; +· Galaxy Digital Holdings Ltd.; +· Hive Blockchain Technologies Inc.; +· Hut 8 Mining Corp.; +· Iris Energy Limited; +· Marathon Digital Holdings, Inc.; +· Northern Data AG; +· Phoenix Group PLC; +· Riot Blockchain, Inc.; +· Stronghold Digital Mining, Inc.; and +· TeraWulf Inc. +Intellectual Property +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. +Accounting for Digital Currencies +Prior to the adoption of Accounting +Standards Update 2023-08, Intangibles - Goodwill and Other - Crypto Assets (Topic 350-60): Accounting for and Disclosure of Crypto +Assets , digital currencies were accounted for as intangible assets with indefinite useful lives and are recorded at cost less impairment +in accordance with Accounting Standards Codification (“ASC”) 350, Intangibles-Goodwill and Other . An intangible asset +with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances +occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Whenever the exchange-traded price of digital +currencies declines below its carrying value, we have determined that it is more likely than not that an impairment exists and record +an impairment equal to the amount by which the carrying value exceeds the fair value at that point in time. We have deemed the price of +digital assets to be a Level 1 input under the ASC 820, Fair Value Measurement , hierarchy as these were based on observable quoted +prices in the principal market for identical assets. Subsequent reversal of impairment losses is not permitted. +21 +Blockchain Background +Blockchain technology first +came to public attention in 2008 as the database technology that underpins Bitcoin, the world’s first cryptocurrency. Blockchains +are generally open-source, peer-to-peer software programs that act as decentralized digital ledgers, each comprising a series of data +“blocks” that are linked and secured using cryptography in a “chain.” The blockchain program consists of a software +protocol with several functions. The software protocol is run by multiple computer systems or “nodes.” For many blockchain +networks, each node has its own copy of the blockchain ledger, which contains a historical record of every transaction. The digital ledger +continuously grows as new blocks are added to it to record the most recent transactions in a linear, chronological order. The same information +is stored across a network of computers all over the world, and this record makes it possible to track the ownership and transfer of cryptocurrency +from the creation of the blockchain to its current state, and effectively, records of all account balances (as you can identify what account +holds what value through the decentralized ledger). +We do not operate a complete +node; rather, as noted above under the heading “Cryptocurrency Mining and Mining Pools,” we provide computing power to a pool +operator. +The blockchain protocol allows +users to submit transactions to the network for confirmation. However, a transaction will not be accepted by the protocol if the inputs +to the transaction have previously been used in another transaction. This prevention of “double spending” is a key security +feature of blockchain networks. +Another key function of the +blockchain that protects the integrity of the network is the hashing process, which acts as a tamper-evident seal that confirms the validity +of the new block and all earlier blocks. Hashing is the process of a block being posted to the network. Hashing results from miners, who +are responsible for receiving broadcast transactions, processing those transactions into new blocks and updating the blockchain with the +new blocks through hashing. The hashing process ties every new block to the existing block on the blockchain to ensure each is a continuous +record of verified transactions. +The hashing algorithm on a +proof-of-work blockchain network is a mathematical transformation function with two key properties. The first important function of hashing +is that the algorithm accepts any alphanumeric dataset as an input and produces a unique output code. The smallest change in the dataset +results in a significant change in the unique code. Any tampering of the dataset can be detected by re-hashing the data and checking for +a change in the unique code. Any user that runs the hash algorithm on the same data will derive the same unique code. Consequently, the +data on the distributed ledger can be run through a series of hash algorithms to create a unique code, which would reveal if any changes +to the ledger have been made. +Second, whenever a new set +or “block” of transactions is added to the ledger, it is appended with the code from the prior state of the ledger before +it is hashed. Thus, the hash created from the new block will incorporate the hash from the previous block. An alteration made to an earlier +block would make the hashes of all subsequent blocks invalid, as the discrepancy would be easily detected by future miners through the +protocols governing the blockchain. If a hacker were to attempt to make a change to an earlier block and broadcast it along with following +blocks to the other nodes on the network, that broadcast would be discarded in favor of one from a different node which complied with +the requirements of the protocol. +Thus, in addition to creating +new block, miners “vote” with their computer power, expressing their acceptance of valid blocks by working on adding them +to the blockchain, and rejecting invalid blocks by refusing to work on them. If a miner’s proposed block is added to the blockchain +by a majority of the nodes on the network, it is considered part of the blockchain. The nodes on the network synchronize with each other +to ensure that once a block is accepted by the majority, the new block will eventually be added to all the nodes. Thus, the historical +state of the ledger can be changed if control of more than 50% of the network is obtained; however, in the case of widely held cryptocurrencies +with non-trivial valuations, it may be economically prohibitive for any actor or group of actors acting in concert to obtain computing +power that consists of more than 50% of the network. +Unlike proof-of-work networks, +in which miners expend computational resources to compete to validate transactions and are rewarded cryptocurrency in proportion to the +amount of computational resources expended, in a proof-of-stake network, miners (sometimes called validators) risk or “stake” +assets to compete to be randomly selected to validate transactions and are rewarded cryptocurrency in proportion to the amount of assets +staked. Any malicious activity, such as mining multiple blocks, disagreeing with the eventual consensus or otherwise violating protocol +rules, results in the forfeiture or “slashing” of a portion of the staked assets. Proof-of-stake is viewed by some as more +energy efficient and scalable than proof-of-work. +Blockchain technology enables +the secure use and transfer of digital assets. “Digital asset” is a broad term that encompasses additional applications, including +ownership, transaction tracking, identity management, and smart contracts. A digital asset can represent physical or virtual assets, a +value, or a use right/service (e.g., computer storage space). +Whereas digital assets can +take many forms and be used for a variety of functions, cryptocurrencies are a type of digital asset that primarily function as a medium +of exchange, a unit of account, and/or a store of value. Cryptocurrencies allow anyone who holds a compatible wallet, anywhere in the +world, to hold and transfer that cryptocurrency without the need for an intermediary or trusted third party. Units of a cryptocurrency +may exist only as data on the internet, and often are not issued or controlled by any single institution, authority or government. Whereas +most of the world’s money currently exists in the form of electronic records managed by central authorities such as banks, units +of a non-government cryptocurrency exist as electronic records in a decentralized blockchain database. Because cryptocurrencies have no +inherent intrinsic value, the value of cryptocurrencies is determined by the value that various market participants place on them through +their transactions. Bitcoin, Ethereum and other cryptocurrencies have historically exhibited high price volatility relative to more traditional +asset classes. +22 +Private entities also issue +digital assets called “stablecoins” whose prices are pegged to those of an underlying fiat currency, a commodity or other +financial instrument or other physical asset and therefore less susceptible to volatility. Stablecoins can be backed by fiat money, physical +assets, or other crypto assets. Government institutions are also reportedly testing and considering issuing Central Bank Digital Currencies +(“CBDC’s”). While stablecoins or CBDC’s may exhibit less price volatility than other cryptocurrencies, both rely +on a central authority to establish the value of the asset, and therefore represent an exception to the general discussion of the design +of cryptocurrencies herein. +Each cryptocurrency has a +source code that comprises the basis for the cryptographic and algorithmic protocols, which govern the blockchain. The source code is +commonly open-source and therefore can be inspected by anyone, and is maintained on an ongoing basis through contributors proposing amendments +to the protocol, which are peer reviewed and adopted by consensus among participants on the blockchain network. These protocols govern +the functioning of the network, including the ownership and transfer of the cryptocurrency, and are executed on the decentralized peer-to-peer +blockchain infrastructure. The peer-to-peer infrastructure on which a blockchain operates is not owned or operated by a single entity. +Instead, the infrastructure is collectively maintained by a decentralized user base. Each peer user is generally known as a “node” +or “miner,” and each miner processes transactions on the network in accordance with the protocols of the relevant cryptocurrency. +As a result, these cryptocurrencies +do not rely on either governmental authorities or financial institutions to create, transmit or determine the value of units of cryptocurrency. +Rather: +· the creation of units of cryptocurrency generally is governed by the +source code, not a central entity; +· the transmission of a cryptocurrency is governed by the source code and processed +by the decentralized peer-to-peer network of nodes or miners; and +· the value of a cryptocurrency is generally determined by the market supply +of and demand for the cryptocurrency, with prices set in transfers by mutual agreement or barter, as well as through acceptance directly +by merchants in exchange for goods and services. +Cryptocurrencies may be open-source +projects with no official developer or group of developers that control the network. However, certain networks’ development may +be overseen informally by a core group of developers that may propose quasi-official releases of updates and other changes to the network’s +source code. The release of updates to a blockchain network’s source code does not guarantee that the updates will be automatically +adopted. Users and miners must accept any changes made to the source code by downloading the proposed modification of the network’s +source code. A modification of the network’s source code is effective only with respect to the users and miners that download it. +If a modification is accepted by only a percentage of users and miners, a division in the network will occur such that one network +will run the pre-modification source code and the other network will run the modified source code. Such a division is known as a “fork.” +Consequently, a modification to the source code becomes part of a blockchain network only if accepted by participants collectively having +most of the processing power on the network. +Each “account” +on a blockchain network is identified by its unique public key, and is secured with its associated private key (which the account holder +must keep secret, like a password). Cryptocurrencies are treated as bearer assets, because possession of the private key generally determines +who controls or owns a cryptocurrency. Protecting private keys from unwarranted access and theft is critically important, as once the +private key is taken, in most circumstances, control over the related cryptocurrency is gone. The combination of private and public cryptographic +keys constitutes a secure digital identity in the form of a digital signature. As long as the private key is kept private (i.e., confidential +to the owner of the account) it provides strong control of ownership. +23 +Ault Lending +Ault +Lending provides commercial loans to companies throughout the U.S. to provide them with operating capital to finance the growth of their +businesses. The loans range in duration from six months to three years. Ault Lending loans are made or arranged pursuant to a California +Financing Law license (Lic.no. 60 DBO77905). +Ault +Lending acquires controlling or non-controlling interests in and actively manages businesses that we generally believe (i) are undervalued +and have disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, +(iii) have the potential for positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, +and (v) have strong management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading +middle-market businesses in the niche-industrial and branded-consumer sectors. +Ault +Lending uses a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing +the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. +Ault +Lending believes that private company operators and corporate parents looking to sell their business units may consider us an attractive +purchaser because of our ability to: +· provide ongoing strategic and financial support +for their businesses, including professionalization of our subsidiaries at scale; +· maintain a long-term outlook as to the ownership +of those businesses; +· sustainably invest in growth capital and/or add-on +acquisitions where appropriate; and +· consummate transactions efficiently without being dependent on third-party +transaction financing. +In +particular, we believe that our outlook on length of ownership and active management on our part may alleviate the concern that many private +company operators and parent companies may have with regard to their businesses going through multiple sale processes in a short period +of time. We believe this outlook enhances our ability to develop a comprehensive strategy to grow the earnings and cash flows of each +of our businesses. +Finally, +it has been our experience that our ability to acquire businesses without the cumbersome delays and conditions typical of third party +transactional financing is appealing to sellers of businesses who are interested in confidentiality, speed and certainty to close. +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2023, we believe that these businesses have strong +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Ault Lending provides funding +to businesses through loans and investments. Ault Lending offers a variety of loan types including commercial loans, convertible notes +and revolving lines of credit. Ault Lending is engaged in providing commercial loans to companies throughout the United States to provide +them with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to 12 months, +but may be of longer duration. These terms are subject to change as market needs dictate, and Ault Lending anticipates offering additional +products in the future. +24 +Ault Lending uses its considerable +financial experience, data analytics, and a credit scoring model to assess the creditworthiness of each small business borrower applicant. +If the business meets Ault Lending’s criteria, Ault Lending sets the initial interest rate according to its credit and financial +models. The final interest rate offered to the borrower will be determined by Ault Lending’s interpretation of the marketplace. +In order to borrow from Ault Lending, borrowers must display characteristics indicative of durable business and financial situations. +These include factors such as revenue, time in business, number of employees, and financial and credit variables. In order to qualify, +business borrower applicants must be approved through Ault Lending’s underwriting process, which analyzes credit and financial data +of both the business and the business owner. Ault Lending takes into account several business factors (including revenue, age of business, +cash flows, and other variables). The underwriting process determines the loan amount to approve, how loans will be priced, and whether +to include a blanket lien is based on the above analysis, as well as additional factors (including length of loan, estimated default rates +by type and grade, and general economic environment). +Our Executive Committee, which +is comprised of our Executive Chairman, Chief Executive Officer and President, acts as the underwriting committee for Ault Lending and +approves all lending transactions. The Executive Committee has decades of experience in financial, investing and securities transactions. +Under its business model, Ault Lending generates revenue through origination fees charged to borrowers and interest generated from each +loan. Ault Lending may also generate income from appreciation of investments in marketable securities as well as any shares of common +stock underlying convertible notes or warrants issued to Ault Lending in any particular financing. +As noted above, we will from +time to time, through Ault Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2024, we anticipate +providing significant new funding to expand Ault Lending’s loan and investment portfolio. Ault Lending loans are made or arranged +pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +RiskOn International, Inc. +BitNile.com, Inc. +Overview +BNC is primarily engaged in +the development and operation of an online metaverse platform (the “Metaverse”). The Metaverse represents a significant development +in the online metaverse landscape, offering immersive, interconnected digital experiences that are inclusive, engaging, and dynamic. By +integrating various elements such as virtual markets, real world goods marketplaces and VIP experiences, gaming, social activities, sweepstakes, +gambling, and more, ROI aims to revolutionize the way people interact online. ROI’s virtual world, located at BitNile.com, is accessible +via any device using any web browser, without requiring permissions, downloads, or apps, and the platform can be enjoyed without the need +for bulky and costly virtual reality headsets. +BNC’s games operate +on a free-to-play model, whereby game players may collect coins free of charge through the passage of time and, if a game player wishes +to obtain coins above and beyond the level of free coins available to that player, the player may purchase additional coin packages (“Freemium” +gaming model). Once obtained, Nile Tokens and Nile Coins (either free or purchased) cannot be redeemed for cash or exchanged for anything +outside of the Metaverse. When coins are used and played in the games, the game player could “win” and would be awarded additional +coins or could “lose” and lose the future use of those coins. +BNC’s current and planned products and experiences +are: +· Virtual markets. The platform facilitates sales of virtual goods +and items from BNC as well as third party vendors like virtual real estate, digital art, user customizations, and unique collectibles. +· Real world goods marketplaces. The platform allows users to shop +for a diverse range of real world products and VIP experiences. +25 +· Gaming. The platform provides an extensive selection of gaming +options, including participation in games, sweepstakes and social gaming experiences, such as Blackjack and roulette. +· Sweepstakes gaming. The platform features a dedicated gaming +zone for users to engage in sweepstakes gaming, offering opportunities to win virtual and real money. +· Contests of skill. The platform organizes competitions for users +to showcase their talents and compete against others for prizes and recognition in various disciplines. +· Building private spaces. The platform allows users to construct +and customize their dream homes or private spaces. +· Socialization and connectivity. The platform’s ongoing +mission will be to foster global connections by enabling users to interact with individuals from around the world, forming new friendships, +collaborating on projects or engaging in conversations within various social hubs. +· Real and virtual concerts. BNC believes that the platform may, +in the future, host live and virtual concerts within the Metaverse, featuring performances from both real world and virtual artists, allowing +users to attend and enjoy shows in an immersive environment. +Business Strategy +The metaverse industry is +experiencing rapid growth and expansion, driven by advancements in technology, increased interest in virtual experiences and the rise +of digital economies. BNC’s business strategy revolves around creating a seamless, all-encompassing platform that caters to various +user needs and interests. +The strategic pillars for +the growth of the BitNile.com metaverse platform include (i) leveraging cutting-edge technology to offer a user-friendly, browser-based +platform compatible with virtual reality headsets and other modern devices for an enhanced experience, (ii) providing a diverse range +of products and experiences that caters to users with different interests and preferences, (iii) fostering global connections and a sense +of community among users, encouraging socialization and collaboration, and (iv) focusing on continuous innovation to stay ahead of industry +trends and customer expectations. +Competition +BNC faces competition from +existing metaverse platforms and new entrants. Key competitors include: +· Established metaverse platforms, such as Decentraland, The Sandbox, and Second +Life, as well as companies that develop metaverse tools and platforms such as META; +· Gaming-focused platforms, like Fortnite and Roblox; and +· Social media platforms that integrate metaverse elements, such as Facebook’s +Horizon Workrooms. +Regulatory Environment: Present and Future Challenges +As the metaverse industry +continues to grow and evolve, regulatory challenges and considerations are becoming increasingly important. The unique nature of the metaverse, +which often combines elements of virtual reality, gaming, social networking, and digital economies, presents a complex landscape for regulators +to navigate. +To navigate the complex and +evolving regulatory landscape, BNC will prioritize compliance with relevant laws and regulations in all jurisdictions where it operates. +This includes data privacy and protection regulations, gaming and sweepstakes regulations, and intellectual property rights. By maintaining +a strong focus on regulatory compliance, BNC aims to minimize potential legal risks and build trust with users and partners. +26 +Present Regulatory Challenges +The metaverse industry is +currently grappling with several regulatory challenges, including: +· Data Privacy and Security: As users share personal +information and engage in transactions within the metaverse, concerns about data privacy and security are paramount. Regulators must ensure +that platforms adhere to existing data protection regulations, such as the General Data Protection Regulation (“GDPR”) and +the California Consumer Privacy Act (“CCPA”); +· Intellectual Property Rights: The metaverse’s +reliance on user-generated content and virtual goods and items raises questions about intellectual property rights and the enforcement +of copyright, trademark, and patent laws in virtual environments; +· Taxation and Financial Regulations: The growth +of virtual economies and the increasing popularity of cryptocurrencies and non-fungible tokens have raised questions about taxation and +financial regulations. Regulators must determine how to classify and tax digital assets and transactions, as well as ensure compliance +with anti-money laundering and know-your-customer regulations; and +· Content Moderation and Liability: Metaverse platforms +face challenges in moderating content and managing user behavior, raising questions about the platforms’ liability for user-generated +content and potential violations of existing laws, such as those related to hate speech, harassment, and misinformation. +Future Regulatory Challenges +As the metaverse industry +continues to develop and expand, several future regulatory challenges are likely to emerge, including: +· Cross-border jurisdictional issues: With the +metaverse being a global, borderless environment, determining jurisdiction and applying national laws to activities and transactions within +the metaverse will become increasingly complex; +· Virtual reality and augmented reality regulations: +As VR and AR technologies become more integrated into the metaverse, new regulations may be needed to address issues related to safety, +privacy, and ethical considerations in the use of these technologies; +· Decentralization and governance: The increasing +trend towards decentralized metaverse platforms raises questions about governance and regulatory oversight, as traditional regulatory +mechanisms may not be applicable or effective in these environments; and +· Ethics and inclusivity: As the metaverse becomes more intertwined with daily +life, ethical considerations related to inclusivity, accessibility, and the potential for digital divides will become increasingly important +for regulators to address. +GuyCare +Overview +GuyCare, a subsidiary of ROI, +seeks to become a leading provider of comprehensive healthcare solutions tailored to address the unique needs of the male population. +Launched in 2023, GuyCare is building a consumer-centric platform that leverages innovative technologies, personalized treatments, and +a patient-focused approach to transform the way men access and receive care for their health and wellness needs. GuyCare’s mission +is to empower men worldwide to lead healthier, more fulfilling lives through the power of better health. +Addressing Unique Healthcare Needs +GuyCare recognizes the unique +healthcare challenges faced by men and strives to offer a wide range of innovative products and services to meet those needs. +27 +GuyCare’s portfolio +of products and services addresses critical areas of men’s health, including sexual health, hair restoration, weight management, +regenerative joint treatments, and overall well-being. GuyCare offers advanced treatments such as medication-based therapies, Acoustic +Wave Therapy for erectile dysfunction, and Platelet-Rich Plasma (“PRP”) injections for joint health, all delivered through +a user-friendly digital platform and a network of highly qualified healthcare professionals. +In the area of sexual health, +GuyCare provides treatments for erectile dysfunction, low testosterone, and premature ejaculation, utilizing medication-based therapies +and innovative procedures like Acoustic Wave Therapy. This non-invasive treatment uses high-frequency sound waves to improve blood flow +and promote tissue regeneration in the targeted area. +For hair restoration, GuyCare +offers medication-based treatments in the form of pills and topical applications, carefully formulated to promote healthy hair growth +and reduce hair loss. +Weight management solutions +include products such as Semaglutide, a medication that regulates appetite and promotes feelings of fullness, as well as alternative options +like weight loss pills. These treatments are selected based on their safety and efficacy profiles to support men in their weight loss +journey. +Regenerative joint treatments, +such as Adipose Derived Allograft and PRP injections, harness the body’s natural healing capabilities to promote tissue regeneration +and reduce inflammation in affected joints. These treatments are complemented by a range of vitamins and supplements formulated to support +joint health and overall well-being. +GuyCare’s platform enables +men to access these healthcare solutions conveniently and discreetly, connecting patients with highly qualified healthcare professionals +for personalized treatment plans. +Business Strategy and Market Differentiation +GuyCare’s business strategy +is centered around three key pillars: +· Trusted Brand . GuyCare strives to build +a brand that is trusted by customers, easy-to-use, and normalizes the practice of seeking and receiving treatment by empowering men with +personalized care and an omnichannel experience; +· Individualized Products and Services . +GuyCare leverages insights and customer feedback to offer personalized prescription and non-prescription treatments designed to meet individual +needs; and +· Clinical Excellence . The foundation of +GuyCare’s platform is the consumer trust established through clinical excellence. Care delivered through the platform is subject +to evidence-based clinical guidelines and provided by highly trained healthcare professionals to ensure consistency and quality. +GuyCare operates through a +hybrid model that integrates a proprietary telehealth platform with a physical clinic located in Utah. This approach enables GuyCare to +extend its geographic reach and provide accessible, confidential healthcare services to men across diverse locations. By leveraging technology +and personalized care, GuyCare aims to deliver high-quality services while emphasizing patient convenience and privacy. GuyCare competes +with established entities such as Hims and medRx. However, ROI believes that GuyCare’s comprehensive suite of offerings, unique +delivery model combining in-person and virtual care, and strategic partnership with ROI, provide GuyCare with the potential to navigate +market challenges effectively and capture a growing portion of the expanding men’s health sector. +Growth Opportunities +GuyCare, having recently entered +the market in 2023, is focused on several key growth strategies to establish itself as a competitive player in the men’s health +sector: +· Attracting New Customers . By leveraging +its innovative products and developing targeted, omnichannel acquisition strategies, GuyCare aims to attract new customers seeking treatment +for their specific health concerns, building brand recognition and trust in the process; +28 +· Nurturing Existing Customer Relationships . +As GuyCare expands its offerings and introduces personalized products, it seeks to foster long-term relationships with its existing customer +base, encourages subscription-based purchases and explores cross-selling opportunities to drive growth; +· Gradual Specialty Expansion . GuyCare is +carefully planning its specialty expansion, initially focusing on conditions that can be safely and effectively treated through its telehealth +platform, require ongoing customer engagement, and have well-established generic medications as treatment options. This measured approach +allows GuyCare to build a strong foundation before expanding into additional areas; and +· Exploring New Markets . While currently +focused on the U.S. market, GuyCare’s digital-first, cloud-based business model has the potential to be adapted to new markets and +languages in the future. As GuyCare grows and solidifies its position in the domestic market, it will explore potential international +expansion opportunities to extend its reach and impact on men’s health globally. +Regulatory Environment +As a consumer-focused health +and wellness company delivering comprehensive telehealth technologies, services, and products (both prescription and over the counter), +GuyCare is required to comply with complex healthcare laws and regulations, as well as consumer protection laws, at both the state and +federal levels. GuyCare’s business and operations are subject to extensive regulation in areas such as the practice of medicine, +use of telehealth, relationships with healthcare providers, privacy and security of personal health information and product safety. +· Government Regulation of Healthcare . While +GuyCare currently accepts payments only from customers and not from third-party payors, GuyCare remains subject to various healthcare +regulations that affect the industry as a whole and may impact customer use of its solutions; +· Practice of Medicine and Telehealth . GuyCare's +telemedicine services are currently licensed in four states, with plans to expand its operations to all 41 states that allow nurse practitioners +to operate telemedicine services that GuyCare provides. The approval of the licensing in these additional states is expected to occur +on a rolling basis in 2024. For the remaining nine states, which require such services to be provided by a licensed doctor, GuyCare is +seeking to contract with medical groups or hire licensed doctors to provide such services. GuyCare has established systems to ensure that +providers are appropriately licensed and that telehealth services are delivered in compliance with applicable rules; +· Affiliated Pharmacies . GuyCare contracts +with affiliated pharmacies to provide pharmaceutical services. When medication is prescribed, the client pays GuyCare directly for the +prescription, and GuyCare then sends the prescription to one or more mail order pharmacies that GuyCare contracts with, which then dispenses +the medication directly to the client; +· U.S. Federal and State Fraud and Abuse Laws. +Given its current operations, GuyCare believes that the Anti-Kickback Law, the federal False Claims Act, and the Stark Law should not +apply to its business. However, if the scope of these laws is extended or GuyCare begins accepting reimbursement payments from third-party +payors, it may become subject to these laws and need to modify its business model accordingly; +· U.S. Food and Drug Administration (“FDA”) +Regulation . Certain products available through GuyCare’s platform, as well as the third-party suppliers and manufacturers of +these products, are subject to extensive FDA regulation. GuyCare believes that its product promotion is conducted in material compliance +with FDA and other regulations. However, if the FDA determines that GuyCare’s product promotion constitutes promotion of an unapproved +use or unapproved product, GuyCare could face regulatory and/or legal enforcement actions; and +· Health Information Privacy and Security Laws . +GuyCare has developed and maintains policies and procedures to protect customers’ health and personal information, including the +adoption of administrative, physical, and technical safeguards. As GuyCare’s business operations continue to develop, it may collect +additional sensitive information from customers, creating further compliance obligations and increasing exposure to regulatory risks. +29 +Innovative Delivery Model +GuyCare operates through a +hybrid model comprising a single brick-and-mortar clinic and an advanced telehealth platform. This approach enables it to extend its reach, +offering accessible and confidential healthcare services to men across diverse geographic locations. By leveraging technology and personalization, +GuyCare strives to deliver exceptional care while prioritizing convenience and comfort for its patients. +Strategic Partnerships and Synergies +As part of ROI, GuyCare benefits +from shared resources, infrastructure, and expertise, enabling it to scale its operations efficiently. GuyCare’s growth strategy +revolves around expanding its clinic network, further enhancing its telehealth capabilities, and forging strategic partnerships and acquisitions +that align with GuyCare’s mission to improve men’s health outcomes globally. +Conclusion +GuyCare stands at the forefront +of men’s health and wellness, committed to delivering personalized, discreet, and comprehensive solutions that empower men to lead +healthier, more fulfilling lives. With GuyCare’s unwavering dedication to innovation, excellence, and patient-centered care, it +is poised to capitalize on the growing demand for specialized men’s healthcare services and make a meaningful impact on the well-being +of its clients nationwide. +Further, GuyCare is well-positioned +to capitalize on the growing demand for specialized men’s healthcare services by leveraging its brand, innovative products and services, +and commitment to clinical excellence. As GuyCare expands its clinic network, enhance its telehealth capabilities, and forge strategic +partnerships, it is poised to make a lasting impact on the well-being of men worldwide while driving long-term value. GuyCare’s +strong focus on compliance with the complex regulatory landscape governing healthcare, telehealth, and privacy ensures that it can navigate +the challenges and opportunities in the evolving men’s health market. +askROI.com +Overview +askROI.com, a division of +ROI, is a cutting-edge, AI-powered software-as-a-service platform designed to revolutionize the way businesses leverage their data for +competitive advantage. At the core of askROI.com’s technology is a state-of-the-art large language model (“LLM”), which +is exclusively licensed from a leading third-party provider for use in North America. This strategic partnership is anticipated to enable +askROI.com to harness the full potential of the LLM’s advanced natural language processing capabilities while ensuring compliance +with the highest standards of data security and privacy. +By seamlessly integrating +with a company’s existing tools and data sources, askROI.com goes beyond traditional search to deliver actionable insights, intelligent +analysis, and data-driven decision support. The platform’s LLM-powered technology allows it to interpret complex queries, identify +relevant information, and provide highly contextualized responses, all while continuously learning and adapting to each organization’s +unique language and terminology. +Whether it be empowering sales +teams to close deals faster, enabling support teams to resolve customer issues quickly, or providing administrators with real-time analytics, +askROI.com is poised to transform how businesses operate in the digital age. With its exclusive access to cutting-edge LLM technology +and commitment to delivering tangible business value, ROI believes that askROI.com sets a new standard for AI-powered insights and decision +support in the North American market. +askROI.com’s current +and planned product functionality are: +· Seamless Integration : askROI.com connects +with a wide range of business tools, including customer relationship management, cloud storage systems (OneDrive, Google Drive), and communication +platforms (Slack, Teams). Ongoing expansion of integration partnerships will further streamline data access and analysis; +· Contextualized Understanding : By leveraging +the power of its exclusively licensed LLM, askROI.com learns each company’s unique terminology, product names, and project codes, +providing highly relevant and tailored insights. Continuous enhancements to the platform’s natural language processing capabilities +will enable even more nuanced and context-aware analysis; +30 +· Actionable Insights : askROI.com analyzes +data to generate custom reports, draft data-rich presentations, and create visualizations like charts and graphs. Introduction of industry-specific +templates for reports, data visualizations, and analytics dashboards will provide additional value for users in targeted sectors; +· Transparency and Security : askROI.com +cites specific data sources for its answers and provides direct document links for reference. Robust data security measures, including +access controls, encryption, and audit trails, seek to ensure the protection of sensitive information. Future updates will focus on achieving +compliance with key regulations such as GDPR, SOC 2, and Payment Card Industry Data Security Standards; +· Ethical AI : Implementation of strict guidelines +and oversight mechanisms to ensure responsible development and use of askROI.com’s AI models, mitigating risks of bias, discrimination, +or misuse; and +· Partner Ecosystem : Development of a robust +network of consultancies, system integrators, and industry-specific solution providers to accelerate adoption and create tailored solutions +for diverse business needs. +By continually enhancing and +expanding askROI.com’s capabilities, ROI aims to position the platform as an indispensable tool for businesses seeking to leverage +their data for competitive advantage and operational excellence. +Business Strategy +askROI.com is currently in +beta testing, focusing on support and commercial applications. However, the platform’s flexible architecture and powerful AI capabilities, +underpinned by its exclusive licensing agreement for the LLM technology in North America, position it for broad applicability across industries. +The go-to-market strategy involves continued refinement of the core product based on beta user feedback, followed by a staged rollout +to additional sectors. +Key strategic initiatives +include: +· Leveraging the exclusive LLM licensing agreement +to differentiate askROI.com from competitors and establish a strong market position in North America. By emphasizing the unique capabilities +and benefits of the underlying LLM technology, askROI.com aims to attract customers through seeking cutting-edge AI solutions for their +business needs; +· Aggressive expansion of integration partnerships +to make askROI.com a seamless fit for a wide range of business tech stacks. By prioritizing integrations with the most widely used tools +and platforms, askROI.com aims to minimize adoption barriers and maximize its potential user base; +· Targeted marketing campaigns highlighting askROI.com’s +singular ability to turn a company’s own data into its most valuable competitive asset. These campaigns will focus on demonstrating +real-world use cases and ROI, showcasing how askROI.com can drive tangible business outcomes across various functions and industries; +· Development of a robust partner ecosystem, including +consultancies, system integrators, and industry-specific solution providers. These partnerships will serve to accelerate adoption by providing +customers with end-to-end solutions tailored to their specific needs, as well as offering valuable insights and feedback to guide future +product development; +· Continuous investment in research and development +to advance askROI.com’s AI capabilities and maintain a competitive edge in the rapidly evolving market. This will involve ongoing +collaboration with the LLM technology provider to ensure askROI.com remains at the forefront of natural language processing, machine learning, +and data analytics capabilities; and +· Establishment of a world-class customer success +program to ensure users are able to fully leverage askROI.com’s capabilities and achieve maximum value from the platform. This will +include comprehensive onboarding, training, and support resources, as well as regular check-ins and consultations to help customers optimize +their use of askROI.com over time. +31 +By adopting these strategic +initiatives and leveraging the exclusive LLM licensing agreement, askROI.com aims to establish itself as the leading AI-powered insights +engine for businesses in North America, setting the standard for data-driven decision-making and operational excellence. +Competition +ROI believes that askROI.com’s +unique positioning as an AI-powered insights engine that operates exclusively on a company’s own data, combined with its exclusive +licensing agreement for the state-of-the-art LLM technology in North America, sets it apart from both generic AI tools and other enterprise +search and analytics platforms. +Key differentiators include: +· Exclusive Access to Cutting-Edge LLM Technology : +askROI.com’s licensing agreement provides a significant competitive advantage, enabling the platform to leverage advanced natural +language processing capabilities available in the North American market; +· Seamless Integration with Existing Business +Tools : By minimizing disruption to established workflows and enabling rapid adoption, askROI.com will reduce barriers to entry and +increases its appeal to potential customers; +· Ability to Learn Company-Specific Language +and Context : askROI.com’s LLM-powered technology allows it to provide highly relevant and actionable insights tailored to each +organization’s unique needs, setting it apart from generic AI solutions; +· Focus on Delivering Actionable Insights : +askROI.com goes beyond simple data aggregation, empowering users to make informed decisions and drive tangible business outcomes; and +· Commitment to Data Security and Privacy : +By ensuring that sensitive information remains protected and compliant with evolving regulations, askROI.com addresses a key concern for +businesses considering AI-driven solutions. +ROI believes that as the market +for AI-driven business tools continues to grow, askROI.com is well-positioned to capture market share in North America through its powerful +capabilities, ease of use, and strong commitment to customer success. The exclusive LLM licensing agreement serves as a significant barrier +to entry for potential competitors, providing askROI.com with a sustainable competitive advantage in the region. +However, askROI.com recognizes +the potential for competition from established players in the enterprise software space, as well as from emerging startups focused on +AI-powered analytics and decision support. To mitigate these risks, askROI.com will focus on building a strong brand identity, cultivating +a loyal customer base, and leveraging its partner ecosystem to create advantages focused on its core offerings. +Ultimately, askROI.com’s +success will depend on its ability to consistently deliver value to customers, stay at the forefront of technological innovation, and +adapt to the evolving needs of the market. By remaining agile, customer-centric, and committed to its vision of empowering businesses +through AI-driven insights, askROI.com is confident in its ability to thrive in the face of competition and emerge as a leader in the +North American market. +Regulatory Environment (Present and Future) +The regulatory landscape for +AI and data-driven technologies is evolving rapidly, presenting both challenges and opportunities for askROI.com. ROI’s exclusive +licensing agreement for the LLM technology in North America adds an additional layer of complexity, as it must ensure compliance not only +with regional regulations but also with the terms and conditions of the licensing agreement itself. +On one hand, the increasing +focus on data privacy and security, as exemplified by regulations such as the GDPR, highlights the critical importance of responsible +data management and protection. This aligns closely with ROI’s core values and its commitment to ensuring the security and confidentiality +of customer data. +32 +On the other hand, the lack +of clear and consistent guidelines around the ethical development and use of AI technologies creates a degree of uncertainty for companies +operating in this space. As regulators and policymakers work to catch up with the rapid pace of technological advancement, there is a +risk of overregulation or fragmented regulatory frameworks that could hinder innovation and growth. +To navigate this complex regulatory +environment, askROI.com is proactively taking steps to ensure compliance with existing regulations while also staying ahead of potential +future developments, including: +· Collaborating closely with the LLM technology +provider to ensure that askROI.com’s use of licensed technology adheres to all relevant legal and ethical guidelines, both in North +America and in the provider’s home jurisdiction; +· Investing in robust data security measures and +processes, such as access controls, encryption, and audit trails, to safeguard customer data and maintain the highest standards of data +privacy; +· Developing and implementing strict guidelines +and oversight mechanisms for the ethical development and use of its AI models, drawing on best practices from industry leaders and academic +experts; +· Engaging with regulators, policymakers, and other +key stakeholders to provide input and guidance on the development of AI-related regulations, ensuring that askROI.com’s perspective +is heard and that future regulations are informed by practical realities; and +· Maintaining a commitment to transparency, both +in terms of how askROI.com uses and protects customer data, as well as in how its AI models are developed and deployed. This should help +to build trust with customers and demonstrate askROI.com’s dedication to responsible, ethical AI practices. +By proactively addressing +these regulatory considerations, staying at the forefront of industry best practices, and working closely with its LLM technology provider, +askROI aims to ensure its own compliance and success while delivering innovative AI solutions to its customers. +As the regulatory landscape +continues to evolve, askROI.com will remain vigilant and adaptable, always prioritizing the needs of its customers and the integrity of +its platform. By doing so, ROI is confident in its ability to navigate any regulatory challenges that may arise and emerge as a leader +in responsible, compliant AI innovation for businesses in the North American market. +RiskOn 360 +RiskOn 360, a wholly owned +subsidiary of ROI, is a company dedicated to organizing and hosting an annual global success conference that serves as a promotional vehicle +for ROI and its various offerings. The conference is designed to foster growth and success among attendees by providing a platform for +renowned speakers to share their experiences and strategies for achieving success in both their professional and personal lives. +The primary objective of the +RiskOn 360 conference is to educate and inspire attendees by exposing them to a wide range of success stories, innovative ideas, and best +practices from across various industries. By bringing together successful individuals from diverse backgrounds, RiskOn 360 aims to create +a unique learning environment that encourages networking, collaboration, and personal growth. +In addition to the annual +conference, RiskOn 360 is responsible for managing and coordinating the numerous speaking engagements of ROI’s representatives. +These speaking engagements serve as an important tool for promoting ROI’s overall objectives, educating potential clients and partners +about ROI’s offerings, and establishing ROI representatives as a thought leader in their respective fields. +Through its conference and +speaking engagement activities, RiskOn 360 plays a crucial role in supporting ROI’s mission to provide innovative solutions and +valuable insights to its clients, ultimately contributing to their success and growth. RiskOn 360’s efforts in organizing these +events not only help to strengthen ROI’s brand recognition but also provide a platform for showcasing ROI’s expertise and +capabilities to a wide audience. +33 +Circle 8 +Description of the Business +Headquartered in Houston, +Circle 8 is a premier lifting services provider serving clients in Texas, Oklahoma, Louisiana and New Mexico with five strategically located +branches in Texas and Oklahoma. Its modern fleet consists of 55 mobile all-terrain and hydraulic cranes, with lifting capacities of up +to 350 tons that provides services across the Eagle Ford, Permian, Delaware and Haynesville basins. Circle 8 is poised for organic growth +through a strengthened financial profile following its recapitalization in December 2022. Circle 8’s fleet consists of Grove, Xuzhou +Construction Machinery Group (“XCMG”) and other leading original equipment manufacturers. +Circle 8 provides experienced +professionally certified operators to deliver customized solutions to lifting clients in oil field services, construction, commercial, +refining / marketing and wind energy markets. Circle 8 maintains an industry leading safety record. Safety personnel hold certifications +and undergo in-house training. +New Management +In April 2023, Circle 8 hired +Arnold Mabee as its new CEO. Mr. Mabee has a longstanding, successful track record, as he was previously the President of Sterling Crane +USA, LLC (“Sterling Crane”), which has a portfolio of diverse cranes and locations serving multiple business segments. As +such, Mr. Mabee is responsible for one of the larger mobile crane companies in the US. +Prior to joining Sterling +Crane, Mr. Mabee was the Partner in Charge / Administration at R.S. Phillips Steel LLC, a fourth-generation family-owned Steel Service +Center that serves the Tri-State Area of New York, New Jersey and Pennsylvania. During his time there, Mr. Mabee pioneered several new +innovative ideas to enhance safety, compliance and productivity. +Mr. Mabee has thirty years +of operations and senior level management experience in a variety of industries including all aspects mobile crane & heavy haul services, +steel service centers and other industrial services businesses. Mr. Mabee has a long history of improving profitability, significantly +growing businesses, and where appropriate, taking them through successful restructuring and segmentation events. +Competitive Advantage +Circle 8’s operating +experience and the mid-sized diverse fleet that it has developed serves the oil services and petrochemical industries, providing full-service +lifting solutions with an industry leading safety record. Key strengths of Circle 8 include: +· Leading lifting solutions platform +○ Leading provider of comprehensive lifting solutions to diversified end markets, including oil & gas +and with expanding operations in infrastructure, plant turn-around and commercial/industrial construction; and +○ Leading market position with five branches strategically located throughout Texas and Oklahoma. +· Industry leading safety record, commitment and policy +○ Safety is a core value and Circle 8 is a market leader in employee training and practices; and +○ Dedicated team focused on safety programs. +· Proven strength of management, recently enhanced and augmented +○ Proven ability to navigate a secular downturn by maintaining strong customer relationships and scale operations +to capture additional market share; +○ Seasoned industry leaders who have positioned Circle 8 for future growth; and +○ Additional advisory team to supplement full time management with strategic industry knowledge, contacts +and corporate transaction capability. +34 +· High quality fleet with the opportunity to expand by 100% creates a barrier +to entry. Circle 8’s fleet of 55 cranes, as of the date of this Annual Report, comprises 45 all-terrain cranes and 10 hydraulic +truck cranes with a combined average age of 9 years and capacity of up to 350 tons. +· Diversified blue-chip customers +○ Entrenched provider to leading, well-capitalized oil and gas industry operators in Texas, New Mexico, +Louisiana and Oklahoma; +○ Diverse customer base with minimal customer concentration risk; and +○ Longstanding relationships enable company to easily scale up operations with customers’ demands +in the oilfield (upstream), commercial, construction, refining & marketing (downstream) and wind energy markets. +· Compelling utilization and financial profile +○ Recently downsized underutilized cranes to return to pre-pandemic fleet utilization over 160%; and +○ Substantial upside remains as the Company efficiently relocates and repurposes its fleet across geographies +and end markets. +Industry +There continues to be some +consolidation within the industry recently, including the acquisitions of Rental Services Corporation, NES Rentals, Neff Corporation and +Ahern Rentals by United Rentals, Inc. (“URI”) and the acquisitions of Contractors Building Supply Co. and Cloverdale Equipment +Co. by Herc Holdings, Inc. (“HRI”). However, the U.S. lifting solution equipment distribution and rental industry remains +highly fragmented and consists mainly of a small number of multi-location regional or national operators and a large number of relatively +small, independent businesses serving discrete local markets. The industry is driven by a broad range of economic factors including total +U.S. residential and non-residential construction trends, construction machinery demand, demand for rental equipment and additional, region-specific +factors. Lifting solutions equipment is largely distributed to end users through two channels: equipment rental companies and equipment +dealers. Examples of equipment rental companies include URI, Sunbelt Rentals, and HRI. Examples of equipment dealers include Finning and +Toromont. Circle 8 operates substantially in a segment of the rental business whereby Circle 8 provides all labor and consumables to complete +a project or an assignment. Like Circle 8, many other pure equipment rental companies may also provide parts and service support to customers. +Sales and Marketing +Led by Phillip Bryson and +Brett Rhuland, the sales force is highly specialized in lifting solutions sales to oil services customers, seeking long term purchase +orders and master service agreements. Circle 8 plans to continue the extensive training program which involves original equipment manufacturer +(“OEM”) training sessions on operations and maintenance to ensure the entire sales force knows the fleet inside and out. +Circle 8 will be working with +continuing management to implement a back-office content resource management system that will be heavily focused on data collection so +that it can continue to improve margin and help streamline scheduling, operations and fleet management to optimize utilization. +Competitive Business Strategy +The oil services’ lifting +solutions demand has historically been one of the leading sub-segments of the industry for profitability due to high utilization rates +that coincide with the continuous workstreams of extraction. Circle 8 plans to expand this business line in both topline sales through +optimizing service and quality operations with a strong safety record. +In addition to expanding the +existing business, Circle 8 will seek to make additional forays into the infrastructure construction, the refinery and manufacturing plant +turn-around and industrial facility construction with the availability of new cranes as they become available. +Customers +With a focus on the oil services +sub-segment of the lifting solutions business in the Eagle Ford, Haynesville, Permian, Delaware and Anadarko basins, Circle 8 has a diversified +base of blue-chip customers in TX and OK. While about a third of its sales are expected to be made up from six of the largest players +in the industry, the remaining two thirds of sales will be highly diversified, leading to minimal concentration risk. With its longstanding +relationships with blue-chip customers and incoming fleet units, Circle 8 believes it has the ability to scale up sales with these customers +locally and most likely into other adjacent areas. +35 +Competition +Due to the highly skilled +nature and competitive nature of the lifting solutions business, the sector typically consists of companies like Circle 8 that provide +full service lifting solutions on rental or contract basis, including the manpower required to operate the equipment or companies that +require extensive lifting solutions straight purchasing the equipment and hiring crane operators directly. +The full-service lifting solutions +business is highly fragmented and local with only a few national service providers. In Circle 8’s existing subsegment of the lifting +solutions business to the petrochemical industry, the competition is not as strong as it is in others as the contract terms are usually +longer term and driven by maintaining strong customer relationships. The diversification strategy for Circle 8 into other subsegments +will be faced with competition that is largely driven based on availability, quality (including safety record), reliability and price. +Environmental and Safety Regulations +Circle 8’s equipment, +facilities and operations are subject to comprehensive and frequently changing federal, state and local environmental and occupational +health and safety laws, which may vary locally. These laws regulate (1) the handling, storage, use and disposal of hazardous materials +and waste and, if any, the associated cleanup of properties affected by pollutants; (2) air quality (emissions); and (3) wastewater. While +lifting solutions’ operations generally do not raise significant environmental risks, Circle 8 uses petroleum products, solvents +and other hazardous substances for fueling and maintaining its fleet and vehicles. Circle 8 has made, and will continue to make, capital +and other expenditures to comply with environmental requirements. Circle 8 does not currently anticipate any material adverse effect on +its business, financial condition or competitive position as a result of its efforts to comply with such requirements. +In the future, federal, state +or local governments could enact new or more stringent laws or issue new or more stringent regulations concerning environmental and worker +health and safety matters, reporting and disclosure obligations, or effect a change in their enforcement of existing laws or regulations, +that could affect operations and increase operational and compliance expenditures. Also, in the future, contamination may be found to +exist at Circle 8’s facilities or off-site locations where waste has been sent. There can be no assurance that Circle 8, or various +environmental regulatory agencies, will not discover previously unknown environmental non-compliance or contamination. Circle 8 could +be held liable for such newly discovered non-compliance or contamination. It is possible that changes in environmental and worker health +and safety laws or liabilities from newly discovered non-compliance or contamination could have a material adverse effect on Circle 8’s +business, financial condition and results of operations. +AGREE +AGREE has invested in various +classes of commercial and residential real estate including hospitality, multifamily, and industrial properties targeting the middle market +segment in locations demonstrating relative value. AGREE’s objective is to generate risk adjusted returns through development, capital +investment and operational improvement. AGREE owns and operates both Third Avenue Apartments and AGREE Madison. +In September 2023, we committed +to a plan for our wholly owned subsidiary AGREE to list for sale its four recently renovated Midwest hotels, the Hilton Garden Inn in +Madison West, the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford. The decision to +sell the hotels follows the decision to also list the multifamily development site in St. Petersburg, Florida and is driven by our desire +to focus on our core businesses, Energy, Fintech and Sentinum. We plan to use the proceeds from the sales of the hotel properties to pay +off debt and commit more capital to our core businesses. Our real estate properties, which include both hotels and land, are currently +listed for sale. +In connection with the planned +sale of AGREE’s assets, we concluded that the net assets of AGREE met the criteria for classification as held for sale. In addition, +the proposed sale represents a strategic shift that will have a major effect on our operations and financial results. As a result, we +have presented the results of operations, cash flows and financial position of AGREE as discontinued operations in the accompanying consolidated +financial statements and notes for all periods presented. +36 +SMC +Overview +SMC +is a consumer electronics manufacturer of retail karaoke products. Based in Fort Lauderdale, Florida, and founded over forty years ago, +SMC is primarily engaged in the development, marketing, and sale of a wide assortment of at-home and in-car consumer karaoke audio equipment, +accessories, musical recordings and products. SMC’s portfolio is marketed under both proprietary brands and licenses, including +Carpool Karaoke and Sesame Street. SMC’s products are sold in locations worldwide, primarily through mass merchandisers and warehouse +clubs, on-line retailers and to a lesser extent department stores, lifestyle merchants, direct mail catalogs and showrooms, music and +record stores, and specialty stores. +Recent Developments +Private Placement +On +November 20, 2023, SMC entered into an agreement to sell $2,000,000 in common stock through a private placement of common stock. The +private placement was completed with two affiliates, both of which were existing shareholders with representation on SMC’s board +of directors. The private placement was completed at $0.91 per share of SMC’s common stock, with a total of approximately 2,199,000 +shares issued. Net proceeds from the transaction were approximately $1,900,000, net of transaction fees of approximately $100,000. During +the six-month period after the closing date, the purchasers may make a written request for registration under the Securities Act of 1933, +as amended, of all or any portion of the shares purchased. +As +a result of the transaction, our share ownership of SMC was diluted to approximately 28%. Due to the significant change in our +ownership and voting rights, we determined that we no longer met the criteria of the primary beneficiary and, accordingly, we deconsolidated +SMC as of November 20, 2023. We recorded a $3.0 million loss on deconsolidation for the year ended December 31, 2023. +Upon +deconsolidation, we recorded our $2.3 million retained investment in SMC based upon the fair value of the common shares held by us +at November 20, 2023. Due to our significant influence over SMC, we began accounting for our retained interest under the equity method +of accounting. +Hospitality Lease +On +August 23, 2023, MICS Nomad, LLC, a Delaware limited liability company (“MICS NY”), a wholly owned subsidiary of MICS, entered +into an Agreement of Lease (the “Lease Agreement”) with OAC 111 Flatiron, LLC and OAC Adelphi, LLC (the “Landlord”), +pursuant to which MICS NY agreed to lease approximately 10,000 square feet of ground floor retail space and a portion of the basement +underneath the ground floor retail space in the property located at 111 West 24 th Street, New York, New York (the “Premises”). +MICS NY intends to use the Premises as a new karaoke venue, offering immersive karaoke technology and audio-visual capabilities, with +restaurant and bar offerings. +The +term of the Lease Agreement is for fifteen (15) years, or on such earlier date upon which the term shall expire, be canceled or terminated +pursuant to any of the conditions or covenants of the Lease Agreement. Pursuant to the Lease Agreement, MICS NY is obligated to pay an +initial base rent in the amount of $30,000 beginning August 1, 2024, with scheduled increases over the term, as set forth in the Lease +Agreement. +TurnOnGreen +Overview +TurnOnGreen, +Inc. (formerly known as Imperalis Holding Corp.), a Nevada corporation (“TOG”), through its wholly owned subsidiaries Digital +Power Corporation (“Digital Power”) and TOG Technologies Inc. (“TOGT”), is engaged in the design, development, +manufacture and sale of highly engineered, feature-rich, high-grade power conversion and power system solutions for mission-critical +applications and processes. For more than 50 years, Digital Power has been devoted to the perfection of power solution products that +have enabled customer innovation in complex applications covering a wide range of industries. A natural outgrowth of TOGT’s development +of these power systems has been its effort to apply TOG’s proprietary core power technologies to optimizing the design and performance +of electric vehicle (“EV”) charging solutions. TOGT began commercial sales of its product line of high-speed charging solutions +in mid-2021. TOG believes that its charging solutions represent an entire generation of new chargers due to improvements in terms of +size reduction in electronic circuitry and higher output density. TOG also believes that, by leveraging its experience and expertise +in power conversion and generation, it can become a leader in the EV charging solution market. +37 +At +Digital Power, TOG provides a comprehensive range of integrated power system solutions that are designed to meet the diverse and precise +needs of its customers with the highest levels of efficiency, flexibility and scalability. TOG designs, develops and manufactures custom +power systems to meet performance and/or form-factor requirements that cannot be met with standard power products. These power system +solutions are designed to function reliably in harsh environments associated with defense and aerospace applications, while also being +utilized for applications ranging from industrial and telecommunications equipment to medical instrumentation. TOG believes that Digital +Power’s power products are highly adaptive and feature digital power management and software configurations that allow them to achieve +higher power efficiency to meet the requirements of both its customers and its OEMs. In addition to Digital Power’s custom power +system solutions, it also provides a wide range of industry-standard power products. These products include the AC/DC Open Frame product +series, which TOG believes to be among the industry’s leading power switchers in terms of power efficiency. The Open Frame products +are deployed in highly compact form factors and modular power series that support configurable multiple DC outputs. Additionally, Digital +Power offers high-power and high-voltage laser power supplies tailored to meet the unique requirements of medical, dental, and industrial +pulsed energy systems. Digital Power’s expertise also encompasses high-performance and high-power data-center power supplies, semiconductor +fabrication equipment power source supplies, desktop power supplies, and a comprehensive range of value-added customized AC/DC and DC/DC +ruggedized power supply and system solutions. +TOGT’s EV Charging +Solutions +TOG +formed TOGT following more than two years of engineering design and product prototypes, to provide EV drivers of all types with easy access +to convenient, reliable and high-speed EV charging solutions. TOGT offers Level 2 AC charging infrastructure for use in single family +homes, multi-family unit developments, parking garages and lots, commercial retail properties and fleet environments. TOGT provides Level +3 DC fast charger infrastructure for high traffic, high density urban, suburban, exurban locations, and portable microgrid charging infrastructure. +Prior to August 2021, Digital Power operated the EV business presently conducted by TOGT. TOGT’s EV charging solutions are designed +to address what TOG expects to be a rapid expansion of infrastructure required to support broad adoption of EVs globally. With more +than 50 years of expertise in power technology, TOGT provides EV charging solutions to enable the eMobility of +tomorrow. TOGT’s innovative charging solutions produce a full charge for an EV with a 250-mile range battery in approximately 30 +minutes. TOGT provides a wide range of EV charging solutions, including a Level 2 AC charging product +line compatible with the SAE J1772 standard, and a Level 3 DC fast charging product line compatible +with the combined charging system standard and the CHArge de MOve (“CHAdeMO”) standard. +TOGT’s +network is capable of natively charging (i.e., charging without an adapter) all EV models and supports all charging standards currently +available in the United States. Its network can serve a wide variety of private, retail, commercial and fleet customers. TOGT’s +charging systems maintain what TOG believes to be the highest standards in the market and are backed by an internationally recognized +certificate of safety and performance. TOG anticipates rapid growth in the number of EVs in North America, and TOG intends to expand TOGT’s +network of charging stations to accommodate this growth while prioritizing development of locations with favorable traffic and utilization +characteristics. +GIGA +Gresham Worldwide, Inc., formerly +Giga-tronics, Incorporated (“GIGA”) designs, manufactures and distributes purpose-built electronics equipment, automated test +solutions, power electronics, supply and distribution solutions, as well as radio, microwave and millimeter wave communication systems +and components for a variety of applications with a focus on the global defense industry and the healthcare market. +GIGA has two subsidiaries, +Gresham Holdings, Inc. (“Gresham Holdings”) and Microsource Inc. (“Microsource”). GIGA also has a division. GIGA +is a majority owned subsidiary of the Company and currently operates as an operating segment of AAI. Gresham Holdings has three wholly +owned subsidiaries, Gresham Power Electronics Ltd. (“Gresham Power”), Relec Electronics Ltd. (“Relec”), and Enertec +Systems 2001 Ltd. (“Enertec”), and one majority owned subsidiary, Microphase Corporation (“Microphase”). GIGA’s +operations consist of three business segments: +· Radio Frequency Solutions (“RF Solutions”) +– consists of Microphase which is located in Connecticut. Microphase designs and manufactures custom microwave hardware products +for military applications and generates revenue primarily through production contracts for custom engineered components and RADAR filters; +· Precision Electronic Solutions – consists +of two subsidiaries and one division. The subsidiaries are Enertec located in Israel and Microsource located in California. The division +is referred to as the Giga-tronics Division. Enertec develops and supplies advanced command & control, test and calibration systems +for use in failsafe military and medical applications. The legacy business of Giga-tronics (the “Giga-tronics Business”) consists +of Microsource, a wholly owned subsidiary that develops and manufactures sophisticated RADAR filters used in fighter aircraft, and the +Giga-tronics Division which markets “EW Test and Training,” which serves the defense electronics market with a signal generation +platform; and +· Power Electronics & Displays – consists +of two subsidiaries, namely Relec and Gresham Power located in the United Kingdom (the “UK”) which primarily engineer and +provide integrated, mobile power electronics and display solutions that distribute and supply continuous, dependable, clean low voltage +power. +GIGA is focused on products +that are getting designed in to military systems such as fighter jet, ships and ground vehicles or missiles, which provide a recurring +revenue stream for years to come and decrease competition because the cost of replacing designed in products is prohibitive for both the +competition and the customer. +38 +GIGA operates both within +the U.S. and at three locations abroad. A summary of GIGA’s locations and high level review of its operations at each facility is +provided in the table below: +Name +Location +Nature of Business +Corporate Headquarters +Scottsdale, Arizona +Offices +Microsource and Giga-tronics Division +Livermore, California +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +Microphase Corporation* +Shelton, Connecticut +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +Enertec Systems 2001 Ltd. +Karmiel, Israel +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +Relec Electronics Ltd. +Wareham, Dorset, England UK +Offices and warehouse operations +Gresham Power Electronics Ltd. +Salisbury, Wiltshire, England UK +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +* 63% owned +Industry +GIGA’s operations focus +exclusively on the market for electronic solutions that support the defense industry and other mission critical applications, including +medical technology, transportation, and telecommunication. The essential nature of these applications provides a degree of insulation +from volatility associated with other segments of the global economy while accounting for stability and steady growth of the addressable +market opportunities available in segments that GIGA serves. Demand for solutions to meet these requirements continues unaffected, and +in many instances increases in times of global crisis. Total defense spending in the three countries in which we currently operate was +expected to total more than an estimated $919 billion in 2023 (https://www.globalfirepower.com/defense-spending-budget.php). +GIGA sells to the militaries and defense contractors in 15 other countries as well. Overall global defense spending hit $2.1 trillion +in 2023 and is expected to grow at a compounded annual growth rate (“CAGR”) of 3% through 2028 with U.S. spending continuing +to lead the world in the same period (ASD Reports, Global Defense Budget Analysis - Forecast to 2028). The current wars in the Ukraine +and Israel and tensions with China and in the Middle East have intensified interest and investment in defense platforms throughout the +UK and Europe. +GIGA believes that the increasing +emphasis on electromagnetic spectrum operations and close coordination of air, land, sea, space and cyber operations will fuel an increase +in defense modernization, force protection and situational awareness, all of which will drive increased spending in procurement of components +and systems to enable electronic warfare, countermeasures and unattended solutions. The Defense Electronics Market was estimated +to be $220.3 billion in 2023 and is projected to reach $ 289.0 billion by 2028, at a CAGR of 5.6%. (https://www.marketsandmarkets.com/Market-Reports/defense-electronics-market-183642563.html). +The drive for greater connectivity and analytics will in turn increase demand for radio frequency (“RF”) communications, power +electronics and electronic control solutions content in new major military platforms, which are the core offerings of GIGA’s operating +units. +Thousands of companies compete +in this market to deliver electronics solutions to meet defense and other mission critical applications. However, GIGA’s operating +units have longstanding relationships with dominant defense contractors in the U.S., in the UK, in Israel and other countries who hold +contracts for major defense platforms with very long life cycles. GIGA’s customers typically have unique needs, and they engage +with GIGA in funding development contracts for custom solutions. Once a solution is proven in its application, GIGA typically realizes +a secure, recurring revenue stream for products, services and/or repairs for many years (sometimes decades) until the technology +becomes outdated. Because GIGA is often sole-sourced for developmental projects, GIGA believes that it is unlikely that a competitor +will replace such a designed-in product as the cost and re-qualification time to do so is prohibitive. These relationships enable us to +narrow the field of competition considerably and grow based on repeat business with relatively low selling costs. As technology evolves, +prime contractors may, over subsequent years, migrate to systems other than those GIGA produces. +Beyond the defense arena, +initiatives to complete $42 billion in upgrades to the current National Railway System in the UK over the next three years while spending +$115 billion over the next 10 years to build high speed rail to link London with the Midlands cities of Birmingham, Leeds and Manchester +will generate significant opportunities for growth in demand for power electronics to upgrade and replace current infrastructure, both +in rolling stock and track side controls. Relec’s current relationships and track record for supplying power solutions to the UK +rail industry position us ideally to capitalize on these ongoing refurbishment and expansion efforts. A similarly robust market in the +medical power supply markets with a compound annual growth rate of 6.9% to reach $1.8 billion in 2025 creates growth opportunities for +Relec in the UK. Increases in contracts for the precision manufacturing of medical diagnostic and calibration tools drive growth opportunities +for Enertec as well. +39 +Business +Strengths +GIGA has the following core +strengths that its management believes give it a competitive advantage: +· Developing and producing classified military +products requiring a Sensitive Compartmented Information Facility and personnel with appropriate security clearances. These +products are designed-in to military systems such as fighter jets, military ships and vehicles; +· Military grade quality (AS9100), ultra-reliable +technology offerings with elegant designs and precision “high touch” manufacture that stand the test of time, narrow the field +of competition and command enhanced operating margins; +· Enduring relationships with “blue chip” +customers in the defense market provide stable revenue growth and reduce sales cost; and +· Substantial growth in backlog of orders with +definite delivery dates for solutions engineered into long life cycle platforms that provide revenue base for years to come. Global operations +expand GIGA’s market opportunities, extend its operational reach and diversify its business base. +Strategy +GIGA’s goal is to become +the supplier of choice for the major players in the defense industry and provide solutions for mission critical applications in health +care. +GIGA’s near-term strategies +are focused on developing synergies as a result of the acquisition of Gresham Holdings: +· Gresham Holdings incurred major overhead expenses +being a subsidiary of a larger company. GIGA incurred large expenses being a public company with very limited sales. GIGA is combining +the overhead functions, shrinking its leased facilities and focusing on cost reductions; +· Consolidate duplicate functions and reduce the +costs of sales, human resources, information technologies, quality management and contracts administration; and +· Combine the RF Solutions group into one subsidiary +and reduce operating costs. +In addition, GIGA is focused +on securing sufficient working capital to execute on a substantial backlog of orders with definite delivery dates, take on additional +significant orders and further improve access to capital resources. +GIGA’s long-term strategy +includes the following key elements: +· maintain, strengthen and expand relationships +with current customers, by increasing on-time delivery, diversifying solutions offered and maximizing quality of solutions; +· acquire designed-in products or companies. GIGA +believes that there are many small well run, profitable defense contractors whose principal owner is nearing retirement which could be +attractive acquisition targets; +· attract new customers through building business +development, marketing and sales infrastructure to raise market awareness and identify opportunities early in the design process; +· take advantage of the cross-selling opportunities +among GIGA’s operating subsidiaries to leverage current resources; and +· enhance GIGA’s geographic footprint by +increasing marketing outreach, forming alliances with leading companies located in areas beyond its current reach and acquiring businesses +that expand reach into other geographies. +40 +Our +Strategy +Our business strategy is designed +to increase shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +shareholder value, such as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase cash flows +and stockholder value. Ault Alliance actively oversees and supports the management teams of each of our businesses by, among other things: +· recruiting and retaining talented managers to +operate our businesses using structured incentive compensation programs, including non-controlling equity ownership, tailored to each +business; +· regularly monitoring financial and operational +performance, instilling consistent financial discipline, and supporting management in the development and implementation of information +systems to effectively achieve these goals; +· identifying and aligning with external policy +and performance tailwinds such as those influenced by growing climate, health, and social justice concerns (and similar environmental, +social and governance (“ESG”) drivers); +· assisting management in their analysis and pursuit +of prudent organic growth strategies; +· identifying and working with management to execute +attractive external growth and acquisition opportunities; +· assisting management in controlling and right-sizing +overhead costs; +· nurturing an internal culture of transparency, +alignment, accountability and governance, including regular reporting; +· professionalizing our subsidiaries at scale; +and +· forming strong subsidiary level boards of directors to supplement management +in their development and implementation of strategic goals and objectives. +41 +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Ault Alliance to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +· making selective capital investments to expand +geographic reach, increase capacity, or reduce manufacturing costs of our businesses; +· investing in product research and development +for new products, processes or services for customers; +· improving and expanding existing sales and marketing +programs; +· pursuing reductions in operating costs through +improved operational efficiency or outsourcing of certain processes and products; and +· consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +· leverage manufacturing and distribution operations; +· leverage branding and marketing programs, as +well as customer relationships; +· add experienced management or management expertise; +· increase market share and penetrate new markets; +and +· realize cost synergies by allocating the corporate overhead expenses of our +businesses across a larger number of businesses and by implementing and coordinating improved management practices. +Compliance with Material Government (Including +Environmental) Regulations +Sentinum +Sentinum is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. Sentinum continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While Sentinum’s regulatory compliance +costs are currently not considered material, it is possible that costs incurred to ensure continued environmental compliance could have +a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Michigan Facility is subject +to a final corrective measures plan with the Environment Protection Agency. The seller performed remedial activities at the Michigan Facility +relating to historical soil and groundwater contamination and Sentinum is responsible for ongoing monitoring and final remediation plans. +We estimate cost of the environmental remediation obligation is approximately $0.4 million and reflects our best estimate of probable +future costs for remediation based on the current assessment data and regulatory obligations. Future costs will depend on many factors, +including the extent of work necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. +We may incur actual costs in the future that are materially different than this estimate and such costs could have a material impact on +results of operations, financial condition, and cash flows during the period in which they are recorded. +TurnOnGreen +TurnOnGreen’s businesses +are heavily regulated in most of its markets. TurnOnGreen handles power electronics products mainly in the form of power conversion. TurnOnGreen +must take into account several standards for electronic safety to protect the health of humans and animals. TurnOnGreen serves diverse +markets including automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set +of safety regulations and standards that TurnOnGreen must comply with. +42 +Government Contracts . +The U.S. Government, and other governments, may terminate any of TurnOnGreen’s government contracts at their convenience, as well +as for default based on our failure to meet specified performance requirements. If any of TurnOnGreen’s U.S. Government contracts +were to be terminated for convenience, TurnOnGreen would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of TurnOnGreen’s government contracts were to be terminated for default, generally the U.S. Government +would pay only for the work that has been accepted and could require TurnOnGreen to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold +TurnOnGreen liable for damages resulting from the default. +Medical device power supplies . +TurnOnGreen’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. TurnOnGreen must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +Environmental . TurnOnGreen +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TurnOnGreen continually assesses its compliance status +and management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of TurnOnGreen’s operations. +Non-U.S. Sales . TurnOnGreen’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +GIGA +GIGA’s businesses are +heavily regulated in most of its markets. GIGA transacts with numerous U.S. Government agencies and entities, including but not limited +to the U.S. Department of Defense (“DoD”), branches of the U.S. military and the Department of Homeland Security. Similar +government authorities exercise similar regulatory oversight in GIGA’s non-U.S. markets. +Government Contracts . +The governments of the U.S., U.K. and Israel may terminate any of GIGA’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of GIGA’s contracts for convenience, GIGA generally would be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of GIGA’s government contracts were to be terminated for default, generally the U.S. government would +pay only for the work that has been accepted and could require GIGA to pay the difference between the original contract price and the +cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold GIGA liable +for damages resulting from the default. Similar provisions apply to GIGA’s contracts with other governments and to GIGA’s +subcontractors with major defense contractors who provide systems or military platforms directly to the government. +Power Electronics . +In all of GIGA’s markets in the U.S., GIGA’s commercial power electronics offerings must comply with safety, energy use and +operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. In +the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the U.K., Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, GIGA’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . GIGA +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies, or as applicable +local regulations or laws require. The products that GIGA markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of +certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, GIGA’s industry began phasing in RoHS +and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. GIGA believes that RoHS and WEEE-compliant +components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. REACH (Registration, +Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 December 2006. REACH +addresses the production and use of chemical substances, and their potential impacts on both human health and the environment. +43 +These regulatory mandates +apply to all of GIGA’s operating subsidiaries. GIGA has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +Non-U.S. Sales . GIGA’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Security Clearance +As a U.S. Government contractor +working on classified projects, Microphase is required to maintain facility and personnel security clearances complying with the DoD and +other federal agency requirements. Microphase maintains strict protocols for handling classified information and Confidential Unclassified +Information (“CUI”) associated with its work for the DoD and has built a secure restricted area within its Shelton production +facility certified for generating, storing and reviewing classified information. +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the U.K. Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “DCAA”), +the Defense Contract Management Agency (the “DCMA”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the DOJ and Congressional Committees. From time-to-time, these and other agencies investigate or +conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. The +DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the Ministry of Defense does most of +its business. All its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +the U.K. Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the +customer the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government +and typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified information and CUI from disclosure and unauthorized access. That mandate includes a requirement that +Microphase formulate and implement a system security plan with 110 different elements and protocols for handling and protecting classified +information and CUI. Over the next three years, the DoD will require all participants in the defense supply chain to demonstrate compliance +with the Capability Model Maturity Cybersecurity as verified through an independent third-party auditor. Compliance with these mandates +requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance requires extensive +security controls on access to Microphase information technology systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +44 +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Plus Compliant.” Cyber Essentials Plus is a government-backed, industry-supported +scheme to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials Plus program criteria. +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December +31, 2023 and 2022, we spent approximately $7.2 million and $2.8 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries. +Employee Profile +As of December 31, 2023, we +had 643 employees located in the U.S., the U.K. and Israel, of whom 71 were engaged in engineering and product development, 62 in sales +and marketing, 369 in general operations and 141 in general administration and finance. All but 56 of these employees are employed on +a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be +good. +As of December 31, 2023, approximately +28% of our current workforce is female, 72% male, and our average tenure is 6.4 years, a decrease of 17% from an average tenure of +7.7 years as of December 31, 2022. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of 6.4 years as +of the end of the fiscal year 2023 reflects the engagement of our employees in this core talent system tenet. +45 +We believe we materially comply +with all applicable state, local and international laws governing nondiscrimination in employment in every location in which we operate. +All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, national +origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees’ needs. We plan to conduct annual confidential employee +surveys as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. +Our employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new +stretch goals. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +ITEM 1A. RISK FACTORS +An investment in our common +stock involves significant risks. You should carefully consider the following risks and all other information set forth in this Annual +Report before deciding to invest in our common stock. If any of the events or developments described below occurs, our business, financial +condition and results of operations may suffer. In that case, the value of our common stock may decline and you could lose all or part +of your investment. +You should consider each of +the following risk factors and any other information set forth in this Annual Report and the other reports filed by the Company with the +SEC, including the Company’s financial statements and related notes, in evaluating the Company’s business and prospects. The +risks and uncertainties described below are not the only ones that impact on the Company’s operations and business. Additional risks +and uncertainties not presently known to the Company, or that the Company currently considers immaterial, may also impair its business +or operations. If any of the following risks actually occurs, the Company’s business and financial condition, results or prospects +could be harmed. Please also read carefully the section entitled “Cautionary Note About Forward-Looking Statements” at the +beginning of this Annual Report. +46 +Risks Related to Our Company +We have an evolving business model, which increases the complexity +of our business. +Our business model has evolved +in the past and continues to do so. In prior years we have added additional types of services and product offerings and in some cases, +we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products or services, and +we do not know whether any of them will be successful. From time to time we have also modified aspects of our business model relating +to our product mix. We do not know whether these or any other modifications will be successful. The additions and modifications to our +business have increased the complexity of our business and placed significant strain on our management, personnel, operations, systems, +technical performance, financial resources, and internal financial control and reporting functions. Future additions to or modifications +of our business are likely to have similar effects. Further, any new business or website we launch that is not favorably received by the +market could damage our reputation or our brand. The occurrence of any of the foregoing could have a material adverse effect on our business. +We are heavily dependent on our senior management, +and a loss of a member of our senior management team could cause our stock price to suffer . +If we lose the services of +Milton C. Ault, III, our Executive Chairman, William B. Horne, our Chief Executive Officer, Henry Nisser, our President and General Counsel, +or Ken Cragun, our Chief Financial Officer and/or certain key employees, we may not be able to find appropriate replacements on a timely +basis, and our business could be adversely affected. Our existing operations and continued future development depend to a significant +extent upon the performance and active participation of these individuals and certain key employees. Although we have entered into employment +agreements with Messrs. Ault, Horne and Nisser, and we may enter into employment agreements with additional key employees in the future, +we cannot guarantee that we will be successful in retaining the services of these individuals. If we were to lose any of these individuals, +we may not be able to find appropriate replacements on a timely basis and our financial condition and results of operations could be materially +adversely affected. +We rely on highly skilled personnel and the +continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our business may be +severely disrupted. +Our performance largely depends +on the talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise held by our Executive +Chairman, Milton C. Ault, III. His absence, were it to occur, would materially and adversely impact development and implementation of +our projects and businesses. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly +skilled personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract, among +others, new technology developers and to retain and motivate our existing contractors. If one or more of our executive officers are unable +or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may +be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives +joins a competitor or forms a competing company, we may lose some customers. +We may not be able to utilize our net operating loss carryforwards. +As of December 31, 2023, we +had federal and state net operating loss carryforwards (“NOLs”) for income tax purposes of approximately $23.7 million and +$104.2 million, respectively, after application of the limitations set forth in Section 382 of the Internal Revenue Code. In accordance +with Section 382, future utilization of our NOLs is subject to an annual limitation as a result of ownership changes that occurred previously. +We also maintain NOLs in various foreign jurisdictions. +Our corporate structure and intercompany arrangements +are subject to the tax laws of various jurisdictions, and we could face greater than anticipated tax liabilities, which would harm our +results of operations. +We are subject to tax laws +in the U.S. and certain foreign jurisdictions, including Israel and the U.K. Our income tax obligations +are based in part on our corporate structure and intercompany arrangements. The tax laws applicable to our business are increasingly complex, +are subject to interpretation and their application can be uncertain. The amount of taxes we pay in the jurisdictions in which we operate +could increase substantially as a result of changes in the applicable tax principles, including increased tax rates, new tax laws or revised +interpretations of existing tax laws and precedents. +We are subject to the examination +of our income tax returns by the IRS and foreign tax authorities in the jurisdictions in which we operate, and we may be subject to assessments +or audits in the future in any such jurisdictions. The tax authorities in these jurisdictions may aggressively interpret their laws in +an effort to raise additional tax revenue and may claim that various withholding requirements apply to us or our subsidiaries, challenge +the availability to us or our subsidiaries of certain benefits under tax treaties, and challenge our methodologies for valuing developed +technology or intercompany arrangements or our revenue recognition policies, which could result in an increase of our worldwide effective +tax rate and have a material adverse effect on our financial condition and operating results. +47 +Risks Related to Our Indebtedness and Liquidity +We will need to raise additional capital to +fund our operations in furtherance of our business plan. +Until +we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business plan. +The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred +stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development partners or some combination +of each. Any additional equity financings may be financially dilutive to, and will be dilutive from an ownership perspective to, our stockholders, +and such dilution may be significant based upon the size of such financing. Additionally, we cannot assure that such funding will be available +on a timely basis, in needed quantities, or on terms favorable to us, if at all. +If we are unable to +comply with the covenants or restrictions contained in the Loan Agreement with our senior secured lender, the lender could declare all +amounts outstanding under the Loan Agreement to be due and payable and foreclose on its collateral, which could materially adversely affect +our financial condition and operations. +As +previously announced, on December 14, 2023, we, along with our wholly owned subsidiaries Sentinum, Third Avenue, ACS, BNI Montana, Ault +Lending, Ault Aviation and AGREE, entered into the Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed +$36 million and issued Secured Notes to the lenders in the aggregate amount of $38,918,919. Pursuant to the Loan Agreement, we, and the +other Guarantors, agreed to act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various +agreements as collateral in support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to +which Sentinum granted to the Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated +from the Miners and (c) the membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, +pursuant to which those entities granted to the lenders a security interest in substantially all of their assets, as well as a pledge +of equity interests in Ault Aviation, AGREE, Sentinum, Third Avenue, Ault Energy, ADTC, Eco Pack, and Circle 8 Holdco, (iii) a mortgage +and security agreement by Third Avenue on the Florida Property, (iv) a future advance mortgage by ACS on the Michigan Property, (v) an +aircraft mortgage and security agreement by Ault Aviation on the Aircraft, and (vi) deposit account control agreements over certain bank +accounts held by certain of our subsidiaries. The Loan Agreement has customary representations, warranties and covenants including restrictions +on indebtedness, liens, restricted payments and dividends, investments, asset sales and similar covenants and contains customary events +of default. +The +covenants and other restrictions contained in the Loan Agreement and other current or future debt agreements could, among other things, +restrict our ability to dispose of assets, incur additional indebtedness, pay dividends or make other restricted payments, create liens +on assets, make investments, loans or advances, make acquisitions, engage in mergers or consolidations and engage in certain transactions +with affiliates. These restrictions could limit our ability to plan for or react to market conditions or meet extraordinary capital needs +or otherwise restrict corporate activities. In addition, substantially all of our borrowed money obligations are secured by certain of +our assets. +A +failure to comply with any restrictions or covenants in the Loan Agreement, or to make payments into the Segregated Account when due or +make other payments we are obligated to make under Loan Agreement, could have serious consequences to our financial condition or result +in a default under the Loan Agreement and under other agreements containing cross-default provisions. A default would permit lenders to +accelerate the maturity of the debt under these debt agreements and to foreclose upon collateral securing the debt, among other remedies. +Furthermore, an event of default or an acceleration under one of our debt agreements could also cause a cross-default or cross-acceleration +of another debt instrument or contractual obligation, which would adversely impact our liquidity. Under these circumstances, we might +not have sufficient funds or other resources to satisfy all of our obligations. We may not be granted waivers or other amendments to these +debt agreements if for any reason we are unable to comply with these debt agreements, and we may not be able to restructure or refinance +our debt on terms acceptable to us, or at all. Whether or not those kinds of actions are successful, we might seek protections of applicable +bankruptcy laws. Additionally, all of our indebtedness is senior to the existing common stock in our capital structure. If we were to +seek certain restructuring transactions, our creditors would experience better returns as compared to our equity holders. Any of these +actions could have a material adverse effect on the value of our equity and on our business, financial performance, and liquidity. +48 +To service any future indebtedness and other obligations, +we will require a significant amount of cash. +Our ability to generate cash +depends on many factors beyond our control, and any failure to meet our debt service obligations, of which we currently have very few +but may in the future incur, including our obligations under our indebtedness or future outstanding shares of preferred stock, could harm +our business, financial condition and results of operations. Our ability to make payments on and to refinance any indebtedness and outstanding +preferred stock and to fund working capital needs and planned capital expenditures will depend on our ability to generate cash in the +future. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other +factors that are beyond our control. +If our business does not generate +sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to enable us and our subsidiaries +to pay our indebtedness or make dividend payments with respect to our any shares of preferred stock that we may issue, or to fund our +other liquidity needs, we may need to refinance all or a portion of our indebtedness or redeem the preferred stock, on or before the maturity +thereof, sell assets, reduce or delay capital investments or seek to raise additional capital, any of which could have a material adverse +effect on us. +In addition, we may not be +able to effect any of these actions, if necessary, on commercially reasonable terms or at all. Our ability to restructure or refinance +our indebtedness or redeem the preferred stock will depend on the condition of the capital markets and our financial condition at such +time. Any refinancing of our debt or financings related to the redemption of any shares of preferred stock that we may issue could be +at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. +The terms of future debt instruments or preferred stock may limit or prevent us from taking any of these actions. In addition, any failure +to make scheduled payments of interest and principal on any future outstanding indebtedness or dividend payments on any shares of preferred +stock that we may issue could harm our ability to incur additional indebtedness or otherwise raise capital on commercially reasonable +terms or at all. Our inability to generate sufficient cash flow to satisfy any future debt service and other obligations, or to refinance +or restructure our obligations on commercially reasonable terms or at all, would have an adverse effect, which could be material, on our +business, financial condition and results of operations. +Risks Related to Circle 8 +Circle 8 uses substantial leverage in its capital +structure which could adversely affect its financial condition. Although Circle 8’s debt-to-EBITDA ratio is below the industry median, +operational disruptions or economic shocks could hinder Circle 8’s ability to service its debt and impact its solvency. Additionally, +the industry tends to heavily rely on debt to finance expansionary initiatives, whether through organic growth or acquisitions. +Circle 8 currently has a substantial +amount of outstanding debt. As of December 31, 2023, it had total outstanding indebtedness of approximately $22.5 million, of which $15.9 +million was borrowed from First Citizens Bank (“FCB”) in a senior secured asset-based revolving line of credit and $4.8 million +consists of outstanding equipment notes with De Lage Landen Group, LLC (“DLL”) and MidCap Equipment Finance (“MicCap”). +Circle 8 has the ability to increase the FCB loan by $10 million. Circle 8 may further increase its debt balance where permitted by incumbent +lenders for growth and expansionary purposes. Circle 8’s substantial indebtedness could have important consequences. For example, +it may: +· increase Circle 8’s vulnerability to general adverse economic, industry and competitive conditions; +· require management to dedicate a substantial portion of Circle 8’s cash flow from operations to +interest payments and principal repayment, thereby reducing the availability of cash flow to fund working capital, capital expenditures, +acquisitions, dividend payments to its owners and other general corporate purposes; +· limit Circle 8’s flexibility in planning for, or reacting to, changes in Circle 8’s specific +business and the industry in which it operates; +· place Circle 8 at a competitive disadvantage compared to its competitors that have less debt; and +· limit Circle 8’s ability to obtain additional financing for working capital, capital expenditures, +acquisitions or general corporate purposes. +49 +Circle 8 expects to use cash +flow from operations and borrowings under the FCB commitment to meet current and future financial obligations, including funding operations, +debt service and capital expenditures. Circle 8’s ability to make these payments depends on future operational performance, which +will be affected by financial, business, economic and other factors, many of which Circle 8 cannot control. Circle 8’s business +may not generate sufficient cash flow from operations in the future or be able to appropriately adjust operations to suit organic industry +developments, which could result in Circle 8’s inability to service its debt obligations, or to fund other liquidity needs. If Circle +8 has insufficient capital to cover its debt obligations, it may be forced to reduce or delay ongoing or growth activities and capital +expenditures, sell assets, obtain additional debt or dilutive equity capital or restructure or refinance all or a portion of its debt, +including the incumbent FCB, DLL and MidCap loans, and any other incremental loans, on or before maturity. There can be no assurance that +Circle 8 will be able to accomplish any of these alternatives on terms acceptable to it or to us, if at all. In addition, the terms of +existing or future indebtedness, including the agreements governing the incumbent loans, may limit Circle 8’s ability to pursue +any other alternatives. +While Circle 8 has had an industry-leading +safety record throughout its history, it operates in a potentially hazardous industry, and any safety incident could significantly impact +its operations. A blemish on Circle 8’s safety record could lead to direct consequences such as fines, levies, and increased insurance +premiums, as well as indirect consequences such as customers preferring competitors with better safety records. +The lifting solutions business +is inherently risky, and accidents can occur due to a variety of factors, including negligence and unforeseeable events. Despite this, +Circle 8 has maintained an industry-leading safety record and has not experienced any incidents that have significantly impacted its operations. +While Circle 8 has a safety program in place, it cannot guarantee protection against unforeseeable events or “acts of God.” +Any safety transgressions can have a material impact on sales and operating results, leading to fines and levies, and potentially causing +customers to prefer competitors with better safety records. Therefore, Circle 8 places a great emphasis on maintaining its safety program +and continually improving its practices to minimize the risk of incidents occurring. +The lifting solutions business is dependent +on the domestic oil markets’ activity, oil pricing, construction and industrial activities, and the overall economic conditions. +Any downturn in these areas could adversely affect the demand for lifting solutions, leading to decreased sales and lower lifting solutions +prices, which may result in a decline in Circle 8’s revenues, gross margins and operating results. +Circle 8 primarily provides +lifting solutions for the U.S. domestic oil market. As such, any downturn in the U.S. domestic oil market or the economy as a whole could +result in reduced demand for its services or lower sales prices. Additionally, its business may face temporary or long-term negative impacts +due to: +· a reduction in extraction levels by customers due to increased costs and break-even oil price and lower +levels of reserves due to depletion of existing reserves and resources; +· exploration and drilling are capital intensive and results are uncertain, which may limit Circle 8’s +current clients’ demand for Circle 8’s services and adversely affect its ability to generate new clients; +· until it executes on its expansion program, dependence on a limited number of clients in a niche oil services +market could make Circle 8 vulnerable compared to larger industry incumbents with greater client diversity; +· unfavorable credit and equity markets affecting end-user access to capital or cost of capital, also potentially +increasing the all-in cash costs and break-even oil prices may make operations of its current and future clients no longer economically +viable; +· adverse changes in federal, state, tribal and local government infrastructure spending; +50 +· an increase in the cost of consumables and construction materials related to oil extraction and infrastructure +construction; +· adverse weather conditions or natural disasters which may affect a particular region; +· a decrease in the level of exploration, development, production activity and capital spending by oil and +natural gas companies; +· an increase in inflationary pressure on materials and labor; +· labor issues such as strikes or worker shortages; +· a prolonged shutdown of the U.S. government; +· an increase in interest rates; +· supply chain disruptions; +· changes in federal and state regulations related to climate change and greenhouse gas emissions may materially +adversely impact Circle 8’s and/or its clients’ revenues, operating results and profitability; +· public health crises and epidemics; or +· terrorism or hostilities involving the United States and/or its allies. +Weakness or deterioration +in the oil services industry, renewables infrastructure construction, plant turn-around and public and industrial infrastructure construction +sectors caused by the above or other factors could have a material adverse effect on Circle 8’s financial position, results of operations +and cash flows in the future and may also have a material adverse effect on residual values realized on the disposition of the existing +and future rental fleet. +Circle 8’s business is highly reliant +on the availability of specialized skilled labor, and this dependency is particularly pronounced given the current scarcity of domestic +U.S. skilled labor. This scarcity is at an all-time high, which is further compounded as labor requirements to operate in Circle 8 ‘s +business becomes even more specialized. +The lifting solutions business +requires licensed operators to operate safely and within U.S. domestic regulatory requirements. It takes several months and material funding +to be trained to become a licensed crane operator, making the availability of qualified labor scarce for the lifting solutions industry +in general and specifically in remote locations in which Circle 8’s client set operates its oil services. Availability of labor +may have a significant impact on Circle 8’s ability to service its current client set and to be able to execute on its expansion +program. +Additionally, the training +and licensing requirements for crane operators can vary by state and even by municipality, which can create further challenges for Circle +8 in sourcing and deploying qualified labor in different geographic locations. Moreover, the competitive labor market for skilled workers +in the oil services industry could potentially drive-up labor costs for Circle 8, which would impact its profitability and competitiveness. +Circle 8’s business is, directly and +indirectly, dependent on a functioning global supply chain system. The oil and steel markets are global, and many suppliers, vendors, +OEM’s and parts manufacturers for Circle 8 and its clients’ industries are offshore. +The lifting solutions business +success is heavily dependent on the availability and efficient conversion to elevated utilization rates of the lifting assets. These metrics +can be fundamentally impacted by the functionality of the global supply chain, which plays several roles in the lifting solutions business. +For example, supply chain disruptions could delay the delivery of critical parts and components needed for maintenance and repair of lifting +assets, leading to longer downtime periods and reduced utilization rates. +In addition, fluctuations +in commodity prices could impact the cost of raw materials needed to manufacture lifting assets, potentially affecting the company’s +profitability. These fluctuations, among others, could impact the efficiency and profitability of Circle 8’s lifting solutions business +and can be impacted by a variety of factors, including the following: +· possible geopolitical unrest and conflict may impact ability to receive new parts or new cranes in a timely +manner, if at all, to optimize utilization and ultimately, profitability; +51 +· reliance on foreign suppliers for cranes and exposure to trade embargoes could impede its ability to procure +necessary parts and equipment to execute its growth strategies and maintain its fleet; +· inflationary pressures resulting from supply chain disruptions and labor shortages could make it difficult +for Circle 8 to repair and replace its crane equipment at regular costs; +· fuel price escalation could have a material impact on gross profit since it is typically approximately +7% of the operating cost structure in recent history; +· oil market sanctions and political pressure on domestic production reduction may adversely impact Circle +8’s core clients and its revenues and profitability; or +· steel market sanctions, trade embargoes and other supply chain shocks may adversely impact public and +private infrastructure and renewables new construction and maintenance projects, ultimately slowing Circle 8’s strategic transition +to diversify its end markets and client base. +Furthermore, as Circle 8 expands +its operations, it may need to rely on suppliers and logistics partners in new geographic regions, which could expose the company to additional +supply chain risks. +Circle 8’s reliance on a limited number +of equipment manufacturers exposes the company to significant risks, as the termination or disruption of relationships with any of these +manufacturers could adversely impact Circle 8’s ability to obtain equipment in a timely or adequate manner, potentially leading +to operational disruptions and financial losses. +Circle 8 purchases most of +its equipment from a leading, nationally recognized OEM. For the year ended December 31, 2023, the company did not purchase any new cranes +as it was in a period of restructuring and right sizing its fleet. Prior thereto, it purchased 100% of its equipment from Manitowoc/Grove, +one of the leading worldwide heavy equipment manufacturers. Utilizing one OEM reduces the number of parts and inventory items kept on +hand resulting in savings, while still allowing for efficient and timely repairs and maintenance of Circle 8’s cranes. Circle 8 +may diversify its equipment supplier options going forward to diversify its fleet somewhat. Utilizing a new OEM equipment manufacturer +creates risk from requiring an increase in parts inventory and could have an adverse effect on the business, financial condition or results +of operations if the new OEM were unable to supply Circle 8 in an adequate or timely manner. +Circle 8 faces risks related to heightened +inflation, recession, financial and credit market disruptions and other economic conditions. +Circle 8’s financial +results, operations and forecasts depend significantly on worldwide economic and geopolitical conditions, the demand for Circle 8’s +products, and the financial condition of its customers and suppliers. Economic weakness and geopolitical uncertainty have in the past +resulted, and may result in the future, in reduced demand for lifting solutions resulting in decreased sales, margins and earnings. In +2022 and 2023, the U.S. experienced significantly heightened inflationary pressures which have continued into 2024. It is difficult to +fully mitigate the impact of inflation through price increases passed through to customers that are operating in commodity sector with +global end market pricing mechanisms, productivity initiatives and cost savings, which could have an adverse effect on Circle 8’s +financial results and position. In addition, if the U.S. economy enters a recession, Circle 8’s sales may decline, which could have +an adverse effect on its overall business, operating results and financial condition. Similarly, disruptions in financial and/or credit +markets may impact Circle 8’s ability to manage normal commercial relationships with its customers, suppliers and creditors. Further, +in the event of a recession or threat of a recession, Circle 8’s customers and suppliers may suffer their own financial and economic +challenges and as a result they may demand pricing accommodations, delay payment, or become insolvent, which could harm Circle 8’s +ability to meet its customer demands or collect revenue or otherwise could harm the business and its ability to service incumbent loans, +ultimately leading to possible insolvency. An economic or credit crisis could occur and impair credit availability and Circle 8’s +ability to raise capital as required for ongoing working capital, maintenance capital and expansion capex. A disruption in the financial +markets could impair Circle 8’s banking or other business partners, on whom it relies for access to capital. In addition, changes +in tax or interest rates in the U.S. or other nations, whether due to recession, economic disruptions or other reasons, could have an +adverse effect on Circle 8’s operating results. Economic weakness and geopolitical uncertainty may also lead to asset impairment, +restructuring actions or adjust Circle 8’s operating strategy and reduce expenses in response to decreased sales or margins. Circle +8 may not be able to adequately adjust its cost structure in a timely fashion, which could have an adverse effect on its operating results +and financial condition. Uncertainty about economic conditions may increase foreign currency volatility in markets in which it transacts +business, which could have an adverse effect on Circle 8’s operating results. +52 +The inability to forecast trends accurately +may have an adverse impact on Circle 8’s business and financial condition. +An economic downturn or economic +uncertainty makes it difficult to forecast trends. For example, the economic uncertainty caused by COVID-19, and its impact on Circle +8’s operational and financial performance was highly dependent on the depth and duration of the pandemic, as well as the government-mandated +restrictions on economic activity and government economic stimulus packages passed in response to the economic downturn. More recently, +rising interest rates, higher than expected inflation, and several bank failures also underscore the potential impact of ongoing economic +risks to Circle 8’s operations and financial performance. These factors can lead to increased borrowing costs, reduced consumer +spending, and reduced access to credit, among other potential challenges. +This uncertainty makes it +difficult to forecast Circle 8’s future operating performance, cash flows and financial position, which could have an adverse impact +on its business and financial condition. Additionally, uncertainty regarding future oil and natural gas prices have negatively impacted +the exploration, production and construction activity of Circle 8’s customers in those markets. Uncertainty regarding future lifting +solutions demand could cause Circle 8 to maintain excess equipment inventory and increase its equipment inventory carrying costs, decrease +utilization and cause a technical default in certain covenants. Alternatively, difficulty forecasting, in addition to labor shortages +and supply chain disruptions could cause a shortage incremental rental equipment that could result in an inability to satisfy demand for +Circle 8 service and a loss of market share. +Circle 8’s revenue and operating results +may fluctuate, which could result in a decline in profitability and make it more difficult to grow the business. +Circle 8’s revenue and +operating results have historically varied from month to month and quarter to quarter. Periods of decline could result in an overall decline +in profitability and make it more difficult to adequately service indebtedness and grow the business using incremental leverage. It can +be expected that Circle 8’s quarterly results will continue to fluctuate in the future due to a number of factors, including the +following: +· general economic conditions in the markets in which the company operates; +· the cyclical nature of Circle 8’s customers’ business, particularly Circle 8’s oil services +customer and prospective customers in the construction industry; +· sales patterns in general in the construction industry, with sales activity tending to be lower in the +winter months, which causes significant volatility in utilization; +· changes in the size of Circle 8’s fleet due to rapid growth followed by a slow-down and Circle 8’s +ability to service and maintain its fleet in a timely manner; +· an overcapacity of fleet in the crane services industry; +· severe weather and seismic conditions temporarily affecting the regions in which Circle 8 operates; +· supply chain or other disruptions that impact its ability to obtain equipment and other supplies from +key suppliers on acceptable terms or at all; +· changes in corporate spending for plants and facilities or changes in government spending for infrastructure +projects; +· changes in interest rates and related changes in Circle 8’s interest expense and debt service obligations; +or +· the possible need, from time to time, to record impairment charges or other write-offs or charges due +to a variety of occurrences, such as the impairment of assets, existing location divestitures, dislocation in the equity and/or credit +markets, consolidations or closings, restructurings, or the refinancing of existing indebtedness. +53 +Circle 8 is subject to competition, which may +have a material adverse effect on its business by reducing its ability to increase or maintain revenues or profitability. +The full-service crane services +and lifting solutions industry is highly competitive and fragmented. Many of the markets in which Circle 8 operates are served by numerous +competitors, ranging from global, national and multi-regional equipment rental companies to small, independent businesses with a limited +number of locations. Circle 8 has historically competed on the basis of availability, quality, reliability, delivery and price. Some of +Circle 8’s competitors have significantly greater financial, marketing and other resources than it does, and may be able to reduce +rates. Circle 8 may encounter increased competition from existing competitors or new market entrants in the future, which could have a +material adverse effect on its business, financial condition and results of operations. +The cost of new Circle 8 rental fleet units +may increase and therefore may require a larger equity investment equipment. In some cases, it may not be possible to procure equipment +on a timely basis due to supplier constraints, among other reasons. +The cost of new equipment +from manufacturers of Circle 8 fleet may increase because of increased raw material costs, including increases in the cost of steel, which +is a primary material used in almost all of the equipment Circle 8 uses, labor shortages, supply chain disruptions or due to increased +regulatory requirements, such as those related to emissions. In addition, in an effort to combat climate change, Circle 8’s customers +may require Circle 8’s fleet to meet certain standards which may not be able to be met without capital intensive and time-consuming +fleet unit retrofits or ultimately cost prohibitive replacements. If such retrofits or replacements cannot be achieved in a timely manner, +or at all, Circle 8’s sales, financial results and financial position would be materially adversely impacted. These increases could +materially impact Circle 8’s financial condition or results of operations in future periods if Circle 8 is not able to pass such +cost increases through to its customers. +Circle 8’s fleet is subject to residual +value risk upon disposition. +The market value of any given +piece of equipment could be less than its depreciated value at the time it is sold. The market value of used rental equipment depends +on several factors, including: +· general economic conditions in the markets in which the company operates; +· wear and tear on the equipment relative to its age; +· the time of year that it is sold (prices are generally higher during the busy season); +· worldwide and domestic demands for used equipment; +· the supply of used equipment on the market; and +· general economic conditions. +Circle 8 typically includes +in operating income the difference between the sales price and the depreciated value of an item of equipment sold. Although for the year +ended December 31, 2023, Circle 8 sold used equipment from Circle 8 rental fleet reducing its fleet from 75 to 55 cranes at an average +selling price above of net orderly liquidation value, it cannot be assured that used equipment selling prices will not decline. Any significant +decline in the selling prices for used equipment could have a material adverse effect on Circle 8’s business, financial condition, +results of operations or cash flows. +As Circle 8’s rental fleet ages, its +operating costs may increase, it may be unable to pass along such costs to customers, and earnings may decrease. The costs of new fleet +units may increase, requiring Circle 8 to spend more for replacement equipment or preventing it from procuring equipment on a timely basis. +If Circle 8’s rental +equipment ages, the costs of maintaining such equipment, if not replaced within a certain period of time, will likely increase. The costs +of maintenance may materially increase in the future and could lead to material adverse effects on Circle 8’s results of operations. +The cost of new equipment for use in Circle 8’s rental fleet could also increase due to increased material costs for its suppliers +(including tariffs on raw materials) or other factors beyond Circle 8’s control. Such increases could materially adversely impact +Circle 8’s financial condition and results of operations in future periods. Furthermore, changes in customer demand could cause +certain of Circle 8’s existing equipment to become obsolete and require Circle 8 to purchase new equipment at increased costs. +54 +Labor disputes could disrupt Circle 8’s +ability to serve its customers and/or lead to higher labor costs. +As of December 31, 2023, Circle +8 had approximately 143 employees in Texas, Louisiana and Oklahoma, none of whom is unionized. While Circle 8 has no current plans to +unionize any of its locations, it recognizes the possibility of a branch or group of branches in a state becoming unionized against Circle +8’s wishes in the future. However, Circle 8 is committed to maintaining positive and productive relationships with its employees +without union influence, prioritizing open communication and collaboration to address any concerns and ensure a positive work environment. +Any Circle 8 employee’s +union organizing efforts or collective bargaining negotiations could potentially lead to work stoppages and/or slowdowns or strikes by +certain Circle 8 employees, which could adversely affect its ability to serve its customers. +Climate change, climate change regulations +and greenhouse effects may materially adversely impact Circle 8 operations and markets. +Climate change and its association +with greenhouse gas emissions is receiving increased attention from the scientific and political communities. The U.S. federal government, +certain U.S. states and certain other countries and regions have adopted or are considering legislation or regulation imposing overall +caps or taxes on greenhouse gas emissions from certain sectors or facility categories. Such new laws or regulations, or stricter enforcement +of existing laws and regulations, could increase the costs of operating Circle 8’s businesses, reduce the demand for its products +and services and impact the prices charged to customers, any or all of which could adversely affect Circle 8’s results of operations. +Failure to comply with any legislation or regulations could potentially result in substantial fines, criminal sanctions or operational +changes. Moreover, even without such legislation or regulation, the perspectives of Circle 8’s customers, employees and other stakeholders +regarding climate change are continuing to evolve, and increased awareness of, or any adverse publicity regarding, the effects of greenhouse +gases could harm Circle 8’s reputation or reduce customer demand for Circle 8’s products and services. Additionally, as severe +weather events become increasingly common, Circle 8’s and its customers’ operations may be disrupted, which could result in +increased operational costs or reduced demand for its products and services, which could have an adverse effect on Circle 8’s results +of operations. In addition, climate change may also reduce the availability or increase the cost of insurance for weather-related events +and may impact the global economy, including as a result of disruptions to supply chains. Circle 8 anticipates that climate change-related +risks will increase over time. +Risks Related to Our Bitcoin Operations +Risks Related to Our Bitcoin Operations – General +To remain competitive in our industry, we would +need to seek to grow our hash rate to match the growing network hash rate and increasing network difficulty of the Bitcoin blockchain, +and if we are unable to grow our hash rate at pace with the network hash rate, our chance of earning Bitcoin from our Mining operations +would decline. +As the adoption of Bitcoin +has increased, the price of Bitcoin has generally appreciated, causing the demand for new Bitcoin rewards for successfully solving blocks +on the Bitcoin blockchain to likewise increase. This has encouraged more miners to attempt to mine Bitcoin, which increases the global +network hash rate deployed in support of the Bitcoin blockchain. +Because a miner’s relative +chance of successfully solving a block and earning a new Bitcoin reward is generally a function of the ratio the miner’s individual +hash rate bears to the global network hash rate, as the global network hash rate increases, a miner must increase its individual hash +rate to maintain its chances of earning new Bitcoin rewards. Therefore, as new miners enter the industry and as miners deploy greater +and greater numbers of increasingly powerful machines, existing miners must seek to continually increase their hash rate to remain competitive. +Thus, a feedback loop is created: as Bitcoin gains popularity and its relative market price increases, more miners attempt to mine Bitcoin +and the Bitcoin network hash rate is increased; in response, existing miners and new miners devote more and more hash rate to the Bitcoin +blockchain by deploying greater numbers of increasingly powerful machines in an attempt to ensure their ability to earn additional Bitcoin +rewards does not decrease. Compounding this feedback loop, the network difficulty of the Bitcoin network (i.e., the amount of work (measured +in hashes) necessary to solve a block) is periodically adjusted to maintain the pace of new block additions (with one new block added +to the blockchain approximately every ten minutes), and thereby control the supply of Bitcoin. As miners deploy more hash rate and the +Bitcoin network hash rate is increased, the Bitcoin network difficulty is adjusted upwards by requiring more hash rate to be deployed +to solve a block. Thus, miners are further incentivized to grow their hash rate to maintain their chance of earning new Bitcoin rewards. +In theory, these dual processes should continually replicate themselves until the supply of available Bitcoin is exhausted. In response, +miners have attempted to achieve greater hash rate by deploying increasingly sophisticated miners and expensive miners in ever greater +quantities. This has become the Bitcoin mining industry’s great “arms race.” Moreover, because there are very few manufacturers +of miners capable of producing a sufficient number of miners of adequate quality to meet this need, scarcity results, leading to higher +prices. Compounding this phenomenon, it has been observed that some manufacturers of Bitcoin miners may increase the prices for new miners +as the market price of Bitcoin increases. +55 +Accordingly, to maintain our +chances of earning new Bitcoin rewards and remaining competitive in our industry, we would need to seek to continually add new miners +to grow our hash rate at pace with the growth in the Bitcoin network hash rate. However, until such time as we have access to a sufficient +amount of power to run all of our existing Bitcoin miners outside of our Michigan Facility, we do not anticipate purchasing additional +miners to grow our hash rate. Further, as demand has increased and scarcity in the supply of new miners has resulted, the price of new +miners has increased sharply, and we expect this process to continue in the future as demand for Bitcoin increases. Therefore, if and +when we do look to purchase additional miners, if the price of Bitcoin is not sufficiently high to allow us to fund our hash rate growth +through new miner acquisitions and if we are otherwise unable to access additional capital to acquire these miners, our hash rate may +further stagnate and we may fall behind our competitors. If this happens, our chances of earning new Bitcoin rewards would decline and, +as such, our results of operations and financial condition may suffer. +Acceptance and/or widespread use of Bitcoin +is uncertain. +Currently, there is a limited +use of any Bitcoin in the retail and commercial marketplace, thus contributing to price volatility that could adversely affect an investment +in our securities. Banks and other established financial institutions may refuse to process funds for Bitcoin transactions or process +wire transfers to or from Bitcoin exchanges, Bitcoin-related companies or service providers, which we have experienced, or maintain accounts +for persons or entities transacting in Bitcoin. Conversely, a significant portion of Bitcoin demand is generated by investors seeking +a long-term store of value or speculators seeking to profit from the short- or long-term holding of the asset. Price volatility undermines +Bitcoin’s role as a medium of exchange, as retailers are much less likely to accept it as a form of payment. Market capitalization +for a Bitcoin as a medium of exchange and payment method may always be low. +The relative lack of acceptance +of Bitcoins in the retail and commercial marketplace, or a reduction of such use, limits the ability of end users to use them to pay for +goods and services. Such lack of acceptance or decline in acceptances could have a material adverse effect on our ability to continue +as a going concern or to pursue our business strategy at all, which could have a material adverse effect on our business, prospects or +operations and potentially the value of Bitcoins we mine or otherwise acquire or hold for our own account. +The development and acceptance of cryptographic +and algorithmic protocols governing the issuance of and transactions in cryptocurrencies is subject to a variety of special economic, +geopolitical and regulatory factors, which could slow the growth of the industry in general and our company as a result. +The use of cryptocurrencies, +including Bitcoin, to, among other things, buy and sell goods and services and complete transactions, is part of a new and rapidly evolving +industry that employs cryptocurrency assets based upon a computer-generated mathematical and/or cryptographic protocol. Large-scale acceptance +of cryptocurrencies as a means of payment has not, and may never, occur. The growth of this industry in general, and the use of Bitcoin +in particular, is subject to a high degree of uncertainty, and the slowing or stopping of the development or acceptance of developing +protocols may occur unpredictably. The factors include, but are not limited to: +· the progress of worldwide growth in the adoption and use of Bitcoin and other cryptocurrencies as a medium +of exchange; +· the experience of businesses in using Bitcoin; +· the impact from prominent business leaders in criticizing Bitcoin’s potential harm to the environment +and the effect of announcements critical of Bitcoin, such as those that occurred with Elon Musk of Tesla; +· governmental and organizational regulation of Bitcoin and other cryptocurrencies and their use, or restrictions +on or regulation of access to and operation of the network or similar cryptocurrency systems (such as the 2021 ban in China); +56 +· changes in consumer demographics and public tastes and preferences, including as may result from coverage +of Bitcoin or other cryptocurrencies by journalists and other sources of information and media; +· the maintenance and development of the open-source software protocol of the network; +· the increased consolidation of contributors to the Bitcoin blockchain through mining pools and scaling +of mining equipment by well-capitalized market participants; +· the availability and popularity of other forms or methods of buying and selling goods and services, including +new means of using fiat currencies; +· the use of the networks supporting Bitcoin or other cryptocurrencies for developing smart contracts and +distributed applications; +· general economic conditions and the regulatory environment relating to Bitcoin and other cryptocurrencies; +· the impact of regulators focusing on cryptocurrencies and the costs, financial and otherwise, associated +with such regulatory oversight; and +· a decline in the popularity or acceptance of Bitcoin could adversely affect an investment in us. +The outcome of these factors +could have negative effects on our ability to continue as a going concern or to pursue our business strategy, which could have a material +adverse effect on our business, prospects or operations as well as potentially negative effects on the value of any Bitcoin or other cryptocurrencies +we mine or otherwise acquire, which would harm investors in our securities. If Bitcoin or other cryptocurrencies we mine do not gain widespread +market acceptance or accrete in value over time, our prospects and your investment in us would diminish. +The digital asset exchanges on which cryptocurrencies, +including Bitcoin, trade are relatively new and largely unregulated, and thus may be exposed to fraud and failure. Such failures may result +in a reduction in the price of Bitcoin and other cryptocurrencies and can adversely affect an investment in us. +Digital asset exchanges on +which cryptocurrencies trade are relatively new and, in most cases, largely unregulated. Many digital exchanges do not provide the public +with significant information regarding their ownership structure, management teams, corporate practices or regulatory compliance. As a +result, the marketplace may lose confidence in, or may experience problems relating to, cryptocurrency exchanges, including prominent +exchanges handling a significant portion of the volume of digital asset trading. +A perceived lack of stability +in the digital asset exchange market and the closure or temporary shutdown of digital asset exchanges due to business failure, hackers +or malware, government-mandated regulation, or fraud, may reduce confidence in digital asset networks and result in greater volatility +in cryptocurrency values. These potential consequences of a digital asset exchange’s failure could adversely affect an investment +in us. +We may face several risks due to disruptions +in the digital asset markets, including but not limited to the risk from depreciation in our stock price, financing risk, risk of increased +losses or impairments in our investments or other assets, risks of legal proceedings and government investigations, and risks from price +declines or price volatility of digital assets. +In the second half of 2022 +and beginning of 2023, some of the well-known digital asset market participants, including Celsius Network, Voyager Digital Ltd., Three +Arrows Capital and Genesis Global Holdco LLC, declared bankruptcy, resulting in a loss of confidence in participants of the digital asset +ecosystem and negative publicity surrounding digital assets more broadly. In November 2022, FTX, the third-largest digital asset exchange +by volume at the time, halted customer withdrawals, and shortly thereafter, FTX and its subsidiaries filed for bankruptcy. +In response to these and other +similar events (including significant activity by various regulators regarding digital asset activities, such as enforcement actions, +against a variety of digital asset entities, including Coinbase and Binance), the digital asset markets, including the market for Bitcoin +specifically, have experienced extreme price volatility and several other entities in the digital asset industry have been, and may continue +to be, negatively affected, further undermining confidence in the digital asset markets and in Bitcoin. These events have also negatively +impacted the liquidity of the digital asset markets as certain entities affiliated with FTX and platforms such as Coinbase and Binance +have engaged, or may continue to engage, in significant trading activity. If the liquidity of the digital asset markets continues to be +negatively impacted by these events, digital asset prices (including the price of Bitcoin) may continue to experience significant volatility +and confidence in the digital asset markets may be further undermined. These events are continuing to develop and it is not possible to +predict at this time all of the risks that they may pose to us, our service providers or on the digital asset industry as a whole. +57 +Although we had no direct +exposure to FTX or any of the above-mentioned cryptocurrency companies, nor any material assets that may not be recovered or may otherwise +be lost or misappropriated due to the above-mentioned bankruptcies, the failure or insolvency of large exchanges like FTX or other significant +players in the digital asset space may cause the price of Bitcoin to fall and decrease confidence in the ecosystem, which could adversely +affect an investment in us. To date, the disruptions to the digital assets markets have not materially impacted our operations or financial +condition. However, no assurances can be given that future disruptions will not have a material and adverse effect on our results of operations +or financial condition. +Political or economic crises may motivate large-scale sales +of cryptocurrencies, which could result in a reduction in values of cryptocurrencies such as Bitcoin and adversely affect an investment +in us. +Geopolitical crises, in particular +major ones such as Russia’s invasion of Ukraine and the conflict between Israel and Hamas as well as its supporters, may motivate +large-scale purchases of Bitcoin and other cryptocurrencies, which could increase the price of Bitcoin and other cryptocurrencies rapidly. +This may increase the likelihood of a subsequent price decrease as crisis-driven purchasing behavior dissipates, adversely affecting the +value of our Bitcoin following such downward adjustment. Such risks are similar to the risks of purchasing commodities in general uncertain +times, such as the risk of purchasing, holding or selling gold. Alternatively, as an emerging asset class with limited acceptance as a +payment system or commodity, global crises and general economic downturn may discourage investment in cryptocurrencies as investors focus +their investment on less volatile asset classes as a means of hedging their investment risk. +As an alternative to fiat +currencies that are backed by central governments, cryptocurrencies, which are relatively new, are subject to supply and demand forces. +How such supply and demand will be impacted by geopolitical events is largely uncertain but could be harmful to us and investors in our +common stock. Political or economic crises may motivate large-scale acquisitions or sales of cryptocurrencies either globally or locally. +Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which +could have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin or any other cryptocurrencies +we mine or otherwise acquire or hold for our own account. +Negative media attention and public perception +surrounding energy consumption by cryptocurrency mining may adversely affect our reputation and, consequently, our stock price; particularly +in the eyes of some of our investors who may be more interested in our non-crypto operations as a holding company. +Cryptocurrency mining has +experienced negative media attention surrounding its perceived high electricity use and environmental impact, which has adversely influenced +public perception of the industry as a whole. We believe these factors are overstated for the cryptocurrency mining industry because of +the informational disparity between cryptocurrency mining and other energy intensive industries. Cryptocurrency miners (particularly Bitcoin +miners) have freely and publicly disclosed their energy consumption statistics because electricity usage, and the associated utility fees, +is a cost of production. As increasing numbers of publicly traded cryptocurrency miners enter the market, more data, reliably disclosed +in compliance with generally accepted accounting principles in the United States of America (“GAAP”), has become available; +however, such data has not been made as readily available for competitive payment systems and fiat currencies. +Nevertheless, this negative +media attention and public perception may materially and adversely affect our reputation and, consequently, our stock price, particularly +in the eyes of our investors who are more interested in our non-crypto operations as a holding company. As a single company within the +broader cryptocurrency industry, we are likely incapable of effectively countering this negative media attention and affecting public +perception. Therefore, we may not be able to adequately respond to these external pressures, which may cause a significant decline in +the price of our common stock. +58 +Banks and financial institutions may not provide +banking services, or may cut off services, to businesses like us that engage in cryptocurrency-related activities. +A number of companies that +engage in Bitcoin and/or other cryptocurrency-related activities have been unable to find banks or financial institutions that are +willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated +with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial +institutions in response to government action. The difficulty that many businesses that provide Bitcoin and/or derivatives on other cryptocurrency-related activities +have and may continue to have in finding banks and financial institutions willing to provide them services may be decreasing the usefulness +of cryptocurrencies as a payment system and harming public perception of cryptocurrencies, and could decrease their usefulness and harm +their public perception in the future. +The usefulness of cryptocurrencies +as a payment system and the public perception of cryptocurrencies could be damaged if banks or financial institutions were to close the +accounts of businesses engaging in Bitcoin and/or other cryptocurrency-related activities. This could occur as a result of compliance +risk, cost, government regulation or public pressure. The risk applies to securities firms, clearance and settlement firms, national securities +exchanges and derivatives on commodities exchanges, the over-the-counter market, and the Depository Trust Company (“DTC”), +which, if any of such entities adopts or implements similar policies, rules or regulations, could negatively affect our relationships +with financial institutions and impede our ability to convert cryptocurrencies to fiat currencies. Such factors could have a material +adverse effect on our ability to continue as a going concern or to monetize our mining efforts, which could have a material adverse effect +on our business, prospects or operations and harm investors. +The price of cryptocurrencies may be affected +by the sale of such cryptocurrencies by other vehicles investing in cryptocurrencies or tracking cryptocurrency markets. Such events could +have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin we mine. +The global market for cryptocurrency +is characterized by supply constraints that differ from those present in the markets for commodities or other assets such as gold and +silver. The mathematical protocols under which certain cryptocurrencies are mined permit the creation of a limited, predetermined amount +of digital currency, while others have no limit established on total supply. Increased numbers of miners and deployed mining power globally +will likely continue to increase the available supply of Bitcoin and other cryptocurrencies, which may depress their market price. Further, +large “block sales” involving significant numbers of Bitcoin following appreciation in the market price of Bitcoin may also +increase the supply of Bitcoin available on the market, which, without a corresponding increase in customer demand, may cause its price +to fall. Currently, the loss of customer demand is also accentuated by disruptions in the crypto assets market. Additionally, to the extent +that other vehicles investing in cryptocurrencies or tracking cryptocurrency markets form and come to represent a significant proportion +of the customer demand for cryptocurrencies, including the recent approval of Bitcoin exchange traded funds, large redemptions of the +securities of those vehicles and the subsequent sale of cryptocurrencies by such vehicles could negatively affect cryptocurrency prices +and therefore affect the value of the cryptocurrency inventory we hold. Such events could have a material adverse effect on our business, +prospects or operations and potentially the value of any Bitcoin or other cryptocurrencies we may in the future mine. +The nature of our business requires the application +of complex financial accounting rules, and there is limited guidance from accounting standard setting bodies. If financial accounting +standards undergo significant changes, our operating results could be adversely affected. +The +accounting rules and regulations that we must comply with are complex and subject to interpretation by the Financial Accounting Standards +Board (“FASB”), the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles. In addition, +the accounting policies of many companies are being subjected to heightened scrutiny by regulators and the public, and we have received +comments from the staff of the SEC’s Division of Corporation Finance Office of Crypto Assets (the “Staff”) during fiscal +year 2023 related to the accounting of our Bitcoin-related operations, among other things. +A +change in these principles or interpretations could have a significant effect on our reported financial results, and may even affect the +reporting of transactions completed before the announcement or effectiveness of a change. Recent actions and public comments from the +FASB and the SEC have focused on the integrity of financial reporting and internal controls. In addition, many companies’ accounting +policies are being subject to heightened scrutiny by regulators and the public. Further, there have been limited precedents for the financial +accounting of crypto assets and related valuation and revenue recognition. As such, there remains significant uncertainty on how companies +can account for crypto asset transactions, crypto assets, and related revenue. Uncertainties in or changes to in regulatory or financial +accounting standards, particularly as they relate to the Company, the financial accounting of our Bitcoin-related operations, and the +SEC comments we have received in respect of such matters, could result in the need to changing our accounting methods and restate our +financial statements and impair our ability to provide timely and accurate financial information, which could adversely affect our financial +statements, result in a loss of investor confidence, and more generally impact our business, operating results, and financial condition. +Recent additional FASB and additional guidance may also impact our business, including our accounting policies and procedures. In +addition, receipt of SEC comments as a result of the limited precedent set for financial accounting of digital assets may impact or delay +our ability to register certain securities and our ability to access capital markets needed to fund our ongoing growth and operations. +59 +Since +there has been a limited precedent set for financial accounting of digital assets, including Bitcoin, it is unclear how we will be required +to account for transactions involving digital assets. +Because +there has been limited precedent set for the financial accounting of cryptocurrencies and related revenue recognition and no official +guidance has yet been provided by the FASB or the SEC for Bitcoin miners, it is unclear how Bitcoin miners may in the future be required +to account for cryptocurrency transactions and assets and related revenue recognition. A change in regulatory or financial accounting +standards or interpretations by the SEC, part icularly as they relate to the Company and the financial +accounting of our Bitcoin-related operations, could result in changes in our accounting and the necessity to restate our financial statements. +In addition, the accounting policies of many companies are being subjected to heightened scrutiny by regulators and the public, and we +have received comments from the Staff during fiscal year 2023 related to the accounting of our Bitcoin-related operations. +Such continued uncertainty with regard to financial accounting matters, particularly as they relate to the Company, the financial accounting +of our bitcoin-related operations and the SEC comments we have received in respect of such matters, could negatively impact our business, +prospects, financial condition and results of operations and our ability to raise capital. In addition, receipt of SEC comments may impact +or delay our ability to register certain securities and our ability to access capital markets needed to fund our ongoing growth and operations. +Risks Related to Our Bitcoin Operations – Operational and +Financial +Our results of operations are expected to be +impacted by fluctuations in the price of Bitcoin because a significant portion of our revenue is expected to come from Bitcoin mining +production. +The price of Bitcoin has experienced +significant fluctuations over its relatively short existence and may continue to fluctuate significantly in the future. Bitcoin prices +ranged from approximately $16,548 per coin as of December 31, 2022 to $42,280 per coin as of December 31, 2023, with a high of $44,705 +per coin and a low of $16,521 per coin during 2023, according to Coin Market Cap. During the first three months of 2024, Bitcoin prices +have ranged as low as $38,522 and as high as $73,750. As of April 10, 2024, the price of Bitcoin was approximately $70,500. +We expect our results of operations +to continue to be affected by the Bitcoin price as a significant portion of our revenue is expected to come from Bitcoin mining production. +Any future significant reductions in the price of Bitcoin will likely have a material and adverse effect on our results of operations +and financial condition. We cannot assure you that the Bitcoin price will remain high enough to sustain our operations or that the price +of Bitcoin will not decline significantly in the future. Further, fluctuations in the Bitcoin price can have an immediate impact on the +trading price of our shares even before our financial performance is affected, if at all. +Various factors, mostly beyond +our control, could impact the Bitcoin price. For example, the usage of Bitcoins in the retail and commercial marketplace is relatively +low in comparison with the usage for speculation, which contributes to Bitcoin’s price volatility. Additionally, the reward for +Bitcoin mining will decline over time, with the most recent halving event having occurred in May 2020 and the next one expected to occur +in April 2024, which may further contribute to Bitcoin price volatility. +Risk related to technological advancements +and obsolescence of current bitcoin mining equipment. +Our operations are exposed +to the risk of rapid technological advancements in the development and production of Bitcoin mining equipment, which could render our +existing mining infrastructure obsolete and adversely impact our financial performance. +The Bitcoin mining industry +is characterized by rapid technological change, with companies continually developing and deploying new mining equipment and techniques +to enhance computational efficiency and reduce energy consumption. These advancements may outpace our ability to adapt, maintain, and +upgrade our mining equipment, thereby negatively affecting our competitive position and operational efficiency. As a result, we may be +required to make significant capital investments to acquire and implement new technology to maintain our competitiveness. +60 +If we are unable to anticipate +or adapt to such advancements, or if we fail to allocate our resources efficiently, we may be forced to rely on outdated equipment that +becomes increasingly inefficient and expensive to maintain. Moreover, the emergence of more advanced mining technologies could lead to +an increase in the overall mining difficulty, further reducing the effectiveness of our existing equipment and diminishing our mining +rewards. +Additionally, there is a risk +that our competitors, who may have greater financial resources and flexibility, will be better positioned to adopt emerging technologies +and gain a competitive advantage. This could result in a decline in our market share, revenue, and profitability. +Inability to manage these +risks could have a material adverse effect on our business, financial condition, and operating results. +Because of our focus on Bitcoin mining, the +trading price of shares of our common stock may increase or decrease with the trading price of Bitcoin, which subjects investors to pricing +risks, including “bubble” type risks, and volatility. +The trading prices of our +common stock may at times be tied to the trading prices of Bitcoin. Specifically, we may experience adverse effects on our stock price +when the value of Bitcoin drops. Furthermore, if the market for Bitcoin mine operators’ shares or the stock market in general experiences +a loss of investor confidence, the trading price of our stock could decline for reasons unrelated to our business, operating results or +financial condition. The trading price of our common stock could be subject to arbitrary pricing factors that are not necessarily associated +with traditional factors that influence stock prices or the value of non-cryptocurrency assets such as revenue, cash flows, profitability, +growth prospects or business activity since the value and price, as determined by the investing public, may be influenced by uncertain +contingencies such as future anticipated adoption or appreciation in value of cryptocurrencies or blockchains generally, and other factors +over which we have little or no influence or control. +Bitcoin and other cryptocurrency +market prices, which have historically been volatile and are impacted by a variety of factors, are determined primarily using data from +various exchanges, over-the-counter markets and derivative platforms. Furthermore, such prices may be subject to factors such as +those that impact commodities, more so than business activities, which could be affected by additional influence from fraudulent or illegitimate +actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue +to result in, speculation regarding future appreciation in the value of cryptocurrencies, or our share price, making their market prices +more volatile or creating “bubble” type risks for the trading price of Bitcoin. +The price of Bitcoin has experienced +significant fluctuations over its relatively short existence and may continue to fluctuate significantly in the future. For example, the +price of Bitcoin ranged from approximately $17,000 to approximately $44,000 during 2023, and was approximately $70,500 as of April 10, +2024, according to Coin Market Cap. There can be no assurance that similar fluctuations in the trading price of Bitcoin will not occur +in 2024 and in the future. Accordingly, since our revenue will depend in part on the price of Bitcoin, and the trading price of our securities +may therefore at times be connected to the trading price of Bitcoin, if the trading price of Bitcoin again experiences a significant decline, +we could experience a similar decline in revenue and/or in the trading price for shares of our common stock. If this occurs, you may lose +some or all of your investment. +Our future success will depend in part upon +the value of Bitcoin. The value of Bitcoin may be subject to pricing risk and has historically been subject to wide swings. +Our operating results from +this sector will depend in part upon the value of Bitcoin because it is the sole digital asset we currently mine. Specifically, our revenues +from our Bitcoin mining operations are principally based upon two factors: the number of Bitcoin rewards we successfully mine and the +value of Bitcoin. We also receive transaction fees paid in Bitcoin by participants who initiated transactions associated with new blocks +that we mine. Our strategy currently focuses primarily on Bitcoin (as opposed to other digital assets). Further, our miners are principally +utilized for mining Bitcoin and cannot mine other digital assets that are not mined utilizing the “SHA-256 algorithm.” If +other digital assets were to achieve acceptance at the expense of Bitcoin, causing the value of Bitcoin to decline, or if Bitcoin were +to switch its proof of work algorithm from SHA-256 to another algorithm for which our miners are not specialized, or the value of Bitcoin +were to decline for other reasons, particularly if such decline were significant or over an extended period of time, our operating results +would be adversely affected, and there could be a material adverse effect on our ability to continue as a going concern or to pursue our +business strategy at all, which could have a material adverse effect on our business, prospects or operations, and harm investors. +61 +Bitcoin and other cryptocurrency +market prices, which have historically been volatile and are impacted by a variety of factors are determined primarily using data from +various exchanges, over-the-counter markets and derivative platforms. Such prices may be subject to factors such as those that impact +commodities, more so than business activities, which could be subject to additional influence from fraudulent or illegitimate actors, +real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue to +result in, speculation regarding future appreciation in the value of digital assets, or our share price, inflating and making their market +prices more volatile or creating “bubble” type risks for both Bitcoin and our shares of common stock. +We may be unable to raise additional capital needed to grow our +Bitcoin mining business. +We have operated and expect +to continue to operate at a loss as we continue to establish our business model and as Bitcoin prices continue to experience significant +volatility. In addition, we expect to need to raise additional capital to fund our working capital requirements, expand our operations, +pursue our growth strategy and to respond to competitive pressures or working capital requirements. We may not be able to obtain additional +debt or equity financing on favorable terms, if at all, which could impair our growth and adversely affect our existing operations. The +global economy, including credit and financial markets, has recently experienced extreme volatility and disruptions, including diminished +credit availability, rising interest and inflation rates, declines in consumer confidence, declines in economic growth, increases in unemployment +rates and uncertainty about economic stability. Such macroeconomic conditions could also make it more difficult for us to incur additional +debt or obtain equity financing. If we raise additional equity financing, our stockholders may experience significant dilution of their +ownership interests, and the per share value of our common stock could decline. Further, if we engage in additional debt financing, the +holders of debt likely would have priority over the holders of our common stock on order of payment preference. We may be required to +accept terms that restrict our ability to incur additional indebtedness, take other actions including accepting terms that require us +to maintain specified liquidity or other ratios that could otherwise not be in the interests of our stockholders. Further, the crypto +assets industry has been negatively impacted by recent events such as the bankruptcies of Celsius Network, Voyager Digital, BlockFi, FTX +and Genesis Global. In response to these events, the digital asset markets, including the market for Bitcoin specifically, have experienced +extreme price volatility and several other entities in the digital asset industry have been, and may continue to be, negatively affected, +further undermining confidence in the digital assets markets and in Bitcoin. Increased credit pressures on the cryptocurrency industry, +such as banks, investors and other companies reducing or eliminating their exposure to the cryptocurrency industry through lending, have +had and may continue to have a material impact on our business. In light of conditions impacting our industry, it may be more difficult +for us to obtain equity or debt financing in the future. +The emergence of competing blockchain platforms +or technologies may harm our business as presently conducted by preventing us from realizing the anticipated profits from our investments +and forcing us to expend additional capital in an effort to adapt. +If blockchain platforms or +technologies which compete with Bitcoin and its blockchain, including competing cryptocurrencies which our miners may not be able to mine, +such as cryptocurrencies being developed or that may be developed by popular social media platforms, online retailers, or government sponsored +cryptocurrencies, consumers may use such alternative platforms or technologies. If that were to occur, we would face difficulty adapting +to such emergent digital ledgers, blockchains, or alternative platforms, cryptocurrencies or other digital assets. This may adversely +affect us by preventing us from realizing the anticipated profits from our investments and forcing us to expend additional capital in +an effort to adapt. Further, to the extent we cannot adapt, be it due to our specialized miners or otherwise, we could be forced to cease +our mining or other cryptocurrency-related operations. Such circumstances would have a material adverse effect on our business, and +in turn your investment in our securities. +There is a risk that some or all of the Bitcoin +we hold could be lost or stolen. +There is a risk that some +or all of the Bitcoin we hold could be lost or stolen. In general, cryptocurrencies are stored in cryptocurrency sites commonly referred +to as “wallets” by holders of cryptocurrencies which may be accessed to exchange a holder’s cryptocurrency assets. Access +to our Bitcoin could also be restricted by cybercrime (such as a denial of service attack). While we have taken steps to attempt to secure +the Bitcoin we hold, there can be no assurance our efforts to protect our cryptocurrencies will be successful. +Hackers or malicious actors +may launch attacks to steal, compromise or secure cryptocurrencies, such as by attacking the cryptocurrency network source code, exchange +miners, third-party platforms, cold and hot storage locations or software, or by other means. Any of these events may adversely affect +our operations and, consequently, our ability to generate revenue and become profitable. The loss or destruction of a private key required +to access our digital wallets may be irreversible and we may be denied access for all time to our Bitcoin holdings. Our loss of access +to our private keys or our experience of a data loss relating to our digital wallets could adversely affect our business. +62 +Cryptocurrencies are controllable +only by the possessor of both the unique public and private keys relating to the local or online digital wallet in which they are held, +which wallet’s public key or address is reflected in the network’s public blockchain. We will be required to publish the public +key relating to digital wallets in use when we verify the receipt of transfers and disseminate such information into the network, but +we will need to safeguard the private keys relating to such digital wallets. To the extent such private keys are lost, destroyed or otherwise +compromised, we will be unable to access our Bitcoin rewards and such private keys may not be capable of being restored by any network. +Any loss of private keys relating to digital wallets used to store our mined Bitcoin could have a material adverse effect on our results +of operations and ability to continue as a going concern, which could have a material adverse effect on our business, prospects or operations +and potentially the value of any Bitcoin we mine. For example, the New York Times reported in January 2021 that about 20% of +existing Bitcoin appears to be “lost” due to password issues. +We rely on one or more third parties for depositing, +storing and withdrawing the Bitcoin we receive, which could result in a loss of assets, disputes and other liabilities or risks which +could adversely impact our business. +We currently use a custodial +wallet to store the Bitcoin we receive. In order to own, transfer and use Bitcoin on the blockchain network, we must have a private and +public key pair associated with a network address, commonly referred to as a “wallet.” Each wallet is associated with a unique +“public key” and “private key” pair, each of which is a string of alphanumerical characters. To deposit Bitcoin +into our digital wallet, we must direct the transaction to the public key of a wallet that our Gemini custodial account controls and provides +to us, and broadcast the deposit transaction onto the underlying blockchain network. To withdraw Bitcoin from our custodial account, an +assigned account representative must initiate the transaction from our custodial account, then an approver must approve the transaction. +Once the custodian has verified that the request is valid and who the recipient is through Know Your Customer/Anti-Money Laundering protocols, +the custodian then “signs” a transaction authorizing the transfer. In addition, some cryptocurrency networks require additional +information to be provided in connection with any transfer of cryptocurrency such as Bitcoin. +A number of errors or other +adverse events can occur in the process of depositing, storing or withdrawing Bitcoin into or from our custodial account, such as typos, +mistakes or the failure to include the information required by the blockchain network. For instance, a user may incorrectly enter our +wallet’s public key or the desired recipient’s public key when depositing and withdrawing Bitcoin. Additionally, our reliance +on third parties such as Gemini and the maintenance of keys to access and utilize our digital wallet will expose us to enhanced cybersecurity +risks from unauthorized third parties employing illicit operations such as hacking, phishing and social engineering, notwithstanding the +security systems and safeguards employed by us and others. Cyberattacks upon systems across a variety of industries, including the cryptocurrency +industry, are increasing in frequency, persistence and sophistication and, in many cases, are being conducted by sophisticated, well-funded, +and organized groups and individuals. For example, attacks may be designed to deceive employees and service providers into releasing control +of the systems on which we depend to a hacker, while others may aim to introduce computer viruses or malware into such systems with a +view to stealing confidential or proprietary data. These attacks may occur on our digital wallet or the systems of our third-party service +providers or partners, which could result in asset losses and other adverse consequences. Insurance held by third parties may not cover +related losses. Alternatively, we may inadvertently transfer Bitcoin to a wallet address that we do not own, control or hold the private +keys to. In addition, a Bitcoin wallet address can only be used to send and receive Bitcoin, and if the Bitcoin is inadvertently sent +to an Ethereum or other cryptocurrency wallet address, or if any of the foregoing errors occur, all of the Bitcoin will be permanently +and irretrievably lost with no means of recovery. Such incidents could result in asset loss or disputes, any of which could materially +and adversely affect our business. +If a malicious actor or botnet obtains control +of more than 50% of the processing power on a cryptocurrency network, such actor or botnet could manipulate blockchains to adversely affect +us, which would adversely affect an investment in our company and our ability to operate. +If a malicious actor or botnet +(a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority +of the processing power dedicated to mining a cryptocurrency, it may be able to alter blockchains on which transactions of cryptocurrency +reside and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. The +malicious actor or botnet could control, exclude or modify the ordering of transactions, though it could not generate new units or transactions +using such control. The malicious actor could “double-spend” its own cryptocurrency (i.e., spend the same Bitcoin in more +than one transaction) and prevent the confirmation of other users’ transactions for as long as it maintained control. To the extent +that such malicious actor or botnet does not yield its control of the processing power on the network or the cryptocurrency community +does not reject the fraudulent blocks as malicious, reversing any changes made to blockchains may not be possible. The foregoing description +is not the only means by which the entirety of blockchains or cryptocurrencies may be compromised but is only an example. +63 +Although we are unaware of +any reports of malicious activity or control of blockchains achieved through controlling over 50% of the processing power on the network, +it is believed that certain mining pools may have exceeded the 50% threshold in Bitcoin. The possible crossing of the 50% threshold indicates +a greater risk that a single mining pool could exert authority over the validation of Bitcoin transactions. To the extent that the Bitcoin +community, and the administrators of mining pools, do not act to ensure greater decentralization of Bitcoin mining processing power, the +feasibility of a botnet or malicious actor obtaining control of the blockchain’s processing power will increase, because such botnet +or malicious actor could more readily infiltrate and seize control over the blockchain by compromising a single mining pool, if the mining +pool compromises more than 50% of the mining power on the blockchain, than it could if the mining pool had a smaller share of the blockchain’s +total hashing power. Conversely, if the blockchain remains decentralized it is inherently more difficult for the botnet or malicious actor +to aggregate enough processing power to gain control of the blockchain. If this were to occur, the public may lose confidence in the Bitcoin +blockchain, and blockchain technology more generally. This would likely have a material and adverse effect on the price of Bitcoin, which +could have a material adverse effect on our business, financial results and operations, and harm investors. +Our reliance on a +third-party mining pool service provider for our mining revenue payouts may have a negative impact on our operations such as a result +of cyber-attacks against the mining pool operator and/or our limited recourse against the mining pool operator with respect to rewards +paid to us. +We +receive crypto asset mining rewards from our mining activity through a third-party mining pool operator. Mining pools allow miners to +combine their processing power, increasing their chances of solving a block and getting paid by the network. The rewards are distributed +by the pool operator, proportionally to our contribution to the pool’s overall mining power, used to generate each block. Should +the pool operator’s system suffer downtime due to a cyber-attack, software malfunction or other similar issues, it will negatively +impact our ability to mine and receive revenue. Furthermore, we are dependent on the accuracy of the mining pool operator’s record +keeping to accurately record the total processing power provided to the pool for a given Bitcoin mining application in order to assess +the proportion of that total processing power we provided. +While +we have internal methods of tracking both our power provided and the total used by the pool, the mining pool operator uses its own recordkeeping +to determine our proportion of a given reward. We have little means of recourse against the mining pool operator if we determine the proportion +of the reward paid out to us by the mining pool operator is incorrect, other than leaving the pool. If we are unable to consistently obtain +accurate proportionate rewards from our mining pool operators, we may experience reduced reward for our efforts, which would have an adverse +effect on our business and operations. +Crypto assets may +have concentrated ownership and large sales or distributions by holders of such crypto assets could have an adverse effect on the market +price of such crypto asset. +As +of December 31, 2023, the largest 111 and 2,103 Bitcoin wallets held approximately 15% and 44%, respectively, of the Bitcoin in circulation. +Moreover, it is possible that other persons or entities control multiple wallets that collectively hold a significant number of Bitcoins, +even if they individually only hold a small amount, and it is possible that some of these wallets are controlled by the same person or +entity. Similar or more concentrated levels of concentrated ownership may exist for other crypto assets as well. As a result of this concentration +of ownership, large sales or distributions by such holders could have an adverse effect on the market price of Bitcoin and other crypto +assets. +Risks Related to Our Bitcoin Operations – Legal and Regulatory +We are subject to a highly evolving regulatory landscape and any +adverse changes to, or our failure to comply with, any laws and regulations could adversely affect our business, prospects or operations. +Our business is subject to +extensive laws, rules, regulations, policies and legal and regulatory guidance, including those governing securities, commodities, crypto +asset custody, exchange and transfer, data governance, data protection, cybersecurity and tax. Many of these legal and regulatory regimes +were adopted prior to the advent of the Internet, mobile technologies, crypto assets and related technologies. As a result, they do not +contemplate or address unique issues associated with the crypto economy, are subject to significant uncertainty, and vary widely across +U.S. federal, state and local and international jurisdictions. These legal and regulatory regimes, including the laws, rules and regulations +thereunder, evolve frequently and may be modified, interpreted and applied in an inconsistent manner from one jurisdiction to another, +and may conflict with one another. Moreover, the complexity and evolving nature of our business and the significant uncertainty surrounding +the regulation of the crypto economy requires us to exercise our judgement as to whether certain laws, rules and regulations apply to +us, and it is possible that governmental bodies and regulators may disagree with our conclusions. To the extent we have not complied with +such laws, rules and regulations, we could be subject to significant fines and other regulatory consequences, which could adversely affect +our business, prospects or operations. As Bitcoin has grown in popularity and in market size, the Federal Reserve Board, U.S. Congress +and certain U.S. agencies (e.g., the CFTC, SEC, FinCEN and the FBI) have begun to examine the operations of the Bitcoin network, Bitcoin +users and the Bitcoin exchange market. Regulatory developments and/or our business activities may require us to comply with certain regulatory +regimes. For example, to the extent that our activities cause us to be deemed a money service business under the regulations promulgated +by FinCEN under the authority of the BSA, we may be required to comply with FinCEN regulations, including those that would mandate us +to implement certain anti-money laundering programs, make certain reports to FinCEN and maintain certain records. +64 +On November 23, 2022, the +governor of New York signed into law a two-year moratorium on new or renewed permits for certain electricity-generating facilities that +use fossil fuel and provide energy for proof-of-work digital asset mining operations. While this action does not directly impact our current +operations, as our power generation plans are currently located in Michigan and we have no plans to establish any facilities in New York, +it may be the beginning of a new wave of climate change regulations aimed at preventing or reducing the growth of Bitcoin mining in jurisdictions +in the United States, including potentially jurisdictions in which we now operate or may in the future operate. The above-described developments +could also demonstrate the beginning of a regional or global regulatory trend in response to environmental and energy preservation or +other concerns surrounding crypto assets, and similar action in a jurisdiction in which we operate or in general could have a devastating +effect on our operations. If further regulation follows, it is possible that the Bitcoin mining industry may not be able to adjust to +a sudden and dramatic overhaul to our ability to deploy energy towards the operation of mining equipment. We are not currently aware of +any legislation in Michigan being a near-term possibility. If further regulatory action is taken by various governmental entities, our +business may suffer and investors in our securities may lose part or all of their investment. +We cannot quantify the effects +of this regulatory action on our industry as a whole. If further regulation follows, it is possible that our industry may not be able +to cope with the sudden and extreme loss of mining power. Because we are unable to influence or predict future regulatory actions taken +by governments in China, the United States, or elsewhere, we may have little opportunity or ability to respond to rapidly evolving regulatory +positions which may have a materially adverse effect on our industry and, therefore, our business and results of operations. +Ongoing and future regulatory actions may impact +our ability to continue to operate, and such actions could affect our ability to continue as a going concern or to pursue our strategy +at all, which could have a material adverse effect on our business, prospects or operations. +The crypto economy is novel and has little to no access to policymakers +or lobbying organizations, which may harm our ability to effectively react to proposed legislation and regulation of crypto assets or +crypto asset platforms adverse to our business. +As crypto assets have grown +in both popularity and market size, various U.S. federal, state and local and foreign governmental organizations, consumer agencies and +public advocacy groups have been examining the operations of crypto networks, users and platforms, with a focus on how crypto assets can +be used to launder the proceeds of illegal activities, fund criminal or terrorist enterprises, and the safety and soundness of platforms +and other service providers that hold crypto assets for users. Many of these entities have called for heightened regulatory oversight, +and have issued consumer advisories describing the risks posed by crypto assets to users and investors. For instance, in July 2019, then-U.S. +Treasury Secretary Steven Mnuchin stated that he had “very serious concerns” about crypto assets. In recent months, members +of Congress have made inquiries into the regulation of crypto assets, and Gary Gensler, Chair of the SEC, has made public statements regarding +increased regulatory oversight of crypto assets. Outside the United States, several jurisdictions have banned so-called initial coin offerings, +such as China and South Korea, while Canada, Singapore, Hong Kong, have opined that token offerings may constitute securities offerings +subject to local securities regulations. In July 2019, the United Kingdom’s Financial Conduct Authority proposed rules to address +harm to retail customers arising from the sale of derivatives and exchange-traded notes that reference certain types of crypto assets, +contending that they are “ill-suited” to retail investors due to extreme volatility, valuation challenges and association +with financial crimes. In May 2021, the Chinese government called for a crackdown on Bitcoin mining and trading, and in September 2021, +Chinese regulators instituted a blanket ban on all crypto mining and transactions, including overseas crypto exchange services taking +place in China, effectively making all crypto-related activities illegal in China. In January 2022, the Central Bank of Russia called +for a ban on cryptocurrency activities ranging from mining to trading, and on March 8, 2022, President Biden announced an executive order +on cryptocurrencies which seeks to establish a unified federal regulatory regime for currencies. +The crypto economy is novel +and has little to no access to policymakers and lobbying organizations in many jurisdictions. Competitors from other, more established +industries, including traditional financial services, may have greater access to lobbyists or governmental officials, and regulators that +are concerned about the potential for crypto assets for illicit usage may affect statutory and regulatory changes with minimal or discounted +inputs from the crypto economy. As a result, new laws and regulations may be proposed and adopted in the United States and internationally, +or existing laws and regulations may be interpreted in new ways, that harm the crypto economy or crypto asset platforms, which could adversely +impact our business. +65 +Pending regulation +related to electricity consumption by mining companies may impact our results of operations. +On +September 16, 2022, the U.S. Department of the Treasury (“Treasury”), the Department of Justice (the “DOJ”), and +other U.S. government agencies released eight reports (the “Reports”), including Action Plan to Address Illicit Financial +Risks of Digital Assets issued by Treasury, Crypto-Assets: Implications for Consumers, Investors and Businesses issued by Treasury, +The Future of Money and Payments issued by Treasury, Climate and Energy Implications of Crypto-Assets in the United States issued +by the White House, Policy Objectives for a U.S. Central Bank Digital Currency System issued by the White House, Technical Evaluation +for a U.S. Central Bank Digital Currency System issued by the White House, The Role of Law Enforcement in Directing, Investigating, +and Prosecuting Criminal Activity Related to Digital Assets issued by the DOJ, and Responsible Advancement of US Competitiveness +in Digital Assets issued by the U.S. Department of Commerce. The Reports were issued in response to White House Executive Order 14067 +on Ensuring Responsible Development of Digital Assets, which calls for a whole-of-government alignment of the federal government’s +approach to digital assets. +In December 2022, Senator +Edward J. Markey, Chair of the Senate Environment and Public Works Subcommittee on Clean Air, Climate, and Nuclear Safety, and Representative +Jared Huffman Senate introduced the Crypto-Asset Environmental Transparency Act. The legislation would require the Environmental Protection +Agency to conduct a comprehensive impact study of U.S. crypto mining activity and require the reporting of greenhouse gas emissions from +crypto mining operations that consume more than 5 megawatts of power. If the bill is passed by both the Senate and the House and +signed into law, mining facilities may be required to report greenhouse gas emissions and to obtain permits and the price to rent +mining facilities may increase. If the price increases significantly and if we are not able to find alternative facilities with reasonable +prices acceptable to us, our operation will be disrupted and our results of operation will be negatively impacted. +A particular digital asset’s status as +a “security” in any relevant jurisdiction is subject to a high degree of uncertainty and if a regulator disagrees with our +characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines, and penalties, which may adversely +affect our business, operating results and financial condition. Furthermore, a determination that Bitcoin or any other digital asset that +we own or mine is a “security” may adversely affect the value of Bitcoin and our business. +The SEC and its staff have +taken the position that certain digital assets fall within the definition of a “security” under the U.S. federal securities +laws. The legal test for determining whether any given digital asset is a security, as described below, is a highly complex, fact-driven +analysis that may evolve over time, and the outcome is difficult to predict. Our determination that the digital assets we hold are not +securities is a risk-based assessment and not a legal standard or one binding on regulators. The SEC generally does not provide advance +guidance or confirmation on the status of any particular digital asset as a security. Furthermore, the SEC’s views in this area +have evolved over time and it is difficult to predict the direction or timing of any continuing evolution. It is also possible that a +change in the governing administration or the appointment of new SEC commissioners could substantially impact the views of the SEC and +its staff. Public statements made by senior officials at the SEC indicate that the SEC does not intend to take the position that Bitcoin +is a security (as currently offered and sold). However, such statements are not official policy statements by the SEC and reflect only +the speakers’ views, which are not binding on the SEC or any other agency or court and cannot be generalized to any other digital +asset. As of the date of this Annual Report, with the exception of certain centrally issued digital assets that have received “no-action” +letters from the SEC staff, Bitcoin and Ethereum are the only digital assets which senior officials at the SEC have publicly stated are +unlikely to be considered securities. As a Bitcoin mining company, we do not believe we are an issuer of any “securities” +as defined under the federal securities laws. Our internal process for determining whether the digital assets we hold or plan to hold +is based upon the public statements of the SEC and existing case law. The digital assets we hold or plan to hold, other than Bitcoin, +may have been created by an issuer as an investment contract under the Howey test, SEC v. Howey Co ., 328 U.S. 293 (1946), +and may be deemed to be securities by the SEC. However, the Company was not the issuer that created these digital assets and is holding +them on an interim basis until liquidated. Should the SEC state that Bitcoin, or other digital assets we hold should be deemed to be securities, +we may no longer be able to hold any of these digital assets. It will then likely become difficult or impossible for such digital asset +to be traded, cleared or custodied in the United States through the same channels used by non-security digital assets, which in addition +to materially and adversely affecting the trading value of the digital asset is likely to cause substantial volatility and significantly +impact its liquidity and market participants’ ability to convert the digital asset into U.S. dollars. Our inability to exchange +Bitcoin for fiat or other digital assets (and vice versa) to administer our treasury management objectives may decrease our earnings potential +and have an adverse impact on our business and financial condition. +66 +Under the Investment Company +Act, a company may fall within the definition of an investment company under section 3(c)(1)(A) thereof if it is or holds itself out as +being engaged primarily, or proposes to engage primarily in the business of investing, reinvesting or trading in securities, or under +section 3(a)(1)(C) thereof if it is engaged or proposes to engage in business of investing, reinvesting, owning, holding, or trading in +securities, and owns or proposes to acquire “investment securities” (as defined therein) having a value exceeding 40% of its +total assets (exclusive of government securities and cash items) on an unconsolidated basis. There is no authoritative law, rule or binding +guidance published by the SEC regarding the status of digital assets as “securities” or “investment securities” +under the Investment Company Act. Although we believe that we are not engaged in the business of investing, reinvesting, or trading in +investment securities, and we do not hold ourselves out as being primarily engaged, or proposing to engage primarily, in the business +of investing, reinvesting or trading in securities, to the extent the digital assets which we mine, own, or otherwise acquire may be deemed +“securities” or “investment securities” by the SEC or a court of competent jurisdiction, we may meet the definition +of an investment company. If we fall within the definition of an investment company under the Investment Company Act, we would be required +to register with the SEC. If an investment company fails to register, it likely would have to stop doing almost all business, and its +contracts would become voidable. Generally speaking, non-U.S. issuers may not register as an investment company without an SEC order. +The classification of a digital +asset as a security under applicable law has wide-ranging implications for the regulatory obligations that flow from the mining, sale +and trading of such assets. For example, a digital asset that is a security in the United States may generally only be offered or sold +in the United States pursuant to a registration statement filed with the SEC or in an offering that qualifies for an exemption from registration. +Persons that effect transactions in digital assets that are securities in the United States may be subject to registration with the SEC +as a “broker” or “dealer.” +There can be no assurances +that we will properly characterize any given digital asset as a security or non-security for purposes of determining which digital assets +to mine, hold and trade, or that the SEC, or a court, if the question was presented to it, would agree with our assessment. We could be +subject to judicial or administrative sanctions for failing to offer or sell digital assets in compliance with the registration requirements, +or for acting as a broker or dealer without appropriate registration. Such an action could result in injunctions, cease and desist orders, +as well as civil monetary penalties, fines, and disgorgement, criminal liability, and reputational harm. For instance, all transactions +in such supported digital asset would have to be registered with the SEC, or conducted in accordance with an exemption from registration, +which could severely limit its liquidity, usability and transactability. Further, it could draw negative publicity and a decline in the +general acceptance of the digital asset. Also, it may make it difficult for such digital asset to be traded, cleared, and custodied as +compared to other digital assets that are not considered to be securities. +If the SEC or another regulatory body considers +Bitcoin to be a security under U.S. securities laws, we may be required to comply with significant SEC registration and/or other requirements. +In general, novel or unique +assets such as Bitcoin and other digital assets may be classified as securities if they meet the definition of investment contracts under +U.S. law. In recent years, the offer and sale of digital assets other than Bitcoin, most notably Kik Interactive Inc.’s Kin tokens +and Telegram Group Inc.’s TON tokens, have been deemed to be investment contracts by the SEC. While we believe that Bitcoin is unlikely +to be considered an investment contract, and thus a security under the investment contract definition, we cannot provide any assurances +that digital assets that we mine or otherwise acquire or hold for our own account, including Bitcoin, will never be classified as securities +under U.S. law. This would obligate us to comply with registration and other requirements by the SEC and, therefore, cause us to incur +significant, non-recurring expenses, thereby materially and adversely impacting an investment in the Company. +Several foreign jurisdictions +have taken a broad-based approach to classifying crypto assets as “securities,” while other foreign jurisdictions, such as +Switzerland, Malta, and Singapore, have adopted a narrower approach. As a result, certain crypto assets may be deemed to be a “security” +under the laws of some jurisdictions but not others. Various foreign jurisdictions may, in the future, adopt additional laws, regulations, +or directives that affect the characterization of crypto assets as “securities.” If Bitcoin or any other supported crypto +asset is deemed to be a security under any U.S. federal, state, or foreign jurisdiction, or in a proceeding in a court of law or otherwise, +it may have adverse consequences for such supported crypto asset. For instance, all transactions in such supported crypto asset would +have to be registered with the SEC or other foreign authority, or conducted in accordance with an exemption from registration, which could +severely limit its liquidity, usability and transactability. Moreover, the networks on which such supported crypto assets are utilized +may be required to be regulated as securities intermediaries, and subject to applicable rules, which could effectively render the network +impracticable for its existing purposes. Further, it could draw negative publicity and a decline in the general acceptance of the crypto +asset. Also, it may make it difficult for such supported crypto asset to be traded, cleared, and custodied as compared to other crypto +assets that are not considered to be securities. +67 +Current interpretations require the regulation +of Bitcoin under the Commodity Exchange Act by the Commodity Futures Trading Commission, and we may be required to register and comply +with such regulations. Any disruption of our operations in response to the changed regulatory circumstances may be at a time that is disadvantageous +to our investors. +Current and future legislation, +regulation by the Commodity Futures Trading Commission (the “CFTC”) and other regulatory developments, including interpretations +released by a regulatory authority, may impact the manner in which Bitcoin and other cryptocurrencies are treated for classification and +clearing purposes. In particular, derivatives on these assets are not excluded from the definition of “commodity future” by +the CFTC. We cannot be certain as to how future regulatory developments will impact the treatment of Bitcoin and other cryptocurrencies +under the law. +Bitcoin has been deemed to +fall within the definition of a commodity and, we may be required to register and comply with additional regulation under the Commodity +Exchange Act, including additional periodic report and disclosure standards and requirements. Moreover, we may be required to register +as a commodity pool operator and to register as a commodity pool with the CFTC through the National Futures Association. Such additional +registrations may result in extraordinary, non-recurring expenses, thereby materially and adversely impacting an investment in us. +If we determine not to comply with such additional regulatory and registration requirements, we may seek to cease certain of our operations. +Any such action may adversely affect an investment in us. +Additionally, governments +may develop and deploy their own blockchain-based digital assets, which may have a material adverse impact on Bitcoin’s price +and utility. +Governmental action against digital assets +and Bitcoin mining may have a materially adverse effect on the industry, and could affect us if widely adopted. +We and the cryptocurrencies +on which our operations will depend are and could become subject to bans and other regulations aimed at preventing what are perceived +as some of the negative attributes of Bitcoin and Bitcoin mining. For example, on September 24, 2021, China declared all transactions +in and mining of cryptocurrencies, including Bitcoin, illegal. While the ultimate long-term effect of this ban remains uncertain, +it could significantly hinder our prospects by limiting a large market for cryptocurrencies within a growing economy. In the hours +following China’s announcement of the ban, the price of Bitcoin, which is tied to some extent to public perception of its future +value as a form of currency, dropped by nearly $4,000. The ban followed piecemeal regulatory action within China against cryptocurrencies, +which was due in part to concerns about the potential for manipulative practices and excessive energy consumption. This could demonstrate +the beginning of a regional or global regulatory trend in response to these or other concerns surrounding cryptocurrencies, and similar +action in a jurisdiction in which we operate or in general could have devastating effects to our operations. If further regulation follows, +it is possible that our industry may not be able to adjust to a sudden and dramatic overhaul to our ability to deploy energy towards the +operation of mining equipment. +Because we are unable to influence +or predict future regulatory actions taken by governments, we may face difficulty monitoring and responding to rapid regulatory developments +affecting Bitcoin mining, which may have a materially adverse effect on our industry and, therefore, our business and results of operations. +If further regulatory action is taken by governments in the U.S., our business may be materially harmed, and you could lose some or all +of your investment. +The markets for Bitcoin and other cryptocurrencies +and the existing markets may be under-regulated and, as a result, the market price of Bitcoin may be subject to significant volatility +or manipulation, which could decrease consumer confidence in cryptocurrencies and have a materially adverse effect on our business and +results of operations. +Cryptocurrencies that are +represented and trade on a ledger-based platform and those who hold them may not enjoy the same benefits as traditional securities +available on trading markets and their investors. Stock exchanges have listing requirements and vet issuers, requiring them to be subjected +to rigorous listing standards and rules, and monitor investors transacting on such platform for fraud and other improprieties. These conditions +may not necessarily be replicated on a distributed ledger platform, depending on the platform’s controls and other policies. The +more lax a distributed ledger platform is about vetting issuers of cryptocurrency assets or users that transact on the platform, the higher +the potential risk for fraud or the manipulation of the ledger due to a control event. We believe that Bitcoin is not a security under +federal and state law. +Bitcoin and other cryptocurrency +market prices have historically been volatile, are impacted by a variety of factors, and are determined primarily using data from various +exchanges, over-the-counter markets and derivative platforms. Furthermore, such prices may be subject to factors such as those that +impact commodities, more so than business activities, which could be subjected to additional influence from fraudulent or illegitimate +actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue +to result in, speculation regarding future appreciation in the value of cryptocurrencies, or our share price, making their market prices +more volatile or creating “bubble” type risks for both Bitcoin and shares of our common stock. +68 +These factors may inhibit +consumer trust in and market acceptance of cryptocurrencies as a means of exchange which could have a material adverse effect on our business, +prospects, or operations and potentially the value of any Bitcoin or other cryptocurrencies we mine or otherwise acquire. +We are subject to risks associated with our +need for significant electrical power. Government regulators may potentially restrict the ability of electricity suppliers to provide +electricity to mining operations, such as ours. +The operation of a Bitcoin +mining center, as well as AI hyperscale data centers, can require massive amounts of electrical power. We presently have access to approximately +30 MWs of capacity at our Michigan Facility, which we plan to dedicate to our AI hyperscale data center operations, and 10 MWs of capacity +at our Montana Facilities for our mining operations. However, we require additional capacity to operate all of our miners outside the +Michigan Facility and Montana Facilities and to support the growing power demands of our AI hyperscale data centers. Our mining operations +can only be successful and ultimately profitable if the costs, including electrical power costs, associated with mining a Bitcoin are +lower than the price of a Bitcoin. Similarly, our AI hyperscale data centers require a reliable and cost-effective power supply to ensure +optimal performance and profitability. As a result, any facilities we establish can only be successful if we can obtain sufficient electrical +power on a cost-effective basis. The establishment of new mining and AI hyperscale data centers requires us to find locations where this +is the case. There may be significant competition for suitable locations for both mining operations and AI hyperscale data centers. Government +regulators may potentially restrict the ability of electricity suppliers to provide electricity to these operations in times of electricity +shortage or may otherwise potentially restrict or prohibit the provision of electricity to such operations. Any shortage of electricity +supply or increase in electricity cost in a jurisdiction may negatively impact the viability and the expected economic return for our +Bitcoin mining activities and AI hyperscale data center operations in that jurisdiction. +Our interactions with a blockchain may expose +us to specially designated nationals or blocked persons or cause us to violate provisions of law that did not contemplate distributed +ledger technology. +The Office of Financial Assets +Control of the U.S. Department of Treasury (“OFAC”) requires us to comply with its sanction program and not conduct business +with persons named on its specially designated nationals (“SDN”) list. However, because of the pseudonymous nature of blockchain +transactions, we may inadvertently and without our knowledge engage in transactions with persons named on OFAC’s SDN list. Our internal +policies prohibit any transactions with such SDN individuals, but we may not be adequately capable of determining the ultimate identity +of the individual with whom we transact with respect to selling digital assets. In addition, in the future OFAC or another regulator may +require us to screen transactions for OFAC addresses or other bad actors before including such transactions in a block, which may increase +our compliance costs, decrease our anticipated transaction fees and lead to decreased traffic on our network. Any of these factors, consequently, +could have a material adverse effect on our business, prospects, financial condition, and operating results. +Moreover, federal law prohibits +any U.S. person from knowingly or unknowingly possessing any visual depiction commonly known as child pornography. Recent media reports +have suggested that persons have imbedded such depictions on one or more blockchains. Because our business requires us to download and +retain one or more blockchains to effectuate our ongoing business, it is possible that such digital ledgers contain prohibited depictions +without our knowledge or consent. To the extent government enforcement authorities literally enforce these and other laws and regulations +that are impacted by decentralized distributed ledger technology, we may be subject to investigation, administrative or court proceedings, +and civil or criminal monetary fines and penalties, all of which could harm our reputation and could have a material adverse effect on +our business, prospects, financial condition, and operating results. +Risks Related to Our Bitcoin Operations – Technological +Cryptocurrencies face significant +scaling obstacles that can lead to high fees or slow transaction settlement times and attempts to increase the volume of transactions +may not be effective, which could adversely affect an investment in our securities. +Cryptocurrencies face significant +scaling obstacles that can lead to high fees or slow transaction settlement times and attempts to increase the volume of transactions +may not be effective. Scaling cryptocurrencies is essential to the widespread acceptance of cryptocurrencies as a means of payment, which +widespread acceptance is necessary to the continued growth and development of our business. Many Bitcoin networks face significant scaling +challenges. For example, cryptocurrencies are limited with respect to how many transactions can occur per second. Participants in the +Bitcoin ecosystem debate potential approaches to increasing the average number of transactions per second that the network can handle +and have implemented mechanisms or are researching ways to increase scale, such as increasing the allowable sizes of blocks, and therefore +the number of transactions per block, and sharding (a horizontal partition of data in a database or search engine), which would not require +every single transaction to be included in every single miner’s or validator’s block. However, there is no guarantee that +any of the mechanisms in place or being explored for increasing the scale of settlement of Bitcoin transactions will be effective, or +how long they will take to become effective, which could adversely affect an investment in our securities. +69 +There is a possibility of Bitcoin mining algorithms +transitioning to proof of stake validation and other mining related risks, which could make us less competitive and ultimately adversely +affect our business and the value of our shares. +The protocol pursuant to which +transactions are confirmed automatically on the Bitcoin blockchain through mining is known as proof of work. Proof of stake is an alternative +method in validating digital asset transactions. Should the Bitcoin algorithm shift from a proof of work validation method to a proof +of stake method, mining would require less energy and may render any company that maintains advantages in the current climate (for example, +from lower priced electricity, processing, real estate, or hosting) less competitive. For example, in September 2022, the Ethereum network +transitioned from a proof of work to a proof of stake method. We, as a result of our efforts to optimize and improve the efficiency of +our Bitcoin mining operations, may be exposed to the risk in the future of losing the benefit of our capital investments and the competitive +advantage we hope to gain from this as a result, and may be negatively impacted if a switch to proof of stake validation were to occur. +This may additionally have an impact on other various investments of ours. Such events could have a material adverse effect on our ability +to continue as a going concern or to pursue our business strategy at all, which could have a material adverse effect on our business, +prospects or operations and potentially the value of any Bitcoin or other digital assets we mine or otherwise acquire or hold for our +own account. +Bitcoin is subject to halving, meaning that +the Bitcoin rewarded for solving a block will be reduced in the future and its value may not commensurately adjust to compensate us for +such reductions, and the overall supply of Bitcoin is finite. +Bitcoin is subject to “halving,” +which is the process by which the Bitcoin reward for solving a block is reduced by 50% for every 210,000 blocks that are solved. This +means that the amount of Bitcoin we (or any other mining company) are rewarded for solving a block in the blockchain is permanently cut +in half. For example, the latest halving having is expected to occur in April 2024, with a revised payout of 3.125 Bitcoin per block solved, +down from the current reward rate of 6.25 Bitcoin per block solved. There can be no assurance that the price of Bitcoin will sufficiently +increase to justify the increasingly high costs of mining for Bitcoin given the halving feature. If a corresponding and proportionate +increase in the trading price of these cryptocurrencies does not follow these anticipated halving events, the revenue we earn from our +mining operations would see a corresponding decrease, which would have a material adverse effect on our business and operations. To illustrate, +even if the price of Bitcoin remains at its current price, all other factors being equal (including the same number of miners and a stable +hash rate), our revenue would decrease substantially upon the next halving. +Further, due to the halving +process, unless the underlying code of the Bitcoin blockchain is altered (which may be unlikely given its decentralized nature), the supply +of Bitcoin is finite. Once 21 million Bitcoin have been generated by virtue of solving blocks in the blockchain, the network will +stop producing more which is anticipated to occur in approximately 2140. Currently, there are approximately 19.7 million Bitcoin +in circulation representing about 93.6% of the total supply of Bitcoin under the current source code. For the foregoing reasons, the halving +feature exposes us to inherent uncertainty and reliance upon the historically volatile price of Bitcoin, rendering an investment in us +particularly speculative, especially in the long-term. If the price of Bitcoin does not significantly increase in value, your investment +in our common stock could decline significantly. +Bitcoin has forked multiple times and additional +forks may occur in the future which may affect the value of Bitcoin that we hold or mine. +To the extent that a significant +majority of users and mining companies on a cryptocurrency network install software that changes the cryptocurrency network or properties +of a cryptocurrency, including the irreversibility of transactions and limitations on the mining of new cryptocurrency, the cryptocurrency +network would be subject to new protocols and software. However, if less than a significant majority of users and mining companies on +the cryptocurrency network consent to the proposed modification, and the modification is not compatible with the software prior to its +modification, the consequence would be what is known as a “fork” of the network, with one prong running the pre-modified software +and the other running the modified software. The effect of such a fork would be the existence of two versions of the cryptocurrency running +in parallel yet lacking interchangeability and necessitating exchange-type transaction to convert currencies between the two forks. +Additionally, it may be unclear following a fork which fork represents the original cryptocurrency and which is the new cryptocurrency. +Different metrics adopted by industry participants to determine which is the original asset include: referring to the wishes of the core +developers of a cryptocurrency, blockchains with the greatest amount of hashing power contributed by miners or validators; or blockchains +with the longest chain. A fork in the network of a particular cryptocurrency could adversely affect an investment in our securities or +our ability to operate. +70 +Since August 1, 2017, +Bitcoin’s blockchain was forked multiple times creating alternative versions of the cryptocurrency such as Bitcoin Cash, Bitcoin +Gold and Bitcoin SV. The forks resulted in a new blockchain being created with a shared history, and a new path forward. The value +of the newly created versions including Bitcoin Cash, Bitcoin Gold and Bitcoin SV may or may not have value in the long run and may affect +the price of Bitcoin if interest is shifted away from Bitcoin to the newly created cryptocurrencies. The value of Bitcoin after the creation +of a fork is subject to many factors including the value of the fork product, market reaction to the creation of the fork product, and +the occurrence of forks in the future. As such, the value of Bitcoin could be materially reduced if existing and future forks have a negative +effect on Bitcoin’s value. +The characteristics of crypto assets have been, +and may in the future continue to be, exploited to facilitate illegal activity such as fraud, money laundering, tax evasion and ransomware +scams; if any of our customers do so or are alleged to have done so, it could adversely affect us. +Digital currencies and the +digital currency industry are relatively new and, in many cases, lightly regulated or largely unregulated. Some types of digital currency +have characteristics, such as the speed with which digital currency transactions can be conducted, the ability to conduct transactions +without the involvement of regulated intermediaries, the ability to engage in transactions across multiple jurisdictions, the irreversible +nature of certain digital currency transactions and encryption technology that anonymizes these transactions, that make digital currency +particularly susceptible to use in illegal activity such as fraud, money laundering, tax evasion and ransomware scams. Two prominent examples +of marketplaces that accepted digital currency payments for illegal activities include Silk Road, an online marketplace on the dark web +that, among other things, facilitated the sale of illegal drugs and forged legal documents using digital currencies and AlphaBay, another +darknet market that utilized digital currencies to hide the locations of its servers and identities of its users. Both of these marketplaces +were investigated and closed by U.S. law enforcement authorities. U.S. regulators, including the SEC, CFTC and Federal Trade Commission, +as well as non-U.S. regulators, have taken legal action against persons alleged to be engaged in Ponzi schemes and other fraudulent schemes +involving digital currencies. In addition, the FBI has noted the increasing use of digital currency in various ransomware scams. +While our board and management +believe that our risk management processes and policies in light of current crypto asset market conditions, which include thorough reviews +we conduct as part of our due diligence process, is reasonably designed to detect any such illicit activities conducted by our potential +or existing counterparties, we cannot ensure that we will be able to detect any such illegal activity in all instances. Because the speed, +irreversibility and anonymity of certain digital currency transactions make them more difficult to track, fraudulent transactions may +be more likely to occur. We or our potential banking counterparties may be specifically targeted by individuals seeking to conduct fraudulent +transfers, and it may be difficult or impossible for us to detect and avoid such transactions in certain circumstances. If one of our +customers (or in the case of digital currency exchanges, their customers) were to engage in or be accused of engaging in illegal activities +using digital currency, we could be subject to various fines and sanctions, including limitations on our activities, which could also +cause reputational damage and adversely affect our business, financial condition and results of operations. +Incorrect or fraudulent cryptocurrency transactions +may be irreversible and it is possible that, through computer or human error, or through theft or criminal action, our cryptocurrency +rewards could be transferred in incorrect amounts or to unauthorized third parties. +Cryptocurrency transactions +are irrevocable and stolen or incorrectly transferred cryptocurrencies may be irretrievable. As a result, any incorrectly executed or +fraudulent cryptocurrency transactions, such as a result of a cybersecurity breach against our Bitcoin holdings, could adversely affect +our investments and assets. This is because cryptocurrency transactions are not, from an administrative perspective, reversible without +the consent and active participation of the recipient of the cryptocurrencies from the transaction. Once a transaction has been verified +and recorded in a block that is added to a blockchain, an incorrect transfer of a cryptocurrency or a theft thereof generally will not +be reversible and we may not have sufficient recourse to recover our losses from any such transfer or theft. Further, it is possible that, +through computer or human error, or through theft or criminal action, our cryptocurrency rewards could be transferred in incorrect amounts +or to unauthorized third parties, or to uncontrolled accounts. If an errant or fraudulent transaction in our Bitcoin were to occur, we +would have very limited means of seeking to reverse the transaction or seek recourse. To the extent that we are unable to recover our +losses from such action, error or theft, such events could have a material adverse effect on our business. +71 +Because many of our digital assets may in the +future be held by digital asset exchanges, we could face heightened risks from cybersecurity attacks and financial stability of digital +asset exchanges . +We may transfer our digital +assets from our wallet to digital asset exchanges prior to selling them. Digital assets not held in our wallet are subject to the risks +encountered by digital asset exchanges including a DDoS Attack or other malicious hacking, a sale of the digital asset exchange, loss +of the digital assets by the digital asset exchange and other risks similar to those described herein. We do not expect to maintain a +custodian agreement with any of the digital asset exchanges that may in the future hold our digital assets. These digital asset exchanges +do not provide insurance and may lack the resources to protect against hacking and theft. If this were to occur, we may be materially +and adversely affected. +Cryptocurrencies, including those maintained +by or for us, may be exposed to cybersecurity threats and hacks. +As with any computer code +generally, flaws in crypto asset codes, including Bitcoin codes, may be exposed by malicious actors. Several errors and defects have been +found previously, including those that disabled some functionality for users and exposed users’ information. Exploitation of flaws +in the source code that allow malicious actors to take or create money have previously occurred. Additionally, as AI capabilities improve +and are increasingly adopted, we may see cyberattacks created through AI. These attacks could be crafted with an AI tool to directly attack +information systems with increased speed and/or efficiency than a human threat actor or create more effective phishing emails. Despite +our efforts and processes to prevent breaches, our devices, as well as our miners, computer systems and those of third parties that we +use in our operations, are vulnerable to cyber security risks, including cyber-attacks such as viruses and worms, phishing attacks, denial-of-service +attacks, physical or electronic break-ins, employee theft or misuse, and similar disruptions from unauthorized tampering with our miners +and computer systems or those of third parties that we use in our operations. As technological change occurs, the security threats to +our cryptocurrencies will likely change and previously unknown threats may emerge. Human error and the constantly evolving state of cybercrime +and hacking techniques may render present security protocols and procedures ineffective in ways which we cannot predict. Such events could +have a material adverse effect on our ability to continue as a going concern or to pursue our strategy at all, which could have a material +adverse effect on our business, prospects or operations and potentially the value of any Bitcoin we mine or otherwise acquire or hold +for our own account. +Our use of third-party +mining pools exposes us to additional risks. +We +receive Bitcoin rewards from our mining activity through third-party mining pool operators. Mining pools allow miners to combine their +processing power, increasing their chances of solving a block and getting paid by the network. The rewards are distributed by the pool +operator, proportionally to our contribution to the pool’s overall mining power, used to solve a block on the Bitcoin blockchain. +Should the pool operator’s system suffer downtime due to a cyber-attack, software malfunction or other issue, it will negatively +impact our ability to mine and receive revenue. Furthermore, we are dependent on the accuracy of the mining pool operator’s record +keeping to accurately record the total processing power provided to the pool for a given Bitcoin mining application in order to assess +the proportion of that total processing power we provided. While we have internal methods of tracking both the hash rate we provide and +the total used by the pool, the mining pool operator uses its own record-keeping to determine our proportion of a given reward, which +may not match our own. If we are unable to consistently obtain accurate proportionate rewards from our mining pool operators, we may experience +reduced reward for our efforts, which would have an adverse effect on our business and operations. +Risks Related to Our Status as a Holding +Company +Our inability to successfully integrate new +acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our +growth strategy through acquisitions is fraught with risk. Since 2017, we acquired a majority interest in Microphase, all of Enertec, +all of Relec, the Michigan Facility, a majority interest in IMHC, the four hotel properties in and around Madison, Wisconsin, certain +real property located in St. Petersburg, Florida, a majority interest in SMC, substantially all the assets and certain specified liabilities +of Circle 8 Crane Service and a position in ROI with which we consolidate as a VIE. Our strategy and business plan are dependent on our +ability to successfully integrate acquisitions. In addition, while we are based in Las Vegas, NV, our finance and legal departments are +located elsewhere in the U.S., and certain subsidiary’s operations are located across the U.S. and internationally. These distant +locations and others that we may become involved with in the future will stretch our resources and management time. Further, failure to +quickly and adequately integrate all of these operations and personnel could adversely affect our combined business and our ability to +achieve our objectives and strategy. No assurance can be given that we will realize synergies in the areas we currently operate. +72 +If we make any additional acquisitions, they may disrupt or have +a negative impact on our business. +We have plans to eventually +make additional acquisitions. Whenever we make acquisitions, we could have difficulty integrating the acquired companies’ personnel +and operations with our own. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot predict +the effect expansion may have on our core business. Regardless of whether we are successful in making an acquisition, the negotiations +could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to the risks described +above, acquisitions are accompanied by a number of inherent risks, including, without limitation, the following: +· If senior management and/or management of future acquired companies terminate their employment prior to +our completion of integration; +· difficulty of integrating acquired products, services or operations; +· integration of new employees and management into our culture while maintaining focus on operating efficiently +and providing consistent, high-quality goods and services; +· potential disruption of the ongoing businesses and distraction of our management and the management of +acquired companies; +· unanticipated issues with transferring customer relationships; +· complexity associated with managing our combined company; +· difficulty of incorporating acquired rights or products into our existing business; +· difficulties in disposing of the excess or idle facilities of an acquired company or business and expenses +in maintaining such facilities; +· difficulties in maintaining uniform standards, controls, procedures and policies; +· potential impairment of relationships with employees and customers as a result of any integration of new +management personnel; +· potential inability or failure to achieve additional sales and enhance our customer base through cross-marketing +of the products to new and existing customers; +· effect of any government regulations which relate to the business acquired; and +· potential unknown liabilities associated with acquired businesses or product lines, or the need to spend +significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense of any litigation, whether +or not successful, resulting from actions of the acquired company prior to our acquisition. +Our business could be severely +impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection +with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract +our management and employees, increase our expenses and adversely affect our results of operations. +We may not be able to successfully identify +suitable acquisition targets and complete acquisitions to meet our growth strategy, and even if we are able to do so, we may not realize +the full anticipated benefits of such acquisitions, and our business, financial conditions and results of operations may suffer. +Increasing revenues through +acquisitions is one of the key components of our growth strategy. Identifying suitable acquisition candidates can be difficult, time-consuming +and costly, and we may not be able to identify suitable candidates or complete acquisitions in a timely manner, on a cost-effective basis +or at all. +73 +We will have to pay cash, +incur debt, or issue equity as consideration in any future acquisitions, each of which could adversely affect our financial condition +or the market price of our common stock. The sale of equity or issuance of equity-linked debt to finance any future acquisitions could +result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could limit our +flexibility in managing our business due to covenants or other restrictions contained in debt instruments. +Further, we may not be able +to realize the anticipated benefits of completed acquisitions. Some acquisition targets may not have a developed business or are experiencing +inefficiencies and incur losses. Additionally, small defense contractors which we consider suitable acquisition targets may be uniquely +dependent on their prior owners and the loss of such owners’ services following the completion of acquisitions may adversely affect +their business. Therefore, we may lose our investment in the event that the acquired businesses do not develop as planned, we cannot retain +key employees or that we are unable to achieve the anticipated cost efficiencies or reduction of losses. +Additionally, our acquisitions +have previously required, and any similar future transactions may also require, significant management efforts and expenditures. Regardless +of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, divert the attention of our +management and key employees and increase our expenses. +We face risks with respect to the evaluation and management of future +platform or add-on acquisitions . +A component of our strategy +is to continue to acquire additional add-on businesses for our existing businesses. Generally, because such acquisition targets are held +privately, we may experience difficulty in evaluating potential target businesses as the information concerning these businesses is not +publicly available. In addition, we and our subsidiary companies may have difficulty effectively managing or integrating acquisitions. +We may experience greater than expected costs or difficulties relating to such acquisition, in which case we might not achieve the anticipated +returns from any particular acquisition, which may have a material adverse effect on our financial condition, business and results of +operations. +We may not be able to successfully fund future +acquisitions of new businesses due to the lack of availability of debt or equity financing at the parent company level on acceptable terms, +which could impede the implementation of our acquisition strategy and materially adversely impact our financial condition, business and +results of operations . +In order to make future acquisitions, +we intend to raise capital primarily through debt financing, additional equity offerings, the sale of stock or assets of our businesses, +or by undertaking a combination of any of the above. Since the timing and size of acquisitions cannot be readily predicted, we may need +to be able to obtain funding on short notice to benefit fully from attractive acquisition opportunities. Such funding may not be available +on acceptable terms, if at all. In addition, the level of our indebtedness that we may incur may impact our ability to borrow. Another +source of capital for us may be the sale of additional shares, subject to market conditions and investor demand for the shares at prices +that we consider to be in the interests of our stockholders. These risks may materially adversely affect our ability to pursue our acquisition +strategy successfully and materially adversely affect our financial condition, business and results of operations. +Because we face significant competition for +acquisition and business opportunities, including from numerous companies with a business plan similar to ours, it may be difficult for +us to fully execute our business strategy. Additionally, our subsidiaries also operate in highly competitive industries, limiting their +ability to gain or maintain their positions in their respective industries. +We expect to encounter intense +competition for acquisition and business opportunities from both strategic investors and other entities having a business objective similar +to ours, such as private investors (which may be individuals or investment partnerships), blank check companies including special purpose +acquisition companies, and other entities, domestic and international, competing for the type of businesses that we may acquire. Many +of these competitors possess greater technical, human and other resources, or more local industry knowledge, or greater access to capital, +than we do, and our financial resources may be relatively limited when contrasted with those of many of these competitors. These factors +may place us at a competitive disadvantage in successfully completing future acquisitions and investments. +In addition, while we believe +that there are numerous target businesses that we could potentially acquire or invest in, our ability to compete with respect to the acquisition +of certain target businesses that are sizable will be limited by our available financial resources. We may need to obtain additional financing +in order to consummate future acquisitions and investment opportunities and cannot assure you that any additional financing will be available +to us on acceptable terms, or at all, or that the terms of our existing financing arrangements will not limit our ability to do so. This +inherent competitive limitation gives others an advantage in pursuing acquisition and investment opportunities. +74 +Furthermore, our subsidiaries +also face competition from both traditional and new market entrants that may adversely affect them as well, as discussed elsewhere in +these risk factors. +We may be required to expend substantial sums +in order to bring the companies we have acquired or may acquire in the future, into compliance with the various reporting requirements +applicable to public companies and/or to prepare required financial statements, and such efforts may harm our operating results or be +unsuccessful altogether. +The Sarbanes-Oxley Act requires +our management to assess the effectiveness of the internal control over financial reporting for the companies we acquire and our external +auditor to audit these companies. In order to comply with the Sarbanes-Oxley Act, we will need to implement or enhance internal control +over financial reporting at acquired companies and evaluate the internal controls. We do not conduct a formal evaluation of companies’ +internal control over financial reporting prior to an acquisition. We may be required to hire additional staff and incur substantial costs +to implement the necessary new internal controls at the companies we acquire. Any failure to implement required internal controls, or +difficulties encountered in their implementation, could harm our operating results or increase the risk of material weaknesses in internal +controls, which could, if not remediated, adversely affect our ability to report our financial condition and results of operations in +a timely and accurate manner. +Future acquisitions or business opportunities +could involve unknown risks that could harm our business and adversely affect our financial condition and results of operations . +We are a diversified holding +company that owns interests in a number of different businesses across several industries. We have in the past, and intend in the future, +to acquire businesses or make investments, directly or indirectly through our subsidiaries, that involve unknown risks, some of which +will be particular to the industry in which the investment or acquisition targets operate, including risks in industries with which we +are not familiar or experienced. There can be no assurance our due diligence investigations will identify every matter that could have +a material adverse effect on us or the entities that we may acquire. We may be unable to adequately address the financial, legal and operational +risks raised by such investments or acquisitions, especially if we are unfamiliar with the relevant industry, which can lead to significant +losses on material investments. The realization of any unknown risks could expose us to unanticipated costs and liabilities and prevent +or limit us from realizing the projected benefits of the investments or acquisitions, which could adversely affect our financial condition +and liquidity. In addition, our financial condition, results of operations and the ability to service our debt may be adversely impacted +depending on the specific risks applicable to any business we invest in or acquire and our ability to address those risks. +We face certain risks associated with the acquisition +or disposition of businesses and lack of control over certain of our investments. +In pursuing our corporate +strategy, we may acquire, dispose of or exit businesses or reorganize existing investments. The success of this strategy is dependent +upon our ability to identify appropriate opportunities, negotiate transactions on favorable terms and ultimately complete such transactions. +In the course of our acquisitions, +we may not acquire 100% ownership of certain of our operating subsidiaries or we may face delays in completing certain acquisitions, including +in acquiring full ownership of certain of our operating companies. Once we complete acquisitions or reorganizations there can be no assurance +that we will realize the anticipated benefits of any transaction, including revenue growth, operational efficiencies or expected synergies. +If we fail to recognize some or all of the strategic benefits and synergies expected from a transaction, goodwill and intangible assets +may be impaired in future periods. The negotiations associated with the acquisition and disposition of businesses could also disrupt our +ongoing business, distract management and employees or increase our expenses. +In addition, we may not be +able to integrate acquisitions successfully and we could incur or assume unknown or unanticipated liabilities or contingencies, which +may impact our results of operations. If we dispose of or otherwise exit certain businesses, there can be no assurance that we will not +incur certain disposition related charges, or that we will be able to reduce overhead related to the divested assets. +75 +In the ordinary course of +our business, we evaluate the potential disposition of assets and businesses that may no longer help us meet our objectives or that no +longer fit with our broader strategy. When we decide to sell assets or a business, we may encounter difficulty in finding buyers or alternative +exit strategies on acceptable terms in a timely manner, which could delay the accomplishment of our strategic objectives, or we may dispose +of a business at a price or on terms which are less than we had anticipated. In addition, there is a risk that we sell a business whose +subsequent performance exceeds our expectations, in which case our decision would have potentially sacrificed enterprise value. +Our development stage companies may never produce +revenues or income. +We have made investments in +and own stakes, either majority or minority, in a certain development stage companies. Each of these companies is at an early stage of +development and is subject to all business risks associated with a new enterprise, including constraints on their financial and personnel +resources, lack of established credit, the need to establish meaningful and beneficial vendor and customer relationships and uncertainties +regarding product development and future revenues. We anticipate that many of these companies will continue to incur substantial additional +operating losses for at least the next several years and expect their losses to increase as research and development efforts expand. There +can be no assurance as to when or whether any of these companies will be able to develop significant sources of revenue or that any of +their respective operations will become profitable, even if any of them is able to commercialize any products. As a result, we may not +realize any returns on our investments in these companies for a significant period of time, if at all, which could adversely affect our +business, results of operations, financial condition or liquidity. +Divestitures and contingent liabilities from +divested businesses could adversely affect our business and financial results . +We continually evaluate the +performance and strategic fit of all of our businesses and may sell businesses or product lines. Divestitures involve risks, including +difficulties in the separation of operations, services, products and personnel, the diversion of management’s attention from other +business concerns, the disruption of our business, the potential loss of key employees and the retention of uncertain contingent liabilities, +including environmental liabilities, related to the divested business. When we decide to sell assets or a business, we may encounter difficulty +in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the achievement of our strategic +objectives. We may also dispose of a business at a price or on terms that are less desirable than we had anticipated, which could result +in significant asset impairment charges, including those related to goodwill and other intangible assets, that could have a material adverse +effect on our financial condition and results of operations. In addition, we may experience greater dis-synergies than expected, the impact +of the divestiture on our revenue growth may be larger than projected, and some divestitures may be dilutive to earnings. There can be +no assurance whether the strategic benefits and expected financial impact of the divestiture will be achieved. We cannot assure you that +we will be successful in managing these or any other significant risks that we encounter in divesting a business or product line, and +any divestiture we undertake could materially and adversely affect our business, financial condition, results of operations and cash flows. +Risks Related to Related Party Transactions +There may be conflicts of +interest between our company and certain of our related parties and their respective directors and officers which might not be resolved +in our favor. More importantly, there may be conflicts between certain of our related parties and their respective directors and officers +which might not be resolved in our favor. These risks are set forth below appurtenant to the relevant related party. +Ault & Company +Our relationship with Ault & Company may +enhance the difficulty inherent in obtaining financing for us as well as expose us to certain conflicts of interest. +As of April 15, 2024, Ault +& Company, of which Milton C. (Todd) Ault, III is the chief executive officer, beneficially owned 452,443 shares of our common stock, +consisting of (i) 229 shares of common stock owned and (ii) 452,214 shares of common stock issuable upon conversion of Series C Convertible +Preferred Stock. While as of April 15, 2024, Ault & Company beneficially owned 1.5% of our common stock, Ault & Company owned +additional shares of Series C Convertible Preferred Stock and warrants to purchase shares of common stock that cannot be converted and/or +exercised in accordance with the rules and regulations of the NYSE American, LLC unless we first obtain stockholder approval. If stockholder +approval was obtained and there were no restrictions on the conversion and/or exercise of the Series C Convertible Preferred Stock and +warrants owned by Ault & Company as of April 15, 2024, then Ault & Company would beneficially own 82.2% of our common stock. +In addition, pursuant to the +November 2023 SPA, as amended in March 2024, Ault & Company has the right to purchase up to an additional $31.5 million of Series +C Convertible Preferred Stock and Series C Warrants, which would further increase their beneficial ownership. Given the close relationship +between Ault & Company, on the one hand, and our company, on the other, it is not inconceivable that we could further amend the November +2023 SPA or enter into additional securities purchase agreements with Ault & Company. +76 +Although we have relied on +Ault & Company to finance us in the past, we cannot assure you that Ault & Company will assist us in the future. We would far +prefer to rely on Ault & Company’s assistance compared to other sources of financing as the terms they provide us are in general +more favorable to us than we could obtain elsewhere. However, Messrs. Ault, Horne and Nisser could face a conflict of interest in that +they serve on the board of directors of each of Ault & Company and our company. If they determine that an investment in our company +is not in Ault & Company’s best interest, we could be forced to seek financing from other sources that would not necessarily +be likely to provide us with equally favorable terms. +Other conflicts of interest +between us, on the one hand, and Ault & Company, on the other hand, may arise relating to commercial or strategic opportunities or +initiatives. Mr. Ault, as the controlling stockholder of Ault & Company, may not resolve such conflicts in our favor. For example, +we cannot assure you that Ault & Company would not pursue opportunities to provide financing to other entities whether or not it currently +has a relationship with such other entities. Furthermore, our ability to explore alternative sources of financing other than Ault & +Company may be constrained due to Mr. Ault’s vision for us and he may not wish for us to receive any financing at all other than +from entities that he controls. +Alzamend +Our relationship with Alzamend may expose us +to certain conflicts of interest. +As of April 15, 2024, +we beneficially own 2,092,427 shares of Alzamend’s common stock, representing approximately 25.5%, consisting of (i) +1,111 shares underlying currently exercisable warrants we own, (ii) 768,365 shares held by Ault Lending and (iii) 1,322,951 shares issuable +upon conversion of series B convertible preferred stock of Alzamend (the “ALZN Series B Preferred”) held by Ault Lending. In +addition, Ault Lending owns additional shares of ALZN Series B Preferred and warrants to purchase shares of common stock that cannot +be converted and/or exercised in accordance with the rules and regulations of the Nasdaq Stock Market unless Alzamend first obtains stockholder +approval. In addition, the warrants are either not currently exercisable, as the initial exercise dates are six months after issuance, +while other warrants contain beneficial ownership blockers. If stockholder approval was obtained and there were no restrictions on the +conversion and/or exercise of the ALZN Series B Preferred and warrants owned by Ault Lending as of April 15, 2024, then we would beneficially +own 43.8% of Alzamend’s common stock. +In addition, pursuant +to the January 2024 SPA, Ault Lending has the right to purchase up to an additional $4.0 million of ALZN Series B Preferred and warrants, +which would further increase our beneficial ownership. Beyond the securities we beneficially own, Mr. Ault, our Chief Executive Officer, +beneficially owns an additional 1,168,560 shares of common stock, consisting of (i) 166,865 shares +held by Mr. Ault, (ii) 996,197 shares held by Ault Life Sciences, Inc. (“ALSI”) and (iii) 5,498 shares held by Ault Life Sciences +Fund, LLC (“ALSF”). Mr. Ault has sole voting and investment power with respect to the securities held of record by ALSI and +ALSF. +Messrs. Ault, Horne and Nisser +could face a conflict of interest in that they serve on the board of directors of each of Alzamend and our company. +Avalanche +We have lent a substantial amount of funds +to Avalanche, a related party, whose ability to repay us is subject to significant doubt; in addition, we currently beneficially own a +significant percentage of Avalanche’s issued and outstanding shares of common stock, for which there is presently no market. +On September 6, 2017, we entered +into a Loan and Security Agreement with Avalanche (as amended, the “AVLP Loan Agreement”) with an effective date of August +21, 2017 pursuant to which we provided Avalanche a non-revolving credit facility. The AVLP Loan Agreement was increased to up to $20.0 +million in June of 2021 and extended to December 31, 2023. +While Avalanche received funds +from a third party in the amount of $2.75 million in early April of 2019 in consideration for its issuance of a convertible promissory +note to such third party (the “Third Party Note”), $2.7 million was used to pay an outstanding receivable due us and no amount +was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, Ault Alpha LP (“Ault Alpha”), +an entity that was an affiliate of ours at that time, repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 +million shares of AVLP common stock. In consideration therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, +which term note had a maturity date of June 30, 2022. +77 +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for a 10% senior secured convertible note in the principal face amount of $3.8 million due June +15, 2024 (the “Ault Alpha Note”). The Ault Alpha Note is convertible, subject to adjustment, at $0.50 per share. AVLP also +issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise price of $0.50. Pursuant +to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the +foregoing parties, our company and certain other persons, Ault Alpha was granted a second priority interest in AVLP’s assets securing +the repayment of the Ault Alpha Note. In connection with the liquidation of Ault Alpha in December 2023, Ault Lending assumed the Ault +Alpha Note, the warrants to purchase Avalanche common stock and the secured party rights. +On July 11, 2022, AVLP issued +us a 10% senior secured convertible note in the principal face amount of $3.0 million due July 10, 2024 (the “AVLP Note”). +The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an aggregate of 41.0 +million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into by Avalanche and +Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and certain other persons, +we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +We previously held a convertible +note issued to us by AVLP in the amount of $20.0 million, referred to as the AVLP Loan Agreement. On June 1, 2022, we converted the entire +principal and accrued interest on the AVLP Loan Agreement into an aggregate of 51.9 million shares of common stock of Avalanche, +representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. There is currently no liquid market +for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common stock on the open market, our ability +to do so would be severely limited. Avalanche is not current in its filings with the SEC and is not required to register the shares of +its common stock underlying the AVLP Loan Agreement or any other loan arrangement we have made with Avalanche described above. +There is doubt as to whether +Avalanche will ever have the ability to repay its debt to us, as well as our ability to sell the shares we beneficially own since at present +there is no market for these shares. If we are unable to recoup our investment in Avalanche in the foreseeable future or at all, such +failure would have a materially adverse effect on our financial condition and future prospects. +Milton C. Ault, III and William B. Horne, our +Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. +Milton C. Ault, III and William +B. Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors, are also directors of Avalanche. +Certain conflicts of interest between us, on the one hand, and Avalanche, on the other hand, may arise relating to commercial or strategic +opportunities or initiatives, in addition to the conflicts related to the debt that Avalanche owes us. For example, Messrs. Ault and Horne +may find it difficult to determine how to meet their fiduciary duties to us as well as Avalanche, which could result in a less favorable +result for us than would be the case if they were solely directors of our company. Further, even if Messrs. Ault and Horne were able to +successfully meet their fiduciary obligations to us and Avalanche, the fact that they are members of the board of directors of both companies +could attenuate their ability to focus on our business and best interests, possibly to the detriment of both companies. +ROI +Our relationship with ROI may expose us to certain conflicts of +interest. +As of April 15, 2024, we beneficially own 1,701,969 +shares of ROI’s common stock, consisting of (i) 745,244 shares held by Ault Lending, +(ii) 293,358 shares issuable upon the conversion of outstanding shares of Series A Convertible Redeemable Preferred Stock (“ROI +Series A Preferred”) we own, and (iii) 663,367 shares issuable upon the conversion of outstanding shares of ROI Series D Preferred +we own. While as of April 15, 2024, we beneficially owned approximately 5.1% of ROI’s common stock, we own shares of Series B Convertible +Preferred Stock (“ROI Series B Preferred”) and additional shares of ROI Series D Preferred that cannot be converted unless +we first obtain shareholder approval, in addition to beneficial ownership blockers and other restrictions. If shareholder approval was +obtained and there were no restrictions on the conversion of the securities we own, as of April 15, 2024, then we would beneficially own +58.2% of ROI’s common stock. +78 +Messrs. Ault and Nisser could +face a conflict of interest in that they serve on the board of directors of each of ROI and our company. +Risks Related to +RiskOn +Risks Related to BNC +If BNC does not successfully +develop its business, the shares that we own as well as those we are entitled to may have very little value, if any. +We +sold BNC to ROI under the assumption that BNC is worth $100 million, of which we would receive shares of Series B Preferred valued at +$86 million, assuming ROI obtains Shareholder Approval, as discussed above. However, if BNC does not successfully develop its business +within the foreseeable future, ROI could be required to seek additional capital, which could result in a decrease in the value of our +shares of Series B Preferred, whether due to dilution or the terms of such financing. There can be no assurance that ROI would be able +to raise the requisite financing to maintain or develop its business on reasonably favorable terms, whether to it or to us, if at all. +Further, whether or not BNC seeks or receives additional financing, if its business never develops, then our shares of Series B Preferred +will in all likelihood have no value at all. +Risks Related to BNC’s +Product Offerings +If BNC fails to retain +existing users or add new users, or if BNC’s users decrease their level of engagement with BNC’s products, BNC’s revenue, +financial results, and business may be significantly harmed. +The +size of BNC’s user base and BNC’s users’ level of engagement across BNC’s products are critical to BNC’s +success. BNC’s financial performance will be significantly determined by BNC’s success in adding, retaining, and engaging +active users of BNC’s products that deliver ad impressions. User growth and engagement are also impacted by a number of other factors, +including competitive products and services, such as TikTok, that could reduce some users’ engagement with BNC’s products +and services, as well as global and regional business, macroeconomic, and geopolitical conditions. Any future declines in the size of +BNC’s active user base, which to date is minimal, may adversely impact BNC’s ability to deliver ad impressions and, in turn, +BNC’s financial performance. +If +people do not perceive BNC’s products to be useful, reliable, and trustworthy, BNC may not be able to attract or retain users or +otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved +early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee +that BNC will not experience a similar inability to generate a significant used baser or, if achieved, subsequent erosion of BNC’s +active user base or engagement levels. User engagement can be difficult to measure, particularly as BNC introduces new and different products +and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: +· users increasingly engage with other competitive +products or services; +· BNC fails to introduce new features, products, +or services that users find engaging or if BNC introduces new products or services, or makes changes to existing products and services, +that are not favorably received; +· users feel that their experience is diminished as a result of the decisions BNC makes with respect to +the frequency, prominence, format, size, and quality of ads that BNC displays; +· users have difficulty installing, updating, or otherwise accessing BNC’s products on mobile devices +as a result of actions by BNC or third parties that BNC relies on to distribute BNC’s products and deliver BNC’s services; +· BNC is unable to develop products for mobile devices that users find engaging, that work with a variety +of mobile operating systems and networks, and that achieve a high level of market acceptance; +· there are decreases in user sentiment due to questions about the quality or usefulness of BNC’s +products or BNC’s user data practices, concerns about the nature of content made available on BNC’s products, or concerns +related to privacy, safety, security, well-being, or other factors; +79 +· BNC is unable to manage and prioritize information to ensure users are presented with content that is +appropriate, interesting, useful, and relevant to them; +· BNC is unable to obtain or attract engaging third-party content; +· BNC is unable to successfully maintain or grow usage of and engagement with applications that integrate +with BNC’s products; +· users adopt new technologies where BNC’s products may be displaced in favor of other products or +services, or may not be featured or otherwise available; +· there are changes mandated by legislation, government and regulatory authorities, or litigation that adversely +affect BNC’s products or users; +· BNC is unable to offer a number of BNC’s products and services in Europe, or are otherwise limited +in BNC’s business operations, as a result of European regulators, courts, or legislative bodies determining that BNC’s reliance +on Standard Contractual Clauses or other legal basis BNC may rely upon to transfer user data from the European Union to the United States +is invalid; +· there is decreased engagement with BNC’s products, or failure to accept BNC’s terms of service, +as part of privacy-focused changes that BNC has implemented or may implement in the future, whether voluntarily, in connection with the +General Data Protection Regulation (“GDPR”), the European Union’s ePrivacy Directive, the California Privacy Rights +Act (“CPRA”), or other laws, regulations, or regulatory actions, or otherwise; +· technical or other problems prevent BNC from delivering its products in a rapid and reliable manner or +otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content, or users feel +their experience is diminished as a result of BNC’s efforts to protect the security and integrity of the Platform; +· BNC adopts terms, policies, or procedures related to areas such as sharing, content, user data, or advertising, +or BNC takes, or fails to take, actions to enforce BNC’s policies, that are perceived negatively by BNC’s users or the general +public; +· BNC elects to focus its product decisions on longer-term initiatives that do not prioritize near-term +user growth and engagement; +· BNC makes changes in its user account login or registration processes or changes in how BNC promotes different +products and services across its family of products; +· initiatives designed to attract and retain users and engagement, including the use of new technologies +such as artificial intelligence, are unsuccessful, whether as a result of actions by BNC, its competitors, or other third parties, or +otherwise; +· there is decreased engagement with BNC’s products as a result of taxes imposed on the use of social +media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility +of BNC’s products in their countries; +· BNC fails to provide adequate customer service to users, marketers, developers, or other partners; or +· BNC, developers whose products are integrated with BNC’s products, or other partners and companies +in BNC’s industry are the subject of adverse media reports or other negative publicity, including as a result of BNC’s or +its user data practices. +80 +From +time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If BNC are +unable to maintain or increase BNC’s user base and user engagement, particularly for BNC’s significant revenue-generating +products like Facebook and Instagram, BNC’s revenue and financial results may be adversely affected. Any significant decrease in +user retention, growth, or engagement could render BNC’s products less attractive to users, marketers, and developers, which is +likely to have a material and adverse impact on BNC’s ability to deliver ad impressions and, accordingly, BNC’s revenue, business, +financial condition, and results of operations. As the size of BNC’s active user base fluctuates in one or more markets from time +to time, BNC will become increasingly dependent on BNC’s ability to maintain or increase levels of user engagement and monetization +in order to grow revenue. +BNC’s user growth, +engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, +products, and standards that BNC does not control. +The +substantial majority of BNC’s revenue is expected to be generated from advertising on mobile devices. There is no guarantee that +popular mobile devices will feature BNC’s products, or that mobile device users will ever use BNC’s products rather than competing +products. BNC is dependent on the interoperability of BNC’s products with popular mobile operating systems, networks, technologies, +products, and standards that BNC does not control, such as the Android and iOS operating systems and mobile browsers. Changes, bugs, or +technical issues in such systems, or changes in BNC’s relationships with mobile operating system partners, handset manufacturers, +browser developers, or mobile carriers, or in the content or application of their terms of service or policies that degrade BNC’s +products’ functionality, reduce or eliminate BNC’s ability to update or distribute BNC’s products, give preferential +treatment to competitive products, limit BNC’s ability to deliver, target, or measure the effectiveness of ads, or charge fees related +to the distribution of BNC’s products or BNC’s delivery of ads have in the past adversely affected, and could in the future +adversely affect, the usage of BNC’s products and monetization on mobile devices. +BNC’s products +and changes to such products could fail to attract or retain users or generate revenue and profits, or otherwise adversely affect BNC’s +business. +BNC’s +ability to retain, increase, and engage its user base and to increase BNC’s revenue depends heavily on BNC’s ability to continue +to evolve BNC’s existing products and to create successful new products, both independently and in conjunction with developers or +other third parties. BNC may introduce significant changes to BNC’s products or acquire or introduce new and unproven products, +including using technologies with which BNC has little or no prior development or operating experience. For example, BNC does not have +significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect BNC’s +ability to successfully develop and market these products and technologies. BNC will incur substantial costs, and BNC may not be successful +in generating profits, in connection with these efforts. These efforts, including the introduction of new products or changes to existing +products, may result in new or enhanced governmental or regulatory scrutiny, litigation, ethical concerns, or other complications that +could adversely affect BNC’s business, reputation, or financial results. If BNC’s new products or changes to existing products +fail to engage users, marketers, or developers, or if BNC’s business plans are unsuccessful, BNC may fail to attract or retain users +or to generate sufficient revenue, operating margin, or other value to justify BNC’s investments, and BNC’s business may be +adversely affected. +BNC may not be successful +in its metaverse strategy and investments, which could adversely affect BNC’s business, reputation, or financial results. +BNC +believes that the metaverse, an embodied internet where people have immersive experiences beyond two-dimensional screens, is the next +evolution in social technology. BNC intends to focus on helping to bring the metaverse to life. BNC expects this will b e +a complex, evolving, and long-term initiative that will involve the development of new and emerging technologies, require significant +investment in infrastructure as well as pri vacy, safety, and security efforts, and collaboration with other companies, developers, +partners, and other participants. However, the metaverse may not develop in accordance with BNC’s expectations, and market acceptance +of features, products, or services BNC may build for the metaverse is uncertain. BNC intends to regularly evaluate BNC’s product +roadmaps and make significant changes as BNC’s understanding of the technological challenges and market landscape and BNC’s +product ideas and designs evolve. In addition, BNC has virtually no experience with consumer hardware products and virtual and augmented +reality technology, which may enable other companies to compete more effectively than it can. BNC may be unsuccessful in BNC’s future +research and product development efforts, including if BNC is unable to develop relationships with key participants in the metaverse or +develop products that operate effectively with metaverse technologies, products, systems, networks, or standards. BNC hopes to make investments +in virtual and augmented reality and other technologies to support these efforts, and BNC’s ability to support these efforts is +dependent on generating sufficient profits from BNC’s business. In addition, as BNC’s metaverse efforts evolve, BNC may be +subject to a variety of existing or new laws and regulations in the United States and international jurisdictions, including in the areas +of privacy, safety, competition, content regulation, consumer protection, and e-commerce, which may delay or impede the development of +BNC’s products and services, increase BNC’s operating costs, require significant management time and attention, or otherwise +harm BNC’s business. As a result of these or other factors, BNC’s metaverse strategy and investments may not be successful +in the foreseeable future, or at all, which could adversely affect BNC’s business, reputation, or financial results. +81 +BNC may not be able +to successfully grow usage of and engagement with applications that integrate with BNC’s products. +BNC +hopes to make investments to enable developers to build, grow, and monetize applications that integrate with BNC’s products. Such +existing and prospective developers may not be successful in building, growing, or monetizing applications that create and maintain user +engagement. Additionally, developers may choose to build on other platforms, including platforms controlled by third parties, rather than +building products that integrate with BNC’s products. BNC is continuously seeking to balance the distribution objectives of BNC’s +developers with BNC’s desire to provide an optimal user experience, and BNC may not be successful in achieving a balance that attracts +or retains such developers. In addition, as part of BNC’s efforts related to privacy, safety, and security, BNC intends to conduct +investigations and audits of platform applications from time to time. In some instances, these actions will adversely affect BNC’s +relationships with developers. If BNC is not successful in BNC’s efforts to grow the number of developers that choose to build products +that integrate with BNC’s products or if BNC is unable to continue to build and maintain good relations with such developers, BNC’s +user growth and user engagement as well as its financial results may be adversely affected. +Risks Related to BNC’s +Business Operations and Financial Results +Our business is highly +competitive. Competition presents an ongoing threat to the success of BNC’s business. +BNC +expects to compete with companies providing connection, sharing, discovery, and communication products and services to users online, as +well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing +advertising campaigns. BNC faces significant competition in every aspect of BNC’s business, including, but not limited to, companies +that facilitate the ability of users to create, share, communicate, and discover content and information online or enable marketers to +reach their existing or prospective audiences. BNC expects to compete to attract, engage, and retain people who use BNC’s products, +to attract and retain businesses that use BNC’s free or paid business and advertising services, and to attract and retain developers +who build compelling applications that integrate with BNC’s products. BNC also expects to compete with companies that develop and +deliver virtual and augmented reality products and services. As BNC introduces or acquires new products, or as other companies introduce +new products and services, including as part of efforts to develop the metaverse or innovate through the application of new technologies +such as artificial intelligence, BNC may become subject to additional competition. +Virtually +all BNC’s current and potential competitors have greater resources, experience, or stronger competitive positions in the product +segments, geographic regions, or user demographics in which BNC intends to operate than BNC does. For example, some of BNC’s competitors +may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively +than BNC could. These factors may allow BNC’s competitors to respond more effectively than BNC to new or emerging technologies and +changes in market conditions. In the event that users engage with other products and services, BNC may never see any growth in use and +engagement in key user demographics or more broadly, in which case BNC’s business would be harmed. +BNC’s +competitors may develop products, features, or services that are similar to its own or that achieve greater acceptance, may undertake +more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. Some +competitors may gain a competitive advantage against BNC, including: by making acquisitions; by limiting BNC’s ability to deliver, +target, or measure the effectiveness of ads; by imposing fees or other charges related to BNC’s delivery of ads; by making access +to BNC’s products more difficult or impossible; by making it more difficult to communicate with BNC’s users; or by integrating +competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, +or e-commerce platforms. BNC’s competitors may, and in some cases will, acquire and engage users or generate advertising or other +revenue at the expense of BNC’s own efforts, which would negatively affect BNC’s business and financial results. In addition, +from time to time, BNC may take actions in response to competitive threats, but BNC cannot assure you that these actions will be successful +or that they will not negatively affect BNC’s business and financial results. +Real or perceived +inaccuracies in BNC’s community and other metrics may harm BNC’s reputation and negatively affect BNC’s business. +The +numbers for BNC’s key metrics are calculated using internal company data based on the activity of user accounts, at times augmented +by other sources. While these numbers are based on what BNC believes to be reasonable estimates of BNC’s user base for the applicable +period of measurement, there are inherent challenges in measuring usage of BNC’s products across online and mobile populations around +the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other +technical errors. In addition, BNC is seeking to establish mechanisms to improve its estimates of its user base, and such estimates may +change due to improvements or changes in BNC’s methodology. BNC intends to regularly review BNC’s processes for calculating +these metrics, and from time to time BNC expects to discover inaccuracies in these metrics or make adjustments to improve their accuracy. +82 +The lack of comprehensive +encryption for communications on the Platform may increase the impact of a data security incident. +Communications +on the Platform are not comprehensively encrypted at this time. As such, any data security incident that involves unauthorized access, +acquisition, disclosure, or use may be highly impactful to BNC’s business. BNC may experience considerable incident response forensics, +data recovery, legal fees, and costs of notification related to any such potential incident, and BNC may face an increased risk of reputational +harm, regulatory enforcement, and consumer litigation, which could further harm BNC’s business, financial condition, results of +operations, and future business opportunities. +Risks Related to Government +Regulation and Enforcement Regarding BNC +Actions by governments +that restrict access to BNC’s products in their countries, censor or moderate content on BNC’s products in their countries, +or otherwise impair BNC’s ability to sell advertising in their countries, could substantially harm BNC’s business and financial +results. +BNC +expects that governments will from time to time seek to censor or moderate content available on BNC’s products, should such products +ever be developed, distributed and used by customers, in their country, restrict access to BNC’s products from their country partially +or entirely, or impose other restrictions that may affect the accessibility of BNC’s products in their country for an extended period +of time or indefinitely. In addition, government authorities may seek to restrict user access to BNC’s products if they consider +us to be in violation of their laws or a threat to public safety or for other reasons. It is also possible that government authorities +could take action that impairs BNC’s ability to sell advertising, including in countries where access to BNC’s consumer-facing +products may be blocked or restricted. In the event that content shown on BNC’s products is subject to censorship, access to BNC’s +products is restricted, in whole or in part, in one or more countries, BNC would be required to or could elect to make changes to BNC’s +future operations, or other restrictions are imposed on BNC’s products, or BNC’s competitors are able to successfully penetrate +new geographic markets or capture a greater share of existing geographic markets that BNC cannot access or where BNC face other restrictions, +BNC’s ability to increase BNC’s user base, user engagement, or the level of advertising by marketers may be adversely affected, +and BNC may not be able to grow BNC’s revenue as anticipated, and BNC’s financial results could be adversely affected. +Our business is subject +to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, safety +and consumer protection, e-commerce, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, +and could result in claims, changes to BNC’s products and business practices, monetary penalties, increased cost of operations, +or declines in user growth or engagement, or otherwise harm BNC’s business. +BNC +is subject to a variety of laws and regulations in the United States and abroad that will involve matters central to BNC’s business, +including privacy, data use, data protection and personal information, biometrics, encryption, rights of publicity, content, integrity, +intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, +data disclosure, artificial intelligence and machine learning, electronic contracts and other communications, competition, protection +of minors, consumer protection, civil rights, accessibility, telecommunications, product liability, e-commerce, taxation, economic or +other trade controls including sanctions, anti-corruption and political law compliance, securities law compliance, and online payment +services. The introduction of new products, expansion of BNC’s activities in certain jurisdictions, or other actions that BNC may +take may subject it to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, +competition, consumer protection, and other laws and regulations can impose different obligations or be more restrictive than those in +the United States. +These +U.S. federal, state, and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government +entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement +of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which BNC operates, and may +be interpreted and applied inconsistently from jurisdiction to jurisdiction and inconsistently with BNC’s current policies and practices. +For example, regulatory or legislative actions or litigation affecting the manner in which BNC displays content to BNC’s users, +moderate content, or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect +the manner in which BNC provides its services or adversely affect BNC’s financial results. +83 +As +its business develops, BNC expects to become subject to significant legislative and regulatory developments, and proposed or new legislation +and regulations could significantly affect BNC’s business in the future. For example, BNC intends to implement certain product changes +and controls as a result of requirements under the European General Data Protection Regulation (“GDPR”), and may implement +additional changes in the future. The interpretation of the GDPR is still evolving and draft decisions in investigations are subject to +review by several European privacy regulators as part of the GDPR’s consistency mechanism, which may lead to significant changes +in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and +amount of penalties for non-compliance, are subject to significant uncertainty. The California Consumer Privacy Act (“CCPA”), +as amended by the California Privacy Rights Act (“CPRA”), also establishes certain transparency rules and creates new data +privacy rights for users, including limitations on BNC’s use of certain sensitive personal information and more ability for users +to control the purposes for which their data is shared with third parties. Other states have proposed or enacted similar comprehensive +privacy laws that afford users with similar data privacy rights and controls. These laws and regulations are evolving and subject to interpretation, +and resulting limitations on BNC’s advertising services, or reductions of advertising by marketers, could adversely affect BNC’s +advertising business. +These +laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past +led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, loss of revenue, delays or impediments +in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time +and attention, and remedies that harm BNC’s business, including fines or demands or orders that BNC modify or cease existing business +practices. +Changes in laws affecting +gaming and gambling or the public perception of gaming and gambling may adversely impact BNC’s business. +BNC offers a number of products +and services, which may include a selection of gaming options, including games, sweepstakes, gambling, and social gaming experiences. +Social gaming experiences have recently been the subject of civil lawsuits, and some jurisdictions have taken an adverse position to interactive +social gaming, including “social casinos” and sweepstakes-based gaming. This could lead to states adopting legislation or +imposing a regulatory framework to govern interactive social gaming or social casino or sweepstakes-based gaming specifically. These could +also result in a prohibition on interactive social gaming or social casino or sweepstakes-based gaming altogether, restrict BNC’s +ability to advertise its games, or substantially increase BNC or our costs to comply with these regulations, all of which could have an +adverse effect on our or BNC’s results of operations, cash flows and financial condition. It is not possible to predict the likelihood, +timing, scope, or terms of any such legislation or regulation or the extent to which they may affect our or BNC’s business. +Regulators in the future may +pass additional rules and regulations that could adversely affect our or BNC’s business. In May 2019, the World Health Organization +adopted a new edition of its International Classification of Diseases, which lists gaming addiction as a disorder. The American Psychiatric +Association (“APA”) and U.S. regulators have yet to decide whether gaming addiction should be considered a behavioral disorder, +but the APA has noted that research and the debate on its classification are ongoing. Certain countries, including China and South Korea, +have enacted regulations, such as imposing both gaming curfews and spending limits for minors, and established treatment +programs aimed at addressing gaming addiction. It is not possible to predict the likelihood, timing, scope, or terms of any +similar regulations in any of the markets in which BNC operates, or the extent to which implementation of such regulations may adversely +affect our or BNC’s reputation and business. +Consumer protection and health +concerns regarding games and gambling such as BNC’s have been raised in the past and may again be raised in the future. Such concerns +could lead to increased scrutiny over the manner in which BNC’s games are designed, developed, distributed, and presented. We and +BNC cannot predict the likelihood, timing or scope of any concern reaching a level that will impact its business, or whether it would +suffer any adverse impacts to our or BNC’s results of operations, cash flows and financial condition. +Our reputation may +be harmed due to unfamiliarity or negative press associated with activities BNC is undertaking, including the online metaverse landscape, +virtual markets, real world goods marketplaces, gaming, social activities, sweepstakes, gambling, and digital assets. +BNC is focused on the development +of the online metaverse landscape and is focused on immersive digital experiences, including virtual markets, real world goods marketplaces, +gaming, social activities, sweepstakes, gambling, and more. The activities BNC is undertaking are based on technology that is relatively +new. Many companies operating in similar industries are unlicensed, unregulated and/or operate without supervision by any governmental +authorities. As a result, users and the general public may lose confidence in BNC’s products and services. Companies like BNC that +deal in digital assets are appealing targets for hackers and malware and may also be more likely to be targets of regulatory enforcement +actions. Negative perception, a lack of stability and standardized regulation in the industries in which BNC operates and the failure +of similar companies due to fraud, business failure, hackers or malware, or government mandated regulation, may reduce confidence in our +or BNC’s business. Any of these events could have a material and adverse impact on our or BNC’s reputation and business. +84 +We may be subject +to regulatory and other government investigations, enforcement actions, settlements, and other inquiries in the future, which could cause +us to incur substantial costs or require us or BNC to change its business practices in a manner materially adverse to its business. +Should +BNC’s business ever expand to a significant degree, we and BNC’s management expects to receive formal and informal inquiries +from government authorities and regulators regarding BNC’s compliance with laws and regulations, many of which are evolving and +subject to interpretation. In such a scenario, we and BNC expect to be the subject of investigations, inquiries, data requests, requests +for information, actions, and audits in the United States, particularly in the areas of privacy and data protection, including with respect +to minors, law enforcement, consumer protection, civil rights, content moderation, blockchain technologies, sweepstakes, promotions, gaming, +gambling, and competition. In addition, we or BNC may in the future be subject to regulatory orders or consent decrees. +We +or BNC may also become subject to various litigation and formal and informal inquiries and investigations by competition authorities in +the United States, which may relate to many aspects of BNC’s future business, including with respect to users and advertisers, as +well as BNC’s industry. Such inquiries, investigations, and lawsuits concern, among other things, BNC’s business practices +in the areas of social networking or social media services, digital advertising, gambling, and sweepstakes activities and/or mobile or +online applications. +Orders +issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us or BNC to incur substantial +costs, expose us to civil and criminal liability (including liability for personnel) or penalties (including substantial monetary remedies), +interrupt or require us or BNC to change its business practices in a manner materially adverse to our or BNC’s business (including +changes products or user data practices), result in negative publicity and reputational harm, divert resources and the time and attention +of management from our or BNC’s business, or subject us or BNC to other structural or behavioral remedies that adversely affect +our or BNC’s business. +BNC expects, should +its business ever develop, to be subject to regulatory and other government investigations, enforcement actions, settlements and other +inquiries in the future, which could cause us BNC incur substantial costs or require BNC to change its business practices in a manner +materially adverse to its business. +Should +BNC’s business ever expand and to a significant degree, its management expects it to receive formal and informal inquiries from +government authorities and regulators regarding BNC’s compliance with laws and regulations, many of which are evolving and subject +to interpretation. In such a scenario, BNC expects to be the subject of investigations, inquiries, data requests, requests for information, +actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy and data protection, including +with respect to minors, law enforcement, consumer protection, civil rights, content moderation, and competition. In addition, BNC may +in the future be subject to regulatory orders or consent decrees. +BNC +may also become subject to various litigation and formal and informal inquiries and investigations by competition authorities in the United +States, Europe, and other jurisdictions, which may relate to many aspects of BNC’s future business, including with respect to users +and advertisers, as well as BNC’s industry. Such inquiries, investigations, and lawsuits concern, among other things, BNC’s +business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications. +Orders +issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause BNC to incur substantial +costs, expose us to civil and criminal liability (including liability for BNC’s personnel) or penalties (including substantial monetary +remedies), interrupt or require BNC to change its business practices in a manner materially adverse to BNC’s business (including +changes to BNC’s products or user data practices), result in negative publicity and reputational harm, divert resources and the +time and attention of management from BNC’s business, or subject it to other structural or behavioral remedies that adversely affect +BNC’s business. +85 +Payment transactions +may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm +BNC’s business. +Several +of BNC’s future products may offer payments functionality, including enabling BNC’s users to purchase tangible, virtual, and +digital goods from merchants and developers that offer applications using BNC’s payment infrastructure, send money to other users, +and make donations to certain charitable organizations, among other activities. BNC is or may become subject to a variety of laws and +regulations in the United States, Europe and elsewhere, including those governing anti-money laundering and counter-terrorist financing, +money transmission, stored value, gift cards and other prepaid access instruments, electronic funds transfer, virtual currency, consumer +protection, charitable fundraising, trade sanctions, and import and export restrictions. Depending on how BNC’s payment products +evolve, BNC may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, +the application or interpretation of these laws and regulations is not clear. BNC’s efforts to comply with these laws and regulations +could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that BNC is +found to be in violation of any such legal or regulatory requirements, BNC may be subject to monetary fines or other penalties such as +a cease and desist order, or BNC may be required to make product changes, any of which could have an adverse effect on BNC’s business +and financial results. +Risks Related to Data, +Security, and Intellectual Property +Security breaches, +improper access to or disclosure of BNC’s data or user data, other hacking and phishing attacks on BNC’s systems, or other +cyber incidents could harm BNC’s reputation and adversely affect BNC’s business. +BNC’s +industry is prone to cyber-attacks by third parties seeking unauthorized access to BNC’s data or users’ data or to disrupt +BNC’s ability to provide service. BNC’s products and services involve the collection, storage, processing, and transmission +of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of BNC’s data +or user data, including personal information, content, or payment information from users, or information from marketers, could result +in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm BNC’s business and reputation +and diminish BNC’s competitive position. In addition, computer malware, viruses, social engineering (such as spear phishing attacks), +scraping, and general hacking continue to be prevalent in BNC’s industry and are expected to occur on BNC’s systems in the +future. BNC expects to regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions +on BNC’s platform for purposes such as spamming, spreading misinformation, or other objectionable ends. Such attacks may cause interruptions +to the services BNC intends to provide, degrade the user experience, cause users or marketers to lose confidence and trust in BNC’s +products, impair BNC’s internal systems, or result in financial harm to BNC. BNC’s efforts to protect its data or the information +BNC receives, and to disable undesirable activities on BNC’s platform, may also be unsuccessful due to software bugs or other technical +malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in BNC’s vendors’ +information technology systems or offerings; government surveillance; breaches of physical security of BNC’s facilities or technical +infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose +information in order to gain access to BNC’s data or BNC’s users’ data. Cyber-attacks continue to evolve in sophistication +and volume, and inherently may be difficult to detect for long periods of time. Although BNC intends to try to develop systems and processes +that are designed to protect BNC’s data and user data, to prevent data loss, to disable undesirable accounts and activities on BNC’s +platform, and to prevent or detect security breaches, BNC cannot assure you that such measures, if implemented, will provide adequate +security, that BNC will be able to react in a timely manner, or that BNC’s remediation efforts will be successful. The changes in +BNC’s work environment as a result of certain personnel working remotely could also impact the security of BNC’s systems, +as well as BNC’s ability to protect against attacks and detect and respond to them quickly. +In +addition, some of BNC’s developers or other partners, such as those that help us measure the effectiveness of ads, may receive or +store information provided by us or by BNC’s users through mobile or web applications integrated with BNC’s products. BNC +provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers +fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, BNC’s data or BNC’s +users’ data may be improperly accessed, used, or disclosed. +To +date, BNC has not, to its knowledge, experienced a cyber-attack or other security incident, however, it does expect to experience such +cyber-attacks and other security incidents of varying degrees from time to time, and BNC expects to incur significant costs in protecting +against or remediating such incidents. In addition, BNC is subject to a variety of laws and regulations in the United States and abroad +relating to cybersecurity and data protection. As a result, affected users or government authorities could initiate legal or regulatory +actions against BNC in connection with any actual or perceived security breaches or improper access to or disclosure of data, which has +occurred in the past and which could cause BNC to incur significant expense and liability or result in orders or consent decrees forcing +BNC to modify its business practices. Such incidents or BNC’s efforts to remediate such incidents may also result in a decline in +BNC’s active user base or engagement levels. Any of these events could have a material and adverse effect on BNC’s business, +reputation, or financial results. +86 +We anticipate that +BNC’s efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data +or other undesirable activity by third parties on BNC’s platform. +In +addition to BNC’s efforts to mitigate cybersecurity risks, BNC intends to make investments in privacy, safety, security, and content +review efforts to combat misuse of BNC’s services and user data by third parties, including investigations and audits of platform +applications, as well as other enforcement efforts. As a result of these efforts BNC anticipates that BNC will discover and announce additional +incidents of misuse of user data or other undesirable activity by third parties. BNC may not discover all such incidents or activity, +whether as a result of BNC’s data or technical limitations, including BNC’s lack of visibility over BNC’s encrypted +services, the allocation of resources to other projects, or other factors, and BNC may be notified of such incidents or activity by the +FTC, the media or other third parties. Such incidents and activities may in the future include the use of user data or BNC’s systems +in a manner inconsistent with BNC’s terms, contracts or policies, the existence of false or undesirable user accounts, improper +advertising practices, activities that threaten people’s safety on or offline, or instances of spamming, scraping, data harvesting, +unsecured datasets, or spreading misinformation. BNC may also be unsuccessful in its efforts to enforce BNC’s policies or otherwise +remediate any such incidents. Consequences of any of the foregoing developments include negative effects on user trust and engagement, +harm to BNC’s reputation, changes to BNC’s business practices in a manner adverse to BNC’s business, and adverse effects +on BNC’s business and financial results. Any such developments may also subject BNC to additional litigation and regulatory inquiries, +which could subject BNC to monetary penalties and damages, divert management’s time and attention, and lead to enhanced regulatory +oversight. +BNC’s products +and internal systems rely on software and hardware that is highly technical, and any errors, bugs, or vulnerabilities in these systems, +or failures to address or mitigate technical limitations in BNC’s systems, could adversely affect BNC’s business. +BNC’s +products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or +by third parties, that is highly technical and complex. In addition, BNC’s products and internal systems depend on the ability of +such software and hardware to store, retrieve, process, and manage considerable amounts of data. The software and hardware on which BNC +relies is expected to contain, errors, bugs, or vulnerabilities, and BNC’s systems are subject to certain technical limitations +that may compromise BNC’s ability to meet BNC’s objectives. Some errors, bugs, or vulnerabilities inherently may be difficult +to detect and may only be discovered after the code has been released for external or internal use. Errors, bugs, vulnerabilities, design +defects, or technical limitations within the software and hardware on which BNC relies, or human error in using such systems, may in the +future lead to outcomes including a negative experience for users and marketers who use BNC’s products, compromised ability of BNC’s +products to perform in a manner consistent with BNC’s terms, contracts, or policies, delayed product introductions or enhancements, +targeting, measurement, or billing errors, compromised ability to protect the data of BNC’s users and/or BNC’s intellectual +property or other data, or reductions in BNC’s ability to provide some or all of BNC’s services. In addition, any errors, +bugs, vulnerabilities, or defects in BNC’s systems or the software and hardware on which BNC relies, failures to properly address +or mitigate the technical limitations in BNC’s systems, or associated degradations or interruptions of service or failures to fulfill +BNC’s commitments to BNC’s users, are expected to lead to outcomes including damage to BNC’s reputation, loss of users, +loss of marketers, prevention of its ability to generate revenue, regulatory inquiries, litigation, or liability for fines, damages, or +other remedies, any of which could adversely affect BNC’s business and financial results. +If BNC is unable to +protect BNC’s intellectual property, the value of its brands and other intangible assets may be diminished, and its business may +be adversely affected. +BNC +relies, and expects to continue to rely on a combination of confidentiality, assignment, and license agreements with BNC’s employees, +consultants, and third parties with whom BNC has relationships, as well as intellectual property laws, to protect BNC’s proprietary +rights. In the United States and internationally, BNC expects to file various applications for protection of certain aspects of BNC’s +intellectual property. Third parties may knowingly or unknowingly infringe BNC’s proprietary rights, third parties may challenge +proprietary rights held by BNC in the future, and future trademark and patent applications may not be approved. In addition, effective +intellectual property protection may not be available in every country in which BNC operates or intends to operate. In any or all of these +cases, BNC may be required to expend significant time and expense in order to prevent infringement or to enforce BNC’s rights. Although +BNC expects to take measures to protect BNC’s proprietary rights, there can be no assurance that others will not offer products +or concepts that are substantially similar to BNC’s and compete with BNC’s business. If the protection of BNC’s proprietary +rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of BNC’s brands and other intangible +assets may be diminished and competitors may be able to more effectively mimic BNC’s products, services and methods of operations. +Any of these events could have an adverse effect on BNC’s business and financial results. +87 +BNC expects to be +party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, +could have a significant impact on BNC’s business, financial condition, or results of operations. +Companies, +in particular established ones, in the internet, technology, and media industries typically own large numbers of patents, copyrights, +trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations +of intellectual property or other rights. In the event that BNC ever develops a significant intellectual property portfolio, it would +face similar challenges that established companies do. In addition, various “non-practicing entities” that own patents and +other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. +Furthermore, from time to time BNC may introduce or acquire new products, which could increase BNC’s exposure to patent and other +intellectual property claims from competitors and non-practicing entities. +From time to time, BNC may receive notices from +patent holders and other parties alleging that certain of BNC’s products and services, or user content, infringe their intellectual +property rights. BNC expects, should its business ever develop, to be involved in a number of intellectual property lawsuits. Defending +patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there +can be no assurances that favorable final outcomes will be obtained in all or even most cases. In addition, plaintiffs may seek, and BNC +may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions +requiring us to cease some or all of BNC’s anticipated operations. BNC may seek, if possible, to settle such lawsuits and disputes +on terms that are unfavorable to it. Similarly, if any litigation to which BNC is a party is resolved adversely, BNC may be subject to +an unfavorable judgment that may not be reversed upon appeal, if appealed. The terms of such a settlement or judgment may require us to +cease some or all of BNC’s operations or require us pay substantial amounts to the other party, which we may not be able to afford. +In addition, BNC may have to seek a license to continue practices found to be in violation of a third party’s rights, which may +not be available on reasonable terms, or at all, and may significantly increase BNC’s operating costs and expenses. As a result, +BNC may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of +alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology +or practices or otherwise negatively affect the user experience, or may not be feasible. BNC’s business, financial condition, and +results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to +above. +Risks Related to askROI +askROI is heavily dependent upon on an exclusive +licensing agreement. +askROI is heavily dependent +upon one single exclusive licensing agreement (the “License Agreement”), which involves a number of risks, not all of which +may be adequately summarized in this section. Primarily, however, they consist of the following: (i) reliance on a single licensing agreement +for core technology could lead to significant disruptions if the License Agreement is terminated, not renewed, or does not provide the +benefits that askROI presently expects to derive from it; and (ii) the exclusive nature of the licensing agreement may restrict askROI’s +ability to expand its operations beyond North America, potentially limiting growth opportunities. If askROI’s rights benefits under +the License Agreement do not materialize in the way it presently expects, its business and future prospects could be materially and adversely +affected. +askROI is heavily dependent on its LLM provider. +askROI is heavily dependent +on its Large Language Model (“LLM”) provider, which presents a number of risks, which are related to the risks outlined immediately +above and include the following: (i) askROI’s platform heavily relies on the LLM technology provided by its development partner, +or licensor of the License Agreement (the “Licensor”), which means that any issues with the LLM’s performance, reliability, +or adaptability could directly and adversely impact askROI’s product quality and customer satisfaction; (ii) any disputes or disagreements +over intellectual property rights related to the LLM technology or jointly developed components could lead to legal challenges and operational +disruptions, and (iii) any divergence in strategic objectives, priorities, or values between askROI and the Licensor, which is the same +entity that provides services to RiskOn with respect to BNC, could strain the relationship and hinder effective collaboration. +Further, any negative publicity, +security breaches, or ethical controversies associated with the Licensor could indirectly impact askROI’s reputation and customer +trust. In addition, the Licensor’s financial instability or a change in ownership of the Licensor could disrupt the partnership +and force askROI to seek alternative providers, which it may or may not be able to do, whether on a timely basis or at all. +88 +Moreover, any unfavorable +changes in the Licensor’s pricing model or license fees could increase askROI’s operational costs and reduce its profit margins, +if any, and any uncertainty around the renewal terms of the licensing agreement or partnership contract could create long-term planning +challenges for askROI. +If any of the foregoing risks +were to materialize, askROI’s business and future prospects could be materially and adversely affected. +askROI faces risks commonly associated with +start-up companies. +askROI faces risks commonly +associated with start-up companies. As a start-up company, askROI may face difficulties in validating market demand for its AI-powered +insights platform, which could adversely impact its ability to attract and acquire customers. Further, enterprise sales cycles can be +lengthy, particularly for a start-up company without an established track record. Prolonged sales cycles could strain askROI’s cash +flow and hinder growth, and (iii) reliance on a few large customers could make askROI vulnerable to revenue volatility and adversely impact +its bargaining power. If any of the foregoing risks were to materialize, askROI’s business and future prospects could be materially +and adversely affected. +askROI faces adoption and integration and other +challenges. +askROI faces adoption and +integration challenges. Complex onboarding processes or steep learning curves could slow customer adoption and time-to-value realization. +Further, its software could be difficult to integrate with a customer’s legacy systems, leading to challenges with customers’ +legacy systems and tools. Any difficulties associated with integration of different systems could limit askROI’s market penetration +and customer satisfaction. In addition, the Licensor’s development team may have limited capacity to support askROI’s platform +development needs, particularly if askROI were to begin seeing significant growth and require more rapid iterations and customizations. +Also, the LLM technology may not be optimized for the scale and performance requirements of askROI’s growing user base, leading +to performance bottlenecks and customer dissatisfaction. Additionally, as a new entrant in the market, askROI may struggle to establish +brand awareness and credibility, making it harder to attract customers and partners. Similarly, any negative publicity or customer complaints +could disproportionately impact askROI’s reputation as a startup, hindering its growth and ability to compete against established +players. If any of the foregoing risks were to materialize, askROI’s business and future prospects could be materially and adversely +affected. +Customer retention risks could pose a challenge +for askROI. +askROI may experience difficulties +in retaining customers. Any failure on its part to achieve strong product-market fit could lead to high customer churn rates, as businesses +may not perceive sufficient value in askROI’s offerings. Further, as a newly formed entity, askROI may struggle to provide the level +of customer support expected by enterprise clients, which could have a materially adverse impact on customer satisfaction and retention. +Finally, low barriers to entry and minimal switching costs in the AI and analytics market could make it easier for customers to move to +competitors, thereby increasing askROI’s customer retention risks. If any of these developments were to occur, askROI’s business +and future prospects could be materially and adversely affected. +Ethical AI concerns. +The AI industry is commonly +associated with ethical concerns, whether real or perceived, which askROI must overcome in order to successfully develop its business. +Such concerns include the risk that unintended biases in askROI’s AI models could lead to discriminatory or unfair outcomes, damaging +the entity’s reputation and exposing it to legal risks, and that difficulty in providing clear explanations for AI-generated insights +could erode customer trust and hinder adoption of askROI’s product offerings. If askROI cannot substantially mitigate or prevent +such concerns from arising, its business and future prospects could be materially and adversely affected. +89 +Risks Related to GuyCare +GuyCare’s limited operating history and +evolving business model make it difficult to evaluate GuyCare’s future prospects and may increase the risk of your investment. +As a newly launched subsidiary +in 2023, GuyCare faces significant challenges in establishing its brand presence, attracting and retaining customers, and achieving profitability +in a competitive market. GuyCare’s limited operating history makes it difficult for investors, analysts, and other stakeholders +to evaluate its business model, financial performance, and future prospects accurately, all the more so as GuyCare is merely one subsidiary +of RiskOn, which has other subsidiaries. GuyCare may encounter unexpected obstacles, such as market resistance to its offerings, difficulties +in scaling its operations, or unforeseen regulatory hurdles, which could hinder its ability to execute its business plan effectively. +Additionally, as a new entrant, GuyCare may need to invest heavily in marketing, technology infrastructure, and talent acquisition to +gain market share and compete with established players, which could strain its and its parent RiskOn’s financial resources and delay +profitability. +GuyCare operates in a highly regulated industry +with complex and evolving healthcare laws and regulations, which could adversely affect GuyCare’s business, financial condition, +and results of operations. +GuyCare operates in the highly +regulated healthcare industry, which is subject to a complex web of laws and regulations at both the state and federal levels. These regulations +cover various aspects of GuyCare’s business, including telehealth services, data privacy, healthcare marketing, and the practice +of medicine. As a new entrant, GuyCare may face a steep learning curve in ensuring compliance with all applicable regulations, which could +divert management’s attention and resources from other critical business functions. Failure to comply with these regulations could +result in significant penalties, legal liabilities, and reputational damage. Moreover, the regulatory landscape for telehealth and men’s +health is constantly evolving, with new laws, regulations, and enforcement priorities emerging in response to technological advancements +and public health concerns. GuyCare must proactively monitor these changes and adapt its business practices accordingly to mitigate compliance +risks and maintain its competitive edge. This may require significant investments in legal and compliance resources, which could impact +GuyCare’s financial performance. +The rapidly evolving telehealth industry presents +unique challenges and risks for GuyCare as a new entrant in the market. +GuyCare’s business model +is heavily reliant on telehealth services, which have gained significant traction in recent years due to advancements in technology and +the COVID-19 pandemic. However, the telehealth industry is still relatively new and evolving rapidly, which presents several risks for +GuyCare as a new entrant. First, GuyCare may face challenges in ensuring the quality, reliability, and security of its telehealth platform, +which could impact customer satisfaction and loyalty. Second, GuyCare may encounter resistance from traditional healthcare providers or +regulatory bodies who are skeptical of telehealth’s efficacy or concerned about its potential risks. Third, the telehealth market +is becoming increasingly crowded, with numerous players vying for market share and customer attention. GuyCare must differentiate its +offerings and value proposition to stand out in this competitive landscape. Finally, the long-term sustainability of telehealth as a primary +mode of healthcare delivery is still uncertain, as it may be impacted by factors such as changes in reimbursement policies, technological +disruptions, or shifts in consumer preferences. GuyCare must navigate these risks and uncertainties to establish a strong foothold in +the telehealth industry and drive long-term growth. +GuyCare’s hybrid business model, which +includes brick-and-mortar clinics, exposes GuyCare to additional operational risks and challenges. +While GuyCare will focus primarily +on telehealth services, GuyCare’s hybrid model also includes operating brick-and-mortar clinics, which presents a unique set of +risks and challenges. As a new entrant, GuyCare may face significant upfront costs in acquiring or leasing clinic space, purchasing equipment +and supplies and hiring clinical staff. These investments may strain GuyCare’s and thereby RiskOn’s financial resources and +divert management’s attention from other critical business functions. Additionally, operating physical clinics exposes GuyCare to +various operational risks, such as property maintenance, staffing challenges, and potential liability for on-site accidents or medical +malpractice. GuyCare must also ensure compliance with a wide range of regulations governing the operation of healthcare facilities, including +safety standards, accessibility requirements, and waste management protocols. Any lapses in compliance or negative incidents at GuyCare’s +clinics could result in legal liabilities, regulatory penalties and reputational damage. +90 +GuyCare faces intense competition from established +players in the men’s health market, which could hinder GuyCare’s ability to gain market share and achieve profitability. The +men’s health market is becoming increasingly crowded, with numerous established players and new entrants vying for market share. +As a new company in the men’s +health market, GuyCare faces intense competition from various sources, including traditional healthcare providers, telehealth platforms, +direct-to-consumer health brands, and retail pharmacies. Many of these competitors have significant advantages over GuyCare, such as greater +brand recognition, larger customer bases, more extensive provider networks, and vastly greater financial resources. To survive in this +competitive landscape, GuyCare must differentiate itself through innovative offerings, personalized customer experiences, and compelling +marketing campaigns. GuyCare must also continuously monitor and adapt to changes in competitor strategies, pricing, and market positioning +to avoid being outmaneuvered. However, as a new entrant, GuyCare may lack the market intelligence, customer insights, and agility to respond +quickly to competitive threats, which could hinder its ability to gain market share and achieve profitability. Additionally, intense competition +may lead to price wars, margin erosion, and customer churn, which could further strain GuyCare’s financial performance. +As a healthcare company collecting sensitive +customer information, GuyCare faces significant cybersecurity and data privacy risks that could expose GuyCare to legal liabilities, regulatory +penalties, and reputational damage . +As a healthcare company that +collects, stores, and processes sensitive customer information, including personal health data, GuyCare is a prime target for cybersecurity +threats and data breaches. A successful cyber-attack or data breach could result in the unauthorized access, disclosure, or theft of customer +data, which could lead to significant legal liabilities, regulatory penalties, and reputational damage. For example, under state and federal +consumer privacy laws, such as the California Consumer Privacy Act, companies that collect personal data must provide customers with certain +rights and protections, such as the right to access, delete, or opt out of the sale of their data. Violations of these laws could lead +to significant penalties and class-action lawsuits. As a new entrant, GuyCare may lack the robust cybersecurity infrastructure and data +privacy controls needed to safeguard customer data effectively. GuyCare must invest heavily in building a secure, compliant data management +system and training its employees in data privacy best practices. GuyCare must also regularly monitor and adapt to changes in cybersecurity +threats and regulatory requirements to stay ahead of potential risks. +GuyCare’s reliance on third-party suppliers, +manufacturers, and partners exposes GuyCare to various operational and financial risks. +GuyCare’s business model +depends heavily on third-party suppliers, manufacturers, and partners for various aspects of its operations, including pharmaceutical +products, medical supplies, technology infrastructure and marketing services. As a new entrant, GuyCare may lack the bargaining power +and established relationships needed to secure favorable terms and reliable service from these third parties. Any disruptions or quality +issues in GuyCare’s supply chain or partner network could significantly impact GuyCare’s ability to serve its customers and +maintain business continuity. For example, if a key supplier experiences production delays or quality control issues, GuyCare may face +shortages of critical products or be forced to recall defective items, which could lead to customer dissatisfaction, legal liabilities, +and financial losses. Similarly, if a technology partner experiences a service outage or data breach, GuyCare’s telehealth platform +may become unavailable or compromised, leading to lost revenue and reputational damage. +As a new business, GuyCare faces significant +challenges in developing, protecting, and commercializing its proprietary technology and other intellectual property assets. +GuyCare’s success depends +on its ability to develop, protect, and commercialize its proprietary technology, trade secrets, and other intellectual property (“IP”) +assets. As a new entrant in the highly competitive men’s health market, GuyCare may face significant challenges in securing and +enforcing its IP rights. For example, GuyCare may lack the financial resources and legal expertise needed to file and prosecute patent +applications effectively, or to defend against IP infringement claims by competitors. Additionally, GuyCare’s IP may be vulnerable +to reverse engineering, unauthorized disclosure, or independent development by third parties, particularly if GuyCare fails to implement +adequate safeguards and confidentiality agreements. Any loss or compromise of GuyCare’s IP could significantly undermine its competitive +position and ability to differentiate itself in the market. +91 +Relying on contracted medical groups or hired +doctors in certain states introduces additional legal, operational, and quality control risks for GuyCare. +In states where GuyCare cannot +directly provide telemedicine services through the use of a nurse practitioner, GuyCare will need to rely on contracted medical groups +or hired doctors. These relationships may introduce additional legal, operational, and quality control risks, as GuyCare will have less +direct oversight over the care provided to its clients in these states. GuyCare may face increased exposure to malpractice claims or other +legal issues arising from the actions of contracted or hired healthcare providers. While these providers should carry their own malpractice +insurance, GuyCare could still be named in lawsuits or face reputational damage if the quality of care provided does not meet GuyCare’s +standards. Furthermore, GuyCare may have limited ability to enforce its own quality control measures and clinical guidelines when working +with external providers. Inconsistencies in the quality of care, adherence to best practices, or bedside manner of contracted or hired +providers could undermine GuyCare's brand reputation and customer loyalty. +GuyCare's ambitious multi-state expansion plan +may face unforeseen challenges, potentially impacting its financial performance and growth prospects. +GuyCare plans to rapidly expand +its telemedicine services to all 41 states that all nurse practitioners to provide its services, which is anticipated to occur within +the next five months, is ambitious and may face unforeseen challenges. Delays in obtaining licenses, recruiting providers, or setting +up necessary infrastructure could impact GuyCare’s ability to meet its expansion targets and may negatively affect its financial +performance and growth prospects. +The loss of key management or healthcare professionals +could significantly disrupt GuyCare’s operations and hinder GuyCare’s ability to achieve its growth objectives. +As a new subsidiary, GuyCare’s +success is heavily dependent on the skills, experience, and leadership of its key management and healthcare professionals. These individuals +play a critical role in setting GuyCare’s strategic direction, building its organizational culture, and executing its business plan. +The loss of one or more key personnel, whether due to resignation, illness, or other reasons, could significantly disrupt GuyCare’s +operations and hinder its ability to achieve its growth objectives. +As a provider of healthcare products and services, +GuyCare faces inherent risks related to product liability claims and lawsuits, which could result in significant legal expenses, damages, +and reputational harm. +As a provider of healthcare +products and services, GuyCare faces inherent risks related to product liability claims and lawsuits. If a customer experiences an adverse +event or injury while using one of GuyCare’s products or services, they may take legal action against GuyCare for damages. Product +liability claims can be costly to defend and settle, even if they are ultimately found to be without merit. Additionally, negative publicity +surrounding a product liability lawsuit could significantly damage GuyCare’s brand reputation and customer trust, particularly as +a new entrant in the market. +Economic downturns or uncertainties could lead +to reduced demand for GuyCare’s products and services, negatively impacting GuyCare’s revenue and growth prospects. +As a new business operating +in the discretionary healthcare market, GuyCare is particularly vulnerable to economic downturns and uncertainties. During times of economic +stress, consumers may cut back on non-essential health and wellness spending, such as elective procedures, preventive care and premium +products. This could lead to reduced demand for GuyCare’s offerings, lower revenue, and increased customer churn. Additionally, +economic uncertainties may make it harder for GuyCare to secure funding from investors or lenders, particularly as a new entrant with +a limited track record of financial performance. This could hinder GuyCare’s ability to invest in growth initiatives, such as new +product development, market expansion, and talent acquisition. +Negative publicity or customer feedback could +significantly damage GuyCare’s brand reputation and customer trust, hindering GuyCare’s ability to attract and retain customers . +As a new entrant in the highly +competitive men’s health market, GuyCare’s success depends heavily on its ability to build and maintain a strong brand reputation. +A positive brand image can help GuyCare attract and retain customers, partners, and employees, as well as differentiate itself from competitors. +However, building and maintaining a strong brand is a complex and ongoing process that requires significant investments in marketing, +customer experience, and product quality. As a new business, GuyCare may face challenges in establishing brand awareness and credibility, +particularly in a market where established players have a strong presence. Additionally, any negative publicity or customer feedback, +whether justified or not, can quickly erode brand trust and loyalty. +92 +GuyCare faces significant risks and challenges +in executing its marketing and advertising strategy effectively and compliantly in the highly regulated healthcare industry . +As a new entrant in the men’s +health market, GuyCare must invest heavily in marketing and advertising to build brand awareness, generate demand, and attract new customers. +However, GuyCare faces significant risks and challenges in executing its marketing strategy effectively and compliantly. For example, +the healthcare industry is subject to strict regulations around marketing and advertising, particularly with respect to product claims, +testimonials, and disclosures. Failure to comply with these regulations could result in legal penalties, reputational damage, and loss +of customer trust. Additionally, the digital advertising landscape is becoming increasingly complex and competitive, with numerous players +vying for consumer attention and data. This can make it difficult for GuyCare to achieve its desired return on investment and to differentiate +itself from competitors. +GuyCare may face intellectual property infringement +claims from competitors or other third parties, which could result in costly legal battles and damage to GuyCare’s reputation and +financial performance . +As GuyCare develops and commercializes +its proprietary products and technologies, it may face the risk of intellectual property infringement claims from competitors, patent +trolls, or other third parties. These claims can be costly and time-consuming to defend, even if they are ultimately found to be without +merit. In some cases, GuyCare may be forced to pay significant damages or royalties, or to cease using certain technologies or products +altogether. Additionally, the publicity surrounding an intellectual property dispute can damage GuyCare’s reputation and customer +relationships, particularly as a new entrant in the market. +Any disruptions, outages, or security breaches +in GuyCare’s technology infrastructure could significantly impact GuyCare’s ability to deliver its products and services as +well as and maintain customer trust and loyalty . +GuyCare’s digital-first +approach to men’s health relies heavily on its technology infrastructure, including its telehealth platform, mobile apps, and data +management systems. Any disruptions, outages, or security breaches in these systems could significantly impact GuyCare’s ability +to deliver its products and services, and to maintain customer trust and loyalty. For example, if GuyCare’s telehealth platform +experiences a prolonged outage or a data breach, customers may be unable to access care or may have their personal health information +compromised. This could result in lost revenue, regulatory penalties, and reputational damage. Additionally, as a new entrant, GuyCare +may face challenges in building and maintaining a scalable and resilient technology infrastructure that can keep pace with its growth +and evolving customer needs. +Pursuing strategic acquisitions or investments +could introduce significant risks and challenges for GuyCare, particularly as a new entrant with limited experience in mergers and acquisitions. +As GuyCare grows and expands +its business, it may pursue strategic acquisitions or investments to accelerate its growth, enter new markets, or acquire new capabilities. +However, these transactions can also introduce significant risks and challenges, particularly for a new entrant with limited experience +in mergers and acquisitions. For example, GuyCare may face difficulties in integrating the acquired company’s technology, products, +and personnel into its own operations, leading to culture clashes, redundancies, or loss of key talent. Additionally, the acquisition +may not deliver the expected synergies or financial returns, leading to a loss of RiskOn’s shareholder value and confidence. +As a new business, GuyCare may face challenges +in securing the necessary financing to fund its growth and expansion plans, which could hinder GuyCare’s ability to achieve its +strategic objectives +As a new business operating +in a highly competitive and rapidly evolving market, GuyCare may require significant capital to fund its growth and expansion plans. However, +securing financing can be challenging for a new entrant, particularly if it has a limited track record of revenue and profitability. Additionally, +the terms of any financing, such as interest rates, covenants, and dilution, can have a significant impact on GuyCare’s financial +flexibility and long-term value creation. +93 +GuyCare’s dependence on key suppliers +and vendors for critical products and services could expose GuyCare to significant operational and financial risks. +GuyCare’s ability to +deliver high-quality products and services to its customers depends heavily on its relationships with key suppliers and vendors, such +as manufacturers, distributors, and technology providers. However, as a new entrant, GuyCare may have limited bargaining power and may +be vulnerable to supply chain disruptions, price increases, or quality issues. Additionally, if GuyCare becomes overly dependent on a +single supplier or vendor, it may be exposed to significant risks if that relationship is terminated or becomes strained. +GuyCare’s success heavily depends on +its ability to attract, retain, and motivate a skilled and diverse workforce in a highly competitive and regulated industry. +As a new business in a highly +regulated and customer-facing industry, GuyCare’s success depends heavily on its ability to attract, retain, and motivate a skilled +and diverse workforce. However, GuyCare may face significant challenges in competing for talent, particularly in a tight labor market +or in high-cost locations. Additionally, any allegations of discrimination, harassment, or other employment-related issues could expose +GuyCare to legal and reputational risks and impact its ability to attract and retain employees. +Expanding into prescription medications and +other regulated substances could expose GuyCare to increased regulatory scrutiny, legal liabilities, and reputational risks. +As GuyCare expands its product +offerings to include prescription medications and other regulated substances, it may face increased risks and complexities related to +pharmaceutical regulations and safety. For example, GuyCare may be subject to strict licensing, manufacturing, labeling, and distribution +requirements, as well as ongoing monitoring and reporting obligations. Additionally, any adverse events or safety issues related to GuyCare’s +products could expose GuyCare to legal and reputational risks and impact its ability to operate in certain markets. +As a new entrant in the highly regulated and +litigious healthcare industry, GuyCare may face a heightened risk of litigation and regulatory investigations related to its products, +services, or business practices. +As a new entrant in the highly +regulated and litigious healthcare industry, GuyCare may face a heightened risk of litigation and regulatory investigations related to +its products, services, or business practices. These legal and regulatory challenges can be costly, time-consuming, and distracting for +GuyCare, and may impact its reputation, financial performance, and ability to operate in certain markets. Additionally, GuyCare may be +subject to regulatory investigations or enforcement actions related to its compliance with healthcare laws and regulations. +Risks Related to RiskOn +360 +Our dependence on key speakers and attendees +may adversely affect our conference’s impact and overall success. +The success of RiskOn 360’s +annual conference heavily relies on the participation of high-profile speakers and the attendance of key industry professionals. If RiskOn +360 fails to secure the involvement of influential speakers or experiences a significant decline in attendee numbers, the conference’s +impact and overall success may be adversely affected, potentially harming RiskOn 360’s reputation and financial performance. +Prevailing economic and market conditions may +influence the demand for our conferences and speaking engagements. +The demand for business conferences +and speaking engagements may be influenced by prevailing economic and market conditions. In times of economic uncertainty or downturn, +companies and individuals may be less willing to invest in attending conferences or hiring speakers, which could result in reduced revenue +for RiskOn 360 and negatively impact its ability to organize successful events. +94 +RiskOn 360 operates in a competitive landscape, +and its market share and revenue may be adversely affected by other conferences and events. +RiskOn 360 operates in a competitive +landscape, with numerous companies organizing similar business conferences and events. If competitors are able to attract a larger audience, +secure more prominent speakers, or offer more compelling content, RiskOn 360’s market share and revenue may be adversely affected, +potentially impacting the subsidiary’s long-term growth and profitability. +Logistic and operational challenges in organizing +large-scale conferences may lead to attendee dissatisfaction, reputational damage, and financial losses. +Organizing large-scale conferences +involves significant logistical and operational challenges, such as venue selection, event management, and technology integration. Any +disruptions, delays, or failures in the planning and execution of the annual conference could lead to attendee dissatisfaction, reputational +damage, and financial losses for RiskOn 360 and, by extension, RiskOn itself. +The actions and content presented at our conferences +and speaking engagements may impact the reputation of RiskOn 360’s parent company, RiskOn. +As a subsidiary of RiskOn, +RiskOn 360’s actions and the content presented at its conferences and speaking engagements have the potential to impact the reputation +of the parent company. If speakers or attendees engage in misconduct, express controversial opinions, or if the conference content fails +to meet attendees’ expectations, it could lead to negative publicity and reputational harm for both RiskOn 360 and RiskOn, potentially +affecting their ability to attract future speakers, attendees, and clients. +Risks Related to +GIGA +Risks Related to Our Business and Industry - Overview +If we fail to anticipate and adequately respond +to rapid technological changes in our industry, including evolving industry-wide standards, in a timely and cost-effective manner, our +business, financial condition and results of operations would be materially and adversely affected. +The markets in which we operate +are characterized by technological changes. Such changes, including evolving industry standards, changes in customer requirements and +new product introductions and enhancements, could render our products obsolete. Accordingly, we are required to constantly monitor and +anticipate technological changes in our industry and develop new product offerings and technologies or adapt or modify our existing offerings +and technologies to keep pace with technological advances in our industry and remain competitive. +Our ability to implement our +business strategy and continue to grow our revenues will depend on a number of factors, including our continuing ability to: +· identify emerging technological trends in our current and target markets; +· identify additional uses for our existing technology to address customer needs in our current and future +markets; +· enhance our offerings by adding innovative features that differentiate our offerings from those of our +competitors; and +· design, develop, manufacture, assemble, test, market and support new products and enhancements in a timely +and cost-effective manner. +We believe that, to remain +competitive in the future, we will need to continue to invest significant financial resources in developing new offerings and technologies +or to adapt or modify our existing offerings and technologies, including through internal research and development, strategic acquisitions +and joint ventures or other arrangements. However, these efforts may be more costly than we anticipate and there can be no assurance that +they will be successful. +95 +If we are unable to identify, attract, train +and retain qualified personnel, especially our design and technical personnel, our business and results of operations would be materially +and adversely affected and we may not be able to effectively execute our business strategy. +Our performance and future +success largely depends on our continuing ability to identify, attract, train, retain and motivate qualified personnel, including our +management, sales and marketing, finance and in particular our engineering, design and technical personnel. For example, we currently +have limited number of qualified personnel for the assembling and testing processes. We do not know whether we will be able to retain +all these personnel as we continue to pursue our business strategy. Our engineering, design and technical personnel represent a significant +asset. The competition for qualified personnel in our industries is intense and constrains our ability to attract qualified personnel. +The loss of the services of one or more of our key employees, especially of our key engineering, design and technical personnel, or our +inability to attract, retain and motivate qualified personnel could have a material adverse effect on our business, financial condition +and operating results. +Our future results will depend on our ability +to maintain and expand our existing sales channels and to build out marketing, business development and sales functions for the operating +subsidiaries. +To grow our legacy businesses, +we must add new customers for our products in addition to retaining and increasing sales to our current customers. Currently, only Relec, +the operating subsidiary that we acquired in November 2020, has an effective sales force focused on establishing relationships with customers +that we expect to endure over time. In other subsidiaries, we have historically relied on key executives to drive growth through return +business with existing customers. Building out marketing, business development and sales functions in all operating subsidiaries is critical +to drive significant growth in line with our strategic plans. While we perform certain of these activities ourselves, we may contract +for marketing services to improve our websites, manage public relations and optimize our social media presence. Failure to recruit and +retain the business development and sale personnel to execute on outreach and capture of new business, or the failure of those new hires +or marketing services to perform as expected, will limit our ability to achieve our growth targets. +We are dependent upon our ability, and our +contract manufacturers’ ability, to timely procure electronic components. +Because of the global economy, +many raw material vendors have reduced capacities, closed production lines and, in some cases, even discontinued their operations. As +a result, there is a global shortage of certain electronic or mineral components, which may extend our production lead-time and our production +costs. Some materials are no longer available to support some of our products, thereby requiring us to search for cross materials or, +even worse, redesign some of our products to support currently available materials. Such redesign efforts may require certain regulatory +and safety agency re-submittals, which may cause further production delays. While we have initiated actions that we believe will limit +our exposure to such problems, the dynamic business conditions in many of our markets may challenge the solutions that have been put in +place, and issues may recur in the future. +In addition, some of our products +are manufactured, assembled and tested by third party subcontractors and contract manufacturers located in Asia. While we have had relationships +with many of these third parties in the past, we cannot predict how or whether these relationships will continue in the future. In addition, +changes in management, financial viability, manufacturing demand or capacity, or other factors, at these third parties could hurt our +ability to manufacture our products. +We depend +upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the +quantity of products that they purchase from us, would significantly reduce our revenues and net income. +We currently depend upon a +few major OEMs and other customers for a significant portion of our revenues. If our major OEM customers will reduce or cancel their orders +scaling back some of their activities, our revenues and net income would be significantly reduced. Furthermore, diversions in the capital +spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, +which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more +of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, +a substantial decrease in our revenues would likely result. We are dependent on the electronic equipment industry, and accordingly will +be affected by the impact on that industry of current economic conditions. +Substantially all of our existing +customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, +and large fluctuations in demand. This industry is further characterized by intense competition and volatility. The OEMs serving this +industry are pressured for increased product performance and lower product prices. OEMs, in turn, make similar demands on their suppliers, +such as us, for increased product performance and lower prices. Such demands may adversely affect our ability to successfully compete +in certain markets or our ability to sustain our gross margins. +96 +Our reliance on subcontract manufacturers to +manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality. +Since we do not own significant +manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture +our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing +costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures +on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing +components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our +subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition +to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, and delays in, or cancellations +or rescheduling of, orders or shipments, any of which would materially harm our business. +We outsource, and are dependent upon developer +partners for, the development of some of our custom design products. +We made an operational decision +to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the +custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer +specifications and requirements might affect our ability to transition to a volume production stage of the custom designed product where +the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability +to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production. +We face intense industry competition, price +erosion and product obsolescence, which, in turn, could reduce our profitability. +We operate in an industry +that is generally characterized by intense competition. We believe that the principal bases of competition in our markets are breadth +of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price +erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to +retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, +therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross +margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price +erosion in the future. +Our future results are dependent on our ability +to establish, maintain and expand our manufacturers’ representative OEM relationships and our other relationships. +We market and sell our products +through domestic and international OEM relationships and other distribution channels, such as manufacturers’ representatives and +distributors. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as +with manufacturers’ representatives and distributors to sell our products. If, however, the third parties with whom we have entered +into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business +with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which +would have an adverse effect on our revenues. +We may not be able to procure necessary key +components for our products, or we may purchase too much inventory or the wrong inventory. +The power supply industry, +and the electronics industry as a whole, can be subject to business cycles. During periods of growth and high demand for our products, +we may not have adequate supplies of inventory on hand to satisfy our customers’ needs. Furthermore, during these periods of growth, +our suppliers may also experience high demand and, therefore, may not have adequate levels of the components and other materials that +we require to build products so that we can meet our customers’ needs. Our inability to secure sufficient components to build products +for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels +of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should +our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much +inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material +adverse effect on our gross margins and on our results of operations. +97 +Although we depend on sales of our legacy products +for a meaningful portion of our revenues, these products are mature and their sales will decline. +A relatively large portion +of our sales have historically been attributable to our legacy products. However, these sales are declining. Although we are unable to +predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward +pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent +on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and +sell new products such as custom design and value-added products. We cannot assure you that we will be able to expand our customer base, +increase unit sales volumes of existing products or develop, introduce and/or sell new products. +Failure of our information technology infrastructure +to operate effectively could adversely affect our business. +We depend heavily on information +technology infrastructure to achieve our business objectives. If a problem occurs that impairs this infrastructure, the resulting disruption +could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal +course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate. +We are subject to certain governmental regulatory +restrictions relating to our international sales. +Some of our products are subject +to International Traffic In Arms Regulation (“ITAR”), which are interpreted, enforced and administered by the U.S. Department +of State. ITAR regulation controls not only the export, import and trade of certain products specifically designed, modified, configured +or adapted for military systems, but also the export of related technical data and defense services as well as foreign production. Any +delays in obtaining the required export, import or trade licenses for products subject to ITAR regulation and rules could have a material +adverse effect on our business, financial condition, and/or operating results. In addition, changes in U.S. export and import laws that +require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could +cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions +or charges imposed by the U.S. or any other country on our international sales or foreign subsidiary could have a materially adverse effect +on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the +Israeli Ministry of Defense which were governed by the U.S. Foreign Military Financing program (“FMF”). Any such future sales +would be subject to these regulations. Failure to comply with ITAR or FMF rules could have a material adverse effect on our financial +condition, and/or operating results. +We depend on international operations for a +substantial majority of our components and products. +We purchase a substantial +majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, +and tested by subcontractors located outside the U.S. These activities are subject to the uncertainties associated with international +business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange +fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, +or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect +on our business, financial condition, and/or operating results. +We depend on international sales for a portion of our revenues. +Sales to customers outside +of North America accounted for 19% and 37% of net revenues for the years ended December 31, 2023 and 2022, respectively, and we expect +that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks +of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts +receivable, and currency restrictions. In addition, GIGA supports our European and other international customers, distributors, and sales +representatives, and therefore is also subject to local regulation. International sales are also subject to the export laws and regulations +of the U.S. and other countries. +98 +Because a significant portion of our revenues +and expenses is denominated in foreign currencies, fluctuations in exchange rates could have a material adverse effect on our operating +results. +We face foreign exchange risks because a significant portion of our +revenue and expenses is denominated in foreign currencies. Further, some suppliers to Enertec and Relec require payment in U.S. dollars, +which exposes us to risk. Generally, U.S. dollar strength adversely impacts the translation of the portion of our revenue that is generated +in foreign currencies into the U.S. dollar. For the years ended December 31, 2023 and 2022, approximately 16.9% and 35.9% of our revenue, +respectively, was denominated in currencies other than U.S. dollars. Our results of operations could also be negatively impacted by a +strengthening of the U.S. dollar as a large portion of our costs are U.S. dollar denominated. We also have foreign exchange risk exposure +with respect to certain of our assets, that are denominated in currencies other than the functional currency of our subsidiaries, and +our financial results are affected by the re-measurement and translation of these non-U.S. currencies into U.S. dollars, which is reflected +in the effect of exchange rate changes on cash, cash equivalents, and restricted cash on the consolidated statements of cash flows. For +the years ended December 31, 2023 and 2022, the effects of exchange rates on our cash, cash equivalents, and restricted cash totaled ($0.8) +million and $0.9 million, respectively, due to fluctuations in exchange rates and the strengthening of the U.S. dollar. While we may choose +to enter into transactions to hedge portions of our foreign currency translation and balance sheet exposure in the future, it is impossible +to predict or eliminate the effects of foreign exchange rate exposure. Strengthening of the U.S. dollar could materially adversely affect +our results of operations and financial condition. +Our insurance coverage and indemnity may be +insufficient to cover potential liabilities we may face due to the risks inherent in the products and services we provide. +We are exposed to liabilities +that are unique to the products and services we provide. A significant portion of our business relates to designing, developing and manufacturing +components, integrated assemblies and subsystems for advanced defense, medical, transportation, industrial, technology and communications +systems and products. New technologies associated with these systems and products may be untested or unproven. Components of certain of +the defense systems and products we develop are inherently dangerous. Failures of satellites, missile systems, air traffic control systems, +homeland security applications and aircraft have the potential to cause loss of life and extensive property damage. In most circumstances, +we may receive indemnification from the government end users of our defense offerings in the U.S., the U.K. +and Israel. In addition, failures of products and systems that we manufacture or distribute for medical devices, transportation +controls or industrial systems also have the potential to result in loss of life, personal injury and/or extensive property damage. +While we maintain insurance +for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and we may be forced to +bear substantial costs from an accident or incident. It also is not possible for us to obtain insurance to protect against all operational +risks and liabilities. Substantial claims resulting from an incident in excess of government indemnity and our insurance coverage would +harm our financial condition, results of operations and cash flows. Moreover, any accident or incident for which we are liable, even if +fully insured, could negatively affect our standing with our customers and the public, thereby making it more difficult for us to compete +effectively, and could significantly impact the cost and availability of adequate insurance in the future. +If we are unable to satisfy our customers’ +specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be +harmed. +Our customers demand that +our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying +such standards. Defects or failures have occurred in the past, and may in the future occur, relating to our product quality, performance +and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products +to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such +required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and +costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, +any of which would harm our business. +Some +of our business is subject to U.S. Government procurement laws and regulations . +We +must comply with certain laws and regulations relating to the formation, administration and performance of federal government contracts. +These laws and regulations affect how we conduct business with our federal government contracts, including the business that we do as +a subcontractor. In complying with these laws and regulations, we may incur additional costs, and non-compliance may lead to the assessment +of fines and penalties, including contractual damages, or the loss of business. +99 +Failure to comply with anti-bribery, anti-corruption, +anti-money laundering laws, and similar laws, or allegations of such failure, could have a material adverse effect on our business, financial +condition and operating results. +We are subject to various +anti-bribery, anti-corruption, anti-money laundering laws, including the U.S. Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”), +the U.S. Travel Act, the USA PATRIOT Act, the United Kingdom Bribery Act 2010, the Proceeds of Crime Act 2002, Chapter 9 (sub-chapter +5) of the Israeli Penal Law, 1977, the Israeli Prohibition on Money Laundering Law–2000, and possibly other similar laws in countries +outside of the U.S. in which we conduct our business. Anti-corruption and anti-bribery laws have been enforced aggressively in recent +years and are interpreted broadly to generally prohibit companies, their employees, agents, representatives, business partners, and third-party +intermediaries from authorizing, offering, or providing, directly or indirectly, improper payments or benefits to recipients in the public +or private sector. +We, our employees, agents, +representatives, business partners and third-party intermediaries may have direct or indirect interactions with officials and employees +of government agencies or state-owned or affiliated entities and may be held liable for the corrupt or other illegal activities of these +employees, agents, representatives, business partners or third-party intermediaries even if we do not explicitly authorize such activities. +These laws also require that +we keep accurate records and maintain internal controls and compliance procedures designed to prevent any such actions. While we have +policies and procedures to address compliance with such laws, we cannot assure you that none of our employees, agents, representatives, +business partners or third-party intermediaries will take actions in violation of our policies and applicable law, for which we may be +ultimately held responsible. In addition, we may be held liable for violations committed of the FCPA or similar foreign laws by companies +that we acquire. +Any alleged or actual violation +of the FCPA or other applicable anti-bribery, anti-corruption laws, and anti-money laundering laws could result in whistleblower complaints, +investigations, enforcement actions, fines and other criminal or civil sanctions, adverse media coverage, loss of export privileges, or +suspension or termination of government contracts. Responding to any investigation or enforcement action would require significant attention +of our management and resources, including significant defense costs and other professional fees. Failure to comply with anti-bribery, +anti-corruption, anti-money laundering laws, and similar laws, or allegations of such failure, could therefore have a material adverse +effect on our business, results of operations, financial condition and future prospects. +Compliance with the regulations, standards, +and contractual obligations promulgated by the European Union related to privacy, data protection, and data security, may cause Gresham +Power and Relec to incur additional expenses and failure to comply with such obligations could harm our business and future results of +operations. +The European Union General +Data Protection Regulation (“GDPR”) contains robust obligations on data “controllers” and data “processors” +with heavy documentation requirements for data protection compliance programs that apply to both Gresham Power and Relec. Among other +requirements, the GDPR regulates the transfer of personal data subject to the GDPR to third countries that have not been found to provide +adequate protection to such personal data, including the U.S. In the U.K., the GDPR requires informed consent for disclosure of names, +transfer of email addresses, the use of cookies and direct electronic marketing. The GDPR also imposes conditions on obtaining valid consent +to transfer of any personal data that Gresham Power or Relec collect or process. Failure to comply with the GDPR could result in penalties +for noncompliance (including possible fines of up to the greater of £8.7 million and 2% of our global annual revenue for the preceding +financial year for the violations, as well as the right to compensation for financial or non-financial damages claimed by individuals +under Article 82 of the GDPR). +The U.K. has enacted a Data +Protection Act substantially implementing the GDPR, effective in May 2018, which was further amended to align more substantially with +the GDPR following Brexit. The latest revisions of the GDPR in the U.K. post-Brexit have resulted in even more stringent restrictions +on the transfer of data about a person. Data considered in the public domain in the U.S. now falls within the protections of GDPR, which +complicates documenting business, marketing, sales outreach, securing infrastructure, audit and business management. +Compliance with the regulations, +standards, and contractual obligations promulgated by the U.K. related to privacy, data protection, and data security, may cause Gresham +Power and Relec to incur additional expenses and failure to comply with such obligations could harm our business and future results of +operations. +100 +Risks Related to Our Business and Industry - Microphase +Microphase has a history of losses and our +future profitability on a quarterly or annual basis is uncertain, which could have a harmful effect on our business and the value of our +company. +Microphase has incurred losses +from operations during 2019. These losses are attributable to lower volumes of its products sold to major defense contractors partially +as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. While Microphase has been profitable, +to a certain extent, during 2021 and 2022, there is always the possibility that its results of operations could worsen in the future, +whether as a result of new outbreaks of COVID-19, supply chain issues or any of a number of other factors. Since the financial crisis +of 2008, Microphase has been significantly short of capital needed to acquire parts for production of its products to complete orders +for such products. At times, Microphase has not had the cash available to make advance payments for the purchase of parts, and then, as +a consequence, Microphase would not receive the parts from its vendors required to finish a customer order. This would then delay the +delivery of products to customers, and would also delay recognition of the resulting revenues and the receipt of cash from the customer. +Sometimes after experiencing a delay in delivery of an order from Microphase, the customer would not place its next order with Microphase, +resulting in a loss of business. +Microphase’s future +profitability depends upon many factors, including several that are beyond its control. These factors include, without limitation: +· economic dislocation, supply chain disruption or mandated shutdowns attributable to the COVID-19 pandemic; +· changes in the demand for its products and services; +· loss of key customers or contracts; +· the introduction of competitive products; +· the failure to gain market acceptance of its new and existing products; and +· the failure to successfully and cost effectively develop, introduce and market new products, services +and product enhancements in a timely manner. +A large percentage of Microphase’s current +revenue is derived from prime defense contractors to the U.S. Government and its allies, and the loss of these relationships, a reduction +in U.S. Government funding or a change in U.S. Government spending priorities or bidding processes could have an adverse impact on its +business, financial condition, results of operations and cash flows. +Microphase’s defense +programs may compete with other policy needs, which may be viewed as more necessary. For example, budget and appropriations decisions +made by the governments of the U.S, the UK and Israel are outside of Microphase’s control and have long-term consequences for its +business. Government spending priorities and levels remain uncertain and difficult to predict and are affected by numerous factors, and +the purchase of Microphase’s products could be superseded by alternate arrangements. The current prolonged delay in providing new +aid to Ukraine and Israel are evidence of the political uncertainties. While defense budgets in countries around the world have generally +increased, there can be no assurance that such increases will continue for the foreseeable future. A change in government spending priorities +or an increase in non-procurement spending at the expense of Microphase’s programs, or a reduction in total defense spending, could +have material adverse consequences on its future business. +101 +Microphase’s products with military applications +are subject to export regulations, and compliance with these regulations may be costly. +Microphase is required to +obtain export licenses before filling foreign orders for many of its products that have military or other governmental applications. U.S. +Export Administration regulations control technology exports like its products for reasons of national security and compliance with foreign +policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of a destination +country. Thus, any foreign sales of its products requiring export licenses must comply with these general policies. Compliance with these +regulations is costly, and these regulations are subject to change, and any such change may require Microphase to improve its technologies, +incur expenses or both in order to comply with such regulations. +Microphase depends on U.S. Government contracts +issued to major defense contractors, which often are only partially funded, subject to immediate termination, and heavily regulated and +audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could have an adverse impact +on Microphase’s business. +Over its lifetime, a U.S. +Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts and subcontracts. +The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts may be authorized and +appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year basis. Procurement funds are +typically made available for obligations over the course of one to three years. Consequently, programs often receive only partial funding +initially, and additional funds are designated only as Congress authorizes further appropriations. The termination of funding for a U.S. +Government program with respect to major defense contractors for which Microphase is a subcontractor would result in a loss of anticipated +future revenue attributable to that program, which could have an adverse impact on its operations. In addition, the termination of, or +failure to commit additional funds to, a program for which Microphase is a subcontractor could result in lost revenue and increase its +overall costs of doing business. +Generally, U.S. Government +contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to Microphase’s +contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed +must be refunded. Microphase has recorded contract revenues based on costs Microphase expect to realize upon final audit. However, Microphase +does not know the outcome of any future audits and adjustments, and Microphase may be required to materially reduce its revenues or profits +upon completion and final negotiation of audits. Negative audit findings could also result in termination of a contract, forfeiture of +profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting or subcontracting for a period of +time. +In addition, U.S. Government +contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s +convenience upon the payment only for work done and commitments made at the time of termination. Microphase can give no assurance that +one or more of the U.S. Government contracts with a major defense contractor under which Microphase provides component products will not +be terminated under these circumstances. Also, Microphase can give no assurance that it will be able to procure new contracts to offset +the revenue or backlog lost as a result of any termination of its U.S. Government contracts. Because a significant portion of Microphase’s +revenue is dependent on its performance and payment under its U.S. Government contracts, the loss of one or more large contracts could +have a material adverse impact on its business, financial condition, results of operations and cash flows. +Microphase’s government +business is also subject to specific procurement regulations and other requirements. These requirements, though customary in U.S. Government +contracts, increase its performance and compliance costs. In addition, these costs might increase in the future, thereby reducing Microphase’s +margins, which could have an adverse effect on its business, financial condition, results of operations and cash flows. Failure to comply +with these regulations and requirements could lead to fines, penalties, repayments, or compensatory or treble damages, or suspension or +debarment from U.S. Government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various +laws, including those related to procurement integrity, export control, U.S. Government security regulations, employment practices, protection +of the environment, accuracy of records, proper recording of costs and foreign corruption. The termination of a U.S. Government contract +or relationship as a result of any of these acts would have an adverse impact on Microphase’s operations and could have an adverse +effect on its standing and eligibility for future U.S. Government contracts. +Microphase’s business could be negatively +impacted by cybersecurity threats and other security threats and disruptions. +As a U.S. Government defense +contractor, Microphase faces certain security threats, including threats to its information technology infrastructure, attempts to gain +access to its proprietary or classified information, threats to physical security, and domestic terrorism events. Microphase’s information +technology networks and related systems are critical to the operation of its business and essential to its ability to successfully perform +day-to-day operations. Microphase is also involved with information technology systems for certain customers and other third parties, +which generally face similar security threats. Cybersecurity threats, in particular, are persistent, evolve quickly and include, but are +not limited to, computer viruses, attempts to access information, denial of service and other electronic security breaches. Microphase +believes that it has implemented appropriate measures and controls and has invested in skilled information technology resources to appropriately +identify threats and mitigate potential risks, but there can be no assurance that such actions will be sufficient to prevent disruptions +to mission critical systems, the unauthorized release of confidential information or corruption of data. A security breach or other significant +disruption involving these types of information and information technology networks and related systems could: +· disrupt the proper functioning of these networks and systems and therefore its operations and/or those +of certain of its customers; +102 +· result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of, proprietary, +confidential, sensitive or otherwise valuable information of Microphase or its customers, including trade secrets, which others could +use to compete against Microphase or for disruptive, destructive or otherwise harmful purposes and outcomes; +· compromise national security and other sensitive government functions; +· require significant management attention and resources to remedy the damages that result; +· subject Microphase to claims for breach of contract, damages, credits, penalties or termination; and +· damage Microphase’s reputation with its customers (particularly agencies of the U.S. Government) +and the public generally. +Any or all of the foregoing could have a negative +impact on its business, financial condition, results of operations and cash flows. Compliance with Defense Department requirements for +information security require Microphase to invest significant resources to implement and maintain cyber defenses against compromise of +information technology architecture, malicious attacks and data breaches. +Microphase enters into fixed-price contracts +that could subject it to losses in the event of cost overruns or a significant increase in inflation. +Microphase has a number of +fixed-price contracts which allow it to benefit from cost savings but subject it to the risk of potential cost overruns, particularly +for firm fixed-price contracts, because Microphase assumes the entire cost burden. If its initial estimates are incorrect, Microphase +can lose money on these contracts. U.S. Government contracts can expose Microphase to potentially large losses because the U.S. Government +can hold Microphase responsible for completing a project or, in certain circumstances, paying the entire cost of its replacement by another +provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. Because many of these +contracts involve new technologies and applications, unforeseen events such as technological difficulties, fluctuations in the price of +raw materials, problems with its suppliers and cost overruns, can result in the contractual price becoming less favorable or even unprofitable +to Microphase. The U.S. and other countries also may experience a significant increase in inflation. A significant increase in inflation +rates could have a significant adverse impact on the profitability of these contracts. Furthermore, if Microphase does not meet contract +deadlines or specifications, Microphase may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated +damages or suffer major losses if the customer exercises its right to terminate. In addition, some of its contracts have provisions relating +to cost controls and audit rights, and if Microphase fails to meet the terms specified in those contracts Microphase may not realize their +full benefits. Microphase’s results of operations are dependent on its ability to maximize its earnings from its contracts. Cost +overruns could have an adverse impact on its financial results. +Compliance with the regulations, standards, +and contractual obligations related to privacy, data protection, and data security, may cause us to incur additional expenses and failure +to comply with such obligations could harm our business and future results of operations. +We expect that the regulatory +framework for privacy, data protection and data security will continue to evolve, which may result in additional operating costs for internal +compliance and risks to our business. Nearly all of Microphase’s current contracts include provisions that require compliance with +detailed cyber security standards laid out in NIST 800-171, which mandates implementation of security controls to protect Microphase’s +information systems from compromise, malicious attacks and/or data breaches. Microphase must maintain a System Security Plan with a Plan +of Action & Milestones for any controls not yet implemented. To continue doing business with the DoD or major prime contractors working +with DoD, Microphase must ultimately achieve Cybersecurity Model Maturity Certification not later than 2026. In addition, Microphase maintains +a certified restricted area and must obtain and maintain authority to operate equipment to perform work on classified projects. Compliance +with all of these mandates will require Microphase to invest substantial resources to implement, maintain and monitor information systems +security controls, facility clearances, personnel clearance and authorities to operate classified systems, which adds to the costs of +operating the business. +103 +Risks Related to Our Business and Industry - Enertec +Potential political, economic and military instability in +Israel could adversely affect our operations. +A significant portion of our +business is conducted through Enertec, our Israeli subsidiary. Accordingly, political, economic and military conditions in Israel and +the surrounding region may directly affect our Israeli operations. In recent years, Israel has been involved in sporadic armed conflicts +with Hamas, an Islamist terrorist group that controls the Gaza Strip, with Hezbollah, an Islamist terrorist group that controls large +portions of Southern Lebanon, and with Iranian-backed military forces in Syria. Some of these hostilities were accompanied by missile +strikes from the Gaza Strip against civilian targets in various parts of Israel, including areas in which our facilities are located, +and negatively affected business conditions in Israel. The change in the U.S. Presidency may continue to change the dynamics in the Middle +East as forces hostile to the existence of Israel seek to reverse the recent stability and commercial opportunities created by the Abraham +Accords. For example, there have been increasing concerns related to a potential attack by Iran. The tension between Israel and Iran and/or +these groups may escalate in the future and turn even more violent, which could affect the Israeli economy in general and us in particular. +A deterioration in the political and security situation in Israel (for example, the significant instability with regards to changes promoted +by the Israeli government in the judiciary branch) may have a negative effect on Israel’s economic situation and on Enertec’s +ability to execute new projects, to raise funding for its operations and plans. +Our commercial insurance does +not cover losses that may occur as a result of events associated with war and terrorism. Although the Israeli government currently covers +the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government +coverage will be maintained or that it will sufficiently cover our potential damages. Any losses or damage incurred by us could have a +material adverse effect on our business. +In addition, Israel-based +companies and companies doing business with Israel have been the subject of an economic boycott by members of the Arab League and certain +other predominantly Muslim countries since Israel’s establishment. Although Israel has entered into various agreements with certain +Arab countries and the Palestinian Authority, and various declarations have been signed in connection with efforts to resolve some of +the economic and political problems in the Middle East, we cannot predict whether or in what manner these problems will be resolved. Wars +and acts of terrorism have resulted in significant damage to the Israeli economy, including reducing the level of foreign and local investment. +Many of our Enertec employees are obligated +to perform military reserve duty in Israel, which could have a disruptive impact on our business. +Generally, Israeli adult male +and certain female citizens and permanent residents are obligated to perform annual military reserve duty in the Israel Defense Forces +up to a specified age. They also may be called to active military duty at any time under emergency circumstances. These military service +obligations could have a disruptive impact on our business, if hostilities develop in the future. +Enertec may become subject to claims for remuneration +or royalties for assigned service invention rights by its employees, which could result in litigation and harm our business. +A significant portion of the +intellectual property covered by Enertec’s products has been developed by Enertec’s employees in the course of their employment +for Enertec. Under the Israeli Patent Law, 5727-1967, or the Patent Law, and recent decisions by the Israeli Supreme Court and the Israeli +Compensation and Royalties Committee, a body constituted under the Patent Law, Israeli employees may be entitled to remuneration for intellectual +property that they develop for us unless they explicitly waive any such rights. To the extent that Enertec is unable to enter into agreements +with its future employees pursuant to which they agree that any inventions created in the scope of their employment or engagement are +owned exclusively by Enertec (as it has done in the past), Enertec may face claims demanding remuneration. As a consequence of such claims, +Enertec could be required to pay additional remuneration or royalties to its current and former employees, or be forced to litigate such +claims, which could negatively affect its business. +Risks Related to Our Business and Industry – Relec +The third parties on which we rely to supply +certain products are located outside the United States. +Relec distributes products +from foreign manufacturers located in Europe, Asia and North America. Our future operating results will depend, among other things, on +our ability to continue to rely on these arrangements. If we are no longer able to rely on these or other similar arrangements for the +supply of certain products, or if our cost of relying on such arrangements materially increases, as the result of the imposition of or +changes in customs, tariffs, quotas, trade barriers, or other trade protection measures, or otherwise, it could have a materially adverse +effect on our business, financial condition, and operating results. +104 +Our strategic focus on our custom power supply +and display solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete. +As a result of our strategic +focus on custom power supply solutions, we will continue to devote significant resources to developing and manufacturing custom power +supply solutions for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s +requirements. Failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards +may put us at risk with one or more of these customers. Moreover, changes in market conditions and strategic changes at the direction +of our customers may affect their decision to continue to purchase from us. The loss of one or more of our significant custom power supply +solution customers could have a material adverse impact on our revenues, business or financial condition. +We have also implemented a +series of initiatives designed to increase efficiency and reduce costs. While we believe that these actions will reduce costs, they may +not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market +or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, +including those involving our personnel, which may negatively impact quarterly earnings and profitability as we account for severance +and other related costs. In addition, there is the risk that such measures could have long-term adverse effects on our business by reducing +our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, +limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire +and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be. +Risks Related to Ownership of Our Common +Stock and Future Offerings +If we do not continue +to satisfy the NYSE American continued listing requirements, our common stock could be delisted from NYSE American. +The +listing of our common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for continued +listing. While we are presently in compliance with all such conditions, it is possible that we will fail to meet one or more of these +conditions in the future. +If +we were to fail to meet a NYSE American listing requirement, we may be subject to delisting by the NYSE American. In the event our common +stock is no longer listed for trading on the NYSE American, our trading volume and share price may decrease and we may experience further +difficulties in raising capital which could materially affect our operations and financial results. Further, delisting from the NYSE American +could also have other negative effects, including potential loss of confidence by partners, lenders, suppliers and employees and could +also trigger various defaults under our lending agreements and other outstanding agreements. Finally, delisting could make it harder for +us to raise capital and sell securities. You may experience future dilution as a result of future equity offerings. In order to raise +additional capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable +for our common stock at prices that may not be the same as the price per share in this offering. We may sell shares or other securities +in any other offering at a price per share that is less than the price per share paid by investors in this offering, and investors purchasing +shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional +shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower +than the price per share paid by investors in this offering. +You may experience future dilution as a result of future equity +offerings. +In order to raise additional +capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable for our +common stock at prices that may not be the same as the price per share in this offering. We may sell shares or other securities in any +other offering at a price per share that is less than the price per share paid by investors in this offering, and investors purchasing +shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional +shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower +than the price per share paid by investors in this offering. +105 +Our common stock price is volatile. +Our common stock is listed on the NYSE American. In the past, our trading +price has fluctuated widely, depending on many factors that may have little to do with our operations or business prospects. During the +past 52-week period (through April 15, 2024), our stock closed at prices between $775.83 per share and $0.2779 per share, as reported +on Nasdaq.com. On April 15, 2024, the price of our common stock closed at $0.2779 per +share. +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our common stock may continue +to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, coupled with +depressed economic conditions, could continue to have a depressive effect on the market price of our common stock. The following factors, +many of which are beyond our control, may influence our stock price: +· the status of our growth strategy including the development of new products with any proceeds we may be +able to raise in the future; +· announcements of technological or competitive developments; +· announcements or expectations of additional financing efforts; +· our ability to market new and enhanced products on a timely basis; +· changes in laws and regulations affecting our business; +· commencement of, or involvement in, litigation involving us; +· regulatory developments affecting us, our customers or our competitors; +· announcements regarding patent or other intellectual property litigation or the issuance of patents to +us or our competitors or updates with respect to the enforceability of patents or other intellectual property rights generally in the +US or internationally; +· actual or anticipated fluctuations in our quarterly financial results or the quarterly financial results +of companies perceived to be similar to us; +· changes in the market’s expectations about our operating results; +· our operating results failing to meet the expectations of securities analysts or investors in a particular +period; +· changes in the economic performance or market valuations of our competitors; +· additions or departures of our executive officers; +· sales or perceived sales of our common stock by us, our insiders or our other stockholders; +· share price and volume fluctuations attributable to inconsistent trading volume levels of our shares; +and +· general economic, industry, political and market conditions and overall fluctuations in the financial +markets in the United States and abroad. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock +and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of a company’s +securities, stockholders have often instituted securities class action litigation against that company. If we were involved in a class +action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense +and, whether or not adversely determined, have a material adverse effect on our business, financial condition, results of operations and +prospects. +106 +Volatility in our common stock price may subject us to securities +litigation. +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our common stock may continue +to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, coupled with +depressed economic conditions, could have a depressing effect on the market price of our common stock. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock +and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of a company’s +securities, stockholders have often instituted securities class action litigation against that company. If we were involved in a class +action suit or other securities litigation, it would divert the attention of our senior management, require us to incur significant expense +and, whether or not adversely determined, have a material adverse effect on our business, financial condition, results of operations and +prospects. +We have a substantial +number of convertible notes, warrants, options and preferred stock outstanding that could affect our price. +Due to a number of financings, +we have a substantial number of shares that are subject to issuance pursuant to outstanding convertible debt, warrants and options. As +of the date of this annual report, the number of shares of common stock subject to convertible notes, warrants, options, Series A Convertible +Preferred Stock, Series C Convertible Preferred Stock and Series D Preferred Stock were 6,108,816, 14,769,824, 779, 7,040, 43,500 and +323,835 respectively. We had outstanding options to purchase an aggregate of 779 shares of Common Stock, with a weighted average exercise +price of $17,423 per share, exercisable at prices ranging from $13,425 to $19,628 per share and warrants to purchase up to 14,769,824 +shares of common stock, with a weighted average exercise price of $1.83 per share, at exercise prices ranging from $0.35 to $90,000 per +share. The issuance of common stock pursuant to convertible notes, warrants, options and preferred stock at conversion or exercise prices +less than market prices may have the effect of limiting an increase in market price of our common stock until all of these underling shares +have been issued. +A possible “short squeeze” due +to a sudden increase in demand of our common stock that largely exceeds supply may lead to price volatility in our common stock. +Investors may purchase our +common stock to hedge existing exposure in our common stock or to speculate on the price of our common stock. Speculation on the price +of our common stock may involve long and short exposures. To the extent aggregate short exposure exceeds the number of shares of our common +stock available for purchase in the open market, investors with short exposure may have to pay a premium to repurchase our common stock +for delivery to lenders of our common stock. Those repurchases may in turn, dramatically increase the price of our common stock until +investors with short exposure are able to purchase additional common shares to cover their short position. This is often referred to as +a “short squeeze.” A short squeeze could lead to volatile price movements in our common stock that are not directly correlated +to the performance or prospects of our company and once investors purchase the shares of common stock necessary to cover their short position +the price of our common stock may decline. +The issuance of shares of our Class B common +stock to our management or others could provide such persons with voting control leaving our other stockholders unable to elect our directors +and the holders of our shares of common stock will have little influence over our management. +Although there are currently +no shares of our Class B common stock issued and outstanding, our certificate of incorporation authorizes the issuance of 25 million shares +of Class B common stock. Each share of Class B common stock provides the holder thereof with ten votes on all matters submitted to a stockholder +vote. Our certificate of incorporation does not provide for cumulative voting for the election of directors. Any person or group who controls +or can obtain more than 50% of the votes cast for the election of each director will control the election of directors and the other stockholders +will not be able to elect any directors or exert any influence over management decisions. As a result of the super-voting rights of our +shares of Class B common stock, the issuance of such shares to our management or others could provide such persons with voting control +and our other stockholders will not be able to elect our directors and will have little influence over our management. While we are listed +on the NYSE American or any other national securities exchange it is highly unlikely that we would issue any shares of Class B common +stock as doing so would jeopardize our continued listing on any such exchange. However, if were to be delisted for some other reason and +our shares of Class A common stock trade on an over-the-counter market, then we would face no restriction on issuing shares of Class B +common stock. +107 +General Risk Factors +Our limited operating history makes it difficult +to evaluate our future business prospects and to make decisions based on our historical performance . +Although our executive officers +have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our current business +until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate our business on the +basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future results based upon our historical +data. Reliance on our historical results may not be representative of the results we will achieve, and for certain areas in which we operate, +principally those unrelated to defense contracting, will not be indicative at all. Because of the uncertainties related to our lack of +historical operations, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in sales, product costs +or expenses. If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, +which may result in a decline in our stock price. +Deterioration of global economic conditions +could adversely affect our business . +The global economy and capital +and credit markets have experienced exceptional turmoil and upheaval over the past several years. Ongoing concerns about the systemic +impact of potential long-term and widespread recession and potentially prolonged economic recovery, volatile energy costs, fluctuating +commodity prices and interest rates, volatile exchange rates, geopolitical issues, including the conflicts between Russia and Ukraine +and between Israel and Hamas, natural disasters and pandemic illness, instability in credit markets, cost and terms of credit, consumer +and business confidence and demand, a changing financial, regulatory and political environment, and substantially increased unemployment +rates have all contributed to increased market volatility and diminished expectations for many established and emerging economies, including +those in which we operate. Furthermore, austerity measures that certain countries may agree to as part of any debt crisis or disruptions +to major financial trading markets may adversely affect world economic conditions and have an adverse impact on our business. These general +economic conditions could have a material adverse effect on our cash flow from operations, results of operations and overall financial +condition. +The availability, cost and +terms of credit also have been and may continue to be adversely affected by illiquid markets and wider credit spreads. Concern about the +stability of the markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors +to reduce credit to businesses and consumers. These factors have led to a decrease in spending by businesses and consumers over the past +several years, and a corresponding slowdown in global infrastructure spending. +Continued uncertainty in the +U.S. and international markets and economies and prolonged stagnation in business and consumer spending may adversely affect our liquidity +and financial condition, and the liquidity and financial condition of our customers, including our ability to access capital markets and +obtain capital lease financing to meet liquidity needs. +No assurance of successful expansion of operations. +Our significant increase in +the scope and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher operating +expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make significant demands +on our management, finances and other resources. Our ability to manage the anticipated future growth, should it occur, will depend upon +a significant expansion of our accounting and other internal management systems and the implementation and subsequent improvement of a +variety of systems, procedures and controls. We cannot assure you that significant problems in these areas will not occur. Failure to +expand these areas and implement and improve such systems, procedures and controls in an efficient manner at a pace consistent with our +business could have a material adverse effect on our business, financial condition and results of operations. We cannot assure that attempts +to expand our marketing, sales, manufacturing and customer support efforts will succeed or generate additional sales or profits in any +future period. As a result of the expansion of our operations and the anticipated increase in our operating expenses, along with the difficulty +in forecasting revenue levels, we expect to continue to experience significant fluctuations in its results of operations. +108 +If we fail to establish and maintain an effective +system of internal control over financial reporting, we may not be able to report our financial results accurately or prevent fraud. Any +inability to report and file our financial results accurately and timely could harm our reputation and adversely impact the trading price +of our common stock. +Effective internal control +over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial +reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, +and our business and reputation with investors may be harmed. As a result, our small size and any current internal control deficiencies +may adversely affect our financial condition, results of operations and access to capital. We have carried out an evaluation under the +supervision and with the participation of our management, including our principal executive officer and principal financial officer, of +the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent period covered +by this report. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure +controls and procedures were not effective at the reasonable assurance level due to the material weakness described below. +A material weakness is a deficiency, +or a combination of deficiencies, within the meaning of Public Company Accounting Oversight Board (“PCAOB”) Audit Standard +No. 5, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual +or interim financial statements will not be prevented or detected on a timely basis. Management has identified the following material +weakness which has caused management to conclude that as of December 31, 2023, our internal control over financial reporting (“ICFR”) +was not effective at the reasonable assurance level. +We do not have sufficient +resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial +reporting, including fair value estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting +duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, +the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of +our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the resulting +control deficiency represented a material weakness. +We are currently working to +improve and simplify our internal processes and implement enhanced controls to address the material weakness in our internal control over +financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. This material weakness will not be considered +to be remediated until the applicable remediated controls are operating for a sufficient period of time and management has concluded, +through testing, that these controls are operating effectively. +If our accounting +controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We +evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and annually review and evaluate our internal control +over financial reporting in order to comply with the SEC’s rules relating to internal control over financial reporting adopted pursuant +to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect +misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become +inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail +to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such internal +control, we may be subject to regulatory sanctions, and our reputation may decline. +Our internal computer +systems may fail or suffer security breaches, which could result in a material disruption of our operations . +Like +any other business, we rely on e-mail and other digital communications methods as part of our normal operations. As such, our internal +computer systems and servers could fail or suffer security breaches, possibly resulting in a material disruption to our operations. The +secure operation of our IT networks and systems as well as the secure processing and maintenance of information is critical to our operations +and business strategy. Notwithstanding these priorities, we have experienced attempts at cybercrime such as phishing and other electronic +fraud, including efforts to misdirect payments to imposter vendors and service providers. After experiencing a financial loss due to e-mail +fraud in November 2021, we have instituted greater internal controls and procedures, both electronic and non-electronic, to combat such +fraudulent conduct. We also maintain an insurance policy to cover any losses or injuries suffered from cybercrime of this nature; however, +it may not be sufficient to cover all damages. Despite our efforts, attempts at fraud such as spoofed e-mails, requests for payment and +similar deceptions have become commonplace in the world of e-commerce and are expected to continue. If we are unable to prevent such security +breaches in the future, these events or circumstances could materially and adversely affect our operations, financial condition and operating +results and impair our ability to execute our business strategy. +109 +We face significant competition, including changes in pricing. +The markets for our products +are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing resources, plus +experience in research and development, and compete with us by offering lower prices. Competitors could develop new technologies that +compete with our products to achieve a lower unit price. If a competitor develops lower cost and/or superior technology or cost-effective +alternatives to our products and services, our business could be seriously harmed. +The markets for some of our +products are also subject to specific competitive risks because these markets are highly price sensitive. Our competitors have competed +in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering our prices. This would +reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also impact sales and aggravate +losses. +Many of our competitors are larger and have +greater financial and other resources than we do. +Our products compete and will +compete with similar if not identical products produced by our competitors. These competitive products could be marketed by well-established, +successful companies that possess greater financial, marketing, distribution personnel, and other resources than we do. Using said resources, +these companies can implement extensive advertising and promotional campaigns, both generally and in response to specific marketing efforts +by competitors. They can introduce new products to new markets more rapidly. In certain instances, competitors with greater financial +resources may be able to enter a market in direct competition with us, offering attractive marketing tools to encourage the sale of products +that compete with our products or present cost features that consumers may find attractive. +Our growth strategy is subject to a significant +degree of risk. +Our +growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition +targets or made a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. Therefore, +we may lose our investment in the event that these companies’ businesses do not develop as planned or that they are unable to achieve +the anticipated cost efficiencies or reduction of losses. +Further, +in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement our +plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that provide +revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development and investments +will produce sufficient revenues to offset these increases in expenditures. +Our operating results may vary from quarter to quarter. +Our operating results have +in the past been subject to quarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in +magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products +in our customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or +fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven +by budgetary and other concerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you +that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of +large individual sales and the ability to obtain acceptances of those sales, where applicable, have been difficult for us to predict, +and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. +The loss or deferral of one or more significant sales in a quarter could harm our operating results for such quarter. It is possible that, +in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the +event adverse conditions prevail, the market price of our common stock may decline significantly. +Changes in the U.S. tax and other laws and regulations may adversely +affect our business. +The U.S. Government may revise +tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, including modifications +that could reduce the profits that we can effectively realize from our international operations, or that could require costly changes +to those operations, or the way in which they are structured. For example, the effective tax rates for most U.S. companies reflect the +fact that income earned and reinvested outside the U.S. is generally taxed at local rates, which may be much lower than U.S. tax rates. +If we expand abroad and there are changes in tax laws, regulations or interpretations that significantly increase the tax rates on non-U.S. +income, our effective tax rate could increase and our profits could be reduced. If such increases resulted from our status as a U.S. company, +those changes could place us at a disadvantage to our non-U.S. competitors if those competitors remain subject to lower local tax rates. +110 +Our sales and profitability may be affected by changes in +economic, business and industry conditions . +If the economic climate in +the U.S. or abroad deteriorates, customers or potential customers could reduce or delay their technology investments. Reduced or delayed +technology and entertainment investments could decrease our sales and profitability. In this environment, our customers may experience +financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and professional services. +This may lead to longer sales cycles, delays in purchase decisions, payment and collection, and can also result in downward price pressures, +causing our sales and profitability to decline. In addition, general economic uncertainty and general declines in capital spending in +the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and the markets +we serve. There are many other factors which could affect our business, including: +· The introduction and market acceptance of new technologies, products and services; +· New competitors and new forms of competition; +· The size and timing of customer orders (for retail distributed physical product); +· The size and timing of capital expenditures by our customers; +· Adverse changes in the credit quality of our customers and suppliers; +· Changes in the pricing policies of, or the introduction of, new products and services by us or our competitors; +· Changes in the terms of our contracts with our customers or suppliers; +· The availability of products from our suppliers; and +· Variations in product costs and the mix of products sold. +These trends and factors could adversely affect +our business, profitability and financial condition and diminish our ability to achieve our strategic objectives. +The sale of our products is dependent upon +our ability to satisfy the proprietary requirements of our customers. +We depend upon a relatively +narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance +by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to +satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. +The sale of our products is dependent on our +ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, +and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products. +Rapid technological change, +including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place +of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products +and adversely affect the revenues from such products. +111 +Our limited ability to protect our proprietary +information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property +rights of others, resulting in claims against us, the results of which could be costly. +Many of our products consist +entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, +trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual +property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior +to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent +as the laws of the U.S. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, +we may be required to institute legal proceedings, which would be costly and would divert our resources from the development of our business. +If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results +could be adversely affected. +Although we attempt to avoid +infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and +claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party +proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require +us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to +us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the U.S. +or abroad. +If we ship products that contain defects, the +market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us. +Our products are complex, +and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have +been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, +error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, +resulting in substantial costs for us and our customers as well as the cancellation of orders, warranty costs and product returns. In +addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the +use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. +Although we maintain product liability insurance, it may not be adequate. +The rights of the holders of common stock may +be impaired by the potential issuance of preferred stock. +Our certificate of incorporation +gives our Board the right to create new series of preferred stock. As a result, the Board may, without stockholder approval, issue preferred +stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting power and equity interest +of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote per share, could be utilized +as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect +the price of our common stock. We may issue shares of preferred stock in the future. +The requirements of being a public company +may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company and +subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among other +things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act +requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial reporting. +For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of our internal controls +structure and procedures for financial reporting. Section 404 compliance may divert internal resources and will take a significant +amount of time and effort to complete. If we fail to maintain compliance under Section 404, or if our internal control over financial +reporting continues to not be effective as defined under Section 404, we could be subject to sanctions or investigations by the NYSE +American, the SEC, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause +a decline in the market price of our common stock. Any failure of our internal controls could have a material adverse effect on our stated +results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could harm our +operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent +auditors. We may need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing +obligations as a public company, particularly if we become fully subject to Section 404 and its auditor attestation requirements, which +will increase costs. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives +and to meeting the obligations that are associated with being a public company, which may divert attention from other business concerns, +which could have a material adverse effect on our business, financial condition and results of operations. +112 +We have identified material weaknesses in our +internal control over financial reporting and may identify additional material weaknesses in the future or otherwise fail to maintain +an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to +meet our periodic reporting obligations. +We are required to comply +with certain provisions of Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”). Section 404 requires that +we document and test our internal control over financial reporting and issue management’s assessment of our internal control over +financial reporting. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2023. In +making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) +in Internal Control — Integrated Framework. A material weakness is a deficiency, or a combination of deficiencies, in internal control +over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial +statements will not be prevented or detected on a timely basis. Based on our assessment, as of December 31, 2023, we concluded that our +internal control over financial reporting contained material weaknesses. +The weakness will not be considered +remediated, however, until the applicable controls operate for a sufficient period of time and our management has concluded, through testing, +that these controls are operating effectively. If we fail to comply with the requirements of Section 404 of the Sarbanes-Oxley Act, the +accuracy and timeliness of the filing of our annual and quarterly reports may be materially adversely affected and could cause investors +to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock. +In addition, a material weakness in the effectiveness of our internal control over financial reporting could result in an increased chance +of fraud and the loss of customers, reduce our ability to obtain financing and require additional expenditures to comply with these requirements, +each of which could have a material adverse effect on our business, results of operations and financial condition. +If we fail to comply with the rules under +the Sarbanes-Oxley Act of 2002 related to accounting controls and procedures, or if we discover material weaknesses and deficiencies in +our internal control and accounting procedures, our stock price could decline significantly and raising capital could be more difficult. +If we fail to comply with +the rules under the Sarbanes-Oxley Act of 2002 related to disclosure controls and procedures, or, if we discover material weaknesses +and other deficiencies in our internal control and accounting procedures, our stock price could decline significantly and raising capital +could be more difficult. Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our +internal control over financial reporting. If material weaknesses or significant deficiencies are discovered or if we otherwise fail to +achieve and maintain the adequacy of our internal control, we may not be able to ensure that we can conclude on an ongoing basis that +we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, +effective internal controls are necessary for us to produce reliable financial reports and are important to helping prevent financial +fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors +could lose confidence in our reported financial information, and the trading price of our common stock could drop significantly. +If securities or industry analysts do not publish +research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading +volume could decline. +The trading market for our +common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. Our +research coverage by industry and financial analysts is currently limited. Even if our analyst coverage increases, if one or more of the +analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our +company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock +price or trading volume to decline. +The elimination of monetary liability against +our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, officers +and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees. +Our certificate of incorporation +contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders for damages for the +breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have contractual indemnification +obligations under any future employment agreements with our officers. The foregoing indemnification obligations could result in us incurring +substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. +These provisions and the resulting costs may also discourage us from bringing a lawsuit against directors and officers for breaches of +their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and +officers even though such actions, if successful, might otherwise benefit us and our stockholders. +We do not anticipate paying cash dividends +on our common stock and, accordingly, stockholders must rely on stock appreciation for any return on their investment. +We have never declared or +paid cash dividends on our common stock and do not expect to do so in the foreseeable future. The declaration of dividends is subject +to the discretion of our Board and will depend on various factors, including our operating results, financial condition, future prospects +and any other factors deemed relevant by our Board. You should not rely on an investment in our company if you require dividend income +from your investment in our company. The success of your investment will likely depend entirely upon any future appreciation of the market +price of our common stock, which is uncertain and unpredictable. There is no guarantee that our common stock will appreciate in value. +113 +ITEM 1B. UNRESOLVED STAFF COMMENTS +Because we are a smaller reporting company, this +section is not applicable. +ITEM 1C. CYBERSECURITY +Information Security Program: +The mission of our information +security program is to design, implement, and maintain a comprehensive information security program that protects our systems, services, +and data against unauthorized access, disclosure, modification, damage, and loss. Our information security program is comprised of internal +and external security and technology professionals who work collaboratively to identify, assess, manage, and mitigate cybersecurity risks +and threats across the Company, our subsidiaries, and third-party contractors. +We recognize the importance +of effectively managing material risks associated with cybersecurity threats, as defined in Item 106(a) of Regulation S-K. Our risk management +program integrates the monitoring and management of these risks and threats and is informed by applicable laws, regulations, industry +standards, and best practices. We continue to invest in information security resources to mature, expand, and adapt our capabilities to +address emerging cybersecurity risks and threats. +Our information security organization +is committed to maintaining a robust and resilient security posture that enables us to protect our assets, maintain our stakeholders' +trust, and support our business's overall success. +Cybersecurity Risk Management and Strategy +Our cybersecurity risk management +and strategy are integral components of our comprehensive information security program. They guide our continuous efforts to evaluate +and improve the confidentiality, integrity, and availability of our critical systems, data, and operations. +We have adopted an Information +Security Policy (the “Info-Sec Policy”) and an Incident Response Plan (the “Response Plan”) that establish administrative, +physical, and technical controls and procedures to protect sensitive data throughout the Company. These policies also outline processes +to assess, identify, manage, and report cybersecurity risks and incidents. The Info-Sec Policy applies to all persons working for the +Company and any third parties working with us in any capacity. +Our approach to controls and +risk management is informed by applicable laws and regulations, as well as industry standards and best practices. These serve as a guide +to help us identify, assess, and manage cybersecurity controls and risks relevant to our business. +Our cybersecurity risk management +program includes: +1. Identifying cybersecurity risks that could impact our facilities, third-party vendors/partners, operations, +critical systems, information, and broader enterprise information technology environment. Risks are informed by threat intelligence, current +and historical adversarial activity, and industry-specific threats; +2. Performing cybersecurity risk assessments to evaluate our readiness if the risks were to materialize; +3. Ensuring risk is addressed and tracking any necessary remediation through an action plan; +4. Analyzing all third-party vendors for compliance with our internal Info-Sec Policy to assess potential +risks associated with their security controls. We generally require third parties to maintain security controls, notify us promptly of +any data breach or cybersecurity incident that may impact our data, and provide written assurance of corrective actions; and +5. Engaging and utilizing a comprehensive suite of security solutions, including enterprise mobility management, +endpoint protection, secure file transfer, and security information and event management to monitor and actively respond to cybersecurity +threats. These solutions work together to secure our endpoints, protect against malware, ensure the safe transfer of files, and provide +our cybersecurity team with the functionality to build alerts on specific use cases that are important and unique to our business. +114 +Cybersecurity Governance +Our Board oversees cybersecurity +risk as part of its overall risk oversight function. Our information technology department (the “IT Department”), which functions +as our Information Security Advisory Team, is responsible for managing our information security program and implementing cybersecurity +risk management practices. The IT Department is led by our Chief Technology Officer and Chief Information Officer, who oversee our cybersecurity +strategy and ensure its alignment with business objectives. +The IT Department collaborates +with various stakeholders across the organization to identify, assess, and mitigate cybersecurity risks. They regularly monitor and adapt +our information security program to address the evolving threat landscape. +In the event of a cybersecurity +incident, the IT Department promptly reports the matter to the Executive Committee, which consists of our senior leadership team. The +Executive Committee is responsible for assessing the severity and potential impact of the incident and determining the appropriate course +of action. The Executive Committee keeps the Board informed of significant cybersecurity incidents and provides updates on the overall +status of our cybersecurity program as needed. +This governance structure +ensures that cybersecurity risks are effectively managed by the IT Department, with oversight from the Executive Committee and the Board. +It maintains clear lines of communication and accountability, enabling timely decision-making and response to cybersecurity matters. +In 2023, we did not identify +any cybersecurity threats that have materially affected or are reasonably likely to materially affect our business strategy, results of +operations or financial condition. However, despite our efforts, we may not successfully eliminate all risks from cybersecurity threats +and can provide no assurance that undetected cybersecurity incidents have not occurred. +ITEM 2. PROPERTIES +Our corporate headquarters +office utilizes 17,376 square feet of leased office space in Las Vegas, Nevada. One of our Las Vegas leases is currently leased on a month-to-month +basis. Our other Las Vegas lease commenced in August 2021 and expires in August 2024. The annual base rent under the leases, payable on +a monthly basis, was approximately $0.3 million during 2023. +We also lease additional corporate +offices in Costa Mesa, California and New York, New York. Some leases previously expired and are now on a month-to-month basis, while +remaining leases expire between December 2024 and July 2026. The annual base rent under the leases, payable on a monthly basis, was approximately +$0.2 million during 2023. +We own a 617,000 square foot +data center in Dowagiac, Michigan, in which we operate our cryptocurrency mining operations for Sentinum, in addition to renting commercial +office and warehouse space. +Our +GIGA segment leases 47,771 square feet of office, engineering, laboratory and warehouse space in Scottsdale, Arizona, Shelton, Connecticut +and Dublin, California. Our leases expire between August 2023 and May 2026. The annual base rent under the leases, payable on a monthly +basis, was approximately $0.5 million during 2023. Our GIGA segment also leases 65,390 square feet of office and manufacturing space +internationally in Salisbury, United Kingdom, Dorset, United Kingdom, and Karmeil, Israel. The annual base rent, payable on a monthly +basis, was approximately $0.5 million in 2023. The leases expire between September 2024 and May 2031. +Our +TurnOnGreen segment leases 39,965 square feet of office, engineering, laboratory and warehouse space in two locations in Milpitas, California. +Our leases expire between November 2024 and January 2026. The annual base rent under the leases, payable on a monthly basis, was approximately +$0.5 million during 2023. +Our +Energy segment crane rental business leases 27,909 of commercial buildings and 10 acres of land in Carthage, Texas, Clinton, Oklahoma, +Houston, Texas, and Robstown, Texas. Our leases expire between March 2024 and April 2027. The annual base rent under the leases, payable +on a monthly basis, was approximately $0.5 million in 2023. +We currently anticipate that the current leased +space will be sufficient to support our current and foreseeable future needs. +115 +ITEM 3. LEGAL PROCEEDINGS +Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory and government +investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, suits, regulatory +and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable +that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss +or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could +affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and +make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount +of a loss related to such matters. +With respect to our other +outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either +individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, +or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +116 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY +SECURITIES +Market Information +Our common stock is listed +on the NYSE American under the symbol AULT. +Record Holders +As of April 15, 2024, 30,065,339 shares of our common stock were issued +and outstanding and were owned by 5 holders of record. A number of holders of our common stock are “street name” or beneficial +holders whose shares of record are held by banks, brokers, and other financial institutions. +Dividend Policy +We have not declared or paid +any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends +in the future, if any, will be at the discretion of our Board and will depend upon our earnings, capital requirements, and financial position. +Equity Compensation Information +The +information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 +of this Annual Report on Form 10-K. +Recent Sales of Unregistered Securities +Not applicable. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +From +October 1, 2023 through December 31, 2023, Ault Alpha LP purchased 13,866 shares of common stock and 178 shares of Series D Preferred +Stock. Ault Alpha LP may be deemed to be an “affiliated purchaser” as defined in Rule 10b-18(a)(3) under the Securities Exchange +Act of 1934, as amended. The purchases were made through open-market transactions. +Common Stock Purchased +Total +Number of +Shares +Purchased +Average +Price Paid +Per Share +Total Number of +Shares Purchased +as Part of Publicly +Announced Plans +or Programs +Maximum +Number of Shares +That May Yet Be +Purchased Under +Plans or Programs +October 1, 2023 – October 31, 2023 +- +$ - +November 1, 2023 – November 30, 2023 +13,866 +$ 2.22 +December 1, 2023 – December 31, 2023 +- +$ - +Total +13,866 +$ 2.22 +- +- +117 +Series D Preferred +Stock Purchased +Total +Number of +Shares +Purchased +Average Price +Paid Per +Share +Total Number of +Shares Purchased +as Part of Publicly +Announced Plans +or Programs +Maximum +Number of Shares +That May Yet Be +Purchased Under +Plans or Programs +October 1, 2023 – October 31, 2023 +- +$ - +November 1, 2023 – November 30, 2023 +178 +$ 21.96 +December 1, 2023 – December 31, 2023 +- +$ - +Total +178 +$ 21.96 +- +- +ITEM 6. RESERVED +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form +10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking +statements. Such forward-looking statements include statements regarding, among others, (a) our expectations about possible business combinations, +(b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs for working capital. Forward-looking statements, +which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words +“may,” “will,” “should,” “expect,” “anticipate,” “approximate,” +“estimate,” “believe,” “intend,” “plan,” “budget,” “could,” “forecast,” +“might,” “predict,” “shall” or “project,” or the negative of these words or other variations +on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that +may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements +expressed or implied by any forward-looking statements. These statements may be found in this Annual Report. +Forward-looking statements +are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other future +conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks, +and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking +statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in this +Annual Report, changes in local, regional, national or global political, economic, business, competitive, market (supply and demand) and +regulatory conditions and the following: +· Adverse economic conditions; +· Our ability to effectively execute our business plan; +· Inability to raise sufficient additional capital to operate our business; +· Our ability to manage our expansion, growth and operating expenses; +· Our ability to evaluate and measure our business, prospects and performance metrics; +· Our ability to compete and succeed in highly competitive and evolving industries; +· Our ability to respond and adapt to changes in technology and customer behavior; +· Our ability to protect our intellectual property and to develop, maintain and enhance a strong brand; +and +· Other specific risks referred to in the section entitled “ Risk Factors ”. +We caution you therefore that +you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances of future +performance. All forward-looking statements speak only as of the date of this Annual Report. We undertake no obligation to update any +forward-looking statements or other information contained herein unless required by law. +Information regarding market +and industry statistics contained in this Annual Report is included based on information available to us that we believe is accurate. +It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. +Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional +uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services. Except as required +by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect actual results or changes in assumptions +or other factors that could affect those statements. See the section entitled “ Risk Factors ” for a more detailed discussion +of risks and uncertainties that may have an impact on our future results. +118 +In this Annual Report, the +“Company,” “ AAI ,” “we,” “us” and “our” +refer to Ault Alliance, Inc., a Delaware corporation formerly known as BitNile Holdings, which was incorporated in September 2017. AAI +is a diversified holding company pursuing growth by acquiring undervalued businesses and disruptive technologies with a global impact. +Through our wholly- and majority-owned +subsidiaries and strategic investments, we own and operate a data center at which we mine Bitcoin, and provide mission-critical products +that support a diverse range of industries, including crane services, oil exploration, defense/aerospace, industrial, automotive, medical/biopharma, +consumer electronics and textiles. In addition, we extend credit to select entrepreneurial businesses through a licensed lending subsidiary. +. Our direct and indirect +wholly owned subsidiaries include (i) Sentinum, Inc. (“Sentinum”), (ii) Alliance Cloud Services, LLC (“ACS”), +(iii) BNI Montana, LLC (“BNI Montana”), (iv) Ault Capital Group, Inc. (“Ault Capital”), (v) Ault Lending, LLC +(“Ault Lending”), (vii) Ault Global Real Estate Equities, Inc. (“AGREE”), (viii) Ault Disruptive Technologies +Company, LLC (“ADTC”), which is the sponsor, Manager and the majority owner of Ault Disruptive Technologies Corporation (“Ault +Disruptive”), (ix) Eco Pack Technologies, Inc. (“Eco Pack”), which has a controlling interest in Eco Pack Technologies +Limited, (x) Ault Aviation, LLC (“Ault Aviation”) and (xi) Third Avenue Apartments, LLC (“Third Avenue”). +We also have a direct controlling +interest in (i) Circle 8 Holdco LLC (“Circle 8 Holdco”), which wholly owns Circle 8 Crane Services, LLC (“Circle 8”), +(ii) TurnOnGreen, Inc., formerly known as Imperalis Holding Corp. (“TurnOnGreen”), which wholly owns TOG Technologies, Inc. +(“TOG Technologies”) and Digital Power Corporation (“Digital Power”), (iii) Gresham Worldwide, Inc., formerly +known as Giga-tronics Incorporated (“GIGA”), which wholly owns Gresham Holdings, Inc., formerly Gresham Worldwide, Inc. (“GWW”), +which in turn wholly owns Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems 2001 Ltd. (“Enertec”), +Relec Electronics Ltd. (“Relec”) and has a controlling interest in Microphase Corporation (“Microphase”) and (iv) +Avalanche International Corp. (“Avalanche” or “AVLP”), which does business as MTIX International (“MTIX”). +We have minority interests in (i) RiskOn International, Inc., formerly known as BitNile Metaverse, Inc. (“ROI”), which wholly +owns BitNile.com, Inc. (“BNC”), RiskOn 360, Inc., formerly known as Ault Iconic, Inc. (“RiskOn 360”), RiskOn Learning, +Inc. and GuyCare, Inc. and (ii) The Singing Machine Company, Inc. (“SMC”). We consolidate each of ROI and SMC as variable +interest entities. +Recent Events and Developments +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant Capital Markets, LLC (“Ascendiant”) +to sell shares of common stock having an aggregate offering price of up to $200 million from time to time, through an “at the market +offering” program (the “2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering +was made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained +therein (Registration Statement No. 333-260618) which became effective on November 12, 2021. Through March 13, 2023, we received gross +proceeds of approximately $177 million through the sale of approximately 42,382 shares of common stock from the 2022 ATM Offering. The +2022 Sales Agreement has been terminated. +On June 10, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Preferred Sales Agreement”) with Ascendiant to sell shares of our +13.00% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred Shares”) having an aggregate offering price +of up to $46.4 million from time to time, through an “at the market offering” program (the “2022 ATM Preferred Offering”). +The offer and sale of Series D Preferred Shares from the 2022 ATM Preferred Offering was made pursuant to our effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) which +became effective on November 12, 2021. Through June 16, 2023, we received gross proceeds of approximately $3.4 million through the sale +of 0.3 million Series D Preferred Shares in the 2022 ATM Preferred Offering. The 2022 Preferred Sales Agreement has been terminated. +On November 7, 2022, we and +certain of our subsidiaries borrowed $18.9 million of principal amount of term loans (the “Term Loans”) from a group of institutional +investors (the “Financing”). The Term Loans matured in 18 months, which may have been extended to 24 months, accrued interest +at the rate of 8.5% per annum and were secured by certain of our and certain of our subsidiaries’ assets. Starting in January 2023, +the lenders had the right to require us to make monthly payments of $0.6 million, which increased to $1.1 million in November 2023. The +Term Loans were issued with an original issue discount of $1.9 million. +119 +The lenders received warrants +to purchase 604 shares of our common stock, exercisable for four years at $3,375 per share and warrants to purchase another 604 shares +of our common stock, exercisable for four years at $5,625 per share, subject to adjustment. +On July 19, 2023, we entered +into an amendment to the loan documents governing the Financing described above. Pursuant to the amendment, the aggregate size of the +Loan increased from $18.9 million to $24.3 million. The loan was repaid in December 2023. +On December 16, 2022 we entered +into a Securities Purchase Agreement (the “SPA”) with an accredited investor (the “December 2022 Investor”) providing +for the issuance of a secured promissory note (the “December 2022 Note”) with an aggregate principal face amount of $14.7 +million. On December 29, 2022, the Company and the December 2022 Investor entered into an amended and restated amendment to the SPA, pursuant +to which the total amount of the financing was increased to $17.5 million and the Company sold an additional note to a second accredited +investor. +Under the SPA, we were obligated +to repay, while the December 2022 Note remains outstanding, (i) eighty percent (80%) of the proceeds we may receive from any financing +conducted, other than at-the-market offerings and (ii) one hundred percent (100%) of the proceeds we may receive from the sale of marketable +securities by Ault Lending. In addition, if Third Avenue Apartments, LLC (“Third Avenue”), our wholly owned subsidiary, sold +the property it owns in St. Peterburg, Florida, then we would use the net proceeds from the sale of such property in excess of $10 million, +to repay the December 2022 Note. In addition, we agreed to issue 1,547 shares of our common stock to the December 2022 Investor in exchange +for the cancellation of all outstanding warrants previously issued to the December 2022 Investor, which warrants were exercisable for +1,547 shares of our common stock. +On January 23, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable +preferred stock which, effective upon filing, eliminated the Series C convertible redeemable preferred stock. +On February 8, 2023, we entered +into a Share Exchange Agreement (the “February 2023 Agreement”) with ROI and the other signatories thereto. The February 2023 +Agreement provided that, subject to the terms and conditions set forth therein, ROI would acquire all of the outstanding shares of capital +stock of our then subsidiary, BNC, of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders (the +“Minority Shareholders”), as well as RiskOn 360, in exchange for the following: (i) 8,637.5 shares of newly designated Series +B Convertible Preferred Stock of ROI that were issued to our company (the “Series B Preferred”), and (ii) 1,362.5 shares of +newly designated Series C Convertible Preferred Stock of ROI that were issued to the to the Minority Shareholders (the “Series C +Preferred,” and together with the Series B Preferred, the “Preferred Stock”). The Series B Preferred and the Series +C Preferred each have a stated value of $10,000 per share (the “Stated Value”), for a combined stated value of the Preferred +Stock to be issued by ROI, of $100 million, and subject to adjustment, are convertible into shares of common stock of ROI. However, pending +approval of the transaction by ROI’s shareholders, the Preferred Stock is subject to a 19.9% beneficial ownership limitation, including +the Series A Convertible Preferred Stock that we acquired from ROI in June of 2022. +Pursuant to the Certificates +of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred +Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of ROI common stock determined by +dividing the Stated Value by $0.25 (the “Conversion Price”), or 40,000 shares of ROI common stock. The Conversion Price will +be subject to certain adjustments, including potential downward adjustment if ROI closes a qualified financing resulting in at least $25.0 +million in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock +will be entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend +Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather +than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If +ROI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as +long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the +event of a liquidation, change of control event, dissolution or winding up of ROI, and will rank senior to all other capital stock of +ROI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred +was originally entitled to vote with the ROI common stock at a rate of 10 votes per share of common stock into which the Series B Preferred +is convertible, but that provision was subsequently eliminated, as were the conventional voting rights of the Series C Preferred. Other +than certain rights granted to the Company relating to amendments or waiver of various negative covenants, the terms, rights, preferences +and limitations of the Preferred Stock Certificates are essentially identical. The February 2023 Agreement closed on March 6, 2023. +120 +On February 24, 2023, BNI +Montana entered into an asset purchase agreement with TypeX, LLC (“TypeX”), to acquire two land lease agreements and two corresponding +power purchase agreements in Montana. The lease and power agreements run for a period of 10 years, with a 10-year renewal option. Sentinum +is building out and developing fully operational data centers dedicated to Bitcoin mining operations on the properties (the “Montana +Facilities”). We anticipate that upon completion, the Montana Facilities will provide up to a combined 20 megawatts of power, enabling +up to 6,500 S19j Pro Antminers to operate. The substations providing power to the Montana Facilities have the ability to handle additional +capacity and Sentinum has initiated a load study to determine future capacity and, if economically viable, intends to acquire such additional +power capacity. We are redeploying S19j Pro Antminers that are currently mining in our Michigan data center, allowing us to focus on expansion +at our Michigan site to support the rapid growth of high-performance computing and AI use cases. +On April 6, 2023, we issued +a term note with a principal amount of $1.1 million, bearing an interest rate of 12% (the “Term Note”). The Term Note was +issued at a discount, with net proceeds to us amounting to $1.0 million. The Term Note was scheduled to mature on June 5, 2023. We exercised +the option to extend the maturity date by one month, by paying a $30,000 extension fee. Ault & Company guaranteed repayment of the +Term Note. +On April 20, 2023, Sentinum +entered into an amended Master Services Agreement with Core Scientific, Inc. (“Core Scientific”) for hosting services related +to the deployment of Bitcoin miners. This agreement provides for the sale of Bitcoin mined on a daily basis with the proceeds from such +sales generally being applied to operations fees of $25 per miner, hosting services fees, other miscellaneous fees and then any remaining +amounts, if any, are distributed 60% to Sentinum and 40% to Core Scientific. We have deployed 10,200 S19 Pro and S19j Pro Antminers with +Core Scientific, securing approximately 30 MW of power. The agreement terminates on August 31, 2024, unless terminated sooner pursuant +to the terms of the agreement. Notwithstanding the foregoing, either party may terminate the agreement with respect to 1,000 units in +any thirty (30) day period on thirty (30) days written notice on or after November 30, 2023. The Core Scientific hosting services agreement +expedited the deployment of our Bitcoin miners to approximately 19,200, representing a mining production capacity of approximately 2.1 +exahashes per second. Under the terms of the Core Scientific hosting services agreement, we expect that Sentinum will pay Core Scientific +a monthly fee for operations and hosting services of approximately $1.1 million, which amount excludes the profit sharing arrangement +described above between the parties. +On June 8, 2023, we entered +into a Loan Agreement (the “Credit Agreement”) with Ault & Company as the lender. The Credit Agreement provided for an +unsecured, non-revolving credit facility in an aggregate principal amount of up to $10,000,000. All loans under the Credit Agreement (collectively, +the “Advances”) were due within five business days after request by Ault & Company and Ault & Company was not obligated +to make any further Advances under the Credit Agreement after December 8, 2023. Advances under the Credit Agreement bore interest at the +rate of 9.5% per annum and may be repaid at any time without penalty or premium. +On June 9, 2023, we entered +into an At-the-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC, as sales agent +(the “Agent”) to sell shares of our common stock having an aggregate offering price of up to $10,000,000 (the “Shares”) +from time to time, through an “at the market offering” (the “ATM Offering”) as defined in Rule 415 under the Securities +Act. On June 9, 2023, we filed a prospectus supplement with the SEC relating to the offer and sale of up to $10.0 million of common stock +in the ATM Offering. The offer and sale of the Shares are being made pursuant to our effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) filed with the SEC on October +29, 2021 and declared effective by the SEC on November 12, 2021. On July 13, 2023 and September 8, 2023, we filed prospectus supplements +increasing the size of the ATM Offering to $20.0 million and $50.0 million, respectively. +On June 26, 2023, we established +a record date for our initial distribution of securities of TurnOnGreen. Stockholders as of this date were entitled to 40 shares of TurnOnGreen +common stock, along with warrants to purchase 40 shares of TurnOnGreen common stock (the “TurnOnGreen Securities”) for every +share of our common stock they held on the record date. The initial distribution was finalized in July 2023. We distributed 58.7 million +TurnOnGreen Securities in the first distribution. +On July 24, 2023, we established +a record date for our second partial distribution of TurnOnGreen Securities. Stockholders as of this date were entitled to 15 shares of +TurnOnGreen Securities for every share of the Company’s common stock they held on the record date. The second distribution was finalized +on August 7, 2023. We distributed 56.4 million TurnOnGreen Securities in the second distribution. +On July 19, 2023 we along +with certain of our subsidiaries entered into a First Amendment and Joinder to Loan and Guarantee Agreement (the “Amendment”) +with the institutional investors pursuant to which the (i) Loan and Guarantee Agreement, dated November 7, 2022, entered into between +us and the institutional investors (the “Loan Agreement”) and (ii) Security Agreement, dated November 7, 2022, entered into +between the institutional investors and Sentinum (the “Security Agreement”) was amended. Pursuant to the Amendment, we borrowed +an additional $8.8 million. The net proceeds of the additional loan amount were $7.5 million. +121 +Effective August 3, 2023, +we and certain holders of preferred stock (the “Investors”) entered into an Exchange Agreement (the “Exchange Agreement”) +pursuant to which the Investors exchanged all of their preferred shares as well as their demand notes (the “Demand Notes”) +issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount of approximately $0.8 +million for two new 10% Secured OID Promissory Notes (the “Exchange Notes”), each with a principal face amount of $5.3 million, +for an aggregate of amount owed of $10.5 million (the “Principal Amount”). We and Milton “Todd” Ault, III, our +Executive Chairman, entered into guaranty agreements with the March 2023 Investors guaranteeing repayment by Ault & Company of the +Exchange Notes. +Effective as of August 3, +2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, +we issued a 10% demand promissory note in the principal face amount of $10.5 million (the “First Ault & Company Demand Note”) +to Ault & Company. +Effective as of August 10, +2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued +a 12% demand promissory note in the principal face amount of $1.1 million (the “Second Demand Note”) to Ault & Company. +On September 8, 2023, we issued +to an accredited investor a term note (the “Short-Term Note”) with a principal face amount of $2,200,000 with a maturity date +of September 25, 2023. The Short-Term Note was issued with an original issue discount of $200,000 and did not bear interest unless an +event of default occurred under the Short-Term Note. The maturity date of the Short-Term Note was September 25, 2023. The purchase price +for the Short-Term Note was $2 million. Repayment of the Short-Term Note was secured by a guaranty provided by Ault & Company as well +as by Milton C. Ault, our Executive Chairman of the Company and the Chief Executive Officer of Ault & Company. +On September 27, 2023 we entered +into a securities exchange agreement with the holder of the Short-Term Note, pursuant to which we issued and sold in a registered direct +offering to the investor, a $2.2 million principal face amount convertible promissory note (the “Convertible Note”). The Convertible +Note bears no interest (unless an event of default occurs) as it was issued in exchange for the Short-Term Note, which contained an original +issue discount. The Convertible Note is convertible into shares of common stock at a conversion price equal to 90% of the lowest volume +weighted average price of the common stock during the five consecutive trading days prior to the date of conversion. +The Short-Term Note will mature +on the Maturity Date, which for purposes of this note means the earlier of (i) +September 28, 2024 or (ii) one (1) month after the date when no more Conversion Shares may be issued by the Company because of the Exchange +Cap (such date, the “ Exchange Cap Acceleration Date ”), provided, however, that this clause (ii) shall not apply so +long as (A) the Company is seeking Stockholder Consent (as defined in the Securities Exchange Agreement) and (B) the Company is in compliance +with all filing and meeting deadlines in connection with the Stockholder and provided, further, however that in the event that in the +event that Stockholder Consent is obtained after the Exchange Cap Acceleration Date but prior to one (1) month thereafter, the Maturity +Date shall remain September 28, 2024. +On October 13, 2023, we entered +into a note purchase agreement with Ault & Company, pursuant to which we sold to Ault & Company (i) a senior secured convertible +promissory note in the principal face amount of $17.5 million (the “Senior Note”) and warrants (the “Warrants”) +to purchase shares of our common stock for a total purchase price of up to $17.5 million (the “Transaction”). +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the loan +agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming +liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares +of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault +& Company to us. +The Senior Note had a principal +face amount of $17.5 million and a maturity date of October 12, 2028. The Senior Note bore interest at the rate of 10% per annum. Interest +was payable, at Ault & Company’s option, in cash or shares of common stock at the applicable conversion price. Accrued interest +was payable on the maturity date, provided, however, that Ault & Company had the option, on not less than 10 calendar days’ +notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. +The Senior Note was convertible +into shares of common stock at a conversion price equal to the greater of (i) $0.10 per share (the “Floor Price”), and (ii) +the lesser of (A) $7.38 or (B) 105% of the volume weighted average price of the common stock during the ten trading days immediately prior +to the date of conversion. The conversion price was subject to adjustment in the event of an issuance of common stock at a price per share +lower than the conversion price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. +The Floor Price shall not be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +122 +The Warrants grant Ault & Company the right to purchase 1.9 million +shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary of the closing date, and become exercisable +on the first business day after the six-month anniversary of the closing date. The exercise price of the Warrants is $0.35, which is subject +to adjustment in the event of customary stock splits, stock dividends, combinations or similar events or in the event of an issuance of +Common Stock at a price per share lower than the exercise price. +In addition, we and various +of our subsidiaries granted Ault & Company a senior security interest in substantially all of our assets as collateral for the repayment +of the Senior Note, which was subordinated to the security interest granted to the holders of the outstanding secured promissory notes. +On November 6, 2023, we entered +into a securities purchase agreement (the “November 2023 SPA”) with Ault & Company, pursuant to which we agreed to sell, +in one or more closings, to Ault & Company up to 50,000 shares of Series C convertible preferred stock and warrants to purchase up +to 14.8 million shares of common stock for a total purchase price of up to $50 million. The consummation of the transactions contemplated +by the November 2023 SPA, specifically the conversion of the Series C convertible preferred stock and the exercise of the warrants in +an aggregate number in excess of 19.99% on the execution date of the November 2023 SPA, are subject to various customary closing conditions +as well as regulatory and stockholder approval. In addition to customary closing conditions, the closing of the financing is also conditioned +upon the receipt by Ault & Company of financing to consummate the transaction. +On November 15, 2023, we purchased +from ROI 603.44 shares of ROI’s newly designated Series D convertible preferred stock (“ROI Series D Preferred”) for +a total purchase price of $15.1 million. The purchase price was paid by the cancellation of $15.1 million of cash advances made by us +to ROI between January 1, 2023 and November 9, 2023. Each share of ROI Series D Preferred has a stated value of $25,000 per share and +each share of ROI Series D Preferred is convertible into a number of shares of ROI’s common stock determined by dividing the stated +value by $0.51, subject to adjustment in the event of an issuance of ROI common stock at a price per share lower than the conversion price, +as well as upon customary stock splits, stock dividends, combinations or similar events. The ROI Series D Preferred holders are entitled +to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. In addition, for as long as at least 25% of the +ROI Series D Preferred remain outstanding, ROI must obtain our consent with respect to certain corporate events, including reclassifications, +fundamental transactions, stock redemptions or repurchases, increases in the number of directors, and declarations or payment of dividends, +and further ROI is subject to certain negative covenants, including covenants against issuing additional shares of capital stock or derivative +securities, incurring indebtedness, engaging in related party transactions, selling of properties having a value of over $50,000, altering +the number of directors, and discontinuing the business of any subsidiary, subject to certain exceptions and limitations. However, pending +approval of the transaction by ROI’s shareholders, the ROI Series D Preferred is subject to a 19.99% beneficial ownership limitation. +On December 8, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series B convertible preferred stock +which, effective upon filing, eliminated the Series B convertible preferred stock. +On December 14, 2023, pursuant +to the November 2023 SPA entered into with Ault & Company on November 6, 2023, we sold to Ault & Company, in three separate closings +that occurred on the closing date, an aggregate of 41,500 shares of Series C convertible preferred stock (the “Series C Convertible +Preferred Stock”), and warrants (the “Series C Warrants”) to purchase 12.3 million shares of common stock, for a total +purchase price of $41.5 million. At the first closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred Stock +and Series C Warrants to purchase 6.3 million shares of common stock, for a purchase price of $21.5 million, paid in cash (the “Initial +Closing”). Immediately upon the Initial Closing, we paid $20.4 million to satisfy in full the outstanding secured convertible notes +issued to the lenders pursuant to the Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +second closing (the “Second Closing”), Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock +and Series C Warrants to purchase 3.0 million shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately +upon the Second Closing, we paid $10.0 million to partially satisfy the outstanding Senior Note. Promptly thereafter, at the third closing +(the “Third Closing”), Ault & Company purchased another 10,000 shares of Series C Convertible Preferred Stock and Series +C Warrants to purchase another 3.0 million shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon +the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance on the outstanding Senior Note. +123 +On December 14, 2023, we, along with our wholly owned subsidiaries +Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending, Ault Aviation and AGREE (collectively with our company, Sentinum, Third Avenue, +ACS, BNI Montana, Ault Lending and Ault Aviation, the “Guarantors”) entered into a Loan and Guaranty Agreement (the “Loan +Agreement”) with institutional lenders, pursuant to which Ault & Company borrowed $36 million and issued secured promissory +notes to the lenders in the aggregate amount of $38.9 million (collectively, the “Secured Notes”; and the transaction, the +“Loan”). The Loan Agreement was amended on April 15, 2024. +Pursuant to the Loan Agreement, the Guarantors, as well as Milton C. +Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to act as guarantors for repayment of +the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in support of the guarantee of the Secured +Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the Lenders a security interest in (a) 19,226 +Antminers (the “Miners”), (b) all of the digital currency mined or otherwise generated from the Miners and (c) the membership +interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those entities granted +to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault Aviation, AGREE, +Sentinum, Third Avenue, Ault Energy, ADTC, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue on the +real estate property owned by Third Avenue in St. Petersburg, Florida (the “Florida Property”), (iv) a future advance mortgage +by ACS on the real estate property owned by ACS in Dowagiac, Michigan (the “Michigan Property”), (v) an aircraft mortgage +and security agreement by Ault Aviation on a private aircraft owned by Ault Aviation (the “Aircraft”), and (vi) deposit account +control agreements over certain bank accounts held by certain of our subsidiaries. +In addition, pursuant to the Loan Agreement, we agreed to establish +a segregated deposit account (the “Segregated Account”), which would be used as a further guarantee of repayment of the Secured +Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. We are required to have the minimum balance in the +Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and +two-year anniversaries of the closing date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million +monthly into the Segregated Account, which increases to $400,000 monthly starting March 31, 2025. Further, we agreed to deposit into the +Segregated Account, (i) up to the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, the +Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on a +per dividend basis) received from Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, +which shall not exceed $9 million in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans +or other investments made by Ault Lending (including but not limited to sales of loans or investments, dividends, interest payments and +amortization payments), which shall not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further +agreed to deposit funds into the Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida +Property, (ii) $11 million from the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, +subject to a de minimis threshold of $1 million, and (v) $10 million from the sale of Circle 8. +On January 12, 2024, pursuant +to the approval provided by our stockholders at the annual meeting of stockholders, we filed an Amendment to our Certificate of Incorporation +with the State of Delaware to effectuate a reverse stock split of our common stock affecting both the authorized and issued and outstanding +number of such shares by a ratio of one-for-twenty-five. The reverse stock split became effective on January 16, 2024. All share amounts +in this Annual Report have been updated to reflect the reverse stock split. +On January 31, 2024, Ault +Lending entered into a securities purchase agreement with Alzamend (the “January 2024 SPA”), pursuant to which Alzamend agreed +to sell, in one or more closings, to Ault Lending up to 6,000 shares of Series B convertible preferred stock (the “ALZN Series B +Preferred”) and warrants to purchase up to 6.0 million shares of Alzamend common stock (the “ALZN Series B Warrants”) +for a total purchase price of up to $6.0 million. On January 31, 2024, Ault Lending purchased 1,220 +shares of ALZN Series B Preferred and warrants to purchase 1.22 million shares for a total purchase price of $1.22 million. The purchase +price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend between November 9, 2023 and January +31, 2023. E ach share of ALZN Series B Preferred has a stated value of $1.00 per share and is convertible into a number of shares +of Alzamend’s common stock determined by dividing the stated value by $1.00, subject to adjustment in the event of an issuance of +Alzamend common stock at a price per share lower than the conversion price, as well as upon customary stock splits, stock dividends, combinations +or similar events. The ALZN Series B Warrants are exercisable +on the first business day after the six-month anniversary of issuance and have a five-year term, expiring on the fifth anniversary of +the initial exercise date. The exercise price of the ALZN Series B Warrants is $1.20, subject +to adjustment in the event of an issuance of Alzamend common stock at a price per share lower than the conversion price, as well as upon +customary stock splits, stock dividends, combinations or similar events. +On each of March 7, 2024, +March 8, 2024, March 18, 2024 and March 19, 2024, pursuant to the November 2023 SPA, we sold to Ault & Company 500 +shares of Series C Convertible Preferred Stock and Series C Warrants to +purchase 147,820 shares of common stock to the Purchaser, for a purchase price of $0.5 million. As +of April 15, 2024, Ault & Company has purchased an aggregate of 43,500 shares of Series C Convertible Preferred Stock and Series C +Warrants to purchase an aggregate of 12.9 million shares of common stock, for an aggregate purchase price of $43.5 million. +124 +On +March 11, 2024 we entered into a note purchase agreement (the “Purchase Agreement”) with two institutional investors (the +“Buyers”) pursuant to which the Buyers purchased from the Company, on March 12, 2024 in a registered direct offering to the +Buyers an aggregate of $2.0 million principal face amount convertible promissory notes (the “Notes”). The Notes were sold +to the Buyers for an aggregate purchase price of $1.8 million, which reflects an original issue discount of $0.2 million. The Notes accrue +interest at the rate of 6% per annum, unless an event of default (as defined in the Notes) occurs, at which time the Notes would accrue +interest at 12% per annum. The Notes will mature on June 12, 2024, provided, however, that we have the right, upon written notice to the +Buyers, to extend the maturity date to September 12, 2024, for which we would increase the principal amount of the Notes then outstanding +by 5%. The Notes are convertible into shares of common stock at a conversion price of $0.35 per share. +On March 26, 2024, pursuant +to the January 2024 SPA, Ault Lending purchased 780 shares of ALZN Series B Preferred Stock +and ALZN Series B Warrants to purchase 0.8 million +shares of Alzamend common , for a purchase price of $0.8 million. As of April 15, +2024, Ault Lending has purchased an aggregate of 2,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to +purchase an aggregate of 2.0 million shares of Alzamend common stock, for an aggregate purchase price of $2.0 million. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +warrants (the “Series C Warrants”), to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred +Stock that Ault & Company may purchase from us from $50.0 million to $75.0 million and (B) extended the date of on which the final +closing may occur to June 30, 2024, subject to Ault & Company’s ability to further extended such date for ninety days. +Presentation +of AGREE as Discontinued Operations +In September 2023, we committed +to a plan for our wholly owned subsidiary AGREE to list for sale its four recently renovated Midwest hotels, the Hilton Garden Inn in +Madison West, the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford. The decision to +sell the hotels follows the decision to also list the multifamily development site in St. Petersburg, Florida and is driven by our desire +to focus on our core businesses, Energy, Fintech and Sentinum. We plan to use the proceeds from +the sales of the hotel properties to pay off debt and commit more capital to our core businesses. Our real estate properties, which +include both hotels and land, are currently listed for sale. +In connection with the planned +sale of AGREE’s assets, we concluded that the net assets of AGREE met the criteria for classification as held for sale. In addition, +the proposed sale represents a strategic shift that will have a major effect on our operations and financial results. As a result, we +have presented the results of operations, cash flows and financial position of AGREE as discontinued operations in the accompanying consolidated +financial statements and notes for all periods presented. +Our Corporate Structure +Our common stock is traded +on the NYSE American under the symbol “AULT.” +Our corporate structure is +currently as follows: +125 +General +As a holding company, our +business objective is designed to increase stockholder value. Under the strategy we have adopted, we are focused on managing and financially +supporting our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value +returned to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual +partner companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as +well as other opportunities to maximize stockholder value. We anticipate returning value to stockholders after satisfying our debt obligations +and working capital needs. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary or partner company’s further growth and development can best be +supported by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek +to sell or dispose of some or all of our position in the subsidiary or partner company. These sales or dispositions may take the form +of privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities, dividends and, in the case of publicly traded partner companies, sales of their securities in the open market. Our plans may +include taking subsidiaries or partner companies public through rights offerings and directed share subscription programs. We will continue +to consider these (or similar) initiatives and the sale of certain subsidiary or partner company interests in secondary market transactions +to maximize value for our stockholders. +In recent years, we have provided +capital and relevant expertise to fuel the growth of businesses in metaverse platform, oil exploration, crane services, defense/aerospace, +industrial, automotive, medical/biopharma, consumer electronics and textiles. We have provided capital to subsidiaries as well as partner +companies in which we have an equity interest or may be actively involved, influencing development through board representation and management +support. +We are a Delaware corporation +with our corporate office located at 11411 Southern Highlands Pkwy, Suite 240, Las Vegas, NV 89141. Our phone number is 949-444-5464 and +our website address is www.ault.com. +126 +Results of Operations +Results of Operations for the Years ended December 31, 2023 and +2022 +The following table summarizes +the results of our operations for the years ended December 31, 2023 and 2022. +For the Year Ended December 31, +2023 +2022 +Revenue +$ 76,137,000 +$ 61,561,000 +Revenue, digital currencies mining +33,107,000 +16,693,000 +Revenue, crane operations +49,198,000 +2,739,000 +Revenue, lending and trading activities +(1,998,000 ) +36,644,000 +Total revenue +156,444,000 +117,637,000 +Cost of revenue, products +57,788,000 +44,508,000 +Cost of revenue, digital currencies mining +36,446,000 +21,508,000 +Cost of revenue, crane operations +29,971,000 +940,000 +Cost of revenue, lending and trading activities +1,180,000 +- +Total cost of revenue +125,385,000 +66,956,000 +Gross profit +31,059,000 +50,681,000 +Total operating expenses +184,780,000 +190,158,000 +Loss from operations +(153,721,000 ) +(139,477,000 ) +Other income (expense): +Interest and other income +5,294,000 +2,594,000 +Interest expense +(36,595,000 ) +(37,342,000 ) +Interest expense +(664,000 ) +- +Other expense, guarantee +(35,400,000 ) +- +Loss on extinguishment of debt +(8,719,000 ) +- +Loss on extinguishment of debt, related party +(4,164,000 ) +- +Loss from investment in unconsolidated entity +(302,000 ) +(924,000 ) +Loss on deconsolidation of subsidiary +(3,040,000 ) +- +Impairment of equity securities +(9,555,000 ) +(11,500,000 ) +Gain from bargain purchase of business +- +806,000 +Gain on the sale of fixed assets +2,069,000 +- +Change in fair value of warrant and derivative liabilities +4,544,000 +(2,280,000 ) +Total other expense, net +(86,532,000 ) +(48,946,000 ) +Loss before income taxes +(240,253,000 ) +(188,423,000 ) +Income tax (benefit) provision +337,000 +(4,485,000 ) +Net loss from continuing operations +(240,590,000 ) +(183,938,000 ) +Net loss from discontinued operations +(15,704,000 ) +(5,895,000 ) +Net loss +(256,294,000 ) +(189,833,000 ) +Net loss attributable to non-controlling interest +25,268,000 +8,017,000 +Net loss attributable to Ault Alliance, Inc. +(231,026,000 ) +(181,816,000 ) +Preferred dividends +(1,375,000 ) +(393,000 ) +Net loss available to common stockholders +$ (232,401,000 ) +$ (182,209,000 ) +Comprehensive loss +Net loss available to common stockholders +$ (232,401,000 ) +$ (182,209,000 ) +Other comprehensive loss +Foreign currency translation adjustment +(997,000 ) +(995,000 ) +Other comprehensive loss +(997,000 ) +(995,000 ) +Total comprehensive loss +$ (233,398,000 ) +$ (183,204,000 ) +127 +Revenues +Revenues by segment for the +years ended December 31, 2023 and 2022 were as follows: +For the Year Ended December 31, +Increase +2023 +2022 +(Decrease) +% +Sentinum +Revenue, digital currencies mining +$ 33,107,000 +$ 16,693,000 +$ 16,414,000 +98 % +Revenue, commercial real estate leases +1,416,000 +1,105,000 +311,000 +28 % +Energy +Revenue, crane operations +49,198,000 +2,739,000 +46,459,000 +1696 % +Other +899,000 +216,000 +683,000 +316 % +Fintech: +Revenue, lending and trading activities +(1,998,000 ) +36,644,000 +(38,642,000 ) +-105 % +Other +- +239,000 +(239,000 ) +-100 % +GIGA +37,759,000 +30,255,000 +7,504,000 +25 % +SMC +32,357,000 +24,224,000 +7,333,000 +30 % +TurnOnGreen +4,201,000 +5,522,000 +(1,321,000 ) +-24 % +ROI +305,000 +- +- +Total revenue +$ 156,444,000 +$ 117,637,000 +$ 38,502,000 +33 % +Our revenues increased by +$38.5 million, or 33%, to $156.4 million for the year ended December 31, 2023, from $117.6 million for the year ended December 31, +2022. +Sentinum +Revenues from Sentinum’s +digital currencies mining operations increased $16.4 million as a result of our increased digital currencies mining activities from the +prior period and a 2% higher average Bitcoin price, partially offset by a 72% increase in average Bitcoin mining difficulty level in the +current year period. +Energy +Energy revenues increased +by $47.1 million primarily due to the acquisition of Circle 8 in December 2022. +Fintech +Revenues from our lending +and trading activities were negative for the year ended December 31, 2023, due to a $6.2 million impairment related to investments in +equity securities, a $5.6 million unrealized loss from our investment in Alzamend and a $1.2 million negative adjustment to dividend income, +partially offset by $11.0 million of realized and unrealized losses from our investment portfolio. During the year ended December 31, +2022, Ault Lending generated income from realized gains from investments in marketable securities as well as shares of common stock underlying +equity securities issued to Ault Lending in certain financing transactions. Ault Lending also generates revenue through origination fees +charged to borrowers and interest generated from each loan. +Revenues +from our trading activities for the year ended December 31, 2023 included net losses on equity securities, including unrealized gains +and losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in our periodic +earnings. +GIGA +The $7.5 million increase +in our GIGA segment revenue for the year ended December 31, 2023 included $2.6 million attributable to our acquisition of Giga-tronics +Incorporated on September 8, 2022. Continued conflicts and tensions worldwide are driving defense-related investments in force protection +technologies at GIGA across the United States, UK, Europe, Asia, and the Middle East. Additionally, demand for key electronics solutions, +particularly for customers in medicine and telecommunications, accelerated in the year ended December 31, 2023. +128 +SMC +SMC revenues increased by +$7.3 million. Due to the acquisition of SMC in June 2022, we recorded approximately six months of SMC revenue for the year ended December +31, 2022. On November 20, 2023, SMC entered into an agreement to sell 2.2 million shares of its +common stock for $2.0 million to two affiliates of SMC, both of which are existing shareholders with representation on the board of directors +of SMC. As a result of the transaction, our share ownership of SMC was diluted to approximately 28%. Due to the significant change +in our ownership and voting rights, we determined that we no longer met the criteria of the primary beneficiary of SMC and, accordingly, +we deconsolidated SMC as of November 20, 2023. As a result of the deconsolidation, we recorded approximately 11 months of SMC revenue +for the year ended December 31, 2023. The increase in SMC revenue is primarily due to the increase in the number of months consolidated +for the year ended December 31, 2023 compared to the year ended December 31, 2022, partially offset by an overall decrease in SMC revenue +for the full year ended December 31, 2023 compared to the full year ended December 31, 2022. +TurnOnGreen +TurnOnGreen revenues were +down $1.3 million for the year ended December 31, 2023, compared to the year ended December 31, 2022 due to the cancellation of large +projects that contributed to revenue in 2022. +Gross Margins +Gross margins decreased to +20% for the year ended December 31, 2023, compared to 43% for the year ended December 31, 2022. Our gross margins of 20% recognized during +the year ended December 31, 2023 were impacted by negative margins from our Sentinum digital currencies mining segment due to the increase +in Bitcoin mining difficulty level, in addition to negative margins from our lending and trading activities as compared to other segments. +Excluding the effects of margin from our lending and trading activities and digital currencies mining operations, our adjusted gross margins +for the year ended December 31, 2023 and 2022 would have been 30% and 29%, respectively. +Research and Development +Research and development expenses +increased by $4.5 million for the year ended December 31, 2023, primarily due to expenditures related to development work on ROI’s +BitNile metaverse platform. +Selling and Marketing +Selling and marketing expenses +were $33.5 million for the year ended December 31, 2023, compared to $29.4 million for the year ended December 31, 2022, an increase of +$4.2 million, or 14%. The increase was the result of $5.7 million higher advertising and promotion costs related to ROI’s BitNile +metaverse platform and $0.7 million higher travel expenditures, partially offset by a $2.2 million decline in employee related costs and +consulting expenses. +General and Administrative +General and administrative +expenses were $77.8 million for the year ended December 31, 2023, compared to $60.3 million for the year ended December 31, 2022, +an increase of $17.5 million, or 29%. General and administrative expenses increased from the comparative prior period, mainly due to increases +from new acquisitions and higher cost from our use of the corporate aircraft: +· general and administrative costs of $10.4 million from Circle 8, which was acquired in December 2022; +· general and administrative costs of $7.5 million from ROI, which was acquired in March 2023; +· general and administrative costs of $6.1 million from SMC, which was acquired in June 2022; +· general and administrative costs of $4.4 million from GIGA, which was acquired in September 2022; +· general and administrative costs of $1.2 million from AVLP, which was acquired in June 2022; and +· $4.4 million costs, including $1.9 million depreciation expense, related to our use of the corporate aircraft. +The increases above were partially offset by the +following decreases in general and administrative expenses: +· $8.4 million lower performance bonus related to 2022 realized gains on trading activities; +· $4.5 million lower corporate legal fees; and +· $3.6 million lower costs related to our Michigan data center due to higher utilization of the facilities +by Sentinum and lower maintenance and repairs costs. +129 +Impairment of Goodwill and Intangible Assets +Impairment of Intangible Assets +During +the year ended December 31, 2023, we recognized $24.7 million and $1.5 million impairment of intangible assets related to AVLP and +Microphase, respectively. During the year ended December 31, 2022, we recognized no impairment of intangible assets. +Impairment of AVLP Goodwill +We test the recorded amount +of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount of the +goodwill exceeds its carried value. We performed a goodwill impairment test as of June 30, 2023 related to AVLP as there were indicators +of impairment related to certain unforeseen business developments and changes in financial projections. +The valuation of the AVLP +reporting unit was determined using a market and income approach methodology of valuation. The income approach was based on the projected +cash flows discounted to their present value using discount rates, that in our judgment, consider the timing and risk of the forecasted +cash flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated +value of a market participant’s cost of capital and debt, derived using customary market metrics. The analysis included assumptions +regarding AVLP’s revenue forecast and discount rates of 26.7% using a weighted average cost of capital analysis. The market approach +utilized the guideline public company method. +The results of the quantitative +test indicated the fair value of the AVLP reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $18.6 million carrying amount of AVLP’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2023. +Impairment of Microphase Goodwill +During the fourth quarter +of 2023, Microphase experienced a significant decline in sales and, as a result, we performed a goodwill impairment test as of December +31, 2023. +The valuation of Microphase +was determined using an income approach methodology of valuation. The income approach is based on the projected cash flows discounted +to their present value using discount rates, that in our judgment, consider the timing and risk of the forecasted cash flows using internally +developed forecasts and assumptions. The market approach was also considered; however, the income approach was chosen as we determined +it was a better representation of Microphase’s projected long-term performance. +The results of the quantitative +test indicated the fair value of the Microphase reporting unit did not exceed its carrying amounts, including goodwill, in excess of the +carrying value of the goodwill. As a result, the entire $3.2 million carrying amount of Microphase’s goodwill was recognized as +a non-cash impairment charge during the year ended December 31, 2023. +Impairment of SMC Goodwill +During the fourth quarter +of 2022, SMC experienced adverse changes in business climate, a significant decline in sales and a drop in the trading price of its common +stock. +Due to these factors, we determined +that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, 2022. The valuation +of the SMC reporting units was determined using a market approach with observable inputs, primarily based on the trading price of SMC’s +common stock plus an estimated control premium of approximately 20%. +The results of the quantitative +test indicated the fair value of the SMC reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $3.2 million carrying amount of SMC’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +130 +Impairment of GIGA Goodwill +During the fourth quarter +of 2022, GIGA experienced a significant decline in sales and a drop in the trading price of its common stock. +Due to these factors, we determined +that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, 2022. The valuation +of the GIGA reporting units was determined using an income approach methodology of valuation. +The income approach is based +on the projected cash flows discounted to their present value using discount rates that in our judgment consider the timing and risk of +the forecasted cash flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the +average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. Other significant +assumptions include revenue growth rates, profitability projections, and terminal value growth rates. The market approach was also considered; +however, the income approach was chosen as the Company determined it is a better representation of GIGA’s projected long-term performance. +The results of the quantitative +test indicated the fair value of the GIGA reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $9.9 million carrying amount of GIGA’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +Impairment of Deposit due to Vendor Bankruptcy +Filing +On September 22, 2022, Compute +North filed for bankruptcy protection. We had a deposit of approximately $2.0 million with Compute North for services yet to be performed +by Compute North. We assessed this financial exposure and recorded an impairment of the deposit totaling $2.0 million during the +year ended December 31, 2022. +Impairment of Property and Equipment +During the year ended December +31, 2023, certain unforeseen business developments and changes in financial projections at AVLP indicated that an impairment triggering +event had occurred. Testing performed indicated the estimated fair value of AVLP property and equipment as of December 31, 2023 was $0, +and an impairment charge of $14.0 million was recognized. During the year ended December 31, 2023, we recognized an impairment charge +of $3.9 million related to property and equipment at ROI. +During the year ended December +31, 2022, adverse changes in business climate, including a decrease in the price of Bitcoin and resulting decrease in the market price +of miners, indicated that an impairment triggering event had occurred. Testing performed indicated the estimated fair value of our miners +to be less than their net carrying value as of December 31, 2022, and an impairment charge of $79.6 million was recognized, decreasing +the net carrying value of our Bitcoin mining equipment to their estimated fair value. +Impairment of Mined Digital Currencies +Impairment of mined digital +currencies for the years ended December 31, 2023 and 2022 was $0.5 million and $3.1 million, respectively. Impairment losses are attributable +to the volatility of the Bitcoin market when market price of Bitcoin drops below our carrying value within the respective periods. The +impairment of mined cryptocurrency for the year ended December 31, 2023 is lower than the comparable prior year period as the average +amount of digital currency held decreased during 2023 as we generally sold our mined digital currency the next business day. +Other Expense, Net +Other expense, net was $86.5 million for the year ended December 31, +2023, compared to $48.9 million for the year ended December 31, 2022. +Interest and other income was $5.3 million for the year ended December +31, 2023, compared to $2.6 million for the year ended December 31, 2022. The increase in interest and other income is primarily due to +higher interest rates resulting in higher income from ADRT’s cash and marketable securities held in the trust account, partially +offset by lower cash and marketable securities held in the trust account as a result of redemptions that occurred in June 2023. +131 +Interest expense was $36.6 million for the year ended December 31, +2023, compared to $37.3 million for the year ended December 31, 2022. Interest expense for the year ended December 31, 2023 included amortization +of debt discount of $21.5 million, contractual interest of $9.6 million, and forbearance and extension fees of $5.5 million. Interest +expense for the year ended December 31, 2022 related primarily to amortization of debt discount of $29.1 million, contractual interest +of $6.8 million, and forbearance and extension fees of $1.5 million. +Interest expense, related party +was $0.7 million for the year ended December 31, 2023, compared to $0 for the year ended December 31, 2022. Interest expense for the year +ended December 31, 2023 related primarily to interest expense from the related party convertible note with Ault & Company. +Other expense, guarantee was +$35.4 million for the year ended December 31, 2023, compared to $0 for the year ended December 31, 2022. Pursuant to our financial guarantee +obligation related to our December 2023 issuance of Series C preferred stock, related party we recorded a guarantee liability of $38.9 +million using the practical expedient to fair value as set forth in ASC 460-10-30-2(a) and recorded other expense, guarantee of $35.4 +million (the amount of the guarantee liability, less $3.5 million restricted cash related to the guarantee obligation). +Loss on extinguishment of debt was $8.7 million for the year ended +December 31, 2023. Approximately $3.6 million of loss on extinguishment of debt related to the December 2023 AAI exchange of notes payable +for preferred stock, related party. Approximately $1.4 million of the loss on extinguishment of debt related to an October 2023 GIGA exchange +and waiver agreement related to its senior secured convertible promissory notes. Approximately $2.0 million of the loss on extinguishment +related to the April 2023 restructuring of an AAI note payable. Approximately $1.5 million of the loss on extinguishment of debt related +to the August 2023 exchange of AAI preferred stock liabilities for secured notes. +Loss on extinguishment of debt, +related party was $4.2 million for the year ended December 31, 2023 related to the October 2023 AAI exchange of convertible notes, related +party for preferred stock, related party. +Loss from investment in unconsolidated +entity was $0.3 million for the year ended December 31, 2023, representing our share of losses from our equity method investment in SMC, +subsequent to the November 2023 deconsolidation. Loss from investment in unconsolidated entity was $0.9 million for the year ended December +31, 2022, representing our share of losses from our equity method investment in AVLP prior to the June 2022 acquisition. +Cumulative downward adjustments +for impairments for our equity securities without readily determinable fair values held at December 31, 2023 were $9.6 million. +Income Tax Provision +Provision for income taxes +was $0.3 million during the year ended December 31, 2023 compared to a benefit of $4.4 million during the year ended December 31, 2022. +The effective income tax provision rate was 0.1% for the year ended December 31, 2023 as compared to a benefit of 2.4% for the year ended +December 31, 2022. The Company’s 2022 tax benefit included a $5.0 million tax benefit to reduce the Company’s valuation allowance +related to establishing a deferred tax liability from AVLP acquisition accounting. +Liquidity and Capital Resources +On December 31, 2023, excluding +cash and cash equivalents from discontinued operations, we had cash and cash equivalents of $8.6 million (excluding restricted cash of +$5.0 million), compared to cash and cash equivalents of $7.9 million (excluding restricted cash of $0.7 million) at December 31, 2022. +The increase in cash and cash equivalents was primarily due to cash provided by financing activities related to the sale of common and +preferred stock, as well as proceeds from notes and convertible notes partially offset by cash used in operating activities, the payment +of debt, purchases of property and equipment and investments in equity securities. +Net cash used in operating +activities totaled $5.4 million for the year ended December 31, 2023, compared to net cash provided by operating activities of $26.5 million +for the year ended December 31, 2022. Cash used in operating activities for the year ended December 31, 2023 included $71.2 million net +cash provided by marketable equity securities from trading activities related to the operations of Ault Lending and $29.1 million proceeds +from the sale of digital currencies from our Sentinum Bitcoin mining operations, offset by operating losses and changes in working capital. +Net cash used in operating activities for the year ended December 31, 2023 included $4.6 million cash used in operating activities from +discontinued operations. +132 +Net cash used in investing +activities was $29.5 million for the year ended December 31, 2023, compared to $158.6 million for the year ended December 31, 2022, which +included $99.3 million of capital expenditures, primarily for Bitcoin mining equipment. Net cash used in investing activities for the +year ended December 31, 2023 was primarily related to $8.7 million purchase of property and equipment, the $11.0 million purchase of equity +securities, and the $6.3 million decrease in cash from the deconsolidation of SMC, partially offset by proceeds from the sale of fixed +assets of $4.5 million. Net cash used in investing activities for the year ended December 31, 2023 included $6.3 million cash used in +investing activities from discontinued operations. +Net cash provided by financing +activities was $37.0 million for the year ended December 31, 2023, compared to net cash provided by financing activities of $124.1 million +for the year ended December 31, 2022, and primarily reflects the following transactions: +· 2022 Common ATM Offering – During the year ended December 31, 2023, we sold an aggregate +of 4,268 shares of common stock pursuant to the 2022 Common ATM Offering for gross proceeds of $4.2 million and effective March 17, 2023, +the 2022 Common ATM Offering was terminated; +· 2022 Preferred ATM Offering – During the year ended December 31, 2023, we sold an aggregate +of 252,359 shares of Series D Preferred Stock pursuant to the 2022 Preferred ATM Offering for gross proceeds of $3.0 million and effective +June 16, 2023, the 2022 Preferred ATM Offering was terminated; +· 2023 Common ATM Offering –On June 9, 2023, we entered into the 2023 Common ATM Offering with +Ascendiant Capital. During the year ended December 31, 2023, we sold an aggregate of 4.3 million shares of common stock pursuant to the +2023 Common ATM Offering for gross proceeds of $35.3 million; +· $65.0 million payments on notes payable, partially offset by $38.8 million proceeds from notes payable; +· $7.3 million proceeds from subsidiaries’ sale of stock to non-controlling interests; +· $5.2 million proceeds from convertible notes payable, partially offset by $1.0 million payments on convertible +notes payable; +· $4.6 million proceeds from convertible notes payable, related party, partially offset by $0.2 million +payments on convertible notes payable, related party; and +· $3.8 million net proceeds from sales of Series C preferred stock, related party. +Net cash provided by +financing activities for the year ended December 31, 2023 included $5.2 million cash provided by financing activities from +discontinued operations. +Financing Transactions Subsequent to December +31, 2023 +Financing transactions subsequent +to December 31, 2023 include the following: +2023 Common ATM Offering +During the period between +January 1, 2024 through March 13, 2024, we sold an aggregate of 25.6 million shares of common stock pursuant to the 2023 Common ATM Offering +for gross proceeds of $14.6 million and effective March 14, 2024, the 2023 Common ATM Offering was terminated. +6% Convertible Promissory +Notes +On March 11, 2024, we entered into a note purchase agreement with two +institutional investors pursuant to which we sold in a registered direct offering to the investors an aggregate of $2.0 million convertible +promissory notes, bearing interest of 6%. The convertible promissory notes were issued at a discount, with net proceeds to us of $1.8 +million. The convertible promissory notes are scheduled to mature June 12, 2024, we have the option to extend the maturity date to September +12, 2024, for which we will increase the principal amount of the convertible promissory notes by 5%. The convertible promissory notes +are convertible into shares of common stock at a conversion price of $0.35 per share. As of April 15, 2024, none of the convertible promissory +notes have been converted into shares of common stock. +133 +Additional Closings +of Series C Preferred Stock, Related Party +On each +of March 7, 2024, March 8, 2024 , March 18, 2024 and March 19, 2024, pursuant to the November 2023 SPA entered into with Ault & +Company on November 6, 2023, we sold to Ault & Company 500 shares of Series C preferred stock and warrants to purchase 147,820 shares +of common stock, for a total purchase price of $0.5 million. As of April 15, 2024, Ault & Company has purchased an aggregate of 43,500 +shares of Series C preferred stock and warrants to purchase an aggregate of 12,860,311 shares of common stock, for an aggregate purchase +price of $43.5 million. The November 2023 SPA provides that Ault & Company may purchase up to $75.0 million of Series C preferred +stock and warrants in one or more closings. +Amendment to the November 2023 +SPA +On March 25, +2024, the November 2023 SPA entered into with Ault & Company was amended to increase the amount of Series C Convertible Preferred +Stock and Series C Warrants that may be purchase under the agreement from $50.0 million to $75.0 million and an extension of the date +to closing the final tranche of the financing to June 30, 2024. +Critical Accounting Estimates +We have the following critical +accounting estimates: +· We review and evaluate the net carrying value of our long-lived assets for impairment upon the +occurrence of events or changes in circumstances that indicate that the related carrying amounts may not be recoverable. A test for +recoverability is performed based on the estimated undiscounted future cash flows that will be generated from operations and the +estimated salvage value of assets. There are many assumptions underlying future cash flows that are subject to significant risks and +uncertainties, which include the estimated value of the assets. We review our business and operations for indications of impairment +and, when indications are present, perform an impairment test. We involve a third-party expert when needed. However, it is possible +that changes could occur in the near term that could adversely affect the estimate of future cash flows and salvage values to be +generated from operating assets resulting in an impairment loss. +· Goodwill and indefinite-lived intangible asset impairment reviews include determining the estimated fair +values of our reporting units and of indefinite-lived intangible assets. Several methods may be used to estimate fair values, including +market quotations, multiples of earnings and other valuation techniques. We primarily use discounted projected future earnings or cash +flow methods in determining fair values. The key assumptions and inputs used in such determinations may include forecasting revenues and +expenses, cash flows and capital expenditures, as well as an appropriate discount rate and other inputs. Significant judgment by management +is required in estimating the fair value of a reporting unit and in performing impairment reviews. Due to the inherent subjectivity and +uncertainty in forecasting future cash flows and earnings over long periods of time, actual results may differ materially from the forecasts. +If the carrying value of a reporting unit exceeds the estimated fair value of the reporting unit, then the excess, limited to the carrying +amount of goodwill, is charged to earnings as an impairment loss. If the carrying value of the indefinite-lived intangible asset exceeds +fair value, the excess is charged to earnings as an impairment loss. +· On an ongoing basis, we evaluate our estimates and judgments, including those related to fair value of +financial instruments. We base our estimates on known trends and events and various other factors that we believe to be reasonable under +the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are +not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller reporting +company, this section is not applicable. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements required +by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not required to provide +supplementary financial information. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable. +134 +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2023, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company’s management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules +13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our +disclosure controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance +of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with +generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2023. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2023, our internal control over financial reporting was not effective. +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting department, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting, related party transactions, fair value estimates and analysis of financial instruments for proper classification in the consolidated +financial statements, in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +135 +3. Our primary user access controls (i.e., provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +4. The Company did not design and/or implement user access controls to ensure appropriate segregation of +duties or program change management controls for certain financially relevant systems impacting the Company’s processes around revenue +recognition and digital assets to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, and (iii) underlying accounting records, are identified, tested, authorized and implemented appropriately +to validate that data produced by its relevant IT system(s) were complete and accurate. Automated process-level controls and manual controls +that are dependent upon the information derived from such financially relevant systems were also determined to be ineffective as a result +of such deficiency. In addition, the Company has not effectively designed a manual key control to detect material misstatements in revenue. +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis: +· Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls; +· Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· Continuing to increase headcount across the Company, with a particular focus on hiring individuals with +strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Control over Financial Reporting +During the most recent fiscal +quarter in 2023, there were no significant changes in our internal control over financial reporting (as such term is defined in Rules +13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal +control over financial reporting. +136 +ITEM 9B. OTHER +INFORMATION +Trading Plans +During the three months ended +December 31, 2023, no director or Section 16 officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” +or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K. +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +Not applicable. +137 +PART III +ITEM 10. DIRECTORS, +EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The following table sets forth +the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. Ault, III (1) +54 +Executive Chairman of the Board +2017 +William B. Horne (1) +55 +Chief Executive Officer, Vice Chairman and Director +2016 +Henry Nisser (1) +55 +President, General Counsel and Director +2019 +Kenneth S. Cragun (1) +63 +Chief Financial Officer +2020 +Robert O. Smith +79 +Lead Independent Director +2016 +Moti Rosenberg +76 +Director +2015 +Jeffrey A. Bentz +64 +Director +2018 +Howard Ash +64 +Director +2020 +(1) Executive Officer. +Each of the directors named +above will serve until the next annual meeting of our stockholders or until his respective successor is elected and qualified. Subject +to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Milton C. (Todd) Ault, +III has served as our Executive Chairman since January 2021. Between December 2017 and January +2021, Mr. Ault was our Chief Executive Officer and between March 2017 and December 2017, Mr. Ault served as our Executive Chairman. Mr. +Ault has served as a director of Alzamend since January 2024. Mr. Ault is Alzamend’s founder +and served as Chairman of the Board and a director from inception in 2016 until its initial public offering in June 2021. Mr. Ault has +served as the Chairman of the Board of Ault Disruptive since its inception in February 2021. Since January 2024, Mr. Ault has served as +the Chairman of the Board and Chief Executive Officer of ROI . Since April 2023, Mr. Ault +has served as the Executive Chairman of the Board of the MICS . Mr. Ault has served as Chairman +of the Board and Chief Executive Officer of Ault & Company since December 2015, and as +Chairman of the Board of Avalanche since September 2014. Since January 2011, Mr. Ault has +been the Vice President of Business Development for MCKEA Holdings, LLC, a family office. Mr. Ault is a seasoned business professional +and entrepreneur who has spent more than twenty-seven years identifying value in various financial markets including equities, fixed income, +commodities, and real estate. Throughout his career, Mr. Ault has consulted for a few publicly traded and privately held companies, providing +each of them the benefit of his diversified experience, that range from development stage to seasoned businesses. +William +B. Horne has been a member of our board of directors since October 2016. In January 2018, Mr. Horne was appointed as our Chief Financial +Officer until August 2020, when he resigned as our Chief Financial Officer and was appointed as our President. On January 12, 2021, Mr. +Horne resigned as our President and became our Chief Executive Officer. Mr. Horne has served as a director of Alzamend since June 2016 +and upon the effectiveness of its initial public offering in June 2021, Mr. Horne become its Chairman of the Board. Mr. Horne served as +Alzamend’s Chief Financial Officer from June 2016 through December 2018. Mr. Horne has been the Chief Executive Officer and a member +of the board of directors of Ault Disruptive since its inception in February 2021. Mr. Horne has served as a director and Chief Financial +Officer of Avalanche since June 2016. Mr. Horne has served as a director and Chief Financial Officer of Ault & Company since October +2017. Mr. Horne has served as a director of GIGA since September 2022. He served as the Chief Financial Officer of Targeted Medical Pharma, +Inc. from August 2013 to May 2019. Mr. Horne previously held the position of Chief Financial Officer in various public and private companies +in the healthcare and high-tech field. Mr. Horne has a Bachelor of Arts Magna Cum Laude in Accounting from Seattle University. +138 +Henry C.W. Nisser , +has been our President since May 2019, and has served as our Executive Vice President and General Counsel and as one of our directors +since September 2020. Mr. Nisser has been the President, General Counsel and a member of the board of directors of Ault Disruptive +since its inception in February 2021. Mr. Nisser has served as Alzamend’s Executive Vice President and General Counsel on a part-time +basis since May 2019. Mr. Nisser was appointed as a director of Alzamend in September 2020. Since March 2023, Mr. Nisser +has served as the President, General Counsel and director of ROI. Since April 2023, Mr. Nisser has served as a director of MICS. Mr. Nisser +is the Executive Vice President and General Counsel of Avalanche. Mr. Nisser has served as a President, General Counsel and a director +of Ault & Company since May 2019. From December 15, 2021 through March 16, 2022, Mr. Nisser served as Chief Executive Officer and +on the board of directors of TurnOnGreen. From October 2011 through April 2019, Mr. Nisser was an associate and subsequently +a partner with Sichenzia Ross Ference LLP, a law firm in New York. While with this law firm, his practice was concentrated on national +and international corporate law, with a particular focus on U.S. securities compliance, public as well as private M&A, equity and +debt financings and corporate governance. Mr. Nisser received his B.A. degree from Connecticut College, where he majored in International +Relations and Economics. He received his LL.B. from University of Buckingham School of Law in the United Kingdom. +Kenneth S. Cragun has +been our Chief Financial Officer since August 2020 and between October 2018 and August 2020, served +as our Chief Accounting Officer. Since June 2021, Mr. Cragun has served as Senior Vice President of Finance at Alzamend on a part-time +basis. Between December 2018 and June 2021, Mr. Cragun served as the Chief Financial Officer of Alzamend. Mr. Cragun has been the +Chief Financial Officer of Ault Disruptive since its inception in February 2021. Since September +2018, Mr. Cragun has served on the board of directors and Chairman of the Audit Committee of Verb Technology Company, Inc. Since July +2022, Mr. Cragun has served on the board of directors of MICS. He served as a CFO Partner at Hardesty, LLC, a national executive services +firm between October 2016 and October 2018. His assignments at Hardesty included serving as Chief Financial Officer of CorVel Corporation, +a publicly traded company and a nationwide leader in technology driven, healthcare-related, risk management programs, and of RISA Tech, +Inc., a private structural design and optimization software company. Mr. Cragun was also Chief Financial Officer of two Nasdaq-traded +companies, Local Corporation, a publicly held local search company (“ Local Corp. ”), +from April 2009 to September 2016, and Modtech Holdings, Inc., from June 2006 to March 2009, a supplier of modular +buildings. Prior thereto, he had financial leadership roles with increasing responsibilities at MIVA, Inc., ImproveNet, Inc., NetCharge +Inc., C-Cube Microsystems, Inc, and 3-Com Corporation. Mr. Cragun began his professional career at Deloitte. Mr. Cragun holds +a Bachelor of Science degree in accounting from Colorado State University-Pueblo. +Robert O. Smith has +served as a director since September 2016, and was previously a member of our board from November 2010 to May 2015. Mr. Smith is currently +an independent C-level executive consultant working with Bay Area high-tech firms on various strategic initiatives in all aspects of their +business. Mr. Smith has served on the board of directors of GWW since September 2022. Mr. Smith has served on the board of directors of +ROI since October of 2023, where he acts as ROI’s lead independent director as well as the chairman of its audit committee. Mr. +Smith has served on the board of directors of Ault Disruptive since its inception in February 2021. From 2004 to 2007, he served on the +board of directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman of the Board. +From 1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of its Compower/Boschert +division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with the JM Smucker Company. Mr. Smith +received his BBA degree in Accounting from Ohio University. +Mordechai Rosenberg has +served as a director since June 2015. Mr. Rosenberg serves as one of our independent directors. He has served as an independent consultant +to various companies in the design and implementation of homeland security systems in Europe and Africa since 2010. From 2004 to 2009, +he served as a special consultant to Bullet Plate Ltd., a manufacturer of armor protection systems, and NovIdea Ltd., a manufacturer of +perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg was the general manager of ZIV U.P.V.C Products Ltd.’s doors +and window factory. Mr. Rosenberg is an active reserve officer and a retired colonel from the Israeli Defense Force (“IDF”), +where he served for 26 years and was involved in the development of weapon systems. In the IDF, Mr. Rosenberg served in various capacities, +including, company, battalion and brigade commander, head of the training center for all IDF infantry, and head of the Air Force’s +Special Forces. Mr. Rosenberg received a B.A in History from the University of Tel Aviv and a Master of Arts in Political Science from +the University of Haifa in Israel. Mr. Rosenberg graduated from the course of Directors & Officers at the College of Management, Tel +Aviv. +Jeffrey A. Bentz has +served as a director since January 2018. Mr. Bentz is an experienced businessman who served from 1994 to 2022 as President of North Star +Terminal & Stevedore Company, a full-service stevedoring company located in Alaska and whose major areas of business include terminal +operations and management, stevedore services and heavy equipment operations. Mr. Bentz has served as a director of Ault Disruptive since +its inception in February 2021 and GWW since September 2022. He also has served as a director and advisor to several private companies +and agencies. Mr. Bentz obtained a B.A. degree in Business and Finance from Western Washington University. +139 +Howard Ash has served +as a director since August 2020. Mr. Ash is an accomplished executive with extensive experience in business and finance, who served as +CEO, COO and CFO to a variety of high profile, international companies. Mr. Ash continues to serve as Chairman of Claridge Management +since 2000. Mr. Ash was a director of Net Element, Inc. (NASDAQ-NETE) from June 13, 2016 through July 13, 2020, serving as Chairman of +both the Audit and Compensation committees, as well as the Nominating and Governance Committees during his tenure. He served as Chief +Operating Officer of BioCard Corporation from 1997 to 2007. He served as Chief Operating Officer of CITA Americas, Inc. from 1996 to 1997. +Mr. Ash served as Chief Executive Officer of IEDC Marketing, Inc. from 1992 to 1996. He held a CFO/Chief Strategist position at Abrams, +Ash & Associates from 1990 to 1992. Mr. Ash currently serves on the Advisory Board of the U.K. based E2Exchange, the Institute of +Entrepreneurs, since 2011, and is the only non-UK citizen holding that position. Mr. Ash served from 2009 to 2014 in a senior development +and strategic capacity for One Laptop Per Child, a global NGO created to provide educational opportunities providing laptops to the world’s +poorest children. Prior Chairmanships include the 2009 through 2012 term for the Sturge Weber Foundation, a non-profit organization dedicated +to curing this rare but fatal syndrome affecting children. Previously, Mr. Ash was an Advisory Board Member to Edge Global Investment +Limited which forged a strategic partnership with the Africa Forum, consisting of 37 former Heads of State and Government. Mr. Ash started +an interest-free micro-loan society in 1987 that has provided more than $15 million in micro-loans throughout the U.S. and Israel. In +1999, Mr. Ash founded the Circle of Life Resource Center, Inc., a food bank in Miami, Florida that feeds several hundred families per +week. Mr. Ash earned a Bachelor of Commerce degree, with Honors in Accounting and Law from the University of Witwatersrand (South Africa) +in 1980. +Corporate Governance +Our Board is currently composed +of seven members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) +the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, +from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters +for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at https://www.ault.com . +Audit Committee +Messrs. Ash, Smith and Bentz +currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee +satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE American. Our Board has +also determined that Messrs. Ash and Smith qualify as an “audit committee financial expert” as defined in SEC regulations +and satisfy the financial sophistication requirements set forth in the NYSE American Rules. Mr. Ash serves as the Chairman of the Audit +Committee. +The Audit Committee is responsible +for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to +be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress +and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to +ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services +rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Bentz and Rosenberg +currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation +Committee meets the requirements for independence under the standards of the NYSE American. Mr. Bentz serves as Chairman of the Compensation +Committee. +The Compensation Committee +is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving +salaries, bonuses and other benefits paid to our officers, including our Executive Chairman, Chief Executive Officer, President and Chief +Financial Officer; and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith, Ash and Rosenberg +currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members of +the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE American. Mr. Smith serves +as Chairman of the Nominating and Governance Committee. +The Nominating and Governance +Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees +for each annual meeting of stockholders to the Board; developing and recommending governance principles applicable to our Board; overseeing +the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +140 +The Nominating and Governance +Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based +business and professional skills, experiences and global business and social perspective. +In addition, the Committee +seeks directors who exhibit personal integrity and a concern for the long-term interests of stockholders, as well as those who have time +available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract +and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +Executive Committee +As a holding company, our +business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on various objectives that +the Company sets, including financings and all acquisition targets and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities, dividends and, in the case of publicly +traded partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for Ault Lending and approves all lending transactions. Under its business model, Ault Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to Ault Lending in any particular financing. Ault Lending’s activities are more fully described elsewhere in this Annual Report; +see page 22. +141 +Involvement in Certain Legal Proceedings +Except as set forth below, +to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former director, +executive officer, or employee: +· been convicted in a criminal proceeding or been +subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +· had any bankruptcy petition filed by or against +the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or +executive officer, either at the time of the bankruptcy filing or within two years prior to that time; * +· been subject to any order, judgment, or decree, +not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or +temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, +investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; +· been found by a court of competent jurisdiction +in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities +law, and the judgment has not been reversed, suspended, or vacated; ** +· been the subject of, or a party to, any federal +or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including +any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or +commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited +to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist +order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business +entity; +· or been the subject of, or a party to, any sanction +or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the +Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, +entity or organization that has disciplinary authority over its members or persons associated with a member. +* Mr. Cragun served as Chief Financial Officer +of Local Corporation (April 2009 to September 2016), formerly based in Irvine, California, and, in June 2015, Local Corporation filed +a voluntary petition in the United States Bankruptcy Court for the Central District of California seeking relief under the provisions +of Chapter 11 of Title 11 of the United States Code. +** Please see the press release issued by the +Company on August 15, 2023. +Except as set forth in our +discussion below in “Certain Relationships and Related Transactions,” none of our directors or executive officers has been +involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed +pursuant to the rules and regulations of the SEC. +Family Relationships +There are no family relationships among our directors +and executive officers. +142 +Code of Ethics +We have adopted the Code of +Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller +or person performing similar functions. The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical +conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website +at https://www.ault.com . We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit +or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request to our President, Henry Nisser, +we will provide without charge, a copy of our Code of Ethical Conduct. +143 +ITEM 11. EXECUTIVE COMPENSATION +Summary Compensation Table +The following Summary Compensation +Table sets forth all compensation earned in all capacities during the years ended December 31, 2023 and 2022, by our principal executive +officer. Because we are a Smaller Reporting Company, we only have to report information of our principal executive officer and our two +other most highly compensated executive officers. +SUMMARY COMPENSATION TABLE +Name and principal position +Year +Salary ($) +Bonus ($) +Stock Awards ($) (1) +Option +Awards ($) (1) +All Other Compensation ($) (2) +Total ($) +Milton C. Ault, III +2023 +400,000 +16,667 +- +- +325,773 +742,440 +Executive Chairman of the Board +2022 +400,000 +1,716,667 +- +- +56,392 +2,173,059 +William B. Horne +2023 +375,000 +16,667 +- +- +98,195 +489,862 +Chief Executive Officer +2022 +300,000 +1,812,500 +- +- +49,664 +2,162,164 +Henry C. Nisser +2023 +300,000 +12,500 +- +- +55,727 +368,227 +President and General Counsel +2022 +300,000 +912,000 +- +- +36,251 +1,248,251 +(1) The values reported in the “Stock Awards” and “Option Awards” columns represent the aggregate grant date fair value, computed in accordance with Accounting Standards Codification (“ASC”) 718 Share Based Payments , of grants of stock options and stock awards to our named executive officer in the years shown. +(2) The amounts in “All Other Compensation” consist of 401(k) matching amounts, vehicle +allowance, personal use of the Company’s corporate aircraft, health insurance benefits, long-term and short-term disability +insurance benefits, and travel and entertainment expenses. The personal use of corporate aircraft, reflects the incremental cost to +Ault Alliance for use of the corporate aircraft, determined on the basis of the variable operational costs of each flight, including +fuel, maintenance, flight crew travel expense. Summary table of “All Other Compensation” for the year ended December 31, +2023 is set forth below: +Name +401(k) Matching +Contribution ($) +Automobile +Expenses ($) +Personal Use of +Aircraft ($) +Medical and Life +Insurance Benefits ($) +Travel and +Entertainment ($) +Total All Other +Compensation ($) +Milton C. Ault, III +16,500 +12,000 +262,134 +23,179 +11,960 +325,773 +William B. Horne +16,500 +12,000 +5,719 +52,016 +11,960 +98,195 +Henry C. Nisser +12,763 +- +20,301 +10,704 +11,960 +55,727 +Compensation from Related Companies +The compensation table above +does not include compensation paid to those executives from related companies for the year ended December 31, 2023 as set forth below: +AVLP +Alzamend +Circle 8 +SMC +Name +Board +Fees +Officer +Compensation +Board +Fees +Officer +Compensation +Board +Fees +Board +Fees +Milton C. Ault, III +$ 100,000 +$ - +$ 50,000 +$ - +$ - +$ - +William B. Horne +$ - +$ 50,000 +$ 50,000 +$ - +$ 25,000 +$ - +Henry C. Nisser +$ - +$ 50,000 +$ - +$ 50,000 +$ - +$ 16,000 +Employment Agreements +Milton C. Ault, III +On +June 17, 2018, the Company entered into a ten-year executive employment agreement with Milton C. Ault, III, to serve as Chief Executive +Officer of the Company. On January 19, 2021, Mr. Ault was appointed as Executive Chairman of the Company. For his services, Mr. +Ault will be paid a base salary of $400,000 per annum (the “Base Salary”). +144 +Pursuant +to the terms and subject to the conditions set forth in the agreement, if the Company meets or exceeds criteria adopted by the Company’s +compensation committee (the “Compensation Committee”) for earning bonuses which shall be adopted by the Compensation Committee +annually, Mr. Ault shall be eligible to receive an annual bonus, which percentage shall be based on achievement of applicable performance +goals determined by the Compensation Committee. +In +addition, Mr. Ault shall be eligible to receive a performance-based award (the “CEO Performance Award”), provided that the +Company, for any given fiscal year during the term of this agreement, meets the following criteria: (A) an increase in revenue, as calculated +under GAAP over the previous fiscal year as reported in the Annual Report on Form 10-K or successor form for such fiscal year; provided +that any increase less than thirty-five percent (35%) (the “Revenue Percentage”) shall reduce the CEO Performance Award correspondingly; +(B) positive net income, as calculated under GAAP, as reported in the Annual Report on Form 10-K or successor form for such fiscal year, +provided that any increase less than five percent (5%) (the “Net Income Percentage”) shall reduce the CEO Performance Award +correspondingly; and (C) positive net cash flow from operations on a year-to-year basis, where cash flow is defined as the net amount +of cash and cash-equivalents being transferred into and out of the Company. The CEO Performance Award shall consist of a number of shares +of the Company’s common stock having a maximum value equal to ten percent (10%) of any appreciation in the Company’s Market +Capitalization above the High Water Mark (as such terms are defined in the agreement) as measured by the daily average closing bid price +of the Company’s common stock for the applicable fiscal year subject to proration obtained by the product of Revenue Percentage +and the Net Income Percentage. If the CEO Performance Award in a fiscal year is less than ten percent (10%) due to a reduction caused +by an annual shortfall in either the Revenue Percentage or the Net Income Percentage, the prior year’s targets would be deemed to +have been achieved if a corresponding overage in a subsequent fiscal year results in the achievement of the cumulative targets. +The annual and cumulative targets for revenue and net income, which are provided solely for the purpose of establishing cumulative totals, +are set forth in the agreement. +Upon +termination of Mr. Ault’s employment (other than upon the expiration of the employment), Mr. Ault shall be entitled to receive: +(A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued +but unused vacation time. +Further, +unless Mr. Ault’s employment is terminated as a result of his death or disability or for cause or he terminates his employment without +good reason, then upon the termination or non-renewal of Mr. Ault’s employment, the Company shall pay to Mr. Ault a “Separation +Payment” as follows: (A) an amount equal to four (4) weeks of base salary for each full year of service and +credit for his service commencing from September 22, 2016, (B) should Mr. Ault provide the Company with a separation, waiver and release +agreement within 60 days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “Separation +Period”) of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may +be, but in no event an amount greater than the Base Salary payable should either such period expire within two years, or (2) the 12-month +period commencing on the date Mr. Ault is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, +dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum +annual bonus as Mr. Ault would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar +months worked including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options +and other equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence +of a change in control, Mr. Ault will be paid an amount equal to the greater of: (i) five times his then current Base Salary or (ii) the +Separation Payment amount set forth above, without regard to whether Mr. Ault continues in the employ of the Company or its successor. +William B. Horne +On January 25, 2018, we entered +into an employment agreement with William Horne to serve as Chief Financial Officer and Executive Vice President of the Company and its +subsidiaries for an initial term through September 30, 2022, which automatically renews thereafter for successive one-year terms unless +either party provides written notification at least four months prior to the end of a term of their desire to terminate. Mr. Horne’s +base salary was $300,000 per annum, which was increased to $400,000 effective April 1, 2023. Mr. Horne is eligible to receive an annual +cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s +compensation committee. +Upon +termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to receive: +(i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and (iii) any accrued +but unused vacation time. +145 +Further, +unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne a “Separation +Payment” as follows: (A) an amount equal to four weeks of base salary for each full year of service, (B) should +Mr. Horne provide the Company with a separation, waiver and release agreement within 60 days of termination, then the Company shall: +(i) pay his base salary until the last to occur (the “Separation Period”) of (1) the expiration of the remaining portion of +the initial term or the then applicable renewal term, as the case may be, or (2) the 12-month period commencing on the date Mr. Horne +is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life +insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Horne would have been +otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the entire +month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity awards shall immediately +vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will +be paid an amount equal to four times his Separation Payment. +Henry Nisser +On April 12, 2019, the Company +entered into an employment agreement (the “Agreement”) with Henry Nisser to serve as General Counsel and Executive Vice President +of the Company and its subsidiaries for an initial term through May 1, 20223 which automatically renews thereafter for successive one-year +terms unless either party provides written notification at least four months prior to the end of a term of their desire to terminate. +The effective date of the Agreement was May 1, 2019. For 2023, Mr. Nisser’s base salary was $300,000 per annum (the “Base +Salary”). +Mr. Nisser is eligible to +receive an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined +by the Company’s compensation committee. +Mr. Nisser’s bonuses, +if any, and all stock based compensation shall be subject to “Company Clawback Rights” if during the period that Mr. Nisser +is employed by the Company and upon the termination of Mr. Nisser’s employment and for a period of two years thereafter, there is +a restatement of any of the Company’s financial results from which any bonuses and stock based compensation to Mr. Nisser shall +have been determined. +Upon termination of Mr. Nisser’s +employment (other than upon the expiration of the employment), Mr. Nisser shall be entitled to receive: (A) any earned but unpaid base +salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued but unused vacation time. +Further, +unless Mr. Nisser’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Nisser’s employment, the Company shall pay to Mr. Nisser a +“Separation Payment” as follows: (a) an amount equal to four weeks of base salary for each full year of service, (b) commencing +on the date that shall be one (1) year from the effective date, should Mr. Nisser provide the Company with a separation, waiver and release +agreement within 30 days of termination, then the Company shall pay to Mr. Nisser the Base Salary (in effect immediately prior to the +termination date) an amount equal to the lesser of what Mr. Nisser would have received if the employment period ended after (1) the expiration +of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or (2) the 18-month period commencing +on the date Executive is terminated, payable in one lump sum; (ii) provide during the separation period the same medical, dental, long-term +disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. +Nisser would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked +including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other +equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change +in control, Mr. Nisser will be paid an amount equal to four times his Separation Payment. +CEO Pay Ratio +As required by Section 953(b) +of the Dodd-Frank Wall Street Reform and Consumer Protection Act, we are providing disclosure regarding the ratio of annual total compensation +of Mr. Ault, our Executive Chairman, to that of our median employee. Our median employee earned $52,400 in total compensation for 2023. +Based upon the total 2023 compensation reported for Mr. Ault of $742,440 as reported under “Total” in the Summary Compensation +Table, our ratio of PEO to median employee pay was 12:1. Our median employee is employed in our Circle 8 subsidiary. +146 +Our Chief Executive Officer +and Principal Executive Officer, however, is not Mr. Ault but William B. Horne. In order to follow the intent of the SEC’s rules, +which appear to presume that the CEO is the highest paid executive officer of an issuer, we chose to present the total annual compensation +of Mr. Ault, who is paid marginally more than Mr. Horne. +While Mr. Ault’s salary +exceeds Mr. Horne’s by $25,000 and $100,000 for both fiscal years ended December 31, 2023 and 2022, respectively, his annual total +compensation exceeds Mr. Horne’s by no more than $252,578 and $10,895, respectively. +Calculation Methodology +To identify our median employee, +we identified our total employee population worldwide as of December 31, 2023, excluding our Executive Chairman, in accordance with SEC +rules. On December 31, 2023, 80% of our employee population was located in the U.S., with 20% in non-U.S. locations. +We collected full-year 2023 +actual gross earnings data for the December 31, 2023 employee population, including cash-based compensation and equity-based compensation +that was realized in 2023, relying on our internal payroll records. Compensation was annualized on a straight-line basis for non-temporary +new hire employees who did not work with our company for the full calendar year. +Once we determined the median +employee, we calculated total compensation for the median employee in the same manner in which we determine the compensation shown for +our named executive officers in the Summary Compensation Table, in accordance with SEC rules. +Pay Versus Performance +Pay Versus Performance Table +The following table sets forth +information concerning: (1) the compensation of our Executive Chairman, Mr. Ault (referred to in the table below as “EC”) +and the average compensation for our other Named Executive Officers (“NEOs”), Mr. Horne (our PEO) and Mr. Nisser, both as +reported in the Summary Compensation Table and with certain adjustments to reflect the “compensation actually paid” to such +individuals, as defined under SEC rules, for each of the fiscal years ended December 31, 2021, 2022 and 2023 and (2) our cumulative total +shareholder return (“TSR”), the cumulative TSR of our selected peer group (Bitfarms Limited, Cipher Mining, Inc., CleanSpark, +Inc., Hive Digital Technologies Limited, Riot Platforms, Inc., Titan Machinery Inc., Alta Equipment Group Inc., B. Riley Financial, Inc.), +net loss and revenue over such years, in each case determined in accordance with SEC rules: +Value of Initial Fixed $100 Investment Based on: +Year +Summary +Compensation +Table Total +for PEO ($) +Compensation +Actually Paid +to PEO ($) +Average +Summary +Compensation +Table Total +for Non-PEO +NEOs ($) +Average +Compensation +Actually Paid +to Non-PEO +NEOs ($) +Total +Shareholder +Return ($) +Peer Group +Total +Shareholder +Return ($) +Net Income +($) +Total +Revenue ($) +2023 +742,440 +689,052 +429,045 +375,657 +0.01 +88.88 +(232,401,000 ) +156,444,000 +2022 +2,173,059 +1,120,398 +1,705,208 +652,547 +3.64 +62.62 +(182,209,000 ) +117,637,000 +2021 +4,195,025 +2,418,538 +3,681,239 +1,904,752 +27.36 +147.19 +(23,269,000 ) +52,400,000 +Compensation actually paid +to our EC represents the “Total” compensation reported in the Summary Compensation Table for the applicable fiscal year, adjusted +as follows: +2023 +2022 +2021 +Name +EC ($) +Average of +NEOs ($) +EC ($) +Average of +NEOs ($) +EC ($) +Average of +NEOs ($) +Summary compensation table total +742,440 +429,045 +2,173,059 +1,705,208 +4,195,025 +3,681,239 +Deduction for amounts reported under the stock awards column in the summary compensation table +- +- +- +- +2,933,440 +2,933,440 +Year end value of equity awards granted during year that remain unvested as of year-end +- +- +- +- +1,156,953 +1,156,953 +Year over year change in fair value of outstanding and unvested equity awards +- +- +(525,468 ) +(525,468 ) +- +- +Year over year change in fair value of equity awards granted in prior years and vested in the year +(53,388 ) +(53,388 ) +(527,193 ) +(527,193 ) +- +- +Compensation actually paid +689,052 +375,657 +1,120,398 +652,547 +2,418,538 +1,904,752 +147 +Narrative Disclosure to Pay Versus Performance +Table +Relationship between Financial Performance +Measures +The line graphs below compare +(i) the compensation actually paid to our EC and the average of the compensation actually paid to our remaining NEOs, with (ii) our cumulative +TSR, (iii) our peer group TSR, (iv) our net loss, and (v) our revenue, in each case, for the fiscal years ended December 31, 2021, 2022 +and 2023. +TSR amounts reported in the +graph assume an initial fixed investment of $100, and that all dividends, if any, were reinvested. The term “PEO” as used +in the tables below refers to the EC, not the PEO. +148 +Policies on Ownership, Insider Trading, 10b5-1 +Plans and Hedging +We do not have formal stock +ownership guidelines for our employees or directors, because the Board is satisfied that stock and option holdings among our employees +or directors are sufficient at this time to provide motivation and to align this group’s interests with those of our stockholders. +149 +We have established an insider +trading policy that provides guidelines to, and imposes restrictions on, officers, directors and employees with respect to transactions +in the Company’s securities. The Company’s insider trading policy prohibits certain actions by such individuals relating to +buying and selling common stock of the Company, and discourages certain other actions in other situations. Such individuals are authorized +to enter into trading plans established according to Section 10b5-1 of the Exchange Act with an independent broker-dealer. Under these +plans, the individual must not exercise any influence over the amount of the securities to be traded, the price at which they are to be +traded or the date of the trade. The plan must either specify the amount, pricing and timing of transactions in advance or delegate discretion +on these matters to an independent third party. Such plans provide a defense from insider trading liability. +We have not adopted any hedging +policies. +Advisory Vote on Executive Compensation +At the annual meeting of stockholders +on November 23, 2022, the stockholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. +An advisory vote on executive compensation is held every three years. +Outstanding Equity Awards at Fiscal Year-End +The following table provides information on outstanding +equity awards as of December 31, 2023 to the named executive officers. +OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2023 +OPTION AWARDS +Name +Number of Securities +Underlying +Unexercised Options +(#) Exercisable +Number of Securities +Underlying +Unexercised Options +(#) Unexercisable +Equity Incentive Plan +Awards: Number of +Securities Underlying +Unexercised +Unearned Options (#) +Option +Exercise +Price +($) +Option +Expiration +Date +Milton C. Ault, III +27 +- +- +13,425.00 +9/17/2030 +53 +- +- +19,125.00 +4/26/2031 +William B. Horne +27 +- +- +13,425.00 +9/17/2030 +53 +- +- +19,125.00 +4/26/2031 +Henry C. Nisser +27 +- +- +13,425.00 +9/17/2030 +53 +- +- +19,125.00 +4/26/2031 +Director Compensation +The Company pays each independent +director an annual base amount of $45,000 annually, other than Messrs. Smith and Ash, who each receive a base amount of $55,000 annually +due to the additional services provided by Mr. Smith as a lead independent director and Mr. Ash as Audit Committee Chairman. Additionally, +our Board makes recommendations for adjustments to an independent director’s compensation when the level of services provided is +significantly above what was anticipated. In addition, independent directors are eligible, at the Board’s discretion, to receive +a bonus. +The table below sets forth, +for each non-employee director, the total amount of compensation related to his service during the year ended December 31, 2023: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($) +Total ($) +Robert O. Smith +55,000 +— +— +— +55,000 +Jeffrey A. Bentz +45,000 +— +— +— +45,000 +Mordechai Rosenberg +45,000 +— +— +— +45,000 +Howard Ash +55,000 +— +— +— +55,000 +150 +Stock Incentive Plans +On December 28, 2018, the +stockholders approved the 2018 Stock Incentive Plan (as amended on May 5, 2019), which amendment was approved by the stockholders on July +19, 2019, the “2018 Stock Incentive Plan”), under which options to acquire up to 5,000 shares of common stock may be +granted to the Company’s directors, officers, employees and consultants. The 2018 Stock Incentive Plan is in addition to the Company’s +(ii) 2016 Stock Incentive Plan, under which options to acquire up to 1 share of common stock may be granted to the Company’s directors, +officers, employees and consultants, (iv) 2021 Stock Incentive Plan, under which 1,000 stock options, restricted stock, stock appreciation +rights, restricted stock units, and other stock-based compensation. be granted to the Company’s directors, officers, employees and +consultants, (v) 2021 Employee Stock Purchase Plan, intended to assist our employees in acquiring share ownership up to an aggregate of +131 shares of common stock, and (vi) 2022 Stock Incentive Plan, under which 10,000 stock options, restricted stock, stock appreciation +rights, restricted stock units, and other stock-based compensation. be granted to the Company’s directors, officers, employees and +consultants (collectively the “Plans”). +The purpose of the Plans is +to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial responsibility +for the direction and management of the Company, as well as certain directors and consultants of the Company, additional incentives to +exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, to reward outstanding +performance and to provide a means to attract and retain persons of outstanding ability to the service of the Company. +As of December 31, 2023, options +to purchase 779 shares of common stock were issued and outstanding, and 10,411 shares are available for future issuance under the Plans. +401(k) Plans +Ault Alliance, TurnOnGreen +and Microphase have adopted tax-qualified employee savings and retirement plan, or 401(k) plans, which generally cover all of their full-time +employees. Pursuant to the 401(k) plans, eligible employees may make voluntary contributions to the plan up to a maximum of pursuant to +the current Internal Revenue Code limits. The Microphase 401(k) plan permits, but does not require, matching contributions by them on +behalf of plan participants. The Ault Alliance and TurnOnGreen 401(k) plans include matching contributions at the rate of (1) $1.00 for +each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary and +permits discretionary contributions. The 401(k) plans are intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue +Code of 1986, as amended. Contributions to such a qualified plan are deductible by the Company when made, and neither the contributions +nor the income earned on those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited +to separate accounts maintained in trust. +Effective January 1, 2001, +SMC adopted a voluntary 401(k) plan. All SMC employees with at least one year of service are eligible to participate in the 401(k) plan. +SMC makes a matching contribution of 100% of salary deferral contributions up to 3% of pay, plus 50% of salary deferral contributions +from 3% to 5% of pay for each payroll period. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +Except as otherwise indicated below, the following table sets forth +certain information regarding beneficial ownership of our common stock as of April 15, 2024 by (1) each of our current directors; (2) +each of the executive officers; (3) each person known to us to be the beneficial owner of more than 5% of the outstanding shares of our +common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors and executive officers as a group. As of +April 15, 2024, there were 30,065,339 shares of our common stock issued and outstanding. +Beneficial ownership is determined in accordance with the rules of +the SEC and includes voting or investment power with respect to the securities. Common stock subject to options or warrants that are currently +exercisable or exercisable within 60 days of April 15, 2024 are deemed to be outstanding and to be beneficially owned by the person or +group holding such options or warrants for the purpose of computing the percentage ownership of such person or group, but are not treated +as outstanding for the purpose of computing the percentage ownership of any other person or group. Unless otherwise indicated by footnote, +to our knowledge, the persons named in the table have sole voting and sole investment power with respect to all common stock shown as +beneficially owned by them, subject to applicable community property laws. +151 +Name and address of beneficial owner (1) +Number of +shares +beneficially +owned +Approximate +percent +of class +Milton C. Ault, III +452,785 +(2) +1.48 % +William Horne +162 +(3) +* +Henry Nisser +162 +(3) +* +Ken Cragun +72 +(4) +* +Robert Smith +45 +(5) +* +Mordechai Rosenberg +48 +(6) +* +Jeffrey A. Bentz +48 +(6) +* +Howard Ash +41 +(7) +* +All directors and executive officers as a group (eight persons) +453,364 +1.49 % +* Less than one percent. +(1) Unless otherwise indicated, the business address of each of the individuals is c/o Ault Alliance, Inc., +11411 Southern Heights Pkwy, Suite 240, Las Vegas, NV 89141. +(2) Represents (i) 261 shares of Common Stock, (ii) 81 shares of Common Stock underlying stock options currently +exercisable or exercisable within 60 days of April 15, 2024, (iii) 229 shares of Common Stock held by Ault & Company, and (iv) 452,214 +shares of Common Stock issuable upon conversion of the Series C Preferred Stock held by Ault & Company. Excludes (i) 123,833,499 additional +shares of Common Stock issuable upon conversion of Series C Preferred Stock owned by Ault & Company, (ii) 1,907,440 shares of Common +Stock issuable upon exercise of a warrant issued October 13, 2023 and an aggregate of 12,860,311 shares of Common Stock issuable upon +exercise of warrants issued December 14, 2023, March 7, 2024, March 8, 2024, March 18, 2024 and March 19, 2024 to Ault & Company (the +“Warrants”). No more than 452,214 shares of Common Stock may be issued in the aggregate upon conversion of the Series C Preferred +Stock and/or exercise of the Warrants, in accordance with the rules and regulations of the NYSE American, LLC unless the Company first +obtains stockholder approval. Mr. Ault is the Chief Executive Officer of Ault & Company. +(3) Represents (i) 81 shares of Common Stock and (ii) 81 shares of Common Stock underlying stock options currently +exercisable or exercisable within 60 days of April 15, 2024. +(4) Represents (i) 28 shares of Common Stock and (ii) 44 shares of Common Stock underlying stock options currently +exercisable or exercisable within 60 days of April 15, 2024. +(5) Represents (i) 18 shares of Common Stock and (ii) 27 shares of Common Stock underlying stock options currently +exercisable or exercisable within 60 days of April 15, 2024. +(6) Represents (i) 21 shares of Common Stock and (ii) 27 shares of Common Stock underlying stock options currently +exercisable or exercisable within 60 days of April 15, 2024. +(7) Represents (i) 14 shares of Common Stock and (ii) 27 shares of Common Stock underlying stock options currently +exercisable or exercisable within 60 days of April 15, 2024. +152 +Equity Compensation Information +The following table summarizes information about +our equity compensation plans as of December 31, 2023. +Number of securities +Number of securities +Weighted- +remaining available for +to be issued +average +future issuance under +upon exercise +exercise price +equity compensation plans +of outstanding +of outstanding +(excluding securities +options, warrants and rights +options, warrants and rights +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation plans approved by stockholders +421 +$ 17,546 +10,411 +Equity compensation plans not approved by stockholders +358 +$ 17,278 +- +Total +779 +$ 17,423 +10,411 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• +the aggregate amount involved is determined to by the Audit Committee to be material; +• +we are a participant; and +• +any of the following has or will have a direct or indirect interest in the transaction: +• +an executive officer, director, or nominee for election as a director; +• +a greater than five percent beneficial owner of our common stock; or +• +any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. +Ault & Company, Inc. +On +February 25, 2021, Ault & Company sold and issued an 8% Secured Promissory Note in the +principal amount of $2,500,000 (the “2021 Note ”) to us. The principal amount +of the 2021 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was originally due and payable on August 5, 2021 but +the maturity date was subsequently extended to December 31, 2022. +On June 8, 2023, we entered +into the Credit Agreement with Ault & Company as the lender. The Credit Agreement provided for an unsecured, non-revolving credit +facility in an aggregate principal amount of up to $10,000,000. All Advances were due within five business days after request by Ault +& Company and Ault & Company was not obligated to make any further Advances under the Credit Agreement after December 8, 2023. +Advances under the Credit Agreement bore interest at the rate of 9.5% per annum and may be repaid at any time without penalty or premium. +As of April 15, 2024, no Advances were outstanding. +Effective August 3, 2023, +we and the Investors entered into the Exchange Agreement pursuant to which the Investors exchanged all of their preferred shares as well +as their Demand Notes issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount +of approximately $0.8 million for the Exchange Notes, each with a principal face amount of $5.3 million, for an aggregate Principal Amount +of $10.5 million. We and Mr. Ault, our Executive Chairman, entered into guaranty agreements with the March 2023 Investors guaranteeing +repayment by Ault & Company of the Exchange Notes. +153 +Effective as of August 3, +2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, +we issued the First Ault & Company Demand Note to Ault & Company. +Effective as of August 10, +2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued +the Second Demand Note to Ault & Company. +On October 13, 2023, we entered +into a note purchase agreement with Ault & Company, pursuant to which we sold to Ault & Company (i) the Senior Note and Warrants +to purchase shares of our common stock for a total purchase price of up to $17.5 million. +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the Credit +Agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming +liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares +of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault +& Company to us. +The Senior Note had a principal +face amount of $17.5 million and a maturity date of October 12, 2028. The Senior Note bore interest at the rate of 10% per annum. Interest +was payable, at Ault & Company’s option, in cash or shares of common stock at the applicable conversion price. Accrued interest +was payable on the maturity date, provided, however, that Ault & Company had the option, on not less than 10 calendar days’ +notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. +The Senior Note was convertible +into shares of common stock at a conversion price equal to the greater of (i) the Floor Price, and (ii) the lesser of (A) $7.38 or (B) +105% of the volume weighted average price of the common stock during the ten trading days immediately prior to the date of conversion. +The conversion price was subject to adjustment in the event of an issuance of common stock at a price per share lower than the conversion +price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor Price shall not +be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +The Warrants grant Ault & +Company the right to purchase 1,907,440 shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary +of the closing date, and become exercisable on the first business day after the six-month anniversary of the closing date. The exercise +price of the Warrants is $0.35, which is subject to adjustment in the event of customary stock splits, stock dividends, combinations or +similar events or in the event of an issuance of common stock at a price per share lower than the exercise price. +On November 6, 2023, we entered +into the November 2023 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 50,000 shares of Series C Convertible Preferred Stock and the Series C Warrants to purchase up to 14.8 million shares of common +stock for a total purchase price of up to $50 million. The consummation of the transactions contemplated by the November 2023 SPA, specifically +the conversion of the Series C Convertible Preferred Stock and the exercise of the Series C Warrants in an aggregate number in excess +of 19.99% on the execution date of the November 2023 SPA, are subject to various customary closing conditions as well as regulatory and +stockholder approval. +Additionally, until the earlier +of (i) four years from the initial closing date of the November 2023 SPA (the “Initial Closing Date”), or (ii) the date when +Ault & Company holds fewer than 10,000 shares of Series C Convertible Preferred Stock, the Company will be prohibited from (A) entering +into any financing, whether debt or equity, other than conventional loans from a commercial bank, at a price per share less than the Series +C Conversion Price (as defined below) or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 10,000 shares of Series C Convertible Preferred Stock, Ault & Company shall have a right to participate +in any subsequent financing (a “Subsequent Financing”) allowing Ault & Company to purchase such number of securities in +the Subsequent Financing to allow Ault & Company to maintain its percentage beneficial ownership of the Company that Ault & Company +held immediately prior to the Subsequent Financing. +In addition, the Company must +establish a reserve account to be funded with no less than 12.5% of the gross proceeds received from the sale of the Series C Convertible +Preferred Stock, which shall be maintained for a period of at least nine months from the Initial Closing Date. +154 +On December 14, 2023, pursuant +to the November 2023 SPA, we sold to Ault & Company, in three separate closings that occurred on the closing date, an aggregate of +41,500 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 12,269,031 shares of common stock, for a total +purchase price of $41.5 million. At the Initial Closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred +Stock and Series C Warrants to purchase 6,356,245 shares of common stock, for a purchase price of $21.5 million, paid in cash. Immediately +upon the Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes issued to the lenders pursuant +to the Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +Second Closing, Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 2,956,393 +shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon the Second Closing, we paid $10.0 million +to partially satisfy the outstanding Senior Note. Promptly thereafter, at the Third Closing, Ault & Company purchased another 10,000 +shares of Series C Convertible Preferred Stock and Series C Warrants to purchase another 2,956,393 shares of common stock, for a purchase +price of $10.0 million, paid in cash. Immediately upon the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance +on the outstanding Senior Note. +On December 14, 2023, we, along with the Guarantors entered into the +Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed $36 million and issued the Secured Notes to the +lenders in the aggregate amount of $38.9 million. The Loan Agreement was amended on April 15, 2024. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated from the Miners and (c) the +membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those entities +granted to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault Aviation, +AGREE, Sentinum, Third Avenue, Ault Energy, ADTC, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue +on the Florida Property, (iv) a future advance mortgage by ACS on the Michigan Property, (v) an aircraft mortgage and security agreement +by Ault Aviation on the Aircraft, and (vi) deposit account control agreements over certain bank accounts held by certain of our subsidiaries. +In addition, pursuant to the Loan Agreement, we agreed to establish +the Segregated Account, which would be used as a further guarantee of repayment of the Secured Notes. $3.5 million of cash was paid into +the Segregated Account on the closing date. We are required to have the minimum balance in the Segregated Account be not less than $7 +million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and two-year anniversaries of the closing +date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million monthly into the Segregated Account, +which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into the Segregated Account, (i) up to +the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, the Residence Inn in Madison West, +the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on a per dividend basis) received from +Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, which shall not exceed $9 million +in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans or other investments made by Ault +Lending (including but not limited to sales of loans or investments, dividends, interest payments and amortization payments), which shall +not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further agreed to deposit funds into the +Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida Property, (ii) $11 million from +the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, subject to a de minimis threshold +of $1 million, and (v) $10 million from the sale of Circle 8. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50,000,000.00 to $75,000,000.00 and (B) extended the date of on which the final closing may occur to June 30, +2024, subject to Ault & Company’s ability to further extended such date for ninety days. +155 +Description of the Series C Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) the Floor Price, and (ii) the lesser of (A) $0.35 or (B) 105% of the volume weighted average price of the +common stock during the ten trading days immediately prior to the date of conversion (the “Series C Conversion Price”). The +Series C Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the Series +C Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor +Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations or similar transactions. +Voting Rights +The holders of the Series +C Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series C Convertible Preferred Stock is entitled to +cast, shall not be lower than $3.075 (the “Voting Floor Price”), which represents the closing sale price of the common stock +on the trading day immediately prior to the date of execution of the November 2023 SPA. The Voting Floor Price shall be adjusted for stock +dividends, stock splits, stock combinations and other similar transactions. +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series C Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +The conversion of the Series +C Preferred Stock is subject to approval by the NYSE American and our stockholders. +Description of the Series C Warrants +On each closing date, the Company will issue Ault & Company the +Series C Warrants, which grant Ault & Company the right to purchase a specified number of common stock (the “Warrant Shares”). +The exercise price of the Series C Warrants is $0.35 (the “Exercise Price”) and the number of Warrant Shares is determined +by dividing the actual investment amount by the Exercise Price. The Exercise Price is subject to adjustment in the event of customary +stock splits, stock dividends, combinations or similar events. +The Series C Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +The exercise of the Warrants +is also subject to approval by the NYSE American and our stockholders. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer and a director of +Ault & Company. William B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief +Financial Officer and a director of Ault & Company. Henry Nisser, our President, General Counsel and a member of our board of directors, +is also the President, General Counsel and a director of Ault & Company. +ROI +On +June 8, 2022, Ault Lending entered into a securities purchase agreement with ROI whereby Ault Lending agreed to purchase $12,000,000 of +a new series of convertible preferred stock of ROI, which transaction closed on June 29, 2022. As part of the transaction we were issued +102,881 shares of ROI’s common stock and a warrant to purchase forty-nine percent (49%) of ROI’s common stock calculated on +a fully diluted basis, subject to certain terms and conditions. +On July 11, 2022, we announced +the formation of Ault Energy. Ault Energy will partner with White River Holdings Corp. (“White River”), a then subsidiary +of ROI, on drilling projects across 30,000 acres in Texas, Louisiana and Mississippi. Ault Energy, as Ault Lending’s designee, has +the right to purchase up to 25%, or such higher percentages at the discretion of White River, in various drilling projects of White River. +In August 2022, Ault Energy committed to purchasing 40% of the first drilling project offered, at a cost to Ault Energy of approximately +$1 million. In October 2022, Ault Energy committed to purchasing 37.5% of the second drilling project offered, at a cost to Ault Energy +of approximately $1.6 million. In March 2023, Ault Energy committed to purchasing 20% of the third drilling project offered, at a cost +to Ault Energy of approximately $1.0 million. +156 +On February 8, 2023, we entered +into the February 2023 Agreement with ROI and the other signatories thereto. The February 2023 Agreement provided that, subject to the +terms and conditions set forth therein, ROI would acquire all of the outstanding shares of capital stock of our then subsidiary, BNC, +of which we owned approximately 86%, and the remaining 14% was owned by the Minority Shareholders, as well as RiskOn 360, in exchange +for the following: (i) 8,637.5 shares of Series B Preferred that were issued to us, and (ii) 1,362.5 shares of Series C Preferred that +were issued to the to the Minority Shareholders. The Series B Preferred and the Series C Preferred each have a Stated Value of $10,000 +per share, for a combined stated value of the Preferred Stock to be issued by ROI, of $100,000,000, and subject to adjustment, are convertible +into shares of common stock of ROI. However, pending approval of the transaction by ROI’s shareholders, the Preferred Stock is subject +to a 19.9% beneficial ownership limitation, including the Series A Convertible Preferred Stock that we acquired from ROI in June of 2022. +Pursuant to the Preferred +Stock Certificates, each share of Preferred Stock will be convertible into a number of shares of ROI common stock determined by dividing +the Stated Value by the Conversion Price, or 40,000 shares of ROI common stock. The Conversion Price will be subject to certain adjustments, +including potential downward adjustment if ROI closes a qualified financing resulting in at least $25,000,000 in gross proceeds at a price +per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock will be entitled to receive dividends +at a rate of 5% of the Stated Value per annum during the Dividend Term. During the first two years of the Dividend Term, dividends will +be payable in additional shares of Preferred Stock rather than cash, and thereafter dividends will be payable in either additional shares +of Preferred Stock or cash as each holder may elect. If ROI fails to make a dividend payment as required by the Preferred Stock Certificates, +the dividend rate will be increased to 12% for as long as such default remains ongoing and uncured. Each share of Preferred Stock will +also have an $11,000 liquidation preference in the event of a liquidation, change of control event, dissolution or winding up of ROI, +and will rank senior to all other capital stock of ROI with respect thereto, except that the Series B Preferred and Series C Preferred +shall rank pari passu. Each share of Series B Preferred was originally entitled to vote with the ROI common stock at a rate of 10 votes +per share of common stock into which the Series B Preferred is convertible, but that provision was subsequently eliminated, as were the +conventional voting rights of the Series C Preferred. Other than certain rights granted to the Company relating to amendments or waiver +of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially identical. +The February 2023 Agreement closed on March 6, 2023. +On November 15, 2023, we purchased +from ROI 603.44 shares of ROI Series D Preferred for a total purchase price of $15.1 million. The purchase price was paid by the cancellation +of $15.1 million of cash advances made by us to ROI between January 1, 2023 and November 9, 2023. Each share of ROI Series D Preferred +has a stated value of $25,000 per share and each share of ROI Series D Preferred is convertible into a number of shares of ROI’s +common stock determined by dividing the stated value by $0.51, subject to adjustment in the event of an issuance of ROI common stock at +a price per share lower than the conversion price, as well as upon customary stock splits, stock dividends, combinations or similar events. +The ROI Series D Preferred holders are entitled to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. +In addition, for as long as at least 25% of the ROI Series D Preferred remain outstanding, ROI must obtain our consent with respect to +certain corporate events, including reclassifications, fundamental transactions, stock redemptions or repurchases, increases in the number +of directors, and declarations or payment of dividends, and further ROI is subject to certain negative covenants, including covenants +against issuing additional shares of capital stock or derivative securities, incurring indebtedness, engaging in related party transactions, +selling of properties having a value of over $50,000, altering the number of directors, and discontinuing the business of any subsidiary, +subject to certain exceptions and limitations. However, pending approval of the transaction by ROI’s shareholders, the ROI Series +D Preferred is subject to a 19.99% beneficial ownership limitation. +Milton +C. Ault, III, our Executive Chairman, is also the Executive Chairman of ROI. Henry Nisser, our President, +General Counsel and a member of our board of directors, is also the President, General Counsel and a director of ROI. +Alzamend +In November 2022, we entered +into a marketing and brand development agreement with Alzamend, effective August 1, 2022, whereby we provided various marketing services +over twelve months valued at $1.4 million. Alzamend had the right to pay the fee in cash or shares of its common stock with a value of +$22.50 per share. On November 11, 2022, Alzamend elected to pay the fee in shares, and issued us 62,222 shares of its common stock. +On January 31, 2024, Ault +Lending entered into the January 2024 SPA with Alzamend, pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending +up to 6,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to purchase up to 6.0 million shares of Alzamend common stockfor +a total purchase price of up to $6.0 million. On January 31, 2024, Ault Lending purchased 1,220 +shares of ALZN Series B Preferred and warrants to purchase 1.22 million shares for a total purchase price of $1.22 million. The purchase +price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend between November 9, 2023 and January +31, 2023. On March 26, 2024, pursuant to the January 2024 SPA, Ault Lending purchased 780 +shares of ALZN Series B Preferred Stock and ALZN Series B Warrants to +purchase 780,000 shares of Alzamend common , for a purchase price of $780,000. As +of April 15, 2024, Ault Lending has purchased an aggregate of 2,000 shares of ALZN Series B Preferred and ALZN Series B Warrants +to purchase an aggregate of 2.0 million shares of Alzamend common stock, for an aggregate purchase +price of $2.0 million. +157 +Description of the ALZN Series B Preferred +The +terms of the ALZN Series B Preferred are as set forth in the Amended and Restated Certificates of Designations of the Rights, Preferences +and Limitations of the Series B Convertible Preferred Stock, as amended (the “ Series B Certificate of Designation ”). +Each share of ALZN Series B Preferred has a stated value of $1,000 per share (the “ALZN Stated Value ”). +The ALZN Series B Preferred does not accrue dividends. +Conversion Rights +Each +share of ALZN Series B Preferred is convertible into a number of shares of Alzamend common +stock (“ALZN Conversion Shares”) determined by dividing the ALZN Stated Value by +$1.00 (the “ALZN Conversion Price”). The ALZN Conversion Price is subject to adjustment in the event of an issuance +of common stock at a price per share lower than the ALZN Conversion Price then in effect, as well as upon customary stock splits, stock +dividends, combinations or similar events. +158 +Voting Rights +The +holders of the ALZN Series B Preferred are entitled to vote with the common stock as a single +class on an as-converted basis, subject to applicable law provisions of the Delaware General Company Law and Nasdaq, provided however, +that for purposes of complying with Nasdaq regulations, the conversion price, for purposes of determining the number of votes the holder +of ALZN Series B Preferred is entitled to cast, shall not be lower than $0.873 (the “ALZN +Voting Floor Price”). The ALZN Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other +similar transactions. +Liquidation Rights +In +the event of liquidation, dissolution, or winding up of Alzamend, the holders of ALZN Series B Preferred +have a preferential right to receive an amount equal to the ALZN Stated Value per share of ALZN +Series B Preferred before any distribution to other classes of capital stock. If the assets are insufficient, the distribution +will be prorated among the holders of ALZN Series B Preferred . The remaining assets, if any, +will then be distributed pro rata to the holders of outstanding Alzamend common stock. Any transaction that constitutes a change of control +transaction shall be deemed to be a liquidation under the Series B Certificate of Designation. +Description of the +Series B Warrants +At +each closing, Alzamend will issue Ault Lending Series B Warrants, which grant Ault Lending the right to purchase a specified number of +Alzamend common stock (the “ALZN Warrant Shares”). The exercise price of the Series B Warrants is $1.20 (the “ALZN Exercise +Price”) and the number of ALZN Warrant Shares is equal to the number of ALZN Conversion Shares issuable upon the ALZN +Series B Preferred issued at that closing. The ALZN Exercise Price is subject to adjustment in the event of an issuance of common +stock at a price per share lower than the ALZN Exercise Price then in effect, as well as upon customary stock splits, stock dividends, +combinations or similar events. +The +Series B Warrants become exercisable on the first business day after the six-month anniversary of issuance (the “ALZN Initial Exercise +Date”) and have a five-year term, expiring on the fifth anniversary of the ALZN Initial Exercise Date. +Messrs. Ault, Horne and Nisser +are each paid $50,000 annually by Alzamend. +Milton +C. Ault, III, our Executive Chairman, is also the Vice Chairman of Alzamend. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also the Chairman of Alzamend . +Henry Nisser, our President, General Counsel and a member of our board of directors, is also the Executive Vice President, General Counsel +and a director of Alzamend. +Avalanche +On September 6, 2017, we entered into the AVLP Loan Agreement with +an effective date of August 21, 2017, pursuant to which we provided Avalanche a non-revolving credit facility. The AVLP Loan Agreement +has been increased to up to $20.0 million and extended to December 31, 2023. +At December 31, 2021, we had provided Avalanche with $17.8 million +and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase 35.6 million shares of AVLP common +stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. As of December 31, 2021, +we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and a provision for loan losses of $2.0 +million. The warrants issued in conjunction with the non-revolving credit facility entitles us to purchase up to 35.6 million shares of +Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment +for customary stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +While Avalanche received funds from a third party in the amount of +$2.75 million in early April of 2019 in consideration for its issuance of the Third Party Note, $2.7 million was used to pay an outstanding +receivable due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, +Ault Alpha repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. In consideration +therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note had a maturity date of June 30, +2022. +159 +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for the Ault Alpha Note. The Ault Alpha Note is convertible, subject to adjustment, at $0.50 +per share. AVLP also issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise +price of $0.50. Pursuant to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered +into by and among the foregoing parties, our company and certain other persons, Ault Alpha was granted a second priority interest in AVLP’s +assets securing the repayment of the Ault Alpha Note. In connection with the liquidation of Ault Alpha in December 2023, Ault Lending +assumed the Ault Alpha Note, the warrants to purchase Avalanche common stock and the secured party rights. +On July 11, 2022, AVLP issued +us the AVLP Note. The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an +aggregate of 41.0 million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into +by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and +certain other persons, we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +We previously held the Prior +AVLP Note. On June 1, 2022, we converted the entire principal and accrued interest on the Prior AVLP Note into an aggregate of 51.9 million +shares of common stock of Avalanche, representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. +There is currently no liquid market for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common +stock on the open market, our ability to do so would be severely limited. Avalanche is not current in its filings with the SEC and is +not required to register the shares of its common stock underlying the Prior AVLP Note or any other loan arrangement we have made with +Avalanche described above. +Mr. Ault is paid $100,000 +annually by AVLP, and each of Messrs. Horne and Nisser is paid $50,000 annually by AVLP. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is a former affiliate +of our company, whereby Ault Lending was the largest limited partner and Ault & Company controlled the general partner and investment +manager. See immediately above for its involvement with respect to the Third Party Note. In addition, Ault Alpha previously purchased +an aggregate of 27,199 shares of our common stock and 101,362 Series D Preferred Shares, for aggregate purchase prices of $28.4 million +and $2.3 million, respectively. In connection with the liquidation of Ault Alpha on December 28, 2023, those shares of common stock and +Series D Preferred Shares were distributed to Ault Lending, who then returned the shares to our treasury. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. Bentz +Yes +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairman of committee +X – Member of committee +160 +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +Marcum LLP served as our independent +registered public accounting firm for the years ended December 31, 2023 and 2022. Ziv Haft, a BDO Member Firm, served as the independent +registered public accounting firm of Enertec for the years ended December 31, 2023 and 2022. +Fees and Services +The following table shows +the aggregate fees billed to us for professional services by Marcum LLP and Ziv Haft for the years ended December 31, 2023 and 2022: +2023 +2022 +Audit Services +$ 2,241,000 +$ 3,280,000 +Audit-Related Services +— +— +Tax Services +— +— +All Other Services +— +— +Total +$ 2,241,000 +$ 3,280,000 +Audit Fees. This +category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years +ended December 31, 2023 and 2022, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2023 +and 2022, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings +or engagements for the relevant years. +Audit-Related Fees. This +category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors +that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under “Audit +Fees,” and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, +internal control-related matters, and audits of employee benefit plans. +Tax Fees . This category +includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax +compliance, tax planning and tax advice. +All Other Fees. This +category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors +that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s +policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, +tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent +auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such +pre-approval. +161 +PART IV +ITEM 15. EXHIBITS +Exhibit +Number +Description +2.1 +Agreement and Plan of Merger dated January 7, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 3.1 thereto. +2.2 +Agreement and Plan of Merger dated December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 2.1 thereto. +2.3 +Agreement and Plan of Merger dated December 20, 2022. Incorporated by reference to the Current Report on Form 8-K filed on December 21, 2022 as Exhibit 2.1 thereto. +3.1 +Certificate of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.1 thereto. +3.2 +Certificate of Designations of Rights and Preferences of 10% Series A Cumulative Redeemable Perpetual Preferred Stock, dated September 13, 2018. Incorporated herein by reference to the Current Report on Form 8-K filed on September 14, 2018 as Exhibit 3.1 thereto. +3.3 +Certificate of Amendment to Certificate of Incorporation, dated January 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2019 as Exhibit 3.1 thereto. +3.4 +Certificate of Amendment to Certificate of Incorporation (1-for-20 Reverse Stock Split of Common Stock), dated March 14, 2019. Incorporated herein by reference to the Current Report on Form 8-K filed on March 14, 2019 as Exhibit 3.1 thereto. +3.5 +Certificate of Ownership and Merger. Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 2.1 thereto. +3.6 +Certificate of Ownership and Merger, as filed with the Secretary of State of the State of Delaware on December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 3.1 thereto. +3.7 +Certificate of Designation, Preferences and Rights relating to the 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated May 25, 2022. Incorporated by reference to the Registration Statement on Form 8-A filed on May 26, 2022 as Exhibit 3.6 thereto. +3.8 +Certificate of Increase of the Designated Number of Shares of 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated June 10, 2022. Incorporated by reference to the Current Report on Form 8-K filed on June 14, 2022 as Exhibit 3.1 thereto. +3.9 +Certificate of Correction to the Certificate of Designation, Rights and Preferences of 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated June 16, 2022. Incorporated by reference to the Current Report on Form 8-K filed on June 17, 2022 as Exhibit 3.1 thereto. +3.10 +Certificate of Amendment to Certificate of Incorporation (1-for-300 Reverse Stock Split of Common Stock), dated May 15, 2023. Incorporated herein by reference to the Current Report on Form 8-K filed on May 16, 2023 as Exhibit 3.1 thereto. +3.11 +Certificate of Elimination of the Series E convertible redeemable preferred stock of Ault Alliance, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on August 18, 2023 as Exhibit 3.1 thereto. +3.12 +Certificate of Elimination of the Series F convertible redeemable preferred stock of Ault Alliance, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on August 18, 2023 as Exhibit 3.2 thereto. +3.13 +Certificate of Elimination of the Series G convertible redeemable preferred stock of Ault Alliance, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on August 18, 2023 as Exhibit 3.3 thereto. +3.14 +Certificate of Designation of Preferences, Rights and Limitations of Series C Cumulative Preferred Stock, dated November 15, 2023. Incorporated herein by reference to the Current Report on Form 8-K filed on November 21, 2023 as Exhibit 3.1 thereto. +3.15 +Certificate of Elimination of the Series B convertible redeemable preferred stock of Ault Alliance, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on December 12, 2023 as Exhibit 3.1 thereto. +3.16 +Certificate of Amendment to Certificate of Incorporation filed with the Delaware Secretary of State on January 12, 2024. Incorporated by reference to the Current Report on Form 8-K filed on January 12, 2024 as Exhibit 3.2 thereto. +3.17 +Second Amended and Restated Bylaws, effective as of January 11, 2024. Incorporated by reference to the Current Report on Form 8-K filed on January 12, 2024 as Exhibit 3.1 thereto. +3.18 +Certificate of Increase to Certificate Designations of Preferences, Rights and Limitations of Series C Convertible Preferred Stock. Incorporated herein by reference to the Current Report on Form 8-K filed on April 4, 2024 as Exhibit 3.1 thereto. +4.1 +Form of Warrant, dated as of May 28, 2020. Incorporated by reference to the Current Report on Form 8-K filed on May 29, 2020 as Exhibit 4.3 thereto. +4.2 +Form of Warrant, dated June 26, 2020. Incorporated by reference to the Current Report on Form 8-K filed on June 29, 2020 as Exhibit 4.2 thereto. +4.3 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on July 17, 2020 as Exhibit 4.2 thereto. +4.4 +Form of Warrant, dated October 22, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 23, 2020 as Exhibit 4.2 thereto. +162 +Exhibit +Number +Description +4.5 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.3 thereto. +4.6 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.4 thereto. +4.7 +Form of Warrant issued to Esousa Holdings, LLC, dated November 19, 2020. Incorporated by reference to the Current Report on Form 8-K filed on November 20, 2020 as Exhibit 4.3 thereto. +4.8 +Form of Senior Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.1 thereto. +4.9 +Form of Subordinated Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.2 thereto. +4.10 +Form of Class A Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.2 thereto. +4.11 +Form of Class B Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.3 thereto. +4.12 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2022 as Exhibit 4.1 thereto. +4.13 +Form of Class A Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 4.1 thereto. +4.14 +Form of Class B Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 4.2 thereto. +4.15 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 4.1 thereto. +4.16 +Form of amendment #1 to senior secured promissory note. Incorporated by reference to the Quarterly Report on Form 10-Q filed on May 22, 2023 as Exhibit 10.7 thereto. +4.17 +Form of 7.00% Senior Note due 2024. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 4.1 thereto. +4.18 +Form of 8.50% Senior Note due 2026. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 4.2 thereto. +4.19 +Form of 10.50% Senior Note due 2028. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 4.3 thereto. +4.20 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on September 28, 2023 as Exhibit 4.1 thereto. +4.21 +Form of Warrant issued October 13, 2023. Incorporated by reference to the Current Report on Form 8-K filed on October 16, 2023 as Exhibit 4.2 thereto. +4.22 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 7, 2023 as Exhibit 10.2 thereto. +4.23 +Securities Purchase Agreement, dated as of November 14, 2023, by and between Ault Alliance, Inc. and RiskOn International, Inc. Incorporated by reference to the Current Report on Form 8-K filed on November 15, 2023 as Exhibit 10.1 thereto. +4.24 +Form of Certificate of Designations of Rights, Preferences and Limitations of Series D Convertible Preferred Stock of RiskOn International, Inc. Incorporated by reference to the Current Report on Form 8-K filed on November 15, 2023 as Exhibit 10.2 thereto. +4.25 +Note Purchase Agreement, dated March 11, 2024, by and among the Company and the Investors. Incorporated by reference to the Current Report on Form 8-K filed on March 12, 2024 as Exhibit 10.1 thereto. +4.26 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on March 12, 2024 as Exhibit 4.1 thereto. +4.27** +Description of Capital Stock. +10.1 +Loan and Security Agreement between the Company and Avalanche International Corp., dated August 21, 2017. Incorporated by reference to the Current Report on Form 8-K filed on September 7, 2017 as Exhibit 10.1 thereto. +10.2 +Amendment to MTIX Limited Purchase Order Number 2121. Incorporated by reference to the Current Report on Form 8-K filed on February 25, 2020 as Exhibit 10.2 thereto. +10.3* +2021 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix B thereto . +10.4* +2021 Employee Stock Purchase Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix C thereto. +10.5* +Form of Stock Option Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.3 thereto. +10.6* +Form of Restricted Stock Unit Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.4 thereto. +163 +Exhibit +Number +Description +10.7 +Form of Construction Loan Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.1 thereto. +10.8 +Form of Mortgage, Assignment of Rents and Leases, Security Agreement and Fixture Filing. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.2 thereto. +10.9 +Form of Assignment of Leases, Rents and Profits. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.3 thereto. +10.10 +Form of Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.4 thereto. +10.11* +2022 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on September 23, 2022 as Annex B thereto . +10.12 +Form of Securities Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 10.1 thereto. +10.13 +Form of Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 10.3 thereto. +10.14 +Form of Amended and Restated Amendment to Securities Purchase Agreement. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2023 as Exhibit 10.4 thereto. +10.15 +Form of Share Exchange Agreement, entered into February 8, 2023. Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.1 thereto. +10.16 +Form of Series B Preferred Stock Certificate of Designations. Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.2 thereto. +10.17 +Form of Series C Preferred Stock Certificate of Designations. Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.3 thereto. +10.18 +Form of Ault Alliance, Inc. Investor Agreement relating to 7.00% Senior Notes due 2024, 8.50% Senior Notes due 2026 and 10.50% Senior Notes due 2028. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 10.1 thereto. +10.19 +Securities Exchange Agreement, dated September 27, 2023, by and between the Company and the Investor. Incorporated by reference to the Current Report on Form 8-K filed on September 28, 2023 as Exhibit 1 0 .1 thereto. +10.20 +Securities Purchase Agreement, dated November 6, 2023, by and between Ault Alliance, Inc. and Ault & Company, Inc. Incorporated by reference to the Current Report on Form 8-K filed on November 7, 2023 as Exhibit 10.1 thereto. +10.21 +Form of Loan and Guaranty Agreement, dated December 14, 2023. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.1 thereto. +10.22 +Form of Security Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.2 thereto. +10.23 +Form of Security Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.3 thereto. +10.24 +Form of Florida Mortgage. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.4 thereto. +10.25 +Form of Michigan Mortgage. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.5 thereto. +10.26 +Form of Aircraft Mortgage. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.6 thereto. +10.27 +Amendment to the Securities Purchase Agreement, Certificate of Designation and Series C Warrants, dated March 25, 2024. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2024 as Exhibit 10.3 thereto. +10.28** +Luxor Mining Pool Service Level Agreement, dated March 28, 2023, by and between Bitnile Inc. (n/k/a Sentinum Inc.) and Luxor Technology Corporation. +10.29** +Master Services Agreement, dated March 23, 2023, by and between Bitnile, Inc. (n/k/a Sentinum Inc.) and Core Scientific, Inc. +10.30 +Amendment to the Loan and Guaranty Agreement, dated April 15, 2024. Incorporated by reference to the Current Report on Form 8-K filed on April 16, 2024 as Exhibit 10.1 thereto. +21** +List of subsidiaries. +23.1** +Consent of Marcum LLP. +23.2** +Consent of Ziv Haft, BDO member firm. +31.1** +Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a). +31.2** +Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a). +32.1*** +Certification of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. +97.1** +Ault Alliance, Inc. Clawback Policy. +101.INS** +Inline XBRL Instance Document. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH** +Inline XBRL Taxonomy Extension Schema Document. +101.CAL** +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF** +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB** +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE** +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +* +Indicates management contract or compensatory plan or arrangement. +** +Filed herewith. +*** +Furnished herewith. +ITEM 16. FORM 10–K SUMMARY +None. +164 +SIGNATURES +Pursuant to the requirements of Section 13 +or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned +thereunto duly authorized. +Dated: April 16, 2024 +AULT ALLIANCE, INC. +By: +/s/ William B. Horne +William B. Horne +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ Kenneth S. Cragun +Kenneth S. Cragun +Chief Financial Officer +(Principal Financial and Accounting Officer) +Pursuant to the requirements of the Securities +Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +April 16, 2024 +/s/ Milton C. Ault, III +Milton C. Ault, III, Executive Chairman of the Board +April 16, 2024 +/s/ William B. Horne +William B. Horne, Chief Executive Officer and Director +April 16, 2024 +/s/ Henry Nisser +Henry Nisser, President, General Counsel and Director +April 16, 2024 +/s/ Howard Ash +Howard Ash, Director +April 16, 2024 +/s/ Robert O. Smith +Robert O. Smith, Director +April 16, 2024 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, Director +April 16, 2024 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +165 +ITEM 8. FINANCIAL STATEMENTS +AULT ALLIANCE, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm – Marcum LLP (PCAOB ID Number 688 ) +F-2 +Report of Independent Registered Public Accounting Firm – Ziv Haft. (PCAOB ID Number 1185) +F-4 +Consolidated Balance Sheets as of December 31, 2023 and 2022 +F-6 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2023 and 2022 +F-8 +Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2023 and 2022 +F-9 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2023 and 2022 +F-11 +Notes to Consolidated Financial Statements +F-13 – F-54 +F- 1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Stockholders and Board of Directors of +Ault Alliance, Inc. and Subsidiaries +Opinion on the Financial Statements +We have audited the statements of financial +position of Enertec systems 2001 Ltd. (“the Company”) as of December 31, 2023 and 2022, the related statements of comprehensive +profit /(loss), changes in shareholders’ equity, and cash flows for each of the years then ended, and the related notes (collectively, +the financial statements (not presented herein)). In our opinion, the financial statements present fairly, in all material respects, the +financial position of the Company at December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then +ended, in conformity with accounting principles generally accepted in the United States of America. +We did not audit the December 31, 2023 and 2022 +financial statements of Enertec Systems 2001 Ltd., a wholly-owned subsidiary, which statements reflect 5% and 3% of the total consolidated +assets as of December 31, 2023 and 2022, respectively, 10% and 11% of the total consolidated revenues for the year ended December 31, +2023 and 2022, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar +as it relates to the amounts included for Enertec Systems 2001 Ltd., is based solely on the report of the other auditors. +Explanatory Paragraph – Going Concern +The accompanying consolidated financial statements +have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the Company has a working +capital deficiency, has incurred net losses and needs to raise additional funds to meet its obligations and sustain its operations. These +conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard +to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result +from the outcome of this uncertainty. +Basis for Opinion +These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our +audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) +and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable +rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the +standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial +statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged +to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding +of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s +internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is +a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the +audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially +challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on +the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion +on the critical audit matter or on the accounts or disclosures to which it relates. +F- 2 +Evaluation +of the Accounting for and Disclosure of Bitcoin Mining Revenue +As disclosed in Note 3, the Company participates +in a digital asset mining pool by providing hash calculation services to the mining pool operator. During the years ended December 31, +2023 and 2022, the Company recognized revenue from bitcoin mining of approximately $33.1 million and $16.7 million, respectively. +We identified the auditing of revenue recognized +from bitcoin mining as a critical audit matter due to the nature and extent of audit effort required to perform audit procedures over +the completeness and occurrence of bitcoin mining revenue recognized by the Company. +The primary procedures we performed to address +this critical audit matter included the following: +· We performed site visits of the facilities where the Company’s mining hardware is located, which +included observations of the physical controls and mining equipment observation procedures. +· On a sample basis, we tested the hash calculation services contributed by the Company’s mining hardware. +· We performed certain substantive analytical procedures developing an expectation for the amount to be +recorded using hash calculation services data, the calculation prescribed in the contract with the mining pool operator and electricity +consumption data and comparing our expectation to the amount recorded by the Company. +· We evaluated and tested management’s valuation of bitcoin earned by obtaining independent bitcoin +prices and comparing those to the prices used by the Company. +· We obtained and evaluated the contract with the third-party mining pool operator and independently confirmed +with the third-party mining pool operator the significant contractual terms utilized in the determination of mining revenue, total mining +rewards earned, and the digital asset wallet addresses in which the rewards are deposited. +· We independently obtained evidence from the Bitcoin blockchain to test the occurrence and accuracy of +mining revenue. +/s/ Marcum llp +Marcum llp +We have served as the Company’s auditor +since 2016. +New York, New York +April 16, 2024 +F- 3 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING +FIRM +To the Board of Directors and Management of Enertec systems 2001 Ltd. +Karmiel, Israel. +Opinion on the Financial Statements +We have audited the statements of financial position of Enertec systems +2001 Ltd. ("the Company") as of December 31, 2023 and 2022, the related statements of comprehensive profit /(loss), changes +in shareholders' equity, and cash flows for each of the years then ended, and the related notes (collectively, the financial statements +(not presented herein)). In our opinion, the financial statements present fairly, in all material respects, the financial position of +the Company at December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity +with accounting principles generally accepted in the United States of America. +Basis for Opinion +These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are +a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be +independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of +the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the +standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require +that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, +whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over +financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but +not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, +we express no such opinion. +Our audits included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is +a matter arising from the current period audit of the financial statements that was communicated and that: (1) relates to accounts or +disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. +The communication of critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we +are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts +or disclosures to which it relates. +Estimation of total contract +costs to be incurred for fixed-price long-term contract revenue +As described in Note 2 to the financial statements, +the Company recognizes a significant portion of its revenue over time using the cost-to-cost measure of progress, which measures a contract's +progress toward completion based on the ratio of actual contract costs incurred to date to the Company’s estimated costs at completion. +The cost estimation process for these contracts is based on the knowledge and experience of the Company's project managers, engineers, +and financial professionals. Changes in job performance, job conditions and management’s assessment of expected variable consideration +are factors that influence estimates of the total contract transaction price, total costs to complete those contracts and the Company’s +revenue recognition. +F- 4 +We identified estimated costs to complete on certain +revenue contracts as a critical audit matter. The determination of the total estimated cost and progress toward completion requires management +to make significant estimates and assumptions. Total estimated costs to complete projects include various costs such as direct labor, +material, and subcontract costs. Changes in these estimates can have a significant impact on the revenue recognized each period. Auditing +these estimates involved especially challenging auditor judgment in evaluating the reasonableness of management’s assumptions and +estimates over the duration of these contracts. +The primary procedures we performed to address +this critical audit matter included: +· Examining a sample of revenue contracts to evaluate the appropriateness of the Company’s identification +of performance obligations and the determination of method for measuring contract progress. +· Assessing the reasonableness of the estimated costs to complete by selecting a sample of open projects +and (i) testing consistency of the estimated total contract costs projected in the current year versus the original or prior period, (ii) +assessing the status of completion by testing of a sample of project costs incurred to date and interviewing the Company’s management +to evaluate progress to date, the estimate of remaining costs to be incurred, and factors impacting the amount of time and cost to complete. +· Assessing the reasonableness of changes in estimated costs to complete by comparing project profitability +estimates in the current period to historical estimates and actual performance and investigating reasons for changes in expected costs +and project margins. +· Evaluating the reasonableness of management’s budgeting process by selecting a sample of contract +budgets for projects that were completed during the period and performing a retrospective review of budget to actual variances. +/S/ Ziv Haft. +Certified Public Accountants (Isr.) +BDO Member Firm +We have served as the Company’s auditor since 2012. +Tel-Aviv, Israel +April 15, 2024 +F- 5 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +December 31, +2023 +2022 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ 8,626,000 +$ 7,942,000 +Restricted cash +4,966,000 +732,000 +Cash and marketable securities held in trust account +- +118,193,000 +Marketable equity securities +27,000 +6,590,000 +Accounts receivable, net +10,839,000 +19,322,000 +Inventories +8,384,000 +22,036,000 +Investment in promissory notes and other, related party +3,968,000 +2,868,000 +Loans receivable, current +1,234,000 +7,593,000 +Prepaid expenses and other current assets +9,450,000 +5,074,000 +Current assets of discontinued operations +90,991,000 +5,959,000 +TOTAL CURRENT ASSETS +138,485,000 +196,309,000 +Cash and marketable securities held in trust account +2,200,000 +- +Intangible assets, net +5,754,000 +34,786,000 +Goodwill +6,088,000 +27,902,000 +Property and equipment, net +108,829,000 +146,779,000 +Right-of-use assets +6,315,000 +8,419,000 +Investments in common stock, related parties +679,000 +6,449,000 +Investments in other equity securities +21,767,000 +42,494,000 +Other assets +9,073,000 +5,841,000 +Non-current assets of discontinued operations +- +92,535,000 +TOTAL ASSETS +$ 299,190,000 +$ 561,514,000 +LIABILITIES AND STOCKHOLDERS’ EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ +66,443,000 +$ 60,428,000 +Operating lease liability, current +2,119,000 +2,975,000 +Notes payable, current +12,866,000 +39,621,000 +Notes payable, related party, current +2,375,000 +352,000 +Convertible notes payable, current +11,763,000 +1,325,000 +Redeemable non-controlling interests in equity of subsidiaries +- +117,993,000 +Guarantee liability +38,900,000 +- +Current liabilities of discontinued operations +70,361,000 +2,631,000 +TOTAL CURRENT LIABILITIES +204,827,000 +225,325,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 6 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +December 31, +December 31, +2023 +2022 +LONG TERM LIABILITIES +Operating lease liability, non-current +4,402,000 +5,836,000 +Notes payable, non-current +18,158,000 +29,831,000 +Convertible notes payable, non-current +9,453,000 +11,451,000 +Deferred underwriting commissions of Ault Disruptive Technologies Corporation (“Ault Disruptive”) subsidiary +3,450,000 +3,450,000 +Non-current liabilities of discontinued operations +- +61,633,000 +TOTAL LIABILITIES +240,290,000 +337,526,000 +COMMITMENTS AND CONTINGENCIES +Redeemable non-controlling interests in equity of subsidiaries +2,224,000 +- +STOCKHOLDERS’ EQUITY +Series A Convertible Preferred Stock, $ 25 stated value per share, $ 0.001 par value – 1,000,000 shares authorized; 7,040 shares issued and outstanding at December 31, 2023 and December 31, 2022 (liquidation preference of $ 176,000 as of December 31, 2023 and December 31, 2022) +- +- +Series B Convertible Preferred Stock, $ 10 stated value per share, share, $ 0.001 par value – 500,000 shares authorized; 0 and 125,000 shares issued and outstanding at December 31, 2023 and 2022, respectively (liquidation preference of $ 0 and $ 1,190,000 at December 31, 2023 and 2022, respectively) +- +- +Series C Convertible Preferred Stock, $ 1,000 stated value per share, share, $ 0.001 par value – 50,000 shares authorized; 41,500 and 0 shares issued and outstanding at December 31, 2023 and December 31, 2022, respectively (liquidation preference of $ 41,500,000 at December 31, 2023) +- +- +Series D Cumulative Redeemable Perpetual Preferred Stock, $ 25 stated value per share, $ 0.001 par value – 2,000,000 shares authorized; 425,197 shares and 172,838 shares issued and outstanding at December 31, 2023 and December 31, 2022, respectively (liquidation preference of $ 10,630,000 and $ 4,321,000 as of December 31, 2023 and December 31, 2022, respectively) +- +- +Class A Common Stock, $ 0.001 par value – 500,000,000 shares authorized; 4,483,459 and 50,966 shares issued and outstanding at December 31, 2023 and December 31, 2022, respectively +4,000 +- +Class B Common Stock, $ 0.001 par value – 25,000,000 shares authorized; 0 shares issued and outstanding at December 31, 2023 and December 31, 2022 +- +- +Additional paid-in capital +644,852,000 +565,905,000 +Accumulated deficit +( 567,469,000 ) +( 329,078,000 ) +Accumulated other comprehensive loss +( 2,097,000 ) +( 1,100,000 ) +Treasury stock, at cost +( 30,571,000 ) +( 29,235,000 ) +TOTAL AULT ALLIANCE STOCKHOLDERS’ EQUITY +44,719,000 +206,492,000 +Non-controlling interest +11,957,000 +17,496,000 +TOTAL STOCKHOLDERS’ EQUITY +56,676,000 +223,988,000 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ 299,190,000 +$ 561,514,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 7 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE +LOSS +For the Year Ended +December 31, +2023 +2022 +Revenue +$ 76,137,000 +$ 61,561,000 +Revenue, digital currencies mining +33,107,000 +16,693,000 +Revenue, crane operations +49,198,000 +2,739,000 +Revenue, lending and trading activities +( 1,998,000 ) +36,644,000 +Total revenue +156,444,000 +117,637,000 +Cost of revenue, products +57,788,000 +44,508,000 +Cost of revenue, digital currencies mining +36,446,000 +21,508,000 +Cost of revenue, crane operations +29,971,000 +940,000 +Cost of revenue, lending and trading activities +1,180,000 +- +Total cost of revenue +125,385,000 +66,956,000 +Gross profit +31,059,000 +50,681,000 +Operating expenses +Research and development +7,234,000 +2,773,000 +Selling and marketing +33,529,000 +29,364,000 +General and administrative +77,806,000 +60,302,000 +Impairment of goodwill and intangible assets +47,561,000 +13,064,000 +Impairment of property and equipment +18,161,000 +79,556,000 +Impairment of deposit due to vendor bankruptcy filing +- +2,000,000 +Impairment of mined digital currencies +489,000 +3,099,000 +Total operating expenses +184,780,000 +190,158,000 +Loss from operations +( 153,721,000 ) +( 139,477,000 ) +Other income (expense): +Interest and other income +5,294,000 +2,594,000 +Interest expense +( 36,595,000 ) +( 37,342,000 ) +Interest expense, related party +( 664,000 ) +- +Other expense, guarantee +( 35,400,000 ) +- +Loss on extinguishment of debt +( 8,719,000 ) +- +Loss on extinguishment of debt, related party +( 4,164,000 ) +- +Loss from investment in unconsolidated entity +( 302,000 ) +( 924,000 ) +Loss on deconsolidation of subsidiary +( 3,040,000 ) +- +Impairment of equity securities +( 9,555,000 ) +( 11,500,000 ) +Gain from bargain purchase of business +- +806,000 +Gain on the sale of fixed assets +2,069,000 +- +Change in fair value of warrant and derivative liabilities +4,544,000 +( 2,580,000 ) +Total other expense, net +( 86,532,000 ) +( 48,946,000 ) +Loss before income taxes +( 240,253,000 ) +( 188,423,000 ) +Income tax provision (benefit) +337,000 +( 4,485,000 ) +Net loss from continuing operations +( 240,590,000 ) +( 183,938,000 ) +Net loss from discontinued operations +( 15,704,000 ) +( 5,895,000 ) +Net loss +( 256,294,000 ) +( 189,833,000 ) +Net loss attributable to non-controlling interest +25,268,000 +8,017,000 +Net loss attributable to Ault Alliance, Inc. +( 231,026,000 ) +( 181,816,000 ) +Preferred dividends +( 1,375,000 ) +( 393,000 ) +Net loss available to common stockholders +$ ( 232,401,000 ) +$ ( 182,209,000 ) +Basic and diluted net loss per common share: +Continuing operations +$ ( 306.07 ) +$ ( 5,877.13 ) +Discontinued operations +( 22.18 ) +( 196.50 ) +Net loss per common share +$ ( 328.25 ) +$ ( 6,073.63 ) +Weighted average basic and diluted common shares outstanding +708,000 +30,000 +Comprehensive loss +Net loss available to common stockholders +$ ( 232,401,000 ) +$ ( 182,209,000 ) +Foreign currency translation adjustment +( 997,000 ) +( 995,000 ) +Other comprehensive loss +( 997,000 ) +( 995,000 ) +Total comprehensive loss +$ ( 233,398,000 ) +$ ( 183,204,000 ) +The accompanying +notes are an integral part of these consolidated financial statements. +F- 8 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Preferred Stock +Additional +Other +Non- +Total +Series A +Series B +Series C +Series D +Class A Common Stock +Paid-In +Accumulated +Comprehensive +Controlling +Treasury +Stockholders’ +Shares +Par Amount +Shares +Par Amount +Shares +Par Amount +Shares +Par Amount +Shares +Amount +Capital +Deficit +Loss +Interest +Stock +Equity +BALANCES, January 1, 2023 +7,040 +$ - +125,000 +$ - +- +$ - +172,838 +$ - +50,966 +$ - +$ 565,905,000 +$ ( 329,078,000 ) +$ ( 1,100,000 ) +$ 17,496,000 +$ ( 29,235,000 ) +$ 223,988,000 +Issuance of Class A common stock for restricted stock awards +- +- +- +- +- +- +- +- +199 +- +- +- +- +- +- +- +Issuance of Series C preferred stock, related party +- +- +- +- +41,500 +- +- +- +- +- +27,042,000 +- +- +- +- +27,042,000 +Fair value of warrants issued in connection with Series C preferred stock, related party +- +- +- +- +- +- +- +- +- +- +10,958,000 +- +- +- +- +10,958,000 +Series C preferred stock issuance costs +- +- +- +- +- +- +- +- +- +- +( 500,000 ) +- +- +- +- +( 500,000 ) +Issuance of Series D preferred stock +- +- +- +- +- +- +252,359 +- +- +- +2,982,000 +- +- +- +- +2,982,000 +Series D preferred stock offering costs +- +- +- +- +- +- +- +- +- +- +( 105,000 ) +- +- +- +- +( 105,000 ) +Series B preferred stock exchanged for convertible note, related party +- +- +( 125,000 ) +- +- +- +- +- +- +- +( 1,190,000 ) +- +- +- +- +( 1,190,000 ) +Stock-based compensation +6,615,000 +- +- +4,253,000 +- +10,868,000 +Issuance of Class A common stock for cash +- +- +- +- +- +- +- +- +4,340,336 +4,000 +39,411,000 +- +- +- +- +39,415,000 +Financing cost in connection with sales of Class A common stock +- +- +- +- +- +- +- +- +- +- +( 1,344,000 ) +- +- +- +- +( 1,344,000 ) +Issuance of Class A common stock for conversion of preferred stock liabilities +- +- +- +- +- +- +- +- +5,736 +- +912,000 +- +- +- +- +912,000 +Issuance of Class A common stock for conversion of debt +- +- +- +- +- +- +- +- +84,632 +- +527,000 +- +- +- +- +527,000 +Class A common stock issued in connection with issuance of notes payable +- +- +- +- +- +- +- +- +1,590 +- +162,000 +- +- +- +- +162,000 +Warrants issued in connection with issuance of convertible notes payable, related party +- +- +- +- +- +- +- +- +- +- +4,164,000 +- +- +- +- +4,164,000 +Remeasurement of Ault Disruptive subsidiary temporary equity +- +- +- +- +- +- +- +- +- +- +- +( 5,990,000 ) +- +- +- +( 5,990,000 ) +Increase in ownership interest of subsidiary +- +- +- +- +- +- +- +- +- +- +13,000 +- +- +( 1,086,000 ) +- +( 1,073,000 ) +Non-controlling interest in RiskOn International, Inc. (“ROI”) subsidiary acquired +- +- +- +- +- +- +- +- +- +- +- +- +- +6,357,000 +- +6,357,000 +Non-controlling interest in Eco Pack Technologies Limited (“Eco Pack”) subsidiary acquired +- +- +- +- +- +- +- +- +- +- +- +- +- +856,000 +- +856,000 +Sale of subsidiary stock to non-controlling interests +- +- +- +- +- +- +- +- +- +- +- +- +- +7,342,000 +- +7,342,000 +Distribution to Circle 8 Crane Services, LLC (“Circle 8”) non-controlling interest +- +- +- +- +- +- +- +- +- +- +- +- +- +( 729,000 ) +- +( 729,000 ) +Deconsolidation of The Singing Machine Company, Inc. (“SMC”) +- +- +- +- +- +- +- +- +- +- +- +- +- +( 7,966,000 ) +- +( 7,966,000 ) +Purchase of treasury stock - Ault Alpha LP (“Ault Alpha”) +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 1,336,000 ) +( 1,336,000 ) +Net loss +- +- +- +- +- +- +- +- +- +- +- +( 231,026,000 ) +- +- +- +( 231,026,000 ) +Preferred dividends +- +- +- +- +- +- +- +( 1,375,000 ) +- +- +- +( 1,375,000 ) +Foreign currency translation adjustments +- +- +- +- +- +- +- +- +- +- +- +- +( 997,000 ) +- +- +( 997,000 ) +Net loss attributable to non-controlling interest +- +- +- +- +- +- +- +- +- +- +- +- +- +( 25,268,000 ) +- +( 25,268,000 ) +Distribution of securities of TurnOnGreen, Inc. (“TurnOnGreen”) to Ault Alliance Class A common stockholders ($2.02 per share) +- +- +- +- +- +- +- +- +- +- +( 10,700,000 ) +- +- +10,700,000 +- +- +Other +- +- +- +- +- +- +- +- +- +- +- +- +- +2,000 +2,000 +BALANCES, December 31, 2023 +7,040 +$ - +- +$ - +41,500 +$ - +425,197 +$ - +4,483,459 +$ 4,000 +$ 644,852,000 +$ ( 567,469,000 ) +$ ( 2,097,000 ) +$ 11,957,000 +$ ( 30,571,000 ) +$ +56,676,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 9 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Preferred Stock +Additional +Other +Non- +Total +Series A +Series B +Series D +Class A Common Stock +Paid-In +Accumulated +Comprehensive +Controlling +Treasury +Stockholders’ +Shares +Par Amount +Shares +Par Amount +Shares +Par Amount +Shares +Amount +Capital +Deficit +Loss +Interest +Stock +Equity +BALANCES, January 1, 2022 +7,040 +$ - +125,000 +$ - +- +$ - +11,246 +$ - +$ 385,728,000 +$ ( 145,600,000 ) +$ ( 106,000 ) +$ 1,613,000 +$ ( 13,180,000 ) +$ 228,455,000 +Issuance of Class A common stock for restricted stock awards +- +- +- +- +- +- +125 +- +- +- +- +- +- +- +Series D preferred stock issued for cash +- +- +- +- +172,838 +- +- +- +4,321,000 +- +- +- +- +4,321,000 +Series D preferred stock offering costs +- +- +- +- +- +- +- +- +( 811,000 ) +- +- +- +- +( 811,000 ) +Stock-based compensation +- +- +6,363,000 +- +- +839,000 +- +7,202,000 +Issuance of Gresham Worldwide common stock for Gresham Worldwide, Inc., formerly known as Giga-tronics Incorporated (“GIGA”) acquisition +- +- +- +- +- +- +- +- +1,669,000 +- +- +- +- +1,669,000 +Issuance of Class A common stock for cash +- +- +- +- +- +- +38,048 +- +172,253,000 +- +- +- +- +172,253,000 +Financing cost in connection with sales of Class A common stock +- +- +- +- +- +- +- +- +( 4,210,000 ) +- +- +- +- +( 4,210,000 ) +Issuance of Class A common stock upon exercise of warrants +- +- +- +- +- +- +1,547 +- +1,196,000 +- +- +- +- +1,196,000 +Fair value of warrants issued in connection with notes payable +- +- +- +- +- +- +- +- +1,296,000 +- +- +- +- +1,296,000 +Remeasurement of Ault Disruptive subsidiary temporary equity +- +- +- +- +- +- +- +- +- +( 1,268,000 ) +- +- +- +( 1,268,000 ) +Increase in ownership interest of subsidiary +- +- +- +- +- +- +- +- +( 1,900,000 ) +- +- +( 2,365,000 ) +- +( 4,265,000 ) +Non-controlling interest from Avalanche International Corp. (“AVLP”) acquisition +- +- +- +- +- +- +- +- +- +- +- +7,790,000 +- +7,790,000 +Non-controlling interest from SMC acquisition +- +- +- +- +- +- +- +- +- +- +- +10,336,000 +- +10,336,000 +Non-controlling interest from GIGA acquisition +- +- +- +- +- +- +- +- +- +- +- +2,735,000 +- +2,735,000 +Non-controlling interest from Circle 8 acquisition +- +- +- +- +- +- +- +- +- +- +- +4,565,000 +- +4,565,000 +Purchase of treasury stock - Ault Alpha +- +- +- +- +- +- +- +- +- +- +- +- +( 16,054,000 ) +( 16,054,000 ) +Net loss +- +- +- +- +- +- +- +- +- +( 181,816,000 ) +- +- +- +( 181,816,000 ) +Preferred dividends +- +- +- +- +- +- +( 393,000 ) +- +- +- +( 393,000 ) +Foreign currency translation adjustments +- +- +- +- +- +- +- +- +- +- +( 995,000 ) +- +- +( 995,000 ) +Net loss attributable to non-controlling interest +- +- +- +- +- +- +- +- +- +- +- +( 8,017,000 ) +- +( 8,017,000 ) +Other +- +- +- +- +- +- +- +- +- +( 1,000 ) +1,000 +- +( 1,000 ) +( 1,000 ) +BALANCES, December 31, 2022 +7,040 +$ - +125,000 +$ - +172,838 +$ - +50,966 +$ - +$ 565,905,000 +$ ( 329,078,000 ) +$ ( 1,100,000 ) +$ 17,496,000 +$ ( 29,235,000 ) +$ 223,988,000 +The accompanying +notes are an integral part of these consolidated financial statements. +F- 10 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +For the Year Ended December 31, +2023 +2022 +Cash flows from operating activities: +Net loss +$ ( 256,294,000 ) +$ ( 189,833,000 ) +Net loss from discontinued operations +( 15,704,000 ) +( 5,895,000 ) +Net loss from continuing operations +( 240,590,000 ) +( 183,938,000 ) +Adjustments to reconcile net loss to net cash provided by operating activities: +Depreciation and amortization +26,974,000 +14,676,000 +Amortization of debt discount +21,507,000 +29,581,000 +Amortization of right-of-use assets +2,882,000 +1,745,000 +Other expense, guarantee +35,400,000 +- +Deferred tax benefit +- +( 5,000,000 ) +Impairment of goodwill and intangible assets +47,561,000 +13,064,000 +Impairment of property and equipment +18,161,000 +79,556,000 +Stock-based compensation +10,868,000 +7,202,000 +Impairment of deposit due to vendor bankruptcy filing +2,000,000 +Accretion of original issue discount on notes receivable +- +( 5,549,000 ) +Gain on the sale of fixed assets +( 2,069,000 ) +- +Impairment of equity securities +15,755,000 +11,500,000 +Impairment of digital currencies +489,000 +3,099,000 +Realized gain on the sale of digital currencies +( 520,000 ) +( 1,045,000 ) +Revenue, digital currencies mining +( 33,107,000 ) +( 16,693,000 ) +Realized gains on sale of marketable securities +( 8,437,000 ) +( 12,111,000 ) +Unrealized (gains) losses on marketable securities +( 2,509,000 ) +13,889,000 +Unrealized losses on investments in common stock, related parties +5,785,000 +11,682,000 +Unrealized gains on equity securities +- +( 41,994,000 ) +Income from cash held in trust +( 2,590,000 ) +- +Loss from investment in unconsolidated entity +302,000 +924,000 +Loss on remeasurement of investment in unconsolidated entity +- +2,700,000 +Provision for loan losses +1,180,000 +- +Change in the fair value of warrant and derivative liabilities +( 4,544,000 ) +1,672,000 +Loss on extinguishment of debt +12,883,000 +- +Loss on deconsolidation of subsidiary +3,040,000 +- +Other +( 1,173,000 ) +( 1,004,000 ) +Changes in operating assets and liabilities: +Proceeds from the sale of digital currencies +29,111,000 +15,832,000 +Marketable equity securities +46,457,000 +78,951,000 +Accounts receivable +( 415,000 ) +( 58,000 ) +Inventories +4,312,000 +( 1,068,000 ) +Prepaid expenses and other current assets +3,214,000 +3,802,000 +Other assets +( 3,232,000 ) +( 3,969,000 ) +Accounts payable and accrued expenses +15,662,000 +9,466,000 +Lease liabilities +( 3,187,000 ) +( 1,919,000 ) +Net cash (used in) provided by operating activities from continuing operations +( 830,000 ) +26,993,000 +Net cash used in operating activities from discontinued operations +( 4,598,000 ) +( 504,000 ) +Net cash (used in) provided by operating activities +( 5,428,000 ) +26,489,000 +Cash flows from investing activities: +Purchase of property and equipment +( 8,666,000 ) +( 99,305,000 ) +Investment in promissory notes and other, related parties +- +( 2,200,000 ) +Investments in common stock and warrants, related parties +- +( 4,901,000 ) +Purchase of SMC, net of cash received +- +( 8,239,000 ) +Purchase of GIGA, net of cash received +- +( 3,687,000 ) +Cash received upon acquisition of AVLP +- +1,245,000 +Purchase of Circle 8, net of cash received +- +( 11,101,000 ) +Purchase of Eco Pack, net of cash received +( 132,000 ) +- +Cash decrease upon deconsolidation of subsidiary +( 6,285,000 ) +- +Acquisition of non-controlling interests +( 1,072,000 ) +( 4,265,000 ) +Purchase of marketable equity securities +- +( 2,017,000 ) +Sales of marketable equity securities +- +11,748,000 +Investments in loans receivable +( 501,000 ) +( 11,309,000 ) +Principal payments on loans receivable +- +11,050,000 +Investments in non-marketable equity securities +( 10,952,000 ) +( 26,551,000 ) +Proceeds from the sale of fixed assets +4,515,000 +- +Other +( 78,000 ) +- +Net cash used in investing activities from continuing operations +( 23,171,000 ) +( 149,532,000 ) +Net cash used in investing activities from discontinued operations +( 6,347,000 ) +( 9,111,000 ) +Net cash used in investing activities +( 29,518,000 ) +( 158,643,000 ) +The accompanying +notes are an integral part of these consolidated financial statements. +F- 11 +AULT ALLIANCE, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) +For the Year Ended December 31, +2023 +2022 +Cash flows from financing activities: +Gross proceeds from sales of Class A common stock +$ 39,415,000 +$ 172,253,000 +Financing cost in connection with sales of Class A common stock +( 1,344,000 ) +( 4,210,000 ) +Proceeds from sales of Series D preferred stock +2,983,000 +4,321,000 +Financing cost in connection with sales of Series D preferred stock +( 105,000 ) +( 811,000 ) +Proceeds from sales of Series C preferred stock, related party +3,841,000 +- +Financing cost in connection with sales of Series C preferred stock, related party +( 500,000 ) +- +Proceeds from subsidiaries’ sale of stock to non-controlling interests +7,342,000 +- +Distribution to Circle 8 non-controlling interest +( 729,000 ) +- +Proceeds from notes payable +38,782,000 +53,314,000 +Proceeds from convertible notes payable, related party +4,625,000 +- +Proceeds from notes payable, related party +2,337,000 +- +Repayment of margin accounts +( 767,000 ) +( 17,721,000 ) +Payments on notes payable +( 65,049,000 ) +( 73,927,000 ) +Payments on convertible notes payable, related party +( 150,000 ) +- +Payments on notes payable, related party +( 314,000 ) +- +Payments of preferred dividends +( 1,375,000 ) +( 393,000 ) +Purchase of treasury stock +( 1,336,000 ) +( 16,054,000 ) +Proceeds from sales of convertible notes +5,165,000 +- +Payments on convertible notes +( 1,022,000 ) +- +Net cash provided by financing activities from continuing operations +31,799,000 +116,772,000 +Net cash provided by financing activities from discontinued operations +5,237,000 +7,340,000 +Net cash provided by financing activities +37,036,000 +124,112,000 +Effect of exchange rate changes on cash and cash equivalents +( 776,000 ) +864,000 +Net increase (decrease in cash and cash equivalents and restricted cash +1,314,000 +( 7,178,000 ) +Cash and cash equivalents and restricted cash at beginning of period - continuing operations +8,674,000 +14,842,000 +Cash and cash equivalents and restricted cash at beginning of period - discontinued operations +5,381,000 +6,391,000 +Cash and cash equivalents and restricted cash at beginning of period +14,055,000 +21,233,000 +Cash and cash equivalents and restricted cash at end of period +15,369,000 +14,055,000 +Less cash and cash equivalents and restricted cash of discontinued operations at end of period +( 1,777,000 ) +( 5,381,000 ) +Cash and cash equivalents and restricted cash of continued operations at end of period +$ 13,592,000 +$ 8,674,000 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest - continuing operations +$ 4,744,000 +$ 8,294,000 +Cash paid during the period for interest - discontinued operations +$ 7,506,000 +$ 4,813,000 +Non-cash investing and financing activities: +Settlement of accounts payable with digital currency +$ 28,000 +$ 418,000 +Conversion of investment in unconsolidated entity for acquisition of AVLP +$ - +$ 20,706,000 +Conversion of convertible notes payable, related party into shares of Class A common stock +$ 400,000 +$ 400,000 +Conversion of debt and equity securities to marketable securities +$ 23,703,000 +$ 44,782,000 +Conversion of loans receivable to marketable securities +$ 5,430,000 +$ 11,502,000 +Conversion of interest receivable to marketable securities +$ - +$ 386,000 +Recognition of new operating lease right-of-use assets and lease liabilities +$ 4,372,000 +$ 2,198,000 +Remeasurement of Ault Disruptive temporary equity +$ 5,990,000 +$ 1,268,000 +Preferred stock exchanged for notes payable +$ 9,224,000 +$ - +Notes payable exchanged for notes payable, related party +$ 11,645,000 +$ - +Redeemable non-controlling interests in equity of subsidiaries paid with cash and marketable securities held in trust account +$ 120,064,000 +$ - +Dividend paid in TurnOnGreen common stock in additional paid-in capital +$ 10,700,000 +$ - +Exchange of notes payable for preferred stock liabilities +$ 8,437,000 +$ - +Exchange of notes payable for preferred stock, related party +$ 20,194,000 +$ - +Exchange of convertible notes payable for preferred stock, related party +$ 17,370,000 +$ - +Exchange of preferred stock for convertible notes payable, related party +$ 1,250,000 +$ - +Fair value of warrants and Class A common stock issued in connection with notes +$ - +$ 2,491,000 +Debt discount from accrued lender profit participation rights +$ - +$ 6,000,000 +Prepaid expenditures capitalized to property and equipment +$ - +$ 2,150,000 +The accompanying notes are an integral part of +these consolidated financial statements. +F- 12 +AULT ALLIANCE, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2023 +1. DESCRIPTION OF BUSINESS +Ault +Alliance, Inc., a Delaware corporation (“Ault Alliance” or the “Company”) is a diversified holding company pursuing +growth by acquiring undervalued businesses and disruptive technologies with a global impact. Through its wholly- and majority-owned subsidiaries +and strategic investments, the Company owns and operates a data center at which it mines Bitcoin and offers colocation and hosting services +for the emerging artificial intelligence ecosystems and other industries, and provides mission-critical products that support a diverse +range of industries, including metaverse platform, oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, +consumer electronics, hotel operations and textiles. In addition, the Company extends credit to select entrepreneurial businesses through +a licensed lending subsidiary. +The +Company has the following eight reportable segments: +· Energy and Infrastructure (“Energy”) – crane operations, advanced textiles processing +and oil exploration; +· Technology and Finance (“Fintech”) – commercial lending, activist investing, stock trading, +media, and digital learning; +· SMC – consumer electronics; +· Sentinum, Inc. (“Sentinum”) – digital currencies mining operations and colocation and +hosting services for the emerging artificial intelligence ecosystems and other industries; +· GIGA – defense industry; +· TurnOnGreen – commercial electronics solutions; +· ROI – immersive metaverse platform; and +· Ault Disruptive – a special purpose acquisition company. +Reverse Stock Splits +On +May 15, 2023, pursuant to the authorization provided by the Company’s stockholders at a special meeting of stockholders, the Company’s +board of directors approved an amendment to the Certificate of Incorporation to effectuate a reverse stock split of the Company’s +issued and outstanding common stock by a ratio of one-for-three hundred (the “ 1-for-300 Reverse Split ”). The 1-for-300 Reverse +Split did not affect the number of authorized shares of common stock, preferred stock or their respective par value per share. As a result +of the 1-for-300 Reverse Split, each three hundred shares of common stock issued and outstanding prior to the 1-for-300 Reverse Split +were converted into one share of common stock. The 1-for-300 Reverse Split became effective in the State of Delaware on May 17, 2023. +On +January 12, 2024, pursuant to the authorization provided by the Company’s stockholders at the annual meeting of stockholders, the +Company’s board of directors approved an amendment to the Certificate of Incorporation to effectuate a reverse stock split of the +Company’s issued and outstanding common stock by a ratio of one-for-twenty-five (the “ 1-for-25 Reverse Split ”). The +1-for-25 Reverse Split did not affect the number of authorized shares of common stock, preferred stock or their respective par value per +share. As a result of the 1-for-25 Reverse Split, each twenty-five shares of common stock issued and outstanding prior to the 1-for-25 +Reverse Split were converted into one share of common stock. The 1-for-25 Reverse Split became effective in the State of Delaware on January +16, 2024. +All +share amounts in these financial statements have been updated to reflect the 1-for-300 Reverse Split and the 1-for-25 Reverse Split. +F- 13 +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +As of December 31, 2023, the +Company had cash and cash equivalents of $ 8.6 million (excluding cash of discontinued operations), negative working capital of $ 66.3 million +and a history of net operating losses. The Company has financed its operations principally through issuances of convertible debt, promissory +notes and equity securities. These factors create substantial doubt about the Company’s ability to continue as a going concern for +at least one year after the date that these condensed consolidated financial statements are issued. +The condensed consolidated +financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. Accordingly, +the condensed consolidated financial statements have been prepared on a basis that assumes the Company will continue as a going concern +and which contemplates the realization of assets and satisfaction of liabilities and commitments in the ordinary course of business. +In making this assessment +management performed a comprehensive analysis of the Company’s current circumstances, including its financial position, cash flow +and cash usage forecasts, as well as obligations and debts. Although management has a long history of successful capital raises, the analysis +used to determine the Company’s ability as a going concern does not include cash sources beyond the Company’s direct control +that management expects to be available within the next 12 months. +Management expects that the +Company’s existing cash and cash equivalents, accounts receivable and marketable securities as of December 31, 2023, will not be +sufficient to enable the Company to fund its anticipated level of operations through one year from the date these financial statements +are issued. Management anticipates raising additional capital through the private and public sales of the Company’s equity or debt +securities and selling its marketable securities and digital currencies, or a combination thereof. Although management believes that such +capital sources will be available, there can be no assurances that financing will be available to the Company when needed in order to +allow the Company to continue its operations, or if available, on terms acceptable to the Company. If the Company does not raise sufficient +capital in a timely manner, among other things, the Company may be forced to scale back its operations or cease operations altogether. +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated +financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial +statements include the accounts of Ault Alliance and its wholly owned and majority-owned subsidiaries. The consolidated financial statements +also include the accounts of all entities that the Company controls as the primary beneficiary of a variable interest entity (“VIE”). +All intercompany accounts and transactions have been eliminated upon consolidation. +The accounting guidance requires +an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling +financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary +of a VIE; to eliminate the solely quantitative approach previously required for determining the primary beneficiary of a VIE; to add an +additional reconsideration event for determining whether an entity is a VIE when any changes in facts and circumstances occur such that +holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct +the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures +that will provide readers of financial statements with more transparent information about an enterprise’s involvement in a VIE. +Variable Interest Entities +For VIEs, the Company assesses +whether it is the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. +The Company evaluates its +business relationships with related parties to identify potential VIEs under Accounting Standards Codification (“ASC”) 810, +Consolidation . The Company consolidates VIEs of which the Company is considered to be the primary beneficiary. Entities are considered +to be the primary beneficiary if they have both of the following characteristics: (i) the power to direct the activities that, when taken +together, most significantly impact the VIE’s performance; and (ii) the obligation to absorb losses and right to receive the returns +from the VIE that would be significant to the VIE. The Company’s judgment with respect to its level of influence or control of an +entity involves the consideration of various factors including the form of its ownership interest, its representation in the entity’s +governance, the size of its investment, estimates of future cash flows, its ability to participate in policy making decisions and the +rights of the other investors to participate in the decision making process and to replace the Company as manager and/or liquidate the +joint venture, if applicable. +F- 14 +Revenue Recognition +The Company recognizes revenue +under ASC 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 is that a company should +recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which +the company expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve that core +principle: +· Step 1: Identify the contract with the customer; +· Step 2: Identify the performance obligations +in the contract; +· Step 3: Determine the transaction price; +· Step 4: Allocate the transaction price to the +performance obligations in the contract; and +· Step 5: Recognize revenue when the company satisfies +a performance obligation. +Sales of Products +The Company generates revenues +from the sale of its products through a direct and indirect sales force. The Company’s performance obligations to deliver products +are satisfied at the point in time when title transfers to the customer. Generally, products are shipped FOB shipping point and title +transfers to the customer at the time the products are placed on a common carrier. The Company provides standard assurance warranties, +which are not separately priced, that the products function as intended. The Company primarily receives fixed consideration for sales +of products. Some of the Company’s contracts with distributors include stock rotation rights after six months for slow-moving inventory, +which represents variable consideration. The Company uses an expected value method to estimate variable consideration and constrains revenue +for estimated stock rotations until it is probable that a significant reversal in the amount of cumulative revenue recognized will not +occur. To date, returns have been insignificant. The Company’s customers generally pay within 30 days from the receipt of an invoice. +Because the Company’s +product sales agreements have an expected duration of one year or less, the Company has elected to adopt the practical expedient in ASC +606-10-50-14(a) of not disclosing information about its remaining performance obligations. +Manufacturing Services +For manufacturing services, +which include revenues generated by the Company’s subsidiary, Enertec Systems 2001 Ltd. (“Enertec”), and in certain +instances, revenues generated by the Company’s subsidiary, Gresham Power Electronics Ltd. (“Gresham Power”), the Company’s +performance obligation for manufacturing services is satisfied over time as the Company creates or enhances an asset based on criteria +that are unique to the customer and that the customer controls as the asset is created or enhanced. Generally, the Company recognizes +revenue based upon proportional performance over time using a cost-to-cost method which measures progress based on the costs incurred +to total expected costs in satisfying its performance obligation. This method provides a depiction of the progress in providing the manufacturing +service because there is a direct relationship between the costs incurred by the Company and the transfer of the manufacturing service +to the customer. Manufacturing services that are recognized based upon the proportional performance method are considered revenue from +services transferred over time and to the extent the customer has not been invoiced for these revenues, as accrued revenue in the accompanying +consolidated balance sheets. Revisions to the Company’s estimates may result in increases or decreases to revenues and income and +are reflected in the consolidated financial statements in the periods in which they are first identified. +The Company has elected the +practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component to the extent +that the period between when the Company transfers its promised good or service to the customer and when the customer pays in one year +or less. +Lending and Trading Activities +Lending Activities +The Fintech segment, through Ault Lending, +LLC (“Ault Lending”), generates revenue from lending activities primarily through interest, origination fees and late/other +fees. Interest income on these products is calculated based on the contractual interest rate and recorded as interest income as earned. +The origination fees or original issue discounts are recognized over the life of the loan using the effective interest method. +F- 15 +Trading Activities +The Fintech segment, through Ault Lending, +also generates revenue from trading activities primarily through sales of securities and unrealized gains and losses from held securities. +All investment transactions are recorded on a trade date basis. Financial instruments utilized in trading activities are carried at fair +value. For more information on fair value, see Note 6. Fair Value of Financial Instruments. Trading-related revenue can be volatile and +is largely driven by general market conditions. Also, trading-related revenue is dependent on the volume and type of transactions, the +level of risk assumed, and the volatility of price and rate movements at any given time within the ever-changing market environment. Realized +and unrealized gains and losses are recognized in revenue from trading activities. +Bitcoin Mining +The Company has entered into +a digital asset mining pool by executing a contract with a mining pool operator to provide hash calculation services to the mining pool. +The Company’s customer, as defined in ASC 606-10-20, is the mining pool operator with which the Company has agreed to the terms +of service and user service agreement. The Company supplies hash calculation services, in exchange for consideration, to the pool operator +who in turn provides transaction verification services to third parties via a mining pool that includes other participants. The Company’s +performance obligation is the provision of hash calculation services to the pool operator and this performance obligation is an output +of the Company’s ordinary activities for which it decides when to provide services under the contract. +The Company’s enforceable +right to compensation begins only when, and lasts as long as, the Company provides hash calculation services to the mining pool operator +and is created as power is provided over time. The only consideration due to the Company relates to the provision of hash calculation +services. The contract with the pool operator provides both parties the unilateral enforceable right to terminate the contract at any +time without penalty. The customer termination option results in a contract that continuously renews throughout the day and therefore +has a duration of less than 24 hours. The implied renewal option is not a material right because there are no upfront or incremental fees +in the initial contract and the terms, conditions, and compensation amount for the renewal options are at the then market rates. Providing +such hash calculation services is the only performance obligation in the Company’s contracts with mining pool operators. +The transaction consideration +the Company receives, if any, is non-cash consideration in the form of Bitcoin. Changes in the fair value of the non-cash consideration +due to form of the consideration (changes in the market price of Bitcoin) are not included in the transaction price and are therefore +not included in revenue. The mining pool operator charges fees to cover the costs of maintaining the pool and are deducted from amounts +the Company may otherwise earn and are treated as a reduction to the consideration received. Fees fluctuate and historically have been +approximately 0.3% per reward earned, on average. +The Company participated in +mining pools that used the FPPS payout method for the year ended December 31, 2023. The Company is entitled to compensation once it begins +to perform hash calculations for the pool operator in accordance with the operator’s specifications over a 24-hour period beginning +midnight UTC and ending 23:59:59 UTC on a daily basis. The non-cash consideration that the Company is entitled to for providing hash calculations +to the pool operator under the FPPS payout method is made up of block rewards and transaction fees less pool operator fees determined +as follows: +· The non-cash consideration in the form of a block reward is based on the total blocks expected to be generated +on the Bitcoin network for the daily 24-hour period beginning midnight UTC and ending 23:59:59 UTC in accordance with the following formula: +the daily hash calculations that the Company provided to the pool operator as a percent of the Bitcoin network’s implied hash calculations +as determined by the network difficulty, multiplied by the total Bitcoin network block rewards expected to be generated for the same daily +period. +· The non-cash consideration in the form of transaction fees paid by transaction requestors is based on +the share of standard transaction fees over the daily 24-hour period beginning midnight UTC and ending 23:59:59 UTC. The pool operator +calculates the standard transaction fee during the 24-hour period using a rolling 144 block moving average of actual transaction fees. +· The block reward and transaction fees earned by the Company are reduced by mining pool fees charged by +the operator for operating the pool based on a rate schedule per the mining pool contract. The mining pool fee is only incurred to the +extent the Company performs hash calculations and generates revenue in accordance with the pool operator’s payout formula during +the same 24-hour period beginning midnight UTC daily. +F- 16 +The contract is in effect +until terminated by either party. +All consideration pursuant +to this arrangement is variable. It is not probable that a significant reversal of cumulative revenue will occur and the Company is able +to calculate the payout based on the contractual formula, non-cash revenue is estimated and recognized based on the spot price of the +Company’s principal market for Bitcoin at the inception of each contract, which is determined to be daily. Non-cash consideration +is measured at fair value at contract inception. Fair value of the crypto asset consideration is determined using the midnight UTC spot +price of the Company’s principal market for Bitcoin at the beginning of the contract period. This amount is estimated and recognized +in revenue upon inception, which is when hash rate is provided. The Company recognizes non-cash consideration on the same day that control +of the contracted service is transferred to the pool operator, which is the same day as the contract inception. +There is no significant financing +component in these transactions. +Expenses associated with running +the digital currencies mining business, such as equipment depreciation and electricity costs, are recorded as a component of cost of revenues. +Crane Operations - Heavy Lifting and Pump +Maintenance Services +The Company generates revenue +by providing heavy lifting and pump maintenance services to customers under various short-term agreements which may be hourly, daily, +weekly or monthly. Each service agreement generally has one performance obligation and includes a promise to complete the service at a +specified location and time and identifies the billing rate to be charged. Payment terms are identified in the terms of the contract and +agreed to by both parties for each promised service within the contract prior to the commencement or performance of said services. The +collectability of payment is considered probable based on management’s history with the certain type and class of customers and +their ability and intention of payment. The customer simultaneously receives and consumes the benefits as the Company provides the hourly, +daily, weekly or monthly service. +Cash and Cash Equivalents +The Company considers all +highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments +that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash +is maintained in checking accounts, money market funds and certificates of deposits with reputable financial institutions. These balances +exceed the United States (“U.S.”) Federal Deposit Insurance Corporation insurance limits. The Company had cash and cash equivalents +of $ 1.5 million at both December 31, 2023 and 2022 in the United Kingdom (“U.K.”), and $ 1.7 million and $ 0.6 million, respectively, +in Israel. The Company has not experienced any losses on deposits of cash and cash equivalents. +Restricted Cash +As +of December 31, 2023, restricted cash included $4.3 million of cash collateral for notes payable and $0.7 million of cash held in +trust related to environmental contingencies related to the Michigan data center. As of December 31, 2022, restricted cash included $0.7 +million of cash held in trust related to environmental contingencies related to the Michigan data center. +Cash, +cash equivalents and restricted cash consisted of the following: +Schedule of cash equivalents and restricted cash +December 31, +December 31, +2023 +2022 +Cash and cash equivalents +$ 8,625,000 +$ 7,942,000 +Restricted cash +4,966,000 +732,000 +Total cash, cash equivalents and restricted cash +$ 13,591,000 +$ 8,674,000 +Cash and Marketable Securities Held +in Trust Account +As +of December 31, 2023 and 2022, the Company held $ 2.2 +million and $ 118.2 million, respectively, in cash and marketable securities in a trust account. Cash and marketable securities held +in the trust account represents cash and money market funds that primarily invest in U.S. treasury bills that were purchased with +funds raised through the initial public offering of Ault Disruptive, a consolidated special purpose acquisition company. The funds +raised are held in a trust account that is restricted for use and may only be used for purposes of completing an initial business +combination or redemption of the common stock of Ault Disruptive, as set forth in the trust agreement. The funds held in trust are +included within Level 1 of the fair value hierarchy. +F- 17 +Bitcoin +Bitcoin +awarded to the Company through its mining activities are accounted for in connection with the Company’s revenue recognition policy. +Bitcoin +held are accounted for as intangible assets with indefinite useful lives. Bitcoin is sold on a first-in first-out basis and measured for +impairment whenever indicators of impairment are identified based on the intraday low quoted price of Bitcoin. To the extent an impairment +loss is recognized, the loss establishes the new cost basis of the Bitcoin. Subsequent reversal of impairment losses is not permitted. +Bitcoin is classified on our balance sheet as a current asset due to the Company’s ability to sell it in a highly liquid marketplace +and its intent to liquidate most, but not all, of its Bitcoin to support operations. +Sales +of Bitcoin by the Company and Bitcoin awarded to the Company are included within cash flows from operating activities on the consolidated +statements of cash flows. Realized gains or losses from sales of Bitcoin are included in loss from operations on the consolidated statements +of operations. +Fair Value of Financial Instruments +In accordance with ASC 820, +Fair Value Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for the +sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +The guidance also establishes +a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable +inputs by requiring that the most observable inputs be used when available. Observable inputs include those that market participants would +use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable +inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset +or liability. The guidance establishes three levels of inputs that may be used to measure fair value: +· Level 1: Quoted market prices in active markets +for identical assets or liabilities. +· Level 2: Inputs other than Level 1 that are +observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are +not active; or model-derived valuations. All significant inputs used in the Company’s valuations are observable or can be derived +principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs +also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed +models such as a discounted cash flow model. +· Level 3: Unobservable inputs that are supported +by little or no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts of financial +instruments carried at cost, including cash and cash equivalents, accounts receivables and accounts and other receivable – related +party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the +short-term maturities of such instruments. +The +categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to +the fair value measurement. +Equity Investments +The +Company’s marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 +and 2 in the fair value hierarchy because the Company uses quoted prices for identical assets in active markets or inputs that are based +upon quoted prices for similar instruments in active markets. +For +investments where little or no public market exists, management’s determination of fair value is based on the best available information +which may incorporate management’s own assumptions and involves a significant degree of judgment, taking into consideration various +factors including earnings history, financial condition, recent sales prices of the issuer’s securities and liquidity risks. +F- 18 +Other +equity securities also include investments in entities that do not have a readily determinable fair value and do not report net asset +value per share. These investments are accounted for using a measurement alternative under which they are measured at cost and adjusted +for observable price changes and impairments. Observable price changes result from, among other things, equity transactions for the same +issuer executed during the reporting period, including subsequent equity offerings or other reported equity transactions related to the +same issuer. For these transactions to be considered observable price changes of the same issuer, the Company evaluates whether these +transactions have similar rights and obligations, including voting rights, distribution preferences, conversion rights, and other factors, +to the investments the Company holds. Any investments adjusted to their fair value by applying the measurement alternative are disclosed +as nonrecurring fair value measurements, including the level in the fair value hierarchy that was used. +Accounts Receivable and Allowance for Credit Losses +The Company’s receivables +are recorded when invoiced and represent claims against third parties that will be settled in cash. The Company records accounts receivable +at the invoiced amount less an allowance for any potentially uncollectible accounts under the current expected credit loss impairment +model and discloses the net amount of the financial instrument expected to be collected. The Company estimates the allowance for credit +losses based on an ongoing review of existing economic conditions, the financial conditions of the customers, historical trends in credit +losses, and the amount and age of past due accounts. Past-due receivable balances are written off when the Company’s internal collection +efforts have been unsuccessful in collecting the amount due. +Concentration of Credit Risk +Financial instruments that +potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. +Cash and cash equivalents +are invested in banks in the U.S., U.K. and Israel. Such deposits in the U.S. may be in excess of insured limits and are not insured in +other jurisdictions. +Trade receivables of the Company +and its subsidiaries are mainly derived from sales to customers located primarily in the U.S., Europe and Israel. The Company performs +ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is +determined with respect to those amounts that the Company and its subsidiaries have determined to be doubtful of collection. +Inventories +Inventories are stated at +the lower of cost or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological +obsolescence. +Cost of inventories is determined as +follows: +Raw materials, parts +and supplies - using the “first-in, first-out” method; and +Work-in-progress and finished products +- on the basis of direct manufacturing costs with the addition of indirect manufacturing costs. +Inventories are stated at +the lower of cost (first-in, first-out method) or net realizable value. Inbound shipping and handling costs are classified as a component +of cost of revenues in the consolidated statements of operations. The Company reviews the components of its inventory and its inventory +purchase commitments on a regular basis for excess and obsolete inventory based on estimated future usage and sales. Write-downs in inventory +value or losses on inventory purchase commitments depend on various items, including factors related to customer demand, economic and +competitive conditions, technological advances or new product introductions by the Company or its customers that vary from its current +expectations. Whenever inventory is written down, a new cost basis is established and the inventory is not subsequently written up if +market conditions improve. +During the years ended December +31, 2023 and 2022, the Company did not record inventory write-offs within the cost of revenue. +F- 19 +Property and Equipment, Net +Property and equipment are stated at cost, net of accumulated depreciation. +Gains or losses on disposals of property and equipment are recorded within income from operations. Repairs and maintenance costs are expensed +as incurred. Significant improvements or betterments are capitalized and depreciated over the estimated life of the asset. Depreciation +is calculated using the straight-line method over the estimated useful lives of the assets, at the following annual rates: +Schedule of estimated useful life of property, plant and equipment +Useful lives (in years) +Bitcoin mining equipment +3 +Computer, software and related equipment +3 – 5 +Office furniture and equipment +5 – 10 +Crane rental equipment +7 – 10 +Aircraft +7 +Vehicles +5 – 7 +Building and building improvements +29 – 39 +Leasehold improvements +Over the term of the lease or the life of the asset, whichever is shorter. +Leases +The Company accounts for its +leases under ASC 842, Leases . Under this guidance, arrangements meeting the definition of a lease are classified as operating or +financing leases. The Company only has operating leases. Operating leases are recognized as right-of-use assets, operating lease liability, +current, and operating lease liability, non-current on the Company’s consolidated balance sheets. Lease assets and liabilities are +recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s +leases do not provide an implicit rate, the Company uses the Company’s incremental borrowing rate based on the information available +at commencement date in determining the present value of future payments. In certain of the Company’s lease agreements, the Company +receives periods of reduced rent or free rent and other incentives. The Company recognizes lease costs on a straight-line basis over the +lease term without regard to deferred payment terms, such as rent holidays, that defer the commencement date of required payments. The +Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise +that option. Leasehold improvements are capitalized at cost and amortized over the lesser of their expected useful life or the life of +the lease, without assuming renewal features, if any, are exercised. The Company does not separate lease and non-lease components for +the Company’s leases. +Impairment of Long-Lived Assets +Management reviews long-lived +assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. +Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future +cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured +by comparing the carrying amount of the assets to their fair value. +Impairment of Debt Securities +Debt securities are evaluated +periodically to determine whether a decline in their value is other than temporary. The Company utilizes criteria such as the magnitude +and duration of the decline, in addition to the reason underlying the decline, to determine whether the loss in value is other than temporary. +The term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects +for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, +or greater than, the carrying value of the investment. Once a decline in value is determined to be other than temporary, the value of +the security is reduced and a corresponding charge to earnings is recognized. +Business Combination +The +Company allocates the purchase price of an acquired business to the tangible and intangible assets acquired and liabilities assumed based +upon their estimated fair values on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired +is recorded as goodwill. The purchase price allocation process requires management to make significant estimates and assumptions at the +acquisition date with respect to intangible assets. The allocation of the consideration transferred in certain cases may be subject to +revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition +date. Direct transaction costs associated with the business combination are expensed as incurred. The Company includes the results of +operations of the business that it has acquired in its consolidated results prospectively from the date of acquisition. +If +the business combination is achieved in stages, the acquisition date carrying value of the acquirer’s previously held equity interest +in the acquirer is re-measured to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized +in profit or loss. +F- 20 +Goodwill +The Company evaluates its +goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other . Goodwill is recorded when the +purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. +The Company tests the recorded +amount of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount +of the goodwill exceeds its carried value. +Intangible Assets +The Company acquired amortizable +intangibles assets as part of asset purchase agreements consisting of customer relationships, trade names and proprietary technology. +The Company also has the trade names and trademarks associated with the acquisitions of Microphase Corporation (“Microphase”) +and Relec Electronics Ltd. (“Relec”), which were determined to have an indefinite life. +The Company reviews intangible +assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets might not be +recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant underperformance +of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes +in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares +forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying +value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset +are less than its carrying amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its +fair value, determined based on discounted cash flows. +Common Stock Purchase Warrants and Other +Derivative Financial Instruments +The Company classifies common +stock purchase warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical +settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical +settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement +to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty +a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions, +as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine +whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, +which principally consist of issuance of warrants to purchase shares of common stock in connection with convertible notes and to employees +of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features +or variable settlement provisions that cause them to not be indexed to the Company’s own stock. +Fair value option +The Company has elected to record the senior secured +convertible promissory note, related party (“Convertible Notes”) at fair value on the date of issuance, with gains and losses +arising from changes in fair value recognized in the consolidated statements of operations at each period end while those are outstanding. +Issuance costs are recognized in the consolidated statement of operations in the period in which they are incurred. The Company utilized +a Monte-Carlo simulation at inception to value the Note. The Monte-Carlo simulation is calculated as the average present value over all +simulated paths. The key inputs and assumptions used in the Monte-Carlo Simulation, including volatility, estimated market yield, risk-free +rate, the probability of various scenarios, including held to maturity and subsequent preferred stock offering and various simulated paths. +The Company assesses the inputs used to measure +fair value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market. +For instruments where little or no public market exists, management’s determination of fair value is based on the best available +information which may incorporate management’s own assumptions and involves a significant degree of judgment, taking into consideration +various factors including earnings history, financial condition, recent sales prices of the issuer’s securities and liquidity risks. +Convertible Instruments +The Company accounts for hybrid +contracts that feature conversion options in accordance with ASC 815, Derivatives and Hedging Activities (“ASC 815”). +ASC 815 requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative +financial instruments according to certain criteria. The criteria include circumstances in which (a) the economic characteristics +and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host +contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured +at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument +with the same terms as the embedded derivative instrument would be considered a derivative instrument. +Conversion options that contain +variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities +at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible +instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, +in accordance with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”). Under ASC 470-20, the Company +records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based +upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective +conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded +conversion options should be bifurcated from their host instruments) in accordance with ASC 815. +F- 21 +Debt Discounts +The Company accounts for debt +discount according to ASC 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through periodic charges +to interest expense over the term of the related financial instrument using the effective interest method. +Guarantee Liability +The Company maintains a guarantee liability that represents its exposure +related to guarantees associated with related party debt. The guarantee liability is reported in current liabilities as a separate line +item on the consolidated balance sheets, and the provision for guarantee liability is reported in other income (expense) as a separate +line item on the consolidated statement of operations. The guarantee liability represents management’s estimate of the Company’s +exposure to losses pursuant to the Company’s related party guarantee obligations. +Redeemable +Non-Controlling Interests in Equity of Subsidiary +The +Company records redeemable non-controlling interests in equity of subsidiaries to reflect the economic interests of the common +stockholders in Ault Disruptive. These interests are presented as redeemable non-controlling interests in equity of subsidiaries +within the consolidated balance sheets, outside of the permanent equity section. The common stockholders in Ault Disruptive have +redemption rights that are considered to be outside of the Company’s control. As of December 31, 2023 and 2022, the carrying amount of +the redeemable non-controlling interest in equity of subsidiaries was recorded at its redemption value of $ 2.2 million and $ 117.9 million, respectively. Remeasurements +to the redemption value of the redeemable non-controlling interest in equity of subsidiaries are recorded within additional paid-in capital. +Activity +for the years ended December 31, 2023 and 2022 reconciled in the following table: +Schedule of redeemable non-controlling interest +Gross proceeds +$ 115,000,000 +Less: +Proceeds allocated to Ault Disruptive public warrants +( 4,313,000 ) +Issuance costs allocated to Ault Disruptive common stock +( 6,867,000 ) +Plus: +Remeasurement of carrying value to redemption value +14,173,000 +Redeemable non-controlling interests in equity of subsidiaries as of December 31, 2022 +117,993,000 +Less: +Redemptions of Ault Disruptive common stock +( 120,064,000 ) +Plus: +Remeasurement of carrying value to redemption value +1,963,000 +Extension proceeds paid by the Ault Disruptive sponsor +2,332,000 +Redeemable non-controlling interests in equity of subsidiaries as of December 31, 2023 +$ 2,224,000 +Treasury Stock +The Company records the aggregate +purchase price of treasury stock at cost and includes treasury stock as a reduction to stockholders’ equity. +Stock-Based Compensation +The Company accounts for stock-based +compensation in accordance with ASC 718, Compensation – Stock Compensation (“ASC 718”). +The Company uses the Black-Scholes +option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions +which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying +stock. +Under ASC 718: +· the Company recognizes stock-based expenses related to stock option awards on a straight-line basis over +the requisite service period of the awards, which is generally the vesting term of two to four years; +· stock-based expenses are recognized net of forfeitures as they occur; +· the expected term assumption, using the simplified method, reflects the period for which the Company believes +the option will remain outstanding; +· the Company determined the volatility of its stock by looking at the historic volatility of its stock +over the expected term of the grant; and +· the risk-free rate reflects the U.S. Treasury yield for a similar expected term in effect at the time +of the grant. +Income Taxes +The Company determines its +income taxes under the asset and liability method in accordance with ASC 740, Income Taxes , which requires recognition of +deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements +or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and +tax bases of assets and liabilities using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. +Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets +will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in +the fiscal years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities +of a change in tax rates is recognized in the Statements of Operations and Comprehensive Loss in the period that includes the enactment +date. +F- 22 +The Company accounts for uncertain +tax positions in accordance with ASC 740-10-25, which addresses the determination of whether tax benefits claimed or expected to be claimed +on a tax return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit from an +uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, +based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that +has a greater than fifty percent likelihood of being realized upon ultimate settlement. To the extent that the final tax outcome of these +matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is +made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. +ASC 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has +taken uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management +of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2023 and 2022, there were no +uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in +the financial statements. +Foreign Currency Translation +A substantial portion of the +Company’s revenues are generated in U.S. dollars. In addition, a substantial portion of the Company’s costs are incurred in +U.S. dollars. Company management has determined that the U.S. dollar is the functional currency of the primary economic environment in +which it operates. +Accordingly, monetary accounts +maintained in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with FASB issued ASC 830, Foreign +Currency Matters (“ASC 830”). All transaction gains and losses from the re-measurement of monetary balance sheet +items are reflected in the statements of operations as financial income or expenses as appropriate. +The financial statements of +Gresham Power, Relec, and Enertec, whose functional currencies have been determined to be their local currencies, the British Pound (“GBP”), +GBP, and the Israeli Shekel, respectively, have been translated into U.S. dollars in accordance with ASC 830. All balance sheet accounts +have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated +using the average exchange rate in effect for the reporting period. The resulting translation adjustments are reported as other comprehensive +loss in the consolidated statement of comprehensive loss and accumulated comprehensive loss in statement of changes in stockholders’ +equity. +Comprehensive Loss +The Company reports comprehensive +loss in accordance with ASC 220, Comprehensive Income . This statement establishes standards for the reporting and presentation +of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents +all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined +that its items of other comprehensive loss relate to changes in foreign currency translation adjustments and impairment of debt securities. +Accounting Estimates +The preparation of the consolidated +financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of +assets and liabilities at the date of the consolidated financial statements and reported amounts of revenue and expense during the reporting +period. Estimates are used when accounting for certain items such as valuation of securities, reserves for trade receivables and inventories, +the fair value of loans receivables, intangible assets and goodwill, useful lives and the recoverability of long-lived assets, stock-based +arrangements, contingent consideration, and deferred income taxes and related valuation allowance. Estimates are based on historical experience, +where applicable, and assumptions that management believes are reasonable under the circumstances. Due to the inherent uncertainty involved +with estimates, actual results may differ. +Preferred Stock Liabilities +The Company follows ASC 480-10, +Distinguishing Liabilities from Equity , in its evaluation of the accounting for preferred stock liabilities. ASC 480-10-25-14 requires +liability accounting for certain financial instruments, including shares that embody an unconditional obligation to transfer a variable +number of shares, provided that the monetary value of the obligation is based solely or predominantly on one of the following three characteristics: +· A fixed monetary amount known at inception; +· Variations in something other than the fair value of the issuer’s shares; or +· Variations in the fair value of the issuer’s equity shares, but the monetary value to the counterparty +moves in the opposite direction as the value of the issuer’s shares. +The number of shares delivered +is determined on the basis of (1) the fixed monetary amount determined as the stated value and (2) the current stock price at settlement, +so that the aggregate fair value of the shares delivered equals the monetary value of the obligation, which is fixed or predominantly +fixed. Accordingly, the holder is not significantly exposed to gains and losses attributable to changes in the fair value of the Company’s +equity shares. Instead, the Company is using its own equity shares as currency to settle a monetary obligation. +F- 23 +Discontinued Operations +The Company records discontinued +operations when the disposal of a separately identified business unit constitutes a strategic shift in the Company’s operations, +as defined in ASC Topic 205-20, Discontinued Operations (“ASC Topic 205-20”). +Reclassifications +Certain prior year amounts +have been reclassified for comparative purposes to conform to the current-year financial statement presentation. These reclassifications +had no effect on previously reported results of operations. The impact on any prior period disclosures was immaterial. +Recently Adopted Accounting Pronouncements +In June 2016, the FASB issued +Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses +on Financial Instruments . The amendments included in ASU 2016-13 require the measurement of all expected credit losses for financial +assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Although +the new standard, known as the current expected credit loss (“CECL”) model, has a greater impact on financial institutions, +most other organizations with financial instruments or other assets (trade receivables, contract assets, lease receivables, financial +guarantees, loans and loan commitments, and held-to-maturity debt securities) are subject to the CECL model and will need to use forward-looking +information to better evaluate their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, +although the inputs to those techniques will change to reflect the full amount of expected credit losses. The Company adopted this standard +as of January 1, 2023. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements. +In October 2021, the FASB +issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with +Customers , which requires an acquirer in a business combination to recognize and measure contract assets and contract liabilities +in accordance with ASC Topic 606. The Company adopted this standard as of January 1, 2023. The adoption of this guidance did not have +a material impact on the Company’s consolidated financial statements. +Recently +Issued Accounting Pronouncements +The Company continually assesses +any new accounting pronouncements to determine their applicability. When it is determined that a new accounting pronouncement may affect +the Company’s financial reporting, the Company undertakes an analysis to determine any required changes to its consolidated financial +statements. +On December 14, 2023, the +FASB issued ASU No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. ASU 2023-09 requires entities to +disclose specific rate reconciliations, amount of income taxes separated by federal and individual jurisdiction, and the amount of income +(loss) from continuing operations before income tax expense (benefit) disaggregated between federal, state, and foreign. The new standard +is effective for the Company for its fiscal year beginning January 1, 2025, with early adoption permitted. The Company is currently evaluating +the impact of adopting the standard. +On December 13, 2023, the +FASB issued ASU No. 2023-08, Intangibles - Goodwill and Other - Crypto Assets (Topic 350-60): Accounting for and Disclosure of Crypto +Assets (“ASU 2023-08”). ASU 2023-08 requires entities to measure crypto assets that meet specific criteria at fair value +with changes recognized in net income each reporting period. Additionally, ASU 2023-08 requires an entity to present crypto assets measured +at fair value separately from other intangible assets in the balance sheets and record changes from remeasurement of crypto assets separately +from changes in the carrying amounts of other intangible assets in the income statement. The new standard is effective for the Company +for its fiscal year beginning January 1, 2025, with early adoption permitted. The Company early adopted ASU 2023-08 effective as of January +1, 2024, which, at the time of adoption, did not have a material impact on its consolidated financial statements. +On November 27, 2023, the +FASB issued ASU No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures (“ASU 2023-07”). +ASU 2023-07 is designed to improve the reportable segment disclosure requirements, primarily through enhanced disclosures about significant +segment expenses that are regularly provided to the chief operating decision maker. The new standard is effective for the Company for +its fiscal year beginning January 1, 2025, with early adoption permitted. The Company is currently evaluating the impact of adopting the +standard. +F- 24 +4. ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS +Presentation of AGREE Operations +In September 2023, the Company +committed to a plan for its wholly owned subsidiary AGREE to list for sale its four recently renovated Midwest hotels, the Hilton Garden +Inn in Madison West, the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford. The decision +to sell the hotels follows the decision to also list the multifamily development site in St. Petersburg, Florida and is driven by the +Company’s desire to focus on its core businesses, Energy, Fintech and Sentinum. The Company’s real estate properties, which +include both hotels and land, are currently listed for sale. +In connection with the planned +sale of AGREE assets, the Company concluded that the net assets of AGREE met the criteria for classification as held for sale. In addition, +the proposed sale represents a strategic shift that will have a significant effect on the Company’s operations and financial results. +As a result, the Company has presented the results of operations, cash flows and financial position of AGREE as discontinued operations +in the accompanying consolidated financial statements and notes for all periods presented. The assets held for sale were measured at the +lower of their carrying amount or fair value less cost to sell. The Company performed a fair value analysis for the disposal group utilizing +an income approach for the hotels and a market approach for the land, resulting in an $8.3 million impairment of property and equipment. +As of December 31, 2023, the +Company expected the planned sale of AGREE assets to close within one year and, as a result, the Company has classified the total assets +and total liabilities associated with AGREE as current in the consolidated balance sheets as of December 31, 2023. +The following table presents +the assets and liabilities of AGREE operations: +Schedule of assets and liabilities of agree operations +December 31, +December 31, +2023 +2022 +Cash and cash equivalents +$ 1,080,000 +$ 2,550,000 +Restricted cash +697,000 +2,831,000 +Accounts receivable +247,000 +264,000 +Inventories +50,000 +44,000 +Property and equipment, net - current +88,525,000 +- +Prepaid expenses and other current assets +392,000 +270,000 +Total current assets +90,991,000 +5,959,000 +Property and equipment, net +- +92,535,000 +Total assets +90,991,000 +98,494,000 +Accounts payable and accrued expenses +3,099,000 +2,631,000 +Notes payable, current +67,262,000 +- +Total current liabilities +70,361,000 +2,631,000 +Notes payable +- +61,633,000 +Total liabilities +70,361,000 +64,264,000 +Net assets of discontinued operations +$ 20,630,000 +$ 34,230,000 +A disposal group classified +as held for sale shall be measured at the lower of its carrying amount or fair value less costs to sell. No impairment was recognized +upon reclassification of the disposal group as held for sale. +The following table presents +the results of AGREE operations: +Schedule of estimated costs to sell and expected +For the Year Ended +December 31, +2023 +2022 +Revenue, hotel and real estate operations +$ 16,161,000 +$ 16,697,000 +Cost of revenue, hotel operations +12,300,000 +11,406,000 +Gross profit +3,861,000 +5,291,000 +General and administrative +3,383,000 +5,982,000 +Impairment of property and equipment +8,284,000 +- +Total operating expenses +11,667,000 +5,982,000 +Loss from operations +( 7,806,000 ) +( 691,000 ) +Interest expense +( 7,898,000 ) +( 5,204,000 ) +Net loss from discontinued operations +$ ( 15,704,000 ) +$ ( 5,895,000 ) +F- 25 +The cash flow activity related +to discontinued operations is presented separately on the statement of cash flows as summarized below: +Schedule of cash flow activity related +to discontinued operations +For the Year Ended December 31, +2023 +2022 +Cash flows from operating activities: +Net loss +$ ( 15,704,000 ) +$ ( 5,895,000 ) +Adjustments to reconcile net loss to net cash provided by operating activities: +Depreciation and amortization +2,074,000 +3,322,000 +Amortization of debt discount +392,000 +391,000 +Impairment of property and equipment +8,284,000 +- +Changes in operating assets and liabilities: +Accounts receivable +17,000 +( 213,000 ) +Inventories +( 6,000 ) +( 13,000 ) +Prepaid expenses and other current assets +( 122,000 ) +349,000 +Accounts payable and accrued expenses +467,000 +2,026,000 +Net cash used in operating activities +( 4,598,000 ) +( 33,000 ) +Cash flows from investing activities: +Purchase of property and equipment +( 6,347,000 ) +( 9,111,000 ) +Net cash used in investing activities +( 6,347,000 ) +( 9,111,000 ) +Cash flows from financing activities: +Proceeds from notes payable +5,237,000 +7,340,000 +Cash contributions from parent +2,104,000 +794,000 +Net cash provided by financing activities +7,341,000 +8,134,000 +Net decrease in cash and cash equivalents and restricted cash +( 3,604,000 ) +( 1,010,000 ) +Cash and cash equivalents and restricted cash at beginning of period +5,381,000 +6,391,000 +Cash and cash equivalents and restricted cash at end of period +$ 1,777,000 +$ 5,381,000 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ 7,506,000 +$ 4,813,000 +5. REVENUE DISAGGREGATION +The following tables summarize +disaggregated customer contract revenues and the source of the revenue for the years ended December 31, 2023 and 2022. Revenues from lending +and trading activities included in consolidated revenues were primarily interest, dividend and other investment income, which are not +considered to be revenues from contracts with customers under GAAP. +The Company’s disaggregated +revenues consisted of the following for the year ended December 31, 2023: +Schedule of disaggregated revenues +Year +ended December 31, 2023 +GIGA +TurnOnGreen +Fintech +Sentinum +SMC +Energy +ROI +Total +Primary Geographical Markets +North America +$ 13,161,000 +$ 3,879,000 +$ - +$ 34,523,000 +$ 31,099,000 +$ 49,431,000 +$ 305,000 +$ 132,398,000 +Europe +8,351,000 +29,000 +- +- +238,000 +666,000 +- +9,394,000 +Middle East and other +16,247,000 +293,000 +- +- +220,000 +- +- +16,760,000 +Revenue from contracts with customers +37,759,000 +4,201,000 +- +34,523,000 +31,557,000 +50,097,000 +305,000 +158,442,000 +Revenue, lending and trading activities (North +America) +- +- +( 1,998,000 ) +- +- +- +- +( 1,998,000 ) +Total revenue +$ 37,759,000 +$ 4,201,000 +$ ( 1,998,000 ) +$ 34,523,000 +$ 31,557,000 +$ 50,097,000 +$ 305,000 +$ 156,444,000 +Major Goods or Services +Radio frequency/microwave filters +$ 8,196,000 +$ - +$ - +$ - +$ - +$ - +$ - +$ 8,196,000 +Power supply units and systems +8,973,000 +4,201,000 +- +- +- +- +- +13,174,000 +Healthcare diagnostic systems +4,095,000 +- +- +- +- +- +- +4,095,000 +Defense systems +16,495,000 +- +- +- +- +- +- +16,495,000 +Digital currencies mining +- +- +- +33,107,000 +- +- +- +33,107,000 +Karaoke machines and related consumer goods +- +- +- +- +31,557,000 +- +- +31,557,000 +Crane rental +- +- +- +- +- +49,198,000 +- +49,198,000 +Other +- +- +- +1,416,000 +- +899,000 +305,000 +2,620,000 +Revenue from contracts with customers +37,759,000 +4,201,000 +- +34,523,000 +31,557,000 +50,097,000 +305,000 +158,442,000 +Revenue, lending and trading activities +- +- +( 1,998,000 ) +- +- +- +- +( 1,998,000 ) +Total revenue +$ 37,759,000 +$ 4,201,000 +$ ( 1,998,000 ) +$ 34,523,000 +$ 31,557,000 +$ 50,097,000 +$ 305,000 +$ 156,444,000 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 20,647,000 +$ 348,000 +$ - +$ 34,523,000 +$ 31,557,000 +$ 999,000 +$ 305,000 +$ 88,279,000 +Services transferred over time +17,112,000 +3,853,000 +- +- +- +49,198,000 +- +70,163,000 +Revenue from contracts with customers +$ 37,759,000 +$ 4,201,000 +$ - +$ 34,523,000 +$ 31,557,000 +$ 50,207,000 +$ 305,000 +$ 158,442,000 +F- 26 +The Company’s disaggregated +revenues consisted of the following for the year ended December 31, 2022: +Year +ended December 31, 2022 +GIGA +TurnOnGreen +Fintech +Sentinum +SMC +Energy +Total +Primary Geographical Markets +North America +$ 7,317,000 +$ 4,514,000 +$ 239,000 +$ 17,798,000 +$ 23,217,000 +$ 2,739,000 +$ 55,824,000 +Europe +9,907,000 +115,000 +- +- +337,000 +216,000 +10,575,000 +Middle East and other +13,031,000 +893,000 +- +- +670,000 +- +14,594,000 +Revenue from contracts with customers +30,255,000 +5,522,000 +239,000 +17,798,000 +24,224,000 +2,955,000 +80,993,000 +Revenue, lending and trading +activities (North America) +- +- +36,644,000 +- +- +- +36,644,000 +Total revenue +$ 30,255,000 +$ 5,522,000 +$ 36,883,000 +$ 17,798,000 +$ 24,224,000 +$ 2,955,000 +$ 117,637,000 +Major Goods or Services +Radio frequency/microwave filters +$ 6,130,000 +$ - +$ - +$ - +$ - +$ - +$ 6,130,000 +Power supply units and systems +11,605,000 +5,522,000 +- +- +- +- +17,127,000 +Healthcare diagnostic systems +4,073,000 +- +- +- +- +- +4,073,000 +Defense systems +8,447,000 +- +- +- +- +- +8,447,000 +Digital currencies mining +- +- +- +16,693,000 +- +- +16,693,000 +Karaoke machines and related consumer goods +- +- +- +- +24,224,000 +- +24,224,000 +Crane rental +- +- +- +- +- +2,739,000 +2,739,000 +Other +- +- +239,000 +1,105,000 +- +216,000 +1,560,000 +Revenue from contracts with customers +30,255,000 +5,522,000 +239,000 +17,798,000 +24,224,000 +2,955,000 +80,993,000 +Revenue, lending and trading activities +- +- +36,644,000 +- +- +- +36,644,000 +Total revenue +$ 30,255,000 +$ 5,522,000 +$ 36,883,000 +$ 17,798,000 +$ 24,224,000 +$ 2,955,000 +$ 117,637,000 +Timing of Revenue Recognition +Goods transferred at a point in time +$ 18,430,000 +$ 5,519,000 +$ 239,000 +$ 17,798,000 +$ 24,224,000 +$ 216,000 +$ 66,426,000 +Services transferred over time +11,825,000 +3,000 +- +- +- +2,739,000 +14,567,000 +Revenue from contracts with customers +$ 30,255,000 +$ 5,522,000 +$ 239,000 +$ 17,798,000 +$ 24,224,000 +$ 2,955,000 +$ 80,993,000 +6. +FAIR VALUE OF FINANCIAL INSTRUMENTS +The following table sets forth +the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy: +Fair value, assets measured on recurring basis +Fair Value Measurement at December 31, 2023 +Total +Level 1 +Level 2 +Level 3 +Assets: +Investment in common stock of Alzamend Neuro, Inc. (“Alzamend”) – a related party +$ 679,000 +$ 679,000 +$ - +$ - +Investments in marketable equity securities +27,000 +27,000 +- +- +Cash and marketable securities held in trust account +2,200,000 +2,200,000 +- +- +Total assets measured at fair value +$ 2,906,000 +$ 2,906,000 +$ - +$ - +Liabilities: +Warrant and embedded conversion feature liabilities +$ 1,742,000 +$ - +$ - +$ 1,742,000 +Convertible promissory notes +22,485,000 +- +- +22,485,000 +Total liabilities measured at fair value +$ 24,227,000 +$ - +$ - +$ 24,227,000 +Fair Value Measurement at December 31, 2022 +Total +Level 1 +Level 2 +Level 3 +Assets: +Investment in common stock of Alzamend – a related party +$ 6,449,000 +$ 6,449,000 +$ - +$ - +Investments in marketable equity securities +6,590,000 +6,590,000 +- +- +Cash and marketable securities held in trust account +118,193,000 +118,193,000 +- +- +Investments in other equity securities +13,340,000 +- +- +13,340,000 +Total assets measured at fair value +$ 144,572,000 +$ 131,232,000 +$ - +$ 13,340,000 +Liabilities: +Warrant and embedded conversion feature liabilities +$ 2,967,000 +$ - +$ - +$ 2,967,000 +Convertible promissory notes +12,776,000 +- +- +12,776,000 +Total liabilities measured at fair value +$ 15,743,000 +$ - +$ - +$ 15,743,000 +F- 27 +The Company assesses the inputs +used to measure fair value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable +in the market. For investments where little or no public market exists, management’s determination of fair value is based on the +best available information which may incorporate management’s own assumptions and involves a significant degree of judgment, taking +into consideration various factors including earnings history, financial condition, recent sales prices of the issuer’s securities +and liquidity risks. +The +following table summarizes the changes in investments in other equity securities measured and carried at fair value on a recurring basis +with the use of significant unobservable inputs (Level 3) for the year ended December 31, 2023: +Schedule of investments in +other equity securities +Investments in +other equity +securities +Balance at January 1, 2023 +$ 13,340,000 +Conversion to Level 1 marketable securities +( 13,340,000 ) +Balance at December 31, 2023 +$ - +Equity Investments +for Which Measurement Alternative Has Been Selected +As +of December 31, 2023 and 2022, the Company held equity investments in other securities valued at $ 21.8 million and $ 29.2 million, +respectively, that were valued using a measurement alternative. These investments are included in other equity securities in the accompanying +consolidated balance sheets. +The +Company has made cumulative downward adjustments for impairments for equity securities that do not have readily determinable fair values +as of December 31, 2023 and 2022, totaling $ 15.8 +million and $ 11.5 +million, respectively. For the year ended December 31, 2023, $ 6.2 +million of the impairment charge was recorded as an offset to revenue from lending and trading activities at Ault Lending. The +remaining amount of these adjustments have been reflected in impairment of equity securities within other income (expense) on the consolidated +statement of operations and comprehensive loss. +7. Marketable Securities +Marketable securities in +equity securities with readily determinable market prices consisted of the following as of December 31, 2023 and 2022: +Schedule of marketable securities +Marketable equity securities at December 31, 2023 +Gross unrealized +Gross unrealized +Cost +gains +losses +Fair value +Common shares +$ 5,119,000 +$ 12,000 +$ ( 5,104,000 ) +$ 27,000 +Marketable equity securities at December 31, 2022 +Gross unrealized +Gross unrealized +Cost +gains +losses +Fair value +Common shares +$ 10,271,000 +$ 383,000 +$ ( 4,064,000 ) +$ 6,590,000 +The Company’s investment in marketable equity +securities is revalued on each balance sheet date. +F- 28 +8. DIGITAL CURRENCIES +The following table presents +the activities of the digital currencies for the years ended December 31, 2023 and 2022: +Schedule of activities of the digital currencies +Digital +Currencies +Balance at January 1, 2022 +$ 2,165,000 +Additions of mined digital currencies +16,693,000 +Payments to vendors +( 418,000 ) +Impairment of mined digital currencies +( 3,099,000 ) +Sales of digital currencies +( 15,832,000 ) +Realized gain on sales of digital currencies +1,045,000 +Balance at December 31, 2022 +554,000 +Additions of mined digital currencies +29,100,000 +Payments to vendors +( 28,000 ) +Impairment of mined digital currencies +( 489,000 ) +Sales of digital currencies +( 29,111,000 ) +Realized gain on sales of digital currencies +520,000 +Balance at December 31, 2023 +$ 546,000 +9. INVENTORIES +At December 31, 2023 and 2022, inventories +consisted of: +Schedule of inventories +December 31, +December 31, +2023 +2022 +Raw materials, parts and supplies +$ 5,247,000 +$ 3,653,000 +Work-in-progress +1,578,000 +3,836,000 +Finished products +1,559,000 +14,547,000 +Total inventories +$ 8,384,000 +$ 22,036,000 +10. PROPERTY AND EQUIPMENT, NET +At December 31, 2023 and +2022, property and equipment consisted of: +Schedule of property and equipment +December 31, 2023 +December 31, 2022 +Building, land and improvements +$ 15,752,000 +$ 12,995,000 +Bitcoin mining equipment +50,640,000 +42,438,000 +Crane rental equipment +34,469,000 +32,453,000 +Computer, software and related equipment +14,335,000 +23,168,000 +Aircraft +15,983,000 +15,983,000 +Other property and equipment +8,603,000 +4,896,000 +139,782,000 +131,933,000 +Accumulated depreciation and amortization +( 30,953,000 ) +( 5,882,000 ) +Property and equipment placed in service, net +108,829,000 +126,051,000 +Construction in progress AVLP equipment +- +9,400,000 +Deposits on Bitcoin mining equipment +- +11,328,000 +Property and equipment, net +$ +108,829,000 +$ 146,779,000 +Summary of depreciation expense: +Schedule of depreciation +For the Year Ended December 31, +2023 +2022 +Depreciation expense +$ 25,660,000 +$ 13,939,000 +Impairment of Property and Equipment +During the year ended December +31, 2023, certain unforeseen business developments and changes in financial projections at AVLP indicated that an impairment triggering +event had occurred. Testing performed indicated the estimated fair value of AVLP property and equipment as of December 31, 2023 was $0, +and an impairment charge of $ 14.0 million was recognized. +F- 29 +During the year ended December +31, 2023, the Company recognized an impairment charge of $ 3.9 +million related to property and equipment at ROI. +During the year ended December +31, 2022, adverse changes in business climate, including decreases in the price of Bitcoin and resulting decrease in the market price +of miners, indicated that an impairment triggering event had occurred. Testing performed indicated the estimated fair value of the Company’s +miners to be less than their net carrying value as of December 31, 2022, and an impairment charge of $ 79.6 million was recognized, decreasing +the net carrying value of the Company’s Bitcoin mining equipment to their estimated fair value. The estimated fair value of the +Company’s miners is classified in Level 2 of the fair value hierarchy due to the quoted market prices for similar assets. +Compute North Bankruptcy +On September 22, 2022, Compute +North Holdings, Inc. (along with its affiliated debtors, collectively, “Compute North”), filed for bankruptcy protection. +The Company had a deposit of approximately $ 2.0 million with Compute North for services yet to be performed by Compute North. The Company +assessed this financial exposure and recorded an impairment of the deposit totaling $2 million during the year ended December 31, +2022. +11. INTANGIBLE ASSETS, NET +At December 31, 2023 and 2022, intangible +assets consisted of: +Schedule of intangible asset +Definite lived intangible assets: +Useful Life +December 31, +2023 +December 31, +2022 +Developed technology +3 - 8 years +$ 1,949,000 +$ 24,584,000 +Customer list +8 - 10 years +3,596,000 +5,865,000 +Trade names +5 - 10 years +1,030,000 +4,316,000 +Domain name and other intangible assets +5 years +612,000 +630,000 +7,187,000 +35,395,000 +Accumulated amortization +( 1,910,000 ) +( 2,102,000 ) +Total definite-lived intangible assets +$ 5,277,000 +$ 33,293,000 +Indefinite lived intangible assets: +Trade name and trademark +Indefinite life +477,000 +1,493,000 +Total intangible assets, net +$ 5,754,000 +$ 34,786,000 +The Company’s trademarks +and certain trade names were determined to have an indefinite life. The remaining definite lived intangible assets are primarily being +amortized on a straight-line basis over their estimated useful lives. Amortization expense was $ 1.0 million for each of the years ended +December 31, 2023 and 2022. +The customer +relationships, developed technology and certain trade names are subject to amortization over their estimated useful lives, which +range between 5 and 10 years with an average remaining useful life of 7.9 years. The following table presents estimated amortization expense +for each of the succeeding five calendar years and thereafter. +Schedule of estimated amortization expense +2024 +$ 724,000 +2025 +724,000 +2026 +724,000 +2027 +724,000 +2028 +724,000 +Thereafter +1,657,000 +$ 5,277,000 +During +the year ended December 31, 2023, the Company recognized $ 24.7 +million and $ 1.5 +million impairment of intangible assets related to AVLP and Microphase, respectively. During the year ended December 31, +2022, the Company recognized no impairment of intangible assets. Intangible assets decreased $ 3.9 million during the year ended December 31, 2023 from the deconsolidation of SMC. +12. GOODWILL +The following table summarizes +the changes in the Company’s goodwill for the years ended December 31, 2023 and 2022: +Schedule of goodwill +Goodwill +Balance as of January 1, 2022 +$ 10,090,000 +Acquisition of AVLP +18,570,000 +Acquisition of SMC +3,184,000 +Acquisition of GIGA +9,881,000 +Impairment of goodwill +( 13,064,000 ) +Effect of exchange rate changes +( 759,000 ) +Balance as of December 31, 2022 +27,902,000 +Impairment of goodwill +( 21,387,000 ) +Effect of exchange rate changes +( 427,000 ) +Balance as of December 31, 2023 +$ 6,088,000 +F- 30 +During the year ended December +31, 2023, the Company recognized $ 18.6 million and $ 3.2 million in impairment of goodwill related to AVLP and Microphase, respectively. +During the year ended December 31, 2022, the Company recognized $ 3.2 million and $ 9.9 million impairment of goodwill related to SMC and +GIGA, respectively. +Impairment of AVLP Goodwill +The Company tests the recorded +amount of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount +of the goodwill exceeds its carried value. The Company performed a goodwill impairment test as of June 30, 2023 related to AVLP as there +were indicators of impairment related to certain unforeseen business developments and changes in financial projections. +The valuation of AVLP was +determined using an income approach methodology of valuation. The income approach is based on the projected cash flows discounted to their +present value using discount rates, that in the Company’s judgment, consider the timing and risk of the forecasted cash flows using +internally developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated value of a +market participant’s cost of capital and debt, derived using customary market metrics. The analysis included assumptions regarding +AVLP’s revenue forecast and discount rates of 26.7% using a weighted average cost of capital analysis. The market approach was also +considered; however, the income approach was chosen as the Company determined it was a better representation of AVLP’s projected +long-term performance. +The results of the quantitative +test indicated the fair value of the AVLP reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $ 18.6 million carrying amount of AVLP’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2023. +Impairment of Microphase Goodwill +During the fourth quarter +of 2023, Microphase experienced a significant decline in sales and, as a result, the Company performed a goodwill impairment test as of +December 31, 2023. +The valuation of Microphase +was determined using an income approach methodology of valuation. The income approach is based on the projected cash flows discounted +to their present value using discount rates, that in the Company’s judgment, consider the timing and risk of the forecasted cash +flows using internally developed forecasts and assumptions. The market approach was also considered; however, the income approach was +chosen as the Company determined it was a better representation of Microphase’s projected long-term performance. +The results of the quantitative +test indicated the fair value of the Microphase reporting unit did not exceed its carrying amounts, including goodwill, in excess of the +carrying value of the goodwill. As a result, the entire $ 3.2 million carrying amount of Microphase’s goodwill was recognized as +a non-cash impairment charge during the year ended December 31, 2023. +Impairment of SMC Goodwill +During the fourth quarter +of 2022, SMC experienced adverse changes in business climate, a significant decline in sales and a drop in the trading price of its common +stock. +Due to these factors, the +Company determined that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, +2022. The valuation of the SMC reporting units was determined using a market approach with observable inputs, primarily based on the trading +price of SMC’s common stock plus an estimated control premium of approximately 20%. +The results of the quantitative +test indicated the fair value of the SMC reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $ 3.2 million carrying amount of SMC’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +F- 31 +Impairment of GIGA Goodwill +During the fourth quarter +of 2022, GIGA experienced a significant decline in sales and a drop in the trading price of its common stock. +Due to these factors, the +Company determined that a triggering event had occurred, and therefore, performed a goodwill impairment assessment as of December 31, +2022. The valuation of the GIGA reporting units was determined using an income approach methodology of valuation. +The income approach is based +on the projected cash flows discounted to their present value using discount rates, that in the Company’s judgment, consider the +timing and risk of the forecasted cash flows using internally developed forecasts and assumptions. Under the income approach, the discount +rate used is the average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. +The analysis included assumptions regarding GIGA’s revenue forecast, with negligible or declining growth rates and discount rates +of 17.5% using a weighted average cost of capital analysis. The market approach was also considered; however, the income approach was +chosen as the Company determined it was a better representation of GIGA’s projected long-term performance. +The results of the quantitative +test indicated the fair value of the GIGA reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying +value of the goodwill. As a result, the entire $ 9.9 million carrying amount of GIGA’s goodwill was recognized as a non-cash impairment +charge during the year ended December 31, 2022. +13. INVESTMENTS – RELATED PARTIES +Investment in Promissory Note, Related Parties +– Ault & Company, Inc. (“Ault & Company”) +Investments in Ault & +Company, an affiliate, and Alzamend, a related party, at December 31, 2023 and 2022, were comprised of the following: +Schedule of investment +Interest +Due +December 31, +December 31, +Rate +Date +2023 +2022 +Investment in promissory note of Ault & Company +8 % +Dec. 31, 2024 +$ 2,500,000 +$ 2,500,000 +Accrued interest receivable Ault & Company +568,000 +368,000 +Other - Alzamend +900,000 +- +Total investment in promissory notes and other, related parties +$ 3,968,000 +$ 2,868,000 +The Company recorded related +party interest income of $0.2 million for each of the years ended December 31, 2023 and 2022 in interest income. +Investment in Common Stock, Related Parties +– Alzamend +Schedule of investment of common stock +Investments in common stock, related parties at December 31, 2023 +Cost +Gross unrealized losses +Fair value +Common shares +$ 24,688,000 +$ ( 24,009,000 ) +$ 679,000 +Investments in common stock, related parties at December 31, 2022 +Cost +Gross unrealized losses +Fair value +Common shares +$ 24,673,000 +$ ( 18,224,000 ) +$ 6,449,000 +F- 32 +The following table summarizes +the changes in the Company’s investments in Alzamend during the years ended December 31, 2023 and 2022: +Schedule of investment in warrants and common stock +Investment in +common stock of +Alzamend +Investment in +promissory notes and +advances of Alzamend +and Other +Balance at January 1, 2022 +$ 13,230,000 +$ 173,000 +Investment in common stock of Alzamend +4,901,000 +- +Alzamend stock received for marketing services +989,000 +- +Unrealized loss in common stock of Alzamend +( 12,671,000 ) +- +Amortization of related party investment +- +( 173,000 ) +Balance at December 31, 2022 +6,449,000 +- +Investment in common stock of Alzamend +15,000 +- +Unrealized loss in common stock of Alzamend +( 5,785,000 ) +- +Balance at December 31, 2023 +$ 679,000 +$ - +Messrs. Ault, Horne and Nisser +are each paid $ 50,000 annually by Alzamend. +14. EQUITY METHOD INVESTMENTS +Equity Investments in Unconsolidated Entity +– AVLP +The following table summarizes +the changes in the Company’s equity investments in an unconsolidated entity, AVLP, during the year ended December 31, 2022: +Schedule of investments in an unconsolidated entity, AVLP +Investment in +Investment in +warrants and +promissory notes +Total +common stock +and advances +investment +Balance at January 1, 2022 +$ 39,000 +$ 22,091,000 +$ 22,130,000 +Investment in convertible promissory notes +- +2,200,000 +2,200,000 +Loss from equity investment +( 39,000 ) +( 885,000 ) +( 924,000 ) +Accrued interest +- +143,000 +143,000 +Loss on remeasurement upon conversion +- +( 2,700,000 ) +( 2,700,000 ) +Conversion of AVLP convertible promissory notes +- +( 17,040,000 ) +( 17,040,000 ) +Elimination of intercompany debt after conversion +- +( 3,809,000 ) +( 3,809,000 ) +Balance at December 31, 2022 +$ - +$ - +$ - +Equity Investments in Unconsolidated Entity +– SMC +On +November 20, 2023, SMC, a consolidated VIE of the Company, completed a transaction pursuant to which SMC entered +into an agreement to sell 2.2 million shares of its common stock for $2.0 million to two affiliates of SMC, both of which are existing +shareholders with representation on the board of directors of SMC. As a result of the transaction, Ault Alliance’s share ownership +of SMC was diluted to approximately 28%. As a result of SMC’s transaction with its affiliates, the Company initiated a derivative +lawsuit against SMC and certain Board members. Due to the significant change in Ault Alliance’s ownership and voting rights, +the Company determined that it no longer met the criteria of the primary beneficiary and, accordingly, the Company deconsolidated SMC +as of November 20, 2023. The Company recorded a $3.0 million loss on deconsolidation for the year ended December 31, 2023. +Upon +deconsolidation, the Company recorded its $ 2.3 million retained investment in SMC based upon the fair value of the common shares +held by the Company at November 20, 2023. Due to the Company’s significant influence over SMC, the Company began accounting for +its retained interest under the equity method of accounting. +The following table summarizes +the changes in the Company’s equity investments in an unconsolidated entity, SMC, during the year ended December 31, 2023: +Schedule of equity investments in unconsolidated entity +– SMC +Rollforward investment in unconsolidated entity +Amount +Beginning balance - January 1, 2023 +$ - +Equity method investment in SMC upon deconsolidation +2,259,000 +Loss from investment in unconsolidated entity +( 302,000 ) +Ending balance - December 31, 2023 +$ 1,957,000 +F- 33 +The following table provides +summarized financial information for the Company’s ownership interest in SMC accounted for under the equity method for the December +31, 2023 period presented and has been compiled from SMC’s financial statements. Amounts presented represent totals at the investee +level and not the Company’s proportionate share: +Summarized Statements of Operations +Schedule of summarized statements of operations +For the Year +Ended +December 31, +2023 +Revenue +$ 32,581,000 +Gross profit +$ 6,964,000 +Loss from operations +$ ( 8,290,000 ) +Net loss +$ ( 9,384,000 ) +Summarized Balance Sheet Information +Schedule of summarized balance sheet information +December 31, +2023 +Current assets +$ 23,206,000 +Non-current assets +$ 4,509,000 +Current liabilities +$ 16,209,000 +Non-current liabilities +$ 3,928,000 +15. CONSOLIDATED VARIABLE INTEREST ENTITY - +ALPHA FUND +Alpha Fund – Consolidated Variable +Interest Entity +As of December 31, 2022, the +Company held an investment in the Alpha Fund. The Alpha Fund was liquidated during the year ended December 31, 2023. Alpha Fund operated +as a private investment fund. The general partner of Alpha Fund, Ault Alpha GP LLC (“Alpha GP”) was owned by Ault Capital +Management LLC (the “Investment Manager”), which also acted as the investment manager to Alpha Fund. The Investment Manager +was owned by Ault & Company. Messrs. Ault, Horne, Nisser and Cragun, who serve as executive officers and/or directors of the Company, +were executive officers of the Investment Manager, and Messrs. Ault, Horne and Nisser are executive officers and directors of Ault & +Company. +Prior to the liquidation +of the Alpha Fund, the Company consolidated Alpha Fund as a VIE due to its significant level of influence and control of Alpha Fund, +the size of its investment, and its ability to participate in policy making decisions. The Company was considered the primary beneficiary +of the VIE. +16. BUSINESS COMBINATIONS +ROI Acquisition +On March 6, 2023, the Company +closed a share exchange agreement with ROI and sold to ROI all the outstanding shares of capital stock of the Company’s subsidiary, +BitNile.com, Inc. as well as RiskOn360, Inc. (formerly known as Ault Iconic, Inc.) and the securities of Earnity, Inc. beneficially owned +by BitNile.com, Inc. as of the date of the Agreement. As consideration for the acquisition, ROI issued shares of preferred stock that +could have been convertible into common stock, subject to shareholder approval, of ROI representing approximately 73.2% of ROI’s +outstanding common stock at the time of the transaction. Total consideration included $0.3 million purchase consideration, representing +the fair value of ROI common stock acquired by the Company, and $6.4 million allocated for the fair value of the non-controlling interest. +AVLP Acquisition +On June 1, 2022, the Company +converted the principal amount under the convertible promissory notes issued to it by AVLP and accrued unpaid interest into common stock +of AVLP. The Company converted $ 20.0 million in principal and $ 5.9 million of accrued interest receivable at a conversion price of $ 0.50 +per share and received 51,889,168 shares of common stock increasing its common stock ownership of AVLP from less than 20 % to approximately +92 % . +F- 34 +Prior to the conversion of +the convertible promissory notes, the Company accounted for its investment in AVLP as an investment in an unconsolidated entity under +the equity method of accounting. In connection with the conversion of the convertible promissory notes, the Company’s consolidated +financial statements now include all of the accounts of AVLP, and any significant intercompany balances and transactions have been eliminated +in consolidation. +The consideration transferred +for the Company’s approximate 92% ownership interest in connection with this acquisition aggregated $20.7 million, which represented +the fair value of the Company’s holdings in AVLP immediately prior to conversion. The carrying amount of the Company’s holdings +in AVLP immediately prior to conversion was $23.4 million, resulting in a $2.7 million loss for the related remeasurement, which was recognized +in interest and other income. +The Company estimated the +fair values of assets acquired and liabilities assumed using valuation techniques, such as the income, cost and market approaches. The +fair values are based on available historical information and on future expectations and assumptions deemed reasonable by management but +are inherently uncertain. The income method to measure the fair value of intangible assets, is based on forecasts of the expected future +cash flows attributable to the respective assets. Significant estimates and assumptions inherent in the valuations reflected a consideration +of other marketplace participants and included the amount and timing of future cash flows (including expected growth rates and profitability), +the underlying product or technology life cycles, economic barriers to entry and the discount rate applied to the cash flows. Unanticipated +market or macroeconomic events and circumstances could affect the accuracy or validity of the estimates and assumptions. +The trade names and patents/developed +technology intangible assets were valued using the relief-from-royalty method. The relief-from-royalty method is one of the methods under +the income approach wherein estimates of a company’s earnings attributable to the intangible asset are based on the royalty rate +the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying royalty rates of +20% for patents and developed technology and 0.25% for trademarks. The resulting net annual royalty payments are then discounted to present +value using a discount factor of 24.6%. +Goodwill represents the excess +of the purchase price over the fair value of identifiable assets acquired and liabilities assumed at the acquisition date and is primarily +attributable to the assembled workforce and expected synergies at the time of the acquisition. The goodwill resulting from this acquisition +is not tax deductible. +The Company invested in AVLP +based on the potential global impact of the novel technology of AVLP. AVLP has developed a novel cost effective and environmentally friendly +material synthesis technology for textile applications. AVLP’s Multiplex Laser Surface Enhancement is a unique technology that has +the ability to treat both natural and synthetic textiles for a wide variety of functionalities, including dyeability and printing enhancements, +hydrophilicity, hydrophobicity, fire retardancy and anti-microbial properties. The use of water, harmful chemicals and energy is significantly +reduced in comparison to conventional textile treatment methods. +The following table presents +the allocation of the consideration transferred to the assets acquired and liabilities assumed based on their fair values. +Schedule of business acquisitions by acquisition, contingent consideration +Allocation +Total purchase consideration +$ 22,143,000 +Fair value of non-controlling interest +7,790,000 +Total consideration +$ 29,933,000 +Identifiable net liabilities assumed: +Cash +$ 1,245,000 +Prepaid expenses and other current assets +55,000 +Property and equipment +5,057,000 +Intangible asset - patents/developed technology (not yet placed in service; upon being placed in service, 7 year estimated useful life) +23,984,000 +Intangible asset - trademarks ( 9 year estimated useful life) +816,000 +Accounts payable and accrued expenses +( 4,689,000 ) +Deferred tax liability +( 5,000,000 ) +Convertible notes payable, principal +( 10,104,000 ) +Net assets assumed +11,364,000 +Goodwill +$ 18,569,000 +F- 35 +The Company consolidates the +results of AVLP on a one-month lag, therefore the statements of operations include results for AVLP for the post-acquisition periods ended +November 30, 2023 and 2022. +AVLP Related Party Transaction +During the period from June +2022 to November 2022, MTIX Ltd., a subsidiary of AVLP, incurred fees of $ 0.3 million from 313M Technology Ltd, a U.K. company (“313M”), +for the use of facilities and personnel. The Managing Director of 313M is Kristina Mistry, the daughter of Pravin Mistry, who served as +a director of AVLP and the Chief Executive Officer of MTIX Ltd. at the time. +Overview of SMC Acquisition +Beginning in June 2022, the +Company, through its subsidiary Ault Lending, began making open market purchases of SMC common stock. These purchases granted the Company +a greater than 20% effective ownership on June 9, 2022, and subsequently, on June 15, 2022, the Company owned more than 50% of the issued +and outstanding common stock of SMC. The Company’s ownership of SMC stood at approximately 57% as of December 31, 2022. +SMC is a NASDAQ-listed seller +of consumer karaoke products. SMC leverages a top-tier global distribution network through major mass merchandisers and online retailers. +As of June 15, 2022 (“Acquisition +Date”), the purchase price of the common stock acquired totaled $ 7.4 million and on June 15, 2022 a $ 3.1 million gain +was recognized in interest and other income for the remeasurement of the Company’s previously held ownership interest to $ 10.5 million, +based on the trading price of SMC common stock. The Company also recognized non-controlling interest at fair value as of the Acquisition +Date in the amount of $ 10.3 million. +The trade names and developed +technology intangible assets were valued using the relief-from-royalty method. The relief-from-royalty method is one of the methods under +the income approach wherein estimates of a company’s earnings attributable to the intangible asset are based on the royalty rate +the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying royalty rates between +0.5% and 1.0% to the prospective revenue attributable to the intangible asset. The resulting net annual royalty payments are then discounted +to present value using a discount factor of 12.0%. +The Company determined an +estimated fair value of customer relationships using an income approach utilizing a discounted cash flow methodology. The analysis included +assumptions regarding the development of new businesses and 3% organic growth rates, a discount rate of 12% using a weighted average cost +of capital analysis, and capital expenditure requirements associated with any new initiatives developed by SMC. Significant assumptions +utilized in the income approach were based on company specific information and projections which are not observable in the market and +are therefore considered Level 3 fair value measurements. +The goodwill resulting from +this acquisition is not tax deductible. +The following table presents +the allocation of the consideration transferred to the assets acquired and liabilities assumed based on their fair values. +Schedule of business acquisitions by acquisition, contingent consideration +Allocation +Total purchase consideration +$ 10,517,000 +Fair value of non-controlling interest +10,336,000 +Total consideration +$ 20,853,000 +Identifiable net assets acquired: +Cash +$ 2,278,000 +Accounts receivable +9,891,000 +Prepaid expenses and other assets +756,000 +Inventories +12,840,000 +Property and equipment, net +529,000 +Right-of-use assets +1,073,000 +Intangible assets: +Trade names ( 10 year estimated useful life) +2,470,000 +Customer relationships ( 10 year estimated useful life) +1,380,000 +Proprietary technology ( 3 year estimated useful life) +600,000 +Accounts payable and accrued expenses +( 10,052,000 ) +Notes payable +( 2,972,000 ) +Lease liabilities +( 1,124,000 ) +Net assets acquired +17,669,000 +Goodwill +$ 3,184,000 +F- 36 +Overview of GIGA Acquisition +On September 8, 2022, GIGA +acquired 100% of the capital stock of Gresham Worldwide, Inc. (“GWW”) from the Company in exchange for 2.92 million shares +of GIGA’s common stock and 514.8 shares of GIGA’s Series F Convertible Preferred Stock (“Series F”) that +are convertible into an aggregate of 3.96 million shares of GIGA’s common stock. GIGA also assumed GWW’s outstanding equity +awards representing the right to receive up to 749,626 shares of GIGA’s common stock, on an as-converted basis. The transaction +described above resulted in a change of control of GIGA. Assuming the Company were to convert all of the Series F, the common stock owned +by the Company after such conversion would result in the Company owning approximately 71.2% of GIGA’s outstanding shares. +On September 8, 2022, the +Company loaned GIGA $ 4.25 million by purchasing a convertible note that carries an interest rate of 10 % per annum and matured on February +14, 2023. The convertible note between the Company and GIGA is eliminated in consolidation beginning on September 8, 2022. The Company +received the right to appoint four members of a seven-member GIGA board of directors. These factors contributed to the Company’s +determination that GWW be treated as the accounting acquirer. +The Company believes there +are synergies between GIGA and GWW. GIGA manufactures specialized electronics equipment for use in both military test and airborne operational +applications. GIGA focuses on the design and manufacture of custom microwave products for military airborne, sea, and ground applications +as well as the design and manufacture of high-fidelity signal simulation and recording solutions for RADAR and electronic warfare test +applications. GIGA’s results of operations subsequent to the acquisition are included in the Company’s GIGA defense business +segment. +In respect of the above transactions, +the acquired assets and assumed liabilities, together with acquired processes and employees, represent a business as defined in ASC 805, +Business Combinations (“ASC 805”). The transactions were accounted for as a reverse acquisition using the acquisition +method of accounting with GIGA treated as the legal acquirer and GWW treated as the accounting acquirer. In identifying GWW as the acquiring +entity for accounting purposes, GIGA and GWW took into account a number of factors, including the relative voting rights, executive management +and the corporate governance structure of the Company. GWW is considered the accounting acquirer since the Company controls the board +of directors of GIGA following the transactions and received a 71.2% beneficial ownership interest in GIGA. However, no single factor +was the sole determinant in the overall conclusion that GWW is the acquirer for accounting purposes; rather all factors were considered +in arriving at such conclusion. +The fair value of the purchase +consideration was $ 9.5 million, consisting of $ 4.0 million for GIGA’s common stock and prefunded warrants, $ 0.4 million fair value +of vested stock incentives, $ 3.7 million cash and $ 1.3 million related to an existing loan agreement between Ault Lending and GIGA, which +was deemed settled. +The total purchase price to +acquire GIGA has been allocated to the assets acquired and assumed liabilities based upon estimated fair values, with any excess purchase +price allocated to goodwill. The goodwill resulting from this acquisition is not tax deductible. The fair value of the acquired assets +and assumed liabilities as of the date of acquisition are based on reports from a third-party valuation expert. +The purchase price allocation +is as follows: +Schedule of business acquisitions by acquisition, contingent consideration +Allocation +Total purchase consideration +$ 6,763,000 +Fair value of non-controlling interest +2,735,000 +Total consideration +$ 9,498,000 +Identifiable net assets acquired (liabilities assumed): +Cash +$ 107,000 +Trade accounts receivable +536,000 +Inventories +2,930,000 +Prepaid expenses and other assets +1,626,000 +Accounts payable and accrued liabilities +( 4,704,000 ) +Loans payable, net of discounts and issuance costs +( 387,000 ) +Lease obligations +( 491,000 ) +Net liabilities assumed +( 383,000 ) +Goodwill +$ 9,881,000 +F- 37 +Overview of Circle 8 Acquisition +On November 17, 2022, Circle +8, a wholly owned subsidiary of Circle 8 Holdco LLC (“Circle 8 Holdco”) entered into an asset purchase agreement (“Circle +8 Purchase Agreement”) with Circle 8 Crane Services, LLC (“Seller”), to acquire substantially all of Seller’s +operating assets and the recapitalization of the business into Circle 8. The Company has a 65 % direct ownership in Circle 8 Holdco and +a 5.8 % indirect ownership via Circle 8 Crane GP. +In accordance with the Circle +8 Purchase Agreement, on December 16, 2022 (“Closing Date”), Circle 8 completed the acquisition and obtained control of the +Seller. The aggregate purchase price consideration transferred from Circle 8 to the Seller totaled $31.5 million which included (i) extinguishment +of debt amounting to $29.2 million (ii) rollover equity issued to the seller with an estimated fair value of $0.6 million (iii) contingent +consideration of $0.9 million and (iv) Seller’s transaction expenses of $0.7 million. The following summarizes the fair value +of consideration transferred at the acquisition closing: +Schedule of business acquisitions by acquisition, contingent consideration +Extinguishment of debt +$ 29,234,000 +Rollover equity +565,000 +Contingent consideration – earn-out +922,000 +Seller’s transaction expenses reimbursement +742,000 +Total consideration +$ 31,463,000 +In conjunction with the acquisition, +certain individuals of the Seller’s ownership group received rollover equity interest as purchase consideration. The rollover equity +includes Circle 8 issuing to the Seller 6,000 Class D interests in Circle 8 Holdco, which is the sole owner of the equity interests of +Circle 8. Management engaged a valuation specialist to estimate the fair value of the grants as of the Closing Date. +Pursuant to the terms of the +Circle 8 Purchase Agreement, additional purchase consideration would be paid by Circle 8 to the Seller, contingent upon achievement of +a minimum EBITDA threshold for a three-year earn-out measurement period beginning on the day following the Closing Date and ending on +the date that is the 36-month anniversary of the Closing Date, which would then increase for additional EBITDA performance up to a maximum +ceiling. Pursuant to the terms of the Circle 8 Purchase Agreement, the earn-out would be paid to the Seller in an amount ranging from +$0 up to $0.7 million based on a pro rata basis for incremental EBITDA results starting at a minimum of $5.7 million. The fair value of +the earn-out was valued using the Monte Carlo simulation which estimates the fair value based on an analysis of various future outcomes. +As such the fair value measurement includes significant unobservable inputs such as risk-adjusted discount rate and projected results +of operations over the earn-out period, and thus, represented a Level 3 measurement. The fair value of the earn-out as of the Closing +Date was $0.9 million. To date, the year one earn-out measurement period has not been surpassed and thus, no cash payments have been made +from Circle 8 to the Seller for contingent purchase consideration. +The acquisition was accounted +for as a business combination using the acquisition method of accounting in accordance with ASC 805. In accordance with ASU 2014-18, Business +Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination, the Company elected not to separately +recognize intangible assets that would otherwise arise from customer-related intangible assets. The value of these intangible assets is +effectively subsumed into goodwill. +The purchase price has been +allocated to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date, +with the exception of the deferred income tax assets acquired and liabilities assumed which are recognized and measured in accordance +with ASC 740, Income Taxes. The excess of the fair value of purchase consideration over the values of the identifiable assets and liabilities +is recorded as goodwill. +The acquisition resulted in +the fair value of the net assets acquired exceeding the amount of consideration transferred, which occurred as a result of negotiations +with the Seller at a time of depressed EBITA as well as imposing a requirement on the Seller to provide preliminary net working capital +equal to or greater than $3.0 million without the ability for adjustments up or down. ASC 805 refers to this as a “bargain purchase” +and requires Circle 8 to recognize a gain for the amount that the values assigned to the net assets acquired exceed the consideration +transferred and cannot recognize goodwill from the acquisition. +Consequently, the Company +reassessed the recognition and measurement of identifiable assets acquired, and liabilities assumed and concluded that all acquired assets +and assumed liabilities were recognized and that the valuation procedures and resulting measures were appropriate. As a result, the Company +recognized a gain of $0.8 million. The gain is included in the line item “gain from bargain purchase of business” in the consolidated +statement of operations. +F- 38 +The following table summarizes +the estimated fair values of the assets acquired and liabilities assumed at the acquisition date: +Schedule of recognized identified assets acquired and liabilities assumed +Assets +Cash and cash equivalents +$ 290,000 +Trade receivable, net +4,334,000 +Prepaids and other current assets +1,226,000 +Property and equipment, net +36,395,000 +Right-of-use assets +1,558,000 +Intangible assets – trade name ( 10 year estimated useful life) +1,030,000 +Intangible assets – customer relationships ( 8 year estimated useful life) +1,290,000 +Total Assets +$ 46,123,000 +Liabilities +Accounts payable and accrued liabilities +$ ( 1,589,000 ) +Notes payable – equipment notes +( 10,685,000 ) +Operating lease liabilities +( 1,580,000 ) +Total Liabilities +$ ( 13,854,000 ) +Net Assets Acquired +$ 32,269,000 +The fair value of the acquired +trade accounts receivables approximates the carrying value due to the short-term nature of the expected timeframe to collect the amounts +due and the contractual cash flows, which are expected to be collected related to these receivables. +As part of the purchase price +allocation, the Company determined the identifiable intangible assets were: (i) trade name and (ii) customer relationships. The fair value +of the intangible assets was estimated using variations of the income approach. Specifically, the relief from royalty method was utilized +to estimate the fair value of the trade name and the multi-period excess earnings method was utilized to estimate the fair value of the +customer relationships. The trade name relates to the overall consolidated group name and related industry recognition. The customer relationships +represent a source of repeat business that is critical to the operations providing crane operators, engineering, custom rigging and transportation +services for oilfield, construction, commercial and infrastructure markets. The discounted cash flows were based on estimates used to +price the transaction, and the discount rates applied were benchmarked with reference to the implied rate of return from the transaction +model and the weighted average cost of capital. These nonrecurring fair value measurements are primarily determined using unobservable +inputs. Accordingly, these fair value measurements are classified within Level 3 of the fair value hierarchy. +Unaudited Pro Forma Financial Information +The following unaudited pro +forma consolidated results of operations for the year ended December 31, 2022 have been prepared as if the AVLP, SMC, GIGA and Circle +8 acquisitions had occurred on January 1, 2022. This table has been prepared for comparative purposes only and is not indicative of the +actual results that would have been attained had the acquisition occurred as of the beginning of the periods presented, nor is it indicative +of future results. +Business acquisition, pro forma information +For the Year +Ended +December 31, +2022 +Total revenues +$ 214,636,000 +Net loss attributable to Ault Alliance, Inc. +$ ( 185,957,000 ) +17. STOCK-BASED COMPENSATION +The Company provides stock-based +compensation to directors, employees and consultants under the (i) 2021 Stock Incentive Plan, which was approved by stockholders on August +13, 2021 at the 2021 Annual Meeting of Stockholders and which reserved 1,000 shares of common stock for grant of awards under the plan +and (ii) 2022 Stock Incentive Plan, which was approved by stockholders on November 23, 2022 at the 2022 Annual Meeting of Stockholders +and which reserved 10,000 shares of common stock for grant of awards under the plan. +F- 39 +Options granted under the +plans have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and become exercisable +based on a vesting schedule determined at the date of grant. Typically, options granted generally become fully vested after four +years. Any options that are forfeited or cancelled before expiration become available for future grants. The options expire between 5 +and 10 years from the date of grant. Restricted stock awards granted under the plan are subject to a vesting period determined at +the date of grant. As of December 31, 2023, an aggregate of 10,441 shares of the Company’s common stock were available for future +grant. +The options outstanding as +of December 31, 2023, have been classified by exercise price, as follows: +Schedule of exercise price +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ 16,091 - $ 19,628 +421 +7.8 +$ 17,546 +287 +$ 17,577 +Issuances outside of the Plan +$ 13,425 +116 +6.7 +$ 13,425 +116 +$ 13,425 +$ 19,125 +242 +7.3 +$ 19,125 +242 +$ 2,284 +$ 13,425 - $ 19,125 +358 +7.1 +$ 17,278 +358 +$ 17,278 +Total Options +$ 13,425 - $ 19,628 +779 +7.5 +$ 17,423 +645 +$ 17,411 +The total stock-based compensation +expense related to stock options and stock awards issued to the Company’s employees, consultants and directors, included in reported +net loss for the year ended December 31, 2023 and 2022, was comprised as follows: +Schedule of stock-based compensation expense +Year Ended December 31, +2023 +2022 +General and administrative +$ 10,868,000 +$ 7,202,000 +Total stock-based compensation +$ 10,868,000 +$ 7,202,000 +A summary of option activity +under the Company’s stock option plans as of December 31, 2023 and 2022, and changes during the years ended is as follows: +Schedule of option activity +Outstanding Options +Weighted +Weighted +Average +Shares +Average +Remaining +Aggregate +Available +Number +Exercise +Contractual +Intrinsic +for Grant +of Options +Price +Life (years) +Value +January 1, 2022 +379 +453 +$ 18,900 +9.8 +$ 0 +Authorized +10,000 +- +Forfeited +31 +( 31 ) +$ 19,950 +December 31, 2022 +10,410 +422 +$ 18,675 +8.7 +$ 0 +Forfeited +1 +( 1 ) +$ 39,157 +December 31, 2023 +10,411 +421 +$ 17,546 +7.8 +$ 0 +As of December 31, 2023, there +was $ 2.1 million of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the plans. +That cost is expected to be recognized over a weighted average period of 1.5 years. +F- 40 +18. WARRANTS +A summary of warrant activity +for the years ended December 31, 2023 and 2022 is presented below. +Schedule of warrants +Warrants +Weighted- +Average +Exercise Price +Weighted- +Average +Remaining +Contractual +Life (Years) +Outstanding at January 1, 2022 +2,669 +$ 23,175 +4.7 +Granted +1,209 +4,500 +Forfeited +( 1 ) +4,554,717 +Exercised +( 1,803 ) +16,618 +Outstanding at December 31, 2022 +2,074 +16,835 +3.9 +Granted +14,176,472 +3.55 +Forfeited +- +- +Exercised +- +- +Outstanding at December 31, 2023 +14,178,546 +$ 5.10 +4.7 +The following table summarizes +information about common stock warrants outstanding at December 31, 2023: +Schedule of common stock warrants outstanding +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ 3.38 +12,269,032 +4.77 +$ 3.38 +- +$ 4.59 +1,907,440 +4.60 +$ 4.59 +- +$ 3,375 - $ 18,750 +2,067 +2.72 +$ 10,3801 +2,067 +$ 10,381 +$ 66,000 - $ 148,500 +7 +0.24 +$ 84,643 +7 +$ 84,643 +$ 3.38 - $ 148,500 +14,178,546 +4.75 +$ 5.10 +2,074 +$ 10,631 +Warrant Issuances During 2023 +During the year ended December +31, 2023, the Company issued warrants to purchase 14.2 million shares of Class A common stock at a weighted average exercise price of +$ 3.54 per share, subject to adjustment, in connection with the issuance of a senior secured convertible promissory note, related party +(see Note 24) and Series C convertible preferred stock, related party (see Note 26). +Warrant Issuances During 2022 +On November 7, 2022, the Company +issued warrants to purchase 606 shares of common stock at exercise price equal to $3,375 per share and warrants to purchase 606 shares +of common stock at exercise price equal to $ 5,625 per share, subject to adjustment in connection with the issuance of secured promissory +notes in the aggregate principal face amount of $ 18.9 million. +The Company has valued the +warrants issued at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables +such as the warrants’ remaining contractual term, exercise price, current stock price, risk-free interest rate and estimated volatility +of the Company’s stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based +on the implied yield available on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +The Company utilized a variety +of pricing models and the weighted average assumptions used during the years ended December 31, 2023 and 2022 were as follows: +Schedule of weighted average assumptions +December 31, +2023 +December 31, +2022 +Exercise price +$ 3.54 +$ 4,500 +Contractual term in years +5.0 +4.0 +Volatility +168 % +176 % +Dividend yield +0 % +0 % +Risk-free interest rate +4.0 % +4.5 % +F- 41 +19. ACCOUNTS PAYABLE AND ACCRUED EXPENSES +Other current liabilities at December +31, 2023 and 2022 consisted of: +Schedule of other current liabilities +December 31, +December 31, +2023 +2022 +Accounts payable +$ 32,592,000 +$ 20,027,000 +Accrued payroll and payroll taxes +9,779,000 +9,789,000 +Financial instrument liabilities +832,000 +651,000 +Interest payable +4,197,000 +3,207,000 +Accrued legal +2,340,000 +3,168,000 +Accrued lender profit participation rights +- +6,000,000 +Other accrued expenses +16,703,000 +17,586,000 +Total liabilities +$ +66,443,000 +$ 60,428,000 +The following table summarizes +the changes in financial instrument liabilities measured and carried at fair value on a recurring basis with the use of significant unobservable +inputs (Level 3) for the years ended December 31, 2023 and 2022: +Schedule of changes in financial instrument liabilities +For the Year Ended +December 31, +2023 +2022 +Beginning balance +$ 651,000 +$ 4,249,000 +Recognition of financial instrument liabilities +7,262,000 +290,000 +Change in fair value +( 7,081,000 ) +377,000 +Transfer out of level 3 +- +( 4,265,000 ) +Ending balance +$ 832,000 +$ 651,000 +20. LEASES +The Company has operating leases for office space. The Company’s leases have remaining lease terms of 12 months to 9.5 +years, some of which may include options to extend the leases perpetually, and some of which may include options to terminate the +leases within one year. +The following table provides a summary of leases by balance sheet category as of December 31, 2023 and 2022: +Schedule of supplemental balance sheet information related to leases +December 31, +2023 +December 31, +2022 +Operating right-of-use assets +$ 6,315,000 +$ 8,419,000 +Operating lease liability - current +2,119,000 +2,975,000 +Operating lease liability - non-current +4,402,000 +5,836,000 +The components of lease expenses for the years ended December 31, 2023 and 2022, were as follows: +Schedule of lease expenses +Year Ended December 31, +2023 +2022 +Operating lease cost +$ 3,677,000 +$ 2,716,000 +Short-term lease cost +- +- +The following tables provides a summary of other information related to leases for the years ended December 31, 2023 and +2022: +Schedule of supplemental cash flow information related to leases +December 31, 2023 +December 31, 2022 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ 3,699,000 +$ 2,554,000 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ 885,000 +$ 3,791,000 +Weighted-average remaining lease term - operating leases +3.7 years +4.1 years +Weighted-average discount rate - operating leases +8.0 % +7.0 % +Maturity of lease liabilities under the Company’s non-cancellable operating leases as of December 31, 2023, were as follows: +Schedule of maturities of operating lease liabilities +Payments due by period +2024 +$ 2,674,000 +2025 +2,205,000 +2026 +1,258,000 +2027 +414,000 +2028 +357,000 +Thereafter +759,000 +Total lease payments +7,667,000 +Less interest +( 1,146,000 ) +Present value of lease liabilities +$ 6,521,000 +F- 42 +21. NOTES PAYABLE +Notes payable at December +31, 2023 and 2022, were comprised of the following: +Schedule of notes payable +Collateral +Guarantors +Interest +rate +Due date +December 31, +2023 +December 31, +2022 +Circle 8 revolving credit facility +Circle 8 cranes with a book value of $31.7 million +- +8.4 % +December 16, 2025 +$ 15,907,000 +$ 14,724,000 +8.5% secured promissory notes +- +- +8.5 % +May 7, 2024 +- +17,389,000 +16% promissory note (in default at December 31, 2023) +- +Ault & Company and +Milton C. Ault, III +16.0 % +December 16, 2023 +2,572,000 +17,456,000 +Circle 8 equipment financing notes +Circle 8 equipment with a book value of $3.9 million +- +0.0 % +March 15, 2024 through +November 15, 2026 +5,629,000 +10,677,000 +3% secured promissory notes +- +- +3.0 % +- +5,672,000 +8% demand loans +- +- +8.0 % +Upon demand +950,000 +- +Short-term bank credit facilities +- +- +5.9 % +Renews monthly +1,464,000 +1,702,000 +XBTO note payable (in default at December 31, 2023 and repaid in March 2024) +2,482 Antminers with a book value of $3.4 million +- +12.5 % +December 30, 2023 +1,067,000 +2,749,000 +10% secured promissory notes +- +- +10.0 % +- +8,789,000 +Other ($0.9 million in default at December 31, 2023) +- +- +3,518,000 +2,619,000 +Total notes payable +- +- +$ 31,107,000 +$ 81,777,000 +Less: +- +- +Unamortized debt discounts +- +- +( 83,000 ) +( 12,325,000 ) +Total notes payable, net +- +- +$ 31,024,000 +$ 69,452,000 +Less: current portion +- +- +( 12,866,000 ) +( 39,621,000 ) +Notes payable – long-term portion +- +- +$ 18,158,000 +$ 29,831,000 +During the year ended +December 31, 2023, the holders of $ 8.4 +million 10% secured promissory notes exchanged their notes and accrued interest for Series E, Series F and Series G preferred stock +liabilities. The Company recorded a loss on extinguishment of debt of $0.1 +million related to the transaction. When the Series E, Series F and Series G preferred stock liabilities converted to Series A Common stock, the +Company recorded a loss on extinguishment of $ 1.5 million. +During the year ended December 31, 2023, the holders of $ 10.5 million +10% demand promissory notes and $ 1.1 million 12% demand promissory notes exchanged their notes for notes from Ault & Company (see +Note 22), resulting in a loss on extinguishment of debt of $ 0.4 million. +In connection with the December 2023 Series C Preferred Stock offering +(see Note 26), the Company paid $20.4 million to pay the $20.2 million outstanding balance of the 8% senior secured promissory notes, +plus $0.2 million accrued interest payable. The 8% senior secured promissory notes had an unamortized debt discount of $ 3.2 million outstanding, +which was recorded as a loss on extinguishment of debt. +The Company recorded a $ 2.0 +million loss on extinguishment of debt related to the April 2023 restructuring related to one of the 16% promissory notes payable. +F- 43 +Notes Payable Maturities +The contractual maturities +of the Company’s notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s option, +as of December 31, 2023 were: +Schedule Of maturities +Year +2024 +$ 12,866,000 +2025 +17,721,000 +2026 +418,000 +2027 +51,000 +2028 +51,000 +$ 31,107,000 +Interest Expense +Schedule of interest expense +For the Year Ended +December 31, +2023 +2022 +Contractual interest expense +$ 9,619,000 +$ 6,780,000 +Forbearance fees +5,469,000 +1,453,000 +Amortization of debt discount +21,507,000 +29,109,000 +Total interest expense +$ 36,595,000 +$ 37,342,000 +22. NOTES PAYABLE, RELATED PARTY +Notes payable, related party +at December 31, 2023 and December 31, 2022, were comprised of the following: +Schedule of notes payable, related party +Interest +rate +Due date +December 31, +2023 +December 31, +2022 +Notes from officers - AAI +18% +February 1, 2024* +$ +98,000 +$ +- +Notes from officers - TurnOnGreen +14% +Past due +51,000 +25,000 +Notes from board member - ROI +18% +January 19, 2024* +90,000 +- +Ault & Company advances +No interest +Upon demand +1,909,000 +- +Advances from officers - AAI +No interest +Upon demand +- +300,000 +Advances from officers - TurnOnGreen +No interest +Upon demand +- +14,000 +Advances from officers - GIGA +8% +Upon demand +52,000 +- +Other related party advances +No interest +Upon demand +175,000 +13,000 +Total notes payable +$ +2,375,000 +$ +352,000 +F- 44 +Ault & Company +Loan Agreement +On June 8, 2023, the Company entered into a loan agreement with Ault +& Company as lender. The loan agreement provides for an unsecured, non-revolving credit facility in an aggregate principal amount +of up to $ 10 million. All loans under the loan agreement are due within five business days after request by Ault & Company. Ault & +Company is not obligated to make any further advances under the loan agreement after December 8, 2023. Advances under the loan agreement +bear interest at the rate of 9.5 % per annum and may be repaid at any time without penalty or premium. As of December 31, 2023, $ 4.6 million +has been advanced under the loan agreement and was exchanged for a senior secured convertible promissory note with Ault & Company +(see Note 24). +In August 2023, Ault & Company assumed $11.6 million of secured +promissory notes previously issued by the Company for which the Company has issued term notes to Ault & Company in the same amount. +One term note has a principal amount of $1.1 million and bears interest at 12% and the second term note has a principal amount of $10.5 +million and bears interest at 10%. These assumed loans were exchanged for a senior secured convertible promissory note with Ault & +Company (see Note 24). +Summary +of interest expense, related party, recorded within interest expense on the condensed consolidated statement of operations: +Schedule of interest expense, related party +For the Year Ended +December 31, +2023 +2022 +Interest expense, related party +$ 664,000 +$ - +23. CONVERTIBLE NOTES PAYABLE +Convertible notes payable +at December 31, 2023 and 2022, were comprised of the following: +Schedule +of convertible notes payable +Conversion price per +share +Interest rate +Due date +December 31, +2023 +December 31, +2022 +Convertible promissory note +$ 4.00 +4 % +May 10, 2024 +$ - +$ 660,000 +Convertible promissory note – original issue discount (“OID”) only +90 % of 5-day VWAP +OID Only +September 28, 2024 +1,673,000 +- +AVLP convertible promissory notes, principal +$ 0.35 (AVLP stock) +7 % +August 22, 2025 +9,911,000 +9,911,000 +GIGA senior secured convertible notes - in default +$ 0.25 (GIGA stock) +18 % +October 11, 2024 +4,388,000 +- +ROI senior secured convertible note +$ 0.11 (ROI stock) +OID Only +April 27, 2024 +6,513,000 +- +Fair value of embedded conversion options +910,000 +2,316,000 +Total convertible notes payable +23,395,000 +12,887,000 +Less: unamortized debt discounts +( 2,179,000 ) +( 111,000 ) +Total convertible notes payable, net of financing cost, long term +$ 21,216,000 +$ 12,776,000 +Less: current portion +( 11,763,000 ) +( 1,325,000 ) +Convertible notes payable, net of financing cost – long-term portion +$ 9,453,000 +$ 11,451,000 +The contractual maturities +of the Company’s convertible notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s +option, as of December 31, 2023, were: +Schedule +of contractual maturities +Year +Principal +2024 +$ 12,574,000 +2025 +10,821,000 +$ 23,395,000 +Significant +inputs associated with the embedded conversion options include: +Schedule of weighted average assumptions +December 31, 2023 +December 31, 2022 +At Inception +Contractual term in years +0.3 +2.7 +1.0 +Volatility +138 % +82 % +111 % +Dividend yield +0 % +0 % +0 % +Risk-free interest rate +3.8 % +4.0 % +3.5 % +F- 45 +The +following table summarizes the changes in embedded conversion +option derivative liabilities measured and carried at fair value on a recurring basis with the +use of significant unobservable inputs (Level 3) for the years ended December 31, 2023 and 2022: +Schedule of derivative liabilities +For the Year Ended +December 31, +2023 +2022 +Beginning balance +$ 2,316,000 +$ - +Fair value of embedded conversion options issued or acquired +1,652,000 +5,851,000 +Change in fair value +( 3,058,000 ) +( 3,535,000 ) +Ending balance +$ 910,000 +$ 2,316,000 +The +following table summarizes the changes in convertible notes payable measured and carried at fair value on a recurring basis with the use +of significant unobservable inputs (Level 3) for the years ended December 31, 2023 and 2022: +Schedule of convertible notes payable +For the Year Ended +December 31, +2023 +2022 +Beginning balance +$ 10,571,000 +$ 660,000 +Convertible notes from acquisitions +- +9,911,000 +Issuance of convertible notes +12,441,000 +- +Transfer out of level 3 +( 527,000 ) +- +Ending balance +$ 22,485,000 +$ 10,571,000 +In +October 2023 GIGA entered into an exchange and waiver agreement related to its senior secured convertible promissory notes, which resulted +in a loss on extinguishment of debt of $ 1.4 million. +24. SENIOR SECURED CONVERTIBLE NOTE, RELATED PARTY +On October 13, 2023 (the “A&C +Closing Date”), the Company entered into a note purchase agreement with Ault & Company, pursuant to which the Company sold to +Ault & Company (i) a senior secured convertible promissory note in the principal face amount of $17.5 million (the “Note”) +and warrants (the “Warrants”) to purchase shares of the Company’s common stock for a total purchase price of up to $ 17.5 +million (the “Transaction”). +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to the Company since June 8, 2023 pursuant to +the loan agreement; (ii) cancellation of $11.6 million of term loans made by the Company to Ault & Company in exchange for Ault & +Company assuming liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of +125,000 shares of the Company’s Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) +being transferred from Ault & Company to the Company. +The Note had a principal face amount of $17.5 million and had a maturity +date of October 12, 2028 (the “Maturity Date”). The Note bore interest at the rate of 10 % per annum. The Note was repaid in +full in December 2023 and the Company recorded a $ 4.2 million loss on extinguishment for the year ended December 31, 2023. +The Warrants grant Ault & +Company the right to purchase 1.9 million shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary +of the A&C Closing Date, and become exercisable on the first business day after the six-month anniversary of the A&C Closing Date. +The exercise price of the Warrants is $ 4.5925 , which is subject to adjustment in the event of customary stock splits, stock dividends, +combinations or similar events. +The Company elected the fair +value option and utilized a Monte-Carlo simulation at inception to value the Note. The Monte-Carlo simulation is calculated as the average +present value over all simulated paths. The key inputs and assumptions used in the Monte-Carlo Simulation, including volatility, estimated +market yield, risk-free rate, the probability of various scenarios, including held to maturity and subsequent preferred stock offering +and various simulated paths, were utilized to estimate the fair value at $17.8 million or approximately the principal amount outstanding +as of inception. The value of the 2023 Note was calculated as the average present value over 25,000 simulated paths. Given the Notes were +fully satisfied in connection with issuance of the Series C convertible preferred stock, the Company calculated the fair value on the +date of extinguishment as the total principal plus accrued interest outstanding. +F- 46 +The following table summarizes +some of the significant inputs and assumptions used in the Monte-Carlo simulation: +Schedule of senior secured convertible promissory note assumptions +Senior secured convertible promissory note +Amounts +Principal outstanding at valuation date +$ 17.5 million +Volatility +80 % +Interest rate +10.0 % +Risk-free interest rate range +4.7 % to 5.6 % +Estimated yield +19.5 % to 21.0 % +The Company computed the fair value of the warrants using the Black-Scholes +option pricing model and, as a result of this calculation, recorded debt discount in the amount of $4.2 million based on the estimated +fair value of the Warrants. +In addition to a 21% discount +for lack of marketability, significant inputs associated with the calculation of the fair value of the Warrants included the following: +Schedule of convertible note +Contractual term in years +5.0 +Volatility +167.3 % +Dividend yield +0 % +Risk-free interest rate +4.7 % +The rollforward of the senior +secured convertible promissory note notes is as follows: +Schedule of senior +secured convertible promissory note +Senior secured convertible promissory note +Total +Balance as of December 31, 2022 +$ +- +Exchange of loan agreement with Ault & Company +4,625,000 +Ault & Company note from exchange of 12% demand promissory note +1,100,000 +Ault & Company note from exchange of 10% demand promissory note +10,545,000 +Exchange of Series B convertible preferred stock +1,250,000 +Cash payments of senior secured convertible promissory note +( 150,000 +) +Payment from issuance of Series C preferred stock +( 17,370,000 +) +Balance as of December 31, 2023 +$ +- +25. COMMITMENTS AND CONTINGENCIES +Contingencies +Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. The Company is regularly subject to claims, suits, regulatory +and government investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, +suits, regulatory and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. The Company records a liability when it believes that it is +probable that a loss has been incurred and the amount can be reasonably estimated. If the Company determines that a loss is reasonably +possible and the loss or range of loss can be estimated, the Company discloses the reasonably possible loss. The Company evaluates developments +in its legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably +possible losses disclosed, and makes adjustments as appropriate. Significant judgment is required to determine both likelihood of there +being, and the estimated amount of, a loss related to such matters. +With respect to the Company’s +other outstanding matters, based on the Company’s current knowledge, the Company believes that the amount or range of reasonably +possible loss will not, either individually or in aggregate, have a material adverse effect on the Company’s business, consolidated +financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject +to significant uncertainties. +As of December 31, 2023 the +Company has accrued $ 2.3 +million as a loss contingency related to litigation matters. +F- 47 +26. STOCKHOLDERS’ EQUITY +Preferred Stock +The +Company is authorized to issue 25.0 million shares of preferred stock, $0.001 par value. As of December 31, 2023, the Board has designated +1,000,000 shares as Series A Convertible Preferred Stock (the “Series A Preferred Stock”), 50,000 shares as Series C Convertible +Preferred Stock (the “Series C Preferred Stock”) and 2,000,000 shares as 13.00% Series D Cumulative Redeemable Perpetual Preferred +Stock (the “Series D Preferred Stock”). As of December 31, 2023, the rights, preferences, privileges and restrictions on the +remaining authorized 22.0 million shares of preferred stock have not been determined. The Board is authorized to designate a new series +of preferred shares and determine the number of shares, as well as the rights, preferences, privileges and restrictions granted to or +imposed upon any series of preferred shares. +On January 23, 2023, the Company filed a Certificate of Elimination +of the certificate of designations of preferred stock with the Secretary of State of the state of Delaware with respect to the Company’s +Series C convertible preferred stock, par value $ 0.001 per share. +On November 15, 2023, the Company filed a new Certificate of Designations +of Preferences, Rights and Limitations of Series C Convertible Preferred Stock with the Secretary of State of the State of Delaware to +establish the preferences, limitations and relative rights of the Series C Preferred Stock. +On +December 8, 2023, the Company filed a Certificate of Elimination of the certificate of designations of preferred stock with the Secretary +of State of the state of Delaware with respect to the Company’s Series B convertible preferred stock, par value $ 0.001 per share. +Common Stock +Common stock confers upon +the holders the rights to receive notice to participate and vote at any meeting of stockholders of the Company, to receive dividends, +if and when declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. The Class B common stock +carries the voting power of 10 shares of Class A common stock, referred to herein as the common stock. +2023 Issuances +Common ATM Offerings +On +February 25, 2022, the Company entered into an At-The-Market issuance sales agreement with Ascendiant Capital Markets, LLC (“Ascendiant +Capital”) to sell shares of common stock having an aggregate offering price of up to $ 200 million from time to time, through +an “at the market offering” program (the “2022 Common ATM Offering”). During the three months ended March 31, +2023, the Company sold an aggregate of 4,268 shares of common stock pursuant to the 2022 Common ATM Offering for gross proceeds of $ 4.2 million. +Effective March 17, 2023, the 2022 Common ATM Offering was terminated. +On +June 9, 2023, the Company entered into an At-The-Market issuance sales agreement with Ascendiant Capital to sell shares of common stock +having an aggregate offering price of up to $ 10 million from time to time, through an “at the market offering” program +(the “2023 Common ATM Offering”). On July 13, 2023 and September 8, 2023, the sales agreement was amended increasing the size +of the 2023 ATM Offering to $20 million and $50 million, respectively. During the year ended December 31, 2023, the Company sold an aggregate +of 4.3 million shares of common stock pursuant to the 2023 Common ATM Offering for gross proceeds of $ 35.3 million. +Preferred ATM +Offering +On +June 14, 2022, the Company entered into an At-The-Market sales agreement with Ascendiant Capital under which it may sell, from time to +time, shares of its Series D Preferred Stock for aggregate gross proceeds of up to $ 46.4 million (the “2022 Preferred ATM Offering”). +During the year ended December 31, 2023, the Company sold an aggregate of 252,359 shares of Series D Preferred Stock pursuant +to the 2022 Preferred ATM Offering for net proceeds of $ 2.9 million. Effective June 16, 2023, the 2022 Preferred ATM Offering was +terminated. +Issuance of Common +Stock Upon Conversion of Preferred Stock +During +the year ended December 31, 2023, the Investors converted 1,000 shares of Series F Preferred Stock and 6,756 shares +of Series G Preferred Stock into an aggregate of 5,736 shares of the Company’s common stock. A loss on extinguishment +of $0.3 million was recognized on the issuance of common stock based on the fair value of the Company’s common stock at the date +of the conversions. +Proceeds from Subsidiaries’ +Sale of Stock to Non-Controlling Interests +During +the year ended December 31, 2023, SMC and ROI sold an aggregate of $ 7.3 million of common stock to non-controlling interests. +Series C Convertible Preferred Stock Offering, +Related Party +On December 14, 2023, pursuant +to the November 2023 SPA entered into with Ault & Company on November 6, 2023, the Company sold to Ault & Company, in three separate +closings that occurred on the closing date, an aggregate of 41,500 shares of Series C Preferred Stock and Warrants to purchase 12.3 million +shares of common stock, for a total purchase price of $ 41.5 million. +F- 48 +The proceeds from the sale +of Series C Preferred Stock were used in part to pay $ 17.5 million to satisfy the outstanding balance on the outstanding senior secured +convertible promissory note with Ault & Company. The senior secured convertible promissory note with Ault & Company had an unamortized +debt discount of $ 4.2 million outstanding, which was recorded as a loss on extinguishment of debt. +In addition, the Company paid +$ 20.4 million to pay the $20.2 million outstanding balance of the 8% senior secured promissory notes, plus $ 0.2 million accrued interest +payable. The 8% senior secured promissory notes had an unamortized debt discount of $ 3.2 million outstanding, which was recorded as a +loss on extinguishment of debt. +On December 14, 2023, the +Company, along with its wholly owned subsidiaries Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending, Ault Aviation, LLC (“Ault +Aviation”) and AGREE (collectively with the Company, Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending and Ault Aviation, the +“Guarantors”) entered into a Loan and Guaranty Agreement (the “Loan Agreement”) with institutional lenders, pursuant +to which Ault & Company borrowed $36 million and issued secured promissory notes to the lenders in the aggregate amount of $38.9 million +(collectively, the “Secured Notes”; and the transaction, the “Loan”). +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, the Company’s Executive Chairman and the Chief Executive Officer of Ault & Company, +agreed to act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral +in support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to +the Lenders a security interest in (a) 19,226 Antminers (the “Miners”), (b) all of the digital currency mined or otherwise +generated from the Miners and (c) the membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana +and AGREE, pursuant to which those entities granted to the lenders a security interest in substantially all of their assets, as well as +a pledge of equity interests in Ault Aviation, AGREE, Sentinum, Third Avenue, Ault Energy, LLC, the Company’s wholly owned subsidiary, +ADTC, Eco Pack Technologies, Inc., the Company’s wholly owned subsidiary, and Circle 8 Holdco, (iii) a mortgage and security agreement +by Third Avenue on the real estate property owned by Third Avenue in St. Petersburg, Florida (the “Florida Property”), (iv) +a future advance mortgage by ACS on the real estate property owned by ACS in Dowagiac, Michigan (the “Michigan Property”), +(v) an aircraft mortgage and security agreement by Ault Aviation on a private aircraft owned by Ault Aviation (the “Aircraft”), +and (vi) deposit account control agreements over certain bank accounts held by certain of the Company’s subsidiaries. +In addition, pursuant to the Loan Agreement, the Company agreed to +establish a segregated deposit account (the “Segregated Account”), which would be used as a further guarantee of repayment +of the Secured Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. The Company is required to have the +minimum balance in the Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million on the four-month, nine-month, +one-year and two-year anniversaries of the closing date, respectively. In addition, starting on March 31, 2024, the Company is required +to deposit $0.3 million monthly into the Segregated Account, which increases to $0.4 million monthly starting March 31, 2025. Further, +the Company agreed to deposit into the Segregated Account, (i) up to the first $7 million of net proceeds, if any, from the sale of the +Hilton Garden Inn in Madison West, the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; +(ii) 50% of cash dividends (on a per dividend basis) received from Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from +any bond offerings the Company conducts, which shall not exceed $9 million in the aggregate; and (iv) 25% of the net proceeds from cash +flows, collections and revenues from loans or other investments made by Ault Lending (including but not limited to sales of loans or investments, +dividends, interest payments and amortization payments), which shall not exceed $5 million in the aggregate. In addition, if the Company +decides to sell certain assets, the Company further agreed to deposit funds into the Segregated Account from the sale of those assets, +including, (i) $15 million from the sale of the Florida Property, (ii) $11 million from the sale of the Aircraft, (iii) $17 million from +the sale of the Michigan Property, (iv) $350 per Miner, subject to a de minimis threshold of $1 million, and (v) $10 million from the +sale of Circle 8. +Pursuant to the Company’s +financial guarantee obligations noted above, the Company recorded a guarantee liability of $38.9 million using the practical expedient +to fair value as set forth in ASC 460-10-30-2(a) and recorded an expense of $35.4 million (the amount of the guarantee liability, less +the $3.5 million restricted cash in the Segregated Account) within other income (expense) on the consolidated statement of operations +and comprehensive loss for the year ended December 31, 2023. +The guarantee written by the +Company represents a variable interest in Ault & Company. Ault & Company, Inc, founded in 2015, is a private holding company focused +on acquiring undervalued assets and disruptive technologies within the commercial, defense, aerospace, industrial, hospitality, technology +and real estate sectors. Mr. Ault is the Founder and Executive Chairman of its Board of Directors. Ault & Company has demonstrated +its ability to raise capital independently, on a limited basis, however given the nature of its strategic investment policy, there is +no requirement for it to raise additional capital until and unless a strategic opportunity presents itself that requires additional capital. +The nature and amount of the financing that the Company guaranteed indicates that Ault & Company’s lender required the Company’s +collateral and support to close the December 2023 financing. +The accounting guidance requires +the Company to perform an analysis to determine whether its variable interest gives it a controlling financial interest in Ault & +Company. The Company performed a VIE analysis and determined that given the control structure and ownership of Ault & Company that +the Company would not be able to remove the key operating decision maker, Mr. Ault, from his leadership role at Ault & Company and +therefore the Company does not meet the power criterion to be considered the primary beneficiary of Ault & Company. +2022 Issuances +2022 ATM Offering – Common Stock +On February 25, 2022, the +Company entered into an At-The-Market issuance sales agreement with Ascendiant Capital to sell shares of common stock having an aggregate +offering price of up to $ 200 million from time to time, through an “at the market offering” program (the “2022 Common +ATM Offering”). As of December 31, 2022, the Company had sold an aggregate of approximately 38,000 shares of common stock pursuant +to the 2022 Common ATM Offering for gross proceeds of $ 172.4 million. +F- 49 +Public Offering of Series D Preferred Stock +The Company has designated +2.0 million shares of preferred stock, par value $ 0.001 per share, of the Company as the Series D Preferred Stock. +On June 3, 2022, the Company +announced the closing of its public offering of 144,000 shares of its Series D Preferred Stock at a price to the public of $ 25.00 per +share. Gross proceeds from the offering were approximately $ 3.6 million, before deducting offering expenses. Net proceeds to the Company, +after payment of commissions, non-accountable fees and offering expenses were $ 3.1 million. +2022 ATM Offering – Preferred Stock +On June 14, 2022, the Company +entered into an At-The-Market equity offering program with Ascendiant Capital under which it may sell, from time to time, shares of its +Series D Preferred Stock for aggregate gross proceeds of up to $ 46.4 +million (the “2022 Preferred ATM Offering”). As of December 31, 2022, the Company had sold an aggregate of 28,838 +shares of Series D Preferred Stock pursuant to the 2022 Preferred ATM Offering for gross proceeds of $ 0.5 +million. +27. +INCOME TAXES +The following is a geographical +breakdown of income/loss before the provision for income tax, for the years ended December 31, 2023 and 2022: +Schedule of income loss before the provision for income tax +2023 +2022 +Pre-tax loss +U.S. Federal +$ ( 256,824,000 ) +$ ( 189,899,000 ) +Foreign +867,000 +( 4,419,000 +) +Total +$ ( 255,957,000 ) +$ ( 194,318,000 ) +Deferred income taxes reflect +the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes +and income tax purposes. Significant components of the Company’s deferred tax assets are as follows: +Schedule of deferred tax assets +2023 +2022 +Deferred tax asset: +Allowance for doubtful accounts +$ +315,000 +$ +439,000 +Unrealized losses +13,859,000 +11,082,000 +Obsolete inventory +1,996,000 +2,816,000 +Stock compensation +13,383,000 +3,581,000 +Other carryforwards +311,000 +317,000 +Net operating loss carryforwards +94,899,000 +17,878,000 +Lease liability +1,224,000 +1,979,000 +Impairment +29,702,000 +22,822,000 +Accrued expenses +2,360,000 +3,648,000 +Interest expense +14,713,000 +8,668,000 +Outside basis difference +9,308,000 +- +Other +2,095,000 +404,000 +Total deferred tax asset +184,165,000 +73,634,000 +Deferred tax liability: +Right-of-use assets +( 1,112,000 +) +( 1,865,000 +) +Fixed assets, net +( 15,289,000 +) +( 1,575,000 +) +Intangible assets, net +42,000 +( 6,638,000 +) +Bargain gain/loss +- +( 225,000 +) +Total deferred income tax liabilities +( 16,359,000 +) +( 10,303,000 +) +Net deferred income tax assets +167,806,000 +63,331,000 +Valuation allowance +( 167,806,000 +) +( 63,304,000 +) +Deferred tax asset (liability), net +- +$ +27,000 +F- 50 +At December 31, 2023, +the Company had federal net operating loss carryforwards (“NOLs”) for income tax purposes of approximately $ 215.4 +million related to the year after December 31, 2017 that does not have an expiration under current tax law and $ 132.5 +million that expire between 2024 and 2037 after application of limitation set forth in Section 382 of the Internal Revenue Code +(“§382”). The Company had state NOLs for income tax purposes of approximately $251.6 million as of December 31, +2023. The state NOLs may be used to offset future taxable income and will begin to expire in 2038, +unless previously utilized. In accordance with §382, future utilization of the Company’s NOLs is subject to an annual +limitation as a result of ownership changes that occurred previously. The Company also maintains NOLs in various foreign +jurisdictions. +At December 31, 2023, Ault +Disruptive, an entity not consolidated for income tax purposes, utilized its remaining NOLs. The Company has not completed +a formal §382 study and completion of such an analysis in future periods may yield income tax provision impacts in subsequent financial +statements. +In assessing the realization of deferred tax assets, management considers +whether it is more likely than not some portion or all deferred tax assets will not be realized. The ultimate realization of deferred +tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences representing net +future deductible amounts become deductible. Management considers the scheduled reversal of deferred tax assets, projected future taxable +income and tax planning strategies in making this assessment. After consideration of all positive and negative evidence, including the +Company’s generation of NOLs in current and prior periods, there is substantial doubt regarding the Company’s ability to utilize +its deferred tax assets, therefore, the Company recorded a full valuation allowance. For the year ended December 31, 2023, the valuation +allowance increased by $ 104.5 million. +The net income tax provision (benefit) +consisted of the following: +Schedule of reconciliation of income tax attributable to operations +2023 +2022 +Current +U.S. Federal +$ 221,000 +$ 244,000 +U.S. State +( 99,000 ) +143,000 +Foreign +188,000 +132,000 +Total current provision +310,000 +519,000 +Deferred +U.S. Federal +0 +( 4,977,000 ) +U.S. State +27,000 +( 27,000 ) +Foreign +0 +0 +Total deferred provision (benefit) +27,000 +( 5,004,000 ) +Total provision (benefit) for income taxes +$ 337,000 +$ ( 4,485,000 ) +The Company’s effective +tax rates were ( 0.3 )% and 2.3 % for the years ended December 31, 2023 and 2022, respectively. During the year ended December 31, 2023, +the effective tax rate differed from the U.S. federal statutory rate primarily due to the change in valuation allowance. The reconciliation +of income tax attributable to operations computed at U.S. Federal statutory income tax rates of 21 % to income tax expense is as follows: +Schedule of effective income tax rate reconciliation +2023 +2022 +Expected federal income tax benefit +21.0 +% +21.0 +% +State taxes net of federal benefit +- 1.1 +% +7.3 +% +Effect of change in valuation allowance +- 15.8 +% +- 22.1 +% +Permanent differences +1.0 +% +- 1.0 +% +Goodwill impairment +- 2.3 +% +- 1.4 +% +IRC Section 162(m) compensation limitation +0.0 +% +- 0.3 +% +Excess tax benefit - windfall/(shortfall) +- 0.2 +% +- 0.2 +% +Guarantee loss +- 2.9 +% +- +Other +0.2 +% +- 0.9 +% +Income tax benefit +- 0.1 +% +2.3 +% +The Company accounts for uncertain +tax positions in accordance with ASC 740-10-25. ASC 740-10-25 addresses the determination of whether tax benefits claimed or expected +to be claimed on a tax return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit +from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing +authorities, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit +that is greater than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these +matters is different than the amount recorded, such differences impact income tax expense in the period in which such determination is +made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. +ASC 740-10-25 also requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken +uncertain tax positions that more likely than not would not be sustained upon examination by applicable taxing authorities. Management +of the Company has evaluated tax positions taken by the Company and has concluded that as of December 31, 2023 and 2022, there are no +uncertain tax positions taken, or expected to be taken, that would require recognition of a liability that would require disclosure in +the financial statements. +F- 51 +In general, the Company’s +statute of limitations remains open for various taxable years, in various U.S. federal, U.S. state and foreign jurisdictions. However, +if and when the Company claims net operating loss carryforwards against future taxable income, those losses may be examined by taxing +authorities. The Company will perform an analysis to determine the effect, if any, of these loss limitations rules on the NOL carryforward +balances. Earnings in all foreign jurisdictions are permanently reinvested. +28. NET LOSS PER SHARE +Net loss per share is computed +by dividing the net loss to common stockholders by the weighted average number of common shares outstanding. The calculation of the basic +and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock equivalents is anti-dilutive +due to the Company’s net loss position for all periods presented. Anti-dilutive securities, which are convertible into or exercisable +for common stock, consisted of the following at December 31, 2023 and 2022: +Schedule of net loss per share +December 31, +2023 +2022 +Warrants +14,179,000 +2,000 +Convertible preferred stock +8,137,000 +- +Convertible notes +1,339,000 +- +Stock options +1,000 +1,000 +Total +23,656,000 +3,000 +29. SEGMENT AND CUSTOMERS INFORMATION +The Company has eight and +seven reportable segments and the holding company as of December 31, 2023 and 2022, respectively; see Note 1 for a brief description of +the Company’s business. +The following data presents +the revenues, expenditures and other operating data of the Company’s operating segments and presented in accordance with ASC 280. +Segment information for the +year ended December 31, 2023: +Schedule of operating segments +GIGA +TurnOn +Green +Fintech +Sentinum +Ault +Disruptive +SMC +Energy +ROI +Holding +Company +Total +Revenue, product +$ 37,759,000 +$ 4,201,000 +$ - +$ 1,416,000 +$ - +$ 31,557,000 +$ 899,000 +$ 305,000 +$ - +$ 76,137,000 +Revenue, digital currencies mining +- +- +- +33,107,000 +- +- +- +- +- +33,107,000 +Revenue, lending and trading activities +- +- +( 1,998,000 ) +- +- +- +- +- +- +( 1,998,000 ) +Revenue, crane operations +- +- +- +- +- +- +49,198,000 +- +- +49,198,000 +Total revenues +$ 37,759,000 +$ 4,201,000 +$ ( 1,998,000 ) +$ 34,523,000 +$ - +$ 31,557,000 +$ 50,743,000 +$ 305,000 +$ - +$ 156,444,000 +Depreciation and amortization expense +$ 1,097,000 +$ 93,000 +$ - +$ 18,295,000 +$ - +$ 884,000 +$ 4,377,000 +$ 173,000 +$ 2,055,000 +$ 26,974,000 +Impairment of goodwill and intangible assets +$ 4,681,000 +$ - +$ - +$ - +$ - +$ - +$ 42,880,000 +$ - +$ - +$ 47,561,000 +Impairment of property and equipment +$ - +$ - +$ - +$ - +$ - +$ - +$ 14,025,000 +$ 4,136,000 +$ - +$ 18,161,000 +Impairment of mined digital currencies +$ - +$ - +$ - +$ 489,000 +$ - +$ - +$ - +$ - +$ - +$ 489,000 +Income (loss) from operations +$ ( 12,227,000 ) +$ ( 4,381,000 ) +$ ( 3,416,000 ) +$ ( 2,583,000 ) +$ ( 1,325,000 ) +$ ( 6,972,000 ) +$ ( 51,351,000 ) +$ ( 44,353,000 ) +$ ( 27,113,000 ) +$ ( 153,721,000 ) +Interest expense +$ 843,000 +$ 124,000 +$ - +$ 221,000 +$ - +$ 338,000 +$ 2,344,000 +$ 4,383,000 +$ 28,342,000 +$ 36,595,000 +Capital expenditures for the year ended December 31, 2023 +$ 271,000 +$ 145,000 +$ - +$ 2,019,000 +$ - +$ 383,000 +$ 3,603,000 +$ 479,000 +$ 2,757,000 +$ 9,657,000 +Segment identifiable assets as of December 31, 2023 +$ 32,470,000 +$ 4,995,000 +$ 17,027,000 +$ 59,903,000 +$ 2,347,000 +$ - +$ 51,254,000 +$ 9,937,000 +$ 31,266,000 +208,199,000 +Assets of discontinued operations +90,991,000 +Total identifiable assets as of December 31, 2023 +$ 299,190,000 +F- 52 +Segment information for the +year ended December 31, 2022: +GIGA +TurnOn +Green +Fintech +Sentinum +Ault +Disruptive +SMC +Energy +Holding +Company +Total +Revenue +$ 30,255,000 +$ 5,522,000 +$ 239,000 +$ 1,105,000 +$ - +$ 24,224,000 +$ 216,000 +$ - +$ 61,561,000 +Revenue, digital currencies mining +- +- +- +16,693,000 +- +- +- +- +16,693,000 +Revenue, crane operations +- +- +- +- +- +- +2,739,000 +- +2,739,000 +Revenue, lending and trading activities +- +- +36,644,000 +- +- +- +- +- +36,644,000 +Total revenues +$ 30,255,000 +$ 5,522,000 +$ 36,883,000 +$ 17,798,000 +$ - +$ 24,224,000 +$ 2,955,000 +$ - +$ 117,637,000 +Depreciation and amortization expense +$ 1,713,000 +$ 497,000 +$ 475,000 +$ 12,396,000 +$ - +$ 503,000 +$ 281,000 +$ 556,000 +$ 16,421,000 +Impairment of goodwill and intangible assets +$ 9,881,000 +- +$ - +$ - +$ - +$ 3,183,000 +$ - +$ - +$ 13,064,000 +Impairment of property and equipment +$ - +$ - +$ - +$ 79,556,000 +$ - +$ - +$ - +$ - +$ 79,556,000 +Impairment of deposit due to vendor bankruptcy filing +$ - +$ - +$ - +$ 2,000,000 +$ - +$ - +$ - +$ - +$ 2,000,000 +Impairment of mined digital currencies +$ - +$ - +$ - +$ 3,099,000 +$ - +$ - +$ - +$ - +$ 3,099,000 +Income (loss) from operations +$ ( 13,951,000 ) +$ ( 3,843,000 ) +$ 4,430,000 +$ ( 91,614,000 ) +$ ( 1,420,000 ) +$ ( 4,973,000 ) +$ ( 546,000 ) +$ ( 27,560,000 ) +$ ( 139,477,000 ) +Interest expense +$ 745,000 +$ 7,000 +$ 3,000 +$ 233,000 +$ 7,000 +$ 271,000 +$ 1,457,000 +$ 34,619,000 +$ 37,342,000 +Capital expenditures for the year ended December 31, 2022 +$ 600,000 +$ 266,000 +$ 17,374,000 +$ 80,799,000 +$ - +$ 93,000 +$ 31,000 +$ 142,000 +$ 99,305,000 +Segment identifiable assets as of December 31, 2022 +$ 38,520,000 +$ 6,959,000 +$ 82,944,000 +$ 75,731,000 +$ 118,791,000 +$ 27,508,000 +$ 96,255,000 +$ 16,312,000 +$ 463,020,000 +Assets of discontinued operations +98,494,000 +Total identifiable assets as of December 31, 2022 +$ 561,514,000 +30. CONCENTRATIONS +OF CREDIT AND REVENUE RISK +2023 Concentrations +of Credit and Revenue Risk +Accounts +receivable are concentrated with a certain large customer. At December 31, 2023, one Circle 8 customer in North America accounted for +11 % of consolidated accounts receivable. +For the year +ended December 31, 2023, one customer, a mining pool operator in North America, represented 11 % of consolidated revenues. +2022 Concentrations +of Credit and Revenue Risk +Accounts receivable +are concentrated with a certain large customer. At December 31, 2022, one SMC customer in North America accounted for 14 % of consolidated +accounts receivable. +For the year +ended December 31, 2022, one customer, a mining pool operator in North America, represented 14 % of consolidated revenues. +F- 53 +31. SUBSEQUENT EVENTS +2023 Common ATM +Offering +During the +period between January 1, 2024 through April 16, 2024, the Company sold an aggregate of 25.6 million shares of common stock pursuant to +the 2023 Common ATM Offering for gross proceeds of $ 14.6 million. +6% Convertible Promissory +Notes +On March 11, +2024, the Company entered into a note purchase agreement with two institutional investors pursuant to which the Investors agreed to acquire, +and the Company agreed to issue and sell in a registered direct offering to the Investors an aggregate of $ 2.0 million convertible promissory +notes, bearing interest of 6 % . The convertible promissory notes were issued at a discount, with net proceeds to the Company of $ 1.8 million. +The convertible promissory notes are scheduled to mature June 12, 2024, the Company has the option to extend the maturity date to September +12, 2024 , for which the Company will increase the principal amount of the Notes by 5%. The Notes are convertible into shares of common +stock at a conversion price of $ 0.35 per share. +Additional Closings of Series +C Preferred Stock, Related Party +On each +of March 7, 2024, March 8, 2024 , March 18, 2024 and March 19, 2024 pursuant to the November 2023 SPA entered into with Ault & +Company on November 6, 2023, the Company sold to Ault & Company 500 shares of Series C Preferred Stock and Warrants to purchase 147,820 +shares of common stock, for a total purchase price of $0.5 million. As of March 19, 2024, Ault & Company has purchased an aggregate +of 43,500 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase an aggregate of 12,860,312 Warrant Shares, +for an aggregate purchase price of $43.5 million. The November 2023 SPA provides that Ault & Company may purchase up to $75.0 million +of Series C Convertible Preferred Stock and Series C Warrants in one or more closings. +Amendment to the November +2023 SPA and Series C Designation of Preferences, Rights and Limitations +On March 25, 2024, the November 2023 SPA entered into +with Ault & Company was amended to increase the amount of Series C Preferred Stock and Series C Warrants that may be purchase under +the agreement from $50.0 million to $75.0 million and an extension of the date to closing the final tranche of the financing to June 30, +2024. On April 3, 2024, the Company filed a Certificate of Increase to the Series C Designation of Preferences, Rights and Limitations +to increase the number of authorized shares of Series C Preferred Stock from 50,000 to 75,000 . +Ault Lending Investment in Alzamend Series A Convertible Preferred +Stock and Warrants +On January 31, 2024, Ault +Lending entered into a securities purchase agreement with Alzamend pursuant to which Alzamend agreed to sell Ault Lending up to 6,000 +shares of Alzamend Series A convertible preferred stock and warrants to purchase shares of the Alzamend common stock. The Agreement provides +that Ault Lending may purchase up to $6 million of Alzamend Series A Convertible Preferred Stock in one or more closings. +On January 31, 2024, Alzamend +sold 1,220 shares of its Series A convertible preferred stock and warrants to purchase 1.2 million shares of its common stock to Ault +Lending, for a total purchase price of $ 1.2 million. On March 26, 2024, Alzamend sold an additional 780 shares of its Series A convertible +preferred stock and warrants to purchase 0.8 million shares of its common stock to Ault Lending, for a total purchase price of $ 0.8 million. +Amendment to the Loan Agreement +On April 15, +2024, the Loan Agreement was amended to extend the deadline, from the four-month anniversary to the five-month anniversary of the closing +date of the Loans, by which the Company is required to have the minimum balance in the Segregated Account be not less than $7 million. +Final Distribution of TurnOnGreen Securities +Announced +The Company established a +record date of April 15, 2024 for its final distribution of TurnOnGreen securities. Stockholders as of this date are entitled to 0.83 shares +of TurnOnGreen common stock and warrants to purchase 0.83 shares of TurnOnGreen common stock for every share of the Company’s common stock they held on the record date. The Company will distribute +25.0 million TurnOnGreen securities in the final distribution. +F- 54 \ No newline at end of file diff --git a/raw/filings/0000896493/2023/0001214659-24-006963/filing_metadata.csv b/raw/filings/0000896493/2023/0001214659-24-006963/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..d814d71ebdbeda6ad8b2f4b5c256a790e5c96c5e --- /dev/null +++ b/raw/filings/0000896493/2023/0001214659-24-006963/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2024-04-16,2023-12-31,2024-04-16T21:23:35.000Z,0001214659-24-006963,aa32524110k.htm,,20256624,1,1,https://www.sec.gov/Archives/edgar/data/896493/000121465924006963/aa32524110k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465924006963/,2023,2023,1 diff --git a/raw/filings/0000896493/2023/0001214659-24-006963/item1.txt b/raw/filings/0000896493/2023/0001214659-24-006963/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e3630da79702ab6d0b105e6de151956aea08b202 --- /dev/null +++ b/raw/filings/0000896493/2023/0001214659-24-006963/item1.txt @@ -0,0 +1,2249 @@ +ITEM 1. BUSINESS +Company Overview +Ault Alliance, Inc., a Delaware +corporation, was incorporated in September 2017 (sometimes referred to as “AAI,” the “Company,” “we” +or “us”). Through our wholly and majority-owned subsidiaries and strategic investments, we own and/or operate data centers +at which we mine Bitcoin and offer colocation and hosting services for the emerging artificial intelligence (“AI”) ecosystems +and other industries, and provide mission-critical products that support a diverse range of industries, including a metaverse platform, +oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics and textiles. Our +direct and indirect wholly owned subsidiaries include (i) Sentinum, Inc. (“Sentinum”), (ii) Alliance Cloud Services, LLC (“ACS”), +(iii) BNI Montana, LLC (“BNI Montana”), (iv) Ault Capital Group, Inc. (“Ault Capital”), (v) Ault Lending, LLC +(“Ault Lending”), (vii) Ault Global Real Estate Equities, Inc. (“AGREE”), (viii) Ault Disruptive Technologies +Company, LLC (“ADTC”), which is the sponsor, Manager and the majority owner of Ault Disruptive Technologies Corporation (“Ault +Disruptive”), (ix) Eco Pack Technologies, Inc. (“Eco Pack”), which has a controlling interest in Eco Pack Technologies +Limited, (x) Ault Aviation, LLC (“Ault Aviation”) and (xi) Third Avenue Apartments, LLC (“Third Avenue”). +We also have a direct controlling +interest in (i) Circle 8 Holdco LLC (“Circle 8 Holdco”), which wholly owns Circle 8 Crane Services, LLC (“Circle 8”), +(ii) TurnOnGreen, Inc., formerly known as Imperalis Holding Corp. (“TurnOnGreen”), which wholly owns TOG Technologies, Inc. +(“TOG Technologies”) and Digital Power Corporation (“Digital Power”), (iii) Gresham Worldwide, Inc., formerly +known as Giga-tronics Incorporated (“GIGA”), which wholly owns Gresham Holdings, Inc., formerly Gresham Worldwide, Inc. (“GWW”), +which in turn wholly owns Gresham Power Electronics Ltd. (“Gresham Power”), Enertec Systems 2001 Ltd. (“Enertec”), +Relec Electronics Ltd. (“Relec”) and has a controlling interest in Microphase Corporation (“Microphase”) and (iv) +Avalanche International Corp. (“Avalanche” or “AVLP”), which does business as MTIX International (“MTIX”). +We have minority interests in (i) RiskOn International, Inc., formerly known as BitNile Metaverse, Inc. (“ROI”), which wholly +owns BitNile.com, Inc. (“BNC”), RiskOn 360, Inc., formerly known as Ault Iconic, Inc. (“RiskOn 360”), RiskOn Learning, +Inc. and GuyCare, Inc. (“GuyCare”) and (ii) The Singing Machine Company, Inc. (“SMC”). We consolidate each of +ROI and SMC as variable interest entities. +AAI was founded by Milton +C. (Todd) Ault, III, its Executive Chairman, and is led by Mr. Ault, William B. Horne, its Chief Executive Officer and Vice Chairman, +and Henry Nisser, its President and General Counsel. Together, they constitute the Executive Committee, which manages the day-to-day operations +of the holding company. The Company’s long-term objective is to maximize per share intrinsic value. All major investment and capital +allocation decisions are made for us by Mr. Ault and the Executive Committee. +We have the following reportable +segments: +· AAI directly conducts Fintech, commercial lending and trading through Ault Lending; +· Sentinum: Bitcoin mining operation and data center operations through ACS; +1 +· Circle 8: crane rental and lifting solutions provider for oilfield, construction, commercial and infrastructure +markets; +· ROI: operates a software-as-a-service platform called askROI.com, which is a unique, generative AI-driven +platform engineered to provide pertinent and unique data insights through integration with business specific data that pushes beyond the +conventional uses of existing large language models. ROI also owns 100% of BNC, which operates a metaverse platform and 100% of GuyCare, +Inc. which develops products designed to improve men’s health; +· GIGA: defense solutions with operations conducted by GWW’s subsidiaries Microphase, Enertec, Gresham +Power and Relec; +· TurnOnGreen: commercial electronics solutions with operations conducted by Digital Power, and electric +vehicle (“EV”) charging solutions through TOG Technologies; +· SMC: karaoke audio equipment; +· AVLP: advanced textiles processing technology; and +· Ault Disruptive: a special purpose acquisition company. +We operate as a holding company +with operations conducted primarily through our subsidiaries, which are described below. +Recent Events and Developments +On February 25, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with Ascendiant Capital Markets, LLC (“Ascendiant”) +to sell shares of common stock having an aggregate offering price of up to $200 million from time to time, through an “at the market +offering” program (the “2022 ATM Offering”). The offer and sale of shares of common stock from the 2022 ATM Offering +was made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained +therein (Registration Statement No. 333-260618) which became effective on November 12, 2021. Through March 13, 2023, we received gross +proceeds of approximately $177 million through the sale of 42,382 shares of common stock from the 2022 ATM Offering. The 2022 Sales Agreement +has been terminated. +On June 10, 2022, we entered +into an At-The-Market Issuance Sales Agreement (the “2022 Preferred Sales Agreement”) with Ascendiant to sell shares of our +13.00% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred Shares”) having an aggregate offering price +of up to $46.4 million from time to time, through an “at the market offering” program (the “2022 ATM Preferred Offering”). +The offer and sale of Series D Preferred Shares from the 2022 ATM Preferred Offering was made pursuant to our effective “shelf” +registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) which +became effective on November 12, 2021. Through June 16, 2023, we received gross proceeds of approximately $3.4 million through the sale +of 281,197 Series D Preferred Shares in the 2022 ATM Preferred Offering. The 2022 Preferred Sales Agreement has been terminated. +On November 7, 2022, we and +certain of our subsidiaries borrowed $18.9 million of principal amount of term loans (the “Term Loans”) from a group of institutional +investors (the “Financing”). The Term Loans matured in 18 months, which may have been extended to 24 months, accrued interest +at the rate of 8.5% per annum and were secured by certain of our and certain of our subsidiaries’ assets. Starting in January 2023, +the lenders had the right to require us to make monthly payments of $0.6 million, which increased to $1.1 million in November 2023. The +Term Loans were issued with an original issue discount of $1.89 million. +The lenders received warrants +to purchase 604 shares of our common stock, exercisable for four years at $3,375 per share and warrants to purchase another 604 shares +of our common stock, exercisable for four years at $5,625 per share, subject to adjustment. +On July 19, 2023, we along +with certain of our subsidiaries entered into a First Amendment and Joinder to Loan and Guarantee Agreement (the “Amendment”) +with the institutional investors pursuant to which the (i) Loan and Guarantee Agreement, dated November 7, 2022, entered into between +us and the institutional investors (the “Loan Agreement”) and (ii) Security Agreement, dated November 7, 2022, entered into +between the institutional investors and Sentinum (the “Security Agreement”) was amended. Pursuant to the Amendment, we borrowed +an additional $8.8 million. The net proceeds of the additional loan amount were $7.5 million and the aggregate size of the Term Loans +increased from $18.9 million to $24.3 million. The Term Loans were repaid in December 2023. +2 +On December 16, 2022 we entered +into a Securities Purchase Agreement (the “SPA”) with an accredited investor (the “December 2022 Investor”) providing +for the issuance of a secured promissory note (the “December 2022 Note”) with an aggregate principal face amount of $14,700,000. +On December 29, 2022, the Company and the December 2022 Investor entered into an amended and restated amendment to the SPA, pursuant to +which the total amount of the financing was increased to $17,456,245 and the Company sold an additional note to a second accredited investor. +Under the SPA, we were obligated +to repay, while the December 2022 Note remains outstanding, (i) eighty percent (80%) of the proceeds we may receive from any financing +conducted, other than at-the-market offerings and (ii) one hundred percent (100%) of the proceeds we may receive from the sale of marketable +securities by Ault Lending. In addition, if Third Avenue Apartments, LLC (“Third Avenue”), our wholly owned subsidiary, sold +the property it owns in St. Peterburg, Florida, then we would use the net proceeds from the sale of such property in excess of $10 million, +to repay the December 2022 Note. In addition, we agreed to issue 1,547 shares of our common stock to the December 2022 Investor in exchange +for the cancellation of all outstanding warrants previously issued to the December 2022 Investor, which warrants were exercisable for +1,547 shares of our common stock. +On January 23, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable +preferred stock which, effective upon filing, eliminated the Series C convertible redeemable preferred stock. +On February 8, 2023, we entered +into a Share Exchange Agreement (the “February 2023 Agreement”) with ROI and the other signatories thereto. The February 2023 +Agreement provided that, subject to the terms and conditions set forth therein, ROI would acquire all of the outstanding shares of capital +stock of our then subsidiary, BNC, of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders (the +“Minority Shareholders”), as well as RiskOn 360, in exchange for the following: (i) 8,637.5 shares of newly designated Series +B Convertible Preferred Stock of ROI that were issued to our company (the “Series B Preferred”), and (ii) 1,362.5 shares of +newly designated Series C Convertible Preferred Stock of ROI that were issued to the to the Minority Shareholders (the “Series C +Preferred,” and together with the Series B Preferred, the “Preferred Stock”). The Series B Preferred and the Series +C Preferred each have a stated value of $10,000 per share (the “Stated Value”), for a combined stated value of the Preferred +Stock to be issued by ROI, of $100,000,000, and subject to adjustment, are convertible into shares of common stock of ROI. However, pending +approval of the transaction by ROI’s shareholders, the Preferred Stock is subject to a 19.9% beneficial ownership limitation, including +the Series A Convertible Preferred Stock that we acquired from ROI in June of 2022. +Pursuant to the Certificates +of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred +Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of ROI common stock determined by +dividing the Stated Value by $0.25 (the “Conversion Price”), or 40,000 shares of ROI common stock. The Conversion Price will +be subject to certain adjustments, including potential downward adjustment if ROI closes a qualified financing resulting in at least $25,000,000 +in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock will be +entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend +Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather +than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If +ROI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as +long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the +event of a liquidation, change of control event, dissolution or winding up of ROI, and will rank senior to all other capital stock of +ROI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred +was originally entitled to vote with the ROI common stock at a rate of 10 votes per share of common stock into which the Series B Preferred +is convertible, but that provision was subsequently eliminated, as were the conventional voting rights of the Series C Preferred. Other +than certain rights granted to the Company relating to amendments or waiver of various negative covenants, the terms, rights, preferences +and limitations of the Preferred Stock Certificates are essentially identical. The February 2023 Agreement closed on March 6, 2023. +On February 24, 2023, BNI +Montana entered into an asset purchase agreement with TypeX, LLC (“TypeX”), to acquire two land lease agreements and two corresponding +power purchase agreements in Montana. The lease and power agreements run for a period of 10 years, with a 10-year renewal option. Sentinum +is building out and developing fully operational data centers dedicated to Bitcoin mining operations on the properties (the “Montana +Facilities”). We anticipate that upon completion, the Montana Facilities will provide up to a combined 20 megawatts of power, enabling +up to 6,500 S19j Pro Antminers to operate. The first 10 megawatts of power was connected to the utility electrical network in March 2024. +The substations providing power to the Montana Facilities have the ability to handle additional capacity and Sentinum has initiated a +load study to determine future capacity and, if economically viable, intends to acquire such additional power capacity. We are redeploying +S19j Pro Antminers that are currently mining in our Michigan data center, allowing us to focus on expansion at our Michigan site to support +the rapid growth of high-performance computing and AI use cases. +3 +On April 6, 2023, we issued +a term note with a principal amount of $1.1 million, bearing an interest rate of 12% (the “Term Note”). The Term Note was +issued at a discount, with net proceeds to us amounting to $1.0 million. The Term Note was scheduled to mature on June 5, 2023. We exercised +the option to extend the maturity date by one month, by paying a $30,000 extension fee. Ault & Company guaranteed repayment of the +Term Note. +On April 20, 2023, Sentinum +entered into an amended Master Services Agreement with Core Scientific, Inc. (“Core Scientific”) for hosting services related +to the deployment of Bitcoin miners. This agreement provides for the sale of Bitcoin mined on a daily basis with the proceeds from such +sales generally being applied to operations fees of $25 per miner, hosting services fees, other miscellaneous fees and then any remaining +amounts, if any, are distributed 60% to Sentinum and 40% to Core Scientific if the price of Bitcoin is consistently greater than $45,000 +at month’s end. If the price of Bitcoin is less than $45,000, then any remaining amounts, if any, are distributed 50% to Sentinum +and 50% to Core Scientific. We have deployed 10,200 S19 Pro and S19j Pro Antminers with Core Scientific, securing approximately 30 MW +of power. The agreement terminates on August 31, 2024, unless terminated sooner pursuant to the terms of the agreement. Notwithstanding +the foregoing, either party may terminate the agreement with respect to 1,000 units in any thirty (30) day period on thirty (30) days +written notice on or after November 30, 2023. The Core Scientific hosting services agreement expedited the deployment of our Bitcoin miners +to approximately 19,200, representing a mining production capacity of approximately 2.1 exahashes per second. Under the terms of the Core +Scientific hosting services agreement, we expect that Sentinum will pay Core Scientific a monthly fee for operations and hosting services +of approximately $1.1 million, which amount excludes the profit sharing arrangement described above between the parties. +On June 8, 2023, we entered +into a Loan Agreement (the “Credit Agreement”) with Ault & Company as the lender. The Credit Agreement provided for an +unsecured, non-revolving credit facility in an aggregate principal amount of up to $10,000,000. All loans under the Credit Agreement (collectively, +the “Advances”) were due within five business days after request by Ault & Company and Ault & Company was not obligated +to make any further Advances under the Credit Agreement after December 8, 2023. Advances under the Credit Agreement bore interest at the +rate of 9.5% per annum and may be repaid at any time without penalty or premium. +On June 9, 2023, we entered +into an At-the-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital Markets, LLC, as sales agent +(the “Agent”) to sell shares of our common stock having an aggregate offering price of up to $10,000,000 (the “Shares”) +from time to time, through an “at the market offering” (the “ATM Offering”) as defined in Rule 415 under the Securities +Act. On June 9, 2023, we filed a prospectus supplement with the SEC relating to the offer and sale of up to $10,000,000 of common stock +in the ATM Offering. The offer and sale of the Shares are being made pursuant to our effective “shelf” registration statement +on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-260618) filed with the SEC on October +29, 2021 and declared effective by the SEC on November 12, 2021. On July 13, 2023 and September 8, 2023, we filed prospectus supplements +increasing the size of the ATM Offering to $20,000,000 and $50,000,000, respectively. Through March 12, 2024, we received gross proceeds +of approximately $50 million through the sale of 29,945,147 shares of common stock from the ATM Offering. The Sales Agreement has been +terminated. +On June 26, 2023, we established +a record date for our initial distribution of securities of TurnOnGreen. Stockholders as of this date were entitled to 40 shares of TurnOnGreen +common stock, along with warrants to purchase 40 shares of TurnOnGreen common stock (the “TurnOnGreen Securities”) for every +share of our common stock they held on the record date. The initial distribution was finalized in July 2023. We distributed 58.7 million +TurnOnGreen Securities in the first distribution. +On July 24, 2023, we established +a record date for our second partial distribution of TurnOnGreen Securities. Stockholders as of this date were entitled to 15 shares of +TurnOnGreen Securities for every share of the Company’s common stock they held on the record date. The second distribution was finalized +on August 7, 2023. We distributed 56.4 million TurnOnGreen Securities in the second distribution. +Effective August 3, 2023, +we and certain holders of preferred stock (the “Investors”) entered into an Exchange Agreement (the “Exchange Agreement”) +pursuant to which the Investors exchanged all of their preferred shares as well as their demand notes (the “Demand Notes”) +issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount of approximately $0.8 +million for two new 10% Secured OID Promissory Notes (the “Exchange Notes”), each with a principal face amount of $5.3 million, +for an aggregate amount owed of $10.5 million (the “Principal Amount”). We and Mr. Ault, our Executive Chairman, entered into +guaranty agreements with the March 2023 Investors guaranteeing repayment by Ault & Company of the Exchange Notes. +Effective as of August 3, +2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, +we issued a 10% demand promissory note in the principal face amount of $10.5 million (the “First Ault & Company Demand Note”) +to Ault & Company. +4 +Effective as of August 10, +2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued +a 12% demand promissory note in the principal face amount of $1.1 million (the “Second Demand Note”) to Ault & Company. +On September 8, 2023, we issued +to an accredited investor a term note (the “Short-Term Note”) with a principal face amount of $2,200,000 with a maturity date +of September 25, 2023. The Short-Term Note was issued with an original issue discount of $200,000 and did not bear interest unless an +event of default occurred under the Short-Term Note. The maturity date of the Short-Term Note was September 25, 2023. The purchase price +for the Short-Term Note was $2 million. Repayment of the Short-Term Note was secured by a guaranty provided by Ault & Company as well +as by Milton C. Ault, our Executive Chairman of the Company and the Chief Executive Officer of Ault & Company. +On September 27, 2023 we entered +into a securities exchange agreement with the holder of the Short-Term Note, pursuant to which we issued and sold in a registered direct +offering to the investor, a $2.2 million principal face amount convertible promissory note (the “Convertible Note”). The Convertible +Note bears no interest (unless an event of default occurs) as it was issued in exchange for the Short-Term Note, which contained an original +issue discount. The Convertible Note is convertible into shares of common stock at a conversion price equal to 90% of the lowest volume +weighted average price of the common stock during the five consecutive trading days prior to the date of conversion. As of the date of +filing of this Annual Report, we had issued 84,632 shares of common stock on the conversion of approximately $0.5 million of the Convertible +Note and paid an additional $1.2 million. The Convertible Note matured on March 29, 2024, is presently in default and has an outstanding +balance of approximately $0.5 million. +On October 13, 2023, we entered +into a note purchase agreement with Ault & Company, pursuant to which we sold to Ault & Company (i) a senior secured convertible +promissory note in the principal face amount of $17.5 million (the “Senior Note”) and warrants (the “Warrants”) +to purchase shares of our common stock for a total purchase price of up to $17.5 million. +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the Credit +Agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming +liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares +of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault +& Company to us. +The Senior Note had a principal +face amount of $17.5 million and a maturity date of October 12, 2028. The Senior Note bore interest at the rate of 10% per annum. Interest +was payable, at Ault & Company’s option, in cash or shares of common stock at the applicable conversion price. Accrued interest +was payable on the maturity date, provided, however, that Ault & Company had the option, on not less than 10 calendar days’ +notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. +The Senior Note was convertible +into shares of common stock at a conversion price equal to the greater of (i) $0.10 per share (the “Floor Price”), and (ii) +the lesser of (A) $7.38 or (B) 105% of the volume weighted average price of the common stock during the ten trading days immediately prior +to the date of conversion. The conversion price was subject to adjustment in the event of an issuance of common stock at a price per share +lower than the conversion price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. +The Floor Price shall not be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +The Warrants grant Ault & +Company the right to purchase 1,907,440 shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary +of the closing date, and become exercisable on the first business day after the six-month anniversary of the closing date. The exercise +price of the Warrants is $0.35, which is subject to adjustment in the event of customary stock splits, stock dividends, combinations or +similar events or in the event of an issuance of Common Stock at a price per share lower than the exercise price. +In addition, we and various +of our subsidiaries granted Ault & Company a senior security interest in substantially all of our assets as collateral for the repayment +of the Senior Note, which was subordinated to the security interest granted to the holders of the outstanding secured promissory notes. +5 +On November 6, 2023, we entered +into a securities purchase agreement (the “November 2023 SPA”) with Ault & Company, pursuant to which we agreed to sell, +in one or more closings, to Ault & Company up to 50,000 shares of Series C convertible preferred stock and warrants to purchase up +to 14.8 million shares of common stock for a total purchase price of up to $50 million. The consummation of the transactions contemplated +by the November 2023 SPA, specifically the conversion of the Series C convertible preferred stock and the exercise of the warrants in +an aggregate number in excess of 19.99% on the execution date of the November 2023 SPA, are subject to various customary closing conditions +as well as regulatory and stockholder approval. In addition to customary closing conditions, the closing of the financing is also conditioned +upon the receipt by Ault & Company of financing to consummate the transaction. +On November 15, 2023, we purchased +from ROI 603.44 shares of ROI’s newly designated Series D convertible preferred stock (“ROI Series D Preferred”) for +a total purchase price of $15.1 million. The purchase price was paid by the cancellation of $15.1 million of cash advances made by us +to ROI between January 1, 2023 and November 9, 2023. Each share of ROI Series D Preferred has a stated value of $25,000 per share and +each share of ROI Series D Preferred is convertible into a number of shares of ROI’s common stock determined by dividing the stated +value by $0.51, subject to adjustment in the event of an issuance of ROI common stock at a price per share lower than the conversion price, +as well as upon customary stock splits, stock dividends, combinations or similar events. The ROI Series D Preferred holders are entitled +to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. In addition, for as long as at least 25% of the +ROI Series D Preferred remain outstanding, ROI must obtain our consent with respect to certain corporate events, including reclassifications, +fundamental transactions, stock redemptions or repurchases, increases in the number of directors, and declarations or payment of dividends, +and further ROI is subject to certain negative covenants, including covenants against issuing additional shares of capital stock or derivative +securities, incurring indebtedness, engaging in related party transactions, selling of properties having a value of over $50,000, altering +the number of directors, and discontinuing the business of any subsidiary, subject to certain exceptions and limitations. However, pending +approval of the transaction by ROI’s shareholders, the ROI Series D Preferred is subject to a 19.99% beneficial ownership limitation. +On December 8, 2023, we filed +a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series B convertible preferred stock +which, effective upon filing, eliminated the Series B convertible preferred stock. +On December 14, 2023, pursuant +to the November 2023 SPA entered into with Ault & Company on November 6, 2023, we sold to Ault & Company, in three separate closings +that occurred on the closing date, an aggregate of 41,500 shares of Series C convertible preferred stock (the “Series C Convertible +Preferred Stock”), and warrants (the “Series C Warrants”) to purchase 12,269,031 shares of common stock, for a total +purchase price of $41.5 million. At the first closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred Stock +and Series C Warrants to purchase 6,356,245 shares of common stock, for a purchase price of $21.5 million, paid in cash (the “Initial +Closing”). Immediately upon the Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes +issued to the lenders pursuant to the Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +second closing (the “Second Closing”), Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock +and Series C Warrants to purchase 2,956,393 shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon +the Second Closing, we paid $10.0 million to partially satisfy the outstanding Senior Note. Promptly thereafter, at the third closing +(the “Third Closing”), Ault & Company purchased another 10,000 shares of Series C Convertible Preferred Stock and Series +C Warrants to purchase another 2,956,393 shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon +the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance on the outstanding Senior Note. +On December 14, 2023, we, +along with our wholly owned subsidiaries Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending, Ault Aviation and AGREE (collectively +with our company, Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending and Ault Aviation, the “Guarantors”) entered into +a Loan and Guaranty Agreement (the “Loan Agreement”) with institutional lenders, pursuant to which Ault & Company borrowed +$36 million and issued secured promissory notes to the lenders in the aggregate amount of $38.9 million (collectively, the “Secured +Notes”; and the transaction, the “Loan”). The Loan Agreement was amended as of April 15, 2024. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) 19,226 Antminers (the “Miners”), (b) all of the digital currency mined or otherwise generated +from the Miners and (c) the membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, +pursuant to which those entities granted to the lenders a security interest in substantially all of their assets, as well as a pledge +of equity interests in Ault Aviation, AGREE, Sentinum, Third Avenue, Ault Energy, LLC, our wholly owned subsidiary (“Ault Energy”), +ADTC, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue on the real estate property owned by Third +Avenue in St. Petersburg, Florida (the “Florida Property”), (iv) a future advance mortgage by ACS on the real estate property +owned by ACS in Dowagiac, Michigan (the “Michigan Property”), (v) an aircraft mortgage and security agreement by Ault Aviation +on a private aircraft owned by Ault Aviation (the “Aircraft”), and (vi) deposit account control agreements over certain bank +accounts held by certain of our subsidiaries. +6 +In addition, pursuant to the Loan Agreement, we agreed to establish +a segregated deposit account (the “Segregated Account”), which would be used as a further guarantee of repayment of the Secured +Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. We are required to have the minimum balance in the +Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and +two-year anniversaries of the closing date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million +monthly into the Segregated Account, which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into +the Segregated Account, (i) up to the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, +the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on +a per dividend basis) received from Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, +which shall not exceed $9 million in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans +or other investments made by Ault Lending (including but not limited to sales of loans or investments, dividends, interest payments and +amortization payments), which shall not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further +agreed to deposit funds into the Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida +Property, (ii) $11 million from the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, +subject to a de minimis threshold of $1 million, and (v) $10 million from the sale of Circle 8. +On January 12, 2024, pursuant +to the approval provided by our stockholders at the annual meeting of stockholders, we filed an Amendment to our Certificate of Incorporation +with the State of Delaware to effectuate a reverse stock split of our common stock affecting both the authorized and issued and outstanding +number of such shares by a ratio of one-for-twenty-five. The reverse stock split became effective on January 16, 2024. All share amounts +in this Annual Report have been updated to reflect the reverse stock split. +On January 31, 2024, Ault +Lending entered into a securities purchase agreement (the “January 2024 SPA”) with Alzamend Neuro, Inc. (“Alzamend”), +pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending up to 6,000 shares of Series B convertible preferred +stock (the “ALZN Series B Preferred”) and warrants to purchase up to 6.0 million shares of Alzamend common stock (the “ALZN +Series B Warrants”) for a total purchase price of up to $6.0 million. On January 31, 2024, +Ault Lending purchased 1,220 shares of ALZN Series B Preferred and warrants to purchase 1.22 million shares for a total purchase price +of $1.22 million. The purchase price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend +between November 9, 2023 and January 31, 2023. E ach share of ALZN Series B Preferred has a stated value of $1.00 per share and +is convertible into a number of shares of Alzamend’s common stock determined by dividing the stated value by $1.00, subject to adjustment +in the event of an issuance of Alzamend common stock at a price per share lower than the conversion price, as well as upon customary stock +splits, stock dividends, combinations or similar events. The ALZN Series B Warrants are +exercisable on the first business day after the six-month anniversary of issuance and have a five-year term, expiring on the fifth anniversary +of the initial exercise date. The exercise price of the ALZN Series B Warrants is $1.20, +subject to adjustment in the event of an issuance of Alzamend common stock at a price per share lower than the conversion price, +as well as upon customary stock splits, stock dividends, combinations or similar events. +On each of March 7, 2024, +March 8, 2024, March 18, 2024 and March 19, 2024, pursuant to the November 2023 SPA, we sold to Ault & Company 500 +shares of Series C Convertible Preferred Stock and Series C Warrants to +purchase 147,820 shares of common stock to the Purchaser, for a purchase price of $500,000. As +of April 15, 2024, Ault & Company has purchased an aggregate of 43,500 shares of Series C Convertible Preferred Stock and Series C +Warrants to purchase an aggregate of 12,860,311 shares of common stock, for an aggregate purchase price of $43.5 million. +On +March 11, 2024 we entered into a note purchase agreement (the “Purchase Agreement”) with two institutional investors (the +“Buyers”) pursuant to which the Buyers purchased from the Company, on March 12, 2024 in a registered direct offering to the +Buyers an aggregate of $2,000,000 principal face amount convertible promissory notes (the “Notes”). The Notes were sold to +the Buyers for an aggregate purchase price of $1,800,000, which reflects an original issue discount of $200,000. The Notes accrue interest +at the rate of 6% per annum, unless an event of default (as defined in the Notes) occurs, at which time the Notes would accrue interest +at 12% per annum. The Notes will mature on June 12, 2024, provided, however, that we have the right, upon written notice to the Buyers, +to extend the maturity date to September 12, 2024, for which we would increase the principal amount of the Notes then outstanding by 5%. +The Notes are convertible into shares of common stock at a conversion price of $0.35 per share. +7 +On March 26, 2024, pursuant +to the January 2024 SPA, Ault Lending purchased 780 shares of ALZN Series B Preferred Stock +and ALZN Series B Warrants to purchase 780,000 shares +of Alzamend common , for a purchase price of $780,000. As of April 15, 2024, Ault +Lending has purchased an aggregate of 2,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to +purchase an aggregate of 2.0 million shares of Alzamend common stock, for an aggregate purchase price of $2.0 million. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50,000,000.00 to $75,000,000.00 and (B) extended the date of on which the final closing may occur to June 30, +2024, subject to Ault & Company’s ability to further extended such date for ninety days. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +240, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is www.ault.com. +Our Corporate Structure +On January 3, 2023, we changed +our name from BitNile Holdings, Inc. to Ault Alliance, Inc. (the “Name Change”). The Name Change was effected through a parent/subsidiary +short form merger pursuant to an Agreement and Plan of Merger dated December 20, 2022. Neither the merger nor the Name Change affected +the rights of our security holders. Our common stock is traded on the NYSE American under the symbol “AULT.” Existing stock +certificates that reflect a prior corporate name continue to be valid. Certificates reflecting the new corporate name are issued as old +stock certificates are tendered for exchange or transfer to our transfer agent. +In March 2024, we reorganized +our corporate structure pursuant to a series of transactions by and among the Company and its directly and indirectly owned subsidiaries +as well as third parties. The purpose of the reorganization was to simplify our organizational and reporting structure to more accurately +reflect our business operations. As a result of the foregoing transactions, our corporate structure is currently as follows: +8 +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +9 +Our Executive Committee acts +as the underwriting committee for Ault Lending and approves all lending transactions. Under its business model, Ault Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to Ault Lending in any particular financing. +Over the recent past, we have +provided capital and relevant expertise to fuel the growth of businesses in cryptocurrency mining, generative AI and metaverse platform +development, oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics and textiles. +We have provided capital to subsidiaries as well as partner companies in which we have an equity interest or may be actively involved, +influencing development through board representation and management support. +Our Principal Subsidiaries and their Businesses +The following is a brief +summary of the businesses in which we own a controlling interest, or whose financial statements we consolidated in this Annual Report: +Sentinum, Inc. +Sentinum conducts data center +operations and Bitcoin mining through ACS. +Overview +Through +its owned and operated data centers, Sentinum’s mission is to support internal computing requirements and to empower AI-focused +businesses and other businesses requiring high-density power with reliable, scalable, and secure hosting solutions. We currently have +data centers in Michigan and Montana. The Michigan data center design and available power provides Sentinum the ability to create bespoke +solutions enabling it to seize growth opportunities within the broader data center services market. Sentinum can provide a range of service +options tailored to a customer’s needs, including high-performance computing (“HPC”) and AI. HPC and AI are synonymous +with applications requiring immense computational power to process complex models and perform real-time inferences. These use cases are +being adopted by a wide range of industries, such as healthcare, energy, automotive, robotics and other autonomous systems. We are exploring +the potential of working directly with end user companies as well as companies who we could team with to provide comprehensive solutions. +Sentinum’s +attentiveness to disruptive technologies such as HPC, AI and blockchain combined with the foundational elements of data centers, power +infrastructure, telecommunications and security enable it to support the internal operations for Bitcoin mining alongside non-mining solutions +for third party customers. The economies of scale created by Bitcoin mining operations provide a competitive advantage to Sentinum as +it seeks to add non-mining applications to its services portfolio. +We also mine Bitcoin using +purpose-built computers (or “miners”) to solve complex cryptographic algorithms (or “verify” or “solve” +blocks) in the blockchain in exchange for rewards and fees denominated in the native token of that blockchain network. Some of our miners +provide computing power to a Bitcoin mining pool operator, in which all the participants’ machines mine Bitcoin as a collective +group, and we get paid the expected value of both the block reward and transaction fees for doing so; the other miners mine directly for +our own account. The mine pool operators receive block rewards and transaction fees paid in Bitcoin by the blockchain when the mine pool +finds new blocks. The reward and transaction fees are then shared by the pool participants based on their hash rate contributions to the +pool, less a small amount of fees. +We will evaluate each digital +asset in our portfolio, or that we propose to acquire in the future (including by mining), to determine whether it would likely be considered +a security under U.S. federal securities laws, in consultation with outside counsel, as applicable. We will base our analysis on relevant +case law, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance by the SEC and +its staff. See “Risk Factors —  Risks Related to Our Bitcoin Operations – Legal and Regulatory —  +A particular digital asset’s status as a ‘security’ in any relevant jurisdiction is subject to a high degree of uncertainty +and if a regulator disagrees with our characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines +and penalties, which may adversely affect our business, operating results and financial condition. A determination that Bitcoin that we +own or mine is a ‘security’ may adversely affect the value of Bitcoin and our business.” +10 +We do not, however, acquire crypto currencies for investment purposes. +As of December 31, 2023, we held 16.7 Bitcoins valued at $0.5 million, based on cost less impairment as of such date. Our mining operations +generated a net loss of $2.6 million and revenue of $33.1 million during the year ended December 31, 2023 compared to a net loss +of $91.6 million and revenue of $16.7 million during the year ended December 31, 2022. As of December 31, 2023, the $0.5 million +carrying value of our 16.7 Bitcoins represented 0.2% of our total assets of $299.2 million as of such date. +Sentinum Breakeven Analysis +Since commencement of Sentinum’s +mining operations in 2021, we have received approximately 2,669.01 Bitcoin for providing computing power to a Bitcoin mining pool operator +and from hosted mining operations with Core Scientific through March 31, 2024. While the Bitcoin received is available for sale in the +ordinary course of business, we believe that cryptocurrency represents an attractive, appreciating investment opportunity, and as such +we have historically held cryptocurrency assets that we do not otherwise sell to fund our operating expenses. We believe that our integrated +model with close control over our power sources and owning our Bitcoin mining data center helps us to produce Bitcoin with attractive +cost efficiency that helps us to produce Bitcoin at a cost that we believe is attractive versus the price of Bitcoin, and generally below +the prevailing market price of power that many of our peers must pay and may have to pay in the future during periods of uncertain or +elevated power pricing. +Our net cost of power was +between approximately $42 to $62 per megawatt-hour (“MWh”) in the second half of 2023 to present, and we expect that our blended +power cost upon the relocation of approximately 6,500 miners to our Montana facilities, once fully operational, will be approximately +$46 per MWh. This $42 to $62 per MWh corresponds to approximately $23,050 per Bitcoin equivalent with modern miners and assuming a network +hash rate of approximately 2.1 exahash per second (“EH/s”). In addition to the cost of power, we recognize a significant amount +of expenses from depreciation on our investment in miners and hosting fees from Core Scientific. In the aggregate, excluding Sentinum’s +daily general and operating costs of approximately $15,000, these expenses result in a direct cost for each Bitcoin mined of approximately +$51,000. We believe this cost to mine is attractive versus the price of Bitcoin. For example, the price of Bitcoin ranged from approximately +$17,000 to approximately $44,000 during 2023, and was approximately $70,500 as of April 10, 2024, according to Coin Market Cap. +We anticipate that upon completion +of the initial phase of development, the Montana Facilities will provide up to a combined 20 MWs of power, enabling up to 6,500 S19j Pro +Antminers to operate. Inclusive of costs previously incurred to acquire two land lease agreements and two corresponding power purchase +agreements, we estimate that the Montana Facilities will cost approximately $7 million. Further, given the favorable cost differential +for power between Montana and Michigan, we expect the increase in operating costs and depreciation from capitalized expenditures will +approximate the power cost savings. As such, development of the Montana Facilities is not expected to have a negative impact on our operating +results. +Thus, if the price of Bitcoin, +level of difficulty to mine, the amount of the block reward or the amount of Bitcoin earned by miners for mining one block on the Bitcoin +blockchain remained constant, then we would expect that Sentinum would be profitable in 2024. However, given the pending block reward +halving, an event that occurs approximately every four years, we are currently unable to predict with any certainty what effect this will +have on revenues derived from our Bitcoin mining operations, the price of Bitcoin or the level of difficulty to mine. Currently miners +receive 6.5 Bitcoin for mining one block on the Bitcoin blockchain, which will decrease to 3.25 Bitcoin when the halving occurs. While +the pending halving may have an adverse effect on our profitability, the expected cash generated from our Bitcoin mining operations is +still expected to exceed that of our operating costs given the significance of depreciation charges, which is expected to account for +nearly 30% of Sentinum’s total costs of operations during 2024. +During 2024, we also anticipate +large expenditures in our Michigan Facility to facilitate the transition of the facility to support HPC and AI applications. Initially, +these expenditures will likely increase Sentinum’s loss unless we are able to pass these costs on to our future customers. These +uncertainties make it impossible to predict when, if ever, that Sentinum will achieve profitable operations. +During 2023, Sentinum reported a loss from operations of approximately +$2.6 million inclusive of depreciation and amortization of approximately $18.3 million. As such, after capital expenditure of approximately +$2 million, Sentinum generated approximately $15.3 in cash for the year ended December 31, 2023. The cash generated from operations was +used to pay for a portion of costs we incurred. +11 +Cryptocurrency and Cryptocurrency Mining Overview +Blockchain and Cryptocurrencies Overview +Cryptocurrencies are a type +of digital asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). +Cryptocurrencies operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized +digital ledger that enables the secure use and transfer of digital assets. We believe cryptocurrencies and associated blockchain technologies +have potential advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate +settlement of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” Recently, cryptocurrencies +have gained widespread mainstream attention and have begun to experience greater adoption by both retail and institutional investors and +the broader financial markets. For example, Bitcoin’s aggregate market value had appreciated to $1.4 trillion in April 2024 +compared to $512 billion in February 2023. All figures are derived from Yahoo Finance and data furnished by Messari.io, an independent +entity with which we have no relationship and that, in its own words, “brings transparency to the crypto economy.” As cryptocurrencies, +and blockchain technologies more generally, have entered the mainstream, prices of digital assets have reached all-time highs and the +broader ecosystem has continued to develop. While we expect the value of Bitcoin to remain volatile, we believe this increase in aggregate +market value signals institutionalization and wider adoption of cryptocurrency. For example, in January 2024, the SEC approved the listing +and trading of Bitcoin exchange-traded funds, of which, as of April 9, 2024, approximately 20 are trading with over $58 billion of Bitcoin +assets held. +Cryptocurrencies are decentralized +currencies that enable near instantaneous transfers. Transactions occur via an open-source, cryptographic protocol platform which uses +peer-to-peer technology to operate with no central authority. The online network hosts the public transaction ledger, known as the +blockchain, and each cryptocurrency is associated with a source code that comprises the basis for the cryptographic and algorithmic protocols +governing the blockchain. In a cryptocurrency network, every peer has its own copy of the blockchain, which contains records of every +historical transaction — effectively containing records of all account balances. Each account is identified solely by +its unique public key (making it effectively anonymous) and is secured with its associated private key (kept secret, like a password). +The combination of private and public cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing +strong control of ownership. +No single entity owns or operates +the network. The infrastructure is collectively maintained by a decentralized public user base. As the network is decentralized, it does +not rely on either governmental authorities or financial institutions to create, transmit or determine the value of the currency units. +Rather, the value is determined by market factors, supply and demand for the units, the prices being set in transfers by mutual agreement +or barter among transacting parties, as well as the number of merchants that may accept the cryptocurrency. Since transfers do not require +involvement of intermediaries or third parties, there are only nominal transaction costs in direct peer-to-peer transactions. For +example: +· In terms of conventional peer-to-peer transactions, there either are no fees +or they are de minimis (Source: https://www.kraken.com/en-us); +· For purposes of traditional networks, there are nominal fees associated with +any transaction (Source: https://bitinfocharts.com/bitcoin); and +· As of April 1, 2024, the average Bitcoin network fee is $5.82 per transaction, +which is still low compared to conventional transaction fees charged by banks and other more traditional financial institutions (https://bitinfocharts.com/bitcoin). +The network fee is separate +and distinct from the pool fee we pay Luxor Technology (“Luxor”) for its services in acting as a pool operator, discussed +below. The network fee is applicable to anyone who transacts on the blockchain. +Given that block space is +limited, mining fees can and often do fluctuate significantly from transaction to transaction as a result of “congestion.” +However, this congestion does not negate any of the statements made immediately above. +Units of cryptocurrency can +be converted to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as Binance, Coinbase, Bybit, +Kraken, Gemini and others. Cryptocurrency prices are quoted on various exchanges and fluctuate with extreme volatility. +12 +We believe cryptocurrencies, +particularly Bitcoin, the only cryptocurrency we receive for providing computing power to a mining pool operator, offer many advantages +over traditional, fiat currencies, although many of these factors also present potential disadvantages and may introduce additional risks, +including: +· Acting as a fraud deterrent, as cryptocurrencies +are digital and cannot be counterfeited or reversed arbitrarily by a sender; +· Immediate settlement; +· Elimination of counterparty risk; +· No trusted intermediary required; +· Lower fees; +· Identity theft prevention; +· Accessible by everyone; +· Transactions are verified and protected through +a confirmation process, which prevents the problem of double spending; +· Decentralized — no central authority +(government or financial institution); and +· Not recognized universally and not bound by government imposed or market +exchange rates. +However, cryptocurrencies +may not provide all of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, +there are two factors that may affect all digital asset mining companies and Bitcoin in particular: (i) limitations on the supply of the +cryptocurrency being mined; and (ii) the market price of the cryptocurrency. +The blockchain’s method +for creating new Bitcoins is mathematically determined in a manner so that the supply of Bitcoins grows at a limited rate pursuant to +a pre-set schedule. Specifically, the number of Bitcoins awarded for solving a new block is automatically halved for every 210,000 +blocks that are solved. The current fixed reward for solving a new block is 6.25 Bitcoins per block, which was reduced from 12.5 Bitcoins +in May 2020 and will be reduced further to 3.125 Bitcoins per block in April 2024. This deliberately controlled rate of Bitcoin creation +means that the number of Bitcoins in existence will never exceed 21 million and that Bitcoins cannot be devalued through excessive +production unless the Bitcoin network’s source code and the underlying protocol for Bitcoin issuance is altered. This also means, +however, that our revenue prospects will decline unless the price of a Bitcoin increases commensurately or we acquire more miners. +We currently only participate +in mining pools that mine Bitcoin. Our ability to generate revenue from these mining operations will be dependent on the price of Bitcoin. +The prices of cryptocurrencies, specifically Bitcoin, have experienced substantial volatility, including fluctuation patterns which may +reflect “bubble” type volatility, meaning that high or low prices at a given time may not be indicative of the current or +future value of Bitcoin. The price of a Bitcoin may be subject to rapidly changing investor and market sentiment, and may be influenced +by factors such as technology, regulatory developments and media coverage. Further, Bitcoin’s value, like that of other cryptocurrencies, +may be based on various factors, including their acceptance as a means of exchange or purchasing power by consumers and vendors, volume, +liquidity and transferability and market demand. Bitcoin’s current price reflects, in part, the belief by some that Bitcoin could +become a widely accepted form of currency; however, if this prediction turns out to be incorrect its price could decrease dramatically, +as would our prospects for future revenue and profits. See “Risk Factors – Risks Related to Our Bitcoin Operations” +for more information on the risks we face due to our mining of Bitcoin and its speculative and volatile nature. +13 +Cryptocurrency Mining and Mining Pools +As a participant in a cryptocurrency +mining pool, we use specialized miners to solve cryptographic math problems necessary to record and “publish” cryptocurrency +transactions to blockchain ledgers. Generally, each cryptocurrency has its own blockchain, which consists of software code (also known +as a protocol), which is run by all the computers on the network for such blockchain. Within this code, transactions are collated into +blocks, and these blocks must meet certain requirements to be verified by the blockchain software, added to the blockchain or ledger of +all transactions and published to all participants on the network that are running the blockchain software. After a transaction is verified, +it is combined with other transactions to create a new block of data for the blockchain. For proof-of-work blockchains, the process of +verifying valid blocks requires computational effort to solve a cryptographic equation, and this computational effort protects the integrity +of the blockchain ledger. This process is referred to as “mining.” As a reward for verifying a new block, miners receive payment +in the form of the native cryptocurrency of the network (e.g., Bitcoin). This payment is comprised of a block reward (i.e., the automatic +issue of new cryptocurrency tokens) and the aggregated transaction fees for the transactions included in the block (paid in existing cryptocurrency +tokens by the participants to the transactions). The block reward payments and the aggregated transaction fees are what provide the incentive +for miners to contribute hash rate to the network. +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific cryptocurrency, and the blockchain-wide hash rate for a specific cryptocurrency can be understood as the aggregate +of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +and other cryptocurrencies are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known +as the “mining difficulty,” which is the level of computational activity required before a new block is solved and verified. +For example, on the Bitcoin blockchain the protocol is coded such that a new block is solved and verified approximately every ten minutes. +As such, to the extent the hash power on the network is increased or decreased due to, for example, fluctuations in the number of active +miners online, mining difficulty is correspondingly increased or decreased to maintain the preset interval for the verification of new +blocks. +On certain cryptocurrency +networks, including Bitcoin, the rewards for solving a block are also subject to periodic incremental halving. Halving is a process designed +to control the overall supply and reduce the risk of inflation in cryptocurrencies using a proof-of-work consensus algorithm. After a +predetermined number of blocks are added to the blockchain, the mining reward is cut in half, hence the term “halving.” The +last halving for Bitcoin occurred on May 11, 2020 but the next halving is expected to occur in April 2024. Transaction fees are variable +and depend on the level of activity on the network. Generally, transaction fees increase during times of network congestion, as miners +will prefer transactions with higher fees, and therefore a higher fee can reduce the time to process a transaction, and decrease when +there are fewer transactions on the network. +As the total amount of available +hash rate has increased (particularly on the Bitcoin network), it has become increasingly difficult for any individual miner to independently +solve a block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool operator, rather than an individual miner, +validates the block and receives the block reward and related transaction fees. The mining pool is organized by a third party, in our +case, Luxor. In consideration for receiving a percentage of the earned block rewards and transaction fees, Luxor administers the +pool and ensures that the participants in the pool receive their share of the block reward and related transaction fees, generally pro-rata +to their contributed hash rate. Mining pools offer miners more predictable and consistent revenue compared to mining individually. We +participate in mining pools by providing what the industry refers to as “hashrate” to the pool. Hashrate is defined as the +computing power that our mining equipment produces when helping to validate a block that the mining pool is trying to solve. We use the +FPPS, or Full Pay-Per-Share, method when mining with Luxor. Pursuant to the “Full Pay-Per-Share” model, both the block reward +and the mining service charge are settled according to the theoretical profit. It includes the calculation of a standard transaction fee +within a certain period and distributes it to mining pool participants according to their hash power contributions in the pool. It increases +the mining pool participants’ earnings by sharing transaction fees. Standard transaction fees are calculated using a certain period +which are then distributed to miners according to their hash power contributions in the pool. Luxor currently charges us a 0.68% mining +fee. +14 +We provide computing power +to the mining pool, which is run by the mining pool operator with whom we contract, who in turn provides transaction verification services. +Based on the terms of the agreement, in our judgment, the mining pool operator is considered the principal in providing mining pool services. +We recognize revenue, net of certain transaction fees from the mining pool operator, which are not considered material. Our current mining +pool agreement is cancelable at any time by either party without penalty. Revenue received for providing computing power would be directly +impacted positively or negatively should we start and stop providing computing power to the mining pool operator within a given reporting +period. +Our Strategy +Smart Growth +We aim to optimize our mining +by identifying and purchasing the most profitable miners with industry-leading returns on investment and actively monitoring and adjusting +the operation of those machines to enhance their performance. Most recently, in April 2023, we acquired 664 S19 XP Antminers and currently +have no outstanding contracts to acquire additional miners at this time since our focus is primarily centered upon the expansion of our +Michigan and Montana facilities. When planning our short- and long-term operating strategies and capital expenditures, we carefully monitor +fluctuations and longer-term trends in the value of certain cryptocurrencies, which impacts the return on investment of machines. We also +regularly evaluate potential innovations in geography, physical footprint, computing technology and similar areas to improve our operations +and productivity. We believe this smart growth strategy, including our commitment to mining efficiency and return on investment in miners, +will enable us to build value over the long term. +Own and Operate Our Mining Facilities +We are investing heavily in +purchasing, building and operating our mining facilities. By owning and operating our miners at facilities that offer competitive advantages, +including access to reliable, low-cost, renewable power and room for expansion, we expect to have greater control over the timing of the +purchase and deployment of our miners. We also may enhance our ability to intelligently and quickly adapt our operating model and reap +savings compared to paying for outsourced operations and infrastructure. We anticipate that we will continue to consider other opportunities +to integrate our operations, including with respect to both the software utilized by our fleet and the associated hardware. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in cryptocurrency mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable +amounts of electrical energy to perform their functions and mine Bitcoin; consequently, a critical aspect of operating in the cryptocurrency +mining industry is obtaining a reliable supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased +a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan (the “Michigan Facility”). +Since the purchase of the Michigan Facility, we have invested in infrastructure improvements and began both ramping up the power capacity +and installing miners. To date, we have increased power load from 1.5 megawatts (MWs”) to approximately 30 MWs. In addition, we +have received a commitment from the utility company that currently provides our power to expand the Michigan Facility’s capacity +up to approximately 300 MWs, which we are currently evaluating. Our relationship with the utility company has grown as we have demonstrated +our ability to upgrade and use power at our site effectively. +We have also invested in a +data center through BNI Montana, which acquired two land lease agreements and two corresponding power purchase agreements in Montana in +2023. We have completed the build-out at one of the two sites (collectively, the “Montana Facilities”), which provides up +to 10 MWs of power. Once we complete the build-out of the second site, which is expected to occur later in 2024, the Montana Facilities +will provide up to a combined 20 MWs of power. We believe that the capacity of the Montana Facilities can be significantly expanded and +we have begun an electrical load study in collaboration with the local utility to explore potential power upgrades. We anticipate expanding +the capacity at the Montana Facilities to the extent possible, after determination of the completed load study, subject to additional +funding. +15 +We continue to evaluate other +sites, locations, and partnerships for additional and alternative support of future mining operations. While we have not at present entered +into any other agreements, we will continue to explore and evaluate additional facilities that would enable us to expand our mining operations +as needed. +Our Mining Operations +Currently, we have 4,397 S19j +Pro Antminers and 4,628 S19 XP Antminers in operation at our Michigan facility, two S19j Pro Antminers in operation at our Montana facility +and 3,549 S19 Antminers and 6,651 S19J Pro Antminers hosted with Core Scientific, with an aggregate mining production capacity of approximately +2.1 EH/s. +Our strategy includes identifying +less expensive, clean power for our Bitcoin mining operations. Management of the company has considered the issues surrounding the environmental +impact of our Bitcoin mining operations. Based on this review, we have concluded that the environmental impact of our mining operations +is not material given that approximately 85% of the energy we use is “green,” meaning it is sourced from nuclear, wind or +solar power. In addition to our continued expansion investments at the Michigan Facility, we also seek out new locations to support our +bitcoin mining business. We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but +also leasing buildings and facilities (as we have done with the Montana Facilities), hosting relationships and strategic partnerships. +At this time, we have not entered into any new mining agreements at locations other than the Michigan Facility and the Montana Facilities. +We currently mine Bitcoin only. +Coins that are mined are held +in a custodial account as digital assets. We securely store our digital assets at Gemini Trust Company, LLC (“Gemini”), a +regulated, audited and insured cryptocurrency custodian. The custody arrangements require that we mine to a custodial wallet address where +the private key is held by the custodian and all keys for the wallet are held in cold storage. This provides a layer of protection in +both the transaction and liquidation phases of the operations by using multi-factor and multi-person approval processes, to include Know +Your Customer and Anti-Money Laundering procedures of the receiving party. We will either hold the digital assets or may choose to convert +those assets into fiat currency depending on financial needs and plans. When we opt to convert the digital assets we sell or exchange +our Bitcoin through Gemini, the custodian of our digital wallet. When we elect to make a sale or exchange our Senior Vice President - +Finance submits a request to Gemini’s execution department to exchange Bitcoin for U.S. dollars. Gemini sends an approval email +to both our CEO and CFO to approve. Once approved by either our CEO or CFO, Gemini executes the sale/exchange on its trading platform +at current market prices, less commissions, and deposits the U.S. dollars into our bank account. +Beyond the foregoing, our +custody agreement with Gemini provides that: +· Gemini provides a unique custody account in which all our blockchain assets +are held, which are segregated from all others’ assets and are verifiable through the blockchain; and +· Gemini charges us fees in bitcoin, which is deducted from our digital assets +on the last business day of every month. +Currently, we are converting +Bitcoin received from our mining activities into fiat currency on a nearly daily basis to pay for operating costs and purchase commitments +for expansion activities at our facilities. In January 2024, we made a strategic decision to begin holding up to 20% and a minimum of +5% of the Bitcoin we mine for investment. +Regulation +The laws and regulations applicable +to cryptocurrency are evolving and subject to interpretation and change. Governments around the world have reacted differently to cryptocurrencies; +certain governments have deemed them illegal, and others have allowed their use and trade without restriction, while in some jurisdictions, +such as in the United States, cryptocurrencies are subject to extensive, and in some cases overlapping, unclear and evolving regulatory +requirements. As cryptocurrencies have grown in both popularity and market value, the U.S. Congress and a number of U.S. federal and state +agencies, including the Financial Crimes Enforcement Network (“FinCEN”), SEC, the Commodity Futures Trading Commission (“CFTC”), +Financial Industry Regulatory Authority (“FINRA”), the Consumer Financial Protection Bureau, the Department of Justice (“DOJ”), +the Department of Homeland Security, the Federal Bureau of Investigation (“FBI”), the Internal Revenue Service (“IRS”) +and state financial regulators, have been examining the operations of cryptocurrency networks, cryptocurrency users and cryptocurrency +exchange markets, with particular focus on the extent to which cryptocurrencies can be used to launder the proceeds of illegal activities +or fund criminal or terrorist enterprises and the safety and soundness and consumer-protective safeguards of exchanges or other service-providers +that hold, transfer, trade or exchange digital assets for users. Many of these state and federal agencies have issued consumer advisories +regarding the risks posed by cryptocurrencies to investors. In addition, federal and state agencies, and other countries have issued rules +or guidance about the treatment of cryptocurrency transactions or requirements for businesses engaged in activities related to cryptocurrencies. +Depending on the regulatory characterization of the cryptocurrencies we mine, the markets for those cryptocurrencies in general, and our +activities in particular, may be subject to one or more regulators in the United States and globally. Ongoing and future regulatory actions +may alter, perhaps to a materially adverse extent, the nature of cryptocurrency markets and our cryptocurrency operations. Additionally, +U.S. state and federal, and foreign regulators and legislatures have taken action against cryptocurrency businesses or enacted restrictive +regimes in response to adverse publicity arising from hacks, consumer harm, or criminal activity stemming from cryptocurrency activity. +There is also increasing attention being paid by U.S. federal and state energy regulatory authorities as the total load of crypto mining +grows and potentially alters the supply and dispatch functionality of the wholesale grid and retail distribution systems. Many state legislative +bodies are also actively reviewing the impact of crypto mining in their respective states. +16 +For instance, the Cyber-Digital +Task Force of the DOJ published a report entitled “Cryptocurrency: An Enforcement Framework” in October 2020. This report +provides a comprehensive overview of the possible threats and enforcement challenges the DOJ views as associated with the use and prevalence +of cryptocurrency, as well as the regulatory and investigatory means the DOJ has at its disposal to deal with these possible threats and +challenges. Further, in early March 2021, the SEC chairperson nominee expressed an intent to focus on investor protection issues raised +by bitcoin and other cryptocurrencies. Furthermore, on March 9, 2022, President Biden signed an executive order on cryptocurrencies. While +the executive order did not mandate any specific regulations, it instructs various federal agencies to consider potential regulatory measures, +including the evaluation of the creation of a U.S. Central Bank digital currency. +Additionally, we are unable +to predict the effect that any future regulatory change, or any overlapping or unclear regulations, may have on us, but such change, overlap +or lack of clarity could be substantial and make it difficult for us to operate our business or materially impact the market for cryptocurrencies +that we mine or may mine in the future. FinCEN has issued guidance stating its position that it does not differentiate between fiat currency +(which FinCEN calls “real currency”) and cryptocurrencies that are convertible into fiat currency or other forms of convertible +virtual currencies (which FinCEN calls “virtual currency”) for purposes of determining whether a person or entity is engaging +in “money transmission services.” Persons and entities engaging in virtual currency activities that amount to “money +transmission services,” or otherwise cause them to be deemed a “money services business” under FinCEN’s regulations, +must register as a money services business, implement an “effective” anti-money laundering program and comply with FinCEN’s +reporting and recordkeeping requirements. +In May 2019, FinCEN issued +guidance relating to how the BSA and its implementing regulations relating to money services businesses apply to certain businesses that +transact in convertible virtual currencies. Although the guidance generally indicates that certain mining and mining pool operations will +not be treated as money transmission, the guidance also addresses when certain activities, including certain services offered in connection +with operating mining pools such as hosting convertible virtual currency wallets on behalf of pool members or purchasers of computer mining +power, may be subject to regulation. Although we believe that our mining activities do not presently trigger FinCEN registration requirements +under the BSA, if our activities cause us to be deemed a “money transmitter,” “money services business” or equivalent +designation, under federal law, we may be required to register at the federal level and comply with laws that may include the implementation +of anti-money laundering programs, reporting and recordkeeping regimes, and other operational requirements. In such an event, the required +registration and regulatory compliance steps may result in extraordinary, non-recurring expenses to us, as well as on-going recurring +compliance costs, possibly affecting an investment in our shares of common stock, operating results or financial condition in a material +and adverse manner. Failure to comply with these requirements may expose us to fines, penalties and/or interruptions in our operations +that could have a material adverse effect on our financial position, results of operations and cash flows. +According to the CFTC, at +least some cryptocurrencies, including Bitcoin, fall within the definition of a “commodity” under the U.S. Commodities Exchange +Act of 1936, as amended (the “CEA”). Under the CEA, the CFTC has broad enforcement authority to police market manipulation +and fraud in spot cryptocurrency markets in which we may transact. Beyond instances of fraud or manipulation, the CFTC generally does +not oversee cash or spot market exchanges or transactions involving cryptocurrencies that do not utilize margin, leverage, or financing. +The National Futures Association (“NFA”) is the self-regulatory agency for the U.S. futures industry, and as such has jurisdiction +over Bitcoin futures contracts and certain other cryptocurrency derivatives. However, the NFA does not have regulatory oversight authority +for the cash or spot market for cryptocurrency trading or transactions. In addition, CFTC regulations and CFTC oversight and enforcement +authority apply with respect to futures, swaps, other derivative products, and certain retail leveraged commodity transactions involving +cryptocurrencies, including the markets on which these products trade. +17 +The SEC has taken the position +that many cryptocurrencies may be securities under U.S. federal securities laws. Some senior members of the staff of the SEC have expressed +the view that Bitcoin and Ethereum are not securities under U.S. federal securities laws. However, such statements are not official policy +statements by the SEC and reflect only the speakers’ views, which are not binding on the SEC or any other agency or court and cannot +be generalized to any other cryptocurrency. The SEC’s Strategic Hub for Innovation and Financial Technology published a framework +for analyzing whether any given cryptocurrency is a security in April 2019; however, this framework is also not a rule, regulation or +statement of the SEC and is similarly not binding on the SEC. Notwithstanding that the SEC has not asserted regulatory authority over +Bitcoin or trading or ownership of Bitcoin and has not expressed the view that Bitcoin should be classified or treated as a security for +purposes of U.S. federal securities laws, the SEC has commented on Bitcoin and Bitcoin-related market developments and has taken action +against investment schemes involving Bitcoin. For example, the SEC has charged at least three Bitcoin mining companies in connection with +a Ponzi scheme to defraud investors in their mining operation. The SEC has also repeatedly denied proposed rule changes by exchanges to +list and trade shares of certain Bitcoin-related investment vehicles on public markets, citing significant investor protection concerns +regarding the markets for cryptocurrencies, including the potential for market manipulation and fraud. Although the SEC has not stated +that mining Bitcoin is itself a regulated activity, to the extent any cryptocurrencies we mine are deemed to be securities, the offer, +sale, and trading of those cryptocurrencies would be subject to the U.S. federal securities laws. +In addition to the SEC, state +securities regulators and several foreign governments have also issued warnings that certain cryptocurrencies may be classified as securities +in their jurisdictions, and that transactions in such cryptocurrencies may be subject to applicable securities regulations. Furthermore, +certain state securities regulators have taken the position that certain cryptocurrency mining operations may involve the offer of securities. +For example, the Texas State Securities Board (“TSSB”) has taken enforcement action against the operator of a cloud mining +company, whereby customers could purchase hash rate managed by the cloud mining company in exchange for a share of the mining reward, +for offering unregistered securities. +State financial regulators +such as the New York State Department of Financial Services (“NYDFS”) have also implemented licensure regimes, or repurposed +pre-existing fiat money transmission licensure regimes, for the supervision, examination and regulation companies that engage in certain +cryptocurrency activities. The NYDFS requires that businesses apply for and receive a license, known as the “BitLicense,” +to participate in a “virtual currency business activity” in New York or with New York customers, and prohibits any person +or entity involved in such activity from conducting activities without a license. Louisiana also has enacted a licensure regime for companies +engaging in a “virtual currency business activity,” and other states are considering proposed laws to establish licensure +regimes for certain cryptocurrency businesses as well. Some state legislatures have amended their money transmitter statutes to require +businesses engaging in certain cryptocurrency activities to seek licensure as a money transmitter, and some state financial regulators +have issued guidance applying existing money transmitter licensure requirements to certain cryptocurrency businesses. The Conference of +State Bank Supervisors also has proposed a model statute for state level cryptocurrency regulation. Although we believe that our mining +activities do not presently trigger these state licensing requirements in any state in which we operate or plan to operate, if our activities +cause us to be deemed a “money transmitter,” “money services business” or equivalent designation under the law +of any state in which we operate or plan to operate, we may be required to seek a license or register at the state level and comply with +laws that may include the implementation of anti-money laundering programs, reporting and recordkeeping regimes, consumer protective safeguards, +and other operational requirements. In such an event, the required registrations, licensure and regulatory compliance steps may result +in extraordinary, non-recurring expenses to us, as well as on-going recurring compliance costs, possibly affecting an investment in our +shares of common stock, our net income in a material and adverse manner. Failure to comply with these requirements may expose us to fines, +penalties and/or interruptions in our operations that could have a material adverse effect on our financial position, results of operations +and cash flows. +Overall, presently, we do +not believe any U.S. or State regulatory body has taken any action or position adverse to Bitcoin with respect to its production, sale, +and use as a medium of exchange; however, future changes to existing regulations or entirely new regulations may affect our business in +ways it is not presently possible for us to predict with any reasonable degree of reliability. +Further, following the appreciation +of the market price of Bitcoin in the second half of 2020, we have observed increasing media attention directed at the environmental concerns +associated with cryptocurrency mining, particularly its energy-intensive nature. We do not believe any U.S.-based regulators have taken +a position adverse to Bitcoin mining thus far. +As the regulatory and legal +environment evolves, we may become subject to new laws, such as further regulation by the SEC and other agencies, which may affect our +mining and other activities. For additional discussion regarding our belief about the potential risks existing and future regulation pose +to our business, see the “Risk Factors” herein. +18 +Environmental +The +perceived threat of climate change continues to attract considerable attention in the United States and around the world. Numerous proposals +have been made and could continue to be made at the international, national, regional and state levels of government to monitor and limit +emissions of greenhouse gases (“GHGs”). These efforts have included consideration of cap-and-trade programs, carbon taxes, +GHG disclosure obligations and regulations that directly limit GHG emissions from certain sources. In addition, President Biden identified +addressing climate change and the energy transition as priorities under his Administration. He has issued, and may continue to issue, +executive orders and regulatory directives related to climate change, and has recommitted the United States to long-term international +goals to reduce emissions. In recent years, the U.S. Congress has considered legislation to reduce emissions of GHGs and has included +climate change considerations in its funding bills. For example, the Inflation Reduction Act of 2022, which appropriates significant federal +funding for renewable energy initiatives, was signed into law in August 2022 and could accelerate the transition away from fossil fuels. +These laws, initiatives, and associated regulations or other national or regional commitments to reduce GHG emissions could adversely +affect fossil fuel consumption, require the installation of emissions control technologies, and increase the expense associated with the +purchase of emissions reduction credits or allowances to comply with current or future emissions reduction programs. +At +the federal level, the Environmental Protection Agency (“EPA”) has also adopted rules that, among other things, establish +construction and operating permit reviews, emissions control standards, and monitoring and annual reporting for GHG emissions from certain +large stationary sources. In November 2021, the Biden Administration released “The Long-Term Strategy of the United States: Pathways +to Net-Zero Greenhouse Gas Emissions by 2050,” which establishes a roadmap to net zero emissions in the United States by 2050 through, +among other things, improving energy efficiency, decarbonizing energy sources via electricity, hydrogen and sustainable biofuels, eliminating +subsidies provided to the fossil fuel industry, reducing non-CO 2 GHG emissions and increasing the emphasis on climate-related +risks across government agencies and economic sectors. Additionally, from time to time the EPA has proposed, revised, and adopted rules +establishing new source performance standards for certain pollutants from coal-fueled electric generating plants. +We +note that the implementation of the rule depends, in part, on the widespread development, adoption, and availability of carbon capture +and storage technology and solutions, which may not be certain at this time. We also note that this proposed rule is subject to intense +political debate and its adoption or implementation could be impacted by the results of the 2024 election cycle. While no final rule has +been published to date, this proposed rule and any other new agency action or rulemaking that applies to our facilities could increase +our compliance costs or otherwise materially restrict our operations. +At +the international level, the United States re-entered the United Nations-sponsored “Paris Agreement,” a non-binding agreement +for nations to limit their greenhouse gas emissions through individually determined reduction goals every five years after 2020, shortly +after President Biden took office in February 2021. Then, in April 2021, President Biden announced a new, more rigorous nationally determined +emissions reduction level of 50%-52% reduction from 2005 levels in economy-wide net GHG emissions by 2030. The international community +has since gathered again in November 2021, November 2022, and December 2023 for the annual United Nations Climate Change Conference of +the Parties, where the U.S., the European Union, and other partners announced reaffirmed their emissions reduction commitments and made +further climate change goals. Most recently, the parties agreed to transition “away from fossil fuels in energy systems in a just, +orderly and equitable manner” and increase renewable energy capacity so as to achieve net zero by 2050, although no timeline for +doing so was set. The impacts of these orders, pledges, agreements and any legislation or regulation promulgated to fulfill the U.S.’s +commitments under the Paris Agreement or other international conventions cannot be predicted at this time. +Governmental, +scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing financial, political, +and litigation risks in the United States and we anticipate that initiatives to reduce GHG emissions and restrict fossil fuel production +and consumption will continue to develop. Certain states, municipalities, community coalitions, and other parties, including proponents +of renewable energy that are opposed to the burning of fossil fuels have sought to further restrict GHG emissions and recover damages +from fossil fuel companies through lawsuits regardless of federal legislative and regulatory initiatives on the matter. Moreover, financial +risks could increase, as stockholders and bondholders currently invested in fossil fuel energy companies concerned about the potential +effects of climate change may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors. +Institutional investors who provide financing to fossil fuel energy companies also have become more attentive to sustainability issues +and some of them may elect not to provide funding for fossil fuel energy companies in the future. These litigation and financial risks +may result in restrictions or cancellations in our development activities, reduce demand for energy from fossil fuels, or otherwise adversely +impact our ability to raise capital and develop power generation facilities. Enhanced public and private support for low-carbon power +sources and products could impact the public perception of our business. Additionally, there is increased competitiveness of alternative +energy sources (such as Tier I alternative energy sources, including wind and solar photovoltaic) that do not generally have the adverse +impact to the environment that is associated with the combustion of fossil fuels and also are not subject to as much regulatory scrutiny +as are facilities that combust fossil fuels. +19 +Additionally, +increasing concentrations of GHG in the Earth’s atmosphere may produce climate changes that have significant physical effects, such +as increased frequency and severity of storms, droughts, floods, rising sea levels and other climatic vents. These climatic events have +the potential to cause physical damage to our facilities or disrupt our supply chains. Consequently, one or more of these developments +could have an adverse effect on our business, financial condition, results of operations, and cash flows. +Finally, +crypto asset mining has become more heavily scrutinized from a climate change and energy consumption perspective in recent years. Politicians, +regulators, environmental groups, and climate activists alike have called for increased oversight, regulation, and reporting of energy +use and GHG emissions of crypto asset mining companies, among other measures. Certain members of the U.S. Congress and other non-governmental +organizations have made investigations into, and published claims and reports regarding, the crypto asset mining industry’s impact +on global GHG emissions and energy consumption and raised concerns over the diversion of power sources for crypto mining and possible +impacts on consumer electricity prices. These individuals and groups have also urged regulatory agencies to investigate energy and +climate impacts of mining companies and to consider regulations requiring the monitoring and reporting of emissions and energy consumption +by certain crypto asset operations. For example, the Crypto Asset Environmental Transparency Act was introduced to the U.S. Senate on +March 6, 2023, and, if passed, would impose emissions reporting obligations on mining operations that consume electricity above a specified +threshold and would direct the EPA to investigate the environmental and climate impacts of the crypto asset mining industry. Separately, +in September 2022, the Biden Administration released its report on Climate and Energy Implications of Crypto-Assets in the United States, +which recommends that the federal government take action to develop environmental performance standards for crypto asset technologies, +assess the impact of crypto asset mining on electricity system reliability, and minimize emissions and other environmental impacts associated +with crypto asset mining, among other recommendations. More recently, in January and February 2024 the U.S. Energy Information Administration +(“EIA”) initiated a mandatory commercial cryptocurrency miner energy use survey. However, a federal district court granted +a temporary restraining order prohibiting the EIA from collecting data from certain Texas-based cryptocurrency miners who filed a lawsuit +against the energy use survey. Concurrently, the EIA has voluntary paused the survey in the rest of the country. Certain state governments +have also introduced legislation imposing restrictions on the crypto asset mining industry, citing similar concerns. We are unable to +predict whether currently proposed legislation or regulatory initiatives will be implemented, but any action by the federal government +or states in which we operate to restrict, limit, condition, or otherwise regulate our power production or crypto asset mining operations, +whether as part of a climate change or energy transition policy initiative or otherwise, could adversely affect our business, financial +condition, and results of operations. Similarly, public statements by government officials and non-governmental organizations regarding +the impact of crypto asset mining on global energy consumption, GHG emissions and grid stability, whether valid or not, could harm our +reputation and stakeholder goodwill. +Competition +Our business environment is +constantly evolving, and cryptocurrency miners can range from individual enthusiasts to professional mining operations with dedicated +data centers. We compete with other companies that focus all or a portion of their activities on cryptocurrency mining activities at scale. +We face significant competition in every aspect of our business, including, but not limited to, the acquisition of new miners, the ability +to raise capital, obtaining the lowest cost of electricity, obtaining access to energy sites with reliable sources of power, and evaluating +new technology developments in the industry. +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this Annual Report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies: +· Argo Blockchain PLC; +· Bit Digital, Inc.; +20 +· Bitdeer Technologies Group; +· Bitfarms Technologies Ltd.; +· Cipher Mining Inc.; +· CleanSpark, Inc.; +· Core Scientific, Inc.; +· Digihost Technology Inc.; +· Galaxy Digital Holdings Ltd.; +· Hive Blockchain Technologies Inc.; +· Hut 8 Mining Corp.; +· Iris Energy Limited; +· Marathon Digital Holdings, Inc.; +· Northern Data AG; +· Phoenix Group PLC; +· Riot Blockchain, Inc.; +· Stronghold Digital Mining, Inc.; and +· TeraWulf Inc. +Intellectual Property +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. +Accounting for Digital Currencies +Prior to the adoption of Accounting +Standards Update 2023-08, Intangibles - Goodwill and Other - Crypto Assets (Topic 350-60): Accounting for and Disclosure of Crypto +Assets , digital currencies were accounted for as intangible assets with indefinite useful lives and are recorded at cost less impairment +in accordance with Accounting Standards Codification (“ASC”) 350, Intangibles-Goodwill and Other . An intangible asset +with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances +occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Whenever the exchange-traded price of digital +currencies declines below its carrying value, we have determined that it is more likely than not that an impairment exists and record +an impairment equal to the amount by which the carrying value exceeds the fair value at that point in time. We have deemed the price of +digital assets to be a Level 1 input under the ASC 820, Fair Value Measurement , hierarchy as these were based on observable quoted +prices in the principal market for identical assets. Subsequent reversal of impairment losses is not permitted. +21 +Blockchain Background +Blockchain technology first +came to public attention in 2008 as the database technology that underpins Bitcoin, the world’s first cryptocurrency. Blockchains +are generally open-source, peer-to-peer software programs that act as decentralized digital ledgers, each comprising a series of data +“blocks” that are linked and secured using cryptography in a “chain.” The blockchain program consists of a software +protocol with several functions. The software protocol is run by multiple computer systems or “nodes.” For many blockchain +networks, each node has its own copy of the blockchain ledger, which contains a historical record of every transaction. The digital ledger +continuously grows as new blocks are added to it to record the most recent transactions in a linear, chronological order. The same information +is stored across a network of computers all over the world, and this record makes it possible to track the ownership and transfer of cryptocurrency +from the creation of the blockchain to its current state, and effectively, records of all account balances (as you can identify what account +holds what value through the decentralized ledger). +We do not operate a complete +node; rather, as noted above under the heading “Cryptocurrency Mining and Mining Pools,” we provide computing power to a pool +operator. +The blockchain protocol allows +users to submit transactions to the network for confirmation. However, a transaction will not be accepted by the protocol if the inputs +to the transaction have previously been used in another transaction. This prevention of “double spending” is a key security +feature of blockchain networks. +Another key function of the +blockchain that protects the integrity of the network is the hashing process, which acts as a tamper-evident seal that confirms the validity +of the new block and all earlier blocks. Hashing is the process of a block being posted to the network. Hashing results from miners, who +are responsible for receiving broadcast transactions, processing those transactions into new blocks and updating the blockchain with the +new blocks through hashing. The hashing process ties every new block to the existing block on the blockchain to ensure each is a continuous +record of verified transactions. +The hashing algorithm on a +proof-of-work blockchain network is a mathematical transformation function with two key properties. The first important function of hashing +is that the algorithm accepts any alphanumeric dataset as an input and produces a unique output code. The smallest change in the dataset +results in a significant change in the unique code. Any tampering of the dataset can be detected by re-hashing the data and checking for +a change in the unique code. Any user that runs the hash algorithm on the same data will derive the same unique code. Consequently, the +data on the distributed ledger can be run through a series of hash algorithms to create a unique code, which would reveal if any changes +to the ledger have been made. +Second, whenever a new set +or “block” of transactions is added to the ledger, it is appended with the code from the prior state of the ledger before +it is hashed. Thus, the hash created from the new block will incorporate the hash from the previous block. An alteration made to an earlier +block would make the hashes of all subsequent blocks invalid, as the discrepancy would be easily detected by future miners through the +protocols governing the blockchain. If a hacker were to attempt to make a change to an earlier block and broadcast it along with following +blocks to the other nodes on the network, that broadcast would be discarded in favor of one from a different node which complied with +the requirements of the protocol. +Thus, in addition to creating +new block, miners “vote” with their computer power, expressing their acceptance of valid blocks by working on adding them +to the blockchain, and rejecting invalid blocks by refusing to work on them. If a miner’s proposed block is added to the blockchain +by a majority of the nodes on the network, it is considered part of the blockchain. The nodes on the network synchronize with each other +to ensure that once a block is accepted by the majority, the new block will eventually be added to all the nodes. Thus, the historical +state of the ledger can be changed if control of more than 50% of the network is obtained; however, in the case of widely held cryptocurrencies +with non-trivial valuations, it may be economically prohibitive for any actor or group of actors acting in concert to obtain computing +power that consists of more than 50% of the network. +Unlike proof-of-work networks, +in which miners expend computational resources to compete to validate transactions and are rewarded cryptocurrency in proportion to the +amount of computational resources expended, in a proof-of-stake network, miners (sometimes called validators) risk or “stake” +assets to compete to be randomly selected to validate transactions and are rewarded cryptocurrency in proportion to the amount of assets +staked. Any malicious activity, such as mining multiple blocks, disagreeing with the eventual consensus or otherwise violating protocol +rules, results in the forfeiture or “slashing” of a portion of the staked assets. Proof-of-stake is viewed by some as more +energy efficient and scalable than proof-of-work. +Blockchain technology enables +the secure use and transfer of digital assets. “Digital asset” is a broad term that encompasses additional applications, including +ownership, transaction tracking, identity management, and smart contracts. A digital asset can represent physical or virtual assets, a +value, or a use right/service (e.g., computer storage space). +Whereas digital assets can +take many forms and be used for a variety of functions, cryptocurrencies are a type of digital asset that primarily function as a medium +of exchange, a unit of account, and/or a store of value. Cryptocurrencies allow anyone who holds a compatible wallet, anywhere in the +world, to hold and transfer that cryptocurrency without the need for an intermediary or trusted third party. Units of a cryptocurrency +may exist only as data on the internet, and often are not issued or controlled by any single institution, authority or government. Whereas +most of the world’s money currently exists in the form of electronic records managed by central authorities such as banks, units +of a non-government cryptocurrency exist as electronic records in a decentralized blockchain database. Because cryptocurrencies have no +inherent intrinsic value, the value of cryptocurrencies is determined by the value that various market participants place on them through +their transactions. Bitcoin, Ethereum and other cryptocurrencies have historically exhibited high price volatility relative to more traditional +asset classes. +22 +Private entities also issue +digital assets called “stablecoins” whose prices are pegged to those of an underlying fiat currency, a commodity or other +financial instrument or other physical asset and therefore less susceptible to volatility. Stablecoins can be backed by fiat money, physical +assets, or other crypto assets. Government institutions are also reportedly testing and considering issuing Central Bank Digital Currencies +(“CBDC’s”). While stablecoins or CBDC’s may exhibit less price volatility than other cryptocurrencies, both rely +on a central authority to establish the value of the asset, and therefore represent an exception to the general discussion of the design +of cryptocurrencies herein. +Each cryptocurrency has a +source code that comprises the basis for the cryptographic and algorithmic protocols, which govern the blockchain. The source code is +commonly open-source and therefore can be inspected by anyone, and is maintained on an ongoing basis through contributors proposing amendments +to the protocol, which are peer reviewed and adopted by consensus among participants on the blockchain network. These protocols govern +the functioning of the network, including the ownership and transfer of the cryptocurrency, and are executed on the decentralized peer-to-peer +blockchain infrastructure. The peer-to-peer infrastructure on which a blockchain operates is not owned or operated by a single entity. +Instead, the infrastructure is collectively maintained by a decentralized user base. Each peer user is generally known as a “node” +or “miner,” and each miner processes transactions on the network in accordance with the protocols of the relevant cryptocurrency. +As a result, these cryptocurrencies +do not rely on either governmental authorities or financial institutions to create, transmit or determine the value of units of cryptocurrency. +Rather: +· the creation of units of cryptocurrency generally is governed by the +source code, not a central entity; +· the transmission of a cryptocurrency is governed by the source code and processed +by the decentralized peer-to-peer network of nodes or miners; and +· the value of a cryptocurrency is generally determined by the market supply +of and demand for the cryptocurrency, with prices set in transfers by mutual agreement or barter, as well as through acceptance directly +by merchants in exchange for goods and services. +Cryptocurrencies may be open-source +projects with no official developer or group of developers that control the network. However, certain networks’ development may +be overseen informally by a core group of developers that may propose quasi-official releases of updates and other changes to the network’s +source code. The release of updates to a blockchain network’s source code does not guarantee that the updates will be automatically +adopted. Users and miners must accept any changes made to the source code by downloading the proposed modification of the network’s +source code. A modification of the network’s source code is effective only with respect to the users and miners that download it. +If a modification is accepted by only a percentage of users and miners, a division in the network will occur such that one network +will run the pre-modification source code and the other network will run the modified source code. Such a division is known as a “fork.” +Consequently, a modification to the source code becomes part of a blockchain network only if accepted by participants collectively having +most of the processing power on the network. +Each “account” +on a blockchain network is identified by its unique public key, and is secured with its associated private key (which the account holder +must keep secret, like a password). Cryptocurrencies are treated as bearer assets, because possession of the private key generally determines +who controls or owns a cryptocurrency. Protecting private keys from unwarranted access and theft is critically important, as once the +private key is taken, in most circumstances, control over the related cryptocurrency is gone. The combination of private and public cryptographic +keys constitutes a secure digital identity in the form of a digital signature. As long as the private key is kept private (i.e., confidential +to the owner of the account) it provides strong control of ownership. +23 +Ault Lending +Ault +Lending provides commercial loans to companies throughout the U.S. to provide them with operating capital to finance the growth of their +businesses. The loans range in duration from six months to three years. Ault Lending loans are made or arranged pursuant to a California +Financing Law license (Lic.no. 60 DBO77905). +Ault +Lending acquires controlling or non-controlling interests in and actively manages businesses that we generally believe (i) are undervalued +and have disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, +(iii) have the potential for positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, +and (v) have strong management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading +middle-market businesses in the niche-industrial and branded-consumer sectors. +Ault +Lending uses a traditional methodology for valuing securities that primarily looks for deeply depressed prices. Upon making an investment, +we often become actively involved in the companies we seek to acquire. That activity may involve a broad range of approaches, from influencing +the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling interest or outright +ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating +and expanding that business. +Ault +Lending believes that private company operators and corporate parents looking to sell their business units may consider us an attractive +purchaser because of our ability to: +· provide ongoing strategic and financial support +for their businesses, including professionalization of our subsidiaries at scale; +· maintain a long-term outlook as to the ownership +of those businesses; +· sustainably invest in growth capital and/or add-on +acquisitions where appropriate; and +· consummate transactions efficiently without being dependent on third-party +transaction financing. +In +particular, we believe that our outlook on length of ownership and active management on our part may alleviate the concern that many private +company operators and parent companies may have with regard to their businesses going through multiple sale processes in a short period +of time. We believe this outlook enhances our ability to develop a comprehensive strategy to grow the earnings and cash flows of each +of our businesses. +Finally, +it has been our experience that our ability to acquire businesses without the cumbersome delays and conditions typical of third party +transactional financing is appealing to sellers of businesses who are interested in confidentiality, speed and certainty to close. +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2023, we believe that these businesses have strong +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Ault Lending provides funding +to businesses through loans and investments. Ault Lending offers a variety of loan types including commercial loans, convertible notes +and revolving lines of credit. Ault Lending is engaged in providing commercial loans to companies throughout the United States to provide +them with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to 12 months, +but may be of longer duration. These terms are subject to change as market needs dictate, and Ault Lending anticipates offering additional +products in the future. +24 +Ault Lending uses its considerable +financial experience, data analytics, and a credit scoring model to assess the creditworthiness of each small business borrower applicant. +If the business meets Ault Lending’s criteria, Ault Lending sets the initial interest rate according to its credit and financial +models. The final interest rate offered to the borrower will be determined by Ault Lending’s interpretation of the marketplace. +In order to borrow from Ault Lending, borrowers must display characteristics indicative of durable business and financial situations. +These include factors such as revenue, time in business, number of employees, and financial and credit variables. In order to qualify, +business borrower applicants must be approved through Ault Lending’s underwriting process, which analyzes credit and financial data +of both the business and the business owner. Ault Lending takes into account several business factors (including revenue, age of business, +cash flows, and other variables). The underwriting process determines the loan amount to approve, how loans will be priced, and whether +to include a blanket lien is based on the above analysis, as well as additional factors (including length of loan, estimated default rates +by type and grade, and general economic environment). +Our Executive Committee, which +is comprised of our Executive Chairman, Chief Executive Officer and President, acts as the underwriting committee for Ault Lending and +approves all lending transactions. The Executive Committee has decades of experience in financial, investing and securities transactions. +Under its business model, Ault Lending generates revenue through origination fees charged to borrowers and interest generated from each +loan. Ault Lending may also generate income from appreciation of investments in marketable securities as well as any shares of common +stock underlying convertible notes or warrants issued to Ault Lending in any particular financing. +As noted above, we will from +time to time, through Ault Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2024, we anticipate +providing significant new funding to expand Ault Lending’s loan and investment portfolio. Ault Lending loans are made or arranged +pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +RiskOn International, Inc. +BitNile.com, Inc. +Overview +BNC is primarily engaged in +the development and operation of an online metaverse platform (the “Metaverse”). The Metaverse represents a significant development +in the online metaverse landscape, offering immersive, interconnected digital experiences that are inclusive, engaging, and dynamic. By +integrating various elements such as virtual markets, real world goods marketplaces and VIP experiences, gaming, social activities, sweepstakes, +gambling, and more, ROI aims to revolutionize the way people interact online. ROI’s virtual world, located at BitNile.com, is accessible +via any device using any web browser, without requiring permissions, downloads, or apps, and the platform can be enjoyed without the need +for bulky and costly virtual reality headsets. +BNC’s games operate +on a free-to-play model, whereby game players may collect coins free of charge through the passage of time and, if a game player wishes +to obtain coins above and beyond the level of free coins available to that player, the player may purchase additional coin packages (“Freemium” +gaming model). Once obtained, Nile Tokens and Nile Coins (either free or purchased) cannot be redeemed for cash or exchanged for anything +outside of the Metaverse. When coins are used and played in the games, the game player could “win” and would be awarded additional +coins or could “lose” and lose the future use of those coins. +BNC’s current and planned products and experiences +are: +· Virtual markets. The platform facilitates sales of virtual goods +and items from BNC as well as third party vendors like virtual real estate, digital art, user customizations, and unique collectibles. +· Real world goods marketplaces. The platform allows users to shop +for a diverse range of real world products and VIP experiences. +25 +· Gaming. The platform provides an extensive selection of gaming +options, including participation in games, sweepstakes and social gaming experiences, such as Blackjack and roulette. +· Sweepstakes gaming. The platform features a dedicated gaming +zone for users to engage in sweepstakes gaming, offering opportunities to win virtual and real money. +· Contests of skill. The platform organizes competitions for users +to showcase their talents and compete against others for prizes and recognition in various disciplines. +· Building private spaces. The platform allows users to construct +and customize their dream homes or private spaces. +· Socialization and connectivity. The platform’s ongoing +mission will be to foster global connections by enabling users to interact with individuals from around the world, forming new friendships, +collaborating on projects or engaging in conversations within various social hubs. +· Real and virtual concerts. BNC believes that the platform may, +in the future, host live and virtual concerts within the Metaverse, featuring performances from both real world and virtual artists, allowing +users to attend and enjoy shows in an immersive environment. +Business Strategy +The metaverse industry is +experiencing rapid growth and expansion, driven by advancements in technology, increased interest in virtual experiences and the rise +of digital economies. BNC’s business strategy revolves around creating a seamless, all-encompassing platform that caters to various +user needs and interests. +The strategic pillars for +the growth of the BitNile.com metaverse platform include (i) leveraging cutting-edge technology to offer a user-friendly, browser-based +platform compatible with virtual reality headsets and other modern devices for an enhanced experience, (ii) providing a diverse range +of products and experiences that caters to users with different interests and preferences, (iii) fostering global connections and a sense +of community among users, encouraging socialization and collaboration, and (iv) focusing on continuous innovation to stay ahead of industry +trends and customer expectations. +Competition +BNC faces competition from +existing metaverse platforms and new entrants. Key competitors include: +· Established metaverse platforms, such as Decentraland, The Sandbox, and Second +Life, as well as companies that develop metaverse tools and platforms such as META; +· Gaming-focused platforms, like Fortnite and Roblox; and +· Social media platforms that integrate metaverse elements, such as Facebook’s +Horizon Workrooms. +Regulatory Environment: Present and Future Challenges +As the metaverse industry +continues to grow and evolve, regulatory challenges and considerations are becoming increasingly important. The unique nature of the metaverse, +which often combines elements of virtual reality, gaming, social networking, and digital economies, presents a complex landscape for regulators +to navigate. +To navigate the complex and +evolving regulatory landscape, BNC will prioritize compliance with relevant laws and regulations in all jurisdictions where it operates. +This includes data privacy and protection regulations, gaming and sweepstakes regulations, and intellectual property rights. By maintaining +a strong focus on regulatory compliance, BNC aims to minimize potential legal risks and build trust with users and partners. +26 +Present Regulatory Challenges +The metaverse industry is +currently grappling with several regulatory challenges, including: +· Data Privacy and Security: As users share personal +information and engage in transactions within the metaverse, concerns about data privacy and security are paramount. Regulators must ensure +that platforms adhere to existing data protection regulations, such as the General Data Protection Regulation (“GDPR”) and +the California Consumer Privacy Act (“CCPA”); +· Intellectual Property Rights: The metaverse’s +reliance on user-generated content and virtual goods and items raises questions about intellectual property rights and the enforcement +of copyright, trademark, and patent laws in virtual environments; +· Taxation and Financial Regulations: The growth +of virtual economies and the increasing popularity of cryptocurrencies and non-fungible tokens have raised questions about taxation and +financial regulations. Regulators must determine how to classify and tax digital assets and transactions, as well as ensure compliance +with anti-money laundering and know-your-customer regulations; and +· Content Moderation and Liability: Metaverse platforms +face challenges in moderating content and managing user behavior, raising questions about the platforms’ liability for user-generated +content and potential violations of existing laws, such as those related to hate speech, harassment, and misinformation. +Future Regulatory Challenges +As the metaverse industry +continues to develop and expand, several future regulatory challenges are likely to emerge, including: +· Cross-border jurisdictional issues: With the +metaverse being a global, borderless environment, determining jurisdiction and applying national laws to activities and transactions within +the metaverse will become increasingly complex; +· Virtual reality and augmented reality regulations: +As VR and AR technologies become more integrated into the metaverse, new regulations may be needed to address issues related to safety, +privacy, and ethical considerations in the use of these technologies; +· Decentralization and governance: The increasing +trend towards decentralized metaverse platforms raises questions about governance and regulatory oversight, as traditional regulatory +mechanisms may not be applicable or effective in these environments; and +· Ethics and inclusivity: As the metaverse becomes more intertwined with daily +life, ethical considerations related to inclusivity, accessibility, and the potential for digital divides will become increasingly important +for regulators to address. +GuyCare +Overview +GuyCare, a subsidiary of ROI, +seeks to become a leading provider of comprehensive healthcare solutions tailored to address the unique needs of the male population. +Launched in 2023, GuyCare is building a consumer-centric platform that leverages innovative technologies, personalized treatments, and +a patient-focused approach to transform the way men access and receive care for their health and wellness needs. GuyCare’s mission +is to empower men worldwide to lead healthier, more fulfilling lives through the power of better health. +Addressing Unique Healthcare Needs +GuyCare recognizes the unique +healthcare challenges faced by men and strives to offer a wide range of innovative products and services to meet those needs. +27 +GuyCare’s portfolio +of products and services addresses critical areas of men’s health, including sexual health, hair restoration, weight management, +regenerative joint treatments, and overall well-being. GuyCare offers advanced treatments such as medication-based therapies, Acoustic +Wave Therapy for erectile dysfunction, and Platelet-Rich Plasma (“PRP”) injections for joint health, all delivered through +a user-friendly digital platform and a network of highly qualified healthcare professionals. +In the area of sexual health, +GuyCare provides treatments for erectile dysfunction, low testosterone, and premature ejaculation, utilizing medication-based therapies +and innovative procedures like Acoustic Wave Therapy. This non-invasive treatment uses high-frequency sound waves to improve blood flow +and promote tissue regeneration in the targeted area. +For hair restoration, GuyCare +offers medication-based treatments in the form of pills and topical applications, carefully formulated to promote healthy hair growth +and reduce hair loss. +Weight management solutions +include products such as Semaglutide, a medication that regulates appetite and promotes feelings of fullness, as well as alternative options +like weight loss pills. These treatments are selected based on their safety and efficacy profiles to support men in their weight loss +journey. +Regenerative joint treatments, +such as Adipose Derived Allograft and PRP injections, harness the body’s natural healing capabilities to promote tissue regeneration +and reduce inflammation in affected joints. These treatments are complemented by a range of vitamins and supplements formulated to support +joint health and overall well-being. +GuyCare’s platform enables +men to access these healthcare solutions conveniently and discreetly, connecting patients with highly qualified healthcare professionals +for personalized treatment plans. +Business Strategy and Market Differentiation +GuyCare’s business strategy +is centered around three key pillars: +· Trusted Brand . GuyCare strives to build +a brand that is trusted by customers, easy-to-use, and normalizes the practice of seeking and receiving treatment by empowering men with +personalized care and an omnichannel experience; +· Individualized Products and Services . +GuyCare leverages insights and customer feedback to offer personalized prescription and non-prescription treatments designed to meet individual +needs; and +· Clinical Excellence . The foundation of +GuyCare’s platform is the consumer trust established through clinical excellence. Care delivered through the platform is subject +to evidence-based clinical guidelines and provided by highly trained healthcare professionals to ensure consistency and quality. +GuyCare operates through a +hybrid model that integrates a proprietary telehealth platform with a physical clinic located in Utah. This approach enables GuyCare to +extend its geographic reach and provide accessible, confidential healthcare services to men across diverse locations. By leveraging technology +and personalized care, GuyCare aims to deliver high-quality services while emphasizing patient convenience and privacy. GuyCare competes +with established entities such as Hims and medRx. However, ROI believes that GuyCare’s comprehensive suite of offerings, unique +delivery model combining in-person and virtual care, and strategic partnership with ROI, provide GuyCare with the potential to navigate +market challenges effectively and capture a growing portion of the expanding men’s health sector. +Growth Opportunities +GuyCare, having recently entered +the market in 2023, is focused on several key growth strategies to establish itself as a competitive player in the men’s health +sector: +· Attracting New Customers . By leveraging +its innovative products and developing targeted, omnichannel acquisition strategies, GuyCare aims to attract new customers seeking treatment +for their specific health concerns, building brand recognition and trust in the process; +28 +· Nurturing Existing Customer Relationships . +As GuyCare expands its offerings and introduces personalized products, it seeks to foster long-term relationships with its existing customer +base, encourages subscription-based purchases and explores cross-selling opportunities to drive growth; +· Gradual Specialty Expansion . GuyCare is +carefully planning its specialty expansion, initially focusing on conditions that can be safely and effectively treated through its telehealth +platform, require ongoing customer engagement, and have well-established generic medications as treatment options. This measured approach +allows GuyCare to build a strong foundation before expanding into additional areas; and +· Exploring New Markets . While currently +focused on the U.S. market, GuyCare’s digital-first, cloud-based business model has the potential to be adapted to new markets and +languages in the future. As GuyCare grows and solidifies its position in the domestic market, it will explore potential international +expansion opportunities to extend its reach and impact on men’s health globally. +Regulatory Environment +As a consumer-focused health +and wellness company delivering comprehensive telehealth technologies, services, and products (both prescription and over the counter), +GuyCare is required to comply with complex healthcare laws and regulations, as well as consumer protection laws, at both the state and +federal levels. GuyCare’s business and operations are subject to extensive regulation in areas such as the practice of medicine, +use of telehealth, relationships with healthcare providers, privacy and security of personal health information and product safety. +· Government Regulation of Healthcare . While +GuyCare currently accepts payments only from customers and not from third-party payors, GuyCare remains subject to various healthcare +regulations that affect the industry as a whole and may impact customer use of its solutions; +· Practice of Medicine and Telehealth . GuyCare's +telemedicine services are currently licensed in four states, with plans to expand its operations to all 41 states that allow nurse practitioners +to operate telemedicine services that GuyCare provides. The approval of the licensing in these additional states is expected to occur +on a rolling basis in 2024. For the remaining nine states, which require such services to be provided by a licensed doctor, GuyCare is +seeking to contract with medical groups or hire licensed doctors to provide such services. GuyCare has established systems to ensure that +providers are appropriately licensed and that telehealth services are delivered in compliance with applicable rules; +· Affiliated Pharmacies . GuyCare contracts +with affiliated pharmacies to provide pharmaceutical services. When medication is prescribed, the client pays GuyCare directly for the +prescription, and GuyCare then sends the prescription to one or more mail order pharmacies that GuyCare contracts with, which then dispenses +the medication directly to the client; +· U.S. Federal and State Fraud and Abuse Laws. +Given its current operations, GuyCare believes that the Anti-Kickback Law, the federal False Claims Act, and the Stark Law should not +apply to its business. However, if the scope of these laws is extended or GuyCare begins accepting reimbursement payments from third-party +payors, it may become subject to these laws and need to modify its business model accordingly; +· U.S. Food and Drug Administration (“FDA”) +Regulation . Certain products available through GuyCare’s platform, as well as the third-party suppliers and manufacturers of +these products, are subject to extensive FDA regulation. GuyCare believes that its product promotion is conducted in material compliance +with FDA and other regulations. However, if the FDA determines that GuyCare’s product promotion constitutes promotion of an unapproved +use or unapproved product, GuyCare could face regulatory and/or legal enforcement actions; and +· Health Information Privacy and Security Laws . +GuyCare has developed and maintains policies and procedures to protect customers’ health and personal information, including the +adoption of administrative, physical, and technical safeguards. As GuyCare’s business operations continue to develop, it may collect +additional sensitive information from customers, creating further compliance obligations and increasing exposure to regulatory risks. +29 +Innovative Delivery Model +GuyCare operates through a +hybrid model comprising a single brick-and-mortar clinic and an advanced telehealth platform. This approach enables it to extend its reach, +offering accessible and confidential healthcare services to men across diverse geographic locations. By leveraging technology and personalization, +GuyCare strives to deliver exceptional care while prioritizing convenience and comfort for its patients. +Strategic Partnerships and Synergies +As part of ROI, GuyCare benefits +from shared resources, infrastructure, and expertise, enabling it to scale its operations efficiently. GuyCare’s growth strategy +revolves around expanding its clinic network, further enhancing its telehealth capabilities, and forging strategic partnerships and acquisitions +that align with GuyCare’s mission to improve men’s health outcomes globally. +Conclusion +GuyCare stands at the forefront +of men’s health and wellness, committed to delivering personalized, discreet, and comprehensive solutions that empower men to lead +healthier, more fulfilling lives. With GuyCare’s unwavering dedication to innovation, excellence, and patient-centered care, it +is poised to capitalize on the growing demand for specialized men’s healthcare services and make a meaningful impact on the well-being +of its clients nationwide. +Further, GuyCare is well-positioned +to capitalize on the growing demand for specialized men’s healthcare services by leveraging its brand, innovative products and services, +and commitment to clinical excellence. As GuyCare expands its clinic network, enhance its telehealth capabilities, and forge strategic +partnerships, it is poised to make a lasting impact on the well-being of men worldwide while driving long-term value. GuyCare’s +strong focus on compliance with the complex regulatory landscape governing healthcare, telehealth, and privacy ensures that it can navigate +the challenges and opportunities in the evolving men’s health market. +askROI.com +Overview +askROI.com, a division of +ROI, is a cutting-edge, AI-powered software-as-a-service platform designed to revolutionize the way businesses leverage their data for +competitive advantage. At the core of askROI.com’s technology is a state-of-the-art large language model (“LLM”), which +is exclusively licensed from a leading third-party provider for use in North America. This strategic partnership is anticipated to enable +askROI.com to harness the full potential of the LLM’s advanced natural language processing capabilities while ensuring compliance +with the highest standards of data security and privacy. +By seamlessly integrating +with a company’s existing tools and data sources, askROI.com goes beyond traditional search to deliver actionable insights, intelligent +analysis, and data-driven decision support. The platform’s LLM-powered technology allows it to interpret complex queries, identify +relevant information, and provide highly contextualized responses, all while continuously learning and adapting to each organization’s +unique language and terminology. +Whether it be empowering sales +teams to close deals faster, enabling support teams to resolve customer issues quickly, or providing administrators with real-time analytics, +askROI.com is poised to transform how businesses operate in the digital age. With its exclusive access to cutting-edge LLM technology +and commitment to delivering tangible business value, ROI believes that askROI.com sets a new standard for AI-powered insights and decision +support in the North American market. +askROI.com’s current +and planned product functionality are: +· Seamless Integration : askROI.com connects +with a wide range of business tools, including customer relationship management, cloud storage systems (OneDrive, Google Drive), and communication +platforms (Slack, Teams). Ongoing expansion of integration partnerships will further streamline data access and analysis; +· Contextualized Understanding : By leveraging +the power of its exclusively licensed LLM, askROI.com learns each company’s unique terminology, product names, and project codes, +providing highly relevant and tailored insights. Continuous enhancements to the platform’s natural language processing capabilities +will enable even more nuanced and context-aware analysis; +30 +· Actionable Insights : askROI.com analyzes +data to generate custom reports, draft data-rich presentations, and create visualizations like charts and graphs. Introduction of industry-specific +templates for reports, data visualizations, and analytics dashboards will provide additional value for users in targeted sectors; +· Transparency and Security : askROI.com +cites specific data sources for its answers and provides direct document links for reference. Robust data security measures, including +access controls, encryption, and audit trails, seek to ensure the protection of sensitive information. Future updates will focus on achieving +compliance with key regulations such as GDPR, SOC 2, and Payment Card Industry Data Security Standards; +· Ethical AI : Implementation of strict guidelines +and oversight mechanisms to ensure responsible development and use of askROI.com’s AI models, mitigating risks of bias, discrimination, +or misuse; and +· Partner Ecosystem : Development of a robust +network of consultancies, system integrators, and industry-specific solution providers to accelerate adoption and create tailored solutions +for diverse business needs. +By continually enhancing and +expanding askROI.com’s capabilities, ROI aims to position the platform as an indispensable tool for businesses seeking to leverage +their data for competitive advantage and operational excellence. +Business Strategy +askROI.com is currently in +beta testing, focusing on support and commercial applications. However, the platform’s flexible architecture and powerful AI capabilities, +underpinned by its exclusive licensing agreement for the LLM technology in North America, position it for broad applicability across industries. +The go-to-market strategy involves continued refinement of the core product based on beta user feedback, followed by a staged rollout +to additional sectors. +Key strategic initiatives +include: +· Leveraging the exclusive LLM licensing agreement +to differentiate askROI.com from competitors and establish a strong market position in North America. By emphasizing the unique capabilities +and benefits of the underlying LLM technology, askROI.com aims to attract customers through seeking cutting-edge AI solutions for their +business needs; +· Aggressive expansion of integration partnerships +to make askROI.com a seamless fit for a wide range of business tech stacks. By prioritizing integrations with the most widely used tools +and platforms, askROI.com aims to minimize adoption barriers and maximize its potential user base; +· Targeted marketing campaigns highlighting askROI.com’s +singular ability to turn a company’s own data into its most valuable competitive asset. These campaigns will focus on demonstrating +real-world use cases and ROI, showcasing how askROI.com can drive tangible business outcomes across various functions and industries; +· Development of a robust partner ecosystem, including +consultancies, system integrators, and industry-specific solution providers. These partnerships will serve to accelerate adoption by providing +customers with end-to-end solutions tailored to their specific needs, as well as offering valuable insights and feedback to guide future +product development; +· Continuous investment in research and development +to advance askROI.com’s AI capabilities and maintain a competitive edge in the rapidly evolving market. This will involve ongoing +collaboration with the LLM technology provider to ensure askROI.com remains at the forefront of natural language processing, machine learning, +and data analytics capabilities; and +· Establishment of a world-class customer success +program to ensure users are able to fully leverage askROI.com’s capabilities and achieve maximum value from the platform. This will +include comprehensive onboarding, training, and support resources, as well as regular check-ins and consultations to help customers optimize +their use of askROI.com over time. +31 +By adopting these strategic +initiatives and leveraging the exclusive LLM licensing agreement, askROI.com aims to establish itself as the leading AI-powered insights +engine for businesses in North America, setting the standard for data-driven decision-making and operational excellence. +Competition +ROI believes that askROI.com’s +unique positioning as an AI-powered insights engine that operates exclusively on a company’s own data, combined with its exclusive +licensing agreement for the state-of-the-art LLM technology in North America, sets it apart from both generic AI tools and other enterprise +search and analytics platforms. +Key differentiators include: +· Exclusive Access to Cutting-Edge LLM Technology : +askROI.com’s licensing agreement provides a significant competitive advantage, enabling the platform to leverage advanced natural +language processing capabilities available in the North American market; +· Seamless Integration with Existing Business +Tools : By minimizing disruption to established workflows and enabling rapid adoption, askROI.com will reduce barriers to entry and +increases its appeal to potential customers; +· Ability to Learn Company-Specific Language +and Context : askROI.com’s LLM-powered technology allows it to provide highly relevant and actionable insights tailored to each +organization’s unique needs, setting it apart from generic AI solutions; +· Focus on Delivering Actionable Insights : +askROI.com goes beyond simple data aggregation, empowering users to make informed decisions and drive tangible business outcomes; and +· Commitment to Data Security and Privacy : +By ensuring that sensitive information remains protected and compliant with evolving regulations, askROI.com addresses a key concern for +businesses considering AI-driven solutions. +ROI believes that as the market +for AI-driven business tools continues to grow, askROI.com is well-positioned to capture market share in North America through its powerful +capabilities, ease of use, and strong commitment to customer success. The exclusive LLM licensing agreement serves as a significant barrier +to entry for potential competitors, providing askROI.com with a sustainable competitive advantage in the region. +However, askROI.com recognizes +the potential for competition from established players in the enterprise software space, as well as from emerging startups focused on +AI-powered analytics and decision support. To mitigate these risks, askROI.com will focus on building a strong brand identity, cultivating +a loyal customer base, and leveraging its partner ecosystem to create advantages focused on its core offerings. +Ultimately, askROI.com’s +success will depend on its ability to consistently deliver value to customers, stay at the forefront of technological innovation, and +adapt to the evolving needs of the market. By remaining agile, customer-centric, and committed to its vision of empowering businesses +through AI-driven insights, askROI.com is confident in its ability to thrive in the face of competition and emerge as a leader in the +North American market. +Regulatory Environment (Present and Future) +The regulatory landscape for +AI and data-driven technologies is evolving rapidly, presenting both challenges and opportunities for askROI.com. ROI’s exclusive +licensing agreement for the LLM technology in North America adds an additional layer of complexity, as it must ensure compliance not only +with regional regulations but also with the terms and conditions of the licensing agreement itself. +On one hand, the increasing +focus on data privacy and security, as exemplified by regulations such as the GDPR, highlights the critical importance of responsible +data management and protection. This aligns closely with ROI’s core values and its commitment to ensuring the security and confidentiality +of customer data. +32 +On the other hand, the lack +of clear and consistent guidelines around the ethical development and use of AI technologies creates a degree of uncertainty for companies +operating in this space. As regulators and policymakers work to catch up with the rapid pace of technological advancement, there is a +risk of overregulation or fragmented regulatory frameworks that could hinder innovation and growth. +To navigate this complex regulatory +environment, askROI.com is proactively taking steps to ensure compliance with existing regulations while also staying ahead of potential +future developments, including: +· Collaborating closely with the LLM technology +provider to ensure that askROI.com’s use of licensed technology adheres to all relevant legal and ethical guidelines, both in North +America and in the provider’s home jurisdiction; +· Investing in robust data security measures and +processes, such as access controls, encryption, and audit trails, to safeguard customer data and maintain the highest standards of data +privacy; +· Developing and implementing strict guidelines +and oversight mechanisms for the ethical development and use of its AI models, drawing on best practices from industry leaders and academic +experts; +· Engaging with regulators, policymakers, and other +key stakeholders to provide input and guidance on the development of AI-related regulations, ensuring that askROI.com’s perspective +is heard and that future regulations are informed by practical realities; and +· Maintaining a commitment to transparency, both +in terms of how askROI.com uses and protects customer data, as well as in how its AI models are developed and deployed. This should help +to build trust with customers and demonstrate askROI.com’s dedication to responsible, ethical AI practices. +By proactively addressing +these regulatory considerations, staying at the forefront of industry best practices, and working closely with its LLM technology provider, +askROI aims to ensure its own compliance and success while delivering innovative AI solutions to its customers. +As the regulatory landscape +continues to evolve, askROI.com will remain vigilant and adaptable, always prioritizing the needs of its customers and the integrity of +its platform. By doing so, ROI is confident in its ability to navigate any regulatory challenges that may arise and emerge as a leader +in responsible, compliant AI innovation for businesses in the North American market. +RiskOn 360 +RiskOn 360, a wholly owned +subsidiary of ROI, is a company dedicated to organizing and hosting an annual global success conference that serves as a promotional vehicle +for ROI and its various offerings. The conference is designed to foster growth and success among attendees by providing a platform for +renowned speakers to share their experiences and strategies for achieving success in both their professional and personal lives. +The primary objective of the +RiskOn 360 conference is to educate and inspire attendees by exposing them to a wide range of success stories, innovative ideas, and best +practices from across various industries. By bringing together successful individuals from diverse backgrounds, RiskOn 360 aims to create +a unique learning environment that encourages networking, collaboration, and personal growth. +In addition to the annual +conference, RiskOn 360 is responsible for managing and coordinating the numerous speaking engagements of ROI’s representatives. +These speaking engagements serve as an important tool for promoting ROI’s overall objectives, educating potential clients and partners +about ROI’s offerings, and establishing ROI representatives as a thought leader in their respective fields. +Through its conference and +speaking engagement activities, RiskOn 360 plays a crucial role in supporting ROI’s mission to provide innovative solutions and +valuable insights to its clients, ultimately contributing to their success and growth. RiskOn 360’s efforts in organizing these +events not only help to strengthen ROI’s brand recognition but also provide a platform for showcasing ROI’s expertise and +capabilities to a wide audience. +33 +Circle 8 +Description of the Business +Headquartered in Houston, +Circle 8 is a premier lifting services provider serving clients in Texas, Oklahoma, Louisiana and New Mexico with five strategically located +branches in Texas and Oklahoma. Its modern fleet consists of 55 mobile all-terrain and hydraulic cranes, with lifting capacities of up +to 350 tons that provides services across the Eagle Ford, Permian, Delaware and Haynesville basins. Circle 8 is poised for organic growth +through a strengthened financial profile following its recapitalization in December 2022. Circle 8’s fleet consists of Grove, Xuzhou +Construction Machinery Group (“XCMG”) and other leading original equipment manufacturers. +Circle 8 provides experienced +professionally certified operators to deliver customized solutions to lifting clients in oil field services, construction, commercial, +refining / marketing and wind energy markets. Circle 8 maintains an industry leading safety record. Safety personnel hold certifications +and undergo in-house training. +New Management +In April 2023, Circle 8 hired +Arnold Mabee as its new CEO. Mr. Mabee has a longstanding, successful track record, as he was previously the President of Sterling Crane +USA, LLC (“Sterling Crane”), which has a portfolio of diverse cranes and locations serving multiple business segments. As +such, Mr. Mabee is responsible for one of the larger mobile crane companies in the US. +Prior to joining Sterling +Crane, Mr. Mabee was the Partner in Charge / Administration at R.S. Phillips Steel LLC, a fourth-generation family-owned Steel Service +Center that serves the Tri-State Area of New York, New Jersey and Pennsylvania. During his time there, Mr. Mabee pioneered several new +innovative ideas to enhance safety, compliance and productivity. +Mr. Mabee has thirty years +of operations and senior level management experience in a variety of industries including all aspects mobile crane & heavy haul services, +steel service centers and other industrial services businesses. Mr. Mabee has a long history of improving profitability, significantly +growing businesses, and where appropriate, taking them through successful restructuring and segmentation events. +Competitive Advantage +Circle 8’s operating +experience and the mid-sized diverse fleet that it has developed serves the oil services and petrochemical industries, providing full-service +lifting solutions with an industry leading safety record. Key strengths of Circle 8 include: +· Leading lifting solutions platform +○ Leading provider of comprehensive lifting solutions to diversified end markets, including oil & gas +and with expanding operations in infrastructure, plant turn-around and commercial/industrial construction; and +○ Leading market position with five branches strategically located throughout Texas and Oklahoma. +· Industry leading safety record, commitment and policy +○ Safety is a core value and Circle 8 is a market leader in employee training and practices; and +○ Dedicated team focused on safety programs. +· Proven strength of management, recently enhanced and augmented +○ Proven ability to navigate a secular downturn by maintaining strong customer relationships and scale operations +to capture additional market share; +○ Seasoned industry leaders who have positioned Circle 8 for future growth; and +○ Additional advisory team to supplement full time management with strategic industry knowledge, contacts +and corporate transaction capability. +34 +· High quality fleet with the opportunity to expand by 100% creates a barrier +to entry. Circle 8’s fleet of 55 cranes, as of the date of this Annual Report, comprises 45 all-terrain cranes and 10 hydraulic +truck cranes with a combined average age of 9 years and capacity of up to 350 tons. +· Diversified blue-chip customers +○ Entrenched provider to leading, well-capitalized oil and gas industry operators in Texas, New Mexico, +Louisiana and Oklahoma; +○ Diverse customer base with minimal customer concentration risk; and +○ Longstanding relationships enable company to easily scale up operations with customers’ demands +in the oilfield (upstream), commercial, construction, refining & marketing (downstream) and wind energy markets. +· Compelling utilization and financial profile +○ Recently downsized underutilized cranes to return to pre-pandemic fleet utilization over 160%; and +○ Substantial upside remains as the Company efficiently relocates and repurposes its fleet across geographies +and end markets. +Industry +There continues to be some +consolidation within the industry recently, including the acquisitions of Rental Services Corporation, NES Rentals, Neff Corporation and +Ahern Rentals by United Rentals, Inc. (“URI”) and the acquisitions of Contractors Building Supply Co. and Cloverdale Equipment +Co. by Herc Holdings, Inc. (“HRI”). However, the U.S. lifting solution equipment distribution and rental industry remains +highly fragmented and consists mainly of a small number of multi-location regional or national operators and a large number of relatively +small, independent businesses serving discrete local markets. The industry is driven by a broad range of economic factors including total +U.S. residential and non-residential construction trends, construction machinery demand, demand for rental equipment and additional, region-specific +factors. Lifting solutions equipment is largely distributed to end users through two channels: equipment rental companies and equipment +dealers. Examples of equipment rental companies include URI, Sunbelt Rentals, and HRI. Examples of equipment dealers include Finning and +Toromont. Circle 8 operates substantially in a segment of the rental business whereby Circle 8 provides all labor and consumables to complete +a project or an assignment. Like Circle 8, many other pure equipment rental companies may also provide parts and service support to customers. +Sales and Marketing +Led by Phillip Bryson and +Brett Rhuland, the sales force is highly specialized in lifting solutions sales to oil services customers, seeking long term purchase +orders and master service agreements. Circle 8 plans to continue the extensive training program which involves original equipment manufacturer +(“OEM”) training sessions on operations and maintenance to ensure the entire sales force knows the fleet inside and out. +Circle 8 will be working with +continuing management to implement a back-office content resource management system that will be heavily focused on data collection so +that it can continue to improve margin and help streamline scheduling, operations and fleet management to optimize utilization. +Competitive Business Strategy +The oil services’ lifting +solutions demand has historically been one of the leading sub-segments of the industry for profitability due to high utilization rates +that coincide with the continuous workstreams of extraction. Circle 8 plans to expand this business line in both topline sales through +optimizing service and quality operations with a strong safety record. +In addition to expanding the +existing business, Circle 8 will seek to make additional forays into the infrastructure construction, the refinery and manufacturing plant +turn-around and industrial facility construction with the availability of new cranes as they become available. +Customers +With a focus on the oil services +sub-segment of the lifting solutions business in the Eagle Ford, Haynesville, Permian, Delaware and Anadarko basins, Circle 8 has a diversified +base of blue-chip customers in TX and OK. While about a third of its sales are expected to be made up from six of the largest players +in the industry, the remaining two thirds of sales will be highly diversified, leading to minimal concentration risk. With its longstanding +relationships with blue-chip customers and incoming fleet units, Circle 8 believes it has the ability to scale up sales with these customers +locally and most likely into other adjacent areas. +35 +Competition +Due to the highly skilled +nature and competitive nature of the lifting solutions business, the sector typically consists of companies like Circle 8 that provide +full service lifting solutions on rental or contract basis, including the manpower required to operate the equipment or companies that +require extensive lifting solutions straight purchasing the equipment and hiring crane operators directly. +The full-service lifting solutions +business is highly fragmented and local with only a few national service providers. In Circle 8’s existing subsegment of the lifting +solutions business to the petrochemical industry, the competition is not as strong as it is in others as the contract terms are usually +longer term and driven by maintaining strong customer relationships. The diversification strategy for Circle 8 into other subsegments +will be faced with competition that is largely driven based on availability, quality (including safety record), reliability and price. +Environmental and Safety Regulations +Circle 8’s equipment, +facilities and operations are subject to comprehensive and frequently changing federal, state and local environmental and occupational +health and safety laws, which may vary locally. These laws regulate (1) the handling, storage, use and disposal of hazardous materials +and waste and, if any, the associated cleanup of properties affected by pollutants; (2) air quality (emissions); and (3) wastewater. While +lifting solutions’ operations generally do not raise significant environmental risks, Circle 8 uses petroleum products, solvents +and other hazardous substances for fueling and maintaining its fleet and vehicles. Circle 8 has made, and will continue to make, capital +and other expenditures to comply with environmental requirements. Circle 8 does not currently anticipate any material adverse effect on +its business, financial condition or competitive position as a result of its efforts to comply with such requirements. +In the future, federal, state +or local governments could enact new or more stringent laws or issue new or more stringent regulations concerning environmental and worker +health and safety matters, reporting and disclosure obligations, or effect a change in their enforcement of existing laws or regulations, +that could affect operations and increase operational and compliance expenditures. Also, in the future, contamination may be found to +exist at Circle 8’s facilities or off-site locations where waste has been sent. There can be no assurance that Circle 8, or various +environmental regulatory agencies, will not discover previously unknown environmental non-compliance or contamination. Circle 8 could +be held liable for such newly discovered non-compliance or contamination. It is possible that changes in environmental and worker health +and safety laws or liabilities from newly discovered non-compliance or contamination could have a material adverse effect on Circle 8’s +business, financial condition and results of operations. +AGREE +AGREE has invested in various +classes of commercial and residential real estate including hospitality, multifamily, and industrial properties targeting the middle market +segment in locations demonstrating relative value. AGREE’s objective is to generate risk adjusted returns through development, capital +investment and operational improvement. AGREE owns and operates both Third Avenue Apartments and AGREE Madison. +In September 2023, we committed +to a plan for our wholly owned subsidiary AGREE to list for sale its four recently renovated Midwest hotels, the Hilton Garden Inn in +Madison West, the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford. The decision to +sell the hotels follows the decision to also list the multifamily development site in St. Petersburg, Florida and is driven by our desire +to focus on our core businesses, Energy, Fintech and Sentinum. We plan to use the proceeds from the sales of the hotel properties to pay +off debt and commit more capital to our core businesses. Our real estate properties, which include both hotels and land, are currently +listed for sale. +In connection with the planned +sale of AGREE’s assets, we concluded that the net assets of AGREE met the criteria for classification as held for sale. In addition, +the proposed sale represents a strategic shift that will have a major effect on our operations and financial results. As a result, we +have presented the results of operations, cash flows and financial position of AGREE as discontinued operations in the accompanying consolidated +financial statements and notes for all periods presented. +36 +SMC +Overview +SMC +is a consumer electronics manufacturer of retail karaoke products. Based in Fort Lauderdale, Florida, and founded over forty years ago, +SMC is primarily engaged in the development, marketing, and sale of a wide assortment of at-home and in-car consumer karaoke audio equipment, +accessories, musical recordings and products. SMC’s portfolio is marketed under both proprietary brands and licenses, including +Carpool Karaoke and Sesame Street. SMC’s products are sold in locations worldwide, primarily through mass merchandisers and warehouse +clubs, on-line retailers and to a lesser extent department stores, lifestyle merchants, direct mail catalogs and showrooms, music and +record stores, and specialty stores. +Recent Developments +Private Placement +On +November 20, 2023, SMC entered into an agreement to sell $2,000,000 in common stock through a private placement of common stock. The +private placement was completed with two affiliates, both of which were existing shareholders with representation on SMC’s board +of directors. The private placement was completed at $0.91 per share of SMC’s common stock, with a total of approximately 2,199,000 +shares issued. Net proceeds from the transaction were approximately $1,900,000, net of transaction fees of approximately $100,000. During +the six-month period after the closing date, the purchasers may make a written request for registration under the Securities Act of 1933, +as amended, of all or any portion of the shares purchased. +As +a result of the transaction, our share ownership of SMC was diluted to approximately 28%. Due to the significant change in our +ownership and voting rights, we determined that we no longer met the criteria of the primary beneficiary and, accordingly, we deconsolidated +SMC as of November 20, 2023. We recorded a $3.0 million loss on deconsolidation for the year ended December 31, 2023. +Upon +deconsolidation, we recorded our $2.3 million retained investment in SMC based upon the fair value of the common shares held by us +at November 20, 2023. Due to our significant influence over SMC, we began accounting for our retained interest under the equity method +of accounting. +Hospitality Lease +On +August 23, 2023, MICS Nomad, LLC, a Delaware limited liability company (“MICS NY”), a wholly owned subsidiary of MICS, entered +into an Agreement of Lease (the “Lease Agreement”) with OAC 111 Flatiron, LLC and OAC Adelphi, LLC (the “Landlord”), +pursuant to which MICS NY agreed to lease approximately 10,000 square feet of ground floor retail space and a portion of the basement +underneath the ground floor retail space in the property located at 111 West 24 th Street, New York, New York (the “Premises”). +MICS NY intends to use the Premises as a new karaoke venue, offering immersive karaoke technology and audio-visual capabilities, with +restaurant and bar offerings. +The +term of the Lease Agreement is for fifteen (15) years, or on such earlier date upon which the term shall expire, be canceled or terminated +pursuant to any of the conditions or covenants of the Lease Agreement. Pursuant to the Lease Agreement, MICS NY is obligated to pay an +initial base rent in the amount of $30,000 beginning August 1, 2024, with scheduled increases over the term, as set forth in the Lease +Agreement. +TurnOnGreen +Overview +TurnOnGreen, +Inc. (formerly known as Imperalis Holding Corp.), a Nevada corporation (“TOG”), through its wholly owned subsidiaries Digital +Power Corporation (“Digital Power”) and TOG Technologies Inc. (“TOGT”), is engaged in the design, development, +manufacture and sale of highly engineered, feature-rich, high-grade power conversion and power system solutions for mission-critical +applications and processes. For more than 50 years, Digital Power has been devoted to the perfection of power solution products that +have enabled customer innovation in complex applications covering a wide range of industries. A natural outgrowth of TOGT’s development +of these power systems has been its effort to apply TOG’s proprietary core power technologies to optimizing the design and performance +of electric vehicle (“EV”) charging solutions. TOGT began commercial sales of its product line of high-speed charging solutions +in mid-2021. TOG believes that its charging solutions represent an entire generation of new chargers due to improvements in terms of +size reduction in electronic circuitry and higher output density. TOG also believes that, by leveraging its experience and expertise +in power conversion and generation, it can become a leader in the EV charging solution market. +37 +At +Digital Power, TOG provides a comprehensive range of integrated power system solutions that are designed to meet the diverse and precise +needs of its customers with the highest levels of efficiency, flexibility and scalability. TOG designs, develops and manufactures custom +power systems to meet performance and/or form-factor requirements that cannot be met with standard power products. These power system +solutions are designed to function reliably in harsh environments associated with defense and aerospace applications, while also being +utilized for applications ranging from industrial and telecommunications equipment to medical instrumentation. TOG believes that Digital +Power’s power products are highly adaptive and feature digital power management and software configurations that allow them to achieve +higher power efficiency to meet the requirements of both its customers and its OEMs. In addition to Digital Power’s custom power +system solutions, it also provides a wide range of industry-standard power products. These products include the AC/DC Open Frame product +series, which TOG believes to be among the industry’s leading power switchers in terms of power efficiency. The Open Frame products +are deployed in highly compact form factors and modular power series that support configurable multiple DC outputs. Additionally, Digital +Power offers high-power and high-voltage laser power supplies tailored to meet the unique requirements of medical, dental, and industrial +pulsed energy systems. Digital Power’s expertise also encompasses high-performance and high-power data-center power supplies, semiconductor +fabrication equipment power source supplies, desktop power supplies, and a comprehensive range of value-added customized AC/DC and DC/DC +ruggedized power supply and system solutions. +TOGT’s EV Charging +Solutions +TOG +formed TOGT following more than two years of engineering design and product prototypes, to provide EV drivers of all types with easy access +to convenient, reliable and high-speed EV charging solutions. TOGT offers Level 2 AC charging infrastructure for use in single family +homes, multi-family unit developments, parking garages and lots, commercial retail properties and fleet environments. TOGT provides Level +3 DC fast charger infrastructure for high traffic, high density urban, suburban, exurban locations, and portable microgrid charging infrastructure. +Prior to August 2021, Digital Power operated the EV business presently conducted by TOGT. TOGT’s EV charging solutions are designed +to address what TOG expects to be a rapid expansion of infrastructure required to support broad adoption of EVs globally. With more +than 50 years of expertise in power technology, TOGT provides EV charging solutions to enable the eMobility of +tomorrow. TOGT’s innovative charging solutions produce a full charge for an EV with a 250-mile range battery in approximately 30 +minutes. TOGT provides a wide range of EV charging solutions, including a Level 2 AC charging product +line compatible with the SAE J1772 standard, and a Level 3 DC fast charging product line compatible +with the combined charging system standard and the CHArge de MOve (“CHAdeMO”) standard. +TOGT’s +network is capable of natively charging (i.e., charging without an adapter) all EV models and supports all charging standards currently +available in the United States. Its network can serve a wide variety of private, retail, commercial and fleet customers. TOGT’s +charging systems maintain what TOG believes to be the highest standards in the market and are backed by an internationally recognized +certificate of safety and performance. TOG anticipates rapid growth in the number of EVs in North America, and TOG intends to expand TOGT’s +network of charging stations to accommodate this growth while prioritizing development of locations with favorable traffic and utilization +characteristics. +GIGA +Gresham Worldwide, Inc., formerly +Giga-tronics, Incorporated (“GIGA”) designs, manufactures and distributes purpose-built electronics equipment, automated test +solutions, power electronics, supply and distribution solutions, as well as radio, microwave and millimeter wave communication systems +and components for a variety of applications with a focus on the global defense industry and the healthcare market. +GIGA has two subsidiaries, +Gresham Holdings, Inc. (“Gresham Holdings”) and Microsource Inc. (“Microsource”). GIGA also has a division. GIGA +is a majority owned subsidiary of the Company and currently operates as an operating segment of AAI. Gresham Holdings has three wholly +owned subsidiaries, Gresham Power Electronics Ltd. (“Gresham Power”), Relec Electronics Ltd. (“Relec”), and Enertec +Systems 2001 Ltd. (“Enertec”), and one majority owned subsidiary, Microphase Corporation (“Microphase”). GIGA’s +operations consist of three business segments: +· Radio Frequency Solutions (“RF Solutions”) +– consists of Microphase which is located in Connecticut. Microphase designs and manufactures custom microwave hardware products +for military applications and generates revenue primarily through production contracts for custom engineered components and RADAR filters; +· Precision Electronic Solutions – consists +of two subsidiaries and one division. The subsidiaries are Enertec located in Israel and Microsource located in California. The division +is referred to as the Giga-tronics Division. Enertec develops and supplies advanced command & control, test and calibration systems +for use in failsafe military and medical applications. The legacy business of Giga-tronics (the “Giga-tronics Business”) consists +of Microsource, a wholly owned subsidiary that develops and manufactures sophisticated RADAR filters used in fighter aircraft, and the +Giga-tronics Division which markets “EW Test and Training,” which serves the defense electronics market with a signal generation +platform; and +· Power Electronics & Displays – consists +of two subsidiaries, namely Relec and Gresham Power located in the United Kingdom (the “UK”) which primarily engineer and +provide integrated, mobile power electronics and display solutions that distribute and supply continuous, dependable, clean low voltage +power. +GIGA is focused on products +that are getting designed in to military systems such as fighter jet, ships and ground vehicles or missiles, which provide a recurring +revenue stream for years to come and decrease competition because the cost of replacing designed in products is prohibitive for both the +competition and the customer. +38 +GIGA operates both within +the U.S. and at three locations abroad. A summary of GIGA’s locations and high level review of its operations at each facility is +provided in the table below: +Name +Location +Nature of Business +Corporate Headquarters +Scottsdale, Arizona +Offices +Microsource and Giga-tronics Division +Livermore, California +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +Microphase Corporation* +Shelton, Connecticut +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +Enertec Systems 2001 Ltd. +Karmiel, Israel +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +Relec Electronics Ltd. +Wareham, Dorset, England UK +Offices and warehouse operations +Gresham Power Electronics Ltd. +Salisbury, Wiltshire, England UK +Offices, research and development, engineering, fabrication, sourcing, assembly, tuning and testing +* 63% owned +Industry +GIGA’s operations focus +exclusively on the market for electronic solutions that support the defense industry and other mission critical applications, including +medical technology, transportation, and telecommunication. The essential nature of these applications provides a degree of insulation +from volatility associated with other segments of the global economy while accounting for stability and steady growth of the addressable +market opportunities available in segments that GIGA serves. Demand for solutions to meet these requirements continues unaffected, and +in many instances increases in times of global crisis. Total defense spending in the three countries in which we currently operate was +expected to total more than an estimated $919 billion in 2023 (https://www.globalfirepower.com/defense-spending-budget.php). +GIGA sells to the militaries and defense contractors in 15 other countries as well. Overall global defense spending hit $2.1 trillion +in 2023 and is expected to grow at a compounded annual growth rate (“CAGR”) of 3% through 2028 with U.S. spending continuing +to lead the world in the same period (ASD Reports, Global Defense Budget Analysis - Forecast to 2028). The current wars in the Ukraine +and Israel and tensions with China and in the Middle East have intensified interest and investment in defense platforms throughout the +UK and Europe. +GIGA believes that the increasing +emphasis on electromagnetic spectrum operations and close coordination of air, land, sea, space and cyber operations will fuel an increase +in defense modernization, force protection and situational awareness, all of which will drive increased spending in procurement of components +and systems to enable electronic warfare, countermeasures and unattended solutions. The Defense Electronics Market was estimated +to be $220.3 billion in 2023 and is projected to reach $ 289.0 billion by 2028, at a CAGR of 5.6%. (https://www.marketsandmarkets.com/Market-Reports/defense-electronics-market-183642563.html). +The drive for greater connectivity and analytics will in turn increase demand for radio frequency (“RF”) communications, power +electronics and electronic control solutions content in new major military platforms, which are the core offerings of GIGA’s operating +units. +Thousands of companies compete +in this market to deliver electronics solutions to meet defense and other mission critical applications. However, GIGA’s operating +units have longstanding relationships with dominant defense contractors in the U.S., in the UK, in Israel and other countries who hold +contracts for major defense platforms with very long life cycles. GIGA’s customers typically have unique needs, and they engage +with GIGA in funding development contracts for custom solutions. Once a solution is proven in its application, GIGA typically realizes +a secure, recurring revenue stream for products, services and/or repairs for many years (sometimes decades) until the technology +becomes outdated. Because GIGA is often sole-sourced for developmental projects, GIGA believes that it is unlikely that a competitor +will replace such a designed-in product as the cost and re-qualification time to do so is prohibitive. These relationships enable us to +narrow the field of competition considerably and grow based on repeat business with relatively low selling costs. As technology evolves, +prime contractors may, over subsequent years, migrate to systems other than those GIGA produces. +Beyond the defense arena, +initiatives to complete $42 billion in upgrades to the current National Railway System in the UK over the next three years while spending +$115 billion over the next 10 years to build high speed rail to link London with the Midlands cities of Birmingham, Leeds and Manchester +will generate significant opportunities for growth in demand for power electronics to upgrade and replace current infrastructure, both +in rolling stock and track side controls. Relec’s current relationships and track record for supplying power solutions to the UK +rail industry position us ideally to capitalize on these ongoing refurbishment and expansion efforts. A similarly robust market in the +medical power supply markets with a compound annual growth rate of 6.9% to reach $1.8 billion in 2025 creates growth opportunities for +Relec in the UK. Increases in contracts for the precision manufacturing of medical diagnostic and calibration tools drive growth opportunities +for Enertec as well. +39 +Business +Strengths +GIGA has the following core +strengths that its management believes give it a competitive advantage: +· Developing and producing classified military +products requiring a Sensitive Compartmented Information Facility and personnel with appropriate security clearances. These +products are designed-in to military systems such as fighter jets, military ships and vehicles; +· Military grade quality (AS9100), ultra-reliable +technology offerings with elegant designs and precision “high touch” manufacture that stand the test of time, narrow the field +of competition and command enhanced operating margins; +· Enduring relationships with “blue chip” +customers in the defense market provide stable revenue growth and reduce sales cost; and +· Substantial growth in backlog of orders with +definite delivery dates for solutions engineered into long life cycle platforms that provide revenue base for years to come. Global operations +expand GIGA’s market opportunities, extend its operational reach and diversify its business base. +Strategy +GIGA’s goal is to become +the supplier of choice for the major players in the defense industry and provide solutions for mission critical applications in health +care. +GIGA’s near-term strategies +are focused on developing synergies as a result of the acquisition of Gresham Holdings: +· Gresham Holdings incurred major overhead expenses +being a subsidiary of a larger company. GIGA incurred large expenses being a public company with very limited sales. GIGA is combining +the overhead functions, shrinking its leased facilities and focusing on cost reductions; +· Consolidate duplicate functions and reduce the +costs of sales, human resources, information technologies, quality management and contracts administration; and +· Combine the RF Solutions group into one subsidiary +and reduce operating costs. +In addition, GIGA is focused +on securing sufficient working capital to execute on a substantial backlog of orders with definite delivery dates, take on additional +significant orders and further improve access to capital resources. +GIGA’s long-term strategy +includes the following key elements: +· maintain, strengthen and expand relationships +with current customers, by increasing on-time delivery, diversifying solutions offered and maximizing quality of solutions; +· acquire designed-in products or companies. GIGA +believes that there are many small well run, profitable defense contractors whose principal owner is nearing retirement which could be +attractive acquisition targets; +· attract new customers through building business +development, marketing and sales infrastructure to raise market awareness and identify opportunities early in the design process; +· take advantage of the cross-selling opportunities +among GIGA’s operating subsidiaries to leverage current resources; and +· enhance GIGA’s geographic footprint by +increasing marketing outreach, forming alliances with leading companies located in areas beyond its current reach and acquiring businesses +that expand reach into other geographies. +40 +Our +Strategy +Our business strategy is designed +to increase shareholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to shareholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +shareholder value, such as activist trading. We anticipate returning value to shareholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase cash flows +and stockholder value. Ault Alliance actively oversees and supports the management teams of each of our businesses by, among other things: +· recruiting and retaining talented managers to +operate our businesses using structured incentive compensation programs, including non-controlling equity ownership, tailored to each +business; +· regularly monitoring financial and operational +performance, instilling consistent financial discipline, and supporting management in the development and implementation of information +systems to effectively achieve these goals; +· identifying and aligning with external policy +and performance tailwinds such as those influenced by growing climate, health, and social justice concerns (and similar environmental, +social and governance (“ESG”) drivers); +· assisting management in their analysis and pursuit +of prudent organic growth strategies; +· identifying and working with management to execute +attractive external growth and acquisition opportunities; +· assisting management in controlling and right-sizing +overhead costs; +· nurturing an internal culture of transparency, +alignment, accountability and governance, including regular reporting; +· professionalizing our subsidiaries at scale; +and +· forming strong subsidiary level boards of directors to supplement management +in their development and implementation of strategic goals and objectives. +41 +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Ault Alliance to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +· making selective capital investments to expand +geographic reach, increase capacity, or reduce manufacturing costs of our businesses; +· investing in product research and development +for new products, processes or services for customers; +· improving and expanding existing sales and marketing +programs; +· pursuing reductions in operating costs through +improved operational efficiency or outsourcing of certain processes and products; and +· consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +· leverage manufacturing and distribution operations; +· leverage branding and marketing programs, as +well as customer relationships; +· add experienced management or management expertise; +· increase market share and penetrate new markets; +and +· realize cost synergies by allocating the corporate overhead expenses of our +businesses across a larger number of businesses and by implementing and coordinating improved management practices. +Compliance with Material Government (Including +Environmental) Regulations +Sentinum +Sentinum is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. Sentinum continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While Sentinum’s regulatory compliance +costs are currently not considered material, it is possible that costs incurred to ensure continued environmental compliance could have +a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Michigan Facility is subject +to a final corrective measures plan with the Environment Protection Agency. The seller performed remedial activities at the Michigan Facility +relating to historical soil and groundwater contamination and Sentinum is responsible for ongoing monitoring and final remediation plans. +We estimate cost of the environmental remediation obligation is approximately $0.4 million and reflects our best estimate of probable +future costs for remediation based on the current assessment data and regulatory obligations. Future costs will depend on many factors, +including the extent of work necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. +We may incur actual costs in the future that are materially different than this estimate and such costs could have a material impact on +results of operations, financial condition, and cash flows during the period in which they are recorded. +TurnOnGreen +TurnOnGreen’s businesses +are heavily regulated in most of its markets. TurnOnGreen handles power electronics products mainly in the form of power conversion. TurnOnGreen +must take into account several standards for electronic safety to protect the health of humans and animals. TurnOnGreen serves diverse +markets including automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set +of safety regulations and standards that TurnOnGreen must comply with. +42 +Government Contracts . +The U.S. Government, and other governments, may terminate any of TurnOnGreen’s government contracts at their convenience, as well +as for default based on our failure to meet specified performance requirements. If any of TurnOnGreen’s U.S. Government contracts +were to be terminated for convenience, TurnOnGreen would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of TurnOnGreen’s government contracts were to be terminated for default, generally the U.S. Government +would pay only for the work that has been accepted and could require TurnOnGreen to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold +TurnOnGreen liable for damages resulting from the default. +Medical device power supplies . +TurnOnGreen’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. TurnOnGreen must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +Environmental . TurnOnGreen +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TurnOnGreen continually assesses its compliance status +and management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of TurnOnGreen’s operations. +Non-U.S. Sales . TurnOnGreen’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +GIGA +GIGA’s businesses are +heavily regulated in most of its markets. GIGA transacts with numerous U.S. Government agencies and entities, including but not limited +to the U.S. Department of Defense (“DoD”), branches of the U.S. military and the Department of Homeland Security. Similar +government authorities exercise similar regulatory oversight in GIGA’s non-U.S. markets. +Government Contracts . +The governments of the U.S., U.K. and Israel may terminate any of GIGA’s applicable operating subsidiaries’ government contracts +at their convenience, as well as for default based on our failure to meet specified performance requirements. If the U.S. Government terminated +any of GIGA’s contracts for convenience, GIGA generally would be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of GIGA’s government contracts were to be terminated for default, generally the U.S. government would +pay only for the work that has been accepted and could require GIGA to pay the difference between the original contract price and the +cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold GIGA liable +for damages resulting from the default. Similar provisions apply to GIGA’s contracts with other governments and to GIGA’s +subcontractors with major defense contractors who provide systems or military platforms directly to the government. +Power Electronics . +In all of GIGA’s markets in the U.S., GIGA’s commercial power electronics offerings must comply with safety, energy use and +operational performance regulations and standards (IEC/EN/UL/CSA) issued and administered by international standards organizations. In +the U.S., the Department of Energy, the Environmental Protection Agency and the Federal Communications Commission mandate and enforce +compliance with these standards. Outside the U.S., various government agencies in the U.K., Europe and Israel mandate and enforce compliance +with these international requirements for safety, energy use and operational performance. In commercial markets, GIGA’s suppliers +bear most of the expense of compliance with international standards as a standard cost of business. Given the universal application of +these requirements, the costs of compliance do not create any competitive disadvantage because all competitors must comply to sell into +the market. +Environmental . GIGA +must meet applicable regulatory, environmental, emissions, safety and other requirements where its customer specifies, or as applicable +local regulations or laws require. The products that GIGA markets and sells in Europe also may be subject to the 2003 European Directive +on Restriction of Hazardous Substances (“RoHS”), which restricts the use of six hazardous materials in the manufacture of +certain electronic and electrical equipment, as well as the 2002 European Directive on Waste Electrical and Electronic Equipment (“WEEE”), +which determines collection, recycling and recovery goals for electrical goods. In July 2006, GIGA’s industry began phasing in RoHS +and WEEE requirements in most geographical markets with specific emphasis on consumer-based products. GIGA believes that RoHS and WEEE-compliant +components may be subject to longer lead-times and higher prices as the industry transitions to these new requirements. REACH (Registration, +Evaluation, Authorization and Restriction of Chemicals Registration) is a European Union regulation dating from 18 December 2006. REACH +addresses the production and use of chemical substances, and their potential impacts on both human health and the environment. +43 +These regulatory mandates +apply to all of GIGA’s operating subsidiaries. GIGA has structured operations to comply with these requirements and have experienced +little to no impact on lead times or prices. Give the applicability of these requirements to all competitors alike, compliance has had +no impact on the competitive position of any operating subsidiary. +Non-U.S. Sales . GIGA’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Security Clearance +As a U.S. Government contractor +working on classified projects, Microphase is required to maintain facility and personnel security clearances complying with the DoD and +other federal agency requirements. Microphase maintains strict protocols for handling classified information and Confidential Unclassified +Information (“CUI”) associated with its work for the DoD and has built a secure restricted area within its Shelton production +facility certified for generating, storing and reviewing classified information. +Gresham Power works on many +contracts classified as “Official Sensitive” that require individual security clearances and adherence to information security +protocols for receiving, handling and storing confidential information as required in the U.K. Official Secrets Act and its implementing +regulations. +Enertec complies with all +information security requirements included in their customer contracts as well as all the confidentiality laws that the State of Israel +mandates for work related to defense of the country. +Audits and Investigations +As a government contractor, +we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “DCAA”), +the Defense Contract Management Agency (the “DCMA”), the Inspector General of the DoD and other departments and agencies, +the Government Accountability Office, the DOJ and Congressional Committees. From time-to-time, these and other agencies investigate or +conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. The +DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including +the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. +Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us +and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded +if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties +and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension +or prohibition from doing business with the U.S. Government. +Enertec conducts operations +under constant supervision of the Ministry of Defense of Israel and the contractors through which the Ministry of Defense does most of +its business. All its contracts are subject to audits of performance, quality and price reasonableness. +Gresham Power contracts with +the U.K. Ministry of Defence, Royal Navy or major defense contractors serving those agencies include standard provisions which give the +customer the right to audit our performance under those contracts when they see fit. Audits are part of doing business with the government +and typically focus on deliveries – on time project milestones as well as quality. The Royal Navy will review Gresham Power pricing +of services provided under support contract every 12 months for reasonableness. +The Defense Federal Acquisition +Regulation, as implemented in standard contract clauses, mandates that Microphase establish and follow extensive detailed processes and +protocols to protect classified information and CUI from disclosure and unauthorized access. That mandate includes a requirement that +Microphase formulate and implement a system security plan with 110 different elements and protocols for handling and protecting classified +information and CUI. Over the next three years, the DoD will require all participants in the defense supply chain to demonstrate compliance +with the Capability Model Maturity Cybersecurity as verified through an independent third-party auditor. Compliance with these mandates +requires and will require Microphase to invest significant resources to maintain compliance. For instance, compliance requires extensive +security controls on access to Microphase information technology systems, strong firewalls and intrusion monitoring. Microphase will have +to hire a full-time person to ensure information security and act as a Facility Security Officer as well as oversee security of all Microphase +employees. These investments add to indirect cost pools that Microphase must recover in the price of its products for DoD and contractors. +44 +Gresham Power Electronics +Ltd is fully certified as “Cyber Essentials Plus Compliant.” Cyber Essentials Plus is a government-backed, industry-supported +scheme to help organizations protect themselves against common online threats. The UK Government requires all suppliers bidding for contracts +involving the handling of sensitive and personal information to be certified against the Cyber Essentials Plus program criteria. +Enertec has implemented the +strongest possible cyber security protections consistent with the resources available to a company its size. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December +31, 2023 and 2022, we spent approximately $7.2 million and $2.8 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries. +Employee Profile +As of December 31, 2023, we +had 643 employees located in the U.S., the U.K. and Israel, of whom 71 were engaged in engineering and product development, 62 in sales +and marketing, 369 in general operations and 141 in general administration and finance. All but 56 of these employees are employed on +a full-time basis. None of our employees is currently represented by a trade union. We consider our relations with our employees to be +good. +As of December 31, 2023, approximately +28% of our current workforce is female, 72% male, and our average tenure is 6.4 years, a decrease of 17% from an average tenure of +7.7 years as of December 31, 2022. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of 6.4 years as +of the end of the fiscal year 2023 reflects the engagement of our employees in this core talent system tenet. +45 +We believe we materially comply +with all applicable state, local and international laws governing nondiscrimination in employment in every location in which we operate. +All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, national +origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees’ needs. We plan to conduct annual confidential employee +surveys as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. +Our employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new +stretch goals. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. \ No newline at end of file diff --git a/raw/filings/0000896493/2023/0001214659-24-006963/item13.txt b/raw/filings/0000896493/2023/0001214659-24-006963/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..28340bdf7deb5379412e7a80dc0bfad803b02ce2 --- /dev/null +++ b/raw/filings/0000896493/2023/0001214659-24-006963/item13.txt @@ -0,0 +1,391 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• +the aggregate amount involved is determined to by the Audit Committee to be material; +• +we are a participant; and +• +any of the following has or will have a direct or indirect interest in the transaction: +• +an executive officer, director, or nominee for election as a director; +• +a greater than five percent beneficial owner of our common stock; or +• +any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. +Ault & Company, Inc. +On +February 25, 2021, Ault & Company sold and issued an 8% Secured Promissory Note in the +principal amount of $2,500,000 (the “2021 Note ”) to us. The principal amount +of the 2021 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was originally due and payable on August 5, 2021 but +the maturity date was subsequently extended to December 31, 2022. +On June 8, 2023, we entered +into the Credit Agreement with Ault & Company as the lender. The Credit Agreement provided for an unsecured, non-revolving credit +facility in an aggregate principal amount of up to $10,000,000. All Advances were due within five business days after request by Ault +& Company and Ault & Company was not obligated to make any further Advances under the Credit Agreement after December 8, 2023. +Advances under the Credit Agreement bore interest at the rate of 9.5% per annum and may be repaid at any time without penalty or premium. +As of April 15, 2024, no Advances were outstanding. +Effective August 3, 2023, +we and the Investors entered into the Exchange Agreement pursuant to which the Investors exchanged all of their preferred shares as well +as their Demand Notes issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount +of approximately $0.8 million for the Exchange Notes, each with a principal face amount of $5.3 million, for an aggregate Principal Amount +of $10.5 million. We and Mr. Ault, our Executive Chairman, entered into guaranty agreements with the March 2023 Investors guaranteeing +repayment by Ault & Company of the Exchange Notes. +153 +Effective as of August 3, +2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, +we issued the First Ault & Company Demand Note to Ault & Company. +Effective as of August 10, +2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued +the Second Demand Note to Ault & Company. +On October 13, 2023, we entered +into a note purchase agreement with Ault & Company, pursuant to which we sold to Ault & Company (i) the Senior Note and Warrants +to purchase shares of our common stock for a total purchase price of up to $17.5 million. +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the Credit +Agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming +liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares +of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault +& Company to us. +The Senior Note had a principal +face amount of $17.5 million and a maturity date of October 12, 2028. The Senior Note bore interest at the rate of 10% per annum. Interest +was payable, at Ault & Company’s option, in cash or shares of common stock at the applicable conversion price. Accrued interest +was payable on the maturity date, provided, however, that Ault & Company had the option, on not less than 10 calendar days’ +notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. +The Senior Note was convertible +into shares of common stock at a conversion price equal to the greater of (i) the Floor Price, and (ii) the lesser of (A) $7.38 or (B) +105% of the volume weighted average price of the common stock during the ten trading days immediately prior to the date of conversion. +The conversion price was subject to adjustment in the event of an issuance of common stock at a price per share lower than the conversion +price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor Price shall not +be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +The Warrants grant Ault & +Company the right to purchase 1,907,440 shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary +of the closing date, and become exercisable on the first business day after the six-month anniversary of the closing date. The exercise +price of the Warrants is $0.35, which is subject to adjustment in the event of customary stock splits, stock dividends, combinations or +similar events or in the event of an issuance of common stock at a price per share lower than the exercise price. +On November 6, 2023, we entered +into the November 2023 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 50,000 shares of Series C Convertible Preferred Stock and the Series C Warrants to purchase up to 14.8 million shares of common +stock for a total purchase price of up to $50 million. The consummation of the transactions contemplated by the November 2023 SPA, specifically +the conversion of the Series C Convertible Preferred Stock and the exercise of the Series C Warrants in an aggregate number in excess +of 19.99% on the execution date of the November 2023 SPA, are subject to various customary closing conditions as well as regulatory and +stockholder approval. +Additionally, until the earlier +of (i) four years from the initial closing date of the November 2023 SPA (the “Initial Closing Date”), or (ii) the date when +Ault & Company holds fewer than 10,000 shares of Series C Convertible Preferred Stock, the Company will be prohibited from (A) entering +into any financing, whether debt or equity, other than conventional loans from a commercial bank, at a price per share less than the Series +C Conversion Price (as defined below) or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 10,000 shares of Series C Convertible Preferred Stock, Ault & Company shall have a right to participate +in any subsequent financing (a “Subsequent Financing”) allowing Ault & Company to purchase such number of securities in +the Subsequent Financing to allow Ault & Company to maintain its percentage beneficial ownership of the Company that Ault & Company +held immediately prior to the Subsequent Financing. +In addition, the Company must +establish a reserve account to be funded with no less than 12.5% of the gross proceeds received from the sale of the Series C Convertible +Preferred Stock, which shall be maintained for a period of at least nine months from the Initial Closing Date. +154 +On December 14, 2023, pursuant +to the November 2023 SPA, we sold to Ault & Company, in three separate closings that occurred on the closing date, an aggregate of +41,500 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 12,269,031 shares of common stock, for a total +purchase price of $41.5 million. At the Initial Closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred +Stock and Series C Warrants to purchase 6,356,245 shares of common stock, for a purchase price of $21.5 million, paid in cash. Immediately +upon the Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes issued to the lenders pursuant +to the Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +Second Closing, Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 2,956,393 +shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon the Second Closing, we paid $10.0 million +to partially satisfy the outstanding Senior Note. Promptly thereafter, at the Third Closing, Ault & Company purchased another 10,000 +shares of Series C Convertible Preferred Stock and Series C Warrants to purchase another 2,956,393 shares of common stock, for a purchase +price of $10.0 million, paid in cash. Immediately upon the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance +on the outstanding Senior Note. +On December 14, 2023, we, along with the Guarantors entered into the +Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed $36 million and issued the Secured Notes to the +lenders in the aggregate amount of $38.9 million. The Loan Agreement was amended on April 15, 2024. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated from the Miners and (c) the +membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those entities +granted to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault Aviation, +AGREE, Sentinum, Third Avenue, Ault Energy, ADTC, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue +on the Florida Property, (iv) a future advance mortgage by ACS on the Michigan Property, (v) an aircraft mortgage and security agreement +by Ault Aviation on the Aircraft, and (vi) deposit account control agreements over certain bank accounts held by certain of our subsidiaries. +In addition, pursuant to the Loan Agreement, we agreed to establish +the Segregated Account, which would be used as a further guarantee of repayment of the Secured Notes. $3.5 million of cash was paid into +the Segregated Account on the closing date. We are required to have the minimum balance in the Segregated Account be not less than $7 +million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and two-year anniversaries of the closing +date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million monthly into the Segregated Account, +which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into the Segregated Account, (i) up to +the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, the Residence Inn in Madison West, +the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on a per dividend basis) received from +Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, which shall not exceed $9 million +in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans or other investments made by Ault +Lending (including but not limited to sales of loans or investments, dividends, interest payments and amortization payments), which shall +not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further agreed to deposit funds into the +Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida Property, (ii) $11 million from +the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, subject to a de minimis threshold +of $1 million, and (v) $10 million from the sale of Circle 8. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50,000,000.00 to $75,000,000.00 and (B) extended the date of on which the final closing may occur to June 30, +2024, subject to Ault & Company’s ability to further extended such date for ninety days. +155 +Description of the Series C Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) the Floor Price, and (ii) the lesser of (A) $0.35 or (B) 105% of the volume weighted average price of the +common stock during the ten trading days immediately prior to the date of conversion (the “Series C Conversion Price”). The +Series C Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the Series +C Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor +Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations or similar transactions. +Voting Rights +The holders of the Series +C Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series C Convertible Preferred Stock is entitled to +cast, shall not be lower than $3.075 (the “Voting Floor Price”), which represents the closing sale price of the common stock +on the trading day immediately prior to the date of execution of the November 2023 SPA. The Voting Floor Price shall be adjusted for stock +dividends, stock splits, stock combinations and other similar transactions. +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series C Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +The conversion of the Series +C Preferred Stock is subject to approval by the NYSE American and our stockholders. +Description of the Series C Warrants +On each closing date, the Company will issue Ault & Company the +Series C Warrants, which grant Ault & Company the right to purchase a specified number of common stock (the “Warrant Shares”). +The exercise price of the Series C Warrants is $0.35 (the “Exercise Price”) and the number of Warrant Shares is determined +by dividing the actual investment amount by the Exercise Price. The Exercise Price is subject to adjustment in the event of customary +stock splits, stock dividends, combinations or similar events. +The Series C Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +The exercise of the Warrants +is also subject to approval by the NYSE American and our stockholders. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer and a director of +Ault & Company. William B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief +Financial Officer and a director of Ault & Company. Henry Nisser, our President, General Counsel and a member of our board of directors, +is also the President, General Counsel and a director of Ault & Company. +ROI +On +June 8, 2022, Ault Lending entered into a securities purchase agreement with ROI whereby Ault Lending agreed to purchase $12,000,000 of +a new series of convertible preferred stock of ROI, which transaction closed on June 29, 2022. As part of the transaction we were issued +102,881 shares of ROI’s common stock and a warrant to purchase forty-nine percent (49%) of ROI’s common stock calculated on +a fully diluted basis, subject to certain terms and conditions. +On July 11, 2022, we announced +the formation of Ault Energy. Ault Energy will partner with White River Holdings Corp. (“White River”), a then subsidiary +of ROI, on drilling projects across 30,000 acres in Texas, Louisiana and Mississippi. Ault Energy, as Ault Lending’s designee, has +the right to purchase up to 25%, or such higher percentages at the discretion of White River, in various drilling projects of White River. +In August 2022, Ault Energy committed to purchasing 40% of the first drilling project offered, at a cost to Ault Energy of approximately +$1 million. In October 2022, Ault Energy committed to purchasing 37.5% of the second drilling project offered, at a cost to Ault Energy +of approximately $1.6 million. In March 2023, Ault Energy committed to purchasing 20% of the third drilling project offered, at a cost +to Ault Energy of approximately $1.0 million. +156 +On February 8, 2023, we entered +into the February 2023 Agreement with ROI and the other signatories thereto. The February 2023 Agreement provided that, subject to the +terms and conditions set forth therein, ROI would acquire all of the outstanding shares of capital stock of our then subsidiary, BNC, +of which we owned approximately 86%, and the remaining 14% was owned by the Minority Shareholders, as well as RiskOn 360, in exchange +for the following: (i) 8,637.5 shares of Series B Preferred that were issued to us, and (ii) 1,362.5 shares of Series C Preferred that +were issued to the to the Minority Shareholders. The Series B Preferred and the Series C Preferred each have a Stated Value of $10,000 +per share, for a combined stated value of the Preferred Stock to be issued by ROI, of $100,000,000, and subject to adjustment, are convertible +into shares of common stock of ROI. However, pending approval of the transaction by ROI’s shareholders, the Preferred Stock is subject +to a 19.9% beneficial ownership limitation, including the Series A Convertible Preferred Stock that we acquired from ROI in June of 2022. +Pursuant to the Preferred +Stock Certificates, each share of Preferred Stock will be convertible into a number of shares of ROI common stock determined by dividing +the Stated Value by the Conversion Price, or 40,000 shares of ROI common stock. The Conversion Price will be subject to certain adjustments, +including potential downward adjustment if ROI closes a qualified financing resulting in at least $25,000,000 in gross proceeds at a price +per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock will be entitled to receive dividends +at a rate of 5% of the Stated Value per annum during the Dividend Term. During the first two years of the Dividend Term, dividends will +be payable in additional shares of Preferred Stock rather than cash, and thereafter dividends will be payable in either additional shares +of Preferred Stock or cash as each holder may elect. If ROI fails to make a dividend payment as required by the Preferred Stock Certificates, +the dividend rate will be increased to 12% for as long as such default remains ongoing and uncured. Each share of Preferred Stock will +also have an $11,000 liquidation preference in the event of a liquidation, change of control event, dissolution or winding up of ROI, +and will rank senior to all other capital stock of ROI with respect thereto, except that the Series B Preferred and Series C Preferred +shall rank pari passu. Each share of Series B Preferred was originally entitled to vote with the ROI common stock at a rate of 10 votes +per share of common stock into which the Series B Preferred is convertible, but that provision was subsequently eliminated, as were the +conventional voting rights of the Series C Preferred. Other than certain rights granted to the Company relating to amendments or waiver +of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially identical. +The February 2023 Agreement closed on March 6, 2023. +On November 15, 2023, we purchased +from ROI 603.44 shares of ROI Series D Preferred for a total purchase price of $15.1 million. The purchase price was paid by the cancellation +of $15.1 million of cash advances made by us to ROI between January 1, 2023 and November 9, 2023. Each share of ROI Series D Preferred +has a stated value of $25,000 per share and each share of ROI Series D Preferred is convertible into a number of shares of ROI’s +common stock determined by dividing the stated value by $0.51, subject to adjustment in the event of an issuance of ROI common stock at +a price per share lower than the conversion price, as well as upon customary stock splits, stock dividends, combinations or similar events. +The ROI Series D Preferred holders are entitled to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. +In addition, for as long as at least 25% of the ROI Series D Preferred remain outstanding, ROI must obtain our consent with respect to +certain corporate events, including reclassifications, fundamental transactions, stock redemptions or repurchases, increases in the number +of directors, and declarations or payment of dividends, and further ROI is subject to certain negative covenants, including covenants +against issuing additional shares of capital stock or derivative securities, incurring indebtedness, engaging in related party transactions, +selling of properties having a value of over $50,000, altering the number of directors, and discontinuing the business of any subsidiary, +subject to certain exceptions and limitations. However, pending approval of the transaction by ROI’s shareholders, the ROI Series +D Preferred is subject to a 19.99% beneficial ownership limitation. +Milton +C. Ault, III, our Executive Chairman, is also the Executive Chairman of ROI. Henry Nisser, our President, +General Counsel and a member of our board of directors, is also the President, General Counsel and a director of ROI. +Alzamend +In November 2022, we entered +into a marketing and brand development agreement with Alzamend, effective August 1, 2022, whereby we provided various marketing services +over twelve months valued at $1.4 million. Alzamend had the right to pay the fee in cash or shares of its common stock with a value of +$22.50 per share. On November 11, 2022, Alzamend elected to pay the fee in shares, and issued us 62,222 shares of its common stock. +On January 31, 2024, Ault +Lending entered into the January 2024 SPA with Alzamend, pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending +up to 6,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to purchase up to 6.0 million shares of Alzamend common stockfor +a total purchase price of up to $6.0 million. On January 31, 2024, Ault Lending purchased 1,220 +shares of ALZN Series B Preferred and warrants to purchase 1.22 million shares for a total purchase price of $1.22 million. The purchase +price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend between November 9, 2023 and January +31, 2023. On March 26, 2024, pursuant to the January 2024 SPA, Ault Lending purchased 780 +shares of ALZN Series B Preferred Stock and ALZN Series B Warrants to +purchase 780,000 shares of Alzamend common , for a purchase price of $780,000. As +of April 15, 2024, Ault Lending has purchased an aggregate of 2,000 shares of ALZN Series B Preferred and ALZN Series B Warrants +to purchase an aggregate of 2.0 million shares of Alzamend common stock, for an aggregate purchase +price of $2.0 million. +157 +Description of the ALZN Series B Preferred +The +terms of the ALZN Series B Preferred are as set forth in the Amended and Restated Certificates of Designations of the Rights, Preferences +and Limitations of the Series B Convertible Preferred Stock, as amended (the “ Series B Certificate of Designation ”). +Each share of ALZN Series B Preferred has a stated value of $1,000 per share (the “ALZN Stated Value ”). +The ALZN Series B Preferred does not accrue dividends. +Conversion Rights +Each +share of ALZN Series B Preferred is convertible into a number of shares of Alzamend common +stock (“ALZN Conversion Shares”) determined by dividing the ALZN Stated Value by +$1.00 (the “ALZN Conversion Price”). The ALZN Conversion Price is subject to adjustment in the event of an issuance +of common stock at a price per share lower than the ALZN Conversion Price then in effect, as well as upon customary stock splits, stock +dividends, combinations or similar events. +158 +Voting Rights +The +holders of the ALZN Series B Preferred are entitled to vote with the common stock as a single +class on an as-converted basis, subject to applicable law provisions of the Delaware General Company Law and Nasdaq, provided however, +that for purposes of complying with Nasdaq regulations, the conversion price, for purposes of determining the number of votes the holder +of ALZN Series B Preferred is entitled to cast, shall not be lower than $0.873 (the “ALZN +Voting Floor Price”). The ALZN Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other +similar transactions. +Liquidation Rights +In +the event of liquidation, dissolution, or winding up of Alzamend, the holders of ALZN Series B Preferred +have a preferential right to receive an amount equal to the ALZN Stated Value per share of ALZN +Series B Preferred before any distribution to other classes of capital stock. If the assets are insufficient, the distribution +will be prorated among the holders of ALZN Series B Preferred . The remaining assets, if any, +will then be distributed pro rata to the holders of outstanding Alzamend common stock. Any transaction that constitutes a change of control +transaction shall be deemed to be a liquidation under the Series B Certificate of Designation. +Description of the +Series B Warrants +At +each closing, Alzamend will issue Ault Lending Series B Warrants, which grant Ault Lending the right to purchase a specified number of +Alzamend common stock (the “ALZN Warrant Shares”). The exercise price of the Series B Warrants is $1.20 (the “ALZN Exercise +Price”) and the number of ALZN Warrant Shares is equal to the number of ALZN Conversion Shares issuable upon the ALZN +Series B Preferred issued at that closing. The ALZN Exercise Price is subject to adjustment in the event of an issuance of common +stock at a price per share lower than the ALZN Exercise Price then in effect, as well as upon customary stock splits, stock dividends, +combinations or similar events. +The +Series B Warrants become exercisable on the first business day after the six-month anniversary of issuance (the “ALZN Initial Exercise +Date”) and have a five-year term, expiring on the fifth anniversary of the ALZN Initial Exercise Date. +Messrs. Ault, Horne and Nisser +are each paid $50,000 annually by Alzamend. +Milton +C. Ault, III, our Executive Chairman, is also the Vice Chairman of Alzamend. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also the Chairman of Alzamend . +Henry Nisser, our President, General Counsel and a member of our board of directors, is also the Executive Vice President, General Counsel +and a director of Alzamend. +Avalanche +On September 6, 2017, we entered into the AVLP Loan Agreement with +an effective date of August 21, 2017, pursuant to which we provided Avalanche a non-revolving credit facility. The AVLP Loan Agreement +has been increased to up to $20.0 million and extended to December 31, 2023. +At December 31, 2021, we had provided Avalanche with $17.8 million +and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase 35.6 million shares of AVLP common +stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. As of December 31, 2021, +we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and a provision for loan losses of $2.0 +million. The warrants issued in conjunction with the non-revolving credit facility entitles us to purchase up to 35.6 million shares of +Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment +for customary stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +While Avalanche received funds from a third party in the amount of +$2.75 million in early April of 2019 in consideration for its issuance of the Third Party Note, $2.7 million was used to pay an outstanding +receivable due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, +Ault Alpha repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. In consideration +therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note had a maturity date of June 30, +2022. +159 +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for the Ault Alpha Note. The Ault Alpha Note is convertible, subject to adjustment, at $0.50 +per share. AVLP also issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise +price of $0.50. Pursuant to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered +into by and among the foregoing parties, our company and certain other persons, Ault Alpha was granted a second priority interest in AVLP’s +assets securing the repayment of the Ault Alpha Note. In connection with the liquidation of Ault Alpha in December 2023, Ault Lending +assumed the Ault Alpha Note, the warrants to purchase Avalanche common stock and the secured party rights. +On July 11, 2022, AVLP issued +us the AVLP Note. The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an +aggregate of 41.0 million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into +by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and +certain other persons, we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +We previously held the Prior +AVLP Note. On June 1, 2022, we converted the entire principal and accrued interest on the Prior AVLP Note into an aggregate of 51.9 million +shares of common stock of Avalanche, representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. +There is currently no liquid market for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common +stock on the open market, our ability to do so would be severely limited. Avalanche is not current in its filings with the SEC and is +not required to register the shares of its common stock underlying the Prior AVLP Note or any other loan arrangement we have made with +Avalanche described above. +Mr. Ault is paid $100,000 +annually by AVLP, and each of Messrs. Horne and Nisser is paid $50,000 annually by AVLP. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is a former affiliate +of our company, whereby Ault Lending was the largest limited partner and Ault & Company controlled the general partner and investment +manager. See immediately above for its involvement with respect to the Third Party Note. In addition, Ault Alpha previously purchased +an aggregate of 27,199 shares of our common stock and 101,362 Series D Preferred Shares, for aggregate purchase prices of $28.4 million +and $2.3 million, respectively. In connection with the liquidation of Ault Alpha on December 28, 2023, those shares of common stock and +Series D Preferred Shares were distributed to Ault Lending, who then returned the shares to our treasury. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. Bentz +Yes +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairman of committee +X – Member of committee +160 \ No newline at end of file diff --git a/raw/filings/0000896493/2023/0001214659-24-006963/item9a.txt b/raw/filings/0000896493/2023/0001214659-24-006963/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..ecde34a1a90734c01070c684dccaf4a77e845f19 --- /dev/null +++ b/raw/filings/0000896493/2023/0001214659-24-006963/item9a.txt @@ -0,0 +1,89 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2023, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company’s management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules +13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our +disclosure controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance +of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with +generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2023. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2023, our internal control over financial reporting was not effective. +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting department, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting, related party transactions, fair value estimates and analysis of financial instruments for proper classification in the consolidated +financial statements, in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +135 +3. Our primary user access controls (i.e., provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +4. The Company did not design and/or implement user access controls to ensure appropriate segregation of +duties or program change management controls for certain financially relevant systems impacting the Company’s processes around revenue +recognition and digital assets to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, and (iii) underlying accounting records, are identified, tested, authorized and implemented appropriately +to validate that data produced by its relevant IT system(s) were complete and accurate. Automated process-level controls and manual controls +that are dependent upon the information derived from such financially relevant systems were also determined to be ineffective as a result +of such deficiency. In addition, the Company has not effectively designed a manual key control to detect material misstatements in revenue. +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis: +· Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls; +· Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· Continuing to increase headcount across the Company, with a particular focus on hiring individuals with +strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Control over Financial Reporting +During the most recent fiscal +quarter in 2023, there were no significant changes in our internal control over financial reporting (as such term is defined in Rules +13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal +control over financial reporting. +136 \ No newline at end of file diff --git a/raw/filings/0000896493/2023/0001214659-24-006963/rp_note.txt b/raw/filings/0000896493/2023/0001214659-24-006963/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..9e06c4a2aefd187f05fadf33a3de93ad353c777f --- /dev/null +++ b/raw/filings/0000896493/2023/0001214659-24-006963/rp_note.txt @@ -0,0 +1,84 @@ +24. SENIOR SECURED CONVERTIBLE NOTE, RELATED PARTY +On October 13, 2023 (the “A&C +Closing Date”), the Company entered into a note purchase agreement with Ault & Company, pursuant to which the Company sold to +Ault & Company (i) a senior secured convertible promissory note in the principal face amount of $17.5 million (the “Note”) +and warrants (the “Warrants”) to purchase shares of the Company’s common stock for a total purchase price of up to $ 17.5 +million (the “Transaction”). +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to the Company since June 8, 2023 pursuant to +the loan agreement; (ii) cancellation of $11.6 million of term loans made by the Company to Ault & Company in exchange for Ault & +Company assuming liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of +125,000 shares of the Company’s Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) +being transferred from Ault & Company to the Company. +The Note had a principal face amount of $17.5 million and had a maturity +date of October 12, 2028 (the “Maturity Date”). The Note bore interest at the rate of 10 % per annum. The Note was repaid in +full in December 2023 and the Company recorded a $ 4.2 million loss on extinguishment for the year ended December 31, 2023. +The Warrants grant Ault & +Company the right to purchase 1.9 million shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary +of the A&C Closing Date, and become exercisable on the first business day after the six-month anniversary of the A&C Closing Date. +The exercise price of the Warrants is $ 4.5925 , which is subject to adjustment in the event of customary stock splits, stock dividends, +combinations or similar events. +The Company elected the fair +value option and utilized a Monte-Carlo simulation at inception to value the Note. The Monte-Carlo simulation is calculated as the average +present value over all simulated paths. The key inputs and assumptions used in the Monte-Carlo Simulation, including volatility, estimated +market yield, risk-free rate, the probability of various scenarios, including held to maturity and subsequent preferred stock offering +and various simulated paths, were utilized to estimate the fair value at $17.8 million or approximately the principal amount outstanding +as of inception. The value of the 2023 Note was calculated as the average present value over 25,000 simulated paths. Given the Notes were +fully satisfied in connection with issuance of the Series C convertible preferred stock, the Company calculated the fair value on the +date of extinguishment as the total principal plus accrued interest outstanding. +F- 46 +The following table summarizes +some of the significant inputs and assumptions used in the Monte-Carlo simulation: +Schedule of senior secured convertible promissory note assumptions +Senior secured convertible promissory note +Amounts +Principal outstanding at valuation date +$ 17.5 million +Volatility +80 % +Interest rate +10.0 % +Risk-free interest rate range +4.7 % to 5.6 % +Estimated yield +19.5 % to 21.0 % +The Company computed the fair value of the warrants using the Black-Scholes +option pricing model and, as a result of this calculation, recorded debt discount in the amount of $4.2 million based on the estimated +fair value of the Warrants. +In addition to a 21% discount +for lack of marketability, significant inputs associated with the calculation of the fair value of the Warrants included the following: +Schedule of convertible note +Contractual term in years +5.0 +Volatility +167.3 % +Dividend yield +0 % +Risk-free interest rate +4.7 % +The rollforward of the senior +secured convertible promissory note notes is as follows: +Schedule of senior +secured convertible promissory note +Senior secured convertible promissory note +Total +Balance as of December 31, 2022 +$ +- +Exchange of loan agreement with Ault & Company +4,625,000 +Ault & Company note from exchange of 12% demand promissory note +1,100,000 +Ault & Company note from exchange of 10% demand promissory note +10,545,000 +Exchange of Series B convertible preferred stock +1,250,000 +Cash payments of senior secured convertible promissory note +( 150,000 +) +Payment from issuance of Series C preferred stock +( 17,370,000 +) +Balance as of December 31, 2023 +$ +- \ No newline at end of file diff --git a/raw/filings/0000896493/2023/0001214659-24-006963/rpt_disclosure.txt b/raw/filings/0000896493/2023/0001214659-24-006963/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..28340bdf7deb5379412e7a80dc0bfad803b02ce2 --- /dev/null +++ b/raw/filings/0000896493/2023/0001214659-24-006963/rpt_disclosure.txt @@ -0,0 +1,391 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• +the aggregate amount involved is determined to by the Audit Committee to be material; +• +we are a participant; and +• +any of the following has or will have a direct or indirect interest in the transaction: +• +an executive officer, director, or nominee for election as a director; +• +a greater than five percent beneficial owner of our common stock; or +• +any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. +Ault & Company, Inc. +On +February 25, 2021, Ault & Company sold and issued an 8% Secured Promissory Note in the +principal amount of $2,500,000 (the “2021 Note ”) to us. The principal amount +of the 2021 Note, plus any accrued and unpaid interest at a rate of 8% per annum, was originally due and payable on August 5, 2021 but +the maturity date was subsequently extended to December 31, 2022. +On June 8, 2023, we entered +into the Credit Agreement with Ault & Company as the lender. The Credit Agreement provided for an unsecured, non-revolving credit +facility in an aggregate principal amount of up to $10,000,000. All Advances were due within five business days after request by Ault +& Company and Ault & Company was not obligated to make any further Advances under the Credit Agreement after December 8, 2023. +Advances under the Credit Agreement bore interest at the rate of 9.5% per annum and may be repaid at any time without penalty or premium. +As of April 15, 2024, no Advances were outstanding. +Effective August 3, 2023, +we and the Investors entered into the Exchange Agreement pursuant to which the Investors exchanged all of their preferred shares as well +as their Demand Notes issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount +of approximately $0.8 million for the Exchange Notes, each with a principal face amount of $5.3 million, for an aggregate Principal Amount +of $10.5 million. We and Mr. Ault, our Executive Chairman, entered into guaranty agreements with the March 2023 Investors guaranteeing +repayment by Ault & Company of the Exchange Notes. +153 +Effective as of August 3, +2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, +we issued the First Ault & Company Demand Note to Ault & Company. +Effective as of August 10, +2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued +the Second Demand Note to Ault & Company. +On October 13, 2023, we entered +into a note purchase agreement with Ault & Company, pursuant to which we sold to Ault & Company (i) the Senior Note and Warrants +to purchase shares of our common stock for a total purchase price of up to $17.5 million. +The purchase price was comprised +of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the Credit +Agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming +liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares +of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault +& Company to us. +The Senior Note had a principal +face amount of $17.5 million and a maturity date of October 12, 2028. The Senior Note bore interest at the rate of 10% per annum. Interest +was payable, at Ault & Company’s option, in cash or shares of common stock at the applicable conversion price. Accrued interest +was payable on the maturity date, provided, however, that Ault & Company had the option, on not less than 10 calendar days’ +notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. +The Senior Note was convertible +into shares of common stock at a conversion price equal to the greater of (i) the Floor Price, and (ii) the lesser of (A) $7.38 or (B) +105% of the volume weighted average price of the common stock during the ten trading days immediately prior to the date of conversion. +The conversion price was subject to adjustment in the event of an issuance of common stock at a price per share lower than the conversion +price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor Price shall not +be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +The Warrants grant Ault & +Company the right to purchase 1,907,440 shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary +of the closing date, and become exercisable on the first business day after the six-month anniversary of the closing date. The exercise +price of the Warrants is $0.35, which is subject to adjustment in the event of customary stock splits, stock dividends, combinations or +similar events or in the event of an issuance of common stock at a price per share lower than the exercise price. +On November 6, 2023, we entered +into the November 2023 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 50,000 shares of Series C Convertible Preferred Stock and the Series C Warrants to purchase up to 14.8 million shares of common +stock for a total purchase price of up to $50 million. The consummation of the transactions contemplated by the November 2023 SPA, specifically +the conversion of the Series C Convertible Preferred Stock and the exercise of the Series C Warrants in an aggregate number in excess +of 19.99% on the execution date of the November 2023 SPA, are subject to various customary closing conditions as well as regulatory and +stockholder approval. +Additionally, until the earlier +of (i) four years from the initial closing date of the November 2023 SPA (the “Initial Closing Date”), or (ii) the date when +Ault & Company holds fewer than 10,000 shares of Series C Convertible Preferred Stock, the Company will be prohibited from (A) entering +into any financing, whether debt or equity, other than conventional loans from a commercial bank, at a price per share less than the Series +C Conversion Price (as defined below) or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 10,000 shares of Series C Convertible Preferred Stock, Ault & Company shall have a right to participate +in any subsequent financing (a “Subsequent Financing”) allowing Ault & Company to purchase such number of securities in +the Subsequent Financing to allow Ault & Company to maintain its percentage beneficial ownership of the Company that Ault & Company +held immediately prior to the Subsequent Financing. +In addition, the Company must +establish a reserve account to be funded with no less than 12.5% of the gross proceeds received from the sale of the Series C Convertible +Preferred Stock, which shall be maintained for a period of at least nine months from the Initial Closing Date. +154 +On December 14, 2023, pursuant +to the November 2023 SPA, we sold to Ault & Company, in three separate closings that occurred on the closing date, an aggregate of +41,500 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 12,269,031 shares of common stock, for a total +purchase price of $41.5 million. At the Initial Closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred +Stock and Series C Warrants to purchase 6,356,245 shares of common stock, for a purchase price of $21.5 million, paid in cash. Immediately +upon the Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes issued to the lenders pursuant +to the Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +Second Closing, Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 2,956,393 +shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon the Second Closing, we paid $10.0 million +to partially satisfy the outstanding Senior Note. Promptly thereafter, at the Third Closing, Ault & Company purchased another 10,000 +shares of Series C Convertible Preferred Stock and Series C Warrants to purchase another 2,956,393 shares of common stock, for a purchase +price of $10.0 million, paid in cash. Immediately upon the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance +on the outstanding Senior Note. +On December 14, 2023, we, along with the Guarantors entered into the +Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed $36 million and issued the Secured Notes to the +lenders in the aggregate amount of $38.9 million. The Loan Agreement was amended on April 15, 2024. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated from the Miners and (c) the +membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those entities +granted to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault Aviation, +AGREE, Sentinum, Third Avenue, Ault Energy, ADTC, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue +on the Florida Property, (iv) a future advance mortgage by ACS on the Michigan Property, (v) an aircraft mortgage and security agreement +by Ault Aviation on the Aircraft, and (vi) deposit account control agreements over certain bank accounts held by certain of our subsidiaries. +In addition, pursuant to the Loan Agreement, we agreed to establish +the Segregated Account, which would be used as a further guarantee of repayment of the Secured Notes. $3.5 million of cash was paid into +the Segregated Account on the closing date. We are required to have the minimum balance in the Segregated Account be not less than $7 +million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and two-year anniversaries of the closing +date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million monthly into the Segregated Account, +which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into the Segregated Account, (i) up to +the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, the Residence Inn in Madison West, +the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on a per dividend basis) received from +Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, which shall not exceed $9 million +in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans or other investments made by Ault +Lending (including but not limited to sales of loans or investments, dividends, interest payments and amortization payments), which shall +not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further agreed to deposit funds into the +Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida Property, (ii) $11 million from +the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, subject to a de minimis threshold +of $1 million, and (v) $10 million from the sale of Circle 8. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50,000,000.00 to $75,000,000.00 and (B) extended the date of on which the final closing may occur to June 30, +2024, subject to Ault & Company’s ability to further extended such date for ninety days. +155 +Description of the Series C Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) the Floor Price, and (ii) the lesser of (A) $0.35 or (B) 105% of the volume weighted average price of the +common stock during the ten trading days immediately prior to the date of conversion (the “Series C Conversion Price”). The +Series C Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the Series +C Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor +Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations or similar transactions. +Voting Rights +The holders of the Series +C Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series C Convertible Preferred Stock is entitled to +cast, shall not be lower than $3.075 (the “Voting Floor Price”), which represents the closing sale price of the common stock +on the trading day immediately prior to the date of execution of the November 2023 SPA. The Voting Floor Price shall be adjusted for stock +dividends, stock splits, stock combinations and other similar transactions. +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series C Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +The conversion of the Series +C Preferred Stock is subject to approval by the NYSE American and our stockholders. +Description of the Series C Warrants +On each closing date, the Company will issue Ault & Company the +Series C Warrants, which grant Ault & Company the right to purchase a specified number of common stock (the “Warrant Shares”). +The exercise price of the Series C Warrants is $0.35 (the “Exercise Price”) and the number of Warrant Shares is determined +by dividing the actual investment amount by the Exercise Price. The Exercise Price is subject to adjustment in the event of customary +stock splits, stock dividends, combinations or similar events. +The Series C Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +The exercise of the Warrants +is also subject to approval by the NYSE American and our stockholders. +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer and a director of +Ault & Company. William B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief +Financial Officer and a director of Ault & Company. Henry Nisser, our President, General Counsel and a member of our board of directors, +is also the President, General Counsel and a director of Ault & Company. +ROI +On +June 8, 2022, Ault Lending entered into a securities purchase agreement with ROI whereby Ault Lending agreed to purchase $12,000,000 of +a new series of convertible preferred stock of ROI, which transaction closed on June 29, 2022. As part of the transaction we were issued +102,881 shares of ROI’s common stock and a warrant to purchase forty-nine percent (49%) of ROI’s common stock calculated on +a fully diluted basis, subject to certain terms and conditions. +On July 11, 2022, we announced +the formation of Ault Energy. Ault Energy will partner with White River Holdings Corp. (“White River”), a then subsidiary +of ROI, on drilling projects across 30,000 acres in Texas, Louisiana and Mississippi. Ault Energy, as Ault Lending’s designee, has +the right to purchase up to 25%, or such higher percentages at the discretion of White River, in various drilling projects of White River. +In August 2022, Ault Energy committed to purchasing 40% of the first drilling project offered, at a cost to Ault Energy of approximately +$1 million. In October 2022, Ault Energy committed to purchasing 37.5% of the second drilling project offered, at a cost to Ault Energy +of approximately $1.6 million. In March 2023, Ault Energy committed to purchasing 20% of the third drilling project offered, at a cost +to Ault Energy of approximately $1.0 million. +156 +On February 8, 2023, we entered +into the February 2023 Agreement with ROI and the other signatories thereto. The February 2023 Agreement provided that, subject to the +terms and conditions set forth therein, ROI would acquire all of the outstanding shares of capital stock of our then subsidiary, BNC, +of which we owned approximately 86%, and the remaining 14% was owned by the Minority Shareholders, as well as RiskOn 360, in exchange +for the following: (i) 8,637.5 shares of Series B Preferred that were issued to us, and (ii) 1,362.5 shares of Series C Preferred that +were issued to the to the Minority Shareholders. The Series B Preferred and the Series C Preferred each have a Stated Value of $10,000 +per share, for a combined stated value of the Preferred Stock to be issued by ROI, of $100,000,000, and subject to adjustment, are convertible +into shares of common stock of ROI. However, pending approval of the transaction by ROI’s shareholders, the Preferred Stock is subject +to a 19.9% beneficial ownership limitation, including the Series A Convertible Preferred Stock that we acquired from ROI in June of 2022. +Pursuant to the Preferred +Stock Certificates, each share of Preferred Stock will be convertible into a number of shares of ROI common stock determined by dividing +the Stated Value by the Conversion Price, or 40,000 shares of ROI common stock. The Conversion Price will be subject to certain adjustments, +including potential downward adjustment if ROI closes a qualified financing resulting in at least $25,000,000 in gross proceeds at a price +per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock will be entitled to receive dividends +at a rate of 5% of the Stated Value per annum during the Dividend Term. During the first two years of the Dividend Term, dividends will +be payable in additional shares of Preferred Stock rather than cash, and thereafter dividends will be payable in either additional shares +of Preferred Stock or cash as each holder may elect. If ROI fails to make a dividend payment as required by the Preferred Stock Certificates, +the dividend rate will be increased to 12% for as long as such default remains ongoing and uncured. Each share of Preferred Stock will +also have an $11,000 liquidation preference in the event of a liquidation, change of control event, dissolution or winding up of ROI, +and will rank senior to all other capital stock of ROI with respect thereto, except that the Series B Preferred and Series C Preferred +shall rank pari passu. Each share of Series B Preferred was originally entitled to vote with the ROI common stock at a rate of 10 votes +per share of common stock into which the Series B Preferred is convertible, but that provision was subsequently eliminated, as were the +conventional voting rights of the Series C Preferred. Other than certain rights granted to the Company relating to amendments or waiver +of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially identical. +The February 2023 Agreement closed on March 6, 2023. +On November 15, 2023, we purchased +from ROI 603.44 shares of ROI Series D Preferred for a total purchase price of $15.1 million. The purchase price was paid by the cancellation +of $15.1 million of cash advances made by us to ROI between January 1, 2023 and November 9, 2023. Each share of ROI Series D Preferred +has a stated value of $25,000 per share and each share of ROI Series D Preferred is convertible into a number of shares of ROI’s +common stock determined by dividing the stated value by $0.51, subject to adjustment in the event of an issuance of ROI common stock at +a price per share lower than the conversion price, as well as upon customary stock splits, stock dividends, combinations or similar events. +The ROI Series D Preferred holders are entitled to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. +In addition, for as long as at least 25% of the ROI Series D Preferred remain outstanding, ROI must obtain our consent with respect to +certain corporate events, including reclassifications, fundamental transactions, stock redemptions or repurchases, increases in the number +of directors, and declarations or payment of dividends, and further ROI is subject to certain negative covenants, including covenants +against issuing additional shares of capital stock or derivative securities, incurring indebtedness, engaging in related party transactions, +selling of properties having a value of over $50,000, altering the number of directors, and discontinuing the business of any subsidiary, +subject to certain exceptions and limitations. However, pending approval of the transaction by ROI’s shareholders, the ROI Series +D Preferred is subject to a 19.99% beneficial ownership limitation. +Milton +C. Ault, III, our Executive Chairman, is also the Executive Chairman of ROI. Henry Nisser, our President, +General Counsel and a member of our board of directors, is also the President, General Counsel and a director of ROI. +Alzamend +In November 2022, we entered +into a marketing and brand development agreement with Alzamend, effective August 1, 2022, whereby we provided various marketing services +over twelve months valued at $1.4 million. Alzamend had the right to pay the fee in cash or shares of its common stock with a value of +$22.50 per share. On November 11, 2022, Alzamend elected to pay the fee in shares, and issued us 62,222 shares of its common stock. +On January 31, 2024, Ault +Lending entered into the January 2024 SPA with Alzamend, pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending +up to 6,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to purchase up to 6.0 million shares of Alzamend common stockfor +a total purchase price of up to $6.0 million. On January 31, 2024, Ault Lending purchased 1,220 +shares of ALZN Series B Preferred and warrants to purchase 1.22 million shares for a total purchase price of $1.22 million. The purchase +price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend between November 9, 2023 and January +31, 2023. On March 26, 2024, pursuant to the January 2024 SPA, Ault Lending purchased 780 +shares of ALZN Series B Preferred Stock and ALZN Series B Warrants to +purchase 780,000 shares of Alzamend common , for a purchase price of $780,000. As +of April 15, 2024, Ault Lending has purchased an aggregate of 2,000 shares of ALZN Series B Preferred and ALZN Series B Warrants +to purchase an aggregate of 2.0 million shares of Alzamend common stock, for an aggregate purchase +price of $2.0 million. +157 +Description of the ALZN Series B Preferred +The +terms of the ALZN Series B Preferred are as set forth in the Amended and Restated Certificates of Designations of the Rights, Preferences +and Limitations of the Series B Convertible Preferred Stock, as amended (the “ Series B Certificate of Designation ”). +Each share of ALZN Series B Preferred has a stated value of $1,000 per share (the “ALZN Stated Value ”). +The ALZN Series B Preferred does not accrue dividends. +Conversion Rights +Each +share of ALZN Series B Preferred is convertible into a number of shares of Alzamend common +stock (“ALZN Conversion Shares”) determined by dividing the ALZN Stated Value by +$1.00 (the “ALZN Conversion Price”). The ALZN Conversion Price is subject to adjustment in the event of an issuance +of common stock at a price per share lower than the ALZN Conversion Price then in effect, as well as upon customary stock splits, stock +dividends, combinations or similar events. +158 +Voting Rights +The +holders of the ALZN Series B Preferred are entitled to vote with the common stock as a single +class on an as-converted basis, subject to applicable law provisions of the Delaware General Company Law and Nasdaq, provided however, +that for purposes of complying with Nasdaq regulations, the conversion price, for purposes of determining the number of votes the holder +of ALZN Series B Preferred is entitled to cast, shall not be lower than $0.873 (the “ALZN +Voting Floor Price”). The ALZN Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other +similar transactions. +Liquidation Rights +In +the event of liquidation, dissolution, or winding up of Alzamend, the holders of ALZN Series B Preferred +have a preferential right to receive an amount equal to the ALZN Stated Value per share of ALZN +Series B Preferred before any distribution to other classes of capital stock. If the assets are insufficient, the distribution +will be prorated among the holders of ALZN Series B Preferred . The remaining assets, if any, +will then be distributed pro rata to the holders of outstanding Alzamend common stock. Any transaction that constitutes a change of control +transaction shall be deemed to be a liquidation under the Series B Certificate of Designation. +Description of the +Series B Warrants +At +each closing, Alzamend will issue Ault Lending Series B Warrants, which grant Ault Lending the right to purchase a specified number of +Alzamend common stock (the “ALZN Warrant Shares”). The exercise price of the Series B Warrants is $1.20 (the “ALZN Exercise +Price”) and the number of ALZN Warrant Shares is equal to the number of ALZN Conversion Shares issuable upon the ALZN +Series B Preferred issued at that closing. The ALZN Exercise Price is subject to adjustment in the event of an issuance of common +stock at a price per share lower than the ALZN Exercise Price then in effect, as well as upon customary stock splits, stock dividends, +combinations or similar events. +The +Series B Warrants become exercisable on the first business day after the six-month anniversary of issuance (the “ALZN Initial Exercise +Date”) and have a five-year term, expiring on the fifth anniversary of the ALZN Initial Exercise Date. +Messrs. Ault, Horne and Nisser +are each paid $50,000 annually by Alzamend. +Milton +C. Ault, III, our Executive Chairman, is also the Vice Chairman of Alzamend. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also the Chairman of Alzamend . +Henry Nisser, our President, General Counsel and a member of our board of directors, is also the Executive Vice President, General Counsel +and a director of Alzamend. +Avalanche +On September 6, 2017, we entered into the AVLP Loan Agreement with +an effective date of August 21, 2017, pursuant to which we provided Avalanche a non-revolving credit facility. The AVLP Loan Agreement +has been increased to up to $20.0 million and extended to December 31, 2023. +At December 31, 2021, we had provided Avalanche with $17.8 million +and, in addition to the 12% convertible promissory notes, AVLP has issued warrants to us to purchase 35.6 million shares of AVLP common +stock. Under the terms of the AVLP Loan Agreement, any notes issued by AVLP are secured by the assets of AVLP. As of December 31, 2021, +we recorded contractual interest receivable attributed to the AVLP Loan Agreement of $2.0 million and a provision for loan losses of $2.0 +million. The warrants issued in conjunction with the non-revolving credit facility entitles us to purchase up to 35.6 million shares of +Avalanche common stock at an exercise price of $0.50 per share for a period of five years. The exercise price of $0.50 is subject to adjustment +for customary stock splits, stock dividends, combinations or similar events. The warrants may be exercised for cash or on a cashless basis. +While Avalanche received funds from a third party in the amount of +$2.75 million in early April of 2019 in consideration for its issuance of the Third Party Note, $2.7 million was used to pay an outstanding +receivable due us and no amount was used to repay the debt Avalanche owes us pursuant to the AVLP Loan Agreement. On October 12, 2021, +Ault Alpha repaid the Third Party Note in full and also acquired a warrant to purchase 1.6 million shares of AVLP common stock. In consideration +therefor, AVLP issued Ault Alpha a term note in the principal amount of $3.6 million, which term note had a maturity date of June 30, +2022. +159 +On June 27, 2022, AVLP exchanged +the term note it had issued to Ault Alpha for the Ault Alpha Note. The Ault Alpha Note is convertible, subject to adjustment, at $0.50 +per share. AVLP also issued Ault Alpha a warrant to purchase an aggregate of 1,617,647 shares of Avalanche common stock at an exercise +price of $0.50. Pursuant to a security agreement entered into by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered +into by and among the foregoing parties, our company and certain other persons, Ault Alpha was granted a second priority interest in AVLP’s +assets securing the repayment of the Ault Alpha Note. In connection with the liquidation of Ault Alpha in December 2023, Ault Lending +assumed the Ault Alpha Note, the warrants to purchase Avalanche common stock and the secured party rights. +On July 11, 2022, AVLP issued +us the AVLP Note. The AVLP Note is convertible, subject to adjustment, at $0.50 per share. AVLP also issued us warrants to purchase an +aggregate of 41.0 million shares of Avalanche common stock at an exercise price of $0.50. Pursuant to a security agreement entered into +by Avalanche and Ault Alpha, as amended by an intercreditor agreement entered into by and among the foregoing parties, our company and +certain other persons, we have a first priority interest in AVLP’s assets securing the repayment of the AVLP Note. +We previously held the Prior +AVLP Note. On June 1, 2022, we converted the entire principal and accrued interest on the Prior AVLP Note into an aggregate of 51.9 million +shares of common stock of Avalanche, representing approximately 90.2% of Avalanche’s issued and outstanding shares of common stock. +There is currently no liquid market for the Avalanche common stock. Consequently, even if we were inclined to sell such shares of common +stock on the open market, our ability to do so would be severely limited. Avalanche is not current in its filings with the SEC and is +not required to register the shares of its common stock underlying the Prior AVLP Note or any other loan arrangement we have made with +Avalanche described above. +Mr. Ault is paid $100,000 +annually by AVLP, and each of Messrs. Horne and Nisser is paid $50,000 annually by AVLP. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of Avalanche. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of Avalanche. Mr. Ault is the Executive Chairman +of Avalanche. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General +Counsel of Avalanche. +Ault Alpha +Ault Alpha is a former affiliate +of our company, whereby Ault Lending was the largest limited partner and Ault & Company controlled the general partner and investment +manager. See immediately above for its involvement with respect to the Third Party Note. In addition, Ault Alpha previously purchased +an aggregate of 27,199 shares of our common stock and 101,362 Series D Preferred Shares, for aggregate purchase prices of $28.4 million +and $2.3 million, respectively. In connection with the liquidation of Ault Alpha on December 28, 2023, those shares of common stock and +Series D Preferred Shares were distributed to Ault Lending, who then returned the shares to our treasury. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +X +C +X +Howard Ash +Yes +C +X +Jeffrey A. Bentz +Yes +X +C +Mordechai Rosenberg +Yes +X +X +____________ +C – Chairman of committee +X – Member of committee +160 \ No newline at end of file diff --git a/raw/filings/0000896493/2024/0001214659-25-005868/filing.txt b/raw/filings/0000896493/2024/0001214659-25-005868/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..2cc9e67bf8350fdfc9dedeaeb21b0d4bbb01b74c --- /dev/null +++ b/raw/filings/0000896493/2024/0001214659-25-005868/filing.txt @@ -0,0 +1,14529 @@ +false +2024 +FY +0000896493 +0000896493 +2024-01-01 +2024-12-31 +0000896493 +gpus:ClassCommonStock0.001ParValuePerShareMember +2024-01-01 +2024-12-31 +0000896493 +gpus:Sec13.00SeriesDCumulativeRedeemablePerpetualPreferredStockParValue0.001PerShareMember +2024-01-01 +2024-12-31 +0000896493 +2024-06-28 +0000896493 +2025-04-14 +0000896493 +2024-10-01 +2024-12-31 +0000896493 +2024-12-31 +0000896493 +2023-12-31 +0000896493 +us-gaap:CommonClassAMember +2024-12-31 +0000896493 +us-gaap:CommonClassAMember 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transition period from _____________ to ________________ +Commission file number 1-12711 +HYPERSCALE DATA, INC. +(Exact name of registrant as specified in its charter) +Delaware +94-1721931 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification Number) +11411 Southern Highlands Pkwy , Suite 190 , +Las Vegas , NV +89141 +( 949 ) 444-5464 +(Address of principal executive offices) +(Zip Code) +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) +of the Act: +Title of each class +Trading symbol(s) +Name of each exchange on which registered +Class A Common Stock, $0.001 par value per share +GPUS +NYSE American +13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, par value $0.001 per share +GPUS PD +NYSE American +Securities registered pursuant to Section 12(g) +of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No +x +Indicate +by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange +Act. Yes ¨ No +x +Indicate +by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities +Exchange Act of 1934 during the preceding year (or for such shorter period that the registrant was required to file such reports), and +(2) has been subject to such filing requirements for the past 90 days. Yes x No +¨ +Indicate +by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule +405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant +was required to submit such files). Yes x No +¨ +Indicate by check mark whether the registrant +is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. +See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” +and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ¨ +Accelerated filer ¨ +Non-accelerated filer x +Smaller reporting company x +Emerging growth company ¨ +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying +with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ +Indicate +by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of +its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public +accounting firm that prepared or issued its audit report. ¨ +If securities are registered pursuant to Section +12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction +of an error to previously issued financial statements. ¨ +Indicate by check mark whether any of those error +corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s +executive officers during the relevant recovery period pursuant to §240.10D-1(b). ¨ +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No +x +As of June 28, 2024 (the last business day of +the registrant’s most recently completed second fiscal quarter), the aggregate market value of the registrant’s Class A common +stock held by non-affiliates of the registrant was $ 10.4 million based on the closing sale price on June 28, 2024 as reported on +the NYSE American of $10.143. Shares of the registrant’s Class A common stock held by executive officers, directors or 10% +beneficial owners and by each other person who may be deemed to be an affiliate of the registrant have been excluded from this computation. +This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose. +There were 1,529,995 +shares of Class A common stock outstanding as of April 14, 2025. +Documents incorporated by reference: None +HYPERSCALE DATA, INC. AND +SUBSIDIARIES +FORM 10-K +FOR THE FISCAL YEAR ENDED DECEMBER 31, 2024 +INDEX +Page +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +31 +Item 1B. +Unresolved Staff Comments +67 +Item 1C. +Cybersecurity +67 +Item 2. +Properties +69 +Item 3. +Legal Proceedings +69 +Item 4. +Mine Safety Disclosures +70 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +71 +Item 6. +[Reserved] +71 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +71 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +82 +Item 8. +Financial Statements and Supplementary Data +F-1 – F-54 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +82 +Item 9A. +Controls and Procedures +83 +Item 9B. +Other Information +84 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +84 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +85 +Item 11. +Executive Compensation +90 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +97 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +98 +Item 14. +Principal Accountant Fees and Services +104 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +105 +Item 16. +Form 10-K Summary +109 +Signatures +110 +CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (the “Annual +Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of +the Securities Exchange Act of 1934, as amended. These statements relate to future events or our future financial performance. We have +attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” +“can,” “continue,” “could,” “estimates,” “expects,” “intends,” +“may,” “plans,” “potential,” “predict,” “should” or “will” or +the negative of these terms or other comparable terminology. These statements are only predictions; uncertainties and other factors may +cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels or +activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations +reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Our expectations are as of the date this Annual Report is filed, and we do not intend to update any of the forward-looking statements +after the date this Annual Report is filed to confirm these statements to actual results, unless required by law. +This Annual Report also contains estimates and +other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves +a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified +the statistical and other industry data generated by independent parties and contained in this Annual Report and, accordingly, we cannot +guarantee their accuracy or completeness, though we do generally believe the data to be reliable. In addition, projections, assumptions +and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a +high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere +in this Annual Report. These and other factors could cause results to differ materially from those expressed in the estimates made by +the independent parties and by us. +RISK FACTOR SUMMARY +Below +is a summary of the principal factors that make an investment in our securities speculative. This summary does not address all of the +risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found +below under the heading “Risk Factors” and should be carefully considered, together with other information in this Annual +Report and our other filings with the U.S. Securities and Exchange Commission (“SEC”) before making investment decisions regarding +our securities. +· We will need to raise additional capital to fund our operations in furtherance +of our business plan. +· We have an evolving business model, which increases the complexity of our +business. +· Our Bitcoin mining operations present a number of risks, which are delineated +in the Risk Factors section. +· We are highly reliant on the price of Bitcoin and the level of demand for, +and financial performance of, Bitcoin. +· Our holding company model presents certain additional risks, which are delineated +in the Risk factors section. +· Our growth strategy is subject to a significant degree of risk. +· We are heavily dependent on our senior management, and a loss of a member +of our senior management team could cause our stock price to suffer. +· If we fail to anticipate and adequately respond to rapid technological changes +in our industry, including evolving industry-wide standards, in a timely and cost-effective manner, our business, financial condition +and results of operations would be materially and adversely affected. +· We are subject to risks related to governmental +regulation and enforcement with respect to Bitcoin mining, including: +◦ Regulatory changes or actions may restrict the use of bitcoins or the operation of the Bitcoin network +in a manner that adversely affects an investment in our securities; +◦ Due to the unregulated nature and lack of transparency surrounding the operations of many bitcoin trading +venues, they may experience fraud, security failures or operational problems, which may adversely affect the value of our bitcoin; +◦ If regulatory changes or interpretations require the regulation of bitcoins under the Securities Act and +the Investment Company Act of 1940, as amended (the “Investment Act”) by the SEC, we may be required to register and comply +with such regulations. To the extent we decide to continue operations, the required registrations and regulatory compliance steps may +result in extraordinary, non-recurring expenses to us. We may also decide to cease certain operations. Any disruption of our operations +in response to the changed regulatory circumstances may be at a time that is disadvantageous to investors. This would likely have a material +adverse effect on us and investors may lose their investment; and +◦ Changing environmental regulation and public energy policy may expose our business to new risks. +· We may be significantly impacted by developments +and changes in laws and regulations, including increased regulation of the industry in which we operate through legislative action and +revised rules and standards applied by The Financial Crimes Enforcement Network under the authority of the U.S. Bank Secrecy Act. +· If we do not continue to satisfy the NYSE American +continued listing requirements, our securities could be delisted from NYSE American. +· Our +Class A common stock and Series D Preferred Stock prices are volatile +PART I +ITEM 1. BUSINESS +Company Overview +Hyperscale Data, Inc., a Delaware +corporation formerly known as Ault Alliance, Inc., was incorporated in September 2017. Through our wholly and majority owned subsidiaries +and strategic investments, we own and/or operate data centers at which we mine Bitcoin and offer colocation and hosting services for the +emerging artificial intelligence (“AI”) ecosystems and other industries as well as provide mission-critical products that +support a diverse range of industries, including an artificial intelligence software platform, a social gaming platform, equipment rental +services, defense/aerospace, industrial, automotive, medical/biopharma and hotel operations. Our direct and indirect wholly owned subsidiaries +include (i) Sentinum, Inc. (“Sentinum”), (ii) Alliance Cloud Services, LLC (“ACS”) and (iii) BNI Montana, LLC +(“BNI Montana”). +We own Ault Capital Group, +Inc. (“Ault Capital”), which either wholly owns or has a direct controlling interest in, among other entities, (i) Ault Lending, +LLC (“Ault Lending”), (ii) RiskOn International, Inc., formerly known as BitNile Metaverse, Inc. (“ROI”), which +wholly owns BitNile.com, Inc. (“BNC”), (iii) askROI, Inc. (“askROI”), (iv) Ault Global Real Estate Equities, Inc. +(“AGREE”), (v) Eco Pack Technologies, Inc. (“Eco Pack”), (vi) Ault Aviation, LLC (“Ault Aviation”), +(vii) Circle 8 Holdco LLC (“Circle 8 Holdco”), which wholly owns Circle 8 Crane Services, LLC (“Circle 8”) and +(viii) TurnOnGreen, Inc. (“TurnOnGreen”), which wholly owns TOG Technologies, Inc. (“TOG Technologies”) and Digital +Power Corporation (“Digital Power”). +We were founded by Milton +C. (Todd) Ault, III, our Executive Chairman, and are led by Mr. Ault, William B. Horne, our Chief Executive Officer and Vice Chairman, +and Henry Nisser, our President and General Counsel. Together, they constitute the Executive Committee, which manages the day-to-day operations +of the holding company. Our long-term objective is to maximize per share intrinsic value. All major investment and capital allocation +decisions are made for us by Mr. Ault and the Executive Committee. +We currently have the following +reportable segments, though it should be noted that we are in the process of transitioning our data centers away from Bitcoin mining to +operations dedicated to high-performance computing (“HPC”) and AI purposes: +· Technology and Finance (“Fintech”): commercial lending and trading through Ault Lending; +· Sentinum: Bitcoin mining operation and data center operations through ACS; +· AGREE – hotel operations and other commercial real estate holdings; +· Energy and Infrastructure (“Energy”): crane rental and lifting solutions provider for oilfield, +construction, commercial and infrastructure markets through Circle 8; +· ROI: includes askROI, which operates a unique, generative AI-driven platform engineered to provide pertinent +and unique data insights through integration with business specific data that pushes beyond the conventional uses of existing large language +models as well as RiskOn, which owns 100% of BNC, which operates a social gaming platform; and +· TurnOnGreen: commercial electronics solutions with operations conducted by Digital Power, and electric +vehicle (“EV”) charging solutions through TOG Technologies. +We operate as a holding company +with operations conducted primarily through our subsidiaries, which are described below. +Recent Events and Developments +On June 4, 2024, we entered +into a Loan Agreement (the “2024 Credit Agreement”) with OREE Lending Company, LLC and Helios Funds LLC, as lenders (“Lenders”). +Each Lender is a 50% member of (and thus affiliate of) Orion Equity Partners, LLC (“Orion”). The 2024 Credit Agreement provided +for an unsecured, non-revolving credit facility in an aggregate principal amount of up to $20.0 million, provided, however, that at no +point shall we be allowed to have outstanding loans under the 2024 Credit Agreement in a principal amount received of more than $2.0 million +(unless otherwise allowed by Lenders in their sole discretion). All loans under the 2024 Credit Agreement were due December 4, 2024. The +Lenders are not obligated to make any further loans under the 2024 Credit Agreement after the maturity date described above. Loans under +the 2024 Credit Agreement are evidenced by promissory notes (the “Promissory Notes”) and have an original issuance discount +of 20% to the amount of each loan and all Promissory Notes, originally bore interest at the rate of 15.0% per annum and may be repaid +at any time without penalty or premium. +1 +Under the 2024 Credit Agreement, +the Lenders loaned to us $1.5 million on June 4, 2024, $0.5 million on June 20, 2024 and $1.5 million on or about July 2, 2024. As of +the date of this Annual Report, we have repaid $2.0 million to the Lenders. On January 9, 2025, we and each Lender amended (a) the 2024 +Credit Agreement whereby, among other things, upon the effectiveness of a registration statement, the 2024 Credit Agreement shall terminate +and be of no further force and effect, (b) the notes whereby no additional interest (other than the 20% OID) shall accrue on such notes. +As a result of these amendments, the aggregate amount payable to the Lenders by us, above the principal amount of $3.5 million under the +2024 Credit Agreement, is $0.7 million. +On June 20, 2024, we entered +into the ELOC Purchase Agreement, as amended (as amended, the “Purchase Agreement”) with Orion, pursuant to which Orion has +committed to purchase up to an aggregate of $37.5 million of shares of 13.00% Series D Cumulative Redeemable Perpetual Preferred +Stock, par value $0.001 per share (“Series D Preferred Stock”), subject to certain limitations and conditions set forth in +the Purchase Agreement. The shares of our Series D Preferred Stock that may be issued under the Purchase Agreement may be sold by us to +Orion at our discretion from time to time during the term of the Purchase Agreement. +On July 18, 2024, we entered +into a note purchase agreement with an institutional investor pursuant to which the institutional investor agreed to acquire, and we agreed +to issue and sell in a registered direct offering to the institutional investor, a $5.4 million 10% OID Convertible Promissory Note (the +“OID Note”). The OID Note was sold to the institutional investor for a purchase price of $4.9 million, an original issue +discount of $0.5 million. The OID Note will accrue interest at the rate of 15% per annum, unless an event of default occurs, at which +time the OID Note would accrue interest at 18% per annum. The OID Note matured on October 19, 2024. In addition, the OID Note is convertible +into shares of our Class A common stock at a conversion price of $5.867 per share (the “OID Conversion Price”), subject to +adjustment. On December 10, 2024, we entered into a forbearance agreement with the investor pursuant to which the investor agreed to forebear +through the close of business on December 31, 2024, from exercising the rights and remedies it is entitled to under the OID Note, and +we issued the investor a convertible promissory note in the amount of $0.9 million (the “Forbearance Note”). The Forbearance +Note was convertible into shares of Class A common stock at a conversion price equal to $5.47, subject to adjustment. The Forbearance +Note accrued interest at the rate of 18% per annum and matured on February 15, 2025. On February 25, 2025, pursuant to an amended and +restated forbearance agreement we entered into with the institutional investor, we issued to the investor an amended and restated convertible +promissory note in the amount of $3.5 million (the “A&R Forbearance Note”), consisting of (i) the amount +then due under the forbearance note of $0.9 million, (ii) a forbearance extension fee of $0.3 million and (iii) a true-up amount of $2.3 +million. The A&R Forbearance Note shall be convertible into shares of Class A common stock at a conversion price equal to $2.00. The A&R +Forbearance Note will accrue interest at the rate of 18% per annum and mature on May 15, 2025. In exchange, the investor agreed to +forbear through the close of business on May 15, 2025, from exercising any rights and remedies under the $5.4 million 10% OID Convertible +Promissory Note we previously issued to the investor on July 19, 2024 and any related transaction documents. +In October 2024, pursuant +to the securities purchase agreement we entered into with Ault & Company, dated as of November 6, 2023 (the “November 2023 SPA”), +we sold an aggregate of 1,400 shares of Series C Convertible Preferred Stock and warrants to purchase an aggregate of 11,825 shares of +Class A common stock to Ault & Company, for an aggregate purchase price of $1.4 million. +In November 2024, pursuant +to the November 2023 SPA we entered into with Ault & Company, we sold an aggregate of 1,280 shares of Series C Convertible Preferred +Stock and warrants to purchase an aggregate of 10,811 shares of Class A common stock to Ault & Company, for an aggregate purchase +price of $1.3 million. +On December 9, 2024, we completed +the distribution of 650,000 shares of our 10% Series E Redeemable Perpetual Preferred Stock (the “Series E Preferred Stock”), +a $16.25 million stated value, to holders of Class A common stock and Series C Convertible Preferred Stock on an as-converted basis. Dividends +will accrue on the stated amount of $25.00 per share of the Series E Preferred Stock at a rate per annum equal to 10.00%. +On December 16, 2024, we completed +the distribution of approximately 5.0 million shares of our Class B common stock (the “Class B Common Stock”) to all holders +of our Class A common stock and Series C Convertible Preferred Stock on an as-converted basis. There is currently no public trading market +for the Class B Common Stock. While we presently intend to seek to have the Class B Common Stock listed for trading on the NYSE American +within the foreseeable future, there can be no assurance when, or if, such a listing will occur. The Class B Common Stock is identical +to the currently outstanding Class A common stock, with the exception that each share thereof carries 10 times the voting power of a share +of Class A common stock. The Class B Common Stock is convertible at any time into Class A common stock on a one-for-one basis. +2 +On November 20, 2024, pursuant +to the approval provided by our stockholders at the annual meeting of stockholders held on June 28, 2024, we filed an Amendment to our +Certificate of Incorporation with the State of Delaware to effectuate a reverse stock split of our Class A common stock affecting the +issued and outstanding number of such shares by a ratio of one-for-thirty-five. The reverse stock split became effective on November 22, +2024. All share amounts in this Annual Report have been updated to reflect the reverse stock split. +On December 23, 2024, we completed the distribution of 1.0 million +shares of our Series F Exchangeable Preferred Stock (“Series F Preferred Stock”) to holders of Class A common stock and Series +C Convertible Preferred Stock on an as-converted basis. The Series F Preferred Stock has a $1.00 liquidation preference and does not pay +a dividend. Each share of Series F Preferred Stock will be exchangeable, at the option of its holder, for (i) 10 shares of Class A Common +Stock of Ault Capital and (ii) five shares of Class B Common Stock of Ault Capital, at any time beginning on the later of (i) one year +after issuance of the Series F Preferred Stock and (ii) the date of the registration under the Securities Act of 1933, as amended, of +all of the foregoing shares of Ault Capital Class A Common Stock and Ault Capital Class B Common Stock. Once the Series F Preferred Stock +has been exchanged into shares of Ault Capital Class A Common Stock and Class B Common Stock, our sole business will be our ownership +of Sentinum, Inc., through which we operate our Bitcoin mining business as well as its HPC and AI operations. +In December 2024, pursuant to the November +2023 SPA we entered into with Ault & Company, we sold an aggregate of 3,020 shares of Series C Convertible Preferred Stock and warrants +to purchase an aggregate of 25,509 shares of Class A common stock to Ault & Company, for an aggregate purchase price of $3.0 million. +As of the date of this Annual Report, Ault & Company has purchased an aggregate of 50,000 shares of Series C Convertible Preferred +Stock and warrants to purchase an aggregate of 422,337 shares of Class A common stock, for an aggregate purchase price of $50.0 million. +On December 13, 2024 (the “Closing Date”), Third Avenue +Apartments LLC (“Third Avenue”), which was a subsidiary of AGREE, completed the sale of its real property located at the southeast +corner of 5th Street North and 3rd Avenue North in St. Petersburg, Florida (the “Property”). The Property was sold on the +Closing Date to Cats Mirror Lake, LLC (the “Buyer”) pursuant to a contract of sale, as amended, entered into by Third Avenue +and the Buyer. The sale price for the property was $13.0 million. In February 2025, Third Avenue filed a certificate of cancellation with +the Delaware Secretary of State. +On December 21, 2024, we entered +into a securities purchase agreement (the “December 2024 SPA”) with Ault & Company, pursuant to which we agreed to sell, +in one or more closings, to Ault & Company up to 25,000 shares of Series G convertible preferred stock (“Series G Preferred +Stock”) and warrants to purchase up to 4.2 million shares of Class A common stock (the “Series G Warrants”) for a total +purchase price of up to $25.0 million. The December 2024 SPA provides that the financing may be conducted through one or more closings. +Through April 14, 2025, pursuant to the December 2024 SPA, we have sold to Ault & Company 960 shares of Series G Preferred Stock and +Series G Warrants to purchase 162,217 shares of Class A common stock, for a purchase price of $1.0 million. +Each share of Series G Preferred +Stock has a stated value of $1,000.00 and is convertible into shares of Class A common stock at a conversion price equal to the greater +of (i) $0.10 per share, and (ii) the lesser of (A) $6.74 or (B) 105% of the volume weighted average price of the Class A common stock +during the ten trading days immediately prior to the date of conversion. The holders of Series G Preferred Stock are entitled to cumulative +cash dividends at an annual rate of 9.5%, or $95.00 per share, based on the stated value per share. Dividends shall accrue for 10 years +from the date of issuance of such shares of Series G Preferred Stock and are payable monthly in arrears. For the first two years, we may +elect to pay the dividend amount in shares of Class A common stock rather than cash. The holders of the Series G Preferred Stock are entitled +to vote with the Class A common stock as a single class on an as-converted basis. +On February 5, 2025, we entered into an +exchange agreement with an institutional investor, pursuant to which we issued to the investor a convertible promissory note in the principal +face amount of $1.9 million (the “February 2025 Convertible Note”), in exchange for the cancellation of an outstanding term +note we issued to the investor in April 2024. That note had an outstanding principal amount and accrued but unpaid interest of $1.9 million. +The February 2025 Convertible Note accrued interest at the rate of 15% per annum, unless an event of default (as defined in the +February 2025 Convertible Note) occurs, at which time the February 2025 Convertible Note would accrue interest at 18% per annum. The February +2025 Convertible Note was to mature on May 5, 2025. The February 2025 Convertible Note was convertible into shares of Class A common stock +at a fixed conversion price of $4.00 per share. +3 +On March 14, 2025, we entered into an exchange +agreement with an institutional investor pursuant to which we issued to the investor a convertible promissory note in the principal face +amount of $4.2 million in exchange for the cancellation of (i) a term note issued by us on May 16, 2024, with outstanding principal and +accrued but unpaid interest of $0.7 million, (ii) a term note issued by us on May 20, 2024, with outstanding principal and accrued but +unpaid interest of $1.5 million, and (iii) the February 2025 Convertible Note issued by us on February 5, 2025, with outstanding principal +and accrued but unpaid interest of $2.0 million. The note accrues interest at the rate of 15% per annum, unless an event of default (as +defined in the note) occurs, at which time the note would accrue interest at 18% per annum. The note will mature on June 30, 2025. The +note is convertible into shares of Class A common stock at a conversion price equal to the greater of (i) $0.40 per share (the “Floor +Price”) and (ii) the lesser of 75% of the VWAP (as defined in the note) of the class A common stock during the five trading days +immediately prior to (A) the date of issuance of the note or (B) the date of conversion into shares of class A common stock. +On March 21, 2025, we entered into an exchange +agreement with an institutional investor, pursuant to which we issued to the investor a convertible promissory note in the principal face +amount of $4.9 million (the “Exchange Note”) in exchange for the cancellation of (i) a term note issued by us on January 14, +2025, with outstanding principal and accrued but unpaid interest of $2.6 million, (ii) a promissory note issued by us on March 7, +2025, with outstanding principal and accrued but unpaid interest of $0.5 million, (iii) a promissory note issued by us on March 12, +2025, with outstanding principal and accrued but unpaid interest of $1.5 million, and (iv) a promissory note issued by us on March +13, 2025, with outstanding principal and accrued but unpaid interest of $0.3 million. The Exchange Note accrues interest at the rate of +15% per annum, unless an event of default (as defined in the Exchange Note) occurs, at which time the note would accrue interest at 18% +per annum. The Exchange Note will mature on December 31, 2025. The note is convertible into shares of Class A common stock at a conversion +price equal to the greater of (i) the Floor Price and (ii) the lesser of 75% of the VWAP (as defined in the Exchange Note) of the Class +A common stock during the five trading days immediately prior to (A) the date of issuance of the Exchange Note or (B) the date of conversion +into shares of Class A common stock, but not greater than $10.00 per share. +On March 28, 2025, our +majority owned subsidiary, Avalanche International Corp. (“AVLP”), filed a petition +for liquidation under Chapter 7 of the bankruptcy laws. The filing placed AVLP under the control of the bankruptcy court, which will oversee +its liquidation. As a result, we no longer consider AVLP a subsidiary of ours. +On March 30, 2025, we entered into an amendment +to the November 2023 SPA to provide for an extension of the date on which the final closing may occur from December 31, 2024 to March +31, 2025, subject to Ault & Company’s ability to further extend such date for ninety (90) days. +On March 31, 2025, we entered into a securities +purchase agreement with an institutional investor pursuant to which we agreed to sell up to 50,000 shares of Series B Convertible Preferred +Stock (“Series B Preferred Stock”) for a total purchase price of up to $50.0 million. The securities purchase agreement +provides that the transaction shall be conducted through 49 separate tranche closings, provided, however, that the investor has the ability, +exercisable in its sole discretion, to purchase any number of shares of Series B Preferred Stock prior to the dates of the tranche closings +provided for in the securities purchase agreement. The initial tranche closing, which will close promptly after the investor has converted +out of the Exchange Note, will consist of the sale and issuance to the investor of 2,000 shares of Series B Preferred Stock for an aggregate +of $2.0 million. Pursuant to the securities purchase agreement, provided certain closing conditions have been met, the investor shall +purchase up to 4,800 shares of Series B Preferred Stock on a monthly basis, with the investor being required to purchase 1,000 shares +per month. +Each share of Series B Preferred Stock has a stated value of $1,000.00 +and is convertible into shares of Class A common stock at a conversion price equal the lesser of a 25% discount to our volume weighted +average price during the five trading days immediately prior to (A) the date of execution of the securities purchase agreement or (B) +the date of conversion into shares of Class A common stock, but not greater than $10.00 per share. Notwithstanding the foregoing, in no +event shall the Series B Preferred Stock be convertible at less than the Floor Price. The holders of Series B Preferred Stock are entitled +to cumulative cash dividends at an annual rate of 15%, or $150.00 per share, based on the stated value per share. Dividends shall accrue +for as long as any shares of Series B Preferred Stock remain issued and outstanding and are payable monthly in arrears. For the first +two years, we may elect to pay the dividend amount in additional shares of Series B Preferred Stock rather than cash. The holders of the +Series B Preferred Stock are entitled to vote with the Class A common stock as a single class on an as-converted basis. +On April 1, 2025, we issued to an accredited +investor a convertible promissory note in the principal face amount of $1.65 million in consideration for an advance we received +of $1.5 million. The note accrues interest at the rate of 15% per annum, unless an event of default (as defined in the note) occurs, at +which time the note would accrue interest at 18% per annum. The note will mature on September 30, 2025. The note is convertible into shares +of Class A common stock at a conversion price equal to the greater of (i) the Floor Price and (ii) the lesser of 75% of the VWAP (as defined +in the note) of the Class A common stock during the five trading days immediately prior to (A) the date of issuance of the note or (B) +the date of conversion into shares of Class A common stock. +4 +On April 8, 2025, we issued to an accredited +investor a convertible promissory note in the principal face amount of $110,000 in consideration for $100,000. The note accrues interest +at the rate of 15% per annum, unless an event of default (as defined in the note) occurs, at which time the note would accrue interest +at 18% per annum. The note will mature on September 30, 2025. The note is convertible into shares of Class A common stock at a conversion +price equal to the greater of (i) $0.45 and (ii) the lesser of (A) 75% of the VWAP (as defined in the note) of the Class A common +stock during the five trading days immediately prior to the date of issuance of the note or (B) 75% of the lowest daily VWAP of the Class +A common stock during the five trading days immediately prior to the date of conversion into shares of Class A common stock. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +190, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is https://hyperscaledata.com/ . +Our Corporate Structure +On September 10, 2024, we +changed our name from Ault Alliance, Inc. to Hyperscale Data, Inc. (the “Name Change”). The Name Change did not affect the +rights of our security holders. Our Class A common stock is traded on the NYSE American under the symbol “GPUS.” Existing +stock certificates that reflect a prior corporate name continue to be valid. Certificates reflecting the new corporate name are issued +as old stock certificates are tendered for exchange or transfer to our transfer agent. +In March and August of 2024, +we reorganized our corporate structure pursuant to a series of transactions by and among the Company and its directly and indirectly owned +subsidiaries as well as third parties. The purpose of the reorganization was to simplify our organizational and reporting structure to +more accurately reflect our business operations. As a result of the foregoing transactions, our corporate structure is currently as follows: +5 +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Over the recent past, we have provided capital and relevant expertise +to fuel the growth of businesses in Bitcoin mining, generative AI and metaverse platform development, crane services, defense/aerospace, +industrial, automotive, medical/biopharma, consumer electronics and textiles. We have provided capital to subsidiaries as well as partner +companies in which we have an equity interest or may be actively involved, influencing development through board representation and management +support. +Our Principal Subsidiaries and their Businesses +The following is a brief +summary of the businesses in which we own a controlling interest, or whose financial statements we consolidated in this Annual Report: +Sentinum +Sentinum conducts data center +operations and Bitcoin mining through ACS. +Overview +Sentinum’s revenue is +currently generated primarily from mining Bitcoin for our own account. However, during 2024 we began the process of transitioning our +primary operations from Bitcoin mining to developing our Michigan data center, which +constitutes a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan (the +“Michigan Facility”) to support the growing demand of enterprise, HPC and AI cloud providers with high-density workloads. +6 +Through its wholly owned and operated data centers, Sentinum’s +mission is to support internal computing requirements and to empower AI-focused businesses and other businesses requiring high-density +power with reliable, scalable, and secure hosting solutions. We currently have data centers in Michigan and Montana. The Michigan +Facility’s design and available power provides Sentinum the ability to create bespoke solutions enabling it to seize growth +opportunities within the broader data center services market. The Michigan Facility’s +design continues to evolve to address prospective customer requirements, including cooling techniques such as direct to chip heat exchange +and backup power systems such as uninterruptible power supplies with batteries to store energy. Sentinum can provide a range of service +options tailored to a customer’s needs, including HPC and AI. HPC and AI are synonymous with applications requiring immense computational +power to process complex models and perform real-time inferences. These use cases are being adopted by a wide range of industries, such +as healthcare, energy, automotive, robotics and other autonomous systems. We are exploring the potential of working directly with end +user companies as well as companies with which we could collaborate to provide comprehensive solutions. +Sentinum’s attentiveness to disruptive technologies such as HPC, +AI and blockchain combined with the foundational elements of data centers, power infrastructure, telecommunications and security enable +it to support the internal operations for Bitcoin mining alongside non-mining solutions for third party customers. The economies of scale +created by Bitcoin mining operations provide a competitive advantage to Sentinum as it seeks to add non-mining applications to its services +portfolio. If successful in adding non-mining applications, it is highly likely that the Bitcoin mining operations will be gradually phased +out. Sentinum continues to evaluate opportunities to add HPC and AI applications. Sentinum conducts preliminary engineering design sessions +with prospects and provides site tours at its Michigan Facility for prospective +customers that we believe represent qualified opportunities. Sentinum continually monitors critical equipment supply chains and lead times +in support of preferred installation timelines requested by prospective customers. During April 2025, Sentinum completed the installation +requirements for deployment of a 250 kilowatts HPC customer. +Sentinum currently mines Bitcoin using purpose-built computers (or “miners”) to solve complex cryptographic +algorithms (or “verify” or “solve” blocks) in the blockchain in exchange for rewards and fees denominated in the +native token of that blockchain network, which is Bitcoin. Sentinum’s miners provide computing power to a Bitcoin mining pool operator, +in which all the participants’ machines mine Bitcoin as a collective group, and Sentinum gets paid the expected value of both the +block reward and transaction fees for doing so. The mining pool operator receives block rewards and transaction fees paid in Bitcoin by +the blockchain when the mining pool finds new blocks. The reward and transaction fees are then shared by the pool participants based on +their hash rate contributions to the pool, less a small amount of fees. +We have determined that Bitcoin, the only crypto asset that Sentinum +mines, would likely not be considered a security under U.S. federal securities laws, in consultation with outside counsel. We base our +analysis on relevant case law, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance +by the SEC and its staff. A particular crypto asset’s status as a “security” in any relevant jurisdiction is +subject to a high degree of uncertainty and if a regulator disagrees with our characterization of Bitcoin, we may be subject to regulatory +scrutiny, investigations, fines and penalties, which may adversely affect our business, operating results and financial condition. A determination +that Bitcoin that we own or mine is a “security” may adversely affect the value of Bitcoin and our business. +We do not, however, currently +acquire crypto assets for investment purposes. As of December 31, 2024, we held approximately two Bitcoin valued at $183,000, based on +cost less impairment as of such date. Our mining operations generated a net loss of $12.6 million and revenue of $31.5 million during +the year ended December 31, 2024 compared to a net loss of $2.6 million and revenue of $33.1 million during the year ended December 31, +2023. As of December 31, 2024, the $183,000 carrying value of our Bitcoin represented less than 0.1% of our total assets of $219.7 million +as of such date. +Sentinum Breakeven Analysis +Since commencement of Sentinum’s +mining operations in 2021, we have received approximately 3,017 Bitcoin for providing computing power to a Bitcoin mining pool operator +and from hosted mining operations, pursuant to the terms of a Master Services Agreement (“MSA”) with Core Scientific, Inc. +(“Core Scientific”), through December 31, 2024. The MSA terminated on August 31, 2024. The Bitcoin received is available for +sale in the ordinary course of business, and while we believe that holding Bitcoin represents an attractive option to increase our liquid +assets, due to our continued operating losses we currently sell Bitcoin as it is mined to fund our operating expenses. We believe that +our integrated model with close control over our power sources and owning our Bitcoin mining data center helps us to produce Bitcoin with +attractive cost efficiency, since we are not burdened with additional costs that are typical in a third party hosting relationship such +as per miner operational fees and revenue sharing. This helps us to produce Bitcoin, excluding depreciation of our miners which is a non-cash +expense, at a cost that we believe is attractive versus the price of Bitcoin. +7 +Our net cost of power was +between approximately $42 to $62 per megawatt-hour in the second half of 2023 to the present. During the years ended December 31, 2024 +and 2023, we had on average approximately 16,000 miners in operations. In aggregate, these miners generated approximately 677 and 1,607 +Bitcoin during the years ended December 31, 2024 and 2023, respectively, for providing computing power to a Bitcoin mining pool operator +and from hosted mining operations with Core Scientific. Alternatively, during the years ended December 31, 2024 and 2023, we generated +an average of 1.85 and 4.40 Bitcoin per day, respectively, from our mining operations. Due to the termination of our hosting agreement +with Core Scientific and the block reward halving that occurred during April 2024, the average Bitcoin mined from our operations has decreased +to approximately 0.72 Bitcoin per day during the three months ended December 31, 2024. The following table reflects the actual costs that +we incurred to mine one Bitcoin. +Year Ended December 31, +2024 +2023 +Depreciation +$ 21,354 +$ 11,256 +Utilities and other costs +29,377 +11,426 +Hosting fees +17,938 +8,586 +$ 68,669 +$ 31,268 +Additionally, Sentinum’s daily general and operating costs, excluding +an impairment charge of $10.5 million that was recognized and decreased the net carrying value of the Company’s crypto assets mining +equipment to their estimated fair value, were approximately ($1,101) and $410, respectively, per Bitcoin mined during the years ended +December 31, 2024 and 2023. Conversely, the price of Bitcoin ranged from approximately $17,000 to approximately $44,000 during 2023 and +from approximately $38,000 to approximately $108,000 during 2024, and was approximately $79,000 as of April 7, 2025, according to Coin +Market Cap. +On February 24, 2023, BNI Montana entered into an asset purchase agreement +with TypeX, LLC to acquire two land lease agreements and two corresponding power purchase agreements in Montana. The lease and power agreements +run for a period of 10 years, with a 10-year renewal option. Sentinum is building out and developing fully operational data centers dedicated +to Bitcoin mining operations on the properties (the “Montana Facilities”). If we complete the initial phase of development +of the Montana Facilities, which is currently on hold, then we would expect the Montana Facilities to provide up to a combined 20 megawatts +(“MWs”) of power, enabling up to 6,500 S19j Pro Antminers to operate. Inclusive of costs previously incurred to acquire two +land lease agreements and two corresponding power purchase agreements, the Montana Facilities would cost approximately $7 million. Further, +given the favorable cost differential for power between Montana and Michigan, the increase in operating costs and depreciation from capitalized +expenditures is expected to approximate the power cost savings. However, while completion of the development of the Montana Facilities +would not be expected to have a negative impact on our operating results, we have currently placed this project on hold to focus on the +development of our Michigan Facility to support HPC and AI applications. During 2025, we anticipate large expenditures in our Michigan +Facility to facilitate the transition of the facility to support HPC and AI applications. Initially, these expenditures will likely increase +Sentinum’s losses unless we are able to pass these costs on to our future customers. These uncertainties make it impossible to predict +when, if ever, Sentinum will achieve profitable operations. +Thus, if the price of Bitcoin, +level of difficulty to mine, the amount of the block reward or the amount of Bitcoin earned by miners for mining one block on the Bitcoin +blockchain remain constant, then Sentinum will not be profitable in 2025. While we do not expect that Sentinum will achieve profitability +during 2025, the expected cash generated from our Bitcoin mining operations is still expected to exceed that of our operating costs given +the significance of depreciation charges, which is expected to account for nearly 20% of Sentinum’s total costs of operations during +2025. +During 2024, Sentinum reported a loss from operations of approximately +$12.6 million inclusive of depreciation and amortization of approximately $14.8 million and an impairment charge on our miners of $10.5 +million. During 2023, Sentinum reported a loss from operations of approximately $2.6 million inclusive of depreciation and amortization +of approximately $18.3 million. As such, excluding capital expenditures, Sentinum generated approximately $12.7 million and $15.7 million +in cash for the years ended December 31, 2024 and 2023, respectively. The cash generated from operations was used to pay for a portion +of the costs we incurred. +8 +Bitcoin and Bitcoin Mining Overview +Blockchain and Bitcoin Overview +Many forms of crypto assets, including Bitcoin, are a type of digital +asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). Crypto assets +operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized digital ledger +that enables the secure use and transfer of crypto assets. We believe that Bitcoin and the associated blockchain technology has potential +advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate settlement +of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” However, since centralized +exchanges, which operate intermediate processes for executing trades, storing coins and initiating transactions, account for the majority +of Bitcoin trading volume there remains the risk that a malicious actor may be able to alter blockchains on which transactions of crypto +asset reside and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. +Additionally, cybersecurity risks from unauthorized third parties employing illicit operations such as hacking, phishing and social engineering, +could introduce a level of counterparty risk, in other words a risk that a party is unable to fulfill its contractual obligations. Recently, +crypto assets, and Bitcoin in particular, have gained widespread mainstream attention and have begun to experience greater adoption by +both retail and institutional holders and the broader financial markets. For example, Bitcoin’s aggregate market value had appreciated +to $1.64 trillion in March 2025 compared to $828 billion in December 2023. All figures are derived from Coin Market Cap. As Bitcoin, and +blockchain technologies more generally, have entered the mainstream, prices of Bitcoin have reached all-time highs, albeit with periodic +price decreases, and the broader ecosystem has continued to develop. While we expect the value of Bitcoin to remain volatile, we believe +this increase in its aggregate market value signals institutionalization of Bitcoin and wider adoption of crypto asset. For example, in +January 2024, the SEC approved the listing and trading of Bitcoin exchange-traded funds, of which, as of April 8, 2025, approximately +34 are trading with over $167 billion of Bitcoin assets held ( https://etfdb.com/themes/bitcoin-etfs/#complete-list&sort_name=assets_under_management&sort_order=desc&page=1 ). +Bitcoin is a decentralized +asset that enables near instantaneous transfers. Transactions occur via an open-source, cryptographic protocol platform which uses peer-to-peer +technology to operate with no central authority. The online network hosts the public transaction ledger, known as the blockchain, and +each crypto asset is associated with a source code that comprises the basis for the cryptographic and algorithmic protocols governing +the blockchain. In a crypto asset network, every peer has its own copy of the blockchain, which contains records of every historical transaction +— effectively containing records of all account balances. Each account is identified solely by its unique public key (making it +effectively anonymous) and is secured with its associated private key (kept secret, like a password). The combination of private and public +cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing strong control of ownership. +No single entity owns or operates +the network. The infrastructure is collectively maintained by a decentralized public user base. As the network is decentralized, it does +not rely on either governmental authorities or financial institutions to create, transmit or determine the value of the currency units. +Rather, the value is determined by market factors, supply and demand for the units, the prices being set in transfers by mutual agreement +or barter among transacting parties, as well as the number of merchants that may accept the crypto asset. Since transfers do not require +involvement of intermediaries or third parties, there are only nominal transaction costs in direct peer-to-peer transactions. For example: +· +In terms of conventional peer-to-peer transactions, there either are no fees or they are de minimis (Source: https://www.kraken.com/en-us); +· +For purposes of traditional networks, there are nominal fees associated with any transaction (Source: https://bitinfocharts.com/bitcoin); and +· +As of April 8, 2025, the 90-day simple average Bitcoin network transaction fee is $1.71 per transaction, which is still low compared to conventional transaction fees charged by banks and other more traditional financial institutions (https://bitinfocharts.com/bitcoin). +The network fee is separate +and distinct from the pool fee we pay Luxor Technology (“Luxor”) for its services in acting as a pool operator, discussed +below. The network fee is applicable to anyone who transacts on the blockchain. +Given that block space is +limited, mining fees can and often do fluctuate significantly from transaction to transaction as a result of “congestion.” +However, this congestion does not negate any of the statements made immediately above. +Units of Bitcoin can be converted +to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as Binance, Coinbase, Bybit, Kraken, Gemini +and others. Bitcoin prices are quoted on various exchanges and fluctuate with extreme volatility. +9 +We believe that Bitcoin, the only crypto asset we provide computing +power to a mining pool operator for mining purposes, offers many advantages over traditional, fiat currencies, though many of these factors +also present potential disadvantages and may introduce additional risks, including: +· Acting as a fraud deterrent, as crypto assets +are digital and cannot be counterfeited or reversed arbitrarily by a sender; +· Immediate settlement; +· Elimination of counterparty risk; +· No trusted intermediary required; +· Lower fees; +· Identity theft prevention; +· Widespread accessibility; +· Transactions are verified and protected through +a confirmation process, which prevents the problem of double spending; +· Decentralized — no central authority (government +or financial institution); and +· Not recognized universally and not bound by government imposed or market +exchange rates. +However, crypto assets may +not provide all of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, there are two principal factors that may +affect Bitcoin mining companies: (i) limitations on the supply of Bitcoin; and (ii) the market price of Bitcoin. +The blockchain’s method for creating new Bitcoins is mathematically +determined in a manner such that the supply of Bitcoins grows at a limited rate pursuant to a pre-set schedule. Specifically, the number +of Bitcoins awarded for solving a new block is automatically halved for every 210,000 blocks that are solved. The current fixed reward +for solving a new block is 3.125 Bitcoins per block, which was reduced from 6.25 Bitcoins in April 2024 and will be reduced further to +1.5625 Bitcoins per block in approximately March 2028. This deliberately controlled rate of Bitcoin creation means that the number of +Bitcoins in existence will never exceed 21 million and that Bitcoin cannot be devalued through excessive production unless the Bitcoin +network’s source code and the underlying protocol for Bitcoin issuance is altered. This also means, however, that our revenue prospects +will decline unless the price of a Bitcoin increases commensurately or we acquire more miners, which we do not intend to do. +We only participate in mining +pools that mine Bitcoin. Our ability to generate revenue from these mining operations will be dependent on the price of Bitcoin. The price +of Bitcoin has experienced substantial volatility, including fluctuation patterns which may reflect “bubble” type volatility, +meaning that high or low prices at a given time may not be indicative of the current or future value of Bitcoin. The price of a Bitcoin +may be subject to rapidly changing investor and market sentiment, and may be influenced by factors such as technology, regulatory developments +and media coverage. Further, Bitcoin’s value may be based on various factors, including their acceptance as a means of exchange +or purchasing power by consumers and vendors, volume, liquidity and transferability and market demand. Bitcoin’s current price reflects, +in part, the belief by some that Bitcoin could become a widely accepted form of currency; however, if this prediction turns out to be +incorrect its price could decrease dramatically, as would our prospects for future revenue and profits. See “Risk Factors – +Risks Related to Our Bitcoin Operations” for more information on the risks we face due to our mining of Bitcoin and its speculative +and volatile nature. +10 +Bitcoin Mining and Mining Pools +As a participant in a Bitcoin mining pool, we use specialized miners +to solve cryptographic math problems necessary to record and “publish” crypto asset transactions to blockchain ledgers. Generally, +each crypto asset has its own blockchain, which consists of software code (also known as a protocol), which is run by all the computers +on the network for such blockchain. Within this code, transactions are collated into blocks, and these blocks must meet certain requirements +to be verified by the blockchain software, added to the blockchain or ledger of all transactions and published to all participants on +the network that are running the blockchain software. After a transaction is verified, it is combined with other transactions to create +a new block of data for the blockchain. For proof-of-work blockchains, the process of verifying valid blocks requires computational effort +to solve a cryptographic equation, and this computational effort protects the integrity of the blockchain ledger. This process is referred +to as “mining.” As a reward for verifying a new block, miners receive payment in the form of the native crypto asset of the +network, in our case Bitcoin. This payment is comprised of a block reward (i.e., the automatic issuance of new Bitcoin) and the aggregated +transaction fees for the transactions included in the block (paid in existing crypto asset tokens by the participants to the transactions). +The block reward payments and the aggregated transaction fees provide the incentive for miners to contribute hash rate to the network. +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific crypto asset, and the blockchain-wide hash rate for a specific crypto asset, in our case Bitcoin, can be understood +as the aggregate of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known as the “mining difficulty,” +which is the level of computational activity required before a new block is solved and verified. For example, on the Bitcoin blockchain +the protocol is coded such that a new block is solved and verified approximately every ten minutes. As such, to the extent the hash power +on the network is increased or decreased due to, for example, fluctuations in the number of active miners online, mining difficulty is +correspondingly increased or decreased to maintain the preset interval for the verification of new blocks. +On Bitcoin networks, the rewards +for solving a block are also subject to periodic incremental halving. Halving is a process designed to control the overall supply and +reduce the risk of inflation in Bitcoin using a proof-of-work consensus algorithm. After a predetermined number of blocks are added to +the blockchain, the mining reward is cut in half, hence the term “halving.” The last halving for Bitcoin occurred on April +20, 2024. Transaction fees are variable and depend on the level of activity on the network. Generally, transaction fees increase during +times of network congestion, as miners will prefer transactions with higher fees, and therefore a higher fee can reduce the time to process +a transaction, and decrease when there are fewer transactions on the network. +As the total amount of available +hash rate has increased on the Bitcoin network, it has become increasingly difficult for any individual miner to independently solve a +block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool operator, rather than an individual miner, +validates the block and receives the block reward and related transaction fees. The mining pool is organized by a third party, in our +case, Luxor. All of the approximately 9,500 miners currently in operation at our Michigan facility provide hash rate to the Luxor mining +pool. In consideration for receiving a percentage of the earned block rewards and transaction fees, Luxor administers the pool and ensures +that the participants in the pool receive their share of the block reward and related transaction fees, generally pro-rata to their contributed +hash rate. Mining pools offer miners more predictable and consistent revenue compared to mining individually. We participate in mining +pools by providing what the industry refers to as “hashrate” to the pool. Hashrate is defined as the computing power that +our mining equipment produces when helping to validate a block that the mining pool is trying to solve. We use the FPPS, or Full Pay-Per-Share, +method when mining with Luxor. Pursuant to the “Full Pay-Per-Share” model, both the block reward and the mining service charge +are settled according to the theoretical profit. It includes the calculation of a standard transaction fee within a certain period and +distributes it to mining pool participants according to their hash power contributions in the pool. It increases the mining pool participants’ +earnings by sharing transaction fees. Standard transaction fees are calculated using a certain period which are then distributed to miners +according to their hash power contributions in the pool. Luxor currently charges us a 0.68% mining fee. +We provide computing power to the mining pool, which is run by the +mining pool operator with which we contract, which in turn provides transaction verification services. Based on the terms of the agreement, +in our judgment, the mining pool operator is considered the principal in providing mining pool services. We recognize revenue, net of +certain transaction fees from the mining pool operator, which are not considered material. Our current mining pool agreement is cancelable +at any time by either party without penalty. Revenue received for providing computing power would be directly impacted positively or negatively +should we start and stop providing computing power to the mining pool operator within a given reporting period. +11 +Our Strategy +Own and Operate Our Mining Facilities +We have in the past invested +heavily in purchasing, building and operating our mining facilities, though we have no intention of acquiring more miners. By owning and +operating our miners at facilities that offer competitive advantages, including access to reliable, low-cost, renewable power, we expect +to have greater control over the timing of the deployment of our miners. We also may enhance our ability to intelligently and quickly +adapt our operating model and reap savings compared to paying for outsourced operations and infrastructure. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in Bitcoin mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable amounts of electrical energy to perform +their functions and mine Bitcoin; consequently, a critical aspect of operating in the crypto asset mining industry is obtaining a reliable +supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased the Michigan Facility. Since the +purchase of the Michigan Facility, we have invested in infrastructure improvements and began both ramping up the power capacity and installing +miners. To date, we have increased the power load from 1.5 MWs to approximately 30 MWs. ACS recently announced that it has reached an +agreement in principle with the local utility expected to energize the Michigan Facility, enabling ACS to increase its power capacity +from approximately 30 MW s to 300 MWs. The completion of the power upgrade is anticipated to take 44 months from execution +of a formal letter of authorization between ACS and the utility, which is currently being negotiated. In addition, ACS has reached an +agreement in principle with the local natural gas utility to provide the capability to energize the Michigan Facility with an additional +40 MWs. The project is expected to be completed within 18 months of the execution of definitive agreements. Combined, this would enable +ACS to increase its power capacity from approximately 30 MW to approximately 340 MW. Currently, we have approximately 4,900 S19j Pro Antminers +and approximately 4,600 S19 XP Antminers in operation at our Michigan Facility but it is our intention to dedicate all the power capacity +at the Michigan Facility to our AI hyperscale data center operations. If successful, we expect to sell any idle miners in the secondary +market, which could be between 12,500 and 16,500 miners. +We have also invested in a data center through BNI Montana. We have +completed the build-out at one of the two sites at the Montana Facilities, which provides up to 10 MWs of power. If we complete the build-out +of the second site, which is currently on hold pending the transition of our Michigan Facility to support HPC and AI applications, the +Montana Facilities will provide up to a combined 20 MWs of power and allow us to operate approximately 6,500 miners. We believe that the +capacity of the Montana Facilities can be significantly expanded, and we have begun an electrical load study in collaboration with the +local utility to explore potential power upgrades. However, given the current price of Bitcoin and the level of difficulty to mine, at +this time we have no plans to expand the capacity at the Montana Facilities, which has the capacity to operate approximately 2,600 S19j +Pro Antminers. At this time, we have ceased mining at the Montana Facilities and will not resume mining there until the price of Bitcoin +and the level of difficulty to mine improves such that our existing miners can operate profitably. +We continue to evaluate other sites, locations, and partnerships for +additional and alternative support of future mining operations. While we have not at present entered into any other agreements, we continue +to explore and evaluate additional facilities that would enable us to expand our mining operations as needed. +Our Bitcoin Mining Operations +Currently, we have approximately 4,900 S19j Pro Antminers and approximately +4,600 S19 XP Antminers in operation at our Michigan Facility and no Antminers in operation at our Montana facility. Additionally, approximately +9,700 S19j Pro Antminers are not in operation, primarily because of the termination of our hosting agreement with Core Scientific on August +31, 2024. Antminers in operation have an aggregate mining production capacity of approximately 1.13 exahashes per second. +12 +Our strategy includes identifying clean power for our Bitcoin mining +operations. Management has considered the issues surrounding the environmental impact of our Bitcoin mining operations and concluded that +the environmental impact of our mining operations is not material. The basis for this conclusion was that Indiana Michigan Power, the +regulated utility that provides power to our Michigan Facility, reported that in 2023 it generated more than 87% of its energy from emission-free +sources, including solar, wind, hydro and nuclear. The power source for our Montana Facilities, Basin Electric Power Cooperative, reported +that approximately 28% of its power was from emission-free sources, primarily wind and hydro. Since we are only mining Bitcoin at our +Michigan Facility, approximately 87% of our mining operations are being generated from emission-free sources. If we resume operations +at our Montana Facilities, more than 75% of power used in our mining operations would be generated from emission-free sources. In addition +to our continued expansion investments at the Michigan Facility, we also seek out new locations to support our bitcoin mining business. +We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but also leasing buildings +and facilities (as we have done with the Montana Facilities), hosting relationships and strategic partnerships. At this time, we have +not entered into any new mining agreements at locations other than the Michigan Facility and the Montana Facilities. We mine Bitcoin only. +Coins that are mined are held +in a custodial account. We securely store our Bitcoin at Gemini Trust Company, LLC (“Gemini”), a regulated, audited and insured +crypto asset custodian. Gemini is a fiduciary and qualified custodian under the New York Banking Law and is licensed by the New York State +Department of Financial Services. Additionally, Gemini holds numerous money transmitter licenses or the statutory equivalent and has obtained +System and Organization Controls (“SOC”) 1 Type 2 and SOC 2 Type 2 certifications from its independent third-party auditor, +Deloitte and Touche LLP. A SOC 1 report evaluates controls that are applicable to internal control over financial reporting whereas a +SOC 2 report evaluates a security framework that authenticates an organization’s ability to securely handle customer data. Further, +Gemini has insurance coverage against the theft of crypto assets that results from a direct security breach or hack of Gemini’s +systems, or theft by a Gemini employee. +The custody arrangements require +that we mine to a custodial wallet address where the private key is held by the custodian and all keys for the wallet are held in cold +storage. This provides a layer of protection in both the transaction and liquidation phases of the operations by using multi-factor and +multi-person approval processes, to include know your customer and anti-money laundering (“AML”) procedures of the receiving +party. We will either hold the Bitcoin or may choose to convert those assets into fiat currency depending on financial needs and plans. +When we opt to convert the Bitcoins we sell or exchange our Bitcoin through Gemini, the custodian of our digital wallet. When we elect +to make a sale or exchange our Senior Vice President - Finance submits a request to Gemini’s execution department to exchange Bitcoin +for U.S. dollars. Gemini sends an approval email to both our CEO and CFO to approve. Once approved by either our CEO or CFO, Gemini executes +the sale/exchange on its trading platform at current market prices, less commissions, and deposits the U.S. dollars into our bank account. +Beyond the foregoing, our +custody agreement with Gemini provides that: +· +Gemini provides a unique custody account in which all our blockchain assets are held, which are segregated from all others’ assets and are verifiable through the blockchain; and +· +Gemini charges us fees in Bitcoin, which is deducted from our digital +assets on the last business day of every month. +Currently, we are converting Bitcoin received from our mining activities +into fiat currency on a nearly daily basis to pay operating costs and purchase commitments for expansion activities at our facilities. +We do not hold any Bitcoin for investment. +Regulation +The laws and regulations applicable +to crypto asset are evolving and subject to interpretation and change. Governments around the world have reacted differently to crypto +assets; certain governments have deemed them illegal, and others have allowed their use and trade without restriction, while in some jurisdictions, +such as in the United States, many crypto assets are subject to extensive, and in some cases overlapping, unclear and evolving regulatory +requirements, which generally does not apply to Bitcoin. As crypto assets have grown in both popularity and market value, the U.S. Congress +and a number of U.S. federal and state agencies, including the Financial Crimes Enforcement Network (“FinCEN”), the SEC, the +Commodity Futures Trading Commission (“CFTC”), Financial Industry Regulatory Authority (“FINRA”), the Consumer +Financial Protection Bureau, the Department of Justice (“DOJ”), the Department of Homeland Security, the Federal Bureau of +Investigation (“FBI”), the Internal Revenue Service (“IRS”) and state financial regulators, have been examining +the operations of crypto asset networks, crypto asset users and crypto asset exchange markets, with particular focus on the extent to +which crypto assets can be used to launder the proceeds of illegal activities or fund criminal or terrorist enterprises and the safety +and soundness and consumer-protective safeguards of exchanges or other service-providers that hold, transfer, trade or exchange crypto +assets for users. +13 +Many of these state and federal agencies have issued consumer advisories +regarding the risks posed by crypto assets to investors. In addition, federal and state agencies, and other countries have issued rules +or guidance about the treatment of crypto asset transactions or requirements for businesses engaged in activities related to crypto assets. +Depending on the regulatory characterization of the Bitcoin we mine, the markets for Bitcoin in general, and our activities in particular, +may be subject to one or more regulators in the United States and globally. Ongoing and future regulatory actions may alter, perhaps to +a materially adverse extent, the nature of crypto asset markets and our crypto asset operations. Additionally, U.S. state and federal, +and foreign regulators and legislatures have taken action against crypto asset businesses or enacted restrictive regimes in response to +adverse publicity arising from hacks, consumer harm, or criminal activity stemming from crypto asset activity. There is also increasing +attention being paid by U.S. federal and state energy regulatory authorities as the total load of crypto mining grows and potentially +alters the supply and dispatch functionality of the wholesale grid and retail distribution systems. Many state legislative bodies are +also actively reviewing the impact of crypto mining in their respective states. For example, in May 2023, Montana enacted S.B. 178 which +established a right-to-mine for digital assets and prevents local governments from enacting any ordinance, resolution, or rule that selectively +targets digital asset miners. In 2022, Michigan considered a bill that would establish a blockchain and cryptocurrency commission aimed +at, among other things, examining the feasibility of regulating the energy consumption associated with the cryptocurrency industry and +investigate blockchain and cryptocurrency. The bill has, as of the date of this Annual Report, yet to be signed into law. In addition +to Michigan and Montana, other states are also considering or have enacted laws aimed at regulating crypto mining. For example, in 2022, +New York placed a two-year moratorium on certain cryptocurrency mining companies that use fossil fuels, which expired in November 2024. +Environmental +The perceived threat of climate change continues to attract considerable +attention in the United States and around the world. Numerous proposals have been made and could continue to be made at the international, +national, regional and state levels of government to monitor and limit emissions of greenhouse gases (“GHGs”). These efforts +have included consideration of cap-and-trade programs, carbon taxes, GHG disclosure obligations and regulations that directly limit GHG +emissions from certain sources. In addition, President Biden identified addressing climate change and the energy transition as priorities +under his Administration. He has issued executive orders and regulatory directives related to climate change, and has recommitted the +United States to long-term international goals to reduce emissions. In recent years, the U.S. Congress has considered legislation to reduce +emissions of GHGs and has included climate change considerations in its funding bills. For example, the Inflation Reduction Act of 2022, +which appropriates significant federal funding for renewable energy initiatives, was signed into law in August 2022 and could accelerate +the transition away from fossil fuels. These laws, initiatives, and associated regulations or other national or regional commitments to +reduce GHG emissions could adversely affect fossil fuel consumption, require the installation of emissions control technologies, and increase +the expense associated with the purchase of emissions reduction credits or allowances to comply with current or future emissions reduction +programs. It is uncertain how many of the Biden Administration’s initiatives will continue to remain in force under the Trump Administration. +At +the federal level, the Environmental Protection Agency (“EPA”) has also adopted rules that, among other things, establish +construction and operating permit reviews, emissions control standards, and monitoring and annual reporting for GHG emissions from certain +large stationary sources. In November 2021, the Biden Administration released “The Long-Term Strategy of the United States: Pathways +to Net-Zero Greenhouse Gas Emissions by 2050,” which establishes a roadmap to net zero emissions in the United States by 2050 through, +among other things, improving energy efficiency, decarbonizing energy sources via electricity, hydrogen and sustainable biofuels, eliminating +subsidies provided to the fossil fuel industry, reducing non-CO 2 GHG emissions and increasing the emphasis on climate-related +risks across government agencies and economic sectors. Additionally, from time to time the EPA has proposed, revised, and adopted rules +establishing new source performance standards for certain pollutants from coal-fueled electric generating plants. +We note that the implementation of the rule depends, in part, on the +widespread development, adoption, and availability of carbon capture and storage technology and solutions, which may not be certain at +this time. We also note that this proposed rule is subject to intense political debate and its adoption or implementation were impacted +by the results of the 2024 election cycle, though the extent of any changes to the prior regulatory regime remain undetermined. While +no final rule has been published to date, this proposed rule and any other new agency action or rulemaking that applies to our facilities +could increase our compliance costs or otherwise materially restrict our operations. Currently, it is unclear how future legislation and +regulation will affect our Bitcoin mining operations. The course of future legislation and regulation in the United States remains difficult +to predict, and potential increased costs associated with new legislation or regulation cannot be predicted at this time. +14 +Competition +Our business environment is constantly evolving, and cryptocurrency +miners can range from individual enthusiasts to professional mining operations with dedicated data centers. We compete with other companies +that focus all or a portion of their activities on cryptocurrency mining activities at scale. We face significant competition in every +aspect of our business, including, but not limited to, the ability to raise capital, obtaining the lowest cost of electricity, obtaining +access to energy sites with reliable sources of power, and evaluating new technology developments in the industry. +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this Annual Report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies: +· Argo Blockchain PLC; +· Bit Digital, Inc.; +· Bitdeer Technologies Group; +· Bitfarms Technologies Ltd.; +· Cipher Mining Inc.; +· CleanSpark, Inc.; +· Core Scientific, Inc.; +· Digi Power X Inc.; +· Galaxy Digital Holdings Ltd.; +· Hive Blockchain Technologies Inc.; +· Hut 8 Mining Corp.; +· IREN Limited; +· Marathon Digital Holdings, Inc.; +· Northern Data AG; +· Riot Blockchain, Inc.; +· Stronghold Digital Mining, Inc.; and +· TeraWulf Inc. +Intellectual Property +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. +15 +Blockchain Background +Blockchain technology first came to public attention in 2008 as the +database technology that underpins Bitcoin, the world’s first cryptocurrency. Blockchains are generally open-source, peer-to-peer +software programs that act as decentralized digital ledgers, each comprising a series of data “blocks” that are linked and +secured using cryptography in a “chain.” The blockchain program consists of a software protocol with several functions. The +software protocol is run by multiple computer systems or “nodes.” For many blockchain networks, each node has its own copy +of the blockchain ledger, which contains a historical record of every transaction. The digital ledger continuously grows as new blocks +are added to it to record the most recent transactions in a linear, chronological order. The same information is stored across a network +of computers all over the world, and this record makes it possible to track the ownership and transfer of cryptocurrency from the creation +of the blockchain to its current state, and effectively records of all account balances (as one can identify what account holds what value +through the decentralized ledger). +We do not operate a complete +node; rather, as noted above under the heading “Bitcoin Mining and Mining Pools,” we provide computing power to a pool operator. +The blockchain protocol allows +users to submit transactions to the network for confirmation. However, a transaction will not be accepted by the protocol if the inputs +to the transaction have previously been used in another transaction. This prevention of “double spending” is a key security +feature of blockchain networks. +Another key function of the +blockchain that protects the integrity of the network is the hashing process, which acts as a tamper-evident seal that confirms the validity +of the new block and all earlier blocks. Hashing is the process of a block being posted to the network. Hashing results from miners, who +are responsible for receiving broadcast transactions, processing those transactions into new blocks and updating the blockchain with the +new blocks through hashing. The hashing process ties every new block to the existing block on the blockchain to ensure each is a continuous +record of verified transactions. +The hashing algorithm on a +proof-of-work blockchain network is a mathematical transformation function with two key properties. The first important function of hashing +is that the algorithm accepts any alphanumeric dataset as an input and produces a unique output code. The smallest change in the dataset +results in a significant change in the unique code. Any tampering of the dataset can be detected by re-hashing the data and checking for +a change in the unique code. Any user that runs the hash algorithm on the same data will derive the same unique code. Consequently, the +data on the distributed ledger can be run through a series of hash algorithms to create a unique code, which would reveal if any changes +to the ledger have been made. +Second, whenever a new set +or “block” of transactions is added to the ledger, it is appended with the code from the prior state of the ledger before +it is hashed. Thus, the hash created from the new block will incorporate the hash from the previous block. An alteration made to an earlier +block would make the hashes of all subsequent blocks invalid, as the discrepancy would be easily detected by future miners through the +protocols governing the blockchain. If a hacker were to attempt to make a change to an earlier block and broadcast it along with following +blocks to the other nodes on the network, that broadcast would be discarded in favor of one from a different node which complied with +the requirements of the protocol. +Thus, in addition to creating new blocks, miners “vote” +with their computer power, expressing their acceptance of valid blocks by working on adding them to the blockchain, and rejecting invalid +blocks by refusing to work on them. If a miner’s proposed block is added to the blockchain by a majority of the nodes on the network, +it is considered part of the blockchain. The nodes on the network synchronize with each other to ensure that once a block is accepted +by the majority, the new block will eventually be added to all the nodes. Consequently, the historical state of the ledger can be changed +if control of more than 50% of the network is obtained; however, in the case of widely held cryptocurrencies with non-trivial valuations, +it may be economically prohibitive for any actor or group of actors acting in concert to obtain computing power that consists of more +than 50% of the network. +Unlike proof-of-work networks, +in which miners expend computational resources to compete to validate transactions and are rewarded cryptocurrency in proportion to the +amount of computational resources expended, in a proof-of-stake network, miners (sometimes called validators) risk or “stake” +assets to compete to be randomly selected to validate transactions and are rewarded cryptocurrency in proportion to the amount of assets +staked. Any malicious activity, such as mining multiple blocks, disagreeing with the eventual consensus or otherwise violating protocol +rules, results in the forfeiture or “slashing” of a portion of the staked assets. Proof-of-stake is viewed by some as more +energy efficient and scalable than proof-of-work. +16 +Blockchain technology enables +the secure use and transfer of digital assets. “Digital asset” is a broad term that encompasses additional applications, including +ownership, transaction tracking, identity management, and smart contracts. A digital asset can represent physical or virtual assets, a +value, or a use right/service (e.g., computer storage space). +Whereas digital assets can +take many forms and be used for a variety of functions, cryptocurrencies are a type of digital asset that primarily function as a medium +of exchange, a unit of account, and/or a store of value. Cryptocurrencies allow anyone who holds a compatible wallet, anywhere in the +world, to hold and transfer that cryptocurrency without the need for an intermediary or trusted third party. Units of a cryptocurrency +may exist only as data on the internet, and often are not issued or controlled by any single institution, authority or government. Whereas +most of the world’s money currently exists in the form of electronic records managed by central authorities such as banks, units +of a non-government cryptocurrency exist as electronic records in a decentralized blockchain database. Because cryptocurrencies have no +inherent intrinsic value, the value of cryptocurrencies is determined by the value that various market participants place on them through +their transactions. Bitcoin, Ethereum and other cryptocurrencies have historically exhibited high price volatility relative to more traditional +asset classes. +Private entities also issue digital assets called “stablecoins” +whose prices are pegged to those of an underlying fiat currency, a commodity or other financial instrument or other physical asset and +are therefore less susceptible to volatility. Stablecoins can be backed by fiat money, physical assets, or other crypto assets. Government +institutions are also reportedly testing and considering issuing Central Bank Digital Currencies (“CBDC’s”). While stablecoins +or CBDC’s may exhibit less price volatility than other cryptocurrencies, both rely on a central authority to establish the value +of the asset, and therefore represent an exception to the general discussion of the design of cryptocurrencies in this Annual Report. +Each cryptocurrency has a +source code that comprises the basis for the cryptographic and algorithmic protocols, which govern the blockchain. The source code is +commonly open-source and therefore can be inspected by anyone, and is maintained on an ongoing basis through contributors proposing amendments +to the protocol, which are peer reviewed and adopted by consensus among participants on the blockchain network. These protocols govern +the functioning of the network, including the ownership and transfer of the cryptocurrency, and are executed on the decentralized peer-to-peer +blockchain infrastructure. The peer-to-peer infrastructure on which a blockchain operates is not owned or operated by a single entity. +Instead, the infrastructure is collectively maintained by a decentralized user base. Each peer user is generally known as a “node” +or “miner,” and each miner processes transactions on the network in accordance with the protocols of the relevant cryptocurrency. +As a result, these cryptocurrencies +do not rely on either governmental authorities or financial institutions to create, transmit or determine the value of units of cryptocurrency. +Rather: +· +the creation of units of cryptocurrency generally is governed by the source code, not a central entity; +· +the transmission of a cryptocurrency is governed by the source code and processed by the decentralized peer-to-peer network of nodes or miners; and +· +the value of a cryptocurrency is generally determined by the market supply of and demand for the cryptocurrency, with prices set in transfers by mutual agreement or barter, as well as through acceptance directly by merchants in exchange for goods and services. +Cryptocurrencies may be open-source +projects with no official developer or group of developers that control the network. However, certain networks’ development may +be overseen informally by a core group of developers that may propose quasi-official releases of updates and other changes to the network’s +source code. The release of updates to a blockchain network’s source code does not guarantee that the updates will be automatically +adopted. Users and miners must accept any changes made to the source code by downloading the proposed modification of the network’s +source code. A modification of the network’s source code is effective only with respect to the users and miners that download it. +If a modification is accepted by only a percentage of users and miners, a division in the network will occur such that one network +will run the pre-modification source code and the other network will run the modified source code. Such a division is known as a “fork.” +Consequently, a modification to the source code becomes part of a blockchain network only if accepted by participants collectively having +most of the processing power on the network. +Each “account” +on a blockchain network is identified by its unique public key, and is secured with its associated private key (which the account holder +must keep secret, like a password). Cryptocurrencies are treated as bearer assets, because possession of the private key generally determines +who controls or owns a cryptocurrency. Protecting private keys from unwarranted access and theft is critically important, as once the +private key is taken, in most circumstances, control over the related cryptocurrency is gone. The combination of private and public cryptographic +keys constitutes a secure digital identity in the form of a digital signature. As long as the private key is kept private (i.e., confidential +to the owner of the account) it provides strong control of ownership. +17 +Ault Lending +Ault Lending provides commercial loans to companies throughout the +U.S. to provide them with operating capital to finance the growth of their businesses. The loans range in duration from six months to +three years. Ault Lending’s loans are made or arranged pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +Ault +Lending acquires controlling or non-controlling interests in and actively manages businesses that we generally believe (i) are undervalued +and have disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, +(iii) have the potential for positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, +and (v) have strong management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading +middle-market businesses in the niche-industrial and branded-consumer sectors. +Ault Lending uses a traditional methodology for valuing securities +that primarily looks for deeply depressed prices. Upon making an investment, we often become actively involved in the companies we seek +to acquire, whether in its entirety or merely a controlling or non-controlling interest. That activity may involve a broad range of approaches, +from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling +interest or outright ownership of the target company in order to implement changes that we believe are required to improve its business, +and then operating and expanding that business. +Ault +Lending believes that private company operators and corporate parents looking to sell their business units may consider us an attractive +purchaser because of our ability to: +· +provide ongoing strategic and financial support +for their businesses, including professionalization of our subsidiaries at scale; +· +maintain a long-term outlook as to the ownership +of those businesses; +· +sustainably invest in growth capital and/or add-on +acquisitions where appropriate; and +· +consummate transactions efficiently without being dependent on third-party transaction financing. +In particular, we believe that our outlook on length of ownership and +active management on our part may alleviate the concern that many private company operators and parent companies may have with regard +to their businesses going through multiple sale processes in a short period of time. We believe this outlook enhances our ability to develop +a comprehensive strategy to increase the earnings and cash flows of each of our businesses. +Finally, it has been our experience that our ability to acquire businesses +without the cumbersome delays and conditions typical of third-party transactional financing is appealing to sellers of businesses who +are interested in confidentiality, speed and certainty to close. +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2024, we believe that these businesses have stable +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Ault Lending provides funding +to businesses through loans and investments. Ault Lending offers a variety of loan types including commercial loans, convertible notes +and revolving lines of credit. Ault Lending is engaged in providing commercial loans to companies throughout the United States to provide +them with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to 12 months, +but may be of longer duration. These terms are subject to change as market needs dictate, and Ault Lending anticipates offering additional +products in the future. +18 +Ault Lending uses its considerable financial experience, data analytics, +and a credit scoring model to assess the creditworthiness of each small business borrower applicant. If the business meets Ault Lending’s +criteria, Ault Lending sets the initial interest rate according to its credit and financial models. The final interest rate offered to +the borrower will be determined by Ault Lending’s interpretation of the marketplace. In order to borrow from Ault Lending, borrowers +must display characteristics indicative of durable business and financial situations. These include factors such as revenue, time in business, +number of employees, and financial and credit variables. In order to qualify, business borrower applicants must be approved through Ault +Lending’s underwriting process, which analyzes credit and financial data of both the business and the business owner. Ault Lending +takes into account several business factors (including revenue, age of business, cash flows, and other variables). The underwriting process +determines the loan amount to approve, how loans will be priced, and whether to include a blanket lien, as well as additional factors +(including length of loan, estimated default rates by type and grade, and general economic environment). +Our Executive Committee, which is comprised of our Executive Chairman, +Chief Executive Officer and President, acts as the underwriting committee for Ault Lending and must approve all lending transactions. +The Executive Committee has decades of experience in financial, investing and securities transactions. Under its business model, Ault +Lending generates revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate +income from appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or +warrants issued to Ault Lending in any particular financing. +As noted above, we will from +time to time, through Ault Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2025, we anticipate +providing significant new funding to expand Ault Lending’s loan and investment portfolio. Ault Lending loans are made or arranged +pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +RiskOn International, Inc. +Overview +RiskOn’s operations are primarily +those of BNC, which is engaged in the development and operation of an online gaming platform (the “Platform”). The Platform +offers engaging and dynamic online gaming experiences by integrating various elements such as gaming, social activities, sweepstakes, +online gaming and more. ROI aims to provide innovative ways for people in the United States to interact online. The Platform is located +at BitNile.com and is accessible via any device using any web browser, without requiring permissions, downloads, or apps. +BNC’s games operate on a free-to-play model, whereby game players +may collect coins free of charge through the passage of time, free top-up feature, and, if a game player wishes to obtain coins above +and beyond the level of free coins available to that player, the player may purchase additional coin packages (“Freemium” +gaming model). However, no purchase is necessary to participate in any sweepstakes, and sweepstakes entries themselves cannot be purchased . +Once obtained, the coins (either free or purchased) cannot be redeemed for cash or exchanged for anything outside of the Platform. When +coins are used in the games, the game player could “win” and be awarded additional coins, or could “lose” and +lose the future use of those coins. +BNC’s current and planned +products and experiences are: +· +Gaming. The Platform provides an extensive selection of gaming options, including participation in games, sweepstakes and social gaming experiences, such as Blackjack and roulette. +19 +· +Sweepstakes gaming. The Platform features a dedicated gaming zone for users to engage in sweepstakes gaming, offering opportunities to win real money and prizes. +· +Socialization and connectivity. The Platform’s ongoing mission will be to foster global connections by enabling users to interact with individuals, forming new friendships, collaborating on projects or engaging in conversations within various social hubs. +Business Strategy +The online sweepstakes gaming +industry in the United States is experiencing rapid growth and expansion, driven by advancements in technology and increased interest +in free-to-play and social gaming. BNC’s business strategy revolves around creating a seamless, all-encompassing platform that caters +to various user needs and interests, particularly in sweepstakes and social gaming experiences. +The strategic pillars for the growth of the Platform include (i) leveraging +cutting-edge technology to offer a user-friendly, browser-based platform compatible with modern devices for an enhanced experience, (ii) +providing a diverse range of sweepstakes and gaming products that cater to users with different interests and preferences, (iii) fostering +connections and a sense of community among users, encouraging socialization and (iv) focusing on continuous innovation and regulatory +compliance to stay ahead of industry trends and customer expectations. +Competition +BNC faces competition from +both established online gaming platforms and new entrants in the market. It competes with recognized sweepstakes operators—such +as Chumba Casino, Stake.us, and Luckyland—that continually introduce new offerings in this evolving space. BNC also contends with +gaming-focused platforms like Fortnite and Roblox, as well as other social or casual games that vie for user attention. In addition, traditional +brick-and-mortar casinos are increasingly expanding their reach by introducing online components or apps, which further intensifies the +competitive landscape. +Regulatory Environment: Present and Future +Challenges +As the online gaming industry +continues to grow and evolve, regulatory challenges and considerations are becoming increasingly important. The nature of the Platform, +which often combines elements of gaming, social networking, and digital economies, presents a complex landscape for regulators to navigate. +To navigate the complex and +evolving regulatory landscape, BNC will prioritize compliance with relevant laws and regulations in all jurisdictions where it operates. +This includes data privacy and protection regulations, gaming and sweepstakes regulations, and intellectual property rights. By maintaining +a strong focus on regulatory compliance, BNC aims to minimize potential legal risks and build trust with users and partners. +Present Regulatory Challenges +The online gaming industry +is currently grappling with several regulatory challenges. First, data privacy and security concerns loom large, as users share personal +information and engage in transactions within the Platform. Regulators require that platforms comply with existing data protection regulations, +such as the General Data Protection Regulation (“GDPR”) and the California Consumer Privacy Act (“CCPA”). +Second, sweepstakes-specific +compliance poses unique hurdles because sweepstakes must be free to enter and cannot require a purchase for participation. Accordingly, +businesses must structure their sweepstakes to ensure adherence to state and federal laws, such as providing an alternative means of entry +and clear disclosures. +Third, intellectual property +rights become complicated when a platform relies on user-generated content and virtual goods or items. Copyright, trademark, and patent +laws can be difficult to enforce in virtual environments, raising questions about how best to protect and manage these rights. +20 +Fourth, taxation and financial +regulations come into play as virtual economies flourish, particularly with the rise of cryptocurrencies and non-fungible tokens. Regulators +must determine how to classify and tax digital assets and transactions, while also ensuring compliance with anti-money laundering and +know-your-customer requirements. +Lastly, content moderation +and liability remain pressing issues. Platforms must moderate content and user behavior while navigating potential liability for user-generated +content. This includes addressing possible violations of laws related to hate speech, harassment, and misinformation, all of which carry +significant legal and reputational risks. +Future Regulatory Challenges +As sweepstakes gaming continues +to develop and expand, several additional regulatory questions are likely to emerge. Payment processing and banking compliance may draw +heightened scrutiny as operators look for efficient ways to deliver prizes or credits, requiring compliance with anti-money laundering +and know-your-customer regulations in a sweepstakes context. Evolving state sweepstakes laws add further complexity, as each state imposes +unique statutes and regulations regarding contests, forcing operators to stay informed on registration or bonding requirements. Emerging +digital prize formats, such as virtual items or tokens, may require additional clarity from state and federal regulators to determine +their proper classification. Finally, accessibility and inclusivity concerns will likely increase, with regulators paying more attention +to ensuring that sweepstakes remain inclusive and transparent for all eligible participants +askROI +Overview +askROI is an AI-powered software-as-a-service +platform designed to help businesses leverage their data for competitive advantage. At the core of askROI’s technology is a state-of-the-art +large language model (“LLM”), which is exclusively licensed from a third-party provider for use in North America. The askROI +platform is located at askroi.com and askROI dedicated applications are available for download on both the Apple and Google app marketplaces. +By seamlessly integrating +with a company’s existing tools and data sources, askROI seeks to deliver actionable insights, intelligent analysis, and data-driven +decision support. The platform’s LLM-powered technology allows it to interpret complex queries, identify relevant information, and +provide highly contextualized responses, all while continuously learning and adapting to each organization’s unique language and +terminology. +Our vision is that askROI +can transform how businesses operate in the digital age. With our exclusive access to cutting-edge LLM technology and our commitment to +delivering tangible business value, askROI seeks to set a new standard for AI-powered insights and decision support in the North American +market. +askROI’s current and +planned product functionality are: +· Seamless integration : askROI connects +with a wide range of business tools, including customer relationship management, cloud storage systems (e.g., OneDrive, Google Drive), +and communication platforms (e.g., Slack, Teams). Ongoing expansion of integration partnerships will further streamline data access and +analysis; +· Contextualized understanding : By referencing +secure, company-specific workspaces and knowledge bases rather than training the underlying LLM, askROI can deliver tailored insights +aligned with each organization’s unique terminology, product names, and project codes. Ongoing refinements to the platform’s +natural language processing capabilities will enable even more nuanced, context-aware analysis; +· Actionable insights : askROI analyzes data +to generate custom reports, draft data-rich presentations, and create visualizations like charts and graphs. Introduction of industry-specific +templates for reports, data visualizations, and analytics dashboards will provide additional value for users in targeted sectors; +· Transparency and security : askROI cites +specific data sources for its answers and provides direct document links for reference. Robust data security measures, including access +controls, encryption, and audit trails, seek to ensure the protection of sensitive information. Future updates will focus on achieving +compliance with key regulations such as GDPR, SOC 2, and payment card industry data security standards; +21 +· Ethical AI : Implementation of strict guidelines +and oversight mechanisms to ensure responsible development and use of askROI’s AI models, mitigating risks of bias, discrimination, +or misuse; and +· Partner ecosystem : Development of a robust +network of consultancies, system integrators, and industry-specific solution providers to accelerate adoption and create tailored solutions +for diverse business needs. +By continually enhancing and +expanding its capabilities, askROI aims to position its platform as an indispensable tool for businesses seeking to leverage their data +for competitive advantage and operational excellence. +Business Strategy +askROI is currently in early +development, focusing on support and commercial applications. However, the platform’s flexible architecture and powerful AI capabilities, +underpinned by its exclusive licensing agreement for the LLM technology in North America, position it for broad applicability across industries. +The go-to-market strategy involves continued refinement of the core product based on beta user feedback, followed by a staged rollout +to additional sectors. +Key strategic initiatives +include: +· Continued refinement of the core product based +on beta user feedback, followed by a staged rollout to additional sectors; +· Leveraging its exclusive LLM licensing agreement +to differentiate askROI in the North American market, attracting customers seeking advanced AI solutions; +· +Using askROI as a dedicated application in both the Apple and Google app marketplaces, enabling mobile-first +experiences and expanding accessibility to on-the-go users; +· Expanding integration partnerships to ensure +askROI can seamlessly fit into diverse tech stacks, minimizing adoption barriers; +· Focusing marketing efforts on real-world use +cases and demonstrable return on investment, showcasing how askROI can drive tangible business outcomes; +· Building a strong partner ecosystem, including +consultants, system integrators, and industry-specific solution providers, to accelerate adoption; and +· Investing in research and development to maintain +a competitive edge in natural language processing, machine learning, and data analytics. +By adopting these strategic +initiatives and building on what we believe to be its unique LLM licensing advantages, askROI aims to position itself as a leading AI-powered +insights engine, setting the standard for data-driven decision-making and operational excellence. +Competition +We believe that askROI’s +unique positioning as an AI-powered insights engine operating exclusively on a company’s own data, differentiates it from both generic +AI tools and other enterprise search and analytics platforms. +Key differentiators include: +· Exclusive access to advanced LLM : we believe +that askROI’s licensing agreement provides a significant competitive advantage, enabling the platform to leverage advanced natural +language processing capabilities; +22 +· Seamless integration with existing business +tools : By minimizing disruption to established workflows and enabling rapid adoption, askROI will reduce barriers to entry and increases +its appeal to potential customers; +· Ability to provide company-specific context : +Through secure, dedicated workspaces and knowledge bases, askROI accepts and indexes an organization’s proprietary documents without +using them to train the underlying LLM. Instead, the platform queries these internal data sets on demand to generate relevant, context-rich +answers specific to each organization’s terminology and needs. By keeping this data separate from the LLM’s base model training, +askROI maintains data confidentiality while still delivering more accurate and actionable insights than generic AI solutions; +· Focus on delivering actionable insights : +askROI goes beyond simple data aggregation, empowering users to make informed decisions and drive tangible business outcomes; and +· Commitment to data security and privacy : +By ensuring that sensitive information remains protected and compliant with evolving regulations, askROI addresses a key concern for businesses +considering AI-driven solutions. +We believe that as the market +for AI-driven business tools continues to expand, askROI is well-positioned to capture market share through its advanced capabilities, +ease of use and strong commitment to customer success. askROI’s LLM licensing arrangement provides an important differentiator, +but the rapid pace of AI innovation requires it to continually invest in research and development to maintain a competitive edge. +However, askROI also recognizes +the potential for competition from established enterprise software providers and emerging startups focused on AI-powered analytics and +decision support. To mitigate these competitive risks, askROI will focus on building a strong brand identity, cultivating a loyal customer +base, and leveraging its partner ecosystem to create advantages focused on its core offerings. +Ultimately, askROI’s +success will depend on its ability to consistently deliver value to customers, stay at the forefront of technological innovation, and +adapt to the evolving needs of the market. By remaining agile, customer-centric, and committed to its vision of empowering businesses +through AI-driven insights, askROI is confident in its ability to thrive in the face of competition and position itself as a leader in +the market. +Regulatory Environment (Present and Future) +The regulatory landscape for +artificial intelligence and data-driven technologies continues to evolve worldwide, presenting both challenges and opportunities for askROI. +In various regions, including the United States, the European Union, and parts of Asia, governments and regulatory bodies are introducing +new legislation and guidelines specifically related to AI, data privacy, and automated decision-making. For example, the European Union’s +draft AI Act proposes a risk-based approach that could place additional compliance requirements on AI developers. Some of our competitors, +particularly large, established technology companies, already have more extensive compliance frameworks or resources to adapt quickly, +giving them a potential advantage in the event of significant regulatory changes. +To address these developments, +askROI maintains a strong commitment to data protection and security. askROI’s platform employs encryption, access controls, and +audit trails to safeguard customer information. At the same time, askROI recognizes that the rapid evolution of AI regulation may lead +to complex or overlapping legal requirements across various jurisdictions, ultimately increasing its compliance costs or limiting certain +functionalities. Consequently, askROI proactively engages with industry groups, policymakers and external advisors to stay informed about +emerging regulations and ensure that its platform aligns with current and anticipated standards. +Nevertheless, ongoing changes +in AI-related rules and interpretations of existing data-privacy laws could require askROI to make significant investments or modifications +to the askROI platform. Compliance obligations might include adding new audit capabilities or restricting how certain AI features function +to meet transparency or accountability requirements. In the event that these regulatory changes become more restrictive than anticipated, +askROI’s operations could be adversely affected, and its ability to serve customers in certain markets could be limited. +23 +Circle 8 +Description of the Business +Headquartered in Houston, +Circle 8 is a premier lifting services provider serving clients in Texas, Oklahoma, Louisiana and New Mexico with five strategically located +branches in Texas and Oklahoma. Its modern fleet consists of 57 mobile all-terrain and hydraulic cranes, with lifting capacities of up +to 350 tons that provides services across the Eagle Ford, Permian, Delaware and Haynesville basins. Circle 8 is poised for organic growth +through a strengthened financial profile following its recapitalization in December 2022. Circle 8’s fleet consists of Grove, Liebherr, +Xuzhou Construction Machinery Group and other leading original equipment manufacturers (“OEMs”). +Circle 8 provides experienced +professionally certified operators to deliver customized solutions to lifting clients in oil field services, construction, commercial, +refining / marketing and wind energy markets. Circle 8 maintains an industry leading safety record. Safety personnel hold certifications +and undergo in-house training. +Competitive Advantage +Circle 8’s operating experience and the mid-sized diverse fleet +that it has developed serves the oil service and petrochemical industries, providing full-service lifting solutions with an industry leading +safety record. Key strengths of Circle 8 include: +· +Leading lifting solutions platform +○ +Leading provider of comprehensive lifting solutions to diversified end markets, including oil & gas and with expanding operations in infrastructure, plant turn-around and commercial/industrial construction; and +○ +Leading market position with five branches strategically located throughout Texas and Oklahoma. +· +Industry leading safety record, commitment and policy +○ +Safety is a core value and Circle 8 is a market leader in employee training and practices; and +○ +Dedicated team focused on safety programs. +· +Proven strength of management, recently enhanced and augmented +○ +Proven ability to navigate a secular downturn by maintaining strong customer relationships and scale operations to capture additional market share; +○ +Seasoned industry leaders who have positioned Circle 8 for future growth; and +○ +Additional advisory team to supplement full time management with strategic industry knowledge, contacts and corporate transaction capability. +· +High quality fleet with the opportunity to expand by 100% creates a barrier to entry. Circle 8’s fleet of 57 cranes, as of the date of this Annual Report, comprises 47 all-terrain cranes and 10 hydraulic truck cranes with a combined average age of 9 years and capacity of up to 350 tons. +· +Diversified blue-chip customers +○ +Entrenched provider to leading, well-capitalized oil and gas industry operators in Texas, New Mexico, Louisiana and Oklahoma; +○ +Diverse customer base with minimal customer concentration risk; and +○ +Longstanding relationships enable company to easily scale up operations with customers’ demands in the oilfield (upstream), commercial, construction, refining & marketing (downstream) and wind energy markets. +· +Compelling utilization and financial profile +○ +Recently downsized underutilized cranes to return to pre-pandemic fleet utilization over 160%; and +○ +Substantial upside remains as the Company efficiently relocates and repurposes its fleet across geographies and end markets. +24 +Industry +In 2024, the U.S. lifting +solutions equipment distribution and rental industry experienced notable consolidation activities. United Rentals, Inc. (“URI”) +announced its intention to acquire H&E Equipment Services for approximately $4.8 billion, aiming to enhance its equipment capacity +and capitalize on the growing demand for equipment rentals in the United States. Additionally, URI completed the acquisition of Yak Access, +LLC, for approximately $1.1 billion, expanding its specialty business offerings. Herc Holdings, Inc. (“HRI”) also pursued +growth through acquisitions, completing nine acquisitions that added 28 locations and opening 23 new greenfield locations during the year. +Despite these consolidation efforts, the industry remains highly fragmented, comprising a mix of multi-location regional or national operators +and numerous small, independent businesses serving local markets. The industry's dynamics are influenced by various economic factors, +including trends in U.S. residential and non-residential construction, demand for construction machinery, and region-specific considerations. +Lifting solutions equipment continues to be distributed through two primary channels: equipment rental companies and equipment dealers. +Prominent equipment rental companies include URI, Sunbelt Rentals, and HRI, while notable equipment dealers include Finning and Toromont. +Circle 8 operates within a rental business segment that provides comprehensive project services, including labor and consumables. Similarly, +many pure equipment rental companies offer parts and service support to their customers. +Sales and Marketing +Led by Arnold Mabee and Brett +Rhuland, the sales force is highly specialized in lifting solutions sales to oil services customers, seeking long term purchase orders +and master service agreements. Circle 8 plans to continue the extensive training program which involves OEM training sessions on operations +and maintenance to ensure the entire sales force knows the fleet inside and out. +Circle 8 will be working with +continuing management to implement a back-office content resource management system that will be heavily focused on data collection so +that it can continue to improve margin and help streamline scheduling, operations and fleet management to optimize utilization. +Competitive Business Strategy +The oil services’ lifting +solutions demand has historically been one of the leading sub-segments of the industry for profitability due to high utilization rates +that coincide with the continuous workstreams of extraction. Circle 8 plans to expand this business line in both topline sales through +optimizing service and quality operations with a strong safety record. +In addition to expanding the +existing business, Circle 8 will seek to make additional forays into the infrastructure construction, the refinery and manufacturing plant +turn-around and industrial facility construction with the availability of new cranes as they become available. +Customers +With a focus on the oil services +sub-segment of the lifting solutions business in the Eagle Ford, Haynesville, Permian, Delaware and Anadarko basins, Circle 8 has a diversified +base of blue-chip customers in TX and OK. While about a third of its sales are expected to be made up from six of the largest players +in the industry, the remaining two thirds of sales will be highly diversified, leading to minimal concentration risk. With its longstanding +relationships with blue-chip customers and incoming fleet units, Circle 8 believes it has the ability to scale up sales with these customers +locally and most likely into other adjacent areas. +Competition +Due to the highly skilled +nature and competitive nature of the lifting solutions business, the sector typically consists of companies like Circle 8 that provide +full service lifting solutions on rental or contract basis, including the manpower required to operate the equipment or companies that +require extensive lifting solutions straight purchasing the equipment and hiring crane operators directly. +The full-service lifting solutions +business is highly fragmented and local with only a few national service providers. In Circle 8’s existing subsegment of the lifting +solutions business to the petrochemical industry, the competition is not as strong as it is in others as the contract terms are usually +longer term and driven by maintaining strong customer relationships. The diversification strategy for Circle 8 into other subsegments +will be faced with competition that is largely driven based on availability, quality (including safety record), reliability and price. +25 +Environmental and Safety Regulations +Circle 8’s equipment, +facilities and operations are subject to comprehensive and frequently changing federal, state and local environmental and occupational +health and safety laws, which may vary locally. These laws regulate (1) the handling, storage, use and disposal of hazardous materials +and waste and, if any, the associated cleanup of properties affected by pollutants; (2) air quality (emissions); and (3) wastewater. While +lifting solutions’ operations generally do not raise significant environmental risks, Circle 8 uses petroleum products, solvents +and other hazardous substances for fueling and maintaining its fleet and vehicles. Circle 8 has made, and will continue to make, capital +and other expenditures to comply with environmental requirements. Circle 8 does not currently anticipate any material adverse effect on +its business, financial condition or competitive position as a result of its efforts to comply with such requirements. +In the future, federal, state +or local governments could enact new or more stringent laws or issue new or more stringent regulations concerning environmental and worker +health and safety matters, reporting and disclosure obligations, or effect a change in their enforcement of existing laws or regulations, +that could affect operations and increase operational and compliance expenditures. Also, in the future, contamination may be found to +exist at Circle 8’s facilities or off-site locations where waste has been sent. There can be no assurance that Circle 8, or various +environmental regulatory agencies, will not discover previously unknown environmental non-compliance or contamination. Circle 8 could +be held liable for such newly discovered non-compliance or contamination. It is possible that changes in environmental and worker health +and safety laws or liabilities from newly discovered non-compliance or contamination could have a material adverse effect on Circle 8’s +business, financial condition and results of operations. +AGREE +AGREE is actively invested +across a diverse range of commercial real estate asset classes, with a particular focus on hospitality and in the future, multifamily +properties. AGREE strategically targets the middle market segment in geographic areas that present strong fundamentals and offer relative +value, such as emerging or overlooked markets with growth potential. AGREE’s core objective is to deliver attractive, risk-adjusted +returns through a combination of ground-up development, targeted capital investments, and operational enhancements that unlock long-term +value. +In the hospitality sector, +AGREE brings a hands-on, value-driven approach that goes beyond traditional ownership. Recognizing the unique dynamics of hospitality +real estate—which blends real estate investment with service-based business operations—AGREE prioritizes both physical improvements +and elevated guest experiences to drive performance. By focusing on midscale to upper-midscale hotels in underpenetrated markets, AGREE +positions its hospitality assets to capture stable demand from business and leisure travelers alike. +A key component of AGREE’s +hospitality platform is AGREE Madison, a wholly owned subsidiary that operates four recently renovated hotel properties in the Midwest. +These include the Hilton Garden Inn Madison West, Residence Inn Madison West, Courtyard Madison West, and Hilton Garden Inn Rockford. +AGREE operates a total of 526 keys collectively across the four-property portfolio. Each property has undergone substantial upgrades since +acquired to enhance both aesthetic appeal and operational efficiency, ensuring they meet modern traveler expectations while maintaining +cost discipline. Through AGREE Madison, the firm exercises direct oversight of day-to-day operations, ensuring alignment with its broader +investment philosophy of value creation through active management. +TurnOnGreen +Overview +TurnOnGreen, +through its wholly owned subsidiaries Digital Power and TOG Technologies, is an emerging provider of premium power electronic and EV charging +solutions. TurnOnGreen designs, develops, manufactures, and sells highly engineered, feature-rich, high-grade power conversion systems +and power solutions for mission-critical, life-sustaining, and lifesaving applications across a variety of sectors, particularly those +operating in demanding and harsh environments. TurnOnGreen serves a broad range of markets, including defense and aerospace, medical and +healthcare, industrial applications, telecommunications, e-Mobility, and OEM solutions. TurnOnGreen’s products are highly adaptive, +featuring customized firmware meticulously configured to meet the specific requirements and challenges of its customers’ applications. +Approximately 8% of TurnOnGreen’s revenue is generated leveraging its core power technologies to deliver comprehensive EV charging +infrastructure and subscription-based charging network management services for residential, fleet, hospitality, workplace, healthcare, +municipal, and educational environments including universities and schools. +26 +At +Digital Power, TurnOnGreen provides a comprehensive range of integrated power system solutions that are designed to meet the diverse and +precise needs of its customers with the highest levels of efficiency, flexibility and scalability. Digital Power designs, develops and +manufactures custom power systems to meet performance and/or form-factor requirements that cannot be met with standard power products. +These power system solutions are designed to function reliably in harsh environments associated with defense and aerospace applications, +while also being utilized for applications ranging from industrial and telecommunications equipment to medical instrumentation. TurnOnGreen +believes that Digital Power’s power products are highly adaptive and feature digital power management and software configurations +that allow them to achieve higher power efficiency to meet the requirements of both its customers and its OEMs. In addition to Digital +Power’s custom power system solutions, it also provides a wide range of industry-standard power products. These products include +the AC/DC open frame product series, which TurnOnGreen believes to be among the industry’s leading power switchers in terms of power +efficiency. The open frame products are deployed in highly compact form factors and modular power series that support configurable multiple +DC outputs. Additionally, Digital Power offers high-power and high-voltage laser power supplies tailored to meet the unique requirements +of medical, dental, and industrial pulsed energy systems. Digital Power’s expertise also encompasses high-performance and high-power +data-center power supplies, semiconductor fabrication equipment power source supplies, desktop power supplies, and a comprehensive range +of value-added customized AC/DC and DC/DC ruggedized power supply and system solutions. +Our +Strategy +Our business strategy is designed +to increase stockholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to stockholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase cash flows +and stockholder value. Hyperscale Data actively oversees and supports the management teams of each of our businesses by, among other things: +· +recruiting and retaining talented managers to +operate our businesses using structured incentive compensation programs, including non-controlling equity ownership, tailored to each +business; +· +regularly monitoring financial and operational +performance, instilling consistent financial discipline, and supporting management in the development and implementation of information +systems to effectively achieve these goals; +· +assisting management in their analysis and pursuit +of prudent organic growth strategies; +· +identifying and working with management to execute +attractive external growth and acquisition opportunities; +· +assisting management in controlling and right-sizing +overhead costs; +27 +· +nurturing an internal culture of transparency, +alignment, accountability and governance, including regular reporting; +· +professionalizing our subsidiaries at scale; and +· +forming strong subsidiary level boards of directors to supplement management in their development and implementation of strategic goals and objectives. +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Hyperscale Data to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +· +making selective capital investments to expand +geographic reach, increase capacity, or reduce manufacturing costs of our businesses; +· +investing in product research and development +for new products, processes or services for customers; +· +improving and expanding existing sales and marketing +programs; +· +pursuing reductions in operating costs through +improved operational efficiency or outsourcing of certain processes and products; and +· +consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +· +leverage manufacturing and distribution operations; +· +leverage branding and marketing programs, as well +as customer relationships; +· +add experienced management or management expertise; +· +increase market share and penetrate new markets; +and +· +realize cost synergies by allocating the corporate overhead expenses of our businesses across a larger number of businesses and by implementing and coordinating improved management practices. +Compliance with Material Government (Including +Environmental) Regulations +Sentinum +Sentinum is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. Sentinum continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While Sentinum’s regulatory compliance +costs are currently not considered material, it is possible that costs incurred to ensure continued environmental compliance could have +a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Michigan Facility is subject to a final corrective measures plan +with the Environment Protection Agency. The seller performed remedial activities at the Michigan Facility relating to historical soil +and groundwater contamination and Sentinum is responsible for ongoing monitoring and final remediation plans. We estimate the cost of +the environmental remediation obligation is approximately $0.4 million and reflects our best estimate of probable future costs for remediation +based on the current assessment data and regulatory obligations. Future costs will depend on many factors, including the extent of work +necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. We may incur actual costs in +the future that are materially different than this estimate and such costs could have a material impact on results of operations, financial +condition, and cash flows during the period in which they are recorded. +28 +TurnOnGreen +TurnOnGreen’s businesses +are heavily regulated in most of its markets. TurnOnGreen handles power electronics products mainly in the form of power conversion. TurnOnGreen +must take into account several standards for electronic safety to protect the health of humans and animals. TurnOnGreen serves diverse +markets including automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set +of safety regulations and standards that TurnOnGreen must comply with. +Government Contracts . +The U.S. Government, and other governments, may terminate any of TurnOnGreen’s government contracts at their convenience, as well +as for default based on our failure to meet specified performance requirements. If any of TurnOnGreen’s U.S. Government contracts +were to be terminated for convenience, TurnOnGreen would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of TurnOnGreen’s government contracts were to be terminated for default, generally the U.S. Government +would pay only for the work that has been accepted and could require TurnOnGreen to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold +TurnOnGreen liable for damages resulting from the default. +Medical device power supplies . +TurnOnGreen’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. TurnOnGreen must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +Environmental . TurnOnGreen +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TurnOnGreen continually assesses its compliance status +and management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of TurnOnGreen’s operations. +Non-U.S. Sales . TurnOnGreen’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December +31, 2024 and 2023, we spent approximately $11.0 million and $4.4 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +29 +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries. +Employee Profile +As of December 31, 2024, we +had 424 employees located in the U.S. and the U.K., of whom 15 were engaged in engineering and product development, 30 in sales and marketing, +328 in general operations and 51 in general administration and finance. All but 50 of these employees are employed on a full-time basis. +None of our employees is currently represented by a trade union. We consider our relations with our employees to be good. +As of December 31, 2024, approximately +26% of our current workforce is female, 74% male, and our average tenure is 3.5 years, a decrease of 45% from an average tenure of +6.4 years as of December 31, 2023. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. +We believe we materially comply +with all applicable state, local and international laws governing nondiscrimination in employment in every location in which we operate. +All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, national +origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees’ needs. We plan to conduct annual confidential employee +surveys as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. +Our employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new +stretch goals. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +30 +ITEM 1A. RISK FACTORS +An investment in our Class +A common stock involves significant risks. You should carefully consider the following risks and all other information set forth in this +Annual Report before deciding to invest in our Class A common stock. If any of the events or developments described below occurs, our +business, financial condition and results of operations may suffer. In that case, the value of our Class A common stock may decline and +you could lose all or part of your investment. +You should consider each of +the following risk factors and any other information set forth in this Annual Report and the other reports filed by the Company with the +SEC, including the Company’s financial statements and related notes, in evaluating the Company’s business and prospects. The +risks and uncertainties described below are not the only ones that impact on the Company’s operations and business. Additional risks +and uncertainties not presently known to the Company, or that the Company currently considers immaterial, may also impair its business +or operations. If any of the following risks actually occurs, the Company’s business and financial condition, results or prospects +could be harmed. Please also read carefully the section entitled “Cautionary Note About Forward-Looking Statements” at the +beginning of this Annual Report. +Risks Related to Our Company +We have an evolving business model, which increases the complexity +of our business. +Our business model has evolved +in the past and continues to do so. In prior years we have added additional types of services and product offerings and in some cases, +we have modified or discontinued those offerings. We intend to continue to try to offer additional types of products or services, and +we do not know whether any of them will be successful. From time to time we have also modified aspects of our business model relating +to our product mix. We do not know whether these or any other modifications will be successful. The additions and modifications to our +business have increased the complexity of our business and placed significant strain on our management, personnel, operations, systems, +technical performance, financial resources, and internal financial control and reporting functions. Future additions to or modifications +of our business are likely to have similar effects. Further, any new business or website we launch that is not favorably received by the +market could damage our reputation or our brand. The occurrence of any of the foregoing could have a material adverse effect on our business. +We are heavily dependent on our senior management, +and a loss of a member of our senior management team could cause our stock price to suffer . +If we lose the services of +Milton C. Ault, III, our Executive Chairman, William B. Horne, our Chief Executive Officer, Henry Nisser, our President and General Counsel, +or Ken Cragun, our Chief Financial Officer and/or certain key employees, we may not be able to find appropriate replacements on a timely +basis, and our business could be adversely affected. Our existing operations and continued future development depend to a significant +extent upon the performance and active participation of these individuals and certain key employees. Although we have entered into employment +agreements with Messrs. Ault, Horne and Nisser, and we may enter into employment agreements with additional key employees in the future, +we cannot guarantee that we will be successful in retaining the services of these individuals. If we were to lose any of these individuals, +we may not be able to find appropriate replacements on a timely basis and our financial condition and results of operations could be materially +adversely affected. +We rely on highly skilled personnel and the +continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our business may be +severely disrupted. +Our performance largely depends on the talents, knowledge, skills, +know-how and efforts of highly skilled individuals and in particular, the expertise held by our Executive Chairman, Milton C. Ault, III. +His absence, were it to occur, would materially and adversely impact the development and implementation of our projects and businesses. +Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all +areas of our organization. Our continued ability to compete effectively depends on our ability to attract, among others, new technology +developers and to retain and motivate our existing contractors. If one or more of our executive officers are unable or unwilling to continue +in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may be severely disrupted, +and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives joins a competitor or forms +a competing company, we may lose some customers. +31 +We may not be able to utilize our net operating loss carryforwards. +As of December 31, 2024, we +had federal and state net operating loss carryforwards (“NOLs”) for income tax purposes of approximately $134.4 million and +$204.9 million, respectively, after application of the limitations set forth in Section 382 of the Internal Revenue Code. In accordance +with Section 382, future utilization of our NOLs is subject to an annual limitation as a result of ownership changes that occurred previously. +We also maintain NOLs in various foreign jurisdictions. +Risks Related to Our Indebtedness and Liquidity +We will need to raise additional capital to +fund our operations in furtherance of our business plan. +Until +we are profitable, we will need to quickly raise additional capital in order to fund our operations in furtherance of our business plan. +The proposed financing may include shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred +stock, debt securities, units consisting of the foregoing securities, equity investments from strategic development partners or some combination +of each. Any additional equity financings may be financially dilutive to, and will be dilutive from an ownership perspective to, our stockholders, +and such dilution may be significant based upon the size of such financing. Additionally, we cannot assure that such funding will be available +on a timely basis, in needed quantities, or on terms favorable to us, if at all. +If we are unable to +comply with the covenants or restrictions contained in the Loan Agreement with our senior secured lender, the lender could declare all +amounts outstanding under the Loan Agreement to be due and payable and foreclose on its collateral, which could materially adversely affect +our financial condition and operations. +As +previously announced, on December 14, 2023, we, along with our wholly owned subsidiaries Sentinum, ACS, BNI Montana, Ault Lending, Ault +Aviation and AGREE, entered into the Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed $36 million +and issued Secured Notes to the lenders in the aggregate amount of $38.9 million. Pursuant to the Loan Agreement, we, and the other Guarantors, +agreed to act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral +in support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to +the Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated from the Miners and (c) +the membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those +entities granted to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault +Aviation, AGREE, Sentinum, Ault Energy, Eco Pack, and Circle 8 Holdco, (iii) a future advance mortgage by ACS on the Michigan Property, +(iv) an aircraft mortgage and security agreement by Ault Aviation on the Aircraft, and (v) deposit account control agreements over certain +bank accounts held by certain of our subsidiaries. The Loan Agreement has customary representations, warranties and covenants including +restrictions on indebtedness, liens, restricted payments and dividends, investments, asset sales and similar covenants and contains customary +events of default. +The +covenants and other restrictions contained in the Loan Agreement and other current or future debt agreements could, among other things, +restrict our ability to dispose of assets, incur additional indebtedness, pay dividends or make other restricted payments, create liens +on assets, make investments, loans or advances, make acquisitions, engage in mergers or consolidations and engage in certain transactions +with affiliates. These restrictions could limit our ability to plan for or react to market conditions or meet extraordinary capital needs +or otherwise restrict corporate activities. In addition, substantially all of our borrowed money obligations are secured by certain of +our assets. +A +failure to comply with any restrictions or covenants in the Loan Agreement, or to make payments into the Segregated Account when due or +make other payments we are obligated to make under Loan Agreement, could have serious consequences to our financial condition or result +in a default under the Loan Agreement and under other agreements containing cross-default provisions. A default would permit lenders to +accelerate the maturity of the debt under these debt agreements and to foreclose upon collateral securing the debt, among other remedies. +Furthermore, an event of default or an acceleration under one of our debt agreements could also cause a cross-default or cross-acceleration +of another debt instrument or contractual obligation, which would adversely impact our liquidity. Under these circumstances, we might +not have sufficient funds or other resources to satisfy all of our obligations. We may not be granted waivers or other amendments to these +debt agreements if for any reason we are unable to comply with these debt agreements, and we may not be able to restructure or refinance +our debt on terms acceptable to us, or at all. Whether or not those kinds of actions are successful, we might seek protections of applicable +bankruptcy laws. Additionally, all of our indebtedness is senior to the existing common stock in our capital structure. If we were to +seek certain restructuring transactions, our creditors would experience better returns as compared to our equity holders. Any of these +actions could have a material adverse effect on the value of our equity and on our business, financial performance, and liquidity. +32 +To service any future indebtedness and other obligations, +we will require a significant amount of cash. +Our ability to generate cash +depends on many factors beyond our control, and any failure to meet our debt service obligations, of which we currently have very few +but may in the future incur, including our obligations under our indebtedness or future outstanding shares of preferred stock, could harm +our business, financial condition and results of operations. Our ability to make payments on and to refinance any indebtedness and outstanding +preferred stock and to fund working capital needs and planned capital expenditures will depend on our ability to generate cash in the +future. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other +factors that are beyond our control. +If our business does not generate +sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to enable us and our subsidiaries +to pay our indebtedness or make dividend payments with respect to our any shares of preferred stock that we may issue, or to fund our +other liquidity needs, we may need to refinance all or a portion of our indebtedness or redeem the preferred stock, on or before the maturity +thereof, sell assets, reduce or delay capital investments or seek to raise additional capital, any of which could have a material adverse +effect on us. +In addition, we may not be +able to effect any of these actions, if necessary, on commercially reasonable terms or at all. Our ability to restructure or refinance +our indebtedness or redeem the preferred stock will depend on the condition of the capital markets and our financial condition at such +time. Any refinancing of our debt or financings related to the redemption of any shares of preferred stock that we may issue could be +at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. +The terms of future debt instruments or preferred stock may limit or prevent us from taking any of these actions. In addition, any failure +to make scheduled payments of interest and principal on any future outstanding indebtedness or dividend payments on any shares of preferred +stock that we may issue could harm our ability to incur additional indebtedness or otherwise raise capital on commercially reasonable +terms or at all. Our inability to generate sufficient cash flow to satisfy any future debt service and other obligations, or to refinance +or restructure our obligations on commercially reasonable terms or at all, would have an adverse effect, which could be material, on our +business, financial condition and results of operations. +Risks Related to Circle 8 +Circle 8 uses substantial leverage in its capital +structure which could adversely affect its financial condition. Although Circle 8’s debt-to-EBITDA ratio is below the industry median, +operational disruptions or economic shocks could hinder Circle 8’s ability to service its debt and impact its solvency. Additionally, +the industry tends to heavily rely on debt to finance expansionary initiatives, whether through organic growth or acquisitions. +Circle 8 currently has a substantial +amount of outstanding debt. As of December 31, 2024, it had total outstanding indebtedness of approximately $16.6 million, of which $13.1 +million was borrowed from First Citizens Bank (“FCB”) in a senior secured asset-based revolving line of credit, $1.9 million +consists of outstanding equipment notes with Manitowoc Finance (“MANF”) and SQN Capital Management, LLC (“SQN), $.9 +million of outstanding vehicle notes with Ford Motor Credit (“FMC”) and a $.6 million short term unsecured note with Meridian +Finance LLC. Circle 8 has the ability to increase the FCB loan by $7.4 million as of December 31, 2024. Circle 8 may further increase +its debt balance where permitted by incumbent lenders for growth and expansionary purposes. Circle 8’s substantial indebtedness +could have important consequences. For example, it may: +· increase Circle 8’s vulnerability to general +adverse economic, industry and competitive conditions; +· require management to dedicate a substantial +portion of Circle 8’s cash flow from operations to interest payments and principal repayment, thereby reducing the availability +of cash flow to fund working capital, capital expenditures, acquisitions, dividend payments to its owners and other general corporate +purposes; +· limit Circle 8’s flexibility in planning +for, or reacting to, changes in Circle 8’s specific business and the industry in which it operates; +· place Circle 8 at a competitive disadvantage +compared to its competitors that have less debt; and +· limit Circle 8’s ability to obtain additional +financing for working capital, capital expenditures, acquisitions or general corporate purposes. +33 +Circle 8 expects to use cash +flow from operations and borrowings under the FCB commitment to meet current and future financial obligations, including funding operations, +debt service and capital expenditures. Circle 8’s ability to make these payments depends on future operational performance, which +will be affected by financial, business, economic and other factors, many of which Circle 8 cannot control. Circle 8’s business +may not generate sufficient cash flow from operations in the future or be able to appropriately adjust operations to suit organic industry +developments, which could result in Circle 8’s inability to service its debt obligations, or to fund other liquidity needs. If Circle +8 has insufficient capital to cover its debt obligations, it may be forced to reduce or delay ongoing or growth activities and capital +expenditures, sell assets, obtain additional debt or dilutive equity capital or restructure or refinance all or a portion of its debt, +including the incumbent FCB, MANF,SQN and FMC loans, and any other incremental loans, on or before maturity. There can be no assurance +that Circle 8 will be able to accomplish any of these alternatives on terms acceptable to it or to us, if at all. In addition, the terms +of existing or future indebtedness, including the agreements governing the incumbent loans, may limit Circle 8’s ability to pursue +any other alternatives. +While Circle 8 has had an industry-leading +safety record throughout its history, it operates in a potentially hazardous industry, and any safety incident could significantly impact +its operations. A blemish on Circle 8’s safety record could lead to direct consequences such as fines, levies, and increased insurance +premiums, as well as indirect consequences such as customers preferring competitors with better safety records. +The lifting solutions business +is inherently risky, and accidents can occur due to a variety of factors, including negligence and unforeseeable events. Despite this, +Circle 8 has maintained an industry-leading safety record and has not experienced any incidents that have significantly impacted its operations. +While Circle 8 has a safety program in place, it cannot guarantee protection against unforeseeable events or “acts of God.” +Any safety transgressions can have a material impact on sales and operating results, leading to fines and levies, and potentially causing +customers to prefer competitors with better safety records. Therefore, Circle 8 places a great emphasis on maintaining its safety program +and continually improving its practices to minimize the risk of incidents occurring. +The lifting solutions business is dependent +on the domestic oil markets’ activity, oil pricing, construction and industrial activities, and the overall economic conditions. +Any downturn in these areas could adversely affect the demand for lifting solutions, leading to decreased sales and lower lifting solutions +prices, which may result in a decline in Circle 8’s revenues, gross margins and operating results. +Circle 8 primarily provides +lifting solutions for the U.S. domestic oil market. As such, any downturn in the U.S. domestic oil market or the economy as a whole could +result in reduced demand for its services or lower sales prices. Additionally, its business may face temporary or long-term negative impacts +due to: +· a reduction in extraction levels by customers +due to increased costs and break-even oil price and lower levels of reserves due to depletion of existing reserves and resources; +· exploration and drilling are capital intensive +and results are uncertain, which may limit Circle 8’s current clients’ demand for Circle 8’s services and adversely +affect its ability to generate new clients; +· until it executes on its expansion program, dependence +on a limited number of clients in a niche oil services market could make Circle 8 vulnerable compared to larger industry incumbents with +greater client diversity; +· unfavorable credit and equity markets affecting +end-user access to capital or cost of capital, also potentially increasing the all-in cash costs and break-even oil prices may make operations +of its current and future clients no longer economically viable; +· adverse changes in federal, state, tribal and +local government infrastructure spending; +· an increase in the cost of consumables and construction +materials related to oil extraction and infrastructure construction; +· adverse weather conditions or natural disasters +which may affect a particular region; +34 +· a decrease in the level of exploration, development, +production activity and capital spending by oil and natural gas companies; +· an increase in inflationary pressure on materials +and labor; +· labor issues such as strikes or worker shortages; +· a prolonged shutdown of the U.S. government; +· an increase in interest rates; +· supply chain disruptions; +· changes in federal and state regulations related +to climate change and greenhouse gas emissions may materially adversely impact Circle 8’s and/or its clients’ revenues, operating +results and profitability; +· public health crises and epidemics; or +· terrorism or hostilities involving the United +States and/or its allies. +Weakness or deterioration +in the oil services industry, renewables infrastructure construction, plant turn-around and public and industrial infrastructure construction +sectors caused by the above or other factors could have a material adverse effect on Circle 8’s financial position, results of operations +and cash flows in the future and may also have a material adverse effect on residual values realized on the disposition of the existing +and future rental fleet. +Circle 8’s business is highly reliant +on the availability of specialized skilled labor, and this dependency is particularly pronounced given the current scarcity of domestic +U.S. skilled labor. This scarcity is at an all-time high, which is further compounded as labor requirements to operate in Circle 8 ‘s +business becomes even more specialized. +The lifting solutions business +requires licensed operators to operate safely and within U.S. domestic regulatory requirements. It takes several months and material funding +to be trained to become a licensed crane operator, making the availability of qualified labor scarce for the lifting solutions industry +in general and specifically in remote locations in which Circle 8’s client set operates its oil services. Availability of labor +may have a significant impact on Circle 8’s ability to service its current client set and to be able to execute on its expansion +program. +Additionally, the training +and licensing requirements for crane operators can vary by state and even by municipality, which can create further challenges for Circle +8 in sourcing and deploying qualified labor in different geographic locations. Moreover, the competitive labor market for skilled workers +in the oil services industry could potentially drive-up labor costs for Circle 8, which would impact its profitability and competitiveness. +Circle 8’s business is, directly and +indirectly, dependent on a functioning global supply chain system. The oil and steel markets are global, and many suppliers, vendors, +OEM’s and parts manufacturers for Circle 8 and its clients’ industries are offshore. +The lifting solutions business +success is heavily dependent on the availability and efficient conversion to elevated utilization rates of the lifting assets. These metrics +can be fundamentally impacted by the functionality of the global supply chain, which plays several roles in the lifting solutions business. +For example, supply chain disruptions could delay the delivery of critical parts and components needed for maintenance and repair of lifting +assets, leading to longer downtime periods and reduced utilization rates. +In addition, fluctuations +in commodity prices could impact the cost of raw materials needed to manufacture lifting assets, potentially affecting the company’s +profitability. These fluctuations, among others, could impact the efficiency and profitability of Circle 8’s lifting solutions business +and can be impacted by a variety of factors, including the following: +· possible geopolitical unrest and conflict may +impact ability to receive new parts or new cranes in a timely manner, if at all, to optimize utilization and ultimately, profitability; +35 +· reliance on foreign suppliers for cranes and +exposure to trade embargoes could impede its ability to procure necessary parts and equipment to execute its growth strategies and maintain +its fleet; +· inflationary pressures resulting from supply +chain disruptions and labor shortages could make it difficult for Circle 8 to repair and replace its crane equipment at regular costs; +· fuel price escalation could have a material impact +on gross profit since it is typically approximately 7% of the operating cost structure in recent history; +· oil market sanctions and political pressure on +domestic production reduction may adversely impact Circle 8’s core clients and its revenues and profitability; or +· steel market sanctions, trade embargoes and other +supply chain shocks may adversely impact public and private infrastructure and renewables new construction and maintenance projects, ultimately +slowing Circle 8’s strategic transition to diversify its end markets and client base. +Furthermore, as Circle 8 expands +its operations, it may need to rely on suppliers and logistics partners in new geographic regions, which could expose the company to additional +supply chain risks. +Circle 8’s reliance on a limited number +of equipment manufacturers exposes the company to significant risks, as the termination or disruption of relationships with any of these +manufacturers could adversely impact Circle 8’s ability to obtain equipment in a timely or adequate manner, potentially leading +to operational disruptions and financial losses. +Circle 8 purchases most of its equipment from a leading, nationally +recognized OEM. For the year ended December 31, 2024, the company acquired two new cranes pursuant to leases with an option to purchase. +Prior thereto, it purchased 100% of its equipment from Manitowoc/Grove, one of the leading worldwide heavy equipment manufacturers. Utilizing +one OEM reduces the number of parts and inventory items kept on hand resulting in savings, while still allowing for efficient and timely +repairs and maintenance of Circle 8’s cranes. Circle 8 may diversify its equipment supplier options going forward to diversify its +fleet somewhat. Utilizing a new OEM equipment manufacturer creates risk from requiring an increase in parts inventory and could have an +adverse effect on the business, financial condition or results of operations if the new OEM were unable to supply Circle 8 in an adequate +or timely manner. +Circle 8 faces risks related to heightened +inflation, recession, financial and credit market disruptions and other economic conditions. +Circle 8’s financial +results, operations and forecasts depend significantly on worldwide economic and geopolitical conditions, the demand for Circle 8’s +products, and the financial condition of its customers and suppliers. Economic weakness and geopolitical uncertainty have in the past +resulted, and may result in the future, in reduced demand for lifting solutions resulting in decreased sales, margins and earnings. In +2022 and 2023, the U.S. experienced significantly heightened inflationary pressures which have continued into 2025. It is difficult to +fully mitigate the impact of inflation through price increases passed through to customers that are operating in commodity sector with +global end market pricing mechanisms, productivity initiatives and cost savings, which could have an adverse effect on Circle 8’s +financial results and position. In addition, if the U.S. economy enters a recession, Circle 8’s sales may decline, which could have +an adverse effect on its overall business, operating results and financial condition. Similarly, disruptions in financial and/or credit +markets may impact Circle 8’s ability to manage normal commercial relationships with its customers, suppliers and creditors. Further, +in the event of a recession or threat of a recession, Circle 8’s customers and suppliers may suffer their own financial and economic +challenges and as a result they may demand pricing accommodations, delay payment, or become insolvent, which could harm Circle 8’s +ability to meet its customer demands or collect revenue or otherwise could harm the business and its ability to service incumbent loans, +ultimately leading to possible insolvency. An economic or credit crisis could occur and impair credit availability and Circle 8’s +ability to raise capital as required for ongoing working capital, maintenance capital and expansion capex. A disruption in the financial +markets could impair Circle 8’s banking or other business partners, on whom it relies for access to capital. In addition, changes +in tax or interest rates in the U.S. or other nations, whether due to recession, economic disruptions or other reasons, could have an +adverse effect on Circle 8’s operating results. Economic weakness and geopolitical uncertainty may also lead to asset impairment, +restructuring actions or adjust Circle 8’s operating strategy and reduce expenses in response to decreased sales or margins. Circle +8 may not be able to adequately adjust its cost structure in a timely fashion, which could have an adverse effect on its operating results +and financial condition. Uncertainty about economic conditions may increase foreign currency volatility in markets in which it transacts +business, which could have an adverse effect on Circle 8’s operating results. +36 +The inability to forecast trends accurately +may have an adverse impact on Circle 8’s business and financial condition. +An economic downturn or economic +uncertainty makes it difficult to forecast trends. For example, the economic uncertainty caused by COVID-19, and its impact on Circle +8’s operational and financial performance was highly dependent on the depth and duration of the pandemic, as well as the government-mandated +restrictions on economic activity and government economic stimulus packages passed in response to the economic downturn. More recently, +rising interest rates, higher than expected inflation, and several bank failures also underscore the potential impact of ongoing economic +risks to Circle 8’s operations and financial performance. These factors can lead to increased borrowing costs, reduced consumer +spending, and reduced access to credit, among other potential challenges. +This uncertainty makes it +difficult to forecast Circle 8’s future operating performance, cash flows and financial position, which could have an adverse impact +on its business and financial condition. Additionally, uncertainty regarding future oil and natural gas prices have negatively impacted +the exploration, production and construction activity of Circle 8’s customers in those markets. Uncertainty regarding future lifting +solutions demand could cause Circle 8 to maintain excess equipment inventory and increase its equipment inventory carrying costs, decrease +utilization and cause a technical default in certain covenants. Alternatively, difficulty forecasting, in addition to labor shortages +and supply chain disruptions could cause a shortage incremental rental equipment that could result in an inability to satisfy demand for +Circle 8 service and a loss of market share. +Circle 8’s revenue and operating results +may fluctuate, which could result in a decline in profitability and make it more difficult to grow the business. +Circle 8’s revenue and +operating results have historically varied from month to month and quarter to quarter. Periods of decline could result in an overall decline +in profitability and make it more difficult to adequately service indebtedness and grow the business using incremental leverage. It can +be expected that Circle 8’s quarterly results will continue to fluctuate in the future due to a number of factors, including the +following: +· general economic conditions in the markets in +which the company operates; +· the cyclical nature of Circle 8’s customers’ +business, particularly Circle 8’s oil services customer and prospective customers in the construction industry; +· sales patterns in general in the construction +industry, with sales activity tending to be lower in the winter months, which causes significant volatility in utilization; +· changes in the size of Circle 8’s fleet +due to rapid growth followed by a slow-down and Circle 8’s ability to service and maintain its fleet in a timely manner; +· an overcapacity of fleet in the crane services +industry; +· severe weather and seismic conditions temporarily +affecting the regions in which Circle 8 operates; +· supply chain or other disruptions that impact +its ability to obtain equipment and other supplies from key suppliers on acceptable terms or at all; +· changes in corporate spending for plants and +facilities or changes in government spending for infrastructure projects; +· changes in interest rates and related changes +in Circle 8’s interest expense and debt service obligations; or +· the possible need, from time to time, to record +impairment charges or other write-offs or charges due to a variety of occurrences, such as the impairment of assets, existing location +divestitures, dislocation in the equity and/or credit markets, consolidations or closings, restructurings, or the refinancing of existing +indebtedness. +37 +Circle 8 is subject to competition, which may +have a material adverse effect on its business by reducing its ability to increase or maintain revenues or profitability. +The full-service crane services +and lifting solutions industry is highly competitive and fragmented. Many of the markets in which Circle 8 operates are served by numerous +competitors, ranging from global, national and multi-regional equipment rental companies to small, independent businesses with a limited +number of locations. Circle 8 has historically competed on the basis of availability, quality, reliability, delivery and price. Some of +Circle 8’s competitors have significantly greater financial, marketing and other resources than it does, and may be able to reduce +rates. Circle 8 may encounter increased competition from existing competitors or new market entrants in the future, which could have a +material adverse effect on its business, financial condition and results of operations. +The cost of new Circle 8 rental fleet units +may increase and therefore may require a larger equity investment equipment. In some cases, it may not be possible to procure equipment +on a timely basis due to supplier constraints, among other reasons. +The cost of new equipment +from manufacturers of Circle 8 fleet may increase because of increased raw material costs, including increases in the cost of steel, which +is a primary material used in almost all of the equipment Circle 8 uses, labor shortages, supply chain disruptions or due to increased +regulatory requirements, such as those related to emissions. In addition, in an effort to combat climate change, Circle 8’s customers +may require Circle 8’s fleet to meet certain standards which may not be able to be met without capital intensive and time-consuming +fleet unit retrofits or ultimately cost prohibitive replacements. If such retrofits or replacements cannot be achieved in a timely manner, +or at all, Circle 8’s sales, financial results and financial position would be materially adversely impacted. These increases could +materially impact Circle 8’s financial condition or results of operations in future periods if Circle 8 is not able to pass such +cost increases through to its customers. +Circle 8’s fleet is subject to residual +value risk upon disposition. +The market value of any given +piece of equipment could be less than its depreciated value at the time it is sold. The market value of used rental equipment depends +on several factors, including: +· general economic conditions in the markets in +which the company operates; +· wear and tear on the equipment relative to its +age; +· the time of year that it is sold (prices are +generally higher during the busy season); +· worldwide and domestic demands for used equipment; +· the supply of used equipment on the market; and +· general economic conditions. +Circle 8 typically includes +in operating income the difference between the sales price and the depreciated value of an item of equipment sold. In the year ended December +31, 2023, Circle 8 sold used equipment from its rental fleet, reducing the total number of cranes from 75 to 55, with the average selling +price exceeding the net orderly liquidation value. However, in 2024, Circle 8 slightly increased its fleet size by adding two additional +cranes, bringing the total to 57 cranes. While recent equipment sales have remained favorable, there can be no assurance that used equipment +selling prices will not decline in the future. Any significant downturn in the market for used equipment could have a material adverse +effect on Circle 8’s business, financial condition, results of operations, or cash flows. +As Circle 8’s rental fleet ages, its +operating costs may increase, it may be unable to pass along such costs to customers, and earnings may decrease. The costs of new fleet +units may increase, requiring Circle 8 to spend more for replacement equipment or preventing it from procuring equipment on a timely basis. +If Circle 8’s rental +equipment ages, the costs of maintaining such equipment, if not replaced within a certain period of time, will likely increase. The costs +of maintenance may materially increase in the future and could lead to material adverse effects on Circle 8’s results of operations. +The cost of new equipment for use in Circle 8’s rental fleet could also increase due to increased material costs for its suppliers +(including tariffs on raw materials) or other factors beyond Circle 8’s control. Such increases could materially adversely impact +Circle 8’s financial condition and results of operations in future periods. Furthermore, changes in customer demand could cause +certain of Circle 8’s existing equipment to become obsolete and require Circle 8 to purchase new equipment at increased costs. +38 +Labor disputes could disrupt Circle 8’s +ability to serve its customers and/or lead to higher labor costs. +As of December 31, 2024, Circle +8 had approximately 132 employees in Texas, Louisiana and Oklahoma, none of whom is unionized. While Circle 8 has no current plans to +unionize any of its locations, it recognizes the possibility of a branch or group of branches in a state becoming unionized against Circle +8’s wishes in the future. However, Circle 8 is committed to maintaining positive and productive relationships with its employees +without union influence, prioritizing open communication and collaboration to address any concerns and ensure a positive work environment. +Any Circle 8 employee’s +union organizing efforts or collective bargaining negotiations could potentially lead to work stoppages and/or slowdowns or strikes by +certain Circle 8 employees, which could adversely affect its ability to serve its customers. +Climate change, climate change regulations +and greenhouse effects may materially adversely impact Circle 8 operations and markets. +Climate change and its association +with greenhouse gas emissions is receiving increased attention from the scientific and political communities. The U.S. federal government, +certain U.S. states and certain other countries and regions have adopted or are considering legislation or regulation imposing overall +caps or taxes on greenhouse gas emissions from certain sectors or facility categories. Such new laws or regulations, or stricter enforcement +of existing laws and regulations, could increase the costs of operating Circle 8’s businesses, reduce the demand for its products +and services and impact the prices charged to customers, any or all of which could adversely affect Circle 8’s results of operations. +Failure to comply with any legislation or regulations could potentially result in substantial fines, criminal sanctions or operational +changes. Moreover, even without such legislation or regulation, the perspectives of Circle 8’s customers, employees and other stakeholders +regarding climate change are continuing to evolve, and increased awareness of, or any adverse publicity regarding, the effects of greenhouse +gases could harm Circle 8’s reputation or reduce customer demand for Circle 8’s products and services. Additionally, as severe +weather events become increasingly common, Circle 8’s and its customers’ operations may be disrupted, which could result in +increased operational costs or reduced demand for its products and services, which could have an adverse effect on Circle 8’s results +of operations. In addition, climate change may also reduce the availability or increase the cost of insurance for weather-related events +and may impact the global economy, including as a result of disruptions to supply chains. Circle 8 anticipates that climate change-related +risks will increase over time. +Risks Related to Our Bitcoin Operations +Risks Related to Our Bitcoin Operations – General +Acceptance and/or widespread use of Bitcoin +is uncertain. +Currently, there is a limited +use of any Bitcoin in the retail and commercial marketplace, thus contributing to price volatility that could adversely affect an investment +in our securities. Banks and other established financial institutions may refuse to process funds for Bitcoin transactions or process +wire transfers to or from Bitcoin exchanges, Bitcoin-related companies or service providers, which we have experienced, or maintain accounts +for persons or entities transacting in Bitcoin. Conversely, a significant portion of Bitcoin demand is generated by investors seeking +a long-term store of value or speculators seeking to profit from the short- or long-term holding of the asset. Price volatility undermines +Bitcoin’s role as a medium of exchange, as retailers are much less likely to accept it as a form of payment. Market capitalization +for a Bitcoin as a medium of exchange and payment method may always be low. +The relative lack of acceptance +of Bitcoins in the retail and commercial marketplace, or a reduction of such use, limits the ability of end users to use them to pay for +goods and services. Such lack of acceptance or decline in acceptances could have a material adverse effect on our ability to continue +as a going concern or to pursue our business strategy at all, which could have a material adverse effect on our business, prospects or +operations and potentially the value of Bitcoins we mine or otherwise acquire or hold for our own account. +39 +The development and acceptance of cryptographic +and algorithmic protocols governing the issuance of and transactions in cryptocurrencies is subject to a variety of special economic, +geopolitical and regulatory factors, which could slow the growth of the industry in general and our company as a result. +The use of cryptocurrencies, +including Bitcoin, to, among other things, buy and sell goods and services and complete transactions, is part of a new and rapidly evolving +industry that employs cryptocurrency assets based upon a computer-generated mathematical and/or cryptographic protocol. Large-scale acceptance +of cryptocurrencies as a means of payment has not, and may never, occur. The growth of this industry in general, and the use of Bitcoin +in particular, is subject to a high degree of uncertainty, and the slowing or stopping of the development or acceptance of developing +protocols may occur unpredictably. The factors include, but are not limited to: +· the progress of worldwide growth in the adoption +and use of Bitcoin and other cryptocurrencies as a medium of exchange; +· the experience of businesses in using Bitcoin; +· the impact from prominent business leaders in criticizing Bitcoin’s +potential harm to the environment and the effect of announcements critical of Bitcoin, such as those made by Elon Musk of Tesla; +· governmental and organizational regulation of +Bitcoin and other cryptocurrencies and their use, or restrictions on or regulation of access to and operation of the network or similar +cryptocurrency systems (such as the 2021 ban in China); +· changes in consumer demographics and public tastes +and preferences, including as may result from coverage of Bitcoin or other cryptocurrencies by journalists and other sources of information +and media; +· the maintenance and development of the open-source software +protocol of the network; +· the increased consolidation of contributors to +the Bitcoin blockchain through mining pools and scaling of mining equipment by well-capitalized market participants; +· the availability and popularity of other forms +or methods of buying and selling goods and services, including new means of using fiat currencies; +· the use of the networks supporting Bitcoin or +other cryptocurrencies for developing smart contracts and distributed applications; +· general economic conditions and the regulatory +environment relating to Bitcoin and other cryptocurrencies; +· the impact of regulators focusing on cryptocurrencies +and the costs, financial and otherwise, associated with such regulatory oversight; and +· a decline in the popularity or acceptance of +Bitcoin could adversely affect an investment in us. +The outcome of these factors could have +negative effects on our ability to continue as a going concern or to pursue our business strategy, which could have a material adverse +effect on our business, prospects or operations as well as potentially negative effects on the value of any Bitcoin or other cryptocurrencies +we mine or otherwise acquire, which would harm investors in our securities. If Bitcoin does not increase its market acceptance as a mechanism +to buy and sell goods and services or accrete in value over time, our prospects and your investment in us would diminish. +Political or economic crises may motivate large-scale sales +of cryptocurrencies, which could result in a reduction in values of cryptocurrencies such as Bitcoin and adversely affect an investment +in us. +Geopolitical crises, in particular +major ones such as Russia’s invasion of Ukraine and the conflict between Israel and Hamas as well as its supporters, may motivate +large-scale purchases of Bitcoin and other cryptocurrencies, which could increase the price of Bitcoin and other cryptocurrencies rapidly. +This may increase the likelihood of a subsequent price decrease as crisis-driven purchasing behavior dissipates, adversely affecting the +value of our Bitcoin following such downward adjustment. Such risks are similar to the risks of purchasing commodities in general uncertain +times, such as the risk of purchasing, holding or selling gold. Alternatively, as an emerging asset class with limited acceptance as a +payment system or commodity, global crises and general economic downturn may discourage investment in cryptocurrencies as investors focus +their investment on less volatile asset classes as a means of hedging their investment risk. +40 +As an alternative to fiat +currencies that are backed by central governments, cryptocurrencies, which are relatively new, are subject to supply and demand forces. +How such supply and demand will be impacted by geopolitical events is largely uncertain but could be harmful to us and investors in our +Class A common stock. Political or economic crises may motivate large-scale acquisitions or sales of cryptocurrencies either globally +or locally. Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy +at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin or +any other cryptocurrencies we mine or otherwise acquire or hold for our own account. +Negative media attention and public perception +surrounding energy consumption by cryptocurrency mining may adversely affect our reputation and, consequently, our stock price; particularly +in the eyes of some of our investors who may be more interested in our non-crypto operations as a holding company. +Cryptocurrency mining has +experienced negative media attention surrounding its perceived high electricity use and environmental impact, which has adversely influenced +public perception of the industry as a whole. We believe these factors are overstated for the cryptocurrency mining industry because of +the informational disparity between cryptocurrency mining and other energy intensive industries. Cryptocurrency miners (particularly Bitcoin +miners) have freely and publicly disclosed their energy consumption statistics because electricity usage, and the associated utility fees, +is a cost of production. As increasing numbers of publicly traded cryptocurrency miners enter the market, more data, reliably disclosed +in compliance with generally accepted accounting principles in the United States of America (“GAAP”), has become available; +however, such data has not been made as readily available for competitive payment systems and fiat currencies. +Nevertheless, this negative +media attention and public perception may materially and adversely affect our reputation and, consequently, our stock price, particularly +in the eyes of our investors who are more interested in our non-crypto operations as a holding company. As a single company within the +broader cryptocurrency industry, we are likely incapable of effectively countering this negative media attention and affecting public +perception. Therefore, we may not be able to adequately respond to these external pressures, which may cause a significant decline in +the price of our Class A common stock. +Banks and financial institutions may not provide +banking services, or may cut off services, to businesses like us that engage in cryptocurrency-related activities. +A number of companies that +engage in Bitcoin and/or other cryptocurrency-related activities have been unable to find banks or financial institutions that are +willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated +with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial +institutions in response to government action. The difficulty that many businesses that provide Bitcoin and/or derivatives on other cryptocurrency-related activities +have and may continue to have in finding banks and financial institutions willing to provide them services may be decreasing the usefulness +of cryptocurrencies as a payment system and harming public perception of cryptocurrencies, and could decrease their usefulness and harm +their public perception in the future. +The usefulness of cryptocurrencies +as a payment system and the public perception of cryptocurrencies could be damaged if banks or financial institutions were to close the +accounts of businesses engaging in Bitcoin and/or other cryptocurrency-related activities. This could occur as a result of compliance +risk, cost, government regulation or public pressure. The risk applies to securities firms, clearance and settlement firms, national securities +exchanges and derivatives on commodities exchanges, the over-the-counter market, and the Depository Trust Company (“DTC”), +which, if any of such entities adopts or implements similar policies, rules or regulations, could negatively affect our relationships +with financial institutions and impede our ability to convert cryptocurrencies to fiat currencies. Such factors could have a material +adverse effect on our ability to continue as a going concern or to monetize our mining efforts, which could have a material adverse effect +on our business, prospects or operations and harm investors. +41 +The price of cryptocurrencies may be affected +by the sale of such cryptocurrencies by other vehicles investing in cryptocurrencies or tracking cryptocurrency markets. Such events could +have a material adverse effect on our business, prospects or operations and potentially the value of any Bitcoin we mine. +The global market for cryptocurrency is characterized by supply constraints +that differ from those present in the markets for commodities or other assets such as gold and silver. The mathematical protocols under +which certain cryptocurrencies are mined permit the creation of a limited, predetermined amount of digital currency, while others have +no limit established on total supply. Increased numbers of miners and deployed mining power globally will likely continue to increase +the available supply of Bitcoin and other cryptocurrencies, which may depress their market price. Further, large “block sales” +involving significant numbers of Bitcoin following appreciation in the market price of Bitcoin may also increase the supply of Bitcoin +available on the market, which, without a corresponding increase in customer demand, may cause its price to fall. Currently, the loss +of customer demand is also accentuated by disruptions in the crypto assets market. Additionally, to the extent that other vehicles investing +in cryptocurrencies or tracking cryptocurrency markets form and come to represent a significant proportion of the customer demand for +cryptocurrencies, including the recent approval of Bitcoin exchange traded funds, large redemptions of the securities of those vehicles +and the subsequent sale of cryptocurrencies by such vehicles could negatively affect cryptocurrency prices and therefore affect the value +of the cryptocurrency inventory we hold. Such events could have a material adverse effect on our business, prospects or operations and +potentially the value of any Bitcoin. +Risks Related to Our Bitcoin Operations – Operational and +Financial +Risk related to technological advancements +and obsolescence of current bitcoin mining equipment. +Our operations are exposed +to the risk of rapid technological advancements in the development and production of Bitcoin mining equipment, which could render our +existing mining infrastructure obsolete and adversely impact our financial performance. +The Bitcoin mining industry +is characterized by rapid technological change, with companies continually developing and deploying new mining equipment and techniques +to enhance computational efficiency and reduce energy consumption. These advancements may outpace our ability to adapt, maintain, and +upgrade our mining equipment, thereby negatively affecting our competitive position and operational efficiency. As a result, we may be +required to make significant capital investments to acquire and implement new technology to maintain our competitiveness. +If we are unable to anticipate +or adapt to such advancements, or if we fail to allocate our resources efficiently, we may be forced to rely on outdated equipment that +becomes increasingly inefficient and expensive to maintain. Moreover, the emergence of more advanced mining technologies could lead to +an increase in the overall mining difficulty, further reducing the effectiveness of our existing equipment and diminishing our mining +rewards. +Additionally, there is a risk +that our competitors, who may have greater financial resources and flexibility, will be better positioned to adopt emerging technologies +and gain a competitive advantage. This could result in a decline in our market share, revenue, and profitability. +Inability to manage these +risks could have a material adverse effect on our business, financial condition, and operating results. +Our future success will depend in part upon +the value of Bitcoin. The value of Bitcoin may be subject to pricing risk and has historically been subject to wide swings. +Our operating results from +this sector will depend in part upon the value of Bitcoin because it is the sole digital asset we currently mine. Specifically, our revenues +from our Bitcoin mining operations are principally based upon two factors: the number of Bitcoin rewards we successfully mine and the +value of Bitcoin. We also receive transaction fees paid in Bitcoin by participants who initiated transactions associated with new blocks +that we mine. Our strategy currently focuses primarily on Bitcoin (as opposed to other digital assets). Further, our miners are principally +utilized for mining Bitcoin and cannot mine other digital assets that are not mined utilizing the “SHA-256 algorithm.” If +other digital assets were to achieve acceptance at the expense of Bitcoin, causing the value of Bitcoin to decline, or if Bitcoin were +to switch its proof of work algorithm from SHA-256 to another algorithm for which our miners are not specialized, or the value of Bitcoin +were to decline for other reasons, particularly if such decline were significant or over an extended period of time, our operating results +would be adversely affected, and there could be a material adverse effect on our ability to continue as a going concern or to pursue our +business strategy at all, which could have a material adverse effect on our business, prospects or operations, and harm investors. +Bitcoin and other cryptocurrency +market prices, which have historically been volatile and are impacted by a variety of factors are determined primarily using data from +various exchanges, over-the-counter markets and derivative platforms. Such prices may be subject to factors such as those that impact +commodities, more so than business activities, which could be subject to additional influence from fraudulent or illegitimate actors, +real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue to +result in, speculation regarding future appreciation in the value of digital assets, or our share price, inflating and making their market +prices more volatile or creating “bubble” type risks for both Bitcoin and our shares of Class A common stock. +42 +We may be unable to raise additional capital needed to grow our +data center hosting business. +We have operated and expect +to continue to operate at a loss as we continue to establish our business model and as Bitcoin prices continue to experience significant +volatility. In addition, we expect to need to raise additional capital to fund our working capital requirements, expand our operations, +pursue our growth strategy and to respond to competitive pressures or working capital requirements. Specifically, the expansion of our +Michigan Property to potentially 340 MWs of power will require significant capital. We may not be able to obtain additional debt or equity +financing on favorable terms, if at all, which could impair our growth and adversely affect our existing operations. The global economy, +including credit and financial markets, has recently experienced extreme volatility and disruptions, including diminished credit availability, +rising interest and inflation rates, declines in consumer confidence, declines in economic growth, increases in unemployment rates and +uncertainty about economic stability. Such macroeconomic conditions could also make it more difficult for us to incur additional debt +or obtain equity financing. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership +interests, and the per share value of our Class A common stock could decline. Further, if we engage in additional debt financing, the +holders of debt likely would have priority over the holders of our Class A common stock on order of payment preference. We may be required +to accept terms that restrict our ability to incur additional indebtedness, take other actions including accepting terms that require +us to maintain specified liquidity or other ratios that could otherwise not be in the interests of our stockholders. Increased credit +pressures on the cryptocurrency industry, such as banks, investors and other companies reducing or eliminating their exposure to the cryptocurrency +industry through lending, have had and may continue to have a material impact on our business. In light of conditions impacting our industry, +it may be more difficult for us to obtain equity or debt financing in the future. +The emergence of competing blockchain platforms +or technologies may harm our business as presently conducted by preventing us from realizing the anticipated profits from our investments +and forcing us to expend additional capital in an effort to adapt. +If blockchain platforms or +technologies which compete with Bitcoin and its blockchain, including competing cryptocurrencies which our miners may not be able to mine, +such as cryptocurrencies being developed or that may be developed by popular social media platforms, online retailers, or government sponsored +cryptocurrencies, consumers may use such alternative platforms or technologies. If that were to occur, we would face difficulty adapting +to such emergent digital ledgers, blockchains, or alternative platforms, cryptocurrencies or other digital assets. This may adversely +affect us by preventing us from realizing the anticipated profits from our investments and forcing us to expend additional capital in +an effort to adapt. Further, to the extent we cannot adapt, be it due to our specialized miners or otherwise, we could be forced to cease +our mining or other cryptocurrency-related operations. Such circumstances would have a material adverse effect on our business, and +in turn your investment in our securities. +We rely on one or more third parties for depositing, +storing and withdrawing the Bitcoin we receive, which could result in a loss of assets, disputes and other liabilities or risks which +could adversely impact our business. +We currently use a custodial +wallet to store the Bitcoin we receive. In order to own, transfer and use Bitcoin on the blockchain network, we must have a private and +public key pair associated with a network address, commonly referred to as a “wallet.” Each wallet is associated with a unique +“public key” and “private key” pair, each of which is a string of alphanumerical characters. To deposit Bitcoin +into our digital wallet, we must direct the transaction to the public key of a wallet that our Gemini custodial account controls and provides +to us, and broadcast the deposit transaction onto the underlying blockchain network. To withdraw Bitcoin from our custodial account, an +assigned account representative must initiate the transaction from our custodial account, then an approver must approve the transaction. +Once the custodian has verified that the request is valid and who the recipient is through Know Your Customer/Anti-Money Laundering protocols, +the custodian then “signs” a transaction authorizing the transfer. In addition, some cryptocurrency networks require additional +information to be provided in connection with any transfer of cryptocurrency such as Bitcoin. +A number of errors or other +adverse events can occur in the process of depositing, storing or withdrawing Bitcoin into or from our custodial account, such as typos, +mistakes or the failure to include the information required by the blockchain network. For instance, a user may incorrectly enter our +wallet’s public key or the desired recipient’s public key when depositing and withdrawing Bitcoin. Additionally, our reliance +on third parties such as Gemini and the maintenance of keys to access and utilize our digital wallet will expose us to enhanced cybersecurity +risks from unauthorized third parties employing illicit operations such as hacking, phishing and social engineering, notwithstanding the +security systems and safeguards employed by us and others. Cyberattacks upon systems across a variety of industries, including the cryptocurrency +industry, are increasing in frequency, persistence and sophistication and, in many cases, are being conducted by sophisticated, well-funded, +and organized groups and individuals. For example, attacks may be designed to deceive employees and service providers into releasing control +of the systems on which we depend to a hacker, while others may aim to introduce computer viruses or malware into such systems with a +view to stealing confidential or proprietary data. These attacks may occur on our digital wallet or the systems of our third-party service +providers or partners, which could result in asset losses and other adverse consequences. Insurance held by third parties may not cover +related losses. Alternatively, we may inadvertently transfer Bitcoin to a wallet address that we do not own, control or hold the private +keys to. In addition, a Bitcoin wallet address can only be used to send and receive Bitcoin, and if the Bitcoin is inadvertently sent +to an Ethereum or other cryptocurrency wallet address, or if any of the foregoing errors occur, all of the Bitcoin will be permanently +and irretrievably lost with no means of recovery. Such incidents could result in asset loss or disputes, any of which could materially +and adversely affect our business. +43 +If a malicious actor or botnet obtains control +of more than 50% of the processing power on a cryptocurrency network, such actor or botnet could manipulate blockchains to adversely affect +us, which would adversely affect an investment in our company and our ability to operate. +If a malicious actor or botnet +(a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority +of the processing power dedicated to mining a cryptocurrency, it may be able to alter blockchains on which transactions of cryptocurrency +reside and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. The +malicious actor or botnet could control, exclude or modify the ordering of transactions, though it could not generate new units or transactions +using such control. The malicious actor could “double-spend” its own cryptocurrency (i.e., spend the same Bitcoin in more +than one transaction) and prevent the confirmation of other users’ transactions for as long as it maintained control. To the extent +that such malicious actor or botnet does not yield its control of the processing power on the network or the cryptocurrency community +does not reject the fraudulent blocks as malicious, reversing any changes made to blockchains may not be possible. The foregoing description +is not the only means by which the entirety of blockchains or cryptocurrencies may be compromised but is only an example. +Although we are unaware of +any reports of malicious activity or control of blockchains achieved through controlling over 50% of the processing power on the network, +it is believed that certain mining pools may have exceeded the 50% threshold in Bitcoin. The possible crossing of the 50% threshold indicates +a greater risk that a single mining pool could exert authority over the validation of Bitcoin transactions. To the extent that the Bitcoin +community, and the administrators of mining pools, do not act to ensure greater decentralization of Bitcoin mining processing power, the +feasibility of a botnet or malicious actor obtaining control of the blockchain’s processing power will increase, because such botnet +or malicious actor could more readily infiltrate and seize control over the blockchain by compromising a single mining pool, if the mining +pool compromises more than 50% of the mining power on the blockchain, than it could if the mining pool had a smaller share of the blockchain’s +total hashing power. Conversely, if the blockchain remains decentralized it is inherently more difficult for the botnet or malicious actor +to aggregate enough processing power to gain control of the blockchain. If this were to occur, the public may lose confidence in the Bitcoin +blockchain, and blockchain technology more generally. This would likely have a material and adverse effect on the price of Bitcoin, which +could have a material adverse effect on our business, financial results and operations, and harm investors. +Our reliance on a +third-party mining pool service provider for our mining revenue payouts may have a negative impact on our operations such as a result +of cyber-attacks against the mining pool operator and/or our limited recourse against the mining pool operator with respect to rewards +paid to us. +We +receive crypto asset mining rewards from our mining activity through a third-party mining pool operator. Mining pools allow miners to +combine their processing power, increasing their chances of solving a block and getting paid by the network. The rewards are distributed +by the pool operator, proportionally to our contribution to the pool’s overall mining power, used to generate each block. Should +the pool operator’s system suffer downtime due to a cyber-attack, software malfunction or other similar issues, it will negatively +impact our ability to mine and receive revenue. Furthermore, we are dependent on the accuracy of the mining pool operator’s record +keeping to accurately record the total processing power provided to the pool for a given Bitcoin mining application in order to assess +the proportion of that total processing power we provided. +While +we have internal methods of tracking both our power provided and the total used by the pool, the mining pool operator uses its own recordkeeping +to determine our proportion of a given reward. We have little means of recourse against the mining pool operator if we determine the proportion +of the reward paid out to us by the mining pool operator is incorrect, other than leaving the pool. If we are unable to consistently obtain +accurate proportionate rewards from our mining pool operators, we may experience reduced reward for our efforts, which would have an adverse +effect on our business and operations. +44 +Bitcoin may have concentrated ownership and large sales or distributions by holders of Bitcoin assets could have +an adverse effect on the market price of Bitcoin. +As of April 9, 2025, the largest 93 and 2,094 Bitcoin wallets held +approximately 15% and 38%, respectively, of the Bitcoin in circulation. Moreover, it is possible that other persons or entities control +multiple wallets that collectively hold a significant number of Bitcoins, even if they individually only hold a small amount, and it is +possible that some of these wallets are controlled by the same person or entity. As a result of this concentration of ownership, large +sales or distributions by such holders could have an adverse effect on the market price of Bitcoin. +Risks Related to Our Bitcoin Operations – Legal and Regulatory +We are subject to a highly evolving regulatory landscape and any +adverse changes to, or our failure to comply with, any laws and regulations could adversely affect our business, prospects or operations. +Our business is subject to +extensive laws, rules, regulations, policies and legal and regulatory guidance, including those governing securities, commodities, crypto +asset custody, exchange and transfer, data governance, data protection, cybersecurity and tax. Many of these legal and regulatory regimes +were adopted prior to the advent of the Internet, mobile technologies, crypto assets and related technologies. As a result, they do not +contemplate or address unique issues associated with the crypto economy, are subject to significant uncertainty, and vary widely across +U.S. federal, state and local and international jurisdictions. These legal and regulatory regimes, including the laws, rules and regulations +thereunder, evolve frequently and may be modified, interpreted and applied in an inconsistent manner from one jurisdiction to another, +and may conflict with one another. Moreover, the complexity and evolving nature of our business and the significant uncertainty surrounding +the regulation of the crypto economy requires us to exercise our judgement as to whether certain laws, rules and regulations apply to +us, and it is possible that governmental bodies and regulators may disagree with our conclusions. To the extent we have not complied with +such laws, rules and regulations, we could be subject to significant fines and other regulatory consequences, which could adversely affect +our business, prospects or operations. As Bitcoin has grown in popularity and in market size, the Federal Reserve Board, U.S. Congress +and certain U.S. agencies (e.g., the CFTC, SEC, FinCEN and the FBI) have begun to examine the operations of the Bitcoin network, Bitcoin +users and the Bitcoin exchange market. Regulatory developments and/or our business activities may require us to comply with certain regulatory +regimes. For example, to the extent that our activities cause us to be deemed a money service business under the regulations promulgated +by FinCEN under the authority of the BSA, we may be required to comply with FinCEN regulations, including those that would mandate us +to implement certain anti-money laundering programs, make certain reports to FinCEN and maintain certain records. +On November 23, 2022, the +governor of New York signed into law a two-year moratorium on new or renewed permits for certain electricity-generating facilities that +use fossil fuel and provide energy for proof-of-work digital asset mining operations. While this action does not directly impact our current +operations, as our power generation plans are currently located in Michigan and we have no plans to establish any facilities in New York, +it may be the beginning of a new wave of climate change regulations aimed at preventing or reducing the growth of Bitcoin mining in jurisdictions +in the United States, including potentially jurisdictions in which we now operate or may in the future operate. The above-described developments +could also demonstrate the beginning of a regional or global regulatory trend in response to environmental and energy preservation or +other concerns surrounding crypto assets, and similar action in a jurisdiction in which we operate or in general could have a devastating +effect on our operations. If further regulation follows, it is possible that the Bitcoin mining industry may not be able to adjust to +a sudden and dramatic overhaul to our ability to deploy energy towards the operation of mining equipment. We are not currently aware of +any legislation in Michigan being a near-term possibility. If further regulatory action is taken by various governmental entities, our +business may suffer and investors in our securities may lose part or all of their investment. +We cannot quantify the effects +of this regulatory action on our industry as a whole. If further regulation follows, it is possible that our industry may not be able +to cope with the sudden and extreme loss of mining power. Because we are unable to influence or predict future regulatory actions taken +by governments in China, the United States, or elsewhere, we may have little opportunity or ability to respond to rapidly evolving regulatory +positions which may have a materially adverse effect on our industry and, therefore, our business and results of operations. +Ongoing and future regulatory actions may impact +our ability to continue to operate, and such actions could affect our ability to continue as a going concern or to pursue our strategy +at all, which could have a material adverse effect on our business, prospects or operations. +45 +A particular digital asset’s status as +a “security” in any relevant jurisdiction is subject to a high degree of uncertainty and if a regulator disagrees with our +characterization of a digital asset, we may be subject to regulatory scrutiny, investigations, fines, and penalties, which may adversely +affect our business, operating results and financial condition. Furthermore, a determination that Bitcoin or any other digital asset that +we own or mine is a “security” may adversely affect the value of Bitcoin and our business. +The SEC and its staff have taken the position that certain digital +assets fall within the definition of a “security” under the U.S. federal securities laws. The legal test for determining whether +any given digital asset is a security, as described below, is a highly complex, fact-driven analysis that may evolve over time, and the +outcome is difficult to predict. Our determination that the digital assets we hold are not securities is a risk-based assessment and not +a legal standard or one binding on regulators. The SEC generally does not provide advance guidance or confirmation on the status of any +particular digital asset as a security. Furthermore, the SEC’s views in this area have evolved over time and it is difficult to +predict the direction or timing of any continuing evolution. It is also possible that a change in the governing administration or the +appointment of new SEC commissioners could substantially impact the views of the SEC and its staff. Public statements made by senior officials +at the SEC indicate that the SEC does not intend to take the position that Bitcoin is a security (as currently offered and sold). However, +such statements are not official policy statements by the SEC and reflect only the speakers’ views, which are not binding on the +SEC or any other agency or court and cannot be generalized to any other digital asset. As of the date of this Annual Report, with the +exception of certain centrally issued digital assets that have received “no-action” letters from the SEC staff, Bitcoin and +Ethereum are the only digital assets which senior officials at the SEC have publicly stated are unlikely to be considered securities. +As a Bitcoin mining company, we do not believe we are an issuer of any “securities” as defined under the federal securities +laws. Our internal process for determining whether the digital assets we hold or plan to hold is based upon the public statements of the +SEC and existing case law. The digital assets we hold or plan to hold, other than Bitcoin (if any), may have been created by an issuer +as an investment contract under the Howey test, SEC v. Howey Co ., 328 U.S. 293 (1946), and may be deemed to be securities +by the SEC. However, the Company was not the issuer that created these digital assets and is holding them on an interim basis until liquidated. +Should the SEC state that Bitcoin should be deemed to be a security, we may no longer be able to hold any Bitcoin. It will then likely +become difficult or impossible for such digital asset to be traded, cleared or custodied in the United States through the same channels +used by non-security digital assets, which in addition to materially and adversely affecting the trading value of the digital asset is +likely to cause substantial volatility and significantly impact its liquidity and market participants’ ability to convert the digital +asset into U.S. dollars. Our inability to exchange Bitcoin for fiat or other digital assets (and vice versa) to administer our treasury +management objectives may decrease our earnings potential and have an adverse impact on our business and financial condition. +Under the Investment Company +Act, a company may fall within the definition of an investment company under section 3(c)(1)(A) thereof if it is or holds itself out as +being engaged primarily, or proposes to engage primarily in the business of investing, reinvesting or trading in securities, or under +section 3(a)(1)(C) thereof if it is engaged or proposes to engage in business of investing, reinvesting, owning, holding, or trading in +securities, and owns or proposes to acquire “investment securities” (as defined therein) having a value exceeding 40% of its +total assets (exclusive of government securities and cash items) on an unconsolidated basis. There is no authoritative law, rule or binding +guidance published by the SEC regarding the status of digital assets as “securities” or “investment securities” +under the Investment Company Act. Although we believe that we are not engaged in the business of investing, reinvesting, or trading in +investment securities, and we do not hold ourselves out as being primarily engaged, or proposing to engage primarily, in the business +of investing, reinvesting or trading in securities, to the extent the digital assets which we mine, own, or otherwise acquire may be deemed +“securities” or “investment securities” by the SEC or a court of competent jurisdiction, we may meet the definition +of an investment company. If we fall within the definition of an investment company under the Investment Company Act, we would be required +to register with the SEC. If an investment company fails to register, it likely would have to stop doing almost all business, and its +contracts would become voidable. Generally speaking, non-U.S. issuers may not register as an investment company without an SEC order. +If the SEC or another regulatory body considers +Bitcoin to be a security under U.S. securities laws, we may be required to comply with significant SEC registration and/or other requirements. +In general, novel or unique +assets such as Bitcoin and other digital assets may be classified as securities if they meet the definition of investment contracts under +U.S. law. In recent years, the offer and sale of digital assets other than Bitcoin, most notably Kik Interactive Inc.’s Kin tokens +and Telegram Group Inc.’s TON tokens, have been deemed to be investment contracts by the SEC. While we believe that Bitcoin is unlikely +to be considered an investment contract, and thus a security under the investment contract definition, we cannot provide any assurances +that digital assets that we mine or otherwise acquire or hold for our own account, including Bitcoin, will never be classified as securities +under U.S. law. This would obligate us to comply with registration and other requirements by the SEC and, therefore, cause us to incur +significant, non-recurring expenses, thereby materially and adversely impacting an investment in the Company. +46 +Several foreign jurisdictions have taken a broad-based approach to +classifying crypto assets as “securities,” while other foreign jurisdictions, such as Switzerland, Malta, and Singapore, have +adopted a narrower approach. As a result, certain crypto assets may be deemed to be a “security” under the laws of some jurisdictions +but not others. Various foreign jurisdictions may, in the future, adopt additional laws, regulations, or directives that affect the characterization +of crypto assets as “securities.” If Bitcoin is deemed to be a security under any U.S. federal, state, or foreign jurisdiction, +or in a proceeding in a court of law or otherwise, it may have adverse consequences for Bitcoin. For instance, all transactions in Bitcoin +would have to be registered with the SEC or other foreign authority, or conducted in accordance with an exemption from registration, which +could severely limit its liquidity, usability and transactability. Moreover, the networks on which such Bitcoin is utilized may be required +to be regulated as securities intermediaries, and subject to applicable rules, which could effectively render the network impracticable +for its existing purposes. Further, it could draw negative publicity and a decline in the general acceptance of Bitcoin. +Current interpretations require the regulation +of Bitcoin under the Commodity Exchange Act by the Commodity Futures Trading Commission, and we may be required to register and comply +with such regulations. Any disruption of our operations in response to the changed regulatory circumstances may be at a time that is disadvantageous +to our investors. +Current and future legislation, +regulation by the Commodity Futures Trading Commission (the “CFTC”) and other regulatory developments, including interpretations +released by a regulatory authority, may impact the manner in which Bitcoin and other cryptocurrencies are treated for classification and +clearing purposes. In particular, derivatives on these assets are not excluded from the definition of “commodity future” by +the CFTC. We cannot be certain as to how future regulatory developments will impact the treatment of Bitcoin and other cryptocurrencies +under the law. +Bitcoin has been deemed to fall within the definition of a commodity, +and we may be required to register and comply with additional regulation under the Commodity Exchange Act, including additional periodic +report and disclosure standards and requirements. Moreover, we may be required to register as a commodity pool operator and to register +as a commodity pool with the CFTC through the National Futures Association. Such additional registrations may result in extraordinary, +non-recurring expenses, thereby materially and adversely impacting an investment in us. If we determine not to comply with such additional +regulatory and registration requirements, we may seek to cease certain of our operations. Any such action may adversely affect an investment +in us. +Additionally, governments +may develop and deploy their own blockchain-based digital assets, which may have a material adverse impact on Bitcoin’s price +and utility. +We are subject to risks associated with our +need for significant electrical power. Government regulators may potentially restrict the ability of electricity suppliers to provide +electricity to mining operations, such as ours. +The operation of a Bitcoin +mining center, as well as AI hyperscale data centers, can require massive amounts of electrical power. We presently have access to approximately +30 MWs of capacity at our Michigan Facility, which we plan to dedicate to our AI hyperscale data center operations, and 10 MWs of capacity +at our Montana Facilities for our mining operations. However, we require additional capacity to operate all of our miners outside the +Michigan Facility and Montana Facilities and to support the growing power demands of our AI hyperscale data centers. Our mining operations +can only be successful and ultimately profitable if the costs, including electrical power costs, associated with mining a Bitcoin are +lower than the price of a Bitcoin. Similarly, our AI hyperscale data centers require a reliable and cost-effective power supply to ensure +optimal performance and profitability. As a result, any facilities we establish can only be successful if we can obtain sufficient electrical +power on a cost-effective basis. The establishment of new mining and AI hyperscale data centers requires us to find locations where this +is the case. There may be significant competition for suitable locations for both mining operations and AI hyperscale data centers. Government +regulators may potentially restrict the ability of electricity suppliers to provide electricity to these operations in times of electricity +shortage or may otherwise potentially restrict or prohibit the provision of electricity to such operations. Any shortage of electricity +supply or increase in electricity cost in a jurisdiction may negatively impact the viability and the expected economic return for our +Bitcoin mining activities and AI hyperscale data center operations in that jurisdiction. +47 +Our interactions with a blockchain may expose +us to specially designated nationals or blocked persons or cause us to violate provisions of law that did not contemplate distributed +ledger technology. +The Office of Financial Assets Control of the U.S. Department of Treasury +(“OFAC”) requires us to comply with its sanction program and not conduct business with persons named on its list of specially +designated nationals (“SDN”). However, because of the pseudonymous nature of blockchain transactions, we may inadvertently +and without our knowledge engage in transactions with persons named on OFAC’s SDN list. Our internal policies prohibit any transactions +with such SDN individuals, but we may not be adequately capable of determining the ultimate identity of the individual with whom we transact +with respect to selling digital assets. In addition, in the future OFAC or another regulator may require us to screen transactions for +OFAC addresses or other bad actors before including such transactions in a block, which may increase our compliance costs, decrease our +anticipated transaction fees and lead to decreased traffic on our network. Any of these factors, consequently, could have a material adverse +effect on our business, prospects, financial condition, and operating results. +Moreover, federal law prohibits any U.S. person from knowingly or unknowingly +possessing any visual depiction commonly known as child pornography. Recent media reports have suggested that persons have embedded such +depictions on one or more blockchains. Because our business requires us to download and retain one or more blockchains to effectuate our +ongoing business, it is possible that such digital ledgers contain prohibited depictions without our knowledge or consent. To the extent +government enforcement authorities literally enforce these and other laws and regulations that are impacted by decentralized distributed +ledger technology, we may be subject to investigation, administrative or court proceedings, and civil or criminal monetary fines and penalties, +all of which could harm our reputation and could have a material adverse effect on our business, prospects, financial condition, and operating +results. +Risks Related to Our Bitcoin Operations – Technological +The characteristics of crypto assets have been, +and may in the future continue to be, exploited to facilitate illegal activity such as fraud, money laundering, tax evasion and ransomware +scams; if any of our customers do so or are alleged to have done so, it could adversely affect us. +Digital currencies and the +digital currency industry are relatively new and, in many cases, lightly regulated or largely unregulated. Some types of digital currency +have characteristics, such as the speed with which digital currency transactions can be conducted, the ability to conduct transactions +without the involvement of regulated intermediaries, the ability to engage in transactions across multiple jurisdictions, the irreversible +nature of certain digital currency transactions and encryption technology that anonymizes these transactions, that make digital currency +particularly susceptible to use in illegal activity such as fraud, money laundering, tax evasion and ransomware scams. Two prominent examples +of marketplaces that accepted digital currency payments for illegal activities include Silk Road, an online marketplace on the dark web +that, among other things, facilitated the sale of illegal drugs and forged legal documents using digital currencies and AlphaBay, another +darknet market that utilized digital currencies to hide the locations of its servers and identities of its users. Both of these marketplaces +were investigated and closed by U.S. law enforcement authorities. U.S. regulators, including the SEC, CFTC and Federal Trade Commission, +as well as non-U.S. regulators, have taken legal action against persons alleged to be engaged in Ponzi schemes and other fraudulent schemes +involving digital currencies. In addition, the FBI has noted the increasing use of digital currency in various ransomware scams. +While our board and management +believe that our risk management processes and policies in light of current crypto asset market conditions, which include thorough reviews +we conduct as part of our due diligence process, is reasonably designed to detect any such illicit activities conducted by our potential +or existing counterparties, we cannot ensure that we will be able to detect any such illegal activity in all instances. Because the speed, +irreversibility and anonymity of certain digital currency transactions make them more difficult to track, fraudulent transactions may +be more likely to occur. We or our potential banking counterparties may be specifically targeted by individuals seeking to conduct fraudulent +transfers, and it may be difficult or impossible for us to detect and avoid such transactions in certain circumstances. If one of our +customers (or in the case of digital currency exchanges, their customers) were to engage in or be accused of engaging in illegal activities +using digital currency, we could be subject to various fines and sanctions, including limitations on our activities, which could also +cause reputational damage and adversely affect our business, financial condition and results of operations. +Incorrect or fraudulent cryptocurrency transactions +may be irreversible and it is possible that, through computer or human error, or through theft or criminal action, our cryptocurrency +rewards could be transferred in incorrect amounts or to unauthorized third parties. +Cryptocurrency transactions are irrevocable and stolen or incorrectly +transferred cryptocurrencies may be irretrievable. As a result, any incorrectly executed or fraudulent cryptocurrency transactions, such +as a result of a cybersecurity breach against our Bitcoin holdings, could adversely affect our investments and assets. This is because +cryptocurrency transactions are not, from an administrative perspective, reversible without the consent and active participation of the +recipient of the cryptocurrencies from the transaction. Once a transaction has been verified and recorded in a block that is added to +a blockchain, an incorrect transfer of a cryptocurrency or a theft thereof generally will not be reversible and we may not have sufficient +recourse to recover our losses from any such transfer or theft. Further, it is possible that, through computer or human error, or through +theft or criminal action, our cryptocurrency rewards could be transferred in incorrect amounts or to unauthorized third parties, or to +uncontrolled accounts. If an errant or fraudulent transaction in our Bitcoin were to occur, we would have very limited means of seeking +to reverse the transaction or seeking recourse. To the extent that we are unable to recover our losses from such action, error or theft, +such events could have a material adverse effect on our business. +48 +Cryptocurrencies, including those maintained +by or for us, may be exposed to cybersecurity threats and hacks. +As with any computer code +generally, flaws in crypto asset codes, including Bitcoin codes, may be exposed by malicious actors. Several errors and defects have been +found previously, including those that disabled some functionality for users and exposed users’ information. Exploitation of flaws +in the source code that allow malicious actors to take or create money have previously occurred. Additionally, as AI capabilities improve +and are increasingly adopted, we may see cyberattacks created through AI. These attacks could be crafted with an AI tool to directly attack +information systems with increased speed and/or efficiency than a human threat actor or create more effective phishing emails. Despite +our efforts and processes to prevent breaches, our devices, as well as our miners, computer systems and those of third parties that we +use in our operations, are vulnerable to cyber security risks, including cyber-attacks such as viruses and worms, phishing attacks, denial-of-service +attacks, physical or electronic break-ins, employee theft or misuse, and similar disruptions from unauthorized tampering with our miners +and computer systems or those of third parties that we use in our operations. As technological change occurs, the security threats to +our cryptocurrencies will likely change and previously unknown threats may emerge. Human error and the constantly evolving state of cybercrime +and hacking techniques may render present security protocols and procedures ineffective in ways which we cannot predict. Such events could +have a material adverse effect on our ability to continue as a going concern or to pursue our strategy at all, which could have a material +adverse effect on our business, prospects or operations and potentially the value of any Bitcoin we mine or otherwise acquire or hold +for our own account. +Our use of third-party +mining pools exposes us to additional risks. +We receive Bitcoin rewards from our mining activity through third-party +mining pool operators. Mining pools allow miners to combine their processing power, increasing their chances of solving a block and getting +paid by the network. The rewards are distributed by the pool operator, proportionally to our contribution to the pool’s overall +mining power used to solve a block on the Bitcoin blockchain. Should the pool operator’s system suffer downtime due to a cyber-attack, +software malfunction or other issue, it will negatively impact our ability to mine and receive revenue. Furthermore, we are dependent +on the accuracy of the mining pool operator’s record keeping to accurately record the total processing power provided to the pool +for a given Bitcoin mining application in order to assess the proportion of that total processing power we provided. While we have internal +methods of tracking both the hash rate we provide and the total used by the pool, the mining pool operator uses its own record-keeping +to determine our proportion of a given reward, which may not match our own. If we are unable to consistently obtain accurate proportionate +rewards from our mining pool operators, we may experience reduced rewards for our efforts, which would have an adverse effect on our business +and operations. +Risks Related to Our Status as a Holding +Company +Our inability to successfully integrate new +acquisitions could adversely affect our combined business; our operations are widely disbursed. +Our growth strategy +through acquisitions is fraught with risk. Since 2017, we have acquired the Michigan Facility, a majority interest in TurnOnGreen, the +four hotel properties in and around Madison, Wisconsin, substantially all the assets and certain specified liabilities of Circle 8 Crane +Service and a position in ROI that we consolidate as a VIE. We also acquired all or majority interests in other companies and a certain +real property located in St. Petersburg, Florida, all of which we either sold off or are currently no longer consolidated as a result +of bankruptcy. Our strategy and business plan are dependent on our ability to successfully integrate acquisitions. In addition, while +we are based in Las Vegas, NV, our finance and legal departments are located elsewhere in the U.S., and certain subsidiary’s operations +are located across the U.S. and internationally. These distant locations and others that we may become involved with in the future will +stretch our resources and management time. Further, failure to quickly and adequately integrate all of these operations and personnel +could adversely affect our combined business and our ability to achieve our objectives and strategy. No assurance can be given that we +will realize synergies in the areas we currently operate. +49 +If we make any additional acquisitions, they may disrupt or have +a negative impact on our business. +We have plans to eventually +make additional acquisitions. Whenever we make acquisitions, we could have difficulty integrating the acquired companies’ personnel +and operations with our own. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot predict +the effect expansion may have on our core business. Regardless of whether we are successful in making an acquisition, the negotiations +could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to the risks described +above, acquisitions are accompanied by a number of inherent risks, including, without limitation, the following: +· If senior management and/or management of future +acquired companies terminate their employment prior to our completion of integration; +· difficulty of integrating acquired products, +services or operations; +· integration of new employees and management into +our culture while maintaining focus on operating efficiently and providing consistent, high-quality goods and services; +· potential disruption of the ongoing businesses +and distraction of our management and the management of acquired companies; +· unanticipated issues with transferring customer +relationships; +· complexity associated with managing our combined +company; +· difficulty of incorporating acquired rights or +products into our existing business; +· difficulties in disposing of the excess or idle +facilities of an acquired company or business and expenses in maintaining such facilities; +· difficulties in maintaining uniform standards, +controls, procedures and policies; +· potential impairment of relationships with employees +and customers as a result of any integration of new management personnel; +· potential inability or failure to achieve additional +sales and enhance our customer base through cross-marketing of the products to new and existing customers; +· effect of any government regulations which relate +to the business acquired; and +· potential unknown liabilities associated with +acquired businesses or product lines, or the need to spend significant amounts to retool, reposition or modify the marketing and sales +of acquired products or the defense of any litigation, whether or not successful, resulting from actions of the acquired company prior +to our acquisition. +Our business could be severely +impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection +with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract +our management and employees, increase our expenses and adversely affect our results of operations. +We may not be able to successfully identify +suitable acquisition targets and complete acquisitions to meet our growth strategy, and even if we are able to do so, we may not realize +the full anticipated benefits of such acquisitions, and our business, financial conditions and results of operations may suffer. +Increasing revenues through +acquisitions is one of the key components of our growth strategy. Identifying suitable acquisition candidates can be difficult, time-consuming +and costly, and we may not be able to identify suitable candidates or complete acquisitions in a timely manner, on a cost-effective basis +or at all. +We will have to pay cash, +incur debt, or issue equity as consideration in any future acquisitions, each of which could adversely affect our financial condition +or the market price of our Class A common stock. The sale of equity or issuance of equity-linked debt to finance any future acquisitions +could result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could limit +our flexibility in managing our business due to covenants or other restrictions contained in debt instruments. +50 +Further, we may not be able +to realize the anticipated benefits of completed acquisitions. Some acquisition targets may not have a developed business or are experiencing +inefficiencies and incur losses. Additionally, small defense contractors which we consider suitable acquisition targets may be uniquely +dependent on their prior owners and the loss of such owners’ services following the completion of acquisitions may adversely affect +their business. Therefore, we may lose our investment in the event that the acquired businesses do not develop as planned, we cannot retain +key employees or that we are unable to achieve the anticipated cost efficiencies or reduction of losses. +Additionally, our acquisitions +have previously required, and any similar future transactions may also require, significant management efforts and expenditures. Regardless +of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, divert the attention of our +management and key employees and increase our expenses. +Because we face significant competition for +acquisition and business opportunities, including from numerous companies with a business plan similar to ours, it may be difficult for +us to fully execute our business strategy. Additionally, our subsidiaries also operate in highly competitive industries, limiting their +ability to gain or maintain their positions in their respective industries. +We expect to encounter intense +competition for acquisition and business opportunities from both strategic investors and other entities having a business objective similar +to ours, such as private investors (which may be individuals or investment partnerships), blank check companies including special purpose +acquisition companies, and other entities, domestic and international, competing for the type of businesses that we may acquire. Many +of these competitors possess greater technical, human and other resources, or more local industry knowledge, or greater access to capital, +than we do, and our financial resources may be relatively limited when contrasted with those of many of these competitors. These factors +may place us at a competitive disadvantage in successfully completing future acquisitions and investments. +In addition, while we believe +that there are numerous target businesses that we could potentially acquire or invest in, our ability to compete with respect to the acquisition +of certain target businesses that are sizable will be limited by our available financial resources. We may need to obtain additional financing +in order to consummate future acquisitions and investment opportunities and cannot assure you that any additional financing will be available +to us on acceptable terms, or at all, or that the terms of our existing financing arrangements will not limit our ability to do so. This +inherent competitive limitation gives others an advantage in pursuing acquisition and investment opportunities. +Furthermore, our subsidiaries +also face competition from both traditional and new market entrants that may adversely affect them as well, as discussed elsewhere in +these risk factors. +Future acquisitions or business opportunities +could involve unknown risks that could harm our business and adversely affect our financial condition and results of operations . +We are a diversified holding +company that owns interests in a number of different businesses across several industries. We have in the past, and intend in the future, +to acquire businesses or make investments, directly or indirectly through our subsidiaries, that involve unknown risks, some of which +will be particular to the industry in which the investment or acquisition targets operate, including risks in industries with which we +are not familiar or experienced. There can be no assurance our due diligence investigations will identify every matter that could have +a material adverse effect on us or the entities that we may acquire. We may be unable to adequately address the financial, legal and operational +risks raised by such investments or acquisitions, especially if we are unfamiliar with the relevant industry, which can lead to significant +losses on material investments. The realization of any unknown risks could expose us to unanticipated costs and liabilities and prevent +or limit us from realizing the projected benefits of the investments or acquisitions, which could adversely affect our financial condition +and liquidity. In addition, our financial condition, results of operations and the ability to service our debt may be adversely impacted +depending on the specific risks applicable to any business we invest in or acquire and our ability to address those risks. +We face certain risks associated with the acquisition +or disposition of businesses and lack of control over certain of our investments. +In pursuing our corporate +strategy, we may acquire, dispose of or exit businesses or reorganize existing investments. The success of this strategy is dependent +upon our ability to identify appropriate opportunities, negotiate transactions on favorable terms and ultimately complete such transactions. +51 +In the course of our acquisitions, +we may not acquire 100% ownership of certain of our operating subsidiaries or we may face delays in completing certain acquisitions, including +in acquiring full ownership of certain of our operating companies. Once we complete acquisitions or reorganizations there can be no assurance +that we will realize the anticipated benefits of any transaction, including revenue growth, operational efficiencies or expected synergies. +If we fail to recognize some or all of the strategic benefits and synergies expected from a transaction, goodwill and intangible assets +may be impaired in future periods. The negotiations associated with the acquisition and disposition of businesses could also disrupt our +ongoing business, distract management and employees or increase our expenses. +In addition, we may not be +able to integrate acquisitions successfully and we could incur or assume unknown or unanticipated liabilities or contingencies, which +may impact our results of operations. If we dispose of or otherwise exit certain businesses, there can be no assurance that we will not +incur certain disposition related charges, or that we will be able to reduce overhead related to the divested assets. +In the ordinary course of +our business, we evaluate the potential disposition of assets and businesses that may no longer help us meet our objectives or that no +longer fit with our broader strategy. When we decide to sell assets or a business, we may encounter difficulty in finding buyers or alternative +exit strategies on acceptable terms in a timely manner, which could delay the accomplishment of our strategic objectives, or we may dispose +of a business at a price or on terms which are less than we had anticipated. In addition, there is a risk that we sell a business whose +subsequent performance exceeds our expectations, in which case our decision would have potentially sacrificed enterprise value. +Our development stage companies may never produce +revenues or income. +We have made investments in +and own stakes, either majority or minority, in a certain development stage companies. Each of these companies is at an early stage of +development and is subject to all business risks associated with a new enterprise, including constraints on their financial and personnel +resources, lack of established credit, the need to establish meaningful and beneficial vendor and customer relationships and uncertainties +regarding product development and future revenues. We anticipate that many of these companies will continue to incur substantial additional +operating losses for at least the next several years and expect their losses to increase as research and development efforts expand. There +can be no assurance as to when or whether any of these companies will be able to develop significant sources of revenue or that any of +their respective operations will become profitable, even if any of them is able to commercialize any products. As a result, we may not +realize any returns on our investments in these companies for a significant period of time, if at all, which could adversely affect our +business, results of operations, financial condition or liquidity. +Divestitures and contingent liabilities from +divested businesses could adversely affect our business and financial results . +We continually evaluate the +performance and strategic fit of all of our businesses and may sell businesses or product lines. Divestitures involve risks, including +difficulties in the separation of operations, services, products and personnel, the diversion of management’s attention from other +business concerns, the disruption of our business, the potential loss of key employees and the retention of uncertain contingent liabilities, +including environmental liabilities, related to the divested business. When we decide to sell assets or a business, we may encounter difficulty +in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the achievement of our strategic +objectives. We may also dispose of a business at a price or on terms that are less desirable than we had anticipated, which could result +in significant asset impairment charges, including those related to goodwill and other intangible assets, that could have a material adverse +effect on our financial condition and results of operations. In addition, we may experience greater dis-synergies than expected, the impact +of the divestiture on our revenue growth may be larger than projected, and some divestitures may be dilutive to earnings. There can be +no assurance whether the strategic benefits and expected financial impact of the divestiture will be achieved. We cannot assure you that +we will be successful in managing these or any other significant risks that we encounter in divesting a business or product line, and +any divestiture we undertake could materially and adversely affect our business, financial condition, results of operations and cash flows. +Risks Related to Related Party Transactions +There may be conflicts of +interest between our company and certain of our related parties and their respective directors and officers which might not be resolved +in our favor. More importantly, there may be conflicts between certain of our related parties and their respective directors and officers +which might not be resolved in our favor. These risks are set forth below appurtenant to the relevant related party. +52 +Ault & Company +Our relationship with Ault & Company may +enhance the difficulty inherent in obtaining financing for us as well as expose us to certain conflicts of interest. +As of April 14, 2025, Ault & Company, of which Milton C. (Todd) +Ault, III is the chief executive officer, beneficially owned 34,832,482 shares of our common stock, consisting of (i) 8,249 shares of +Class A Common Stock owned, (ii) 4,234,561 shares of Class B Common Stock that are convertible into 4,234,561 shares of Class A Common +Stock and carries the voting power of 42,345,610 shares of Class A Common Stock, (iii) 29,561,308 shares of Class A Common Stock issuable +upon conversion of Series C Convertible Preferred Stock that carry the voting power of 464,576 shares of Class A Common Stock, (iv) 567,578 +shares of Class A Common Stock issuable upon conversion of Series G Convertible Preferred Stock that carry the voting power of 153,748 +shares of Class A Common Stock and (v) 460,786 shares of Class A Common Stock underlying warrants that are either presently exercisable +or exercisable within 60 days. As of April 14, 2025, Ault & Company beneficially owns approximately 95.8% of our common stock and +had the right to cast total votes of approximately 82.5% of all votes entitled to be cast at a stockholder meeting. +In addition, pursuant to the (i) November 2023 SPA, as amended, Ault +& Company has the right to purchase up to an additional $25 million of Series C Convertible Preferred Stock and Series C Warrants +and (ii) December 2024 SPA, Ault & Company has the right to purchase up to an additional $49.0 million of Series G Convertible Preferred +Stock and Series G Warrants, which would further increase their beneficial ownership. Given the close relationship between Ault & +Company, on the one hand, and our company, on the other, it is not inconceivable that we could further amend the November 2023 SPA or +December 2024 SPA or enter into additional securities purchase agreements with Ault & Company. +Although we have relied on +Ault & Company to finance us in the past, we cannot assure you that Ault & Company will assist us in the future. We would far +prefer to rely on Ault & Company’s assistance compared to other sources of financing as the terms they provide us are in general +more favorable to us than we could obtain elsewhere. However, Messrs. Ault, Horne and Nisser could face a conflict of interest in that +they serve on the board of directors of each of Ault & Company and our company. If they determine that an investment in our company +is not in Ault & Company’s best interest, we could be forced to seek financing from other sources that would not necessarily +be likely to provide us with equally favorable terms. +Other conflicts of interest +between us, on the one hand, and Ault & Company, on the other hand, may arise relating to commercial or strategic opportunities or +initiatives. Mr. Ault, as the controlling stockholder of Ault & Company, may not resolve such conflicts in our favor. For example, +we cannot assure you that Ault & Company would not pursue opportunities to provide financing to other entities whether or not it currently +has a relationship with such other entities. Furthermore, our ability to explore alternative sources of financing other than Ault & +Company may be constrained due to Mr. Ault’s vision for us and he may not wish for us to receive any financing at all other than +from entities that he controls. +Alzamend +Our relationship with Alzamend may expose us +to certain conflicts of interest. +As of April 14, 2025, we beneficially own 3,386,340 shares of Alzamend’s +common stock, representing approximately 34.2%, consisting of (i) 111 shares of common stock underlying currently exercisable warrants +we own, (ii) 77,268 shares of common stock held by Ault Lending, (iii) 2,982,107 shares of common stock issuable upon conversion of series +B convertible preferred stock of Alzamend (the “ALZN Series B Preferred”) held by Ault Lending and (iv) 210,000 shares +of common stock issuable upon exercise of currently exercisable warrants held by Ault Lending. In +addition, Ault Lending owns additional warrants to purchase shares of common stock that cannot be exercised due to beneficial ownership +blockers. Beyond the securities we beneficially own, Mr. Ault, our Chief Executive Officer, beneficially owns an additional 177,436 shares +of common stock, consisting of (i) 77,268 shares held by Mr. Ault, (ii) 99,619 shares held by Ault +Life Sciences, Inc. (“ALSI”) and (iii) 549 shares held by Ault Life Sciences Fund, LLC (“ALSF”). Mr. Ault has +sole voting and investment power with respect to the securities held of record by ALSI and ALSF. +Messrs. Ault, Horne and Nisser +could face a conflict of interest in that they serve on the board of directors of each of Alzamend and our company. +53 +ROI +Our relationship with ROI may expose us to certain conflicts of +interest. +As of April 14, 2025, we beneficially +own 1,829,901 shares of ROI’s common stock, consisting of (i) 873,176 shares held by +Ault Lending, (ii) 293,358 shares issuable upon the conversion of outstanding shares of Series A Convertible Redeemable Preferred Stock +(“ROI Series A Preferred”) we own, and (iii) 663,367 shares issuable upon the conversion of outstanding shares of ROI Series +D Preferred we own. While as of April 14, 2025, we beneficially owned approximately 5.6% of ROI’s common stock, we own shares of +Series B Convertible Preferred Stock (“ROI Series B Preferred”) and additional shares of ROI Series D Preferred that cannot +be converted unless we first obtain shareholder approval, in addition to beneficial ownership blockers and other restrictions. If shareholder +approval was obtained and there were no restrictions on the conversion of the securities we own, as of April 14, 2025, then we would beneficially +own 58.2% of ROI’s common stock. +Messrs. Ault and Nisser could +face a conflict of interest in that they serve on the board of directors of each of ROI and our company. +Risks Related to RiskOn +Our growth and profitability depend on continued +interest in social gaming and sweepstakes within the U.S., and shifts in consumer preferences could harm our business +The acceptance of our Platform +hinges on sustained enthusiasm for sweepstakes-based social gaming and free-to-play models among U.S. consumers. If players begin favoring +alternative forms of entertainment, such as skill-based gaming, peer-to-peer betting, traditional online casino gambling (where legal), +or other digital experiences, then we may see a decline in user engagement. Rapid shifts in consumer taste, technological advancements +in gaming, or the emergence of more immersive entertainment platforms could all undermine the appeal of our Platform. +Maintaining user engagement +also requires us to stay current with ongoing trends, user preferences, and competing product offerings. If our platform does not frequently +update its game portfolio, introduce new sweepstakes concepts, or provide attractive incentives, users might lose interest and switch +to platforms perceived as more innovative. Additionally, negative publicity, whether founded or unfounded, about the integrity of our +sweepstakes, fairness of gameplay, or general user experience can substantially reduce engagement and erode trust, thus impacting our +revenue streams and brand reputation. +BNC’s products and changes to such products +could fail to attract or retain users or generate revenue and profits, or otherwise adversely affect BNC’s business. +BNC’s ability to sustain +and grow its user base, and thereby increase revenue, relies substantially on introducing new sweepstakes offerings, social gaming experiences, +and platform features that remain engaging to existing players while attracting new ones. For example, rolling out a fresh sweepstakes +model, collaborating with third-party developers on innovative mini-games, or upgrading interactive social elements can entail substantial +costs. These initiatives also carry significant risk: if the new content fails to resonate with users or presents unanticipated technical +issues, BNC may struggle to see a return on its investments. Additionally, changes to the product line such as altering the way players +earn in-game currency or modifying prize structures—could prompt user dissatisfaction or confusion, leading to attrition. +Adapting the Platform to different +regulatory interpretations or market shifts may further complicate these efforts. While BNC concentrates on free-to-play sweepstakes that +are legally distinct from gambling, any adjustments to product features might draw heightened scrutiny from federal or state authorities +responsible for consumer protection or gaming laws. This scrutiny could increase the Company’s compliance burden, potentially delay +product rollouts, or even lead to direct legal challenges. If BNC’s new offerings or updates fail to meet users’ expectations +or do not comply with regulatory requirements, the Company’s ability to generate revenue, maintain user engagement, or grow its +market share may be significantly compromised, ultimately harming its business and reputation. +Our reliance on third-party certified game +providers creates operational, compliance, and reputational vulnerabilities that could adversely impact our business. +BNC depends significantly +on third-party game providers to supply certified, compliance-tested games and core technological features—such as random number +generation modules, sweepstakes mechanics, and other elements that users rely on for fairness and transparency. If any provider fails +to maintain its certification, lapses in meeting regulatory standards, or experiences quality-control issues, we may have to remove or +suspend those games until the issues are resolved. This can lead to service gaps, user dissatisfaction, and potential regulatory scrutiny. +Moreover, we have limited oversight of our providers’ security protocols, development practices, and ongoing maintenance, which +means vulnerabilities or exploits in their systems could expose BNC to data breaches, game manipulation, or other cyber threats. Even +well-vetted vendors can face resource limitations, operational disruptions, or legal challenges that could prevent them from delivering +timely updates or patches. +54 +In addition, switching providers +or bringing certain gaming functions in-house on short notice can be time-consuming, technically complex and costly. We may need to develop +new applications that integrate into our Platform, which applications are currently provided by third party vendors, license alternative +software, or reconfigure our Platform infrastructure, each of which could interrupt users’ experience. Negotiating with new providers +may also require navigating different commercial and compliance frameworks, which can introduce delays and increase our administrative +burden. Furthermore, if a single major provider supplies several key games, that concentration of risk heightens our exposure should that +partner encounter financial difficulties or cease offering its products to us. Ultimately, any disruptions or degradations in third-party +game performance, or in the relationships themselves, may harm our users’ satisfaction as well as our revenue streams, and overall +ability to compete in the sweepstakes gaming area. +The lack of comprehensive encryption for communications +on the Platform may increase the impact of a data security incident. +Communications on the Platform +are not comprehensively encrypted at this time. As such, any data security incident that involves unauthorized access, acquisition, disclosure, +or use may be highly impactful to BNC’s business. BNC may experience considerable incident response forensics, data recovery, legal +fees, and costs of notification related to any such potential incident, and BNC may face an increased risk of reputational harm, regulatory +enforcement, and consumer litigation, which could further harm BNC’s business, financial condition, results of operations, and future +business opportunities. +Challenges in advertising and promoting our +sweepstakes could hinder our user acquisition and revenue growth. +Advertising our sweepstakes-based +social gaming platform presents unique legal and operational complexities. Federal and state regulations often place restrictions on how +promotional materials may be worded to avoid the appearance of gambling or any implication that a purchase is necessary to enter. These +rules can mandate specific disclosures, such as “No Purchase Necessary” or detailed eligibility requirements, and impose substantial +penalties for noncompliance, including fines or injunctions. The heightened scrutiny around promotional statements also means we must +carefully vet all advertising, whether digital, print or social media, to ensure we do not inadvertently violate regulations in any state +where our users reside. +Moreover, major online advertising +channels such as Google Ads, Facebook, and mobile app networks frequently maintain strict policies against content perceived as gambling +or misleading “pay-to-play” promotions. Our ads may be subject to frequent reviews, suspensions, or outright bans if deemed +non-compliant with these platforms’ terms. Even when ads are allowed, we may need to invest heavily in specialized compliance expertise +or premium ad placements to achieve visibility, pushing user-acquisition costs higher than in other online gaming segments. Additionally, +because our revenue hinges on attracting engaged users who understand the sweepstakes model, any misperception in advertising, such as +implying guaranteed payouts or pay-only entries, could invite reputational damage, user dissatisfaction, or regulatory scrutiny. These +challenges can collectively reduce our ability to scale efficiently, constrain our marketing strategies, and, ultimately, affect our ability +to generate revenue from new or existing users. +A perceived lack of fairness in outcomes or +prize distribution could severely damage brand trust. +Transparency around how winners +are chosen, and assurances that virtual coin purchases do not guarantee victory, form the bedrock of our Platform’s integrity. Any +misperception that sweepstakes are rigged, or that some participants have insider advantages, can spread virally. Users might abandon +the platform in droves, while regulators could initiate investigations into alleged unfair practices. Even if claims prove baseless, the +time and resources spent defending our practices could distract management and strain finances. +Risks Related to Government Regulation and +Enforcement Regarding BNC +Our sweepstakes model could be reclassified +as gambling or otherwise face tighter restrictions in certain U.S. states, which would materially affect our operations. +We carefully structure our +Platform to comply with sweepstakes rules and avoid classification as gambling, yet the line between “promotional sweepstakes” +and “illegal gambling” can sometimes be blurry. Individual states have differing definitions of what constitutes consideration, +chance, and prize, which constitute the three criteria generally used to determine legality. Should one or more states enact new legislation +or reinterpret existing laws to classify our sweepstakes model as gambling, our ability to operate in those states could be significantly +curtailed. +55 +Such a determination could +subject us to new licensing requirements, higher taxes, or additional consumer protection measures. In extreme circumstances, states could +ban our activities entirely. The financial and operational costs of complying with gambling regulations, obtaining licenses, or redesigning +our platform to exclude users from certain states would be substantial. Any actual or perceived classification as gambling might also +deter users who are uncomfortable with real or perceived gambling-related activities, reducing participation and revenue. +We are subject to complex and evolving U.S. +federal and state sweepstakes and consumer protection laws, which may impose substantial compliance burdens and operational constraints. +Operating as a sweepstakes +social gaming platform in the United States requires adherence to a tangle of rules and regulations, including federal guidelines on sweepstakes +and promotions, as well as a variety of state-specific laws. Many of these laws mandate alternative methods of entry, specific disclosures, +detailed recordkeeping, and in certain cases, bonding or registration. The costs and administrative burdens of fulfilling these requirements +can be significant, especially as we expand to new states or introduce new sweepstakes features. +Furthermore, any misstep, +even if inadvertent, in the design or execution of a sweepstakes could lead to allegations of illegal gambling, unfair trade practices, +or other regulatory violations. Certain states are particularly vigilant in policing sweepstakes models to ensure they do not equate to +games of chance that require a license or explicit regulatory oversight. If a regulator determines that some aspect of our Platform falls +outside permissible sweepstakes parameters, we could face fines, injunctions, forced modifications, or even closure of operations in that +jurisdiction. These regulatory uncertainties necessitate ongoing legal review and a level of caution that can delay or complicate product +innovations. +As its business develops, +BNC expects to become subject to significant legislative and regulatory developments; further, new legislation and regulations could significantly +affect BNC’s business in the future. These laws and regulations, as well as any associated claims, inquiries, or investigations +or any other government actions, have in the past led to, and may in the future lead to, unfavorable outcomes including increased compliance +costs, loss of revenue, delays or impediments in the development of new products, negative publicity and reputational harm, increased +operating costs, diversion of management time and attention, and remedies that harm BNC’s business, including fines or demands or +orders that BNC modify or cease existing business practices. +Regulatory inquiries or legal proceedings related +to AML, consumer fraud, or other compliance areas could disrupt our business and harm our reputation. +While our U.S. sweepstakes +platform is not intended to handle large financial transactions typically associated with online casinos, we do permit the purchase of +virtual coins and awards of monetary or tangible prizes. Even these more modest transactions can draw scrutiny from authorities concerned +about AML or potential consumer fraud. If regulators believe our Platform is used, knowingly or otherwise, to facilitate unlawful financial +activities, we could be required to invest in more comprehensive monitoring systems, implement additional customer due diligence, or face +enforcement actions and penalties. +Any high-profile investigation +or lawsuit ,whether or not it leads to a formal penalty, may also attract unwanted media attention, casting doubt on our security measures +and the integrity of our games. Damage to our brand’s reputation could undermine user confidence, leading to reduced engagement, +fewer new sign-ups, and diminished revenue streams. We might also face lawsuits from users or other parties alleging deceptive practices, +demanding refunds, or claiming injuries from fraudulent or unauthorized activities. Even if these claims lack merit, the cost of litigation, +along with the potential impact on our Platform’s public perception, can be considerable. +Risks Related to Data, Security, and Intellectual +Property +Security breaches, unauthorized attempts to +manipulate or “cheat” sweepstakes outcomes, and other cyber incidents could undermine trust in the Platform and adversely +affect BNC’s business. +BNC’s sweepstakes-based +social gaming environment involves the collection, storage, and transmission of substantial amounts of user data, including personal information, +payment details for virtual coin purchases, and records of sweepstakes entries or prize awards. Bad actors who gain access to this data—or +to the underlying mechanics that determine sweepstakes winners—can distort the Platform’s fairness, thereby undermining user +confidence in BNC’s legitimacy. Cheating attempts may include automated scripts or bots designed to submit multiple entries, exploit +software vulnerabilities, or manipulate game outcomes. Similarly, broader cyber threats such as hacking, malware, phishing, and social +engineering attacks can compromise user accounts, disrupt platform availability, and lead to the theft or misuse of sensitive information. +These incidents, in turn, could trigger regulatory investigations, private legal actions, and widespread reputational harm if users believe +that BNC cannot safeguard their data or ensure the integrity of its sweepstakes. +56 +BNC takes measures intended +to prevent, detect, and respond to these threats, including firewalls, encryption, account verification protocols, and ongoing security +monitoring. However, software bugs, configuration errors, or newly emerging hacking techniques can frustrate even the best efforts, especially +as criminals become more sophisticated. Additionally, employee or contractor malfeasance, physical security breaches at data centers, +or oversights by third-party vendors that store or process user information for BNC may expose the Company to further vulnerability. Remote +work arrangements can compound these risks by creating new attack surfaces, such as unsecured home networks or personal devices. Any successful +cyber-attack, or even a serious attempt at one, may require BNC to invest considerable resources in forensics, remediation, user notification, +and litigation defense. This would not only divert management’s attention but could also erode BNC’s active user base and +competitiveness if players perceive the Platform to be unsafe or prone to cheating. Furthermore, compliance with U.S. cybersecurity and +data protection laws could lead to additional costs and operational changes in the wake of a breach. Failure to address these risks promptly +and effectively could have a material adverse effect on BNC’s business, financial results, and reputation among regulators and users +alike. +We anticipate that BNC’s efforts related +to privacy, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity +by third parties on the Platform. +In addition to BNC’s +efforts to mitigate cybersecurity risks, BNC intends to make investments in privacy, safety, security, and content review efforts to combat +misuse of BNC’s services and user data by third parties, including investigations and audits of platform applications, as well as +other enforcement efforts. As a result of these efforts BNC anticipates that BNC will discover and announce additional incidents of misuse +of user data or other undesirable activity by third parties. BNC may not discover all such incidents or activity, whether as a result +of BNC’s data or technical limitations, including BNC’s lack of visibility over BNC’s encrypted services, the allocation +of resources to other projects, or other factors, and BNC may be notified of such incidents or activity by the FTC, the media or other +third parties. Such incidents and activities may in the future include the use of user data or BNC’s systems in a manner inconsistent +with BNC’s terms, contracts or policies, the existence of false or undesirable user accounts, improper advertising practices, activities +that threaten people’s safety on or offline, or instances of spamming, scraping, data harvesting, unsecured datasets, or spreading +misinformation. BNC may also be unsuccessful in its efforts to enforce BNC’s policies or otherwise remediate any such incidents. +Consequences of any of the foregoing developments include negative effects on user trust and engagement, harm to BNC’s reputation, +changes to BNC’s business practices in a manner adverse to BNC’s business, and adverse effects on BNC’s business and +financial results. Any such developments may also subject BNC to additional litigation and regulatory inquiries, which could subject BNC +to monetary penalties and damages, divert management’s time and attention, and lead to enhanced regulatory oversight. +BNC’s products and internal systems rely +on software and hardware that is highly technical, and any errors, bugs, or vulnerabilities in these systems, or failures to address or +mitigate technical limitations in BNC’s systems, could adversely affect BNC’s business. +BNC’s products and internal +systems rely on software and hardware, including software and hardware developed or maintained internally and/or by third parties, that +is highly technical and complex. In addition, BNC’s products and internal systems depend on the ability of such software and hardware +to store, retrieve, process, and manage considerable amounts of data. The software and hardware on which BNC relies is expected to contain +errors, bugs, or vulnerabilities, and BNC’s systems are subject to certain technical limitations that may compromise BNC’s +ability to meet BNC’s objectives. Some errors, bugs, or vulnerabilities inherently may be difficult to detect and may only be discovered +after the code has been released for external or internal use. Errors, bugs, vulnerabilities, design defects, or technical limitations +within the software and hardware on which BNC relies, or human error in using such systems, may in the future lead to outcomes including +a negative experience for users and marketers who use BNC’s products, compromised ability of BNC’s products to perform in +a manner consistent with BNC’s terms, contracts, or policies, delayed product introductions or enhancements, targeting, measurement, +or billing errors, compromised ability to protect the data of BNC’s users and/or BNC’s intellectual property or other data, +or reductions in BNC’s ability to provide some or all of BNC’s services. In addition, any errors, bugs, vulnerabilities, or +defects in BNC’s systems or the software and hardware on which BNC relies, failures to properly address or mitigate the technical +limitations in BNC’s systems, or associated degradations or interruptions of service or failures to fulfill BNC’s commitments +to BNC’s users, are expected to lead to outcomes including damage to BNC’s reputation, loss of users, loss of marketers, prevention +of its ability to generate revenue, regulatory inquiries, litigation, or liability for fines, damages, or other remedies, any of which +could adversely affect BNC’s business and financial results. +57 +Risks Related to askROI +We rely on an exclusive LLM licensing arrangement +and a platform development agreement with the same primary developer, even though we maintain ownership of the askROI platform’s +IP. +askROI’s AI-driven offerings +depend on a proprietary LLM licensed under an exclusive agreement (the “License Agreement”) with a third-party provider (the +“Licensor”), which also serves as the primary developer of our platform under a separate development agreement. Although we +retain ownership of the askROI Platform’s intellectual property, our day-to-day innovation and updates rely heavily on the Licensor’s +technical expertise, resources and timely performance. +If the License Agreement is +terminated, expires, or becomes subject to unfavorable terms, we could lose or face restrictions on the proprietary LLM functionality +integral to our product’s performance. Similarly, if disputes arise or the development agreement is breached, whether due to missed +milestones, shifting priorities, or misaligned strategic objectives, our ability to maintain, enhance, and scale the platform could be +severely compromised. Even though we technically own the underlying software, replacing a primary developer or transitioning to an alternative +solution could be time-consuming, costly and risky, potentially delaying product rollouts and damaging customer relationships. +Because both the License Agreement +and the platform development hinge on a single partner, a deterioration in our relationship with the Licensor could simultaneously threaten +our AI functionality and our capacity to enhance the capability of the askROI Platform. Such a scenario would materially and adversely +affect our competitiveness, financial condition, and prospects for growth. +Despite our multi-LLM routing model, performance +or reliability issues with our primary development partner’s LLM could still harm our product quality and reputation. +Our new “routing model” +allows us to tap into multiple LLMs, theoretically reducing reliance on one provider. However, our primary developer and Licensor remains +the key source of certain proprietary AI functionalities and platform support, meaning that ongoing performance or reliability problems +with its LLM technology could still cause significant product disruptions. Security breaches, downtime, or limited adaptability in the +Licensor’s services may reduce customer satisfaction, delay important product updates or damage our brand. Since we do not control +the Licensor’s internal operations, we are vulnerable to technical or strategic changes that could negatively impact our services. +askROI faces risks commonly associated with +start-up companies. +askROI faces risks commonly +associated with start-up companies. As a start-up company, askROI may face difficulties in validating market demand for its AI-powered +insights platform, which could adversely impact its ability to attract and acquire customers. Further, enterprise sales cycles can be +lengthy, particularly for a start-up company without an established track record. Prolonged sales cycles could strain askROI’s cash +flow and hinder growth, and (iii) reliance on a few large customers could make askROI vulnerable to revenue volatility and adversely impact +its bargaining power. If any of the foregoing risks were to materialize, askROI’s business and future prospects could be materially +and adversely affected. +askROI faces adoption and integration and other +challenges. +askROI faces adoption and +integration challenges. Complex onboarding processes or steep learning curves could slow customer adoption and time-to-value realization. +Further, its software could be difficult to integrate with a customer’s legacy systems, leading to challenges with customers’ +legacy systems and tools. Any difficulties associated with the integration of different systems could limit askROI’s market penetration +and customer satisfaction. In addition, the Licensor’s development team may have limited capacity to support askROI’s platform +development needs, particularly if askROI were to begin seeing significant growth and require more rapid iterations and customizations. +Also, the LLM technology may not be optimized for the scale and performance requirements of askROI’s growing user base, leading +to performance bottlenecks and customer dissatisfaction. Additionally, as a new entrant in the market, askROI may struggle to establish +brand awareness and credibility, making it harder to attract customers and partners. Similarly, any negative publicity or customer complaints +could disproportionately impact askROI’s reputation as a startup, hindering its growth and ability to compete against established +players. If any of the foregoing risks were to materialize, askROI’s business and future prospects could be materially and adversely +affected. +Rapidly changing AI regulation may require +significant adjustments and investments. +Governments and regulatory +bodies worldwide are introducing new laws and guidelines for AI, data privacy, and automated decision-making. These regulations may force +us to modify certain features, require additional transparency or auditing tools, or limit our platform’s functionality. Complying +with emerging or conflicting rules across jurisdictions could raise operating costs or delay product rollouts. Failure to meet these requirements +could result in fines, legal action, or reputational harm. +58 +Data privacy and security laws could increase +compliance costs and limit our flexibility. +Various jurisdictions are +adopting stricter data privacy and security regulations, such as the GDPR in the EU and certain U.S. state privacy laws. We must continually +enhance our security measures, encryption protocols, and data handling procedures to remain compliant. These changes could increase our +operational expenses. Any failure to comply with evolving data protection requirements may lead to enforcement actions, penalties, or +erosion of customer trust. +Established technology companies with greater +resources may outcompete us. +Larger technology firms with +substantial financial and technical resources continue to expand their AI-driven offerings, sometimes bundling analytics solutions into +broader enterprise software suites. These competitors may benefit from existing customer relationships, extensive R&D budgets, and +powerful marketing capabilities. If they introduce more advanced or cost-effective solutions, we may find it difficult to retain or attract +customers, thereby adversely impacting our revenue and market share. +Our future success depends on ongoing innovation +and technological advancements. +The market for AI-driven analytics +is evolving rapidly. We must invest in research and development to remain competitive in natural language processing, data visualization, +and user experience. If we fail to keep pace with or anticipate market trends, or if the capabilities of our platform lag behind those +of our competitors, our solutions may become less attractive, resulting in lost revenue and diminished market position. +Our platform’s integration with third-party +tools and systems may present technical and operational risks. +askROI relies on seamless +integration with a wide range of external applications, including customer relations management platforms, file storage providers, and +communication tools. If these third parties modify their application programming interfaces, introduce incompatibilities, or discontinue +services, we may need to invest significant resources to maintain compatibility. Difficulties integrating with common enterprise systems +could hamper our ability to onboard new customers efficiently. +We rely on secure workspaces and knowledge +bases that may still pose data exposure risks. +Even though we do not train +the underlying LLM on customers’ proprietary information, we host and index their data within dedicated workspaces. Any unauthorized +access, security breach, or deficiency in our data-protection measures could expose confidential information, leading to legal liability, +regulatory scrutiny and reputational damage. +Inaccurate or biased AI outputs could expose +us to reputational and legal risks. +Our AI-driven insights may +occasionally generate incorrect or biased results. Such outcomes could lead customers to make flawed business decisions, undermine confidence +in our platform, or result in litigation. Ongoing model validation and prompt issue resolution are crucial to mitigating these risks. +Our proprietary rights could be inadequately +protected, leading to IP disputes. +The unique components of our +platform and certain enhancements we develop may be subject to intellectual property protection. If we fail to enforce or defend our rights, +or if third parties allege that our technology infringes on their IP, we could face costly litigation and be required to alter or cease +certain offerings. Such disputes can disrupt operations and harm our reputation. +Customer retention risks could pose a challenge +for askROI. +askROI may experience difficulties +in retaining customers. Any failure on its part to achieve strong product-market fit could lead to high customer churn rates, as businesses +may not perceive sufficient value in askROI’s offerings. Further, as a newly formed entity, askROI may struggle to provide the level +of customer support expected by enterprise clients, which could have a materially adverse impact on customer satisfaction and retention. +Finally, low barriers to entry and minimal switching costs in the AI and analytics market could make it easier for customers to move to +competitors, thereby increasing askROI’s customer retention risks. If any of these developments were to occur, askROI’s business +and future prospects could be materially and adversely affected. +59 +Ethical AI concerns. +The AI industry is commonly +associated with ethical concerns, whether real or perceived, which askROI must overcome in order to successfully develop its business. +Such concerns include the risk that unintended biases in askROI’s AI models could lead to discriminatory or unfair outcomes, damage +the entity’s reputation and expose it to legal risks, and that difficulty in providing clear explanations for AI-generated insights +could erode customer trust and hinder adoption of askROI’s product offerings. If askROI cannot substantially mitigate or prevent +such concerns from arising, its business and future prospects could be materially and adversely affected. +Uncertain legal interpretations of emerging +AI regulations could lead to operational constraints. +Because AI-related laws and +guidelines are still developing, legal interpretations can vary widely across different regulators and courts. We may need to adjust our +platform functionality or compliance processes in response to evolving interpretations, which could divert resources from other initiatives +and slow innovation. +If we fail to effectively manage our growth, +our business could suffer. +Rapid or poorly managed growth +could lead to operational inefficiencies, resource strains, and quality control issues. We may also face challenges in maintaining our +corporate culture or onboarding new staff quickly. If we cannot scale responsibly, product quality or customer satisfaction could decline, +harming our market reputation. +Risks Related to TurnOnGreen +TurnOnGreen can provide no assurance of any +successful expansion of its operations. +TurnOnGreen’s significant +increase in the scope and the scale of its operations, including the hiring of additional personnel, has resulted in significantly higher +operating expenses. TurnOnGreen anticipates that its operating expenses will continue to increase. Expansion of its operations may also +make significant demands on its management, finances and other resources. Its ability to manage the anticipated future growth, should +it occur, will depend upon a significant expansion of its accounting and other internal management systems and the implementation and +subsequent improvement of a variety of systems, procedures and controls. TurnOnGreen cannot assure that significant problems in these +areas will not occur. Failure to expand these areas and implement and improve such systems, procedures and controls in an efficient manner +at a pace consistent with its business could have a material adverse effect on its business, financial condition and results of operations. +TurnOnGreen cannot assure that attempts to expand its marketing, sales, manufacturing and customer support efforts will succeed or generate +additional sales or profits in any future period. As a result of the expansion of its operations and the anticipated increase in its operating +expenses, along with the difficulty in forecasting revenue levels, TurnOnGreen expects to continue to experience significant fluctuations +in its results of operations. +Changes in U.S. and international trade policies, +particularly with respect to China, and key trading countries, may adversely impact TurnOnGreen’s business and operating results. +TurnOnGreen currently relies on foreign +third-party manufacturers, and parts suppliers, including those in China, Taiwan, Israel, and other countries. The U.S. government and +persons involved in the Trump administration have made statements and taken certain actions that may lead to potential changes to U.S. +and international trade policies. In April 2025, the U.S. government announced a combined total +rate of at least 145%, which includes the 20% in place since February 2025 on imports from China. If maintained and if extended +to other countries, tariffs, and the potential escalation of trade disputes with China and other countries could pose a significant risk +to its business and could result in higher cost of revenues and operating expenses. The extent and duration of any tariffs and the resulting +impact on general economic conditions and on its business are uncertain and depend on various factors, such as negotiations between the +United States and China and/or other countries, the response of such countries, exemptions or exclusions that may be granted, availability. +TurnOnGreen is in a highly competitive EV charging +services industry and there can be no assurance that TurnOnGreen will be able to compete with many of its competitors which are larger +and have greater financial resources. +TurnOnGreen faces strong competition +from competitors in the EV charging services industry, including competitors who could duplicate its model. Many of these competitors +may have substantially greater financial, marketing and development resources and other capabilities than us. In addition, there are very +few barriers to entry into the market for its services. There can be no assurance, therefore, that any of its current and future competitors, +many of whom may have far greater resources, will not independently develop services that are substantially equivalent or superior to +its services. Therefore, an investment in its company is very risky and speculative due to the competitive environment in which TurnOnGreen +may operate. +60 +Its competitors may be able +to provide customers with different or greater capabilities or benefits than TurnOnGreen can provide in areas such as technical qualifications, +past contract performance, geographic presence and driver price. Further, many of its competitors may be able to utilize substantially +greater resources and economies of scale to develop competing products and technologies, divert sales away from us by winning broader +contracts or hire away its employees by offering more lucrative compensation packages. +Risks Related to Ownership of Our Class +A Common Stock and Future Offerings +If we do not continue to satisfy the NYSE American +continued listing requirements, our Class A common stock could be delisted from NYSE American. +The listing of our Class A +common stock on the NYSE American is contingent on our compliance with the NYSE American’s conditions for continued listing. +We were notified by the NYSE +American on December 18, 2024 that, due to our disclosure in our Form 10-Q filed for the fiscal period ended September 30, 2024, which +reported stockholders’ equity of approximately $2.2 million, we no longer met the requirement that we must have no less than $6 +million or more in stockholders’ equity pursuant to the listing standard set forth under Section 1003(a)(ii) and (iii) of the NYSE +American Company Guide (the “Listing Standards”) because we have reported losses from continuing operations and/or net losses +in five of our most recent fiscal years ended December 31, 2023. Under the applicable NYSE American listing rules, we were required to, +no later than January 17, 2025, submit a compliance plan that demonstrates how we intend to regain compliance with the Listing Standards +within 18 months of the receipt of the notice, or June 18, 2026. The compliance plan was submitted to the NYSE American on January 17, +2025. We have, at the request of the NYSE American, provided supplements to the original compliance plan. On March 4, 2025, the NYSE American +notified us that we have been granted a listing extension until June 18, 2026 on the basis of the compliance plan we recently submitted +to regain compliance with the Listing Standards. +If +we do not make progress consistent with the plan during the plan period, the NYSE American will initiate delisting procedures. We will +be subject to periodic reviews including quarterly monitoring for compliance with the plan. Additionally, if we were to fail to meet any +other NYSE American listing requirement, we may be subject to delisting by the NYSE American. In the event our Class A common stock is +no longer listed for trading on the NYSE American, our trading volume and share price may decrease and we may experience further difficulties +in raising capital which could materially affect our operations and financial results. Further, delisting from the NYSE American could +also have other negative effects, including potential loss of confidence by partners, lenders, suppliers and employees and could also +trigger various defaults under our lending agreements and other outstanding agreements. Finally, delisting could make it harder for us +to raise capital and sell securities. You may experience future dilution as a result of future equity offerings. In order to raise additional +capital, we may in the future offer additional shares of our Class A common stock or other securities convertible into or exchangeable +for our Class A common stock at prices that may not be the same as the price per share in this offering. We may sell shares or other securities +in any other offering at a price per share that is less than the price per share paid by investors in this offering, and investors purchasing +shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional +shares of our Class A common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher +or lower than the price per share paid by existing investors. +You may experience future dilution as a result of future equity +offerings. +In order to raise additional +capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable for our +common stock at prices that may not be the same as the price per share in this offering. We may sell shares or other securities in any +other offering at a price per share that is less than the price per share paid by investors in this offering, and investors purchasing +shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional +shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower +than the price per share paid by investors. +Our Class A common stock price is volatile. +Our Class A common stock is listed on the +NYSE American. In the past, our trading price has fluctuated widely, depending on many factors that may have little to do with our operations +or business prospects. During the past 52-week period (through April 11, 2025), our stock closed at prices between $16.47 per share and +$2.18 per share, as reported on Nasdaq.com. On April 11, 2025, the price of our Class A common stock closed at $2.35 per share. +61 +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our Class A common stock +may continue to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, +coupled with depressed economic conditions, could continue to have a depressive effect on the market price of our Class A common stock. +The following factors, many of which are beyond our control, may influence our stock price: +· the status of our growth strategy including the +development of new products with any proceeds we may be able to raise in the future; +· announcements of technological or competitive +developments; +· announcements or expectations of additional financing +efforts; +· our ability to market new and enhanced products +on a timely basis; +· changes in laws and regulations affecting our +business; +· commencement of, or involvement in, litigation +involving us; +· regulatory developments affecting us, our customers +or our competitors; +· announcements regarding patent or other intellectual +property litigation or the issuance of patents to us or our competitors or updates with respect to the enforceability of patents or other +intellectual property rights generally in the US or internationally; +· actual or anticipated fluctuations in our quarterly +financial results or the quarterly financial results of companies perceived to be similar to us; +· changes in the market’s expectations about +our operating results; +· our operating results failing to meet the expectations +of securities analysts or investors in a particular period; +· changes in the economic performance or market +valuations of our competitors; +· additions or departures of our executive officers; +· sales or perceived sales of our common stock +by us, our insiders or our other stockholders; +· share price and volume fluctuations attributable +to inconsistent trading volume levels of our shares; and +· general economic, industry, political and market +conditions and overall fluctuations in the financial markets in the United States and abroad. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our Class A +common stock and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market +price of a company’s securities, stockholders have often instituted securities class action litigation against that company. If +we were involved in a class action suit or other securities litigation, it would divert the attention of our senior management, require +us to incur significant expense and, whether or not adversely determined, have a material adverse effect on our business, financial condition, +results of operations and prospects. +62 +Volatility in our Class A common stock price may subject us to securities +litigation. +Stock markets, in general, +have experienced, and continue to experience, significant price and volume volatility, and the market price of our Class A common stock +may continue to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased volatility, +coupled with depressed economic conditions, could have a depressing effect on the market price of our Class A common stock. +In addition, the securities +markets have, from time to time, experienced significant price and volume fluctuations that are not related to the operating performance +of particular companies. Any of these factors could result in large and sudden changes in the volume and trading price of our Class A +common stock and could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market +price of a company’s securities, stockholders have often instituted securities class action litigation against that company. If +we were involved in a class action suit or other securities litigation, it would divert the attention of our senior management, require +us to incur significant expense and, whether or not adversely determined, have a material adverse effect on our business, financial condition, +results of operations and prospects. +We have a substantial +number of convertible notes, warrants and preferred stock outstanding that could affect our price. +Due to a number of financings, we have a substantial number of shares +that are subject to issuance pursuant to outstanding convertible debt, warrants and options. As of April 14, 2025, the number of shares +of Class A common stock subject to convertible notes, warrants, class B common stock, Series C Convertible Preferred Stock and Series +G Preferred Stock were 8,248,865, 622,207, 4,995,724, 29,561,308 and 508,455, respectively. The issuance of Class A common stock pursuant +to convertible notes, warrants and preferred stock at conversion or exercise prices lower than market prices may have the effect of limiting +an increase in the market price of our Class A common stock. +General Risk Factors +Our limited operating history makes it difficult +to evaluate our future business prospects and to make decisions based on our historical performance . +Although our executive officers +have been engaged in the industries in which we operate for varying degrees of time, we did not begin operations of our current business +until recently. We have a very limited operating history in our current form, which makes it difficult to evaluate our business on the +basis of historical operations. As a consequence, it is difficult, if not impossible, to forecast our future results based upon our historical +data. Reliance on our historical results may not be representative of the results we will achieve, and for certain areas in which we operate, +principally those unrelated to defense contracting, will not be indicative at all. Because of the uncertainties related to our lack of +historical operations, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in sales, product costs +or expenses. If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, +which may result in a decline in our stock price. +Deterioration of global economic conditions +could adversely affect our business . +The global economy and capital +and credit markets have experienced exceptional turmoil and upheaval over the past several years. Ongoing concerns about the systemic +impact of potential long-term and widespread recession and potentially prolonged economic recovery, volatile energy costs, fluctuating +commodity prices and interest rates, volatile exchange rates, geopolitical issues, including the conflicts between Russia and Ukraine +and between Israel and Hamas, natural disasters and pandemic illness, instability in credit markets, cost and terms of credit, consumer +and business confidence and demand, a changing financial, regulatory and political environment, and substantially increased unemployment +rates have all contributed to increased market volatility and diminished expectations for many established and emerging economies, including +those in which we operate. Furthermore, austerity measures that certain countries may agree to as part of any debt crisis or disruptions +to major financial trading markets may adversely affect world economic conditions and have an adverse impact on our business. These general +economic conditions could have a material adverse effect on our cash flow from operations, results of operations and overall financial +condition. +The availability, cost and +terms of credit also have been and may continue to be adversely affected by illiquid markets and wider credit spreads. Concern about the +stability of the markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors +to reduce credit to businesses and consumers. These factors have led to a decrease in spending by businesses and consumers over the past +several years, and a corresponding slowdown in global infrastructure spending. +63 +Continued uncertainty in the +U.S. and international markets and economies and prolonged stagnation in business and consumer spending may adversely affect our liquidity +and financial condition, and the liquidity and financial condition of our customers, including our ability to access capital markets and +obtain capital lease financing to meet liquidity needs. +If we fail to establish and maintain an effective +system of internal control over financial reporting, we may not be able to report our financial results accurately or prevent fraud. Any +inability to report and file our financial results accurately and timely could harm our reputation and adversely impact the trading price +of our Class A common stock. +Effective internal control +over financial reporting is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial +reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, +and our business and reputation with investors may be harmed. As a result, our small size and any current internal control deficiencies +may adversely affect our financial condition, results of operations and access to capital. We have carried out an evaluation under the +supervision and with the participation of our management, including our principal executive officer and principal financial officer, of +the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent period covered +by this report. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure +controls and procedures were not effective at the reasonable assurance level due to the material weakness described below. +A material weakness is a deficiency, +or a combination of deficiencies, within the meaning of Public Company Accounting Oversight Board (“PCAOB”) Audit Standard +No. 5, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual +or interim financial statements will not be prevented or detected on a timely basis. Management has identified the following material +weakness which has caused management to conclude that as of December 31, 2024, our internal control over financial reporting (“ICFR”) +was not effective at the reasonable assurance level. +We do not have sufficient +resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial +reporting, including fair value estimates, in a timely manner. In addition, due to our size and nature, segregation of all conflicting +duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, +the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of +our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the resulting +control deficiency represented a material weakness. +We are currently working to +improve and simplify our internal processes and implement enhanced controls to address the material weakness in our internal control over +financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. This material weakness will not be considered +to be remediated until the applicable remediated controls are operating for a sufficient period of time and management has concluded, +through testing, that these controls are operating effectively. +If our accounting +controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed. +We +evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and annually review and evaluate our internal control +over financial reporting in order to comply with the SEC’s rules relating to internal control over financial reporting adopted pursuant +to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect +misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become +inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail +to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such internal +control, we may be subject to regulatory sanctions, and our reputation may decline. +Our internal computer +systems may fail or suffer security breaches, which could result in a material disruption of our operations . +Like +any other business, we rely on e-mail and other digital communications methods as part of our normal operations. As such, our internal +computer systems and servers could fail or suffer security breaches, possibly resulting in a material disruption to our operations. The +secure operation of our IT networks and systems as well as the secure processing and maintenance of information is critical to our operations +and business strategy. Notwithstanding these priorities, we have experienced attempts at cybercrime such as phishing and other electronic +fraud, including efforts to misdirect payments to imposter vendors and service providers. After experiencing a financial loss due to e-mail +fraud in November 2021, we have instituted greater internal controls and procedures, both electronic and non-electronic, to combat such +fraudulent conduct. We also maintain an insurance policy to cover any losses or injuries suffered from cybercrime of this nature; however, +it may not be sufficient to cover all damages. Despite our efforts, attempts at fraud such as spoofed e-mails, requests for payment and +similar deceptions have become commonplace in the world of e-commerce and are expected to continue. If we are unable to prevent such security +breaches in the future, these events or circumstances could materially and adversely affect our operations, financial condition and operating +results and impair our ability to execute our business strategy. +64 +We face significant competition, including changes in pricing. +The markets for our products +and services are both competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing resources, +plus experience in research and development, and compete with us by offering lower prices. Competitors could develop new technologies +that compete with our products to achieve a lower unit price. If a competitor develops lower cost and/or superior technology or cost-effective +alternatives to our products and services, our business could be seriously harmed. +The markets for some of our +products are also subject to specific competitive risks because these markets are highly price sensitive. Our competitors have competed +in the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering our prices. This would +reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also impact sales and aggravate +losses. +Many of our competitors are larger and have +greater financial and other resources than we do. +Our products compete and will +compete with similar if not identical products produced by our competitors. These competitive products could be marketed by well-established, +successful companies that possess greater financial, marketing, distribution personnel, and other resources than we do. Using said resources, +these companies can implement extensive advertising and promotional campaigns, both generally and in response to specific marketing efforts +by competitors. They can introduce new products to new markets more rapidly. In certain instances, competitors with greater financial +resources may be able to enter a market in direct competition with us, offering attractive marketing tools to encourage the sale of products +that compete with our products or present cost features that consumers may find attractive. +Our growth strategy is subject to a significant +degree of risk. +Our +growth strategy through acquisitions involves a significant degree of risk. Some of the companies that we have identified as acquisition +targets or made a significant investment in may not have a developed business or are experiencing inefficiencies and incur losses. Therefore, +we may lose our investment in the event that these companies’ businesses do not develop as planned or that they are unable to achieve +the anticipated cost efficiencies or reduction of losses. +Further, +in order to implement our growth plan, we have hired additional staff and consultants to review potential investments and implement our +plan. As a result, we have substantially increased our infrastructure and costs. If we fail to quickly find new companies that provide +revenue to offset our costs, we will continue to experience losses. No assurance can be given that our product development and investments +will produce sufficient revenues to offset these increases in expenditures. +Changes in the U.S. tax and other laws and regulations may adversely +affect our business. +The U.S. Government may revise +tax laws, regulations or official interpretations in ways that could have a significant adverse effect on our business, including modifications +that could reduce the profits that we can effectively realize from our international operations, or that could require costly changes +to those operations, or the way in which they are structured. For example, the effective tax rates for most U.S. companies reflect the +fact that income earned and reinvested outside the U.S. is generally taxed at local rates, which may be much lower than U.S. tax rates. +If we expand abroad and there are changes in tax laws, regulations or interpretations that significantly increase the tax rates on non-U.S. +income, our effective tax rate could increase and our profits could be reduced. If such increases resulted from our status as a U.S. company, +those changes could place us at a disadvantage to our non-U.S. competitors if those competitors remain subject to lower local tax rates. +65 +Our sales and profitability may be affected by changes in economic, +business and industry conditions . +If the economic climate in +the U.S. or abroad deteriorates, customers or potential customers could reduce or delay their technology investments. Reduced or delayed +technology and entertainment investments could decrease our sales and profitability. In this environment, our customers may experience +financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and professional services. +This may lead to longer sales cycles, delays in purchase decisions, payment and collection, and can also result in downward price pressures, +causing our sales and profitability to decline. In addition, general economic uncertainty and general declines in capital spending in +the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and the markets +we serve. There are many other factors which could affect our business, including: +· The introduction and market acceptance of new +technologies, products and services; +· New competitors and new forms of competition; +· The size and timing of customer orders (for retail +distributed physical product); +· The size and timing of capital expenditures by +our customers; +· Adverse changes in the credit quality of our +customers and suppliers; +· Changes in the pricing policies of, or the introduction +of, new products and services by us or our competitors; +· Changes in the terms of our contracts with our +customers or suppliers; +· The availability of products from our suppliers; +and +· Variations in product costs and the mix of products +sold. +These trends and factors could adversely affect +our business, profitability and financial condition and diminish our ability to achieve our strategic objectives. +The rights of the holders of common stock may +be impaired by the potential issuance of preferred stock. +Our certificate of incorporation +gives our Board the right to create new series of preferred stock. As a result, the Board may, without stockholder approval, issue preferred +stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting power and equity interest +of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote per share, could be utilized +as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect +the price of our Class A common stock. We may issue shares of preferred stock in the future. +The requirements of being a public company +may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members. +We are a public company and +subject to the reporting requirements of the Exchange Act, and the Sarbanes-Oxley Act of 2002. The Exchange Act requires, among other +things, that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act +requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial reporting. +For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of our internal controls +structure and procedures for financial reporting. Section 404 compliance may divert internal resources and will take a significant +amount of time and effort to complete. If we fail to maintain compliance under Section 404, or if our internal control over financial +reporting continues to not be effective as defined under Section 404, we could be subject to sanctions or investigations by the NYSE +American, the SEC, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause +a decline in the market price of our Class A common stock. Any failure of our internal controls could have a material adverse effect on +our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could +harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent +auditors. We may need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing +obligations as a public company, particularly if we become fully subject to Section 404 and its auditor attestation requirements, which +will increase costs. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives +and to meeting the obligations that are associated with being a public company, which may divert attention from other business concerns, +which could have a material adverse effect on our business, financial condition and results of operations. +66 +We have identified material weaknesses in our +internal control over financial reporting and may identify additional material weaknesses in the future or otherwise fail to maintain +an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to +meet our periodic reporting obligations. +We are required to comply +with certain provisions of Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”). Section 404 requires that +we document and test our internal control over financial reporting and issue management’s assessment of our internal control over +financial reporting. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2024. In +making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) +in Internal Control — Integrated Framework. A material weakness is a deficiency, or a combination of deficiencies, in internal control +over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial +statements will not be prevented or detected on a timely basis. Based on our assessment, as of December 31, 2024, we concluded that our +internal control over financial reporting contained material weaknesses. +The weakness will not be considered +remediated, however, until the applicable controls operate for a sufficient period of time and our management has concluded, through testing, +that these controls are operating effectively. If we fail to comply with the requirements of Section 404 of the Sarbanes-Oxley Act, the +accuracy and timeliness of the filing of our annual and quarterly reports may be materially adversely affected and could cause investors +to lose confidence in our reported financial information, which could have a negative effect on the trading price of our Class A common +stock. In addition, a material weakness in the effectiveness of our internal control over financial reporting could result in an increased +chance of fraud and the loss of customers, reduce our ability to obtain financing and require additional expenditures to comply with these +requirements, each of which could have a material adverse effect on our business, results of operations and financial condition. +The elimination of monetary liability against +our directors, officers and employees under law and the existence of indemnification rights for or obligations to our directors, officers +and employees may result in substantial expenditures by us and may discourage lawsuits against our directors, officers and employees. +Our certificate of incorporation +contains a provision permitting us to eliminate the personal liability of our directors to us and our stockholders for damages for the +breach of a fiduciary duty as a director or officer to the extent provided by Delaware law. We may also have contractual indemnification +obligations under any future employment agreements with our officers. The foregoing indemnification obligations could result in us incurring +substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. +These provisions and the resulting costs may also discourage us from bringing a lawsuit against directors and officers for breaches of +their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and +officers even though such actions, if successful, might otherwise benefit us and our stockholders. +We do not anticipate paying cash dividends +on our common stock and, accordingly, stockholders must rely on stock appreciation for any return on their investment. +We have never declared or +paid cash dividends on our Class A common stock and do not expect to do so in the foreseeable future. The declaration of dividends is +subject to the discretion of our Board and will depend on various factors, including our operating results, financial condition, future +prospects and any other factors deemed relevant by our Board. You should not rely on an investment in our company if you require dividend +income from your investment in our company. The success of your investment will likely depend entirely upon any future appreciation of +the market price of our Class A common stock, which is uncertain and unpredictable. There is no guarantee that our Class A common stock +will appreciate in value. +ITEM 1B. UNRESOLVED STAFF COMMENTS +Because we are a smaller reporting company, this +section is not applicable. +ITEM 1C. CYBERSECURITY +Information Security Program: +The mission of our information +security program is to design, implement, and maintain a comprehensive information security program that protects our systems, services, +and data against unauthorized access, disclosure, modification, damage, and loss. Our information security program is comprised of internal +and external security and technology professionals who work collaboratively to identify, assess, manage, and mitigate cybersecurity risks +and threats across the Company, our subsidiaries, and third-party contractors . +67 +We recognize the importance +of effectively managing material risks associated with cybersecurity threats, as defined in Item 106(a) of Regulation S-K. Our risk management +program integrates the monitoring and management of these risks and threats and is informed by applicable laws, regulations, industry +standards, and best practices. We continue to invest in information security resources to mature, expand, and adapt our capabilities to +address emerging cybersecurity risks and threats. +Our information security organization +is committed to maintaining a robust and resilient security posture that enables us to protect our assets, maintain our stakeholders' +trust, and support our business's overall success. +Cybersecurity Risk Management and Strategy +Our cybersecurity risk management +and strategy are integral components of our comprehensive information security program. They guide our continuous efforts to evaluate +and improve the confidentiality, integrity, and availability of our critical systems, data, and operations. +We have adopted an Information +Security Policy (the “Info-Sec Policy”) and an Incident Response Plan (the “Response Plan”) that establish administrative, +physical, and technical controls and procedures to protect sensitive data throughout the Company. These policies also outline processes +to assess, identify, manage, and report cybersecurity risks and incidents. The Info-Sec Policy applies to all persons working for the +Company and any third parties working with us in any capacity. +Our approach to controls and +risk management is informed by applicable laws and regulations, as well as industry standards and best practices. These serve as a guide +to help us identify, assess, and manage cybersecurity controls and risks relevant to our business. +Our cybersecurity risk management +program includes: +1. Identifying cybersecurity risks that could impact our facilities, third-party vendors/partners, operations, +critical systems, information, and broader enterprise information technology environment. Risks are informed by threat intelligence, current +and historical adversarial activity, and industry-specific threats ; +2. Performing cybersecurity risk assessments to evaluate our readiness if the risks were to materialize; +3. Ensuring risk is addressed and tracking any necessary remediation through an action plan; +4. Analyzing all third-party vendors for compliance with our internal Info-Sec Policy to assess potential +risks associated with their security controls. We generally require third parties to maintain security controls, notify us promptly of +any data breach or cybersecurity incident that may impact our data, and provide written assurance of corrective actions; and +5. Engaging and utilizing a comprehensive suite of security solutions, including enterprise mobility management, +endpoint protection, secure file transfer, and security information and event management to monitor and actively respond to cybersecurity +threats. These solutions work together to secure our endpoints, protect against malware, ensure the safe transfer of files, and provide +our cybersecurity team with the functionality to build alerts on specific use cases that are important and unique to our business. +Cybersecurity Governance +Our Board oversees cybersecurity risk as part of its overall risk oversight +function. Our information technology department (the “IT Department”), which functions as our Information Security Advisory +Team, is responsible for managing our information security program and implementing cybersecurity risk management practices. The IT Department +is led by our Chief Information Officer, who oversees our cybersecurity strategy and ensure its alignment with business objectives. +The IT Department collaborates +with various stakeholders across the organization to identify, assess, and mitigate cybersecurity risks. They regularly monitor and adapt +our information security program to address the evolving threat landscape. +68 +In the event of a cybersecurity +incident, the IT Department promptly reports the matter to the Executive Committee, which consists of our senior leadership team. The +Executive Committee is responsible for assessing the severity and potential impact of the incident and determining the appropriate course +of action. The Executive Committee keeps the Board informed of significant cybersecurity incidents and provides updates on the overall +status of our cybersecurity program as needed. +This governance structure +ensures that cybersecurity risks are effectively managed by the IT Department, with oversight from the Executive Committee and the Board. +It maintains clear lines of communication and accountability, enabling timely decision-making and response to cybersecurity matters. +In 2023, we did not identify +any cybersecurity threats that have materially affected or are reasonably likely to materially affect our business strategy, results of +operations or financial condition. However, despite our efforts, we may not successfully eliminate all risks from cybersecurity threats +and can provide no assurance that undetected cybersecurity incidents have not occurred. +ITEM 2. PROPERTIES +Our corporate headquarters +office utilizes 10,274 square feet of leased office space in Las Vegas, Nevada. Our Las Vegas leases expire in July 2026. The annual +base rent under the leases, payable on a monthly basis, was approximately $0.2 million during 2024. +We also lease additional corporate +offices in Costa Mesa, California and New York, New York. Our New York lease expires in December 2030 and our Costa Mesa lease expires +in December 2027. The annual base rent under the leases, payable on a monthly basis, was approximately $0.3 million during 2024. +We own a 617,000 square foot +data center in Dowagiac, Michigan, in which we operate our crypto assets mining operations for Sentinum, in addition to renting commercial +office and warehouse space. +Our TurnOnGreen segment leases +39,965 square feet of office, engineering, laboratory and warehouse space in two locations in Milpitas, California. One of the leases +previously expired and is now on a month-to-month basis, while the remaining lease expires on January 2026. The annual base rent under +the leases, payable on a monthly basis, was approximately $0.7 million during 2024. +Our Energy segment crane rental business leases 27,909 square feet +of commercial buildings and 10 acres of land in Carthage, Texas, Clinton, Oklahoma, Houston, Texas, and Robstown, Texas. Our leases expire +between May 2025 and April 2027. The annual base rent under the leases, payable on a monthly basis, was approximately $0.5 million in +2024. +We currently anticipate that the current leased +space will be sufficient to support our current and foreseeable future needs. +ITEM 3. LEGAL PROCEEDINGS +Litigation Matters +The Company is involved in +litigation arising from other matters in the ordinary course of business. We are regularly subject to claims, suits, regulatory and government +investigations, and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, suits, regulatory +and government investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +Certain of these outstanding +matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable +that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss +or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could +affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and +make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount +of a loss related to such matters. +69 +Arena Litigation +Arena Investors, LP (ROI Litigation) +On May 30, 2024, Arena Investors, +LP (“Arena”), in its capacity as collateral agent for five noteholders, filed a Complaint (the “ROI Complaint”) +in the Supreme Court of the State of New York, County of New York against the Company and ROI, in action captioned Arena Investors, +LP v. Ault Alliance, Inc. and RiskOn International, Inc. , Index No. 652792/2024. +The ROI Complaint asserts +a cause of action for breach of contract against the Company based on a Guaranty, dated April 27, 2023, and entered into, amongst others, +the Company and Arena, and seeks damages in the amount of in excess of $3.75 million, plus interest, attorneys’ fees, costs, expenses, +and disbursements. +The ROI Complaint also asserts +a cause of action for breach of contract against ROI based on an alleged breach of that certain Security Agreement, dated April 27, 2023, +and entered into among ROI and Arena. In connection with this cause of action, Arena seeks, among other things, costs and expenses from +the Company and ROI. +On July 31, 2024, the Company +and ROI filed a motion to dismiss seeking to partially dismiss the ROI Complaint, as against the Company, and to dismiss the ROI Compliant, +in its entirety, as against ROI. +On or about January 21, 2025, +the Court entered an order denying the part of the motion which sought partial dismissal of the ROI Complaint, as against Company, and +granting the part of the motion which sought dismissal of the ROI Complaint, in its entirety, as against ROI. +On February 18, 2025, the +Company filed an Answer to the ROI Complaint and asserted numerous affirmative defenses. +Based on the Company’s +assessment of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, the Company cannot +reasonably estimate the potential loss or range of loss that may result from this action. Notwithstanding, the Company has recorded the +unpaid portion of the notes. An unfavorable outcome may have a material adverse effect on the Company’s business, financial condition +and results of operations. +Other Litigation Matters +With respect to our other +outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either +individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, +or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +70 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY +SECURITIES +Market Information +Our Class A common stock is +listed on the NYSE American under the symbol GPUS. +Record Holders +As of April 14, 2025, 1,529,995 +shares of our Class A common stock were issued and outstanding and were owned by four holders of record. A number of holders of our Class +A common stock are “street name” or beneficial holders whose shares of record are held by banks, brokers, and other financial +institutions. +Dividend Policy +We have not declared or paid +any cash dividends since our inception, and we do not intend to pay any cash dividends in the foreseeable future. The declaration of dividends +in the future, if any, will be at the discretion of our Board and will depend upon our earnings, capital requirements, and financial position. +Equity Compensation Information +The +information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 +of this Annual Report on Form 10-K. +Recent Sales of Unregistered Securities +Not applicable. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +None. +ITEM 6. RESERVED +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form +10-K contains forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking +statements. Such forward-looking statements include statements regarding, among others, (a) our expectations about possible business combinations, +(b) our growth strategies, (c) our future financing plans, and (d) our anticipated needs for working capital. Forward-looking statements, +which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words +“may,” “will,” “should,” “expect,” “anticipate,” “approximate,” +“estimate,” “believe,” “intend,” “plan,” “budget,” “could,” “forecast,” +“might,” “predict,” “shall” or “project,” or the negative of these words or other variations +on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that +may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements +expressed or implied by any forward-looking statements. These statements may be found in this Annual Report. +71 +Forward-looking statements +are based on our current expectations and assumptions regarding our business, potential target businesses, the economy and other future +conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks, +and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking +statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in this +Annual Report, changes in local, regional, national or global political, economic, business, competitive, market (supply and demand) and +regulatory conditions and the following: +· Adverse economic conditions; +· Our ability to effectively execute our business +plan; +· Inability to raise sufficient additional capital +to operate our business; +· Our ability to manage our expansion, growth and +operating expenses; +· Our ability to evaluate and measure our business, +prospects and performance metrics; +· Our ability to compete and succeed in highly +competitive and evolving industries; +· Our ability to respond and adapt to changes in +technology and customer behavior; +· Our ability to protect our intellectual property +and to develop, maintain and enhance a strong brand; and +· Other specific risks referred to in the section +entitled “ Risk Factors ”. +We caution you therefore that +you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances of future +performance. All forward-looking statements speak only as of the date of this Annual Report. We undertake no obligation to update any +forward-looking statements or other information contained herein unless required by law. +Information regarding market +and industry statistics contained in this Annual Report is included based on information available to us that we believe is accurate. +It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. +Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional +uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services. Except as required +by U.S. federal securities laws, we have no obligation to update forward-looking information to reflect actual results or changes in assumptions +or other factors that could affect those statements. See the section entitled “ Risk Factors ” for a more detailed discussion +of risks and uncertainties that may have an impact on our future results. +In this Annual Report, the +“Company,” “we,” “us” and “our” refer to Hyperscale Data, Inc., a Delaware corporation +formerly known as Ault Alliance, which was incorporated in September 2017. Hyperscale Data is a diversified holding company pursuing growth +by acquiring undervalued businesses and disruptive technologies with a global impact. +Through our wholly- and majority-owned subsidiaries and strategic investments, we own and operate a data center +at which we mine Bitcoin, and provide mission-critical products that support a diverse range of industries, including a metaverse platform, +crane services, defense, industrial and automotive. In addition, we extend credit to select entrepreneurial businesses through a licensed +lending subsidiary. +We own Ault Capital Group, Inc. (“Ault Capital”), which +in turn either wholly owns or has a direct controlling interest in, among other entities, (i) Ault Lending, LLC (“Ault Lending”), +(ii) RiskOn International, Inc., formerly known as BitNile Metaverse, Inc. (“ROI”), which wholly owns BitNile.com, Inc. (“BNC”), +(iii) askROI, Inc. (“askROI”), (iv) Ault Global Real Estate Equities, Inc. (“AGREE”), (v) Eco Pack Technologies, +Inc. (“Eco Pack”), (vi) Ault Aviation, LLC (“Ault Aviation”), (vii) Circle 8 Holdco LLC (“Circle 8 Holdco”), +which wholly owns Circle 8 Crane Services, LLC (“Circle 8”), and (viii) TurnOnGreen, Inc. (“TurnOnGreen”), which +wholly owns TOG Technologies, Inc. and Digital Power Corporation. We consolidate ROI as a variable interest entity. +Recent Events and Developments +On November 15, 2024, we announced +the distribution of 5.0 million shares of our Class B Common Stock (the “Class B Common Stock”) to all holders of our Class +A common stock and Series C Convertible Preferred Stock on an as-converted basis. The record date for this dividend was November 29, 2024, +and the payment date is December 16, 2024. There is currently no public trading market for the Class B Common Stock. While we presently +intend to seek to have the Class B Common Stock listed for trading on the NYSE American within the foreseeable future, there can be no +assurance when, or if, such a listing will occur. The Class B Common Stock is identical to the currently outstanding Class A common stock, +with the exception that each share thereof carries 10 times the voting power of a share of Class A common stock. The Class B Common Stock +is convertible at any time after the payment date into Class A common stock on a one-for-one basis. +On November 20, 2024, pursuant +to the approval provided by our stockholders at the annual meeting of stockholders held on June 28, 2024, we filed an Amendment to our +Certificate of Incorporation with the State of Delaware to effectuate a reverse stock split of our Class A common stock affecting the +issued and outstanding number of such shares by a ratio of one-for-thirty-five. The reverse stock split became effective on November 22, +2024. All share amounts in this Annual Report have been updated to reflect the reverse stock split. +72 +On November 26, 2024, we announced +the distribution of 1.0 million shares of our Series F Exchangeable Preferred Stock (“Series F Preferred Stock”) to holders +of Class A common stock and Series C Convertible Preferred Stock on an as-converted basis. The record date for this dividend was December +13, 2024, and the payment date was December 23, 2024. The Series F Preferred Stock has a $1.00 liquidation preference and will not pay +a dividend. Each share of Series F Preferred Stock will be exchangeable, at the option of its holder, for (i) 10 shares of Class A Common +Stock of Ault Capital and (ii) five shares of Class B Common Stock of Ault Capital, at any time beginning on the later of (i) one year +after issuance of the Series F Preferred Stock and (ii) the date of the registration under the Securities Act of 1933, as amended, of +all of the foregoing shares of Ault Capital Class A Common Stock and Ault Capital Class B Common Stock. Once the Series F Preferred Stock +has been exchanged into shares of Ault Capital Class A Common Stock and Class B Common Stock, our sole business will be our ownership +of Sentinum, Inc. through which we operate our Bitcoin mining business as well as its HPC and AI operations. +On December 13, 2024 (the +“Closing Date”), Third Avenue Apartments LLC (“Third Avenue”), which was a subsidiary of AGREE, completed the +sale of its real property located at the southeast corner of 5th Street North and 3rd Avenue North in St. Petersburg, Florida (the “Property”). +The Property was sold on the Closing Date to Cats Mirror Lake, LLC (the “Buyer”) pursuant to a contract of sale, as amended +entered into by Third Avenue and the Buyer. The sale price for the property was $13.0 million. In February 2025, Third Avenue filed a +certificate of cancellation with the Delaware Secretary of State. +On December 21, 2024, we entered +into a securities purchase agreement (the “December 2024 SPA”) with Ault & Company, pursuant to which we agreed to sell, +in one or more closings, to Ault & Company up to 25,000 shares of Series G convertible preferred stock (“Series G Preferred +Stock”) and warrants to purchase up to 4.2 million shares of Class A common stock (the “Series G Warrants”) for a total +purchase price of up to $25.0 million. The December 2024 SPA provides that the financing may be conducted through one or more closings. +Through April 14, 2025, pursuant to the December 2024 SPA, we have sold to Ault & Company 960 shares of Series G Preferred Stock and +Series G Warrants to purchase 162,217 shares of Class A common stock, for a purchase price of $1.0 million. +Each share of Series G Preferred +Stock has a stated value of $1,000.00 and is convertible into shares of Class A common stock at a conversion price equal to the greater +of (i) $0.10 per share, and (ii) the lesser of (A) $6.74 or (B) 105% of the volume weighted average price of the Class A common stock +during the 10 trading days immediately prior to the date of conversion. The holders of Series G Preferred Stock are entitled to cumulative +cash dividends at an annual rate of 9.5%, or $95.00 per share, based on the stated value per share. Dividends shall accrue for 10 years +from the date of issuance of such shares of Series G Preferred Stock and are payable monthly in arrears. For the first two years, we may +elect to pay the dividend amount in shares of Class A common stock rather than cash. The holders of the Series G Preferred Stock are entitled +to vote with the Class A common stock as a single class on an as-converted basis. +On March 28, 2025, our +majority owned subsidiary, Avalanche International Corp. (“AVLP”), filed a petition +for liquidation under Chapter 7 of the bankruptcy laws. The filing placed AVLP under the control of the bankruptcy court, which will oversee +its liquidation. As a result, we no longer consider AVLP as a subsidiary of ours. +On March 31, 2025, we entered +into a securities purchase agreement with an institutional investor pursuant to which we agreed to sell up to 50,000 shares of Series +B Convertible Preferred Stock (“Series B Preferred Stock”) for a total purchase price of up to $50.0 million. The securities +purchase agreement provides that the transaction shall be conducted through 49 separate tranche closings, provided, however, that the +investor has the ability, exercisable in its sole discretion, to purchase any number of shares of Series B Preferred Stock prior to the +dates of the tranche closings provided for in the securities purchase agreement. The initial tranche closing, which will close promptly +after the investor has converted out of the Exchange Note, will consist of the sale and issuance to the investor of 2,000 shares of Series +B Preferred Stock for an aggregate of $2.0 million. Pursuant to the securities purchase agreement, provided certain closing conditions +have been met, the investor shall purchase up to 4,800 shares of Series B Preferred Stock on a monthly basis, with the investor being +required to purchase 1,000 shares per month. +Each share of Series B Preferred +Stock has a stated value of $1,000.00 and is convertible into shares of Class A common stock at a at a conversion price equal the lesser +of a 25% discount to our volume weighted average price during the five trading days immediately prior to (A) the date of execution of +the securities purchase agreement or (B) the date of conversion into shares of Class A common stock, but not greater than $10.00 per share. +Notwithstanding the foregoing, in no event shall the Series B Preferred Stock be convertible at less than the Floor Price. The holders +of Series B Preferred Stock are entitled to cumulative cash dividends at an annual rate of 15%, or $150.00 per share, based on the stated +value per share. Dividends shall accrue for as long as any shares of Series B Preferred Stock remain issued and outstanding and are payable +monthly in arrears. For the first two years, we may elect to pay the dividend amount in additional shares of Series B Preferred Stock +rather than cash. The holders of the Series B Preferred Stock are entitled to vote with the Class A common stock as a single class on +an as-converted basis. +73 +Presentation of GIGA as Discontinued Operations +On +August 14, 2024, our majority owned subsidiary, Gresham Worldwide, Inc. (“ GIGA”), filed +a petition for reorganization under Chapter 11 of the bankruptcy laws. The filing placed GIGA under the control of the bankruptcy court, +which oversees its reorganization and restructuring process. We assessed the inherent uncertainties associated with the outcome of the +Chapter 11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate GIGA and +its subsidiaries effective on the petition date. We recognized a gain on deconsolidation of GIGA of $2.0 million during the year ended +December 31, 2024, which is included in net gain (loss) from discontinued operations. +In connection with the Chapter +11 reorganization process , we concluded that the operations of GIGA met the criteria for discontinued operations as this strategic +shift will have a significant effect on our operations and financial results. As a result, we have presented the results of operations, +cash flows and financial position of GIGA as discontinued operations in the accompanying consolidated financial statements and notes for +all periods presented. +Change in Plan of Sales of AGREE Hotel Properties +On April 30, 2024, we had +a change in plan of sale for our four hotels owned and operated by AGREE. As a result, as of April 30, 2024, the assets no longer met +the held for sale criteria and were required to be reclassified as held and used at the lower of adjusted carrying value or the fair value +at the date of the not to sell. +For presentation purposes, +the assets and liabilities previously held for sale as of December 31, 2023, were reclassified in the December 31, 2023 balance sheet +in the accompanying financial statements back to their original asset and liability groups at their previous carrying values. In connection +with this change in plan of sale, we recorded a loss on impairment of property and equipment related to the real estate assets of AGREE +of $8.0 million during the year ended December 31, 2024. +General +As a holding company, our +business objective is to increase stockholder value through developing and growing our subsidiaries. Under the strategy we have adopted, +we are focused on managing and financially supporting our existing subsidiaries and partner companies, with the goal of pursuing monetization +opportunities and maximizing the value returned to stockholders. We have, are and will consider initiatives including, among others: public +offerings, the sale of individual partner companies, the sale of certain or all partner company interests in secondary market transactions, +or a combination thereof, as well as other opportunities to maximize stockholder value. We anticipate returning value to stockholders +after satisfying our debt obligations and working capital needs. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary or partner company’s further growth and development can best be +supported by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek +to sell all or a portion of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales +of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case +of publicly traded partner companies, sales of their securities in the open market. Our plans may include taking subsidiaries or partner +companies public through rights offerings and directed share subscription programs. We will continue to consider these (or similar) initiatives +and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our stockholders. +In recent years, we have provided +capital and relevant expertise to fuel the growth of businesses in AI software platform, social gaming platform, equipment rental services, +defense, industrial and hotel operations. We have provided capital to subsidiaries as well as partner companies in which we have an equity +interest or may be actively involved, influencing development through board representation and management support. +We are a Delaware corporation +with our corporate office located at 11411 Southern Highlands Pkwy, Suite 190, Las Vegas, NV 89141. Our phone number is 949-444-5464 and +our website address is https://hyperscaledata.com/. +74 +Results of Operations +Results of Operations for the Years ended December 31, 2024 and +2023 +The following table summarizes +the results of our operations for the years ended December 31, 2024 and 2023. +For the Year Ended December 31, +2024 +2023 +Revenue, crane operations +$ 47,475,000 +$ 49,198,000 +Revenue, crypto assets mining +30,598,000 +33,107,000 +Revenue, hotel and real estate operations +18,891,000 +17,577,000 +Revenue, lending and trading activities +1,893,000 +(1,998,000 ) +Revenue +7,805,000 +36,962,000 +Total revenue +106,662,000 +134,846,000 +Cost of revenue, crane operations +30,745,000 +29,971,000 +Cost of revenue, crypto assets mining +34,338,000 +36,446,000 +Cost of revenue, hotel and real estate operations +12,928,000 +12,300,000 +Cost of revenue, lending and trading activities +(1,205,000 ) +1,180,000 +Cost of revenue, products +5,639,000 +30,165,000 +Total cost of revenue +82,445,000 +110,062,000 +Gross profit +24,217,000 +24,784,000 +Operating expenses +Research and development +11,011,000 +4,418,000 +Selling and marketing +14,019,000 +31,653,000 +General and administrative +35,245,000 +68,200,000 +Impairment of property and equipment +19,446,000 +26,445,000 +Impairment of goodwill and intangible assets +1,500,000 +42,880,000 +Impairment of mined crypto assets +- +489,000 +Total operating expenses +81,221,000 +174,085,000 +Loss from operations +(57,004,000 ) +(149,301,000 ) +Other income (expense): +Interest and other income +2,236,000 +4,444,000 +Interest expense +(19,671,000 ) +(44,314,000 ) +Other expense, guarantee +- +(35,400,000 ) +Gain on conversion of investment in equity securities to marketable equity securities +17,900,000 +- +Gain (loss) on extinguishment of debt +2,981,000 +(7,322,000 ) +Loss on extinguishment of debt, related party +- +(4,164,000 ) +Loss from investment in unconsolidated entity +(1,958,000 ) +(302,000 ) +Loss on deconsolidation of subsidiary +- +(3,040,000 ) +Impairment of equity securities +(6,266,000 ) +(9,555,000 ) +Change in fair value of warrant liability +- +6,319,000 +Gain on the sale of fixed assets +79,000 +2,069,000 +Total other expense, net +(4,699,000 ) +(91,265,000 ) +Loss before income taxes +(61,703,000 ) +(240,566,000 ) +Income tax provision +56,000 +348,000 +Net loss from continuing operations +(61,759,000 ) +(240,914,000 ) +Net loss from discontinued operations +(779,000 ) +(12,355,000 ) +Net loss +(62,538,000 ) +(253,269,000 ) +Net loss attributable to non-controlling interest +6,334,000 +22,242,000 +Net loss attributable to Hyperscale Data, Inc. +(56,204,000 ) +(231,027,000 ) +Preferred dividends +(5,277,000 ) +(1,375,000 ) +Net loss available to common stockholders +$ (61,481,000 ) +$ (232,402,000 ) +Comprehensive loss +Net loss available to common stockholders +$ (61,481,000 ) +$ (232,402,000 ) +Other comprehensive loss +Foreign currency translation adjustment +(66,000 ) +(698,000 ) +Other comprehensive income +(66,000 ) +(698,000 ) +Total comprehensive loss +$ (61,547,000 ) +$ (233,100,000 ) +75 +Revenues +Revenues by segment for the +years ended December 31, 2024 and 2023 were as follows: +For the Year Ended December 31, +Increase +2024 +2023 +(Decrease) +% +Sentinum +Revenue, crypto assets mining +$ 30,598,000 +$ 33,107,000 +$ (2,509,000 ) +-8 % +Revenue, commercial real estate leases +876,000 +1,416,000 +(540,000 ) +-38 % +Energy +Revenue, crane operations +47,475,000 +49,198,000 +(1,723,000 ) +-4 % +Other +116,000 +130,000 +(14,000 ) +-11 % +AGREE +18,015,000 +16,161,000 +1,854,000 +11 % +SMC +- +31,557,000 +(31,557,000 ) +-100 % +TurnOnGreen +4,913,000 +4,201,000 +712,000 +17 % +Fintech +Revenue, lending and trading activities +1,893,000 +(1,998,000 ) +3,891,000 +n/m +ROI +253,000 +305,000 +(52,000 ) +-17 % +Other +2,523,000 +769,000 +1,754,000 +228 % +Total revenue +$ 106,662,000 +$ 134,846,000 +$ (28,184,000 ) +-21 % +n/m - not meaningful +Sentinum +Revenues from Sentinum’s +crypto assets mining operations decreased $2.5 million to $30.6 million for the year ended December 31, 2024, compared to $33.1 million +for the year ended December 31, 2023. The decrease was due primarily to a $4.1 million decline in revenue from mined crypto assets at +Sentinum owned and operated facilities, partially offset by a $1.6 million increase in revenue from Sentinum crypto mining equipment hosted +at third-party facilities. The $4.1 million decrease in revenue from mined crypto assets at Sentinum owned and operated facilities was +due to the April 2024 Bitcoin halving event that occurred on the Bitcoin network and a 70% increase in the average Bitcoin mining difficulty +level, partially offset by a 129% increase in the average Bitcoin price for the year ended December 31, 2024, compared to the corresponding +period in 2023. +Energy +Energy revenues from Circle 8’s crane operations decreased by +$1.7 million, or 4%, for the year ended December 31, 2024, remaining essentially flat compared to the prior period. This decrease was +primarily due to competitive pricing pressures and lower utilization of the crane fleet, as five cranes were out of service during the +year ended December 31, 2024. +Fintech +Revenues +from our lending and trading activities were $1.9 million for the year ended December 31, 2024, driven primarily by $2.4 million in realized +gains from trading activities and $2.7 million in fee income, partially offset by a $0.6 million unrealized loss from our investment in +Alzamend and a $2.4 million impairment for equity securities that did not have readily determinable fair values related to Fintech lending +operations. In comparison, revenues from lending and trading activities for the same period in 2023 were negative $2.0 million, driven +primarily by a $5.6 million unrealized loss from our investment in Alzamend and a $6.2 million impairment for equity securities that did +not have readily determinable fair values related to Fintech lending operations, partially offset by $11.0 million in net realized and +unrealized gains on investments in marketable equity securities. +Revenues +from our trading activities for the year ended December 31, 2024 included net gains on equity securities, including unrealized gains and +losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in our periodic +earnings. +76 +SMC +Due +to the significant change in our ownership and voting rights, we determined that we no longer met the criteria of the primary beneficiary +and, accordingly, we deconsolidated SMC as of November 20, 2023. SMC revenues were $0 for the year ended December 31, 2024, a decrease +of $31.6 million compared to the corresponding period in 2023. +TurnOnGreen +TurnOnGreen’s revenues +increased by $0.7 million, to $4.9 million for the year ended December 31, 2024, compared to $4.2 million in the corresponding period +in 2023. This rise was primarily due to higher sales from a single, higher-margin customer in the defense industry during the year ended +December 31, 2024. +Other +Other revenues increased by +$1.8 million, to $2.5 million for the year ended December 31, 2024, compared to $0.8 million in the corresponding period in 2023. This +rise was primarily due to higher corporate aircraft charter revenue from third parties. +Gross Margins +Gross margins rose to 23% +for the year ended December 31, 2024, compared to 18% for the same period in 2023. This increase was influenced by our lending and trading +activities, which contributed favorably to our gross margins for the year ended December 31, 2024 and unfavorably to our gross margins +for the year ended December 31, 2023. In both periods, gross margins were adversely affected by negative margins from our crypto assets +mining operations. Excluding the impacts of both our lending and trading activities and our crypto assets mining operations, adjusted +gross margins for the year ended December 31, 2024, and 2023 would have been 34% and 30%, respectively. Gross margins improved due to +the deconsolidation of the lower margin of SMC’s business. +Research and Development +Research and development expenses +increased by $6.6 million to $11.0 million for the year ended December 31, 2024, from $4.4 million in the prior corresponding period, +due to increased expenditures primarily related to development work on ROI’s social gaming platform and askROI’s AI-powered +platform. +Selling and Marketing +Selling and marketing expenses were $14.0 million for the year ended +December 31, 2024, compared to $31.7 million for the year ended December 31, 2023, a decrease of $17.6 million, or 56%. The decrease was +primarily the result of a $14.1 million decrease in sales and marketing expenses at ROI primarily due to lower advertising and promotion +costs and a $3.3 million decrease in sales and marketing expenses from SMC due to the deconsolidation +of SMC as of November 20, 2023 . +General and Administrative +General and administrative +expenses were $35.2 million for the year ended December 31, 2024, compared to $68.2 million for the year ended December 31, 2023, +a decrease of $33.0 million, or 48%. General and administrative expenses decreased from the comparative prior period, mainly due to the +following: +· $11.2 million decrease in general and administrative expenses from SMC due to the deconsolidation +of SMC as of November 20, 2023 ; +· $6.3 million lower professional fees; +· $5.7 million lower performance bonus related to realized gains on trading activities; +· $5.1 million lower stock compensation expense; and +· $5.1 million lower salaries and benefits. +77 +Impairment of Goodwill and Intangible Assets +Impairment of Intangible Assets +During +the year ended December 31, 2024, we recognized $1.5 million impairment of intangible assets related to Eco Pack. During the year ended +December 31, 2023, we recognized $24.7 million impairment of intangible assets related to AVLP. +Impairment of AVLP Goodwill +We test the recorded amount +of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount of the +goodwill exceeds its carried value. We performed a goodwill impairment test as of June 30, 2023 related to AVLP as there were indicators +of impairment related to certain unforeseen business developments and changes in financial projections. +The valuation of the AVLP +reporting unit was determined using a market and income approach methodology of valuation. The income approach was based on the projected +cash flows discounted to their present value using discount rates, that in our judgment, consider the timing and risk of the forecasted +cash flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated +value of a market participant’s cost of capital and debt, derived using customary market metrics. The analysis included assumptions +regarding AVLP’s revenue forecast and discount rates of 26.7% using a weighted average cost of capital analysis. The market approach +utilized the guideline public company method. +The results of the quantitative test indicated that the fair value +of the AVLP reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying value of the goodwill. As +a result, the entire $18.6 million carrying amount of AVLP’s goodwill was recognized as a non-cash impairment charge during the +year ended December 31, 2023. +Impairment of Property and Equipment +During the year ended December +31, 2024, due to increases in the Bitcoin mining difficulty level, which compounded the continued impact of the Bitcoin halving event, +we concluded that indicated that an impairment triggering event had occurred. Testing performed indicated the estimated fair value of +our miners to be less than their net carrying value and an impairment charge of $10.5 million was recognized, decreasing the net +carrying value of our crypto assets mining equipment to their estimated fair value. +In addition, we recorded $8.9 +million in impairment charges related to real estate assets of AGREE during the year ended December 31, 2024. +During the year ended December 31, 2023, certain unforeseen business +developments and changes in financial projections at AVLP indicated that an impairment triggering event had occurred. Testing performed +indicated the estimated fair value of AVLP property and equipment as of December 31, 2023 was $0, and an impairment charge of $14.0 million +was recognized. During the year ended December 31, 2023, we recognized an impairment charge of $4.1 million related to property and equipment +at ROI. +Impairment of Mined Digital Currencies +Impairment of mined digital +currencies for the year ended December 31, 2023 was $0.5 million. +Other Income (Expense), Net +Other expense, net was $4.7 +million for the year ended December 31, 2024, compared to other expense, net of $91.3 million for the year ended December 31, 2023. +Interest and other income +was $2.2 million for the year ended December 31, 2024, compared to $4.4 million for the year ended December 31, 2023. The decrease in +interest and other income is primarily due to the decline in Ault Disruptive’s interest income as a result of the decline in cash +and marketable securities held in the trust account as a result of redemptions of Ault Disruptive common stock subject to possible redemption. +Interest expense was $19.7 +million for the year ended December 31, 2024, compared to $44.3 million for the year ended December 31, 2023. Interest expense for the +year ended December 31, 2024 included contractual interest of $11.9 million, amortization of debt discount of $5.5 million, and forbearance +and extension fees of $2.2 million. Interest expense for the year ended December 31, 2023 included amortization of debt discount of $21.5 +million, contractual interest of $17.3 million and forbearance and extension fees of $5.5 million. +78 +Other expense, guarantee was +$0 for the year ended December 31, 2024, compared to $35.4 million for the year ended December 31, 2023. Pursuant to our financial guarantee +obligation related to our December 2023 issuance of Series C preferred stock, related party, we recorded a guarantee liability of $38.9 +million using the practical expedient to fair value as set forth in ASC 460-10-30-2(a) and recorded other expense, guarantee of $35.4 +million (the amount of the guarantee liability, less $3.5 million restricted cash related to the guarantee obligation). +Gain on conversion of investment +in equity securities to marketable equity securities of $17.9 million relates to ROI conversion of White River common stock. During the +year ended December 31, 2024, ROI transferred 14.5 million shares of White River common stock with a fair value of $19.2 million at the +date of transfer. In conjunction with the transfers, ROI converted a portion of their White River Series A convertible preferred stock +into White River common stock and recorded a noncash $17.9 million gain on conversion. No such gains were recognized during the year ended +December 31, 2023. +During the year ended December +31, 2024, ROI converted $2.3 million of ROI senior secured convertible notes that had a fair value of $0.9 million at the time of conversion +and recognized a $1.4 million gain on extinguishment of debt. During the year ended December 31, 2024, holders of our convertible notes +converted $2.0 million of convertible notes that had a fair value of $2.7 million at the time of conversion and recognized a $0.7 million +loss on extinguishment of debt. +During the year ended December +31, 2024, an investor converted $1.2 million of a convertible note into 0.2 million shares of Class A common stock that had a fair value +of $1.5 million at the time of conversion and we recognized a $0.3 million loss on extinguishment of debt. +Loss from investment in unconsolidated +entity was $2.0 million for the year ended December 31, 2024, representing our share of losses from our equity method investment in SMC. +Cumulative downward adjustments +for impairments for our equity securities without readily determinable fair values held at were $6.3 million for the year ended December +31, 2024, compared to $9.6 million for the year ended December 31, 2023. +Income Tax Provision +Provision for income taxes +was $0.1 million and 0.3 million for the years ended December 31, 2024 and 2023, respectively. The effective income tax provision rate +was 0.1% for both of the years ended December 31, 2024 and 2023. +Liquidity and Capital Resources +On December 31, 2024, we had +cash and cash equivalents of $4.6 million (excluding restricted cash of $20.5 million), compared to cash and cash equivalents of $6.1 +million (excluding restricted cash of $5.0 million) at December 31, 2023. The increase in cash and cash equivalents was primarily due +to cash provided by financing activities related to the sale of common and preferred stock, as well as proceeds from notes payable and +convertible notes, partially offset by the payment of debt, purchases of property and equipment and cash used in operating activities. +Net cash used in operating +activities totaled $19.4 million for the year ended December 31, 2024, compared to $5.4 million for the year ended December 31, 2023. +Cash used in operating activities for the year ended December 31, 2024 included $25.4 million proceeds from the sale of crypto assets +from our Sentinum crypto assets mining operations, offset by operating losses and changes in working capital. Net cash used in operating +activities for the year ended December 31, 2024 included $6.4 million cash used in operating activities from discontinued operations. +Net cash provided by investing +activities was $3.2 million for the year ended December 31, 2024, compared to net cash used in investing activities of $29.5 million for +the year ended December 31, 2023. Net cash provided by investing activities for the year ended December 31, 2024 included proceeds from +the sale of real property located in St. Petersburg, Florida for $13.0 million, partially offset by capital expenditures of $4.8 million +and investments in loans receivable of $1.0 million. Net cash provided by investing activities for the year ended December 31, 2024 included +$3.8 million cash used in investing activities from discontinued operations. +79 +Net cash provided by financing +activities was $25.8 million for the year ended December 31, 2024, compared to $37.0 million for the year ended December 31, 2023, +and primarily reflects the following transactions: +· During the period between January 1, 2024 through March 13, 2024, +we sold an aggregate of 0.7 million shares of common stock pursuant to an At-The-Market issuance sales agreement for gross proceeds of +$14.6 million ; +· $60.9 million gross proceeds from notes payable, offset by $60.2 million payments on notes payable; +· $6.7 million gross proceeds from convertible notes payable, partially offset by $1.3 million payments +on convertible notes payable; +· $8.0 million gross proceeds from sales of Series C preferred stock, +related party; +· $1.9 million gross proceeds from subsidiaries’ sale of stock +to non-controlling interests; +· $5.3 million payments of preferred dividends; and +· $1.9 million payments on notes payable, related party. +Net cash provided by financing +activities for the year ended December 31, 2024 included $2.6 million cash provided by financing activities from discontinued operations. +Financing Transactions Subsequent to December +31, 2024 +Sales of Series G Preferred Stock and Warrants +Between January +and April 2025, we sold to Ault & Company an aggregate of 960 shares of Series G Preferred Stock and Series G Warrants to purchase +an aggregate of 0.2 million shares of Class A common stock, for an aggregate purchase price of $1.0 million. +Issuances of Series D Preferred Stock +From January 1, 2025 through +April 14, 2025, we issued a total of 135,957 shares of our Series D preferred stock for the settlement of ELOC advances totaling $2.0 +million. +OID Only Term Note +On January 14, 2025, we entered +into a term note agreement with institutional investors for $2.5 million. The term note was issued at a discount, with net proceeds to +us of $2.2 million. The term note does not accrue any interest. The term note was scheduled to mature on March 1, 2025. The term note +is guaranteed by Mr. Ault. +15% Promissory Note +On March 7, 2025, we entered +into a promissory note agreement with an institutional investor with a principal amount of $0.5 million and an interest rate of 15%. +The maturity date of the promissory note is December 7, 2025. Mr. Ault entered into a personal guaranty agreement for the benefit of the +investor. +Convertible Promissory Note +On March 21, 2025 we entered +into an exchange agreement with SJC Lending, LLC, a Delaware limited liability company (“SJC”), pursuant to which we issued +to SJC a convertible promissory note in the principal face amount of $4.9 million (the “Note”) in exchange for the cancellation +of the following notes we issued to Steve J. Caspi, the sole member of SJC, who transferred such notes to SJC, (i) a term note issued +on January 14, 2025 in the principal face amount of $2.5 million, (ii) a promissory note issued on March 7, 2025 in the principal face +amount of $0.5 million, (iii) a promissory note issued on March 12, 2025 in the principal face amount of $1.5 million and (iv) a +promissory note issued on March 13, 2025 in the principal face amount of $0.3 million. +80 +The Note accrues interest +at the rate of 15% per annum, unless an event of default (as defined in the Note) occurs, at which time the Note would accrue interest +at 18% per annum. The Note will mature on December 31, 2025. The Note is convertible into shares of Class A common stock at any time after +NYSE American (“NYSE”) approval of the Supplemental Listing Application (the “SLAP”) at a conversion price equal +to the greater of (i) $0.40 per share (the “Note Floor Price”), which Note Floor Price shall not be adjusted for stock dividends, +stock splits, stock combinations and other similar transactions and (ii) the lesser of 75% of the VWAP (as defined in the Note) of the +Class A common stock during the five trading days immediately prior to (A) the date of issuance of the Note or (B) the date of conversion +into shares of Class A common stock, but not greater than $10.00 per share (the “Maximum Price”), which Maximum Price shall +be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +Series B Convertible Preferred Stock Securities +Purchase Agreement +On March 31, 2025, we entered +into a securities purchase agreement with an institutional investor pursuant to which we agreed to sell up to 50,000 shares of Series +B Convertible Preferred Stock (“Series B Preferred Stock”) for a total purchase price of up to $50 million. The securities +purchase agreement provides that the transaction shall be conducted through 49 separate tranche closings, provided, however, that the +investor has the ability, exercisable in its sole discretion, to purchase any number of shares of Series B Preferred Stock prior to the +dates of the tranche closings provided for in the securities purchase agreement. The initial tranche closing, which will close promptly +after the investor has converted out of the Exchange Note, will consist of the sale and issuance to the investor of two thousand (2,000) +shares of Series B Preferred Stock for an aggregate of $2 million. Pursuant to the securities purchase agreement, provided certain closing +conditions have been met, the investor shall purchase up to four thousand, eight hundred (4,800) shares of Series B Preferred Stock on +a monthly basis, with the investor being required to purchase one thousand (1,000) shares per month. +Each share of Series B Preferred +Stock has a stated value of $1,000.00 and is convertible into shares of Class A common stock at a at a conversion price equal the lesser +of a 25% discount to our volume weighted average price during the five trading days immediately prior to (A) the date of execution of +the securities purchase agreement or (B) the date of conversion into shares of Class A common stock, but not greater than $10.00 per share. +Notwithstanding the foregoing, in no event shall the Series B Preferred Stock be convertible at less than the Floor Price. The holders +of Series B Preferred Stock are entitled to cumulative cash dividends at an annual rate of 15%, or $150.00 per share, based on the stated +value per share. Dividends shall accrue for as long as any shares of Series B Preferred Stock remain issued and outstanding and are payable +monthly in arrears. For the first two years, we may elect to pay the dividend amount in additional shares of Series B Preferred Stock +rather than cash. The holders of the Series B Preferred Stock are entitled to vote with the Class A common stock as a single class on +an as-converted basis. +Short-Term OID Promissory Notes +Between March 21, 2025 and +April 2, 2025, we entered into term note agreements with an institutional investor for an aggregate of $0.6 million. The term notes were +issued at a 15% discount, with net proceeds to us of $0.6 million. The term notes accrue interest at the rate of 24% per annum. The term +notes mature on April 30, 2025. +April 2025 Convertible Promissory Note +On April 1, 2025, we issued +to an institutional investor, a convertible promissory note in the principal face amount of $1.7 million (the “April 2025 Note”) +in consideration for an advance of $1.5 million previously made by the investor to us (the “Transaction”). The April 2025 +Note has a principal face amount of $1.7 million and was issued with an OID of 10%. The April 2025 Note accrues interest at the rate of +15% per annum, unless an event of default (as defined in the April 2025 Note) occurs, at which time the April 2025 Note would accrue interest +at 18% per annum. The April 2025 Note will mature on September 30, 2025. The April 2025 Note is convertible into shares of our class A +common stock at any time after NYSE approval of the SLAP at a conversion price equal to the greater of (i) $0.40 per share, which shall +not be adjusted for stock dividends, stock splits, stock combinations and other similar transactions and (ii) the lesser of 75% of the +VWAP (as defined in the April 2025 Note) of the Class A common stock during the five trading days immediately prior to the closing date +or the date of conversion. +April 2025 Convertible Note +On April 8, 2025, we issued +to an accredited investor a convertible promissory note in the principal face amount of $110,000 in consideration for $100,000. The note +accrues interest at the rate of 15% per annum, unless an event of default (as defined in the note) occurs, at which time the note would +accrue interest at 18% per annum. The note will mature on September 30, 2025. The note is convertible into shares of Class A common stock +at a conversion price equal to the greater of (i) $0.45 and (ii) the lesser of (A) 75% of the VWAP (as defined in the note) of the +Class A common stock during the five trading days immediately prior to the date of issuance of the note or (B) 75% of the lowest daily +VWAP of the Class A common stock during the five trading days immediately prior to the date of conversion into shares of Class A common +stock. +81 +Deficiency Letter from the NYSE American +We were notified by the NYSE +American on December 18, 2024 that due to our disclosure in our Form 10-Q filed for the fiscal period ended September 30, 2024, which +reported stockholders’ equity of approximately $2.2 million, we no longer meet the requirement that we must have no less than $6 +million or more in stockholders’ equity pursuant to the listing standard set forth under Section 1003(a)(ii) and (iii) of the NYSE +American Company Guide (the “Listing Standards”) because we have reported losses from continuing operations and/or net losses +in five of its most recent fiscal years ended December 31, 2023. +Under the applicable NYSE +American listing rules, we were required by January 17, 2025 to submit a compliance plan that demonstrates how we intend to regain compliance +with the Listing Standards within 18 months of the receipt of the notice, or June 18, 2026. The compliance plan was submitted to the NYSE +American on January 17, 2025. We, at the request of the NYSE American, provided supplements to the original compliance plan. On March +4, 2025, the NYSE American accepted the compliance plan and granted us a listing extension until June 18, 2026. We will be subject to +periodic reviews including quarterly monitoring for compliance with the plan. Failure to make progress consistent with the plan or to +regain compliance with the continued Listing Standards by the end of the extension period could result in us being delisted from the NYSE +American. +Critical Accounting Estimates +We have the following critical +accounting estimates: +· We review and evaluate the net carrying value +of our long-lived assets for impairment upon the occurrence of events or changes in circumstances that indicate that the related carrying +amounts may not be recoverable. A test for recoverability is performed based on the estimated undiscounted future cash flows that will +be generated from operations and the estimated salvage value of assets. There are many assumptions underlying future cash flows that are +subject to significant risks and uncertainties, which include the estimated value of the assets. We review our business and operations +for indications of impairment and, when indications are present, perform an impairment test. We involve a third-party expert when needed. +However, it is possible that changes could occur in the near term that could adversely affect the estimate of future cash flows and salvage +values to be generated from operating assets resulting in an impairment loss; and +· On an ongoing basis, we evaluate our estimates +and judgments, including those related to fair value of financial instruments. We base our estimates on known trends and events and various +other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about +the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates +under different assumptions or conditions. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Because we are a smaller reporting +company, this section is not applicable. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements required +by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not required to provide +supplementary financial information. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +Not applicable. +82 +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2024, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company’s management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules +13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our +disclosure controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance +of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with +generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2024. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2024, our internal control over financial reporting was not effective. +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting department, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting, related party transactions, fair value estimates and analysis of financial instruments for proper classification in the consolidated +financial statements, in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +3. Our primary user access controls (i.e., provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +83 +4. The Company did not design and/or implement user access controls to ensure appropriate segregation of +duties or program change management controls for certain financially relevant systems impacting the Company’s processes around revenue +recognition and digital assets to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, and (iii) underlying accounting records, are identified, tested, authorized and implemented appropriately +to validate that data produced by its relevant IT system(s) were complete and accurate. Automated process-level controls and manual controls +that are dependent upon the information derived from such financially relevant systems were also determined to be ineffective as a result +of such deficiency. In addition, the Company has not effectively designed a manual key control to detect material misstatements in revenue. +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis: +· Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls; +· Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· Continuing to increase headcount across the Company, with a particular focus on hiring individuals with +strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Control over Financial Reporting +During the most recent fiscal +quarter in 2024, there were no significant changes in our internal control over financial reporting (as such term is defined in Rules +13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal +control over financial reporting. +ITEM 9B. OTHER INFORMATION +Trading Plans +During the three months ended +December 31, 2024, no director or Section 16 officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” +or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K. +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +Not applicable. +84 +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The following table sets forth +the positions and offices presently held by each of our current directors and executive officers and their ages: +Served as a +Position and Offices +Director and +Name +Age +Held with the Company +Officer Since +Milton C. +Ault, III (1) +55 +Executive Chairman of the Board +2017 +William +B. Horne (1) +56 +Chief Executive Officer, Vice Chairman and Director +2016 +Henry +Nisser (1) +56 +President, General Counsel and Director +2019 +Kenneth +S. Cragun (1) +64 +Chief Financial Officer +2020 +Robert O. Smith +80 +Lead Independent Director +2016 +Moti Rosenberg +77 +Director +2015 +Jeffrey A. Bentz +65 +Director +2018 +(1) Executive Officer. +Each of the directors named +above will serve until the next annual meeting of our stockholders or until his respective successor is elected and qualified. Subject +to the terms of applicable employment agreements, our executive officers serve at the discretion of our Board. +Milton C. (Todd) Ault, +III has served as our Executive Chairman since January 2021. Between December 2017 and January +2021, Mr. Ault was our Chief Executive Officer and between March 2017 and December 2017, Mr. Ault served as our Executive Chairman. Mr. +Ault has served as a director of Alzamend since January 2024. Mr. Ault is Alzamend’s founder +and served as Chairman of the Board and a director from inception in 2016 until its initial public offering in June 2021. Mr. Ault served +as the Chairman of the Board of Ault Disruptive since its incorporation in February 2021 until October 2024. Since January 2024, Mr. Ault +has served as the Chairman and Chief Executive Officer of ROI. Between April 2023 and September 2024, Mr. Ault served as the Executive +Chairman of the board of directors of Algorhythm Holdings, Inc., an issuer listed on Nasdaq (“RIME”). Mr. Ault has served +as Chairman and Chief Executive Officer of Ault & Company since December 2015, and as Chairman of AVLP since September 2014. Since +January 2011, Mr. Ault has been the Vice President of Business Development for MCKEA Holdings, LLC, a family office. Mr. Ault is a seasoned +business professional and entrepreneur who has spent more than twenty-seven years identifying value in various financial markets including +equities, fixed income, commodities, and real estate. Throughout his career, Mr. Ault has consulted for a few publicly traded and privately +held companies, providing each of them the benefit of his diversified experience, that range from development stage to seasoned businesses. +William +B. Horne has been a member of our board of directors since October 2016. In January 2018, Mr. Horne was appointed as our Chief Financial +Officer until August 2020, when he resigned as our Chief Financial Officer and was appointed as our President. On January 12, 2021, Mr. +Horne resigned as our President and became our Chief Executive Officer. Mr. Horne has served as a director of Alzamend since June 2016 +and upon the effectiveness of its initial public offering in June 2021, Mr. Horne become its Chairman of the Board. Mr. Horne served as +Alzamend’s Chief Financial Officer from June 2016 through December 2018. Mr. Horne served as a director and Chief Executive Officer +of Ault Disruptive since its inception in February 2021 until October 2024. Mr. Horne has served as a director and Chief Financial Officer +of AVLP since June 2016. Mr. Horne has served as a director and Chief Financial Officer of Ault & Company since October 2017. He served +as the Chief Financial Officer of Targeted Medical Pharma, Inc. from August 2013 to May 2019. Mr. Horne previously held the position of +Chief Financial Officer in various public and private companies in the healthcare and high-tech field. Mr. Horne has a Bachelor of +Arts Magna Cum Laude in Accounting from Seattle University. +Henry C.W. Nisser , +has been our President since May 2019, and has served as our Executive Vice President and General Counsel and as one of our directors +since September 2020. Mr. Nisser has served as Alzamend’s Executive Vice President and General Counsel on a part-time basis +since May 2019. Mr. Nisser was appointed as a director of Alzamend in September 2020. Since March 2023, Mr. Nisser has +served as the President, General Counsel and director of ROI. Between February 2021 and October 2024, Mr. Nisser served as the President, +General Counsel and a director of Ault Disruptive. Between April 2023 and August 2024, Mr. Nisser served as a director of RIME. Mr. Nisser +is the Executive Vice President and General Counsel of AVLP. From December 15, 2021 through March 16, 2022, Mr. Nisser served as Chief +Executive Officer and on the board of directors of TurnOnGreen. From October 2011 through April 2019, Mr. Nisser was an +associate and subsequently a partner with Sichenzia Ross Ference LLP, a law firm in New York. While with this law firm, his practice was +concentrated on national and international corporate law, with a particular focus on U.S. securities compliance, public as well as private +M&A, equity and debt financings and corporate governance. Mr. Nisser received his B.A. degree from Connecticut College, where +he majored in International Relations and Economics. He received his LL.B. from University of Buckingham School of Law in the United Kingdom. +85 +Kenneth S. Cragun has +been our Chief Financial Officer since August 2020 and between October 2018 and August 2020, served +as our Chief Accounting Officer. Since June 2021, Mr. Cragun has served as Senior Vice President of Finance at Alzamend on a part-time +basis. Between December 2018 and June 2021, Mr. Cragun served as the Chief Financial Officer of Alzamend. Between February 2021 and October +2024, Mr. Cragun served as the Chief Financial Officer of Ault Disruptive. Since September 2018, Mr. Cragun has served on the board of +directors and Chairman of the Audit Committee of Verb Technology Company, Inc. Between July 2022 and September 2024, Mr. Cragun served +on the board of directors of RIME. He served as a CFO Partner at Hardesty, LLC, a national executive services firm between October 2016 +and October 2018. His assignments at Hardesty included serving as Chief Financial Officer of CorVel Corporation, a publicly traded company +and a nationwide leader in technology driven, healthcare-related, risk management programs, and of RISA Tech, Inc., a private structural +design and optimization software company. Mr. Cragun was also Chief Financial Officer of two Nasdaq-traded companies, Local Corporation, +from April 2009 to September 2016, and Modtech Holdings, Inc., from June 2006 to March 2009, a supplier of modular +buildings. Prior thereto, he had financial leadership roles with increasing responsibilities at MIVA, Inc., ImproveNet, Inc., NetCharge +Inc., C-Cube Microsystems, Inc, and 3-Com Corporation. Mr. Cragun began his professional career at Deloitte. Mr. Cragun holds +a Bachelor of Science degree in accounting from Colorado State University-Pueblo. +Robert O. Smith has +served as a director since September 2016, and was previously a member of our board from November 2010 to May 2015. Mr. Smith is currently +an independent C-level executive consultant working with Bay Area high-tech firms on various strategic initiatives in all aspects of their +business. Mr. Smith has served on the board of directors of GWW since September 2022. Mr. Smith has served on the board of directors of +ROI since October of 2023, where he acts as ROI’s lead independent director as well as the chairman of its audit committee. Mr. +Smith served on the board of directors of Ault Disruptive since its inception in February 2021 until October 2024. From 2004 to 2007, +he served on the board of directors of Castelle Corporation. From 1990 to 2002, he was our President, Chief Executive Officer and Chairman +of the Board. From 1980 to 1990, he held several management positions with Computer Products, Inc., the most recent being President of +its Compower/Boschert division. From 1970 to 1980, he held managerial accounting positions with Ametek/Lamb Electric and with the JM Smucker +Company. Mr. Smith received his BBA degree in Accounting from Ohio University. +Mordechai Rosenberg has +served as a director since June 2015. Mr. Rosenberg serves as one of our independent directors. He has served as an independent consultant +to various companies in the design and implementation of homeland security systems in Europe and Africa since 2010. From 2004 to 2009, +he served as a special consultant to Bullet Plate Ltd., a manufacturer of armor protection systems, and NovIdea Ltd., a manufacturer of +perimeter and border security systems. From 2000 to 2003, Mr. Rosenberg was the general manager of ZIV U.P.V.C Products Ltd.’s doors +and window factory. Mr. Rosenberg is an active reserve officer and a retired colonel from the Israeli Defense Force (“IDF”), +where he served for 26 years and was involved in the development of weapon systems. In the IDF, Mr. Rosenberg served in various capacities, +including, company, battalion and brigade commander, head of the training center for all IDF infantry, and head of the Air Force’s +Special Forces. Mr. Rosenberg received a B.A in History from the University of Tel Aviv and a Master of Arts in Political Science from +the University of Haifa in Israel. Mr. Rosenberg graduated from the course of Directors & Officers at the College of Management, Tel +Aviv. +Jeffrey A. Bentz has +served as a director since January 2018. Mr. Bentz is an experienced businessman who served from 1994 to 2022 as President of North Star +Terminal & Stevedore Company, a full-service stevedoring company located in Alaska and whose major areas of business include terminal +operations and management, stevedore services and heavy equipment operations. Mr. Bentz has served as a director of Ault Disruptive since +its inception in February 2021 and GWW since September 2022. He also has served as a director and advisor to several private companies +and agencies. Mr. Bentz obtained a B.A. degree in Business and Finance from Western Washington University. +Corporate Governance +Our Board is currently composed +of six members and maintains the following three standing committees: (1) the Audit Committee; (2) the Compensation Committee; and (3) +the Nominating and Governance Committee. The membership and the function of each of the committees are described below. Our Board may, +from time to time, establish a new committee or dissolve an existing committee depending on the circumstances. Current copies of the charters +for the Audit Committee, the Compensation Committee and the Nominating and Governance Committee can be found on our website at https://hyperscaledata.com/. +86 +Audit Committee +Messrs. Smith, Rosenberg and +Bentz currently comprise the Audit Committee of our Board. Our Board has determined that each of the current members of the Audit Committee +satisfies the requirements for independence and financial literacy under the standards of the SEC and the NYSE American. Our Board has +also determined that Mr. Smith qualifies as an “audit committee financial expert” as defined in SEC regulations and satisfy +the financial sophistication requirements set forth in the NYSE American Rules. Mr. Smith serves as the Chairman of the Audit Committee. +The Audit Committee is responsible +for, among other things, selecting and hiring our independent auditors, approving the audit and pre-approving any non-audit services to +be performed by our independent auditors; reviewing the scope of the annual audit undertaken by our independent auditors and the progress +and results of their work; reviewing our financial statements, internal accounting and auditing procedures, and corporate programs to +ensure compliance with applicable laws; and reviewing the services performed by our independent auditors to determine if the services +rendered are compatible with maintaining the independent auditors’ impartial opinion. +Compensation Committee +Messrs. Smith, Rosenberg and +Bentz currently comprise the Compensation Committee of our Board. Our Board has determined that each of the current members of the Compensation +Committee meets the requirements for independence under the standards of the NYSE American. Mr. Bentz serves as Chairman of the Compensation +Committee. +The Compensation Committee +is responsible for, among other things, reviewing and approving executive compensation policies and practices; reviewing and approving +salaries, bonuses and other benefits paid to our officers, including our Executive Chairman, Chief Executive Officer, President and Chief +Financial Officer; and administering our stock option plans and other benefit plans. +Nominating and Governance Committee +Messrs. Smith, Rosenberg and +Bentz currently comprise the Nominating and Governance Committee of our Board. Our Board has determined that each of the current members +of the Nominating and Governance Committee meets the requirements for independence under the standards of the NYSE American. Mr. Rosenberg +serves as Chairman of the Nominating and Governance Committee. +The Nominating and Governance +Committee is responsible for, among other things, assisting our Board in identifying prospective director nominees and recommending nominees +for each annual meeting of stockholders to the Board; developing and recommending governance principles applicable to our Board; overseeing +the evaluation of our Board and management; and recommending potential members for each Board committee to our Board. +The Nominating and Governance +Committee considers diversity when identifying Board candidates. In particular, it considers such criteria as a candidate’s broad-based +business and professional skills, experiences and global business and social perspective. +In addition, the Committee +seeks directors who exhibit personal integrity and a concern for the long-term interests of stockholders, as well as those who have time +available to devote to Board activities and to enhancing their knowledge of the power-supply industry. Accordingly, we seek to attract +and retain highly qualified directors who have sufficient time to attend to their substantial duties and responsibilities. +Executive Committee +As a holding company, our +business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +87 +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on various objectives that +the Company sets, including financings and all acquisition targets and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities, dividends and, in the case of publicly +traded partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Our Executive Committee acts +as the underwriting committee for Ault Lending and approves all lending transactions. Under its business model, Ault Lending generates +revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate income from +appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or warrants issued +to Ault Lending in any particular financing. Ault Lending’s activities are more fully described elsewhere in this Annual Report; +see page 19. +Involvement in Certain Legal Proceedings +Except as set forth below, +to the best of our knowledge, during the past ten years, none of the following occurred with respect to a present or former director, +executive officer, or employee: +· been convicted in a criminal proceeding or been +subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); +· had any bankruptcy petition filed by or against +the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or +executive officer, either at the time of the bankruptcy filing or within two years prior to that time; *+ +· been subject to any order, judgment, or decree, +not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or +temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, +investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; +· been found by a court of competent jurisdiction +in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities +law, and the judgment has not been reversed, suspended, or vacated; ** +88 +· been the subject of, or a party to, any federal +or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including +any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or +commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited +to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist +order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business +entity; +· or been the subject of, or a party to, any sanction +or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the +Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, +entity or organization that has disciplinary authority over its members or persons associated with a member. +* Mr. Cragun served as Chief Financial Officer +of Local Corporation (April 2009 to September 2016), formerly based in Irvine, California, and, in June 2015, Local Corporation filed +a voluntary petition in the United States Bankruptcy Court for the Central District of California seeking relief under the provisions +of Chapter 11 of Title 11 of the United States Code. +** Please see the press release issued by the +Company on August 15, 2023. ++ Mr. Horne has served as Chief Financial Officer +of AVLP since June 2016, and, in March 2025, AVLP filed a voluntary petition in the United States Bankruptcy Court for the District of +Nevada seeking relief under the provisions of Chapter 7 of Title 11 of the United States Code. +Except as set forth in our +discussion below in “Certain Relationships and Related Transactions,” none of our directors or executive officers has been +involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed +pursuant to the rules and regulations of the SEC. +Family Relationships +There are no family relationships among our directors +and executive officers. +Code of Ethics +We have adopted the Code of +Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer, controller +or person performing similar functions. The Code of Ethical Conduct is designed to deter wrongdoing and to promote honest and ethical +conduct and compliance with applicable laws and regulations. The full text of our Code of Ethical Conduct is published on our website +at https://hyperscaledata.com/. We will disclose any substantive amendments to the Code of Ethical Conduct or any waivers, explicit +or implicit, from a provision of the Code on our website or in a current report on Form 8-K. Upon request to our President, Henry Nisser, +we will provide without charge, a copy of our Code of Ethical Conduct. +89 +ITEM 11. EXECUTIVE COMPENSATION +Summary Compensation Table +The following Summary Compensation +Table sets forth all compensation earned in all capacities during the years ended December 31, 2024 and 2023, by our principal executive +officer. Because we are a Smaller Reporting Company, we only have to report information of our principal executive officer and our two +other most highly compensated executive officers. +SUMMARY COMPENSATION TABLE +Name +and principal position +Year +Salary +($) +Bonus +($) +Stock +Awards ($) (1) +Option +Awards ($) +(1) +All +Other Compensation ($) (2) +Total +($) +Milton C. Ault, III +2024 +400,000 +16,667 +- +- +126,950 +543,617 +Executive Chairman of the Board +2023 +400,000 +16,667 +- +- +325,773 +742,440 +William B. Horne +2024 +400,000 +16,667 +- +- +84,502 +501,169 +Chief Executive Officer +2023 +375,000 +16,667 +- +- +98,195 +489,862 +Henry C. Nisser +2024 +300,000 +12,500 +- +- +24,921 +337,421 +President and General Counsel +2023 +300,000 +12,500 +- +- +55,727 +368,227 +(1) +The values reported in the “Stock Awards” and “Option +Awards” columns represent the aggregate grant date fair value, computed in accordance with Accounting Standards Codification (“ASC”) +718 Share Based Payments , of grants of stock options and stock awards to our named executive officer in the years shown. +(2) +The amounts in “All Other Compensation” consist of 401(k) +matching amounts, vehicle allowance, personal use of the Company’s corporate aircraft, health insurance benefits, long-term and +short-term disability insurance benefits, and travel and entertainment expenses. The personal use of corporate aircraft, reflects the +incremental cost to Hyperscale Data for use of the corporate aircraft, determined on the basis of the variable operational costs of each +flight, including fuel, maintenance, flight crew travel expense. Summary table of “All Other Compensation” for the year ended +December 31, 2024 is set forth below: +Name +401(k) Matching +Contribution ($) +Automobile +Expenses ($) +Personal Use of +Aircraft ($) +Medical and Life +Insurance Benefits ($) +Total All Other +Compensation ($) +Milton C. Ault, III +9,442 +12,000 +78,324 +27,184 +126,950 +William B. Horne +17,250 +12,000 +- +55,252 +84,502 +Henry C. Nisser +12,500 +- +- +12,421 +24,921 +Compensation from Related Companies +The compensation table above +does not include compensation paid to those executives from related companies for the year ended December 31, 2024 as set forth below: +AVLP +Alzamend +Circle 8 +Name +Officer +Compensation +Board +Fees +Officer +Compensation +Board +Fees +Milton C. Ault, III +$ - +$ 37,500 +$ - +$ - +William B. Horne +$ 33,333 +$ 50,000 +$ - +$ 25,000 +Henry C. Nisser +$ 33,333 +$ - +$ 50,000 +$ - +Employment Agreements +Milton C. Ault, III +On June 17, 2018, the +Company entered into a ten-year executive employment agreement with Milton C. Ault, III, to serve as Chief Executive Officer of the Company. +On January 19, 2021, Mr. Ault was appointed as Executive Chairman of the Company. For his services, Mr. Ault will be paid a base salary +of $400,000 per annum (the “Base Salary”). +90 +Pursuant +to the terms and subject to the conditions set forth in the agreement, if the Company meets or exceeds criteria adopted by the Company’s +compensation committee (the “Compensation Committee”) for earning bonuses which shall be adopted by the Compensation Committee +annually, Mr. Ault shall be eligible to receive an annual bonus, which percentage shall be based on achievement of applicable performance +goals determined by the Compensation Committee. +In +addition, Mr. Ault shall be eligible to receive a performance-based award (the “CEO Performance Award”), provided that the +Company, for any given fiscal year during the term of this agreement, meets the following criteria: (A) an increase in revenue, as calculated +under GAAP over the previous fiscal year as reported in the Annual Report on Form 10-K or successor form for such fiscal year; provided +that any increase less than thirty-five percent (35%) (the “Revenue Percentage”) shall reduce the CEO Performance Award correspondingly; +(B) positive net income, as calculated under GAAP, as reported in the Annual Report on Form 10-K or successor form for such fiscal year, +provided that any increase less than five percent (5%) (the “Net Income Percentage”) shall reduce the CEO Performance Award +correspondingly; and (C) positive net cash flow from operations on a year-to-year basis, where cash flow is defined as the net amount +of cash and cash-equivalents being transferred into and out of the Company. The CEO Performance Award shall consist of a number of shares +of the Company’s common stock having a maximum value equal to ten percent (10%) of any appreciation in the Company’s Market +Capitalization above the High Water Mark (as such terms are defined in the agreement) as measured by the daily average closing bid price +of the Company’s common stock for the applicable fiscal year subject to proration obtained by the product of Revenue Percentage +and the Net Income Percentage. If the CEO Performance Award in a fiscal year is less than ten percent (10%) due to a reduction caused +by an annual shortfall in either the Revenue Percentage or the Net Income Percentage, the prior year’s targets would be deemed to +have been achieved if a corresponding overage in a subsequent fiscal year results in the achievement of the cumulative targets. +The annual and cumulative targets for revenue and net income, which are provided solely for the purpose of establishing cumulative totals, +are set forth in the agreement. +Upon +termination of Mr. Ault’s employment (other than upon the expiration of the employment), Mr. Ault shall be entitled to receive: +(A) any earned but unpaid base salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued +but unused vacation time. +Further, +unless Mr. Ault’s employment is terminated as a result of his death or disability or for cause or he terminates his employment without +good reason, then upon the termination or non-renewal of Mr. Ault’s employment, the Company shall pay to Mr. Ault a “Separation +Payment” as follows: (A) an amount equal to four (4) weeks of base salary for each full year of service and +credit for his service commencing from September 22, 2016, (B) should Mr. Ault provide the Company with a separation, waiver and release +agreement within 60 days of termination, then the Company shall: (i) pay his base salary until the last to occur (the “Separation +Period”) of (1) the expiration of the remaining portion of the initial term or the then applicable renewal term, as the case may +be, but in no event an amount greater than the Base Salary payable should either such period expire within two years, or (2) the 12-month +period commencing on the date Mr. Ault is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, +dental, long-term disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum +annual bonus as Mr. Ault would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar +months worked including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options +and other equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence +of a change in control, Mr. Ault will be paid an amount equal to the greater of: (i) five times his then current Base Salary or (ii) the +Separation Payment amount set forth above, without regard to whether Mr. Ault continues in the employ of the Company or its successor. +William B. Horne +On January 25, 2018, we entered +into an employment agreement with William Horne to serve as Chief Financial Officer and Executive Vice President of the Company and its +subsidiaries for an initial term through September 30, 2022, which automatically renews thereafter for successive one-year terms unless +either party provides written notification at least four months prior to the end of a term of their desire to terminate. Mr. Horne’s +base salary was $300,000 per annum, which was increased to $400,000 effective April 1, 2023. Mr. Horne is eligible to receive an annual +cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined by the Company’s +compensation committee. +Upon +termination of Mr. Horne’s employment (other than upon the expiration of the employment), Mr. Horne shall be entitled to receive: +(i) any earned but unpaid base salary through the termination date; (ii) all reasonable expenses paid or incurred; and (iii) any accrued +but unused vacation time. +91 +Further, +unless Mr. Horne’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Horne’s employment, the Company shall pay to Mr. Horne a “Separation +Payment” as follows: (A) an amount equal to four weeks of base salary for each full year of service, (B) should +Mr. Horne provide the Company with a separation, waiver and release agreement within 60 days of termination, then the Company shall: +(i) pay his base salary until the last to occur (the “Separation Period”) of (1) the expiration of the remaining portion of +the initial term or the then applicable renewal term, as the case may be, or (2) the 12-month period commencing on the date Mr. Horne +is terminated, payable in one lump sum; (ii) provide during the Separation Period the same medical, dental, long-term disability and life +insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. Horne would have been +otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked including the entire +month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other equity awards shall immediately +vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change in control, Mr. Horne will +be paid an amount equal to four times his Separation Payment. +Henry Nisser +On April 12, 2019, the Company +entered into an employment agreement (the “Agreement”) with Henry Nisser to serve as General Counsel and Executive Vice President +of the Company and its subsidiaries for an initial term through May 1, 20223 which automatically renews thereafter for successive one-year +terms unless either party provides written notification at least four months prior to the end of a term of their desire to terminate. +The effective date of the Agreement was May 1, 2019. For 2023, Mr. Nisser’s base salary was $300,000 per annum (the “Base +Salary”). +Mr. Nisser is eligible to +receive an annual cash bonus equal to a percentage of his annual base salary based on achievement of applicable performance goals determined +by the Company’s compensation committee. +Mr. Nisser’s bonuses, +if any, and all stock based compensation shall be subject to “Company Clawback Rights” if during the period that Mr. Nisser +is employed by the Company and upon the termination of Mr. Nisser’s employment and for a period of two years thereafter, there is +a restatement of any of the Company’s financial results from which any bonuses and stock based compensation to Mr. Nisser shall +have been determined. +Upon termination of Mr. Nisser’s +employment (other than upon the expiration of the employment), Mr. Nisser shall be entitled to receive: (A) any earned but unpaid base +salary through the termination date; (B) all reasonable expenses paid or incurred; and (C) any accrued but unused vacation time. +Further, +unless Mr. Nisser’s employment is terminated as a result of his death or disability or for cause or he terminates his employment +without good reason, then upon the termination or non-renewal of Mr. Nisser’s employment, the Company shall pay to Mr. Nisser a +“Separation Payment” as follows: (a) an amount equal to four weeks of base salary for each full year of service, (b) commencing +on the date that shall be one (1) year from the effective date, should Mr. Nisser provide the Company with a separation, waiver and release +agreement within 30 days of termination, then the Company shall pay to Mr. Nisser the Base Salary (in effect immediately prior to the +termination date) an amount equal to the lesser of what Mr. Nisser would have received if the employment period ended after (1) the expiration +of the remaining portion of the initial term or the then applicable renewal term, as the case may be, or (2) the 18-month period commencing +on the date Executive is terminated, payable in one lump sum; (ii) provide during the separation period the same medical, dental, long-term +disability and life insurance; and (iii) pay an amount equal to the product obtained by multiplying (x) the maximum annual bonus as Mr. +Nisser would have been otherwise entitled to receive by (y) the fraction in which the numerator is the number of calendar months worked +including the entire month in which severance occurred and the denominator of which is 12; and (iv) all outstanding options and other +equity awards shall immediately vest and become fully exercisable for a period of 24 months. Finally, upon the occurrence of a change +in control, Mr. Nisser will be paid an amount equal to four times his Separation Payment. +CEO Pay Ratio +As required by Section 953(b) +of the Dodd-Frank Wall Street Reform and Consumer Protection Act, we are providing disclosure regarding the ratio of annual total compensation +of Mr. Ault, our Executive Chairman, to that of our median employee. Our median employee earned $50,000 in total compensation for 2024. +Based upon the total 2024 compensation reported for Mr. Ault of $543,617 as reported under “Total” in the Summary Compensation +Table, our ratio of PEO to median employee pay was 11:1. Our median employee is employed in our ROI subsidiary. +92 +Our Chief Executive Officer +and Principal Executive Officer, however, is not Mr. Ault but William B. Horne. In order to follow the intent of the SEC’s rules, +which appear to presume that the CEO is the highest paid executive officer of an issuer, we chose to present the total annual compensation +of Mr. Ault, who is paid marginally more than Mr. Horne. +While Mr. Ault’s salary +is the same as Mr. Horne’s for the fiscal year ended December 31, 2024 and exceeds Mr. Horne’s salary by $25,000 for the fiscal +year ended December 31, 2023, respectively, his annual total compensation exceeds Mr. Horne’s by no more than $42,448 and $252,578 +for the fiscal years ended December 31, 2024 and 2023, respectively. +Calculation Methodology +To identify our median employee, +we identified our total employee population worldwide as of December 31, 2024, excluding our Executive Chairman, in accordance with SEC +rules. On December 31, 2024, 95% of our employee population was located in the U.S., with 5% in non-U.S. locations. +We collected full-year 2024 +actual gross earnings data for the December 31, 2024 employee population, including cash-based compensation and equity-based compensation +that was realized in 2024, relying on our internal payroll records. Compensation was annualized on a straight-line basis for non-temporary +new hire employees who did not work with our company for the full calendar year. +Once we determined the median +employee, we calculated total compensation for the median employee in the same manner in which we determine the compensation shown for +our named executive officers in the Summary Compensation Table, in accordance with SEC rules. +Pay Versus Performance +Pay Versus Performance Table +The following table sets forth +information concerning: (1) the compensation of our Executive Chairman, Mr. Ault (referred to in the table below as “EC”) +and the average compensation for our other Named Executive Officers (“NEOs”), Mr. Horne (our PEO) and Mr. Nisser, both as +reported in the Summary Compensation Table and with certain adjustments to reflect the “compensation actually paid” to such +individuals, as defined under SEC rules, for each of the fiscal years ended December 31, 2022, 2023 and 2024 and (2) our cumulative total +shareholder return (“TSR”), the cumulative TSR of our selected peer group (Bitfarms Limited, Cipher Mining, Inc., CleanSpark, +Inc., Hive Digital Technologies Limited, Riot Platforms, Inc., Titan Machinery Inc., Alta Equipment Group Inc., B. Riley Financial, Inc.), +net loss and revenue over such years, in each case determined in accordance with SEC rules: +Value of Initial Fixed $100 Investment Based on: +Year +Summary +Compensation +Table Total for +PEO ($) +Compensation +Actually Paid to +PEO ($) +Average Summary +Compensation +Table Total for +Non-PEO NEOs ($) +Average +Compensation +Actually Paid to +Non-PEO NEOs ($) +Total +Shareholder +Return ($) +Peer Group +Total +Shareholder +Return ($) +Net Income ($) +Total Revenue ($) +2024 +543,617 +543,617 +419,295 +419,295 +0.00 +48.64 +(61,481,000 ) +106,662,000 +2023 +742,440 +689,052 +429,045 +375,657 +0.03 +70.86 +(232,402,000 ) +134,846,000 +2022 +2,173,059 +1,120,398 +1,705,208 +652,547 +10.08 +40.15 +(182,209,000 ) +104,079,000 +Compensation actually paid +to our EC represents the “Total” compensation reported in the Summary Compensation Table for the applicable fiscal year, adjusted +as follows: +2024 +2023 +2022 +Name +EC ($) +Average of +NEOs ($) +EC ($) +Average of +NEOs ($) +EC ($) +Average of +NEOs ($) +Summary compensation table total +543,617 +419,295 +742,440 +429,045 +2,173,059 +1,705,208 +Deduction for amounts reported under the stock awards column in the summary compensation table +- +- +- +- +- +- +Year end value of equity awards granted during year that remain unvested as of year-end +- +- +- +- +- +- +Year over year change in fair value of outstanding and unvested equity awards +- +- +- +- +(525,468 ) +(525,468 ) +Year over year change in fair value of equity awards granted in prior years and vested in the year +- +- +(53,388 ) +(53,388 ) +(527,193 ) +(527,193 ) +Compensation actually paid +543,617 +419,295 +689,052 +375,657 +1,120,398 +652,547 +93 +Narrative Disclosure to Pay Versus Performance +Table +Relationship between Financial Performance +Measures +The line graphs below compare +(i) the compensation actually paid to our EC and the average of the compensation actually paid to our remaining NEOs, with (ii) our cumulative +TSR, (iii) our peer group TSR, (iv) our net loss, and (v) our revenue, in each case, for the fiscal years ended December 31, 2022, 2023 +and 2024. +TSR amounts reported in the +graph assume an initial fixed investment of $100, and that all dividends, if any, were reinvested. The term “PEO” as used +in the tables below refers to the EC, not the PEO. +94 +Policies on Ownership, Insider Trading, 10b5-1 +Plans and Hedging +We do not have formal stock +ownership guidelines for our employees or directors, because the Board is satisfied that stock and option holdings among our employees +or directors are sufficient at this time to provide motivation and to align this group’s interests with those of our stockholders. +We have established an insider +trading policy that provides guidelines to, and imposes restrictions on, officers, directors and employees with respect to transactions +in the Company’s securities. The Company’s insider trading policy prohibits certain actions by such individuals relating to +buying and selling common stock of the Company, and discourages certain other actions in other situations. Such individuals are authorized +to enter into trading plans established according to Section 10b5-1 of the Exchange Act with an independent broker-dealer. Under these +plans, the individual must not exercise any influence over the amount of the securities to be traded, the price at which they are to be +traded or the date of the trade. The plan must either specify the amount, pricing and timing of transactions in advance or delegate discretion +on these matters to an independent third party. Such plans provide a defense from insider trading liability. +We have not adopted any hedging +policies. +Policies and Practices Related to the Grant +of Certain Equity Awards Close in Time to the Release of Material Nonpublic Information +We do not have any formal +policy that requires us to grant, or avoid granting, equity-based compensation to our executive officers at certain times. The timing +of any equity grants to executive officers in connection with new hires, promotions, or other non-routine grants is tied to the event +giving rise to the award (such as an executive officer’s commencement of employment or promotion effective date). As a result, in +all cases, the timing of grants of equity awards, including stock options, occurs independent of the release of any material nonpublic +information, and we do not time the disclosure of material nonpublic information for the purpose of affecting the value of equity-based +compensation. +During fiscal 2024, there +were no equity grants made to our executive officers during any period beginning four business days before the filing of a periodic report +or current report disclosing material non-public information and ending one business day after the filing or furnishing of such report +with the SEC. +95 +Advisory Vote on Executive Compensation +At the annual meeting of stockholders +on November 23, 2022, the stockholders approved, on an advisory basis, the compensation paid to the Company’s named executive officers. +An advisory vote on executive compensation is held every three years. +Director Compensation +The Company pays each independent +director an annual base amount of $45,000 annually, other than Mr. Smith, who receives a base amount of $55,000 annually due to the additional +services provided by Mr. Smith as a lead independent director and Audit Committee Chairman. Additionally, our Board makes recommendations +for adjustments to an independent director’s compensation when the level of services provided is significantly above what was anticipated. +In addition, independent directors are eligible, at the Board’s discretion, to receive a bonus. +The table below sets forth, +for each non-employee director, the total amount of compensation related to his service during the year ended December 31, 2024: +Fees earned or +Stock +Option +All other +Name +paid in cash ($) +awards ($) +awards ($) +compensation ($) +Total ($) +Robert O. Smith +55,000 +— +— +— +55,000 +Jeffrey A. Bentz +45,000 +— +— +— +45,000 +Mordechai Rosenberg +45,000 +— +— +— +45,000 +Stock Incentive Plans +On December 28, 2018, the +stockholders approved the 2018 Stock Incentive Plan (as amended on May 5, 2019), which amendment was approved by the stockholders on July +19, 2019, the “2018 Stock Incentive Plan”), under which options to acquire up to 5,000 shares of common stock may be +granted to the Company’s directors, officers, employees and consultants. The 2018 Stock Incentive Plan is in addition to the Company’s +(ii) 2016 Stock Incentive Plan, under which options to acquire up to 1 share of common stock may be granted to the Company’s directors, +officers, employees and consultants, (iv) 2021 Stock Incentive Plan, under which 1,000 stock options, restricted stock, stock appreciation +rights, restricted stock units, and other stock-based compensation. be granted to the Company’s directors, officers, employees and +consultants, (v) 2021 Employee Stock Purchase Plan, intended to assist our employees in acquiring share ownership up to an aggregate of +131 shares of common stock, and (vi) 2022 Stock Incentive Plan, under which 10,000 stock options, restricted stock, stock appreciation +rights, restricted stock units, and other stock-based compensation. be granted to the Company’s directors, officers, employees and +consultants (collectively the “Plans”). +The purpose of the Plans is +to advance the interests of the Company by providing to key employees of the Company and its affiliates, who have substantial responsibility +for the direction and management of the Company, as well as certain directors and consultants of the Company, additional incentives to +exert their best efforts on behalf of the Company, to increase their proprietary interest in the success of the Company, to reward outstanding +performance and to provide a means to attract and retain persons of outstanding ability to the service of the Company. +As of December 31, 2024, no +options to purchase shares of Class A common stock were issued and outstanding, and 297 shares are available for future issuance under +the Plans. +401(k) Plans +Hyperscale Data and TurnOnGreen +have adopted tax-qualified employee savings and retirement plan, or 401(k) plans, which generally cover all of their full-time employees. +Pursuant to the 401(k) plans, eligible employees may make voluntary contributions to the plan up to a maximum of pursuant to the current +Internal Revenue Code limits. The Hyperscale Data and TurnOnGreen 401(k) plans include matching contributions at the rate of (1) $1.00 +for each $1.00 contributed, up to 3% of the base salary and (2) $0.50 for each $1.00 contributed thereafter, up to 5% of the base salary +and permits discretionary contributions. The 401(k) plans are intended to qualify under Sections 401(k) and 401(a) of the Internal Revenue +Code of 1986, as amended. Contributions to such a qualified plan are deductible by the Company when made, and neither the contributions +nor the income earned on those contributions is taxable to plan participants until withdrawn. All 401(k) plan contributions are credited +to separate accounts maintained in trust. +96 +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +Except as otherwise indicated +below, the following table sets forth certain information regarding beneficial ownership of our common stock as of April 14, 2025 by +(1) each of our current directors; (2) each of the executive officers; (3) each person known to us to be the beneficial owner of more +than 5% of the outstanding shares of our common stock based upon Schedules 13G or 13D filed with the SEC; and (4) all of our directors +and executive officers as a group. As of April 14, 2025, there were 1,529,995 shares of our common stock issued and outstanding. +Beneficial ownership is determined +in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Common stock subject to +options or warrants that are currently exercisable or exercisable within 60 days of April 14, 2025 are deemed to be outstanding and to +be beneficially owned by the person or group holding such options or warrants for the purpose of computing the percentage ownership of +such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or +group. Unless otherwise indicated by footnote, to our knowledge, the persons named in the table have sole voting and sole investment power +with respect to all common stock shown as beneficially owned by them, subject to applicable community property laws. +Number of +shares +Approximate +beneficially +percent +Name and address of beneficial owner (1) +owned +of class +Greater than 5% Beneficial Owners: +Ault & Company, Inc. +34,832,482 +(2) +95.81 % +Directors and Officers: (1) +Milton C. Ault, III +34,833,328 +(3) +95.82 % +William Horne +1 +(4) +* +Henry Nisser +3 +(5) +* +Ken Cragun +0 +* +Robert Smith +0 +* +Mordechai Rosenberg +0 +* +Jeffrey A. Bentz +0 +* +All directors and executive officers as a group (eight persons) +34,833,332 +95.82 % +* Less than one percent. +(1) Unless otherwise indicated, the business address of each of the individuals is c/o Hyperscale Data, Inc., +11411 Southern Heights Pkwy, Suite 190, Las Vegas, NV 89141. +(2) +Represents (i) 8,249 shares of Class A Common Stock owned, (ii) 4,234,561 +shares of Class B Common Stock that are convertible into 4,234,561 shares of Class A Common Stock and carries the voting power of 42,345,610 +shares of Class A Common Stock, (iii) 29,561,308 shares of Class A Common Stock issuable upon conversion of Series C Convertible Preferred +Stock that carry the voting power of 464,576 shares of Class A Common Stock, (iv) 567,578 shares of Class A Common Stock issuable upon +conversion of Series G Convertible Preferred Stock that carry the voting power of 153,748 shares of Class A Common Stock and (v) 460,786 +shares of Class A Common Stock underlying warrants that are either presently exercisable or exercisable within 60 days. +(3) +Represents (i) 34,832,482 shares of Class A Common Stock beneficially +held by Ault & Company, as discussed in footnote 2 above, (ii) 500 shares of Class A Common Stock, and (iii) 346 shares of Class B +Common Stock that is convertible into 346 share of Class A Common Stock and carries the voting power of 3,460 shares of Class A Common +Stock. Mr. Ault is the Chief Executive Officer of Ault & Company. +(4) Represents 1 share of Class B Common Stock that is convertible into +1 share of Class A Common Stock and carries the voting power of 10 shares of Class A Common Stock. +(5) Represents (i) 2 shares of Class A Common Stock and (ii) 1 share of +Class B Common Stock that is convertible into 1 share of Class A Common Stock and carries the voting power of 10 shares of Class A Common +Stock. +97 +Equity Compensation Information +The following table summarizes information about +our equity compensation plans as of December 31, 2024. +Number of securities +Number of securities +Weighted- +remaining available for +to be issued +average +future issuance under +upon exercise +exercise price +equity compensation plans +of outstanding +of outstanding +(excluding securities +options, warrants and rights +options, warrants and rights +reflected in column (a)) +Plan Category +(a) +(b) +(c) +Equity compensation plans approved by stockholders +0 +- +297 +Equity compensation plans not approved by stockholders +0 +- +- +Total +0 +- +297 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• +the aggregate amount involved is determined to by the Audit Committee to be material; +• +we are a participant; and +• +any of the following has or will have a direct or indirect interest in the transaction: +• +an executive officer, director, or nominee for election as a director; +• +a greater than five percent beneficial owner of our common stock; or +• +any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. +Ault & Company, Inc. +Series C Preferred Stock Purchase Agreement +On November 6, 2023, we entered +into the November 2023 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 50,000 shares of Series C Convertible Preferred Stock and the Series C Warrants to purchase up to 0.4 million shares of common stock +for a total purchase price of up to $50 million. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50 million to $75 million and (B) extended the date of on which the final closing may occur to June 30, 2024, +subject to Ault & Company’s ability to further extended such date for ninety days. +98 +On +September 17, 2024, we and Ault & Company entered into the Second Amendment. Pursuant to the Second Amendment, the “Termination +Date” was amended from June 30, 2024 to December 31, 2024, in each case subject to the right of Ault & Company to extend such +date for an additional ninety (90) days. +As +of the date of filing of this Form 10-K, Ault & Company has purchased an aggregate of 50,000 shares of Series C Convertible Preferred +Stock and Series C Warrants to purchase an aggregate of 422,337 Warrant Shares, for an aggregate purchase price of $50.0 million. +Additionally, until the earlier +of (i) four years from the initial closing date of the November 2023 SPA or (ii) the date when Ault & Company holds fewer than 10,000 +shares of Series C Convertible Preferred Stock, the Company will be prohibited from (A) entering into any financing, whether debt or equity, +other than conventional loans from a commercial bank, at a price per share less than the Series C Conversion Price (as defined below) +or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 10,000 shares of Series C Convertible Preferred Stock, Ault & Company shall have a right to participate +in any subsequent financing (a “Subsequent Financing”) allowing Ault & Company to purchase such number of securities in +the Subsequent Financing to allow Ault & Company to maintain its percentage beneficial ownership of the Company that Ault & Company +held immediately prior to the Subsequent Financing. +On December 14, 2023, pursuant +to the November 2023 SPA, we sold to Ault & Company, in three separate closings that occurred on the closing date, an aggregate of +41,500 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 350,543 shares of common stock, for a total purchase +price of $41.5 million. At the Initial Closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred Stock and +Series C Warrants to purchase 181,607 shares of common stock, for a purchase price of $21.5 million, paid in cash. Immediately upon the +Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes issued to the lenders pursuant to the +Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +Second Closing, Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 84,468 +shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon the Second Closing, we paid $10.0 million +to partially satisfy the outstanding Senior Note. Promptly thereafter, at the Third Closing, Ault & Company purchased another 10,000 +shares of Series C Convertible Preferred Stock and Series C Warrants to purchase another 84,468 shares of common stock, for a purchase +price of $10.0 million, paid in cash. Immediately upon the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance +on the outstanding Senior Note. +On December 14, 2023, we, +along with the Guarantors entered into the Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed $36 +million and issued the Secured Notes to the lenders in the aggregate amount of $38.9 million. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated from the Miners and (c) the +membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those entities +granted to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault Aviation, +AGREE, Sentinum, Third Avenue, Ault Energy, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue on +the Florida Property, (iv) a future advance mortgage by ACS on the Michigan Property, (v) an aircraft mortgage and security agreement +by Ault Aviation on the Aircraft, and (vi) deposit account control agreements over certain bank accounts held by certain of our subsidiaries. +In addition, pursuant to the +Loan Agreement, we agreed to establish the Segregated Account, which would be used as a further guarantee of repayment of the Secured +Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. We are required to have the minimum balance in the +Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and +two-year anniversaries of the closing date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million +monthly into the Segregated Account, which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into +the Segregated Account, (i) up to the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, +the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on +a per dividend basis) received from Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, +which shall not exceed $9 million in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans +or other investments made by Ault Lending (including but not limited to sales of loans or investments, dividends, interest payments and +amortization payments), which shall not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further +agreed to deposit funds into the Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida +Property, (ii) $11 million from the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, +subject to a de minimis threshold of $1 million, and (v) $10 million from the sale of Circle 8. +99 +Amendments to Loan and Guarantee Agreement +On +September 17, 2024, the loan and guarantee agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed +financial obligations of Ault & Company borrowings, was amended regarding the Company’s obligations to fund the restricted cash +Segregated Account. +The Company agreed to deposit +in the Segregated Account: (i) $0.4 million monthly commencing on September 30, 2024 and ending on February 28, 2025; and (ii) $0.5 +million monthly commencing on March 31, 2025 and ending on the earlier of the term loan maturity date, prepayment of the term loan in +full or the date on which the balance of the Segregated Account exceeds 110% of the outstanding balance of the term loan. As of December +31, 2024, the Company had deposited $18.4 million in the Segregated Account. +On +March 7, 2025 the loan and guarantee agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed +financial obligations of Ault & Company borrowings, was further amended regarding the Company’s obligations to fund the restricted +cash Segregated Account. +Pursuant +to the March 7, 2025 amendment, the Company agreed to deposit in the Segregated Account: (i) $0.2 million monthly commencing on April 11, +2025 and ending on June 11, 2025; and (ii) $0.4 million monthly commencing on July 11, 2025 and ending on the earlier of the term loan +maturity date, prepayment of the term loan in full or the date on which the balance of the Segregated Account exceeds 110% of the outstanding +balance of the term loan. +Description of the Series C Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) $0.10 (the “Preferred Floor Price”), and (ii) the lesser of (A) $0.35 or (B) 105% of the volume +weighted average price of the common stock during the ten trading days immediately prior to the date of conversion (the “Series +C Conversion Price”). The Series C Conversion Price is subject to adjustment in the event of an issuance of common stock at a price +per share lower than the Series C Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations +or similar events. The Preferred Floor Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations +or similar transactions. +Voting Rights +The holders of the Series +C Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series C Convertible Preferred Stock is entitled to +cast, shall not be lower than $107.625 (the “Series C Voting Floor Price”), which represents the closing sale price of the +common stock on the trading day immediately prior to the date of execution of the November 2023 SPA. The Series C Voting Floor Price shall +be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series C Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +100 +Description of the Series C Warrants +On each closing date, the +Company will issue Ault & Company the Series C Warrants, which grant Ault & Company the right to purchase a specified number of +common stock (the “Series C Warrant Shares”). The exercise price of the Series C Warrants is $118.39 (the “Series C +Exercise Price”) and the number of Series C Warrant Shares is determined by dividing the actual investment amount by the Series +C Exercise Price. The Series C Exercise Price is subject to adjustment in the event of customary stock splits, stock dividends, combinations +or similar events. +The Series C Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +Series G Preferred Stock Purchase Agreement +On December 21, 2024, we entered +into the December 2024 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 25,000 shares of Series G Convertible Preferred Stock and the Series G Warrants to purchase up to 4.2 million shares of common stock +for a total purchase price of up to $25 million. +The +December 2024 SPA shall automatically terminate if the closing has not occurred prior to December 31, 2025, though such date may be extended +by Ault & Company as set forth in the December 2024 SPA. The December 2024 SPA provides that the financing may be conducted through +one or more closings. +As +of the date of filing of this Form 10-K, Ault & Company has purchased an aggregate of 960 shares of Series G Convertible Preferred +Stock and Series G Warrants to purchase an aggregate of 162,217 Warrant Shares, for an aggregate purchase price of $1.0 million. +Additionally, until the earlier +of (i) four years from the initial closing date of the December 2024 SPA or (ii) the date when Ault & Company holds fewer than 5,000 +shares of Series G Convertible Preferred Stock, the Company will be prohibited from (A) entering into any financing, whether debt or equity, +other than conventional loans from a commercial bank, at a price per share less than the Series G Conversion Price (as defined below) +or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 5,000 shares of Series G Convertible Preferred Stock, Ault & Company shall have a right to participate +in a Subsequent Financing allowing Ault & Company to purchase such number of securities in the Subsequent Financing to allow Ault +& Company to maintain its percentage beneficial ownership of the Company that Ault & Company held immediately prior to the Subsequent +Financing. +Description of the Series G Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) the Preferred Floor Price, and (ii) the lesser of (A) $6.74 or (B) 105% of the volume weighted average price +of the common stock during the ten trading days immediately prior to the date of conversion (the “Series G Conversion Price”). +The Series G Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the +Series G Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The +Preferred Floor Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations or similar transactions. +Voting Rights +The holders of the Series +G Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series G Convertible Preferred Stock is entitled to +cast, shall not be lower than $6.244 (the “Series G Voting Floor Price”), which represents the closing sale price of the Class +A common stock on the trading day immediately prior to the date of execution of the December 2024 SPA plus the estimated value of the +Series G Warrants. The Series G Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other similar +transactions. +101 +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series G Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +Description of the Series G Warrants +On each closing date, the +Company will issue Ault & Company the Series G Warrants, which grant Ault & Company the right to purchase a specified number of +shares of class A common stock (the “Series G Warrant Shares”). The exercise price of the Series G Warrants is $5.92 (the +“Series G Exercise Price”) and the number of Series G Warrant Shares is determined by dividing the actual investment amount +by the Series G Exercise Price. The Series G Exercise Price is subject to adjustment in the event of customary stock splits, stock dividends, +combinations or similar events. +The Series G Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +Nature of Related Parties +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer and a director of +Ault & Company. William B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief +Financial Officer and a director of Ault & Company. Henry Nisser, our President, General Counsel and a member of our board of directors, +is also the President, General Counsel and a director of Ault & Company. +Alzamend +On January 31, 2024, Ault +Lending entered into the January 2024 SPA with Alzamend, pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending +up to 6,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to purchase up to 0.6 million shares of Alzamend common stock +for a total purchase price of up to $6.0 million. On January 31, 2024, Ault Lending purchased 1,220 +shares of ALZN Series B Preferred and warrants to purchase 0.1 million shares for a total purchase price of $1.22 million. The purchase +price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend between November 9, 2023 and January +31, 2023. On March 26, 2024, pursuant to the January 2024 SPA, Ault Lending purchased 780 +shares of ALZN Series B Preferred Stock and ALZN Series B Warrants to +purchase 0.1 million shares of Alzamend common , for a purchase price of $780,000. As +of March 31, 2025, Ault Lending has purchased an aggregate of 2,100 shares of ALZN Series B Preferred and ALZN Series B Warrants +to purchase an aggregate of 0.2 million shares of Alzamend common stock, for an aggregate purchase +price of $2.1 million. +Description of the ALZN Series B Preferred +The +terms of the ALZN Series B Preferred are as set forth in the Amended and Restated Certificates of Designations of the Rights, Preferences +and Limitations of the Series B Convertible Preferred Stock, as amended (the “ Series B Certificate of Designation ”). +Each share of ALZN Series B Preferred has a stated value of $1,000 per share (the “ALZN Stated Value ”). +The ALZN Series B Preferred does not accrue dividends. +Conversion Rights +Each +share of ALZN Series B Preferred is convertible into a number of shares of Alzamend common +stock (“ALZN Conversion Shares”) determined by dividing the ALZN Stated Value by +$10.00 (the “ALZN Conversion Price”). The ALZN Conversion Price is subject to adjustment in the event of an issuance +of common stock at a price per share lower than the ALZN Conversion Price then in effect, as well as upon customary stock splits, stock +dividends, combinations or similar events. +Voting Rights +The +holders of the ALZN Series B Preferred are entitled to vote with the common stock as a single +class on an as-converted basis, subject to applicable law provisions of the Delaware General Company Law and Nasdaq, provided however, +that for purposes of complying with Nasdaq regulations, the conversion price, for purposes of determining the number of votes the holder +of ALZN Series B Preferred is entitled to cast, shall not be lower than $8.73 (the “ALZN +Voting Floor Price”). The ALZN Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other +similar transactions. +102 +Liquidation Rights +In +the event of liquidation, dissolution, or winding up of Alzamend, the holders of ALZN Series B Preferred +have a preferential right to receive an amount equal to the ALZN Stated Value per share of ALZN +Series B Preferred before any distribution to other classes of capital stock. If the assets are insufficient, the distribution +will be prorated among the holders of ALZN Series B Preferred . The remaining assets, if any, +will then be distributed pro rata to the holders of outstanding Alzamend common stock. Any transaction that constitutes a change of control +transaction shall be deemed to be a liquidation under the Series B Certificate of Designation. +Description of the +Series B Warrants +At +each closing, Alzamend issued Ault Lending Series B Warrants, which grant Ault Lending the right to purchase a specified number of Alzamend +common stock (the “ALZN Warrant Shares”). The exercise price of the Series B Warrants is $12.00 (the “ALZN Exercise +Price”) and the number of ALZN Warrant Shares is equal to the number of ALZN Conversion Shares issuable upon the ALZN +Series B Preferred issued at that closing. The ALZN Exercise Price is subject to adjustment in the event of an issuance of common +stock at a price per share lower than the ALZN Exercise Price then in effect, as well as upon customary stock splits, stock dividends, +combinations or similar events. +The +Series B Warrants become exercisable on the first business day after the six-month anniversary of issuance (the “ALZN Initial Exercise +Date”) and have a five-year term, expiring on the fifth anniversary of the ALZN Initial Exercise Date. +Nature of Related Parties +Messrs. Ault, Horne and Nisser +are each paid $50,000 annually by Alzamend. +Milton +C. Ault, III, our Executive Chairman, is also the Vice Chairman of Alzamend. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also the Chairman of Alzamend . +Henry Nisser, our President, General Counsel and a member of our board of directors, is also the Executive Vice President, General Counsel +and a director of Alzamend. +AVLP +Nature of Related Parties +Prior to the filing of Chapter +7 bankruptcy by AVLP in March 2025, Mr. Ault was paid $100,000 annually by AVLP, and each of Messrs. Horne and Nisser was paid $50,000 +annually by AVLP. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of AVLP. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of AVLP. Mr. Ault is the Executive Chairman +of AVLP. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General Counsel +of AVLP. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +C +X +X +Jeffrey A. Bentz +Yes +X +X +C +Mordechai Rosenberg +Yes +X +C +X +____________ +C – Chairman of committee +X – Member of committee +103 +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +Marcum LLP served as our independent +registered public accounting firm for the years ended December 31, 2024 and 2023. Ziv Haft, a BDO Member Firm, served as the independent +registered public accounting firm of Enertec for the year ended December 31, 2023. +Fees and Services +The following table shows +the aggregate fees billed to us for professional services by Marcum LLP for the years ended December 31, 2024 and 2023 and Ziv Haft for +the year ended December 31, 2023: +2024 +2023 +Audit Services +$ 1,623,000 +$ 2,241,000 +Audit-Related Services +— +— +Tax Services +— +— +All Other Services +— +— +Total +$ 1,623,000 +$ 2,241,000 +Audit Fees. This +category includes the aggregate fees billed for professional services rendered for the audits of our financial statements for the years +ended December 31, 2024 and 2023, for the reviews of the financial statements included in our quarterly reports on Form 10-Q during 2024 +and 2023, and for other services that are normally provided by the independent auditors in connection with statutory and regulatory filings +or engagements for the relevant years. +Audit-Related Fees. This +category includes the aggregate fees billed in each of the last two years for assurance and related services by the independent auditors +that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under “Audit +Fees,” and generally consist of fees for other engagements under professional auditing standards, accounting and reporting consultations, +internal control-related matters, and audits of employee benefit plans. +Tax Fees . This category +includes the aggregate fees billed in each of the last two years for professional services rendered by the independent auditors for tax +compliance, tax planning and tax advice. +All Other Fees. This +category includes the aggregate fees billed in each of the last two years for products and services provided by the independent auditors +that are not reported above under “Audit Fees,” “Audit-Related Fees,” or “Tax Fees.” +The Audit Committee’s +policy is to pre-approve all services provided by our independent auditors. These services may include audit services, audit-related services, +tax services and other services. The Audit Committee may also pre-approve particular services on a case-by-case basis. Our independent +auditors are required to report periodically to the Audit Committee regarding the extent of services they provide in accordance with such +pre-approval. +104 +PART IV +ITEM 15. EXHIBITS +Exhibit +Number +Description +2.1 +Agreement and Plan of Merger dated January 7, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 3.1 thereto. +2.2 +Agreement and Plan of Merger dated December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 2.1 thereto. +2.3 +Agreement and Plan of Merger dated December 20, 2022. Incorporated by reference to the Current Report on Form 8-K filed on December 21, 2022 as Exhibit 2.1 thereto. +3.1 +Certificate of Incorporation, dated September 22, 2017. Incorporated herein by reference to the Current Report on Form 8-K filed on December 29, 2017 as Exhibit 3.1 thereto. +3.2 +Certificate of Designations of Rights and Preferences of 10% Series A Cumulative Redeemable Perpetual Preferred Stock, dated September 13, 2018. Incorporated herein by reference to the Current Report on Form 8-K filed on September 14, 2018 as Exhibit 3.1 thereto. +3.3 +Certificate of Amendment to Certificate of Incorporation, dated January 2, 2019. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2019 as Exhibit 3.1 thereto. +3.4 +Certificate of Amendment to Certificate of Incorporation (1-for-20 Reverse Stock Split of Common Stock), dated March 14, 2019. Incorporated herein by reference to the Current Report on Form 8-K filed on March 14, 2019 as Exhibit 3.1 thereto. +3.5 +Certificate of Ownership and Merger. Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2021 as Exhibit 2.1 thereto. +3.6 +Certificate of Ownership and Merger, as filed with the Secretary of State of the State of Delaware on December 1, 2021. Incorporated by reference to the Current Report on Form 8-K filed on December 13, 2021 as Exhibit 3.1 thereto. +3.7 +Certificate of Designation, Preferences and Rights relating to the 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated May 25, 2022. Incorporated by reference to the Registration Statement on Form 8-A filed on May 26, 2022 as Exhibit 3.6 thereto. +3.8 +Certificate of Increase of the Designated Number of Shares of 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated June 10, 2022. Incorporated by reference to the Current Report on Form 8-K filed on June 14, 2022 as Exhibit 3.1 thereto. +3.9 +Certificate of Correction to the Certificate of Designation, Rights and Preferences of 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock, dated June 16, 2022. Incorporated by reference to the Current Report on Form 8-K filed on June 17, 2022 as Exhibit 3.1 thereto. +3.10 +Certificate of Amendment to Certificate of Incorporation (1-for-300 Reverse Stock Split of Common Stock), dated May 15, 2023. Incorporated herein by reference to the Current Report on Form 8-K filed on May 16, 2023 as Exhibit 3.1 thereto. +3.11 +Certificate of Elimination of the Series E convertible redeemable preferred stock of Hyperscale Data, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on August 18, 2023 as Exhibit 3.1 thereto. +3.12 +Certificate of Elimination of the Series F convertible redeemable preferred stock of Hyperscale Data, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on August 18, 2023 as Exhibit 3.2 thereto. +3.13 +Certificate of Elimination of the Series G convertible redeemable preferred stock of Hyperscale Data, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on August 18, 2023 as Exhibit 3.3 thereto. +3.14 +Certificate of Designation of Preferences, Rights and Limitations of Series C Cumulative Preferred Stock, dated November 15, 2023. Incorporated herein by reference to the Current Report on Form 8-K filed on November 21, 2023 as Exhibit 3.1 thereto. +3.15 +Certificate of Elimination of the Series B convertible redeemable preferred stock of Hyperscale Data, Inc. Incorporated herein by reference to the Current Report on Form 8-K filed on December 12, 2023 as Exhibit 3.1 thereto. +3.16 +Certificate of Amendment to Certificate of Incorporation filed with the Delaware Secretary of State on January 12, 2024. Incorporated by reference to the Current Report on Form 8-K filed on January 12, 2024 as Exhibit 3.2 thereto. +3.17 +Second Amended and Restated Bylaws, effective as of January 11, 2024. Incorporated by reference to the Current Report on Form 8-K filed on January 12, 2024 as Exhibit 3.1 thereto. +3.18 +Certificate of Increase to Certificate Designations of Preferences, Rights and Limitations of Series C Convertible Preferred Stock. Incorporated herein by reference to the Current Report on Form 8-K filed on April 4, 2024 as Exhibit 3.1 thereto. +3.19 +Certificate of Amendment to Certificate of Incorporation filed with the Delaware Secretary of State on September 6, 2024 and effective September 10, 2024. Incorporated herein by reference to the Current Report on Form 8-K filed on September 6, 2024 as Exhibit 3.1 thereto. +3.20 +Certificate of Designation, Preferences and Rights relating to the 10.00% Series E Cumulative Redeemable Perpetual Preferred Stock, dated November 11, 2024. Incorporated by reference to the Current Report on Form 8-K filed on November 12, 2024 as Exhibit 3.1 thereto. +105 +Exhibit +Number +Description +3.21 +Certificate of Amendment to Certificate of Incorporation filed with the Delaware Secretary of State on November 20, 2024. Incorporated herein by reference to the Current Report on Form 8-K filed on November 20, 2024 as Exhibit 3.1 thereto. +3.22 +Certificate of Designation, Preferences and Rights relating to the Series F Exchangeable Preferred Stock, dated November 22, 2024. Incorporated by reference to the Current Report on Form 8-K filed on November 25, 2024 as Exhibit 3.1 thereto. +3.23 +Form of Certificate of Designation of Preferences, Rights and Limitations of Series G Cumulative Preferred Stock, dated December 21, 2024. Incorporated herein by reference to the Current Report on Form 8-K filed on December 23, 2024 as Exhibit 4.1 thereto. +3.24 +Certificate of Amendment to Certificate of Incorporation filed with the Delaware Secretary of State on February 5, 2025. Incorporated herein by reference to the Current Report on Form 8-K filed on February 10, 2025 as Exhibit 3.1 thereto. +3.25 +Certificate of Designation of Preferences, Rights and Limitations of Series B Cumulative Preferred Stock, dated March 31, 2025. Incorporated herein by reference to the Current Report on Form 8-K filed on April 1, 2025 as Exhibit 3.1 thereto. +4.1 +Form of Warrant, dated as of May 28, 2020. Incorporated by reference to the Current Report on Form 8-K filed on May 29, 2020 as Exhibit 4.3 thereto. +4.2 +Form of Warrant, dated June 26, 2020. Incorporated by reference to the Current Report on Form 8-K filed on June 29, 2020 as Exhibit 4.2 thereto. +4.3 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on July 17, 2020 as Exhibit 4.2 thereto. +4.4 +Form of Warrant, dated October 22, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 23, 2020 as Exhibit 4.2 thereto. +4.5 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.3 thereto. +4.6 +Form of Warrant dated October 27, 2020. Incorporated by reference to the Current Report on Form 8-K filed on October 27, 2020 as Exhibit 4.4 thereto. +4.7 +Form of Warrant issued to Esousa Holdings, LLC, dated November 19, 2020. Incorporated by reference to the Current Report on Form 8-K filed on November 20, 2020 as Exhibit 4.3 thereto. +4.8 +Form of Senior Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.1 thereto. +4.9 +Form of Subordinated Indenture between BitNile Holdings, Inc. and the Trustee. Incorporated by reference to the Registration Statement on Form S-3 filed on October 29, 2021 as Exhibit 4.2 thereto. +4.10 +Form of Class A Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.2 thereto. +4.11 +Form of Class B Warrant, dated December 29, 2021. Incorporated by reference to the Current Report on Form 8-K filed on January 3, 2022 as Exhibit 4.3 thereto. +4.12 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on August 11, 2022 as Exhibit 4.1 thereto. +4.13 +Form of Class A Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 4.1 thereto. +4.14 +Form of Class B Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 8, 2022 as Exhibit 4.2 thereto. +4.15 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on December 19, 2022 as Exhibit 4.1 thereto. +4.16 +Form of amendment #1 to senior secured promissory note. Incorporated by reference to the Quarterly Report on Form 10-Q filed on May 22, 2023 as Exhibit 10.7 thereto. +4.17 +Form of 7.00% Senior Note due 2024. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 4.1 thereto. +4.18 +Form of 8.50% Senior Note due 2026. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 4.2 thereto. +4.19 +Form of 10.50% Senior Note due 2028. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 4.3 thereto. +4.20 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on September 28, 2023 as Exhibit 4.1 thereto. +4.21 +Form of Warrant issued October 13, 2023. Incorporated by reference to the Current Report on Form 8-K filed on October 16, 2023 as Exhibit 4.2 thereto. +4.22 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on November 7, 2023 as Exhibit 10.2 thereto. +4.23 +Securities Purchase Agreement, dated as of November 14, 2023, by and between Hyperscale Data, Inc. and RiskOn International, Inc. Incorporated by reference to the Current Report on Form 8-K filed on November 15, 2023 as Exhibit 10.1 thereto. +106 +Exhibit +Number +Description +4.24 +Form of Certificate of Designations of Rights, Preferences and Limitations of Series D Convertible Preferred Stock of RiskOn International, Inc. Incorporated by reference to the Current Report on Form 8-K filed on November 15, 2023 as Exhibit 10.2 thereto. +4.25 +Note Purchase Agreement, dated March 11, 2024, by and among the Company and the Investors. Incorporated by reference to the Current Report on Form 8-K filed on March 12, 2024 as Exhibit 10.1 thereto. +4.26 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on March 12, 2024 as Exhibit 4.1 thereto. +4.27 +Form of Term Note. Incorporated by reference to the Current Report on Form 8-K filed on April 30, 2024 as Exhibit 4.1 thereto. +4.28 +Form of Note. Incorporated by reference to the Current Report on Form 8-K filed on July 19, 2024 as Exhibit 4.1 thereto. +4.29 +Note Purchase Agreement, dated July 18, 2024, by and among the Company and Esousa Group Holdings, LLC. Incorporated by reference to the Current Report on Form 8-K filed on July 19, 2024 as Exhibit 10.1 thereto. +4.30 +Form of Forbearance Note. Incorporated by reference to the Current Report on Form 8-K filed on December 11, 2024 as Exhibit 4.1 thereto. +4.31 +Securities Purchase Agreement, dated as of December 21, 2024, by and between the Company and Ault & Company, Inc. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2024 as Exhibit 10.1 thereto. +4.32 +Form of Warrant. Incorporated by reference to the Current Report on Form 8-K filed on January 6, 2025 as Exhibit 10.2 thereto. +4.33 +Form of Convertible Promissory Note. Incorporated by reference to the Current Report on Form 8-K filed on February 6, 2025 as Exhibit 4.1 thereto. +4.34 +Form of Amended and Restated Forbearance Note. Incorporated by reference to the Current Report on Form 8-K filed on February 26, 2025 as Exhibit 4.1 thereto. +4.35 +Form of Convertible Promissory Note. Incorporated by reference to the Current Report on Form 8-K filed on March 17, 2025 as Exhibit 4.1 thereto. +4.36 +Form of Convertible Promissory Note. Incorporated by reference to the Current Report on Form 8-K filed on March 24, 2025 as Exhibit 4.1 thereto. +4.37 +Form of Convertible Promissory Note. Incorporated by reference to the Current Report on Form 8-K filed on April 1, 2025 as Exhibit 4.1 thereto. +4.38 +Form of Convertible Promissory Note. Incorporated by reference to the Current Report on Form 8-K filed on April 9, 2025 as Exhibit 4.1 thereto. +4.39** +Description of Capital Stock. +10.1* +2021 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix B thereto . +10.2* +2021 Employee Stock Purchase Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on July 6, 2021 as Appendix C thereto. +10.3* +Form of Stock Option Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.3 thereto. +10.4* +Form of Restricted Stock Unit Grants. Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on August 26, 2021 as Exhibit 99.4 thereto. +10.5 +Form of Construction Loan Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.1 thereto. +10.6 +Form of Mortgage, Assignment of Rents and Leases, Security Agreement and Fixture Filing. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.2 thereto. +10.7 +Form of Assignment of Leases, Rents and Profits. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.3 thereto. +10.8 +Form of Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on December 23, 2021 as Exhibit 10.4 thereto. +10.9* +2022 Stock Incentive Plan. Incorporated by reference to the Company’s Definitive Proxy Statement on Form DEF 14A filed on September 23, 2022 as Annex B thereto . +10.10 +Form of Share Exchange Agreement, entered into February 8, 2023. Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.1 thereto. +10.11 +Form of Series B Preferred Stock Certificate of Designations. Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.2 thereto. +10.12 +Form of Series C Preferred Stock Certificate of Designations. Incorporated by reference to the Current Report on Form 8-K filed on February 10, 2023 as Exhibit 10.3 thereto. +10.13 +Form of Hyperscale Data, Inc. Investor Agreement relating to 7.00% Senior Notes due 2024, 8.50% Senior Notes due 2026 and 10.50% Senior Notes due 2028. Incorporated by reference to the Current Report on Form 8-K filed on September 1, 2023 as Exhibit 10.1 thereto. +10.14 +Securities Purchase Agreement, dated November 6, 2023, by and between Hyperscale Data, Inc. and Ault & Company, Inc. Incorporated by reference to the Current Report on Form 8-K filed on November 7, 2023 as Exhibit 10.1 thereto. +107 +Exhibit +Number +Description +10.15 +Form of Loan and Guaranty Agreement, dated December 14, 2023. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.1 thereto. +10.16 +Form of Security Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.2 thereto. +10.17 +Form of Security Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.3 thereto. +10.18 +Form of Michigan Mortgage. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.5 thereto. +10.19 +Form of Aircraft Mortgage. Incorporated by reference to the Current Report on Form 8-K filed on December 15, 2023 as Exhibit 10.6 thereto. +10.20 +Amendment to the Securities Purchase Agreement, Certificate of Designation and Series C Warrants, dated March 25, 2024. Incorporated by reference to the Current Report on Form 8-K filed on March 26, 2024 as Exhibit 10.3 thereto. +10.21 +Luxor Mining Pool Service Level Agreement, dated March 28, 2023, by and between Bitnile Inc. (n/k/a Sentinum Inc.) and Luxor Technology Corporation. Incorporated by reference to the Annual Report on Form 10-K filed on April 16, 2024 as Exhibit 10.28 thereto. +10.22 +Amendment to the Loan and Guaranty Agreement, dated April 15, 2024. Incorporated by reference to the Current Report on Form 8-K filed on April 16, 2024 as Exhibit 10.1 thereto. +10.23 +Form of Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on April 30, 2024 as Exhibit 10.1 thereto. +10.24 +Form of Second Amendment to Loan and Guaranty Agreement, dated May 15, 2024. Incorporated by reference to the Current Report on Form 8-K filed on May 16, 2024 as Exhibit 10.1 thereto. +10.25 +Form of Loan Agreement. Incorporated by reference to the Current Report on Form 8-K filed on June 5, 2024 as Exhibit 10.1 thereto. +10.26 +Form of Guaranty. Incorporated by reference to the Current Report on Form 8-K filed on June 5, 2024 as Exhibit 10.2 thereto. +10.27 +Purchase Agreement, dated June 20, 2024, by and between Hyperscale Data, Inc. and Orion Equity Partners, LLC. Incorporated by reference to the Current Report on Form 8-K filed on June 21, 2024 as Exhibit 10.1 thereto. +10.28 +Contract dated October 23, 2021 by and between Indiana Michigan Power Company and Alliance Cloud Services, a subsidiary of Hyperscale Data, Inc +10.29 +Amendment to the Securities Purchase Agreement, dated March 30, 2025, by and between the Company and Ault & Company, Inc. Incorporated by reference to the Current Report on Form 8-K filed on April1 , 2025 as Exhibit 10.1 thereto. +10.30 +First Supplement and Amendment dated November 1, 2024 by and among Hyperscale Data, Inc., Orion Equity Partners, LLC and Ascendiant Capital Markets, LLC. Incorporated by reference to the Current Report on Form 8-K filed on November 1, 2024 as Exhibit 10.1 thereto. +10.31 +Form of Forbearance Agreement. Incorporated by reference to the Current Report on Form 8-K filed on December 11, 2024 as Exhibit 10.1 thereto. +10.32 +Second Supplement and Amendment to Purchase Agreement dated January 9, 2025 by and among Hyperscale Data, Inc., Orion Equity Partners, LLC, Ascendiant Capital Markets, LLC and Northland Securities, Inc. Incorporated by reference to the Registration Statement on Form S-1/A filed on January 14, 2025 as Exhibit 10.40 thereto. +10.33 +First Amendment to Loan Agreement dated January 9, 2025 by and among Hyperscale Data, Inc., OREE Lending Company, LLC and Helios Funds LLC. Incorporated by reference to the Registration Statement on Form S-1/A filed on January 14, 2025 as Exhibit 10.41 thereto. +10.34 +Exchange Agreement, dated February 5, 2025, by and between the Company and the Investor. Incorporated by reference to the Current Report on Form 8-K filed on February 6, 2025 as Exhibit 10.1 thereto. +10.35 +Form of Amended and Restated Forbearance Agreement. Incorporated by reference to the Current Report on Form 8-K filed on February 26, 2025 as Exhibit 10.1 thereto. +10.36 +Exchange Agreement, dated March 14, 2025, by and between the Company and the Investor. Incorporated by reference to the Current Report on Form 8-K filed on March 17, 2025 as Exhibit 10.1 thereto. +10.37 +Exchange Agreement, dated March 21, 2025, by and between the Company and the Investor. Incorporated by reference to the Current Report on Form 8-K filed on March 24, 2025 as Exhibit 10.1 thereto. +10.38 +Amendment to the Securities Purchase Agreement, dated March 30, 2025, by and between the Company and Ault & Company, Inc. Incorporated by reference to the Current Report on Form 8-K filed on April1 , 2025 as Exhibit 10.1 thereto. +10.39 +Securities Purchase Agreement, dated March 31, 2025, by and between Hyperscale Data, Inc. and SJC Lending, LLC. Incorporated by reference to the Current Report on Form 8-K filed on April 1, 2025 as Exhibit 10.1 thereto. +10.40 +Registration Rights Agreement, dated March 31, 2025, by and between Hyperscale Data, Inc. and SJC Lending, LLC. Incorporated by reference to the Current Report on Form 8-K filed on April 1, 2025 as Exhibit 10.2 thereto. +19.1** +Insider Trading Policy of Hyperscale Data, Inc. +21** +List of subsidiaries. +31.1** +Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a). +108 +Exhibit +Number +Description +31.2** +Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a). +32.1*** +Certification of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. +97.1** +Hyperscale Data, Inc. Clawback Policy. Incorporated by reference to the Annual Report on Form 10-K filed on April 16, 2024 as Exhibit 97.2 thereto. +101.INS** +Inline XBRL Instance Document. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH** +Inline XBRL Taxonomy Extension Schema Document. +101.CAL** +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF** +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB** +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE** +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +* Indicates management contract or compensatory plan or arrangement. +** Filed herewith. +*** Furnished herewith. +ITEM 16. FORM 10–K SUMMARY +None. +109 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the +Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly +authorized. +Dated: April 15, 2025 +HYPERSCALE DATA, INC. +By: +/s/ William B. Horne +William B. Horne +Chief Executive Officer +(Principal Executive Officer) +By: +/s/ Kenneth S. Cragun +Kenneth S. Cragun +Chief Financial Officer +(Principal Financial and Accounting Officer) +Pursuant to the requirements of the Securities Exchange Act of +1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. +April 15, 2025 +/s/ Milton C. Ault, III +Milton C. Ault, III, Executive Chairman of the Board +April 15, 2025 +/s/ William B. Horne +William B. Horne, Chief Executive Officer and Director +April 15, 2025 +/s/ Henry Nisser +Henry Nisser, President, General Counsel and Director +April 15, 2025 +/s/ Robert O. Smith +Robert O. Smith, Director +April 15, 2025 +/s/ Mordechai Rosenberg +Mordechai Rosenberg, Director +April 15, 2025 +/s/ Jeffrey A. Bentz +Jeffrey A. Bentz, Director +110 +ITEM 8. FINANCIAL STATEMENTS +HYPERSCALE DATA, INC. AND SUBSIDIARIES +INDEX TO FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm – Marcum LLP (PCAOB ID Number 688 ) +F-2 +Consolidated Balance Sheets as of December 31, 2024 and 2023 +F-4 +Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2024 and 2023 +F-6 +Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2024 and 2023 +F-7 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2024 and 2023 +F-9 +Notes to Consolidated Financial Statements +F-11 +F- 1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Shareholders and Board of Directors of +Hyperscale Data, Inc. and Subsidiaries (f/k/a +Ault Alliance, Inc.) +Opinion on the Financial Statements +We have audited the accompanying consolidated +balance sheet s of Hyperscale Data, Inc. (the “Company”) (f/k/a Ault Alliance, Inc.) as of December 31, 2024, the related +consolidated statements of operations and comprehensive loss, changes in stockholders’ equity and cash flows for each of the two +years in the period ended December 31, 2024 and 2023, and the related notes (collectively referred to as the “financial statements”). +In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December +31, 2024, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2024 and 2023, +in conformity with accounting principles generally accepted in the United States of America. +Explanatory Paragraph – Going Concern +The accompanying consolidated financial statements +have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the Company has a significant +working capital deficiency, has incurred significant losses and needs to raise additional funds to meet its obligations and sustain its +operations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in +regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might +result from the outcome of this uncertainty. +Basis for Opinion +These financial statements are the responsibility +of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We +are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are +required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and +regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the +standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial +statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged +to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding +of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal +control over financial reporting. Accordingly, we express no such opinion. +Our audit included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond +to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. +Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating +the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matters communicated below +are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to +the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our +especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion +on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions +on the critical audit matters or on the accounts or disclosures to which they relate. +Evaluation +of the Accounting for and Disclosure of Bitcoin Mining Revenue +As disclosed in Note 3, the Company participates +in a digital asset mining pool by providing hash calculation services to the mining pool operator. During the years ended December 31, +2024 and 2023, the Company recognized revenue from bitcoin mining of approximately $30.6 million and $33.1 million, respectively. +F- 2 +We identified the auditing of revenue recognized +from bitcoin mining as a critical audit matter due to the nature and extent of audit effort required to perform audit procedures over +the completeness and occurrence of bitcoin mining revenue recognized by the Company. +The primary procedures we performed to address +this critical audit matter included the following: +· We performed site visits of the facilities where the Company’s mining hardware is located, which +included observations of the physical controls and mining equipment observation procedures. +· On a sample basis, we tested the hash calculation services contributed by the Company’s mining hardware. +· We performed certain substantive analytical procedures developing an expectation for the amount to be +recorded using hash calculation services data, the calculation prescribed in the contract with the mining pool operator and electricity +consumption data and comparing our expectation to the amount recorded by the Company. +· We evaluated and tested management’s valuation of bitcoin earned by obtaining independent bitcoin +prices and comparing those to the prices used by the Company. +· We obtained and evaluated the contract with the third-party mining pool operator and independently confirmed +with the third-party mining pool operator the significant contractual terms utilized in the determination of mining revenue, total mining +rewards earned, and the digital asset wallet addresses in which the rewards are deposited. +· We independently obtained evidence from the Bitcoin blockchain to test the occurrence and accuracy of +mining revenue. +/s/ Marcum llp +Marcum LLP +We have served as the Company’s auditor since 2016. +New York, New York +April 15, 2025 +F- 3 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +December 31, +2024 +2023 +ASSETS +CURRENT ASSETS +Cash and cash equivalents +$ 4,546,000 +$ 6,106,000 +Restricted cash +20,476,000 +4,962,000 +Accounts receivable, net +6,165,000 +6,736,000 +Inventories +1,817,000 +1,790,000 +Investment in promissory notes and other, related party +20,802,000 +3,968,000 +Loans receivable, current +1,369,000 +1,234,000 +Prepaid expenses and other current assets +3,238,000 +5,247,000 +Current assets of discontinued operations +- +32,367,000 +TOTAL CURRENT ASSETS +58,413,000 +62,410,000 +Cash and marketable securities held in trust account +- +2,200,000 +Intangible assets, net +1,844,000 +4,047,000 +Property and equipment, net +144,357,000 +195,666,000 +Right-of-use assets +3,697,000 +3,409,000 +Investments in common stock and equity securities, related party +2,190,000 +679,000 +Investments in other equity securities +2,802,000 +21,767,000 +Other assets +7,463,000 +9,012,000 +TOTAL ASSETS +$ 220,766,000 +$ 299,190,000 +LIABILITIES AND STOCKHOLDERS’ EQUITY +CURRENT LIABILITIES +Accounts payable and accrued expenses +$ 59,475,000 +$ 55,422,000 +Operating lease liability, current +1,627,000 +1,376,000 +Notes payable, current +95,768,000 +11,692,000 +Notes payable, related party, current +164,000 +2,375,000 +Convertible notes payable, current +19,569,000 +7,375,000 +Guarantee liability +38,900,000 +38,900,000 +Current liabilities of discontinued operations +- +22,664,000 +TOTAL CURRENT LIABILITIES +215,503,000 +139,804,000 +LONG TERM LIABILITIES +Operating lease liability, non-current +2,269,000 +2,163,000 +Notes payable, non-current +904,000 +85,420,000 +Convertible notes payable, non-current +- +9,453,000 +Deferred underwriting commissions of Ault Disruptive Technologies Corporation (“Ault Disruptive”) subsidiary +- +3,450,000 +TOTAL LIABILITIES +218,676,000 +240,290,000 +The accompanying notes are an integral part of these consolidated +financial statements. +F- 4 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS (continued) +December 31, +December 31, +2024 +2023 +COMMITMENTS AND CONTINGENCIES +Redeemable non-controlling interests in equity of subsidiaries +- +2,224,000 +STOCKHOLDERS’ EQUITY +Preferred stock, $ 0.001 par value - +25,000,000 shares authorized; 2,029,450 and 473,737 +shares issued and outstanding at December 31, 2024 and December 31, 2023, respectively (liquidation preference of $ 75,521,000 +as of December 31, 2024) +2,000 +- +Class A Common Stock, $ 0.001 par value – 500,000,000 shares authorized; 1,259,893 and 127,322 shares issued and outstanding at December 31, 2024 and December 31, 2023, respectively +1,000 +- +Class B Common Stock, $ 0.001 par value – 25,000,000 shares authorized; 4,998,597 and 0 shares issued and outstanding at December 31, 2024 and December 31, 2023 +5,000 +- +Additional paid-in capital +668,817,000 +644,856,000 +Accumulated deficit +( 628,950,000 ) +( 567,469,000 ) +Accumulated other comprehensive loss +( 668,000 ) +( 2,097,000 ) +Treasury stock, at cost +( 30,571,000 ) +( 30,571,000 ) +TOTAL HYPERSCALE DATA STOCKHOLDERS’ EQUITY +8,636,000 +44,719,000 +Non-controlling interest +( 6,546,000 ) +11,957,000 +TOTAL STOCKHOLDERS’ EQUITY +2,090,000 +56,676,000 +TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY +$ 220,766,000 +$ 299,190,000 +The accompanying notes are an integral part of these consolidated +financial statements. +F- 5 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS +For the Year Ended +December 31, +2024 +2023 +Revenue, crane operations +$ 47,475,000 +$ 49,198,000 +Revenue, crypto assets mining +30,598,000 +33,107,000 +Revenue, hotel and real estate operations +18,891,000 +17,577,000 +Revenue, lending and trading activities +1,893,000 +( 1,998,000 ) +Revenue, other +7,805,000 +36,962,000 +Total revenue +106,662,000 +134,846,000 +Cost of revenue, crane operations +30,745,000 +29,971,000 +Cost of revenue, crypto assets mining +34,338,000 +36,446,000 +Cost of revenue, hotel and real estate operations +12,928,000 +12,300,000 +Cost of revenue, lending and trading activities +( 1,205,000 ) +1,180,000 +Cost of revenue, other +5,639,000 +30,165,000 +Total cost of revenue +82,445,000 +110,062,000 +Gross profit +24,217,000 +24,784,000 +Operating expenses +Research and development +11,011,000 +4,418,000 +Selling and marketing +14,019,000 +31,653,000 +General and administrative +35,245,000 +68,200,000 +Impairment of property and equipment +19,446,000 +26,445,000 +Impairment of goodwill and intangible assets +1,500,000 +42,880,000 +Impairment of mined crypto assets +- +489,000 +Total operating expenses +81,221,000 +174,085,000 +Loss from operations +( 57,004,000 ) +( 149,301,000 ) +Other income (expense): +Interest and other income +2,236,000 +4,444,000 +Interest expense +( 19,671,000 ) +( 44,314,000 ) +Other expense, guarantee +- +( 35,400,000 ) +Gain on conversion of investment in equity securities to marketable equity securities +17,900,000 +- +Gain (loss) on extinguishment of debt +2,981,000 +( 7,322,000 ) +Loss on extinguishment of debt, related party +- +( 4,164,000 ) +Loss from investment in unconsolidated entity +( 1,958,000 ) +( 302,000 ) +Loss on deconsolidation of subsidiary +- +( 3,040,000 ) +Impairment of equity securities +( 6,266,000 ) +( 9,555,000 ) +Change in fair value of warrant liability +- +6,319,000 +Gain on the sale of fixed assets +79,000 +2,069,000 +Total other expense, net +( 4,699,000 ) +( 91,265,000 ) +Loss before income taxes +( 61,703,000 ) +( 240,566,000 ) +Income tax provision +56,000 +348,000 +Net loss from continuing operations +( 61,759,000 ) +( 240,914,000 ) +Net loss from discontinued operations +( 779,000 ) +( 12,355,000 ) +Net loss +( 62,538,000 ) +( 253,269,000 ) +Net loss attributable to non-controlling interest +6,334,000 +22,242,000 +Net loss attributable to Hyperscale Data, Inc. +( 56,204,000 ) +( 231,027,000 ) +Preferred dividends +( 5,277,000 ) +( 1,375,000 ) +Net loss available to common stockholders +$ ( 61,481,000 ) +$ ( 232,402,000 ) +Basic and diluted net loss per common share: +Continuing operations +$ ( 67.23 ) +$ ( 2,075.91 ) +Discontinued operations +( 0.86 ) +( 116.56 ) +Net loss per common share +$ ( 68.09 ) +$ ( 2,192.47 ) +Weighted average basic and diluted common shares outstanding +903,000 +106,000 +Comprehensive loss +Net loss available to common stockholders +$ ( 61,481,000 ) +$ ( 232,402,000 ) +Foreign currency translation adjustment +( 66,000 ) +( 698,000 ) +Other comprehensive loss +( 66,000 ) +( 698,000 ) +Total comprehensive loss +$ ( 61,547,000 ) +$ ( 233,100,000 ) +The accompanying notes are an integral part of these consolidated +financial statements. +F- 6 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Preferred Stock +Class A +Class B +Accumulated +Series A +Series C +Series D +Series E +Series F +Common Stock +Common Stock +Additional +Other +Total +Shares +Par +Amount +Shares +Par +Amount +Shares +Par +Amount +Shares +Par +Amount +Shares +Par +Amount +Shares +Amount +Shares +Amount +Paid-In +Capital +Accumulated +Deficit +Comprehensive +Loss +Non-Controlling +Interest +Treasury +Stock +Stockholders’ +Equity +BALANCES, January 1, 2024 +7,040 +$ - - +41,500 +$ - +425,197 +$ - +- +$ - +- +$ - +127,322 +$ - +- +$ - +$ 644,856,000 +$ ( 567,469,000 ) +$ ( 2,097,000 ) +$ 11,957,000 +$ ( 30,571,000 ) +$ 56,676,000 +Issuance of Series C preferred stock, related party for cash +- +- +8,500 +- +- +- +- +- +- +- +- +- +- +- +8,123,000 +- +- +- +- +8,123,000 +Fair value of warrants issued in connection with Series C preferred stock, related party +- +- +- +- +- +- +- +- +- +- +- +- +- +- +377,000 +- +- +- +- +377,000 +Class B common stock dividend +- +- +- +- +- +- +- +- +- +- +- +- +4,998,597 +5,000 +( 5,000 ) +- +- +- +- +- +Series E preferred stock dividend +- +- +- +- +- +- +649,998 +1,000 +- +- +- +- +- +- +( 1,000 ) +- +- +- +- +- +Series F preferred stock dividend +- +- +- +- +- +- +- +- +998,577 +1,000 +- +- +- +- +( 1,000 ) +- +- +- +- +- +Stock-based compensation +- +- +- +- +- +- +- +- +- +- +- +- +- +- +1,505,000 +- +- +- +- +1,505,000 +Issuance of Class A common stock for cash +- +- +- +- +- +- +- +- +- +- +731,686 +1,000 +- +- +14,597,000 +- +- +- +- +14,598,000 +Financing cost in connection with sales of Class A common stock +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 513,000 ) +- +- +- +- +( 513,000 ) +Issuance of Class A common stock for conversion of debt +- +- +- +- +- +- +- +- +- +- +400,885 +- +- +- +4,779,000 +- +- +- +- +4,779,000 +Increase in ownership interest of subsidiary +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 893,000 ) +- +( 893,000 ) +Sale of subsidiary stock to non-controlling interests +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +1,898,000 +- +1,898,000 +Financing cost in connection with sale of subsidiary stock to non-controlling interests +( 2,600,000 ) +( 2,600,000 ) +Conversion of RiskOn International, Inc. (“ROI”) convertible note +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +863,000 +- +863,000 +Net loss attributable to Hyperscale Data, Inc. +- +- - +- +- +- +- +- +- +- +- +- +- +- +- +- +( 56,204,000 ) +- +- +- +( 56,204,000 ) +Series A preferred dividends ($1.88 per share) +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 18,000 ) +- +- +- +( 18,000 ) +Series C preferred dividends ($71.22 per share) +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 4,207,000 ) +- +- +- +( 4,207,000 ) +Series D preferred dividends ($2.44 per share) +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 1,052,000 ) +- +- +- +( 1,052,000 ) +Foreign currency translation adjustments +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 66,000 ) +- +- +( 66,000 ) +Net loss attributable to non-controlling interest +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 6,334,000 ) +- +( 6,334,000 ) +Distribution of securities of TurnOnGreen, Inc. (TurnOnGreen”) to Hyperscale Data Class A common stockholders ($5.70 per share) +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 4,900,000 ) +- +- +4,900,000 +- +- +Distribution of ROI investment in White River Holdings Corp. (“White River”) to ROI stockholders +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 19,210,000 ) +- +( 19,210,000 ) +Net loss attributable to non-controlling interest of deconsolidated subsidiary +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 1,555,000 ) +- +( 1,555,000 ) +Deconsolidation of subsidiary +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +1,495,000 +4,428,000 +- +5,923,000 +Other +- +- +- +- +( 101,362 ) +- +- +- +- +- +- +- +- +- +- +- +- +- +- +- +BALANCES, December 31, 2024 +7,040 +$ - - +50,000 +$ - +323,835 +$ - +649,998 +$ 1,000 +998,577 +$ 1,000 +1,259,893 +$ 1,000 +4,998,597 +$ 5,000 +$ 668,817,000 +$ ( 628,950,000 ) +$ ( 668,000 ) +$ ( 6,546,000 ) +$ ( 30,571,000 ) +$ 2,090,000 +The accompanying notes are an integral part of these consolidated +financial statements. +F- 7 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ +EQUITY +Accumulated +Preferred Stock +Additional +Other +Total +Series A +Series B +Series C +Series D +Class A Common Stock +Paid-In +Accumulated +Comprehensive +Non-Controlling +Treasury +Stockholders’ +Shares +Par Amount +Shares +Par Amount +Shares +Par Amount +Shares +Par Amount +Shares +Amount +Capital +Deficit +Loss +Interest +Stock +Equity +BALANCES, January 1, 2023 +7,040 +$ - +125,000 +$ - +- +$ - +172,838 +$ - +1,456 +$ - +$ 565,905,000 +$ ( 329,078,000 ) +$ ( 1,100,000 ) +$ 17,496,000 +$ ( 29,235,000 ) +$ 223,988,000 +Issuance of Class A common stock for restricted stock awards +- +- +- +- +- +- +- +- +6 +- +- +- +- +- +- +- +Issuance of Series C preferred stock, related party +- +- +- +- +41,500 +- +- +- +- +- +27,042,000 +- +- +- +- +27,042,000 +Fair value of warrants issued in connection with Series C preferred stock, related party +- +- +- +- +- +- +- +- +- +- +10,958,000 +- +- +- +- +10,958,000 +Series C preferred stock issuance costs +- +- +- +- +- +- +- +- +- +- +( 500,000 ) +- +- +- +- +( 500,000 ) +Issuance of Series D preferred stock +- +- +- +- +- +- +252,359 +- +- +- +2,982,000 +- +- +- +- +2,982,000 +Series D preferred stock offering costs +- +- +- +- +- +- +- +- +- +- +( 105,000 ) +- +- +- +- +( 105,000 ) +Series B preferred stock exchanged for convertible note, related party +- +- +( 125,000 ) +- +- +- +- +- +- +- +( 1,190,000 ) +- +- +- +- +( 1,190,000 ) +Stock-based compensation +- +6,615,000 +- +- +4,253,000 +- +10,868,000 +Issuance of Class A common stock for cash +- +- +- +- +- +- +- +- +124,010 +- +39,415,000 +- +- +- +- +39,415,000 +Financing cost in connection with sales of Class A common stock +- +- +- +- +- +- +- +- +- +- +( 1,344,000 ) +- +- +- +- +( 1,344,000 ) +Issuance of Class A common stock for conversion of preferred stock liabilities +- +- +- +- +- +- +- +- +164 +- +912,000 +- +- +- +- +912,000 +Issuance of Class A common stock for conversion of debt +- +- +- +- +- +- +- +- +2,418 +- +527,000 +- +- +- +- +527,000 +Class A common stock issued in connection with issuance of notes payable +- +- +- +- +- +- +- +- +45 +- +162,000 +- +- +- +- +162,000 +Warrants issued in connection with issuance of convertible notes payable, related party +- +- +- +- +- +- +- +- +- +- +4,164,000 +- +- +- +- +4,164,000 +Remeasurement of Ault Disruptive subsidiary temporary equity +- +- +- +- +- +- +- +- +- +- +- +( 5,990,000 ) +- +- +- +( 5,990,000 ) +Increase in ownership interest of subsidiary +- +- +- +- +- +- +- +- +- +- +13,000 +- +- +( 1,086,000 ) +- +( 1,073,000 ) +Non-controlling interest in ROI subsidiary acquired +- +- +- +- +- +- +- +- +- +- +- +- +- +6,357,000 +- +6,357,000 +Non-controlling interest in Eco Pack Technologies Limited (“Eco Pack”) subsidiary acquired +- +- +- +- +- +- +- +- +- +- +- +- +- +856,000 +- +856,000 +Sale of subsidiary stock to non-controlling interests +- +- +- +- +- +- +- +- +- +- +- +- +- +7,342,000 +- +7,342,000 +Distribution to Circle 8 Crane Services, LLC (“Circle 8”) non-controlling interest +- +- +- +- +- +- +- +- +- +- +- +- +- +( 729,000 ) +- +( 729,000 ) +Deconsolidation of Algorhythm Holdings, Inc. (f/k/a The Singing Machine Company) (“SMC”) +- +- +- +- +- +- +- +- +- +- +- +- +- +( 7,966,000 ) +- +( 7,966,000 ) +Purchase of treasury stock - Ault Alpha LP (“Ault Alpha”) +- +- +- +- +- +- +- +- +- +- +- +- +- +- +( 1,336,000 ) +( 1,336,000 ) +Net loss +- +- +- +- +- +- +- +- +- +- +- +( 231,026,000 ) +- +- +- +( 231,026,000 ) +Series A preferred dividends ($2.50 per share) +( 18,000 ) +( 18,000 ) +Series D preferred dividends ($3.25 per share) +- +- +- +- +- +- +- +( 1,107,000 ) +- +- +- +( 1,107,000 ) +Foreign currency translation adjustments +- +- +- +- +- +- +- +- +- +- +- +- +( 997,000 ) +- +- +( 997,000 ) +Net loss attributable to non-controlling interest +- +- +- +- +- +- +- +- +- +- +- +- +- +( 25,268,000 ) +- +( 25,268,000 ) +Distribution of securities of TurnOnGreen to Hyperscale Data Class A common stockholders ($1,770 per share) +- +- +- +- +- +- +- +- +- +- +( 10,700,000 ) +- +- +10,700,000 +- +- +Other +- +- +- +- +- +- +- +- +( 777 ) +- +- +( 250,000 ) +- +2,000 +- +( 248,000 ) +BALANCES, December 31, 2023 +7,040 +$ - +- +$ - +41,500 +$ - +425,197 +$ - +127,322 +$ - +$ 644,856,000 +$ ( 567,469,000 ) +$ ( 2,097,000 ) +$ 11,957,000 +$ ( 30,571,000 ) +$ 56,676,000 +The accompanying notes are an integral part of these consolidated +financial statements. +F- 8 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +For the Year Ended December 31, +2024 +2023 +Cash flows from operating activities: +Net loss +$ ( 62,538,000 ) +$ ( 253,269,000 ) +Net loss from discontinued operations +( 779,000 ) +( 12,355,000 ) +Net loss from continuing operations +( 61,759,000 ) +( 240,914,000 ) +Adjustments to reconcile net loss to net cash used in operating activities: +Depreciation and amortization +24,437,000 +27,952,000 +Amortization of debt discount +7,773,000 +21,899,000 +Amortization of right-of-use assets +1,743,000 +1,878,000 +Other expense, guarantee +- +35,400,000 +Impairment of goodwill and intangible assets +1,500,000 +42,880,000 +Stock-based compensation +3,256,000 +9,069,000 +Gain on the sale of fixed assets +( 79,000 ) +( 2,069,000 ) +Impairment of property and equipment +19,446,000 +26,445,000 +Impairment of equity securities +8,616,000 +15,755,000 +Impairment of crypto assets +- +489,000 +Realized gains on the sale of crypto assets +( 684,000 ) +( 520,000 ) +Change in fair value of crypto assets +( 29,000 ) +- +Revenue, crypto assets mining +( 24,960,000 ) +( 33,107,000 ) +Proceeds from the sale of crypto assets +25,350,000 +29,111,000 +Realized gains on sale of marketable securities +( 8,173,000 ) +( 8,437,000 ) +Gain on conversion of investment in equity securities to marketable equity securities +( 17,900,000 ) +- +Unrealized losses (gains) on marketable securities +418,000 +( 2,509,000 ) +Realized losses on non-marketable equity securities +5,083,000 +- +Unrealized losses on investments in common stock, related parties +598,000 +5,785,000 +Income from cash held in trust +( 41,000 ) +( 2,590,000 ) +Loss from investment in unconsolidated entity +1,957,000 +302,000 +Gain from reversal of deferred underwriting commissions of Ault Disruptive subsidiary +( 3,450,000 ) +- +(Benefit) provision for loan losses +( 1,205,000 ) +1,180,000 +Change in the fair value of warrant liability +- +( 4,544,000 ) +(Gain) loss on extinguishment of debt +( 2,981,000 ) +12,883,000 +Loss on deconsolidation of subsidiary +- +3,040,000 +Other +( 2,721,000 ) +( 1,173,000 ) +Changes in operating assets and liabilities: +- +Marketable equity securities +11,457,000 +46,457,000 +Accounts receivable +316,000 +( 1,555,000 ) +Inventories +( 36,000 ) +2,517,000 +Prepaid expenses and other current assets +948,000 +4,277,000 +Other assets +( 2,609,000 ) +( 3,232,000 ) +Accounts payable and accrued expenses +2,409,000 +15,566,000 +Lease liabilities +( 1,725,000 ) +( 2,075,000 ) +Net cash (used in) provided by operating activities from continuing operations +( 13,045,000 ) +160,000 +Net cash used in operating activities from discontinued operations +( 6,366,000 ) +( 5,588,000 ) +Net cash used in operating activities +( 19,411,000 ) +( 5,428,000 ) +Cash flows from investing activities: +Purchase of property and equipment +( 4,828,000 ) +( 14,742,000 ) +Cash decrease upon deconsolidation of subsidiary +- +( 6,285,000 ) +Acquisition of non-controlling interests +- +( 1,072,000 ) +Investments in loans receivable +( 1,034,000 ) +( 501,000 ) +Investments in non-marketable equity securities +- +( 10,952,000 ) +Proceeds from the sale of fixed assets +12,957,000 +4,515,000 +Investment in notes receivable, related party +- +( 3,934,000 ) +Other +( 109,000 ) +( 210,000 ) +Net cash provided by (used in) investing activities from continuing operations +6,986,000 +( 33,181,000 ) +Net cash (used in) provided by investing activities from discontinued operations +( 3,799,000 ) +3,663,000 +Net cash provided by (used in) investing activities +3,187,000 +( 29,518,000 ) +The accompanying notes are an integral part of these consolidated +financial statements. +F- 9 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) +For the Year Ended December 31, +2024 +2023 +Cash flows from financing activities: +Gross proceeds from sales of Class A common stock +$ 14,598,000 +$ 39,415,000 +Financing cost in connection with sales of Class A common stock +( 513,000 ) +( 1,344,000 ) +Proceeds from sales of Series D preferred stock +- +2,983,000 +Financing cost in connection with sales of Series D preferred stock +- +( 105,000 ) +Proceeds from sales of Series C preferred stock and warrants, related party +8,500,000 +3,841,000 +Financing cost in connection with sales of Series C preferred stock, related party +- +( 500,000 ) +Proceeds from subsidiaries’ sale of stock to non-controlling interests +1,898,000 +7,342,000 +Distribution to Circle 8 non-controlling interest +- +( 729,000 ) +Proceeds from notes payable +60,948,000 +91,461,000 +Proceeds from convertible notes payable, related party +- +4,625,000 +Proceeds from notes payable, related party +- +2,337,000 +Repayment of margin accounts +- +( 767,000 ) +Payments on notes payable +( 60,172,000 ) +( 116,349,000 ) +Payments on convertible notes payable, related party +( 243,000 ) +( 150,000 ) +Payments on notes payable, related party +( 1,864,000 ) +( 314,000 ) +Payments of preferred dividends +( 5,277,000 ) +( 1,375,000 ) +Purchase of treasury stock +- +( 1,336,000 ) +Proceeds from sales of convertible notes +6,700,000 +5,165,000 +Payments on convertible notes +( 1,280,000 ) +( 1,022,000 ) +Net cash provided by financing activities from continuing operations +23,295,000 +33,178,000 +Net cash provided by financing activities from discontinued operations +2,552,000 +3,858,000 +Net cash provided by financing activities +25,847,000 +37,036,000 +Effect of exchange rate changes on cash and cash equivalents from continuing operations +30,000 +( 776,000 ) +Net increase in cash and cash equivalents and restricted cash +9,653,000 +1,314,000 +Cash and cash equivalents and restricted cash at beginning of period - continuing operations +11,068,000 +11,860,000 +Cash and cash equivalents and restricted cash at beginning of period - discontinued operations +4,301,000 +2,195,000 +Cash and cash equivalents and restricted cash at beginning of period +15,369,000 +14,055,000 +Cash and cash equivalents and restricted cash at end of period +25,022,000 +15,369,000 +Less cash and cash equivalents and restricted cash of discontinued operations at end of period +- +( 4,301,000 ) +Cash and cash equivalents and restricted cash of continued operations at end of period +$ 25,022,000 +$ 11,068,000 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest - continuing operations +$ 10,721,000 +$ 3,966,000 +Cash paid during the period for interest - discontinued operations +$ - +$ 778,000 +Non-cash investing and financing activities: +Settlement of accounts payable with crypto assets +$ 39,000 +$ 28,000 +Settlement of interest payable with crypto assets +$ 142,000 +$ - +Settlement of note payable with crypto assets +$ 506,000 +$ - +Offset of fees receivable against note payable +$ 2,200,000 +$ - +Conversion of convertible notes payable into shares of Class A common stock +$ 4,780,000 +$ - +Conversion of convertible notes payable, related party into shares of Class A common stock +$ - +$ 400,000 +Conversion of debt and equity securities to marketable securities +$ 4,996,000 +$ 23,703,000 +Conversion of loans receivable to marketable securities +$ - +$ 5,430,000 +Exchange of related party advances for investment in other equity securities, related party +$ 2,000,000 +$ - +Recognition of new operating lease right-of-use assets and lease liabilities +$ 2,080,000 +$ 4,372,000 +Remeasurement of Ault Disruptive temporary equity +$ - +$ 5,990,000 +Preferred stock exchanged for notes payable +$ - +$ 9,224,000 +Notes payable exchanged for convertible notes payable +$ - +$ - +Notes payable exchanged for notes payable, related party +$ - +$ 11,645,000 +Dividend of ROI investment in White River to ROI shareholders +$ 19,210,000 +$ - +Redeemable non-controlling interests in equity of subsidiaries paid with cash and marketable securities held in trust account +$ 2,225,000 +$ 120,064,000 +Dividend paid in TurnOnGreen common stock in additional paid-in capital +$ 4,900,000 +$ 10,700,000 +Exchange of notes payable for preferred stock liabilities +$ - +$ 8,437,000 +Exchange of notes payable for preferred stock, related party +$ - +$ 20,194,000 +Exchange of convertible notes payable for preferred stock, related party +$ - +$ 17,370,000 +Exchange of preferred stock for convertible notes payable, related party +$ - +$ 1,250,000 +Accrued ROI commitment shares payable to non-controlling interests +$ 2,600,000 +$ - +The accompanying notes are an integral part of these consolidated +financial statements. +F- 10 +HYPERSCALE DATA, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2024 +1. DESCRIPTION OF BUSINESS +Hyperscale Data, Inc. (f/k/a Ault Alliance, +Inc.), a Delaware corporation (“Hyperscale Data” or the “Company”) is a diversified holding company pursuing growth +by acquiring and developing undervalued businesses and disruptive technologies with a global impact. Through its wholly- and majority-owned +subsidiaries and strategic investments, the Company owns and/or operates data centers at which it mines Bitcoin and offers colocation +and hosting services for the emerging artificial intelligence (“AI”) ecosystems and other industries, and provides products +and services that support a diverse range of industries, including crane rental services, hotel operations, defense, industrial, an AI +software platform and a social gaming platform. In addition, the Company extends credit to select entrepreneurial businesses through a +licensed lending subsidiary. +The Company has the following reportable +segments: +· Energy and Infrastructure (“Energy”) – crane operations; +· Technology and Finance (“Fintech”) – commercial lending, activist investing, and stock +trading; +· Sentinum, Inc. (“Sentinum”) – crypto assets mining operations and colocation and hosting +services for the emerging artificial intelligence ecosystems and other industries; +· TurnOnGreen – commercial electronics solutions; +· ROI – AI software platform and a social gaming platform; and +· Ault Global Real Estate Equities, Inc. (“AGREE”) – hotel operations and other commercial +real estate holdings. +The Company had changes to its reportable segments due to the discontinued +operations of its majority - owned subsidiary, Gresham +Worldwide, Inc. (“GIGA”), and the deconsolidation of its previously consolidated variable interest entity, SMC. See Note 4 +and Note 15 below. +On September 10, 2024, the Company changed +its name from Ault Alliance, Inc. to Hyperscale Data, Inc. and its Class A common stock ticker symbol was changed to “GPUS.” +The name change did not affect the rights of security holders of the Company. +Reverse Stock Splits +All share amounts in these financial statements +have been updated to reflect a 1-for-25 reverse stock split and a 1-for-35 reverse stock split, effective January 16, 2024 and November +22, 2024, respectively. The reverse stock splits did not affect the number of authorized shares of Class A common stock, preferred stock +or their respective par value per share. +2. LIQUIDITY, GOING CONCERN AND MANAGEMENT’S PLANS +As of December 31, 2024, the Company had +cash and cash equivalents of $ 4.5 million (excluding restricted cash of $20.5 million), negative working capital of $ 157.1 million +and a history of net operating losses. The Company has financed its operations principally through issuances of convertible debt, promissory +notes and equity securities. These factors create substantial doubt about the Company’s ability to continue as a going concern for +at least one year after the date that these consolidated financial statements are issued. +The consolidated financial statements do +not include any adjustments that might be necessary if the Company is unable to continue as a going concern. Accordingly, the consolidated +financial statements have been prepared on a basis that assumes the Company will continue as a going concern and which contemplates the +realization of assets and satisfaction of liabilities and commitments in the ordinary course of business. +In making this assessment management performed +a comprehensive analysis of the Company’s current circumstances, including its financial position, cash flow and cash usage forecasts, +as well as obligations and debts. Although management has a long history of successful capital raises, the analysis used to determine +the Company’s ability as a going concern does not include cash sources beyond the Company’s direct control that management +expects to be available within the next 12 months. +F- 11 +Management expects that the Company’s +existing cash and cash equivalents, accounts receivable and marketable securities as of December 31, 2024, will not be sufficient to enable +the Company to fund its anticipated level of operations through one year from the date these financial statements are issued. Management +anticipates raising additional capital through the private and public sales of the Company’s equity or debt securities and selling +its marketable securities as well as crypto assets, or a combination thereof. Although management believes that such capital sources will +be available, there can be no assurances that financing will be available to the Company when needed in order to allow the Company to +continue its operations, or if available, on terms acceptable to the Company. If the Company does not raise sufficient capital in a timely +manner, among other things, the Company may be forced to scale back or cease its operations altogether. +3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES +Basis of Presentation +The accompanying consolidated financial +statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). +Prior Period Revision - Statement of Cash Flows +For the year ended December 31, 2024, the +Company disclosed the borrowings of lines of credit and repayments of lines of credit as separate line items within notes payable activity +of the financing activities section of the consolidated statement of cash flows. The Company has corrected these line items for the year +ended December 31, 2023 for comparability purposes. +Principles of Consolidation +The consolidated financial statements include +the accounts of Hyperscale Data and its wholly owned and majority-owned subsidiaries. The consolidated financial statements also include +the accounts of all entities that the Company controls as the primary beneficiary of a variable interest entity (“VIE”). All +intercompany accounts and transactions have been eliminated upon consolidation. +The accounting guidance requires an enterprise +to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest +in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE; to eliminate +the solely quantitative approach previously required for determining the primary beneficiary of a VIE; to add an additional reconsideration +event for determining whether an entity is a VIE when any changes in facts and circumstances occur such that holders of the equity investment +at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that +most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide readers of financial +statements with more transparent information about an enterprise’s involvement in a VIE. +Variable Interest Entities +For VIEs, the Company assesses whether it +is the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. +The Company evaluates its business relationships +with related parties to identify potential VIEs under Accounting Standards Codification (“ASC”) 810, Consolidation . +The Company consolidates VIEs of which the Company is considered to be the primary beneficiary. Entities are considered to be the primary +beneficiary if they have both of the following characteristics: (i) the power to direct the activities that, when taken together, most +significantly impact the VIE’s performance; and (ii) the obligation to absorb losses and right to receive the returns from the VIE +that would be significant to the VIE. The Company’s judgment with respect to its level of influence or control of an entity involves +the consideration of various factors including the form of its ownership interest, its representation in the entity’s governance, +the size of its investment, estimates of future cash flows, its ability to participate in policy making decisions and the rights of the +other investors to participate in the decision making process and to replace the Company as manager and/or liquidate the joint venture, +if applicable. +F- 12 +Revenue Recognition +The Company recognizes revenue under ASC +606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 is that a company should recognize +revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company +expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve that core principle: +· Step 1: Identify the contract with the customer; +· Step 2: Identify the performance obligations in the contract; +· Step 3: Determine the transaction price; +· Step 4: Allocate the transaction price to the performance obligations +in the contract; and +· Step 5: Recognize revenue when the company satisfies a performance +obligation. +Sales of Products +The Company generates revenues from the +sale of its products through a direct and indirect sales force. The Company’s performance obligations to deliver products are +satisfied at the point in time when title transfers to the customer. Generally, products are shipped FOB shipping point and title transfers +to the customer at the time the products are placed on a common carrier. The Company provides standard assurance warranties, which are +not separately priced, that the products function as intended. The Company primarily receives fixed consideration for sales of products. +Some of the Company’s contracts with distributors include stock rotation rights after six months for slow-moving inventory, which +represents variable consideration. The Company uses an expected value method to estimate variable consideration and constrains revenue +for estimated stock rotations until it is probable that a significant reversal in the amount of cumulative revenue recognized will not +occur. To date, returns have been insignificant. The Company’s customers generally pay within 30 days from the receipt of an invoice. +Because the Company’s product sales +agreements have an expected duration of one year or less, the Company has elected to adopt the practical expedient in ASC 606-10-50-14(a) +of not disclosing information about its remaining performance obligations. +Lending and Trading Activities +Lending Activities +The Fintech segment, through Ault Lending, LLC (“Ault +Lending”), generates revenue from lending activities primarily through interest, origination fees and late/other fees. Interest +income on these products is calculated based on the contractual interest rate and recorded as interest income as earned. The origination +fees or original issue discounts (“OIDs”) are recognized over the life of the loan using the effective interest method. +Trading Activities +The Fintech segment, through Ault Lending, also generates +revenue from trading activities primarily through sales of securities and unrealized gains and losses from held securities. All investment +transactions are recorded on a trade date basis. Financial instruments utilized in trading activities are carried at fair value. For more +information on fair value, see Note 7. Fair Value of Financial Instruments. Trading-related revenue can be volatile and is largely driven +by general market conditions. Also, trading-related revenue is dependent on the volume and type of transactions, the level of risk assumed, +and the volatility of price and rate movements at any given time within the ever-changing market environment. Realized and unrealized +gains and losses are recognized in revenue from trading activities. +Crypto Assets Mining +The Company has entered into a crypto assets +mining pool by executing a contract with a mining pool operator to provide hash calculation services to the mining pool. The Company’s +customer, as defined in ASC 606-10-20, is the mining pool operator with which the Company has agreed to the terms of service and user +service agreement. The Company supplies hash calculation services, in exchange for consideration, to the pool operator who in turn provides +transaction verification services to third parties via a mining pool that includes other participants. The Company’s performance +obligation is the provision of hash calculation services to the pool operator and this performance obligation is an output of the Company’s +ordinary activities for which it decides when to provide services under the contract. +The Company’s enforceable right to +compensation begins only when, and lasts as long as, the Company provides hash calculation services to the mining pool operator and is +created as power is provided over time. The only consideration due to the Company relates to the provision of hash calculation services. +The contract with the pool operator provides both parties the unilateral enforceable right to terminate the contract at any time without +penalty. The customer termination option results in a contract that continuously renews throughout the day and therefore has a duration +of less than 24 hours. The implied renewal option is not a material right because there are no upfront or incremental fees in the initial +contract and the terms, conditions, and compensation amount for the renewal options are at the then market rates. Providing such hash +calculation services is the only performance obligation in the Company’s contracts with mining pool operators. +F- 13 +The transaction consideration the Company +receives, if any, is non-cash consideration in the form of Bitcoin. Changes in the fair value of the non-cash consideration due to form +of the consideration (changes in the market price of Bitcoin) are not included in the transaction price and are therefore not included +in revenue. The mining pool operator charges fees to cover the costs of maintaining the pool and are deducted from amounts the Company +may otherwise earn and are treated as a reduction to the consideration earned. Fees fluctuate and historically have been approximately +0.3% per reward earned, on average. +The Company participated in mining pools +that used the full pay-per-share (“FPPS”) payout method for the year ended December 31, 2024. The Company is entitled to compensation +once it begins to perform hash calculations for the pool operator in accordance with the operator’s specifications over a 24-hour +period beginning midnight UTC and ending 23:59:59 UTC on a daily basis. The non-cash consideration that the Company is entitled to for +providing hash calculations to the pool operator under the FPPS payout method is made up of block rewards and transaction fees less pool +operator fees determined as follows: +· The non-cash consideration in the form of a block reward is based on the total blocks expected to be generated +on the Bitcoin network for the daily 24-hour period beginning midnight UTC and ending 23:59:59 UTC in accordance with the following formula: +the daily hash calculations that the Company provided to the pool operator as a percent of the Bitcoin network’s implied hash calculations +as determined by the network difficulty, multiplied by the total Bitcoin network block rewards expected to be generated for the same daily +period. +· The non-cash consideration in the form of transaction fees paid by transaction requestors is based on +the share of standard transaction fees over the daily 24-hour period beginning midnight UTC and ending 23:59:59 UTC. The pool operator +calculates the standard transaction fee during the 24-hour period using a rolling 144 block moving average of actual transaction fees. +· The block reward and transaction fees earned by the Company are reduced by mining pool fees charged by +the operator for operating the pool based on a rate schedule per the mining pool contract. The mining pool fee is only incurred to the +extent the Company performs hash calculations and generates revenue in accordance with the pool operator’s payout formula during +the same 24-hour period beginning midnight UTC daily. +The contract is in effect until terminated +by either party. +All consideration pursuant to this arrangement +is variable. It is not probable that a significant reversal of cumulative revenue will occur. The Company is able to calculate the payout +based on the contractual formula, non-cash revenue is estimated and recognized based on the fair value of Bitcoin on the date of contract +inception. Fair value of the crypto assets consideration is determined using the midnight UTC spot price of the Company’s principal +market for Bitcoin. The Company recognizes non-cash consideration on the same day that control of the contracted service is transferred +to the pool operator, which is the same day as the contract inception. +There is no significant financing component +in these transactions. +Expenses associated with running the crypto +assets mining business, such as equipment depreciation and electricity costs, are recorded as a component of cost of revenues. +Hotel Operations +The primary sources of revenue include room +and food and beverage revenue from the Company’s hotels. +Rooms revenue represents revenue from the +occupancy of the Company’s hotel rooms, which is driven by the occupancy and average daily rate charged. Rooms revenue includes +revenue from guest no-shows, daily use, and early/late departure fees. The contracts for room stays with customers are generally short +in duration and revenues are recognized as services are provided over the course of the hotel stay at the daily transaction price agreed +to under the contract. +Food and beverage revenue consists of revenue +from the restaurants and lounges, in room dining and mini bars, and banquet/catering revenue from group and social functions. Payment +of the transaction price is due immediately when the customer purchases the goods and services. Therefore, revenue is recognized at a +point in time when the physical possession has transferred to the customer. +F- 14 +Crane Operations - Heavy Lifting and Pump Maintenance +Services +The Company generates revenue by providing +heavy lifting and pump maintenance services to customers under various short-term agreements which may be hourly, daily, weekly or monthly. +Each service agreement generally has one performance obligation and includes a promise to complete the service at a specified location +and time and identifies the billing rate to be charged. Payment terms are identified in the terms of the contract and agreed to by both +parties for each promised service within the contract prior to the commencement or performance of said services. The collectability of +payment is considered probable based on management’s history with the certain type and class of customers and their ability and +intention of payment. The customer simultaneously receives and consumes the benefits as the Company provides the hourly, daily, weekly +or monthly service. +Cash and Cash Equivalents +The Company considers all highly liquid +investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments that potentially +subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash is maintained in +checking accounts, money market funds and certificates of deposits with reputable financial institutions. These balances exceed the United +States (“U.S.”) Federal Deposit Insurance Corporation insurance limits. The Company has not experienced any losses on deposits +of cash and cash equivalents. +Restricted Cash +As of December 31, 2024, restricted +cash included $18.4 million related to the Company’s guarantee obligations (see Note +29), $1.3 million of cash collateral for notes payable and $0.8 million of cash held in trust related to environmental +contingencies related to the Michigan data center. As of December 31, 2023, restricted cash included $4.3 million of cash collateral +for notes payable and $0.7 million of cash held in trust related to environmental +contingencies related to the Michigan data center. +Cash, cash equivalents and restricted +cash consisted of the following: +Schedule of cash equivalents and restricted cash +December 31, +December 31, +2024 +2023 +Cash and cash equivalents +$ 4,546,000 +$ 6,106,000 +Restricted cash +20,476,000 +4,962,000 +Total cash, cash equivalents and restricted cash +$ 25,022,000 +$ 11,068,000 +Cash and Marketable Securities Held in Trust Account +As of December 31, 2023, the Company held +$ 2.2 million in cash and marketable securities in a trust account. Cash and marketable securities held in the trust account represented +cash and money market funds that primarily invested in U.S. treasury bills that were purchased with funds raised through the initial public +offering of Ault Disruptive, a consolidated special purpose acquisition company. The funds raised were held in a trust account that was +restricted for use and may only be used for purposes of completing an initial business combination or redemption of the common stock of +Ault Disruptive, as set forth in the trust agreement. The funds held in trust are included within Level 1 of the fair value hierarchy. +During the year ended December 31, 2024, all shares of Ault Disruptive common stock were redeemed with the cash and marketable securities +previously held in the trust account. +Bitcoin +Bitcoin awarded to the Company through its +mining activities are accounted for in connection with the Company’s revenue recognition policy. +In accordance with Accounting Standards +Update (“ASU”) 2023-08, Accounting for and Disclosure of Crypto Assets , the Company measures Bitcoin at fair value +with changes recognized in operating expenses on the consolidated statements of operations. The Company tracks its cost basis of digital +assets by wallet in accordance with the first-in, first-out method of accounting. +Sales of Bitcoin by the Company and Bitcoin +awarded to the Company are included within cash flows from operating activities on the consolidated statements of cash flows. Realized +gains or losses from sales of Bitcoin are included in loss from operations on the consolidated statements of operations. +Fair Value of Financial Instruments +In accordance with ASC 820, Fair Value +Measurements and Disclosures , fair value is defined as the exit price, or the amount that would be received for the sale of an asset +or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. +F- 15 +The guidance also establishes a hierarchy +for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring +that the most observable inputs be used when available. Observable inputs include those that market participants would use in valuing +the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are +inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset or liability. +The guidance establishes three levels of inputs that may be used to measure fair value: +· Level 1: Quoted market prices in active markets for identical +assets or liabilities. +· Level 2: Inputs other than Level 1 that are observable, +either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; +or model-derived valuations. All significant inputs used in the Company’s valuations are observable or can be derived principally +from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs also include +quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed models such +as a discounted cash flow model. +· Level 3: Unobservable inputs that are supported by little or +no market activity and that are significant to the fair value of the assets or liabilities. +The carrying amounts of financial instruments +carried at cost, including cash and cash equivalents, accounts receivables and accounts and other receivable – related party, investments, +notes receivable, trade payables and trade payables – related party approximate their fair value due to the short-term maturities +of such instruments. +The categorization of a financial instrument +within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. +Equity Investments +The Company’s marketable equity securities +are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because the +Company uses quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments +in active markets. +For investments where little or no public +market exists, management’s determination of fair value is based on the best available information which may incorporate management’s +own assumptions and involves a significant degree of judgment, taking into consideration various factors including earnings history, financial +condition, recent sales prices of the issuer’s securities and liquidity risks. +Other equity securities also include investments +in entities that do not have a readily determinable fair value and do not report net asset value per share. These investments are accounted +for using a measurement alternative under which they are measured at cost and adjusted for observable price changes and impairments. Observable +price changes result from, among other things, equity transactions for the same issuer executed during the reporting period, including +subsequent equity offerings or other reported equity transactions related to the same issuer. For these transactions to be considered +observable price changes of the same issuer, the Company evaluates whether these transactions have similar rights and obligations, including +voting rights, distribution preferences, conversion rights, and other factors, to the investments the Company holds. Any investments adjusted +to their fair value by applying the measurement alternative are disclosed as nonrecurring fair value measurements, including the level +in the fair value hierarchy that was used. +Accounts Receivable and Allowance for Credit Losses +The Company’s receivables are recorded +when invoiced and represent claims against third parties that will be settled in cash. The Company records accounts receivable at the +invoiced amount less an allowance for any potentially uncollectible accounts under the current expected credit loss impairment model and +discloses the net amount of the financial instrument expected to be collected. The Company estimates the allowance for credit losses based +on an ongoing review of existing economic conditions, the financial conditions of the customers, historical trends in credit losses, and +the amount and age of past due accounts. Past-due receivable balances are written off when the Company’s internal collection efforts +have been unsuccessful in collecting the amount due. +F- 16 +Concentration of Credit Risk +Financial instruments that potentially subject +the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. +Cash and cash equivalents are invested in +banks in the U.S. Such deposits in the U.S. may be in excess of insured limits and are not insured in other jurisdictions. +Trade receivables of the Company and its +subsidiaries are mainly derived from sales to customers located primarily in the U.S. The Company performs ongoing credit evaluations +of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is determined with respect to +those amounts that the Company and its subsidiaries have determined to be doubtful of collection. +Inventories +Inventories are stated at the lower of cost +or net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological obsolescence. +Cost of inventories is determined as follows: +Raw materials, parts and supplies +- using the first-in, first-out method; and +Finished products - on the basis of direct manufacturing +costs with the addition of indirect manufacturing costs. +Inventories are stated at the lower of cost +(first-in, first-out method) or net realizable value. Inbound shipping and handling costs are classified as a component of cost of revenues +in the consolidated statements of operations. The Company reviews the components of its inventory and its inventory purchase commitments +on a regular basis for excess and obsolete inventory based on estimated future usage and sales. Write-downs in inventory value or losses +on inventory purchase commitments depend on various items, including factors related to customer demand, economic and competitive conditions, +technological advances or new product introductions by the Company or its customers that vary from its current expectations. Whenever +inventory is written down, a new cost basis is established and the inventory is not subsequently written up if market conditions improve. +Property and Equipment, Net +Property and equipment are stated at cost, +net of accumulated depreciation. Gains or losses on disposals of property and equipment are recorded within income from operations. Repairs +and maintenance costs are expensed as incurred. Significant improvements or betterments are capitalized and depreciated over the estimated +life of the asset. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, at the following +annual rates: +Schedule of estimated useful life of property, plant and equipment +Useful lives (in years) +Bitcoin mining equipment +1.5 +Computer, software and related equipment +3 – 5 +Office furniture and equipment +5 – 15 +Crane rental equipment +5 – 10 +Aircraft +7 +Vehicles +5 – 10 +Building and building improvements +7 – 39 +Leasehold improvements +Over the term of the lease or the life of the asset, whichever is shorter. +Leases +The Company accounts for its leases under +ASC 842, Leases . Under this guidance, arrangements meeting the definition of a lease are classified as operating or financing leases. +The Company only has operating leases. Operating leases are recognized as right-of-use assets, operating lease liability, current, and +operating lease liability, non-current on the Company’s consolidated balance sheets. Lease assets and liabilities are recognized +based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s +leases do not provide an implicit rate, the Company uses the Company’s incremental borrowing rate based on the information available +at commencement date in determining the present value of future payments. In certain of the Company’s lease agreements, the Company +receives periods of reduced rent or free rent and other incentives. The Company recognizes lease costs on a straight-line basis over the +lease term without regard to deferred payment terms, such as rent holidays, that defer the commencement date of required payments. The +Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise +that option. Leasehold improvements are capitalized at cost and amortized over the lesser of their expected useful life or the life of +the lease, without assuming renewal features, if any, are exercised. The Company does not separate lease and non-lease components for +the Company’s leases. +F- 17 +Impairment of Long-Lived Assets +Management reviews long-lived assets for +impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability +of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future cash flows +expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by comparing +the carrying amount of the assets to their fair value. +Impairment of Debt Securities +Debt securities are evaluated periodically +to determine whether a decline in their value is other than temporary. The Company utilizes criteria such as the magnitude and duration +of the decline, in addition to the reason underlying the decline, to determine whether the loss in value is other than temporary. The +term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects for +a near-term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater +than, the carrying value of the investment. Once a decline in value is determined to be other than temporary, the value of the security +is reduced and a corresponding charge to earnings is recognized. +Business Combination +The Company allocates the purchase price +of an acquired business to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values +on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. The +purchase price allocation process requires management to make significant estimates and assumptions at the acquisition date with respect +to intangible assets. The allocation of the consideration transferred in certain cases may be subject to revision based on the final determination +of fair values during the measurement period, which may be up to one year from the acquisition date. Direct transaction costs associated +with the business combination are expensed as incurred. The Company includes the results of operations of the business that it has acquired +in its consolidated results prospectively from the date of acquisition. +If the business combination is achieved +in stages, the acquisition date carrying value of the acquirer’s previously held equity interest in the acquirer is re-measured +to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized in profit or loss. +Intangible Assets +The Company acquired amortizable intangibles +assets as part of asset purchase agreements consisting of customer relationships, trade names and proprietary technology. +The Company reviews intangible assets for +impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets might not be recoverable. +Factors that the Company considers in deciding when to perform an impairment review include significant underperformance of the business +in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in the use of +the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares forecasts of +undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying value. An impairment +loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset are less than its carrying +amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its fair value, determined based +on discounted cash flows. +Common Stock Purchase Warrants and Other Derivative Financial +Instruments +The Company classifies common stock purchase +warrants and other free standing derivative financial instruments as equity if the contracts (i) require physical settlement or net-share +settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share +settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement to net cash settle +the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty a choice of +net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions, as +either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine +whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, +which principally consist of issuance of warrants to purchase shares of Class A common stock in connection with convertible notes and +to employees of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement +features or variable settlement provisions that cause them to not be indexed to the Company’s own stock. +F- 18 +Fair Value Option +The Company has elected to record the senior +secured convertible promissory notes, related party (“Convertible Notes”) at fair value on the date of issuance, with gains +and losses arising from changes in fair value recognized in the consolidated statements of operations at each period end while those are +outstanding. Issuance costs are recognized in the consolidated statement of operations in the period in which they are incurred. The Company +utilized a Monte-Carlo simulation at inception to value the Convertible Notes. The Monte-Carlo simulation is calculated as the average +present value over all simulated paths. The key inputs and assumptions used in the Monte-Carlo Simulation, including volatility, estimated +market yield, risk-free rate, the probability of various scenarios, including held to maturity and subsequent preferred stock offering +and various simulated paths. +The Company assesses the inputs used to +measure fair value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the +market. For instruments where little or no public market exists, management’s determination of fair value is based on the best available +information which may incorporate management’s own assumptions and involves a significant degree of judgment, taking into consideration +various factors including earnings history, financial condition, recent sales prices of the issuer’s securities and liquidity risks. +Convertible Instruments +The Company accounts for hybrid contracts +that feature conversion options in accordance with ASC 815, Derivatives and Hedging Activities (“ASC 815”). ASC 815 +requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative financial +instruments according to certain criteria. The criteria include circumstances in which (a) the economic characteristics and risks +of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, +(b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair +value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument +with the same terms as the embedded derivative instrument would be considered a derivative instrument. +Conversion options that contain variable +settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities +at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument. +The Company accounts for convertible instruments, +when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, in accordance +with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”). Under ASC 470-20, the Company records, when +necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences +between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price +embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded conversion options +should be bifurcated from their host instruments) in accordance with ASC 815. +Debt Discounts +The Company accounts for debt discount according +to ASC 470-20, Debt with Conversion and Other Options . Debt discounts are amortized through periodic charges to interest expense +over the term of the related financial instrument using the effective interest method. +Guarantee Liability +The Company maintains a guarantee liability +that represents its exposure related to guarantees associated with related party debt. The guarantee liability is reported in current +liabilities as a separate line item on the consolidated balance sheets, and the provision for guarantee liability is reported in other +income (expense) as a separate line item on the consolidated statement of operations. The guarantee liability represents management’s +estimate of the Company’s exposure to losses pursuant to the Company’s related party guarantee obligations. +F- 19 +Redeemable Non-Controlling Interests in Equity of Subsidiary +The Company records redeemable non-controlling +interests in equity of subsidiaries to reflect the economic interests of the common stockholders in Ault Disruptive. These interests are +presented as redeemable non-controlling interests in equity of subsidiaries within the consolidated balance sheets, outside of the permanent +equity section. The common stockholders in Ault Disruptive have redemption rights that are considered to be outside of the Company’s +control. As of December 31, 2023, the carrying amount of the redeemable non-controlling interest in equity of subsidiaries was recorded +at its redemption value of $ 2.2 million. During the year ended December 31, 2024, shares of Ault Disruptive common stock were redeemed +for an aggregate redemption amount of $ 2.3 million. Remeasurements to the redemption value of the redeemable non-controlling interest +in equity of subsidiaries are recorded within additional paid-in capital. +Treasury Stock +The Company records the aggregate purchase +price of treasury stock at cost and includes treasury stock as a reduction to stockholders’ equity. +Stock-Based Compensation +The Company accounts for stock-based compensation +in accordance with ASC 718, Compensation – Stock Compensation (“ASC 718”). +The Company uses the Black-Scholes option +pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions +which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying +stock. +Under ASC 718: +· the Company recognizes stock-based expenses related to stock option awards on a straight-line basis over +the requisite service period of the awards, which is generally the vesting term of two to four years; +· stock-based expenses are recognized net of forfeitures as they occur; +· the expected term assumption, using the simplified method, reflects the period for which the Company believes +the option will remain outstanding; +· the Company determined the volatility of its stock by looking at the historic volatility of its stock +over the expected term of the grant; and +· the risk-free rate reflects the U.S. Treasury yield for a similar expected term in effect at the time +of the grant. +Income Taxes +The Company determines its income taxes +under the asset and liability method in accordance with ASC 740, Income Taxes , which requires recognition of deferred tax +assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. +Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and tax bases of assets +and liabilities using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. Deferred tax assets +are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. +Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the fiscal years in which +those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in +tax rates is recognized in the Statements of Operations and Comprehensive Loss in the period that includes the enactment date. +The Company accounts for uncertain tax positions +in accordance with ASC 740-10-25, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax +return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit from an uncertain +tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based +on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that has a +greater than fifty percent likelihood of being realized upon ultimate settlement. To the extent that the final tax outcome of these matters +is different than the amount recorded, such differences impact income tax expense in the period in which such determination is made. Interest +and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. ASC 740-10-25 also +requires management to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions +that more likely than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated +tax positions taken by the Company and has concluded that as of December 31, 2024 and 2023, there were no uncertain tax positions taken, +or expected to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +F- 20 +Foreign Currency Translation +A substantial portion of the Company’s +revenues are generated in U.S. dollars. In addition, a substantial portion of the Company’s costs are incurred in U.S. dollars. +Company management has determined that the U.S. dollar is the functional currency of the primary economic environment in which it operates. +Accordingly, monetary accounts maintained +in currencies other than the U.S. dollar are re-measured into U.S. dollars in accordance with the Financial Accounting Standards Board +(“FASB”) ASC 830, Foreign Currency Matters (“ASC 830”). All transaction gains and losses from +the re-measurement of monetary balance sheet items are reflected in the statements of operations as financial income or expenses as appropriate. +The financial statements of certain foreign +subsidiaries, whose functional currency is not the U.S. dollar, have been translated into U.S. dollars in accordance with ASC 830. Balance +sheet accounts are translated using the exchange rates in effect as of the balance sheet date, while statement of operations amounts are +translated at the average exchange rate for the reporting period. The resulting translation adjustments are recognized as other comprehensive +loss in the consolidated statement of comprehensive loss and as accumulated comprehensive loss in the statement of changes in stockholders’ +equity. +Comprehensive Loss +The Company reports comprehensive loss in +accordance with ASC 220, Comprehensive Income . This statement establishes standards for the reporting and presentation of comprehensive +loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents all changes in +equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined that its +items of other comprehensive loss relate to changes in foreign currency translation adjustments and impairment of debt securities. +Accounting Estimates +The preparation of the consolidated financial +statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and +liabilities at the date of the consolidated financial statements and reported amounts of revenue and expense during the reporting period. +Estimates are used when accounting for certain items such as valuation of securities, reserves for trade receivables and inventories, +intangible assets and goodwill, useful lives and the recoverability of long-lived assets, stock-based arrangements, contingent consideration, +and deferred income taxes and related valuation allowance. Estimates are based on historical experience, where applicable, and assumptions +that management believes are reasonable under the circumstances. Due to the inherent uncertainty involved with estimates, actual results +may differ. +Preferred Stock Liabilities +The Company follows ASC 480-10, Distinguishing +Liabilities from Equity , in its evaluation of the accounting for preferred stock liabilities. ASC 480-10-25-14 requires liability +accounting for certain financial instruments, including shares that embody an unconditional obligation to transfer a variable number of +shares, provided that the monetary value of the obligation is based solely or predominantly on one of the following three characteristics: +· A fixed monetary amount known at inception; +· Variations in something other than the fair value of the issuer’s shares; or +· Variations in the fair value of the issuer’s equity shares, but the monetary value to the counterparty +moves in the opposite direction as the value of the issuer’s shares. +The number of shares delivered is determined +on the basis of (1) the fixed monetary amount determined as the stated value and (2) the current stock price at settlement, so that the +aggregate fair value of the shares delivered equals the monetary value of the obligation, which is fixed or predominantly fixed. Accordingly, +the holder is not significantly exposed to gains and losses attributable to changes in the fair value of the Company’s equity shares. +Instead, the Company is using its own equity shares as currency to settle a monetary obligation. +Discontinued Operations +The Company records discontinued operations +when the disposal of a separately identified business unit constitutes a strategic shift in the Company’s operations, as defined +in ASC Topic 205-20, Discontinued Operations (“ASC Topic 205-20”). +F- 21 +Reclassifications +Certain prior year amounts have been reclassified +for comparative purposes to conform to the current-year financial statement presentation. These reclassifications had no effect on previously +reported results of operations. The impact on any prior period disclosures was immaterial. +Recent Accounting Pronouncements +The Company continually assesses any new +accounting pronouncements to determine their applicability. When it is determined that a new accounting pronouncement may affect the Company’s +financial reporting, the Company undertakes an analysis to determine any required changes to its consolidated financial statements. +On December 14, 2023, the FASB issued ASU +No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures (“ASU 2023-09”). ASU 2023-09 requires entities +to disclose specific rate reconciliations, amount of income taxes separated by federal and individual jurisdiction, and the amount of +income (loss) from continuing operations before income tax expense (benefit) disaggregated between federal, state, and foreign. The new +standard is effective for the Company for its fiscal year beginning January 1, 2025, with early adoption permitted. The Company is currently +evaluating the impact of adopting the standard. +On November 27, 2023, the FASB issued ASU +No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures (“ASU 2023-07”). ASU 2023-07 is +designed to improve the reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses +that are regularly provided to the chief operating decision maker. The Company adopted ASU 2023-07 as required for the year ended December +31, 2024. The adoption required the Company to provide additional disclosures, but otherwise it does not materially impact the accompanying +financial statements. +In November 2024, the FASB issued ASU No. +2024-03, Income Statement - Reporting Comprehensive Income - Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation +of Income Statement Expenses (“ASU 2024-03”). ASU 2024-03 requires additional disclosures of certain expenses in the notes +of the financial statements, to provide enhanced transparency into the expense captions presented on the Consolidated Statements of Operations. +Additionally, in January 2025, the FASB issued ASU 2025-01, Income Statement - Reporting Comprehensive Income - Expense Disaggregation +Disclosures (Subtopic 220-40), to clarify the effective date of ASU 2024-03. The new standard is effective for the Company for its +annual periods beginning January 1, 2027 and for interim periods beginning January 1, 2028, with early adoption permitted. The Company +is currently evaluating the impact of adopting the standard. +4. DECONSOLIDATION OF SUBSIDIARY AND DISCONTINUED OPERATIONS +Presentation of GIGA as Discontinued Operations +On August 14, 2024, GIGA filed a petition +for reorganization under Chapter 11 of the bankruptcy laws. The filing placed GIGA under the control of the bankruptcy court, which oversees +its reorganization and restructuring process. The Company assessed the inherent uncertainties associated with the outcome of the Chapter +11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate GIGA and its subsidiaries +effective on the petition date. The Company recognized a gain on deconsolidation of GIGA of $ 2.0 million included in net gain (loss) from +discontinued operations. +In connection with the Chapter 11 reorganization +process, the Company concluded that the operations of GIGA met the criteria for discontinued operations as this strategic shift that will +have a significant effect on the Company’s operations and financial results. As a result, the Company has presented the results +of operations, cash flows and financial position of GIGA as discontinued operations in the accompanying consolidated financial statements +and notes for all periods presented. +F- 22 +The following table presents the assets +and liabilities of GIGA operations: +Schedule of presents the assets and liabilities +December 31, +December 31, +2024 +2023 +Cash and cash equivalents +$ - +$ 3,601,000 +Restricted cash +- +700,000 +Accounts receivable +- +4,350,000 +Inventories +- +6,643,000 +Prepaid expenses and other current assets +- +4,859,000 +Intangible assets, net +- +1,707,000 +Goodwill +- +5,794,000 +Property and equipment, net - current +- +1,690,000 +Right-of-use assets +- +3,023,000 +Total assets discontinued operations +- +32,367,000 +Accounts payable and accrued expenses +- +14,005,000 +Operating lease liability +- +3,098,000 +Notes payable +- +1,174,000 +Convertible notes payable +- +4,388,000 +Liabilities discontinued operations +- +22,664,000 +Net assets of discontinued operations +$ - +$ 9,703,000 +Net assets of discontinued operations excludes +$ 14.0 million of intercompany notes payable to Hyperscale Data and Ault Lending as of December 31, 2024. +The following table presents the results +of GIGA operations: +Schedule of operations +For the Year Ended +December 31, +2024 +2023 +Revenue, products +$ 30,862,000 +$ 37,759,000 +Cost of revenue, products +23,339,000 +27,623,000 +Gross profit +7,523,000 +10,136,000 +Operating expenses +Research and development +2,617,000 +2,816,000 +Selling and marketing +1,166,000 +1,876,000 +General and administrative +8,033,000 +12,989,000 +Impairment of goodwill and intangible assets +- +4,681,000 +Total operating expenses +11,816,000 +22,362,000 +Loss from operations +( 4,293,000 ) +( 12,226,000 ) +Other income (expense): +Interest and other income +1,594,000 +849,000 +Interest expense +( 1,662,000 ) +( 843,000 ) +Loss on extinguishment of debt +- +( 1,397,000 ) +Change in fair value of warrant liability +- +( 1,775,000 ) +Total other expense, net +( 68,000 ) +( 3,166,000 ) +Loss before income taxes +( 4,361,000 ) +( 15,392,000 ) +Income tax benefit +( 15,000 ) +( 11,000 ) +Net loss +( 4,346,000 ) +( 15,381,000 ) +Net loss attributable to non-controlling interest +1,554,000 +3,026,000 +Net loss available to common stockholders +$ ( 2,792,000 ) +$ ( 12,355,000 ) +The net loss from discontinued operations +for the year ended December 31, 2024 on the consolidated statement of operations and comprehensive loss includes the gain on deconsolidation +as follows: +Schedule of gain on deconsolidation +For the Year +Ended +December 31, +2024 +GIGA net loss +$ ( 2,792,000 ) +Gain on deconsolidation +2,013,000 +Net loss from discontinued operations +$ ( 779,000 ) +F- 23 +The cash flow activity related to discontinued +operations is presented separately on the statement of cash flows as summarized below: +Schedule of statement of cash flows +For the Year Ended December 31, +2024 +2023 +Cash flows from operating activities: +Net loss +$ ( 4,346,000 ) +$ ( 15,381,000 ) +Adjustments to reconcile net loss to net cash provided by operating activities: +Depreciation and amortization +618,000 +823,000 +Amortization of right-of-use assets +684,000 +1,004,000 +Amortization of intangibles +157,000 +273,000 +Impairment of goodwill and intangible assets +- +4,681,000 +Stock-based compensation +( 858,000 ) +1,799,000 +Changes in operating assets and liabilities: +Accounts receivable +( 1,638,000 ) +1,157,000 +Inventories +1,514,000 +1,789,000 +Prepaid expenses and other current assets +( 1,516,000 ) +( 1,185,000 ) +Lease liabilities +( 667,000 ) +( 1,112,000 ) +Accounts payable and accrued expenses +( 314,000 ) +564,000 +Net cash used in operating activities +( 6,366,000 ) +( 5,588,000 ) +Cash flows from investing activities: +Purchase of property and equipment +( 249,000 ) +( 271,000 ) +Cash decrease upon deconsolidation +( 3,550,000 ) +- +Net cash used in investing activities +( 3,799,000 ) +( 271,000 ) +Cash flows from financing activities: +Proceeds from notes payable +2,552,000 +3,858,000 +Cash contributions from parent +3,383,000 +3,934,000 +Net cash provided by financing activities +5,935,000 +7,792,000 +Effect of exchange rate changes on cash and cash equivalents +( 71,000 ) +173,000 +Net (decrease) increase in cash and cash equivalents and restricted cash +( 4,301,000 ) +2,106,000 +Cash and cash equivalents and restricted cash at beginning of period +4,301,000 +2,195,000 +Cash and cash equivalents and restricted cash at end of period +$ - +$ 4,301,000 +Supplemental disclosures of cash flow information: +Cash paid during the period for interest +$ 946,000 +$ 778,000 +5. CHANGE IN PLAN OF SALE OF AGREE HOTEL PROPERTIES +On April 30, 2024, the Company had a change +in plan of sale for its four hotels owned and operated by AGREE. As a result, as of April 30, 2024, the assets no longer met the held +for sale criteria and were required to be reclassified as held and used at the lower of adjusted carrying value or the fair value at the +date of the not to sell. +For presentation purposes, the assets and +liabilities previously held for sale as of December 31, 2023, were reclassified in the December 31, 2023 balance sheet in the accompanying +financial statements back to their original asset and liability groups at their previous carrying values. In connection with this change +in plan of sale, the Company recorded a loss on impairment of property and equipment related to the real estate assets of AGREE of $ 8.0 +million during the year ended December 31, 2024. The fair values of property and equipment related to the real estate assets of AGREE +were based on a discounted cash flow income approach for the hotel properties and a comparable sales market approach for the vacant land +assets. +In connection with the original plan of +sale of AGREE assets, the assets held for sale were measured at the lower of their carrying amount or fair value less cost to sell. The +Company performed a fair value analysis for the disposal group utilizing an income approach for the hotels and a market approach for the +land, resulting in an $ 6.6 million impairment of property and equipment during the year ended December 31, 2023. +F- 24 +6. REVENUE DISAGGREGATION +The following tables summarize disaggregated +customer contract revenues and the source of the revenue for the years ended December 31, 2024 and 2023. Revenues from lending and trading +activities included in consolidated revenues were primarily interest, dividend and other investment income, which are not considered to +be revenues from contracts with customers under GAAP. Revenue is presented by reportable segment. The “Holding Co.” column includes revenue that is not +allocated to a specific reportable segment but is generated within the holding company entity. While not a separate reportable segment, +Holding Co. is included in the table below to reconcile to total consolidated revenue. +The Company’s disaggregated revenues +consisted of the following for the year ended December 31, 2024: +Schedule of disaggregated revenues +TurnOnGreen +Fintech +Sentinum +AGREE +Energy +ROI +Holding Co. +Total +Primary Geographical Markets +North America +$ 4,840,000 +$ - +$ 31,474,000 +$ 18,015,000 +$ 47,475,000 +$ 253,000 +$ 2,523,000 +$ 104,580,000 +Europe +49,000 +- +- +- +116,000 +- +- +165,000 +Middle East and other +24,000 +- +- +- +- +- +- +24,000 +Revenue from contracts with customers +4,913,000 +- +31,474,000 +18,015,000 +47,591,000 +253,000 +2,523,000 +104,769,000 +Revenue, lending and trading activities (North America) +- +1,893,000 +- +- +- +- +- +1,893,000 +Total revenue +$ 4,913,000 +$ 1,893,000 +$ 31,474,000 +$ 18,015,000 +$ 47,591,000 +$ 253,000 +$ 2,523,000 +$ 106,662,000 +Major Goods or Services +Power supply units and systems +$ 4,913,000 +$ - +$ - +$ - +$ - +$ - +$ - +$ 4,913,000 +Revenue from mined crypto assets at Sentinum owned and operated facilities +- +- +24,960,000 +- +- +- +- +24,960,000 +Revenue from Sentinum crypto mining equipment hosted at third-party facilities +- +- +5,638,000 +- +- +- +- +5,638,000 +Hotel and real estate operations +- +- +876,000 +18,015,000 +- +- +- +18,891,000 +Crane rental +- +- +- +- +47,475,000 +- +- +47,475,000 +Other +- +- +- +- +116,000 +253,000 +2,523,000 +2,892,000 +Revenue from contracts with customers +4,913,000 +- +31,474,000 +18,015,000 +47,591,000 +253,000 +2,523,000 +104,769,000 +Revenue, lending and trading activities +- +1,893,000 +- +- +- +- +- +1,893,000 +Total revenue +$ 4,913,000 +$ 1,893,000 +$ 31,474,000 +$ 18,015,000 +$ 47,591,000 +$ 253,000 +$ 2,523,000 +$ 106,662,000 +Timing of Revenue Recognition +Goods and services transferred at a point in time +$ 4,913,000 +$ - +$ 31,474,000 +$ 18,015,000 +$ 116,000 +$ 253,000 +$ 2,523,000 +$ 57,294,000 +Services transferred over time +- +- +- +- +47,475,000 +- +- +47,475,000 +Revenue from contracts with customers +$ 4,913,000 +$ - +$ 31,474,000 +$ 18,015,000 +$ 47,591,000 +$ 253,000 +$ 2,523,000 +$ 104,769,000 +The Company’s disaggregated revenues +consisted of the following for the year ended December 31, 2023: +TurnOnGreen +Fintech +Sentinum +SMC +AGREE +Energy +ROI +Total +Primary Geographical Markets +North America +$ 3,879,000 +$ - +$ 34,523,000 +$ 31,099,000 +$ 16,161,000 +$ 49,431,000 +$ 305,000 +$ 135,398,000 +Europe +29,000 +- +- +238,000 +- +666,000 +- +933,000 +Middle East and other +293,000 +- +- +220,000 +- +- +- +513,000 +Revenue from contracts with customers +4,201,000 +- +34,523,000 +31,557,000 +16,161,000 +50,097,000 +305,000 +136,844,000 +Revenue, lending and trading activities (North America) +- +( 1,998,000 ) +- +- +- +- +- +( 1,998,000 ) +Total revenue +$ 4,201,000 +$ ( 1,998,000 ) +$ 34,523,000 +$ 31,557,000 +$ 16,161,000 +$ 50,097,000 +$ 305,000 +$ 134,846,000 +Major Goods or Services +Power supply units and systems +$ 4,201,000 +$ - +$ - +$ - +$ - +$ - +$ - +$ 4,201,000 +Revenue from mined crypto assets at Sentinum owned and operated facilities +- +- +29,036,000 +- +- +- +- +29,036,000 +Revenue from Sentinum crypto mining equipment hosted at third-party facilities +- +- +4,071,000 +- +- +- +- +4,071,000 +Hotel and real estate operations +- +- +1,416,000 +- +16,161,000 +- +- +17,577,000 +Karaoke machines and related consumer goods +- +- +- +31,557,000 +- +- +- +31,557,000 +Crane rental +- +- +- +- +- +49,198,000 +- +49,198,000 +Other +- +- +- +- +- +899,000 +305,000 +1,204,000 +Revenue from contracts with customers +4,201,000 +- +34,523,000 +31,557,000 +16,161,000 +50,097,000 +305,000 +136,844,000 +Revenue, lending and trading activities +- +( 1,998,000 ) +- +- +- +- +- +( 1,998,000 ) +Total revenue +$ 4,201,000 +$ ( 1,998,000 ) +$ 34,523,000 +$ 31,557,000 +$ 16,161,000 +$ 50,097,000 +$ 305,000 +$ 134,846,000 +Timing of Revenue Recognition +Goods and services transferred at a point in time +$ 3,853,000 +$ - +$ 34,523,000 +$ 31,557,000 +$ 16,161,000 +$ 899,000 +$ 305,000 +$ 87,298,000 +Services transferred over time +348,000 +- +- +- +- +49,198,000 +- +49,546,000 +Revenue from contracts with customers +$ 4,201,000 +$ - +$ 34,523,000 +$ 31,557,000 +$ 16,161,000 +$ 50,097,000 +$ 305,000 +$ 136,844,000 +F- 25 +7. FAIR VALUE OF FINANCIAL INSTRUMENTS +The following table sets forth the Company’s +financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy at December 31, 2023 +(no material financial instruments that were measured at fair value on a recurring basis at December 31, 2024): +Fair value, assets measured on recurring basis +Fair Value Measurement at December 31, 2023 +Total +Level 1 +Level 2 +Level 3 +Assets: +Investment in common stock of Alzamend – a related party +$ 679,000 +$ 679,000 +$ - +$ - +Investments in marketable equity securities +27,000 +27,000 +- +- +Cash and marketable securities held in trust account +2,200,000 +2,200,000 +- +- +Total assets measured at fair value +$ 2,906,000 +$ 2,906,000 +$ - +$ - +Liabilities: +Warrant and embedded conversion feature liabilities +$ 910,000 +$ - +$ - +$ 910,000 +Total liabilities measured at fair value +$ 910,000 +$ - +$ - +$ 910,000 +The Company assesses the inputs used to +measure fair value using the three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the +market. For investments where little or no public market exists, management’s determination of fair value is based on the best available +information which may incorporate management’s own assumptions and involves a significant degree of judgment, taking into consideration +various factors including earnings history, financial condition, recent sales prices of the issuer’s securities and liquidity risks. +The changes in Level 3 fair value hierarchy +during the years ended December 31, 2024 and 2023 were as follows: +Schedule of changes in fair value hierarchy +Level 3 Balance at +Beginning of +Period +Fair Value +Adjustments +Grants +Level 3 Balance at +End of Period +Year ended December 31, 2024 +Embedded conversion feature liabilities +$ 910,000 +$ ( 910,000 ) +$ - +$ - +Year ended December 31, 2023 +Warrant liabilities +$ 651,000 +$ ( 4,981,000 ) +$ 4,330,000 +$ - +Embedded conversion feature liabilities +$ 2,316,000 +$ ( 2,758,000 ) +$ 1,352,000 +$ 910,000 +8. Equity Investments +for Which Measurement Alternative Has Been Selected +As of December 31, 2024 and 2023, the Company +held equity investments in other securities valued at $ 2.8 million and $ 21.8 million, respectively, that were valued using a +measurement alternative. These investments are included in other equity securities in the accompanying consolidated balance sheets. +The Company has made cumulative downward +adjustments for impairments for equity securities that do not have readily determinable fair values for the years ended December 31, 2024 +and 2023, totaling $ 8.6 million and $ 15.8 million, respectively. Approximately $ 6.3 million of the impairment charge for the years ended +December 31, 2024 was reflected in other income (expense) and $2.3 million of the impairment charge related to Fintech lending operations +and was recorded against revenue from lending and trading activities on the consolidated statement of operations and comprehensive loss. +Approximately $ 9.6 million of the impairment charge for the year ended December 31, 2023 was reflected in other income (expense) and $6.2 +million of the impairment charge related to Fintech lending operations and was recorded against revenue from lending and trading activities +on the consolidated statement of operations and comprehensive loss. +9. CRYPTO ASSETS +The following table presents revenue from +mined crypto assets for the years ended December 31, 2024 and 2023: +Schedule of revenue from crypto assets +For the Year Ended +December 31, +2024 +2023 +Revenue from mined crypto assets at Sentinum owned and operated facilities +$ 24,960,000 +$ 29,036,000 +Revenue from Sentinum crypto mining equipment hosted at third-party facilities +5,638,000 +4,071,000 +Revenue, crypto assets mining +$ 30,598,000 +$ 33,107,000 +F- 26 +The following table presents the activities +of the crypto assets (classified within prepaid expenses and other current assets) for the years ended December 31, 2024 and 2023: +Schedule of activities of the crypto assets +For the Year Ended +December 31, +2024 +2023 +Balance at January 1 +$ 546,000 +$ 554,000 +Additions of mined crypto assets +24,960,000 +29,100,000 +Sale of crypto assets +( 25,350,000 ) +( 29,111,000 ) +Payments to vendors with crypto assets +( 39,000 ) +( 28,000 ) +Payment of notes payable with crypto assets +( 506,000 ) +- +Payment of interest payable with crypto assets +( 142,000 ) +- +Realized gain on sale of crypto assets +684,000 +520,000 +Unrealized gain on crypto assets +29,000 +- +Impairment of mined crypto assets +- +( 489,000 ) +Balance at December 31 +$ 182,000 +$ 546,000 +10. INVENTORIES +At December 31, 2024 and 2023, inventories consisted +of: +Schedule of inventories +December 31, +December 31, +2024 +2023 +Raw materials, parts and supplies +$ 309,000 +$ 474,000 +Finished products +1,508,000 +1,316,000 +Total inventories +$ 1,817,000 +$ 1,790,000 +11. PROPERTY AND EQUIPMENT, NET +At December 31, 2024 and 2023, property +and equipment consisted of: +Schedule of property and equipment +December 31, 2024 +December 31, 2023 +Building, land and improvements +$ 80,822,000 +$ 100,184,000 +Crypto assets mining equipment +12,150,000 +50,640,000 +Crane rental equipment +34,588,000 +34,469,000 +Computer, software and related equipment +11,308,000 +10,533,000 +Aircraft +15,983,000 +15,983,000 +Other property and equipment +11,417,000 +11,066,000 +166,268,000 +222,875,000 +Accumulated depreciation and amortization +( 21,911,000 ) +( 27,209,000 ) +Property and equipment, net +$ 144,357,000 +$ 195,666,000 +Summary of depreciation expense: +Schedule of depreciation +For the Year Ended December 31, +2024 +2023 +Depreciation expense +$ 23,784,000 +$ 26,911,000 +Impairment of Property and Equipment +During the year ended December 31, 2024, +due to increases in the Bitcoin mining difficulty level, which compounded the continued impact of the Bitcoin halving event, we concluded +that indicated that an impairment triggering event had occurred. Testing performed indicated the estimated fair value of the Company’s +miners to be less than their net carrying value during the year ended December 31, 2024, and an impairment charge of $ 10.5 million was +recognized, decreasing the net carrying value of the Company’s crypto assets mining equipment to their estimated fair value. The +Company valued the miners using an income approach utilizing a discounted cash flow and a discount rate of 20%. The Company estimated +the cash flow from the miners over a two-year period assuming a utilization rate of 98%, a mining difficulty level of 101.6 trillion, +a Bitcoin price of $ 76,000 and a power cost of $0.055 per kilowatt-hour. The estimated fair value of the Company’s miners is classified +in Level 3 of the fair value hierarchy with no observable inputs using a discounted cash flow methodology. +F- 27 +In addition, the Company recorded +impairment charges of $ 8.9 million related to AGREE’s real estate assets in each of the years ended December 31, 2024 and 2023. +The fair values of property and equipment related to the real estate assets of AGREE were based on a discounted cash flow income approach +for the hotel properties and a comparable sales market approach for the vacant land assets. Assumptions used in the discounted cash flow +analysis included discount rates between 10.5% and 10.75%, terminal capitalization rates between 8.5% and 8.75% and occupancy rates between +59.2% and 78.8%. +During the year ended December 31, 2023, +certain unforeseen business developments and changes in financial projections at Avalanche International Corp. (“AVLP”) indicated +that an impairment triggering event had occurred. Testing performed indicated the estimated fair value of AVLP property and equipment +as of December 31, 2023 was $ 0 , and an impairment charge of $ 14.0 million was recognized, which was based primarily on estimated liquidation +value or expected proceeds from the sale or disposal of the assets. +During the year ended December 31, 2023, +the Company recognized an impairment charge of $ 4.1 million related to property and equipment at ROI, which was based primarily on estimated +liquidation value or expected proceeds from the sale or disposal of the assets. +Sale of St. Petersburg Property +On December 13, 2024, AGREE completed the +sale of its real property located in St. Petersburg, Florida (the “Florida Property”) for $ 13.0 million and recorded a gain +on the sale of $0.2 million included in gain on the sale of fixed assets in the consolidated statement of operations. +12. INTANGIBLE ASSETS, NET +At December 31, 2024 and 2023, intangible assets consisted +of: +Schedule of intangible asset +Useful Life +December 31, 2024 +December 31, 2023 +Definite lived intangible assets: +Developed technology +7 years +$ 60,000 +$ 1,949,000 +Customer list +10 years +1,290,000 +1,290,000 +Trade names +12 years +1,030,000 +1,030,000 +2,380,000 +4,269,000 +Accumulated amortization +( 536,000 ) +( 222,000 ) +Total definite-lived intangible assets +$ 1,844,000 +$ 4,047,000 +Certain of the Company’s trade names +and trademarks were determined to have an indefinite life. The remaining definite-lived intangible assets are primarily being amortized +on a straight-line basis over their estimated useful lives. +Summary of amortization expense: +Schedule of amortization expense +For the Year Ended +December 31, +2024 +2023 +Amortization expense +$ 653,000 +$ 1,041,000 +As of December 31, 2024, intangible assets subject +to amortization had an average remaining useful life of 6.9 years. The following table presents estimated amortization expense for +each of the succeeding five calendar years and thereafter. +Schedule of estimated amortization expense +2025 +324,000 +2026 +264,000 +2027 +264,000 +2028 +264,000 +2029 +264,000 +Thereafter +464,000 +$ 1,844,000 +F- 28 +During the year ended December 31, 2024, +the Company recognized $ 1.5 million impairment of intangible assets related to Eco Pack. Based on internally developed forecasts of undiscounted +expected future cash flows, it was determined that the carrying amount of the assets was not recoverable. +During the year ended December 31, 2023, +the Company recognized $ 24.3 million impairment of intangible assets related to AVLP. Due to indicators of impairment, AVLP intangible +assets were tested for impairment during the year ended December 31, 2023. Based on internally developed forecasts of undiscounted expected +future cash flows, it was determined that the carrying amount of the assets were not recoverable. +The tradenames and patents/developed technology +intangible assets were valued using the relief-from-royalty method. The relief-from-royalty method is one of the methods under the income +approach whereby estimates of a company’s earnings attributable to the intangible asset are based on the royalty rate the Company +would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying royalty rates of 18% for patents +and developed technology and 0.25% for trademarks. The resulting net annual royalty payments are then discounted to present value using +a discount factor of 25.7%. +13. GOODWILL IMPAIRMENT +The Company tests the recorded amount of +goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount of the goodwill +exceeds its carried value. The Company performed a goodwill impairment test as of June 30, 2023 related to AVLP as there were indicators +of impairment related to certain unforeseen business developments and changes in financial projections. +The valuation of AVLP was determined using +an income approach methodology of valuation. The income approach is based on the projected cash flows discounted to their present value +using discount rates, that in the Company’s judgment, consider the timing and risk of the forecasted cash flows using internally +developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated value of a market participant’s +cost of capital and debt, derived using customary market metrics. The analysis included assumptions regarding AVLP’s revenue forecast +and discount rates of 26.7% using a weighted average cost of capital analysis. The market approach was also considered; however, the income +approach was chosen as the Company determined it was a better representation of AVLP’s projected long-term performance. +The results of the quantitative test +indicated that the fair value of the AVLP reporting unit did not exceed its carrying amounts, including goodwill, in excess of the +carrying value of the goodwill. As a result, the entire $ 18.6 +million carrying amount of AVLP’s goodwill was recognized as a non-cash impairment charge during the year ended December 31, +2023. +14. INVESTMENTS – RELATED PARTIES +Investments in Alzamend, Ault & Company, Inc. (“Ault +& Company”) and GIGA at December 31, 2024 and 2023, were comprised of the following: +Investment in Promissory Notes, Related Parties – +Ault & Company and GIGA +Schedule of investment +Interest +December 31, +December 31, +Rate +Due Date +2024 +2023 +Promissory note and accrued interest receivable, Ault & Company +8 % +December 31, 2024 +$ 2,468,000 +$ 3,068,000 +Promissory note and accrued interest receivable, GIGA +6 % - 12 % +In bankruptcy +18,499,000 +- +Other +335,000 +900,000 +Allowance for credit losses +( 500,000 ) +- +Total investment in promissory notes and other, related parties +$ 20,802,000 +$ 3,968,000 +Amounts above are recorded in “Investment +in promissory notes and other, related party” on the consolidated balance sheets. +Summary of interest income, related party, +recorded within interest and other income on the consolidated statement of operations: +Schedule of Interest income, related party +For the Year Ended +December 31, +2024 +2023 +Interest income, related party +$ 1,694,000 +$ 1,308,000 +F- 29 +At each reporting date, the Company applies +its judgment to evaluate the collectability of the note receivable and makes a provision based on the assessed amount of expected credit +loss. This judgment is based on parameters such as interest rates, market conditions and creditworthiness of the creditor. +The Company determined that the collectability +of certain notes receivables is doubtful based on information available. +Upon the deconsolidation +of GIGA, the Company established an allowance for credit losses of $2.6 million related to notes receivable from GIGA included +in net gain (loss) from discontinued operations . As of December 31, 2024, the Company performed an analysis of the allowance for +credit losses of the GIGA notes receivable resulting in a $2.1 million reduction in the allowance, which was recorded within cost of +revenue from lending and trading activities. +Investment in Alzamend Series B Convertible Preferred +Stock, Warrants and Common Stock, Related Parties – Alzamend +Schedule of investment in common stock +Investments in common stock, related parties at December 31, 2024 +Cost +Gross unrealized losses +Fair value +Common shares +$ 24,697,000 +$ ( 24,607,000 ) +$ 90,000 +Alzamend series B convertible preferred stock, warrants +2,100,000 +- +2,100,000 +$ 26,797,000 +$ ( 24,607,000 ) +$ 2,190,000 +Investments in common stock, related parties at December 31, 2023 +Cost +Gross unrealized losses +Fair value +Common shares +$ 24,688,000 +$ ( 24,009,000 ) +$ 679,000 +Amounts above are recorded in “Investments +in common stock and equity securities, related party” on the consolidated balance sheets. +The following tables summarize the changes +in the Company’s investments in Alzamend common stock during the years ended December 31, 2024 and 2023: +Schedule of investment in warrants and common stock +For the Year Ended December 31, +2024 +2023 +Balance at January 1 +$ 679,000 +$ 6,449,000 +Investment in common stock of Alzamend +9,000 +15,000 +Unrealized loss in common stock of Alzamend +( 598,000 ) +( 5,785,000 ) +Balance at December 31 +$ 90,000 +$ 679,000 +Ault Lending Investment in Alzamend Series B Convertible +Preferred Stock and Warrants +Schedule of investment in warrants and preferred stock +December 31, +December 31, +2024 +2023 +Investment in Alzamend preferred stock +$ 2,100,000 +$ - +Total investment in other investments securities, related party +$ 2,100,000 +$ - +In connection with a securities purchase +agreement entered into with Alzamend in January 2024, Ault Lending purchased 2,100 shares of Alzamend Series B Convertible Preferred Stock +and warrants to purchase 0.2 million shares of Alzamend common stock with a five-year term and an exercise price of $12.00 per share for +a total purchase price of $2.1 million. +The agreement provided that Ault Lending +may purchase up to $6 million of Alzamend Series B Convertible Preferred Stock in one or more closings. There have been not been additional +closings subsequent to January 2024 and the agreement terminated by its own terms on March 31, 2025. +The Company has elected to account for investment +in other investments securities, related party, using a measurement alternative under which they are measured at cost and adjusted for +observable price changes and impairments. +Messrs. Ault, Horne and Nisser are each +paid $ 50,000 annually by Alzamend. +F- 30 +VIE Considerations for Ault Lending’s Investments +in Alzamend +Alzamend is considered a VIE based on the +Ault Lending’s investment in Alzamend common stock, Series B convertible preferred stock and warrants. However, Ault Lending is +not deemed to be the primary beneficiary of Alzamend and therefore does not consolidate Alzamend in its financial statements. Ault Lending’s +maximum exposure to loss as a result of its involvement with Alzamend is limited to the $2.2 million carrying value of its investments. +15. EQUITY METHOD INVESTMENT +Equity Investments in Unconsolidated Entity – SMC +On November 20, 2023, SMC, a consolidated +VIE of the Company, completed a transaction pursuant to which the Company’s share ownership of SMC was diluted to approximately +28%. Due to the significant change in Ault Alliance’s ownership and voting rights, the Company determined that it no longer met +the criteria of the primary beneficiary and, accordingly, the Company deconsolidated SMC as of November 20, 2023. The Company recorded +a $3.0 million loss on deconsolidation for the year ended December 31, 2023. +Upon deconsolidation, the Company recorded +its retained investment in SMC based upon the fair value of the common shares held by the Company at November 20, 2023. Due to the Company’s +significant influence over SMC, the Company began accounting for its retained interest under the equity method of accounting. +The following table summarizes the changes +in the Company’s equity investments in an unconsolidated entity, SMC, included in other assets on the consolidated balance sheet, +during the year ended December 31, 2024: +Schedule of equity investments in unconsolidated entity – SMC +Rollforward investment in unconsolidated entity +Amount +Beginning balance - January 1, 2024 +$ 1,957,000 +Loss from investment in unconsolidated entity +( 1,957,000 ) +Ending balance - December 31, 2024 +$ - +On September 5, 2024, three of the Company’s +employees resigned from the board of directors of SMC. As a result of the resignations, and as the Company owned less than 20% of SMC +at the time, the Company no longer had the ability to exert significant influence over the operating and financial policies of SMC. The +Company discontinued the equity method of accounting for the investment in SMC on September 5, 2024. As a result, the Company changed +its accounting for SMC to an investment in marketable equity securities and recognized the investment at fair value, with a gain of $1.3 +million recognized as revenue from lending and trading activities in the consolidated statement of operations and comprehensive loss. +The following table provides summarized +financial information for the Company’s ownership interest in SMC accounted for under the equity method for the December 31, 2023 +period presented and has been compiled from SMC’s financial statements. Amounts presented represent totals at the investee level +and not the Company’s proportionate share: +Summarized Statements of Operations +Schedule of summarized statements of operations +For the Year Ended +December 31, +2023 +Revenue +$ 32,581,000 +Gross profit +$ 6,964,000 +Loss from operations +$ ( 8,290,000 ) +Net loss +$ ( 9,384,000 ) +Summarized Balance Sheet Information +December 31, +2023 +Current assets +$ 23,206,000 +Non-current assets +$ 4,509,000 +Current liabilities +$ 16,209,000 +Non-current liabilities +$ 3,928,000 +F- 31 +16. CONSOLIDATED VARIABLE INTEREST ENTITY - ALPHA FUND +Alpha Fund – Consolidated Variable Interest Entity +As of December 31, 2022, the Company held +an investment in the Alpha Fund. The Alpha Fund was liquidated during the year ended December 31, 2023. Alpha Fund operated as a private +investment fund. The general partner of Alpha Fund, Ault Alpha GP LLC (“Alpha GP”) was owned by Ault Capital Management LLC +(the “Investment Manager”), which also acted as the investment manager to Alpha Fund. The Investment Manager was owned by +Ault & Company. Messrs. Ault, Horne, Nisser and Cragun, who serve as executive officers and/or directors of the Company, were executive +officers of the Investment Manager, and Messrs. Ault, Horne and Nisser are executive officers and directors of Ault & Company. +Prior to the liquidation of the Alpha Fund, +the Company consolidated Alpha Fund as a VIE due to its significant level of influence and control of Alpha Fund, the size of its investment, +and its ability to participate in policy making decisions. The Company was considered the primary beneficiary of the VIE. +17. BUSINESS COMBINATIONS +ROI Acquisition +On March 6, 2023, the Company closed a +share exchange agreement with ROI and sold to ROI all the outstanding shares of capital stock of the Company’s subsidiary, BitNile.com, +Inc. as well as RiskOn360, Inc. (formerly known as Ault Iconic, Inc.) and the securities of Earnity, Inc. beneficially owned by BitNile.com, +Inc. as of the date of the Agreement. As consideration for the acquisition, ROI issued shares of preferred stock that could have been +convertible into common stock, subject to shareholder approval, of ROI representing approximately 73.2% of ROI’s outstanding common +stock at the time of the transaction. Total consideration included $0.3 million purchase consideration, representing the fair value of +ROI common stock acquired by the Company, and $6.4 million allocated for the fair value of the non-controlling interest. +18. WARRANTS +A summary of warrant activity for the years +ended December 31, 2024 and 2023 is presented below. +Schedule of warrants +Warrants +Weighted- +Average +Exercise Price +Weighted- +Average +Remaining +Contractual +Life (Years) +Outstanding at January 1, 2023 +52 +$ 589,255 +3.9 +Granted +405,042 +124.25 +5.0 +Forfeited +- +- +Exercised +- +- +Outstanding at December 31, 2023 +405,094 +178.50 +4.7 +Granted +71,794 +118.39 +5.0 +Forfeited +- +- +Exercised +- +- +Outstanding at December 31, 2024 +476,888 +$ 162.68 +3.9 +The following table summarizes information +about common stock warrants outstanding at December 31, 2024: +Schedule of common stock warrants outstanding +Outstanding +Exercisable +Weighted +Average +Weighted +Weighted +Remaining +Average +Average +Exercise +Number +Contractual +Exercise +Number +Exercise +Price +Outstanding +Life (Years) +Price +Exercisable +Price +$ 118.39 +422,337 +4.0 +$ 118.39 +422,337 +$ 118.39 +$ 160.74 +54,498 +3.8 +$ 160.74 +54,498 +$ 160.74 +$ 118,125 - $ 656,250 +53 +1.9 +$ 355,118 +53 +$ 355,118 +$ 118.39 - $ 656,250 +476,888 +3.9 +$ 162.68 +476,888 +$ 162.68 +F- 32 +Warrant Issuances During 2024 +During the year ended December 31, 2024, +the Company issued warrants to purchase 0.1 million shares of Class A common stock at a weighted average exercise price of $ 118.39 per +share, subject to adjustment, in connection with the issuance of Series C convertible preferred stock (the “Series C Preferred Stock”) +to a related party (see Note 29). +Warrant Issuances During 2023 +During the year ended December 31, 2023, +the Company issued warrants to purchase 0.4 million shares of Class A common stock at a weighted average exercise price of $ 124.08 per +share, subject to adjustment, in connection with the issuance of a senior secured convertible promissory note, related party (see Note +26) and Series C Preferred Stock to a related party (see Note 29). +The Company has valued the warrants issued +at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables such as the warrants’ +remaining contractual term, exercise price, current stock price, risk-free interest rate and estimated volatility of the Company’s +stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based on the implied yield available +on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +The Company utilized a variety of pricing +models and the weighted average assumptions used during the years ended December 31, 2024 and 2023 were as follows: +Schedule of weighted average assumptions +December 31, +2024 +December 31, +2023 +Exercise price +$ 118.39 +$ 124.08 +Contractual term in years +5.0 +5.0 +Volatility +153 % +168 % +Dividend yield +0 % +0 % +Risk-free interest rate +4.2 % +4.0 % +19. ACCOUNTS PAYABLE AND ACCRUED EXPENSES +Other current liabilities at December 31, 2024 and +2023 consisted of: +Schedule of other current liabilities +December 31, +December 31, +2024 +2023 +Accounts payable +$ 25,182,000 +$ 26,777,000 +Accrued payroll and payroll taxes +2,342,000 +8,237,000 +Interest payable +8,249,000 +4,197,000 +Accrued legal +2,399,000 +2,340,000 +Other accrued expenses +21,303,000 +13,871,000 +Total +$ 59,475,000 +$ 55,422,000 +During the year ended December 31, 2024, Ault Lending +reversed a previously accrued $ 5.7 million performance bonus related to realized gains on trading activities. Management determined that +the bonus would not be paid, and accordingly, the reversal was recorded as a reduction to general and administrative expenses. +20. LEASES +The Company has operating leases for office +space. The Company’s leases have remaining lease terms of 1.1 years to 9.0 years, some of which may include options to +extend the leases perpetually, and some of which may include options to terminate the leases within one year. +The following table provides a summary of +leases by balance sheet category as of December 31, 2024 and 2023: +Schedule of supplemental balance sheet information related to leases +December 31, +2024 +December 31, +2023 +Operating right-of-use assets +$ 3,697,000 +$ 3,409,000 +Operating lease liability - current +1,627,000 +1,376,000 +Operating lease liability - non-current +2,269,000 +2,163,000 +F- 33 +The components of lease expenses for the years +ended December 31, 2024 and 2023, were as follows: +Schedule of lease expenses +Year Ended December 31, +2024 +2023 +Operating lease cost +$ 1,918,000 +$ 2,390,000 +Short-term lease cost +- +- +The following tables provides a summary +of other information related to leases for the years ended December 31, 2024 and 2023: +Schedule of supplemental cash flow information related to leases +December 31, 2024 +December 31, 2023 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ 1,654,000 +$ 2,342,000 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ 2,080,000 +$ 820,000 +Weighted-average remaining lease term - operating leases +3.2 years +2.3 years +Weighted-average discount rate - operating leases +8.0 % +7.0 % +Maturity of lease liabilities under the +Company’s non-cancellable operating leases as of December 31, 2024, were as follows: +Schedule of maturities of operating lease liabilities +Payments due by period +2025 +$ 1,888,000 +2026 +1,210,000 +2027 +514,000 +2028 +339,000 +2029 +329,000 +Thereafter +166,000 +Total lease payments +4,446,000 +Less interest +( 550,000 ) +Present value of lease liabilities +$ 3,896,000 +21. DIVIDEND PAYABLE IN TURNONGREEN COMMON STOCK +In March 2024, the Company, in connection +with a planned distribution of its common stock holdings of TurnOnGreen, announced the distribution to its stockholders of 25.0 million +shares of TurnOnGreen common stock and warrants to purchase 25.0 million shares of TurnOnGreen common stock, which resulted in an adjustment +to additional paid in capital and increase to non-controlling interest of $ 4.9 million based on the recorded value of the Company’s +holdings in TurnOnGreen at the record date of the distribution. +22. ROI Transfers +of White River Common Stock +In January 2024, ROI announced that it had +concluded that, for regulatory reasons, ROI would be unable to effect the distribution of its shares of common stock of White River as +contemplated by a registration statement previously filed by White River. During the year ended December 31, 2024, ROI transferred 12.0 +million shares of White River common stock with a fair value of $ 19.2 million at the date of transfer to certain of its accredited investors +to resolve the matters discussed above. +In conjunction with the transfers to non-controlling +interests, shares of ROI’s investment in White River’s Series A Convertible Preferred Stock were converted into shares of +White River common stock, resulting in a non-cash $ 17.9 million gain on conversion. +23. REDEEMABLE NON-CONTROLLING INTERESTS IN EQUITY OF SUBSIDIARY +LIABILITY +The Company records redeemable non-controlling +interests in equity of subsidiaries to reflect the economic interests of the common stockholders in Ault Disruptive. +F- 34 +Redemption of Shares +On September 27, 2024, Ault Disruptive announced +that it would redeem all of its outstanding shares of common stock which occurred as of the close of business on October 11, 2024, because +Ault Disruptive would not consummate an initial business combination within the time period required by its Amended and Restated Certificate +of Incorporation, as amended. During the year ended December 31, 2024, shares of Ault Disruptive common stock were redeemed for an aggregate +redemption amount of $ 2.3 million. +The following table summarizes the changes +in the Company’s redeemable non-controlling interests in equity of subsidiaries during the year December 31, 2024 and 2023: +Redeemable noncontrolling interests in equity of subsidiary liability +For the Year Ended +December 31, +2024 +2023 +Redeemable non-controlling interests in equity of subsidiaries as of January 1 +$ 2,224,000 +$ 117,993,000 +Redemption of Ault Disruptive common stock +( 2,269,000 ) +( 120,064,000 ) +Extension proceeds paid by the Ault Disruptive sponsor +- +2,332,000 +Remeasurement of carrying value to redemption value +45,000 +1,963,000 +Redeemable non-controlling interests in equity of subsidiaries as of December 31 +$ - +$ 2,224,000 +F- 35 +24. NOTES PAYABLE +Notes payable at December 31, 2024 and 2023, +were comprised of the following: +Schedule of notes payable +Collateral +Guarantors +Interest rate +Effective rate (1) +Due date +December 31, 2024 +December 31, 2023 +AGREE secured construction loans (in default) +AGREE hotels +- +7.0 % +8.8 % +March 31, 2026 +$ 68,750,000 +$ 67,632,000 +Circle 8 revolving credit facility +Circle 8 cranes with a book value of $29.6 million +- +8.4 % +8.4 % +December 16, 2025 +13,126,000 +15,907,000 +16% promissory note +- +Ault & Company and Milton C. Ault, III +16.0 % (default rate of 24.0%) +- +- +- +2,572,000 +Circle 8 equipment financing notes +Circle 8 equipment with a book value of $4.3 million +- +10.5 % +10.5 % +September 15, 2025 through June 15, 2027 +2,826,000 +5,629,000 +15% term notes (in default) +- +Milton C. Ault, III +15.0 % (default rate of 22.99%) +48.0 % +October 31, 2024 +3,777,000 +- +8% demand loans +- +- +10.0 % (12.0% default rate) +- +Upon demand +- +950,000 +Sentinum note payable +- +- +12.5 % +- +- +- +1,067,000 +ROI promissory note (in default) +- +- +15.0 % (default rate of 18.0%) +67.2 % +April 30, 2024 +2,367,000 +- +Other ($3.4 million in default) +- +- +- +- +5,826,000 +3,808,000 +Total notes payable +$ 96,672,000 +$ 97,565,000 +Less: +Unamortized debt discounts +- +( 453,000 ) +Total notes payable, net +$ 96,672,000 +$ 97,112,000 +Less: current portion +( 95,768,000 ) +( 11,692,000 ) +Notes payable – long-term portion +$ 904,000 +$ 85,420,000 +(1) Includes forbearance and extension fees and OID costs that are amortized to interest expense over the +life of the notes. +F- 36 +During the year ended December 31, 2023, +the holders of $ 8.4 million 10% secured promissory notes exchanged their notes and accrued interest for preferred stock liabilities. The +Company recorded a loss on extinguishment of debt of $0.1 million related to the transaction. When the preferred stock liabilities converted +to Series A Common stock, the Company recorded a loss on extinguishment of $ 1.5 million. +During the year ended December 31, 2023, the holders of $ 10.5 +million 10% demand promissory notes and $ 1.1 million 12% demand promissory notes exchanged their notes for notes from Ault & Company +(see Note 22), resulting in a loss on extinguishment of debt of $ 0.4 million. +In connection with the December 2023 Series +C Preferred Stock offering (see Note 29), the Company paid $20.4 million to pay the $20.2 million outstanding balance of the 8% senior +secured promissory notes, plus $0.2 million accrued interest payable. The 8% senior secured promissory notes had an unamortized debt discount +of $ 3.2 million outstanding, which was recorded as a loss on extinguishment of debt. +The Company recorded a $ 2.0 million loss +on extinguishment of debt related to the April 2023 restructuring related to one of the 16% promissory notes payable. +OID Only Term Note +On July 2, 2024, the Company entered into +a term note agreement with institutional investors for the sale of up to $ 2.6 million in term notes, of which the principal amount of +$ 1.8 million was immediately funded. A term note was issued at a discount, with net proceeds to the Company of $ 1.5 million. +The term note does not accrue any interest. The term note was scheduled to mature on August 2, 2024. The term note is guaranteed by Mr. +Ault. The term note maturity was extended to September 30, 2024 , and an extension fee of $ 0.2 million accrues monthly until the term note +is paid in full. The term note is currently in default and is included in “Other” in the table above. +ROI 15% Term Note +On February 9, 2024, ROI entered into a +$ 1.77 million term note agreement with an institutional investor bearing interest of 15 % . The term note was issued at a discount, with +net proceeds to ROI of $ 1.75 million. The term note was scheduled to mature February 14, 2024. This note has been guaranteed by Ault & +Company and Mr. Ault. The term note was subsequently amended to increase the principal amount due to $ 2.4 million, increase the interest +rate to 18 % and extend the maturity date to April 30, 2024 . The term note is in default as of May 1, 2024. +In February 2025, term note was amended +to increase the principal amount due to $ 2.6 million, increase the interest rate to 18 % and extend the maturity date to May 15, 2025 . +15% Term Notes +Between April 29, 2024 and August 29, 2024, +the Company entered into note agreements totaling $ 6.0 million with an institutional investor bearing interest of 15 % . The term notes +were issued at a discount, with net proceeds to the Company of $ 5.1 million. The term notes were amended to extend the maturity dates +to October 31, 2024 . The notes are in default as of November 1, 2024. +In December 2024, Ault Lending had a fees +receivable from the institutional investor in the amount of $ 2.2 million related to Ault Lending’s profit participation rights in +an investment made by the institutional investor to Alzamend. On December 31, 2024, the Company and the institutional investor agreed +to offset $ 2.2 million of the term notes payable against the fees receivable. This transaction was accounted for as a non-cash settlement +of financial instruments and had no impact on the Company’s consolidated statement of operations. +In February 2025, the Company entered into +an exchange agreement with the institutional investor, pursuant to which the Company issued to the investor a convertible promissory note +in the principal face amount of $ 1.9 million in exchange for the cancellation of one of the outstanding 15% term notes issued by the Company +to the institutional investor that had outstanding principal and accrued but unpaid interest of $ 1.9 million. +In March 2025, the Company entered into +an exchange agreement with the institutional investor, pursuant to which the Company issued to the investor a convertible promissory note +in the principal face amount of $ 4.2 million in exchange for the cancellation of the outstanding 15% term notes issued by the Company +to the institutional investor that had outstanding principal and accrued but unpaid interest of $ 4.2 million. +F- 37 +The note will mature on June 30, 2025. The +note is convertible into shares of the Company’s Class A common stock at a conversion price equal to the greater of (i) $0.40 per +share (the “Floor Price”), which Floor Price shall not be adjusted for stock dividends, stock splits, stock combinations and +other similar transactions and (ii) the lesser of 75% of the VWAP (as defined in the note) of the Class A common stock during the five +trading days immediately prior to (A) the date of issuance of the note or (B) the date of conversion into shares of Class A common stock. +The Company may not issue shares to the extent such issuances would result in an aggregate number of shares of Class A common stock exceeding +19.99% of the total shares of Class A common stock issued and outstanding as of the date of issuance of the note, in accordance with the +rules and regulations of the NYSE unless the Company first obtains stockholder approval. +$20 Million Credit Agreement +On June 4, 2024 the Company entered into +a Loan Agreement (the “Credit Agreement”) with two institutional investors (collectively, the “Lender”). The Credit +Agreement provides for an unsecured, non-revolving credit facility with an aggregate draw limit of $ 20.0 million. However, the Company +is restricted to having no more than $ 2.0 million in principal amount of outstanding advances at any given time under the Credit Agreement. +As of December 31, 2024, $ 2.0 million has been advanced, exclusive of a $ 0.4 million OID. +All loans under the Credit Agreement will +be evidenced by a promissory note. The Lender made an advance to the Company of $1.5 million on the execution date. The advances were +due December 4, 2024 , however, per the terms of the Credit Agreement as the Company had executed an equity line of credit agreement relating +to the sale of shares of the Company’s 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock (the “Series D Preferred +Stock”), has an effective registration statement relating thereto, the maturity date was automatically extended until June 4, 2025. +The Lender is not obligated to make any further advances under the Credit Agreement after the maturity date. Advances under the Credit +Agreement will include the addition of an OID of 20% to the amount of each advance and all advances will bear interest at the rate of +15.0% per annum and may be repaid at any time without penalty or premium. Amounts outstanding under the Credit Agreement are included +in “Other” in the table above. +The obligations of the Company under the +Credit Agreement are secured by a guaranty provided by Milton C. Ault, the Executive Chairman of the Company. +Circle 8 Revolving Credit Facility +On October 16, 2024, Circle 8 was in default +related to reporting requirements under the terms of their revolving credit facility. Circle 8 was able to obtain waivers to cure the +event of default and defer the requirements until May 31, 2025. +Amendment to AGREE Secured Construction Loans +The AGREE secured construction loans with +an original due date of January 1, 2025, were amended on February 2, 2025, whereby AGREE agreed to pay monthly installments of interest +only based on an annualized interest rate of Term SOFR plus 4.75% . In addition, AGREE agreed to make principal payments of $1.0 million +in June 2025 and $2.0 million in September 2025 and December 2025 with the balance due March 1, 2026. AGREE has defaulted by failure +to make timely payments per the amended payment terms. +Notes Payable Maturities +Principal maturities of the Company’s +notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s option, as of December 31, 2024 +were: +Schedule of maturities +Year +2025 +$ 95,768,000 +2026 +794,000 +2027 +110,000 +$ 96,672,000 +Interest Expense +Interest expense includes amounts incurred on +notes payable, convertible notes payable, and notes payable to related parties. The components of interest expense for the years ended +December 31, 2024 and 2023 were as follows: +Schedule of interest expense +For the Year Ended +December 31, +2024 +2023 +Contractual interest expense +$ 11,925,000 +$ 17,338,000 +Forbearance fees +2,214,000 +5,469,000 +Amortization of debt discount +5,532,000 +21,507,000 +Total interest expense +$ 19,671,000 +$ 44,314,000 +F- 38 +25. NOTES PAYABLE, RELATED PARTY +Notes payable, related party at December +31, 2024 and 2023, were comprised of the following: +Schedule of notes payable, related party +Interest rate +Effective rate +Due date +December 31, +2024 +December 31, +2023 +Notes from officers - Hyperscale Data +18 % +18 % +- +$ - +$ 98,000 +Notes from officers - TurnOnGreen +14 % +14 % +Past due +46,000 +51,000 +Notes from board member - ROI +No interest +No interest +Upon demand +- +90,000 +Ault & Company advances +No interest +No interest +Upon demand +- +1,909,000 +Other related party advances +No interest +No interest +Upon demand +118,000 +227,000 +Total notes payable +$ 164,000 +$ 2,375,000 +Ault & Company Loan Agreement +On June 8, 2023, the Company entered into +a loan agreement with Ault & Company as lender. The loan agreement provides for an unsecured, non-revolving credit facility in an +aggregate principal amount of up to $ 10 million. All loans under the loan agreement are due within five business days after request by +Ault & Company. Ault & Company is not obligated to make any further advances under the loan agreement after December 8, 2023. +Advances under the loan agreement bear interest at the rate of 9.5 % per annum and may be repaid at any time without penalty or premium. +A total of $ 4.6 million was advanced under the loan agreement and was exchanged for a senior secured convertible promissory note with +Ault & Company (see Note 27). +In August 2023, Ault & Company assumed +$11.6 million of secured promissory notes previously issued by the Company for which the Company has issued term notes to Ault & Company +in the same amount. One term note has a principal amount of $1.1 million and bears interest at 12% and the second term note has a principal +amount of $10.5 million and bears interest at 10%. These assumed loans were exchanged for a senior secured convertible promissory note +with Ault & Company (see Note 27). +Summary of interest expense, related party, +recorded within interest expense on the consolidated statement of operations: +Schedule of interest expense, related party +For the Year Ended +December 31, +2024 +2023 +Interest expense, related party +$ 22,000 +$ - +26. CONVERTIBLE NOTES PAYABLE +Convertible notes payable at December 31, +2024 and 2023, were comprised of the following: +Schedule of convertible notes payable +Conversion price +per share +Interest rate +Effective rate (1) +Due date +December 31, +2024 +December 31, +2023 +Convertible promissory note –OID only, in default +90% of 5-day VWAP +OID Only +33.1 % +September 28, 2024 +$ 393,000 +$ 1,673,000 +10% OID convertible promissory note, in default +$ 5.80 +15 % +39.5 % +October 19, 2024 +5,020,000 +- +AVLP convertible promissory notes, principal +$0.35 (AVLP stock) +7 % +8.9 % +August 22, 2025 +9,911,000 +9,911,000 +ROI senior secured convertible note, in default +$ 0.11 (ROI stock) +OID Only +26.6 % +April 27, 2024 +4,245,000 +6,513,000 +Fair value of embedded conversion options +- +910,000 +Total convertible notes payable +19,569,000 +19,007,000 +Less: unamortized debt discounts +- +( 2,179,000 ) +Total convertible notes payable, net of financing cost, long term +$ 19,569,000 +$ 16,828,000 +Less: current portion +( 19,569,000 ) +( 7,375,000 ) +Convertible notes payable, net of financing cost – long-term portion +$ - +$ 9,453,000 +(1) Includes forbearance and extension fees and OID costs that are amortized to interest expense over the +life of the notes. +F- 39 +10% OID Convertible Promissory Note +On July 18, 2024, the Company entered into +a note purchase agreement (the “Purchase Agreement”) with an institutional investor (the “Investor”) pursuant +to which the Investor purchased from the Company, on July 19, 2024, in a registered direct offering, a $ 5.4 million 10% OID +Convertible Promissory Note (the “Note”). The Note was sold to the Investor for a purchase price of $ 4.9 million, which +included an OID of $0.5 million. The Note accrues interest at the rate of 15 % . The Note matured on October 19, 2024 and is in +default as of October 20, 2024. The Note is convertible into shares of Class A common stock at a conversion price of $ 5.80 per share. +During the year ended December 31, 2024, +the Investor converted $ 1.2 million of the Note into 0.2 million shares of Class A common stock that had a fair value of $ 1.5 million +at the time of conversion and the Company recognized a $ 0.3 million loss on extinguishment of debt. +In December 2024, the Company and the Investor +entered into a forbearance agreement pursuant to which the Investor agreed to forebear through the close of business on December 31, 2024, +from exercising the rights and remedies it is entitled in consideration for the Company’s agreement to issue a convertible promissory +note in the amount of $ 0.9 million (the “Forbearance Note”). +In February 2025, the Company and the Investor +entered into an amended and restated forbearance agreement pursuant to which the Investor agreed to forebear through the close of business +on May 15, 2025, from exercising the rights and remedies it is entitled in consideration for the Company’s agreement to issue to +the Investor an amended and restated convertible promissory note in the amount of $3.5 million (the “A&R Forbearance Note”), +consisting of (i) the amount then due under the Forbearance Note of $0.9 million, (ii) a forbearance extension fee of $0.3 million +and (iii) a true-up amount of $2.3 million. Subject to the approval by the NYSE and the Company’s stockholders, the A&R Forbearance +Note is convertible into shares of Class A common stock at a conversion price equal to $2.00, subject to adjustment. The A&R Forbearance +Note accrues interest at the rate of 18% per annum and matures on May 15, 2025. +6% Convertible Promissory Notes +On March 11, 2024, the Company entered into +a note purchase agreement with two institutional investors pursuant to which the investors agreed to acquire, and the Company agreed to +issue and sell in a registered direct offering to the investors an aggregate of $ 2.0 million convertible promissory notes, bearing +interest of 6 % . The convertible promissory notes were converted into shares of Class A common stock in May 2024 at a conversion price +of $ 12.25 per share and the Company recognized a $ 0.7 million loss on extinguishment of debt. +ROI Gain on Extinguishment of Senior Secured Convertible +Notes +During the year ended December 31, 2024, +ROI converted $ 2.3 million of ROI senior secured convertible notes that had a fair value of $ 0.9 million at the time of conversion and +recognized a $ 1.4 million gain on extinguishment of debt. +Contractual Maturities +Principal maturities of the Company’s +convertible notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s option, as of December +31, 2024, were: +Schedule of contractual maturities +Year +Principal +2025 +$ 19,569,000 +$ 19,569,000 +27. SENIOR SECURED CONVERTIBLE NOTE, RELATED PARTY +On October 13, 2023 (the “A&C +Closing Date”), the Company entered into a note purchase agreement with Ault & Company, pursuant to which the Company sold to +Ault & Company (i) a senior secured convertible promissory note in the principal face amount of $ 17.5 million (the “2023 Note”) +and warrants (the “Warrants”) to purchase shares of the Company’s common stock for a total purchase price of up to $17.5 +million. +The purchase price was comprised of the +following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to the Company since June 8, 2023 pursuant to the loan +agreement; (ii) cancellation of $11.6 million of term loans made by the Company to Ault & Company in exchange for Ault & Company +assuming liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 +shares of the Company’s Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being +transferred from Ault & Company to the Company. +F- 40 +The 2023 Note had a principal face amount +of $17.5 million and had a maturity date of October 12, 2028 (the “Maturity Date”). The 2023 Note bore interest at the rate +of 10 % per annum. The 2023 Note was repaid in full in December 2023 and the Company recorded a $4.2 million loss on extinguishment for +the year ended December 31, 2023. +The Warrants grant Ault & Company the +right to purchase 0.1 million shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary of the A&C +Closing Date, and become exercisable on the first business day after the six-month anniversary of the A&C Closing Date. The exercise +price of the Warrants is $ 160.74 , which is subject to adjustment in the event of customary stock splits, stock dividends, combinations +or similar events. +The Company elected the fair value option +and utilized a Monte-Carlo simulation at inception to value the 2023 Note. The Monte-Carlo simulation is calculated as the average present +value over all simulated paths. The key inputs and assumptions used in the Monte-Carlo Simulation, including volatility, estimated market +yield, risk-free rate, the probability of various scenarios, including held to maturity and subsequent preferred stock offering and various +simulated paths, were utilized to estimate the fair value at $17.8 million or approximately the principal amount outstanding as of inception. +The value of the 2023 Note was calculated as the average present value over 25,000 simulated paths. Given the 2023 Note was fully satisfied +in connection with issuance of the Series C Preferred Stock, the Company calculated the fair value on the date of extinguishment as the +total principal plus accrued interest outstanding. +The following table summarizes some of the +significant inputs and assumptions used in the Monte-Carlo simulation: +Schedule of senior secured convertible promissory note assumptions +2023 Note +Amounts +Principal outstanding at valuation date +$ 17.5 million +Volatility +80 % +Interest rate +10.0 % +Risk-free interest rate range +4.7 % to 5.6 % +Estimated yield +19.5 % to 21.0 % +The Company computed the fair value of the +warrants using the Black-Scholes option pricing model and, as a result of this calculation, recorded debt discount in the amount of $ 4.2 +million based on the estimated fair value of the Warrants. +In addition to a 21% discount for lack of +marketability, significant inputs associated with the calculation of the fair value of the Warrants included the following: +Schedule of convertible note +Contractual term in years +5.0 +Volatility +167.3 % +Dividend yield +0 % +Risk-free interest rate +4.7 % +The rollforward of the 2023 Note is as follows: +Schedule of senior secured convertible promissory note +2023 Note +Total +Balance as of December 31, 2022 +$ - +Exchange of loan agreement with Ault & Company +4,625,000 +Ault & Company note from exchange of 12% demand promissory note +1,100,000 +Ault & Company note from exchange of 10% demand promissory note +10,545,000 +Exchange of Series B convertible preferred stock +1,250,000 +Cash payments of senior secured convertible promissory note +( 150,000 ) +Payment from issuance of Series C Preferred Stock +( 17,370,000 ) +Balance as of December 31, 2023 +$ - +28. COMMITMENTS AND CONTINGENCIES +Contingencies +Litigation Matters +The Company is involved in litigation arising +from other matters in the ordinary course of business. The Company is regularly subject to claims, suits, regulatory and government investigations, +and other proceedings involving labor and employment, commercial disputes, and other matters. Such claims, suits, regulatory and government +investigations, and other proceedings could result in fines, civil penalties, or other adverse consequences. +F- 41 +Certain of these outstanding matters include +speculative, substantial or indeterminate monetary amounts. The Company records a liability when it believes that it is probable that +a loss has been incurred and the amount can be reasonably estimated. If the Company determines that a loss is reasonably possible and +the loss or range of loss can be estimated, the Company discloses the reasonably possible loss. The Company evaluates developments in +its legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible +losses disclosed, and makes adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and +the estimated amount of a loss related to such matters. +Arena Litigation +Arena Investors, LP (ROI Litigation) +On May 30, 2024, Arena Investors, LP (“Arena”), +in its capacity as collateral agent for five noteholders, filed a Complaint (the “ROI Complaint”) in the Supreme Court of +the State of New York, County of New York against the Company and ROI, in action captioned Arena Investors, LP v. Ault Alliance, Inc. +and RiskOn International, Inc. , Index No. 652792/2024. +This litigation relates to the $ 4.2 million +ROI senior secured convertible note disclosed in Note 26. +The ROI Complaint asserts a cause of action +for breach of contract against the Company based on a Guaranty, dated April 27, 2023, and entered into, amongst others, the Company and +Arena, and seeks damages in the amount of in excess of $ 3.75 million, plus interest, attorneys’ fees, costs, expenses, and disbursements. +The ROI Complaint also asserts a cause of +action for breach of contract against ROI based on an alleged breach of that certain Security Agreement, dated April 27, 2023, and entered +into among ROI and Arena. In connection with this cause of action, Arena seeks, among other things, costs and expenses from the Company +and ROI. +On July 31, 2024, the Company and ROI filed +a motion to dismiss seeking to partially dismiss the ROI Complaint, as against the Company, and to dismiss the ROI Compliant, in its entirety, +as against ROI. +On or about January 21, 2025, the Court +entered an order denying the part of the motion which sought partial dismissal of the ROI Complaint, as against Company, and granting +the part of the motion which sought dismissal of the ROI Complaint, in its entirety, as against ROI. +On February 18, 2025, the Company filed +an Answer to the ROI Complaint and asserted numerous affirmative defenses. +Based on the Company’s assessment +of the facts underlying the claims, the uncertainty of litigation, and the preliminary stage of the case, the Company cannot reasonably +estimate the potential loss or range of loss that may result from this action. Notwithstanding, the Company has recorded the unpaid portion +of the notes. An unfavorable outcome may have a material adverse effect on the Company’s business, financial condition and results +of operations. +Other Litigation Matters +With respect to the Company’s other +outstanding matters, based on the Company’s current knowledge, the Company believes that the amount or range of reasonably possible +loss will not, either individually or in aggregate, have a material adverse effect on the Company’s business, consolidated financial +position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant +uncertainties. +The Company had accrued loss contingencies +related to litigation matters of $ 2.3 million as of December 31, 2024 and 2023. +29. STOCKHOLDERS’ EQUITY +Class A Common Stock +Class A common stock confers upon the holders +the rights to receive notice to participate and vote at any meeting of stockholders of the Company, to receive dividends, if and when +declared, and to participate in a distribution of surplus of assets upon liquidation of the Company. +F- 42 +Class B Common Stock +The Class B common stock is identical to +the Class A common stock, with the exception that each share thereof carries 10 times the voting power of a share of Class A common stock. +The Class B common stock is convertible at any time into Class A common stock on a one-for-one basis. +Distribution of Class B Common Stock to Class A Common and +Series C Preferred Stockholders +On November 15, 2024, the Company announced +the distribution of 5.0 million shares of its Class B common stock to all holders of its Class A common stock and Series C Convertible +Preferred Stock on an as-converted basis. The record date for this dividend was November 29, 2024, and the payment date was December 16, +2024. +Preferred Stock +Preferred stock as of December 31, 2024 +consisted of the following: +Stockholders’ equity +Par Value +Per Share +Stated Value +Per Share +Shares +Authorized +Liquidation +Preference +Shares Issued and +Outstanding at +December 31, 2024 +Series A Convertible Preferred Stock +$ 0.001 +$ 25 +1,000,000 +$ 176,000 +7,040 +Series C Convertible Preferred Stock +$ 0.001 +$ 1,000 +75,000 +50,000,000 +50,000 +Series D Cumulative Redeemable Perpetual Preferred Stock +$ 0.001 +$ 25 +2,000,000 +8,096,000 +323,835 +Series E Redeemable Perpetual Preferred Stock +$ 0.001 +$ 25 +2,500,000 +16,250,000 +649,998 +Series F Exchangeable Preferred Stock +$ 0.001 +$ 1,000 +1,000,000 +999,000 +998,577 +Series G Convertible Preferred Stock +$ 0.001 +$ 1,000 +25,000 +- +- +Unallocated +18,400,000 +Total +25,000,000 +$ 75,521,000 +2,029,450 +Preferred stock as of December 31, 2023 +consisted of the following: +Par Value +Per Share +Stated Value +Per Share +Shares +Authorized +Liquidation +Preference +Shares Issued and +Outstanding at +December 31, 2023 +Series A Convertible Preferred Stock +$ 0.001 +$ 25 +1,000,000 +$ 176,000 +7,040 +Series C Convertible Preferred Stock +$ 0.001 +$ 1,000 +75,000 +41,500,000 +41,500 +Series D Cumulative Redeemable Perpetual Preferred Stock +$ 0.001 +$ 25 +2,000,000 +10,630,000 +425,197 +Unallocated +21,925,000 +Total +25,000,000 +$ 52,306,000 +473,737 +The Company is authorized to issue 25.0 +million shares of preferred stock, $0.001 par value. As of December 31, 2024, the rights, preferences, privileges and restrictions on +the remaining authorized 18.4 million shares of preferred stock have not been determined. The Board is authorized to designate a new series +of preferred shares and determine the number of shares, as well as the rights, preferences, privileges and restrictions granted to or +imposed upon any series of preferred shares. +10.00% Series E Cumulative Redeemable Perpetual Preferred +Stock (the “Series E Preferred Stock”) +On November 11, 2024 the Company filed a +Certificate of Designation, Rights and Preferences (the “Certificate of Designation”) with the Secretary of State of the State +of Delaware to establish the preferences, voting powers, limitations as to dividends or other distributions, qualifications, terms and +conditions of redemption and other terms and conditions of the Company’s Series E Preferred Stock. The following is a summary description +of those terms and the general effect of the issuance of the shares of Series E Preferred Stock on the Company’s other classes of +registered securities. +The Series E Preferred Stock will, as to +dividend rights and rights as to the distribution of assets upon the Company’s liquidation, dissolution or winding-up, rank: (1) +senior to all classes or series of Common Stock and to all other equity securities issued by the Company other than equity securities +referred to in clauses (2) and (3); (2) on parity with any future class or series of the Company’s equity securities expressly designated +as ranking on parity with the Series E Preferred Stock, (3) junior to the Company’s Series A Cumulative Redeemable Perpetual Preferred +Stock and its Series C Convertible Preferred Stock; and all equity securities issued by the Company expressly designated as ranking senior +to the Series E Preferred Stock; and (4) junior to all the Company’s existing and future indebtedness. +F- 43 +To the extent the shares of Series E Preferred +Stock are issued, the Company will pay cumulative cash dividends on the Series E Preferred Stock when, as and if declared by its board +of directors (or a duly authorized committee of its board of directors), only out of funds legally available for payment of dividends. +Dividends on the Series E Preferred Stock will accrue on the stated amount of $25.00 per share of the Series E Preferred Stock at a rate +per annum equal to 10.00% (equivalent to $3.00 per year), payable monthly in arrears. +The Series E Preferred Stock is redeemable +by the Company. Holders of shares of the Series E Preferred Stock generally will have no voting rights, except as required by law and +as provided in the Certificate of Designation. Voting rights for holders of the Series E Preferred Stock exist primarily with respect +to material and adverse changes in the terms of the Series E Preferred Stock and the creation of additional classes or series of preferred +stock that rank senior to the Series E Preferred Stock. +Distribution of Series E Preferred Stock to Class A Common +and Series C Preferred Stockholders +On November 13, 2024, the Company announced +the distribution of 0.7 million shares of its Series E Preferred Stock, a $16.3 million stated value, to holders of Class A common stock +and Series C preferred stock on an as-converted basis. The record date for this dividend was November 26, 2024, and the payment date was +December 9, 2024. +Series F Preferred Stock +On November 22, 2024, the Company filed +a Certificate of Designation, Rights and Preferences with the Secretary of State of the State of Delaware to establish the preferences, +voting powers, limitations as to dividends or other distributions, qualifications, terms and conditions of redemption and other terms +and conditions of the Company’s Series F Exchangeable Preferred Stock (the “Series F Preferred Stock”). The following +is a summary description of those terms and the general effect of the issuance of the shares of Series F Preferred Stock on the Company’s +other classes of registered securities. +There are 1.0 million shares of the Series +F Preferred Stock designated. +Each share of Series F Preferred Stock is +exchangeable, at the option of its holder, into (i) 10 shares of Class A Common Stock of Ault Capital Group, Inc., a Nevada corporation +and currently a wholly owned subsidiary of the Company (“ACG”) and (ii) five shares of Class B Common Stock of ACG at any +time beginning on the later of (i) one year after issuance of the Series F Preferred Stock and (ii) the date of the registration under +the Securities Act of all of the shares of Ault Class A Common Stock and Ault Class B Common Stock issuable upon the Exchange of the Series +F Preferred Stock. +The Series F Preferred Stock will, as to +rights as to the distribution of assets upon the Company’s liquidation, dissolution or winding-up, rank: (1) senior to all classes +or series of Common Stock and to all other equity securities issued by the Company other than equity securities referred to in clauses +(2) and (3); (2) on parity with any future class or series of the Company’s equity securities expressly designated as ranking on +parity with the Series F Preferred Stock, (3) junior to the Company’s Series A Cumulative Redeemable Perpetual Preferred Stock, +Series C Convertible Preferred Stock, Series D Preferred Stock and Series E Cumulative Redeemable Perpetual Preferred Stock; and all equity +securities issued by the Company expressly designated as ranking senior to the Series F Preferred Stock; and (4) junior to all the Company’s +existing and future indebtedness. +Distribution of Series F Preferred Stock to Class A Common +and Series C Preferred Stockholders +On November 26, 2024, the Company announced +the distribution of 1.0 million shares of its Series F Exchangeable Preferred Stock to holders of its Class A Common Stock and Series +C Convertible Preferred Stock. The record date for this dividend was December 13, 2024, and the payment date was December 23, 2024. +Series G Convertible Preferred Stock +On December 21, 2024, the Company filed +a Certificate of Designation (the “Series G Certificate of Designation”), which was amended on February 5, 2025, with the +Secretary of State of Delaware to establish the rights and preferences of the Series G Convertible Preferred Stock (the “Series +G Preferred Stock”). Each share has a stated value of $1,000.00 and is convertible into shares of Class A common stock at a conversion +price equal to the greater of (i) $0.10 per share or (ii) the lesser of (A) $6.74 or (B) 105% of the volume weighted average price for +the ten trading days prior to conversion. The conversion price is subject to adjustments for certain dilutive events. +Holders of Series G Preferred Stock vote +with common stockholders on an as-converted basis, subject to a voting floor price of $ 6.244 (as amended from $5.38). The stock ranks +senior to Series A, D, E, and F Preferred Stock in liquidation but is on parity with Series C Preferred Stock. +F- 44 +Series G Preferred Stock stockholders receive +cumulative cash dividends at an annual rate of 9.5% ($ 95.00 per share), payable monthly. For the first two years, the Company may elect +to pay dividends in Class A common stock at the conversion price. If dividends are in arrears, the rate increases to 12% per annum, payable +in cash, additional Series G Preferred Stock, or, if applicable, freely tradeable Class A common stock. +In the event of liquidation, holders receive +the stated value before distributions to junior classes. A change of control is treated as a liquidation event. +Series G Preferred Stock Sales Agreement with Ault & +Company +On December 21, 2024, the Company entered +into a Securities Purchase Agreement (the “Agreement”) with Ault & Company pursuant to which the Company agreed to sell +to Ault & Company up to 25,000 shares of Series G Preferred Stock and warrants (the “Series G Warrants”) to purchase shares +of Class A common stock for a total purchase price of up to $25.0 million. There were no sales under the Agreement during the year ended +December 31, 2024. +At closing, the Company will issue the Purchaser +the Series G Warrants, which grant Ault & Company the right to purchase a specified number of shares of Class A common stock (the +“Warrant Shares”). The exercise price of the Series G Warrants is $ 5.92 (the “Exercise Price”) and the number +of Warrant Shares is 4.2 million, which is the figure derived by dividing the actual investment amount by the Exercise Price. The Exercise +Price is subject to adjustment in the event of customary stock splits, stock dividends, combinations or similar events. +The Series G Warrants have a five-year term, +expiring on the fifth anniversary of issuance, and become exercisable on the first business day after the six-month anniversary of issuance. +Between January and April 2025, the +Company sold to Ault & Company an aggregate of 960 shares of Series G Convertible Preferred Stock and Series G Warrants to +purchase 0.2 million shares of Class A common stock, for a purchase price of $ 1.0 +million. +Series C Convertible Preferred Stock +On December 14, 2023, pursuant to the securities +purchase agreement the Company entered into with Ault & Company, dated as of November 6, 2023, the Company sold to Ault & Company, +in three separate closings that occurred on the closing date, an aggregate of 41,500 shares of Series C Preferred Stock and warrants (the +“Series C Warrants”) to purchase 0.4 million shares of Class A common stock, for a total purchase price of $ 41.5 million. +The proceeds from the sale of Series C Preferred +Stock were used in part to pay $ 17.5 million to satisfy the outstanding balance on the outstanding senior secured convertible promissory +note with Ault & Company. The senior secured convertible promissory note with Ault & Company had an unamortized debt discount +of $ 4.2 million outstanding, which was recorded as a loss on extinguishment of debt. +In addition, the Company paid $ 20.4 million +to pay the $20.2 million outstanding balance of the 8% senior secured promissory notes, plus $ 0.2 million accrued interest payable. The +8% senior secured promissory notes had an unamortized debt discount of $ 3.2 million outstanding, which was recorded as a loss on extinguishment +of debt. +On December 14, 2023, the Company, along +with its wholly owned subsidiaries Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending, Ault Aviation, LLC (“Ault Aviation”) +and AGREE (collectively with the Company, Sentinum, Third Avenue, ACS, BNI Montana, Ault Lending and Ault Aviation, the “Guarantors”) +entered into a Loan and Guaranty Agreement (the “Loan Agreement”) with institutional lenders, pursuant to which Ault & +Company borrowed $36 million and issued secured promissory notes to the lenders in the aggregate amount of $38.9 million (collectively, +the “Secured Notes”; and the transaction, the “Loan”). +Pursuant to the Loan Agreement, the Guarantors, +as well as Milton C. Ault, III, the Company’s Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) 19,226 Antminers (the “Miners”), (b) all of the digital currency mined or otherwise generated +from the Miners and (c) the membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, +pursuant to which those entities granted to the lenders a security interest in substantially all of their assets, as well as a pledge +of equity interests in Ault Aviation, AGREE, Sentinum, Third Avenue, Ault Energy, LLC, the Company’s wholly owned subsidiary, Ault +Disruptive, Eco Pack Technologies, Inc., the Company’s wholly owned subsidiary, and Circle 8 Holdco, (iii) a mortgage and security +agreement by Third Avenue on the Florida Property, (iv) a future advance mortgage by ACS on the real estate property owned by ACS in Dowagiac, +Michigan (the “Michigan Property”), (v) an aircraft mortgage and security agreement by Ault Aviation on a private aircraft +owned by Ault Aviation (the “Aircraft”), and (vi) deposit account control agreements over certain bank accounts held by certain +of the Company’s subsidiaries. +F- 45 +In addition, pursuant to the Loan Agreement, +the Company agreed to establish a segregated deposit account (the “Segregated Account”), which would be used as a further +guarantee of repayment of the Secured Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. The Company +was required to have the minimum balance in the Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million +on the four-month, nine-month, one-year and two-year anniversaries of the closing date, respectively. In addition, starting on March 31, +2024, the Company was required to deposit $0.3 million monthly into the Segregated Account, which increased to $0.4 million monthly starting +March 31, 2025. Further, the Company agreed to deposit into the Segregated Account, (i) up to the first $7 million of net proceeds, if +any, from the sale of the Hilton Garden Inn in Madison West, the Residence Inn in Madison West, the Courtyard in Madison West, and the +Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on a per dividend basis) received from Circle 8 on or after June 30, 2024; +(iii) 30% of the net proceeds from any bond offerings the Company conducts, which shall not exceed $9 million in the aggregate; and (iv) +25% of the net proceeds from cash flows, collections and revenues from loans or other investments made by Ault Lending (including but +not limited to sales of loans or investments, dividends, interest payments and amortization payments), which shall not exceed $5 million +in the aggregate. In addition, if the Company decides to sell certain assets, the Company further agreed to deposit funds into the Segregated +Account from the sale of those assets, including, (i) $15 million from the sale of the Florida Property, (ii) $11 million from the sale +of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, subject to a de minimis threshold of $1 +million, and (v) $10 million from the sale of Circle 8. +Pursuant to the Company’s financial +guarantee obligations noted above, the Company recorded a guarantee liability of $38.9 million using the practical expedient to fair +value as set forth in ASC 460-10-30-2(a) and recorded an expense of $35.4 million (the amount of the guarantee liability, less the $3.5 +million restricted cash in the Segregated Account) within other income (expense) on the consolidated statement of operations and comprehensive +loss for the year ended December 31, 2023. +The guarantee written by the Company represents +a variable interest in Ault & Company. Ault & Company, founded in 2015, is a private holding company focused on acquiring undervalued +assets and disruptive technologies within the commercial, defense, aerospace, industrial, hospitality, technology and real estate sectors. +Mr. Ault is the Founder and Executive Chairman of its Board of Directors. Ault & Company has demonstrated its ability to raise capital +independently, on a limited basis, however given the nature of its strategic investment policy, there is no requirement for it to raise +additional capital until and unless a strategic opportunity presents itself that requires additional capital. The nature and amount of +the financing that the Company guaranteed indicates that Ault & Company’s lender required the Company’s collateral and +support to close the December 2023 financing. +The accounting guidance requires the Company +to perform an analysis to determine whether its variable interest gives it a controlling financial interest in Ault & Company. The +Company performed a VIE analysis and determined that given the control structure and ownership of Ault & Company that the Company +would not be able to remove the key operating decision maker, Mr. Ault, from his leadership role at Ault & Company and therefore the +Company does not meet the power criterion to be considered the primary beneficiary of Ault & Company. +During the year ended December 31, 2024, +the Company sold to Ault & Company an aggregate of 8,500 shares of Series C Preferred Stock and Warrants to purchase 0.1 million shares +of Class A common stock, for a total purchase price of $ 8.5 million, respectively. +Amendments to Loan and Guarantee Agreement +On September 17, 2024, the loan and guarantee +agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed financial obligations of Ault & +Company borrowings, was amended regarding the Company’s obligations to fund the restricted cash Segregated Account. +The Company agreed to deposit in the Segregated +Account: (i) $0.4 million monthly commencing on September 30, 2024 and ending on February 28, 2025; and (ii) $0.5 million monthly +commencing on March 31, 2025 and ending on the earlier of the term loan maturity date, prepayment of the term loan in full or the date +on which the balance of the Segregated Account exceeds 110% of the outstanding balance of the term loan. As of December 31, 2024, the +Company had deposited $ 18.4 million in the Segregated Account. +On March 7, 2025 the loan and guarantee +agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed financial obligations of Ault & +Company borrowings, was further amended regarding the Company’s obligations to fund the restricted cash Segregated Account. +F- 46 +Pursuant to the March 7, 2025 amendment, +the Company agreed to deposit in the Segregated Account: (i) $0.2 million monthly commencing on April 11, 2025 and ending on June +11, 2025; and (ii) $0.4 million monthly commencing on July 11, 2025 and ending on the earlier of the term loan maturity date, prepayment +of the term loan in full or the date on which the balance of the Segregated Account exceeds 110% of the outstanding balance of the term +loan. +Common ATM Offering +During the year ended December 31, 2024, +the Company sold an aggregate of 0.7 million shares of Class A common stock pursuant to the At-The-Market issuance sales agreement, as +amended, entered into with Ascendiant Capital Markets, LLC in 2023 (the “2023 Common ATM Offering”) for gross proceeds of +$ 14.6 million. +ELOC Purchase Agreement +On June 20, 2024, the Company entered into +a purchase agreement, as amended on November 1, 2024 (the “ELOC Purchase Agreement”) with Orion Equity Partners, LLC (“Orion”), +which provides that, upon the terms and subject to the conditions and limitations set forth therein, the Company has the right to direct +Orion to purchase up to an aggregate of $ 37.5 million of shares of Series D Preferred Stock over the 36 -month term of the ELOC Purchase +Agreement at a purchase price equal to 94.5% of the average closing stock price during the seven consecutive trading days immediately +preceding a given purchase date. +The ELOC Purchase Agreement may be terminated +by the Company at any time after commencement, at its discretion, provided that at the time of termination, the Company does not have +any outstanding amounts owed to the Lenders, who are affiliates of Orion, pursuant to the Credit Agreement. +During the year ended December 31, 2024, +there were no purchases under the ELOC Purchase Agreement. +30. INCOME TAXES +The following is a geographical breakdown +of income/loss from continuing operations before the provision for income tax, for the years ended December 31, 2024 and 2023: +Schedule of income loss before the provision for income tax +2024 +2023 +Pre-tax loss +U.S. Federal +$ ( 58,979,000 ) +$ ( 240,483,000 ) +Foreign +( 2,724,000 ) +( 83,000 ) +Total +$ ( 61,703,000 ) +$ ( 240,566,000 ) +Deferred income taxes reflect the net tax +effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and income tax +purposes. Significant components of the Company’s deferred tax assets are as follows: +Schedule of deferred tax assets +2024 +2023 +Deferred tax asset: +Allowance for doubtful accounts +$ 502,000 +$ 314,000 +Unrealized losses +14,603,000 +13,172,000 +Obsolete inventory +- +351,000 +Stock compensation +4,192,000 +13,383,000 +Other carryforwards +- +- +Net operating loss carryforwards +55,001,000 +86,565,000 +Lease liability +790,000 +770,000 +Impairment +32,626,000 +29,701,000 +Accrued expenses +1,823,000 +2,228,000 +Interest expense +16,293,000 +14,713,000 +Outside basis difference +3,325,000 +9,308,000 +Intangible assets, net +9,000 +50,000 +Other +1,563,000 +1,356,000 +Total deferred tax asset +130,727,000 +171,911,000 +Deferred tax liability: +Right-of-use assets +( 734,000 ) +( 678,000 ) +Fixed assets, net +( 15,514,000 ) +( 15,226,000 ) +Total deferred income tax liabilities +( 16,248,000 ) +( 15,904,000 ) +Net deferred income tax assets +114,479,000 +156,007,000 +Valuation allowance +$ ( 114,479,000 ) +$ ( 156,007,000 ) +Deferred tax asset (liability), net +$ - +$ - +F- 47 +At +December 31, 2024, the Company had federal net operating loss carryforwards (“NOLs”) for income tax purposes of approximately +$ 191.9 million related to the years after December 31, 2017 that do not have an expiration under current tax law and $8.2 million related to the +years before January 1, 2018 subject to expiration after application of limitation set forth in Section 382 of the Internal Revenue Code +(“§382”). The Company had state NOLs for income tax purposes of approximately $ 238.2 million as of December 31, 2024. +The state NOLs may be used to offset future taxable income and will begin to expire in 2029, unless previously utilized. In accordance +with § 382, future utilization of the Company’s NOLs is subject to an annual +limitation as a result of ownership changes that occurred previously. The Company also maintains NOLs in various foreign jurisdictions. +In assessing the realization of deferred +tax assets, management considers whether it is more likely than not some portion or all deferred tax assets will not be realized. The +ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary +differences representing net future deductible amounts become deductible. Management considers the scheduled reversal of deferred tax +assets, projected future taxable income and tax planning strategies in making this assessment. After consideration of all positive and +negative evidence, including the Company’s generation of NOLs in current and prior periods, there is substantial doubt regarding +the Company’s ability to utilize its deferred tax assets, therefore, the Company recorded a full valuation allowance. For the year +ended December 31, 2024, the valuation allowance decreased by $ 41.5 million. +The net income tax provision (benefit) on continuing +operations consisted of the following: +Schedule of reconciliation of income tax attributable to operations +2024 +2023 +Current +U.S. Federal +$ 51,000 +$ 424,000 +U.S. State +5,000 +( 103,000 ) +Foreign +- +- +Total current provision +56,000 +321,000 +Deferred +U.S. Federal +- +- +U.S. State +- +27,000 +Foreign +- +- +Total deferred provision +- +27,000 +Total provision for income taxes +$ 56,000 +$ 348,000 +The Company’s effective tax rates +were ( 0.1 )% and ( 0.1 )% for the years ended December 31, 2024 and 2023, respectively. During the year ended December 31, 2024, the effective +tax rate differed from the U.S. federal statutory rate primarily due to the change in valuation allowance. The reconciliation of income +tax attributable to operations computed at U.S. Federal statutory income tax rates of 21 % to income tax expense is as follows: +Schedule of effective income tax rate reconciliation +2024 +2023 +Expected federal income tax benefit +21 .0 % +21 .0 % +State taxes net of federal benefit +8.2 % +- 1.5 % +Effect of change in valuation allowance +79.6 % +- 19.1 % +Permanent differences +2.6 % +1.4 % +Goodwill impairment +- +- 2.2 % +IRC Section 162(m) compensation limitation +- +0.0 % +Excess tax benefit - windfall/(shortfall) +- +- 0.3 % +Deconsolidation adjustments +- 110.5 % +- +Foreign rate differential +0.1 % +- +Other +- 1.1 % +0.5 % +Income tax benefit +- 0.1 % +- 0.1 % +F- 48 +The Company accounts for uncertain tax positions +in accordance with ASC 740-10-25. ASC 740-10-25 addresses the determination of whether tax benefits claimed or expected to be claimed +on a tax return should be recorded in the financial statements. Under ASC 740-10-25, the Company may recognize the tax benefit from an +uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, +based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater +than fifty percent likely of being realized upon ultimate settlement. To the extent that the final tax outcome of these matters is different +than the amount recorded, such differences impact income tax expense in the period in which such determination is made. Interest and penalties, +if any, related to accrued liabilities for potential tax assessments are included in income tax expense. ASC 740-10-25 also requires management +to evaluate tax positions taken by the Company and recognize a liability if the Company has taken uncertain tax positions that more likely +than not would not be sustained upon examination by applicable taxing authorities. Management of the Company has evaluated tax positions +taken by the Company and has concluded that as of December 31, 2024 and 2023, there are no uncertain tax positions taken, or expected +to be taken, that would require recognition of a liability that would require disclosure in the financial statements. +In general, the Company’s statute +of limitations remains open for various taxable years, in various U.S. federal, U.S. state and foreign jurisdictions. However, if and +when the Company claims net operating loss carryforwards against future taxable income, those losses may be examined by taxing authorities. +The Company will perform an analysis to determine the effect, if any, of these loss limitations rules on the NOL carryforward balances. +Earnings in all foreign jurisdictions are permanently reinvested. +31. NET LOSS PER SHARE +Net loss per share is computed by dividing +the net loss to common stockholders by the weighted average number of Class A common shares outstanding. The calculation of the basic +and diluted earnings per share is the same for all periods presented, as the effect of the potential common stock equivalents is anti-dilutive +due to the Company’s net loss position for all periods presented. Anti-dilutive securities, which are convertible into or exercisable +for Class A common stock, consisted of the following at December 31, 2024 and 2023: +Schedule of net loss per share +December 31, +2024 +2023 +Convertible preferred stock +9,142,000 +9,000 +Class B common stock +4,999,000 +- +Convertible notes +882,000 +2,000 +Warrants +477,000 +16,000 +Total +15,500,000 +27,000 +F- 49 +32. SEGMENT AND CUSTOMERS INFORMATION +The Company had the following reportable +segments as of December 31, 2024 and 2023; see Note 1 for a brief description of the Company’s business. The Company’s Chief +Operating Decision Maker (“CODM”) is its Executive Chairman, Mr. Ault. The performance measure of the Company’s reportable +segments is primarily income or (loss) from operations. Income or (loss) from operations for each segment includes all revenues, cost +of revenues, gross profit and other operating expenses directly attributable to the segment. The CODM is also provided with key non-cash +expenses by segment, including depreciation and amortization, impairment of property and equipment and impairment of goodwill and intangible +assets. These financial metrics are used for evaluating the performance of each segment and making decisions about allocating capital +and other resources to each segment. +The “Holding Co.” +column includes financial results that are not allocated to a specific reportable segment but are primarily generated within the holding +company entity. +The following data presents the revenues, +expenditures and other operating data of the Company and its operating segments for the year ended December 31, 2024: +Schedule of operating segments +TurnOnGreen +Fintech +Sentinum +AGREE +Energy +ROI +Holding Co. +Total +Revenue +$ 4,913,000 +$ - +$ - +$ - +$ 116,000 +$ 253,000 +$ 2,523,000 +$ 7,805,000 +Revenue, crypto assets mining +- +- +30,598,000 +- +- +- +- +30,598,000 +Revenue, hotel and real estate operations +- +- +876,000 +18,015,000 +- +- +- +18,891,000 +Revenue, crane operations +- +- +- +- +47,475,000 +- +- +47,475,000 +Revenue, lending and trading activities +- +1,893,000 +- +- +- +- +- +1,893,000 +Total revenue +4,913,000 +1,893,000 +31,474,000 +18,015,000 +47,591,000 +253,000 +2,523,000 +106,662,000 +Cost of revenue +2,647,000 +( 1,205,000 ) +34,338,000 +12,928,000 +31,411,000 +1,086,000 +1,240,000 +82,445,000 +Gross profit (loss) +2,266,000 +3,098,000 +( 2,864,000 ) +5,087,000 +16,180,000 +( 833,000 ) +1,283,000 +24,217,000 +Operating expenses +Research and development +1,008,000 +- +- +- +- +10,003,000 +- +11,011,000 +Selling and marketing +1,293,000 +- +- +- +- +12,726,000 +- +14,019,000 +General and administrative +4,038,000 +( 5,556,000 ) +( 746,000 ) +4,830,000 +16,267,000 +- +16,412,000 +35,245,000 +Impairment of property and equipment +- +- +10,500,000 +8,946,000 +- +- +- +19,446,000 +Impairment of goodwill and intangible assets +- +- +- +- +1,500,000 +- +- +1,500,000 +Total operating expenses +6,339,000 +( 5,556,000 ) +9,754,000 +13,776,000 +17,767,000 +22,729,000 +16,412,000 +81,221,000 +(Loss) income from operations +$ ( 4,073,000 ) +$ 8,654,000 +$ ( 12,618,000 ) +$ ( 8,689,000 ) +$ ( 1,587,000 ) +$ ( 23,562,000 ) +$ ( 15,129,000 ) +( 57,004,000 ) +Other income (expense): +Interest and other income +2,236,000 +Interest expense +( 19,671,000 ) +Gain on conversion of investment in equity +securities to marketable equity securities +17,900,000 +Gain on extinguishment of debt +2,981,000 +Loss from investment in unconsolidated entity +( 1,958,000 ) +Impairment of equity securities +( 6,266,000 ) +Gain on the sale of fixed assets +79,000 +Total other expense, net +( 4,699,000 ) +Loss before income taxes +$ ( 61,703,000 ) +Depreciation and amortization expense +$ 98,000 +$ - +$ 14,879,000 +$ 2,735,000 +$ 4,641,000 +$ 74,000 +$ 2,010,000 +$ 24,437,000 +Interest expense +$ - +$ ( 97,000 ) +$ ( 125,000 ) +$ ( 6,039,000 ) +$ ( 2,808,000 ) +$ ( 3,879,000 ) +$ ( 6,723,000 ) +$ ( 19,671,000 ) +Capital expenditures for the year ended +December 31, 2024 +$ 53,000 +$ - +$ 1,697,000 +$ 797,000 +$ 2,023,000 +$ 157,000 +$ 101,000 +$ 4,828,000 +Segment identifiable assets as of December 31, +2024 +$ 3,050,000 +$ 6,676,000 +$ 35,260,000 +$ 69,130,000 +$ 45,524,000 +$ 1,130,000 +$ 59,701,000 +$ 220,471,000 +F- 50 +Segment information for the year ended +December 31, 2023: +TurnOnGreen +Fintech +Sentinum +SMC +AGREE +Energy +ROI +Holding Co. +Total +Revenue +$ 4,201,000 +$ - +$ - +$ 31,557,000 +$ - +$ 899,000 +$ 305,000 +$ - +$ 36,962,000 +Revenue, crypto assets mining +- +- +33,107,000 +- +- +- +- +- +33,107,000 +Revenue, hotel and real estate operations +- +- +1,416,000 +- +16,161,000 +- +- +- +17,577,000 +Revenue, crane operations +- +- +- +- +- +49,198,000 +- +- +49,198,000 +Revenue, lending and trading activities +- +( 1,998,000 ) +- +- +- +- +- +- +( 1,998,000 ) +Total revenue +4,201,000 +( 1,998,000 ) +34,523,000 +31,557,000 +16,161,000 +50,097,000 +305,000 +- +134,846,000 +Cost of revenue +3,306,000 +1,180,000 +36,446,000 +23,971,000 +12,300,000 +30,686,000 +2,173,000 +- +110,062,000 +Gross profit (loss) +895,000 +( 3,178,000 ) +( 1,923,000 ) +7,586,000 +3,861,000 +19,411,000 +( 1,868,000 ) +- +24,784,000 +Operating expenses +Research and development +418,000 +- +- +- +- +- +4,000,000 +- +4,418,000 +Selling and marketing +1,446,000 +- +- +3,345,000 +- +- +26,862,000 +- +31,653,000 +General and administrative +3,412,000 +238,000 +171,000 +11,213,000 +3,383,000 +13,857,000 +7,487,000 +28,439,000 +68,200,000 +Impairment of property and equipment +- +- +- +- +8,284,000 +14,025,000 +4,136,000 +- +26,445,000 +Impairment of goodwill and intangible assets +- +- +- +- +- +42,880,000 +- +- +42,880,000 +Impairment of mined crypto assets +- +- +489,000 +- +- +- +- +- +489,000 +Total operating expenses +5,276,000 +238,000 +660,000 +14,558,000 +11,667,000 +70,762,000 +42,485,000 +28,439,000 +174,085,000 +Loss from operations +$ ( 4,381,000 ) +$ ( 3,416,000 ) +$ ( 2,583,000 ) +$ ( 6,972,000 ) +$ ( 7,806,000 ) +$ ( 51,351,000 ) +$ ( 44,353,000 ) +$ ( 28,439,000 ) +( 149,301,000 ) +Other income (expense): +Interest and other income +4,444,000 +Interest expense +( 44,314,000 ) +Other expense, guarantee +( 35,400,000 ) +Loss on extinguishment of debt +( 7,322,000 ) +Loss on extinguishment of debt, related party +( 4,164,000 ) +Loss from investment in unconsolidated entity +( 302,000 ) +Loss on deconsolidation of subsidiary +( 3,040,000 ) +Impairment of equity securities +( 9,555,000 ) +Change in fair value of warrant liability +6,319,000 +Gain on the sale of fixed assets +2,069,000 +Total other expense, net +( 91,265,000 ) +Loss before income taxes +$ ( 240,566,000 ) +Depreciation and amortization expense +$ 93,000 +$ - +$ 18,295,000 +$ 884,000 +$ 2,074,000 +$ 4,377,000 +$ 173,000 +$ 2,056,000 +$ 27,952,000 +Interest expense +$ 124,000 +$ - +$ 221,000 +$ 338,000 +$ 7,898,000 +$ 2,344,000 +$ 4,383,000 +$ 29,006,000 +$ 44,314,000 +Capital expenditures for the year ended +December 31, 2023 +$ 145,000 +$ - +$ 2,019,000 +$ 383,000 +$ 6,347,000 +$ 3,603,000 +$ 479,000 +$ 1,766,000 +$ 14,742,000 +Segment identifiable assets as of December 31, +2023 +$ 4,717,000 +$ 17,027,000 +$ 59,903,000 +$ - +$ 90,991,000 +$ 51,254,000 +$ 9,920,000 +$ 32,716,000 +$ 266,528,000 +Assets of discontinued operations +32,367,000 +Total identifiable assets as of December 31, +2023 +$ 298,895,000 +33. CONCENTRATIONS OF CREDIT AND REVENUE RISK +Significant customers are those that represent +more than 10% of the Company’s total revenue or accounts receivable balances for the periods and as of each balance sheet date presented. +For each significant customer, revenue as a percentage of total revenue and gross accounts receivable as a percentage of total gross accounts +receivable as of the periods presented were as follows: +Schedule of concentrations of credit and revenue risk +Accounts Receivable +Revenue +December 31, +December 31, +For the Year Ended December 31, +2024 +2023 +2024 +2023 +Customer A +* +* +23 % +13 % +Customer B +19 % +17 % +* +* +Customer C +10 % +13 % +* +* +* less than 10% +34. SUBSEQUENT EVENTS +Issuances of Series D Preferred Stock +From January 1, 2025 through April 14, +2025, the Company issued a total of 135,957 +shares of its Series D preferred stock for the settlement of ELOC advances totaling $ 2.0 +million. +F- 51 +OID Only Term Note +On January 14, 2025, the Company entered +into a term note agreement with institutional investors for $2.5 million. The term note was issued at a discount, with net proceeds to +the Company of $ 2.2 million. The term note does not accrue any interest. The term note was scheduled to mature on March 1, 2025. The term +note is guaranteed by Mr. Ault. +15% Promissory Note +On March 7, 2025, the Company entered into +a promissory note agreement with an institutional investor with a principal amount of $ 0.5 million and an interest rate of 15 % . The maturity +date of the promissory note is December 7, 2025 . Mr. Ault entered into a personal guaranty agreement for the benefit of the investor. +March 2025 Convertible Promissory Note +On March 21, 2025 the Company entered into +an exchange agreement with SJC Lending, LLC, a Delaware limited liability company (“SJC”), pursuant to which the Company issued +to SJC a convertible promissory note in the principal face amount of $ 4.9 million (the “Note”) in exchange for the cancellation +of the following notes the Company issued to Steve J. Caspi, the sole member of SJC, who transferred such notes to SJC, (i) a term note +issued on January 14, 2025 in the principal face amount of $2.5 million, (ii) a promissory note issued on March 7, 2025 in the principal +face amount of $0.5 million, (iii) a promissory note issued on March 12, 2025 in the principal face amount of $1.5 million and (iv) +a promissory note issued on March 13, 2025 in the principal face amount of $0.3 million. +The Note accrues interest at the rate of +15% per annum, unless an event of default (as defined in the Note) occurs, at which time the Note would accrue interest at 18% per annum. +The Note will mature on December 31, 2025. The Note is convertible into shares of Class A common stock at any time after NYSE American +(“NYSE”) approval of the Supplemental Listing Application (the “SLAP”) at a conversion price equal to the greater +of (i) $0.40 per share (the “Floor Price”), which Floor Price shall not be adjusted for stock dividends, stock splits, stock +combinations and other similar transactions and (ii) the lesser of 75% of the VWAP (as defined in the Note) of the Class A common stock +during the five trading days immediately prior to (A) the date of issuance of the Note or (B) the date of conversion into shares of Class +A common stock, but not greater than $10.00 per share (the “Maximum Price”), which Maximum Price shall be adjusted for stock +dividends, stock splits, stock combinations and other similar transactions. +Amendment to Securities Purchase Agreement +On March 30, 2025, the Company entered into +an amendment to the (i) November 2023 Securities Purchase Agreement (the “SPA”) with Ault & Company and (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Convertible Preferred Stock, to (A) eliminate the ability +of the purchaser to satisfy the purchase price for the securities through the surrender of a portion of the outstanding note, thereby +requiring that all future closings under the SPA be funded solely in cash, and (B) extend the outside date by which the final closing +may occur to March 31, 2025, subject to the purchaser’s right to further extend such date for an additional ninety (90) days. +April 2025 Convertible Promissory Note +On April 1, 2025, the Company issued to +an institutional investor, a convertible promissory note in the principal face amount of $1.7 million (the “April 2025 Note”) +in consideration for an advance of $1.5 million previously made by the investor to the Company (the “Transaction”). The April +2025 Note has a principal face amount of $ 1.7 million and was issued with an OID of 10 % . The April 2025 Note accrues interest at the rate +of 15 % per annum, unless an event of default (as defined in the April 2025 Note) occurs, at which time the April 2025 Note would accrue +interest at 18% per annum. The April 2025 Note will mature on September 30, 2025. The April 2025 Note is convertible into shares of the +Company’s class A common stock at any time after NYSE approval of the SLAP at a conversion price equal to the greater of (i) $0.40 +per share, which shall not be adjusted for stock dividends, stock splits, stock combinations and other similar transactions and (ii) the +lesser of 75% of the VWAP (as defined in the April 2025 Note) of the Class A common stock during the five trading days immediately prior +to the closing date or the date of conversion. +Series B Convertible Preferred Stock Securities Purchase +Agreement +On March 31, 2025 (the “Execution +Date”), the Company entered into a Securities Purchase Agreement (the “Series B Agreement”) with SJC, pursuant to which +the Company agreed to sell to SJC up to 50,000 shares of Series B convertible preferred stock (the “Series B Convertible Preferred +Stock”), which are convertible into the Company’s Class A common stock for a total purchase price of up to $50.0 million (the +“Preferred Transaction”). +F- 52 +The consummation of the transactions contemplated +by the Series B Agreement, specifically the conversion of the Series G Convertible Preferred Stock in an aggregate number in excess of +19.99% on the execution date of the Series B Agreement, are subject to various customary closing conditions as well as regulatory and +stockholder approval. +The Series B Agreement contains customary +termination provisions for the Purchaser under certain circumstances, and the Series B Agreement shall automatically terminate if the +closing has not occurred prior to June 30, 2025, though such date may be extended by SJC as set forth in the Series B Agreement. The Series +B Agreement provides that the Financing may be conducted through up to 49 closings. +The material terms of the Series B Agreement +and the Series B Convertible Preferred Stock are summarized below. +Description of the Series B Agreement +Holders of the Series B Preferred Stock +are entitled to written notice of stockholder meetings or written consents, along with related materials and information, in accordance +with the Company’s Bylaws and the Delaware General Corporation Law. +The Series B Agreement provides that the +Preferred Transaction shall be conducted through 49 separate Tranche Closings, provided, however, that the Investor has the ability, exercisable +in its sole discretion, to purchase any number of shares of Series B Preferred Stock prior to the dates of the Tranche Closings provided +for in the Series B Agreement. Pursuant to the Series B Agreement, the initial Tranche Closing, which will close promptly after SJC has +converted out of certain convertible notes that it holds, will consist of the sale and issuance to SJC of 2,000 shares of Series B Preferred +Stock for an aggregate of $ 2.0 million (the “Initial Tranche Closing”). +Pursuant to the Series B Agreement, SJC, +provided certain closing conditions have been met, including that all underlying shares of Class A Comon Stock shall have been registered +for resale under the Securities Act of 1933, as amended (the “Securities Act”), shall purchase up to 4,800 shares of Series +B Preferred Stock on a monthly basis, with SJC being required to purchase 1,000 shares per month (each, a “Subsequent Tranche Closing”) +until all shares of Series B Preferred Stock have been issued and sold to SJC. +Commencing on the Execution Date and continuing +for a period of 90 days thereafter, neither the Company nor any subsidiary thereof shall issue, enter into any agreement to issue or announce +the issuance or proposed issuance of any shares of Common Stock or instruments convertible into, exercisable or exchangeable for such +shares of Class A common stock, with certain exceptions. +Additionally, commencing on the Execution +Date and continuing for a period of one year thereafter, the Company shall be prohibited from entering into a variable rate transaction. +From the Execution Date and continuing until +the date that is two years therefrom, SJC shall have a right of first refusal with respect to any investment proposed to be made by any +individual or entity for each and every future public or private equity offering, including a debt instrument convertible into equity +of the Company during such period. +Description of the Series B Preferred +Stock +Conversion Rights +Each share of Series B Preferred Stock has +a stated value of $1,000 and is convertible into shares of Class A common stock (the “Conversion Shares”) at a at a conversion +price equal the lesser of a 25% discount to the Company’s Volume Weighted Average Price during the five trading days immediately +prior to (A) the Execution Date or (B) the date of conversion into shares of Class A common stock, but not greater than $10 per share +(the “Maximum Price”), which Maximum Price shall be adjusted for stock dividends, stock splits, stock combinations and other +similar transactions (the “Conversion Price”). Notwithstanding the foregoing, in no event shall the Series B Preferred Stock +be convertible at less than $0.40 (the “Floor Price”). The Conversion Price is subject to adjustment in the event of an issuance +of Class A common stock at a price per share lower than the Conversion Price then in effect, as well as upon customary stock splits, stock +dividends, combinations or similar events. The Floor Price will under no circumstances be adjusted for stock dividends, stock splits, +stock combinations or similar transactions. +Voting Rights +The holders of the Series B Preferred Stock +are entitled to vote with the Class A common stock as a single class on an as-converted basis, subject to applicable law provisions of +the Delaware General Corporation Law and the NYSE American (at times referred to as the “Exchange”), provided however, that +for purposes of complying with Exchange regulations, the conversion price, for purposes of determining the number of votes the holder +of Series B Convertible Preferred Stock is entitled to cast, shall not be lower than $2.44 (the “Voting Floor Price”), which +represents the closing sale price of the Class A common stock on the trading day immediately prior to the Execution Date. The Voting Floor +Price shall be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +F- 53 +Dividend Rights +The holders of Series B Convertible Preferred +Stock are entitled to cumulative cash dividends at an annual rate of 15%, or $150 per share, based on the stated value per share. Dividends +shall accrue from the date of the Initial Tranche Closing, for as long as any shares of Series B Preferred Stock remain issued and outstanding +and are payable monthly in arrears. For the first two years, the Company may elect to pay the dividend amount in Class A common stock +(the “PIK Shares”) rather than cash, with the number of shares of Class A common stock issued at the Conversion Price at the +date that the dividend payment is due. Dividends will accrue regardless of the Company’s earnings or funds availability and will +not exceed the full cumulative dividends. +Liquidation Rights +In the event of liquidation, dissolution, +or winding up of the Company, the holders of Series B Preferred Stock have a preferential right to receive an amount equal to the stated +value per share of Series B Preferred Stock before any distribution to other classes of capital stock, provided, however, that it ranks +on a pari passu basis with the Series C Preferred Stock and the Series G Preferred Stock. If the assets are insufficient, the distribution +will be prorated among the holders of Series B Preferred Stock, Series C Preferred Stock and Series G Preferred Stock. The remaining assets +will be distributed pro rata to the holders of outstanding Capital Stock and all holders of Series B Preferred Stock as if they had converted +their Series B Preferred Stock into Class A common stock. The Series B Preferred Stock rank senior over other classes of preferred stock, +including the Series A, D, E and F Preferred Stock. Additionally, any transaction that constitutes a change of control transaction shall +be deemed to be a liquidation under the Certificate of Designation of the Preferences, Rights and Limitations of Series B Convertible +Preferred Stock (the “Series B Certificate of Designation”). +The Company may not issue Conversion Shares +to the extent such issuances would result in an aggregate number of shares of Class A common stock exceeding 19.99% of the total shares +of Class A common stock issued and outstanding as of the Execution Date, in accordance with the rules and regulations of the Exchange +unless the Company first obtains stockholder approval (the “Stockholder Approval”). Pursuant to the Series B Agreement and +as required by the Exchange, the Company agreed to file a proxy statement to obtain the Stockholder Approval. +F- 54 \ No newline at end of file diff --git a/raw/filings/0000896493/2024/0001214659-25-005868/filing_metadata.csv b/raw/filings/0000896493/2024/0001214659-25-005868/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..97083e8084671ae5d15f460cb59ac19f09c7abcd --- /dev/null +++ b/raw/filings/0000896493/2024/0001214659-25-005868/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000896493,AULT,"Hyperscale Data, Inc.",10-K,2025-04-15,2024-12-31,2025-04-15T13:10:16.000Z,0001214659-25-005868,r4925210k.htm,,18093601,1,1,https://www.sec.gov/Archives/edgar/data/896493/000121465925005868/r4925210k.htm,https://www.sec.gov/Archives/edgar/data/896493/000121465925005868/,2024,2024,1 diff --git a/raw/filings/0000896493/2024/0001214659-25-005868/item1.txt b/raw/filings/0000896493/2024/0001214659-25-005868/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..a8620d593b40f1463d9debb09fea2533e7dfbaec --- /dev/null +++ b/raw/filings/0000896493/2024/0001214659-25-005868/item1.txt @@ -0,0 +1,1484 @@ +ITEM 1. BUSINESS +Company Overview +Hyperscale Data, Inc., a Delaware +corporation formerly known as Ault Alliance, Inc., was incorporated in September 2017. Through our wholly and majority owned subsidiaries +and strategic investments, we own and/or operate data centers at which we mine Bitcoin and offer colocation and hosting services for the +emerging artificial intelligence (“AI”) ecosystems and other industries as well as provide mission-critical products that +support a diverse range of industries, including an artificial intelligence software platform, a social gaming platform, equipment rental +services, defense/aerospace, industrial, automotive, medical/biopharma and hotel operations. Our direct and indirect wholly owned subsidiaries +include (i) Sentinum, Inc. (“Sentinum”), (ii) Alliance Cloud Services, LLC (“ACS”) and (iii) BNI Montana, LLC +(“BNI Montana”). +We own Ault Capital Group, +Inc. (“Ault Capital”), which either wholly owns or has a direct controlling interest in, among other entities, (i) Ault Lending, +LLC (“Ault Lending”), (ii) RiskOn International, Inc., formerly known as BitNile Metaverse, Inc. (“ROI”), which +wholly owns BitNile.com, Inc. (“BNC”), (iii) askROI, Inc. (“askROI”), (iv) Ault Global Real Estate Equities, Inc. +(“AGREE”), (v) Eco Pack Technologies, Inc. (“Eco Pack”), (vi) Ault Aviation, LLC (“Ault Aviation”), +(vii) Circle 8 Holdco LLC (“Circle 8 Holdco”), which wholly owns Circle 8 Crane Services, LLC (“Circle 8”) and +(viii) TurnOnGreen, Inc. (“TurnOnGreen”), which wholly owns TOG Technologies, Inc. (“TOG Technologies”) and Digital +Power Corporation (“Digital Power”). +We were founded by Milton +C. (Todd) Ault, III, our Executive Chairman, and are led by Mr. Ault, William B. Horne, our Chief Executive Officer and Vice Chairman, +and Henry Nisser, our President and General Counsel. Together, they constitute the Executive Committee, which manages the day-to-day operations +of the holding company. Our long-term objective is to maximize per share intrinsic value. All major investment and capital allocation +decisions are made for us by Mr. Ault and the Executive Committee. +We currently have the following +reportable segments, though it should be noted that we are in the process of transitioning our data centers away from Bitcoin mining to +operations dedicated to high-performance computing (“HPC”) and AI purposes: +· Technology and Finance (“Fintech”): commercial lending and trading through Ault Lending; +· Sentinum: Bitcoin mining operation and data center operations through ACS; +· AGREE – hotel operations and other commercial real estate holdings; +· Energy and Infrastructure (“Energy”): crane rental and lifting solutions provider for oilfield, +construction, commercial and infrastructure markets through Circle 8; +· ROI: includes askROI, which operates a unique, generative AI-driven platform engineered to provide pertinent +and unique data insights through integration with business specific data that pushes beyond the conventional uses of existing large language +models as well as RiskOn, which owns 100% of BNC, which operates a social gaming platform; and +· TurnOnGreen: commercial electronics solutions with operations conducted by Digital Power, and electric +vehicle (“EV”) charging solutions through TOG Technologies. +We operate as a holding company +with operations conducted primarily through our subsidiaries, which are described below. +Recent Events and Developments +On June 4, 2024, we entered +into a Loan Agreement (the “2024 Credit Agreement”) with OREE Lending Company, LLC and Helios Funds LLC, as lenders (“Lenders”). +Each Lender is a 50% member of (and thus affiliate of) Orion Equity Partners, LLC (“Orion”). The 2024 Credit Agreement provided +for an unsecured, non-revolving credit facility in an aggregate principal amount of up to $20.0 million, provided, however, that at no +point shall we be allowed to have outstanding loans under the 2024 Credit Agreement in a principal amount received of more than $2.0 million +(unless otherwise allowed by Lenders in their sole discretion). All loans under the 2024 Credit Agreement were due December 4, 2024. The +Lenders are not obligated to make any further loans under the 2024 Credit Agreement after the maturity date described above. Loans under +the 2024 Credit Agreement are evidenced by promissory notes (the “Promissory Notes”) and have an original issuance discount +of 20% to the amount of each loan and all Promissory Notes, originally bore interest at the rate of 15.0% per annum and may be repaid +at any time without penalty or premium. +1 +Under the 2024 Credit Agreement, +the Lenders loaned to us $1.5 million on June 4, 2024, $0.5 million on June 20, 2024 and $1.5 million on or about July 2, 2024. As of +the date of this Annual Report, we have repaid $2.0 million to the Lenders. On January 9, 2025, we and each Lender amended (a) the 2024 +Credit Agreement whereby, among other things, upon the effectiveness of a registration statement, the 2024 Credit Agreement shall terminate +and be of no further force and effect, (b) the notes whereby no additional interest (other than the 20% OID) shall accrue on such notes. +As a result of these amendments, the aggregate amount payable to the Lenders by us, above the principal amount of $3.5 million under the +2024 Credit Agreement, is $0.7 million. +On June 20, 2024, we entered +into the ELOC Purchase Agreement, as amended (as amended, the “Purchase Agreement”) with Orion, pursuant to which Orion has +committed to purchase up to an aggregate of $37.5 million of shares of 13.00% Series D Cumulative Redeemable Perpetual Preferred +Stock, par value $0.001 per share (“Series D Preferred Stock”), subject to certain limitations and conditions set forth in +the Purchase Agreement. The shares of our Series D Preferred Stock that may be issued under the Purchase Agreement may be sold by us to +Orion at our discretion from time to time during the term of the Purchase Agreement. +On July 18, 2024, we entered +into a note purchase agreement with an institutional investor pursuant to which the institutional investor agreed to acquire, and we agreed +to issue and sell in a registered direct offering to the institutional investor, a $5.4 million 10% OID Convertible Promissory Note (the +“OID Note”). The OID Note was sold to the institutional investor for a purchase price of $4.9 million, an original issue +discount of $0.5 million. The OID Note will accrue interest at the rate of 15% per annum, unless an event of default occurs, at which +time the OID Note would accrue interest at 18% per annum. The OID Note matured on October 19, 2024. In addition, the OID Note is convertible +into shares of our Class A common stock at a conversion price of $5.867 per share (the “OID Conversion Price”), subject to +adjustment. On December 10, 2024, we entered into a forbearance agreement with the investor pursuant to which the investor agreed to forebear +through the close of business on December 31, 2024, from exercising the rights and remedies it is entitled to under the OID Note, and +we issued the investor a convertible promissory note in the amount of $0.9 million (the “Forbearance Note”). The Forbearance +Note was convertible into shares of Class A common stock at a conversion price equal to $5.47, subject to adjustment. The Forbearance +Note accrued interest at the rate of 18% per annum and matured on February 15, 2025. On February 25, 2025, pursuant to an amended and +restated forbearance agreement we entered into with the institutional investor, we issued to the investor an amended and restated convertible +promissory note in the amount of $3.5 million (the “A&R Forbearance Note”), consisting of (i) the amount +then due under the forbearance note of $0.9 million, (ii) a forbearance extension fee of $0.3 million and (iii) a true-up amount of $2.3 +million. The A&R Forbearance Note shall be convertible into shares of Class A common stock at a conversion price equal to $2.00. The A&R +Forbearance Note will accrue interest at the rate of 18% per annum and mature on May 15, 2025. In exchange, the investor agreed to +forbear through the close of business on May 15, 2025, from exercising any rights and remedies under the $5.4 million 10% OID Convertible +Promissory Note we previously issued to the investor on July 19, 2024 and any related transaction documents. +In October 2024, pursuant +to the securities purchase agreement we entered into with Ault & Company, dated as of November 6, 2023 (the “November 2023 SPA”), +we sold an aggregate of 1,400 shares of Series C Convertible Preferred Stock and warrants to purchase an aggregate of 11,825 shares of +Class A common stock to Ault & Company, for an aggregate purchase price of $1.4 million. +In November 2024, pursuant +to the November 2023 SPA we entered into with Ault & Company, we sold an aggregate of 1,280 shares of Series C Convertible Preferred +Stock and warrants to purchase an aggregate of 10,811 shares of Class A common stock to Ault & Company, for an aggregate purchase +price of $1.3 million. +On December 9, 2024, we completed +the distribution of 650,000 shares of our 10% Series E Redeemable Perpetual Preferred Stock (the “Series E Preferred Stock”), +a $16.25 million stated value, to holders of Class A common stock and Series C Convertible Preferred Stock on an as-converted basis. Dividends +will accrue on the stated amount of $25.00 per share of the Series E Preferred Stock at a rate per annum equal to 10.00%. +On December 16, 2024, we completed +the distribution of approximately 5.0 million shares of our Class B common stock (the “Class B Common Stock”) to all holders +of our Class A common stock and Series C Convertible Preferred Stock on an as-converted basis. There is currently no public trading market +for the Class B Common Stock. While we presently intend to seek to have the Class B Common Stock listed for trading on the NYSE American +within the foreseeable future, there can be no assurance when, or if, such a listing will occur. The Class B Common Stock is identical +to the currently outstanding Class A common stock, with the exception that each share thereof carries 10 times the voting power of a share +of Class A common stock. The Class B Common Stock is convertible at any time into Class A common stock on a one-for-one basis. +2 +On November 20, 2024, pursuant +to the approval provided by our stockholders at the annual meeting of stockholders held on June 28, 2024, we filed an Amendment to our +Certificate of Incorporation with the State of Delaware to effectuate a reverse stock split of our Class A common stock affecting the +issued and outstanding number of such shares by a ratio of one-for-thirty-five. The reverse stock split became effective on November 22, +2024. All share amounts in this Annual Report have been updated to reflect the reverse stock split. +On December 23, 2024, we completed the distribution of 1.0 million +shares of our Series F Exchangeable Preferred Stock (“Series F Preferred Stock”) to holders of Class A common stock and Series +C Convertible Preferred Stock on an as-converted basis. The Series F Preferred Stock has a $1.00 liquidation preference and does not pay +a dividend. Each share of Series F Preferred Stock will be exchangeable, at the option of its holder, for (i) 10 shares of Class A Common +Stock of Ault Capital and (ii) five shares of Class B Common Stock of Ault Capital, at any time beginning on the later of (i) one year +after issuance of the Series F Preferred Stock and (ii) the date of the registration under the Securities Act of 1933, as amended, of +all of the foregoing shares of Ault Capital Class A Common Stock and Ault Capital Class B Common Stock. Once the Series F Preferred Stock +has been exchanged into shares of Ault Capital Class A Common Stock and Class B Common Stock, our sole business will be our ownership +of Sentinum, Inc., through which we operate our Bitcoin mining business as well as its HPC and AI operations. +In December 2024, pursuant to the November +2023 SPA we entered into with Ault & Company, we sold an aggregate of 3,020 shares of Series C Convertible Preferred Stock and warrants +to purchase an aggregate of 25,509 shares of Class A common stock to Ault & Company, for an aggregate purchase price of $3.0 million. +As of the date of this Annual Report, Ault & Company has purchased an aggregate of 50,000 shares of Series C Convertible Preferred +Stock and warrants to purchase an aggregate of 422,337 shares of Class A common stock, for an aggregate purchase price of $50.0 million. +On December 13, 2024 (the “Closing Date”), Third Avenue +Apartments LLC (“Third Avenue”), which was a subsidiary of AGREE, completed the sale of its real property located at the southeast +corner of 5th Street North and 3rd Avenue North in St. Petersburg, Florida (the “Property”). The Property was sold on the +Closing Date to Cats Mirror Lake, LLC (the “Buyer”) pursuant to a contract of sale, as amended, entered into by Third Avenue +and the Buyer. The sale price for the property was $13.0 million. In February 2025, Third Avenue filed a certificate of cancellation with +the Delaware Secretary of State. +On December 21, 2024, we entered +into a securities purchase agreement (the “December 2024 SPA”) with Ault & Company, pursuant to which we agreed to sell, +in one or more closings, to Ault & Company up to 25,000 shares of Series G convertible preferred stock (“Series G Preferred +Stock”) and warrants to purchase up to 4.2 million shares of Class A common stock (the “Series G Warrants”) for a total +purchase price of up to $25.0 million. The December 2024 SPA provides that the financing may be conducted through one or more closings. +Through April 14, 2025, pursuant to the December 2024 SPA, we have sold to Ault & Company 960 shares of Series G Preferred Stock and +Series G Warrants to purchase 162,217 shares of Class A common stock, for a purchase price of $1.0 million. +Each share of Series G Preferred +Stock has a stated value of $1,000.00 and is convertible into shares of Class A common stock at a conversion price equal to the greater +of (i) $0.10 per share, and (ii) the lesser of (A) $6.74 or (B) 105% of the volume weighted average price of the Class A common stock +during the ten trading days immediately prior to the date of conversion. The holders of Series G Preferred Stock are entitled to cumulative +cash dividends at an annual rate of 9.5%, or $95.00 per share, based on the stated value per share. Dividends shall accrue for 10 years +from the date of issuance of such shares of Series G Preferred Stock and are payable monthly in arrears. For the first two years, we may +elect to pay the dividend amount in shares of Class A common stock rather than cash. The holders of the Series G Preferred Stock are entitled +to vote with the Class A common stock as a single class on an as-converted basis. +On February 5, 2025, we entered into an +exchange agreement with an institutional investor, pursuant to which we issued to the investor a convertible promissory note in the principal +face amount of $1.9 million (the “February 2025 Convertible Note”), in exchange for the cancellation of an outstanding term +note we issued to the investor in April 2024. That note had an outstanding principal amount and accrued but unpaid interest of $1.9 million. +The February 2025 Convertible Note accrued interest at the rate of 15% per annum, unless an event of default (as defined in the +February 2025 Convertible Note) occurs, at which time the February 2025 Convertible Note would accrue interest at 18% per annum. The February +2025 Convertible Note was to mature on May 5, 2025. The February 2025 Convertible Note was convertible into shares of Class A common stock +at a fixed conversion price of $4.00 per share. +3 +On March 14, 2025, we entered into an exchange +agreement with an institutional investor pursuant to which we issued to the investor a convertible promissory note in the principal face +amount of $4.2 million in exchange for the cancellation of (i) a term note issued by us on May 16, 2024, with outstanding principal and +accrued but unpaid interest of $0.7 million, (ii) a term note issued by us on May 20, 2024, with outstanding principal and accrued but +unpaid interest of $1.5 million, and (iii) the February 2025 Convertible Note issued by us on February 5, 2025, with outstanding principal +and accrued but unpaid interest of $2.0 million. The note accrues interest at the rate of 15% per annum, unless an event of default (as +defined in the note) occurs, at which time the note would accrue interest at 18% per annum. The note will mature on June 30, 2025. The +note is convertible into shares of Class A common stock at a conversion price equal to the greater of (i) $0.40 per share (the “Floor +Price”) and (ii) the lesser of 75% of the VWAP (as defined in the note) of the class A common stock during the five trading days +immediately prior to (A) the date of issuance of the note or (B) the date of conversion into shares of class A common stock. +On March 21, 2025, we entered into an exchange +agreement with an institutional investor, pursuant to which we issued to the investor a convertible promissory note in the principal face +amount of $4.9 million (the “Exchange Note”) in exchange for the cancellation of (i) a term note issued by us on January 14, +2025, with outstanding principal and accrued but unpaid interest of $2.6 million, (ii) a promissory note issued by us on March 7, +2025, with outstanding principal and accrued but unpaid interest of $0.5 million, (iii) a promissory note issued by us on March 12, +2025, with outstanding principal and accrued but unpaid interest of $1.5 million, and (iv) a promissory note issued by us on March +13, 2025, with outstanding principal and accrued but unpaid interest of $0.3 million. The Exchange Note accrues interest at the rate of +15% per annum, unless an event of default (as defined in the Exchange Note) occurs, at which time the note would accrue interest at 18% +per annum. The Exchange Note will mature on December 31, 2025. The note is convertible into shares of Class A common stock at a conversion +price equal to the greater of (i) the Floor Price and (ii) the lesser of 75% of the VWAP (as defined in the Exchange Note) of the Class +A common stock during the five trading days immediately prior to (A) the date of issuance of the Exchange Note or (B) the date of conversion +into shares of Class A common stock, but not greater than $10.00 per share. +On March 28, 2025, our +majority owned subsidiary, Avalanche International Corp. (“AVLP”), filed a petition +for liquidation under Chapter 7 of the bankruptcy laws. The filing placed AVLP under the control of the bankruptcy court, which will oversee +its liquidation. As a result, we no longer consider AVLP a subsidiary of ours. +On March 30, 2025, we entered into an amendment +to the November 2023 SPA to provide for an extension of the date on which the final closing may occur from December 31, 2024 to March +31, 2025, subject to Ault & Company’s ability to further extend such date for ninety (90) days. +On March 31, 2025, we entered into a securities +purchase agreement with an institutional investor pursuant to which we agreed to sell up to 50,000 shares of Series B Convertible Preferred +Stock (“Series B Preferred Stock”) for a total purchase price of up to $50.0 million. The securities purchase agreement +provides that the transaction shall be conducted through 49 separate tranche closings, provided, however, that the investor has the ability, +exercisable in its sole discretion, to purchase any number of shares of Series B Preferred Stock prior to the dates of the tranche closings +provided for in the securities purchase agreement. The initial tranche closing, which will close promptly after the investor has converted +out of the Exchange Note, will consist of the sale and issuance to the investor of 2,000 shares of Series B Preferred Stock for an aggregate +of $2.0 million. Pursuant to the securities purchase agreement, provided certain closing conditions have been met, the investor shall +purchase up to 4,800 shares of Series B Preferred Stock on a monthly basis, with the investor being required to purchase 1,000 shares +per month. +Each share of Series B Preferred Stock has a stated value of $1,000.00 +and is convertible into shares of Class A common stock at a conversion price equal the lesser of a 25% discount to our volume weighted +average price during the five trading days immediately prior to (A) the date of execution of the securities purchase agreement or (B) +the date of conversion into shares of Class A common stock, but not greater than $10.00 per share. Notwithstanding the foregoing, in no +event shall the Series B Preferred Stock be convertible at less than the Floor Price. The holders of Series B Preferred Stock are entitled +to cumulative cash dividends at an annual rate of 15%, or $150.00 per share, based on the stated value per share. Dividends shall accrue +for as long as any shares of Series B Preferred Stock remain issued and outstanding and are payable monthly in arrears. For the first +two years, we may elect to pay the dividend amount in additional shares of Series B Preferred Stock rather than cash. The holders of the +Series B Preferred Stock are entitled to vote with the Class A common stock as a single class on an as-converted basis. +On April 1, 2025, we issued to an accredited +investor a convertible promissory note in the principal face amount of $1.65 million in consideration for an advance we received +of $1.5 million. The note accrues interest at the rate of 15% per annum, unless an event of default (as defined in the note) occurs, at +which time the note would accrue interest at 18% per annum. The note will mature on September 30, 2025. The note is convertible into shares +of Class A common stock at a conversion price equal to the greater of (i) the Floor Price and (ii) the lesser of 75% of the VWAP (as defined +in the note) of the Class A common stock during the five trading days immediately prior to (A) the date of issuance of the note or (B) +the date of conversion into shares of Class A common stock. +4 +On April 8, 2025, we issued to an accredited +investor a convertible promissory note in the principal face amount of $110,000 in consideration for $100,000. The note accrues interest +at the rate of 15% per annum, unless an event of default (as defined in the note) occurs, at which time the note would accrue interest +at 18% per annum. The note will mature on September 30, 2025. The note is convertible into shares of Class A common stock at a conversion +price equal to the greater of (i) $0.45 and (ii) the lesser of (A) 75% of the VWAP (as defined in the note) of the Class A common +stock during the five trading days immediately prior to the date of issuance of the note or (B) 75% of the lowest daily VWAP of the Class +A common stock during the five trading days immediately prior to the date of conversion into shares of Class A common stock. +Corporate Information +We are a Delaware corporation, +initially formed in California in 1969 and reincorporated in Delaware in 2017. We are located at 11411 Southern Highlands Parkway, Suite +190, Las Vegas, NV 89141. Our phone number is (949) 444-5464 and our website address is https://hyperscaledata.com/ . +Our Corporate Structure +On September 10, 2024, we +changed our name from Ault Alliance, Inc. to Hyperscale Data, Inc. (the “Name Change”). The Name Change did not affect the +rights of our security holders. Our Class A common stock is traded on the NYSE American under the symbol “GPUS.” Existing +stock certificates that reflect a prior corporate name continue to be valid. Certificates reflecting the new corporate name are issued +as old stock certificates are tendered for exchange or transfer to our transfer agent. +In March and August of 2024, +we reorganized our corporate structure pursuant to a series of transactions by and among the Company and its directly and indirectly owned +subsidiaries as well as third parties. The purpose of the reorganization was to simplify our organizational and reporting structure to +more accurately reflect our business operations. As a result of the foregoing transactions, our corporate structure is currently as follows: +5 +Our Business Strategy +As principally a holding company, +our business strategy is designed to increase stockholder value. Under this strategy, we are focused on managing and financially supporting +our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned +to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner +companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as +other opportunities to maximize stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying +our debt obligations and working capital needs. +On October 7, 2019, we created +an Executive Committee which is comprised of our Executive Chairman, Chief Executive Officer and President. The Executive Committee meets +on a daily basis to address the Company’s critical needs and provides a forum to approve transactions which are communicated to +our Chief Financial Officer and Senior Vice President of Finance on a bi-weekly basis by our Chief Executive Officer. +Our Executive Committee approves +and manages our investment and trading strategy. The Executive Committee has decades of experience in financial, investing and securities +transactions. Led by our Founder and Executive Chairman, Milton C. (Todd) Ault, III, we seek to find undervalued companies and disruptive +technologies with a global impact. We use a traditional methodology for valuing securities that primarily looks for deeply depressed prices. +Upon making an investment, we often become actively involved in the companies we seek to acquire. That activity may involve a broad range +of approaches, from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or sizable +but non-controlling interest or outright ownership of the target company in order to implement changes that we believe are required to +improve its business, and then operating and expanding that business. Mr. Ault relies heavily on William B. Horne, our Vice Chairman and +Chief Executive Officer, and Henry Nisser, our President and General Counsel, to provide analysis and guidance on all acquisition targets +and throughout the acquisition process. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings, mergers or spin-offs and directed share subscription programs. We will continue to consider these and +functionally equivalent programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize +value for our stockholders. +Over the recent past, we have provided capital and relevant expertise +to fuel the growth of businesses in Bitcoin mining, generative AI and metaverse platform development, crane services, defense/aerospace, +industrial, automotive, medical/biopharma, consumer electronics and textiles. We have provided capital to subsidiaries as well as partner +companies in which we have an equity interest or may be actively involved, influencing development through board representation and management +support. +Our Principal Subsidiaries and their Businesses +The following is a brief +summary of the businesses in which we own a controlling interest, or whose financial statements we consolidated in this Annual Report: +Sentinum +Sentinum conducts data center +operations and Bitcoin mining through ACS. +Overview +Sentinum’s revenue is +currently generated primarily from mining Bitcoin for our own account. However, during 2024 we began the process of transitioning our +primary operations from Bitcoin mining to developing our Michigan data center, which +constitutes a 617,000 square foot energy-efficient facility located on a 34.5 acre site in southern Michigan (the +“Michigan Facility”) to support the growing demand of enterprise, HPC and AI cloud providers with high-density workloads. +6 +Through its wholly owned and operated data centers, Sentinum’s +mission is to support internal computing requirements and to empower AI-focused businesses and other businesses requiring high-density +power with reliable, scalable, and secure hosting solutions. We currently have data centers in Michigan and Montana. The Michigan +Facility’s design and available power provides Sentinum the ability to create bespoke solutions enabling it to seize growth +opportunities within the broader data center services market. The Michigan Facility’s +design continues to evolve to address prospective customer requirements, including cooling techniques such as direct to chip heat exchange +and backup power systems such as uninterruptible power supplies with batteries to store energy. Sentinum can provide a range of service +options tailored to a customer’s needs, including HPC and AI. HPC and AI are synonymous with applications requiring immense computational +power to process complex models and perform real-time inferences. These use cases are being adopted by a wide range of industries, such +as healthcare, energy, automotive, robotics and other autonomous systems. We are exploring the potential of working directly with end +user companies as well as companies with which we could collaborate to provide comprehensive solutions. +Sentinum’s attentiveness to disruptive technologies such as HPC, +AI and blockchain combined with the foundational elements of data centers, power infrastructure, telecommunications and security enable +it to support the internal operations for Bitcoin mining alongside non-mining solutions for third party customers. The economies of scale +created by Bitcoin mining operations provide a competitive advantage to Sentinum as it seeks to add non-mining applications to its services +portfolio. If successful in adding non-mining applications, it is highly likely that the Bitcoin mining operations will be gradually phased +out. Sentinum continues to evaluate opportunities to add HPC and AI applications. Sentinum conducts preliminary engineering design sessions +with prospects and provides site tours at its Michigan Facility for prospective +customers that we believe represent qualified opportunities. Sentinum continually monitors critical equipment supply chains and lead times +in support of preferred installation timelines requested by prospective customers. During April 2025, Sentinum completed the installation +requirements for deployment of a 250 kilowatts HPC customer. +Sentinum currently mines Bitcoin using purpose-built computers (or “miners”) to solve complex cryptographic +algorithms (or “verify” or “solve” blocks) in the blockchain in exchange for rewards and fees denominated in the +native token of that blockchain network, which is Bitcoin. Sentinum’s miners provide computing power to a Bitcoin mining pool operator, +in which all the participants’ machines mine Bitcoin as a collective group, and Sentinum gets paid the expected value of both the +block reward and transaction fees for doing so. The mining pool operator receives block rewards and transaction fees paid in Bitcoin by +the blockchain when the mining pool finds new blocks. The reward and transaction fees are then shared by the pool participants based on +their hash rate contributions to the pool, less a small amount of fees. +We have determined that Bitcoin, the only crypto asset that Sentinum +mines, would likely not be considered a security under U.S. federal securities laws, in consultation with outside counsel. We base our +analysis on relevant case law, applying the frameworks established by the U.S. Supreme Court and taking into consideration relevant guidance +by the SEC and its staff. A particular crypto asset’s status as a “security” in any relevant jurisdiction is +subject to a high degree of uncertainty and if a regulator disagrees with our characterization of Bitcoin, we may be subject to regulatory +scrutiny, investigations, fines and penalties, which may adversely affect our business, operating results and financial condition. A determination +that Bitcoin that we own or mine is a “security” may adversely affect the value of Bitcoin and our business. +We do not, however, currently +acquire crypto assets for investment purposes. As of December 31, 2024, we held approximately two Bitcoin valued at $183,000, based on +cost less impairment as of such date. Our mining operations generated a net loss of $12.6 million and revenue of $31.5 million during +the year ended December 31, 2024 compared to a net loss of $2.6 million and revenue of $33.1 million during the year ended December 31, +2023. As of December 31, 2024, the $183,000 carrying value of our Bitcoin represented less than 0.1% of our total assets of $219.7 million +as of such date. +Sentinum Breakeven Analysis +Since commencement of Sentinum’s +mining operations in 2021, we have received approximately 3,017 Bitcoin for providing computing power to a Bitcoin mining pool operator +and from hosted mining operations, pursuant to the terms of a Master Services Agreement (“MSA”) with Core Scientific, Inc. +(“Core Scientific”), through December 31, 2024. The MSA terminated on August 31, 2024. The Bitcoin received is available for +sale in the ordinary course of business, and while we believe that holding Bitcoin represents an attractive option to increase our liquid +assets, due to our continued operating losses we currently sell Bitcoin as it is mined to fund our operating expenses. We believe that +our integrated model with close control over our power sources and owning our Bitcoin mining data center helps us to produce Bitcoin with +attractive cost efficiency, since we are not burdened with additional costs that are typical in a third party hosting relationship such +as per miner operational fees and revenue sharing. This helps us to produce Bitcoin, excluding depreciation of our miners which is a non-cash +expense, at a cost that we believe is attractive versus the price of Bitcoin. +7 +Our net cost of power was +between approximately $42 to $62 per megawatt-hour in the second half of 2023 to the present. During the years ended December 31, 2024 +and 2023, we had on average approximately 16,000 miners in operations. In aggregate, these miners generated approximately 677 and 1,607 +Bitcoin during the years ended December 31, 2024 and 2023, respectively, for providing computing power to a Bitcoin mining pool operator +and from hosted mining operations with Core Scientific. Alternatively, during the years ended December 31, 2024 and 2023, we generated +an average of 1.85 and 4.40 Bitcoin per day, respectively, from our mining operations. Due to the termination of our hosting agreement +with Core Scientific and the block reward halving that occurred during April 2024, the average Bitcoin mined from our operations has decreased +to approximately 0.72 Bitcoin per day during the three months ended December 31, 2024. The following table reflects the actual costs that +we incurred to mine one Bitcoin. +Year Ended December 31, +2024 +2023 +Depreciation +$ 21,354 +$ 11,256 +Utilities and other costs +29,377 +11,426 +Hosting fees +17,938 +8,586 +$ 68,669 +$ 31,268 +Additionally, Sentinum’s daily general and operating costs, excluding +an impairment charge of $10.5 million that was recognized and decreased the net carrying value of the Company’s crypto assets mining +equipment to their estimated fair value, were approximately ($1,101) and $410, respectively, per Bitcoin mined during the years ended +December 31, 2024 and 2023. Conversely, the price of Bitcoin ranged from approximately $17,000 to approximately $44,000 during 2023 and +from approximately $38,000 to approximately $108,000 during 2024, and was approximately $79,000 as of April 7, 2025, according to Coin +Market Cap. +On February 24, 2023, BNI Montana entered into an asset purchase agreement +with TypeX, LLC to acquire two land lease agreements and two corresponding power purchase agreements in Montana. The lease and power agreements +run for a period of 10 years, with a 10-year renewal option. Sentinum is building out and developing fully operational data centers dedicated +to Bitcoin mining operations on the properties (the “Montana Facilities”). If we complete the initial phase of development +of the Montana Facilities, which is currently on hold, then we would expect the Montana Facilities to provide up to a combined 20 megawatts +(“MWs”) of power, enabling up to 6,500 S19j Pro Antminers to operate. Inclusive of costs previously incurred to acquire two +land lease agreements and two corresponding power purchase agreements, the Montana Facilities would cost approximately $7 million. Further, +given the favorable cost differential for power between Montana and Michigan, the increase in operating costs and depreciation from capitalized +expenditures is expected to approximate the power cost savings. However, while completion of the development of the Montana Facilities +would not be expected to have a negative impact on our operating results, we have currently placed this project on hold to focus on the +development of our Michigan Facility to support HPC and AI applications. During 2025, we anticipate large expenditures in our Michigan +Facility to facilitate the transition of the facility to support HPC and AI applications. Initially, these expenditures will likely increase +Sentinum’s losses unless we are able to pass these costs on to our future customers. These uncertainties make it impossible to predict +when, if ever, Sentinum will achieve profitable operations. +Thus, if the price of Bitcoin, +level of difficulty to mine, the amount of the block reward or the amount of Bitcoin earned by miners for mining one block on the Bitcoin +blockchain remain constant, then Sentinum will not be profitable in 2025. While we do not expect that Sentinum will achieve profitability +during 2025, the expected cash generated from our Bitcoin mining operations is still expected to exceed that of our operating costs given +the significance of depreciation charges, which is expected to account for nearly 20% of Sentinum’s total costs of operations during +2025. +During 2024, Sentinum reported a loss from operations of approximately +$12.6 million inclusive of depreciation and amortization of approximately $14.8 million and an impairment charge on our miners of $10.5 +million. During 2023, Sentinum reported a loss from operations of approximately $2.6 million inclusive of depreciation and amortization +of approximately $18.3 million. As such, excluding capital expenditures, Sentinum generated approximately $12.7 million and $15.7 million +in cash for the years ended December 31, 2024 and 2023, respectively. The cash generated from operations was used to pay for a portion +of the costs we incurred. +8 +Bitcoin and Bitcoin Mining Overview +Blockchain and Bitcoin Overview +Many forms of crypto assets, including Bitcoin, are a type of digital +asset that function as a medium of exchange, a unit of account and/or a store of value (i.e. a new form of digital money). Crypto assets +operate by means of blockchain technology, which generally uses open-source, peer-to-peer software to create a decentralized digital ledger +that enables the secure use and transfer of crypto assets. We believe that Bitcoin and the associated blockchain technology has potential +advantages over traditional payment systems, including: the tamper-resistant nature of blockchain networks; rapid-to-immediate settlement +of transactions; lower fees; elimination of counterparty risk; protection from identify theft; broad accessibility; and a decentralized +nature that enhances network security by reducing the likelihood of a “single point of failure.” However, since centralized +exchanges, which operate intermediate processes for executing trades, storing coins and initiating transactions, account for the majority +of Bitcoin trading volume there remains the risk that a malicious actor may be able to alter blockchains on which transactions of crypto +asset reside and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. +Additionally, cybersecurity risks from unauthorized third parties employing illicit operations such as hacking, phishing and social engineering, +could introduce a level of counterparty risk, in other words a risk that a party is unable to fulfill its contractual obligations. Recently, +crypto assets, and Bitcoin in particular, have gained widespread mainstream attention and have begun to experience greater adoption by +both retail and institutional holders and the broader financial markets. For example, Bitcoin’s aggregate market value had appreciated +to $1.64 trillion in March 2025 compared to $828 billion in December 2023. All figures are derived from Coin Market Cap. As Bitcoin, and +blockchain technologies more generally, have entered the mainstream, prices of Bitcoin have reached all-time highs, albeit with periodic +price decreases, and the broader ecosystem has continued to develop. While we expect the value of Bitcoin to remain volatile, we believe +this increase in its aggregate market value signals institutionalization of Bitcoin and wider adoption of crypto asset. For example, in +January 2024, the SEC approved the listing and trading of Bitcoin exchange-traded funds, of which, as of April 8, 2025, approximately +34 are trading with over $167 billion of Bitcoin assets held ( https://etfdb.com/themes/bitcoin-etfs/#complete-list&sort_name=assets_under_management&sort_order=desc&page=1 ). +Bitcoin is a decentralized +asset that enables near instantaneous transfers. Transactions occur via an open-source, cryptographic protocol platform which uses peer-to-peer +technology to operate with no central authority. The online network hosts the public transaction ledger, known as the blockchain, and +each crypto asset is associated with a source code that comprises the basis for the cryptographic and algorithmic protocols governing +the blockchain. In a crypto asset network, every peer has its own copy of the blockchain, which contains records of every historical transaction +— effectively containing records of all account balances. Each account is identified solely by its unique public key (making it +effectively anonymous) and is secured with its associated private key (kept secret, like a password). The combination of private and public +cryptographic keys constitutes a secure digital identity in the form of a digital signature, providing strong control of ownership. +No single entity owns or operates +the network. The infrastructure is collectively maintained by a decentralized public user base. As the network is decentralized, it does +not rely on either governmental authorities or financial institutions to create, transmit or determine the value of the currency units. +Rather, the value is determined by market factors, supply and demand for the units, the prices being set in transfers by mutual agreement +or barter among transacting parties, as well as the number of merchants that may accept the crypto asset. Since transfers do not require +involvement of intermediaries or third parties, there are only nominal transaction costs in direct peer-to-peer transactions. For example: +· +In terms of conventional peer-to-peer transactions, there either are no fees or they are de minimis (Source: https://www.kraken.com/en-us); +· +For purposes of traditional networks, there are nominal fees associated with any transaction (Source: https://bitinfocharts.com/bitcoin); and +· +As of April 8, 2025, the 90-day simple average Bitcoin network transaction fee is $1.71 per transaction, which is still low compared to conventional transaction fees charged by banks and other more traditional financial institutions (https://bitinfocharts.com/bitcoin). +The network fee is separate +and distinct from the pool fee we pay Luxor Technology (“Luxor”) for its services in acting as a pool operator, discussed +below. The network fee is applicable to anyone who transacts on the blockchain. +Given that block space is +limited, mining fees can and often do fluctuate significantly from transaction to transaction as a result of “congestion.” +However, this congestion does not negate any of the statements made immediately above. +Units of Bitcoin can be converted +to fiat currencies, such as the U.S. dollar, at rates determined on various exchanges, such as Binance, Coinbase, Bybit, Kraken, Gemini +and others. Bitcoin prices are quoted on various exchanges and fluctuate with extreme volatility. +9 +We believe that Bitcoin, the only crypto asset we provide computing +power to a mining pool operator for mining purposes, offers many advantages over traditional, fiat currencies, though many of these factors +also present potential disadvantages and may introduce additional risks, including: +· Acting as a fraud deterrent, as crypto assets +are digital and cannot be counterfeited or reversed arbitrarily by a sender; +· Immediate settlement; +· Elimination of counterparty risk; +· No trusted intermediary required; +· Lower fees; +· Identity theft prevention; +· Widespread accessibility; +· Transactions are verified and protected through +a confirmation process, which prevents the problem of double spending; +· Decentralized — no central authority (government +or financial institution); and +· Not recognized universally and not bound by government imposed or market +exchange rates. +However, crypto assets may +not provide all of the benefits they purport to offer. +Limitations on Bitcoin Mining +In addition to competition, there are two principal factors that may +affect Bitcoin mining companies: (i) limitations on the supply of Bitcoin; and (ii) the market price of Bitcoin. +The blockchain’s method for creating new Bitcoins is mathematically +determined in a manner such that the supply of Bitcoins grows at a limited rate pursuant to a pre-set schedule. Specifically, the number +of Bitcoins awarded for solving a new block is automatically halved for every 210,000 blocks that are solved. The current fixed reward +for solving a new block is 3.125 Bitcoins per block, which was reduced from 6.25 Bitcoins in April 2024 and will be reduced further to +1.5625 Bitcoins per block in approximately March 2028. This deliberately controlled rate of Bitcoin creation means that the number of +Bitcoins in existence will never exceed 21 million and that Bitcoin cannot be devalued through excessive production unless the Bitcoin +network’s source code and the underlying protocol for Bitcoin issuance is altered. This also means, however, that our revenue prospects +will decline unless the price of a Bitcoin increases commensurately or we acquire more miners, which we do not intend to do. +We only participate in mining +pools that mine Bitcoin. Our ability to generate revenue from these mining operations will be dependent on the price of Bitcoin. The price +of Bitcoin has experienced substantial volatility, including fluctuation patterns which may reflect “bubble” type volatility, +meaning that high or low prices at a given time may not be indicative of the current or future value of Bitcoin. The price of a Bitcoin +may be subject to rapidly changing investor and market sentiment, and may be influenced by factors such as technology, regulatory developments +and media coverage. Further, Bitcoin’s value may be based on various factors, including their acceptance as a means of exchange +or purchasing power by consumers and vendors, volume, liquidity and transferability and market demand. Bitcoin’s current price reflects, +in part, the belief by some that Bitcoin could become a widely accepted form of currency; however, if this prediction turns out to be +incorrect its price could decrease dramatically, as would our prospects for future revenue and profits. See “Risk Factors – +Risks Related to Our Bitcoin Operations” for more information on the risks we face due to our mining of Bitcoin and its speculative +and volatile nature. +10 +Bitcoin Mining and Mining Pools +As a participant in a Bitcoin mining pool, we use specialized miners +to solve cryptographic math problems necessary to record and “publish” crypto asset transactions to blockchain ledgers. Generally, +each crypto asset has its own blockchain, which consists of software code (also known as a protocol), which is run by all the computers +on the network for such blockchain. Within this code, transactions are collated into blocks, and these blocks must meet certain requirements +to be verified by the blockchain software, added to the blockchain or ledger of all transactions and published to all participants on +the network that are running the blockchain software. After a transaction is verified, it is combined with other transactions to create +a new block of data for the blockchain. For proof-of-work blockchains, the process of verifying valid blocks requires computational effort +to solve a cryptographic equation, and this computational effort protects the integrity of the blockchain ledger. This process is referred +to as “mining.” As a reward for verifying a new block, miners receive payment in the form of the native crypto asset of the +network, in our case Bitcoin. This payment is comprised of a block reward (i.e., the automatic issuance of new Bitcoin) and the aggregated +transaction fees for the transactions included in the block (paid in existing crypto asset tokens by the participants to the transactions). +The block reward payments and the aggregated transaction fees provide the incentive for miners to contribute hash rate to the network. +A “hash” is the +actual cryptographic function run by the miners, and is a unique set of numbers and letters derived from the content of the block. The +protocol governing the relevant blockchain sets certain requirements for the hash. Miners compete to be the first to generate a valid +hash meeting these requirements and, thereby, secure payment for solving the block. Hash rate is the speed at which miners can complete +the calculation, and therefore is a critical measure of performance and computational power. A high rate means a miner may complete more +calculations over a given period and has a greater chance to solve a block. An individual miner has a hash rate total of its miners seeking +to mine a specific crypto asset, and the blockchain-wide hash rate for a specific crypto asset, in our case Bitcoin, can be understood +as the aggregate of the hash rates of all of the miners actively trying to solve a block on that blockchain at a given time. +The protocols governing Bitcoin +are coded to regulate the frequency at which new blocks are verified by automatically adjusting what is known as the “mining difficulty,” +which is the level of computational activity required before a new block is solved and verified. For example, on the Bitcoin blockchain +the protocol is coded such that a new block is solved and verified approximately every ten minutes. As such, to the extent the hash power +on the network is increased or decreased due to, for example, fluctuations in the number of active miners online, mining difficulty is +correspondingly increased or decreased to maintain the preset interval for the verification of new blocks. +On Bitcoin networks, the rewards +for solving a block are also subject to periodic incremental halving. Halving is a process designed to control the overall supply and +reduce the risk of inflation in Bitcoin using a proof-of-work consensus algorithm. After a predetermined number of blocks are added to +the blockchain, the mining reward is cut in half, hence the term “halving.” The last halving for Bitcoin occurred on April +20, 2024. Transaction fees are variable and depend on the level of activity on the network. Generally, transaction fees increase during +times of network congestion, as miners will prefer transactions with higher fees, and therefore a higher fee can reduce the time to process +a transaction, and decrease when there are fewer transactions on the network. +As the total amount of available +hash rate has increased on the Bitcoin network, it has become increasingly difficult for any individual miner to independently solve a +block and as a result “mining pools” have emerged as an efficient way for miners to pool resources. Mining pools aggregate +the hash rate of various miners participating in the mining pool. In this way the mining pool operator, rather than an individual miner, +validates the block and receives the block reward and related transaction fees. The mining pool is organized by a third party, in our +case, Luxor. All of the approximately 9,500 miners currently in operation at our Michigan facility provide hash rate to the Luxor mining +pool. In consideration for receiving a percentage of the earned block rewards and transaction fees, Luxor administers the pool and ensures +that the participants in the pool receive their share of the block reward and related transaction fees, generally pro-rata to their contributed +hash rate. Mining pools offer miners more predictable and consistent revenue compared to mining individually. We participate in mining +pools by providing what the industry refers to as “hashrate” to the pool. Hashrate is defined as the computing power that +our mining equipment produces when helping to validate a block that the mining pool is trying to solve. We use the FPPS, or Full Pay-Per-Share, +method when mining with Luxor. Pursuant to the “Full Pay-Per-Share” model, both the block reward and the mining service charge +are settled according to the theoretical profit. It includes the calculation of a standard transaction fee within a certain period and +distributes it to mining pool participants according to their hash power contributions in the pool. It increases the mining pool participants’ +earnings by sharing transaction fees. Standard transaction fees are calculated using a certain period which are then distributed to miners +according to their hash power contributions in the pool. Luxor currently charges us a 0.68% mining fee. +We provide computing power to the mining pool, which is run by the +mining pool operator with which we contract, which in turn provides transaction verification services. Based on the terms of the agreement, +in our judgment, the mining pool operator is considered the principal in providing mining pool services. We recognize revenue, net of +certain transaction fees from the mining pool operator, which are not considered material. Our current mining pool agreement is cancelable +at any time by either party without penalty. Revenue received for providing computing power would be directly impacted positively or negatively +should we start and stop providing computing power to the mining pool operator within a given reporting period. +11 +Our Strategy +Own and Operate Our Mining Facilities +We have in the past invested +heavily in purchasing, building and operating our mining facilities, though we have no intention of acquiring more miners. By owning and +operating our miners at facilities that offer competitive advantages, including access to reliable, low-cost, renewable power, we expect +to have greater control over the timing of the deployment of our miners. We also may enhance our ability to intelligently and quickly +adapt our operating model and reap savings compared to paying for outsourced operations and infrastructure. +Reliable, Low-Cost, Renewable Power +Power represents our highest +variable direct cost for our mining operations, with electrical power required to operate the miners. We believe the combination of increased +mining difficulty, driven by greater hash rates, and the periodic adjustment of reward rates, such as the halving of Bitcoin rewards, +will drive the increasing importance of power efficiency in Bitcoin mining over the long term. As a result, we are focused on deploying +our miners at locations with access to reliable, renewable power sources, as successfully doing so should enable us to reduce our power +costs. +Miners require considerable amounts of electrical energy to perform +their functions and mine Bitcoin; consequently, a critical aspect of operating in the crypto asset mining industry is obtaining a reliable +supply of electricity at a relatively low and stable cost. To this end, in January 2021, ACS purchased the Michigan Facility. Since the +purchase of the Michigan Facility, we have invested in infrastructure improvements and began both ramping up the power capacity and installing +miners. To date, we have increased the power load from 1.5 MWs to approximately 30 MWs. ACS recently announced that it has reached an +agreement in principle with the local utility expected to energize the Michigan Facility, enabling ACS to increase its power capacity +from approximately 30 MW s to 300 MWs. The completion of the power upgrade is anticipated to take 44 months from execution +of a formal letter of authorization between ACS and the utility, which is currently being negotiated. In addition, ACS has reached an +agreement in principle with the local natural gas utility to provide the capability to energize the Michigan Facility with an additional +40 MWs. The project is expected to be completed within 18 months of the execution of definitive agreements. Combined, this would enable +ACS to increase its power capacity from approximately 30 MW to approximately 340 MW. Currently, we have approximately 4,900 S19j Pro Antminers +and approximately 4,600 S19 XP Antminers in operation at our Michigan Facility but it is our intention to dedicate all the power capacity +at the Michigan Facility to our AI hyperscale data center operations. If successful, we expect to sell any idle miners in the secondary +market, which could be between 12,500 and 16,500 miners. +We have also invested in a data center through BNI Montana. We have +completed the build-out at one of the two sites at the Montana Facilities, which provides up to 10 MWs of power. If we complete the build-out +of the second site, which is currently on hold pending the transition of our Michigan Facility to support HPC and AI applications, the +Montana Facilities will provide up to a combined 20 MWs of power and allow us to operate approximately 6,500 miners. We believe that the +capacity of the Montana Facilities can be significantly expanded, and we have begun an electrical load study in collaboration with the +local utility to explore potential power upgrades. However, given the current price of Bitcoin and the level of difficulty to mine, at +this time we have no plans to expand the capacity at the Montana Facilities, which has the capacity to operate approximately 2,600 S19j +Pro Antminers. At this time, we have ceased mining at the Montana Facilities and will not resume mining there until the price of Bitcoin +and the level of difficulty to mine improves such that our existing miners can operate profitably. +We continue to evaluate other sites, locations, and partnerships for +additional and alternative support of future mining operations. While we have not at present entered into any other agreements, we continue +to explore and evaluate additional facilities that would enable us to expand our mining operations as needed. +Our Bitcoin Mining Operations +Currently, we have approximately 4,900 S19j Pro Antminers and approximately +4,600 S19 XP Antminers in operation at our Michigan Facility and no Antminers in operation at our Montana facility. Additionally, approximately +9,700 S19j Pro Antminers are not in operation, primarily because of the termination of our hosting agreement with Core Scientific on August +31, 2024. Antminers in operation have an aggregate mining production capacity of approximately 1.13 exahashes per second. +12 +Our strategy includes identifying clean power for our Bitcoin mining +operations. Management has considered the issues surrounding the environmental impact of our Bitcoin mining operations and concluded that +the environmental impact of our mining operations is not material. The basis for this conclusion was that Indiana Michigan Power, the +regulated utility that provides power to our Michigan Facility, reported that in 2023 it generated more than 87% of its energy from emission-free +sources, including solar, wind, hydro and nuclear. The power source for our Montana Facilities, Basin Electric Power Cooperative, reported +that approximately 28% of its power was from emission-free sources, primarily wind and hydro. Since we are only mining Bitcoin at our +Michigan Facility, approximately 87% of our mining operations are being generated from emission-free sources. If we resume operations +at our Montana Facilities, more than 75% of power used in our mining operations would be generated from emission-free sources. In addition +to our continued expansion investments at the Michigan Facility, we also seek out new locations to support our bitcoin mining business. +We consider sites with a variety of offerings, including purchasing the site (as we have done in Michigan), but also leasing buildings +and facilities (as we have done with the Montana Facilities), hosting relationships and strategic partnerships. At this time, we have +not entered into any new mining agreements at locations other than the Michigan Facility and the Montana Facilities. We mine Bitcoin only. +Coins that are mined are held +in a custodial account. We securely store our Bitcoin at Gemini Trust Company, LLC (“Gemini”), a regulated, audited and insured +crypto asset custodian. Gemini is a fiduciary and qualified custodian under the New York Banking Law and is licensed by the New York State +Department of Financial Services. Additionally, Gemini holds numerous money transmitter licenses or the statutory equivalent and has obtained +System and Organization Controls (“SOC”) 1 Type 2 and SOC 2 Type 2 certifications from its independent third-party auditor, +Deloitte and Touche LLP. A SOC 1 report evaluates controls that are applicable to internal control over financial reporting whereas a +SOC 2 report evaluates a security framework that authenticates an organization’s ability to securely handle customer data. Further, +Gemini has insurance coverage against the theft of crypto assets that results from a direct security breach or hack of Gemini’s +systems, or theft by a Gemini employee. +The custody arrangements require +that we mine to a custodial wallet address where the private key is held by the custodian and all keys for the wallet are held in cold +storage. This provides a layer of protection in both the transaction and liquidation phases of the operations by using multi-factor and +multi-person approval processes, to include know your customer and anti-money laundering (“AML”) procedures of the receiving +party. We will either hold the Bitcoin or may choose to convert those assets into fiat currency depending on financial needs and plans. +When we opt to convert the Bitcoins we sell or exchange our Bitcoin through Gemini, the custodian of our digital wallet. When we elect +to make a sale or exchange our Senior Vice President - Finance submits a request to Gemini’s execution department to exchange Bitcoin +for U.S. dollars. Gemini sends an approval email to both our CEO and CFO to approve. Once approved by either our CEO or CFO, Gemini executes +the sale/exchange on its trading platform at current market prices, less commissions, and deposits the U.S. dollars into our bank account. +Beyond the foregoing, our +custody agreement with Gemini provides that: +· +Gemini provides a unique custody account in which all our blockchain assets are held, which are segregated from all others’ assets and are verifiable through the blockchain; and +· +Gemini charges us fees in Bitcoin, which is deducted from our digital +assets on the last business day of every month. +Currently, we are converting Bitcoin received from our mining activities +into fiat currency on a nearly daily basis to pay operating costs and purchase commitments for expansion activities at our facilities. +We do not hold any Bitcoin for investment. +Regulation +The laws and regulations applicable +to crypto asset are evolving and subject to interpretation and change. Governments around the world have reacted differently to crypto +assets; certain governments have deemed them illegal, and others have allowed their use and trade without restriction, while in some jurisdictions, +such as in the United States, many crypto assets are subject to extensive, and in some cases overlapping, unclear and evolving regulatory +requirements, which generally does not apply to Bitcoin. As crypto assets have grown in both popularity and market value, the U.S. Congress +and a number of U.S. federal and state agencies, including the Financial Crimes Enforcement Network (“FinCEN”), the SEC, the +Commodity Futures Trading Commission (“CFTC”), Financial Industry Regulatory Authority (“FINRA”), the Consumer +Financial Protection Bureau, the Department of Justice (“DOJ”), the Department of Homeland Security, the Federal Bureau of +Investigation (“FBI”), the Internal Revenue Service (“IRS”) and state financial regulators, have been examining +the operations of crypto asset networks, crypto asset users and crypto asset exchange markets, with particular focus on the extent to +which crypto assets can be used to launder the proceeds of illegal activities or fund criminal or terrorist enterprises and the safety +and soundness and consumer-protective safeguards of exchanges or other service-providers that hold, transfer, trade or exchange crypto +assets for users. +13 +Many of these state and federal agencies have issued consumer advisories +regarding the risks posed by crypto assets to investors. In addition, federal and state agencies, and other countries have issued rules +or guidance about the treatment of crypto asset transactions or requirements for businesses engaged in activities related to crypto assets. +Depending on the regulatory characterization of the Bitcoin we mine, the markets for Bitcoin in general, and our activities in particular, +may be subject to one or more regulators in the United States and globally. Ongoing and future regulatory actions may alter, perhaps to +a materially adverse extent, the nature of crypto asset markets and our crypto asset operations. Additionally, U.S. state and federal, +and foreign regulators and legislatures have taken action against crypto asset businesses or enacted restrictive regimes in response to +adverse publicity arising from hacks, consumer harm, or criminal activity stemming from crypto asset activity. There is also increasing +attention being paid by U.S. federal and state energy regulatory authorities as the total load of crypto mining grows and potentially +alters the supply and dispatch functionality of the wholesale grid and retail distribution systems. Many state legislative bodies are +also actively reviewing the impact of crypto mining in their respective states. For example, in May 2023, Montana enacted S.B. 178 which +established a right-to-mine for digital assets and prevents local governments from enacting any ordinance, resolution, or rule that selectively +targets digital asset miners. In 2022, Michigan considered a bill that would establish a blockchain and cryptocurrency commission aimed +at, among other things, examining the feasibility of regulating the energy consumption associated with the cryptocurrency industry and +investigate blockchain and cryptocurrency. The bill has, as of the date of this Annual Report, yet to be signed into law. In addition +to Michigan and Montana, other states are also considering or have enacted laws aimed at regulating crypto mining. For example, in 2022, +New York placed a two-year moratorium on certain cryptocurrency mining companies that use fossil fuels, which expired in November 2024. +Environmental +The perceived threat of climate change continues to attract considerable +attention in the United States and around the world. Numerous proposals have been made and could continue to be made at the international, +national, regional and state levels of government to monitor and limit emissions of greenhouse gases (“GHGs”). These efforts +have included consideration of cap-and-trade programs, carbon taxes, GHG disclosure obligations and regulations that directly limit GHG +emissions from certain sources. In addition, President Biden identified addressing climate change and the energy transition as priorities +under his Administration. He has issued executive orders and regulatory directives related to climate change, and has recommitted the +United States to long-term international goals to reduce emissions. In recent years, the U.S. Congress has considered legislation to reduce +emissions of GHGs and has included climate change considerations in its funding bills. For example, the Inflation Reduction Act of 2022, +which appropriates significant federal funding for renewable energy initiatives, was signed into law in August 2022 and could accelerate +the transition away from fossil fuels. These laws, initiatives, and associated regulations or other national or regional commitments to +reduce GHG emissions could adversely affect fossil fuel consumption, require the installation of emissions control technologies, and increase +the expense associated with the purchase of emissions reduction credits or allowances to comply with current or future emissions reduction +programs. It is uncertain how many of the Biden Administration’s initiatives will continue to remain in force under the Trump Administration. +At +the federal level, the Environmental Protection Agency (“EPA”) has also adopted rules that, among other things, establish +construction and operating permit reviews, emissions control standards, and monitoring and annual reporting for GHG emissions from certain +large stationary sources. In November 2021, the Biden Administration released “The Long-Term Strategy of the United States: Pathways +to Net-Zero Greenhouse Gas Emissions by 2050,” which establishes a roadmap to net zero emissions in the United States by 2050 through, +among other things, improving energy efficiency, decarbonizing energy sources via electricity, hydrogen and sustainable biofuels, eliminating +subsidies provided to the fossil fuel industry, reducing non-CO 2 GHG emissions and increasing the emphasis on climate-related +risks across government agencies and economic sectors. Additionally, from time to time the EPA has proposed, revised, and adopted rules +establishing new source performance standards for certain pollutants from coal-fueled electric generating plants. +We note that the implementation of the rule depends, in part, on the +widespread development, adoption, and availability of carbon capture and storage technology and solutions, which may not be certain at +this time. We also note that this proposed rule is subject to intense political debate and its adoption or implementation were impacted +by the results of the 2024 election cycle, though the extent of any changes to the prior regulatory regime remain undetermined. While +no final rule has been published to date, this proposed rule and any other new agency action or rulemaking that applies to our facilities +could increase our compliance costs or otherwise materially restrict our operations. Currently, it is unclear how future legislation and +regulation will affect our Bitcoin mining operations. The course of future legislation and regulation in the United States remains difficult +to predict, and potential increased costs associated with new legislation or regulation cannot be predicted at this time. +14 +Competition +Our business environment is constantly evolving, and cryptocurrency +miners can range from individual enthusiasts to professional mining operations with dedicated data centers. We compete with other companies +that focus all or a portion of their activities on cryptocurrency mining activities at scale. We face significant competition in every +aspect of our business, including, but not limited to, the ability to raise capital, obtaining the lowest cost of electricity, obtaining +access to energy sites with reliable sources of power, and evaluating new technology developments in the industry. +At present, the information +concerning the activities of these enterprises may not be readily available as the vast majority of the participants in this sector do +not publish information publicly or the information may be unreliable. Published sources of information include “bitcoin.org” +and “blockchain.info”; however, the reliability of that information and its continued availability cannot be assured and the +contents of these sites are not incorporated into this Annual Report. +A number of public companies +(traded in the U.S. and internationally) and private companies may be considered to compete with us, including the following companies: +· Argo Blockchain PLC; +· Bit Digital, Inc.; +· Bitdeer Technologies Group; +· Bitfarms Technologies Ltd.; +· Cipher Mining Inc.; +· CleanSpark, Inc.; +· Core Scientific, Inc.; +· Digi Power X Inc.; +· Galaxy Digital Holdings Ltd.; +· Hive Blockchain Technologies Inc.; +· Hut 8 Mining Corp.; +· IREN Limited; +· Marathon Digital Holdings, Inc.; +· Northern Data AG; +· Riot Blockchain, Inc.; +· Stronghold Digital Mining, Inc.; and +· TeraWulf Inc. +Intellectual Property +We do not currently own, and +do not have any current plans to seek, any patents in connection with our existing and planned blockchain and cryptocurrency related operations. +We do expect to rely upon trade secrets, trademarks, service marks, trade names, copyrights and other intellectual property rights and +expect to license the use of intellectual property rights owned and controlled by others. +15 +Blockchain Background +Blockchain technology first came to public attention in 2008 as the +database technology that underpins Bitcoin, the world’s first cryptocurrency. Blockchains are generally open-source, peer-to-peer +software programs that act as decentralized digital ledgers, each comprising a series of data “blocks” that are linked and +secured using cryptography in a “chain.” The blockchain program consists of a software protocol with several functions. The +software protocol is run by multiple computer systems or “nodes.” For many blockchain networks, each node has its own copy +of the blockchain ledger, which contains a historical record of every transaction. The digital ledger continuously grows as new blocks +are added to it to record the most recent transactions in a linear, chronological order. The same information is stored across a network +of computers all over the world, and this record makes it possible to track the ownership and transfer of cryptocurrency from the creation +of the blockchain to its current state, and effectively records of all account balances (as one can identify what account holds what value +through the decentralized ledger). +We do not operate a complete +node; rather, as noted above under the heading “Bitcoin Mining and Mining Pools,” we provide computing power to a pool operator. +The blockchain protocol allows +users to submit transactions to the network for confirmation. However, a transaction will not be accepted by the protocol if the inputs +to the transaction have previously been used in another transaction. This prevention of “double spending” is a key security +feature of blockchain networks. +Another key function of the +blockchain that protects the integrity of the network is the hashing process, which acts as a tamper-evident seal that confirms the validity +of the new block and all earlier blocks. Hashing is the process of a block being posted to the network. Hashing results from miners, who +are responsible for receiving broadcast transactions, processing those transactions into new blocks and updating the blockchain with the +new blocks through hashing. The hashing process ties every new block to the existing block on the blockchain to ensure each is a continuous +record of verified transactions. +The hashing algorithm on a +proof-of-work blockchain network is a mathematical transformation function with two key properties. The first important function of hashing +is that the algorithm accepts any alphanumeric dataset as an input and produces a unique output code. The smallest change in the dataset +results in a significant change in the unique code. Any tampering of the dataset can be detected by re-hashing the data and checking for +a change in the unique code. Any user that runs the hash algorithm on the same data will derive the same unique code. Consequently, the +data on the distributed ledger can be run through a series of hash algorithms to create a unique code, which would reveal if any changes +to the ledger have been made. +Second, whenever a new set +or “block” of transactions is added to the ledger, it is appended with the code from the prior state of the ledger before +it is hashed. Thus, the hash created from the new block will incorporate the hash from the previous block. An alteration made to an earlier +block would make the hashes of all subsequent blocks invalid, as the discrepancy would be easily detected by future miners through the +protocols governing the blockchain. If a hacker were to attempt to make a change to an earlier block and broadcast it along with following +blocks to the other nodes on the network, that broadcast would be discarded in favor of one from a different node which complied with +the requirements of the protocol. +Thus, in addition to creating new blocks, miners “vote” +with their computer power, expressing their acceptance of valid blocks by working on adding them to the blockchain, and rejecting invalid +blocks by refusing to work on them. If a miner’s proposed block is added to the blockchain by a majority of the nodes on the network, +it is considered part of the blockchain. The nodes on the network synchronize with each other to ensure that once a block is accepted +by the majority, the new block will eventually be added to all the nodes. Consequently, the historical state of the ledger can be changed +if control of more than 50% of the network is obtained; however, in the case of widely held cryptocurrencies with non-trivial valuations, +it may be economically prohibitive for any actor or group of actors acting in concert to obtain computing power that consists of more +than 50% of the network. +Unlike proof-of-work networks, +in which miners expend computational resources to compete to validate transactions and are rewarded cryptocurrency in proportion to the +amount of computational resources expended, in a proof-of-stake network, miners (sometimes called validators) risk or “stake” +assets to compete to be randomly selected to validate transactions and are rewarded cryptocurrency in proportion to the amount of assets +staked. Any malicious activity, such as mining multiple blocks, disagreeing with the eventual consensus or otherwise violating protocol +rules, results in the forfeiture or “slashing” of a portion of the staked assets. Proof-of-stake is viewed by some as more +energy efficient and scalable than proof-of-work. +16 +Blockchain technology enables +the secure use and transfer of digital assets. “Digital asset” is a broad term that encompasses additional applications, including +ownership, transaction tracking, identity management, and smart contracts. A digital asset can represent physical or virtual assets, a +value, or a use right/service (e.g., computer storage space). +Whereas digital assets can +take many forms and be used for a variety of functions, cryptocurrencies are a type of digital asset that primarily function as a medium +of exchange, a unit of account, and/or a store of value. Cryptocurrencies allow anyone who holds a compatible wallet, anywhere in the +world, to hold and transfer that cryptocurrency without the need for an intermediary or trusted third party. Units of a cryptocurrency +may exist only as data on the internet, and often are not issued or controlled by any single institution, authority or government. Whereas +most of the world’s money currently exists in the form of electronic records managed by central authorities such as banks, units +of a non-government cryptocurrency exist as electronic records in a decentralized blockchain database. Because cryptocurrencies have no +inherent intrinsic value, the value of cryptocurrencies is determined by the value that various market participants place on them through +their transactions. Bitcoin, Ethereum and other cryptocurrencies have historically exhibited high price volatility relative to more traditional +asset classes. +Private entities also issue digital assets called “stablecoins” +whose prices are pegged to those of an underlying fiat currency, a commodity or other financial instrument or other physical asset and +are therefore less susceptible to volatility. Stablecoins can be backed by fiat money, physical assets, or other crypto assets. Government +institutions are also reportedly testing and considering issuing Central Bank Digital Currencies (“CBDC’s”). While stablecoins +or CBDC’s may exhibit less price volatility than other cryptocurrencies, both rely on a central authority to establish the value +of the asset, and therefore represent an exception to the general discussion of the design of cryptocurrencies in this Annual Report. +Each cryptocurrency has a +source code that comprises the basis for the cryptographic and algorithmic protocols, which govern the blockchain. The source code is +commonly open-source and therefore can be inspected by anyone, and is maintained on an ongoing basis through contributors proposing amendments +to the protocol, which are peer reviewed and adopted by consensus among participants on the blockchain network. These protocols govern +the functioning of the network, including the ownership and transfer of the cryptocurrency, and are executed on the decentralized peer-to-peer +blockchain infrastructure. The peer-to-peer infrastructure on which a blockchain operates is not owned or operated by a single entity. +Instead, the infrastructure is collectively maintained by a decentralized user base. Each peer user is generally known as a “node” +or “miner,” and each miner processes transactions on the network in accordance with the protocols of the relevant cryptocurrency. +As a result, these cryptocurrencies +do not rely on either governmental authorities or financial institutions to create, transmit or determine the value of units of cryptocurrency. +Rather: +· +the creation of units of cryptocurrency generally is governed by the source code, not a central entity; +· +the transmission of a cryptocurrency is governed by the source code and processed by the decentralized peer-to-peer network of nodes or miners; and +· +the value of a cryptocurrency is generally determined by the market supply of and demand for the cryptocurrency, with prices set in transfers by mutual agreement or barter, as well as through acceptance directly by merchants in exchange for goods and services. +Cryptocurrencies may be open-source +projects with no official developer or group of developers that control the network. However, certain networks’ development may +be overseen informally by a core group of developers that may propose quasi-official releases of updates and other changes to the network’s +source code. The release of updates to a blockchain network’s source code does not guarantee that the updates will be automatically +adopted. Users and miners must accept any changes made to the source code by downloading the proposed modification of the network’s +source code. A modification of the network’s source code is effective only with respect to the users and miners that download it. +If a modification is accepted by only a percentage of users and miners, a division in the network will occur such that one network +will run the pre-modification source code and the other network will run the modified source code. Such a division is known as a “fork.” +Consequently, a modification to the source code becomes part of a blockchain network only if accepted by participants collectively having +most of the processing power on the network. +Each “account” +on a blockchain network is identified by its unique public key, and is secured with its associated private key (which the account holder +must keep secret, like a password). Cryptocurrencies are treated as bearer assets, because possession of the private key generally determines +who controls or owns a cryptocurrency. Protecting private keys from unwarranted access and theft is critically important, as once the +private key is taken, in most circumstances, control over the related cryptocurrency is gone. The combination of private and public cryptographic +keys constitutes a secure digital identity in the form of a digital signature. As long as the private key is kept private (i.e., confidential +to the owner of the account) it provides strong control of ownership. +17 +Ault Lending +Ault Lending provides commercial loans to companies throughout the +U.S. to provide them with operating capital to finance the growth of their businesses. The loans range in duration from six months to +three years. Ault Lending’s loans are made or arranged pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +Ault +Lending acquires controlling or non-controlling interests in and actively manages businesses that we generally believe (i) are undervalued +and have disruptive technologies with a global impact, (ii) operate in industries with long-term macroeconomic growth opportunities, +(iii) have the potential for positive and stable cash flows, (iv) face minimal threats of technological or competitive obsolescence, +and (v) have strong management teams largely in place. We offer investors a unique opportunity to own a diverse group of leading +middle-market businesses in the niche-industrial and branded-consumer sectors. +Ault Lending uses a traditional methodology for valuing securities +that primarily looks for deeply depressed prices. Upon making an investment, we often become actively involved in the companies we seek +to acquire, whether in its entirety or merely a controlling or non-controlling interest. That activity may involve a broad range of approaches, +from influencing the management of a target to take steps to improve stockholder value, to acquiring a controlling or non-controlling +interest or outright ownership of the target company in order to implement changes that we believe are required to improve its business, +and then operating and expanding that business. +Ault +Lending believes that private company operators and corporate parents looking to sell their business units may consider us an attractive +purchaser because of our ability to: +· +provide ongoing strategic and financial support +for their businesses, including professionalization of our subsidiaries at scale; +· +maintain a long-term outlook as to the ownership +of those businesses; +· +sustainably invest in growth capital and/or add-on +acquisitions where appropriate; and +· +consummate transactions efficiently without being dependent on third-party transaction financing. +In particular, we believe that our outlook on length of ownership and +active management on our part may alleviate the concern that many private company operators and parent companies may have with regard +to their businesses going through multiple sale processes in a short period of time. We believe this outlook enhances our ability to develop +a comprehensive strategy to increase the earnings and cash flows of each of our businesses. +Finally, it has been our experience that our ability to acquire businesses +without the cumbersome delays and conditions typical of third-party transactional financing is appealing to sellers of businesses who +are interested in confidentiality, speed and certainty to close. +We +believe our management team’s strong relationships with industry executives, accountants, attorneys, business brokers, commercial +and investment bankers, and other potential sources of acquisition opportunities offer us substantial opportunities to assess small businesses +available for acquisition. In addition, the flexibility, creativity, experience and expertise of our management team in structuring transactions +allows us to consider non-traditional and complex transactions tailored to fit a specific acquisition target. +In +terms of the businesses in which we have a controlling interest as of December 31, 2024, we believe that these businesses have stable +management teams, operate in strong markets with defensible market niches, and maintain long-standing customer relationships. +Ault Lending provides funding +to businesses through loans and investments. Ault Lending offers a variety of loan types including commercial loans, convertible notes +and revolving lines of credit. Ault Lending is engaged in providing commercial loans to companies throughout the United States to provide +them with operating capital to finance the growth of their businesses. The loans are primarily short-term, ranging from six to 12 months, +but may be of longer duration. These terms are subject to change as market needs dictate, and Ault Lending anticipates offering additional +products in the future. +18 +Ault Lending uses its considerable financial experience, data analytics, +and a credit scoring model to assess the creditworthiness of each small business borrower applicant. If the business meets Ault Lending’s +criteria, Ault Lending sets the initial interest rate according to its credit and financial models. The final interest rate offered to +the borrower will be determined by Ault Lending’s interpretation of the marketplace. In order to borrow from Ault Lending, borrowers +must display characteristics indicative of durable business and financial situations. These include factors such as revenue, time in business, +number of employees, and financial and credit variables. In order to qualify, business borrower applicants must be approved through Ault +Lending’s underwriting process, which analyzes credit and financial data of both the business and the business owner. Ault Lending +takes into account several business factors (including revenue, age of business, cash flows, and other variables). The underwriting process +determines the loan amount to approve, how loans will be priced, and whether to include a blanket lien, as well as additional factors +(including length of loan, estimated default rates by type and grade, and general economic environment). +Our Executive Committee, which is comprised of our Executive Chairman, +Chief Executive Officer and President, acts as the underwriting committee for Ault Lending and must approve all lending transactions. +The Executive Committee has decades of experience in financial, investing and securities transactions. Under its business model, Ault +Lending generates revenue through origination fees charged to borrowers and interest generated from each loan. Ault Lending may also generate +income from appreciation of investments in marketable securities as well as any shares of common stock underlying convertible notes or +warrants issued to Ault Lending in any particular financing. +As noted above, we will from +time to time, through Ault Lending, engage in discussions with other companies interested in our subsidiaries or partner companies, either +in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary partner company’s further +growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ +best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of +privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s +securities and, in the case of publicly traded partner companies, transactions in their securities in the open market. Our plans may include +taking subsidiaries or partner companies public through rights offerings, mergers or spin-offs and directed share subscription programs. +We will continue to consider these and functionally equivalent programs and the sale of certain subsidiary or partner company interests +in secondary market transactions to maximize value for our stockholders. +During 2025, we anticipate +providing significant new funding to expand Ault Lending’s loan and investment portfolio. Ault Lending loans are made or arranged +pursuant to a California Financing Law license (Lic.no. 60 DBO77905). +RiskOn International, Inc. +Overview +RiskOn’s operations are primarily +those of BNC, which is engaged in the development and operation of an online gaming platform (the “Platform”). The Platform +offers engaging and dynamic online gaming experiences by integrating various elements such as gaming, social activities, sweepstakes, +online gaming and more. ROI aims to provide innovative ways for people in the United States to interact online. The Platform is located +at BitNile.com and is accessible via any device using any web browser, without requiring permissions, downloads, or apps. +BNC’s games operate on a free-to-play model, whereby game players +may collect coins free of charge through the passage of time, free top-up feature, and, if a game player wishes to obtain coins above +and beyond the level of free coins available to that player, the player may purchase additional coin packages (“Freemium” +gaming model). However, no purchase is necessary to participate in any sweepstakes, and sweepstakes entries themselves cannot be purchased . +Once obtained, the coins (either free or purchased) cannot be redeemed for cash or exchanged for anything outside of the Platform. When +coins are used in the games, the game player could “win” and be awarded additional coins, or could “lose” and +lose the future use of those coins. +BNC’s current and planned +products and experiences are: +· +Gaming. The Platform provides an extensive selection of gaming options, including participation in games, sweepstakes and social gaming experiences, such as Blackjack and roulette. +19 +· +Sweepstakes gaming. The Platform features a dedicated gaming zone for users to engage in sweepstakes gaming, offering opportunities to win real money and prizes. +· +Socialization and connectivity. The Platform’s ongoing mission will be to foster global connections by enabling users to interact with individuals, forming new friendships, collaborating on projects or engaging in conversations within various social hubs. +Business Strategy +The online sweepstakes gaming +industry in the United States is experiencing rapid growth and expansion, driven by advancements in technology and increased interest +in free-to-play and social gaming. BNC’s business strategy revolves around creating a seamless, all-encompassing platform that caters +to various user needs and interests, particularly in sweepstakes and social gaming experiences. +The strategic pillars for the growth of the Platform include (i) leveraging +cutting-edge technology to offer a user-friendly, browser-based platform compatible with modern devices for an enhanced experience, (ii) +providing a diverse range of sweepstakes and gaming products that cater to users with different interests and preferences, (iii) fostering +connections and a sense of community among users, encouraging socialization and (iv) focusing on continuous innovation and regulatory +compliance to stay ahead of industry trends and customer expectations. +Competition +BNC faces competition from +both established online gaming platforms and new entrants in the market. It competes with recognized sweepstakes operators—such +as Chumba Casino, Stake.us, and Luckyland—that continually introduce new offerings in this evolving space. BNC also contends with +gaming-focused platforms like Fortnite and Roblox, as well as other social or casual games that vie for user attention. In addition, traditional +brick-and-mortar casinos are increasingly expanding their reach by introducing online components or apps, which further intensifies the +competitive landscape. +Regulatory Environment: Present and Future +Challenges +As the online gaming industry +continues to grow and evolve, regulatory challenges and considerations are becoming increasingly important. The nature of the Platform, +which often combines elements of gaming, social networking, and digital economies, presents a complex landscape for regulators to navigate. +To navigate the complex and +evolving regulatory landscape, BNC will prioritize compliance with relevant laws and regulations in all jurisdictions where it operates. +This includes data privacy and protection regulations, gaming and sweepstakes regulations, and intellectual property rights. By maintaining +a strong focus on regulatory compliance, BNC aims to minimize potential legal risks and build trust with users and partners. +Present Regulatory Challenges +The online gaming industry +is currently grappling with several regulatory challenges. First, data privacy and security concerns loom large, as users share personal +information and engage in transactions within the Platform. Regulators require that platforms comply with existing data protection regulations, +such as the General Data Protection Regulation (“GDPR”) and the California Consumer Privacy Act (“CCPA”). +Second, sweepstakes-specific +compliance poses unique hurdles because sweepstakes must be free to enter and cannot require a purchase for participation. Accordingly, +businesses must structure their sweepstakes to ensure adherence to state and federal laws, such as providing an alternative means of entry +and clear disclosures. +Third, intellectual property +rights become complicated when a platform relies on user-generated content and virtual goods or items. Copyright, trademark, and patent +laws can be difficult to enforce in virtual environments, raising questions about how best to protect and manage these rights. +20 +Fourth, taxation and financial +regulations come into play as virtual economies flourish, particularly with the rise of cryptocurrencies and non-fungible tokens. Regulators +must determine how to classify and tax digital assets and transactions, while also ensuring compliance with anti-money laundering and +know-your-customer requirements. +Lastly, content moderation +and liability remain pressing issues. Platforms must moderate content and user behavior while navigating potential liability for user-generated +content. This includes addressing possible violations of laws related to hate speech, harassment, and misinformation, all of which carry +significant legal and reputational risks. +Future Regulatory Challenges +As sweepstakes gaming continues +to develop and expand, several additional regulatory questions are likely to emerge. Payment processing and banking compliance may draw +heightened scrutiny as operators look for efficient ways to deliver prizes or credits, requiring compliance with anti-money laundering +and know-your-customer regulations in a sweepstakes context. Evolving state sweepstakes laws add further complexity, as each state imposes +unique statutes and regulations regarding contests, forcing operators to stay informed on registration or bonding requirements. Emerging +digital prize formats, such as virtual items or tokens, may require additional clarity from state and federal regulators to determine +their proper classification. Finally, accessibility and inclusivity concerns will likely increase, with regulators paying more attention +to ensuring that sweepstakes remain inclusive and transparent for all eligible participants +askROI +Overview +askROI is an AI-powered software-as-a-service +platform designed to help businesses leverage their data for competitive advantage. At the core of askROI’s technology is a state-of-the-art +large language model (“LLM”), which is exclusively licensed from a third-party provider for use in North America. The askROI +platform is located at askroi.com and askROI dedicated applications are available for download on both the Apple and Google app marketplaces. +By seamlessly integrating +with a company’s existing tools and data sources, askROI seeks to deliver actionable insights, intelligent analysis, and data-driven +decision support. The platform’s LLM-powered technology allows it to interpret complex queries, identify relevant information, and +provide highly contextualized responses, all while continuously learning and adapting to each organization’s unique language and +terminology. +Our vision is that askROI +can transform how businesses operate in the digital age. With our exclusive access to cutting-edge LLM technology and our commitment to +delivering tangible business value, askROI seeks to set a new standard for AI-powered insights and decision support in the North American +market. +askROI’s current and +planned product functionality are: +· Seamless integration : askROI connects +with a wide range of business tools, including customer relationship management, cloud storage systems (e.g., OneDrive, Google Drive), +and communication platforms (e.g., Slack, Teams). Ongoing expansion of integration partnerships will further streamline data access and +analysis; +· Contextualized understanding : By referencing +secure, company-specific workspaces and knowledge bases rather than training the underlying LLM, askROI can deliver tailored insights +aligned with each organization’s unique terminology, product names, and project codes. Ongoing refinements to the platform’s +natural language processing capabilities will enable even more nuanced, context-aware analysis; +· Actionable insights : askROI analyzes data +to generate custom reports, draft data-rich presentations, and create visualizations like charts and graphs. Introduction of industry-specific +templates for reports, data visualizations, and analytics dashboards will provide additional value for users in targeted sectors; +· Transparency and security : askROI cites +specific data sources for its answers and provides direct document links for reference. Robust data security measures, including access +controls, encryption, and audit trails, seek to ensure the protection of sensitive information. Future updates will focus on achieving +compliance with key regulations such as GDPR, SOC 2, and payment card industry data security standards; +21 +· Ethical AI : Implementation of strict guidelines +and oversight mechanisms to ensure responsible development and use of askROI’s AI models, mitigating risks of bias, discrimination, +or misuse; and +· Partner ecosystem : Development of a robust +network of consultancies, system integrators, and industry-specific solution providers to accelerate adoption and create tailored solutions +for diverse business needs. +By continually enhancing and +expanding its capabilities, askROI aims to position its platform as an indispensable tool for businesses seeking to leverage their data +for competitive advantage and operational excellence. +Business Strategy +askROI is currently in early +development, focusing on support and commercial applications. However, the platform’s flexible architecture and powerful AI capabilities, +underpinned by its exclusive licensing agreement for the LLM technology in North America, position it for broad applicability across industries. +The go-to-market strategy involves continued refinement of the core product based on beta user feedback, followed by a staged rollout +to additional sectors. +Key strategic initiatives +include: +· Continued refinement of the core product based +on beta user feedback, followed by a staged rollout to additional sectors; +· Leveraging its exclusive LLM licensing agreement +to differentiate askROI in the North American market, attracting customers seeking advanced AI solutions; +· +Using askROI as a dedicated application in both the Apple and Google app marketplaces, enabling mobile-first +experiences and expanding accessibility to on-the-go users; +· Expanding integration partnerships to ensure +askROI can seamlessly fit into diverse tech stacks, minimizing adoption barriers; +· Focusing marketing efforts on real-world use +cases and demonstrable return on investment, showcasing how askROI can drive tangible business outcomes; +· Building a strong partner ecosystem, including +consultants, system integrators, and industry-specific solution providers, to accelerate adoption; and +· Investing in research and development to maintain +a competitive edge in natural language processing, machine learning, and data analytics. +By adopting these strategic +initiatives and building on what we believe to be its unique LLM licensing advantages, askROI aims to position itself as a leading AI-powered +insights engine, setting the standard for data-driven decision-making and operational excellence. +Competition +We believe that askROI’s +unique positioning as an AI-powered insights engine operating exclusively on a company’s own data, differentiates it from both generic +AI tools and other enterprise search and analytics platforms. +Key differentiators include: +· Exclusive access to advanced LLM : we believe +that askROI’s licensing agreement provides a significant competitive advantage, enabling the platform to leverage advanced natural +language processing capabilities; +22 +· Seamless integration with existing business +tools : By minimizing disruption to established workflows and enabling rapid adoption, askROI will reduce barriers to entry and increases +its appeal to potential customers; +· Ability to provide company-specific context : +Through secure, dedicated workspaces and knowledge bases, askROI accepts and indexes an organization’s proprietary documents without +using them to train the underlying LLM. Instead, the platform queries these internal data sets on demand to generate relevant, context-rich +answers specific to each organization’s terminology and needs. By keeping this data separate from the LLM’s base model training, +askROI maintains data confidentiality while still delivering more accurate and actionable insights than generic AI solutions; +· Focus on delivering actionable insights : +askROI goes beyond simple data aggregation, empowering users to make informed decisions and drive tangible business outcomes; and +· Commitment to data security and privacy : +By ensuring that sensitive information remains protected and compliant with evolving regulations, askROI addresses a key concern for businesses +considering AI-driven solutions. +We believe that as the market +for AI-driven business tools continues to expand, askROI is well-positioned to capture market share through its advanced capabilities, +ease of use and strong commitment to customer success. askROI’s LLM licensing arrangement provides an important differentiator, +but the rapid pace of AI innovation requires it to continually invest in research and development to maintain a competitive edge. +However, askROI also recognizes +the potential for competition from established enterprise software providers and emerging startups focused on AI-powered analytics and +decision support. To mitigate these competitive risks, askROI will focus on building a strong brand identity, cultivating a loyal customer +base, and leveraging its partner ecosystem to create advantages focused on its core offerings. +Ultimately, askROI’s +success will depend on its ability to consistently deliver value to customers, stay at the forefront of technological innovation, and +adapt to the evolving needs of the market. By remaining agile, customer-centric, and committed to its vision of empowering businesses +through AI-driven insights, askROI is confident in its ability to thrive in the face of competition and position itself as a leader in +the market. +Regulatory Environment (Present and Future) +The regulatory landscape for +artificial intelligence and data-driven technologies continues to evolve worldwide, presenting both challenges and opportunities for askROI. +In various regions, including the United States, the European Union, and parts of Asia, governments and regulatory bodies are introducing +new legislation and guidelines specifically related to AI, data privacy, and automated decision-making. For example, the European Union’s +draft AI Act proposes a risk-based approach that could place additional compliance requirements on AI developers. Some of our competitors, +particularly large, established technology companies, already have more extensive compliance frameworks or resources to adapt quickly, +giving them a potential advantage in the event of significant regulatory changes. +To address these developments, +askROI maintains a strong commitment to data protection and security. askROI’s platform employs encryption, access controls, and +audit trails to safeguard customer information. At the same time, askROI recognizes that the rapid evolution of AI regulation may lead +to complex or overlapping legal requirements across various jurisdictions, ultimately increasing its compliance costs or limiting certain +functionalities. Consequently, askROI proactively engages with industry groups, policymakers and external advisors to stay informed about +emerging regulations and ensure that its platform aligns with current and anticipated standards. +Nevertheless, ongoing changes +in AI-related rules and interpretations of existing data-privacy laws could require askROI to make significant investments or modifications +to the askROI platform. Compliance obligations might include adding new audit capabilities or restricting how certain AI features function +to meet transparency or accountability requirements. In the event that these regulatory changes become more restrictive than anticipated, +askROI’s operations could be adversely affected, and its ability to serve customers in certain markets could be limited. +23 +Circle 8 +Description of the Business +Headquartered in Houston, +Circle 8 is a premier lifting services provider serving clients in Texas, Oklahoma, Louisiana and New Mexico with five strategically located +branches in Texas and Oklahoma. Its modern fleet consists of 57 mobile all-terrain and hydraulic cranes, with lifting capacities of up +to 350 tons that provides services across the Eagle Ford, Permian, Delaware and Haynesville basins. Circle 8 is poised for organic growth +through a strengthened financial profile following its recapitalization in December 2022. Circle 8’s fleet consists of Grove, Liebherr, +Xuzhou Construction Machinery Group and other leading original equipment manufacturers (“OEMs”). +Circle 8 provides experienced +professionally certified operators to deliver customized solutions to lifting clients in oil field services, construction, commercial, +refining / marketing and wind energy markets. Circle 8 maintains an industry leading safety record. Safety personnel hold certifications +and undergo in-house training. +Competitive Advantage +Circle 8’s operating experience and the mid-sized diverse fleet +that it has developed serves the oil service and petrochemical industries, providing full-service lifting solutions with an industry leading +safety record. Key strengths of Circle 8 include: +· +Leading lifting solutions platform +○ +Leading provider of comprehensive lifting solutions to diversified end markets, including oil & gas and with expanding operations in infrastructure, plant turn-around and commercial/industrial construction; and +○ +Leading market position with five branches strategically located throughout Texas and Oklahoma. +· +Industry leading safety record, commitment and policy +○ +Safety is a core value and Circle 8 is a market leader in employee training and practices; and +○ +Dedicated team focused on safety programs. +· +Proven strength of management, recently enhanced and augmented +○ +Proven ability to navigate a secular downturn by maintaining strong customer relationships and scale operations to capture additional market share; +○ +Seasoned industry leaders who have positioned Circle 8 for future growth; and +○ +Additional advisory team to supplement full time management with strategic industry knowledge, contacts and corporate transaction capability. +· +High quality fleet with the opportunity to expand by 100% creates a barrier to entry. Circle 8’s fleet of 57 cranes, as of the date of this Annual Report, comprises 47 all-terrain cranes and 10 hydraulic truck cranes with a combined average age of 9 years and capacity of up to 350 tons. +· +Diversified blue-chip customers +○ +Entrenched provider to leading, well-capitalized oil and gas industry operators in Texas, New Mexico, Louisiana and Oklahoma; +○ +Diverse customer base with minimal customer concentration risk; and +○ +Longstanding relationships enable company to easily scale up operations with customers’ demands in the oilfield (upstream), commercial, construction, refining & marketing (downstream) and wind energy markets. +· +Compelling utilization and financial profile +○ +Recently downsized underutilized cranes to return to pre-pandemic fleet utilization over 160%; and +○ +Substantial upside remains as the Company efficiently relocates and repurposes its fleet across geographies and end markets. +24 +Industry +In 2024, the U.S. lifting +solutions equipment distribution and rental industry experienced notable consolidation activities. United Rentals, Inc. (“URI”) +announced its intention to acquire H&E Equipment Services for approximately $4.8 billion, aiming to enhance its equipment capacity +and capitalize on the growing demand for equipment rentals in the United States. Additionally, URI completed the acquisition of Yak Access, +LLC, for approximately $1.1 billion, expanding its specialty business offerings. Herc Holdings, Inc. (“HRI”) also pursued +growth through acquisitions, completing nine acquisitions that added 28 locations and opening 23 new greenfield locations during the year. +Despite these consolidation efforts, the industry remains highly fragmented, comprising a mix of multi-location regional or national operators +and numerous small, independent businesses serving local markets. The industry's dynamics are influenced by various economic factors, +including trends in U.S. residential and non-residential construction, demand for construction machinery, and region-specific considerations. +Lifting solutions equipment continues to be distributed through two primary channels: equipment rental companies and equipment dealers. +Prominent equipment rental companies include URI, Sunbelt Rentals, and HRI, while notable equipment dealers include Finning and Toromont. +Circle 8 operates within a rental business segment that provides comprehensive project services, including labor and consumables. Similarly, +many pure equipment rental companies offer parts and service support to their customers. +Sales and Marketing +Led by Arnold Mabee and Brett +Rhuland, the sales force is highly specialized in lifting solutions sales to oil services customers, seeking long term purchase orders +and master service agreements. Circle 8 plans to continue the extensive training program which involves OEM training sessions on operations +and maintenance to ensure the entire sales force knows the fleet inside and out. +Circle 8 will be working with +continuing management to implement a back-office content resource management system that will be heavily focused on data collection so +that it can continue to improve margin and help streamline scheduling, operations and fleet management to optimize utilization. +Competitive Business Strategy +The oil services’ lifting +solutions demand has historically been one of the leading sub-segments of the industry for profitability due to high utilization rates +that coincide with the continuous workstreams of extraction. Circle 8 plans to expand this business line in both topline sales through +optimizing service and quality operations with a strong safety record. +In addition to expanding the +existing business, Circle 8 will seek to make additional forays into the infrastructure construction, the refinery and manufacturing plant +turn-around and industrial facility construction with the availability of new cranes as they become available. +Customers +With a focus on the oil services +sub-segment of the lifting solutions business in the Eagle Ford, Haynesville, Permian, Delaware and Anadarko basins, Circle 8 has a diversified +base of blue-chip customers in TX and OK. While about a third of its sales are expected to be made up from six of the largest players +in the industry, the remaining two thirds of sales will be highly diversified, leading to minimal concentration risk. With its longstanding +relationships with blue-chip customers and incoming fleet units, Circle 8 believes it has the ability to scale up sales with these customers +locally and most likely into other adjacent areas. +Competition +Due to the highly skilled +nature and competitive nature of the lifting solutions business, the sector typically consists of companies like Circle 8 that provide +full service lifting solutions on rental or contract basis, including the manpower required to operate the equipment or companies that +require extensive lifting solutions straight purchasing the equipment and hiring crane operators directly. +The full-service lifting solutions +business is highly fragmented and local with only a few national service providers. In Circle 8’s existing subsegment of the lifting +solutions business to the petrochemical industry, the competition is not as strong as it is in others as the contract terms are usually +longer term and driven by maintaining strong customer relationships. The diversification strategy for Circle 8 into other subsegments +will be faced with competition that is largely driven based on availability, quality (including safety record), reliability and price. +25 +Environmental and Safety Regulations +Circle 8’s equipment, +facilities and operations are subject to comprehensive and frequently changing federal, state and local environmental and occupational +health and safety laws, which may vary locally. These laws regulate (1) the handling, storage, use and disposal of hazardous materials +and waste and, if any, the associated cleanup of properties affected by pollutants; (2) air quality (emissions); and (3) wastewater. While +lifting solutions’ operations generally do not raise significant environmental risks, Circle 8 uses petroleum products, solvents +and other hazardous substances for fueling and maintaining its fleet and vehicles. Circle 8 has made, and will continue to make, capital +and other expenditures to comply with environmental requirements. Circle 8 does not currently anticipate any material adverse effect on +its business, financial condition or competitive position as a result of its efforts to comply with such requirements. +In the future, federal, state +or local governments could enact new or more stringent laws or issue new or more stringent regulations concerning environmental and worker +health and safety matters, reporting and disclosure obligations, or effect a change in their enforcement of existing laws or regulations, +that could affect operations and increase operational and compliance expenditures. Also, in the future, contamination may be found to +exist at Circle 8’s facilities or off-site locations where waste has been sent. There can be no assurance that Circle 8, or various +environmental regulatory agencies, will not discover previously unknown environmental non-compliance or contamination. Circle 8 could +be held liable for such newly discovered non-compliance or contamination. It is possible that changes in environmental and worker health +and safety laws or liabilities from newly discovered non-compliance or contamination could have a material adverse effect on Circle 8’s +business, financial condition and results of operations. +AGREE +AGREE is actively invested +across a diverse range of commercial real estate asset classes, with a particular focus on hospitality and in the future, multifamily +properties. AGREE strategically targets the middle market segment in geographic areas that present strong fundamentals and offer relative +value, such as emerging or overlooked markets with growth potential. AGREE’s core objective is to deliver attractive, risk-adjusted +returns through a combination of ground-up development, targeted capital investments, and operational enhancements that unlock long-term +value. +In the hospitality sector, +AGREE brings a hands-on, value-driven approach that goes beyond traditional ownership. Recognizing the unique dynamics of hospitality +real estate—which blends real estate investment with service-based business operations—AGREE prioritizes both physical improvements +and elevated guest experiences to drive performance. By focusing on midscale to upper-midscale hotels in underpenetrated markets, AGREE +positions its hospitality assets to capture stable demand from business and leisure travelers alike. +A key component of AGREE’s +hospitality platform is AGREE Madison, a wholly owned subsidiary that operates four recently renovated hotel properties in the Midwest. +These include the Hilton Garden Inn Madison West, Residence Inn Madison West, Courtyard Madison West, and Hilton Garden Inn Rockford. +AGREE operates a total of 526 keys collectively across the four-property portfolio. Each property has undergone substantial upgrades since +acquired to enhance both aesthetic appeal and operational efficiency, ensuring they meet modern traveler expectations while maintaining +cost discipline. Through AGREE Madison, the firm exercises direct oversight of day-to-day operations, ensuring alignment with its broader +investment philosophy of value creation through active management. +TurnOnGreen +Overview +TurnOnGreen, +through its wholly owned subsidiaries Digital Power and TOG Technologies, is an emerging provider of premium power electronic and EV charging +solutions. TurnOnGreen designs, develops, manufactures, and sells highly engineered, feature-rich, high-grade power conversion systems +and power solutions for mission-critical, life-sustaining, and lifesaving applications across a variety of sectors, particularly those +operating in demanding and harsh environments. TurnOnGreen serves a broad range of markets, including defense and aerospace, medical and +healthcare, industrial applications, telecommunications, e-Mobility, and OEM solutions. TurnOnGreen’s products are highly adaptive, +featuring customized firmware meticulously configured to meet the specific requirements and challenges of its customers’ applications. +Approximately 8% of TurnOnGreen’s revenue is generated leveraging its core power technologies to deliver comprehensive EV charging +infrastructure and subscription-based charging network management services for residential, fleet, hospitality, workplace, healthcare, +municipal, and educational environments including universities and schools. +26 +At +Digital Power, TurnOnGreen provides a comprehensive range of integrated power system solutions that are designed to meet the diverse and +precise needs of its customers with the highest levels of efficiency, flexibility and scalability. Digital Power designs, develops and +manufactures custom power systems to meet performance and/or form-factor requirements that cannot be met with standard power products. +These power system solutions are designed to function reliably in harsh environments associated with defense and aerospace applications, +while also being utilized for applications ranging from industrial and telecommunications equipment to medical instrumentation. TurnOnGreen +believes that Digital Power’s power products are highly adaptive and feature digital power management and software configurations +that allow them to achieve higher power efficiency to meet the requirements of both its customers and its OEMs. In addition to Digital +Power’s custom power system solutions, it also provides a wide range of industry-standard power products. These products include +the AC/DC open frame product series, which TurnOnGreen believes to be among the industry’s leading power switchers in terms of power +efficiency. The open frame products are deployed in highly compact form factors and modular power series that support configurable multiple +DC outputs. Additionally, Digital Power offers high-power and high-voltage laser power supplies tailored to meet the unique requirements +of medical, dental, and industrial pulsed energy systems. Digital Power’s expertise also encompasses high-performance and high-power +data-center power supplies, semiconductor fabrication equipment power source supplies, desktop power supplies, and a comprehensive range +of value-added customized AC/DC and DC/DC ruggedized power supply and system solutions. +Our +Strategy +Our business strategy is designed +to increase stockholder value. Under this strategy, we are focused on managing and financially supporting our existing subsidiaries and +partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to stockholders. We have, are +and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain +or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize +stockholder value, such as activist trading. We anticipate returning value to stockholders after satisfying our debt obligations and working +capital needs. +Our Executive Committee approves +and manages our investment strategy. Upon making an investment, we often become actively involved in the companies we seek to acquire. +That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve stockholder +value, to acquiring a controlling or sizable but non-controlling interest or outright ownership of the target company in order to implement +changes that we believe are required to improve its business, and then operating and expanding that business. +From time to time, we engage +in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of +a process we initiate. To the extent we believe that a subsidiary partner company’s further growth and development can best be supported +by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we will seek to sell some +or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, +mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded +partner companies, transactions in their securities in the open market. Our plans may include taking subsidiaries or partner companies +public through rights offerings and directed share subscription programs. We will continue to consider these and functionally equivalent +programs and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our shareholders. +Management Strategy +Our +management strategy involves the proactive financial and operational management of the businesses we own in order to increase cash flows +and stockholder value. Hyperscale Data actively oversees and supports the management teams of each of our businesses by, among other things: +· +recruiting and retaining talented managers to +operate our businesses using structured incentive compensation programs, including non-controlling equity ownership, tailored to each +business; +· +regularly monitoring financial and operational +performance, instilling consistent financial discipline, and supporting management in the development and implementation of information +systems to effectively achieve these goals; +· +assisting management in their analysis and pursuit +of prudent organic growth strategies; +· +identifying and working with management to execute +attractive external growth and acquisition opportunities; +· +assisting management in controlling and right-sizing +overhead costs; +27 +· +nurturing an internal culture of transparency, +alignment, accountability and governance, including regular reporting; +· +professionalizing our subsidiaries at scale; and +· +forming strong subsidiary level boards of directors to supplement management in their development and implementation of strategic goals and objectives. +Specifically, +while our businesses have different growth opportunities and potential rates of growth, we expect Hyperscale Data to work with the management +teams of each of our businesses to increase the value of, and cash generated by, each business through various initiatives, including: +· +making selective capital investments to expand +geographic reach, increase capacity, or reduce manufacturing costs of our businesses; +· +investing in product research and development +for new products, processes or services for customers; +· +improving and expanding existing sales and marketing +programs; +· +pursuing reductions in operating costs through +improved operational efficiency or outsourcing of certain processes and products; and +· +consolidating or improving management of certain overhead functions. +Our +businesses typically acquire and integrate complementary businesses. We believe that complementary add-on acquisitions improve our overall +financial and operational performance by allowing us to: +· +leverage manufacturing and distribution operations; +· +leverage branding and marketing programs, as well +as customer relationships; +· +add experienced management or management expertise; +· +increase market share and penetrate new markets; +and +· +realize cost synergies by allocating the corporate overhead expenses of our businesses across a larger number of businesses and by implementing and coordinating improved management practices. +Compliance with Material Government (Including +Environmental) Regulations +Sentinum +Sentinum is subject to various +federal, state, local and non-U.S. laws and regulations relating to environmental protection and remediation of hazardous substances and +wastes. Sentinum continually assesses compliance status and management of environmental matters to ensure our operations are in compliance +with all applicable environmental laws and regulations. Investigation, remediation, and operation and maintenance costs associated with +environmental compliance and management of sites are a normal, recurring part of operations. While Sentinum’s regulatory compliance +costs are currently not considered material, it is possible that costs incurred to ensure continued environmental compliance could have +a material impact on results of operations, financial condition or cash flows if new areas of soil, air and groundwater contamination +are discovered and/or expansions of work scope are prompted by the results of ongoing monitoring. +The Michigan Facility is subject to a final corrective measures plan +with the Environment Protection Agency. The seller performed remedial activities at the Michigan Facility relating to historical soil +and groundwater contamination and Sentinum is responsible for ongoing monitoring and final remediation plans. We estimate the cost of +the environmental remediation obligation is approximately $0.4 million and reflects our best estimate of probable future costs for remediation +based on the current assessment data and regulatory obligations. Future costs will depend on many factors, including the extent of work +necessary to implement monitoring and final remediation plans and ACS’s time frame for remediation. We may incur actual costs in +the future that are materially different than this estimate and such costs could have a material impact on results of operations, financial +condition, and cash flows during the period in which they are recorded. +28 +TurnOnGreen +TurnOnGreen’s businesses +are heavily regulated in most of its markets. TurnOnGreen handles power electronics products mainly in the form of power conversion. TurnOnGreen +must take into account several standards for electronic safety to protect the health of humans and animals. TurnOnGreen serves diverse +markets including automotive, defense/aerospace, medical/healthcare, industrial and telecommunications, each of which has its own set +of safety regulations and standards that TurnOnGreen must comply with. +Government Contracts . +The U.S. Government, and other governments, may terminate any of TurnOnGreen’s government contracts at their convenience, as well +as for default based on our failure to meet specified performance requirements. If any of TurnOnGreen’s U.S. Government contracts +were to be terminated for convenience, TurnOnGreen would generally be entitled to receive payment for work completed and allowable termination +or cancellation costs. If any of TurnOnGreen’s government contracts were to be terminated for default, generally the U.S. Government +would pay only for the work that has been accepted and could require TurnOnGreen to pay the difference between the original contract price +and the cost to re-procure the contract items, net of the work accepted from the original contract. The U.S. Government can also hold +TurnOnGreen liable for damages resulting from the default. +Medical device power supplies . +TurnOnGreen’s medical power supplies must incorporate one or more means of protection (“MOP”) to avoid electrocution. +A MOP can be safety insulation, a protective earth, a defined creepage distance, an air gap (clearance) or other protective impedance. +These can be used in various combinations - having two MOPs means if one fails, there is another in place. A MOP can be achieved through +safety insulation, protective earth, a defined creepage distance, an air gap, other protective impedances, or by implementing a combination +of these techniques. TurnOnGreen must comply with a standard that treats operators and patients, resulting in the classifications “means +of operator protection” and “means of patient protection.” The latter requirements are more stringent because the patient +may be physically connected via an applied part and unconscious when the fault occurs. +Environmental . TurnOnGreen +is subject to various federal, state, local and non-U.S. laws and regulations relating to environmental protection, including the discharge, +treatment, storage, disposal and remediation of hazardous substances and wastes. TurnOnGreen continually assesses its compliance status +and management of environmental matters to ensure that its operations are in compliance with all applicable environmental laws and regulations. +Investigation, remediation, and operation and maintenance costs associated with environmental compliance and management of sites are a +normal, recurring part of TurnOnGreen’s operations. +Non-U.S. Sales . TurnOnGreen’s +non-U.S. sales are subject to both U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations +relating to import-export control, tariffs, investment, exchange controls, anti-corruption, and repatriation of earnings. Non-U.S. sales +are also subject to varying currency, political and economic risks. +Other Compliance Matters +In addition, we are subject +to the local, state and national laws and regulations of the jurisdictions where we operate that affect companies generally, including +laws and regulations governing commerce, intellectual property, trade, health and safety, contracts, privacy and communications, consumer +protection, web services, tax, and corporate laws and securities laws. These regulations and laws may change over time. Unfavorable changes +in existing and new laws and regulations could increase our cost of doing business and impede our growth. +Research and Development +During the years ended December +31, 2024 and 2023, we spent approximately $11.0 million and $4.4 million, respectively, on research and development. +Human Capital Resources +We are committed to attracting +and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include +industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives +that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development +and training, diversity and inclusion, and compensation and pay equity. None of our employees is represented by a collective bargaining +unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. +29 +The following description +provides an overall view of our Company. Since we are a holding company, however, every statement may not be applicable to every subsidiary, +particularly since some are located in foreign countries. +Employee Profile +As of December 31, 2024, we +had 424 employees located in the U.S. and the U.K., of whom 15 were engaged in engineering and product development, 30 in sales and marketing, +328 in general operations and 51 in general administration and finance. All but 50 of these employees are employed on a full-time basis. +None of our employees is currently represented by a trade union. We consider our relations with our employees to be good. +As of December 31, 2024, approximately +26% of our current workforce is female, 74% male, and our average tenure is 3.5 years, a decrease of 45% from an average tenure of +6.4 years as of December 31, 2023. +Talent +A core tenet of our talent +system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our +employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports +a continuous improvement mindset and our goals of a diverse and inclusive workforce. +We believe we materially comply +with all applicable state, local and international laws governing nondiscrimination in employment in every location in which we operate. +All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, national +origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status. +Employee Engagement and Development +Our employee engagement efforts +include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees +well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes +that support our customers and ensure a deep understanding of our employees’ needs. We plan to conduct annual confidential employee +surveys as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. +Our employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new +stretch goals. +Pay Equity +Our employee compensation +strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; +and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they +do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark +and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, +and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, +to ensure our pay is fair and equitable. +Total Rewards +As part of our compensation +philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract +and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, healthcare and +insurance benefits, paid time off, family leave, family care resources and flexible work schedules. We established a Company matched 401(k) +plan during 2021. +Health and Safety +The success of our business +is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. +We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including +benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health +status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. +30 \ No newline at end of file diff --git a/raw/filings/0000896493/2024/0001214659-25-005868/item13.txt b/raw/filings/0000896493/2024/0001214659-25-005868/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..411a0db2d75f814032190e7e8bd68d62226ab0cb --- /dev/null +++ b/raw/filings/0000896493/2024/0001214659-25-005868/item13.txt @@ -0,0 +1,314 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• +the aggregate amount involved is determined to by the Audit Committee to be material; +• +we are a participant; and +• +any of the following has or will have a direct or indirect interest in the transaction: +• +an executive officer, director, or nominee for election as a director; +• +a greater than five percent beneficial owner of our common stock; or +• +any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. +Ault & Company, Inc. +Series C Preferred Stock Purchase Agreement +On November 6, 2023, we entered +into the November 2023 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 50,000 shares of Series C Convertible Preferred Stock and the Series C Warrants to purchase up to 0.4 million shares of common stock +for a total purchase price of up to $50 million. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50 million to $75 million and (B) extended the date of on which the final closing may occur to June 30, 2024, +subject to Ault & Company’s ability to further extended such date for ninety days. +98 +On +September 17, 2024, we and Ault & Company entered into the Second Amendment. Pursuant to the Second Amendment, the “Termination +Date” was amended from June 30, 2024 to December 31, 2024, in each case subject to the right of Ault & Company to extend such +date for an additional ninety (90) days. +As +of the date of filing of this Form 10-K, Ault & Company has purchased an aggregate of 50,000 shares of Series C Convertible Preferred +Stock and Series C Warrants to purchase an aggregate of 422,337 Warrant Shares, for an aggregate purchase price of $50.0 million. +Additionally, until the earlier +of (i) four years from the initial closing date of the November 2023 SPA or (ii) the date when Ault & Company holds fewer than 10,000 +shares of Series C Convertible Preferred Stock, the Company will be prohibited from (A) entering into any financing, whether debt or equity, +other than conventional loans from a commercial bank, at a price per share less than the Series C Conversion Price (as defined below) +or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 10,000 shares of Series C Convertible Preferred Stock, Ault & Company shall have a right to participate +in any subsequent financing (a “Subsequent Financing”) allowing Ault & Company to purchase such number of securities in +the Subsequent Financing to allow Ault & Company to maintain its percentage beneficial ownership of the Company that Ault & Company +held immediately prior to the Subsequent Financing. +On December 14, 2023, pursuant +to the November 2023 SPA, we sold to Ault & Company, in three separate closings that occurred on the closing date, an aggregate of +41,500 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 350,543 shares of common stock, for a total purchase +price of $41.5 million. At the Initial Closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred Stock and +Series C Warrants to purchase 181,607 shares of common stock, for a purchase price of $21.5 million, paid in cash. Immediately upon the +Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes issued to the lenders pursuant to the +Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +Second Closing, Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 84,468 +shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon the Second Closing, we paid $10.0 million +to partially satisfy the outstanding Senior Note. Promptly thereafter, at the Third Closing, Ault & Company purchased another 10,000 +shares of Series C Convertible Preferred Stock and Series C Warrants to purchase another 84,468 shares of common stock, for a purchase +price of $10.0 million, paid in cash. Immediately upon the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance +on the outstanding Senior Note. +On December 14, 2023, we, +along with the Guarantors entered into the Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed $36 +million and issued the Secured Notes to the lenders in the aggregate amount of $38.9 million. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated from the Miners and (c) the +membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those entities +granted to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault Aviation, +AGREE, Sentinum, Third Avenue, Ault Energy, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue on +the Florida Property, (iv) a future advance mortgage by ACS on the Michigan Property, (v) an aircraft mortgage and security agreement +by Ault Aviation on the Aircraft, and (vi) deposit account control agreements over certain bank accounts held by certain of our subsidiaries. +In addition, pursuant to the +Loan Agreement, we agreed to establish the Segregated Account, which would be used as a further guarantee of repayment of the Secured +Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. We are required to have the minimum balance in the +Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and +two-year anniversaries of the closing date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million +monthly into the Segregated Account, which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into +the Segregated Account, (i) up to the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, +the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on +a per dividend basis) received from Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, +which shall not exceed $9 million in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans +or other investments made by Ault Lending (including but not limited to sales of loans or investments, dividends, interest payments and +amortization payments), which shall not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further +agreed to deposit funds into the Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida +Property, (ii) $11 million from the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, +subject to a de minimis threshold of $1 million, and (v) $10 million from the sale of Circle 8. +99 +Amendments to Loan and Guarantee Agreement +On +September 17, 2024, the loan and guarantee agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed +financial obligations of Ault & Company borrowings, was amended regarding the Company’s obligations to fund the restricted cash +Segregated Account. +The Company agreed to deposit +in the Segregated Account: (i) $0.4 million monthly commencing on September 30, 2024 and ending on February 28, 2025; and (ii) $0.5 +million monthly commencing on March 31, 2025 and ending on the earlier of the term loan maturity date, prepayment of the term loan in +full or the date on which the balance of the Segregated Account exceeds 110% of the outstanding balance of the term loan. As of December +31, 2024, the Company had deposited $18.4 million in the Segregated Account. +On +March 7, 2025 the loan and guarantee agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed +financial obligations of Ault & Company borrowings, was further amended regarding the Company’s obligations to fund the restricted +cash Segregated Account. +Pursuant +to the March 7, 2025 amendment, the Company agreed to deposit in the Segregated Account: (i) $0.2 million monthly commencing on April 11, +2025 and ending on June 11, 2025; and (ii) $0.4 million monthly commencing on July 11, 2025 and ending on the earlier of the term loan +maturity date, prepayment of the term loan in full or the date on which the balance of the Segregated Account exceeds 110% of the outstanding +balance of the term loan. +Description of the Series C Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) $0.10 (the “Preferred Floor Price”), and (ii) the lesser of (A) $0.35 or (B) 105% of the volume +weighted average price of the common stock during the ten trading days immediately prior to the date of conversion (the “Series +C Conversion Price”). The Series C Conversion Price is subject to adjustment in the event of an issuance of common stock at a price +per share lower than the Series C Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations +or similar events. The Preferred Floor Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations +or similar transactions. +Voting Rights +The holders of the Series +C Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series C Convertible Preferred Stock is entitled to +cast, shall not be lower than $107.625 (the “Series C Voting Floor Price”), which represents the closing sale price of the +common stock on the trading day immediately prior to the date of execution of the November 2023 SPA. The Series C Voting Floor Price shall +be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series C Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +100 +Description of the Series C Warrants +On each closing date, the +Company will issue Ault & Company the Series C Warrants, which grant Ault & Company the right to purchase a specified number of +common stock (the “Series C Warrant Shares”). The exercise price of the Series C Warrants is $118.39 (the “Series C +Exercise Price”) and the number of Series C Warrant Shares is determined by dividing the actual investment amount by the Series +C Exercise Price. The Series C Exercise Price is subject to adjustment in the event of customary stock splits, stock dividends, combinations +or similar events. +The Series C Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +Series G Preferred Stock Purchase Agreement +On December 21, 2024, we entered +into the December 2024 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 25,000 shares of Series G Convertible Preferred Stock and the Series G Warrants to purchase up to 4.2 million shares of common stock +for a total purchase price of up to $25 million. +The +December 2024 SPA shall automatically terminate if the closing has not occurred prior to December 31, 2025, though such date may be extended +by Ault & Company as set forth in the December 2024 SPA. The December 2024 SPA provides that the financing may be conducted through +one or more closings. +As +of the date of filing of this Form 10-K, Ault & Company has purchased an aggregate of 960 shares of Series G Convertible Preferred +Stock and Series G Warrants to purchase an aggregate of 162,217 Warrant Shares, for an aggregate purchase price of $1.0 million. +Additionally, until the earlier +of (i) four years from the initial closing date of the December 2024 SPA or (ii) the date when Ault & Company holds fewer than 5,000 +shares of Series G Convertible Preferred Stock, the Company will be prohibited from (A) entering into any financing, whether debt or equity, +other than conventional loans from a commercial bank, at a price per share less than the Series G Conversion Price (as defined below) +or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 5,000 shares of Series G Convertible Preferred Stock, Ault & Company shall have a right to participate +in a Subsequent Financing allowing Ault & Company to purchase such number of securities in the Subsequent Financing to allow Ault +& Company to maintain its percentage beneficial ownership of the Company that Ault & Company held immediately prior to the Subsequent +Financing. +Description of the Series G Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) the Preferred Floor Price, and (ii) the lesser of (A) $6.74 or (B) 105% of the volume weighted average price +of the common stock during the ten trading days immediately prior to the date of conversion (the “Series G Conversion Price”). +The Series G Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the +Series G Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The +Preferred Floor Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations or similar transactions. +Voting Rights +The holders of the Series +G Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series G Convertible Preferred Stock is entitled to +cast, shall not be lower than $6.244 (the “Series G Voting Floor Price”), which represents the closing sale price of the Class +A common stock on the trading day immediately prior to the date of execution of the December 2024 SPA plus the estimated value of the +Series G Warrants. The Series G Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other similar +transactions. +101 +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series G Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +Description of the Series G Warrants +On each closing date, the +Company will issue Ault & Company the Series G Warrants, which grant Ault & Company the right to purchase a specified number of +shares of class A common stock (the “Series G Warrant Shares”). The exercise price of the Series G Warrants is $5.92 (the +“Series G Exercise Price”) and the number of Series G Warrant Shares is determined by dividing the actual investment amount +by the Series G Exercise Price. The Series G Exercise Price is subject to adjustment in the event of customary stock splits, stock dividends, +combinations or similar events. +The Series G Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +Nature of Related Parties +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer and a director of +Ault & Company. William B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief +Financial Officer and a director of Ault & Company. Henry Nisser, our President, General Counsel and a member of our board of directors, +is also the President, General Counsel and a director of Ault & Company. +Alzamend +On January 31, 2024, Ault +Lending entered into the January 2024 SPA with Alzamend, pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending +up to 6,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to purchase up to 0.6 million shares of Alzamend common stock +for a total purchase price of up to $6.0 million. On January 31, 2024, Ault Lending purchased 1,220 +shares of ALZN Series B Preferred and warrants to purchase 0.1 million shares for a total purchase price of $1.22 million. The purchase +price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend between November 9, 2023 and January +31, 2023. On March 26, 2024, pursuant to the January 2024 SPA, Ault Lending purchased 780 +shares of ALZN Series B Preferred Stock and ALZN Series B Warrants to +purchase 0.1 million shares of Alzamend common , for a purchase price of $780,000. As +of March 31, 2025, Ault Lending has purchased an aggregate of 2,100 shares of ALZN Series B Preferred and ALZN Series B Warrants +to purchase an aggregate of 0.2 million shares of Alzamend common stock, for an aggregate purchase +price of $2.1 million. +Description of the ALZN Series B Preferred +The +terms of the ALZN Series B Preferred are as set forth in the Amended and Restated Certificates of Designations of the Rights, Preferences +and Limitations of the Series B Convertible Preferred Stock, as amended (the “ Series B Certificate of Designation ”). +Each share of ALZN Series B Preferred has a stated value of $1,000 per share (the “ALZN Stated Value ”). +The ALZN Series B Preferred does not accrue dividends. +Conversion Rights +Each +share of ALZN Series B Preferred is convertible into a number of shares of Alzamend common +stock (“ALZN Conversion Shares”) determined by dividing the ALZN Stated Value by +$10.00 (the “ALZN Conversion Price”). The ALZN Conversion Price is subject to adjustment in the event of an issuance +of common stock at a price per share lower than the ALZN Conversion Price then in effect, as well as upon customary stock splits, stock +dividends, combinations or similar events. +Voting Rights +The +holders of the ALZN Series B Preferred are entitled to vote with the common stock as a single +class on an as-converted basis, subject to applicable law provisions of the Delaware General Company Law and Nasdaq, provided however, +that for purposes of complying with Nasdaq regulations, the conversion price, for purposes of determining the number of votes the holder +of ALZN Series B Preferred is entitled to cast, shall not be lower than $8.73 (the “ALZN +Voting Floor Price”). The ALZN Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other +similar transactions. +102 +Liquidation Rights +In +the event of liquidation, dissolution, or winding up of Alzamend, the holders of ALZN Series B Preferred +have a preferential right to receive an amount equal to the ALZN Stated Value per share of ALZN +Series B Preferred before any distribution to other classes of capital stock. If the assets are insufficient, the distribution +will be prorated among the holders of ALZN Series B Preferred . The remaining assets, if any, +will then be distributed pro rata to the holders of outstanding Alzamend common stock. Any transaction that constitutes a change of control +transaction shall be deemed to be a liquidation under the Series B Certificate of Designation. +Description of the +Series B Warrants +At +each closing, Alzamend issued Ault Lending Series B Warrants, which grant Ault Lending the right to purchase a specified number of Alzamend +common stock (the “ALZN Warrant Shares”). The exercise price of the Series B Warrants is $12.00 (the “ALZN Exercise +Price”) and the number of ALZN Warrant Shares is equal to the number of ALZN Conversion Shares issuable upon the ALZN +Series B Preferred issued at that closing. The ALZN Exercise Price is subject to adjustment in the event of an issuance of common +stock at a price per share lower than the ALZN Exercise Price then in effect, as well as upon customary stock splits, stock dividends, +combinations or similar events. +The +Series B Warrants become exercisable on the first business day after the six-month anniversary of issuance (the “ALZN Initial Exercise +Date”) and have a five-year term, expiring on the fifth anniversary of the ALZN Initial Exercise Date. +Nature of Related Parties +Messrs. Ault, Horne and Nisser +are each paid $50,000 annually by Alzamend. +Milton +C. Ault, III, our Executive Chairman, is also the Vice Chairman of Alzamend. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also the Chairman of Alzamend . +Henry Nisser, our President, General Counsel and a member of our board of directors, is also the Executive Vice President, General Counsel +and a director of Alzamend. +AVLP +Nature of Related Parties +Prior to the filing of Chapter +7 bankruptcy by AVLP in March 2025, Mr. Ault was paid $100,000 annually by AVLP, and each of Messrs. Horne and Nisser was paid $50,000 +annually by AVLP. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of AVLP. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of AVLP. Mr. Ault is the Executive Chairman +of AVLP. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General Counsel +of AVLP. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +C +X +X +Jeffrey A. Bentz +Yes +X +X +C +Mordechai Rosenberg +Yes +X +C +X +____________ +C – Chairman of committee +X – Member of committee +103 \ No newline at end of file diff --git a/raw/filings/0000896493/2024/0001214659-25-005868/item9a.txt b/raw/filings/0000896493/2024/0001214659-25-005868/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..de7a72d31fc998558689c966eb7bac501ea6cb43 --- /dev/null +++ b/raw/filings/0000896493/2024/0001214659-25-005868/item9a.txt @@ -0,0 +1,88 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +As of December 31, 2024, we +have carried out an evaluation, under the supervision of, and with the participation of, our management, including our principal executive +officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant +to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We have established disclosure +controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange +Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated +to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required +disclosure. +Based upon that evaluation, +our principal executive officer and principal financial officer, with the assistance of other members of the Company’s management, +have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules +13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report and has determined that our +disclosure controls and procedures were not effective due to the material weaknesses as described herein. +Management’s Annual Report on Internal +Control Over Financial Reporting +Our management is responsible +for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). +Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial +reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance +of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with +generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations +of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized +acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, +internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness +to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. +Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2024. In making this assessment, our management used +the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. +Our management has concluded that, as of December 31, 2024, our internal control over financial reporting was not effective. +A material weakness is a control +deficiency (within the meaning of the PCAOB Auditing Standard No. 2) or combination of control deficiencies that result in more than a +remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management +has identified the following material weaknesses: +1. We do not have sufficient resources in our accounting department, which restricts our ability to gather, +analyze and properly review information related to financial reporting, including applying complex accounting principles relating to consolidation +accounting, related party transactions, fair value estimates and analysis of financial instruments for proper classification in the consolidated +financial statements, in a timely manner. +2. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not +be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of +transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties +during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a +material weakness. +3. Our primary user access controls (i.e., provisioning, de-provisioning, privileged access and user access +reviews) to ensure appropriate authorization and segregation of duties that would adequately restrict user and privileged access to the +financially relevant systems and data to appropriate personnel were not designed and/or implemented effectively. We did not design and/or +implement sufficient controls for program change management to certain financially relevant systems affecting our processes. +83 +4. The Company did not design and/or implement user access controls to ensure appropriate segregation of +duties or program change management controls for certain financially relevant systems impacting the Company’s processes around revenue +recognition and digital assets to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, +(ii) digital currency mining equipment, and (iii) underlying accounting records, are identified, tested, authorized and implemented appropriately +to validate that data produced by its relevant IT system(s) were complete and accurate. Automated process-level controls and manual controls +that are dependent upon the information derived from such financially relevant systems were also determined to be ineffective as a result +of such deficiency. In addition, the Company has not effectively designed a manual key control to detect material misstatements in revenue. +Planned Remediation +Management continues to work +to improve its controls related to our material weaknesses, specifically relating to user access and change management surrounding our +IT systems and applications. Management will continue to implement measures to remediate material weaknesses, such that these controls +are designed, implemented, and operating effectively. The remediation actions include: (i) enhancing design and documentation related +to both user access and change management processes and control activities; and (ii) developing and communicating additional policies +and procedures to govern the area of IT change management. In order to achieve the timely implementation of the above, management has +commenced the following actions and will continue to assess additional opportunities for remediation on an ongoing basis: +· Engaging a third-party specialist to assist management with improving the Company’s overall control +environment, focusing on change management and access controls; +· Implementing new applications and systems that are aligned with management’s focus on creating strong +internal controls; and +· Continuing to increase headcount across the Company, with a particular focus on hiring individuals with +strong Sarbanes Oxley and internal control backgrounds. +We are currently working to +improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in +our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures. These material +weaknesses will not be considered to be remediated until the applicable remediated controls are operating for a sufficient period of time +and management has concluded, through testing, that these controls are operating effectively. +Despite the existence of these +material weaknesses, we believe that the consolidated financial statements included in the period covered by this Annual Report on Form +10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented +in conformity with U.S. generally accepted accounting principles. +Changes in Internal Control over Financial Reporting +During the most recent fiscal +quarter in 2024, there were no significant changes in our internal control over financial reporting (as such term is defined in Rules +13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal +control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000896493/2024/0001214659-25-005868/rp_note.txt b/raw/filings/0000896493/2024/0001214659-25-005868/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..ae458daad992125735be49213a709d1b219b00f7 --- /dev/null +++ b/raw/filings/0000896493/2024/0001214659-25-005868/rp_note.txt @@ -0,0 +1,570 @@ +26) and Series C Preferred Stock to a related party (see Note 29). +The Company has valued the warrants issued +at their date of grant utilizing the Black-Scholes option pricing model. This model is dependent upon several variables such as the warrants’ +remaining contractual term, exercise price, current stock price, risk-free interest rate and estimated volatility of the Company’s +stock over the contractual term of the warrants. The risk-free interest rate used in the calculations is based on the implied yield available +on U.S. Treasury issues with an equivalent term approximating the contractual life of the warrants. +The Company utilized a variety of pricing +models and the weighted average assumptions used during the years ended December 31, 2024 and 2023 were as follows: +Schedule of weighted average assumptions +December 31, +2024 +December 31, +2023 +Exercise price +$ 118.39 +$ 124.08 +Contractual term in years +5.0 +5.0 +Volatility +153 % +168 % +Dividend yield +0 % +0 % +Risk-free interest rate +4.2 % +4.0 % +19. ACCOUNTS PAYABLE AND ACCRUED EXPENSES +Other current liabilities at December 31, 2024 and +2023 consisted of: +Schedule of other current liabilities +December 31, +December 31, +2024 +2023 +Accounts payable +$ 25,182,000 +$ 26,777,000 +Accrued payroll and payroll taxes +2,342,000 +8,237,000 +Interest payable +8,249,000 +4,197,000 +Accrued legal +2,399,000 +2,340,000 +Other accrued expenses +21,303,000 +13,871,000 +Total +$ 59,475,000 +$ 55,422,000 +During the year ended December 31, 2024, Ault Lending +reversed a previously accrued $ 5.7 million performance bonus related to realized gains on trading activities. Management determined that +the bonus would not be paid, and accordingly, the reversal was recorded as a reduction to general and administrative expenses. +20. LEASES +The Company has operating leases for office +space. The Company’s leases have remaining lease terms of 1.1 years to 9.0 years, some of which may include options to +extend the leases perpetually, and some of which may include options to terminate the leases within one year. +The following table provides a summary of +leases by balance sheet category as of December 31, 2024 and 2023: +Schedule of supplemental balance sheet information related to leases +December 31, +2024 +December 31, +2023 +Operating right-of-use assets +$ 3,697,000 +$ 3,409,000 +Operating lease liability - current +1,627,000 +1,376,000 +Operating lease liability - non-current +2,269,000 +2,163,000 +F- 33 +The components of lease expenses for the years +ended December 31, 2024 and 2023, were as follows: +Schedule of lease expenses +Year Ended December 31, +2024 +2023 +Operating lease cost +$ 1,918,000 +$ 2,390,000 +Short-term lease cost +- +- +The following tables provides a summary +of other information related to leases for the years ended December 31, 2024 and 2023: +Schedule of supplemental cash flow information related to leases +December 31, 2024 +December 31, 2023 +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ 1,654,000 +$ 2,342,000 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ 2,080,000 +$ 820,000 +Weighted-average remaining lease term - operating leases +3.2 years +2.3 years +Weighted-average discount rate - operating leases +8.0 % +7.0 % +Maturity of lease liabilities under the +Company’s non-cancellable operating leases as of December 31, 2024, were as follows: +Schedule of maturities of operating lease liabilities +Payments due by period +2025 +$ 1,888,000 +2026 +1,210,000 +2027 +514,000 +2028 +339,000 +2029 +329,000 +Thereafter +166,000 +Total lease payments +4,446,000 +Less interest +( 550,000 ) +Present value of lease liabilities +$ 3,896,000 +21. DIVIDEND PAYABLE IN TURNONGREEN COMMON STOCK +In March 2024, the Company, in connection +with a planned distribution of its common stock holdings of TurnOnGreen, announced the distribution to its stockholders of 25.0 million +shares of TurnOnGreen common stock and warrants to purchase 25.0 million shares of TurnOnGreen common stock, which resulted in an adjustment +to additional paid in capital and increase to non-controlling interest of $ 4.9 million based on the recorded value of the Company’s +holdings in TurnOnGreen at the record date of the distribution. +22. ROI Transfers +of White River Common Stock +In January 2024, ROI announced that it had +concluded that, for regulatory reasons, ROI would be unable to effect the distribution of its shares of common stock of White River as +contemplated by a registration statement previously filed by White River. During the year ended December 31, 2024, ROI transferred 12.0 +million shares of White River common stock with a fair value of $ 19.2 million at the date of transfer to certain of its accredited investors +to resolve the matters discussed above. +In conjunction with the transfers to non-controlling +interests, shares of ROI’s investment in White River’s Series A Convertible Preferred Stock were converted into shares of +White River common stock, resulting in a non-cash $ 17.9 million gain on conversion. +23. REDEEMABLE NON-CONTROLLING INTERESTS IN EQUITY OF SUBSIDIARY +LIABILITY +The Company records redeemable non-controlling +interests in equity of subsidiaries to reflect the economic interests of the common stockholders in Ault Disruptive. +F- 34 +Redemption of Shares +On September 27, 2024, Ault Disruptive announced +that it would redeem all of its outstanding shares of common stock which occurred as of the close of business on October 11, 2024, because +Ault Disruptive would not consummate an initial business combination within the time period required by its Amended and Restated Certificate +of Incorporation, as amended. During the year ended December 31, 2024, shares of Ault Disruptive common stock were redeemed for an aggregate +redemption amount of $ 2.3 million. +The following table summarizes the changes +in the Company’s redeemable non-controlling interests in equity of subsidiaries during the year December 31, 2024 and 2023: +Redeemable noncontrolling interests in equity of subsidiary liability +For the Year Ended +December 31, +2024 +2023 +Redeemable non-controlling interests in equity of subsidiaries as of January 1 +$ 2,224,000 +$ 117,993,000 +Redemption of Ault Disruptive common stock +( 2,269,000 ) +( 120,064,000 ) +Extension proceeds paid by the Ault Disruptive sponsor +- +2,332,000 +Remeasurement of carrying value to redemption value +45,000 +1,963,000 +Redeemable non-controlling interests in equity of subsidiaries as of December 31 +$ - +$ 2,224,000 +F- 35 +24. NOTES PAYABLE +Notes payable at December 31, 2024 and 2023, +were comprised of the following: +Schedule of notes payable +Collateral +Guarantors +Interest rate +Effective rate (1) +Due date +December 31, 2024 +December 31, 2023 +AGREE secured construction loans (in default) +AGREE hotels +- +7.0 % +8.8 % +March 31, 2026 +$ 68,750,000 +$ 67,632,000 +Circle 8 revolving credit facility +Circle 8 cranes with a book value of $29.6 million +- +8.4 % +8.4 % +December 16, 2025 +13,126,000 +15,907,000 +16% promissory note +- +Ault & Company and Milton C. Ault, III +16.0 % (default rate of 24.0%) +- +- +- +2,572,000 +Circle 8 equipment financing notes +Circle 8 equipment with a book value of $4.3 million +- +10.5 % +10.5 % +September 15, 2025 through June 15, 2027 +2,826,000 +5,629,000 +15% term notes (in default) +- +Milton C. Ault, III +15.0 % (default rate of 22.99%) +48.0 % +October 31, 2024 +3,777,000 +- +8% demand loans +- +- +10.0 % (12.0% default rate) +- +Upon demand +- +950,000 +Sentinum note payable +- +- +12.5 % +- +- +- +1,067,000 +ROI promissory note (in default) +- +- +15.0 % (default rate of 18.0%) +67.2 % +April 30, 2024 +2,367,000 +- +Other ($3.4 million in default) +- +- +- +- +5,826,000 +3,808,000 +Total notes payable +$ 96,672,000 +$ 97,565,000 +Less: +Unamortized debt discounts +- +( 453,000 ) +Total notes payable, net +$ 96,672,000 +$ 97,112,000 +Less: current portion +( 95,768,000 ) +( 11,692,000 ) +Notes payable – long-term portion +$ 904,000 +$ 85,420,000 +(1) Includes forbearance and extension fees and OID costs that are amortized to interest expense over the +life of the notes. +F- 36 +During the year ended December 31, 2023, +the holders of $ 8.4 million 10% secured promissory notes exchanged their notes and accrued interest for preferred stock liabilities. The +Company recorded a loss on extinguishment of debt of $0.1 million related to the transaction. When the preferred stock liabilities converted +to Series A Common stock, the Company recorded a loss on extinguishment of $ 1.5 million. +During the year ended December 31, 2023, the holders of $ 10.5 +million 10% demand promissory notes and $ 1.1 million 12% demand promissory notes exchanged their notes for notes from Ault & Company +(see Note 22), resulting in a loss on extinguishment of debt of $ 0.4 million. +In connection with the December 2023 Series +C Preferred Stock offering (see Note 29), the Company paid $20.4 million to pay the $20.2 million outstanding balance of the 8% senior +secured promissory notes, plus $0.2 million accrued interest payable. The 8% senior secured promissory notes had an unamortized debt discount +of $ 3.2 million outstanding, which was recorded as a loss on extinguishment of debt. +The Company recorded a $ 2.0 million loss +on extinguishment of debt related to the April 2023 restructuring related to one of the 16% promissory notes payable. +OID Only Term Note +On July 2, 2024, the Company entered into +a term note agreement with institutional investors for the sale of up to $ 2.6 million in term notes, of which the principal amount of +$ 1.8 million was immediately funded. A term note was issued at a discount, with net proceeds to the Company of $ 1.5 million. +The term note does not accrue any interest. The term note was scheduled to mature on August 2, 2024. The term note is guaranteed by Mr. +Ault. The term note maturity was extended to September 30, 2024 , and an extension fee of $ 0.2 million accrues monthly until the term note +is paid in full. The term note is currently in default and is included in “Other” in the table above. +ROI 15% Term Note +On February 9, 2024, ROI entered into a +$ 1.77 million term note agreement with an institutional investor bearing interest of 15 % . The term note was issued at a discount, with +net proceeds to ROI of $ 1.75 million. The term note was scheduled to mature February 14, 2024. This note has been guaranteed by Ault & +Company and Mr. Ault. The term note was subsequently amended to increase the principal amount due to $ 2.4 million, increase the interest +rate to 18 % and extend the maturity date to April 30, 2024 . The term note is in default as of May 1, 2024. +In February 2025, term note was amended +to increase the principal amount due to $ 2.6 million, increase the interest rate to 18 % and extend the maturity date to May 15, 2025 . +15% Term Notes +Between April 29, 2024 and August 29, 2024, +the Company entered into note agreements totaling $ 6.0 million with an institutional investor bearing interest of 15 % . The term notes +were issued at a discount, with net proceeds to the Company of $ 5.1 million. The term notes were amended to extend the maturity dates +to October 31, 2024 . The notes are in default as of November 1, 2024. +In December 2024, Ault Lending had a fees +receivable from the institutional investor in the amount of $ 2.2 million related to Ault Lending’s profit participation rights in +an investment made by the institutional investor to Alzamend. On December 31, 2024, the Company and the institutional investor agreed +to offset $ 2.2 million of the term notes payable against the fees receivable. This transaction was accounted for as a non-cash settlement +of financial instruments and had no impact on the Company’s consolidated statement of operations. +In February 2025, the Company entered into +an exchange agreement with the institutional investor, pursuant to which the Company issued to the investor a convertible promissory note +in the principal face amount of $ 1.9 million in exchange for the cancellation of one of the outstanding 15% term notes issued by the Company +to the institutional investor that had outstanding principal and accrued but unpaid interest of $ 1.9 million. +In March 2025, the Company entered into +an exchange agreement with the institutional investor, pursuant to which the Company issued to the investor a convertible promissory note +in the principal face amount of $ 4.2 million in exchange for the cancellation of the outstanding 15% term notes issued by the Company +to the institutional investor that had outstanding principal and accrued but unpaid interest of $ 4.2 million. +F- 37 +The note will mature on June 30, 2025. The +note is convertible into shares of the Company’s Class A common stock at a conversion price equal to the greater of (i) $0.40 per +share (the “Floor Price”), which Floor Price shall not be adjusted for stock dividends, stock splits, stock combinations and +other similar transactions and (ii) the lesser of 75% of the VWAP (as defined in the note) of the Class A common stock during the five +trading days immediately prior to (A) the date of issuance of the note or (B) the date of conversion into shares of Class A common stock. +The Company may not issue shares to the extent such issuances would result in an aggregate number of shares of Class A common stock exceeding +19.99% of the total shares of Class A common stock issued and outstanding as of the date of issuance of the note, in accordance with the +rules and regulations of the NYSE unless the Company first obtains stockholder approval. +$20 Million Credit Agreement +On June 4, 2024 the Company entered into +a Loan Agreement (the “Credit Agreement”) with two institutional investors (collectively, the “Lender”). The Credit +Agreement provides for an unsecured, non-revolving credit facility with an aggregate draw limit of $ 20.0 million. However, the Company +is restricted to having no more than $ 2.0 million in principal amount of outstanding advances at any given time under the Credit Agreement. +As of December 31, 2024, $ 2.0 million has been advanced, exclusive of a $ 0.4 million OID. +All loans under the Credit Agreement will +be evidenced by a promissory note. The Lender made an advance to the Company of $1.5 million on the execution date. The advances were +due December 4, 2024 , however, per the terms of the Credit Agreement as the Company had executed an equity line of credit agreement relating +to the sale of shares of the Company’s 13.00% Series D Cumulative Redeemable Perpetual Preferred Stock (the “Series D Preferred +Stock”), has an effective registration statement relating thereto, the maturity date was automatically extended until June 4, 2025. +The Lender is not obligated to make any further advances under the Credit Agreement after the maturity date. Advances under the Credit +Agreement will include the addition of an OID of 20% to the amount of each advance and all advances will bear interest at the rate of +15.0% per annum and may be repaid at any time without penalty or premium. Amounts outstanding under the Credit Agreement are included +in “Other” in the table above. +The obligations of the Company under the +Credit Agreement are secured by a guaranty provided by Milton C. Ault, the Executive Chairman of the Company. +Circle 8 Revolving Credit Facility +On October 16, 2024, Circle 8 was in default +related to reporting requirements under the terms of their revolving credit facility. Circle 8 was able to obtain waivers to cure the +event of default and defer the requirements until May 31, 2025. +Amendment to AGREE Secured Construction Loans +The AGREE secured construction loans with +an original due date of January 1, 2025, were amended on February 2, 2025, whereby AGREE agreed to pay monthly installments of interest +only based on an annualized interest rate of Term SOFR plus 4.75% . In addition, AGREE agreed to make principal payments of $1.0 million +in June 2025 and $2.0 million in September 2025 and December 2025 with the balance due March 1, 2026. AGREE has defaulted by failure +to make timely payments per the amended payment terms. +Notes Payable Maturities +Principal maturities of the Company’s +notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s option, as of December 31, 2024 +were: +Schedule of maturities +Year +2025 +$ 95,768,000 +2026 +794,000 +2027 +110,000 +$ 96,672,000 +Interest Expense +Interest expense includes amounts incurred on +notes payable, convertible notes payable, and notes payable to related parties. The components of interest expense for the years ended +December 31, 2024 and 2023 were as follows: +Schedule of interest expense +For the Year Ended +December 31, +2024 +2023 +Contractual interest expense +$ 11,925,000 +$ 17,338,000 +Forbearance fees +2,214,000 +5,469,000 +Amortization of debt discount +5,532,000 +21,507,000 +Total interest expense +$ 19,671,000 +$ 44,314,000 +F- 38 +25. NOTES PAYABLE, RELATED PARTY +Notes payable, related party at December +31, 2024 and 2023, were comprised of the following: +Schedule of notes payable, related party +Interest rate +Effective rate +Due date +December 31, +2024 +December 31, +2023 +Notes from officers - Hyperscale Data +18 % +18 % +- +$ - +$ 98,000 +Notes from officers - TurnOnGreen +14 % +14 % +Past due +46,000 +51,000 +Notes from board member - ROI +No interest +No interest +Upon demand +- +90,000 +Ault & Company advances +No interest +No interest +Upon demand +- +1,909,000 +Other related party advances +No interest +No interest +Upon demand +118,000 +227,000 +Total notes payable +$ 164,000 +$ 2,375,000 +Ault & Company Loan Agreement +On June 8, 2023, the Company entered into +a loan agreement with Ault & Company as lender. The loan agreement provides for an unsecured, non-revolving credit facility in an +aggregate principal amount of up to $ 10 million. All loans under the loan agreement are due within five business days after request by +Ault & Company. Ault & Company is not obligated to make any further advances under the loan agreement after December 8, 2023. +Advances under the loan agreement bear interest at the rate of 9.5 % per annum and may be repaid at any time without penalty or premium. +A total of $ 4.6 million was advanced under the loan agreement and was exchanged for a senior secured convertible promissory note with +Ault & Company (see Note 27). +In August 2023, Ault & Company assumed +$11.6 million of secured promissory notes previously issued by the Company for which the Company has issued term notes to Ault & Company +in the same amount. One term note has a principal amount of $1.1 million and bears interest at 12% and the second term note has a principal +amount of $10.5 million and bears interest at 10%. These assumed loans were exchanged for a senior secured convertible promissory note +with Ault & Company (see Note 27). +Summary of interest expense, related party, +recorded within interest expense on the consolidated statement of operations: +Schedule of interest expense, related party +For the Year Ended +December 31, +2024 +2023 +Interest expense, related party +$ 22,000 +$ - +26. CONVERTIBLE NOTES PAYABLE +Convertible notes payable at December 31, +2024 and 2023, were comprised of the following: +Schedule of convertible notes payable +Conversion price +per share +Interest rate +Effective rate (1) +Due date +December 31, +2024 +December 31, +2023 +Convertible promissory note –OID only, in default +90% of 5-day VWAP +OID Only +33.1 % +September 28, 2024 +$ 393,000 +$ 1,673,000 +10% OID convertible promissory note, in default +$ 5.80 +15 % +39.5 % +October 19, 2024 +5,020,000 +- +AVLP convertible promissory notes, principal +$0.35 (AVLP stock) +7 % +8.9 % +August 22, 2025 +9,911,000 +9,911,000 +ROI senior secured convertible note, in default +$ 0.11 (ROI stock) +OID Only +26.6 % +April 27, 2024 +4,245,000 +6,513,000 +Fair value of embedded conversion options +- +910,000 +Total convertible notes payable +19,569,000 +19,007,000 +Less: unamortized debt discounts +- +( 2,179,000 ) +Total convertible notes payable, net of financing cost, long term +$ 19,569,000 +$ 16,828,000 +Less: current portion +( 19,569,000 ) +( 7,375,000 ) +Convertible notes payable, net of financing cost – long-term portion +$ - +$ 9,453,000 +(1) Includes forbearance and extension fees and OID costs that are amortized to interest expense over the +life of the notes. +F- 39 +10% OID Convertible Promissory Note +On July 18, 2024, the Company entered into +a note purchase agreement (the “Purchase Agreement”) with an institutional investor (the “Investor”) pursuant +to which the Investor purchased from the Company, on July 19, 2024, in a registered direct offering, a $ 5.4 million 10% OID +Convertible Promissory Note (the “Note”). The Note was sold to the Investor for a purchase price of $ 4.9 million, which +included an OID of $0.5 million. The Note accrues interest at the rate of 15 % . The Note matured on October 19, 2024 and is in +default as of October 20, 2024. The Note is convertible into shares of Class A common stock at a conversion price of $ 5.80 per share. +During the year ended December 31, 2024, +the Investor converted $ 1.2 million of the Note into 0.2 million shares of Class A common stock that had a fair value of $ 1.5 million +at the time of conversion and the Company recognized a $ 0.3 million loss on extinguishment of debt. +In December 2024, the Company and the Investor +entered into a forbearance agreement pursuant to which the Investor agreed to forebear through the close of business on December 31, 2024, +from exercising the rights and remedies it is entitled in consideration for the Company’s agreement to issue a convertible promissory +note in the amount of $ 0.9 million (the “Forbearance Note”). +In February 2025, the Company and the Investor +entered into an amended and restated forbearance agreement pursuant to which the Investor agreed to forebear through the close of business +on May 15, 2025, from exercising the rights and remedies it is entitled in consideration for the Company’s agreement to issue to +the Investor an amended and restated convertible promissory note in the amount of $3.5 million (the “A&R Forbearance Note”), +consisting of (i) the amount then due under the Forbearance Note of $0.9 million, (ii) a forbearance extension fee of $0.3 million +and (iii) a true-up amount of $2.3 million. Subject to the approval by the NYSE and the Company’s stockholders, the A&R Forbearance +Note is convertible into shares of Class A common stock at a conversion price equal to $2.00, subject to adjustment. The A&R Forbearance +Note accrues interest at the rate of 18% per annum and matures on May 15, 2025. +6% Convertible Promissory Notes +On March 11, 2024, the Company entered into +a note purchase agreement with two institutional investors pursuant to which the investors agreed to acquire, and the Company agreed to +issue and sell in a registered direct offering to the investors an aggregate of $ 2.0 million convertible promissory notes, bearing +interest of 6 % . The convertible promissory notes were converted into shares of Class A common stock in May 2024 at a conversion price +of $ 12.25 per share and the Company recognized a $ 0.7 million loss on extinguishment of debt. +ROI Gain on Extinguishment of Senior Secured Convertible +Notes +During the year ended December 31, 2024, +ROI converted $ 2.3 million of ROI senior secured convertible notes that had a fair value of $ 0.9 million at the time of conversion and +recognized a $ 1.4 million gain on extinguishment of debt. +Contractual Maturities +Principal maturities of the Company’s +convertible notes payable, assuming the exercise of all extensions that are exercisable solely at the Company’s option, as of December +31, 2024, were: +Schedule of contractual maturities +Year +Principal +2025 +$ 19,569,000 +$ 19,569,000 \ No newline at end of file diff --git a/raw/filings/0000896493/2024/0001214659-25-005868/rpt_disclosure.txt b/raw/filings/0000896493/2024/0001214659-25-005868/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..411a0db2d75f814032190e7e8bd68d62226ab0cb --- /dev/null +++ b/raw/filings/0000896493/2024/0001214659-25-005868/rpt_disclosure.txt @@ -0,0 +1,314 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Our Audit Committee or in +certain instances, a special committee of our Board, monitors and reviews issues involving potential conflicts of interest and approves +all transactions with related persons as defined in Item 404 of Regulation S-K under the securities laws. Examples of such transactions +that must be approved by our Audit Committee or a special committee of our Board include, but are not limited to any transaction, arrangement, +relationship (including any indebtedness) in which: +• +the aggregate amount involved is determined to by the Audit Committee to be material; +• +we are a participant; and +• +any of the following has or will have a direct or indirect interest in the transaction: +• +an executive officer, director, or nominee for election as a director; +• +a greater than five percent beneficial owner of our common stock; or +• +any immediate family member of the foregoing. +When reviewing transactions +with a related person, the Audit Committee or any special committee of our Board formed for that purpose applies the standards for evaluating +conflicts of interest outlined in our written Code of Business Conduct and Ethics. +The following information +sets forth certain related transactions between us and certain of our stockholders or directors. +Ault & Company, Inc. +Series C Preferred Stock Purchase Agreement +On November 6, 2023, we entered +into the November 2023 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 50,000 shares of Series C Convertible Preferred Stock and the Series C Warrants to purchase up to 0.4 million shares of common stock +for a total purchase price of up to $50 million. +On +March 25, 2024 we entered into an amendment to the (i) November 2023 SPA , (ii) the related +Certificate of Designation of Preferences, Rights and Limitations of the Series C Preferred Convertible Stock and (iii) the number of +Series C Warrants, to provide for (A) an increase in the dollar amount of the Series C Convertible Preferred Stock that Ault & Company +may purchase from us from $50 million to $75 million and (B) extended the date of on which the final closing may occur to June 30, 2024, +subject to Ault & Company’s ability to further extended such date for ninety days. +98 +On +September 17, 2024, we and Ault & Company entered into the Second Amendment. Pursuant to the Second Amendment, the “Termination +Date” was amended from June 30, 2024 to December 31, 2024, in each case subject to the right of Ault & Company to extend such +date for an additional ninety (90) days. +As +of the date of filing of this Form 10-K, Ault & Company has purchased an aggregate of 50,000 shares of Series C Convertible Preferred +Stock and Series C Warrants to purchase an aggregate of 422,337 Warrant Shares, for an aggregate purchase price of $50.0 million. +Additionally, until the earlier +of (i) four years from the initial closing date of the November 2023 SPA or (ii) the date when Ault & Company holds fewer than 10,000 +shares of Series C Convertible Preferred Stock, the Company will be prohibited from (A) entering into any financing, whether debt or equity, +other than conventional loans from a commercial bank, at a price per share less than the Series C Conversion Price (as defined below) +or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 10,000 shares of Series C Convertible Preferred Stock, Ault & Company shall have a right to participate +in any subsequent financing (a “Subsequent Financing”) allowing Ault & Company to purchase such number of securities in +the Subsequent Financing to allow Ault & Company to maintain its percentage beneficial ownership of the Company that Ault & Company +held immediately prior to the Subsequent Financing. +On December 14, 2023, pursuant +to the November 2023 SPA, we sold to Ault & Company, in three separate closings that occurred on the closing date, an aggregate of +41,500 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 350,543 shares of common stock, for a total purchase +price of $41.5 million. At the Initial Closing, Ault & Company purchased 21,500 shares of Series C Convertible Preferred Stock and +Series C Warrants to purchase 181,607 shares of common stock, for a purchase price of $21.5 million, paid in cash. Immediately upon the +Initial Closing, we paid $20,432,876 to satisfy in full the outstanding secured convertible notes issued to the lenders pursuant to the +Loan and Guarantee Agreement, dated November 7, 2022, as amended on July 19, 2023. +Promptly thereafter, at the +Second Closing, Ault & Company purchased 10,000 shares of Series C Convertible Preferred Stock and Series C Warrants to purchase 84,468 +shares of common stock, for a purchase price of $10.0 million, paid in cash. Immediately upon the Second Closing, we paid $10.0 million +to partially satisfy the outstanding Senior Note. Promptly thereafter, at the Third Closing, Ault & Company purchased another 10,000 +shares of Series C Convertible Preferred Stock and Series C Warrants to purchase another 84,468 shares of common stock, for a purchase +price of $10.0 million, paid in cash. Immediately upon the Third Closing, we paid $7.5 million to satisfy the remaining outstanding balance +on the outstanding Senior Note. +On December 14, 2023, we, +along with the Guarantors entered into the Loan Agreement with institutional lenders, pursuant to which Ault & Company borrowed $36 +million and issued the Secured Notes to the lenders in the aggregate amount of $38.9 million. +Pursuant to the Loan Agreement, +the Guarantors, as well as Milton C. Ault, III, our Executive Chairman and the Chief Executive Officer of Ault & Company, agreed to +act as guarantors for repayment of the Secured Notes. In addition, certain Guarantors entered into various agreements as collateral in +support of the guarantee of the Secured Notes, including (i) a security agreement by Sentinum, pursuant to which Sentinum granted to the +Lenders a security interest in (a) the Miners, (b) all of the digital currency mined or otherwise generated from the Miners and (c) the +membership interests of ACS, (ii) a security agreement by the Company, Ault Lending, BNI Montana and AGREE, pursuant to which those entities +granted to the lenders a security interest in substantially all of their assets, as well as a pledge of equity interests in Ault Aviation, +AGREE, Sentinum, Third Avenue, Ault Energy, Eco Pack, and Circle 8 Holdco, (iii) a mortgage and security agreement by Third Avenue on +the Florida Property, (iv) a future advance mortgage by ACS on the Michigan Property, (v) an aircraft mortgage and security agreement +by Ault Aviation on the Aircraft, and (vi) deposit account control agreements over certain bank accounts held by certain of our subsidiaries. +In addition, pursuant to the +Loan Agreement, we agreed to establish the Segregated Account, which would be used as a further guarantee of repayment of the Secured +Notes. $3.5 million of cash was paid into the Segregated Account on the closing date. We are required to have the minimum balance in the +Segregated Account be not less than $7 million, $15 million, $20 million and $27.5 million on the five-month, nine-month, one-year and +two-year anniversaries of the closing date, respectively. In addition, starting on March 31, 2024, we are required to deposit $0.3 million +monthly into the Segregated Account, which increases to $0.4 million monthly starting March 31, 2025. Further, we agreed to deposit into +the Segregated Account, (i) up to the first $7 million of net proceeds, if any, from the sale of the Hilton Garden Inn in Madison West, +the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford; (ii) 50% of cash dividends (on +a per dividend basis) received from Circle 8 on or after June 30, 2024; (iii) 30% of the net proceeds from any bond offerings we conduct, +which shall not exceed $9 million in the aggregate; and (iv) 25% of the net proceeds from cash flows, collections and revenues from loans +or other investments made by Ault Lending (including but not limited to sales of loans or investments, dividends, interest payments and +amortization payments), which shall not exceed $5 million in the aggregate. In addition, if we decide to sell certain assets, we further +agreed to deposit funds into the Segregated Account from the sale of those assets, including, (i) $15 million from the sale of the Florida +Property, (ii) $11 million from the sale of the Aircraft, (iii) $17 million from the sale of the Michigan Property, (iv) $350 per Miner, +subject to a de minimis threshold of $1 million, and (v) $10 million from the sale of Circle 8. +99 +Amendments to Loan and Guarantee Agreement +On +September 17, 2024, the loan and guarantee agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed +financial obligations of Ault & Company borrowings, was amended regarding the Company’s obligations to fund the restricted cash +Segregated Account. +The Company agreed to deposit +in the Segregated Account: (i) $0.4 million monthly commencing on September 30, 2024 and ending on February 28, 2025; and (ii) $0.5 +million monthly commencing on March 31, 2025 and ending on the earlier of the term loan maturity date, prepayment of the term loan in +full or the date on which the balance of the Segregated Account exceeds 110% of the outstanding balance of the term loan. As of December +31, 2024, the Company had deposited $18.4 million in the Segregated Account. +On +March 7, 2025 the loan and guarantee agreement, dated as of December 14, 2023, as amended, pursuant to which the Company has guaranteed +financial obligations of Ault & Company borrowings, was further amended regarding the Company’s obligations to fund the restricted +cash Segregated Account. +Pursuant +to the March 7, 2025 amendment, the Company agreed to deposit in the Segregated Account: (i) $0.2 million monthly commencing on April 11, +2025 and ending on June 11, 2025; and (ii) $0.4 million monthly commencing on July 11, 2025 and ending on the earlier of the term loan +maturity date, prepayment of the term loan in full or the date on which the balance of the Segregated Account exceeds 110% of the outstanding +balance of the term loan. +Description of the Series C Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) $0.10 (the “Preferred Floor Price”), and (ii) the lesser of (A) $0.35 or (B) 105% of the volume +weighted average price of the common stock during the ten trading days immediately prior to the date of conversion (the “Series +C Conversion Price”). The Series C Conversion Price is subject to adjustment in the event of an issuance of common stock at a price +per share lower than the Series C Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations +or similar events. The Preferred Floor Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations +or similar transactions. +Voting Rights +The holders of the Series +C Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series C Convertible Preferred Stock is entitled to +cast, shall not be lower than $107.625 (the “Series C Voting Floor Price”), which represents the closing sale price of the +common stock on the trading day immediately prior to the date of execution of the November 2023 SPA. The Series C Voting Floor Price shall +be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series C Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +100 +Description of the Series C Warrants +On each closing date, the +Company will issue Ault & Company the Series C Warrants, which grant Ault & Company the right to purchase a specified number of +common stock (the “Series C Warrant Shares”). The exercise price of the Series C Warrants is $118.39 (the “Series C +Exercise Price”) and the number of Series C Warrant Shares is determined by dividing the actual investment amount by the Series +C Exercise Price. The Series C Exercise Price is subject to adjustment in the event of customary stock splits, stock dividends, combinations +or similar events. +The Series C Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +Series G Preferred Stock Purchase Agreement +On December 21, 2024, we entered +into the December 2024 SPA with Ault & Company, pursuant to which we agreed to sell, in one or more closings, to Ault & Company +up to 25,000 shares of Series G Convertible Preferred Stock and the Series G Warrants to purchase up to 4.2 million shares of common stock +for a total purchase price of up to $25 million. +The +December 2024 SPA shall automatically terminate if the closing has not occurred prior to December 31, 2025, though such date may be extended +by Ault & Company as set forth in the December 2024 SPA. The December 2024 SPA provides that the financing may be conducted through +one or more closings. +As +of the date of filing of this Form 10-K, Ault & Company has purchased an aggregate of 960 shares of Series G Convertible Preferred +Stock and Series G Warrants to purchase an aggregate of 162,217 Warrant Shares, for an aggregate purchase price of $1.0 million. +Additionally, until the earlier +of (i) four years from the initial closing date of the December 2024 SPA or (ii) the date when Ault & Company holds fewer than 5,000 +shares of Series G Convertible Preferred Stock, the Company will be prohibited from (A) entering into any financing, whether debt or equity, +other than conventional loans from a commercial bank, at a price per share less than the Series G Conversion Price (as defined below) +or (B) entering into a variable rate financing transaction. +Further, for as long as Ault +& Company holds at least 5,000 shares of Series G Convertible Preferred Stock, Ault & Company shall have a right to participate +in a Subsequent Financing allowing Ault & Company to purchase such number of securities in the Subsequent Financing to allow Ault +& Company to maintain its percentage beneficial ownership of the Company that Ault & Company held immediately prior to the Subsequent +Financing. +Description of the Series G Convertible Preferred Stock +Conversion Rights +Each share of Series +C Convertible Preferred Stock has a stated value of $1,000.00 and is convertible into shares of common stock at a conversion price +equal to the greater of (i) the Preferred Floor Price, and (ii) the lesser of (A) $6.74 or (B) 105% of the volume weighted average price +of the common stock during the ten trading days immediately prior to the date of conversion (the “Series G Conversion Price”). +The Series G Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the +Series G Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The +Preferred Floor Price will under no circumstances be adjusted for stock dividends, stock splits, stock combinations or similar transactions. +Voting Rights +The holders of the Series +G Preferred Stock are entitled to vote with the common stock as a single class on an as-converted basis, subject to applicable law provisions +of the Delaware General Company Law and the NYSE American, provided, however, that for purposes of complying with NYSE American regulations, +the conversion price, for purposes of determining the number of votes the holder of Series G Convertible Preferred Stock is entitled to +cast, shall not be lower than $6.244 (the “Series G Voting Floor Price”), which represents the closing sale price of the Class +A common stock on the trading day immediately prior to the date of execution of the December 2024 SPA plus the estimated value of the +Series G Warrants. The Series G Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other similar +transactions. +101 +In addition, Ault & Company +will be entitled to elect such number of directors to the Board as shall be equal to a percentage determined by dividing (i) the number +of shares of common stock issuable upon conversion of the Series G Preferred Stock then owned by Ault & Company (the “Conversion +Shares”), by (ii) the sum of the number of shares of common stock then outstanding plus the number of Conversion Shares. +Description of the Series G Warrants +On each closing date, the +Company will issue Ault & Company the Series G Warrants, which grant Ault & Company the right to purchase a specified number of +shares of class A common stock (the “Series G Warrant Shares”). The exercise price of the Series G Warrants is $5.92 (the +“Series G Exercise Price”) and the number of Series G Warrant Shares is determined by dividing the actual investment amount +by the Series G Exercise Price. The Series G Exercise Price is subject to adjustment in the event of customary stock splits, stock dividends, +combinations or similar events. +The Series G Warrants have +a five-year term, expiring on the fifth anniversary of the date of issuance, and become exercisable on the first business day after the +six-month anniversary of the date of issuance. +Nature of Related Parties +Milton +C. Ault, III, our Executive Chairman, is also the Chief Executive Officer and a director of +Ault & Company. William B. Horne, our Chief Executive Officer and Vice Chairman, is also Chief +Financial Officer and a director of Ault & Company. Henry Nisser, our President, General Counsel and a member of our board of directors, +is also the President, General Counsel and a director of Ault & Company. +Alzamend +On January 31, 2024, Ault +Lending entered into the January 2024 SPA with Alzamend, pursuant to which Alzamend agreed to sell, in one or more closings, to Ault Lending +up to 6,000 shares of ALZN Series B Preferred and ALZN Series B Warrants to purchase up to 0.6 million shares of Alzamend common stock +for a total purchase price of up to $6.0 million. On January 31, 2024, Ault Lending purchased 1,220 +shares of ALZN Series B Preferred and warrants to purchase 0.1 million shares for a total purchase price of $1.22 million. The purchase +price was paid by the cancellation of $1.22 million of cash advances made by Ault Lending to Alzamend between November 9, 2023 and January +31, 2023. On March 26, 2024, pursuant to the January 2024 SPA, Ault Lending purchased 780 +shares of ALZN Series B Preferred Stock and ALZN Series B Warrants to +purchase 0.1 million shares of Alzamend common , for a purchase price of $780,000. As +of March 31, 2025, Ault Lending has purchased an aggregate of 2,100 shares of ALZN Series B Preferred and ALZN Series B Warrants +to purchase an aggregate of 0.2 million shares of Alzamend common stock, for an aggregate purchase +price of $2.1 million. +Description of the ALZN Series B Preferred +The +terms of the ALZN Series B Preferred are as set forth in the Amended and Restated Certificates of Designations of the Rights, Preferences +and Limitations of the Series B Convertible Preferred Stock, as amended (the “ Series B Certificate of Designation ”). +Each share of ALZN Series B Preferred has a stated value of $1,000 per share (the “ALZN Stated Value ”). +The ALZN Series B Preferred does not accrue dividends. +Conversion Rights +Each +share of ALZN Series B Preferred is convertible into a number of shares of Alzamend common +stock (“ALZN Conversion Shares”) determined by dividing the ALZN Stated Value by +$10.00 (the “ALZN Conversion Price”). The ALZN Conversion Price is subject to adjustment in the event of an issuance +of common stock at a price per share lower than the ALZN Conversion Price then in effect, as well as upon customary stock splits, stock +dividends, combinations or similar events. +Voting Rights +The +holders of the ALZN Series B Preferred are entitled to vote with the common stock as a single +class on an as-converted basis, subject to applicable law provisions of the Delaware General Company Law and Nasdaq, provided however, +that for purposes of complying with Nasdaq regulations, the conversion price, for purposes of determining the number of votes the holder +of ALZN Series B Preferred is entitled to cast, shall not be lower than $8.73 (the “ALZN +Voting Floor Price”). The ALZN Voting Floor Price shall be adjusted for stock dividends, stock splits, stock combinations and other +similar transactions. +102 +Liquidation Rights +In +the event of liquidation, dissolution, or winding up of Alzamend, the holders of ALZN Series B Preferred +have a preferential right to receive an amount equal to the ALZN Stated Value per share of ALZN +Series B Preferred before any distribution to other classes of capital stock. If the assets are insufficient, the distribution +will be prorated among the holders of ALZN Series B Preferred . The remaining assets, if any, +will then be distributed pro rata to the holders of outstanding Alzamend common stock. Any transaction that constitutes a change of control +transaction shall be deemed to be a liquidation under the Series B Certificate of Designation. +Description of the +Series B Warrants +At +each closing, Alzamend issued Ault Lending Series B Warrants, which grant Ault Lending the right to purchase a specified number of Alzamend +common stock (the “ALZN Warrant Shares”). The exercise price of the Series B Warrants is $12.00 (the “ALZN Exercise +Price”) and the number of ALZN Warrant Shares is equal to the number of ALZN Conversion Shares issuable upon the ALZN +Series B Preferred issued at that closing. The ALZN Exercise Price is subject to adjustment in the event of an issuance of common +stock at a price per share lower than the ALZN Exercise Price then in effect, as well as upon customary stock splits, stock dividends, +combinations or similar events. +The +Series B Warrants become exercisable on the first business day after the six-month anniversary of issuance (the “ALZN Initial Exercise +Date”) and have a five-year term, expiring on the fifth anniversary of the ALZN Initial Exercise Date. +Nature of Related Parties +Messrs. Ault, Horne and Nisser +are each paid $50,000 annually by Alzamend. +Milton +C. Ault, III, our Executive Chairman, is also the Vice Chairman of Alzamend. William +B. Horne, our Chief Executive Officer and Vice Chairman, is also the Chairman of Alzamend . +Henry Nisser, our President, General Counsel and a member of our board of directors, is also the Executive Vice President, General Counsel +and a director of Alzamend. +AVLP +Nature of Related Parties +Prior to the filing of Chapter +7 bankruptcy by AVLP in March 2025, Mr. Ault was paid $100,000 annually by AVLP, and each of Messrs. Horne and Nisser was paid $50,000 +annually by AVLP. +Milton C. Ault, III and William +Horne, our Executive Chairman and Chief Executive Officer, respectively, and two of our directors are directors of AVLP. In addition, +Philou Ventures, of which Ault & Company is the Manager, is the controlling stockholder of AVLP. Mr. Ault is the Executive Chairman +of AVLP. Further, Henry Nisser, our President, General Counsel and one of our directors, is the Executive Vice President and General Counsel +of AVLP. +Director Independence +Independent +Audit Committee +Nominating and +Governance Committee +Compensation Committee +Director +Milton C. Ault III +No +William B. Horne +No +Henry Nisser +No +Robert O. Smith +Yes +C +X +X +Jeffrey A. Bentz +Yes +X +X +C +Mordechai Rosenberg +Yes +X +C +X +____________ +C – Chairman of committee +X – Member of committee +103 \ No newline at end of file diff --git a/raw/filings/0000913241/2014/0001628280-15-001083/filing.txt b/raw/filings/0000913241/2014/0001628280-15-001083/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..cecedd39f53bd573423d016f8a3ee59a955b6e45 --- /dev/null +++ b/raw/filings/0000913241/2014/0001628280-15-001083/filing.txt @@ -0,0 +1,4148 @@ +10-K +1 +shoo-20141231x10k.htm +10-K +SHOO-2014.12.31-10K +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2014 +or +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ________ to ________ +Commission File Number 0-23702 +STEVEN MADDEN, LTD. +(Exact name of registrant as specified in its charter) +Delaware +13-3588231 +(State or other jurisdiction of +(I.R.S. Employer Identification No.) +incorporation or organization) +52-16 Barnett Avenue, Long Island City, New York 11104 +(Address of principal executive offices) (Zip Code) +(718) 446-1800 +(Registrant's Telephone Number, Including Area Code) +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Common Stock, par value $.0001 per share +The NASDAQ Stock Market LLC +Preferred Stock Purchase Rights +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes x No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act. +Yes o No x +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes x No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes x No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer x +Accelerated filer o +Non-accelerated filer o (do not check if smaller reporting company) +Smaller reporting company o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). +Yes o No x +The aggregate market value of the common equity held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and directors are “affiliates” of the registrant) as of June 30, 2014 , the last business day of the registrant's most recently completed second fiscal quarter, was approximately $2,230,508,000 (based on the closing sale price of the registrant's common stock on that date as reported on The NASDAQ Global Select Market). +The number of outstanding shares of the registrant's common stock as of February 24, 2015 was 63,671,301 shares. +DOCUMENTS INCORPORATED BY REFERENCE: +PART III INCORPORATES CERTAIN INFORMATION BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT'S 2015 ANNUAL MEETING OF STOCKHOLDERS. +TABLE OF CONTENTS +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +1 +PART I +ITEM 1 BUSINESS +1 +ITEM 1A RISK FACTORS +8 +ITEM 1B UNRESOLVED STAFF COMMENTS +14 +ITEM 2 PROPERTIES +14 +ITEM 3 LEGAL PROCEEDINGS +16 +ITEM 4 MINE SAFETY DISCLOSURES +16 +PART II +ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER +MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +16 +ITEM 6 SELECTED FINANCIAL DATA +19 +ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION +AND RESULTS OF OPERATIONS +21 +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +31 +ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +31 +ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON +ACCOUNTING AND FINANCIAL DISCLOSURE +31 +ITEM 9A CONTROLS AND PROCEDURES +31 +ITEM 9B OTHER INFORMATION +32 +PART III +ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +32 +ITEM 11 EXECUTIVE COMPENSATION +32 +ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND +MANAGEMENT AND RELATED STOCKHOLDER MATTERS +32 +ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND +DIRECTOR INDEPENDENCE +32 +ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES +33 +PART IV +ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +33 +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K contains “forward-looking statements” (as that term is defined in the federal securities laws), which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with regard to future revenue, projected 2015 results, earnings, spending, margins, cash flow, customer orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives and other future events. More generally, forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. Factors that may affect our results include, but are not limited to, the risks and uncertainties discussed in Item 1A of this Annual Report on Form 10-K. +Any such forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based and could cause our actual results to differ materially from those projected in forward-looking statements. As such, we strongly caution you that these forward-looking statements are not guarantees of future performance or events. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. +PART I +ITEM 1 BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories and license some of our trademarks for use in connection with the manufacture, marketing and sale of various products of our licensees. Our products are marketed through our retail stores and our e-commerce websites, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers throughout the United States, Canada, Mexico and South Africa. In addition, we have special distribution arrangements for the marketing of our products in Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. We offer a broad range of updated styles designed to establish or complement and capitalize on market trends. We have established a reputation for design creativity and our ability to offer quality products in popular styles at affordable prices, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed our initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. The public may read and copy any materials filed by us with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information regarding the operation of the SEC's Public Reference Room is available by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +1 +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company and a Code of Business Conduct and Ethics that is applicable to all of our employees, each of which are attached as exhibits to this Annual Report on Form 10-K and posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Net sales for 2014 increased 2% to $1,334,951 from $1,314,223 in 2013. Net income attributable to Steven Madden, Ltd. decreased 15% to $111,880 in 2014 compared to $132,007 in 2013. Diluted earnings per share in 2014 decreased to $1.76 per share on 63,676,000 diluted weighted average shares outstanding compared to $1.98 per share on 66,836,000 diluted weighted average shares outstanding in the prior year. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Report Signature®, Superga® (under license), Betsey Johnson®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, Wild Pair®, Brian Atwood®, B Brian Atwood® and includes our International business and certain private label footwear business. Our Wholesale Accessories segment includes Big Buddha®, Betseyville®, Betsey Johnson®, Steve Madden®, Steven®, Cejon® accessories brands and includes our International business and certain private label accessories business. These trademarks are registered trademarks owned by us or licensed to us by third parties. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery, women's fashion apparel, jewelry, watches and luggage. In addition, we license our Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, swimwear, eyewear, watches, fragrances and outerwear. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States and Canada. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl is geared for young women ages 13 to 20, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +Steve Madden Men's. We design, source, and market a life style collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range from $70 to $150 at retail. +Madden. T he Madden® brand is a streetwear focused collection of footwear geared to meet the trend directions of the 13 to 21 year old fashion consumer. Madden products range from $45 to $85 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +2 +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department and better footwear specialty stores throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden brand, Steven products are designed to appeal principally to fashion conscious women, ages 25 to 45, who shop at department stores and footwear boutiques. +Stevies and Steve Madden Kids. Our Stevies and Steve Madden Kids brands are designed, sourced and marketed to appeal to young girls, ages six to 12, and are sold at department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson and Betseyville shoe brands are distributed through department stores such as Nordstrom and Dillard's and online retailers such as Amazon and Zappos. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints. +FREEBIRD by Steven . We design, source, and market a full collection of handcrafted, Goodyear welted boots. The designs are inspired by vintage Americana and created using time-honored craftsmanship. The FREEBIRD by Steven® collection conveys a unique fashion life style that transcends multiple generations. FREEBIRD by Steven products are currently sold, at retail prices ranging from $195 to $450 at major department stores, mid-tier retailers, and specialty boutiques. +Report. The Report and Report Signature brands were acquired in our May 2011 acquisition of Topline Corporation ("Topline"). We design, manufacture, market and sell our Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. Formed in April 2011 as a joint venture with the Company, the Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed to Target. +Dolce Vita. On August 13, 2014, the Company acquired the Dolce Vita® and DV® brands and other intellectual property assets in the acquisition of Dolce Vita Holdings, Inc. The Dolce Vita brand is a contemporary women's footwear brand with price points ranging from $120 to $350. The DV brand, which is designed for younger fashion conscious women, has price points ranging from $60 to $200. Both brands are distributed through department stores such as Nordstrom, Bloomingdale's and Macy's and online retailers such as Amazon and Zappos. +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand from Brian Atwood IP Company LLC. Founded in 2011, Brian Atwood is known for luxury shoes manufactured in Italy. +International Division. The International Division works through special distribution arrangements for the marketing and sales of our products in Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands (including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Betseyville® and Big Buddha® brands,) and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States and Canada. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon® and Steve Madden® brand names and private labels to department stores and specialty stores. +3 +Retail Segment +As of December 31, 2014 , we owned and operated 160 retail stores including 122 Steve Madden full price stores, 32 Steve Madden outlet stores, one Steven store, one Superga store and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). In 2014 , we opened three new full price stores, 15 new outlet stores and closed five stores including three full price stores, one Steven store and our FREEBIRD by Steven online store. In addition, we added the Dolce Vita online store through the Dolce Vita acquisition, four stores in South Africa through a joint venture and 21 stores in Mexico through the acquisition of our Mexican distributor. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico and South Africa. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2014 and 2013 ) decreased 8.1% in fiscal year 2014 from the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product development efforts of our two Wholesale segments. We expect to open eight to ten new retail stores and anticipate closing three to four stores in 2015 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that by operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Currently, our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including, Kohl's, K-Mart and Sears. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery and women's fashion apparel, jewelry, watches and luggage. In addition, the Company licenses the Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, swimwear, eyewear, watches, fragrances and outerwear. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note P to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new Steve Madden products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Steve Madden products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Steve Madden brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +4 +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers in China, Mexico, the Netherlands, India, Vietnam, Brazil and Italy. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from four third-party distribution centers, two located in California, one located in Texas and one located in New Jersey and through two Company-operated distribution centers located in New Jersey and Canada. By utilizing distribution facilities specializing in distribution fulfillment to effect distribution to certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers include, Target, Macy's, DSW, Payless, Ross, Walmart, Nordstrom, Dillard's, TJ Maxx and Marshall's. For the year ended December 31, 2014 , Target, Inc. represented 10.5% of net sales and 12.8% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico and South Africa +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants and in our Company-owned retail stores in the United States, Canada, Mexico and South Africa and our e-commerce websites. For the year ended December 31, 2014 , our Retail segment and our two Wholesale segments generated net sales of approximately $205,988 and $1,128,963 , or 15% and 85% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2014 , we operated 122 Steve Madden full price stores, 32 Steve Madden outlet stores, one Steven store, one Superga store and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. Specifically, we often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,900 to 2,100 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal +5 +to a more mature target audience. The typical outlet store is approximately 2,300 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell to over 2,500 doors of 17 department stores throughout the United States and Canada. Our major accounts include Macy's, Nordstrom, Dillard's, Belk and Bon Ton. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-throughs, which, in turn, reduces markdown exposure at season's end. +National chains and mass merchants. We currently sell to national chains and mass merchants throughout the United States and Canada. Our major accounts include Target, Walmart, Kohl's, JC Penney and Sears. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States and Canada. Our major specialty store accounts include DSW, Famous Footwear and Journeys. We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's and Victoria's Secret. +Internet Sales. We operate four Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson and Dolce Vita) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International +Our products are available in many countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Nine West, Jessica Simpson, Guess, Ugg and Aldo. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +6 +Marketing and Sales +We have focused on creating an integrated brand building program to establish Steve Madden as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include product placements in life style and fashion magazines, personal appearances by our founder and Creative and Design Chief, Steve Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products, as well as view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our wholesale information system is an Enterprise Resource Planning (“ERP”) system. This integrated system supports our wholesale business in the areas of finance and accounting, manufacturing, purchase order management, customer order management and inventory control. We completed the implementation of this new ERP system for our wholesale business in 2014 and are currently in the process of its implementation as to businesses acquired since the inception of the ERP implementation. In 2014 we completed the implementation of a new warehouse management system that is utilized by our third-party logistics providers and which interfaces with our ERP system. Additionally, we have a new business-to-consumer e-commerce software platform that we are currently in the process of implementing as to businesses acquired. We are also currently implementing a point of sale system (“POS”) for our retail stores that is integrated with a retail inventory management/store replenishment system. Complimenting all of these systems are ancillary systems and third-party information processing services including, among others, supply chain, data warehouse, Electronic Data Interchange (“EDI”), credit card processing and payroll. We undertake updates and upgrades of all of these information management systems on a periodic basis in order to ensure that our functionality is continuously improved. +Intellectual Property +Trademarks +We consider our trademarks to be among our most valuable assets and have registered many of our marks in the United States and 94 other countries and in numerous International Classes. From time to time we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +Blondo® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective licensing of our brands. As of December 31, 2014 , we license our Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, +7 +outerwear, bedding, hosiery and women's fashion apparel, jewelry, watches and luggage. In addition, the Company licenses the Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, watches, swimwear, eyewear, fragrances and outerwear. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we also license the trademarks of third parties for use in connection with certain of our product lines. Through a license agreement with Basic Properties America Inc. and BasicNet S.p.A we have the right to use the Superga® trademark in connection with the marketing and sale of footwear through December 31, 2022. This licensing agreement requires us to make royalty and advertising payments to the licensor equal to a percentage of our net sales or a minimum royalty and advertising payment in the event that specified net sales targets are not achieved. See Notes A and O to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2015 , we employed approximately 3,256 employees, of whom approximately 1,137 work on a full-time basis and approximately 2,119 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,230 of our employees are located in the United States, approximately 641 employees are located in Hong Kong and China, approximately 296 employees are located in Canada and approximately 89 employees are located in Mexico. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality +Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the timing of holidays, weather, the timing of larger shipments of footwear, market acceptance of our products, product mix, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. +Backlog +We had unfilled wholesale customer orders of approximately $312,000 and $295,000, as of February 1, 2015 and 2014 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. +ITEM 1A RISK FACTORS +You should carefully consider the risks and uncertainties we describe below and the other information in this Annual Report on Form 10-K before deciding to invest in, sell or retain shares of our common stock. These are not the only risks and uncertainties that we face. Other sections of this report may discuss factors that could adversely affect our business. The retail industry is highly competitive and subject to rapid change. There may be additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, which may also harm our business or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, results of operations and liquidity could be materially harmed. +Risks Related to the Industry in Which the Company Operates +Constantly Changing Fashion Trends and Consumer Demands. Our success depends in significant part upon our ability to anticipate and respond to product and fashion trends as well as to anticipate, gauge and react to changing consumer demands in a timely manner. There can be no assurance that our products will correspond to the changes in taste and demand or that we will be able to successfully market products that respond to such trends. If we misjudge the market for our products, we +8 +may be faced with significant excess inventories for some products and missed opportunities as to others. In addition, misjudgments in merchandise selection could adversely affect our image with our customers resulting in lower sales and increased markdown allowances for customers which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Intense Fashion Industry Competition . The fashion footwear and accessories industry is highly competitive and barriers to entry are low. Our competitors include specialty companies as well as companies with diversified product lines. The recent market growth in the sales of fashion footwear and accessories has encouraged the entry of many new competitors and increased competition from established companies. Many of these competitors, including Nine West, Guess, Jessica Simpson, Ugg and Aldo, may have significantly greater financial and other resources than we do and there can be no assurance that we will be able to compete successfully with other fashion footwear and accessories companies. Increased competition could result in pricing pressures, increased marketing expenditures and loss of market share, and could have a material adverse effect on our business, financial condition, results of operations and liquidity. We believe effective advertising and marketing, favorable branding of the Steve Madden® and our other trademarks, fashionable styling, high quality and value are the most important competitive factors and we plan to continue to focus on these elements as we develop new products and businesses. Our inability to effectively advertise and market our products and respond to customer preferences could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Cyclical Nature of the Fashion Industry . The overall fashion industry is cyclical, and purchasing tends to decline during recessionary periods when disposable income is low. Likewise, purchases of contemporary shoes and accessories tends to decline during recessionary periods and also may decline at other times. There can be no assurance that we will be able to grow or even maintain our current level of revenues and earnings, or remain profitable in the future. Continuing slow growth in the international, national or regional economies and uncertainties regarding future economic prospects, among other things, could affect consumer spending habits. The volatility and disruption of global economic and financial market conditions that began in 2008 has caused lingering declines in consumer confidence and spending in the United States and internationally. A further deterioration or a continued weakness of economic and financial market conditions for an extended period of time could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Consolidation Among Retailers . In recent years, the retail industry has experienced consolidation and other ownership changes. In the future, retailers in the United States and in foreign markets may further consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our products or increase the ownership concentration within the retail industry. While such changes in the retail industry to date have not had a material adverse effect on our business or financial condition, results of operations and liquidity, there can be no assurance as to the future effect of any such changes. +Economic Uncertainty and Political Risks . Our opportunities for long-term growth and profitability are accompanied by significant challenges and risks, particularly in the near term. Specifically, our business is dependent on consumer demand for our products. We believe that declining consumer confidence accompanied with the tightening of credit standards, higher energy and food prices and unemployment rates and a decrease in consumers' disposable income has negatively impacted the level of consumer spending for discretionary items during the years ended December 31, 2014 , 2013 and 2012 . During the three year period ended December 31, 2014 , we achieved revenue growth in both our Wholesale and Retail segments but we cannot assume that this growth will be sustained. A continued weak economic environment could have a negative effect on the Company's sales and results of operations during the year ending December 31, 2015 and thereafter. In addition the unstable political conditions in the Middle East and some other parts of the world, including potential or actual international conflicts, or the continuation or escalation of terrorism, could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Risks Related to Our Business +Dependence on Key Personnel. The growth and success of our Company since its inception almost a quarter century ago is attributable, to a significant degree, to the talents, skills and efforts of our founder and Creative and Design Chief, Steven Madden. An extended or permanent loss of the services of Mr. Madden could severely disrupt our business and have a material adverse effect on the Company. Our senior executives have substantial experience and expertise in our business and industry and have made significant contributions to our growth and success as well. Competition for executive talent in the apparel, footwear and accessories industries is intense. While our employment agreements with Mr. Madden and most of our senior executives include a non-compete provision in the event of the termination of employment, the non-compete periods are of limited duration. While we believe we have depth within our senior management team, if we lose the services of our Creative and Design Chief or any of our senior executives, and especially if any of these individuals joins a competitor or forms a competing company, our +9 +business and financial performance could be seriously harmed. A loss of the skills, industry knowledge, contacts and expertise of our Creative and Design Chief or any of our senior executives could cause a setback to our operating plan and strategy. +Dependence Upon Significant Customers . Our customers consist principally of better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers. Certain of our department store customers, including some under common ownership, account for significant portions of our wholesale business. We generally enter into a number of purchase order commitments with our customers for each of our lines every season and do not enter into long-term agreements with any of our customers. Therefore, a decision by a significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to decrease the amount of merchandise purchased from us or to change its manner of doing business could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Risks Associated with Extending Credit to Customers. We sell our products primarily to retail stores across the United States and extend credit based on an evaluation of each customer's financial condition, usually without collateral. Various retailers, including some of our customers, have experienced financial difficulties as a result of the financial crisis that began in 2008, which has increased the risk of extending credit to such retailers. However, our losses due to bad debts have been limited. Pursuant to the terms of our collection agency agreement, our factor, Rosenthal & Rosenthal, Inc., currently assumes the credit risk related to approximately 85% of our trade accounts receivable. In addition, we have letters of credit for approximately 12% of our trade accounts receivable. Still, if any of our customers experiences a shortage of liquidity, the risk that the customer's outstanding payables to us would not be paid could cause us to curtail business with the customer or require us to assume more credit risk relating to the customer's account payable. +Risks Associated with Expansion of Retail Business . Our continued growth depends to a significant degree on whether we are successful in further developing and marketing our brands, and creating new brands, product categories and businesses that are appealing to our customers. The operation of company-owned Steve Madden, Steven and Superga stores and outlets is a significant part of our growth strategy. During the year ended December 31, 2014 , we opened three new full-price stores, 15 new outlet stores, acquired one e-commerce store in connection with our acquisition of Dolce Vita, acquired four stores in connection with our joint venture in South Africa, acquired 21 stores in connection with the acquisition of Mexican distributor and closed five stores, including our FREEBIRD by Steven e-commerce store. We have plans to open eight to ten new retail stores and anticipate closing three to four stores in 2015 . Our future expansion plan includes the opening of stores in new geographic markets as well as strengthening existing markets. New markets have in the past presented, and will continue to present, competitive and merchandising challenges that are different from those faced by us in our existing markets. There can be no assurance that we will be able to open new stores, and if opened, that such new stores will be able to achieve sales and profitability levels consistent with management's expectations. Our retail expansion is dependent on the performance of our wholesale and retail operations, generally, as well as on a number of other factors, including our ability to: +• +locate and obtain favorable store sites; +• +negotiate favorable lease terms; +• +hire, train and retain competent store personnel; +• +anticipate the preferences of our retail customers in new geographic areas; +• +successfully integrate new stores into our existing operations. +Past comparable store sales results may not be indicative of future results and there can be no assurance that our comparable store sales results will increase or even be maintained in the future. +Management of Growth . The size of our business continues to grow organically and as a result of business acquisitions. In order to gain from our acquisitions, we must be effective in integrating the businesses acquired into our overall operations. Further, the expansion of our operations has increased and will continue to increase the demand on our managerial, operational and administrative resources. In recent years, we have invested significant resources in, among other things, our management information systems and hiring and training of new personnel. However, in order to manage currently anticipated levels of future demand, we may be required to, among other things, expand our distribution facilities, establish relationships with new manufacturers to produce our product, and continue to expand and improve our financial, management and operating systems. We may experience difficulty integrating acquired businesses into our operations and may not achieve anticipated synergies from such integration. There can be no assurance that we will be able to manage future growth effectively and a failure to do so could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruptions to Product Delivery Systems and Associated Inventory Management Issues. A majority of our products for U.S. distribution are shipped to us via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on California ports. The trend-focused nature of the fashion industry and the rapid changes in customer preferences leave +10 +us vulnerable to risk of inventory obsolescence. Our reliance upon ocean freight transportation for the delivery of our inventory exposes us to various inherent risks, including port workers’ union disputes and associated strikes, work slow-downs and work stoppages, severe weather conditions, natural disasters and terrorism, any of which could result in delivery delays and inefficiencies, increase our costs and disrupt our business. A severe and prolonged disruption to ocean freight transportation, such as the disruption to California port operations which began in 2014 and is continuing into 2015 due to a port workers’ union dispute, has already caused, and may continue to cause, us to re-route our merchandise through alternate and more expensive transportation systems, such as air freight. Efficient and timely inventory deliveries and proper inventory management are important factors in our operations. Inventory shortages can adversely affect the timing of shipments to customers and diminish sales and brand loyalty. Conversely, excess inventories can result in lower gross margins due to the excessive discounts and markdowns that may be necessary to reduce high inventory levels. Severe and extended delays in the delivery of our inventory or our inability to effectively manage our inventory could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruption of Information Technology Systems and Websites. We are heavily dependent upon our information technology systems to record and process transactions and manage and operate all aspects of our business ranging from product design and testing, production, forecasting, ordering, transportation, sales and distribution, invoicing and accounts receivable management, quick response replenishment, point of sale support and financial management reporting functions. In addition, we have e-commerce and other Internet websites. Given the nature of our business and the significant number of transactions that we engage in on an annual basis, it is essential that we maintain constant operation of our information technology systems and websites and that these systems and our websites operate effectively. We depend on our in-house information technology employees and outside vendors to maintain and periodically upgrade these systems and our websites to support the growth of our business. Despite our preventative efforts, our information technology systems and websites may be vulnerable from time to time to damage or interruption from events such as difficulties in replacing or integrating new systems, computer viruses, security breaches and power outages. Cybersecurity attacks are becoming increasingly sophisticated and run the gamut from malicious software to electronic security breaches to corruption of data and beyond. We are continually evaluating, improving and upgrading our information technology systems and websites in an effort to address these concerns. Any such problems or interruptions could result in loss of valuable business data, our customers' or employees' personal information, disruption of our operations and other adverse impact to our business and require significant expenditures by us to remediate any such failure, problem or breach. In addition, we must comply with increasingly complex regulatory standards enacted to protect business and personal data and an inability to maintain compliance with these regulatory standards could subject us to legal risks and penalties. +We maintain $25 million of network-security insurance coverage, above a $250,000 deductible. This coverage and certain other insurance coverage may reduce our exposure to electronic data theft and sabotage. +Breach of Customer Privacy. A routine part of our business includes the gathering, processing and retention of sensitive and confidential information pertaining to our customers, employees and others. While we believe that our information security and information technology systems and websites allow for the secure storage and transmission of private information regarding our customers and others, including credit card information and personal identification information, we may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber attacks. As a result, our facilities and information technology systems, as well as those of our third party service providers, may be vulnerable to cyber attacks and breaches, acts of vandalism and software viruses. Any actual or threatened cyber attack may cause us to incur costs, including costs related to the hiring additional computer experts, engaging third party cyber security consultants and upgrading our information security technologies. We also may be vulnerable to data and security breaches by us or by persons with whom we have commercial relationships resulting from misplaced or lost data, programming or human error, or other similar events. Any compromise or breach of our information technology systems that results in the misappropriation, loss or other unauthorized disclosure of a customer's or other person’s confidential or proprietary information, whether by the Company or a third party service provider, could result in a loss of confidence and severely damage our reputation and relationship with our customers and others who entrust us with sensitive information, violate applicable privacy and other laws and adversely affect our business, as well as expose the Company to the risk of litigation and significant potential liability. +Foreign Sourcing and Manufacturing. Virtually all of our products are purchased through arrangements with a number of foreign manufacturers, primarily from China, Mexico, the Netherlands, India, Vietnam, Brazil and Italy. During 2014 , approximately 89% of our total purchases were from China. Risks inherent in foreign operations including work stoppages, transportation delays and interruptions, social unrest and political upheaval and changes in economic conditions, can result in the disruption of trade from the countries in which our manufacturers or suppliers are located, the imposition of additional regulations relating to imports, the imposition of additional duties, taxes and other charges on imports, significant fluctuations of the value of the dollar against foreign currencies, or restrictions on the transfer of funds, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. While we believe that we manage our exposure to the risk that any such economic or political condition will materially affect our ability to purchase products because we are aware of the availability of a variety of materials and alternative sources, we cannot be certain that we will be able to identify such alternative +11 +materials and/or sources without delay or without greater cost to us. Our inability to identify and secure alternative sources of supply in this situation could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Impact of Custom Duties and Other Import Regulations . Virtually all of our products are imported and subject to United States custom duties. The United States and the countries in which our products are produced or sold, from time to time, impose new quotas, duties, tariffs or other restrictions on imports or exports, may adversely adjust prevailing quotas, duties or tariff levels, or impose sanctions in the form of additional duties to remedy perceived illegal actions, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Manufacturers' Inability to Produce Our Goods in a Timely Manner or Meet Quality Standards . As is common in the footwear and accessories industries, we contract with foreign manufactures who produce virtually all of our products to our specifications. We do not own or operate any manufacturing facilities; therefore, we are dependent upon third parties for the manufacture of all of our products. The inability of a manufacturer to ship orders of our products in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers for those items, which, in turn, could result in cancellation of orders, refusal to accept deliveries, a reduction in purchase prices and, ultimately, termination of a customer relationship, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +New rules relating to “conflict minerals” will require the Company to incur additional expenses and could adversely affect our business. The SEC has promulgated final rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring the disclosure of the use of tantalum, tin, tungsten and gold, known as “conflict minerals,” included in products either manufactured by public companies or as to which public companies have contracted for the manufacture. These new rules, adopted in an effort to prevent inadvertent support of armed conflict in the Democratic Republic of Congo and certain adjoining countries (collectively, the “DRC”), require companies to investigate their supply chains to determine whether these minerals are present in their products and, if so, from where the minerals originated. The rules also require disclosure and annual reporting as to whether or not conflict minerals, if used in the manufacture of the products offered, originated from the DRC. Compliance with these rules could adversely affect the sourcing, supply and pricing of materials used in our products. We currently require our manufacturers to comply with policies addressing legal and ethical concerns relating to labor, employment, political and social matters including restrictions on the use of conflict minerals. Violation of these policies by our manufacturers could harm our reputation, disrupt our supply chain and/or increase our cost of goods sold. Additionally, violation of any of these policies by our manufacturers could cause us to face disqualification as a supplier for our customers and suffer reputational challenges. Due to the complexity of our supply chain, compliance with the rules requires significant efforts from a cross-operational team and diverts our management and personnel and results in potential costs of additional staff. Any of the foregoing could adversely affect our sales, net earnings, business and financial condition and results of operations. +Difficulty in Locating Replacement Manufacturers. Although we enter into a number of purchase order commitments each season specifying a time frame for delivery, method of payment, design and quality specifications and other standard industry provisions, we do not have long-term contracts with any manufacturer. As a consequence, any of these manufacturing relationships may be terminated, by either party, at any time. In addition, we may seek replacement manufacturers for various reasons, including a significant increase in the prices we are required to pay to existing manufacturers of our goods. Although we believe that other facilities are available for the manufacture of our products, there can be no assurance that such facilities would be available to us on an immediate basis, if at all, or be able to meet our quality standards and delivery requirements, or that the costs charged to us by such manufacturers would not be significantly greater than those presently paid. +Manufacturers' Failure to Use Acceptable Labor Practices . and Comply with Local Laws and Other Standards . Our products are manufactured by numerous independent manufacturers outside of the United States. We also have license agreements that permit our licensees to manufacture or contract to manufacture products using our trademarks. We impose, and require that our licensees impose, on these manufacturers environmental, health, and safety standards for the benefit of their labor force. In addition, we require these manufacturers to comply with applicable standards for product safety. However, we do not control our independent manufacturers or licensing partners or their labor, product safety and other business practices and, from time to time, our independent manufacturers may not comply with such standards or applicable local law or our licensees may not require their manufacturers to comply with such standards or applicable local law. The violation of such standards and laws by one of the independent manufacturers with whom we contract or by one of our licensing partners, or the divergence of a manufacturer's or a licensing partner's labor practices from those generally accepted as ethical in the United States, could harm our reputation, result in a product recall or require us to curtail our relationship with and locate a replacement for such manufacturer, which, as noted in the immediately preceding risk factor, could be challenging. Any of these events could have a material adverse effect on our business, financial condition, results of operations and liquidity. +12 +Seasonal and Quarterly Fluctuations . Our results of operations may fluctuate from quarter to quarter and are affected by a variety of factors, including: +• +the timing of holidays; +• +weather conditions; +• +the timing of larger shipments of footwear; +• +market acceptance of our products; +• +the mix, pricing and presentation of the products offered and sold; +• +the hiring and training of additional personnel; +• +inventory write downs for obsolescence; +• +the cost of materials; +• +the product mix between wholesale, retail and licensing businesses; +• +the incurrence of other operating costs; and +• +factors beyond our control, such as general economic conditions and actions of competitors. +In addition, we expect that our sales and operating results may be significantly impacted by the opening of new retail stores and the introduction of new products. Accordingly, the results of operations in any quarter will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter. +Extreme or unseasonable weather conditions in locations in which we or our customers and suppliers are located could adversely affect our business. Our corporate headquarters and principal operational locations, including retail, distribution and warehousing facilities, may be subject to natural disasters and other severe weather and geological events that could disrupt our operations. The occurrence of such natural events may result in sudden disruptions in business conditions of the local economies affected, as well as of the regional and global economies, and may result in decreased demand for our products and disruptions in our management functions, sales channels and manufacturing and distribution networks, which could have a material adverse effect on our business, financial condition and results of operations. Extreme weather events and changes in weather patterns can also influence customer trends and shopping habits. Extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season may diminish demand for our seasonal merchandise. Heavy snowfall, hurricanes or other severe weather events in the areas in which our retail stores and the retail stores of our wholesale customers are located may decrease customer traffic in those stores and reduce our sales and profitability. If severe weather events force closure of or disrupt operations at the distribution centers we use for our merchandise, we could incur higher costs and experience longer lead times to distribute our products to our retail stores, wholesale customers or e-commerce customers. If prolonged, such extreme or unseasonable weather conditions could adversely affect our business, financial condition and results of operations. +Inadequate Trademark Protections . We believe that our trademarks and other proprietary rights are of major significance to our success and our competitive position and consider some of our trademarks, such as Steve Madden, to be integral to our business and among our most valuable assets. Accordingly, we devote substantial resources to the establishment and protection of our trademarks on a worldwide basis. Nevertheless, there can be no assurance that the actions taken by us to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products on the basis that our products violate the trademarks and proprietary rights of others. Moreover, no assurance can be given that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve such conflicts. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Our failure to establish and then protect such proprietary rights from unlawful and improper utilization could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Litigation and Other Legal Proceedings. We are involved in various claims, litigations and other legal and regulatory proceedings and governmental investigations that arise from time to time in the ordinary course of our business. Due to the inherent uncertainties of litigation and such other proceedings and investigations, we cannot predict with accuracy the ultimate outcome of any such matters. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations and the amount of insurance coverage we maintain to address such matters may be inadequate to cover these or other claims. In addition, any significant litigation, investigation or proceeding, regardless of its merits, could divert financial and management resources that would otherwise be used to benefit our operations. See Item 3 “Legal Proceedings,” below for additional information regarding certain of the matters in which we are involved. +Declines in Our Stock Price Due to Inaccurate Predictions. The trading price of our common stock periodically may rise or fall based on the accuracy of predictions of our future performance. As one of our primary objectives, we strive to maximize the long-term strength, growth and profitability of our Company, rather than to achieve an earnings target in any particular fiscal +13 +quarter. We believe that this longer-term goal is in the best interests of the Company and our stockholders, but recognize that it may be helpful to our stockholders and potential investors for us to provide guidance as to our quarterly and annual forecast of net sales and earnings. While we endeavor to provide meaningful and considered guidance at the time it is provided and generally expect to provide updates to our guidance when we report our results each fiscal quarter, actual results may differ from our predictions as the guidance is based on assumptions and expectations that may or may not come to pass and, as such, we assume no responsibility to update any of our forward-looking statements at such times or otherwise. If and when we announce actual results that differ from those that have been predicted by us, the market price of our common stock could be adversely affected. Investors who rely on these predictions in making investment decisions with respect to our common stock do so at their own risk. We take no responsibility for any losses suffered as a result of such changes in the price of our common stock. +In addition, at any given time outside securities analysts may follow our financial results and issue reports that discuss our historical financial results and the analysts' predictions of our future performance, which our stockholders and potential investors may choose to rely on in making investment decisions. These analysts' predictions are based upon their own opinions and are often different from our own forecasts. Our stock price could decline if our results are below the estimates or expectations of these outside analysts. +Exposure to Foreign Currency Fluctuations . We make approximately 93% of our purchases in U.S. dollars. However, we source substantially all of our products overseas and, as such, the cost of these products may be affected by changes in the value of the relevant currencies. Changes in currency exchange rates may also affect the relative prices at which we and our foreign competitors sell products in the same market. There can be no assurance that foreign currency fluctuations will not have a material adverse effect on our business, financial condition, results of operations and liquidity. +ITEM 1B UNRESOLVED STAFF COMMENTS +None. +ITEM 2 PROPERTIES +We lease space for our headquarters, our retail stores, showrooms and office facilities in various locations in the United States, as well as overseas. We own one improved real property parcel in Long Island City, New York. We believe that our existing facilities are in good operating condition and are adequate for our present level of operations. The following table sets forth information with respect to our key properties: +14 +Location +Leased/Owned +Primary Use +Approximate Area Square Feet +Dongguan, Guangdong Province, China +Leased +Offices and sample production +180,000 +Long Island City, NY +Leased +Executive offices +66,600 +Bayonne, NJ +Leased +Warehouse +50,000 +Bellevue, WA +Leased +Offices, Topline +41,500 +Seattle, Washington +Leased +Offices and showroom, Dolce Vita +32,500 +New York, NY +Leased +Offices and showroom, Accessories +30,000 +Montreal, Canada +Leased +Offices, warehouse +27,000 +New York, NY +Leased +Showroom, Dolce Vita +28,800 +Putian City, Guangdong Province, China +Leased +Offices +23,800 +New York, NY +Leased +Showroom +14,000 +New York, NY +Leased +Offices, Cejon +12,400 +Long Island City, NY +Leased +Storage +7,200 +Guangdong Province, China +Leased +Offices +4,800 +Los Angeles, CA +Leased +Showroom, Steven +4,600 +Kwai Chung, Hong Kong +Leased +Offices +3,800 +Long Island City, NY +Owned +Other +2,200 +Los Angeles, CA +Leased +Showroom, Accessories +1,400 +New York, NY +Leased +Office +850 +Dallas, Texas +Leased +Showroom +800 +All of our retail stores are leased pursuant to leases that, under their original terms, extend for an average of ten years. Many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes over the base year. The current terms of our retail store leases expire as follows: +Years Initial Lease Terms Expire +Number of Stores +2015 +15 +2016 +13 +2017 +19 +2018 +9 +2019 +13 +2020 +7 +2021 +15 +2022 +20 +2023 +22 +2024 +17 +2025 +9 +2026 +1 +15 +ITEM 3 LEGAL PROCEEDINGS +On August 10, 2005, following the conclusion of an audit of the Company conducted by auditors for U.S. Customs and Border Protection (“U.S. Customs”) during 2004 and 2005, U.S. Customs issued a report that asserts that certain commissions that the Company treated as “buying agents’ commissions” (which are non-dutiable) should be treated as “selling agents’ commissions” and hence are dutiable. Subsequently, U.S. Immigration and Customs Enforcement notified the Company’s legal counsel that a formal investigation of the Company’s importing practices had been commenced as a result of the audit. In September 2007, U.S. Customs notified the Company that it had finalized its assessment of the underpaid duties at $1,400 . The Company, with the advice of legal counsel, evaluated the liability in the case, including additional duties, interest and penalties, and believed that it was not likely to exceed $3,045 , and accordingly, a liability for this amount was recorded as of December 31, 2009. The Company contested the conclusions of the U.S. Customs audit and filed a request for review and issuance of rulings thereon by U.S. Customs Headquarters, Office of Regulations and Rulings, under internal advice procedures. On September 20, 2010, U.S. Customs issued a ruling in the matter, concluding that the commissions paid by the Company pursuant to buying agreements entered into by the Company and one of its two buying agents under review were bona fide buying-agent commissions and, therefore, were non-dutiable. With respect to the second buying agent, U.S. Customs also ruled that beginning in February 2002, commissions paid by the Company were bona fide buying agent commissions and, therefore, were non-dutiable. However, U.S. Customs found that the Company’s pre-2002 buying agreements with the second agent were legally insufficient to substantiate a buyer-buyer’s agent relationship between the Company and the agent and that commissions paid to the second agent under such buying agreements, in fact, were dutiable. On the basis of the U.S. Customs ruling, the Company reevaluated the liability in the case and believes that it is not likely to exceed $1,248 and the liability was reduced from $3,045 to such amount as of September 30, 2010. +On November 21, 2011, U.S. Customs issued a pre-penalty notice to the Company in which it alleges that gross negligence by the Company resulted in an underpayment of duties with respect to certain pre-2002 buying agreements and claims that the Company owes $342 as an additional duty and $1,367 in monetary penalties. In its February 16, 2012 response to the pre-penalty notice, the Company submitted that it owes no additional duty and, further, did not through negligence or gross negligence fail to pay any duty or engage in conduct amounting to either gross negligence or negligence. The Company requested that U.S. Customs withdraw its proposal to issue a notice of penalty and take no further adverse action against the Company. In the event that U.S. Customs is not inclined to withdraw the pre-penalty notice after review of the Company’s response, the Company has requested the opportunity to make an oral presentation to U.S. Customs prior to the issuance of a notice of penalty. On June 26, 2014, the Company’s counsel met with U.S. Customs officials and, following the meeting, counsel submitted to U.S Customs a letter and the Company’s check in the amount of $342, representing the Company’s Offer in Compromise of the proposed government claim. In the event that U.S. Customs determines to issue a notice of penalty, the Company intends to file a petition for relief requesting a reduction of the level of culpability and mitigation of the penalty amount assessed. The maximum total amount of damages, including penalty, related to this matter is estimated at approximately $1,700 for which the Company has accrued $1,248 . +We have been named as a defendant in certain other lawsuits in the normal course of business. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these matters should not have a material effect on our financial position or results of operations. +ITEM 4 MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5 +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our shares of common stock have traded on the NASDAQ Global Select Market since August 1, 2007 and were traded on the NASDAQ National Market prior to that date. The following table sets forth the range of high and low closing sales prices for our common stock during each fiscal quarter during the two-year period ended December 31, 2014 as reported by the NASDAQ Global Select Market. The trading volume of our securities fluctuates and may be limited during certain periods. As a result, the liquidity of an investment in our securities may be adversely affected. +16 +Common Stock +High +Low +High +Low +2014 +2013 +Quarter ended +March 31, 2014 +$37.72 +$30.66 +Quarter ended +March 31, 2013 +$31.85 +$27.33 +Quarter ended +June 30, 2014 +$37.35 +$31.23 +Quarter ended +June 30, 2013 +$33.17 +$27.95 +Quarter ended +September 30, 2014 +$35.64 +$30.20 +Quarter ended +September 30, 2013 +$37.73 +$32.24 +Quarter ended +December 31, 2014 +$34.88 +$28.02 +Quarter ended +December 31, 2013 +$39.48 +$33.90 +Holders. As of February 26, 2015, there were 104 holders of record of our common stock. +Dividends . With the exception of a special cash dividend paid in November 2005 and in November 2006, we have not declared or paid any cash dividends in the past to the holders of our common stock. We intend to retain earnings, if any, for potential future dividends and to finance the development and expansion of our business. Future dividend policy will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions, and other factors. Therefore, we can give no assurance that any cash dividends of any kind will be paid to holders of our common stock in the future. +Equity Compensation Plans . Information regarding our equity compensation plans as of December 31, 2014 is disclosed in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” +Issuer Repurchases of Equity Securities. The Company's Board of Directors authorized a share repurchase program (the "Share Repurchase Program") effective as of January 1, 2004. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase. On June 18, 2013, the Board of Directors approved a continuation of the Share Repurchase Program for an additional $125 million in repurchases of the Company's common stock. On April 29, 2014 the Board of Directors approved the continuation of the Company's Share Repurchase Program for up to $150 million in repurchases of the Company's common stock. During fiscal year 2014 , an aggregate of 4,260,868 shares of the Company's common stock was repurchased, in the open market, under the Share Repurchase Program, at an average per share price of $33.38 , for an aggregate purchase price of approximately $142 million . At December 31, 2014 , an aggregate of approximately $50 million remained available for future repurchases of our common stock under the Share Repurchase Program. Subsequent to the year ended December 31, 2014, on February 20, 2015, the Board of Directors approved the extension of the Share Repurchase Program for an additional $150 million in repurchases of the Company's common stock. The program has no set expiration date. The following table presents the total number of shares of the Company's common stock, $.0001 par value, purchased by the Company in the three months ended December 31, 2014 , the average price paid per share and the approximate dollar value of the shares that still could have been purchased at the end of the fiscal period, pursuant to the Company's Share Repurchase Program. +17 +Period +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares Purchased as part of Publicly Announced Plans or Programs +Maximum Dollar Amount of Shares that May Yet Be Purchased Under the Plans or Programs +10/1/2014- 10/31/2014 +421,342 +$ +31.37 +421,342 +$ +77,021 +11/1/2014- 11/30/2014 +391,984 +$ +32.36 +391,984 +$ +64,334 +12/1/2014- 12/31/2014 +446,620 +$ +32.62 +446,620 +$ +49,764 +Total +1,259,946 +$ +32.13 +1,259,946 +$ +49,764 +(1) The Steven Madden, Ltd. 2006 Stock Incentive Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. Of the total number of shares purchased by the Company in the fourth quarter of 2014, 37,623 shares were withheld in connection with the settlement of vested restricted stock to satisfy tax withholding requirements. +Performance Graph . The following graph compares the yearly percentage change in the cumulative total stockholder return on our common stock during the period beginning on December 31, 2009, and ending on December 31, 2014, with the cumulative total return on the Russell 2000 Index and the S&P 500 Footwear Index. The comparison assumes that $100 was invested on December 31, 2009 in our common stock and in the foregoing indices and assumes the reinvestment of dividends. +18 +12/31/2009 +12/31/2010 +12/31/2011 +12/31/2012 +12/31/2013 +12/31/2014 +Steven Madden, Ltd. +$100.00 +$151.72 +$188.22 +$230.61 +$299.43 +$260.47 +Russell 2000 Index +$100.00 +$126.81 +$121.52 +$141.42 +$196.32 +$205.93 +S&P 500 Footwear Index +$100.00 +$131.22 +$150.22 +$163.23 +$252.19 +$312.10 +ITEM 6 SELECTED FINANCIAL DATA +The following selected financial data has been derived from our audited Consolidated Financial Statements. The Income Statement Data relating to 2014 , 2013 and 2012 , and the Balance Sheet data as of December 31, 2014 and 2013 should be read in conjunction with the information provided in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” and the notes to our Consolidated Financial Statements appearing elsewhere in this Annual Report on Form 10-K. +19 +INCOME STATEMENT DATA +Year Ended December 31, +(in thousands, except per share data) +2014 +2013 +2012 +2011 +2010 +Net sales +$ +1,334,951 +$ +1,314,223 +$ +1,227,072 +$ +968,549 +$ +635,418 +Cost of sales +865,951 +831,847 +771,370 +606,601 +359,564 +Gross profit +469,000 +482,376 +455,702 +361,948 +275,854 +Commissions and licensing fee income - net +13,723 +15,632 +15,395 +18,715 +22,629 +Operating expenses +(315,081 +) +(295,223 +) +(283,689 +) +(226,893 +) +(176,859 +) +Impairment charges and provision for litigation +— +983 +(8,432 +) +— +— +Income from operations +167,642 +203,768 +178,976 +153,770 +121,624 +Interest income +3,285 +4,228 +3,067 +4,885 +4,208 +Interest expense +(211 +) +(128 +) +(49 +) +(51 +) +(4 +) +Other income (expense) - net +677 +1,083 +2,193 +188 +29 +Income before provision for income taxes +171,393 +208,951 +184,187 +158,792 +125,857 +Provision for income taxes +58,764 +75,666 +64,623 +61,591 +50,132 +Net income +112,629 +133,285 +119,564 +97,201 +75,525 +Net (income) loss attributable to non-controlling interests +(749 +) +(1,278 +) +62 +118 +— +Net income attributable to Steven Madden, Ltd. +$ +111,880 +$ +132,007 +$ +119,626 +$ +97,319 +$ +75,725 +Basic income per share +$1.82 +$2.04 +$1.85 +$1.53 +$1.22 +Diluted income per share +$1.76 +$1.98 +$1.81 +$1.50 +$1.19 +Basic weighted average shares of common stock +61,451 +64,583 +64,529 +63,396 +62,216 +Effect of dilutive securities - options and restricted stock +2,225 +2,253 +1,726 +1,463 +1,450 +Diluted weighted average shares of common stock outstanding +63,676 +66,836 +66,255 +64,859 +63,665 +BALANCE SHEET DATA +At December 31 , +2014 +2013 +2012 +2011 +2010 +Total assets +$ +911,235 +$ +880,241 +$ +804,039 +$ +639,786 +$ +447,696 +Working capital +264,635 +342,142 +306,776 +211,649 +138,636 +Noncurrent liabilities +64,115 +46,898 +43,161 +29,940 +18,697 +Stockholders' equity +$ +669,529 +$ +678,840 +$ +626,400 +$ +474,758 +$ +357,298 +20 +ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion of our Financial Condition and Results of Operations should be read in conjunction with our audited Consolidated Financial Statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. +Overview: +($ in thousands, except retail sales data per square foot, earnings per share and per share data) +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell name brand and private label fashion handbags and accessories, through our Accessories Division. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers, catalog retailers and in our retail stores and our e-commerce websites throughout the United States, Canada, Mexico and South Africa and under special distribution arrangements in Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Our business is comprised of five distinct segments (Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing). Our Wholesale Footwear segment includes the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Report®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report Signature®, Superga® (under license), Betsey Johnson®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, Wild Pair®, Brian Atwood®, B Brian Atwood® and includes our International business and certain private label footwear business. Our Wholesale Accessories segment includes Big Buddha®, Betseyville®, Betsey Johnson®, Steve Madden®, Steven, Cejon® accessories brands and includes our International business and certain private label accessories business. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven, Superga and International retail stores, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden, Madden Girl and Steven by Steve Madden marks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery, women's fashion apparel, jewelry, watches and luggage. In addition, we license our Betsey Johnson® and Betseyville® marks for use in connection with the manufacture, marketing and sale of apparel, jewelry, swimwear, eyewear, watches, fragrances and outerwear. +Two key growth initiatives of the Company are adding strong brands to our portfolio and expanding our international business. During fiscal year 2014 , we furthered these initiatives through the completion of four strategic transactions. First, in March 2014, the Company purchased the intellectual property and related assets of Brian Atwood® from Brian Atwood IP Company LLC, for a purchase price of approximately $6,750 . The acquired intellectual property portfolio includes the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand. The acquisition provides the Company with brands that expand our business with luxury retailers and provides us with products that have higher retail price points. No B Brian Atwood branded products were sold or offered for sale by the Company during 2014. The Company plans to launch the first B Brian Atwood line in 2015. +Then, on August 13, 2014, the Company purchased all of the outstanding capital stock of Dolce Vita Holdings, Inc., a Washington corporation (“Dolce Vita”). The total purchase price for the acquisition was approximately $61,488 which includes a cash payment at closing of $56,872 plus potential earn-out payments based on achievement of certain earnings targets for each of the twelve month periods ending on September 30, 2015 and 2016 provided that the aggregate minimum earn-out payment for such two year earn-out period shall be no less than $5,000 . The Dolce Vita acquisition presented a significant opportunity to expand our business by combining an outstanding footwear brand and superior design with Steve Madden's proven business model and infrastructure. In 2014 we recorded sales of $28,948 for Dolce Vita products with a gross profit of $5,109. Among our strategic initiatives for 2015, we are implementing efforts aimed at improving the gross profit and operating profit of Dolce Vita in the future. +On December 30, 2014, the Company purchased all of the outstanding capital stock of Trendy Imports S.A. de C.V., Comercial Diecisiette S.A. de C.V., and Maximus Designer Shoes S.A. de C.V. (collectively, “SM Mexico”). SM Mexico was a division of Grupo Dicanco, which had been the exclusive distributor of the Company's products in Mexico since 2005. The total +21 +purchase price for the acquisition was approximately $ 25,172 , which is subject to a working capital adjustment. The total purchase price includes a cash payment at closing of $ 15,336 , plus potential earn-out payments based on the achievement of certain earnings targets for each of the twelve month periods ending December 31, 2015 and 2016. The acquisition was a significant milestone in our strategic initiative to grow our International business. The transaction closed on December 30, 2014 and, accordingly, had no impact on the Company's results of operations for 2014. +Finally, in 2014,we expanded our partnership with House of Busby "Busby" in South Africa. Busby has been our distributor in South Africa and has established the Steve Madden brand in the territory with four Steve Madden retail stores in South Africa and 20 Steve Madden shop-in-shops in the leading South African retailer Edgars. In September 2014 we formed an entity with Busby in which the existing business was contributed. The Company has a 50.1% ownership in the newly formed entity. This new arrangement did not have a material impact on our 2014 operations. +Key Performance Indicators and Statistics +The following measurements are among the key business indicators reviewed by various members of management to measure consolidated and segment results of the Company: +• +net sales +• +gross profit margin +• +operating expenses +• +income from operations +• +adjusted EBITDA +• +adjusted EBIT +• +same store sales +• +inventory turnover +• +accounts receivable average collection days +• +cash flow and liquidity determined by the Company’s working capital and free cash flow +• +store metrics such as sales per square foot, average unit retail, conversion, average units per transaction, and contribution margin. +While not all of these metrics are disclosed due to the proprietary nature of the information, many of these metrics are disclosed and discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Non-GAAP Measures +The Company’s reported results are presented in accordance with GAAP. The Company uses adjusted earnings before interest and taxes ("Adjusted EBIT") and adjusted earnings before interest, taxes, depreciation and amortization ("Adjusted EBITDA"), as calculated in the table below, as non-GAAP measures, in internal management reporting and planning processes as well as in evaluating the performance of the Company. Management believes these measures are useful to investors in evaluating the Company’s ongoing operating and financial results. By providing these non-GAAP measures, as a supplement to GAAP information, we believe we are enhancing investors’ understanding of our business and our results of operations. The non-GAAP financial measures are limited in their usefulness and should be considered in addition to, and not in lieu of, U.S. GAAP financial measures. Further, these non-GAAP measures may be unique to the Company, as they may be different from non-GAAP measures used by other companies. +The table below reconciles these metrics to net income as presented in the consolidated statement of income. +22 +Years Ended December 31 ($ in thousands) +2014 +2013 +2012 +Net Income +$ +112,629 +$ +133,285 +$ +119,564 +Add back: +Provision for income taxes +58,764 +75,666 +64,623 +Deduct: +Other Income (expense) - net +677 +1,083 +2,193 +Interest, net +3,074 +4,100 +3,018 +Adjusted EBIT +167,642 +203,768 +178,976 +Add back: +Depreciation and amortization +14,519 +12,317 +11,655 +Loss on disposal of fixed assets +291 +905 +250 +Adjusted EBITDA +182,452 +216,990 +190,881 +Executive Summary +Net sales for 2014 increased 2% to $1,334,951 from $1,314,223 in 2013. Net sales growth was driven by our acquisition of Dolce Vita which had net sales of $28,948. Excluding Dolce Vita net sales decreased by 1% primarily as a result of lack of fashion trends on which to capitalize. Net income decreased 15% to $111,880 in 2014 compared to $132,007 in 2013. The Company's effective tax rate for 2014 decreased to 34.3% compared to 36.2% recorded in 2013 due primarily to reinvestment of foreign earnings in foreign locations and due to a discrete benefit related to prior years state taxes. Diluted earnings per share in 2014 decreased to $1.76 per share on 63,676,000 diluted weighted average shares outstanding compared to $1.98 per share on 66,836,000 diluted weighted average shares outstanding in the prior year. +In our Retail segment, same store sales (sales of those stores, including the e-commerce websites, that were in operation throughout 2014 and 2013 ) decreased 8.1% , and sales per square foot decreased to $676 in 2014 compared to sales per square foot of $823 in 2013 . As of December 31, 2014 , we had 160 stores in operation, compared to 121 stores as of December 31, 2013 . Our store increase was primarily related to the addition of 21 stores from our acquisition of SM Mexico as well as an increase of 15 outlet store locations. +Our total inventory turnover was 10.4 times compared to 10.3 times in the comparable period of last year. Our accounts receivable average collection days were 68 days in 2014 compared to 66 days in 2013 . As of December 31, 2014 , we had $203,094 in cash, cash equivalents and marketable securities, no short or long-term debt and total stockholders’ equity of $669,529 . Working capital decreased to $264,635 as of December 31, 2014 , compared to $342,142 on December 31, 2013 . +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on California ports. In 2014, port workers' union disputes causing work slow downs and stoppages have adversely impacted ocean freight transportation and caused severe delays in the flow of shipments through ports in California. As a result, in the fourth quarter of 2014, the Company experienced transportation delays of products to customers. To mitigate the risk of losing customer orders, the Company incurred incremental costs to deliver products to customers via air freight. The California port workers' union disputes have continued into 2015 though current reports indicate that a tentative contract was reached between the port workers and their employers on February 20, 2015. While the slow downs and stoppages have adversely impacted the fourth quarter of 2014 and will likely adversely impact the first quarter of 2015, assuming the definitive resolution of the disputes and the commencement of normal port operations, the adverse impact of the union dispute on the Company should gradually be reduced for the remainder of 2015. +23 +The following tables set forth information on operations for the periods indicated: +Years Ended December 31 +($ in thousands) +2014 +2013 +2012 +CONSOLIDATED: +Net sales +$ +1,334,951 +100.0 +% +$ +1,314,223 +100.0 +% +$ +1,227,072 +100.0 +% +Cost of sales +865,951 +64.9 +% +831,847 +63.3 +% +771,370 +62.9 +% +Gross profit +469,000 +35.1 +% +482,376 +36.7 +% +455,702 +37.1 +% +Other operating income – net of expenses +13,723 +1.0 +% +15,632 +1.2 +% +15,395 +1.3 +% +Operating expenses +315,081 +23.6 +% +295,223 +22.5 +% +283,689 +23.1 +% +Impairment charges and provision for litigation +— +— +% +983 +0.1 +% +8,432 +0.7 +% +Income from operations +167,642 +12.6 +% +203,768 +15.5 +% +178,976 +14.6 +% +Interest and other income – net +3,751 +0.3 +% +5,183 +0.4 +% +5,211 +0.4 +% +Income before income taxes +171,393 +12.8 +% +208,951 +15.9 +% +184,187 +15.0 +% +Net income attributable to Steven Madden, Ltd. +111,880 +8.4 +% +132,007 +10.0 +% +119,626 +9.7 +% +By Segment: +WHOLESALE FOOTWEAR SEGMENT: +Net sales +$ +882,355 +100.0 +% +$ +860,448 +100.0 +% +$ +794,486 +100.0 +% +Cost of sales +621,854 +70.5 +% +596,584 +69.3 +% +544,939 +68.6 +% +Gross profit +260,501 +29.5 +% +263,864 +30.7 +% +249,547 +31.4 +% +Operating expenses +154,211 +17.5 +% +146,175 +17.0 +% +145,221 +18.3 +% +Income from operations - before impairment charges and provision for litigation +106,290 +12.0 +% +117,689 +13.7 +% +104,326 +13.1 +% +WHOLESALE ACCESSORIES SEGMENT: +Net sales +$ +246,608 +100.0 +% +$ +244,163 +100.0 +% +$ +241,339 +100.0 +% +Cost of sales +161,968 +65.7 +% +154,856 +63.4 +% +154,284 +63.9 +% +Gross profit +84,640 +34.3 +% +89,307 +36.6 +% +87,055 +36.1 +% +Operating expenses +45,867 +18.6 +% +44,569 +18.3 +% +45,679 +18.9 +% +Income from operations - before impairment charges and provision for litigation +38,773 +15.7 +% +44,738 +18.3 +% +41,376 +17.1 +% +RETAIL SEGMENT: +Net sales +$ +205,988 +100.0 +% +$ +209,612 +100.0 +% +$ +191,247 +100.0 +% +Cost of sales +82,129 +39.9 +% +80,407 +38.4 +% +72,147 +37.7 +% +Gross profit +123,859 +60.1 +% +129,205 +61.6 +% +119,100 +62.3 +% +Operating expenses +115,003 +55.8 +% +104,479 +49.8 +% +92,789 +48.5 +% +Income from operations - before impairment charges and provision for litigation +8,856 +4.3 +% +24,726 +11.8 +% +26,311 +13.8 +% +Number of stores +160 +121 +109 +24 +FIRST COST SEGMENT: +Other commission income – net of expenses +$ +6,438 +100.0 +% +$ +7,988 +100.0 +% +$ +7,778 +100.0 +% +LICENSING SEGMENT: +Licensing income – net of expenses +$ +7,285 +100.0 +% +$ +7,644 +100.0 +% +$ +7,617 +100.0 +% +RESULTS OF OPERATIONS +($ in thousands) +Year Ended December 31, 2014 vs. Year Ended December 31, 2013 +Consolidated : +Total net sales for the year ended December 31, 2014 increased by 2% to $1,334,951 from $1,314,223 for fiscal year 2013 . For the year ended December 31, 2014 , gross margin as a percentage of net sales was 35.1% compared to 36.7% in the prior year. Operating expenses increased in 2014 to $315,081 from $295,223 in 2013 . As a percentage of sales, operating expenses increased to 23.6% in the year ended December 31, 2014 compared to 22.5% in the previous year. Commission and licensing fee income decreased to $13,723 in 2014 compared to $15,632 in 2013 . During the year ended December 31, 2014 , income from operations decreased to $167,642 and net income attributable to Steven Madden, Ltd. decreased to $111,880 compared to income from operations of $203,768 and net income attributable to Steven Madden, Ltd. of $132,007 in 2013 . +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment was $882,355 , or 66% , and $860,448 , or 65% , of our total net sales for the years ended December 31, 2014 and 2013 , respectively. This represents a $21,907 , or 2.5% increase year over year. Excluding sales attributable to acquisitions in each year, organic net sales decreased 0.8%. Organic wholesale branded net sales were flat compared to the year ended 2013 with double digit growth in Steve Madden Men's, Report, Steve Madden Kids and FREEBIRD by Steven products were offset by decreases in sales of Steve Madden Women's products and Olsenboye (licensed brand) products. The decrease in Steve Madden Women's was driven by a lack of fashion footwear trends while Olsenboye decreased as a result of discontinuation of sales under the Olsenboye brand in 2014. Organic wholesale private label business was down 2.2%. +Gross profit margin decreased to 29.5% in 2014 from 30.7% in the prior year, primarily due to the impact of increased product markdown allowances and the Dolce Vita acquisition. Excluding the impact of acquisitions gross profit margin was 29.9% in 2014 . In the year ended December 31, 2014 , operating expenses were $154,211 compared to $146,175 in the same period of 2013 . As a percentage of sales, operating expenses increased to 17.5% in 2014 from 17.0% in 2013 , due to the acquisition of Dolce Vita and deleverage from the organic sales decrease. Excluding the impact of acquisitions, operating expenses as a percentage of sales was 17.2% in 2014 . Income from operations for the Wholesale Footwear segment decreased to $106,290 for the year ended December 31, 2014 compared to $117,689 for the year ended December 31, 2013 . Excluding acquisitions, income from operations for the Wholesale Footwear segment was $108,578 in 2014. +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $246,608 , or 18% , and $244,163 , or 19% , of total Company net sales for the years ended December 31, 2014 and 2013 , respectively. This represents a $2,445 , or 1% increase year over year with double digit increases in private label and Betsey Johnson handbags almost fully offset by decreases in Steve Madden and Big Buddha handbags, cold weather accessories and belts. +Gross profit margin in the Wholesale Accessories segment decreased to 34.3% in 2014 from 36.6% in the prior year primarily due to increased sales in lower margin private label handbags and margin decreases in Steve Madden handbags and cold weather accessories due to increased markdown allowances and higher product returns. In the year ended December 31, 2014 , operating expenses increased to $45,867 compared to $44,569 in the year ended December 31, 2013 . As a percentage of sales, operating expenses increased to 18.6% in 2014 from 18.3% in 2013 . Income from operations for the Wholesale Accessories segment decreased 13% to $38,773 in 2014 compared to $44,738 in 2013 . +25 +Retail Segment : +Net sales generated by the Retail segment accounted for $205,988 , or 15% , and $209,612 , or 16% , of total Company net sales for the years ended December 31, 2014 and 2013 , respectively, which represents a $3,624 or 2% decrease, year over year. This decrease reflects a decline in comparable store sales of 8.1% driven by a lack of fashion footwear trends partially offset by the addition of retail stores since the fourth quarter of 2013 . During 2014 we added three full price stores and 15 outlets and closed five full price locations. We also acquired the Dolce Vita online store, 21 stores from our Mexico acquisition and four stores from our new joint venture in South Africa. As a result, we had 160 retail stores as of December 31, 2014 , compared to 121 stores as of December 31, 2013 . The 160 stores currently in operation include 122 Steve Madden full price stores, 32 Steve Madden outlet stores, one Steven store, one Superga store and four e-commerce websites. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2014 and 2013 ) for the year ended December 31, 2014 decreased 8.1% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2014 , gross margin decreased to 60.1% from 61.6% in 2013 primarily due to increased promotional activity. In 2014 , operating expenses increased to $115,003 from $104,479 in 2013 primarily due to the incremental cost associated with new store openings. As a percentage of sales, operating expenses increased to 55.8% in 2014 from 49.8% in the prior year due to deleverage from negative comparable store sales. For the year ended December 31, 2014 , income from operations for the Retail segment decreased to $8,856 compared to $24,726 in the prior year. +First Cost Segment : +The First Cost segment generated income from operations of $6,438 for the year ended December 31, 2014 , compared to $7,988 in 2013 . The decrease relates to a decline in sales with certain private label customers. +Licensing Segment: +During the year ended December 31, 2014 , licensing income of $7,285 was down slightly compared to the prior year income of $7,644 . +Year Ended December 31, 2013 vs. Year Ended December 31, 2012 +Consolidated : +Total net sales for the year ended December 31, 2013 increased by 7% to $1,314,223 from $1,227,072 for fiscal year 2012 . For the year ended December 31, 2013 , gross margin as a percentage of net sales was 36.7% compared to 37.1% in the prior year. Operating expenses increased in 2013 to $295,223 from $283,689 in 2012 . As a percentage of sales, operating expenses decreased to 22.5% in the year ended December 31, 2013 compared to 23.1% in the previous year. Commission and licensing fee income slightly increased to $15,632 in 2013 compared to $15,395 in 2012 . During the year ended December 31, 2013 , income from operations increased to $203,768 and net income attributable to Steven Madden, Ltd. increased to $132,007 compared to income from operations of $178,976 and net income of $119,626 in 2012 . +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment was $860,448 , or 65% , and $794,486 , or 65% , of our total net sales for the years ended December 31, 2013 and 2012 , respectively. This represents a $65,962 , or 8.3% increase year over year. Excluding sales attributable to SM Canada business in each year, organic net sales growth was 7.8% . Organic net sales growth was driven by a $50,087 or 17.9% increase in net sales in our wholesale private label business, as well as a $8,595 or 15.3% net sales increase in our International business. In addition, our Steve Madden Women's, Madden Girl, Steve Madden Kids, Steve Madden Men's brands realized increased sales revenue in 2013 . Finally, our new FREEBIRD by Steven brand, which began shipping in the fourth quarter of 2012 contributed to the net sales increase. These increases were partially offset by a decline in our Topline business reflecting the loss of two private label customers that are competitors of Steve Madden and elected not to go forward with the Company following the Topline acquisition. +Gross profit margin decreased to 30.7% in 2013 from 31.4% in the prior year, primarily due to sales increase in the lower-margin private label and international businesses. In the year ended December 31, 2013 , operating expenses was $146,175 compared to $145,221 in the same period of 2012 . As a percentage of sales, operating expenses improved to 17.0% in 2013 from +26 +18.3% in 2012 , reflecting cost control and operating expense leverage from increased sales. Income from operations for the Wholesale Footwear Segment increased to $117,689 for the year ended December 31, 2013 compared to $104,326 for the year ended December 31, 2012 . +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $244,163 or 19% , and $241,339 or 20% of total Company net sales for the years ended December 31, 2013 and 2012 , respectively. This represents a $2,824 , or 1% increase year over year primarily driven by double digit sales growth in Steve Madden® and Betsey Johnson® handbags, partially offset by declines in belts and cold weather accessories. +Gross profit margin in the Wholesale Accessories segment increased to 36.6% in 2013 from 36.1% in the prior year primarily due to improvements in sales of cold weather accessories as well as significant sales growth of our Steve Madden® and Betsey Johnson® handbag businesses, which achieve higher gross margins. In the year ended December 31, 2013 , operating expenses decreased to $44,569 compared to $45,679 in the year ended December 31, 2012 , primarily reflecting lower payroll related costs in addition to cost control. As a percentage of sales, operating expenses improved to 18.3% in 2013 from 18.9% in 2012 . Income from operations for the Wholesale Accessories segment increased 8% to $44,738 in 2013 compared to $41,376 in 2012 . +Retail Segment : +Net sales generated by the Retail segment accounted for $209,612 , or 16% , and $191,247 , or 16% , of total Company net sales for the years ended December 31, 2013 and 2012 , respectively, which represents a $18,365 or 10% increase, year over year. This increase is primarily due to the addition of retail stores since the fourth quarter of 2012 , partially offset by a decline of 2.1% in comparable store sales. We opened 12 new stores, closed our one Report store, and established a FREEBIRD by Steven e-commerce store during the year ended December 31, 2013 . As a result, we had 121 retail stores as of December 31, 2013 , compared to 109 stores as of December 31, 2012 . The 121 stores currently in operation include 97 Steve Madden full price stores, 17 Steve Madden outlet stores, two Steven stores, one Superga store and four e-commerce websites. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2013 and 2012 ) for the year ended December 31, 2013 decreased 2.1% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2013 , gross margin decreased to 61.6% from 62.3% in 2012 . Excluding the impact of the acquisition of SM Canada, gross profit margin decreased to 60.4% from 61.6% . In 2013 , operating expenses increased to $104,479 from $92,789 in 2012 primarily due to the incremental cost associated with the net year-over-year increase of our 11 net new retail stores and one e-commerce site. As a percentage of sales, operating expenses increased to 49.8% in 2013 from 48.5% in the prior year. For the year ended December 31, 2013 , income from operations for the Retail segment decreased to $24,726 compared to $26,311 in the prior year. +First Cost Segment : +The First Cost segment generated income from operations of $7,988 for the year ended December 31, 2013 , compared to $7,778 in 2012 . +Licensing Segment: +During the year ended December 31, 2013 , licensing income of $7,644 was flat compared to the prior year income of $7,617 . +LIQUIDITY AND CAPITAL RESOURCES +($ in thousands) +Our primary source of liquidity is cash flows generated from our operations. Our primarily use of this liquidity is to fund our ongoing cash requirements, including working capital requirements, share repurchases, acquisitions, system enhancements and retail store expansion and remodeling. +27 +Cash, cash equivalents and short-term investments totaled $112,648 and $200,866 at December 31, 2014 and December 31, 2013, respectively. Of the total cash, cash equivalents and short-term investments at December 31, 2014, $57,256 , or approximately 51% , was held in our foreign subsidiaries and of the total cash, cash equivalents and short-term investments at December 31, 2013, $124,671 , or approximately 62% , was held in our foreign subsidiaries. To date, deferred taxes have been estimated and accrued for all of our foreign subsidiary earnings that have not been determined to be indefinitely reinvested. As of December 31, 2014 and 2013, the cumulative total amount of earnings considered to be indefinitely reinvested of our foreign subsidiaries was $64,147 and $42,750 , respectively. If such amounts were not indefinitely reinvested, the Company would incur approximately $11,867 in taxes that were not previously provided for in our consolidated statements of income. Management believes that our existing domestic and international cash, cash equivalents, short-term investments and cash flows from operations, which are not considered to be indefinitely reinvested, continue to be sufficient to fund our domestic operating activities. Therefore, we do not intend, nor do we foresee a need, to repatriate foreign earnings of $64,147 as of December 31, 2014, that were considered to be indefinitely reinvested and we do not believe there are any material implications or restrictions on our liquidity as a result of having a significant portion of our cash, cash equivalents and short-term investments held by our foreign subsidiaries. +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”). The agreement provides us with a credit facility in the amount of $30,000 , having a sub-limit of $15,000 on the aggregate face amount of letters of credit, at an interest rate based, at our election, upon either the prime rate or LIBOR. The agreement can be terminated by the Company or Rosenthal at any time with 60 days’ prior written notice. As of December 31, 2014 we had no borrowings against this credit facility. +As of December 31, 2014 , we had working capital of $264,635 . We had cash and cash equivalents of $81,450 , investments in marketable securities short and long term of $121,644 and we did not have any long-term debt. +We believe that based upon our current financial position and available cash, cash equivalents and marketable securities, we will meet all of our financial commitments and operating needs for at least the next 12 months. +OPERATING ACTIVITIES +($ in thousands) +Cash provided by operations was $151,975 in 2014 compared to cash provided by operations of $ 155,453 in the prior year. The primary sources of cash were net income of $112,629 , and increase in accounts payable and accrued expenses of $3,777 and an increase in factor accounts receivable of $3,734 . The primary uses of cash were a decrease of accrued incentive of $1,910 and an increase of inventories of $1,841 . +INVESTING ACTIVITIES +($ in thousands) +During the year ended December 31, 2014 , we invested $137,348 in marketable securities and received $128,663 from the maturities and sales of securities. Cash used for acquisitions was $81,885 related to the acquisitions of Brian Atwood, Dolce Vita and SM Mexico and the formation of our joint venture in South Africa. We also made capital expenditures of $18,341 , principally for systems enhancements and leasehold improvements to office space, 12 new stores and one e-commerce website opened in 2014 and improvements to existing stores. +FINANCING ACTIVITIES +($ in thousands) +During the year ended December 31, 2014 , net cash used by financing activities was $141,889 , which consisted of share repurchases of $142,228 and payment of contingent liabilities related to acquisitions completed in prior years of $8,475 , partially offset by proceeds from the exercise of stock options of $4,943 , the tax benefit from the exercise of options of $2,978 and repayment of the note receivable of $893 . +28 +CONTRACTUAL OBLIGATIONS +($ in thousands) +Our contractual obligations as of December 31, 2014 were as follows: +Payment due by period +Contractual Obligations +Total +2015 +2016 - 2017 +2018 - 2019 +2020 and after +Operating lease obligations +$ +257,773 +$ +36,797 +$ +83,339 +$ +58,742 +$ +78,895 +Purchase obligations +167,480 +167,480 +— +— +— +Contingent payment liability +38,633 +11,455 +27,178 +— +— +Other long-term liabilities (future minimum royalty payments) +7,675 +675 +2,000 +2,000 +3,000 +Total +$ +471,561 +$ +216,407 +$ +112,517 +$ +60,742 +$ +81,895 +At December 31, 2014 , we had un-negotiated open letters of credit for the purchase of inventory of approximately $ 814 . +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s then existing employment agreement with the Company. The amended agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides for a base salary of approximately $7,417 in 2013, approximately $9,667 in 2014, approximately $11,917 in 2015 and approximately $10,698 per annum for the period between January 1, 2016 through the expiration of the term of employment. The employment agreement provided Mr. Madden with the right, exercisable on certain specified dates in fiscal year 2012 only, to elect to receive a grant of restricted stock for a number of shares of the Company’s common stock valued at $40,000 in consideration for a reduction in his annual base salary in years subsequent to 2012 as follows: $4,000 in 2013, approximately $6,125 in 2014, approximately $8,250 in 2015 and approximately $7,026 per annum for the period between January 1, 2016 through the expiration of the employment agreement on December 31, 2023. On June 30, 2012, Mr. Madden exercised this right and on July 3, 2012 he was granted 1,893,342 restricted shares of the Company's common stock at the then market price of $21.13, which will vest in the same manner as the February 8, 2012 restricted stock grant received by Mr. Madden pursuant to the amended agreement. (See Note O to the Consolidated Financial Statements.) Accordingly, Mr. Madden's annual base salary was reduced as described above. In addition to the opportunity for cash bonuses at the sole discretion of the Board of Directors, Mr. Madden’s employment agreement entitles him to an annual life insurance premium payment as well as an annual stock option grant and the potential for an additional one-time stock option grant based on achievement of certain financial performance criteria. The employment agreement also provides for the elimination of interest accrued after December 31, 2011 on an outstanding loan in the original principal amount of $3,000 made by the Company to Mr. Madden, the extension of the maturity date of such loan until December 31, 2023, and the forgiveness of 1/10 th of the principal amount of the loan, together with accrued interest, annually over a ten-year period commencing on December 31, 2014 for so long as Mr. Madden continues to be employed by the Company on each such December 31. As a result of the elimination of further interest accumulation, the outstanding principal and the accrued interest as of December 31, 2011 has been discounted to reflect imputed interest, which will be amortized over the remaining life of the loan. +The Company has employment agreements with certain executive officers, which provide for the payment of compensation aggregating approximately $2,352 in 2015, $1,744 in 2016, and $582 in 2017. In addition, some of these employment agreements provide for discretionary bonuses and some provide for incentive compensation based on various performance criteria as well as other benefits including stock related compensation. +Virtually all of our products are produced by independent manufacturers at overseas locations, the majority of which are located in China, with a small and growing percentage located in Mexico in addition to smaller amounts in Brazil, Italy and India. We have not entered into any long-term manufacturing or supply contracts with any of these foreign manufacturers. We believe that a sufficient number of alternative sources exist outside of the United States for the manufacture of our products. We currently make approximately 93% of our purchases in U.S. dollars. +INFLATION +We do not believe that inflation and price changes have had a significant effect on the Company's sales or profitability for the fiscal year ended December 31, 2014 and the prior two fiscal years. Historically, we have minimized the impact of product cost increases by increasing prices, changing suppliers and by improving operating efficiencies. However, no assurance can be given that we will be able to offset such inflationary cost increases in the future. +29 +OFF BALANCE SHEET ARRANGEMENTS +The Company has no off balance sheet arrangements. +CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our Consolidated Financial Statements included in this Annual Report on Form 10-K, which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Estimates by their nature are based on judgments and available information. Our estimates are made based upon historical factors, current circumstances and the experience and judgment of management. Assumptions and estimates are evaluated on an ongoing basis and we may employ outside experts to assist in evaluations. Therefore, actual results could materially differ from those estimates under different assumptions and conditions. Management believes the following critical accounting estimates are more significantly affected by judgments and estimates used in the preparation of our Consolidated Financial Statements: allowance for bad debts, returns, and customer chargebacks; inventory valuation; valuation of intangible assets, litigation reserves, and contingent payment liabilities. +Allowances for bad debts, returns and customer chargebacks . We provide reserves against our trade accounts receivables for future customer chargebacks, co-op advertising allowances, discounts, returns and other miscellaneous deductions that relate to the current period. The reserve against our non-factored trade receivables also includes estimated losses that may result from customers’ inability to pay. The amount of the reserve for bad debts, returns, discounts and compliance chargebacks are determined by analyzing aged receivables, current economic conditions, the prevailing retail environment and historical dilution levels for customers. We evaluate anticipated customer markdowns and advertising chargebacks by reviewing several performance indicators for our major customers. These performance indicators (which include inventory levels at the retail floors, sell through rates and gross margin levels) are analyzed by management to estimate the amount of the anticipated customer allowance. Failure to correctly estimate the amount of the reserve could materially impact our results of operations and financial position. +Inventory valuation . Inventories are stated at lower-of-cost or market, on a first-in, first-out basis. We review inventory on a regular basis for excess and slow moving inventory. The review is based on an analysis of inventory on hand, prior sales, and expected net realizable value through future sales. The analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales and projections for sales in the foreseeable future as well as subsequent sales. We consider quantities on hand in excess of estimated future sales to be at risk for market impairment. The net realizable value, or market value, is determined based on the estimate of sales prices of such inventory through off-price or discount store channels. The likelihood of any material inventory write-down is dependent primarily on the expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product, the economy, or other failure to estimate correctly, in addition to abnormal weather patterns, could result in inventory valuation changes, compared to the valuation determined to be appropriate as of the balance sheet date. +Valuation of intangible assets and goodwill . Accounting Standards Codification (“ASC”) Topic 350, “Intangible – Goodwill and Other”, requires that goodwill and intangible assets with indefinite lives no longer be amortized, but rather be tested for impairment at least annually. This pronouncement also requires that intangible assets with finite lives be amortized over their respective lives to their estimated residual values, and reviewed for impairment in accordance with ASC Topic 360, “Property, Plant and Equipment” (“ASC Topic 360”). +Indefinite-lived intangible assets and goodwill are assessed for impairment using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment requires an analysis of several estimates including future cash flows or income consistent with management’s strategic business plans, annual sales growth rates and the selection of assumptions underlying a discount rate (weighted average cost of capital) based on market data available at the time. +In accordance with ASC Topic 360, long-lived assets, such as property, equipment, leasehold improvements and intangible assets subject to amortization, are reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the +30 +carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. +Litigation reserves . Estimated amounts for litigation claims that are probable and can be reasonably estimated are recorded as liabilities in our Consolidated Financial Statements. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable events of a particular litigation. As additional information becomes available, management will assess the potential liability related to the pending litigation and revise its estimates. Such revisions in management’s estimates of a contingent liability could materially impact our results of operation and financial position. +Contingent payment liabilities. The Company has completed various acquisitions that require us to make contingent payments to the sellers based on the future financial performance of the acquired businesses over a period of from one to three years. The fair value of the contingent payments was estimated using the present value of management's projections of the financial results of the acquired business. Failure to correctly project the financial results of the acquired businesses could materially impact our results of operations and financial position. +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +($ in thousands) +We do not engage in the trading of market risk sensitive instruments in the normal course of business. Our financing arrangements are subject to variable interest rates primarily based on the prime rate and LIBOR. An analysis of our collection agency agreement with Rosenthal can be found in the “Liquidity and Capital Resources” section under Part II, Item 7, and in Note C to the Consolidated Financial Statements included in this Annual Report on Form 10-K under the caption “Factor Receivable.” +As of December 31, 2014 , we held marketable securities valued at approximately $121,644 , which consisted primarily of corporate bonds and certificates of deposit. These securities are subject to interest rate risk and will decrease in value if interest rates increase. We currently have the ability to hold these securities until maturity. +ITEM 8 +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The information required by this Item is incorporated herein by reference to the Consolidated Financial Statements listed in response to Item 15 of Part IV of this Annual Report on Form 10-K. +ITEM 9 +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions +31 +and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We have excluded Dolce Vita and SM Mexico, which were acquired on August 13, 2014 and December 30, 2014, respectively, from the scope of our annual report on internal control over financial reporting as of December 31, 2014. Dolce Vita represented approximately 7% of our total assets at December 31, 2014, and approximately 2% of our net revenues for the year ended December 31, 2014. SM Mexico represented approximately 2% of our total assets at December 31, 2014, and approximately 0% of our net revenues for the year ended December 31, 2014. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2014 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2014 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2014 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2014 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B OTHER INFORMATION +On February 24, 2015, the Company issued a press release reporting its financial results for the fiscal quarter and fiscal year ended December 31, 2014, a copy of which is attached as Exhibit 99.01 to this Annual Report. +PART III +ITEM 10 +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2015 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 11 +EXECUTIVE COMPENSATION +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2015 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 12 +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2015 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 13 +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2015 Annual Meeting of Stockholders, and is incorporated herein by reference. +32 +ITEM 14 +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2015 Annual Meeting of Stockholders, and is incorporated herein by reference. +PART IV +ITEM 15 +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) Financial Statements and Financial Statements Schedules +See Index to Consolidated Financial Statements included herein. +(b) Exhibits. See the exhibit index included herein. +33 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. +DATE: February 26, 2015 +STEVEN MADDEN, LTD. +/s/ EDWARD R. ROSENFELD +Edward R. Rosenfeld +Chairman and Chief Executive Officer +/s/ ARVIND DHARIA +Arvind Dharia +Chief Financial Officer and Chief Accounting Officer +34 +POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each of the undersigned constitutes and appoints Edward R. Rosenfeld and Arvind Dharia, and each of them, as attorneys-in-fact and agents, with full power of substitution and re-substitution, for and in the name, place and stead of the undersigned, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all that each of said attorney-in-fact or substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. +Signature +Title +Date +/S/ EDWARD R. ROSENFELD +Chairman, Chief Executive Officer and Director +February 26, 2015 +Edward R. Rosenfeld +/S/ ARVIND DHARIA +Chief Financial Officer and Chief Accounting Officer +February 26, 2015 +Arvind Dharia +/S/ JOHN L. MADDEN +Director +February 26, 2015 +John L. Madden +/S/ PETER MIGLIORINI +Director +February 26, 2015 +Peter Migliorini +/S/ RICHARD P. RANDALL +Director +February 26, 2015 +Richard P. Randall +/S/ RAVI SACHDEV +Director +February 26, 2015 +Ravi Sachdev +/S/ THOMAS H. SCHWARTZ +Director +February 26, 2015 +Thomas H. Schwartz +/S/ ROSE LYNCH +Director +February 26, 2015 +Rose Lynch +/S/ ROBERT SMITH +Director +February 26, 2015 +Robert Smith +35 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Balance Sheets as of December 31, 2014 and 2013 +F-3 +Consolidated Statements of Income for the years ended December 31, 2014, 2013 and 2012 +F-4 +Consolidated Statements of Comprehensive Income for the years ended December 31, 2014, 2013 and 2012 +F-5 +Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2014, 2013 and 2012 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and 2012 +F-8 +Notes to Consolidated Financial Statements +F-9 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders +Steven Madden, Ltd. and subsidiaries +We have audited the accompanying consolidated balance sheets of Steven Madden, Ltd. and subsidiaries (the "Company") as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2014. We also have audited the Company's internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting appearing under Item 9A of the Company's December 31, 2014 annual report on Form 10-K. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Steven Madden, Ltd. and subsidiaries as of December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company has maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO. +F-1 +The scope of management’s assessment of the effectiveness of internal control over financial reporting excluded the internal control over financial reporting of Dolce Vita Holdings, Inc. (“Dolce Vita”) and Trendy Imports S.A. de C.V., Comercial Diecisiette S.A. de C.V., and Maximus Designer Shoes S.A. de C.V. (together, “SM Mexico”), which were acquired by the Company in August 2014 and December 2014, respectively. Dolce Vita represented approximately 7% of the Company’s consolidated assets and approximately 2% of the Company’s consolidated net revenues as of and for the year ended December 31, 2014. SM Mexico represented approximately 2% of the Company’s consolidated assets and approximately 0% of the Company’s net revenues as of and for the year ended December 31, 2014. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Dolce Vita and SM Mexico. +/s/ EisnerAmper LLP +New York, New York +February 26, 2015 +F-2 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Balance Sheets +(in thousands) +December 31, +2014 +2013 +ASSETS +Current assets: +Cash and cash equivalents +$ +81,450 +$ +180,275 +Accounts receivable, net of allowances of $2,680 and $2,594 +54,778 +41,873 +Factor accounts receivable, net of allowances of $20,883 and $17,818 +139,816 +143,550 +Inventories +92,677 +73,696 +Marketable securities – available for sale +31,198 +20,591 +Prepaid expenses and other current assets +17,131 +17,194 +Prepaid taxes +11,051 +7,199 +Deferred taxes +14,125 +12,267 +Total current assets +442,226 +496,645 +Notes receivable +1,878 +3,171 +Note receivable – related party +3,328 +3,581 +Property and equipment, net +68,905 +56,606 +Deposits and other +10,036 +3,276 +Marketable securities – available for sale +90,446 +91,267 +Goodwill – net +154,759 +96,132 +Intangibles – net +139,657 +129,563 +Total Assets +$ +911,235 +$ +880,241 +LIABILITIES +Current liabilities: +Accounts payable +$ +92,635 +$ +99,126 +Accrued expenses +67,828 +37,099 +Contingent payment liability – current portion +11,455 +10,695 +Accrued incentive compensation +5,673 +7,583 +Total current liabilities +177,591 +154,503 +Contingent payment liability +27,178 +24,100 +Deferred rent +11,573 +9,435 +Deferred taxes +24,706 +13,224 +Other liabilities +658 +139 +Total Liabilities +241,706 +201,401 +Commitments, contingencies and other +STOCKHOLDERS’ EQUITY +Preferred stock – $.0001 par value, 5,000 shares authorized; none issued; Series A Junior Participating preferred stock – $.0001 par value, 60 shares authorized; none issued +— +— +Common stock – $.0001 par value, 135,000 shares authorized, 83,491 and 82,941 shares issued, 63,625 and 67,336 shares outstanding +6 +7 +Additional paid-in capital +275,039 +247,858 +Retained earnings +783,904 +672,044 +Accumulated other comprehensive loss +(12,752 +) +(6,677 +) +Treasury stock – 19,866 and 15,605 shares at cost +(376,942 +) +(234,715 +) +Total Steven Madden, Ltd. stockholders’ equity +669,255 +678,517 +Non-controlling interests +274 +323 +Total stockholders’ equity +669,529 +678,840 +Total Liabilities and Stockholders’ Equity +$ +911,235 +$ +880,241 +See accompanying notes to consolidated financial statements +F-3 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Income +(in thousands, except per share data) +Years Ended December 31, +2014 +2013 +2012 +Net sales +$ +1,334,951 +$ +1,314,223 +$ +1,227,072 +Cost of sales +865,951 +831,847 +771,370 +Gross profit +469,000 +482,376 +455,702 +Commission and licensing fee income – net +13,723 +15,632 +15,395 +Operating expenses +(315,081 +) +(295,223 +) +(283,689 +) +Provision for litigation +— +983 +(8,432 +) +Income from operations +167,642 +203,768 +178,976 +Interest income +3,285 +4,228 +3,067 +Interest expense +(211 +) +(128 +) +(49 +) +Other income - net +677 +1,083 +2,193 +Income before provision for income taxes +171,393 +208,951 +184,187 +Provision for income taxes +58,764 +75,666 +64,623 +Net income +112,629 +133,285 +119,564 +Net (income) loss attributable to non-controlling interests +(749 +) +(1,278 +) +62 +Net income attributable to Steven Madden, Ltd. +$ +111,880 +$ +132,007 +$ +119,626 +Basic net income per share +$ +1.82 +$ +2.04 +$ +1.85 +Diluted net income per share +$ +1.76 +$ +1.98 +$ +1.81 +Basic weighted average common shares outstanding +61,451 +64,583 +64,529 +Effect of dilutive securities – options/restricted stock +2,225 +2,253 +1,726 +Diluted weighted average common shares outstanding +63,676 +66,836 +66,255 +See accompanying notes to consolidated financial statements +F-4 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Comprehensive Income +(in thousands) +2014 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +112,629 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(6,238 +) +$ +— +(6,238 +) +Losses on cash flow hedging derivatives +(2,081 +) +803 +(1,278 +) +Unrealized gain (loss) on marketable securities +2,362 +(921 +) +1,441 +Total other comprehensive income (loss) +$ +(5,957 +) +$ +(118 +) +(6,075 +) +Comprehensive income +106,554 +Comprehensive income attributable to non-controlling interests +(749 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +105,805 +2013 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +133,285 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(4,282 +) +$ +— +(4,282 +) +Losses on cash flow hedging derivatives +(622 +) +252 +(370 +) +Unrealized gain (loss) on marketable securities +(5,685 +) +2,217 +(3,468 +) +Total other comprehensive income (loss) +$ +(10,589 +) +$ +2,469 +(8,120 +) +Comprehensive income +125,165 +Comprehensive income attributable to non-controlling interests +(1,278 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +123,887 +2012 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +119,564 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(21 +) +$ +— +(21 +) +Gains on cash flow hedging derivatives +162 +(75 +) +87 +Unrealized gain (loss) on marketable securities +1,146 +(447 +) +699 +Total other comprehensive income (loss) +$ +1,287 +$ +(522 +) +765 +Comprehensive income +120,329 +Comprehensive income attributable to non-controlling interests +62 +Comprehensive income attributable to Steven Madden, Ltd. +$ +120,391 +See accompanying notes to consolidated financial statements +F-5 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity +(in thousands) +Common Stock +Additional Paid‑in Capital +Retained Earnings +Shares +Amount +Balance - December 31, 2011 +64,508 +$ +5 +$ +186,325 +$ +420,411 +Exercise of stock options +874 +— +9,271 +— +Tax benefit from stock based compensation +— +— +4,608 +— +Issuance of restricted stock +3,809 +— +— +— +Stock-based compensation +— +— +17,434 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain on securities (net of tax of $447) +— +— +— +— +Cash flow hedge (net of tax of $75) +— +— +— +— +Net income +— +— +— +119,626 +Balance - December 31, 2012 +69,191 +5 +217,638 +540,037 +Share repurchases +(3,000 +) +— +— +— +Exercise of stock options +563 +2 +5,802 +— +Tax benefit from stock based compensation +— +— +4,277 +— +Issuance of restricted stock +582 +— +— +— +Stock-based compensation +— +— +20,141 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding loss on securities (net of tax benefit of $2,217) +— +— +— +— +Cash flow hedge (net of tax benefit of $252) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Net income +— +— +— +132,007 +Balance - December 31, 2013 +67,336 +7 +247,858 +672,044 +Share repurchases +(4,261 +) +(1 +) +— +— +Exercise of stock options +340 +— +4,943 +— +Tax benefit from stock based compensation +— +— +2,978 +— +Issuance of restricted stock +210 +— +— +— +Stock-based compensation +— +— +19,260 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain on securities (net of tax expense of $921) +— +— +— +— +Cash flow hedge (net of tax benefit of $803) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Non-controlling investment in JV +— +— +— +(20 +) +Net income +— +— +— +111,880 +Balance - December 31, 2014 +63,625 +$ +6 +$ +275,039 +$ +783,904 +See accompanying notes to consolidated financial statements +F-6 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity (Continued) +(in thousands) +Accumulated Other Comprehensive Gain (Loss) +Treasury Stock +Non-controlling interest +Total Stockholders' Equity +Shares +Amount +Balance - December 31, 2011 +$ +678 +12,605 +$ +(132,543 +) +$ +(118 +) +$ +474,758 +Exercise of stock options +— +— +— +— +9,271 +Tax benefit from stock based compensation +— +— +— +— +4,608 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +— +17,434 +Foreign currency translation adjustment +(21 +) +— +— +— +(21 +) +Unrealized holding gain on securities (net of tax of $447) +699 +— +— +— +699 +Cash flow hedge (net of tax of $75) +87 +— +— +— +87 +Net income +— +— +— +(62 +) +119,564 +Balance - December 31, 2012 +1,443 +12,605 +(132,543 +) +(180 +) +626,400 +Share repurchases +— +3,000 +(102,172 +) +— +(102,172 +) +Exercise of stock options +— +— +— +— +5,804 +Tax benefit from stock based compensation +— +— +— +— +4,277 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +— +20,141 +Foreign currency translation adjustment +(4,282 +) +— +— +— +(4,282 +) +Unrealized holding loss on securities (net of tax benefit of $2,217) +(3,468 +) +— +— +— +(3,468 +) +Cash flow hedge (net of tax benefit of $252) +(370 +) +— +— +— +(370 +) +Distributions to non-controlling interests, net +— +— +— +(775 +) +(775 +) +Net income +— +— +— +1,278 +133,285 +Balance - December 31, 2013 +(6,677 +) +15,605 +(234,715 +) +323 +678,840 +Share repurchases +— +4,261 +(142,227 +) +— +(142,228 +) +Exercise of stock options +— +— +— +— +4,943 +Tax benefit from stock based compensation +— +— +— +— +2,978 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +— +19,260 +Foreign currency translation adjustment +(6,238 +) +— +— +— +(6,238 +) +Unrealized holding gain on securities (net of tax expense of $921) +1,441 +— +— +— +1,441 +Cash flow hedge (net of tax benefit of $803) +(1,278 +) +— +— +— +(1,278 +) +Distributions to non-controlling interests, net +— +— +— +(946 +) +(946 +) +Non-controlling investment in JV +— +— +— +148 +128 +Net income +— +— +— +749 +112,629 +Balance - December 31, 2014 +$ +(12,752 +) +19,866 +$ +(376,942 +) +$ +274 +$ +669,529 +See accompanying notes to consolidated financial statements +F-7 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +(in thousands) +Year Ended December 31, +2014 +2013 +2012 +Cash flows from operating activities: +Net income +$ +112,629 +$ +133,285 +$ +119,564 +Adjustments to reconcile net income to net cash provided by operating activities: +Stock-based compensation +19,260 +20,141 +17,434 +Tax benefit from stock-based compensation +(2,978 +) +(4,277 +) +(4,608 +) +Depreciation and amortization +15,077 +12,979 +12,642 +Loss on disposal of fixed assets +291 +905 +250 +Impairment charges +— +— +5,932 +Deferred taxes +2,875 +7,106 +1,528 +Accrued interest on note receivable – related party +(156 +) +— +509 +Notes Receivable - related party +409 +— +— +Deferred rent expense and other liabilities +2,769 +1,914 +1,538 +Realized gain (loss) on sale of marketable securities +677 +(1,083 +) +(2,110 +) +Contingent Liability +(2,139 +) +— +— +Changes, net of acquisitions, in: +Accounts receivable, net of allowances +(144 +) +33,672 +20,182 +Factor accounts receivable, net of allowances +3,734 +(51,394 +) +(31,965 +) +Inventories +(1,841 +) +(10,013 +) +(1,819 +) +Prepaid expenses, prepaid taxes, deposits and other +(294 +) +(8,484 +) +1,557 +Accounts payable and accrued expenses +3,777 +20,837 +11,956 +Accrued incentive compensation +(1,910 +) +(135 +) +(9,163 +) +Other liabilities +(61 +) +— +(86 +) +Net cash provided by operating activities +151,975 +155,453 +143,341 +Cash flows from investing activities: +Capital expenditures +(18,341 +) +(20,746 +) +(20,102 +) +Purchases of marketable securities +(137,348 +) +(63,310 +) +(63,822 +) +Purchase of notes receivable, net of collections +— +— +(1,562 +) +Maturity/sale of marketable securities +128,663 +43,675 +46,447 +Acquisitions, net of cash acquired +(81,885 +) +— +(29,367 +) +Net cash used in investing activities +(108,911 +) +(40,381 +) +(68,406 +) +Cash flows from financing activities: +Proceeds from exercise of stock options +4,943 +5,802 +9,271 +Tax benefit from the exercise of options +2,978 +4,277 +4,608 +Payment of contingent liability +(8,475 +) +(11,481 +) +(22,867 +) +Notes Receivable +893 +— +— +Common stock purchased for treasury +(142,228 +) +(102,172 +) +— +Net cash used by financing activities +(141,889 +) +(103,574 +) +(8,988 +) +Net (decrease) increase in cash and cash equivalents +(98,825 +) +11,498 +65,947 +Cash and cash equivalents – beginning of year +180,275 +168,777 +102,830 +Cash and cash equivalents – end of year +$ +81,450 +$ +180,275 +$ +168,777 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +211 +$ +128 +$ +49 +Income taxes +$ +49,829 +$ +57,147 +$ +52,711 +See accompanying notes to consolidated financial statements. +F-8 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies +[1] Organization: +Steven Madden, Ltd. a Delaware corporation, and its subsidiaries, design, source, market and sell name brand and private label women's, men's and children's shoes, worldwide through its wholesale and retail channels under the Steve Madden Women's, Steve Madden Men's, Madden, Madden Girl, Steven, FREEBIRD by Steven, Superga (under license), Dolce Vita and Betsey Johnson brand names and through its wholesale channels under the Stevies and Report brand names. In addition, the Company designs, sources, markets and sells name brand and private label handbags and accessories to customers worldwide through its Wholesale Accessories segment, including the Big Buddha, Betsey Johnson, Betseyville, Cejon, Steve Madden and Steven by Steve Madden accessories brands. Revenue is generated predominantly through the sale of the Company's brand name and private label merchandise and certain licensed products. At December 31, 2014 and 2013 , the Company operated 160 (including four e-commerce websites) and 121 (including four e-commerce websites) retail stores, respectively. Revenue is subject to seasonal fluctuations. See Note P for operating segment information. +[2] Principles of consolidation: +The Consolidated Financial Statements include the accounts of Steven Madden, Ltd. and its wholly-owned subsidiaries Steven Madden Retail, Inc., Diva Acquisition Corp., Adesso Madden, Inc., Stevies, Inc., Daniel M. Friedman and Associates, Inc., Big Buddha, Inc., the Topline Corporation, Cejon, Inc., SML Holdings S.a.r.l., SML Canada Acquisition Corp., Madden International Ltd., DMF International Ltd., Asean Corporation Ltd., Dolce Vita Holdings, Inc., Trendy Imports S.A de C.V., Comercial Diecesiette S.A. de C.V., Maximus Designer Shoes S.A. de C.V., BA Brand Holdings LLC and BAI Holding, LLC (collectively the "Company"). The accounts of Mad Love LLC, a joint venture in which the Company is the majority owner, and Dexascope Proprietary Ltd.. a joint venture in South Africa in which the Company is the majority owner, are included in the Consolidated Financial Statements with the other members' interests reflected in “Net (income) loss attributable to non-controlling interests” in the Consolidated Statements of Income and “Non-controlling interests” in the Consolidated Balance Sheets. All significant intercompany balances and transactions have been eliminated. Certain adjustments were made to prior years' amounts to conform to the 2014 presentation. +[3] Use of Estimates: +The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +Significant areas involving management estimates include allowances for bad debts, returns and customer chargebacks, inventory valuation, valuation of intangible assets, litigation reserves, and contingent payment liabilities. The Company provides reserves on trade accounts receivables and factor receivables for future customer chargebacks and markdown allowances, discounts, returns and other miscellaneous compliance-related deductions that relate to the current period sales. The Company evaluates anticipated chargebacks by reviewing several performance indicators of its major customers. These performance indicators, which include retailers’ inventory levels, sell-through rates and gross margin levels, are analyzed by management to estimate the amount of the anticipated customer allowance. +[4] Cash equivalents: +Cash equivalents at December 31, 2014 and 2013 amounted to approximately $2,280 and $102,247 , respectively, and consisted of money market accounts held primarily at four brokerage companies. The Company considers all highly liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. +F-9 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[5] Marketable securities: +Marketable securities consist of corporate bonds, certificates of deposit and equities. The corporate bonds and certificates of deposit have maturities greater than three months and up to ten years at the time of purchase. These securities, which are classified as available for sale, are carried at fair value, with unrealized gains and losses net of any tax effect reported in stockholders' equity as accumulated other comprehensive income (loss) until realized. Amortization of premiums and discounts is included in interest income. For the years ended December 31, 2014 and 2013 , the amortization of bond premiums was $558 and $661 , respectively. The schedule of maturities at December 31, 2014 and 2013 are as follows: +Maturities as of +December 31, 2014 +Maturities as of +December 31, 2013 +1 Year or Less +1 to 10 Years +1 Year or Less +1 to 10 Years +Corporate bonds +$ +11,363 +$ +90,446 +$ +4,078 +$ +82,888 +Certificates of deposit +19,835 +— +16,513 +8,379 +Total +$ +31,198 +$ +90,446 +$ +20,591 +$ +91,267 +For the year ended December 31, 2014 , losses of $677 were reclassified from Accumulated Other Comprehensive Income and recognized in the Consolidated Statements of Income in Other Income as compared to gains of $1,083 for the year ended December 31, 2013 . +[6] Inventories: +Inventories, which consist of finished goods on hand and in transit, are stated at the lower of cost (first-in, first-out method) or market. +[7] Property and equipment: +Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed utilizing the straight-line method based on estimated useful lives ranging from three to ten years. Leasehold improvements are amortized utilizing the straight-line method over the shorter of their estimated useful lives or the remaining lease term. Impairment losses are recognized for long-lived assets, including definite-lived intangibles, used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are not sufficient to recover the assets' carrying amount. Impairment losses are measured by comparing the fair value of the assets to their carrying amount. +[8] Goodwill and intangible assets: +The Company's goodwill and indefinite lived intangible assets are not amortized, rather they are tested for impairment on an annual basis or more often if events or circumstances change that could cause these assets to become impaired. The Company completed its annual impairment tests on goodwill and intangible assets during the third quarter of 2014 and no impairments were recognized. Goodwill and indefinite-lived intangible assets are assessed for impairment using either a qualitative or quantitative approach. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment requires an analysis of several estimates including future cash flows or income consistent with management’s strategic business plans, annual sales growth rates and the selection of assumptions underlying a discount rate (weighted average cost of capital) based on market data available at the time. +F-10 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +The Company amortizes its intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment. The Company is currently amortizing its acquired intangible assets with definite useful lives over periods typically from three to ten years. +[9] Net Income Per Share of Common Stock: +Basic net income per share is based on the weighted average number of shares of common stock outstanding during the period, which does not include unvested restricted stock subject to forfeiture. Diluted net income per share reflects: a) the potential dilution assuming shares of common stock were issued upon the exercise of outstanding in-the-money options and the proceeds thereof were used to purchase back shares of the Company’s common stock at the average market price during the period, and b) the vesting of granted nonvested restricted stock awards for which the assumed proceeds upon vesting are deemed to be the amount of compensation cost not yet recognized attributable to future services using the treasury stock method, to the extent dilutive. For the years ended December 31, 2014 , 2013 and 2012 , options to purchase approximately 290,000 , 15,000 and 99,000 shares of common stock, respectively, have been excluded in the +calculation of diluted income per share as the result would have been anti-dilutive. For the years ended December 31, 2014 , 2013 and 2012 , all unvested restricted stock awards were dilutive. +[10] Comprehensive Income: +Comprehensive income is the total of net earnings and all other non-owner changes in equity. Comprehensive income for the Company includes net income, foreign currency translation adjustments, cash flow hedging and unrealized gains and losses on marketable securities. The accumulated balances for each component of other comprehensive loss attributable to the Company are as follows: +2014 +2013 +Currency translation adjustment +$ +(10,469 +) +$ +(3,310 +) +Cash flow hedges, net of tax +(1,561 +) +(283 +) +Unrealized loss on securities, net of tax +(722 +) +(3,084 +) +Accumulated other comprehensive loss +$ +(12,752 +) +$ +(6,677 +) +[11] Advertising costs: +The Company expenses costs of print, radio and billboard advertisements as incurred. Advertising expense included in operating expenses amounted to approximately $13,872 in 2014 , $11,529 in 2013 and $9,783 in 2012 . +[12] Revenue Recognition: +The Company recognizes revenue on wholesale sales when (i) products are shipped pursuant to its standard terms, which are freight on board (“FOB”) Company warehouse, or when products are delivered to the consolidators, or any other destination, as per the terms of the customers’ purchase order, (ii) persuasive evidence of an arrangement exists, (iii) the price is fixed and determinable and (iv) collection is reasonably assured. Sales reductions on wholesale sales for anticipated discounts, allowances and other deductions are recognized during the period when sales are recorded. With the exception of our cold weather accessories business, we do not accept returns from our wholesale customers unless there are product quality issues, which we charge back to the vendors. Sales of cold weather accessories to wholesale customers are recorded net of returns, which are estimated based on historical experience. Such amounts have historically not been material. Retail sales are recognized when the payment is received from customers and are recorded net of estimated returns. The Company generates commission income acting as a buying agent by arranging to manufacture private label shoes to the +F-11 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +specifications of its customers. The Company’s commission revenue also includes fees charged for its design, product and development services provided to certain suppliers in connection with the Company’s private label business. Commission revenue and product and development fees are recognized as earned when title to the product transfers from +the manufacturer to the customer and collections are reasonably assured and are reported on a net basis after deducting related operating expenses. +The Company licenses its Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery, women's fashion apparel, jewelry, watches and luggage. In addition, the Company licenses the Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, swimwear, eyewear, watches, fragrances and outerwear. The license agreements require the licensee to pay the Company a royalty and, in substantially all of the agreements, an advertising fee based on the higher of a minimum or a net sales percentage as defined in the various agreements. In addition, under the terms of retail selling agreements, most of the Company’s international distributors are required to pay the Company a royalty based on a percentage of net sales, in addition to a commission and a design fee on the purchases of the Company’s products. Licensing revenue is recognized on the basis of net sales reported by the licensees, or the minimum guaranteed royalties, if higher. +In substantially all of the Company’s license agreements, the minimum guaranteed royalty is earned and receivable on a quarterly basis. +[13] Taxes Collected From Customers: +The Company accounts for certain taxes collected from its customers in accordance with the accounting guidance which permits companies to adopt a policy of presenting taxes in the income statement on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues). Taxes within the scope of this accounting guidance would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes and some types of excise taxes. The Company has consistently recorded all taxes on a net basis. +[14] Sales Deductions: +The Company supports retailers’ initiatives to maximize sales of the Company’s products on the retail floor by subsidizing the co-op advertising programs of such retailers, providing them with inventory markdown allowances and participating in various other marketing initiatives of its major customers. In addition, the majority of the product the Company accepts as returns relates to damaged products for which the Company’s costs are normally charged back to the responsible third-party factory. Such expenses are reflected in the financial statements as deductions to net sales. +[15] Cost of Sales: +All costs incurred to bring finished products to the Company’s distribution center or to the customers’ freight forwarder and, in the Retail segment, the costs to bring products to the Company’s stores, are included in the cost of sales line on the Consolidated Statements of Income. These include the cost of finished products, purchase commissions, letter of credit fees, brokerage fees, sample expenses, custom duty, inbound freight, royalty payments on licensed products, labels and product packaging. All warehouse and distribution costs related to the Wholesale segments and freight to customers, if any, are included in the operating expenses line item of the Company’s Consolidated Statements of Income. The Company’s gross margins may not be comparable to those of other companies in the industry because some companies may include warehouse and distribution costs, as well as other costs excluded from cost of sales by the Company, as a component of cost of sales, while other companies report on the same basis as the Company and include them in operating expenses. +F-12 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[16] Warehouse and shipping costs: +The Company includes all warehouse and distribution costs for the Wholesale segment in the Operating Expenses line on the Consolidated Statements of Income. For the years ended December 31, 2014 , 2013 and 2012 , the total warehouse and distribution costs included in Operating Expenses were $15,646 , $14,887 and $14,140 respectively. Since the Company's standard terms of sales are “FOB Steve Madden warehouse,” the Company's wholesale customers absorb most shipping costs. Shipping costs to wholesale customers incurred by the Company are not considered significant and are included in the Operating Expense line in the Consolidated Statements of Income. +[17] Employee benefit plan: +The Company maintains a tax-qualified 401(k) plan which is available to each of the Company's eligible employees who elect to participate after meeting certain length-of-service requirements. The Company made discretionary matching contributions of 50% of employees' contributions up to a maximum of 6% of employees' compensation which vest to the employees over a period of time. Total matching contributions to the plan for 2014 , 2013 and 2012 were approximately $1,286 , $1,259 and $1,206 , respectively. +[18] Derivative Instruments: +The Company uses derivative instruments to manage its exposure to cash-flow variability from foreign currency risk. Derivatives are carried on the balance sheet at fair value and included in prepaid expenses and other current assets or +accrued expenses. The Company applies cash flow hedge accounting for its derivative instruments. Net derivative gains and losses attributable to derivatives subject to cash flow hedge accounting reside in accumulated other comprehensive income (loss) and will be reclassified to earnings in future periods as the economic transactions to which the derivatives relate affect earnings. See Note L - Derivative Instruments. +[19] Income Taxes: +The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. +The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. See Note N - Income Taxes. +[20] Share-based Compensation: +The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for equity instruments of the Company. Share-based compensation cost for restricted stock units (“RSUs”) is measured based on the closing fair market value of the Company’s common stock on the date of grant. Share-based compensation cost for stock options is measured at the grant date, based on the fair-value as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The BSM option-pricing model incorporates various assumptions including expected volatility, estimated expected life and interest rates. The Company recognizes share-based compensation cost over the award’s requisite service period on a straight-line basis. The Company recognizes a benefit from share-based compensation in the Consolidated Statements of Stockholders' Equity if an incremental tax benefit is realized. See Note I - Stock Based Compensation. +F-13 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note B – Acquisitions +Blondo +Subsequent to year end, on January 23, 2015 the Company acquired the trademarks and other intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, from Regence Footwear Inc. and 3074153 Canada Inc. for a purchase price of approximately $9,129 . +SM Mexico +On December 30, 2014, the Company purchased all of the outstanding capital stock of Trendy Imports S.A. de C.V., Comercial Diecisiette S.A. de C.V., and Maximus Designer Shoes S.A. de C.V. (together, “SM Mexico”). SM Mexico is a division of Grupo Dicanco, which has been the exclusive distributor of the Company's products in Mexico since 2005. The total purchase price for the acquisition was approximately $ 25,172 , which is subject to a working capital adjustment. The total purchase price includes a cash payment at closing of $ 15,336 , plus potential earn-out payments based on the achievement of certain earnings targets for each of the twelve month periods ending December 31, 2015 and 2016. The fair value of the contingent payments was estimated using the present value of management's projections of the financial results of SM Mexico during the earn-out period. At December 31, 2014 , the Company estimated the fair value of the contingent consideration to be $9,836 . +The transaction was accounted for using the acquisition method required by GAAP. Accordingly, the assets and liabilities of SM Mexico were recorded at their fair values, and the excess of the purchase price over the fair value of the assets acquired and liabilities assumed, including identified intangible assets, was recorded as goodwill. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions, which are subject to change. The purchase price has been preliminarily allocated as follows: +Accounts Receivable +$ +890 +Inventory +4,760 +Fixed assets +1,525 +Other assets +4,065 +Accounts payable +(4,144 +) +Deposits & other +(1,241 +) +Total fair value excluding goodwill +5,855 +Goodwill +19,317 +Net assets acquired +$ +25,172 +The allocation of the purchase price is based on certain preliminary valuations and analysis that have not been completed as of the date of this filing. Any changes in the estimated fair values of the assets acquired, including identifiable intangible assets, and liabilities assumed upon the finalization of more detailed analysis, within the measurement period, will change the allocation of the purchase price. Any subsequent changes to the purchase price allocation that are material will be adjusted retroactively. Contingent consideration classified as a liability will be remeasured at fair value at each reporting date, until the contingency is resolved, with changes recognized in earnings. The goodwill related to this transaction is expected to be deductible for tax purposes over 15 years. +Dolce Vita +On August 13, 2014, the Company purchased all of the outstanding capital stock of Dolce Vita Holdings, Inc., a Washington corporation (“Dolce Vita”). The total purchase price for the acquisition was approximately $62,146 which included a cash payment at closing of $56,872 , plus an estimated working capital adjustment of $658 and potential earn-out payments based on achievement of certain earnings targets for each of the twelve month periods ending on September 30, 2015 and 2016 provided that the aggregate minimum earn-out payment for such two year earn-out period shall be no less than $5,000 . The fair value of the contingent payments +F-14 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note B – Acquisitions (continued) +was estimated using the present value of management's projections of the financial results of Dolce Vita during the earn-out period. At December 31, 2014 , the Company estimated the fair value of the contingent consideration to be $4,616 . +The transaction was accounted for using the acquisition method required by GAAP. Accordingly, the assets and liabilities of Dolce Vita were recorded at their fair values, and the excess of the purchase price over the fair value of the assets acquired and liabilities assumed, including identified intangible assets, was recorded as goodwill. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions, which are subject to change. The purchase price has been preliminarily allocated as follows: +Cash +$ +1,481 +Accounts receivable +11,872 +Inventory +11,498 +Fixed assets +2,019 +Trade name +12,200 +Prepaid and other assets +1,289 +Accounts payable +(13,569 +) +Accrued expenses +(2,500 +) +Other liabilities +(1,355 +) +Total fair value excluding goodwill +22,935 +Goodwill +39,211 +Net assets acquired +$ +62,146 +The allocation of the purchase price is based on certain preliminary valuations and analysis that have not been completed as of the date of this filing. Any changes in the estimated fair values of the assets acquired, including identifiable intangible assets, and liabilities assumed upon the finalization of more detailed analysis, within the measurement period, will change the allocation of the purchase price. Any subsequent changes to the purchase price allocation that are material will be adjusted retroactively. Contingent consideration classified as a liability will be remeasured at fair value at each reporting date, until the contingency is resolved, with changes recognized in earnings. The goodwill related to this transaction is expected to be deductible for tax purposes over 15 years. +The unaudited pro forma consolidated revenues and earnings relating to the Dolce Vita and SM Mexico acquisitions for the years ended December 31, 2014 and 2013 have not been presented as it is impracticable to provide due to lack of information from the sellers. +Brian Atwood +In March 2014, the Company, acting through its newly-formed subsidiary BA Brand Holdings LLC (“BA Brands”), purchased the intellectual property and related assets of Brian Atwood® from Brian Atwood IP Company LLC, for a purchase price of approximately $6,750 . The Company owns 80% of BA Brands. The acquired intellectual property portfolio includes the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand. In connection with the acquisition, the Company has licensed the Brian Atwood® designer brand to Brian K. Atwood (“Atwood”), who will have full operational and creative control in the design, production and distribution of the designer brand. The Company will manage the B Brian Atwood® brand and collaborate with Atwood on the design, production, marketing and distribution of B Brian Atwood® brand footwear and handbags. +The purchase price for the acquired assets has primarily been allocated to the trademarks and to the Company's preferred interest in BAI Holding, LLC., which controls the operating company that will sell the Brian Atwood® designer brand. +F-15 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note C – Factor Receivable +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”) that became effective on September 15, 2009. The agreement can be terminated by the Company or Rosenthal at any time upon 60 days prior written notice. Under the agreement, the Company can request advances from Rosenthal in amounts of up to 85% of the aggregate receivables submitted to Rosenthal. The agreement provides the Company with a $30,000 credit facility with a $15,000 sub-limit for letters of credit at an interest rate based, at the Company’s election, upon either the prime rate or LIBOR. As of December 31, 2014 , no borrowings or letters of credit were outstanding. The Company also pays a fee based on a percentage of the gross invoice amount submitted to Rosenthal. Originally the fee was 0.275% of the gross invoice amount but, on July 10, 2012, the agreement was amended to reduce the fee to 0.25% of the gross invoice amount. On December 8, 2014, the fee was further reduced to 0.20% effective January 1, 2015. With respect to receivables related to the Company's private label business, the fee is 0.14% of the gross invoice amount. Rosenthal assumes the credit risk on a substantial portion of the receivables that the Company submits to it. To the extent of any loans made to the Company, Rosenthal maintains a lien on all of the Company’s receivables to secure the Company’s obligations. Rosenthal services the collection of the Company's accounts receivable. Funds collected by Rosenthal are applied against advances owed to Rosenthal (if any), and the balance is due and payable to the Company, net of any fees. The allowance against “factor receivables” is a projected provision based on certain formulas and prior approvals for markdowns, allowances, discounts, advertising and other deductions that customers may deduct against their payments. +Note D – Notes Receivable +As of December 31, 2014 and 2013 , Notes Receivable were comprised of the following: +December 31, +2014 +December 31, +2013 +Due from seller of SM Canada (see below) +$ +1,878 +$ +3,171 +On February 21, 2012, the Company purchased all of the assets of Steve Madden Canada Inc., Steve Madden Retail Canada Inc., Pasa Agency Inc. and Gelati Imports Inc. (collectively, “SM Canada”), the Company’s sole distributor in Canada since 1994, comprising SM Canada’s footwear, handbags and accessories wholesale and retail businesses. The transaction was completed for cash consideration of approximately $26,686 , net of a working capital adjustment of $2,681 , plus potential earn-out payments of up to a maximum of $38,000 Canadian dollars (which converted to approximately $37,327 U.S. dollars at the time of acquisition), in the aggregate, based on achievement of certain earnings targets for each of the 12-month periods ending on March 31, 2013 through 2017, inclusive. In connection with the acquisition, the Company provided an interest free loan to the seller of SM Canada in the principal amount of $3,107 Canadian dollars ( $3,171 in U.S. dollars) pursuant to a promissory note. The note is payable in five annual installments due on the dates the five annual earn-out payments are paid. The first payment of principal was made subsequent to the year ended December 31, 2013 in January 2014. The second payment was made during the fourth quarter of 2014. To the extent the contingent consideration related to the earn-out is not achieved, the repayment terms of the note may result in less than the entire principal amount of the loan being paid. In such event, the unpaid principal amount of the note will be forgiven. The note was recorded net of the imputed interest, which will be amortized to income over the term of the note. +Note E – Note Receivable – Related Party +On June 25, 2007, the Company made a loan to Steve Madden, its Creative and Design Chief and a principal stockholder of the Company, in the amount of $3,000 in order for Mr. Madden to satisfy a personal tax obligation resulting from the exercise of stock options that were due to expire and to retain the underlying Company common stock, which common stock he pledged to the Company as collateral to secure the loan. Mr. Madden executed a secured promissory note in favor of the Company bearing interest at an annual rate of 8% , which was due on the earlier of the date Mr. Madden ceases to be employed by the Company or December 31, 2007. The note was amended and restated as of December 19, 2007 to extend the maturity date to March 31, 2009, and amended and restated again as of April 1, 2009 to change the interest rate to 6% and the maturity date to June 30, 2015 at which time all +F-16 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note E – Note Receivable – Related Party (continued) +principal and accrued interest would become due. On January 3, 2012, in connection with an amendment of Mr. Madden’s employment contract, the note was again amended and restated (the “Third Amended and Restated Note”) to extend the maturity date to December 31, 2023 and eliminate the accrual of interest after December 31, 2011. In addition, the Third Amended and Restated Note provides that, commencing on December 31, 2014, and annually on each December 31 thereafter through the maturity date, one-tenth of the principal amount thereof, together with accrued interest, will be cancelled by the Company, provided that Mr. Madden continues to be employed by the Company on each such December 31. As of December 31, 2011, $1,090 of interest has accrued on the principal amount of the loan related to the period prior to the elimination of the accrual of interest and has been reflected on the Company’s Consolidated Financial Statements. Due to the three-for-two stock split of the Company's common stock effected on May 3, 2010, the number of shares of the Company's common stock securing the loan increased from 510,000 shares to 765,000 shares. Based upon the increase in the market value of the Company’s common stock since the inception of the loan, on July 12, 2010, the Company released from its security interest 555,000 shares of the Company’s common stock, retaining 210,000 shares with a total market value on that date of $6,798 , as collateral for the loan. Additionally, pursuant to the three-for-two stock split of the Company's common stock effected on May 31, 2011, the number of shares of the Company's common stock securing the repayment of the loan increased from 210,000 shares to 315,000 shares and pursuant to the three-for-two stock split of the Company's common stock effected on October 1, 2013, the number of shares of the Company's common stock securing the repayment of the loan has increased from 315,000 shares to 472,500 shares. On December 31, 2014 , the total market value of these shares was $ 15,040 . Pursuant to the elimination of further interest accumulation under the Third Amended and Restated Note, the outstanding principal amount of the loan and the accrued interest as of December 31, 2014 and 2013 has been discounted to reflect imputed interest, which will be amortized over the remaining life of the loan. On December 31, 2014 , the Company also recorded a charge in the amount of $409 to write-off the required one-tenth of the principal amount of the Third Amended and Restated Note, which was partially offset by $156 of accrued interest. +Note F – Fair Value Measurement +The accounting guidance under Accounting Standards Codification “Fair Value Measurements and Disclosures” (“ASC 820-10”) provides guidance for disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those three levels is as follows: +• +Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities. +• +Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. +• +Level 3: Significant unobservable inputs. +The Company’s financial assets and liabilities, subject to fair value measurements, as of December 31, 2014 and 2013 are as follows: +F-17 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note F – Fair Value Measurement (continued) +December 31, 2014 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +2,280 +$ +2,280 +$ +— +$ +— +Current marketable securities – available for sale (a) +31,198 +31,198 +— +— +Note receivable – related party (b) +3,328 +— +— +3,328 +Note receivable – Seller of SM Canada (c) +1,878 +— +— +1,878 +Long-term marketable securities – available for sale (d) +90,446 +90,446 +— +— +Total assets +$ +129,130 +$ +123,924 +$ +— +$ +5,206 +Liabilities: +Forward contracts +$ +2,334 +$ +— +$ +2,334 +$ +— +Contingent consideration (e) +38,633 +— +— +38,633 +Total liabilities +$ +40,967 +$ +— +$ +2,334 +$ +38,633 +(a) Current marketable securities includes unrealized gains of $1 and unrealized losses of $145. +(b) The decrease in the balance of the note receivable from related party is due to one-tenth forgiveness of $409 partially offset by accrued interest income of $156. +(c) The decrease in the balance of the note receivable from seller of SM Canada is due to principal payments of $893 and $400 in foreign currency translation. +(d) Long-term marketable securities includes unrealized gains of $11 and unrealized losses of $589. +(e) The change in the contingent consideration is due to decreases related to an earn-out payment of $3,315 during the second quarter of 2014 to the seller of SM Canada, an earn-out payment of $5,160 during the third quarter of 2014 to the seller of Cejon and a decrease of $2,139 due to a change in estimate of expected payments. These were offset by the addition of earn-out payments to the seller of Dolce Vita of $4,616 and SM Mexico of $9,836. +December 31, 2013 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +102,247 +$ +102,247 +$ +— +$ +— +Current marketable securities – available for sale (a) +20,591 +20,591 +— +— +Note receivable – related party +3,581 +— +— +3,581 +Note receivable – SM Canada +3,171 +— +— +3,171 +Long-term marketable securities – available for sale (b) +91,267 +91,267 +— +— +Total assets +$ +220,857 +$ +214,105 +$ +— +$ +6,752 +Liabilities: +Forward contracts +$ +460 +$ +— +$ +460 +$ +— +Contingent consideration +34,795 +— +— +34,795 +Total liabilities +$ +35,255 +$ +— +$ +460 +$ +34,795 +(a) Current marketable securities includes unrealized gains of $59. +(b) Long-term marketable securities includes unrealized gains of $1,387 and unrealized losses of $4,530. +F-18 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note F – Fair Value Measurement (continued) +Forward contracts are entered into to manage the risk associated with the volatility of future cash flows denominated in Mexican pesos. Fair value of these instruments are based on observable market transactions of spot and forward rates. +For the note receivable due from related party (see Note E) and due from the sellers of SM Canada (see Note D), the carrying value was determined to be the fair value, based upon their actual interest rates, which approximate current market interest rates. +The Company has recorded a liability for potential contingent consideration in connection with the December 30, 2014 acquisition of SM Mexico (see Note B). Pursuant to the terms of an earn-out agreement between the Company and the seller of SM Mexico, earn-out payments will be due annually to the seller of SM Mexico based on the financial performance of SM Mexico for each of the twelve-month periods ending on December 31, 2015 and 2016, inclusive. The fair value of the contingent payments was estimated using the present value of management's projections of the financial results of SM Mexico during the earn-out period. +The Company has recorded a liability for potential contingent consideration in connection with the August 13, 2014 acquisition of Dolce Vita (see Note B). Pursuant to the terms of an earn-out agreement between the Company and the seller of Dolce Vita, earn-out payments will be due annually to the seller of Dolce Vita based on the financial performance of Dolce Vita for each of the twelve-month periods ending on September 30, 2015 and 2016, inclusive, provided that the aggregate minimum earn-out payment shall be no less than $5,000 . The fair value of the contingent payments was estimated using the present value of management’s projections of the financial results of Dolce Vita during the earn-out period. +The Company has recorded a liability for potential contingent consideration in connection with the February 21, 2012 acquisition of SM Canada. Pursuant to the terms of an earn-out agreement between the Company and the seller of SM Canada, earn-out payments will be due annually to the seller of SM Canada based on the financial performance of SM Canada for each of the 12-month periods ending on March 31, 2013 through 2017, inclusive. The earn-out payment of $3,315 for the period ended March 31, 2014 was paid in the second quarter of 2014. The fair value of the contingent payments was estimated using the present value of management’s projections of the financial results of SM Canada during the earn-out period. +The Company has recorded a liability for potential contingent consideration in connection with the May 25, 2011 acquisition of Cejon. Pursuant to the terms of an earn-out agreement between the Company and the sellers of Cejon, earn-out payments will be made annually to the sellers of Cejon, based on the financial performance of Cejon for each of the twelve-month periods ending on June 30, 2012 through 2016, inclusive. The earn-out payment of $5,160 for the period ended June 30, 2014 was paid in the third quarter of 2014. The fair value of the contingent payments was estimated using the present value of management’s projections of the financial results of Cejon during the earn-out period. +Accounting guidance permits entities to choose to measure financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The accounting guidance also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that chose different measurement attributes for similar assets and liabilities. The Company has elected not to measure any eligible items at fair value. +The carrying value of certain financial instruments such as accounts receivable, factor accounts receivable and accounts payable approximates their fair values due to the short-term nature of their underlying terms. The fair values of investment in marketable securities available for sale are determined by reference to publicly quoted prices in an active market. Fair value of the notes receivable held by the Company approximates their carrying value based upon their imputed or actual interest rate, which approximates applicable current market interest rates. +F-19 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note G - Property and Equipment +The major classes of assets and total accumulated depreciation and amortization are as follows: +December 31, +2014 +2013 +Land and building +$ +767 +$ +767 +Leasehold improvements +74,267 +62,087 +Machinery and equipment +8,071 +5,727 +Furniture and fixtures +7,257 +6,498 +Computer equipment +42,177 +38,664 +132,539 +113,743 +Less accumulated depreciation and amortization +(63,634 +) +(57,137 +) +Property and equipment - net +$ +68,905 +$ +56,606 +Depreciation and amortization expense related to property and equipment included in operating expenses amounted to approximately $ 8,377 in 2014 , $ 8,858 in 2013 and $ 8,501 in 2012 . +Note H – Goodwill and Intangible Assets +The following is a summary of the carrying amount of goodwill by segment as of December 31, 2014 and 2013 : +Wholesale +Net Carrying +Footwear +Accessories +Retail +Amount +Balance at January 1, 2013 +$ +36,390 +$ +49,324 +$ +5,845 +$ +91,559 +Purchase accounting adjustment - Canada +1,686 +— +3,496 +5,182 +Translation and other +(485 +) +— +(124 +) +(609 +) +Balance at December 31, 2013 +37,591 +49,324 +9,217 +96,132 +Acquisition of Dolce Vita +39,211 +— +— +39,211 +Acquisition of SM Mexico +10,732 +— +8,585 +19,317 +Translation and other +103 +— +(4 +) +99 +Balance at December 31, 2014 +$ +87,637 +$ +49,324 +$ +17,798 +$ +154,759 +F-20 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note H – Goodwill and Intangible Assets (continued) +The following table details identifiable intangible assets as of December 31, 2014 and 2013 : +2014 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Net Carrying Amount +Trade names +6–10 years +$ +4,590 +$ +2,494 +$ +2,096 +Customer relationships +10 years +27,339 +13,205 +14,134 +License agreements +3–6 years +5,600 +5,600 +— +Non-compete agreement +5 years +2,440 +2,159 +281 +Other +3 years +14 +14 +— +39,983 +23,472 +16,511 +Re-acquired right +indefinite +35,200 +5,192 +30,008 +Trade names +indefinite +93,138 +— +93,138 +$ +168,321 +$ +28,664 +$ +139,657 +(1) Includes the effect of foreign currency translation related primarily to the changes in the Canadian dollar in relation to the U.S. dollar. +2013 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Net Carrying Amount +Trade names +6–10 years +$ +4,590 +$ +2,059 +$ +2,531 +Customer relationships +10 years +27,339 +10,424 +16,915 +License agreements +3–6 years +5,600 +5,600 +— +Non-compete agreement +5 years +2,440 +1,853 +587 +Other +3 years +14 +14 +— +39,983 +19,950 +20,033 +Re-acquired right +indefinite +35,200 +2,558 +32,642 +Trade names +indefinite +76,888 +— +76,888 +$ +152,071 +$ +22,508 +$ +129,563 +(1) Includes the effect of foreign currency translation related primarily to the changes in the Canadian dollar in relation to the U.S. dollar. +The amortization of intangible assets amounted to $ 3,380 for 2014 , $ 3,459 for 2013 and $3,305 for 2012 and is included in operating expenses on the Company's Consolidated Statements of Income. The estimated future amortization expense of purchased intangibles for the next five years is as follows: +2015 +$ +3,023 +2016 +2,725 +2017 +2,490 +2018 +2,351 +2019 +2,276 +Thereafter +3,646 +Total +$ +16,511 +F-21 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note I – Stock-Based Compensation +In March 2006, the Board of Directors of the Company approved the Steven Madden, Ltd. 2006 Stock Incentive Plan (the “Plan”) under which nonqualified stock options, stock appreciation rights, performance shares, restricted stock, other stock-based awards and performance-based cash awards may be granted to employees, consultants and non-employee directors. The Company's stockholders approved the Plan on May 26, 2006. On May 25, 2007, the stockholders approved an amendment to the Plan to increase the maximum number of shares that may be issued under the Plan from 4,050,000 to 5,231,250 . On May 22, 2009, the stockholders approved a second amendment to the Plan that increased the maximum number of shares that may be issued under the Plan to 13,716,000 . On May 25, 2012, the stockholders approved a third amendment to the Plan that increased the maximum number of shares that may be issued under the Plan to 23,466,000 . The following table summarizes the number of shares of common stock authorized for use under the Plan, the number of stock-based awards granted (net of expired or cancelled awards) under the Plan and the number of shares of common stock available for the grant of stock-based awards under the Plan: +Common stock authorized +23,466,000 +Stock-based awards, including restricted stock and stock options granted, net of expired or cancelled +(18,871,508 +) +Common stock available for grant of stock-based awards as of December 31, 2014 +4,594,492 +In accordance with accounting guidance relating to stock-based compensation, the Company records compensation for all awards to employees based on the fair value of options and restricted stock on the date of grant. Equity-based compensation is included in operating expenses on the Company's Consolidated Statements of Income. For the years ended December 31, 2014 , 2013 and 2012 , total equity-based compensation was as follows: +Years Ended December 31, +2014 +2013 +2012 +Restricted stock +$ +15,007 +$ +15,097 +$ +11,622 +Stock options +4,253 +5,044 +5,812 +Total +$ +19,260 +$ +20,141 +$ +17,434 +The Company classifies cash flows resulting from the tax benefits from tax deductions in excess of the compensation costs recognized for those options (tax benefits) as financing cash flows. For the years ended December 31, 2014 , 2013 and 2012 , the Company realized a tax benefit from stock-based compensation of $ 2,978 , $ 4,277 and $ 4,608 , respectively. +Stock Options +The total intrinsic value of options exercised during 2014 , 2013 and 2012 amounted to $ 6,351 , $ 8,016 and $ 15,386 respectively. During the years ended December 31, 2014 , 2013 and 2012 , 537,276 options with a weighted average exercise price of $21.19 , 1,061,513 options with a weighted average exercise price of $12.91 and 1,243,500 options with a weighted average exercise price of $ 12.77 vested, respectively. As of December 31, 2014 , there were unvested options relating to 1,075,325 shares of common stock with a total of $7,520 of unrecognized compensation cost and an average vesting period of 2.7 years. +The Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of options granted, which requires several assumptions. The expected term of the options represents the estimated period of time until exercise and is based on the historical experience of similar awards. Expected volatility is based on the historical volatility of the Company’s common stock. The risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. With the exception of special dividends paid in November 2005 and 2006, the Company historically has not paid regular cash dividends and thus the expected dividend rate is assumed to be zero. The following weighted average assumptions were used for stock options granted: +F-22 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note I – Stock-Based Compensation (continued) +2014 +2013 +2012 +Volatility +27% to 32% +31% to 45% +40% to 47% +Risk-free interest rate +1.06% to 1.80% +0.37% to 1.38% +0.47% to 0.87% +Expected life in years +3 to 5 +4 to 5 +3 to 5 +Dividend yield +0.00% +0.00% +0.00% +Weighted average fair value +$9.90 +$10.21 +$9.43 +Activity relating to stock options granted under the Company’s plans and outside the plans during the three years ended December 31, 2014 is as follows: +Number of Shares +Weighted Average Exercise Price +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at January 1, 2012 +4,054,500 +$ +11.86 +Granted +354,000 +27.09 +Exercised +(874,500 +) +10.61 +Cancelled/Forfeited +(130,500 +) +13.40 +Outstanding at December 31, 2012 +3,403,500 +13.71 +Granted +584,000 +30.03 +Exercised +(563,000 +) +10.28 +Cancelled/Forfeited +(51,500 +) +22.32 +Outstanding at December 31, 2013 +3,373,000 +17.01 +Granted +489,500 +34.69 +Exercised +(340,000 +) +14.57 +Cancelled/Forfeited +(94,500 +) +28.77 +Outstanding at December 31, 2014 +3,428,000 +$ +19.48 +3.0 years +$ +43,999 +Exercisable at December 31, 2014 +2,353,000 +$ +14.51 +2.1 years +$ +40,811 +The following table summarizes information about stock options at December 31, 2014 : +Options Outstanding +Options Exercisable +Range of Exercise Price +Number Outstanding +Weighted Average Remaining Contractual Life (in Years) +Weighted Average Exercise Price +Number Exercisable +Weighted Average Exercise Price +$3.65 to $8.72 +1,000,000 +0.8 +$5.61 +1,000,000 +$5.61 +$9.50 to $14.99 +95,000 +2.2 +13.87 +76,000 +13.70 +$15.29 to $20.86 +769,000 +2.4 +17.08 +645,000 +16.84 +$21.17 to $26.95 +431,000 +3.7 +24.54 +415,000 +24.59 +$27.03 to $38.96 +1,133,000 +5.3 +31.90 +217,000 +29.66 +3,428,000 +3.0 +$19.48 +2,353,000 +$14.51 +F-23 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note I – Stock-Based Compensation (continued) +Restricted Stock +The following table summarizes restricted stock activity during the three years ended December 31, 2014 : +Number of Shares +Weighted Average Fair Value at Grant Date +Outstanding at January 1, 2012 +1,006,500 +$ +16.96 +Granted +3,670,500 +24.23 +Vested +(340,500 +) +16.33 +Forfeited +(3,000 +) +25.40 +Outstanding at December 31, 2012 +4,333,500 +23.16 +Granted +434,000 +29.21 +Vested +(473,500 +) +19.65 +Forfeited +(37,000 +) +18.82 +Outstanding at December 31, 2013 +4,257,000 +24.24 +Granted +182,000 +34.88 +Vested +(345,000 +) +24.11 +Forfeited +(27,000 +) +29.34 +Outstanding at December 31, 2014 +4,067,000 +$ +24.69 +As of December 31, 2014 , there was $77,484 of total unrecognized compensation cost related to restricted stock awards granted under the Plan. This cost is expected to be recognized over a weighted average of 7.9 years. +The Company determines the fair value of its restricted stock awards based on the market price of its common stock on the date of grant. The fair value of the restricted stock that vested during the years ended December 31, 2014 , 2013 and 2012 was $ 8,317 , $ 9,306 and $ 5,553 , respectively. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment of Mr. Madden’s existing employment agreement, pursuant to which, on February 8, 2012, Mr. Madden was granted 1,463,057 restricted shares of the Company’s common stock at the then market price of $27.34 , which will vest in equal annual installments over a seven-year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. Pursuant to the amended employment agreement, on June 30, 2012, Mr. Madden exercised his right to receive an additional restricted stock award, and on July 3, 2012 he was granted 1,893,342 restricted shares of the Company's common stock at the then market price of $21.13 , which will vest in the same manner as the prior grant. +Note J - Preferred Stock +The Company has authorized 5,000,000 shares of preferred stock. The Board of Directors has designated 60,000 shares of such preferred stock as Series A Junior Participating Preferred Stock (“Series A Preferred”). Holders of the shares of Series A Preferred are entitled to dividends equal to 1,000 times dividends declared or paid on the Company's common stock. Each share of Series A Preferred entitles the holder to 1,000 votes on all matters submitted to the holders of common stock. The Series A Preferred has a liquidation preference of $ 1,000 per share, and is not redeemable by the Company. No shares of preferred stock have been issued. +F-24 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note K - Share Repurchase Program +The Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase. On April 29, 2014, the Board of Directors approved the continuation of the Company's Share Repurchase Program for up to $150,000 in repurchases of the Company's common stock which includes amounts remaining under the prior authorization. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. During the twelve months ended December 31, 2014 , an aggregate of 4,260,868 shares of the Company's common stock was repurchased, in the open market, under the Share Repurchase Program, at an average price per share of $33.38 , for an aggregate purchase price of approximately $142,228 . As of December 31, 2014 , approximately $49,764 remained available for future repurchases under the Share Repurchase Program. Subsequent to the year ended December 31, 2014, on February 20, 2015, the Board of Directors approved the extension of the Share Repurchase Program for an additional $150,000 in repurchases of the Company's common stock. +Note L - Derivative Instruments +The Company uses derivative instruments, specifically, forward foreign exchange contracts, to manage the risk associated with the volatility of future cash flows denominated in Mexican pesos. The foreign exchange contracts will be used to mitigate the impact of exchange rate fluctuations on forecasted purchases of inventory from Mexico and are designated as cash flow hedging instruments. The Company enters into forward contracts with terms of no more than two years. As of December 31, 2014 , the fair value of the Company's foreign currency derivatives, which is included on the Consolidated Balance Sheet in accrued expenses, is $2,334 . As of December 31, 2014 , $1,561 of losses related to cash flow hedges are recorded in accumulated other comprehensive income, net of taxes and are expected to be recognized in earnings at the same time the hedged items affect earnings. As of December 31, 2013 , the fair value of the Company's foreign currency derivatives, which is included on the Consolidated Balance Sheet in prepaid expenses and other current assets, was $460 . As of December 31, 2013 , $283 of losses related to cash flow hedges are recorded in accumulated other comprehensive income, net of taxes and are expected to be recognized in earnings at the same time the hedged items affect earnings. As of December 31, 2014 and 2013 , none of the Company's hedging activities were considered ineffective and thus no gains and losses relating to ineffectiveness on its hedging activities were recognized in the Consolidated Statements of Income. For the year ended December 31, 2014 losses of $81 were reclassified from accumulated other comprehensive income and recognized in the Consolidated Statements of Income in cost of sales as compared to gains of $656 for the year ended December 31, 2013 . +Note M - Operating Leases +The Company leases office, showroom, warehouse and retail facilities under noncancelable operating leases with terms expiring at various times through 2023. Future minimum annual lease payments under noncancelable operating leases consist of the following at December 31: +2015 +$ +36,797 +2016 +49,049 +2017 +34,290 +2018 +30,862 +2019 +27,880 +Thereafter +78,895 +Total +$ +257,773 +A majority of the retail store leases provide for contingent rental payments if gross sales exceed certain targets. In addition, many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes. Rent expense for the years ended December 31, 2014 , 2013 and 2012 was approximately $ 43,608 , $ 38,527 and $ 33,073 , respectively. Included in such amounts are contingent rents of $ 84 , $ 140 and $ 169 in 2014 , 2013 and 2012 , respectively. +F-25 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note M - Operating Leases (continued) +Rent expense is calculated by amortizing total base rental payments (net of any rental abatements, construction allowances and other rental concessions), on a straight-line basis, over the lease term. Accordingly, rent expense charged to operations differs from rent paid resulting in the Company recording deferred rent. +Note N - Income Taxes +The components of income before income taxes are as follows: +2014 +2013 +2012 +Domestic +$ +85,988 +$ +125,772 +$ +123,691 +Foreign +85,405 +83,179 +60,496 +$ +171,393 +$ +208,951 +$ +184,187 +The income tax provision (benefit) consists of the following: +2014 +2013 +2012 +Current: +Federal +$ +29,933 +$ +41,334 +$ +41,280 +State and local +4,244 +11,265 +10,319 +Foreign +15,167 +14,385 +11,035 +49,344 +66,984 +62,634 +Deferred: +Federal +10,229 +8,815 +2,272 +State and local +(2,014 +) +(667 +) +(396 +) +Foreign +1,205 +534 +113 +9,420 +8,682 +1,989 +$ +58,764 +$ +75,666 +$ +64,623 +A reconciliation between taxes computed at the federal statutory rate and the effective tax rate is as follows: +December 31, +2014 +2013 +2012 +Income taxes at federal statutory rate +35.0 +% +35.0 +% +35.0 +% +Effects of foreign operations +(2.7 +) +(1.7 +) +(3.3 +) +State and local income taxes - net of federal income tax benefit +1.1 +3 +3.4 +Nondeductible items +0.2 +0.1 +0.1 +Valuation allowance (reversal) +(0.1 +) +— +(0.3 +) +Other +0.8 +(0.2 +) +0.2 +Effective rate +34.3 +% +36.2 +% +35.1 +% +The Company applies the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. +F-26 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note N - Income Taxes (continued) +In accordance with accounting guidance, the Company has opted to classify interest and penalties that would accrue according to the provisions of relevant tax law as income tax expense on the Consolidated Statements of Income. The Company determines the amount of interest expense to be recognized by applying the applicable statutory rate of interest to the difference between the tax position recognized and the amount previously taken or expected to be taken on a tax return. The Company's tax years 2011 through 2014 remain open to examination by most taxing authorities. The Company has no unrecognized tax benefits recorded as of December 31, 2014 and 2013. +The components of deferred tax assets and liabilities are as follows: +December 31, +2014 +2013 +Current deferred tax assets (liabilities): +Receivable allowances +$ +8,663 +$ +8,024 +Inventory +2,119 +1,932 +Unrealized (gain) loss +955 +(23 +) +Accrued expenses +798 +499 +Other +1,590 +1,835 +Gross current deferred tax asset +14,125 +12,267 +Non-current deferred tax assets (liabilities): +Depreciation and amortization +(10,122 +) +(5,033 +) +Deferred compensation +14,146 +10,827 +Unremitted earnings of foreign subsidiaries +(29,268 +) +(20,748 +) +Deferred rent +4,134 +3,741 +Amortization of goodwill +(3,858 +) +(3,293 +) +Unrealized loss (gain) +222 +1,226 +Other +40 +56 +(24,706 +) +(13,224 +) +Net deferred tax (liabilities) assets +$ +(10,581 +) +$ +(957 +) +The Company's consolidated financial statements provide for any related tax liability on amounts that may be repatriated from foreign operations, aside from undistributed earnings of certain of the Company's foreign subsidiaries that are intended to be indefinitely reinvested in operations outside the U.S. The deferred tax liability of $29,268 and $20,748 for the years ended December 31, 2014 and 2013 , respectively, reflects the amounts that may be repatriated from foreign operations. The total amount of indefinitely reinvested earnings of foreign subsidiaries as of December 31, 2014 and 2013 was $64,147 and $ 42,750 , respectively. Accordingly, no provision has been made for United States income taxes that may become payable if those undistributed earnings of foreign subsidiaries are paid as dividends. If such amounts were not indefinitely reinvested, the Company would incur approximately $11,867 in taxes that were not previously provided for in our consolidated statements of income. +F-27 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note O – Commitments, Contingencies and Other +[1] Legal Proceedings: +(a) +On August 10, 2005, following the conclusion of an audit of the Company conducted by auditors for U.S. Customs and Border Protection (“U.S. Customs”) during 2004 and 2005, U.S. Customs issued a report that asserts that certain commissions that the Company treated as “buying agents’ commissions” (which are non-dutiable) should be treated as “selling agents’ commissions” and hence are dutiable. Subsequently, U.S. Immigration and Customs Enforcement notified the Company’s legal counsel that a formal investigation of the Company’s importing practices had been commenced as a result of the audit. In September 2007, U.S. Customs notified the Company that it had finalized its assessment of the underpaid duties at $1,400 . The Company, with the advice of legal counsel, evaluated the liability in the case, including additional duties, interest and penalties, and believed that it was not likely to exceed $3,045 , and accordingly, a liability for this amount was recorded as of December 31, 2009. The Company contested the conclusions of the U.S. Customs audit and filed a request for review and issuance of rulings thereon by U.S. Customs Headquarters, of Regulations and Rulings, under internal advice procedures. On September 20, 2010, U.S. Customs issued a ruling in the matter, concluding that the commissions paid by the Company pursuant to buying agreements entered into by the Company and one of its two buying agents under review were bona fide buying-agent commissions and, therefore, were non-dutiable. With respect to the second buying agent, U.S. Customs also ruled that beginning in February 2002, commissions paid by the Company were bona fide buying agent commissions and, therefore, were +non-dutiable. However, U.S. Customs found that the Company’s pre-2002 buying agreements with the second agent were legally insufficient to substantiate a buyer-buyer’s agent relationship between the Company and the agent and that commissions paid to the second agent under such buying agreements, in fact, were dutiable. On the basis of the U.S. Customs ruling, the Company reevaluated the liability in the case and believes that it is not likely to exceed $1,248 and the liability was reduced from $3,045 to such amount as of September 30, 2010. +On November 21, 2011, U.S. Customs issued a pre-penalty notice to the Company in which it alleges that gross negligence by the Company resulted in an underpayment of duties with respect to certain pre-2002 buying agreements and claims that the Company owes $342 as an additional duty and $1,367 in monetary penalties. In its February 16, 2012 response to the pre-penalty notice, the Company submitted that it owes no additional duty and, further, did not through negligence or gross negligence fail to pay any duty or engage in conduct amounting to either gross negligence or negligence. The Company requested that U.S. Customs withdraw its proposal to issue a notice of penalty and take no further adverse action against the Company. In the event that U.S. Customs is not inclined to withdraw the pre-penalty notice after review of the Company’s response, the Company has requested the opportunity to make an oral presentation to U.S. Customs prior to the issuance of a notice of penalty. On June 26, 2014, the Company’s counsel met with U.S. Customs officials and, following the meeting, counsel submitted to U.S Customs a letter and the Company’s check in the amount of $342 , representing the Company’s Offer in Compromise of the proposed government claim. In the event that U.S. Customs determines to issue a notice of penalty, the Company intends to file a petition for relief requesting a reduction of the level of culpability and mitigation of the penalty amount assessed. The maximum total amount of damages, including penalty, related to this matter is approximately $1,700 for which the Company has accrued $1,248 . +(d) +The Company has been named as a defendant in certain other lawsuits in the normal course of business. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these matters should not have a material effect on the Company’s financial position or results of operations. It is the policy of management to disclose the amount or range of reasonably possible losses in excess of recorded amounts. +[2] Employment agreements: +Robert Schmertz. The Company and Robert Schmertz, the Company’s Brand Director, are currently negotiating the terms of an employment agreement to replace Mr. Schmertz’s employment agreement that expired at the end of 2014. Pursuant to the terms of the expired employment agreement, which was effective from January 1, 2013 until December 31, 2014, Mr. Schmertz received an annual salary of $725 in 2014. Pursuant to the expired employment agreement, on January 4, 2013, Mr. Schmertz received a grant of 25,000 shares of the Company's common stock subject to certain restrictions. The restricted shares were issued under the Company's 2006 Stock Incentive Plan, as amended, and will +F-28 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note O – Commitments, Contingencies and Other (continued) +vest in five substantially equal annual installments over five years commencing on the first anniversary of the date of the grant. +Edward R. Rosenfeld. On December 31, 2012, the Company entered into a new employment agreement with Edward R. Rosenfeld, the Company's Chief Executive Officer and the Chairman of the Board of Directors, to replace an existing employment agreement that expired on December 31, 2012. The agreement, which expires on December 31, 2015, provides for an approximate annual salary of $ 579 through December 31, 2013, $ 608 in 2014 and $ 638 in 2015. In addition, pursuant to his new employment agreement, Mr. Rosenfeld received a grant of 150,000 shares of the Company's common stock subject to certain restrictions. The restricted shares were issued under the Company's 2006 Stock Incentive Plan, as amended, and will vest in equal annual installments over a five -year period commencing on December 1, 2013. Additional compensation and bonuses, if any, are at the sole discretion of the Board of Directors. +Steven Madden. On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden's existing employment agreement with the Company (the “Amended Madden Agreement”). The Amended Madden Agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides for an annual base salary of approximately $ 9,667 in 2014, approximately $ 11,917 in 2015 and approximately $ 10,698 in 2016 and in each year thereafter through the end of the term of employment. Effective in 2012, the Amended Madden Agreement eliminates the annual cash bonuses payable to Mr. Madden based on EBITDA and the annual cash bonus in relation to new business contained in Mr. Madden's previously existing employment agreement and provides that all future cash bonuses will be at the sole discretion of the Company's Board of Directors. Further, the Amended Madden Agreement eliminates the annual non-accountable expense allowance of up to $ 200 provided to Mr. Madden under the previously existing employment agreement. Pursuant to the Amended Madden Agreement, on February 8, 2012, Mr. Madden was granted 1,463,056 restricted shares of the Company's common stock valued at approximately $ 40,000 , which will vest in equal annual installments over seven years commencing on December 31, 2017 through December 31, 2023, subject to Mr. Madden's continued employment with the Company on each such vesting date. Pursuant to the Amended Madden Agreement, on June 30, 2012, Mr. Madden exercised his right to receive an additional restricted stock award and, on July 3, 2012, was granted 1,893,342 restricted shares of the Company's common stock, which will vest in the same manner as the February 8, 2012 grant. As consideration for the additional restricted stock grant, Mr. Madden's annual base salary in years subsequent to 2012 have been reduced as follows: approximately $ 6,125 in 2014, approximately $ 8,250 in 2015 and approximately $ 7,026 in 2016 and in each year thereafter through the end of the term of employment. In addition to the opportunity for discretionary cash bonuses, the Amended Madden Agreement entitles Mr. Madden to an annual life insurance premium reimbursement of up to $ 200 , as well as an annual stock option grant and the potential for an additional one-time stock option grant based upon achievement of certain financial performance criteria. The Amended Madden Agreement also provides for the elimination of interest accrued after December 31, 2011 on an outstanding loan in the original principal amount of $ 3,000 made by the Company to Mr. Madden, the extension of the maturity date of such loan until December 31, 2023, and the forgiveness of 1/10th of the principal amount of the loan, together with accrued interest, annually over a ten-year period commencing on December 31, 2014 for so long as Mr. Madden continues to be employed by the Company on each such December 31st. +Arvind Dharia. On February 2, 2015, the Company and its Chief Financial Officer, Arvind Dharia, entered into an amendment of Mr. Dharia's existing employment agreement. The amendment, among other things, extends the term of Mr. Dharia's employment agreement until December 31, 2017 and increases his annual base salary to $ 582 effective January 1, 2015 through the remainder of the term. Pursuant to the amendment, on February 2, 2015, Mr. Dharia received a restricted stock award for 15,000 restricted shares of the Company's common stock, which will vest in substantially equal annual installments over a five -year period commencing on February 2, 2016 through February 2, 2020. The agreement, as amended, provides for an annual bonus to Mr. Dharia at the discretion of the Board of Directors. +Amelia Newton Varela. Effective January 1, 2014, the Company entered into a new employment agreement with Amelia Newton Varela, the Company's Executive Vice President of Wholesale, to replace an existing employment agreement that expired at the end of 2013. The new agreement, which expires on December 31, 2016 provides for an annual salary +F-29 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note O – Commitments, Contingencies and Other (continued) +of $ 500 through December 31, 2016 and provides the opportunity for annual cash incentive bonuses. In addition, on February 3, 2014, Ms. Varela received an option to purchase 100,000 shares of common stock at an exercise price equal to the market price of the Company's common stock on the last trading day prior to the grant. The option will vest in equal annual installments over a four -year period commencing on the first anniversary of the grant date. +Awadhesh Sinha. Effective January 1, 2014, the Company entered into a new employment agreement with Awadhesh Sinha, the Company's Chief Operating Officer, to replace an existing employment agreement that expired at the end of 2013. The new agreement, which remains in effect until December 31, 2016 provides for an annual salary of $ 600 , $ 630 , and $ 661 for the three years ended December 31, 2014, 2015, and 2016 and provides the opportunity for annual cash and share based incentive bonuses. In addition, on January 15, 2014, Mr. Sinha received a grant of 29,886 shares of restricted common stock, which will vest in equal annual installments over a three -year period on each of December 15, 2014, December 15, 2015, and December 15, 2016. +[3] Letters of credit: +At December 31, 2014 , the Company had open letters of credit for the purchase of imported merchandise of approximately $ 814 . +[4] License agreements: +On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A, under which the Company has the right to use the Superga® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The agreement was amended on April 11, 2013 extending the original agreement through December 31, 2022. +In September 2009, the Company entered into a license agreement with Dualstar Entertainment Group, LLC, under which the Company has the right to use the Olsenboye® trademark in connection with the marketing and sale of footwear and accessories. The agreement required the Company to make royalty and advertising payments equal to a percentage of net sales and a minimum royalty and advertising payment in the event that specified net sales targets were not achieved. The initial term of the agreement, which expired on December 31, 2011, was extended until December 31, 2015. During 2014, the Company discontinued sales of the Olsenboye brand. The license agreement between the Company and Dualstar Entertainment Group LLC has been terminated and is of no further force or effect. +On September 10, 2008, the Company entered into a license agreement with Dualstar Entertainment Group, LLC, under which the Company has the right to use the Elizabeth and James® trademark in connection with the sale and marketing of footwear. The agreement required the Company to make royalty and advertising payments equal to a percentage of net sales and a minimum royalty and advertising payment in the event that specified net sales targets were not achieved. The agreement was terminated by the Company in December of 2013 and a charge was recorded for the remainder of the guaranteed minimum payments. The cash outflows for the guaranteed minimum royalty will continue through the original contract expiration of March 31, 2015. +On July 1, 2008, the Company entered into a license agreement with Jones Investment Co. Inc., under which the Company has the right to use the l.e.i.® trademark in connection with the sale and marketing of women's footwear exclusively to Wal-Mart. The agreement required the Company to pay the licensor a royalty and advertising payments equal to a percentage of net sales and a minimum royalty and advertising payment in the event that specified net sales targets are not achieved. The initial term of this agreement, which expired on December 31, 2011, was renewed for an additional three-year term, which expired on December 31, 2014. +Future minimum royalty payments are $675 for 2015 , $2,000 for 2016 through 2017 , $2,000 for 2018 through 2019 and $3,000 for 2020 and after. Royalty expenses are included in the “cost of goods sold” section of the Company's Consolidated Statements of Income. +F-30 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note O – Commitments, Contingencies and Other (continued) +[5] Related Party Transactions: +On February 23, 2012, the Company entered into an agreement (the "2012 Consulting Agreement") with JLM Consultants, Inc., a company wholly-owned by John Madden, one of the Company's directors and the brother of Steven Madden, the Company's founder and Creative and Design Chief, which replaced an earlier consulting agreement (the "2004 Consulting Agreement") between the Company and JLM Consultants, Inc. that had expired by its terms on December 31, 2005 but under which JLM Consultants, Inc. had continued to provide consulting services for the consideration provided in the 2004 Consulting Agreement. Under the 2012 Consulting Agreement, Mr. Madden and JLM Consultants, Inc. will continue to provide consulting services with respect to the development of international sales of the Company. JLM Consultants, Inc. received fees and expenses of $ 1,240 in 2014 pursuant to the 2012 Consulting Agreement and $ 1,310 and $ 1,447 in 2013 and 2012 , respectively, pursuant to the 2004 Consulting Agreement. Subsequent to 2011, Mr. Madden no longer receives fees for his service as a director of the Company. +[6] Concentrations: +The Company maintains cash and cash equivalents with various major financial institutions which at times are in excess of the amount insured. In addition, the Company's marketable securities are principally held at four brokerage companies . +During the year ended December 31, 2014 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2014 were approximately 89% . +During the year ended December 31, 2013 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2013 were approximately 85% . +During the year ended December 31, 2012 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2012 were approximately 88% . +For the year ended December 31, 2014 , Target, Inc. represented 10.5% of net sales and 12.8% of total accounts receivable. The Company did not have any other customers who account for more than 10% of total net sales or 10% of total accounts receivable. +For the year ended December 31, 2013 , the Company did not have any customers who account for more than 10% of total net sales or 10% of total accounts receivable. +For the year ended December 31, 2012 , the Company did not have any customers who account for more than 10% of total net sales or 10% of total accounts receivable. +Purchases are made primarily in United States dollars. +F-31 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note O – Commitments, Contingencies and Other (continued) +[7] Valuation and qualifying accounts: +The following is a summary of the allowance for chargebacks and doubtful accounts related to accounts receivable and the allowance for chargebacks related to the amount due from factor: +Balance at Beginning of Year +Additions +Deductions +Balance at End of Year +Year ended December 31, 2014 +Allowance for doubtful accounts +$ +119 +$ +234 +$ +150 +$ +203 +Allowance for chargebacks +17,040 +52,265 +51,106 +18,199 +Returns* +3,253 +5,648 +3,741 +5,160 +Year ended December 31, 2013 +Allowance for doubtful accounts +30 +399 +310 +119 +Allowance for chargebacks +18,108 +41,812 +42,880 +17,040 +Returns* +4,299 +702 +1,748 +3,253 +Year ended December 31, 2012 +Allowance for doubtful accounts +62 +153 +185 +30 +Allowance for chargebacks +15,955 +36,885 +34,732 +18,108 +Returns* +$ +2,202 +$ +3,258 +$ +1,161 +$ +4,299 +* The return reserve does not take into consideration the Company's ability to resell returned products. +The following is a summary of goodwill and the related accumulated amortization for the: +Year Ended December 31, +2014 +2013 +2012 +Cost basis +Balance at beginning of year +$ +96,730 +$ +92,157 +$ +76,193 +Acquisitions and purchase price adjustments +58,627 +4,573 +15,964 +Balance at end of year +155,357 +96,730 +92,157 +Accumulated amortization +Balance at beginning of year +598 +598 +598 +Balance at end of year +598 +598 +598 +Goodwill - net +$ +154,759 +$ +96,132 +$ +91,559 +F-32 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note P – Operating Segment Information +The Company operates the following business segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. The Wholesale Footwear segment, through sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores, derives revenue, both domestically and worldwide (via our International business), from sales of branded and private label women’s, men’s, girls’ and children’s footwear. The Wholesale Accessories segment, which includes branded and private label handbags, belts and small leather goods as well as cold weather and selected other fashion accessories, derives revenue, both domestically and worldwide (via our International business), from sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores. Our Wholesale Footwear and Wholesale Accessories segments, through our International business, derive revenue from Canada, Mexico and South Africa and, under special distribution arrangements, from Asia, Australia, Europe, the Middle East, India, South and Central America and New Zealand. The Retail segment, through the operation of Company-owned retail stores in the United States, Canada, Mexico and South Africa and the Company’s websites, derives revenue from sales of branded women’s, men’s and children’s footwear, accessories and licensed products to consumers. The First Cost segment represents activities of a subsidiary that earns commissions and design fees for serving as a buying agent of footwear products to mass-market merchandisers, mid-tier department stores and other retailers with respect to their purchase of footwear. In the Licensing segment, the Company generates revenue by licensing its Steve Madden® and Steven by Steve Madden® trademarks and other trademark rights for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery and women's fashion apparel, jewelry, watches and luggage. In addition, this segment licenses the Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, swimwear, eyewear, watches, fragrances and outerwear. +F-33 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note P – Operating Segment Information (continued) +Year ended +Wholesale Footwear +Wholesale Accessories +Total Wholesale +Retail +First Cost +Licensing +Corporate +Consolidated +December 31, 2014: +Net sales +$ +882,355 +$ +246,608 +$ +1,128,963 +$ +205,988 +$ +— +$ +— +$ +— +$ +1,334,951 +Gross profit +260,501 +84,640 +345,141 +123,859 +— +— +— +469,000 +Commissions and licensing fees – net +— +— +— +— +6,438 +7,285 +— +13,723 +Income from operations +106,290 +38,773 +145,063 +8,856 +6,438 +7,285 +— +167,642 +Depreciation and amortization +7,690 +7,160 +227 +— +— +15,077 +Segment assets +$ +526,420 +$ +190,237 +716,657 +146,927 +47,651 +— +— +911,235 +Capital expenditures +$ +10,188 +$ +8,153 +$ +— +$ +— +$ +— +$ +18,341 +December 31, 2013: +Net sales +$ +860,448 +$ +244,163 +$ +1,104,611 +$ +209,612 +$ +— +$ +— +$ +— +$ +1,314,223 +Gross profit +263,864 +89,307 +353,171 +129,205 +— +— +— +482,376 +Commissions and licensing fees – net +— +— +— +— +7,988 +7,644 +$ +— +15,632 +Income from operations +117,689 +44,738 +162,427 +24,726 +7,988 +7,644 +983 +203,768 +Depreciation and amortization +6,659 +5,542 +116 +— +662 +12,979 +Segment assets +$ +537,609 +$ +152,553 +690,162 +129,549 +60,530 +— +— +880,241 +Capital expenditures +$ +9,276 +$ +11,470 +$ +— +$ +— +$ +— +$ +20,746 +December 31, 2012 +Net sales +$ +794,486 +$ +241,339 +$ +1,035,825 +$ +191,247 +$ +— +$ +— +$ +— +$ +1,227,072 +Gross profit +249,547 +87,055 +336,602 +119,100 +— +— +— +455,702 +Commissions and licensing fees – net +— +— +— +— +7,778 +7,617 +— +15,395 +Income from operations +104,326 +41,376 +145,702 +26,311 +7,778 +7,617 +(8,432 +) +178,976 +Depreciation and amortization +7,717 +4,818 +107 +— +— +12,642 +Segment assets +$ +511,011 +$ +138,602 +649,613 +101,674 +52,752 +— +— +804,039 +Capital expenditures +$ +7,506 +$ +12,596 +$ +— +$ +— +$ +— +$ +20,102 +F-34 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2014 and 2013 +($ in thousands, except share and per share data) +Note P – Operating Segment Information (continued) +Revenues by geographic area are as follows: +Year Ended December 31, +2014 +2013 +2012 +Domestic (a) +$ +1,222,721 +$ +1,200,797 +$ +1,133,077 +International +112,230 +113,426 +93,995 +Total +$ +1,334,951 +$ +1,314,223 +$ +1,227,072 +(a) Includes revenues of $319,089, $315,154 and $261,759 for the years ended 2014, 2013 and 2012 related to sales to U.S. customers where the title is transferred outside the U.S. and the sale is recorded by our International subsidiary. +Note Q - Quarterly Results of Operations (unaudited) +The following is a summary of the quarterly results of operations for the years ended December 31, 2014 and 2013 : +March 31, +June 30, +September 30, +December 31, +2014: +Net sales +$ +304,624 +$ +295,715 +$ +391,992 +$ +342,620 +Cost of sales +196,276 +188,655 +255,895 +225,125 +Gross profit +108,348 +107,060 +136,097 +117,495 +Commissions, royalty and licensing fee income - net +3,171 +3,187 +5,103 +2,262 +Net income attributable to Steven Madden, Ltd. +$ +23,637 +$ +28,002 +$ +39,248 +$ +20,993 +Net income per share: +Basic +0.38 +0.45 +0.64 +0.35 +Diluted +0.36 +0.44 +0.62 +0.34 +2013: +Net sales +$ +278,916 +$ +297,634 +$ +394,791 +$ +342,882 +Cost of sales +176,318 +187,056 +255,088 +213,385 +Gross profit +102,598 +110,578 +139,703 +129,497 +Commissions, royalty and licensing fee income - net +4,366 +3,699 +4,937 +2,630 +Net income attributable to Steven Madden, Ltd. +$ +23,400 +$ +28,956 +$ +43,992 +$ +35,659 +Net income per share: +Basic +0.36 +0.45 +0.68 +0.55 +Diluted +0.35 +0.43 +0.66 +0.54 +Note R - Recent Accounting Pronouncements +In May 2014, the Financial Accounting Standards Board (FASB) issued new accounting guidance, Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, on revenue recognition. The new standard provides for a single five-step model to be applied to all revenue contracts with customers as well as requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. There is no option for early adoption. For public entities, this ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2016. We are currently evaluating the impact of the new guidance on our consolidated financial statements. +F-35 +Exhibit Index +2.01 +Stock Purchase Agreement dated August 13, 2014 among the Company, Dolce Vita Holdings, Inc., Evangelos C. Lamprou and Manuel N. Lucio (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on August 18, 2014) +2.02 +Stock Purchase Agreement dated May 25, 2011 among the Company, David Seerherman, Cejon, Inc., and Kenneth Rogala (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on May 26, 2011) +2.03 +Asset Purchase Agreement, dated as of January 20, 2012, among Steve Madden Canada Inc., Steve Madden Retail Canada Inc., Pasa Agency Inc., Gelati Imports Inc., the Company, SML Canada Acquisition Corp., 6798039 Canada Inc., 6798012 Canada Inc., 3574563 Canada Inc. and Thomas Alberga (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on January 26, 2012) +3.01 +Certificate of Incorporation of Steven Madden, Ltd. (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +3.02 +Amended & Restated By-Laws of Steven Madden, Ltd. (incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K filed with the SEC on March 28, 2008) +4.01 +Specimen Certificate for shares of Common Stock (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +10.01 +Third Amended and Restated Secured Promissory Note dated as of June 25, 2007 of Steven H. Madden to the Company (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 9, 2012) +10.02 +Consulting Agreement dated February 23, 2012 between the Company and J.L.M. Consultants Inc.(incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 1, 2013. +10.03 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2010 filed with the SEC on November 9, 2010) +10.04 +Amendment to Collection Agency Agreement dated February 16, 2010 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2010 filed with the SEC on March 12, 2010) +10.05 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Daniel Friedman & Associates, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.06 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Diva Acquisition Corp. (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.07 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Steven Madden Retail, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.08 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Stevies, Inc. (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.09 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and SML Acquisition Corp. (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.10 +Letter Agreement dated July 10, 2009 among Rosenthal & Rosenthal, Inc., the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.11 +Guarantee dated July 10, 2009 of the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. in favor of Rosenthal & Rosenthal, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.12 +Earn-Out Agreement dated May 25, 2011 among Steven Madden, Ltd., David Seerherman, Cejon, Inc., Cejon Accessories, Inc., New East Designs, LLC and Kenneth Rogala (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on May 26, 2011). +10.13 +Third Amended Employment Agreement dated July 15, 2005 between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 20, 2005) +10.14 +Amendment dated December 14, 2009 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 17, 2009) +10.15 +Amended and Restated Second Amendment dated as of December 31, 2011 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2011 filed with the SEC on February 29, 2012) +10.16 +Employment Agreement dated January 1, 1998 between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.07 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2000 filed with the SEC on March 30, 2001) # +10.17 +Amendment No. 1 dated June 29, 2001 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 99.4 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended June 30, 2001 filed August 14, 2001) # +10.18 +Amendment No. 2 dated October 30, 2002 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2002 filed with the SEC on November 14, 2002) # +10.19 +Amendment No. 3 dated February 1, 2006 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 3, 2006) # +10.20 +Amendment No. 4 dated October 7, 2009 to Employment Agreement of Arvind Dharia between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on October 13, 2009) # +10.21 +Amendment No. 5 dated February 8, 2012 to Employment Agreement of Arvind Dharia between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 14, 2012) # +10.22 +Amendment No. 6 dated February 2, 2015 to Employment Agreement of Arvind Dharia between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 4, 2015)# +10.23 +Employment Agreement dated January 10, 2014 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 16, 2014) # +10.24 +Employment Agreement dated January 2, 2013 between the Company and Robert Schmertz (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 8, 2013) # +10.25 +Employment Agreement dated January 10, 2014 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 16, 2014) # +10.26 +Employment Agreement dated December 31, 2012 between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 3, 2013) # +10.27 +The 1999 Stock Plan, approved and adopted on March 15, 1999, amended as of March 20, 2000 and March 30, 2001 (incorporated by reference to Exhibit 10.A to the Company's Registration Statement on Form S-8 filed with the SEC on July 26, 2004) # +10.28 +2006 Stock Incentive Plan (Amended and Restated Effective May 22, 2009), amended by the Board on April 5, 2012 and approved and adopted by the Company's stockholders on May 25, 2012 (incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 1, 2013) # +14.01 +Code of Ethics for the Chief Executive Officer and Senior Financial Officers † +14.02 +Code of Business Conduct and Ethics for the Board of Directors† +14.03 +Code of Business Conduct and Ethics† +21.01 +Subsidiaries of the Registrant † +23.01 +Consent of EisnerAmper LLP † +24.01 +Power of Attorney (included on signature page hereto) +31.01 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 † +31.02 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 † +32.01 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 †* +32.02 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 †* +99.01 +Press Release, dated February 24, 2015, issued by Steven Madden, Ltd. † +101 +The following materials from Steven Madden, Ltd.'s Annual Report on Form 10-K for the fiscal year ended December 31, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.* +† +Filed herewith. +# +Indicates management contract or compensatory plan or arrangement required to be identified pursuant to Item 15(b) of this Annual Report on Form 10-K. +* +This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Company specifically incorporates it by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2014/0001628280-15-001083/filing_metadata.csv b/raw/filings/0000913241/2014/0001628280-15-001083/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..6dc43a0cbc48a45c2bfc824988078e22b8ee62a8 --- /dev/null +++ b/raw/filings/0000913241/2014/0001628280-15-001083/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000913241,SHOO,"STEVEN MADDEN, LTD.",10-K,2015-02-26,2014-12-31,2015-02-26T20:34:18.000Z,0001628280-15-001083,shoo-20141231x10k.htm,10-K,15771083,1,0,https://www.sec.gov/Archives/edgar/data/913241/000162828015001083/shoo-20141231x10k.htm,https://www.sec.gov/Archives/edgar/data/913241/000162828015001083/,2014,2014,1 diff --git a/raw/filings/0000913241/2014/0001628280-15-001083/item1.txt b/raw/filings/0000913241/2014/0001628280-15-001083/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..98987e51a64afd5671f41136b37bbae3c834eecd --- /dev/null +++ b/raw/filings/0000913241/2014/0001628280-15-001083/item1.txt @@ -0,0 +1,101 @@ +ITEM 1 BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories and license some of our trademarks for use in connection with the manufacture, marketing and sale of various products of our licensees. Our products are marketed through our retail stores and our e-commerce websites, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers throughout the United States, Canada, Mexico and South Africa. In addition, we have special distribution arrangements for the marketing of our products in Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. We offer a broad range of updated styles designed to establish or complement and capitalize on market trends. We have established a reputation for design creativity and our ability to offer quality products in popular styles at affordable prices, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed our initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. The public may read and copy any materials filed by us with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information regarding the operation of the SEC's Public Reference Room is available by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +1 +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company and a Code of Business Conduct and Ethics that is applicable to all of our employees, each of which are attached as exhibits to this Annual Report on Form 10-K and posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Net sales for 2014 increased 2% to $1,334,951 from $1,314,223 in 2013. Net income attributable to Steven Madden, Ltd. decreased 15% to $111,880 in 2014 compared to $132,007 in 2013. Diluted earnings per share in 2014 decreased to $1.76 per share on 63,676,000 diluted weighted average shares outstanding compared to $1.98 per share on 66,836,000 diluted weighted average shares outstanding in the prior year. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Report Signature®, Superga® (under license), Betsey Johnson®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, Wild Pair®, Brian Atwood®, B Brian Atwood® and includes our International business and certain private label footwear business. Our Wholesale Accessories segment includes Big Buddha®, Betseyville®, Betsey Johnson®, Steve Madden®, Steven®, Cejon® accessories brands and includes our International business and certain private label accessories business. These trademarks are registered trademarks owned by us or licensed to us by third parties. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery, women's fashion apparel, jewelry, watches and luggage. In addition, we license our Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, swimwear, eyewear, watches, fragrances and outerwear. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States and Canada. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl is geared for young women ages 13 to 20, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +Steve Madden Men's. We design, source, and market a life style collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range from $70 to $150 at retail. +Madden. T he Madden® brand is a streetwear focused collection of footwear geared to meet the trend directions of the 13 to 21 year old fashion consumer. Madden products range from $45 to $85 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +2 +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department and better footwear specialty stores throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden brand, Steven products are designed to appeal principally to fashion conscious women, ages 25 to 45, who shop at department stores and footwear boutiques. +Stevies and Steve Madden Kids. Our Stevies and Steve Madden Kids brands are designed, sourced and marketed to appeal to young girls, ages six to 12, and are sold at department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson and Betseyville shoe brands are distributed through department stores such as Nordstrom and Dillard's and online retailers such as Amazon and Zappos. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints. +FREEBIRD by Steven . We design, source, and market a full collection of handcrafted, Goodyear welted boots. The designs are inspired by vintage Americana and created using time-honored craftsmanship. The FREEBIRD by Steven® collection conveys a unique fashion life style that transcends multiple generations. FREEBIRD by Steven products are currently sold, at retail prices ranging from $195 to $450 at major department stores, mid-tier retailers, and specialty boutiques. +Report. The Report and Report Signature brands were acquired in our May 2011 acquisition of Topline Corporation ("Topline"). We design, manufacture, market and sell our Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. Formed in April 2011 as a joint venture with the Company, the Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed to Target. +Dolce Vita. On August 13, 2014, the Company acquired the Dolce Vita® and DV® brands and other intellectual property assets in the acquisition of Dolce Vita Holdings, Inc. The Dolce Vita brand is a contemporary women's footwear brand with price points ranging from $120 to $350. The DV brand, which is designed for younger fashion conscious women, has price points ranging from $60 to $200. Both brands are distributed through department stores such as Nordstrom, Bloomingdale's and Macy's and online retailers such as Amazon and Zappos. +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand from Brian Atwood IP Company LLC. Founded in 2011, Brian Atwood is known for luxury shoes manufactured in Italy. +International Division. The International Division works through special distribution arrangements for the marketing and sales of our products in Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands (including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Betseyville® and Big Buddha® brands,) and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States and Canada. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon® and Steve Madden® brand names and private labels to department stores and specialty stores. +3 +Retail Segment +As of December 31, 2014 , we owned and operated 160 retail stores including 122 Steve Madden full price stores, 32 Steve Madden outlet stores, one Steven store, one Superga store and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). In 2014 , we opened three new full price stores, 15 new outlet stores and closed five stores including three full price stores, one Steven store and our FREEBIRD by Steven online store. In addition, we added the Dolce Vita online store through the Dolce Vita acquisition, four stores in South Africa through a joint venture and 21 stores in Mexico through the acquisition of our Mexican distributor. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico and South Africa. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2014 and 2013 ) decreased 8.1% in fiscal year 2014 from the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product development efforts of our two Wholesale segments. We expect to open eight to ten new retail stores and anticipate closing three to four stores in 2015 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that by operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Currently, our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including, Kohl's, K-Mart and Sears. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery and women's fashion apparel, jewelry, watches and luggage. In addition, the Company licenses the Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, swimwear, eyewear, watches, fragrances and outerwear. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note P to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new Steve Madden products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Steve Madden products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Steve Madden brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +4 +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers in China, Mexico, the Netherlands, India, Vietnam, Brazil and Italy. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from four third-party distribution centers, two located in California, one located in Texas and one located in New Jersey and through two Company-operated distribution centers located in New Jersey and Canada. By utilizing distribution facilities specializing in distribution fulfillment to effect distribution to certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers include, Target, Macy's, DSW, Payless, Ross, Walmart, Nordstrom, Dillard's, TJ Maxx and Marshall's. For the year ended December 31, 2014 , Target, Inc. represented 10.5% of net sales and 12.8% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico and South Africa +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants and in our Company-owned retail stores in the United States, Canada, Mexico and South Africa and our e-commerce websites. For the year ended December 31, 2014 , our Retail segment and our two Wholesale segments generated net sales of approximately $205,988 and $1,128,963 , or 15% and 85% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2014 , we operated 122 Steve Madden full price stores, 32 Steve Madden outlet stores, one Steven store, one Superga store and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. Specifically, we often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,900 to 2,100 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal +5 +to a more mature target audience. The typical outlet store is approximately 2,300 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell to over 2,500 doors of 17 department stores throughout the United States and Canada. Our major accounts include Macy's, Nordstrom, Dillard's, Belk and Bon Ton. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-throughs, which, in turn, reduces markdown exposure at season's end. +National chains and mass merchants. We currently sell to national chains and mass merchants throughout the United States and Canada. Our major accounts include Target, Walmart, Kohl's, JC Penney and Sears. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States and Canada. Our major specialty store accounts include DSW, Famous Footwear and Journeys. We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's and Victoria's Secret. +Internet Sales. We operate four Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson and Dolce Vita) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International +Our products are available in many countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Nine West, Jessica Simpson, Guess, Ugg and Aldo. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +6 +Marketing and Sales +We have focused on creating an integrated brand building program to establish Steve Madden as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include product placements in life style and fashion magazines, personal appearances by our founder and Creative and Design Chief, Steve Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products, as well as view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our wholesale information system is an Enterprise Resource Planning (“ERP”) system. This integrated system supports our wholesale business in the areas of finance and accounting, manufacturing, purchase order management, customer order management and inventory control. We completed the implementation of this new ERP system for our wholesale business in 2014 and are currently in the process of its implementation as to businesses acquired since the inception of the ERP implementation. In 2014 we completed the implementation of a new warehouse management system that is utilized by our third-party logistics providers and which interfaces with our ERP system. Additionally, we have a new business-to-consumer e-commerce software platform that we are currently in the process of implementing as to businesses acquired. We are also currently implementing a point of sale system (“POS”) for our retail stores that is integrated with a retail inventory management/store replenishment system. Complimenting all of these systems are ancillary systems and third-party information processing services including, among others, supply chain, data warehouse, Electronic Data Interchange (“EDI”), credit card processing and payroll. We undertake updates and upgrades of all of these information management systems on a periodic basis in order to ensure that our functionality is continuously improved. +Intellectual Property +Trademarks +We consider our trademarks to be among our most valuable assets and have registered many of our marks in the United States and 94 other countries and in numerous International Classes. From time to time we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +Blondo® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective licensing of our brands. As of December 31, 2014 , we license our Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, +7 +outerwear, bedding, hosiery and women's fashion apparel, jewelry, watches and luggage. In addition, the Company licenses the Betsey Johnson® and Betseyville® trademarks for use in connection with the manufacture, marketing and sale of apparel, jewelry, watches, swimwear, eyewear, fragrances and outerwear. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we also license the trademarks of third parties for use in connection with certain of our product lines. Through a license agreement with Basic Properties America Inc. and BasicNet S.p.A we have the right to use the Superga® trademark in connection with the marketing and sale of footwear through December 31, 2022. This licensing agreement requires us to make royalty and advertising payments to the licensor equal to a percentage of our net sales or a minimum royalty and advertising payment in the event that specified net sales targets are not achieved. See Notes A and O to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2015 , we employed approximately 3,256 employees, of whom approximately 1,137 work on a full-time basis and approximately 2,119 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,230 of our employees are located in the United States, approximately 641 employees are located in Hong Kong and China, approximately 296 employees are located in Canada and approximately 89 employees are located in Mexico. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality +Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the timing of holidays, weather, the timing of larger shipments of footwear, market acceptance of our products, product mix, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. +Backlog +We had unfilled wholesale customer orders of approximately $312,000 and $295,000, as of February 1, 2015 and 2014 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. \ No newline at end of file diff --git a/raw/filings/0000913241/2014/0001628280-15-001083/item13.txt b/raw/filings/0000913241/2014/0001628280-15-001083/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..aab50e34ea1aba1e2a9699ca920d065c55c56bc3 --- /dev/null +++ b/raw/filings/0000913241/2014/0001628280-15-001083/item13.txt @@ -0,0 +1,4 @@ +ITEM 13 +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2015 Annual Meeting of Stockholders, and is incorporated herein by reference. +32 \ No newline at end of file diff --git a/raw/filings/0000913241/2014/0001628280-15-001083/item9a.txt b/raw/filings/0000913241/2014/0001628280-15-001083/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..593b2c68f4fd534cc85f2c57977e647ca85da7d5 --- /dev/null +++ b/raw/filings/0000913241/2014/0001628280-15-001083/item9a.txt @@ -0,0 +1,13 @@ +ITEM 9A CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions +31 +and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We have excluded Dolce Vita and SM Mexico, which were acquired on August 13, 2014 and December 30, 2014, respectively, from the scope of our annual report on internal control over financial reporting as of December 31, 2014. Dolce Vita represented approximately 7% of our total assets at December 31, 2014, and approximately 2% of our net revenues for the year ended December 31, 2014. SM Mexico represented approximately 2% of our total assets at December 31, 2014, and approximately 0% of our net revenues for the year ended December 31, 2014. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2014 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2014 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2014 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2014 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000913241/2014/0001628280-15-001083/rp_note.txt b/raw/filings/0000913241/2014/0001628280-15-001083/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000913241/2014/0001628280-15-001083/rpt_disclosure.txt b/raw/filings/0000913241/2014/0001628280-15-001083/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..6473b11206e11f5cd5b9b880639244076145d92b --- /dev/null +++ b/raw/filings/0000913241/2014/0001628280-15-001083/rpt_disclosure.txt @@ -0,0 +1,143 @@ +and Related Party Transactions +JLM +Consultants, Inc. Commencing in 2004, the Company engaged JLM Consultants, Inc., a company wholly-owned by John L. Madden, +who, until his passing in October 2015, had served as a director of the Company for more than 20 years, to provide consulting +services to the Company with respect to the development of international sales of the Company. Mr. Madden was the brother of Steven +Madden, the Company’s founder and Creative and Design Chief. The services were provided under a consulting agreement (the +“JLM Consulting Agreement”) dated February 23, 2012 between the Company and JLM Consultants, Inc. In accordance +with the terms of the JLM Consulting Agreement, for the 2015 Fiscal Year, JLM Consultants, Inc. received the following compensation +from the Company for services rendered: (a) a commission equal to 1% of net sales, excluding retail royalty income; (b) a +commission equal to 10% of retail royalty income; (c) 1% of any commission income to the International division that is not +recognized in net sales; (d) a monthly draw in the amount of $25,000, which amount is offset against commissions earned; +(e) a $1,000 per month travel allowance; and (f) monthly reimbursements, in the aggregate amount of $17,168 in the 2015 +Fiscal Year, for health insurance premiums for John L. Madden. Pursuant to this arrangement, JLM Consultants, Inc. received a +total of $1,372,721 from the Company in the 2015 Fiscal Year. +17 +Pursuant +to the JLM Consulting Agreement, on January 2, 2013, the Company issued 72,012 restricted shares of the Company’s Common +Stock (the number of shares indicated having been adjusted for an October 1, 2013 three-for-two stock split effected as a +stock dividend) to JLM Consultants, Inc. under the Steven Madden, Ltd. 2006 Stock Incentive Plan, as amended (the “2006 +Plan”). The shares vested in twelve substantially equal quarterly installments over a three-year period commencing on April 1, +2013 and ending on January 1, 2016. +Steven +Madden Employment Agreement. Effective as of July 1, 2005, the Company amended and restated its employment agreement with +the Company’s founder and Creative and Design Chief, Steven Madden, pursuant to which Mr. Madden agreed to continue +to serve as the Company’s Creative and Design Chief. The term of Mr. Madden’s employment under his employment +agreement commenced on July 1, 2005 and, in accordance with the amendment of the agreement effective December 31, 2011, will +end on December 31, 2023. Prior to this recent amendment, the agreement had provided for an annual salary of $600,000, with +a 7% increase of base salary on a compound basis in each of the third, fifth, seventh and ninth years of the agreement. The agreement +had also provided for an annual cash bonus in an amount equal to at least 2% of the Company’s EBITDA (the “Annual +Bonus”) and an annual cash bonus in relation to “new business” (as defined in the agreement) in an +amount equal to at least (i) 2.5% of new business gross direct revenues plus (ii) 10% of all license or other fee income +above $2,000,000 (the “New Business Bonus”). The agreement, as amended, increases Mr. Madden’s annual base +salary but eliminates the Annual Bonus and the New Business Bonus and provides that all cash bonuses subsequent to the fiscal +year ended December 31, 2011 will be at the sole discretion of the Company’s Board of Directors. Under the agreement, +as amended, Mr. Madden’s annual base salary was fixed at $5,416,667 in 2012, $7,416,667 in 2013, $9,666,667 in 2014, +$11,916,667 in 2015 and $10,697,917 in 2016 and in each year thereafter through the end of the term of employment. In addition, +the amended agreement entitles Mr. Madden to an annual life insurance premium reimbursement of up to $200,000. The amendment +also eliminates an annual non-accountable expense allowance of $200,000 that had been previously provided to Mr. Madden under +the agreement. Pursuant to the amended agreement, on February 8, 2012, Mr. Madden was granted 1,463,056 restricted shares +of Common Stock (the number of shares indicated having been adjusted for an October 1, 2013 three-for-two stock split effected +as a stock dividend), valued at approximately $40 million, under the 2006 Plan. The restricted Common Stock will vest in +equal annual installments over seven years commencing on December 31, 2017 through December 31, 2023, subject to Mr. Madden’s +continued employment with the Company on each such vesting date. +On +June 30, 2012, pursuant to an election right granted to him under the agreement, as amended, Mr. Madden notified the Company +of his election to receive an additional restricted stock award valued at $40 million in consideration of a reduction in +his annual base salary in years subsequent to 2012. Accordingly, on July 3, 2012, Mr. Madden was issued 1,893,342 restricted +shares of Common Stock (the number of shares indicated having been adjusted for an October 1, 2013 three-for-two stock split +effected as a stock dividend) under the 2006 Plan. The restricted Common Stock will vest in equal annual installments over +six years commencing on December 31, 2018 through December 31, 2023, subject to Mr. Madden’s continued +employment with the Company on each such vesting date. As a result of his election to receive an additional restricted stock award, +Mr. Madden’s annual base salary for years subsequent to 2012 has been reduced as follows: $4,000,000 in 2013, $6,125,000 +in 2014, $8,250,000 in 2015 and $7,026,042 in 2016 and in each year thereafter through the end of the term of employment. +Mr. Madden +is also eligible to receive annually, on or about the date of the Company’s annual meeting of stockholders (but not later +than June 30 th ), an option grant (the “Annual Option”) to purchase a number of shares of Common Stock, +with such number to be equal to the greater of (a) 100% of the largest aggregate number of shares of Common Stock available +upon the exercise of an option or options granted to any other continuing full-time employee of the Company during the preceding +twelve-month period and (b) 100,000 shares of Common Stock; provided, however, that a grant to Mr. Madden in excess +of 150% of the number of shares of Common Stock subject to options granted to such other continuing full-time employee would require +stockholder approval. Any Annual Option granted to Mr. Madden would vest quarterly over a one-year period following the grant +date and would be exercisable at a price equal to the closing price of the Company’s Common Stock on the grant date for +a period of five years following the grant date. In addition to the Annual Option, the agreement, as amended, provides for a potential +additional one-time stock option grant to purchase 750,000 shares of the Company’s Common Stock (the number of shares subject +to this potential stock option award having been adjusted for an October 1, 2013 three-for-two stock split effected as a +stock dividend) in the event that the Company achieves earnings per share, on a fully-diluted basis, equal to $3.00 in any +fiscal year ending December 31, 2015 or after. If granted, the option would vest in equal annual installments of 20% over +a five-year period and be exercisable for a period of seven years at a price equal to the closing price of the Company’s +Common Stock on the date immediately preceding the grant date. +18 +In +the event of Mr. Madden’s death, his employment agreement provides for the payment to Mr. Madden’s estate +of his base salary for the 12-month period immediately subsequent to the date of his death. Further, in the event that Mr. Madden’s +employment agreement is terminated due to Mr. Madden’s total disability (as defined in the agreement), “for cause” +(as defined in the agreement) or due to Mr. Madden’s resignation, the Company is obligated to pay Mr. Madden +the amount of compensation that is accrued and unpaid through the date of termination. In the event Mr. Madden’s employment +agreement is terminated for any reason (other than “for cause” or due to his death, total disability or resignation), +the Company is obligated to pay Mr. Madden, in installments, the balance of his base salary that would have been paid by +the Company under the agreement for the full term of the agreement. If, during the period commencing 120 days prior to a +“change of control” (as defined in the employment agreement) transaction and ending on the first anniversary +of a change of control transaction, Mr. Madden’s employment is terminated by the Company other than for cause or by +the resignation of Mr. Madden for “good reason” (as defined in the employment agreement), or if Mr. Madden +resigns for good reason or without good reason within 30 days following a change of control transaction, all unvested options +to purchase shares of Common Stock held by Mr. Madden will vest on the date of termination or resignation and Mr. Madden +will be entitled to receive a lump sum cash payment equal to the amount of compensation that is accrued and unpaid through the +date of termination plus $35 million. Mr. Madden’s employment agreement contains other customary provisions, including +provisions regarding expense reimbursement, confidentiality, solicitation and competition. +For +the 2015 Fiscal Year, Mr. Madden earned $8,250,000 in base salary and received $200,000 for the payment of an annual life +insurance premium. Mr. Madden opted to waive his right to the Annual Option for the 2015 Fiscal Year. +Loan +to Steven Madden. On June 25, 2007, the Company made a loan to Steven Madden, its Creative and Design Chief and a principal +stockholder of the Company, in the amount of $3,000,000, in order for Mr. Madden to satisfy a personal tax obligation resulting +from the exercise of a stock option which was due to expire and hold the underlying shares of Common Stock. The loan is evidenced +by a secured promissory note executed by Mr. Madden in favor of the Company, the security for which is a security interest in +a certain securities brokerage account maintained by Mr. Madden with his broker; none of the securities in the securities brokerage +account are shares of the Company’s Common Stock. There have been successive amendments to the secured promissory note, +the most recent of which occurred in April 2016, at which time the secured promissory note was amended to substitute the collateral +securing the secured promissory note from shares of the Company’s Common Stock to the security interest in Mr. Madden’s +securities brokerage account. Previously, on January 3, 2012, the secured promissory note was amended and restated to extend the +maturity date of the obligation to December 31, 2023 and eliminate the accrual of interest after December 31, 2011. +Prior to the January 3, 2012 amendment, the secured promissory note had been accruing interest at the rate of 6% per annum. In +addition, the secured promissory note provides that, commencing on December 31, 2014 and annually on each December 31 +thereafter through the maturity date, one-tenth of the principal amount thereof, together with accrued interest, will be cancelled +by the Company provided that Mr. Madden continues to be employed by the Company on each such December 31. Contemporaneously, +the Company will release its security interest in a portion of the securities held in Mr. Madden’s securities brokerage +account generally correlating to the amount of indebtedness cancelled on such date. As of December 31, 2011, interest in +the amount of $1,090,000 had accrued on the principal amount of the secured promissory note and, as noted above, interest was +eliminated after December 31, 2011. On December 31, 2015, the required one-tenth of the principal amount of the secured +promissory note, together with accrued interest, was written-off by the Company. +Steven +Madden is the brother of John L. Madden, who served as a director of the Company until his passing in October 2015. +19 +Review, Approval or Ratification +of Transactions with Related Persons +The +Company’s written Conduct Code and Employee Handbook prohibit all conflicts of interest. Under the Conduct Code, conflicts +of interest occur when private or family interests interfere in any way, or even appear to interfere, with the interests of the +Company. The Company’s prohibition on conflicts of interest under the Conduct Code includes any related person transaction. +Related +person transactions must be approved by the Board, or by a committee of the Board consisting solely of independent directors, +who will approve the transaction only if they determine that it is in the best interests of the Company. In considering the transaction, +the Board or committee will consider all relevant factors, including, as applicable, (i) the Company’s business rationale +for entering into the transaction; (ii) the alternatives to entering into a related person transaction; (iii) whether +the transaction is on terms comparable to those available to third parties or, in the case of employment relationships, to employees +generally; (iv) the potential for the transaction to lead to an actual or apparent conflict of interest and any safeguards +imposed to prevent such actual or apparent conflicts; and (v) the overall fairness of the transaction to the Company. +The +Company has multiple processes for reporting conflicts of interests, including related person transactions. Under the Conduct +Code, all employees are required to report any actual or apparent conflict of interest, or potential conflict of interest, to +management. The Chief Financial Officer distributes a questionnaire to the Company’s executive officers and management personnel +on a quarterly basis and distributes a questionnaire to the members of the Board of Directors on an annual basis requesting certain +information regarding, among other things, their immediate family members, employment and beneficial ownership interests, which +information is then reviewed for any conflicts of interest under the Conduct Code. +The +Board of Directors, the Audit Committee and the Disclosure Committee, which is comprised of management personnel, discuss the +related party transactions, specifically, and in connection with the regular review processes attendant to the Company’s +periodic filings, including related party transaction disclosures. +If +a director is a party to or in some manner involved in a transaction involving the Company, he or she will be recused from all +discussions and decisions about the transaction. The transaction must be approved in advance whenever practicable, and if not +practicable, must be ratified as promptly as practicable. +COMPENSATION \ No newline at end of file diff --git a/raw/filings/0000913241/2016/0001628280-17-001869/filing.txt b/raw/filings/0000913241/2016/0001628280-17-001869/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..233391238751ee643cf0eae6c84f45406d002f3d --- /dev/null +++ b/raw/filings/0000913241/2016/0001628280-17-001869/filing.txt @@ -0,0 +1,4216 @@ +10-K +1 +shoo-20161231x10k.htm +10-K +Document +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2016 +or +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ________ to ________ +Commission File Number 0-23702 +STEVEN MADDEN, LTD. +(Exact name of registrant as specified in its charter) +Delaware +13-3588231 +(State or other jurisdiction of +(I.R.S. Employer Identification No.) +incorporation or organization) +52-16 Barnett Avenue, Long Island City, New York 11104 +(Address of principal executive offices) (Zip Code) +(718) 446-1800 +(Registrant's Telephone Number, Including Area Code) +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Common Stock, par value $.0001 per share +The NASDAQ Stock Market LLC +Preferred Stock Purchase Rights +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes x No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act. +Yes o No x +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes x No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes x No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer x +Accelerated filer o +Non-accelerated filer o (do not check if smaller reporting company) +Smaller reporting company o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). +Yes o No x +The aggregate market value of the common equity held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and directors are “affiliates” of the registrant) as of June 30, 2016 , the last business day of the registrant's most recently completed second fiscal quarter, was $2,074,695,648 (based on the closing sale price of the registrant's common stock on that date as reported on The NASDAQ Global Select Market). +The number of outstanding shares of the registrant's common stock as of February 27, 2017 was 59,882,884 shares. +DOCUMENTS INCORPORATED BY REFERENCE: +PART III INCORPORATES CERTAIN INFORMATION BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT'S 2017 ANNUAL MEETING OF STOCKHOLDERS. +TABLE OF CONTENTS +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +1 +PART I +ITEM 1 BUSINESS +1 +ITEM 1A RISK FACTORS +9 +ITEM 1B UNRESOLVED STAFF COMMENTS +16 +ITEM 2 PROPERTIES +16 +ITEM 3 LEGAL PROCEEDINGS +17 +ITEM 4 MINE SAFETY DISCLOSURES +18 +PART II +ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER +MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +18 +ITEM 6 SELECTED FINANCIAL DATA +21 +ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION +AND RESULTS OF OPERATIONS +22 +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +32 +ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +33 +ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON +ACCOUNTING AND FINANCIAL DISCLOSURE +33 +ITEM 9A CONTROLS AND PROCEDURES +33 +ITEM 9B OTHER INFORMATION +34 +PART III +ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +34 +ITEM 11 EXECUTIVE COMPENSATION +34 +ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND +MANAGEMENT AND RELATED STOCKHOLDER MATTERS +34 +ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND +DIRECTOR INDEPENDENCE +34 +ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES +34 +PART IV +ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +34 +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K contains “forward-looking statements” (as that term is defined in the federal securities laws), which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with regard to future revenue, projected 2017 results, earnings, spending, margins, cash flow, customer orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives and other future events. More generally, forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. Factors that may affect our results include, but are not limited to, the risks and uncertainties discussed in Item 1A of this Annual Report on Form 10-K. +Any such forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based and could cause our actual results to differ materially from those projected in forward-looking statements. As such, we strongly caution you that these forward-looking statements are not guarantees of future performance or events. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. +PART I +ITEM 1 BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories. We also license some of our trademarks for use in connection with the manufacture, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico and South Africa, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we have special distribution arrangements for the marketing of our products in Asia, Australia, Europe (excluding the aforementioned European nations), India, the Middle East, South and Central America and New Zealand. We offer a broad range of updated styles designed to establish or complement and capitalize on market trends. We have established a reputation for design creativity and our ability to offer quality products in popular styles at affordable prices, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. The public may read and copy any materials filed by us with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information regarding the operation of the SEC's Public Reference Room +1 +is available by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company and a Code of Business Conduct and Ethics that is applicable to all of our employees, each of which are attached as exhibits to the 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015 and posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Net sales for 2016 decreased 0.4% to $1,399,551 from $1,405,239 in 2015 . Net income attributable to Steven Madden, Ltd. increased 7.1% to $120,911 in 2016 compared to $112,938 in 2015 . Diluted earnings per share in 2016 increased to $2.03 per share on 59,556,000 diluted weighted average shares outstanding compared to $1.85 per share on 61,142,000 diluted weighted average shares outstanding in the prior year. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, B Brian Atwood®, Blondo®, Madden NYC and includes our International business and certain private label footwear business. Our Wholesale Accessories segment includes Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Cejon®, B Brian Atwood® and Luv Betsey® accessories brands and includes our International business and certain private label accessories business. These trademarks are registered trademarks owned by us with the exception of Superga®, which is licensed to us by a third party. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores along with one multi-branded SHOO by Steve Madden store offering a variety of the Company's brands, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, we license our Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl is geared for young women ages 16 to 23, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +2 +Steve Madden Men's. We design, source, and market a life style collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range from $70 to $150 at retail. +Madden. T he Madden® brand is a denim friendly collection of footwear designed to meet the ever evolving needs of the trend conscious male consumer, ages 13 to 35 years old. Madden products range from $45 to $90 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden brand, Steven products are designed to appeal principally to fashion conscious women, ages 25 to 45, who shop at department stores, footwear boutiques and shopping networks. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12. Our Stevies® brand is sold exclusively to Target, while our Steve Madden Kids® brand is distributed to department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. +FREEBIRD by Steven . We design, source, and market a full collection of handcrafted, Goodyear welted boots. The designs are inspired by vintage Americana and created using time-honored craftsmanship. The FREEBIRD by Steven® collection conveys a unique fashion life style that transcends multiple generations. FREEBIRD by Steven products are currently sold, at retail prices ranging from $195 to $450 at major department stores, mid-tier retailers, and specialty boutiques. +Report. The Report® brand was acquired in our May 2011 acquisition of Topline Corporation ("Topline") and its subsidiaries. The Report® brand is a junior women's footwear brand with price points ranging from $20 to $150. We design, manufacture, market and sell our Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed exclusively to Target. +Dolce Vita. In August 2014, the Company acquired the Dolce Vita® and DV® brands and other intellectual property assets in the acquisition of Dolce Vita Holdings, Inc. Dolce Vita® is a contemporary women's footwear brand with price points ranging from $120 to $350. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. The DV® brand has price points ranging from $20 to $75 and is currently distributed exclusively at Target. +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand from Brian Atwood IP Company LLC. Founded in 2011, Brian Atwood is known for luxury shoes manufactured in Italy. We design, manufacture, market and sell our Brian Atwood branded products primarily to major department stores throughout the United States. +Blondo. In January 2015, the Company acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. +International Division. The International division, utilizing the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, +3 +Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, the International division works through special distribution arrangements for the marketing and sales of our products in Asia, Australia, Europe (excluding the aforementioned nations), India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands (including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Madden NYC, Big Buddha®, B Brian Atwood® and Luv Betsey® brands) and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our International distributor network. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon®, Steve Madden®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2016 , we owned and operated 189 retail stores including 129 Steve Madden full price stores, 52 Steve Madden outlet stores, two Steven stores, one Superga store, one SHOO by Steve Madden store offering a variety of the Company's brands and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). In 2016 , we opened nine new full price stores, twelve new outlet stores and closed one full price store in the United States. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico and South Africa. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2016 and 2015 ) increased 4% in fiscal year 2016 from the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product development efforts of our two Wholesale segments. We expect to open seven to eight new retail stores and close one location in 2017 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Kohl's, Sears and K-Mart. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +4 +See Note O to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new Steve Madden products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Steve Madden products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Steve Madden brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers in China, Mexico, Brazil, India, Indonesia, Vietnam and Italy. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from four third-party distribution centers, two located in California, one located in Texas and one located in New Jersey. Our products are also distributed through two Company-operated distribution centers located in New Jersey and Canada. By utilizing distribution facilities specializing in distribution fulfillment to effect distribution to certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers include Target Corporation, Nordstrom, Inc., Macy's, Inc., The TJX Companies, Inc., Ross Stores, Inc., DSW, Inc., Wal-Mart Stores, Inc., Payless ShoeSource, Inc., Burlington Stores, Inc. and Dillard's, Inc. For the year ended December 31, 2016 , Target Corporation represented 12.0% of net sales and 16.9% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +5 +Distribution Channels +United States, Canada, Mexico, Europe and South Africa +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico, certain European nations including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we sell our products in our Company-owned retail stores in the United States, Canada, Mexico and South Africa and on our e-commerce websites. For the year ended December 31, 2016 , our Retail segment and our two Wholesale segments generated net sales of approximately $262,756 and $1,136,795 , or 19% and 81% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2016 , we operated 129 Steve Madden full price stores within the United States, Canada, Mexico and South Africa. We also operated 52 Steve Madden outlet stores, two Steven stores, one Superga store and one SHOO by Steve Madden store within the United States. Our SHOO by Steve Madden store offers a variety of the Company's brands. The Company also operated four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell to over 2,500 doors of 17 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Macy's, Inc., Nordstrom, Inc., Dillard's, Inc., Belk, Inc. and Lord & Taylor. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at season's end. +National chains and mass merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Target Corporation, Wal-Mart Stores, Inc., Kohl's Corporation, and The J.C. Penney Company. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW, Inc., Famous Footwear, Journeys and Payless ShoeSource, Inc . We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's and Victoria's Secret. +6 +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate four Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson and Dolce Vita) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Nine West, Jessica Simpson, Guess, Ugg and Aldo. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +Marketing and Sales +We have focused on creating an integrated brand building program to establish Steve Madden as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations including product and brand placements in life style and fashion magazines and digital outlets, as well as personal appearances by our founder and Creative and Design Chief, Steve Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products, as well as view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our wholesale information system is an Enterprise Resource Planning (“ERP”) system. This integrated system supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. We completed the implementation of this new ERP system for our wholesale business in 2014. We completed the implementation of such ERP system in three of our acquired businesses in 2015 and in two of our acquired businesses in 2016. We are currently in the process of implementing the ERP system for one of our U.S.-based wholesale businesses and our Asia first-cost and sourcing operations. In 2014 we completed the implementation of a new warehouse management system that is utilized by our third-party logistics providers. During 2015 we implemented this warehouse management system in a company-owned warehouse. This warehouse management system interfaces with our ERP system. We continue to implement our business-to-consumer e-commerce software platform for more recently acquired businesses and brands. We are also currently implementing a point of sale system for our retail stores that is integrated with a retail inventory management/store replenishment system. Complimenting all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing +7 +and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +Intellectual Property +Trademarks +We consider our trademarks to be among our most valuable assets and have registered many of our marks in the United States and 94 other countries and in numerous International Classes. From time to time we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +R Design® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +DV® +LUV BETSEY plus Kiss Design® +Wild Pair® +LUV BETSEY by Betsey Johnson Design® +MadLove® +Blondo® +Betsey Johnson plus Kiss Logo® +Steve Madden plus Design® +Report Seattle® +Blondo Waterproof plus Heart Design® +R2® +SM New York® +Topline® +SM New York plus Design® +Dolcetta® +Madden Girl by Steve Madden® +DV8® +Steve Madden plus Heart Logo® +JD FISK® +Stevies plus Design® +B Blondo plus Design® +Big Buddha plus Design® +Studio B® +Big Buddha love big. Live Buddha plus Design® +Studio Blondo® +Betsey Johnson Too Too® +Blue By Betsey Johnson® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective licensing of our brands. As of December 31, 2016 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, +8 +marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we also license the trademarks of third parties for use in connection with certain of our product lines. Through a license agreement with Basic Properties America Inc. and BasicNet S.p.A we have the right to use the Superga® trademark in connection with the marketing and sale of footwear through December 31, 2022. This licensing agreement requires us to make royalty and advertising payments to the licensor equal to a percentage of our net sales or a minimum royalty and advertising payment in the event that specified net sales targets are not achieved. See Notes A and N to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2017 , we employed approximately 3,925 employees, of whom approximately 2,419 work on a full-time basis and approximately 1,506 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,652 of our employees are located in the United States, approximately 704 employees are located in Hong Kong and China, approximately 356 employees are located in Canada, approximately 144 employees are located in Mexico, approximately 60 employees are located in South Africa and approximately 9 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality +Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the timing of holidays, weather, the timing of larger shipments of footwear, market acceptance of our products, product mix, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. +Backlog +We had unfilled wholesale customer orders of approximately $337,000 and $295,000, as of February 1, 2017 and 2016 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. +ITEM 1A RISK FACTORS +You should carefully consider the risks and uncertainties we describe below and the other information in this Annual Report on Form 10-K before deciding to invest in, sell or retain shares of our common stock. These are not the only risks and uncertainties that we face. Other sections of this report may discuss factors that could adversely affect our business. The retail industry is highly competitive and subject to rapid change. There may be additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, which may also harm our business or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, results of operations and liquidity could be materially harmed. +9 +Risks Related to the Industry in Which the Company Operates +Constantly Changing Fashion Trends and Consumer Demands. Our success depends in significant part upon our ability to anticipate and respond to product and fashion trends as well as to anticipate, gauge and react to changing consumer demands in a timely manner. There can be no assurance that our products will correspond to the changes in taste and demand or that we will be able to successfully market products that respond to such trends. If we misjudge the market for our products, we may be faced with significant excess inventories for some products and missed opportunities as to others. In addition, misjudgments in merchandise selection could adversely affect our image with our customers resulting in lower sales and increased markdown allowances for customers which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Intense Fashion Industry Competition . The fashion footwear and accessories industry is highly competitive and barriers to entry are low. Our competitors include specialty companies as well as companies with diversified product lines. The recent market growth in the sales of fashion footwear and accessories has encouraged the entry of many new competitors and increased competition from established companies. Many of these competitors, including Nine West, Guess, Jessica Simpson, Ugg and Aldo, may have significantly greater financial and other resources than we do and there can be no assurance that we will be able to compete successfully with other fashion footwear and accessories companies. Increased competition could result in pricing pressures, increased marketing expenditures and loss of market share, and could have a material adverse effect on our business, financial condition, results of operations and liquidity. We believe effective advertising and marketing, favorable branding of the Steve Madden® and our other trademarks, fashionable styling, high quality and value are the most important competitive factors and we plan to continue to focus on these elements as we develop new products and businesses. Our inability to effectively advertise and market our products and respond to customer preferences could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Cyclical Nature of the Fashion Industry . The overall fashion industry is cyclical, and purchasing tends to decline during recessionary periods when disposable income is low. Likewise, purchases of contemporary shoes and accessories tends to decline during recessionary periods and also may decline at other times. There can be no assurance that we will be able to grow or even maintain our current level of revenues and earnings, or remain profitable in the future. Continuing slow growth in the international, national or regional economies and uncertainties regarding future economic prospects, among other things, could affect consumer spending habits. The volatility and disruption of global economic and financial market conditions that began in 2008 has caused lingering declines in consumer confidence and spending in the United States and internationally. A further deterioration or a continued weakness of economic and financial market conditions for an extended period of time could have a material adverse effect on our business, financial condition, results of operations and liquidity. +A Rapidly Changing Retail Industry . In recent years, the retail industry has experienced consolidation and other ownership changes. In the future, retailers in the United States and in foreign markets may further consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our products or increase the ownership concentration within the retail industry. Also, online retail shopping is rapidly evolving, and we expect competition in the e-commerce market will intensify. As a greater portion of consumer expenditures with retailers occurs online and through mobile commerce applications, our brick-and-mortar retail customers who fail to successfully integrate their physical retail stores and digital retail may experience financial difficulties, including store closures, bankruptcies or liquidations. This could, in turn, substantially increase our credit risk and have a material adverse effect on our results of operations, financial condition and cash flows. Our future success will be determined, in part, on our ability to identify and capitalize on retail trends, including technology, e-commerce and other process efficiencies that will better service our customers. If we fail to compete successfully, our businesses, market share, results of operations and financial condition will be materially and adversely affected. While such changes in the retail industry to date have not had a material adverse effect on our business or financial condition, results of operations and liquidity, there can be no assurance as to the future effect of any such changes. +Economic Uncertainty . Our opportunities for long-term growth and profitability are accompanied by significant challenges and risks, particularly in the near term. Specifically, our business is dependent on consumer demand for our products. We believe that declining consumer confidence accompanied with the tightening of credit standards, higher energy and food prices and unemployment rates and a decrease in consumers' disposable income has negatively impacted the level of consumer spending for discretionary items during the years ended December 31, 2016 , 2015 and 2014 . A continued weak economic environment could have a negative effect on the Company's sales and results of operations during the year ending December 31, 2017 and thereafter. +10 +Legal, Regulatory and Political Risks of a Global Economy. Our business is subject to risks associated with our operations in international markets, including the burdens of complying with foreign laws and regulations, unexpected changes in tariffs, taxes or regulatory requirements, and political unrest and corruption. Regulatory changes could limit the countries in which we sell or source our products or significantly increase the cost of operating in or obtaining materials originating from certain countries. In addition, political and economic changes or volatility, geopolitical regional conflicts, terrorist activity, political unrest, civil strife, acts of war, public corruption and other economic or political uncertainties could interrupt and negatively affect our business operations. All of these factors could result in increased costs or decreased revenues and could materially and adversely affect our product sales, financial condition and results of operations. +Recently, the leaders of our federal government have increasingly focused on efforts to discourage U.S. corporations from outsourcing manufacturing and production activities to foreign jurisdictions, including through the possibility of imposing tariffs or penalties on goods manufactured outside the United States to attempt to discourage these practices. It has also been suggested that the United States may materially modify or withdraw from some of its existing trade agreements. Any of these actions, if ultimately enacted, could necessitate changes in the way we conduct business that could adversely affect our results of operations or profitability. +We are subject to the U.S. Foreign Corrupt Practices Act, which generally prohibits the payment of bribes to foreign officials to assist in obtaining or retaining business. We are also subject to anti-corruption laws of the foreign countries in which we operate. While we have implemented policies and procedures that are designed to promote compliance with such laws, our employees, contractors and agents may take actions that violate our policies and procedures. Any such violation could result in sanctions or other penalties against the Company and have an adverse effect on our business, reputation and operating results. +In June 2016, voters in the United Kingdom approved an advisory referendum, commonly referred to as “Brexit”, to withdraw from the European Union. Brexit has created political and economic uncertainty, particularly in the United Kingdom and the European Union, that may endure for years. The withdrawal of the United Kingdom from the European Union could significantly disrupt the free movement of goods, services, and people between the United Kingdom and the European Union, and increase legal and regulatory complexities, all of which could lead to higher costs of conducting business in Europe. Brexit could also encourage similar referendums in other European countries in which we do business. The terms of the United Kingdom's withdrawal from the European Union are uncertain. Its consequences could adversely impact consumer and investor confidence, and the level of consumer purchases of discretionary items and retail products, including our products. All of these factors could materially adversely affect our business, results of operations, and financial condition. +Risks Related to Our Business +Dependence on Key Personnel. The growth and success of our Company since its inception more than a quarter century ago is attributable, to a significant degree, to the talents, skills and efforts of our founder and Creative and Design Chief, Steven Madden. An extended or permanent loss of the services of Mr. Madden could severely disrupt our business and have a material adverse effect on the Company. In addition to Mr. Madden, the Company depends on the contributions of the members of our senior management team. Our senior executives have substantial experience and expertise in our business and industry and have made significant contributions to our growth and success as well. Competition for executive talent in the apparel, footwear and accessories industries is intense. While our employment agreements with Mr. Madden and most of our senior executives include a non-compete provision in the event of the termination of employment, the non-compete periods are of limited duration. While we believe we have depth within our senior management team, if we lose the services of our Creative and Design Chief or any of our senior executives, and especially if any of these individuals joins a competitor or forms a competing company, our business and financial performance could be seriously harmed. A loss of the skills, industry knowledge, contacts and expertise of our Creative and Design Chief or any of our senior executives could cause a setback to our operating plan and strategy. +Dependence Upon Significant Customers . Our customers consist principally of better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers. Certain of our department store customers, including some under common ownership, account for significant portions of our wholesale business. We generally enter into a number of purchase order commitments with our customers for each of our lines every season and do not enter into long-term agreements with any of our customers. Therefore, a decision by a significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to decrease the amount of merchandise purchased from us or to change its manner of doing business could have a material adverse effect on our business, financial condition, results of operations and liquidity. +11 +Risks Associated with Extending Credit to Customers. We sell our products primarily to retail stores across the United States and extend credit based on an evaluation of each customer's financial condition, usually without collateral. Various retailers, including some of our customers, have experienced financial difficulties as a result of the financial crisis that began in 2008, which has increased the risk of extending credit to such retailers. However, our losses due to bad debts have been limited. Pursuant to the terms of our collection agency agreement, our factor, Rosenthal & Rosenthal, Inc., currently assumes the credit risk related to approximately 72% of our trade accounts receivable. In addition, we have letters of credit for approximately 6% of our trade accounts receivable. Still, if any of our customers experience a shortage of liquidity, the risk that the customer's outstanding payables to us would not be paid could cause us to curtail business with the customer or require us to assume more credit risk relating to the customer's account payable. +Risks Associated with Expansion of Retail Business . Our continued growth depends to a significant degree on whether we are successful in further developing and marketing our brands, and creating new brands, product categories and businesses that are appealing to our customers. The operation of company-owned Steve Madden, Steven and Superga stores and outlets is a significant part of our growth strategy. During the year ended December 31, 2016 , we opened nine new full price stores, twelve new outlet stores and closed one full price store in the United States. We have plans to open 6 to 10 new retail stores in 2017 . Our future expansion plan includes the opening of stores in new geographic markets as well as strengthening existing markets. New markets have in the past presented, and will continue to present, competitive and merchandising challenges that are different from those faced by us in our existing markets. There can be no assurance that we will be able to open new stores, and if opened, that such new stores will be able to achieve sales and profitability levels consistent with management's expectations. Our retail expansion is dependent on the performance of our wholesale and retail operations, generally, as well as on a number of other factors, including our ability to: +• +locate and obtain favorable store sites; +• +negotiate favorable lease terms; +• +hire, train and retain competent store personnel; +• +anticipate the preferences of our retail customers in new geographic areas; +• +successfully integrate new stores into our existing operations. +Past comparable store sales results may not be indicative of future results and there can be no assurance that our comparable store sales results will increase or even be maintained in the future. +Management of Growth . The size of our business continues to grow organically and as a result of business acquisitions. In order to gain from our acquisitions, we must be effective in integrating the businesses acquired into our overall operations. Further, the expansion of our operations has increased and will continue to increase the demand on our managerial, operational and administrative resources. In recent years, we have invested significant resources in, among other things, our management information systems and hiring and training of new personnel. However, in order to manage currently anticipated levels of future demand, we may be required to, among other things, expand our distribution facilities, establish relationships with new manufacturers to produce our product, and continue to expand and improve our financial, management and operating systems. We may experience difficulty integrating acquired businesses into our operations and may not achieve anticipated synergies from such integration. There can be no assurance that we will be able to manage future growth effectively and a failure to do so could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruptions to Product Delivery Systems and Associated Inventory Management Issues. A majority of our products for U.S. distribution are shipped to us via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on California ports. The trend-focused nature of the fashion industry and the rapid changes in customer preferences leave us vulnerable to risk of inventory obsolescence. Our reliance upon ocean freight transportation for the delivery of our inventory exposes us to various inherent risks, including port workers’ union disputes and associated strikes, work slow-downs and work stoppages, severe weather conditions, natural disasters and terrorism, any of which could result in delivery delays and inefficiencies, increase our costs and disrupt our business. Any severe and prolonged disruption to ocean freight transportation could force us to use alternate and more expensive transportation systems, such as the California port workers' dispute in 2014, which caused us to re-route our merchandise by air transit. Efficient and timely inventory deliveries and proper inventory management are important factors in our operations. Inventory shortages can adversely affect the timing of shipments to customers and diminish sales and brand loyalty. Conversely, excess inventories can result in lower gross margins due to the excessive discounts and markdowns that may be necessary to reduce high inventory levels. Severe and extended delays in the delivery of our inventory or our inability to effectively manage our inventory could have a material adverse effect on our business, financial condition, results of operations and liquidity. +12 +Disruption of Information Technology Systems and Websites. We are heavily dependent upon our information technology systems to record and process transactions and manage and operate all aspects of our business ranging from product design and testing, production, forecasting, ordering, transportation, sales and distribution, invoicing and accounts receivable management, quick response replenishment, point of sale support and financial management reporting functions. In addition, we have e-commerce and other Internet websites. Given the nature of our business and the significant number of transactions that we engage in on an annual basis, it is essential that we maintain constant operation of our information technology systems and websites and that these systems and our websites operate effectively. We depend on our in-house information technology employees and third-parties including “cloud” service providers to maintain and periodically update and/or upgrade these systems and our websites to support the growth of our business. Despite our preventative efforts, our information technology systems and websites may be vulnerable from time to time to damage or interruption from events such as difficulties in replacing or integrating new systems or the systems of acquired businesses, computer viruses, security breaches and power outages. Cybersecurity attacks are becoming increasingly sophisticated and run the gamut from malicious software and ransomware to electronic security breaches to corruption of data and beyond. We are continually evaluating, improving and upgrading our information technology systems and websites in an effort to address these concerns. Any such problems or interruptions could result in loss of valuable business data, our customers' or employees' personal information, disruption of our operations and other adverse impacts to our business and require significant expenditures by us to remediate any such failure, problem or breach. In addition, we must comply with increasingly complex regulatory standards enacted to protect business and personal data and an inability to maintain compliance with these regulatory standards could subject us to legal risks and penalties. +We maintain $25 million of network-security insurance coverage, above a $250,000 deductible. This coverage and certain other insurance coverage may reduce our exposure to electronic data theft and sabotage. +Breach of Customer Privacy. A routine part of our business includes the gathering, processing and retention of sensitive and confidential information pertaining to our customers, employees and others. While we believe that our information security and information technology systems and websites allow for the secure storage and transmission of private information regarding our customers and others, including credit card information and personal identification information, we may not have the resources or technical sophistication to anticipate or prevent the rapidly-evolving and complex cyber-attacks being unleashed by increasingly sophisticated hackers and data thieves. As a result, our facilities and information technology systems, as well as those of our third party service providers, may be vulnerable to cyber-attacks and breaches, acts of vandalism, ransomware, software viruses and other similar types of malicious activities. Any actual or threatened cyber-attack may cause us to incur costs, including costs related to the hiring of additional computer experts, business interruption, engaging third party cyber security consultants and upgrading our information security technologies. We also may be vulnerable to data and security breaches by us or by persons with whom we have commercial relationships resulting from misplaced or lost data, programming or human error, or other similar events. Any compromise or breach of our information technology systems that results in the misappropriation, loss or other unauthorized disclosure of a customer's or other person’s confidential or proprietary information, whether by the Company or a third party service provider, could result in a loss of confidence and severely damage our reputation and relationship with our customers and others who entrust us with sensitive information, violate applicable privacy and other laws and adversely affect our business, as well as expose the Company to the risk of litigation and significant potential liability. +Foreign Sourcing and Manufacturing. Virtually all of our products are purchased through arrangements with a number of foreign manufacturers, primarily from China, Mexico, India, Brazil, Indonesia, Italy and Vietnam. During 2016 , approximately 87% of our total purchases were from China. Risks inherent in foreign operations including work stoppages, transportation delays and interruptions, social unrest and political upheaval and changes in economic conditions, can result in the disruption of trade from the countries in which our manufacturers or suppliers are located, the imposition of additional regulations relating to imports, the imposition of additional duties, taxes and other charges on imports, significant fluctuations of the value of the dollar against foreign currencies, or restrictions on the transfer of funds, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. While we believe that we manage our exposure to the risk that any such economic or political condition will materially affect our ability to purchase products because we are aware of the availability of a variety of materials and alternative sources, we cannot be certain that we will be able to identify such alternative materials and/or sources without delay or without greater cost to us. Our inability to identify and secure alternative sources of supply in this situation could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Impact of Custom Duties and Other Import Regulations . Virtually all of our products are imported and subject to United States custom duties. The United States and the countries in which our products are produced or sold, from time to time, impose new quotas, duties, tariffs or other restrictions on imports or exports, may adversely adjust prevailing quotas, duties or tariff levels, or impose sanctions in the form of additional duties to remedy perceived illegal actions, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +13 +Manufacturers' Inability to Produce Our Goods in a Timely Manner or Meet Quality Standards . As is common in the footwear and accessories industries, we contract with foreign manufactures who produce virtually all of our products to our specifications. We do not own or operate any manufacturing facilities; therefore, we are dependent upon third parties for the manufacture of all of our products. The inability of a manufacturer to ship orders of our products in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers for those items, which, in turn, could result in cancellation of orders, refusal to accept deliveries, a reduction in purchase prices and, ultimately, termination of a customer relationship, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +SEC rules relating to “conflict minerals” require the Company to incur additional expenses and could adversely affect our business. The SEC has promulgated final rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring the disclosure of the use of tantalum, tin, tungsten and gold, known as “conflict minerals,” included in products either manufactured by public companies or as to which public companies have contracted for the manufacture. These rules, adopted in an effort to prevent inadvertent support of armed conflict in the Democratic Republic of Congo and certain adjoining countries (collectively, the “DRC”), require companies to investigate their supply chains to determine whether these minerals are present in their products and, if so, from where the minerals originated. The rules also require disclosure and annual reporting as to whether or not conflict minerals, if used in the manufacture of the products offered, originated from the DRC. Compliance with these rules could adversely affect the sourcing, supply and pricing of materials used in our products. We currently require our manufacturers to comply with policies addressing legal and ethical concerns relating to labor, employment, political and social matters including restrictions on the use of conflict minerals. Violation of these policies by our manufacturers could harm our reputation, disrupt our supply chain and/or increase our cost of goods sold. Additionally, violation of any of these policies by our manufacturers could cause us to face disqualification as a supplier for our customers and suffer reputational challenges. Due to the complexity of our supply chain, compliance with the rules requires significant efforts from a cross-operational team and diverts our management and personnel and results in potential costs of additional staff. Any of the foregoing could adversely affect our sales, net earnings, business and financial condition and results of operations. +Difficulty in Locating Replacement Manufacturers. Although we enter into a number of purchase order commitments each season specifying a time frame for delivery, method of payment, design and quality specifications and other standard industry provisions, we do not have long-term contracts with any manufacturer. As a consequence, any of these manufacturing relationships may be terminated, by either party, at any time. In addition, we may seek replacement manufacturers for various reasons, including a significant increase in the prices we are required to pay to existing manufacturers of our goods. Although we believe that other facilities are available for the manufacture of our products, there can be no assurance that such facilities would be available to us on an immediate basis, if at all, or be able to meet our quality standards and delivery requirements, or that the costs charged to us by such manufacturers would not be significantly greater than those presently paid. +Manufacturers' Failure to Use Acceptable Labor Practices and Comply with Local Laws and Other Standards . Our products are manufactured by numerous independent manufacturers outside of the United States. We also have license agreements that permit our licensees to manufacture or contract to manufacture products using our trademarks. We impose, and require that our licensees impose, on these manufacturers environmental, health, and safety standards for the benefit of their labor force. In addition, we require these manufacturers to comply with applicable standards for product safety. However, we do not control our independent manufacturers or licensing partners or their labor, product safety and other business practices and, from time to time, our independent manufacturers may not comply with such standards or applicable local law or our licensees may not require their manufacturers to comply with such standards or applicable local law. The violation of such standards and laws by one of the independent manufacturers with whom we contract or by one of our licensing partners, or the divergence of a manufacturer's or a licensing partner's labor practices from those generally accepted as ethical in the United States, could harm our reputation, result in a product recall or require us to curtail our relationship with and locate a replacement for such manufacturer, which, as noted in the immediately preceding risk factor, could be challenging. Any of these events could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Seasonal and Quarterly Fluctuations . Our results of operations may fluctuate from quarter to quarter and are affected by a variety of factors, including: +• +the timing of holidays; +• +weather conditions; +• +the timing of larger shipments of footwear; +• +market acceptance of our products; +• +the mix, pricing and presentation of the products offered and sold; +• +the hiring and training of additional personnel; +14 +• +inventory write downs for obsolescence; +• +the cost of materials; +• +the product mix between wholesale, retail and licensing businesses; +• +the incurrence of other operating costs; and +• +factors beyond our control, such as general economic conditions and actions of competitors. +In addition, we expect that our sales and operating results may be significantly impacted by the opening of new retail stores and the introduction of new products. Accordingly, the results of operations in any quarter will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter. +Extreme or unseasonable weather conditions in locations in which we or our customers and suppliers are located could adversely affect our business. Our corporate headquarters and principal operational locations, including retail, distribution and warehousing facilities, may be subject to natural disasters and other severe weather and geological events that could disrupt our operations. The occurrence of such natural events may result in sudden disruptions in business conditions of the local economies affected, as well as of the regional and global economies, and may result in decreased demand for our products and disruptions in our management functions, sales channels and manufacturing and distribution networks, which could have a material adverse effect on our business, financial condition and results of operations. Extreme weather events and changes in weather patterns can also influence customer trends and shopping habits. Extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season may diminish demand for our seasonal merchandise. Heavy snowfall, hurricanes or other severe weather events in the areas in which our retail stores and the retail stores of our wholesale customers are located may decrease customer traffic in those stores and reduce our sales and profitability. If severe weather events force closure of or disrupt operations at the distribution centers we use for our merchandise, we could incur higher costs and experience longer lead times to distribute our products to our retail stores, wholesale customers or e-commerce customers. If prolonged, such extreme or unseasonable weather conditions could adversely affect our business, financial condition and results of operations. +Inadequate Trademark Protections . We believe that our trademarks and other proprietary rights are of major significance to our success and our competitive position and consider some of our trademarks, such as Steve Madden, to be integral to our business and among our most valuable assets. Accordingly, we devote substantial resources to the establishment and protection of our trademarks on a worldwide basis. Nevertheless, there can be no assurance that the actions taken by us to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products on the basis that our products violate the trademarks and proprietary rights of others. Moreover, no assurance can be given that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve such conflicts. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Our failure to establish and then protect such proprietary rights from unlawful and improper utilization could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Litigation and Other Legal Proceedings. We are involved in various claims, litigations and other legal and regulatory proceedings and governmental investigations that arise from time to time in the ordinary course of our business. Due to the inherent uncertainties of litigation and such other proceedings and investigations, we cannot predict with accuracy the ultimate outcome of any such matters. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations and the amount of insurance coverage we maintain to address such matters may be inadequate to cover these or other claims. In addition, any significant litigation, investigation or proceeding, regardless of its merits, could divert financial and management resources that would otherwise be used to benefit our operations. See Item 3 “Legal Proceedings,” below for additional information regarding certain of the matters in which we are involved. +Declines in Our Stock Price Due to Inaccurate Predictions. The trading price of our common stock periodically may rise or fall based on the accuracy of predictions of our future performance. As one of our primary objectives, we strive to maximize the long-term strength, growth and profitability of our Company, rather than to achieve an earnings target in any particular fiscal quarter. We believe that this longer-term goal is in the best interests of the Company and our stockholders, but recognize that it may be helpful to our stockholders and potential investors for us to provide guidance as to our quarterly and annual forecast of net sales and earnings. While we endeavor to provide meaningful and considered guidance at the time it is provided and generally expect to provide updates to our guidance when we report our results each fiscal quarter, actual results may differ from our predictions as the guidance is based on assumptions and expectations that may or may not come to pass and, as such, we assume no responsibility to update any of our forward-looking statements at such times or otherwise. If and when we announce actual results that differ from those that have been predicted by us, the market price of our common stock could be adversely affected. Investors who rely on these predictions in making investment decisions with respect to our common stock do so at their own risk. We take no responsibility for any losses suffered as a result of such changes in the price of our common stock. +15 +In addition, at any given time outside securities analysts may follow our financial results and issue reports that discuss our historical financial results and the analysts' predictions of our future performance, which our stockholders and potential investors may choose to rely on in making investment decisions. These analysts' predictions are based upon their own opinions and are often different from our own forecasts. Our stock price could decline if our results are below the estimates or expectations of these outside analysts. +Exposure to Foreign Currency Fluctuations . We make the majority of our purchases in U.S. dollars. However, we source substantially all of our products overseas and, as such, the cost of these products may be affected by changes in the value of the relevant currencies. Changes in currency exchange rates may also affect the relative prices at which we and our foreign competitors sell products in the same market. We use forward foreign exchange contracts to hedge material exposure to adverse changes in foreign exchange rates. However, no hedging strategy can completely insulate us from foreign exchange risk. We are also exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our financial statements due to the translation of operating results and financial position of our foreign subsidiaries. There can be no assurance that foreign currency fluctuations will not have a material adverse effect on our business, financial condition, results of operations and liquidity. +ITEM 1B UNRESOLVED STAFF COMMENTS +None. +ITEM 2 PROPERTIES +We lease space for our headquarters, our retail stores, showrooms and office facilities in various locations in the United States, as well as overseas. We own one improved real property parcel in Long Island City, New York. We believe that our existing facilities are in good operating condition and are adequate for our present level of operations. The following table sets forth information with respect to our key properties: +Location +Leased/Owned +Primary Use +Approximate Area Square Feet +Dongguan, Guangdong Province, China +Leased +Offices and sample production +166,800 +Long Island City, NY +Leased +Executive offices +90,000 +Bayonne, NJ +Leased +Warehouse +83,000 +Montreal, Canada +Leased +Offices, warehouse +82,422 +Bellevue, WA +Leased +Offices, Topline +41,500 +New York, NY +Leased +Offices and showroom, Accessories +30,000 +Putian City, Guangdong Province, China +Leased +Offices +13,800 +New York, NY +Leased +Showroom +13,401 +Seattle, Washington +Leased +Offices and showroom, Dolce Vita +10,537 +New York, NY +Leased +Offices and showroom, Dolce Vita +10,000 +Long Island City, NY +Leased +Storage +7,200 +Kwai Chung, Hong Kong +Leased +Offices +3,800 +Mexico City, Mexico +Leased +Offices, SM Mexico +3,520 +Los Angeles, CA +Leased +Showroom, Steven +2,700 +Long Island City, NY +Owned +Other +2,200 +New York, NY +Leased +Apartments +1,800 +New York, NY +Leased +Office +850 +Dallas, Texas +Leased +Showroom +800 +All of our retail stores are leased pursuant to leases that, under their original terms, extend for an average of ten years. Many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes over the base year. The current terms of our retail store leases expire as follows: +16 +Years Initial Lease Terms Expire +Number of Stores +2017 +22 +2018 +13 +2019 +19 +2020 +12 +2021 +20 +2022 +20 +2023 +24 +2024 +18 +2025 +21 +2026 +15 +2027 +1 +ITEM 3 LEGAL PROCEEDINGS +($ in thousands) +On August 10, 2005, following the conclusion of an audit of the Company conducted by auditors for U.S. Customs and Border Protection (“U.S. Customs”) during 2004 and 2005, U.S. Customs issued a report that asserts that certain commissions that the Company treated as “buying agents’ commissions” (which are non-dutiable) should be treated as “selling agents’ commissions” and hence are dutiable. Subsequently, U.S. Immigration and Customs Enforcement notified the Company’s legal counsel that a formal investigation of the Company’s importing practices had been commenced as a result of the audit. In September 2007, U.S. Customs notified the Company that it had finalized its assessment of the underpaid duties at $1,400 . The Company, with the advice of legal counsel, evaluated the liability in the case, including additional duties, interest and penalties, and believed that it was not likely to exceed $3,050 , and, accordingly, a liability for this amount was recorded as of December 31, 2009. The Company contested the conclusions of the U.S. Customs audit and filed a request for review and issuance of rulings thereon by U.S. Customs Headquarters, Office of Regulations and Rulings, under internal advice procedures. On September 20, 2010, U.S. Customs issued a ruling in the matter, concluding that the commissions paid by the Company pursuant to buying agreements entered into by the Company and one of its two buying agents under review were bona fide buying-agent commissions and, therefore, were non-dutiable. With respect to the second buying agent, U.S. Customs also ruled that beginning in February 2002, commissions paid by the Company were bona fide buying agent commissions and, therefore, were non-dutiable. However, U.S. Customs found that the Company’s pre-2002 buying agreements with the second agent were legally insufficient to substantiate a buyer-buyer’s agent relationship between the Company and the agent and that commissions paid to the second agent under such buying agreements, in fact, were dutiable. On the basis of the U.S. Customs ruling, the Company reevaluated the liability in the case and believes that it is not likely to exceed $1,248 and the liability was reduced from $3,050 to such amount as of September 30, 2010. +On November 21, 2011, U.S. Customs issued a pre-penalty notice to the Company in which it alleges that gross negligence by the Company resulted in an underpayment of duties with respect to certain pre-2002 buying agreements and claims that the Company owes $342 as an additional duty and $1,367 in monetary penalties. In its February 16, 2012 response to the pre-penalty notice, the Company submitted that it owes no additional duty and, further, did not through negligence or gross negligence fail to pay any duty or engage in conduct amounting to either gross negligence or negligence. The Company requested that U.S. Customs withdraw its proposal to issue a notice of penalty and take no further adverse action against the Company. In the event that U.S. Customs is not inclined to withdraw the pre-penalty notice after review of the Company’s response, the Company has requested the opportunity to make an oral presentation to U.S. Customs prior to the issuance of a notice of penalty. On June 26, 2014, the Company’s counsel met with U.S. Customs officials and, following the meeting, counsel submitted to U.S. Customs a letter and the Company’s check in the amount of $342, representing the Company’s Offer in Compromise of the proposed government claim. The Offer in Compromise was filed without any admission or acceptance by the Company with respect to the proposed claim. In the event that U.S. Customs determines to issue a notice of penalty, the Company intends to file a petition for relief requesting a reduction of the level of culpability and mitigation of the penalty amount assessed. The maximum total amount of damages, including penalty, related to this matter is estimated at approximately $1,700 for which the Company has accrued $1,248 . +We have been named as a defendant in certain other lawsuits in the normal course of business. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these matters should not have a material effect on our financial position or results of operations or cash flows. +17 +ITEM 4 MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5 +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our shares of common stock have traded on the NASDAQ Global Select Market since August 1, 2007 and were traded on the NASDAQ National Market prior to that date. The following table sets forth the range of high and low closing sales prices for our common stock during each fiscal quarter during the two-year period ended December 31, 2016 as reported by the NASDAQ Global Select Market. The trading volume of our securities fluctuates and may be limited during certain periods. As a result, the liquidity of an investment in our securities may be adversely affected. +Common Stock +High +Low +High +Low +2016 +2015 +Quarter ended +March 31, 2016 +$38.48 +$27.80 +Quarter ended +March 31, 2015 +$38.48 +$29.33 +Quarter ended +June 30, 2016 +$38.06 +$31.68 +Quarter ended +June 30, 2015 +$43.47 +$36.93 +Quarter ended +September 30, 2016 +$36.97 +$32.69 +Quarter ended +September 30, 2015 +$44.73 +$35.68 +Quarter ended +December 31, 2016 +$40.55 +$32.30 +Quarter ended +December 31, 2015 +$38.76 +$29.98 +Holders. As of February 27, 2017, there were 135 holders of record of our common stock. +Dividends . With the exception of a special cash dividend paid in November 2005 and in November 2006, we have not declared or paid any cash dividends in the past to the holders of our common stock. We intend to retain earnings, if any, for potential future dividends and to finance the development and expansion of our business. Future dividend policy will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions, and other factors. Therefore, we can give no assurance that any cash dividends of any kind will be paid to holders of our common stock in the future. +Equity Compensation Plans . Information regarding our equity compensation plans as of December 31, 2016 is disclosed in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” +Issuer Repurchases of Equity Securities. The Company's Board of Directors authorized a share repurchase program (the "Share Repurchase Program") effective as of January 1, 2004. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase, most recently on February 22, 2016 when the Board of Directors approved the continuation of the Share Repurchase Program for an additional $136 million. During fiscal year 2016 , an aggregate of 2,141,823 shares of the Company's common stock were repurchased under the Share Repurchase Program, at an average per share price of $35.11 , for an aggregate purchase price of approximately $75 million . At December 31, 2016 , an aggregate of approximately $117 million remained available for future repurchases of our common stock under the Share Repurchase Program. The following table presents the total number of shares of the Company's common stock, $.0001 par value, purchased by the Company in the three months ended December 31, 2016 , the average price paid per share and the approximate dollar value of the shares that still could have been purchased at the end of the fiscal period, pursuant to the Company's Share Repurchase Program. +18 +Period +Total Number of Shares Purchased (1) +Average Price Paid per Share (1) +Total Number of Shares Purchased as part of Publicly Announced Plans or Programs +Maximum Dollar Amount of Shares that May Yet Be Purchased Under the Plans or Programs +10/1/2016 - 10/31/2016 +— +$ +— +— +$ +134,126 +11/1/2016 - 11/30/2016 +67,576 +$ +38.60 +19,906 +$ +133,374 +12/1/2016 - 12/31/2016 +448,261 +$ +37.93 +421,829 +$ +117,374 +Total +515,837 +$ +38.02 +441,735 +$ +117,374 +(1) The Steven Madden, Ltd. 2006 Stock Incentive Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. Of the total number of shares purchased by the Company in the fourth quarter of 2016, 74,102 shares were withheld in connection with the settlement of vested restricted stock to satisfy tax withholding requirements. +Performance Graph . The following graph compares the yearly percentage change in the cumulative total stockholder return on our common stock during the period beginning on December 31, 2011, and ending on December 31, 2016, with the cumulative total return on the Russell 2000 Index, the S&P 500 Footwear Index and a peer group index. In 2016, the Company has decided that going forward the Company will remove the S&P 500 Footwear Index and replace it with a peer group index of companies believed to be engaged in similar businesses, as we believe the composition of the new peer group is more representative of our current business. The peer group index consists of six companies: Caleres, Inc., Crocs, Inc., Deckers Outdoor Corporation, Genesco Inc., Skechers U.S.A., Inc. and Wolverine World Wide, Inc. +The comparison assumes that $100 was invested on December 31, 2011 in our common stock and in the foregoing indices and assumes the reinvestment of dividends. +19 +12/31/2011 +12/31/2012 +12/31/2013 +12/31/2014 +12/31/2015 +12/31/2016 +Steven Madden, Ltd. +$100.00 +$122.52 +$159.09 +$138.39 +$131.39 +$155.43 +Russell 2000 Index +$100.00 +$116.35 +$161.52 +$169.42 +$161.95 +$196.45 +S&P 500 Footwear Index +$100.00 +$108.66 +$167.88 +$207.76 +$272.97 +$224.64 +Peer Group +$100.00 +$93.53 +$149.43 +$160.21 +$137.38 +$138.84 +20 +ITEM 6 SELECTED FINANCIAL DATA +The following selected financial data has been derived from our audited Consolidated Financial Statements. The Income Statement Data relating to 2016 , 2015 and 2014 , and the Balance Sheet data as of December 31, 2016 and 2015 should be read in conjunction with the information provided in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” and the notes to our Consolidated Financial Statements appearing elsewhere in this Annual Report on Form 10-K. +INCOME STATEMENT DATA +Year Ended December 31, +(in thousands, except per share data) +2016 +2015 +2014 +2013 +2012 +Net sales +$ +1,399,551 +$ +1,405,239 +$ +1,334,951 +$ +1,314,223 +$ +1,227,072 +Cost of sales +877,568 +904,747 +865,951 +831,847 +771,370 +Gross profit +521,983 +500,492 +469,000 +482,376 +455,702 +Commissions and licensing fee income - net +11,884 +16,647 +13,723 +15,632 +15,395 +Operating expenses +(364,691 +) +(342,446 +) +(315,081 +) +(295,223 +) +(283,689 +) +Impairment charges +— +(3,045 +) +— +983 +(8,432 +) +Income from operations +169,176 +171,648 +167,642 +203,768 +178,976 +Interest income (expense) - net +2,488 +2,191 +3,074 +4,100 +3,018 +Other income (expense) - net +(664 +) +(1,373 +) +677 +1,083 +2,193 +Income before provision for income taxes +171,000 +172,466 +171,393 +208,951 +184,187 +Provision for income taxes +49,726 +58,811 +58,764 +75,666 +64,623 +Net income +121,274 +113,655 +112,629 +133,285 +119,564 +Net (income) loss attributable to non-controlling interests +(363 +) +(717 +) +(749 +) +(1,278 +) +62 +Net income attributable to Steven Madden, Ltd. +$ +120,911 +$ +112,938 +$ +111,880 +$ +132,007 +$ +119,626 +Basic income per share +$2.12 +$1.91 +$1.82 +$2.04 +$1.85 +Diluted income per share +$2.03 +$1.85 +$1.76 +$1.98 +$1.81 +Basic weighted average shares of common stock +57,109 +58,997 +61,451 +64,583 +64,529 +Effect of dilutive securities - options and restricted stock +2,447 +2,145 +2,225 +2,253 +1,726 +Diluted weighted average shares of common stock outstanding +59,556 +61,142 +63,676 +66,836 +66,255 +BALANCE SHEET DATA +At December 31 , +2016 +2015 +2014 +2013 +2012 +Total assets +$ +973,047 +$ +914,385 +$ +911,235 +$ +880,241 +$ +804,039 +Working capital +359,529 +284,178 +266,513 +345,313 +309,861 +Noncurrent liabilities +48,848 +60,923 +64,115 +46,898 +43,161 +Stockholders' equity +$ +741,072 +$ +678,663 +$ +669,529 +$ +678,840 +$ +626,400 +21 +ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion of our Financial Condition and Results of Operations should be read in conjunction with our audited Consolidated Financial Statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. +Overview: +($ in thousands, except retail sales data per square foot, earnings per share and per share data) +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell name brand and private label fashion handbags and accessories, through our Accessories Division. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers, catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico and South Africa, and under special distribution arrangements in Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Our business is comprised of five distinct segments (Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing). Our Wholesale Footwear segment includes the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Report®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, B Brian Atwood®, Blondo®, Madden NYC and includes our International business and certain private label footwear business. Our Wholesale Accessories segment includes Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Luv Betsey®, B Brian Atwood®, Cejon® accessories brands and includes our International business and certain private label accessories business. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven, Superga and International retail stores, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, we license our Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +In April 2016, the Company formed a joint venture ("SM Europe") with SPM Shoetrade Holding B.V. through its subsidiary, Steve Madden Europe B.V. The Company is the majority interest holder in SM Europe and controls the joint venture. SM Europe is the exclusive distributor of the Company's products in Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden, Switzerland, and Tunisia. Additionally, the Company had strong retail growth during the year with net sales increasing 9% to $262,756 compared to $240,312 in the prior year period. This increase reflects a comparable store sales, which represent sales of stores (including the e-commerce websites) that were in operation throughout 2016 and 2015 , increase of 4% driven by better fashion trends and stronger product assortment coupled with a net increase of twenty stores year over year. Further, despite a challenging environment, the Company is pleased with the growth of the Steve Madden Women's, Dolce Vita and Blondo brands. +Subsequent to the end of the 2016 fiscal year, on January 30, 2017, the Company entered into an Equity Purchase Agreement (the “Purchase Agreement”) with Schwartz & Benjamin, Inc., a New York corporation (“S&A”), B.D.S., Inc., a Delaware corporation (“B.D.S”), Quinby Ridge Enterprises LLC, a Delaware limited liability company (“QRE”), DANIELBARBARA Enterprises LLC, a New York limited liability company (“DBE” and, collectively with S&A, B.D.S. and QRE, “Schwartz & +22 +Benjamin”), the owners of all of the issued and outstanding equity interests in Schwartz & Benjamin (the “Sellers”), and Daniel Schwartz, as designated agent for the Sellers, pursuant to which the Company purchased all of the outstanding equity interests in Schwartz & Benjamin from the Sellers. The purchase price payable to the Sellers in the acquisition consists of (i) $15,750 in cash paid at closing, subject to a post-closing working capital adjustment, plus (ii) a cash earn-out payment based on the performance of Schwartz & Benjamin in each of the next six years (beginning on February 1 and ending on January 31 of each year) equal to, in the case of earn-out years one through four, 40% of the EBITDA (as defined in the Purchase Agreement) of Schwartz & Benjamin and, in the case of earn-out years five and six, 75% of the EBITDA of Schwartz & Benjamin. The sum of $1,000 of the purchase price was deposited into escrow at closing to secure potential indemnification obligations of the Sellers. Schwartz & Benjamin, which was founded in 1923, engages in the design, sourcing and sale of branded and private label footwear and distributes it fashion footwear to wholesale customers, including better department stores and specialty boutiques, as well as the retail stores of its brand partners. +Key Performance Indicators and Statistics +The following measurements are among the key business indicators reviewed by various members of management to measure consolidated and segment results of the Company: +• +net sales +• +gross profit margin +• +operating expenses +• +income from operations +• +adjusted EBITDA +• +adjusted EBIT +• +same store sales +• +inventory turnover +• +accounts receivable average collection days +• +cash flow and liquidity determined by the Company’s working capital and free cash flow +• +store metrics such as sales per square foot, average unit retail, conversion, average units per transaction, and contribution margin. +While not all of these metrics are disclosed due to the proprietary nature of the information, many of these metrics are disclosed and discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Non-GAAP Measures +The Company’s reported results are presented in accordance with GAAP. The Company uses adjusted earnings before interest and taxes ("Adjusted EBIT") and adjusted earnings before interest, taxes, depreciation and amortization ("Adjusted EBITDA"), as calculated in the table below, as non-GAAP measures, in internal management reporting and planning processes as well as in evaluating the performance of the Company. Management believes these measures are useful to investors in evaluating the Company’s ongoing operating and financial results. By providing these non-GAAP measures, as a supplement to GAAP information, we believe we are enhancing investors’ understanding of our business and our results of operations. The non-GAAP financial measures are limited in their usefulness and should be considered in addition to, and not in lieu of, U.S. GAAP financial measures. Further, these non-GAAP measures may be unique to the Company, as they may be different from non-GAAP measures used by other companies. +23 +The table below reconciles these metrics to net income as presented in the consolidated statement of income. +Years Ended December 31 ($ in thousands) +2016 +2015 +2014 +Net Income +$ +121,274 +$ +113,655 +$ +112,629 +Add back: +Provision for income taxes +49,726 +58,811 +58,764 +Deduct: +Other Income (expense) - net * +(664 +) +(1,373 +) +677 +Interest, net +2,488 +2,191 +3,074 +Adjusted EBIT +169,176 +171,648 +167,642 +Add back: +Depreciation and amortization +19,868 +19,379 +14,519 +Loss on disposal of fixed assets +652 +1,780 +291 +Adjusted EBITDA +189,696 +192,807 +182,452 +* Consists of realized (losses) gains on marketable securities and foreign exchange (losses) gains. +Executive Summary +Net sales for 2016 slightly decreased by 0.4% to $1,399,551 from $1,405,239 in 2015 . The net sales decrease is due to a decline in both the Wholesale Footwear segment and the Wholesale Accessories segment partially offset by an increase in our Retail segment. Net income increased 7.1% to $120,911 in 2016 compared to $112,938 in 2015 . The Company's effective tax rate for 2016 decreased to 29.1% compared to 34.1% recorded in 2015 due primarily to the tax benefit received in connection with the early adoption of Accounting Standard Update No. 2016-09 ("ASU 2016-09"), Improvements to Employee Share-Based Payment Accounting, which changes the accounting for certain aspects of share-based payments to employees (refer to Note Q in the Consolidated Financial Statements) coupled with the planned reinvestment of foreign earnings in foreign locations. Diluted earnings per share in 2016 increased to $2.03 per share on 59,556,000 diluted weighted average shares outstanding compared to $1.85 per share on 61,142,000 diluted weighted average shares outstanding in the prior year. +In our Retail segment, same store sales (sales attributable to those stores, including the e-commerce websites, that were in operation throughout 2016 and 2015 ) increased 4% , and sales per square foot increased to $752 in 2016 compared to sales per square foot of $723 in 2015 . As of December 31, 2016 , we had 189 stores in operation, compared to 169 stores as of December 31, 2015 . Our store increase was primarily related to the addition of nine full price stores and twelve outlet store locations partially offset by one full price store closing. +Our total inventory turnover was 8.2 times compared to 8.7 times in the comparable period of last year. Our accounts receivable average collection days were 66 days in 2016 compared to 67 days in 2015 . As of December 31, 2016 , we had $236,169 in cash, cash equivalents and marketable securities, no short or long-term debt and total stockholders’ equity of $741,072 . Working capital increased to $359,529 as of December 31, 2016 , compared to $284,178 on December 31, 2015 . +24 +The following tables set forth information on operations for the periods indicated: +Years Ended December 31 +($ in thousands) +2016 +2015 +2014 +CONSOLIDATED: +Net sales +$ +1,399,551 +100.0 +% +$ +1,405,239 +100.0 +% +$ +1,334,951 +100.0 +% +Cost of sales +877,568 +62.7 +% +904,747 +64.4 +% +865,951 +64.9 +% +Gross profit +521,983 +37.3 +% +500,492 +35.6 +% +469,000 +35.1 +% +Other operating income – net of expenses +11,884 +0.8 +% +16,647 +1.2 +% +13,723 +1.0 +% +Operating expenses +364,691 +26.1 +% +342,446 +24.4 +% +315,081 +23.6 +% +Impairment charges +— +— +% +(3,045 +) +(0.2 +)% +— +0.1 +% +Income from operations +169,176 +12.1 +% +171,648 +12.2 +% +167,642 +12.6 +% +Interest and other income – net +1,824 +0.1 +% +818 +0.1 +% +3,751 +0.3 +% +Income before income taxes +171,000 +12.2 +% +172,466 +12.3 +% +171,393 +12.8 +% +Net income attributable to Steven Madden, Ltd. +120,911 +8.6 +% +112,938 +8.0 +% +111,880 +8.4 +% +By Segment: +WHOLESALE FOOTWEAR SEGMENT: +Net sales +$ +881,864 +100.0 +% +$ +898,364 +100.0 +% +$ +881,041 +100.0 +% +Cost of sales +602,028 +68.3 +% +632,542 +70.4 +% +621,277 +70.5 +% +Gross profit +279,836 +31.7 +% +265,822 +29.6 +% +259,764 +29.5 +% +Operating expenses +178,622 +20.3 +% +167,156 +18.6 +% +154,171 +17.5 +% +Income from operations - before impairment charges +101,214 +11.5 +% +98,666 +11.0 +% +105,593 +12.0 +% +WHOLESALE ACCESSORIES SEGMENT: +Net sales +$ +254,931 +100.0 +% +$ +266,563 +100.0 +% +$ +246,608 +100.0 +% +Cost of sales +170,510 +66.9 +% +178,202 +66.9 +% +161,968 +65.7 +% +Gross profit +84,421 +33.1 +% +88,361 +33.1 +% +84,640 +34.3 +% +Operating expenses +45,389 +17.8 +% +48,683 +18.3 +% +45,867 +18.6 +% +Income from operations - before impairment charges +39,032 +15.3 +% +39,678 +14.9 +% +38,773 +15.7 +% +RETAIL SEGMENT: +Net sales +$ +262,756 +100.0 +% +$ +240,312 +100.0 +% +$ +207,302 +100.0 +% +Cost of sales +105,030 +40.0 +% +94,003 +39.1 +% +82,706 +39.9 +% +Gross profit +157,726 +60.0 +% +146,309 +60.9 +% +124,596 +60.1 +% +Operating expenses +140,680 +53.5 +% +126,607 +52.7 +% +115,043 +55.5 +% +Income from operations - before impairment charges +17,046 +6.5 +% +19,702 +8.2 +% +9,553 +4.6 +% +Number of stores +189 +169 +160 +FIRST COST SEGMENT: +Other commission income – net of expenses +$ +3,824 +100.0 +% +$ +6,795 +100.0 +% +$ +6,438 +100.0 +% +LICENSING SEGMENT: +Licensing income – net of expenses +$ +8,060 +100.0 +% +$ +9,852 +100.0 +% +$ +7,285 +100.0 +% +25 +RESULTS OF OPERATIONS +($ in thousands) +Year Ended December 31, 2016 vs. Year Ended December 31, 2015 +Consolidated : +Net sales for the year ended December 31, 2016 slightly decreased by 0.4% to $1,399,551 from $1,405,239 for fiscal year 2015 . For the year ended December 31, 2016 , gross margin as a percentage of net sales increased to 37.3% compared to 35.6% in the prior year primarily resulting from higher initial mark-ups, decreased markdown allowances, and reduced close-outs coupled with sales mix in the Wholesale Footwear segment. Operating expenses increased in 2016 to $364,691 from $342,446 in 2015 . Operating expenses for the year ended December 31, 2015 included a benefit of $3,048 related to income arising from the early termination of our lease for our 5th Avenue, New York store, which was closed during the first quarter of 2015. Excluding this benefit, operating expenses in 2015 were $345,494 . Excluding the aforementioned benefit, the increase in operating expenses in 2016 is primarily due to the increase in retail store locations, employee-related expenses, charges related to an increase in contingent liabilities related to the Dolce Vita acquisition and costs associated with our new joint venture in Europe. As a result, operating expenses as a percentage of sales increased to 26.1% in the year ended December 31, 2016 compared to 24.6% , excluding the aforementioned benefit, in the previous year. Commission and licensing fee income decreased to $11,884 in 2016 compared to $16,647 in 2015 primarily due to a decline in our First Cost segment. During the year ended December 31, 2016 , income from operations decreased to $169,176 and net income attributable to Steven Madden, Ltd. increased to $120,911 compared to income from operations of $171,648 and net income attributable to Steven Madden, Ltd. of $112,938 in 2015 . Net income attributable to Steven Madden, Ltd. for the year ended December 30, 2016 included a tax benefit of $5,244 related to the adoption of Accounting Standards Update No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which changes the accounting for certain aspects of share-based payments to employees. Net income attributable to Steven Madden, Ltd. for the year ended December 30, 2015 included the $3,048 pre-tax benefit related to the closure of our 5th Avenue, New York store location as well as a pre-tax charge of $3,045 related to the partial impairment of our Wild Pair trademark. +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment was $881,864 , or 63.0% , and $898,364 , or 63.9% , of our total net sales for the years ended December 31, 2016 and 2015 , respectively. The decrease was driven by decreases in our private label business, international distributor business and our Madden Girl brand partially offset by increases in our Dolce Vita, Steve Madden Women's and Blondo brands. +Gross profit margin increased to 31.7% in 2016 from 29.6% in the prior year primarily resulting from higher initial mark-ups, decreased markdown allowances, and reduced close-outs coupled with sales mix. Operating expenses increased to $178,622 in 2016 compared to $167,156 in the same period of 2015 primarily due to charges related to an increase in contingent liabilities related to the Dolce Vita acquisition coupled with increases in employee-related expenses, advertising and promotion, and costs associated with our new joint venture in Europe. As a percentage of sales, operating expenses increased to 20.3% in 2016 from 18.6% in 2015 due to the increase in expenses discussed above coupled with deleverage on lower sales. Income from operations, excluding a pre-tax charge of $3,045 related to the partial impairment of our Wild Pair trademark in 2015, increased to $101,214 for the year ended December 31, 2016 compared to $98,666 for the year ended December 31, 2015 . +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $254,931 , or 18.2% , and $266,563 , or 19.0% , of total Company net sales for the years ended December 31, 2016 and 2015 , respectively. The decrease year over year is primarily driven by decreases in sales of Big Buddha handbags, cold weather accessories and belts partially offset by increases in sales of private label handbags. +Gross profit margin in the Wholesale Accessories segment remained flat at 33.1% in 2016 and 2015 . In the year ended December 31, 2016 , operating expenses decreased to $45,389 compared to $48,683 in the year ended December 31, 2015 . As a percentage of sales, operating expenses decreased to 17.8% in 2016 from 18.3% in 2015 primarily due to the impact of the year-over-year benefit received for the reversal of contingent liabilities related to acquisitions in the third quarter of 2016 and 2015 . Income from operations for the Wholesale Accessories segment decreased to $39,032 in 2016 compared to $39,678 in 2015 . +26 +Retail Segment : +Net sales generated by the Retail segment accounted for $262,756 , or 18.8% , and $240,312 , or 17.1% , of total Company net sales for the years ended December 31, 2016 and 2015 , respectively, which represents a $22,444 or 9.3% increase, year over year. This growth is primarily due to the net addition of twenty stores from the prior year coupled with an increase in comparable store sales of 4.0% driven by strong fashion footwear trends and stronger product assortment. During 2016 , we added nine full price stores and twelve outlets and closed one full price location. As a result, we had 189 retail stores as of December 31, 2016 , compared to 169 stores as of December 31, 2015 . The 189 stores currently in operation include 129 Steve Madden full price stores, 52 Steve Madden outlet stores, two Steven store, one Superga store, one multi-branded SHOO store and four e-commerce websites. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2016 and 2015 ) for the year ended December 31, 2016 increased 4.0% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2016 , gross margin decreased to 60.0% from 60.9% in 2015 primarily due to the impact of foreign currency fluctuations on our international operations. In 2016 , operating expenses increased to $140,680 from $126,607 in 2015 primarily due to the incremental cost associated with new store openings and increases in employee-related and rent expenses in existing locations. Operating expenses in 2015 included a benefit of $3,048 related to income arising from the early termination of our lease for our 5th Avenue, New York store, which was closed during the first quarter of 2015. Excluding this benefit, operating expenses in 2015 were $129,655 . Excluding the lease benefit in 2015, operating expenses as a percentage of sales decreased to 53.5% in 2016 from 54.0% in the prior year. For the year ended December 31, 2016 , income from operations for the Retail segment decreased to $17,046 compared to $19,702 in the prior year. Excluding the benefit of $3,048 in 2015, income from operations for the Retail segment in 2015 was $16,654 . +First Cost Segment : +Income for the First Cost segment, which includes net commission income and fees, decreased to $3,824 for the year ended December 31, 2016 , compared to $6,795 in 2015 due to a reduction in business with certain private label footwear customers. +Licensing Segment: +During the year ended December 31, 2016 , income for the Licensing segment decreased to $8,060 as compared to the prior year income of $9,852 primarily driven by the discontinuation of the Steve Madden eyewear licenses. +Year Ended December 31, 2015 vs. Year Ended December 31, 2014 +Consolidated : +Net sales for the year ended December 31, 2015 increased by 5.3% to $1,405,239 from $1,334,951 for fiscal year 2014 . For the year ended December 31, 2015 , gross margin as a percentage of net sales increased to 35.6% compared to 35.1% in the prior year. Operating expenses increased in 2015 to $342,446 from $315,081 in 2014 . Operating expenses, in 2015, included a benefit of $3,048 related to income arising from the early termination of our lease for our 5th Avenue, New York store, which was closed during the first quarter of 2015. Excluding this benefit, operating expenses were $345,494 . Excluding the aforementioned benefit, the increase in operating expenses is primarily due to the increase in retail store locations and the impact of recent acquisitions, partially offset by the reversal of contingent liabilities. Operating expenses, excluding the aforementioned lease termination income, as a percentage of sales increased to 24.6% in the year ended December 31, 2015 compared to 23.6% in the previous year due to operating expense deleverage on lower organic sales. Commission and licensing fee income increased to $16,647 in 2015 compared to $13,723 in 2014 . During the year ended December 31, 2015 , income from operations increased to $171,648 and net income attributable to Steven Madden, Ltd. increased to $112,938 compared to income from operations of $167,642 and net income attributable to Steven Madden, Ltd. of $111,880 in 2014 . Net income attributable to Steven Madden, Ltd. included the $3,048 pre-tax benefit related to the closure of our 5th Avenue, New York store location. Net income attributable to Steven Madden, Ltd. also included a pre-tax charge of $3,045 related to the partial impairment of our Wild Pair trademark, which was triggered by a decrease in expected sales stream from a significant customer. +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment was $898,364 , or 63.9% , and $881,041 , or 66.0% , of our total net sales for the years ended December 31, 2015 and 2014 , respectively. Excluding net sales attributable to the acquisitions of +27 +Dolce Vita, SM Mexico and Blondo in each year, organic net sales decreased 6.4% to $791,468 in fiscal year 2015 compared to $845,827 in the prior year. The prior year amount of $881,041 was adjusted to exclude sales of SM Mexico as a distributor prior to our acquisition of SM Mexico, and Dolce Vita sales due to the partial period. Excluding acquisitions, the decrease in net sales in 2015 was driven by declines in both branded and private label footwear. +Gross profit margin slightly increased to 29.6% in 2015 from 29.5% in the prior year, primarily due to the impact of acquisitions. Excluding the impact of acquisitions, gross profit margin was 29.4% in 2015 compared to 30.1% in 2014 . In the year ended December 31, 2015 , operating expenses were $167,156 compared to $154,171 in the same period of 2014 . As a percentage of sales, operating expenses increased to 18.6% in 2015 from 17.5% in 2014 , due to deleverage from the organic sales decrease and acquisitions. Excluding the impact of acquisitions, operating expenses as a percentage of sales were 17.8% in 2015 and 17.3% in 2014. Income from operations for the Wholesale Footwear segment, excluding a pre-tax charge of $3,045 related to the partial impairment of our Wild Pair trademark, decreased to $98,666 for the year ended December 31, 2015 compared to $105,593 for the year ended December 31, 2014 . Excluding acquisitions, income from operations for the Wholesale Footwear segment was $90,934 in 2015 compared to $107,866 in 2014. +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $266,563 , or 19.0% , and $246,608 , or 18.5% , of total Company net sales for the years ended December 31, 2015 and 2014 , respectively. The increase year over year is primarily due to double digit increases in Betsey Johnson, Steve Madden and private label handbags partially offset by decreases in Big Buddha handbags, cold weather accessories and belts. +Gross profit margin in the Wholesale Accessories segment decreased to 33.1% in 2015 from 34.3% in the prior year primarily due to increased sales to value priced retailers and increased sales of private label handbags both of which have lower margins. In the year ended December 31, 2015 , operating expenses increased to $48,683 compared to $45,867 in the year ended December 31, 2014 . As a percentage of sales, operating expenses decreased to 18.3% in 2015 from 18.6% in 2014 due to the current year amounts including a favorable impact from a benefit received for the reversal of contingent liabilities. Income from operations for the Wholesale Accessories segment increased to $39,678 in 2015 compared to $38,773 in 2014 . +Retail Segment : +Net sales generated by the Retail segment accounted for $240,312 , or 17.1% , and $207,302 , or 15.5% , of total Company net sales for the years ended December 31, 2015 and 2014 , respectively, which represents a $33,010 or 15.9% increase, year over year. This growth is primarily due to an increase in comparable store sales of 11.2% driven by better fashion footwear trends, stronger product assortment and improvement in conversion rate, and the net addition of nine stores from the prior year. Excluding the acquisition of SM Mexico retail stores, net sales increased 12.0% . During 2015 , we added seven full price stores and eight outlets and closed six full price locations. As a result, we had 169 retail stores as of December 31, 2015 , compared to 160 stores as of December 31, 2014 . The 169 stores in operation as of December 31, 2015 include 123 Steve Madden full price stores, 40 Steve Madden outlet stores, one Steven store, one Superga store and four e-commerce websites. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2015 and 2014 ) for the year ended December 31, 2015 increased 11.2% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2015 , gross margin increased to 60.9% from 60.1% in 2014 primarily due to decreased promotional activity compared to the prior year. In 2015 , operating expenses increased to $126,607 from $115,043 in 2014 primarily due to the incremental cost associated with new store openings and the acquisition of SM Mexico. Operating expenses included a benefit of $3,048 related to income arising from the early termination of our lease for our 5th Avenue, New York store, which was closed during the first quarter of 2015. Excluding this benefit, operating expenses were $129,655 . Excluding the lease benefit, operating expenses as a percentage of sales decreased to 54.0% in 2015 from 55.5% in the prior year. For the year ended December 31, 2015 , income from operations for the Retail segment increased to $19,702 compared to $9,553 in the prior year. Excluding the benefit of $3,048 in the first quarter of 2015, income from operations for the Retail segment was $16,654 . +First Cost Segment : +The First Cost segment generated income from operations of $6,795 for the year ended December 31, 2015 , compared to $6,438 in 2014 . +28 +Licensing Segment: +During the year ended December 31, 2015 , the Licensing segment generated income of $9,852 as compared to the prior year income of $7,285 . +LIQUIDITY AND CAPITAL RESOURCES +($ in thousands) +Our primary source of liquidity is cash flows generated from our operations. Our primary use of this liquidity is to fund our ongoing cash requirements, including working capital requirements, share repurchases, acquisitions, system enhancements and retail store expansion and remodeling. +Cash, cash equivalents and short-term investments totaled $165,610 and $104,838 at December 31, 2016 and December 31, 2015 , respectively. Of the total cash, cash equivalents and short-term investments at December 31, 2016 , $70,450 , or approximately 43% , was held in our foreign subsidiaries and of the total cash, cash equivalents and short-term investments at December 31, 2015 , $73,640 , or approximately 70% , was held in our foreign subsidiaries. To date, deferred taxes have been estimated and accrued for all of our foreign subsidiary earnings that have not been determined to be indefinitely reinvested. As of December 31, 2016 and 2015 , the cumulative total amount of earnings considered to be indefinitely reinvested of our foreign subsidiaries was $134,249 and $85,147 , respectively. If such amounts were not indefinitely reinvested, the Company would incur approximately $26,615 in taxes that were not previously provided for in our consolidated statements of income. Management believes that our existing domestic and international cash, cash equivalents, short-term investments and cash flows from operations, which are not considered to be indefinitely reinvested, continue to be sufficient to fund our domestic operating activities. Therefore, we do not intend, nor do we foresee a need, to repatriate foreign earnings of $134,249 as of December 31, 2016 , that were considered to be indefinitely reinvested and we do not believe there are any material implications or restrictions on our liquidity as a result of having a significant portion of our cash, cash equivalents and short-term investments held by our foreign subsidiaries. +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”). The agreement provides us with a credit facility in the amount of $30,000, having a sub-limit of $15,000 on the aggregate face amount of letters of credit, at an interest rate based, at our election, upon either the prime rate or LIBOR. The agreement can be terminated by the Company or Rosenthal at any time with 60 days’ prior written notice. As of December 31, 2016 we had no borrowings against this credit facility. +As of December 31, 2016 , we had working capital of $359,529 . We had cash and cash equivalents of $126,115 , investments in marketable securities short and long term of $110,054 and we did not have any long-term debt. +We believe that based upon our current financial position and available cash, cash equivalents and marketable securities, we will meet all of our financial commitments and operating needs for at least the next 12 months. +OPERATING ACTIVITIES +($ in thousands) +Cash provided by operations was $153,604 in 2016 compared to cash provided by operations of $ 135,963 in the prior year. The primary source of cash was net income of $121,274 and increases in our accounts payable and accrued expenses of $ 15,324 . The primary use of cash was an increase of inventories of $17,744 . +INVESTING ACTIVITIES +($ in thousands) +During the year ended December 31, 2016 , we invested $40,451 in marketable securities and received $52,215 from the maturities and sales of securities. We made capital expenditures of $15,897 , principally for new stores and improvements to existing stores, systems enhancements and leasehold improvements to office space. Cash of $249 was received in the repayment of the note receivable from the seller of SM Canada. +FINANCING ACTIVITIES +($ in thousands) +During the year ended December 31, 2016 , net cash used by financing activities was $95,453 , which consisted of share repurchases of $86,005 , payment of contingent liabilities related to acquisitions completed in prior years of $16,402 and cash paid of $3,759 +29 +to acquire the remaining minority interest in Madlove, LLC, partially offset by proceeds from the exercise of stock options of $10,713 . +CONTRACTUAL OBLIGATIONS +($ in thousands) +Our contractual obligations as of December 31, 2016 were as follows: +Payment due by period +Contractual Obligations +Total +2017 +2018 - 2019 +2020 - 2021 +2022 and after +Operating lease obligations +$ +248,258 +$ +41,281 +$ +73,034 +$ +62,912 +$ +71,031 +Purchase obligations +200,460 +200,460 +— +— +— +Contingent payment liability +7,948 +7,948 +— +— +— +Other long-term liabilities (future minimum royalty payments) +6,270 +1,270 +2,000 +2,000 +1,000 +Total +$ +462,936 +$ +250,959 +$ +75,034 +$ +64,912 +$ +72,031 +At December 31, 2016 , we had no open letters of credit for the purchase of inventory. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s then existing employment agreement with the Company. The amended agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides for a base salary of approximately $7,417 in 2013, approximately $9,667 in 2014, approximately $11,917 in 2015 and approximately $10,698 per annum for the period between January 1, 2016 through the expiration of the term of employment. The employment agreement provided Mr. Madden with the right, exercisable on certain specified dates in fiscal year 2012 only, to elect to receive a grant of restricted stock for a number of shares of the Company’s common stock valued at $40,000 in consideration for a reduction in his annual base salary in years subsequent to 2012 as follows: $4,000 in 2013, approximately $6,125 in 2014, approximately $8,250 in 2015 and approximately $7,026 per annum for the period between January 1, 2016 through the expiration of the employment agreement on December 31, 2023. On June 30, 2012, Mr. Madden exercised this right and on July 3, 2012 he was granted 1,893,342 restricted shares of the Company's common stock at the then market price of $21.13, which will vest in the same manner as the February 8, 2012 restricted stock grant received by Mr. Madden pursuant to the amended agreement. (See Note N to the Consolidated Financial Statements.) Accordingly, Mr. Madden's annual base salary was reduced as described above. In addition to the opportunity for cash bonuses at the sole discretion of the Board of Directors, Mr. Madden’s employment agreement entitles him to an annual life insurance premium payment as well as an annual stock option grant and the potential for an additional one-time stock option grant based on achievement of certain financial performance criteria. The employment agreement also provides for the elimination of interest accrued after December 31, 2011 on an outstanding loan in the original principal amount of $3,000 made by the Company to Mr. Madden, the extension of the maturity date of such loan until December 31, 2023, and the forgiveness of 1/10 th of the principal amount of the loan, together with accrued interest, annually over a ten-year period commencing on December 31, 2014 for so long as Mr. Madden continues to be employed by the Company on each such December 31. As a result of the elimination of further interest accumulation, the outstanding principal and the accrued interest as of December 31, 2011 has been discounted to reflect imputed interest, which will be amortized over the remaining life of the loan. +The Company has employment agreements with certain executive officers, which provide for the payment of compensation aggregating approximately $3,217 in 2017, $2,652 in 2018, and $1,393 in 2019. In addition, some of these employment agreements provide for discretionary bonuses and some provide for incentive compensation based on various performance criteria as well as other benefits including stock related compensation. +Virtually all of our products are produced by independent manufacturers at overseas locations, the majority of which are located in China, with a small and growing percentage located in Mexico in addition to smaller amounts in India, Brazil, Indonesia Italy, and Vietnam. We have not entered into any long-term manufacturing or supply contracts with any of these foreign manufacturers. We believe that a sufficient number of alternative sources exist outside of the United States for the manufacture of our products. Purchases are made primarily in United States dollars. +30 +INFLATION +We do not believe that inflation and price changes have had a significant effect on the Company's sales or profitability for the fiscal year ended December 31, 2016 and the prior two fiscal years. Historically, we have minimized the impact of product cost increases by increasing prices, changing suppliers and by improving operating efficiencies. However, no assurance can be given that we will be able to offset such inflationary cost increases in the future. +OFF BALANCE SHEET ARRANGEMENTS +The Company has no off balance sheet arrangements. +CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our Consolidated Financial Statements included in this Annual Report on Form 10-K, which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Estimates by their nature are based on judgments and available information. Our estimates are made based upon historical factors, current circumstances and the experience and judgment of management. Assumptions and estimates are evaluated on an ongoing basis and we may employ outside experts to assist in evaluations. Therefore, actual results could materially differ from those estimates under different assumptions and conditions. Management believes the following critical accounting estimates are more significantly affected by judgments and estimates used in the preparation of our Consolidated Financial Statements: allowance for bad debts, returns, and customer chargebacks; inventory valuation; valuation of intangible assets, litigation reserves, and contingent payment liabilities. +Allowances for bad debts, returns and customer chargebacks . We provide reserves against our trade accounts receivables for future customer chargebacks, co-op advertising allowances, discounts, returns and other miscellaneous deductions that relate to the current period. The reserve against our non-factored trade receivables also includes estimated losses that may result from customers’ inability to pay. The amount of the reserve for bad debts, returns, discounts and compliance chargebacks are determined by analyzing aged receivables, current economic conditions, the prevailing retail environment and historical dilution levels for customers. We evaluate anticipated customer markdowns and advertising chargebacks by reviewing several performance indicators for our major customers. These performance indicators (which include inventory levels at the retail floors, sell through rates and gross margin levels) are analyzed by management to estimate the amount of the anticipated customer allowance. Failure to correctly estimate the amount of the reserve could materially impact our results of operations and financial position. +Inventory valuation . Inventories are stated at lower-of-cost or market, on a first-in, first-out basis. We review inventory on a regular basis for excess and slow moving inventory. The review is based on an analysis of inventory on hand, prior sales, and expected net realizable value through future sales. The analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales and projections for sales in the foreseeable future as well as subsequent sales. We consider quantities on hand in excess of estimated future sales to be at risk for market impairment. The net realizable value, or market value, is determined based on the estimate of sales prices of such inventory through off-price or discount store channels. The likelihood of any material inventory write-down is dependent primarily on the expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product, the economy, or other failure to estimate correctly, in addition to abnormal weather patterns, could result in inventory valuation changes, compared to the valuation determined to be appropriate as of the balance sheet date. +Valuation of intangible assets and goodwill . Accounting Standards Codification (“ASC”) Topic 350, “Intangible – Goodwill and Other”, requires that goodwill and intangible assets with indefinite lives be tested for impairment at least annually. This pronouncement also requires that intangible assets with finite lives be amortized over their respective lives to their estimated residual values, and reviewed for impairment in accordance with ASC Topic 360, “Property, Plant and Equipment” (“ASC Topic 360”). +Indefinite-lived intangible assets and goodwill are assessed for impairment using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment requires an analysis of several estimates including future cash flows or income consistent with management’s strategic business plans, +31 +annual sales growth rates and the selection of assumptions underlying a discount rate (weighted average cost of capital) based on market data available at the time. +In accordance with ASC Topic 360, long-lived assets, such as property, equipment, leasehold improvements and intangible assets subject to amortization, are reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. +Litigation reserves . Estimated amounts for litigation claims that are probable and can be reasonably estimated are recorded as liabilities in our Consolidated Financial Statements. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable events of a particular litigation. As additional information becomes available, management will assess the potential liability related to the pending litigation and revise its estimates. Such revisions in management’s estimates of a contingent liability could materially impact our results of operation and financial position. +Contingent payment liabilities. The Company has completed acquisitions that require us to make contingent payments to the sellers based on the future financial performance of the acquired businesses over a period of from one to six years. The fair value of the contingent payments is estimated using the present value of management's projections of the financial results of the acquired business. Failure to correctly project the financial results of the acquired businesses could materially impact our results of operations and financial position. +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +($ in thousands) +Our financing arrangements are subject to variable interest rates primarily based on the prime rate and LIBOR. An analysis of our collection agency agreement with Rosenthal can be found in the “Liquidity and Capital Resources” section under Part II, Item 7, and in Note C to the Consolidated Financial Statements included in this Annual Report on Form 10-K under the caption “Factor Receivable.” As of December 31, 2016 , we held marketable securities valued at approximately $110,054 , which consisted primarily of corporate bonds and certificates of deposit. These securities are subject to interest rate risk and will decrease in value if interest rates increase. We currently have the ability to hold these securities until maturity. +We face market risk to the extent that our U.S. or foreign operations involve the transaction of business in foreign currencies. Also, our inventory purchases are primarily done in foreign jurisdictions and inventory purchases may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of our contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks primarily by denominating these purchases in U.S. dollars. To mitigate the risk of purchases that are denominated in foreign currencies we may enter into forward foreign exchange contracts for terms of no more than two years. A description of our accounting policies for derivative financial instruments is included in Notes A and K to the Consolidated Financial Statements. +During 2016, the Company entered into forward foreign exchange contracts. We performed a sensitivity analysis based on a model that measures the impact of a hypothetical change in foreign currency exchange rate to determine the effects that market risk exposures may have on the fair values of our forward foreign exchange contracts that were outstanding as of the year-end. As of December 31, 2016, a 10% appreciation or depreciation of the U.S. dollar against the exchange rates for foreign currencies under forward foreign exchange contracts would result in a net increase or decrease, respectively, in the fair value of our derivatives portfolio of approximately $27. +In addition, we are exposed to translation risk in connection with our foreign operations in Canada, Mexico, Europe and South Africa because our subsidiaries and joint ventures in these countries utilize the local currency as their functional currency and those financial results must be translated into U.S. dollars. As currency exchange rates fluctuate, foreign currency exchange rate translation adjustments reflected in our financial statements with respect to our foreign operations affects the comparability of financial results between years +32 +ITEM 8 +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The information required by this Item is incorporated herein by reference to the Consolidated Financial Statements listed in response to Item 15 of Part IV of this Annual Report on Form 10-K. +ITEM 9 +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2016 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2016 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2016 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2016 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +33 +ITEM 9B OTHER INFORMATION +On February 28, 2017, the Company issued a press release reporting its financial results for the fiscal quarter and fiscal year ended December 31, 2016, a copy of which is attached as Exhibit 99.01 to this Annual Report. +PART III +ITEM 10 +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2017 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 11 +EXECUTIVE COMPENSATION +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2017 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 12 +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2017 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 13 +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2017 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 14 +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2017 Annual Meeting of Stockholders, and is incorporated herein by reference. +PART IV +ITEM 15 +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) Financial Statements and Financial Statements Schedules +See Index to Consolidated Financial Statements included herein. +(b) Exhibits. See the exhibit index included herein. +34 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. +DATE: February 28, 2017 +STEVEN MADDEN, LTD. +/s/ EDWARD R. ROSENFELD +Edward R. Rosenfeld +Chairman and Chief Executive Officer +/s/ ARVIND DHARIA +Arvind Dharia +Chief Financial Officer and Chief Accounting Officer +35 +POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each of the undersigned constitutes and appoints Edward R. Rosenfeld and Arvind Dharia, and each of them, as attorneys-in-fact and agents, with full power of substitution and re-substitution, for and in the name, place and stead of the undersigned, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all that each of said attorney-in-fact or substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. +Signature +Title +Date +/S/ EDWARD R. ROSENFELD +Chairman, Chief Executive Officer and Director +February 28, 2017 +Edward R. Rosenfeld +/S/ ARVIND DHARIA +Chief Financial Officer and Chief Accounting Officer +February 28, 2017 +Arvind Dharia +/S/ AMELIA NEWTON VARELA +President and Director +February 28, 2017 +Amelia Newton Varela +/S/ PETER MIGLIORINI +Director +February 28, 2017 +Peter Migliorini +/S/ RICHARD P. RANDALL +Director +February 28, 2017 +Richard P. Randall +/S/ RAVI SACHDEV +Director +February 28, 2017 +Ravi Sachdev +/S/ THOMAS H. SCHWARTZ +Director +February 28, 2017 +Thomas H. Schwartz +/S/ ROSE LYNCH +Director +February 28, 2017 +Rose Lynch +/S/ ROBERT SMITH +Director +February 28, 2017 +Robert Smith +36 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Balance Sheets as of December 31, 2016 and 2015 +F-2 +Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014 +F-3 +Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014 +F-4 +Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2016, 2015 and 2014 +F-5 +Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014 +F-7 +Notes to Consolidated Financial Statements +F-8 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders +Steven Madden, Ltd. and subsidiaries +We have audited the accompanying consolidated balance sheets of Steven Madden, Ltd. and subsidiaries (the "Company") as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2016. We also have audited the Company's internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting appearing under Item 9A of the Company's December 31, 2016 annual report on Form 10-K. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Steven Madden, Ltd. and subsidiaries as of December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company has maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO. +As discussed in Notes H and Q to the consolidated financial statements, effective January 1, 2016 the Company changed its method of accounting for share-based payments to employees due to the adoption of Accounting Standards Update No. 2016-09, “Improvements to Employee Share-Based Payment Accounting”. +/s/ EisnerAmper LLP +New York, New York +February 28, 2017 +F-1 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Balance Sheets +(in thousands) +December 31, +2016 +2015 +ASSETS +Current assets: +Cash and cash equivalents +$ +126,115 +$ +72,414 +Accounts receivable, net of allowances of $1,622 and $2,306 +56,790 +43,173 +Factor accounts receivable, net of allowances of $20,209 and $21,756 +144,168 +155,211 +Inventories +119,824 +102,080 +Marketable securities – available for sale +39,495 +32,424 +Prepaid expenses and other current assets +26,351 +21,799 +Prepaid taxes +15,928 +17,484 +Deferred taxes +13,985 +14,392 +Total current assets +542,656 +458,977 +Note receivable – related party +2,644 +2,990 +Property and equipment, net +72,381 +72,010 +Deposits and other +4,710 +5,088 +Marketable securities – available for sale +70,559 +88,465 +Goodwill – net +135,711 +137,097 +Intangibles – net +144,386 +149,758 +Total Assets +$ +973,047 +$ +914,385 +LIABILITIES +Current liabilities: +Accounts payable +$ +80,584 +$ +79,790 +Accrued expenses +86,635 +72,105 +Contingent payment liability – current portion +7,948 +16,763 +Accrued incentive compensation +7,960 +6,141 +Total current liabilities +183,127 +174,799 +Contingent payment liability +— +8,012 +Deferred rent +14,578 +12,013 +Deferred taxes +31,638 +39,410 +Other liabilities +2,632 +1,488 +Total Liabilities +231,975 +235,722 +Commitments, contingencies and other +STOCKHOLDERS’ EQUITY +Preferred stock – $.0001 par value, 5,000 shares authorized; none issued; Series A Junior Participating preferred stock – $.0001 par value, 60 shares authorized; none issued +— +— +Common stock – $.0001 par value, 135,000 shares authorized, 86,417 and 85,263 shares issued, 60,410 and 61,693 shares outstanding +6 +6 +Additional paid-in capital +353,443 +325,548 +Retained earnings +1,017,753 +896,842 +Accumulated other comprehensive loss +(31,751 +) +(31,413 +) +Treasury stock – 26,007 and 23,570 shares at cost +(598,584 +) +(512,579 +) +Total Steven Madden, Ltd. stockholders’ equity +740,867 +678,404 +Non-controlling interests +205 +259 +Total stockholders’ equity +741,072 +678,663 +Total Liabilities and Stockholders’ Equity +$ +973,047 +$ +914,385 +See accompanying notes to consolidated financial statements +F-2 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Income +(in thousands, except per share data) +Years Ended December 31, +2016 +2015 +2014 +Net sales +$ +1,399,551 +$ +1,405,239 +$ +1,334,951 +Cost of sales +877,568 +904,747 +865,951 +Gross profit +521,983 +500,492 +469,000 +Commission and licensing fee income – net +11,884 +16,647 +13,723 +Operating expenses +(364,691 +) +(342,446 +) +(315,081 +) +Impairment charges +— +(3,045 +) +— +Income from operations +169,176 +171,648 +167,642 +Interest income (expense) - net +2,488 +2,191 +3,074 +Other (expense) income - net +(664 +) +(1,373 +) +677 +Income before provision for income taxes +171,000 +172,466 +171,393 +Provision for income taxes +49,726 +58,811 +58,764 +Net income +121,274 +113,655 +112,629 +Net income attributable to non-controlling interests +(363 +) +(717 +) +(749 +) +Net income attributable to Steven Madden, Ltd. +$ +120,911 +$ +112,938 +$ +111,880 +Basic net income per share +$ +2.12 +$ +1.91 +$ +1.82 +Diluted net income per share +$ +2.03 +$ +1.85 +$ +1.76 +Basic weighted average common shares outstanding +57,109 +58,997 +61,451 +Effect of dilutive securities – options/restricted stock +2,447 +2,145 +2,225 +Diluted weighted average common shares outstanding +59,556 +61,142 +63,676 +See accompanying notes to consolidated financial statements +F-3 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Comprehensive Income +(in thousands) +2016 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +121,274 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(2,147 +) +$ +— +(2,147 +) +Gain or (loss) on cash flow hedging derivatives +797 +(291 +) +506 +Unrealized gain (loss) on marketable securities +2,052 +(749 +) +1,303 +Total other comprehensive income (loss) +$ +702 +$ +(1,040 +) +(338 +) +Comprehensive income +120,936 +Comprehensive income attributable to non-controlling interests +(363 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +120,573 +2015 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +113,655 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(18,734 +) +$ +— +(18,734 +) +Gain or (loss) on cash flow hedging derivatives +1,962 +(716 +) +1,246 +Unrealized gain (loss) on marketable securities +(1,847 +) +674 +(1,173 +) +Total other comprehensive income (loss) +$ +(18,619 +) +$ +(42 +) +(18,661 +) +Comprehensive income +94,994 +Comprehensive income attributable to non-controlling interests +(717 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +94,277 +2014 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +112,629 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(6,238 +) +$ +— +(6,238 +) +Gain or (loss) on cash flow hedging derivatives +(2,081 +) +803 +(1,278 +) +Unrealized gain (loss) on marketable securities +2,362 +(921 +) +1,441 +Total other comprehensive income (loss) +$ +(5,957 +) +$ +(118 +) +(6,075 +) +Comprehensive income +106,554 +Comprehensive income attributable to non-controlling interests +(749 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +105,805 +See accompanying notes to consolidated financial statements +F-4 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity (in thousands) +Common Stock +Additional Paid‑in Capital +Retained Earnings +Shares +Amount +Balance - December 31, 2013 +67,336 +$ +7 +$ +247,858 +$ +672,044 +Share repurchases +(4,261 +) +(1 +) +— +— +Exercise of stock options +340 +— +4,943 +— +Tax benefit from stock-based compensation +— +— +2,978 +— +Issuance of restricted stock +210 +— +— +— +Stock-based compensation +— +— +19,260 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain (loss) on securities (net of tax expense of $921) +— +— +— +— +Cash flow hedge (net of tax benefit of $803) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Non-controlling investment in JV +— +— +— +(20 +) +Net income +— +— +— +111,880 +Balance - December 31, 2014 +63,625 +6 +275,039 +783,904 +Share repurchases +(3,704 +) +— +— +— +Exercise of stock options +1,460 +— +21,301 +— +Tax benefit from stock-based compensation +— +— +10,510 +— +Issuance of restricted stock +312 +— +— +— +Stock-based compensation +— +— +18,698 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain (loss) on securities (net of tax benefit of $674) +— +— +— +— +Cash flow hedge (net of tax expense of $716) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Non-controlling investment in JV +— +— +— +— +Net income +— +— +— +112,938 +Balance - December 31, 2015 +61,693 +6 +325,548 +896,842 +Share repurchases +(2,437 +) +— +— +— +Exercise of stock options +746 +— +10,713 +— +Issuance of restricted stock +408 +— +— +— +Stock-based compensation +— +— +19,509 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain (loss) on securities (net of tax expense of $749) +— +— +— +— +Cash flow hedge (net of tax expense of $291) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Acquisition of minority interest (net of tax benefit of $1,432) +— +— +(2,327 +) +— +Net income +— +— +— +120,911 +Balance - December 31, 2016 +60,410 +$ +6 +$ +353,443 +$ +1,017,753 +See accompanying notes to consolidated financial statements +F-5 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity (Continued) +(in thousands) +Accumulated Other Comprehensive Gain (Loss) +Treasury Stock +Non-controlling interest +Total Stockholders' Equity +Shares +Amount +Balance - December 31, 2013 +$ +(6,677 +) +15,605 +$ +(234,715 +) +$ +323 +$ +678,840 +Share repurchases +— +4,261 +(142,227 +) +— +(142,228 +) +Exercise of stock options +— +— +— +— +4,943 +Tax benefit from stock-based compensation +— +— +— +— +2,978 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +— +19,260 +Foreign currency translation adjustment +(6,238 +) +— +— +— +(6,238 +) +Unrealized holding gain (loss) on securities (net of tax expense of $921) +1,441 +— +— +— +1,441 +Cash flow hedge (net of tax benefit of $803) +(1,278 +) +— +— +— +(1,278 +) +Distributions to non-controlling interests, net +— +— +— +(946 +) +(946 +) +Non-controlling investment in JV +— +— +— +148 +128 +Net income +— +— +— +749 +112,629 +Balance - December 31, 2014 +(12,752 +) +19,866 +(376,942 +) +274 +669,529 +Share repurchases +— +3,704 +(135,637 +) +— +(135,637 +) +Exercise of stock options +— +— +— +— +21,301 +Tax benefit from stock-based compensation +— +— +— +— +10,510 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +— +18,698 +Foreign currency translation adjustment +(18,734 +) +— +— +— +(18,734 +) +Unrealized holding gain (loss) on securities (net of tax benefit of $674) +(1,173 +) +— +— +— +(1,173 +) +Cash flow hedge (net of tax expense of $716) +1,246 +— +— +— +1,246 +Distributions to non-controlling interests, net +— +— +— +(732 +) +(732 +) +Non-controlling investment in JV +— +— +— +— +— +Net income +— +— +— +717 +113,655 +Balance - December 31, 2015 +(31,413 +) +23,570 +(512,579 +) +259 +678,663 +Share repurchases +— +2,437 +(86,005 +) +— +(86,005 +) +Exercise of stock options +— +— +— +— +10,713 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +19,509 +Foreign currency translation adjustment +(2,147 +) +— +— +— +(2,147 +) +Unrealized holding gain (loss) on securities (net of tax expense of $749) +1,303 +— +— +— +1,303 +Cash flow hedge (net of tax expense of $291) +506 +— +— +— +506 +Distributions to non-controlling interests, net +— +— +— +(417 +) +(417 +) +Acquisition of minority interest (net of tax benefit of $1,432) +— +— +— +— +(2,327 +) +Net income +— +— +— +363 +121,274 +Balance - December 31, 2016 +$ +(31,751 +) +26,007 +$ +(598,584 +) +$ +205 +$ +741,072 +See accompanying notes to consolidated financial statements +F-6 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +(in thousands) +Years Ended December 31, +2016 +2015 +2014 +Cash flows from operating activities: +Net income +$ +121,274 +$ +113,655 +$ +112,629 +Adjustments to reconcile net income to net cash provided by operating activities: +Stock-based compensation +19,509 +18,698 +19,260 +Tax benefit from stock-based compensation +— +(10,510 +) +(2,978 +) +Depreciation and amortization +21,102 +20,757 +15,077 +Loss on disposal of fixed assets +652 +1,780 +291 +Impairment charges +— +3,045 +— +Deferred taxes +(6,588 +) +7,271 +4,583 +Accrued interest on note receivable – related party +(63 +) +(71 +) +(156 +) +Deferred rent expense and other liabilities +2,565 +440 +2,769 +Realized loss (gain) on sale of marketable securities +661 +(67 +) +(677 +) +Change in fair value of contingent liability +(425 +) +(5,576 +) +(2,139 +) +Changes, net of acquisitions, in: +Accounts receivable +(13,617 +) +(11,071 +) +(144 +) +Factor accounts receivable +11,043 +7,281 +3,734 +Notes receivable - related party +409 +409 +409 +Inventories +(17,744 +) +(9,403 +) +(1,841 +) +Prepaid expenses, prepaid taxes, deposits and other +(3,461 +) +4,784 +(294 +) +Accounts payable and accrued expenses +15,324 +(8,643 +) +3,777 +Accrued incentive compensation +1,819 +468 +(1,910 +) +Other liabilities +1,144 +2,716 +(61 +) +Net cash provided by operating activities +153,604 +135,963 +152,329 +Cash flows from investing activities: +Capital expenditures +(15,897 +) +(19,459 +) +(18,341 +) +Purchases of marketable securities +(40,451 +) +(48,891 +) +(137,348 +) +Repayment of notes receivable +249 +466 +893 +Maturity/sale of marketable securities +52,215 +43,353 +128,663 +Acquisitions, net of cash acquired +— +(9,129 +) +(81,885 +) +Net cash used in investing activities +(3,884 +) +(33,660 +) +(108,018 +) +Cash flows from financing activities: +Proceeds from exercise of stock options +10,713 +21,301 +4,943 +Purchase of noncontrolling interest +(3,759 +) +— +— +Tax benefit from the exercise of options +— +10,510 +2,978 +Payment of contingent liability +(16,402 +) +(6,270 +) +(8,475 +) +Common stock purchased for treasury +(86,005 +) +(135,637 +) +(142,228 +) +Net cash used by financing activities +(95,453 +) +(110,096 +) +(142,782 +) +Effect of exchange rate changes on cash and cash equivalents +(566 +) +(1,243 +) +(354 +) +Net increase (decrease) in cash and cash equivalents +53,701 +(9,036 +) +(98,825 +) +Cash and cash equivalents – beginning of year +72,414 +81,450 +180,275 +Cash and cash equivalents – end of year +$ +126,115 +$ +72,414 +$ +81,450 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +520 +$ +469 +$ +211 +Income taxes +$ +55,384 +$ +39,424 +$ +49,829 +See accompanying notes to consolidated financial statements. +F-7 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies +[1] Organization: +Steven Madden, Ltd. a Delaware corporation, and its subsidiaries, design, source, market and sell name brand and private label women's, men's and children's shoes, worldwide through its wholesale and retail channels under the Steve Madden Women's, Steve Madden Men's, Madden, Madden Girl, Steven, FREEBIRD by Steven, Superga (under license), Dolce Vita and Betsey Johnson brand names and through its wholesale channels under the Stevies, Report, B Brian Atwood, Mad Love and Blondo brand names. In addition, the Company designs, sources, markets and sells name brand and private label handbags and accessories to customers worldwide through its Wholesale Accessories segment, including the Big Buddha, Betsey Johnson, Madden Girl, Betseyville, Cejon, Steve Madden, Steven by Steve Madden, Luv Betsey and B Brian Atwood accessories brands. Revenue is generated predominantly through the sale of the Company's brand name and private label merchandise and certain licensed products. At December 31, 2016 and 2015 , the Company operated 189 (including four e-commerce websites) and 169 (including four e-commerce websites) retail stores, respectively. Revenue is subject to seasonal fluctuations. See Note O for operating segment information. +[2] Principles of consolidation: +The Consolidated Financial Statements include the accounts of Steven Madden, Ltd. and its wholly-owned subsidiaries Steven Madden Retail, Inc., Diva Acquisition Corp., Diva International, Inc., Madden Direct, Inc., Adesso Madden, Inc., Stevies, Inc., Daniel M. Friedman and Associates, Inc., Big Buddha, Inc., the Topline Corporation, Cejon, Inc., SML Holdings S.a.r.l., SML Canada Acquisition Corp., Madden International Ltd., DMF International Ltd., Asean Corporation Ltd., Dolce Vita Holdings, Inc., Trendy Imports S.A de C.V., Comercial Diecesiette S.A. de C.V., Maximus Designer Shoes S.A. de C.V., BA Brand Holdings LLC, BAI Holding, LLC and Mad Love LLC, a joint venture in which the Company acquired the remaining minority interest in 2016 (collectively the "Company"). The accounts of Dexascope Proprietary Ltd., a joint venture in South Africa in which the Company is the majority owner, BA Brand Holdings LLC, a joint venture in which the Company is the majority owner, and SPM Shoetrade Holding B.V., a joint venture in certain regions of Europe in which the Company is the majority owner, are included in the Consolidated Financial Statements with the other members' interests reflected in “Net (income) loss attributable to non-controlling interests” in the Consolidated Statements of Income and “Non-controlling interests” in the Consolidated Balance Sheets. All significant intercompany balances and transactions have been eliminated. Certain reclassifications were made to prior years' amounts to conform to the 2016 presentation. +[3] Use of Estimates: +The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +Significant areas involving management estimates include allowances for bad debts, returns and customer chargebacks, inventory valuation, valuation of intangible assets, litigation reserves and contingent payment liabilities. The Company provides reserves on trade accounts receivables and factor receivables for future customer chargebacks and markdown allowances, discounts, returns and other miscellaneous compliance-related deductions that relate to the current period sales. The Company evaluates anticipated chargebacks by reviewing several performance indicators of its major customers. These performance indicators, which include retailers’ inventory levels, sell-through rates and gross margin levels, are analyzed by management to estimate the amount of the anticipated customer allowance. +F-8 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[4] Cash equivalents: +Cash equivalents at December 31, 2016 and 2015 amounted to approximately $3,309 and $2,242 , respectively, and consisted of money market accounts held primarily at three brokerage companies. The Company considers all highly liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. +[5] Marketable securities: +Marketable securities consist primarily of certificates of deposit and corporate bonds with maturities greater than three months and up to three years at the time of purchase as well as marketable equity securities. These securities, which are classified as available-for-sale, are carried at fair value, with unrealized gains and losses, net of any tax effect, reported in stockholders' equity as accumulated other comprehensive income (loss). These securities are classified as current and non-current marketable securities based upon their maturities. Amortization of premiums and discounts is included in interest income. For the years ended December 31, 2016 and 2015 , the amortization of bond premiums totaled $1,234 and $1,375 , respectively. The values of these securities may fluctuate as a result of changes in market interest rates and credit risk. The schedule of maturities at December 31, 2016 and 2015 are as follows: +Maturities as of +December 31, 2016 +Maturities as of +December 31, 2015 +1 Year or Less +1 to 10 Years +1 Year or Less +1 to 10 Years +Corporate bonds +$ +11,527 +$ +70,559 +$ +11,240 +$ +88,465 +Certificates of deposit +27,968 +— +21,184 +— +Total +$ +39,495 +$ +70,559 +$ +32,424 +$ +88,465 +For the year ended December 31, 2016 , losses of $661 were reclassified from Accumulated Other Comprehensive Income and recognized in the Consolidated Statements of Income in Other Income as compared to gains of $67 for the year ended December 31, 2015 . At December 31, 2016 , current marketable securities included unrealized losses of $279 and long-term marketable securities included unrealized gains of $89 and unrealized losses of $118 . At December 31, 2015 , current marketable securities included unrealized losses of $530 and long-term marketable securities included unrealized gains of $52 and unrealized losses of $1,133 . +[6] Inventories: +Inventories, which consist of finished goods on hand and in transit, are stated at the lower of cost (first-in, first-out method) or market. +[7] Property and equipment: +Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed utilizing the straight-line method based on estimated useful lives ranging from three to ten years. Leasehold improvements are amortized utilizing the straight-line method over the shorter of their estimated useful lives or the remaining lease term. Impairment losses are recognized for long-lived assets, including definite-lived intangibles, used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are not sufficient to recover the assets' carrying amount. Impairment losses are measured by comparing the fair value of the assets to their carrying amount. +[8] Goodwill and intangible assets: +The Company's goodwill and indefinite lived intangible assets are not amortized, rather they are tested for impairment on an annual basis, or more often if events or circumstances change that could cause these assets to become impaired. +F-9 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +During the first quarter of 2015, the Company recognized an impairment charge of $3,045 related to the Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows. The Company completed its annual impairment tests on goodwill and its remaining intangible assets during the third quarter of 2016 , and no impairments were recognized. Goodwill and indefinite-lived intangible assets are assessed for impairment using either a qualitative or quantitative approach. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If the qualitative assessment indicates +that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment requires an analysis of several estimates including future cash flows or income consistent with management’s strategic business plans, annual sales growth rates and the selection of assumptions underlying a discount rate (weighted average cost of capital) based on market data available at the time. The Company amortizes its intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment. The Company is currently amortizing its acquired intangible assets with definite useful lives over periods typically from two to ten years using the straight-line method. +[9] Net Income Per Share of Common Stock: +Basic net income per share is based on the weighted average number of shares of common stock outstanding during the period, which does not include unvested restricted common stock subject to forfeiture. Diluted net income per share reflects: a) the potential dilution assuming shares of common stock were issued upon the exercise of outstanding in-the-money options and the proceeds thereof were used to purchase shares of the Company’s common stock at the average market price during the period, and b) the vesting of granted nonvested restricted stock awards for which the assumed proceeds upon vesting are deemed to be the amount of compensation cost not yet recognized attributable to future services using the treasury stock method, to the extent dilutive. For the years ended December 31, 2016 , 2015 and 2014 , options to purchase approximately 374,000 , 26,000 and 290,000 shares of common stock, respectively, have been excluded in the calculation of diluted income per share as the result would have been anti-dilutive. For the years ended December 31, 2016 , 2015 and 2014 , all unvested restricted stock awards were dilutive. +[10] Comprehensive Income: +Comprehensive income is the total of net earnings and all other non-owner changes in equity. Comprehensive income for the Company includes net income, foreign currency translation adjustments, cash flow hedging and unrealized gains and losses on marketable securities. The accumulated balances for each component of other comprehensive loss attributable to the Company are as follows: +2016 +2015 +Currency translation adjustment +$ +(31,634 +) +$ +(29,487 +) +Cash flow hedges, net of tax +191 +(315 +) +Unrealized loss on securities, net of tax +(308 +) +(1,611 +) +Accumulated other comprehensive loss +$ +(31,751 +) +$ +(31,413 +) +[11] Advertising costs: +The Company expenses costs of print, radio and billboard advertisements as incurred. Advertising expenses included in operating expenses amounted to approximately $16,024 in 2016 , $14,892 in 2015 and $13,872 in 2014 . +F-10 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[12] Revenue Recognition: +The Company recognizes revenue on wholesale sales when (i) products are shipped pursuant to its standard terms, which are freight on board (“FOB”) Company warehouse, or when products are delivered to the consolidators, or any other destination, as per the terms of the customers’ purchase order, (ii) persuasive evidence of an arrangement exists, (iii) the price is fixed and determinable and (iv) collection is reasonably assured. Sales reductions on wholesale sales for anticipated discounts, allowances and other deductions are recognized during the period when sales are recorded. With the exception of our cold weather accessories and Blondo businesses, normally we do not accept returns from our wholesale customers unless there are product quality issues, which we charge back to the vendors at cost. Sales of cold weather accessories +and Blondo products to wholesale customers are recorded net of returns, which are estimated based on historical experience. Such amounts have historically not been material. +Retail sales are recognized when the payment is received from customers and are recorded net of estimated returns. The Company generates commission income acting as a buying agent by arranging to manufacture private label shoes to the specifications of its customers. The Company’s commission revenue also includes fees charged for its design, product and development services provided to certain suppliers in connection with the Company’s private label business. Commission revenue and product and development fees are recognized as earned when title to the product transfers from +the manufacturer to the customer and collections are reasonably assured and are reported on a net basis after deducting related operating expenses. +The Company licenses its Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas and household goods. The Company also licenses the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. The license agreements require the licensee to pay the Company a royalty and, in substantially all of the agreements, an advertising fee based on the higher of a minimum or a net sales percentage as defined in the various agreements. In addition, under the terms of retail selling agreements, most of the Company’s international distributors are required to pay the Company a royalty based on a percentage of net sales, in addition to a commission and a design fee on the purchases of the Company’s products. In substantially all of the Company’s license agreements, the minimum guaranteed royalty is earned and receivable on a quarterly basis. Licensing revenue is recognized on the basis of net sales reported by the licensees, or the minimum guaranteed royalties, if higher. +[13] Taxes Collected From Customers: +The Company accounts for certain taxes collected from its customers in accordance with the accounting guidance which permits companies to adopt a policy of presenting taxes in the income statement on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues). Taxes within the scope of this accounting guidance would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes and some types of excise taxes. The Company records all taxes on a net basis. +[14] Sales Deductions: +The Company supports retailers’ initiatives to maximize sales of the Company’s products on the retail floor by subsidizing the co-op advertising programs of such retailers, providing them with inventory markdown allowances and participating in various other marketing initiatives of its major customers. In addition, the Company accepts returns for damaged products for which the Company’s costs are normally charged back to the responsible third-party factory. Such expenses are reflected in the Consolidated Financial Statements as deductions to arrive at net sales. +F-11 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[15] Cost of Sales: +All costs incurred to bring finished products to the Company’s distribution center or to the customers’ freight forwarder and, in the Retail segment, the costs to bring products to the Company’s stores, are included in the cost of sales line on the Consolidated Statements of Income. These include the cost of finished products, purchase commissions, letter of credit fees, brokerage fees, sample expenses, custom duty, inbound freight, royalty payments on licensed products, labels and product packaging. All warehouse and distribution costs related to the Wholesale segments and freight to customers, if any, are included in the operating expenses line item of the Company’s Consolidated Statements of Income. The +Company’s gross margins may not be comparable to those of other companies in the industry because some companies may include warehouse and distribution costs, as well as other costs excluded from cost of sales by the Company, as a component of cost of sales, while other companies report on the same basis as the Company and include them in operating expenses. +[16] Warehouse and shipping costs: +The Company includes all warehouse and shipping costs for the Wholesale segment in the Operating Expenses line on the Consolidated Statements of Income. For the years ended December 31, 2016 , 2015 and 2014 , the total warehouse and distribution costs included in Operating Expenses were $27,079 , $24,176 and $21,030 respectively. Since the Company's standard terms of sales are “FOB Steve Madden warehouse,” the Company's wholesale customers absorb most shipping costs. Shipping costs to wholesale customers incurred by the Company are not considered significant and are included in the Operating Expense line in the Consolidated Statements of Income. +[17] Employee benefit plan: +The Company maintains a tax-qualified 401(k) plan which is available to each of the Company's eligible employees who elect to participate after meeting certain length-of-service requirements. The Company made discretionary matching contributions of 50% of employees' contributions up to a maximum of 6% of employees' compensation which vest to the employees over a period of time. Total matching contributions to the plan for 2016 , 2015 and 2014 were approximately $1,633 , $1,602 and $1,450 , respectively. +[18] Derivative Instruments: +The Company uses derivative instruments to manage its exposure to cash-flow variability from foreign currency risk. Derivatives are carried on the balance sheet at fair value and included in prepaid expenses and other current assets or accrued expenses. The Company applies cash flow hedge accounting for its derivative instruments. Net derivative gains and losses attributable to derivatives subject to cash flow hedge accounting reside in accumulated other comprehensive income (loss) and will be reclassified to earnings in future periods as the economic transactions to which the derivatives relate affect earnings. See Note K - Derivative Instruments. +[19] Income Taxes: +The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. +The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits +F-12 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. See Note M - Income Taxes. +[20] Share-based Compensation: +The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for equity instruments of the Company. Share-based compensation cost for restricted stock units (“RSUs”) is measured based on the closing fair market value of the Company’s common stock on the date of grant. Share-based compensation cost for stock options is measured at the grant date, based on the fair-value as calculated by the Black- +Scholes-Merton (“BSM”) option-pricing model. The BSM option-pricing model incorporates various assumptions including expected volatility, estimated expected life and interest rates. The Company recognizes share-based compensation cost over the award’s requisite service period. The Company recognizes a benefit from share-based compensation in the Consolidated Statements of Income if an incremental tax benefit is realized. See Note H - Stock- Based Compensation. +Note B – Acquisitions +Schwartz & Benjamin, Inc. +Subsequent to year end, in January 2017, the Company acquired all of the outstanding capital stock of Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC and DANIELBARBARA Enterprises LLC (together, "Schwartz & Benjamin"). The purchase price payable to the Sellers in the acquisition consists of (i) $15,750 in cash paid at closing, subject to a post-closing working capital adjustment, plus (ii) a cash earn-out payment based on the performance of Schwartz & Benjamin in each of the next six years (beginning on February 1 and ending on January 31 of each year) equal to, in the case of earn-out years one through four, 40% of the EBITDA (as defined in the Purchase Agreement) of Schwartz & Benjamin and, in the case of earn-out years five and six, 75% of the EBITDA of Schwartz & Benjamin. The sum of $1,000 of the purchase price was deposited into escrow at closing to secure potential indemnification obligations of the Sellers. Founded in 1923, Schwartz & Benjamin specializes in the design, sourcing and sale of licensed and private label footwear and distributes its fashion footwear to wholesale customers, including better department stores and specialty boutiques, as well as the retail stores of its brand partners. +Madlove, LLC +In June 2016, the Company paid $3,759 to acquire the remaining minority interest in Madlove, LLC ("Mad Love") thereby making Mad Love a wholly-owned subsidiary. Mad Love was formed as a joint venture in April 2011, in which the Company was the majority interest holder, had financial control and consolidated the financial statements of the joint venture. Mad Love designs and markets women’s footwear under the Mad Love label. The Company has accounted for the acquisition of the minority interest as an equity transaction. +SM Europe +In April 2016, the Company formed a joint venture ("SM Europe") with SPM Shoetrade Holding B.V. through its subsidiary, Steve Madden Europe B.V. The Company is the majority interest holder in SM Europe and controls the joint venture. SM Europe is the exclusive distributor of the Company's products in Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden, Switzerland, and Tunisia. As the Company controls the joint venture and is the majority interest holder in SM Europe, the assets, liabilities and results of operations of SM Europe are included in the Company’s Consolidated Financial Statements. The other member's interest is reflected in “Net income attributable to noncontrolling interests” in the Consolidated Statements of Income and “Noncontrolling interests” in the Consolidated Balance Sheets. +F-13 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note B – Acquisitions (continued) +Blondo +On January 23, 2015 the Company acquired the trademarks and other intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, from Regence Footwear Inc. and 3074153 Canada Inc. for a purchase price of approximately $9,129 . The purchase price has been allocated as follows: +Inventory +$ +233 +Other liabilities +(308 +) +Trademarks +7,196 +Total fair value excluding goodwill +7,121 +Goodwill +2,008 +Net assets acquired +$ +9,129 +Note C – Factor Receivable +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”) that became effective on September 15, 2009. The agreement can be terminated by the Company or Rosenthal at any time upon 60 days prior written notice. Under the agreement, the Company can request advances from Rosenthal in amounts of up to 85% of aggregate receivables submitted to Rosenthal. The agreement provides the Company with a $30,000 credit facility with a $15,000 sub-limit for letters of credit at an interest rate based, at the Company’s election, upon a calculation that utilizes either the prime rate minus 0.5% or LIBOR plus 2.5% . As of December 31, 2016 , no borrowings or letters of credit were outstanding. As of December 31, 2015, there were borrowings of $0 and letters of credit of $337 were outstanding. The Company also pays Rosenthal a fee of 0.20% of the gross invoice amount submitted to Rosenthal. With respect to receivables related to the Company's private label business, the fee is 0.14% of the gross invoice amount. Rosenthal assumes the credit risk on a substantial portion of the receivables that the Company submits to it and, to the extent of any loans made to the Company, Rosenthal maintains a lien on the Company’s receivables to secure the Company’s obligations. Rosenthal services the collection of the Company's accounts receivable. Funds collected by Rosenthal are applied against advances owed to Rosenthal (if any), and the balance is due and payable to the Company, net of any fees. The allowance against “factor receivables” is a projected provision based on certain formulas and prior approvals for markdowns, allowances, discounts, advertising and other deductions that customers may deduct against their payments. +Note D – Note Receivable – Related Party +On June 25, 2007, the Company made a loan to Steve Madden, its Creative and Design Chief and a principal stockholder of the Company, in the amount of $3,000 in order for Mr. Madden to satisfy a personal tax obligation resulting from the exercise of stock options that were due to expire and to retain the underlying Company common stock. Mr. Madden executed a secured promissory note in favor of the Company, for which a securities brokerage account maintained by Mr. Madden with his broker serves as collateral security. None of the securities held in the securities brokerage account are shares of the Company's common stock. There have been successive amendments of the secured promissory note, the most recent of which occurred on April 8, 2016, at which time the secured promissory note was amended to substitute the collateral securing the secured promissory note from shares of the Company's common stock to the security interest in Mr. Madden's securities brokerage account. Previously, on January 3, 2012, in connection with an amendment of Mr. Madden’s employment contract, the secured promissory note was amended and restated to extend the maturity date of the obligation to December 31, 2023 and to eliminate the accrual of interest after December 31, 2011. Prior to its January 3, 2012 amendment and restatement, the secured promissory note was accruing interest at the rate of 6% per annum. In addition, the secured promissory note, as amended, provides that, commencing on December 31, 2014, and annually on each December 31 thereafter through the maturity date, one-tenth of the principal amount thereof, together with accrued interest, will be cancelled by the Company, provided that Mr. Madden continues to be employed by the Company on each such December 31. Contemporaneously, the Company will release its security interest in a portion of the securities held in Mr. Madden's securities brokerage account generally correlating to the amount of indebtedness cancelled on such date. As of December 31, 2011, $1,090 of interest has accrued on the principal amount of the loan evidenced by the secured promissory note related to the period prior to the elimination of the accrual of interest and has been reflected on the Company’s Consolidated Financial +F-14 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note D – Note Receivable – Related Party (continued) +Statements. Pursuant to the elimination of further interest accumulation under the secured promissory note, the outstanding principal amount of the loan and the accrued interest as of December 31, 2016 has been discounted to reflect imputed interest, which will be amortized over the remaining life of the loan. For the years ended December 31, 2016, 2015 and 2014 the Company also recorded a charge in the amount of $409 for each year, respectively, to write-off the required one-tenth of the principal amount of the secured promissory note, which was partially offset by imputed interest income of $63 , $71 and $156 , respectively. +Note E – Fair Value Measurement +The accounting guidance under Accounting Standards Codification “Fair Value Measurements and Disclosures” (“ASC 820-10”) provides guidance for disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those three levels is as follows: +• +Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities. +• +Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. +• +Level 3: Significant unobservable inputs. +The Company’s financial assets and liabilities, subject to fair value measurements, as of December 31, 2016 and 2015 are as follows: +December 31, 2016 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +3,309 +$ +3,309 +$ +— +$ +— +Current marketable securities – available for sale +39,495 +39,495 +— +— +Long-term marketable securities – available for sale +70,559 +70,559 +— +— +Forward contracts +191 +— +191 +— +Total assets +$ +113,554 +$ +113,363 +$ +191 +$ +— +Liabilities: +Contingent consideration +$ +7,948 +$ +— +$ +— +$ +7,948 +Total liabilities +$ +7,948 +$ +— +$ +— +$ +7,948 +F-15 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note E – Fair Value Measurement (continued) +December 31, 2015 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +2,242 +$ +2,242 +$ +— +$ +— +Current marketable securities – available for sale +32,424 +32,424 +— +— +Long-term marketable securities – available for sale +88,465 +88,465 +— +— +Total assets +$ +123,131 +$ +123,131 +$ +— +$ +— +Liabilities: +Contingent consideration +24,775 +— +— +24,775 +Total liabilities +$ +24,775 +$ +— +$ +— +$ +24,775 +The majority of our level 3 balances consist of contingent consideration related to various acquisitions. The changes in our level 3 liabilities for the years ended December 31, 2016 and 2015 are as follows: +Balance at January 1, +Payments +Accrued Interest +Acquisitions +Change in estimate +Foreign Currency Translation +Balance at December 31, +2016 +Liabilities: +Contingent consideration +$ +24,775 +(16,402 +) +(425 +) +— +$ +7,948 +2015 +Liabilities: +Contingent consideration +$ +38,633 +(6,270 +) +(5,576 +) +(2,012 +) +$ +24,775 +Forward contracts are entered into to manage the risk associated with the volatility of future cash flows denominated in foreign currencies. Fair value of these instruments are based on observable market transactions of spot and forward rates. +The Company has recorded a liability for potential contingent consideration in connection with the December 30, 2014 acquisition of all of the outstanding capital stock of Trendy Imports S.A. de C.V., Comercial Diecisiette S.A. de C.V., and Maximus Designer Shoes S.A. de C.V. (together "SM Mexico"). Pursuant to the terms of an earn-out agreement between the Company and the seller +of SM Mexico, earn-out payments will be due annually to the seller of SM Mexico based on the financial performance of SM Mexico for each of the twelve-month periods ending on December 31, 2015 and 2016, inclusive. The fair value of the contingent payments was estimated using the present value of management's projections of the financial results of SM Mexico during the earn-out period. The current portion of the earn-out due, based on the twelve-month period ending December 31, 2016, approximates the recorded value. An earn-out payment of $3,482 for the period ended December 31, 2015 was paid to the seller of SM Mexico in the first quarter of 2016. +F-16 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note E – Fair Value Measurement (continued) +The Company has recorded a liability for potential contingent consideration in connection with the August 13, 2014 acquisition of all of the outstanding capital stock of Dolce Vita Holdings, Inc. ("Dolce Vita"). Pursuant to the terms of an earn-out agreement between the Company and the sellers of Dolce Vita, earn-out payments will be due annually to the sellers of Dolce Vita based on the financial performance of Dolce Vita for each of the twelve-month periods ending on September 30, 2015 and 2016, inclusive, provided that the aggregate minimum earn-out payment shall be no less than $5,000 . The earn-out payment of $1,019 for the period ended September 30, 2015 was paid to the sellers of Dolce Vita in the fourth quarter of 2015 . The fair value of the contingent payments was estimated using the present value of management’s projections of the financial results of Dolce Vita during the earn-out period. A final earn-out payment of $8,355 for the period ended September 30, 2016 was paid to the sellers of Dolce Vita in the fourth quarter of 2016. +The Company has recorded a liability for potential contingent consideration in connection with the February 21, 2012 acquisition of all of the assets of Steve Madden Canada Inc., Steve Madden Retail Canada Inc., Pasa Agency Inc. and Gelati Imports Inc. (collectively, “SM Canada”). Pursuant to the terms of an earn-out agreement between the Company and the seller of SM Canada, earn-out payments will be due annually to the seller of SM Canada based on the financial performance of SM Canada for each of the 12-month periods ending on March 31, 2013 through 2017, inclusive. The fair value of the contingent payments was estimated using the present value of management’s projections of the financial results of SM Canada during the earn-out period. An earn-out payment of $2,798 for the period ended March 31, 2016 was paid to the seller of SM Canada in the second quarter of 2016 . +The Company has recorded a liability for potential contingent consideration in connection with the May 25, 2011 acquisition of all of the outstanding shares of the capital stock of Cejon, Inc. and Cejon Accessories, Inc. and all of the outstanding membership interests in New East Designs, LLC (together, “Cejon”). Pursuant to the terms of an earn-out agreement between the Company and the sellers of Cejon, earn-out payments will be made annually to the sellers of Cejon, based on the financial performance of Cejon for each of the twelve-month periods ending on June 30, 2012 through 2016, inclusive. The fair value of the contingent payments was estimated using the present value of management’s projections of the financial results of Cejon during the earn-out period. A final earn-out payment of $1,767 for the period ended June 30, 2016 was paid to the seller of Cejon in the third quarter of 2016 . +Accounting guidance permits entities to choose to measure financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The accounting guidance also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that chose different measurement attributes for similar assets and liabilities. The Company has elected not to measure any eligible items at fair value. +The carrying value of certain financial instruments such as accounts receivable, factor accounts receivable and accounts payable approximates their fair values due to the short-term nature of their underlying terms. The fair values of investment in marketable securities available for sale are determined by reference to publicly quoted prices in an active market. Fair value of the notes receivable held by the Company approximates their carrying value based upon their imputed or actual interest rate, which approximates applicable current market interest rates. +F-17 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note F - Property and Equipment +The major classes of assets and total accumulated depreciation and amortization are as follows: +December 31, +Average Useful Life +2016 +2015 +Land and building +$ +767 +$ +767 +Leasehold improvements +79,165 +76,844 +Machinery and equipment +10 years +11,112 +8,557 +Furniture and fixtures +5 years +8,881 +7,769 +Computer equipment and software +3 to 5 years +57,855 +50,861 +157,780 +144,798 +Less accumulated depreciation and amortization +(85,399 +) +(72,788 +) +Property and equipment - net +$ +72,381 +$ +72,010 +Depreciation and amortization expense related to property and equipment included in operating expenses amounted to approximately $ 14,346 in 2016 , $ 13,237 in 2015 and $ 11,139 in 2014 . +Note G – Goodwill and Intangible Assets +The following is a summary of the carrying amount of goodwill by segment as of December 31, 2016 and 2015 : +Wholesale +Net Carrying +Footwear +Accessories +Retail +Amount +Balance at January 1, 2015 +87,637 +49,324 +17,798 +154,759 +Acquisition of Blondo +2,008 +— +— +2,008 +Purchase accounting adjustment (1) +(14,665 +) +— +(1,916 +) +(16,581 +) +Translation and other +(1,962 +) +— +(1,127 +) +(3,089 +) +Balance at December 31, 2015 +73,018 +49,324 +14,755 +137,097 +Translation and other +(757 +) +— +(629 +) +(1,386 +) +Balance at December 31, 2016 +72,261 +49,324 +14,126 +135,711 +(1) Amount represents the final purchase price allocation of customer relationships related to the Dolce Vita acquisition originally recorded in goodwill, as well as the final purchase price allocation of customer relationships and re-acquired rights related to the SM Mexico acquisition originally recorded in goodwill. +F-18 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note G – Goodwill and Intangible Assets (continued) +The following table details identifiable intangible assets as of December 31, 2016 and 2015 : +2016 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +4,590 +$ +3,335 +$ +— +$ +1,255 +Customer relationships +10 years +41,509 +21,341 +— +20,168 +License agreements +3–6 years +5,600 +5,600 +— +— +Non-compete agreement +5 years +2,440 +2,426 +— +14 +Re-acquired right +2 years +4,200 +4,200 +— +— +Other +3 years +14 +14 +— +— +58,353 +36,916 +— +21,437 +Re-acquired right +indefinite +35,200 +9,539 +— +25,661 +Trade names +indefinite +100,333 +— +3,045 +97,288 +$ +193,886 +$ +46,455 +$ +3,045 +$ +144,386 +(1) Includes the effect of foreign currency translation related primarily to the changes in the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An impairment charge of $3,045 was recorded in the first quarter of 2015 related to the Company's Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows from a significant customer. +2015 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +4,590 +$ +2,921 +$ +— +$ +1,669 +Customer relationships +10 years +41,509 +17,869 +— +23,640 +License agreements +3–6 years +5,600 +5,600 +— +— +Non-compete agreement +5 years +2,440 +2,357 +— +83 +Re-acquired right +2 years +4,200 +2,008 +— +2,192 +Other +3 years +14 +14 +— +— +58,353 +30,769 +— +27,584 +Re-acquired right +indefinite +35,200 +10,314 +— +24,886 +Trade names +indefinite +100,333 +— +3,045 +97,288 +$ +193,886 +$ +41,083 +$ +3,045 +$ +149,758 +(1) Includes the effect of foreign currency translation related primarily to the changes in the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An impairment charge of $3,045 was recorded in the first quarter of 2015 related to the Company's Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows from a significant customer. +F-19 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note G – Goodwill and Intangible Assets (continued) +The amortization of intangible assets amounted to $ 5,522 for 2016 , $ 6,145 for 2015 and $3,380 for 2014 and is included in operating expenses on the Company's Consolidated Statements of Income. The estimated future amortization expense for intangibles is as follows: +2017 +$ +3,216 +2018 +3,085 +2019 +3,014 +2020 +2,230 +2021 +1,564 +Thereafter +8,328 +Total +$ +21,437 +Note H – Stock-Based Compensation +In March 2006, the Board of Directors of the Company approved the Steven Madden, Ltd. 2006 Stock Incentive Plan (the “Plan”) under which nonqualified stock options, stock appreciation rights, performance shares, restricted stock, other stock-based awards and performance-based cash awards may be granted to employees, consultants and non-employee directors. The Company’s stockholders approved the Plan on May 26, 2006. The stockholders have subsequently approved successive amendments of the Plan, most recently on May 25, 2012, when the stockholders approved a third amendment to the Plan that increased the maximum number of shares that may be issued under the Plan to 23,466,000 . The following table summarizes the number of shares of common stock authorized for use under the Plan, the number of stock-based awards granted (net of expired or cancelled awards) under the Plan and the number of shares of common stock available for the grant of stock-based awards under the Plan: +Common stock authorized +23,466,000 +Stock-based awards, including restricted stock and stock options granted, net of expired or cancelled +(20,315,000 +) +Common stock available for grant of stock-based awards as of December 31, 2016 +3,151,000 +In accordance with accounting guidance relating to stock-based compensation, the Company records compensation for all awards to employees based on the fair value of options and restricted stock on the date of grant. Equity-based compensation is included in operating expenses on the Company's Consolidated Statements of Income. For the years ended December 31, 2016 , 2015 and 2014 , total equity-based compensation was as follows: +Years Ended December 31, +2016 +2015 +2014 +Restricted stock +$ +16,494 +$ +15,543 +$ +15,007 +Stock options +3,015 +3,155 +4,253 +Total +$ +19,509 +$ +18,698 +$ +19,260 +For the years ended December 31, 2015 and 2014, the Company classified cash flows of $10,510 and $2,978 , respectively, resulting from the tax benefits from tax deductions in excess of the compensation costs recognized for those options (tax benefits) as financing cash flows. During the third quarter of 2016, the Company adopted Accounting Standards Update No. 2016-09 ("ASU 2016-09"), Improvements to Employee Share-Based Payment Accounting which changes the accounting for certain aspects of share-based +F-20 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note H – Stock-Based Compensation (continued) +payments to employees (refer to Note Q). As a result of the adoption of ASU 2016-09, the Company classifies cash flows resulting from tax benefits as operating cash flows for the year ended December 31, 2016. For the year ended December 31, 2016 , the Company realized a tax benefit from stock-based compensation of $5,244 . +Stock Options +The total intrinsic value of options exercised during 2016 , 2015 and 2014 amounted to $ 16,983 , $ 12,433 and $ 6,351 respectively. During the years ended December 31, 2016 , 2015 and 2014 , 322,022 options with a weighted average exercise price of $32.37 , 455,528 options with a weighted average exercise price of $27.27 and 537,276 options with a weighted average exercise price of $ 21.19 vested, respectively. As of December 31, 2016 , there were unvested options relating to 596,982 shares of common stock with a total of $3,276 of unrecognized compensation cost and an average vesting period of 1.5 years. +The Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of options granted, which requires several assumptions. The expected term of the options represents the estimated period of time until exercise and is based on the historical experience of similar awards. Expected volatility is based on the historical volatility of the Company’s common stock. The risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. With the exception of special dividends paid in November 2005 and 2006, the Company historically has not paid regular cash dividends and thus the expected dividend rate is assumed to be zero. The following weighted average assumptions were used for stock options granted: +2016 +2015 +2014 +Volatility +22% to 26% +22% to 28% +27% to 32% +Risk-free interest rate +0.86% to 1.90% +0.99% to 1.60% +1.06% to 1.80% +Expected life in years +3 to 5 +3 to 5 +3 to 5 +Dividend yield +0.00% +0.00% +0.00% +Weighted average fair value +$7.11 +$8.81 +$9.90 +Activity relating to stock options granted under the Company’s plans and outside the plans during the three years ended December 31, 2016 is as follows: +F-21 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note H – Stock-Based Compensation (continued) +Number of Shares +Weighted Average Exercise Price +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at January 1, 2014 +3,373,000 +$ +17.01 +Granted +489,500 +34.69 +Exercised +(340,000 +) +14.57 +Expired/Forfeited +(94,500 +) +28.77 +Outstanding at December 31, 2014 +3,428,000 +19.48 +Granted +69,000 +36.59 +Exercised +(1,460,000 +) +14.59 +Expired/Forfeited +(21,000 +) +28.49 +Outstanding at December 31, 2015 +2,016,000 +23.51 +Granted +262,000 +33.86 +Exercised +(746,000 +) +14.36 +Expired/Forfeited +(33,000 +) +30.59 +Outstanding at December 31, 2016 +1,499,000 +$ +29.72 +3.3 years +$ +9,042 +Exercisable at December 31, 2016 +902,000 +$ +27.02 +2.5 years +$ +7,873 +The following table summarizes information about stock options at December 31, 2016 : +Options Outstanding +Options Exercisable +Range of Exercise Price +Number Outstanding +Weighted Average Remaining Contractual Life (in Years) +Weighted Average Exercise Price +Number Exercisable +Weighted Average Exercise Price +$14.99 to $20.07 +323,167 +1.0 +$17.34 +323,167 +$17.34 +$21.17 to $26.95 +7,750 +2.4 +23.95 +7,750 +23.95 +$27.03 to $30.72 +377,444 +3.1 +29.33 +246,885 +29.24 +$31.35 to $36.59 +722,133 +4.3 +34.72 +296,293 +34.76 +$36.68 to $41.95 +68,506 +4.2 +38.18 +27,905 +38.15 +1,499,000 +3.3 +$29.72 +902,000 +$27.02 +F-22 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note H – Stock-Based Compensation (continued) +Restricted Stock +The following table summarizes restricted stock activity during the three years ended December 31, 2016 : +Number of Shares +Weighted Average Fair Value at Grant Date +Outstanding at January 1, 2014 +4,257,000 +$ +24.24 +Granted +182,000 +34.88 +Vested +(345,000 +) +24.11 +Forfeited +(27,000 +) +29.34 +Outstanding at December 31, 2014 +4,067,000 +24.69 +Granted +361,000 +35.71 +Vested +(304,000 +) +23.24 +Forfeited +(69,000 +) +34.23 +Outstanding at December 31, 2015 +4,055,000 +25.32 +Granted +434,000 +34.30 +Vested +(276,000 +) +30.28 +Forfeited +(22,000 +) +33.45 +Outstanding at December 31, 2016 +4,191,000 +$ +25.93 +As of December 31, 2016 , there was $69,606 of total unrecognized compensation cost related to restricted stock awards granted under the Plan. This cost is expected to be recognized over a weighted average period of 5.9 years. +The Company determines the fair value of its restricted stock awards based on the market price of its common stock on the date of grant. The fair value of the restricted stock that vested during the years ended December 31, 2016 , 2015 and 2014 was $9,758 , $6,980 and $8,317 , respectively. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment of Mr. Madden’s existing employment agreement, pursuant to which, on February 8, 2012, Mr. Madden was granted 1,463,057 restricted shares of the Company’s common stock at the then market price of $27.34 , which will vest in equal annual installments over a seven-year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On June 30, 2012, Mr. Madden exercised his right under his employment agreement to receive an additional restricted stock award, and, on July 3, 2012, he was granted 1,893,342 restricted shares of the Company's common stock at the then market price of $21.13 , which will vest in equal annual installments over a six-year period commencing on December 31, 2018 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On August 8, 2016, pursuant to the employment agreement, Mr. Madden was granted an option to purchase 150,000 shares of the Company's common stock at an exercise price of $34.42 per share, which option is exercisable in equal quarterly installments commencing on November 8, 2016. +F-23 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note I - Preferred Stock +The Company has authorized 5,000,000 shares of preferred stock. The Board of Directors has designated 60,000 shares of such preferred stock as Series A Junior Participating Preferred Stock (“Series A Preferred”). Holders of the shares of Series A Preferred are entitled to dividends equal to 1,000 times dividends declared or paid on the Company's common stock. Each share of Series A Preferred entitles the holder to 1,000 votes on all matters submitted to the holders of common stock. The Series A Preferred has a liquidation preference of $ 1,000 per share, and is not redeemable by the Company. No shares of preferred stock have been issued. +Note J - Share Repurchase Program +The Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase, most recently on February 22, 2016 when the Board of Directors approved the extension of the Share Repurchase Program for an additional $136,000 in repurchases of the Company's common stock. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. During the twelve months ended December 31, 2016 , an aggregate of 2,141,823 shares of the Company's common stock was repurchased under the Share Repurchase Program, at an average price per share of $35.11 , for an aggregate purchase price of approximately $75,196 . As of December 31, 2016 , approximately $117,374 remained available for future repurchases under the Share Repurchase Program. +The Steven Madden, Ltd. 2006 Stock Incentive Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. During the twelve months ended December 31, 2016 , an aggregate of 295,362 shares were withheld in connection with the settlement of vested restricted stock to satisfy tax withholding requirements, at an average price per share of $36.60 , for an aggregate purchase price of approximately 10,809 . +Note K - Derivative Instruments +The Company uses derivative instruments, specifically, forward foreign exchange contracts, to manage the risk associated with the volatility of future cash flows. The forward foreign exchange contracts will be used to mitigate the impact of exchange rate fluctuations on forecasted purchases of inventory and are designated as cash flow hedging instruments. The Company enters into forward contracts with terms of no more than two years. As of December 31, 2016 , $191 of gains related to cash flow hedges are recorded in accumulated other comprehensive income, net of taxes and are expected to be recognized in earnings at the same time the hedged items affect earnings. As of December 31, 2016 , the fair value of the Company's foreign currency derivatives, which is included on the Consolidated Balance Sheet in other assets, was $273 . As of December 31, 2015 , $315 of losses related to cash flow hedges were recorded in accumulated other comprehensive income, net of taxes and were recognized in earnings at the same time the hedged items affected earnings. As of December 31, 2016 and 2015 , none of the Company's hedging activities were considered ineffective and thus no gains and losses relating to ineffectiveness on its hedging activities were recognized in the Consolidated Statements of Income. For the year ended December 31, 2016 losses of $472 were reclassified from accumulated other comprehensive income and recognized in the Consolidated Statements of Income in cost of sales as compared to losses of $2,353 for the year ended December 31, 2015 . +F-24 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note L - Operating Leases +The Company leases office, showroom, warehouse and retail facilities under noncancelable operating leases with terms expiring at various times through 2026. Future minimum annual lease payments under noncancelable operating leases consist of the following at December 31: +2017 +$ +41,281 +2018 +37,798 +2019 +35,236 +2020 +33,703 +2021 +29,209 +Thereafter +71,031 +Total +$ +248,258 +A majority of the retail store leases provide for contingent rental payments if gross sales exceed certain targets. In addition, many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes. Rent expense for the years ended December 31, 2016 , 2015 and 2014 was approximately $ 52,294 , $ 47,710 and $ 43,608 , respectively. Included in such amounts are contingent rents of $ 238 , $ 157 and $ 84 in 2016 , 2015 and 2014 , respectively. +Rent expense is calculated by amortizing total base rental payments (net of any rental abatements, construction allowances and other rental concessions), on a straight-line basis, over the lease term. Accordingly, rent expense charged to operations differs from rent paid resulting in the Company recording deferred rent. +Note M - Income Taxes +The components of income before income taxes are as follows: +2016 +2015 +2014 +Domestic +$ +110,526 +$ +81,785 +$ +85,988 +Foreign +60,474 +90,681 +85,405 +$ +171,000 +$ +172,466 +$ +171,393 +The income tax provision (benefit) consists of the following: +2016 +2015 +2014 +Current: +Federal +$ +47,655 +$ +24,838 +$ +29,933 +State and local +6,063 +4,136 +4,244 +Foreign +3,270 +13,960 +15,167 +56,988 +42,934 +49,344 +Deferred: +Federal +(7,050 +) +16,976 +10,229 +State and local +153 +1,961 +(2,014 +) +Foreign +(365 +) +(3,060 +) +1,205 +(7,262 +) +15,877 +9,420 +$ +49,726 +$ +58,811 +$ +58,764 +F-25 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note M - Income Taxes (continued) +A reconciliation between taxes computed at the federal statutory rate and the effective tax rate is as follows: +December 31, +2016 +2015 +2014 +Income taxes at federal statutory rate +35.0 +% +35.0 +% +35.0 +% +Effects of foreign operations +(5.3 +) +(3.6 +) +(2.7 +) +Stock-based compensation +(3.0 +) +— +— +State and local income taxes - net of federal income tax benefit +2.0 +1.7 +1.1 +Nondeductible items +0.2 +0.1 +0.2 +Valuation allowance (reversal) +— +— +(0.1 +) +Other +0.2 +0.9 +0.8 +Effective rate +29.1 +% +34.1 +% +34.3 +% +The Company applies the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. +In accordance with accounting guidance, the Company has opted to classify interest and penalties that would accrue according to the provisions of relevant tax law as income tax expense on the Consolidated Statements of Income. The Company determines the amount of interest expense to be recognized by applying the applicable statutory rate of interest to the difference between the tax position recognized and the amount previously taken or expected to be taken on a tax return. The Company's tax years 2013 through 2016 remain open to examination by most taxing authorities. During 2016, the U.S. Internal Revenue Service ("IRS") commenced an audit of the Company's 2014 U.S. income tax return. As of December 31, 2016 the audit remains open and the Company is working with the IRS on open matters. Management believes that adequate provisions have been made for any adjustments that may result from the audit. The Company does not have any material unrecognized tax benefits recorded as of December 31, 2016 and 2015. +F-26 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note M - Income Taxes (continued) +The components of deferred tax assets and liabilities are as follows: +December 31, +2016 +2015 +Current deferred tax assets (liabilities): +Receivable allowances +$ +8,800 +$ +7,932 +Inventory +2,202 +2,237 +Unrealized loss +— +1,096 +Accrued expenses +751 +796 +Other +2,232 +2,331 +Gross current deferred tax assets +13,985 +14,392 +Non-current deferred tax assets (liabilities) +Depreciation and amortization +(19,264 +) +(16,045 +) +Deferred compensation +17,569 +14,936 +Unremitted earnings of foreign subsidiaries +(31,262 +) +(39,494 +) +Deferred rent +5,327 +4,585 +Amortization of goodwill +(6,640 +) +(3,749 +) +Unrealized loss +177 +(80 +) +Net carryforwards +1,172 +— +Other +1,283 +437 +(31,638 +) +(39,410 +) +Net deferred tax (liabilities) +$ +(17,653 +) +$ +(25,018 +) +The Company's consolidated financial statements provide for any related tax liability on amounts that may be repatriated from foreign operations, aside from undistributed earnings of certain of the Company's foreign subsidiaries that are intended to be indefinitely reinvested in operations outside the U.S. The deferred tax liability of $31,262 and $39,494 for the years ended December 31, 2016 and 2015 , respectively, reflects the amounts that may be repatriated from foreign operations. The total amount of indefinitely reinvested earnings of foreign subsidiaries as of December 31, 2016 and 2015 was $134,249 and $ 85,147 , respectively. Accordingly, no provision has been made for United States income taxes that may become payable if those undistributed earnings of foreign subsidiaries are paid as dividends. If such amounts were not indefinitely reinvested, the Company would incur approximately $26,615 in taxes that were not previously provided for in our consolidated statements of income. +Note N – Commitments, Contingencies and Other +[1] Legal Proceedings: +(a) +On August 10, 2005, following the conclusion of an audit of the Company conducted by auditors for U.S. Customs and Border Protection (“U.S. Customs”) during 2004 and 2005, U.S. Customs issued a report that asserts that certain commissions that the Company treated as “buying agents’ commissions” (which are non-dutiable) should be treated as “selling agents’ commissions” and hence are dutiable. Subsequently, U.S. Immigration and Customs Enforcement notified the Company’s legal counsel that a formal investigation of the Company’s importing practices had been commenced as a result of the audit. In September 2007, U.S. Customs notified the Company that it had finalized its assessment of the underpaid duties at $1,400 . The Company, with the advice of legal counsel, evaluated the liability +F-27 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +in the case, including additional duties, interest and penalties, and believed that it was not likely to exceed $3,050 , and accordingly, a liability for this amount was recorded as of December 31, 2009. The Company contested the +conclusions of the U.S. Customs audit and filed a request for review and issuance of rulings thereon by U.S. Customs Headquarters, of Regulations and Rulings, under internal advice procedures. On September 20, 2010, U.S. Customs issued a ruling in the matter, concluding that the commissions paid by the Company pursuant to buying agreements entered into by the Company and one of its two buying agents under review were bona fide buying-agent commissions and, therefore, were non-dutiable. With respect to the second buying agent, U.S. Customs also ruled that beginning in February 2002, commissions paid by the Company were bona fide buying agent commissions and, therefore, were +non-dutiable. However, U.S. Customs found that the Company’s pre-2002 buying agreements with the second agent were legally insufficient to substantiate a buyer-buyer’s agent relationship between the Company and the agent and that commissions paid to the second agent under such buying agreements, in fact, were dutiable. On the basis of the U.S. Customs ruling, the Company reevaluated the liability in the case and believes that it is not likely to exceed $1,248 and the liability was reduced from $3,050 to such amount as of September 30, 2010. +On November 21, 2011, U.S. Customs issued a pre-penalty notice to the Company in which it alleges that gross negligence by the Company resulted in an underpayment of duties with respect to certain pre-2002 buying agreements and claims that the Company owes $342 as an additional duty and $1,367 in monetary penalties. In its February 16, 2012 response to the pre-penalty notice, the Company submitted that it owes no additional duty and, further, did not through negligence or gross negligence fail to pay any duty or engage in conduct amounting to either gross negligence or negligence. The Company requested that U.S. Customs withdraw its proposal to issue a notice of penalty and take no further adverse action against the Company. In the event that U.S. Customs is not inclined to withdraw the pre-penalty notice after review of the Company’s response, the Company has requested the opportunity to make an oral presentation to U.S. Customs prior to the issuance of a notice of penalty. On June 26, 2014, the Company’s counsel met with U.S. Customs officials and, following the meeting, counsel submitted to U.S Customs a letter and the Company’s check in the amount of $342 , representing the Company’s Offer in Compromise of the proposed government claim. The Offer in Compromise was filed without any admission or acceptance by the Company with respect to the proposed claim. In the event that U.S. Customs determines to issue a notice of penalty, the Company intends to file a petition for relief requesting a reduction of the level of culpability and mitigation of the penalty amount assessed. The maximum total amount of damages, including penalty, related to this matter is approximately $1,700 for which the Company has accrued $1,248 . +(b) +The Company has been named as a defendant in certain other lawsuits in the normal course of business. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these matters should not have a material effect on the Company’s financial position or results of operations. It is the policy of management to disclose the amount or range of reasonably possible losses in excess of recorded amounts. +[2] Employment agreements: +Robert Schmertz. On June 4, 2015, Robert Schmertz, the Company's Brand Director, submitted his resignation of employment to the Company effective immediately. A separation agreement dated June 4, 2015 between Mr. Schmertz and the Company provides to Mr. Schmertz, among other things, a severance of $381 , which was paid to him at regular intervals from the date of his resignation through December 31, 2016. +Edward R. Rosenfeld. On December 31, 2015, the Company entered into a new employment agreement with Edward R. Rosenfeld, the Company's Chief Executive Officer and the Chairman of the Board of Directors, to replace an existing employment agreement that expired on December 31, 2015. The agreement, which expires on December 31, 2018, provides for an annual salary of $ 800 through December 31, 2016, $ 850 in 2017 and $ 900 in 2018. In addition, pursuant to his new employment agreement, on December 31, 2015, Mr. Rosenfeld received a grant of 75,000 shares of the Company's common stock subject to certain restrictions and, on February 5, 2016, a further grant of 75,000 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Rosenfeld on December 31, 2015 and February 5, 2016 were issued under the Company's 2006 Stock Incentive Plan, as amended, and will vest +F-28 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +in equal annual installments over a five -year period commencing on December 1, 2016 and March 5, 2017, respectively. Additional compensation and bonuses, if any, are at the sole discretion of the Board of Directors. +Steven Madden. On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden's existing employment agreement with the Company (the “Amended Madden Agreement”). The Amended Madden Agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides for an annual base salary of approximately $ 9,667 in 2014, approximately $ 11,917 in 2015 and approximately $ 10,698 in 2016 and in each year thereafter through the end of the term of employment. Effective in 2012, the Amended Madden Agreement eliminates the annual cash bonuses payable to Mr. Madden based on EBITDA and the annual cash bonus in relation to new business contained in Mr. Madden's previously existing employment agreement and provides that all future cash bonuses will be at the sole discretion of the Company's Board of Directors. Further, the Amended Madden Agreement eliminates the annual non-accountable expense allowance of up to $ 200 provided to Mr. Madden under the previously existing employment agreement. Pursuant to the Amended Madden Agreement, on February 8, 2012, Mr. Madden was granted 1,463,056 restricted shares of the Company's common stock valued at approximately $ 40,000 , which will vest in equal annual installments over seven years commencing on December 31, 2017 through December 31, 2023, subject to Mr. Madden's continued employment with the Company on each such vesting date. Pursuant to the Amended Madden Agreement, on June 30, 2012, Mr. Madden exercised his right to receive an additional restricted stock award and, on July 3, 2012, was granted 1,893,342 restricted shares of the Company's common stock, which will vest in the same manner as the February 8, 2012 grant. As consideration for the additional restricted stock grant, Mr. Madden's annual base salary in years subsequent to 2012 have been reduced as follows: approximately $ 6,125 in 2014, approximately $ 8,250 in 2015 and approximately $ 7,026 in 2016 and in each year thereafter through the end of the term of employment. In addition to the opportunity for discretionary cash bonuses, the Amended Madden Agreement entitles Mr. Madden to an annual life insurance premium reimbursement of up to $ 200 , as well as an annual stock option grant and the potential for an additional one-time stock option grant based upon achievement of certain financial performance criteria. The Amended Madden Agreement also provides for the elimination of interest accrued after December 31, 2011 on an outstanding loan in the original principal amount of $ 3,000 made by the Company to Mr. Madden, the extension of the maturity date of such loan until December 31, 2023, and the forgiveness of 1/10th of the principal amount of the loan, together with accrued interest, annually over a ten-year period commencing on December 31, 2014 for so long as Mr. Madden continues to be employed by the Company on each such December 31st. +Arvind Dharia. On February 2, 2015, the Company and its Chief Financial Officer, Arvind Dharia, entered into an amendment of Mr. Dharia's existing employment agreement. The amendment, among other things, extends the term of Mr. Dharia's employment agreement until December 31, 2017 and increases his annual base salary to $ 582 effective January 1, 2015 through the remainder of the term. Pursuant to the amendment, on February 2, 2015, Mr. Dharia received a restricted stock award of 15,000 restricted shares of the Company's common stock, which will vest in substantially equal annual installments over a five -year period commencing on February 2, 2016 through February 2, 2020. The agreement, as amended, provides for an annual bonus to Mr. Dharia at the discretion of the Board of Directors. +Amelia Newton Varela. On December 30, 2016, the Company entered into a new employment agreement with Amelia Newton Varela, the Company’s President and a member of the Board of Directors of the Company, to replace an existing employment agreement that expired on December 31, 2016. The agreement, which expires on December 31, 2019, provides for an annual salary of $630 through December 31, 2017, $650 in 2018 and $670 in 2019. In addition, pursuant to her new employment agreement, on January 3, 2017, Ms. Varela was granted an option to purchase 100,000 shares of +the Company's common stock at an exercise price of $35.75 . The option, which was granted under the Company’s 2006 Stock Incentive Plan, as amended, will vest in four equal annual installments on each anniversary of the date of grant, commencing on January 3, 2018. The agreement provides to Ms. Varela the opportunity for an annual performance-based bonus for the fiscal years ended December 31, 2017, 2018 and 2019. +Awadhesh Sinha. On December 30, 2016, the Company entered into a new employment agreement with Awadhesh Sinha, the Company's Chief Operating Officer, to replace an existing employment agreement that expired at the end of 2016. The new agreement, which remains in effect until December 31, 2019, provides for an annual salary of $ 681 , $ 702 , and +F-29 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +$ 723 for the three years ended December 31, 2017, 2018, and 2019 and provides to Mr. Sinha the opportunity for annual cash and share based incentive bonuses. In addition, pursuant to his new employment agreement, on January 3, 2017, Mr. Sinha received a grant of 28,169 shares of the Company's common stock subject to certain restrictions. The restricted +shares received by Mr. Sinha were issued under the Company's 2006 Stock Incentive Plan, as amended, and will vest in equal annual installments over a three -year period on each of December 15, 2017, December 15, 2018, and December 15, 2019. +Karla Frieders. On September 4, 2015, the Company entered into a new employment agreement with Karla Frieders in connection with Ms. Frieders' appointment to the newly-created position of Chief Merchandising Officer of the Company. The agreement, which remains in effect until February 28, 2017, provides to Ms. Frieders an annual salary of $440 throughout the term of the agreement and an annual performance-based bonus for the fiscal years ending December 31, 2015 and 2016 in an amount to be determined at the discretion of the Company. +Michael Paradise. On April 5, 2016, the Company entered into a new employment agreement with Michael Paradise, the Company's Executive Vice President - Legal Counsel. The agreement, which remains in effect until December 31, 2018, provides to Mr. Paradise an annual salary of $400 subject to periodic increases as determined by the Board of Directors, and an annual performance-based bonus for the fiscal years ending December 31, 2016, December 31, 2017 and December 31, 2018 in an amount to be determined at the discretion of the Company. The agreement also provides Mr. Paradise with a signing bonus in the amount of $250 . In addition, pursuant to his employment agreement, on June 1, 2016, Mr. Paradise received a grant of 7,217 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Paradise were issued under the Company's 2006 Stock Incentive Plan, as amended, and will vest in equal annual installments over a four -year period on each of June 1, 2017, June 1, 2018, June 1, 2019 and June 1, 2020. +[3] Letters of credit: +At December 31, 2016 , the Company had no open letters of credit for the purchase of imported merchandise. +[4] License agreements: +On March 1, 2014, the Company entered into a license agreement with ABG Juicy Couture, LLC, under which the Company has the right to use the Juicy Couture® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The initial term of the agreement is effective through December 31, 2018. Subsequently, in February 2017, the initial agreement was amended to terminate, effective as of December 31, 2016. +On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A, under which the Company has the right to use the Superga® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The agreement was amended on April 11, 2013 to extend the term of the agreement through December 31, 2022. +Future minimum royalty payments are $1,270 for 2017 and $1,000 per year for years 2018 through 2022. Royalty expenses are included in the “cost of goods sold” section of the Company's Consolidated Statements of Income. +[5] Related Party Transactions: +On February 23, 2012, the Company entered into an agreement (the "2012 Consulting Agreement") with JLM Consultants, Inc., a company wholly-owned by John Madden, now deceased, formerly a director of the Company and the brother of Steven Madden, the Company's founder and Creative and Design Chief. The 2012 Consulting Agreement, replaced an +F-30 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +earlier consulting agreement between the Company and JLM Consultants, Inc. that had expired by its terms on December 31, 2005 but under which JLM Consultants, Inc. had continued to provide consulting services for the consideration provided therein. Under the 2012 Consulting Agreement, John Madden and JLM Consultants, Inc. provided consulting services to the Company with respect to the development of international sales of the Company. As a result of the passing of Mr. Madden on October 26, 2015, the 2012 Consulting Agreement terminated and the consulting services formerly provided by Mr. Madden and JLM Consultants under the 2012 Consulting Agreement are now being performed by employees of the Company. JLM Consultants, Inc. received no fees during 2016 and received fees and expenses of $ 1,373 and $ 1,240 in 2015 and 2014 , respectively, pursuant to the 2012 Consulting Agreement. Subsequent to 2011, Mr. Madden no longer received fees for his service as a director of the Company. +[6] Concentrations: +The Company maintains cash and cash equivalents with various major financial institutions which at times are in excess of the amount insured. In addition, the Company's marketable securities are principally held at three brokerage companies . +During the year ended December 31, 2016 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2016 were approximately 87% . +During the year ended December 31, 2015 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2015 were approximately 90% . +During the year ended December 31, 2014 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2014 were approximately 89% . +For the year ended December 31, 2016 , Target, Inc. represented 12.0% of net sales and 16.9% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +For the year ended December 31, 2015 , Target, Inc. represented 12.2% of net sales and 16.7% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +For the year ended December 31, 2014 , Target, Inc. represented 10.5% of net sales and 12.8% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +Purchases are made primarily in United States dollars. +[7] Valuation and qualifying accounts: +The following is a summary of the allowance for chargebacks and doubtful accounts related to accounts receivable and the allowance for chargebacks related to the amount due from factor: +F-31 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +Balance at Beginning of Year +Additions +Deductions +Balance at End of Year +Year ended December 31, 2016 +Allowance for doubtful accounts +$ +200 +$ +5 +$ +61 +$ +144 +Allowance for chargebacks +19,040 +67,649 +67,551 +19,138 +Returns +4,822 +5,169 +7,442 +2,549 +Year ended December 31, 2015 +Allowance for doubtful accounts +203 +162 +165 +200 +Allowance for chargebacks +18,199 +76,085 +75,244 +19,040 +Returns* +5,160 +5,868 +6,206 +4,822 +Year ended December 31, 2014 +Allowance for doubtful accounts +119 +234 +150 +203 +Allowance for chargebacks +17,040 +52,265 +51,106 +18,199 +Returns* +$ +3,253 +$ +5,648 +$ +3,741 +$ +5,160 +* The return reserve does not take into consideration the Company's ability to resell returned products. +Note O – Operating Segment Information +The Company operates the following business segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. The Wholesale Footwear segment, through sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores, derives revenue, both domestically and worldwide (via our International business), from sales of branded and private label women’s, men’s, girls’ and children’s footwear. The Wholesale Accessories segment, which includes branded and private label handbags, belts and small leather goods as well as cold weather and selected other fashion accessories, derives revenue, both domestically and worldwide (via our International business), from sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores. Our Wholesale Footwear and Wholesale Accessories segments, through our International business, derive revenue from Albania, Austria, Belgium, Bulgaria, Canada, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, Mexico, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden, Switzerland, and Tunisia and, under special distribution arrangements in various other territories within Asia, Australia, Europe, the Middle East, India, South and Central America and New Zealand. The Retail segment, through the operation of Company-owned retail stores in the United States, Canada, Mexico and South Africa and the Company’s websites, derives revenue from sales of branded women’s, men’s and children’s footwear, accessories and licensed products to consumers. The First Cost segment represents activities of a subsidiary that earns commissions and design fees for serving as a buying agent of footwear products to mass-market merchandisers, mid-tier department stores and other retailers with respect to their purchase of footwear. In the Licensing segment, the Company generates revenue by licensing its Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, this segment licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. The Licensing segment also licenses the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +F-32 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note O – Operating Segment Information (continued) +Year ended +Wholesale Footwear +Wholesale Accessories +Total Wholesale +Retail +First Cost +Licensing +Corporate +Consolidated +December 31, 2016: +Net sales +$ +881,864 +$ +254,931 +$ +1,136,795 +$ +262,756 +$ +— +$ +— +$ +— +$ +1,399,551 +Gross profit +279,836 +84,421 +364,257 +157,726 +— +— +— +521,983 +Commissions and licensing fees – net +— +— +— +— +3,824 +8,060 +— +11,884 +Income from operations +101,214 +39,032 +140,246 +17,046 +3,824 +8,060 +— +169,176 +Depreciation and amortization +11,734 +9,087 +281 +— +— +21,102 +Segment assets +$ +611,145 +$ +235,677 +846,822 +118,168 +8,057 +— +— +973,047 +Capital expenditures +$ +5,990 +$ +9,907 +$ +— +$ +— +$ +— +$ +15,897 +December 31, 2015: +Net sales +$ +898,364 +$ +266,563 +$ +1,164,927 +$ +240,312 +$ +— +$ +— +$ +— +$ +1,405,239 +Gross profit +265,822 +88,361 +354,183 +146,309 +— +— +— +500,492 +Commissions and licensing fees – net +— +— +— +— +6,795 +9,852 +$ +— +16,647 +Income from operations +95,621 +39,678 +135,299 +19,702 +6,795 +9,852 +— +171,648 +Depreciation and amortization +12,624 +7,897 +236 +— +— +20,757 +Segment assets +$ +581,725 +$ +209,213 +790,938 +107,661 +15,786 +— +— +914,385 +Capital expenditures +$ +7,237 +$ +12,222 +$ +— +$ +— +$ +— +$ +19,459 +December 31, 2014 +Net sales +$ +881,041 +$ +246,608 +$ +1,127,649 +$ +207,302 +$ +— +$ +— +$ +— +$ +1,334,951 +Gross profit +259,764 +84,640 +344,404 +124,596 +— +— +— +469,000 +Commissions and licensing fees – net +— +— +— +— +6,438 +7,285 +— +13,723 +Income from operations +105,593 +38,773 +144,366 +9,553 +6,438 +7,285 +— +167,642 +Depreciation and amortization +7,963 +6,887 +227 +— +— +15,077 +Segment assets +$ +581,799 +$ +210,250 +792,049 +104,744 +14,442 +— +— +911,235 +Capital expenditures +$ +10,188 +$ +8,153 +$ +— +$ +— +$ +— +$ +18,341 +F-33 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note O – Operating Segment Information (continued) +Revenues by geographic area are as follows: +Year Ended December 31, +2016 +2015 +2014 +Domestic (a) +$ +1,258,983 +$ +1,255,668 +$ +1,221,771 +International +140,568 +149,571 +113,180 +Total +$ +1,399,551 +$ +1,405,239 +$ +1,334,951 +(a) Includes revenues of $315,566, $329,089 and $323,342 for the years ended 2016, 2015 and 2014 related to sales to U.S. customers where the title is transferred outside the U.S. and the sale is recorded by our International subsidiary. +Note P - Quarterly Results of Operations (unaudited) +The following is a summary of the quarterly results of operations for the years ended December 31, 2016 and 2015 : +March 31, +June 30, +September 30, +December 31, +2016: +Net sales +$ +329,357 +$ +325,402 +$ +408,384 +$ +336,408 +Cost of sales +213,155 +204,357 +253,876 +206,180 +Gross profit +116,202 +121,045 +154,508 +130,228 +Commissions, royalty and licensing fee income - net +2,171 +2,826 +5,358 +1,529 +Net income attributable to Steven Madden, Ltd. +$ +23,659 +$ +24,737 +$ +43,767 +$ +28,748 +Net income per share: +Basic +$ +0.41 +$ +0.43 +$ +0.77 +$ +0.51 +Diluted +$ +0.39 +$ +0.41 +$ +0.74 +$ +0.49 +2015: +Net sales +$ +323,945 +$ +323,582 +$ +413,462 +$ +344,250 +Cost of sales +212,567 +207,436 +264,691 +220,053 +Gross profit +111,378 +116,146 +148,771 +124,197 +Commissions, royalty and licensing fee income - net +3,918 +3,127 +6,643 +2,959 +Net income attributable to Steven Madden, Ltd. +$ +19,824 +$ +24,503 +$ +42,885 +$ +25,726 +Net income per share: +Basic +$ +0.33 +$ +0.41 +$ +0.73 +$ +0.44 +Diluted +$ +0.32 +$ +0.40 +$ +0.70 +$ +0.43 +Note Q - Recent Accounting Pronouncements +Recently Adopted +In March 2016, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update No. 2016-09 ("ASU 2016-09"), Improvements to Employee Share-Based Payment Accounting, which changes the accounting for certain aspects of share-based payments to employees. The guidance requires the recognition in the income statement of the income tax effects of vested or settled awards. Further, the guidance requires that the recognition of anticipated tax windfalls/shortfalls be excluded in the calculation of assumed proceeds when applying the treasury stock method. The guidance also allows for the employer to repurchase more of an employee’s shares for tax withholding purposes and not classify the award as a liability that requires valuation on a mark-to-market basis. In addition, the guidance allows for a policy election to account for forfeitures as they occur rather +F-34 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note Q - Recent Accounting Pronouncements (continued) +than on an estimated basis. The guidance is effective in 2017 with early adoption permitted. The Company elected to adopt the provisions of ASU 2016-09 in the third quarter of 2016. According to the provisions of ASU 2016-09, if an entity adopts the provisions early, all adjustments should be reflected as of the beginning of the fiscal year of adoption. As a result of the adoption of this guidance in 2016, the Company recognized a tax benefit of $5,244 in the Consolidated Statements of Income for the year ended December 31, 2016. Lastly, the Company elected to not change its accounting policy to account for forfeitures as they occur and, as a result, the Company will continue to estimate forfeitures. +Not Yet Adopted +In January 2017, the FASB issued Accounting Standards Update 2017-04 ("ASU 2017-04"), Simplifying the Test for Goodwill Impairment. ASU 2017-04 changes the methodology of applying the quantitative approach during interim or annual impairment testing. The guidance is effective in fiscal years beginning after December 15, 2020. The Company is currently evaluating the +effect that the new guidance will have on its financial statements and related disclosures. +In August 2016, the FASB issued Accounting Standards Update 2016-15 ("ASU 2016-15"), Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 clarifies how certain cash receipts and payments should be presented in the statement of cash flows. The guidance is effective in 2018 with early adoption permitted. We are currently evaluating the timing of adoption of this guidance, however, the guidance is not expected to have a material impact on our financial statements. +In June 2016, the FASB issued Accounting Standards Update 2016-13 ("ASU 2016-13"), Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the +effect that the new guidance will have on its financial statements and related disclosures. +In February 2016, the FASB issued Accounting Standards Update No. 2016-02 ("ASU 2016-02"), Leases, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. Under ASU 2016-02, lessees will be required to recognize for all leases, at the commencement date of the lease, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right-to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures and, while we have not completed the analysis, we expect it will have a material impact on our Consolidated Balance Sheets. +In January 2016, the FASB issued Accounting Standards Update 2016-01 ("ASU 2016-01"), Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 generally requires companies to measure investments in equity securities, except those accounted for under the equity method, at fair value and recognize any changes in fair value in net income. The new guidance must be applied using a modified-retrospective approach and is effective for periods beginning after December 15, 2017 and early adoption is not permitted. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures. +In November 2015, the FASB issued Accounting Standards Update 2015-17 ("ASU 2015-17"), Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 simplifies current guidance and requires companies to classify all deferred tax assets and liabilities as noncurrent on the balance sheet. ASU 2015-17 can be applied either prospectively or retrospectively and is effective for periods beginning after December 15, 2016, with early adoption permitted. The guidance will be effective for the Company’s annual and interim reporting periods beginning January 1, 2017; however, the guidance is not expected to have a material impact on our financial statements. +F-35 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2016, 2015 and 2014 +($ in thousands, except share and per share data) +Note Q - Recent Accounting Pronouncements (continued) +In July 2015, the FASB issued Accounting Standards Update 2015-11 ("ASU 2015-11"), Inventory (Topic 330): Simplifying the Measurement of Inventory, which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. ASU 2015-11 defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new guidance must be applied on a prospective basis and is effective for periods beginning after December 15, 2016, with early adoption permitted. The guidance will be effective for the Company’s annual and interim reporting periods beginning January 1, 2017; however, the guidance is not expected to have a material impact on our financial statements. +In May 2014, the FASB issued new accounting guidance, Accounting Standards Update No. 2014-09 ("ASU 2014-09"), Revenue from Contracts with Customers, on revenue recognition. The new standard provides for a single five-step model to be applied to all revenue contracts with customers as well as requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted, but not before the original effective date of the standard. The Company is currently evaluating the impact of the new guidance on our financial statements and related disclosures. +F-36 +Exhibit Index +2.01 +Stock Purchase Agreement dated August 13, 2014 among the Company, Dolce Vita Holdings, Inc., Evangelos C. Lamprou and Manuel N. Lucio (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on August 18, 2014) +2.02 +Asset Purchase Agreement, dated as of January 20, 2012, among Steve Madden Canada Inc., Steve Madden Retail Canada Inc., Pasa Agency Inc., Gelati Imports Inc., the Company, SML Canada Acquisition Corp., 6798039 Canada Inc., 6798012 Canada Inc., 3574563 Canada Inc. and Thomas Alberga (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on January 26, 2012) +3.01 +Certificate of Incorporation of Steven Madden, Ltd. (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +3.02 +Amended & Restated By-Laws of Steven Madden, Ltd. (incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K filed with the SEC on March 28, 2008) +4.01 +Specimen Certificate for shares of Common Stock (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +10.01 +Third Amended and Restated Secured Promissory Note dated as of June 25, 2007 of Steven H. Madden to the Company (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 9, 2012) +10.02 +First Allonge to Third Amended and Restated Secured Promissory Note made as of April 8, 2016 between the Company and Steven H. Madden (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.03 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2010 filed with the SEC on November 9, 2010) +10.04 +Amendment to Collection Agency Agreement dated February 16, 2010 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2010 filed with the SEC on March 12, 2010) +10.05 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Daniel Friedman & Associates, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.06 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Diva Acquisition Corp. (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.07 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Steven Madden Retail, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.08 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Stevies, Inc. (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.09 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and SML Acquisition Corp. (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.10 +Letter Agreement dated July 10, 2009 among Rosenthal & Rosenthal, Inc., the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.11 +Guarantee dated July 10, 2009 of the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. in favor of Rosenthal & Rosenthal, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.12 +Third Amended Employment Agreement dated July 15, 2005 between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 20, 2005) +10.13 +Amendment dated December 14, 2009 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 17, 2009) +10.14 +Amended and Restated Second Amendment dated as of December 31, 2011 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2011 filed with the SEC on February 29, 2012) +10.15 +Third Amendment dated April 8, 2016 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.16 +Employment Agreement dated January 1, 1998 between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.07 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2000 filed with the SEC on March 30, 2001) # +10.17 +Amendment No. 1 dated June 29, 2001 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 99.4 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended June 30, 2001 filed August 14, 2001) # +10.18 +Amendment No. 2 dated October 30, 2002 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2002 filed with the SEC on November 14, 2002) # +10.19 +Amendment No. 3 dated February 1, 2006 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 3, 2006) # +10.20 +Amendment No. 4 dated October 7, 2009 to Employment Agreement of Arvind Dharia between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on October 13, 2009) # +10.21 +Amendment No. 5 dated February 8, 2012 to Employment Agreement of Arvind Dharia between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 14, 2012) # +10.22 +Amendment No. 6 dated February 2, 2015 to Employment Agreement of Arvind Dharia between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 4, 2015) # +10.23 +Employment Agreement dated December 30, 2016 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2017) # +10.24 +Employment Agreement dated March 11, 2015 between the Company and Robert Schmertz (incorporated by reference to exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 16, 2015) # +10.25 +Employment Agreement dated January 10, 2014 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2017) # +10.26 +Employment Agreement dated September 4, 2015 between the Company and Karla Frieders (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on September 10, 2015) # +10.27 +Employment Agreement dated December 31, 2015 between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2016) # +10.28 +First Amendment dated May 16, 2016 to Employment Agreement dated December 31, 2015 between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2016) # +10.29 +Employment Agreement dated April 5, 2016 between the Company and Michael Paradise #† +10.30 +2006 Stock Incentive Plan (Amended and Restated Effective May 22, 2009), amended by the Board on April 5, 2012 and approved and adopted by the Company's stockholders on May 25, 2012 (incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 1, 2013) # +21.01 +Subsidiaries of the Registrant † +23.01 +Consent of EisnerAmper LLP † +24.01 +Power of Attorney (included on signature page hereto) +31.01 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 † +31.02 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 † +32.01 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 †* +32.02 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 †* +99.01 +Press Release, dated February 28, 2017, issued by Steven Madden, Ltd. † +101 +The following materials from Steven Madden, Ltd.'s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.* +† +Filed herewith. +# +Indicates management contract or compensatory plan or arrangement required to be identified pursuant to Item 15(b) of this Annual Report on Form 10-K. +* +This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Company specifically incorporates it by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2016/0001628280-17-001869/filing_metadata.csv b/raw/filings/0000913241/2016/0001628280-17-001869/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..3a88af1eed37fcb771f4747edb482a3639460502 --- /dev/null +++ b/raw/filings/0000913241/2016/0001628280-17-001869/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000913241,SHOO,"STEVEN MADDEN, LTD.",10-K,2017-02-28,2016-12-31,2017-02-28T16:21:33.000Z,0001628280-17-001869,shoo-20161231x10k.htm,10-K,12198421,1,0,https://www.sec.gov/Archives/edgar/data/913241/000162828017001869/shoo-20161231x10k.htm,https://www.sec.gov/Archives/edgar/data/913241/000162828017001869/,2016,2016,1 diff --git a/raw/filings/0000913241/2016/0001628280-17-001869/item1.txt b/raw/filings/0000913241/2016/0001628280-17-001869/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..af044b593f12bc777300a271b51f7ca7f5fddcd3 --- /dev/null +++ b/raw/filings/0000913241/2016/0001628280-17-001869/item1.txt @@ -0,0 +1,134 @@ +ITEM 1 BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories. We also license some of our trademarks for use in connection with the manufacture, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico and South Africa, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we have special distribution arrangements for the marketing of our products in Asia, Australia, Europe (excluding the aforementioned European nations), India, the Middle East, South and Central America and New Zealand. We offer a broad range of updated styles designed to establish or complement and capitalize on market trends. We have established a reputation for design creativity and our ability to offer quality products in popular styles at affordable prices, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. The public may read and copy any materials filed by us with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information regarding the operation of the SEC's Public Reference Room +1 +is available by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company and a Code of Business Conduct and Ethics that is applicable to all of our employees, each of which are attached as exhibits to the 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015 and posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Net sales for 2016 decreased 0.4% to $1,399,551 from $1,405,239 in 2015 . Net income attributable to Steven Madden, Ltd. increased 7.1% to $120,911 in 2016 compared to $112,938 in 2015 . Diluted earnings per share in 2016 increased to $2.03 per share on 59,556,000 diluted weighted average shares outstanding compared to $1.85 per share on 61,142,000 diluted weighted average shares outstanding in the prior year. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, B Brian Atwood®, Blondo®, Madden NYC and includes our International business and certain private label footwear business. Our Wholesale Accessories segment includes Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Cejon®, B Brian Atwood® and Luv Betsey® accessories brands and includes our International business and certain private label accessories business. These trademarks are registered trademarks owned by us with the exception of Superga®, which is licensed to us by a third party. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores along with one multi-branded SHOO by Steve Madden store offering a variety of the Company's brands, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, we license our Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl is geared for young women ages 16 to 23, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +2 +Steve Madden Men's. We design, source, and market a life style collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range from $70 to $150 at retail. +Madden. T he Madden® brand is a denim friendly collection of footwear designed to meet the ever evolving needs of the trend conscious male consumer, ages 13 to 35 years old. Madden products range from $45 to $90 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden brand, Steven products are designed to appeal principally to fashion conscious women, ages 25 to 45, who shop at department stores, footwear boutiques and shopping networks. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12. Our Stevies® brand is sold exclusively to Target, while our Steve Madden Kids® brand is distributed to department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. +FREEBIRD by Steven . We design, source, and market a full collection of handcrafted, Goodyear welted boots. The designs are inspired by vintage Americana and created using time-honored craftsmanship. The FREEBIRD by Steven® collection conveys a unique fashion life style that transcends multiple generations. FREEBIRD by Steven products are currently sold, at retail prices ranging from $195 to $450 at major department stores, mid-tier retailers, and specialty boutiques. +Report. The Report® brand was acquired in our May 2011 acquisition of Topline Corporation ("Topline") and its subsidiaries. The Report® brand is a junior women's footwear brand with price points ranging from $20 to $150. We design, manufacture, market and sell our Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed exclusively to Target. +Dolce Vita. In August 2014, the Company acquired the Dolce Vita® and DV® brands and other intellectual property assets in the acquisition of Dolce Vita Holdings, Inc. Dolce Vita® is a contemporary women's footwear brand with price points ranging from $120 to $350. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. The DV® brand has price points ranging from $20 to $75 and is currently distributed exclusively at Target. +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand from Brian Atwood IP Company LLC. Founded in 2011, Brian Atwood is known for luxury shoes manufactured in Italy. We design, manufacture, market and sell our Brian Atwood branded products primarily to major department stores throughout the United States. +Blondo. In January 2015, the Company acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. +International Division. The International division, utilizing the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, +3 +Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, the International division works through special distribution arrangements for the marketing and sales of our products in Asia, Australia, Europe (excluding the aforementioned nations), India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands (including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Madden NYC, Big Buddha®, B Brian Atwood® and Luv Betsey® brands) and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our International distributor network. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon®, Steve Madden®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2016 , we owned and operated 189 retail stores including 129 Steve Madden full price stores, 52 Steve Madden outlet stores, two Steven stores, one Superga store, one SHOO by Steve Madden store offering a variety of the Company's brands and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). In 2016 , we opened nine new full price stores, twelve new outlet stores and closed one full price store in the United States. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico and South Africa. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2016 and 2015 ) increased 4% in fiscal year 2016 from the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product development efforts of our two Wholesale segments. We expect to open seven to eight new retail stores and close one location in 2017 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Kohl's, Sears and K-Mart. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +4 +See Note O to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new Steve Madden products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Steve Madden products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Steve Madden brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers in China, Mexico, Brazil, India, Indonesia, Vietnam and Italy. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from four third-party distribution centers, two located in California, one located in Texas and one located in New Jersey. Our products are also distributed through two Company-operated distribution centers located in New Jersey and Canada. By utilizing distribution facilities specializing in distribution fulfillment to effect distribution to certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers include Target Corporation, Nordstrom, Inc., Macy's, Inc., The TJX Companies, Inc., Ross Stores, Inc., DSW, Inc., Wal-Mart Stores, Inc., Payless ShoeSource, Inc., Burlington Stores, Inc. and Dillard's, Inc. For the year ended December 31, 2016 , Target Corporation represented 12.0% of net sales and 16.9% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +5 +Distribution Channels +United States, Canada, Mexico, Europe and South Africa +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico, certain European nations including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we sell our products in our Company-owned retail stores in the United States, Canada, Mexico and South Africa and on our e-commerce websites. For the year ended December 31, 2016 , our Retail segment and our two Wholesale segments generated net sales of approximately $262,756 and $1,136,795 , or 19% and 81% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2016 , we operated 129 Steve Madden full price stores within the United States, Canada, Mexico and South Africa. We also operated 52 Steve Madden outlet stores, two Steven stores, one Superga store and one SHOO by Steve Madden store within the United States. Our SHOO by Steve Madden store offers a variety of the Company's brands. The Company also operated four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell to over 2,500 doors of 17 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Macy's, Inc., Nordstrom, Inc., Dillard's, Inc., Belk, Inc. and Lord & Taylor. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at season's end. +National chains and mass merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Target Corporation, Wal-Mart Stores, Inc., Kohl's Corporation, and The J.C. Penney Company. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW, Inc., Famous Footwear, Journeys and Payless ShoeSource, Inc . We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's and Victoria's Secret. +6 +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate four Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson and Dolce Vita) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Asia, Australia, Europe, India, the Middle East, South and Central America and New Zealand. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Nine West, Jessica Simpson, Guess, Ugg and Aldo. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +Marketing and Sales +We have focused on creating an integrated brand building program to establish Steve Madden as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations including product and brand placements in life style and fashion magazines and digital outlets, as well as personal appearances by our founder and Creative and Design Chief, Steve Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products, as well as view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our wholesale information system is an Enterprise Resource Planning (“ERP”) system. This integrated system supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. We completed the implementation of this new ERP system for our wholesale business in 2014. We completed the implementation of such ERP system in three of our acquired businesses in 2015 and in two of our acquired businesses in 2016. We are currently in the process of implementing the ERP system for one of our U.S.-based wholesale businesses and our Asia first-cost and sourcing operations. In 2014 we completed the implementation of a new warehouse management system that is utilized by our third-party logistics providers. During 2015 we implemented this warehouse management system in a company-owned warehouse. This warehouse management system interfaces with our ERP system. We continue to implement our business-to-consumer e-commerce software platform for more recently acquired businesses and brands. We are also currently implementing a point of sale system for our retail stores that is integrated with a retail inventory management/store replenishment system. Complimenting all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing +7 +and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +Intellectual Property +Trademarks +We consider our trademarks to be among our most valuable assets and have registered many of our marks in the United States and 94 other countries and in numerous International Classes. From time to time we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +R Design® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +DV® +LUV BETSEY plus Kiss Design® +Wild Pair® +LUV BETSEY by Betsey Johnson Design® +MadLove® +Blondo® +Betsey Johnson plus Kiss Logo® +Steve Madden plus Design® +Report Seattle® +Blondo Waterproof plus Heart Design® +R2® +SM New York® +Topline® +SM New York plus Design® +Dolcetta® +Madden Girl by Steve Madden® +DV8® +Steve Madden plus Heart Logo® +JD FISK® +Stevies plus Design® +B Blondo plus Design® +Big Buddha plus Design® +Studio B® +Big Buddha love big. Live Buddha plus Design® +Studio Blondo® +Betsey Johnson Too Too® +Blue By Betsey Johnson® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective licensing of our brands. As of December 31, 2016 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, +8 +marketing and sale of women's and children’s apparel, hosiery, swimwear, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we also license the trademarks of third parties for use in connection with certain of our product lines. Through a license agreement with Basic Properties America Inc. and BasicNet S.p.A we have the right to use the Superga® trademark in connection with the marketing and sale of footwear through December 31, 2022. This licensing agreement requires us to make royalty and advertising payments to the licensor equal to a percentage of our net sales or a minimum royalty and advertising payment in the event that specified net sales targets are not achieved. See Notes A and N to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2017 , we employed approximately 3,925 employees, of whom approximately 2,419 work on a full-time basis and approximately 1,506 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,652 of our employees are located in the United States, approximately 704 employees are located in Hong Kong and China, approximately 356 employees are located in Canada, approximately 144 employees are located in Mexico, approximately 60 employees are located in South Africa and approximately 9 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality +Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the timing of holidays, weather, the timing of larger shipments of footwear, market acceptance of our products, product mix, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. +Backlog +We had unfilled wholesale customer orders of approximately $337,000 and $295,000, as of February 1, 2017 and 2016 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. \ No newline at end of file diff --git a/raw/filings/0000913241/2016/0001628280-17-001869/item13.txt b/raw/filings/0000913241/2016/0001628280-17-001869/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..f591ca5c10538bc81d3d182d2344897e2d32f74e --- /dev/null +++ b/raw/filings/0000913241/2016/0001628280-17-001869/item13.txt @@ -0,0 +1,3 @@ +ITEM 13 +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2017 Annual Meeting of Stockholders, and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2016/0001628280-17-001869/item9a.txt b/raw/filings/0000913241/2016/0001628280-17-001869/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..3201f6ad0f3ca9ed4be078a8e5084d374d65c62d --- /dev/null +++ b/raw/filings/0000913241/2016/0001628280-17-001869/item9a.txt @@ -0,0 +1,12 @@ +ITEM 9A CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2016 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2016 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2016 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2016 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +33 \ No newline at end of file diff --git a/raw/filings/0000913241/2016/0001628280-17-001869/rp_note.txt b/raw/filings/0000913241/2016/0001628280-17-001869/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000913241/2016/0001628280-17-001869/rpt_disclosure.txt b/raw/filings/0000913241/2016/0001628280-17-001869/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..8c5914f7727af1eb827438a0159ea69d8e8d3cd1 --- /dev/null +++ b/raw/filings/0000913241/2016/0001628280-17-001869/rpt_disclosure.txt @@ -0,0 +1,123 @@ +and Related Party Transactions +Steven +Madden Employment Agreement. Effective as of July 1, 2005, the Company amended and restated its employment agreement with +the Company’s founder and Creative and Design Chief, Steven Madden, pursuant to which Mr. Madden agreed to continue +to serve as the Company’s Creative and Design Chief. The term of Mr. Madden’s employment under his employment +agreement commenced on July 1, 2005 and, in accordance with the amendment of the agreement effective December 31, 2011, will +end on December 31, 2023. Prior to this recent amendment, the agreement had provided for an annual salary of $600,000, with +a 7% increase of base salary on a compound basis in each of the third, fifth, seventh and ninth years of the agreement. The agreement +had also provided for an annual cash bonus in an amount equal to at least 2% of the Company’s EBITDA (the “Annual +Bonus”) and an annual cash bonus in relation to “new business” (as defined in the agreement) in an +amount equal to at least (i) 2.5% of new business gross direct revenues plus (ii) 10% of all license or other fee income +above $2,000,000 (the “New Business Bonus”). The agreement, as amended, increases Mr. Madden’s annual base +salary but eliminates the Annual Bonus and the New Business Bonus and provides that all cash bonuses subsequent to the fiscal +year ended December 31, 2011 will be at the sole discretion of the Company’s Board of Directors. Under the agreement, +as amended, Mr. Madden’s annual base salary was fixed at $5,416,667 in 2012, $7,416,667 in 2013, $9,666,667 in 2014, +$11,916,667 in 2015 and $10,697,917 in 2016 and in each year thereafter through the end of the term of employment. In addition, +the amended agreement entitles Mr. Madden to an annual life insurance premium reimbursement of up to $200,000. The amendment +also eliminates an annual non-accountable expense allowance of $200,000 that had been previously provided to Mr. Madden under +the agreement. Pursuant to the amended agreement, on February 8, 2012, Mr. Madden was granted 1,463,056 restricted shares +of Common Stock (the number of shares indicated having been adjusted for an October 1, 2013 three-for-two stock split effected +as a stock dividend), valued at approximately $40 million, under the 2006 Plan. The restricted Common Stock will vest in +equal annual installments over seven years commencing on December 31, 2017 through December 31, 2023, subject to Mr. Madden’s +continued employment with the Company on each such vesting date. +17 +On +June 30, 2012, pursuant to an election right granted to him under the agreement, as amended, Mr. Madden notified the Company +of his election to receive an additional restricted stock award valued at $40 million in consideration of a reduction in +his annual base salary in years subsequent to 2012. Accordingly, on July 3, 2012, Mr. Madden was issued 1,893,342 restricted +shares of Common Stock (the number of shares indicated having been adjusted for an October 1, 2013 three-for-two stock split +effected as a stock dividend) under the 2006 Plan. The restricted Common Stock will vest in equal annual installments over +six years commencing on December 31, 2018 through December 31, 2023, subject to Mr. Madden’s continued +employment with the Company on each such vesting date. As a result of his election to receive an additional restricted stock award, +Mr. Madden’s annual base salary for years subsequent to 2012 has been reduced as follows: $4,000,000 in 2013, $6,125,000 +in 2014, $8,250,000 in 2015 and $7,026,042 in 2016 and in each year thereafter through the end of the term of employment. +Mr. Madden +is also eligible to receive annually, on or about the date of the Company’s annual meeting of stockholders (but not later +than June 30 th ), an option grant (the “Annual Option”) to purchase a number of shares of Common Stock, +with such number to be equal to the greater of (a) 100% of the largest aggregate number of shares of Common Stock available +upon the exercise of an option or options granted to any other continuing full-time employee of the Company during the preceding +twelve-month period and (b) 100,000 shares of Common Stock; provided, however, that a grant to Mr. Madden in excess +of 150% of the number of shares of Common Stock subject to options granted to such other continuing full-time employee would require +stockholder approval. Any Annual Option granted to Mr. Madden would vest quarterly over a one-year period following the grant +date and would be exercisable at a price equal to the closing price of the Company’s Common Stock on the grant date for +a period of five years following the grant date. In addition to the Annual Option, the agreement, as amended, provides for a potential +additional one-time stock option grant to purchase 750,000 shares of the Company’s Common Stock (the number of shares subject +to this potential stock option award having been adjusted for an October 1, 2013 three-for-two stock split effected as a +stock dividend) in the event that the Company achieves earnings per share, on a fully-diluted basis, equal to $3.00 in any +fiscal year ending December 31, 2015 or after. If granted, the option would vest in equal annual installments of 20% over +a five-year period and be exercisable for a period of seven years at a price equal to the closing price of the Company’s +Common Stock on the date immediately preceding the grant date. +In +the event of Mr. Madden’s death, his employment agreement provides for the payment to Mr. Madden’s estate +of his base salary for the 12-month period immediately subsequent to the date of his death. Further, in the event that Mr. Madden’s +employment agreement is terminated due to Mr. Madden’s total disability (as defined in the agreement), “for cause” +(as defined in the agreement) or due to Mr. Madden’s resignation, the Company is obligated to pay Mr. Madden +the amount of compensation that is accrued and unpaid through the date of termination. In the event Mr. Madden’s employment +agreement is terminated for any reason (other than “for cause” or due to his death, total disability or resignation), +the Company is obligated to pay Mr. Madden, in installments, the balance of his base salary that would have been paid by +the Company under the agreement for the full term of the agreement. If, during the period commencing 120 days prior to a +“change of control” (as defined in the employment agreement) transaction and ending on the first anniversary +of a change of control transaction, Mr. Madden’s employment is terminated by the Company other than for cause or by +the resignation of Mr. Madden for “good reason” (as defined in the employment agreement), or if Mr. Madden +resigns for good reason or without good reason within 30 days following a change of control transaction, all unvested options +to purchase shares of Common Stock held by Mr. Madden will vest on the date of termination or resignation and Mr. Madden +will be entitled to receive a lump sum cash payment equal to the amount of compensation that is accrued and unpaid through the +date of termination plus $35 million. Mr. Madden’s employment agreement contains other customary provisions, including +provisions regarding expense reimbursement, confidentiality, solicitation and competition. +18 +For +the 2016 Fiscal Year, Mr. Madden earned $7,026,042 in base salary and received $200,000 for the payment of an annual life +insurance premium. Mr. Madden also received as his Annual Option for the 2016 Fiscal Year an option to purchase 150,000 shares +of Common Stock at a price per share of $34.42. +Loan +to Steven Madden. On June 25, 2007, the Company made a loan to Steven Madden, its Creative and Design Chief and a principal +stockholder of the Company, in the amount of $3,000,000, in order for Mr. Madden to satisfy a personal tax obligation resulting +from the exercise of a stock option which was due to expire and hold the underlying shares of Common Stock. The loan is evidenced +by a secured promissory note executed by Mr. Madden in favor of the Company, the security for which is a security interest in +a certain securities brokerage account maintained by Mr. Madden with his broker; none of the securities in the securities brokerage +account are shares of the Company’s Common Stock. There have been successive amendments to the secured promissory note, +the most recent of which occurred in April 2016, at which time the secured promissory note was amended to substitute the collateral +securing the secured promissory note from shares of the Company’s Common Stock to the security interest in Mr. Madden’s +securities brokerage account. Previously, on January 3, 2012, the secured promissory note was amended and restated to extend the +maturity date of the obligation to December 31, 2023 and eliminate the accrual of interest after December 31, 2011. +Prior to the January 3, 2012 amendment, the secured promissory note had been accruing interest at the rate of 6% per annum. In +addition, the secured promissory note provides that, commencing on December 31, 2014 and annually on each December 31 +thereafter through the maturity date, one-tenth of the principal amount thereof, together with accrued interest, will be cancelled +by the Company provided that Mr. Madden continues to be employed by the Company on each such December 31. Contemporaneously, +the Company will release its security interest in a portion of the securities held in Mr. Madden’s securities brokerage +account generally correlating to the amount of indebtedness cancelled on such date. As of December 31, 2011, interest in +the amount of $1,090,000 had accrued on the principal amount of the secured promissory note and, as noted above, interest was +eliminated after December 31, 2011. On December 31, 2016, the required one-tenth of the principal amount of the secured +promissory note, together with accrued interest, was written-off by the Company. +Review, Approval or Ratification +of Transactions with Related Persons +The +Company’s written Conduct Code and Employee Handbook prohibit all conflicts of interest. Under the Conduct Code, conflicts +of interest occur when private or family interests interfere in any way, or even appear to interfere, with the interests of the +Company. The Company’s prohibition on conflicts of interest under the Conduct Code includes any related person transaction. +Related +person transactions must be approved by the Board, or by a committee of the Board consisting solely of independent directors, +who will approve the transaction only if they determine that it is in the best interests of the Company. In considering the transaction, +the Board or committee will consider all relevant factors, including, as applicable, (i) the Company’s business rationale +for entering into the transaction; (ii) the alternatives to entering into a related person transaction; (iii) whether +the transaction is on terms comparable to those available to third parties or, in the case of employment relationships, to employees +generally; (iv) the potential for the transaction to lead to an actual or apparent conflict of interest and any safeguards +imposed to prevent such actual or apparent conflicts; and (v) the overall fairness of the transaction to the Company. +The +Company has multiple processes for reporting conflicts of interests, including related person transactions. Under the Conduct +Code, all employees are required to report any actual or apparent conflict of interest, or potential conflict of interest, to +management. The Chief Financial Officer distributes a questionnaire to the Company’s executive officers and management personnel +on a quarterly basis and distributes a questionnaire to the members of the Board of Directors on an annual basis requesting certain +information regarding, among other things, their immediate family members, employment and beneficial ownership interests, which +information is then reviewed for any conflicts of interest under the Conduct Code. +The +Board of Directors, the Audit Committee and the Disclosure Committee, which is comprised of management personnel, discuss the +related party transactions, specifically, and in connection with the regular review processes attendant to the Company’s +periodic filings, including related party transaction disclosures. +If +a director is a party to or in some manner involved in a transaction involving the Company, he or she will be recused from all +discussions and decisions about the transaction. The transaction must be approved in advance whenever practicable, and if not +practicable, must be ratified as promptly as practicable. +19 +COMPENSATION \ No newline at end of file diff --git a/raw/filings/0000913241/2017/0001628280-18-002589/filing.txt b/raw/filings/0000913241/2017/0001628280-18-002589/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..0829813c90ae5d5df01c20890dd49f629251e628 --- /dev/null +++ b/raw/filings/0000913241/2017/0001628280-18-002589/filing.txt @@ -0,0 +1,4299 @@ +10-K +1 +shoo-20171231x10k.htm +10-K +Document +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2017 +or +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ________ to ________ +Commission File Number 0-23702 +STEVEN MADDEN, LTD. +(Exact name of registrant as specified in its charter) +Delaware +13-3588231 +(State or other jurisdiction of +(I.R.S. Employer Identification No.) +incorporation or organization) +52-16 Barnett Avenue, Long Island City, New York 11104 +(Address of principal executive offices) (Zip Code) +(718) 446-1800 +(Registrant's Telephone Number, Including Area Code) +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Common Stock, par value $.0001 per share +The NASDAQ Stock Market LLC +Preferred Stock Purchase Rights +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes x No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act. +Yes o No x +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes x No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes x No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”,“smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer x +Accelerated filer o +Non-accelerated filer o (do not check if smaller reporting company) +Smaller reporting company o +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). +Yes o No x +The aggregate market value of the common equity held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and directors are “affiliates” of the registrant) as of June 30, 2017 , the last business day of the registrant's most recently completed second fiscal quarter, was $2,341,862,448 (based on the closing sale price of the registrant's common stock on that date as reported on The NASDAQ Global Select Market). +The number of outstanding shares of the registrant's common stock as of February 27, 2018 was 58,782,009 shares. +DOCUMENTS INCORPORATED BY REFERENCE: +PART III INCORPORATES CERTAIN INFORMATION BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT'S 2018 ANNUAL MEETING OF STOCKHOLDERS. +TABLE OF CONTENTS +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +1 +PART I +ITEM 1 BUSINESS +1 +ITEM 1A RISK FACTORS +10 +ITEM 1B UNRESOLVED STAFF COMMENTS +18 +ITEM 2 PROPERTIES +18 +ITEM 3 LEGAL PROCEEDINGS +19 +ITEM 4 MINE SAFETY DISCLOSURES +20 +PART II +ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER +MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +20 +ITEM 6 SELECTED FINANCIAL DATA +23 +ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION +AND RESULTS OF OPERATIONS +24 +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +34 +ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +34 +ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON +ACCOUNTING AND FINANCIAL DISCLOSURE +34 +ITEM 9A CONTROLS AND PROCEDURES +35 +ITEM 9B OTHER INFORMATION +35 +PART III +ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +35 +ITEM 11 EXECUTIVE COMPENSATION +36 +ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND +MANAGEMENT AND RELATED STOCKHOLDER MATTERS +36 +ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND +DIRECTOR INDEPENDENCE +36 +ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES +36 +PART IV +ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +36 +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K contains “forward-looking statements” (as that term is defined in the federal securities laws), which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with regard to future revenue, projected 2018 results, earnings, spending, margins, cash flow, customer orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives and other future events. More generally, forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. Factors that may affect our results include, but are not limited to, the risks and uncertainties discussed in Item 1A of this Annual Report on Form 10-K. +Any such forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based and could cause our actual results to differ materially from those projected in forward-looking statements. As such, we strongly caution you that these forward-looking statements are not guarantees of future performance or events. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. +PART I +ITEM 1. BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories. We also license some of our trademarks for use in connection with the manufacture, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico, our joint ventures in South Africa, China and Taiwan, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we have special distribution arrangements for the marketing of our products in Asia, Europe (excluding the aforementioned nations), India, the Middle East, South and Central America and New Zealand. We offer a broad range of updated styles designed to establish or complement and capitalize on market trends. We have established a reputation for design creativity and our ability to offer quality products in popular styles at affordable prices, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. The public may read and copy any materials filed by us with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information regarding the operation of the SEC's Public Reference Room is available by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +1 +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company and a Code of Business Conduct and Ethics that is applicable to all of our employees, each of which are attached as exhibits to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015 and posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Net sales for 2017 increased 10.5% to $1,546,098 from $1,399,551 in 2016 . Net income attributable to Steven Madden, Ltd. decreased 2.5% to $117,948 in 2017 compared to $120,911 in 2016 . Diluted earnings per share in 2017 increased to $2.04 per share on 57,830,000 diluted weighted average shares outstanding compared to $2.03 per share on 59,556,000 diluted weighted average shares outstanding in the prior year. +Recent Developments +On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act. The Tax Cuts and Jobs Act made broad and complex changes to the U.S. tax code which impacts 2017 in many ways, including, by reducing the U.S. federal corporate tax rate and imposing a one-time transition tax on certain undistributed earnings of foreign subsidiaries. See additional information regarding the impact of the Tax Cuts and Jobs Act in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” and Note M "Income Taxes" to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Madden NYC, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, B Brian Atwood®, Blondo®, Kate Spade® (under license), Avec Les Filles® (under license), Alice & Olivia® (through a joint venture) and includes our International business and certain private label footwear business. The agreement with the Alice & Olivia® terminated on December 31, 2017. +Our Wholesale Accessories segment is comprised of Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Cejon®, B Brian Atwood®, Luv Betsey®, DKNY® (under license) and Donna Karan® (under license) accessories brands and also includes our International business and certain private label accessories business. +Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites and comprises our Retail segment. +Our First Cost segment represents activities of one of our wholly-owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in the manufacture, marketing and sale of outerwear exclusively to Target. In addition, we license our Betsey Johnson® trademark for use in the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United +2 +States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared for young women ages 16 to 23, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +Steve Madden Men's. We design, source, and market a life style collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range in price from $70 to $150 at retail per pair. +Madden. T he Madden® brand is a denim friendly collection of footwear designed to meet the ever evolving needs of the trend conscious male consumer, ages 13 to 35 years old. Madden products range from $45 to $90 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal principally to fashion conscious women, ages 25 to 45, who shop at department stores, footwear boutiques and shopping networks. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12. Our Stevies® brand is sold exclusively to Target, while our products sold under Steve Madden Kids® brand are distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. +FREEBIRD by Steven . We design, source, and market a full collection of handcrafted, Goodyear welted boots. The designs are inspired by vintage Americana and created using time-honored craftsmanship. The FREEBIRD by Steven® collection conveys a unique fashion life style that transcends multiple generations. FREEBIRD by Steven® products are currently sold, at retail prices ranging from $195 to $450 per pair at major department stores, mid-tier retailers, and specialty boutiques. +Report. The Report® brand was acquired in our May 2011 acquisition of Topline Corporation ("Topline") and its subsidiaries. The Report® brand is a junior women's footwear brand with price points ranging from $20 to $150 per pair. We design, manufacture, market and sell our Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed exclusively to Target. +Dolce Vita. In August 2014, the Company acquired the Dolce Vita® and DV® brands and other intellectual property assets in the acquisition of Dolce Vita Holdings, Inc. Dolce Vita® is a contemporary women's footwear brand with price points ranging from $120 to $350 per pair. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. The DV® brand has price points ranging from $20 to $75 per pair and is currently distributed exclusively at Target. +3 +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand from Brian Atwood IP Company LLC. Founded in 2011, Brian Atwood is known for luxury shoes manufactured in Italy. We design, manufacture, market and sell our Brian Atwood branded products primarily to major department stores throughout the United States. +Blondo. In January 2015, the Company acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. +In January 2017, the Company acquired all of the issued and outstanding capital stock of Schwartz & Benjamin, Inc., a family-owned business that specialized in licensed brands and private label footwear. As a consequence of the acquisition, the Company acquired licenses to manufacture, market and sell footwear under the Kate Spade® and Avec Les Filles® trademarks as well as a design/manufacturing agreement with Rebecca Minkoff® and a joint venture with Alice & Olivia®. +Kate Spade. The Kate Spade® brand, known for its whimsical fashion, is an entry-level luxury footwear brand primarily distributed through department stores throughout the United States. The price points of footwear bearing the Kate Spade® brand range from $48 to $400 per pair with the core product price ranging from $198 to $298 per pair. +Avec Les Filles. The Avec Les Filles® brand is geared toward the millennial customer and is primarily distributed through department stores throughout the United States as well as online at core product prices ranging from $98 to $150 per pair. +Alice & Olivia. The Alice & Olivia® brand is a contemporary luxury footwear brand distributed primarily through department stores throughout the United States with core product prices ranging from $195 to $450 per pair. +Anne Klein. In January 2018, the Company entered into a license agreement with Nine West Development LLC for a license to use the Anne Klein® trademark in connection in the marketing and sale of footwear. Established in the U.S. in 1968, the Anne Klein® brand is recognized as being synonymous with American sportswear. +International Division. The International division, utilizing the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, the International division works through special distribution arrangements for the marketing and sales of our products in Asia, Europe (excluding the aforementioned nations), India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands (including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Madden NYC, Big Buddha®, B Brian Atwood®, DKNY® (under license), Donna Karan® (under license), Anne Klein® (under license beginning in 2018) and Luv Betsey® brands) and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our International distributor network. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon®, Steve Madden®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2017 , we owned and operated 206 retail stores including 138 Steve Madden full price stores, 60 Steve Madden outlet stores, three Steven stores, one Superga store and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). In 2017 , we opened 13 new full price stores, six new outlet stores and closed two full price stores in the United States. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, China and Taiwan. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2017 and 2016 ) decreased 3.2% in fiscal year 2017 from the prior year. The Company excludes +4 +new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product development efforts of our two Wholesale segments. We expect to open 11 to 13 new retail stores and close 8 to 10 locations in 2018 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Kohl's, Sears and K-Mart. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note O to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new Steve Madden products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Steve Madden products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Steve Madden brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers in China, Italy, Brazil, Mexico, India, Vietnam, The Netherlands, The Dominican Republic and South Korea. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and +5 +incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California and New Jersey, also via truck from Mexico to our third party distribution facility in Texas, with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from five third-party distribution centers, three located in California, one located in Texas and one located in New Jersey. Our products are also distributed through two Company-operated distribution centers located in New Jersey and Canada. By utilizing distribution facilities specializing in distribution fulfillment to effect distribution to certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers include Target Corporation, Nordstrom, Inc., Macy's, Inc., The TJX Companies, Inc., Wal-Mart Stores, Inc., DSW, Inc., Ross Stores, Inc., Kohl's Corporation, Amazon.com, Inc. and Payless ShoeSource, Inc. For the year ended December 31, 2017 , Target Corporation represented 13.4% of total accounts receivable and Wal-Mart Stores, Inc. represented 14.6% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, China and Taiwan +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico, certain European nations including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in South Africa, China and Taiwan, and on our e-commerce websites. For the year ended December 31, 2017 , our Retail segment and our two Wholesale segments generated net sales of approximately $272,246 and $1,273,852 , or 18% and 82% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2017 , we operated 138 Steve Madden full price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China and Taiwan. We also operated 60 Steve Madden outlet stores, three Steven stores and one Superga store within the United States. The Company also operated four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer +6 +profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell our products to over 2,500 doors of 17 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Macy's, Inc., Dillard's, Inc., Nordstrom, Inc., Belk, Inc. and Lord & Taylor. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at season's end. +National chains and mass merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Target Corporation, Wal-Mart Stores, Inc., Kohl's Corporation, and The J.C. Penney Company. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW, Inc., Famous Footwear, Journeys and Payless ShoeSource, Inc . We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's and Victoria's Secret. +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate four Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson and Dolce Vita) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Asia, certain European nations, India, the Middle East, South and Central America and New Zealand. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Jessica Simpson, Sam Edelman, Ugg and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +7 +Marketing and Sales +We have focused on creating an integrated brand building program to establish Steve Madden as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations including product and brand placements in life style and fashion magazines and digital outlets, as well as personal appearances by our founder and Creative and Design Chief, Steve Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson, Blondo and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products, as well as view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our wholesale information system is an Enterprise Resource Planning (“ERP”) system. This integrated system supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. We completed the implementation of this new ERP system for our wholesale business in 2014 and implemented the system in three of our acquired businesses in 2015 and in two additional acquired businesses in 2016. In 2017, we completed the implementation of the ERP system for Asia first-cost and sourcing operations and for recently-acquired Schwartz & Benjamin. In 2014, we completed the implementation of a new warehouse management system that is utilized by our third-party logistics providers and, during 2015, implemented this warehouse management system in a company-owned warehouse. This warehouse management system is fully integrated with our ERP system. All of our North American wholesale businesses (other than Canada which has a separate ERP system) are now operating on this ERP system. In 2017, we completed the implementation of a new point of sale system for our U.S. retail stores that is integrated with a retail inventory management/store replenishment system. Complimenting all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +Intellectual Property +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 94 other countries and in numerous International Classes. From time to time we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +8 +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +R Design® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +DV® +LUV BETSEY plus Kiss Design® +Wild Pair® +LUV BETSEY by Betsey Johnson Design® +MadLove® +Blondo® +Betsey Johnson plus Kiss Logo® +Steve Madden plus Design® +Report Seattle® +Blondo Waterproof plus Heart Design® +R2® +SM New York® +Topline® +SM New York plus Design® +Dolcetta® +Madden Girl by Steve Madden® +DV8® +Steve Madden plus Heart Logo® +JD FISK® +Stevies plus Design® +B Blondo plus Design® +Big Buddha plus Design® +Studio B® +Big Buddha love big. Live Buddha plus Design® +Studio Blondo® +Betsey Johnson Too Too® +Blue By Betsey Johnson® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective out-licensing of our brands. As of December 31, 2017 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we also in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +• +In August 2017, we entered into a license agreement with Donna Karan Studio LLC for the right to manufacture, market and sell women's belts with the DKNY® and Donna Karan® brands. The agreement, unless extended, expires on December 31, 2020. +• +In January 2017, we acquired all of the outstanding capital stock of Schwartz & Benjamin, Inc., and, as a consequence of the acquisition, acquired (i) licenses to manufacture, market and sell footwear under the Kate Spade® and Avec Les +9 +Filles® brands and (ii) a joint venture for the Alice & Olivia® brand. As of December 31, 2017, the Alice & Olivia® joint venture agreement was terminated. +• +Through a license agreement with Basic Properties America Inc. and BasicNet S.p.A, we have the right to use the Superga® trademark in connection with the marketing and sale of footwear through December 31, 2022. +See Notes A and N to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2018 , we employed approximately 3,884 employees, of whom approximately 2,497 work on a full-time basis and approximately 1,387 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,554 of our employees are located in the United States, approximately 709 employees are located in Hong Kong and China, approximately 353 employees are located in Canada, approximately 163 employees are located in Mexico, approximately 84 employees are located in South Africa and approximately 21 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales have occurred in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales have occurred in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Sales levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $367,101 and $337,000, as of February 1, 2018 and 2017 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. +ITEM 1A. RISK FACTORS +You should carefully consider the risks and uncertainties we describe below and the other information in this Annual Report on Form 10-K before deciding to invest in, sell or retain shares of our common stock. These are not the only risks and uncertainties that we face. Other sections of this report may discuss factors that could adversely affect our business. The retail industry is highly competitive and subject to rapid change. There may be additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, which may also harm our business or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, results of operations and liquidity could be materially harmed. +Risks Related to the Industry in Which the Company Operates +Constantly Changing Fashion Trends and Consumer Demands. The strength of our brands and our success depends in significant part upon our ability to anticipate and respond to product and fashion trends as well as to anticipate, gauge and react to changing consumer demands in a timely manner. There can be no assurance that our products will correspond to the changes in taste and demand or that we will be able to successfully market products that respond to such trends. If we misjudge the market +10 +for our products, we may be faced with significant excess inventories for some products and missed opportunities as to others. In addition, misjudgments in merchandise selection could adversely affect our image with our customers resulting in lower sales and increased markdown allowances for customers which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Intense Fashion Industry Competition . The fashion footwear and accessories industry is highly competitive and barriers to entry are low. Our competitors include specialty companies as well as companies with diversified product lines. The recent market growth in the sales of fashion footwear and accessories has encouraged the entry of many new competitors and increased competition from established companies. Many of these competitors, including Nine West, Guess?, Jessica Simpson, Ugg and Aldo, may have significantly greater financial and other resources than we do and there can be no assurance that we will be able to compete successfully with other fashion footwear and accessories companies. Increased competition could result in pricing pressures, increased marketing expenditures and loss of market share, and could have a material adverse effect on our business, financial condition, results of operations and liquidity. We believe effective advertising and marketing, favorable branding of Steve Madden® and our other trademarks, fashionable styling, high quality, competitive pricing and value are the most important competitive factors. We plan to continue to focus on these elements as we develop new products and businesses. Our inability to effectively advertise and market our products and respond to customer preferences could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Cyclical Nature of the Fashion Industry . The overall fashion industry is cyclical, and purchasing tends to decline during recessionary periods when disposable income is low. Likewise, purchases of contemporary shoes and accessories tend to decline during recessionary periods and also may decline at other times. There can be no assurance that we will be able to grow or even maintain our current level of revenues and earnings, or remain profitable in the future. Slow growth in the international, national or regional economies and uncertainties regarding future economic prospects, among other things, could affect consumer spending habits. The volatility and disruption of global economic and financial market conditions that began in 2008 has caused lingering declines in consumer confidence and spending in the United States and internationally. A further deterioration or a continued weakness of economic and financial market conditions for an extended period of time could have a material adverse effect on our business, financial condition, results of operations and liquidity. +A Rapidly Changing Retail Industry . In recent years, the retail industry has experienced consolidation and other ownership changes. In the future, retailers in the United States and in foreign markets may further consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our products or our licensees’ products or increase the ownership concentration within the retail industry. Changing shopping patterns, including the rapid expansion of online retail shopping, have adversely affected customer traffic in mall and outlet centers, particularly in North America. We expect competition in the e-commerce market will intensify. As a greater portion of consumer expenditures with retailers occurs online and through mobile commerce applications, our brick-and-mortar retail customers who fail to successfully integrate their physical retail stores and digital retail may experience financial difficulties, including store closures, bankruptcies or liquidations. A continuation or worsening of these trends could cause financial difficulties for one or more of our major customers, which, in turn, could substantially increase our credit risk and have a material adverse effect on our results of operations, financial condition and cash flows. Our future success will be determined, in part, on our ability to manage the impact of the rapidly changing retail environment and identify and capitalize on retail trends, including technology, e-commerce and other process efficiencies that will better service our customers. If we fail to compete successfully, our businesses, market share, results of operations and financial condition will be materially and adversely affected. While such changes in the retail industry to date have not had a material adverse effect on our business or financial condition, results of operations and liquidity, there can be no assurance as to the future effect of any such changes. +Economic Uncertainty . Our opportunities for long-term growth and profitability are accompanied by significant challenges and risks, particularly in the near term. Specifically, our business is dependent on consumer demand for our products and the purchase of our products by consumers is largely discretionary. We believe that declining consumer confidence accompanied with the tightening of credit standards, higher energy and food prices and unemployment rates and a decrease in consumers' disposable income has negatively impacted the level of consumer spending for discretionary items during the years ended December 31, 2017 , 2016 and 2015 . In addition, economic factors such as inflation, higher labor costs, increased transportation costs and higher healthcare and insurance costs may increase our costs of sales and operating expenses. Changes in economic conditions may have a negative effect on the Company's sales and results of operations during the year ending December 31, 2018 and thereafter. +Legal, Regulatory and Political Risks of a Global Economy. As a result of our large and growing international operations, we are subject to risks associated with our operations in international markets as a result of a number of factors, many of which are beyond our control. These risks include, among other things: +11 +• +the challenge of managing broadly dispersed foreign operations; +• +inflationary pressures and economic changes or volatilities in foreign economies; +• +the burdens of complying with the laws and regulations of the U.S. and foreign nations; +• +additional or increased customs duties, tariffs, taxes and other charges on imports or exports; +• +political corruption or instability; +• +geopolitical regional conflicts, terrorist activity, political unrest, civil strife, acts of war; +• +local business practices that do not conform to legal or ethical guidelines; +• +anti-American sentiment in foreign countries in which we operate; +• +delays in receipts of our products at our distribution centers due to labor unrest, increasing security requirements or other factors at U.S. or other ports; +• +significant fluctuations in the value of the dollar against foreign currencies; +• +increased difficulty in protecting our intellectual property in foreign nations; +• +restrictions on the transfer of funds between the U.S. and foreign nations; and +• +natural disasters in areas in which our businesses, customers, suppliers and licensees are located. +All of these factors could disrupt or limit the countries in which we sell or source our products or significantly increase the cost of operating in or obtaining materials originating from certain countries, result in decreased revenues and could materially and adversely affect our product sales, financial condition and results of operations. +Following the November 2016 U.S. election, the leaders of the U.S. government have increasingly focused on efforts to discourage U.S. corporations from outsourcing manufacturing and production activities to foreign jurisdictions, including through the possibility of imposing tariffs or penalties on goods manufactured outside the United States to attempt to discourage these practices. Changes in tax policy or trade regulations, such as the recently passed Tax Cuts and Jobs Act in the United States, material modifications or withdrawal from existing trade agreements, including the United States’ withdrawal from or significant renegotiation of the North America Free Trade Agreement (NAFTA), the disallowance of tax deductions on imported merchandise, or the imposition of new tariffs on imported products, could necessitate changes in the way we conduct business, including our product sourcing operations, and have a material adverse effect on our business and results of operations. +In June 2016, voters in the United Kingdom approved an advisory referendum, commonly referred to as “Brexit”, to withdraw from the European Union. Brexit has created political and economic uncertainty, particularly in the United Kingdom and the European Union, that may endure for years. The withdrawal of the United Kingdom from the European Union could significantly disrupt the free movement of goods, services, and people between the United Kingdom and the European Union, and increase legal and regulatory complexities, all of which could lead to higher costs of conducting business in Europe. Brexit could also encourage similar referendums in other European countries in which we do business. The terms of the United Kingdom's withdrawal from the European Union are uncertain. Its consequences could adversely impact consumer and investor confidence, and the level of consumer purchases of discretionary items and retail products, including our products. All of these factors could materially adversely affect our business, results of operations, and financial condition. +We are subject to the U.S. Foreign Corrupt Practices Act, which generally prohibits the payment of bribes to foreign officials to assist in obtaining or retaining business. We are also subject to anti-corruption laws of the foreign countries in which we operate. Although we have implemented policies and procedures that are designed to promote compliance with such laws, our employees, contractors and agents may take actions that violate our policies and procedures. Any such violation could result in sanctions or other penalties against the Company and have an adverse effect on our business, reputation and operating results. +Changes in Tax Laws Could Have an Adverse Effect Upon Our Financial Results. We are subject to income tax requirements in various jurisdictions in the United States and internationally. Legislation or other changes in the tax laws of the jurisdictions where we do business could increase our liability and adversely affect our after-tax profitability. In the United States, the Tax Cuts and Jobs Act, which was enacted on December 22, 2017, could have a significant impact on our effective tax rate, net deferred tax assets and cash tax expenses. Among other things, the Tax Cuts and Jobs Act reduces the U.S. corporate statutory tax rate, eliminates or limits deduction of several expenses which were previously deductible, requires a minimum tax on earnings generated by foreign subsidiaries, imposes a mandatory deemed repatriation tax on undistributed historic earnings of foreign subsidiaries and permits a tax-free repatriation of foreign earnings through a dividends-received deduction. We are currently evaluating the overall impact of the Tax Cuts and Jobs Act on our effective tax rate and balance sheet, but expect that the impact may be significant for our fiscal year 2018 and future periods. +Other jurisdictions are contemplating changes or have unpredictable enforcement activity. Increases in applicable tax rates, implementation of new taxes, changes in applicable tax laws and interpretations of these tax laws and actions by tax authorities in jurisdictions in which we operate could reduce our after tax income and have an adverse effect on our results of operations. +12 +We May Be Subject to Additional Tax Liabilities as a Result of Audits by Various Taxing Authorities. We are subject to the tax laws and regulations of numerous jurisdictions as a result of our international operations. These tax laws and regulations are highly complex and significant judgment and specialized expertise is required in evaluating and estimating our worldwide provision for income taxes. We are subject to audit by the taxing authorities in each jurisdiction where we conduct our business., and any one of these jurisdictions may assess additional taxes against us as a result of an audit. Although we believe our tax estimates are reasonable, and we undertake to prepare our tax filings in accordance with all applicable tax laws, the final determination with respect to any tax audits, and any related litigation, could be materially different from our estimates or from our historical tax provisions and accruals. The outcome of any audit or audit-related litigation could have a material adverse effect on our operating results or cash flows in the periods for which that determination is made, and may require a restatement of prior financial reports. In addition, future period earnings may be adversely impacted by litigation costs, settlement payments or interest or penalty assessments. +Risks Related to Our Business +Dependence on Key Personnel. The growth and success of our Company since its inception more than a quarter century ago is attributable, to a significant degree, to the talents, skills and efforts of our founder and Creative and Design Chief, Steven Madden. An extended or permanent loss of the services of Mr. Madden could severely disrupt our business and have a material adverse effect on the Company. In addition to Mr. Madden, the Company depends on the contributions of the members of our senior management team. Our senior executives have substantial experience and expertise in our business and industry and have made significant contributions to our growth and success as well. Competition for executive talent in the apparel, footwear and accessories industries is intense. While our employment agreements with Mr. Madden and most of our senior executives include a non-compete provision in the event of the termination of employment, the non-compete periods are of limited duration. Although we believe we have depth within our senior management team, if we were to lose the services of our Creative and Design Chief or any of our senior executives, and especially if any of these individuals were to join a competitor or form a competing company, our business and financial performance could be seriously harmed. A loss of the skills, industry knowledge, contacts and expertise of our Creative and Design Chief or any of our senior executives could cause a setback to our operating plan and strategy. +Dependence Upon Significant Customers . Our customers consist principally of better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers. Certain of our department store customers, including some under common ownership, account for significant portions of our wholesale business. We generally enter into a number of purchase order commitments with our customers for each of our lines every season and do not enter into long-term agreements with any of our customers. Therefore, a decision by a significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to decrease the amount of merchandise purchased from us or to change its manner of doing business could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Risks Associated with Extending Credit to Customers. We sell our products primarily to retail stores across the United States and extend credit based on an evaluation of each customer's financial condition, usually without collateral. Various retailers, including some of our customers, have experienced financial difficulties, which has increased the risk of extending credit to such retailers. However, our losses due to bad debts have been limited. Pursuant to the terms of our collection agency agreement, our factor, Rosenthal & Rosenthal, Inc., currently assumes the credit risk related to approximately 84% of our trade accounts receivable. In addition, we have letters of credit for approximately 3% of our trade accounts receivable. Still, if any of our customers experience a shortage of liquidity, the risk that the customer's outstanding payables to us would not be paid could cause us to curtail business with the customer or require us to assume more credit risk relating to the customer's account payable. +Risks Associated with Expansion of Retail Business . Our continued growth depends to a significant degree on whether we are successful in further developing and marketing our brands, and creating new brands, product categories and businesses that are appealing to our customers. The operation of company-owned Steve Madden, Steven and Superga stores and outlets is a significant part of our growth strategy. During the year ended December 31, 2017 , we opened 13 new full price stores, six new outlet stores and closed two full price stores in the United States. We have plans to open 11 to 13 new retail stores and close 8 to 10 locations in 2018 . Our future expansion plan includes the opening of stores in new geographic markets as well as strengthening existing markets. New store openings involve substantial investments. New markets have in the past presented, and will continue to present, competitive and merchandising challenges that are different from those faced by us in our existing markets. There can be no assurance that we will be able to open new stores, and if opened, that such new stores will be able to achieve sales and profitability levels consistent with management's expectations. Our retail expansion is dependent on the performance of our wholesale and retail operations, generally, as well as on a number of other factors, including our ability to: +• +locate and obtain favorable store sites; +13 +• +negotiate favorable lease terms; +• +hire, train and retain competent store personnel; +• +anticipate the preferences of our retail customers in new geographic areas; +• +successfully integrate new stores into our existing operations. +Past comparable store sales results may not be indicative of future results and there can be no assurance that our comparable store sales results will increase or even be maintained in the future. Also, as we expand the number of our retail stores, we run the risk that our wholesale customers will perceive that we are increasingly competing directly with them, which may lead them to reduce or terminate purchases of our products. +Management of Growth . The size of our business continues to grow organically and as a result of business acquisitions. In order to gain from our acquisitions, we must be effective in integrating the businesses acquired into our overall operations. Further, the expansion of our operations has increased and will continue to increase the demand on our managerial, operational and administrative resources. In recent years, we have invested significant resources in, among other things, our management information systems and hiring and training of new personnel. However, in order to manage currently anticipated levels of future demand, we may be required to, among other things, expand our distribution facilities, establish relationships with new manufacturers to produce our product, and continue to expand and improve our financial, management and operating systems. We may experience difficulty integrating acquired businesses into our operations and may not achieve anticipated synergies from such integration. There can be no assurance that we will be able to manage future growth effectively and a failure to do so could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruptions to Product Delivery Systems and Associated Inventory Management Issues. A majority of our products for U.S. distribution are shipped to us via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on California ports. The trend-focused nature of the fashion industry and the rapid changes in customer preferences leave us vulnerable to risk of inventory obsolescence. Our reliance upon ocean freight transportation for the delivery of our inventory exposes us to various inherent risks, including port workers’ union disputes and associated strikes, work slow-downs and work stoppages, severe weather conditions, natural disasters and terrorism, any of which could result in delivery delays and inefficiencies, increase our costs and disrupt our business. Any severe and prolonged disruption to ocean freight transportation could force us to use alternate and more expensive transportation systems. For example, during the California port workers' dispute in 2014, we were forced to re-route our merchandise by air transit. Efficient and timely inventory deliveries and proper inventory management are important factors in our operations. Inventory shortages can adversely affect the timing of shipments to customers and diminish sales and brand loyalty. Conversely, excess inventories can result in lower gross margins due to the excessive discounts and markdowns that may be necessary to reduce high inventory levels. Severe and extended delays in the delivery of our inventory or our inability to effectively manage our inventory could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruption of Information Technology Systems and Websites. We are heavily dependent upon our information technology systems to record and process transactions and manage and operate all aspects of our business ranging from product design and testing, production, forecasting, ordering, transportation, sales and distribution, invoicing and accounts receivable management, quick response replenishment, point of sale support and financial management reporting functions. In addition, we have e-commerce websites. Given the nature of our business and the significant number of transactions in which we engage on an annual basis, it is essential that we maintain constant operation of our information technology systems and websites and that these systems and our websites operate effectively. We depend on our in-house information technology employees and third-parties including “cloud” service providers to maintain and periodically update and/or upgrade these systems and our websites to support the growth of our business. Despite our preventative efforts, our information technology systems and websites may, from time to time, be vulnerable to damage or interruption from events such as difficulties in replacing or integrating the systems of acquired businesses, computer viruses, security breaches and power outages. Cybersecurity attacks are becoming increasingly sophisticated and run the gamut from malicious software and ransomware to electronic security breaches to corruption of data and beyond. We are continually evaluating, improving and upgrading our information technology systems and websites in an effort to address these concerns. Any such problems or interruptions could result in loss of valuable business data, our customers' or employees' personal information, disruption of our operations and other adverse impacts to our business and require significant expenditures by us to remediate any such failure, problem or breach. In addition, we must comply with increasingly complex regulatory standards enacted to protect business and personal data and an inability to maintain compliance with these regulatory standards could subject us to legal risks and penalties. +We maintain $40 million of network-security insurance coverage, above a $250,000 deductible. This coverage and certain other insurance coverage may reduce our exposure to electronic data theft and sabotage. While we maintain other insurance +14 +coverage aimed at addressing certain of these other risks, there can be no assurance that depending upon the nature of the issue presented, we will have insurance coverage available or that the amounts of coverage will be adequate. +Breach of Customer Privacy. A routine part of our business includes the gathering, processing and retention of sensitive and confidential information pertaining to our customers, employees and others. Although we believe that our information security and information technology systems and websites allow for the secure storage and transmission of private information regarding our customers and others, including credit card information and personal identification information, we may not have the resources or technical sophistication to anticipate or prevent the rapidly-evolving and complex cyber-attacks being unleashed by increasingly sophisticated hackers and data thieves. As a result, our facilities and information technology systems, as well as those of our third party service providers, may be vulnerable to cyber-attacks and breaches, acts of vandalism, ransomware, software viruses and other similar types of malicious activities. Any actual or threatened cyber-attack may cause us to incur costs, including costs related to the hiring of additional computer experts, business interruption, engaging third party cyber security consultants and upgrading our information security technologies. We also may be vulnerable to data and security breaches by us or by persons with whom we have commercial relationships resulting from misplaced or lost data, programming or human error, or other similar events. As a result of recent security breaches at a number of prominent companies, the media and public scrutiny of information security and privacy has become more intense and the regulatory environment has become more uncertain. Any compromise or breach of our information technology systems that results in the misappropriation, loss or other unauthorized disclosure of a customer's or other person’s confidential or proprietary information, whether by the Company or a third party service provider, could result in a loss of confidence and severely damage our reputation and relationship with our customers and others who entrust us with sensitive information, violate applicable privacy and other laws and adversely affect our business, as well as expose the Company to the risk of litigation and significant potential liability. +Foreign Sourcing and Manufacturing. Virtually all of our products are purchased through arrangements with a number of foreign manufacturers, primarily from China, Italy, Brazil, Mexico, India and Vietnam. During 2017 , approximately 93% of our total purchases were from China. Risks inherent in foreign operations including work stoppages, transportation delays and interruptions, social unrest and political upheaval and changes in economic conditions, can result in the disruption of trade from the countries in which our manufacturers or suppliers are located, the imposition of additional regulations relating to imports, the imposition of additional duties, taxes and other charges on imports, significant fluctuations of the value of the dollar against foreign currencies, or restrictions on the transfer of funds, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. Although we believe that we manage our exposure to the risk that any such economic or political condition will materially affect our ability to purchase products because we are aware of the availability of a variety of materials and alternative sources, we cannot be certain that we will be able to identify such alternative materials and/or sources without delay or without greater cost to us. Our inability to identify and secure alternative sources of supply in this situation could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Impact of Custom Duties and Other Import Regulations . Virtually all of our products are imported and subject to United States custom duties. In addition, over time we have increased our sales of products outside of the United States. The United States and the countries in which our products are produced or sold, from time to time, may impose new quotas, duties, tariffs or other restrictions on imports or exports, may adversely adjust prevailing quotas, duties or tariff levels, or may impose sanctions in the form of additional duties to remedy perceived illegal actions. The current political landscape has introduced greater uncertainty with respect to future tax and trade regulations for United States companies like ours with significant business and sourcing operations outside the United States. We cannot predict whether, and to what extent, there may be changes to international trade agreements or whether quotas, duties, tariffs, exchange controls or other restrictions will be changed or imposed by the United States or by other countries. If we or our suppliers or licensees are unable to source raw materials or finished goods from the countries where we or they wish to purchase them, either because of such regulatory changes or for any other reason, or if the cost of doing so should increase, it could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Manufacturers' Inability to Produce Our Goods in a Timely Manner or Meet Quality Standards . As is common in the footwear and accessories industries, we contract with foreign manufactures who produce virtually all of our products to our specifications. We do not own or operate any manufacturing facilities; therefore, we are dependent upon third parties for the manufacture of all of our products. The inability of a manufacturer to ship orders of our products in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers for those items, which, in turn, could result in cancellation of orders, refusal to accept deliveries, a reduction in purchase prices and, ultimately, termination of a customer relationship, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +15 +SEC Rules Relating to “Conflict Minerals” Require the Company to Incur Additional Expenses and Could Adversely Affect our Business. The SEC has promulgated final rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring the disclosure of the use of tantalum, tin, tungsten and gold, known as “conflict minerals,” included in products either manufactured by public companies or as to which public companies have contracted for the manufacture. These rules, adopted in an effort to prevent inadvertent support of armed conflict in the Democratic Republic of Congo and certain adjoining countries (collectively, the “DRC”), require companies to investigate their supply chains to determine whether these minerals are present in their products and, if so, from where the minerals originate. The rules also require disclosure and annual reporting as to whether or not conflict minerals, if used in the manufacture of the products offered, originate from the DRC. We currently require our manufacturers to comply with policies addressing legal and ethical concerns relating to labor, employment, political and social matters including restrictions on the use of conflict minerals. Violation of these policies by our manufacturers could harm our reputation, disrupt our supply chain and/or increase our cost of goods sold. Additionally, violation of any of these policies by our manufacturers could cause us to face disqualification as a supplier for our customers and suffer reputational challenges. Due to the complexity of our supply chain, compliance with the rules requires significant efforts from a cross-operational team and diverts our management and personnel and results in potential costs of additional staff. Any of the foregoing could adversely affect our sales, net earnings, business and financial condition and results of operations. +Difficulty in Locating Replacement Manufacturers. Although we enter into a number of purchase order commitments each season specifying a time frame for delivery, method of payment, design and quality specifications and other standard industry provisions, we do not have long-term contracts with any manufacturer. As a consequence, any of these manufacturing relationships may be terminated, by either party, at any time. In addition, we may seek replacement manufacturers for various reasons, including a significant increase in the prices we are required to pay to existing manufacturers of our goods. Although we believe that other facilities are available for the manufacture of our products, there can be no assurance that such facilities would be available to us on an immediate basis, if at all, or be able to meet our quality standards and delivery requirements, or that the costs charged to us by such manufacturers would not be significantly greater than those presently paid. +Manufacturers' Failure to Use Acceptable Labor Practices and Comply with Local Laws and Other Standards . Our products are manufactured by numerous independent manufacturers outside of the United States. We also have license agreements that permit our licensees to manufacture or contract to manufacture products using our trademarks. We impose, and require that our licensees impose, on these manufacturers environmental, health, and safety standards for the benefit of their labor force. In addition, we require these manufacturers to comply with applicable standards for product safety. However, we do not control our independent manufacturers or licensing partners or their labor, product safety and other business practices and, from time to time, our independent manufacturers may not comply with such standards or applicable local law or our licensees may not require their manufacturers to comply with such standards or applicable local law. The violation of such standards and laws by one of the independent manufacturers with whom we contract or by one of our licensing partners, or the divergence of a manufacturer's or a licensing partner's labor practices from those generally accepted as ethical in the United States, could harm our reputation, result in a product recall or require us to curtail our relationship with and locate a replacement for such manufacturer, which, as noted in the immediately preceding risk factor, could be challenging. Any of these events could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Seasonal and Quarterly Fluctuations . Our results of operations may fluctuate from quarter to quarter and are affected by a variety of factors, including: +• +the timing of holidays; +• +weather conditions; +• +the timing of larger shipments of product; +• +market acceptance of our products; +• +the mix, pricing and presentation of the products offered and sold; +• +the hiring and training of additional personnel; +• +inventory write downs for obsolescence; +• +the cost of materials; +• +the product mix between wholesale, retail and licensing businesses; +• +the incurrence of other operating costs; and +• +factors beyond our control, such as general economic conditions, declines in consumer confidence and actions of competitors. +In addition, we expect that our sales and operating results may be significantly impacted by the opening of new retail stores and the introduction of new products. Accordingly, the results of operations in any quarter will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter. +16 +Extreme or Unseasonable Weather Conditions in Locations in Which We or Our Customers and Suppliers are Located Could Adversely Affect our Business. Our corporate headquarters and principal operational locations, including retail, distribution and warehousing facilities, may be subject to natural disasters and other severe weather and geological events that could disrupt our operations. The occurrence of such natural events may result in sudden disruptions in business conditions of the local economies affected, as well as of the regional and global economies, and may result in decreased demand for our products and disruptions in our management functions, sales channels and manufacturing and distribution networks, which could have a material adverse effect on our business, financial condition and results of operations. Extreme weather events and changes in weather patterns can also influence customer trends and shopping habits. Extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season may diminish demand for our seasonal merchandise. Heavy snowfall, hurricanes or other severe weather events in the areas in which our retail stores and the retail stores of our wholesale customers are located may decrease customer traffic in those stores and reduce our sales and profitability. If severe weather events force closure of or disrupt operations at the distribution centers we use for our merchandise, we could incur higher costs and experience longer lead times to distribute our products to our retail stores, wholesale customers or e-commerce customers. If prolonged, such extreme or unseasonable weather conditions could adversely affect our business, financial condition and results of operations. +Inadequate Trademark Protections . We believe that our trademarks and other proprietary rights are of major significance to our success and our competitive position and consider some of our trademarks, such as Steve Madden, to be integral to our business and among our most valuable assets. Accordingly, we devote substantial resources to the establishment and protection of our trademarks on a worldwide basis. Nevertheless, policing unauthorized use of our intellectual property is difficult, expensive and time consuming and there can be no assurance that the actions taken by us to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products on the basis that our products violate the trademarks and proprietary rights of others. Moreover, no assurance can be given that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve such conflicts. We could incur substantial costs in legal actions relating to our use of intellectual property or the use of our intellectual property by others. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Our failure to establish and then protect such proprietary rights from unlawful and improper utilization could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Our Licensees’ Conduct Could Harm our Business. We license to others the rights to produce and market certain products that are sold under our trademarks. Although we retain significant control over our licensees’ products and advertising, we rely on our licensees for operational and financial control over their businesses. If the quality, image or distribution of our licensed products diminish, customer acceptance of and demand for our brands and products could decline. This could materially and adversely affect our business and results of operations. In fiscal year 2017, approximately 76% of our net royalties were derived from our top five licensed product lines. A decrease in customer demand for any of these product lines could have a material adverse effect on our results of operations and financial condition. Although we believe that in most circumstances we could replace existing licensees if necessary, our inability to do so effectively or for any period of time could adversely affect our revenues and results of operations. +Litigation and Other Legal Proceedings. We are involved in various claims, litigations and other legal and regulatory proceedings and governmental investigations that arise from time to time in the ordinary course of our business. Due to the inherent uncertainties of litigation and such other proceedings and investigations, we cannot predict with accuracy the ultimate outcome of any such matters. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations and the amount of insurance coverage we maintain to address such matters may be inadequate to cover these or other claims. In addition, any significant litigation, investigation or proceeding, regardless of its merits, could divert financial and management resources that would otherwise be used to benefit our operations. See Item 3 “Legal Proceedings,” below for additional information regarding legal proceedings in which we are involved. +Declines in Our Stock Price Due to Inaccurate Predictions. The trading price of our common stock periodically may rise or fall based on the accuracy of predictions of our future performance. As one of our primary objectives, we strive to maximize the long-term strength, growth and profitability of our Company, rather than to achieve an earnings target in any particular fiscal quarter. We believe that this longer-term goal is in the best interests of the Company and our stockholders, but recognize that it may be helpful to our stockholders and potential investors for us to provide guidance as to our quarterly and annual forecast of net sales and earnings. Although we endeavor to provide meaningful and considered guidance at the time it is provided and generally expect to provide updates to our guidance when we report our results each fiscal quarter, actual results may differ from our predictions as the guidance is based on assumptions and expectations that may or may not come to pass and, as such, we assume no responsibility to update any of our forward-looking statements at such times or otherwise. If and when we announce actual results that differ from those that have been predicted by us, the market price of our common stock could be adversely +17 +affected. Investors who rely on these predictions in making investment decisions with respect to our common stock do so at their own risk. We take no responsibility for any losses suffered as a result of such changes in the price of our common stock. +In addition, at any given time outside securities analysts may follow our financial results and issue reports that discuss our historical financial results and the analysts' predictions of our future performance, which our stockholders and potential investors may choose to rely on in making investment decisions. These analysts' predictions are based upon their own opinions and are often different from our own forecasts. Our stock price could decline if our results are below the estimates or expectations of these outside analysts. +Exposure to Foreign Currency Fluctuations . We make the majority of our purchases in U.S. dollars. However, we source substantially all of our products overseas and, as such, the cost of these products may be affected by changes in the value of the relevant currencies. Changes in currency exchange rates may also affect the relative prices at which we and our foreign competitors sell products in the same market. We use forward foreign exchange contracts to hedge material exposure to adverse changes in foreign exchange rates. However, no hedging strategy can completely insulate us from foreign exchange risk. We are also exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our financial statements due to the translation of operating results and financial position of our foreign subsidiaries. There can be no assurance that foreign currency fluctuations will not have a material adverse effect on our business, financial condition, results of operations and liquidity. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +We lease space for our headquarters, our retail stores, showrooms and office facilities in various locations in the United States, as well as overseas. We own one improved real property parcel in Long Island City, New York. We believe that our existing facilities are in good operating condition and are adequate for our present level of operations. The following table sets forth information with respect to our key properties: +18 +Location +Leased/Owned +Primary Use +Approximate Area Square Feet +Dongguan, Guangdong Province, China +Leased +Offices and sample production +166,800 +Montreal, Canada +Leased +Offices, warehouse +117,422 +Long Island City, NY +Leased +Executive offices +90,000 +Peabody, MA +Leased +Offices and warehouse, Schwartz & Benjamin +80,424 +Bayonne, NJ +Leased +Warehouse +83,000 +Bellevue, WA +Leased +Offices, Topline +41,500 +New York, NY +Leased +Offices and showroom, Accessories +30,000 +New York, NY +Leased +Offices and showroom, Schwartz & Benjamin +14,110 +Putian City, Guangdong Province, China +Leased +Offices +13,800 +New York, NY +Leased +Showroom +13,401 +Seattle, Washington +Leased +Offices and showroom, Dolce Vita +10,537 +New York, NY +Leased +Offices and showroom +10,000 +Long Island City, NY +Leased +Storage +7,200 +Kowloon, Hong Kong +Leased +Offices +4,800 +Mexico City, Mexico +Leased +Offices, SM Mexico +3,520 +Los Angeles, CA +Leased +Showroom, Steven +2,700 +New York, NY +Leased +Offices +2,700 +Long Island City, NY +Owned +Other +2,200 +New York, NY +Leased +Apartments +1,800 +Bucharest, Romania +Leased +Offices, Customer Service +1,722 +New York, NY +Leased +Offices +850 +Dallas, Texas +Leased +Showroom +800 +All of our retail stores are leased pursuant to leases that, under their original terms, extend for an average of ten years. Many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes over the base year. The current terms of our retail store leases expire as follows: +Years Initial Lease Terms Expire +Number of Stores +2018 +18 +2019 +22 +2020 +24 +2021 +19 +2022 +28 +2023 +24 +2024 +19 +2025 +20 +2026 +16 +2027 +6 +2028 +3 +2029 +3 +ITEM 3. LEGAL PROCEEDINGS +In the ordinary course of business, we have various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on our financial condition, results of operations or cash flows. +19 +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5 +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our shares of common stock have traded on the NASDAQ Global Select Market since August 1, 2007 and were traded on the NASDAQ National Market prior to that date. The following table sets forth the range of high and low closing sales prices for our common stock during each fiscal quarter during the two-year period ended December 31, 2017 as reported by the NASDAQ Global Select Market. The trading volume of our securities fluctuates and may be limited during certain periods. As a result, the liquidity of an investment in our securities may be adversely affected. +Common Stock +High +Low +High +Low +2017 +2016 +Quarter ended +March 31, 2017 +$38.95 +$33.50 +Quarter ended +March 31, 2016 +$38.48 +$27.80 +Quarter ended +June 30, 2017 +$40.75 +$35.55 +Quarter ended +June 30, 2016 +$38.06 +$31.68 +Quarter ended +September 30, 2017 +$43.80 +$38.20 +Quarter ended +September 30, 2016 +$36.97 +$32.69 +Quarter ended +December 31, 2017 +$47.55 +$37.25 +Quarter ended +December 31, 2016 +$40.55 +$32.30 +Holders. As of February 27, 2018 , there were 152 holders of record of our common stock. +Dividends. Historically, with the exception of a special cash dividend paid in each of November 2005 and November 2006, we have not declared or paid any cash dividends to our common stockholders in the past. Instead, we have chosen to retain earnings, if any, for potential future dividends and to finance the development and expansion of our business. +In February 2018, the Board of Directors of the Company declared a quarterly cash dividend of $0.20 per share on the Company’s outstanding shares of common stock. The dividend is payable on March 29, 2018, to stockholders of record as of the close of business on March 12, 2018. The Company currently expects to continue the practice of paying a cash dividend each quarter; however, the payment of future dividends will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions, and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +Equity Compensation Plans . Information regarding our equity compensation plans as of December 31, 2017 is disclosed in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” +Issuer Repurchases of Equity Securities. The Company's Board of Directors authorized a share repurchase program (the "Share Repurchase Program") effective as of January 1, 2004. The Share Repurchase Program permits the Company to effect repurchases of the Company's common stock from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase, most recently, on July 28, 2017, when the Board of Directors approved the continuation of the Share Repurchase Program for an additional $200 million in repurchases of the Company's common stock. During fiscal year 2017 , an aggregate of 2,253,802 shares of the Company's common stock were repurchased under the Share Repurchase Program, at an average per share price of $37.62 , for an aggregate purchase price of approximately $85 million . At December 31, 2017 , an aggregate of approximately $181 million remained available for +20 +future repurchases of our common stock under the Share Repurchase Program. The following table presents the total number of shares of the Company's common stock, $.0001 par value, purchased by the Company in the three months ended December 31, 2017 , the average price paid per share and the approximate dollar value of the shares that still could have been purchased at the end of the fiscal period, pursuant to the Company's Share Repurchase Program. +Period +Total Number of Shares Purchased (1) +Average Price Paid per Share (1) +Total Number of Shares Purchased as part of Publicly Announced Plans or Programs +Maximum Dollar Amount of Shares that May Yet Be Purchased Under the Plans or Programs +10/1/2017 - 10/31/2017 +20,982 +$ +42.91 +20,982 +$ +194,803 +11/1/2017 - 11/30/2017 +474,435 +$ +39.38 +334,571 +$ +193,902 +12/1/2017 - 12/31/2017 +143,745 +$ +45.94 +— +$ +180,861 +Total +639,162 +$ +40.97 +355,553 +$ +180,861 +(1) The Steven Madden, Ltd. 2006 Stock Incentive Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. Included in this table are shares withheld during the fourth quarter of 2017 in connection with the settlement of vested restricted stock and exercises of stock options to satisfy tax withholding requirements, in addition to the shares repurchased pursuant to the Share Repurchase Program. Of the total number of shares repurchased by the Company in the fourth quarter of 2017, 283,609 shares were withheld at an average price per share of $43.17, for an aggregate purchase price of approximately $12,244, in connection with the settlement of vested restricted stock and exercises of stock options to satisfy tax withholding requirements. Excluding the shares withheld in connection with the settlement of vested restricted stock and exercises of stock options, the average price per share was $42.91 in October 2017, $38.98 in November 2017 and $39.21 in the period October 1, 2017 to December 31, 2017. +Performance Graph . The following graph compares the yearly percentage change in the cumulative total stockholder return on our common stock during the period beginning on December 31, 2012, and ending on December 31, 2017, with the cumulative total return on the Russell 2000 Index and a peer group index. In 2016, the Company decided to remove the S&P 500 Footwear Index and replace it with a peer group index of companies believed to be engaged in similar businesses, as we believe the composition of the new peer group is more representative of our current business. The peer group index consists of six companies: Caleres, Inc., Crocs, Inc., Deckers Outdoor Corporation, Genesco Inc., Skechers U.S.A., Inc. and Wolverine World Wide, Inc. +The comparison assumes that $100 was invested on December 31, 2012 in our common stock and in the foregoing indices and assumes the reinvestment of dividends. +21 +12/31/2012 +12/31/2013 +12/31/2014 +12/31/2015 +12/31/2016 +12/31/2017 +Steven Madden, Ltd. +$100.00 +$129.84 +$112.95 +$107.24 +$126.86 +$165.72 +Russell 2000 Index +$100.00 +$138.82 +$145.62 +$139.19 +$168.85 +$193.58 +Peer Group +$100.00 +$159.77 +$171.29 +$146.88 +$148.44 +$198.83 +22 +ITEM 6. SELECTED FINANCIAL DATA +The following selected financial data has been derived from our audited consolidated financial statements. The Income Statement Data relating to 2017 , 2016 and 2015 , and the Balance Sheet data as of December 31, 2017 and 2016 should be read in conjunction with the information provided in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” and the notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. +INCOME STATEMENT DATA +Year Ended December 31, +(in thousands, except per share data) +2017 +2016 +2015 +2014 +2013 +Net sales +$ +1,546,098 +$ +1,399,551 +$ +1,405,239 +$ +1,334,951 +$ +1,314,223 +Cost of sales +968,357 +877,568 +904,747 +865,951 +831,847 +Gross profit +577,741 +521,983 +500,492 +469,000 +482,376 +Commissions and licensing fee income - net +14,259 +11,788 +16,565 +13,723 +15,632 +Operating expenses +(421,216 +) +(364,595 +) +(342,364 +) +(315,081 +) +(295,223 +) +Impairment charges +(1,000 +) +— +(3,045 +) +— +(983 +) +Income from operations +169,784 +169,176 +171,648 +167,642 +203,768 +Interest income - net +2,548 +2,488 +2,191 +3,074 +4,100 +Other income (expense) - net +(5 +) +(664 +) +(1,373 +) +677 +1,083 +Income before provision for income taxes +172,327 +171,000 +172,466 +171,393 +208,951 +Provision for income taxes +53,189 +49,726 +58,811 +58,764 +75,666 +Net income +119,138 +121,274 +113,655 +112,629 +133,285 +Net (income) attributable to non-controlling interests +(1,190 +) +(363 +) +(717 +) +(749 +) +(1,278 +) +Net income attributable to Steven Madden, Ltd. +$ +117,948 +$ +120,911 +$ +112,938 +$ +111,880 +$ +132,007 +Basic income per share +$2.14 +$2.12 +$1.91 +$1.82 +$2.04 +Diluted income per share +$2.04 +$2.03 +$1.85 +$1.76 +$1.98 +Basic weighted average shares of common stock +55,157 +57,109 +58,997 +61,451 +64,583 +Effect of dilutive securities - options and restricted stock +2,673 +2,447 +2,145 +2,225 +2,253 +Diluted weighted average shares of common stock outstanding +57,830 +59,556 +61,142 +63,676 +66,836 +BALANCE SHEET DATA +At December 31 , +2017 +2016 +2015 +2014 +2013 +Total assets +$ +1,057,161 +$ +960,875 +$ +914,385 +$ +911,235 +$ +880,241 +Working capital +438,906 +345,544 +284,178 +264,635 +342,142 +Noncurrent liabilities +41,617 +36,676 +60,923 +64,115 +46,898 +Stockholders' equity +$ +808,932 +$ +741,072 +$ +678,663 +$ +669,529 +$ +678,840 +23 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +The following discussion of our Financial Condition and Results of Operations should be read in conjunction with our audited consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. +Overview: +($ in thousands, except retail sales data per square foot, earnings per share and per share data) +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell name brand and private label fashion handbags and accessories, through our Accessories Division. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers, and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico, our joint ventures in South Africa, China and Taiwan, and under special distribution arrangements in Asia, Europe (excluding the aforementioned nations), India, the Middle East, South and Central America and New Zealand. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Our business is comprised of five distinct segments (Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing). Our Wholesale Footwear segment includes the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Madden NYC, Report®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, B Brian Atwood®, Blondo®, Kate Spade® (under license), Avec Les Filles® (under license), Alice & Olivia® (through a joint venture), and includes our International business and certain private label footwear business. The agreement with Alice & Olivia® was terminated on December 31, 2017. Our Wholesale Accessories segment includes Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Luv Betsey®, DKNY® (under license), Donna Karan® (under license), and Cejon® accessories brands and includes our International business and certain private label accessories business. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven, Superga and International retail stores, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites and comprises our Retail segment. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, we license our Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +On January 30, 2017, the Company entered into an equity purchase agreement (the “Purchase Agreement”) with Schwartz & Benjamin, Inc., a New York corporation (“S&A”), its affiliated companies B.D.S., Inc., a Delaware corporation (“B.D.S.”), Quinby Ridge Enterprises LLC, a Delaware limited liability company (“QRE”), and DANIELBARBARA Enterprises LLC, a New York limited liability company (“DBE” and, collectively with S&A, B.D.S. and QRE, “Schwartz & Benjamin”), the owners of all of the issued and outstanding equity interests in Schwartz & Benjamin (the “Sellers”), and Daniel Schwartz, as designated agent for the Sellers, pursuant to which the Company purchased all of the outstanding equity interests in Schwartz & Benjamin from the Sellers. The total purchase price for the acquisition was approximately $37,112 , which included a cash payment at closing of $17,396 less a working capital adjustment of $901 , plus potential earn-out payments based on the achievement of certain earnings targets for each of the twelve month periods ending on January 31, 2018 through 2023, inclusive. The fair value of the contingent payments was estimated using the present value of the payments based on management's projections of the financial results of Schwartz & Benjamin during the earn-out period and was finalized at $20,617 . On November 27, 2017, the Company entered into an amendment to the Purchase Agreement with the sellers of Schwartz & Benjamin to change the manner of calculating the earn- +24 +out and to provide for payments based on the performance of certain specified license agreements. In connection with this amendment, the Company reduced the earn-out liability from $20,617 to $10,000 and recorded a credit to operating expenses in the amount of $10,617 . At December 31, 2017, the Company estimated the fair value of the contingent consideration to be approximately $10,000 . Schwartz & Benjamin, which was founded in 1923, engages in the design, sourcing and sale of licensed and private label footwear and distributes its fashion footwear to wholesale customers, including better department stores and specialty boutiques, as well as the retail stores of its brand partners. +In 2017, the Company formed a joint venture ("SM Taiwan") with Dolce Limited through its subsidiary, SM Dolce Limited. The Company is the majority interest holder in SM Taiwan and controls all of the significant participating rights of the joint venture. SM Taiwan is the exclusive distributor of the Company's products in Taiwan. Additionally in 2017, the Company formed a joint venture ("SM China") with Xuzhou C. Banner Footwear, Ltd. through its subsidiary, SM (Jiangsu) Co., Ltd. The Company controls all of the significant participating rights of the joint venture. SM China is the exclusive distributor of the Company's products in China. +On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act made significant changes to the Internal Revenue Code of 1986, as amended, including, but not limited to, reducing the U.S. corporate statutory tax rate, eliminating or limiting deduction of several expenses which were previously deductible, requiring a minimum tax on earnings generated by foreign subsidiaries, imposing a mandatory deemed repatriation tax on undistributed historic earnings of foreign subsidiaries and permitting a tax-free repatriation of foreign earnings through a dividends received deduction. The Tax Act could have a significant impact on our effective tax rate, net deferred tax assets and cash tax expenses. We are currently evaluating the overall impact of the Tax Act on our effective tax rate and balance sheet, but expect that the impact may be significant for our fiscal year 2018 and future periods. See additional information regarding the impact of the Tax Act below in this Item and in Note M Income Taxes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. +Additionally, in February 2018, the Board of Directors of the Company declared a quarterly cash dividend of $0.20 per share on the Company’s outstanding shares of common stock as part of its cash deployment strategy to drive shareholder value or enhance shareholder returns. The dividend is payable on March 29, 2018, to stockholders of record as of the close of business on March 12, 2018. The Company currently expects to continue the practice of paying a cash dividend each quarter; however, the payment of future dividends will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +Key Performance Indicators and Statistics +The following measurements are among the key business indicators reviewed by various members of management to measure consolidated and segment results of the Company: +• +net sales +• +gross profit margin +• +operating expenses +• +income from operations +• +adjusted EBITDA +• +adjusted EBIT +• +same store sales +• +inventory turnover +• +accounts receivable average collection days +• +cash flow and liquidity determined by the Company’s working capital and free cash flow +• +store metrics, such as sales per square foot, average unit retail, conversion, average units per transaction, and contribution margin. +While not all of these metrics are disclosed due to the proprietary nature of the information, many of these metrics are disclosed and discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Non-GAAP Financial Measures +The Company reports its financial results in accordance with GAAP. The Company also uses adjusted earnings before interest and taxes ("Adjusted EBIT") and adjusted earnings before interest, taxes, depreciation and amortization ("Adjusted +25 +EBITDA"), which are derived from our consolidated financial information but are not presented in our consolidated financial statements and are considered non-GAAP financial measures, in internal management reporting and planning processes as well as in evaluating the performance of the Company. Management believes these measures are useful to investors in evaluating the Company’s ongoing operating and financial results. By providing these non-GAAP measures, as a supplement to GAAP information, we believe we are enhancing investors’ understanding of our business and our results of operations. The non-GAAP financial measures are limited in their usefulness and should be considered in addition to, and not in lieu of, U.S. GAAP financial measures. Further, these non-GAAP measures may be unique to the Company, as they may be different from non-GAAP measures used by other companies. +The table below reconciles these metrics to net income as presented in the consolidated statement of income. +Years Ended December 31 ($ in thousands) +2017 +2016 +2015 +Net Income +$ +119,138 +$ +121,274 +$ +113,655 +Add back: +Provision for income taxes +53,189 +49,726 +58,811 +Provision for legal and early lease termination charges (benefit) +11,836 +— +(3,048 +) +Schwartz & Benjamin amendment to the equity purchase agreement +(10,215 +) +— +— +Bad debt expense related to the Payless ShoeSource bankruptcy +5,470 +— +— +Schwartz & Benjamin acquisition integration charges +3,639 +— +— +Charges related to preferred interest investment +2,700 +— +— +Impairment of Wild Pair trademark +1,000 +— +3,045 +Schwartz & Benjamin acquisition inventory fair value adjustment +591 +— +— +Deduct: +Other Income (expense) - net * +(5 +) +(664 +) +(1,373 +) +Interest, net +2,548 +2,488 +2,191 +Adjusted EBIT +$ +184,805 +$ +169,176 +$ +171,645 +Add back: +Depreciation and amortization +$ +20,406 +$ +19,868 +$ +19,382 +Loss on disposal of fixed assets +1,455 +652 +1,780 +Adjusted EBITDA +$ +206,666 +$ +189,696 +$ +192,807 +* Consists of realized (losses) gains on marketable securities and foreign exchange (losses) gains. +Executive Summary +Net sales for 2017 increased by 10.5% to $1,546,098 from $1,399,551 in 2016 . Net sales growth was driven by our acquisition of Schwartz & Benjamin, which contributed net sales of $80,020 , as well as growth in our core business. Net income attributable to Steven Madden, Ltd. decreased 2.5% to $117,948 in 2017 compared to $120,911 in 2016 . The Company's effective tax rate for 2017 increased to 30.9% compared to 29.1% recorded in 2016 . Diluted earnings per share in 2017 increased to $2.04 per share on 57,830,000 diluted weighted average shares outstanding compared to $2.03 per share on 59,556,000 diluted weighted average shares outstanding in the prior year. +In our Retail segment, same store sales (sales attributable to those stores, including the e-commerce websites, that were in operation throughout 2017 and 2016 ) decreased 3.2% , and sales per square foot decreased to $656 in 2017 compared to sales per square foot of $707 in 2016 . As of December 31, 2017 , we had 206 stores in operation, compared to 189 stores as of December 31, 2016 which increase resulted from the opening of 13 full price stores and six outlet store locations partially offset by the closing of two full price stores. +Our total inventory turnover was 8.6 times compared to 8.2 times in the comparable period of last year. Our accounts receivable average collection days were 75 days in 2017 compared to 66 days in 2016 primarily due to changes in payment terms with certain customers. As of December 31, 2017 , we had $274,764 in cash, cash equivalents and marketable securities, no short +26 +or long-term debt and total stockholders’ equity of $808,932 . Working capital increased to $438,906 as of December 31, 2017 , compared to $345,544 on December 31, 2016 . +The following table sets forth information on operations for the periods indicated: +Years Ended December 31 +($ in thousands) +2017 +2016 +2015 +CONSOLIDATED: +Net sales +$ +1,546,098 +100.0 +% +$ +1,399,551 +100.0 +% +$ +1,405,239 +100.0 +% +Cost of sales +968,357 +62.6 +% +877,568 +62.7 +% +904,747 +64.4 +% +Gross profit +577,741 +37.4 +% +521,983 +37.3 +% +500,492 +35.6 +% +Other operating income – net of expenses +14,259 +0.9 +% +11,788 +0.8 +% +16,565 +1.2 +% +Operating expenses +421,216 +27.2 +% +364,595 +26.1 +% +342,364 +24.4 +% +Impairment charges +(1,000 +) +(0.1 +)% +— +— +% +(3,045 +) +(0.2 +)% +Income from operations +169,784 +11.0 +% +169,176 +12.1 +% +171,648 +12.2 +% +Interest and other income – net +2,543 +0.2 +% +1,824 +0.1 +% +818 +0.1 +% +Income before income taxes +172,327 +11.1 +% +171,000 +12.2 +% +172,466 +12.3 +% +Net income attributable to Steven Madden, Ltd. +117,948 +7.6 +% +120,911 +8.6 +% +112,938 +8.0 +% +By Segment: +WHOLESALE FOOTWEAR SEGMENT: +Net sales +$ +1,017,557 +100.0 +% +$ +881,864 +100.0 +% +$ +898,363 +100.0 +% +Cost of sales +685,190 +67.3 +% +602,029 +68.3 +% +632,541 +70.4 +% +Gross profit +332,367 +32.7 +% +279,835 +31.7 +% +265,822 +29.6 +% +Operating expenses +197,722 +19.4 +% +169,796 +19.3 +% +157,941 +17.6 +% +Income from operations - before impairment charges +134,645 +13.2 +% +110,039 +12.5 +% +107,881 +12.0 +% +WHOLESALE ACCESSORIES SEGMENT: +Net sales +$ +256,295 +100.0 +% +$ +254,931 +100.0 +% +$ +266,564 +100.0 +% +Cost of sales +175,566 +68.5 +% +170,509 +66.9 +% +178,203 +66.9 +% +Gross profit +80,729 +31.5 +% +84,422 +33.1 +% +88,361 +33.1 +% +Operating expenses +57,092 +22.3 +% +52,860 +20.7 +% +55,749 +20.9 +% +Income from operations - before impairment charges +23,637 +9.2 +% +31,562 +12.4 +% +32,612 +12.2 +% +RETAIL SEGMENT: +Net sales +$ +272,246 +100.0 +% +$ +262,756 +100.0 +% +$ +240,312 +100.0 +% +Cost of sales +107,601 +39.5 +% +105,030 +40.0 +% +94,003 +39.1 +% +Gross profit +164,645 +60.5 +% +157,726 +60.0 +% +146,309 +60.9 +% +Operating expenses +165,771 +60.9 +% +141,939 +54.0 +% +128,674 +53.5 +% +(Loss) income from operations - before impairment charges +(1,126 +) +(0.4 +)% +15,787 +6.0 +% +17,635 +7.3 +% +Number of stores +206 +189 +169 +FIRST COST SEGMENT: +Other commission income – net of expenses +$ +5,159 +100.0 +% +$ +3,728 +100.0 +% +$ +6,713 +100.0 +% +LICENSING SEGMENT: +Licensing income – net of expenses +$ +9,100 +100.0 +% +$ +8,060 +100.0 +% +$ +9,852 +100.0 +% +27 +RESULTS OF OPERATIONS +($ in thousands) +Year Ended December 31, 2017 vs. Year Ended December 31, 2016 +Consolidated : +Net sales for the year ended December 31, 2017 increased by 10.5% to $1,546,098 from $1,399,551 for fiscal year 2016 . For the year ended December 31, 2017 , gross margin as a percentage of net sales increased slightly to 37.4% in the current year compared to 37.3% in the prior year. Excluding the impact from the Schwartz & Benjamin acquisition, gross margin as a percentage of net sales increased to 38.3% driven by improvement in the Wholesale Footwear and Retail segments. Operating expenses increased in 2017 to $421,216 , or 27.2% of total revenue, from $364,595 , or 26.1% of total revenue, in 2016 . The increase is primarily related to (i) the impact of the Schwartz & Benjamin acquisition, (ii) legal charges consisting of costs and estimated settlement amounts, (iii) bad debt related to the Payless ShoeSource bankruptcy, and (iv) charges to preferred interest investments related to the Brian Atwood acquisition. These increases were partially offset by the benefit received for the reversal of contingent liabilities related to the amended purchase agreement for the Schwartz & Benjamin acquisition. Commission and licensing fee income increased to $14,259 in 2017 compared to $11,788 in 2016 . The effective tax rate for the year ended December 31, 2017 increased to 30.9% compared to 29.3% in the same period last year primarily due to the impact of the year-over-year benefit resulting from the exercising and vesting of share based awards coupled with a shift in profitability to jurisdictions with higher tax rates. These were partially offset by the net benefit related to the recently enacted Tax Cuts and Jobs Act in the United States. Net income attributable to Steven Madden, Ltd. for the year ended December 31, 2017 decreased to $117,948 compared to $120,911 for the year ended December 31, 2016 . +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment was $1,017,557 , or 65.8% , and $881,864 , or 63.0% , of our total net sales for the years ended December 31, 2017 and 2016 , respectively. Excluding net sales related to the Schwartz & Benjamin acquisition, net sales increased 6.3%. The increase in net sales is primarily driven by strong growth in our core Steve Madden Women's brand coupled with growth in our Steve Madden Men's, Madden Girl, Steve Madden Kid's and Blondo brands, as well as growth in the SM Europe joint venture. +Gross profit margin increased to 32.7% in 2017 from 31.7% in the prior year period. Excluding the impact from the Schwartz & Benjamin acquisition, gross profit margin was 33.8%. The increase in gross profit margin primarily resulted from reduced mark-downs and closeouts, as well as a sales mix shift between our branded and private label businesses. Operating expenses increased to $197,722 , or 19.4% , in 2017 compared to $169,796 , or 19.3% , in the same period of 2016 primarily due to (i) the impact of the Schwartz & Benjamin acquisition, (ii) legal charges consisting of costs and estimated settlement amounts, (iii) bad debt related to the Payless ShoeSource bankruptcy, and (iv) charges to preferred interest investments related to the Brian Atwood acquisition. These increases were partially offset with a benefit due to a decrease in contingent liabilities related to the amended purchase agreement for the Schwartz & Benjamin acquisition. Income from operations before impairment charges increased to $134,645 for the year ended December 31, 2017 compared to $110,039 for the year ended December 31, 2016 . +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $256,295 , or 16.6% , and $254,931 , or 18.2% , of total Company net sales for the years ended December 31, 2017 and 2016 , respectively. +Gross profit margin in the Wholesale Accessories segment decreased to 31.5% in 2017 from 33.1% in the prior year period primarily due to lower margins in our cold weather business driven by prior season inventory closeouts. In the year ended December 31, 2017 , operating expenses increased to $57,092 , or 22.3% of revenue, compared to $52,860 , or 20.7% of revenue, in the year ended December 31, 2016 due to the impact of the year-over-year benefit received for the reversal of contingent liabilities related to the Cejon acquisition in 2016 . Income from operations for the Wholesale Accessories segment decreased to $23,637 in 2017 compared to $31,562 in 2016 . +Retail Segment : +Net sales generated by the Retail segment accounted for $272,246 , or 17.6% , and $262,756 , or 18.8% , of total Company net sales for the years ended December 31, 2017 and 2016 , respectively, which represents a $9,490 or 3.6% increase, year-over-year. This growth is due to the net addition of seventeen stores from the prior year partially offset by a decrease in comparable +28 +store sales of 3.2% . During 2017 , we added thirteen full price stores and six outlets, and closed two full price locations. As a result, we had 206 retail stores as of December 31, 2017 , compared to 189 stores as of December 31, 2016 . The 206 stores currently in operation include 138 Steve Madden full price stores, 60 Steve Madden outlet stores, three Steven stores, one Superga store and four e-commerce websites. In addition, during 2017, we opened 21 concessions in Asia through our China and Taiwan joint ventures, and ended the year with 38 company-operated concessions in international markets. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2017 and 2016 ) for the year ended December 31, 2017 decreased 3.2% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2017 , gross margin increased to 60.5% from 60.0% in 2016 primarily due to lower promotional activity during 2017. In 2017 , operating expenses increased to $165,771 , or 60.9% of revenue, from $141,939 , or 54.0% of revenue, in 2016 primarily due to the incremental costs associated with new store openings, legal charges consisting of costs and estimated settlement amounts related to early lease terminations and increases in employee-related costs. For the year ended December 31, 2017 , losses from operations for the Retail segment were $1,126 compared income from operations of $15,787 in the prior year. +First Cost Segment : +Income for the First Cost segment, which includes net commission income and fees, increased to $5,159 for the year ended December 31, 2017 , compared to $3,728 in 2016 due to an increase in business with certain private label footwear customers. +Licensing Segment: +During the year ended December 31, 2017 , income for the Licensing segment increased to $9,100 as compared to the prior year income of $8,060 primarily due to gains with our Steve Madden licensed products. +Year Ended December 31, 2016 vs. Year Ended December 31, 2015 +Consolidated : +Net sales for the year ended December 31, 2016 decreased slightly by 0.4% to $1,399,551 from $1,405,239 for fiscal year 2015 . For the year ended December 31, 2016 , gross margin as a percentage of net sales increased to 37.3% compared to 35.6% in the prior year primarily resulting from higher initial mark-ups, decreased markdown allowances, and reduced close-outs coupled with sales mix in the Wholesale Footwear segment. Operating expenses increased in 2016 to $364,595 from $342,364 in 2015 . Operating expenses for the year ended December 31, 2015 included a benefit of $3,048 related to income arising from the early termination of our lease for our 5th Avenue, New York store, which was closed during the first quarter of 2015. Excluding this benefit, operating expenses in 2015 were $345,412 . Excluding the aforementioned benefit, the increase in operating expenses in 2016 is primarily due to the increase in retail store locations, employee-related expenses, charges related to an increase in contingent liabilities related to the Dolce Vita acquisition and costs associated with our SM Europe joint venture. As a result, operating expenses as a percentage of sales increased to 26.1% in the year ended December 31, 2016 compared to 24.6% , excluding the aforementioned benefit, in the previous year. Commission and licensing fee income decreased to $11,788 in 2016 compared to $16,565 in 2015 primarily due to a decline in our First Cost segment. During the year ended December 31, 2016 , income from operations decreased to $169,176 and net income attributable to Steven Madden, Ltd. increased to $120,911 compared to income from operations of $171,648 and net income attributable to Steven Madden, Ltd. of $112,938 in 2015 . Net income attributable to Steven Madden, Ltd. for the year ended December 30, 2016 included a tax benefit of $5,244 related to the adoption of Accounting Standards Update No. 2016-09, "Improvements to Employee Share-Based Payment Accounting," which changes the accounting for certain aspects of share-based payments to employees. Net income attributable to Steven Madden, Ltd. for the year ended December 30, 2015 included the $3,048 pre-tax benefit related to the closure of our 5th Avenue, New York store location as well as a pre-tax charge of $3,045 related to the partial impairment of our Wild Pair trademark. (See Note A to the Consolidated Financial Statements under “Good will and intangible assets.”) +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment was $881,864 , or 63.0% , and $898,363 , or 63.9% , of our total +net sales for the years ended December 31, 2016 and 2015 , respectively. The decrease was driven by decreases in sales in our private label business, international distributor business and our Madden Girl brand partially offset by increases in sales of our Dolce Vita, Steve Madden Women's and Blondo brands. +Gross profit margin increased to 31.7% in 2016 from 29.6% in the prior year primarily resulting from higher initial mark-ups, decreased markdown allowances, and reduced close-outs coupled with sales mix. Operating expenses increased to $169,796 +29 +in 2016 compared to $157,941 in the same period of 2015 primarily due to charges related to an increase in contingent liabilities related to the Dolce Vita acquisition coupled with increases in employee-related expenses, advertising and promotion, and costs associated with our SM Europe joint venture. As a percentage of sales, operating expenses increased to 19.3% in 2016 from 17.6% in 2015 due to the increase in expenses discussed above coupled with deleverage on lower sales. Income from operations, excluding a pre-tax charge of $3,045 related to the partial impairment of our Wild Pair trademark in 2015, increased to $110,039 for the year ended December 31, 2016 compared to $107,881 for the year ended December 31, 2015 . +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $254,931 , or 18.2% , and $266,564 , or 19.0% , of total Company net sales for the years ended December 31, 2016 and 2015 , respectively. The decrease year over year is primarily driven by decreases in sales of Big Buddha handbags, cold weather accessories and belts partially offset by increases in sales of private label handbags. +Gross profit margin in the Wholesale Accessories segment remained flat at 33.1% in 2016 and 2015 . In the year ended December 31, 2016 , operating expenses decreased to $52,860 compared to $55,749 in the year ended December 31, 2015 . As a percentage of sales, operating expenses decreased to 20.7% in 2016 from 20.9% in 2015 primarily due to the impact of the year-over-year benefit received for the reversal of contingent liabilities related to acquisitions in the third quarter of 2016 and 2015 . Income from operations for the Wholesale Accessories segment decreased to $31,562 in 2016 compared to $32,612 in 2015 . +Retail Segment : +Net sales generated by the Retail segment accounted for $262,756 , or 18.8% , and $240,312 , or 17.1% , of total Company net sales for the years ended December 31, 2016 and 2015 , respectively, which represents a $22,444 or 9.3% increase, year over year. This growth is primarily due to the net addition of twenty stores from the prior year coupled with an increase in comparable store sales of 4.0% driven by strong fashion footwear trends and stronger product assortment. During 2016 , we added nine full price stores and twelve outlets and closed one full price location. As a result, we had 189 retail stores as of December 31, 2016 , compared to 169 stores as of December 31, 2015 . The 189 stores in operation as of December 31, 2016 include 129 Steve Madden full price stores, 52 Steve Madden outlet stores, two Steven stores, one Superga store, one multi-branded SHOO store and four e-commerce websites. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2016 and 2015 ) for the year ended December 31, 2016 increased 4.0% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2016 , gross margin decreased to 60.0% from 60.9% in 2015 primarily due to the impact of foreign currency fluctuations on our international operations. In 2016 , operating expenses increased to $141,939 from $128,674 in 2015 primarily due to the incremental cost associated with new store openings and increases in employee-related and rent expenses in existing locations. Operating expenses in 2015 included a benefit of $3,048 related to income arising from the early termination of our lease for our 5th Avenue, New York store, which was closed during the first quarter of 2015. Excluding this benefit, operating expenses in 2015 were $131,722 . Excluding the lease benefit in 2015, operating expenses as a percentage of sales decreased to 54.0% in 2016 from 54.8% in the prior year. For the year ended December 31, 2016 , income from operations for the Retail segment decreased to $15,787 compared to $17,635 in the prior year. Excluding the benefit of $3,048 in 2015, income from operations for the Retail segment in 2015 was $14,587 . +First Cost Segment : +Income for the First Cost segment, which includes net commission income and fees, decreased to $3,728 for the year ended December 31, 2016 , compared to $6,713 in 2015 due to a reduction in business with certain private label footwear customers. +Licensing Segment: +During the year ended December 31, 2016 , income for the Licensing segment decreased to $8,060 as compared to the prior year income of $9,852 primarily driven by the discontinuation of the Steve Madden eyewear licenses. +30 +LIQUIDITY AND CAPITAL RESOURCES +($ in thousands) +Our primary source of liquidity is cash flows generated from our operations. Our primary use of this liquidity is to fund our ongoing cash requirements, including working capital requirements, share repurchases, acquisitions, system enhancements and retail store expansion and remodeling. +Cash, cash equivalents and short-term investments totaled $245,241 and $165,610 at December 31, 2017 and December 31, 2016 , respectively. Of the total cash, cash equivalents and short-term investments at December 31, 2017 , $135,884 , or approximately 55% , was held in our foreign subsidiaries and of the total cash, cash equivalents and short-term investments at December 31, 2016 , $70,450 , or approximately 43% , was held in our foreign subsidiaries. +As of December 31, 2017, the Company has recorded $21,944 related to the one-time transition tax and related withholding tax expense on the deemed repatriation of cumulative foreign earnings under the Tax Cuts and Jobs Act, of which $1,566 is expected to be paid within one year. The remaining portion of the tax will be paid over an eight-year period, starting in 2018, and will not accrue interest. +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”). The agreement provides us with a credit facility in the amount of $30,000, having a sub-limit of $15,000 on the aggregate face amount of letters of credit, at an interest rate based, at our election, upon either the prime rate or LIBOR. The agreement can be terminated by the Company or Rosenthal at any time with 60 days’ prior written notice. As of December 31, 2017 we had no borrowings against this credit facility. +As of December 31, 2017 , we had working capital of $438,906 , cash and cash equivalents of $181,214 , investments in marketable securities short and long term of $93,550 and we did not have any long-term debt. +We believe that based upon our current financial position and available cash, cash equivalents and marketable securities, we will meet all of our financial commitments and operating needs for at least the next 12 months. +OPERATING ACTIVITIES +($ in thousands) +Cash provided by operations was $157,935 in 2017 compared to cash provided by operations of $ 153,604 in the prior year. The primary sources of cash were net income of $119,138 and decreases in inventories and accounts receivable of $21,135 and $20,715 , respectively. The primary use of cash was an increase in factor accounts receivable of $57,268 . +INVESTING ACTIVITIES +($ in thousands) +During the year ended December 31, 2017 , we invested $61,209 in marketable securities and received $79,141 from the maturities and sales of securities. We made capital expenditures of $14,775 , principally for new stores and improvements to existing stores, systems enhancements and leasehold improvements to office space. Cash of $221 was received in the repayment of the note receivable from the seller of SM Canada. Lastly, we made a payment in the amount of $16,495 for the acquisition of Schwartz & Benjamin. +FINANCING ACTIVITIES +($ in thousands) +During the year ended December 31, 2017 , net cash used by financing activities was $90,338 , which consisted of share repurchases of $99,412 and payment of contingent liabilities related to acquisitions completed in prior years of $7,359 , partially offset by proceeds from the exercise of stock options of $16,433 . +CONTRACTUAL OBLIGATIONS +($ in thousands) +Our contractual obligations as of December 31, 2017 were as follows: +31 +Payment due by period +Contractual Obligations +Total +2018 +2019 - 2020 +2021 - 2022 +2023 and after +Operating lease obligations +$ +249,276 +$ +44,629 +$ +78,515 +$ +59,160 +$ +66,972 +Purchase obligations +156,532 +156,532 +— +— +— +Contingent payment liability +10,000 +7,000 +3,000 +— +— +Other long-term liabilities (future minimum royalty payments) +16,138 +4,078 +10,060 +2,000 +— +Total +$ +431,946 +$ +212,239 +$ +91,575 +$ +61,160 +$ +66,972 +At December 31, 2017 , we had no open letters of credit for the purchase of inventory. +Virtually all of our products are produced by independent manufacturers at overseas locations, the majority of which are located in China, with a small and growing percentage located in Italy in addition to smaller volumes in Brazil, Mexico, India, Vietnam, The Netherlands, The Dominican Republic and South Korea. We have not entered into any long-term manufacturing or supply contracts with any of these foreign manufacturers. We believe that a sufficient number of alternative sources exist outside of the United States for the manufacture of our products. Purchases are made primarily in United States dollars. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s then existing employment agreement with the Company. The amended agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides, among other things, for a base salary of approximately $7,026 per annum for the period between January 1, 2016 through the expiration of the term of employment. Also under the employment agreement, Mr. Madden received the right, exercisable on certain specified dates in fiscal year 2012 only, to elect to receive a grant of restricted stock for a number of shares of the Company’s common stock valued at $40,000 in consideration for certain specified reductions in his annual base salary in years subsequent to 2012. Mr. Madden exercised this right and, on July 3, 2012, he was granted 1,893,342 restricted shares of the Company's common stock at the then market price of $21.13, which shares vest in the same manner as the February 8, 2012 restricted stock grant received by Mr. Madden pursuant to the amended agreement. (See Note N to the consolidated financial statements.) Further, in addition to the opportunity for cash bonuses at the sole discretion of the Board of Directors, Mr. Madden’s employment agreement entitles him to an annual life insurance premium payment as well as an annual stock option grant. The employment agreement also provides Mr. Madden the potential for an additional one-time stock option award for 750,000 shares of the Company’s common stock (the “EPS Option”) in the event that the Company achieves earnings per share on a fully-diluted basis equal to $2.00 as to any fiscal year ending December 31, 2015 or thereafter, which performance criteria was achieved for the fiscal year ended December 31, 2016. On March 1, 2017, Mr. Madden was granted the EPS Option at an exercise price of $37.35 per share. The EPS Option vests in equal annual installments over a five-year period commencing on the first anniversary of the grant date. +The Company has employment agreements with certain executive officers, which provide for the payment of compensation aggregating approximately $3,898 in 2018, $1,978 in 2019 and $148 in 2020. In addition, some of these employment agreements provide for discretionary bonuses and some provide for incentive compensation based on various performance criteria as well as other benefits including stock related compensation. +DIVIDENDS +In February 2018, the Board of Directors of the Company declared a quarterly cash dividend of $0.20 per share on the Company’s outstanding shares of common stock. The dividend is payable on March 29, 2018, to stockholders of record as of the close of business on March 12, 2018. The Company currently expects to continue the practice of paying a quarterly cash dividend; however, the payment of future dividends will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions, and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +INFLATION +We do not believe that inflation and price changes have had a significant effect on the Company's sales or profitability for the fiscal year ended December 31, 2017 and the prior two fiscal years. Historically, we have minimized the impact of product cost increases by increasing prices, changing suppliers and by improving operating efficiencies. However, no assurance can be given that we will be able to offset such inflationary cost increases in the future. +32 +OFF BALANCE SHEET ARRANGEMENTS +The Company has no off balance sheet arrangements. +CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Estimates by their nature are based on judgments and available information. Our estimates are made based upon historical factors, current circumstances and the experience and judgment of management. Assumptions and estimates are evaluated on an ongoing basis and we may employ outside experts to assist in evaluations. Therefore, actual results could materially differ from those estimates under different assumptions and conditions. Management believes the following critical accounting estimates are more significantly affected by judgments and estimates used in the preparation of our consolidated financial statements: allowance for bad debts, returns, and customer chargebacks; inventory valuation; valuation of intangible assets, litigation reserves, and contingent payment liabilities. +Allowances for bad debts, returns and customer chargebacks . We provide reserves against our trade accounts receivables for future customer chargebacks, co-op advertising allowances, discounts, returns and other miscellaneous deductions that relate to the current period. The reserve against our non-factored trade receivables also includes estimated losses that may result from customers’ inability to pay. The amount of the reserve for bad debts, returns, discounts and compliance chargebacks are determined by analyzing aged receivables, current economic conditions, the prevailing retail environment and historical dilution levels for customers. We evaluate anticipated customer markdowns and advertising chargebacks by reviewing several performance indicators for our major customers. These performance indicators (which include inventory levels at the retail floors, sell through rates and gross margin levels) are analyzed by management to estimate the amount of the anticipated customer allowance. Failure to correctly estimate the amount of the reserve could materially impact our results of operations and financial position. +Inventory valuation . Inventories are stated at lower-of-cost or market, on a first-in, first-out basis. We review inventory on a regular basis for excess and slow moving inventory. The review is based on an analysis of inventory on hand, prior sales, and expected net realizable value through future sales. The analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales and projections for sales in the foreseeable future as well as subsequent sales. We consider quantities on hand in excess of estimated future sales to be at risk for market impairment. The net realizable value, or market value, is determined based on the estimate of sales prices of such inventory through off-price or discount store channels. The likelihood of any material inventory write-down is dependent primarily on the expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product, the economy, or other failure to estimate correctly, in addition to abnormal weather patterns, could result in inventory valuation changes, compared to the valuation determined to be appropriate as of the balance sheet date. +Valuation of intangible assets and goodwill . Accounting Standards Codification (“ASC”) Topic 350, “Intangible – Goodwill and Other”, requires that goodwill and intangible assets with indefinite lives be tested for impairment at least annually. This pronouncement also requires that intangible assets with finite lives be amortized over their respective lives to their estimated residual values, and reviewed for impairment in accordance with ASC Topic 360, “Property, Plant and Equipment” (“ASC Topic 360”). +Indefinite-lived intangible assets and goodwill are assessed for impairment by performing a qualitative assessment which evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible or a reporting unit is less than its carrying amount. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the reporting unit is less than its carrying amount, the fair value of the reporting unit is compared with its carrying amount and, if the fair value of the reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount. We perform this annual assessment during our third quarter. +In accordance with ASC Topic 360, long-lived assets, such as property, equipment, leasehold improvements and intangible assets subject to amortization, are reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying +33 +amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. +Litigation reserves . Estimated amounts for litigation claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable events of a particular litigation. As additional information becomes available, management will assess the potential liability related to the pending litigation and revise its estimates. Such revisions in management’s estimates of a contingent liability could materially impact our results of operation and financial position. +Contingent payment liabilities. The Company has completed acquisitions that require us to make contingent payments to the sellers based on the future financial performance of the acquired businesses over a period of from one to six years. The fair value of the contingent payments is estimated using the present value of management's projections of the financial results of the acquired business. Failure to correctly project the financial results of the acquired businesses could materially impact our results of operations and financial position. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +($ in thousands) +Our financing arrangements are subject to variable interest rates primarily based on the prime rate and LIBOR. An analysis of our collection agency agreement with Rosenthal can be found in the “Liquidity and Capital Resources” section under Part II, Item 7, and in Note C to the Consolidated Financial Statements included in this Annual Report on Form 10-K under the caption “Factor Receivable.” As of December 31, 2017 , we held marketable securities valued at approximately $93,550 , which consisted primarily of corporate bonds and certificates of deposit. These securities are subject to interest rate risk and will decrease in value if interest rates increase. We currently have the ability to hold these securities until maturity. +We face market risk to the extent that our U.S. or foreign operations involve the transaction of business in foreign currencies. Also, our inventory purchases are primarily done in foreign jurisdictions and inventory purchases may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of our contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks primarily by denominating these purchases in U.S. dollars. To mitigate the risk of purchases that are denominated in foreign currencies we may enter into forward foreign exchange contracts for terms of no more than two years. A description of our accounting policies for derivative financial instruments is included in Notes A and K to the Consolidated Financial Statements. +During 2017, the Company entered into forward foreign exchange contracts. We performed a sensitivity analysis based on a model that measures the impact of a hypothetical change in foreign currency exchange rate to determine the effects that market risk exposures may have on the fair values of our forward foreign exchange contracts that were outstanding as of the year-end. As of December 31, 2017, a 10% appreciation or depreciation of the U.S. dollar against the exchange rates for foreign currencies under forward foreign exchange contracts would result in a net increase or decrease, respectively, in the fair value of our derivatives portfolio of approximately $78. +In addition, we are exposed to translation risk in connection with our foreign operations in Canada, Mexico, Europe, South Africa, China and Taiwan because our subsidiaries and joint ventures in these countries utilize the local currency as their functional currency and those financial results must be translated into U.S. dollars. As currency exchange rates fluctuate, foreign currency exchange rate translation adjustments reflected in our financial statements with respect to our foreign operations affects the comparability of financial results between years +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The information required by this Item is incorporated herein by reference to the consolidated financial statements listed in response to Item 15 of Part IV of this Annual Report on Form 10-K. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND +FINANCIAL DISCLOSURE +None. +34 +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2017 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2017 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2017 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2017 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. OTHER INFORMATION +On February 27, 2018, the Company issued a press release reporting its financial results for the fiscal quarter and fiscal year ended December 31, 2017, a copy of which is attached as Exhibit 99.01 to this Annual Report. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2018 Annual Meeting of Stockholders, and is incorporated herein by reference. +35 +ITEM 11. EXECUTIVE COMPENSATION +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2018 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND +RELATED STOCKHOLDER MATTERS +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2018 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2018 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2018 Annual Meeting of Stockholders, and is incorporated herein by reference. +PART IV +ITEM 15 +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) Financial Statements and Financial Statements Schedules +See Index to Consolidated Financial Statements included herein. +(b) Exhibits. See the exhibit index included herein. +36 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. +DATE: March 1, 2018 +STEVEN MADDEN, LTD. +/s/ EDWARD R. ROSENFELD +Edward R. Rosenfeld +Chairman and Chief Executive Officer +/s/ ARVIND DHARIA +Arvind Dharia +Chief Financial Officer and Chief Accounting Officer +37 +POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each of the undersigned constitutes and appoints Edward R. Rosenfeld and Arvind Dharia, and each of them, as attorneys-in-fact and agents, with full power of substitution and re-substitution, for and in the name, place and stead of the undersigned, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all that each of said attorney-in-fact or substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. +Signature +Title +Date +/S/ EDWARD R. ROSENFELD +Chairman, Chief Executive Officer and Director +March 1, 2018 +Edward R. Rosenfeld +/S/ ARVIND DHARIA +Chief Financial Officer and Chief Accounting Officer +March 1, 2018 +Arvind Dharia +/S/ AMELIA NEWTON VARELA +President and Director +March 1, 2018 +Amelia Newton Varela +/S/ PETER MIGLIORINI +Director +March 1, 2018 +Peter Migliorini +/S/ RICHARD P. RANDALL +Director +March 1, 2018 +Richard P. Randall +/S/ RAVI SACHDEV +Director +March 1, 2018 +Ravi Sachdev +/S/ THOMAS H. SCHWARTZ +Director +March 1, 2018 +Thomas H. Schwartz +/S/ ROSE LYNCH +Director +March 1, 2018 +Rose Lynch +/S/ ROBERT SMITH +Director +March 1, 2018 +Robert Smith +38 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Balance Sheets as of December 31, 2017 and 2016 +F-3 +Consolidated Statements of Income for the years ended December 31, 2017, 2016 and 2015 +F-4 +Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016 and 2015 +F-5 +Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2017, 2016 and 2015 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015 +F-8 +Notes to Consolidated Financial Statements +F-9 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Steven Madden, Ltd. and subsidiaries +Opinion on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Steven Madden, Ltd. and subsidiaries (the “Company") as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017 and 2016, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in the Internal Control - Integrated Framework (2013) issued by COSO. +Basis for Opinion +The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. +Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +An entity’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. An entity’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the entity; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effect on the financial statements. +F-1 +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ EisnerAmper LLP +We have served as the Company’s auditor since 1995. +EISNERAMPER LLP +New York, New York +March 1, 2018 +F-2 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Balance Sheets +(in thousands) +December 31, +2017 +2016 +ASSETS +Current assets: +Cash and cash equivalents +$ +181,214 +$ +126,115 +Accounts receivable, net of allowances of $1,973 and $1,622 +39,473 +56,790 +Factor accounts receivable, net of allowances of $26,213 and $20,209 +201,436 +144,168 +Inventories +110,324 +119,824 +Marketable securities – available for sale +64,027 +39,495 +Prepaid expenses and other current assets +19,538 +26,351 +Prepaid taxes +29,506 +15,928 +Total current assets +645,518 +528,671 +Note receivable – related party +2,289 +2,644 +Property and equipment, net +71,498 +72,381 +Deferred taxes +6,370 +1,813 +Deposits and other +2,121 +4,710 +Marketable securities – available for sale +29,523 +70,559 +Goodwill – net +148,538 +135,711 +Intangibles – net +151,304 +144,386 +Total Assets +$ +1,057,161 +$ +960,875 +LIABILITIES +Current liabilities: +Accounts payable +$ +66,955 +$ +80,584 +Accrued expenses +120,624 +86,635 +Income taxes payable +1,566 +— +Contingent payment liability – current portion +7,000 +7,948 +Accrued incentive compensation +10,467 +7,960 +Total current liabilities +206,612 +183,127 +Contingent payment liability +3,000 +— +Deferred rent +16,033 +14,578 +Deferred taxes +3,602 +19,466 +Other liabilities +18,982 +2,632 +Total Liabilities +248,229 +219,803 +Commitments, contingencies and other +STOCKHOLDERS’ EQUITY +Preferred stock – $.0001 par value, 5,000 shares authorized; none issued; Series A Junior Participating preferred stock – $.0001 par value, 60 shares authorized; none issued +— +— +Common stock – $.0001 par value, 135,000 shares authorized, 87,306 and 86,417 shares issued, 58,698 and 60,410 shares outstanding +6 +6 +Additional paid-in capital +390,723 +353,443 +Retained earnings +1,135,701 +1,017,753 +Accumulated other comprehensive loss +(25,613 +) +(31,751 +) +Treasury stock – 28,608 and 26,007 shares at cost +(697,996 +) +(598,584 +) +Total Steven Madden, Ltd. stockholders’ equity +802,821 +740,867 +Non-controlling interests +6,111 +205 +Total stockholders’ equity +808,932 +741,072 +Total Liabilities and Stockholders’ Equity +$ +1,057,161 +$ +960,875 +See accompanying notes to consolidated financial statements +F-3 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Income +(in thousands, except per share data) +Years Ended December 31, +2017 +2016 +2015 +Net sales +$ +1,546,098 +$ +1,399,551 +$ +1,405,239 +Cost of sales +968,357 +877,568 +904,747 +Gross profit +577,741 +521,983 +500,492 +Commission and licensing fee income – net +14,259 +11,788 +16,565 +Operating expenses +(421,216 +) +(364,595 +) +(342,364 +) +Impairment charges +(1,000 +) +— +(3,045 +) +Income from operations +169,784 +169,176 +171,648 +Interest income (expense) - net +2,548 +2,488 +2,191 +Other (expense) income - net +(5 +) +(664 +) +(1,373 +) +Income before provision for income taxes +172,327 +171,000 +172,466 +Provision for income taxes +53,189 +49,726 +58,811 +Net income +119,138 +121,274 +113,655 +Net income attributable to non-controlling interests +(1,190 +) +(363 +) +(717 +) +Net income attributable to Steven Madden, Ltd. +$ +117,948 +$ +120,911 +$ +112,938 +Basic net income per share +$ +2.14 +$ +2.12 +$ +1.91 +Diluted net income per share +$ +2.04 +$ +2.03 +$ +1.85 +Basic weighted average common shares outstanding +55,157 +57,109 +58,997 +Effect of dilutive securities – options/restricted stock +2,673 +2,447 +2,145 +Diluted weighted average common shares outstanding +57,830 +59,556 +61,142 +See accompanying notes to consolidated financial statements +F-4 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Comprehensive Income +(in thousands) +2017 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +119,138 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +6,836 +— +6,836 +(Loss) on cash flow hedging derivatives +(1,282 +) +468 +(814 +) +Unrealized gain on marketable securities +183 +(67 +) +116 +Total other comprehensive income +$ +5,737 +$ +401 +6,138 +Comprehensive income +125,276 +Comprehensive income attributable to non-controlling interests +(1,190 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +124,086 +2016 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +121,274 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(2,147 +) +$ +— +(2,147 +) +Gain on cash flow hedging derivatives +797 +(291 +) +506 +Unrealized gain on marketable securities +2,052 +(749 +) +1,303 +Total other comprehensive (loss) +$ +702 +$ +(1,040 +) +(338 +) +Comprehensive income +120,936 +Comprehensive income attributable to non-controlling interests +(363 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +120,573 +2015 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +113,655 +Other comprehensive income (loss): +Foreign currency translation adjustment +$ +(18,734 +) +$ +— +(18,734 +) +Gain on cash flow hedging derivatives +1,962 +(716 +) +1,246 +Unrealized (loss) on marketable securities +(1,847 +) +674 +(1,173 +) +Total other comprehensive (loss) +$ +(18,619 +) +$ +(42 +) +(18,661 +) +Comprehensive income +94,994 +Comprehensive income attributable to non-controlling interests +(717 +) +Comprehensive income attributable to Steven Madden, Ltd. +$ +94,277 +See accompanying notes to consolidated financial statements +F-5 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity +(in thousands) +Common Stock +Additional Paid‑in Capital +Retained Earnings +Shares +Amount +Balance - December 31, 2014 +63,625 +$ +6 +$ +275,039 +$ +783,904 +Share repurchases +(3,704 +) +— +— +— +Exercise of stock options +1,460 +— +21,301 +— +Tax benefit from stock-based compensation +— +— +10,510 +— +Issuance of restricted stock +312 +— +— +— +Stock-based compensation +— +— +18,698 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding (loss) on securities (net of tax benefit of $674) +— +— +— +— +Cash flow hedge (net of tax expense of $716) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Non-controlling investment in JV +— +— +— +— +Net income +— +— +— +112,938 +Balance - December 31, 2015 +61,693 +6 +325,548 +896,842 +Share repurchases +(2,437 +) +— +— +— +Exercise of stock options +746 +— +10,713 +— +Issuance of restricted stock +408 +— +— +— +Stock-based compensation +— +— +19,509 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain on securities (net of tax expense of $749) +— +— +— +— +Cash flow hedge (net of tax expense of $291) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Acquisition of Minority Interest (net of tax benefit of $1,432) +— +— +(2,327 +) +— +Net income +— +— +— +120,911 +Balance - December 31, 2016 +60,410 +6 +353,443 +1,017,753 +Share repurchases +(2,601 +) +— +— +— +Exercise of stock options +655 +— +16,433 +— +Issuance of restricted stock +234 +— +— +— +Stock-based compensation +— +— +20,847 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain on securities (net of tax expense of $67) +— +— +— +— +Cash flow hedge (net of tax benefit of $468) +— +— +— +— +Non-controlling investment in JV +— +— +— +— +Net income +— +— +— +117,948 +Balance - December 31, 2017 +58,698 +$ +6 +$ +390,723 +$ +1,135,701 +See accompanying notes to consolidated financial statements +F-6 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity (Continued) +(in thousands) +Accumulated Other Comprehensive Gain (Loss) +Treasury Stock +Non-controlling interest +Total Stockholders' Equity +Shares +Amount +Balance - December 31, 2014 +$ +(12,752 +) +19,866 +$ +(376,942 +) +$ +274 +$ +669,529 +Share repurchases +— +3,704 +(135,637 +) +— +(135,637 +) +Exercise of stock options +— +— +— +— +21,301 +Tax benefit from stock-based compensation +— +— +— +— +10,510 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +— +18,698 +Foreign currency translation adjustment +(18,734 +) +— +— +— +(18,734 +) +Unrealized holding (loss) on securities (net of tax benefit of $674) +(1,173 +) +— +— +— +(1,173 +) +Cash flow hedge (net of tax expense of $716) +1,246 +— +— +— +1,246 +Distributions to non-controlling interests, net +— +— +— +(732 +) +(732 +) +Non-controlling investment in JV +— +— +— +— +— +Net income +— +— +— +717 +113,655 +Balance - December 31, 2015 +(31,413 +) +23,570 +(512,579 +) +259 +678,663 +Share repurchases +— +2,437 +(86,005 +) +— +(86,005 +) +Exercise of stock options +— +— +— +— +10,713 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +19,509 +Foreign currency translation adjustment +(2,147 +) +— +— +— +(2,147 +) +Unrealized holding gain on securities (net of tax expense of $749) +1,303 +— +— +— +1,303 +Cash flow hedge (net of tax expense of $291) +506 +— +— +— +506 +Distributions to non-controlling interests, net +— +— +— +(417 +) +(417 +) +Acquisition of Minority Interest (net of tax benefit of $1,432) +— +— +— +— +(2,327 +) +Net income +— +— +— +363 +121,274 +Balance - December 31, 2016 +(31,751 +) +26,007 +(598,584 +) +205 +741,072 +Share repurchases +— +2,601 +(99,412 +) +— +(99,412 +) +Exercise of stock options +— +— +— +— +16,433 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +20,847 +Foreign currency translation adjustment +6,836 +— +— +— +6,836 +Unrealized holding gain on securities (net of tax expense of $67) +116 +— +— +— +116 +Cash flow hedge (net of tax benefit of $468) +(814 +) +— +— +— +(814 +) +Non-controlling investment in JV +— +— +— +4,716 +4,716 +Net income +— +— +— +1,190 +119,138 +Balance - December 31, 2017 +$ +(25,613 +) +28,608 +$ +(697,996 +) +$ +6,111 +$ +808,932 +See accompanying notes to consolidated financial statements +F-7 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +(in thousands) +Years Ended December 31, +2017 +2016 +2015 +Cash flows from operating activities: +Net income +$ +119,138 +$ +121,274 +$ +113,655 +Adjustments to reconcile net income to net cash provided by operating activities: +Stock-based compensation +20,847 +19,509 +18,698 +Tax benefit from stock-based compensation +— +— +(10,510 +) +Depreciation and amortization +21,389 +21,102 +20,757 +Loss on disposal of fixed assets +1,455 +652 +1,780 +Impairment charges +1,000 +— +3,045 +Deferred taxes +(19,274 +) +(6,588 +) +7,271 +Accrued interest on note receivable – related party +(54 +) +(63 +) +(71 +) +Deferred rent expense and other liabilities +1,455 +2,565 +440 +Realized loss (gain) on sale of marketable securities +(5 +) +661 +(67 +) +Change in fair value of contingent liability +(11,206 +) +(425 +) +(5,576 +) +Bad debt expense from bankruptcy +5,470 +— +— +Changes, net of acquisitions, in: +Accounts receivable +22,683 +(13,617 +) +(11,071 +) +Factor accounts receivable +(57,268 +) +11,043 +7,281 +Notes receivable - related party +409 +409 +409 +Inventories +21,135 +(17,744 +) +(9,403 +) +Prepaid expenses, prepaid taxes, deposits and other +2,403 +(3,461 +) +4,784 +Accounts payable and accrued expenses +9,501 +15,324 +(8,643 +) +Accrued incentive compensation +2,507 +1,819 +468 +Other liabilities +16,350 +1,144 +2,716 +Net cash provided by operating activities +157,935 +153,604 +135,963 +Cash flows from investing activities: +Capital expenditures +(14,775 +) +(15,897 +) +(19,459 +) +Purchases of marketable securities +(61,209 +) +(40,451 +) +(48,891 +) +Repayment of notes receivable +221 +249 +466 +Maturity/sale of marketable securities +79,141 +52,215 +43,353 +Acquisitions, net of cash acquired +(16,795 +) +— +(9,129 +) +Net cash used in investing activities +(13,417 +) +(3,884 +) +(33,660 +) +Cash flows from financing activities: +Proceeds from exercise of stock options +16,433 +10,713 +21,301 +Purchase of noncontrolling interest +— +(3,759 +) +— +Tax benefit from the exercise of options +— +— +10,510 +Payment of contingent liability +(7,359 +) +(16,402 +) +(6,270 +) +Common stock purchased for treasury +(99,412 +) +(86,005 +) +(135,637 +) +Net cash used by financing activities +(90,338 +) +(95,453 +) +(110,096 +) +Effect of exchange rate changes on cash and cash equivalents +919 +(566 +) +(1,243 +) +Net increase (decrease) in cash and cash equivalents +55,099 +53,701 +(9,036 +) +Cash and cash equivalents – beginning of year +126,115 +72,414 +81,450 +Cash and cash equivalents – end of year +$ +181,214 +$ +126,115 +$ +72,414 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +24 +$ +222 +$ +328 +Income taxes +$ +61,979 +$ +55,384 +$ +39,424 +See accompanying notes to consolidated financial statements. +F-8 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies +[1] Organization: +Steven Madden, Ltd. a Delaware corporation, and its subsidiaries, design, source, market and sell name brand and private label women's, men's and children's shoes, worldwide through its wholesale and retail channels under the Steve Madden Women's, Steve Madden Men's, Madden, Madden Girl, Steven, FREEBIRD by Steven, Superga (under license), Dolce Vita and Betsey Johnson brand names and through its wholesale channels under the Stevies, Report, B Brian Atwood, Mad Love and Blondo brand names and, under license, the Kate Spade and Avec Les Filles brand names. The Company had a design and production agreement with Rebecca Minkoff and a joint venture with Alice & Olivia, both of which were terminated as of December 31, 2017. +In addition, the Company designs, sources, markets and sells name brand and private label handbags and accessories to customers worldwide through its Wholesale Accessories segment, including the Big Buddha, Betsey Johnson, Madden Girl, Betseyville, Cejon, Steve Madden, Steven by Steve Madden, Luv Betsey, B Brian Atwood, DKNY (under license) and Donna Karan (under license) accessories brands. Revenue is generated predominantly through the sale of the Company's brand name and private label merchandise and certain licensed products. At December 31, 2017 and 2016 , the Company operated 206 (including four e-commerce websites) and 189 (including four e-commerce websites) retail stores, respectively. Revenue is subject to seasonal fluctuations. See Note O for operating segment information. +[2] Principles of consolidation: +The consolidated financial statements include the accounts of Steven Madden, Ltd. and its wholly-owned subsidiaries Steven Madden Retail, Inc., Diva Acquisition Corp., Diva International, Inc., Madden Direct, Inc., Adesso Madden, Inc., Stevies, Inc., Daniel M. Friedman and Associates, Inc., Big Buddha, Inc., the Topline Corporation, Cejon, Inc., SML Holdings S.a.r.l., SML Canada Acquisition Corp., Madden International Ltd., DMF International Ltd., Asean Corporation Ltd., Dolce Vita Holdings, Inc., Trendy Imports S.A de C.V., Comercial Diecesiette S.A. de C.V., Maximus Designer Shoes S.A. de C.V., BA Brand Holdings LLC, BAI Holding, LLC, Mad Love LLC (formerly a joint venture in which the Company acquired the remaining minority interest in 2016) and Schwartz & Benjamin, Inc. (collectively the "Company"). The accounts of (i) Dexascope Proprietary Ltd., a joint venture in South Africa in which the Company is the majority owner, (ii) BA Brand Holdings LLC, a joint venture in which the Company is the majority owner, (iii) SPM Shoetrade Holding B.V., a joint venture in certain regions of Europe in which the Company is the majority owner, (iv) SM (Jiangsu) Co., Ltd., a joint venture in which the Company controls all of the significant participating rights and (v) SM Dolce Limited, a joint venture in which the Company is the majority interest holder, are included in the consolidated financial statements with the other members' interests reflected in “Net (income) loss attributable to non-controlling interests” in the Consolidated Statements of Income and “Non-controlling interests” in the Consolidated Balance Sheets. All significant intercompany balances and transactions have been eliminated. Certain reclassifications were made to prior years' amounts to conform to the 2017 presentation. +[3] Use of Estimates: +The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +Significant areas involving management estimates include allowances for bad debts, returns and customer chargebacks, inventory valuation, valuation of intangible assets, litigation reserves and contingent payment liabilities. The Company provides reserves on trade accounts receivables and factor receivables for future customer chargebacks and markdown allowances, discounts, returns and other miscellaneous compliance-related deductions that relate to the current period sales. The Company evaluates anticipated chargebacks by reviewing several performance indicators of its major customers. +F-9 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +These performance indicators, which include retailers’ inventory levels, sell-through rates and gross margin levels, are analyzed by management to estimate the amount of the anticipated customer allowance. +[4] Cash equivalents: +Cash equivalents at December 31, 2017 and 2016 amounted to approximately $58,436 and $3,309 , respectively, and consisted of money market accounts. The Company considers all highly liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. +[5] Marketable securities: +Marketable securities consist primarily of certificates of deposit and corporate bonds with maturities greater than three months and up to four years at the time of purchase. These securities, which are classified as available-for-sale, are carried at fair value, with unrealized gains and losses, net of any tax effect, reported in stockholders' equity as accumulated other comprehensive income (loss). These securities are classified as current and non-current marketable securities based upon their maturities. Amortization of premiums and discounts is included in interest income. For the years ended December 31, 2017 and 2016 , the amortization of bond premiums totaled $983 and $1,234 , respectively. The values of these securities may fluctuate as a result of changes in market interest rates and credit risk. The schedule of maturities at December 31, 2017 and 2016 are as follows: +Maturities as of +December 31, 2017 +Maturities as of +December 31, 2016 +1 Year or Less +1 to 4 Years +1 Year or Less +1 to 4 Years +Corporate bonds +$ +11,979 +$ +29,523 +$ +11,527 +$ +70,559 +Certificates of deposit +52,048 +— +27,968 +— +Total +$ +64,027 +$ +29,523 +$ +39,495 +$ +70,559 +For the year ended December 31, 2017 , gains of $5 were reclassified from Accumulated Other Comprehensive Income and recognized in the Consolidated Statements of Income in Other Income as compared to losses of $661 for the year ended December 31, 2016 . At December 31, 2017 , current marketable securities included unrealized losses of $106 and unrealized gains of $1 while long-term marketable securities included unrealized gains of $3 and unrealized losses of $90 . At December 31, 2016 , current marketable securities included unrealized losses of $279 and long-term marketable securities included unrealized gains of $89 and unrealized losses of $118 . +[6] Inventories: +Inventories, which consist of finished goods on hand and in transit, are stated at the lower of cost (first-in, first-out method) or market. +[7] Property and equipment: +Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed utilizing the straight-line method based on estimated useful lives ranging from three to ten years. Leasehold improvements are amortized utilizing the straight-line method over the shorter of their estimated useful lives or the remaining lease term. Impairment losses are recognized for long-lived assets, including definite-lived intangibles, used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are not sufficient to recover the assets' carrying amount. Impairment losses are measured by comparing the fair value of the assets to their carrying amount. +F-10 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[8] Goodwill and intangible assets: +The Company's goodwill and indefinite lived intangible assets are not amortized, rather they are tested for impairment on an annual basis, or more often if events or circumstances change that could cause these assets to become impaired. +In January 2017, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2017-04, “Intangibles - Goodwill and Other” (Topic 350) “Simplifying the Test for Goodwill Impairment”. Under the amendments in this update, indefinite-lived intangible assets and goodwill are assessed for impairment by performing a qualitative assessment which evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible asset or reporting unit is less than its carrying amount. The factors that are considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the intangible asset or reporting unit is less than its carrying amount, the fair value of the intangible asset or reporting unit is compared with its carrying amount and, if the fair value of the intangible asset or reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the carrying value of the intangible asset or reporting unit exceeds its fair value, not to exceed the carrying amount. The guidance is effective in fiscal years beginning after December 15, 2020. The Company adopted the new guidance in the second quarter of 2017. During the fourth quarter of 2017, the Company recognized an impairment charge of $1,000 related to the Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows. The Company completed its annual impairment tests on goodwill and its remaining indefinite-lived intangible assets during the third quarter of 2017 , and no other impairments were recognized. +The Company amortizes its intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment when there is a triggering event. The Company is currently amortizing its acquired intangible assets with definite useful lives over periods typically from two to ten years using the straight-line method. +[9] Net Income Per Share of Common Stock: +Basic net income per share is based on the weighted average number of shares of common stock outstanding during the period, which does not include unvested restricted common stock subject to forfeiture. Diluted net income per share reflects: a) the potential dilution assuming shares of common stock were issued upon the exercise of outstanding in-the-money options and the proceeds thereof were used to purchase shares of the Company’s common stock at the average market price during the period, and b) the vesting of granted nonvested restricted stock awards for which the assumed proceeds upon vesting are deemed to be the amount of compensation cost not yet recognized attributable to future services using the treasury stock method, to the extent dilutive. For the years ended December 31, 2017 , 2016 and 2015 , options to purchase approximately 9,000 , 374,000 and 26,000 shares of common stock, respectively, have been excluded in the calculation of diluted income per share as the result would have been anti-dilutive. For the years ended December 31, 2017 , 2016 and 2015 , all unvested restricted stock awards were dilutive. +[10] Comprehensive Income: +Comprehensive income is the total of net earnings and all other non-owner changes in equity. Comprehensive income for the Company includes net income, foreign currency translation adjustments, cash flow hedging and unrealized gains and losses on marketable securities. The accumulated balances for each component of other comprehensive loss attributable to the Company are as follows: +F-11 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +2017 +2016 +Currency translation adjustment +$ +(24,798 +) +$ +(31,634 +) +Cash flow hedges, net of tax +(623 +) +191 +Unrealized loss on securities, net of tax +(192 +) +(308 +) +Accumulated other comprehensive loss +$ +(25,613 +) +$ +(31,751 +) +[11] Advertising costs: +The Company expenses costs of print, radio and billboard advertisements as incurred. Advertising expenses included in operating expenses amounted to approximately $19,629 in 2017 , $16,024 in 2016 and $14,892 in 2015 . +[12] Revenue Recognition: +The Company recognizes revenue on wholesale sales when (i) products are shipped pursuant to its standard terms, which are freight on board (“FOB”) Company warehouse, or when products are delivered to the consolidators, or any other destination, as per the terms of the customers’ purchase order, (ii) persuasive evidence of an arrangement exists, (iii) the price is fixed and determinable and (iv) collection is reasonably assured. Sales reductions on wholesale sales for anticipated discounts, allowances and other deductions are recognized during the period when sales are recorded. With the exception of our cold weather accessories and Blondo businesses, normally we do not accept returns from our wholesale customers unless there are product quality issues, which we charge back to the vendors at cost. Sales of cold weather accessories +and Blondo products to wholesale customers are recorded net of returns, which are estimated based on historical experience. Such amounts have historically not been material. +Retail sales are recognized when the payment is received from customers and are recorded net of estimated returns. The Company generates commission income acting as a buying agent by arranging to manufacture private label shoes to the specifications of its customers. The Company’s commission revenue also includes fees charged for its design, product and development services provided to certain suppliers in connection with the Company’s private label business. Commission revenue and product and development fees are recognized as earned when title to the product transfers from +the manufacturer to the customer and collections are reasonably assured and are reported on a net basis after deducting related operating expenses. +The Company licenses its Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas and household goods. The Company also licenses the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. The license agreements require the licensee to pay the Company a royalty and, in substantially all of the agreements, an advertising fee based on the higher of a minimum or a net sales percentage as defined in the various agreements. In addition, under the terms of retail selling agreements, most of the Company’s international distributors are required to pay the Company a royalty based on a percentage of net sales, in addition to a commission and a design fee on the purchases of the Company’s products. In substantially all of the Company’s license agreements, the minimum guaranteed royalty is earned and receivable on a quarterly basis. Licensing revenue is recognized on the basis of net sales reported by the licensees, or the minimum guaranteed royalties, if higher. +F-12 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[13] Taxes Collected From Customers: +The Company accounts for certain taxes collected from its customers in accordance with the accounting guidance which permits companies to adopt a policy of presenting taxes in the income statement on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues). Taxes within the scope of this accounting guidance would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes and some types of excise taxes. The Company records all taxes on a net basis. +[14] Sales Deductions: +The Company supports retailers’ initiatives to maximize sales of the Company’s products on the retail floor by subsidizing the co-op advertising programs of such retailers, providing them with inventory markdown allowances and participating in various other marketing initiatives of its major customers. In addition, the Company accepts returns for damaged products for which the Company’s costs are normally charged back to the responsible third-party factory. Such expenses are reflected in the consolidated financial statements as deductions to arrive at net sales. +[15] Cost of Sales: +All costs incurred to bring finished products to the Company’s distribution center or to the customers’ freight forwarder and, in the Retail segment, the costs to bring products to the Company’s stores, are included in the cost of sales line on the Consolidated Statements of Income. These include the cost of finished products, purchase commissions, letter of credit fees, brokerage fees, sample expenses, custom duty, inbound freight, royalty payments on licensed products, labels and product packaging. All warehouse and distribution costs related to the Wholesale segments and freight to customers, if any, are included in the operating expenses line item of the Company’s Consolidated Statements of Income. The Company’s gross margins may not be comparable to those of other companies in the industry because some companies may include warehouse and distribution costs, as well as other costs excluded from cost of sales by the Company, as a component of cost of sales, while other companies report on the same basis as the Company and include them in operating expenses. +[16] Warehouse and shipping costs: +The Company includes all warehouse and shipping costs for the Wholesale segment in the Operating Expenses line on the Consolidated Statements of Income. For the years ended December 31, 2017 , 2016 and 2015 , the total warehouse and distribution costs included in Operating Expenses were $32,395 , $27,079 and $24,176 respectively. Since the Company's standard terms of sales are “FOB Steve Madden warehouse,” the Company's wholesale customers absorb most shipping costs. Shipping costs to wholesale customers incurred by the Company are not considered significant and are included in the Operating Expense line in the Consolidated Statements of Income. +[17] Employee benefit plan: +The Company maintains a tax-qualified 401(k) plan which is available to each of the Company's eligible employees who elect to participate after meeting certain length-of-service requirements. The Company made discretionary matching contributions of 50% of employees' contributions up to a maximum of 6% of employees' compensation which vest to the employees over a period of time. Total matching contributions to the plan for 2017 , 2016 and 2015 were approximately $1,819 , $1,633 and $1,602 , respectively. +F-13 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies (continued) +[18] Derivative Instruments: +The Company uses derivative instruments to manage its exposure to cash-flow variability from foreign currency risk. Derivatives are carried on the balance sheet at fair value and included in prepaid expenses and other current assets or accrued expenses. The Company applies cash flow hedge accounting for its derivative instruments. Net derivative gains and losses attributable to derivatives subject to cash flow hedge accounting reside in accumulated other comprehensive income (loss) and will be reclassified to earnings in future periods as the economic transactions to which the derivatives relate affect earnings. See Note K - Derivative Instruments. +[19] Income Taxes: +The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. +The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits +recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. See Note M - Income Taxes. +[20] Share-based Compensation: +The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for equity instruments of the Company. Share-based compensation cost for restricted stock units (“RSUs”) is measured based on the closing fair market value of the Company’s common stock on the date of grant. Share-based compensation cost for stock options is measured at the grant date, based on the fair-value as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The BSM option-pricing model incorporates various assumptions including expected volatility, estimated expected life and interest rates. The Company recognizes share-based compensation cost over the award’s requisite service period. The Company recognizes a benefit from share-based compensation in the Consolidated Statements of Income if an incremental tax benefit is realized. See Note H - Stock- Based Compensation. +Note B – Acquisitions +SM Dolce Limited +In September 2017, the Company formed a joint venture ("SM Taiwan") with Dolce Limited through its subsidiary, SM Dolce Limited. The Company is the majority interest holder in SM Taiwan and controls all of the significant participating rights of the joint venture. SM Taiwan is the exclusive distributor of the Company's products in Taiwan. As the Company controls all of the significant participating rights of the joint venture and is the majority interest holder in SM Taiwan, the assets, liabilities and results of operations of SM Taiwan are consolidated and included in the Company’s consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interests” in the Consolidated Statements of Income and “Noncontrolling interests” in the Consolidated Balance Sheets. +SM (Jiangsu) Co., Ltd. +In September 2017, the Company formed a joint venture ("SM China") with Xuzhou C. banner Footwear, Ltd. through its subsidiary, SM (Jiangsu) Co., Ltd. The Company controls all of the significant participating rights of the joint venture. SM China is the exclusive distributor of the Company's products in China. As the Company controls all of the significant participating rights of +F-14 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note B – Acquisitions (continued) +the joint venture in SM China, the assets, liabilities and results of operations of SM China are consolidated and included in the Company’s consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interests” in the Consolidated Statements of Income and “Noncontrolling interests” in the Consolidated Balance Sheets. +Schwartz & Benjamin +In January 2017, the Company acquired all of the outstanding capital stock of each of Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC and DANIELBARBARA Enterprises LLC (collectively, "Schwartz & Benjamin"). Founded in 1923, Schwartz & Benjamin specializes in the design, sourcing and sale of licensed and private label footwear and distributes its fashion footwear to wholesale customers, including department stores and specialty boutiques, as well as the retail stores of its brand partners. The total purchase price for the acquisition was approximately $37,112 , which included a cash payment at closing of $17,396 less a working capital adjustment of $901 , plus potential earn-out payments based on the achievement of certain earnings targets for each of the twelve month periods ending on January 31, 2018 through 2023, inclusive. The fair value of the contingent payments was estimated using the present value of the payments based on management's projections of the financial results of Schwartz & Benjamin during the earn-out period and was finalized at $20,617. On November 27, 2017, the Company entered into +an amendment to the equity purchase agreement with the sellers of Schwartz & Benjamin to change the manner of calculating the earn-out and to provide for payments based on the performance of certain specified license agreements. In connection with this amendment, the Company reduced the earn-out liability from $20,617 to $10,000 and recorded a credit to operating expenses in the amount of $10,617 . +The transaction was accounted for using the acquisition method required by GAAP. Accordingly, the assets and liabilities of Schwartz & Benjamin were recorded at their fair values, and the excess of the purchase price over the fair value of the assets acquired and liabilities assumed, including identified intangible assets, was recorded as goodwill. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions. The purchase price has been allocated as follows: +Inventory +$ +11,635 +Accounts receivable +10,836 +Trademarks +4,630 +Customer relations +5,210 +Fixed assets +3,281 +Prepaids and other assets +2,063 +Accounts payable +(7,756 +) +Accrued expenses +(4,669 +) +Total fair value excluding goodwill +25,230 +Goodwill +11,882 +Net assets acquired +$ +37,112 +Contingent consideration classified as a liability will be remeasured at fair value at each reporting date, until the contingency is resolved, with changes recognized in earnings. The goodwill related to this transaction is expected to be deductible for tax purposes over 15 years. +Note C – Factor Receivable +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”) that became effective on September 15, 2009. The agreement can be terminated by the Company or Rosenthal at any time upon 60 days prior written notice. +F-15 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note C – Factor Receivable (continued) +Under the agreement, the Company can request advances from Rosenthal in amounts of up to 85% of aggregate receivables submitted to Rosenthal. The agreement provides the Company with a $30,000 credit facility with a $15,000 sub-limit for letters of credit at an interest rate based, at the Company’s election, upon a calculation that utilizes either the prime rate minus 0.5% or LIBOR plus 2.5% . As of December 31, 2017 and 2016, no borrowings or letters of credit were outstanding. The Company also pays Rosenthal a fee of 0.20% of the gross invoice amount submitted to Rosenthal. With respect to receivables related to the Company's private label business, the fee is 0.14% of the gross invoice amount. Rosenthal assumes the credit risk on a substantial portion of the receivables that the Company submits to it and, to the extent of any loans made to the Company, Rosenthal maintains a lien on the Company’s receivables to secure the Company’s obligations. Rosenthal services the collection of the Company's accounts receivable. Funds collected by Rosenthal are applied against advances owed to Rosenthal (if any), and the balance is due and payable to the Company, net of any fees. The allowance against “factor receivables” is a projected provision based on certain formulas and prior approvals for markdowns, allowances, discounts, advertising and other deductions that customers may deduct against their payments. +Note D – Note Receivable – Related Party +On June 25, 2007, the Company made a loan to Steve Madden, its Creative and Design Chief and a principal stockholder of the Company, in the amount of $3,000 in order for Mr. Madden to satisfy a personal tax obligation resulting from the exercise of stock options that were due to expire and to retain the underlying Company common stock. The loan, as amended, is secured by non-company securities held in Mr. Madden's brokerage account. The Company has agreed to forgive a portion of the note as long as Mr. Madden remains an employee of the Company through the note's maturity on December 31, 2023. For the years ended December 31, 2017, 2016 and 2015 the Company also recorded a charge in the amount of $409 for each year, respectively, to write-off the required one-tenth of the principal amount of the secured promissory note, which was partially offset by imputed interest income of $55 , $63 and $71 , respectively. +Note E – Fair Value Measurement +The accounting guidance under Accounting Standards Codification “Fair Value Measurements and Disclosures” (“ASC 820-10”) provides guidance for disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those three levels is as follows: +• +Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities. +• +Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. +• +Level 3: Significant unobservable inputs. +The Company’s financial assets and liabilities, subject to fair value measurements, as of December 31, 2017 and 2016 are as follows: +F-16 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note E – Fair Value Measurement (continued) +December 31, 2017 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +58,436 +$ +58,436 +$ +— +$ +— +Current marketable securities – available for sale +64,027 +64,027 +— +— +Long-term marketable securities – available for sale +29,523 +29,523 +— +— +Total assets +$ +151,986 +$ +151,986 +$ +— +$ +— +Liabilities: +Contingent consideration +$ +10,000 +$ +— +$ +— +$ +10,000 +Forward contracts +783 +— +783 +— +Total liabilities +$ +10,783 +$ +— +$ +783 +$ +10,000 +December 31, 2016 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +3,309 +$ +3,309 +$ +— +$ +— +Current marketable securities – available for sale +39,495 +39,495 +— +— +Long-term marketable securities – available for sale +70,559 +70,559 +— +— +Forward contracts +191 +— +191 +— +Total assets +$ +113,554 +$ +113,363 +$ +191 +$ +— +Liabilities: +Contingent consideration +$ +7,948 +$ +— +$ +— +$ +7,948 +Total liabilities +$ +7,948 +$ +— +$ +— +$ +7,948 +Our level 3 balance consists of contingent consideration related to the Schwartz & Benjamin acquisition. The changes in our level 3 liabilities for the years ended December 31, 2017 and 2016 are as follows: +F-17 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note E – Fair Value Measurement (continued) +Balance at January 1, +Payments +Accrued Interest +Acquisitions +Change in estimate +Foreign Currency Translation +Balance at December 31, +2017 +Liabilities: +Contingent consideration +$ +7,948 +(7,359 +) +— +20,617 +(11,206 +) +— +$ +10,000 +2016 +Liabilities: +Contingent consideration +$ +24,775 +(16,402 +) +— +— +(425 +) +— +$ +7,948 +The change in estimate of the contingent consideration as of December 31, 2017 and 2016 of $11,206 and $425 has been reflected as a reduction in operating expenses on the Consolidated Statement of Income. +Forward contracts are entered into to manage the risk associated with the volatility of future cash flows denominated in foreign currencies. Fair value of these instruments are based on observable market transactions of spot and forward rates. +The Company has recorded a liability for potential contingent consideration in connection with the January 30, 2017 acquisition of Schwartz & Benjamin. Pursuant to the terms of an earn-out provision contained in the equity purchase agreement, as amended, between the Company and the sellers of Schwartz & Benjamin, earn-out payments are based on the performance of certain specified license agreements. The fair value of the contingent payments was estimated using the present value of the payments based on management’s projections of the financial results of Schwartz & Benjamin during the earn-out period. +The Company recorded a liability for potential contingent consideration in connection with the December 30, 2014 acquisition of all of the outstanding capital stock of Trendy Imports S.A. de C.V., Comercial Diecisiette S.A. de C.V., and Maximus Designer Shoes S.A. de C.V. (together "SM Mexico"). Pursuant to the terms of an earn-out agreement between the Company and the seller +of SM Mexico, earn-out payments were due annually to the seller of SM Mexico based on the financial performance of SM Mexico for each of the twelve-month periods ending on December 31, 2015 and 2016, inclusive. The fair value of the contingent payments was estimated using the present value of management's projections of the financial results of SM Mexico during the earn-out period. The first earn-out payment of $3,482 for the period ended December 31, 2015 was paid to the seller of SM Mexico in the first quarter of 2016. The earn-out payment of $4,618 for the period ended December 31, 2016 was paid to the seller of SM Mexico in 2017. +The Company recorded a liability for potential contingent consideration in connection with the February 21, 2012 acquisition of all of the assets of Steve Madden Canada Inc., Steve Madden Retail Canada Inc., Pasa Agency Inc. and Gelati Imports Inc. (collectively, “SM Canada”). Pursuant to the terms of an earn-out agreement between the Company and the seller of SM Canada, earn-out payments were due annually to the seller of SM Canada based on the financial performance of SM Canada for each of the 12-month periods ending on March 31, 2013 through 2017, inclusive. The fair value of the contingent payments was estimated using the present value of management’s projections of the financial results of SM Canada during the earn-out period. The final earn-out payment of $2,741 for the period ended March 31, 2017 was paid to the seller of SM Canada in 2017 . +Accounting guidance permits entities to choose to measure financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The accounting guidance also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that chose different measurement attributes for similar assets and liabilities. The Company has elected not to measure any eligible items at fair value. +The carrying value of certain financial instruments such as accounts receivable, factor accounts receivable and accounts payable approximates their fair values due to the short-term nature of their underlying terms. The fair values of investment in marketable securities available for sale are determined by reference to publicly quoted prices in an active market. Fair value of the notes receivable held by the Company approximates their carrying value based upon their imputed or actual interest rate, which approximates applicable current market interest rates. +F-18 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note F - Property and Equipment +The major classes of assets and total accumulated depreciation and amortization are as follows: +December 31, +Average Useful Life +2017 +2016 +Land and building +$ +767 +$ +767 +Leasehold improvements +81,554 +79,165 +Machinery and equipment +10 years +7,132 +11,112 +Furniture and fixtures +5 years +8,629 +8,881 +Computer equipment and software +3 to 5 years +58,448 +57,855 +156,530 +157,780 +Less accumulated depreciation and amortization +(85,032 +) +(85,399 +) +Property and equipment - net +$ +71,498 +$ +72,381 +Depreciation and amortization expense related to property and equipment included in operating expenses amounted to approximately $ 15,160 in 2017 , $ 14,346 in 2016 and $ 13,237 in 2015 . +Note G – Goodwill and Intangible Assets +The following is a summary of the carrying amount of goodwill by segment as of December 31, 2017 and 2016 : +Wholesale +Net Carrying +Footwear +Accessories +Retail +Amount +Balance at January 1, 2016 +$ +73,018 +$ +49,324 +$ +14,755 +$ +137,097 +Translation and other +(757 +) +— +(629 +) +(1,386 +) +Balance at December 31, 2016 +72,261 +49,324 +14,126 +135,711 +Acquisition of Schwartz & Benjamin +11,882 +— +— +11,882 +Translation and other +719 +— +226 +945 +Balance at December 31, 2017 +$ +84,862 +$ +49,324 +$ +14,352 +$ +148,538 +The following table details identifiable intangible assets as of December 31, 2017 and 2016 : +F-19 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note G – Goodwill and Intangible Assets (continued) +2017 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +9,220 +$ +4,760 +$ +— +$ +4,460 +Customer relationships +10 years +47,019 +24,127 +— +22,892 +License agreements +3–6 years +5,600 +5,600 +— +— +Non-compete agreement +5 years +2,440 +2,375 +— +65 +Re-acquired right +2 years +4,200 +4,200 +— +— +Other +3 years +14 +14 +— +— +68,493 +41,076 +— +27,417 +Re-acquired right +indefinite +35,200 +7,601 +— +27,599 +Trade names +indefinite +100,333 +— +4,045 +96,288 +$ +204,026 +$ +48,677 +$ +4,045 +$ +151,304 +(1) Includes the effect of foreign currency translation related primarily to the changes in the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An initial impairment charge of $3,045 was recorded in the first quarter of 2015, and a final impairment charge of $1,000 was recorded in the fourth quarter of 2017 related to the Company's Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows from a significant customer . +2016 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +4,590 +$ +3,335 +$ +— +$ +1,255 +Customer relationships +10 years +41,509 +21,341 +— +20,168 +License agreements +3–6 years +5,600 +5,600 +— +— +Non-compete agreement +5 years +2,440 +2,426 +— +14 +Re-acquired right +2 years +4,200 +4,200 +— +— +Other +3 years +14 +14 +— +— +58,353 +36,916 +— +21,437 +Re-acquired right +indefinite +35,200 +9,539 +— +25,661 +Trade names +indefinite +100,333 +— +3,045 +97,288 +$ +193,886 +$ +46,455 +$ +3,045 +$ +144,386 +(1) Includes the effect of foreign currency translation related primarily to the changes in the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An impairment charge of $3,045 was recorded in the first quarter of 2015 related to the Company's Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows from a significant customer. +F-20 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note G – Goodwill and Intangible Assets (continued) +The amortization of intangible assets amounted to $ 5,245 for 2017 , $ 5,522 for 2016 and $6,145 for 2015 and is included in operating expenses on the Company's Consolidated Statements of Income. The estimated future amortization expense for intangibles is as follows: +2018 +$ +4,621 +2019 +4,547 +2020 +3,721 +2021 +2,095 +2022 +1,563 +Thereafter +10,870 +Total +$ +27,417 +Note H – Stock-Based Compensation +In March 2006, the Board of Directors of the Company approved the Steven Madden, Ltd. 2006 Stock Incentive Plan (the “Plan”) under which nonqualified stock options, stock appreciation rights, performance shares, restricted stock, other stock-based awards and performance-based cash awards may be granted to employees, consultants and non-employee directors. The Company’s stockholders approved the Plan on May 26, 2006. The stockholders have subsequently approved successive amendments of the Plan, most recently on May 25, 2012, when the stockholders approved a third amendment to the Plan that increased the maximum number of shares that may be issued under the Plan to 23,466,000 . The following table summarizes the number of shares of common stock authorized for use under the Plan, the number of stock-based awards granted (net of expired or cancelled awards) under the Plan and the number of shares of common stock available for the grant of stock-based awards under the Plan: +Common stock authorized +23,466,000 +Stock-based awards, including restricted stock and stock options granted, net of expired or cancelled +(21,818,000 +) +Common stock available for grant of stock-based awards as of December 31, 2017 +1,648,000 +In accordance with accounting guidance relating to stock-based compensation, the Company records compensation for all awards to employees based on the fair value of options and restricted stock on the date of grant. Equity-based compensation is included in operating expenses on the Company's Consolidated Statements of Income. For the years ended December 31, 2017 , 2016 and 2015 , total equity-based compensation was as follows: +Years Ended December 31, +2017 +2016 +2015 +Restricted stock +$ +16,616 +$ +16,494 +$ +15,543 +Stock options +4,231 +3,015 +3,155 +Total +$ +20,847 +$ +19,509 +$ +18,698 +F-21 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note H – Stock-Based Compensation (continued) +For the year ended December 31, 2015, the Company classified cash flows of $10,510 resulting from the tax benefit from tax deductions in excess of the compensation costs recognized for those options (tax benefits) as financing cash flows. During the third quarter of 2016, the Company adopted Accounting Standards Update No. 2016-09 ("ASU 2016-09"), Improvements to Employee Share-Based Payment Accounting which changes the accounting for certain aspects of share-based payments to employees (refer to Note Q). As a result of the adoption of ASU 2016-09, the Company classifies cash flows resulting from tax benefits as operating cash flows for the years ended December 31, 2017 and 2016. For the years ended December 31, 2017 and 2016, the Company realized a tax benefit from stock-based compensation of $4,019 and $5,244 , respectively. +Stock Options +The total intrinsic value of options exercised during 2017 , 2016 and 2015 amounted to $ 9,936 , $ 16,983 and $ 12,433 respectively. During the years ended December 31, 2017 , 2016 and 2015 , 409,522 options with a weighted average exercise price of $34.02 , 322,022 options with a weighted average exercise price of $32.37 and 455,528 options with a weighted average exercise price of $ 27.27 vested, respectively. As of December 31, 2017 , there were unvested options relating to 1,241,187 shares of common stock with a total of $8,426 of unrecognized compensation cost and an average vesting period of 3.2 years. +The Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of options granted, which requires several assumptions. The expected term of the options represents the estimated period of time until exercise and is based on the historical experience of similar awards. Expected volatility is based on the historical volatility of the Company’s common stock. The risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. Historically, with the exception of a special dividend paid in each of November 2005 and November 2006, the Company historically has not paid regular cash dividends and, thus, the expected dividend rate is assumed to be zero. The following weighted average assumptions were used for stock options granted: +2017 +2016 +2015 +Volatility +23% to 26% +22% to 26% +22% to 28% +Risk-free interest rate +1.48% to 1.99% +0.86% to 1.90% +0.99% to 1.60% +Expected life in years +3 to 5 +3 to 5 +3 to 5 +Dividend yield +0.00% +0.00% +0.00% +Weighted average fair value +$8.91 +$7.11 +$8.81 +Activity relating to stock options granted under the Company’s plans and outside the plans during the three years ended December 31, 2017 is as follows: +F-22 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note H – Stock-Based Compensation (continued) +Number of Shares +Weighted Average Exercise Price +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at January 1, 2015 +3,428,000 +$ +19.48 +Granted +69,000 +36.59 +Exercised +(1,460,000 +) +14.59 +Expired/Forfeited +(21,000 +) +28.49 +Outstanding at December 31, 2015 +2,016,000 +23.51 +Granted +262,000 +33.86 +Exercised +(746,000 +) +14.36 +Expired/Forfeited +(33,000 +) +30.59 +Outstanding at December 31, 2016 +1,499,000 +29.72 +Granted +1,062,000 +37.55 +Exercised +(655,000 +) +24.73 +Expired/Forfeited +(9,000 +) +35.23 +Outstanding at December 31, 2017 +1,897,000 +$ +35.80 +4.9 years +$ +20,680 +Exercisable at December 31, 2017 +656,000 +$ +33.67 +3.1 years +$ +8,540 +The following table summarizes information about stock options at December 31, 2017 : +Options Outstanding +Options Exercisable +Range of Exercise Price +Number Outstanding +Weighted Average Remaining Contractual Life (in Years) +Weighted Average Exercise Price +Number Exercisable +Weighted Average Exercise Price +$19.70 to $26.95 +9,051 +1.2 +$22.71 +9,056 +$22.71 +$27.03 to $29.45 +80,309 +1.8 +28.64 +80,352 +28.64 +$30.19 to $33.99 +263,045 +3.1 +31.60 +181,717 +31.66 +$34.06 to $38.05 +1,359,071 +5.3 +36.53 +328,974 +35.25 +$38.96 to $43.30 +185,524 +6.0 +40.11 +55,901 +39.96 +1,897,000 +4.9 +$35.80 +656,000 +$33.67 +F-23 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note H – Stock-Based Compensation (continued) +Restricted Stock +The following table summarizes restricted stock activity during the three years ended December 31, 2017 : +Number of Shares +Weighted Average Fair Value at Grant Date +Outstanding at January 1, 2015 +4,067,000 +$ +24.69 +Granted +361,000 +35.71 +Vested +(304,000 +) +23.24 +Forfeited +(69,000 +) +34.23 +Outstanding at December 31, 2015 +4,055,000 +25.32 +Granted +434,000 +34.30 +Vested +(276,000 +) +30.28 +Forfeited +(22,000 +) +33.45 +Outstanding at December 31, 2016 +4,191,000 +25.93 +Granted +275,000 +37.67 +Vested +(508,000 +) +30.58 +Forfeited +(42,000 +) +35.47 +Outstanding at December 31, 2017 +3,916,000 +$ +26.05 +As of December 31, 2017 , there was $63,140 of total unrecognized compensation cost related to restricted stock awards granted under the Plan. This cost is expected to be recognized over a weighted average period of 5.4 years. +The Company determines the fair value of its restricted stock awards based on the market price of its common stock on the date +of grant. The fair value of the restricted stock that vested during the years ended December 31, 2017 , 2016 and 2015 was $21,549 , $9,758 and $6,980 , respectively. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment of Mr. Madden’s existing employment agreement, pursuant to which, on February 8, 2012, Mr. Madden was granted 1,463,057 restricted shares of the Company’s common stock at the then market price of $27.34 , which will vest in equal annual installments over a seven-year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On June 30, 2012, Mr. Madden exercised his right under his employment agreement to receive an additional restricted stock award, and, on July 3, 2012, he was granted 1,893,342 restricted shares of the Company's common stock at the then market price of $21.13 , which vests in equal annual installments over a six-year period commencing on December 31, 2018 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On July 20, 2017, pursuant to the employment agreement, Mr. Madden was granted an option to purchase 150,000 shares of the Company's common stock at an exercise price of $40.15 per share, which option is exercisable in equal quarterly installments commencing on October 20, 2017. On March 1, 2017, pursuant to his employment agreement, Mr. Madden was granted an option to purchase 750,000 shares of the Company’s common stock at an exercise price of $37.35 per share, which option is exercisable in equal annual installments over a five-year period commencing on the first anniversary of the grant date. +F-24 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note I - Preferred Stock +The Company has authorized 5,000,000 shares of preferred stock. The Board of Directors has designated 60,000 shares of such preferred stock as Series A Junior Participating Preferred Stock (“Series A Preferred”). Holders of the shares of Series A Preferred are entitled to dividends equal to 1,000 times dividends declared or paid on the Company's common stock. Each share of Series A Preferred entitles the holder to 1,000 votes on all matters submitted to the holders of common stock. The Series A Preferred has a liquidation preference of $ 1,000 per share, and is not redeemable by the Company. No shares of preferred stock have been issued. +Note J - Share Repurchase Program +The Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase, most recently on July 28, 2017 when the Board of Directors approved the extension of the Share Repurchase Program for an additional $200,000 in repurchases of the Company's common stock. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. During the twelve months ended December 31, 2017 , an aggregate of 2,253,802 shares of the Company's common stock was repurchased under the Share Repurchase Program, at an average price per share of $37.62 , for an aggregate purchase price of approximately $84,783 . As of December 31, 2017 , approximately $180,861 remained available for future repurchases under the Share Repurchase Program. +The Steven Madden, Ltd. 2006 Stock Incentive Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. During the twelve months ended December 31, 2017 , an aggregate of 346,820 shares were withheld in connection with the settlement of vested restricted stock to satisfy tax withholding requirements, at an average price per share of $42.18 , for an aggregate purchase price of approximately $14,629 . +Note K - Derivative Instruments +The Company uses derivative instruments, specifically, forward foreign exchange contracts, to manage the risk associated with the volatility of future cash flows. The forward foreign exchange contracts will be used to mitigate the impact of exchange rate fluctuations on forecasted purchases of inventory and are designated as cash flow hedging instruments. The Company enters into forward contracts with terms of no more than two years. As of December 31, 2017 , $623 of losses related to cash flow hedges are recorded in accumulated other comprehensive income, net of taxes and are expected to be recognized in earnings at the same time the hedged items affect earnings. As of December 31, 2017 , the fair value of the Company's foreign currency derivatives, which is included on the Consolidated Balance Sheet in accrued expenses, was $783 . As of December 31, 2016 , $191 of gains related to cash flow hedges were recorded in accumulated other comprehensive income, net of taxes and were recognized in earnings at the same time the hedged items affected earnings. As of December 31, 2017 and 2016 , none of the Company's hedging activities were considered ineffective and thus no gains and losses relating to ineffectiveness on its hedging activities were recognized in the Consolidated Statements of Income. For the year ended December 31, 2017 losses of $57 were reclassified from accumulated other comprehensive income and recognized in the Consolidated Statements of Income in cost of sales as compared to losses of $472 for the year ended December 31, 2016 . +F-25 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note L - Operating Leases +The Company leases office, showroom, warehouse and retail facilities under noncancelable operating leases with terms expiring at various dates through 2030. Future minimum annual lease payments under noncancelable operating leases consist of the following at December 31: +2018 +$ +44,629 +2019 +40,510 +2020 +38,005 +2021 +32,440 +2022 +26,720 +Thereafter +66,972 +Total +$ +249,276 +A majority of the retail store leases provide for contingent rental payments if gross sales exceed certain targets. In addition, many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes. Rent expense for the years ended December 31, 2017 , 2016 and 2015 was approximately $ 56,027 , $ 52,294 and $ 47,710 , respectively. Included in such amounts are contingent rents of $ 424 , $ 238 and $ 157 in 2017 , 2016 and 2015 , respectively. +Rent expense is calculated by amortizing total base rental payments (net of any rental abatements, construction allowances and other rental concessions), on a straight-line basis, over the lease term. Accordingly, rent expense charged to operations differs from rent paid resulting in the Company recording deferred rent. +Note M - Income Taxes +The components of income before income taxes are as follows: +2017 +2016 +2015 +Domestic +$ +124,472 +$ +110,526 +$ +81,785 +Foreign +47,855 +60,474 +90,681 +$ +172,327 +$ +171,000 +$ +172,466 +The components of provision for income taxes for all periods presented were as follows: +F-26 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note M - Income Taxes (continued) +2017 +2016 +2015 +Current: +Federal +$ +56,836 +$ +47,655 +$ +24,838 +State and local +5,746 +6,063 +4,136 +Foreign +10,773 +3,270 +13,960 +73,355 +56,988 +42,934 +Deferred: +Federal +(22,061 +) +(7,050 +) +16,976 +State and local +800 +153 +1,961 +Foreign +1,095 +(365 +) +(3,060 +) +(20,166 +) +(7,262 +) +15,877 +$ +53,189 +$ +49,726 +$ +58,811 +On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law making significant changes to the Internal Revenue Code of 1986, as amended. Changes include, but are not limited to, a reduction in the U.S. corporate statutory tax rate from 35% to 21% effective for tax years beginning after December 31, 2017, the transition from a worldwide tax system to a territorial regime, and a one-time transition tax on the deemed repatriation of cumulative foreign earnings as of December 31, 2017. The Company has calculated its best estimate of the impact of the Tax Act in its year end income tax provision in accordance with its understanding of the Tax Act and guidance available as of the filing of this Annual Report on Form 10-K, and as a result recorded $7,599 as an additional net income tax benefit in the fourth quarter of 2017, the period in which the legislation was enacted. The provisional amount related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future resulted in a $2,315 expense. The provisional amount, comprised of a one-time transition tax on the mandatory deemed repatriation of foreign earnings, resulted in a $9,914 benefit (consisting of a $21,994 tax expense, offset by a $31,908 tax benefit from reversal of existing deferred tax liability on unremitted earnings of foreign subsidiaries) based on cumulative foreign earnings of $310,134 . In accordance with Staff Accounting Bulletin No. 118, any adjustments to these provisional amounts will be reported as a component of the Income Tax Provision (Benefit) during the reporting period in which any such adjustments are determined, all of which will be reported no later than the fourth quarter of 2018. The Company continues to evaluate the impacts of the Tax Act on its indefinite reinvestment assertion, as further discussed below. +The Company is subject to the provisions of the FASB ASC 740-10, Income Taxes, which requires that the effect on deferred tax assets and liabilities of a change in tax rates be recognized in the period the tax rate change was enacted. However, in December of 2017, the SEC staff issued Staff Accounting Bulletin 118 which provides that companies that have not completed their accounting for the effects of the Tax Act but can determine a reasonable estimate of those effects should include a provisional amount based on their reasonable estimate in their financial statements. The Company, as explained below, has made reasonable estimates in order to account for the effects of the Tax Act. +Although the $7,599 net benefit represents what the Company believes is a reasonable estimate of the impact of the income tax effects of the Tax Act as of December 31, 2017, it should be considered provisional. In light of the complexity of the Tax Act, the Company anticipates additional interpretive guidance from the U.S. Treasury and adjustments during the one year measurement period are probable. Once the Company finalizes certain tax positions when it files its 2017 U.S. tax return it will be able to conclude whether any further adjustments are required to its deferred tax balances in the U.S., as well as to the total liability associated with the one-time mandatory tax. +F-27 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note M - Income Taxes (continued) +A reconciliation between taxes computed at the Federal statutory rate and the effective tax rate is as follows: +December 31, +2017 +2016 +2015 +Income taxes at federal statutory rate +35.0 +% +35.0 +% +35.0 +% +Effects of foreign operations +(4.5 +) +(5.3 +) +(3.6 +) +Stock-based compensation +(2.2 +) +(3.0 +) +— +State and local income taxes - net of federal income tax benefit +2.0 +2.0 +1.7 +Nondeductible items +0.5 +0.2 +0.1 +Impact of tax reform +(4.4 +) +— +— +Receivable Adjustment +2.7 +— +— +Other +1.8 +0.2 +0.9 +Effective rate +30.9 +% +29.1 +% +34.1 +% +The components of deferred tax assets and liabilities are as follows: +December 31, +2017 +2016 +Deferred taxes assets +Receivable allowances +7,315 +8,800 +Inventory +901 +2,202 +Unrealized loss +321 +177 +Accrued expenses +1,796 +751 +Deferred compensation +11,071 +17,569 +Deferred rent +3,737 +5,327 +Net carryforwards +300 +1,172 +Other +3,842 +3,515 +Gross deferred tax assets +29,283 +39,513 +Deferred tax liabilities +Depreciation and amortization +(16,210 +) +(19,264 +) +Unremitted earnings of foreign subsidiaries +(2,422 +) +(31,262 +) +Amortization of goodwill +(7,883 +) +(6,640 +) +Gross deferred tax liabilities +(26,515 +) +(57,166 +) +Net deferred tax assets (liabilities) +$ +2,768 +$ +(17,653 +) +F-28 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note M - Income Taxes (continued) +The Company applies the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. +In accordance with accounting guidance, the Company has opted to classify interest and penalties that would accrue according to the provisions of relevant tax law as income tax expense on the Consolidated Statements of Income. The Company determines the amount of interest expense to be recognized by applying the applicable statutory rate of interest to the difference between the tax position recognized and the amount previously taken or expected to be taken on a tax return. The Company's tax years 2014 through 2017 remain open to examination by most taxing authorities. During 2017, the U.S. Internal Revenue Service ("IRS") completed its audit of the Company's 2014 U.S. income tax return. The Company does not have any material unrecognized tax benefits recorded as of December 31, 2017 and 2016. +The Company's consolidated financial statements provide for any related tax liability on amounts that may be repatriated from foreign operations, aside from undistributed earnings of certain of the Company's foreign subsidiaries that are intended to be indefinitely reinvested in operations outside the U.S. The deferred tax liability of $2,422 at December 31, 2017 reflects the withholding and state and local tax on amounts that may be repatriated from foreign operations. The Company continues to analyze the impact of the Tax Act on its indefinite reinvestment assertion, and as of December 31, 2017 has recorded a provisional estimate for the potential taxes related to the one-time mandatory tax. +Note N – Commitments, Contingencies and Other +[1] Legal Proceedings: +In the ordinary course of business, the Company has various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on the Company's financial condition, results of operations or cash flows. It is the policy of management to disclose the amount or range of reasonably possible losses in excess of recorded amounts. +[2] Employment agreements: +Edward R. Rosenfeld. On December 31, 2015, the Company entered into a new employment agreement with Edward R. Rosenfeld, the Company's Chief Executive Officer and the Chairman of the Board of Directors, to replace an existing employment agreement that expired on December 31, 2015. The agreement, which expires on December 31, 2018, provides for an annual salary of $ 900 in 2018. In addition, pursuant to his new employment agreement, on December 31, 2015, Mr. Rosenfeld received a grant of 75,000 shares of the Company's common stock subject to certain restrictions and, on February 5, 2016, a further grant of 75,000 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Rosenfeld on December 31, 2015 and February 5, 2016 were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a five -year period commencing on December 1, 2016 and March 5, 2017, respectively. Additional compensation and bonuses, if any, are at the sole discretion of the Board of Directors. +Steven Madden. On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s then existing employment agreement with the Company. The amended agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides, +among other things, for a base salary of approximately $7,026 per annum for the period between January 1, 2016 through the expiration of the term of employment. Also under the amended agreement, Mr. Madden received the right, exercisable on certain specified dates in fiscal year 2012 only, to elect to receive a grant of restricted stock for a number of shares of the Company’s common stock valued at $40,000 in consideration for certain specified reductions in his annual base salary +F-29 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +in years subsequent to 2012. Mr. Madden exercised this right and, on July 3, 2012, he was granted 1,893,342 restricted shares of the Company's common stock at the then market price of $21.13 , which shares vest in the same manner as the February 8, 2012 restricted stock grant received by Mr. Madden pursuant to the amended agreement. (See Note N to the Consolidated Financial Statements.) Further, in addition to the opportunity for cash bonuses at the sole discretion of the Board of Directors, Mr. Madden’s amended agreement entitles him to an annual life insurance premium payment as well as an annual stock option grant. The amended agreement also provides Mr. Madden the potential for an additional one-time stock option award for 750,000 shares of the Company’s common stock (the “EPS Option”) in the event that the Company achieves earnings per share on a fully-diluted basis equal to $2.00 as to any fiscal year ending December 31, 2015 or thereafter, which performance criteria was achieved for the fiscal year ended December 31, 2016 and, as such. on March 1, 2017, Mr. Madden was granted the EPS Option at an exercise price of $37.35 per share. The EPS Option vests in equal annual installments over a five -year period commencing on the first anniversary of the grant date. +Arvind Dharia. On February 2, 2015, the Company and its Chief Financial Officer, Arvind Dharia, entered into an amendment of Mr. Dharia's existing employment agreement. The amendment, among other things, increased his annual base salary to $ 582 effective January 1, 2015 through the remainder of the term of the employment agreement, which ends on December 31, 2018. Pursuant to the amendment, on February 2, 2015, Mr. Dharia received a restricted stock award of 15,000 restricted shares of the Company's common stock, which vests in substantially equal annual installments over a five -year period commencing on February 2, 2016 through February 2, 2020. The agreement, as amended, provides for an annual bonus to Mr. Dharia at the discretion of the Board of Directors. +Amelia Newton Varela. On December 30, 2016, the Company entered into a new employment agreement with Amelia Newton Varela, the Company’s President and a member of the Board of Directors of the Company, to replace an existing employment agreement that expired on December 31, 2016. The agreement, which remains in effect through December 31, 2019, provides for an annual salary of $650 in 2018 and $670 in 2019. In addition, pursuant to her new employment agreement, on January 3, 2017, Ms. Varela was granted an option to purchase 100,000 shares of the Company's common stock at an exercise price of $35.75 . The option, which was granted under the Company’s 2006 Stock Incentive Plan, as amended, vests in four equal annual installments on each anniversary of the date of grant, commencing on January 3, 2018. The agreement provides to Ms. Varela the opportunity for an annual performance-based bonus for the fiscal years ended December 31, 2017, 2018 and 2019. +Awadhesh Sinha. On December 30, 2016, the Company entered into a new employment agreement with Awadhesh Sinha, the Company's Chief Operating Officer, to replace an existing employment agreement that expired at the end of 2016. The new agreement, which remains in effect through December 31, 2019, provides for an annual salary of $ 702 , and $ 723 for the years ended December 31, 2018, and 2019, respectively, and provides to Mr. Sinha the opportunity for annual cash and share based incentive bonuses. In addition, pursuant to his new employment agreement, on January 3, 2017, Mr. Sinha received a grant of 28,169 shares of the Company's common stock subject to certain restrictions. The restricted +shares received by Mr. Sinha were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a three -year period on each of December 15, 2017, December 15, 2018, and December 15, 2019. +Karla Frieders. On April 11, 2017, the Company entered into a new employment agreement with Karla Frieders, the Company’s Chief Merchandising Officer, to replace an existing employment agreement which expired on February 28, +2017. The agreement, which remains in effect through April 30, 2020, provides to Ms. Frieders an annual salary of $550 for the period commencing on April 11, 2017 and ending on April 30, 2018; $570 for the period commencing on May 1, 2018 and ending on April 30, 2019; and $590 for the period commencing on May 1, 2019 and ending on April 30, 2020; and an annual performance-based bonus for the fiscal years ending December 31, 2017, 2018 and 2019 in an amount to be determined at the discretion of the Company. In addition, pursuant to her new employment agreement, on April 11, 2017, Ms. Frieders received a grant of 20,000 shares of the Company's common stock subject to certain restrictions. The +restricted shares received by Ms. Frieders were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a five-year period commencing on April 1, 2018 and ending on April 1, 2022. +F-30 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +Michael Paradise. On April 5, 2016, the Company entered into a new employment agreement with Michael Paradise, the Company's Executive Vice President - Legal Counsel. The agreement, which remains in effect through December 31, 2018, provides to Mr. Paradise an annual salary of $400 subject to periodic increases as determined by the Board of Directors, and an annual performance-based bonus for the fiscal years ending December 31, 2016, December 31, 2017 and December 31, 2018 in an amount to be determined at the discretion of the Company. The agreement also provides Mr. Paradise with a signing bonus in the amount of $250 . In addition, pursuant to his employment agreement, on June +1, 2016, Mr. Paradise received a grant of 7,217 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Paradise were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a four -year period commencing on June 1, 2017 and ending on June 1, 2020. +[3] Letters of credit: +At December 31, 2017 , the Company had no open letters of credit for the purchase of imported merchandise. +[4] License agreements: +On January 30, 2017, the Company acquired all of the outstanding capital stock of Schwartz & Benjamin, which holds licenses to manufacture, market and sell footwear with the Kate Spade® and Avec Les Filles® trademarks. The license agreements require Schwartz & Benjamin to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The license agreements extend through December 31, 2020. +In August 2017, the Company entered into a license agreement with Donna Karan Studio LLC for the right to manufacture, market and sell women's belts with the DKNY® and Donna Karan® brands. The agreement, unless extended, expires on December 31, 2020. The agreement requires that the Company pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. +On March 1, 2014, the Company entered into a license agreement with ABG Juicy Couture, LLC, under which the Company has the right to use the Juicy Couture® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The agreement terminated on December 31, 2017. +On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A, under which the Company has the right to use the Superga® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The agreement was amended on April 11, 2013 to extend the term of the agreement through December 31, 2022. +Future minimum royalty payments are $4,078 for 2018, $10,060 for 2019 through 2020 and $2,000 for 2021 through 2022. Royalty expenses are included in the “cost of goods sold” section of the Company's Consolidated Statements of Income. +[5] Concentrations: +The Company maintains cash and cash equivalents with various major financial institutions which at times are in excess of the amount insured. In addition, the Company's marketable securities are principally held at three brokerage companies . +F-31 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note N – Commitments, Contingencies and Other (continued) +During the year ended December 31, 2017 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2017 were approximately 93% . +During the year ended December 31, 2016 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2016 were approximately 87% . +During the year ended December 31, 2015 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2015 were approximately 90% . +For the year ended December 31, 2017 , Target Corporation represented 13.4% of total accounts receivable and Wal-Mart Stores, Inc. represented 14.6% of total accounts receivable. The Company did not have customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +For the year ended December 31, 2016 , Target Corporation represented 12.0% of net sales and 16.9% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +For the year ended December 31, 2015 , Target Corporation represented 12.2% of net sales and 16.7% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or 10% of total accounts receivable. +Purchases are made primarily in United States dollars. +[6] Valuation and qualifying accounts: +The following is a summary of the allowance for chargebacks and doubtful accounts related to accounts receivable and the allowance for chargebacks related to the amount due from factor: +Balance at Beginning of Year +Additions +Deductions +Balance at End of Year +Year ended December 31, 2017 +Allowance for doubtful accounts +$ +144 +$ +15,070 +$ +14,598 +$ +616 +Allowance for chargebacks +19,138 +83,076 +76,766 +25,448 +Returns +2,549 +8,750 +9,177 +2,122 +Year ended December 31, 2016 +Allowance for doubtful accounts +200 +5 +61 +144 +Allowance for chargebacks +19,040 +67,649 +67,551 +19,138 +Returns* +4,822 +5,169 +7,442 +2,549 +Year ended December 31, 2015 +Allowance for doubtful accounts +203 +162 +165 +200 +Allowance for chargebacks +18,199 +76,085 +75,244 +19,040 +Returns* +$ +5,160 +$ +5,868 +$ +6,206 +$ +4,822 +* The return reserve does not take into consideration the Company's ability to resell returned products. +F-32 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note O – Operating Segment Information +The Company operates the following business segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. The Wholesale Footwear segment, through sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores, derives revenue, both domestically and worldwide (via our International business), from sales of branded and private label women’s, men’s, girls’ and children’s footwear. The Wholesale Accessories segment, which includes branded and private label handbags, belts and small leather goods as well as cold weather and selected other fashion accessories, derives revenue, both domestically and worldwide (via our International business), from sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores. Our Wholesale Footwear and Wholesale Accessories segments, through our International business, derive revenue from Albania, Austria, Belgium, Bulgaria, Canada, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, Mexico, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden, Switzerland, and Tunisia and, under special distribution arrangements in various other territories within Asia, Europe (excluding the aforementioned nations), the Middle East, India, South and Central America and New Zealand. The Retail segment, through the operation of Company-owned retail stores in the United States, Canada and Mexico, our joint ventures in South Africa, China and Taiwan and the Company’s websites, derives revenue from sales of branded women’s, men’s and children’s footwear, accessories and licensed products to consumers. The First Cost segment represents activities of a subsidiary that earns commissions and design fees for serving as a buying agent of footwear products to mass-market merchandisers, mid-tier department stores and other retailers with respect to their purchase of footwear. In the Licensing segment, the Company generates revenue by licensing its Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, this segment licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. The Licensing segment also licenses the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +F-33 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note O – Operating Segment Information (continued) +Year ended +Wholesale Footwear +Wholesale Accessories +Total Wholesale +Retail +First Cost +Licensing +Consolidated +December 31, 2017: +Net sales +$ +1,017,557 +$ +256,295 +$ +1,273,852 +$ +272,246 +$ +— +$ +— +$ +1,546,098 +Gross profit +332,367 +80,729 +413,096 +164,645 +— +— +577,741 +Commissions and licensing fees – net +— +— +— +— +5,159 +9,100 +14,259 +Income from operations +133,014 +23,637 +156,651 +(1,126 +) +5,159 +9,100 +169,784 +Depreciation and amortization +11,287 +9,645 +457 +— +21,389 +Segment assets +$ +784,334 +$ +138,720 +923,054 +122,111 +11,996 +— +1,057,161 +Capital expenditures +$ +5,590 +$ +9,185 +$ +— +$ +— +$ +14,775 +December 31, 2016: +Net sales +$ +881,864 +$ +254,931 +$ +1,136,795 +$ +262,756 +$ +— +$ +— +$ +1,399,551 +Gross profit +279,835 +84,422 +364,257 +157,726 +— +— +521,983 +Commissions and licensing fees – net +— +— +— +— +3,728 +8,060 +11,788 +Income from operations +110,039 +31,562 +141,601 +15,787 +3,728 +8,060 +169,176 +Depreciation and amortization +11,734 +9,087 +281 +— +21,102 +Segment assets +$ +648,738 +$ +186,075 +834,813 +118,168 +7,894 +— +960,875 +Capital expenditures +$ +5,990 +$ +9,907 +$ +— +$ +— +$ +15,897 +December 31, 2015 +Net sales +$ +898,363 +$ +266,564 +$ +1,164,927 +$ +240,312 +$ +— +$ +— +$ +1,405,239 +Gross profit +265,822 +88,361 +354,183 +146,309 +— +— +500,492 +Commissions and licensing fees – net +— +— +— +— +6,713 +9,852 +16,565 +Income from operations +104,836 +32,612 +137,448 +17,635 +6,713 +9,852 +171,648 +Depreciation and amortization +12,624 +7,897 +236 +— +20,757 +Segment assets +$ +604,015 +$ +187,895 +791,910 +106,823 +15,652 +— +914,385 +Capital expenditures +$ +7,237 +$ +12,222 +$ +— +$ +— +$ +19,459 +Revenues by geographic area are as follows: +Year Ended December 31, +2017 +2016 +2015 +Domestic (a) +$ +1,383,841 +$ +1,258,973 +$ +1,255,709 +International +162,257 +140,578 +149,530 +Total +$ +1,546,098 +$ +1,399,551 +$ +1,405,239 +(a) Includes revenues of $329,107, $312,491 and $331,481 for the years ended 2017, 2016 and 2015 related to sales to U.S. customers where the title is transferred outside the U.S. and the sale is recorded by our International subsidiary. +F-34 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note P - Quarterly Results of Operations (unaudited) +The following is a summary of the quarterly results of operations for the years ended December 31, 2017 and 2016 : +March 31, +June 30, +September 30, +December 31, +2017: +Net sales +$ +366,387 +$ +374,148 +$ +441,193 +$ +364,370 +Cost of sales +233,669 +234,751 +275,303 +224,634 +Gross profit +132,718 +139,397 +165,890 +139,736 +Commissions, royalty and licensing fee income - net +3,927 +2,166 +4,745 +3,421 +Net income attributable to Steven Madden, Ltd. +$ +20,158 +$ +28,964 +$ +44,229 +$ +24,597 +Net income per share: +Basic +$ +0.36 +$ +0.53 +$ +0.81 +$ +0.45 +Diluted +$ +0.35 +$ +0.50 +$ +0.77 +$ +0.43 +2016: +Net sales +$ +329,357 +$ +325,402 +$ +408,384 +$ +336,408 +Cost of sales +213,155 +204,357 +253,876 +206,180 +Gross profit +116,202 +121,045 +154,508 +130,228 +Commissions, royalty and licensing fee income - net +2,171 +2,826 +5,358 +1,529 +Net income attributable to Steven Madden, Ltd. +$ +23,659 +$ +24,737 +$ +43,767 +$ +28,748 +Net income per share: +Basic +$ +0.41 +$ +0.43 +$ +0.77 +$ +0.51 +Diluted +$ +0.39 +$ +0.41 +$ +0.74 +$ +0.49 +Note Q - Recent Accounting Pronouncements +Recently Adopted +In January 2017, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update 2017-04 ("ASU 2017-04"), "Simplifying the Test for Goodwill Impairment." ASU 2017-04 changes the methodology of applying the quantitative approach during interim or annual impairment testing. The guidance is effective in fiscal years beginning after December 15, 2020 with early adoption permitted. The Company adopted the provisions of ASU 2017-04 in the second quarter of 2017; the adoption did not have a material impact on the Company's financial statements. +In July 2015, the FASB issued Accounting Standards Update 2015-11 ("ASU 2015-11"), "Inventory (Topic 330): Simplifying the Measurement of Inventory", which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. ASU 2015-11 defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company adopted the provisions of ASU 2015-11 in the first quarter of 2017; the adoption did not have a material impact on the Company's financial statements. +In November 2015, the FASB issued Accounting Standards Update 2015-17 ("ASU 2015-17"), "Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes." ASU 2015-17 simplifies current guidance and requires companies to classify all deferred tax assets and liabilities as noncurrent on the balance sheet. The Company adopted the provisions of ASU 2015-17 in the first quarter of 2017 under the retrospective approach and, as such, the Company reclassified $13,985 of deferred taxes from current to non-current on our balance sheet as of December 31, 2016. +F-35 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note Q - Recent Accounting Pronouncements (continued) +Not Yet Adopted +In February 2018, the FASB issued Accounting Standards Update No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”), which allows for stranded tax effects in accumulated other comprehensive income resulting from the U.S. Tax Cuts and Jobs Act to be reclassified to retained earnings. ASU 2018-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of adopting the new standard and does not expect the new standard to have a material impact on the Company’s financial position or results of operations. +In August 2017, the FASB issued Accounting Standards Update 2017-12 ("ASU 2017-12"), "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 changes the recognition and presentation requirements of hedge accounting. The guidance provides new alternatives for applying hedge accounting to additional hedging strategies and measuring the hedged item in fair value hedges of interest rate risk, as well as applies new alternatives for reducing the cost and complexity of applying hedge accounting by easing the requirements for effectiveness testing, hedge documentation and application of the critical terms match method, and reducing the risk of material error correction if a company applies the shortcut method inappropriately. The guidance is effective for annual and interim periods in fiscal years beginning after December 15, 2018 and early adoption is permitted any time after the issuance of the ASU, including in an interim period. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures. +In August 2016, the FASB issued Accounting Standards Update 2016-15 ("ASU 2016-15"), "Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 clarifies how certain cash receipts and payments should be presented in the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years with early adoption permitted. We will adopt the guidance when it becomes effective in the first quarter of 2018; the guidance is not expected to have a material impact on our financial statements. +In June 2016, the FASB issued Accounting Standards Update 2016-13 ("ASU 2016-13"), "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the +effect that the new guidance will have on its financial statements and related disclosures. +In February 2016, the FASB issued Accounting Standards Update No. 2016-02 ("ASU 2016-02"), "Leases," which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. Under ASU 2016-02, lessees will be required to recognize for all leases with terms longer than twelve months, at the commencement date of the lease, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right-to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures and, although the analysis is not complete, it is expected to have a material impact on the consolidated financial statements. +In January 2016, the FASB issued Accounting Standards Update 2016-01 ("ASU 2016-01"), "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." ASU 2016-01 generally requires companies to measure investments in equity securities, except those accounted for under the equity method, at fair value and recognize any changes in fair value in net income. The new guidance must be applied using a modified-retrospective approach and is effective for periods beginning after December 15, 2017 and early adoption is not permitted. We will adopt the guidance when it becomes effective in the first quarter of 2018; the guidance is not expected to have a material impact on our financial statements. +In May 2014, the FASB issued new accounting guidance, Accounting Standards Update No. 2014-09 ("ASU 2014-09"), "Revenue from Contracts with Customers," on revenue recognition. The new standard provides for a single five-step model to be applied to +F-36 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2017, 2016 and 2015 +($ in thousands, except share and per share data) +Note Q - Recent Accounting Pronouncements (continued) +all revenue contracts with customers as well as requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2017, and the Company plans to adopt the provisions of the new standard in the first quarter of 2018 using the cumulative effect adjustment approach. The Company is utilizing a comprehensive approach to assess the impact of the guidance on each of our operating segments' revenue streams, including assessment of our performance obligations, principal versus agent considerations and variable consideration. Additionally, the Company is evaluating the impact of the new guidance on disclosures, as well as the impact on controls to support the recognition. Based on the foregoing, at the current time the Company does not believe the adoption to have a material impact on its consolidated financial statements as the Company’s current revenue recognition policies are in-line with the principles of the new guidance. +F-37 +Exhibit Index +2.1 +Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 31, 2017). +2.2 +First Amendment to Equity Purchase Agreement, dated November 21, 2017, to Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers † +3.01 +Certificate of Incorporation of Steven Madden, Ltd. (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +3.02 +Amended & Restated By-Laws of Steven Madden, Ltd. (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on March 28, 2008) +4.01 +Specimen Certificate for shares of Common Stock (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +10.01 +Third Amended and Restated Secured Promissory Note dated as of June 25, 2007 of Steven H. Madden to the Company (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 9, 2012) +10.02 +First Allonge to Third Amended and Restated Secured Promissory Note made as of April 8, 2016 between the Company and Steven H. Madden (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.03 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2010 filed with the SEC on November 9, 2010) +10.04 +Amendment to Collection Agency Agreement dated February 16, 2010 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2010 filed with the SEC on March 12, 2010) +10.05 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Daniel Friedman & Associates, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.06 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Diva Acquisition Corp. (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.07 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Steven Madden Retail, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.08 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Stevies, Inc. (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.09 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and SML Acquisition Corp. (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.10 +Letter Agreement dated July 10, 2009 among Rosenthal & Rosenthal, Inc., the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.11 +Guarantee dated July 10, 2009 of the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. in favor of Rosenthal & Rosenthal, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.12 +Third Amended Employment Agreement dated July 15, 2005 between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 20, 2005) +10.13 +Amendment dated December 14, 2009 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 17, 2009) +10.14 +Amended and Restated Second Amendment dated as of December 31, 2011 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2011 filed with the SEC on February 29, 2012) +10.15 +Third Amendment dated April 8, 2016 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.16 +Employment Agreement dated January 1, 1998 between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.07 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2000 filed with the SEC on March 30, 2001)# +10.17 +Amendment No. 1 dated June 29, 2001 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 99.4 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended June 30, 2001 filed August 14, 2001)# +10.18 +Amendment No. 2 dated October 30, 2002 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2002 filed with the SEC on November 14, 2002)# +10.19 +Amendment No. 3 dated February 1, 2006 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 3, 2006)# +10.20 +Amendment No. 4 dated October 7, 2009 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on October 13, 2009)# +10.21 +Amendment No. 5 dated February 8, 2012 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 14, 2012)# +10.22 +Amendment No. 6 dated February 2, 2015 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 4, 2015)# +10.23 +Amendment No. 7 dated as of May 15, 2017 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.24 +Employment Agreement dated December 30, 2016 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2017)# +10.25 +First Amendment dated as of May 15, 2017 to Employment Agreement dated as of December 30, 2016 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.26 +Employment Agreement dated December 30, 2016 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2017)# +10.27 +First Amendment dated as of May 15, 2017 to Employment Agreement dated December 30, 2016 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.28 +Employment Agreement dated April 11, 2017 between the Company and Karla Frieders (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended March 31, 2017 filed with the SEC on May 9, 2017)# +10.29 +Employment Agreement dated December 31, 2015 between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2016)# +10.30 +First Amendment dated May 16, 2016 to Employment Agreement dated December 31, 2015 between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2016)# +10.31 +Employment Agreement dated April 5, 2016 between the Company and Michael Paradise (incorporated by reference to Exhibit 10.29 to the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2016 filed with the SEC on February 28, 2017)# +10.32 +First Amendment dated as of May 15, 2017 to Employment Agreement dated April 5, 2016 between the Company and Michael Paradise (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.33 +2006 Stock Incentive Plan (Amended and Restated Effective May 22, 2009), amended by the Board of Directors of the Company on April 5, 2012 and approved and adopted by the Company's stockholders on May 25, 2012 (incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 1, 2013)# +21.01 +Subsidiaries of the Registrant† +23.01 +Consent of EisnerAmper LLP† +24.01 +Power of Attorney (included on signature page hereto) +31.01 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +31.02 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +32.01 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +32.02 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +99.01 +Press Release, dated February 27, 2018, issued by Steven Madden, Ltd.† +101 +The following materials from Steven Madden, Ltd.'s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.* +† +Filed herewith. +# +Indicates management contract or compensatory plan or arrangement required to be identified pursuant to Item 15(b) of this Annual Report on Form 10-K. +* +This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Company specifically incorporates it by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2017/0001628280-18-002589/filing_metadata.csv b/raw/filings/0000913241/2017/0001628280-18-002589/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..91738dc494b7afa2342e0fed635e94451abd28ec --- /dev/null +++ b/raw/filings/0000913241/2017/0001628280-18-002589/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000913241,SHOO,"STEVEN MADDEN, LTD.",10-K,2018-03-01,2017-12-31,2018-03-01T16:17:23.000Z,0001628280-18-002589,shoo-20171231x10k.htm,10-K,11827141,1,0,https://www.sec.gov/Archives/edgar/data/913241/000162828018002589/shoo-20171231x10k.htm,https://www.sec.gov/Archives/edgar/data/913241/000162828018002589/,2017,2017,1 diff --git a/raw/filings/0000913241/2017/0001628280-18-002589/item1.txt b/raw/filings/0000913241/2017/0001628280-18-002589/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..86bec02022342f471e062f7be6700853486593dc --- /dev/null +++ b/raw/filings/0000913241/2017/0001628280-18-002589/item1.txt @@ -0,0 +1,154 @@ +ITEM 1. BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories. We also license some of our trademarks for use in connection with the manufacture, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico, our joint ventures in South Africa, China and Taiwan, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we have special distribution arrangements for the marketing of our products in Asia, Europe (excluding the aforementioned nations), India, the Middle East, South and Central America and New Zealand. We offer a broad range of updated styles designed to establish or complement and capitalize on market trends. We have established a reputation for design creativity and our ability to offer quality products in popular styles at affordable prices, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. The public may read and copy any materials filed by us with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information regarding the operation of the SEC's Public Reference Room is available by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +1 +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company and a Code of Business Conduct and Ethics that is applicable to all of our employees, each of which are attached as exhibits to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015 and posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Net sales for 2017 increased 10.5% to $1,546,098 from $1,399,551 in 2016 . Net income attributable to Steven Madden, Ltd. decreased 2.5% to $117,948 in 2017 compared to $120,911 in 2016 . Diluted earnings per share in 2017 increased to $2.04 per share on 57,830,000 diluted weighted average shares outstanding compared to $2.03 per share on 59,556,000 diluted weighted average shares outstanding in the prior year. +Recent Developments +On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act. The Tax Cuts and Jobs Act made broad and complex changes to the U.S. tax code which impacts 2017 in many ways, including, by reducing the U.S. federal corporate tax rate and imposing a one-time transition tax on certain undistributed earnings of foreign subsidiaries. See additional information regarding the impact of the Tax Cuts and Jobs Act in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” and Note M "Income Taxes" to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Madden NYC, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, FREEBIRD by Steven®, Stevies®, B Brian Atwood®, Blondo®, Kate Spade® (under license), Avec Les Filles® (under license), Alice & Olivia® (through a joint venture) and includes our International business and certain private label footwear business. The agreement with the Alice & Olivia® terminated on December 31, 2017. +Our Wholesale Accessories segment is comprised of Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Cejon®, B Brian Atwood®, Luv Betsey®, DKNY® (under license) and Donna Karan® (under license) accessories brands and also includes our International business and certain private label accessories business. +Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson and Dolce Vita e-commerce websites and comprises our Retail segment. +Our First Cost segment represents activities of one of our wholly-owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in the manufacture, marketing and sale of outerwear exclusively to Target. In addition, we license our Betsey Johnson® trademark for use in the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United +2 +States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared for young women ages 16 to 23, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +Steve Madden Men's. We design, source, and market a life style collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range in price from $70 to $150 at retail per pair. +Madden. T he Madden® brand is a denim friendly collection of footwear designed to meet the ever evolving needs of the trend conscious male consumer, ages 13 to 35 years old. Madden products range from $45 to $90 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal principally to fashion conscious women, ages 25 to 45, who shop at department stores, footwear boutiques and shopping networks. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12. Our Stevies® brand is sold exclusively to Target, while our products sold under Steve Madden Kids® brand are distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. +FREEBIRD by Steven . We design, source, and market a full collection of handcrafted, Goodyear welted boots. The designs are inspired by vintage Americana and created using time-honored craftsmanship. The FREEBIRD by Steven® collection conveys a unique fashion life style that transcends multiple generations. FREEBIRD by Steven® products are currently sold, at retail prices ranging from $195 to $450 per pair at major department stores, mid-tier retailers, and specialty boutiques. +Report. The Report® brand was acquired in our May 2011 acquisition of Topline Corporation ("Topline") and its subsidiaries. The Report® brand is a junior women's footwear brand with price points ranging from $20 to $150 per pair. We design, manufacture, market and sell our Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed exclusively to Target. +Dolce Vita. In August 2014, the Company acquired the Dolce Vita® and DV® brands and other intellectual property assets in the acquisition of Dolce Vita Holdings, Inc. Dolce Vita® is a contemporary women's footwear brand with price points ranging from $120 to $350 per pair. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. The DV® brand has price points ranging from $20 to $75 per pair and is currently distributed exclusively at Target. +3 +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand from Brian Atwood IP Company LLC. Founded in 2011, Brian Atwood is known for luxury shoes manufactured in Italy. We design, manufacture, market and sell our Brian Atwood branded products primarily to major department stores throughout the United States. +Blondo. In January 2015, the Company acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. +In January 2017, the Company acquired all of the issued and outstanding capital stock of Schwartz & Benjamin, Inc., a family-owned business that specialized in licensed brands and private label footwear. As a consequence of the acquisition, the Company acquired licenses to manufacture, market and sell footwear under the Kate Spade® and Avec Les Filles® trademarks as well as a design/manufacturing agreement with Rebecca Minkoff® and a joint venture with Alice & Olivia®. +Kate Spade. The Kate Spade® brand, known for its whimsical fashion, is an entry-level luxury footwear brand primarily distributed through department stores throughout the United States. The price points of footwear bearing the Kate Spade® brand range from $48 to $400 per pair with the core product price ranging from $198 to $298 per pair. +Avec Les Filles. The Avec Les Filles® brand is geared toward the millennial customer and is primarily distributed through department stores throughout the United States as well as online at core product prices ranging from $98 to $150 per pair. +Alice & Olivia. The Alice & Olivia® brand is a contemporary luxury footwear brand distributed primarily through department stores throughout the United States with core product prices ranging from $195 to $450 per pair. +Anne Klein. In January 2018, the Company entered into a license agreement with Nine West Development LLC for a license to use the Anne Klein® trademark in connection in the marketing and sale of footwear. Established in the U.S. in 1968, the Anne Klein® brand is recognized as being synonymous with American sportswear. +International Division. The International division, utilizing the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico, certain European nations, including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, the International division works through special distribution arrangements for the marketing and sales of our products in Asia, Europe (excluding the aforementioned nations), India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands (including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Madden NYC, Big Buddha®, B Brian Atwood®, DKNY® (under license), Donna Karan® (under license), Anne Klein® (under license beginning in 2018) and Luv Betsey® brands) and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our International distributor network. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon®, Steve Madden®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2017 , we owned and operated 206 retail stores including 138 Steve Madden full price stores, 60 Steve Madden outlet stores, three Steven stores, one Superga store and four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). In 2017 , we opened 13 new full price stores, six new outlet stores and closed two full price stores in the United States. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, China and Taiwan. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2017 and 2016 ) decreased 3.2% in fiscal year 2017 from the prior year. The Company excludes +4 +new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product development efforts of our two Wholesale segments. We expect to open 11 to 13 new retail stores and close 8 to 10 locations in 2018 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Kohl's, Sears and K-Mart. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note O to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new Steve Madden products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Steve Madden products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Steve Madden brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers in China, Italy, Brazil, Mexico, India, Vietnam, The Netherlands, The Dominican Republic and South Korea. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and +5 +incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California and New Jersey, also via truck from Mexico to our third party distribution facility in Texas, with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from five third-party distribution centers, three located in California, one located in Texas and one located in New Jersey. Our products are also distributed through two Company-operated distribution centers located in New Jersey and Canada. By utilizing distribution facilities specializing in distribution fulfillment to effect distribution to certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers include Target Corporation, Nordstrom, Inc., Macy's, Inc., The TJX Companies, Inc., Wal-Mart Stores, Inc., DSW, Inc., Ross Stores, Inc., Kohl's Corporation, Amazon.com, Inc. and Payless ShoeSource, Inc. For the year ended December 31, 2017 , Target Corporation represented 13.4% of total accounts receivable and Wal-Mart Stores, Inc. represented 14.6% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, China and Taiwan +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico, certain European nations including Albania, Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Kosovo, Latvia, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden and Switzerland, and Tunisia. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in South Africa, China and Taiwan, and on our e-commerce websites. For the year ended December 31, 2017 , our Retail segment and our two Wholesale segments generated net sales of approximately $272,246 and $1,273,852 , or 18% and 82% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2017 , we operated 138 Steve Madden full price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China and Taiwan. We also operated 60 Steve Madden outlet stores, three Steven stores and one Superga store within the United States. The Company also operated four e-commerce websites (Steve Madden, Superga, Betsey Johnson and Dolce Vita). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer +6 +profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell our products to over 2,500 doors of 17 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Macy's, Inc., Dillard's, Inc., Nordstrom, Inc., Belk, Inc. and Lord & Taylor. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at season's end. +National chains and mass merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Target Corporation, Wal-Mart Stores, Inc., Kohl's Corporation, and The J.C. Penney Company. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW, Inc., Famous Footwear, Journeys and Payless ShoeSource, Inc . We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's and Victoria's Secret. +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate four Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson and Dolce Vita) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Asia, certain European nations, India, the Middle East, South and Central America and New Zealand. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Jessica Simpson, Sam Edelman, Ugg and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +7 +Marketing and Sales +We have focused on creating an integrated brand building program to establish Steve Madden as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations including product and brand placements in life style and fashion magazines and digital outlets, as well as personal appearances by our founder and Creative and Design Chief, Steve Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, FREEBIRD by Steven, Superga, Betsey Johnson, Blondo and Dolce Vita, as well as selected styles of Madden Girl, footwear and accessory products, as well as view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our wholesale information system is an Enterprise Resource Planning (“ERP”) system. This integrated system supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. We completed the implementation of this new ERP system for our wholesale business in 2014 and implemented the system in three of our acquired businesses in 2015 and in two additional acquired businesses in 2016. In 2017, we completed the implementation of the ERP system for Asia first-cost and sourcing operations and for recently-acquired Schwartz & Benjamin. In 2014, we completed the implementation of a new warehouse management system that is utilized by our third-party logistics providers and, during 2015, implemented this warehouse management system in a company-owned warehouse. This warehouse management system is fully integrated with our ERP system. All of our North American wholesale businesses (other than Canada which has a separate ERP system) are now operating on this ERP system. In 2017, we completed the implementation of a new point of sale system for our U.S. retail stores that is integrated with a retail inventory management/store replenishment system. Complimenting all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +Intellectual Property +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 94 other countries and in numerous International Classes. From time to time we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +8 +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +R Design® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +DV® +LUV BETSEY plus Kiss Design® +Wild Pair® +LUV BETSEY by Betsey Johnson Design® +MadLove® +Blondo® +Betsey Johnson plus Kiss Logo® +Steve Madden plus Design® +Report Seattle® +Blondo Waterproof plus Heart Design® +R2® +SM New York® +Topline® +SM New York plus Design® +Dolcetta® +Madden Girl by Steve Madden® +DV8® +Steve Madden plus Heart Logo® +JD FISK® +Stevies plus Design® +B Blondo plus Design® +Big Buddha plus Design® +Studio B® +Big Buddha love big. Live Buddha plus Design® +Studio Blondo® +Betsey Johnson Too Too® +Blue By Betsey Johnson® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective out-licensing of our brands. As of December 31, 2017 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, and men’s leather accessories. We license the Stevies® trademark for use in connection with the manufacture, marketing and sale of outerwear exclusively to Target. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, stationary, umbrellas, and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we also in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +• +In August 2017, we entered into a license agreement with Donna Karan Studio LLC for the right to manufacture, market and sell women's belts with the DKNY® and Donna Karan® brands. The agreement, unless extended, expires on December 31, 2020. +• +In January 2017, we acquired all of the outstanding capital stock of Schwartz & Benjamin, Inc., and, as a consequence of the acquisition, acquired (i) licenses to manufacture, market and sell footwear under the Kate Spade® and Avec Les +9 +Filles® brands and (ii) a joint venture for the Alice & Olivia® brand. As of December 31, 2017, the Alice & Olivia® joint venture agreement was terminated. +• +Through a license agreement with Basic Properties America Inc. and BasicNet S.p.A, we have the right to use the Superga® trademark in connection with the marketing and sale of footwear through December 31, 2022. +See Notes A and N to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2018 , we employed approximately 3,884 employees, of whom approximately 2,497 work on a full-time basis and approximately 1,387 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,554 of our employees are located in the United States, approximately 709 employees are located in Hong Kong and China, approximately 353 employees are located in Canada, approximately 163 employees are located in Mexico, approximately 84 employees are located in South Africa and approximately 21 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales have occurred in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales have occurred in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Sales levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $367,101 and $337,000, as of February 1, 2018 and 2017 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. \ No newline at end of file diff --git a/raw/filings/0000913241/2017/0001628280-18-002589/item13.txt b/raw/filings/0000913241/2017/0001628280-18-002589/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..de747aafef2ef75d28ef93d48ca48fa833d0c0f2 --- /dev/null +++ b/raw/filings/0000913241/2017/0001628280-18-002589/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2018 Annual Meeting of Stockholders, and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2017/0001628280-18-002589/item9a.txt b/raw/filings/0000913241/2017/0001628280-18-002589/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..4aa4fa821425b05e08e120848033b0be3b8de9b3 --- /dev/null +++ b/raw/filings/0000913241/2017/0001628280-18-002589/item9a.txt @@ -0,0 +1,11 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2017 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2017 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2017 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2017 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000913241/2017/0001628280-18-002589/rp_note.txt b/raw/filings/0000913241/2017/0001628280-18-002589/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000913241/2017/0001628280-18-002589/rpt_disclosure.txt b/raw/filings/0000913241/2017/0001628280-18-002589/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..8e99ca76243989f8bcf68c10be1e9ee977dfa4d5 --- /dev/null +++ b/raw/filings/0000913241/2017/0001628280-18-002589/rpt_disclosure.txt @@ -0,0 +1,117 @@ +and Related Party Transactions +Steven +Madden Employment Agreement. The Company believes that Steven Madden, the Company’s founder and Creative and Design +Chief, provides unique and significant value in guiding the leadership of the Company’s creative process, both in his hands +on work for the Company and his collaboration with the Company’s designers, product professionals and marketing executives. +In addition, the public’s association of Mr. Madden’s name and likeness with our branded products is significant, +meaningful, and integral to the Company’s success and has been, and continues to be, instrumental in creating long-term +stockholder value. Based upon that belief, the Company further believes that his continuing involvement with the Company is essential +and to this end has for many years had an employment agreement with Mr. Madden as described below. +19 +Mr. +Madden’s agreement in its current form dates back to July 1, 2005, as subsequently amended on various occasions most recently +on March 25, 2019 (the “SM Employment Agreement”). Under the SM Employment Agreement, Mr. Madden has agreed to continue +to serve as the Company’s Creative and Design Chief for a term continuing through December 31, 2026, for a base salary of +$7,026,042 per annum together with the potential for cash bonuses at the sole discretion of the Company’s Board of Directors +and an annual life insurance premium reimbursement of up to $200,000. Pursuant to the SM Agreement, on February 8, 2012, Mr. Madden +was granted 2,194,584 restricted shares of Common Stock (the number of shares indicated having been adjusted for an October 11, +2018 three-for-two stock split effected as a stock dividend), valued at approximately $40 million, under the Company’s Amended +and Restated 2006 Stock Incentive Plan, which is referred to herein as the “2006 Plan,” vesting in equal annual installments +over seven years commencing on December 31, 2017 through December 31, 2023, subject to Mr. Madden’s continued employment +with the Company on each such vesting date. On June 30, 2012, as allowed under the SM Agreement, Mr. Madden elected to receive +an additional restricted stock award valued at approximately $40 million in consideration of a reduction in his annual base salary +in years subsequent to 2012 to the amount reflected above. As a consequence, on July 3, 2012, Mr. Madden received 2,840,013 restricted +shares of Common Stock vesting in six annual installments commencing on December 31, 2018 through December 31, 2023, again, subject +to his continued employment with the Company on each such vesting date. +Under +the SM Agreement, Mr. Madden is also eligible to receive annually, on or about the date of the Company’s annual meeting +of stockholders (but not later than June 30th), an option (the “Annual Option”) to purchase shares of Common Stock +equal to the greater of (a) 100% of the largest aggregate number of shares of Common Stock available upon the exercise of an option +or options granted to any other continuing full-time employee of the Company during the preceding twelve-month period and (b) +225,000 shares of Common Stock; provided, however, that a grant to Mr. Madden in excess of 150% of the number of shares of Common +Stock subject to options granted to such other continuing full-time employee would require stockholder approval. Any Annual Option +so granted vests quarterly over a one-year period and is exercisable at a price equal to the closing price of the Company’s +Common Stock on the grant date for a period of five years. In addition, pursuant to the SM Agreement, on March 1, 2017, Mr. Madden +received a one-time stock option grant to purchase 1,125,000 shares of the Company’s Common Stock at an exercise price of +$24.90 as a result of the Company having achieved for the fiscal year ended December 31, 2016 earnings per share performance criteria +set forth in the SM Agreement; such option vests in equal annual installments over a five-year period which commenced on the first +anniversary of the grant date. +Under +the SM Agreement, in the event of Mr. Madden’s death, his estate would receive a payment equal to his base salary for the +12-month period immediately subsequent to the date of his death. Further, in the event that Mr. Madden’s employment is terminated +due to his total disability (as defined in the agreement), “for cause” (as defined in the agreement) or due to Mr. +Madden’s resignation, the Company is obligated to pay Mr. Madden the amount of compensation that is accrued and unpaid through +the date of termination. In the event that Mr. Madden’s employment is terminated for any reason (other than “for cause” +or due to his death, total disability or resignation), the Company is obligated to pay Mr. Madden, in installments, the balance +of his base salary through the end of the term of the SM Agreement. If, during the period commencing 120 days prior to a “change +of control” transaction (as defined in the agreement) and ending on the first anniversary of a change of control transaction, +Mr. Madden’s employment is terminated other than for cause or by his resignation for “good reason” (as defined +in the agreement), or if Mr. Madden resigns for good reason or without good reason within 30 days following a change of control +transaction, all unvested options held by Mr. Madden will be accelerated and vest on the date of termination or resignation and +Mr. Madden will be entitled to receive a lump sum cash payment equal to the amount of compensation that is accrued and unpaid +through the date of termination plus $35 million. The SM Agreement contains other customary provisions, including provisions regarding +expense reimbursement, confidentiality, solicitation and competition. +For +the 2018 Fiscal Year, Mr. Madden earned $7,026,042 in base salary and received $200,000 for the payment of an annual life insurance +premium. Mr. Madden also received as his Annual Option for the 2018 Fiscal Year an option to purchase 225,000 shares of Common +Stock at a price per share of $35.95. +The +most recent amendment entered into on March 25, 2019, effected the extension of the term of the SM Agreement for three years through +December 31, 2026. In consideration of this extension, the Company has granted to Mr. Madden 200,000 shares of Common Stock under +the 2006 Plan, which shares are subject to certain restrictions including, without limitation, that the Employee will not sell, +transfer, pledge, hypothecate, assign or otherwise dispose of the restricted shares except as set forth under the 2006 Plan or +Mr. Madden’s award agreement. Vesting of the shares occurs in annual installments over three years commencing on December +31, 2024 on which date 66,666 shares will vest and continuing to vest thereafter on each of December 31, 2025 and December 31, +2026 when 66,667 shares will vest; provided, in each case, that Mr. Madden continues to be employed by the Company on each such +date through December 31, 2026. +20 +Loan +to Steven Madden. On June 25, 2007, the Company made a loan to Mr. Madden in the amount of $3,000,000, in order for Mr. Madden +to satisfy a personal tax obligation resulting from the exercise of a stock option which was due to expire and hold the underlying +shares of Common Stock. The loan is evidenced by a secured promissory note executed by Mr. Madden in favor of the Company, the +security for which is a security interest in a certain securities brokerage account maintained by Mr. Madden with his broker; +none of the securities in the securities brokerage account are shares of the Company’s Common Stock. There have been successive +amendments to the secured promissory note, the most recent of which occurred in April 2016, at which time the secured promissory +note was amended to substitute the collateral securing the secured promissory note from shares of the Company’s Common Stock +to the security interest in Mr. Madden’s securities brokerage account noted above. Previously, on January 3, 2012, the secured +promissory note was amended and restated to extend the maturity date of the obligation to December 31, 2023 and eliminate the +accrual of interest after December 31, 2011. Prior to the January 3, 2012 amendment, the secured promissory note had been accruing +interest at the rate of 6% per annum. In addition, the secured promissory note provides that, commencing on December 31, 2014 +and annually on each December 31 thereafter through the maturity date, one-tenth of the principal amount thereof, together with +accrued interest, will be cancelled by the Company provided that Mr. Madden continues to be employed by the Company on each such +December 31. Contemporaneously, on each such December 31, the Company will release its security interest in a portion of the securities +held in Mr. Madden’s securities brokerage account generally correlating to the amount of indebtedness cancelled on such +date. As of December 31, 2011, interest in the amount of $1,090,000 had accrued on the principal amount of the secured promissory +note and, as noted above, interest was eliminated after December 31, 2011. On December 31, 2018, the required one-tenth of the +principal amount of the secured promissory note, together with accrued interest, was written-off by the Company. +Review, Approval or Ratification +of Transactions with Related Persons +The +Company’s written Conduct Code and Employee Handbook prohibit all conflicts of interest. Under the Conduct Code, conflicts +of interest occur when private or family interests interfere in any way, or even appear to interfere, with the interests of the +Company. The Company’s prohibition on conflicts of interest under the Conduct Code includes any related person transaction. +Related +person transactions must be approved by the Board, or by a committee of the Board consisting solely of independent directors, +who will approve the transaction only if they determine that it is in the best interests of the Company. In considering the transaction, +the Board or committee will consider all relevant factors, including, as applicable, (i) the Company’s business rationale +for entering into the transaction; (ii) the alternatives to entering into a related person transaction; (iii) whether +the transaction is on terms comparable to those available to third parties or, in the case of employment relationships, to employees +generally; (iv) the potential for the transaction to lead to an actual or apparent conflict of interest and any safeguards +imposed to prevent such actual or apparent conflicts; and (v) the overall fairness of the transaction to the Company. +The +Company has multiple processes for reporting conflicts of interests, including related person transactions. Under the Conduct +Code, all employees are required to report any actual or apparent conflict of interest, or potential conflict of interest, to +management. The Chief Financial Officer distributes a questionnaire to the Company’s executive officers and management personnel +on a quarterly basis and distributes a questionnaire to the members of the Board of Directors on an annual basis requesting certain +information regarding, among other things, their immediate family members, employment and beneficial ownership interests, which +information is then reviewed for any conflicts of interest under the Conduct Code. +The +Board of Directors, the Audit Committee and the Disclosure Committee, which is comprised of management personnel, discuss the +related party transactions, specifically, and in connection with the regular review processes attendant to the Company’s +periodic filings, including related party transaction disclosures. +If +a director is a party to or in some manner involved in a transaction involving the Company, he or she will be recused from all +discussions and decisions about the transaction. The transaction must be approved in advance whenever practicable, and if not +practicable, must be ratified as promptly as practicable. +21 +COMPENSATION \ No newline at end of file diff --git a/raw/filings/0000913241/2018/0001628280-19-002264/filing.txt b/raw/filings/0000913241/2018/0001628280-19-002264/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..95383c481fa8fe6c6442a8570a27083e7f8e6b1a --- /dev/null +++ b/raw/filings/0000913241/2018/0001628280-19-002264/filing.txt @@ -0,0 +1,4347 @@ +10-K +1 +shoo-20181231x10k.htm +10-K +Document +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2018 +or +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ________ to ________ +Commission File Number 0-23702 +STEVEN MADDEN, LTD. +(Exact name of registrant as specified in its charter) +Delaware +13-3588231 +(State or other jurisdiction of +(I.R.S. Employer Identification No.) +incorporation or organization) +52-16 Barnett Avenue, Long Island City, New York 11104 +(Address of principal executive offices) (Zip Code) +(718) 446-1800 +(Registrant's Telephone Number, Including Area Code) +Securities Registered Pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Common Stock, par value $.0001 per share +The NASDAQ Stock Market LLC +Preferred Stock Purchase Rights +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes x No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act. +Yes o No x +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes x No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes x No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”,“smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer x +Accelerated filer o +Non-accelerated filer o (do not check if smaller reporting company) +Smaller reporting company o +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). +Yes o No x +The aggregate market value of the common equity held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and directors are “affiliates” of the registrant) as of June 29, 2018 , the last business day of the registrant's most recently completed second fiscal quarter, was $3,074,989,742 (based on the closing sale price of the registrant's common stock on that date as reported on The NASDAQ Global Select Market). +The number of outstanding shares of the registrant's common stock as of February 27, 2019 was 85,907,841 shares. +DOCUMENTS INCORPORATED BY REFERENCE: +PART III INCORPORATES CERTAIN INFORMATION BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT'S 2019 ANNUAL MEETING OF STOCKHOLDERS. +TABLE OF CONTENTS +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +1 +PART I +ITEM 1 BUSINESS +1 +ITEM 1A RISK FACTORS +9 +ITEM 1B UNRESOLVED STAFF COMMENTS +18 +ITEM 2 PROPERTIES +19 +ITEM 3 LEGAL PROCEEDINGS +20 +ITEM 4 MINE SAFETY DISCLOSURES +20 +PART II +ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER +MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +20 +ITEM 6 SELECTED FINANCIAL DATA +23 +ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION +AND RESULTS OF OPERATIONS +24 +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +34 +ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +35 +ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON +ACCOUNTING AND FINANCIAL DISCLOSURE +35 +ITEM 9A CONTROLS AND PROCEDURES +35 +ITEM 9B OTHER INFORMATION +36 +PART III +ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +36 +ITEM 11 EXECUTIVE COMPENSATION +36 +ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND +MANAGEMENT AND RELATED STOCKHOLDER MATTERS +36 +ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND +DIRECTOR INDEPENDENCE +37 +ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES +37 +PART IV +ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +37 +SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K contains “forward-looking statements” (as that term is defined in the federal securities laws), which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with regard to future revenue, projected 2019 results, earnings, spending, margins, cash flow, customer orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives and other future events. More generally, forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. Factors that may affect our results include, but are not limited to, the risks and uncertainties discussed in Item 1A of this Annual Report on Form 10-K. +Any such forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based and could cause our actual results to differ materially from those projected in forward-looking statements. As such, we strongly caution you that these forward-looking statements are not guarantees of future performance or events. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. +PART I +ITEM 1. BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories. We also license some of our trademarks for use in connection with the manufacturing, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico, our joint ventures in South Africa, China, Taiwan and Israel, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico, certain European nations and Tunisia. In addition, we have special distribution arrangements for the marketing of our products in Asia, certain European nations, Australia, India, the Middle East, South and Central America, New Zealand and pursuant to a partnership agreement in Singapore. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company, each of which is attached as an exhibit to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015. We also have a Code of Conduct that is applicable to all of our employees, which is attached as an exhibit to this Annual Report on Form 10-K. Each of these codes is posted on our website, http:// +1 +www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Recent Developments +Stock Split. On September 11, 2018, the Board of Directors of the Company declared a three-for-two stock split of the Company's outstanding shares of common stock, effected in the form of a stock dividend on the Company's outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. The additional shares were distributed on October 11, 2018. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. All share and per share data provided herein gives effect to this stock split, applied retroactively. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Madden NYC, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, Stevies®, Brian Atwood®, Blondo®, Kate Spade® (under license), Anne Klein® (under license) and includes our International business and certain private label footwear business. An agreement under which the Company licensed the Avec Les Filles® trademark terminated on December 31, 2018. +Our Wholesale Accessories segment is comprised of Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Cejon®, Luv Betsey®, DKNY® (under license), Donna Karan® (under license), Anne Klein® (under license) and Jocelyn® accessories brands and also includes our International business and certain private label accessories business. +Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn e-commerce websites. +Our First Cost segment represents activities of one of our wholly-owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market retailers, shoe chains and other value priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, we license our Betsey Johnson® trademark for use in the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. We also license FREEBIRD by Steven® for operation of retail stores. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35 years old) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared for young women ages 13 to 25 years old, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +2 +Steve Madden Men's. We design, source and market a lifestyle collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range in price from $70 to $190 at retail per pair. +Madden. T he Madden® brand is a denim friendly collection of footwear designed to meet the ever evolving needs of the trend conscious male consumer, ages 13 to 35 years old. Madden products range from $45 to $90 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal to fashion conscious women ages 25 to 45 years old who grew up wearing Steve Madden footwear and are looking for a shoe with an emphasis on comfort. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12 years old. Our Stevies® and Steve Madden Kids® brands are distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. +Report. The Report® brand was acquired in May 2011. The Report® brand is a junior women's footwear brand with price points ranging from $20 to $100 per pair. We design, manufacture, market and sell Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed exclusively to Target. +Dolce Vita. In August 2014, the Company acquired the Dolce Vita® and DV® brands. Dolce Vita® is a contemporary women's footwear brand with price points ranging from $90 to $300 per pair. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently-owned boutiques primarily throughout the United States. The DV® brand is a contemporary women's footwear brand with price points ranging from $20 to $75 per pair. DV® products are distributed through off-price department stores, online retailers and independently-owned boutiques primarily throughout the United States. +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand. Brian Atwood is known for luxury shoes manufactured in China and Italy. +Blondo. In January 2015, the Company acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. +Kate Spade and Avec Les Filles. In January 2017, the Company acquired all of the issued and outstanding capital stock of Schwartz & Benjamin, Inc. As a consequence of the acquisition, the Company acquired licenses to manufacture, market and sell footwear under the Kate Spade® and Avec Les Filles® trademarks. +The Kate Spade® brand, known for its whimsical fashion, is an entry-level luxury footwear brand primarily distributed through department stores and Kate Spade retail stores throughout the United States. The price points of footwear bearing the Kate Spade® brand range from $98 to $400 per pair with the core product price ranging from $198 to $298 per pair. As of December 31, 2018, the agreement to license the Avec Les Filles® trademark was terminated. +3 +Anne Klein. In January 2018, the Company entered into a license agreement with Nine West Development LLC for license to use the Anne Klein®, AK Sport®, AK Anne Klein Sport® and the Lion Head Design® trademarks in connection with the marketing and sale of footwear and accessories. The Anne Klein® brand is recognized as being synonymous with American sportswear. +International Division. The International division, utilizing the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers through wholly owned subsidiaries in Canada and Mexico and joint venture partnerships in Europe (excluding Italy and Greece, where we had preexisting distributors), South Africa, Israel, China and Taiwan. In addition, the International division works through special distribution arrangements for the marketing and sale of our products in Indonesia, Thailand, Vietnam, Malaysia, certain European nations, Australia, India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands, including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Madden NYC, Big Buddha®, DKNY® (under license), Donna Karan® (under license), Anne Klein® (under license), Jocelyn® and Luv Betsey® brands, and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our International distributor network. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon®, Steve Madden®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2018 , we owned and operated 229 retail stores including 157 Steve Madden full price stores, 62 Steve Madden outlet stores, 2 Steven stores, 1 Superga store and 7 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn). In 2018 , we added 23 full price stores, 5 outlet stores and 3 e-commerce websites and closed 6 full price stores and 2 outlet stores. In addition, during 2018 , we opened 16 concessions in China, Taiwan and South Africa, and ended the year with 42 company-operated concessions in international markets. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, Israel, China and Taiwan. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2018 ) increased 2.8% in fiscal year 2018 from the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product assortment of our two Wholesale segments. We expect to open 14 to 16 new retail stores and close 8 to 10 locations in 2019 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market retailers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Payless ShoeSource, Kohl's, Fred Meyer and Meijers. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. In 2018, one of the Company's wholesale customers transitioned from the wholesale model to the buying agency model. +4 +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, fragrance, umbrellas, bedding, luggage and men’s leather accessories. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note P to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Company's products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Company's brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers primarily in China, Italy, Mexico, Vietnam, Cambodia, Brazil, India, The Netherlands, The Dominican Republic, Spain and South Korea. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out and markdown of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California and New Jersey, also via truck from Mexico to our third party distribution facility in Texas, with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from six third-party distribution centers, four located in California, one located in Texas and one located in New Jersey. Our products are also distributed through a Company-operated distribution center located in Canada. By utilizing distribution facilities specializing in fulfillment for certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico and our joint ventures in South Africa, China, Taiwan and Israel are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retaile rs and catalog retailers. These customers +5 +include Wal-Mart Stores, Inc., Macy's Inc., Nordstrom, Inc., The TJX Companies, Inc., DSW, Inc., Target Corporation, Ross Stores, Inc., Kohl's Corporation, and Burlington Stores, Inc. At December 31, 2018 , Wal-Mart Stores, Inc. represented 17.6% of total accounts receivable, Target Corporation represented 13.8% of total accounts receivable and Nordstrom, Inc. represented 10.6% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, China, Taiwan and Israel +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico, certain European nations and Tunisia. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in South Africa, China, Taiwan and Israel, and on our e-commerce websites. For the year ended December 31, 2018 , our Retail segment and our two Wholesale segments generated net sales of approximately $295,152 and $1,358,457 , or 18% and 82% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2018 , we operated 157 Steve Madden full price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China, Taiwan and Israel. We also operated 62 Steve Madden outlet stores, 2 Steven stores and 1 Superga store within the United States. The Company also operated 7 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell our products to approximately 2,200 doors of 15 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Macy's, Inc., Nordstrom, Inc., Dillard's, Inc., Belk, Inc. and Lord & Taylor. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at season's end. +National Chains and Mass Merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Target Corporation, Wal-Mart Stores, Inc. and Kohl's Corporation. +6 +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW, Inc., Famous Footwear and Journeys. We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's. +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate 7 Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn footwear and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Australia, the Middle East, India, South and Central America, New Zealand and, pursuant to a partnership agreement, in Singapore. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Sam Edelman, Ugg and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +Marketing and Sales +We have focused on creating an integrated brand building program to establish the Company as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations including product and brand placements in life style and fashion magazines and digital outlets, as well as personal appearances by our founder and Creative and Design Chief, Steven Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn footwear and accessory products, as well as selected styles of Madden Girl footwear and accessory products, and view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our Enterprise Resource Planning (“ERP”) system is an integrated system that supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. All of our North American wholesale businesses (other than Canada which has a separate ERP system) and our Asia first-cost and sourcing operations are operated through this ERP system. Our warehouse management system is utilized by our third-party logistics providers and is fully integrated with our ERP system. A point of sale system for our U.S. retail stores is integrated with a retail inventory management/store replenishment system. We are currently transitioning our e-commerce software to a major cloud-based provider. Complimenting all of these systems are ancillary systems and third-party information processing services, +7 +including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 128 other countries and in numerous International Classes. From time to time, we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +Stevies plus Design® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Big Buddha plus Design® +DV8® +Big Buddha love big. Live Buddha plus® +Sweet Life® +Topline® +Blondo Waterproof plus Heart Design® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +DV® +LUV BETSEY plus Kiss Design® +Wild Pair® +LUV BETSEY by Betsey Johnson Design® +MadLove® +Blue by Betsey Johnson® +Blondo® +Steve Madden plus Design® +By Steve Madden plus Heart® +SM New York® +SM Pass plus Design® +SM New York plus Design® +Jocelyn® +FREEBIRD By Steven® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective licensing of our brands. As of December 31, 2018 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. We also license FREEBIRD by Steven® for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +8 +In addition to the licensing of our trademarks, we also in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +In January 2018, we entered into a license agreement with Nine West Development LLC for the right to manufacture, market and sell women's fashion footwear and handbags under the Anne Klein®, AK Sport®, AK Anne Klein Sport® and the Lion Head Design®. The agreement, unless extended, expires on June 30, 2023. +See Notes A and O to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2019 , we employed approximately 3,900 employees, of whom approximately 2,600 work on a full-time basis and approximately 1,300 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,400 of our employees are located in the United States, approximately 700 employees are located in Hong Kong and China, approximately 400 employees are located in Canada, approximately 200 employees are located in Mexico, approximately 90 employees are located in Israel, approximately 90 employees are located in South Africa and approximately 30 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales occur in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales occur in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Sales levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $ 369,458 and $ 367,101 , as of February 1, 2019 and 2018 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. +ITEM 1A. RISK FACTORS +You should carefully consider the risks and uncertainties we describe below and the other information in this Annual Report on Form 10-K before deciding to invest in, sell or retain shares of our common stock. These are not the only risks and uncertainties that we face. Other sections of this report may discuss factors that could adversely affect our business. The retail industry is highly competitive and subject to rapid change. There may be additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, which may also harm our business or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, results of operations and liquidity could be materially harmed. +Risks Related to the Industry in Which the Company Operates +Constantly Changing Fashion Trends and Consumer Demands. The strength of our brands and our success depends in significant part upon our ability to anticipate and respond to product and fashion trends as well as to anticipate, gauge and react +9 +to changing consumer demands in a timely manner. There can be no assurance that our products will correspond to the changes in taste and demand or that we will be able to successfully advertise and market products that respond to trends and customer preferences. If we misjudge the market for our products, we may be faced with significant excess inventories for some products and missed opportunities as to others. In addition, misjudgments in merchandise selection could adversely affect our image with our customers resulting in lower sales and increased markdown allowances for customers which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Intense Fashion Industry Competition . The fashion footwear and accessories industry is highly competitive and barriers to entry are low. Our competitors include specialty companies as well as companies with diversified product lines. Market growth in the sales of fashion footwear and accessories has encouraged the entry of many new competitors and increased competition from established companies. Many of these competitors, including Aldo, Sam Edelman, Ugg and Vince Camuto, may have significantly greater financial and other resources than we do and there can be no assurance that we will be able to compete successfully with other fashion footwear and accessories companies. Increased competition could result in pricing pressures, increased marketing expenditures and loss of market share, and could have a material adverse effect on our business, financial condition, results of operations and liquidity. We believe effective advertising and marketing, favorable branding of Steve Madden® and our other trademarks, fashionable styling, high quality, competitive pricing and speed to market are the most important competitive factors. We plan to continue to focus on these elements as we develop new products and businesses. +Cyclical Nature of the Fashion Industry . The overall fashion industry is cyclical, and purchasing tends to decline during recessionary periods when disposable income is low. Likewise, purchases of contemporary shoes and accessories tend to decline during recessionary periods and also may decline at other times. There can be no assurance that we will be able to grow or even maintain our current level of revenues and earnings, or remain profitable in the future. Slow growth in the international, national or regional economies and uncertainties regarding future economic prospects, among other things, could affect consumer spending habits. +A Rapidly Changing Retail Industry . In recent years, the retail industry has experienced consolidation and other ownership changes. In the future, retailers in the United States and in foreign markets may further consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our products or our licensees’ products or increase the ownership concentration within the retail industry. Changing shopping patterns, including the rapid expansion of online retail shopping, have adversely affected customer traffic in mall and outlet centers, particularly in North America. We expect competition in the e-commerce market will intensify. As a greater portion of consumer expenditures with retailers occurs online and through mobile commerce applications, our brick-and-mortar retail customers who fail to successfully integrate their physical retail stores and digital retail may experience financial difficulties, including store closures, bankruptcies or liquidations. A continuation or worsening of these trends could cause financial difficulties for one or more of our major customers, which, in turn, could substantially increase our credit risk and have a material adverse effect on our results of operations, financial condition and cash flows. Our future success will be determined, in part, on our ability to manage the impact of the rapidly changing retail environment and identify and capitalize on retail trends, including technology, e-commerce and other process efficiencies that will better service our customers. If we fail to compete successfully, our businesses, market share, results of operations and financial condition will be materially and adversely affected. While such changes in the retail industry to date have not had a material adverse effect on our business or financial condition, results of operations and liquidity, there can be no assurance as to the future effect of any such changes. +Economic Uncertainty . Our opportunities for long-term growth and profitability are accompanied by significant challenges and risks, particularly in the near term. Specifically, our business is dependent on consumer demand for our products and the purchase of our products by consumers is largely discretionary. Consumer confidence and discretionary spending could be adversely affected in response to financial market volatility, negative financial news, conditions in the real estate and mortgage markets, declines in income or asset values, changes to fuel and other energy costs, labor and healthcare costs, food costs and other economic factors. A downturn in economic conditions leading to a reduction in consumer confidence and discretionary spending could have a negative effect on the Company's sales and results of operations during the year ending December 31, 2019 and thereafter. +Legal, Regulatory and Political Risks of a Global Economy. As a result of our large and growing international operations, we are subject to risks associated with our operations in international markets as a result of a number of factors, many of which are beyond our control. These risks include, among other things: +• +the challenge of managing broadly dispersed foreign operations; +• +inflationary pressures and economic changes or volatilities in foreign economies; +• +the burdens of complying with the laws and regulations of the U.S. and foreign nations; +• +additional or increased customs duties, tariffs, taxes and other charges on imports or exports; +10 +• +political corruption or instability; +• +geopolitical regional conflicts, terrorist activity, political unrest, civil strife, acts of war; +• +local business practices that do not conform to legal or ethical guidelines; +• +anti-American sentiment in foreign countries in which we operate; +• +delays in receipts of our products at our distribution centers due to labor unrest, increasing security requirements or other factors at U.S. or other ports; +• +significant fluctuations in the value of the dollar against foreign currencies; +• +increased difficulty in protecting our intellectual property in foreign nations; +• +restrictions on the transfer of funds between the U.S. and foreign nations; and +• +natural disasters in areas in which our businesses, customers, suppliers and licensees are located. +All of these factors could disrupt or limit the countries in which we sell or source our products or significantly increase the cost of operating in or obtaining materials originating from certain countries, result in decreased revenues and could materially and adversely affect our product sales, financial condition and results of operations. +In June 2016, voters in the United Kingdom approved an advisory referendum, commonly referred to as “Brexit”, to withdraw from the European Union. Brexit has created political and economic uncertainty, particularly in the United Kingdom and the European Union, that may endure for years. The United Kingdom's impending withdrawal from the European Union could significantly disrupt the free movement of goods, services and people between the United Kingdom and the European Union, and increase legal and regulatory complexities, all of which could lead to higher costs of conducting business in Europe. Brexit could also encourage similar referendums in other European countries in which we do business. The terms of the United Kingdom's withdrawal from the European Union remain uncertain but is scheduled to occur on March 29, 2019. Its consequences could adversely impact consumer and investor confidence, and the level of consumer purchases of discretionary items and retail products, including our products. All of these factors could materially adversely affect our business, results of operations and financial condition. +We are subject to the U.S. Foreign Corrupt Practices Act, which prohibits the payment of bribes to foreign officials to assist in obtaining or retaining business. We are also subject to anti-corruption laws of the foreign countries in which we operate. Although we have implemented policies and procedures that are designed to promote compliance with such laws, our employees, contractors and agents may take actions that violate our policies and procedures. Any such violation could result in sanctions or other penalties against the Company and have an adverse effect on our business, reputation and operating results. +Changes in Tax Laws Could Have an Adverse Effect Upon Our Financial Results. We are subject to income tax requirements in various jurisdictions in the United States and numerous foreign jurisdictions. Tax laws and regulations, or their interpretation and application, in any jurisdiction are subject to significant changes. Legislation or other changes in the tax laws of the jurisdictions where we do business could increase our liability and adversely affect our after-tax profitability. In the United States, the Tax Cuts and Jobs Act, which was enacted on December 22, 2017, includes a number of significant changes to previous U.S. tax laws that impact us, including provisions for a one-time transition tax on deemed repatriation of undistributed foreign earnings, and a reduction in the corporate tax rate from 35% to 21% for tax years beginning after December 31, 2017, among other changes. Due primarily to these changes, our effective tax rate decreased to 26.4% in fiscal year 2018. Adjustments to the incremental provisional tax expense may be made in future periods as actual amounts may differ due to, among other factors, a change in interpretation of the U.S. tax code and related tax accounting guidance, changes in assumptions made in developing these estimates, regulatory guidance that may be issued with respect to the applicable revisions to the U.S. tax code, and state tax implications. The Company has completed its accounting for all of the enactment-date income tax effects of the Tax Act. Changes or challenges to or the repeal of the Tax Cuts and Jobs Act cannot be predicted with certainty and could have a material impact on our future tax expense. +Other jurisdictions are contemplating changes or have unpredictable enforcement activity. Increases in applicable tax rates, implementation of new taxes, changes in applicable tax laws and interpretations of these tax laws and actions by tax authorities in jurisdictions in which we operate could reduce our after tax income and have an adverse effect on our results of operations. +We May Be Subject to Additional Tax Liabilities as a Result of Audits by Various Taxing Authorities. We are subject to the tax laws and regulations of numerous jurisdictions as a result of our international operations. These tax laws and regulations are highly complex and significant judgment and specialized expertise is required in evaluating and estimating our worldwide provision for income taxes. We are subject to audit by the taxing authorities in each jurisdiction where we conduct our business and any one of these jurisdictions may assess additional taxes against us as a result of an audit. Although we believe our tax estimates are reasonable, and we undertake to prepare our tax filings in accordance with all applicable tax laws, the final determination with respect to any tax audits, and any related litigation, could be materially different from our estimates or from +11 +our historical tax provisions and accruals. The outcome of any audit or audit-related litigation could have a material adverse effect on our operating results or cash flows in the periods for which that determination is made, and may require a restatement of prior financial reports. In addition, future period earnings may be adversely impacted by litigation costs, settlement payments or interest or penalty assessments. +Changes in Trade Policies and Tariffs Imposed by the United States Government and the Governments of Other Nations Could Have a Material Adverse Effect on the Company’s Business and Results of Operations. Our operations are dependent upon products purchased, manufactured and sold internationally. Our sources of supply are subject to the usual risks of doing business abroad, such as the implementation of, or potential changes in, foreign and domestic trade policies, increases in import duties, anti-dumping measures, quotas, safeguard measures, trade restrictions, restrictions on the transfer of funds and, in certain parts of the world, political instability and terrorism. In 2018, the United States government imposed significant tariffs and created the potential for significant additional changes in trade policies, including tariffs and government regulations affecting trade between the United States and countries where we purchase, manufacture and sell out products. These trends are affecting many global manufacturing and service sectors, including the footwear and accessories industries, and may cause us to face trade protectionism in many different regions of the world. These protectionist measures could result in increases in the cost of our products and adversely affect our sales and/or profitability. We continue to monitor protectionist trends and developments throughout the world that may materially impact our business and, when appropriate, we will engage in administrative and judicial processes to mitigate trade restrictions. We are actively monitoring actions that may result in additional anti-dumping measures and could affect our industry. We are also monitoring for other impediments that may limit or delay customs clearance for imports of footwear and accessories. +Effective September 24, 2018, the United States government imposed additional tariffs on approximately $200 billion of goods imported from China. The additional tariffs on Chinese imports was initially set at a level of 10% and would increase to 25% by the end of 2018. However, the United States government agreed to postpone until March 1, 2019 further tariff hikes on China while the parties negotiate. In recent days, President Trump announced the March 1, 2019 deadline will be extended to allow for negotiations to continue. If the United States and China are unable to reach an agreement on trade and the United States government does not continue to postpone the tariff hike, the 10% tariff on $200 billion of Chinese imports will rise to 25%. China has already imposed retaliatory tariffs on a wide range of American products in response to these additional tariffs. An overwhelming majority of the products that we sell in the United States are manufactured in China. A decrease in gross margin in our wholesale business in the fourth quarter of 2018 was due, in part, to the impact of the 10% tariff on handbags and certain other accessory categories. Although it is too early to predict the extent to which the recently enacted tariffs will impact our business, the imposition of tariffs on footwear and accessory items imported by us from China could require us to increase prices to our customers or, if we are unable to do so, result in a further lowering of our gross margin on products sold. Tariffs on footwear and accessories products that we import from China could have a material adverse effect on our business and results of operations. +On September 30, 2018, the United States of America, the United Mexican States, and Canada Trade Agreement (the “USMCA”) was drafted as part of the renegotiation of the North American Free Trade Agreement (“NAFTA”) among the United States, Mexico and Canada. The USMCA has yet to be ratified and until such time as it, NAFTA will continue in full force. The USMCA, when it becomes effective, could necessitate changes in the way we conduct our business, including our product sourcing operations, and could have a material adverse effect on our business and results of operations. +Risks Related to Our Business +Dependence on Key Personnel. The growth and success of our Company since its inception more than a quarter century ago is attributable, to a significant degree, to the talents, skills and efforts of our founder and Creative and Design Chief, Steven Madden. An extended or permanent loss of the services of Mr. Madden could severely disrupt our business and have a material adverse effect on the Company. In addition to Mr. Madden, the Company depends on the contributions of the members of our senior management team. Our senior executives have substantial experience and expertise in our business and industry and have made significant contributions to our growth and success as well. Competition for executive talent in the apparel, footwear and accessories industries is intense. While our employment agreements with Mr. Madden and most of our senior executives include a non-compete provision in the event of the termination of employment, the non-compete periods are of limited duration and scope. Although we believe we have depth within our senior management team, if we were to lose the services of our Creative and Design Chief or any of our senior executives, and especially if any of these individuals were to join a competitor or form a competing company, our business and financial performance could be seriously harmed. A loss of the skills, industry knowledge, contacts and expertise of our Creative and Design Chief or any of our senior executives could cause a setback to our operating plan and strategy. +12 +Dependence Upon Significant Customers . Our customers consist principally of better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and catalog retailers. Certain of our department store customers, including some under common ownership, account for significant portions of our wholesale business. We generally enter into a number of purchase order commitments with our customers for each of our lines every season and do not enter into long-term agreements with any of our customers. Therefore, a decision by a significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to decrease the amount of merchandise purchased from us or to change its manner of doing business could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Risks Associated with Extending Credit to Customers. We sell our products primarily to retail stores across the United States and extend credit based on an evaluation of each customer's financial condition, usually without collateral. Various retailers, including some of our customers, have experienced financial difficulties, which has increased the risk of extending credit to such retailers. However, our losses due to bad debts have been limited. Pursuant to the terms of our collection agency agreement, our factor, Rosenthal & Rosenthal, Inc., currently assumes the credit risk related to approximately 84% of our trade accounts receivable. In addition, we have letters of credit for approximately 3% of our trade accounts receivable. Still, if any of our customers experience a shortage of liquidity, the risk that the customer's outstanding payables to us would not be paid could cause us to curtail business with the customer or require us to assume more credit risk relating to the customer's account payable. +Risks Associated with Expansion of Retail Business . Our continued growth depends to a significant degree on whether we are successful in further developing and marketing our brands, and creating new brands, product categories and businesses that are appealing to our customers. The operation of company-owned Steve Madden, Steven and Superga stores and outlets is a significant part of our growth strategy. During the year ended December 31, 2018 , we added 23 full price stores, 5 outlet stores and 3 e-commerce websites and closed 6 full price stores and 2 outlet locations. We have plans to open 14 to 16 new retail stores and close 8 to 10 locations in 2019 . Our future expansion plan includes the opening of stores in new geographic markets as well as strengthening existing markets. New store openings involve substantial investments. New markets have in the past presented, and will continue to present, competitive and merchandising challenges that are different from those faced by us in our existing markets. There can be no assurance that we will be able to open new stores, and if opened, that such new stores will be able to achieve sales and profitability levels consistent with management's expectations. Our retail expansion is dependent on the performance of our wholesale and retail operations, generally, as well as on a number of other factors, including our ability to: +• +locate and obtain favorable store sites; +• +negotiate favorable lease terms; +• +hire, train and retain competent store personnel; +• +anticipate the preferences of our retail customers in new geographic areas; +• +successfully integrate new stores into our existing operations. +Past comparable store sales results may not be indicative of future results and there can be no assurance that our comparable store sales results will increase or even be maintained in the future. Also, as we expand the number of our retail stores, we run the risk that our wholesale customers will perceive that we are increasingly competing directly with them, which may lead them to reduce or terminate purchases of our products. +Management of Growth . The size of our business continues to grow organically and as a result of business acquisitions. In order to gain from our acquisitions, we must be effective in integrating the businesses acquired into our overall operations. Further, the expansion of our operations has increased and will continue to increase the demand on our managerial, operational and administrative resources. In recent years, we have invested significant resources in, among other things, our management information systems and hiring and training of new personnel. However, in order to manage currently anticipated levels of future demand, we may be required to, among other things, expand our distribution facilities, establish relationships with new manufacturers to produce our product, and continue to expand and improve our financial, management and operating systems. We may experience difficulty integrating acquired businesses into our operations and may not achieve anticipated synergies from such integration. There can be no assurance that we will be able to manage future growth effectively and a failure to do so could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruptions to Product Delivery Systems and Associated Inventory Management Issues. A majority of our products for U.S. distribution are shipped to us via ocean freight carriers to ports in California, New Jersey and Texas with the greatest reliance on California ports. The trend-focused nature of the fashion industry and the rapid changes in customer preferences leave us vulnerable to risk of inventory obsolescence. Our reliance upon ocean freight transportation for the delivery of our inventory exposes us to various inherent risks, including port workers’ union disputes and associated strikes, work slow-downs and work stoppages, severe weather conditions, natural disasters and terrorism, any of which could result in delivery delays and inefficiencies, +13 +increase our costs and disrupt our business. Any severe and prolonged disruption to ocean freight transportation could force us to use alternate and more expensive transportation systems. For example, during the California port workers' dispute in 2014, we were forced to re-route our merchandise by air transit. Efficient and timely inventory deliveries and proper inventory management are important factors in our operations. Inventory shortages can adversely affect the timing of shipments to customers and diminish sales and brand loyalty. Conversely, excess inventories can result in lower gross margins due to the excessive discounts and markdowns that may be necessary to reduce high inventory levels. Severe and extended delays in the delivery of our inventory or our inability to effectively manage our inventory could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruption of Information Technology Systems and Websites. We are heavily dependent upon our information technology systems to record and process transactions and manage and operate all aspects of our business ranging from product design and testing, production, forecasting, ordering, transportation, sales and distribution, invoicing and accounts receivable management, quick response replenishment, point of sale support and financial management reporting functions. In addition, we have e-commerce websites. Given the nature of our business and the significant number of transactions in which we engage on an annual basis, it is essential that we maintain constant operation of our information technology systems and websites and that these systems and our websites operate effectively. We depend on our in-house information technology employees and third-parties including “cloud” service providers to maintain and periodically update and/or upgrade these systems and our websites to support the growth of our business. Despite our preventative efforts, our information technology systems and websites may, from time to time, be vulnerable to damage or interruption from events such as difficulties in replacing or integrating the systems of acquired businesses, computer viruses, security breaches and power outages. Cybersecurity attacks are becoming increasingly sophisticated and run the gamut from malicious software and ransomware to electronic security breaches to corruption of data and beyond. We are continually evaluating, improving and upgrading our information technology systems and websites in an effort to address these concerns. Any such problems or interruptions could result in loss of valuable business data, our customers' or employees' personal information, disruption of our operations and other adverse impacts to our business and require significant expenditures by us to remediate any such failure, problem or breach. In addition, we must comply with increasingly complex regulatory standards enacted to protect business and personal data and an inability to maintain compliance with these regulatory standards could subject us to legal risks and penalties. +We maintain $40 million of network-security insurance coverage, above a $250,000 deductible. This coverage and certain other insurance coverage may reduce our exposure to electronic data theft and sabotage. While we maintain other insurance coverage aimed at addressing certain of these other risks, there can be no assurance that depending upon the nature of the issue presented, we will have insurance coverage available or that the amounts of coverage will be adequate. +Data Security Breaches. In addition to our own confidential and proprietary business information, a routine part of our business includes the gathering, processing and retention of sensitive and confidential information pertaining to our customers, employees and others. Although we believe that our information security and information technology systems and websites allow for the secure storage and transmission of private information regarding our customers, employees and others, including credit card information and personal identification information, we may not have the resources or technical sophistication to anticipate or prevent the rapidly-evolving and complex cyber-attacks being unleashed by increasingly sophisticated hackers and data thieves. As a result, our facilities and information technology systems, as well as those of our third party service providers, may be vulnerable to cyber-attacks and breaches, acts of vandalism, ransomware, software viruses and other similar types of malicious activities. Any actual or threatened cyber-attack may cause us to incur costs, including costs related to the hiring of additional computer experts, business interruption, engaging third party cyber security consultants and upgrading our information security technologies. We also may be vulnerable to data security breaches by us or by persons with whom we have commercial relationships resulting from misplaced or lost data, programming or human error, or other similar events. As a result of recent security breaches at a number of prominent companies, the media and public scrutiny of information security and privacy has become more intense and the regulatory environment has become more uncertain. Any compromise or breach of our information technology systems that results in the misappropriation, loss or other unauthorized disclosure of a customer's or other person’s private, confidential or proprietary information, whether by the Company or a third party service provider, could result in a loss of confidence and severely damage our reputation and relationship with our customers and others who entrust us with sensitive information, violate applicable privacy and other laws and adversely affect our business, as well as expose the Company to the risk of litigation and significant potential liability. We may need to expend significant resources to protect against and redress problems caused by a breach of our information technology systems. +We must also comply with increasingly rigorous regulatory standards for the protection of business and personal data enacted in the U.S., Europe and elsewhere. For example, the European Union’s General Data Protection Regulation (the “GDPR”) became effective on May 25, 2018. The GDPR imposes additional obligations on companies concerning the handling of personal data and provides certain individual privacy rights to persons whose data is stored. Our compliance with existing, proposed and +14 +recently enacted laws (including implementation of the privacy and process enhancements required by the GDPR) and regulations can be costly. Any failure by us to comply with these regulatory standards could subject us to significant legal and reputational harm. +Foreign Sourcing and Manufacturing. Virtually all of our products are purchased through arrangements with a number of foreign manufacturers, primarily from China, Italy, Mexico, Vietnam and Cambodia. During 2018 , 94% of our total purchases were from China. Risks inherent in foreign operations including work stoppages, transportation delays and interruptions, social unrest and political upheaval and changes in economic conditions, can result in the disruption of trade from the countries in which our manufacturers or suppliers are located, the imposition of additional regulations relating to imports, the imposition of additional duties, taxes and other charges on imports, significant fluctuations of the value of the dollar against foreign currencies, or restrictions on the transfer of funds, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. Although we believe that we manage our exposure to the risk that any such economic or political condition will materially affect our ability to purchase products because we are aware of the availability of a variety of materials and alternative sources, we cannot be certain that we will be able to identify such alternative materials and/or sources without delay or without greater cost to us. Our inability to identify and secure alternative sources of supply in this situation could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Impact of Custom Duties and Other Import Regulations . Virtually all of our products are imported and subject to United States custom duties. In addition, over time we have increased our sales of products outside of the United States. The United States and the countries in which our products are produced or sold, from time to time, may impose new quotas, duties, tariffs or other restrictions on imports or exports, may adversely adjust prevailing quotas, duties or tariff levels, or may impose sanctions in the form of additional duties to remedy perceived illegal actions. The current political landscape has introduced greater uncertainty with respect to future tax and trade regulations for United States companies like ours with significant business and sourcing operations outside the United States. We cannot predict whether, and to what extent, there may be changes to international trade agreements or whether quotas, duties, tariffs, exchange controls or other restrictions will be changed or imposed by the United States or by other countries. If we or our suppliers or licensees are unable to source raw materials or finished goods from the countries where we or they wish to purchase them, either because of such regulatory changes or for any other reason, or if the cost of doing so should increase, it could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Manufacturers' Inability to Produce Our Goods in a Timely Manner or Meet Quality Standards . As is common in the footwear and accessories industries, we contract with foreign manufactures who produce virtually all of our products to our specifications. We do not own or operate any manufacturing facilities; therefore, we are dependent upon third parties for the manufacture of all of our products. The inability of a manufacturer to ship orders of our products in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers for those items, which, in turn, could result in cancellation of orders, refusal to accept deliveries, a reduction in purchase prices and, ultimately, termination of a customer relationship, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +SEC Rules Relating to “Conflict Minerals” Require the Company to Incur Additional Expenses and Could Adversely Affect our Business. The SEC has promulgated final rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring the disclosure of the use of tantalum, tin, tungsten and gold, known as “conflict minerals,” included in products either manufactured by public companies or as to which public companies have contracted for the manufacture. These rules, adopted in an effort to prevent inadvertent support of armed conflict in the Democratic Republic of Congo and certain adjoining countries (collectively, the “DRC”), require companies to investigate their supply chains to determine whether these minerals are present in their products and, if so, from where the minerals originate. The rules also require disclosure and annual reporting as to whether or not conflict minerals, if used in the manufacture of the products offered, originate from the DRC. We currently require our manufacturers to comply with policies addressing legal and ethical concerns relating to labor, employment, political and social matters including restrictions on the use of conflict minerals. Violation of these policies by our manufacturers could harm our reputation, disrupt our supply chain and/or increase our cost of goods sold. Additionally, violation of any of these policies by our manufacturers could cause us to face disqualification as a supplier for our customers and suffer reputational challenges. Due to the complexity of our supply chain, compliance with the rules requires significant efforts from a cross-operational team and diverts our management and personnel and results in potential costs of additional staff. Any of the foregoing could adversely affect our sales, net earnings, business and financial condition and results of operations. +Difficulty in Locating Replacement Manufacturers. Although we enter into a number of purchase order commitments each season specifying a time frame for delivery, method of payment, design and quality specifications and other standard industry provisions, we do not have long-term contracts with any manufacturer. As a consequence, any of these manufacturing relationships +15 +may be terminated, by either party, at any time. In addition, we may seek replacement manufacturers for various reasons, including a significant increase in the prices we are required to pay to existing manufacturers of our goods. Although we believe that other facilities are available for the manufacture of our products, there can be no assurance that such facilities would be available to us on an immediate basis, if at all, or be able to meet our quality standards and delivery requirements, or that the costs charged to us by such manufacturers would not be significantly greater than those presently paid. +Manufacturers' Failure to Use Acceptable Labor Practices and Comply with Local Laws and Other Standards . Our products are manufactured by numerous independent manufacturers outside of the United States. We also have license agreements that permit our licensees to manufacture or contract to manufacture products using our trademarks. We impose, and require that our licensees impose, on these manufacturers environmental, health, and safety standards for the benefit of their labor force. In addition, we require these manufacturers to comply with applicable standards for product safety. However, we do not control our independent manufacturers or licensing partners or their labor, product safety and other business practices and, from time to time, our independent manufacturers may not comply with such standards or applicable local law or our licensees may not require their manufacturers to comply with such standards or applicable local law. The violation of such standards and laws by one of the independent manufacturers with whom we contract or by one of our licensing partners, or the divergence of a manufacturer's or a licensing partner's labor practices from those generally accepted as ethical in the United States, could harm our reputation, result in a product recall or require us to curtail our relationship with and locate a replacement for such manufacturer, which, as noted in the immediately preceding risk factor, could be challenging. Any of these events could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Seasonal and Quarterly Fluctuations . Our results of operations may fluctuate from quarter to quarter and are affected by a variety of factors, including: +• +the timing of holidays; +• +weather conditions; +• +the timing of larger shipments of product; +• +market acceptance of our products; +• +the mix, pricing and presentation of the products offered and sold; +• +the hiring and training of additional personnel; +• +inventory write downs for obsolescence; +• +the cost of materials; +• +the product mix between wholesale, retail and licensing businesses; +• +the incurrence of other operating costs; and +• +factors beyond our control, such as general economic conditions, declines in consumer confidence and actions of competitors. +In addition, we expect that our sales and operating results may be significantly impacted by the opening of new retail stores and the introduction of new products. Accordingly, the results of operations in any quarter will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter. +Extreme or Unseasonable Weather Conditions in Locations in Which We or Our Customers and Suppliers are Located Could Adversely Affect our Business. Our corporate headquarters and principal operational locations, including retail, distribution and warehousing facilities, may be subject to natural disasters and other severe weather and geological events that could disrupt our operations. The occurrence of such natural events may result in sudden disruptions in business conditions of the local economies affected, as well as of the regional and global economies, and may result in decreased demand for our products and disruptions in our management functions, sales channels and manufacturing and distribution networks, which could have a material adverse effect on our business, financial condition and results of operations. Extreme weather events and changes in weather patterns can also influence customer trends and shopping habits. Extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season may diminish demand for our seasonal merchandise. Heavy snowfall, hurricanes or other severe weather events in the areas in which our retail stores and the retail stores of our wholesale customers are located may decrease customer traffic in those stores and reduce our sales and profitability. If severe weather events force closure of or disrupt operations at the distribution centers we use for our merchandise, we could incur higher costs and experience longer lead times to distribute our products to our retail stores, wholesale customers or e-commerce customers. If prolonged, such extreme or unseasonable weather conditions could adversely affect our business, financial condition and results of operations. +Inadequate Trademark Protections . We believe that our trademarks and other proprietary rights are of major significance to our success and our competitive position and consider some of our trademarks, such as Steve Madden, to be integral to our business and among our most valuable assets. Accordingly, we devote substantial resources to the establishment and protection +16 +of our trademarks on a worldwide basis. Nevertheless, policing unauthorized use of our intellectual property is difficult, expensive and time consuming and there can be no assurance that the actions taken by us to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products on the basis that our products violate the trademarks and proprietary rights of others. Moreover, no assurance can be given that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve such conflicts. We could incur substantial costs in legal actions relating to our use of intellectual property or the use of our intellectual property by others. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Our failure to establish and then protect such proprietary rights from unlawful and improper utilization could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Our Licensees’ Conduct Could Harm our Business. We license to others the rights to produce and market certain products that are sold under our trademarks. Although we retain significant control over our licensees’ products and advertising, we rely on our licensees for operational and financial control over their businesses. If the quality, image or distribution of our licensed products diminish, customer acceptance of and demand for our brands and products could decline. This could materially and adversely affect our business and results of operations. In fiscal year 2018 , approximately 90% of our net royalties were derived from our top five licensed product lines. A decrease in customer demand for any of these product lines could have a material adverse effect on our results of operations and financial condition. Although we believe that in most circumstances we could replace existing licensees if necessary, our inability to do so effectively or for any period of time could adversely affect our revenues and results of operations. +Litigation and Other Legal Proceedings. We are involved in various claims, litigations and other legal and regulatory proceedings and governmental investigations that arise from time to time in the ordinary course of our business. Due to the inherent uncertainties of litigation and such other proceedings and investigations, we cannot predict with accuracy the ultimate outcome of any such matters. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations and the amount of insurance coverage we maintain to address such matters may be inadequate to cover these or other claims. In addition, any significant litigation, investigation or proceeding, regardless of its merits, could divert financial and management resources that would otherwise be used to benefit our operations. See Item 3 “Legal Proceedings,” below for additional information regarding legal proceedings in which we are involved. +Declines in Our Stock Price Due to Inaccurate Predictions. The trading price of our common stock periodically may rise or fall based on the accuracy of predictions of our future performance. As one of our primary objectives, we strive to maximize the long-term strength, growth and profitability of our Company, rather than to achieve an earnings target in any particular fiscal quarter. We believe that this longer-term goal is in the best interests of the Company and our stockholders, but recognize that it may be helpful to our stockholders and potential investors for us to provide guidance as to our quarterly and annual forecast of net sales and earnings. Although we endeavor to provide meaningful and considered guidance at the time it is provided and generally expect to provide updates to our guidance when we report our results each fiscal quarter, actual results may differ from our predictions as the guidance is based on assumptions and expectations that may or may not come to pass and, as such, we assume no responsibility to update any of our forward-looking statements at such times or otherwise. If and when we announce actual results that differ from those that have been predicted by us, the market price of our common stock could be adversely affected. Investors who rely on these predictions in making investment decisions with respect to our common stock do so at their own risk. We take no responsibility for any losses suffered as a result of such changes in the price of our common stock. +In addition, at any given time outside securities analysts may follow our financial results and issue reports that discuss our historical financial results and the analysts' predictions of our future performance, which our stockholders and potential investors may choose to rely on in making investment decisions. These analysts' predictions are based upon their own opinions and are often different from our own forecasts. Our stock price could decline if our results are below the estimates or expectations of these outside analysts. +Exposure to Foreign Currency Fluctuations . We make the majority of our purchases in U.S. dollars. However, we source substantially all of our products overseas and, as such, the cost of these products may be affected by changes in the value of the relevant currencies. Changes in currency exchange rates may also affect the relative prices at which we and our foreign competitors sell products in the same market. We use forward foreign exchange contracts to hedge material exposure to adverse changes in foreign exchange rates. However, no hedging strategy can completely insulate us from foreign exchange risk. We are also exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our financial statements due to the translation of operating results and financial position of our foreign subsidiaries. There can be no assurance that foreign currency fluctuations will not have a material adverse effect on our business, financial condition, results of operations and liquidity. +17 +Any Failure to Maintain Effective Internal Control Over Our Financial Reporting Could Materially Adversely Affect Us. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include in our annual reports on Form 10-K an assessment by management of the effectiveness of our internal control over financial reporting. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002. Our compliance with Section 404 may require that we incur substantial accounting expense and expend significant management efforts. +We previously reported a material weakness in our internal control over financial reporting related to certain control deficiencies in our information technology general controls as a result of ineffective risk assessment relative to certain of our processes and procedures. As a result of the material weakness, we concluded that our internal control over financial reporting and related disclosure controls and procedures were not effective as of December 31, 2017. Management of the Company believes that the remedial measures we have taken in 2018 are sufficient to have fully remediated the material weakness in the Company’s internal control over financial reporting that existed at December 31, 2017; however, we cannot guarantee that these steps have been or will be sufficient to remediate the deficiencies or that in the future we will not have a material weakness that prevents us from concluding that our internal control over financial reporting is effective. If our remedial measures are insufficient to address the material weakness or if additional material weaknesses arise in the future, this could result in a loss of investor confidence in the reliability of our financial statements, which, in turn, could negatively affect the price of our common stock. Furthermore, our interim or annual financial statements may contain material misstatements or omissions and we could be required to restate our financial results. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +18 +ITEM 2. PROPERTIES +We lease space for our headquarters, our retail stores, showrooms and office facilities in various locations in the United States, as well as overseas. We own one improved real property parcel in Long Island City, New York. We believe that our existing facilities are in good operating condition and are adequate for our present level of operations. The following table sets forth information with respect to our key properties: +Location +Leased/Owned +Primary Use +Approximate Area Square Feet +Dongguan, China +Leased +Offices and sample production +154,900 +Montreal, Canada +Leased +Offices, warehouse +117,400 +Long Island City, NY +Leased +Executive offices +90,000 +Peabody, MA +Leased +Offices +85,000 +Bellevue, WA +Leased +Offices, Topline +41,500 +Seattle, WA +Leased +Offices and showroom, Dolce Vita +32,600 +New York, NY +Leased +Offices and showroom, Accessories +27,200 +New York, NY +Leased +Offices and showroom, Schwartz & Benjamin +15,700 +Putian City, China +Leased +Offices +13,800 +New York, NY +Leased +Showroom +13,400 +New York, NY +Leased +Offices and showroom +10,000 +Long Island City, NY +Leased +Storage +7,200 +León, Mexico +Leased +Offices +6,400 +Mexico City, Mexico +Leased +Offices, SM Mexico +5,700 +Kowloon, Hong Kong +Leased +Offices +4,800 +Miami Gardens, FL +Leased +Storage +3,600 +Los Angeles, CA +Leased +Showroom, Steven +2,700 +New York, NY +Leased +Offices +2,700 +Long Island City, NY +Owned +Other +2,200 +New York, NY +Leased +Offices +1,000 +Mississauga, Canada +Leased +Showroom +1,000 +Dallas, TX +Leased +Showroom +800 +All of our retail stores are leased pursuant to leases that, under their original terms, extend for an average of ten years. Many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes over the base year. The current terms of our retail store leases expire as follows: +Year +Number of Stores +2019 +26 +2020 +30 +2021 +26 +2022 +28 +2023 +25 +2024 +22 +2025 +24 +2026 +17 +2027 +10 +2028 +7 +2029 +5 +2030 +1 +19 +ITEM 3. LEGAL PROCEEDINGS +In the ordinary course of business, we have various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on our financial condition, results of operations or liquidity. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND +ISSUER PURCHASES OF EQUITY SECURITIES +($ in thousands, except share and per share data) +Market Information. Our shares of common stock have traded on the NASDAQ Global Select Market since August 1, 2007 and were traded on the NASDAQ National Market prior to that date. The following table sets forth the range of high and low closing sales prices for our common stock during each fiscal quarter during the two-year period ended December 31, 2018 as reported by the NASDAQ Global Select Market. The trading volume of our securities fluctuates and may be limited during certain periods. As a result, the liquidity of an investment in our securities may be adversely affected. +Common Stock +2018 +High +Low +2017 +High +Low +Quarter ended March 31, 2018 +$32.85 +$27.77 +Quarter ended +March 31, 2017 +$25.97 +$22.33 +Quarter ended +June 30, 2018 +$37.00 +$28.60 +Quarter ended +June 30, 2017 +$27.17 +$23.70 +Quarter ended +September 30, 2018 +$39.30 +$34.54 +Quarter ended +September 30, 2017 +$29.20 +$25.47 +Quarter ended December 31, 2018 +$35.56 +$27.88 +Quarter ended +December 31, 2017 +$31.70 +$24.83 +Holders. As of February 27, 2019 , there were 164 holders of record of our common stock. +Stock Split. On September 17, 2018, the Company announced that on September 11, 2018 its Board of Directors declared a three-for-two stock split of the Company's outstanding shares of common stock, effected in the form of a stock dividend on the Company's outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. The additional shares were distributed on October 11, 2018. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. All share and per share data provided herein gives effect to this stock split, applied retroactively. +Dividends. Beginning in the first quarter of 2018, the Company began paying a quarterly cash dividend on the Company's outstanding shares of common stock. The Company currently expects to continue to pay a comparable cash dividend each quarter; however, the payment of future dividends will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +20 +The Company’s Board of Directors approved a quarterly cash dividend of $0.14 per share. The dividend will be paid on March 29, 2019, to stockholders of record at the close of business on March 19, 2019. +Equity Compensation Plans . Information regarding our equity compensation plans as of December 31, 2018 is disclosed in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” +Issuer Repurchases of Equity Securities. The Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase, most recently on July 28, 2017 when the Board of Directors approved the extension of the Share Repurchase Program for an additional $200,000 in repurchases of the Company's common stock. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. During the twelve months ended December 31, 2018 , an aggregate of 2,838,649 shares of the Company's common stock were repurchased under the Share Repurchase Program, at a weighted average price per share of $31.68 , for an aggregate purchase price of approximately $89,919 . As of December 31, 2018 , approximately $90,942 remained available for future repurchases under the Share Repurchase Program. The following table presents the total number of shares of the Company's common stock, $.0001 par value, purchased by the Company in the three months ended December 31, 2018 , the average price paid per share and the approximate dollar value of the shares that still could have been purchased at the end of the fiscal period, pursuant to the Company's Share Repurchase Program. +Period +Total Number of Shares Purchased (1) +Average Price Paid per Share (1) +Total Number of Shares Purchased as part of Publicly Announced Plans or Programs +Maximum Dollar Amount of Shares that May Yet Be Purchased Under the Plans or Programs +10/1/2018 - 10/31/2018 +1,761 +$ +33.66 +— +$ +132,597 +11/1/2018 - 11/30/2018 +459,842 +$ +31.45 +457,395 +$ +118,215 +12/1/2018 - 12/31/2018 +1,346,007 +$ +30.11 +909,406 +$ +90,942 +Total +1,807,610 +$ +30.45 +1,366,801 +$ +90,942 +(1) The Steven Madden, Ltd. 2006 Stock Incentive Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy all or part of the tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. Included in this table are shares withheld during the fourth quarter of 2018 in connection with the settlement of vested restricted stock to satisfy tax withholding requirements, in addition to the shares repurchased pursuant to the Share Repurchase Program. Of the total number of shares repurchased by the Company in the fourth quarter of 2018 , 440,809 shares were withheld at an average price per share of $30.37, for an aggregate purchase price of approximately $13,389, in connection with the settlement of vested restricted stock and exercises of stock options to satisfy tax withholding requirements. Excluding the shares withheld in connection with the settlement of vested restricted stock and exercises of stock options, the average price per share was $31.44 in November 2018, $29.99 in December 2018 and $30.48 in the period October 1, 2018 to December 31, 2018. +Performance Graph . The following graph compares the yearly percentage change in the cumulative total stockholder return on our common stock during the period beginning on December 31, 2013 , and ending on December 31, 2018 , with the cumulative total return on the Russell 2000 Index and a peer group index. In 2016, the Company decided to remove the S&P 500 Footwear Index and replace it with a peer group index of companies believed to be engaged in similar businesses, as we believe the composition of the new peer group is more representative of our current business. The peer group index consists of six companies: Caleres, Inc., Crocs, Inc., Deckers Outdoor Corporation, Genesco Inc., Skechers U.S.A., Inc. and Wolverine World Wide, Inc. +The comparison assumes that $100 was invested on December 31, 2013 in our common stock and in the foregoing indices and assumes the reinvestment of dividends. +21 +12/31/2013 +12/31/2014 +12/31/2015 +12/31/2016 +12/31/2017 +12/31/2018 +Steven Madden, Ltd. +$100.00 +$86.99 +$82.59 +$97.70 +$127.63 +$126.10 +Russell 2000 Index +$100.00 +$104.89 +$100.26 +$121.63 +$139.44 +$124.09 +Peer Group +$100.00 +$107.21 +$91.93 +$92.91 +$124.45 +$125.74 +22 +ITEM 6. SELECTED FINANCIAL DATA +The following selected financial data has been derived from our audited consolidated financial statements. The Income Statement data relating to 2018 , 2017 and 2016 , and the Balance Sheet data as of December 31, 2018 and 2017 should be read in conjunction with the information provided in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” and the notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. +INCOME STATEMENT DATA +Year Ended December 31, +(in thousands, except per share data) +2018 +2017 +2016 +2015 +2014 +Net sales +$ +1,653,609 +$ +1,546,098 +$ +1,399,551 +$ +1,405,239 +$ +1,334,951 +Cost of sales +1,037,571 +968,357 +877,568 +904,747 +865,951 +Gross profit +616,038 +577,741 +521,983 +500,492 +469,000 +Commissions and licensing fee income - net +5,417 +14,259 +11,788 +16,565 +13,723 +Operating expenses +448,073 +421,216 +364,595 +342,364 +315,081 +Impairment charges +— +1,000 +— +3,045 +— +Income from operations +173,382 +169,784 +169,176 +171,648 +167,642 +Interest and other income - net +3,958 +2,543 +1,824 +818 +3,751 +Income before provision for income taxes +177,340 +172,327 +171,000 +172,466 +171,393 +Provision for income taxes +46,841 +53,189 +49,726 +58,811 +58,764 +Net income +130,499 +119,138 +121,274 +113,655 +112,629 +Less: net income attributable to non-controlling interests +1,363 +1,190 +363 +717 +749 +Net income attributable to Steven Madden, Ltd. +$ +129,136 +$ +117,948 +$ +120,911 +$ +112,938 +$ +111,880 +Basic net income per share +$ +1.58 +$ +1.43 +$ +1.41 +$ +1.28 +$ +1.21 +Diluted net income per share +$ +1.50 +$ +1.36 +$ +1.35 +$ +1.23 +$ +1.17 +Basic weighted average common shares outstanding +81,664 +82,736 +85,664 +88,496 +92,177 +Effect of dilutive securities - options/restricted stock +4,433 +4,009 +3,670 +3,217 +3,337 +Diluted weighted average common stock outstanding +86,097 +86,745 +89,334 +91,713 +95,514 +Cash dividends declared per common share +$ +0.53 +$ +— +$ +— +$ +— +$ +— +BALANCE SHEET DATA +At December 31 , +2018 +2017 +2016 +2015 +2014 +Total assets +$ +1,072,570 +$ +1,057,161 +$ +960,875 +$ +914,385 +$ +911,235 +Working capital +478,436 +438,906 +345,544 +284,178 +264,635 +Noncurrent liabilities +33,199 +41,617 +36,676 +60,923 +64,115 +Stockholders' equity +$ +814,682 +$ +808,932 +$ +741,072 +$ +678,663 +$ +669,529 +23 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +The following discussion of our Financial Condition and Results of Operations should be read in conjunction with our audited consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. +Overview: +($ in thousands, except retail sales data per square foot, earnings per share and per share data) +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell brand and private label fashion handbags and accessories. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers, and catalog retailers throughout the United States, Canada, Mexico, certain European nations and Tunisia. In addition, our products are marketed through our retail stores and our e-commerce websites within the United States, Canada and Mexico, our joint ventures in South Africa, China, Taiwan and Israel, and under special distribution arrangements in Asia, certain European nations, Australia, India, the Middle East, South and Central America and New Zealand and pursuant to a partnership agreement in Singapore. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +On September 11, 2018, the Company's Board of Directors declared a three-for-two stock split of the Company's outstanding shares of common stock, effected in the form of a stock dividend on the Company's outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. The additional shares were distributed to the Company's stockholders on October 11, 2018. All share and per share data provided herein gives effect to this stock split, applied retroactively. +Our business is comprised of five distinct segments (Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing). Our Wholesale Footwear segment includes the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Madden NYC, Report®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, Stevies®, Brian Atwood®, Blondo® and Kate Spade® (under license), and includes our International business and certain private label footwear business. An agreement to license the Avec Les Filles® trademark was terminated as of December 31, 2018. Our Wholesale Accessories segment includes Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Luv Betsey®, Brian Atwood®, DKNY® (under license), Donna Karan® (under license), Anne Klein® (under license), Jocelyn® and Cejon® accessories brands and includes our International business and certain private label accessories business. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven, Superga and International retail stores, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn e-commerce websites and comprises our Retail segment. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, sunglasses, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, we license our Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. We also license FREEBIRD by Steven® for operation of retail stores. +In November 2018, the Company formed a joint venture ("SM Israel") with Inter Jeans Ltd. through its subsidiary, SM Distribution Israel L.P. The Company controls all of the significant participating rights of the joint venture and is the majority interest holder in SM Israel. SM Israel is the exclusive distributor of the Company’s products in Israel. +In February 2018, the Board of Directors of the Company approved the initiation of the Company's quarterly cash dividend. A quarterly cash dividend of $0.13 per share on the Company's outstanding shares of common stock was paid on each of March 29, 2018, June 29, 2018 and September 28, 2018. A quarterly cash dividend of $0.14 per share on the Company's outstanding +24 +shares of common stock was paid on December 31, 2018. The aggregate cash dividends paid for the quarter ended December 31, 2018 was $12,169 . The aggregate cash dividends paid for the twelve months ended December 31, 2018 was $ 47,316 . +Key Performance Indicators and Statistics +The following measurements are among the key business indicators reviewed by various members of management to measure consolidated and segment results of the Company: +• +net sales +• +gross profit margin +• +operating expenses +• +income from operations +• +adjusted EBITDA +• +adjusted EBIT +• +inventory turnover +• +accounts receivable average collection days +• +cash flow and liquidity determined by the Company’s working capital and free cash flow +• +store metrics, such as same store sales, sales per square foot, average unit retail, conversion, average units per transaction, and contribution margin. +While not all of these metrics are disclosed due to the proprietary nature of the information, many of these metrics are disclosed and discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Non-GAAP Financial Measures +The Company’s reported results are presented in accordance with generally accepted accounting principles in the United States ("GAAP"). The Company uses adjusted earnings before interest and taxes ("Adjusted EBIT") and adjusted earnings before interest, taxes, depreciation and amortization ("Adjusted EBITDA"), as calculated in the table below, as non-GAAP measures, in internal management reporting and planning processes as well as in evaluating the performance of the Company. Management believes these measures are useful to investors in evaluating the Company’s ongoing operating and financial results. By providing these non-GAAP measures, as a supplement to GAAP information, we believe we are enhancing investors’ understanding of our business and our results of operations. The non-GAAP financial measures are limited in their usefulness and should be considered in addition to, and not in lieu of, U.S. GAAP financial measures. Further, these non-GAAP measures may be unique to the Company, as they may be different from non-GAAP measures used by other companies. +25 +The table below reconciles these metrics to net income as presented in the Consolidated Statements of Income. +Years Ended December 31 ($ in thousands) +2018 +2017 +2016 +Net Income +$ +130,499 +$ +119,138 +$ +121,274 +Add back: +Provision for income taxes +46,841 +53,189 +49,726 +Provision for legal charges +2,837 +6,713 +— +Provision for early lease termination charges +1,693 +5,123 +— +Schwartz & Benjamin amendment to the equity purchase agreement +— +(10,215 +) +— +Provisions for bad debt expense and write-off of an unamortized buying agency agreement support payment associated with the Payless ShoeSource bankruptcies +12,123 +5,470 +— +Schwartz & Benjamin acquisition integration charges and related restructuring +2,065 +3,639 +— +Charges related to preferred interest investment +— +2,700 +— +Impairment of Wild Pair trademark +— +1,000 +— +Schwartz & Benjamin acquisition inventory fair value adjustment +— +591 +— +Deduct: +Other (expense)/income - net * +(66 +) +(5 +) +(664 +) +Interest, net +4,024 +2,548 +2,488 +Adjusted EBIT +$ +192,100 +$ +184,805 +$ +169,176 +Add back: +Depreciation and amortization +$ +21,754 +$ +20,406 +$ +19,868 +Loss on disposal of fixed assets +1,220 +1,455 +652 +Adjusted EBITDA +$ +215,074 +$ +206,666 +$ +189,696 +* Consists of realized (losses)/gains on marketable securities and foreign exchange (losses)/gains. +Executive Summary +Net sales for 2018 increased by 7.0% to $1,653,609 from $1,546,098 in 2017 . Net sales growth was driven by our Wholesale Accessories, Footwear and Retail segments. Net sales in the Wholesale Accessories increased by $43,796, or 17.1%, when compared to the prior year. Net sales in the Wholesale Footwear segment increased by $40,809, or 4.0%, when compared to the prior year. Net sales in the Retail segment increased by $22,906, or 8.4%, when compared to the prior year. +Net income attributable to Steven Madden, Ltd. increased 9.5% to $129,136 in 2018 compared to $117,948 in 2017 . The Company's effective tax rate for 2018 decreased to 26.4% compared to 30.9% recorded in 2017 . Diluted earnings per share in 2018 increased to $1.50 per share on 86,097,000 diluted weighted average shares outstanding compared to $1.36 per share on 86,745,000 diluted weighted average shares outstanding in the prior year. +In our Retail segment, same store sales (sales attributable to those stores, including the e-commerce websites, that were in operation throughout 2018 ) increased 2.8% , and sales per square foot decreased to $612 in 2018 compared to sales per square foot of $656 in 2017 . As of December 31, 2018 , we had 229 stores in operation, compared to 206 stores as of December 31, 2017 which increase resulted from the addition of 23 full price stores, 5 outlet stores and 3 e-commerce websites partially offset by the closing of 6 full price stores and 2 outlet stores. +Our inventory turnover (calculated on a trailing twelve-month average) for the years ended December 31, 2018 and 2017 was 8.1 times and 8.6 times, respectively. Our total company accounts receivable average collection days were 69 days in 2018 compared to 75 days in 2017 primarily due to better collection efforts by the Company and the transition, in 2018, of one of the Company's wholesale customers from the wholesale model to the buying agency model. As of December 31, 2018 , we had $266,999 +26 +in cash, cash equivalents and marketable securities, no short or long-term debt and total stockholders’ equity of $814,682 . Working capital increased to $478,436 as of December 31, 2018 , compared to $438,906 on December 31, 2017 . +The following table sets forth information on operations for the periods indicated: +Years Ended December 31, +($ in thousands) +2018 +2017 +2016 +CONSOLIDATED: +Net sales +$ +1,653,609 +100.0 +% +$ +1,546,098 +100.0 +% +$ +1,399,551 +100.0 +% +Cost of sales +1,037,571 +62.7 +% +968,357 +62.6 +% +877,568 +62.7 +% +Gross profit +616,038 +37.3 +% +577,741 +37.4 +% +521,983 +37.3 +% +Commission and licensing fee income - net of expenses +5,417 +0.3 +% +14,259 +0.9 +% +11,788 +0.8 +% +Operating expenses +448,073 +27.1 +% +421,216 +27.2 +% +364,595 +26.1 +% +Impairment charges +— +— +% +1,000 +0.1 +% +— +— +% +Income from operations +173,382 +10.5 +% +169,784 +11.0 +% +169,176 +12.1 +% +Interest and other income – net +3,958 +0.2 +% +2,543 +0.2 +% +1,824 +0.1 +% +Income before income taxes +177,340 +10.7 +% +172,327 +11.1 +% +171,000 +12.2 +% +Net income attributable to Steven Madden, Ltd. +$ +129,136 +7.8 +% +$ +117,948 +7.6 +% +$ +120,911 +8.6 +% +By Segment: +WHOLESALE FOOTWEAR SEGMENT: +Net sales +$ +1,058,366 +100.0 +% +$ +1,017,557 +100.0 +% +$ +881,864 +100.0 +% +Cost of sales +712,457 +67.3 +% +685,190 +67.3 +% +602,029 +68.3 +% +Gross profit +345,909 +32.7 +% +332,367 +32.7 +% +279,835 +31.7 +% +Operating expenses +205,771 +19.4 +% +197,722 +19.4 +% +169,796 +19.3 +% +Income from operations - before impairment charges +$ +140,138 +13.2 +% +$ +134,645 +13.2 +% +$ +110,039 +12.5 +% +WHOLESALE ACCESSORIES SEGMENT: +Net sales +$ +300,091 +100.0 +% +$ +256,295 +100.0 +% +$ +254,931 +100.0 +% +Cost of sales +208,352 +69.4 +% +175,566 +68.5 +% +170,509 +66.9 +% +Gross profit +91,739 +30.6 +% +80,729 +31.5 +% +84,422 +33.1 +% +Operating expenses +64,647 +21.5 +% +57,092 +22.3 +% +52,860 +20.7 +% +Income from operations - before impairment charges +$ +27,092 +9.0 +% +$ +23,637 +9.2 +% +$ +31,562 +12.4 +% +RETAIL SEGMENT: +Net sales +$ +295,152 +100.0 +% +$ +272,246 +100.0 +% +$ +262,756 +100.0 +% +Cost of sales +116,762 +39.6 +% +107,601 +39.5 +% +105,030 +40.0 +% +Gross profit +178,390 +60.4 +% +164,645 +60.5 +% +157,726 +60.0 +% +Operating expenses +177,655 +60.2 +% +165,771 +60.9 +% +141,939 +54.0 +% +Income/(loss) from operations - before impairment charges +$ +735 +0.2 +% +$ +(1,126 +) +(0.4 +)% +$ +15,787 +6.0 +% +Number of stores +229 +206 +189 +FIRST COST SEGMENT: +Other commission (loss)/income – net of expenses +$ +(4,549 +) +100.0 +% +$ +5,159 +100.0 +% +$ +3,728 +100.0 +% +LICENSING SEGMENT: +Licensing income – net of expenses +$ +9,966 +100.0 +% +$ +9,100 +100.0 +% +$ +8,060 +100.0 +% +27 +RESULTS OF OPERATIONS +($ in thousands) +Year Ended December 31, 2018 vs. Year Ended December 31, 2017 +Consolidated : +Net sales for the year ended December 31, 2018 increased by 7.0% to $1,653,609 from $1,546,098 for fiscal year 2017 . For the year ended December 31, 2018 , gross margin as a percentage of net sales decreased slightly to 37.3% in the current year compared to 37.4% in the prior year. Operating expenses increased in 2018 to $448,073 , or 27.1% of total revenue, from $421,216 , or 27.2% of total revenue, in 2017 . For the years ended 2018 and 2017, operating expenses included certain charges of $10,211 and $14,430, respectively. (See "Non-GAAP Financial Measures" above for a description of these charges.) Excluding these charges, the increase in operating expenses primarily comprised of (i) higher payroll and related expenses, (ii) higher warehouse and distribution expenses, (iii) legal charges consisting of costs and estimated settlement amounts, (iv) higher occupancy related expenses, (v) higher selling expenses, (vi) higher marketing expenses and (vii) higher consulting expenses. Commission and licensing fee income decreased to $5,417 in 2018 compared to $14,259 in 2017 , resulting from provisions for bad debt expense and the write-off of an unamortized buying agency agreement support payment of $8,507 associated with the Payless ShoeSource bankruptcy. (See "Non-GAAP Financial Measures" above.) The effective tax rate for the year ended December 31, 2018 decreased to 26.4% compared to 30.9% in the same period last year primarily due to changes to U.S. tax laws impacting us resulting from the Tax Cuts and Jobs Act, partially offset by a prepaid tax adjustment related to prior years. Net income attributable to Steven Madden, Ltd. for the year ended December 31, 2018 increased to $129,136 compared to $117,948 for the year ended December 31, 2017 . +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment were $1,058,366 , or 64.0% , and $1,017,557 , or 65.8% , of our total net sales for the years ended December 31, 2018 and 2017 , respectively. The increase in net sales is primarily driven by strong growth in our Steve Madden and Blondo brands in both domestic and international markets. +Gross profit margin in 2018 was 32.7% , flat from the prior year. Operating expenses increased to $205,771 , or 19.4% of revenue, in 2018 compared to $197,722 , or 19.4% of revenue, in the same period of 2017 . Operating expenses in 2018 included $8,518 of certain charges, which consisted of $3,616 of bad debt expense related to the Payless ShoeSource bankruptcy, $2,837 related to provisions for legal charges, and $2,065 related to Schwartz & Benjamin acquisition integration charges and related restructuring. Operating expenses in 2017 included $8,307 of certain net charges, which consisted of $6,713 related to provisions for legal charges, $5,470 related to bad debt expenses for the Payless ShoeSource bankruptcy, $3,639 related to Schwartz & Benjamin acquisition integration charges and related restructuring, $2,700 related to charges due to preferred interest investment, partially offset by a benefit of $10,215 related to an amendment of the purchase agreement for the acquisition of Schwartz & Benjamin. Excluding these charges, the increase in operating expenses was primarily comprised of higher payroll and related expenses, and warehouse and distribution expenses. Income from operations before impairment charges increased to $140,138 for the year ended December 31, 2018 compared to $134,645 for the year ended December 31, 2017 . +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $300,091 , or 18.1% , and $256,295 , or 16.6% , of total Company net sales for the years ended December 31, 2018 and 2017 , respectively. The increase in net sales is primarily driven by strong growth in our private label business and our Steve Madden brand, as well as the addition of the Anne Klein handbag business. +Gross profit margin in the Wholesale Accessories segment decreased to 30.6% in 2018 from 31.5% in the prior year period primarily due to sales mix. In the year ended December 31, 2018 , operating expenses increased to $64,647 , or 21.5% of revenue, compared to $57,092 , or 22.3% of revenue, in the year ended December 31, 2017 . In 2018, operating expenses included certain charges of $1,241 related to provisions for early lease termination charges. Excluding these charges, operating expenses increased primarily due to higher warehouse and distribution expenses. Income from operations for the Wholesale Accessories segment increased to $27,092 in 2018 compared to $23,637 in 2017 . +28 +Retail Segment : +Net sales generated by the Retail segment accounted for $295,152 , or 17.8% , and $272,246 , or 17.6% , of total Company net sales for the years ended December 31, 2018 and 2017 , respectively, which represents a $22,906 or 8.4% increase, year-over-year. This growth is due to the net addition of 23 stores from the prior year and an increase in comparable store sales of 2.8% . During 2018 , we added 23 full price stores, 5 outlets, 3 e-commerce websites and closed 6 full price locations and 2 outlet locations. As a result, we had 229 retail stores as of December 31, 2018 , compared to 206 stores as of December 31, 2017 . The 229 stores currently in operation include 157 Steve Madden full price stores, 62 Steve Madden outlet stores, 2 Steven stores, 1 Superga store and 7 e-commerce websites. In addition, during 2018, we opened 16 concessions in China, Taiwan and South Africa, and ended the year with 42 company-operated concessions in international markets. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2018 ) for the year ended December 31, 2018 increased 2.8% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2018 , the gross margin slightly decreased to 60.4% from 60.5% in 2017 primarily due to slightly higher promotional activity during 2018 in our full price retail stores. In 2018 , operating expenses increased to $177,655 , or 60.2% of revenue, from $165,771 , or 60.9% of revenue, in 2017 . In 2018 and 2017 operating expenses included $452 and $5,123, respectively, of provisions for early lease termination charges. Excluding these charges, operating expenses increased primarily due to the incremental costs associated with new store openings, such as higher selling costs, payroll and related expenses, warehouse expenses, and occupancy related expenses. For the year ended December 31, 2018 , income from operations for the Retail segment was $735 compared to losses from operations of $1,126 in the prior year. +First Cost Segment : +The First Cost segment, which includes net commission income and fees decreased to a loss of $4,549 for the year ended December 31, 2018 compared to an income of $5,159 in 2017 . The decrease is primarily due to a charge of $8,507 for provisions for bad debt expense and a write-off of an unamortized buying agency agreement support payment related to the Payless ShoeSource bankruptcy. +Licensing Segment: +During the year ended December 31, 2018 , income for the Licensing segment increased to $9,966 as compared to the prior year income of $9,100 primarily due to an increase in income from the licensing of the FREEBIRD by Steven brand for operation of retail stores. +Year Ended December 31, 2017 vs. Year Ended December 31, 2016 +Consolidated : +Net sales for the year ended December 31, 2017 increased by 10.5% to $1,546,098 from $1,399,551 for fiscal year 2016. For the year ended December 31, 2017, gross margin as a percentage of net sales increased slightly to 37.4% in the current year compared to 37.3% in the prior year. Excluding the impact from the Schwartz & Benjamin acquisition, gross profit margin as a percentage of net sales increased to 38.3% driven by improvement in the Wholesale Footwear and Retail segments. Operating expenses increased in 2017 to $421,216, or 27.2% of total revenue, from $364,595, or 26.1% of total revenue, in 2016. The increase is primarily related to (i) the impact of the Schwartz & Benjamin acquisition, (ii) legal charges consisting of costs and estimated settlement amounts, (iii) bad debt related to the Payless ShoeSource bankruptcy, and (iv) charges to preferred interest investments related to the Brian Atwood acquisition. These increases were partially offset by the benefit received for the reversal of contingent liabilities related to the amended purchase agreement for the Schwartz & Benjamin acquisition. Commission and licensing fee income increased to $14,259 in 2017 compared to $11,788 in 2016. The effective tax rate for the year ended December 31, 2017 increased to 30.9% compared to 29.3% in the same period in the prior year primarily due to the impact of the year-over-year benefit resulting from the exercising and vesting of share based awards coupled with a shift in profitability to jurisdictions with higher tax rates. These were partially offset by the net benefit related to the recently enacted Tax Cuts and Jobs Act in the United States. Net income attributable to Steven Madden, Ltd. for the year ended December 31, 2017 decreased to $117,948 compared to $120,911 for the year ended December 31, 2016. +29 +Wholesale Footwear Segment : +Net sales generated by the Wholesale Footwear segment was $1,017,557, or 65.8%, and $881,864, or 63.0%, of our total net sales for the years ended December 31, 2017 and 2016, respectively. Excluding net sales related to the Schwartz & Benjamin acquisition, net sales increased 6.3%. The increase in net sales is primarily driven by strong growth in our core Steve Madden Women's brand coupled with growth in our Steve Madden Men's, Madden Girl, Steve Madden Kid's and Blondo brands, as well as growth in the SM Europe joint venture. +Gross profit margin increased to 32.7% in 2017 from 31.7% in the prior year period. Excluding the impact from the Schwartz & Benjamin acquisition, gross profit margin was 33.8%. The increase in gross profit margin primarily resulted from reduced mark-downs and closeouts, as well as a sales mix shift between our branded and private label businesses. Operating expenses increased to $197,722, or 19.4%, in 2017 compared to $169,796, or 19.3%, in the same period of 2016 primarily due to (i) the impact of the Schwartz & Benjamin acquisition, (ii) legal charges consisting of costs and estimated settlement amounts, (iii) bad debt related to the Payless ShoeSource bankruptcy, and (iv) charges to preferred interest investments related to the Brian Atwood acquisition. These increases were partially offset with a benefit due to a decrease in contingent liabilities related to the Schwartz & Benjamin acquisition. Income from operations before impairment charges increased to $134,645 for the year ended December 31, 2017 compared to $110,039 for the year ended December 31, 2016. +Wholesale Accessories Segment : +Net sales generated by the Wholesale Accessories segment accounted for $256,295, or 16.6%, and $254,931, or 18.2%, of total Company net sales for the years ended December 31, 2017 and 2016, respectively. +Gross profit margin in the Wholesale Accessories segment decreased to 31.5% in 2017 from 33.1% in the prior year period primarily due to lower margins in our cold weather business driven by prior season inventory closeouts. In the year ended December 31, 2017, operating expenses increased to $57,092, or 22.3% of revenue, compared to $52,860, or 20.7% of revenue, in the year ended December 31, 2016 due to the impact of the year-over-year benefit received for the reversal of contingent liabilities related to the Cejon acquisition in 2016. Income from operations for the Wholesale Accessories segment decreased to $23,637 in 2017 compared to $31,562 in 2016. +Retail Segment : +Net sales generated by the Retail segment accounted for $272,246, or 17.6%, and $262,756, or 18.8%, of total Company net sales for the years ended December 31, 2017 and 2016, respectively, which represents a $9,490 or 3.6% increase, year-over-year. This growth is due to the net addition of seventeen stores from the prior year partially offset by a decrease in comparable store sales of 3.2%. During 2017, we added thirteen full price stores and six outlets, and closed two full price locations. As a result, we had 206 retail stores as of December 31, 2017, compared to 189 stores as of December 31, 2016. The 206 stores in operation as of December 31, 2017 include 138 Steve Madden full price stores, 60 Steve Madden outlet stores, three Steven stores, one Superga store and four e-commerce websites. In addition, during 2017, we opened 21 concessions in Asia through our China and Taiwan joint ventures, and ended the year with 38 company-operated concessions in international markets. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2017 and 2016) for the year ended December 31, 2017 decreased 3.2% when compared to the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2017, gross margin increased to 60.5% from 60.0% in 2016 primarily due to lower promotional activity during 2017. In 2017, operating expenses increased to $165,771, or 60.9% of revenue, from $141,939, or 54.0% of revenue, in 2016 primarily due to the incremental costs associated with new store openings, legal charges consisting of costs and estimated settlement amounts related to early lease terminations and increases in employee-related costs. For the year ended December 31, 2017, losses from operations for the Retail segment were $1,126 compared to income from operations of $15,787 in the prior year. +First Cost Segment : +Income for the First Cost segment, which includes net commission income and fees, increased to $5,159 for the year ended December 31, 2017, compared to $3,728 in 2016 due to an increase in business with certain private label footwear customers. +30 +Licensing Segment: +During the year ended December 31, 2017, income for the Licensing segment increased to $9,100 as compared to the prior year income of $8,060 primarily due to gains with our Steve Madden licensed products. +LIQUIDITY AND CAPITAL RESOURCES +($ in thousands) +Our primary source of liquidity is cash flows generated from our operations. Our primary use of this liquidity is to fund our ongoing cash requirements, including working capital requirements, share repurchases, acquisitions, system enhancements, retail store expansion and remodeling and payment of dividends. +Cash, cash equivalents and short-term investments totaled $266,999 and $245,241 at December 31, 2018 and December 31, 2017 , respectively. Of the total cash, cash equivalents and short-term investments at December 31, 2018 , $198,110 , or 74% , was held in our foreign subsidiaries and of the total cash, cash equivalents and short-term investments at December 31, 2017 , $135,884 , or 55% , was held in our foreign subsidiaries. +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”). The agreement provides us with a credit facility in the amount of $30,000, having a sub-limit of $15,000 on the aggregate face amount of letters of credit, at an interest rate based, at our election, upon either the prime rate or LIBOR. The agreement can be terminated by the Company or Rosenthal at any time with 60 days’ prior written notice. As of December 31, 2018 we had no borrowings against this credit facility. +As of December 31, 2018 , we had working capital of $478,436 , cash and cash equivalents of $200,031 , investments in marketable securities of $66,968 and we did not have any long-term debt. +We believe that based upon our current financial position and available cash, cash equivalents and marketable securities, the Company will meet all of its financial commitments and operating needs for at least the next twelve months. +OPERATING ACTIVITIES +($ in thousands) +Cash provided by operations was $154,376 in 2018 compared to cash provided by operations of $ 157,935 in the prior year. The primary sources of cash were net income of $130,499 and increases in accounts payable, accrued expenses and income taxes payable of $21,249 and prepaid expenses, prepaid tax, deposits and other of $14,633. The primary use of cash was an increase in factor accounts receivable of $39,959 and inventories of $26,923. +INVESTING ACTIVITIES +($ in thousands) +During the year ended December 31, 2018 cash provided by investing activities was $11,065, of which we invested $77,262 in marketable securities and received $100,777 from the maturities and sales of securities. We made capital expenditures of $12,450 , principally for new stores and improvements to existing stores, systems enhancements and leasehold improvements to office and showroom space. +FINANCING ACTIVITIES +($ in thousands) +During the year ended December 31, 2018 , net cash used by financing activities was $145,810 , which primarily consisted of share repurchases of $105,924 , payment of cash dividends of $47,316 and payment of contingent liabilities related to acquisitions completed in prior years of $7,000 , partially offset by proceeds from the exercise of stock options of $13,036 . +31 +CONTRACTUAL OBLIGATIONS +($ in thousands) +Our contractual obligations as of December 31, 2018 were as follows: +Payment due by period +Contractual Obligations +Total +2019 +2020-2021 +2022-2023 +2024 and after +Operating lease obligations +$ +229,971 +$ +44,551 +$ +79,235 +$ +52,846 +$ +53,339 +Purchase obligations +98,131 +98,131 +— +— +— +Contingent payment liabilities +3,000 +3,000 +— +— +— +Future minimum royalty and advertising payments +49,602 +13,073 +24,644 +11,885 +— +Transition tax +17,973 +$ +1,563 +$ +3,126 +$ +4,493 +$ +8,791 +Total +$ +398,677 +$ +160,318 +$ +107,005 +$ +69,224 +$ +62,130 +At December 31, 2018 , we had no open letters of credit for the purchase of inventory. +Virtually all of our products are produced by independent manufacturers at overseas locations, the majority of which are located in China, with a small and growing percentage located in Italy, Mexico, Vietnam and Cambodia and smaller volumes in Brazil, India, The Netherlands, The Dominican Republic, Spain and South Korea. We have not entered into any long-term manufacturing or supply contracts with any of these foreign manufacturers. We believe that a sufficient number of alternative sources exist outside of the United States for the manufacture of our products. Purchases are made primarily in United States dollars. +The Company has employment agreements with its Creative and Design Chief, Steven Madden, and certain executive officers, which provide for the payment of compensation aggregating approximately $11,101 in 2019 , $9,378 in 2020 and $8,668 in 2021 . In addition, some of these employment agreements provide for discretionary bonuses and some provide for incentive compensation based on various performance criteria as well as other benefits including stock-related compensation. +In connection with our acquisition of Schwartz & Benjamin on January 30, 2017, we are subject to a potential payment of $3,000 to the sellers of Schwartz & Benjamin contingent upon the non-cancellation of a certain license agreement through certain dates. +Transition tax of $17,973 was the result of the Tax Cuts and Jobs Act of 2017 (the "Tax Act"). For further information, refer to Note N to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Excluded from the contractual obligations table above are long-term taxes payable of $1,511 as of December 31, 2018 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond one year due to uncertainties in the timing of tax audit outcomes. +DIVIDENDS +In February 2018, the Board of Directors of the Company declared a quarterly cash dividend of $0.13 per share on the Company’s outstanding shares of common stock. The dividend was paid on March 29, 2018, to stockholders of record as of the close of business on March 12, 2018. The total cash dividends paid for the three months ended March 31, 2018 was $11,758. +In April 2018, the Board of Directors of the Company declared an additional quarterly cash dividend of $0.13 per share on the Company’s outstanding shares of common stock. The dividend was paid on June 29, 2018 to stockholders of record as of the close of business on June 12, 2018. The total cash dividends paid for the three months ended June 30, 2018 was $11,716. +In July 2018, the Board of Directors of the Company declared an additional quarterly cash dividend of $0.13 per share on the Company’s outstanding shares of common stock. The dividend was paid on September 28, 2018 to stockholders of record as of the close of business on September 18, 2018. The total cash dividends paid for the three months ended September 30, 2018 was $11,673. +In October 2018, the Board of Directors of the Company declared an additional quarterly cash dividend of $0.14 per share on the Company’s outstanding shares of common stock. The dividend was paid on December 31, 2018 to stockholders of record as of the close of business on December 21, 2018. The total cash dividends paid for the three months ended December 31, 2018 was $12,169 . +The aggregate cash dividends paid for the twelve months ended December 31, 2018 was $47,316 . +32 +Future quarterly cash dividend payments are subject to the discretion of our Board of Directors and contingent upon future earnings, our financial condition, capital requirements, general business conditions and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +The Company’s Board of Directors approved a quarterly cash dividend of $0.14 per share. The dividend will be paid on March 29, 2019, to stockholders of record at the close of business on March 19, 2019. +INFLATION +We do not believe that inflation and price changes have had a significant effect on the Company's sales or profitability for the fiscal year ended December 31, 2018 and the prior two fiscal years. Historically, we have minimized the impact of product cost increases by increasing prices, changing suppliers and by improving operating efficiencies. However, no assurance can be given that we will be able to offset any such inflationary cost increases in the future. +OFF-BALANCE SHEET ARRANGEMENTS +The Company has no off-balance sheet arrangements. +CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Estimates by their nature are based on judgments and available information. Our estimates are made based upon historical factors, current circumstances and the experience and judgment of management. Assumptions and estimates are evaluated on an ongoing basis and we may employ outside experts to assist in evaluations. Therefore, actual results could materially differ from those estimates under different assumptions and conditions. Management believes the following critical accounting estimates are more significantly affected by judgments and estimates used in the preparation of our consolidated financial statements: allowance for bad debts, returns, and customer chargebacks; inventory valuation; valuation of intangible assets, litigation reserves, and contingent payment liabilities. +Allowances for bad debts . Accounts receivable are reduced by an allowance for amounts that may be uncollectible in the future. Estimates are used in determining the allowance for doubtful accounts and are based on an analysis of the aging of accounts receivable, assessments of collectability based on historical trends, the financial condition of the Company’s customers and an evaluation of economic conditions. In general, the actual bad debt losses have historically been within the Company’s expectations and the allowances it established. The reserve against our non-factored trade receivables also includes estimated losses that may result from customers’ inability to pay. +Customer returns and chargebacks . We provide variable consideration to our customers for chargebacks, co-op advertising allowances, discounts, returns and other miscellaneous deductions that relate to the current period. The amount of the consideration for returns, discounts and compliance chargebacks are determined by analyzing aged receivables, current economic conditions, the prevailing retail environment and historical dilution levels for customers. We evaluate anticipated customer markdowns and advertising chargebacks by reviewing several performance indicators for our major customers. These performance indicators (which include inventory levels at the retail floors, sell through rates and gross margin levels) are analyzed by management to estimate the amount of the anticipated customer allowance. Failure to correctly estimate the amount of the reserve could materially impact our results of operations and financial position. +Inventory valuation . Inventories are stated at lower-of-cost or market, on a first-in, first-out basis. We review inventory on a regular basis for excess and slow moving inventory. The review is based on an analysis of inventory on hand, prior sales, and expected net realizable value through future sales. The analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales and projections for sales in the foreseeable future as well as subsequent sales. We consider quantities on hand in excess of estimated future sales to be at risk for market impairment. The net realizable value, or market value, is determined based on the estimate of sales prices of such inventory through off-price or discount store channels. The likelihood of any material inventory write-down is dependent primarily on the expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product, the economy, or other failure to estimate correctly, in addition to abnormal weather patterns, could result in inventory valuation changes, compared to the valuation determined to be appropriate as of the balance sheet date. +33 +Valuation of intangible assets and goodwill . In accordance with applicable accounting guidance, the Company tests goodwill and intangible assets with indefinite lives at least annually. This accounting guidance also requires that intangible assets with finite lives be amortized over their respective lives to their estimated residual values, and reviewed for impairment in accordance with applicable accounting guidance. +Indefinite-lived intangible assets and goodwill are assessed for impairment by performing a qualitative assessment which evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible or a reporting unit is less than its carrying amount. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the reporting unit is less than its carrying amount, the fair value of the reporting unit is compared with its carrying amount and, if the fair value of the reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount. We perform this annual assessment during our third quarter. +Litigation reserves . Estimated amounts for litigation claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable events of a particular litigation. As additional information becomes available, management will assess the potential liability related to the pending litigation and revise its estimates. Such revisions in management’s estimates of a contingent liability could materially impact our results of operation and financial position. +Contingent payment liabilities. The Company has completed acquisitions that require us to make contingent payments to the sellers based on the future financial performance of the acquired businesses over a period of from one to six years. The fair value of the contingent payments is estimated using the present value of management's projections of the financial results of the acquired business. Failure to correctly project the financial results of the acquired businesses could materially impact our results of operations and financial position. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +($ in thousands) +Our financing arrangements are subject to variable interest rates primarily based on the prime rate and LIBOR. An analysis of our collection agency agreement with Rosenthal can be found in the “Liquidity and Capital Resources” section under Part II, Item 7, and in Note D to the Consolidated Financial Statements included in this Annual Report on Form 10-K under the caption “Factor Receivable.” As of December 31, 2018 , we held marketable securities valued at approximately $66,968 , which consisted primarily of corporate bonds and certificates of deposit. The values of these securities may fluctuate as a result of changes in values, market interest rates and credit risk. We have the ability to hold these investments until maturity. In addition, any decline in interest rates would be expected to reduce our interest income. +We face market risk to the extent that our U.S. or foreign operations involve the transaction of business in foreign currencies. Also, our inventory purchases are primarily done in foreign jurisdictions and inventory purchases may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of our contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks primarily by denominating these purchases in U.S. dollars. To mitigate the risk of purchases that are denominated in foreign currencies we may enter into forward foreign exchange contracts for terms of no more than two years. A description of our accounting policies for derivative financial instruments is included in Notes A and L to the Consolidated Financial Statements. +During 2018 , the Company entered into forward foreign exchange contracts totaling $56,879 . We performed a sensitivity analysis based on a model that measures the impact of a hypothetical change in foreign currency exchange rates to determine the effects that market risk exposures may have on the fair values of our forward foreign exchange contracts that were outstanding as of the year-end. As of December 31, 2018 , a 10% appreciation or depreciation of the U.S. dollar against the exchange rates for foreign currencies under forward foreign exchange contracts would result in a net increase or decrease, respectively, in the fair value of our derivatives portfolio of approximately $2,919 . +In addition, we are exposed to translation risk in connection with our foreign operations in Canada, Mexico, Europe, South Africa, China, Taiwan and Israel because our subsidiaries and joint ventures in these countries utilize the local currency as their functional currency and those financial results must be translated into U.S. dollars. As currency exchange rates fluctuate, foreign currency exchange rate translation adjustments reflected in our financial statements with respect to our foreign operations affects the comparability of financial results between years. +34 +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The information required by this Item is incorporated herein by reference to the consolidated financial statements listed in response to Item 15 of Part IV of this Annual Report on Form 10-K. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND +FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2018 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2018 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2018 . Their report appears in this Annual Report on Form 10-K. +Remediation of Material Weakness +A material weakness is a deficiency or a combination of deficiencies in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s financial statements will not be prevented or detected on a timely basis. The material weakness that we previously reported was identified as of December 31, 2017 related to the design and implementation of effective control over risk assessment with regard to certain processes and procedures commensurate with our financial reporting requirements. Specifically, we did not design and maintain adequate information technology general controls +35 +for information systems that are relevant to the preparation of financial statements in certain areas. The deficiencies in internal control over financial reporting were detailed in Item 9A of the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2017. +During the fourth quarter of 2018, management of the Company implemented measures that it believes are sufficient to fully remediate each of the deficiencies resulting in the material weakness, which measures are described in Item 4 of the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2018. During the fourth quarter of fiscal 2018, we successfully completed the testing necessary to conclude that the material weakness has been remediated. We will continue to monitor the effectiveness of these and other processes, procedures, and controls and will make any further changes that management determines to be appropriate. +Changes in Internal Control Over Financial Reporting +We have taken actions to remediate the material weakness related to our internal control over financial reporting, as described in Remediation of Material Weakness above. During the quarter ended December 31, 2018, we also implemented a plan that called for modifications to our internal controls over financial reporting (“ICFR”) related to the accounting for leases as a result of ASU 2016-02. The modified controls have been designed to address risks associated with accounting for lease assets and liabilities and the related income and expenses under ASC 842. We have therefore augmented ICFR as follows: +• +Implementing a new IT system to capture, calculate, and account for leases. +• +Modified existing and implemented new controls that address risks associated with accounting for lease assets and liabilities and the related income and expense, including the revision of our contract review controls. +Other than remediation of the material weakness referenced above and changes in controls relating to ASC 842, there was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2018, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. OTHER INFORMATION +On February 27, 2019, the Company issued a press release reporting its financial results for the fiscal quarter and fiscal year ended December 31, 2018 , a copy of which is attached as Exhibit 99.01 to this Annual Report. +The Company’s press release on February 27, 2019 also announced that the Company’s Board of Directors has declared a quarterly cash dividend of $0.14 per share on the Company’s outstanding shares of common stock. The dividend is payable on March 29, 2019, to the stockholders of record as of the close of business on March 19, 2019. The full text of the press release is attached as Exhibit 99.01 to this Annual Report. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2019 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 11. EXECUTIVE COMPENSATION +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2019 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND +RELATED STOCKHOLDER MATTERS +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2019 Annual Meeting of Stockholders, and is incorporated herein by reference. +36 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2019 Annual Meeting of Stockholders, and is incorporated herein by reference. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2019 Annual Meeting of Stockholders, and is incorporated herein by reference. +PART IV +ITEM 15 +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) Financial Statements and Financial Statements Schedules +See Index to Consolidated Financial Statements included herein. +(b) Exhibits. See the exhibit index included herein. +37 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. +DATE: February 28, 2019 +STEVEN MADDEN, LTD. +/s/ EDWARD R. ROSENFELD +Edward R. Rosenfeld +Chairman and Chief Executive Officer +/s/ ARVIND DHARIA +Arvind Dharia +Chief Financial Officer and Chief Accounting Officer +38 +POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each of the undersigned constitutes and appoints Edward R. Rosenfeld and Arvind Dharia, and each of them, as attorneys-in-fact and agents, with full power of substitution and re-substitution, for and in the name, place and stead of the undersigned, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all that each of said attorney-in-fact or substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. +Signature +Title +Date +/S/ EDWARD R. ROSENFELD +Chairman, Chief Executive Officer and Director +February 28, 2019 +Edward R. Rosenfeld +/S/ ARVIND DHARIA +Chief Financial Officer and Chief Accounting Officer +February 28, 2019 +Arvind Dharia +/S/ AMELIA NEWTON VARELA +President and Director +February 28, 2019 +Amelia Newton Varela +/S/ PETER MIGLIORINI +Director +February 28, 2019 +Peter Migliorini +/S/ RICHARD P. RANDALL +Director +February 28, 2019 +Richard P. Randall +/S/ RAVI SACHDEV +Director +February 28, 2019 +Ravi Sachdev +/S/ THOMAS H. SCHWARTZ +Director +February 28, 2019 +Thomas H. Schwartz +/S/ ROSE LYNCH +Director +February 28, 2019 +Rose Lynch +/S/ ROBERT SMITH +Director +February 28, 2019 +Robert Smith +/S/ MITCHELL S. KLIPPER +Director +February 28, 2019 +Mitchell S. Klipper +39 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Reports of Independent Registered Public Accounting Firm +F-1 +Consolidated Balance Sheets as of December 31, 2018 and 2017 +F-3 +Consolidated Statements of Income for the years ended December 31, 2018, 2017 and 2016 +F-4 +Consolidated Statements of Comprehensive Income for the years ended December 31, 2018, 2017 and 2016 +F-5 +Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2018, 2017 and 2016 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017 and 2016 +F-8 +Notes to Consolidated Financial Statements +F-9 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Steven Madden Ltd. and Subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Steven Madden Ltd. and Subsidiaries (the “Company") as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2018 and 2017, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework ( 2013 ) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 28, 2019 expressed an unqualified opinion. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +We have served as the Company’s auditor since 1995 +/s/ EisnerAmper LLP +EISNERAMPER LLP +New York, New York +February 28, 2019 +F-1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders +Steven Madden, Ltd. and Subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited Steven Madden Ltd. and Subsidiaries’ (the “Company") internal control over financial reporting as of December 31, 2018, based on criteria established in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in the Internal Control - Integrated Framework ( 2013 ) issued by COSO. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the consolidated balance sheets of Steven Madden Ltd. and Subsidiaries’ as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes and our report dated February 28, 2019 expressed an unqualified opinion. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +An entity’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. An entity’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the entity; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ EisnerAmper LLP +EISNERAMPER LLP +New York, New York +February 28, 2019 +F-2 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Balance Sheets +(in thousands) +December 31, +2018 +2017 +ASSETS +Current assets: +Cash and cash equivalents +$ +200,031 +$ +181,214 +Accounts receivable, net of allowances of $10,849 and $1,973 +25,057 +39,473 +Factor accounts receivable +241,395 +201,436 +Inventories +137,247 +110,324 +Marketable securities – available for sale +66,968 +64,027 +Prepaid expenses and other current assets +23,425 +19,538 +Prepaid taxes +9,002 +29,506 +Total current assets +703,125 +645,518 +Note receivable – related party +1,927 +2,289 +Property and equipment, net +64,807 +71,498 +Deferred taxes +9,321 +6,370 +Deposits and other +1,967 +2,121 +Marketable securities – available for sale +— +29,523 +Goodwill – net +148,112 +148,538 +Intangibles – net +143,311 +151,304 +Total Assets +$ +1,072,570 +$ +1,057,161 +LIABILITIES +Current liabilities: +Accounts payable +$ +79,802 +$ +66,955 +Accrued expenses +130,592 +120,624 +Income taxes payable +— +1,566 +Contingent payment liability – current portion +3,000 +7,000 +Accrued incentive compensation +11,295 +10,467 +Total current liabilities +224,689 +206,612 +Contingent payment liability +— +3,000 +Deferred rent +15,786 +16,033 +Deferred taxes +4,041 +3,602 +Other liabilities +13,372 +18,982 +Total Liabilities +257,888 +248,229 +Commitments, contingencies and other (Note O) +STOCKHOLDERS’ EQUITY +Preferred stock – $.0001 par value, 5,000 shares authorized; none issued; Series A Junior Participating preferred stock – $.0001 par value, 60 shares authorized; none issued +— +— +Common stock – $.0001 par value, 135,000 shares authorized, 131,991 and 130,960 shares issued, 85,715 and 88,047 shares outstanding +6 +6 +Additional paid-in capital +424,835 +390,723 +Retained earnings +1,217,521 +1,135,701 +Accumulated other comprehensive loss +(32,628 +) +(25,613 +) +Treasury stock – 46,276 and 42,913 shares at cost +(803,920 +) +(697,996 +) +Total Steven Madden, Ltd. stockholders’ equity +805,814 +802,821 +Noncontrolling interest +8,868 +6,111 +Total stockholders’ equity +814,682 +808,932 +Total Liabilities and Stockholders’ Equity +$ +1,072,570 +$ +1,057,161 +See accompanying notes to consolidated financial statements +F-3 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Income +(in thousands, except per share data) +Years Ended December 31, +2018 +2017 +2016 +Net sales +$ +1,653,609 +$ +1,546,098 +$ +1,399,551 +Cost of sales +1,037,571 +968,357 +877,568 +Gross profit +616,038 +577,741 +521,983 +Commission and licensing fee income – net +5,417 +14,259 +11,788 +Operating expenses +448,073 +421,216 +364,595 +Impairment charges +— +1,000 +— +Income from operations +173,382 +169,784 +169,176 +Interest and other income - net +3,958 +2,543 +1,824 +Income before provision for income taxes +177,340 +172,327 +171,000 +Provision for income taxes (Note N) +46,841 +53,189 +49,726 +Net income +130,499 +119,138 +121,274 +Less: net income attributable to noncontrolling interest +1,363 +1,190 +363 +Net income attributable to Steven Madden, Ltd. +$ +129,136 +$ +117,948 +$ +120,911 +Basic net income per share +$ +1.58 +$ +1.43 +$ +1.41 +Diluted net income per share +$ +1.50 +$ +1.36 +$ +1.35 +Basic weighted average common shares outstanding +81,664 +82,736 +85,664 +Effect of dilutive securities – options/restricted stock +4,433 +4,009 +3,670 +Diluted weighted average common shares outstanding +86,097 +86,745 +89,334 +Cash dividends declared per common share +$ +0.53 +$ +— +$ +— +See accompanying notes to consolidated financial statements +F-4 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Comprehensive Income +(in thousands) +2018 +Pre-tax amounts +Tax (expense) +After-tax amounts +Net income +$ +130,499 +Other comprehensive (loss): +Foreign currency translation adjustment +$ +(7,983 +) +$ +— +(7,983 +) +Gain on cash flow hedging derivatives +1,150 +(276 +) +874 +Unrealized gain on marketable securities +124 +(30 +) +94 +Total other comprehensive (loss) +$ +(6,709 +) +$ +(306 +) +(7,015 +) +Comprehensive income +123,484 +Less: comprehensive income attributable to noncontrolling interests +1,363 +Comprehensive income attributable to Steven Madden, Ltd. +$ +122,121 +2017 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +119,138 +Other comprehensive income: +Foreign currency translation adjustment +$ +6,836 +$ +— +6,836 +(Loss) on cash flow hedging derivatives +(1,282 +) +468 +(814 +) +Unrealized gain on marketable securities +183 +(67 +) +116 +Total other comprehensive income +$ +5,737 +$ +401 +6,138 +Comprehensive income +125,276 +Less: comprehensive income attributable to noncontrolling interests +1,190 +Comprehensive income attributable to Steven Madden, Ltd. +$ +124,086 +2016 +Pre-tax amounts +Tax (expense) +After-tax amounts +Net income +$ +121,274 +Other comprehensive (loss): +Foreign currency translation adjustment +$ +(2,147 +) +$ +— +(2,147 +) +Gain on cash flow hedging derivatives +797 +(291 +) +506 +Unrealized gain on marketable securities +2,052 +(749 +) +1,303 +Total other comprehensive income/(loss) +$ +702 +$ +(1,040 +) +(338 +) +Comprehensive income +120,936 +Less: comprehensive income attributable to noncontrolling interests +363 +Comprehensive income attributable to Steven Madden, Ltd. +$ +120,573 +See accompanying notes to consolidated financial statements +F-5 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity +(in thousands) +Common Stock +Additional Paid‑in Capital +Retained Earnings +Shares +Amount +Balance - December 31, 2015 +92,540 +$ +6 +$ +325,548 +$ +896,842 +Share repurchases +(3,656 +) +— +— +— +Exercise of stock options +1,119 +— +10,713 +— +Issuance of restricted stock +612 +— +— +— +Stock-based compensation +— +— +19,509 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain on securities (net of tax expense of $749) +— +— +— +— +Cash flow hedge (net of tax expense of $291) +— +— +— +— +Distributions to non-controlling interests, net +— +— +— +— +Acquisition of Minority Interest (net of tax benefit of $1,432) +— +— +(2,327 +) +— +Net income +— +— +— +120,911 +Balance - December 31, 2016 +90,615 +6 +353,443 +1,017,753 +Share repurchases +(3,902 +) +— +— +— +Exercise of stock options +983 +— +16,433 +— +Issuance of restricted stock +351 +— +— +— +Stock-based compensation +— +— +20,847 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain on securities (net of tax expense of $67) +— +— +— +— +Cash flow hedge (net of tax benefit of $468) +— +— +— +— +Non-controlling investment in JV +— +— +— +— +Net income +— +— +— +117,948 +Balance - December 31, 2017 +88,047 +6 +390,723 +1,135,701 +Share repurchases +(3,363 +) +— +— +— +Exercise of stock options +593 +— +13,036 +— +Issuance of restricted stock +438 +— +— +— +Stock-based compensation +— +— +21,076 +— +Foreign currency translation adjustment +— +— +— +— +Unrealized holding gain on securities (net of tax expense of $30) +— +— +— +— +Cash flow hedge (net of tax expense of $276) +— +— +— +— +Dividends on common stock ($0.53 per share) +— +— +— +(47,316 +) +Distributions to non-controlling interests, net +— +— +— +— +Non-controlling investment in JV +— +— +— +— +Net income +— +— +— +129,136 +Balance - December 31, 2018 +85,715 +$ +6 +$ +424,835 +$ +1,217,521 +See accompanying notes to consolidated financial statements +F-6 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity (Continued) +(in thousands) +Accumulated Other Comprehensive (Loss) +Treasury Stock +Non-controlling Interest +Total Stockholders' Equity +Shares +Amount +Balance - December 31, 2015 +$ +(31,413 +) +35,355 +$ +(512,579 +) +$ +259 +$ +678,663 +Share repurchases +— +3,656 +(86,005 +) +— +(86,005 +) +Exercise of stock options +— +— +— +— +10,713 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +— +19,509 +Foreign currency translation adjustment +(2,147 +) +— +— +— +(2,147 +) +Unrealized holding gain on securities (net of tax expense of $749) +1,303 +— +— +— +1,303 +Cash flow hedge (net of tax expense of $291) +506 +— +— +— +506 +Distributions to non-controlling interests, net +— +— +— +(417 +) +(417 +) +Acquisition of Minority Interest (net of tax benefit of $1,432) +— +— +— +— +(2,327 +) +Net income +— +— +— +363 +121,274 +Balance - December 31, 2016 +(31,751 +) +39,011 +(598,584 +) +205 +741,072 +Share repurchases +— +3,902 +(99,412 +) +— +(99,412 +) +Exercise of stock options +— +— +— +— +16,433 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +20,847 +Foreign currency translation adjustment +6,836 +— +— +— +6,836 +Unrealized holding gain on securities (net of tax expense of $67) +116 +— +— +— +116 +Cash flow hedge (net of tax benefit of $468) +(814 +) +— +— +— +(814 +) +Non-controlling investment in JV +— +— +— +4,716 +4,716 +Net income +— +— +— +1,190 +119,138 +Balance - December 31, 2017 +(25,613 +) +42,913 +(697,996 +) +6,111 +808,932 +Share repurchases +— +3,363 +(105,924 +) +— +(105,924 +) +Exercise of stock options +— +— +— +— +13,036 +Issuance of restricted stock +— +— +— +— +— +Stock-based compensation +— +— +— +21,076 +Foreign currency translation adjustment +(7,983 +) +— +— +— +(7,983 +) +Unrealized holding gain on securities (net of tax expense of $30) +94 +— +— +— +94 +Cash flow hedge (net of tax expense of $276) +874 +— +— +— +874 +Dividends on common stock ($0.53 per share) +— +— +— +— +(47,316 +) +Distributions to non-controlling interests, net +— +— +— +(1,183 +) +(1,183 +) +Non-controlling investment in JV +— +— +— +2,577 +2,577 +Net income +— +— +— +1,363 +130,499 +Balance - December 31, 2018 +$ +(32,628 +) +46,276 +$ +(803,920 +) +$ +8,868 +$ +814,682 +See accompanying notes to consolidated financial statements +F-7 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +(in thousands) +Years Ended December 31, +2018 +2017 +2016 +Cash flows from operating activities: +Net income +$ +130,499 +$ +119,138 +$ +121,274 +Adjustments to reconcile net income to net cash provided by operating activities: +Stock-based compensation +21,076 +20,847 +19,509 +Depreciation and amortization +22,482 +21,389 +21,102 +Loss on disposal of fixed assets +1,220 +1,455 +652 +Impairment charges +— +1,000 +— +Deferred taxes +(2,512 +) +(19,274 +) +(6,588 +) +Accrued interest on note receivable – related party +(47 +) +(54 +) +(63 +) +Deferred rent (benefit)/expense +(247 +) +1,455 +2,565 +Realized loss/(gain) on sale of marketable securities +189 +(5 +) +661 +Change in fair value of contingent liability +— +(11,206 +) +(425 +) +Provisions for bad debt expense and write-off of an unamortized buying agency agreement support payment associated with the Payless ShoeSource bankruptcies +12,123 +5,470 +— +Changes, net of acquisitions, in: +Accounts receivable +4,966 +22,683 +(13,617 +) +Factor accounts receivable +(39,959 +) +(57,268 +) +11,043 +Notes receivable - related party +409 +409 +409 +Inventories +(26,923 +) +21,135 +(17,744 +) +Prepaid expenses, prepaid taxes, deposits and other +14,633 +2,403 +(3,461 +) +Accounts payable and accrued expenses +21,249 +9,501 +15,324 +Accrued incentive compensation +828 +2,507 +1,819 +Other liabilities +(5,610 +) +16,350 +1,144 +Net cash provided by operating activities +154,376 +157,935 +153,604 +Cash flows from investing activities: +Capital expenditures +(12,450 +) +(14,775 +) +(15,897 +) +Purchases of marketable securities +(77,262 +) +(61,209 +) +(40,451 +) +Proceeds from notes receivable +— +221 +249 +Maturity/sale of marketable securities +100,777 +79,141 +52,215 +Acquisitions, net of cash acquired +— +(16,795 +) +— +Net cash provided by/(used in) investing activities +11,065 +(13,417 +) +(3,884 +) +Cash flows from financing activities: +Proceeds from exercise of stock options +13,036 +16,433 +10,713 +Investment of noncontrolling interest +2,577 +— +(3,759 +) +Distribution of noncontrolling interests earnings +(1,183 +) +— +— +Payment of contingent liability +(7,000 +) +(7,359 +) +(16,402 +) +Common stock purchased for treasury +(105,924 +) +(99,412 +) +(86,005 +) +Cash dividends paid on common stock +(47,316 +) +— +— +Net cash (used in) financing activities +(145,810 +) +(90,338 +) +(95,453 +) +Effect of exchange rate changes on cash and cash equivalents +(814 +) +919 +(566 +) +Net increase in cash and cash equivalents +18,817 +55,099 +53,701 +Cash and cash equivalents – beginning of year +181,214 +126,115 +72,414 +Cash and cash equivalents – end of year +$ +200,031 +$ +181,214 +$ +126,115 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +36 +$ +24 +$ +222 +Income taxes +$ +37,105 +$ +61,979 +$ +55,384 +See accompanying notes to consolidated financial statements. +F-8 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Note A – Summary of Significant Accounting Policies +[1] Organization: +Steven Madden, Ltd. a Delaware corporation, and its subsidiaries, design, source, market and sell name brand and private label women's, men's and children's shoes, worldwide through its wholesale and retail channels under the Steve Madden Women's, Steve Madden Men's, Madden, Madden Girl, Steven, Superga (under license), Dolce Vita and Betsey Johnson brand names and through its wholesale channels under the Stevies, Report, Mad Love and Blondo brand names and, under license, the Kate Spade and Anne Klein brand names. An agreement under which the Company licensed the Avec Les Filles® trademark terminated as of December 31, 2018. +In addition, the Company designs, sources, markets and sells name brand and private label handbags and accessories to customers worldwide through its Wholesale Accessories segment, including the Big Buddha, Betsey Johnson, Madden Girl, Betseyville, Cejon, Steve Madden, Steven by Steve Madden, Luv Betsey, DKNY (under license), Anne Klein (under license) and Donna Karan (under license) accessories brands. Revenue is generated predominantly through the sale of the Company's brand name and private label merchandise and certain licensed products. At December 31, 2018 and 2017 , the Company operated 229 (including 7 e-commerce websites) and 206 (including 4 e-commerce websites) retail stores, respectively. Revenue is subject to seasonal fluctuations. See Note P for operating segment information. +[2] Principles of Consolidation: +The consolidated financial statements include the accounts of Steven Madden, Ltd. and its wholly-owned subsidiaries Steven Madden Retail, Inc., Diva Acquisition Corp., Diva International, Inc., Madden Direct, Inc., Adesso Madden, Inc., Stevies, Inc., Daniel M. Friedman and Associates, Inc., Big Buddha, Inc., the Topline Corporation, Cejon, Inc., SML Holdings S.a.r.l., SML Canada Acquisition Corp., Madden International Ltd., DMF International Ltd., Asean Corporation Ltd., Dolce Vita Holdings, Inc., Trendy Imports S.A de C.V., Comercial Diecesiette S.A. de C.V., Maximus Designer Shoes S.A. de C.V., BA Brand Holdings LLC, BAI Holding, LLC, Mad Love LLC and Schwartz & Benjamin, Inc. (collectively the "Company"). The accounts of (i) Dexascope Proprietary Ltd., a joint venture in South Africa in which the Company is the majority owner, (ii) BA Brand Holdings LLC, a joint venture in which the Company is the majority owner, (iii) SPM Shoetrade Holding B.V., a joint venture in certain regions of Europe in which the Company is the majority owner, (iv) SM (Jiangsu) Co., Ltd., a joint venture in which the Company controls all of the significant participating rights, (v) SM Dolce Limited, a joint venture in which the Company is the majority interest holder and (vi) SM Distribution Israel L.P., a joint venture in which the Company is the majority interest holder, are included in the consolidated financial statements with the other members' interests reflected in “Net income attributable to noncontrolling interest” in the Consolidated Statements of Income and “Noncontrolling interest” in the Consolidated Balance Sheets. All significant intercompany balances and transactions have been eliminated. Certain reclassifications were made to prior years' amounts to conform to the 2018 presentation. +[3] Use of Estimates: +The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +Significant areas involving management estimates include variable consideration included in revenue, allowances for bad debts, inventory valuation, valuation of intangible assets, litigation reserves and contingent payment liabilities. The Company estimates variable consideration on trade accounts receivables and factor receivables for future customer chargebacks and markdown allowances, discounts, returns and other miscellaneous compliance-related deductions that relate to the current period sales. The Company evaluates +F-9 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +anticipated chargebacks by reviewing several performance indicators of its major customers. These performance indicators, which include retailers’ inventory levels, sell-through rates and gross margin levels, are analyzed by management to estimate the amount of the anticipated customer allowance. +[4] Cash Equivalents: +Cash equivalents at December 31, 2018 and 2017 amounted to approximately $77,050 and $58,436 , respectively, and consisted of money market accounts. The Company considers all highly liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. +[5] Marketable Securities: +Marketable securities consist primarily of certificates of deposit and corporate bonds with maturities greater than three months and up to four years at the time of purchase. These securities, which are classified as available-for-sale, are carried at fair value, with unrealized gains and losses, net of any tax effect, reported in stockholders’ equity as accumulated other comprehensive income/(loss). These securities are classified as current and non-current marketable securities based upon their maturities. Amortization of premiums and discounts is included in interest income. For the years ended December 31, 2018 and 2017 , the amortization of bond premiums totaled $728 and $983 , respectively. The values of these securities may fluctuate as a result of changes in market interest rates and credit risk. The schedule of maturities at December 31, 2018 and 2017 is as follows: +Maturities as of +December 31, 2018 +Maturities as of +December 31, 2017 +1 Year or Less +1 to 4 Years +1 Year or Less +1 to 4 Years +Corporate bonds +$ +24,617 +$ +— +$ +11,979 +$ +29,523 +Certificates of deposit +42,351 +— +52,048 +— +Total +$ +66,968 +$ +— +$ +64,027 +$ +29,523 +For the year ended December 31, 2018 , losses of $189 were reclassified from accumulated other comprehensive income and recognized in the Consolidated Statements of Income in interest and other income as compared to gains of $5 for the year ended December 31, 2017 . At December 31, 2018 , current marketable securities included unrealized losses of $67 and no non-current marketable securities were held by the Company. At December 31, 2017 , current marketable securities included unrealized losses of $106 and unrealized gains of $1 and non-current marketable securities included unrealized gains of $3 and unrealized losses of $90 . +[6] Inventories: +Inventories, which consist of finished goods on hand and in transit, are stated at the lower of cost (first-in, first-out method) or net realizable value. +[7] Property and Equipment: +Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed utilizing the straight-line method based on estimated useful lives ranging from three to ten years. Leasehold improvements are amortized utilizing the straight-line method over the shorter of their estimated useful lives or the remaining lease term. Impairment losses are recognized for long-lived assets, including definite-lived intangibles, used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are not sufficient to recover the assets' carrying amount. Impairment losses are measured by comparing the fair value of the assets to their carrying amount. +F-10 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +[8] Goodwill and Intangible Assets: +The Company's goodwill and indefinite lived intangible assets are not amortized, rather they are tested for impairment on an annual basis, or more often if events or circumstances change that could cause these assets to become impaired. +In accordance with applicable accounting guidance, indefinite-lived intangible assets and goodwill are assessed for impairment by performing a qualitative assessment which evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible asset or reporting unit is less than its carrying amount. The factors that are considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the intangible asset or reporting unit is less than its carrying amount, the fair value of the intangible asset or reporting unit is compared with its carrying amount and, if the fair value of the intangible asset or reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the carrying value of the intangible asset or reporting unit exceeds its fair value, not to exceed the carrying amount. During the fourth quarter of 2017, the Company recognized an impairment charge of $1,000 related to the Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows. The Company completed its annual impairment tests on goodwill and its remaining indefinite-lived intangible assets during the third quarter of 2018 , and no other impairments were recognized. +The Company amortizes its intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment when there is a triggering event. The Company is currently amortizing its acquired intangible assets with definite useful lives over periods typically from two to ten years using the straight-line method. +[9] Net Income Per Share of Common Stock: +Basic net income per share is based on the weighted average number of shares of common stock outstanding during the period, which does not include unvested restricted common stock subject to forfeiture of 5,135,000 , 5,874,000 and 6,287,000 for the years ended December 31, 2018 , 2017 , and 2016 , respectively. Diluted net income per share reflects: a) the potential dilution assuming shares of common stock were issued upon the exercise of outstanding in-the-money options and the proceeds thereof were used to purchase shares of the Company’s common stock at the average market price during the period, and b) the vesting of granted nonvested restricted stock awards for which the assumed proceeds upon vesting are deemed to be the amount of compensation cost not yet recognized attributable to future services using the treasury stock method, to the extent dilutive. For the years ended December 31, 2018 , 2017 and 2016 , options to purchase approximately 45,000 , 14,000 and 561,000 shares of common stock, respectively, have been excluded in the calculation of diluted income per share as the result would have been anti-dilutive. For the years ended December 31, 2018 , 2017 and 2016 , all unvested restricted stock awards were dilutive. +[10] Comprehensive Income: +Comprehensive income is the total of net earnings and all other non-owner changes in equity. Comprehensive income for the Company includes net income, foreign currency translation adjustments, cash flow hedging and unrealized gains and losses on marketable securities. The accumulated balances for each component of other comprehensive loss attributable to the Company are as follows: +2018 +2017 +Currency translation adjustment +$ +(33,091 +) +$ +(24,798 +) +Cash flow hedges, net of tax +530 +(623 +) +Unrealized loss on securities, net of tax +(67 +) +(192 +) +Accumulated other comprehensive loss +$ +(32,628 +) +$ +(25,613 +) +F-11 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +[11] Advertising costs: +The Company expenses costs of print, radio and billboard advertisements as incurred. Advertising expenses included in operating expenses amounted to approximately $21,921 in 2018 , $19,629 in 2017 and $16,024 in 2016 . +[12] Revenue Recognition: +In May 2014, the Financial Accounting Standards Board (the "FASB") issued new accounting guidance ("Topic 606"), as amended, Accounting Standards Update No. 2014-09 ("ASU 2014-09"), "Revenue from Contracts with Customers," on revenue recognition. The new standard has replaced Revenue Recognition Topic 605 and provides for a single five-step model to be applied to all revenue contracts with customers as well as requiring additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Effective January 1, 2018, the Company adopted the requirements of Topic 606 using the cumulative effect adjustment approach. The impacts to the financial statements of this adoption are primarily related to balance sheet classification, including amounts associated with the change in balance sheet classification of the sales returns reserves, with no significant impact to the income statement as the Company's previous revenue recognition policies are in line with Topic 606. +The Company recognizes revenue when performance obligations identified under the terms of contracts with its customers are satisfied, which generally occurs upon the transfer of control in accordance with the contractual terms and conditions of the sale. The majority of the Company’s revenue is recognized at a point in time when product is shipped to the customer. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods, which includes estimates for variable consideration. Variable consideration mainly includes markdown allowances, co-op advertising programs and product returns. The revenue recognition for the Company's segments are described below (see Note P for disaggregated revenue amounts by segment). +A. Disaggregation of Revenue +Wholesale Sales Segment. The Company generates revenue through the design, sourcing and sale of branded footwear and accessories to both domestic and international customers who, in turn, sell the products to the consumer. The Company recognizes revenue when performance obligations identified under the terms of contracts with its customers are satisfied, which occurs upon the transfer of control of the merchandise in accordance with the contractual terms and conditions of the sale. The Company's revenue associated with its branded footwear and accessories products is recognized at a point in time when product is shipped to the customer. The Company also generates revenue through the design, sourcing and sale of private label footwear and accessories to both domestic and international customers who brand the products and sell them to the consumer. The Company's revenue associated with private label footwear and accessories products is recognized at a point in time when product is physically delivered to the customer's freight forwarder. +Retail Segment. The Company owns and operates 229 retail stores throughout the United States, Canada, Mexico, South Africa, Israel and China, including 7 e-commerce sites. The Company generates revenue through the sale of branded footwear and accessories directly to the consumer. The Company's revenue associated with Retail segment sales is recognized at the time of the point of sale when the customer takes control of the goods and payment is received. +First Cost Segment. The Company earns commissions for serving as a buying agent for footwear products under private labels and certain owned brands for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, the Company utilizes its expertise and relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. The Company’s commission revenue also includes fees charged for its design and product development services provided to certain suppliers. The Company satisfies its performance obligation to its customers by performing the services in buyer agency agreements and thereby earning its commission fee at the point in time when the customer’s +F-12 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +freight forwarder takes control of the goods. The Company satisfies its performance obligation with the suppliers and earns its design fee from the factory at the point in time when the customer’s freight forwarder takes control of the goods. +Licensing Segment. The Company licenses various trademarks it owns under licensing agreements for use in connection with the manufacture, marketing and sale of eyewear, outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, fragrance, men’s leather accessories, women's and children's apparel, swimwear and household goods. The license agreements require the licensee to pay the Company a royalty and, in substantially all of the agreements, an advertising fee, both of which are based on the higher of a minimum or actual net sales percentage as defined in the various agreements. Licensing revenue is recognized on the basis of net sales reported by the licensees, or the minimum guaranteed royalties, if higher. In substantially all of the Company’s license agreements, the minimum guaranteed royalty is earned and receivable on a quarterly basis. The Company recognizes licensing revenue over the period of time in which the license is provided to the benefit of the licensee. +B. Variable Consideration +Markdown Allowances +The Company provides markdown allowances to its retailer customers, which are recorded as a reduction of revenue in the period in which the branded footwear and accessories revenues are recognized. The Company estimates its markdown allowances by reviewing several performance indicators, including retailers' inventory levels, sell-through rates and gross margin levels. +Co-op Advertising Programs +Under co-op advertising programs, the Company agrees to reimburse the retailer for a portion of the costs incurred by the retailer to advertise and promote certain of the Company's products. The Company estimates the costs of co-op advertising programs based on the terms of the agreements with its retailer customers. +Rights of Return +The Company’s Retail segment accepts returns within 30 days from the date of sale for unworn merchandise which the Company is able to re-sell through the channel. The Company does not accept returns as a normal business practice from its branded and private label wholesale customers except for our cold weather accessories business and our Blondo and Kate Spade brands product lines. The Company estimates returns based on historical experience and current market conditions. Such amounts have historically not been material. +Sales Deductions +The Company supports retailers’ initiatives to maximize sales of the Company’s products on the retail floor by subsidizing the co-op advertising programs of such retailers, providing them with inventory markdown allowances and participating in various other marketing initiatives of its major customers. In addition, the Company accepts returns for damaged products for which the Company’s costs are normally charged back to the responsible third-party factory. Such expenses are reflected in the consolidated financial statements as deductions to arrive at net sales. +[13] Taxes Collected from Customers: +The Company accounts for certain taxes collected from its customers in accordance with the accounting guidance which permits companies to adopt a policy of presenting taxes in the income statement on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues). Taxes within the scope of this accounting guidance would include taxes that are imposed on a revenue transaction between a seller and a customer, for +F-13 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +example, sales taxes, use taxes, value-added taxes and some types of excise taxes. The Company records all taxes on a net basis. +[14] Cost of Sales: +All costs incurred to bring finished products to the Company’s distribution center or to the customers’ freight forwarder and, in the Retail segment, the costs to bring products to the Company’s stores, are included in the cost of sales line on the Consolidated Statements of Income. These include the cost of finished products, purchase commissions, letter of credit fees, brokerage fees, sample expenses, custom duty, inbound freight, royalty payments on licensed products, labels and product packaging. All warehouse and distribution costs related to the Wholesale segments and freight to customers, if any, are included in the operating expenses line item of the Company’s Consolidated Statements of Income. The Company’s gross margins may not be comparable to those of other companies in the industry because some companies may include warehouse and distribution costs, as well as other costs excluded from cost of sales by the Company, as a component of cost of sales, while other companies report on the same basis as the Company and include them in operating expenses. +[15] Warehouse and Shipping Costs: +The Company includes all warehouse and shipping costs for the Wholesale segment in the operating expenses line on the Consolidated Statements of Income. For the years ended December 31, 2018 , 2017 and 2016 , the total warehouse and distribution costs included in operating expenses were $43,340 , $32,395 and $27,079 , respectively. Since the Company's standard terms of sales are “FOB Steve Madden warehouse,” the Company's wholesale customers absorb most shipping costs. Shipping costs to wholesale customers incurred by the Company are not considered significant and are included in the operating expenses line item in the Consolidated Statements of Income. +[16] Employee Benefit Plan: +The Company maintains a tax-qualified 401(k) plan which is available to each of the Company's eligible employees who elect to participate after meeting certain length-of-service requirements. The Company made discretionary matching contributions of 50% of employees' contributions up to a maximum of 6% of employees' compensation which vest to the employees over a period of time. Total matching contributions to the plan for 2018 , 2017 and 2016 were approximately $1,893 , $1,819 and $1,633 , respectively. +[17] Derivative Instruments: +The Company uses derivative instruments to manage its exposure to cash-flow variability from foreign currency risk. Derivatives are carried on the balance sheet at fair value and included in prepaid expenses and other current assets or accrued expenses. The Company applies cash flow hedge accounting for its derivative instruments. Net derivative gains and losses attributable to derivatives subject to cash flow hedge accounting reside in accumulated other comprehensive income/(loss) and will be reclassified to earnings in future periods as the economic transactions to which the derivatives relate affect earnings. See Note L - Derivative Instruments. +[18] Income Taxes: +The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. +The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the +F-14 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +largest benefit that has a greater than 50% likelihood of being realized upon settlement. See Note N - Income Taxes. +[19] Share-based Compensation: +The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for equity instruments of the Company. Share-based compensation cost for restricted stock units (“RSUs”) is measured based on the closing fair market value of the Company’s common stock on the date of grant. Share-based compensation cost for stock options is measured at the grant date, based on the fair-value as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The BSM option-pricing model incorporates various assumptions including expected volatility, estimated expected life and interest rates. The Company recognizes share-based compensation cost over the award’s requisite service period. The Company recognizes a benefit from share-based compensation in operating expenses in the Consolidated Statements of Income if an incremental tax benefit is realized. See Note I - Equity- Based Compensation. +Note B – Stock Split +On September 17, 2018, the Company announced that on September 11, 2018 its Board of Directors declared a three-for-two stock split of the Company's outstanding shares of common stock, effected in the form of a stock dividend on the Company's outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. The additional shares were distributed on October 11, 2018. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. All share and per share data provided herein gives effect to this stock split, applied retroactively. +Note C – Acquisitions +SM Distribution Israel, Limited Partnership +In November 2018, the Company formed a joint venture ("SM Israel") with Inter Jeans Ltd. through its subsidiary, SM Distribution Israel L.P. The Company is the majority interest holder in SM Israel and controls all of the significant participating rights of the joint venture. SM Israel is the exclusive distributor of the Company's products in Israel. As the Company controls all of the significant participating rights of the joint venture and is the majority interest holder in SM Israel, the assets, liabilities and results of operations of SM Israel are consolidated and included in the Company’s consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interests” in the Consolidated Statements of Income and “Noncontrolling interests” in the Consolidated Balance Sheets. +SM Dolce Limited +In September 2017, the Company formed a joint venture ("SM Taiwan") with Dolce Limited through its subsidiary, SM Dolce Limited. The Company is the majority interest holder in SM Taiwan and controls all of the significant participating rights of the joint venture. SM Taiwan is the exclusive distributor of the Company's products in Taiwan. As the Company controls all of the significant participating rights of the joint venture and is the majority interest holder in SM Taiwan, the assets, liabilities and results of operations of SM Taiwan are consolidated and included in the Company’s consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interests” in the Consolidated Statements of Income and “Noncontrolling interests” in the Consolidated Balance Sheets. +SM (Jiangsu) Co., Ltd. +In September 2017, the Company formed a joint venture ("SM China") with Xuzhou C. banner Footwear, Ltd. through its subsidiary, SM (Jiangsu) Co., Ltd. The Company controls all of the significant participating rights of the joint venture. SM China is the exclusive distributor of the Company's products in China. As the Company controls all of the significant participating rights of the joint venture in SM China, the assets, liabilities and results of operations of SM China are consolidated and included in the Company’s consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interests” in the Consolidated Statements of Income and “Noncontrolling interests” in the Consolidated Balance Sheets. +F-15 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Schwartz & Benjamin +In January 2017, the Company acquired all of the outstanding capital stock of each of Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC and DANIELBARBARA Enterprises LLC (collectively, "Schwartz & Benjamin"). Founded in 1923, Schwartz & Benjamin specializes in the design, sourcing and sale of licensed and private label footwear and distributes its fashion footwear to wholesale customers, including department stores and specialty boutiques, as well as the retail stores of its brand partners. The total purchase price for the acquisition was approximately $37,112 , which included a cash payment at closing of $17,396 less a working capital adjustment of $901 , plus potential earn-out payments based on the achievement of certain earnings targets for each of the twelve month periods ending on January 31, 2018 through 2023, inclusive. The fair value of the contingent payments was estimated using the present value of the payments based on management's projections of the financial results of Schwartz & Benjamin during the earn-out period and was finalized at $20,617. On November 27, 2017, the Company entered into an amendment to the equity purchase agreement with the sellers of Schwartz & Benjamin to change the manner of calculating the earn-out and to provide for payments based on the performance of certain specified license agreements. In connection with this amendment, the Company reduced the earn-out liability from $20,617 to $10,000 and recorded a credit to operating expenses in the amount of $10,617 . +The transaction was accounted for using the acquisition method required by GAAP. Accordingly, the assets and liabilities of Schwartz & Benjamin were recorded at their fair values, and the excess of the purchase price over the fair value of the assets acquired and liabilities assumed, including identified intangible assets, was recorded as goodwill. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions. +Contingent consideration classified as a liability is remeasured at fair value at each reporting date, until the contingency is resolved, with changes recognized in earnings. The goodwill related to this transaction is deductible for tax purposes over 15 years. +Note D – Factor Receivable +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”). The agreement can be terminated by the Company or Rosenthal at any time upon 60 days prior written notice. Under the agreement, the Company can request advances from Rosenthal of up to 85% of aggregate receivables submitted to Rosenthal. The agreement provides the Company with a $30,000 credit facility with a $15,000 sub-limit for letters of credit at an interest rate based, at the Company’s election, upon a calculation that utilizes either the prime rate minus 0.5% or LIBOR plus 2.5% . As of December 31, 2018 and 2017 , no borrowings were outstanding under the credit facility and there were no open letters of credit. The Company also pays Rosenthal a fee based on a percentage of the gross invoice amount submitted to Rosenthal. With respect to receivables related to our private label business, the fee is 0.14% of the gross invoice amount. With respect to all other receivables, the fee is 0.20% of the gross invoice amount. Rosenthal assumes the credit risk on a substantial portion of the receivables that the Company submits to it and, to the extent of any loans made to the Company, Rosenthal maintains a lien on the Company’s receivables to secure the Company’s obligations. +Note E – Note Receivable – Related Party +On June 25, 2007, the Company made a loan to Steven Madden, its Creative and Design Chief and a principal stockholder of the Company, in the amount of $3,000 in order for Mr. Madden to satisfy a personal tax obligation resulting from the exercise of stock options that were due to expire and to retain the underlying Company common stock. The loan, as amended, is secured by non-company securities held in Mr. Madden's brokerage account. The Company has agreed to forgive a portion of the note as long as Mr. Madden remains an employee of the Company through the note's maturity on December 31, 2023. For the years ended December 31, 2018 , 2017 and 2016 the Company also recorded a charge in the amount of $409 for each year, respectively, to write-off the required one-tenth of the principal amount of the secured promissory note, which was partially offset by imputed interest income of $47 , $55 and $63 , respectively. +Note F – Fair Value Measurement +The accounting guidance under Accounting Standards Codification 820-10, “Fair Value Measurements and Disclosures” (“ASC 820-10”) requires the Company to make disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability +F-16 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those three levels is as follows: +• +Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities. +• +Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. +• +Level 3: Significant unobservable inputs. +The Company’s financial assets and liabilities, subject to fair value measurements, as of December 31, 2018 and 2017 are as follows: +December 31, 2018 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +77,050 +$ +77,050 +$ +— +$ +— +Current marketable securities – available for sale +66,968 +66,968 +— +— +Forward contracts +707 +— +707 +— +Total assets +$ +144,725 +$ +144,018 +$ +707 +$ +— +Liabilities: +Contingent consideration +$ +3,000 +$ +— +$ +— +$ +3,000 +Total liabilities +$ +3,000 +$ +— +$ +— +$ +3,000 +December 31, 2017 +Fair Value Measurements +Using Fair Value Hierarchy +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +58,436 +$ +58,436 +$ +— +$ +— +Current marketable securities – available for sale +64,027 +64,027 +— +— +Long-term marketable securities – available for sale +29,523 +29,523 +— +— +Forward contracts +— +— +— +— +Total assets +$ +151,986 +$ +151,986 +$ +— +$ +— +Liabilities: +Contingent consideration +$ +10,000 +$ +— +$ +— +$ +10,000 +Forward contracts +783 +— +783 +— +Total liabilities +$ +10,783 +$ +— +$ +783 +$ +10,000 +F-17 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Our level 3 balance consists of contingent consideration related to an acquisition. The changes in our level 3 liabilities for the years ended December 31, 2018 and 2017 are as follows: +Balance at January 1, +Payments +Acquisitions +Change in estimate +Balance at December 31, +2018 +Liabilities: +Contingent consideration +$ +10,000 +(7,000 +) +— +— +$ +3,000 +2017 +Liabilities: +Contingent consideration +$ +7,948 +(7,359 +) +20,617 +(11,206 +) +$ +10,000 +The change in estimate of the contingent consideration for the year ended December 31, 2017 of $11,206 , which occurred in the fourth quarter, has been reflected as a reduction in operating expenses on the Consolidated Statements of Income for the year ended December 31, 2017 . +Forward contracts are entered into to manage the risk associated with the volatility of future cash flows (see Note L - Derivative Instruments). Fair value of these instruments is based on observable market transactions of spot and forward rates. +The Company has recorded a liability for potential contingent consideration in connection with the January 30, 2017 acquisition. Pursuant to the terms of an earn-out provision contained in the equity purchase agreement, as amended, between the Company and the sellers of Schwartz & Benjamin, earn-out payments are based on the performance of certain specified license agreements. The fair value of the contingent payments was estimated using the present value of the payments based on management’s projections of the financial results of Schwartz & Benjamin during the earn-out period. An earn-out payment in the aggregate amount of $7,000 was paid to the sellers of Schwartz & Benjamin in the first quarter of 2018, leaving a remaining balance of $3,000 . +The Company recorded a liability for potential contingent consideration in connection with the December 30, 2014 acquisition of all of the outstanding capital stock of Trendy Imports S.A. de C.V., Comercial Diecisiette S.A. de C.V., and Maximus Designer Shoes S.A. de C.V. (together "SM Mexico"). The final earn-out payment of $4,618 for the period ended December 31, 2016 was paid to the seller of SM Mexico in 2017. +The Company recorded a liability for potential contingent consideration in connection with the February 21, 2012 acquisition of all of the assets of Steve Madden Canada Inc., Steve Madden Retail Canada Inc., Pasa Agency Inc. and Gelati Imports Inc. (collectively, “SM Canada”). The final earn-out payment of $2,741 for the period ended March 31, 2017 was paid to the seller of SM Canada in 2017 . +Accounting guidance permits entities to choose to measure financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The accounting guidance also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that chose different measurement attributes for similar assets and liabilities. The Company has elected not to measure any eligible items at fair value. +The carrying value of certain financial instruments such as accounts receivable, factor accounts receivable and accounts payable approximates their fair values due to the short-term nature of their underlying terms. The fair values of investment in marketable securities available for sale are determined by reference to publicly quoted prices in an active market. Fair value of the notes receivable held by the Company approximates their carrying value based upon their imputed or actual interest rate, which approximates applicable current market interest rates. +F-18 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Note G - Property and Equipment +The major classes of assets and total accumulated depreciation and amortization are as follows: +December 31, +Average Useful Life +2018 +2017 +Land and building +$ +767 +$ +767 +Leasehold improvements +84,512 +81,554 +Machinery and equipment +10 years +7,098 +7,132 +Furniture and fixtures +5 years +9,039 +8,629 +Computer equipment and software +3 to 5 years +58,089 +58,448 +159,505 +156,530 +Less accumulated depreciation and amortization +(94,698 +) +(85,032 +) +Property and equipment - net +$ +64,807 +$ +71,498 +Depreciation and amortization expense related to property and equipment included in operating expenses amounted to approximately $ 16,036 in 2018 , $ 15,160 in 2017 and $ 14,346 in 2016 . +Note H – Goodwill and Intangible Assets +The following is a summary of the carrying amount of goodwill by segment as of December 31, 2018 and 2017 : +Wholesale +Net Carrying +Footwear +Accessories +Retail +Amount +Balance at January 1, 2017 +$ +72,261 +$ +49,324 +$ +14,126 +$ +135,711 +Acquisition of Schwartz & Benjamin +11,882 +— +— +11,882 +Translation and other +719 +— +226 +945 +Balance at December 31, 2017 +84,862 +49,324 +14,352 +148,538 +Translation and other +(311 +) +— +(115 +) +(426 +) +Balance at December 31, 2018 +$ +84,551 +$ +49,324 +$ +14,237 +$ +148,112 +F-19 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +The following table details identifiable intangible assets as of December 31, 2018 and 2017 : +2018 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +9,220 +$ +6,582 +$ +— +$ +2,638 +Customer relationships +10 years +47,019 +28,049 +— +18,970 +License agreements +3–6 years +5,600 +5,600 +— +— +Non-compete agreement +5 years +2,440 +2,440 +— +— +Re-acquired right +2 years +4,200 +4,200 +— +— +Other +3 years +14 +14 +— +— +68,493 +46,885 +— +21,608 +Re-acquired right +indefinite +35,200 +9,785 +— +25,415 +Trademarks +indefinite +100,333 +— +4,045 +96,288 +$ +204,026 +$ +56,670 +$ +4,045 +$ +143,311 +(1) Includes the effect of foreign currency translation related primarily to the movements of the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An initial impairment charge of $3,045 was recorded in the first quarter of 2015 and a final impairment charge of $1,000 was recorded in the fourth quarter of 2017 related to the Company's Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows from a significant customer. +2017 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +9,220 +$ +4,760 +$ +— +$ +4,460 +Customer relationships +10 years +47,019 +24,127 +— +22,892 +License agreements +3–6 years +5,600 +5,600 +— +— +Non-compete agreement +5 years +2,440 +2,375 +— +65 +Re-acquired right +2 years +4,200 +4,200 +— +— +Other +3 years +14 +14 +— +— +68,493 +41,076 +— +27,417 +Re-acquired right +indefinite +35,200 +7,601 +— +27,599 +Trademarks +indefinite +100,333 +— +4,045 +96,288 +$ +204,026 +$ +48,677 +$ +4,045 +$ +151,304 +(1) Includes the effect of foreign currency translation related primarily to the movement of the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An initial impairment charge of $3,045 was recorded in the first quarter of 2015 and a final impairment charge of $1,000 was recorded in the fourth quarter of 2017 related to the Company's Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows from a significant customer. +F-20 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +The amortization of intangible assets amounted to $ 5,718 for 2018 , $ 5,245 for 2017 and $5,522 for 2016 and is included in operating expenses on the Company's Consolidated Statements of Income. The estimated future amortization expense for intangibles is as follows: +2019 +$ +4,329 +2020 +3,543 +2021 +1,994 +2022 +1,487 +2023 +1,487 +Thereafter +8,768 +Total +$ +21,608 +Note I – Equity-Based Compensation +In March 2006, the Company's Board of Directors approved the Steven Madden, Ltd. 2006 Stock Incentive Plan, as amended (the “Plan”), under which nonqualified stock options, stock appreciation rights, performance shares, restricted stock, other stock-based awards and performance-based cash awards may be granted to employees, consultants and non-employee directors. The Company's stockholders approved the Plan as well as successive amendments of the Plan, most recently on May 25, 2012. The following table summarizes the number of shares of common stock authorized for use under the Plan, the number of stock-based awards granted (net of expired or cancelled awards) under the Plan and the number of shares of common stock available for the grant of stock-based awards under the Plan: +Common stock authorized +35,199,000 +Stock-based awards, including restricted stock and stock options granted, net of expired or cancelled +(34,131,866 +) +Common stock available for grant of stock-based awards as of December 31, 2018 +1,067,134 +For the years ended December 31, 2018 , 2017 and 2016 , total equity-based compensation was as follows: +Years Ended December 31, +2018 +2017 +2016 +Restricted stock +$ +16,720 +$ +16,616 +$ +16,494 +Stock options +4,356 +4,231 +3,015 +Total +$ +21,076 +$ +20,847 +$ +19,509 +Equity-based compensation is included in operating expenses on the Company’s Consolidated Statements of Income. +F-21 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Stock Options +Cash proceeds and intrinsic values related to total stock options exercised during December 31, 2018 , 2017 , 2016 are as follows: +Years Ended December 31, +2018 +2017 +2016 +Proceeds from stock options exercised +$ +13,036 +$ +16,433 +$ +10,713 +Intrinsic value of stock options exercised +$ +6,841 +$ +9,936 +$ +16,983 +During the years ended December 31, 2018 , 2017 and 2016 , options to purchase approximately 773,351 shares of common stock with a weighted average exercise price of $26.38 , 614,283 options with a weighted average exercise price of $22.68 and 483,033 options with a weighted average exercise price of $21.58 vested, respectively. As of December 31, 2018 , there were unvested options relating to 1,651,337 shares of common stock outstanding with a total of $7,863 of unrecognized compensation cost and an average vesting period of 2.6 years. +The Company uses the Black-Scholes option-pricing model to estimate the fair value of options granted, which requires several assumptions. The expected term of the options represents the estimated period of time until exercise and is based on the historical experience of similar awards. Expected volatility is based on the historical volatility of the Company’s common stock. The risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The dividend yield is based on the Company's annualized dividend per share amount divided by the Company's stock price. The following weighted average assumptions were used for stock options granted during 2018 , 2017 , and 2016 : +2018 +2017 +2016 +Volatility +25.1% to 33.2% +23.0% to 26.4% +22.2% to 26.2% +Risk free interest rate +2.1% to 2.9% +1.5% to 2.0% +0.9% to 1.9% +Expected life in years +3.0 to 5.0 +3.0 to 5.0 +3.0 to 5.0 +Dividend yield +1.7% +0.0% +0.0% +Weighted average fair value +$6.75 +$5.94 +$4.74 +F-22 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Activity relating to stock options granted under the Company’s plans and outside the plans during the three years ended December 31, 2018 is as follows: +Number of Shares +Weighted Average Exercise Price +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at January 1, 2016 +3,024,000 +$ +15.67 +Granted +393,000 +22.57 +Exercised +(1,119,000 +) +9.57 +Forfeited +(49,000 +) +20.39 +Outstanding at December 31, 2016 +2,249,000 +19.81 +Granted +1,593,000 +25.03 +Exercised +(983,000 +) +16.49 +Forfeited +(13,000 +) +23.49 +Outstanding at December 31, 2017 +2,846,000 +23.87 +Granted +585,000 +32.39 +Exercised +(593,000 +) +22.04 +Forfeited +(23,000 +) +22.59 +Outstanding at December 31, 2018 +2,815,000 +$ +26.03 +4.7 +$ +11,911 +Exercisable at December 31, 2018 +1,164,000 +$ +25.27 +3.8 +$ +5,813 +The following table summarizes information about stock options at December 31, 2018 : +Options Outstanding +Options Exercisable +Range of Exercise Price +Number Outstanding +Weighted Average Remaining Contractual Life (in Years) +Weighted Average Exercise Price +Number Exercisable +Weighted Average Exercise Price +$17.97 to $21.97 +164,000 +1.9 +$20.11 +127,000 +$20.02 +$21.98 to $25.98 +1,806,000 +4.5 +24.40 +679,000 +23.94 +$25.99 to $29.99 +532,000 +5.7 +28.08 +245,000 +26.77 +$30.00 to $34.00 +52,000 +6.6 +30.88 +— +— +$34.01 to $38.01 +261,000 +4.7 +35.85 +113,000 +35.95 +2,815,000 +4.7 +$26.03 +1,164,000 +$25.27 +F-23 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Restricted Stock +The following table summarizes restricted stock activity during the three years ended December 31, 2018 : +Number of Shares +Weighted Average Fair Value at Grant Date +Outstanding at January 1, 2016 +6,083,000 +$ +16.88 +Granted +651,000 +22.87 +Vested +(414,000 +) +20.19 +Forfeited +(33,000 +) +22.30 +Outstanding at December 31, 2016 +6,287,000 +17.29 +Granted +413,000 +25.11 +Vested +(762,000 +) +20.39 +Forfeited +(64,000 +) +23.65 +Outstanding at December 31, 2017 +5,874,000 +17.37 +Granted +509,000 +31.70 +Vested +(1,177,000 +) +18.44 +Forfeited +(71,000 +) +25.61 +Outstanding at December 31, 2018 +5,135,000 +$ +18.42 +As of December 31, 2018 , the Company had $60,517 of total unrecognized compensation cost related to restricted stock awards granted under the Plan. This cost is expected to be recognized over a weighted average period of 4.5 years. +The Company determines the fair value of its restricted stock awards based on the market price of its common stock on the date of grant. The fair value of the restricted stock that vested during the years ended December 31, 2018 , 2017 and 2016 was $36,122 , $21,549 and $9,758 , respectively. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment of Mr. Madden’s existing employment agreement, pursuant to which, on February 8, 2012, Mr. Madden was granted 2,194,586 restricted shares of the Company’s common stock at the then market price of $18.23 , which will vest in equal annual installments over a seven -year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On June 30, 2012, Mr. Madden exercised his right under his employment agreement to receive an additional restricted stock award and, on July 3, 2012, he was granted 2,840,013 restricted shares of the Company's common stock at the then market price of $14.09 , which vests in equal annual installments over a six -year period commencing on December 31, 2018 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On July 20, 2017, pursuant to the employment agreement, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $26.77 per share, which option is exercisable in equal quarterly installments commencing on October 20, 2017. On March 1, 2017, pursuant to his employment agreement, Mr. Madden was granted an option to purchase 1,125,000 shares of the Company’s common stock at an exercise price of $24.90 per share, which option is exercisable in equal annual installments over a five -year period commencing on the first anniversary of the grant date. On June 18, 2018, pursuant to his employment agreement, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $35.95 per share, which option is exercisable in equal quarterly installments commencing on September 18, 2018. As of December 31, 2018 , 4,946,738 shares remain unvested. +F-24 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Note J - Preferred Stock +The Company has authorized 5,000,000 shares of preferred stock. The Board of Directors has designated 60,000 shares of such preferred stock as Series A Junior Participating Preferred Stock (“Series A Preferred”). Holders of the shares of Series A Preferred are entitled to dividends equal to 1,000 times dividends declared or paid on the Company's common stock. Each share of Series A Preferred entitles the holder to 1,000 votes on all matters submitted to the holders of common stock. The Series A Preferred has a liquidation preference of $ 1,000 per share, and is not redeemable by the Company. No shares of preferred stock have been issued. +Note K - Share Repurchase Program +The Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase, most recently on July 28, 2017 when the Board of Directors approved the extension of the Share Repurchase Program for an additional $200,000 in repurchases of the Company's common stock. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. During the twelve months ended December 31, 2018 , an aggregate of 2,838,649 shares of the Company's common stock were repurchased under the Share Repurchase Program, at a weighted average price per share of $31.68 , for an aggregate purchase price of approximately $89,919 . As of December 31, 2018 , approximately $90,942 remained available for future repurchases under the Share Repurchase Program. +The Steven Madden, Ltd. 2006 Stock Incentive Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. During the twelve months ended December 31, 2018 , an aggregate of 524,403 shares were withheld in connection with the settlement of vested restricted stock to satisfy tax withholding requirements, at an average price per share of $30.52 , for an aggregate purchase price of approximately $16,005 . +Note L - Derivative Instruments +The Company uses derivative instruments, specifically, forward foreign exchange contracts, to manage the risk associated with the volatility of future cash flows. The forward foreign exchange contracts will be used to mitigate the impact of exchange rate fluctuations on forecasted purchases of inventory and are designated as cash flow hedging instruments. As of December 31, 2018 , the fair value of the Company's foreign currency derivatives, which is included on the Consolidated Balance Sheets in other current assets, was $707 . As of December 31, 2018 and 2017 , the Company's hedging activities were considered effective and, thus, no ineffectiveness from hedging activities was recognized in the Consolidated Statements of Income. The following table presents the pre-tax amounts from derivative instruments affecting income and other comprehensive income ("OCI") for the years ended December 31, 2018 , 2017 , and 2016 , respectively: +Cash Flow Hedges +Forward Contracts: +Location of Gain or Loss Recognized in Net Income on Derivative +Gain/(Loss) Recognized in Accumulated OCI +Gain/(Loss) Reclassified into Income From Accumulated OCI +2018 +Cost of Sales +$ +748 +$ +(39 +) +2017 +Cost of Sales +$ +(802 +) +$ +(57 +) +2016 +Cost of Sales +$ +258 +$ +(472 +) +F-25 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Note M - Operating Leases +The Company leases office, showroom, warehouse and retail facilities under noncancelable operating leases with terms expiring at various dates through 2030 . Future minimum annual lease payments under noncancelable operating leases consist of the following at December 31: +2019 +$ +44,551 +2020 +42,495 +2021 +36,740 +2022 +30,054 +2023 +22,793 +Thereafter +53,338 +Total +$ +229,971 +A majority of the retail store leases provide for contingent rental payments if gross sales exceed certain targets. In addition, many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes. Rent expense for the years ended December 31, 2018 , 2017 and 2016 was approximately $ 58,332 , $ 56,027 and $ 52,294 , respectively. Included in such amounts are contingent rents of $ 516 , $ 424 and $ 238 in 2018 , 2017 and 2016 , respectively. +Rent expense is calculated by amortizing total base rental payments (net of any rental abatements, construction allowances and other rental concessions), on a straight-line basis, over the lease term. Accordingly, rent expense charged to operations differs from rent paid resulting in the Company recording deferred rent. +Note N - Income Taxes +The components of income before income taxes are as follows: +2018 +2017 +2016 +Domestic +$ +121,674 +$ +124,472 +$ +110,526 +Foreign +55,666 +47,855 +60,474 +$ +177,340 +$ +172,327 +$ +171,000 +F-26 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +The components of provision for income taxes for all periods presented were as follows: +2018 +2017 +2016 +Current: +Federal +$ +32,880 +$ +56,836 +$ +47,655 +State and local +5,012 +5,746 +6,063 +Foreign +11,771 +10,773 +3,270 +49,663 +73,355 +56,988 +Deferred: +Federal +(2,489 +) +(22,061 +) +(7,050 +) +State and local +(200 +) +800 +153 +Foreign +(133 +) +1,095 +(365 +) +(2,822 +) +(20,166 +) +(7,262 +) +$ +46,841 +$ +53,189 +$ +49,726 +On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law, which made significant changes to the Internal Revenue Code of 1986, as amended. Changes include, but are not limited to, a reduction in the U.S. corporate statutory tax rate from 35% to 21% effective for tax years beginning after December 31, 2017, the transition from a worldwide tax system to a territorial regime and a one-time transition tax on the deemed repatriation of cumulative foreign earnings as of December 31, 2017. The Tax Act also includes a provision to tax global intangible low-taxed income of foreign subsidiaries, a special tax deduction for foreign-derived intangible income (“GILTI”), and a base erosion anti-abuse tax measure that may tax certain payments between a U.S. corporation and its subsidiaries. These additional provisions of the Tax Act are effective for the Company beginning after December 31, 2017. The Company has elected to account for GILTI as a period cost in the year the tax is incurred. +At December 31, 2017, the Company recorded provisional amounts which netted to a benefit of approximately $7,599 for certain items pertaining to the Tax Act in accordance with the guidance of Staff Accounting Bulletin No. 118 (“SAB 118”) because it had not yet completed accounting for these effects. These items included the one-time transition tax liability related to undistributed earnings of certain foreign subsidiaries that were not previously taxed, the revaluation of deferred tax assets and liabilities, and other deferred tax impacts. During the fourth quarter of 2018, the Company has now completed its accounting for all of the enactment-date income tax effects of the Tax Act and has recognized an incremental expense of $ 3,474 to the provisional amounts. +F-27 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +A reconciliation between taxes computed at the Federal statutory rate and the effective tax rate is as follows: +December 31, +2018 +2017 +2016 +Income taxes at federal statutory rate +21.0 +% +35.0 +% +35.0 +% +Effects of foreign operations +(0.7 +) +(4.5 +) +(5.3 +) +Stock-based compensation +(2.1 +) +(2.2 +) +(3.0 +) +State and local income taxes - net of federal income tax benefit +2.4 +2.0 +2.0 +Nondeductible items +0.1 +0.5 +0.2 +Impact of tax reform +2.0 +(4.4 +) +— +Receivable adjustment +— +2.7 +— +Prepaid tax adjustment related to prior years +3.8 +— +— +Other +(0.1 +) +1.8 +0.2 +Effective rate +26.4 +% +30.9 +% +29.1 +% +F-28 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +The components of deferred tax assets and liabilities are as follows: +December 31, +2018 +2017 +Deferred taxes assets +Receivable allowances +$ +8,702 +$ +7,315 +Inventory +2,274 +901 +Unrealized loss +282 +321 +Accrued expenses +1,113 +1,796 +Deferred compensation +10,217 +11,071 +Deferred rent +4,257 +3,737 +Net carryforwards +647 +300 +Other +1,557 +3,842 +Gross deferred tax assets before valuation allowance +29,049 +29,283 +Less: valuation allowance +(649 +) +— +Gross deferred tax assets after valuation allowance +28,400 +29,283 +Deferred tax liabilities +Depreciation and amortization +(13,009 +) +(16,210 +) +Unremitted earnings of foreign subsidiaries +(2,597 +) +(2,422 +) +Amortization of goodwill +(7,514 +) +(7,883 +) +Gross deferred tax liabilities +(23,120 +) +(26,515 +) +Net deferred tax assets +$ +5,280 +$ +2,768 +The Company applies the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. +The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income and tax‑planning strategies in making this assessment. +The Company maintained a valuation allowance in the amount of $649 for the year ended December 31, 2018. This valuation allowance relates to a deferred tax asset on an outside basis difference which the Company does not expect to realize. +F-29 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +December 31, +2018 +2017 +2016 +Beginning Balance +$ +361 +$ +1,407 +$ +1,407 +Additions related to current period tax positions +1,150 +— +— +Reductions for tax positions of prior years +— +(1,046 +) +— +Ending Balance +$ +1,511 +$ +361 +$ +1,407 +For the years ended December 31, 2018, 2017 and 2016 the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is approximately $ 1,511 , $ 361 and $ 1,407 , in the aggregate, respectively. The Company recognizes interest and penalties, if any, related to uncertain income tax positions in income tax expense. Accrued interest and penalties on unrecognized tax benefits and interest and penalty expense was immaterial to the consolidated financial statements for all periods presented. The unrecognized tax benefits are not expected to materially change in the next twelve months. +The Company files income tax returns in the U.S. for federal, state and local purposes, and in certain foreign jurisdictions. The Company's tax years 2015 through 2018 remain open to examination by most taxing authorities. During 2017, the U.S. Internal Revenue Service ("IRS") completed its audit of the Company's 2014 U.S. income tax return. +The Company’s consolidated financial statements provide for any related tax liability on amounts that may be repatriated from foreign operations, aside from undistributed earnings of certain of the Company’s foreign subsidiaries that are intended to be indefinitely reinvested in operations outside the U.S. The deferred tax liability of $ 2,597 at December 31, 2018 reflects the withholding tax on amounts that may be repatriated from foreign operations. +Note O – Commitments, Contingencies and Other +[1] Legal Proceedings: +In the ordinary course of business, the Company has various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on the Company's financial condition, results of operations or cash flows. It is the policy of management to disclose the amount or range of reasonably possible losses in excess of recorded amounts. +[2] Employment agreements: +Edward R. Rosenfeld. On December 31, 2018, the Company entered into a new employment agreement with Edward R. Rosenfeld, the Chief Executive Officer and the Chairman of the Board of Directors of the Company, to replace an existing employment agreement that expired on that date. The agreement, which expires on December 31, 2021, provides for an annual salary of (i) $ 945 for the period from January 1, 2019 through December 31, 2019, (ii) approximately $992 for the period from January 1, 2020 through December 31, 2020 and (iii) approximately $1,042 for the period from January 1, 2021 through December 31, 2021. In addition, pursuant to his new employment agreement, on December 31, 2018, Mr. Rosenfeld received a grant of 87,500 shares of the Company's common stock subject to certain restrictions and, on February 1, 2019, Mr. Rosenfeld received an additional grant of 87,500 shares of the Company's common stock also subject to certain restrictions. The restricted shares received by Mr. Rosenfeld on December 31, 2018 and February 1, 2019 were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a five -year period commencing on December 1, 2019 and February 1, 2020, respectively. Additional compensation and bonuses, if any, are at the sole discretion of the Company's Board of Directors. +Steven Madden. On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s then existing employment agreement with the Company. +F-30 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +The amended agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides for a base salary of approximately $7,026 per annum for the period between January 1, 2016 through the expiration of the term of employment. Pursuant to the amended agreement, on February 8, 2012, Mr. Madden was granted 2,194,586 restricted shares of the Company’s common stock at the then market price of $18.23 , which will vest in equal annual installments over a seven -year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. Also under the amended agreement, Mr. Madden received the right, exercisable on certain specified dates in fiscal year 2012 only, to elect to receive a grant of restricted stock for a number of shares of the Company’s common stock valued at $40,000 in consideration for certain specified reductions in his annual base salary in years subsequent to 2012. Mr. Madden exercised this right and, on July 3, 2012, he was granted 2,840,013 restricted shares of the Company's common stock at the then market price of $14.09 , which shares will vest in equal annual installments over a six -year period commencing on December 31, 2018. Further, in addition to the opportunity for cash bonuses at the sole discretion of the Board of Directors, Mr. Madden’s amended agreement entitles him to an annual life insurance premium payment as well as an annual stock option grant. The amended agreement also provides Mr. Madden the potential for an additional one-time stock option award for 1,125,000 shares of the Company’s common stock (the “EPS Option”) in the event that the Company achieves earnings per share on a fully-diluted basis equal to $1.33 as to any fiscal year ending December 31, 2015 or thereafter, which performance criteria was achieved for the fiscal year ended December 31, 2016 and, as such. On March 1, 2017, Mr. Madden was granted the EPS Option at an exercise price of $24.90 per share. The EPS Option vests in equal annual installments over a three -year period commencing on the first anniversary of the grant date. On June 18, 2018, pursuant to his employment agreement, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $35.95 per share, which option is exercisable in equal quarterly installments commencing on September 18, 2018. +Arvind Dharia. On April 20, 2018, the Company and its Chief Financial Officer, Arvind Dharia, entered into an amendment of Mr. Dharia's existing employment agreement. The amendment, which was effective as of January 1, 2018, (i) extends the term of Mr. Dharia's employment agreement, which by its terms expired on December 31, 2017, to December 31, 2020 and (ii) sets Mr. Dharia's base salary at approximately $582 , $ 612 and $642 for the annual periods ended December 31, 2018, 2019 and 2020, respectively. Pursuant to the amendment, on May 1, 2018, Mr. Dharia received a restricted stock award of 18,750 restricted shares of the Company's common stock under the Company's 2006 Stock Incentive Plan, as amended. The restricted shares vest in three nearly equal annual installments that commenced on December 15, 2018. The agreement, as amended, provides for an annual bonus to Mr. Dharia at the discretion of the Board of Directors. +Amelia Newton Varela. On December 30, 2016, the Company entered into a new employment agreement with Amelia Newton Varela, the Company’s President and a member of the Board of Directors of the Company, to replace an existing employment agreement that expired on December 31, 2016. The agreement, which remains in effect through December 31, 2019, provides for an annual salary of $670 in 2019. In addition, pursuant to her new employment agreement, on January 3, 2017, Ms. Varela was granted an option to purchase 150,000 shares of the Company's common stock at an exercise price of $23.83 . The option, which was granted under the Company’s 2006 Stock Incentive Plan, as amended, vests in 4 equal annual installments on each anniversary of the date of grant and commenced on January 3, 2018. The agreement provides to Ms. Varela the opportunity for an annual performance-based bonus for the fiscal years ended December 31, 2017, 2018 and 2019. +Awadhesh Sinha. On December 30, 2016, the Company entered into a new employment agreement with Awadhesh Sinha, the Company's Chief Operating Officer, to replace an existing employment agreement that expired at the end of 2016. The new agreement, which remains in effect through December 31, 2019, provides for an annual salary of $ 723 for the year ended December 31, 2019 and provides to Mr. Sinha the opportunity for annual cash and share-based incentive bonuses. In addition, pursuant to his new employment agreement, on January 3, 2017, Mr. Sinha received a grant of 42,254 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Sinha were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a three -year period on each of December 15, 2017, December 15, 2018, and December 15, 2019. +Karla Frieders. On April 11, 2017, the Company entered into a new employment agreement with Karla Frieders, the Company’s Chief Merchandising Officer, to replace an existing employment agreement which expired on February 28, 2017. The agreement, which remains in effect through April 30, 2020, provides to Ms. Frieders an annual salary of $570 +F-31 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +for the period that commenced on May 1, 2018 and ends on April 30, 2019; and $590 for the period commencing on May 1, 2019 and ending on April 30, 2020; and an annual performance-based bonus for the fiscal years ending December 31, 2017, 2018 and 2019 in an amount to be determined at the discretion of the Company. In addition, pursuant to her new employment agreement, on April 11, 2017, Ms. Frieders received a grant of 30,000 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Ms. Frieders were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a five -year period commencing on April 1, 2018 and ending on April 1, 2022. +Michael Paradise. On January 2, 2019, the Company entered into a new employment agreement with Michael Paradise, the Company's Executive Vice President - Legal Counsel, to replace an existing employment agreement that expired on December 31, 2018. The agreement, which expires on December 31, 2021, provides to Mr. Paradise (i) an annual salary of $540 for the period from January 1, 2019 through December 31, 2019, $570 for the period from January 1, 2020 through December 31, 2020 and $600 for the period from January 1, 2021 through December 31, 2021 and (ii) an annual performance-based bonus for the fiscal years ending December 31, 2019, December 31, 2020 and December 31, 2021 in an amount to be determined at the discretion of the Company. Pursuant to the agreement, in January 2019, Mr. Paradise received a cash bonus of $100,000 as an advance against his discretionary 2018 bonus payable on or about March 15, 2019. In addition, pursuant to the agreement, on January 2, 2019, Mr. Paradise received a grant of 15,000 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Paradise were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a four -year period commencing on the first anniversary of the grant date. +[3] Letters of credit: +At December 31, 2018 , the Company had no open letters of credit for the purchase of imported merchandise. +[4] License agreements: +In January 2018, the Company entered into a license agreement with Nine West Development LLC for the right to manufacture, market and sell women's fashion footwear and handbags under the Anne Klein®, AK Sport®, AK Anne Klein Sport® and the Lion Head Design®. The agreement, unless extended, expires on June 30, 2023. The agreement requires that the Company pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. +On January 30, 2017, the Company acquired all of the outstanding capital stock of Schwartz & Benjamin, which held licenses to manufacture, market and sell footwear with the Kate Spade® and Avec Les Filles® trademarks. The license agreements require Schwartz & Benjamin to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The license agreement for the Kate Spade® trademark extends through December 31, 2020. As of December 31, 2018, the agreement for the license of the Avec Les Filles® trademark was terminated. +In August 2017, the Company entered into a license agreement with Donna Karan Studio LLC for the right to manufacture, market and sell women's belts with the DKNY® and Donna Karan® brands. The agreement, unless extended, expires on December 31, 2020. The agreement requires that the Company pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. +On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A, under which the Company has the right to use the Superga® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The agreement was amended on April 11, 2013 to extend the term of the agreement through December 31, 2022. +Future minimum royalty payments are $13,073 for 2019, $24,644 for 2020 through 2021 and $11,885 for 2022 through 2023. Royalty expenses are included in the “cost of goods” section of the Company's Consolidated Statements of Income. +F-32 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +[5] Concentrations: +The Company maintains cash and cash equivalents with various major financial institutions which at times are in excess of the amount insured. In addition, the Company's marketable securities are principally held at three brokerage companies . +During the year ended December 31, 2018 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2018 were 94% . +During the year ended December 31, 2017 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2017 were approximately 93% . +During the year ended December 31, 2016 , the Company did not purchase more than 10% of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2016 were approximately 87% . +At December 31, 2018 , Wal-Mart Stores, Inc. represented 17.6% of total accounts receivable, Target Corporation represented 13.8% of total accounts receivable and Nordstrom, Inc. represented 10.6% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +At December 31, 2017 , Wal-Mart Stores, Inc. represented 14.6% of total accounts receivable and Target Corporation represented 13.4% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +For the year ended December 31, 2016 , Target Corporation represented 12.0% of net sales and at December 31, 2016 , 16.9% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +Purchases are made primarily in United States dollars. +[6] Valuation and qualifying accounts: +The following is a summary of the allowance for doubtful accounts related to accounts receivable: +Balance at Beginning of Year +Additions +Deductions +Balance at End of Year +Year ended December 31, 2018 +Allowance for doubtful accounts +$ +616 +$ +10,887 +$ +654 +$ +10,849 +Year ended December 31, 2017 +Allowance for doubtful accounts +144 +15,070 +14,598 +616 +Year ended December 31, 2016 +Allowance for doubtful accounts +200 +5 +61 +144 +Note P – Operating Segment Information +The Company operates the following business segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. The Wholesale Footwear segment, through sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores, derives revenue, both domestically and internationally (via our International business), from sales of branded and private label women’s, men’s, girls’ and children’s footwear. The Wholesale Accessories segment, which includes branded and private label handbags, belts and small leather goods as well as cold weather and selected other fashion accessories, +F-33 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +derives revenue, both domestically and worldwide (via our International business), from sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores. Our Wholesale Footwear and Wholesale Accessories segments, through our International business, derive revenue from certain territories within Asia, Europe, North America (excluding the United States) and Africa and, under special distribution arrangements, in various other territories within Australia, the Middle East, India, South and Central America and New Zealand and pursuant to a partnership agreement in Singapore. The Retail segment, through the operation of Company-owned retail stores in the United States, Canada and Mexico, our joint ventures in South Africa, China, Taiwan and Israel and the Company’s websites, derives revenue from sales of branded women’s, men’s and children’s footwear, accessories and licensed products to consumers. The First Cost segment represents activities of a subsidiary that earns commissions and design fees for serving as a buying agent of footwear products to mass-market merchandisers, mid-tier department stores and other retailers with respect to their purchase of footwear. In the Licensing segment, the Company generates revenue by licensing its Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks and other trademark rights for use in connection with the manufacture, marketing and sale of eyewear, outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, this segment licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel, hosiery, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. The Licensing segment also licenses the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. +Year ended +Wholesale Footwear +Wholesale Accessories +Total Wholesale +Retail +First Cost +Licensing +Consolidated +December 31, 2018 +Net sales to external customers +$ +1,058,366 +$ +300,091 +$ +1,358,457 +$ +295,152 +$ +— +$ +— +$ +1,653,609 +Gross profit +345,909 +91,739 +437,648 +178,390 +— +— +616,038 +Commissions and licensing fees – net +— +— +— +— +(4,549 +) +9,966 +5,417 +Income/(loss) from operations +140,138 +27,092 +167,230 +735 +(4,549 +) +9,966 +173,382 +Depreciation and amortization +10,810 +10,593 +944 +135 +22,482 +Segment assets +$ +774,837 +$ +149,790 +924,627 +113,292 +28,210 +6,441 +1,072,570 +Capital expenditures +$ +6,790 +$ +5,660 +$ +— +$ +— +$ +12,450 +December 31, 2017 +Net sales to external customers +$ +1,017,557 +$ +256,295 +$ +1,273,852 +$ +272,246 +$ +— +$ +— +$ +1,546,098 +Gross profit +332,367 +80,729 +413,096 +164,645 +— +— +577,741 +Commissions and licensing fees – net +— +— +— +— +5,159 +9,100 +14,259 +Income/(loss) from operations +133,014 +23,637 +156,651 +(1,126 +) +5,159 +9,100 +169,784 +Depreciation and amortization +11,287 +9,645 +457 +— +21,389 +Segment assets +$ +784,334 +$ +138,720 +923,054 +122,111 +11,996 +— +1,057,161 +Capital expenditures +$ +5,590 +$ +9,185 +$ +— +$ +— +$ +14,775 +December 31, 2016 +Net sales to external customers +$ +881,864 +$ +254,931 +$ +1,136,795 +$ +262,756 +$ +— +$ +— +$ +1,399,551 +Gross profit +279,835 +84,422 +364,257 +157,726 +— +— +521,983 +Commissions and licensing fees – net +— +— +— +— +3,728 +8,060 +11,788 +Income from operations +110,039 +31,562 +141,601 +15,787 +3,728 +8,060 +169,176 +Depreciation and amortization +11,734 +9,087 +281 +— +21,102 +Segment assets +$ +648,738 +$ +186,075 +834,813 +118,168 +7,894 +— +960,875 +Capital expenditures +$ +5,990 +$ +9,907 +$ +— +$ +— +$ +15,897 +F-34 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Revenues by geographic area are as follows: +Year Ended December 31, +2018 +2017 +2016 +Domestic (a) +$ +1,455,177 +$ +1,383,841 +$ +1,258,973 +International +198,432 +162,257 +140,578 +Total +$ +1,653,609 +$ +1,546,098 +$ +1,399,551 +(a) Includes revenues of $323,036, $329,107 and $312,491 for the years ended 2018, 2017 and 2016 related to sales to U.S. customers where the title is transferred outside the U.S. and the sale is recorded by our international business. +Note Q - Quarterly Results of Operations (unaudited) +The following is a summary of the quarterly results of operations for the years ended December 31, 2018 and 2017 : +March 31, +June 30, +September 30, +December 31, +2018: +Net sales +$ +389,014 +$ +395,753 +$ +458,482 +$ +410,360 +Cost of sales +248,281 +247,979 +283,265 +258,046 +Gross profit +140,733 +147,774 +175,217 +152,314 +Commissions, royalty and licensing fee income/(loss) - net +3,659 +2,244 +4,994 +(5,480 +) +Net income attributable to Steven Madden, Ltd. +$ +28,673 +$ +32,410 +$ +55,563 +$ +12,490 +Net income per share: +Basic +$ +0.35 +$ +0.40 +$ +0.68 +$ +0.15 +Diluted +$ +0.33 +$ +0.37 +$ +0.64 +$ +0.15 +2017: +Net sales +$ +366,387 +$ +374,148 +$ +441,193 +$ +364,370 +Cost of sales +233,669 +234,751 +275,303 +224,634 +Gross profit +132,718 +139,397 +165,890 +139,736 +Commissions, royalty and licensing fee income - net +3,927 +2,166 +4,745 +3,421 +Net income attributable to Steven Madden, Ltd. +$ +20,158 +$ +28,964 +$ +44,229 +$ +24,597 +Net income per share: +Basic +$ +0.24 +$ +0.35 +$ +0.54 +$ +0.30 +Diluted +$ +0.23 +$ +0.33 +$ +0.51 +$ +0.28 +As each quarter is calculated as a discrete period, the sum of the four quarters may not equal the calculated full year amount. This is in accordance with prescribed reporting requirements. +During the fourth quarter of 2018, the Company recorded provisions for bad debt expense and a write-off of an unamortized buying agency agreement support payment of $12,123 , of which $8,507 was recorded in commissions, royalty and licensing fee income/(loss) - net and $3,616 was recorded in operating expenses, related to the bankruptcy of Payless ShoeSource. Also during the fourth quarter of 2018, the Company recorded $8,794 , related to a prepaid tax adjustment related to prior years. +F-35 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +Note R - Recent Accounting Pronouncements +Recently Adopted +In May 2014, the Financial Accounting Standards Board (the"FASB") issued new accounting guidance ("Topic 606"), Accounting Standards Update No. 2014-09 ("ASU 2014-09"), "Revenue from Contracts with Customers," on revenue recognition. The new standard is an update to Revenue Recognition Topic 605 and provides for a single five-step model to be applied to all revenue contracts with customers as well as requiring additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Effective January 1, 2018, the Company adopted the requirements of Topic 606 using the cumulative effect adjustment approach. The impacts to the financial statements of this adoption are primarily related to balance sheet classification, including amounts associated with the change in balance sheet classification of the sales returns reserves, with no impact to the income statement as the Company's existing revenue recognition policies are in line with Topic 606. +In January 2016, the FASB issued Accounting Standards Update 2016-01 ("ASU 2016-01"), "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." ASU 2016-01 generally requires companies to measure investments in equity securities, except those accounted for under the equity method, at fair value and recognize any changes in fair value in net income. The new guidance must be applied using a modified-retrospective approach and is effective for periods beginning after December 15, 2017 and early adoption is not permitted. The Company adopted the provisions of ASU 2016-01 in the first quarter of 2018 and the adoption did not have a material impact on the Company's financial statements as the Company does not carry investments in equity securities. +In August 2016, the FASB issued Accounting Standards Update 2016-15 ("ASU 2016-15"), "Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 clarifies how certain cash receipts and payments should be presented in the statement of cash flows. The main provisions are related to certain types of debt, contingent consideration, insurance proceeds and equity method investee distributions. The guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years with early adoption permitted. The Company adopted the provisions of ASU 2016-15 in the first quarter of 2018. The adoption did not have a material impact on the Company's financial statements as the Company's current financial statements are in line with the provision. +In August 2017, the FASB issued Accounting Standards Update 2017-12 ("ASU 2017-12"), "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 changes the recognition and presentation requirements of hedge accounting. The guidance provides new alternatives for applying hedge accounting to additional hedging strategies and measuring the hedged item in fair value hedges of interest rate risk, as well as applies new alternatives for reducing the cost and complexity of applying hedge accounting by easing the requirements for effectiveness testing, hedge documentation and application of the critical terms match method, and reducing the risk of material error correction if a company applies the shortcut method inappropriately. The guidance is effective for annual and interim periods in fiscal years beginning after December 15, 2018 and early adoption is permitted any time after the issuance of ASU 2017-12, including in an interim period. The Company elected to early adopt the new standard in the fourth quarter of 2018 and applied the presentation and disclosure guidance on its forward contracts entered into described in Note L - Derivative Instruments. The adoption of the new standard did not have a material impact on the Company's consolidated financial statements. +Not Yet Adopted +In August 2018, the FASB issued Accounting Standards Update No. 2018-15, “Intangibles-Goodwill and Other-Internal-Use Software (Topic 350): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract.” This new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This new guidance is effective for the Company on a prospective or retrospective basis beginning on January 1, 2020, with early adoption permitted. While the Company is currently assessing the impact of the new guidance, it is not expected to have a material impact on the Company’s consolidated financial statements. +In August 2018, the FASB issued Accounting Standards Update No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This new guidance removes certain disclosure +F-36 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2018, 2017 and 2016 +($ in thousands, except share and per share data) +requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. This new guidance is effective for the Company beginning on January 1, 2020, with early adoption permitted. Certain disclosures in the new guidance will need to be applied on a retrospective basis and others on a prospective basis. While the Company is currently assessing the impact of the new guidance, it is not expected to have a material impact on the Company’s consolidated financial statements. +In February 2018, the FASB issued Accounting Standards Update No. 2018-02 ("ASU 2018-02"), "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income," which allows for stranded tax effects in accumulated other comprehensive income resulting from the U.S. Tax Cuts and Jobs Act to be reclassified to retained earnings. ASU 2018-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of adopting the new standard and does not expect the new standard to have a material impact on the Company’s financial position or results of operations. +In June 2016, the FASB issued Accounting Standards Update 2016-13 ("ASU 2016-13"), "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures. +In February 2016, the FASB issued Accounting Standards Update No. 2016-02 ("ASU 2016-02"), "Leases," as amended, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. Under ASU 2016-02, lessees will be required to recognize for all leases with terms longer than twelve months, at the commencement date of the lease, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right-to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition. The Company will adopt the new standard on the effective date January 1, 2019. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. The Company will continue to apply ASC-840, including disclosure requirements, in the comparative periods in the year the Company adopts the new guidance. +The new standard provides a number of optional practical expedients. The Company will elect the package of three practical expedients. As such, the Company will not reassess whether expired or existing contracts are or contain a lease and will not need to reassess the lease classifications or reassess the initial direct costs associated with expired or existing leases. The Company will not elect the hindsight practical expedient and the land easement practical expedient, neither of which are applicable to the Company. Also, the Company has elected to take the practical expedient to not separate lease and non-lease components for all asset classes. +The Company expects that this standard will have a material effect on our financial statements. While the Company continues to assess all of the effects of adoption, the Company believes the most significant effects relate to: (i) the recognition of new right of use assets and lease liabilities on our balance sheet for primarily real estate operating leases and (ii) providing significant new disclosures about our leasing activities. The Company does not expect a significant change in our leasing activities between now and adoption. +Based on our portfolio of leases as of December 31, 2018, approximately $ 195,000 of lease right-of-use assets and $210,000 of lease right-of use liabilities will be recognized on our balance sheet upon adoption, primarily relating to real estate. We are substantially complete with our implementation efforts. +F-37 +Exhibit Index +2.01 +Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 31, 2017). +2.02 +First Amendment to Equity Purchase Agreement, dated November 21, 2017, to Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers (incorporated by reference to Exhibit 2.2 to the Company’s Annual Report on Form 10-K for the annual period ended December 31, 2017 filed with the SEC on February March 1, 2018) † +3.01 +Certificate of Incorporation of Steven Madden, Ltd. (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +3.02 +Amended & Restated By-Laws of Steven Madden, Ltd. (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2017 filed with the SEC on August 4, 2017) +4.01 +Specimen Certificate for shares of Common Stock (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +10.01 +Third Amended and Restated Secured Promissory Note dated as of June 25, 2007 of Steven H. Madden to the Company (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 9, 2012) +10.02 +First Allonge to Third Amended and Restated Secured Promissory Note made as of April 8, 2016 between the Company and Steven H. Madden (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.03 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2010 filed with the SEC on November 9, 2010) +10.04 +Amendment to Collection Agency Agreement dated February 16, 2010 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2010 filed with the SEC on March 12, 2010) +10.05 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Daniel Friedman & Associates, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.06 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Diva Acquisition Corp. (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.07 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Steven Madden Retail, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.08 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Stevies, Inc. (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.09 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and SML Acquisition Corp. (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.10 +Letter Agreement dated July 10, 2009 among Rosenthal & Rosenthal, Inc., the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.11 +Guarantee dated July 10, 2009 of the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. in favor of Rosenthal & Rosenthal, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.12 +Third Amended Employment Agreement dated July 15, 2005 between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 20, 2005) +10.13 +Amendment dated December 14, 2009 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 17, 2009) +10.14 +Amended and Restated Second Amendment dated as of December 31, 2011 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2011 filed with the SEC on February 29, 2012) +10.15 +Third Amendment dated April 8, 2016 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.16 +Employment Agreement dated January 1, 1998 between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.07 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2000 filed with the SEC on March 30, 2001)# +10.17 +Amendment No. 1 dated June 29, 2001 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 99.4 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended June 30, 2001 filed August 14, 2001)# +10.18 +Amendment No. 2 dated October 30, 2002 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2002 filed with the SEC on November 14, 2002)# +10.19 +Amendment No. 3 dated February 1, 2006 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 3, 2006)# +10.20 +Amendment No. 4 dated October 7, 2009 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on October 13, 2009)# +10.21 +Amendment No. 5 dated February 8, 2012 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 14, 2012)# +10.22 +Amendment No. 6 dated February 2, 2015 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 4, 2015)# +10.23 +Amendment No. 7 dated as of May 15, 2017 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.24 +Amendment No. 8 dated as of April 20, 2018 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 26, 2018)# +10.25 +Employment Agreement dated December 30, 2016 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2017)# +10.26 +First Amendment dated as of May 15, 2017 to Employment Agreement dated as of December 30, 2016 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.27 +Employment Agreement dated December 30, 2016 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 4, 2017)# +10.28 +First Amendment dated as of May 15, 2017 to Employment Agreement dated December 30, 2016 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.29 +Employment Agreement dated April 11, 2017 between the Company and Karla Frieders (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended March 31, 2017 filed with the SEC on May 9, 2017)# +10.30 +Employment Agreement, dated as of December 31, 2018, between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 4, 2019)# +10.31 +Employment Agreement dated April 5, 2016 between the Company and Michael Paradise (incorporated by reference to Exhibit 10.29 to the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2016 filed with the SEC on February 28, 2017)# +10.32 +First Amendment dated as of May 15, 2017 to Employment Agreement dated April 5, 2016 between the Company and Michael Paradise (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.33 +Employment Agreement dated January 2, 2019 between the Company and Michael Paradise †# +10.34 +2006 Stock Incentive Plan (Amended and Restated Effective May 22, 2009), amended by the Board of Directors of the Company on April 5, 2012 and approved and adopted by the Company's stockholders on May 25, 2012 (incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 1, 2013)# +14.01 +Code of Ethics for the Chief Executive Officer and Senior Financial Officers (incorporated by reference to Exhibit 14.01 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2014 filed with the SEC on February 26, 2015) +14.02 +Code of Business Conduct and Ethics for the Board of Directors (incorporated by reference to Exhibit 14.01 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2014 filed with the SEC on February 26, 2015) +14.03 +Code of Business Conduct and Ethics† +21.01 +Subsidiaries of the Registrant† +23.01 +Consent of EisnerAmper LLP† +24.01 +Power of Attorney (included on signature page hereto) +31.01 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +31.02 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +32.01 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +32.02 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +99.01 +Press Release, dated February 27, 2019, issued by Steven Madden, Ltd.† +101 +The following materials from Steven Madden, Ltd.'s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.* +† +Filed herewith. +# +Indicates management contract or compensatory plan or arrangement required to be identified pursuant to Item 15(b) of this Annual Report on Form 10-K. +* +This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Company specifically incorporates it by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2018/0001628280-19-002264/filing_metadata.csv b/raw/filings/0000913241/2018/0001628280-19-002264/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..22c85be7f9d9daafcfea12b1c33e7022616cb430 --- /dev/null +++ b/raw/filings/0000913241/2018/0001628280-19-002264/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000913241,SHOO,"STEVEN MADDEN, LTD.",10-K,2019-02-28,2018-12-31,2019-02-28T21:06:49.000Z,0001628280-19-002264,shoo-20181231x10k.htm,10-K,17888304,1,0,https://www.sec.gov/Archives/edgar/data/913241/000162828019002264/shoo-20181231x10k.htm,https://www.sec.gov/Archives/edgar/data/913241/000162828019002264/,2018,2018,1 diff --git a/raw/filings/0000913241/2018/0001628280-19-002264/item1.txt b/raw/filings/0000913241/2018/0001628280-19-002264/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..c0f477dcb3504288d07c0c12ad4499bdaa59d6f5 --- /dev/null +++ b/raw/filings/0000913241/2018/0001628280-19-002264/item1.txt @@ -0,0 +1,134 @@ +ITEM 1. BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories. We also license some of our trademarks for use in connection with the manufacturing, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico, our joint ventures in South Africa, China, Taiwan and Israel, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico, certain European nations and Tunisia. In addition, we have special distribution arrangements for the marketing of our products in Asia, certain European nations, Australia, India, the Middle East, South and Central America, New Zealand and pursuant to a partnership agreement in Singapore. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated as a New York corporation on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol “SHOO”. Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge, on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of the Company, each of which is attached as an exhibit to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015. We also have a Code of Conduct that is applicable to all of our employees, which is attached as an exhibit to this Annual Report on Form 10-K. Each of these codes is posted on our website, http:// +1 +www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Recent Developments +Stock Split. On September 11, 2018, the Board of Directors of the Company declared a three-for-two stock split of the Company's outstanding shares of common stock, effected in the form of a stock dividend on the Company's outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. The additional shares were distributed on October 11, 2018. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. All share and per share data provided herein gives effect to this stock split, applied retroactively. +Product Distribution Segments +Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing. +Our Wholesale Footwear segment is comprised of the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Madden NYC, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Report®, Superga® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, Stevies®, Brian Atwood®, Blondo®, Kate Spade® (under license), Anne Klein® (under license) and includes our International business and certain private label footwear business. An agreement under which the Company licensed the Avec Les Filles® trademark terminated on December 31, 2018. +Our Wholesale Accessories segment is comprised of Big Buddha®, Madden NYC, Betsey Johnson®, Steve Madden®, Steven by Steve Madden®, Madden Girl®, Cejon®, Luv Betsey®, DKNY® (under license), Donna Karan® (under license), Anne Klein® (under license) and Jocelyn® accessories brands and also includes our International business and certain private label accessories business. +Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn e-commerce websites. +Our First Cost segment represents activities of one of our wholly-owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market retailers, shoe chains and other value priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, we license our Betsey Johnson® trademark for use in the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license our Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. We also license FREEBIRD by Steven® for operation of retail stores. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35 years old) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine if the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared for young women ages 13 to 25 years old, and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. +2 +Steve Madden Men's. We design, source and market a lifestyle collection of men's footwear for the fashion forward man, ages 18 to 45 years old, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Price points for Steve Madden Men's products range in price from $70 to $190 at retail per pair. +Madden. T he Madden® brand is a denim friendly collection of footwear designed to meet the ever evolving needs of the trend conscious male consumer, ages 13 to 35 years old. Madden products range from $45 to $90 and are sold to national specialty stores, better department stores, mid-tier department stores, online retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States as well as in our retail stores. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal to fashion conscious women ages 25 to 45 years old who grew up wearing Steve Madden footwear and are looking for a shoe with an emphasis on comfort. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12 years old. Our Stevies® and Steve Madden Kids® brands are distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. +Betsey Johnson . On October 5, 2010, the Company acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. +Superga. On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. +Report. The Report® brand was acquired in May 2011. The Report® brand is a junior women's footwear brand with price points ranging from $20 to $100 per pair. We design, manufacture, market and sell Report branded products to major department stores, mid-tier department stores and independently-owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street life style brand created to appeal to women with a young attitude and active life style and marketed exclusively to Target. +Dolce Vita. In August 2014, the Company acquired the Dolce Vita® and DV® brands. Dolce Vita® is a contemporary women's footwear brand with price points ranging from $90 to $300 per pair. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently-owned boutiques primarily throughout the United States. The DV® brand is a contemporary women's footwear brand with price points ranging from $20 to $75 per pair. DV® products are distributed through off-price department stores, online retailers and independently-owned boutiques primarily throughout the United States. +Brian Atwood. In March 2014, the Company acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand. Brian Atwood is known for luxury shoes manufactured in China and Italy. +Blondo. In January 2015, the Company acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. +Kate Spade and Avec Les Filles. In January 2017, the Company acquired all of the issued and outstanding capital stock of Schwartz & Benjamin, Inc. As a consequence of the acquisition, the Company acquired licenses to manufacture, market and sell footwear under the Kate Spade® and Avec Les Filles® trademarks. +The Kate Spade® brand, known for its whimsical fashion, is an entry-level luxury footwear brand primarily distributed through department stores and Kate Spade retail stores throughout the United States. The price points of footwear bearing the Kate Spade® brand range from $98 to $400 per pair with the core product price ranging from $198 to $298 per pair. As of December 31, 2018, the agreement to license the Avec Les Filles® trademark was terminated. +3 +Anne Klein. In January 2018, the Company entered into a license agreement with Nine West Development LLC for license to use the Anne Klein®, AK Sport®, AK Anne Klein Sport® and the Lion Head Design® trademarks in connection with the marketing and sale of footwear and accessories. The Anne Klein® brand is recognized as being synonymous with American sportswear. +International Division. The International division, utilizing the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers through wholly owned subsidiaries in Canada and Mexico and joint venture partnerships in Europe (excluding Italy and Greece, where we had preexisting distributors), South Africa, Israel, China and Taiwan. In addition, the International division works through special distribution arrangements for the marketing and sale of our products in Indonesia, Thailand, Vietnam, Malaysia, certain European nations, Australia, India, the Middle East, South and Central America and New Zealand. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third party brands, such as Material Girl® and Candies®. +Wholesale Accessories Segment +Our Wholesale Accessories segment designs, sources and markets name brands, including our Steve Madden®, Steven by Steve Madden®, Madden Girl®, Betsey Johnson®, Madden NYC, Big Buddha®, DKNY® (under license), Donna Karan® (under license), Anne Klein® (under license), Jocelyn® and Luv Betsey® brands, and private label fashion handbags and accessories to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our International distributor network. In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Cejon®, Steve Madden®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2018 , we owned and operated 229 retail stores including 157 Steve Madden full price stores, 62 Steve Madden outlet stores, 2 Steven stores, 1 Superga store and 7 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn). In 2018 , we added 23 full price stores, 5 outlet stores and 3 e-commerce websites and closed 6 full price stores and 2 outlet stores. In addition, during 2018 , we opened 16 concessions in China, Taiwan and South Africa, and ended the year with 42 company-operated concessions in international markets. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, Israel, China and Taiwan. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for all of 2018 ) increased 2.8% in fiscal year 2018 from the prior year. The Company excludes new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We anticipate that the Retail segment can enhance the Company's overall sales and profitability while increasing recognition for our brands. Additionally, our retail stores enable us to evaluate the appeal of new products and designs to our customers and respond accordingly, which, in turn, strengthens the product assortment of our two Wholesale segments. We expect to open 14 to 16 new retail stores and close 8 to 10 locations in 2019 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market retailers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label, mass merchandising market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Payless ShoeSource, Kohl's, Fred Meyer and Meijers. In addition, by leveraging the strength of our Steve Madden brands and product designs, we have been able to partially recover our design, product and development costs from our suppliers. In 2018, one of the Company's wholesale customers transitioned from the wholesale model to the buying agency model. +4 +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, fragrance, umbrellas, bedding, luggage and men’s leather accessories. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note P to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Company's products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide the Company's brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently-owned manufacturers primarily in China, Italy, Mexico, Vietnam, Cambodia, Brazil, India, The Netherlands, The Dominican Republic, Spain and South Korea. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. We use retailers' feedback to adjust the production of products on a timely basis, which helps reduce the close out and markdown of slow-moving products. +The manufacturers of our products are required to meet our quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and a majority of our products filling domestic orders are shipped via ocean freight carriers to ports in California and New Jersey, also via truck from Mexico to our third party distribution facility in Texas, with the greatest reliance on the California ports. To a lesser extent we rely on air and ground freight carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from six third-party distribution centers, four located in California, one located in Texas and one located in New Jersey. Our products are also distributed through a Company-operated distribution center located in Canada. By utilizing distribution facilities specializing in fulfillment for certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. For our international markets, products for our businesses in Canada and Mexico and our joint ventures in South Africa, China, Taiwan and Israel are shipped to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stores, national chains, mass merchants, value priced retailers, specialty stores, online retaile rs and catalog retailers. These customers +5 +include Wal-Mart Stores, Inc., Macy's Inc., Nordstrom, Inc., The TJX Companies, Inc., DSW, Inc., Target Corporation, Ross Stores, Inc., Kohl's Corporation, and Burlington Stores, Inc. At December 31, 2018 , Wal-Mart Stores, Inc. represented 17.6% of total accounts receivable, Target Corporation represented 13.8% of total accounts receivable and Nordstrom, Inc. represented 10.6% of total accounts receivable. The Company did not have any customers who accounted for more than 10% of total net sales or any other customers who accounted for more than 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, China, Taiwan and Israel +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico, certain European nations and Tunisia. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in South Africa, China, Taiwan and Israel, and on our e-commerce websites. For the year ended December 31, 2018 , our Retail segment and our two Wholesale segments generated net sales of approximately $295,152 and $1,358,457 , or 18% and 82% of our total net sales, respectively. Each of these distribution channels is described below. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2018 , we operated 157 Steve Madden full price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China, Taiwan and Israel. We also operated 62 Steve Madden outlet stores, 2 Steven stores and 1 Superga store within the United States. The Company also operated 7 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn). We believe that our retail stores will continue to enhance overall sales, profitability, and our ability to react swiftly to changing consumer trends. Our stores also serve as a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues through which to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +Department Stores. We currently sell our products to approximately 2,200 doors of 15 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Macy's, Inc., Nordstrom, Inc., Dillard's, Inc., Belk, Inc. and Lord & Taylor. +We provide merchandising support to our department store customers including, in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which to showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot of retail space. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at season's end. +National Chains and Mass Merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Target Corporation, Wal-Mart Stores, Inc. and Kohl's Corporation. +6 +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW, Inc., Famous Footwear and Journeys. We offer our specialty store accounts the same merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through various catalogs, such as Bloomingdale's. +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate 7 Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn footwear and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from the Company and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates through February 14, 2031 and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include Australia, the Middle East, India, South and Central America, New Zealand and, pursuant to a partnership agreement, in Singapore. +Competition +The fashion industry is highly competitive. We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Sam Edelman, Ugg and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +Marketing and Sales +We have focused on creating an integrated brand building program to establish the Company as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations including product and brand placements in life style and fashion magazines and digital outlets, as well as personal appearances by our founder and Creative and Design Chief, Steven Madden, and in-store promotions. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita, Brian Atwood and Jocelyn footwear and accessory products, as well as selected styles of Madden Girl footwear and accessory products, and view exclusive content, participate in contests and “live chat” with customer service representatives. We also connect with our customers through social media forums including Twitter, Facebook and Instagram. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support continued growth. Our Enterprise Resource Planning (“ERP”) system is an integrated system that supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. All of our North American wholesale businesses (other than Canada which has a separate ERP system) and our Asia first-cost and sourcing operations are operated through this ERP system. Our warehouse management system is utilized by our third-party logistics providers and is fully integrated with our ERP system. A point of sale system for our U.S. retail stores is integrated with a retail inventory management/store replenishment system. We are currently transitioning our e-commerce software to a major cloud-based provider. Complimenting all of these systems are ancillary systems and third-party information processing services, +7 +including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 128 other countries and in numerous International Classes. From time to time, we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying the Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +Stevies plus Design® +Madden Girl® +Brian Atwood® +Stevies® +B Brian Atwood® +Big Buddha® +Dolce Vita® +Big Buddha plus Design® +DV8® +Big Buddha love big. Live Buddha plus® +Sweet Life® +Topline® +Blondo Waterproof plus Heart Design® +Betseyville® +DV BY DOLCE VITA® +Betsey Johnson® +DV® +LUV BETSEY plus Kiss Design® +Wild Pair® +LUV BETSEY by Betsey Johnson Design® +MadLove® +Blue by Betsey Johnson® +Blondo® +Steve Madden plus Design® +By Steve Madden plus Heart® +SM New York® +SM Pass plus Design® +SM New York plus Design® +Jocelyn® +FREEBIRD By Steven® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks throughout all of the world. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations and liquidity. +Trademark Licensing +Our strategy for the continued growth of the Company's business includes expanding the Company's presence beyond footwear and accessories through the selective licensing of our brands. As of December 31, 2018 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, the Company licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. We also license FREEBIRD by Steven® for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +8 +In addition to the licensing of our trademarks, we also in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +In January 2018, we entered into a license agreement with Nine West Development LLC for the right to manufacture, market and sell women's fashion footwear and handbags under the Anne Klein®, AK Sport®, AK Anne Klein Sport® and the Lion Head Design®. The agreement, unless extended, expires on June 30, 2023. +See Notes A and O to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 1, 2019 , we employed approximately 3,900 employees, of whom approximately 2,600 work on a full-time basis and approximately 1,300 work on a part-time basis. Most of our part-time employees work in the Retail segment. Approximately 2,400 of our employees are located in the United States, approximately 700 employees are located in Hong Kong and China, approximately 400 employees are located in Canada, approximately 200 employees are located in Mexico, approximately 90 employees are located in Israel, approximately 90 employees are located in South Africa and approximately 30 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. The Company has never experienced a material interruption of its operations due to a labor dispute. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales occur in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales occur in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Sales levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $ 369,458 and $ 367,101 , as of February 1, 2019 and 2018 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. \ No newline at end of file diff --git a/raw/filings/0000913241/2018/0001628280-19-002264/item13.txt b/raw/filings/0000913241/2018/0001628280-19-002264/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..6bdf57e86220fad871bd6e17b369ef7a00b7224e --- /dev/null +++ b/raw/filings/0000913241/2018/0001628280-19-002264/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2019 Annual Meeting of Stockholders, and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2018/0001628280-19-002264/item9a.txt b/raw/filings/0000913241/2018/0001628280-19-002264/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..bfea41b1ceaec244348ac34900c5e29c2351ffdf --- /dev/null +++ b/raw/filings/0000913241/2018/0001628280-19-002264/item9a.txt @@ -0,0 +1,21 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2018 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2018 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited the Company's consolidated financial statements and the effectiveness of the Company's internal control over financial reporting as of December 31, 2018 . Their report appears in this Annual Report on Form 10-K. +Remediation of Material Weakness +A material weakness is a deficiency or a combination of deficiencies in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s financial statements will not be prevented or detected on a timely basis. The material weakness that we previously reported was identified as of December 31, 2017 related to the design and implementation of effective control over risk assessment with regard to certain processes and procedures commensurate with our financial reporting requirements. Specifically, we did not design and maintain adequate information technology general controls +35 +for information systems that are relevant to the preparation of financial statements in certain areas. The deficiencies in internal control over financial reporting were detailed in Item 9A of the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2017. +During the fourth quarter of 2018, management of the Company implemented measures that it believes are sufficient to fully remediate each of the deficiencies resulting in the material weakness, which measures are described in Item 4 of the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2018. During the fourth quarter of fiscal 2018, we successfully completed the testing necessary to conclude that the material weakness has been remediated. We will continue to monitor the effectiveness of these and other processes, procedures, and controls and will make any further changes that management determines to be appropriate. +Changes in Internal Control Over Financial Reporting +We have taken actions to remediate the material weakness related to our internal control over financial reporting, as described in Remediation of Material Weakness above. During the quarter ended December 31, 2018, we also implemented a plan that called for modifications to our internal controls over financial reporting (“ICFR”) related to the accounting for leases as a result of ASU 2016-02. The modified controls have been designed to address risks associated with accounting for lease assets and liabilities and the related income and expenses under ASC 842. We have therefore augmented ICFR as follows: +• +Implementing a new IT system to capture, calculate, and account for leases. +• +Modified existing and implemented new controls that address risks associated with accounting for lease assets and liabilities and the related income and expense, including the revision of our contract review controls. +Other than remediation of the material weakness referenced above and changes in controls relating to ASC 842, there was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2018, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000913241/2018/0001628280-19-002264/rp_note.txt b/raw/filings/0000913241/2018/0001628280-19-002264/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000913241/2018/0001628280-19-002264/rpt_disclosure.txt b/raw/filings/0000913241/2018/0001628280-19-002264/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..8e99ca76243989f8bcf68c10be1e9ee977dfa4d5 --- /dev/null +++ b/raw/filings/0000913241/2018/0001628280-19-002264/rpt_disclosure.txt @@ -0,0 +1,117 @@ +and Related Party Transactions +Steven +Madden Employment Agreement. The Company believes that Steven Madden, the Company’s founder and Creative and Design +Chief, provides unique and significant value in guiding the leadership of the Company’s creative process, both in his hands +on work for the Company and his collaboration with the Company’s designers, product professionals and marketing executives. +In addition, the public’s association of Mr. Madden’s name and likeness with our branded products is significant, +meaningful, and integral to the Company’s success and has been, and continues to be, instrumental in creating long-term +stockholder value. Based upon that belief, the Company further believes that his continuing involvement with the Company is essential +and to this end has for many years had an employment agreement with Mr. Madden as described below. +19 +Mr. +Madden’s agreement in its current form dates back to July 1, 2005, as subsequently amended on various occasions most recently +on March 25, 2019 (the “SM Employment Agreement”). Under the SM Employment Agreement, Mr. Madden has agreed to continue +to serve as the Company’s Creative and Design Chief for a term continuing through December 31, 2026, for a base salary of +$7,026,042 per annum together with the potential for cash bonuses at the sole discretion of the Company’s Board of Directors +and an annual life insurance premium reimbursement of up to $200,000. Pursuant to the SM Agreement, on February 8, 2012, Mr. Madden +was granted 2,194,584 restricted shares of Common Stock (the number of shares indicated having been adjusted for an October 11, +2018 three-for-two stock split effected as a stock dividend), valued at approximately $40 million, under the Company’s Amended +and Restated 2006 Stock Incentive Plan, which is referred to herein as the “2006 Plan,” vesting in equal annual installments +over seven years commencing on December 31, 2017 through December 31, 2023, subject to Mr. Madden’s continued employment +with the Company on each such vesting date. On June 30, 2012, as allowed under the SM Agreement, Mr. Madden elected to receive +an additional restricted stock award valued at approximately $40 million in consideration of a reduction in his annual base salary +in years subsequent to 2012 to the amount reflected above. As a consequence, on July 3, 2012, Mr. Madden received 2,840,013 restricted +shares of Common Stock vesting in six annual installments commencing on December 31, 2018 through December 31, 2023, again, subject +to his continued employment with the Company on each such vesting date. +Under +the SM Agreement, Mr. Madden is also eligible to receive annually, on or about the date of the Company’s annual meeting +of stockholders (but not later than June 30th), an option (the “Annual Option”) to purchase shares of Common Stock +equal to the greater of (a) 100% of the largest aggregate number of shares of Common Stock available upon the exercise of an option +or options granted to any other continuing full-time employee of the Company during the preceding twelve-month period and (b) +225,000 shares of Common Stock; provided, however, that a grant to Mr. Madden in excess of 150% of the number of shares of Common +Stock subject to options granted to such other continuing full-time employee would require stockholder approval. Any Annual Option +so granted vests quarterly over a one-year period and is exercisable at a price equal to the closing price of the Company’s +Common Stock on the grant date for a period of five years. In addition, pursuant to the SM Agreement, on March 1, 2017, Mr. Madden +received a one-time stock option grant to purchase 1,125,000 shares of the Company’s Common Stock at an exercise price of +$24.90 as a result of the Company having achieved for the fiscal year ended December 31, 2016 earnings per share performance criteria +set forth in the SM Agreement; such option vests in equal annual installments over a five-year period which commenced on the first +anniversary of the grant date. +Under +the SM Agreement, in the event of Mr. Madden’s death, his estate would receive a payment equal to his base salary for the +12-month period immediately subsequent to the date of his death. Further, in the event that Mr. Madden’s employment is terminated +due to his total disability (as defined in the agreement), “for cause” (as defined in the agreement) or due to Mr. +Madden’s resignation, the Company is obligated to pay Mr. Madden the amount of compensation that is accrued and unpaid through +the date of termination. In the event that Mr. Madden’s employment is terminated for any reason (other than “for cause” +or due to his death, total disability or resignation), the Company is obligated to pay Mr. Madden, in installments, the balance +of his base salary through the end of the term of the SM Agreement. If, during the period commencing 120 days prior to a “change +of control” transaction (as defined in the agreement) and ending on the first anniversary of a change of control transaction, +Mr. Madden’s employment is terminated other than for cause or by his resignation for “good reason” (as defined +in the agreement), or if Mr. Madden resigns for good reason or without good reason within 30 days following a change of control +transaction, all unvested options held by Mr. Madden will be accelerated and vest on the date of termination or resignation and +Mr. Madden will be entitled to receive a lump sum cash payment equal to the amount of compensation that is accrued and unpaid +through the date of termination plus $35 million. The SM Agreement contains other customary provisions, including provisions regarding +expense reimbursement, confidentiality, solicitation and competition. +For +the 2018 Fiscal Year, Mr. Madden earned $7,026,042 in base salary and received $200,000 for the payment of an annual life insurance +premium. Mr. Madden also received as his Annual Option for the 2018 Fiscal Year an option to purchase 225,000 shares of Common +Stock at a price per share of $35.95. +The +most recent amendment entered into on March 25, 2019, effected the extension of the term of the SM Agreement for three years through +December 31, 2026. In consideration of this extension, the Company has granted to Mr. Madden 200,000 shares of Common Stock under +the 2006 Plan, which shares are subject to certain restrictions including, without limitation, that the Employee will not sell, +transfer, pledge, hypothecate, assign or otherwise dispose of the restricted shares except as set forth under the 2006 Plan or +Mr. Madden’s award agreement. Vesting of the shares occurs in annual installments over three years commencing on December +31, 2024 on which date 66,666 shares will vest and continuing to vest thereafter on each of December 31, 2025 and December 31, +2026 when 66,667 shares will vest; provided, in each case, that Mr. Madden continues to be employed by the Company on each such +date through December 31, 2026. +20 +Loan +to Steven Madden. On June 25, 2007, the Company made a loan to Mr. Madden in the amount of $3,000,000, in order for Mr. Madden +to satisfy a personal tax obligation resulting from the exercise of a stock option which was due to expire and hold the underlying +shares of Common Stock. The loan is evidenced by a secured promissory note executed by Mr. Madden in favor of the Company, the +security for which is a security interest in a certain securities brokerage account maintained by Mr. Madden with his broker; +none of the securities in the securities brokerage account are shares of the Company’s Common Stock. There have been successive +amendments to the secured promissory note, the most recent of which occurred in April 2016, at which time the secured promissory +note was amended to substitute the collateral securing the secured promissory note from shares of the Company’s Common Stock +to the security interest in Mr. Madden’s securities brokerage account noted above. Previously, on January 3, 2012, the secured +promissory note was amended and restated to extend the maturity date of the obligation to December 31, 2023 and eliminate the +accrual of interest after December 31, 2011. Prior to the January 3, 2012 amendment, the secured promissory note had been accruing +interest at the rate of 6% per annum. In addition, the secured promissory note provides that, commencing on December 31, 2014 +and annually on each December 31 thereafter through the maturity date, one-tenth of the principal amount thereof, together with +accrued interest, will be cancelled by the Company provided that Mr. Madden continues to be employed by the Company on each such +December 31. Contemporaneously, on each such December 31, the Company will release its security interest in a portion of the securities +held in Mr. Madden’s securities brokerage account generally correlating to the amount of indebtedness cancelled on such +date. As of December 31, 2011, interest in the amount of $1,090,000 had accrued on the principal amount of the secured promissory +note and, as noted above, interest was eliminated after December 31, 2011. On December 31, 2018, the required one-tenth of the +principal amount of the secured promissory note, together with accrued interest, was written-off by the Company. +Review, Approval or Ratification +of Transactions with Related Persons +The +Company’s written Conduct Code and Employee Handbook prohibit all conflicts of interest. Under the Conduct Code, conflicts +of interest occur when private or family interests interfere in any way, or even appear to interfere, with the interests of the +Company. The Company’s prohibition on conflicts of interest under the Conduct Code includes any related person transaction. +Related +person transactions must be approved by the Board, or by a committee of the Board consisting solely of independent directors, +who will approve the transaction only if they determine that it is in the best interests of the Company. In considering the transaction, +the Board or committee will consider all relevant factors, including, as applicable, (i) the Company’s business rationale +for entering into the transaction; (ii) the alternatives to entering into a related person transaction; (iii) whether +the transaction is on terms comparable to those available to third parties or, in the case of employment relationships, to employees +generally; (iv) the potential for the transaction to lead to an actual or apparent conflict of interest and any safeguards +imposed to prevent such actual or apparent conflicts; and (v) the overall fairness of the transaction to the Company. +The +Company has multiple processes for reporting conflicts of interests, including related person transactions. Under the Conduct +Code, all employees are required to report any actual or apparent conflict of interest, or potential conflict of interest, to +management. The Chief Financial Officer distributes a questionnaire to the Company’s executive officers and management personnel +on a quarterly basis and distributes a questionnaire to the members of the Board of Directors on an annual basis requesting certain +information regarding, among other things, their immediate family members, employment and beneficial ownership interests, which +information is then reviewed for any conflicts of interest under the Conduct Code. +The +Board of Directors, the Audit Committee and the Disclosure Committee, which is comprised of management personnel, discuss the +related party transactions, specifically, and in connection with the regular review processes attendant to the Company’s +periodic filings, including related party transaction disclosures. +If +a director is a party to or in some manner involved in a transaction involving the Company, he or she will be recused from all +discussions and decisions about the transaction. 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+2019-01-01 +2019-12-31 +0000913241 +us-gaap:OperatingExpenseMember +2019-10-01 +2019-12-31 +0000913241 +2019-10-01 +2019-12-31 +0000913241 +2019-01-01 +2019-03-31 +0000913241 +2018-07-01 +2018-09-30 +0000913241 +2018-04-01 +2018-06-30 +0000913241 +2018-10-01 +2018-12-31 +xbrli:shares +xbrli:pure +iso4217:USD +shoo:Website +iso4217:USD +xbrli:shares +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2019 +or +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from ________ to ________ +Commission File Number 0-23702 +STEVEN MADDEN, LTD. +(Exact name of registrant as specified in its charter) +Delaware +13-3588231 +(State or other jurisdiction of +(I.R.S. Employer Identification No.) +incorporation or organization) +52-16 Barnett Avenue , Long Island City , New York 11104 +(Address of principal executive offices) (Zip Code) +( 718 ) 446-1800 +(Registrant's Telephone Number, Including Area Code) +Securities Registered Pursuant to Section 12(b) of the Act: +Title of each class +Trading symbol(s) +Name of each exchange on which registered +Common Stock, par value $.0001 per share +SHOO +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act. +Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Emerging growth company +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). +Yes ☐ No ☒ +The aggregate market value of the common equity held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and directors are “affiliates” of the registrant) as of June 28, 2019 , the last business day of the registrant's most recently completed second fiscal quarter, was $ 2,847,066,470 (based on the closing sale price of the registrant's common stock on that date as reported on The NASDAQ Global Select Market). +The number of outstanding shares of the registrant's common stock as of February 26, 2020 was 83,799,288 shares. +DOCUMENTS INCORPORATED BY REFERENCE: +PART III INCORPORATES CERTAIN INFORMATION BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT'S 2020 ANNUAL MEETING OF STOCKHOLDERS. +TABLE OF CONTENTS +SAFE HARBOR STATEMENT +1 +PART I +ITEM 1 BUSINESS +1 +ITEM 1A RISK FACTORS +11 +ITEM 1B UNRESOLVED STAFF COMMENTS +19 +ITEM 2 PROPERTIES +20 +ITEM 3 LEGAL PROCEEDINGS +21 +ITEM 4 MINE SAFETY DISCLOSURES +21 +PART II +ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER +MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +21 +ITEM 6 SELECTED FINANCIAL DATA +24 +ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION +AND RESULTS OF OPERATIONS +25 +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +37 +ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +37 +ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON +ACCOUNTING AND FINANCIAL DISCLOSURE +37 +ITEM 9A CONTROLS AND PROCEDURES +37 +ITEM 9B OTHER INFORMATION +38 +PART III +ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +38 +ITEM 11 EXECUTIVE COMPENSATION +38 +ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND +MANAGEMENT AND RELATED STOCKHOLDER MATTERS +38 +ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND +DIRECTOR INDEPENDENCE +39 +ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES +39 +PART IV +ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +39 +SAFE HARBOR STATEMENT UNDER THE U.S. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, among others, statements regarding revenue and earnings guidance, plans, strategies, objectives, expectations and intentions. You can identify forward-looking statements by words such as: “may,” “will,” “expect,” “believe,” “should,” “anticipate,” “project,” “predict,” “plan,” “intend,” or “estimate,” and similar expressions or the negative of these expressions. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they represent our current beliefs, expectations and assumptions regarding anticipated events and trends affecting our business and industry based on information available as of the time such statements are made. We caution investors that such forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted with accuracy and some of which may be outside of our control. Our actual results and financial condition may differ materially from those indicated in these forward-looking statements. As such, investors should not rely upon them. Important risk factors include: +• +our ability to accurately anticipate fashion trends and promptly respond to consumer demand; +• +our ability to compete effectively in a highly competitive market; +• +our ability to adapt our business model to rapid changes in the retail industry; +• +our dependence on the hiring and retention of key personnel; +• +our ability to successfully implement growth strategies and integrate acquired businesses; +• +our reliance on independent manufacturers to produce our products in a timely manner especially when faced with adversities such as work stoppages, transportation delays, public health emergencies, social unrest, changes in local economic conditions, and political upheavals as well as meet our quality standards; +• +changes in trade policies and tariffs imposed by the United States government and the governments of other nations in which we manufacture and sell our products; +• +disruptions to product delivery systems and our ability to properly manage inventory; +• +our ability to adequately protect our trademarks and other intellectual property rights; +• +legal, regulatory, political and economic risks that may affect our sales in international markets; +• +changes in U.S. and foreign tax laws that could have an adverse effect on our financial results; +• +additional tax liabilities resulting from audits by various taxing authorities; +• +our ability to achieve operating results that are consistent with prior financial guidance; and +• +other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission. +These risks and uncertainties, along with the risk factors discussed under Item 1A. “Risk Factors” in this Annual Report on Form 10-K, should be considered in evaluating any forward-looking statements contained in this report. We do not undertake any obligation to publicly update any forward-looking statement, including without limitation, any guidance regarding revenue or earnings, whether as a result of new information, future developments or otherwise. +PART I +ITEM 1. BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", or "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags, apparel and accessories. We also license some of our trademarks for use in connection with the manufacturing, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico, our joint ventures in Europe, South Africa, Israel, Taiwan and China, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico and certain European nations. In addition, we have special distribution arrangements for the marketing of our products in Spain, Italy, Australia, the Middle East, India, South and Central America, New Zealand and Singapore. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +1 +Steven Madden, Ltd. was incorporated in New York on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol "SHOO." Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of our Company, each of which is attached as an exhibit to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015. We also have a Code of Conduct that is applicable to all of our employees, which is attached as an exhibit to our 2018 Annual Report on Form 10-K filed with the SEC on February 28, 2019. Each of these codes is posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Recent Developments +Acquisition. On August 9, 2019, we acquired 90% of the outstanding common stock of GREATS Brand, Inc., owner of GREATS, a pioneering digitally native sneaker brand, for an initial payment of $12,829 and a future contingent payment of $5,000 based on the GREATS brand achieving certain EBITA targets. In connection therewith, we recorded a non-current liability of $4,354 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by GREATS' future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $16,893 , net of cash acquired of approximately $290 . The acquisition was funded by cash on hand and adds a new footwear brand with added growth potential to our Company. +Acquisition. On August 12, 2019, we acquired 100% of the outstanding common stock of B.B. Dakota, Inc., owner of BB Dakota, a contemporary women's apparel company, for an initial payment of $24,568 and a future contingent payment on the BB Dakota brand achieving certain EBITDA targets. In connection therewith, we recorded a non-current liability of $4,770 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by BB Dakota's future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $29,404 , net of cash acquired of approximately $353 and a post-closing working capital adjustment of $419. The acquisition was funded by cash on hand and adds new apparel brands with added growth potential to our Company. +Joint Venture. In September 2019, we formed SM Distribution China Co., Ltd. ("SM China"), a joint venture with Channelink LLP through its subsidiary. We hold a 51% interest holder in SM China and control all of the significant participating rights of the joint venture. SM China is the exclusive distributor of our products in China. Because we control all of the significant participating rights of the joint venture and are the majority interest holder in SM China, the assets, liabilities and results of operations of the joint venture are consolidated and included in our consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interest” in the Consolidated Statements of Income and “Noncontrolling interest” in the Consolidated Balance Sheets. +Dividend. In October 2019, our Board of Directors declared an increase to the quarterly cash dividend to $0.15 per share on our outstanding shares of common stock. The dividend was paid on December 27, 2019 to stockholders of record as of the close of business on December 16, 2019. +Our Board of Directors approved a quarterly cash dividend of $0.15 per share on February 25, 2020. The dividend will be paid on March 27, 2020, to stockholders of record at the close of business on March 17, 2020. +2 +Product Distribution Segments +Our business comprises five distinct segments: Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing. +Our Wholesale Footwear segment comprises the following brands: +Steve Madden® +DV by Dolce Vita® +Stevies® +Madden Girl® +Mad Love® +Brian Atwood® +Madden® +Steven by Steve Madden® +Blondo® +Madden NYC +Report® +Anne Klein® (under license) +Dolce Vita® +Superga® (under license) +Betsey Johnson® +GREATS® +AK Sport® (under license) +The segment also includes our International business and part of our private label footwear business. An agreement under which we licensed the Kate Spade® trademark terminated on December 31, 2019. +Our Wholesale Accessories/Apparel segment comprises the following brands: +Steve Madden® +Madden Girl® +Big Buddha® +Cejon® +Madden NYC +Luv Betsey® +Betsey Johnson® +Anne Klein® (under license) +Steven by Steve Madden® +Jocelyn® +BB Dakota® +DKNY® (under license) +Cupcakes & Cashmere® (under license) +It also includes our International business and part of our private label accessories business. An agreement under which we licensed the Donna Karan® trademark terminated on December 31, 2019. +Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven, Superga and GREATS retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn e-commerce websites. +Our First Cost segment represents activities of one of our wholly-owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market retailers, shoe chains and other value priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses, hair accessories, fragrance, umbrellas, bedding and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, headbands, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and FREEBIRD by Steven® for operation of retail stores. +3 +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine whether the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. Retail price points for Steve Madden Women's products range from $59 to $189. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared towards girls and young women ages 13 to 25 and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. Retail price points for Madden Girl products range from $39 to $79. +Steve Madden Men's. We design, source and market a lifestyle collection of men's footwear for the fashion forward man, ages 18 to 45, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Retail price points for Steve Madden Men's products range from $69 to $169. +Madden. The Madden® brand is a casual and business casual collection of footwear designed to meet the ever-evolving needs of the trend conscious young male consumer, ages 16 to 35. Madden products range from $40 to $90 and are sold to national specialty stores, department stores, mid-tier department stores, online retailers, off-price retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal to fashion conscious women ages 25 to 45 who grew up wearing Steve Madden footwear and are looking for a shoe with an emphasis on comfort. Retail price points for Steven products range from $89 to $169. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12. These brands are distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. Retail price points for Steve Madden Kids products range from $49 to $89. +Betsey Johnson . On October 5, 2010, we acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. Retail price points for Betsey Johnson products range from $99 to $139. +Superga. On February 9, 2011, we entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. Retail price points for Superga products range from $65 to $99. +Report. We acquired the Report® brand in May 2011. It is a junior women's footwear brand with retail price points ranging from $20 to $100 per pair. We design, manufacture, market and sell Report branded products to major department stores, mid-tier department stores and independently owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street lifestyle brand created to appeal to women with a young attitude and active lifestyle and marketed exclusively to Target. Retail price points for Mad Love products range from $15 to $23. +Dolce Vita. In August 2014, we acquired the Dolce Vita® and DV® brands. Dolce Vita® is a contemporary women's footwear brand with retail price points ranging from $79 to $225. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently owned boutiques primarily throughout the United States. The DV® brand is a contemporary women's footwear brand with retail price points ranging from $20 to $75. DV® products are distributed through major department stores, off-price department stores, online retailers and independently owned boutiques primarily throughout the United States. +4 +Brian Atwood. In March 2014, we acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand. Brian Atwood is known for luxury shoes manufactured in China and Italy. In the second quarter of 2019, we stopped distribution of the Brian Atwood brand. +Blondo. In January 2015, we acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. Retail price points for Blondo products range from $99 to $199. +GREATS . In August 2019, we acquired the intellectual property and related assets of GREATS, a digitally native footwear brand specializing in premium quality, responsibly made sneakers for men and women. Founded in 2014, GREATS is a pioneer and the first digitally native sneaker brand. GREATS partners with better department stores like Nordstrom as well as specialty boutiques in the United States. Retail price points for GREATS products range from $119 to $199. +Kate Spade. In January 2017, as a consequence of the acquisition of Schwartz & Benjamin, Inc., we acquired licenses to manufacture, market and sell footwear under the Kate Spade® trademark. The Kate Spade® brand, known for its whimsical fashion, is an entry-level luxury footwear brand primarily distributed through department stores and Kate Spade retail stores throughout the United States. The price points of footwear bearing the Kate Spade® brand range from $98 to $400 per pair with the core product price ranging from $198 to $298. As of December 31, 2019, the agreement to license the Kate Spade® trademark was terminated. +Anne Klein. In January 2018, we entered into a license agreement with Nine West Development LLC for a license to use the Anne Klein®, AK Sport®, AK Anne Klein Sport® and Lion Head Design® trademarks in connection with the marketing and sale of footwear. The Anne Klein® brand is recognized as being synonymous with American sportswear. Retail price points for Anne Klein products range from $49 to $129. +International Division. The International division, utilizing some of the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers through wholly owned subsidiaries in Canada and Mexico and joint venture partnerships in Europe (excluding Italy, Spain and Greece, where we had preexisting distributors), South Africa, Israel, China and Taiwan. In addition, the International division works through special distribution arrangements for the marketing and sale of our products in Spain, Italy, Australia, the Middle East, India, South and Central America, New Zealand and Singapore. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third-party brands, such as Material Girl® and Candies®. +Wholesale Accessories/Apparel Segment +Our Wholesale Accessories/Apparel segment designs, sources and markets name brands and sells them to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our joint ventures and International distributor network. These brands include the following brands as well as private label fashion handbags and accessories: +Steve Madden® +Big Buddha® +Steven by Steve Madden® +BB Dakota® +Madden Girl® +Anne Klein® (under license) +Betsey Johnson® +Jocelyn® +Madden NYC +Luv Betsey® +DKNY® (under license) +Cupcakes & Cashmere® (under license) +In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Steve Madden®, BB Dakota®, Cejon®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +5 +Retail Segment +As of December 31, 2019 , we owned and operated 227 retail stores, including 146 Steve Madden full-price stores, 68 Steve Madden outlet stores, 2 Steven stores, 2 GREATS stores, 1 Superga store and 8 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn). In 2019 , we added 8 full-price stores, 8 outlet stores and 2 e-commerce websites and closed 17 full-price stores, 2 outlet stores and 1 e-commerce website. In addition, during 2019 , we closed 12 concessions in China and opened 1 concession in Taiwan, ending the year with 31 company-operated concessions in international markets. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, Israel, China and Taiwan. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for at least twelve months) increased 6.1% in fiscal year 2019 from the prior year. We exclude new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We believe that our retail stores will continue to enhance overall sales and profitability, and our ability to react swiftly to changing consumer trends. Our stores play an important role in our integrated retail strategy and serve as fulfillment and return locations for our e-commerce business. We are also launching buy-online-return-in-store in select locations. Our stores also serve as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. We expect to open 10 to 13 new retail stores and close 4 to 6 locations in 2020 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market retailers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Kohl's, Fred Meyer and Meijers. In addition, by leveraging the strength of our Steve Madden brands and product designs, we are able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses, hair accessories, fragrance, umbrellas, bedding and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, headbands, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and FREEBIRD by Steven® for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note Q to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Company's products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models +6 +provide our brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate any foreign manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently owned manufacturers primarily in China and also in Cambodia, Mexico, Brazil, India, Vietnam, Italy and other European nations. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. +The manufacturers of our products are required to meet quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and most of our products are shipped via ocean freight carriers to ports principally in California and to a lesser extent in New Jersey, and via truck from Mexico to our third-party distribution facility in Texas. We rely to a lesser extent on air carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from eight third-party distribution centers, five located in California, one located in Texas, one located in Tennessee and one located in New Jersey. Our products are also distributed through a Company-operated distribution center located in Canada. Our products are also distributed through our third-party distribution facility in Mexico. By utilizing distribution facilities specializing in fulfillment for certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. Suppliers of products for our businesses in Canada and Mexico and our joint ventures in Europe, South Africa, Israel, Taiwan and China ship to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stor es, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers, in no particular order, include: +Nordstrom, Inc. +The TJX Companies, Inc. +Dillard's, Inc. +Burlington Stores, Inc. +Macy's, Inc. +Ross Stores, Inc. +Designer Brands, Inc. +Wal-Mart Stores, Inc. +Kohl's Corporation +Target Corporation +For the year ended December 31, 2019 , Wal-Mart Stores, Inc. represented 11.9% of total revenue. At December 31, 2019 , Wal-Mart Stores, Inc. represented 17.9% of total accounts receivable, Target Corporation represented 13.6% of total accounts receivable and Nordstrom, Inc. represented 10.6% of total accounts receivable. We did not have any other customers who accounted for more than 10% of total revenue or any other customers who accounted for more than 10% of total accounts receivable. +7 +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, Israel, Taiwan and China +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico and certain European nations. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in Europe, South Africa, Israel, Taiwan and China, and on our e-commerce websites. For the year ended December 31, 2019 , our two Wholesale segments and our Retail segment generated net sales of approximately $1,446,953 and $321,182 , or 81% and 18% of our total revenue, respectively. Each of these distribution channels is described below. +Department Stores. We currently sell our products to approximately 2,200 doors of 15 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Nordstrom, Inc., Macy's, Inc., Dillard's, Inc., Belk, Inc. and Bloomingdale's, Inc. +We provide merchandising support to our department store customers, including in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which we showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at the end of the season. +National Chains and Mass Merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Wal-Mart Stores, Inc., Target Corporation and Kohl's Corporation. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW Designer Shoe Warehouse, Famous Footwear and Gap, Inc. We offer our specialty store accounts similar merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through certain catalogs. +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate 8 Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and Jocelyn apparel and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +Steve Madden, Steve Madden Outlet, Steven, Superga and GREATS Retail Stores. As of December 31, 2019 , we operated 146 Steve Madden full-price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China, Taiwan and Israel. We also operated 68 Steve Madden outlet stores, 2 Steven stores, 2 GREATS stores and 1 Superga store within the United States. We also operated 8 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn). We believe that our retail stores will continue to enhance overall sales and profitability, and our ability to react swiftly to changing consumer trends. Our stores play an important role in our integrated retail strategy and serve as fulfillment and return locations for our e-commerce business. We are also launching buy-online-return-in-store in select locations. Our stores also serve as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage +8 +sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The GREATS stores are approximately 1,000 to 1,500 square feet and are located in New York and Miami. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from us and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include certain European territories, the Middle East, South and Central America, Oceania and various countries in Asia. +Competition +The fashion industry is highly competitive. We compete with specialty shoe, apparel and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Sam Edelman, Deckers Outdoor Corporation and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective marketing and advertising, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +Marketing and Sales +We have focused on creating an integrated brand building program to establish our Company as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations, including product and brand placements in lifestyle and fashion magazines and digital outlets, in-store promotions, as well as personal appearances by our founder and Creative and Design Chief, Steven Madden. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and Jocelyn apparel and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also connect with our customers through social media forums including Instagram, Facebook and Twitter. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support our growth. Our Enterprise Resource Planning (“ERP”) system is an integrated system that supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. All of our North American wholesale businesses (other than Canada, which has a separate ERP system) and our Asia first-cost and sourcing operations are operated through this ERP system. Our warehouse management system is utilized by our third-party logistics providers and is fully integrated with our ERP system. A point of sale system for our U.S. retail stores is integrated with a retail inventory management/store replenishment system. We have transitioned our e-commerce software to a major cloud-based provider. Complementing all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +9 +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 131 other countries and in numerous International Classes. From time to time, we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying our Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +Brian Atwood® +Madden Girl® +B Brian Atwood® +Stevies® +Dolce Vita® +Stevies plus Design® +DV8® +Big Buddha® +Sweet Life® +Topline® +DV® +Betseyville® +DV DOLCE VITA® +Betsey Johnson® +Wild Pair® +LUV BETSEY plus Kiss Design® +MadLove® +LUV BETSEY by Betsey Johnson Design® +Blondo® +Blue by Betsey Johnson® +Blondo Waterproof plus Heart Design® +Steve Madden plus Design® +By Steve Madden plus Heart® +SM New York® +SM Pass® +SM New York plus Design® +Jocelyn® +FREEBIRD By Steven® +BB Dakota® +The Factory by Steve Madden® +JACK BB Dakota® +GREATS® +JAIME® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks worldwide. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations. +Trademark Licensing +Our strategy for the continued growth of our business includes expanding our presence beyond footwear, apparel and accessories through the selective licensing of our brands. As of December 31, 2019 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and FREEBIRD by Steven® for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +10 +See Notes B and P to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 3, 2020 , we employed approximately 4,000 employees, of whom approximately 2,500 work full-time and approximately 1,500 work part-time. Most of our part-time employees work in the Retail segment. Approximately 2,600 of our employees are located in the United States, approximately 700 employees are located in Hong Kong and China, approximately 400 employees are located in Canada, approximately 200 employees are located in Mexico, approximately 100 employees are located in Israel, approximately 80 employees are located in South Africa and approximately 40 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. We have never experienced a material interruption of our operations due to a labor dispute. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales occur in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales occur in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Revenue levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $ 328,600 and $ 369,458 , as of February 3, 2020 and February 1, 2019 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. +ITEM 1A. RISK FACTORS +You should carefully consider the risks and uncertainties we describe below and the other information in this Annual Report on Form 10-K before deciding to invest in, sell or retain shares of our common stock. These are not the only risks and uncertainties that we face. Other sections of this report may discuss factors that could adversely affect our business. Our industry is highly competitive and subject to rapid change. There may be additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, which may also harm our business or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, results of operations and liquidity could be materially harmed. +The fashion footwear, accessories and apparel industry is subject to rapid changes in consumer preferences. If we do not accurately anticipate fashion trends and promptly respond to consumer demand, we could lose sales, our relationships with customers could be harmed and our brand loyalty could be diminished. +The strength of our brands and our success depends in significant part upon our ability to anticipate and promptly respond to product and fashion trends as well as to anticipate, gauge and react to changing consumer demands in a timely manner. There can be no assurance that our products will correspond to the changes in taste and demand or that we will be able to successfully advertise and market products that respond to trends and customer preferences. If we misjudge the market for our products, we may be faced with significant excess inventories for some products and missed opportunities as to others. In addition, misjudgments in merchandise selection could adversely affect our image with our customers resulting in lower sales and increased markdown allowances for customers, which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +11 +We face intense competition from both established companies and newer entrants into the market. Our failure to compete effectively could cause our market share to decline, which could harm our reputation and have a material adverse impact on our financial condition, results of operations and liquidity. +The fashion footwear, accessories and apparel industry is highly competitive and barriers to entry are low. Our competitors include specialty companies as well as companies with diversified product lines. Market growth in the sales of fashion footwear, accessories and apparel has encouraged the entry of many new competitors and increased competition from established companies. Many of these competitors, including Aldo, Sam Edelman, Deckers Outdoor Corporation and Vince Camuto, may have significantly greater financial and other resources than we do, and there can be no assurance that we will be able to compete successfully with these and other fashion footwear, accessories and apparel companies. Increased competition could result in pricing pressures, increased marketing expenditures and loss of market share and could have a material adverse effect on our business, financial condition, results of operations and liquidity. +If we and our customers are unable to adapt to recent and anticipated changes in the retail industry, the sales of our products may decline, which could have a material adverse effect on our financial condition, results of operations and liquidity. +In recent years, the retail industry has experienced consolidation and other ownership changes. In the future, retailers in the United States and in foreign markets may further consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our or our licensees’ products or increase the ownership concentration within the retail industry. Changing shopping patterns, including the rapid expansion of online retail shopping, have adversely affected customer traffic in mall and outlet centers, particularly in North America. We expect competition in the e-commerce market will intensify. As a greater portion of consumer expenditures with retailers occurs online and through mobile commerce applications, our brick-and-mortar retail customers who fail to successfully integrate their physical retail stores and digital retail may experience financial difficulties, including store closures, bankruptcies or liquidations. A continuation or worsening of these trends could cause financial difficulties for one or more of our major customers, which, in turn, could substantially increase our credit risk and have a material adverse effect on our results of operations, financial condition and cash flows. We have little or no control over how our customers will respond to the challenges posed by these changes in the retail industry. Our success will be determined, in part, on our and our customers’ ability to manage the impact of the rapidly changing retail environment and identify and capitalize on retail trends, including technology, e-commerce and other process efficiencies that will better service our customers. If we and our customers fail to compete successfully, our businesses, market share, results of operations and financial condition could be materially and adversely affected. While such changes in the retail industry to date have not had a material adverse effect on our business or financial condition, results of operations and liquidity, there can be no assurance as to the future effect of any such changes. +The loss of Steve Madden, our founder and Creative and Design Chief, or members of our executive management team could have a material adverse effect on our business. +The growth and success of our Company since its inception more than a quarter century ago is attributable, to a significant degree, to the talents, skills and efforts of our founder and Creative and Design Chief, Steven Madden. An extended or permanent loss of the services of Mr. Madden could severely disrupt our business and have a material adverse effect on our Company. We also depend on the contributions of the members of our senior management team. Our senior executives have substantial experience and expertise in our business and industry and have made significant contributions to our growth and success. Competition for executive talent in the fashion footwear, accessories and apparel industries is intense. While our employment agreements with Mr. Madden and most of our senior executives include a non-compete provision in the event of the termination of employment, the non-compete periods are of limited duration and scope. Although we believe we have depth within our senior management team, if we were to lose the services of our Creative and Design Chief or any of our senior executives, and especially if any of these individuals were to join a competitor or form a competing company, our business and financial performance could be seriously harmed. A loss of the skills, industry knowledge, contacts and expertise of our Creative and Design Chief or any of our senior executives could cause a setback to our operating plan and strategy. +If we are not successful in implementing our growth strategy or integrating acquired businesses, we may not be able to take advantage of certain market opportunities and may become less competitive . +The size of our business continues to grow organically and as a result of business acquisitions. In order to gain from our acquisitions, we must be effective in integrating the businesses acquired into our overall operations. Further, the expansion of our operations has increased and will continue to increase the demand on our managerial, operational and administrative resources. In recent years, we have invested significant resources in, among other things, our management information systems and hiring +12 +and training of new personnel. However, in order to manage currently anticipated levels of future demand, we may be required to, among other things, expand our distribution facilities, establish relationships with new manufacturers to produce our products and continue to expand and improve our financial, management and operating systems. We may experience difficulty integrating acquired businesses into our operations and may not achieve anticipated synergies from such integration. There can be no assurance that we will be able to manage future growth effectively and a failure to do so could have a material adverse effect on our business, financial condition, results of operations and liquidity. +If one or more of our significant customers were to reduce or stop purchases of our products, our sales and profits could decline. +Our customers consist principally of better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, catalog retailers and pure-play e-commerce retailers. Certain of our department store customers, including some under common ownership, account for significant portions of our wholesale business. We generally enter into a number of purchase order commitments with our customers for each of our lines every season and do not enter into long-term agreements with any of our customers. Therefore, a decision by a significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to decrease the amount of merchandise purchased from us or to change its manner of doing business could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruptions to our product delivery systems and failure to effectively manage inventory based on business trends across various distribution channels could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Most of our products for U.S. distribution are shipped to us via ocean freight carriers to ports primarily in California, and to a lesser extent in New Jersey and Texas. The trend-focused nature of the fashion industry and the rapid changes in customer preferences leave us vulnerable to risk of inventory obsolescence. Our reliance upon ocean freight transportation for the delivery of our inventory exposes us to various inherent risks, including port workers’ union disputes and associated strikes, work slow-downs and stoppages, severe weather conditions, natural disasters, and terrorism, any of which could result in delivery delays and inefficiencies, increase our costs and disrupt our business. Any severe and prolonged disruption to ocean freight transportation could force us to use alternate and more expensive transportation systems. Efficient and timely inventory deliveries and proper inventory management are important factors in our operations. Inventory shortages can adversely affect the timing of shipments to customers and diminish sales and brand loyalty. Conversely, excess inventories can result in lower gross margins due to the excessive discounts and markdowns that may be necessary to reduce high inventory levels. Severe and extended delays in the delivery of our inventory or our inability to effectively manage our inventory could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Our foreign manufacturers’ inability to produce our goods in a timely manner or to meet our quality standards could adversely affect our financial results and harm our brands’ reputation. +We do not own or operate any foreign manufacturing facilities and, therefore, are dependent upon third parties to manufacture most of our products. The risks inherent in reliance on foreign manufacturing include work stoppages, transportation delays, public health emergencies, social unrest, changes in local economic conditions, and political upheavals. During 2019, 88% of our total purchases were from China. China is currently experiencing a public health emergency due to the spread of the coronavirus, and manufacturing facilities that produce our products have been shut down beyond the customary lunar new year holiday. Although manufacturing has resumed, manufacturers are currently not at full capacity. We cannot accurately predict when and whether those manufacturers will return to full capacity or the extent to which the coronavirus epidemic will have short- or long-term adverse effects on the ability of manufacturers in China and other countries to produce our products. The inability of Chinese or other manufacturers to ship orders of our products in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers for those items. Such failures could result in the cancellation of orders, customers’ refusal to accept deliveries, a reduction in purchase prices, and ultimately, termination of a customer relationship, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. In that case, we may be required to seek alternative sources of materials or products. Although we believe that we can manage our exposure to these risks, we cannot be certain that we will be able to identify such alternative materials or sources without delay or without greater cost to us. Our inability to identify and secure alternative sources of supply in this situation could have a material adverse effect on our ability to satisfy customer orders. +13 +Changes in trade policies and tariffs imposed by the United States government and the governments of other nations could have a material adverse effect on our business and results of operations. +Our operations are dependent upon products purchased, manufactured and sold internationally. Our sources of supply are subject to the usual risks of doing business abroad, such as the implementation of, or potential changes in, foreign and domestic trade policies, increases in import duties, anti-dumping measures, quotas, safeguard measures, trade restrictions, restrictions on the transfer of funds and, in certain parts of the world, political instability and terrorism. In 2018 and 2019, the United States government imposed significant tariffs and created the potential for significant additional changes in trade policies, including tariffs and government regulations affecting trade between the United States and countries where we purchase, manufacture and sell our products. These trends are affecting many global manufacturing and service sectors, including the footwear, accessories and apparel industries, and may cause us to face trade protectionism in many different regions of the world. These protectionist measures could result in increases in the cost of our products and adversely affect our sales and profitability. +Effective September 24, 2018, the United States government imposed additional tariffs on approximately $200 billion of goods imported from China. The additional tariffs on Chinese imports were initially set at a level of 10% and were increased to 25% in May 2019. This initial round of tariffs applied to handbags and certain other accessories that we produce. In August 2019, the United States government announced a second round of tariffs set at a level of 15% on approximately $300 billion of goods imported from China, including footwear, apparel and certain other accessories that we produce. The second round of tariffs became effective on September 1, 2019, for a portion of the covered products that we produce. Tariffs for the remaining covered products that we produce were scheduled to become effective on December 15, 2019, but were suspended indefinitely as part of the phase I trade agreement between the United States and China that was signed on January 15, 2020. In addition, as of February 14, 2020, the 15% tariff that was implemented on September 1, 2019 was reduced to 7.5%. China has already imposed retaliatory tariffs on a wide range of American products in response to these tariffs. Most of the products that we sell in the United States have been manufactured in China. The negative impact in gross margin in our wholesale business in the fourth quarter of 2018 and throughout 2019 was due, in part, to the impact of the 25% tariff on handbags and certain other accessory categories as well as the 15% tariff on footwear, apparel, and other accessory categories. Our efforts to mitigate the impact of these tariffs may not be successful, and the continued imposition of tariffs on products that we import from China could have a material adverse effect on our business and results of operations. +On November 30, 2018, the United States of America, the United Mexican States, and Canada Trade Agreement (the “USMCA”) was drafted as part of the renegotiation of the North American Free Trade Agreement (“NAFTA”) among the United States, Mexico and Canada. The U.S. House of Representatives ratified a revised version of the USMCA on December 19, 2019, and the Senate ratified it on January 16, 2020. It became effective upon the president's signature on January 29, 2020. We are presently evaluating the extent to which the USMCA would affect our business. Depending on how it is applied, it could necessitate changes in the way we conduct our business, including our product sourcing operations, and could have a material adverse effect on our business and results of operations. +If our manufacturers, the manufacturers used by our licensees or our licensees themselves fail to use acceptable labor practices or otherwise comply with local laws and other standards, our business could suffer. +Our products are manufactured by numerous independent manufacturers outside of the United States. We also have license agreements that permit our licensees to manufacture or contract to manufacture products using our trademarks. We impose, and require our licensees to impose, on these manufacturers environmental, health and safety standards for the benefit of their labor force. In addition, we require these manufacturers to comply with applicable standards for product safety. However, we do not control our independent manufacturers or licensing partners or their labor, product safety and other business practices. From time to time, our independent manufacturers may not comply with such standards or applicable local law or our licensees may not require their manufacturers to comply with such standards or applicable local law. The violation of such standards and laws by one of our independent manufacturers or by one of our licensing partners, or the divergence of a manufacturer's or a licensing partner's labor practices from those generally accepted as ethical in the United States, could harm our reputation, result in a product recall or require us to curtail our relationship with and locate a replacement for such manufacturer. We could also be the focus of adverse publicity and our reputation could be damaged. Any of these events could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Disruption of our information technology systems and websites could adversely affect our financial results and our business reputation. +We are heavily dependent upon our information technology systems to record and process transactions and manage and operate all aspects of our business. +14 +We also have e-commerce websites for direct retail sales. Given the nature of our business and the significant number of transactions in which we engage annually, it is essential that we maintain constant operation of our information technology systems and websites and that they operate effectively. We depend on our in-house information technology employees and third parties, including “cloud” service providers, to maintain and periodically update and upgrade our systems and websites to support the growth of our business. We also maintain an off-site server data facility that records and processes information regarding our vendors and customers and their transactions with us. Despite our preventative efforts, our information technology systems and websites may, from time to time, be vulnerable to damage or interruption from events such as computer viruses, security breaches, power outages and difficulties in replacing or integrating the systems of acquired businesses. Any such problems or interruptions could result in loss of valuable business data, our customers' or employees' personal information, disruption of our operations and other adverse impacts to our business and require significant expenditures by us to remediate any such failure, problem or breach. In addition, we must comply with increasingly complex regulatory standards enacted to protect business and personal data and an inability to maintain compliance with these regulatory standards could subject us to legal risks and penalties. Although we maintain insurance coverage aimed at addressing certain of these risks, there can be no assurance that insurance coverage will be available or that the amounts of coverage will be adequate to cover a specific loss. +Our business and reputation could be adversely affected if our computer systems or the systems of our business partners or service providers, become subject to a data security or privacy breach or other disruption from a third party. +In addition to our own confidential and proprietary business information, a routine part of our business includes the gathering, processing and retention of sensitive and confidential information pertaining to our customers, employees and others. We, our business partners or our service providers may not have the resources or technical sophistication to anticipate or prevent the rapidly evolving and complex cyber-attacks being unleashed by increasingly sophisticated hackers and data thieves. As a result, our facilities and information technology systems, as well as those of our business partners and third-party service providers, may be vulnerable to cyber-attacks and breaches, acts of vandalism, ransomware, software viruses and other similar types of malicious activities. Any actual or threatened cyber-attack may cause us to incur unanticipated costs, including costs related to the hiring of additional computer experts, business interruption, engaging third-party cyber security consultants and upgrading our information security technologies. As a result of recent security breaches at a number of prominent companies, the media and public scrutiny of information security and privacy has become more intense and the regulatory environment has become more uncertain. Any compromise or breach of our information technology systems or those of our business partners or service providers that results in the misappropriation, loss or other unauthorized disclosure of a customer’s or other person’s private, confidential or proprietary information could result in: +• +a loss of confidence in us by our customers and business partners; +• +violate applicable privacy and other laws; +• +expose us to litigation and significant potential liability; or +• +require us to expend significant resources to remedy any such breach and redress any damages cause by such a breach. +We must also comply with increasingly rigorous regulatory standards for the protection of business and personal data enacted in the U.S., Europe and elsewhere. For example, the European Union’s General Data Protection Regulation (the “GDPR”) became effective on May 25, 2018. The GDPR imposes additional obligations on companies concerning the handling of personal data and provides certain individual privacy rights to persons whose data is stored. Our compliance with existing, proposed and recently enacted laws (including implementation of the privacy and process enhancements required by the GDPR) and regulations can be costly. Any failure by us to comply with these regulatory standards could subject us to significant legal and reputational harm. +Our financial results are subject to quarterly fluctuations . +Our results of operations may fluctuate from quarter to quarter and are affected by a variety of factors, including: +• +the timing of larger shipments of product; +• +market acceptance of our products; +• +the mix, pricing and presentation of the products offered and sold; +• +the hiring and training of additional personnel; +• +inventory write downs for obsolescence; +• +the cost of materials; +• +the product mix between wholesale, retail and licensing businesses; +• +the incurrence of other operating costs; +15 +• +factors beyond our control, such as general economic conditions, declines in consumer confidence and actions of competitors; +• +the timing of holidays; and +• +weather conditions. +In addition, we expect that our sales and operating results may be significantly impacted by the opening of new retail stores and the introduction of new products. Accordingly, the results of operations in any quarter will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter. +Extreme or unseasonable weather conditions in locations where we or our customers and suppliers are located could adversely affect our business. +Our corporate headquarters and principal operational locations, including retail, distribution and warehousing facilities, may be subject to natural disasters and other severe weather and geological events that could disrupt our operations. The occurrence of such natural events may result in sudden disruptions in business conditions of the local economies affected, as well as of the regional and global economies. Such disruptions may result in decreased demand for our products and disruptions in our management functions, sales channels and manufacturing and distribution networks, which could have a material adverse effect on our business, financial condition and results of operations. Extreme weather events and changes in weather patterns can also influence customer trends and shopping habits. Extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season may diminish demand for our seasonal merchandise. Heavy snowfall, hurricanes or other severe weather events where our retail stores and the retail stores of our wholesale customers are located may decrease customer traffic in those stores and reduce our sales and profitability. If severe weather events force closure of or disrupt operations at the distribution centers we use for our merchandise, we could incur higher costs and experience longer lead times to distribute our products to our retail stores, wholesale customers or e-commerce customers. If prolonged, such extreme or unseasonable weather conditions could adversely affect our business, financial condition and results of operations. +Failure to adequately protect our trademarks and intellectual property rights, to prevent counterfeiting of our products or to defend claims against us related to our trademarks and intellectual property rights could reduce sales and adversely affect the value of our brands. +We believe that our trademarks and other proprietary rights are of major significance to our success and our competitive position, and we consider some of our trademarks, such as Steve Madden®, to be integral to our business and among our most valuable assets. Accordingly, we devote substantial resources to the establishment and protection of our trademarks on a worldwide basis. Nevertheless, policing unauthorized use of our intellectual property is difficult, expensive and time consuming. There can be no assurance that the actions we take to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products on the basis that our products violate the trademarks or other proprietary rights of others. Moreover, no assurance can be given that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve such conflicts. We could incur substantial costs in legal actions relating to our use of intellectual property or the use of our intellectual property by others. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Our failure to establish and protect such proprietary rights from unlawful and improper use could have a material adverse effect on our business, financial condition, results of operations and liquidity. +A portion of our revenue is dependent on licensing our trademarks. The actions of our licensees or the loss of a significant licensee could diminish our brand integrity and adversely affect our revenue and results of operations. +We license to others the rights to produce and market certain products that are sold under our trademarks. Although we retain significant control over our licensees’ products and advertising, we rely on our licensees for operational and financial control over their businesses. If the quality, image or distribution of our licensed products diminish, customer acceptance of and demand for our brands and products could decline. This could materially and adversely affect our business and results of operations. In fiscal year 2019, approximately 90% of our net royalties were derived from our top five licensed product lines. A decrease in customer demand for any of these product lines could have a material adverse effect on our results of operations and financial condition. Furthermore, if we are unable to engage an adequate replacement for a terminated licensee or to engage such a replacement for an extended period, our revenues and results of operations could be adversely affected. +16 +Changes in economic conditions may adversely affect our financial condition, results of operations and liquidity. +Our opportunities for long-term growth and profitability are accompanied by significant challenges and risks, particularly in the near term. Specifically, our business is dependent on consumer demand for our products and the purchase of our products by consumers is largely discretionary. Consumer confidence and discretionary spending could be adversely affected in response to financial market volatility, negative financial news, conditions in the real estate and mortgage markets, declines in income or asset values, changes to fuel and other energy costs, labor and healthcare costs, food costs and other economic factors. A downturn in economic conditions leading to a reduction in consumer confidence and discretionary spending could have a negative effect on our sales and results of operations during the year ending December 31, 2020 and thereafter. +Our global operations expose us to a variety of legal, regulatory, political and economic risks that may adversely impact our results of operations in certain regions. +As a result of our growing international operations, we are subject to risks associated with our operations in international markets as a result of a number of factors, many of which are beyond our control. These risks include, among other things: +• +the challenge of managing broadly dispersed foreign operations; +• +inflationary pressures and economic changes or volatility in foreign economies; +• +the burdens of complying with the laws and regulations of both U.S. and foreign jurisdictions; +• +additional or increased customs duties, tariffs, taxes and other charges on imports or exports; +• +political corruption or instability; +• +geopolitical regional conflicts, terrorist activity, political unrest, civil strife and acts of war; +• +local business practices that do not conform to U.S. legal or ethical guidelines; +• +anti-American sentiment in foreign countries in which we operate; +• +delays in receipts of our products at our distribution centers due to labor unrest, increasing security requirements or other factors at U.S. or foreign ports; +• +significant fluctuations in the value of the dollar against foreign currencies; +• +increased difficulty in protecting our intellectual property in foreign jurisdictions; +• +restrictions on the transfer of funds between the U.S. and foreign nations; and +• +natural disasters or health epidemics in areas in which our businesses, customers, suppliers and licensees are located. +All of these factors could disrupt our operations or limit the countries in which we sell or source our products, significantly increase the cost of operating in or obtaining materials originating from certain countries, result in decreased revenues, and materially and adversely affect our product sales, financial condition and results of operations. +We are subject to the U.S. Foreign Corrupt Practices Act, which prohibits the payment of bribes to foreign officials to assist in obtaining or retaining business. We are also subject to anti-corruption laws of the foreign countries in which we operate. Although we have implemented policies and procedures that are designed to promote compliance with such laws, our employees, contractors and agents may take actions that violate our policies and procedures. Any such violation could result in sanctions or other penalties against the Company and have an adverse effect on our business, reputation and operating results. +Our business is exposed to foreign exchange rate fluctuations. +We make most of our purchases in U.S. dollars. However, we source substantially all of our products overseas, and as such, the cost of these products may be affected by changes in the value of the relevant currencies against the U.S. dollar. Changes in currency exchange rates may also affect the relative prices at which we and our foreign competitors sell products in the same market. We use forward foreign exchange contracts to hedge material exposure to adverse changes in foreign exchange rates. However, no hedging strategy can completely insulate us from foreign exchange risk. We are also exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our financial statements due to the translation of operating results and financial position of our foreign subsidiaries. There can be no assurance that foreign currency fluctuations will not have a material adverse effect on our business, financial condition, results of operations and liquidity. +Changes in tax laws could have an adverse effect upon our financial results. +We are subject to income taxation in various jurisdictions in the United States and numerous foreign jurisdictions. Tax laws and regulations, or their interpretation and application, in any jurisdiction are subject to significant changes. Legislation or other changes in the tax laws of the jurisdictions where we do business could increase our tax liability and adversely affect our +17 +after-tax profitability. Adjustments to the incremental provisional tax expense may be made in future periods as actual amounts may differ due to, among other factors, a change in interpretation of the U.S. tax code and related tax accounting guidance, changes in assumptions made in developing these estimates, regulatory guidance that may be issued with respect to the applicable revisions to the U.S. tax code and state tax implications. +Other jurisdictions are contemplating changes or have unpredictable enforcement activity. Increases in applicable tax rates, implementation of new taxes, changes in applicable tax laws and interpretations of these tax laws and actions by tax authorities in jurisdictions in which we operate could reduce our after tax income and have an adverse effect on our results of operations. +We may be subject to additional tax liabilities as a result of audits by various taxing authorities. +We are subject to the tax laws and regulations of numerous jurisdictions as a result of our international operations. These tax laws and regulations are highly complex and significant judgment and specialized expertise is required in evaluating and estimating our worldwide provision for income taxes. We are subject to audit by the taxing authorities in each jurisdiction where we conduct our business and any one of these jurisdictions may assess additional taxes against us as a result of an audit. The final determination with respect to any tax audits, and any related litigation, could be materially different from our estimates or from our historical tax provisions and accruals. The outcome of any audit or audit-related litigation could have a material adverse effect on our operating results or cash flows in the periods for which that determination is made and may require a restatement of prior financial reports. In addition, future period earnings may be adversely impacted by litigation costs, settlement payments or interest or penalty assessments. +SEC rules relating to “conflict minerals” require us to incur additional expenses and could adversely affect our business. +The SEC has promulgated final rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring the disclosure of the use of tantalum, tin, tungsten and gold, known as “conflict minerals,” included in products either manufactured by public companies or as to which public companies have contracted for the manufacture. These rules, adopted in an effort to prevent inadvertent support of armed conflict in the Democratic Republic of Congo and certain adjoining countries (collectively, the “DRC”), require companies to investigate their supply chains to determine whether these minerals are present in their products and, if so, from where the minerals originate. The rules also require disclosure and annual reporting as to whether or not conflict minerals, if used in the manufacture of the products offered, originate from the DRC. We currently require our manufacturers to comply with policies addressing legal and ethical concerns relating to labor, employment, political and social matters, including restrictions on the use of conflict minerals. Violation of these policies by our manufacturers could harm our reputation, disrupt our supply chain or increase our cost of goods sold. Additionally, violation of any of these policies by our manufacturers could cause us to face disqualification as a supplier for our customers and suffer reputational challenges. Due to the complexity of our supply chain, compliance with the rules requires significant efforts from a cross-operational team and diverts our management and personnel and results in potential costs of additional staff. Any of the foregoing could adversely affect our sales, net earnings, business and financial condition and results of operations. +Litigation or other legal proceedings could divert management resources and result in costs that adversely affect our operating results from quarter to quarter. +We are involved in various claims, litigations and other legal and regulatory proceedings and governmental investigations that arise from time to time in the ordinary course of our business. Due to the inherent uncertainties of litigation and such other proceedings and investigations, we cannot predict with accuracy the ultimate outcome of any such matters. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations, and the amount of insurance coverage we maintain to address such matters may be inadequate to cover those claims. In addition, any significant litigation, investigation or proceeding, regardless of its merits, could divert financial and management resources that would otherwise be used to benefit our operations. See Item 3 “Legal Proceedings,” below for additional information regarding legal proceedings in which we are involved. +We extend credit to most of our customers in the United States, and their failure to pay for products shipped to them could adversely affect our financial results. +We sell our products primarily to retail stores across the United States and extend credit based on an evaluation of each customer's financial condition, usually without collateral. Various retailers, including some of our customers, have experienced financial difficulties, which has increased the risk of extending credit to such retailers. Even though we seek to mitigate the risks of extending credit by factoring most of our accounts receivable and obtaining letters of credit for others, if any of our customers +18 +were to experience a shortage of liquidity, the risk that the customer's outstanding payables to us would not be paid could cause us to curtail business with the customer or require us to assume more credit risk relating to the customer's account payable. +Our stock price may fluctuate substantially if our operating results are inconsistent with our forecasts or those of analysts who follow us. +The trading price of our common stock periodically may rise or fall based on the accuracy of forecasts of our future performance. One of our primary business objectives is to maximize the long-term strength, growth and profitability of our Company, rather than to achieve an earnings target in any particular fiscal quarter. We believe that this longer-term goal is in our best interests and those of our stockholders. However, we recognize that it may be helpful to our stockholders and potential investors for us to provide guidance as to our quarterly and annual forecast of net sales and earnings. Although we endeavor to provide meaningful and considered guidance at the time it is provided and generally expect to provide updates to our guidance when we report our quarterly results, actual results may differ from our forecasts as the guidance is based on assumptions and expectations that may or may not come to pass. As such, we assume no responsibility to update any of our forward-looking statements at such times or otherwise. If and when we announce actual results that differ from those that we have forecast, the market price of our common stock could be adversely affected. Investors who rely on these forecasts in making investment decisions with respect to our common stock do so at their own risk. We take no responsibility for any losses suffered as a result of such changes in the price of our common stock. +In addition, at any given time outside securities analysts may follow our financial results and issue reports that discuss our historical financial results and their predictions of our future performance. These analysts' predictions are based upon their own opinions and are often different from our own forecasts. Our stock price could decline if our results are below the estimates or expectations of these outside analysts. +Any failure to maintain effective internal control over our financial reporting could materially adversely affect us. +Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include in our annual reports on Form 10-K an assessment by management of the effectiveness of our internal control over financial reporting. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002. Our compliance with Section 404 may require us to incur substantial accounting expense and expend significant management efforts. Our failure to maintain effective internal controls could result in a determination by our auditors that a material weakness or significant deficiency exists in our internal controls. Such a determination could result in a loss of investor confidence in the reliability of our financial statements and could require us to restate our quarterly or annual financial statements. These factors could, in turn, negatively affect the price of our common stock. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +19 +ITEM 2. PROPERTIES +We lease space for our headquarters, our retail stores, showrooms and office facilities in various locations in the United States, as well as overseas. We own one improved real property parcel in Long Island City, New York. We believe that our existing facilities are in good operating condition and are adequate for our present level of operations. The following table sets forth information with respect to our key properties: +Location +Leased/Owned +Primary Use +Approximate Area Square Feet +Dongguan, China +Leased +Offices and sample production +154,900 +Montreal, Canada +Leased +Offices, warehouse +117,400 +Long Island City, NY +Leased +Executive offices +111,000 +Bellevue, WA +Leased +Offices, Topline +41,500 +New York, NY +Leased +Offices and showroom, Accessories +27,200 +New York, NY +Leased +Offices and showroom, Schwartz & Benjamin +15,700 +Putian City, China +Leased +Offices +13,800 +New York, NY +Leased +Showroom +13,400 +Costa Mesa, CA +Leased +Offices, BB Dakota +10,500 +New York, NY +Leased +Offices and showroom +10,000 +Long Island City, NY +Leased +Storage +7,200 +León, Mexico +Leased +Offices +6,400 +Mexico City, Mexico +Leased +Offices, SM Mexico +5,700 +New York, NY +Leased +Offices, BB Dakota +5,300 +Kowloon, Hong Kong +Leased +Offices +4,800 +Los Angeles, CA +Leased +Offices, BB Dakota +4,800 +Brooklyn, NY +Leased +Offices, GREATS +3,800 +Los Angeles, CA +Leased +Offices, BB Dakota +3,600 +Miami Gardens, FL +Leased +Storage +3,600 +Los Angeles, CA +Leased +Showroom, Steven +2,700 +Seattle, WA +Leased +Showroom +2,400 +Long Island City, NY +Owned +Other +2,200 +New York, NY +Leased +Offices +1,000 +Mississauga, Canada +Leased +Showroom +1,000 +Dallas, TX +Leased +Showroom +1,000 +All of our retail stores are leased pursuant to leases that, under their original terms, extend for an average of ten years. Many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes over the base year. The current terms of our retail store leases expire as follows: +Year +Number of Stores +2020 +33 +2021 +32 +2022 +44 +2023 +34 +2024 +20 +2025 +25 +2026 +15 +2027 +9 +2028 +6 +2029 +5 +2030 +1 +20 +ITEM 3. LEGAL PROCEEDINGS +In the ordinary course of business, we have various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on our financial condition, results of operations or liquidity. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND +ISSUER PURCHASES OF EQUITY SECURITIES +($ in thousands, except share and per share data) +Market Information. Our shares of common stock have traded on the NASDAQ Global Select Market since August 1, 2007 under the trading symbol SHOO and were traded on the NASDAQ National Market prior to that date. The following table sets forth the range of high and low closing sales prices for our common stock during each fiscal quarter during the two-year period ended December 31, 2019 as reported by the NASDAQ Global Select Market. The trading volume of our securities fluctuates and may be limited during certain periods. As a result, the liquidity of an investment in our securities may be adversely affected. +Common Stock +2019 +High +Low +2018 +High +Low +Quarter ended +March 31, 2019 +$35.38 +$29.71 +Quarter ended +March 31, 2018 +$32.85 +$27.77 +Quarter ended +June 30, 2019 +$36.87 +$29.43 +Quarter ended +June 30, 2018 +$37.00 +$28.60 +Quarter ended +September 30, 2019 +$36.82 +$28.85 +Quarter ended +September 30, 2018 +$39.30 +$34.54 +Quarter ended +December 31, 2019 +$44.80 +$33.20 +Quarter ended +December 31, 2018 +$35.56 +$27.88 +Holders. As of February 26, 2020 , there were 171 holders of record and approximately 19,000 beneficial owners of our common stock. +Stock Split. On September 17, 2018, we announced that on September 11, 2018 our Board of Directors declared a three-for-two stock split of our outstanding shares of common stock, effected in the form of a stock dividend on our outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. The additional shares were distributed on October 11, 2018. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. All share and per share data provided herein gives retroactive effect to this stock split. +Dividends. Beginning in the first quarter of 2018, we began paying a quarterly cash dividend on our outstanding shares of common stock. We currently expect to continue to pay a comparable cash dividend each quarter; however, the payment of future dividends will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +21 +In October 2019, our Board of Directors declared an increase to the quarterly cash dividend to $0.15 per share on the Company’s outstanding shares of common stock. Our first quarterly dividend of 2020 will be paid on March 27, 2020, to stockholders of record at the close of business on March 17, 2020. +Equity Compensation Plans . Information regarding our equity compensation plans as of December 31, 2019 is disclosed in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” +Issuer Repurchases of Equity Securities. Our Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase of our common stock. Most recently, on April 24, 2019, the Board of Directors approved the extension of our Share Repurchase Program for up to $200,000 in repurchases of our common stock, which includes the amount remaining under the prior authorization. The Share Repurchase Program permits us to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in our best interest. During the twelve months ended December 31, 2019 , we repurchased an aggregate of 2,381,340 shares of our common stock under the Share Repurchase Program, at a weighted average price per share of $32.76 , for an aggregate purchase price of approximately $78,001 , which includes the amount remaining under the prior authorization. As of December 31, 2019 , approximately $136,959 remained available for future repurchases under the Share Repurchase Program. The following table presents the total number of shares of our common stock, $.0001 par value, purchased by us in the three months ended December 31, 2019 , the average price paid per share and the approximate dollar value of the shares that still could have been purchased at the end of the fiscal period, pursuant to our Share Repurchase Program. +Period +Total Number of Shares Purchased (1) +Average Price Paid per Share (1) +Total Number of Shares Purchased as part of Publicly Announced Plans or Programs +Maximum Dollar Amount of Shares that May Yet Be Purchased Under the Plans or Programs +10/1/2019 - 10/31/2019 +2,411 +$ +34.84 +— +$ +141,759 +11/1/2019 - 11/30/2019 +9,114 +41.94 +— +141,759 +12/1/2019 - 12/31/2019 +578,284 +42.88 +112,921 +136,959 +Total +589,809 +$ +42.83 +112,921 +(1) The Steven Madden, Ltd. 2019 Incentive Compensation Plan and its predecessor plan, the Steven Madden, Ltd. Amended and Restated 2006 Stock Incentive Plan, each provide us with the right to deduct or withhold, or require participants to remit to us, an amount sufficient to satisfy all or part of the tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, participants may elect to satisfy all or part of such withholding obligations by tendering to us previously owned shares or by having us withhold shares having a fair market value equal to the minimum statutory tax withholding rate that could be imposed on the transaction. Included in this table are shares withheld during the fourth quarter of 2019 in connection with the settlement of vested restricted stock to satisfy tax withholding requirements, in addition to the shares repurchased pursuant to the Share Repurchase Program. Of the total number of shares repurchased by us in the fourth quarter of 2019 , 476,888 shares were withheld at an average price per share of $42.91 , for an aggregate purchase price of approximately $20,464 , in connection with the settlement of vested restricted stock and exercises of stock options to satisfy tax withholding requirements. Excluding the shares withheld in connection with the settlement of vested restricted stock and exercises of stock options, the average price per share was $42.50 in December 2019. +22 +Performance Graph . The following graph compares the yearly percentage change in the cumulative total stockholder return on our common stock during the period beginning on December 31, 2014 , and ending on December 31, 2019 , with the cumulative total return on the Russell 2000 Index and a peer group index. In 2016, we decided to remove the S&P 500 Footwear Index and replace it with a peer group index of companies we believe are engaged in similar businesses, because we believe the composition of the new peer group is more representative of our current business. The peer group index consists of six companies: Caleres, Inc., Crocs, Inc., Deckers Outdoor Corporation, Genesco Inc., Skechers U.S.A., Inc. and Wolverine World Wide, Inc. +The comparison assumes that $100 was invested on December 31, 2014 in our common stock and in the foregoing indices and assumes the reinvestment of dividends. +12/31/2014 +12/31/2015 +12/31/2016 +12/31/2017 +12/31/2018 +12/31/2019 +Steven Madden, Ltd. +$ +100.00 +$ +94.94 +$ +112.32 +$ +146.72 +$ +144.96 +$ +209.38 +Russell 2000 Index +$ +100.00 +$ +95.59 +$ +115.95 +$ +132.94 +$ +118.30 +$ +148.49 +Peer Group +$ +100.00 +$ +85.75 +$ +86.66 +$ +116.08 +$ +117.28 +$ +163.63 +23 +ITEM 6. SELECTED FINANCIAL DATA +($ in thousands, except share and per share data) +The following selected financial data has been derived from our audited consolidated financial statements. The Income Statement data relating to 2019 , 2018 and 2017 , and the Balance Sheet data as of December 31, 2019 and 2018 should be read in conjunction with the information provided in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” and the notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. +INCOME STATEMENT DATA +Year Ended December 31, +2019 +2018 +2017 +2016 +2015 +Net sales +$ +1,768,135 +$ +1,653,609 +$ +1,546,098 +$ +1,399,551 +$ +1,405,239 +Commission and licensing fee income +19,022 +24,125 +20,985 +20,301 +25,681 +Total revenue +1,787,157 +1,677,734 +1,567,083 +1,419,852 +1,430,920 +Cost of sales +1,101,140 +1,037,571 +968,357 +877,568 +904,747 +Gross profit +686,017 +640,163 +598,726 +542,284 +526,173 +Operating expenses +505,153 +466,781 +427,942 +373,108 +351,480 +Impairment charges +4,050 +— +1,000 +— +3,045 +Income from operations +176,814 +173,382 +169,784 +169,176 +171,648 +Interest and other income - net +4,412 +3,958 +2,543 +1,824 +818 +Income before provision for income taxes +181,226 +177,340 +172,327 +171,000 +172,466 +Provision for income taxes +39,504 +46,841 +53,189 +49,726 +58,811 +Net income +141,722 +130,499 +119,138 +121,274 +113,655 +Less: net income attributable to non-controlling interests +411 +1,363 +1,190 +363 +717 +Net income attributable to Steven Madden, Ltd. +$ +141,311 +$ +129,136 +$ +117,948 +$ +120,911 +$ +112,938 +Basic net income per share +$ +1.78 +$ +1.58 +$ +1.43 +$ +1.41 +$ +1.28 +Diluted net income per share +$ +1.69 +$ +1.50 +$ +1.36 +$ +1.35 +$ +1.23 +Basic weighted average common shares outstanding +79,577 +81,664 +82,736 +85,664 +88,496 +Effect of dilutive securities - options/restricted stock +4,069 +4,433 +4,009 +3,670 +3,217 +Diluted weighted average common stock outstanding +83,646 +86,097 +86,745 +89,334 +91,713 +Cash dividends declared per common share +$ +0.57 +$ +0.53 +$ +— +$ +— +$ +— +BALANCE SHEET DATA +At December 31 , +2019 +2018 +2017 +2016 +2015 +Total assets +$ +1,278,647 +$ +1,072,570 +$ +1,057,161 +$ +960,875 +$ +914,385 +Working capital +437,608 +478,436 +438,906 +345,544 +284,178 +Noncurrent liabilities +156,152 +33,199 +41,617 +36,676 +60,923 +Stockholders' equity +$ +841,224 +$ +814,682 +$ +808,932 +$ +741,072 +$ +678,663 +24 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. +Overview: +($ in thousands, except retail sales data per square foot, earnings per share and per share data) +Steven Madden, Ltd. and its subsidiaries design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell branded fashion handbags, apparel and accessories, as well as private label fashion handbags and accessories. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, and online retailers, throughout the United States, Canada, Mexico, Italy and certain other European nations. In addition, our products are marketed through our retail stores and our e-commerce websites within the United States, Canada and Mexico, our joint ventures in Europe, South Africa, Israel, Taiwan and China, and under special distribution arrangements in European territories, the Middle East, South and Central America, Oceania and various countries in Asia. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +On September 11, 2018, our Board of Directors declared a three-for-two stock split of our outstanding shares of common stock, effected in the form of a stock dividend on our outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. The additional shares were distributed to our stockholders on October 11, 2018. All share and per share data provided herein gives retroactive effect to this stock split. +Our business comprises five distinct segments (Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing). Our Wholesale Footwear segment includes the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Madden NYC, Report®, Dolce Vita®, DV by Dolce Vita®, Mad Love®, Steven by Steve Madden®, Superga® (under license), Anne Klein® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, Stevies®, Brian Atwood®, GREATS® and Blondo®, and includes our International business and certain private label footwear business. An agreement to license the Kate Spade® trademark was terminated as of December 31, 2019. Our Wholesale Accessories/Apparel segment includes Steve Madden®, Big Buddha®, Madden NYC, Betsey Johnson®, Steven by Steve Madden®, Madden Girl®, Luv Betsey®, Brian Atwood®, DKNY® (under license), Anne Klein® (under license), Jocelyn, Cejon®, BB Dakota® and Cupcakes & Cashmere® (under license) brands and includes our International business and certain private label accessories business. Steven Madden Retail, Inc., our wholly-owned retail subsidiary, that comprises of our Retail segment, operates Steve Madden, Steven, Superga, GREATS and International retail stores, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses, hair accessories, fragrance, umbrellas, bedding and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, headbands, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and FREEBIRD by Steven® for operation of retail stores. +Acquisitions +On August 9, 2019, we acquired 90% of the outstanding common stock of GREATS Brand, Inc., owner of GREATS, a pioneering digitally native sneaker brand, for an initial payment of $12,829 and a future contingent payment of $5,000 based on the GREATS brand achieving certain EBITA targets. In connection therewith, we recorded a long-term liability of $4,354 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by GREATS' future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $16,893, net of cash acquired of approximately $290. The acquisition was funded by cash on hand and adds a new footwear brand with added growth potential to our Company. +25 +On August 12, 2019, we acquired 100% of the outstanding common stock of B.B. Dakota, Inc., owner of BB Dakota, a contemporary women's apparel company, for an initial payment of $24,568 and a future contingent payment on the BB Dakota brand achieving certain EBITDA targets. In connection therewith, we recorded a long-term liability of $4,770 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by BB Dakota's future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $29,404 net of cash acquired of approximately $353 and a post working capital adjustment of $419. The acquisition was funded by cash on hand and adds new apparel brands with added growth potential to our Company. +In September 2019, we formed a joint venture with Channelink LLP through its subsidiary, SM Distribution China Co., Ltd. We control all of the significant participating rights and are the majority interest holder in the joint venture. +Dividends +A quarterly cash dividend of $0.14 per share on our outstanding shares of common stock was paid on each of March 29, 2019, June 28, 2019 and September 27, 2019. In October 2019, our Board of Directors declared an increase to the quarterly cash dividend to $0.15 per share on our outstanding shares of common stock. A quarterly cash dividend of $0.15 per share on our outstanding shares of common stock was paid on December 27, 2019. The aggregate cash dividends paid for the quarter ended December 31, 2019 was $12,621 . The aggregate cash dividends paid for the twelve months ended December 31, 2019 was $48,426 . +Reclassifications +We reclassed commission and licensing fee income into Total Revenue and reclassed its respective expenses into Operating Expenses from previously labeled Commission and Licensing Fee Income - Net on the Company’s Consolidated Statements of Income for all reporting periods. +Key Performance Indicators and Statistics +The following measurements are among the key business indicators reviewed by various members of our management to measure our consolidated and segment results: +• +total revenue +• +gross profit margin +• +operating expenses +• +income from operations +• +adjusted EBITDA +• +adjusted EBIT +• +inventory turnover +• +accounts receivable average collection days +• +cash flow and liquidity determined by our working capital and free cash flow +• +store metrics, such as same store sales, sales per square foot, average unit retail, conversion, average units per transaction, and contribution margin. +While not all of these metrics are disclosed due to the proprietary nature of the information, many of these metrics are disclosed and discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Non-GAAP Financial Measures +Our reported results are presented in accordance with accounting principles generally accepted in the United States of America ("GAAP"). We use adjusted earnings before interest and taxes ("Adjusted EBIT") and adjusted earnings before interest, taxes, depreciation and amortization ("Adjusted EBITDA"), as calculated in the table below, as non-GAAP measures, in internal management reporting and planning processes as well as in evaluating the performance of our Company. Management believes these measures are useful to investors in evaluating our ongoing operating and financial results. By providing these non-GAAP measures, as a supplement to GAAP information, we believe we are enhancing investors’ understanding of our business and our results of operations. The non-GAAP financial measures are limited in their usefulness and should be considered in addition to, and not in lieu of, GAAP financial measures. Further, these non-GAAP measures may be unique to our Company, as they may be different from non-GAAP measures used by other companies. +26 +The table below reconciles these metrics to net income as presented in the Consolidated Statements of Income: +Years Ended December 31, +2019 +2018 +2017 +($ in thousands) +Net Income +$ +141,722 +$ +130,499 +$ +119,138 +Add back: +Provision for income taxes +39,504 +46,841 +53,189 +Vendor support, bad debt expense, net of recovery and write-off of an unamortized buying agency agreement support payment related to the Payless ShoeSource bankruptcy (in First Cost segment) +10,355 +8,507 +— +Provision for early lease termination charges and impairment of lease right-of-use asset +5,423 +1,693 +5,123 +Impairment of the Brian Atwood trademark +4,050 +— +— +Provision for legal charges and settlements +3,977 +2,837 +6,713 +Acquisition costs +1,120 +— +— +Divisional headquarters relocation expenses +669 +— +— +Loss related to a termination of a joint venture +544 +— +— +Provisions for bad debt expense, net of recovery related to the Payless ShoeSource bankruptcy (in Wholesale Footwear segment) +(1,668 +) +3,616 +5,470 +Net benefit in connection with the reversal of a contingent liability partially offset by the acceleration of amortization related to the termination of the Kate Spade license agreement +(1,868 +) +— +— +Schwartz & Benjamin acquisition integration charges and related restructuring +— +2,065 +3,639 +Charges related to preferred interest investment +— +— +2,700 +Impairment of Wild Pair trademark +— +— +1,000 +Schwartz & Benjamin acquisition inventory fair value adjustment +— +— +591 +Schwartz & Benjamin amendment to the equity purchase agreement +— +— +(10,215 +) +Deduct: +Interest and other income - net* +4,412 +3,958 +2,543 +Adjusted EBIT +199,416 +192,100 +184,805 +Add back: +Depreciation and amortization +21,119 +21,754 +20,406 +Loss on disposal of fixed assets +920 +1,220 +1,455 +Adjusted EBITDA +$ +221,455 +$ +215,074 +$ +206,666 +(*) Includes realized (losses)/gains on marketable securities and foreign exchange (losses)/gains. +Executive Summary +Total revenue for 2019 increased by 6.5% to $1,787,157 from $1,677,734 in 2018 . Total revenue growth was primarily driven by our Wholesale Accessories/Apparel, Footwear and Retail segments, partially offset by a decline in revenue from our First Cost and Licensing segments. Net sales in the Wholesale Footwear segment increased by $53,725 , or 5.1% , when compared to the prior year. Net sales in the Wholesale Accessories/Apparel increased by $34,771 , or 11.6% , when compared to the prior year. Net sales in the Retail segment increased by $26,030 , or 8.8% , when compared to the prior year. First Cost segment revenue decreased by $3,785 or 33.7%, when compared to the prior year. Licensing segment revenue decreased by $1,318, or 10.2%, when compared to the prior year. +Net income attributable to Steven Madden, Ltd. increased 9.4% to $141,311 in 2019 compared to $129,136 in 2018 . Our effective tax rate for 2019 decreased to 21.8% compared to 26.4% recorded in 2018 . Diluted earnings per share in 2019 increased to $1.69 per share on 83,646 diluted weighted average shares outstanding compared to $1.50 per share on 86,097 diluted weighted average shares outstanding in the prior year. +27 +In our Retail segment, same store sales (sales attributable to those stores, including the e-commerce websites, that were in operation for at least twelve months) increased 6.1% , and sales per square foot decreased to approximately $580 in 2019 compared to sales per square foot of $612 in 2018 . As of December 31, 2019 , we had 227 stores in operation, compared to 229 stores as of December 31, 2018 . This decrease resulted from the closure of 17 full-price stores, 2 outlet stores and 1 e-commerce website partially offset by the opening of 8 full-price stores, 8 outlet stores and 2 e-commerce websites. +Our inventory turnover (calculated on a trailing four quarter average) for both years ended December 31, 2019 and 2018 was 8.1 times. Our total company accounts receivable average collection days were 70 days in 2019 compared to 69 days in 2018 . As of December 31, 2019 , we had $304,622 in cash, cash equivalents and marketable securities, no short or long-term debt and total stockholders’ equity of $841,224 . Working capital decreased to $437,608 as of December 31, 2019 , compared to $478,436 on December 31, 2018 . The decrease in working capital was primarily the result of the addition of current operating lease liabilities of $38,624 in accordance with our adoption of ASU 2016-02, "Leases" and cash used for our acquisitions, net of cash acquired of $37,173. +Despite significant headwinds from the bankruptcy of Payless ShoeSource and the tariffs implemented on accessories, footwear and apparel from China, we were pleased with our financial results for 2019. +Looking ahead, while we are cautious on the near-term outlook due to additional headwinds from the coronavirus outbreak, China tariffs and the termination of the Kate Spade footwear license, we are confident that the strength of our brands and our business model will enable us to drive earnings growth and shareholder value creation over the long term. +28 +The following table sets forth information on operations for the periods indicated: +Years Ended December 31, +($ in thousands) +2019 +2018 +2017 +CONSOLIDATED: +Net sales +$ +1,768,135 +98.9 +% +$ +1,653,609 +98.6 +% +$ +1,546,098 +98.7 +% +Commission and licensing fee income +19,022 +1.1 +% +24,125 +1.4 +% +20,985 +1.3 +% +Total revenue +1,787,157 +100.0 +% +1,677,734 +100.0 +% +1,567,083 +100.0 +% +Cost of sales +1,101,140 +61.6 +% +1,037,571 +61.8 +% +968,357 +61.8 +% +Gross profit +686,017 +38.4 +% +640,163 +38.2 +% +598,726 +38.2 +% +Operating expenses +505,153 +28.3 +% +466,781 +27.8 +% +427,942 +27.3 +% +Impairment charges +4,050 +0.2 +% +— +— +% +1,000 +0.1 +% +Income from operations +176,814 +9.9 +% +173,382 +10.3 +% +169,784 +10.8 +% +Interest and other income – net +4,412 +0.2 +% +3,958 +0.2 +% +2,543 +0.2 +% +Income before income taxes +181,226 +10.1 +% +177,340 +10.6 +% +172,327 +11.0 +% +Net income attributable to Steven Madden, Ltd. +$ +141,311 +7.9 +% +$ +129,136 +7.7 +% +$ +117,948 +7.5 +% +By Segment: +WHOLESALE FOOTWEAR SEGMENT: +Net sales +$ +1,112,091 +100.0 +% +$ +1,058,366 +100.0 +% +$ +1,017,557 +100.0 +% +Cost of sales +738,504 +66.4 +% +712,457 +67.3 +% +685,190 +67.3 +% +Gross profit +373,587 +33.6 +% +345,909 +32.7 +% +332,367 +32.7 +% +Operating expenses +206,055 +18.5 +% +205,771 +19.4 +% +198,353 +19.5 +% +Impairment charges +4,050 +0.4 +% +— +— +% +1,000 +0.1 +% +Income from operations +$ +163,482 +14.7 +% +$ +140,138 +13.2 +% +$ +133,014 +13.1 +% +WHOLESALE ACCESSORIES/APPAREL SEGMENT: +Net sales +$ +334,862 +100.0 +% +$ +300,091 +100.0 +% +$ +256,295 +100.0 +% +Cost of sales +236,731 +70.7 +% +208,352 +69.4 +% +175,566 +68.5 +% +Gross profit +98,131 +29.3 +% +91,739 +30.6 +% +80,729 +31.5 +% +Operating expenses +75,676 +22.6 +% +64,647 +21.5 +% +57,092 +22.3 +% +Income from operations +$ +22,455 +6.7 +% +$ +27,092 +9.0 +% +$ +23,637 +9.2 +% +RETAIL SEGMENT: +Net sales +$ +321,182 +100.0 +% +$ +295,152 +100.0 +% +$ +272,246 +100.0 +% +Cost of sales +125,905 +39.2 +% +116,762 +39.6 +% +107,601 +39.5 +% +Gross profit +195,277 +60.8 +% +178,390 +60.4 +% +164,645 +60.5 +% +Operating expenses +204,327 +63.6 +% +177,655 +60.2 +% +165,771 +60.9 +% +(Loss)/income from operations +$ +(9,050 +) +(2.8 +)% +$ +735 +0.2 +% +$ +(1,126 +) +(0.4 +)% +Number of stores +227 +229 +206 +FIRST COST SEGMENT: +Commission fee income +$ +7,441 +100.0 +% +$ +11,226 +100.0 +% +$ +9,493 +100.0 +% +Gross profit +7,441 +100.0 +% +11,226 +100.0 +% +9,493 +100.0 +% +Operating expenses +15,618 +209.9 +% +15,775 +140.5 +% +4,334 +45.7 +% +(Loss)/income from operations +$ +(8,177 +) +(109.9 +)% +$ +(4,549 +) +(40.5 +)% +$ +5,159 +54.3 +% +LICENSING SEGMENT: +Licensing fee income +$ +11,581 +100.0 +% +$ +12,899 +100.0 +% +$ +11,492 +100.0 +% +Gross profit +11,581 +100.0 +% +12,899 +100.0 +% +11,492 +100.0 +% +Operating expenses +3,477 +30.0 +% +2,933 +22.7 +% +2,392 +20.8 +% +Income from operations +$ +8,104 +70.0 +% +$ +9,966 +77.3 +% +$ +9,100 +79.2 +% +29 +RESULTS OF OPERATIONS +($ in thousands) +Year Ended December 31, 2019 vs. Year Ended December 31, 2018 +Consolidated : +Total revenue for the year ended December 31, 2019 increased by 6.5% to $1,787,157 from $1,677,734 for fiscal 2018 . Net sales for fiscal 2019 increased by 6.9% to $1,768,135 from $1,653,609 for fiscal 2018. Commission and licensing fee income for fiscal 2019 decreased by 21.2% to $19,022 from $24,125 for fiscal 2018. For the year ended December 31, 2019 , gross margin as a percentage of total revenue increased to 38.4% in the current year compared to 38.2% in the prior year. For the year ended 2019, gross margin included a charge of $386 related to a termination of a joint venture. Operating expenses increased in 2019 to $505,153 , or 28.3% of total revenue, from $466,781 , or 27.8% of total revenue, in 2018 . For the years ended 2019 and 2018, operating expenses included certain charges of $18,167 and $18,718 , respectively. (See "Non-GAAP Financial Measures" above for a description of these charges.) Excluding these charges, the increase in operating expenses primarily comprised (i) higher payroll and related expenses, (ii) higher warehouse and distribution expenses, (iii) higher marketing expenses, and (iv) higher occupancy related expenses. The effective tax rate for the year ended December 31, 2019 decreased to 21.8% compared to 26.4% in the same period last year primarily due to the year-over-year benefit resulting from the exercising and vesting of share-based awards, a decrease in the state taxes incurred, a decrease in prepaid tax adjustments, and an increase in 2019 pre-tax income in jurisdictions with low tax rates. Net income attributable to Steven Madden, Ltd. for the year ended December 31, 2019 increased to $141,311 compared to $129,136 for the year ended December 31, 2018 . Net income attributable to Steven Madden, Ltd. for fiscal 2019 and 2018 included net after-tax charges of $21,449 and $28,574, respectively. In 2019, these net charges included a (i) $8,602 after-tax expense, net of recovery associated with the Payless ShoeSource bankruptcy, (ii) $4,063 after-tax expense in connection with a provision for early lease termination charges and impairment of lease right-of-use asset, (iii) $3,033 after-tax impact of an impairment of the Brian Atwood trademark, (iv) $3,016 after-tax expense for a legal settlement and charges, (v) $2,590 tax expense in connection with deferred tax and other tax adjustments, (vi) $1,399 after-tax net benefit associated with the change in a contingent liability, partially offset by the acceleration of amortization related to the termination of the Kate Spade license agreement on December 31, 2019, (vii) $839 after-tax impact expense in connection with the acquisitions of GREATS and BB Dakota brands, (viii) $501 after-tax expense associated with a divisional headquarters relocation, and (ix) $204 after-tax expense related to the termination of a joint venture. In 2018, these charges included a (i) $11,481 after-tax expense, net of recovery associated with the Payless ShoeSource bankruptcy, (ii) $11,137 after tax expense in connection with the Tax Cuts and Jobs Act transition tax and taxing authorities audit and prepaid tax adjustments related to prior years, (iii) $2,478 after-tax expense in connection with a provision for legal and early lease termination charges, (iv) $1,536 after-tax expense in connection with the integration of the Schwartz & Benjamin acquisition and the related restructuring, (v) $1,028 tax expense related to an impairment to the preferred interest investment in Brian Atwood Italia Holding, LLC and (vi) $914 after-tax impact of expense related to a warehouse consolidation. Excluding these net charges, net income attributable to Steven Madden, Ltd. for the year 2019 and 2018 was $162,760 and $157,710, respectively. +Wholesale Footwear Segment : +Revenue generated by the Wholesale Footwear segment was $1,112,091 , or 62.2% , and $1,058,366 , or 63.1% , of our total revenue for the years ended December 31, 2019 and 2018 , respectively. The increase in net revenue is primarily driven by strong growth in our Steve Madden Women's, along with the full year of recognizing revenue for the Anne Klein brand and an increase in our private label business, partially offset by not recognizing sales to Payless ShoeSource in the first half of 2019 compared to the first half of 2018. +Gross profit margin in 2019 was 33.6% , while gross profit margin in 2018 was 32.7% . The increase in gross profit margin of 90 basis points was primarily attributable to strong growth in Steve Madden Women's, along with not recognizing sales to the low-margin Payless ShoeSource customer. Operating expenses increased to $206,055 , or 18.5% of revenue, in 2019 compared to $205,771 , or 19.4% of revenue, in the same period of 2018 . In 2019, operating expenses included a net benefit of $2,750 , comprising of a net benefit of $1,868 associated with the change of a contingent liability and the acceleration of amortization related to the termination of the Kate Spade license agreement on December 31, 2019 and a recovery of $1,668 related to the Payless ShoeSource bankruptcy, partially offset by divisional headquarters relocation expenses of $669 and a charge of $117 related to an early lease termination. Also recorded in the Wholesale Footwear segment was a $4,050 impairment charge for the Brian Atwood trademark impacting operating income. In 2018, operating expenses included charges of $8,518 , which consisted of $3,616 of bad debt expense related to the Payless ShoeSource bankruptcy, $2,837 related to provisions for legal charges, and $2,065 related to Schwartz & Benjamin acquisition integration charges and related restructuring. Excluding these items, operating expenses increased to $208,805 or 18.8% of net sales, in 2019 compared to $197,253 or 18.6% of net sales in the same period of 2018. The increase in +30 +operating expenses primarily resulted from higher payroll and related expenses, warehouse and distribution expenses and other selling expenses associated with higher sales and the addition of the Anne Klein footwear business. Income from operations increased to $163,482 for 2019 compared to $140,138 for 2018. Income from operations, excluding the charges mentioned above, increased to $164,782 for the year ended December 31, 2019 compared to $148,656 for the year ended December 31, 2018 . +Wholesale Accessories/Apparel Segment : +Revenue generated by the Wholesale Accessories/Apparel segment accounted for $334,862 , or 18.7% , and $300,091 , or 17.9% , of total revenue for the years ended December 31, 2019 and 2018 , respectively. The increase in revenue was primarily due to growth in our Steve Madden branded handbags, the full year of recognizing sales for the Anne Klein brand, as well as the addition of the BB Dakota apparel business. +Gross profit margin in the Wholesale Accessories/Apparel segment decreased to 29.3% in 2019 from 30.6% in the prior year period. The 1.3% decrease in gross margin resulted from tariffs imposed on accessories when compared to 2018. In the year ended December 31, 2019 , operating expenses increased to $75,676 , or 22.6% of revenue, compared to $64,647 , or 21.5% of revenue, in the year ended December 31, 2018 . In 2019, operating expenses included a charge of $513 related to costs in the acquisition of the BB Dakota apparel brand and in 2018, operating expenses included a charge of $1,241 related to a warehouse consolidation. Excluding these charges, operating expenses in 2019 increased to $75,163 , or 22.4% of revenue, compared to $63,406 , or 21.1% of revenue. The increase primarily resulted from higher payroll related expenses associated with the increase in sales, as well as the addition of the BB Dakota apparel business. Also, contributing to the increase was higher warehouse and distribution expenses, other selling expenses and marketing expenses all based on higher sales volume. Income from operations for the Wholesale Accessories/Apparel segment decreased to $22,455 in 2019 compared to $27,092 in 2018 . Income from operations, excluding the charges mentioned above, decreased to $22,968 in 2019 compared to $28,333 in 2018. +Retail Segment : +Revenue generated by the Retail segment accounted for $321,182 , or 18.0% , and $295,152 , or 17.6% , of total revenue for the years ended December 31, 2019 and 2018 , respectively, which represents a $26,030 , or 8.8% , increase. The increase in revenue is primarily due to an increase in comparable store sales of 6.1% driven by the significant growth in our e-commerce business. During 2019 , we had net closures of 2 stores. The net closures comprised 17 full-price locations, 2 outlet locations and 1 e-commerce website closures, partially offset by the addition of 8 full-price stores, 8 outlets and 2 e-commerce websites, which included the additional stores and e-commerce sites from the acquisition of GREATS and BB Dakota brands. As a result, we had 227 retail stores as of December 31, 2019 , compared to 229 stores as of December 31, 2018 . The 227 stores currently in operation include 146 Steve Madden® full-price stores, 68 Steve Madden® outlet stores, 2 Steven® stores, 2 GREATS® stores, 1 Superga store and 8 e-commerce websites. In addition, we operated 31 concessions in our international markets. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2019 ) for the year ended December 31, 2019 increased 6.1% when compared to the prior year. We exclude new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2019 , the gross profit margin increased to 60.8% from 60.4% in 2018 primarily due to higher margins in our e-commerce business partially offset by a loss of $386 related to the termination of a joint venture in China. In 2019 , operating expenses increased to $204,327 , or 63.6% of revenue, from $177,655 , or 60.2% of revenue, in 2018 . In 2019, operating expenses included charges of $10,049 , which comprised charges of $3,977 related to a legal settlement and charges, $3,423 related to early lease terminations, $1,883 of impairment of lease right-of-use assets, $608 of costs related to the acquisition of the GREATS brand and $158 related to the termination of a joint venture in China. In 2018, operating expenses included a charge $452 related to early lease terminations. Excluding these charges, operating expenses increased to $194,278 , or 60.5% of revenue, from $177,203 , or 60.0% of revenue, in 2018, primarily due to growth in our e-commerce business, along with the addition of the GREATS brand. For the year ended December 31, 2019 , loss from operations for the Retail segment was $9,050 compared to income from operations of $735 in the prior year. Income from operations, excluding the charges mentioned above, increased to $1,385 in 2019 compared to $1,187 in 2018. +First Cost Segment : +Commission fee income generated by the First Cost segment accounted for $7,441 , or 0.4%, and $11,226 , or 0.7% of total revenue for the years ended December 31, 2019 and 2018, respectively, which represents a $3,785, or 33.7%, decrease. The decrease in commission fee income is primarily due to the Payless ShoeSource bankruptcy that occurred in 2019. Operating expenses slightly decreased to $15,618 in 2019 from $15,775 in 2018. Operating expenses included charges associated with the Payless ShoeSource bankruptcy of $10,355 in 2019 related to vendor support, net recovery of bad debt expenses, and $8,507 in 2018 related to bad debt expenses and write-off of an unamortized buying agency support agreement. Excluding these charges, operating expenses +31 +decreased to $5,263 in 2019, compared to $7,268 due to the Payless ShoeSource bankruptcy. Loss from operations was $8,177 for the year ended December 31, 2019 compared to $4,549 in 2018 . Income from operations, excluding the charges mentioned above, decreased to $2,178 in 2019 compared to $3,958 in 2018. +Licensing Segment: +Licensing fee income generated by the Licensing segment accounted for $11,581 , or 0.6%, and $12,899 , or 0.8% of total revenue for the years ended December 31, 2019 and 2018, respectively, which represents a $1,318, or 10.2%, decrease. The decrease in licensing fee income is primarily due to a decrease in royalties in connection with Payless ShoeSource bankruptcy. Operating expenses increased to $3,477 in 2019 from $2,933 in 2018. The increase in operating expenses was primarily due to higher marketing and payroll related expenses. During the year ended December 31, 2019 , income for the Licensing segment amounted to $8,104 as compared to the prior year income of $9,966 . +Year Ended December 31, 2018 vs. Year Ended December 31, 2017 +Consolidated : +Total revenue for fiscal 2018 increased by 7.1% to $1,677,734 from $1,567,083 for fiscal 2017, which was attributable to an increase in net sales for fiscal 2018 of 7.0% to $1,653,609 from $1,546,098 for fiscal 2017 and increase in commission and licensing fee income of 15.0% to $24,125 for fiscal 2018 from $20,985 for fiscal 2017. For the year ended December 31, 2018, gross margin as a percentage of total revenue was flat at 38.2% in the current year, when compared to the prior year. Operating expenses increased in 2018 to $466,781, or 27.8% of total revenue, from $427,942, or 27.3% of total revenue, in 2017. For the years ended 2018 and 2017, operating expenses included certain charges of $18,718 and $13,430, respectively. (See "Non-GAAP Financial Measures" above for a description of these charges.) Excluding these charges, the increase in operating expenses primarily comprised (i) higher payroll and related expenses, (ii) higher warehouse and distribution expenses, (iii) legal charges consisting of costs and estimated settlement amounts, (iv) higher occupancy related expenses, (v) higher selling expenses, (vi) higher marketing expenses and (vii) higher consulting expenses. The effective tax rate for the year ended December 31, 2018 decreased to 26.4% compared to 30.9% in the same period last year primarily due to changes to U.S. tax laws impacting us resulting from the Tax Cuts and Jobs Act, partially offset by a prepaid tax adjustment related to prior years. Net income attributable to Steven Madden, Ltd. for the year ended December 31, 2018 increased to $129,136 compared to $117,948 for the year ended December 31, 2017. +Wholesale Footwear Segment : +Revenue generated by the Wholesale Footwear segment was $1,058,366, or 63.1%, and $1,017,557, or 64.9%, of our total revenue for the years ended December 31, 2018 and 2017, respectively. The increase in revenue was primarily driven by strong growth in our Steve Madden and Blondo brands in both domestic and international markets. +Gross profit margin in 2018 was 32.7%, flat from the prior year. Operating expenses increased to $205,771, or 19.4% of revenue, in 2018 compared to $197,722, or 19.4% of revenue, in the same period of 2017. Operating expenses in 2018 included $8,518 of certain charges, which consisted of $3,616 of bad debt expense related to the Payless ShoeSource bankruptcy, $2,837 related to provisions for legal charges, and $2,065 related to Schwartz & Benjamin acquisition integration charges and related restructuring. Operating expenses in 2017 included $8,307 of certain net charges, which consisted of $6,713 related to provisions for legal charges, $5,470 related to bad debt expenses for the Payless ShoeSource bankruptcy, $3,639 related to Schwartz & Benjamin acquisition integration charges and related restructuring, $2,700 related to charges due to preferred interest investment, partially offset by a benefit of $10,215 related to an amendment of the purchase agreement for the acquisition of Schwartz & Benjamin. Excluding these charges, the increase in operating expenses primarily comprised higher payroll and related expenses, and warehouse and distribution expenses. Income from operations before impairment charges increased to $140,138 for the year ended December 31, 2018 compared to $134,645 for the year ended December 31, 2017. +Wholesale Accessories/Apparel Segment : +Revenue generated by the Wholesale Accessories/Apparel segment accounted for $300,091, or 17.9%, and $256,295, or 16.4%, of total Company net sales for the years ended December 31, 2018 and 2017, respectively. The increase in net sales was primarily driven by strong growth in our private label business and our Steve Madden brand, as well as the addition of the Anne Klein handbag business. +Gross profit margin in the Wholesale Accessories/Apparel segment decreased to 30.6% in 2018 from 31.5% in the prior-year period primarily due to sales mix. In the year ended December 31, 2018, operating expenses increased to $64,647, or 21.5% of revenue, +32 +compared to $57,092, or 22.3% of revenue, in the year ended December 31, 2017. In 2018, operating expenses included certain charges of $1,241 related to provisions for early lease termination charges. Excluding these charges, operating expenses increased primarily due to higher warehouse and distribution expenses. Income from operations for the Wholesale Accessories/Apparel segment increased to $27,092 in 2018 compared to $23,637 in 2017. +Retail Segment : +Revenue generated by the Retail segment accounted for $295,152, or 17.6%, and $272,246, or 17.4%, of total revenue for the years ended December 31, 2018 and 2017, respectively, which represents a $22,906, or 8.4%, increase, year-over-year. This growth is due to the net addition of 23 stores from the prior year and an increase in comparable store sales of 2.8%. During 2018, we added 23 full-price stores, 5 outlets and 3 e-commerce websites and closed 6 full-price locations and 2 outlet locations. As a result, we had 229 retail stores as of December 31, 2018, compared to 206 stores as of December 31, 2017. The 229 stores in operation at the end of 2018 included 157 Steve Madden full-price stores, 62 Steve Madden outlet stores, 2 Steven stores, 1 Superga store and 7 e-commerce websites. In addition, during 2018, we opened 16 concessions in China, Taiwan and South Africa, and ended the year with 42 company-operated concessions in international markets. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2018) for the year ended December 31, 2018 increased 2.8% when compared to the prior year. We exclude new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2018, the gross margin slightly decreased to 60.4% from 60.5% in 2017 primarily due to slightly higher promotional activity during 2018 in our full-price retail stores. In 2018, operating expenses increased to $177,655, or 60.2% of revenue, from $165,771, or 60.9% of revenue, in 2017. In 2018 and 2017 operating expenses included $452 and $5,123, respectively, of provisions for early lease termination charges. Excluding these charges, operating expenses increased primarily due to the incremental costs associated with new store openings, such as higher selling costs, payroll and related expenses, warehouse expenses, and occupancy related expenses. For the year ended December 31, 2018, income from operations for the Retail segment was $735 compared to losses from operations of $1,126 in the prior year. +First Cost Segment : +Commission fee income generated by the First Cost segment accounted for $11,226, or 0.7%, and $9,943, or 0.6%, of total revenue for the years ended December 31, 2018 and 2017, respectively, which represents a $1,283, or 12.9%, increase. Operating expenses increased to $15,775 in 2018 from $4,334 in 2017. Operating expenses in 2018 included a charge of $8,507 for provisions for bad debt expense and a write-off of an unamortized buying agency agreement support payment related to the Payless ShoeSource bankruptcy. Operating income decreased to a loss of $4,549 for the year ended December 31, 2018 compared to income of $5,159 in 2017. +Licensing Segment: +Licensing fee income generated by the Licensing segment accounted for $12,899, or 0.8%, and $11,492, or 0.7%, of total revenue for the years ended December 31, 2018 and 2017, respectively, which represents a $1,407, or 12.2%, increase. Operating expenses increased to $2,933 in 2018 from $2,392 in 2017. Operating income increased to $9,966 for the year ended December 31, 2018 compared to the prior year income of $9,100 primarily due to an increase in income from the licensing of the FREEBIRD by Steven brand for operation of retail stores. +LIQUIDITY AND CAPITAL RESOURCES +($ in thousands) +Our primary source of liquidity is cash flows generated from our operations. We use this liquidity primarily to fund our ongoing cash requirements, including working capital requirements, share repurchases, acquisitions, system enhancements, retail store expansion and remodeling, and payment of dividends. +Cash, cash equivalents and short-term investments totaled $304,622 and $266,999 at December 31, 2019 and December 31, 2018 , respectively. At December 31, 2019 , we held $137,072 , or approximately 45% , of our total cash, cash equivalents and short-term investments in our foreign subsidiaries, and at December 31, 2018 , we held $198,110 , or approximately 74% , in our foreign subsidiaries. +We have a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”). The agreement provides us with a credit facility in the amount of $30,000, having a sub-limit of $15,000 on the aggregate face amount of letters of credit, at an interest +33 +rate based, at our election, upon either the prime rate or LIBOR. The agreement can be terminated by us or Rosenthal at any time with 60 days’ prior written notice. As of December 31, 2019 , we had no borrowings against this credit facility. +As of December 31, 2019 , we had working capital of $437,608 , cash and cash equivalents of $264,101 , and investments in marketable securities of $40,521 and did not have any long-term debt. +We believe that based upon our current financial position and available cash, cash equivalents and marketable securities, we will meet all of our financial commitments and operating needs for at least the next twelve months. +OPERATING ACTIVITIES +($ in thousands) +Cash provided by operations was $233,780 in 2019 compared to cash provided by operations of $ 154,376 in the prior year. The primary sources of cash were net income of $141,722 and decreases in factor account receivables of $24,924 , increases in accounts payable, accrued expenses and income taxes payable of $11,036 and prepaid expenses, prepaid tax, deposits and other of $9,466 . This source of cash was partially offset by the use of cash as a result of an increase in accounts receivable of $17,837 . +INVESTING ACTIVITIES +($ in thousands) +During the year ended December 31, 2019 cash used in investing activities was $27,748 , of which we invested $67,935 in marketable securities and received $95,671 from the maturities and sales of securities. We invested in two acquisitions, net of cash of $37,173 , and made capital expenditures of $18,311 , principally for systems enhancements, leasehold improvements to office and improvements to existing stores and new stores. +FINANCING ACTIVITIES +($ in thousands) +During the year ended December 31, 2019 , net cash used in financing activities was $142,178 , which primarily consisted of share repurchases of $101,768 , and payment of cash dividends of $48,426 , partially offset by proceeds from the exercise of stock options of $6,212 . +CONTRACTUAL OBLIGATIONS +($ in thousands) +Our contractual obligations as of December 31, 2019 were as follows: +Payment due by period +Contractual Obligations +Total +2020 +2021-2022 +2023-2024 +2025 and after +Operating lease obligations +$ +193,914 +$ +46,035 +$ +70,060 +$ +39,700 +$ +38,119 +Purchase obligations +62,869 +62,869 +— +— +— +Future minimum royalty and advertising payments +28,680 +8,535 +16,520 +3,625 +— +Transition tax +16,410 +1,563 +3,126 +6,837 +4,884 +Total +$ +301,873 +$ +119,002 +$ +89,706 +$ +50,162 +$ +43,003 +At December 31, 2019 , we had no open letters of credit for the purchase of inventory. +Virtually all of our products are produced by independent manufacturers at overseas locations, the majority of which are located in China, with a small and growing percentage located in Cambodia, Mexico, Brazil, Italy, India, Vietnam and other European nations. We have not entered into any long-term manufacturing or supply contracts with any of these foreign manufacturers. We believe that a sufficient number of alternative sources exist outside of the United States for the manufacture of our products. Purchases are made primarily in United States dollars. +34 +We have employment agreements with our Creative and Design Chief, Steven Madden, and certain executive officers, which provide for the payment of compensation aggregating approximately $10,253 in 2020 , $9,560 in 2021 , $7,776 in 2022 and $7,026 in 2023 . In addition, some of these employment agreements provide for discretionary bonuses and some provide for incentive compensation based on various performance criteria as well as other benefits, including stock-related compensation. +Transition tax of $16,410 was the result of the Tax Cuts and Jobs Act of 2017 (the "Tax Act"). For further information, refer to Note O to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Excluded from the contractual obligations table above are long-term taxes payable of $1,150 as of December 31, 2019 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond one year due to uncertainties in the timing of tax audit outcomes. +DIVIDENDS +In February 2019, our Board of Directors declared a quarterly cash dividend of $0.14 per share on our outstanding shares of common stock. The dividend was paid on March 29, 2019, to stockholders of record as of the close of business on March 19, 2019. We paid total cash dividends for the three months ended March 31, 2019 of $12,042. +In April 2019, our Board of Directors declared a quarterly cash dividend of $0.14 per share on our outstanding shares of common stock. The dividend was paid on June 28, 2019 to stockholders of record as of the close of business on June 18, 2019. We paid total cash dividends for the three months ended June 30, 2019 of $11,945. +In July 2019, our Board of Directors declared a quarterly cash dividend of $0.14 per share on our outstanding shares of common stock. The dividend was paid on September 27, 2019 to stockholders of record as of the close of business on September 17, 2019. We paid total cash dividends for the three months ended September 30, 2019 of $11,818. +In October 2019, our Board of Directors declared an additional quarterly cash dividend of $0.15 per share on our outstanding shares of common stock. The dividend was paid on December 27, 2019 to stockholders of record as of the close of business on December 16, 2019. We paid total cash dividends for the three months ended December 31, 2019 of $12,621 . +The aggregate cash dividends paid for the twelve months ended December 31, 2019 was $48,426 . +Our Board of Directors approved a quarterly cash dividend of $0.15 per share in February 2020. The dividend will be paid on March 27, 2020, to stockholders of record at the close of business on March 17, 2020. +Future quarterly cash dividend payments are subject to the discretion of our Board of Directors and contingent upon future earnings, our financial condition, capital requirements, general business conditions and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +INFLATION +We do not believe that inflation and price changes have had a significant effect on our sales or profitability for the fiscal year ended December 31, 2019 and the prior two fiscal years. Historically, we have minimized the impact of product cost increases by increasing prices, changing suppliers and improving operating efficiencies. However, no assurance can be given that we will be able to offset any such inflationary cost increases in the future. +OFF-BALANCE SHEET ARRANGEMENTS +We have no off-balance sheet arrangements. +CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES +This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Estimates by their nature are based on judgments and available information. Our estimates are made based upon historical factors, current circumstances and the experience and judgment of management. Assumptions and estimates are evaluated on an ongoing basis, and we may employ outside experts to assist in evaluations. Therefore, actual results could materially differ from those estimates under different assumptions and conditions. Management believes the following critical accounting estimates are more significantly affected by judgments and estimates used in the preparation of our consolidated financial statements: allowance for bad debts; returns and customer chargebacks; inventory valuation; valuation of intangible assets; litigation reserves; and contingent payment liabilities. +35 +Allowances for bad debts . Accounts receivable are reduced by an allowance for amounts that may be uncollectible in the future. Estimates are used in determining the allowance for doubtful accounts and are based on an analysis of the aging of accounts receivable, assessments of collectability based on historical trends, the financial condition of our customers and an evaluation of economic conditions. In general, the actual bad debt losses have historically been within our expectations and the allowances we have established. The reserve against our non-factored trade receivables also includes estimated losses that may result from customers’ inability to pay. +Customer returns and chargebacks . We provide variable consideration to our customers for chargebacks, co-op advertising allowances, discounts, returns and other miscellaneous deductions that relate to the current period. The amount of the consideration for returns, discounts and compliance chargebacks is determined by analyzing aged receivables, current economic conditions, the prevailing retail environment and historical dilution levels for customers. We evaluate anticipated customer markdowns and advertising chargebacks by reviewing several performance indicators for our major customers. These performance indicators (which include inventory levels at the retail floors, sell through rates and gross margin levels) are analyzed by management to estimate the amount of the anticipated customer allowance. Failure to correctly estimate the amount of the reserve could materially impact our results of operations and financial position. +Inventory valuation . Inventories are stated at lower of cost or market, on a first-in, first-out basis. We review inventory on a regular basis for excess and slow moving inventory. The review is based on an analysis of inventory on hand, prior sales, and expected net realizable value through future sales. The analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales and projections for sales in the foreseeable future as well as subsequent sales. We consider quantities on hand in excess of estimated future sales to be at risk for market impairment. The net realizable value, or market value, is determined based on the estimate of sales prices of such inventory through off-price or discount store channels. The likelihood of any material inventory write-down is dependent primarily on the expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product, the economy, or other failure to estimate correctly, in addition to abnormal weather patterns, could result in inventory valuation changes, compared to the valuation determined to be appropriate as of the balance sheet date. +Valuation of intangible assets and goodwill . In accordance with applicable accounting guidance, we test goodwill and intangible assets with indefinite lives at least annually. This accounting guidance also requires that intangible assets with finite lives be amortized over their respective lives to their estimated residual values and reviewed for impairment in accordance with applicable accounting guidance. +Indefinite-lived intangible assets and goodwill are assessed for impairment by performing a qualitative assessment that evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible or a reporting unit is less than its carrying amount. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the reporting unit is less than its carrying amount, the fair value of the reporting unit is compared with its carrying amount, and if the fair value of the reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount. We perform this annual assessment during our third quarter. +Litigation reserves. Estimated amounts for litigation claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable events of a particular litigation. As additional information becomes available, management will assess the potential liability related to the pending litigation and revise its estimates. Such revisions in management’s estimates of a contingent liability could materially impact our results of operation and financial position. +Contingent payment liabilities. We have completed acquisitions that require us to make contingent payments to the sellers based on the future financial performance of the acquired businesses over a period from one to six years. The fair value of the contingent payments is estimated using the present value of management's projections of the financial results of the acquired business. Failure to correctly project the financial results of the acquired businesses could materially impact our results of operations and financial position. +36 +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +($ in thousands) +Our financing arrangements are subject to variable interest rates primarily based on the prime rate and LIBOR. An analysis of our collection agency agreement with Rosenthal can be found in the “Liquidity and Capital Resources” section under Part II, Item 7, and in Note E to the Consolidated Financial Statements included in this Annual Report on Form 10-K under the caption “Factor Receivable.” As of December 31, 2019 , we held marketable securities valued at approximately $40,521 , which consisted of certificates of deposit. The values of these securities may fluctuate as a result of changes in values, market interest rates and credit risk. We have the ability to hold these investments until maturity. In addition, any decline in interest rates would be expected to reduce our interest income. +We face market risk to the extent that our U.S. or foreign operations involve the transaction of business in foreign currencies. Also, our inventory purchases are primarily done in foreign jurisdictions and inventory purchases may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of our contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks primarily by denominating these purchases in U.S. dollars. To mitigate the risk of purchases that are denominated in foreign currencies we may enter into forward foreign exchange contracts for terms of no more than two years. A description of our accounting policies for derivative financial instruments is included in Notes B and M to the Consolidated Financial Statements. +During 2019 , we entered into forward foreign exchange contracts with notional amounts totaling $72,409 . We performed a sensitivity analysis based on a model that measures the impact of a hypothetical change in foreign currency exchange rates to determine the effects that market risk exposures may have on the fair values of our forward foreign exchange contracts that were outstanding as of the year-end. As of December 31, 2019 , a 10% increase or decrease of the U.S. dollar against the exchange rates for foreign currencies under forward foreign exchange contracts would result in a net increase or decrease, respectively, in the fair value of our derivatives portfolio of approximately $4,591 . +In addition, we are exposed to translation risk in connection with our foreign operations in Canada, Mexico, Europe, South Africa, China, Taiwan and Israel because our subsidiaries and joint ventures in these countries utilize the local currency as their functional currency, and those financial results must be translated into U.S. dollars. As currency exchange rates fluctuate, foreign currency exchange rate translation adjustments reflected in our financial statements with respect to our foreign operations affects the comparability of financial results between years. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The information required by this Item is incorporated herein by reference to the consolidated financial statements listed in response to Item 15 of Part IV of this Annual Report on Form 10-K. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND +FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +37 +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2019 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2019 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited our consolidated financial statements and the effectiveness of our internal control over financial reporting as of December 31, 2019 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2019 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. OTHER INFORMATION +On February 27, 2020 , we issued a press release reporting our financial results for the fiscal quarter and fiscal year ended December 31, 2019 , a copy of which is attached as Exhibit 99.01 to this Annual Report. +Our press release on February 27, 2020 also announced that our Board of Directors has declared a quarterly cash dividend of $0.15 per share on our outstanding shares of common stock. The dividend is payable on March 27, 2020, to the stockholders of record as of the close of business on March 17, 2020. The full text of the press release is attached as Exhibit 99.01 to this Annual Report. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2020 Annual Meeting of Stockholders and is incorporated herein by reference. +ITEM 11. EXECUTIVE COMPENSATION +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2020 Annual Meeting of Stockholders and is incorporated herein by reference. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND +RELATED STOCKHOLDER MATTERS +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2020 Annual Meeting of Stockholders and is incorporated herein by reference. +38 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2020 Annual Meeting of Stockholders and is incorporated herein by reference. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2020 Annual Meeting of Stockholders and is incorporated herein by reference. +PART IV +ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) Exhibits. See the exhibit index included herein. +(b) Financial Statements and Financial Statements Schedules +See Index to Consolidated Financial Statements included herein. +39 +Exhibit Index +2.01 +Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 31, 2017) +2.02 +First Amendment to Equity Purchase Agreement, dated November 21, 2017, to Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers (incorporated by reference to Exhibit 2.2 to the Company’s Annual Report on Form 10-K for the annual period ended December 31, 2017 filed with the SEC on March 1, 2018) +3.01 +Certificate of Incorporation of Steven Madden, Ltd., as amended (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2019 filed with the SEC on August 5, 2019) +3.02 +Amended & Restated By-Laws of Steven Madden, Ltd., as further amended (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2017 filed with the SEC on August 4, 2017) +4.01 +Specimen Certificate for shares of Common Stock (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +10.01 +Third Amended and Restated Secured Promissory Note dated as of June 25, 2007 of Steven H. Madden to the Company (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 9, 2012) +10.02 +First Allonge to Third Amended and Restated Secured Promissory Note made as of April 8, 2016 between the Company and Steven H. Madden (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.03 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2010 filed with the SEC on November 9, 2010) +10.04 +Amendment to Collection Agency Agreement dated February 16, 2010 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2010 filed with the SEC on March 12, 2010) +10.05 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Daniel Friedman & Associates, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.06 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Diva Acquisition Corp. (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.07 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Steven Madden Retail, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.08 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Stevies, Inc. (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.09 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and SML Acquisition Corp. (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.10 +Letter Agreement dated July 10, 2009 among Rosenthal & Rosenthal, Inc., the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.11 +Guarantee dated July 10, 2009 of the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. in favor of Rosenthal & Rosenthal, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.12 +Third Amended Employment Agreement dated July 15, 2005 between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 20, 2005) +10.13 +Amendment dated December 14, 2009 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 17, 2009) +10.14 +Amended and Restated Second Amendment dated as of December 31, 2011 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2011 filed with the SEC on February 29, 2012) +10.15 +Third Amendment dated April 8, 2016 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.16 +Fourth Amendment dated March 25, 2019 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 26, 2019) +10.17 +Employment Agreement dated January 1, 1998 between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.07 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2000 filed with the SEC on March 30, 2001)# +10.18 +Amendment No. 1 dated June 29, 2001 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 99.4 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended June 30, 2001 filed August 14, 2001)# +10.19 +Amendment No. 2 dated October 30, 2002 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2002 filed with the SEC on November 14, 2002)# +10.20 +Amendment No. 3 dated February 1, 2006 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 3, 2006)# +10.21 +Amendment No. 4 dated October 7, 2009 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on October 13, 2009)# +10.22 +Amendment No. 5 dated February 8, 2012 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 14, 2012)# +10.23 +Amendment No. 6 dated February 2, 2015 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 4, 2015)# +10.24 +Amendment No. 7 dated as of May 15, 2017 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.25 +Amendment No. 8 dated as of April 20, 2018 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 26, 2018)# +10.26 +Employment Agreement dated April 11, 2017 between the Company and Karla Frieders (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended March 31, 2017 filed with the SEC on May 9, 2017)# +10.27 +Employment Agreement, dated as of December 31, 2018, between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 4, 2019)# +10.28 +Employment Agreement dated December 27, 2019 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 3, 2020)# +10.29 +Employment Agreement dated December 27, 2019 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 3, 2020)# +10.30 +2006 Stock Incentive Plan (Amended and Restated Effective May 22, 2009), amended by the Board of Directors of the Company on April 5, 2012 and approved and adopted by the Company's stockholders on May 25, 2012 (incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 1, 2013)# +10.31 +2019 Incentive Compensation Plan, as adopted by the Board of Directors of the Company on February 25, 2019 and approved and adopted by the Company's stockholders on May 24, 2019 (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2019 filed with the SEC on August 5, 2019)# +14.01 +Code of Ethics for the Chief Executive Officer and Senior Financial Officers (incorporated by reference to Exhibit 14.01 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2014 filed with the SEC on February 26, 2015) +14.02 +Code of Business Conduct and Ethics for the Board of Directors (incorporated by reference to Exhibit 14.02 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2014 filed with the SEC on February 26, 2015) +14.03 +Code of Business Conduct and Ethics (incorporated by reference to Exhibit 14.03 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2018 filed with the SEC on February 28, 2019) +21.01 +Subsidiaries of the Registrant† +23.01 +Consent of EisnerAmper LLP† +24.01 +Power of Attorney (included on signature page hereto) +31.01 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +31.02 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +32.01 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +32.02 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +99.01 +Press Release, dated February 27, 2020, issued by Steven Madden, Ltd.† +101 +The following materials from Steven Madden, Ltd.'s Annual Report on Form 10-K for the fiscal year ended December 31, 2019, formatted in iXBRL (Inline Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.* +104 +Cover Page Interactive Data File, formatted in Inline Extensible Business Reporting Language (iXBRL).* +† +Filed herewith. +# +Indicates management contract or compensatory plan or arrangement required to be identified pursuant to Item 15(b) of this Annual Report on Form 10-K. +* +This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Company specifically incorporates it by reference. +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. +DATE: March 2, 2020 +STEVEN MADDEN, LTD. +/s/ EDWARD R. ROSENFELD +Edward R. Rosenfeld +Chairman and Chief Executive Officer +/s/ ARVIND DHARIA +Arvind Dharia +Chief Financial Officer +43 +POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each of the undersigned constitutes and appoints Edward R. Rosenfeld and Arvind Dharia, and each of them, as attorneys-in-fact and agents, with full power of substitution and re-substitution, for and in the name, place and stead of the undersigned, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all that each of said attorney-in-fact or substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. +Signature +Title +Date +/S/ EDWARD R. ROSENFELD +Chairman, Chief Executive Officer and Director +March 2, 2020 +Edward R. Rosenfeld +/S/ ARVIND DHARIA +Chief Financial Officer +March 2, 2020 +Arvind Dharia +/S/ AMELIA NEWTON VARELA +President and Director +March 2, 2020 +Amelia Newton Varela +/S/ PETER MIGLIORINI +Director +March 2, 2020 +Peter Migliorini +/S/ RICHARD P. RANDALL +Director +March 2, 2020 +Richard P. Randall +/S/ RAVI SACHDEV +Director +March 2, 2020 +Ravi Sachdev +/S/ THOMAS H. SCHWARTZ +Director +March 2, 2020 +Thomas H. Schwartz +/S/ ROSE LYNCH +Director +March 2, 2020 +Rose Lynch +/S/ ROBERT SMITH +Director +March 2, 2020 +Robert Smith +/S/ MITCHELL S. KLIPPER +Director +March 2, 2020 +Mitchell S. Klipper +/S/ AL FERRARA +Director +March 2, 2020 +Al Ferrara +44 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Reports of Independent Registered Public Accounting Firm +F-1 +Consolidated Balance Sheets as of December 31, 2019 and 2018 +F-4 +Consolidated Statements of Income for the years ended December 31, 2019, 2018 and 2017 +F-5 +Consolidated Statements of Comprehensive Income for the years ended December 31, 2019, 2018 and 2017 +F-6 +Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2019, 2018 and 2017 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018 and 2017 +F-8 +Notes to Consolidated Financial Statements +F-9 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Steven Madden Ltd. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Steven Madden Ltd. and Subsidiaries (the “Company") as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, changes to stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2019 and 2018, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework ( 2013 ) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 2, 2020 expressed an unqualified opinion. +Adoption of New Accounting Standard +As discussed in Note N to the consolidated financial statements, the Company changed its method for accounting for leases in 2019. As explained below, auditing the Company’s valuation and accounting for leases was a critical audit matter. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +Revenue recognition-variable consideration +As described in Note B to the financial statements, the Company recognizes revenue for the amount it expects to receive from its customers including variable consideration for discounts that the Company expects to grant to customers. Estimating the amount of variable consideration to be recorded as revenue requires management to estimate the ultimate amount of discounts that will be granted to customers. +We identified management’s estimate of variable consideration as a critical audit matter. The evaluation of the uncertainty in the amounts that will ultimately be received from customers for their purchases required significant auditor judgement. Factors that +F-1 +may affect the estimate include expectations for future sales of the product at the customer’s locations, and historical trends in the granting of discounts. +We obtained an understanding of management’s process, evaluated the design, and tested the operating effectiveness of controls over the revenue recognition process, including controls related to the estimation of variable consideration. Our substantive audit procedures also included testing the completeness and accuracy of management’s identification and evaluation of the discounts granted and testing management’s assumptions used in formulating the estimate and testing the accuracy of the Company’s calculation of variable consideration. +Valuation and accounting for leases +As described above and in Note N to the consolidated financial statements, the Company adopted Accounting Standards Update 2016-02, “Leases (Topic 842)” (“ASC 842”) on January 1, 2019. In conjunction with the adoption of ASC 842, the Company evaluated the overall accounting implications, including review of contracts and vendor agreements to determine whether such agreements contained a lease. The Company determined its material operating leases consist of approximately 250 retail store and office locations. On the adoption date, the Company recorded $182 million in operating lease assets and $196 million in current and long-term operating lease liabilities on its consolidated balance sheet for existing operating leases. The calculation of the Company’s operating lease assets and liabilities include an estimate of the present value of future lease payments. Management estimated the Company’s incremental borrowing rates used in its present value calculation which required judgement. The incremental borrowing rate is the rate of interest that the lessee would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. +Auditing management’s contract evaluation performed in conjunction with the adoption of ASC 842 was complex and required judgment to analyze the terms within the contracts to determine whether we concurred with management’s evaluation. Further, auditing management’s assessment of its incremental borrowing rate is especially subjective and judgmental as the Company has no outstanding debt nor committed credit facilities, secured or otherwise that would have comparable collateral or similar terms as their underlying retail locations and office space. +Addressing the matter in our audit, we obtained an understanding of management’s processes, evaluated the design, and tested the operating effectiveness of controls over the implementation of ASC 842, including the Company’s controls with regards to the contract evaluation, and review of the methodology, inputs, and assumptions used to determine the incremental borrowing rate. Our substantive audit procedures included, among others, involving specialists to assist in evaluating management’s methodology and assumptions used to determine the Company’s incremental borrowing rate at the date of adoption of ASC 842. The considerations to determine the appropriateness of the Company’s incremental borrowing rate included the Company’s credit rating, current market environment for recent debt transactions, and market data available to support the adjustment required to reflect a collateralized borrowing rate. We obtained and inspected a sample of individual leases to test the completeness and accuracy of the lease inputs and terms used in the Company’s calculation and tested the computational accuracy. Additionally we performed procedures to determine the completeness of the lease population used in the Company’s analysis. We tested a sample of contracts and vendor agreements to determine whether management appropriately evaluated whether such agreements contained a lease. These procedures included, among others, inspecting contracts and vendor agreements, analyzing contractual terms. We also evaluated the Company’s lease disclosures included in Note N in relation to these matters. +/s/ EisnerAmper LLP +We have served as the Company’s auditor since 1995. +EISNERAMPER LLP +Iselin, New Jersey +March 2, 2020 +F-2 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders +Steven Madden, Ltd +Opinion on Internal Control over Financial Reporting +We have audited Steven Madden, Ltd. and Subsidiaries’ (the “Company") internal control over financial reporting as of December 31, 2019, based on criteria established in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in the Internal Control - Integrated Framework (2013) issued by COSO. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the consolidated balance sheets of Steven Madden, Ltd. and Subsidiaries as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes and our report dated March 2, 2020 expressed an unqualified opinion. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +An entity’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. An entity’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the entity; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ EisnerAmper LLP +EISNERAMPER LLP +Iselin, New Jersey +March 2, 2020 +F-3 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Balance Sheets +(in thousands) +December 31, +2019 +2018 +ASSETS +Current assets: +Cash and cash equivalents +$ +264,101 +$ +200,031 +Accounts receivable, net of allowances of $11,066 and $10,849 +38,166 +25,057 +Factor accounts receivable +216,471 +241,395 +Inventories +136,896 +137,247 +Marketable securities – available for sale +40,521 +66,968 +Prepaid expenses and other current assets +22,066 +23,425 +Prepaid taxes +658 +9,002 +Total current assets +718,879 +703,125 +Note receivable – related party +1,558 +1,927 +Property and equipment, net +65,504 +64,807 +Operating lease right-of-use asset +155,700 +— +Deferred taxes +— +9,321 +Deposits and other +2,948 +1,967 +Goodwill – net +171,349 +148,112 +Intangibles – net +162,709 +143,311 +Total Assets +$ +1,278,647 +$ +1,072,570 +LIABILITIES +Current liabilities: +Accounts payable +$ +61,706 +$ +79,802 +Accrued expenses +169,895 +130,592 +Operating leases - current portion +38,624 +— +Contingent payment liability – current portion +— +3,000 +Accrued incentive compensation +11,046 +11,295 +Total current liabilities +281,271 +224,689 +Contingent payment liability +9,124 +— +Deferred rent +— +15,786 +Operating leases - long-term portion +133,172 +— +Deferred taxes +5,877 +4,041 +Other liabilities +7,979 +13,372 +Total Liabilities +437,423 +257,888 +Commitments, contingencies and other (Note P) +STOCKHOLDERS’ EQUITY +Preferred stock – $.0001 par value, 5,000 shares authorized; none issued; Series A Junior Participating preferred stock – $.0001 par value, 60 shares authorized; none issued +— +— +Common stock – $.0001 par value, 245,000 shares authorized, 132,754 and 131,991 shares issued, 83,520 and 85,715 shares outstanding +6 +6 +Additional paid-in capital +454,217 +424,835 +Retained earnings +1,310,406 +1,217,521 +Accumulated other comprehensive loss +( 30,440 +) +( 32,628 +) +Treasury stock – 49,234 and 46,276 shares at cost +( 905,688 +) +( 803,920 +) +Total Steven Madden, Ltd. stockholders’ equity +828,501 +805,814 +Noncontrolling interest +12,723 +8,868 +Total stockholders’ equity +841,224 +814,682 +Total Liabilities and Stockholders’ Equity +$ +1,278,647 +$ +1,072,570 +See accompanying notes to consolidated financial statements +F-4 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Income +(in thousands, except per share data) +Years Ended December 31, +2019 +2018 +2017 +Net sales +$ +1,768,135 +$ +1,653,609 +$ +1,546,098 +Commission and licensing fee income +19,022 +24,125 +20,985 +Total revenue +1,787,157 +1,677,734 +1,567,083 +Cost of sales +1,101,140 +1,037,571 +968,357 +Gross profit +686,017 +640,163 +598,726 +Operating expenses +505,153 +466,781 +427,942 +Impairment charges +4,050 +— +1,000 +Income from operations +176,814 +173,382 +169,784 +Interest and other income - net +4,412 +3,958 +2,543 +Income before provision for income taxes +181,226 +177,340 +172,327 +Provision for income taxes (Note O) +39,504 +46,841 +53,189 +Net income +141,722 +130,499 +119,138 +Less: net income attributable to noncontrolling interest +411 +1,363 +1,190 +Net income attributable to Steven Madden, Ltd. +$ +141,311 +$ +129,136 +$ +117,948 +Basic net income per share +$ +1.78 +$ +1.58 +$ +1.43 +Diluted net income per share +$ +1.69 +$ +1.50 +$ +1.36 +Basic weighted average common shares outstanding +79,577 +81,664 +82,736 +Effect of dilutive securities – options/restricted stock +4,069 +4,433 +4,009 +Diluted weighted average common shares outstanding +83,646 +86,097 +86,745 +Cash dividends declared per common share +$ +0.57 +$ +0.53 +$ +— +See accompanying notes to consolidated financial statements +F-5 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Comprehensive Income +(in thousands) +2019 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +141,722 +Other comprehensive income: +Foreign currency translation adjustment +$ +2,885 +$ +— +2,885 +(Loss) on cash flow hedging derivatives +( 1,387 +) +333 +( 1,054 +) +Unrealized gain on marketable securities +116 +( 28 +) +88 +Total other comprehensive income +$ +1,614 +$ +305 +1,919 +Comprehensive income +143,641 +Less: comprehensive income attributable to noncontrolling interests +142 +Comprehensive income attributable to Steven Madden, Ltd. +$ +143,499 +2018 +Pre-tax amounts +Tax (expense) +After-tax amounts +Net income +$ +130,499 +Other comprehensive (loss): +Foreign currency translation adjustment +$ +( 7,983 +) +$ +— +( 7,983 +) +Gain on cash flow hedging derivatives +1,150 +( 276 +) +874 +Unrealized gain on marketable securities +124 +( 30 +) +94 +Total other comprehensive (loss) +$ +( 6,709 +) +$ +( 306 +) +( 7,015 +) +Comprehensive income +123,484 +Less: comprehensive income attributable to noncontrolling interests +1,363 +Comprehensive income attributable to Steven Madden, Ltd. +$ +122,121 +2017 +Pre-tax amounts +Tax benefit/(expense) +After-tax amounts +Net income +$ +119,138 +Other comprehensive income: +Foreign currency translation adjustment +$ +6,836 +$ +— +6,836 +(Loss) on cash flow hedging derivatives +( 1,282 +) +468 +( 814 +) +Unrealized gain on marketable securities +183 +( 67 +) +116 +Total other comprehensive income +$ +5,737 +$ +401 +6,138 +Comprehensive income +125,276 +Less: comprehensive income attributable to noncontrolling interests +1,190 +Comprehensive income attributable to Steven Madden, Ltd. +$ +124,086 +See accompanying notes to consolidated financial statements +F-6 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity +(in thousands) +Common Stock +Additional Paid-in Capital +Retained Earnings +Accumulated Other Comprehensive (Loss) +Treasury Stock +Non-Controlling Interest +Total Stockholders' Equity +Shares +Amount +Shares +Amount +Balance - December 31, 2016 +90,615 +$ +6 +$ +353,443 +$ +1,017,753 +$ +( 31,751 +) +39,011 +$ +( 598,584 +) +$ +205 +$ +741,072 +Share repurchases +( 3,902 +) +— +— +— +— +3,902 +( 99,412 +) +— +( 99,412 +) +Exercise of stock options +983 +— +16,433 +— +— +— +— +— +16,433 +Issuance of restricted stock, net of forfeitures +351 +— +— +— +— +— +— +— +— +Stock-based compensation +— +— +20,847 +— +— +— +— +— +20,847 +Foreign currency translation adjustment +— +— +— +— +6,836 +— +— +— +6,836 +Unrealized holding gain on securities (net of tax expense of $67) +— +— +— +— +116 +— +— +— +116 +Cash flow hedge (net of tax benefit of $468) +— +— +— +— +( 814 +) +— +— +— +( 814 +) +Investment of noncontrolling interest +— +— +— +— +— +— +— +4,716 +4,716 +Net income +— +— +— +117,948 +— +— +— +1,190 +119,138 +Balance - December 31, 2017 +88,047 +6 +390,723 +1,135,701 +( 25,613 +) +42,913 +( 697,996 +) +6,111 +808,932 +Share repurchases +( 3,363 +) +— +— +— +— +3,363 +( 105,924 +) +— +( 105,924 +) +Exercise of stock options +593 +— +13,036 +— +— +— +— +— +13,036 +Issuance of restricted stock, net of forfeitures +438 +— +— +— +— +— +— +— +— +Stock-based compensation +— +— +21,076 +— +— +— +— +— +21,076 +Foreign currency translation adjustment +— +— +— +— +( 7,983 +) +— +— +— +( 7,983 +) +Unrealized holding gain on securities (net of tax expense of $30) +— +— +— +— +94 +— +— +— +94 +Cash flow hedge (net of tax expense of $276) +— +— +— +— +874 +— +— +— +874 +Dividends on common stock ($0.53 per share) +— +— +— +( 47,316 +) +— +— +— +— +( 47,316 +) +Distributions to noncontrolling interests, net +— +— +— +— +— +— +— +( 1,183 +) +( 1,183 +) +Investment of noncontrolling interest +— +— +— +— +— +— +— +2,577 +2,577 +Net income +— +— +— +129,136 +— +— +— +1,363 +130,499 +Balance - December 31, 2018 +85,715 +6 +424,835 +1,217,521 +( 32,628 +) +46,276 +( 803,920 +) +8,868 +814,682 +Share repurchases +( 2,958 +) +— +— +— +— +2,958 +( 101,768 +) +— +( 101,768 +) +Exercise of stock options +273 +— +6,212 +— +— +— +— +— +6,212 +Issuance of restricted stock, net of forfeitures +490 +— +— +— +— +— +— +— +— +Stock-based compensation +— +— +23,170 +— +— +— +— +— +23,170 +Foreign currency translation adjustment +— +— +— +— +3,154 +— +— +( 269 +) +2,885 +Unrealized holding gain on securities (net of tax expense of $28) +— +— +— +— +88 +— +— +— +88 +Cash flow hedge (net of tax benefit of $333) +— +— +— +— +( 1,054 +) +— +— +— +( 1,054 +) +Dividends on common stock ($0.57 per share) +— +— +— +( 48,426 +) +— +— +— +— +( 48,426 +) +Distributions to noncontrolling interests, net +— +— +— +— +— +— +— +( 1,444 +) +( 1,444 +) +Investment of noncontrolling interest +— +— +— +— +— +— +— +3,248 +3,248 +Acquisition of noncontrolling interest +— +— +— +— +— +— +— +1,909 +1,909 +Net income +— +— +— +141,311 +— +— +— +411 +141,722 +Balance - December 31, 2019 +83,520 +$ +6 +$ +454,217 +$ +1,310,406 +$ +( 30,440 +) +49,234 +$ +( 905,688 +) +$ +12,723 +$ +841,224 +See accompanying notes to consolidated financial statements +F-7 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +(in thousands) +Years Ended December 31, +2019 +2018 +2017 +Cash flows from operating activities: +Net income +$ +141,722 +$ +130,499 +$ +119,138 +Adjustments to reconcile net income to net cash provided by operating activities: +Stock-based compensation +23,170 +21,076 +20,847 +Depreciation and amortization +21,337 +22,482 +21,389 +Loss on disposal of fixed assets +920 +1,220 +1,455 +Impairment of intangible +4,050 +— +1,000 +Impairment of lease right-of-use asset +1,883 +— +— +Deferred taxes +5,144 +( 2,512 +) +( 19,274 +) +Accrued interest on note receivable – related party +( 40 +) +( 47 +) +( 54 +) +Deferred rent (benefit)/expense +— +( 247 +) +1,455 +Realized loss/(gain) on sale of marketable securities +5 +189 +( 5 +) +Change in fair value of contingent liability +— +— +( 11,206 +) +Net benefit in connection with the reversal of a contingent liability partially offset by the acceleration of amortization related to the termination of the Kate Spade license agreement +( 1,868 +) +— +— +Provisions for bad debt expense, net of recovery and write-off of an unamortized buying agency agreement support payment associated with the Payless ShoeSource bankruptcies +8,687 +12,123 +5,470 +Changes, net of acquisitions, in: +Accounts receivable +( 17,837 +) +4,966 +22,683 +Factor accounts receivable +24,924 +( 39,959 +) +( 57,268 +) +Notes receivable - related party +409 +409 +409 +Inventories +8,436 +( 26,923 +) +21,135 +Prepaid expenses, prepaid taxes, deposits and other +9,466 +14,633 +2,403 +Accounts payable and accrued expenses +11,036 +21,249 +9,501 +Accrued incentive compensation +( 249 +) +828 +2,507 +Lease and other liabilities +( 7,415 +) +( 5,610 +) +16,350 +Net cash provided by operating activities +233,780 +154,376 +157,935 +Cash flows from investing activities: +Capital expenditures +( 18,311 +) +( 12,450 +) +( 14,775 +) +Purchases of marketable securities +( 67,935 +) +( 77,262 +) +( 61,209 +) +Proceeds from notes receivable +— +— +221 +Maturity/sale of marketable securities +95,671 +100,777 +79,141 +Acquisitions, net of cash acquired +( 37,173 +) +— +( 16,795 +) +Net cash (used in)/provided by investing activities +( 27,748 +) +11,065 +( 13,417 +) +Cash flows from financing activities: +Proceeds from exercise of stock options +6,212 +13,036 +16,433 +Investment of noncontrolling interest +3,248 +2,577 +— +Distribution of noncontrolling interest earnings +( 1,444 +) +( 1,183 +) +— +Payment of contingent liability +— +( 7,000 +) +( 7,359 +) +Common stock purchased for treasury +( 101,768 +) +( 105,924 +) +( 99,412 +) +Cash dividends paid on common stock +( 48,426 +) +( 47,316 +) +— +Net cash (used in) financing activities +( 142,178 +) +( 145,810 +) +( 90,338 +) +Effect of exchange rate changes on cash and cash equivalents +216 +( 814 +) +919 +Net increase in cash and cash equivalents +64,070 +18,817 +55,099 +Cash and cash equivalents – beginning of year +200,031 +181,214 +126,115 +Cash and cash equivalents – end of year +$ +264,101 +$ +200,031 +$ +181,214 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +25 +$ +36 +$ +24 +Income taxes +$ +29,552 +$ +37,105 +$ +61,979 +See accompanying notes to consolidated financial statements. +F-8 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Note A – Reclassification +The Company reclassed commission and licensing fee income into Total Revenue and reclassed its respective expenses into Operating Expenses from previously labeled Commission and Licensing Fee Income - Net on the Company’s Consolidated Statements of Income for all reporting periods. +Note B – Summary of Significant Accounting Policies +[1] Organization: +Steven Madden, Ltd. a Delaware corporation, and its subsidiaries, design, source, market and sell name brand and private label women's, men's and children's shoes, worldwide through its wholesale and retail channels under the Steve Madden Women's, Steve Madden Men's, Madden, Madden Girl, Steven, Superga (under license), GREATS, Dolce Vita and Betsey Johnson brand names and through its wholesale channels under the Stevies, Report, Mad Love and Blondo brand names and, under license, the Anne Klein brand name. An agreement under which the Company licensed the Kate Spade® trademark terminated as of December 31, 2019. +In addition, the Company designs, sources, markets and sells name brand and private label handbags, accessories and apparel to customers worldwide through its Wholesale Accessories/Apparel segment, including the Steve Madden, Big Buddha, Betsey Johnson, Madden Girl, Betseyville, Cejon, Steven by Steve Madden, Luv Betsey, DKNY (under license), BB Dakota, Cupcakes & Cashmere (under license) and Anne Klein (under license) brands. Revenue is generated predominantly through the sale of the Company's brand name and private label merchandise and certain licensed products. At December 31, 2019 and 2018 , the Company operated 227 (including 8 e-commerce websites) and 229 (including 7 e-commerce websites) retail stores, respectively. Revenue is subject to seasonal fluctuations. See Note Q for operating segment information. +[2] Principles of Consolidation: +The consolidated financial statements include the accounts of Steven Madden, Ltd. and its wholly-owned subsidiaries, Steven Madden Retail, Inc., Diva Acquisition Corp., Diva International, Inc., Madden Direct, Inc., Adesso Madden, Inc., Stevies, Inc., Daniel M. Friedman and Associates, Inc., Big Buddha, Inc., the Topline Corporation, Cejon, Inc., SML Holdings S.a.r.l., SML Canada Acquisition Corp., Madden International Ltd., DMF International Ltd., Asean Corporation Ltd., Dolce Vita Holdings, Inc., Trendy Imports S.A de C.V., Comercial Diecesiette S.A. de C.V., Maximus Designer Shoes S.A. de C.V., BA Brand Holdings LLC, BAI Holding, LLC, Mad Love LLC, Schwartz & Benjamin, Inc., B.B. Dakota, Inc. and GREATS Brand, Inc. (collectively the "Company"). The accounts of (i) Dexascope Proprietary Ltd., a joint venture in South Africa in which the Company is the majority owner, (ii) BA Brand Holdings LLC, a joint venture in which the Company is the majority owner, (iii) SPM Shoetrade Holding B.V., a joint venture in certain regions of Europe in which the Company is the majority owner, (iv) SM (Jiangsu) Co., Ltd., a joint venture in which the Company controls all of the significant participating rights, (v) SM Dolce Limited, a joint venture in which the Company is the majority interest holder, (vi) SM Distribution Israel L.P., a joint venture in which the Company is the majority interest holder and (vii) SM Distribution China Co., Ltd., a joint venture in which the Company is the majority interest holder, are included in the consolidated financial statements with the other members' interests reflected in “Net income attributable to noncontrolling interest” in the Consolidated Statements of Income and “Noncontrolling interest” in the Consolidated Balance Sheets. All intercompany balances and transactions have been eliminated. Certain reclassifications were made to prior years' amounts to conform to the 2019 presentation. +[3] Use of Estimates: +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +F-9 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Significant areas involving management estimates include variable consideration included in revenue, allowances for bad debts, inventory valuation, valuation of intangible assets, litigation reserves and contingent payment liabilities. The Company estimates variable consideration on trade accounts receivables and factor receivables for future customer chargebacks and markdown allowances, discounts, returns and other miscellaneous compliance-related deductions that relate to the current period sales. The Company evaluates anticipated chargebacks by reviewing several performance indicators of its major customers. These performance indicators, which include retailers’ inventory levels, sell-through rates and gross margin levels, are analyzed by management to estimate the amount of the anticipated customer allowance. +[4] Cash Equivalents: +Cash equivalents at December 31, 2019 and 2018 amounted to approximately $ 107,535 and $ 77,050 , respectively, and consisted of money market accounts. The Company considers all highly liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. +[5] Marketable Securities: +Marketable securities consist primarily of certificates of deposit and corporate bonds with maturities greater than three months and up to four years at the time of purchase. These securities, which are classified as available-for-sale, are carried at fair value, with unrealized gains and losses, net of any tax effect, reported in stockholders’ equity as accumulated other comprehensive income/(loss). Amortization of premiums and discounts is included in interest income. These securities are classified as current and non-current marketable securities based upon their maturities. As of December 31, 2019 , all bonds previously held by the Company reached maturity. For the years ended December 31, 2019 and 2018 , the amortization of bond premiums totaled $ 218 and $ 728 , respectively. The values of these securities may fluctuate as a result of changes in market interest rates and credit risk. The schedule of maturities at December 31, 2019 and 2018 is as follows: +Maturities as of +December 31, 2019 +Maturities as of +December 31, 2018 +1 Year or Less +1 to 4 Years +1 Year or Less +1 to 4 Years +Corporate bonds +$ +— +$ +— +$ +24,617 +$ +— +Certificates of deposit +40,521 +— +42,351 +— +Total +$ +40,521 +$ +— +$ +66,968 +$ +— +For the year ended December 31, 2019 , losses of $ 5 were reclassified from accumulated other comprehensive income and recognized in the Consolidated Statements of Income in interest and other income as compared to losses of $ 189 for the year ended December 31, 2018 . As of December 31, 2019 , there were no unrealized gains or losses, because all bonds previously held by the Company reached maturity. At December 31, 2018 , current marketable securities included unrealized losses of $ 67 and no non-current marketable securities were held by the Company. +[6] Inventories: +Inventories, which consist of finished goods on hand and in transit, are stated at the lower of cost (first-in, first-out method) or net realizable value. +[7] Property and Equipment: +Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed utilizing the straight-line method based on estimated useful lives ranging from three to ten years. Leasehold improvements are amortized utilizing the straight-line method over the shorter of their estimated useful lives or the remaining lease term. Impairment losses are recognized for long-lived assets, including definite-lived intangibles, used in operations when +F-10 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are not sufficient to recover the assets' carrying amount. Impairment losses are measured by comparing the fair value of the assets to their carrying amount. +[8] Goodwill and Intangible Assets: +The Company's goodwill and indefinite-lived intangible assets are not amortized; rather they are tested for impairment on an annual basis, or more often if events or circumstances change that could cause these assets to become impaired. +In accordance with applicable accounting guidance, indefinite-lived intangible assets and goodwill are assessed for impairment by performing a qualitative assessment that evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible asset or reporting unit is less than its carrying amount. The factors that are considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the intangible asset or reporting unit is less than its carrying amount, the fair value of the intangible asset or reporting unit is compared with its carrying amount, and if the fair value of the intangible asset or reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the carrying value of the intangible asset or reporting unit exceeds its fair value, not to exceed the carrying amount. During the fourth quarter of 2017, the Company recognized an impairment charge of $ 1,000 related to the Wild Pair trademark. The impairment was triggered by a loss of future anticipated cash flows. In addition, in the second quarter of 2019, the Company recognized an impairment charge of $ 4,050 related to the Brian Atwood trademark. The impairment was triggered by the Company's decision to discontinue distribution of the brand. The Company completed its annual impairment tests on goodwill and its remaining indefinite-lived intangible assets during the third quarter of 2019 , and no other impairments were recognized. +The Company amortizes its intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment when there is a triggering event. The Company is currently amortizing its acquired intangible assets with definite useful lives over periods typically from two to twenty years using the straight-line method. +[9] Net Income Per Share of Common Stock: +Basic net income per share is based on the weighted average number of shares of common stock outstanding during the period, which does not include unvested restricted common stock subject to forfeiture of 4,427,000 , 5,137,000 and 5,876,000 shares for the years ended December 31, 2019 , 2018 and 2017 , respectively. Diluted net income per share reflects: a) the potential dilution assuming shares of common stock were issued upon the exercise of outstanding in-the-money options and the proceeds thereof were used to purchase shares of the Company’s common stock at the average market price during the period, and b) the vesting of granted non-vested restricted stock awards for which the assumed proceeds upon vesting are deemed to be the amount of compensation cost not yet recognized attributable to future services using the treasury stock method, to the extent dilutive. For the years ended December 31, 2019 , 2018 and 2017 , options to purchase approximately 5,000 , 45,000 and 14,000 shares of common stock, respectively, have been excluded from the calculation of diluted net income per share as the result would have been anti-dilutive. For the years ended December 31, 2019 , 2018 and 2017 , all unvested restricted stock awards were dilutive. +F-11 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +[10] Comprehensive Loss: +Comprehensive loss is the total of net earnings and all other non-owner changes in equity. Comprehensive loss for the Company includes net income, foreign currency translation adjustments, cash flow hedging and unrealized gains and losses on marketable securities. The accumulated balances for each component of other comprehensive loss attributable to the Company are as follows: +2019 +2018 +Currency translation adjustment +$ +( 29,636 +) +$ +( 33,091 +) +Cash flow hedges, net of tax +( 804 +) +530 +Unrealized loss on securities, net of tax +— +( 67 +) +Accumulated other comprehensive loss +$ +( 30,440 +) +$ +( 32,628 +) +[11] Advertising Costs: +The Company expenses costs of print, radio and billboard advertisements as incurred. Advertising expenses included in operating expenses amounted to approximately $ 30,165 in 2019 , $ 21,921 in 2018 and $ 19,629 in 2017 . +[12] Revenue Recognition: +In May 2014, the Financial Accounting Standards Board (the "FASB") issued new accounting guidance ("Topic 606"), as amended, Accounting Standards Update No. 2014-09 ("ASU 2014-09"), "Revenue from Contracts with Customers," on revenue recognition. The new standard has replaced Revenue Recognition Topic 605 and provides for a single five-step model to be applied to all revenue contracts with customers as well as requiring additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Effective January 1, 2018, the Company adopted the requirements of Topic 606 using the cumulative effect adjustment approach. The impacts to the financial statements of this adoption are primarily related to balance sheet classification, including amounts associated with the change in balance sheet classification of the sales returns reserves, with no significant impact to the income statement as the Company's previous revenue recognition policies are in line with Topic 606. +The Company recognizes revenue when performance obligations identified under the terms of contracts with its customers are satisfied, which generally occurs upon the transfer of control in accordance with the contractual terms and conditions of the sale. Most of the Company’s revenue is recognized at a point in time when product is shipped to the customer. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods, which includes estimates for variable consideration. Variable consideration mainly includes markdown allowances, co-op advertising programs and product returns. The revenue recognition for the Company's segments are described below (see Note Q for disaggregated revenue amounts by segment). +A. Disaggregation of Revenue +Wholesale Sales Segments. The Company generates revenue through the design, sourcing and sale of branded footwear, accessories and apparel to both domestic and international customers who, in turn, sell the products to the consumer. The Company recognizes revenue when performance obligations identified under the terms of contracts with its customers are satisfied, which occurs upon the transfer of control of the merchandise in accordance with the contractual terms and conditions of the sale. The Company's revenue associated with its branded footwear, accessories and apparel products is recognized at a point in time when product is shipped to the customer. The Company also generates revenue through the design, sourcing and sale of private label footwear and accessories to both domestic and international customers who brand the products and sell them to the consumer. The Company's revenue associated with private label footwear and accessories products is recognized at a point in time when product is physically delivered to the customer's freight forwarder. +F-12 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Retail Segment. The Company owns and operates 227 retail stores throughout the United States, Canada, Mexico, South Africa, Israel and China, including 8 e-commerce sites. The Company generates revenue through the sale of branded footwear and accessories directly to the consumer. The Company's revenue associated with Retail segment sales is recognized at the time of the point of sale when the customer takes control of the goods and payment is received. +First Cost Segment. The Company earns commissions for serving as a buying agent for footwear products under private labels and certain owned brands for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, the Company utilizes its expertise and relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. The Company’s commission revenue also includes fees charged for its design and product development services provided to certain suppliers. The Company satisfies its performance obligation to its customers by performing the services in buyer agency agreements and thereby earning its commission fee at the point in time when the customer’s freight forwarder takes control of the goods. The Company satisfies its performance obligation with the suppliers and earns its design fee from the factory at the point in time when the customer’s freight forwarder takes control of the goods. +Licensing Segment. The Company licenses various trademarks it owns under licensing agreements for use in connection with the manufacture, marketing and sale of eyewear, outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, fragrance, men’s leather accessories, women's and children's apparel, swimwear and household goods. The license agreements require the licensee to pay the Company a royalty and, in substantially all of the agreements, an advertising fee, both of which are based on the higher of a minimum or actual net sales percentage as defined in the various agreements. Licensing revenue is recognized on the basis of net sales reported by the licensees, or the minimum guaranteed royalties, if higher. In substantially all of the Company’s license agreements, the minimum guaranteed royalty is earned and receivable on a quarterly basis. The Company recognizes licensing revenue over the period of time in which the license is provided to the benefit of the licensee. +B. Variable Consideration +Markdown Allowances +The Company provides markdown allowances to its retailer customers, which are recorded as a reduction of revenue in the period in which the branded footwear and accessories revenues are recognized. The Company estimates its markdown allowances by reviewing several performance indicators, including retailers' inventory levels, sell-through rates and gross margin levels. +Co-op Advertising Programs +Under co-op advertising programs, the Company agrees to reimburse the retailer for a portion of the costs incurred by the retailer to advertise and promote certain of the Company's products. The Company estimates the costs of co-op advertising programs based on the terms of the agreements with its retailer customers. +Rights of Return +The Company’s Retail segment accepts returns within 30 days from the date of sale for unworn merchandise that the Company is able to re-sell through the channel. The Company does not accept returns as a normal business practice from its branded and private label wholesale customers except for its cold weather accessories business and its Blondo and Kate Spade brands product lines. The Company estimates returns based on historical experience and current market conditions. Such amounts have historically not been material. +F-13 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Sales Deductions +The Company supports retailers’ initiatives to maximize sales of the Company’s products on the retail floor by subsidizing the co-op advertising programs of such retailers, providing them with inventory markdown allowances and participating in various other marketing initiatives of its major customers. In addition, the Company accepts returns for damaged products for which the Company’s costs are normally charged back to the responsible third-party factory. Such expenses are reflected in the consolidated financial statements as deductions to arrive at net sales. +[13] Taxes Collected from Customers: +The Company accounts for certain taxes collected from its customers in accordance with the accounting guidance that permits companies to adopt a policy of presenting taxes in the income statement on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues). Taxes within the scope of this accounting guidance would include taxes that are imposed on a revenue transaction between a seller and a customer, such as sales taxes, use taxes, value-added taxes and some types of excise taxes. The Company records all taxes on a net basis. +[14] Cost of Sales: +All costs incurred to bring finished products to the Company’s distribution center or to the customers’ freight forwarder and, in the Retail segment, the costs to bring products to the Company’s stores are included in the cost of sales line on the Consolidated Statements of Income. These include the cost of finished products, purchase commissions, letter of credit fees, brokerage fees, sample expenses, custom duty, inbound freight, royalty payments on licensed products, labels and product packaging. All warehouse and distribution costs related to the Wholesale segments and freight to customers, if any, are included in the operating expenses line item of the Company’s Consolidated Statements of Income. The Company’s gross margins may not be comparable to those of other companies in the industry because some companies may include warehouse and distribution costs, as well as other costs excluded from cost of sales by the Company, as a component of cost of sales, while other companies report on the same basis as the Company and include them in operating expenses. +[15] Warehouse and Shipping Costs: +The Company includes all warehouse and shipping costs for the Wholesale segments in the operating expenses line on the Consolidated Statements of Income. For the years ended December 31, 2019 , 2018 and 2017 , the total warehouse and distribution costs included in operating expenses were $ 58,019 , $ 47,812 and $ 41,369 , respectively. Since the Company's standard terms of sales are “FOB Steve Madden warehouse,” the Company's wholesale customers absorb most shipping costs. Shipping costs to wholesale customers incurred by the Company are not considered significant and are included in the operating expenses line item in the Consolidated Statements of Income. +[16] Employee Benefit Plan: +The Company maintains a tax-qualified 401(k) plan, which is available to each of the Company's eligible employees who elect to participate after meeting certain length-of-service requirements. The Company made discretionary matching contributions of 50 % of employees' contributions up to a maximum of 6 % of employees' compensation, which vest to the employees over a period of time. Total matching contributions to the plan for 2019 , 2018 and 2017 were approximately $ 2,048 , $ 1,893 and $ 1,819 , respectively. +[17] Derivative Instruments: +The Company uses derivative instruments to manage its exposure to cash-flow variability from foreign currency risk. Derivatives are carried on the balance sheet at fair value and included in prepaid expenses and other current assets or accrued expenses. The Company applies cash flow hedge accounting for its derivative instruments. Net derivative gains and losses attributable to derivatives subject to cash flow hedge accounting reside in accumulated other comprehensive +F-14 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +income/(loss) and will be reclassified to earnings in future periods as the economic transactions to which the derivatives relate affect earnings. See Note M - Derivative Instruments. +[18] Income Taxes: +The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. +The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. See Note O - Income Taxes. +[19] Share-based Compensation: +The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for equity instruments of the Company. Share-based compensation cost for restricted stock awards is measured based on the closing fair market value of the Company’s common stock on the date of grant. Share-based compensation cost for stock options is measured at the grant date, based on the fair-value as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The BSM option-pricing model incorporates various assumptions including expected volatility, estimated expected life and interest rates. The Company recognizes share-based compensation cost over the award’s requisite service period. The Company recognizes a benefit from share-based compensation in operating expenses in the Consolidated Statements of Income if an incremental tax benefit is realized. See Note J - Equity- Based Compensation. +Note C – Stock Split +On September 17, 2018, the Company announced that on September 11, 2018 its Board of Directors declared a three-for-two stock split of the Company's outstanding shares of common stock, effected in the form of a stock dividend on the Company's outstanding common stock. Stockholders of record at the close of business on October 1, 2018 received one additional share of Steven Madden, Ltd. common stock for every two shares of common stock owned on that date. The additional shares were distributed on October 11, 2018. Stockholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. All share and per share data provided herein gives retroactive effect to this stock split. +Note D – Acquisitions +GREATS Brand, Inc. +On August 9, 2019, the Company acquired 90 % of the outstanding common stock of GREATS Brand, Inc., owner of GREATS, a pioneering digitally native sneaker brand, for an initial payment of $ 12,829 and a future contingent payment of $ 5,000 based on the GREATS brand achieving certain EBITA targets. In connection therewith, the Company recorded a long-term liability of $ 4,354 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by GREATS' future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $ 16,893 , net of cash acquired of approximately $ 290 . The acquisition was funded by cash on hand and adds a new footwear brand with added growth potential to the Company. +The results of the GREATS brand have been included in the consolidated financial statements since the date of acquisition within the U.S. location of the Retail segment. +F-15 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +The following table summarizes the fair value of the assets acquired and liabilities assumed as of the August 9, 2019 acquisition date: +Cash +$ +290 +Accounts receivable +41 +Inventory +1,387 +Prepaid and other assets +6,447 +Fixed assets +200 +Trademark (1) +13,590 +Customer relationships (2) +1,140 +Accounts payable +( 1,963 +) +Accrued expenses +( 1,168 +) +Deferred tax liabilities long-term +( 3,463 +) +Noncontrolling interest +( 1,909 +) +Total fair value excluding goodwill +14,592 +Goodwill +2,591 +Net assets acquired +$ +17,183 +(1) Trademark is indefinitely lived. +(2) Customer relationships will be amortized over 20 years. +B.B. Dakota, Inc. +On August 12, 2019, the Company acquired 100 % of the outstanding common stock of B.B. Dakota, Inc., owner of BB Dakota, a contemporary women's apparel company, for an initial payment of $ 24,568 and a future contingent payment on the BB Dakota brand achieving certain EBITDA targets. In connection therewith, the Company recorded a long-term liability of $ 4,770 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by BB Dakota's future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $ 29,404 , net of cash acquired of approximately $ 353 and a post-closing working capital adjustment of $ 419 . The acquisition was funded by cash on hand and adds new apparel brands with added growth potential to the Company. +The results of the BB Dakota brand have been included in the consolidated financial statements since the date of acquisition within the U.S. location of the Wholesale Accessories/Apparel segment. +F-16 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +The following table summarizes the fair value of the assets acquired and liabilities assumed as of the August 12, 2019 acquisition date: +Cash +$ +353 +Accounts receivable +4,419 +Inventory +6,696 +Prepaid and other assets +855 +Fixed assets +382 +Trademark (1) +9,670 +Customer relationships (2) +2,530 +Accounts payable +( 2,885 +) +Accrued expenses +( 2,893 +) +Deferred tax liabilities long-term +( 2,735 +) +Total fair value excluding goodwill +16,392 +Goodwill +13,365 +Net assets acquired +$ +29,757 +(1) Trademark is indefinitely lived. +(2) Customer relationships will be amortized over 10 years. +The acquisitions were accounted for in accordance with FASB Topic ASC 805 ("Business Combinations"), which requires that the total cost of an acquisition be allocated to tangible and intangible assets acquired and liabilities assumed based upon their respective fair values at the date of acquisition. +The Company recorded goodwill for both acquisitions based on the amount by which the purchase price exceeded the fair value of the net assets acquired, which consists largely of the synergies expected from the acquisitions. +Preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revision, which may result in adjustments to the preliminary values discussed above. +SM Distribution China Co., Ltd. +In September 2019, the Company formed SM Distribution China Co., Ltd. ("SM China"), a joint venture with Channelink LLP through its subsidiary. The Company is 51 % interest holder in SM China and controls all of the significant participating rights of the joint venture. SM China is the exclusive distributor of the Company's products in China. Because the Company controls all of the significant participating rights of the joint venture and is the majority interest holder in SM China, the assets, liabilities and results of operations of the joint venture are consolidated and included in the Company’s consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interest” in the Consolidated Statements of Income and “Noncontrolling interest” in the Consolidated Balance Sheets. +SM Distribution Israel, Limited Partnership +In November 2018, the Company formed a joint venture ("SM Israel") with Inter Jeans Ltd. through its subsidiary, SM Distribution Israel L.P. The Company is the majority interest holder in SM Israel and controls all of the significant participating rights of the joint venture. SM Israel is the exclusive distributor of the Company's products in Israel. As the Company controls all of the significant participating rights of the joint venture and is the majority interest holder in SM Israel, the assets, liabilities and results of operations of SM Israel are consolidated and included in the Company’s consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interests” in the Consolidated Statements of Income and “Noncontrolling interests” in the Consolidated Balance Sheets. +F-17 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Note E – Factor Receivable +The Company has a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”). The agreement can be terminated by the Company or Rosenthal at any time upon 60 days' prior written notice. Under the agreement, the Company can request advances from Rosenthal of up to 85 % of aggregate receivables submitted to Rosenthal. The agreement provides the Company with a $ 30,000 credit facility with a $ 15,000 sub-limit for letters of credit at an interest rate based, at the Company’s election, upon a calculation that utilizes either the prime rate minus 0.5 % or LIBOR plus 2.5 % . As of December 31, 2019 and 2018 , no borrowings were outstanding under the credit facility and there were no open letters of credit. The Company also pays Rosenthal a fee based on a percentage of the gross invoice amount submitted to Rosenthal. With respect to receivables related to the Company's private label business, the fee is 0.14 % of the gross invoice amount. With respect to all other receivables, the fee is 0.20 % of the gross invoice amount. Rosenthal assumes the credit risk on a substantial portion of the receivables that the Company submits to it, and to the extent of any loans made to the Company, Rosenthal maintains a lien on the Company’s receivables to secure the Company’s obligations. +Note F – Note Receivable – Related Party +On June 25, 2007, the Company made a loan to Steven Madden, its Creative and Design Chief and a principal stockholder of the Company, in the amount of $ 3,000 in order for Mr. Madden to satisfy a personal tax obligation resulting from the exercise of stock options that were due to expire and to retain the underlying Company common stock. The loan, as amended, is secured by non-company securities held in Mr. Madden's brokerage account. The Company has agreed to forgive a portion of the note as long as Mr. Madden remains an employee of the Company through the note's maturity on December 31, 2023. For the years ended December 31, 2019 , 2018 and 2017 the Company also recorded a charge in the amount of $ 409 for each year, respectively, to write-off the required one-tenth of the principal amount of the secured promissory note, which was partially offset by imputed interest income of $ 40 , $ 47 and $ 55 , respectively. +Note G – Fair Value Measurement +The accounting guidance under Accounting Standards Codification 820-10, “Fair Value Measurements and Disclosures” (“ASC 820-10”) requires the Company to make disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those three levels is as follows: +• +Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities. +• +Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. +• +Level 3: Significant unobservable inputs. +F-18 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +The Company’s financial assets and liabilities, subject to fair value measurements, as of December 31, 2019 and 2018 are as follows: +December 31, 2019 +Fair Value Measurements +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +107,535 +$ +107,535 +$ +— +$ +— +Current marketable securities – available for sale +40,521 +40,521 +— +— +Total assets +$ +148,056 +$ +148,056 +$ +— +$ +— +Liabilities: +Contingent consideration +$ +9,124 +$ +— +$ +— +$ +9,124 +Forward contracts +495 +— +495 +— +Total liabilities +$ +9,619 +$ +— +$ +495 +$ +9,124 +December 31, 2018 +Fair Value Measurements +Fair value +Level 1 +Level 2 +Level 3 +Assets: +Cash equivalents +$ +77,050 +$ +77,050 +$ +— +$ +— +Current marketable securities – available for sale +66,968 +66,968 +— +— +Forward contracts +707 +— +707 +— +Total assets +$ +144,725 +$ +144,018 +$ +707 +$ +— +Liabilities: +Contingent consideration +$ +3,000 +$ +— +$ +— +$ +3,000 +Total liabilities +$ +3,000 +$ +— +$ +— +$ +3,000 +Our level 3 balance consists of contingent consideration related to acquisitions. The changes in our level 3 liabilities for the years ended December 31, 2019 and 2018 are as follows: +Balance at January 1, +Payments +Acquisitions +Change in estimate +Balance at December 31, +2019 +Liabilities: +Contingent consideration +$ +3,000 +— +9,124 +( 3,000 +) +$ +9,124 +2018 +Liabilities: +Contingent consideration +$ +10,000 +( 7,000 +) +— +— +$ +3,000 +Forward contracts are entered into to manage the risk associated with the volatility of future cash flows (see Note M - Derivative Instruments). Fair value of these instruments is based on observable market transactions of spot and forward rates. +F-19 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +The Company recorded a $ 4,354 liability for potential contingent consideration in connection with the August 9, 2019 acquisition of GREATS Brand, Inc. Pursuant to the terms of an earn-out provision contained in the equity purchase agreement, between the Company and the sellers of GREATS Brand, Inc., earn-out payments are based on EBIT performance. The fair value of the contingent payments was estimated using the present value of the payments based on management’s projections of the financial results of GREATS Brand, Inc. during the earn-out period. +The Company recorded a $ 4,770 liability for potential contingent consideration in connection with the August 12, 2019 acquisition of B.B. Dakota, Inc. Pursuant to the terms of an earn-out provision contained in the equity purchase agreement, between the Company and the sellers of B.B. Dakota, Inc., earn-out payments are based on EBITDA performance. The fair value of the contingent payments was estimated using the present value of the payments based on management’s projections of the financial results of B.B. Dakota, Inc. during the earn-out period. +The Company recorded a liability for potential contingent consideration in connection with the January 30, 2017 acquisition of Schwartz & Benjamin. The fair value of the contingent payments was estimated using the present value of the payments based on management’s projections of the financial results of Schwartz & Benjamin during the earn-out period. An earn-out payment in the aggregate amount of $ 7,000 was paid to the sellers of Schwartz & Benjamin in the first quarter of 2018, leaving a remaining balance of $ 3,000 at December 31, 2018. In the first quarter of 2019, the Company reversed the $ 3,000 balance, because it will not be paid due to the termination of the Kate Spade license agreement held by Schwartz & Benjamin as of December 31, 2019. +The carrying value of certain financial instruments such as accounts receivable, factor accounts receivable and accounts payable approximates their fair values due to the short-term nature of their underlying terms. The fair values of investments in marketable securities available for sale are determined by reference to publicly quoted prices in an active market. Fair value of the notes receivable held by the Company approximates their carrying value based upon their imputed or actual interest rate, which approximates applicable current market interest rates. +Note H - Property and Equipment +The major classes of assets and total accumulated depreciation and amortization are as follows: +December 31, +Average Useful Life +2019 +2018 +Land and building +$ +947 +$ +767 +Leasehold improvements +91,341 +84,512 +Machinery and equipment +10 years +6,597 +7,098 +Furniture and fixtures +5 years +11,972 +9,039 +Computer equipment and software +3 to 5 years +65,093 +58,089 +175,950 +159,505 +Less accumulated depreciation and amortization +( 110,446 +) +( 94,698 +) +Property and equipment - net +$ +65,504 +$ +64,807 +Depreciation and amortization expense related to property and equipment included in operating expenses amounted to approximately $ 15,993 in 2019 , $ 16,036 in 2018 and $ 15,160 in 2017 . +F-20 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Note I – Goodwill and Intangible Assets +The following is a summary of the carrying amount of goodwill by segment as of December 31, 2019 and 2018 : +Wholesale +Footwear +Accessories/Apparel +Retail +Net Carrying Amount +Balance at January 1, 2018 +$ +84,862 +$ +49,324 +$ +14,352 +$ +148,538 +Translation and other +( 311 +) +— +( 115 +) +( 426 +) +Balance at December 31, 2018 +84,551 +49,324 +14,237 +148,112 +Acquisitions +— +11,955 +4,644 +16,599 +Purchase accounting adjustment +— +1,409 +( 2,053 +) +( 644 +) +Translation and other +7,021 +— +261 +7,282 +Balance at December 31, 2019 +$ +91,572 +$ +62,688 +$ +17,089 +$ +171,349 +The following tables detail identifiable intangible assets as of December 31, 2019 and 2018 : +2019 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +8,770 +$ +8,418 +$ +— +$ +352 +Customer relationships +10-20 years +43,880 +24,409 +— +19,471 +Non-compete agreement +5 years +455 +455 +— +— +Re-acquired right +2 years +4,200 +4,200 +— +— +57,305 +37,482 +— +19,823 +Re-acquired right +indefinite +35,200 +8,299 +— +26,901 +Trademarks +indefinite +120,035 +— +4,050 +115,985 +$ +212,540 +$ +45,781 +$ +4,050 +$ +162,709 +(1) Includes the effect of foreign currency translation related primarily to the movement of the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An impairment charge of $ 4,050 was recorded in the second quarter of 2019 related to the Company's Brian Atwood trademark. The impairment was triggered by the Company's decision to discontinue distribution of the brand as the Company explores alternatives. +F-21 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +2018 +Estimated Lives +Cost Basis +Accumulated Amortization (1) +Impairment (2) +Net Carrying Amount +Trade names +6–10 years +$ +9,220 +$ +6,582 +$ +— +$ +2,638 +Customer relationships +10-20 years +47,019 +28,049 +— +18,970 +License agreements +3–6 years +5,600 +5,600 +— +— +Non-compete agreement +5 years +2,440 +2,440 +— +— +Re-acquired right +2 years +4,200 +4,200 +— +— +Other +3 years +14 +14 +— +— +68,493 +46,885 +— +21,608 +Re-acquired right +indefinite +35,200 +9,785 +— +25,415 +Trademarks +indefinite +100,333 +— +4,045 +96,288 +$ +204,026 +$ +56,670 +$ +4,045 +$ +143,311 +(1) Includes the effect of foreign currency translation related primarily to the movement of the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) Impairment charges related to the Wild Pair trademark. +The amortization of intangible assets amounted to $ 6,258 for 2019 , $ 5,718 for 2018 and $ 5,245 for 2017 and is included in operating expenses on the Company's Consolidated Statements of Income. The estimated future amortization expense for intangibles as of December 31, 2019 is as follows: +2020 +$ +2,913 +2021 +2,236 +2022 +1,802 +2023 +1,802 +2024 +1,802 +Thereafter +9,268 +Total +$ +19,823 +Note J – Equity-Based Compensation +In February 2019, the Company's Board of Directors approved the Steven Madden, Ltd. 2019 Incentive Compensation Plan (the “2019 Plan”), under which nonqualified stock options, stock appreciation rights, performance shares, restricted stock, other stock-based awards and performance-based cash awards may be granted to employees, consultants and non-employee directors. The 2019 Plan is the successor to the Company's Amended and Restated 2006 Stock Incentive Plan, as amended (the "2006 Plan"), the term of which expired on April 6, 2019. The Company's stockholders approved the 2019 Plan at the Company's annual meeting of stockholders held on May 24, 2019. +The following table summarizes the number of shares of common stock authorized for issuance under the 2019 Plan, the number of stock-based awards granted (net of expired or cancelled awards) under the 2019 Plan and the number of shares of common stock available for the grant of stock-based awards under the 2019 Plan: +Common stock authorized +11,000,000 +Stock-based awards, including restricted stock and stock options granted, net of expired or cancelled awards +( 483,185 +) +Common stock available for grant of stock-based awards as of December 31, 2019 +10,516,815 +F-22 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +For the years ended December 31, 2019 , 2018 and 2017 , total equity-based compensation was as follows: +Years Ended December 31, +2019 +2018 +2017 +Restricted stock +$ +19,143 +$ +16,720 +$ +16,616 +Stock options +4,027 +4,356 +4,231 +Total +$ +23,170 +$ +21,076 +$ +20,847 +Equity-based compensation is included in operating expenses on the Company’s Consolidated Statements of Income. +Stock Options +Cash proceeds and intrinsic values related to total stock options exercised during December 31, 2019 , 2018 and 2017 are as follows: +Years Ended December 31, +2019 +2018 +2017 +Proceeds from stock options exercised +$ +6,212 +$ +13,036 +$ +16,433 +Intrinsic value of stock options exercised +$ +4,268 +$ +6,841 +$ +9,936 +During the years ended December 31, 2019 , 2018 and 2017 , options to purchase approximately 738,903 shares of common stock with a weighted average exercise price of $ 28.20 , 773,351 options with a weighted average exercise price of $ 26.38 and 614,283 options with a weighted average exercise price of $ 22.68 vested, respectively. As of December 31, 2019 , there were unvested options relating to 1,171,934 shares of common stock outstanding with a total of $ 4,982 of unrecognized compensation cost and an average vesting period of 2.0 years. +The Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of options granted, which requires several assumptions. The expected term of the options represents the estimated period of time until exercise and is based on the historical experience of similar awards. Expected volatility is based on the historical volatility of the Company’s common stock. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The dividend yield is based on the Company's annualized dividend per share amount divided by the Company's stock price. The following weighted average assumptions were used for stock options granted during 2019 , 2018 and 2017 : +2019 +2018 +2017 +Volatility +32.0% to 39.6% +25.1% to 33.2% +23.0% to 26.4% +Risk free interest rate +1.6% to 2.5% +2.1% to 2.9% +1.5% to 2.0% +Expected life in years +1.0 to 5.0 +3.0 to 5.0 +3.0 to 5.0 +Dividend yield +1.6 % +1.7 % +0.0 % +Weighted average fair value +$ 5.38 +$ 6.75 +$ 5.94 +F-23 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Activity relating to stock options granted under the Company’s plans and outside the plans during the three years ended December 31, 2019 is as follows: +Number of Shares +Weighted Average Exercise Price +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at January 1, 2017 +2,249,000 +$ +19.81 +Granted +1,593,000 +25.03 +Exercised +( 983,000 +) +16.49 +Forfeited +( 13,000 +) +23.49 +Outstanding at December 31, 2017 +2,846,000 +23.87 +Granted +585,000 +32.39 +Exercised +( 593,000 +) +22.04 +Forfeited +( 23,000 +) +22.59 +Outstanding at December 31, 2018 +2,815,000 +26.03 +Granted +272,000 +30.93 +Exercised +( 273,000 +) +22.77 +Forfeited +( 12,000 +) +20.17 +Outstanding at December 31, 2019 +2,802,000 +$ +26.85 +4.1 +$ +45,284 +Exercisable at December 31, 2019 +1,630,000 +$ +27.02 +3.7 +$ +26,069 +The following table summarizes information about stock options at December 31, 2019 : +Options Outstanding +Options Exercisable +Range of Exercise Price +Number Outstanding +Weighted Average Remaining Contractual Life (in Years) +Weighted Average Exercise Price +Number Exercisable +Weighted Average Exercise Price +$19.59 to $23.91 +468,000 +2.2 +$ 22.79 +347,000 +$ 22.54 +$23.92 to $28.24 +1,474,000 +4.1 +25.18 +775,000 +25.43 +$28.25 to $32.57 +557,000 +5.7 +29.81 +275,000 +29.58 +$32.58 to $36.90 +291,000 +3.9 +35.55 +233,000 +35.93 +$36.91 to $41.23 +12,000 +6.5 +41.18 +— +— +2,802,000 +4.1 +$ 26.85 +1,630,000 +$ 27.02 +F-24 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Restricted Stock +The following table summarizes restricted stock activity during the three years ended December 31, 2019 : +Number of Shares +Weighted Average Fair Value at Grant Date +Outstanding at January 1, 2017 +6,287,000 +$ +17.29 +Granted +413,000 +25.11 +Vested +( 762,000 +) +20.39 +Forfeited +( 62,000 +) +23.65 +Outstanding at December 31, 2017 +5,876,000 +17.37 +Granted +509,000 +31.70 +Vested +( 1,177,000 +) +18.44 +Forfeited +( 71,000 +) +25.61 +Outstanding at December 31, 2018 +5,137,000 +18.42 +Granted +633,000 +32.64 +Vested +( 1,200,000 +) +19.40 +Forfeited +( 143,000 +) +28.61 +Outstanding at December 31, 2019 +4,427,000 +$ +19.84 +As of December 31, 2019 , the Company had $ 57,134 of total unrecognized compensation cost related to restricted stock awards granted under the 2019 Plan and the 2006 Plan. This cost is expected to be recognized over a weighted average period of 3.96 years. +The Company determines the fair value of its restricted stock awards based on the market price of its common stock on the date of grant. The fair value of the restricted stock that vested during the years ended December 31, 2019 , 2018 and 2017 was $ 23,263 , $ 36,122 and $ 21,549 , respectively. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment of Mr. Madden’s existing employment agreement, pursuant to which, on February 8, 2012, Mr. Madden was granted 2,194,586 restricted shares of the Company’s common stock at the then market price of $ 18.23 , which will vest in equal annual installments over a seven-year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On June 30, 2012, Mr. Madden exercised his right under his employment agreement to receive an additional restricted stock award, and on July 3, 2012, he was granted 2,840,013 restricted shares of the Company's common stock at the then market price of $ 14.09 , which vests in equal annual installments over a six-year period commencing on December 31, 2018 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On March 1, 2017, pursuant to his employment agreement, Mr. Madden was granted an option to purchase 1,125,000 shares of the Company’s common stock at an exercise price of $ 24.90 per share, which option is exercisable in equal annual installments over a five-year period commencing on the first anniversary of the grant date. +On March 25, 2019, pursuant to an amendment of the employment agreement between the Company and its Creative and Design Chief, Steven Madden, which effected the extension of the term of the agreement for three years through December 31, 2026, Mr. Madden was granted 200,000 restricted shares of the Company's common stock. The restricted stock award will vest in three nearly equal annual installments commencing on December 31, 2024. On August 19, 2019, pursuant to his employment agreement with the Company, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $ 30.14 per share, which option will vest in four equal installments commencing on November 19, 2019 and ending on June 30, +F-25 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +2020. As of December 31, 2019 , Mr. Madden has unvested options to purchase 843,750 shares of the Company's common stock and 3,347,390 restricted shares of the Company's common stock. +Note K - Preferred Stock +The Company has authorized 5,000,000 shares of preferred stock. The Board of Directors has designated 60,000 shares of such preferred stock as Series A Junior Participating Preferred Stock (“Series A Preferred”). Holders of the shares of Series A Preferred are entitled to dividends equal to 1,000 times dividends declared or paid on the Company's common stock. Each share of Series A Preferred entitles the holder to 1,000 votes on all matters submitted to the holders of common stock. The Series A Preferred has a liquidation preference of $ 1,000 per share and is not redeemable by the Company. No shares of preferred stock have been issued. +Note L - Share Repurchase Program +The Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase of the Company's common stock. Most recently, on April 24, 2019, the Board of Directors approved the extension of the Company's Share Repurchase Program for up to $ 200,000 in repurchases of the Company's common stock, which includes the amount remaining under the prior authorization. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. During the twelve months ended December 31, 2019 , an aggregate of 2,381,340 shares of the Company's common stock were repurchased under the Share Repurchase Program, at a weighted average price per share of $ 32.76 , for an aggregate purchase price of approximately $ 78,001 , which includes the amount remaining under the prior authorization. As of December 31, 2019 , approximately $ 136,959 remained available for future repurchases under the Share Repurchase Program. +The Steven Madden, Ltd. 2019 Incentive Compensation Plan provides the Company with the right to deduct or withhold, or require participants to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, participants may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the employee's withholding tax obligation. During the twelve months ended December 31, 2019 , an aggregate of 577,413 shares were withheld in connection with the settlement of vested restricted stock to satisfy tax withholding requirements, at an average price per share of $ 41.16 , for an aggregate purchase price of approximately $ 23,767 . +F-26 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Note M - Derivative Instruments +The Company uses derivative instruments, specifically, forward foreign exchange contracts, to manage the risk associated with the volatility of future cash flows. The foreign exchange contracts are used to mitigate the impact of exchange rate fluctuations on certain forecasted purchases of inventory and are designated as cash flow hedging instruments. As of December 31, 2019 , the fair value of the Company's foreign currency derivatives, which is included on the Consolidated Balance Sheets in other liabilities , is $ 495 . As of December 31, 2019 and 2018 , the Company's hedging activities were considered effective and, thus, no ineffectiveness from hedging activities was recognized in the Consolidated Statements of Income. The following table presents the pre-tax amounts from derivative instruments affecting income and other comprehensive income ("OCI") for the years ended December 31, 2019 , 2018 and 2017 , respectively: +Cash Flow Hedges +Forward Contracts: +Location of Gain or Loss Recognized in Net Income on Derivative +Gain/(Loss) Recognized in Accumulated OCI +Gain/(Loss) Reclassified into Income From Accumulated OCI +2019 +Cost of Sales +$ +( 454 +) +$ +( 10 +) +2018 +Cost of Sales +748 +( 39 +) +2017 +Cost of Sales +( 802 +) +( 57 +) +Note N - Leases +During the first quarter 2019, the Company adopted ASU No. 2016-02, “Leases (Topic 842),” which requires leases with durations greater than twelve months to be recognized on the balance sheet. The Company adopted the standard using the modified retrospective approach with an effective date as of January 1, 2019. Upon adoption the Company recorded $ 194,100 for right-of-use asset and $ 209,000 for lease liabilities. The Company did not apply the new standard to comparative periods and therefore, those amounts are not presented below. +The Company elected the package of three practical expedients. As such, the Company did not reassess whether expired or existing contracts are or contain a lease and did not need to reassess the lease classifications or reassess the initial direct costs associated with expired or existing leases. The Company did not elect the hindsight practical expedient or the land easement practical expedient, neither of which are applicable to the Company. Also, the Company has elected to take the practical expedient to not separate lease and non-lease components for all asset classes. +The Company leases office space, sample production space, warehouses, showrooms, storage and retail stores under operating leases. The Company’s portfolio of leases is primarily related to real estate and since most of our leases do not provide a readily determinable implicit rate, the Company estimated its incremental borrowing rate to discount the lease payments based on information available at lease commencement. +F-27 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Lease Position +The table below presents the lease-related assets and liabilities recorded on the balance sheet as of December 31, 2019 : +Classification on the Balance Sheet +December 31, 2019 +Assets +Noncurrent (1) +Operating lease right-of-use asset +$ +155,700 +Liabilities +Current +Operating leases - current portion +$ +38,624 +Noncurrent +Operating leases - long-term portion +133,172 +Total operating lease liabilities +$ +171,796 +Weighted-average remaining lease term +5.5 years +Weighted-average discount rate (2) +4.4 +% +(1) During the third quarter of 2019, the Company recorded a pre-tax charge related to the right-of-use asset of $ 1,883 . +(2) Upon adoption of the new lease standard, discount rates used for existing leases were established at January 1, 2019. +Lease Costs +The table below presents certain information related to lease costs for the year ended December 31, 2019 : +Operating lease cost +$ +48,387 +Short-term lease cost +239 +Less: sublease income +644 +Total lease cost +$ +47,982 +Other Information +The table below presents supplemental cash flow information related to leases for the year ended December 31, 2019 : +Cash paid for amounts included in the measurement of lease liabilities +Operating cash flows used for operating leases +$ +46,324 +Undiscounted Cash Flows +The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the lease liabilities recorded on the balance sheet as of December 31, 2019 : +2020 +$ +46,035 +2021 +39,586 +2022 +30,474 +2023 +21,680 +2024 +18,020 +Thereafter +38,119 +Total minimum lease payments +193,914 +Less: interest +22,118 +Present value of lease liabilities +$ +171,796 +F-28 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +A majority of the retail store leases provide for contingent rental payments if gross sales exceed certain targets. In addition, many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes. Rent expense for the years ended December 31, 2019 , 2018 and 2017 was approximately $ 61,283 , $ 58,332 and $ 56,027 , respectively. Included in such amounts are contingent rents of $ 138 , $ 516 and $ 424 in 2019 , 2018 and 2017 , respectively. +Rent expense is calculated by amortizing total base rental payments (net of any rental abatements, construction allowances and other rental concessions), on a straight-line basis, over the lease term. Accordingly, rent expense charged to operations differs from rent paid resulting in the Company recording deferred rent in 2018 and 2017. +Note O - Income Taxes +The components of income before income taxes are as follows: +2019 +2018 +2017 +Domestic +$ +119,166 +$ +121,674 +$ +124,472 +Foreign +62,060 +55,666 +47,855 +$ +181,226 +$ +177,340 +$ +172,327 +The components of provision for income taxes for all periods presented were as follows: +2019 +2018 +2017 +Current: +Federal +$ +18,655 +$ +32,880 +$ +56,836 +State and local +3,765 +5,012 +5,746 +Foreign +11,940 +11,771 +10,773 +34,360 +49,663 +73,355 +Deferred: +Federal +2,309 +( 2,489 +) +( 22,061 +) +State and local +1,343 +( 200 +) +800 +Foreign +1,492 +( 133 +) +1,095 +5,144 +( 2,822 +) +( 20,166 +) +$ +39,504 +$ +46,841 +$ +53,189 +F-29 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +A reconciliation between taxes computed at the federal statutory rate and the effective tax rate is as follows: +December 31, +2019 +2018 +2017 +Income taxes at federal statutory rate +21.0 +% +21.0 +% +35.0 +% +Effects of foreign operations +( 0.1 +) +( 0.7 +) +( 4.5 +) +Stock-based compensation +( 3.4 +) +( 2.1 +) +( 2.2 +) +State and local income taxes - net of federal income tax benefit +2.3 +2.4 +2.0 +Nondeductible items +0.7 +0.1 +0.5 +Impact of tax reform +— +2.0 +( 4.4 +) +Receivable adjustment +— +— +2.7 +Prepaid tax adjustment related to prior years +— +3.8 +— +Other +1.3 +( 0.1 +) +1.8 +Effective rate +21.8 +% +26.4 +% +30.9 +% +The primary changes between the Company’s effective tax rate for the year ended December 31, 2019 and 2018 are due to the year-over-year benefit resulting from the exercising and vesting of shared-based awards, a decrease in the state taxes incurred, a decrease in prepaid tax adjustments, and an increase in 2019 pre-tax income in jurisdictions with low tax rates. +F-30 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +The components of deferred tax assets and liabilities are as follows: +December 31, +2019 +2018 +Deferred taxes assets +Receivable allowances +$ +8,537 +$ +8,702 +Inventory +3,247 +2,274 +Unrealized loss +— +282 +Accrued expenses +1,453 +1,113 +Deferred compensation +8,643 +10,217 +Deferred rent +— +4,257 +Net carryforwards +7,531 +647 +Lease liability +41,382 +— +Other +493 +1,557 +Gross deferred tax assets before valuation allowance +71,286 +29,049 +Less: valuation allowance +( 2,230 +) +( 649 +) +Gross deferred tax assets after valuation allowance +69,056 +28,400 +Deferred tax liabilities +Depreciation and amortization +( 26,978 +) +( 13,009 +) +Unremitted earnings of foreign subsidiaries +( 3,025 +) +( 2,597 +) +Right-of-use asset +( 37,248 +) +— +Amortization of goodwill +( 7,682 +) +( 7,514 +) +Gross deferred tax liabilities +( 74,933 +) +( 23,120 +) +Net deferred tax (liabilities)/assets +$ +( 5,877 +) +$ +5,280 +The Company applies the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. +The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax‑planning strategies in making this assessment. +The Company’s aggregate valuation allowance of $ 2,230 for the year ended December 31, 2019 relates to a deferred tax asset on an outside basis difference that the Company does not expect to realize, a net operating loss deferred tax asset in its Luxembourg subsidiary, and a net operating loss deferred tax asset in its China joint venture. +F-31 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +December 31, +2019 +2018 +2017 +Beginning Balance +$ +1,511 +$ +361 +$ +1,407 +Additions related to current period tax positions +— +1,150 +— +Reductions for tax positions of prior years +( 361 +) +— +( 1,046 +) +Ending Balance +$ +1,150 +$ +1,511 +$ +361 +For the years ended December 31, 2019, 2018 and 2017 the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is approximately $ 1,150 , $ 1,511 and $ 361 , in the aggregate, respectively. The Company recognizes interest and penalties, if any, related to uncertain income tax positions in income tax expense. Accrued interest and penalties on unrecognized tax benefits and interest and penalty expense was immaterial to the consolidated financial statements for all periods presented. The unrecognized tax benefits are not expected to materially change in the next twelve months. +The Company files income tax returns in the U.S., for federal, state, and local purposes, and in certain foreign jurisdictions. The Company's tax years 2016 through 2019 remain open to examination by most taxing authorities. During 2017, the U.S. Internal Revenue Service ("IRS") completed its audit of the Company's 2014 U.S. income tax return. +The Company’s consolidated financial statements provide for any related tax liability on amounts that may be repatriated from foreign operations, aside from undistributed earnings of certain of the Company’s foreign subsidiaries that are intended to be indefinitely reinvested in operations outside the U.S. The deferred tax liability of $ 3,025 at December 31, 2019 reflects the withholding tax on amounts that may be repatriated from foreign operations. +Note P – Commitments, Contingencies and Other +[1] Legal Proceedings: +In the ordinary course of business, the Company has various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on the Company's financial condition, results of operations or cash flows. It is the policy of management to disclose the amount or range of reasonably possible losses in excess of recorded amounts. +[2] Employment agreements: +Edward R. Rosenfeld. On December 31, 2018, the Company entered into a new employment agreement with Edward R. Rosenfeld, the Chief Executive Officer and the Chairman of the Board of Directors of the Company, to replace an existing employment agreement that expired on that date. The agreement, which expires on December 31, 2021, provides for an annual salary of (i) approximately $ 992 for the period from January 1, 2020 through December 31, 2020 and (ii) approximately $ 1,042 for the period from January 1, 2021 through December 31, 2021. In addition, pursuant to his new employment agreement, on December 31, 2018, Mr. Rosenfeld received a grant of 87,500 shares of the Company's common stock subject to certain restrictions and, on February 1, 2019, Mr. Rosenfeld received an additional grant of 87,500 shares of the Company's common stock also subject to certain restrictions. The restricted shares received by Mr. Rosenfeld on December 31, 2018 and February 1, 2019 were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a five-year period that commenced on December 1, 2019 and February 1, 2020, respectively. Additional compensation and bonuses, if any, are at the sole discretion of the Company's Board of Directors. +Steven Madden. On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s existing employment agreement with the Company. The +F-32 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +amended agreement, which extends the term of Mr. Madden's employment through December 31, 2023, provides for a base salary of approximately $ 7,026 per annum for the period between January 1, 2016 and December 31, 2023. Pursuant to the amended agreement, on February 8, 2012, Mr. Madden was granted 2,194,586 restricted shares of the Company’s common stock at the then market price of $ 18.23 , which will vest in equal annual installments over a seven-year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. Also under the amended agreement, Mr. Madden received the right, exercisable on certain specified dates in fiscal year 2012 only, to elect to receive a grant of restricted stock for a number of shares of the Company’s common stock valued at $ 40,000 in consideration for certain specified reductions in his annual base salary in years subsequent to 2012. Mr. Madden exercised this right, and on July 3, 2012, he was granted 2,840,013 restricted shares of the Company's common stock at the then market price of $ 14.09 , which shares will vest in equal annual installments over a six-year period commencing on December 31, 2018. Further, in addition to the opportunity for cash bonuses at the sole discretion of the Board of Directors, Mr. Madden’s amended agreement entitles him to an annual life insurance premium payment as well as an annual stock option grant. The amended agreement also provides Mr. Madden the potential for an additional one-time stock option award for 1,125,000 shares of the Company’s common stock (the “EPS Option”) in the event that the Company achieves earnings per share on a fully-diluted basis equal to $ 1.33 as to any fiscal year ending December 31, 2015 or thereafter, which performance criteria was achieved for the fiscal year ended December 31, 2016. As such, on March 1, 2017, Mr. Madden was granted the EPS Option at an exercise price of $ 24.90 per share. The EPS Option vests in equal annual installments over a five-year period commencing on the first anniversary of the grant date. +On March 25, 2019, the Company and its Creative Design Chief, Steven Madden, entered into an amendment to Mr. Madden's existing employment agreement with the Company. The amended agreement extends the term of Mr. Madden's employment for three years through December 31, 2026. Pursuant to the amended agreement, on March 25, 2019 Mr. Madden was granted 200,000 restricted shares of the Company's common stock. The restricted stock award will vest in three nearly equal annual installments commencing on December 31, 2024. On August 19, 2019, pursuant to his employment agreement with the Company, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $ 30.14 per share, which option will vest in four equal installments commencing on November 19, 2019 and ending on June 30, 2020. +Arvind Dharia. On April 20, 2018, the Company and its Chief Financial Officer, Arvind Dharia, entered into an amendment of Mr. Dharia's existing employment agreement. The amendment, which was effective as of January 1, 2018, (i) extends the term of Mr. Dharia's employment agreement, which by its terms expired on December 31, 2017, to December 31, 2020 and (ii) provides for an annual salary of $ 642 in 2020. Pursuant to the amendment, on May 1, 2018, Mr. Dharia received a restricted stock award of 18,750 restricted shares of the Company's common stock under the Company's 2006 Stock Incentive Plan, as amended. The restricted shares vest in three nearly equal annual installments that commenced on December 15, 2018. The agreement, as amended, provides for an annual bonus to Mr. Dharia at the discretion of the Board of Directors. +Amelia Newton Varela. On December 27, 2019, the Company entered into a new employment agreement with Amelia Newton Varela, the Company’s President and a member its Board of Directors, to replace an existing employment agreement that expired on December 31, 2019. The agreement, which remains in effect through December 31, 2022, provides for an annual salary of $ 700 in 2020, $ 725 in 2021 and $ 750 in 2022. In addition, pursuant to her new employment agreement, on January 2, 2020, Ms. Varela was granted 27,000 restricted shares of the Company's common stock under the Company's 2019 Incentive Compensation Plan. The restricted shares vest in five equal annual installments commencing on January 2, 2021. The agreement provides to Ms. Varela the opportunity for an annual performance-based bonus for the fiscal years ended December 31, 2020, 2021 and 2022. +Awadhesh Sinha. On December 27, 2019, the Company entered into a new employment agreement with Awadhesh Sinha, the Company's Chief Operating Officer, to replace an existing employment agreement that expired on December 31, 2019. The new agreement, which remains in effect through December 31, 2021, provides for an annual salary of $ 745 in 2020 and $ 767 in 2021 and provides to Mr. Sinha the opportunity for annual cash and share-based incentive bonuses. In addition, pursuant to his new employment agreement, on January 2, 2020, Mr. Sinha received a grant of 11,598 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Sinha were issued +F-33 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +under the Company's 2019 Incentive Compensation Plan and vest in equal annual installments over a two-year period on each of December 15, 2020 and December 15, 2021. +Karla Frieders. On April 11, 2017, the Company entered into a new employment agreement with Karla Frieders, the Company’s Chief Merchandising Officer, to replace an existing employment agreement which expired on February 28, 2017. The agreement, which remains in effect through April 30, 2020, provides to Ms. Frieders an annual salary of $ 590 for the period commencing on May 1, 2019 and ending on April 30, 2020 and an annual performance-based bonus for the fiscal years ending December 31, 2017, 2018 and 2019 in an amount to be determined at the discretion of the Company. In addition, pursuant to her new employment agreement, on April 11, 2017, Ms. Frieders received a grant of 30,000 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Ms. Frieders were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a five-year period commencing on April 1, 2018 and ending on April 1, 2022. +[3] Letters of credit: +At December 31, 2019 , the Company had no open letters of credit for the purchase of imported merchandise. +[4] License agreements: +In January 2018, the Company entered into a license agreement with Nine West Development LLC, subsequently acquired by WHP Global, for the right to manufacture, market and sell women's fashion footwear and handbags under the Anne Klein®, AK Sport®, AK Anne Klein Sport® and the Lion Head Design®. The agreement, unless extended, expires on June 30, 2023. The agreement requires that the Company pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. +On January 30, 2017, the Company acquired all of the outstanding capital stock of Schwartz & Benjamin, which held licenses to manufacture, market and sell footwear with the Kate Spade® trademark. The license agreement required Schwartz & Benjamin to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. As of December 31, 2019, the agreement for the license of the Kate Spade® trademark was terminated. +In August 2017, the Company entered into a license agreement with Donna Karan Studio LLC for the right to manufacture, market and sell women's belts with the DKNY® and Donna Karan® brands. The agreement, unless extended, expires on December 31, 2020. The agreement requires that the Company pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. As of December 31, 2019, the agreement for the license of the Donna Karan® trademark was terminated. +On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A, under which the Company has the right to use the Superga® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The agreement was amended on April 11, 2013 to extend the term of the agreement through December 31, 2022. +Future minimum royalty payments are $ 8,535 for 2020 , $ 16,520 for 2021 through 2022 and $ 3,625 for 2023 . Royalty expenses are included in the “cost of goods” section of the Company's Consolidated Statements of Income. +[5] Concentrations: +The Company maintains cash and cash equivalents with various major financial institutions which at times are in excess of the amount insured. +During the year ended December 31, 2019 , the Company did not purchase more than 10 % of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2019 were 88 % . +F-34 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +During the year ended December 31, 2018 , the Company did not purchase more than 10 % of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2018 were 94 % . +During the year ended December 31, 2017 , the Company did not purchase more than 10 % of its merchandise from any single supplier. Total product purchases from China for the year ended December 31, 2017 were approximately 93 % . +For the year ended December 31, 2019 , Wal-Mart Stores, Inc. represented 11.9 % of total revenue. At December 31, 2019 , Wal-Mart Stores, Inc. represented 17.9 % of total accounts receivable, Target Corporation represented 13.6 % of total accounts receivable and Nordstrom, Inc. represented 10.6 % of total accounts receivable. The Company did not have any other customers who accounted for more than 10 % of total revenue or any other customers who accounted for more than 10 % of total accounts receivable. +At December 31, 2018 , Wal-Mart Stores, Inc. represented 17.6 % of total accounts receivable, Target Corporation represented 13.8 % of total accounts receivable and Nordstrom, Inc. represented 10.6 % of total accounts receivable. The Company did not have any customers who accounted for more than 10 % of total net revenue or any other customers who accounted for more than 10 % of total accounts receivable. +At December 31, 2017 , Wal-Mart Stores, Inc. represented 14.6 % of total accounts receivable and Target Corporation represented 13.4 % of total accounts receivable. The Company did not have any customers who accounted for more than 10 % of total revenue or any other customers who accounted for more than 10 % of total accounts receivable. +Purchases are made primarily in United States dollars. +[6] Valuation and qualifying accounts: +The following is a summary of the allowance for doubtful accounts related to accounts receivable: +Balance at Beginning of Year +Additions +Deductions +Balance at End of Year +Year ended December 31, 2019 +Allowance for doubtful accounts +$ +10,849 +$ +679 +$ +462 +$ +11,066 +Year ended December 31, 2018 +Allowance for doubtful accounts +616 +10,887 +654 +10,849 +Year ended December 31, 2017 +Allowance for doubtful accounts +144 +15,070 +14,598 +616 +F-35 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Note Q – Operating Segment Information +The Company operates the following business segments: Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing. The Wholesale Footwear segment, through sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores, derives revenue, both domestically and internationally (via our International business), from sales of branded and private label women’s, men’s, girls’ and children’s footwear. The Wholesale Accessories/Apparel segment, which includes branded and private label handbags, apparel, belts and small leather goods as well as cold weather and selected other fashion accessories, derives revenue, both domestically and internationally, from sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores. Our Wholesale Footwear and Wholesale Accessories/Apparel segments, through our International business, derive revenue from certain territories within Asia, Europe, North America (excluding the United States) and Africa and, under special distribution arrangements, in various other territories within Australia, the Middle East, India, South and Central America and New Zealand and pursuant to a partnership agreement in Singapore. The Retail segment, through the operation of Company-owned retail stores in the United States, Canada and Mexico, our joint ventures in South Africa, China, Taiwan and Israel and the Company’s websites, derives revenue from sales of branded women’s, men’s and children’s footwear, accessories, apparel and licensed products to consumers. The First Cost segment represents activities of a subsidiary that earns commissions and design fees for serving as a buying agent of footwear products to mass-market merchandisers, mid-tier department stores and other retailers with respect to their purchase of footwear. In the Licensing segment, the Company generates revenue by licensing its Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks and other trademark rights for use in connection with the manufacture, marketing and sale of eyewear, outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, this segment licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel, hosiery, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. The Licensing segment also licenses the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. +F-36 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Year ended +Wholesale Footwear +Wholesale Accessories/Apparel +Total Wholesale +Retail +First Cost +Licensing +Consolidated +December 31, 2019 +Total revenue +$ +1,112,091 +$ +334,862 +$ +1,446,953 +$ +321,182 +$ +7,441 +$ +11,581 +$ +1,787,157 +Gross profit +373,587 +98,131 +471,718 +195,277 +7,441 +11,581 +686,017 +Income/(loss) from operations +163,482 +22,455 +185,937 +( 9,050 +) +( 8,177 +) +8,104 +176,814 +Depreciation and amortization +11,247 +9,580 +510 +— +21,337 +Segment assets +$ +873,654 +$ +119,999 +993,653 +269,574 +8,979 +6,441 +1,278,647 +Capital expenditures +$ +13,356 +$ +4,955 +$ +— +$ +— +$ +18,311 +December 31, 2018 +Total revenue +$ +1,058,366 +$ +300,091 +$ +1,358,457 +$ +295,152 +$ +11,226 +$ +12,899 +$ +1,677,734 +Gross profit +345,909 +91,739 +437,648 +178,390 +11,226 +12,899 +640,163 +Income/(loss) from operations +140,138 +27,092 +167,230 +735 +( 4,549 +) +9,966 +173,382 +Depreciation and amortization +10,810 +10,593 +944 +135 +22,482 +Segment assets +$ +774,837 +$ +149,790 +924,627 +113,292 +28,210 +6,441 +1,072,570 +Capital expenditures +$ +6,790 +$ +5,660 +$ +— +$ +— +$ +12,450 +December 31, 2017 +Total revenue +$ +1,017,557 +$ +256,295 +$ +1,273,852 +$ +272,246 +$ +9,493 +$ +11,492 +$ +1,567,083 +Gross profit +332,367 +80,729 +413,096 +164,645 +9,493 +11,492 +598,726 +Income/(loss) from operations +133,014 +23,637 +156,651 +( 1,126 +) +5,159 +9,100 +169,784 +Depreciation and amortization +11,287 +9,645 +457 +— +21,389 +Segment assets +$ +784,334 +$ +138,720 +923,054 +122,111 +11,996 +— +1,057,161 +Capital expenditures +$ +5,590 +$ +9,185 +$ +— +$ +— +$ +14,775 +Revenues by geographic area are as follows: +Year Ended December 31, +2019 +2018 +2017 +Domestic (a) +$ +1,572,056 +$ +1,473,229 +$ +1,404,254 +International +215,101 +204,505 +162,829 +Total +$ +1,787,157 +$ +1,677,734 +$ +1,567,083 +(a) Includes revenues of $337,028, $326,655 and $326,945 for the years ended 2019, 2018 and 2017 related to sales to U.S. customers where the title is transferred outside the U.S. and the sale is recorded by our international business. +F-37 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +Note R - Quarterly Results of Operations (unaudited) +The following is a summary of the quarterly results of operations for the years ended December 31, 2019 and 2018 : +March 31, +June 30, +September 30, +December 31, +2019: +Net sales +$ +410,940 +$ +444,974 +$ +497,308 +$ +414,912 +Commission and licensing fee income +4,848 +4,655 +4,806 +4,713 +Total revenue +415,788 +449,629 +502,114 +419,625 +Cost of sales +253,943 +279,629 +306,277 +261,291 +Gross profit +161,845 +170,000 +195,837 +158,334 +Net income attributable to Steven Madden, Ltd. +$ +34,525 +$ +36,572 +$ +52,463 +$ +17,751 +Net income per share: +Basic +$ +0.43 +$ +0.46 +$ +0.66 +$ +0.23 +Diluted +$ +0.41 +$ +0.44 +$ +0.63 +$ +0.21 +2018: +Net sales +$ +389,014 +$ +395,753 +$ +458,482 +$ +410,360 +Commission and licensing fee income +4,964 +3,921 +8,755 +6,485 +Total revenue +393,978 +399,674 +467,237 +416,845 +Cost of sales +248,281 +247,979 +283,265 +258,046 +Gross profit +145,697 +151,695 +183,972 +158,799 +Net income attributable to Steven Madden, Ltd. +$ +28,673 +$ +32,410 +$ +55,563 +$ +12,490 +Net income per share: +Basic +$ +0.35 +$ +0.40 +$ +0.68 +$ +0.15 +Diluted +$ +0.33 +$ +0.37 +$ +0.64 +$ +0.15 +As each quarter is calculated as a discrete period, the sum of the four quarters may not equal the calculated full year amount. This is in accordance with prescribed reporting requirements. +During the fourth quarter of 2019, the Company recorded in net income attributable to Steven Madden, Ltd. an after-tax bad debt expense of $ 8,934 related to the Payless ShoeSource bankruptcy and an after-tax charge related to a legal settlement of $ 3,016 . Also during the fourth quarter of 2019, the Company recorded in net income attributable to Steven Madden, Ltd. a tax expense of $ 2,219 in connection with deferred tax and tax rate adjustments, an after-tax expense of $ 204 related to the termination of a China joint venture and an after-tax charge of $ 31 related to the acquisition of GREATS and BB Dakota brands. +Note S - Recent Accounting Pronouncements +Recently Adopted +In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2016-02 ("ASU 2016-02"), "Leases," as amended, which is effective January 1, 2019. Under ASU 2016-02, lessees will be required to recognize for all leases with terms longer than twelve months, at the commencement date of the lease, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right-to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition. The Company adopted the new standard on the effective date January 1, 2019. A modified retrospective transition approach was used, applying the new standard to all leases existing at the date of initial application. The Company applied ASC-840, including disclosure requirements, in the comparative periods in the year the Company adopted the new guidance. (See Note N - Leases) +F-38 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2019, 2018 and 2017 +($ in thousands, except share and per share data) +In February 2018, the FASB issued Accounting Standards Update No. 2018-02 ("ASU 2018-02"), "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income," which allows for stranded tax effects in accumulated other comprehensive income resulting from the U.S. Tax Cuts and Jobs Act to be reclassified to retained earnings. ASU 2018-02 is effective January 1, 2019 and did not have any significant impact on the Company’s financial position or results of operations. +Not Yet Adopted +In August 2018, the FASB issued Accounting Standards Update No. 2018-15, “Intangibles-Goodwill and Other-Internal-Use Software (Topic 350): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract.” This new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This new guidance is effective for the Company on a prospective or retrospective basis beginning on January 1, 2020. Adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements. +In August 2018, the FASB issued Accounting Standards Update No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This new guidance removes certain disclosure requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. This new guidance is effective for the Company beginning on January 1, 2020. Certain disclosures in the new guidance will need to be applied on a retrospective basis and others on a prospective basis. Adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements. +In June 2016, the FASB issued Accounting Standards Update 2016-13 ("ASU 2016-13"), "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This new guidance is effective for the Company beginning on January 1, 2020. Adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements. +F-39 \ No newline at end of file diff --git a/raw/filings/0000913241/2019/0001628280-20-002674/filing_metadata.csv b/raw/filings/0000913241/2019/0001628280-20-002674/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b2bfb153ae343879bd6cc91b84a72a355e82ada1 --- /dev/null +++ b/raw/filings/0000913241/2019/0001628280-20-002674/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000913241,SHOO,"STEVEN MADDEN, LTD.",10-K,2020-03-02,2019-12-31,2020-03-02T19:35:42.000Z,0001628280-20-002674,shoo-20191231x10k.htm,10-K,17132840,1,1,https://www.sec.gov/Archives/edgar/data/913241/000162828020002674/shoo-20191231x10k.htm,https://www.sec.gov/Archives/edgar/data/913241/000162828020002674/,2019,2019,1 diff --git a/raw/filings/0000913241/2019/0001628280-20-002674/item1.txt b/raw/filings/0000913241/2019/0001628280-20-002674/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..a081222a212a23ab4a917c251673e4ba5d803fd7 --- /dev/null +++ b/raw/filings/0000913241/2019/0001628280-20-002674/item1.txt @@ -0,0 +1,197 @@ +ITEM 1. BUSINESS +($ in thousands, except share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", or "us", as applicable) design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags, apparel and accessories. We also license some of our trademarks for use in connection with the manufacturing, marketing and sale of various products by third party licensees. Our products are marketed through our retail stores and our e-commerce websites within the United States, Canada, Mexico, our joint ventures in Europe, South Africa, Israel, Taiwan and China, as well as better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States, Canada, Mexico and certain European nations. In addition, we have special distribution arrangements for the marketing of our products in Spain, Italy, Australia, the Middle East, India, South and Central America, New Zealand and Singapore. Our product line includes a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +1 +Steven Madden, Ltd. was incorporated in New York on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol "SHOO." Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of our Company, each of which is attached as an exhibit to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015. We also have a Code of Conduct that is applicable to all of our employees, which is attached as an exhibit to our 2018 Annual Report on Form 10-K filed with the SEC on February 28, 2019. Each of these codes is posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Recent Developments +Acquisition. On August 9, 2019, we acquired 90% of the outstanding common stock of GREATS Brand, Inc., owner of GREATS, a pioneering digitally native sneaker brand, for an initial payment of $12,829 and a future contingent payment of $5,000 based on the GREATS brand achieving certain EBITA targets. In connection therewith, we recorded a non-current liability of $4,354 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by GREATS' future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $16,893 , net of cash acquired of approximately $290 . The acquisition was funded by cash on hand and adds a new footwear brand with added growth potential to our Company. +Acquisition. On August 12, 2019, we acquired 100% of the outstanding common stock of B.B. Dakota, Inc., owner of BB Dakota, a contemporary women's apparel company, for an initial payment of $24,568 and a future contingent payment on the BB Dakota brand achieving certain EBITDA targets. In connection therewith, we recorded a non-current liability of $4,770 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by BB Dakota's future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $29,404 , net of cash acquired of approximately $353 and a post-closing working capital adjustment of $419. The acquisition was funded by cash on hand and adds new apparel brands with added growth potential to our Company. +Joint Venture. In September 2019, we formed SM Distribution China Co., Ltd. ("SM China"), a joint venture with Channelink LLP through its subsidiary. We hold a 51% interest holder in SM China and control all of the significant participating rights of the joint venture. SM China is the exclusive distributor of our products in China. Because we control all of the significant participating rights of the joint venture and are the majority interest holder in SM China, the assets, liabilities and results of operations of the joint venture are consolidated and included in our consolidated financial statements. The other member's interest is reflected in “Net income attributable to noncontrolling interest” in the Consolidated Statements of Income and “Noncontrolling interest” in the Consolidated Balance Sheets. +Dividend. In October 2019, our Board of Directors declared an increase to the quarterly cash dividend to $0.15 per share on our outstanding shares of common stock. The dividend was paid on December 27, 2019 to stockholders of record as of the close of business on December 16, 2019. +Our Board of Directors approved a quarterly cash dividend of $0.15 per share on February 25, 2020. The dividend will be paid on March 27, 2020, to stockholders of record at the close of business on March 17, 2020. +2 +Product Distribution Segments +Our business comprises five distinct segments: Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing. +Our Wholesale Footwear segment comprises the following brands: +Steve Madden® +DV by Dolce Vita® +Stevies® +Madden Girl® +Mad Love® +Brian Atwood® +Madden® +Steven by Steve Madden® +Blondo® +Madden NYC +Report® +Anne Klein® (under license) +Dolce Vita® +Superga® (under license) +Betsey Johnson® +GREATS® +AK Sport® (under license) +The segment also includes our International business and part of our private label footwear business. An agreement under which we licensed the Kate Spade® trademark terminated on December 31, 2019. +Our Wholesale Accessories/Apparel segment comprises the following brands: +Steve Madden® +Madden Girl® +Big Buddha® +Cejon® +Madden NYC +Luv Betsey® +Betsey Johnson® +Anne Klein® (under license) +Steven by Steve Madden® +Jocelyn® +BB Dakota® +DKNY® (under license) +Cupcakes & Cashmere® (under license) +It also includes our International business and part of our private label accessories business. An agreement under which we licensed the Donna Karan® trademark terminated on December 31, 2019. +Steven Madden Retail, Inc., our wholly-owned retail subsidiary, operates Steve Madden, Steven, Superga and GREATS retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn e-commerce websites. +Our First Cost segment represents activities of one of our wholly-owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the country's large mass-market retailers, shoe chains and other value priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses, hair accessories, fragrance, umbrellas, bedding and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, headbands, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and FREEBIRD by Steven® for operation of retail stores. +3 +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers throughout the United States. The Steve Madden brand has become a leading life-style brand in the fashion conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking exciting, new footwear designs at affordable prices. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine whether the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. Retail price points for Steve Madden Women's products range from $59 to $189. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared towards girls and young women ages 13 to 25 and is an “opening price point” brand currently sold at major department stores, mid-tier retailers and specialty stores. Retail price points for Madden Girl products range from $39 to $79. +Steve Madden Men's. We design, source and market a lifestyle collection of men's footwear for the fashion forward man, ages 18 to 45, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Retail price points for Steve Madden Men's products range from $69 to $169. +Madden. The Madden® brand is a casual and business casual collection of footwear designed to meet the ever-evolving needs of the trend conscious young male consumer, ages 16 to 35. Madden products range from $40 to $90 and are sold to national specialty stores, department stores, mid-tier department stores, online retailers, off-price retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal to fashion conscious women ages 25 to 45 who grew up wearing Steve Madden footwear and are looking for a shoe with an emphasis on comfort. Retail price points for Steven products range from $89 to $169. +Stevies and Steve Madden Kids. Our Stevies® and Steve Madden Kids® brands are designed, sourced and marketed to appeal to young girls, ages 6 to 12. These brands are distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. Retail price points for Steve Madden Kids products range from $49 to $89. +Betsey Johnson . On October 5, 2010, we acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. Retail price points for Betsey Johnson products range from $99 to $139. +Superga. On February 9, 2011, we entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. Retail price points for Superga products range from $65 to $99. +Report. We acquired the Report® brand in May 2011. It is a junior women's footwear brand with retail price points ranging from $20 to $100 per pair. We design, manufacture, market and sell Report branded products to major department stores, mid-tier department stores and independently owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street lifestyle brand created to appeal to women with a young attitude and active lifestyle and marketed exclusively to Target. Retail price points for Mad Love products range from $15 to $23. +Dolce Vita. In August 2014, we acquired the Dolce Vita® and DV® brands. Dolce Vita® is a contemporary women's footwear brand with retail price points ranging from $79 to $225. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently owned boutiques primarily throughout the United States. The DV® brand is a contemporary women's footwear brand with retail price points ranging from $20 to $75. DV® products are distributed through major department stores, off-price department stores, online retailers and independently owned boutiques primarily throughout the United States. +4 +Brian Atwood. In March 2014, we acquired the Brian Atwood® designer brand and the B Brian Atwood® contemporary brand. Brian Atwood is known for luxury shoes manufactured in China and Italy. In the second quarter of 2019, we stopped distribution of the Brian Atwood brand. +Blondo. In January 2015, we acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in waterproof leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. Retail price points for Blondo products range from $99 to $199. +GREATS . In August 2019, we acquired the intellectual property and related assets of GREATS, a digitally native footwear brand specializing in premium quality, responsibly made sneakers for men and women. Founded in 2014, GREATS is a pioneer and the first digitally native sneaker brand. GREATS partners with better department stores like Nordstrom as well as specialty boutiques in the United States. Retail price points for GREATS products range from $119 to $199. +Kate Spade. In January 2017, as a consequence of the acquisition of Schwartz & Benjamin, Inc., we acquired licenses to manufacture, market and sell footwear under the Kate Spade® trademark. The Kate Spade® brand, known for its whimsical fashion, is an entry-level luxury footwear brand primarily distributed through department stores and Kate Spade retail stores throughout the United States. The price points of footwear bearing the Kate Spade® brand range from $98 to $400 per pair with the core product price ranging from $198 to $298. As of December 31, 2019, the agreement to license the Kate Spade® trademark was terminated. +Anne Klein. In January 2018, we entered into a license agreement with Nine West Development LLC for a license to use the Anne Klein®, AK Sport®, AK Anne Klein Sport® and Lion Head Design® trademarks in connection with the marketing and sale of footwear. The Anne Klein® brand is recognized as being synonymous with American sportswear. Retail price points for Anne Klein products range from $49 to $129. +International Division. The International division, utilizing some of the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, online retailers and catalog retailers through wholly owned subsidiaries in Canada and Mexico and joint venture partnerships in Europe (excluding Italy, Spain and Greece, where we had preexisting distributors), South Africa, Israel, China and Taiwan. In addition, the International division works through special distribution arrangements for the marketing and sale of our products in Spain, Italy, Australia, the Middle East, India, South and Central America, New Zealand and Singapore. +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third-party brands, such as Material Girl® and Candies®. +Wholesale Accessories/Apparel Segment +Our Wholesale Accessories/Apparel segment designs, sources and markets name brands and sells them to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, Mexico and our joint ventures and International distributor network. These brands include the following brands as well as private label fashion handbags and accessories: +Steve Madden® +Big Buddha® +Steven by Steve Madden® +BB Dakota® +Madden Girl® +Anne Klein® (under license) +Betsey Johnson® +Jocelyn® +Madden NYC +Luv Betsey® +DKNY® (under license) +Cupcakes & Cashmere® (under license) +In addition, we market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Steve Madden®, BB Dakota®, Cejon®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +5 +Retail Segment +As of December 31, 2019 , we owned and operated 227 retail stores, including 146 Steve Madden full-price stores, 68 Steve Madden outlet stores, 2 Steven stores, 2 GREATS stores, 1 Superga store and 8 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn). In 2019 , we added 8 full-price stores, 8 outlet stores and 2 e-commerce websites and closed 17 full-price stores, 2 outlet stores and 1 e-commerce website. In addition, during 2019 , we closed 12 concessions in China and opened 1 concession in Taiwan, ending the year with 31 company-operated concessions in international markets. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, Israel, China and Taiwan. Comparative store sales (sales of those stores, including the e-commerce websites, that were open for at least twelve months) increased 6.1% in fiscal year 2019 from the prior year. We exclude new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. +We believe that our retail stores will continue to enhance overall sales and profitability, and our ability to react swiftly to changing consumer trends. Our stores play an important role in our integrated retail strategy and serve as fulfillment and return locations for our e-commerce business. We are also launching buy-online-return-in-store in select locations. Our stores also serve as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. We expect to open 10 to 13 new retail stores and close 4 to 6 locations in 2020 . +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market retailers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers, including Kohl's, Fred Meyer and Meijers. In addition, by leveraging the strength of our Steve Madden brands and product designs, we are able to partially recover our design, product and development costs from our suppliers. +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses, hair accessories, fragrance, umbrellas, bedding and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, headbands, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and FREEBIRD by Steven® for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note Q to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Company's products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models +6 +provide our brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate any foreign manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently owned manufacturers primarily in China and also in Cambodia, Mexico, Brazil, India, Vietnam, Italy and other European nations. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. +The manufacturers of our products are required to meet quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and most of our products are shipped via ocean freight carriers to ports principally in California and to a lesser extent in New Jersey, and via truck from Mexico to our third-party distribution facility in Texas. We rely to a lesser extent on air carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from eight third-party distribution centers, five located in California, one located in Texas, one located in Tennessee and one located in New Jersey. Our products are also distributed through a Company-operated distribution center located in Canada. Our products are also distributed through our third-party distribution facility in Mexico. By utilizing distribution facilities specializing in fulfillment for certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. Suppliers of products for our businesses in Canada and Mexico and our joint ventures in Europe, South Africa, Israel, Taiwan and China ship to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China where the distributor arranges for subsequent shipment. +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stor es, national chains, mass merchants, value priced retailers, specialty stores, online retailers and catalog retailers. These customers, in no particular order, include: +Nordstrom, Inc. +The TJX Companies, Inc. +Dillard's, Inc. +Burlington Stores, Inc. +Macy's, Inc. +Ross Stores, Inc. +Designer Brands, Inc. +Wal-Mart Stores, Inc. +Kohl's Corporation +Target Corporation +For the year ended December 31, 2019 , Wal-Mart Stores, Inc. represented 11.9% of total revenue. At December 31, 2019 , Wal-Mart Stores, Inc. represented 17.9% of total accounts receivable, Target Corporation represented 13.6% of total accounts receivable and Nordstrom, Inc. represented 10.6% of total accounts receivable. We did not have any other customers who accounted for more than 10% of total revenue or any other customers who accounted for more than 10% of total accounts receivable. +7 +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, Israel, Taiwan and China +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico and certain European nations. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in Europe, South Africa, Israel, Taiwan and China, and on our e-commerce websites. For the year ended December 31, 2019 , our two Wholesale segments and our Retail segment generated net sales of approximately $1,446,953 and $321,182 , or 81% and 18% of our total revenue, respectively. Each of these distribution channels is described below. +Department Stores. We currently sell our products to approximately 2,200 doors of 15 department stores throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Nordstrom, Inc., Macy's, Inc., Dillard's, Inc., Belk, Inc. and Bloomingdale's, Inc. +We provide merchandising support to our department store customers, including in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which we showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at the end of the season. +National Chains and Mass Merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Wal-Mart Stores, Inc., Target Corporation and Kohl's Corporation. +Specialty Stores/Catalog Sales. We currently sell to specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW Designer Shoe Warehouse, Famous Footwear and Gap, Inc. We offer our specialty store accounts similar merchandising, sell-through and inventory tracking support offered to our department store accounts. Sales of our products are also made through certain catalogs. +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate 8 Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and Jocelyn apparel and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also sell to online retailers throughout the United States and Canada. Our major accounts include Zappos and Amazon. +Steve Madden, Steve Madden Outlet, Steven, Superga and GREATS Retail Stores. As of December 31, 2019 , we operated 146 Steve Madden full-price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China, Taiwan and Israel. We also operated 68 Steve Madden outlet stores, 2 Steven stores, 2 GREATS stores and 1 Superga store within the United States. We also operated 8 e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS, BB Dakota and Jocelyn). We believe that our retail stores will continue to enhance overall sales and profitability, and our ability to react swiftly to changing consumer trends. Our stores play an important role in our integrated retail strategy and serve as fulfillment and return locations for our e-commerce business. We are also launching buy-online-return-in-store in select locations. Our stores also serve as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with venues to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have been able to leverage +8 +sales information gathered at Steve Madden retail stores to assist our wholesale customers in order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The GREATS stores are approximately 1,000 to 1,500 square feet and are located in New York and Miami. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. In addition to carefully analyzing mall demographics and locations, we set profitability guidelines for each potential store site. Specifically, we target well trafficked sites at which the demographics fit our consumer profile and seek new locations where the projected fixed annual rent expense stays within our guidelines. By setting these guidelines, we seek to identify stores that will contribute to our overall profitability both in the near and longer terms. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from us and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include certain European territories, the Middle East, South and Central America, Oceania and various countries in Asia. +Competition +The fashion industry is highly competitive. We compete with specialty shoe, apparel and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Sam Edelman, Deckers Outdoor Corporation and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective marketing and advertising, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +Marketing and Sales +We have focused on creating an integrated brand building program to establish our Company as a leading designer of fashion footwear for style-conscious young women and men. Principal marketing activities include social media and digital marketing efforts, public relations, including product and brand placements in lifestyle and fashion magazines and digital outlets, in-store promotions, as well as personal appearances by our founder and Creative and Design Chief, Steven Madden. We continue to promote our e-commerce websites where customers can purchase Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and Jocelyn apparel and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also connect with our customers through social media forums including Instagram, Facebook and Twitter. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support our growth. Our Enterprise Resource Planning (“ERP”) system is an integrated system that supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. All of our North American wholesale businesses (other than Canada, which has a separate ERP system) and our Asia first-cost and sourcing operations are operated through this ERP system. Our warehouse management system is utilized by our third-party logistics providers and is fully integrated with our ERP system. A point of sale system for our U.S. retail stores is integrated with a retail inventory management/store replenishment system. We have transitioned our e-commerce software to a major cloud-based provider. Complementing all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +9 +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 131 other countries and in numerous International Classes. From time to time, we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying our Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® +Report® +Steven by Steve Madden® +Report Signature® +Steven® +Brian Atwood® +Madden Girl® +B Brian Atwood® +Stevies® +Dolce Vita® +Stevies plus Design® +DV8® +Big Buddha® +Sweet Life® +Topline® +DV® +Betseyville® +DV DOLCE VITA® +Betsey Johnson® +Wild Pair® +LUV BETSEY plus Kiss Design® +MadLove® +LUV BETSEY by Betsey Johnson Design® +Blondo® +Blue by Betsey Johnson® +Blondo Waterproof plus Heart Design® +Steve Madden plus Design® +By Steve Madden plus Heart® +SM New York® +SM Pass® +SM New York plus Design® +Jocelyn® +FREEBIRD By Steven® +BB Dakota® +The Factory by Steve Madden® +JACK BB Dakota® +GREATS® +JAIME® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks worldwide. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations. +Trademark Licensing +Our strategy for the continued growth of our business includes expanding our presence beyond footwear, apparel and accessories through the selective licensing of our brands. As of December 31, 2019 , we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, hair accessories, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and FREEBIRD by Steven® for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +10 +See Notes B and P to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Employees +On February 3, 2020 , we employed approximately 4,000 employees, of whom approximately 2,500 work full-time and approximately 1,500 work part-time. Most of our part-time employees work in the Retail segment. Approximately 2,600 of our employees are located in the United States, approximately 700 employees are located in Hong Kong and China, approximately 400 employees are located in Canada, approximately 200 employees are located in Mexico, approximately 100 employees are located in Israel, approximately 80 employees are located in South Africa and approximately 40 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. We have never experienced a material interruption of our operations due to a labor dispute. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales occur in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales occur in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Revenue levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $ 328,600 and $ 369,458 , as of February 3, 2020 and February 1, 2019 , respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. \ No newline at end of file diff --git a/raw/filings/0000913241/2019/0001628280-20-002674/item13.txt b/raw/filings/0000913241/2019/0001628280-20-002674/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..a2eea626d466ef628de05e986f8135b7f95923b0 --- /dev/null +++ b/raw/filings/0000913241/2019/0001628280-20-002674/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2020 Annual Meeting of Stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2019/0001628280-20-002674/item9a.txt b/raw/filings/0000913241/2019/0001628280-20-002674/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..6fb5c69782d8059e4b4e0a0a13a12f94d3c6b929 --- /dev/null +++ b/raw/filings/0000913241/2019/0001628280-20-002674/item9a.txt @@ -0,0 +1,12 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +37 +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2019 , of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2019 , our internal control over financial reporting was effective. +Our independent registered public accounting firm, EisnerAmper LLP, has audited our consolidated financial statements and the effectiveness of our internal control over financial reporting as of December 31, 2019 . Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2019 , which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000913241/2019/0001628280-20-002674/rp_note.txt b/raw/filings/0000913241/2019/0001628280-20-002674/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000913241/2019/0001628280-20-002674/rpt_disclosure.txt b/raw/filings/0000913241/2019/0001628280-20-002674/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..50ef35aff457e16f22711afb6b99c7344200d51f --- /dev/null +++ b/raw/filings/0000913241/2019/0001628280-20-002674/rpt_disclosure.txt @@ -0,0 +1,6 @@ +related party transaction disclosures. +If +a director is a party to or in some manner involved in a transaction involving us, he or she will be recused from all discussions +and decisions about the transaction. 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Employer Identification No.) +incorporation or organization) +52-16 Barnett Avenue , Long Island City , New York 11104 +(Address of principal executive offices) (Zip Code) +(Registrant's Telephone Number, Including Area Code): ( 718 ) 446-1800 +Securities Registered Pursuant to Section 12(b) of the Act: +Title of each class Trading symbol(s) Name of each exchange on which registered +Common Stock, par value $.0001 per share SHOO The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act. +Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). +Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☒ Accelerated filer ☐ Emerging growth company ☐ +Non-accelerated filer ☐ Smaller reporting company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. +☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). +Yes ☐ No ☒ +The aggregate market value of the common equity held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and directors are “affiliates” of the registrant) as of June 30, 2020, the last business day of the registrant's most recently completed second fiscal quarter, was $ 2,027,460,245 (based on the closing sale price of the registrant's common stock on that date as reported on The NASDAQ Global Select Market). +The number of outstanding shares of the registrant's common stock as of February 25, 2021 was 82,715,209 shares. +DOCUMENTS INCORPORATED BY REFERENCE: +PART III INCORPORATES CERTAIN INFORMATION BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT'S 2021 ANNUAL MEETING OF STOCKHOLDERS. +TABLE OF CONTENTS +SAFE HARBOR STATEMENT +1 +PART I +ITEM 1 BUSINESS +1 +ITEM 1A RISK FACTORS +12 +ITEM 1B UNRESOLVED STAFF COMMENTS +21 +ITEM 2 PROPERTIES +21 +ITEM 3 LEGAL PROCEEDINGS +22 +ITEM 4 MINE SAFETY DISCLOSURES +22 +PART II +ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER +MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +22 +ITEM 6 SELECTED FINANCIAL DATA +25 +ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION +AND RESULTS OF OPERATIONS +26 +ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +35 +ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +36 +ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON +ACCOUNTING AND FINANCIAL DISCLOSURE +36 +ITEM 9A CONTROLS AND PROCEDURES +36 +ITEM 9B OTHER INFORMATION +37 +PART III +ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +37 +ITEM 11 EXECUTIVE COMPENSATION +37 +ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND +MANAGEMENT AND RELATED STOCKHOLDER MATTERS +37 +ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND +DIRECTOR INDEPENDENCE +37 +ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES +37 +PART IV +ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +37 +SAFE HARBOR STATEMENT UNDER THE U.S. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, among others, statements regarding revenue and earnings guidance, plans, strategies, objectives, expectations and intentions. You can identify forward-looking statements by words such as: “may,” “will,” “expect,” “believe,” “should,” “anticipate,” “project,” “predict,” “plan,” “intend,” or “estimate,” and similar expressions or the negative of these expressions. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they represent our current beliefs, expectations and assumptions regarding anticipated events and trends affecting our business and industry based on information available as of the time such statements are made. We caution investors that such forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted with accuracy and some of which may be outside of our control. Our actual results and financial condition may differ materially from those indicated in these forward-looking statements. As such, investors should not rely upon them. Important risk factors include: +• our ability to maintain adequate liquidity when negatively impacted by unforeseen events such as an epidemic or pandemic (COVID-19), which may cause disruption to our business operations and temporary closure of Company-operated and wholesale partner retail stores, resulting in a significant reduction in revenue for an indeterminable period of time; +• our ability to accurately anticipate fashion trends and promptly respond to consumer demand; +• our ability to compete effectively in a highly competitive market; +• our ability to adapt our business model to rapid changes in the retail industry; +• our dependence on the retention and hiring of key personnel; +• our ability to successfully implement growth strategies and integrate acquired businesses; +• our ability to achieve operating results that are consistent with prior financial guidance; +• disruptions to product delivery systems and our ability to properly manage inventory; +• our reliance on independent manufacturers to produce and deliver products in a timely manner, especially when faced with adversities such as work stoppages, transportation delays, public health emergencies, social unrest, changes in local economic conditions, and political upheavals as well as their ability to meet our quality standards; +• changes in trade policies and tariffs imposed by the United States government and the governments of other nations in which we manufacture and sell products; +• legal, regulatory, political and economic risks that may affect our sales in international markets; +• additional tax liabilities resulting from audits by various taxing authorities; +• our ability to adequately protect our trademarks and other intellectual property rights; +• changes in U.S. and foreign tax laws that could have an adverse effect on our financial results; and +• other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission. +These risks and uncertainties, along with the risk factors discussed under Item 1A. “Risk Factors” in this Annual Report on Form 10-K, should be considered in evaluating any forward-looking statements contained in this report. We do not undertake any obligation to publicly update any forward-looking statement, including without limitation, any guidance regarding revenue or earnings, whether as a result of new information, future developments or otherwise. +PART I +ITEM 1. BUSINESS +($ in thousands, except earnings per share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", or "us", as applicable) design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell branded fashion handbags, apparel and accessories, as well as private label fashion handbags and accessories. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, and online retailers, throughout the United States, Canada, Mexico and certain other European nations. In addition, our products are marketed through our retail stores and our e-commerce websites within the United States, Canada and Mexico, our joint ventures in Europe, South Africa, Israel, Taiwan and China, and under special distribution arrangements in certain European countries, the Middle East, South and Central America, Oceania and various countries in Asia. Our product lines include a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have +1 +established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated in New York on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol "SHOO." Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of our Company, each of which is attached as an exhibit to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015. We also have a Code of Conduct that is applicable to all of our employees, which is attached as an exhibit to our 2018 Annual Report on Form 10-K filed with the SEC on February 28, 2019. Each of these codes is posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Recent Developments +On December 8, 2020, our Board of Directors appointed Zine Mazouzi to be our Chief Financial Officer, effective January 1, 2021, upon the retirement of Arvind Dharia, effective December 31, 2020. +On January 4, 2021, upon the recommendation of the Nominating/Corporate Governance Committee, our Board of Directors appointed Maria Teresa Kumar to fill the newly created directorship resulting from the expansion in the size of the Board of Directors from nine members to ten members. Ms. Kumar has also been appointed to serve on the Corporate Social Responsibility Committee. +On February 24, 2021, our Board of Directors approved the reinstatement of a quarterly cash dividend. The quarterly dividend of $0.15 per share is payable on March 26, 2021 to stockholders of record as of the close of business on March 16, 2021. +Product Distribution Segments +Our business comprises five distinct segments: Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing. +Our Wholesale Footwear segment comprises the following brands: +Steve Madden® DV Dolce Vita® Blondo® +Madden Girl® Mad Love® Anne Klein® (under license) +Madden® Steven by Steve Madden® GREATS® +Betsey Johnson® Report® +Dolce Vita® Superga® (under license) +The segment also includes our International business and part of our private label footwear business. +2 +Our Wholesale Accessories/Apparel segment comprises the following brands: +Steve Madden® BB Dakota® +Steven by Steve Madden® BB Dakota x Steve Madden® +Madden Girl® Anne Klein® (under license) +Betsey Johnson® Luv Betsey® +Big Buddha® Cupcakes & Cashmere® (under license) +Cejon® +It also includes our International business and part of our private label accessories business. The agreements under which we licensed the Jocelyn® and DKNY® trademarks terminated as of December 31, 2020. The agreement under which we license the Cupcakes & Cashmere® trademark will terminate in April 2021. +Steven Madden Retail, Inc., our wholly owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota e-commerce websites. +Our First Cost segment represents activities of one of our wholly owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the U.S. large mass-market retailers, shoe chains and other value-priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of apparel, outerwear, hosiery, jewelry, watches, eyeglasses, sunglasses, hair accessories, umbrellas, bedding and bath, and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, hair accessories, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and the FREEBIRD by Steven® trademark for operation of retail stores. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, and online retailers. The Steve Madden brand has become a leading life-style brand in the fashion-conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking trending footwear designs at affordable price points. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine whether the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. Retail price points for Steve Madden Women's products range from $59 to $189. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared towards girls and young women ages 13 to 25 and is an “opening price point” brand currently sold at major department stores, mid-tier retailers, online retailers and specialty stores. Retail price points for Madden Girl products range from $39 to $79. +Steve Madden Men's. We design, source and market a lifestyle collection of men's footwear for the fashion-forward man, ages 18 to 45, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Retail price points for Steve Madden Men's products range from $69 to $169. +Madden. The Madden® brand is a collection of casual and business casual footwear designed to meet the ever-evolving needs of the trend-conscious young male consumer, ages 16 to 35. Madden products range from $40 to $90 and are sold to national specialty stores, department stores, mid-tier department stores, online retailers, off-price retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal to fashion conscious women ages 25 to 45 who grew up +3 +wearing Steve Madden footwear and are looking for a shoe with an emphasis on comfort. Retail price points for Steven products range from $89 to $169. +Steve Madden Kids. Our Steve Madden Kids® brand is designed, sourced and marketed to appeal to toddlers, ages 3 to 6, young girls, ages 6 to 11, and tweens, ages 11 to 14. This brand is distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. Retail price points for Steve Madden Kids products range from $49 to $89. +Betsey Johnson . On October 5, 2010, we acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. Retail price points for Betsey Johnson products range from $79 to $189. +Superga. On February 9, 2011, we entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. Retail price points for Superga products range from $65 to $129. +Report. We acquired the Report® brand in May 2011. It is a junior women's footwear brand with retail price points ranging from $20 to $100 per pair. We design, manufacture, market and sell Report branded products to major department stores, mid-tier department stores and independently owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street lifestyle brand created to appeal to women with a young attitude and active lifestyle and marketed exclusively to Target. Beginning in spring 2021, Mad Love® will become a sustainable brand, designed and created with the mission to make our earth a better place. Retail price points for Mad Love products range from $15 to $23. +Dolce Vita. In August 2014, we acquired the Dolce Vita® and DV® brands. Dolce Vita® is a contemporary women's footwear brand with retail price points ranging from $79 to $225. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently owned boutiques primarily throughout the United States. The DV® brand is a contemporary women's footwear brand with retail price points ranging from $39 to $99. DV® products are distributed through major department stores, off-price department stores, online retailers and independently owned boutiques primarily throughout the United States. +Blondo. In January 2015, we acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in water resistant leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. Retail price points for Blondo products range from $99 to $250. +GREATS . In August 2019, we acquired GREATS, a Brooklyn-based digitally native footwear brand specializing in premium quality, responsibly made sneakers for men and women, which are sold primarily via the Internet. Founded in 2014, GREATS is a pioneer and the first digitally native sneaker brand. GREATS also partners with better department stores like Nordstrom as well as specialty boutiques in the United States. Retail price points for GREATS products range from $119 to $199. +Anne Klein. In January 2018, we entered into a license agreement with Nine West Development LLC for a license to use the Anne Klein®, AK Sport®, AK Anne Klein Sport® and Lion Head Design® trademarks in connection with the marketing and sale of footwear. The Anne Klein® brand is recognized as being synonymous with American sportswear. Retail price points for Anne Klein products range from $49 to $129. +International Division. The International division, utilizing some of the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and online retailers through wholly owned subsidiaries in Canada and Mexico and joint venture partnerships in Europe (excluding Italy, Spain and Greece, where we had preexisting distributors), South Africa, Israel, China and Taiwan. In addition, the International division works through special distribution arrangements for the marketing and sale of our products in Spain, Italy, Greece, South Korea, Australia, the Middle East, India, South and Central America, New Zealand and Southeast Asia. +4 +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third-party brands, such as Material Girl® and Candies®. +Wholesale Accessories/Apparel Segment +Our Wholesale Accessories/Apparel segment designs, sources and markets name brands and sells them to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, and Mexico and through our joint ventures and International distributor network. These products include the following brands as well as private label fashion handbags and accessories: +Steve Madden® BB Dakota® +Steven by Steve Madden® BB Dakota x Steve Madden® +Madden Girl® Anne Klein® (under license) +Betsey Johnson® Luv Betsey® +Big Buddha® Cupcakes & Cashmere® (under license) +The agreements under which we licensed the Jocelyn® and DKNY® trademarks terminated as of December 31, 2020. The agreement under which we license the Cupcakes & Cashmere® trademark will terminate in April 2021. +We market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Steve Madden®, BB Dakota®, Cejon®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2020, we owned and operated 218 retail stores, including 143 Steve Madden full-price stores, 66 Steve Madden outlet stores, one Steven store, one Superga store and seven e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota; our Jocelyn website was terminated as of December 31, 2020). In 2020, we added three full-price stores and two outlet stores and closed nine full-price stores, four outlet stores and one e-commerce website. In addition, during 2020, we closed 14 concessions in South Africa and one concession in Taiwan and opened one concession in China, ending the year with 17 company-operated concessions in international markets. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, Israel, China and Taiwan. +We believe that our direct to consumer business ("DTC") will continue to enhance overall sales and profitability as well as our ability to react quickly to changing consumer trends. Our DTC business also serves as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, it provides us with a channel to test and introduce new products, designs and merchandising strategies. We often test new designs of Steve Madden products in our retail business before scheduling them for mass production and wholesale distribution. In addition to these benefits, we have been able to leverage sales information gathered at Steve Madden retail to assist our wholesale customers in their order placement and inventory management. Our stores play an important role in our integrated retail strategy and also serve as fulfillment and return locations for our e-commerce business. We have also launched buy online, pickup in-store in all U.S. full-price locations. We expect to open three to five new retail stores in international markets and close two to five locations, globally in 2021. +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market retailers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers. In addition, by leveraging the strength of our Steve Madden brands and product designs, we are able to partially recover our design, product and development costs from our suppliers. +5 +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of apparel, outerwear, hosiery, jewelry, watches, eyeglasses, sunglasses, hair accessories, umbrellas, bedding and bath, and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, hair accessories, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and the FREEBIRD by Steven® trademark for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note Q to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects our products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide our brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate any foreign manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently owned manufacturers primarily in China and also in Cambodia, Mexico, Brazil, India, Vietnam, Italy and other European nations. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. +The manufacturers of our products are required to meet quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and most of our products are shipped via ocean freight carriers to ports principally in California and to a lesser extent in New Jersey, and via truck from Mexico to our third-party distribution facility in Texas. We rely to a lesser extent on air carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from six third-party distribution centers, four located in California, one located in Texas, and one located in New Jersey. Our products are also distributed through a Company-operated distribution center located in Canada. Our products are also distributed through our third-party distribution facility in Mexico. By utilizing distribution facilities specializing in fulfillment for certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. Suppliers of products for our businesses in Canada and Mexico and our joint ventures in Europe, South Africa, Israel, Taiwan and China ship to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China and Mexico where the distributor arranges for subsequent shipment. +6 +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stor es, national chains, mass merchants, value priced retailers, specialty stores and online retailers. These customers, in no particular order, include: +Nordstrom, Inc. The TJX Companies, Inc. +Dillard's, Inc. Amazon.com, Inc. +Macy's, Inc. Ross Stores, Inc. +Designer Brands, Inc. Walmart Inc. +Kohl's Corporation Target Corporation +For the year ended December 31, 2020, Walmart Inc. represented approximately 13.9% of total revenue. At December 31, 2020, Walmart Inc. represented 19.0% of total accounts receivable, Target Corporation represented 14.9% of total accounts receivable, Ross Stores, Inc. represented 11.8% of total accounts receivable, The TJX Companies, Inc. represented 11.7% of total accounts receivable and Nordstrom, Inc. represented 10.3% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total revenue or any other customers who accounted for more than 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, Israel, Taiwan and China +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico and certain European nations. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in Europe, South Africa, Israel, Taiwan and China, and on our e-commerce websites. For the year ended December 31, 2020, our two Wholesale segments and our Retail segment generated net sales of approximately $949,554 and $239,389, or 79% and 20% of our total revenue, respectively. Each of these distribution channels is described below. +Department Stores. We currently sell our products to approximately 1,800 doors of 12 department store retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Nordstrom, Inc., Macy's, Inc., Dillard's, Inc., Belk, Inc. and Bloomingdale's, Inc. +We provide merchandising support to our department store customers, including in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which we showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We also leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at the end of the season. +National Chains and Mass Merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Walmart Inc., Target Corporation and Kohl's Corporation. +Shoe Chains/Specialty Stores. We currently sell to shoe chains and specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW Designer Brands, Famous Footwear and Gap, Inc. We offer our specialty store accounts similar merchandising, sell-through and inventory tracking support offered to our department store accounts. +7 +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate seven Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota; our Jocelyn website was terminated as of December 31, 2020) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and BB Dakota x Steve Madden apparel and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also sell to online retailers throughout the United States, Europe, and Canada. Our major accounts include Zappos, Amazon, Zolando, and ASOS. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2020, we operated 143 Steve Madden full-price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China, Taiwan and Israel. We also operated 66 Steve Madden outlet stores, one Steven store and one Superga store within the United States. We also operated seven e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota; our Jocelyn website was terminated as of December 31, 2020). We believe that our retail stores will continue to enhance overall sales and profitability, and our ability to react swiftly to changing consumer trends. Our stores play an important role in our integrated retail strategy and also serve as fulfillment and return locations for our e-commerce business. In 2020 we launched a program where customers can buy online and pick up in store at all of our Steve Madden full-price locations within the United States. We have also launched buy-online-return-in-store in select locations. Our stores also serve as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with a channel to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have also been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in their order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. Our stores play an important role in our integrated retail strategy and serve as fulfillment and return locations for our e-commerce business. We have also launched buy online, pickup in-store in select locations. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from us and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include certain European countries, the Middle East, South and Central America, Oceania and various countries in Asia. +Competition +The fashion industry is highly competitive. We compete with specialty shoe, apparel and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Sam Edelman, Jessica Simpson, Lucky Brand and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective marketing and advertising, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors, and we intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +8 +Marketing and Sales +We have focused on creating an integrated-brand building program to establish our Company as a leading designer of fashion footwear for style-conscious women and men. Principal marketing activities include social media and digital marketing efforts, influencer marketing, public relations, including product and brand placements in lifestyle and fashion magazines and digital outlets, in-store promotions, and events, as well as public and media appearances by our founder and Creative and Design Chief, Steven Madden. We continue to promote our e-commerce websites where customers can purchase Steve Madden, Steven, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and BB Dakota x Steve Madden apparel and accessory products, as well as select styles of Madden Girl footwear and accessory products. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support our growth. Our Enterprise Resource Planning (“ERP”) system is an integrated system that supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. All of our North American wholesale businesses (other than Canada, which has a separate ERP system) and our Asia first-cost and sourcing operations are operated through this ERP system. Our warehouse management system is utilized by the majority of our third-party logistics providers and is fully integrated with our ERP system. A point-of-sale system for our U.S. retail stores is integrated with a retail inventory management/store replenishment system. We have transitioned our e-commerce software to a major cloud-based provider. Complementing all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. In 2019, we invested $8,200 in a new data and recovery center, with substantially all of the project going into production in 2020. +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 151 other countries and in numerous International Classes. From time to time, we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying our Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® Report® +Steven by Steve Madden® Report Signature® +Steven® Dolce Vita® +Madden Girl® DV8® +Stevies® DV® +Stevies plus Design® DV DOLCE VITA® +Topline® MadLove® +Betseyville® Blondo® +Betsey Johnson® Blondo Waterproof plus Heart Design® +LUV BETSEY plus Kiss Design® By Steve Madden plus Heart® +LUV BETSEY by Betsey Johnson Design® SM Pass® +Blue by Betsey Johnson® +COOL PLANET TM +Steve Madden plus Design® BB Dakota® +FREEBIRD By Steven® GREATS® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks worldwide. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations. +9 +Trademark Licensing +Our strategy for the continued growth of our business includes expanding our presence beyond footwear, apparel and accessories through the selective licensing of our brands. As of December 31, 2020, we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, slippers, fragrance and beauty, sleepwear, activewear, medical scrubs, jewelry, watches, eyeglasses and sunglasses bedding and bath, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and the FREEBIRD by Steven® trademark for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +See Notes C and P to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Human Capital Resources +On February 1, 2021, we employed approximately 2,800 employees, of whom approximately 2,100 work full-time and approximately 700 work part-time. Most of our part-time employees work in the Retail segment. Approximately 1,700 of our employees are located in the United States, approximately 600 employees are located in China and Hong Kong, approximately 180 employees are located in Canada, approximately 160 employees are located in Mexico, approximately 60 employees are located in Taiwan, approximately 60 employees are located in South Africa and approximately 40 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. We have never experienced a material interruption of our operations due to a labor dispute. +Culture +Steve Madden is for the bold, expressive, and ambitious. Our core values – authenticity, initiative, tenacity, humility and trust are key to our competitive edge and are embedded throughout all levels of our Company. They motivate our growth, inspire our innovation, define our culture, and set the standard for all of our actions. +Authenticity : Show up to work as your true self +Initiative : Act upon good ideas quickly and be ready to iterate +Tenacity : Look at problems from all sides and be resourceful +Humility : Think from the perspective of others and always be open to learning +Trust : Build strong relationships with good will and integrity +Career Development +The fashion landscape is constantly shifting and evolving, which makes it especially important for us to invest in the ongoing career development of our employees. In service of this objective, we constantly seek out, promote, and improve upon internal programs and processes that make it possible for employees to reach their full potential. Some examples of this focus include our ongoing professional development relationship with the University of Arizona Global Campus, our tuition reimbursement program, our internal employee learning opportunities, and external conference and workshop offerings around specific industry content as well as leadership, coaching, and management training in general. Mentoring, timely performance evaluations and feedback are also key elements of our career development efforts at our Company. +Diversity and Inclusion +We believe that finding, employing and retaining people from all backgrounds, ethnicities, genders, lifestyles and belief systems have been the cornerstones of meeting the needs of our diverse consumer base and building a global business. By +10 +embracing a diverse and inclusive workplace, we create an environment that offers all our employees opportunities to succeed. We want all our employees to be as successful as they can be and to reach their full potential no matter who they are, where they are from or what they believe. In the spirit of this core belief, we strive to build an increasingly inclusive culture where all employees feel free to express themselves and have opportunities to grow. In 2020, we engaged in the following diversity initiatives, among others: +• we established a Diversity and Inclusion Council made up of key leaders in our Company to oversee the implementation of our detailed Diversity and Inclusion Strategic Plan; +• employees formed two employee resource groups - one for Black employees and allies called Black Sole and one for LGBTQ employees and allies called SM Pride; +• we signed the Open to All pledge with other major brands and retailers; +• we joined the Black in Fashion Council; +• we implemented Company-wide Diversity and Inclusion training; +• we joined Hive Diversity and are partnering with Historically Black Colleges and Universities to establish diverse pipelines of talent and expand our recruiting; and +• we launched Adaptive Kids footwear, soon to expand to adults. +Wellness +We see personal health and fitness of our employees as key to long-term professional success, which is why we offer benefits and programs focused on physical, emotional, and financial well-being. These include mindfulness and meditation training, financial wellness seminars, health fairs, discounted gym memberships, free flu shots, and on-site discounted food. We also offer an Employee Assistance Program with a range of programs, resources and tools that can help with myriad issues. To help manage work-life balance, we offer a paid membership to Care.com so employees can find childcare, senior care, special needs care and other related services. +COVID-19 +The health and safety of our team members is of the highest importance. Our focus on the safety of our team members is evident in our response to COVID-19 starting back in March 2020. We initially closed down all stores to ensure the safety of our customers and retail associates, and then we added working from home flexibility for our corporate positions that can be accomplished remotely. We increased cleaning protocols, implemented onsite temperature screening, upgraded our HVAC systems, provided personal protective equipment and related supplies as needed, established new spacing and schedules to maximize social distancing while at work, and have also provided regular communications regarding impacts of COVID-19, including health and safety protocols and procedures. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales occur in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales occur in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Revenue levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $310,198 and $328,600, as of February 1, 2021 and February 3, 2020, respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. +11 +ITEM 1A. RISK FACTORS +You should carefully consider the risks and uncertainties we describe below and the other information in this Annual Report on Form 10-K before deciding to invest in, sell or retain shares of our common stock. These are not the only risks and uncertainties that we face. Other sections of this report may discuss factors that could adversely affect our business. Our industry is highly competitive and subject to rapid change. There may be additional risks and uncertainties that we do not currently know about, that we currently believe are immaterial, or that we have not predicted, which may also harm our business or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, results of operations and liquidity could be materially harmed. +COVID-19 RISKS +Our ability to maintain adequate liquidity when negatively impacted by unforeseen events such as an epidemic or pandemic such as COVID-19, which may cause disruption to our business operations and temporary closure of Company-operated and wholesale partner retail stores, resulting in a significant reduction in revenue for an indeterminable period of time. +In December 2019, COVID-19 emerged and spread worldwide. The World Health Organization declared COVID-19 a pandemic in March 2020, resulting in federal, state and local governments and private entities mandating various restrictions, including the closure of non-essential businesses, travel restrictions, restrictions on public gatherings, stay-at-home orders and advisories and quarantining of people who may have been exposed to the virus. After closely monitoring and taking into consideration the guidance from federal, state and local governments, in March 2020, we temporarily closed all of our stores and our corporate offices in the U.S. and the vast majority of our stores and offices globally. As of August 2020, the vast majority of our stores and corporate offices in the U.S. and globally reopened. In the fourth quarter 2020, we had to re-close one-third of our stores, and currently almost all our stores are open again. However, there can be no assurance that our stores or offices will continue to remain open if there is a subsequent surge in COVID-19 cases or national or local governments institute lock-down or other restrictive measures where we manufacture or sell our products. These and other similar factors have had and may continue to have a material adverse impact on our business, results of operations, financial position and cash flow. +INDUSTRY RISKS +The fashion footwear, accessories and apparel industry is subject to rapid changes in consumer preferences. If we do not accurately anticipate fashion trends and promptly respond to consumer demand, we could lose sales, our relationships with customers could be harmed and our brand loyalty could be diminished. +The strength of our brands and our success depends in significant part upon our ability to anticipate and promptly respond to product and fashion trends as well as to anticipate, gauge and react to changing consumer demands in a timely manner. There can be no assurance that our products will correspond to the changes in taste and demand or that we will be able to successfully advertise and market products that respond to trends and customer preferences. If we misjudge the market for our products, we may be faced with significant excess inventories for some products and missed opportunities as to others. In addition, misjudgments in merchandise selection could adversely affect our image with our customers resulting in lower sales and increased markdown allowances for customers, which could have a material adverse effect on our business, financial condition, results of operations and liquidity. +We face intense competition from both established companies and newer entrants into the market. Our failure to compete effectively could cause our market share to decline, which could harm our reputation and have a material adverse impact on our financial condition, results of operations and liquidity. +The fashion footwear, accessories and apparel industry is highly competitive and barriers to entry are low. Our competitors include specialty companies as well as companies with diversified product lines. Market growth in the sales of fashion footwear, accessories and apparel has encouraged the entry of many new competitors and increased competition from established companies. Many of these competitors, including Aldo, Sam Edelman, Jessica Simpson, Lucky Brand and Vince Camuto, may have significantly greater financial and other resources than we do, and there can be no assurance that we will be able to compete successfully with these and other fashion footwear, accessories and apparel companies. Increased competition could result in pricing pressures, increased marketing expenditures and loss of market share and could have a material adverse effect on our business, financial condition, results of operations and liquidity. +12 +If we and the retailers that are our customers are unable to adapt to recent and anticipated changes in the retail industry, the sales of our products may decline, which could have a material adverse effect on our financial condition, results of operations and liquidity. +In recent years, the retail industry has experienced consolidation and other ownership changes. In the future, retailers in the United States and in foreign markets may further consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our or our licensees’ products or increase the ownership concentration within the retail industry. Changing shopping patterns, including the rapid expansion of online retail shopping and the effect of the COVID-19 pandemic, have adversely affected customer traffic in mall and outlet centers, particularly in North America. We expect competition in the e-commerce market will intensify. As a greater portion of consumer expenditures with retailers occurs online and through mobile commerce applications, our brick-and-mortar retail customers who fail to successfully integrate their physical retail stores and digital retail may experience financial difficulties, including store closures, bankruptcies or liquidations. A continuation or worsening of these trends could cause financial difficulties for one or more of our major customers, which, in turn, could substantially increase our credit risk and have a material adverse effect on our results of operations, financial condition and cash flows. We have little or no control over how our customers will respond to the challenges posed by these changes in the retail industry. Our success will be determined, in part, on our and our customers’ ability to manage the impact of the rapidly changing retail environment and identify and capitalize on retail trends, including technology, e-commerce and other process efficiencies that will better service our customers. If we and our customers fail to compete successfully, our businesses, market share, results of operations and financial condition could be materially and adversely affected. While such changes in the retail industry themselves to date have not had a material adverse effect on our business or financial condition, results of operations and liquidity, there can be no assurance as to the future effect of any such changes. +RISKS RELATING TO OUR COMPANY +The loss of Steve Madden, our founder and Creative and Design Chief, or members of our executive management team could have a material adverse effect on our business. +The growth and success of our Company since its inception more than a quarter century ago is attributable, to a significant degree, to the talents, skills and efforts of our founder and Creative and Design Chief, Steven Madden. An extended or permanent loss of the services of Mr. Madden could severely disrupt our business and have a material adverse effect on our Company. We also depend on the contributions of the members of our senior management team. Our senior executives have substantial experience and expertise in our business and industry and have made significant contributions to our growth and success. Competition for executive talent in the fashion footwear, accessories and apparel industries is intense. While our employment agreements with Mr. Madden and most of our senior executives include a non-compete provision in the event of the termination of employment, the non-compete periods are of limited duration and scope. Although we believe we have depth within our senior management team, if we were to lose the services of Mr. Madden or any of our senior executives, and especially if any of these individuals were to join a competitor or form a competing company, our business and financial performance could be seriously harmed. A loss of the skills, industry knowledge, contacts and expertise of Mr. Madden or any of our senior executives could cause a setback to our operating plan and strategy. +If we are not successful in implementing our growth strategy or integrating acquired businesses, we may not be able to take advantage of certain market opportunities and may become less competitive . +Our business has grown organically and as a result of business acquisitions. In order to gain from our acquisitions, we must be effective in integrating the businesses acquired into our overall operations. Further, the expansion of our operations has increased and will continue to increase the demand on our managerial, operational and administrative resources. In recent years, we have invested significant resources in, among other things, our management information systems and hiring and training of new personnel. However, in order to manage currently anticipated levels of future demand, we may be required to, among other things, expand our distribution facilities, establish relationships with new manufacturers to produce our products and continue to expand and improve our financial, management and operating systems. We may experience difficulty integrating acquired businesses into our operations and may not achieve anticipated synergies from such integration. There can be no assurance that we will be able to manage future growth effectively and a failure to do so could have a material adverse effect on our business, financial condition, results of operations and liquidity. +13 +If one or more of our significant customers were to reduce or stop purchases of our products, our sales and profits could decline. +The retailers that are our customers consist principally of better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, and pure-play e-commerce retailers. Certain of our department store customers, including some under common ownership, account for significant portions of our wholesale business. We generally enter into a number of purchase order commitments with our customers for each of our lines every season and do not enter into long-term agreements with any of our customers. Therefore, a decision by a significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to decrease the amount of merchandise purchased from us or to change its manner of doing business could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Our financial results are subject to quarterly fluctuations . +Our results of operations may fluctuate from quarter to quarter and are affected by a variety of factors, including: +• the timing of larger shipments of products; +• market acceptance of our products; +• the mix, pricing and presentation of the products offered and sold; +• the hiring and training of additional personnel; +• inventory write downs for obsolescence; +• the cost of materials; +• the product mix between wholesale, retail and licensing businesses; +• the incurrence of other operating costs; +• factors beyond our control, such as general economic conditions, declines in consumer confidence and actions of competitors; +• the timing of holidays; and +• weather conditions. +In addition, we expect that our sales and operating results may be significantly impacted by the opening of new retail stores and the introduction of new products. Accordingly, the results of operations in any quarter will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter. +Extreme or unseasonable weather conditions in locations where we or our customers and suppliers are located could adversely affect our business. +Our corporate headquarters and principal operational locations, including retail, distribution and warehousing facilities, may be subject to natural disasters and other severe weather and geological events that could disrupt our operations. The occurrence of such natural events may result in sudden disruptions in business conditions of the local economies affected, as well as of the regional and global economies. Such disruptions may result in decreased demand for our products and disruptions in our management functions, sales channels and manufacturing and distribution networks, which could have a material adverse effect on our business, financial condition and results of operations. Extreme weather events and changes in weather patterns can also influence customer trends and shopping habits. Extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season may diminish demand for our seasonal merchandise. Heavy snowfall, hurricanes or other severe weather events where our retail stores and the retail stores of our wholesale customers are located may decrease customer traffic in those stores and reduce our sales and profitability. If severe weather events force closure of or disrupt operations at the distribution centers we use for our merchandise, we could incur higher costs and experience longer lead times to distribute our products to our retail stores, wholesale customers or e-commerce customers. If prolonged, such extreme or unseasonable weather conditions could adversely affect our business, financial condition and results of operations. +We extend credit to most of our customers in the United States, and their failure to pay for products shipped to them could adversely affect our financial results. +We sell our products primarily to retail stores across the United States and extend credit based on an evaluation of each customer's financial condition, usually without collateral. Various retailers, including some of our customers, have experienced financial difficulties, which has increased the risk of extending credit to such retailers. Even though we seek to mitigate the risks of extending credit by factoring most of our accounts receivable and obtaining letters of credit for others, if any of our customers were to experience a shortage of liquidity, the risk that the customer's outstanding payables to us would not be paid +14 +could cause us to curtail business with the customer or require us to assume more credit risk relating to the customer's accounts payable. +Our stock price may fluctuate substantially if our operating results are inconsistent with our forecasts or those of analysts who follow us. +The trading price of our common stock periodically may rise or fall based on the accuracy of forecasts of our future performance. One of our primary business objectives is to maximize the long-term strength, growth and profitability of our Company, rather than to achieve an earnings target in any particular fiscal quarter. We believe that this longer-term goal is in our best interests and those of our stockholders. Although we have temporarily suspended offering guidance as to our quarterly and annual forecast of net sales and earnings, we recognize that it may be helpful to our stockholders and potential investors to provide such guidance in the future. In that case, we will endeavor to provide meaningful and considered guidance at the time it is provided and generally expect to provide updates to our guidance when we report our quarterly results. However, our actual results may differ from our forecasts as the guidance is based on assumptions and expectations that may or may not come to pass. As such, we assume no responsibility to update any of our forward-looking statements at such times or otherwise. If and when we announce actual results that differ from those that we have forecast, the market price of our common stock could be adversely affected. Investors who rely on these forecasts in making investment decisions with respect to our common stock do so at their own risk. We take no responsibility for any losses suffered as a result of such changes in the price of our common stock. +In addition, outside securities analysts may follow our financial results and issue reports that discuss our historical financial results and their predictions of our future performance. These analysts' predictions are based upon their own opinions and are often different from our own forecasts. Our stock price could decline if our results are below the estimates or expectations of these outside analysts. +FOREIGN SOURCING RISKS +Disruptions to our product delivery systems and failure to effectively manage inventory based on business trends across various distribution channels could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Most of our products for U.S. distribution are shipped to us via ocean freight carriers to ports primarily in California, and to a lesser extent in New Jersey and Texas. The trend-focused nature of the fashion industry and the rapid changes in customer preferences leave us vulnerable to the risk of inventory obsolescence. Our reliance upon ocean freight transportation for the delivery of our inventory exposes us to various inherent risks, including port workers’ union disputes and associated strikes, work slow-downs and stoppages, severe weather conditions, natural disasters, and terrorism, any of which could result in delivery delays and inefficiencies, increase our costs and disrupt our business. Any severe and prolonged disruption to ocean freight transportation could force us to use alternate and more expensive transportation systems. Efficient and timely inventory deliveries and proper inventory management are important factors in our operations. Inventory shortages can adversely affect the timing of shipments to customers and diminish sales and brand loyalty. Conversely, excess inventories can result in lower gross margins due to the excessive discounts and markdowns that may be necessary to reduce high inventory levels. Severe and extended delays in the delivery of our inventory or our inability to effectively manage our inventory could have a material adverse effect on our business, financial condition, results of operations and liquidity. +Our foreign manufacturers’ inability to produce our goods in a timely manner or to meet our quality standards could adversely affect our financial results and harm our brands’ reputation. +We do not own or operate any foreign manufacturing facilities and, therefore, are dependent upon third parties to manufacture most of our products. The risks inherent in reliance on foreign manufacturing include work stoppages, transportation delays, public health emergencies, social unrest, changes in local economic conditions, and political upheavals. During 2020, 78% of our total purchases were from China. In the first quarter of 2020, China experienced a public health emergency due to the spread of COVID-19, and manufacturing facilities that produce our products were initially shut down and then resumed at limited capacity. Subsequently, COVID-19 became a world-wide pandemic, affecting all of our foreign manufacturing facilities. Due to a resurgence of the COVID-19 virus, some of those facilities have shut down entirely and others are operating at limited capacity. We cannot accurately predict when and whether those manufacturers will return to full capacity or the extent to which the COVID-19 pandemic will have short- or long-term adverse effects on the ability of manufacturers in China and other countries to produce our products. The inability of Chinese or other manufacturers to ship orders of our products in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers for those items. Such failures could result in the cancellation of orders, customers’ refusal to accept deliveries, +15 +a reduction in purchase prices, and ultimately, termination of a customer relationship, any of which could have a material adverse effect on our business, financial condition, results of operations and liquidity. In that case, we may be required to seek alternative sources of materials or products. Although we believe that we can manage our exposure to these risks, we cannot be certain that we will be able to identify such alternative materials or sources without delay or without greater cost to us. Our inability to identify and secure alternative sources of supply in this situation could have a material adverse effect on our ability to satisfy customer orders. +Changes in trade policies and tariffs imposed by the United States government and the governments of other nations could have a material adverse effect on our business and results of operations. +Our operations are dependent upon products purchased, manufactured and sold internationally. Our sources of supply are subject to the usual risks of doing business abroad, such as the implementation of, or potential changes in, foreign and domestic trade policies, increases in import duties, anti-dumping measures, quotas, safeguard measures, trade restrictions, restrictions on the transfer of funds and, in certain parts of the world, political instability and terrorism. In 2018 and 2019, the United States government imposed significant tariffs and created the potential for significant additional changes in trade policies, including tariffs and government regulations affecting trade between the United States and countries where we purchase, manufacture and sell our products. These trends are affecting many global manufacturing and service sectors, including the footwear, accessories and apparel industries, and may cause us to face trade protectionism in many different regions of the world. These protectionist measures could result in increases in the cost of our products and adversely affect our sales and profitability. +Effective September 24, 2018, the United States government imposed additional tariffs on approximately $200 billion of goods imported from China. The additional tariffs on Chinese imports were initially set at a level of 10% and were increased to 25% in May 2019. This initial round of tariffs applied to handbags and certain other accessories that we produce. In August 2019, the United States government announced a second round of tariffs set at a level of 15% on approximately $300 billion of goods imported from China, including footwear, apparel and certain other accessories that we produce. The second round of tariffs became effective on September 1, 2019, for a portion of the covered products that we produce. Tariffs for the remaining covered products that we produce were scheduled to become effective on December 15, 2019, but were suspended indefinitely as part of the phase I trade agreement between the United States and China that was signed on January 15, 2020. In addition, as of February 14, 2020, the 15% tariff that was implemented on September 1, 2019 was reduced to 7.5%. China has already imposed retaliatory tariffs on a wide range of American products in response to these tariffs. Most of the products that we sell in the United States have been manufactured in China. The negative impact in gross margin in our wholesale business in the fourth quarter of 2018 and throughout 2019 was due, in part, to the impact of the 25% tariff on handbags and certain other accessory categories as well as the 15% tariff on footwear, apparel, and other accessory categories. Our efforts to mitigate the impact of these tariffs may not be successful, and the continued imposition of tariffs on products that we import from China could have a material adverse effect on our business and results of operations. +On December 31, 2020, the Generalized System of Preferences ("GSP") expired. GSP is a trade program that provides nonreciprocal, duty-free treatment for certain U.S. imports (including handbags) from qualifying developing countries including Cambodia, Myanmar, Thailand, Indonesia, Sri Lanka, the Philippines, and Pakistan, among others. We currently manufacture handbags in GSP countries, primarily Cambodia. The additional tariff to be paid on such products ranges from 3.3% to 17.6%. GSP has historically been renewed, despite lapsing several times, and upon renewal has been retroactive in nature. There is a current debate in Congress as to whether reauthorize the program “as is” or revise GSP eligibility criteria to include environmental and labor conditions. If GSP is not renewed and our efforts to mitigate the impact of this additional tariff are not successful, the imposition of tariffs on handbags that we manufacture in related countries could have a material adverse effect on our business and results of operations. +If our manufacturers, the manufacturers used by our licensees or our licensees themselves fail to use acceptable labor practices or to otherwise comply with local laws and other standards, our business could suffer. +Our products are manufactured by numerous independent manufacturers outside of the United States. We also have license agreements that permit our licensees to manufacture or contract to manufacture products using our trademarks. We impose, and require our licensees to impose, on these manufacturers environmental, health and safety standards for the benefit of their labor force. In addition, we require these manufacturers to comply with applicable standards for product safety. However, we do not control our independent manufacturers or licensing partners or their labor, product safety and other business practices. From time to time, our independent manufacturers may not comply with such standards or applicable local law or our licensees may not require their manufacturers to comply with such standards or applicable local law. The violation of such standards and laws by one of our independent manufacturers or by one of our licensing partners, or the divergence of a manufacturer's or a licensing partner's labor practices from those generally accepted as ethical in the United States, could harm our reputation, result in a product recall or require us to curtail our relationship with and locate a replacement for such +16 +manufacturer. We could also be the focus of adverse publicity and our reputation could be damaged. Any of these events could have a material adverse effect on our business, financial condition, results of operations and liquidity. +GLOBAL BUSINESS RISKS +Our global operations expose us to a variety of legal, regulatory, political and economic risks that may adversely impact our results of operations in certain regions. +As a result of our international operations, we are subject to risks associated with our operations in international markets as a result of a number of factors, many of which are beyond our control. These risks include, among other things: +• the challenge of managing broadly dispersed foreign operations; +• inflationary pressures and economic changes or volatility in foreign economies; +• the burdens of complying with the laws and regulations of both U.S. and foreign jurisdictions; +• additional or increased customs duties, tariffs, taxes and other charges on imports or exports; +• political corruption or instability; +• geopolitical regional conflicts, terrorist activity, political unrest, civil strife and acts of war; +• local business practices that do not conform to U.S. legal or ethical guidelines; +• anti-American sentiment in foreign countries in which we operate; +• delays in receipts of our products at our distribution centers due to labor unrest, increasing security requirements or other factors at U.S. or foreign ports; +• significant fluctuations in the value of the dollar against foreign currencies; +• increased difficulty in protecting our intellectual property in foreign jurisdictions; +• restrictions on the transfer of funds between the U.S. and foreign nations; and +• natural disasters or health epidemics in areas in which our businesses, customers, suppliers and licensees are located. +All of these factors could disrupt our operations or limit the countries in which we sell or source our products, significantly increase the cost of operating in or obtaining materials originating from certain countries, result in decreased revenues, and materially and adversely affect our product sales, financial condition and results of operations. +We are subject to the U.S. Foreign Corrupt Practices Act, which prohibits the payment of bribes to foreign officials to assist in obtaining or retaining business. We are also subject to anti-corruption laws of the foreign countries in which we operate. Although we have implemented policies and procedures that are designed to promote compliance with such laws, our employees, contractors and agents may take actions that violate our policies and procedures. Any such violation could result in sanctions or other penalties against us and have an adverse effect on our business, reputation and operating results. +Our business is exposed to foreign exchange rate fluctuations. +We make most of our purchases in U.S. dollars. However, we source substantially all of our products overseas, and as such, the cost of these products may be affected by changes in the value of the relevant currencies against the U.S. dollar. Changes in currency exchange rates may also affect the relative prices at which we and our foreign competitors sell products in the same market. We use forward foreign exchange contracts to hedge material exposure to adverse changes in foreign exchange rates. However, no hedging strategy can completely insulate us from foreign exchange risk. We are also exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our financial statements due to the translation of operating results and financial position of our foreign subsidiaries. There can be no assurance that foreign currency fluctuations will not have a material adverse effect on our business, financial condition, results of operations and liquidity. +17 +We may be subject to additional tax liabilities as a result of audits by various taxing authorities. +We are subject to the tax laws and regulations of numerous jurisdictions as a result of our international operations. These tax laws and regulations are highly complex and significant judgment and specialized expertise is required in evaluating and estimating our worldwide provision for income taxes. We are subject to audit by the taxing authorities in each jurisdiction where we conduct our business and any one of these jurisdictions may assess additional taxes against us as a result of an audit. The final determination with respect to any tax audits, and any related litigation, could be different from our estimates or from our historical tax provisions and accruals. The outcome of any audit or audit-related litigation could have a material adverse effect on our operating results or cash flows in the periods for which that determination is made and may require a restatement of prior financial reports. In addition, future period earnings may be adversely impacted by litigation costs, settlement payments or interest or penalty assessments. +INFORMATION TECHNOLOGY RISKS +Disruption of our information technology systems and websites could adversely affect our financial results and our business reputation. +We are heavily dependent upon our information technology systems to record and process transactions and manage and operate all aspects of our business. We also have e-commerce websites for direct retail sales. +Given the nature of our business and the significant number of transactions in which we engage annually, it is essential that we maintain constant operation of our information technology systems and websites and that they operate effectively. We depend on our in-house information technology employees and third parties, including “cloud” service providers, to maintain and periodically update and upgrade our systems and websites to support the growth of our business. We also maintain an off-site server data facility that records and processes information regarding our vendors and customers and their transactions with us. Our internal cybersecurity controls and systems are audited on an annual basis to ensure they are working effectively. External security testing is also conducted annually on our stores, corporate locations and e-commerce sites. Issues noted during audit or testing are remediated and subsequently retested to ensure proper closure. We are also audited both internally and externally to maintain compliance with the Sarbanes-Oxley Act, PCI-DSS, GDPR and CCPA. In addition, security training is conducted annually for our employees via a recognized market leading platform for Security Awareness and Training Solutions. Email Phishing campaigns are also conducted via this platform by the Information Security team throughout the year. A cyber security awareness campaign is launched each October in conjunction with Cyber Security Awareness Month. Despite our preventative efforts, our information technology systems and websites may, from time to time, be vulnerable to damage or interruption from events such as computer viruses, security breaches, power outages and difficulties in replacing or integrating the systems of acquired businesses. Any such problems or interruptions could result in loss of valuable business data, our customers' or employees' personal information, disruption of our operations and other adverse impacts to our business and require significant expenditures by us to remediate any such failure, problem or breach. In addition, we must comply with increasingly complex regulatory standards enacted to protect business and personal data and an inability to maintain compliance with these regulatory standards could subject us to legal risks and penalties. Although we maintain insurance coverage aimed at addressing certain of these risks, there can be no assurance that insurance coverage will be available or that the amounts of coverage will be adequate to cover a specific loss. +Our business and reputation could be adversely affected if our computer systems or the systems of our business partners or service providers, become subject to a data security or privacy breach or other disruption from a third party. +In addition to our own confidential and proprietary business information, a routine part of our business includes the gathering, processing and retention of sensitive and confidential information pertaining to our customers, employees and others. We, our business partners or our service providers may not have the resources or technical sophistication to anticipate or prevent the rapidly evolving and complex cyber-attacks being unleashed by increasingly sophisticated hackers and data thieves. As a result, our facilities and information technology systems, as well as those of our business partners and third-party service providers, may be vulnerable to cyber-attacks and breaches, acts of vandalism, ransomware, software viruses and other similar types of malicious activities. Any actual or threatened cyber-attack may cause us to incur unanticipated costs, including costs related to the hiring of additional computer experts, business interruption, engaging third-party cyber security consultants and upgrading our information security technologies. As a result of recent security breaches at a number of prominent companies, the media and public scrutiny of information security and privacy has become more intense and the regulatory environment has become more uncertain. Any compromise or breach of our information technology systems or those of our business partners or service providers that results in the misappropriation, loss or other unauthorized disclosure of a customer’s or other person’s private, confidential or proprietary information could result in: +18 +• a loss of confidence in us by our customers and business partners; +• violate applicable privacy and other laws; +• expose us to litigation and significant potential liability; or +• require us to expend significant resources to remedy any such breach and redress any damages cause by such a breach. +We must also comply with increasingly rigorous regulatory standards for the protection of business and personal data enacted in the U.S., Europe and elsewhere. For example, the European Union’s General Data Protection Regulation (the “GDPR”) became effective on May 25, 2018. The GDPR imposes additional obligations on companies concerning the handling of personal data and provides certain individual privacy rights to persons whose data is stored. Our compliance with existing, proposed and recently enacted laws (including implementation of the privacy and process enhancements required by the GDPR) and regulations can be costly. Any failure by us to comply with these regulatory standards could subject us to significant legal and reputational harm. +INTELLECTUAL PROPERTY RISKS +Failure to adequately protect our trademarks and intellectual property rights, to prevent counterfeiting of our products or to defend claims against us related to our trademarks and intellectual property rights could reduce sales and adversely affect the value of our brands. +We believe that our trademarks and other proprietary rights are of major significance to our success and our competitive position, and we consider some of our trademarks, such as Steve Madden®, to be integral to our business and among our most valuable assets. Accordingly, we devote substantial resources to the establishment and protection of our trademarks on a worldwide basis. Nevertheless, policing unauthorized use of our intellectual property is difficult, expensive and time consuming. There can be no assurance that the actions we take to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products on the basis that our products violate the trademarks or other proprietary rights of others. Moreover, no assurance can be given that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve such conflicts. We could incur substantial costs in legal actions relating to our use of intellectual property or the use of our intellectual property by others. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Our failure to establish and protect such proprietary rights from unlawful and improper use could have a material adverse effect on our business, financial condition, results of operations and liquidity. +A portion of our revenue is dependent on licensing our trademarks. The actions of our licensees or the loss of a significant licensee could diminish our brand integrity and adversely affect our revenue and results of operations. +We license to others the rights to produce and market certain products that are sold under our trademarks. Although we retain significant control over our licensees’ products and advertising, we rely on our licensees for operational and financial control over their businesses. If the quality, image or distribution of our licensed products diminish, customer acceptance of and demand for our brands and products could decline. This could materially and adversely affect our business and results of operations. In fiscal year 2020, approximately 90% of our net royalties were derived from our top five licensed product lines. A decrease in customer demand for any of these product lines could have a material adverse effect on our results of operations and financial condition. Furthermore, if we are unable to engage an adequate replacement for a terminated licensee or to engage such a replacement for an extended period, our revenues and results of operations could be adversely affected. +GENERAL RISK FACTORS +Changes in economic conditions may adversely affect our financial condition, results of operations and liquidity. +Our opportunities for long-term growth and profitability are accompanied by significant challenges and risks, particularly in the near term. Specifically, our business is dependent on consumer demand for our products and the purchase of our products by consumers is largely discretionary. Consumer confidence and discretionary spending could be adversely affected in response to financial market volatility, negative financial news, conditions in the real estate and mortgage markets, declines in income or asset values, changes to fuel and other energy costs, labor and healthcare costs, food costs and other economic factors. A downturn in economic conditions leading to a reduction in consumer confidence and discretionary spending could have a negative effect on our sales and results of operations during the year ending December 31, 2021 and thereafter. +19 +Litigation or other legal proceedings could divert management resources and result in costs that adversely affect our operating results from quarter to quarter. +We are involved in various claims, litigations and other legal and regulatory proceedings and governmental investigations that arise from time to time in the ordinary course of our business. Due to the inherent uncertainties of litigation and such other proceedings and investigations, we cannot predict with accuracy the ultimate outcome of any such matters. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations, and the amount of insurance coverage we maintain to address such matters may be inadequate to cover those claims. In addition, any significant litigation, investigation or proceeding, regardless of its merits, could divert financial and management resources that would otherwise be used to benefit our operations. See Item 3 “Legal Proceedings,” below for additional information regarding legal proceedings in which we are involved. +Changes in tax laws could have an adverse effect upon our financial results. +We are subject to income taxation in various jurisdictions in the United States and numerous foreign jurisdictions. Tax laws and regulations, or their interpretation and application, in any jurisdiction are subject to significant changes. Legislation or other changes in the tax laws of the jurisdictions where we do business could increase our tax liability and adversely affect our after-tax profitability. Adjustments to the incremental provisional tax expense may be made in future periods as actual amounts may differ due to, among other factors, a change in interpretation of the U.S. tax code and related tax accounting guidance, changes in assumptions made in developing these estimates, regulatory guidance that may be issued with respect to the applicable revisions to the U.S. tax code and state tax implications. +Other jurisdictions are contemplating changes or have unpredictable enforcement activity. Increases in applicable tax rates, implementation of new taxes, changes in applicable tax laws and interpretations of these tax laws and actions by tax authorities in jurisdictions in which we operate could reduce our after-tax income and have an adverse effect on our results of operations. +SEC rules relating to “conflict minerals” require us to incur additional expenses and could adversely affect our business. +The SEC has promulgated final rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring the disclosure of the use of tantalum, tin, tungsten and gold, known as “conflict minerals,” included in products either manufactured by public companies or as to which public companies have contracted for the manufacture. These rules, adopted in an effort to prevent inadvertent support of armed conflict in the Democratic Republic of Congo and certain adjoining countries (collectively, the “DRC”), require companies to investigate their supply chains to determine whether these minerals are present in their products and, if so, from where the minerals originate. The rules also require disclosure and annual reporting as to whether or not conflict minerals, if used in the manufacture of the products offered, originate from the DRC. We currently require our manufacturers to comply with policies addressing legal and ethical concerns relating to labor, employment, political and social matters, including restrictions on the use of conflict minerals. Violation of these policies by our manufacturers could harm our reputation, disrupt our supply chain or increase our cost of goods sold. Additionally, violation of any of these policies by our manufacturers could cause us to face disqualification as a supplier for our customers and suffer reputational challenges. Due to the complexity of our supply chain, compliance with the rules requires significant efforts from a cross-operational team and diverts our management and personnel and results in potential costs of additional staff. Any of the foregoing could adversely affect our sales, net earnings, business and financial condition and results of operations. +Any failure to maintain effective internal control over our financial reporting could materially adversely affect us. +Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include in our annual reports on Form 10-K an assessment by management of the effectiveness of our internal control over financial reporting. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002. Our compliance with Section 404 may require us to incur substantial accounting expense and expend significant management efforts. Our failure to maintain effective internal controls could result in a determination by our auditors that a material weakness or significant deficiency exists in our internal controls. Such a determination could result in a loss of investor confidence in the reliability of our financial statements and could require +20 +us to restate our quarterly or annual financial statements. These factors could, in turn, negatively affect the price of our common stock. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +We lease space for our headquarters, our retail stores, showrooms and office facilities in various locations in the United States, as well as overseas. We own one improved real property parcel in Long Island City, New York. We believe that our existing facilities are in good operating condition and are adequate for our present level of operations. The following table sets forth information with respect to our key properties: +Location Leased/Owned Primary Use Approximate Area Square Feet +Dongguan, China Leased Offices and sample production 154,900 +Long Island City, NY Leased Executive offices 111,000 +Montreal, Canada Leased Offices, warehouse 105,800 +Bellevue, WA Leased Offices, Topline 41,500 +New York, NY Leased Offices and showroom, Accessories 27,200 +New York, NY Leased Showroom 21,800 +New York, NY Leased Offices and showroom, Schwartz & Benjamin 20,500 +Costa Mesa, CA Leased Offices, BB Dakota 10,500 +New York, NY Leased Offices and showroom 10,000 +Putian City, China Leased Offices 8,700 +Long Island City, NY Leased Storage 7,200 +León, Mexico Leased Offices 6,400 +Mexico City, Mexico Leased Offices, SM Mexico 5,700 +Kowloon, Hong Kong Leased Offices 4,800 +Los Angeles, CA Leased Offices, BB Dakota 4,800 +Brooklyn, NY Leased Offices, GREATS 3,800 +Miami Gardens, FL Leased Storage 3,600 +Los Angeles, CA Leased Showroom, Steven 2,700 +Seattle, WA Leased Showroom and offices, Topline 2,400 +Long Island City, NY Owned Other 2,200 +Shanghai, China Leased Showroom 1,700 +Mississauga, Canada Leased Showroom 1,000 +Dallas, TX Leased Showroom 1,000 +21 +All of our retail stores are leased pursuant to leases that, under their original terms, extend for an average of ten years. Many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes over the base year. The current terms of our retail store leases expire as follows: +Year Number of Stores +2021 31 +2022 56 +2023 36 +2024 21 +2025 26 +2026 23 +2027 9 +2028 6 +2029 5 +2030 2 +ITEM 3. LEGAL PROCEEDINGS +In the ordinary course of business, we have various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on our financial condition, results of operations or liquidity. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +($ in thousands, except share and per share data) +Market Information. Our shares of common stock have traded on the NASDAQ Global Select Market since August 1, 2007 under the trading symbol SHOO and were traded on the NASDAQ National Market prior to that date. The following table sets forth the range of high and low closing sales prices for our common stock during each fiscal quarter during the two-year period ended December 31, 2020 as reported by the NASDAQ Global Select Market. The trading volume of our securities fluctuates and may be limited during certain periods. As a result, the liquidity of an investment in our securities may be adversely affected. +Common Stock +2020 High Low 2019 High Low +Quarter ended +March 31, 2020 $43.47 $16.38 Quarter ended +March 31, 2019 $35.38 $29.71 +Quarter ended +June 30, 2020 $30.00 $17.83 Quarter ended +June 30, 2019 $36.87 $29.43 +Quarter ended +September 30, 2020 $25.13 $18.47 Quarter ended +September 30, 2019 $36.82 $28.85 +Quarter ended +December 31, 2020 $36.05 $19.24 Quarter ended +December 31, 2019 $44.80 $33.20 +22 +Holders. As of February 25, 2021, there were 156 holders of record and approximately 23,000 beneficial owners of our common stock. +Dividends. Beginning in the first quarter of 2018, we began paying a quarterly cash dividend on our outstanding shares of common stock. At the end of March 2020, in response to the COVID-19 pandemic, as a precautionary measure our Board of Directors temporarily suspended the payment of dividends. In February 2021, our Board of Directors declared a quarterly dividend of $0.15 per share payable on March 26, 2021 to stockholders of record on March 16, 2021. The payment of future dividends will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, our financial condition, capital requirements, general business conditions and other factors. Therefore, we can give no assurance that cash dividends of any kind will be paid to holders of our common stock in the future. +Equity Compensation Plans . Information regarding our equity compensation plans as of December 31, 2020 is disclosed in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” +Issuer Repurchases of Equity Securities. Our Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase of our common stock. Most recently, on April 24, 2019, the Board of Directors approved the extension of our Share Repurchase Program for up to $200,000 in repurchases of our common stock, which included the amount remaining under the prior authorization. The Share Repurchase Program permits us to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in our best interest. In the middle of March 2020, in response to the COVID-19 pandemic, as a precautionary measure the Board of Directors temporarily suspended the repurchase of our common stock, which the Board of Directors reinstated on February 24, 2021. During the twelve months ended December 31, 2020, we repurchased an aggregate of 769,526 shares of our common stock under the Share Repurchase Program, at a weighted average price per share of $32.97, for an aggregate purchase price of approximately $25,369, which includes the amount remaining under the prior authorization. As of December 31, 2020, approximately $111,590 remained available for future repurchases under the Share Repurchase Program. The following table presents the total number of shares of our common stock, $.0001 par value, purchased by us in the three months ended December 31, 2020, the average price paid per share and the approximate dollar value of the shares that still could have been purchased at the end of the fiscal period pursuant to our Share Repurchase Program. See also Note L to the Consolidated Financial Statements. During the three months ended December 31, 2020, there were no sales by us of unregistered shares of common stock. +Period +Total Number of Shares Purchased (1) +Average Price Paid per Share (1) +Maximum Dollar Amount of Shares that May Yet Be Purchased Under the Plans or Programs +10/1/2020 - 10/31/2020 2,505 $ 20.05 $ 111,590 +11/1/2020 - 11/30/2020 5,350 27.54 111,590 +12/1/2020 - 12/31/2020 479,809 34.57 111,590 +Total 487,664 $ 34.42 +(1) The Steven Madden, Ltd. 2019 Incentive Compensation Plan and its predecessor plan, the Steven Madden, Ltd. Amended and Restated 2006 Stock Incentive Plan, each provide us with the right to deduct or withhold, or require employees to remit to us, an amount sufficient to satisfy all or part of the tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, participants may elect to satisfy all or part of such withholding obligations by tendering to us previously owned shares or by having us withhold shares having a fair market value equal to the minimum statutory tax-withholding rate that could be imposed on the transaction. Included in this table are shares withheld during the fourth quarter of 2020 in connection with the settlement of vested restricted stock to satisfy tax-withholding requirements with an aggregate purchase price of approximately $16,786. +23 +Performance Graph . The following graph compares the yearly percentage change in the cumulative total stockholder return on our common stock during the period beginning on December 31, 2015, and ending on December 31, 2020, with the cumulative total return on the Russell 2000 Index and a peer group index. In 2016, we decided to remove the S&P 500 Footwear Index and replace it with a peer group index of companies we believe are engaged in similar businesses, because we believe the composition of the new peer group is more representative of our current business. The peer group index consists of six companies: Caleres, Inc., Crocs, Inc., Deckers Outdoor Corporation, Genesco Inc., Skechers U.S.A., Inc. and Wolverine World Wide, Inc. +The comparison assumes that $100 was invested on December 31, 2015 in our common stock and in the foregoing indices and assumes the reinvestment of dividends. +12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019 12/31/2020 +Steven Madden, Ltd. $ 100.00 $ 118.30 $ 154.53 $ 152.69 $ 220.54 $ 182.35 +Russell 2000 Index $ 100.00 $ 121.31 $ 139.08 $ 123.76 $ 155.35 $ 186.36 +Peer Group $ 100.00 $ 101.06 $ 135.37 $ 136.77 $ 190.82 $ 220.39 +24 +ITEM 6. SELECTED FINANCIAL DATA +($ in thousands, except share and per share data) +The following selected financial data has been derived from our audited consolidated financial statements. The Income Statement data relating to 2020, 2019 and 2018, and the Balance Sheet data as of December 31, 2020 and 2019 should be read in conjunction with the information provided in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” and the notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. +INCOME STATEMENT DATA +Year Ended December 31, +2020 2019 2018 2017 2016 +Net sales $ 1,188,943 $ 1,768,135 $ 1,653,609 $ 1,546,098 $ 1,399,551 +Commission and licensing fee income 12,871 19,022 24,125 20,985 20,301 +Total revenue 1,201,814 1,787,157 1,677,734 1,567,083 1,419,852 +Cost of sales (exclusive of depreciation and amortization) 737,273 1,101,140 1,037,571 968,357 877,568 +Gross profit 464,541 686,017 640,163 598,726 542,284 +Operating expenses 414,978 503,270 466,781 427,942 373,108 +Impairment charges 44,273 4,050 — 1,000 — +Impairment of lease right-of-use asset and store fixed assets 36,895 1,883 — — — +(Loss)/income from operations (31,605) 176,814 173,382 169,784 169,176 +Interest and other income - net 1,620 4,412 3,958 2,543 1,824 +(Loss)/income before provision for income taxes (29,985) 181,226 177,340 172,327 171,000 +(Benefit)/provision for income taxes (11,704) 39,504 46,841 53,189 49,726 +Net (loss)/income (18,281) 141,722 130,499 119,138 121,274 +Less: net income attributable to non-controlling interests 116 411 1,363 1,190 363 +Net (loss)/income attributable to Steven Madden, Ltd. $ (18,397) $ 141,311 $ 129,136 $ 117,948 $ 120,911 +Basic net (loss)/income per share $ (0.23) $ 1.78 $ 1.58 $ 1.43 $ 1.41 +Diluted net (loss)/income per share $ (0.23) $ 1.69 $ 1.50 $ 1.36 $ 1.35 +Basic weighted average common shares outstanding 78,635 79,577 81,664 82,736 85,664 +Effect of dilutive securities - options/restricted stock — 4,069 4,433 4,009 3,670 +Diluted weighted average common stock outstanding 78,635 83,646 86,097 86,745 89,334 +Cash dividends declared per common share $ 0.15 $ 0.57 $ 0.53 $ — $ — +BALANCE SHEET DATA +At December 31 , +2020 2019 2018 2017 2016 +Total assets $ 1,137,761 $ 1,278,647 $ 1,072,570 $ 1,057,161 $ 960,875 +Working capital 462,325 437,608 478,436 438,906 345,544 +Noncurrent liabilities 111,476 156,152 33,199 41,617 36,676 +Stockholders' equity $ 790,369 $ 841,224 $ 814,682 $ 808,932 $ 741,072 +25 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. +Overview: +($ in thousands, except retail sales data per square foot, earnings per share and per share data) +Steven Madden, Ltd. and its subsidiaries design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell branded fashion handbags, apparel and accessories, as well as private label fashion handbags and accessories. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, and online retailers, throughout the United States, Canada, Mexico and certain other European nations. In addition, our products are marketed through our retail stores and our e-commerce websites within the United States, Canada and Mexico, our joint ventures in Europe, South Africa, Israel, Taiwan and China, and under special distribution arrangements in certain European countries, the Middle East, South and Central America, Oceania and various countries in Asia. Our product lines include a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Our business comprises five distinct segments: Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing. Our Wholesale Footwear segment includes the following brands: Steve Madden Women's®, Madden Girl®, Steve Madden Men's®, Madden®, Report®, Dolce Vita®, DV Dolce Vita®, Mad Love®, Steven by Steve Madden®, Superga® (under license), Anne Klein® (under license), Betsey Johnson®, Betseyville®, Steve Madden Kids®, GREATS® and Blondo®, and includes our International business and certain private label footwear business. Our Wholesale Accessories/Apparel segment includes Steve Madden®, Big Buddha®, Betsey Johnson®, Steven by Steve Madden®, Madden Girl®, Luv Betsey®, Anne Klein® (under license), Cejon®, BB Dakota®, BB Dakota x Steve Madden, and Cupcakes & Cashmere® (under license) brands and includes our International business and certain private label accessories business. Steven Madden Retail, Inc., our wholly owned retail subsidiary, that comprises our Retail segment, operates Steve Madden, Steven, Superga and International retail stores, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota e-commerce websites. The First Cost segment represents activities of a subsidiary that earns commissions for serving as a buying agent for footwear products under private labels for many U.S. large mass-market merchandisers, shoe chains and other value priced retailers. Our Licensing segment is engaged in the licensing of Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of apparel, outerwear, hosiery, jewelry, watches, eyeglasses, sunglasses, hair accessories, umbrellas, bedding and bath, and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, hair accessories, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and the FREEBIRD by Steven® trademark for operation of retail stores. +Dividends +A quarterly cash dividend of $0.15 per share on our outstanding shares of common stock was paid on March 27, 2020. At the end of March 2020, in response to the COVID-19 pandemic, as a precautionary measure our Board of Directors temporarily suspended the payments of dividends. The aggregate cash dividends paid for the twelve months ended December 31, 2020 was $12,459. +On February 24, 2021, our Board of Directors approved the reinstatement of a quarterly cash dividend. The quarterly dividend of $0.15 per share is payable on March 26, 2021 to stockholders of record as of the close of business on March 16, 2021. +Reclassifications +Certain reclassifications were made to prior years' amounts to conform to the 2020 presentation. +Executive Summary +In December 2019, COVID-19 emerged and spread worldwide. The World Health Organization declared COVID-19 a +26 +pandemic in March 2020, resulting in federal, state and local governments and private entities mandating various restrictions, including the closure of non-essential businesses, travel restrictions, restrictions on public gatherings, stay-at-home orders and advisories and quarantining of people who may have been exposed to the virus. After closely monitoring and taking into consideration the guidance from federal, state and local governments, in March 2020, we temporarily closed all of our stores and our corporate offices in the U.S. and the vast majority of our stores and offices globally. As of August 2020, the vast majority of our stores and corporate offices in the U.S. and globally reopened. These and other factors have had and may continue to have a material impact on our business, results of operations, financial position and cash flow. In response to the COVID-19 pandemic, we took precautionary measures to maintain adequate liquidity and financial flexibility by temporarily suspending share repurchases and the quarterly cash dividend; temporarily suspending salaries of our founder and Creative and Design Chief, Steve Madden, our Chairman and Chief Executive Officer, Edward Rosenfeld, and our Board of Directors (all of which were reinstated on October 1); temporarily reducing salaries by 30% for our President, Chief Financial Officer, Chief Operating Officer and Chief Merchandising Officer (all of which were reinstated on August 1); temporarily reducing salaries by graduated amounts for all other employees earning over $100 per year (all of which were reinstated on August 1); significantly scaling back on non-essential operating expenses, and capital expenditures and inventory purchases. +The impact of COVID-19 resulted in an unprecedented decline in our revenue and earnings during the year ended 2020, including but not limited to, charges from adjustments to the carrying amount of certain trademarks, long-lived asset impairment charges and restructuring and other related charges. We expect the pandemic will continue to have a significant negative impact on our revenue and earnings during 2021. +Total revenue for 2020 decreased by 32.8% to $1,201,814 from $1,787,157 in 2019, with decreases in all segments as a result of the impact of the COVID-19 pandemic. +Net loss attributable to Steven Madden, Ltd. was $18,397 in 2020 compared to net income attributable to Steven Madden, Ltd. of $141,311 in 2019. Our effective tax rate for 2020 increased to 39.0% compared to 21.8% recorded in 2019. Diluted loss per share in 2020 was $0.23 per share on 78,635 diluted weighted average shares outstanding compared to diluted earnings of $1.69 per share on 83,646 diluted weighted average shares outstanding in the prior year. +We did not report same store sales or sales per square foot data in 2020 due to the COVID-19 pandemic and the subsequent closure of our brick-and-mortar stores from the second half of March through at least the end of May and subsequent mandated closures. As of December 31, 2020, we had 218 stores in operation, compared to 227 stores as of December 31, 2019. This decrease resulted from the closure of nine full-price stores, four outlet stores and one e-commerce website partially offset by the opening of three full-price stores and two outlet stores. +Our inventory turnover (calculated on a trailing four quarter average) for the years ended December 31, 2020 and 2019 was 7.1 times and 8.1 times, respectively. Our total company accounts receivable average collection days were 73 days in 2020 compared to 70 days in 2019. As of December 31, 2020, we had $287,166 in cash, cash equivalents and short-term investments, no debt and total stockholders’ equity of $790,369. Working capital increased to $462,325 as of December 31, 2020, compared to $437,608 on December 31, 2019. The increase in working capital was primarily due to actions taken as a result of the COVID-19 pandemic. +As we look ahead, we remain focused on delivering trend-right product, deepening connections with our consumers, enhancing our digital commerce business, and efficiently managing our inventory and expenses. +27 +The following table sets forth information on operations for the periods indicated: +Selected Financial Information +Years Ended December 31, +($ in thousands) +2020 2019 2018 +CONSOLIDATED: +Net sales $ 1,188,943 98.9 % $ 1,768,135 98.9 % $ 1,653,609 98.6 % +Commission and licensing fee income 12,871 1.1 % 19,022 1.1 % 24,125 1.4 % +Total revenue 1,201,814 100.0 % 1,787,157 100.0 % 1,677,734 100.0 % +Cost of sales (exclusive of depreciation and amortization) 737,273 61.3 % 1,101,140 61.6 % 1,037,571 61.8 % +Gross profit 464,541 38.7 % 686,017 38.4 % 640,163 38.2 % +Operating expenses 414,978 34.5 % 503,270 28.2 % 466,781 27.8 % +Impairment of intangibles 44,273 3.7 % 4,050 0.2 % — — % +Impairment of lease right-of-use asset and store fixed assets 36,895 3.1 % 1,883 0.1 % — — % +(Loss)/income from operations (31,605) (2.6) % 176,814 9.9 % 173,382 10.3 % +Interest and other income – net 1,620 0.1 % 4,412 0.2 % 3,958 0.2 % +(Loss)/income before income taxes (29,985) (2.5) % 181,226 10.1 % 177,340 10.6 % +Net (loss)/income attributable to Steven Madden, Ltd. $ (18,397) (1.5) % $ 141,311 7.9 % $ 129,136 7.7 % +By Segment: +WHOLESALE FOOTWEAR SEGMENT: +Net sales $ 713,662 100.0 % $ 1,112,091 100.0 % $ 1,058,366 100.0 % +Cost of sales (exclusive of depreciation and amortization) 487,106 68.3 % 738,504 66.4 % 712,457 67.3 % +Gross profit 226,556 31.7 % 373,587 33.6 % 345,909 32.7 % +Operating expenses 162,357 22.7 % 206,055 18.5 % 205,771 19.4 % +Impairment of intangibles 16,345 2.3 % 4,050 0.4 % — — % +Income from operations $ 47,854 6.7 % $ 163,482 14.7 % $ 140,138 13.2 % +WHOLESALE ACCESSORIES/APPAREL SEGMENT: +Net sales $ 235,892 100.0 % $ 334,862 100.0 % $ 300,091 100.0 % +Cost of sales (exclusive of depreciation and amortization) 164,984 69.9 % 236,731 70.7 % 208,352 69.4 % +Gross profit 70,908 30.1 % 98,131 29.3 % 91,739 30.6 % +Operating expenses 60,932 25.8 % 75,676 22.6 % 64,647 21.5 % +Impairment of intangibles 27,472 11.6 % — — % — — % +(Loss)/income from operations $ (17,496) (7.4) % $ 22,455 6.7 % $ 27,092 9.0 % +RETAIL SEGMENT: +Net sales $ 239,389 100.0 % $ 321,182 100.0 % $ 295,152 100.0 % +Cost of sales (exclusive of depreciation and amortization) 85,183 35.6 % 125,905 39.2 % 116,762 39.6 % +Gross profit 154,206 64.4 % 195,277 60.8 % 178,390 60.4 % +Operating expenses 186,103 77.7 % 202,444 63.0 % 177,655 60.2 % +Impairment of intangibles 456 0.2 % — — % — — % +Impairment of lease right-of-use asset and store fixed assets 36,895 15.4 % 1,883 0.6 % — — % +(Loss)/income from operations $ (69,248) (28.9) % $ (9,050) (2.8) % $ 735 0.2 % +Number of stores 218 227 229 +FIRST COST SEGMENT: +Commission fee income $ 3,902 100.0 % $ 7,441 100.0 % $ 11,226 100.0 % +Gross profit 3,902 100.0 % 7,441 100.0 % 11,226 100.0 % +Operating expenses 2,395 61.4 % 15,618 209.9 % 15,775 140.5 % +Income/(loss) from operations $ 1,507 38.6 % $ (8,177) (109.9) % $ (4,549) (40.5) % +LICENSING SEGMENT: +Licensing fee income $ 8,969 100.0 % $ 11,581 100.0 % $ 12,899 100.0 % +Gross profit 8,969 100.0 % 11,581 100.0 % 12,899 100.0 % +Operating expenses 3,191 35.6 % 3,477 30.0 % 2,933 22.7 % +Income from operations $ 5,778 64.4 % $ 8,104 70.0 % $ 9,966 77.3 % +28 +RESULTS OF OPERATIONS +($ in thousands) +Year Ended December 31, 2020 vs. Year Ended December 31, 2019 +Consolidated : +Total revenue for the year ended December 31, 2020 decreased by 32.8% to $1,201,814 from $1,787,157 for fiscal 2019,with decreases in all segments as a result of the impact of the COVID-19 pandemic. For the year ended December 31, 2020, gross profit was $464,541, or 38.7% of total revenue, as compared to $686,017, or 38.4% of total revenue, in the prior year. The increase in gross profit as a percentage of total revenue was primarily due to the shift in sales to our higher-margin e-commerce business. Operating expenses in 2020 were $414,978, or 34.5% of total revenue, as compared $503,270, or 28.2% of total revenue, in 2019. The increase in operating expenses as a percentage of total revenue was primarily attributable to a deleverage on a lower sales base, but was also impacted by the impairment of lease right-of-use assets and store fixed assets, early lease termination and modification charges, and restructuring and other related charges as a result of the COVID-19 pandemic. The increase was partially offset by our reduction in workforce, furloughs, temporary salary reductions and reduced discretionary spending as a result of our initiatives to control expenses, along with the change in valuation of contingent considerations. In addition, for the years 2020 and 2019, impairments of intangibles of $44,273 and $4,050 were recorded, respectively. Also in 2020 and 2019, impairments for lease right-of-use assets and store fixed assets of $36,895 and $1,883 were recorded, respectively. The effective tax rate for the year ended December 31, 2020 increased to 39.0% compared to 21.8% last year. The increase in the effective tax rate is primarily due to the year-over-year benefit resulting from the exercising and vesting of share-based awards, an increase in tax benefit related to a net operating loss carryback claim set forth by the CARES Act, an increase in the GILTI tax, a decrease in the state taxes incurred, and an increase in 2019 pre-tax losses in jurisdictions with higher tax rates. Net loss attributable to Steven Madden, Ltd. for the year ended December 31, 2020 was $18,397 compared to net income attributable to Steven Madden, Ltd. of $141,311 for the year ended December 31, 2019. +Wholesale Footwear Segment : +Revenue from the Wholesale Footwear segment was $713,662, or 59.4%, and $1,112,091, or 62.2%, of our total revenue for the years ended December 31, 2020 and 2019, respectively. The decrease of 35.8% in revenue is primarily driven by the impact of the COVID-19 pandemic, including significant order cancellations. Gross profit in 2020 was $226,556, or 31.7% of Wholesale Footwear revenue, as compared to gross profit of $373,587, or 33.6% of Wholesale Footwear revenue, in 2019. The decrease in gross profit as a percentage of Wholesale Footwear revenue was primarily due to close-outs of excess inventory resulting from store closures and order cancellations from the impact of the COVID-19 pandemic and higher sales mix of our private label business, partially offset by lower markdowns. Operating expenses were $162,357, or 22.7% of Wholesale Footwear revenue, in 2020 compared to $206,055, or 18.5% of Wholesale Footwear revenue, in 2019. The increase in operating expenses as a percentage of Wholesale Footwear revenue was primarily attributable to a deleverage on a lower sales base in addition to restructuring and other related charges as a result of the COVID-19 pandemic, partially offset by our reduction in workforce, furloughs, temporary salary reductions and reduced discretionary spending as a result of our initiatives to control expenses. For 2020 and 2019, intangible impairment charges of $16,345 and $4,050 were recorded, respectively. Income from operations decreased to $47,854 for 2020 compared to $163,482 for 2019. +Wholesale Accessories/Apparel Segment : +Revenue from the Wholesale Accessories/Apparel segment accounted for $235,892, or 19.6%, and $334,862, or 18.7%, of total revenue for the years ended December 31, 2020 and 2019, respectively. The decrease of 29.6% in revenue was primarily attributable to the impact of the COVID-19 pandemic, including order cancellations. Gross profit was $70,908, or 30.1% of Wholesale Accessories/Apparel revenue, for 2020 as compared to $98,131, or 29.3% of Wholesale Accessories/Apparel revenue, in the prior year. The increase in gross profit as a percentage of Wholesale Accessories/Apparel revenue was primarily due to lower markdowns and an increase penetration of the higher margin BB Dakota apparel business. Operating expenses for 2020 were $60,932, or 25.8% of Wholesale Accessories/Apparel revenue, as compared to $75,676, or 22.6% of Wholesale Accessories/Apparel revenue, in 2019. The increase in operating expenses as a percentage of Wholesale Accessories/Apparel revenue was primarily attributable to a deleverage on a lower sales base, but was also impacted by restructuring and other related charges as a result of the COVID-19 pandemic. The increase in expenses was partially offset by our reduction in workforce, furloughs, temporary salary reductions and reduced discretionary spending as a result of our initiatives to control expenses, along with a change in valuation of a contingent consideration. For 2020, an intangible impairment charge of $27,472 +29 +was recorded. Loss from operations for the Wholesale Accessories/Apparel segment was $17,496 in 2020 compared to income from operations of $22,455 in 2019. +Retail Segment : +Revenue from the Retail segment accounted for $239,389, or 19.9% of total revenue, and $321,182, or 18.0%, of total revenue for the years ended December 31, 2020 and 2019, respectively. The decrease of 25.5% in revenue is primarily due to the COVID-19 pandemic, including the temporary closure of all of our brick-and-mortar stores in the U.S. and the vast majority of our brick-and-mortar stores globally from the second half of March through at least the end of May and subsequent mandated closures. During 2020, we added five stores and closed 14 stores. As of December 31, 2020 we had 218 retail stores compared to 227 stores as of December 31, 2019. The 218 stores currently in operation include 143 Steve Madden® full-price stores, 66 Steve Madden® outlet stores, one Steven® store, one Superga store and seven e-commerce websites. In addition, we operated 17 concessions in our international markets. During the year ended December 31, 2020, gross profit was $154,206, or 64.4% of Retail revenue compared to $195,277, or 60.8% of Retail revenue in 2019. The increase in gross profit as a percentage of Retail revenue was primarily due to a shift in sales to the higher-margin e-commerce business and less discounting. In 2020, operating expenses were $186,103, or 77.7% of Retail revenue, compared to $202,444, or 63.0% of Retail revenue in 2019. The increase in operating expenses as a percentage of Retail revenue was primarily attributable to a deleverage on a lower sales base, but was also impacted by the impairment of lease right-of-use assets and store fixed assets and restructuring and related charges as a result of the COVID-19 pandemic. The increase in expenses was partially offset by our reduction in workforce, furloughs, temporary salary reductions, rent reductions and reduced discretionary spending as a result of our initiatives to control expenses, along with the change in valuation of a contingent consideration. Also in 2020 and 2019, impairments for lease right-of-use assets and store fixed assets of $36,895 and $1,883 were recorded, respectively. For 2020, an intangible impairment charge of $456 was recorded. For the year ended December 31, 2020, loss from operations for the Retail segment was $69,248 compared to $9,050 in the prior year. +First Cost Segment : +Commission fee income generated by the First Cost segment accounted for $3,902, or 0.3% of total revenue, and $7,441, or 0.4% of total revenue for the years ended December 31, 2020 and 2019, respectively. Operating expenses decreased to $2,395 in 2020 from $15,618 in 2019. Operating expenses in 2020, included a benefit associated with the recovery from the Payless ShoeSource bankruptcy of $1,081 and in 2019 included charges to bad debt expenses associated with the Payless ShoeSource bankruptcy of $10,355. Income from operations was $1,507 for the year ended December 31, 2020 compared to a loss from operations of $8,177 in 2019. +Licensing Segment: +Licensing fee income generated by the Licensing segment accounted for $8,969, or 0.7% of total revenue, and $11,581, or 0.6% of total revenue for the years ended December 31, 2020 and 2019, respectively, which represents a $2,612, or 22.6%, decrease. Operating expenses decreased to $3,191 in 2020 from $3,477 in 2019. During the year ended December 31, 2020, income for the Licensing segment amounted to $5,778 as compared to the prior year income of $8,104. +Year Ended December 31, 2019 vs. Year Ended December 31, 2018 +Consolidated: +Total revenue for the year ended December 31, 2019 increased by 6.5% to $1,787,157 from $1,677,734 for fiscal 2018. Net sales for fiscal 2019 increased by 6.9% to $1,768,135 from $1,653,609 for fiscal 2018. Commission and licensing fee income for fiscal 2019 decreased by 21.2% to $19,022 from $24,125 for fiscal 2018. For the year ended December 31, 2019, gross margin as a percentage of total revenue increased to 38.4% in the current year compared to 38.2% in the prior year. For the year ended 2019, gross margin included a charge of $386 related to a termination of a joint venture. Operating expenses increased in 2019 to $503,270, or 28.2% of total revenue, from $466,781, or 27.8% of total revenue, in 2018. In addition, in 2019 impairments of intangibles of $4,050 were recorded. Also in 2019, impairments for lease right-of-use assets of $1,883 were recorded. The effective tax rate for the year ended December 31, 2019 decreased to 21.8% compared to 26.4% in the same period of 2018 primarily due to the year-over-year benefit resulting from the exercising and vesting of share-based awards, a decrease in the state taxes incurred, a decrease in prepaid tax adjustments, and an increase in 2019 pre-tax income in +30 +jurisdictions with low tax rates. Net income attributable to Steven Madden, Ltd. for the year ended December 31, 2019 increased to $141,311 compared to $129,136 for the year ended December 31, 2018. +Wholesale Footwear Segment: +Revenue generated by the Wholesale Footwear segment was $1,112,091, or 62.2% of total revenue, and $1,058,366, or 63.1%, of our total revenue for the years ended December 31, 2019 and 2018, respectively. The increase in net revenue was primarily driven by strong growth in Steve Madden Women's, along with the full year of recognizing revenue for the Anne Klein brand and an increase in our private label business, partially offset by not recognizing sales to Payless ShoeSource in the first half of 2019 compared to the first half of 2018. +Gross profit margin in 2019 was 33.6%, while gross profit margin in 2018 was 32.7%. The increase in gross profit margin of 90 basis points was primarily attributable to strong growth in Steve Madden Women's, along with not recognizing sales to the low-margin Payless ShoeSource customer. Operating expenses increased to $206,055, or 18.5% of revenue, in 2019 compared to $205,771, or 19.4% of revenue, in the same period of 2018. Recorded in the Wholesale Footwear segment was a $4,050 impairment charge for the Brian Atwood trademark impacting operating income for 2019. The increase in operating expenses primarily resulted from higher payroll and related expenses, warehouse and distribution expenses and other selling expenses associated with higher sales and the addition of the Anne Klein footwear business. Income from operations increased to $163,482 for 2019 compared to $140,138 for 2018. +Wholesale Accessories/Apparel Segment: +Revenue generated by the Wholesale Accessories/Apparel segment accounted for $334,862, or 18.7%, and $300,091, or 17.9%, of total revenue for the years ended December 31, 2019 and 2018, respectively. The increase in revenue was primarily due to growth in our Steve Madden branded handbags, the full year of recognizing sales for the Anne Klein brand, as well as the addition of the BB Dakota apparel business. +Gross profit margin in the Wholesale Accessories/Apparel segment decreased to 29.3% in 2019 from 30.6% in the prior year period. The 1.3% decrease in gross margin resulted from tariffs imposed on accessories when compared to 2018. In the year ended December 31, 2019, operating expenses increased to $75,676, or 22.6% of revenue, compared to $64,647, or 21.5% of revenue, in the year ended December 31, 2018. The increase primarily resulted from higher payroll related expenses associated with the increase in sales, as well as the addition of the BB Dakota apparel business. Also, contributing to the increase were higher warehouse and distribution expenses, other selling expenses and marketing expenses all based on higher sales volume. Income from operations for the Wholesale Accessories/Apparel segment decreased to $22,455 in 2019 compared to $27,092 in 2018. +Retail Segment: +Revenue generated by the Retail segment accounted for $321,182, or 18.0%, and $295,152, or 17.6%, of total revenue for the years ended December 31, 2019 and 2018, respectively, which represents a $26,030, or 8.8%, increase. The increase in revenue was primarily due to an increase in comparable store sales of 6.1% driven by the significant growth in our e-commerce business. During 2019, we had net closures of 2 stores. The net closures comprised 17 full-price locations, 2 outlet locations and 1 e-commerce website, partially offset by the addition of 8 full-price stores, 8 outlets and 2 e-commerce websites, which included the additional stores and e-commerce sites from the acquisition of GREATS and BB Dakota brands. As a result, we had 227 retail stores as of December 31, 2019, compared to 229 stores as of December 31, 2018. The 227 stores currently in operation include 146 Steve Madden® full-price stores, 68 Steve Madden® outlet stores, 2 Steven® stores, 2 GREATS® stores, 1 Superga store and 8 e-commerce websites. In addition, we operated 31 concessions in our international markets. Comparable store sales (sales of those stores, including the e-commerce websites, that were open for all of 2019) for the year ended December 31, 2019 increased 6.1% when compared to the prior year. We exclude new locations from the comparable store base for the first year of operations. Stores that are closed for renovations are removed from the comparable store base. During the year ended December 31, 2019, the gross profit margin increased to 60.8% from 60.4% in 2018 primarily due to higher margins in our e-commerce business partially offset by a loss of $386 related to the termination of a joint venture in China. In 2019, operating expenses increased to $202,444, or 63.0% of revenue, from $177,655, or 60.2% of revenue, in 2018. Also in 2019, impairments for lease right-of-use assets of $1,883 were recorded. For the year ended December 31, 2019, loss from operations for the Retail segment was $9,050 compared to income from operations of $735 in the prior year. +31 +First Cost Segment: +Commission fee income generated by the First Cost segment accounted for $7,441, or 0.4%, and $11,226, or 0.7% of total revenue for the years ended December 31, 2019 and 2018, respectively, which represents a $3,785, or 33.7%, decrease. The decrease in commission fee income is primarily due to the Payless ShoeSource bankruptcy that occurred in 2019. Operating expenses slightly decreased to $15,618 in 2019 from $15,775 in 2018. Loss from operations was $8,177 for the year ended December 31, 2019 compared to $4,549 in 2018. +Licensing Segment: +Licensing fee income generated by the Licensing segment accounted for $11,581, or 0.6%, and $12,899, or 0.8% of total revenue for the years ended December 31, 2019 and 2018, respectively, which represents a $1,318, or 10.2%, decrease. The decrease in licensing fee income is primarily due to a decrease in royalties in connection with Payless ShoeSource bankruptcy. Operating expenses increased to $3,477 in 2019 from $2,933 in 2018. The increase in operating expenses was primarily due to higher marketing and payroll related expenses. During the year ended December 31, 2019, income for the Licensing segment amounted to $8,104 as compared to the prior year income of $9,966. +LIQUIDITY AND CAPITAL RESOURCES +($ in thousands) +In response to the COVID-19 pandemic, we took precautionary measures to maintain adequate liquidity and financial flexibility by temporarily suspending share repurchases and the quarterly cash dividend, furloughing a significant portion of our employees, significantly reducing our corporate workforce, temporarily suspending salaries of our founder and Creative and Design Chief, Steve Madden, our Chairman and Chief Executive Officer, Edward Rosenfeld, and our Board of Directors (which were all reinstated on October 1); temporarily reducing salaries by 30% for our President, Chief Financial Officer, Chief Operating Officer and Chief Merchandising Officer (which were all reinstated on August 1); temporarily reducing salaries by graduated amounts for all other employees earning over $100 per year (which were reinstated on August 1); significantly scaling back on non-essential operating expenses, capital expenditures and planned inventory purchases. +Cash, cash equivalents and short-term investments totaled $287,166 and $304,622 at December 31, 2020 and December 31, 2019, respectively. At December 31, 2020, we held $158,610, or approximately 56%, of our total cash, cash equivalents and short-term investments in our foreign subsidiaries, and at December 31, 2019, we held $137,072, or approximately 45%, in our foreign subsidiaries. +We had a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”) until May 6, 2020. The agreement provided us with a credit facility in the amount of $30,000, having a sub-limit of $15,000 on the aggregate face amounts of letters of credit, at an interest rate based, at our election, upon either the prime rate or LIBOR. Effective May 6, 2020, the credit facility was increased to $50,000 as a precautionary measure in response to the COVID-19 pandemic. +On July 22, 2020, we entered into a new $150,000, five-year, asset-based revolving credit facility with Citizens Bank, N.A. and various participating lenders, which replaced our credit facility with Rosenthal. +As of December 31, 2020, we had working capital of $462,325, cash and cash equivalents of $247,864, and short-term investments of $39,302 and no debt. +We believe that based upon our current financial position and available cash, cash equivalents and short-term investments, we will meet all of our financial commitments and operating needs for at least the next twelve months. In addition, as a precautionary measure, we have entered into the $150,000 asset-based revolving credit facility, which provides additional liquidity and flexibility should we need it. +OPERATING ACTIVITIES +($ in thousands) +Cash provided by operations was $44,206 in 2020 compared to cash provided by operations of $233,780 in the prior year. The reduction in cash provided by operations was primarily driven by the reduction of income as result of the COVID-19 pandemic and unfavorable changes in our working capital, including unfavorable changes in accounts payable and accrued expenses and factor accounts receivable, partially offset by favorable changes in inventories and accounts receivables. +32 +INVESTING ACTIVITIES +($ in thousands) +During the year ended December 31, 2020 cash used in investing activities was $4,884, of which we invested $73,792 in marketable securities and received $75,470 from the maturities and sales of securities. We invested in capital expenditures of $6,562, principally for systems enhancements, leasehold improvements to office and improvements to existing stores and new stores that were committed to and in final stages prior to the COVID-19 pandemic. +FINANCING ACTIVITIES +($ in thousands) +During the year ended December 31, 2020, net cash used in financing activities was $57,074, which primarily consisted of share repurchases of $46,583, and payment of cash dividends of $12,459, partially offset by proceeds from the exercise of stock options of $1,609. +CONTRACTUAL OBLIGATIONS +($ in thousands) +Our contractual obligations as of December 31, 2020 were as follows: +Payment due by period +Contractual Obligations Total 2021 2022-2023 2024-2025 2026 and after +Operating lease obligations $ 147,889 $ 39,700 $ 53,312 $ 32,922 $ 21,955 +Purchase obligations 64,523 64,523 — — — +Future minimum royalty and advertising payments 20,225 8,350 11,875 — — +Transition tax 14,847 1,563 4,493 8,791 — +Total $ 247,484 $ 114,136 $ 69,680 $ 41,713 $ 21,955 +At December 31, 2020, we had $188 open letters of credit outstanding for the purchase of inventory. +Substantially all our products are produced by independent manufacturers at overseas locations, the majority of which are located in China, with a growing percentage located in Cambodia, Mexico, Brazil, India, Vietnam and some European nations. We have not entered into any long-term manufacturing or supply contracts with any of these foreign manufacturers. We believe that a sufficient number of alternative sources exist outside of the United States for the manufacture of our products. Purchases are made primarily in United States dollars. +We have employment agreements with our Creative and Design Chief, Steven Madden, and certain executive officers, which provide for the payment of compensation aggregating approximately $10,700 in 2021, $8,941 in 2022 and $7,774 in 2023. In addition, some of these employment agreements provide for discretionary bonuses and some provide for incentive compensation based on various performance criteria as well as other benefits, including stock-related compensation. +Transition tax of $14,847 was the result of the Tax Cuts and Jobs Act of 2017 (the "Tax Act"). For further information, refer to Note O to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Excluded from the contractual obligations table above are long-term taxes payable of $2,295 as of December 31, 2020 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond one year due to uncertainties in the timing of tax audit outcomes. +DIVIDENDS +In February 2020, our Board of Directors declared a quarterly cash dividend of $0.15 per share on our outstanding shares of common stock. The dividend was paid on March 27, 2020, to stockholders of record as of the close of business on March 17, 2020. We paid total cash dividends for the three months ended March 31, 2020 of $12,459. +At the end of March 2020, in response to the COVID-19 pandemic, as a precautionary measure our Board of Directors temporarily suspended the payment of dividends and the repurchase of our common stock. +On February 24, 2021, our Board of Directors approved the reinstatement of a quarterly cash dividend. The quarterly dividend of $0.15 per share is payable on March 26, 2021 to stockholders of record as of the close of business on March 16, 2021. +33 +Future quarterly cash dividend payments are also subject to the discretion of our Board of Directors and contingent upon future earnings, our financial condition, capital requirements, general business conditions, and other factors. Therefore, we can give no assurance that cash dividends will be paid to holders of our common stock in the future. +INFLATION +We do not believe that inflation and price changes have had a significant effect on our sales or profitability for the fiscal year ended December 31, 2020 and the prior two fiscal years. Historically, we have minimized the impact of product cost increases by increasing prices, changing suppliers and improving operating efficiencies. However, no assurance can be given that we will be able to offset any such inflationary cost increases in the future. +OFF-BALANCE SHEET ARRANGEMENTS +We have no off-balance sheet arrangements. +CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES +This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Estimates by their nature are based on judgments and available information. Our estimates are made based upon historical factors, current circumstances and the experience and judgment of management. Assumptions and estimates are evaluated on an ongoing basis, and we may employ outside experts to assist in evaluations. Therefore, actual results could materially differ from those estimates under different assumptions and conditions. Management believes the following critical accounting estimates are more significantly affected by judgments and estimates used in the preparation of our consolidated financial statements: allowance for bad debts; customer returns, chargebacks and co-op advertising; inventory valuation; valuation of intangible assets; litigation reserves; and contingent payment liabilities. +Allowances for bad debts . Accounts receivable are reduced by an allowance for amounts that may be uncollectible in the future. Estimates are used in determining the allowance for doubtful accounts and are based on an analysis of the aging of accounts receivable, assessments of collectability based on historical trends, the financial condition of our customers and an evaluation of economic conditions. In general, the actual bad debt losses have historically been within our expectations and the allowances we have established. The reserve against our non-factored trade receivables also includes estimated losses that may result from customers’ inability to pay. +Customer returns, chargebacks and co-op advertising . We provide variable consideration to our customers for chargebacks, discounts, co-op advertising, returns and other miscellaneous deductions that relate to the current period. The amount of the consideration for returns, discounts and compliance chargebacks is determined by analyzing aged receivables, current economic conditions, the prevailing retail environment and historical dilution levels for customers. We evaluate anticipated customer markdowns and chargebacks by reviewing several performance indicators for our major customers. These performance indicators (which include inventory levels on the retail floors, sell through rates and gross margin levels) are analyzed by management to estimate the amount of the anticipated customer allowance. Under our co-op advertising programs, we agree to reimburse the retailer for a portion of the costs incurred by the retailer to advertise and promote some of our products. We estimate the costs of co-op advertising programs based on the terms of the agreements with its retailer customers. Failure to correctly estimate the amount of the reserve could materially impact our results of operations and financial position. +Inventory valuation . Inventories are stated at lower of cost or net realizable value, on a first-in, first-out basis. We review inventory on a regular basis for excess and slow-moving inventory. The review is based on an analysis of inventory on hand, prior sales, and expected net realizable value through future sales. The analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales and projections for sales in the foreseeable future as well as subsequent sales. We consider quantities on hand in excess of estimated future sales to be at risk for market impairment. The net realizable value, or market value, is determined based on the estimate of sales prices of such inventory through off-price or discount store channels. The likelihood of any material inventory write-down is dependent primarily on the expectation of future consumer demand for our products. A misinterpretation or misunderstanding of future consumer demand for our products, the economy, or other failure to estimate correctly, in addition to abnormal weather patterns, could result in inventory valuation changes, compared to the valuation determined to be appropriate as of the balance sheet date. +Valuation of intangible assets and goodwill . In accordance with applicable accounting guidance, we test goodwill and intangible assets with indefinite lives at least annually. This accounting guidance also requires that intangible assets with finite +34 +lives be amortized over their respective lives to their estimated residual values and reviewed for impairment in accordance with applicable accounting guidance. +Indefinite-lived intangible assets and goodwill are assessed for impairment by performing a qualitative assessment that evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible or a reporting unit is less than its carrying amount. Factors considered include historical financial performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the reporting unit is less than its carrying amount, the fair value of the reporting unit is compared with its carrying amount, and if the fair value of the reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount. We perform this annual assessment during our third quarter or if impairment indicators warrant a test. +Impairment of long-lived assets. We perform an impairment review of our long-lived assets, once events or changes in circumstances indicate, in management’s judgment, that the carrying value of such assets may not be recoverable. When such a determination has been made, management compares the carrying value of the asset groups with their estimated future undiscounted cash flows. If it is determined that an impairment has occurred, the fair value of the asset group is determined and compared to its carrying value. The excess of the carrying value over the fair value, if any, is recognized as a loss during that period. The impairment is calculated as the difference between asset carrying values and the fair value of the long-lived assets. +Litigation reserves. Estimated amounts for litigation claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable events of a particular litigation. As additional information becomes available, management will assess the potential liability related to the pending litigation and revise its estimates. Such revisions in management’s estimates of a contingent liability could materially impact our results of operation and financial position. +Contingent payment liabilities. We have completed acquisitions that require us to make contingent payments to the sellers based on the future financial performance of the acquired businesses over a period from one to three years. The fair value of the contingent payments is estimated using the present value of management's projections of the financial results of the acquired business. Failure to correctly project the financial results of the acquired businesses could materially impact our results of operations and financial position. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +($ in thousands) +We do not engage in the trading of market risk sensitive instruments in the normal course of business. Our financing arrangements are subject to variable interest rates, primarily based on the prime rate and LIBOR. The terms of our new $150,000 asset-based revolving credit agreement and our collection agency agreements with Rosenthal & Rosenthal, Inc. can be found in the Liquidity and Capital Resources section of Item 7 and in Note T and Note E, respectively, to the Consolidated Financial Statements included in this Annual Report on Form 10-K. +As of December 31, 2020, we held short-term investments valued at $ 39,302 , which consisted of certificates of deposit. We have the ability to hold these investments until maturity. +We face market risk to the extent that our U.S. or foreign operations involve the transaction of business in foreign currencies. In addition, our inventory purchases are primarily done in foreign jurisdictions and inventory purchases may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of our contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks primarily by denominating these purchases in U.S. dollars. To mitigate the risk of purchases that are denominated in foreign currencies we may enter into forward foreign exchange contracts for terms of no more than two years. A description of our accounting policies for derivative financial instruments is included in Notes C and M to the Consolidated Financial Statements. +During 2020, we entered into forward foreign exchange contracts with notional amounts totaling $44,279. We performed a sensitivity analysis based on a model that measures the impact of a hypothetical change in foreign currency exchange rates to determine the effects that market risk exposures may have on the fair values of our forward foreign exchange contracts that were outstanding as of the year-end. As of December 31, 2020, a 10% increase or decrease of the U.S. dollar against the exchange rates for foreign currencies under forward foreign exchange contracts would result in a net increase or decrease, respectively, in the fair value of our derivatives portfolio of approximately $4,075. +In addition, we are exposed to translation risk in connection with our foreign operations in Canada, Mexico, Europe, South Africa, China, Taiwan and Israel because our subsidiaries and joint ventures in these countries utilize the local currency +35 +as their functional currency, and those financial results are translated into U.S. dollars. As currency exchange rates fluctuate, foreign currency exchange rate translation adjustments reflected in our financial statements with respect to our foreign operations affects the comparability of financial results between years. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The information required by this Item is incorporated herein by reference to the consolidated financial statements listed in response to Item 15 of Part IV of this Annual Report on Form 10-K. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +On March 6, 2020, the Audit Committee of our Board of Directors dismissed EisnerAmper LLP (“EisnerAmper”) as our independent registered public accounting firm effective immediately and appointed Ernst & Young LLP (“EY”) as our independent public accounting firm, effective upon dismissal of EisnerAmper. +In connection with the audits of our consolidated financial statements for each of the two fiscal years ended December 31, 2019 and 2018, and in the subsequent interim period through March 6, 2020, there were (i) no disagreements between us and EisnerAmper on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of EisnerAmper, would have caused it to make reference to the subject matter of the disagreements in connection with its report on the financial statements for such years and (ii) no “reportable events” as defined in Section 304(a)(1)(v) of SEC Regulation S-K and the related instructions thereto. +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the Board of Directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2020, of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the +36 +Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2020, our internal control over financial reporting was effective. +Our independent registered public accounting firm, Ernst & Young LLP, has audited our consolidated financial statements and the effectiveness of our internal control over financial reporting as of December 31, 2020. Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, as identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2020, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. OTHER INFORMATION +On February 25, 2021, we issued a press release reporting our financial results for the fiscal quarter and fiscal year ended December 31, 2020. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2021 Annual Meeting of Stockholders and is incorporated herein by reference. +ITEM 11. EXECUTIVE COMPENSATION +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2021 Annual Meeting of Stockholders and is incorporated herein by reference. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2021 Annual Meeting of Stockholders and is incorporated herein by reference. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2021 Annual Meeting of Stockholders and is incorporated herein by reference. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2021 Annual Meeting of Stockholders and is incorporated herein by reference. +PART IV +ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) Exhibits. See the exhibit index included herein. +(b) Financial Statements and Financial Statements Schedules +See Index to Consolidated Financial Statements included herein. +37 +Exhibit Index +2.01 +Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 31, 2017) +2.02 +First Amendment to Equity Purchase Agreement, dated November 21, 2017, to Equity Purchase Agreement, dated January 30, 2017, among the Company, Schwartz & Benjamin, Inc., B.D.S., Inc., Quinby Ridge Enterprises LLC, DANIELBARBARA Enterprises LLC, the Sellers party thereto, and Daniel Schwartz, as agent for the Sellers (incorporated by reference to Exhibit 2.2 to the Company’s Annual Report on Form 10-K for the annual period ended December 31, 2017 filed with the SEC on March 1, 2018) +3.01 +Certificate of Incorporation of Steven Madden, Ltd., as amended (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2019 filed with the SEC on August 5, 2019) +3.02 +Amended & Restated By-Laws of Steven Madden, Ltd., as further amended (incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2017 filed with the SEC on August 4, 2017) +4.01 +Specimen Certificate for shares of Common Stock (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013 filed with the SEC on August 8, 2013) +10.01 +Third Amended and Restated Secured Promissory Note dated as of June 25, 2007 of Steven H. Madden to the Company (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 9, 2012) +10.02 +First Allonge to Third Amended and Restated Secured Promissory Note made as of April 8, 2016 between the Company and Steven H. Madden (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.03 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2010 filed with the SEC on November 9, 2010) +10.04 +Amendment to Collection Agency Agreement dated February 16, 2010 between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2010 filed with the SEC on March 12, 2010) +10.05 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Daniel Friedman & Associates, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.06 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Diva Acquisition Corp. (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.07 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Steven Madden Retail, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.08 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and Stevies, Inc. (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.09 +Collection Agency Agreement dated July 10, 2009 between Rosenthal & Rosenthal, Inc. and SML Acquisition Corp. (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.10 +Letter Agreement dated July 10, 2009 among Rosenthal & Rosenthal, Inc., the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.11 +Guarantee dated July 10, 2009 of the Company, Daniel Friedman & Associates, Inc., Diva Acquisition Corp., Steven Madden Retail, Inc., Stevies, Inc., and SML Acquisition Corp. in favor of Rosenthal & Rosenthal, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed with the SEC on July 16, 2009) +10.12 +Amendment to Collection Agency Agreement, dated May 6, 2020, between Rosenthal & Rosenthal, Inc. and the Company (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on May 28, 2020) +10.13 +Credit Agreement, dated as of July 22, 2020, among Steven Madden, Ltd., the other subsidiary borrowers from time to time party thereto, the lenders from time to time party thereto, and Citizens Bank, N.A., as administrative agent (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 28, 2020) +10.14 +Amended and Restated Deferred Purchase Factoring Agreement, dated as of July 22, 2020, among Steven Madden, Ltd., certain subsidiaries of Steven Madden, Ltd. party thereto and Rosenthal & Rosenthal, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on July 28, 2020) +10.15 +Third Amended Employment Agreement dated July 15, 2005 between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 20, 2005) +10.16 +Amendment dated December 14, 2009 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 17, 2009) +10.17 +Amended and Restated Second Amendment dated as of December 31, 2011 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2011 filed with the SEC on February 29, 2012) +10.18 +Third Amendment dated April 8, 2016 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed with the SEC on May 6, 2016) +10.19 +Fourth Amendment dated March 25, 2019 to Third Amended Employment Agreement between the Company and Steven Madden (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 26, 2019) +10.20 +Employment Agreement dated January 1, 1998 between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.07 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2000 filed with the SEC on March 30, 2001)# +10.21 +Amendment No. 1 dated June 29, 2001 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 99.4 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended June 30, 2001 filed August 14, 2001)# +10.22 +Amendment No. 2 dated October 30, 2002 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for its fiscal quarter ended September 30, 2002 filed with the SEC on November 14, 2002)# +10.23 +Amendment No. 3 dated February 1, 2006 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 3, 2006)# +10.24 +Amendment No. 4 dated October 7, 2009 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on October 13, 2009)# +10.25 +Amendment No. 5 dated February 8, 2012 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 14, 2012)# +10.26 +Amendment No. 6 dated February 2, 2015 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on February 4, 2015)# +10.27 +Amendment No. 7 dated as of May 15, 2017 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 16, 2017)# +10.28 +Amendment No. 8 dated as of April 20, 2018 to Employment Agreement between the Company and Arvind Dharia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 26, 2018)# +10.29 +Employment Agreement dated as of May 11, 2020 between the Company and Karla Frieders (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on May 14, 2020)# +10.30 +Employment Agreement, dated as of December 31, 2018, between the Company and Edward R. Rosenfeld (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 4, 2019)# +10.31 +Employment Agreement dated December 27, 2019 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 3, 2020)# +10.32 +Amendment No. 1 to Employment Agreement dated February 25, 2021 between the Company and Awadhesh Sinha (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2021)# +10.33 +Employment Agreement dated December 27, 2019 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on January 3, 2020)# +10.34 +Amendment No. 1 to Employment Agreement dated February 25, 2021 between the Company and Amelia Newton Varela (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2021)# +10.35 +Employment Agreement dated December 8, 2020 between the Company and Zine Mazouzi (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 10, 2020)# +10.36 +2006 Stock Incentive Plan (Amended and Restated Effective May 22, 2009), amended by the Board of Directors of the Company on April 5, 2012 and approved and adopted by the Company's stockholders on May 25, 2012 (incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 1, 2013)# +10.37 +2019 Incentive Compensation Plan, as adopted by the Board of Directors of the Company on February 25, 2019 and approved and adopted by the Company's stockholders on May 24, 2019 (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2019 filed with the SEC on August 5, 2019)# +14.01 +Code of Ethics for the Chief Executive Officer and Senior Financial Officers (incorporated by reference to Exhibit 14.01 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2014 filed with the SEC on February 26, 2015) +14.02 +Code of Business Conduct and Ethics for the Board of Directors (incorporated by reference to Exhibit 14.02 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2014 filed with the SEC on February 26, 2015) +14.03 +Code of Business Conduct and Ethics (incorporated by reference to Exhibit 14.03 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2018 filed with the SEC on February 28, 2019) +21.01 +Subsidiaries of the Registrant† +23.01 +Consent of Ernst & Young LLP† +23.02 +Consent of EisnerAmper LLP† +24.01 +Power of Attorney (included on signature page hereto) +31.01 +Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +31.02 +Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† +32.01 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +32.02 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†* +101 The following materials from Steven Madden, Ltd.'s Annual Report on Form 10-K for the fiscal year ended December 31, 2020, formatted in iXBRL (Inline Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of (Loss)/Income, (iii) the Consolidated Statements of Comprehensive (Loss)/Income, (iv) the Consolidated Statements of Changes in Stockholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.* +104 Cover Page Interactive Data File, formatted in Inline Extensible Business Reporting Language (iXBRL).* +† Filed herewith. +# Indicates management contract or compensatory plan or arrangement required to be identified pursuant to Item 15(b) of this Annual Report on Form 10-K. +* This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Company specifically incorporates it by reference. +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. +DATE: March 16, 2021 +STEVEN MADDEN, LTD. +/s/ EDWARD R. ROSENFELD +Edward R. Rosenfeld +Chairman and Chief Executive Officer +/s/ ZINE MAZOUZI +Zine Mazouzi +Chief Financial Officer +41 +POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each of the undersigned constitutes and appoints Edward R. Rosenfeld and Zine Mazouzi, and each of them, as attorneys-in-fact and agents, with full power of substitution and re-substitution, for and in the name, place and stead of the undersigned, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all that each of said attorney-in-fact or substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. +Signature Title Date +/S/ EDWARD R. ROSENFELD Chairman, Chief Executive Officer and Director March 16, 2021 +Edward R. Rosenfeld +/s/ ZINE MAZOUZI Chief Financial Officer March 16, 2021 +Zine Mazouzi +/S/ AMELIA NEWTON VARELA President and Director March 16, 2021 +Amelia Newton Varela +/S/ PETER MIGLIORINI Director March 16, 2021 +Peter Migliorini +/S/ RAVI SACHDEV Director March 16, 2021 +Ravi Sachdev +/S/ THOMAS H. SCHWARTZ Director March 16, 2021 +Thomas H. Schwartz +/S/ ROSE LYNCH Director March 16, 2021 +Rose Lynch +/S/ ROBERT SMITH Director March 16, 2021 +Robert Smith +/S/ MITCHELL S. KLIPPER Director March 16, 2021 +Mitchell S. Klipper +/S/ AL FERRARA Director March 16, 2021 +Al Ferrara +/S/ MARÍA TERESA KUMAR Director March 16, 2021 +María Teresa Kumar +42 +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Reports of Independent Registered Public Accounting Firms +F - 1 +Consolidated Balance Sheets as of December 31, 2020 and 2019 +F- 6 +Consolidated Statements of (Loss)/Income for the years ended December 31, 2020, 2019 and 2018 +F- 7 +Consolidated Statements of Comprehensive (Loss)/ Income for the years ended December 31, 2020, 2019 and 2018 +F- 8 +Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2020, 2019 and 2018 +F- 9 +Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and 2018 +F- 10 +Notes to Consolidated Financial Statements +F- 11 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of Steven Madden, Ltd. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheet of Steven Madden, Ltd. and subsidiaries (the Company) as of December 31, 2020, the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for the year ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020, and the results of its operations and its cash flows for the year ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 16, 2021 expressed an unqualified opinion thereon. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +F-1 +Impairment of Long-Lived Assets at Retail Stores +Description of the Matter As discussed in Notes H and N to the consolidated financial statements, the Company evaluates its long-lived assets, including property and equipment and operating lease right-of-use assets at retail stores, for impairment whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. In determining whether an impairment indicator exists, the Company considers store operating performance criteria and qualitative measures at the lowest level for which identifiable cash flows are largely independent of cash flows for other assets and liabilities, which is at the store level. During the year ended December 31, 2020, the Company recognized impairment charges of $14.7 million and $22.2 million related to property and equipment and operating lease right-of-use assets, respectively, at certain of its retail stores. +Auditing the Company’s impairment assessment of retail store long-lived assets was complex and highly judgmental due to the significant estimation required in determining the future cash flows used to assess recoverability of each retail store long-lived asset group (undiscounted) and determining the fair value (discounted). The significant assumptions used include estimated future cash flows directly related to the future operation of the stores and the discount rate used to determine fair value. Significant assumptions used in determining the fair value of certain operating lease right-of-use assets include the current market rent and discount rate for the remaining lease term of the related stores. These assumptions are subjective in nature and are affected by expectations about future market or economic conditions (including the effects of the global pandemic). +How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the retail store long-lived assets impairment process, including, determining the undiscounted future cash flows of the stores and the fair value of the long-lived assets for the stores that were deemed to be impaired. We also tested controls over management’s review of the significant assumptions described above. Our testing of the Company’s impairment measurement included, among other procedures, evaluating the significant assumptions and operating data used to calculate the estimated future cash flows and to determine the fair value of the store long lived assets. For a sample of retail stores, we tested the completeness and accuracy of the data used by the Company in its analyses and we compared the significant assumptions used to determine the forecasted cash flows to historical results of the retail stores, current industry and economic trends and inquired of the Company’s executives to understand the business initiatives supporting the assumptions in the future cash flows. We involved our internal valuation specialists to assist in evaluating the fair value of certain operating lease right-of-use assets, which included assessing the estimated market rental rates of these leases by comparing them to rental rates for comparable leases and evaluating the applied discount rate. +F-2 +Markdown Allowances +Description of the Matter As described in Note C to the consolidated financial statements, revenue recognized by the Company is measured as the amount of consideration the Company expects to receive in exchange for transferring goods, which includes estimates for variable consideration. Variable consideration includes markdown allowances which are recorded as a reduction of revenue in the period in which revenue is recognized. Estimating the amount of markdown allowances to be recorded requires management to review several performance indicators, including retailers’ inventory levels, sell-through rates and gross margin levels. +Auditing management's estimate of markdown allowances reserves was complex and judgmental as reserve amounts are sensitive to changes in market or economic conditions (including the effects of the global pandemic), and have a direct, material impact on the amount of revenue recognized by the Company. There is also significant estimation required to establish markdown reserve rates by brand and customer, which are based on the Company's review of periodic negotiations with each customer and the expected performance of the products in the customers' stores. +How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of internal controls over the Company's process to calculate the markdown allowances, including the consideration of historical experience, actual and forecasted results, and current economic and market conditions (including the effects of the global pandemic). +To test the estimate of markdown allowances, we performed audit procedures that included, among others, assessing methodologies and testing the assumptions regarding periodic negotiations with each customer which include the application of market and economic conditions to individual customers and the expected performance of the products in the customers' stores that were used by the Company to calculate the projected markdown allowances to be issued upon settlement. We compared the significant assumptions used by management to current market and economic trends, historical results and other relevant factors. We also examined the historical accuracy of management's estimates and performed sensitivity analyses of significant assumptions to substantively test the changes in the estimate that would result from reasonable changes in the assumptions. +/s/ Ernst & Young LLP +We served as the Company's auditor since 2020. +New York, New York +March 16, 2021 +F-3 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of Steven Madden, Ltd. +Opinion on Internal Control Over Financial Reporting +We have audited Steven Madden, Ltd. and subsidiaries’ internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Steven Madden, Ltd. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2020, the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for the year ended December 31, 2020, and the related notes and our report dated March 16, 2021 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +New York, New York +March 16, 2021 +F-4 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Steven Madden Ltd. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheet of Steven Madden Ltd. and Subsidiaries (the “Company”) as of December 31, 2019, and the related consolidated statements of income, comprehensive income, changes to stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2019, and the consolidated results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. +Adoption of New Accounting Standard +As discussed in Note N to the consolidated financial statements, the Company changed its method for accounting for leases in 2019. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ EisnerAmper LLP +We have served as the Company’s auditor from 1995 through 2020. +Iselin, New Jersey +March 2, 2020 +F-5 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Balance Sheets +(in thousands) +December 31, +2020 2019 +ASSETS +Current assets: +Cash and cash equivalents $ 247,864 $ 264,101 +Short-term investments 39,302 40,521 +Accounts receivable, net of allowances of $ 8,943 and $ 11,066 +25,044 38,166 +Factor accounts receivable 252,671 216,471 +Inventories 101,420 136,896 +Prepaid expenses and other current assets 17,415 22,066 +Income tax receivable and prepaid income taxes 14,525 658 +Total current assets 698,241 718,879 +Note receivable – related party 1,180 1,558 +Property and equipment, net 43,268 65,504 +Operating lease right-of-use asset 101,379 155,700 +Deferred tax assets 5,415 — +Deposits and other 4,822 2,948 +Goodwill – net 168,265 171,349 +Intangibles – net 115,191 162,709 +Total Assets $ 1,137,761 $ 1,278,647 +LIABILITIES +Current liabilities: +Accounts payable $ 73,904 $ 61,706 +Accrued expenses 118,083 169,895 +Operating leases - current portion 34,257 38,624 +Income taxes payable 5,799 — +Accrued incentive compensation 3,873 11,046 +Total current liabilities 235,916 281,271 +Contingent payment liability 207 9,124 +Operating leases - long-term portion 98,592 133,172 +Deferred tax liabilities 2,562 5,877 +Other liabilities 10,115 7,979 +Total Liabilities 347,392 437,423 +Commitments, contingencies and other (Note P) +STOCKHOLDERS’ EQUITY +Preferred stock – $ 0.0001 par value, 5,000 shares authorized; none issued; Series A Junior Participating preferred stock – $ 0.0001 par value, 60 shares authorized; none issued +— — +Common stock – $ 0.0001 par value, 245,000 shares authorized, 133,247 and 132,754 shares issued, 82,616 and 83,520 shares outstanding +8 6 +Additional paid-in capital 478,463 454,217 +Retained earnings 1,279,550 1,310,406 +Accumulated other comprehensive loss ( 29,164 ) ( 30,440 ) +Treasury stock – 50,631 and 49,234 shares at cost +( 952,271 ) ( 905,688 ) +Total Steven Madden, Ltd. stockholders’ equity 776,586 828,501 +Noncontrolling interest 13,783 12,723 +Total stockholders’ equity 790,369 841,224 +Total Liabilities and Stockholders’ Equity $ 1,137,761 $ 1,278,647 +See accompanying notes to consolidated financial statements +F-6 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of (Loss)/Income +(in thousands, except per share data) +Years Ended December 31, +2020 2019 2018 +Net sales $ 1,188,943 $ 1,768,135 $ 1,653,609 +Commission and licensing fee income 12,871 19,022 24,125 +Total revenue 1,201,814 1,787,157 1,677,734 +Cost of sales (exclusive of depreciation and amortization) 737,273 1,101,140 1,037,571 +Gross profit 464,541 686,017 640,163 +Operating expenses 414,978 503,270 466,781 +Impairment of intangibles 44,273 4,050 — +Impairment of lease right-of-use assets and store fixed assets 36,895 1,883 — +(Loss)/income from operations ( 31,605 ) 176,814 173,382 +Interest and other income - net 1,620 4,412 3,958 +(Loss)/income before provision for income taxes ( 29,985 ) 181,226 177,340 +(Benefit)/provision for income taxes (Note O) ( 11,704 ) 39,504 46,841 +Net (loss)/income ( 18,281 ) 141,722 130,499 +Less: net income attributable to noncontrolling interest 116 411 1,363 +Net (loss)/income attributable to Steven Madden, Ltd. $ ( 18,397 ) $ 141,311 $ 129,136 +Basic net (loss)/income per share $ ( 0.23 ) $ 1.78 $ 1.58 +Diluted net (loss)/income per share $ ( 0.23 ) $ 1.69 $ 1.50 +Basic weighted average common shares outstanding 78,635 79,577 81,664 +Effect of dilutive securities – options/restricted stock — 4,069 4,433 +Diluted weighted average common shares outstanding 78,635 83,646 86,097 +Cash dividends declared per common share $ 0.15 $ 0.57 $ 0.53 +See accompanying notes to consolidated financial statements +F-7 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Comprehensive (Loss)/Income +(in thousands) +2020 +Pre-tax amounts Tax benefit After-tax amounts +Net (loss) $ ( 18,281 ) +Other comprehensive income: +Foreign currency translation adjustment $ 2,551 $ — 2,551 +(Loss) on cash flow hedging derivatives ( 526 ) 134 ( 392 ) +Total other comprehensive income $ 2,025 $ 134 2,159 +Comprehensive (loss) ( 16,122 ) +Less: comprehensive income attributable to noncontrolling interests 999 +Comprehensive (loss) attributable to Steven Madden, Ltd. $ ( 17,121 ) +2019 +Pre-tax amounts Tax benefit/(expense) After-tax amounts +Net income $ 141,722 +Other comprehensive income: +Foreign currency translation adjustment $ 2,885 $ — 2,885 +(Loss) on cash flow hedging derivatives ( 1,387 ) 333 ( 1,054 ) +Unrealized gain on marketable securities 116 ( 28 ) 88 +Total other comprehensive income $ 1,614 $ 305 1,919 +Comprehensive income 143,641 +Less: comprehensive income attributable to noncontrolling interests 142 +Comprehensive income attributable to Steven Madden, Ltd. $ 143,499 +2018 +Pre-tax amounts Tax (expense) After-tax amounts +Net income $ 130,499 +Other comprehensive (loss): +Foreign currency translation adjustment $ ( 7,983 ) $ — ( 7,983 ) +Gain on cash flow hedging derivatives 1,150 ( 276 ) 874 +Unrealized gain on marketable securities 124 ( 30 ) 94 +Total other comprehensive (loss) $ ( 6,709 ) $ ( 306 ) ( 7,015 ) +Comprehensive income 123,484 +Less: comprehensive income attributable to noncontrolling interests 1,363 +Comprehensive income attributable to Steven Madden, Ltd. $ 122,121 +See accompanying notes to consolidated financial statements +F-8 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Changes in Stockholders' Equity +(in thousands) +Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive (Loss) Treasury Stock Non-Controlling Interest Total Stockholders' Equity +Shares Amount Shares Amount +Balance - December 31, 2017 88,047 $ 6 $ 390,723 $ 1,135,701 $ ( 25,613 ) 42,913 $ ( 697,996 ) $ 6,111 $ 808,932 +Share repurchases ( 3,363 ) — — — — 3,363 ( 105,924 ) — ( 105,924 ) +Exercise of stock options 593 — 13,036 — — — — — 13,036 +Issuance of restricted stock, net of forfeitures 438 — — — — — — — — +Stock-based compensation — — 21,076 — — — — — 21,076 +Foreign currency translation adjustment — — — — ( 7,983 ) — — — ( 7,983 ) +Unrealized gain on marketable securities (net of tax expense of $ 30 ) +— — — — 94 — — — 94 +Cash flow hedge (net of tax expense of $ 276 ) +— — — — 874 — — — 874 +Dividends on common stock ($ 0.53 per share) +— — — ( 47,316 ) — — — — ( 47,316 ) +Distributions to noncontrolling interests, net — — — — — — — ( 1,183 ) ( 1,183 ) +Investment of noncontrolling interest — — — — — — — 2,577 2,577 +Net income — — — 129,136 — — — 1,363 130,499 +Balance - December 31, 2018 85,715 6 424,835 1,217,521 ( 32,628 ) 46,276 ( 803,920 ) 8,868 814,682 +Share repurchases ( 2,958 ) — — — — 2,958 ( 101,768 ) — ( 101,768 ) +Exercise of stock options 273 — 6,212 — — — — — 6,212 +Issuance of restricted stock, net of forfeitures 490 — — — — — — — — +Stock-based compensation — — 23,170 — — — — — 23,170 +Foreign currency translation adjustment — — — — 3,154 — — ( 269 ) 2,885 +Unrealized gain on marketable securities (net of tax expense of $ 28 ) +— — — — 88 — — — 88 +Cash flow hedge (net of tax benefit of $ 333 ) +— — — — ( 1,054 ) — — — ( 1,054 ) +Dividends on common stock ($ 0.57 per share) +— — — ( 48,426 ) — — — — ( 48,426 ) +Distributions to noncontrolling interests, net — — — — — — — ( 1,444 ) ( 1,444 ) +Investment of noncontrolling interest — — — — — — — 3,248 3,248 +Acquisition of noncontrolling interest — — — — — — — 1,909 1,909 +Net income — — — 141,311 — — — 411 141,722 +Balance - December 31, 2019 83,520 6 454,217 1,310,406 ( 30,440 ) 49,234 ( 905,688 ) 12,723 841,224 +Share repurchases ( 1,397 ) — — — — 1,397 ( 46,583 ) — ( 46,583 ) +Exercise of stock options 80 2 1,607 — — — — — 1,609 +Issuance of restricted stock, net of forfeitures 413 — — — — — — — — +Stock-based compensation — — 22,639 — — — — — 22,639 +Foreign currency translation adjustment — — — — 1,668 — — 883 2,551 +Cash flow hedge (net of tax benefit of $ 134 ) +— — — — ( 392 ) — — — ( 392 ) +Dividends on common stock ($ 0.15 per share) +— — — ( 12,459 ) — — — — ( 12,459 ) +Investment of noncontrolling interest — — — — — — — 359 359 +Acquisition adjustment of noncontrolling interest — — — — — — — ( 298 ) ( 298 ) +Net (loss)/income — — — ( 18,397 ) — — — 116 ( 18,281 ) +Balance - December 31, 2020 82,616 $ 8 $ 478,463 $ 1,279,550 $ ( 29,164 ) 50,631 $ ( 952,271 ) $ 13,783 $ 790,369 +See accompanying notes to consolidated financial statements +F-9 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +(in thousands) +Years Ended December 31, +2020 2019 2018 +Cash flows from operating activities: +Net (loss)/income $ ( 18,281 ) $ 141,722 $ 130,499 +Adjustments to reconcile net (loss)/income to net cash provided by operating activities +Stock-based compensation 22,639 23,170 21,076 +Depreciation and amortization 17,360 21,337 22,482 +Loss on disposal of fixed assets 561 920 1,220 +Impairment of intangibles 44,273 4,050 — +Impairment of lease right-of-use asset and store fixed assets 36,895 1,883 — +Deferred taxes ( 8,353 ) 5,144 ( 2,512 ) +Accrued interest on note receivable – related party ( 31 ) ( 40 ) ( 47 ) +Note receivable - related party 409 409 409 +Deferred rent (benefit) — — ( 247 ) +Realized loss on sale of marketable securities — 5 189 +Change in valuation of contingent liability ( 8,917 ) — — +Net benefit in connection with the reversal of a contingent liability partially offset by the acceleration of amortization related to the termination of the Kate Spade license agreement — ( 1,868 ) — +Recovery, net of provisions for bad debt expense, related to the Payless ShoeSource bankruptcy — 8,687 12,123 +Changes, net of acquisitions, in: +Accounts receivable 13,122 ( 17,837 ) 4,966 +Factor accounts receivable ( 36,200 ) 24,924 ( 39,959 ) +Inventories 35,476 8,436 ( 26,923 ) +Prepaid expenses, prepaid taxes, deposits and other ( 10,129 ) 9,466 14,633 +Accounts payable and accrued expenses ( 34,207 ) 11,036 21,249 +Accrued incentive compensation ( 7,061 ) ( 249 ) 828 +Leases and other liabilities ( 3,350 ) ( 7,415 ) ( 5,610 ) +Net cash provided by operating activities 44,206 233,780 154,376 +Cash flows from investing activities: +Capital expenditures ( 6,562 ) ( 18,311 ) ( 12,450 ) +Purchases of short-term investments ( 73,792 ) ( 67,935 ) ( 77,262 ) +Maturity/sale of marketable securities and short-term investments 75,470 95,671 100,777 +Acquisitions, net of cash acquired — ( 37,173 ) — +Net cash (used in)/provided by investing activities ( 4,884 ) ( 27,748 ) 11,065 +Cash flows from financing activities: +Proceeds from exercise of stock options 1,609 6,212 13,036 +Investment of noncontrolling interest 359 3,248 2,577 +Distribution of noncontrolling interest earnings — ( 1,444 ) ( 1,183 ) +Payment of contingent liability — — ( 7,000 ) +Common stock purchased for treasury ( 46,583 ) ( 101,768 ) ( 105,924 ) +Cash dividends paid on common stock ( 12,459 ) ( 48,426 ) ( 47,316 ) +Advances from factor 176,784 — — +Repayments of advances from factor ( 176,784 ) — — +Net cash (used in) financing activities ( 57,074 ) ( 142,178 ) ( 145,810 ) +Effect of exchange rate changes on cash and cash equivalents 1,515 216 ( 814 ) +Net (decrease)/increase in cash and cash equivalents ( 16,237 ) 64,070 18,817 +Cash and cash equivalents – beginning of year 264,101 200,031 181,214 +Cash and cash equivalents – end of year $ 247,864 $ 264,101 $ 200,031 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest $ 354 $ 25 $ 36 +Income taxes $ 5,147 $ 29,552 $ 37,105 +See accompanying notes to consolidated financial statements. +F-10 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Note A - COVID-19 +In December 2019, COVID-19 emerged and spread worldwide. The World Health Organization declared COVID-19 a pandemic in March 2020, resulting in federal, state and local governments and private entities mandating various restrictions, including the closure of non-essential businesses, travel restrictions, restrictions on public gatherings, stay-at-home orders and advisories and quarantining of people who may have been exposed to the virus. After closely monitoring and taking into consideration the guidance from federal, state and local governments, in March 2020, the Company temporarily closed all of its brick-and-mortar stores and its corporate offices in the U.S. and the vast majority of its brick-and-mortar stores and offices globally. On April 1, 2020, the Company temporarily furloughed a significant number of its employees. Employees with medical benefits continued to receive those benefits at no personal cost for a duration determined by the Company. As of September 20, 2020, most of our brick-and-mortar stores and corporate offices globally were reopened at limited capacity, most employees returned from furlough and a number of safety protocols and restrictions were implemented to ensure the safety of the Company's employees and customers. The COVID-19 pandemic had and may continue to have a material impact on the Company's business, results of operations, financial position and cash flow. In response to the COVID-19 pandemic, the Company has taken precautionary measures to maintain adequate liquidity and financial flexibility by temporarily suspending share repurchases and the quarterly cash dividend; temporarily suspending salaries of the Company's founder and Creative and Design Chief, Steve Madden, the Company's Chairman and Chief Executive Officer, Edward Rosenfeld, and its Board of Directors (all of which were reinstated on October 1); temporarily reducing salaries by 30 % for the Company's President, Chief Financial Officer, Chief Operating Officer and Chief Merchandising Officer (all of which were reinstated on August 1); reducing salaries by graduated amounts for all other employees earning over $ 100 per year (all of which were reinstated on August 1); and significantly scaling back on non-essential operating expenses, capital expenditures and planned inventory purchases. The Company also implemented a restructuring plan that resulted in the reduction of a significant number of its corporate employees. The Company experienced other adverse impacts as a result of the COVID-19 pandemic, including, but not limited to, charges from adjustments to the carrying amount of certain trademarks, long-lived asset impairment charges and restructuring and other related charges. +Included in operating expenses for the twelve months ended December 31, 2020, was a pre-tax charge recorded in the United States during the second quarter 2020 of $ 5,414 related to restructuring and other related items. This charge was related to the lay-off of approximately 250 employees. The pre-tax charge of $ 5,414 comprised $ 2,958 recorded in the Wholesale Footwear segment, $ 1,678 recorded in the Accessories/Apparel segment, $ 646 recorded in the Retail segment, $ 125 recorded in the First Cost segment and $ 6 recorded in the Licensing segment. In addition, during the third quarter of 2020, the Company recorded a pre-tax charge in the United States of $ 978 related to restructuring and other related items. This charge was primarily related to the additional reduction to the workforce. The pre-tax charge of $ 978 comprised of $ 216 recorded in the Wholesale Footwear segment, $ 293 recorded in the Accessories/Apparel segment, $ 462 recorded in the Retail segment and $ 7 recorded in the First Cost segment. In addition, during the fourth quarter 2020, the Company recorded a pre-tax charge in Canada of $ 249 related to additional reduction in the workforce. The pre-tax net charge of $ 249 comprised a pre-tax charge of $ 254 recorded in the Retail segment, a pre-tax charge of $ 33 recorded in the Wholesale Footwear segment and a benefit of $ 38 in the Wholesale Accessories/Apparel segment. During the twelve months ended December 31, 2020, the Company in aggregate recorded a pre-tax charge of $ 7,181 as described above, of which $ 490 was the remainder unpaid in accrued expenses. +Note B - Reclassification +Certain reclassifications were made to prior years' amounts to conform to the 2020 presentation. +Note C – Summary of Significant Accounting Policies +[1] Organization: +Steven Madden, Ltd., a Delaware corporation, and its subsidiaries, design, source, market and sell name brand and private label women's, men's and children's shoes, worldwide through its wholesale and retail channels under the Steve Madden Women's, Steve Madden Men's, Madden, Madden Girl, Steven, Superga (under license), GREATS, Dolce Vita and Betsey Johnson brand names and through its wholesale channels under the Report, Mad Love and Blondo brand names and, under license, the Anne Klein brand name. +F-11 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +In addition, the Company designs, sources, markets and sells name brand and private label handbags, accessories and apparel to customers worldwide through its Wholesale Accessories/Apparel segment, including the Steve Madden, Big Buddha, Betsey Johnson, Madden Girl, Cejon, Steven by Steve Madden, Luv Betsey, BB Dakota, BB Dakota x Steve Madden, Cupcakes & Cashmere (under license) and Anne Klein (under license) brands. Revenue is generated predominantly through the sale of the Company's brand name and private label merchandise and certain licensed products. At December 31, 2020 and 2019, the Company operated 218 (including seven e-commerce websites) and 227 (including eight e-commerce websites) retail stores, respectively. Revenue is subject to seasonal fluctuations. See Note Q for operating segment information. +[2] Principles of Consolidation: +The consolidated financial statements include the accounts of Steven Madden, Ltd. and its wholly-owned subsidiaries, Adesso-Madden, Inc., The Asean Corporation Limited, BA Brand Holdings LLC, BA Brand Management LLC, BAI Holding, LLC, B.B. Dakota, Inc., BJ Acquisition LLC, Cejon Accessories Inc, Comercial Diecesiette S.A. de C.V., Daniel M. Friedman & Associates, Inc., Diva Acquisition Corp., Dolce Vita Footwear Inc, Dolce Vita Holdings, Inc., DV Retail Inc, GREATS Brand, Inc., Importadora Steve Madden Mexico S de RL de CV, Madden Asia Holding Limited, Madden International Limited, Maddman Productions LLC, Madlove LLC, Maximus Designer Shoes, Report Footwear Inc, Schwartz & Benjamin, Inc., SMI Holding I S.C.S., SMI Holding II S.C.S., SMI, LLC, SML Canada Acquisition Corp., SML Holdings S.a.r.l, SML Industries LLC, Steven Madden Retail, Inc., The Topline Corporation and Trendy Imports S de RL de CV (collectively the "Company"). The accounts of (i) Dexascope Proprietary Ltd., a joint venture in South Africa in which the Company is the majority owner, (ii) BA Brand Holdings LLC, a joint venture in the United States which the Company is the majority owner, (iii) SPM Shoetrade Holding B.V., a joint venture in certain regions of Europe in which the Company is the majority owner, (iv) SM (Jiangsu) Co., Ltd., a joint venture in China which the Company controls all of the significant participating rights, (v) SM Dolce Limited, a joint venture in Taiwan which the Company is the majority interest holder, (vi) SM Distribution Israel L.P., a joint venture in which the Company is the majority interest holder and (vii) SM Distribution China Co., Ltd., a joint venture in which the Company is the majority interest holder, are included in the consolidated financial statements with the other members' interests reflected in “Net income attributable to noncontrolling interest” in the Consolidated Statements of (Loss)/Income and “Noncontrolling interest” in the Consolidated Balance Sheets. All intercompany balances and transactions have been eliminated. +[3] Use of Estimates: +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. +Significant areas involving management estimates include variable consideration included in revenue, allowances for bad debts, inventory valuation, valuation of intangible assets, impairment of long-lived assets related to retail stores, litigation reserves and contingent payment liabilities. The Company estimates variable consideration on trade accounts receivables and factor receivables for future customer chargebacks and markdown allowances, discounts, returns and other miscellaneous compliance-related deductions that relate to the current-period sales. The Company evaluates anticipated chargebacks by reviewing several performance indicators of its major customers. These performance indicators, which include retailers’ inventory levels, sell-through rates and gross margin levels, are analyzed by management to estimate the amount of the anticipated customer allowance. +[4] Cash Equivalents: +Cash equivalents at December 31, 2020 and 2019 amounted to approximately $ 4,575 and $ 107,535 , respectively, and consisted of money market accounts. The Company considers all highly liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. +F-12 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +[5] Short-Term Investments : +As of December 31, 2020 and 2019, short-term investments consisted of certificates of deposit. These securities are classified as current based upon their maturities. As of December 31, 2020 and 2019 short-term investments amounted to $ 39,302 and $ 40,521 , respectively, and have maturities of one year or less. +[6] Inventories: +Inventories, which consist of finished goods on hand and in transit, are stated at the lower of cost (first-in, first-out method) or net realizable value. +[7] Property and Equipment: +Property and equipment are stated at cost less accumulated depreciation and amortization and impairment. Depreciation is computed utilizing the straight-line method based on estimated useful lives ranging from three to 27.5 years. Leasehold improvements are amortized utilizing the straight-line method over the shorter of their estimated useful lives or the remaining lease term. Impairment losses are recognized in operations for property and equipment and other long-lived assets when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are not sufficient to recover the assets' carrying amount. Impairment losses are measured by comparing the fair value of the assets to their carrying amount. See Note H for further information. +[8] Goodwill and Intangible Assets: +The Company's goodwill and indefinite-lived intangible assets are not amortized; rather they are tested for impairment on an annual basis at the beginning of the third quarter, or more often if events or circumstances change that could cause these assets to become impaired. +In accordance with applicable accounting guidance, indefinite-lived intangible assets and goodwill may be assessed for impairment by performing a qualitative assessment that evaluates relevant events or circumstances in order to determine whether it is more likely than not that the fair value of an intangible asset or reporting unit is less than its carrying amount. The factors that are considered include, but are not limited to, historical financial performance, expected future performance, macroeconomic and industry conditions and legal and regulatory environment. If it is more likely than not that the fair value of the intangible asset or reporting unit is less than its carrying amount, a quantitative impairment test is performed. The quantitative impairment test identifies the existence of potential impairment by comparing the fair value of the intangible asset or reporting unit to its carrying amount, and if the fair value of the intangible asset or reporting unit is less than its carrying amount, an impairment is recognized equal to the amount by which the carrying value of the intangible asset or reporting unit exceeds its fair value, not to exceed the carrying amount. See Note I for further information. +The Company amortizes its intangible assets with definite useful lives over their estimated useful lives and reviews these assets for impairment when there are indicators of impairment are present. The Company is currently amortizing its acquired intangible assets with definite useful lives over periods typically from two to 20 years using the straight-line method. +[9] Net (Loss)/Income Per Share of Common Stock: +Basic net (loss)/income per share is based on the weighted average number of shares of common stock outstanding during the period, which does not include unvested restricted common stock subject to forfeiture of 3,651,000 , 4,427,000 and 5,137,000 shares for the years ended December 31, 2020, 2019 and 2018, respectively. Diluted net income per share reflects: a) the potential dilution assuming shares of common stock were issued upon the exercise of outstanding in-the-money options and the assumed proceeds, which are deemed to be the proceeds from the exercise plus compensation cost not yet recognized attributable to future services using the treasury method, were used to purchase shares of the Company’s common stock at the average market price during the period, and b) the vesting of +F-13 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +granted non-vested restricted stock awards for which the assumed proceeds upon vesting are deemed to be the amount of compensation cost not yet recognized attributable to future services using the treasury stock method, to the extent dilutive. The year ended December 31, 2020 resulted in a net loss; therefore, there was no difference in the weighted average number of common shares for basic and diluted loss per share as the effect of all potentially dilutive shares outstanding was anti-dilutive. For the years ended December 31, 2020, 2019 and 2018, options to purchase approximately 89,000 , 5,000 and 45,000 shares of common stock, respectively, have been excluded from the calculation of diluted net (loss)/income per share, as the result would have been anti-dilutive. For the year ended December 31, 2020, 2,524,000 restricted shares were excluded from the calculation of diluted net (loss) per share, as the result would have been anti-dilutive. For the years ended December 31, 2019 and 2018, all unvested restricted stock awards were dilutive. +[10] Comprehensive Loss: +Comprehensive loss is the total of net earnings and all other non-owner changes in equity. Comprehensive loss for the Company includes net (loss)/income, foreign currency translation adjustments, unrealized loss /gains on cash flow hedging and marketable securities. The accumulated balances for each component of other comprehensive loss attributable to the Company are as follows: +2020 2019 2018 +Currency translation adjustment $ ( 28,421 ) $ ( 29,636 ) $ ( 33,091 ) +Cash flow hedges, net of tax ( 743 ) ( 804 ) 530 +Unrealized loss on securities, net of tax — — ( 67 ) +Accumulated other comprehensive loss $ ( 29,164 ) $ ( 30,440 ) $ ( 32,628 ) +Amounts reclassified from accumulated other comprehensive loss to operating loss/ income in the Consolidated Statement of (Loss)/ Income during 2020, 2019, 2018 were a loss of $ 89 , $ 15 , $ 150 , respectively. +[11] Advertising Costs: +Advertising costs are expensed as incurred, including digital, print, and radio advertisements. Advertising expenses included in operating expenses amounted to approximately $ 33,068 in 2020, $ 30,165 in 2019 and $ 21,921 in 2018. +[12] Revenue Recognition: +In May 2014, the Financial Accounting Standards Board (the "FASB") issued new accounting guidance ("Topic 606"), as amended, Accounting Standards Update No. 2014-09 ("ASU 2014-09"), "Revenue from Contracts with Customers," on revenue recognition. The new standard has replaced Revenue Recognition Topic 605 and provides for a single five-step model to be applied to all revenue contracts with customers as well as requiring additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Effective January 1, 2018, the Company adopted the requirements of Topic 606 using the cumulative effect adjustment approach. The impacts to the financial statements of this adoption are primarily related to balance sheet classification, including amounts associated with the change in balance sheet classification of the sales returns reserves, with no significant impact to the income statement as the Company's previous revenue recognition policies are in line with Topic 606. +The Company recognizes revenue when performance obligations identified under the terms of contracts with its customers are satisfied, which generally occurs upon the transfer of control in accordance with the contractual terms and conditions of the sale. Most of the Company’s revenue is recognized at a point in time when product is shipped to the customer. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods, which includes estimates for variable consideration. Variable consideration mainly includes markdown allowances, co-op advertising programs and product returns. The revenue recognition for the Company's segments is described below (see Note Q for disaggregated revenue amounts by segment). +F-14 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +A. Disaggregation of Revenue +Wholesale Sales Segments. The Company generates revenue through the design, sourcing and sale of branded footwear, accessories and apparel to both domestic and international customers who, in turn, sell the products to the consumer. The Company recognizes revenue when performance obligations identified under the terms of contracts with its customers are satisfied, which occurs upon the transfer of control of the merchandise in accordance with the contractual terms and conditions of the sale. The Company's revenue associated with its branded footwear, accessories and apparel products is recognized at a point in time when product is shipped to the customer. The Company also generates revenue through the design, sourcing and sale of private label footwear and accessories to both domestic and international customers who brand the products and sell them to the consumer. The Company's revenue associated with private label footwear and accessories products is recognized at a point in time when product is physically delivered to the customer's freight forwarder. +Retail Segment. The Company owns and operates 218 retail stores throughout the United States, Canada, Mexico, South Africa, Israel and China, including seven e-commerce sites. The Company generates revenue through the sale of branded footwear, apparel and accessories directly to the consumer. The Company's revenue associated with Retail segment sales is recognized at the time of the point of sale when the customer takes control of the goods and payment is received. The Company's e-commerce business recognizes sales upon receipt of the customer. +First Cost Segment. The Company earns commissions for serving as a buying agent for footwear products under private labels and certain owned brands for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, the Company utilizes its expertise and relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. The Company’s commission revenue also includes fees charged for its design and product development services provided to certain suppliers. The Company satisfies its performance obligation to its customers by performing the services in buyer agency agreements and thereby earning its commission fee at the point in time when the customer’s freight forwarder takes control of the goods. The Company satisfies its performance obligation with the suppliers and earns its design fee from the factory at the point in time when the customer’s freight forwarder takes control of the goods. +Licensing Segment. The Company licenses various trademarks it owns under licensing agreements for use in connection with the manufacture, marketing and sale of eyewear, outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage, fragrance, men’s leather accessories, women's and children's apparel, swimwear and household goods. The license agreements require the licensee to pay the Company a royalty and, in substantially all of the agreements, an advertising fee, both of which are based on the higher of a minimum or actual net sales percentage as defined in the various agreements. For license agreements where the sales-based percentage fee exceeds the contractual minimum fee, the Company recognizes revenues as the licensed products are sold as reported to the Company by its licensees. In substantially all of the Company’s license agreements, the minimum guaranteed royalty is earned and received on a quarterly basis. For license agreements where the sales-based percentage fee does not exceed the contractual minimum fee, the Company recognizes the contractual minimum fee as revenue ratably over the contractual period. +B. Variable Consideration +The Company supports retailers’ initiatives to maximize sales of the Company’s products on the retail floor by providing markdown allowances and participating in various other marketing initiatives such as subsidizing certain co-op advertising programs of such retailers. Such expenses are reflected in the consolidated financial statements as deductions to arrive at net sales. +Markdown Allowances +The Company provides markdown allowances to its retailer customers, which are recorded as a reduction of revenue in the period in which the branded footwear and accessories revenues are recognized. The Company estimates its markdown allowances by reviewing several performance indicators, including retailers' inventory levels, sell-through rates and gross margin levels. +F-15 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Co-op Advertising Programs +Under co-op advertising programs, the Company agrees to reimburse the retailer for a portion of the costs incurred by the retailer to advertise and promote some of the Company's products. The Company estimates the costs of co-op advertising programs based on the terms of the agreements with its retailer customers. +Rights of Return +The Company’s Retail segment accepts returns within 30 days from the date of sale for unworn merchandise that the Company is able to re-sell through the channel. The Company does not accept returns as a normal business practice from its branded and private label wholesale customers except for its Blondo brand product lines. The Company estimates returns based on historical experience and current market conditions. Such amounts have historically not been material. In addition, the Company's wholesale business may, from time to time, accept returns for damaged products from its wholesale customers or which the Company’s costs are normally charged back to the responsible third-party factory. +[13] Taxes Collected from Customers: +The Company accounts for certain taxes collected from its customers in accordance with the accounting guidance that permits companies to adopt a policy of presenting taxes in the income statement on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues). Taxes within the scope of this accounting guidance would include taxes that are imposed on a revenue transaction between a seller and a customer, such as sales taxes, use taxes, value-added taxes and some types of excise taxes. The Company records all taxes on a net basis. +[14] Cost of Sales: +All costs incurred to bring finished products to the Company’s distribution center or to the customers’ freight forwarder and, in the Retail segment, the costs to bring products to the Company’s stores (exclusive of depreciation and amortization) are included in the Cost of sales line on the Consolidated Statements of (Loss)/Income. These include the cost of finished products, purchase commissions, letter of credit fees, brokerage fees, sample expenses, custom duties, inbound freight, royalty payments on licensed products, labels and product packaging. All warehouse and distribution costs related to the Wholesale segments and freight to customers, if any, are included in the operating expenses line item of the Company’s Consolidated Statements of (Loss)/Income. The Company’s gross margins may not be comparable to those of other companies in the industry because they may include warehouse and distribution costs, as well as other costs excluded from cost of sales by the Company, as a component of cost of sales, while other companies report those costs on the same basis as the Company and include them in operating expenses. +[15] Warehouse and Shipping Costs: +The Company includes all warehouse and shipping costs for the Wholesale segments in the operating expenses line on the Consolidated Statements of (Loss)/Income. For the years ended December 31, 2020, 2019 and 2018, the total warehouse and distribution costs (except costs included to ship from warehouse to retail stores) included in operating expenses were $ 58,621 , $ 58,019 and $ 47,812 , respectively. Since the Company's standard terms of sales are “FOB Steve Madden warehouse,” the Company's wholesale customers absorb most shipping costs. Shipping costs to wholesale customers incurred by the Company are not considered significant and are included in the operating expenses line item in the Consolidated Statements of (Loss)/Income. +F-16 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +[16] Employee Benefit Plan: +The Company maintains a tax-qualified 401(k) plan, which is available to each of the Company's eligible employees who elect to participate after meeting certain length-of-service requirements. The Company made discretionary matching contributions of 50 % of employees' contributions up to a maximum of 6 % of employees' compensation, which vest to the employees over a period of time. Total matching contributions to the plan for 2020, 2019 and 2018 were approximately $ 1,809 , $ 2,048 and $ 1,893 , respectively. +[17] Derivative Instruments: +The Company uses derivative instruments to manage its exposure to cash-flow variability from foreign currency risk. Derivatives are carried on the balance sheet at fair value and included in prepaid expenses and other current assets or accrued expenses. The Company applies cash flow hedge accounting for its derivative instruments. Net derivative gains and losses attributable to derivatives subject to cash flow hedge accounting reside in accumulated other comprehensive income/(loss) and will be reclassified to earnings in future periods as the economic transactions to which the derivatives relate affect earnings. See Note M - Derivative Instruments. +[18] Income Taxes: +The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. +The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. See Note O - Income Taxes. +[19] Share-based Compensation: +The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for equity instruments of the Company. Share-based compensation cost for restricted stock awards is measured based on the closing fair market value of the Company’s common stock on the date of grant. Share-based compensation cost for stock options is measured at the grant date, based on the fair-value as calculated by the Black-Scholes-Merton (“BSM”) option-pricing model. The BSM option-pricing model incorporates various assumptions, including expected volatility, estimated expected life and interest rates. The Company recognizes share-based compensation cost over the award’s requisite service period which is presented in operating expenses in the Consolidated Statements of (Loss) / Income. See Note J - Equity- Based Compensation. +Note D – Acquisitions +GREATS Brand, Inc. +On August 9, 2019, the Company acquired 90 % of the outstanding common stock of GREATS Brand, Inc., owner of GREATS, a pioneering digitally native sneaker brand, for an initial payment of $ 12,829 and a future contingent payment of $ 5,000 based on the GREATS brand achieving certain EBITA targets in any full consecutive four quarters beginning on October 1, 2019 and ending on December 31, 2022 (See Note G - Fair Value Measurements). The amount of future payments will be determined by GREATS' future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $ 14,209 , net of cash acquired of approximately $ 290 . The acquisition was funded by cash on hand and adds a new digitally native footwear brand with added growth potential to the Company. +F-17 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +The results of the GREATS brand have been included in the consolidated financial statements since the date of acquisition within the Retail and Wholesale Footwear segments. +The following table summarizes the adjusted fair value of the assets acquired and liabilities assumed in the acquisition: +Cash $ 290 +Accounts receivable 41 +Inventory 1,387 +Prepaid and other assets 6,447 +Fixed assets 200 +Trademark (1) +13,086 +Customer relationships (2) +1,140 +Accounts payable ( 1,963 ) +Accrued expenses ( 1,055 ) +Deferred tax liabilities long-term ( 3,463 ) +Noncontrolling interest ( 1,611 ) +Total fair value of assets acquired $ 14,499 +(1) Trademark assigned an indefinite life. +(2) Customer relationships will be amortized over 20 years. +B.B. Dakota, Inc. +On August 12, 2019, the Company acquired 100 % of the outstanding common stock of B.B. Dakota, Inc., owner of BB Dakota, a contemporary women's apparel company, for an initial payment of $ 24,568 and a future contingent payment on the BB Dakota brand achieving certain EBITDA targets for each of the three consecutive full calendar years following the acquisition (See Note G - Fair Value Measurements). In connection therewith, the Company recorded a long-term liability of $ 4,770 as of the date of acquisition to reflect the estimated fair value of the contingent purchase price. The amount of future payments will be determined by BB Dakota's future performance with no minimum future payment. After the effect of closing adjustments, the purchase price was $ 29,404 , net of cash acquired of approximately $ 353 . The acquisition was funded by cash on hand and adds new apparel brands with added growth potential to the Company. +The results of the BB Dakota brand have been included in the consolidated financial statements since the date of acquisition within the Wholesale Accessories/Apparel and Retail segments. +F-18 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +The following table summarizes the adjusted fair value of the assets acquired and liabilities assumed as of the August 12, 2019 acquisition date: +Cash $ 353 +Accounts receivable 4,419 +Inventory 6,696 +Prepaid and other assets 855 +Fixed assets 382 +Trademark (1) +9,670 +Customer relationships (2) +2,530 +Accounts payable ( 2,885 ) +Accrued expenses ( 2,893 ) +Deferred tax liabilities long-term ( 2,735 ) +Total fair value excluding goodwill 16,392 +Goodwill 13,365 +Net assets acquired $ 29,757 +(1) Trademark assigned an indefinite life. +(2) Customer relationships will be amortized over 10 years. +The acquisitions were accounted for in accordance with FASB Topic ASC 805, Business Combinations, which requires that the total cost of an acquisition be allocated to tangible and intangible assets acquired and liabilities assumed based upon their respective fair values at the date of acquisition. +The Company recorded goodwill for the BB Dakota acquisition based on the amount by which the purchase price exceeded the fair value of the net assets acquired, which consists largely of the synergies expected from the acquisition. +Note E – Factoring Agreement +The Company had a collection agency agreement with Rosenthal & Rosenthal, Inc. (“Rosenthal”), until May 6, 2020. The agreement provided the Company with a credit facility in the amount of $ 30,000 , having a sub-limit of $ 15,000 on the aggregate face amount of letters of credit, at an interest rate based, at the Company's election, upon either the prime rate or LIBOR. Effective May 6, 2020, the credit facility was increased to $ 50,000 as a precautionary measure in response to the COVID-19 pandemic. +In conjunction with the Credit Agreement described in Note T below, on July 22, 2020, the Company and certain of its subsidiaries (collectively, the “Madden Entities”) entered into an Amended and Restated Deferred Purchase Factoring Agreement (the “Factoring Agreement”) with Rosenthal. Pursuant to the Factoring Agreement, Rosenthal serves as the collection agent with respect to certain receivables of the Madden Entities and is entitled to receive a base commission of 0.20 % of the gross invoice amount of each receivable assigned for collection, plus certain additional fees and expenses, subject to certain minimum annual commissions. Rosenthal will generally assume the credit risk resulting from a customer’s financial inability to make payment of credit-approved receivables. The initial term of the Factoring Agreement is twelve months, subject to automatic renewal for additional twelve-month periods, and the Factoring Agreement may be terminated at any time by Rosenthal or the Madden Entities on 60 days notice and upon the occurrence of certain other events. The Madden Entities pledged all of their rights under the Factoring Agreement to the Agent (see Note T ) under the Credit Agreement to secure obligations arising under the Credit Agreement. +F-19 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Note F – Note Receivable – Related Party +On June 25, 2007, the Company made a loan to Steven Madden, its Creative and Design Chief and a principal stockholder of the Company, in the amount of $ 3,000 in order for Mr. Madden to satisfy a personal tax obligation resulting from the exercise of stock options that were due to expire and to retain the underlying Company common stock. The loan, as amended, is secured by non-company securities held in Mr. Madden's brokerage account. The Company has agreed to forgive a portion of the note as long as Mr. Madden remains an employee of the Company through the note's maturity on December 31, 2023. For the years ended December 31, 2020, 2019 and 2018 the Company recorded a charge in the amount of $ 409 for each year, respectively, to write-off the required one-tenth of the principal amount of the secured promissory note, which was partially offset by imputed interest income of $ 31 , $ 40 and $ 47 , respectively. +Note G – Fair Value Measurement +The accounting guidance under Accounting Standards Codification 820-10, “Fair Value Measurements and Disclosures” (“ASC 820-10”) requires the Company to make disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those three levels is as follows: +• Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities. +• Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. +• Level 3: Significant unobservable inputs. +The Company’s financial assets and liabilities, subject to recurring fair value measurements, as of December 31, 2020 and 2019 are as follows: +December 31, 2020 +Fair Value Measurements +Fair value Level 1 Level 2 Level 3 +Liabilities: +Contingent consideration $ 207 $ — $ — $ 207 +Forward contracts 997 — 997 — +Total liabilities $ 1,204 $ — $ 997 $ 207 +December 31, 2019 +Fair Value Measurements +Fair value Level 1 Level 2 Level 3 +Liabilities: +Contingent consideration $ 9,124 $ — $ — $ 9,124 +Forward contracts 495 — 495 — +Total liabilities $ 9,619 $ — $ 495 $ 9,124 +Forward contracts are entered into to manage the risk associated with the volatility of future cash flows (see Note M - Derivative Instruments). Fair value of these instruments is based on observable market transactions of spot and forward rates. +F-20 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +The Company's Level 3 balance consists of contingent consideration related to acquisitions. The changes in the Company's Level 3 liabilities for the years ended December 31, 2020 and 2019 are as follows: +Balance at January 1, Acquisitions +Adjustments (1)(2) +Balance at December 31, +2020 +Liabilities: +Contingent consideration $ 9,124 — ( 8,917 ) $ 207 +2019 +Liabilities: +Contingent consideration $ 3,000 9,124 ( 3,000 ) $ 9,124 +(1) In 2020, amount consists of adjustments of $ 4,570 and $ 4,347 to the purchase accounting of B.B. Dakota, Inc. and GREATS Brand, Inc, respectively. The adjustment of $ 4,570 was a benefit to operating expenses, related to the change in valuation of the contingent consideration in connection with acquisition of B.B. Dakota, Inc. The adjustment of 4,347 , comprises an adjustment of $ 2,684 to the preliminary fair value, recorded during the first quarter 2020, and a benefit of $ 1,663 to operating expenses related to the change in valuation of the contingent consideration in connection with the acquisition of GREATS Brand, Inc. +(2) In 2019, amount consists of a benefit of $ 3,000 to operating expenses related to the Schwartz and Benjamin acquisition. +At December 31, 2020, the liability for potential contingent consideration was $ 7 in connection with the August 9, 2019 acquisition of GREATS Brand, Inc. Pursuant to the terms of an earn-out provision contained in the equity purchase agreement, between the Company and the sellers of GREATS Brand, Inc., earn-out payments are based on EBITA performance. The fair value of the contingent payments was estimated using a risk neutral simulation model to model the probability of different financial results of GREATS Brand, Inc. during the earn-out period, utilizing a discount rate of 10.0 %. +At December 31, 2020, the liability for potential contingent consideration was $ 200 in connection with the August 12, 2019 acquisition of B.B. Dakota, Inc. Pursuant to the terms of an earn-out provision contained in the equity purchase agreement, between the Company and the sellers of B.B. Dakota, Inc., earn-out payments are based on EBITDA performance. The fair value of the contingent payments was estimated using the Black-Scholes-Merton option pricing method with a nonlinear payoff structure based on a set of financial metrics of B.B. Dakota, Inc. during the earn-out period, utilizing a discount rate of 10.5 %. +The Company recorded a liability for potential contingent consideration in connection with the January 30, 2017 acquisition of Schwartz & Benjamin. The fair value of the contingent payments was estimated using the present value of the payments based on management’s projections of the financial results of Schwartz & Benjamin during the earn-out period. An earn-out payment in the aggregate amount of $ 7,000 was paid to the sellers of Schwartz & Benjamin in the first quarter of 2018, leaving a remaining balance of $ 3,000 at December 31, 2018. In the first quarter of 2019, the Company reversed the $ 3,000 balance, because it did not have to be paid due to the termination of the Kate Spade license agreement held by Schwartz & Benjamin as of December 31, 2019. +The fair value of trademarks is measured on a non-recurring basis using Level 3 inputs, including forecasted cash flows, discount rates and implied royalty rates. (see Note I) +The fair values of right-of-use lease assets and fixed assets related to Company-owned retail stores were determined using Level 3 inputs, including estimated discounted future cash flows associated with the assets using market rents and market participant assumptions. (see Notes H and N) +The carrying value of certain financial instruments such as cash equivalents, certificates of deposit, accounts receivable, factor accounts receivable and accounts payable approximates their fair values due to the short-term nature of their underlying terms. Fair value of the notes receivable held by the Company approximates their carrying value based upon their imputed or actual interest rate, which approximates applicable current market interest rates. Some assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances. These assets can include long-lived assets +F-21 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +that have been reduced to fair value when impaired. Assets that are written down to fair value when impaired are not subsequently adjusted to fair value unless further impairment occurs. +Note H - Property and Equipment +The major classes of assets and total accumulated depreciation and amortization are as follows: +December 31, +Average Useful Life 2020 2019 +Land and building +27.5 (Building) +$ 882 $ 947 +Leasehold improvements Lesser of remaining lease or asset life 88,012 86,625 +Machinery and equipment 10 years 6,340 6,257 +Furniture and fixtures +3 to 5 years +11,201 11,354 +Computer equipment and software +3 to 10 years +71,601 61,732 +Construction in progress 744 9,035 +178,780 175,950 +Less impairment (1) +( 14,712 ) — +Less accumulated depreciation and amortization ( 120,800 ) ( 110,446 ) +Property and equipment - net $ 43,268 $ 65,504 +1) Due to COVID-19 pandemic, impairment was recorded related to stores (see below for further explanation). +Depreciation and amortization expense related to property and equipment included in operating expenses amounted to approximately $ 13,350 in 2020, $ 15,933 in 2019 and $ 16,036 in 2018. Includes computer software amortization expense for 2020, 2019 and 2018 of $ 3,007 , $ 2,788 and $ 3,024 , respectively. +Property and equipment, along with other long-lived assets, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Due to the impacts of the COVID-19 pandemic on the Company’s operations and declines in the retail real estate market, the Company identified indicators of impairment for long-lived assets at certain of its retail stores. For such stores, the Company performed a recoverability test, comparing estimated undiscounted cash flows to the carrying value of the related long-lived assets. When the carrying value was more than the estimated undiscounted cash flows, the Company determined if an impairment test was required. Fair values of the long-lived assets were estimated using an income approach based on management’s forecast of future cash flows derived from continued retail operations and the fair values of individual operating lease assets were determined using estimated market rental rates. Significant estimates are used in determining future cash flows of each store over its remaining lease term, including the Company's expectations of future projected cash flows that include revenues, operating expenses, and market conditions. An impairment loss is recorded if the carrying amount of the long-lived asset group exceeds its fair value. As a result, the Company recorded impairment charges of $ 14,712 related to furniture fixtures and leasehold improvements for the year ended December 31, 2020. The impairment charges were recorded in the Retail segment. +F-22 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Note I – Goodwill and Intangible Assets +The following is a summary of the carrying amount of goodwill by segment as of December 31, 2020 and 2019: +Wholesale +Footwear Accessories/Apparel Retail Net Carrying Amount +Balance at January 1, 2019 $ 84,551 $ 49,324 $ 14,237 $ 148,112 +Acquisition — 11,955 4,644 16,599 +Purchase accounting adjustment — 1,409 ( 2,053 ) ( 644 ) +Translation and other 7,021 — 261 7,282 +Balance at December 31, 2019 91,572 62,688 17,089 171,349 +Purchase accounting adjustment — — ( 2,591 ) ( 2,591 ) +Translation and other ( 249 ) — ( 244 ) ( 493 ) +Balance at December 31, 2020 $ 91,323 $ 62,688 $ 14,254 $ 168,265 +The following tables detail identifiable intangible assets as of December 31, 2020 and 2019: +2020 +Estimated Lives Cost Basis Accumulated Amortization Impairment and other (1) (2) Net Carrying Amount +Trade names +6 – 10 years +$ 8,770 $ 8,770 $ — $ — +Customer relationships +10 - 20 years +38,980 20,805 ( 1,813 ) 16,362 +47,750 29,575 ( 1,813 ) 16,362 +Re-acquired right indefinite 35,200 — ( 7,800 ) 27,400 +Trademarks indefinite 115,481 — ( 44,052 ) 71,429 +$ 198,431 $ 29,575 $ ( 53,665 ) $ 115,191 +(1) Includes the effect of foreign currency translation related primarily to the movements of the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) Impairment charges of $ 44,273 were recorded, of which $ 27,025 , $ 16,345 , $ 456 and $ 447 were related to the Company's Cejon, Report, GREATS and Jocelyn trademarks, respectively. +2019 +Estimated Lives Cost Basis Accumulated Amortization Impairment and other (1)(2) Net Carrying Amount +Trade names +6 – 10 years +$ 8,770 $ 8,418 $ — $ 352 +Customer relationships +10 - 20 years +43,880 22,627 ( 1,782 ) 19,471 +52,650 31,045 ( 1,782 ) 19,823 +Re-acquired right indefinite 35,200 — ( 8,299 ) 26,901 +Trademarks indefinite 120,035 — ( 4,050 ) 115,985 +$ 207,885 $ 31,045 $ ( 14,131 ) $ 162,709 +(1) Includes the effect of foreign currency translation related primarily to the movement of the Canadian dollar and Mexican peso in relation to the U.S. dollar. +(2) An impairment charge of $ 4,050 was recorded in the second quarter of 2019 related to the Company's Brian Atwood trademark. The impairment was the result of the Company's decision to discontinue distribution of the brand as the Company explores alternatives. +F-23 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +The Company evaluates its goodwill and indefinite-lived intangible assets for indicators of impairment at least annually in the beginning of the third quarter of each year or whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. +In the first quarter of 2020, the Company conducted an interim quantitative impairment assessment of goodwill assigned to its reporting units as of March 31, 2020 and as a result, the fair values of the reporting units exceeded their carrying values by a substantial margin. In the third quarter of 2020, the Company performed a qualitative assessment of goodwill assigned to its reporting units as of July 1, 2020 and concluded that it is more likely than not that the fair values of its reporting units exceeded their respective carrying values and therefore, no goodwill impairment charges were recorded. +In the third quarter of 2020, the Company performed a qualitative assessment of certain indefinite-lived intangible assets as of July 1, 2020 and concluded that it is more likely than not that the fair values of those trademarks exceeded their respective carrying values, and therefore, no impairment charges were recorded. For the Company’s Cejon, Report, GREATS and Jocelyn trademarks, the Company performed quantitative impairment testing throughout the year due to indicators of impairment observed resulting primarily from the COVID-19 pandemic. The estimated fair values of these trademarks were determined using an excess earnings method. The excess earnings method utilizes the present value of the earnings attributable to the intangible asset after providing for the proportion of the earnings that attribute to returns for contributory assets. As a result of the Company’s impairment testing, during the twelve months ended December 31, 2020, the Company’s Cejon, Report, GREATS and Jocelyn trademarks with an aggregate carrying amount of $ 57,198 were written down to their fair values of $ 12,925 , resulting in a pre-tax impairment charge of $ 44,273 . Of the $ 44,273 impairment charge, $ 27,472 , $ 16,345 and $ 456 were recorded in impairment of intangibles in the Wholesale Accessories/Apparel, Wholesale Footwear, and Retail segments, respectively. +The amortization of intangible assets amounted to $ 4,010 for 2020, $ 6,258 for 2019 and $ 5,718 for 2018 and is included in operating expenses on the Company's Consolidated Statements of (Loss)/Income. The estimated future amortization expense for intangibles as of December 31, 2020 is as follows: +2021 $ 2,163 +2022 1,743 +2023 1,743 +2024 1,743 +2025 1,743 +Thereafter 7,227 +Total $ 16,362 +Note J – Equity-Based Compensation +In February 2019, the Company's Board of Directors approved the Steven Madden, Ltd. 2019 Incentive Compensation Plan (the “2019 Plan”), under which non-qualified stock options, stock appreciation rights, performance shares, restricted stock, other stock-based awards and performance-based cash awards may be granted to employees, consultants and non-employee directors. The 2019 Plan is the successor to the Company's Amended and Restated 2006 Stock Incentive Plan, as amended (the "2006 Plan"), the term of which expired on April 6, 2019. The Company's stockholders approved the 2019 Plan at the Company's annual meeting of stockholders held on May 24, 2019. +The following table summarizes the number of shares of common stock authorized for issuance under the 2019 Plan, the number of stock-based awards granted (net of expired or cancelled awards) under the 2019 Plan and the number of shares of common stock available for the grant of stock-based awards under the 2019 Plan: +Common stock authorized 11,000,000 +Stock-based awards, including restricted stock and stock options granted, net of expired or cancelled awards ( 2,126,956 ) +Common stock available for grant of stock-based awards as of December 31, 2020 8,873,044 +F-24 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +For the years ended December 31, 2020, 2019 and 2018, total equity-based compensation was as follows: +Years Ended December 31, +2020 2019 2018 +Restricted stock $ 18,740 $ 19,143 $ 16,720 +Stock options 3,899 4,027 4,356 +Total $ 22,639 $ 23,170 $ 21,076 +We calculate an estimated forfeiture rate annually based on historical forfeiture and expectations about future forfeitures. Equity-based compensation is included in operating expenses on the Company’s Consolidated Statements of Income. +Stock Options +Cash proceeds and intrinsic values related to total stock options exercised during December 31, 2020, 2019 and 2018 are as follows: +Years Ended December 31, +2020 2019 2018 +Proceeds from stock options exercised $ 1,609 $ 6,212 $ 13,036 +Intrinsic value of stock options exercised $ 993 $ 4,268 $ 6,841 +During the years ended December 31, 2020, 2019 and 2018, options to purchase approximately 642,534 shares of common stock with a weighted average exercise price of $ 26.72 , 738,903 options with a weighted average exercise price of $ 28.20 and 773,351 options with a weighted average exercise price of $ 26.38 vested, respectively. As of December 31, 2020, there were unvested options relating to 746,316 shares of common stock outstanding with a total of $ 3,547 of unrecognized compensation cost and an average vesting period of 1.2 years. Total consideration received for stock option exercises during the twelve months ended December 31, 2020, 2019 and 2018 was $ 1,609 , $ 6,212 , and $ 13,036 , respectively. The windfall tax benefit realized on these exercises in 2020, 2019 and 2018 was approximately $ 234 , $ 1,010 and $ 713 , respectively. +The Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of options granted, which requires several assumptions. The expected term of the options represents the estimated period of time until exercise and is based on the historical experience of similar awards. Expected volatility is based on the historical volatility of the Company’s common stock. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The dividend yield is based on the Company's annualized dividend per share amount divided by the Company's stock price. The following weighted average assumptions were used for stock options granted during 2020, 2019 and 2018: +2020 2019 2018 +Volatility +33.9 % to 56.7 % +32.0 % to 39.6 % +25.1 % to 33.2 % +Risk free interest rate +0.2 % to 1.6 % +1.6 % to 2.5 % +2.1 % to 2.9 % +Expected life in years +3.0 to 5.0 +1.0 to 5.0 +3.0 to 5.0 +Dividend yield 1.2 % 1.6 % 1.7 % +Weighted average fair value $ 10.15 $ 5.38 $ 6.75 +F-25 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Activity relating to stock options granted under the Company’s plans during the three years ended December 31, 2020 is as follows: +Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value +Outstanding at January 1, 2018 2,846,000 $ 23.87 +Granted 585,000 32.39 +Exercised ( 593,000 ) 22.04 +Forfeited ( 23,000 ) 22.59 +Outstanding at December 31, 2018 2,815,000 26.03 +Granted 272,000 30.93 +Exercised ( 273,000 ) 22.77 +Forfeited ( 12,000 ) 20.17 +Outstanding at December 31, 2019 2,802,000 26.85 +Granted 509,000 34.40 +Exercised ( 80,000 ) 21.57 +Forfeited ( 557,000 ) 34.74 +Outstanding at December 31, 2020 2,674,000 $ 26.80 3.2 $ 23,278 +Exercisable at December 31, 2020 1,928,000 $ 26.89 3.0 $ 16,416 +The following table summarizes information about stock options at December 31, 2020: +Options Outstanding Options Exercisable +Range of Exercise Price Number Outstanding Weighted Average Remaining Contractual Life (in Years) Weighted Average Exercise Price Number Exercisable Weighted Average Exercise Price +$20.15 to $24.72 465,000 1.5 $ 23.30 400,000 $ 23.22 +$24.73 to $29.30 1,605,000 3.3 25.18 1,031,000 25.33 +$29.31 to $33.88 290,000 5.3 30.45 252,000 30.26 +$33.89 to $38.47 263,000 2.7 35.85 242,000 35.90 +$38.48 to $43.05 51,000 5.8 42.14 3,000 41.18 +2,674,000 3.2 $ 26.80 1,928,000 $ 26.89 +F-26 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Restricted Stock +The following table summarizes restricted stock activity during the three years ended December 31, 2020: +Number of Shares Weighted Average Fair Value at Grant Date +Outstanding at January 1, 2018 5,876,000 $ 17.37 +Granted 509,000 31.70 +Vested ( 1,177,000 ) 18.44 +Forfeited ( 71,000 ) 25.61 +Outstanding at December 31, 2018 5,137,000 18.42 +Granted 633,000 32.64 +Vested ( 1,200,000 ) 19.40 +Forfeited ( 143,000 ) 28.61 +Outstanding at December 31, 2019 4,427,000 19.84 +Granted 561,000 30.35 +Vested ( 1,189,000 ) 19.96 +Forfeited ( 148,000 ) 34.89 +Outstanding at December 31, 2020 3,651,000 $ 20.81 +As of December 31, 2020, the Company had $ 50,210 of total unrecognized compensation cost related to restricted stock awards granted under the 2019 Plan and the 2006 Plan. This cost is expected to be recognized over a weighted average period of 3.4 years. The Company determines the fair value of its restricted stock awards based on the market price of its common stock on the date of grant. +The fair value of the restricted stock that vested during the years ended December 31, 2020, 2019 and 2018 was $ 23,839 , $ 23,263 and $ 36,122 , respectively. +On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment of Mr. Madden’s existing employment agreement, pursuant to which, on February 8, 2012, Mr. Madden was granted 2,194,586 restricted shares of the Company’s common stock at the then market price of $ 18.23 , which vest in equal annual installments over a seven -year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On June 30, 2012, Mr. Madden exercised his right under his employment agreement to receive an additional restricted stock award, and on July 3, 2012, he was granted 2,840,013 restricted shares of the Company's common stock at the then market price of $ 14.09 , which vest in equal annual installments over a six -year period commencing on December 31, 2018 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. On March 1, 2017, pursuant to his employment agreement, Mr. Madden was granted an option to purchase 1,125,000 shares of the Company’s common stock at an exercise price of $ 24.90 per share, which option is exercisable in equal annual installments over a five -year period commencing on the first anniversary of the grant date. On March 25, 2019, pursuant to an amendment of the employment agreement between the Company and Mr. Madden, which effected the extension of the term of the agreement through December 31, 2026, Mr. Madden was granted 200,000 restricted shares of the Company's common stock. The restricted stock award will vest in three nearly equal annual installments commencing on December 31, 2024. +On August 19, 2019, pursuant to his employment agreement with the Company, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $ 30.14 per share, which option vested in four equal installments on November 19, 2019, February 19, 2020, May 19, 2020 and June 30, 2020. +F-27 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +On June 30, 2020, pursuant to his employment agreement with the Company, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $ 24.83 per share, which option vests in four equal quarterly installments commencing on September 30, 2020 and ending on June 30, 2021. As of December 31, 2020, Mr. Madden had unvested options to purchase 562,500 shares of the Company's common stock and 2,560,543 restricted shares of the Company's common stock. +Note K - Preferred Stock +The Company has authorized 5,000,000 shares of preferred stock. The Board of Directors has designated 60,000 shares of such preferred stock as Series A Junior Participating Preferred Stock (“Series A Preferred”). Holders of the shares of Series A Preferred are entitled to dividends equal to 1,000 times dividends declared or paid on the Company's common stock. Each share of Series A Preferred entitles the holder to 1,000 votes on all matters submitted to the holders of common stock. The Series A Preferred has a liquidation preference of $ 1,000 per share and is not redeemable by the Company. No shares of preferred stock have been issued. +Note L - Share Repurchase Program +The Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), effective as of January 1, 2004. The Share Repurchase Program does not have a fixed expiration or termination date and may be modified or terminated by the Board of Directors at any time. On several occasions the Board of Directors has increased the amount authorized for repurchase of the Company's common stock. Most recently, on April 24, 2019, the Board of Directors approved the extension of the Company's Share Repurchase Program for up to $ 200,000 in repurchases of the Company's common stock, which includes the amount remaining under the prior authorizations. The Share Repurchase Program permits the Company to effect repurchases from time to time through a combination of open market repurchases or in privately negotiated transactions at such prices and times as are determined to be in the best interest of the Company. In the middle of March 2020, in response to the COVID-19 pandemic, as a precautionary measure the Board of Directors temporarily suspended the repurchase of the Company's common stock which the Board of Directors reinstated on February 24, 2021. During the twelve months ended December 31, 2020, an aggregate of 769,526 shares of the Company's common stock were repurchased under the Share Repurchase Program, at a weighted average price per share of $ 32.97 , for an aggregate purchase price of approximately $ 25,369 , which includes the amount remaining under the prior authorization. As of December 31, 2020, approximately $ 111,590 remained available for future repurchases under the Share Repurchase Program. +The Steven Madden, Ltd. 2019 Incentive Compensation Plan provides the Company with the right to deduct or withhold, or require employees to remit to the Company, an amount sufficient to satisfy any applicable tax withholding obligations applicable to stock-based compensation awards. To the extent permitted, employees may elect to satisfy all or part of such withholding obligations by tendering to the Company previously owned shares or by having the Company withhold shares having a fair market value equal to the employee's withholding tax obligation. During the twelve months ended December 31, 2020, an aggregate of 627,087 shares were withheld in connection with the settlement of vested restricted stock to satisfy tax withholding requirements, at an average price per share of $ 33.83 , for an aggregate purchase price of approximately $ 21,214 . +F-28 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Note M - Derivative Instruments +The Company uses derivative instruments, specifically, forward foreign exchange contracts, to manage the risk associated with the volatility of future cash flows. The foreign exchange contracts are used to mitigate the impact of exchange rate fluctuations on certain forecasted purchases of inventory and are designated as cash flow hedging instruments. As of December 31, 2020, the Company's entire net forward contracts hedging portfolio consisted of a notional amount of $ 30,203 , with the fair value included on the Consolidated Balance Sheets in other liabilities of $ 997 . For the twelve months ended December 31, 2020, the Company's hedging activities were considered ineffective due to COVID-19, and, thus, gains of $ 176 related to ineffectiveness from hedging activities were recognized in the Consolidated Statements of (Loss)/Income during the first quarter of 2020. As of December 31, 2019, the Company's hedging activities were considered effective and, thus, no ineffectiveness from hedging activities was recognized in the Consolidated Statements of Income. The following table presents the pre-tax amounts from derivative instruments affecting income and other comprehensive income ("OCI") for the years ended December 31, 2020, 2019 and 2018, respectively: +Cash Flow Hedges +Forward Contracts: Location of Gain or Loss Recognized in Net Income on Derivative Gain/(Loss) Recognized in Accumulated OCI Gain/(Loss) Reclassified into Income From Accumulated OCI +2020 Cost of Sales $ ( 997 ) $ ( 89 ) +2019 Cost of Sales ( 454 ) ( 10 ) +2018 Cost of Sales 748 ( 39 ) +Note N - Leases +During the first quarter 2019, the Company adopted ASU No. 2016-02, “Leases (Topic 842),” which requires leases with durations greater than twelve months to be recognized on the balance sheet. The Company adopted the standard using the modified retrospective approach with an effective date as of January 1, 2019. Upon adoption the Company recorded $ 194,100 of right-of-use asset and $ 209,000 of lease liabilities. +The Company elected the package of three practical expedients. As such, the Company did not reassess whether expired or existing contracts are or contain a lease and did not need to reassess the lease classifications or reassess the initial direct costs associated with expired or existing leases. The Company did not elect the hindsight practical expedient or the land easement practical expedient, neither of which are applicable to the Company. In addition, the Company has elected to take the practical expedient to not separate lease and non-lease components for all asset classes. +The Company leases office space, sample production space, warehouses, showrooms, storage and retail stores under operating leases. The Company’s portfolio of leases is primarily related to real estate. Because most of its leases do not provide a readily determinable implicit rate, the Company estimated its incremental borrowing rate to discount the lease payments based on information available at lease commencement. +Certain of the leases for the Company’s retail store facilities provide for variable lease payments based on future sales volumes at the leased location, which are not measurable at the inception of the lease and are therefore not included in the measurement of the right-of-use assets and lease liabilities. Under ASC 842, these variable lease costs are expensed as incurred. +As a result of the effects of the COVID-19 pandemic, during the third quarter of 2020, the Company executed amendments to certain leases in its existing operating lease portfolio, which included changes to rental payments either to be fully or partially based on the future sales volumes at the leased location. The Company considered these concessions in accordance with the FASB Staff Q&A—Topic 842 and Topic 840: Accounting For Lease Concessions Related to the Effects of the COVID-19 Pandemic (the “Lease Modification Q&A”), and determined that the concessions resulted in the total payments required by the modified contract being substantially the same as or less than total payments required by the original contract consistent with how they would be accounted for as though enforceable rights and obligations for those concessions existed in the original +F-29 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +contract. Consequently, the Company elected to account for these concessions as if they were contemplated in the enforceable rights and obligations of the existing contract. Please see Note S for further information. +The Company made payments amounting to $ 12,064 for COVID-19 lease amendments during the year ended December 31, 2020, which are included in variable lease costs. +Lease right-of-use assets, along with other long-lived assets, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Due to the impact of the COVID-19 pandemic on the Company’s operations and the decline in the retail real estate market, the Company identified indicators of impairment for long-lived assets at certain of its retail stores. For such stores, the Company performed a recoverability test, comparing estimated undiscounted cash flows to the carrying value of the related long-lived assets. When the carrying value was more than the estimated undiscounted cash flows, the Company wrote the assets down to their fair value. Fair values of the long-lived assets were estimated using an income approach based on management’s forecast of future cash flows derived from continued retail operations and the fair values of individual operating lease assets were determined using estimated market rental rates. Significant estimates are used in determining future cash flows of each store over its remaining lease term, including the Company's expectations of future projected cash flows. An impairment loss is recorded if the carrying amount of the long-lived asset group exceeds its fair value. As a result, the Company recorded impairment charges of $ 22,183 related to store lease right-of-use assets for the year ended December 31, 2020. The impairment charges were recorded in operating expenses in the Retail segment. +Lease Position +The table below presents the lease-related assets and liabilities recorded on the balance sheet as of December 31, 2020: +Classification on the Balance Sheet December 31, 2020 December 31, 2019 +Assets +Noncurrent (1) (2) +Operating lease right-of-use asset $ 101,379 $ 155,700 +Liabilities +Current Operating leases - current portion $ 34,257 $ 38,624 +Noncurrent Operating leases - long-term portion 98,592 133,172 +Total operating lease liabilities $ 132,849 $ 171,796 +Weighted-average remaining lease term 5.0 years 5.5 years +Weighted-average discount rate 4.3 % 4.4 % +(1) During the year ended December 31, 2020, the Company recorded pre-tax impairment charges related to the right-of-use assets of $ 22,183 . +(2) During the third quarter of 2019, the Company recorded a pre-tax charge related to the right-of-use asset of $ 1,883 . +Lease Costs +The table below presents certain information related to lease costs for the years ended December 31, 2020 and 2019: +Years Ended December 31, +2020 2019 +Operating lease cost $ 42,368 $ 48,387 +Variable lease cost (1) +13,412 172 +Short-term lease cost 238 239 +Less: sublease income 562 644 +Total lease cost $ 55,456 $ 48,154 +(1) The Company has incurred lease modification expenses of $ 12,064 , which have been included in variable lease costs for the year ended December 31, 2020. +F-30 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Other Information +The table below presents supplemental cash flow information related to leases for the years ended December 31, 2020 and 2019: +Years Ended December 31, +2020 2019 +Cash paid for amounts included in the measurement of lease liabilities +Operating cash flows used for operating leases $ 43,582 $ 46,324 +Years Ended December 31, +2020 2019 +Noncash transactions: +Right-of-use asset obtained in exchange for new operating lease liabilities $ 2,746 $ — +Right-of-use asset amortization expense $ 38,228 $ 36,170 +Undiscounted Cash Flows +The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the lease liabilities recorded on the balance sheet as of December 31, 2020: +2021 $ 39,700 +2022 30,905 +2023 22,407 +2024 18,128 +2025 14,794 +Thereafter 21,955 +Total minimum lease payments 147,889 +Less: interest 15,040 +Present value of lease liabilities $ 132,849 +A majority of the retail store leases provide for contingent rental payments if gross sales exceed certain targets. In addition, many of the leases contain rent escalation clauses to compensate for increases in operating costs and real estate taxes. Rent expense for the years ended December 31, 2020, 2019 and 2018 was approximately $ 49,619 , $ 61,283 and $ 58,332 , respectively. Included in such amounts are contingent rents of $ 46 , $ 138 and $ 516 in 2020, 2019 and 2018, respectively. +Rent expense is calculated by amortizing total base rental payments (net of any rental abatements, construction allowances and other rental concessions), on a straight-line basis, over the lease term. +F-31 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Note O - Income Taxes +The components of (loss)/income before income taxes are as follows: +2020 2019 2018 +Domestic $ ( 63,025 ) $ 119,166 $ 121,674 +Foreign 33,040 62,060 55,666 +$ ( 29,985 ) $ 181,226 $ 177,340 +The components of (benefit)/provision for income taxes were as follows: +2020 2019 2018 +Current: +Federal $ ( 10,764 ) $ 18,655 $ 32,880 +State and local ( 545 ) 3,765 5,012 +Foreign 7,958 11,940 11,771 +( 3,351 ) 34,360 49,663 +Deferred: +Federal ( 4,940 ) 2,309 ( 2,489 ) +State and local ( 2,962 ) 1,343 ( 200 ) +Foreign ( 451 ) 1,492 ( 133 ) +( 8,353 ) 5,144 ( 2,822 ) +$ ( 11,704 ) $ 39,504 $ 46,841 +A reconciliation between income taxes computed at the federal statutory rate and the effective tax rate is as follows: +December 31, +2020 2019 2018 +Income taxes at federal statutory rate 21.0 % 21.0 % 21.0 % +Effects of foreign operations 10.3 ( 0.1 ) ( 0.7 ) +Stock-based compensation 11.8 ( 3.4 ) ( 2.1 ) +State and local income taxes - net of federal income tax benefit 12.9 2.3 2.4 +Nondeductible items ( 0.4 ) 0.7 0.1 +Impact of tax reform 14.0 — 2.0 +Global intangible low-taxed income ("GILTI") ( 18.2 ) — — +Valuation allowance ( 9.3 ) 0.6 0.4 +Prepaid tax adjustment related to prior years — — 3.8 +Other ( 3.1 ) 0.7 ( 0.5 ) +Effective tax rate 39.0 % 21.8 % 26.4 % +The primary changes between the Company’s effective tax rate for the year ended December 31, 2020 and 2019 are due to the year-over-year benefit resulting from the exercising and vesting of share-based awards, an increase in tax benefit related to a net operating loss carryback claim set forth by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), an +F-32 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +increase in the GILTI tax, a decrease in the state taxes incurred, and an increase in pre-tax losses in jurisdictions with higher tax rates. +The components of deferred tax assets and liabilities are as follows: +December 31, +2020 2019 +Deferred tax assets +Receivable allowances $ 5,226 $ 8,537 +Inventory 4,681 3,247 +Accrued expenses 1,109 1,453 +Deferred compensation 7,418 8,643 +Net operating loss carryforwards 9,987 7,531 +Lease liability 31,975 41,382 +Other 1,345 493 +Gross deferred tax assets before valuation allowance 61,741 71,286 +Less: valuation allowance ( 4,968 ) ( 2,230 ) +Gross deferred tax assets after valuation allowance 56,773 69,056 +Deferred tax liabilities +Depreciation and amortization ( 13,744 ) ( 17,532 ) +Unremitted earnings of foreign subsidiaries ( 2,964 ) ( 3,025 ) +Right-of-use asset ( 24,211 ) ( 37,248 ) +Amortization of goodwill ( 7,665 ) ( 7,682 ) +Indefinite-lived intangibles ( 5,336 ) ( 9,446 ) +Gross deferred tax liabilities ( 53,920 ) ( 74,933 ) +Net deferred tax assets/(liabilities) $ 2,853 $ ( 5,877 ) +The Company applies the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. +The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax‑planning strategies in making this assessment. +The Company’s increase in valuation allowance of $ 2,738 is due to a deferred tax asset on an outside basis difference which the Company does not expect to realize, and net operating loss deferred tax assets in various foreign subsidiaries, which resulted in an aggregate valuation allowance of $ 4,968 for the year ended December 31, 2020. +F-33 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +December 31, +2020 2019 2018 +Beginning Balance $ 1,150 $ 1,511 $ 361 +Additions for tax positions of prior years 1,145 — — +Additions related to current period tax positions — — 1,150 +Reductions for tax positions of prior years — ( 361 ) — +Ending Balance $ 2,295 $ 1,150 $ 1,511 +For the years ended December 31, 2020, 2019 and 2018 the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is approximately $ 2,295 , $ 1,150 and $ 1,511 , in the aggregate, respectively. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. Accrued interest and penalties on unrecognized tax benefits and interest and penalty expense was immaterial to the consolidated financial statements for all periods presented. The unrecognized tax benefits are not expected to materially change in the next twelve months. +The Company files income tax returns in the U.S., for federal, state, and local purposes, and in certain other foreign jurisdictions. The Company's tax years 2017 through 2020 remain open to examination by most taxing authorities. During 2017, the U.S. Internal Revenue Service completed its audit of the Company's 2014 U.S. income tax return. +The Company’s consolidated financial statements provide for any related tax liability on amounts that may be repatriated from foreign operations, aside from undistributed earnings of certain of the Company’s foreign subsidiaries that are intended to be indefinitely reinvested in operations outside the U.S. The deferred tax liability of $ 2,964 at December 31, 2020 reflects the withholding tax on amounts that may be repatriated from foreign operations. +In response to the COVID-19 pandemic, the CARES Act was signed into law on March 27, 2020, which includes significant corporate income tax and payroll tax provisions aimed at providing economic relief. The Company received or expects to continue to receive a corporate income tax benefit on the net operating loss carryback provision set forth by the CARES act, as well as favorable cash flow benefits related to the employee retention credit, employer payroll tax deferral, and accelerated depreciation related to qualified improvement property. The Company will continue to assess the impact of the CARES Act and other COVID-19 related incentives. +Note P – Commitments, Contingencies and Other +[1] Legal Proceedings: +In the ordinary course of business, the Company has various pending cases involving contractual disputes, employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these legal proceedings should not have a material impact on the Company's financial condition, results of operations or cash flows. It is the policy of management to disclose the amount or range of reasonably possible losses in excess of recorded amounts. +[2] Employment agreements: +Edward R. Rosenfeld. On December 31, 2018, the Company entered into a new employment agreement with Edward R. Rosenfeld, the Chief Executive Officer and the Chairman of the Board of Directors of the Company, to replace an existing employment agreement that expired on that date. The agreement, which expires on December 31, 2021, provides for an annual salary of approximately $ 1,042 for the period from January 1, 2021 through December 31, 2021. In addition, pursuant to his new employment agreement, on December 31, 2018, Mr. Rosenfeld received a grant of 87,500 shares of the Company's common stock subject to certain restrictions and, on February 1, 2019, Mr. Rosenfeld received an additional grant of 87,500 shares of the Company's common stock also subject to certain +F-34 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +restrictions. The restricted shares received by Mr. Rosenfeld on December 31, 2018 and February 1, 2019 were issued under the Company's 2006 Stock Incentive Plan, as amended, and vest in equal annual installments over a five -year period that commenced on December 1, 2019 and February 1, 2020, respectively. On March 16, 2020, Mr. Rosenfeld received a grant of 108,030 shares of the Company’s common stock under the 2019 Incentive Compensation Plan, which vest in five equal annual installments of 21,606 shares commencing on March 1, 2021. Additional compensation and bonuses, if any, are at the sole discretion of the Company's Board of Directors. +Steven Madden. On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s existing employment agreement with the Company. The amended agreement, which extended the term of Mr. Madden's employment through December 31, 2023, provides for a base salary of approximately $ 7,026 per annum for the period between January 1, 2016 and December 31, 2023. Pursuant to the amended agreement, on February 8, 2012, Mr. Madden was granted 2,194,586 restricted shares of the Company’s common stock at the then market price of $ 18.23 , which vest in equal annual installments over a seven -year period commencing on December 31, 2017 and, thereafter, on each December 31 through December 31, 2023, subject to Mr. Madden’s continued employment on each such vesting date. Also under the amended agreement, Mr. Madden received the right, exercisable on certain specified dates in fiscal year 2012 only, to elect to receive a grant of restricted stock for a number of shares of the Company’s common stock valued at $ 40,000 in consideration for certain specified reductions in his annual base salary in years subsequent to 2012. Mr. Madden exercised this right, and on July 3, 2012, he was granted 2,840,013 restricted shares of the Company's common stock at the then market price of $ 14.09 , which shares vest in equal annual installments over a six -year period commencing on December 31, 2018. Further, in addition to the opportunity for cash bonuses at the sole discretion of the Board of Directors, Mr. Madden’s amended agreement entitles him to an annual life insurance premium payment as well as an annual stock option grant. The amended agreement also provided Mr. Madden the potential for an additional one-time stock option award for 1,125,000 shares of the Company’s common stock (the “EPS Option”) in the event that the Company achieves earnings per share on a fully-diluted basis equal to $ 1.33 as to any fiscal year ending December 31, 2015 or thereafter, which performance criteria was achieved for the fiscal year ended December 31, 2016. As such, on March 1, 2017, Mr. Madden was granted the EPS Option at an exercise price of $ 24.90 per share. The EPS Option vests in equal annual installments over a five -year period commencing on the first anniversary of the grant date. On March 25, 2019, the Company and Mr. Madden, entered into an amendment to Mr. Madden's existing employment agreement with the Company. The amended agreement extends the term of Mr. Madden's employment for three years through December 31, 2026. Pursuant to the amended agreement, on March 25, 2019 Mr. Madden was granted 200,000 restricted shares of the Company's common stock. The restricted stock award will vest in three nearly equal annual installments commencing on December 31, 2024. +On August 19, 2019, pursuant to his employment agreement with the Company, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $ 30.14 per share, which option vested in four equal installments on November 19, 2019, February 19, 2020, May 19, 2020 and June 30, 2020. +On June 30, 2020, pursuant to his employment agreement with the Company, Mr. Madden was granted an option to purchase 225,000 shares of the Company's common stock at an exercise price of $ 24.83 per share, which option vests in four equal quarterly installments commencing on September 30, 2020 and ending on June 30, 2021. +Zine Mazouzi. On December 8, 2020, the Company named Zine Mazouzi its Chief Financial Officer, replacing Arvind Dharia, whose employment agreement ended December 31, 2020. The agreement, which went into effect on January 1, 2021, remains in effect through December 31, 2023. Mr. Mazouzi's agreement provides for an annual salary of $ 550 in 2021, $ 575 in 2022 and $ 600 in 2023. In addition, pursuant to his employment agreement, on January 4, 2021, Mr. Mazouzi was granted 29,155 restricted shares of the Company's common stock under the Company's 2019 Incentive Compensation Plan. The restricted shares vest in five equal annual installments commencing on January 4, 2022. The agreement provides to Mr. Mazouzi the opportunity for an annual performance-based bonus for the fiscal years ended December 31, 2021, 2022 and 2023. +Amelia Newton Varela. On December 27, 2019, the Company entered into a new employment agreement with Amelia Newton Varela, the Company’s President and a member its Board of Directors, to replace an existing employment agreement that expired on December 31, 2019. The agreement, which remains in effect through December 31, 2022, +F-35 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +provides for an annual salary of $ 725 in 2021 and $ 750 in 2022. In addition, pursuant to her new employment agreement, on January 2, 2020, Ms. Varela was granted 27,000 restricted shares of the Company's common stock under the Company's 2019 Incentive Compensation Plan. The restricted shares vest in five equal annual installments commencing on January 2, 2021. The agreement provides to Ms. Varela the opportunity for an annual performance-based bonus for the fiscal years ended December 31, 2020, 2021 and 2022. +The Company and Ms. Varela entered into an amendment to her employment agreement, dated February 25, 2021. The amendment set a cap on bonuses payable to Ms. Varela based on our financial performance in 2021 and 2022 of $ 450 . In addition, the Company issued 26,350 restricted shares of common stock to Ms. Varela on March 1, 2021. All of the other terms and provisions of Ms. Varela's 2019 agreement remain in full force and effect. +Awadhesh Sinha. On December 27, 2019, the Company entered into a new employment agreement with Awadhesh Sinha, the Company's Chief Operating Officer, to replace an existing employment agreement that expired on December 31, 2019. The new agreement, which remains in effect through December 31, 2021, provides for an annual salary of $ 767 in 2021 and provides to Mr. Sinha the opportunity for annual cash and share-based incentive bonuses. In addition, pursuant to his new employment agreement, on January 2, 2020, Mr. Sinha received a grant of 11,598 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Mr. Sinha were issued under the Company's 2019 Incentive Compensation Plan and vest in equal annual installments over a two -year period on each of December 15, 2020 and December 15, 2021. +The Company and Mr. Sinha entered into an amendment to his employment agreement, dated February 25, 2021. This amendment extends the term of Mr. Sinha’s employment with the Company through December 31, 2023. Under this amendment, Mr. Sinha will be required to devote not more than four days per week to his duties as Chief Operating Officer beginning on January 1, 2022, and on January 1, 2023, he will become a Senior Advisor to the Company and will be required to devote not more than two days per week to such executive-level duties as are reasonably assigned to him by our Chief Executive Officer. The amendment (i) provides that Mr. Sinha’s base compensation will be $ 500 for calendar year 2022 and $ 300 for calendar year 2023, (ii) his bonus based on our financial performance in 2021 will be capped at $ 450 , (iii) his bonus based on our financial performance in 2022 will be capped at $ 200 , and (iv) he will not be entitled to a performance bonus for 2023. All of the other terms and provisions of Mr. Sinha's 2019 agreement remain in full force and effect. +Karla Frieders. On May 11, 2020, the Company entered into a new employment agreement with Karla Frieders, the Company’s Chief Merchandising Officer, to replace an existing employment agreement which expired on April 30, 2020. The agreement, which remains in effect through April 30, 2023, provides to Ms. Frieders an annual salary of $ 590 for the period commencing on May 1, 2020 and ending on April 30, 2023 and an annual performance-based bonus for the fiscal years ending December 31, 2020, 2021 and 2022 in an amount to be determined at the discretion of the Company. In addition, pursuant to her new employment agreement, on May 11, 2020, Ms. Frieders received a grant of 32,758 shares of the Company's common stock subject to certain restrictions. The restricted shares received by Ms. Frieders were issued under the Company's 2019 Incentive Compensation Plan and vest in equal annual installments over a five -year period commencing on May 1, 2021 and ending on May 1, 2025. +[3] Letters of credit: +At December 31, 2020, the Company had $ 188 open letters of credit for the purchase of inventory. +[4] License agreements: +In January 2018, the Company entered into a license agreement with Nine West Development LLC, subsequently acquired by WHP Global, for the right to manufacture, market and sell women's fashion footwear and handbags under the Anne Klein®, AK Sport®, AK Anne Klein Sport® and the Lion Head Design® trademarks. The agreement, unless extended, expires on June 30, 2023. The agreement requires that the Company pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. +F-36 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +On February 9, 2011, the Company entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A, under which the Company has the right to use the Superga® trademark in connection with the sale and marketing of women's footwear. The agreement requires the Company to pay the licensor a royalty equal to a percentage of net sales and a minimum royalty in the event that specified net sales targets are not achieved. The agreement was amended on April 11, 2013 to extend the term of the agreement through December 31, 2022. +Future minimum royalty payments under all of the Company's license agreements are $ 8,350 for 2021 and $ 11,875 for 2022 through 2023. Royalty expenses are included in the “cost of goods” section of the Company's Consolidated Statements of (Loss)/Income. +[5] Concentrations: +The Company maintains cash and cash equivalents with various major financial institutions, which at times are in excess of the amount insured. +During the year ended December 31, 2020, the Company did not purchase more than 10 % of its merchandise from any single supplier. Total product purchases from vendors located in China for the year ended December 31, 2020 were 78 %. +During the year ended December 31, 2019, the Company did not purchase more than 10 % of its merchandise from any single supplier. Total product purchases from vendors located in China for the year ended December 31, 2019 were 88 %. +During the year ended December 31, 2018, the Company did not purchase more than 10 % of its merchandise from any single supplier. Total product purchases from vendors located in China for the year ended December 31, 2018 were approximately 94 %. +For the year ended December 31, 2020, sales to Walmart Inc. represented approximately 13.9 % of total revenue. At December 31, 2020, Walmart Inc. represented 19.0 % of total accounts receivable, Target Corporation represented 14.9 % of total accounts receivable, Ross Stores, Inc. represented 11.8 % of total accounts receivable, The TJX Companies, Inc. represented 11.7 % of total accounts receivable and Nordstrom, Inc. represented 10.3 % of total accounts receivable. The Company did not have any other customers who accounted for more than 10 % of total revenue or any other customers who accounted for more than 10 % of total accounts receivable. +At December 31, 2019, sales to Walmart Inc. represented approximately 11.9 % of total revenue. At December 31, 2019, Walmart Inc. represented 17.9 % of total accounts receivable, Target Corporation represented 13.6 % of total accounts receivable and Nordstrom, Inc. represented 10.6 % of total accounts receivable. The Company did not have any other customers who accounted for more than 10 % of total revenue or any other customers who accounted for more than 10 % of total accounts receivable. +At December 31, 2018, sales to Walmart Inc. represented approximately 17.6 % of total accounts receivable, Target Corporation represented 13.8 % of total accounts receivable and Nordstrom, Inc. represented 10.6 % of total accounts receivable. The Company did not have any other customers who accounted for more than 10 % of total net revenue or any other customers who accounted for more than 10 % of total accounts receivable. +Purchases are made primarily in United States dollars. +F-37 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +[6] Valuation and qualifying accounts: +The following is a summary of markdown and chargeback allowances, allowance for doubtful accounts related to accounts receivable and deferred tax asset valuation allowance: +Balance at Beginning of Year Additions Deductions Balance at End of Year +Year ended December 31, 2020 +Markdown and chargeback allowances $ 34,207 $ 30,508 $ 45,883 $ 18,832 +Allowance for doubtful accounts 11,066 1,405 3,528 8,943 +Deferred tax asset valuation allowance 2,230 2,738 — 4,968 +Total $ 47,503 $ 34,651 $ 49,411 $ 32,743 +Year ended December 31, 2019 +Markdown and chargeback allowances $ 31,357 $ 90,031 $ 87,181 $ 34,207 +Allowance for doubtful accounts 10,849 679 462 11,066 +Deferred tax asset valuation allowance 649 1,581 — 2,230 +Total $ 42,855 $ 92,291 $ 87,643 $ 47,503 +Year ended December 31, 2018 +Markdown and chargeback allowances $ 26,213 $ 86,463 $ 81,319 $ 31,357 +Allowance for doubtful accounts 616 10,887 654 10,849 +Deferred tax asset valuation allowance — 649 — 649 +Total $ 26,829 $ 97,999 $ 81,973 $ 42,855 +Note Q – Operating Segment Information +The Company operates the following operating segments, which are presented as reportable segments: Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing. The Wholesale Footwear segment, through sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores, derives revenue, both domestically and internationally, from sales of branded and private label women’s, men’s, girls’ and children’s footwear. The Wholesale Accessories/Apparel segment, which includes branded and private label handbags, apparel, belts and small leather goods as well as cold weather and selected other fashion accessories, derives revenue, both domestically and internationally, from sales to department stores, mid-tier retailers, mass market merchants, online retailers and specialty stores. The Company's Wholesale Footwear and Wholesale Accessories/Apparel segments derive revenue from certain countries in Asia, Europe, North America, and Africa and, under special distribution arrangements, in Australia, the Middle East, India, South and Central America, New Zealand, Southeast Asia and pursuant to a partnership agreement in Singapore. The Retail segment, through the operation of Company-owned retail stores in the United States, Canada and Mexico, the Company's joint ventures in South Africa, China, Taiwan and Israel and its websites, derives revenue from sales of branded women’s, men’s and children’s footwear, accessories, apparel and licensed products to consumers. The First Cost segment represents activities of a subsidiary that earns commissions and design fees for serving as a buying agent of footwear products to mass-merchants, mid-tier department stores and other retailers with respect to their purchase of footwear. In the Licensing segment, the Company generates revenue by licensing its Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks and other trademark rights for use in connection with the manufacture, marketing and sale of eyewear, outerwear, hosiery, activewear, sleepwear, jewelry, watches, hair accessories, umbrellas, bedding, luggage and fragrance. In addition, this segment licenses the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children's apparel, hosiery, outerwear, sleepwear, activewear, jewelry, watches, bedding, luggage, umbrellas and household goods. The Licensing segment also licenses the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear. +F-38 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Year ended Wholesale Footwear Wholesale Accessories/Apparel Total Wholesale Retail First Cost Licensing Consolidated +December 31, 2020 +Total revenue $ 713,662 $ 235,892 $ 949,554 $ 239,389 $ 3,902 $ 8,969 $ 1,201,814 +Gross profit 226,556 70,908 297,464 154,206 3,902 8,969 464,541 +Income/(loss) from operations 47,854 ( 17,496 ) 30,358 ( 69,248 ) 1,507 5,778 ( 31,605 ) +Depreciation and amortization 6,763 2,586 9,349 7,447 564 — 17,360 +Segment assets 812,654 111,621 924,275 196,019 11,026 6,441 1,137,761 +Capital expenditures 3,733 1,427 5,160 1,402 — — 6,562 +December 31, 2019 +Total revenue $ 1,112,091 $ 334,862 $ 1,446,953 $ 321,182 $ 7,441 $ 11,581 $ 1,787,157 +Gross profit 373,587 98,131 471,718 195,277 7,441 11,581 686,017 +Income/(loss) from operations 163,482 22,455 185,937 ( 9,050 ) ( 8,177 ) 8,104 176,814 +Depreciation and amortization 8,061 3,186 11,247 9,580 510 — 21,337 +Segment assets 868,059 119,231 987,290 275,937 8,979 6,441 1,278,647 +Capital expenditures 9,573 3,783 13,356 4,955 — — 18,311 +December 31, 2018 +Total revenue $ 1,058,366 $ 300,091 $ 1,358,457 $ 295,152 $ 11,226 $ 12,899 $ 1,677,734 +Gross profit 345,909 91,739 437,648 178,390 11,226 12,899 640,163 +Income/(loss) from operations 140,138 27,092 167,230 735 ( 4,549 ) 9,966 173,382 +Depreciation and amortization 8,536 2,274 10,810 10,593 944 135 22,482 +Segment assets 774,081 149,644 923,725 114,194 28,210 6,441 1,072,570 +Capital expenditures 5,362 1,428 6,790 5,660 — — 12,450 +Revenues by geographic area are as follows: +Year Ended December 31, +2020 2019 2018 +Domestic (a) $ 1,054,343 $ 1,572,045 $ 1,473,588 +International 147,471 215,112 204,146 +Total $ 1,201,814 $ 1,787,157 $ 1,677,734 +(a) Includes revenues of $ 249,982 , $ 337,028 and $ 326,635 for the years ended 2020, 2019 and 2018 related to sales to U.S. customers where the title is transferred outside the U.S. and the sale is recorded by our international entities. +F-39 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Note R - Quarterly Results of Operations (unaudited) +The following is a summary of the quarterly results of operations for the years ended December 31, 2020 and 2019: +March 31, June 30, September 30, December 31, +2020: +Net sales $ 355,684 $ 141,363 $ 342,830 $ 349,066 +Commission and licensing fee income 3,484 1,449 4,037 3,901 +Total revenue 359,168 142,812 346,867 352,967 +Cost of sales (exclusive of depreciation and amortization) 225,704 86,924 206,990 217,655 +Gross profit 133,464 55,888 139,877 135,312 +Net (loss)/income attributable to Steven Madden, Ltd. $ ( 17,451 ) $ ( 16,586 ) $ ( 6,951 ) $ 22,591 +Net (loss)/income per share: +Basic $ ( 0.22 ) $ ( 0.21 ) $ ( 0.09 ) $ 0.29 +Diluted $ ( 0.22 ) $ ( 0.21 ) $ ( 0.09 ) $ 0.28 +2019: +Net sales $ 410,940 $ 444,974 $ 497,308 $ 414,912 +Commission and licensing fee income 4,848 4,655 4,806 4,713 +Total revenue 415,788 449,629 502,114 419,625 +Cost of sales (exclusive of depreciation and amortization) 253,943 279,629 306,277 261,291 +Gross profit 161,845 170,000 195,837 158,334 +Net income attributable to Steven Madden, Ltd. $ 34,525 $ 36,572 $ 52,463 $ 17,751 +Net income per share: +Basic $ 0.43 $ 0.46 $ 0.66 $ 0.23 +Diluted $ 0.41 $ 0.44 $ 0.63 $ 0.21 +Because each quarter is calculated as a discrete period, the sum of the four quarters may not equal the full-year amount as reflected in the Company’s Consolidated Statements of (Loss)/Income. This is in accordance with prescribed reporting requirements. +During the fourth quarter of 2020, the Company recorded an after-tax expense of $ 3,879 related to payments and a provision for early lease charges and an after-tax charge related to trademark impairments of $ 1,360 . Also during the fourth quarter of 2020, the Company recorded in net income attributable to Steven Madden, Ltd. a tax benefit of $ 4,191 in connection with the carryback provision of the CARES Act, an after-tax benefit of $ 932 related to the recovery from the Payless ShoeSource bankruptcy and an after-tax benefit of $ 930 related to the change in valuation of a contingent considerations. +Note S - Recent Accounting Pronouncements +Recently Adopted +In April 2020, the FASB staff issued Staff Q&A—Topic 842 and Topic 840: Accounting For Lease Concessions Related to the Effects of the COVID-19 Pandemic (the “Lease Modification Q&A”) focused on the application of lease accounting guidance to lease concessions provided as a result of the COVID-19 global pandemic. The FASB staff indicated that it would be acceptable for entities to elect to not evaluate whether a concession provided by a lessor due to COVID-19 is a lease modification. Entities making this election can then elect to apply the lease modification guidance in ASC 842 or to account for lease concessions related to the effects of the COVID-19 pandemic consistent with how they would be accounted for as though those concessions existed in the original contract. The election is available for concessions related to the effects of the COVID-19 pandemic that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee. +F-40 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +In accordance with this interpretive guidance, the Company elected to account for lease concessions related to the effects of the COVID-19 pandemic that resulted in the total payments required by the modified contract being substantially the same as or less than total payments required by the original contract consistent with how they would be accounted for as though enforceable rights and obligations for those concessions existed in the original contract. +In August 2018, the FASB issued Accounting Standards Update No. 2018-15 (“ASU 2018-15”), “Intangibles-Goodwill and Other-Internal-Use Software (Topic 350): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract.” This new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 was effective January 1, 2020 and did not have any significant impact on the Company’s financial position or results of operations. +In August 2018, the FASB issued Accounting Standards Update No. 2018-13 (“ASU 2018-13”), “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This new guidance removes certain disclosure requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 was effective January 1, 2020 and did not have any significant impact on the Company’s financial position or results of operations. +In June 2016, the FASB issued Accounting Standards Update 2016-13 ("ASU 2016-13"), "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 was effective January 1, 2020 and did not have any significant impact on the Company’s financial position or results of operations. +In December 2019, the FASB issued ASU No. 2019-12 (“ASU 2019-12”), Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU is intended to simplify various aspects related to accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and clarifying certain aspects of the current guidance to promote consistency among reporting entities. ASU 2019-12 is effective for annual periods beginning after December 15, 2020 and interim periods within those annual periods, with early adoption permitted. An entity that elects early adoption must adopt all the amendments in the same period. Most amendments within this ASU are required to be applied on a prospective basis, while certain amendments must be applied on a retrospective or modified retrospective basis. On April 1, 2020, the Company early adopted the new standard, with no impact to its consolidated financial statements and related disclosures. +Not Yet Adopted +In March 2020, the FASB issued ASU 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting,” (“ASU No. 2020-04”), which provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable the Company's borrowing instruments that use LIBOR as a reference rate, and is effective immediately, but is only available through December 31, 2022. The Company is currently evaluating the impact of ASU 2020-04; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its condensed consolidated financial statements. +F-41 +STEVEN MADDEN, LTD. AND SUBSIDIARIES +Notes to Consolidated Financial Statements +December 31, 2020, 2019 and 2018 +($ in thousands, except share and per share data) +Note T – Credit Agreement +Credit Agreement +On July 22, 2020, the Company entered into a $ 150,000 , secured revolving credit agreement (the “Credit Agreement”) with various lenders and Citizens Bank, N.A., as administrative agent (the “Agent”), which replaced the Company’s existing credit facility provided by Rosenthal & Rosenthal, Inc. (“Rosenthal”). The Credit Agreement provides for a revolving credit facility (the “Credit Facility”) scheduled to mature on July 22, 2025. The Company uses the Credit Facility for general corporate purposes. +The initial $ 150,000 maximum availability under the Credit Facility is subject to a borrowing base calculation consisting of certain eligible accounts receivable, credit card receivables, inventory, and in-transit inventory. Availability under the Credit Facility is reduced by outstanding letters of credit. The Company may from time-to-time increase the maximum availability under the Credit Agreement by up to $ 100,000 if certain conditions are satisfied. +Borrowings under the Credit Agreement generally bear interest at a variable rate equal to, at the Company’s election, (i) LIBOR for the applicable interest period or (ii) the base rate. The base rate is the highest of (a) the prime rate announced by Citizens Bank, N.A. or its parent company, (b) the sum of the federal funds effective rate plus 0.50 %, and (c) the sum of one-month LIBOR plus 1 %), plus in each case a specified margin, which is based upon average availability under the Credit Facility from time to time. +Under the Credit Agreement, the Company must also pay (i) a commitment fee to the Agent, for the account of each lender, which accrues at a rate equal to 0.40 % per annum on the average daily unused amount of the commitment of such lender, (ii) a letter of credit participation fee to the Agent, for the account of each lender, ranging from 2.00 % to 2.50 % per annum, based upon average availability under the Credit Facility from time to time, multiplied by the average daily amount available to be drawn under the applicable letter of credit, and (iii) a letter of credit fronting fee to each issuer of a letter of credit under the Credit Agreement, which will accrue at a rate per annum separately agreed upon between the Company and such issuer. +The Credit Agreement contains various restrictions and covenants applicable to the Company and its subsidiaries. Among other requirements, availability under the Credit Facility must, at all times, (i) prior to the occurrence of the permanent borrowing base trigger (as defined in the Credit Agreement), equal or exceed the greater of $ 22,500 and 15 % of the line cap (as defined in the Credit Agreement), and (ii) after the occurrence of the permanent borrowing base trigger, equal or exceed the greater of $ 15,000 and 10 % of the line cap. Other than this minimum availability requirement, the Credit Agreement does not include any financial maintenance covenants. +The Credit Agreement requires the Company and various subsidiaries of the Company to guarantee each other’s obligations arising from time to time under the Credit Facility, as well as obligations arising in respect of certain cash management and hedging transactions. Subject to customary exceptions and limitations, all borrowings under the Credit Agreement are secured by a lien on all or substantially all of the assets of the Company and each subsidiary guarantor. +The Credit Agreement also contains customary events of default. If an event of default under the Credit Agreement occurs and is continuing, then the Agent may, and at the request of the required lenders shall, terminate the loan commitments under the Credit Agreement, declare any outstanding obligations under the Credit Agreement to be immediately due and payable or require the Company to adequately cash collateralize outstanding letter of credit obligations. If the Company or, with certain exceptions, a subsidiary becomes the subject of a proceeding under any bankruptcy, insolvency or similar law, then the loan commitments under the Credit Agreement will automatically terminate, and any outstanding obligations under the Credit Agreement and the cash collateral required under the Credit Agreement for any outstanding letter of credit obligations will become immediately due and payable. +As of December 31, 2020, the Company had no cash borrowings and $ 188 letters of credit outstanding under the Credit Facility. +F-42 \ No newline at end of file diff --git a/raw/filings/0000913241/2020/0001628280-21-004895/filing_metadata.csv b/raw/filings/0000913241/2020/0001628280-21-004895/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..1b9d344ead395544e456e80d3ba000d2169e4b72 --- /dev/null +++ b/raw/filings/0000913241/2020/0001628280-21-004895/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000913241,SHOO,"STEVEN MADDEN, LTD.",10-K,2021-03-16,2020-12-31,2021-03-16T20:19:16.000Z,0001628280-21-004895,shoo-20201231.htm,10-K,14606724,1,1,https://www.sec.gov/Archives/edgar/data/913241/000162828021004895/shoo-20201231.htm,https://www.sec.gov/Archives/edgar/data/913241/000162828021004895/,2020,2020,1 diff --git a/raw/filings/0000913241/2020/0001628280-21-004895/item1.txt b/raw/filings/0000913241/2020/0001628280-21-004895/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..89b5d7e4348ac63be4a36b69d991ca8be97263e1 --- /dev/null +++ b/raw/filings/0000913241/2020/0001628280-21-004895/item1.txt @@ -0,0 +1,164 @@ +ITEM 1. BUSINESS +($ in thousands, except earnings per share and per share data) +Overview +Steven Madden, Ltd. and its subsidiaries (collectively, the “Company”, "we", "our", or "us", as applicable) design, source, market and sell fashion-forward branded and private label footwear for women, men and children. In addition, we design, source, market and sell branded fashion handbags, apparel and accessories, as well as private label fashion handbags and accessories. We market and sell our products through better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants, and online retailers, throughout the United States, Canada, Mexico and certain other European nations. In addition, our products are marketed through our retail stores and our e-commerce websites within the United States, Canada and Mexico, our joint ventures in Europe, South Africa, Israel, Taiwan and China, and under special distribution arrangements in certain European countries, the Middle East, South and Central America, Oceania and various countries in Asia. Our product lines include a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have +1 +established a reputation for design creativity and our ability to offer quality products in popular styles at accessible price points, delivered in an efficient manner and time frame. +Steven Madden, Ltd. was incorporated in New York on July 9, 1990, reincorporated under the same name in Delaware in November 1998 and completed its initial public offering in December 1993. Shares of Steven Madden, Ltd. common stock, $0.0001 par value per share, currently trade on the NASDAQ Global Select Market under the symbol "SHOO." Our principal executive offices are located at 52-16 Barnett Avenue, Long Island City, NY 11104. Our telephone number is (718) 446-1800 and our website address is http://www.stevemadden.com. +We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and information with the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports, any amendments to such reports, and our proxy statements for our stockholders' meetings are available free of charge on the "Investor Relations" section of our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. We will provide paper copies of such filings free of charge upon request. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding us, which is available at http://www.sec.gov. +We have a Code of Ethics for our Chief Executive Officer and our senior financial officers, as well as a Code of Business Conduct and Ethics specific to directors of our Company, each of which is attached as an exhibit to our 2014 Annual Report on Form 10-K filed with the SEC on February 26, 2015. We also have a Code of Conduct that is applicable to all of our employees, which is attached as an exhibit to our 2018 Annual Report on Form 10-K filed with the SEC on February 28, 2019. Each of these codes is posted on our website, http://www.stevemadden.com. We will provide paper copies of these codes free of charge upon request. We intend to disclose on our website any amendments to, or waivers of, these codes that would otherwise be reportable on a current report on Form 8-K. Such disclosure would be posted within four business days following the date of the amendment or waiver. +Recent Developments +On December 8, 2020, our Board of Directors appointed Zine Mazouzi to be our Chief Financial Officer, effective January 1, 2021, upon the retirement of Arvind Dharia, effective December 31, 2020. +On January 4, 2021, upon the recommendation of the Nominating/Corporate Governance Committee, our Board of Directors appointed Maria Teresa Kumar to fill the newly created directorship resulting from the expansion in the size of the Board of Directors from nine members to ten members. Ms. Kumar has also been appointed to serve on the Corporate Social Responsibility Committee. +On February 24, 2021, our Board of Directors approved the reinstatement of a quarterly cash dividend. The quarterly dividend of $0.15 per share is payable on March 26, 2021 to stockholders of record as of the close of business on March 16, 2021. +Product Distribution Segments +Our business comprises five distinct segments: Wholesale Footwear, Wholesale Accessories/Apparel, Retail, First Cost and Licensing. +Our Wholesale Footwear segment comprises the following brands: +Steve Madden® DV Dolce Vita® Blondo® +Madden Girl® Mad Love® Anne Klein® (under license) +Madden® Steven by Steve Madden® GREATS® +Betsey Johnson® Report® +Dolce Vita® Superga® (under license) +The segment also includes our International business and part of our private label footwear business. +2 +Our Wholesale Accessories/Apparel segment comprises the following brands: +Steve Madden® BB Dakota® +Steven by Steve Madden® BB Dakota x Steve Madden® +Madden Girl® Anne Klein® (under license) +Betsey Johnson® Luv Betsey® +Big Buddha® Cupcakes & Cashmere® (under license) +Cejon® +It also includes our International business and part of our private label accessories business. The agreements under which we licensed the Jocelyn® and DKNY® trademarks terminated as of December 31, 2020. The agreement under which we license the Cupcakes & Cashmere® trademark will terminate in April 2021. +Steven Madden Retail, Inc., our wholly owned retail subsidiary, operates Steve Madden, Steven and Superga retail stores, domestically and internationally, as well as Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota e-commerce websites. +Our First Cost segment represents activities of one of our wholly owned subsidiaries that earns commissions for serving as a buying agent for footwear products under private labels for many of the U.S. large mass-market retailers, shoe chains and other value-priced retailers. +Our Licensing segment is engaged in the licensing of the Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of apparel, outerwear, hosiery, jewelry, watches, eyeglasses, sunglasses, hair accessories, umbrellas, bedding and bath, and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, hair accessories, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and the FREEBIRD by Steven® trademark for operation of retail stores. +Wholesale Footwear Segment +Steve Madden Women's. We design, source and market our Steve Madden brand to department stores, specialty stores, luxury retailers, value priced retailers, national chains, and online retailers. The Steve Madden brand has become a leading life-style brand in the fashion-conscious marketplace. Steve Madden Women's offers fashion forward footwear designed to appeal to customers (primarily women ages 16 to 35) seeking trending footwear designs at affordable price points. New products for Steve Madden Women's are test marketed at Company-owned retail stores. Typically, within a few days, we can determine whether the test product appeals to our customers. This enables us to use our flexible sourcing model to rapidly respond to changing trends and customer preferences, which we believe is essential for success in the fashion industry. Retail price points for Steve Madden Women's products range from $59 to $189. +Madden Girl. We design, source and market a full collection of directional young women's shoes under the Madden Girl® brand. Madden Girl® is geared towards girls and young women ages 13 to 25 and is an “opening price point” brand currently sold at major department stores, mid-tier retailers, online retailers and specialty stores. Retail price points for Madden Girl products range from $39 to $79. +Steve Madden Men's. We design, source and market a lifestyle collection of men's footwear for the fashion-forward man, ages 18 to 45, under the Steve Madden® brand. Retail channels include major department stores, mid-tier department stores, better specialty stores, online retailers and independent shoe stores throughout the United States. Retail price points for Steve Madden Men's products range from $69 to $169. +Madden. The Madden® brand is a collection of casual and business casual footwear designed to meet the ever-evolving needs of the trend-conscious young male consumer, ages 16 to 35. Madden products range from $40 to $90 and are sold to national specialty stores, department stores, mid-tier department stores, online retailers, off-price retailers and independent specialty stores. +Steven. We design, source and market women's fashion footwear under the Steven® trademark through major department stores, better footwear specialty stores and shopping networks throughout the United States. Priced a tier above the Steve Madden Women's brand, Steven products are designed to appeal to fashion conscious women ages 25 to 45 who grew up +3 +wearing Steve Madden footwear and are looking for a shoe with an emphasis on comfort. Retail price points for Steven products range from $89 to $169. +Steve Madden Kids. Our Steve Madden Kids® brand is designed, sourced and marketed to appeal to toddlers, ages 3 to 6, young girls, ages 6 to 11, and tweens, ages 11 to 14. This brand is distributed through department stores, specialty stores, online retailers and independent boutiques throughout the United States. Retail price points for Steve Madden Kids products range from $49 to $89. +Betsey Johnson . On October 5, 2010, we acquired the Betsey Johnson® trademark and substantially all other intellectual property of Betsey Johnson LLC. Products branded under the Betsey Johnson shoe brand are distributed through department stores and online retailers. Retail price points for Betsey Johnson products range from $79 to $189. +Superga. On February 9, 2011, we entered into a license agreement with Basic Properties America Inc. and BasicNet S.p.A., for the use of the Superga® trademark in connection with the marketing and sale of footwear. Founded in Italy in 1911, Superga is recognized for its fashion sneakers in a wide range of colors, fabrics and prints for women, men and children. Retail price points for Superga products range from $65 to $129. +Report. We acquired the Report® brand in May 2011. It is a junior women's footwear brand with retail price points ranging from $20 to $100 per pair. We design, manufacture, market and sell Report branded products to major department stores, mid-tier department stores and independently owned boutiques throughout the United States. +Mad Love. The Mad Love® brand is an exclusive beach-to-the-street lifestyle brand created to appeal to women with a young attitude and active lifestyle and marketed exclusively to Target. Beginning in spring 2021, Mad Love® will become a sustainable brand, designed and created with the mission to make our earth a better place. Retail price points for Mad Love products range from $15 to $23. +Dolce Vita. In August 2014, we acquired the Dolce Vita® and DV® brands. Dolce Vita® is a contemporary women's footwear brand with retail price points ranging from $79 to $225. Our Dolce Vita® brand products are distributed through major department stores, mid-tier department stores and independently owned boutiques primarily throughout the United States. The DV® brand is a contemporary women's footwear brand with retail price points ranging from $39 to $99. DV® products are distributed through major department stores, off-price department stores, online retailers and independently owned boutiques primarily throughout the United States. +Blondo. In January 2015, we acquired the intellectual property and related assets of Blondo, a fashion-oriented footwear brand specializing in water resistant leather boots, booties, shoes and sneakers. Founded over 100 years ago, Blondo products are sold to wholesale customers, including better department stores and specialty boutiques in both the United States and Canada. Retail price points for Blondo products range from $99 to $250. +GREATS . In August 2019, we acquired GREATS, a Brooklyn-based digitally native footwear brand specializing in premium quality, responsibly made sneakers for men and women, which are sold primarily via the Internet. Founded in 2014, GREATS is a pioneer and the first digitally native sneaker brand. GREATS also partners with better department stores like Nordstrom as well as specialty boutiques in the United States. Retail price points for GREATS products range from $119 to $199. +Anne Klein. In January 2018, we entered into a license agreement with Nine West Development LLC for a license to use the Anne Klein®, AK Sport®, AK Anne Klein Sport® and Lion Head Design® trademarks in connection with the marketing and sale of footwear. The Anne Klein® brand is recognized as being synonymous with American sportswear. Retail price points for Anne Klein products range from $49 to $129. +International Division. The International division, utilizing some of the brands discussed above, markets products to better department stores, major department stores, mid-tier department stores, specialty stores, luxury retailers, value priced retailers, national chains, mass merchants and online retailers through wholly owned subsidiaries in Canada and Mexico and joint venture partnerships in Europe (excluding Italy, Spain and Greece, where we had preexisting distributors), South Africa, Israel, China and Taiwan. In addition, the International division works through special distribution arrangements for the marketing and sale of our products in Spain, Italy, Greece, South Korea, Australia, the Middle East, India, South and Central America, New Zealand and Southeast Asia. +4 +Private label business. We design, source and market private label footwear primarily to mid-tier chains and mass market merchants. In addition, we design, source and market footwear for third-party brands, such as Material Girl® and Candies®. +Wholesale Accessories/Apparel Segment +Our Wholesale Accessories/Apparel segment designs, sources and markets name brands and sells them to department stores, mass merchants, value priced retailers, online retailers and specialty stores throughout the United States, Canada, and Mexico and through our joint ventures and International distributor network. These products include the following brands as well as private label fashion handbags and accessories: +Steve Madden® BB Dakota® +Steven by Steve Madden® BB Dakota x Steve Madden® +Madden Girl® Anne Klein® (under license) +Betsey Johnson® Luv Betsey® +Big Buddha® Cupcakes & Cashmere® (under license) +The agreements under which we licensed the Jocelyn® and DKNY® trademarks terminated as of December 31, 2020. The agreement under which we license the Cupcakes & Cashmere® trademark will terminate in April 2021. +We market and sell cold weather accessories, fashion scarves, wraps and other trend accessories primarily under our Steve Madden®, BB Dakota®, Cejon®, Betsey Johnson® and Big Buddha® brand names and private labels to department stores and specialty stores. +Retail Segment +As of December 31, 2020, we owned and operated 218 retail stores, including 143 Steve Madden full-price stores, 66 Steve Madden outlet stores, one Steven store, one Superga store and seven e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota; our Jocelyn website was terminated as of December 31, 2020). In 2020, we added three full-price stores and two outlet stores and closed nine full-price stores, four outlet stores and one e-commerce website. In addition, during 2020, we closed 14 concessions in South Africa and one concession in Taiwan and opened one concession in China, ending the year with 17 company-operated concessions in international markets. Steve Madden stores are located in major shopping malls and in urban street locations across the United States, Canada, Mexico, South Africa, Israel, China and Taiwan. +We believe that our direct to consumer business ("DTC") will continue to enhance overall sales and profitability as well as our ability to react quickly to changing consumer trends. Our DTC business also serves as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, it provides us with a channel to test and introduce new products, designs and merchandising strategies. We often test new designs of Steve Madden products in our retail business before scheduling them for mass production and wholesale distribution. In addition to these benefits, we have been able to leverage sales information gathered at Steve Madden retail to assist our wholesale customers in their order placement and inventory management. Our stores play an important role in our integrated retail strategy and also serve as fulfillment and return locations for our e-commerce business. We have also launched buy online, pickup in-store in all U.S. full-price locations. We expect to open three to five new retail stores in international markets and close two to five locations, globally in 2021. +First Cost Segment +The First Cost segment earns commissions for serving as a buying agent for footwear products under private labels for many of the large mass-market retailers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to customer specifications. We believe that operating in the private label market provides us additional non-branded sales opportunities and leverages our overall sourcing and design capabilities. Our First Cost segment earns commissions serving as a buying agent for the procurement of women's, men's and children's footwear for large retailers. In addition, by leveraging the strength of our Steve Madden brands and product designs, we are able to partially recover our design, product and development costs from our suppliers. +5 +Licensing Segment +We license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of apparel, outerwear, hosiery, jewelry, watches, eyeglasses, sunglasses, hair accessories, umbrellas, bedding and bath, and luggage. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, fragrance and beauty, sleepwear, swimwear, activewear, jewelry, hair accessories, watches, slippers, bedding and bath, luggage, umbrellas and medical scrubs. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and the FREEBIRD by Steven® trademark for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +See Note Q to our consolidated financial statements included in this Annual Report on Form 10-K for additional information relating to our five operating segments. +Product Design and Development +We have established a reputation for our creative designs, marketing and trendy products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react swiftly to changing consumer demands. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs that fit our image, reflect current or anticipated trends and can be manufactured in a timely and cost-effective manner. Most new products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects our products that are then offered for wholesale and retail distribution nationwide. We believe that our design and testing processes and flexible sourcing models provide our brands with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +Product Sourcing and Distribution +We source each of our product lines separately based on the individual design, style and quality specifications of the products in such product lines. We do not own or operate any foreign manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently owned manufacturers primarily in China and also in Cambodia, Mexico, Brazil, India, Vietnam, Italy and other European nations. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data and incorporate input on product demand from wholesale customers. +The manufacturers of our products are required to meet quality, human rights, safety and other standard requirements. We are committed to the safety and well-being of the workers throughout our supply chain. +Our products are manufactured overseas and most of our products are shipped via ocean freight carriers to ports principally in California and to a lesser extent in New Jersey, and via truck from Mexico to our third-party distribution facility in Texas. We rely to a lesser extent on air carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from six third-party distribution centers, four located in California, one located in Texas, and one located in New Jersey. Our products are also distributed through a Company-operated distribution center located in Canada. Our products are also distributed through our third-party distribution facility in Mexico. By utilizing distribution facilities specializing in fulfillment for certain wholesale accounts, Steve Madden retail stores and Internet customers, we believe that our customers are served more promptly and efficiently. Suppliers of products for our businesses in Canada and Mexico and our joint ventures in Europe, South Africa, Israel, Taiwan and China ship to ports in the respective countries, and products for our overseas distributors are shipped to freight forwarders primarily in China and Mexico where the distributor arranges for subsequent shipment. +6 +Customers +Our wholesale customers consist principally of better department stores, major department stores, mid-tier department stor es, national chains, mass merchants, value priced retailers, specialty stores and online retailers. These customers, in no particular order, include: +Nordstrom, Inc. The TJX Companies, Inc. +Dillard's, Inc. Amazon.com, Inc. +Macy's, Inc. Ross Stores, Inc. +Designer Brands, Inc. Walmart Inc. +Kohl's Corporation Target Corporation +For the year ended December 31, 2020, Walmart Inc. represented approximately 13.9% of total revenue. At December 31, 2020, Walmart Inc. represented 19.0% of total accounts receivable, Target Corporation represented 14.9% of total accounts receivable, Ross Stores, Inc. represented 11.8% of total accounts receivable, The TJX Companies, Inc. represented 11.7% of total accounts receivable and Nordstrom, Inc. represented 10.3% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total revenue or any other customers who accounted for more than 10% of total accounts receivable. +Distribution Channels +United States, Canada, Mexico, Europe, South Africa, Israel, Taiwan and China +We sell our products principally through department stores, specialty stores, online retailers, luxury retailers, national chains and mass merchants in the United States, Canada, Mexico and certain European nations. In addition, we sell our products in our Company-owned retail stores in the United States, Canada and Mexico, under our joint ventures in Europe, South Africa, Israel, Taiwan and China, and on our e-commerce websites. For the year ended December 31, 2020, our two Wholesale segments and our Retail segment generated net sales of approximately $949,554 and $239,389, or 79% and 20% of our total revenue, respectively. Each of these distribution channels is described below. +Department Stores. We currently sell our products to approximately 1,800 doors of 12 department store retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Nordstrom, Inc., Macy's, Inc., Dillard's, Inc., Belk, Inc. and Bloomingdale's, Inc. +We provide merchandising support to our department store customers, including in-store fixtures and signage, supervision of displays and merchandising of our various product lines. Our wholesale merchandising effort includes the creation of in-store concept shops in which we showcase a broader collection of our branded products. These in-store concept shops create an environment that is consistent with our image and are designed to enable the retailer to display and sell a greater volume of our products per square foot. In addition, these in-store concept shops encourage longer term commitment by the retailer to our products and enhance consumer brand awareness. +In addition to merchandising support, our key account executives maintain weekly communications with their respective accounts to guide them in placing orders and to assist them in managing inventory, assortment and retail sales. We also leverage our sell-through data gathered at our retail stores to assist department stores in allocating their open-to-buy dollars to the most popular styles in the product line and phasing out styles with weaker sell-through, which, in turn, reduces markdown exposure at the end of the season. +National Chains and Mass Merchants. We currently sell to national chains and mass merchants throughout the United States, Canada, Mexico and certain European nations. Our major accounts include Walmart Inc., Target Corporation and Kohl's Corporation. +Shoe Chains/Specialty Stores. We currently sell to shoe chains and specialty store locations throughout the United States, Canada, Mexico and certain European nations. Our major specialty store accounts include DSW Designer Brands, Famous Footwear and Gap, Inc. We offer our specialty store accounts similar merchandising, sell-through and inventory tracking support offered to our department store accounts. +7 +Off-Price. We currently sell to off-price retailers throughout the United States, Canada, Mexico and certain European nations. Our major accounts include The TJX Companies, Inc., Ross Stores, Inc. and Burlington Stores, Inc. +Internet Sales. We operate seven Internet e-commerce website stores (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota; our Jocelyn website was terminated as of December 31, 2020) where customers can purchase numerous styles of our Steve Madden Women's, Steven, Madden Men's, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and BB Dakota x Steve Madden apparel and accessory products, as well as selected styles of Madden Girl footwear and accessory products. We also sell to online retailers throughout the United States, Europe, and Canada. Our major accounts include Zappos, Amazon, Zolando, and ASOS. +Steve Madden, Steve Madden Outlet, Steven and Superga Retail Stores. As of December 31, 2020, we operated 143 Steve Madden full-price stores within the United States, Canada and Mexico and under our joint ventures in South Africa, China, Taiwan and Israel. We also operated 66 Steve Madden outlet stores, one Steven store and one Superga store within the United States. We also operated seven e-commerce websites (Steve Madden, Superga, Betsey Johnson, Blondo, Dolce Vita, GREATS and BB Dakota; our Jocelyn website was terminated as of December 31, 2020). We believe that our retail stores will continue to enhance overall sales and profitability, and our ability to react swiftly to changing consumer trends. Our stores play an important role in our integrated retail strategy and also serve as fulfillment and return locations for our e-commerce business. In 2020 we launched a program where customers can buy online and pick up in store at all of our Steve Madden full-price locations within the United States. We have also launched buy-online-return-in-store in select locations. Our stores also serve as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. Furthermore, our retail stores provide us with a channel to test and introduce new products, designs and merchandising strategies. We often test new designs at our Steve Madden retail stores before scheduling them for mass production and wholesale distribution. In addition to these test marketing benefits, we have also been able to leverage sales information gathered at Steve Madden retail stores to assist our wholesale customers in their order placement and inventory management. +A typical Steve Madden store is approximately 1,500 to 2,000 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base. The Steven and Superga stores, which are generally the same size as our Steve Madden stores, have a more sophisticated design and format styled to appeal to a more mature target audience. The typical outlet store is approximately 2,000 to 2,500 square feet and is located within outlet malls throughout the United States. Our stores play an important role in our integrated retail strategy and serve as fulfillment and return locations for our e-commerce business. We have also launched buy online, pickup in-store in select locations. +International Distributors +In addition to the countries and territories mentioned above, our products are available in many other countries and territories worldwide via retail selling and distribution agreements. Under the terms of these agreements, the distributors and retailers purchase product from us and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates and include automatic renewals at the distributors' option provided certain conditions are met. These agreements are exclusive in their specific territories, which include certain European countries, the Middle East, South and Central America, Oceania and various countries in Asia. +Competition +The fashion industry is highly competitive. We compete with specialty shoe, apparel and accessory companies as well as companies with diversified footwear product lines, such as Aldo, Sam Edelman, Jessica Simpson, Lucky Brand and Vince Camuto. Our competitors may have greater financial and other resources than we do. We believe effective marketing and advertising, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors, and we intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +8 +Marketing and Sales +We have focused on creating an integrated-brand building program to establish our Company as a leading designer of fashion footwear for style-conscious women and men. Principal marketing activities include social media and digital marketing efforts, influencer marketing, public relations, including product and brand placements in lifestyle and fashion magazines and digital outlets, in-store promotions, and events, as well as public and media appearances by our founder and Creative and Design Chief, Steven Madden. We continue to promote our e-commerce websites where customers can purchase Steve Madden, Steven, Superga, Betsey Johnson, Blondo, Dolce Vita and GREATS footwear and BB Dakota and BB Dakota x Steve Madden apparel and accessory products, as well as select styles of Madden Girl footwear and accessory products. +Management Information Systems (MIS) Operations +Sophisticated information systems are essential to our ability to maintain our competitive position and to support our growth. Our Enterprise Resource Planning (“ERP”) system is an integrated system that supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management and inventory control. All of our North American wholesale businesses (other than Canada, which has a separate ERP system) and our Asia first-cost and sourcing operations are operated through this ERP system. Our warehouse management system is utilized by the majority of our third-party logistics providers and is fully integrated with our ERP system. A point-of-sale system for our U.S. retail stores is integrated with a retail inventory management/store replenishment system. We have transitioned our e-commerce software to a major cloud-based provider. Complementing all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence/data warehouse, Electronic Data Interchange, credit card processing and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. In 2019, we invested $8,200 in a new data and recovery center, with substantially all of the project going into production in 2020. +Trademarks +We consider our Company-owned trademarks to be among our most valuable assets and have registered many of our marks in the United States and 151 other countries and in numerous International Classes. From time to time, we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying our Company, the marketing of our products and the products of our licensees, distinguishing them from the products of others. What follows is a list of the trademarks we believe are most significant to our business: +Steve Madden® Report® +Steven by Steve Madden® Report Signature® +Steven® Dolce Vita® +Madden Girl® DV8® +Stevies® DV® +Stevies plus Design® DV DOLCE VITA® +Topline® MadLove® +Betseyville® Blondo® +Betsey Johnson® Blondo Waterproof plus Heart Design® +LUV BETSEY plus Kiss Design® By Steve Madden plus Heart® +LUV BETSEY by Betsey Johnson Design® SM Pass® +Blue by Betsey Johnson® +COOL PLANET TM +Steve Madden plus Design® BB Dakota® +FREEBIRD By Steven® GREATS® +We act aggressively to register trademarks and we monitor their use in order to protect them against infringement. There can be no assurance, however, that we will be able to effectively obtain rights to our marks worldwide. Moreover, no assurance can be given that others will not assert rights in, or ownership of, our marks and other proprietary rights or that we will be able to resolve any such conflicts successfully. Our failure to adequately protect our trademarks from unlawful and improper appropriation may have a material adverse effect on our business, financial condition, results of operations. +9 +Trademark Licensing +Our strategy for the continued growth of our business includes expanding our presence beyond footwear, apparel and accessories through the selective licensing of our brands. As of December 31, 2020, we license our Steve Madden®, Steven by Steve Madden® and Madden Girl® trademarks for use in connection with the manufacture, marketing and sale of outerwear, hosiery, jewelry, watches, eyeglasses and sunglasses, umbrellas, bedding, luggage, fragrance and men’s leather accessories. In addition, we license the Betsey Johnson® trademark for use in connection with the manufacture, marketing and sale of women's and children’s apparel, hosiery, swimwear, slippers, fragrance and beauty, sleepwear, activewear, medical scrubs, jewelry, watches, eyeglasses and sunglasses bedding and bath, luggage, umbrellas and household goods. We also license the Dolce Vita® trademark for use in connection with the manufacture, marketing and sale of swimwear and the FREEBIRD by Steven® trademark for operation of retail stores. Most of our license agreements require the licensee to pay us a royalty based on actual net sales, a minimum royalty in the event that specified net sales targets are not achieved and a percentage of sales for advertising the brand. +In addition to the licensing of our trademarks, we in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our net sales and/or a minimum royalty and in some cases additional payments in the event that specified net sales targets are not achieved. +See Notes C and P to our consolidated financial statements included in this Annual Report on Form 10-K for additional disclosure regarding these licensing arrangements. +Human Capital Resources +On February 1, 2021, we employed approximately 2,800 employees, of whom approximately 2,100 work full-time and approximately 700 work part-time. Most of our part-time employees work in the Retail segment. Approximately 1,700 of our employees are located in the United States, approximately 600 employees are located in China and Hong Kong, approximately 180 employees are located in Canada, approximately 160 employees are located in Mexico, approximately 60 employees are located in Taiwan, approximately 60 employees are located in South Africa and approximately 40 employees are located in Europe. None of our employees are represented by a union. Our management considers relations with our employees to be good. We have never experienced a material interruption of our operations due to a labor dispute. +Culture +Steve Madden is for the bold, expressive, and ambitious. Our core values – authenticity, initiative, tenacity, humility and trust are key to our competitive edge and are embedded throughout all levels of our Company. They motivate our growth, inspire our innovation, define our culture, and set the standard for all of our actions. +Authenticity : Show up to work as your true self +Initiative : Act upon good ideas quickly and be ready to iterate +Tenacity : Look at problems from all sides and be resourceful +Humility : Think from the perspective of others and always be open to learning +Trust : Build strong relationships with good will and integrity +Career Development +The fashion landscape is constantly shifting and evolving, which makes it especially important for us to invest in the ongoing career development of our employees. In service of this objective, we constantly seek out, promote, and improve upon internal programs and processes that make it possible for employees to reach their full potential. Some examples of this focus include our ongoing professional development relationship with the University of Arizona Global Campus, our tuition reimbursement program, our internal employee learning opportunities, and external conference and workshop offerings around specific industry content as well as leadership, coaching, and management training in general. Mentoring, timely performance evaluations and feedback are also key elements of our career development efforts at our Company. +Diversity and Inclusion +We believe that finding, employing and retaining people from all backgrounds, ethnicities, genders, lifestyles and belief systems have been the cornerstones of meeting the needs of our diverse consumer base and building a global business. By +10 +embracing a diverse and inclusive workplace, we create an environment that offers all our employees opportunities to succeed. We want all our employees to be as successful as they can be and to reach their full potential no matter who they are, where they are from or what they believe. In the spirit of this core belief, we strive to build an increasingly inclusive culture where all employees feel free to express themselves and have opportunities to grow. In 2020, we engaged in the following diversity initiatives, among others: +• we established a Diversity and Inclusion Council made up of key leaders in our Company to oversee the implementation of our detailed Diversity and Inclusion Strategic Plan; +• employees formed two employee resource groups - one for Black employees and allies called Black Sole and one for LGBTQ employees and allies called SM Pride; +• we signed the Open to All pledge with other major brands and retailers; +• we joined the Black in Fashion Council; +• we implemented Company-wide Diversity and Inclusion training; +• we joined Hive Diversity and are partnering with Historically Black Colleges and Universities to establish diverse pipelines of talent and expand our recruiting; and +• we launched Adaptive Kids footwear, soon to expand to adults. +Wellness +We see personal health and fitness of our employees as key to long-term professional success, which is why we offer benefits and programs focused on physical, emotional, and financial well-being. These include mindfulness and meditation training, financial wellness seminars, health fairs, discounted gym memberships, free flu shots, and on-site discounted food. We also offer an Employee Assistance Program with a range of programs, resources and tools that can help with myriad issues. To help manage work-life balance, we offer a paid membership to Care.com so employees can find childcare, senior care, special needs care and other related services. +COVID-19 +The health and safety of our team members is of the highest importance. Our focus on the safety of our team members is evident in our response to COVID-19 starting back in March 2020. We initially closed down all stores to ensure the safety of our customers and retail associates, and then we added working from home flexibility for our corporate positions that can be accomplished remotely. We increased cleaning protocols, implemented onsite temperature screening, upgraded our HVAC systems, provided personal protective equipment and related supplies as needed, established new spacing and schedules to maximize social distancing while at work, and have also provided regular communications regarding impacts of COVID-19, including health and safety protocols and procedures. +Seasonality and Other Factors +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales occur in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales occur in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Retail segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write downs for obsolescence, the cost of materials, the product mix among our wholesale, retail and licensing businesses, the incurrence of other operating costs and factors beyond our control, such as general economic conditions and actions of competitors. Revenue levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice to us. +Backlog +We had unfilled wholesale customer orders of approximately $310,198 and $328,600, as of February 1, 2021 and February 3, 2020, respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, timing of market weeks and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of eventual shipments. +11 \ No newline at end of file diff --git a/raw/filings/0000913241/2020/0001628280-21-004895/item13.txt b/raw/filings/0000913241/2020/0001628280-21-004895/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..01f8387a7ad8e2177576b0666bb2d6d1cbc8d519 --- /dev/null +++ b/raw/filings/0000913241/2020/0001628280-21-004895/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2021 Annual Meeting of Stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2020/0001628280-21-004895/item9a.txt b/raw/filings/0000913241/2020/0001628280-21-004895/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..6d92f0af5dbab65760efd31930aa8252bb11dd2b --- /dev/null +++ b/raw/filings/0000913241/2020/0001628280-21-004895/item9a.txt @@ -0,0 +1,13 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the Board of Directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2020, of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the +36 +Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation our management has concluded that, as of December 31, 2020, our internal control over financial reporting was effective. +Our independent registered public accounting firm, Ernst & Young LLP, has audited our consolidated financial statements and the effectiveness of our internal control over financial reporting as of December 31, 2020. Their report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, as identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2020, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000913241/2020/0001628280-21-004895/rp_note.txt b/raw/filings/0000913241/2020/0001628280-21-004895/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000913241/2020/0001628280-21-004895/rpt_disclosure.txt b/raw/filings/0000913241/2020/0001628280-21-004895/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..343c0693e14629cd4a3c09a8c64c19bbe1d62c14 --- /dev/null +++ b/raw/filings/0000913241/2020/0001628280-21-004895/rpt_disclosure.txt @@ -0,0 +1,111 @@ +Related Party Transactions +Steven +Madden Employment Agreement. We believe that Steven Madden, our founder and Creative and Design Chief, provides unique and +significant value in guiding the leadership of our creative process, both in his hands-on work for the Company and his collaboration +with our designers, product professionals and marketing executives. Mr. Madden is a beneficial owner of more than 5% of the +outstanding shares of our Common Stock. In addition, the public’s association of Mr. Madden’s name and likeness +with our branded products is significant, meaningful, and integral to our success and has been, and continues to be, instrumental +in creating long-term stockholder value. Based upon that belief, we further believe that his continuing involvement with the Company +is essential, and to this end, we have for many years had an employment agreement with Mr. Madden as described below. +Mr. Madden’s +agreement in its current form dates back to July 1, 2005, as subsequently amended on various occasions, most recently on March +25, 2019 (the “SM Agreement”). Under the SM Agreement, Mr. Madden has agreed to continue to serve as our Creative +and Design Chief for a term continuing through December 31, 2026, for a base salary of $7,026,042 per annum together with the +potential for cash bonuses at the sole discretion of our Board of Directors and an annual life insurance premium reimbursement +of up to $200,000. Pursuant to the SM Agreement, on February 8, 2012, Mr. Madden was granted 2,194,584 restricted shares +of Common Stock (as adjusted for our 2018 three-for-two stock split effected as a stock dividend), valued at approximately $40 +million, under our Amended and Restated 2006 Stock Incentive Plan, which is referred to herein as the “2006 Plan.” +The restricted stock vests in equal annual installments over seven years commencing on December 31, 2017 through December 31, +2023, subject to Mr. Madden’s continued employment with the Company on each such vesting date. On June 30, 2012, as +allowed under the SM Agreement, Mr. Madden elected to receive an additional restricted stock award valued at approximately +$40 million in consideration of a reduction in his annual base salary in years after 2012 to the amount reflected above. As a +consequence, on July 3, 2012, Mr. Madden received 2,840,013 additional restricted shares of Common Stock vesting in six annual +installments commencing on December 31, 2018 through December 31, 2023, subject to his continued employment with the Company on +each such vesting date. +Under the +SM Agreement, Mr. Madden is also eligible to receive annually, on or about the date of our annual meeting of stockholders +(but not later than June 30), an option (the “Annual Option”) to purchase shares of Common Stock equal to the greater +of (a) 100% of the largest aggregate number of shares of Common Stock available upon the exercise of an option or options granted +to any other continuing full-time employee of the Company during the preceding twelve-month period or (b) 225,000 shares of Common +Stock; provided, however, that a grant to Mr. Madden in excess of 150% of the number of shares of Common Stock subject to +options granted to such other continuing full-time employee would require stockholder approval. Any Annual Option so granted vests +quarterly over a one-year period and is exercisable for a period of five years at a price equal to the closing price of our Common +Stock on the grant date. In addition, pursuant to the SM Agreement, on March 1, 2017, Mr. Madden received a one-time stock +option grant to purchase 1,125,000 shares of our Common Stock at an exercise price of $24.90 as a result of our having achieved +for the fiscal year ended December 31, 2016 earnings per share performance criteria set forth in the SM Agreement; such option +vests in equal annual installments over a five-year period, which commenced on the first anniversary of the grant date. +Under the +SM Agreement, if Mr. Madden dies, his estate would receive a payment equal to his base salary for the 12-month period immediately +after the date of his death. Further, if Mr. Madden’s employment is terminated due to his total disability (as defined +in the agreement), “for cause” (as defined in the agreement) or due to Mr. Madden’s resignation, we are +obligated to pay Mr. Madden the amount of compensation that is accrued and unpaid through the date of termination. If Mr. Madden’s +employment is terminated for any reason (other than “for cause” or due to his death, total disability or resignation), +we are obligated to pay Mr. Madden, in installments, the balance of his base salary through the end of the term of the SM +Agreement. If, during the period commencing 120 days prior to a “change of control” transaction (as defined in the +SM Agreement) and ending on the first anniversary of a change of control transaction, Mr. Madden’s employment is terminated +other than for cause or by his resignation for “good reason” (as defined in the SM Agreement), or if Mr. Madden +resigns within 30 days following a change of control transaction, all unvested options held by Mr. Madden will be accelerated +and vest on the date of termination or resignation, and Mr. Madden will be entitled to receive a lump sum cash payment equal +to the amount of compensation that is accrued and unpaid through the date of termination plus $35 million. The SM Agreement contains +other customary provisions, including provisions regarding expense reimbursement, confidentiality, non-solicitation and non-competition. +21 +For the +2021 Fiscal Year, Mr. Madden earned $7,026,042 in base salary and received $200,000 for the payment of an annual life insurance +premium. Mr. Madden also received his Annual Option for the 2021 Fiscal Year to purchase 225,000 shares of Common Stock at +a price per share of $43.83. +The most +recent amendment entered into on March 25, 2019, effected the extension of the term of the SM Agreement for three years through +December 31, 2026. In consideration of this extension, we have granted to Mr. Madden 200,000 shares of Common Stock, which +shares are subject to certain restrictions, including that he will not sell, transfer, pledge, hypothecate, assign or otherwise +dispose of the restricted shares except as set forth under his award agreement. The shares will vest in substantially equal annual +installments over three years commencing on December 31, 2024, provided that Mr. Madden continues to be employed by the Company +on each vesting date through December 31, 2026. +Loan +to Steven Madden. On June 25, 2007, we made a loan to Mr. Madden in the amount of $3,000,000 to enable Mr. Madden +to satisfy a personal tax obligation resulting from the exercise of a stock option that was due to expire. The loan is evidenced +by a secured promissory note executed by Mr. Madden in our favor, the security for which is a certain securities brokerage +account maintained by Mr. Madden with his broker; none of the securities in the securities brokerage account are shares of +Common Stock. There have been successive amendments to the secured promissory note, the most recent of which occurred in April +2016. At that time the secured promissory note was amended to substitute the collateral securing the secured promissory note from +shares of our Common Stock to the security interest in Mr. Madden’s securities brokerage account. Previously, on January +3, 2012, the secured promissory note was amended and restated to extend the maturity date of the obligation to December 31, 2023 +and eliminate the accrual of interest after December 31, 2011. Prior to the January 3, 2012 amendment, the secured promissory +note had been accruing interest at the rate of 6% per annum. In addition, the secured promissory note provides that, commencing +on December 31, 2014 and annually on each December 31 thereafter through the maturity date, one-tenth of the principal amount +thereof, together with accrued interest, will be cancelled by the Company provided that we have employed Mr. Madden on each +such December 31. Contemporaneously, on each such December 31, we will release our security interest in a portion of the securities +held in Mr. Madden’s securities brokerage account generally correlating to the amount of indebtedness cancelled on +such date. As of December 31, 2011, interest in the amount of $1,090,000 had accrued on the principal amount of the secured promissory +note and, as noted above, interest was eliminated after December 31, 2011. On December 31, 2021, we released Mr. Madden from +his obligation to pay the required one-tenth of the original principal amount of the secured promissory note, together with accrued +interest. +Review, Approval or Ratification +of Transactions with Related Persons +Our Conduct +Codes and Employee Handbook prohibit all conflicts of interest. Under the Conduct Codes, conflicts of interest occur when personal +or professional interests interfere in any way, or even appear to interfere, with our interests. Our prohibition on conflicts +of interest under the Conduct Codes includes any related party transaction. +Related +person transactions must be approved by the Board, or by a committee of the Board consisting solely of independent directors, +who will approve the transaction only if they determine that it is in our best interests. In considering the transaction, the +Board or committee will consider all relevant factors, including, as applicable, (i) the business rationale for entering into +the transaction; (ii) the alternatives to entering into a related person transaction; (iii) whether the transaction is on terms +comparable to those available to third parties or, in the case of employment relationships, to employees generally; (iv) the potential +for the transaction to lead to an actual or apparent conflict of interest and any safeguards imposed to prevent such actual or +apparent conflicts; and (v) the overall fairness of the transaction to the Company. +We have +multiple processes for reporting conflicts of interest, including related party transactions. Under the Conduct Codes, all employees +are required to report any actual or apparent conflict of interest, or potential conflict of interest, to management. The Chief +Financial Officer distributes a questionnaire to our executive officers and management personnel quarterly and distributes a questionnaire +to the members of the Board of Directors annually requesting certain information regarding, among other things, their immediate +family members, employment and beneficial ownership interests, which information is then reviewed for any conflicts of interest +under the Conduct Codes. +22 +The Board +of Directors, the Audit Committee and the Disclosure Committee, which consists of management personnel, discuss the related party +transactions, specifically, and in connection with the regular review processes attendant to our periodic filings, including related +party transaction disclosures. +If a director +is a party to or in some manner involved in a transaction involving the Company, he or she will be recused from all discussions +and decisions about the transaction. The transaction must be approved in advance whenever practicable, and if not practicable, +must be ratified as promptly as practicable. \ No newline at end of file diff --git a/raw/filings/0000913241/2023/0001628280-24-008331/item1.txt b/raw/filings/0000913241/2023/0001628280-24-008331/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..4650b0cd1a9180caac1600033972a33af6afe83d --- /dev/null +++ b/raw/filings/0000913241/2023/0001628280-24-008331/item1.txt @@ -0,0 +1,100 @@ +ITEM 1. BUSINESS +Steven Madden, Ltd. and its subsidiaries design, source, and market fashion-forward branded and private label footwear, accessories, and apparel. We distribute our products in the wholesale channel through department stores, mass merchants, off-price retailers, shoe chains, online retailers, national chains, specialty retailers, independent stores, and clubs throughout the United States, Canada, Mexico, and Europe, and other international markets through our joint ventures in Israel, South Africa, China, Taiwan, Malaysia, and the Middle East along with special distribution arrangements in certain European countries, North Africa, South and Central America, Australia, and various countries in Asia. In addition, our products are distributed through our direct-to-consumer channel within the United States, Canada, Mexico, and Europe, and our joint ventures in Israel, South Africa, China, Taiwan, and the Middle East. +Our product lines include a broad range of contemporary styles designed to establish or capitalize on market trends, complemented by core product offerings. We have established a reputation for design creativity and our ability to offer quality, trend-right products at accessible price points, delivered in an efficient manner and time frame. +The following is a description of our business as of December 31, 2023. +OUR SEGMENTS +Wholesale Footwear +Our Wholesale Footwear segment designs, sources, and markets our brands and sells our products to department stores, mass merchants, off-price retailers, shoe chains, online retailers, national chains, specialty retailers, independent stores, and clubs throughout the United States, Canada, Mexico, and Europe, and through our joint ventures and international distributor network. Our products are designed and marketed for various lifestyles and include dress shoes, boots, booties, fashion sneakers, sandals, and casual shoes. The Wholesale Footwear segment primarily consists of the following brands: Steve Madden ® , Dolce Vita ® , Betsey Johnson ® , Blondo ® , GREATS ® , and Anne Klein ® . This segment also includes our private label footwear business. This segment represented 52.9% of total revenue during 2023. +Wholesale Accessories/Apparel +Our Wholesale Accessories/Apparel segment designs, sources, and markets our brands and sells our products to department stores, mass merchants, off-price retailers, online retailers, specialty retailers, independent stores, and clubs throughout the United States, Canada, Mexico, and Europe and through our joint ventures and international distributor network. Our Wholesale Accessories/Apparel business primarily consists of handbags, apparel, small leather goods, belts, soft accessories, fashion scarves, wraps, gifting, and other trend accessories. The Wholesale Accessories/Apparel segment primarily consists of the following brands: Steve Madden ® , Anne Klein ® , Betsey Johnson ® , and Dolce Vita ® . This segment also includes our private label handbag and accessories business. This segment represented 21.0% of total revenue during 2023. +Direct-to-Consumer +Our Direct-to-Consumer segment consists of Steve Madden ® and Dolce Vita ® full-price retail stores, Steve Madden ® outlet stores, Steve Madden ® concessions in international markets, and our directly-operated digital e-commerce websites. We operate retail locations in regional malls and shopping centers, as well as high streets in major cities across the United States, Canada, Mexico, Europe, Israel, South Africa, Taiwan, China, and the Middle East. Our stores play an important role in our test-and-react strategy, and also serve as fulfillment and return locations for our e-commerce business. Our stores also serve as a marketing tool that allows us to strengthen global brand recognition and to showcase selected items from our full line of branded and licensed products. In addition to these testing and marketing benefits, we have also been able to leverage sales information gathered at Steve Madden retail stores and our websites to assist our wholesale customers in their order placement and inventory management. We believe that our retail stores and websites enhance overall sales and profitability and our ability to react quickly to changing consumer demands. +In 2023, we added 38 brick-and-mortar stores and closed 15 brick-and-mortar stores and one e-commerce site. As of December 31, 2023, we operated 255 brick-and-mortar retail stores, including 181 Steve Madden ® full-price stores, 71 Steve Madden ® outlet stores and three Dolce Vita ® full-price store. In addition, we ended the year with 20 concessions in Taiwan, four concessions in China, and one concession in Portugal, ending the year with 25 Steve Madden ® concessions in international markets. +3 +In addition to our brick-and-mortar stores, our Direct-to-Consumer business offers products online through our e-commerce sites in the United States, Canada, Mexico, Europe, Israel, South Africa, Asia, and the Middle East. We operate five branded e-commerce sites, which include: www.stevemadden.com, www.dolcevita.com, www.betseyjohnson.com, www.blondo.com, and www.greats.com. This segment represented 25.6% of total revenue during 2023. +Licensing +Our Licensing segment is engaged in the licensing of the Steve Madden ® and Betsey Johnson ® trademarks for use in the sale of select apparel, accessory, and home categories as well as various other non-core products. Most of our license agreements require the licensee to pay us a royalty based on actual revenue, a minimum royalty in the event the specified revenue targets are not achieved and a percentage of sales for brand advertising. +Corporate +Corporate does not constitute a reportable segment and includes costs not directly attributable to the segments. These costs are primarily related to expenses associated with corporate executives, corporate finance, corporate social responsibility, legal, human resources, information technology, cyber security, and other shared services. +For additional information on our segments, refer to Note S – Operating Segment Information in the Notes to our consolidated financial statements included in this Annual Report. +OUR BRANDS +Steve Madden. We design, source, and market fashion-forward footwear, accessories, and apparel under the Steve Madden ® brand. The Steve Madden ® brand is a leader in the fashion footwear industry with permission from the customer to sell products across most footwear categories including dress shoes, boots, booties, fashion sneakers, and casuals. While the brand appeals to a wide demographic, the core target consumer is 18 to 40 years old. The Steve Madden ® brand is sold globally, including the U.S., Canada, Mexico, Europe, Asia-Pacific, Africa, and Latin America. +Dolce Vita. Dolce Vita ® is a contemporary women's brand known for its effortless style for the modern individual. Dolce Vita ® is more than just shoes and handbags, it’s about creating a community, supporting underrepresented voices, and responsibly building a brand that we can be proud of with every step. The Dolce Vita ® brand is sold globally, including the U.S., Canada, Mexico, Europe, Israel, Australia, and Indonesia. We acquired the Dolce Vita ® footwear trademark in August of 2014 and in December 2021, we acquired the remaining intellectual property rights of Dolce Vita ® including handbags and other accessories. +Betsey Johnson. The Betsey Johnson ® brand is recognized for its unique and original designs – both pretty and punk, lots of color, and movement and modernity – that embrace girl power at any age. Betsey Johnson ® footwear and accessories are designed for inclusive, punky, and fiercely independent women with a target age of 25 to 45 yrs. old. The Betsey Johnson brand is primarily sold in the U.S, and in select international markets. We acquired the Betsey Johnson ® trademark and substantially all other intellectual property of Betsey Johnson LLC in October of 2010. +Blondo. The Blondo ® brand is a 100+ year-old footwear brand recognized for its quality water-resistant leather boots, booties, casual shoes, and sneakers. The Blondo ® brand is primarily sold in the U.S. and Canada. We acquired the intellectual property and related assets of Blondo ® in January of 2015. +GREATS. The GREATS ® brand is a Brooklyn-based, digitally native footwear brand founded in 2014 which specializes in premium quality, responsibly made sneakers. The GREATS ® brand is primarily sold in the U.S. We acquired the GREATS ® brand in August of 2019. +LICENSED BRAND +Anne Klein. The Anne Klein ® brand has a rich heritage going back over 50 years and is recognized for its dedication to timeless American classics. Anne Klein ® footwear and accessories are sold in the U.S., Canada, Mexico, and Israel. In January 2018, we entered into a license agreement with WHP Global for a license to use the Anne Klein ® , AK Sport ® , AK Anne Klein Sport ® , and Lion Head Design ® (collectively "Anne Klein ® ") trademarks in connection with the design, marketing, and sale of footwear and accessories. +PRODUCT DESIGN AND DEVELOPMENT +We have established a reputation for our creative designs, marketing, and trend-right products at affordable price points. Our future success will substantially depend on our ability to continue to anticipate and react quickly to changing +4 +consumer demands. To meet this objective, we have developed what we believe is an unparalleled design team and process. Our design team strives to create designs that are true to our DNA, reflect current or anticipated trends, and can be manufactured in a timely and cost-effective manner. Most new products are tested in select retail stores and on directly-operated e-commerce websites. Based on these tests, among other things, management selects products that are then offered for wholesale and direct-to-consumer distribution worldwide. We believe that our design and testing processes combined with our flexible sourcing model provide our brands with a significant competitive advantage and allow us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs. +MANUFACTURING AND SUPPLY CHAIN +We source each of our product lines separately based on the individual design, style, and quality specifications of our various brands and product categories. We do not own or operate any foreign manufacturing facilities; rather, we use agents and our own sourcing offices to source our products from independently owned manufacturers in China, Cambodia, Mexico, Brazil, Italy, Vietnam, India, and other European countries. We have established relationships with a number of manufacturers and agents in each of these countries. We have not entered into any long-term manufacturing or supply contracts. We believe that a sufficient number of alternative sources exist for the manufacture of our products. +We continually monitor the availability of the principal raw materials used in our footwear, accessories, and apparel which are currently available from a number of sources in various parts of the world. We track inventory flow on a regular basis, monitor sell-through data, and incorporate input on product demand from wholesale customers. +The suppliers and manufacturers of our products are required to adopt our Supplier Code of Conduct 2.0 which specifies that they comply with all local laws and regulations governing human rights, working conditions, anti-corruption laws, restricted substances, and environmental compliance, including animal welfare and conflict minerals, before we conduct business with them. We are committed to working with manufacturers, suppliers, vendors, and agents that share our Company’s goal of maintaining socially responsible and sustainable business practices. +Our products are manufactured overseas and most of our products are shipped via ocean freight carriers to our third-party distribution facilities in California and to a lesser extent New Jersey, and via truck from Mexico to our third-party distribution facility in Texas. We rely to a lesser extent on air carriers for the shipping of products. Once our products arrive in the U.S., we distribute them mainly from six third-party distribution centers, four located in California, one located in Texas, and one located in New Jersey. Our products are also distributed through a Company-operated distribution center located in Canada and through our third-party distribution facilities in Mexico and Europe. By utilizing distribution facilities specializing in fulfillment for certain wholesale customers and Steve Madden retail stores we believe that our consumers are served in a prompt and efficient manner. Suppliers of products for our businesses in Canada, Mexico, Europe, and our joint ventures in Israel, South Africa, China, Taiwan, Malaysia, and the Middle East ship directly to the respective countries. Products for our overseas distributors are shipped to freight forwarders primarily in China and Mexico where the distributor arranges for subsequent shipment. See Item 1A “Risk Factors” below for a discussion of the risk of supply chain disruptions. +DISTRIBUTION +For the year ended December 31, 2023, our Wholesale and our Direct-to-Consumer businesses generated revenue of approximately $1,464,980 and $506,494, or 73.9% and 25.6% of our total revenue, respectively. Each of these distribution channels is described below. +Wholesale. Our products are distributed in our wholesale channel to over 2,000 retailers, including department stores, mass merchants, off-price retailers, shoe chains, online retailers, national chains, specialty retailers, independent stores, and clubs throughout the United States, Canada, Mexico, and Europe, and other international markets through our joint ventures in Israel, South Africa, China, Taiwan, Malaysia, and the Middle East along with special distribution arrangements in certain European countries, North Africa, South and Central America, Australia, and various countries in Asia. Under the terms of the distribution agreements, the distributors and retailers purchase product from us and are generally required to open a minimum number of stores each year and to pay a fee for each pair of footwear purchased and an additional sales royalty as a percentage of sales or a predetermined amount per unit of sale. Most of the distributors are required to purchase a minimum number of our products within specified periods. The agreements currently in place expire on various dates and include automatic renewals at the distributors' option provided certain conditions are met. +Our top ten wholesale customers, in no particular order, include: Nordstrom, Macy's, Dillard's, DSW, The TJX Companies, Ross Stores, Burlington Stores, Amazon, Walmart, and Target. +5 +For the year ended December 31, 2023, the Company did not have any customers who accounted for more than 10% of total revenue. At December 31, 2023, three customers accounted for 16.1%, 12.7%, and 12.4% of total accounts receivable. The Company did not have any other customers who accounted for more than 10% of total accounts receivable. +Direct-to-Consumer. Our Direct-to-Consumer segment consists of Steve Madden ® and Dolce Vita ® full-price retail stores, Steve Madden ® outlet stores, Steve Madden ® concessions in international markets, and our directly-operated digital e-commerce websites. We operate retail locations in regional malls and shopping centers, as well as high streets in major cities across the United States, Canada, Mexico, Europe, Israel, South Africa, Taiwan, China, and the Middle East. +As of December 31, 2023, we operated 255 brick-and-mortar retail stores, including three Dolce Vita ® full-price stores and 71 Steve Madden ® outlet stores, and five e-commerce websites. In addition, we had 25 Steve Madden ® concessions in international markets. Out of the 255 total brick-and-mortar retail stores, 135 were located outside of the U.S. +COMPETITION +The fashion industry is highly competitive. We compete with numerous domestic and international footwear, apparel, and accessory companies. Our competitors may have greater financial and other resources than we do. We believe effective marketing, favorable brand image, fashionable styling, high quality, value, and fast manufacturing turnaround are the most important competitive factors, and we intend to continue to employ these elements in our business. However, we cannot be certain that we will be able to compete successfully against our current and future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition, and results of operations. +MARKETING +We have focused on creating a full-funnel marketing strategy that covers all stages of the customer journey, to establish our Company as a leading designer and marketer of fashion footwear, accessories, and apparel for a diverse set of style-conscious consumers. Principal top of funnel marketing activities include digital brand marketing, social media and influencer marketing, experiential events, in-store and online promotions, and public relations focusing primarily on digital product and brand placements, celebrity seeding, as well as public and media appearances by our Founder and Creative and Design Chief, Steve Madden. We foster high value lifetime customer relationships with investments in marketing technology and talent, both in-house and via strategic partnerships with external agencies. We continue to promote our e-commerce websites where customers can purchase Steve Madden ® , Dolce Vita ® , Betsey Johnson ® , Blondo ® , and GREATS ® products. +MANAGEMENT INFORMATION SYSTEM (MIS) OPERATIONS +Sophisticated information systems are essential to our ability to maintain our competitive position and to support our growth. Our Enterprise Resource Planning (“ERP”) system is an integrated system that supports our wholesale business in the areas of finance and accounting, manufacturing-sourcing, purchase order management, customer order management, and inventory control. All of our North American wholesale businesses (other than Canada, which has a separate ERP system) and our Asia sourcing operations are operated through this ERP system. Our warehouse management system is utilized by the majority of our third-party logistics providers and is fully integrated with our ERP system. A point-of-sale system for our U.S. retail stores is integrated with a retail inventory management and store replenishment system. We have transitioned our e-commerce platform to a major cloud-based provider. Complementing all of these systems are ancillary systems and third-party information processing services, including, among others, supply chain, business intelligence, data warehousing, Electronic Data Interchange, credit card processing, human resources, and payroll. We undertake updates of all of these management information systems on a periodic basis in order to ensure that our functionality is continuously improved. +INFORMATION SYSTEMS +The Company maintains its information technology and security policies, comprised of risk management policies and procedures surrounding the Company’s information systems, cybersecurity practices, and protection of confidential information. The Company’s Chief Information Security Officer has ultimate oversight of the Company’s cyber risk management policies and procedures, and chairs quarterly Information Security Steering Committee meetings, which provides cooperation, collaboration, and consensus driven information security guidance to both the Information Technology Department, and the Company as a whole. Our Chief Information Security Officer oversees our cybersecurity risk management and information security programs and provides quarterly status reports to the Information Security Steering Committee and the Audit Committee. As part of the Company's information security program, all global employees including high-risk users and executives, are required to complete annual training on information security awareness, including cybersecurity, global data privacy requirements, and information technology compliance measures. Certain roles require additional role-based, specialized cybersecurity training, such as tabletop exercises to ensure proactive preparation and effective coordination in the event of a security incident. An annual network and application penetration test is conducted by a reputable external vendor. The +6 +outcomes and findings of the penetration testing are shared with the Information Security Steering Committee and the Audit Committee, as well as any steps the Company has taken to mitigate and remediate any identified risks. Additionally, we maintain network security and cyber liability insurance in order to provide a level of financial protection in the event of certain covered cyber losses and data breaches. +TRADEMARKS +Our strategy for the continued growth of our business includes expanding our presence beyond footwear, accessories, and apparel through the selective licensing of our brands. We consider our company-owned trademarks to be among our most valuable assets, and have registered many of our trademarks in the United States and 149 other countries and in numerous International Classes. From time to time, we adopt new trademarks and new logos and/or stylized versions of our trademarks in connection with the marketing of new product lines. We believe that these trademarks have significant value and are important for purposes of identifying our Company, the marketing of our products and the products of our licensees, and distinguishing them from the products of others. +Trademarks we believe to be most significant to our business include: Steve Madden ® , Madden Girl ® , Madden NYC™, Betsey Johnson ® , Dolce Vita ® , and Blondo ® . We license our Steve Madden ® and the Betsey Johnson ® trademark for use in connection with the manufacture, marketing, and sale of select apparel, accessories, and home categories as well as various other non-core products. +In addition to the licensing of our trademarks, we in-license the trademarks of third parties for use in connection with certain of our product lines. Generally, these licensing arrangements require us to make advertising payments to the licensor as well as royalty payments equal to a percentage of our revenue and/or a minimum royalty and in some cases additional payments in the event that specified revenue targets are not achieved. +For additional information on our licensing arrangements, refer to Note B – Summary of Significant Accounting Policies and Note O – Commitments, Contingencies, and Other in the notes to our consolidated financial statements included in this Annual Report. +HUMAN CAPITAL RESOURCES +As of February 1, 2024, we employed approximately 4,200 employees globally, with approximately 2,200 of these employees located in the United States and 2,000 located internationally. Of these employees, approximately 2,900 work full-time and approximately 1,300 work part-time. Most of our part-time employees work in the Direct-to-Consumer segment. None of our employees are represented by a union, and we consider our relations with our employees to be good. We have never experienced a material interruption of our operations due to a labor dispute. +Culture +Steve Madden is for the bold, expressive, and ambitious. Our guiding principles are key to our competitive edge and are embedded throughout all levels of our Company. They motivate our growth, inspire our innovation, define our culture, and set the standard for all of our actions. +• First things first. Take care of the fundamentals before anything else. +• It starts with trust. Great teams are built upon trust. We build trust through honesty, care for the greater good, and follow-through. +• Don’t coast . Celebrate success, but don’t rest on your laurels. Hustle and grind are what set us apart. +• Think big and small. Have your eyes on the big picture while obsessing over the details. +• The customer is our muse. Study our customers, connect with them directly, and always be open to inspiration. +• Place team ownership over personal ego. The company wins when the team has ownership. Don’t let your ego control you. +• Everyone can be creative. Creativity is about more than making art. It’s about seeing around corners, working within limitations, and being original. +• Progress, not perfection. Act upon good ideas quickly and always be ready to iterate. +Career Development +In the dynamic world of fashion, it is vital that we support the continuous learning and personal growth of our employees. Our talent development initiatives focus on enhancing internal programs and processes that empower our +7 +employees to excel and feel a strong sense of belonging and fulfillment in their roles. Key initiatives include our long-standing professional development relationship with the University of Arizona Global Campus, a comprehensive tuition reimbursement program, leadership and management training, and access to external conferences and workshops that focus on specific industry knowledge. In 2021, we introduced the SM Learning Sessions, a monthly, company-wide initiative that brings together internal and external experts to share knowledge on diverse topics. This program not only enhances skillsets, but also fosters a collaborative and inclusive environment, encouraging cross-departmental interaction and networking. Furthermore, annual performance evaluations and constructive feedback mechanisms are integral to our strategy. By investing in employee development, we aim to create a workplace where employees are not only equipped to meet the challenges of the ever-evolving fashion industry but are also deeply engaged and committed to our long-term success. +Diversity, Equity, and Inclusion +We believe that recruiting, employing, and retaining people from all backgrounds, ethnicities, genders, lifestyles, and belief systems have been the cornerstones of meeting the needs of our diverse consumer base and building a global business. By embracing a diverse and inclusive workplace, we create an environment that offers all our employees opportunities to succeed. We want all our employees to be as successful as they can be and to reach their full potential no matter who they are, where they are from, or what they believe. In the spirit of this core belief, we strive to build an increasingly inclusive culture where all employees feel free to express themselves and have opportunities to grow. A few highlights of our diversity initiatives include: +• we established a Diversity and Inclusion Council made up of key leaders in our Company to oversee the implementation of our detailed Diversity, Equity, and Inclusion Strategic Plan; +• we added three members to our Board of Directors, each of whom are people of color and bring new perspectives to the highest level of Company leadership; +• our employees formed three employee resource groups – one for Black employees and allies called Black Sole, one for LGBTQ+ employees and allies called SM Pride, and one for Hispanic employees and allies called De La Sole; +• we launched “Tune-In Tuesday,” a weekly email of internal job openings to encourage career development and advancement; +• we signed the “Open to All” pledge with other major brands and retailers; +• we joined the Black in Fashion Council; +• we implemented Company-wide diversity and inclusion training; +• we sponsored scholarships provided for the country’s most talented young students from diverse backgrounds through the Fashion Scholarship Fund; +• we provided financial support and hands-on retail education programs for Howard University, thereby enhancing the students’ educational experience and creating a talent pipeline from the university to Steve Madden; and +• we launched Adaptive Kids footwear, soon to expand to adults, and engaged partners such as Open Style Lab and Runway of Dreams to enhance and promote our adaptive styles along people with disabilities. +Employee Wellness +At Steve Madden, we prioritize the well-being of our employees, which is why we’ve established #SMWellness as a monthly opportunity for our team to invest in themselves. During these sessions, employees can take a break from their work routines to indulge in rejuvenating activities like meditation sessions, soothing back massages, and nutritious snacks. Additionally, we offer financial wellness seminars, health fairs, discounted gym memberships, and on-site discounted food. We also offer an Employee Assistance Program with a range of programs, resources, and tools that can help with various wellness issues. We collaborate with featured vendors to enhance the experience and provide even more ways for our employees to prioritize their wellness. +Charitable Giving +In December 2021, the Company formed The Steve Madden Corporate Foundation, a donor-advised fund established under Fidelity Charitable and managed by Rockefeller Capital Management. As part of the Company's charitable giving strategy, we made a one million dollar contribution for each of 2023 and 2022, and we have since launched multiple shop-to-give campaigns across our various company-operated e-commerce websites. +GOVERNMENT REGULATIONS +Our business is subject to various United States federal, state, local, and foreign laws and regulations, including environmental, health, and safety laws and regulations. In addition, we may incur liability under environmental statutes and +8 +regulations with respect to the contamination of sites that we own, or operate, or previously owned, or operated (including contamination caused by prior owners and operators of such sites and neighboring properties, or other persons) and the off-site disposal of hazardous materials. We believe our operations are in compliance with the terms of all applicable laws and regulations and our compliance with these laws and regulations has not had, and is not expected to have, a material effect on our capital expenditures, cash flows, earnings, or competitive position. +SEASONALITY AND OTHER FACTORS +Our operating results are subject to some variability due to seasonality and other factors. For example, the highest percentage of our boot sales occur in the fall and winter months (our third and fourth fiscal quarters) and the highest percentage of our sandal sales occur in the spring and summer months (our first and second fiscal quarters). Historically, some of our businesses, including our Direct-to-Consumer segment, have experienced holiday retail seasonality. Our diverse range of product offerings, however, provides some mitigation to the impact of seasonal changes in demand for certain items. In addition to seasonal fluctuations, our operating results fluctuate from quarter to quarter as a result of the weather, the timing of holidays and larger shipments of footwear, market acceptance of our products, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, inventory write-downs for obsolescence, the cost of materials, the product mix among our wholesale, direct-to-consumer and licensing businesses, the incurrence of other operating costs, and factors beyond our control, such as general economic conditions and actions of competitors. Revenue levels in any period are also impacted by customer decisions to increase or decrease their inventory levels in response to anticipated consumer demand. Our customers may cancel orders, change delivery dates, or change the mix of products ordered with minimal notice to us. +BACKLOG +We had unfilled wholesale customer orders of approximately $533,609 and $500,921, as of February 1, 2024 and February 1, 2023, respectively. Our backlog at a particular time is affected by a number of factors, including seasonality, supply chain lead times, timing of market weeks, and wholesale customer purchases of our core products through our open stock program. Accordingly, a comparison of backlog from period to period may not be indicative of actual future shipments. +9 \ No newline at end of file diff --git a/raw/filings/0000913241/2023/0001628280-24-008331/item13.txt b/raw/filings/0000913241/2023/0001628280-24-008331/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..29ef6e4aaff6673aad1fc2a809b6841ff9bdee18 --- /dev/null +++ b/raw/filings/0000913241/2023/0001628280-24-008331/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required to be furnished pursuant to this Item will be set forth in our proxy statement for the 2024 Annual Meeting of Stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000913241/2023/0001628280-24-008331/item9a.txt b/raw/filings/0000913241/2023/0001628280-24-008331/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..4196d28491f9336775af713a06495b5346d14d56 --- /dev/null +++ b/raw/filings/0000913241/2023/0001628280-24-008331/item9a.txt @@ -0,0 +1,13 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Disclosure Controls and Procedures +As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K. +Management's Annual Report on Internal Control Over Financial Reporting +Management of Steven Madden, Ltd. is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). +Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by the Board of Directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Our internal control over financial reporting includes those policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness, as of the end of our fiscal year ended December 31, 2023, of our internal control over financial reporting based on the framework and criteria established in the 2013 Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation our management has concluded that, as of December 31, 2023, our internal control over financial reporting was effective. +In accordance with SEC guidance, our management's assessment of the effectiveness of internal control over financial reporting did not include the internal controls of Almost Famous, which we acquired in October 2023 and is included in the December 31, 2023 consolidated financial statements. The acquired business constituted 8.8% of consolidated total assets as of December 31, 2023 and 1.9% of consolidated total revenue for the year ended December 31, 2023. +Our independent registered public accounting firm, Ernst & Young LLP, has audited our consolidated financial statements and the effectiveness of our internal control over financial reporting as of December 31, 2023. Their attestation report appears in this Annual Report on Form 10-K. +Changes in Internal Control Over Financial Reporting +There was no change in our internal control over financial reporting, as identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 of the Exchange Act, that occurred during the fiscal quarter ended December 31, 2023, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +34 \ No newline at end of file diff --git a/raw/filings/0000913241/2023/0001628280-24-008331/rp_note.txt b/raw/filings/0000913241/2023/0001628280-24-008331/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391